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Rising Capital inThe Financial Markets

2002, Prentice Hall, Inc.

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Q: What are SECURITIES?

A: Financial Assets that

Investors purchase hoping toearn a high rate of return.

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Types of Securities

Treasury Bills and Treasury Bonds Municipal Bonds

Corporate Bonds

Preferred Stocks

Common Stocks

Which of these are RISKY?

Which promise HIGH RETURNS?

Is there a relationship between RISK andRETURN?

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Corporate Financing

Sources

In 1999, over $400 billion in external

corporate financing was raised. From 1996 through 1999, capital has been

raised through the following sources:

Corporate Bonds and Notes 75.3%

Equities 24.7%

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Movement of Savings

Direct Transfer of Funds

saver

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Movement of Savings

Direct Transfer of Funds

saverfirm

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Movement of Savings

Direct Transfer of Funds

cashcash

saverfirm

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Movement of Savings

Direct Transfer of Funds

cashcash

securitiessecurities

saverfirm

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Movement of Savings

Indirect Transfer using Investment Banker

investmentbanker

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Movement of Savings

Indirect Transfer using Investment Banker

investmentbanker

firm

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Movement of Savings

Indirect Transfer using Investment Banker

fundsfunds

investmentbanker

firm

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Movement of Savings

Indirect Transfer using Investment Banker

fundsfunds

securitiessecurities

investmentbanker

firm

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Movement of Savings

Indirect Transfer using Investment Banker

fundsfunds

securitiessecurities

saver

investmentbanker

firm

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Movement of Savings

Indirect Transfer using Investment Banker

fundsfundsfundsfunds

securitiessecurities

saver

investmentbanker

firm

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Movement of Savings

Indirect Transfer using Investment Banker

securitiessecurities

fundsfundsfundsfunds

securitiessecurities

saver

investmentbanker

firm

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Movement of Savings

Indirect Transfer using a Financial Intermediary

financialintermediary

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Movement of Savings

Indirect Transfer using a Financial Intermediary

financialintermediary

firm

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Movement of Savings

Indirect Transfer using a Financial Intermediary

fundsfunds

financialintermediary

firm

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Movement of Savings

Indirect Transfer using a Financial Intermediary

fundsfunds

firmfirm

securitiessecurities

financialintermediary

firm

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Movement of Savings

Indirect Transfer using a Financial Intermediary

fundsfunds

firmfirm

securitiessecurities

financialintermediary

firm

saver

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Movement of Savings

Indirect Transfer using a Financial Intermediary

fundsfunds f undsfunds

firmfirm

securitiessecurities

financialintermediary

firm

saver

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Movement of Savings

Indirect Transfer using a Financial Intermediary

fundsfunds

intermediaryintermediary

secu

ritiessecu

rities

fundsfunds

firmfirm

securitiessecurities

financialintermediary

firm

saver

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Financial Market Components

Public Offering

Firm issues securities, which are

made available to both individualand institutional investors.

Private Placement

Securities are offered and sold to alimited number of investors.

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Financial Market Components

Primary Market

Market in which new issues of a

security are sold to initial buyers. Secondary Market

Market in which previously issued

securities are traded.

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Financial Market Components

Money Market

Market for short-term debt

instruments (maturity periods ofone year or less).

Capital Market

Market for long-term securities(maturity greater than one year).

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Financial Market Components Organized Exchanges Buyers and sellers meet in one central

location to conduct trades.

Over-the-Counter (OTC)

Securities dealers operate at manydifferent locations across the country

Connected by Nasdaq system

(National Association of SecuritiesDealers Automated Quotation

system).

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Investment Banking

How do investment bankers help

firms issue securities?

Underwriting the issue.

Distributing the issue.

Advising the firm.

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Distribution Methods

Negotiated Purchase

Issuing firm selects an investment

banker to underwrite the issue.

The firm and the investment bankernegotiate the terms of the offer.

Competitive Bid

Several investment bankers bid for theright to underwrite the firms issue.

The firm selects the banker offering the

highest price.

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Distribution Methods

Best Efforts

Issue is not underwritten.

Investment bank attempts to sell the

issue for a commission.

Privileged Subscription

Investment banker helps market the

new issue to a select group of investors.

Usually targeted to current

stockholders, employees, or customers.

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Distribution Methods

Direct Sale

Issuing firm sells the securities directly

to the investing public. No investment banker is involved.

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What type of issue is this?

Its a negotiated purchase.

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

How many shares will be sold?

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

How many shares will be sold?

$100,000,000 / $20 = 5 million newshares of common stock.

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Stock Issue Example:

Our firm needs to raise approximately $100million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What are the flotation costs?

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What are the flotation costs?

Underwriting spread: 2% of $100 million= $2 million.

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What are the flotation costs?

Underwriting spread: 2% of $100 million= $2 million.

Issuing costs: printing and engraving

costs; legal, accounting and trustee fees.

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What are the risks?

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Stock Issue Example:

Our firm needs to raise approximately $100

million for expansion. Our stock price is

$20. We Select Merrill Lynch to

underwrite the issue for a 2%

underwriting spread.

What are the risks?

The investment bank accepts the risk ofbeing able to sell the new stock issue for

$20 per share. If the stock price falls, the

investment bank could lose money