financial markets_ch03.ppt
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Financial Markets andthe Investment Banking Process
Chapter 3Requests for permission to make
copies of any part of the work should be mailed to:
Thomson/South-Western5191 Natorp Blvd.Mason, OH 45040
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Financial Markets
A system comprised of individuals and institutions, instruments, and procedures that bring together borrowers and savers.
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Flow of Funds
Provides the ability to transfer income through timeBorrowing sacrifices
future income to increase current income.
Saving, or investing, sacrifices current income in exchange for greater expected income in the future.
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Flow of Funds
1. Direct Transfer business sells its stock directly to investors
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Flow of Funds
2. Indirect Transfer through Investment Bankers investment banker acts as middleman and
facilitates issuance of securities by reselling the securities to savers
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Flow of Funds
3. Indirect Transfer through financial intermediarybank or mutual fund obtains funds
from savers and uses the money to lend or purchase securities
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Market Efficiency
Economic EfficiencyFunds are allocated to their optimal use at
the lowest costTransactions costs associated with buying
and selling
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Market Efficiency
Information EfficiencyPrices of investments reflect
existing information and adjust quickly when new information enters the market
Three categories
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Informational Efficiency
1. Weak-form efficiency all information contained in past price
movements is fully reflected in current market prices
information about recent or past price trends is of no use when searching for abnormal returns
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Informational Efficiency
2. Semistrong-form efficiency current market prices reflect all publicly
available information financial analysis is of no use for finding
mispriced securities insiders can profit on their own company’s
stock
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Informational Efficiency
3. Strong-form efficiency current market prices reflect all pertinent
information, whether publicly available or privately held
even insiders cannot earn abnormal returns
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Types of Financial Markets
Money Markets instruments traded mature in one year or
less
Capital Markets includes instruments with maturities greater
than one year
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Types of Financial Markets
Debt Markets treasury, corporate, mortgage-backed,
money market, municipal, etc...
Equity Markets stock markets
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Equity Markets
Primary corporations raise funds by issuing new
securities
Secondary securities are traded among investors after
they have been issued
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Derivatives Markets
Options, futures and swaps are securities whose value is determined, or derived directly from other assets
These can be used to manage risk or to speculate
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Types of Stock Market Transactions
1. Secondary market trading existing stocks
2. Primary market existing firm issues additional shares
3. Initial Public Offering (IPO) privately held company offers stock to the
public for the first time called “going public”
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The Physical Stock Exchanges
Physical exchangesNew York Stock Exchange (NYSE)American Stock Exchange (AMEX)Chicago Stock Exchange (CHX)Philadelphia Stock Exchange (PHLX)
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NYSE Members
1. Commission brokers
2. Independent brokers
3. Competitive traders
4. Specialists
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Listing Requirements
Quantitative and qualitative characteristics a firm must possess to be listed on an exchange
Vary by exchange
Number of shareholders, number of public shares, market value of public shares, pre-tax income, etc...
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Organized Investment Networks—The Over-the-Counter Market (OTC)
Collection of brokers and dealers connected electronically
Provides for trading in securities not listed on the organized exchanges
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Over-the-Counter Market (OTC)
1. Dealers hold inventory and make a market
2. Brokers act as agents in bringing together dealers with investors
3. Electronic network provides communications link
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NASD
Many of the dealers and brokers of the OTC are members of the National Association of Securities Dealers (NASD), which licenses and oversees trading practices.
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NASDAQ
The computerized trading network used by NASD is the NASD Automated Quotation System (NASDAQ) and is a sophisticated market of its own, separate from the OTC.
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Electronic Communications Networks (ECN)
Electronic systems that transfer information about securities transactions to facilitate the execution of orders
Automatically matches buy and sell orders for a large number of transactions
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Investment Banker
Organization that underwrites and distributes new issues of securities
Helps businesses and other entities obtain needed financing
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Investment Banking Process
1. Help corporations design securities with the features that are most attractive to investors given existing market conditions.
2. Buy these securities from the corporations.
3. Then resell the securities to investors (savers).
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Raising Capital: Stage I Decisions
1. Dollars to be raised
2. Type of securities used
3. Competitive bid or negotiated deal
4. Selection of an investment banker
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Raising Capital: Stage II Decisions
1. Reevaluating the initial decisions
2. Best efforts or underwritten issues
3. Issuance (flotation) costs
4. Setting the offering price
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Selling Procedures
Registration statement filed with the SEC
Prospectus summarizes a new security issue and the
issuing company
Underwriting syndicategroup of investment banking firms to
distribute the new issue
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Shelf Registration
Securities registered with the SEC for sale at a later date
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Maintenance of the Secondary Market
To facilitate orderly market for the new security, the investment banker maintains a market for the security following its issue.
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Regulation of Securities Markets
Securities and Exchange Commission (SEC)U.S. government agency regulates the
issuance and trading of stocks and bonds to ensure investors receive fair financial
disclosures to discourage fraud and misleading stock
manipulation
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SEC Regulation
1. Jurisdiction over interstate offerings of new securities to the general public in amounts of $1.5 million or more
2. Regulates national securities exchanges, and listed companies must file annual reports
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SEC Regulation
3. Control stock trades by corporate insiders
4. Prohibit manipulation of securities prices by pools or wash sales
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International Financial Markets
Increasingly global markets
Greatest growth in emerging markets of the Pacific Rim
U. S. exchanges still dominate worldwide trading activity
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End of Chapter 3
Financial Markets and the Investment
Banking Process