McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Financial Markets
Financing Decision
Source of Funds (Capital)
Capital Structure
2-2

The Flow of Capital:
Closely Held Corporations
2-3

The Flow of Capital:
Public Corporations
2-4

The Flow of Capital:
Public Corporations
Financial Market:
Market where securities are issued and traded.
Primary Market:
Market for the sale of new securities by corporations.
Secondary Market:
Market in which previously issued securities are traded among investors.
2-5

Financial Markets
Initial Public Offering (IPO):
First offering of stock to the general public.
Fixed-Income Market:
Market for debt securities
2-6

Financial Markets:
Markets for Debt
Capital Markets are used for long-term financing
Example of long-term debt: Bonds
Money Markets are used for short-term financing.
Example of short-term debt: Commercial Paper
2-7

Information Provided by
Financial Markets:
•
Commodity Prices
•
Interest Rates
•
Company Value
•
Cost of Capital
2-8

Financial Intermediaries
•
Mutual Fund
•
An investment company that pools the savings of many investors and invests in a portfolio of securities
• Hedge Fund
•
A private investment pool, open to wealthy or institutional investors, that is only lightly regulated and therefore can pursue more speculative policies than mutual funds
• Pension Fund
• Fund set up by an employer to provide for employees’ retirement
2-9

Flow of Cash Example:
Mutual Fund
$ $
Bank of
America
Explorer
Fund
Investors
Sells shares
Issues shares
2-10

A Closer Look:
Financial Institutions
Commercial Bank
Investment Bank
Insurance Company
2-11

Companies and Intermediaries
Company
Obligations
Funds
Intermediaries
Banks
Insurance Companies
Brokerage Firms
2-12

Intermediaries and Investors
Intermediaries
Obligations
Funds
Investors
Depositors
Policyholders
Investors
2-13

Cash Flow Example:
Banks
Company
Loan $2.5 mil
Banks Intermediary
Deposits
Cash
Investor
Depositors
2-14

Cash Flow Example:
Insurance Company
Company
Issue Debt $2.5 mil
Insurance
Company
Intermediary
Sell Policies
Cash
Investor
Policyholders
2-15

Function of Financial Markets and Intermediaries

Transport cash across time

Risk transfer and diversification

Liquidity
2-16

Function of Financial Markets and Intermediaries

Payment mechanism

Provide information
2-17

Financial Crisis 2007-2009:
Federal Reserve
Easy-Money
Policy
Credit Rating
Agencies gave many
AAA ratings to MBS that shortly went into default
Causes
The U.S.
Government encouraged expansion of credit to low-income housing
Bankers aggressively promoted subprime mortgages
Homebuyers overextended
A Perfect Storm:
•
Falling Housing Prices
•
Bankruptcy
•
Credit Freeze
•
International Effect
2-18

Financial Crisis 2007-2009:
The Response

Government Bailouts
Government Bailout
(or arranged acquisition)
Bear Stearns (JP Morgan Chase)
Fannie Mae
Freddie Mac
Merrill Lynch (Bank of America)
No Government Bailout
Lehman Brothers
AIG
Did this response effectively decrease the uncertainty in the market?

Government Response: TARP
What was the rationale behind TARP?
2-19

Appendix A:
Total U.S. Equity Financing
Holdings of Corporate Equities, 3 rd Quarter 2010
2-20

Appendix B:
Total U.S. Debt Financing
Holdings of Corporate & Foreign Bonds, 3 rd Quarter 2010
2-21