Name: __________________________________________________ Period:__________________
CHAPTER 2.3 – FINANCIAL MARKETS
Goals – Financial Markets
 Discuss the purpose and general structure of financial markets
 Describe the major types of financial markets
 Define authorized, issued, outstanding and treasury shares
 Understand the role of investment banking in financial markets
 Explain the types of financial exchanges
 Calculate spreads, net proceeds of issues, bond payments, amount of shares that can be issued
Vocabulary
financial market
term
commodity markets
spot markets
futures markets
face value/par value/principal
discount
coupon bonds
bearer bonds
registered bonds
semi-annual
stock markets
stock exchanges
organized exchange (e.g. NYSE)
buy price
sell price
listed
Over the counter (OTC) exchange (e.g.
NASDAQ)
bid price
ask price
dealer
broker
public placement
private offering
authorized shares
issued shares
outstanding shares
treasury shares
investment banking
spread
underwriting
best-efforts basis
prospectus
red herring
initial public offering (IPO)
primary market/offering
secondary market/offering
private/closely held corporation
public corporation
board of directors
charter
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SECTION 2.3 TYPES OF FINANCIAL MARKETS
1.
A financial market provides an organized process for the exchange of money. Businesses and
governments use the money to obtain ____________________ to operate the business or provide
services. Consumers use the money to fill ______________________. When deciding which market
to invest in, investors consider __________, __________________ and the ___________ of the
investment. Each market helps to set the supply and demand for a specific investment, thereby setting
the ____________.
2. Shares of stock that a company can sell are known as __________________________ shares. The
number of shares of stock a company can sell is listed in the company _____________________.
Stocks that have been sold in the marketplace are known as ___________________ shares. Issued
shares held by investors are called ____________________________ shares. Sometimes the
company issuing the stock buys some of its own shares back. These shares then become
__________________________ stock and are no longer considered to be outstanding.
3. When a company decides to offer securities they can choose between a private placement and a public
offering. With a ________________________________, the company knows exactly who will
purchase the security when it goes to market. This type of offering is most common with small
companies that are owned by a small number of people. These types are companies are known as
_______________________ or ___________________ corporations. Large companies may also
use a private placement when the security is purchased by an ________________________ investor
such as a mutual fund. The sale of securities to the general public is known as a _________________
offering. When a company issues stock for the very first time ever it’s called the company’s
____________________________________ or _________. If the company decides to issue more
of its authorized shares at a later date, those shares are known as the company’s
_______________________ offering. Public offerings often bring in _______________ money,
but they are __________ expensive than private offerings.
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IPO Process
1. Consult an
investment
banker
2. Obtain
necessay
approvals
3. Notify the
public of issue
•underwriting
•stockholders
•prospectus
•best-efforts
•SEC Registration
•red herring
4. When a security is issued for the first time,
4. Sell the issues
at the issue price
Underwriting Calculation
it is sold in the _____________________
Issue Price
market. The primary market is the place
-
Administrative Fees
where both __________________ and
-
Selling Costs
_____________________ offerings are
-
Sales Commission
sold. Once a share is issued, it can then be
-
Required Profit
traded by the public in the
=
Net Proceeds
__________________ market.
5. The __________________________ market is used to trade raw materials and other basic
production resources. Spot markets buy and sell commodities for ________________________
delivery. Futures markets negotiate ___________________ to buy and sell commodities at a
______________ date. Futures markets help protect against the __________ of uncertain markets.
6. Bond markets trade _________ securities issued by ____________________ and
___________________. Bonds in the United States are issued with face amounts, or ________
values, of __________________. Some bonds earn interest which is payable to the
_____________________ every ____ months. These types of bonds are called _______________
bonds. Bonds that do not earn interest are called _________________________ bonds. These
bonds are issued at a _______________________ which means they are sold for less than the par
value, or _________ amount. In the past, bond payments were made to whoever had physical
possession on the bond. These types of bonds are called ______________ bonds. Because these
bonds could be easily stolen, the SEC now requires bonds to be _______________________ in a
computer which keeps track of the owner of the bond. Payments are then made to the registered
owner.
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7. Securities _________________________________ provide the marketplace for the sale and
purchase of securities. ____________________________________ exchanges are formal
organizations with ________________ locations. They act as secondary markets for securities by
holding ____________. The goal of trading is to fill ________ orders at the lowest price and
_________ orders at the highest price. These exchanges own the rights to trade the stocks of
_____________ companies. The largest organized exchange in the U.S. is the
_____________________________________________. Other major organized exchanges include
the ____________ (American Stock Exchange), regional exchanges in _______________________,
__________________, ______________________ and _______________________ and
international exchanges in _____________, _____________, __________________,
____________________________, _______________________, ________________________
and _____________________.
8. An over-the-counter, or ________, exchange is used to trade securities that are not ____________
on any of the organized exchanges. These markets do not have a ____________________ location.
Trades in this market are made by a collection of _______________ who hold
_______________________ of OTC securities. Thousands of ___________________ act as
agents in bringing together the dealers and potential investors. Telephones and computers are used to
continuously communicate the dealer’s current ______________ price (price at which the dealer will
purchase securities) and the dealer’s ___________ price (the price at which the dealer will sell
securities). The largest OTC market in the U.S. is the National Association of Securities Dealers
Automated Quotation, or ___________________.
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SECTION 2.3 REVIEW QUESTIONS
1.
2.
3.
4.
5.
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7.
8.
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10.
11.
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14.
15.
16.
Why are financial markets important to firms and investors?
What are (a) initial public offerings and (b) secondary offerings?
Distinguish between public offerings and private placements.
What functions does an investment banker perform?
Explain the sequence of events in the issuing of a new security?
How are underwriting costs affected by the size and type of an issue?
What is the purpose of a prospectus?
Hildreth Recycling is interested in selling common stock to raise capital for a plant expansion. The firm
has hired First Atlanta Company, a large investment banking firm, to serve as underwriter. First
Atlanta believes that the stock can be sold for $80 per share, that its administrative costs will be 2%
of the sale price, and that its selling costs will be 1.5% of the sale price. If First Atlanta requires a
profit equal to 1% of the sale price, how much will the spread have to be, in dollars, to cover its costs
and profits?
RM International wishes to sell $100 million of bonds whose net proceeds will be used in the acquisition
of Little Books. The company has estimated that the net proceeds, after paying underwriting costs,
should provide an amount sufficient to make the acquisition. The underwriter believes that the
100,000 bonds can be sold to the public for par and estimates that its administrative costs will be
$4.25 million. The underwriting commission (in addition to recovery of its administrative costs) is 1% of
the par value of the offering.
a. Calculate the per bond spread required by the underwriter to cover its costs.
b. How much money will RM International net from the issue?
c. How much will the underwriter receive from the issue?
d. Assuming that this is a public offering, describe the nature of the underwriter’s risk.
Why are secondary markets important?
Charter Corp. has issued 2,500 bonds with a total value of $2,500,000. The bonds have a 7%coupon
rate.
a. What dollar amount of interest per bond can an investor expect to receive every six months
from Charter Corp.?
b. What is Charter’s total interest expense per year associated with these bonds?
Aspin Corporation’s charter authorizes issuance of 2,000,000 shares of common stock. Currently,
1,400,000 shares are outstanding and 100,000 shares are being held as treasury stock. The firm
wishes to raise $48,000,000 for a plant expansion. Discussions with its investment bankers indicate
that the sale of new common stock will net the firm $60 per share.
a. What is the maximum number of new shares of common stock the firm can sell without
receiving further authorization from shareholders?
b. Based on the data given and your finding in part a, will the firm be able to raise the needed
funds without receiving further authorization?
c. What must the firm do to obtain authorization to the number of shares needed?
Why might the financial manager of a company buy its own shares? Why might the manager sell the
treasury shares?
Compare and contrast organized exchanges with OTC exchanges.
What are bid prices and ask prices? Why are prices in the OTC quoted in this way?
Answer the following questions from your textbook:
a. Page 40 - Questions 4, 5
b. Page 45 – Checkpoint question
c. Page 47 – Questions 1, 2, 4, 5
d. Page 52 – Questions 1, 2, 3, 4, 5
e. Page 57 – Questions 1, 3, 4
f. Pages 59 to 62 – Questions 11, 12, 13, 17, 20, 21, 22, 23, Stock Market Activity 1, 2, 3
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