Chapter 2
The Creation of
Financial Assets
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The Transfer of Funds from
Savers to Business
• Income that is saved is
subsequently invested
• The process of investing creates
financial claims
• Financial claims are either
–debt
–equity
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The Direct Transfer
Security
Corporation
Money
General
Public
(Savers)
• The saver has a claim (debt or
equity) on the issuer
• The issuer receives the money
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The Indirect Transfer through
a Financial Intermediary
Account
Financial
Intermediary
Money
General
Public
(Savers)
• The saver has a claim on the financial
intermediary
• The financial intermediary has a claim
on the ultimate user of the funds
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The Private Placement
• Direct sale of securities
• Eliminates selling costs
• Features can be tailor made for
both parties
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The Sale of New Securities to
the General Public
• Initial public offerings (IPOs)
• The role of investment bankers
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The Sale of New Securities To
the General Public
• The mechanics of security underwriting
–the originating house or managing
underwriter
–the guaranteed sale - firm commitment
–underwriter bears the risk
–the syndicate
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The Sale of New Securities To
the General Public
• The mechanics of security
underwriting
–underwriting discount
–prospectus
• Best effort agreements
–issuing firm bears the risk
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Pricing an IPO
• Underpricing leads to windfall gains
to initial buyers
• Overpricing inflicts losses on initial
buyers and the investment bankers
• Tendency to underprice to assure a
successful sale
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The Price Volatility of IPOs
• Prices can rise dramatically
• Many firms eventually fail
• Few investors get to participate in
an IPO
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Regulation of Initial Public
Offerings
• Registration of new securities
• The prospectus
• Securities and Exchange
Commission (SEC)
• The shelf-registration
• The lock-up
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Financial Intermediaries and
Investment Bankers Differ
• Financial intermediaries create
claims on themselves
• Investment bankers
–facilitate the sale of new
securities
–do not create claims on
themselves
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The Variety of Financial
Intermediaries
•Commercial banks
•Savings and loan associations
•Mutual savings banks
•Credit unions
•Life insurance companies
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The Variety of Financial
Intermediaries
• Pension plans
• Money market mutual funds
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Financial Intermediaries
• Each financial intermediary creates
claims on itself and transfers funds
from savers to
–firms
–governments
–people who need funds
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Depository Financial Institutions
• The Depository Institutions
Deregulation and Monetary Control
Act of 1980
• Subject to the regulation of the
Federal Reserve
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Regulation Covers
• Types of deposits each
intermediary may issue
• Amounts that must be held in
reserve against deposits
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Federal Deposit Insurance
Corporation (FDIC)
• Insures accounts up to specified
limit
• Another source of regulation
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Regulatory Trends
• The consolidation of regulation
through the Federal Reserve
• The increased ability to issue
various types of accounts
• Reduced or blurred the distinctions
among the different types of
depository institutions
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Money Market Mutual Funds
• A specialized investment company
• Makes only short-term investments
• Acquires money market
instruments
• Shares in money funds have
become popular investments
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Money Market Mutual Funds
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The Money Market
Instruments
•Certificates of deposit (CDs)
•Negotiable CDs
•Eurodollar CDs
•U.S. Treasury bills
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The Money Market
Instruments
•
•
•
•
Commercial Paper
Repurchase agreements (repos)
Bankers' acceptances
Tax (or revenue) anticipation notes
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The Money Market
Instruments
• These instruments are
–safe
–liquid
• Offer competitive short-term rates
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