Chapter 2
COMPONENTS OF FINANCIAL
MARKET SYSTEM
Financial Markets
•
•
•
•
•
•
Primary Market
Second Market
Money Market
Capital Market
Organized Securities Exchanges
Over-the-Counter Markets
• Public Offerings and Private Placement
Organized Securities
Exchanges
•
•
•
•
•
•
(1)
(2)
(3)
(4)
(5)
(6)
New York Stock Exchange, (NYSE)
American Stock Exchange, (AMEX)
Mid-west Stock Exchange,
Pacific Stock Exchange,
Philadelphia Stock Exchange,
Boston Stock Exchange, and
New York Stock Exchange
(NYSE)
•
•
•
•
•
•
•
•
Membership
seat：1366 seats since 1953.
Seat fee: $760,000 to a high of $830,000.' 1995
auction :“make a market”
matching
pricing (asked and offered)
Price Quotes
82%
Function of the NYSE
• 1 Providing a continuous market.
• 2. Establishing and publicizing fair
security prices.
• 3. Helping business raise new capital.
Listing Requirements
•
•
•
•
(1)
(2)
(3)
(4)
profitability
size
market value
public ownership.
• Profitability
• EBT: at 1east $2.5 million.
• For the two years preceding EBT:at least
$2.0 million.
• Size
• Net tangible assets: at least $18.0 million.
•
•
•
•
Market Value
The market value: at least $18.0 million.
Public Ownership
common shares :1 .1 million publicly held
holders of 100 shares :at least 2,000.
THE INVESTMENT
BANKER
• a financial specialist involved as an
intermediary in the merchandising of
securities.
• Banking Act of 1933(also known as the
Glass-Steagall Act of 1933).
Functions of Institutes
• (1) underwriting,
• (2) distributing,
• (3) advising.
Distribution Methods
•
•
•
•
•
•
•
Most competitive bid purchases
(1) rail-road issues,
(2) public utility issues,
(3) state and municipal bond issues.
(4) Commission or Lest-Efforts Basis
(5) Privileged Subscription
(6) Direct Sale
• (1) current stockholders,
• (2) employees, or
• (3) customers.
PRIVATE PLACEMENTS
• (1) life insurance companies,
• (2) state and local retirement funds,
• (3) private pension funds.
Advantages of private placement
• 1.
• 2.
• 3.
Speed.
Reduced flotation costs.
Financing flexibility.
disadvantages
• 1.
• 2.
• 3.
Interest costs.
Restrictive covenants.
The possibility of future SEC
registration.
Leading U.S. Investment Bankers, 1995 (Domestic debt and Equity
issue) (BILLION OF DOLLARS
FIRM
UNDERWRITING VOLUME
＄ 122.3
Percent
1
Merrill Lynch
2
Lehman Brothers
70.3
9.9
3
Golden Sachs
68.5
9.7
3
Morgan Stanley
68.5
9.7
5
Salomon Brother
68.1
9.6
6
CS First Boston
64.6
9.1
7
J.R. Morgan
40.2
5.7
8
Bear, Sterns
25.4
3.6
９
Donaldson Lufkin & Jenrette
10
Smith Barney
20.7
17.9%
22.2
3.1
2.9
Table 2-6 Public and Privately Placed Corporate Debt Placed Domestically (Gross
proceeds of All New U.S. Corporate Debt Issue)
Total Volume
Year
(S Millions)
Percent Publicly
Placed (%)
Percent Privately
Placed (%)
1994
$441287
82．8
17．2
1993
361860
79．3
20．7
1992
443911
85．2
14．8
1991
603119
80．7
19．3
1990
276259
68．5
31．5
1989
298813
60．7
39．3
1988
329919
61．3
38．7
1987
301447
69．5
30．5
1986
313502
74．2
25．8
FLOTATION COSTS
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•
•
•
•
•
•
(1) the underwriters spread
(2) issuing costs.
(a) printing and engraving,
(b) legal fees,
(3) accounting fees,
(4) trustee fees,
several other miscellaneous components.
REGULATION
• 1929--1932, State statutes (blue sky laws)
• Securities Acts Amendments of 1975
• Primary Market Regulations 1982
•
25 investors not be registered
• 1. less than $1.5 billion of new securities
per year.
• 2. Issues that are sold entirely intrastate.
• 3. short-term instruments: maturity periods
of 270 days or less.
• 4. Issues that are already regulated or
controlled by some other federal agency
• Mr. Ivan F. Boesky, a loophole in the 1940
Ponzis Scheme
• Enron and WorldCom
Primary market regulation
• Full public disclosure
• Firm file a registration statement with the
SEC
• a minimum 20-day waiting period,
• registration process a preliminary
prospectus (the red herring非招募章程)
Secondary Market Regulations
Shelf Registration
• 1. Major security exchanges must register
with the SEC.
• 2. Insider trading is regulated.
• 3. Manipulative trading
• 4. The SEC is given control over proxy
procedures代理程序.
• 5. The Board of Governors of the Federal
Reserve System
Figure 2-4 Average Annual Returns and Standard
Deviations of Returns, 1926-1995
40
Average annual returns
35
34.8
Standard deviations
30
（%）
25
20.5
20
17.6
15
12.3
8.7
10
5
4.7
3.2
3.73.3
5.4
8.4
5.9
0
inflation
Treasury long-term long-term
government corporat
bills
bonds
bonds
common
stock
common
stocks of
small firms
Figure 2-5 Rates of Return and Standard Deviations, 1926-1995
40
common stocks
of small companys
35
percentage
30
25
20
common
stocks
15
long-term
corporate bonds
10
Treasury
bills
5
long-term
government bonds
Inflation
0
0
5
10
Standard deviation of returns
15
20
Table 2-7 Interest Rate Level and Inflation Rates 1981-1995
3-Month
Treasury Bills
30-Year
AAA Rated
Treasury Bonds Corporate Bonds
Inflation
rate
1981
14.08
13.44
14.17
8.9
1982
10.69
12.76
13.79
3.9
1983
8.63
11.18
12.04
3.8
1984
9.52
12.39
12.71
4.0
1985
7.49
10.79
11.37
3.8
1986
5.98
7.80
9.02
1.1
1987
5.82
8.58
9.38
4.4
1988
6.68
8.96
9.71
4.4
1989
8.12
8.45
9.26
4.6
1990
7.51
8.61
9.32
6.1
1991
5.42
8.14
8.77
3.1
1992
3.45
7.67
8.14
2.9
1993
3.02
6.59
7.22
2.7
16
14
Aaa Bonds
12
%
10
8
30-Years Bonds
3-Month Bills
6
4
Inflation rate
2
0
1980
1982
1984
1986
1988
1990
1992
1994
INTEREST RATE and
DETERMINANTS
• k = k* + IRP + DRP + MP + LP
•
•
•
•
•
•
k = the nominal or observed rate
k* = the real risk--free rate of interest,
IRP = inflation-risk premium.
DRP = default-risk premium
MP = maturity
LP = liquidity premium
Nominal Interest rate
• k = k* + IRP + DRP + MP + LP
•
•
•
•
k=?
k* = 3.1%,
DRP = 0.05%
LP = 0.05%
IRP = 1.5%
MP = 0.02%
• K = 3.1% + 1.5% +0.05% +
0.02%+ 0.05% = 4.72%
In reality
• 2.75% - 4.72%
= - 1.97% ???
Housing ??
Medical care??
Education??
Electricity??
Special interest group.
Krf = k* + IRP
(2-2)
The Effects of Inflation on
Rates of Return and the Fisher
Effect
• Krf =k *+ IRP + (k*. IRP)
• 0.113 = k* + .05 + '05k*
– K* = .06 = 6%
MEAN
MEAN
NOMINAL YIELD INFLATION RATE
SECURITY
%
Treasury bills
7.08
%
INFERRED
REAL RATE
%
3.93
3.15
Treasury bonds
9.31
3.93
5.38
Corporate bonds
10.03
3.93
6.10
THE TERM STRUCTURE OF
INTEREST RATES
14
13
Percentage
12
11.5
10
9
8
6
0
5
10
Year to maturity
15
20
25
Historical Interest Rates
Oct 31, 19 79
13
Int
er
est
rat
e
9
Mar 31, 19 90
Nov 13, 19 91
1
2
10
Years to maturity
30
Explaining Term Structure
•
• (1) the unbiased expectations theory,
• (2) the liquidity preference theory,
• (3) the market segmentation theory.
SUMMARY
•
•
•
•
market environment
structure of financial markets
the institution of investment banking
various methods for distributing securities
role of interest rates
Components of financial market
•
•
•
•
•
•
•
•
public offerings
private placements：institutional investors.
financial instruments
The secondary market
money and capital markets
primary and secondary
organized security exchanges
over-the-counter market
Investment banker
• functions of (l) underwriting, (2)
distributing, and (3) advising.
• the negotiated purchase, (2) the competitive
bid purchase, (3) the commission or bestefforts basis, (4) privileged subscriptions,
and (5) direct sales.
Private placements
• (l) life insurance firms, (2) state and local
retirement funds, and (3) private pension
funds.
• advantages and disadvantages
• Flotation costs
• securities Act Of l933.
• Rates of return