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Chapter 2 Cont.
Terms in this set (37)
Financial Markets and Institutions
- Financial markets and the institutions in them are the cornerstones of the global financial system in which financial managers operate
- individuals use both for investing, since they are considered to be net suppliers of funds to the financial system
- corporations and governments use both for financing, as they are net users/demanders of funds
markets in which users of funds (corps. and govs.) raise funds by issuing financial instruments (stocks and bonds)
markets where financial instruments are traded among investors (NYSE, NASDAQ)
- market where investors trade highly liquid securities with maturities of 1 year or less
- most money market transactions are made in marketable securities which are low-risk, short term debt instruments such as: US Treasury Bills, Commercial paper issued by businesses, Negotiable certificates of deposit issued by financial institutions
Eurocurrency Market (Money Market)
-International equivalent of the domestic money market
- It is a market for short-term, time deposits denominated mostly in U.S. dollars or other marketable currencies.
- Market has grown rapidly mainly because it is unregulated and because it meets the needs of international borrowers and lenders.
a market that enables suppliers and demanders of long-term funds to make transactions
Key Securities traded
- securities traded in the capital market fall into two broad categories:
Bonds (debt) and stock (equity)
- common stock
- preferred stock
where they trade: in the securities exchange
Long-term debt instruments used by businesses and government to raise large sums of money, generally from a diverse group of lenders
unit of ownership interest or equity in a corporation
special form of ownership that has features of both a bond and common stock
International Capital Markets
- Foreign Bond Market
- Eurobond Market
- International Equity Market
Foreign Bond Market
Bonds issued by foreign corporations or governments in the local currency of the country where the bonds are issued
When corporations and governments issue bonds denominated in a currency different than that of the country where the bonds are issued.
International Equity Market
when corporations sell stock in multiple countries
Efficient Market Hypothesis (Role of Capital Markets)
- Securities are typically in equilibrium, which means they are fairly priced and their expected returns equal their appropriate returns given their respective risk
- At any point in time, security prices fully reflect all information available about the firm and its securities, and these prices react swiftly to new information
- Because stocks are fully and fairly priced, investors need not waste their time trying to find mispriced (undervalued or overvalued) securities.
Behavioral Finance (Role of Capital Markets)
Argues that stock prices and prices of other securities can deviate from their true values for extended periods and that these deviations may lead to predictable patterns in stock prices.
The Bid Quote
The highest price anyone in the exchange is willing to pay for a round lot (100 units) of a given security
The Ask Quote
The lowest price anyone in the exchange is willing to accept for a round lot of a given security.
the difference between the bid price and the asked price
B/A Spread = Ask - Bid
- Securities exchanges in which the two sides of a transaction, the buyer and seller, are brought together (matched with each other) by an intermediary at the exchange.
- The transactions usually take place at the mid-point of the bid-ask spread, and they typically result in only a percentage or flat dollar commission per trade paid to the stock broker.
- When a counterparty to a transaction cannot be found, the intermediary can act as a dealer, buying/selling the securities for/from his own inventory.
- Trading takes place on centralized trading floors of national exchanges, such as NYSE Euronext, and on some regional exchanges.
- Markets in which buyers and sellers are not brought together directly, but instead have their orders filled by "market makers" in the given security.
- They have no centralized trading floors. Like the NASDAQ, these markets are made up of a large number of market makers who are linked via a telecommunication network.
- Dealers are in essence resellers of securities, buying them at the quoted bid and selling them at the ask. Thus, half of the bid-ask spread is considered to be part of the transaction costs of the trade, along with a flat or percentage commission payable to the stock broker for the transaction
Foreign Exchange Markets
- "FX" markets deal in trading one currency for another (dollar for yen)
- the "spot" FX transaction involves immediate exchange of currencies at the current exchange rate
- the "forward" FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate
Derivative Security Markets
markets in which derivative securities trade
an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future
Overview of Financial Institutions
institutions that perform essential function of channeling funds from those with surplus funds to those with shortages of funds
Commercial Banks, Thrifts, Insurance Companies
1. Depository institutions whose majors assets are loans and major liabilities are deposits
2. Depository institutions in the form of savings and loans, credit unions
3. Financial Institutions that protect individuals and corporations from adverse events
Securities Firms and Investment Banks, Financing Companies
1. financial institutions that underwrite securities and engage in securities brokerage and trading
2. Make loans to individuals and businesses; since they do not accept deposits they are not subject to the same regulations as traditional banks, constituting a de facto "shadowing banking system"
Mutual Funds, Hedge Funds, Pension Funds
1. investment company that pools savings from individuals and invests in diversified portfolios
2. private investment companies, open to wealthy and institutional investors, that pursues more speculative investment options
3. Fund set up by an employer to offer retirement investments to its employees
Private Equity (Security Issuing Process)
External equity financing that is raised via a private placement, typically by a private early-stage firm with attractive growth prospectus but thirsty for capital
- Angel Investors: Wealthy individuals who are willing to invest in promising startups in exchange for a portion of the firm's equity
- Venture Capitalists: Formal business entities that take in private equity capital from many individual investors, often institutional investors such as endowments and pension funds or individuals of high net worth, and make private equity investment decisions on their behalf
Private Equity Deal Structure and Pricing (Security Issuing Process)
- The deal structure allocates responsibilities and ownership interests between the existing owners (typically the founders) and the venture capitalist
- Its terms depend on numerous factors related to the founders, the business structure, stage of development, the firm's outlook, and other market and timing issues.
- Typically, VC's require more equity ownership and pay less for it, depending on how risky and developed the business is.
Going Public (Security Issuing Process)
- Private Placement: firm sells new securities directly to an investor or group of investors
- Rights Offering: firm sells new shares to existing stockholders
- Public Offering: firm sells new shares to the general public
Initial Public Offering (IPO), Prospectus (Going Public)
1. The first public sale of a firm's stock, typically made by small, rapidly growing firms that need additional capital to continue growing or have met a milestone established by a VC.
2. Formal document filed with the SEC that describes the key aspects of the equity issue, the issuer, its management, and its financial position. A preliminary version of it is referred to as a "red herring."
Roadshow, Quiet Period
1. A series of presentations to potential investors around the country, providing investors with information about the new issue. They also help investment banks gauge demand for the offering and set a preliminary offer price range.
2. Period around the IPO date in which company officials are forbidden to deviate from the information provided in the prospectus.
Investment Bank's Role (Going Public)
Investment Bank: Financial intermediary that specializes in selling new security issues and advising firms with regard to major financial transactions
Underwriting: the role of the investment bank in bearing the risk of reselling, at a profit, the securities purchased from an issuing corporation at an agreed-on discounted price.
IPO Offer Price: price at which the securities are offered to the investment public
Total Proceeds, Market Price, Market Capitalization (IB Role; Going Public)
1. the total amount of proceeds for all shares sold in the IPO
Total Proceeds = IPO Offer Price × # of IPO Shares Issued
2. price of the firm's shares in the secondary market immediately after going public
3. total market value of a publicly traded firm's outstanding stock
IPO Market Price, IPO Under-pricing (IB Role; Going Public)
1. final trading price on the first day in the secondary market
2. percentage change from the final IPO offer price to the IPO market price, which is the final trading price on the first day in the secondary market; this is also called the IPO initial return
IPO Underpricing = (Market Price − Offer Price) ÷ Offer Price
Crisis of 2007-2009
- The housing market slows in 2005 and crashes in the spring of 2007 in several countries.
- Two hedge funds at Bear Stearns fail in July 2007.
- Northern Rock Bank is bailed out by the Bank of England.
- September 2007 sees several bank runs around the globe.
- Commodity prices skyrocket in 2008 with crude oil peaking at $147/barrel in July .
- US Government places Fannie Mae and Freddie Mac into conservatorship on September 7, 2008.
- Lehman Brothers fails on September 14, 2008.
- Equity markets plunge on September 15, 2008.
- AIG rescued with an $85 billion bailout September 16, 2008.
- The Greek crisis began to unfold in late 2009 and was protracted until 2012 when it finally defaulted.
- In mid-2015 it failed to repay the IMF bailout. It's sovereign debt was about more than €300bn at the time
Seeds of Crisis
- Change in legislation
- easy money
- subprime mortgages
- mortgage backed securities
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