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Financial Markets and the Investment Banking Process

Financial Markets and the Investment Banking Process. Chapter 3. Financial Markets. A system comprised of individuals and institutions, instruments, and procedures that bring together borrowers and savers. Flow of Funds. Provides the ability to transfer income through time

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Financial Markets and the Investment Banking Process

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  1. Financial Markets andthe Investment Banking Process Chapter 3

  2. Financial Markets • A system comprised of individuals and institutions, instruments, and procedures that bring together borrowers and savers.

  3. Flow of Funds • Provides the ability to transfer income through time • Borrowing sacrifices future income to increase current income. • Saving, or investing, sacrifices current income in exchange for greater expected income in the future.

  4. Flow of Funds • 1. Direct Transfer • business sells its stock directly to investors

  5. Flow of Funds • 2. Indirect Transfer through Investment Bankers • investment banker acts as middleman and facilitates issuance of securities by reselling the securities to savers

  6. Flow of Funds • 3. Indirect Transfer through financial intermediary • bank or mutual fund obtains funds from savers and uses the money to lend or purchase securities

  7. Market Efficiency • Economic Efficiency • Funds are allocated to their optimal use at the lowest cost • Transactions costs associated with buying and selling

  8. Market Efficiency • Information Efficiency • Prices of investments reflect existing information and adjust quickly when new information enters the market • Three categories

  9. Informational Efficiency • 1. Weak-form efficiency • all information contained in past price movements is fully reflected in current market prices • information about recent or past price trends is of no use when searching for abnormal returns

  10. Informational Efficiency • 2. Semistrong-form efficiency • current market prices reflect all publicly available information • financial analysis is of no use for finding mispriced securities • insiders can profit on their own company’s stock

  11. Informational Efficiency • 3. Strong-form efficiency • current market prices reflect all pertinent information, whether publicly available or privately held • even insiders cannot earn abnormal returns

  12. Types of Financial Markets • Money Markets • instruments traded mature in one year or less • Capital Markets • includes instruments with maturities greater than one year

  13. Types of Financial Markets • Debt Markets • treasury, corporate, mortgage-backed, money market, municipal, etc... • Equity Markets • stock markets

  14. Equity Markets • Primary • corporations raise funds by issuing new securities • Secondary • securities are traded among investors after they have been issued

  15. Derivatives Markets • Options, futures and swaps are securities whose value is determined, or derived directly from other assets • These can be used to manage risk or to speculate

  16. Types of Stock Market Transactions • 1. Secondary market • trading existing stocks • 2. Primary market • existing firm issues additional shares • 3. Initial Public Offering (IPO) • privately held company offers stock to the public for the first time • called “going public”

  17. The Stock Exchanges • Organized security exchanges • tangible physical entities • New York Stock Exchange (NYSE) • American Stock Exchange (AMEX) • Chicago Stock Exchange (CHX) • Philadelphia Stock Exchange (PHLX)

  18. NYSE Members • 1. Commission brokers • 2. Independent brokers • 3. Competitive traders • 4. Specialists

  19. Listing Requirements • Quantitative and qualitative characteristics a firm must possess to be listed on an exchange • Vary by exchange • Number of shareholders, number of public shares, market value of public shares, pre-tax income, etc...

  20. Over-the-Counter Market (OTC) • Collection of brokers and dealers connected electronically • Provides for trading in securities not listed on the organized exchanges

  21. Over-the-Counter Market (OTC) • 1. Dealers hold inventory and make a market • 2. Brokers act as agents in bringing together dealers with investors • 3. Electronic network provides communications link

  22. NASD • Many of the dealers and brokers of the OTC are members of the National Association of Securities Dealers (NASD), which licenses and oversees trading practices.

  23. NASDAQ • The computerized trading network used by NASD is the NASD Automated Quotation System (NASDAQ) and is a sophisticated market of its own, separate from the OTC.

  24. Investment Banker • Organization that underwrites and distributes new issues of securities • Helps businesses and other entities obtain needed financing

  25. Investment Banking Process • 1. Help corporations design securities with the features that are most attractive to investors given existing market conditions. • 2. Buy these securities from the corporations. • 3. Then resell the securities to investors (savers).

  26. Raising Capital: Stage I Decisions • 1. Dollars to be raised • 2. Type of securities used • 3. Competitive bid or negotiated deal • 4. Selection of an investment banker

  27. Raising Capital: Stage II Decisions • 1. Reevaluating the initial decisions • 2. Best efforts or underwritten issues • 3. Issuance (flotation) costs • 4. Setting the offering price

  28. Selling Procedures • Registration statement • filed with the SEC • Prospectus • summarizes a new security issue and the issuing company • Underwriting syndicate • group of investment banking firms to distribute the new issue

  29. Shelf Registration • Securities registered with the SEC for sale at a later date

  30. Maintenance of the Secondary Market • To facilitate orderly market for the new security, the investment banker maintains a market for the security following its issue.

  31. Regulation of Securities Markets • Securities and Exchange Commission (SEC) • U.S. government agency regulates the issuance and trading of stocks and bonds • to ensure investors receive fair financial disclosures • to discourage fraud and misleading stock manipulation

  32. SEC Regulation • 1. Jurisdiction over interstate offerings of new securities to the general public in amounts of $1.5 million or more • 2. Regulates national securities exchanges, and listed companies must file annual reports

  33. SEC Regulation • 3. Control stock trades by corporate insiders • 4. Prohibit manipulation of securities prices by pools or wash sales

  34. International Financial Markets • Increasingly global markets • Greatest growth in emerging markets of the Pacific Rim • U. S. exchanges still dominate worldwide trading activity

  35. End of Chapter 3 Financial Markets and the Investment Banking Process

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