The Financial Markets and the Investment Banking Process

1. The Financial Markets and the Investment Banking Process • What are financial markets and what role do they play in improving the standard of living in an economy? • Why is it important for financial markets to be somewhat efficient? • Why are there so many different types of financial markets? • What is an investment banking house? • What is a financial intermediary? • How do financial markets in the U.S. differ from financial markets in other parts of the world?

2. What is a Financial Market? • A mechanism by which borrowers (those with a need for funds) and lenders (those with excess fund) get together. • The primary role of financial markets is to facilitate the flow of funds from those who have surplus funds to those who have needs for funds in excess of their current income.

3. Flow of Funds • Three financial phases • Young adults borrow • Older working adults save • Retired adults use savings • Funds transferred from savers to borrowers • Direct transfer • Investment banking house • Financial intermediary

4. Transfer of Funds Direct Transfers Securities (stocks or bonds) Borrower (Business) Saver (Investor) Dollars Indirect Transfers through an Investment Banker Securities Securities Investment Banker Saver (Investor) Borrower (Business) Dollars Dollars Indirect Transfers through a Financial Intermediary Intermediary Securities Business Securities Financial Intermediary Saver (Investor) Borrower (Business) Dollars (Loans) Dollars (Deposits)

5. Market Efficiency • Economic Efficiency—funds are allocated to their optimal use at the lowest costs • Informational Efficiency—investment prices are adjusted quickly to reflect current information • Weak-form—all information contained in past price movements is reflected in current market prices • Semistrong-form—current prices reflect all publicly available information • Strong-form form—current prices reflect all pertinent information, both public and private

6. Types of Financial Markets • Money versus capital markets • Debt versus equity markets • Primary versus secondary markets • Derivatives markets

7. General Stock Market Activities • The secondary market—trading of outstanding, previously issued shares of stock • The primary market—new shares of stock sold by companies to raise funds • Initial Public Offering (IPO) market—privately/closely held firms go public for the first time

8. Stock Markets • Physical stock exchanges • NYSE, AMEX, and regional exchanges • Exchange members • Floor brokers • House broker • Independent broker • Specialists • Listing requirements

9. Stock Markets • Over-the-Counter Markets and the Nasdaq • Network of brokers and dealers • Auction market • Organized Investment Network • Electronic Communications Networks

10. Regulation of Securities Markets • Securities and Exchange Commission (SEC) • Jurisdiction over most interstate offerings of new securities to the general public • Regulation of national securities exchanges • Power to prohibit manipulation of securities’ prices • Control over stock trades by corporate insiders

11. The Investment Banking Process • Investment Banker • Helps corporations design securities attractive to investors • Buys these securities from the corporation • Resells the securities to investors

12. The Investment Banking Process • Raising Capital: Stage I Decisions • Dollars to be raised • Type of securities used • Competitive bid versus negotiated deal • Selection of an investment banker

13. The Investment Banking Process • Raising Capital: Stage II Decisions • Reevaluating the initial decisions • Best efforts or underwritten issues • Underwritten Arrangement—investment bank guarantees the sale by purchasing the securities from the issuer • Best Effort Arrangement—investment bank gives no guarantee that the securities will be sold • Issuance (flotation) Costs • Setting the offering price

14. The Investment Banking Process • Selling Procedures • Underwriting Syndicate—to spread risk • Lead Underwriter—manages the distribution • Selling Group—network of brokerage firms • Shelf Registration—approved by the SEC, but held for sale at a later date • Maintenance of the Secondary Market—investment banker wants to “make a market” for the issue (especially for an IPO)

15. International Stock Markets • U.S. stock markets • Less than 40% of the total value worldwide • Still dominate the international stock markets • U.S. investors can participate in international markets by through American Depository Receipts (ADR)

16. Types of Financial Intermediaries • Commercial banks • Credit unions • Savings and loan associations • Mutual funds • Whole life insurance companies • Pension funds

17. The Roles of Financial Intermediaries • Facilitate the transfer of funds from those who have funds (savers) to those who need funds (borrowers) • Manufacture a variety of financial products

18. Benefits of Financial Intermediaries • Improved standard of living • Reduced costs • Risk/diversification • Funds divisibility/pooling • Financial flexibility • Related services

19. Financial Organizations in Other Parts of the World • U.S. financial institutions are more heavily regulated than foreign institutions • U.S. financial institutions face greater limitations on branching, services, and relationships with non-financial businesses than foreign institutions

20. The Financial Markets and the Investment Banking Process • What are financial markets? • The mechanisms by which borrowers and lenders are brought together. • Why is it important for financial markets to be somewhat efficient? • If we can borrow at the lowest cost and invest at the highest returns, the use of money is efficient and the standard of living is higher than it otherwise would be. • Why are there so many different types of financial markets? • Savers and borrowers have different needs.

21. The Financial Markets and the Investment Banking Process • What is an investment banking house? • An organization that acts as a middleman to help firms and governments raise funds by issuing financial instruments • What is a financial intermediary? • An organization that takes “deposits” and uses the money to generate returns by creating loans or other investments • How do financial markets in the U.S. differ from financial markets in other parts of the world? • U.S. financial markets/intermediaries face greater restrictions. • More participants in U.S. markets. • U.S. financial markets are more efficient. • More independent financial intermediaries in U.S.