Financial Management –Spring 2013

Financial Management –Spring 2013

Chapter 2: Financial Markets And Institutions

1.The Importance of Financial Institutions

2.The Flow of Savings to Corporations

3.Functions of Financial Markets and

Intermediaries

4.Value Maximization and the Cost of Capital

FINANCIAL MARKETS AND INSTITUTIONS

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The Flow of Savings to Corporations

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2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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The Financial Market

Financial Market:

Market where equity securities are issued and traded.

1. Primary Market:

Market for the sale of new securities by corporations.

2. Secondary Market:

Market in which previously issued securities are traded

among investors.

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2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Miscellaneous Financial Markets

Bond or Fixed-Income Market:

Debt securities

Money Market:

Short-term, high quality, and liquid debt financing:

Commercial Papers

Capital Market:

Long-term debt financing: Bonds

Other Markets:

Foreign exchange, futures, options

Commodity markets

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2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Financial Intermediaries: Funds

Mutual Fund

An investment company that pools the savings of many

investors and invests in a portfolio of securities

Hedge Fund

A private investment pool, open to wealthy or institutional

investors, that is only lightly regulated and therefore can

pursue

more speculative policies than mutual funds

Pension Fund

Fund set up by an employer to provide for employees’

retirement

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2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Intermediaries and Investors2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

Intermediaries

InvestorsDepositors

Policyholders

Investors

ObligationsFunds

Company

IntermediariesBanks

Insurance Companies

Brokerage Firms

ObligationsFunds

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FINANCIAL MARKETS AND INSTITUTIONS

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Financial Institutions Commercial Banks

Intermediate from savings to investments

Checking services

Money transfers etc.

Investment Banks

Help raising capital by selling stocks/bonds in fin markets

Provide advice on mergers and acquisitions of companies

Insurance Companies

Protect individuals/corporations

Invest in corporation securities

2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Flow of Funds Banks

Insurance companies

2.2•The Flow of Savings to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Functions of Financial Markets and Intermediaries

1. Transport cash across time

Savers transport purchasing power from current period to

future

Borrowers transport funds from future to current period

2. Risk transfer and diversification

Reduction and reallocation of risk

Risk may be hedged via futures, options, and swap contracts

Pure insurance benefit, i.e. against casualty risks

Advantage of holding assets in portfolio: diversification

benefit

2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Functions of Financial Markets and Intermediaries

1. Transport cash across time

Savers transport purchasing power from current period to

future

Borrowers transport funds from future to current period

2. Risk transfer and diversification

Reduction and reallocation of risk

Risk may be hedged via futures, options, and swap contracts

Pure insurance benefit, i.e. against casualty risks

Advantage of holding assets in portfolio: diversification

benefit

2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Functions of Financial Markets and Intermediaries

3. Liquidity

Liquidity: the ability to get cash, is a function of time and

transaction cost

Some liquidity channels: commercial paper, bank CD, or line

of credit

4. Payment mechanism

The efficiency of payment mechanism

Send/receive payments readily

5. Provide information on

Security Prices , Commodity Prices , Interest Rates ,

Company Value, Cost of Capital

Information to financial markets

Information to managers

2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Value Maximization2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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FINANCIAL MARKETS AND INSTITUTIONS

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The Opportunity Cost of Capital2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

Minimum acceptable rate of return

Set by rates of return on investment opportunities in financial

markets

Investment projects with rate of returns > opp. cost of capital

Investment projects with rate of returns < opp. cost of capital

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FINANCIAL MARKETS AND INSTITUTIONS

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Assignments

1. Read Chapter 3

2. Problems (Chapter 2 – Brealy, Myers, and Marcus 6th Edition)

4 , 7 , 9 ,12 , 15 , 17 , 20 , 22

Note: The slides are based on Brealy, Myers, and Marcus 6th Edition

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2.2•The Flow of Savings

to Corporations

2.3•Functions of Financial Markets and Intermediaries

2.4•Value Maximization and the Cost of Capital

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