in the Financial Markets
This chapter considers the market environment in which long-term capital is raised. The underlying rationale for the existence of security markets is presented, investment banking services and procedures are detailed, private placements are discussed, and security market regulation is reviewed.
The mix of corporate securities sold in the capital market. A.
When corporations raise cash in the capital market, what type of financing vehicle is most favored? The answer to this question is corporate bonds. The corporate debt markets clearly dominate the corporate equity markets when new (external) funds are being raised. B.
From our discussion on the cost of capital, we understand that the U.S. tax system inherently favors debt as a means of raising capital. During the 1999-2001 period, bonds and notes accounted for about 76.9 percent of new corporate securities sold for cash. II.
Why financial markets exist
Financial markets consist of institutions and procedures that facilitate transactions in all types of financial claims. B.
Some economic units spend more than they earn during a given period of time. Some economic units spend less than they earn. Accordingly, a mechanism is needed to facilitate the transfer of savings from those economic units that have a savings surplus to those that have a savings deficit. Financial markets provide such a mechanism. C.
The function of financial markets then is to allocate savings in an economy to the ultimate demander (user) of the savings. D.
If there were no financial markets, the wealth of an economy would be lessened. Savings could not be transferred to economic units, such as business firms, which are most in need of those funds. III.
Financing business: The movement of funds through the economy. A.
In a normal year the household sector is the largest net supplier of funds to the financial markets. We call the household sector then a savings-surplus sector. 1.
The household sector can also be a savings-deficit sector. 2.
From 1995 – 1999, the household sector was a net user of financial capital as a result of taking advantage of low interest rate mortgages. B.
In contrast, the nonfinancial business sector is typically a savings-deficit sector. 1.
The nonfinancial business sector can also be a savings-surplus sector. 2.
Economic conditions and corporate profitability influence the ability of this sector to provide funds to the financial market. C.
In recent years, the foreign sector has become a major savings-surplus sector. D.
Within the domestic economy, the nonfinancial business sector is dependent on the household sector to finance its investment needs. E.
The movement of savings through the economy occurs in three distinct ways: 1.
The direct transfer of funds
Indirect transfer using the investment banker
Indirect transfer using the financial intermediary
Components of the U.S. financial market system
Public offerings can be distinguished from private placements. 1.
The public (financial) market is an impersonal market in which both individual and institutional investors have the opportunity to acquire securities. a.
A public offering takes place in the public market.
The security-issuing firm does not meet (face-to-face) the actual investors in the securities. 2.
In a private placement of securities, only a limited number of investors have the opportunity to purchase a portion of the issue. a.
The market for private placements is more personal than its public counterpart. b.
The specific details of the issue may actually be developed on a face-to-face basis among the potential investors and the issuer.
Start-up firms often turn to venture capitalists to raise funds. (a)
Broader public markets find these firms too risky.
Venture capitalists are willing to accept the risks because of an expectation of higher returns....
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