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An Overview of the Financial System Chapter 2 By: Juliya Andrushchak and Ronald Huang.

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Presentation on theme: "An Overview of the Financial System Chapter 2 By: Juliya Andrushchak and Ronald Huang."— Presentation transcript:

1 An Overview of the Financial System Chapter 2 By: Juliya Andrushchak and Ronald Huang

2 Web Exercises 1.

3 Web Exercise 2. a). Dow will increase value from 13,074 to 13,187 in three months b). 0.8643% increase

4 AT&T Brief History

5 AT&T Timeline – 1876 to 2001 AT&T issues its stockMcCaw acquired $35.5 Bill invested inSpinoff the wireless in an IPO(AT&T Wireless) acquisitions & upgradesunit 1876 - Founded19841994 1996-20002001 187719911995 2000 Bell formed and stockAT&T acquires NCR Restructuring - Splitoff Issued a tracking stock issued to 7 shareholders Lucent for AT&T Wireless NCR AT&T Debt - bank loan orAT&T - shares sold onNeed more funds Corporate (convertible)No cash generated, private borrowingNYSE and Munich($11.5 billion) bond, foreign bonddivestiture IPO - Bell financedBorrow funds andDivestiture Receive cash, tax free, through equityacquire new assetsIssue different shares new share class ( $7.3 billion)

6 Debt – finance the using a bank loan (indirect finance) or borrow privately (direct finance) A. Graham was the borrower-spender Equity – seven original shareholders held the stock after the IPO. Deal details worked out with a broker (no underwriting in this case)

7 Post-Divestiture Events AT&T issues its own stock on the primary market. Shares are traded on NYSE and Munich exchanges. The new company is valued at $34 bill from the total of $149.5 bill. Shares traded on the secondary market. Equity issued through an investment bank. Divestiture – anti-trust lawsuit; monopoly issues.

8 Classifications of Financial Markets Secondary Markets Exchanges Trades conducted in central locations (e.g., Toronto Stock Exchange and New York Stock Exchange) Over-the-Counter Markets Dealers at different locations buy and sell

9 Subsequent Restructurings NCR acquired for $7.3 bill. Finance through long-term debt (commercial paper, and convertible corporate bonds, bearer form or registered, foreign bonds) and secondary issues. Use short- and medium-term debt for cash needs, and invest excess funds in money market securities and other liquid financial instruments. Adopt a dividend policy. Investment of $35 billion made from 1996-2000 in acquisitions and upgrades – major need for financing.

10 Classifications of Financial Markets Debt Markets Short-term (maturity < 1 year) – the Money Market Long-term (maturity > 10 year) – the Capital Market Medium-term (maturity >1 and < 10 years)

11 Stock Issues and Restructurings 1995 – split off into three separate companies: NCR, AT&T, and Lucent. 2000 – issued a tracking stock to track the performance of the wireless division. Created a different stock class. 2001 – spun off AT&T Wireless to the current shareholders. Distributed as a dividend. 2005 – proposed merger with SBC.

12 Financial Market Instruments Stock- equity claims in the net income and assets of a corporation Mortgages- loans to households or firms to purchase housing, land, or other real structures, where the structure or land serves as collateral for the loans. Corporate Bonds- long term bonds issued by corporations with very strong credit ratings Gov’t of Canada Bonds- are issued by the federal government to finance its deficit. Other : Canada savings bonds Provincial and municipal bonds Government agencies securities

13 Internationalization of Financial Markets International Bond Market Foreign bonds - sold in a foreign country and denominated in that country Eurobonds – denominated in a currency other than the country in which it is sold Eurocurrencies – foreign currencies deposited in banks outside the home country

14 World Stock Markets

15 Transactions Costs Financial intermediaries make profits by reducing transactions costs. They reduce transactions costs by developing expertise and taking advantage of economies of scale. Risk Sharing Create and sell assets with low risk characteristics and then use the funds to buy assets with more risk (also called asset transformation) Lower risk by helping people to diversify portfolios

16 Asymmetric Information Adverse Selection Before transaction occurs Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected Moral Hazard After transaction occurs Hazard that borrower has incentives to engage in undesirable activities making it more likely that loan won’t be paid back

17 Financial Intermediaries

18 Size of Financial Intermediaries

19 Regulation of Financial Markets

20 Primary Reasons for Regulation 1.Increase information to investors - Decreases adverse selection and moral hazard problems - Securities commissions force corporations to disclose information 2. Ensuring the soundness of intermediaries -Prevents financial panics -Restrictions on entry/assets/activities, disclosure, deposit insurance, limits on competition

21 Financial Intermediaries: Keywords Financial Intermediaries Lower Transaction Costs Provide Liquidity Services Economies of Scale Problem of Assymetric Information Risk Sharing Asset Transformation CreditworthinessDiversification

22 Any Questions?

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