Financial Markets 2 CHAPTER 2 Copyright © 1999 Addison Wesley Longman

2 Chapter 2: Financial Markets Objectives 1.Markets establish security prices 2.Markets increase liquidity 3.The Structure of Markets 4.The Money Markets 5.The Capital Markets

Copyright © 1999 Addison Wesley Longman 3 Chapter 2: Financial Markets Financial Markets Establish Prices by: 1.High Volume 2.Standardized Securities 3.Concentration of Traders

Copyright © 1999 Addison Wesley Longman 4 Chapter 2: Financial Markets The Markets Minimize Transaction Costs By: 1.High volume markets 2.Rules 3.Standardization 4.Lowered search costs

Copyright © 1999 Addison Wesley Longman 5 Chapter 2: Financial Markets Organization of the Markets 1.Primary vs. Secondary 2.Money Markets vs. Capital Markets 3.Organized vs. Over-the-Counter

Copyright © 1999 Addison Wesley Longman 6 Chapter 2: Financial Markets Primary vs. Secondary  Primary New Securities Initial Public Offerings (IPO’s) Seasoned Equity Offerings (SEOs)  Secondary Used Securities Traded on an exchange

Copyright © 1999 Addison Wesley Longman 7 Chapter 2: Financial Markets Listing Requirements of NYSE Profits > $2.5 million Assets > $40 million Stock Valued at > $9 million > 1,100,000 Shares outstanding > 2,000 Stockholders

Copyright © 1999 Addison Wesley Longman 8 Chapter 2: Financial Markets Stock Specialists and Dealers  Help the market establish prices by adjusting bid / ask prices to maintain constant inventory

Copyright © 1999 Addison Wesley Longman 9 Chapter 2: Financial Markets Money Markets  For securities with an original maturity of less than one year  Where liquidity is bought and sold

Copyright © 1999 Addison Wesley Longman 10 Chapter 2: Financial Markets Users of the Money Markets  U.S. Treasury  Federal Reserve  Banks  Money Market Mutual Funds

Copyright © 1999 Addison Wesley Longman 11 Chapter 2: Financial Markets Money Market Instruments  Treasury Bills  Fed Funds  Repurchase agreements  NCO  Commercial paper  Bankers’ acceptance

Copyright © 1999 Addison Wesley Longman 12 Chapter 2: Financial Markets FIGURE 2.1 Average Money Market Fund Investment Portfolio

Copyright © 1999 Addison Wesley Longman 13 Chapter 2: Financial Markets Money Market Rates The Wall Street Journal publishes daily a list of interest rates on many different financial instruments in its “Money Rates” column. (See “Today’s Contents” on page 1 of the Journal for the location.)

Copyright © 1999 Addison Wesley Longman 14 Chapter 2: Financial Markets  Prime rate: The base interest rate on corporate bank loans, an indicator of the cost of business borrowing from banks. The four interest rates in the “Money Rates” column that are discussed most often in the media are these:

Copyright © 1999 Addison Wesley Longman 15 Chapter 2: Financial Markets  Federal funds rate: the interest rate charged on overnight loans in the federal funds market, a sensitive indicator of the cost to banks of borrowing funds from other banks and the stance of monetary policy.

Copyright © 1999 Addison Wesley Longman 16 Chapter 2: Financial Markets  Treasury bill rate: The interest rate on U.S. Treasury bills, an indicator of general interest-rate movements.  Federal Home Loan Mortgage Corporation rates: Interest rates on “Freddie Mac” guaranteed mortgages, an indicator of the cost of finacing residential housing purchases.

Copyright © 1999 Addison Wesley Longman 17 Chapter 2: Financial Markets FIGURE 2.4 Interest Rates on Money Market Securities

Copyright © 1999 Addison Wesley Longman 18 Chapter 2: Financial Markets Capital Markets  For securities with an original maturity greater than one year  Market for future growth and development

Copyright © 1999 Addison Wesley Longman 19 Chapter 2: Financial Markets Capital Market Instruments  U.S. Treasury Notes and Bonds  Stocks  Bonds  Mortgages

Copyright © 1999 Addison Wesley Longman 20 Chapter 2: Financial Markets FIGURE 2.5 Sohio/BP Corporate Bond

Copyright © 1999 Addison Wesley Longman 21 Chapter 2: Financial Markets FIGURE 2.6 Total Bonds Issued per Year

Copyright © 1999 Addison Wesley Longman 22 Chapter 2: Financial Markets Types of Bonds  Mortgage  Debentures  Variable Rate  Government Vs. Corporate

Copyright © 1999 Addison Wesley Longman 23 Chapter 2: Financial Markets Bond Features  Sinking funds  Covenants  Call provision  Conversion

Copyright © 1999 Addison Wesley Longman 24 Chapter 2: Financial Markets FIGURE 2.7 Interest Rates on Corporate Bonds

Copyright © 1999 Addison Wesley Longman 25 Chapter 2: Financial Markets FIGURE 2.8 Wien Consolidated Airlines Stock. Stock Represents Ownership

Copyright © 1999 Addison Wesley Longman 26 Chapter 2: Financial Markets FIGURE 2.9 Proportion of Preferred to Common Stock

Copyright © 1999 Addison Wesley Longman 27 Chapter 2: Financial Markets FIGURE 2.10 Stock Market Indexes

Copyright © 1999 Addison Wesley Longman 28 Chapter 2: Financial Markets Dow Jones Industrial Average  An index that shows the performance of 30 large industrial firms.

Copyright © 1999 Addison Wesley Longman 29 Chapter 2: Financial Markets Table 2.2The Thirty Firms That Make Up the Dow Jones Industrial Average 1.AlliedSignal Inc. 9.DuPont Co. 2.Aluminum Co. of America 10.Eastman Kodak Co. 3.American Express Co. 11.Exxon Corp. 4.AT&T 12.General Electric Co. 5.Boeing Co. 13.General Motors Corp. 6.Caterpillar Inc. 14.Goodyear Tire & Rubber Co. 7.Chevron Corp. 15.Hewlett-Packard 8.Coca-Cola Co.

Copyright © 1999 Addison Wesley Longman 30 Chapter 2: Financial Markets Table 2.2 continued 16.IBM Co. 24.Procter & Gamble Co. 17.International Paper Co. 25.Sears, Roebuck & Co. 18.J.P. Morgan & Co. 26.Travelers Group 19.Johnson and Johnson 27.Union Carbide Corp. 20.McDonald’s Corp. 28.United Technologies Corp. 21.Merck & Co. 29.Wal-Mart 22.Minnesota Mining & 30.Walt Disney Co. Manufacturing Co. 23.Philip Morris Co.

Copyright © 1999 Addison Wesley Longman 31 Chapter 2: Financial Markets Stock Prices Stock prices are published daily, and in the Wall Street Journal they are reported in the sections “NYSE— Composite Transactions,” “Amex—Composite Transactions,” and “ Over-the-counter Markets.”

Copyright © 1999 Addison Wesley Longman 32 Chapter 2: Financial Markets The New York Stock Exchange (NYSE) and American Stock Exchange (Amex) stock prices are quoted in the following format: 52 weeksYld VolNet Hi LoStock SymDiv%PE 100s Hi Lo CloseChg 3124 InAltumIAL / /8 - 1/ /8 89 1/8 IBMIBM / / /4 + 7/8 27 1/2 25 1/2 IBM dep pf … /8 26 3/8 26 5/8 + 1/4 19 1/8 12 7/8 InFam Entn B FAM … / /8 4 1/4 3 3/8 IntFinBear wt …… /2 3 1/4 3 1/2 … Source: Wall Street Journal, January 30, 1997, p. C5.

Copyright © 1999 Addison Wesley Longman 33 Chapter 2: Financial Markets Price quoted for shares traded over-the-counter (through dealers rather than on an exchange) are sometimes quoted with the same information, but in many cases only the bid and ask price are quoted Over the Counter Stock Quotes

Copyright © 1999 Addison Wesley Longman 34 Chapter 2: Financial Markets Bid The best price the dealer is willing to pay for the stock AskThe best price the dealer is willing to sell the stock for Over the Counter Stock Quotes