RECAP LECTURE 6

RECAP LECTURE 6 WHAT IS CAPITAL MARKET? WHAT IS PRIMARY MARKET? WHAT IS SECONDARY MARKET?

RECAP LECTURE 6 WHAT IS WNDERWRITER? WHAT IS IPO’s?

RECAP LECTURE 6 DEALERS AND BROKERS? OVER THE COUNTER MARKET? ROLE OF STOCK EXCHANGE AND SECP?

CAPITAL STRUCTURE CAPITAL STRUCTURE IS THE COMPOSITION OF DEBT AND EQUITY SECURITIES THAT COMPRISE A FIRM’S FINANCING OF ITS ASSETS. BOTH DEBT AND EQUITY SECURITIES ARE USED IN MOST LARGE CORPORATIONS.

CAPITAL STRUCTURE THE CHOICE OF THE AMOUNT OF DEBT AND EQUITY IS MADE AFTER A COMPARISION OF CERTAIN CHARACTERISTICS OF EACH KIND OF SECURITY, OF INTERNAL FACTORS RELATED TO THE FIRM’S OPERATIONS, AND OF EXTERNAL FACTORS THAT CAN AFFECT THE FIRM

CAPITAL STRUCTURE SECURITYCHARACTERISTICS THAT AFFECT SECURITY CHARACTERISTICS THAT AFFECT THE FIRM’S CAPITAL STRUCTURE FALL UNDER 4 CLASSIFICATION

CAPITAL STRUCTURE OWNERSHIP RIGHTS REPAYMENT REQUIREMENTS CLAIM ON ASSETS CLAIM ON PROFITS

CAPITAL STRUCTURE OWNERSHIP RIGHTS THE ISSUANCE OF NEW SECURITIES INVOLVES THE QUESTION OF EXTENDING THE OWNERSHIP RIGHTS TO THE NEW SECURITY HOLDERS CREDITORS EXERCISE NO OWNERSHIP CONTROL DURING ROUTINE PERIODS OF OPERATION

CAPITAL STRUCTURE OWNERSHIP RIGHTS IN SOME CASES, THE DEBT AGREEMENT MIGHT PLACE RESTRICTIONS ON MANAGEMENT ACTIVITIES, SUCH AS PROHIBITION OF PAYING DIVIDENDS THE HOLDERS OF PREFERRED STOCK MAY OR MAY NOT HAVE ANY OWNERSHIP RIGHTS, DEPENDING ON WHETHER THE STOCK IS VOTING OR NON VOTING

CAPITAL STRUCTURE REPAYMENT REQUIREMENTS DEBT MATURES AND MUST BE REPAID ACCORDING THE CONDITIONS IN THE BOND INDENTURE OR OTHER AGREEMENT PREFERRED STOCK ORDINARILY HAS NO MATURITY DATE COMMON STOCK INVOLVES NO REPAYMENT REQUIREMENTS

CAPITAL STRUCTURE CLAIMS ON ASSETS THE BONDHOLDERS HAVE THE FIRST CLAIM ON ASSETS IN THE EVENT OF LIQUIDATION, THE PREFERRED SHAREHOLDERS THE NEXT CLAIM AND THE COMMON SHAREHOLDERS THE RESIDUAL CLAIM

CAPITAL STRUCTURE CLAIMS ON PROFITS INTEREST MUST BE PAID ON BONDS REGARDLESS OF THE LEVEL OF PROFITS. ALTHOUGH BONDHOLDERS HAVE NO RIGHT TO SHARE IN PROFITS, THEY HAVE A LEGALLY ENFORCEABLE RIGHT TO THE PAYMENT OF THE STIPULATED INTEREST

CAPITAL STRUCTURE CLAIMS ON PROFITS THE PREFERRED SHAREHOLDERS HAVE THE FIRST RIGHT TO SHARE IN THE PROFITS BUT ONLY UP TO A SPECIFIED LIMIT THE COMMON SHAREHOLDERS HAVE THE ABSOLUTE RIGHT TO SHARE IN THE PROFITS OF THE FIRM IF THE FIRM WANTS TO RESTRICT THE RIGHT OF NEW INVESTORS TO SHARE IN THE FIRM’S PROFITS, DEBT OR PREFERRED STOCK IS DESIRABLE

CAPITAL STRUCTURE INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE MATCHING FLUCTUATING NEEDS AGAINST SHORT-TERM SOURCES DEGREE OF RISK INCREASING OWNER’S PROFITS SURRENDERING OPERATIONAL CONTROL FUTURE FLEXIBILITY

CAPITAL STRUCTURE INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 1. MATCHING FLUCTUATING NEEDS AGAINST SHORT-TERM SOURCES: A FIRM MAY HAVE A BUSY SEASON JUST BEFORE EID AND MAY NEED EXTRA MONEY DURING THAT PERIOD. SINCE THE NEED IS ONLY FOR THAT PERIOD, IT WOULD BE EXPENSIVE TO USE LONG-TERM FINANCING THAT REQUIRES INTEREST OR DIVIDEND ON AN ANNUAL BASIS.

CAPITAL STRUCTURE INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE MATCHING FLUCTUATING NEEDS AGAINST SHORT-TERM SOURCES: FOR FLUCTUATING NEEDS, THE FIRM WOULD PROBABLY REJECT DEBT AND EQUITY SECURITIES AND PREFER A SHORT-TERM LOAN FROM A BANK

CAPITAL STRUCTURE 2. DEGREE OF RISK INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 2. DEGREE OF RISK THE MORE DEBT A FIRM HAS, THE LARGER THE INTEREST PAYMENTS AND THE GREATER THE CHANCE OF INABILITY TO MAKE THE PAYMENTS, WITH CONSEQUENT BANKRUPTCY EQUITY SECURITIES NEED NOT TO BE REPAID AND DIVIDENDS NEED NOT BE DECLARED. THUS, EQUITY SECURITIES REDUCE RISK, DEBT SECURITIES INCREASES RISK

CAPITAL STRUCTURE 3. INCREASING OWNER’S PROFITS INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 3. INCREASING OWNER’S PROFITS IF THE FIRM CAN BORROW AT 11% AND EARN 16% WITH THE MONEY, ALL PROFITS ABOVE THE 11% INTEREST WILL BE DISTRIBUTED TO THE OWNERS (AFTER TAXES ARE PAID). THE ABILITY TO INCREASE THE OWNER’S RETURN WITHOUT INCREASING THEIR INVESTMENT IS AN ARGUMENT FOR DEBT FINANCING.

CAPITAL STRUCTURE INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 4. SURRENDERING OPERATIONAL CONTROL IN SOME CASES A FIRM IS UNABLE TO SELL BONDS WITHOUT AGREEING TO ALLOW THE BONDHOLDERS TO EXERCISE CERTAIN OPERATIONAL CONTROLS, SUCH AS SELECTING A MEMBER OF THE BOARD OF DIRECTORS IF INTEREST PAYMENTS ARE NOT MADE ON TIME AT THE SAME TIME, THE SALE OF COMMON STOCK BRINGS NEW VOTING INVESTORS INTO THE FIRM AND DILUTES THE CONTROL OF THE EXISTING SHAREHOLDERS

CAPITAL STRUCTURE INTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 5. FUTURE FLEXIBILITY A FIRM IS EXPECTED TO MAINTAIN A BALANCED MIXTURE OF DEBT AND EQUITY SECURITIES. EXCESSIVE DEBT REDUCES THE FIRM’S ABILITY TO BORROW AND HENCE REDUCE FLEXIBILITY. THE NEED TO MAINTAIN A BALANCE TO ENSURE FLEXIBILITY OF FINANCING ALTERNATIVES AFFECTS THE CAPITAL STRUCTURE

CAPITAL STRUCTURE GENERAL LEVEL OF BUSINESS ACTIVITY EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE GENERAL LEVEL OF BUSINESS ACTIVITY LEVEL OF INTEREST RATES LEVEL OF STOCK PRICES AVAILABILITY OF FUNDS IN THE MARKETS TAX POLICY ON INTEREST AND DIVIDENDS

CAPITAL STRUCTURE GENERAL LEVEL OF BUSINESS ACTIVITY EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE GENERAL LEVEL OF BUSINESS ACTIVITY IF THE OVERALL LEVEL OF BUSINESS ACTIVITY IS RISING, MOST FIRMS NEED MONEY TO EXPAND THEIR OPERATIONS. THE NEED FOR ADDITIONAL LONG-TERM FUNDS BRINGS A FIRM TO THE MONEY MARKETS FOR EITHER DEBT OR EQUITY FUNDS.

CAPITAL STRUCTURE 2. LEVEL OF INTEREST RATES EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 2. LEVEL OF INTEREST RATES INTERESTS RATES ON BONDS FLUCTUATE IN THE MARKET IN RESPONSE TO SUPPLY AND DEMAND FACTORS. IF INTEREST RATES BECOME EXCESSIVE, FIRMS DELAY DEBT FINANCING, SWITCH TO SHORTTERM FINANCING UNTIL LONG-TERM DEBT CAN BE OFFERED AT LOWER RATES OR SWITCH TO EQUITY SECURITIES

CAPITAL STRUCTURE 3. LEVEL OF STOCK PRICES EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 3. LEVEL OF STOCK PRICES WHEN FIRMS ISSUE NEW COMMON STOCK, THEY HOPE TO RECEIVE AS MUCH MONEY AS POSSIBLE FROM EACH SHARE. WHEN STOCK PRICES ARE HIGH, THE FIRM CAN RAISE RELATIVELY LARGE AMOUNTS OF MONEY BY ISSUING RELATIVELY FEW SHARES

CAPITAL STRUCTURE 4. AVAILABILITY OF FUNDS IN THE MARKETS EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 4. AVAILABILITY OF FUNDS IN THE MARKETS MONEY AND CAPITAL MARKETS IN THE USA ARE A CONSTANTLY CHANGING, COMPLEX PHENOMENON. AT TIMES MONEY IS PLENTIFUL AND ANY REASONABLE PRICED DEBT OR EQUITY OFFERING CAN BE SOLD. AT OTHER TIMES, MONEY IS SCARCE AND OFFERING FAIL TO SELL OUT. THE AVAIABILITY OF FUNDS AFFECT THE FIRM’S ABILITY TO OFFER DEBT AND EQUITY SECURITIES

CAPITAL STRUCTURE 5. TAX POLICY ON INTEREST AND DIVIDENDS EXTERNAL FACTORS THAT AFFECT CAPITAL STRUCTURE 5. TAX POLICY ON INTEREST AND DIVIDENDS AT PRESENT, INTEREST IS PAID ON DEBT PRIOR TO THE CALCULATION OF THE CORPORATE INCOME TAX. DIVIDENDS ARE DECLARED AFTER THE TAX CALCULATION. THIS TAX POLICY MAKES THE PAYMENT OF DIVIDENDS MORE COSTLY THAN THE PAYMENT OF INTEREST AND HAS SEVERELY REDUCED THE NUMBERS OF ISSUES OF PREFERRED STOCK IN RECENT YEARS