1. Chapter 14 - Raising Capital in the Financial Markets

2. Q: What are SECURITIES? A: Financial Assets that Investors purchase hoping to earn a high rate of return.

3. Types of Securities  Treasury Bills and Treasury Bonds  Municipal Bonds  Corporate Bonds  Preferred Stocks  Common Stocks Which of these are RISKY? Which promise HIGH RETURNS? Is there a relationship between RISK and RETURN?

4. Corporate Financing Sources From 1999 through 2001, capital has been raised through the following sources:  Corporate Bonds and Notes76.9%  Equities23.1%

5. Movement of Savings  Direct Transfer of Funds cash securities saver firm

6. Movement of Savings  Indirect Transfer using Investment Banker securities fundsfunds securities saver investment banker firm

7. Movement of Savings  Indirect Transfer using a Financial Intermediary funds intermediarysecurities funds firmsecurities financial intermediary firm saver

8. Financial Market Components Public Offering  Firm issues securities, which are made available to both individual and institutional investors. Private Placement  Securities are offered and sold to a limited number of investors.

9. Financial Market Components Primary Market  Market in which new issues of a security are sold to initial buyers. Secondary Market  Market in which previously issued securities are traded.

10. Financial Market Components Money Market  Market for short-term debt instruments (maturity periods of one year or less). Capital Market  Market for long-term securities (maturity greater than one year).

11. Financial Market Components Organized Exchanges  Buyers and sellers meet in one central location to conduct trades. Over-the-Counter (OTC)  Securities dealers operate at many different locations across the country.  Connected by Nasdaq system (National Association of Securities Dealers Automated Quotation system).

12. Investment Banking How do investment bankers help firms issue securities?  Underwriting the issue.  Distributing the issue.  Advising the firm.

13. Distribution Methods Negotiated Purchase  Issuing firm selects an investment banker to underwrite the issue.  The firm and the investment banker negotiate the terms of the offer. Competitive Bid  Several investment bankers bid for the right to underwrite the firm’s issue.  The firm selects the banker offering the highest price.

14. Distribution Methods Best Efforts  Issue is not underwritten.  Investment bank attempts to sell the issue for a commission. Privileged Subscription  Investment banker helps market the new issue to a select group of investors.  Usually targeted to current stockholders, employees, or customers.

15. Distribution Methods Direct Sale  Issuing firm sells the securities directly to the investing public.  No investment banker is involved.

16. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.  What type of issue is this?  It’s a negotiated purchase.

17. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.  How many shares will be sold?  $100,000,000 / $20 = 5 million new shares of common stock.

18. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.  What are the flotation costs?  Underwriting spread: 2% of $100 million = $2 million.  Issuing costs: printing and engraving costs; legal, accounting, and trustee fees.

19. Stock Issue Example: Our firm needs to raise approximately $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwriting spread.  What are the risks?  The investment bank accepts the risk of being able to sell the new stock issue for $20 per share. If the stock price falls, the investment bank could lose money.

20. Regulations: The Primary Market The Securities Act of 1933  Firms register with the Securities Exchange Commission (SEC).  SEC has 20 days to review.  SEC may ask for more information.  The firm cannot solicit buyers during the review period but can advertise.

21. Regulations: The Secondary Market The Securities Exchange Act of 1934  Exchanges must register with SEC.  Company information must be available to the public.  Insider trading is regulated.