Module 4 The Financial Market Environment PDF

 MODULE 3: The Financial Market Environment Learning Objectives 1. Explain the role that financial institutions play in managerial finance. 2. Describe the role that financial markets play in managerial finance. 3. Describe the differences between the capital markets and the money...

 MODULE 3: The Financial Market Environment Learning Objectives 1. Explain the role that financial institutions play in managerial finance. 2. Describe the role that financial markets play in managerial finance. 3. Describe the differences between the capital markets and the money markets. 4. Demonstrate the major regulations and regulatory bodies that affect financial institutions and markets. 5. Describe the process of issuing common stock, including venture capital, going public, and the role of the investment bank. 6. Explain what is meant by financial markets in crisis and describe some of the root causes of the great recession I. Financial Institutions and Markets Three Ways to Obtain Funds 1. financial institutions 2. financial markets 3. private placements 1. Financial Institutions - serve as intermediaries by channeling the savings of individuals, businesses, and governments into loans or investments - directly or indirectly pay savers interest on deposited funds - provide services for a fee (for example, checking accounts for which customers pay service charges) 1. Financial Institutions - some accept customers’ savings deposits and lend this money to other customers or to firms - others invest customers’ savings in earning assets such as real estate or stocks and bonds, and some do both - required by the government to operate within established regulatory guidelines. 1.1 Key Customers of Financial Institutions 1.individuals (net suppliers) - supply funds (savings) and also demands funds (loans) - save more money than they borrow 1.business firms (net demanders) - deposits some of their funds - they borrow more money than they save 1.1 Key Customers of Financial Institutions 3. governments (net demander) - maintain deposits of temporary idle funds - tax payments - do not borrow funds directly from financial institutions - sells debt securities to various institutions - borrows more than it saves 1.2 Major Financial Institutions Commercial Banks - they provide savers with a secure place to invest funds and they offer both individuals and companies loans to finance investments. U.S. - JP Morgan Chase, Wells Fargo, Bank of America Corp., Citigroup Inc. PH - Bank of Commerce, BDO Private Bank, Inc., Robinsons Bank Corporation, Maybank Philippines, Incorporated Glass-Steagall Act - an act of Congress in 1933 that created the federal deposit insurance program and separated the activities of commercial and investment banks. 1.2 Major Financial Institutions Investment Banks - are institutions that (1) assist companies in raising capital, (2) advise firms on major transactions such as mergers or financial restructurings, and (3) engage in trading and market making activities. example: U.S. - JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup, Bank of America, Credit Suisse, and Deutsche Bank Reference: Investopedia Investment Banks PH - BDO Capital and Investment Corp. (BDO Capital), SB Capital Investment Corporation, BPI Capital Corp. 1.2 Major Financial Institutions Shadow banking systems - a group of institutions that engage in lending activities, much like traditional banks, but do not accept deposits and therefore are not subject to the same regulations as traditional banks. hedge funds mutual funds special purpose entities structured investment vehicles 2. Financial Markets - are forums in which suppliers of funds and demanders of funds can transact business directly. - loans made by financial institutions are granted without the direct knowledge of the suppliers of funds (savers) - suppliers in the financial markets know where their funds are being lent or invested 2.1 How firms raise money? private placement - involves the sale of a new security directly to an investor or group of investors, such as an insurance company or pension fund. public offering - the sale of either bonds or stocks to the general public, mostly used by firms. 2.2 Primary & Secondary market, what’s the difference? primary market - financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction. secondary market - financial market in which preowned securities (those that are not new issues) are traded. 3. The Relationship Between Institutions and Markets Two Key Financial Markets money market capital market - a financial - a market that relationship created enables suppliers between suppliers and demanders of and demanders of long-term funds to short-term funds. make transactions. 4. Money Market marketable securities - are short-term debt instruments such as U.S. Treasury bills, commercial paper, and negotiable certificates of deposit issued by government, business, and financial institutions, respectively. - least risky investments, preferred by investors 4. Money Market (continued) Eurocurrency market - international equivalent of the domestic money market. - Eurocurrency deposits arise when a corporation or individual makes a bank deposit in a currency other than the local currency of the country where the bank is located 5. Capital Market - is a market that enables suppliers and demanders of long-term funds to make transactions. - included are securities issues of business and government - its backbone is formed by the broker and dealer markets that provide a forum for bond and stock transactions - international capital markets also exist 5.1 Key Securities Traded: Bonds and Stocks The key capital market securities are bonds (long-term debt) common stock and preferred stock (equity, or ownership). 5.1 Key Securities Traded: Bonds and Stocks bond (continued) - long-term debt instrument used by business and government to raise large sums of money, generally from a diverse group of lenders. - corporate bonds typically pay interest semiannually (every 6 months) at a stated coupon interest rate. - initial maturity of from 10 to 30 years - par or face, value of $l,000 that must be repaid at maturity. 5.1 Key Securities Traded: Bonds and Stocks (continued) 5.1 Key Securities Traded: Bonds and Stocks (continued) common stock preferred stock - are units of - a special form of ownership, or ownership having a fixed equity, in a periodic dividend that corporation must be paid prior to - common payment of any dividends stockholders earn a to common stockholders. return by receiving - has features of both a dividends or; bond and common stock - by realizing 5.2 Broker Markets and Dealer Markets (continued) broker market - the securities exchanges on which the two sides of a transaction, the buyer and seller, are brought together to trade securities. Party A sells his or her securities directly to the buyer, Party B. In a sense, with the help of a broker, the securities effectively change hands, perhaps literally on the floor of the exchange. securities exchanges - organizations that provide the marketplace in which firms can raise funds through the sale of new securities and purchasers can resell securities. 5.2 Broker Markets and Dealer Markets (continued) dealer market - the market in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that “make markets” in the given security. Two separate trades are made: Party A sells his or her securities (in, say, Dell) to a dealer, and Party B buys his or her securities (in Dell) from another, or possibly even the same, dealer. Primary market is a dealer market all new issues are sold to the investing public by securities dealers, acting on behalf of the investment banker. 5.2 Broker Markets and Dealer Markets (continued) market makers - securities dealers who “make markets” by offering to buy or sell certain securities at stated prices. ○ Nasdaq market - an all-electronic trading platform used to execute securities trades. (NASDAQ National Association of Securities Dealers Automated Quotation System) ○ over-the-counter (OTC) market - where smaller, unlisted securities are traded. bid price - the highest price offered to purchase a security. 5.3 International Capital Markets Eurobond market - the market in which corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States. ○ issuing firms and governments can tap a much larger pool of investors ○ refers only to the fact the bond is issued outside of the borders of the currency's home country; it doesn't mean the bond was issued in Europe. 5.3 International Capital Markets (continued) foreign bond - a bond that is issued by a foreign corporation or government and is denominated in the investor’s home currency and sold in the investor’s home market. ○ risks the impact of two interest rates, currency exchange rates international equity market - a market that allows corporations to sell blocks of shares to investors in a number of different countries simultaneously. 5.4. The Role of Capital Market to be a liquid market where firms can interact with investors to obtain valuable external financing resources. to be an efficient market - that establishes correct prices for the securities that firms sell and allocates funds to their most productive uses. securities are actively traded in broker or dealer markets, where intense competition among investors determines the prices of securities 5.4. The Role of Capital Market (continued) The price of an individual security is determined by the interaction between buyers and sellers in the market. If the market is efficient, the price of a stock is an unbiased estimate of its true value. Investors compete with one another for information about a stock’s true value, so at any given time, a stock’s price reflects all the information that is known about the stock. Changes in the price reflect new information that 5.4. The Role of Capital Market (continued) For example, suppose that a certain stock currently trades at $40 per share. If this company announces that sales of a new product have been higher than expected, and if investors have not already anticipated that announcement, investors will raise their estimate of what the stock is truly worth. At $40, the stock is a relative bargain, so there will temporarily be more buyers than sellers wanting to trade the stock, and its price will have to rise to restore equilibrium in the market. 6. The Financial Crisis What causes financial crisis? if institutions or assets are overvalued and can be exacerbated by irrational systemic failures unanticipated or uncontrollable human behavior, incentives to take too much risk regulatory absence or failures source: https://www.investopedia.com/terms/f/financial-crisis.asp 6.1 Financial institutions and Real Estate Finance securitization - the process of pooling mortgages or other types of loans and then selling claims or securities against that pool in the secondary market. ○ mortgage-backed securities - securities that represent claims on the cash flows generated by a pool of mortgages. - can be purchased by individual investors, pension funds, mutual funds, or virtually any other investor. 6.2 Falling Home Prices and Delinquent Mortgages 6.2 Falling Home Prices and Delinquent Mortgages Subprime mortgages are mortgage loans made to borrowers with lower incomes and poorer credit histories as compared to “prime” borrowers. often have adjustable, rather than fixed, interest rates, which makes subprime borrowers particularly vulnerable if interest rates rise. Many of these borrowers (and lenders) assumed that rising home prices would allow borrowers to refinance their loans if they had difficulties making payments The Financial Market Environment End of Module 3