fm10e ch14

Chapter 14 - Raising Capital Chapter 14 - Raising Capital in the Financial Marketsin the Financial Markets

2005, Pearson Prentice Hall

Q: What are SECURITIES?Q: What are SECURITIES?

A:A: Financial Assets that Financial Assets that Investors purchase hoping to Investors purchase hoping to

earn a earn a high rate of return.high rate of return.

Types of SecuritiesTypes of Securities

Treasury Bills and Treasury BondsTreasury Bills and Treasury Bonds Municipal BondsMunicipal Bonds Corporate BondsCorporate Bonds Preferred StocksPreferred Stocks Common StocksCommon Stocks

Which of these are Which of these are RISKYRISKY??Which promise Which promise HIGH RETURNSHIGH RETURNS??Is there a relationship betweenIs there a relationship between RISKRISK

and and RETURNRETURN??

Corporate FinancingCorporate FinancingSourcesSources

From 1999 through 2001, capital has been From 1999 through 2001, capital has been raised through the following sources:raised through the following sources:

Corporate Bonds and NotesCorporate Bonds and Notes 76.9%76.9% EquitiesEquities 23.1%23.1%

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds

saver

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds

saver

firm

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds

cashcash

saver

firm

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds

cashcash

securitiessecurities

saver

firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

investmentbanker

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

investmentbanker firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

fundsfunds

investmentbanker firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

fundsfunds

securitiessecurities

investmentbanker firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

fundsfunds

securitiessecurities

saver

investmentbanker firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

fundsfundsfundsfunds

securitiessecurities

saver

investmentbanker firm

Movement of SavingsMovement of Savings

Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker

securitiessecurities

fundsfundsfundsfunds

securitiessecurities

saver

investmentbanker firm

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

financialintermediary

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

financialintermediary firm

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

fundsfunds

financialintermediary firm

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

fundsfunds

firmfirmsecuritiessecurities

financialintermediary firm

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

fundsfunds

firmfirmsecuritiessecurities

financialintermediary firm

saver

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

fundsfunds fundsfunds

firmfirmsecuritiessecurities

financialintermediary firm

saver

Movement of SavingsMovement of Savings Indirect Transfer using a Financial IntermediaryIndirect Transfer using a Financial Intermediary

fundsfunds

intermediaryintermediarysecuritiessecurities

fundsfunds

firmfirmsecuritiessecurities

financialintermediary firm

saver

Financial Market ComponentsFinancial Market Components

Public OfferingPublic Offering

Financial Market ComponentsFinancial Market Components

Public OfferingPublic Offering Firm issues securities, which are Firm issues securities, which are

made available to both individual made available to both individual and institutional investors.and institutional investors.

Financial Market ComponentsFinancial Market Components

Public OfferingPublic Offering Firm issues securities, which are Firm issues securities, which are

made available to both individual made available to both individual and institutional investors.and institutional investors.

Private PlacementPrivate Placement

Financial Market ComponentsFinancial Market Components

Public OfferingPublic Offering Firm issues securities, which are Firm issues securities, which are

made available to both individual made available to both individual and institutional investors.and institutional investors.

Private PlacementPrivate Placement Securities are offered and sold to a Securities are offered and sold to a

limited number of investors.limited number of investors.

Financial Market ComponentsFinancial Market Components

Primary MarketPrimary Market

Financial Market ComponentsFinancial Market Components

Primary MarketPrimary Market Market in which new issues of a Market in which new issues of a

security are sold to initial buyers.security are sold to initial buyers.

Financial Market ComponentsFinancial Market Components

Primary MarketPrimary Market Market in which new issues of a Market in which new issues of a

security are sold to initial buyers.security are sold to initial buyers.

Secondary MarketSecondary Market

Financial Market ComponentsFinancial Market Components

Primary MarketPrimary Market Market in which new issues of a Market in which new issues of a

security are sold to initial buyers.security are sold to initial buyers.

Secondary MarketSecondary Market Market in which previously issued Market in which previously issued

securities are traded.securities are traded.

Financial Market ComponentsFinancial Market Components

Money MarketMoney Market

Financial Market ComponentsFinancial Market Components

Money MarketMoney Market Market for short-term debt Market for short-term debt

instruments (maturity periods of instruments (maturity periods of one year or less).one year or less).

Financial Market ComponentsFinancial Market Components

Money MarketMoney Market Market for short-term debt Market for short-term debt

instruments (maturity periods of instruments (maturity periods of one year or less).one year or less).

Capital MarketCapital Market

Financial Market ComponentsFinancial Market Components

Money MarketMoney Market Market for short-term debt Market for short-term debt

instruments (maturity periods of instruments (maturity periods of one year or less).one year or less).

Capital MarketCapital Market Market for long-term securities Market for long-term securities

(maturity greater than one year).(maturity greater than one year).

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges Buyers and sellers meet in one central Buyers and sellers meet in one central

location to conduct trades.location to conduct trades.

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges Buyers and sellers meet in one central Buyers and sellers meet in one central

location to conduct trades.location to conduct trades.

Over-the-Counter (OTC)Over-the-Counter (OTC)

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges Buyers and sellers meet in one central Buyers and sellers meet in one central

location to conduct trades.location to conduct trades.

Over-the-Counter (OTC)Over-the-Counter (OTC) Securities dealers operate at many Securities dealers operate at many

different locations across the country.different locations across the country.

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges Buyers and sellers meet in one central Buyers and sellers meet in one central

location to conduct trades.location to conduct trades.

Over-the-Counter (OTC)Over-the-Counter (OTC) Securities dealers operate at many Securities dealers operate at many

different locations across the country.different locations across the country. Connected by Connected by NasdaqNasdaq system (National system (National

Association of Securities Dealers Association of Securities Dealers Automated Quotation system).Automated Quotation system).

Investment BankingInvestment Banking

How do investment bankers help How do investment bankers help firms issue securities?firms issue securities?

Underwriting the issue.Underwriting the issue. Distributing the issue.Distributing the issue. Advising the firm.Advising the firm.

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Issuing firm selects an investment Issuing firm selects an investment

banker to underwrite the issue.banker to underwrite the issue.

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Issuing firm selects an investment Issuing firm selects an investment

banker to underwrite the issue.banker to underwrite the issue. The firm and the investment banker The firm and the investment banker

negotiate the terms of the offer.negotiate the terms of the offer.

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Issuing firm selects an investment Issuing firm selects an investment

banker to underwrite the issue.banker to underwrite the issue. The firm and the investment banker The firm and the investment banker

negotiate the terms of the offer.negotiate the terms of the offer.

Competitive BidCompetitive Bid

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Issuing firm selects an investment Issuing firm selects an investment

banker to underwrite the issue.banker to underwrite the issue. The firm and the investment banker The firm and the investment banker

negotiate the terms of the offer.negotiate the terms of the offer.

Competitive BidCompetitive Bid Several investment bankers bid for the Several investment bankers bid for the

right to underwrite the firm’s issue.right to underwrite the firm’s issue.

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Issuing firm selects an investment Issuing firm selects an investment

banker to underwrite the issue.banker to underwrite the issue. The firm and the investment banker The firm and the investment banker

negotiate the terms of the offer.negotiate the terms of the offer.

Competitive BidCompetitive Bid Several investment bankers bid for the Several investment bankers bid for the

right to underwrite the firm’s issue.right to underwrite the firm’s issue. The firm selects the banker offering The firm selects the banker offering

the highest price. the highest price.

Distribution Methods Distribution Methods

Best EffortsBest Efforts

Distribution Methods Distribution Methods

Best EffortsBest Efforts Issue is not underwritten.Issue is not underwritten.

Distribution Methods Distribution Methods

Best EffortsBest Efforts Issue is not underwritten.Issue is not underwritten. Investment bank attempts to sell the Investment bank attempts to sell the

issue for a commission. issue for a commission.

Distribution Methods Distribution Methods

Best EffortsBest Efforts Issue is not underwritten.Issue is not underwritten. Investment bank attempts to sell the Investment bank attempts to sell the

issue for a commission. issue for a commission.

Privileged SubscriptionPrivileged Subscription

Distribution Methods Distribution Methods

Best EffortsBest Efforts Issue is not underwritten.Issue is not underwritten. Investment bank attempts to sell the Investment bank attempts to sell the

issue for a commission. issue for a commission.

Privileged SubscriptionPrivileged Subscription Investment banker helps market the Investment banker helps market the

new issue to a select group of investors.new issue to a select group of investors.

Distribution Methods Distribution Methods

Best EffortsBest Efforts Issue is not underwritten.Issue is not underwritten. Investment bank attempts to sell the Investment bank attempts to sell the

issue for a commission. issue for a commission.

Privileged SubscriptionPrivileged Subscription Investment banker helps market the Investment banker helps market the

new issue to a select group of investors.new issue to a select group of investors. Usually targeted to current Usually targeted to current

stockholders, employees, or customers.stockholders, employees, or customers.

Distribution Methods Distribution Methods

Direct SaleDirect Sale

Distribution Methods Distribution Methods

Direct SaleDirect Sale Issuing firm sells the securities directly Issuing firm sells the securities directly

to the investing public.to the investing public.

Distribution Methods Distribution Methods

Direct SaleDirect Sale Issuing firm sells the securities directly Issuing firm sells the securities directly

to the investing public.to the investing public. No investment banker is involved. No investment banker is involved.

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What type of issue is this?What type of issue is this? It’s a It’s a negotiated purchasenegotiated purchase..

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

How many shares will be sold?How many shares will be sold?

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

How many shares will be sold?How many shares will be sold? $100,000,000 / $20 = $100,000,000 / $20 = 5 million5 million new new

shares of common stock.shares of common stock.

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What are the flotation costs?What are the flotation costs?

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What are the flotation costs?What are the flotation costs? Underwriting spreadUnderwriting spread: 2% of $100 : 2% of $100

million = $2 million.million = $2 million.

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What are the flotation costs?What are the flotation costs? Underwriting spreadUnderwriting spread: 2% of $100 : 2% of $100

million = $2 million.million = $2 million. Issuing costsIssuing costs: printing and engraving : printing and engraving

costs; legal, accounting, and trustee fees.costs; legal, accounting, and trustee fees.

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What are the risks?What are the risks?

Stock Issue Example:Stock Issue Example:

Our firm needs to raise approximately Our firm needs to raise approximately $100 million for expansion. Our stock $100 million for expansion. Our stock price is $20. We Select Merrill Lynch to price is $20. We Select Merrill Lynch to underwrite the issue for a 2% underwrite the issue for a 2% underwriting spread.underwriting spread.

What are the risks?What are the risks? The investment bank accepts the risk of The investment bank accepts the risk of

being able to sell the new stock issue for being able to sell the new stock issue for $20 per share. If the stock price falls, the $20 per share. If the stock price falls, the investment bank could lose money.investment bank could lose money.

Regulations:Regulations:The Primary MarketThe Primary Market

The Securities Act of 1933The Securities Act of 1933 Firms register with the Securities Firms register with the Securities

Exchange Commission (SEC).Exchange Commission (SEC). SEC has 20 days to review.SEC has 20 days to review.

Regulations:Regulations:The Primary MarketThe Primary Market

The Securities Act of 1933The Securities Act of 1933 Firms register with the Securities Firms register with the Securities

Exchange Commission (SEC).Exchange Commission (SEC). SEC has 20 days to review.SEC has 20 days to review.

SEC may ask for more information.SEC may ask for more information.

Regulations:Regulations:The Primary MarketThe Primary Market

The Securities Act of 1933The Securities Act of 1933 Firms register with the Securities Firms register with the Securities

Exchange Commission (SEC).Exchange Commission (SEC). SEC has 20 days to review.SEC has 20 days to review.

SEC may ask for more information.SEC may ask for more information.The firm cannot solicit buyers during The firm cannot solicit buyers during

the review period but can advertise.the review period but can advertise.

Regulations:Regulations:The Secondary MarketThe Secondary Market

The Securities Exchange Act of 1934The Securities Exchange Act of 1934Established the SEC.Established the SEC.Exchanges must register with SEC.Exchanges must register with SEC.Company information must be Company information must be

available to the public.available to the public. Insider trading is regulatedInsider trading is regulated..

Regulations:Regulations:Recent DevelopmentsRecent Developments

Securities Acts Amendments of 1975Securities Acts Amendments of 1975Created National Market System.Created National Market System.Eliminated fixed brokerage Eliminated fixed brokerage

commissions.commissions.

SEC Rule 415SEC Rule 415Allows Shelf RegistrationAllows Shelf Registration