Chapter 2

COMPONENTS OF FINANCIAL MARKET SYSTEM

Financial Markets

• Primary Market

• Second Market

• Money Market

• Capital Market

• Organized Securities Exchanges

• Over-the-Counter Markets • Public Offerings and Private Placement

Organized Securities Exchanges

• (1)    New York Stock Exchange, (NYSE)

• (2)    American Stock Exchange, (AMEX)

• (3)    Mid-west Stock Exchange,

• (4)    Pacific Stock Exchange,

• (5)    Philadelphia Stock Exchange,

• (6) Boston Stock Exchange, and

New York Stock Exchange (NYSE)

• Membership• seat ： 1366 seats since 1953. • Seat fee: $760,000 to a high of $830,000.' 1995• auction :“make a market”• matching• pricing (asked and offered)• Price Quotes • 82%

Function of the NYSE

• 1 Providing a continuous market.

• 2. Establishing and publicizing fair security prices.

• 3. Helping business raise new capital.

Listing Requirements

• (1)    profitability

• (2)    size

• (3)    market value

• (4) public ownership.

• Profitability

• EBT: at 1east $2.5 million.

• For the two years preceding EBT:at least $2.0 million.

• Size

• Net tangible assets: at least $18.0 million.

• Market Value

• The market value: at least $18.0 million.

• Public Ownership

• common shares :1 .1 million publicly held holders of 100 shares :at least 2,000.

THE INVESTMENT BANKER

• a financial specialist involved as an intermediary in the merchandising of securities.

• Banking Act of 1933(also known as the Glass-Steagall Act of 1933).

Functions of Institutes

• (1)    underwriting,

• (2)    distributing,

• (3) advising.

Distribution Methods

• Most competitive bid purchases

• (1)    rail-road issues,

• (2)    public utility issues,

• (3)    state and municipal bond issues.

• (4)    Commission or Lest-Efforts Basis

• (5) Privileged Subscription

• (6) Direct Sale

• (1)    current stockholders,

• (2)    employees, or

• (3) customers.

PRIVATE PLACEMENTS

• (1)    life insurance companies,

• (2)    state and local retirement funds,

• (3) private pension funds.

Advantages of private placement

• 1.       Speed.

• 2.       Reduced flotation costs.

• 3.       Financing flexibility.

disadvantages

• 1.       Interest costs.

• 2.       Restrictive covenants.

• 3. The possibility of future SEC registration.

Leading U.S. Investment Bankers, 1995 (Domestic debt and Equity issue) (BILLION OF DOLLARS

FIRM UNDERWRITING VOLUME Percent

1 Merrill Lynch ＄ 122.3 17.9%

2 Lehman Brothers 70.3 9.9

3 Golden Sachs 68.5 9.7

3 Morgan Stanley 68.5 9.7

5 Salomon Brother 68.1 9.6

6 CS First Boston 64.6 9.1

7 J.R. Morgan 40.2 5.7

8 Bear, Sterns 25.4 3.6

９　 Donaldson Lufkin & Jenrette 　 22.2 3.1

10 Smith Barney 20.7 2.9

Table 2-6 Public and Privately Placed Corporate Debt Placed Domestically (Gross proceeds of All New U.S. Corporate Debt Issue)

Total Volume Percent Publicly Percent Privately

Year (S Millions) Placed (%) Placed (%)

1994 $441287 82 ． 8 　　　 17 ． 2

1993 361860 79 ． 3 20 ． 7

1992 443911 85 ． 2 14 ． 8

1991 603119 80 ． 7 19 ． 3

1990 276259 68 ． 5 31 ． 5

1989 298813 60 ． 7 39 ． 3

1988 329919 61 ． 3 38 ． 7

1987 301447 69 ． 5 30 ． 5

1986 313502 74 ． 2 25 ． 8

1985 165754 72 ． 1 27 ． 9

1984 　　 109903 66 ． 9 33 ． 1

FLOTATION COSTS

• (1)    the underwriters spread

• (2)    issuing costs.

• (a) printing and engraving,

• (b) legal fees,

• (3)    accounting fees,

• (4)    trustee fees,

• several other miscellaneous components.

REGULATION

• 1929--1932, State statutes (blue sky laws)

• Securities Acts Amendments of 1975

• Primary Market Regulations 1982

•

25 investors not be registered

• 1. less than $1.5 billion of new securities per year.

• 2. Issues that are sold entirely intrastate.

• 3. short-term instruments: maturity periods of 270 days or less.

• 4. Issues that are already regulated or controlled by some other federal agency

• Mr. Ivan F. Boesky, a loophole in the 1940

Ponzis Scheme

• Enron and WorldCom

Primary market regulation

• Full public disclosure

• Firm file a registration statement with the SEC

• a minimum 20-day waiting period,

• registration process a preliminary prospectus (the red herring 非招募章程 )

Secondary Market RegulationsShelf Registration

• 1. Major security exchanges must register with the SEC.

• 2. Insider trading is regulated. • 3. Manipulative trading• 4. The SEC is given control over proxy proc

edures 代理程序 .• 5. The Board of Governors of the Federal R

eserve System

3. 2 3. 75. 4 5. 9

12. 3

17. 6

4. 73. 3

8. 7 8. 4

20. 5

34. 8

0

5

10

15

20

25

30

35

40

%（

）Average annual returns

Standard devi ati ons

i nfl at i on Treasurybi l l s

l ong- termgovernment

bonds

l ong- termcorporat

bonds

commonstock

commonstocks of

smal l fi rms

Figure 2-4 Average Annual Returns and Standard Deviations of Returns, 1926-1995

0

5

10

15

20

25

30

35

40

0 5 10 15 20

perc

enta

ge

Treasurybi l l s I nfl ati on

l ong- termcorporate bonds

commonstocks

l ong- termgovernment bonds

common stocksof smal l companys

Standard devi ati on of returns

Figure 2-5 Rates of Return and Standard Deviations, 1926-1995

Table 2-7 Interest Rate Level and Inflation Rates 1981-1995

3-Month 30-Year AAA Rated Inflation

Treasury Bills Treasury Bonds Corporate Bonds rate

1981 14.08 13.44 14.17 8.9

1982 10.69 12.76 13.79 3.9

1983 8.63 11.18 12.04 3.8

1984 9.52 12.39 12.71 4.0

1985 7.49 10.79 11.37 3.8

1986 5.98 7.80 9.02 1.1

1987 5.82 8.58 9.38 4.4

1988 6.68 8.96 9.71 4.4

1989 8.12 8.45 9.26 4.6

1990 7.51 8.61 9.32 6.1

1991 5.42 8.14 8.77 3.1

1992 3.45 7.67 8.14 2.9

1993 3.02 6.59 7.22 2.7

1994 4.29 7.37 7.97 2.7

1995 5.51 6.88 7.59 2.5

Mean 7.08 9.31 10.03 3.93

0

2

4

6

8

10

12

14

16

1980 1982 1984 1986 1988 1990 1992 1994

%

Aaa Bonds

30- Years Bonds

3- Month Bi l l s

I nfl at i on rate

INTEREST RATE and DETERMINANTS

• k = k* + IRP + DRP + MP + LP

• k = the nominal or observed rate

• k* = the real risk--free rate of interest,

• IRP = inflation-risk premium.

• DRP = default-risk premium

• MP = maturity

• LP = liquidity premium

Nominal Interest rate

• k = k* + IRP + DRP + MP + LP • k = ?

• k* = 3.1%, IRP = 1.5%

• DRP = 0.05% MP = 0.02%

• LP = 0.05%

• K = 3.1% + 1.5% +0.05% + 0.02%+ 0.05% = 4.72%

In reality

• 2.75% - 4.72%

= - 1.97% ???

Housing ??

Medical care??

Education??

Electricity?? Special interest group.

Krf = k* + IRP (2-2)

The Effects of Inflation on Rates of Return and the Fisher

Effect

• Krf =k *+ IRP + (k*. IRP)

• 0.113 = k* + .05 + '05k*– K* = .06 = 6%

 

MEAN MEAN INFERRED

NOMINAL YIELD INFLATION RATE REAL RATE

SECURITY % % %

Treasury bills 7.08 3.93 3.15

Treasury bonds 9.31 3.93 5.38

Corporate bonds 10.03 3.93 6.10

 

THE TERM STRUCTURE OF INTEREST RATES

9

11. 5

13

6

8

10

12

14

0 5 10 15 20 25Year to matur i ty

Perc

enta

ge

Historical Interest Rates

2 10 30

9

13

1

Years to maturity

Int

ere

st

rat

eOct 31, 19 79

Mar 31, 19 90

Nov 13, 19 91

Explaining Term Structure

•

• (1)    the unbiased expectations theory,

• (2)    the liquidity preference theory,

• (3)    the market segmentation theory.

SUMMARY

market environment

• structure of financial markets

• the institution of investment banking

• various methods for distributing securities

• role of interest rates

Components of financial market

• public offerings• private placements ： institutional investors.• financial instruments• The secondary market• money and capital markets• primary and secondary • organized security exchanges• over-the-counter market

Investment banker

• functions of (l) underwriting, (2) distributing, and (3) advising.

• the negotiated purchase, (2) the competitive bid purchase, (3) the commission or best-efforts basis, (4) privileged subscriptions, and (5) direct sales.

Private placements

• (l) life insurance firms, (2) state and local retirement funds, and (3) private pension funds.

• advantages and disadvantages

• Flotation costs

• securities Act Of l933.

• Rates of return