<ul><li>Corporate Finance </li></ul><ul><li>CHAPTER TWO </li></ul><ul><li>J.D. Han </li></ul>
Learning Objectives <ul><li>What kind of choices is a corporate financial manager faced with in funding a project? </li></...
2.1 How to Fund a Corporate Project? <ul><li>1) Where does the fund for  a corporate project come from? </li></ul><ul><li>...
2.2 Financial Instruments or Assets: <ul><li>2 classifications of financial assets(instruments): </li></ul><ul><li>1. Debt...
*Sources of External Corporate Financing in U. S.:  Choice of Capital Structure Two puzzling findings 1) “Equities are not...
<ul><li>** It is due to both (lack of) supply and demand: </li></ul><ul><li>- (Fund)  Supply Side Limitation:  financial i...
2.3 Financial Intermediaries <ul><li>The “ four pillars ” of Canada’s financial system include: </li></ul><ul><ul><li>Char...
**  Investment Dealers: the Big Hands <ul><li>Securities Firms /Houses </li></ul><ul><li>Banks’ M & A Division of Investme...
*Structure of Securities Firm
*Important Concepts in Investment Banking <ul><li>Issuing Securities: IPO versus Seasoned Issuing </li></ul><ul><li>Underw...
Financial Market <ul><li>Definition:  An organized institutional structure or mechanism for creating and exchanging  finan...
<ul><li>Financial Assets/(Liabilities) </li></ul><ul><li>= F inancial Instruments  </li></ul><ul><li>= Loans + Bonds + Equ...
2.4 Kinds of Financial Markets <ul><li>1)  Primary vs. Secondary Market by Newness: </li></ul><ul><li>Primary Market :  ne...
2)  short-term  Money Market vs.  long-term  Capital Market <ul><li>by term periods of financial instruments </li></ul>
* Money Market <ul><li>Short-term financial assets – Highly Liquid </li></ul><ul><li>Operates as a  dealer  or  over-the-c...
* Capital Market 1: Bond Market <ul><li>Intermediate and long term horizon finanical assets </li></ul><ul><li>Bond markets...
* Capital Market II : Equity/stock Market <ul><li>Common stocks, preferred stock and warrants trade in equity markets </li...
<ul><li>*Canadian Stock Markets </li></ul><ul><li>Before 1999, there were 5 stock exchanges: TSE, ME, VSE. WSE, and ASE </...
3) Domestic vs.  Global Financial Markets   <ul><li>Investment banks act as global coordinators through underwriting syndi...
4) Derivatives Markets <ul><li>Derivative securities  - derive the value from underlying assets such as common shares or b...
*  Derivative Markets in North America <ul><li>Options : </li></ul><ul><li>-Montreal exchange (ME) - Canada </li></ul><ul>...
Summary <ul><li>1. Efficient financial markets are required to channel funds from surplus-spending units (savers) to defic...
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Chapter 2 Lecture Note

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Chapter 2 Lecture Note

  1. 1. <ul><li>Corporate Finance </li></ul><ul><li>CHAPTER TWO </li></ul><ul><li>J.D. Han </li></ul>
  2. 2. Learning Objectives <ul><li>What kind of choices is a corporate financial manager faced with in funding a project? </li></ul><ul><li>2. What financial market instruments would he/she choose? What are the advantages and disadvantages of different funding sources? </li></ul><ul><li>4.What kind of institutional structures is the financial manager faced with? - Why does each country exhibit different characteristics in financial market? </li></ul>
  3. 3. 2.1 How to Fund a Corporate Project? <ul><li>1) Where does the fund for a corporate project come from? </li></ul><ul><li>internal financing vs </li></ul><ul><li>external financing </li></ul><ul><li>2) How to do external financing? </li></ul><ul><li>direct financing vs. </li></ul><ul><li>indirect financing through Financial intermediaries </li></ul><ul><li>3) What kinds of financial instruments to issue? bonds; loans; and/or equities (stocks) </li></ul>
  4. 4. 2.2 Financial Instruments or Assets: <ul><li>2 classifications of financial assets(instruments): </li></ul><ul><li>1. Debt versus Equity </li></ul><ul><li>Debt: Bank Loans and Bonds- Contractual claims </li></ul><ul><li>Equity: Residual claims </li></ul><ul><li>2. Loans versus Marketable Securities </li></ul><ul><li>Loans : personalized </li></ul><ul><li>Marketable Securities : Bonds, Equities, Derivatives (options, swaps, futures, and forwards) </li></ul><ul><li>- arm’s length deals through securities exchanges </li></ul>
  5. 5. *Sources of External Corporate Financing in U. S.: Choice of Capital Structure Two puzzling findings 1) “Equities are not a major instruments for corporate financing.” 2) “Marketable Securities are not so important as bank loans.”
  6. 6. <ul><li>** It is due to both (lack of) supply and demand: </li></ul><ul><li>- (Fund) Supply Side Limitation: financial investors are concerned about “Information Asymmetry”, “Moral Hazard”, “Principal-Agent Problem”, and “Adverse Selection” </li></ul><ul><li>- (Fund) Demand Side Limitation: firms may prefer bonds to equities under the current hostile M & A environment and tax laws. </li></ul><ul><li>*** In the Canadian corporate financing, equities are somewhat more important than in the U.S. coroporate financing. </li></ul>
  7. 7. 2.3 Financial Intermediaries <ul><li>The “ four pillars ” of Canada’s financial system include: </li></ul><ul><ul><li>Chartered banks – for Self liquidating short-term investment in principle </li></ul></ul><ul><ul><li>Trust companies </li></ul></ul><ul><ul><li>Insurance companies and Pension Funds </li></ul></ul><ul><ul><li>Investment dealers –for Long term/large scale investment </li></ul></ul>
  8. 8. ** Investment Dealers: the Big Hands <ul><li>Securities Firms /Houses </li></ul><ul><li>Banks’ M & A Division of Investment Banking Department </li></ul><ul><li>For instance </li></ul><ul><li>- Morgan Stanley Dean Witter </li></ul><ul><li>- Goldman Sachs </li></ul><ul><li>- Salomon Smith Barney </li></ul><ul><li>- Merrill Lynch </li></ul><ul><li>Donald Trump; Drexel Burnham, Campeu Co., T. Boone Pickens (Mesa Petrolium) </li></ul><ul><li>Dominion Securities; Mellon; McLeod; Waterhouse. </li></ul>
  9. 9. *Structure of Securities Firm
  10. 10. *Important Concepts in Investment Banking <ul><li>Issuing Securities: IPO versus Seasoned Issuing </li></ul><ul><li>Underwriting: advice, issue, risk-sharing, and stabilization. </li></ul><ul><li>Bought Deal vs Best Efforts </li></ul><ul><li>Private Placement </li></ul>
  11. 11. Financial Market <ul><li>Definition: An organized institutional structure or mechanism for creating and exchanging financial assets. </li></ul>
  12. 12. <ul><li>Financial Assets/(Liabilities) </li></ul><ul><li>= F inancial Instruments </li></ul><ul><li>= Loans + Bonds + Equities </li></ul><ul><li>= Loans + Marketable Securities </li></ul><ul><li>= Debts + Equities </li></ul><ul><li>Market includes </li></ul><ul><li>Stock Exchange and OTC, and Loan Market </li></ul>
  13. 13. 2.4 Kinds of Financial Markets <ul><li>1) Primary vs. Secondary Market by Newness: </li></ul><ul><li>Primary Market : new securities are issued, and it is Corporate financing source </li></ul><ul><li>Secondary Market(Aftermarkets): existing securities are traded or exchanged </li></ul>
  14. 14. 2) short-term Money Market vs. long-term Capital Market <ul><li>by term periods of financial instruments </li></ul>
  15. 15. * Money Market <ul><li>Short-term financial assets – Highly Liquid </li></ul><ul><li>Operates as a dealer or over-the-counter market (OTC) </li></ul><ul><li>Sold in denominations > $100,000 </li></ul><ul><li>Most recognized money market instrument are T-bills </li></ul><ul><li>Other money market instruments include commercial paper, Banker Acceptances, and eurodollars </li></ul>
  16. 16. * Capital Market 1: Bond Market <ul><li>Intermediate and long term horizon finanical assets </li></ul><ul><li>Bond markets: </li></ul><ul><li>-represent the most important markets for intermediate and long-term debt </li></ul><ul><li>- operates as OTC market </li></ul><ul><li>- Government bonds are most important items </li></ul><ul><li>- Coporate bonds accounts for 20% only </li></ul><ul><li>Asset-backed Securities (ABS): </li></ul><ul><li>- example Mortgage-backed securities (MBS) </li></ul><ul><li>- Securitization </li></ul>
  17. 17. * Capital Market II : Equity/stock Market <ul><li>Common stocks, preferred stock and warrants trade in equity markets </li></ul><ul><li>Equity securities trade on stock exchanges </li></ul><ul><li>Stock exchanges operate as: </li></ul><ul><li>Auction markets is called Stock Exchanges (TSE, CDNX, ME; and NYSE) </li></ul><ul><li>or </li></ul><ul><li>Over-the-counter is a sales network (NASDAQ). </li></ul>
  18. 18. <ul><li>*Canadian Stock Markets </li></ul><ul><li>Before 1999, there were 5 stock exchanges: TSE, ME, VSE. WSE, and ASE </li></ul><ul><li>After March 1999, there are only TSE, ME, and Canadian Venture Exchange(CDNX) </li></ul><ul><li>** Global Equity Market </li></ul><ul><li>*** Emerging Equity Market in newly developing economies </li></ul>
  19. 19. 3) Domestic vs. Global Financial Markets <ul><li>Investment banks act as global coordinators through underwriting syndicates; it has </li></ul><ul><li>FOREX market </li></ul><ul><li>International Money Market </li></ul><ul><li>eg )Eurocurrency Market </li></ul><ul><li>(definition of Eurocurency Market ) a market for deposits and loans denomitated in a currency other than that of the country in which the bank is located </li></ul><ul><li>International Capital Markets; International Bond Market and International Equity Market ; Emerging Markets </li></ul>
  20. 20. 4) Derivatives Markets <ul><li>Derivative securities - derive the value from underlying assets such as common shares or bonds </li></ul><ul><li>Options - a contract that grants the holder the right to buy or sell a security at a given price on or before a given date </li></ul><ul><li>Future contracts - agreements to trade assets at a specific price and time in the future </li></ul><ul><li>Two types of futures: </li></ul><ul><li>Real commodities  commodity futures contract </li></ul><ul><li>Financial obligations  financial future contract </li></ul>
  21. 21. * Derivative Markets in North America <ul><li>Options : </li></ul><ul><li>-Montreal exchange (ME) - Canada </li></ul><ul><li>-Chicago Board Options Exchange (CBOT) – US </li></ul><ul><li>Futures: commodities, stocks, and foreign exchanges </li></ul><ul><li>-Canada’s only commodity futures exchange is the Winnipeg commodity exchange (WCE) </li></ul><ul><li>-Major US futures exchanges Chicago Board of Trade (CBOT) </li></ul><ul><li>Chicago Mercantile Exchange (CME) </li></ul>
  22. 22. Summary <ul><li>1. Efficient financial markets are required to channel funds from surplus-spending units (savers) to deficit-spending units. Typically, such securities entitle the holder to a stream of periodic future cash payments. </li></ul><ul><li>2. Financial intermediaries allow economies of scale to be realized when matching surplus-spending units with deficit-spending units. Greater opportunities for portfolio diversification and money management can be gained. </li></ul>

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