lecture_3 finance

Raising Capital in the Financial

Markets

EBF 1023 BASIC FINANCEEBF 1023 BASIC FINANCE

Q: What are SECURITIES?

Ans: Financial Assets that Investors purchase hoping to earn a high rate of return.

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?

Corporate Financing Sources

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

• Corporate Bonds and Notes 76.9%• Equities 23.1%

Movement of Savings• Direct Transfer of Funds


saver


saver

firm


cashcash

saver

firm


cashcash

securitiessecurities

saver

firm

Movement of Savings• Indirect Transfer using Investment Banker


investmentbanker


investmentbanker firm


fundsfunds



fundsfunds


saver



fundsfundsfundsfunds


saver


Movement of Savings• Indirect Transfer using a Financial Intermediary


financialintermediary


financialintermediary firm


fundsfunds



fundsfunds

firmfirmsecuritiessecurities



fundsfunds



saver


fundsfunds fundsfunds



saver


fundsfunds

intermediaryintermediarysecuritiessecurities

fundsfunds



saver

What is Market??

Financial Market Components

Public OfferingPublic Offering– Firm issues securities, which are

made available to both individual and institutional investors.

Private Placement (direct Private Placement (direct placement)placement)– Securities are offered and sold to a

limited number of investors.


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.


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).


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.

Investment Banking

How do investment bankers help firms issue securities?

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

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.

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.



Direct Sale– Issuing firm sells the securities directly

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


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.


• How many shares will be sold?• $100,000,000 / $20

= 5 million new shares of common stock.


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

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

costs; legal, accounting, and trustee fees.

End of Lecture 3

lecture_3 finance

Documents