Financial Management Chapter 2

Importance of Financial Markets

-Well-functioning (efficient) financial markets facilitate to flow of capital from investors to the users of capital -Well-functioning markets promote economic growth -Economies with well-developed markets perform better than economies with poorly-functioning markets - We need them to boost financial growth -The account is also very imperative for markets and to promote economic growth

How is capital transferred?

1. Direct Transfers 2. Investment Banking Houses 3. Financial intermediaries

Closely Held Corporation

A corporation that is owned by a few individuals who are typically associated with the firm's management.

Publicly Owned Corporation

A corporation that is owned by a relatively large number of individuals who are not actively involved in the firm's management.

Financial Services Corporation

A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking.

Over-the-Counter (OTC) Market

A large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities.

Investment Bank

An organization that underwrites and distributes new investment securities and helps businesses obtain financing. -Raise capital (cash from stock and bond sales) for (mostly) corporate clients. -Perform corporate finance functions for the corporate clients including estimation of value, IPO pricing as well as selling their corporate client's securities, etc. When they guarantee an amount of capital for the sale of securities, they are called underwriters.

Derivative

Any financial asset whose value is derived from the value of some other "underlying" asset.

Investment Banking Houses

Businesses and corporations go to issue stocks and bonds - Help us find people to find and buy our stocks - Capital:consists of stocks and bonds - specializes in helping us with interest rates and what to price it

Physical Location Exchanges

Formal organizations having tangible physical locations that conduct auction markets in designated ("listed") securities.

Dealer Market

Includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges.

Financial Intermediaries

Lending other people's money out to you (banks) -Much more efficient -You pay more with intermediaries than direct transfers

Primary Markets

Markets in which corporations raise capital by issuing new securities. (new stock, new bonds) -Corporation gets cash, purchaser of stock is person

Secondary Markets

Markets in which securities and other financial assets are traded among investors after they have been issued by corporations. (Ex. NASDAQ, NYSE, America Stock Exchange)

Public Markets

Markets in which standardized contracts are traded on organized exchanges.

Private Markets

Markets in which transactions are worked out directly between two parties.

Money Market Funds

Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts.

Mutual Funds

Organization that pool investor funds to purchase financial instruments and thus reduce risks through diversification.The funds are typically managed by professionals who oversee the funds on a daily basis and there are literally thousands of different funds with different investment objectives and goals.

Going Public

The act of selling stock to the public at large by a closely held corporation or its principal stockholders.

Initial Public Offering (IPO) Market

The market for stocks of companies that are in the process of going public.

Commercial Bank

The traditional department store of finance serving a variety of savers and borrowers. "One stop banking shop", e.g. Wells Fargo, TD, Citibank, etc. Auto loans, mortgage loans, business loans, etc. -A bank we would go to to give money or get loans, etc.

Life Insurance Companies

are companies that take revenues in the form of a premium payments and make investments in corporate stocks, bonds, real estate and mortgages with the goal of paying beneficiaries while making a profit for themselves.

Credit Unions

are cooperative associations, typically employee oriented which provide low cost loans to its employee members.

Financial Institutions

are financial intermediaries which bring a supply of funds to borrowers who demand those funds. They make a market. Over time distinct differences in these institutions have diminished.

Demanders (borrowers or users) of capital

are individuals and institutions (firms) who need to raise funds to finance their investment opportunities. They pay a rate of return on the capital they borrow/use.

Suppliers (savers/investors) of capital

are individuals and institutions with "excess funds." Savers are looking for a rate of return on their investment.

Hedge Funds

are like mutual funds but are unregulated by the SEC. The main characteristics are that it takes big money yo participate and expose their investors to higher risk (such as "short sales") in the hopes of getting greater returns.

Pension Funds

are retirement funds provided by government agencies and unions which are invested for growth. Government agencies might have their own internal trust departments or use the external trust departments of commercial banks or insurance companies. CALPERS (California Public Employee's' Retirement System) is an example of the former with approx. $237 billion in assets under management at April 30, 2012. Typically pension funds invest in corporate stock and bonds, mortgages and real estate and perhaps a minority interest in a private equity companies.

Exchange Traded Funds

are similar to mutual funds but have a narrower portfolio focus and are traded in secondary markets.

Private Equity Companies

are typically LLC or LLP companies that raise equity capital from individuals capable of investing large sums. Combined with large amounts of debt, the PE Company acquires portfolio companies which it believes will increase in value due to acquisition, better management, etc. Once the portfolio company's value has matured the PE company will either issue an IPO or sell the company to another PE firm for a handsome profit. The large amounts of debt on the portfolio company's balance sheet offer significant tax advantage but place the company at higher risk for default. Because of the high level of debt portfolio companies are typically cash "starved"

Direct Transfers

go directly to a person who can give (lend) you money

Capital Allocation Process

is the efficient flow of funds from those who supply capital to those who demand it. "Efficient" is the operative word.

Future Price

locked-in price base don the "now" price

Future Markets

markets where assets are bought and sold for future delivery. Future contracts mitigate risk by "locking in a price in volatile or price ascending markets. Options to buy or sell assets at a future date also mitigate risk in markets where asset prices are volatile.

Spot Markets

markets where assets are bought or sold for imminent delivery (within a few days).

Financial Assets

paper assets with a claim or right to other assets, e.g. stocks, bonds, notes, etc.

NYSE vs. NASDAQ

physical v. virtual

Auction Markets

place where people are buying/selling

Physical Assets

tangible, real assets, e.g. heating oil, pork bellies, orange juice, etc. -which are traded

Stock Market Efficiency

term used to describe is how efficiently financial and operating information about companies is transmitted to the market as a whole for integration into the decision making process of buying or selling stock

Spot Price

today's price now

Dealer Markets

where there's an intermediary (ex. Goldman Sachs)

Dis-intermediation

you don't use any intermediary and are lending out to people directly to maximize lending gain or profit.