Transcript CHAPTER TWO Corporate Finance J.D. Han

Corporate Finance
CHAPTER TWO
J.D. Han
Learning Objectives
1.
What kind of choices is a corporate financial
manager faced with in funding a project?
2. What financial market instruments would he/she
choose? What are the advantages and
disadvantages of different funding sources?
4.What kind of institutional structures is the financial
manager faced with? - Why does each country
exhibit different characteristics in financial
market?
2.1 How to Fund a Corporate Project?
1) How to fund a corporate project?
internal financing vs external financing
2) How to raise funds outside of the firm?
direct financing vs. indirect financing
- Direct financing may not work
- Financial intermediaries create a system of indirect
financing.
3) What kinds of finanical instruments to issue?
2.2 Financial Instruments or Assets:
2 classifications of financial assets(instruments):
1. Debt versus Equity
Debt: Bank Loans and Bonds- Contractual claims
Equity: Residual claims
2. Loans versus Marketable Securities
Loans: personalized
Marketable Securities: Bonds, Equities,
Derivatives (options, swaps, futures, and forwards)
- arm’s length deals through securities exchanges
*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.”
equities
2%
bonds
32%
loans
66%
** It is due to the limited demand for marketable
securities by financial investors, and the limited
supply of marketable securities:
- (Fund) Supply Side: financial investors are
concerned about which is a good financial asset
and which is not - “Information Asymmetry”,
“Moral Hazard”, “Principal-Agent Problem”, and
“Adverse Selection”
- (Fund) Demand Side: firms may prefer bonds to
equities under the current hostile M & A
environment.
*** In the Canadian corporate financing, equities are
somewhat more important than in the U.S.
coroporate financing.
2.3 Financial Intermediaries

The “four pillars” of Canada’s financial
system include:
1. Chartered banks – Self liquidating short-term
investment in principle
2. Trust companies
3. Insurance companies and Pension Funds
4. Investment dealers –For Long term/large
scale investment
** Investment Dealers: the Big Hands

Securities Firms /Houses
 Banks’ M & A Division of Investment Banking
Department
 For instance
- Morgan Stanley Dean Witter
- Goldman Sachs
- Salomon Smith Barney
- Merrill Lynch
- Donald Trump; Drexel Burnham, Campeu Co., T.
Boone Pickens (Mesa Petrolium)
*Structure of Securities Firm
Securities Firm
Mergers and Aquisitions
Investment Banking
Initial Public Offering
Bought Deal
Underwriting
Marketed Deal
Private Issue
securities dealing and brockerage
Important Concepts in
Investment Banking

Issuing Securities: IPO versus Seasoned
Issuing
 Underwriting: advice, issue, risk-sharing,
and stabilization.
 Bought Deal vs Best Efforts
 Private Placement
2.4 Financial Markets
1. Primary vs. Secondary Market by Newness:
- Primary Market: new securities are issued.
Corporate financing source
- Secondary Market: existing securities are traded
2. short-term Money Market vs. long-term Capital
Market by term periods of financial instruments
3. Domestic vs. Glabal Market by Location
Investment banks act as global coordinators
through underwriting syndicates
2.5 Classification of Money Markets by Assets’ Time
Horizons
1. Money Market
 Short-term financial assets –Highly Liquid
 Operates as a dealer or over-the-counter market
(OTC)
 Sold in denominations > $100,000
 Most recognized money market instrument are Tbills
 Other money market instruments include
commercial paper, Banker Acceptances, and
eurodollars
2. Debt Market: Capital Market 1
Intermediate and long term horizon finanical assets
 Bond markets:
-represent the most important markets for
intermediate and long-term debt
- operates as OTC market
- Government bonds are most important items
-
Coporate bonds accounts for 20% only
Asset-backed Securities (ABS):
- - example Mortgage-backed securities (MBS)
- - Securitization
-
3. Equity/stock Market:
Capital Market 2

Common stocks, preferred stock and warrants
trade in equity markets
 Equity securities trade on stock exchanges
 Stock exchanges operate as:
- Auction markets is called Stock Exchanges
(TSE, CDNX, ME; and NYSE)
or
- Over-the-counter is a sales network (NASDAQ).
*Canadian Stock Markets
 Before 1999, there were 5 stock exchanges: TSE,
ME, VSE. WSE, and ASE

After March 1999, there are only TSE, ME, and
Canadian Venture Exchange(CDNX)
** Global Equity Market
*** Emgerging Equity Market in newly
developing economies
4. Derivatives Markets




-
Derivative securities - derive the value from
underlying assets such as common shares or bonds
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
Future contracts - agreements to trade assets at a
specific price and time in the future
Two types of futures:
Real commodities  commodity futures contract
Financial obligations  financial future contract
* Derivative Markets in North America

Options :
- -Montreal exchange (ME) - Canada
- -Chicago Board Options Exchange (CBOT) – US
Futures: commodities, stocks, and foreign exchanges
-Canada’s only commodity futures exchange is the
Winnipeg commodity exchange (WCE)
-Major US futures exchanges Chicago Board of Trade
(CBOT)
- Chicago Mercantile Exchange (CME)
2.6 Stock Market Indicators


-
Canadian indicators include:
TSE 300 Composite Index
S & P /TSE 60 Index
Four CDNX Indexes
International indicators include
Dow Jones Industrial Average (US)
S & P 500 Index (US)
Nasdaq Composite Index (US)
Nikkei 225 Average (Japan)
FT-SE 100 Index (UK)
MSCI (International/Global)
Summary
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.
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.