Chapter Fifteen

1. Chapter Fifteen Australian Financial Markets: Short-term Financing Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

2. Chapter Organisation 15.1 The Financial System 15.2 Financial Markets 15.3 Financial Intermediaries 15.4 Short-term Financing 15.5 Short-term Financing Sources 15.6 Summary and Conclusions Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

3. Chapter Objectives • Understand the operations of the Australian financial system. • Outline the assets traded in the listed and unlisted markets. • Discuss the role of individual financial intermediaries. • Understand the different current asset financing policies. • Discuss the various short-term financing sources. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

4. The Financial System Saving Lenders Financial markets Borrowing Productive investment Financial intermediaries Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

5. Financial Markets Financial Markets Primary Market Secondary Market Foreign exchange market Futures & options markets Long-term debt market Short-term debt market Share markets Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

6. The Listed Market Ordinary shares Contributing shares Preference shares Rights Company options Property and equity trusts Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

7. Financial Intermediaries Source: Council of Financial Supervisors Annual Report 2001, RBA. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

8. Banks • Trading banks includes activities such as deposits, loans, insurance, superannuation and stockbroking, usually through subsidiaries and affiliated companies. • Retail banking  involves transactions with the general public. • Wholesale banking  involves transactions with companies or businesses. • Hold approximately 44 per cent of market share. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

9. Merchant Banks • Primarily concerned with wholesale finance. • Responsible for the development of CMTs, rebatable preference shares, the commercial bills market, the promissory note market, the currency hedge market and the unofficial deposit market. • Activities now include ‘investment banking’. • Market share has decreased dramatically since the 1980s, now approximately 5 per cent. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

10. Superannuation and Life Insurance Companies • Crucial for the saving and provision of funds for retirement (superannuation) or ‘one-off’ events such as death, disability or trauma (insurance). • Diversified operations to include general insurance, short-term money market dealing and merchant banking. • Hold approximately 30 per cent of market share. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

11. Finance Companies • Initially responsible for the provision of hire purchase and instalment credit, financing of vehicles and home loans, lease financing and factoring. • Funds obtained mainly through the issue of debentures. • Deregulation in 1980s led to many finance companies’ activities being absorbed by their large parent banks. • Market share now only approximately 6 per cent. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

12. Building Societies and Credit Unions • Building societies • Traditionally provide housing finance to small savers. • Diversified activities to include lending for other purposes. • Credit unions • Pool the funds of people with common interests to provide consumer-type financing and lending to ‘members’. • Both have very small market share, totalling approximately 2 per cent. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

13. Unit Trusts • Pool funds of small investors with the aim of earning a greater return collectively than that achieved individually. • Cash management trusts, equity trusts, property trusts, mortgage trusts. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

14. Other Intermediaries • Authorised foreign exchange dealers  perform a full range of foreign exchange transactions. • Australian Stock Exchange (ASX) and share brokers  provide the medium for buying and selling shares and other listed securities. • Friendly societies  non-profit, state-controlled intermediaries for small groups to pool funds to be used for funerals, sickness or, simply, savings. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

15. Financing Policy for an ‘Ideal’ Economy Long-term debtplus ordinary shares Time In an ideal world, net working capital is always zero because short-term assets are financed by short-term debt. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

16. Optimal Amount of Short-term Borrowing Factors to consider: • Cash reserves—reducing the probability of financial distress vs investments in zero NPV securities. • Maturity hedging—match maturity of asset with maturity of liability. • Relative interest rates—cheaper to have short-term borrowing than long-term borrowing. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

17. Alternative Asset Financing Policies Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

18. A Compromise Financing Policy With a compromise policy, the firm keeps a reserve of liquidity which it uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

19. Short-term Financing • Used for: • Working capital requirements in the day-to-day operations of the business. • Transactions that are self-financing over short periods. • Main providers are trading banks, merchant banks and finance companies. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

20. Short-term Financing Sources • Overdrafts • A credit arrangement where the bank permits the customer to draw more money from the bank account than has been put in it, up to an agreed limit. • Repayable on demand although this is rarely required. Interest rate is variable and account balance fluctuates between positive (deposit) and negative (loan) over the business cycle. • Short-term loans • An advance of funds made by a financial institution for a specific purpose, repayable over a fixed period. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

21. Short-term Financing Sources Bills of exchange • A negotiable instrument requiring the payment of a specific sum of money, either on demand or at a specified time. • Trade bills versus accommodation bills. • Three parties to a bill: drawer (borrower), acceptor (endorser) and payee (owner). • Discounted value (price) of a bill: Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

22. Short-term Financing Sources • Promissory notes • A negotiable instrument whereby the borrower promises to repay the face value to the holder at maturity. • Different to bills of exchange because they are unsecured (no acceptor). • Most borrowers are well-known large organisations. There is an active secondary market. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright

23. Short-term Financing Sources • Inventory loans • A short-term loan used specifically to purchase inventory, including a blanket inventory lien, a trust receipt and field warehouse financing. • Letters of credit • Irrevocable and unconditional undertaking by a bank to repay a loan if the borrower defaults. • Short-term eurocurrency funding • Financing in a currency outside the country of issue. • Factoring • Selling of accounts receivables to a factor. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright