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Chapter 2

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  1. Chapter 2 COMPONENTS OF FINANCIAL MARKET SYSTEM

  2. Financial Markets • Primary Market • Second Market • Money Market • Capital Market • Organized Securities Exchanges • Over-the-Counter Markets • Public Offerings and Private Placement

  3. Organized Securities Exchanges • (1)New York Stock Exchange, (NYSE) • (2)American Stock Exchange, (AMEX) • (3)Mid-west Stock Exchange, • (4)Pacific Stock Exchange, • (5)Philadelphia Stock Exchange, • (6) Boston Stock Exchange, and

  4. New York Stock Exchange (NYSE) • Membership • seat:1366 seats since 1953. • Seat fee: $760,000 to a high of $830,000.' 1995 • auction :“make a market” • matching • pricing (asked and offered) • Price Quotes • 82%

  5. Function of the NYSE • 1 Providing a continuous market. • 2. Establishing and publicizing fair security prices. • 3. Helping business raise new capital.

  6. Listing Requirements • (1)profitability • (2)size • (3)market value • (4) public ownership.

  7. Profitability • EBT: at 1east $2.5 million. • For the two years preceding EBT:at least $2.0 million. • Size • Net tangible assets: at least $18.0 million.

  8. Market Value • The market value: at least $18.0 million. • Public Ownership • common shares :1 .1 million publicly held holders of 100 shares :at least 2,000.

  9. THE INVESTMENT BANKER • a financial specialist involved as an intermediary in the merchandising of securities. • Banking Act of 1933(also known as the Glass-Steagall Act of 1933).

  10. Functions of Institutes • (1)underwriting, • (2)distributing, • (3) advising.

  11. Distribution Methods • Most competitive bid purchases • (1)rail-road issues, • (2)public utility issues, • (3)state and municipal bond issues. • (4)Commission or Lest-Efforts Basis • (5) Privileged Subscription • (6) Direct Sale

  12. (1)current stockholders, • (2)employees, or • (3) customers.

  13. PRIVATE PLACEMENTS • (1)life insurance companies, • (2)state and local retirement funds, • (3) private pension funds.

  14. Advantages of private placement • 1.Speed. • 2.Reduced flotation costs. • 3.Financing flexibility.

  15. disadvantages • 1.Interest costs. • 2.Restrictive covenants. • 3. The possibility of future SEC registration.

  16. Leading U.S. Investment Bankers, 1995 (Domestic debt and Equity issue) (BILLION OF DOLLARS FIRM UNDERWRITING VOLUME Percent 1 Merrill Lynch $ 122.3 17.9% 2 Lehman Brothers 70.3 9.9 3 Golden Sachs 68.5 9.7 3 Morgan Stanley 68.5 9.7 5 Salomon Brother 68.1 9.6 6 CS First Boston 64.6 9.1 7 J.R. Morgan 40.2 5.7 8 Bear, Sterns 25.4 3.6 9 Donaldson Lufkin & Jenrette22.2 3.1 10 Smith Barney 20.7 2.9

  17. Table 2-6 Public and Privately Placed Corporate Debt Placed Domestically (Gross proceeds of All New U.S. Corporate Debt Issue) Total Volume Percent Publicly Percent Privately Year (S Millions) Placed (%) Placed (%) 1994 $441287 82.817.2 1993 361860 79.3 20.7 1992 443911 85.2 14.8 1991 603119 80.7 19.3 1990 276259 68.5 31.5 1989 298813 60.7 39.3 1988 329919 61.3 38.7 1987 301447 69.5 30.5 1986 313502 74.2 25.8 1985 165754 72.1 27.9 1984 109903 66.9 33.1

  18. FLOTATION COSTS • (1)the underwriters spread • (2)issuing costs. • (a) printing and engraving, • (b) legal fees, • (3)accounting fees, • (4)trustee fees, • several other miscellaneous components.

  19. REGULATION • 1929--1932, State statutes (blue sky laws) • Securities Acts Amendments of 1975 • Primary Market Regulations 1982

  20. 25 investors not be registered • 1. less than $1.5 billion of new securities per year. • 2. Issues that are sold entirely intrastate. • 3. short-term instruments: maturity periods of 270 days or less. • 4. Issues that are already regulated or controlled by some other federal agency

  21. Mr. Ivan F. Boesky, a loophole in the 1940 Ponzis Scheme • Enron and WorldCom

  22. Primary market regulation • Full public disclosure • Firm file a registration statement with the SEC • a minimum 20-day waiting period, • registration process a preliminary prospectus (the red herring非招募章程)

  23. Secondary Market RegulationsShelf Registration • 1. Major security exchanges must register with the SEC. • 2. Insider trading is regulated. • 3. Manipulative trading • 4. The SEC is given control over proxy procedures代理程序. • 5. The Board of Governors of the Federal Reserve System

  24. Figure 2-4 Average Annual Returns and Standard Deviations of Returns, 1926-1995

  25. Figure 2-5 Rates of Return and Standard Deviations, 1926-1995

  26. Table 2-7 Interest Rate Level and Inflation Rates 1981-1995 3-Month 30-Year AAA Rated Inflation Treasury Bills Treasury Bonds Corporate Bonds rate 1981 14.08 13.44 14.17 8.9 1982 10.69 12.76 13.79 3.9 1983 8.63 11.18 12.04 3.8 1984 9.52 12.39 12.71 4.0 1985 7.49 10.79 11.37 3.8 1986 5.98 7.80 9.02 1.1 1987 5.82 8.58 9.38 4.4 1988 6.68 8.96 9.71 4.4 1989 8.12 8.45 9.26 4.6 1990 7.51 8.61 9.32 6.1 1991 5.42 8.14 8.77 3.1 1992 3.45 7.67 8.14 2.9 1993 3.02 6.59 7.22 2.7 1994 4.29 7.37 7.97 2.7 1995 5.51 6.88 7.59 2.5 Mean 7.08 9.31 10.03 3.93

  27. INTEREST RATE and DETERMINANTS • k = k* + IRP + DRP + MP + LP • k = the nominal or observed rate • k* = the real risk--free rate of interest, • IRP = inflation-risk premium. • DRP = default-risk premium • MP = maturity • LP = liquidity premium

  28. Nominal Interest rate • k = k* + IRP + DRP + MP + LP • k = ? • k* = 3.1%, IRP = 1.5% • DRP = 0.05% MP = 0.02% • LP = 0.05% • K = 3.1% + 1.5% +0.05% + 0.02%+ 0.05% = 4.72%

  29. In reality • 2.75% - 4.72% = - 1.97% ??? Housing ?? Medical care?? Education?? Electricity?? Special interest group.

  30. Krf = k* + IRP (2-2)

  31. The Effects of Inflation on Rates of Return and the Fisher Effect • Krf =k *+ IRP + (k*. IRP) • 0.113 = k* + .05 + '05k* • K* = .06 = 6%

  32. MEAN MEAN INFERRED NOMINAL YIELD INFLATION RATE REAL RATE SECURITY % % % Treasury bills 7.08 3.93 3.15 Treasury bonds 9.31 3.93 5.38 Corporate bonds 10.03 3.93 6.10

  33. THE TERM STRUCTURE OF INTEREST RATES

  34. Oct 31, 19 79 13 Interest rate 9 Mar 31, 19 90 Nov 13, 19 91 1 2 10 30 Years to maturity Historical Interest Rates

  35. Explaining Term Structure • (1)the unbiased expectations theory, • (2)the liquidity preference theory, • (3)the market segmentation theory.

  36. SUMMARY market environment • structure of financial markets • the institution of investment banking • various methods for distributing securities • role of interest rates

  37. Components of financial market • public offerings • private placements:institutional investors. • financial instruments • The secondary market • money and capital markets • primary and secondary • organized security exchanges • over-the-counter market

  38. Investment banker • functions of (l) underwriting, (2) distributing, and (3) advising. • the negotiated purchase, (2) the competitive bid purchase, (3) the commission or best-efforts basis, (4) privileged subscriptions, and (5) direct sales.

  39. Private placements • (l) life insurance firms, (2) state and local retirement funds, and (3) private pension funds. • advantages and disadvantages

  40. Flotation costs • securities Act Of l933. • Rates of return