Chapter 14: Financial Markets; Money Flows and Sources Capital Markets: long-term markets; bonds, common stock, preferred stock, and convertible securities; found under long-term liabilities and equities. Money Markets: short-term markets; securities with maturities of one year or less usually Treasury bills, commercial paper, negotiable certificates of deposit Government securities: most efficient market; federally sponsored credit agencies (Fannie Mae, Freddie Mac, Sallie Mae); state and local securities (tax exempt offerings) Corporate securities: Corporate bonds (debt instruments, have a fixed life and must be repaid at maturity); Preferred stock (least used-divided isn’t tax deductible); Common stock (used to create new equity capital, no maturity date) Internal sources of funding: retained earnings and cash flows after depreciation (funds are 40% internal, 60% external) Household funding: households receive wages and transfer payments from the government and wages and dividends and save a portion of their income. The savings are usually funneled to financial intermediaries that makeinvestments in the capital markets with the funds received from the household sector. Security Markets: aid the allocation of capital among households, corporations, and governmental units with financial institutions acting as intermediaries. Provide liquidity in two ways: 1. Enable corporations to raise funds by selling new issues of securities rapidly at fair, competitive prices. 2. Allow the investor who purchases securities to sell them easily and then turn a paper asset into cash. Market Efficiency: Markets are efficient when: 1. Prices adjust rapidly to new information 2. There is a continuousmarket, in which each successive trade is made at a price close to the previous price 3. The market can absorb large dollar amounts of securities without destabilizing the prices * the faster the price responds to new information and the smaller the differences in price changes, the more efficient the market * the more certain the expected income, the less volatile price movements will be Regulations: Securities Act of 1933; provides full disclosure of info whenever a corporation sold a new issue of securities. Securities Exchange Act of 1934; created the SEC which enforces securities laws Chapter 15: Getting Money; “Food Chain”, Family, and Angels Investment Bankers: link between the corporation in need of funds and the investor. Responsible for designing and packaging a security offering and selling securities to the public. Underwriter-underwrite any risks associated with a new issue; Market Maker-engage in the buying and selling of the security to ensure a liquid market; Advisor- advise of the types of securities to be sold, number of shares, and timing of sales; Agency Functions- may act as an agent for a corporation that wishes to place its securities privately *debt market is larger than equity market Advantages of going public: greater access to funds, prestige,#2 liquidity market #1 capital raised will go a long way in fueling growth during next few yearsDisadvantages: Must open books to the public and potential stockholders, report expenses, executive time, lack of control, short-term mindset=pressure Going private: Two ways: 1. A publicly owned company is purchased by a private company/equity fund. 2. A company repurchases all of its publicly traded shares from its stockholders. Leveraged buyouts: management or other investor group borrows the needed cash to repurchase all the shares of the company Restructuring: reduces debt load; divisions and products are sold and assets redeployed into new, higher-return areas. Immediate Dilution: Earnings per share before stock issue; (total earnings(12mil)/shares outstanding(6mil)) = (small dollar amount($2)) Earnings per share after stock issue; (total earnings(12mil)/shares outstanding + new issued stock(7.5mil) =($1.60) The difference is the dilution ($2-1.60 = .40) EPS before stock issue= (total earnings / shares outstanding) = small dollar amountEPS after stock issue= (total earnings / shares outstanding + new issued stock)The difference = DilutionNew income vs. Dilution: New income; (percentage x (new share issued x price per share) then new income + previous income = total income EPS(Earnings per share): total income/(previous income + news shares issued)Chapter 16 & 8: Bonds Par Value: initial value of bond; principal/face value (most corporate bonds are initially traded in $1,000 units) Coupon Rate: actual interest rate of a bond (usually paid in semiannual installments); dollar amount interest rate/par value = percentage coupon rate Current Yield: (stated interest payment $) / (current price of bond)Yield to Maturity: [(annual interest payment$ + (principal payment –price of bond) / (#of years to maturity)) / (0.6price of bond + 0.4 principal payment)]Maturity Date: the final date on which repayment of the bond principal is due. Secured Debt: specific assets are pledged to bondholders in the event of default (mortgage agreement); Senior thenjunior Unsecured debt (Debentures): long-term, unsecured corporate bond; Senior then subordinated Lower priority claims: preferred stock then common stock Bond Ratings: the higher the rating assigned at issue the lower the required interest payments Bond ratings protect against: Business risk, Maturity risk, Default risk, Financial risk, Market risk  criticized for conflict of interest, time lag, unknown basisAdvantages of bonds: Interest payments are tax-deductible, financial obligation is specified, the use of debt may lower the cost of capital to a firm, debt may be paid back with “cheaper dollars”Disadvantages of bonds: interest and principal payment obligations are set by contract, debt may depress outstanding common stock Current yield: dollar amount interest rate/market price = (percentage current yield) Yield to maturity: (Annual interest rate($85) + (principal pyt(1,000) –price of bond (860)/years to maturity))/.6 x price of bond(860) + .4 x principal pyt (1000) Effective interest rate: based on the loan amount, the dollar interest paid, the length of the loan, and the method of repayment = [(interest/principal)*(360/days loan is outstanding)]Cost of Commercial bank financing: (Interest [dollar amt]/Principal) x (Days in the year (360) / Days loan is outstanding) = effective interest rate Discounted loan: (Interest[dollar amt]/Principal-Interest[dollar amt]) x (Days in the