Conceptual Checks for Chapter 1

Give an example of (a) investment decisions and (b) financing

decisions.
What is limited liability?
What are agency costs/problems? What are the possible ways
to reduce the problems?
Discuss which of the following forms of compensation is more
likely to line up the interests of managers and shareholders?

1.

2.
3.

4.

a.
b.

A fixed salary.
A compensation that is paid partly in the form of the companys
shares.

FINC 210
Financial Management
Chapter 2
Financial Markets and Institutions

Learning Objectives

Understand

basic methods of financing available in the financial

market;
different types of financial markets and financial market
activity;
how to search for information about listed companies;
financial intermediaries such as commercial banks, mutual
funds, pensions, insurance companies, etc.;
the functions of financial markets.

Questions about the Video

1.

2.

3.

Chapter02PublicAndCorpFinMarkets .wmv

What are traded in financial market? Why do we

need financial markets?
What is the main difference between public and
corporate financial markets?
What are the two major options available to
corporations when they raise money?

The Flow of Savings to a Closely Held

Corporation
(2)

(1)

Investors

Firm's
operations

Financial
Manager

(4a)

Real assets
(timberland)

(3)
(1) Investors buy shares with cash
(2)Cash is invested
(3) Timber harvest generates cash
(4a) Cash reinvested
(4b) Cash returned to investors

(4b)

(stockholders
save and invest
in closely held
firm.)

The Flow of Savings to a Large Public

Corporation
Financial
Markets

Firms
Operations
Real Assets

Stock markets
Bond markets
Markets for
commodities,
foreign exchange

Investors
worldwide

Financial
Manager
Financial
Intermediaries
Mutual funds
Pension funds
Banks
Insurance companies

Financial Market Stock (Equity)

Market
A market where shares of corporations are issued and
traded.
Primary market. Market for the sale of new securities
by corporations.

Initial public offering (IPO).

Seasoned equity offering (SEO).

Chapter02Initial Public Offering (IPO) Explained.flv

Private

placement.
Rights offering.
Shelf registration.

Stock Market (cont.)

Secondary market. Market in which previously issued

shares are traded among investors.

Exchange versus over-the-counter (OTC) market.

Examples

of stock exchanges: Hong Kong Exchange, New

York Stock Exchange.
Example of OTC markets: NASDAQ

Secondary Market - Exchange System

Flow of order

Investor

Investor
Broker /
Investor

Investor

Investor
Broker /
Investor

Computer
System

Broker /
Investor

Investor

Investor
Broker /
Investor

Broker /
Investor
Investor

Investor
Investor

Investor

Investor

Secondary Market - OTC Market

Investor

Broker/
Investor

Broker/
Investor
Dealer

Investor

Broker/
Investor

Dealer

Investor

Broker/
Investor

Broker/
Investor
Dealer

Investor
Broker/
Investor
Investor

Investor

Investor

Dealer

Broker/
Investor

Investor
Broker/
Investor

Investor

Investor

Financial Market Debt (Fixed-Income)

Market
Most corporate debt securities are traded over-thecounter. Only a few of them are traded on the
exchanges.
Classifications of corporate fixed-income securities

Fixed

rate vs. floating rate

Long-term (capital market) vs. short-term (money
market)
Secured vs. unsecured

Other Financial Markets

Foreign exchange market (OTC)
Commodities markets

Derivatives (options, futures, ) markets

Chicago Mercantile Exchange (CME)

CME webpage http://www.cmegroup.com/
Chicago Board Options Exchange (CBOE)
CBOE webpage http://www.cboe.com/

Prediction (Gambling) markets

Soccer / Basketball match outcome

Presidential election outcome

Financial Intermediaries

1.

A financial intermediary is an organization that raises money

from investors and provides financing for individuals,
companies and organizations.
Mutual fund an investment plan that raises money by selling
units to investors then invests in stock market, bond market or
other financial markets.
Q: Why do we invest in mutual funds, not directly in stock
markets?
Bank of
America

$
Sells
shares

$
Windsor
Fund

Investors
Issues
shares

Financial Intermediaries (cont.)

2.

3.

Pension fund An investment plan set up by an

employer to provide for employees retirement. In
general, there are two types of pension plans: (1)
defined-contribution plans, and (2) defined-benefit
plans.
Hedge fund An investment plan that aims for high
returns by following complex, high-risk investment
strategies

Financial Institutions

Financial institutions raise financing by accepting

deposits, selling insurance policies, or who provide
financial services and advices to their clients.
Examples include
commercial banks
insurance companies
investment banks

Comparisons of Commercial Banks and

Insurance Companies
Commercial banks

Insurance companies

Example: Bank of China

Example: AIA, Prudential

Highly regulated, especially

subject to reserve requirements
and liquidity requirements

Relatively Less regulated

Taking deposit. Depositors are

protected by deposit insurance.

Selling insurance policies and

collecting insurance premiums.
Policy holders are unsecured
creditors.

Investment portfolios mostly

consist of debt instruments such
as government bonds, business
and personal loans.

Investment portfolios are more

diversified in terms of products
and in particular include more
equity investment.

Financial Institutions Investment Banks

Investment bankers provide the following services:

investment in start-ups and other ventures

investment advicesolicited and unsolicited
wealth management services
underwriting functions
analyst coverage
financial engineering, structured products

Total Financing of U.S. Corporations

% Holdings of Corporate and Foreign Bonds (Qtr 3, 2007)

Institutional
investors

Total U.S. Financing (cont.)

% Holdings of Corporate Equities (Qtr 3, 2007)

Functions of Financial Markets and

Intermediaries
1.

Transporting Cash across Time transport money

forward.
Spending

Goods
Goods

Income from
your job

Income from
your job

Savings

Today

Bank
account

Savings
plus
interest

Bank
account

Bank
account

Future

Functions of Financial Markets and

Intermediaries (cont.)
1.

Transporting Cash across Time transport money

back.
Spending

Goods

No income

Goods

Borrowing

Today

Bank

Borrowing
Amount plus
interest

Income from
your job
Bank
account

Future

Functions of Financial Markets and

Intermediaries (cont.)
Liquidity the ability to sell or exchange an asset for
cash on short notice. For example,

2.

3.

4.

stock market allows for trading of stocks at a low

transaction costs;
payment mechanism such as checking account, electronic
transfer, , enhance economic activities.

Risk transfer and diversification by buying

insurance, investing in mutual funds,
Information from financial analysts, listed
companies, stock prices, interest rates,