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Capital Markets (Chapter 14)

Capital Markets (Chapter 14). Financial Markets and Institutions Sources of Funds for Corporations Security Exchanges and OTC Market Indices Efficient Market Hypothesis Regulation of Security Markets. FINANCIAL MARKETS. Money Markets (Short-Term) Treasury Bills Negotiable CDs

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Capital Markets (Chapter 14)

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  1. Capital Markets(Chapter 14) • Financial Markets and Institutions • Sources of Funds for Corporations • Security Exchanges and OTC • Market Indices • Efficient Market Hypothesis • Regulation of Security Markets

  2. FINANCIAL MARKETS • Money Markets (Short-Term) • Treasury Bills • Negotiable CDs • Bankers’ Acceptances • Commercial Paper • Capital Markets (Long-Term) • Common Stock • Bonds • Preferred Stock • Convertible Securities

  3. Financial Markets (Continued) • Primary Markets • New Issues • Secondary Markets • Outstanding Issues • Spot Markets • Price today - Delivery today • Futures Markets • Price today - Delivery in the future.

  4. DERIVATIVES MARKETS • A derivative is any security whose value is derived from the price of some other underlying security. • Some examples of derivatives • Put and call options • Futures contracts • Zero coupon bonds • Can be used to increase risk (e.g., options) • Can also be rather low in risk (e.g., zero coupon government bonds)

  5. FINANCIAL INSTITUTIONS • Many Different Financial Intermediaries • Investment Bankers • Commercial Banks • Savings & Loan Associations • Credit Unions • Pension Funds • Life Insurance Companies • Mutual Funds • Financial Service Corporations • Offers a diversified list of financial services (banking, insurance, etc. - e.g., Citigroup, Prudential)

  6. Sources of Funds for Corporations • External Sources:(About 60% of total sources during the 1990s) • Bonds – Largest source of external financing. • Preferred Stock – Least used external source compared to bonds and common stock. • Common Stock • Internal Sources: (About 40% of total sources during the 1990s) • Retained Earnings – Increases in highly profitable years. • Cash Flow from Depreciation – Increases as a percentage of internal sources generated during years of low profitability.

  7. SECURITIES MARKETS • New York Stock Exchange (NYSE) • American Stock Exchange (AMEX) • Regional Exchanges • Foreign Exchanges • Over-The-Counter Markets

  8. New York Stock Exchange (NYSE) • Largest and most important of all exchanges. • Number of members (seats) - exceeds 1,300 • Commission Brokers - About half of the members - (Buy and sell orders placed by the public). Merrill Lynch is an example. • Specialists – A substantial number of the members (each stock is assigned to a specialist). • In addition to stock, there are hundreds of bonds listed on the NYSE. • Stringent listing requirements in terms of earnings, assets, number of shares outstanding, etc.

  9. AMERICAN STOCK EXCHANGE (AMEX) • The “other” national exchange. • Dollar volume of trading is only a small percentage of that on the NYSE. • Listing requirements are less stringent than the NYSE

  10. REGIONAL EXCHANGES • Chicago, Pacific, Philadelphia, Boston • About 90% of the stocks are dually listed on the NYSE • Composite Transactions • In the Wall Street Journal, dually listed stocks on the regional exchanges are reported on the NYSE or AMEX.

  11. OVER-THE-COUNTER MARKETS(Unlisted Securities) • Several thousand stocks are actively traded. • Supervised by the NASD (National Association of Securities Dealers) • NASDAQ (Automated Quotations) • Biggest Companies - National Market List • Others - Supplemental Lists • Merged with the AMEX in 1998 (NASDAQ – Amex Market Group) • Referred to as a screen-based market (no physical location – trading via computers.)

  12. OVER-THE-COUNTER MARKETS(Continued) • Most bonds are traded OTC. In fact, U.S. Govt issues make OTC the largest securities market of all in total dollars. NYSE, however, is the largest for stocks. • Online Trading Systems • Electronic Communications Networks (ECNs) • Instinet is the largest.

  13. MARKET INDICES • Dow Jones Industrial Average • 30 large widely held companies • S&P 500 • 500 large-cap companies • NASDAQ • More than 5000 companies • Many high tech stocks • Wilshire 5000 • Includes more than 7000 U.S. equity securities

  14. MARKET INDICES(Continued) • Russell 2000 • A widely used “small stock” index. • Numerous International Indices • Many “specialized” indices • Utilities • Banks • Etc.

  15. Equilibrium and Disequilibrium in the Stock Market Expected Return Appropriate Risk/Return Tradeoff Underpriced Overpriced In Equilibrium Risk

  16. Efficient Market Hypothesis • The Hypothesis in General: Securities are always in a state of equilibrium. They are neither undervalued nor overvalued. • Weak Form of the Hypothesis: Security prices fully reflect past market data (e.g., prices, volume, odd lots, etc.) • Semistrong Form of the Hypothesis: Security prices fully reflect all publicly available information. • Strong Form of the Hypothesis: Security prices fully reflect all information (public and insider). • Empirical Evidence: With some exceptions, markets tend to be fairly efficient in the weak and semistrong sense, but definitely inefficient in the strong sense.

  17. Regulation of Security Markets • Securities Act of 1933 • Provide full disclosure of information regarding new issues of securities (primary market) • Securities Exchange Act of 1934 • Created the Securities and Exchange Commission • Regulates trading in the securities markets (secondary market) • Controls insider trading • Securities Acts Amendments of 1975 • Develop a central market place (national securities market)

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