An Overview of the Financial System

Chapter 2

By: Juliya Andrushchak and Ronald Huang

Web Exercises1.

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DJIAM 1系列

Web Exercise2. a). Dow will increase value from 13,074 to

13,187 in three months

b). 0.8643% increase

AT&T Brief History

 

 

AT&T Timeline – 1876 to 2001

    AT&T issues its stock McCaw acquired   $35.5 Bill invested in Spinoff the wireless

    in an IPO (AT&T Wireless)   acquisitions & upgrades unit

1876 - Founded 1984 1994   1996-2000 2001

                   

                     

  1877 1991 1995   2000  

  Bell formed and stock AT&T acquires NCR Restructuring - Splitoff   Issued a tracking stock  

  issued to 7 shareholders       Lucent   for AT&T Wireless  

            NCR        

            AT&T        

                     

Debt - bank loan or AT&T - shares sold on Need more funds   Corporate (convertible) No cash generated,

private borrowing NYSE and Munich ($11.5 billion)   bond, foreign bond divestiture

                   

                     

  IPO - Bell financed Borrow funds and Divestiture   Receive cash, tax free,  

  through equity acquire new assets Issue different shares   new share class  

      ( $7.3 billion)            

 

 

• Debt – finance the using a bank loan (indirect finance) or borrow privately (direct finance)

• A. Graham was the borrower-spender

• Equity – seven original shareholders held the stock after the IPO. Deal details worked out with a broker (no underwriting in this case)

Post-Divestiture Events

• AT&T issues its own stock on the primary market. Shares are traded on NYSE and Munich exchanges. The new company is valued at $34 bill from the total of $149.5 bill. Shares traded on the secondary market.

• Equity issued through an investment bank. • Divestiture – anti-trust lawsuit; monopoly

issues.

Classifications of Financial Markets

Secondary Markets Exchanges• Trades conducted in central locations

(e.g., Toronto Stock Exchange and New York Stock Exchange)

Over-the-Counter Markets• Dealers at different locations buy and sell

Subsequent Restructurings

• NCR acquired for $7.3 bill. Finance through long-term debt (commercial paper, and convertible corporate bonds, bearer form or registered, foreign bonds) and secondary issues.

• Use short- and medium-term debt for cash needs, and invest excess funds in money market securities and other liquid financial instruments. Adopt a dividend policy.

• Investment of $35 billion made from 1996-2000 in acquisitions and upgrades – major need for financing.

Classifications of Financial Markets

Debt Markets• Short-term (maturity < 1 year) – the

Money Market

• Long-term (maturity > 10 year) – the Capital Market

• Medium-term (maturity >1 and < 10 years)

Stock Issues and Restructurings

• 1995 – split off into three separate companies: NCR, AT&T, and Lucent.

• 2000 – issued a tracking stock to track the performance of the wireless division. Created a different stock class.

• 2001 – spun off AT&T Wireless to the current shareholders. Distributed as a dividend.

• 2005 – proposed merger with SBC.

Financial Market Instruments•Stock- equity claims in the net income and assets of a corporation •Mortgages- loans to households or firms to purchase housing, land, or other real structures, where the structure or land serves as collateral for the loans. •Corporate Bonds- long term bonds issued by corporations with very strong credit ratings

•Gov’t of Canada Bonds- are issued by the federal government to finance its deficit.

Other:•Canada savings bonds•Provincial and municipal bonds•Government agencies securities

Internationalization of Financial Markets

International Bond Market• Foreign bonds - sold in a foreign country and

denominated in that country• Eurobonds – denominated in a currency

other than the country in which it is sold • Eurocurrencies – foreign currencies

deposited in banks outside the home country

World Stock Markets

Transactions Costs• Financial intermediaries make profits by reducing

transactions costs. • They reduce transactions costs by developing

expertise and taking advantage of economies of scale.

Risk Sharing• Create and sell assets with low risk characteristics

and then use the funds to buy assets with more risk (also called asset transformation)

• Lower risk by helping people to diversify portfolios

Asymmetric Information

Adverse Selection• Before transaction occurs• Potential borrowers most likely to produce

adverse outcomes are ones most likely to seek loans and be selected

Moral Hazard• After transaction occurs• Hazard that borrower has incentives to

engage in undesirable activities making it more likely that loan won’t be paid back

Financial Intermediaries

Size of Financial Intermediaries

Regulation of Financial Markets

Regulation of Financial Markets

Primary Reasons for Regulation1. Increase information to investors

- Decreases adverse selection and moral hazard problems

- Securities commissions force corporations to disclose information

2. Ensuring the soundness of intermediaries- Prevents financial panics- Restrictions on entry/assets/activities, disclosure,

deposit insurance, limits on competition

Financial Intermediaries: Keywords

Diversification

Creditworthiness

Asset Transformation

Risk Sharing

Problem of Assymetric Information

Economies of Scale

Provide Liquidity Services

Lower Transaction Costs

Financial Intermediaries

Any Questions?