Fundamentals of Corporate Finance/3e,ch15

Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3eRoss, Thompson, Christensen, Westerfield and JordanSlides prepared by Sue Wright

15-1

Chapter Fifteen

Australian Financial Markets:

Short-term Financing


15-2

15.1 The Financial System

15.2 Financial Markets

15.3 Financial Intermediaries

15.4 Short-term Financing

15.5 Short-term Financing Sources

15.6 Summary and Conclusions

Chapter Organisation


15-3

Chapter Objectives• Understand the operations of the Australian financial system.

• Outline the assets traded in the listed and unlisted markets.

• Discuss the role of individual financial intermediaries.

• Understand the different current asset financing policies.

• Discuss the various short-term financing sources.


15-4

The Financial System

Saving

Lenders

Borrowing

Productive

investment

Financial markets

Financial

intermediaries


15-5

Financial Markets

Financial Markets

PrimaryMarket

SecondaryMarket

Foreign exchange marketFutures & options markets

Long-term debt marketShort-term debt market

Share markets


15-6

The Listed Market

E q u ity in ves tm en ts

B on d sD eb en tu res

an dN otes

D eb t secu rit ies

E xch an g e-trad edop tion s

F in an c ia l fu tu res

O th er lis tedin ves tm en ts

Th e lis ted m arke t

Ordinary sharesContributing sharesPreference sharesRightsCompany optionsProperty and equitytrusts


15-7

Financial Intermediaries

Type ofInstitution

MainSupervisor

Number ofInstitutions

Total assets($b)

Banks APRA 52 835Building societies APRA 17 12Credit unions APRA 201 25Merchant banks ASIC 40 86Finance companies ASIC 73 88Securitisers ASIC 113 97Life insurance APRA 33 188Friendly societies APRA 38 6Super funds APRA 11 702 331Public unit trusts ASIC 97 152General insurance APRA 97 64

Source: Council of Financial Supervisors Annual Report 2001, RBA.


15-8

Banks

• Trading banks includes activities such as deposits, loans, insurance, superannuation and stockbroking, usually through subsidiaries and affiliated companies.

• Retail banking involves transactions with the general public.

• Wholesale banking involves transactions with companies or businesses.

• Hold approximately 44 per cent of market share.


15-9

Merchant Banks

• Primarily concerned with wholesale finance.

• Responsible for the development of CMTs, rebatable preference shares, the commercial bills market, the promissory note market, the currency hedge market and the unofficial deposit market.

• Activities now include ‘investment banking’.

• Market share has decreased dramatically since the 1980s, now approximately 5 per cent.


15-10

Superannuation and Life Insurance Companies

• Crucial for the saving and provision of funds for retirement (superannuation) or ‘one-off’ events such as death, disability or trauma (insurance).

• Diversified operations to include general insurance, short-term money market dealing and merchant banking.

• Hold approximately 30 per cent of market share.


15-11

Finance Companies

• Initially responsible for the provision of hire purchase and instalment credit, financing of vehicles and home loans, lease financing and factoring.

• Funds obtained mainly through the issue of debentures.

• Deregulation in 1980s led to many finance companies’ activities being absorbed by their large parent banks.

• Market share now only approximately 6 per cent.


15-12

Building Societies and Credit Unions

• Building societies– Traditionally provide housing finance to small savers.– Diversified activities to include lending for other purposes.

• Credit unions– Pool the funds of people with common interests to provide

consumer-type financing and lending to ‘members’.

• Both have very small market share, totalling approximately 2 per cent.


15-13

Unit Trusts

• Pool funds of small investors with the aim of earning a greater return collectively than that achieved individually.

• Cash management trusts, equity trusts, property trusts, mortgage trusts.


15-14

Other Intermediaries

• Authorised foreign exchange dealers perform a full range of foreign exchange transactions.

• Australian Stock Exchange (ASX) and share brokers provide the medium for buying and selling shares and other listed securities.

• Friendly societies non-profit, state-controlled intermediaries for small groups to pool funds to be used for funerals, sickness or, simply, savings.


15-15

Financing Policy for an ‘Ideal’ Economy

Long-term debtplus ordinary shares

In an ideal world, net working capital is always zero because short-term assets are financed by short-term debt.

Time


15-16

Optimal Amount of Short-term Borrowing

Factors to consider:

• Cash reserves—reducing the probability of financial distress vs investments in zero NPV securities.

• Maturity hedging—match maturity of asset with maturity of liability.

• Relative interest rates—cheaper to have short-term borrowing than long-term borrowing.


15-17

Alternative Asset Financing Policies


15-18

A Compromise Financing Policy

With a compromise policy, the firm keeps a reserve of liquidity which it uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.


15-19

Short-term Financing• Used for:

– Working capital requirements in the day-to-day operations of the business.

– Transactions that are self-financing over short periods.

• Main providers are trading banks, merchant banks and finance companies.


15-20

Short-term Financing Sources

• Overdrafts– A credit arrangement where the bank permits the

customer to draw more money from the bank account than has been put in it, up to an agreed limit.

– Repayable on demand although this is rarely required. Interest rate is variable and account balance fluctuates between positive (deposit) and negative (loan) over the business cycle.

• Short-term loans– An advance of funds made by a financial institution for a

specific purpose, repayable over a fixed period.


15-21


Bills of exchange• A negotiable instrument requiring the payment of a specific

sum of money, either on demand or at a specified time.• Trade bills versus accommodation bills.• Three parties to a bill: drawer (borrower), acceptor (endorser)

and payee (owner).• Discounted value (price) of a bill:

00maturity/1 todays Yield 365

value Face 365


15-22


• Promissory notes– A negotiable instrument whereby the borrower promises

to repay the face value to the holder at maturity.

– Different to bills of exchange because they are unsecured (no acceptor).

– Most borrowers are well-known large organisations. There is an active secondary market.


15-23

Short-term Financing Sources• Inventory loans

– A short-term loan used specifically to purchase inventory, including a blanket inventory lien, a trust receipt and field warehouse financing.

• Letters of credit– Irrevocable and unconditional undertaking by a bank to

repay a loan if the borrower defaults.

• Short-term eurocurrency funding– Financing in a currency outside the country of issue.

• Factoring– Selling of accounts receivables to a factor.

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Fundamentals of Corporate Finance/3e,ch15

Economy & Finance