Chapter 2Fundamentals of
Corporate FinanceFourth Edition
The Financial Environment
PRESENTED BYD-R EVGENI ZOGRAFSKI
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Topics Covered
The Flow of Savings to CorporationsFunctions of Financial MarketsFunctions of Financial Intermediaries
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The Flow of Savings to Corporations
The ultimate source of financing is individual’s savings
Two forms of financing: internal and externalInternal-retained cash and selling new sharesExternal-loans and bonds
Savings flow through financial markets (stock exchanges) and financial intermediaries (mutual funds, pension funds, insurance companies)
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Financial
Manager
Firm's
operations
Investors
(1) Investors buy shares with cash
(1)
(2)Cash is invested
(2)
(3) Timber harvest generates cash
(3)
(4a) Cash reinvested
(4a)
(4b) Cash returned to investors
(4b)
The Flow of Savings to Corporations
Real assets
(timberland)
(stockholders save and invest in closely held firm.)
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Financial Markets
Financial market-a market where securities are issued and traded Securities – a traded financial assets (shares; bonds) Shares-a proportion of ownership claim on the firm, with no
maturity Bonds-debt securities issued by a company representing a
obligation to investors to make regular interest payments and principal on a specified date in the future
Stock market (stock exchange) is the most important financial market
Stock market or equity market – trading own common equity (ordinary shares) of the firm
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Financial Markets
Primary market- market for sale of new issue of securities (shares, bonds); its organized in banks, brokerage co. (outside the exchange)
Secondary market - market in which previously issued securities are traded among investors
Secondary market: Stock exchange and OTC Stock exchange-organized market for trading securities OTC-over the counter market
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Financial Markets
Primary
Markets
Secondary
Markets
OTC
Markets
Money
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Other Financial Markets
Fixed income market-market for debt securities (bonds)
Capital market- market for long-term financingMoney market- market for short-term financing
(less than 1 year)Foreign-exchange market- inter bank market for
trading foreign currenciesCommodities market- organized market for trading
commodities (corn, wheat, cotton, oil)Derivatives market- organized market for trading
derivatives (options, futures, warrants, forwards, swaps)
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Financial Markets
Company
Issue Debt
CashInvestors
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Financial Intermediaries
Financial intermediaries- an organization that rises money from investors and provide financing for individuals, companies e t.c.mutual funds,pension funds,insurance co., banks
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Mutual Funds
Mutual funds- pools the savings of many investors and invests in a portfolio of securities; mutual funds offer investors low-cost
diversification and professional management;Two types: Open-end funds and Close-end fundsfunds pursue a wide variety of investment
strategies (only stocks, only bonds, only dot.com.co’s,high-tech growth stocks, mixture of stock and bonds “balanced” funds, funds of funds)
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Mutual Funds
Bank of AmericaBank of America
Windsor Fund
Windsor Fund
Investors
Investors
$ $
Sells shares
Issues shares
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Pension Funds
Pension funds- investment plan set up by employer (companies) for providing employees retirementDefined contribution pension plan (a % of
monthly pay is contributed to a pension fund-partly by employer, partly by employee)
Defined benefit pension plan (the employer invest to the pension fund)
Tax advantagesMacedonian experience
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Other financial institutions
Insurance companies- sells insurance policies and with cash finance companies
Banks- collect deposits and lend money to individuals and companies (short term and long term loans)
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Functions of Financial Markets
Financial markets and intermediaries channel savings to real investment
Financial markets and intermediaries provide financing for business
Other functionsTransporting cash across time Provide liquidityReduce and reallocate risk
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Financial Markets
Funds
Funds
Banks
Insurance Cos.
Brokerage Firms
Obligations
Depositors
Policyholders
Investors
Obligations
Company
Intermediary
Investor
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Financial Markets
Banks
Depositors
$2.5 mil
Cash
Loan
Deposits
Company
Intermediary
Investor
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Financial Markets
Insurance Company
Policyholders
$250 mil
Cash
Loan
Sell policies Issue Stock
Company
Intermediary
Investor
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Information Provided by Financial Markets
Securities and commodity pricesInterest ratesCompany values
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Opportunity Cost of Capital
Cost of capital- minimum acceptable rate of return of invested capital;
The cost of capital for corporate investment is set by the rates of return on investment opportunities in financial market; it’s an opportunity cost-the safest form of investment (yield on treasury bills)
Investment projects offering higher return that the cost of capital are acceptable
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Key Words
Securities-hartii od vrednostShares(Stocks)-akciiBonds-obvrzniciDerivatives-derivati na hartii od
vrednost(opcii,fju~ersi)Stock market (stock exchange)-berzaMutual fund-investicionen fondOpportunity cost of capital-oportunitetna
stapka na povrat na kapitalot
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Web Resources
www.nyse.com
www.nasdaq.com
www.federalreserve.gov/releases/h15/update
www.investorlinks.com
www.indexfunds.com
www.morningstar.com
Click to access web sitesClick to access web sites
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