Copyright © 2003 South-Western/Thomson Learning All rights reserved. Chapter 2 The Creation of Financial Assets

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Transfer of Funds from Savers to Business Income that is saved is subsequently invested The process of investing creates financial claims Financial claims are either –debt –equity

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Direct Transfer The saver has a claim (debt or equity) on the issuer The issuer receives the money Corporation General Public (Savers) Security Money

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Indirect Transfer through a Financial Intermediary The saver has a claim on the financial intermediary The financial intermediary has a claim on the ultimate user of the funds Financial Intermediary General Public (Savers) Account Money

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Private Placement Direct sale of securities Eliminates selling costs Features can be tailor made for both parties

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Sale of New Securities to the General Public Initial public offerings (IPOs) The role of investment bankers

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Sale of New Securities To the General Public The mechanics of security underwriting –the originating house or managing underwriter –the guaranteed sale - firm commitment –underwriter bears the risk –the syndicate

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Sale of New Securities To the General Public The mechanics of security underwriting –underwriting discount –prospectus Best effort agreements –issuing firm bears the risk

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Pricing an IPO Underpricing leads to windfall gains to initial buyers Overpricing inflicts losses on initial buyers and the investment bankers Tendency to underprice to assure a successful sale

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Price Volatility of IPOs Prices can rise dramatically Many firms eventually fail Few investors get to participate in an IPO

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Regulation of Initial Public Offerings Registration of new securities The prospectus Securities and Exchange Commission (SEC) The shelf-registration The lock-up

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Financial Intermediaries and Investment Bankers Differ Financial intermediaries create claims on themselves Investment bankers –facilitate the sale of new securities –do not create claims on themselves

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Variety of Financial Intermediaries Commercial banks Savings and loan associations Mutual savings banks Credit unions Life insurance companies

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Variety of Financial Intermediaries Pension plans Money market mutual funds

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Financial Intermediaries Each financial intermediary creates claims on itself and transfers funds from savers to –firms –governments –people who need funds

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Depository Financial Institutions The Depository Institutions Deregulation and Monetary Control Act of 1980 Subject to the regulation of the Federal Reserve

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Regulation Covers Types of deposits each intermediary may issue Amounts that must be held in reserve against deposits

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Federal Deposit Insurance Corporation (FDIC) Insures accounts up to specified limit Another source of regulation

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Regulatory Trends The consolidation of regulation through the Federal Reserve The increased ability to issue various types of accounts Reduced or blurred the distinctions among the different types of depository institutions

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Money Market Mutual Funds A specialized investment company Makes only short-term investments Acquires money market instruments Shares in money funds have become popular investments

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Money Market Mutual Funds

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Money Market Instruments Certificates of deposit (CDs) Negotiable CDs Eurodollar CDs U.S. Treasury bills

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Money Market Instruments Commercial Paper Repurchase agreements (repos) Bankers' acceptances Tax (or revenue) anticipation notes

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Money Market Instruments These instruments are –safe –liquid Offer competitive short-term rates