The Creation of Financial Assets Chapter 2 The Creation of Financial Assets
Forms of Business Sole proprietorships Partnerships Limited partnerships General partners Limited partners
Corporations Charter from a state Bylaws Relationship between firm and stockholders (owners)
S corporations and limited liability companies (LLC) Advantages of Limited liability Permanence Transfer of title S corporations and limited liability companies (LLC)
Importance of liquidity The Role of Money Medium of exchange Importance of liquidity
M-1 sum of cash, coin, and checking accounts Money Supply M-1 sum of cash, coin, and checking accounts M-2 sum of cash, coin, checking accounts, plus savings accounts
Money Supply M-2 is a broader definition M-2 is not affected by shifting funds between checking and savings accounts
The Role of Interest Rates Allocate scarce credit Short-term / Money market Long-term / Capital market
Structure of Yield Yield curve Generally long-term implies higher rates (positively sloped yield curve)
Time and Yields Positively sloped yield curve
Time and Yields Negatively sloped yield curve
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
The saver has a claim (debt or equity) on the issuer The Direct Transfer Security General Public (Savers) Corporation Money The saver has a claim (debt or equity) on the issuer The issuer receives the money
The Indirect Transfer through a Financial Intermediary Account General Public (Savers) Financial Intermediary Money The saver has a claim on the financial intermediary The financial intermediary has a claim on the ultimate user of the funds
Issuing and Selling New Securities Difference between Primary markets - the first sale Secondary markets - subsequent sales
The Sale of New Securities to the General Public Initial public offerings (IPOs) The role of investment bankers
Underwriting Firm commitment The guaranteed sale Underwriter bears the risk
The Sale of New Securities To the General Public Best effort agreements issuing firm bears the risk
The Sale of New Securities to the General Public The mechanics of security underwriting the originating house or managing undewriter the syndicate the underwriting disconnect
Regulation of Initial Public Offerings Registration of new securities The prospectus Securities and Exchange Commission (SEC) The shelf-registration
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
The Price Volatility of IPOs Prices can rise dramatically Many firms eventually fail Few investors get to participate in an IPO
Financial Intermediaries and Investment Bankers Differ Financial Intermediaries create claims on themselves (e.g. a savings account) Investment bankers facilitate the sale of new securities do not create claims on themselves
Information filed with the SEC Shelf Registration Information filed with the SEC Flexibility Securities sold when funds are needed
The Private Placement Direct sale of securities Reduces selling costs Features can be tailor made for both parties
Financial Intermediaries Middleman Creation of Claims
Financial Intermediaries Each financial intermediary creates claims on itself and transfers funds from savers to firms governments people who need funds
The Variety of Financial Intermediaries Commercial Banks Savings and loan associations Mutual savings banks Credit unions Life insurance companies Pension plans Money market mutual funds
Assets and Liabilities Commercial Bank’s Assets and Liabilities Importance of loans Importance of deposit liabilities Small equity base
Variety of Deposits Demand deposits (checking accounts) Savings account Certificates of deposits Negotiable CDs
Reserves Required reserves Excess reserves Secondary reserves
Regulation of Depository Institutions The Depository Institutions Deregulation and Monetary Control Act of 1980 Subject to the Regulation of the Federal Reserve
Federal Deposit Insurance Corporation (FDIC) Insures accounts up to specified limit Another source of regulation of banks Add stability to the banking system
Regulatory Trends The consolidation of regulation through the Federal Reserve Reduced or blurred the distinctions among the different types of depository institutions and other financial institutions (e.g., brokerage and insurance firms)
Life Insurance Companies and Pension Plans Alternatives for savings May serve as financial intermediaries
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
The Money Market Instruments Certificates of deposit (CDs) Negotiable CDs U.S. Treasury bills
The Money Market Instruments Commercial Paper Repurchase agreements (repos) Bankers' acceptances Tax (or revenue) anticipation notes Eurodollar CDs
The Money Market Instruments These instruments are safe liquid Offer competitive short-term rates