1. 2 The Domestic and International Financial Marketplace ©2006 Thomson/South-Western

2. 2 Introduction This chapter looks at the domestic and international financial marketplaces that allocate scarce resources.

3. 3 Finance Decisions Affecting SWM Form of business organization Types of financing Investment projects All based on after-tax cash flow

4. 4 Implication Of Income Taxes For Financial Managers Capital structure policy  Tax advantage of debt financing Dividend policy  Capital gains vs. Dividend policy Capital budgeting  After-tax CFs, Depreciation, Net present value (NPV) Leasing  Motivated by tax effects

5. 5 Corporate Tax Rates Progressive  The average tax rate increases for increasing levels of income. Marginal  The tax rate on the next dollar of income  Marginal tax rate used in text 40% = State + Fed http://www.tax.org/

6. 6 Corporate Tax Rates

7. 7 Net Savers Become Investors Credit Unions Primary and Secondary Markets Sole Proprietorship Partnership Corporations Financial Markets Savings Institution Mutual Funds Pension Funds Insurance Companies Financial Institutions Financial Companies Banks Supply Funds Money Markets Capital Markets The National Financial System

8. 8 Saving and Investment http://www.bea.doc.gov/bea/pubs.htm

9. 9 Flow of Funds

10. 10 Primary Market Investment banks help corporations sell new security issues Underwrite  Guarantee sale at a fixed price Best effort  No guarantee of sale

11. 11 Secondary Market Listed exchanges  Designated place of business  Requirements of securities listed or traded Over-the-counter (OTC) market  Networks connected by communications  Dealers post prices to buy and sell Stock market indexes  DJIA, DJTA, S&P 500, NASDAQ

12. 12 Financial Intermediaries Commercial Banks Thrift Institutions Investment Companies Pension Funds Insurance Companies Finance Companies

13. 13 Security Exchanges Listed exchanges  New York Stock Exchange  American Stock Exchange  Chicago, Pacific, Philadelphia, Boston, Cincinnati exchanges Over the counter markets

14. 14 Regulations State  Blue sky laws Federal  Securities Act of 1933 & 1934  Securities & Exchange Commission (SEC)  Ethical issues Insider trading  SEC attempts to prevent profiting from unpublished information. http://www.uncle-sam.com/

15. 15 Global Financial Transactions Import Export Foreign Branch Licensing Arrangements Joint Ventures Multinational Corporations ManufacturingDistribution International Finance

16. 16 Global Risks Fluctuating exchange rates Government regulations Tax laws Business practices Political environment

17. 17 Eurocurrency Market Eurocurrency  Currency deposited outside of the country of origin Eurodollars  Dollars deposited outside of the United States Euro  A new currency created by many European countries  The euro is not the same as Eurocurrency. http://www.xe.com/euro.htm

18. 18 Some Important Terms Exchange rate Direct quote Indirect quote Spot rate Forward exchange rate http://www.futuresmag.com/

19. 19 Forward Exchange Rates Exchange rates for currencies delivered at some future date, i.e., 30, 90, or 180 days Premium  Where spot rate is expected to increase in the future Discount  Where spot rate is expected to decrease in the future

20. 20 Annualized Forward Premium Or Discount 100% # of months forward 12 Spot rate Forward rate – Spot rate  

21. 21 Foreign Currency Futures Foreign currency futures contract Standard amount of currency Standard future time At a price set at the present time Contracts traded on Chicago Mercantile Exchange (CME)

22. 22 Foreign Currency Options A call is the right to buy a currency. A put is the right to sell a currency.

23. 23 European and American Options What is the difference between an American and European option?  You can exercise an American option anytime until expiration.  The European option can be exercised only at expiration.

24. 24 Market Efficiency “Glue” that bonds the PV of a firm’s net cash flow to shareholders’ wealth Capital markets are efficient if prices instantaneously and fully reflect all the risk and economically relevant information about a security’s prospective returns.

25. 25 Stock Prices

26. 26 Three Degrees Of Market Efficiency Weak form Semi-strong form Strong form

27. 27 Weak Form Security prices fully reflect all historical information. No investor can earn excess returns using historical prices or returns.

28. 28 Semi-Strong Form Security prices fully reflect historical and publicly available information. No investor can earn excess returns based on an investment strategy using public information.

29. 29 Strong Form Security prices fully reflect all historical, public, and private information. Markets are quite efficient!

30. 30 Implications For Financial Managers Timing or gambling An expected NPV of zero Corporate diversification expensive Security price adjustment Behavioral finance perspective

31. 31 New Thinking About Behavioral Finance Evidence of irrational behavior exists Explanation?  Self-delusion  Herding

32. 32 Barriers To Market Efficiency Outside The United States Foreign exchange risk Legal restrictions on investments Taxation policies discourage capital flows. High transaction costs Political risks of expropriation

33. 33 Holding Period Rate Of Return HPR The return from holding an investment for one period

34. 34 Equation 100%  Beginning price Ending price – Beginning price + Distributions % HPR =

35. 35 Returns Ex post = realized (after the fact) Ex ante = expected (before the fact)