1. The Creation of Financial Assets
Chapter 2
The Creation of
Financial Assets

2. Forms of Business Sole proprietorships Partnerships
Limited partnerships
General partners
Limited partners

3. Corporations Charter from a state Bylaws
Relationship between firm and stockholders (owners)

4. S corporations and limited liability companies (LLC)
Advantages of
Limited liability
Permanence
Transfer of title
S corporations and limited liability companies (LLC)

5. Importance of liquidity
The Role of Money
Medium of exchange
Importance of liquidity

6. 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

7. Money Supply
M-2 is a broader definition
M-2 is not affected by shifting funds between checking and savings accounts

8. The Role of Interest Rates
Allocate scarce credit
Short-term / Money market
Long-term / Capital market

9. Structure of Yield
Yield curve
Generally long-term implies higher rates (positively sloped yield curve)

10. Time and Yields
Positively sloped yield curve

11. Time and Yields
Negatively sloped yield curve

12. 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

13. 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

14. 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

15. Issuing and Selling New Securities
Difference between
Primary markets - the first sale
Secondary markets - subsequent sales

16. The Sale of New Securities to the General Public
Initial public offerings (IPOs)
The role of investment bankers

17. Underwriting
Firm commitment
The guaranteed sale
Underwriter bears the risk

18. The Sale of New Securities To the General Public
Best effort agreements
issuing firm bears the risk

19. 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

20. Regulation of Initial Public Offerings
Registration of new securities
The prospectus
Securities and Exchange Commission (SEC)
The shelf-registration

21. 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

22. The Price Volatility of IPOs
Prices can rise dramatically
Many firms eventually fail
Few investors get to participate in an IPO

23. 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

24. Information filed with the SEC
Shelf Registration
Information filed with the SEC
Flexibility
Securities sold when funds are needed

25. The Private Placement
Direct sale of securities
Reduces selling costs
Features can be tailor made for both parties

26. Financial Intermediaries
Middleman
Creation of Claims

27. Financial Intermediaries
Each financial intermediary creates claims on itself and transfers funds from savers to
firms
governments
people who need funds

28. 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

29. Assets and Liabilities
Commercial Bank’s
Assets and Liabilities
Importance of loans
Importance of deposit liabilities
Small equity base

30. Variety of Deposits
Demand deposits (checking accounts)
Savings account
Certificates of deposits
Negotiable CDs

31. Reserves
Required reserves
Excess reserves
Secondary reserves

32. Regulation of Depository Institutions
The Depository Institutions Deregulation and Monetary Control Act of 1980
Subject to the Regulation of the Federal Reserve

33. Federal Deposit Insurance Corporation (FDIC)
Insures accounts up to specified limit
Another source of regulation of banks
Add stability to the banking system

34. 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)

35. Life Insurance Companies and Pension Plans
Alternatives for savings
May serve as financial intermediaries

36. 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

37. The Money Market Instruments
Certificates of deposit (CDs)
Negotiable CDs
U.S. Treasury bills

38. The Money Market Instruments
Commercial Paper
Repurchase agreements (repos)
Bankers' acceptances
Tax (or revenue) anticipation notes
Eurodollar CDs

39. The Money Market Instruments
These instruments are
safe
liquid
Offer competitive short-term rates