Chapter 14 - Raising Capital

in the Financial Markets

Q: What are SECURITIES?

A: Financial Assets that

Investors purchase hoping to
earn a high rate of return.
 Types of Securities
 Treasury Bills and Treasury Bonds
 Municipal Bonds
 Corporate Bonds
 Preferred Stocks
 Common Stocks
Which of these are RISKY?
Which promise HIGH RETURNS?
Is there a relationship between RISK
and RETURN?
 Corporate Financing
Sources
From 1999 through 2001, capital has been
raised through the following sources:

 Corporate Bonds and Notes 76.9%

 Equities 23.1%
 Movement of Savings
 Direct Transfer of Funds
 Movement of Savings
 Direct Transfer of Funds

saver
 Movement of Savings
 Direct Transfer of Funds

firm
saver
 Movement of Savings
 Direct Transfer of Funds
cash
firm
saver
 Movement of Savings
 Direct Transfer of Funds
cash
firm
saver

securities
 Movement of Savings
 Indirect Transfer using Investment Banker
 Movement of Savings
 Indirect Transfer using Investment Banker

investment
banker
 Movement of Savings
 Indirect Transfer using Investment Banker

investment
banker firm
 Movement of Savings
 Indirect Transfer using Investment Banker
funds

investment
banker firm
 Movement of Savings
 Indirect Transfer using Investment Banker
funds

investment
banker firm

securities
 Movement of Savings
 Indirect Transfer using Investment Banker
funds

saver

investment
banker firm

securities
 Movement of Savings
 Indirect Transfer using Investment Banker
funds funds

saver

investment
banker firm

securities
 Movement of Savings
 Indirect Transfer using Investment Banker
funds funds

saver

investment
banker firm

securities securities
 Movement of Savings
 Indirect Transfer using a Financial Intermediary
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

financial
intermediary
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

financial
intermediary firm
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

funds

financial
intermediary firm
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

funds

financial
intermediary firm
firm
securities
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

funds

saver financial
intermediary firm
firm
securities
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

funds funds

saver financial
intermediary firm
firm
securities
 Movement of Savings
 Indirect Transfer using a Financial Intermediary

funds funds

saver financial
intermediary firm
intermediary firm
securities securities
Financial Market Components
Public Offering
Financial Market Components
Public Offering
 Firm issues securities, which are
made available to both individual
and institutional investors.
Financial Market Components
Public Offering
 Firm issues securities, which are
made available to both individual
and institutional investors.
Private Placement
Financial Market Components
Public Offering
 Firm issues securities, which are made
available to both individual and
institutional investors.
Private Placement
 Securities are offered and sold to a
limited number of investors.
Financial Market Components
Primary Market
Financial Market Components
Primary Market
 Market in which new issues of a
security are sold to initial buyers.
Financial Market Components
Primary Market
 Market in which new issues of a
security are sold to initial buyers.
Secondary Market
Financial Market Components
Primary Market
 Market in which new issues of a
security are sold to initial buyers.
Secondary Market
 Market in which previously issued
securities are traded.
Financial Market Components
Money Market
Financial Market Components
Money Market
 Market for short-term debt
instruments (maturity periods of
one year or less).
Financial Market Components
Money Market
 Market for short-term debt
instruments (maturity periods of
one year or less).
Capital Market
Financial Market Components
Money Market
 Market for short-term debt
instruments (maturity periods of one
year or less).
Capital Market
 Market for long-term securities
(maturity greater than one year).
Financial Market Components
Organized Exchanges
Financial Market Components
Organized Exchanges
 Buyers and sellers meet in one central
location to conduct trades.
Financial Market Components
Organized Exchanges
 Buyers and sellers meet in one central
location to conduct trades.
Over-the-Counter (OTC)
Financial Market Components
Organized Exchanges
 Buyers and sellers meet in one central
location to conduct trades.
Over-the-Counter (OTC)
 Securities dealers operate at many
different locations across the country.
Financial Market Components
Organized Exchanges
 Buyers and sellers meet in one central
location to conduct trades.
Over-the-Counter (OTC)
 Securities dealers operate at many
different locations across the country.
 Connected by Nasdaq system (National
Association of Securities Dealers
Automated Quotation system).
 Investment Banking

How do investment bankers help

firms issue securities?

 Underwriting the issue.

 Distributing the issue.
 Advising the firm.
 Distribution Methods
 Negotiated Purchase
 Distribution Methods
Negotiated Purchase
 Issuing firm selects an investment
banker to underwrite the issue.
 Distribution Methods
Negotiated Purchase
 Issuing firm selects an investment
banker to underwrite the issue.
 The firm and the investment banker
negotiate the terms of the offer.
 Distribution Methods
Negotiated Purchase
 Issuing firm selects an investment
banker to underwrite the issue.
 The firm and the investment banker
negotiate the terms of the offer.
Competitive Bid
 Distribution Methods
Negotiated Purchase
 Issuing firm selects an investment
banker to underwrite the issue.
 The firm and the investment banker
negotiate the terms of the offer.
Competitive Bid
 Several investment bankers bid for the
right to underwrite the firm’s issue.
 Distribution Methods
Negotiated Purchase
 Issuing firm selects an investment
banker to underwrite the issue.
 The firm and the investment banker
negotiate the terms of the offer.
Competitive Bid
 Several investment bankers bid for the
right to underwrite the firm’s issue.
 The firm selects the banker offering
the highest price.
 Distribution Methods
Best Efforts
 Distribution Methods
Best Efforts
 Issue is not underwritten.
 Distribution Methods
Best Efforts
 Issue is not underwritten.
 Investment bank attempts to sell the
issue for a commission.
 Distribution Methods
Best Efforts
 Issue is not underwritten.
 Investment bank attempts to sell the
issue for a commission.
Privileged Subscription
 Distribution Methods
Best Efforts
 Issue is not underwritten.
 Investment bank attempts to sell the
issue for a commission.
Privileged Subscription
 Investment banker helps market the
new issue to a select group of investors.
 Distribution Methods
Best Efforts
 Issue is not underwritten.
 Investment bank attempts to sell the
issue for a commission.
Privileged Subscription
 Investment banker helps market the
new issue to a select group of investors.
 Usually targeted to current
stockholders, employees, or customers.
 Distribution Methods

Direct Sale
 Distribution Methods

Direct Sale
 Issuing firm sells the securities directly
to the investing public.
 Distribution Methods

Direct Sale
 Issuing firm sells the securities directly
to the investing public.
 No investment banker is involved.
 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What type of issue is this?

 It’s a negotiated purchase.
 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 How many shares will be sold?

 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 How many shares will be sold?

 $100,000,000 / $20 = 5 million new
shares of common stock.
 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What are the flotation costs?

 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What are the flotation costs?

 Underwriting spread: 2% of $100
million = $2 million.
 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What are the flotation costs?

 Underwriting spread: 2% of $100
million = $2 million.
 Issuing costs: printing and engraving
costs; legal, accounting, and trustee fees.
 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What are the risks?

 Stock Issue Example:
Our firm needs to raise approximately
$100 million for expansion. Our stock
price is $20. We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread.

 What are the risks?

 The investment bank accepts the risk of
being able to sell the new stock issue for
$20 per share. If the stock price falls, the
investment bank could lose money.
 Regulations:
The Primary Market

The Securities Act of 1933

 Firms register with the Securities
Exchange Commission (SEC).
 SEC has 20 days to review.
 Regulations:
The Primary Market

The Securities Act of 1933

 Firms register with the Securities
Exchange Commission (SEC).
 SEC has 20 days to review.
 SEC may ask for more information.
 Regulations:
The Primary Market

The Securities Act of 1933

 Firms register with the Securities
Exchange Commission (SEC).
 SEC has 20 days to review.
 SEC may ask for more information.
 The firm cannot solicit buyers during
the review period but can advertise.
 Regulations:
The Secondary Market

The Securities Exchange Act of 1934

 Established the SEC.
 Exchanges must register with SEC.
 Company information must be
available to the public.
 Insider trading is regulated.
 Regulations:
Recent Developments

Securities Acts Amendments of 1975

 Created National Market System.
 Eliminated fixed brokerage
commissions.
SEC Rule 415
 Allows Shelf Registration