Financial Management and Securities Markets

Financial Management and Securities Markets

Chapter 16

Chapter 16 Learning Goals

• How do finance and the financial manager affect the firm’s overall strategy?

• What types of short-term and long-term expenditures does a firm make?

• What are the main sources and costs of unsecured and secured short-term financing?

• What are the key differences between debt and equity, and the major types and features of long-term debt?

• When and how do firms issue equity, and what are the costs?

Chapter 16 Learning Goals (cont’d.)

• How do securities markets help firms raise funding, and what securities trade in the capital markets?

• What are the major U.S. securities exchanges and how are they regulated?

• What are the current developments in financial management and the securities markets?

Learning Goal 1• How do finance and the financial manager affect the firm’s

overall strategy? – Finance involves managing firm’s money– Financial manager decides

• How much money is needed and when• How best to use the available funds• How to get the required financing

– Financial manager’s responsibilities• Financial planning• Investing (spending money)• Financing (raising money)

– Goal of the financial manager • Maximize the value of the firm

Financial managementFinancial management::

The art & science of managing a firm’s money so that it can meet its goals

Cash Flow Through a Business

$$

Borrowedfunds Sale of

fixed assets

Collection ofaccounts receivable

Payment ofexpenses

Purchase ofinventory

Payment ofdividends

Purchase offixed assets

Cash sales

Owners’investment

Learning Goal 2• What types of short-term and long-term

expenditures does a firm make?– Short-term expenditures

• Supplies• Inventory• Wages

– Long-term expenditures • Fixed assets

– Land– Buildings– Equipment

• Projects are carefully analyzed by financial managers to determine which offer best returns

How Organizations Use Funds

• short-term expenses– cash management– accounts receivable– inventory

• long-term expenditures– capital expenditures– capital budgeting

Learning Goal 3• What are the main sources and costs of unsecured

and secured short-term financing?– Main sources of unsecured short-term financing

• Trade credit

• Bank loans

• Commercial paper

– Secured short-term financing• Require pledge of assets as security for loan

• Selling accounts receivable outright at a discount

Obtaining Short-term Financing

• unsecured short-term loans– trade credit, bank loans, commercial paper

• secured short-term loans– collateral, factoring

Learning Goal 4• What are the key differences between debt and

equity, and the major types and features of long-term debt? – Debt financing

• Interest is tax-deductible

• Requires payment of interest and principal on specified dates

– Equity• Common and preferred stock

• Permanent form of financing

• Firm may or may not pay dividends

• Dividends are not tax-deductible

Learning Goal 4 (cont’d.)• What are the key differences between debt and

equity, and the major types and features of long-term debt? – Long-term debt

• Types– Term loans

» Secured or unsecured

» 5- to 12-year maturity

– Bonds» 10- to 30-year maturity

– Mortgage loans» Secured by real estate

Learning Goal 5• When and how do firms issue equity, and what are the costs?

– Chief sources of equity financing• Common stock

– Cost includes issuing costs and potential dividend payments

• Retained earnings– Profits reinvested in firm

• Preferred stock– More expensive than debt– Dividends not tax-deductible– Claims are secondary to those of debtholders– Less expensive than common stock

• Venture capital– Often a source of equity financing for young companies

Raising Long-term Financing

• debt financing– financial risk– term loan, bonds, mortgage loan

• equity financing– common stock, dividends, retained earnings,

preferred stock, venture capital

Debt vs. Equity Financing

Management

Claim on income & assets

Maturity

Tax treatment

DebtDebtcreditors have none

greater claim

stated maturity

interest is deductible

EquityEquitystockholders

vote

residual claim

no maturity

dividends not deductible

Learning Goal 6• How do securities markets help firms raise funding,

and what securities trade in the capital markets? – Securities markets

• Allow stocks, bonds, and other securities to be bought and sold quickly and at a fair price

• New issues are sold in primary market• Securities are traded in secondary market

– Investment bankers• Specialize in issuing and selling new security issues

– Stockbrokers• Licensed professionals who buy and sell securities on behalf of

their clients

SecuritiesSecurities::

Investment certificates issued by corporations or governments that represent either equity or debt

Types of Securities Markets

• Primary– new securities sold to the public– issuer gets proceeds

• Secondary– already issued securities are traded– stock exchanges, commodities exchanges, over-

the-counter market

Other Popular Securities

• U.S. Government securities and municipal bonds

• Mutual funds– pools investors’ funds

• Futures contracts

• Options

Learning Goal 7• What are the major U.S. securities exchanges and how are they regulated?

– Securities are resold on:

• Organized stock exchanges, such as the New York Stock Exchange• Regional stock exchanges• Over-the-counter market

– Securities markets are regulated by• Securities Act of 1933

– Requires disclosure of important information on new securities issues

• Securities Exchange Act of 1934 and 1964 amendment– Formally empowered the SEC to regulate organized securities exchanges and over-the-

counter market

• Investment Company Act of 1940– Places investment companies such as mutual funds under SEC control

• Self-regulatory groups such as the NASD• “Circuit breakers” to halt trading if the Dow Jones Industrial Average drops rapidly

Securities Exchanges

• Organized stock exchanges– re-sell securities in an auction-type format

– US stock exchanges• New York Stock Exchange

• American Stock Exchange

– Global trading & foreign exchanges

• Over-the-Counter Market– electronic-based Nasdaq

Securities Exchanges: NYSE

• To prevent a fast crash, the New York Stock Exchange has several “circuit breakers”– a 1,100-point drop1,100-point drop stops trading for

1 hour if it occurs before 2:00 pm– a 2,250-point2,250-point dropdrop stops trading for

2 hours if it occurs before 1:00 pm– a 3,350-point3,350-point dropdrop stops trading for the rest of

the day

Source: Associated Press in The Arizona Republic, Jan. 3, 2000, pg. D3.

Learning Goal 8• What are the current developments in financial

management and the securities markets? – Financial managers are spending more time on risk

management• Identifying and evaluating risks

• Selecting techniques to control and reduce risk

– Securities markets and the investment industry are changing considerably

• New York Stock Exchange no longer dominates equity market activity

• Nasdaq is challenging the Big Board

• Emergence of electronic exchanges