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Copyright © 2003 South-Western/Thomson Learning All rights reserved.
Chapter 2
The Creation of
Financial Assets
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
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
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Direct Transfer
• The saver has a claim (debt or equity) on the issuer
• The issuer receives the money
CorporationGeneral Public(Savers)
Security
Money
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The Indirect Transfer through a Financial Intermediary
• The saver has a claim on the financial intermediary
• The financial intermediary has a claim on the ultimate user of the funds
Financial Intermediary
General Public(Savers)
Account
Money
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The Private Placement
• Direct sale of securities
• Eliminates selling costs
• Features can be tailor made for both parties
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The Sale of New Securities to the General Public
• Initial public offerings (IPOs)
• The role of investment bankers
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The Sale of New Securities To the General Public
• The mechanics of security underwriting
–the originating house or managing underwriter
–the guaranteed sale - firm commitment
–underwriter bears the risk
–the syndicate
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Sale of New Securities To the General Public
• The mechanics of security underwriting
–underwriting discount
–prospectus
• Best effort agreements
–issuing firm bears the risk
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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
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The Price Volatility of IPOs
• Prices can rise dramatically
• Many firms eventually fail
• Few investors get to participate in an IPO
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Regulation of Initial Public Offerings
• Registration of new securities
• The prospectus
• Securities and Exchange Commission (SEC)
• The shelf-registration
• The lock-up
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Financial Intermediaries and Investment Bankers Differ
• Financial intermediaries create claims on themselves
• Investment bankers
–facilitate the sale of new securities
–do not create claims on themselves
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The Variety of Financial Intermediaries
•Commercial banks
•Savings and loan associations
•Mutual savings banks
•Credit unions
•Life insurance companies
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The Variety of Financial Intermediaries
• Pension plans
• Money market mutual funds
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Financial Intermediaries
• Each financial intermediary creates claims on itself and transfers funds from savers to
–firms
–governments
–people who need funds
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Depository Financial Institutions
• The Depository Institutions Deregulation and Monetary Control Act of 1980
• Subject to the regulation of the Federal Reserve
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Regulation Covers
• Types of deposits each intermediary may issue
• Amounts that must be held in reserve against deposits
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Federal Deposit Insurance Corporation (FDIC)
• Insures accounts up to specified limit
• Another source of regulation
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Regulatory Trends
• The consolidation of regulation through the Federal Reserve
• The increased ability to issue various types of accounts
• Reduced or blurred the distinctions among the different types of depository institutions
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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
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The Money Market Instruments
•Certificates of deposit (CDs)
•Negotiable CDs
•Eurodollar CDs
•U.S. Treasury bills
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The Money Market Instruments
• Commercial Paper
• Repurchase agreements (repos)
• Bankers' acceptances
• Tax (or revenue) anticipation notes