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
securities

firm

Movement of Savings
Indirect Transfer using Investment Banker
funds
saver
investment
banker
securities

firm

Movement of Savings
Indirect Transfer using Investment Banker
funds

funds

saver
investment
banker
securities

firm

Movement of Savings
Indirect Transfer using Investment Banker
funds

funds

saver
investment
banker
securities

securities

firm

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
securities

firm

Movement of Savings
Indirect Transfer using a Financial Intermediary
funds

saver

financial
intermediary
firm
securities

firm

Movement of Savings
Indirect Transfer using a Financial Intermediary
funds

saver

funds

financial
intermediary
firm
securities

firm

Movement of Savings
Indirect Transfer using a Financial Intermediary
funds

saver

funds

financial
intermediary

intermediary
securities

firm
securities

firm

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 firms 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 firms 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?

Its 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.