Chapter 2

Fundamentals of
Corporate Why Corporations Need
Finance Financial Markets and
Institutions
Fifth Edition

Slides by
Matthew Will

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Topics Covered

Why Finance Matters

The Flow of Savings to Corporations
Functions of Financial Markets
Functions of Financial Intermediaries
Value Maximization and Cost of Capital

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Financial Markets

Money

OTC
Primary
Markets
Markets (Over-the-
counter)
Secondary
Markets
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Financial Markets

Financing Decision
Source of Funds “Capital”
Capital Structure
Money Markets
Euros

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Financial Markets

(2) (1)
Firm's Investors
Financial
operations (4a)
Manager (stockholders
save and invest
Real assets in closely held
firm.)
(timberland) (4b)
(3)
(1) Investors buy shares with cash
(2)Cash is invested
(3) Timber harvest generates cash
(4a) Cash reinvested
(4b) Cash returned to investors

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Financial Markets

Issue Debt

Company Investors
Cash

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Financial Markets

$ $
Bank of Windsor
Investors
America Fund
Sells Issues
shares shares

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Financial Markets
Company

Banks Obligations Funds

Insurance Cos. Intermediary

Brokerage Firms
Obligations Funds
Depositors
Investor
Policyholders
Investors

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Financial Markets
Company

Loan $2.5 mil

Banks Intermediary

Deposits Cash

Investor
Depositors

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Financial Markets
Company

Loan $250 mil

Insurance
Company Intermediary

Sell policies Cash

Issue Stock

Investor
Policyholders

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Total U.S. Financing

% Holdings of Corporate and Foreign Bonds (Qtr 1, 2005)

10.3 6.9 Households

12.2 Rest of world
24.6
Banks
Insurance Cos
9.2 Pension Funds
Mutual Funds
9.1
27.7 Other

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Total U.S. Financing

% Holdings of Corporate Equities (Qtr 1, 2005)

1.2 Households
23.2
Rest of world
37.9
Banks
Insurance Cos
Pension Funds
17.4 Mutual Funds
7.6 1.3 11.1 Other

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Function of Financial Markets

Transporting cash across time

Risk transfer and diversification
Liquidity
Payment mechanism
Provide information

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U.S. Financing

Information Provided by Financial Markets

 Commodity prices
 Interest rates
 Company values

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Value of Alaska Air Group

Data as of April, 2005

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Value Maximization

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