Corporate Finance

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• Corporate Finance
• CHAPTER TWO
• J.D. Han

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Learning Objectives

• What kind of choices is a corporate financial
  manager faced with in funding a project?
• 2. What financial market instruments would he/she
  choose? What are the advantages and
  disadvantages of different funding sources?
• 4.What kind of institutional structures is the
  financial manager faced with? - Why does each
  country exhibit different characteristics in
  financial market?

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2.1 How to Fund a Corporate Project?

• 1) Where does the fund for a corporate project
  come from?
• internal financing vs
• external financing
• 2) How to do external financing?
• direct financing vs.
• indirect financing through Financial
  intermediaries
• 3) What kinds of financial instruments to
  issue?bonds loans and/or equities (stocks)

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2.2 Financial Instruments or Assets

• 2 classifications of financial
  assets(instruments)
• 1. Debt versus Equity
• Debt Bank Loans and Bonds- Contractual claims
• Equity Residual claims
• 2. Loans versus Marketable Securities
• Loans personalized
• Marketable Securities Bonds, Equities,
  Derivatives (options, swaps, futures, and
  forwards)
• - arms length deals through securities
  exchanges

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Sources of External Corporate Financing in U.
S. Choice of Capital StructureTwo puzzling
findings1) Equities are not a major instruments
for corporate financing.2) Marketable
Securities are not so important as bank loans.
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• It is due to both (lack of) supply and demand
• - (Fund) Supply Side Limitation financial
  investors are concerned about Information
  Asymmetry, Moral Hazard, Principal-Agent
  Problem, and Adverse Selection
• - (Fund) Demand Side Limitation firms may prefer
  bonds to equities under the current hostile M A
  environment and tax laws.
• In the Canadian corporate financing, equities
  are somewhat more important than in the U.S.
  coroporate financing.

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2.3 Financial Intermediaries

• The four pillars of Canadas financial system
  include
• Chartered banks for Self liquidating short-term
  investment in principle
• Trust companies
• Insurance companies and Pension Funds
• Investment dealers for Long term/large scale
  investment

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Investment Dealers the Big Hands

• Securities Firms /Houses
• Banks M A Division of Investment Banking
  Department
• For instance
• - Morgan Stanley Dean Witter
• - Goldman Sachs
• - Salomon Smith Barney
• - Merrill Lynch
• Donald Trump Drexel Burnham, Campeu Co., T.
  Boone Pickens (Mesa Petrolium)
• Dominion Securities Mellon McLeod Waterhouse.

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Structure of Securities Firm
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Important Concepts in Investment Banking

• Issuing Securities IPO versus Seasoned Issuing
• Underwriting advice, issue, risk-sharing, and
  stabilization.
• Bought Deal vs Best Efforts
• Private Placement

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Financial Market

• Definition An organized institutional structure
  or mechanism for creating and exchanging
  financial assets.

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• Financial Assets/(Liabilities)
• Financial Instruments
• Loans Bonds Equities
• Loans Marketable Securities
• Debts Equities
• Market includes
• Stock Exchange and OTC, and Loan Market

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2.4 Kinds of Financial Markets

• 1) Primary vs. Secondary Market by Newness
• Primary Market new securities are issued, and it
  is Corporate financing source
• Secondary Market(Aftermarkets) existing
  securities are traded or exchanged

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2) short-term Money Market vs. long-term Capital
Market

• by term periods of financial instruments

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Money Market

• Short-term financial assets Highly Liquid
• Operates as a dealer or over-the-counter market
  (OTC)
• Sold in denominations gt 100,000
• Most recognized money market instrument are
  T-bills
• Other money market instruments include commercial
  paper, Banker Acceptances, and eurodollars

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Capital Market 1 Bond Market

• Intermediate and long term horizon finanical
  assets
• Bond markets
• -represent the most important markets for
  intermediate and long-term debt
• - operates as OTC market
• - Government bonds are most important items
• - Coporate bonds accounts for 20 only
• Asset-backed Securities (ABS)
• - example Mortgage-backed securities (MBS)
• - Securitization

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Capital Market II Equity/stock Market

• Common stocks, preferred stock and warrants trade
  in equity markets
• Equity securities trade on stock exchanges
• Stock exchanges operate as
• Auction markets is called Stock Exchanges (TSE,
  CDNX, ME and NYSE)
• or
• Over-the-counter is a sales network (NASDAQ).

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• Canadian Stock Markets
• Before 1999, there were 5 stock exchanges TSE,
  ME, VSE. WSE, and ASE
• After March 1999, there are only TSE, ME, and
  Canadian Venture Exchange(CDNX)
• Global Equity Market
• Emerging Equity Market in newly developing
  economies

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3) Domestic vs. Global Financial Markets

• Investment banks act as global coordinators
  through underwriting syndicates it has
• FOREX market
• International Money Market
• eg )Eurocurrency Market
• (definition of Eurocurency Market ) a market
  for deposits and loans denomitated in a currency
  other than that of the country in which the bank
  is located
• International Capital Markets International Bond
  Market and International Equity Market Emerging
  Markets

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4) Derivatives Markets

• Derivative securities - derive the value from
  underlying assets such as common shares or bonds
• Options - a contract that grants the holder the
  right to buy or sell a security at a given price
  on or before a given date
• Future contracts - agreements to trade assets at
  a specific price and time in the future
• Two types of futures
• Real commodities ? commodity futures contract
• Financial obligations ? financial future contract

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Derivative Markets in North America

• Options
• -Montreal exchange (ME) - Canada
• -Chicago Board Options Exchange (CBOT) US
• Futures commodities, stocks, and foreign
  exchanges
• -Canadas only commodity futures exchange is
  the Winnipeg commodity exchange (WCE)
• -Major US futures exchanges Chicago Board of
  Trade (CBOT)
• Chicago Mercantile Exchange (CME)

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Summary

• 1. Efficient financial markets are required to
  channel funds from surplus-spending units
  (savers) to deficit-spending units. Typically,
  such securities entitle the holder to a stream of
  periodic future cash payments.
• 2. Financial intermediaries allow economies of
  scale to be realized when matching
  surplus-spending units with deficit-spending
  units. Greater opportunities for portfolio
  diversification and money management can be
  gained.