What are three ways that capital is transferred between savers and borrowers?
Direct transfer (e.g., corporation issues commercial paper to insurance company) Through an investment banking house (e.g., IPO, seasoned equity offering, or debt placement) Through a financial intermediary (e.g., individual deposits money in bank, bank makes commercial loan to a company)
Transferring Capital
Direct Transfer of Funds Cash firm
saver
Securities
Transferring Capital
Indirect Transfer using Investment Banker Funds saver investment banker Securities Securities Funds
firm
Investment Banking
How do investment bankers help firms issue securities? Advising the firm. Underwriting the issue. Distributing the issue.
Transferring Capital
Indirect Transfer using a Financial Intermediary Funds Funds
saver
firm
Intermediary Securities
What is a market?
A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds.
Capital markets are the markets for longterm debt and corporate stocks.
The New York Stock Exchange is an example of a capital market.
Well-functioning markets promote economic growth. Economies with well-developed markets perform better than economies with poorly-functioning markets.
What are derivatives? How can they be used to reduce or increase risk?
A derivative securitys value is derived from the price of another security (e.g., options and futures). Can be used to hedge or reduce risk. For example, an importer, whose profit falls when the dollar loses value, could purchase currency futures that do well when the dollar weakens. Also, speculators can use derivatives to bet on the direction of future stock prices, interest rates, exchange rates, and commodity prices. In many cases, these transactions produce high returns if you guess right, but large losses if you guess wrong. Here, derivatives can increase risk.
Financial Intermediary
An organization that raises money from investors and provides financing for individuals, corporations, or other organizations.
Financial Intermediaries
Commercial Banks in Malaysia
Pension fund
Investment plan set up by an employer to provide for employees retirement. Designed for long-run investment. Provide professional management & diversification. Tax advantage: contributions are taxdeductible, & investment returns inside the plan are not taxed until cash is finally withdrawn.
Pension funds
The EPF is a scheme which provides retirement benefits for members through management of their savings in an efficient and reliable manner. The EPF also provides a convenient framework for employers to meet their statutory and moral obligations to their employees.
Mutual Fund
Corporations that pool investor funds to purchase financial instruments and thus reduce risks through diversification. Achieve economies of scale in analyzing securities, managing portfolios, and buying and selling securities. Different funds are designed to meet the objectives of different types of savers.
5-24
Question
As an investor has two options:
1. 2.
Buy bonds and stocks directly. Invest money in a mutual fund or a pension fund.
Answer
What if instead an investor buys existing shares of Apple stock in the open market is this a primary or secondary market transaction?
Since no new shares are created, this is a secondary market transaction.
What is an IPO?
An initial public offering (IPO) is where a company issues stock in the public market for the first time. Going public enables a companys owners to raise capital from a wide variety of outside investors. Once issued, the stock trades in the secondary market. Public companies are subject to additional regulations and reporting requirements.
Where can you find a stock quote, and what does one look like?
Stock quotes can be found in a variety of print sources (Wall Street Journal or the local newspaper) and online sources (Yahoo!Finance, CNNMoney, or MSN MoneyCentral).
Source: finance.yahoo.com
Production opportunities
The returns available within an economy from investment in productive (cash-generating) assets.
2.
3.
Risk
The chance that an investment will provide a low or negative return.
4.
Expected Inflation
The higher the expected rate of inflation, the larger the required return.
5-35
0.5
10
30
Maturity (years)
IPN =
INFL
t =1
MRPt = 0.1% ( t - 1 )
Add the IPs and MRPs to r* to find the appropriate nominal rates
Step 3 Adding the premiums to r*. rRF, t = r* + IPt + MRPt Assume r* = 3%, rRF, 1 = 3% + 5.0% + 0.0% = 8.0% rRF, 10 = 3% + 7.5% + 0.9% = 11.4% rRF, 20 = 3% + 7.75% + 1.9% = 12.65%
10
Inflation premium
5
Real risk-free rate
An upward sloping yield curve. Upward slope due to an increase in expected inflation and increasing maturity risk premium.
Years to 20 Maturity
0 1 10
What is the relationship between the Treasury yield curve and the yield curves for corporate issues? Corporate yield curves are higher than that of Treasury securities, though not necessarily parallel to the Treasury curve. The spread between corporate and Treasury yield curves widens as the corporate bond rating decreases.
BB-Rated
10
5.2%
0 0 1 5 10 15 20
Years to
Maturity
If PEH holds, what does the market expect will be the interest rate on one-year securities, one year from now? Three-year securities, two years from now?
PEH says that one-year securities will yield 6.4004%, one year from now. Notice, if an arithmetic average is used, the answer is still very close. Solve: 6.2% = (6.0% + x)/2, and the result will be 6.4%.
(1.065)5 = (1.062)2 (1+x)3 1.37009/1.12784 = (1+x)3 6.7005% = x PEH says that three-year securities will yield 6.7005%, two years from now.