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Fundamentals of

Chapter 2 Corporate Finance


Fourth Edition

The Financial
Environment

PRESENTED BY
D-R EVGENI ZOGRAFSKI

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Topics Covered

The Flow of Savings to Corporations


Functions of Financial Markets
Functions of Financial Intermediaries

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The Flow of Savings to Corporations


The ultimate source of financing is
individuals savings
Two forms of financing: internal and external
Internal-retainedcash and selling new shares
External-loans and bonds

Savings flow through financial markets (stock


exchanges) and financial intermediaries
(mutual funds, pension funds, insurance
companies)

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The Flow of Savings to Corporations

(2) (1)
Firm's Investors
Financial
operations (4a)
Manager (stockholders
save and invest
Real assets in closely held
firm.)
(timberland)
(3) (4b)

(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
Financial market-a market where securities are issued
and traded
Securities a traded financial assets (shares; bonds)
Shares-a proportion of ownership claim on the firm, with no
maturity
Bonds-debt securities issued by a company representing a
obligation to investors to make regular interest payments
and principal on a specified date in the future
Stock market (stock exchange) is the most important
financial market
Stock market or equity market trading own common
equity (ordinary shares) of the firm

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Financial Markets
Primary market- market for sale of new issue of
securities (shares, bonds); its organized in banks,
brokerage co. (outside the exchange)

Secondary market - market in which previously


issued securities are traded among investors

Secondary market: Stock exchange and OTC


Stock
exchange-organized market for trading securities
OTC-over the counter market

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Financial Markets

Money

Primary OTC
Markets Markets
Secondary
Markets
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Other Financial Markets


Fixed income market-market for debt securities
(bonds)
Capital market- market for long-term financing
Money market- market for short-term financing
(less than 1 year)
Foreign-exchange market- inter bank market for
trading foreign currencies
Commodities market- organized market for trading
commodities (corn, wheat, cotton, oil)
Derivatives market- organized market for trading
derivatives (options, futures, warrants, forwards,
swaps)

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Financial Markets

Issue Debt

Company Investors
Cash

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Financial Intermediaries
Financial intermediaries- an
organization that rises money from
investors and provide financing for
individuals, companies e t.c.
mutual funds,
pension funds,
insurance co.,
banks

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Mutual Funds

Mutual funds- pools the savings of many


investors and invests in a portfolio of
securities;
mutual funds offer investors low-cost
diversification and professional management;
Two types: Open-end funds and Close-end funds
funds pursue a wide variety of investment
strategies (only stocks, only bonds, only
dot.com.cos,high-tech growth stocks, mixture of
stock and bonds balanced funds, funds of
funds)

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Mutual Funds

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

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Pension Funds

Pension funds- investment plan set up by


employer (companies) for providing
employees retirement
Defined contribution pension plan (a % of
monthly pay is contributed to a pension fund-
partly by employer, partly by employee)
Defined benefit pension plan (the employer
invest to the pension fund)
Tax advantages
Macedonian experience

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Other financial institutions

Insurance companies- sells insurance


policies and with cash finance companies
Banks- collect deposits and lend money to
individuals and companies (short term and
long term loans)

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Functions of Financial Markets

Financial markets and intermediaries


channel savings to real investment
Financial markets and intermediaries
provide financing for business
Other functions
Transporting cash across time
Provide liquidity
Reduce and reallocate risk

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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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Information Provided by Financial 2- 19

Markets

Securities and commodity prices


Interest rates
Company values

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Opportunity Cost of Capital

Cost of capital- minimum acceptable rate of


return of invested capital;
The cost of capital for corporate investment is
set by the rates of return on investment
opportunities in financial market; its an
opportunity cost-the safest form of investment
(yield on treasury bills)
Investment projects offering higher return that
the cost of capital are acceptable

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Key Words
Securities-hartii od vrednost
Shares(Stocks)-akcii
Bonds-obvrznici
Derivatives-derivati na hartii od
vrednost(opcii,fju~ersi)
Stock market (stock exchange)-berza
Mutual fund-investicionen fond
Opportunity cost of capital-oportunitetna stapka
na povrat na kapitalot

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Web Resources
Click to access web sites
Internet connection required

www.nyse.com
www.nasdaq.com
www.federalreserve.gov/releases/h15/update
www.investorlinks.com
www.indexfunds.com

www.morningstar.com

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