An Overview of the Financial System

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An Overview of the Financial System

• Chapter 2
• By Juliya Andrushchak and Ronald Huang

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Web Exercises

• 1.

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Web Exercise

• 2. a). Dow will increase value from 13,074 to
  13,187 in three months
• b). 0.8643 increase

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ATT Brief History
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ATT Timeline 1876 to 2001
    ATT issues its stock ATT issues its stock McCaw acquired McCaw acquired   35.5 Bill invested in 35.5 Bill invested in Spinoff the wireless Spinoff the wireless
    in an IPO in an IPO (ATT Wireless) (ATT Wireless)   acquisitions upgrades acquisitions upgrades unit unit
1876 - Founded 1876 - Founded 1984 1984 1994 1994   1996-2000 1996-2000 2001 2001
                   
                     
  1877 1877 1991 1991 1995 1995   2000 2000  
  Bell formed and stock Bell formed and stock ATT acquires NCR ATT acquires NCR Restructuring - Splitoff Restructuring - Splitoff   Issued a tracking stock Issued a tracking stock  
  issued to 7 shareholders issued to 7 shareholders       Lucent   for ATT Wireless for ATT Wireless  
            NCR        
            ATT        
                     
Debt - bank loan or Debt - bank loan or ATT - shares sold on ATT - shares sold on Need more funds Need more funds   Corporate (convertible) Corporate (convertible) No cash generated, No cash generated,
private borrowing private borrowing NYSE and Munich NYSE and Munich (11.5 billion) (11.5 billion)   bond, foreign bond bond, foreign bond divestiture divestiture
                   
                     
  IPO - Bell financed IPO - Bell financed Borrow funds and Borrow funds and Divestiture Divestiture   Receive cash, tax free, Receive cash, tax free,  
  through equity through equity acquire new assets acquire new assets Issue different shares Issue different shares   new share class new share class  
      ( 7.3 billion) ( 7.3 billion)            
 
 
 
 
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• Debt finance the using a bank loan (indirect
  finance) or borrow privately (direct finance)
• A. Graham was the borrower-spender
• Equity seven original shareholders held the
  stock after the IPO. Deal details worked out with
  a broker (no underwriting in this case)

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Post-Divestiture Events

• ATT issues its own stock on the primary market.
  Shares are traded on NYSE and Munich exchanges.
  The new company is valued at 34 bill from the
  total of 149.5 bill. Shares traded on the
  secondary market.
• Equity issued through an investment bank.
• Divestiture anti-trust lawsuit monopoly
  issues.

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Classifications of Financial Markets

• Secondary Markets
• Exchanges
• Trades conducted in central locations (e.g.,
  Toronto Stock Exchange and New York Stock
  Exchange)
• Over-the-Counter Markets
• Dealers at different locations buy and sell

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Subsequent Restructurings

• NCR acquired for 7.3 bill. Finance through
  long-term debt (commercial paper, and convertible
  corporate bonds, bearer form or registered,
  foreign bonds) and secondary issues.
• Use short- and medium-term debt for cash needs,
  and invest excess funds in money market
  securities and other liquid financial
  instruments. Adopt a dividend policy.
• Investment of 35 billion made from 1996-2000 in
  acquisitions and upgrades major need for
  financing.

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Classifications of Financial Markets

• Debt Markets
• Short-term (maturity lt 1 year) the Money Market
• Long-term (maturity gt 10 year) the Capital
  Market
• Medium-term (maturity gt1 and lt 10 years)

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Stock Issues and Restructurings

• 1995 split off into three separate companies
  NCR, ATT, and Lucent.
• 2000 issued a tracking stock to track the
  performance of the wireless division. Created a
  different stock class.
• 2001 spun off ATT Wireless to the current
  shareholders. Distributed as a dividend.
• 2005 proposed merger with SBC.

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Financial Market Instruments

• Stock- equity claims in the net income and assets
  of a corporation
• Mortgages- loans to households or firms to
  purchase housing, land, or other real
  structures, where the structure or land serves as
  collateral for the loans.
• Corporate Bonds- long term bonds issued by
  corporations with very strong credit
  ratings
• Govt of Canada Bonds- are issued by the federal
  government to finance its deficit.
• Other
• Canada savings bonds
• Provincial and municipal bonds
• Government agencies securities

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Internationalization of Financial Markets

• International Bond Market
• Foreign bonds - sold in a foreign country and
  denominated in that country
• Eurobonds denominated in a currency other than
  the country in which it is sold
• Eurocurrencies foreign currencies deposited in
  banks outside the home country

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• World Stock Markets

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• Transactions Costs
• Financial intermediaries make profits by reducing
  transactions costs.
• They reduce transactions costs by developing
  expertise and taking advantage of economies of
  scale.
• Risk Sharing
• Create and sell assets with low risk
  characteristics and then use the funds to buy
  assets with more risk (also called asset
  transformation)
• Lower risk by helping people to diversify
  portfolios

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Asymmetric Information

• Adverse Selection
• Before transaction occurs
• Potential borrowers most likely to produce
  adverse outcomes are ones most likely to seek
  loans and be selected
• Moral Hazard
• After transaction occurs
• Hazard that borrower has incentives to engage in
  undesirable activities making it more likely that
  loan wont be paid back

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Financial Intermediaries
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Size of Financial Intermediaries
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Regulation of Financial Markets
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Regulation of Financial Markets

• Primary Reasons for Regulation
• Increase information to investors
• - Decreases adverse selection and moral hazard
  problems
• - Securities commissions force corporations to
  disclose information
• 2. Ensuring the soundness of intermediaries
• Prevents financial panics
• Restrictions on entry/assets/activities,
  disclosure, deposit insurance, limits on
  competition

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Financial Intermediaries Keywords
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Any Questions?