2 The Domestic and International Financial Marketplace ©2006 Thomson/South-Western.
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Transcript of 2 The Domestic and International Financial Marketplace ©2006 Thomson/South-Western.
2
The Domestic and International Financial Marketplace
©2006 Thomson/South-Western
2
Introduction
This chapter looks at the domestic and international financial marketplaces that allocate scarce resources.
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Finance Decisions Affecting SWM Form of business organization
Types of financing
Investment projects
All based on after-tax cash flow
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Implication Of Income Taxes For Financial Managers Capital structure policy
Tax advantage of debt financing Dividend policy
Capital gains vs. Dividend policy Capital budgeting
After-tax CFs, Depreciation, Net present value (NPV)
Leasing Motivated by tax effects
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Corporate Tax Rates
Progressive The average tax rate increases for increasing
levels of income. Marginal
The tax rate on the next dollar of income Marginal tax rate used in text
40% = State + Fed
http://www.tax.org/
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Corporate Tax Rates
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Net Savers Become Investors
Credit Unions
Primary and Secondary
Markets
Sole Proprietorship Partnership Corporations
Financial Markets
Savings Institution Mutual FundsPension FundsInsurance Companies
Financial Institutions
Financial Companies
Banks
Supply Funds Supply Funds
Money Markets
Capital Markets
The National Financial System
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Saving and Investment
http://www.bea.doc.gov/bea/pubs.htm
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Flow of Funds
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Primary Market
Investment banks help corporations sell new security issues
Underwrite Guarantee sale at a fixed price
Best effort No guarantee of sale
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Secondary Market
Listed exchanges Designated place of business Requirements of securities listed or traded
Over-the-counter (OTC) market Networks connected by communications Dealers post prices to buy and sell
Stock market indexes DJIA, DJTA, S&P 500, NASDAQ
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Financial Intermediaries
Commercial Banks Thrift Institutions Investment Companies Pension Funds Insurance Companies Finance Companies
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Security Exchanges
Listed exchanges New York Stock Exchange American Stock Exchange Chicago, Pacific, Philadelphia, Boston,
Cincinnati exchanges
Over the counter markets
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Regulations
State Blue sky laws
Federal Securities Act of 1933 & 1934 Securities & Exchange Commission (SEC) Ethical issues
Insider trading SEC attempts to prevent profiting from
unpublished information. http://www.uncle-sam.com/
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Global Financial
Transactions
Import
Export
Foreign Branch
Licensing Arrangements
Joint Ventures
Multinational Corporations
Manufacturing Distribution
International Finance
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Global Risks
Fluctuating exchange rates
Government regulations
Tax laws
Business practices
Political environment
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Eurocurrency Market
Eurocurrency Currency deposited outside of the country of origin
Eurodollars Dollars deposited outside of the United States
Euro A new currency created by many European
countries
The euro is not the same as Eurocurrency.
http://www.xe.com/euro.htm
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Some Important Terms
Exchange rate
Direct quote
Indirect quote
Spot rate
Forward exchange rate
http://www.futuresmag.com/
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Forward Exchange Rates
Exchange rates for currencies delivered at some future date, i.e., 30, 90, or 180 days
Premium Where spot rate is expected to increase in the
future Discount
Where spot rate is expected to decrease in the future
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Annualized Forward Premium Or Discount
100%
# of months forward
12Spot rate
Forward rate – Spot rate
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Foreign Currency Futures
Foreign currency futures contract
Standard amount of currency
Standard future time
At a price set at the present time
Contracts traded on Chicago Mercantile Exchange (CME)
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Foreign Currency Options
A call is the right to buy a currency.
A put is the right to sell a currency.
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European and American Options
What is the difference between an American and European option? You can exercise an American option
anytime until expiration. The European option can be exercised
only at expiration.
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Market Efficiency
“Glue” that bonds the PV of a firm’s net cash flow to shareholders’ wealth
Capital markets are efficient if prices instantaneously and fully reflect all the risk and economically relevant information about a security’s prospective returns.
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Stock Prices
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Three Degrees Of Market Efficiency Weak form
Semi-strong form
Strong form
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Weak Form
Security prices fully reflect all historical information.
No investor can earn excess returns using historical prices or returns.
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Semi-Strong Form
Security prices fully reflect historical and publicly available information.
No investor can earn excess returns based on an investment strategy
using public information.
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Strong Form
Security prices fully reflect all historical, public, and private information.
Markets are quite efficient!
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Implications For Financial Managers
Timing or gambling An expected NPV of zero Corporate diversification expensive Security price adjustment Behavioral finance perspective
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New Thinking About Behavioral Finance
Evidence of irrational behavior exists
Explanation? Self-delusion Herding
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Barriers To Market Efficiency Outside The United States Foreign exchange risk
Legal restrictions on investments
Taxation policies discourage capital
flows.
High transaction costs
Political risks of expropriation
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Holding Period Rate Of Return
HPR
The return from holding an investment for one period
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Equation
100%
Beginning price
Ending price – Beginning price + Distributions
% HPR =
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Returns
Ex post = realized (after the fact)
Ex ante = expected (before the fact)