Why do Financial Markets Exist Anyway?

Ice cream and restaurant.Opening new Frizzles around the world for the past five years.One of the most popular ice cream restaurants in the United States and Europe.20% market share.25,000 employees in multiple locations in the United States and Europe.Headquartered in New York, NY.Looking to expand to China or Russia.Needs $500 million in order to expand.Financial statements indicate a healthy, profitable company.Frizzle, Inc.

Borrow money from a bankIssue StockIssue BondsFrizzle, Inc.Frizzle, Inc.Frizzle, Inc. has 3 choices to borrow money

Similar to an individual borrowing moneyMust be paid back in a certain time by a specified date with interest

Borrowing from a BankCompany can secure a loan from abank in order to secure capital

AdvantagesMay be able to secure loan quicklyNot giving up controlCan use money for anythingDisadvantagesMay be more expensive and have to pay a higher rate of interestPotential prepayment penaltyCould decrease cash flowBorrowing from a Bank

What is stock?Individuals ownership in a corporationAlso known as EquityStockholders gain more ownership as they acquire more stockThe more stock a company issues, the less ownership they retain in the companyIssuing Stock (Equity)StockholdersCompany# ofStockIssued# ofStockIssuedOwnershipOwnership

DividendsPortion of a companys earnings distributed to their stockholdersWhen companies are secure and stable, they usually offer dividends to their stockholdersIssuer, or Frizzle, Inc., can elect not to pay the dividend, especially when they are in expansion modeTiming and the amount of the dividends are uncertainIssuing Stock

LiquidateWhen a company sells all of their assets

Issuing Stock

Those who buy common stock have some control of the companyCommon StockOwnership in a publicly traded companyElect a board of directorsVote in annual meetingsGenerally exercise control of the company

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If a company liquidates, common stockholders are the last to get their investment backCommon StockOwnership in a publicly traded companyBondholders and preferred stockholders have rights to the companys assets before common shareholdersLiquidation of Company XBondholdersPreferredStockholdersCommonStockholders

Little of no voice in the decisions of how a company should be managedGet paid fixed dividends before any payment is made to the common stockholdersIf a company liquidates, they are the first of the stockholders to get their money backCompany must pay the preferred stockholders their dividend first before common stockholdersUnlike common stockholders, preferred stockholders usually do not have voting rightsPreferred StockEquity in a corporation, to a limited degree

Issuing StockStock Cash Flow012345YearPerpetuityDividend

Dividend

Dividend

Dividend

Dividend

Perpetuity A constant stream of identical cash flows with no endNew Company that has never issued stockIPO (Initial Public Offering) Company sells stock for the first timeCompany is valuedOpening price is decided (per share)Investors are now able to buy Frizzle stockFrizzle is listed on an exchange (NASDAQ)

Frizzle, Inc.

AdvantagesCompany can raise a lot of money from external investorsCompany can use money to grow/expandCompany wont have to borrow money from the bank and pay back at a high interest rateDisadvantagesCompany is giving up some controlCompany has to share ownership of company with other stockholdersStock dilution can occur from the issue of additional common shares by a companyIssuing Stock

AT&T TombstoneAT&T Tombstone

What is a bond?Form of debt issued by the Federal government, cities, states, and corporationsWhen an individual buys a bond from a company, they are essentially loaning money to that companyBondsLender/Bondholder the individual buying the bond from the companyIssuer The company or municipality borrowing the money

BondsThe issuer is repaying the lenders/bondholders original investment (principal) and any interest (coupon payments) that is due at maturity

BondsPrincipal/Face Value: The original investment, face value, is repaid when the bond matures

Maturity Date: Predetermined date in the future when the bond matures and the lender/bondholder receives the principal investment plus interest

Coupon Rate (%): The interest that the lender/bondholder receives

Coupon Payment ($): A dollar amount that is paid to the lender/bondholder regularly until the bond matures (payment is based on the coupon rate and the principal)

Principal+ CouponPayment

BondsCash Flows of a Bond012345

CouponPayment

CouponPayment

CouponPayment

CouponPaymentYearMaturity

Bonds012345

CouponPayment

CouponPayment

CouponPayment

CouponPaymentYearCredit risk is the chance that a bond issuer will fail to repay the principal and interest on the specified date

BondsMaturity DateCoupon RateFace Value (Par)Coupon Payment

AdvantagesCompany can raise money for expansionInterest on bonds are deductible on a corporation's income tax returnCompany can borrow at a lower interest rate than they would have to pay the bank

DisadvantagesCompany may have difficulty issuing bonds if they are experiencing financial difficulties within their companyCompany may not be large enough to issue bondsIssuing a Bond

Assists a company in facilitating the process by:Advising companies on financing alternatives raising capitalManaging the issuance of bonds and stocksHelping the company determine the characteristics of the stock or bond offering (Example: the maturity of a bond)Determining the price of the stock or bond - For stock, the price per share; for a bond, the coupon rateDetermining the opening price at which. For example, Frizzle, Inc. will sell its IPO.Assessing the issuer for a credit rating if a bond is issuedUnderwriting the security offering the investment bank buys the stocks and bonds from the issuers and then distributes them into the marketplace

Role of an Investment Bank

Major ratings agencies are:

Rating Process For Bonds

A AAA high grade bond offers more security but a lower yield than a C bondA C bond is more riskybut has a higher yield

Ratings are based on whether or not the issuer will be able to make their principal and interest payments, to the bond holder, on timeCREDIT RATINGS*MOODYSSTANDARD & POORSFITCHINVESTMENT GRADESTRONGESTAaaAAAAAAAaAAAAAAABaaBBBBBBNON-INVESTMENT GRADEWEAKESTBaBBBBBBBCaaCCCCCCCaCCCCCCCCDD*These credit ratings are reflective of obligations with long-term maturities.

Borrow money from a bankIssue StockIssue BondsFrizzle, Inc.Frizzle, Inc.As an executive of Frizzle, Inc., which option would you choose?