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Fundamentals of Corporate Finance

Sixth Edition

Chapter 2
Why Corporations Need Financial Markets and Institutions

Richard A. Brealey Stewart C. Myers

Alan J. Marcus

Slides by Matthew Will

McGraw Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved

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Topics Covered
The Importance of Financial Markets and Institutions The Flow of Savings to Corporations Functions of Financial Markets and of Financial Intermediaries Value Maximization and the Cost of Capital

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Financial Markets
Money

Primary
Markets

OTC
Markets

Secondary
Markets

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Financial Markets
Financing Decision
Source of Funds Capital Capital Structure Money Markets Euros

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Financial Markets

Issue Securities

Company

Cash Reinvested

Investors

Cash

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Financial Markets
Financial markets Stock markets Fixed-income markets Money markets Markets for Commodities Foreign exchange Derivatives

Corporation Investment in real assets

Reinvestment

Investors worldwide

Financial Intermediaries
Mutual Funds Pension funds Financial Institutions Banks Insurance companies

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Financial Institutions
Company

Obligations

Funds

Intermediaries
Banks Insurance Cos. Brokerage Firms

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Financial Institutions
Intermediaries

Obligations

Funds

Investors
Depositors Policyholders Investors

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Financial Markets

$ Bank of America
Sells shares

$ Explorer Fund
Issues shares

Investors

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Financial Markets
Company Banks Insurance Cos.
Obligations Funds

Intermediary
Obligations Funds

Brokerage Firms
Depositors Policyholders Investors Investor

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Financial Markets
Company
Loan $2.5 mil

Banks

Intermediary
Deposits Cash

Depositors

Investor

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Financial Markets
Company
Issue Debt $2.5 mil

Insurance Company

Intermediary
Sell policies Cash

Policyholders

Investor

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Total U.S. Financing

% Holdings of Corporate and Foreign Bonds (Qtr 3, 2007)
12.3 14.2 9.5 28.1 Households Rest of world Banks Insurance Cos Pension Funds Mutual Funds Other

5.4 20.6 10

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Total U.S. Financing

% Holdings of Corporate Equities (Qtr 3, 2007)
1.4 28.3 27.1 Households Rest of world Banks Insurance Cos Pension Funds Mutual Funds Other

12.6 22.3 8 0.3

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Function of Financial Markets

Transporting cash across time Risk transfer and diversification Liquidity Payment mechanism Provide information

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U.S. Financing
Information Provided by Financial Markets
Commodity prices Interest rates Company values

Interest rates on 30-year corporate bonds, February 2008.

Credit Rating AAA AA A BBB BB B

Interest Rate 5.71% 5.78 6.38 7.12 9.84 10.82

Source: Bloomberg Composite Corporate Bond Indexes.

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Value of Alaska Air Group

Data as of January, 2008

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Value Maximization

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