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Chapter8nt - Chapter 8 Understanding Financial Markets and...

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1 Chapter 8 Understanding Financial Markets and Institutions
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2 Chapter 8 Learning Goals LG1: Differentiate between primary and secondary markets and between money and capital markets LG2: List the types of securities traded in money and capital markets LG3: Identify different types of financial institutions and the services that each financial institution provides LG4: Analyze specific factors that influence interest rates LG5: Offer different theories that explain the shape of the term structure of interest rates LG6: Demonstrate how forward interest rates derive from the term structure of interest rates
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3 Financial Markets Financial markets exist to manage the flow of funds from investors to borrowers Financial markets can be distinguished along two dimensions: Primary versus secondary markets Money versus capital markets
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4 Primary Markets Provide a forum in which corporations and governments raise funds by issuing new financial instruments (stocks and bonds) Because many companies and government entities can’t generate enough cash flow from internal sources to fund their needs, they must raise capital from external sources (households)
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5 Financial institutions called investment banks arrange most primary market transactions for businesses Morgan Stanley Goldman Sachs Investment banks provide a number of important services to businesses that need to raise capital Advice Pricing Attracting investors
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6 One of the best-known types of primary market transactions is an initial public offering (IPO) Company’s shares are publicly traded for the first time When a firm that is already public issues new securities it is called a seasoned offering Example: Procter & Gamble issues $500 million worth of stock
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7 Once a company’s bonds or shares of stock are issued in the primary market they trade among investors in the secondary market NYSE AMEX NASDAQ Secondary markets provide a centralized marketplace where economic agents know they can buy or sell securities quickly and efficiently
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8 Securities brokers such as Charles Schwab or other brokerage firms act as intermediaries in the secondary market Note: the firm that originally issued the bond or stock is not involved in secondary transactions If you buy shares of IBM through your broker, you are buying them from another investor. IBM has nothing to do with the transaction
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9 Secondary markets offer benefits to both investors and issuers Investors gain liquidity and diversification benefits Issuers gain information about the value of their securities Publicly-traded firms can observe what investors think of their firm value and corporate decisions by tracking their stock price
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10 Trading volume in the secondary market is huge On August 16, 2007, trading volume on the NYSE broke the all-time record at 5.8 billion shares In contrast, in the 1980s a 250 million share day was considered a high-volume day
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