Chapter 2

The Financial
Market
Environment AND
Long term
Financing
Financial Institutions & Markets: Financial
Institutions
• Financial institutions are intermediaries that
channel the savings of individuals, businesses, and
governments into loans or investments.
• The key suppliers and demanders of funds are
individuals, businesses, and governments.
• In general, individuals are net suppliers of funds,
while businesses and governments are net
demanders of funds.

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Commercial Banks, Investment Banks,
and the Shadow Banking System
• Commercial banks are institutions that:
– provide savers with a secure place to invest their funds
– offer loans to individual and business borrowers
• Investment banks are institutions that:
– assist companies in raising capital
– advise firms on major transactions such as mergers or
financial restructurings
– engage in trading and market making activities

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https://www.slideshare.net/yuslina/investment-bank-
59853494
• It is a financial institution that related to the
creation of capital for other companies.
• Investment banks underwrite new debt and equity
securities for all types of corporations and also
provide guidance to issuers regarding the issue and
placement of stock, also aid in the sale of securities in
some instances. Investment banks also aid in the sale
of securities in some instances.
• They also help to facilitate mergers and acquisitions,
reorganizations and broker trades for both institutions
and private investors. • They can also trade securities
for their own accounts.

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1. Raising Capital & Security Underwriting
• Banks are middlemen between a company that
wants to issue new securities and the buying public.
2. Mergers & Acquisitions
• Banks advise buyers and sellers on business
valuation, negotiation, pricing and structuring of
transactions, as well as procedure and
implementation.
3. Sales & Trading and Equity Research
• Banks match up buyers and sellers as well as buy
and sell securities out of their own account to
facilitate the trading of securities FUNCTION

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• 4. Providing brokerage services for trading of
stocks, bonds, derivatives, commodity and equity
securities
• 5. Managing investments
• 6. Acting as intermediary between an issuer of
securities and the investing public
• 7. Facilitating private equity, corporate
restructuring, placements, merger and acquisitions
and others

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Financial Institutions & Markets: Financial
Markets
• Financial markets are forums in which suppliers
of funds and demanders of funds can transact
business directly.
• Transactions in short term marketable securities
take place in the money market while transactions
in long-term securities take place in the capital
market.
• A private placement involves the sale of a new
security directly to an investor or group of
investors.
• Most firms, however, raise money through a public
offering of securities, which is the sale of either
bonds or stocks to the general public.

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Financial Institutions & Markets: Financial
Markets (cont.)
EXAMPLES OF PRIVATE EQUITY FUND FIRMS
•CIMB Islamic Bank Berhad.
•Kuwait Finance House (Malaysia) Berhad.
•Newfields Property Management Sdn Bhd.
•Rashid Hussain Berhad.

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Figure 2.1
Flow of Funds

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The Money Market

• The money market is created by a financial

relationship between suppliers and demanders of
short-term funds.
• Most money market transactions are made in
marketable securities which are short-term debt
instruments, such as:
• Treasury bills issues by the federal government
• commercial paper issued by businesses
• Investors generally consider marketable securities
to be among the least risky investments available.

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The Money Market (cont.)

• The international equivalent of the domestic (U.S.)

money market is the Eurocurrency market.
• The Eurocurrency market is a market for short-term
bank deposits denominated in U.S. dollars or other
marketable currencies.
• The Eurocurrency market has grown rapidly mainly
because it is unregulated and because it meets the
needs of international borrowers and lenders.
• Nearly all Eurodollar deposits are time deposits.

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The Capital Market

• The capital market is a market that enables

suppliers and demanders of long-term funds to
make transactions.
• The key capital market securities are bonds (long-
term debt) and both common and preferred stock
(equity, or ownership).
– Bonds are long-term debt instruments used by businesses
and government to raise large sums of money, generally
from a diverse group of lenders.
– Common stock are units of ownership interest or equity
in a corporation.
– Preferred stock is a special form of ownership that has
features of both a bond and common stock.

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LONG-TERM FINANCING
 Long-term Financing
• form of financing that is provided for a period
of more than a year
• provided to those business entities that face a
shortage of capital. It is different from short
term financing
• necessary for all kinds of business entities
irrespective of their sizes or stature
 Uses of Long-term Financing
• used in separate ways by different types of
business entities
• The business entities that are not corporations
are only supposed to use long term financing
for the purposes of debt
• the corporations can use long term financing
for both debt and equity purposes.
 Sources
• Where does the financing come from?
– Debt
– Equity
• Internal
• external
 Long Term Financing Products
• Debentures
• Secured Loan
• Unsecured Loan
• Convertible Notes/Bond
• Mortgages
• Preference Shares
 Common Equity Financing
-Internal
• common equity
– The dollar amount of common shareholders'
investment in a company, including common stock,
retained earnings, and additional paid-in capital.
• Retain earning
– earnings not paid out in dividends to common
stockholders
– It doesn’t incur any floatation cost, thus the investor’s
rate of return is the same as the firm’s cost of new
equity capital
 Common Equity Financing
-External
• Sale of new common shares or issues new
share to raise equity capital
• Incur the flotation costs
• Adjust the investor’s required rate of return
for flotation cost
 Primary Market
• The primary market is that part of the capital markets
that deals with the issuance of new securities.
• Companies, governments or public sector institutions
can obtain funding through the sale of a new stock or
bond issue.
• This is typically done through a syndicate of securities
dealers. The process of selling new issues to investors
is called underwriting.
• In the case of a new stock issue, this sale is an
initial public offering (IPO). Dealers earn a commission
that is built into the price of the security offering,
though it can be found in the prospectus.
 Secondary Market
• The secondary market, also known as the
aftermarket, is the financial market where
previously issued securities and
financial instruments such as stock, bonds,
options, and futures are bought and sold.
• The term "secondary market" is also used to refer
to the market for any used goods or assets, or an
alternative use for an existing product or asset
where the customer base is the second market
 Secondary Market
• The major stock exchanges are the most visible
example of liquid secondary markets - in this
case, for stocks of publicly traded companies.
• Exchanges such as the Bursa Malaysia,
New York Stock Exchange, Nasdaq and etc.
provide a centralized, liquid secondary market for
the investors who own stocks that trade on those
exchanges.
• Most bonds and structured products trade “over
the counter,” or by phoning the bond desk of
one’s broker-dealer.
 Secondary Market
• Secondary marketing is vital to an efficient and modern
capital market
• In the secondary market, securities are sold by and
transferred from one investor or speculator to another.
• It is therefore important that the secondary market be
highly liquid (originally, the only way to create this liquidity
was for investors and speculators to meet at a fixed place
regularly; this is how stock exchanges originated.
• As a general rule, the greater the number of investors that
participate in a given marketplace, and the greater the
centralization of that marketplace, the more liquid the
market.
 Leasing
• Leasing is a process by which a firm can obtain the use
of a certain fixed assets for which it must pay a series
of contractual, periodic, tax deductible payments.
• The lessee is the receiver of the services or the assets
under the lease contract
• the lessor is the owner of the assets.
• The relationship between the tenant and the landlord
is called a tenancy, and can be for a fixed or an
indefinite period of time (called the term of the lease).
• The consideration for the lease is called rent.
 Venture Capital
• Venture capital (also known as VC or Venture) is a type
of private equity capital typically provided to early-
stage, high-potential, growth companies in the interest
of generating a return through an eventual realization
event such as an IPO or trade sale of the company.
• Venture capital investments are generally made as cash
in exchange for shares in the invested company.
• It is typical for venture capital investors to identify and
back companies in high technology industries such as
biotechnology and ICT.