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Firms that require funds from external sources can obtain them in three ways:
Financial Institutions
demanders of funds.
• The Glass-Steagall Act was an act of Congress in 1933 that created the federal deposit insurance
program and separated the activities of commercial and investment banks. It was repealed it 1999 by
Congress.
Matter of Fact
– The U.S. banking industry has been going through a long period of consolidation.
– According to the FDIC, the number of commercial banks in the United States declined from 11,463 in
1992 to 6,048 in 2013, a decline of 47%.
– The decline is concentrated among small, community banks, which larger institutions have been
acquiring at a rapid pace.
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
• The primary market is the financial market in which securities are initially issued; the only market
are traded.
• 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:
• Investors generally consider marketable securities to be among the least risky investments available.
• 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
• 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 (longterm 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.
– Preferred stock is a special form of ownership that has features of both a bond and common stock.
Lakeview Industries, a major microprocessor manufacturer, has issued a 9 percent coupon interest
rate, 20-year bond with a $1,000 par value that pays interest semiannually.
– Investors who buy this bond receive the contractual right to $90 annual interest (9% coupon interest
rate $1,000 par value) distributed as $45 at the end of each 6 months (1/2 $90) for 20 years.
– Investors are also entitled to the $1,000 par value at the end of year 20.
Focus on Practice
Berkshire Hathaway – Can Buffett Be Replaced?
$114,000/share.
– The share price of BRKA has never been split. Why might
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exchanges.
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security.
price).
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2012:
Europe.
trillion.
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extended periods.
value include:
crisis
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States in the 1930s. These laws are designed to ensure that all
insiders?
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22. The Financial Crisis: Financial Institutions and Real Estate Finance
investor.
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23. The Financial Crisis: Falling Home Prices and Delinquent Mortgages
unable to refinance.
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24. The Financial Crisis: Falling Home Prices and Delinquent Mortgages
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180
160
140
120
100
80
60
40
20
2007
2008
2009
2010
2011
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27. The Financial Crisis: Spillover Effects and the Great Recession
made.
• Corporations found that they could no longer raise
activity contracted.
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28. Regulation of Financial Institutions and Markets: Regulations Governing Financial Institutions
soundness.
investment banks.
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29. Regulation of Financial Institutions and Markets: Regulations Governing Financial Institutions
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30. Regulation of Financial Institutions and Markets: Regulations Governing Financial Markets
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income.
taxes.
income.
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Example
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by taxable income.
Example
= $80,750/$250,000 = 32.3%
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is fully taxed.
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dividends paid.
demonstrate.
Example
interest expenses.
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paid.
of organization.
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price.
Example
Ross Company has just sold for $150,000 and asset that
was purchased 2 years ago for $125,000. Because the
asset was sold for more than its initial purchase price,
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mortgage delinquencies rose, the value of the mortgagebacked securities held by banks plummeted,
causing some
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to limit the risks that banks could take and to protect depositors.
financial institutions.
secondary market. The 1934 Act also created the Securities and
financial decisions.
asset is sold for more than its initial purchase price; they
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• Chapter Cases
• Group Exercises
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operations.
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Formula
Price Earnings (P/E) Ratio = Market price per share of common stock ÷ Earnings
per share
Example/Computation
If Bartlett Company’s common stock at the end of 2015 was selling at $32.25,
using the EPS of $2.90, What is the P/E ratio at year-end 2015?
Given: Market price per share = $32.25
Earnings per share = $2.90
Definition
The market/book (M/B) ratio provides an assessment of how investors view the
firm’s performance.
Formula
where,
Example/Computation
Substituting the appropriate values for Bartlett Company from its 2015 balance
sheet, what is the book value per share of common stock?
Given: Common stock equity = $1,754,000
(Total SHs’ equity is 1,954,000 minus Preferred stock of 200,000 = 1,754,000)
Earnings per share = 76,262
Substituting Bartlett Company’s end of 2015 common stock price of $32.25 and
its $23.00 book value per share of common stock (calculated above) into the M/B
ratio formula, what is the M/B ratio? Given: Market price per share = $32.25
Book value per share =
The Dupont System of Analysis is used to dissect the firm’s financial statements
and to assess its financial condition.
It merges the income statement and balance sheet into two summary measures
of profitability.
ROA and ROE are the series of equations for Dupont analysis
Dupont Formula:
Return on Total Assets (ROA) = Net Profit Margin x Total Asset Turn Over
ROA = NPM x TATO
The DuPont Equation focuses on expense control (profit margin), asset utilization
(total asset turn-over), and debt utilization (equity multiplier).
a. The current ratio measures the ability of the firm to meet its short-
term obligations.
e. Total asset turnover indicates the efficiency with which the firm uses
its assets to generate sales.
c. The times interest earned ratio measures the firm’s ability to make
contractual interest payments; sometimes called the interest coverage
ratio.
d. Earnings per share represents the number of dollars earned during the
period on the behalf of each outstanding share of common stock.
e. The return on total assets measures the overall
effectiveness of management in generating profits with
its available assets. Return on total assets (ROA) =
Earnings available for common stockholders ÷ Total
assets
where,
Capital market – relates to the market where interest rates are determined
Investments – decisions concerning stocks and bonds
Financial services – is the area of finance concerned with the design and delivery
of advice and financial products to individuals
- Career opportunities include , banking, personal finance
planning, investment, real estate, insurance.