Chapter 2 Finance

Firms that require funds from external sources can obtain them in three ways

through a financial institution
through financial markets
through private placements

Financial institutions are intermediaries that channel

the savings of individuals, businesses, and governments into loans or investments.

Commercial banks

institutions that provide savers with a secure place to invest their funds and that 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, and engage in trading and market making activities.

Financial markets

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

transactions in long-term securities take place in

the capital market

private placement

involves the sale of a new security directly to an investor or group of investors.

public offering

Most firms, however, raise money through a public offering of securities, which is the sale of either bonds or stocks to the general public.

primary market

is the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction.

Secondary markets

are financial markets in which preowned securities (those that are not new issues) are traded.

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 U.S. Treasury bills, commercial paper, and negotiab

Eurocurrency market.

The international equivalent of the domestic (U.S.) money 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 unr

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).


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.

Broker markets

are securities exchanges on which the two sides of a transaction, the buyer and seller, are brought together to trade securities.
Trading takes place on centralized trading floors.
Examples include: NYSE Euronext, Pacific Stock Exchange and American Stock

Dealer markets

are markets in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that "make markets" in the given security: over-the-counter market.
The dealer market has no centralized trading floor

Eurobond market

corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States.

foreign bond market

is a market for bonds issued by a foreign corporation or government that is denominated in the investor's home currency and sold in the investor's home market.

international equity market

allows corporations to sell blocks of shares to investors in a number of different countries simultaneously.

efficient market

allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value.


is the process of pooling mortgages or other types of loans and then selling claims or securities against that pool in a secondary market.

Mortgage-backed securities

represent claims on the cash flows generated by a pool of mortgages and can be purchased by individual investors, pension funds, mutual funds, or virtually any other investor.

A primary risk associated with mortgage-back securities

is that homeowners may not be able to, or may choose not to, repay their loans.