11. Reading: Financial system

  

  

Corporations have the need to raise capital for a number of reasons. Smaller firms need capital to start up operations. Larger firms need capital to expand operations and to finance inventory. There are various ways in which a firm can raise capital through the financial system and numerous individuals and entities that can assist a corporation in this crucial venture.

Start-up firms and small businesses petition investors for what is known as venture capital. Venture capital comes from wealthy investors, usually a group, who see the potential for growth in smaller businesses. In the early 1990’s the Securities and Exchange Commission (SEC) expanded its role to assist small businesses. The SEC made it easier for small businesses to raise capital through public stock offerings.

Corporations also raise money to finance debt. Businesses sell bonds to investors in order to raise money for working capital and capital expenditures. The corporation agrees to pay back the principal plus interest, therefore making the investors creditors. Bond holders are able to sell bonds to others before they are due. Selling bonds are beneficial to corporations because, in addition to raising capital, bonds also have much lower interest rates that are tax deductible. The down side is that corporations must make interest payments regardless of whether they turn a profit. This often is not an option for smaller businesses.

Larger corporations that exist as public companies can also sell bonds in order to raise capital. Public companies can issue preferred stock along with common stock. Preferred stock is a higher-ranking stock than common stock and preferred stock holders have a greater claim to a company’s assets and earnings. Holders of preferred stock may also have dividends paid before holders of common stock and these dividends are paid at regular intervals, whereas common stock dividends are only paid out when a board of director’s decides to make a payout. Preferred stock often has no voting rights, however, as opposed to common stock. Preferred stock is usually offered to investors, where as common stock is usually offered to employees.

Another means of raising both short and long-term capital is through international markets. According to authors Stanley Block and Geoffrey Hirt (2005), “When the markets are good, money is cheap and easy to find, and when the markets are bad, money is hard to find and relatively expensive. The world economic markets often move back and forth between the two extremes”.

Short-term markets, or money markets, consist of securities that will mature in a year or less. Money markets provide short-term funding for the global financing system. Treasury bills and commercial paper are bought and sold in money markets.

Corporations may also use more traditional methods for raising capital by borrowing from banks and other established lenders. Businesses that require financing for inventory often borrow from banks. Firms can use retained earning, or profits, to raise capital. Depending on the size of the corporation some or all of a company’s profits may be held back for further investment before issuing dividends.

Corporations often look to investment bankers to handle many of these functions. Investment bankers typically have a solid background in finance and economics and are specialists in financial analysis. These bankers act as intermediaries, or middle men, between corporations looking to raise capital and investors. Investment bankers oversee the issuing of bonds, manage selling a company’s stock and advise corporations on acquiring and merging with other companies.

 

 

1. Corporations do not raise money to finance debt.

    

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2. The corporation agrees to pay back the principal plus interest, therefore making the investors creditors.

   

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3. Treasury bills and commercial paper are bought and sold in money markets.

   

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