1980s Affecting Corporate Finance From About the Article Review

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1980s Affecting Corporate Finance

From about the mid 1980s, the trend has been for companies, especially large ones, in industrialized countries to seek financing directly from financial markets rather than borrowing from commercial banks. This practice was motivated by various changes affecting corporate finance (Topsy-turvy, 1986). The main external source of corporate financing currently can be traced back to these past developments although more recent developments are also important.

Two changes traced to the mid 1980s that affected corporate finance were deregulation and internationalization. Deregulation caused increases in the cost of loans from commercial banks and in the number and types of entities offering financing (Topsy-turvy, 1986). Deregulation of interest rates permitted banks to pay higher rates for deposits, eventually increasing the price for loans. Consequently, it was cheaper for top-rated companies to obtain money by issuing commercial paper than by borrowing from banks. Deregulation also allowed more entities to enter the intermediation business between original lenders and ultimate borrowers. For example, saving and loan associations were permitted to make industrial loans. Internationalization meant that companies could seek financing from foreign investors. The effect of deregulation and internationalization on financial markets in the 1980s motivated some American commercial banks to become investment banks (Topsy-turvy, 1986).

While the article points to important developments in corporate finance in the 1980s, it misses other significant factors concerning corporate finance in the period. Yet while financial markets increasingly became the preferred source of money for corporations, small and medium-sized companies, usually perceived as higher-risk borrowers, continued to depend on commercial banks. Nonetheless, these higher-risk companies also eventually entered the financial markets borrowing in the form of high-yield junk bonds.

Developments in the 1980s Affecting Corporate Finance

Drexel Burnham Lambert was a major Wall Street investment banking firm, which first rose to prominence and then was driven into bankruptcy in the 1980s by its involvement in illegal activities in the junk bond market, driven by Drexel employee Michael Milken.

.Click the link for more information.In the 1980s, the outstanding debt of American nonfinancial companies skyrocketed. Part of the explanation was the receptivity of investors to bonds lured by the enticement of high yields and the desire to diversify their portfolios. With increasing debt, indicators of corporate financial features worsened and bond default rates started to increase. Yet institutional investors came to perceive that the higher yields were worth the greater risks, especially if the bonds were part of a diversified portfolio. fa vor a ble adj.

1. Advantageous; helpful: favorable winds.

2. Encouraging; propitious: a favorable diagnosis.

3.

.Click the link for more information.The move toward financial markets coincided with the increase in financial needs due to mergers and restructuring. Mergers and acquisitions were strong in the 1980s. These concomitant developments led to a significant surge of junk bonds.

With maturing junk bond markets, new instruments emerged to provide companies that had issued such bonds with greater flexibility lee way

n.

1. The drift of a ship or an aircraft to leeward of the course being steered.

2. A margin of freedom or variation, as of activity, time, or expenditure; latitude. See Synonyms at room.

.Click the link for more information.to determine the timing of interest payments. These instruments came about due to the need that corporations had to decrease interest payments until they were able to have more cash from sales. Two examples of these instruments were the deferred-cash-payment bond and the reset note. reset note

A debt security with terms that can be reset on one or more dates during the life of the note. At the time the terms are changed, the holder usually has the right to redeem the security.

.Click the link for more information.

Other important developments were taking place in the second half of the 1980s. The differences between debt and equity as means of corporate financing became more tenuous with the greater utilization of instruments having shared characteristics. Also, interest rate swaps Interest Rate Swap

A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans in another country. These can be either the same or different currencies.

.Click the link for more information. also diminished the difference between short-term and long-term debt Long-Term Debt

Loans and financial obligations lasting over one year.

Notes:

For example debts obligations such as bonds and notes which have maturities greater than one year would be considered long-term debt.

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Medium-term note (MTN)

A corporate debt instrument that is continuously offered to investors over a period of time by an agent of the issuer. Investors can select from maturity bands of: 9 months to 1 year, more than 1 year to 18 months, more than 18 months to 2 years, etc.

.Click the link for more information. Institutional Investor

A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions.

.Click the link for more information.The trend toward the predominance of investment banks over commercial banks in corporate financing that took off in the 1980s is alive and well in 2010. For example, we see the recent move on the part of European banking companies to set up investment banking businesses on Wall Street. Recently, the investment banking business has been a big source of fee income many banks such as Credit Suisse and JP Morgan Chase.

Developments in the 1980s Affecting Corporate Finance

The article delineates factors, such as deregulation and internationalization, that explain the rising predominance of financial markets over commercial banks in the 1980s for corporate finance but leaves out a number of important developments in corporate finance at the time.

Developments in the 1980s Affecting Corporate Finance

Reference

Topsy-Turvy: A Survey Of Corporate Finance (1986, June 7). The Economist 299(7449), p. S1

Retrieved from http://www.lexisnexis.com.ezproxy.fiu.edu/hottopics/lnacademic/

Financial Markets and Corporate Finance

Financial Markets and Corporate Finance

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Financial Markets and Corporate Finance

In the first week of September of 2010, $51 billion of new corporate bond and leveraged loans hit the market and investors were eager to take them (Gongloff, 2010). Corporations are flooding the bond markets spurred by very low interest rates (about 3.4%) and global investors eager to acquire higher-yielding assets, given that depositing money in banks yields almost nothing and the stock market is stalled. Expecting that interest rates may increase, corporations are taking advantage of investors' appetite to lock in borrowing at low rates (Gongloff, 2010). The booming business in financial markets is reflected in the recent surge in profits by investment banks such as Goldman Sacks. These banks recovered quickly from the financial turmoil at the end of 2008 and paid back the TARP loans they received from the government.

The article points to the importance of financial markets for corporate finance in 2010 and to the low interest rates on deposits and the stalled stock market as factors contributing to the salience of financial markets as a source of money for nonfinancial corporations. Yet the article is limited in a number of ways. Someone reading the article might think that the importance of financial markets, in contrast to commercial banks, for corporate finance is a particular event emerging in 2010. However, this is a trend that started in the 1980s. Two changes traced to the mid 1980s that spurred financial markets as a key source of corporate finance were deregulation and internationalization. Deregulation of interest rates increased the cost of loans from commercial banks as banks paid higher interest rates for deposits. Deregulation had another aspect, allowing nontraditional institutions to enter the financial markets business. Internationalization meant that companies could seek financing from foreign investors. An example of the role of internationalization carried over from developments in the 1980s is the Financial…

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