market capitalization

Examples of market capitalization in the following topics:

• Types of Financial Markets

  • Financial markets are of many types, including general and specialized; capital and money; and primary and secondary.
  • Examples of financial markets include capital markets, derivative markets, money markets, and currency markets.
  • There are many different ways to divide and classify financial markets: for example, into general markets and specialized markets, capital markets and money markets, and primary and secondary markets.
  • A key division within the capital markets is between the primary markets and secondary markets.
  • While capital markets and money markets constitute the narrower definition of financial markets, other markets are often included in the more general sense of the word.

• Role of Financial Markets in Capital Allocation

  • One of the main functions of financial markets is to allocate capital, matching those who have capital to those who need it.
  • One of the main functions of financial markets is to allocate capital.
  • Capital markets especially facilitate the raising of capital while money markets facilitate the transfer of liquidity, matching those who have capital to those who need it.
  • Money markets allow firms to borrow funds on a short-term basis, while capital markets allow corporations to gain long-term funding to support expansion.
  • The Frankfurt Bond Market is an example of a financial market that allocates capital.

• Chapter Questions

  • Why would people deposit their savings into financial intermediaries, instead of directly investing in the financial markets?
  • Why did the financial markets in the modern world become international?
  • Distinguish between a money-market mutual fund and a money-market deposit account.

• Impact of the SML on the Cost of Capital

  • The security market line is a graphical representation of the capital asset pricing model that illustrates the idea that investments are priced efficiently based on the expected return and beta-value (risk).
  • Companies often turn to capital markets in order to generate funds -- using the issuance of either debt or equity.
  • This market situation would be quite attractive from the perspective of a company raising capital; however, such an investment wouldn't make sense for a rational buyer.
  • This would not be an attractive market situation for a company looking to raise capital.
  • The location of a financial instrument above, below, or on the security market line will lead to consequences for a company's cost of capital.

• MVA and EVA

  • MVA = PV (EVAs); MVA is the difference between current market value and investors' capital., and EVA is an estimate of a firm's economic profit.
  • Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed by investors.
  • where: MVA is market value added, V is the market value of the firm, including the value of the firm's equity and debt, and K is the capital invested in the firm.
  • EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital.
  • where r is the return on investment capital (ROIC); c is the weighted average of cost of capital (WACC); K is the economic capital employed; NOPAT is the net operating profit after tax.

• Dividend Irrelevance Theory

  • Under perfect market conditions, stockholders would ultimately be indifferent between returns from dividends or returns from capital gains.
  • Dividend irrelevance follows from this capital structure irrelevance.
  • Under these frictionless perfect capital market assumptions, dividend irrelevance follows from the Modigliani-Miller theorem.
  • However, the total return from both dividends and capital gains to stockholders should be the same.
  • Merton Miller, one of the co-authors of the capital irrelevance theory which implied dividend irrelevance.

• Optimal Capital Structure Considerations

  • The optimal capital structure is the mix of debt and equity that maximizes a firm's return on capital, thereby maximizing its value.
  • The theorem states that in a perfect market, how a firm is financed is irrelevant to its value.
  • However, as with many theories, it is difficult to use this abstract theory as a basis to evaluate conditions in the real world, where markets are imperfect and capital structure will indeed affect the value of the firm.
  • Actual market considerations when dealing with capital structure include bankruptcy costs, agency costs, taxes, and information asymmetry.
  • Explain the influence of a company's cost of capital on its capital structure and therefore its value

• Evaluating Interest Rates

  • The interest rate most commonly used in working capital management is the cost of capital.
  • The cost of capital, in a financial market equilibrium, will be the same as the market rate of return on the financial asset mixture the firm uses to finance capital investment.
  • In market equilibrium, investors will determine what return they expect from providing funds to a company.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions.
  • Interest rates of working capital financing can be largely affected by discount rate, WACC and cost of capital.

• Weighted Average Cost of Capital

  • The WACC is the cost of capital taking into account the weights of each component of a company's capital structure.
  • The weighted average cost of capital (WACC) is the rate a company is expected to pay, on average, to its security holders.
  • Stated differently, the return on capital of a new project must be greater than the weighted average cost of capital.
  • As the above equation states, the cost of debt, rD(1 - T), is multiplied by the ratio of debt to total market value of the company.
  • This is then added to the cost of equity, rE , multiplied by the ratio of equity to total market value.

• Relationship Between Financial Policy and the Cost of Capital

  • As opposed to strictly using cost of capital, decisions must be made using opportunity cost of capital.
  • Other facets include portfolio theory, hedging, and capital structure.
  • For example, to the extent prices in the stock market move differently from prices in the bond market, a collection of both types of assets can, in theory, face lower overall risk than either could individually.
  • Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment.
  • Capital structure may be highly complex and include dozens of sources.