Principles of Managerial Finance

CHAPTER 1 The Role and Environment of Managerial Finance 27

international equity market
A market that allows corpora-
tions to sell blocks of shares to
investors in a number of different
countries simultaneously.

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

foreign bond
Bond that is issued by a foreign
corporation or government and is
denominated in the investor’s
home currency and sold in the
investor’s home market.

Q 0

Number of Shares Traded

Share Price

P 1

P 0

Q 1

D 1

D 0

D 1

S

D 0

S

FIGURE 1.5

Supply and Demand

Supply and demand for a

security

bonds that would be purchased by investors in Belgium, Germany, or Switzerland.

Through the Eurobond market, issuing firms and governments can tap a much

larger pool of investors than would be generally available in the local market.

The foreign bond market is another international market for long-term debt

securities. Aforeign bondis a bond issued by a foreign corporation or govern-

ment that is denominated in the investor’s home currency and sold in the

investor’s home market. A bond issued by a U.S. company that is denominated in

Swiss francs and sold in Switzerland is an example of a foreign bond. Although

the foreign bond market is much smaller than the Eurobond market, many issuers

have found this to be an attractive way of tapping debt markets in Germany,

Japan, Switzerland, and the United States.

Finally, the international equity marketallows corporations to sell blocks of

shares to investors in a number of different countries simultaneously. This mar-

ket enables corporations to raise far larger amounts of capital than they could

raise in any single national market. International equity sales have also proven to

be indispensable to governments that have sold state-owned companies to private

investors during recent years.

The Role of Securities Exchanges

Securities exchanges create continuous liquid markets in which firms can obtain

needed financing. They also createefficient marketsthat allocate funds to their

most productive uses. This is especially true for securities that are actively traded

on major exchanges, where the competition among wealth-maximizing investors

determines and publicizes prices that are believed to be close to their true value.

The price of an individual security is determined by the demand for and

supply of the security. Figure 1.5 depicts the interaction of the forces of demand

(represented by lineD 0 ) and supply (represented by lineS) for a given security

currently selling at an equilibrium priceP 0. At that price,Q 0 shares of the stock

are traded.

Changing evaluations of a firm’s prospects cause changes in the demand for

and supply of its securities and ultimately result in a new price for the securities.