FIN 300 Lecture 2 voice notes - Interedt Rates and Taxes on Dividends

  • Introduction to Lecture 2

    • Focus on interest rates, taxes, and financial markets.

    • Financial markets connect capital sources (investors) with capital users (borrowers).

  • Purpose of Financial Markets

    • Enable companies to raise capital:

      • Companies can take loans for short-term needs.

      • For long-term funding, companies often sell bonds or issue stock.

    • Statistics:

      • Approximately 75% of funds raised come from bonds.

      • Roughly 25% come from stock issuance.

  • Interest and Tax Deductions

    • Interest on bonds is tax-deductible, lowering costs for companies.

    • When issuing stock:

      • Preferred stock guarantees dividends which are paid post-tax.

      • Common stock represents ownership without tax advantages.

  • Comparison of Bonds and Stocks

    • Bonds:

      • Considered less risky and do not dilute ownership.

      • Companies favor bonds due to lower costs from interest deductions.

    • Stocks:

      • More expensive due to higher risks and no tax benefits on dividends.

  • Financial Markets Types

    • Money Market:

      • Involves short-term securities: T-Bills, CDs.

    • Commercial Paper:

      • Corporations can borrow directly from another corporation (e.g., IBM lending to AT&T).

      • Generally cheaper than bank loans and considered safe.

  • Capital Markets

    • Deal with long-term securities:

      • Stocks and bonds.

    • Reselling of Securities:

      • Primary Market: Original sale of securities.

      • Secondary Market: Subsequent buying and selling do not affect the issuing company.

  • Role of Investment Bankers

    • Assist companies in raising funds by underwriter functions.

    • Advise on market conditions and timing for selling securities.

  • Securities Regulations

    • Securities Act of 1933:

      • Mandates full disclosure on new issues.

    • Securities Exchange Act of 1934:

      • Established SEC for securities regulation.

    • 1975 Amendments:

      • Created NASDAQ and changed commission structures.

    • Shelf Registration:

      • Allows companies to register multiple shares at once for future sales.

  • Treasury Securities

    • T-Bills and T-Bonds are considered risk-free investments.

    • Reinvestment Risk:

      • The risk related to having to reinvest T-Bills at lower rates upon maturity.

  • Understanding Interest Rates

    • Risk-Free Rate:

      • Represents the theoretical return on riskless investment.

      • Formed from real rates plus inflation premiums.

    • Nominal Rate:

      • Actual rate including risk premiums.

      • Takes into account risks like default, maturity, and liquidity.

  • Tax Considerations for Corporations

    • Income Statement Basics:

      • Calculate taxable income: sales - costs - expenses - interest = taxable income.

    • Corporate Tax Rates:

      • Marginal rates vary, affecting how overall average tax rates are calculated.

    • Dividends and Double Taxation:

      • Dividends are taxed at both corporate and personal levels.

      • Corporations may exclude a percentage of dividends received based on ownership stakes:

        • Under 20% ownership: 70% exclusion.

        • 20%-80% ownership: 80% exclusion.

        • Over 80% ownership: 100% exclusion.