12.2 Government And Corporate Finance

In this chapter, we will explore how governments and corporations raise capital to meet their funding requirements. The process varies significantly between public and private entities, and between different types of organizations, such as governments versus corporations. This chapter aims to describe these processes comprehensively, shedding light on the mechanisms, participants, and instruments involved.

The Process Governments and Corporations Use to Raise Capital to Finance Funding Requirements

Government Financing

Governments often need substantial capital to finance public projects, support services, or manage national debt. The process typically involves two primary methods: auctions and fiscal agencies.

Government Auctions

Governments often issue debt securities through an auction system. In these auctions, government bonds are sold to the highest bidders, providing the required funds directly to the state’s treasury.

Advantages of Auctions:

1. Market Determination: Prices of bonds are market-determined, ensuring transparency and fair evaluation.
2. Efficiency: The auction process often spans short timeframes, enabling quick capital access.

Example: United States Treasury Auctions, where T-bonds, T-notes, and T-bills are sold.

Fiscal Agency

Occasionally, governments finance their needs through a fiscal agent such as a central bank. The central bank issues notes, bonds, or other financial instruments on behalf of the government, subsequently making them available to institutional and retail investors.

Corporate Financing

Public companies, which trade on exchanges and over-the-counter markets, finance their operations primarily through debt and equity instruments.

Debt Instruments

Corporations issue bonds to raise capital. These corporate bonds are bought by investors who receive interest payments (coupons) and the return of principal at maturity.

Equity Instruments

Public companies may issue additional stock, thereby gaining capital from shareholders. This can either be through initial public offerings (IPOs) or secondary offerings.

Advantages of Equity Financing:

1. No Interest Payments: Companies are not required to make fixed interest payments unlike debt financing.
2. Permanent Capital: The funds remain with the company without needing to be paid back.

Public vs. Private Financing

While public companies raise funds through well-regulated public markets, private financing involves direct investment from private investors or institutions. These investments often come in the form of venture capital or private equity, which we will discuss briefly here.

Alliance Capital: A notable paradigm of private financing where companies receive substantial funds without public exchange inclusion.

Frequently Asked Questions

What is the difference between government bonds and corporate bonds?

Government Bonds: Issued by national governments; considered low-risk with lower interest rates.

Corporate Bonds: Issued by companies; typically higher risk with correspondingly higher interest rates.

How does an auction-based bond issuance work?

In an auction-based system, entities or individuals bid for securities. The government awards the bonds to the highest bidders at prevailing bids, ensuring transparency and efficient price discovery.

Key Takeaways

• Governments primarily use auctions and fiscal agencies to raise required capital through bonds and other securities.
• Corporations raise funds either by selling bonds or issuing stock, with inherent differences and sets of advantages in each method.
• Public and Private Financing involves regulatory oversight in the public domain, contrasting the relatively private, negotiated investments in private financing.

Glossary:

• Auction-based bond issuance: A procedure where government bonds are auctioned to bidders, with prices determined by the market.
• Fiscal Agency: Method where central authorities (like a central bank) issue the financial instruments on behalf of the government.
• Corporate Bonds: Debt securities issued by corporations, promising to pay back with interest.
• Equity Instruments: Shares issued by a company representing ownership, used to raise capital.
• Initial Public Offering (IPO): First-time sale of stock by a company to the public.
• Private Equity/Venture Capital: Private investments made in firms not listed on public exchanges.

Visual Aids

Concept Flowchart of Financing Processes:

    graph LR
	A[Start] --> B[Determine Financing Need]
	B --> C{Government}
	C --> D[Bond Issuance via Auction]
	C --> E[Bond Issuance via Fiscal Agent]
	B --> F{Corporation}
	F --> G[Debt Instruments #40;Bonds#41;]
	F --> H[Equity Instruments #40;Stock#41;]
	H --> I[IPO]
	H --> J[Secondary Offering]

In this section

• 12.2.1 Investment Dealer Finance Department
  Comprehensive guide on the role and responsibilities of the finance department within investment dealers, focusing on both government and corporate finance.
• 12.2.2 Canadian Government Issues
  An in-depth look at Canadian Government Issues, including the competitive tender system for marketable bonds and Treasury bills, types of bonds, bid structures, and the example auction process.
• 12.2.3 Provincial And Municipal Issues
  An in-depth look at the issuance, management, and characteristics of provincial and municipal bonds in Canada. Understand the roles of financial agents, syndicate groups, and institutional portfolios in these securities.
• 12.2.4 Corporate Financing
  Comprehensive guide on corporate financing including equity and debt financing in Canada. Explore types of securities, share capital, market capitalization and public float with real-world examples.