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Internal Capital Market and External Capital

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1. What distinguishes the internal capital market from the external capital market?
2. What important factor(s) might affect a firm's internal-external financing choice?
3. Why might firms prefer to issue new debt securities rather than new common stock?
4. How does the U.S. tax system affect a firm's financing choices?
5. What are financial markets?
6. Why will an economy suffer without a developed financial market system?
7. What distinguishes a real asset from a financial asset?
8 Can you distinguish between direct securities and indirect securities?
9. What is the difference between a savings-surplus sector and a savings deficit sector? Give an example of each.
10. Why cannot all sectors be savings-deficit sectors?
11. Within the financial markets, what do we mean by "private placements"?
12. What are the possible advantages and disadvantages of private placements?

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Solution Summary

This solution discusses various financial choices.

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ANSWERS
Question 1
The external capital market is where a company can raise funds from third parties in exchange of a debt or equity security of the firm. Examples of external capital markets are stock exchanges and banking institutions.
The internal capital market, on the other hand, is the mechanism where businesses source its funds from its own operations. The sources of these funds are usually from the company's retained earnings.

Question 2
Factors that might affect a company's internal-external financing choice are:
? Its optimal capital structure
? Ease of raising funds from the internal and external markets
? Cost of capital sourced from the internal and external markets

Question 3
Sometimes firms prefer to issue new debt securities rather than new common stock because
? Interest expenses for the debt securities are tax deductible which effectively decreases the firms' tax payable while the dividends to ...

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