10. Financial markets and identification of financing needs Flashcards
How does a primary market differ from secondary market?
A primary market is a ‘new issues market’ where companies can raise ‘new’ funds by issuing shares or loan stock. A secondary market permits the primary market to operate more efficiently by facilitating deals in existing securities.
Why do companies list their share on a stock exchange?
Why do companies list their shares on a stock exchange?
Companies issue shares in the stock market to:
raise funds for business requirements;
to comply with the requirement of a stock exchange flotation where a minimum proportion of shares must be made available to the public;
to provide an exit to investors who have invested in the company by providing liquidity to the stocks of the company;
to increase the brand image of the company; and
for many other reasons.
What are the key functions of a stock exchange?
Key functions of a stock exchange include:
providing the value of stock of a company;
acting as a barometer for the economic performance of the country;
ensuring fair dealing between investors;
regulating intermediaries and companies; and
promoting economic growth.
What are the key advantages of a public over a private market?
What are the key advantages of a public market over a private market?
Public markets are markets where the general public can participate in such as stock market. A person can participate in such a market with as little as £10. Public markets also offer greater liquidity, thereby enabling a smooth purchase or sale. The risk profile of public markets is relatively small because of regulations, transparency and monitoring by seasoned investors and regulators.
Key advantages of public markets over private markets include:
no qualification or net worth criteria is required to be fulfilled to enter the market;
highly regulated and transparent markets, thereby reducing risk; and
highly liquid investments.
What are the three forms of market efficiency?
- What are the three forms of market efficiency?
There are three levels of market efficiency as per the EMH:
Weak form: the market prices are reflective of all historical information contained in the record of past prices. Share prices will follow a ‘random
walk’ and move up or down depending on the next piece of information about the company that reaches the market. The weak form implies that it is impossible to predict future prices by reference to past share price movements.
Semi-strong form: the market prices reflect not just the past and historical data but all information which is currently publicly available.
Investors are unable to gain abnormal returns by analysing publicly available information after it has been released. The price will alter only
when new information is published. With this level of efficiency, share prices can be predicted only if unpublished information were known. This would be known as insider dealing.
Strong form: share prices reflect all available relevant information, published and unpublished including- insider information. This implies that even insiders are unable to make abnormal returns as the market price already reflects all information.
In what form of market efficiency can money be made by insider dealing?
In what form of market efficiency can money be made by insider dealing?
Evidence suggests that stock markets are semistrong market efficient at best. Any new information is rapidly reflected in the share price. In semi-strong efficiency, all public information is already reflected in the share price. With this level of efficiency, share price can be predicted only if unpublished information is known through insider dealing.
Provide an example of exceptions when a sudden price change is not triggered by new information about the company reaching the market
There are times when sudden large price changes do not appear to be triggered by new information reaching the market. There are also instances when prices change quickly, but not instantaneously, over short periods before price-sensitive information is released by companies. For example, in October 1987 the value of shares on the London Stock Exchange fell by one-quarter during the course of the month with no specific new information identified as the cause of the fall. In contrast, the steep fall in share prices in 2008 could be associated with the accumulated impact of the global credit crisis that started with sub-prime lending failures in the US.
How can companies raise finance from the following institutional
investors?
- Private equity
Private equity finance is not publicly traded but raised through private investors that are typically large institutional investors, university endowments, or wealthy individuals. It is organised through the mediation of a venture capital company or private equity business.
Raising private equity finance does not expose the
company to the similar scrutiny and regulation of a stock market.
It is perceived to be an investment with relatively high risk for investors. Investors provide finance through placing as they yield higher returns than they would from a stock market listed company. Placing is a way of raising equity capital by selling shares directly to third party investors (usually a merchant bank).
Business angels are a source of private equity finance to start-up and early-stage businesses in return for a share of the company’s equity. - Pension funds
A pension fund, also known as a superannuation fund in some countries, is a fund from which pensions are paid.
Pension funds typically have large amounts of money to invest in both listed and private companies. Pension funds, along with insurance companies, make up a large proportion of the institutional investors that dominate stock markets.
In most pension funds, there is a surplus of incoming funds from contributions over outgoings as pension payments. This surplus is invested to maximise the best possible return, while maintaining the security of the funds.
Types of budget
Master Budget: Master Budget is the combined result of all the budgets of the company
Static Budget: A budget that projects a fixed level of activity ( input, output and costs).
Flexible Budget : A budget that can be adjusted with the changing volume of activity.
Budgetary control
Budgetary control is the process of using the budget to control and monitor the actual results against the budgeted results.
Variance is the difference between the budget and the actual results.
Analysis of variance helps to evaluate the performance. It also helps to identify areas where corrective action is required.
This control mechanism is called a feedback-control mechanism.
