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Corporate Finance Revision > Capital Markets and Securities > Flashcards

Capital Markets and Securities Flashcards

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1
Q

What is a financial market?

A

The participants, commentators and facilitators which contribute to setting the price of a financial asset.

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2
Q

Who are participants within a financial market?

A
  1. Investors

2. Traders - Buying shares/bonds from a seller then selling it on for a higher price.

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3
Q

What are financial markets there for?

A

There to set financial price of asset. Using info from equity analysts.

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4
Q

Who provides information in the market?

A

Equity analysts.

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5
Q

Who facilitates financial markets?

A

Exchanges and banks.

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6
Q

What are the 4 main types of financial market?

A
  1. Capital Markets
  2. Money Markets
  3. Derivative markets
  4. Foreign exchage market.
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7
Q

What is a capital market?

A

Involves long term securities one year in the future.

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8
Q

what is a money market?

A

Short-term securities (< 1 year from issue to maturity) (maximum of a year).

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9
Q

What is a derivative market?

A

Futures and options

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10
Q

What is a foreign exchange market?

A

Currencies and forwards

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11
Q

What is a security?

A

A financial instrument that can br traded for a monetary value. E.g. Stock.

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12
Q

Who issues securities in the capital market? (primary capital market).

A

¥ Companies – issue equities and bonds to finance growth

¥ Governments – issue bonds to make up tax shortfall

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13
Q

Does the investor have legal reights to recieve future cash flows from the issuer of these securities?

A

yes.

Equities (shares?) – dividends and liquidation proceeds. Infinite.

Bonds – interest (fixed) and redemption proceeds

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14
Q

What happens in a secondary capital market?

A

Investors buying and selling shares between themselves

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15
Q

What is a stock exchange?

A

Infrastructure for and regulation of:

¥ Primary market (issuance of “new” securities)
¥ Secondary markets (trading of “old” securities)

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16
Q

What does a stock market demonsrate?

A

Security prices
Corporate News
Index Values

17
Q

What does an equity indeces do (page 2 on my word document).

A

Reflects prices of it’s constituent securities.

18
Q

What does an equity index do?

A

Provide a weighted average of the prices of however many successful companies. E.g. FTSE 100 is the 100 largest companies. Shows the overall equity of these companies that day.

19
Q

What does an equity index ignore?

A

Dividends

20
Q

How are equity index’s useful?

A

They allow us to compare the performance of share prices.

E.g. Can see how meggit compares to other companies of a similar size.

21
Q

Why are equity prices important for shareholders and directors in secondary markets?

A
  1. Shareholder wealth creation
  2. Financial efficiency through reselling.
  3. Remuneration (i.e. Executive Share Option Schemes.)
22
Q

What does it mean when the price rises in a secondary market?

A

There is more buyers than sellers.

23
Q

Why do participants trade an equity?

A

They have different opinions on the intrinsic value of a company’s shares.

Determined by the amount, timing and certainty of it’s expected future cash flows. Subjective and rarely the same as it’s price. Optimism vs pessimism.

24
Q

What factors could make a participant more optimisitic in a secondary market?

A
  1. Financial results and trading updates
  2. Management changes
  3. Mergers and acquisitions
  4. Close competitors
  5. Economic data
  6. Equity analyst forecast upgrades
25
Q

What terms should a share price performance be stated?

A

Relative terms to an appropriate equity index. Comparing to the equity index basically. (average of all other companies within this stock market).

E.g. -15% shareprice change (individual). -2% Index change.

Relative performance of a shareprice: -15% + 2% = -13%.

26
Q

What makes a market efficient?

A
  1. Many participants
  2. Low transaction costs
  3. readily accessible information
27
Q

What happens to security prices when they are in an efficient market?

A

They react fully, rapidly and rationally to all new information which is relevant to instrinsic value.

Directors can be confident that actions which create or destroy shareholder wealth will be reflected in the share price

28
Q

What are the 3 types of market efficiency?

A
  1. Weak Efficiency
  2. Semi - strong efficiency
  3. Strong efficiency
29
Q

What are the characteristics of a weak efficient market?

A
  1. ¥ Prices fully, rapidly and rationally reflect all information contained in past prices
  2. ¥ Strongly supported by tests of empirical evidence
  3. ¥ Not possible to make consistent abnormal returns by predicting future price movements based on past price movements
30
Q

What are the characteristics of a semi - string efficient market?

A
  1. Prices fully, rapidly and rationally reflect all information contained in past prices and all relevant publicly available information.
  2. Not possible to make consistent abnormal returns by using past prices or publicly available information
  3. Fairly well supported by tests of empirical evidence despite anomalies such as existience of star investors.
31
Q

What are the characteristics of a strong efficient market?

A
  1. Prices fully, rapidly and rationally reflect all information contained in past prices and all relevant publicly available information and all relevant inside information
  2. Not possible to make consistent abnormal returns with any information
  3. Not well supported by tests of empirical evidence such as abnormal returns by directors dealing in their company’s shares.
32
Q

What classification of efficiency are major capital markets and why?

A

Weak to semi strong efficiency because security prices:

  1. Absorb new information quickly and rationally.
  2. Fully reflect information contained in past price movements.
  3. Do not reflect inside information
33
Q

What’s the academic theory of the equity shares valuation?

A

The intrinsic value of a company is the present value of its expected future cash flows discounted at an appropriate, risk-adjusted, rate

  • impossible to do with bonds.
34
Q

What is the reality of the equity shares valuation?

A
  1. Future company cash flows are inherently uncertain
  2. Many and varying factors affect the discount rate
  3. Non-cash flow methodologies to estimate equity value are used in practice which are:

The Price Earnings Ratio (PER)
The Dividend Yield (DY)

35
Q

What is the formula for the price earnings ratio?

A

PER = Share price (clean)/ prospective annual earnings per share.

36
Q

What are the 4 considerations for the PER? (Page 8 of word document).

A
  1. Cannot use if company is loss-making
  2. Forward looking but inherent uncertainty in forecasts
  3. Earnings per share is partly subjective (accounting profits)
  4. Measure of relative (not absolute) value.
37
Q

What is the formula for the dividend yield?

A

DY = prospective annual dividend per share ÷ share price (clean).

38
Q

What are the 4 considerations for the dividend yield? (Page 9 of my word document).

A
  1. Cannot use if company has a zero dividend policy
  2. Forward looking
  3. Dividends per share are objective
  4. Measure of relative and absolute value

Corporate Finance Revision (10 decks)

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