Ch2 Capital market Flashcards
Financial instruments
shares
bonds
derrivatives
commodities
currencies
Five sub-markets
- capital market: shares and bonds
- money market: assets < one year
- derivative market
- commodities market
- currencies market
Capital market
- securities are issued to raise medium- to long-term financing
- market participants trade securities
- securities - ownership in corporations, and creditor relationship in government / corporations
Purpose of capital market
- a conduit for demand and supply of debt and equity
- a secondary market for security holders to exchange them at market prices
Two components of capital market
- stockmarket
- bond market
Within the markets:
1. primary market: transaction only once
2. secondary market: where most transactions take place
3. over-the-count market:usually for small companies not able to meet listing requirements
Money market
- also a part of financial market
- for borrowing and lending short-term (< a year)
- term deposits, treasury bills, and commercial paper
Two kinds of public issues
- cash offer: offered to the public as part of a public offering
- rights offer: offered to existing shareholders in porpotion to their current holdings
Public offering
- Prospectus:
- approval of the prospectus only certifies that all information relevant to eh issue is included in the prospectus and the information is accurate
- the approval doesn’t imply any conclusion regarding the merits of the security or the fairness of the sale price - preliminary prospectus: no price determined, red herring. price is determined prior to the date the shares are available for sale after being consulted with large institutional invetors
- unseasoned offering - IPO / seasoned offering
4.prompt offering prospectus: short-form prospectus
bond indenture
- senior bonds: rank ahead of other lenders in the event of default
- junior or subordinated bonds
- call provision: issuer repay earlier than maturity
- sinking fund provision: issuer deposit money annually with a trustee, ensuring enough cash to pay off bond
- conversion provision: to be converted into shares rather than being repaid in cash
- protective covenants
Private placement
- securities issue is sold to a group of institutional investors such as insurance company, pension plan, mutual fund
- no prospectus is required
- offering memorandum required
- private placement investors are more sophisticated
- majority of bonds and preferred shares are sold through private placement
- the issue sold in a private placement cannot be freely traded in the market
Flotation costs
all the costs incurred to complete a new issue of shares or bonds
disadvantages of private placement
- higher financial cost (low flotation costs)
varieties of underwriting arrangements of cash offering
- bought deal: underwriter syndicate offers to buy all the issue at a guaranteed price - for seasoned offerings of large companies
- regular underwriting: aka firm commitment underwriter takes the risk
- best efforts: issuer takes the risk
- Dutch auction: the price at which the # of shares issued is reached is determined to be the issue price.
each bidder gets % (# of shares issued/# of shares bidded) of shares at the issue price
Other issues
- overallotment option: Green Shoe provision
additional % of shares are given to underwriters at initial agreed price - lockup agreement
underpricing at IPO
Underwriters determine the “right” price of shares to be offered to the market
underpricing is an opportunity cost for the issuer
information impact on current prices
- company-specific information
- actual earnings or forecasts of future earnings
- dividends, acquisitions, or divestitures
- change in strategy
- introduction of new products or discontinance - industry-wide performance indicators, including announcement by competitors
- economic indicators such as changes in:
- interest rate
- fx rate
- economic outlook
- inflation or deflation
- prices for oil, energy costs, minerals and metals
Market efficiency
- efficient captial market
- prices of securities fully reflect available information related to their valuation and adjust quickly to new information
- market price = intrinsic value, determined by the PV of expected future cash flows from the security
How information affects prices
Investment analysts facilitate how information is reflected in security prices
- they collect information regardng securities, evaluate the information and determine its impact on intrinsic (fundamental) values
Forms of market efficiency
- historica information - weak form of market efficiency: traders not likely to make higher profits - price based on “past” information
- publicly available information - semi-strong market: traders not likely to make higher profits because publicly-available information already reflected in the price - insider information can make higher profits - price based on “past and public available information”
- insider information - strong market: no one can consistently earn a higher profit than could - price based on “past + public available + private” information
Credit rating agencies
- Moody’s Investor Services
- Standard & Poor’s Financial Services
- Fitch Ratings
Bond rating - S&P
based on default in payment
- AAA - AA - A - BBB : investment grade bonds
- BB and below: speculative bonds, or junk bonds
