Introduction Flashcards
What are capital markets?
Capital markets are financial markets where entities like corporates, sovereigns, and semi-state bodies raise medium- to long-term finance.
What are the main modern capital markets?
- Debt and equity capital markets
- Securitisation and structured finance markets
- Derivatives and structured finance markets
How are capital markets categorised?
Primary Markets: Where securities are issued
Secondary Markets: Where securities are traded
Also categorized into equity, debt, securitisation, and derivatives markets.
How do the UK FCA and European Commission define capital markets?
FCA: Markets where shares, derivatives, bonds, and other instruments are bought and sold.
European Commission: Markets for raising longer-term finance via shares or loans not expected to be fully repaid for at least a year.
What roles do issuers and investors play in capital markets?
Issuers: Raise money by issuing securities.
Investors: Invest money, hoping for financial returns.
In exchange for an investor transferring money to the issuer, the issuer will issue financial instruments known as securities to the investors.
What are securities?
Contracts representing an investment between issuers and investors. They can be bought and sold on capital markets.
Why do issuers access the capital markets?
- Provide issuers with an alternative source of funding that can be used instead of or with bank financing.
- Issuers have access to a larger number of investors.
- Capital markets offer more flexibilitiy, longer maturities and a wider investor base.
Why do investors access the capital markets?
- Investors in a capital markets transaction can include (amongst others) financial institutions, pension funds, governments, high-net-worth individuals and retail customers. The capital markets provide these investors with an alternative venue for investing their excess money to a standard bank deposit.
- By investing through the capital markets, investors can buy securities that they either hold as an investment or trade with other investors.
Are capital markets a form of bank disintermediation?
While financial institutions remain involved and help to place securities with potential investors, issuers borrow/receive funds directly from investors. Investors can, therefore, choose which issuers they want to provide funding to, and which securities their money will buy.
What are the benefits of raising funds via capital markets over bank loans?
Access to a wider pool of investors
More flexibility, better pricing, and longer maturities
Alternative or additional source of funding
What types of investors participate in capital markets?
Financial institutions, pension funds, governments, high-net-worth individuals, and retail customers.
Why do investors prefer capital markets over standard bank deposits?
Alternative investment options
Ability to hold or trade securities
How do capital markets reduce the role of financial intermediaries like banks?
Investors provide funds directly to issuers by purchasing securities.
Example:
Investors > Securities > Issuers
Issuers > Funds (£) > Investors
What are the types of capital markets based on currency and location?
- Domestic: Issuer and investors are in the same country, using the local currency.
E.g., a UK company issuing GBP bonds in the UK. - Foreign: Issuer and investors are in different countries, using the investors’ currency.
E.g., a Turkish company issuing USD bonds in the U.S. - International/Eurobond: Securities issued in a currency different from the issuer’s home country.
E.g., a UK company issuing Japanese Yen bonds in Luxembourg.
What was the first eurobond issuance?
Italian company Autostrade issued $15M bonds listed on the Luxembourg Stock Exchange.
A&O helped establish modern debt capital markets through this transaction.
What are the three broad categories of capital market products?
- Debt securities: Bonds or notes evidencing debt owed by issuers.
- Securitisation: Bonds secured by predictable cashflows (e.g., mortgages).
- Derivatives: Instruments deriving value from underlying assets (e.g., swaps, futures).
What are debt securities?
Evidence a debt owed by the issuer to the investor. Create a contractual relationship between the issuer and bondholder - issuer promises to redeem the secuirty at maturity or on the occurance of a particular event.
What are securities?
Bonds that are secured on predictable cashflows derived from a pool of assets.
What are derivatives?
Value is dependent upon an underlying asset. Various types of contracts are used to derive value from these underlying assets, such as options, futures, forwards and swaps. These instruments are used by market participants to manage risk, to speculate on future price movements or to hedge (protect) against potential future losses.
What led to the GFC in 2007/2008?
- Risky loans and the growth of the subprime mortgage market.
- Securitisation of mortgages into risky mortgage-backed securities (MBS).
- Failure in transparency and accurate risk ratings for these securities.
How has regulation changed post-GFC?
- Increased focus on financial stability and systemic risk management.
- Emphasis on transparency and stronger market oversight.
What is systemic risk?
The risk of an event causing instability or collapse of an entire industry or economy (e.g., failure of a major bank).
What are the two types of securities issued to investors in capital markets?
Debt securities: Acknowledging a debt.
Equity securities: Acknowledging an investment.
What is a bond?
A financial instrument evidencing a debt owed by an issuer, promising:
Repayment of the debt (principal) at a future date.
Interest (coupon) payments to investors during the life of the bond (if applicable).
Bonds are essentially a promise to repay a loan.
When is the principal amount of a bond repaid?
On a specified maturity date.
Sometimes on multiple dates between the issue and maturity date.
What happens on maturity of the bond?
At maturity of the bond or upon the occurrence of a particular event - the issuer will redeem the bond certificates and in doing so will repay investors their original investment.
What are perpetual bonds?
Bonds with no maturity date, redeemed upon the occurrence of a specific event.
What do the Terms and Conditions of bonds specify?
- Redemption terms
- Interest payment details
- Other key provisions
What are debt securities?
Debt is money that is borrowed and must be repaid.
What are equity securities?
Equity is a financial investment in a company.
Repayment for debt securities vs equity securities
Debt: The issuer promises to repay the principal to the investor.
Equity: Shares evidence an investor’s ownership interest in the issuing company, they are not a debt and there is generally no obligation on the issuer to repay the investment.
Periodic returns for debt securities vs equity securities
Debt: Investors will typically have the right to be paid interest (coupon). This coupon can be fixed or floating. Some bonds are zero coupon.
Equity: There are no guaranteed payments. Instead, an issuer may pay shareholders a dividend.
Interest on the issuer for debt securities vs equity securities
Debt: A bondholder does not take any ownership interest in the issuer’s equity.
Equity: A shareholder takes an ownership interest in the issuer. This ownership usually gives the shareholder the power to vote on major issues relating to the issuer and to have access to information about the issuer.
Typical issuers for for debt securities vs equity securities
Debt: Bond issuers are borrowers and can be a variety of different types of entity, including:
* national government (known as a “sovereign bond”);
* companies;
* supranational entities; and
* Special Purpose Vehicle - SPVs.
Equity: Only a company can issue shares as the process of issuing shares requires the existence of a company’s separate legal personality.
Typical investors fro debt vs equity
Debt: Bonds can be marketed to a wide number of investors. In wholesale bond issuances, these investors are sophisticated or institutional investors; in retail bond issuances, these investors include individuals who are not professional investors.
Equity: Shares in private companies will typically be placed with a small group of targeted investors. Shares in public companies can be marketed to a wide number of wholesale and retail investors.
Listing for debt vs equity
Debt: Cannot be listed on a stock exchange
Equity: Shares in private companies are not listed on a stock exchange. Shares in a public company may or may not be listed on a stock exchange (although typically will be).
Tradeability of debt vs equity
Debt: Bonds are negotiable (i.e. tradable) instruments, meaning that they can generally be bought and sold on the secondary market (as such, once you purchase a bond certificate, you are not required to hold onto it until maturity, you can generally sell it to another investor and try to recover your initial investment).
Equity: Shares are tradable instruments, but shares in private companies may be subject to transfer restrictions as provided for in the issuer’s constitutional documents (such as pre-emption rights).
What is the primary advantage of issuing bonds over shares?
Issuing bonds avoids dilution of ownership because bondholders do not receive a share in the issuer’s ownership or participate in its control—they are merely creditors.
Why might an issuer prefer bonds over bank loans for large funding needs?
- Access to a large investor base, especially if bonds are listed on a stock exchange.
- Capability to issue large-sized loans (e.g., USD 1 billion) with long tenors (e.g., 30+ years).
- Risk is spread across many investors instead of a few lenders.
- Bonds often have fewer business restrictions compared to loans.
- Flexible interest rate options are available.
- Plain vanilla bonds are typically unsecured, unlike most bank loans.
What are the benefits for investors in bonds?
- Reliable payment stream via interest payments and principal repayment upon maturity.
- Priority over shareholders in case of the issuer’s liquidation.
- Tradability: Bonds can be sold before maturity to realize investment or profit.
