L5 - A Detailed look at the Capital Market Flashcards
What is the Capital Market?
- The capital market is where long term funds are raised to finance the needs of companies, particularly, though not exclusively, for investent finance, Equity gives shareholders residual claim on the company and the right to share in profit
- a market economy cannot function without a capital market and an efficient allocation of resources depends, on other things, on an efficient captial market
What is an issue with ‘‘efficient allocation of resources”?
Assumes their is an optimal income level
- the power to influence the market depends on your preferences and in turn what you want to spend your income on, if you say that the distribution of income is sub-optimal –> not happy with your income, then the allocation of resources must also be sub optimal
- so when economist refer to markets as having an efficient allocation of resources - it might not be the distribution of income that you want
- it depends on assumptions you make about the distribution of income
What are the different Types of Equity?
- Ordinary (Common) Shares
- Preferred (Preference) Shares
What are Ordinary Shares?
- These represent partial ownership of a company and provide shareholders with a potential claim against future profits, commonly referred to as dividends.
- Ordinary shareholders are residual claimants, that is, they are entitled to a share of the profits only after the claims of bond holders and preference shareholders have been met.
- The increased risk comes with voting rights and the ability to change the board of directors.
Returns to ordinary shareholders can be relatively volatile partly depending on the proportion of debt to equity, the so called gearing ratio.
What are Preferred Shares?
These represent an equity interest in a company that confers no voting rights on the owners. Typically preferred shares give a prior claim on profits but do not carry the obligation on a company to pay any dividend. Payments is made only after payments on debt instruments have been met in full.
What is the Primary Capital Market?
- When equity is initially issued, it is sold in the primary market. The primary market has two dimensions: A public market and a private placement market.
- We concern ourselves only with the former because in the latter, securities are sold directly to investors and such arrangements are not registered with the Securities and Exchange Commission.
- There are different regulatory requirements for such arrangements.
Initial Public Offering (IPO) –> is how raise new finance in the primary market when this is accompanied by a Stock Exchange listing for the first time. This allows a company to raise funds from the public.
What is a Secondary Public Offering?
occurs when a company which already has a Stock Exchange listing issues additional equity and offer this for sale. Note that sometimes an SPO raises no equity for the issuing company because the new equity is simply used to achieve a switch from unquoted shares to quoted shares.
What is the Secondary Capital Market?
- Equity instruments are traded in the secondary capital market. No ne capital is raised here and the issuer of the security does not benefit directly from the sale.
- Trading on secondary markets takes place between investors but this is usually done brokers who act on behalf of their client and transact business with dealers.
What is generally needed by a company to trade on the stock market?
- Stock markets have central trading locations in which instruments are traded.
- However, only equity in listed public companies can be traded and to obtain a listing a company must satisfy the requirement set by the stock exchange.
- Each stock exchange sets its own requirements but these are likely to include minimum earnings requirements, the size of net tangible assets, the size of market capitalisation, the number and distribution of shares help publicly and so on.
What are Electronic Stock Markets?
Since the middle of the 1990s a number of electronic stock markets have been created. While publicly displaying buy and sell orders of stock, they are primarily adapted to serve the execution of orders from institutional investors without the need for any physical broker to place the order
How has the development of Electronic Communication Network (ECNs) increased competition?
- The development of electronic stock exchanges followed the development electronic communications networks (ECNs). Since these facilitate execution of orders on different electronic stock exchanges competition on stock exchanges has increased as a consequence.
- One way in which this might happen is that because ECNs allow complete access to orders to be placed on other organised exchanges the practice of providing more favourable quotes exclusively to a dealer’s most important clients is no longer possible.
What are the two types of Alternative Trading Systems that have been developed from electronic trading?
These have developed out of the idea that with electronic trading, there is no longer any necessity to use an intermediary in the conduct of a transaction between two parties, that is, the services of a broker or a dealer are no longer required to execute a trade.
he direct trading of stocks between two customers without the use of a broker or an exchange is called an ATS and there are two types of alternative trading systems:
- Crossing networks
- dark pools.
What are the features of Electronic Crossing Networks?
These do not display quotes but instead match relatively large buy and sell orders of a pool of clients (dealers, brokers, institutional investors and so on) anonymously at relatively low cost. Anonymity is especially important for institutional investors who place relatively large orders. Cost is also clearly important.
- Orders are lumped together in batches, throughout the day each batch is satified at predetermined times a day, and a buy is matched with a sell order at the midpoint of the bid-offer-spread
- The reasons costs have fallen in with this trading network is due to the fact that orders can be held then matched later
, What are the features of Dark Pools?
These are private crossing networks which perform the traditional role of a stock exchange. Participants submit orders to cross trades at prices which are determined externally, that is, by the market. They thus provide anonymous (‘dark’) source of liquidity
What are order-driven markets?
Order driven markets developed some years ago. These are markets without active market makers and buy and sell orders are simply matched directly. If not all orders at a price can be executed, priority is given to the oldest order.
