The capital market Purpose of the capital market For long term investment Capital market participants

The capital market The capital market Purpose of the capital market For long term investment Capital market participants Federal and local governments Corporations Largest purchasers Households Capita.

The capital market

Purpose of the capital

market

For long-term investment

 Capital market participants

Federal and local governments

Corporations Largest purchasers :

Households

Capital market trading

 Occurs in either the Primary Market

or the Secondary Market

 Primary Market

 Secondary Market

 Organized exchange

 Over-the-counter exchange

 Organized securities exchange

 An organized exchange has a building

where securities ( stocks, bonds,

options, futures) trade.

 Largest organized securities exchange in USA:

NewYork stock exchange (NYSE)

- Minimum requirement to

list on the NYSE:

 At least 2000 stockholders , each owning

earning in each of the prior two years

 Net asset of $ 18 million

 A total of $ 18 million in market value of

publicly traded shares

Over-the counter market:

 securities not listed on one of the

exchange trade in the

over-the-counter market

 Trading occurs over a sophisticated

telecommunication network (National Association of securities Dealers

Automated Quotation System –

NASDAQ)

Capital market securities:

Bonds

 The capital market are where securities with

original maturities of greater than one year

trade.

 Capital market securities: bonds, stocks and

mortgages

 Bonds are securities that represent a debt owed

by the issuer to the investor

 Par, face, maturity value of the bond is the

amount that the issuer must pay at maturity

 The coupon rate is the rate of interest that the issuer must pay This rate is usually fixed for

the duration of the bond and does not fluctuate with market interest rate.

registered interest and principal securities)

+ interest payment

+ principal repayment (zero-coupon bond)

Agency bond

 Issuer of agency bonds include:

the government national mortgage association,

the farmers home administration,

the federal housing administration

 characteristic:

low risk

interest is higher than treasury

securities due to the lower liquidity

Municipal bonds:

 Issued by local, county and state government

 Purpose: to finance public interest project

( schools, transportation systems )

+ advantage: low interest because it is exempt bond

+Tax-free municipal interest rate = taxable interest rate x (1 – marginal tax rate)

Ex: taxable corp Bond interest rate : 9 %

Marginal tax rate : 28%

Equivalent tax-free rate for an investor is

9% x (1 – 0,28) = 6,48%

specific assets pledged as security or a

specific source of revenue allocated for

their repayment The issuer promises to use every resource available to repay the bond.

particular revenue-generating project (high risk)

note: municipal bonds have default risk

(local government cannot print money)

Corporate bonds

 issuer: large corp.

 Face value: $ 1000 ;

 Pay interest : semi-annually

 Can be redeemed anytime the issuer

Characteristics of Corp Bonds

+ Bearer bonds: payment were made to

whoever had physical possession of the bonds + registered bonds: do not have coupons

Owner must register with the firm to receive interest payment.

amount of dividends the firm can pay and the ability of the firm to issue additional debt.

Call provisions, Conversion

to sell the bond back.

(1) if interest rate fall, bond price will rise When rates fall enough, price will rise above call price : firm will call the bonds;

(2)make issuers possible to buy back their bonds according to the term

of the sinking fund.

Sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year ( reduce probability of default) + Sinking fund provision makes the issue more attractive

+ firm can reduce bonds interest rate

(3) firm may have to retire a bond issue if the covenants of the issue

restrict the firm from some activity that it feels is in the best interest of stockholders.

(4) if firm wishes to alter its capital structure.

Convertible bonds will state that the bond can be converted into a

certain number of common shares at the discretion of the bondholder.

Types of corp Bonds

periodically

speculative-grade bonds are often called Junk bond.

Financial guarantees for

bonds

 Financially weaker security issuers

frequently purchase financial

guarantees to lower the risk of their bonds A financial guarantee ensures that the lender (bond purchaser) will

be paid both principal and interest in the event the issuer default

Capital market securities:

Stock

ways: either the price of the stock rises over time or the firm pay the stockholder dividends

have a lower priority than bondholders when the

firm is in trouble, the return to investors are less

assured because dividends can be easily changed and stock price increases are not guaranteed.

rights regarding the firm:

+ a residual claimant: claim on all assets and

income left (get nothing or get rich);

+ right to vote for directors and on certain issues.

Common stock versus

Valuing stock

 The price of a share of stock is the

present value of expected future

cash flows which consist of dividends plus a final selling price

 The problem is predicting the future cash flow of the firm

Po = - + - + - + … + -

P : price of stock at time 0 (present)

D : dividend paid at time n

i : discount rate applied to computing the present value of the dividends.

Stock market indexes

 A stock market index is used to

monitor the behavior of a group of

Buying foreign stocks

 Risk

“Do not put all your eggs in one

basket”

 systematic risk: risk can not be

eliminated through diversification;

 nonsystematic risk: risk can be

eliminated through diversification if you hold enough different securities in your portfolio

Public issues of stocks & bonds

 There are two principal ways for a

firm to sell securities to the public:

+ Through a public sale organized by investment bankers;

+ Through a private placement