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Capital Final
Capital Final
STOCK EXCHANGE
A stock exchange is an entity that provides "trading" facilities for stock brokers and
traders, to trade stocks, bonds, and other securities.
Stock exchanges also provide facilities for issue and redemption of securities and
other financial instruments, and capital events including the payment of income and
dividends.
Securities traded on a stock exchange include shares issued by companies, unit trusts,
derivatives, pooled investment products and bonds.
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contrasted with exchange trading, which occurs via facilities constructed for the
purpose of trading, such as futures exchanges or stock exchanges.
NEW YORK STOCK EXCHANGE
The New York Stock Exchange (NYSE) is a stock exchange located at 11 Wall Street in
lower Manhattan, New York City, USA. It is the world's largest stock exchange by market
capitalization of its listed companies at US$ 11.92 trillion as of Aug 2010. Average daily
trading value was approximately US$ 153 billion in 2008.
On the NYSE, all trades occur in a physical place.
The NYSE is an auction market , wherein individuals are typically buying and selling
between one another and there is an auction occurring; that is, the highest bidding price will
be matched with the lowest asking price.
The companies on NYSE are perceived to be more well established. Its listings include many
of the blue chip firms and industrials that were around before our parents, and its stocks are
considered to be more stable and established.
A company's decision to list on a particular exchange is affected also by the listing costs and
requirements set by each individual exchange. The entry fee a company can expect to pay on
the NYSE is up to $250,000 while on the Nasdaq, it is only $50,000-$75,000.
NASDAQ
The Nasdaq, on the other hand, is located not on a physical trading floor but on a
telecommunications network. People are not on a floor of the exchange matching buy
and sell orders on behalf of investors.
Instead, trading takes place directly between investors and their buyers or sellers, who
are the market makers through an elaborate system of companies electronically
connected to one another.
The Nasdaq is a dealer's market.
The Nasdaq is typically known as a high-tech market, attracting many of the firms
dealing with the internet or electronics. Accordingly, the stocks on this exchange are
considered to be more volatile and growth oriented.
THIRD MARKET
Third market in finance, refers to the trading of exchange-listed securities in the over-
the-counter (OTC) market. These trades allow institutional investors to trade blocks of
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securities directly, rather than through an exchange, providing liquidity and anonymity
to buyers.
FOURTH MARKET
Fourth market trading is direct institution-to-institution trading without using the
service of broker-dealers. It is impossible to estimate the volume of fourth market
activity because trades are not subject to reporting requirements. Studies have
suggested that several million shares are traded per day.
PREEMPTIVE RIGHTS
A corporation can issue new common stock directly to existing shareholders via a preemptive
rights offering. A preemptive rights grants existing shareholders the rights to buy some
proportion of the new shares issued at a price below market value. The price at which new
shares can be purchased is called the subscription price.
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Motivation For Raising Funds Outside Of the Domestic Market
A corporation may seek to raise funds outside of its domestic market for four reasons.
First, in some countries, large corporations seeking to raise a substantial amount of
funds may have no other choice but to obtain financing in either the foreign market
sector of another country or the Euromarket, because the fund-raising corporation's
domestic market is not fully developed enough to be able to satisfy its demand for
funds on globally competitive terms.
The second reason is the opportunities for obtaining a reduced cost of funding (taking
into consideration issuing costs) compared to that available in the domestic market. In
the case of debt the cost will reflect two factors: (1) the risk-free rate, which is
accepted as the interest rate on a U.S. Treasury security with the same maturity or
some other low-risk security (called the base rate); and (2) a spread to reflect the
greater risks that investors perceive as being associated with the issue or issuer.
The third reason to seek funds in foreign markets is a desire by corporate treasurers to
diversify their source of funding in order to reduce reliance on domestic investors. In
the case of equities, diversifying funding sources may encourage foreign investors
who have different perspectives of the future performance of the corporation. Two
additional advantages of raising foreign equity funds, from the perspective of U.S.
corporations, include (1) some market observers believe that certain foreign investors
are more loyal to corporations and look at long-term performance rather than short-
term performance as do investors in the United States;6 and (2) diversifying the
investor base reduces the dominance of U.S. institutional holdings and its impact on
corporate governance.
Finally, a corporation may issue a security denominated in a foreign currency as part
of its overall foreign currency management. For example, consider a U.S. corporation
that plans to build a factory in a foreign country where the construction costs will be
denominated in the foreign currency. Also assume that the corporation plans to sell the
output of the factory in the same foreign country. Therefore, the revenue will be
denominated in the foreign currency.
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In secondary markets, investors buy and sell the stocks and bonds among
themselves. The issuer of the asset doesnt receive funds from the buyer.
Functions of Secondary Markets
Provides regular information about the value of security.
Helps to observe prices of bonds and their interest rates.
Offers to investors liquidity for their assets.
Secondary markets bring together many interested parties.
It keeps the cost of transactions low.
PERFECT MARKET
In perfect market, all buyers and sellers are price takers and market price is determined at the
point that supply equals demand.
Brokers
A broker is an entity that acts on behalf of an investor who wishes to execute orders.
In economic and legal terms, a broker is said to be an agent of the investors.
Brokers aid investors by collecting and transmitting orders to the market, by bringing
willing buyers and sellers together, by negotiating prices, and by executing order. The
fee for these service is the brokers commission.
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Dealers have to be compensated for bearing risk. A dealers position may involve carrying
inventory of a security(a long position) or selling a security that is not in inventory(a short
position).
PRICING EFFICIENCY
Pricing efficiency refers to a market where prices at all times fully reflect all available
information that is relevant to the valuation of securities
THREE FORMS
In defining the relevant information set that prices should reflect. Pricing efficiency of a
market was classified in three forms.
Weak efficiency
Semi-strong efficiency
Strong efficiency
Weak efficiency : means that price of the security reflect the past price and trading history of
the securities.
Keen investors looking for profitable companies can earn profits by researching financial
statements.
Semi-strong efficiency : means that the price of the security reflects all public information
which includes but is not limited to historical price and trading patterns.
Meaning that neither fundamental nor technical analysis can be used to achieve superior
gains.
Strong efficiency : exists in a market where the price of security reflects all information
whether or not it is publicly available.
Not even insider information could give an investor the advantage.
TRANSACTION COSTS
Transaction costs consist of commissions, fees, execution costs and opportunity costs.
Commissions are the fees paid to brokers to trade securities.
Fees are separated two group custodial fees and transfer fees.
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Custodial fees are fees charged by an institution that hold securities in safekeeping for
an investor.
Execution costs represent the difference between the execution price of a security and the
price that would have existed in the absence of the trade.
OPPORTUNITY COSTS
The cost of not transacting represents an opportunity cost. It may arise when a desired trade
fails to be executed. This component of costs represents the difference in performance
between an investors desired investment and the same investors actual investment after
adjusting for execution costs, commissions and fees.
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parties agree to transact in the future is called the futures price. The designated date at
which the parties must transact is called the settlement date.
LIQUIDATING A POSITION
Most financial futures contracts have settlement dates in the months of March, June,
September, or December.
The contract with the closest settlement date is called the nearby futures contract.
The contract farthest away in time from the settlement is called the most distant
futures contract.
A party to a futures contract has two choices on liquidation of the position.
First, the position can be liquidated prior to the settlement date.
The alternative is to wait until the settlement date.
Clearinghouse
A clearinghouse is agency associated with an exchange, which settles trades and
regulates delivery.
MARGIN REQUIREMENTS
When a position is first taken in a futures contract, the investor must deposit a
minimum dollar amount per contract as specified by the exchange.
Three kinds of margins specified by the exchange:
1) initial margin (may be an interest-bearing security such as a Treasury bill,
cash, or line of credit)
2) maintenance margin (specified by the exchange)
3) variation margin (additional margin to bring it back to the initial margin if the
equity falls below the maintenance margin, must be in cash).
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Where to be traded organized exchanges over-the-counter
(primary market) instrument
Credit risk (default risk) no yes
Clearinghouse yes no
Regulations yes no
The amount of the loss or profit on a hedge will be determined by the relationship
between the cash price and the futures price when a hedge is placed and when it is lifted.
The difference between the cash price and the futures price is called the basis.
That is, basis = cash price - futures price
if a futures contract is priced according to its theoretical value, the difference between
the cash price and the futures price should be equal to the cost of carry. The risk that
the hedger takes is that the basis will change, called basis risk.
INSURANCE COMPANIES
Insurance companes promise to pay specfed sums contgent on the occurance of
future events,such as death or an automobile accident.
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Insurance companies are risk bearers.
They accept or underwrite the risk in return for an insurance premium paid by the
polcyholder or owner of the policy.
A major task for the nsurance company is deciding which applications for nsurance
they should accept and which ones should reject.they must also determine how much
to charge for the insurance if they accept the applicatons .this decsons called the
underwrtng process.
INVESTMENT BANKING
Investment banking firm performs two general functions:
To assist in obtaining funds for the capital seekers.
To act as a brokers or dealer for the capital provider.
The traditional role associated with investment banking is underwriting of securities.
The traditional process in U.S for issuing in new securities involves investment
bankers performing one or more of following three functions.
1. Advising the issuer on the terms and the timing of the offering
2. Buying the securities from the issuer
3. Distributing the issue to public
UNDERWRTING
Buying the securities from the issuer is called underwriting.
When an investment banking firms buys the securities from issuer and accepts the risk of
selling securities to investor at a lower price, it is referred underwriter.
PRIVATIZATION
Investment bankers also may assist in offering the securities of government-owned
companies to private investors. This process is referred to as privatization.
RISKLESS ARBITRAGE
Profiting from price differences when the same asset is traded in different markets.
For example, an arbitrageur simultaneously buys one contract of silver in the Chicago
market and sells one contract of silver at a different price in the New York market, locking in
a profit if the selling price is higher than the buying price.
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RISK ARBITRAGE
A form of arbitrage which involves the simultaneous purchase of shares in one company and
the short sale of assets in another. This strategy is typically used in expectation of a pending
announcement of a take-over by a company. By purchasing shares in the company that is
expected to be taken over and selling short shares in the acquiring company, an investor hopes
to gain from both sides of the trade. Risk arbitrage may also be used in situations involving
tender offers or reorganizations. Also called equity arbitrage.
Firm A may make an offer to acquire Firm B by exchanging one share of its own stock for
two shares of Firm B's stock. If the stock of Firm A is trading at $50 and the stock of Firm B
is trading at $23, the risk arbitrager would buy shares in Firm B and sell short one-half this
number of shares in Firm A. If the buyout offer is, the two stocks will exchange on a one-for-
two basis and the arbitrage position will be profitable. The risk is that the buyout will be
unsuccessful and the exchange of stock will not take place.
SECURITIZATION OF ASSETS
securitization of home mortgage loans to create mortgage-backed securities was the
first example of the process.
securities backed by a pool of loans or receivables are called asset-backed securities
when an investment banker works with a corporation to issue an asset-backed security
it generates revenue from the bid-ask spread in the sale of the security
when an investment banker buys loan and receivables and then issues securities ,it
generates a profit on an asset-backed security transaction as follows; the differences
between the price the security is sold for minus the price it paid to purchase to
collateral minus the interest cost of "warehousing" the collateral purchased until the
securities are sold.
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