1、3.FINANCIAL MARKETSAND INSTRUMENTS2 Financial markets&instruments Businesses raise money to finance current operations as well as for future growth Money is raised In financial markets(capital markets and money markets)By issuing financial instruments(also called securities)which give the holders cl
2、aims on future cash flows of the business3Financial markets Financial markets describes the distribution system by which cash-deficit entities engage in transactions with cash-surplus entities.Besides businesses,participants include government agencies,pension funds,endowments,individuals,commercial
3、 banks,insurance companies Regulated by Securities&Exchange Commission Capital markets deal with long term instruments like stocks and bonds while money markets deal with short-term instruments with maturity less than one year such as commercial paper.4Financial instruments Instruments must appeal t
4、o investors and meet the needs of the company.They are designed keeping in mind Investors claims on future cash flowsInvestors right to participate in company decisionsInvestors claims on company assets in the event of liquidation SEC regulations require adequate disclosure before purchase.5Types of
5、 instruments Debt instruments offer fixed claims.Equity offers residual claims.Hybrids such as convertible debt combine both.Derivatives such as forwards,futures and options provide a hedge against risk6 BONDS Fixed income security interest paid periodically Repayment of principal at maturity.Bonds
6、are sold to the public in small increments,such as$1000,and can be traded on an exchange after issue.Yield(return with reference to market price)inversely related to market price7Bond characteristics Par value Maturity date Coupon rate Current yield vs.yield to maturity(YTM)Sinking fund for periodic
7、 repayment of principal Variable rate vs.fixed rate bonds8Call Provisions提前赎回条款 Right to retire bonds prior to maturity.Investors require a premium for call provisions.Call price is typically a modest premium above par.Delayed call prevents retirement before some date.Call options help companies tak
8、e advantage of declines in interest rates and rearrange capital structure9Covenants契约 Contractual terms to protect bondholders by impacting management decisions.Examples:Lower limit on current ratioUpper limit on D/E ratioRequired approval by bondholders before major acquisition or sale of assets Bo
9、ndholders have no direct say in a company unless it defaults on its interest,sinking fund,or covenant obligations.10Rights in Liquidation清偿权利 Rights of absolute priorityGovernment in respect to taxes past dueSenior creditorsGeneral creditorsSubordinated creditorsPreferred shareholdersCommon sharehol
10、ders11Secured Creditors Secured credit involves collateral.In liquidation,proceeds from the sale of collateral only go to the secured creditor up to the amount of the secured credit.Any residual goes into the pool shared by the other investors.If the sale of collateral is insufficient,the secured cr
11、editor becomes a general creditor for the balance.12Bonds Issuers perspectiveAdvantages:Lower cost of funds Interest is tax deductible No loss of controlDisadvantages:Interest payment mandatoryRedemption cash outflows13Bonds investors perspective Fixed income,no capital appreciation Convertible bond
12、s seek to provide both Risk return tradeoff Lesser risk than equity,lower returnsAnnualized returns over 10 yrs for Barclays Bond Index 7.6%vs.S&P 500 10.4%Also refer Table 5-1 Real vs.nominal returnsir=(1+in)/(1+p)-1 whereir=Real return,in =Nominal return,p=Inflation rate 14 TABLE 5-1 Rate of Retur
13、n on Selected U.S.Securities 1900-200715Bond ratings Expression of the opinion of the rating agency on the creditworthiness of the borrower Measures credit risk/default risk Credit rating agencies-S&P,D&B,MoodysAAA High creditworthinessBBB AdequateCCC -PoorD Default Bond ratings and interest rates16
14、Junk Bonds Investment grade is“BBB”and above.Junk bonds are speculative or high yield bonds and are below investment grade.Junk bond market is an alternative to bank and insurance company loans for smaller,less prominent companies.Junk bonds have been used to finance mergers and acquisitions.17EQUIT
15、Y or COMMON STOCK Residual income securities Represent ownership securities-proportionate to shareholding Right to control-Voting rights Shareholders are represented through a board of directors,through which they exercise control.Right in liquidation residual claim over assets Riskier than debt ins
16、truments18Risk and return What is the expected rate of return on equity?Rate of return=Dividend yield+capital appreciation =Div/Mkt price +%change in share price Risk return tradeoff:Higher the risk in an investment,higher the expected returns Equity investors expect a risk premium to compensate for
17、 the enhanced risk So return on equity=Risk free rate+Risk premium Risk free rate taken as Govt.Bond rate Risk premium(Table 5-1)=11.6 -5.3=6.3%19Common stock(contd)Advantages to investor *Higher returns than debt*Liquidity*Wealth sharing Disadvantages to investor *Higher risk *Dividend payment not
18、mandatory20Common stock(contd)Advantages to issuer*Dividend payment not mandatory*No redemption cash outflows*Higher equity means better borrowing ability Disadvantages *Costlier source of funds than debt *Dilution in control *Dividends not tax deductible(unlike interest)21A note on retained earning
19、s Readily available source of funds internally(internal equity)No issue costs No dilution in control Reflects the robustness of companys health and reduces dependance on outside funding The only point to be remembered is that retained earnings also has a cost in terms of opportunity cost to investor
20、s22 Higher priority over common stockholders in payment of dividends and in repayment of capital Annual fixed dividend at coupon rate x par value Dividend is discretionary Cumulative dividends feature Dividend not tax deductible for issuer No voting rights except in matters which concern themPREFERR
21、ED STOCK23Preferred stock(contd)To the investor:Lesser risk,but lesser returns and less liquid than common stock To the issuer:Lesser cost,dividend payment not mandatory(but not tax deductible),no loss of control 24 MARKET CHANNELS Market Channels for raising fundsPrivate equityVenture capitalInitia
22、l public offers(IPOs)and seasoned equity issues(SEOs)Shelf registrationPrivate placementInternational markets25Private Equity Financing Source of funds for startups,new or small businesses viewed as too risky for bank lending and too small to attract the attention of investors in public markets.Fund
23、ing done by strategic investors,venture capital firms who provide seed money with potential acquisition on their minds.26Private Equity Partnerships Structured as limited partnerships with a specified duration such as 10 years.General partner is the private equity firm,which raises a pool of money f
24、rom limited partners,such as institutional investors and insurance companies.Limited partners have limited liability.Typical fee structure is 2 and 20,the sum of a management fee and carried interest based on capital appreciation.Induce managers to create value over long run27 Venture capital A vent
25、ure capital company is a financing institution which joins an entrepreneur as a co-promoter in a project and shares the risks and rewards of the enterprise.Projects are generally high risk with potential high rewards.Sought by new/untried businesses having little/no access to public capital/bank loa
26、ns.28Venture capital-features Long term equity finance high stakes.Returns through capital gains at the time of exit by selling out equity holdings at high premiums.Selective-generally seek above average returns.Generally financing of new/untried technology,new/no track record promoters Not only fin
27、ancing but also active role in mgmt.Medium to long term investment horizon.Incentives to promoters on performance.29Exit route Going public Sale of shares to promoter.Sale of company to another company management buyin or buyout.Selling to a new investor.Liquidation30FIGURE 5-3 Venture Capital Inves
28、tment in U.S.Companies31Initial Public Offerings (IPOs)When companies raise capital for the first time by issuing new shares Seasoned equity offerings(SEOs)refer to issue of new shares by a company that is already publicly traded(already made an IPO)Company assesses proposals from investment banks a
29、nd chooses one managing underwriter32IPO Risks Managing underwriter advises the company on security designregisters the issue with the SEC(30-90 days)orchestrates a“road show”assembles an underwriting syndicate who engage in book building Syndicate acts as wholesaler.Offer price set hours before sto
30、ck goes public.Company bears price risk during the registration process;syndicate bears risk associated with unsold shares,which they cannot sell above the offer price.33Shelf registration Shelf registration is a general purpose registration giving broad terms of the securities to be issued,good up
31、to two years,that allows the firm to get quick approval A single underwriter often buys the entire issue.Cuts the time lag from several months to a few days Competitive bids lower the issue costs.34Private Placement Corporations can avoid registering with SEC by placing the securities privately with
32、 institutional investors.The private placement market is about half the size of the public market,excluding bank loans.Attractive option if public investors not especially receptive for reasons of complexity.Advantages to company are quicker and easier to negotiate,can be custom tailored to specific
33、 needs Disadvantage is that as unregistered securities they cannot be traded on financial markets less liquid Rule 144A now allows for trading of privately placed securities among institutional investors.35Issue Costs For privately negotiated transactions,issue cost amounts to the investment banking
34、 fee.For public issues,there are also legal,accounting,and printing fees.Cost comparisons2.2%for straight debt.3.8%for convertible bonds.7.1%for secondary offerings.11%for IPOs.36ComparisonIPO Pvt.PlmntCapital raisedHighLesserDistributionWidely distributedLimitedDilution of ControlHighLowerFloatatio
35、n cost&timeHighLower37Efficient Markets Issues in raising new capitalTimingPricing Market efficiency is with reference to how quickly prices in competitive markets respond to new information Efficient market is one where prices adjust rapidly to new information and current prices fully reflect avail
36、able information 38Efficiency in Degrees A market is weak-form efficient when prices fully reflect all information about past pricesSemi-strong form efficient when prices fully reflect all publicly available informationstrong form efficient when prices fully reflect all information,public or private
37、.39Empirical evidence-implication Markets are not strong form efficient.With limited exceptions,markets are semi-strong form efficient and hence Publicly available information has no predictive power in respect to market prices.Typical investors should not expect to earn abnormal returns trading on
38、publicly available information.It is pointless to time the purchase or sale of the firms securities.40Conclusions to Draw Apart from market sentiment,managers can use private information about their own companies in making timing decisions.Pricing decisions in practice are based on Market value Fair
39、 valuePrice discovery thro book building 41Managing Risk Risk is defined as the variability of returns from the expected values In financial markets volatility results in risk Companies use derivatives to manage risk and incentivize managers.Derivatives include forwards,futures,options So called as
40、their value is derived from that of the underlying assets which could be shares/currency/commodities 42Forward contracts You can buy in spot market today for immediate delivery spot contract.You can contract today at a predetermined price for future delivery forward contract.By locking in a price to
41、day,you can avoid price risk An exporter with 1 million receivable in 90 days,can sell (an importer with a payable can buy)at a predetermined rate in the forward market Futures contracts are similar to forwards except that they are exchange traded(while forwards are bilateral)43写在最后写在最后成功的基础在于好的学习习惯成功的基础在于好的学习习惯The foundation of success lies in good habits 结束语当你尽了自己的最大努力时，失败也是伟大的，所以不要放弃，坚持就是正确的。When You Do Your Best,Failure Is Great,So DonT Give Up,Stick To The End演讲人：XXXXXX 时 间：XX年XX月XX日
