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					                  Capital Markets
   The capital markets are made up of securities that have a life of one year
    or longer (often much longer).

   The primary participants raising funds in the capital markets are the U.S.
    Treasury; other agencies of the federal, state, and local governments;
    and corporations.

   The United States is a three-sector economy in which households,
    corporations, and governmental units allocate funds among themselves.

   Securities markets consist of organized exchanges and over-the counter
    markets.

   Security markets are considered to be efficient when prices adjust rapidly
    to new information.

   Security legislation is intended to protect investors against fraud,
    manipulation, and illegal insider trading.
    Money and Capital Markets
Money market: Short-term market for
 securities maturing in a year or less.
Capital market: Long-term market for
 securities with maturities greater than one
 year.
More often, companies search all capital
 markets including world markets for capital
 at the lowest cost.
   International Capital Markets

Competition for low cost funding is
 worldwide.

Money flows between countries include
 U.S. investment abroad and foreign
 investments in the U.S. See Table 14-1.
 Competition for Funds in the
    U.S. Capital Market


Government Securities

Corporate Securities
         Government Securities
 Long-term financing of the U.S. is no longer a
  major issue as the government
  reached a surplus in 1998 and is projected to
  continue in this situation for the
  next decade.
 Large amounts of long-term capital in the United
  States have been supplied
  by foreigners. Foreign investors have been
  attracted by the relatively high
  interest rates and political stability available in
  the United States.
          Government Securities
 Federally sponsored credit agencies, charged with
  funding the large numbers of federal programs, issue
  securities in the capital markets. Agencies such as the
  Federal National Mortgage Association, the Federal
  Home Loan Banks, the Farm Credit Banks, has varied
  widely but has been rising in percentage terms as the
  U.S. Treasury has no need to finance large deficits by
  selling U.S. government securities.

 State and local municipalities are usually required by law
  to balance their budgets so their borrowing is often short-
  term or project related. The interest paid on these issues
  is exempt from federal income tax.
          Corporate Securities

• New issues of corporate securities have been
  predominantly bonds in recent years. Bonds are
  more widely used to raise capital when interest
  rates are low.
• Though very similar to debt, the lack of the tax
  deductibility of preferred stock dividends has
  constrained the popularity of preferred stock
  issues.
• New issues of common stock mushroomed in
  the late 1990s as the dot.com craze swept the
  IPO market.
The majority of internally generated funds
are not included in reported earnings.
Funds from operations but not included in
reported earnings through the depreciation
process provide the primary "source" of
internal funding. Although the percentage
between retained earnings and
depreciation varies based on profits and
capital spending patterns.
                                     PPT 14-1
FIGURE 14-1
Internally generated funds:
Depreciation and retained earnings
                PPT 14-2
FIGURE 14-2
Flow of funds
through the
economy
                        PPT 14-3
FIGURE 14-3
Suppliers of funds to
credit markets
  The Role of the Security Markets
 Securities markets aid the allocation of capital
  between the sectors of the economy and the
  financial intermediaries.
 Security markets enable the demanders of
  capital to issue securities by providing the
  necessary liquidity for investors in two ways:
    a. Corporations are able to sell new issues of
     securities rapidly at fair competitive prices.
    b. The markets allow the purchaser of securities to
     convert the securities to cash with relative ease.
 The Organization of the Security
            Markets
 Several national and regional exchanges provide a
  centrally located auction market for buyers and sellers of
  securities who use the services of brokers having
  representatives on the floor of the exchanges.

 The primary exchanges are the New York Stock
  Exchange (NYSE) and the American Stock Exchange
  (AMEX) which merged with NASDAQ in 1998.

 Exchanges of lesser importance include the Midwest,
  Pacific, Detroit, Boston, Cincinnati, and PBW
  (Philadelphia, Baltimore, and Washington) exchanges.
  Ninety percent of the volume on these regional
  Exchanges is from dually traded stocks on the NYSE.
New York Stock Exchange (NYSE)

 The NYSE accounts for approximately 80 percent of the
  dollar volume of all listed stock traded in the U.S.

 To be listed on the NYSE, firms must meet certain
  minimum requirements pertaining to earnings power,
  level of assets, market value and number of shares of
  publicly-held common stock, and the number of
  shareholders.

 Beginning in August 2000, U.S. security markets started
  trading in decimals rather than fractions. The impact of
  this move by the SEC is still being scrutinized.
The global nature of capital markets is evidenced by the
increasing volume and security listings on stock markets
around the world.

The Tokyo stock exchange is the largest in the world and
companies such as Intel, IBM, and McDonald's trade
there and on the Frankfurt stock exchange.

Likewise, many foreign companies trade on the NYSE.

As more companies trade on exchanges around the
world in multiple time zones, the easier it will be for
trading to be continuous for 24 hours per day.
• Finance In Action: Long Term Capital
  Management LP- The Collapse of a Hedge
  Fund
  One of the most significant events in the capital
  markets during the 1990s was the near collapse
  of Long Term Capital when Russia defaulted on
  their sovereign debt. To make matters more
  intense for the academic community, two Nobel
  Laureates, Myron Scholes and Robert Merton,
  were involved with the firm. No matter how smart
  you are, you can make mistakes if you misjudge
  your risks or take too many risks. Markets are
  not always rational and when markets become
  perverse, even smart people can lose money.
• Corporations that do not meet listing
  requirements or choose not to be listed on
  the exchanges are traded in the over-the-
  counter market (OTC).
– 1. The OTC market is a national network of
  dealers linked by computer display terminals,
  telephones, and teletypes.

– 2. OTC dealers own the securities they trade
  and seek to earn a profit from their buying and
  selling, whereas brokers receive a
  commission as an agent of the buyer or seller
  of securities.
– 3. The National Association of Securities Dealers
  (NASD) which supervises the OTC market has
  divided the OTC market into groups:
  a. The National Market List is composed of the largest
     OTC companies.
  b. The National List includes smaller firms centered in
     one state or city.
  c. The Supplemental List includes very small
    developmental companiesand closely held firms
    with very few shares available for trading
– 4. Due to the lower prices of OTC stocks, the dollar
  volume of exchange listed stocks is larger. Due to the
  great amount of debt securities traded OTC, however,
  the OTC market is the largest market for all security
  transactions in total dollars.
• Electronic Communications Networks
  (ECNs) are electronic trading systems that
  match, buy and sell orders at specified
  prices. ECNs lower the cost of trading by
  creating better execution, more price
  transparency and by allowing “after hours
  trading.”
              Market Efficiency

• A. Criteria of Efficiency
   – 1. Rapid adjustment of prices to new information
   – 2. Continuous market; successive prices are close
   – 3. Market is capable of absorbing large dollar
     amounts of securities without destabilizing the price.
• B. The more certain the income stream, the less
  volatile price movements will be and the more
  efficient the market will be.
• C. Screen based trading systems versus floor
  trading is becoming a trend that most observers
  would agree increase market efficiency.
           Market Efficiency

• D. The efficiency of the stock market is
  stated in three forms.
  – 1. Weak form: Past price information is
    unrelated to future prices, trends cannot be
    predicted and taken advantage of by
    investors.
  – 2. Semi-strong form: Prices reflect all public
    information.
  – 3. Strong form: Prices reflect all public and
    private information.
           Market Efficiency

• E. A fully efficient market, if it exists,
  precludes insiders and large institutions
  from making profits from security
  transactions in excess of the market in
  general.
• F. The efficiency of the market is
  debatable but most would agree that the
  movement is toward greater efficiency.
    Regulation of the Security
             Markets
• Organized securities markets are
  regulated by the Securities and Exchange
  Commission (SEC) and through self-
  regulation. The OTC market is regulated
  by the National Association of Securities
  Dealers (NASD).
Four major laws govern the sale and trading of
securities.
1. Securities Act of 1933: This act was a response to abuses present
in the securities markets during the Wall Street "Crash" era. Its
purpose was to provide full disclosure of all pertinent investment
information on new corporate security issues.

2. The Securities Exchange Act of 1934 created the Securities and
Exchange Commission (SEC) and empowered it to regulate the
securities markets.

3. The Securities Acts Amendments of 1975 directed the SEC to
supervise the development of a national securities market,
prohibited fixed commissions on public transactions, and prohibited
financial institutions and insurance companies from buying stock
exchange memberships to save commission costs.

4. The Sarbanes-Oxley Act of 2002 authorized an independent
private-sector board to oversee the accounting profession. The act
was in response to the many accounting frauds perpetrated on
investors by companies such as Enron, World Com, and Tyco.
                       PPT 14-4




TABLE 14-3
Global stock markets
 Chapter 14 - Outline
Capital Markets vs. Money
 Markets
Government Securities
Corporate Securities
Organized Stock Exchanges
Over-the-Counter Market
Regulation of the Securities
 Markets

				
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