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 100 shares or more; A minimum of 1.1 million shares traded publicly; Pretax earning of $ 2.5 million at the time of listing plus at least $ million in pretax 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-thecounter 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 Treasury bonds      Notes have an original maturity of to 10 years Bonds -10 to 30-Notes & bonds are free of default risk but not risk free Treasury bond interest rates: very low because no default risk Treasury STRIPS (Separate trading of 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 taxexempt bond +Tax-free municipal interest rate = taxable interest rate x (1 – marginal tax rate) Ex: taxable corp Bond interest rate : % Marginal tax rate : 28% Equivalent tax-free rate for an investor is 9% x (1 – 0,28) = 6,48%  Types   General obligation bond: not have 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 revenue bonds: repay by cash flow of a 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 wishes Bond indenture: a contract that states the lenders rights and privileges and the borrowers obligations degree of risk : very difference between corp Difference of interest Characteristics of Corp Bonds    Bearer bonds , registered bonds + Bearer bonds: payment were made to whoever had physical possession of the bonds + registered bonds: not have coupons Owner must register with the firm to receive interest payment Restrictive covenants: usually limit the amount of dividends the firm can pay and the ability of the firm to issue additional debt Purpose: protect the bondholders interest Call provisions, Conversion    Call provisions: state that the issuer has the right to force the holder to sell the bond back Reasons: (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 Conversion : bonds can be converted into shares of common stock 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 secured bonds: + mortgage bond + equipment trust certificates  unsecured bonds + debentures + subordinated debentures + variable-rate bonds: the interest rate on these securities is tied to another market interest rate such as rate on treasury bonds and adjusted periodically  junk bond: 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     investors can earn a return from stock in one of two ways: either the price of the stock rises over time or the firm pay the stockholder dividends stock is more risky than bonds because stockholders 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 Stock does not mature Ownership of stock gives the stockholder certain 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 preferred stock Common stock: - vote - variable dividend - fluctuate price  preferred stock: - fixed dividend - stable price - no vote  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 Application  D1 D2 D3 Dn Po = - + + + … + -(1+i)1 (1+i)2 (1+i)3 (1+i)n P : price of stock at time (present) D : dividend paid at time n i : discount rate applied to computing the present value of the dividends Gordon growth model: D1 P0 = i-g g : constant dividend growth rate expected Stock market indexes   A stock market index is used to monitor the behavior of a group of stocks Stock market indexes are reported to give investors an indication of the performance of different groups of stocks 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  ... 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. .. 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... 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