FINS1612 W3 Lecture

8/19/2019 FINS1612 W3 Lecture

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FINS1612 Capital Markets and Institutions

Week 3

Chapter 4

Equity Markets 1The Share Marketand the Corporation


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RE ISI!N

Week 2


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"earnin# !$%e&ti'es

Understand the nature of corporations and reasons (or pu$li&listin#)nderstand the role o( a *arket


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+,1 The Nature o( a Corporation

A corporation is a company that is a legal entity established underthe Corporations Law of a nation-statePublicly listed corporation – A company whose shares are quoted and traded on a formal stock

e change !"#$%he corporation differs from other business forms – &wnership claims are -idespread and easily trans(era$le

– &wners !shareholders$ do '&% affect the day -to- day affairs of thecompany

– "hareholders( liability is limited to) %he issue price of shares of a li*ited liability company

) Any partly paid portion of shares of a no -liability company or forfeit theownership


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+,1 Nature o( &orporation

%he o$%e&ti'es and poli&ies of corporation are determined by aboard of directors*oard of +irectors are ,oted on by the o-ners !shareholders $ at a#eneral meeting

+irectors ha,e a le#al responsibility to ensure that the corporationoperates in the interest of the owners%he board of directors appoint e ecuti,e *ana#e*ent to run dayto day operation of the company to achie,e the ob ecti,es andpolicies of the corporation

.anagement team !specifically the e ecuti,e manager$ isresponsible to the $oard%he board of directors is responsible to the o-ners of the companyi/e/ shareholders


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+,1 The Nature o( a Corporation .&ont,/

0d'anta#es o( the &orporate (or*Can obtain lar#e amounts of finance more easily%he liquidity of securities facilitates in,estor di,ersification andencourages in'est*ent in corporate securities

Separation of ownership and control facilitates) Appointment of specialised management) 0reater effecti,eness in the planning and implementation of strategic

decisions

Perpetual succession(1the corporate form is una((e&ted bychanges in management or ownership%he corporate form is suited to large-scale operations – with goodcredit rating they ha,e access to the wider range of equity andde$t sources of funds that are a,ailable in the capital markets


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+isad,antages of the corporate form

.ain disad,antage arises due to the separation of o-nership and&ontrol

– Conflict of interest between o-ners !principals$ and *ana#ers !agents$ known as the a#en&y problem

– .anagement may try to run business for their own benefit2 ratherthan that of shareholders2 i/e/ instead of ma imising shareholder,alue !share price$2 growth ma imisation strategy is implemented

– .anagement maybe short term oriented rather than long term/


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3actors moderating conflict of interest between owners andmanagers

n,estors( ability to sell shares in a corporation2 causing the shareprice to (all

is*issal from the board at A0. by shareholders%hreat of takeo,er and loss of e*ploy*entUse of performance in&enti'es 2 such as share options.ore rigorous corporate #o'ernan&e !relationship betweenshareholder 2$oard 5 *ana#e*ent $- clear responsibility and

reporting structures need to be established to facilitate the long-term sur,i,al of the organi6ation and the ma imisation ofshareholder ,alue


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The nature o( a &orporation

3ollowing the 03C2 many corporations were forced to raiseadditional capital through the stock market%his was to 7sure up( their balance sheets during the tougheconomic en,ironment that followed the crisis

%he ad,antage of the corporate form is highlighted by suchbeha,iour "maller firms are not able to access capital as easily and wouldnormally be e pected to pay a higher rate of return


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Chapter !r#anisation

4/8%he 'ature of a Corporation4/9%he "tock : change4/;"ummary


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The Nature o( a Corporation .&ont,/

"hare market – A formal e change facilitating the issue 2 $uyin# and sellin# of

equity securities

An ordinary share is a (inan&ial asset2 that is2 a security that

entitles a shareholder to share in the net pro(it of the company andto 'ote for the board of directors2 and any resolutions put by theboard of shareholders at general meetings/Publicly listed corporation – A company whose shares are quoted and traded on a formal

e change


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W 0T IS 0 M0R ET4


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0 se&urities e5&han#e .*arket/

!r#anised and super'ised market place where financialassets are traded


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!'erall !$%e&ti'e%he o,erall ob ecti,e of a market !e change$ is to attractliquidity 2 to e ecute orders with reasonable speed andminimal &ost and to find appropriate prices for customersi/e/ fair and orderly pri&e dis&o'ery%o achie,e the o,erall ob ecti,e the following must beconsidered – arti&ipants

– Instru*ents

– Re#ulations

– Te&hnolo#y

– proto&ols


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Fun&tions o( a sto&k e5&han#e

Principal functions of a modern and efficient stock e change in aglobalised market are the pro,ision of> – Markets for a range of financial securities

– "ecurities tradin# system

– Clearin# and settle*ent system – Re#ulation and *onitorin# of market integrity

– ?ell- in(or*ed market

– .arket &on(iden&e in the integrity of the share market

%he principal determinant of an efficient market is the speed atwhich ne- information flows to the market – "peed at which that information is absorbed and then reflected in

share prices


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Capital formation !primary market - listing and capital raising$ – Listing @ules - Continuous +isclosure !;/8$

Price disco,ery !trading of securities to disco,er market ,alue$ – %rading Platforms – A"# %rade2 A"# %rade 94

@isk transfer – Clearing ouse – %rade 'o,ation

– "ettlement 3acility !C :""$

– +eri,ati,es

urpose o( *arkets


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ri*ary *arket role

%he primary market role of a stock e change is to facilitates theefficient and orderly sale of ne- financial securities – 'ew floatsBinitial public offerings ! P&s$

) nitial listing of a corporation on the "#

– @ights issue) ssue of additional shares to e isting shareholders on a pro-rata basis

– Placements) ssue of new shares to selected institutional in,estors

– +i,idend rein,estment plans) @ein,estment of di,idends into corporation for additional shares


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ri*ary *arket role .&ont,/


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Se&ondary *arket role

%he secondary market facilitates trading in e5istin# shares – No ne- funds are raised by the issuing company

– An acti,e2 liquid2 well-organised secondary market increases theappeal of buying new shares in the pri*ar y market

) Market liquidity @atio of share turno,er to market capitalisation

) Market Capitalisation 'umber of shares on issue current share price

t is important to recognise that a corporation whose shares arebeing traded in the secondary market does not feature in the (lo-o( (unds,

"econdary market transactions ha,e no direct impact on the &ash(lo-s of the corporation


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The se&ondary *arketD %he secondary &o*ple*ents the primary market by enabling in,estors

to trade securitiesD Actual marketplace which allows shares !securities$ to be bought and

soldD &nly the shares of publicly listed companies can ha,e their securities

traded on the secondary marketD &nly *e*$ers of the stock e change ha,e the right to trade in these

securitiesD %he price for such securities is determined by supply and demand –

market price


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Se&ondary *arket role .&ont,/


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Equity $ased *ana#ed produ&ts

:quity-based managed products pro,ide in,estors with the opportunityto gain a di'ersi(ied e posure to a market through a singlein,estment product rather than directly purchasing all the indi,idualsecurities in the market: change traded funds !:%3$ – *y purchasing units in the :%3 an in,estor gains access to a

di,ersified portfolio of securities/ :/g/ i"hares ."C Australia 9EEfund2 pro,ides e posure to the top 9EE shares listed on the A"#

Contracts 3or +ifference !C3+$ – A contract listed on an e change that is an agreement between a

buyer and seller to e change the difference in the ,alue of a C3+ – %he difference in ,alue is calculated by subtracting the ,alue of the

C3+ contract at the start date from the ,alue of the contract at theclosing date


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– %he C3+ may be based on security2 indices2 currencies or commodities

– C3+ pro,ides a high le,el of le'era#e for an in,estor as the buyer of aC3+ only pays a deposit or initial margin/

– igh le,erage translates to high return but also high risk

– An in,estor may use C3+ to $uy in a rising market2 or sell in a fallingmarket

@eal :state n,estment %rusts !@: %$ – Units in the @: % maybe listed on a stock e change and traded

– 0ain di,ersified real estate portfolio that otherwise would not be

possible for the a,erage in,estor – %he type of property held in a @: % will be specified in the fund(s trust

deed) ndustrial2 otel and Leisure2 @etail2 office


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nfrastructure funds – A managed funds that maybe listed on a stock e change and enables

in,estors to gain access to in,estment opportunities in large-scaleinfrastructure pro ects such as toll roads2 power stations2 airportterminals2 communication towers/

– %he infrastructure fund accepts funds from a large number of in,estorsto create a significant pool of funds/

– %his enables the fund manager to then in,est in these types of pro ectsor assets

– @eturns to in,estors may take the form of capital gains and income

generated from the pro ect&ptions?arrants3utures


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eri'ati'e *arket role

%he "# pro,ides a market for trading equity-related deri,ati,e products – A deri,ati,e is a financial security that deri,es its price from anunderlyin# commodity !e/g/ gold$ or financial instrument !e/g/ 3ostersshares$

– +eri,ati,e products are described as) E5&han#e7traded contracts

– "tandardised financial contracts traded on a formal e change

) !'er7the7&ounter contracts

– 'on-standardised contracts negotiated between writer and buyer

%he "# pro,ides market for deri,ati,e product to gi,e in,estors theopportunity to *ana#e 2 or hed#e 2 a risk e posure in their in,estmentportfolio – i/e/ control risk+eri,ati,es traded on a "# include options2 warrants and futurescontracts


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Interest rate *arket role .&ont,/

%his role adds ,alue to a debt issue due to – Transparen&y

) nformation about price2 yield2 maturity2 credit rating of debt instruments

– Ease o( entry

) :lectronic trading system facilitates buy and sell orders at minimum costand time delay at current market prices

– "iquidity) Fuotation on a "# pro,ides access to a wider market

%he listing2 quotation and trading of typically longer-term debtinstruments on a "# e/g/ straight corporate bonds2 floating ratenotes2 con,ertible notes2 preference shares etc


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Tradin# and settle*ent roles

%he A"# uses A"# %rade2 A"# %rade 942 an integrated computer-based trading system to trade all listed securities – Clients( orders are e ecuted ,ia computer from the broker(s office

– &rders are e ecuted in order of time recei,ed and the buyBsell

price


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Tradin# and settle*ent roles .&ont,/

%he A"# uses C :"" !Clearing ouse :lectronic "ub-register"ystem$ – 3acilitates the settlement of transactions conducted through A"#

%rade 94

– "ettlement of transactions within ; days!% G ;$

– Pro,ides an electronic sub-register that records the ownership oflisted securities


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In(or*ation role

n,estor confidence in the Australian "tock : change !A"#$ relies on in(or*ational efficiency – %he current share prices should reflect all information a'aila$le in the

market

%he A"# has a critical role in facilitating the flow of in(or*ation to the market

Listing rules are "# rules with which a listed entity must &o*ply%he A"# has a number of specific listing rules that relate to the pro,ision ofinformation2 in particular continuous disclosure rules that are designed toensure a well-informed market: amples of information disclosures required by A"# listing rules – A change in a company(s financial forecasts

– Appointment of a liquidator – +eclaration of a di,idend

– 'otice of a takeo,er bid

– +isclosure of directors( interests


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Re#ulatory role

%he aim of regulation is to ensure market participants ha,e&on(iden&e in the inte#rity of market operations%wo main super,isors in Australia – Australian "tock : change !A"#$

– Australian "ecurities and n,estment Commission !A" C$


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Re#ulatory role .&ont,/

A"#:nsures listed companies meet specified limited le,els ofper(or*an&e and standards of information disclosure so in,estorscan make informed decisions

) Continuous disclosure

Prescribes appropriate $eha'iour of broker participants on thee change

) "anctions include discipline2 penalties2 loss of licence

:lectronic sur'eillan&e systems to monitor trading beha,iour of

market participants%he 'ational 0uarantee 3und !'30$ compensates in,estors in thee,ent of failure or misconduct by a stockbroker


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Re#ulatory role .&ont,/

A" C@esponsible for the super,ision of Corporations Law and *arketsin Australia ! Corporations Act 2001 !Cwlth$$@esponsible for market inte#rity and consumer prote&tion across

the financial system2 co,ering in,estment2 insurance andsuperannuation products"uper,ises the A"#2 addressing the potential conflict of interests asa publicly listed corporation


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+,3 The ri'ate Equity Market

Pri,ate equity is an alternati,e funding source for companies una$le ornot wanting to access equity capital though a public issue

"ource of funds – "uperannuation funds and life insurance offices i/e/ institutional

in,estors

Use of funds – "tartups2 business e pansion2 reco,ery finance for distressed

companies2 management buyouts

– Aim is generally to>) impro,e profitability sufficiently to realise ,alue though an P&

) break up business to achie,e return on in,estment


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6,1 Share7*arket In'est*ent .&ont,/

%wo types of risk impact on security returns

8/ "ystematic risk

) 3actors that generally impact on share prices in the market2 e/g/ economicgrowth2 and changes in interest rates and e change rates

9/ Unsystematic risk) 3actors that impact specifically on the share price of a corporation2 e/g/

resignation of the C:&2 technology failure2 board problems


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6,1 Share7*arket In'est*ent .&ont,/

+i,ersified in,estment portfolio

– A portfolio containing a wide range of securities

– +i,ersifies most of the unsystematic risk of the indi,idualsecurities

) n,estors will not recei,e higher returns for unnecessarily bearingunsystematic risk

– %he remaining risk is systematic risk2 which is measured bybeta

) *eta is a measure of the sensiti,ity of the price of an asset relati,e tothe market


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+,3 Su**ary

Corporate form of organisation has ad,antages !fundraising andmanagement$ and disad,antage of separation of ownership andcontrol%he "# has a number of market roles – Primary and secondary

– +eri,ati,e – nterest rate

– %rading and settlement

– nformation

– @egulatory0S8 monitors market participants and 0SIC super,isesCorporations Law and market integrity

Documents

FINS1612 W3 Lecture