Introduction to Financial Markets

• Financial markets facilitate trading through regulated exchanges or over-the-counter (OTC) setups.
• Exchange-traded markets utilize centralized exchanges like the New York Exchange or London Exchange.
• OTC markets are decentralized networks linking buyers and sellers through dealers.

Types of Financial Markets

• Foreign Exchange (Forex) Market: Involves buying and selling currencies.
• Equity (Stock) Market: Focuses on buying and selling shares of companies, where shares represent ownership.
• Commodities Market: Facilitates the trade of raw materials rather than manufactured goods.
• Bond or Fixed Income Market: Involves lending money to governments or corporations through debt and securities trading.
• Derivatives Market: Trades financial contracts whose value is derived from an underlying asset.

Derivatives

• Instruments whose value depends on or is derived from another asset.
• Commodity derivatives are based on commodities like energy contracts derived from oil and gas.
• Financial derivatives, such as stock and index contracts, are based on financial instruments.

Types of Derivatives

• Futures: Standardized contracts for buying or selling an asset at a predetermined price and date in the future.
• Options: Provide the right, but not the obligation, to buy (call option) or sell (put option) a security at a specified price.
• Contract for Difference (CFD): A speculative tool used against changes in the value of an underlying asset.
• Benefits: Include margin trading, going long and short, and potential tax exemptions.
• Margin Trading: Increases both profit potential and risk.

Stock Exchange

• Organizes the marketplace for the movement of large sums of money.
• Securities represent rights to assets, primarily in the form of shares.

Share Market Terms

• Earnings per Share (EPS): Total company profit divided by the number of stock shares outstanding.
• Going Public: Refers to a company's plan to have an Initial Public Offering (IPO).
• IPO (Initial Public Offering): When a company sells its shares of stock for the first time.
• Market Cap (Market Capitalization): Total amount to pay for every company share, calculated by multiplying the number of shares by the price per share.
• Shares represent one unit of investor ownership, exchanged for cash.
• Ticker Symbol: A short group of letters representing a stock on the stock market.
• Underwriting: A financial institution manages the paperwork and orchestrates a company's IPO.
• Stocks represent ownership in a company.
• Shareholder benefits: Dividends (profit distribution) and capital gains (increase in stock value).

Types of Stocks

• Common Stock: Voting rights and variable dividends.
• Preferred Stock: Fixed dividends but no voting rights.
• Stock Market Exchange: where stocks are bought and sold.
• Offers high return potential but carries risks due to market volatility.

Market Efficiency

• Buying and selling of popular shares.
• Firms deal with other firms, leading to large quantities of money being borrowed and lent.
• Money markets are for short-term finance. Capital markets are for long-term finance.
• Stock Exchanges: Raise equity capital for firms in return for securities like ordinary or preference shares.
• Ordinary Shares: Shareholders have ownership and typically receive dividends and voting rights.
• Preference Shares: Dividends are fixed and do not have voting rights, with liquidation preference.

Money Markets

• Deal with short-term debt instruments for liquidity purposes.
• Instruments include Treasury bills and certificates of deposit.
• Characterized by high liquidity, low risk, and lower returns.

Regulation and Oversight

• Regulation and oversight ensure stability and liquidity in the financial system.

Capital Markets

• Handle long-term debt and equity instruments.
• Instruments are associated with higher risk and higher potential returns.
• Regulation and oversight ensure fair trading practices, transparency, and investor protection.

Bond Market

• Bonds are debt securities issued by governments, municipalities, and corporations to raise capital.
• Lending money to the issuer in exchange for periodic interest payments and the return of the face value.
• Features include face value, coupon rate, maturity date, and issuer responsibilities.

Types of Bonds

• Government Bonds: Issued by national governments and considered low-risk.
• Municipal Bonds: Issued by states, cities, or local government entities, often tax-exempt.
• Corporate Bonds: Issued by companies, offering higher yields but come with higher risk.
• Bond prices and yields are inverse.
• Bonds provide steady income and diversified portfolio.
• Inflation Risk: Inflation erodes purchasing power.
• Interest Rate Risk: Changes affect bond prices.
• Credit Risk: Possibility that the issuer will default.

Types of Financial Markets

• Security Market:
  • Primary Market: Issuing stocks/bonds.
  • Secondary Market: Existing shares traded.
• Money Market: Short-term instruments.
• Foreign Exchange (Forex) Market: Banks buy/sell currencies.
• Futures and Options (Derivatives) Market: Hedging risks.
• Derivatives derive from an underlying asset.
• Hedging price.

Types of Derivatives

• Forward Agreement: Custom contracts.
• Futures: Standardized contracts traded on exchange.
• Options: Right to buy/sell at a fixed price
• Swaps: Exchange currency payments.

Central Banks

• Maintain currency, promote efficiency, ensure stability.

Financial Institutions

• Manage funds, balance assets/liabilities, connections instability.
• Investment Banks obtain funds from private individuals.
• Building Societies less mortgages.

Money Multiplier Effect

• Banks receive deposits, lend the rest, creates money, increases leverage risks.
• Investment Trusts are companies in stocks, gilts, property, and overseas securities.
• Unit Trusts buy/sell units, don't issue stocks/debt.
• Pension Funds for employees.
• Investment Strategy: Short-term bonds to maintain liquidity.

Financing Companies

Internal sources of Finance

• Long Term Finance: Retailed profits
• Short Term Finance: Tight credit control of receivables.

External Sources of Finance

• Share capital: Funds are raised by selling shares.
• Ordinary Shares: Returns from dividends and share value increase.
• Preference shares: Fixed dividend.
• Loan capital: Funds are raised by obtaining a loan.
• Loan: Return to investor is interest (plus repayment of capital).
• Finance Leases: Lessee takes on risks of ownership.
• Operating Leases: Owner of asset retains risks.
• Bank loans: interest payments, usually secured.
• Bank overdrafts: immediate payment can be demanded.
• Trade credit: agreement between a company and supplier to pay later.

Types of shares

• Ordinary shares return dividends and share value increases.
• Preference shares have fixed dividends.
• Loan capital has interests.
• Unsecured loan stocks lacks security for loan, greater risk.
• Debentures are loans secured on some of the assets, with floating charge debentures allowing use of trading assets.

Eurobond Loan Capital

• eurobond loan capital issued in a currency is not under tax control and has lower interests

Leasing

• leased asset rented

Finance Leases

• finance leases have risks of ownership

Operating Leases

• operating leases have owner retains risks

Company Finance

• interest payments and demand overdrafts

Company Agreements

• Company trades and pays later

Stock Market

Raising Funds

• Raising Finance occurs from restructuring the market.

Routes to listing

• Routes to offer include determining offers for sales.

Additional Methods

• Additional methods include; subscription offers and other underwritings.

Right issues

• Right issues help maintain existing stakeholders proportions.

Stock Bonus

• Stock is issued to existing shareholders and no money is raised.
  • Purpose: increase marketability of shares.

Time Value of Money

Future Value (FV) Formula

• FV = PV * (1 + r)^t
• Where PV = Present Value, r = interest rate, and t = number of periods.
• Used to find later money on a timeline.
• FV interest factors = (1 + r)^t

Example

• Investing $100 at 10% for one year yields $110.

Simple vs. Compound Interest

• Simple interest is earned only on the original principal.
• Compound interest is earned on both principal and accumulated interest.
• Calculating compounded yearly $6 becomes $575694.50 today, over 200 years.

Present Value (PV) and Discounting

• PV gives the current value of future cash flows discounted at the correct discount rate.
• PV formula: PV = FV / (1 + r)^t
• Finding present value of one or more future amounts is discounting.

Example

• Needing $400 for a textbook. You can earn 7%. How much needed. $373.83.

Discount rate

• Finding the number of a new car that cost $20,000 to buy.

Net-Present Value (NPV)

• Sum of all discounted future cash flows minus initial investment (and initial investment)

Formula

• NPV = -C0 + (C1 / (1 + r)) + (C2 / (1 + r)^2) + ...

Example

• Find NPV if you pay $100 now for the investment.
• Suppose you expect to receive $110 in 1 year and $121 in 2 years.

Financial Assets Valuation - Bonds

• Face Value: Nominal value repaid at maturity.
• Maturity: Date on bond's principal is repaid.
• Coupon Rate: Pays on fixed interest annually.

Bonds value

• Bonds often called fixed instrument and requires calculation to give value

Formula

• P = C / (1 + r) + C / (1 + r)^2 + ... + (C + FV) / (1 + r)^n
• Bond issued at 3% for 3 years is valued at market
• A bond is to be at par when its market price is equal to its face value.

Bond interest rate

• Coupon Rate: Bond interest rate, Price = Face Value. A bond is to be at par when its market price is equal to its face value. existing bond has higher coupon and low investments.

Perpetual Cash Flow (Flat Perpetuity)

• An investment that provides constant cash flows indefinitely.,

Formula

• PV = CF / r
• Formula: PV = C / r

Example

• Consider a perpetuity paying $100 a year with a discount rates goes to $1,666.67

Rate Formula

• PV= d/(r-g) the smaller rate goes to infinity

Price Share

• Price bet share p: on per shared forecasts

Discount

• The discount depends on firms cash

Growth Rate

• The growth is difficult and guesswork
• Efficient Markets: Hypothesis says differ and has different information.

Value of a stock

Price Formula

• Price Fo=E1/r-g
• WhereE1 Expected earning next year R Required rate return
• E represents stock ratio

Example

• price formula Po/10 = E1 - r g
• Where discount rate of stock price is equal discount rate and dividends

Earnings Decision

• Dividend decision is closely financing decision internal
• Retailed have not flotation costs

Example

• M Model theory
• Argued doesn't affect
• Theory dividend affects capital.

Gordon Dividend

• Gordon Dividend relevance certain over capital gain

Birds dividends

• investors value dividend
• making dividend increase

Example

• retention ratio

Dividend Growth

• dividend returns are a large percentage due to business returns due to low dividends and equities

Formula

• G=bxR
• Returns rate
• Discount dividend