CAPITAL MARKETS - Reviewer (Midterm) PDF

CAPITAL MARKETS INTRODUCTION TO CAPITAL MARKET What Are Capital Markets? Capital markets are those where savings and investments are channeled between suppliers and those in need. Suppliers are people or institutions with capital to lend or invest. They typically include banks and investors. Tho...

CAPITAL MARKETS INTRODUCTION TO CAPITAL MARKET What Are Capital Markets? Capital markets are those where savings and investments are channeled between suppliers and those in need. Suppliers are people or institutions with capital to lend or invest. They typically include banks and investors. Those who seek capital in this market are businesses, governments, and individuals. The most common capital markets are the stock market and the bond market. They seek to improve transactional efficiencies by bringing suppliers together with those seeking capital and providing a place where they can exchange securities. The term “capital market” is a broad one that’s used to describe the in-person and digital spaces in which various entities trade types of financial instruments. Capital markets are composed of the suppliers and users of funds. Suppliers include households through the savings accounts and products they hold with banks as well as institutions such as pension and retirement funds, life insurance companies, charitable foundations, and nonfinancial companies that generate excess cash. Primary Market ✓ A company engages in the primary capital market when it publicly sells new stocks or bonds for the first time, such as in an initial public offering (IPO). This market is sometimes referred to as the new issues market. ✓ The company that offers the securities hires an underwriting firm when investors purchase securities on the primary capital market. The firm reviews it and creates a prospectus outlining the price and other details of the securities to be issued. ✓ Small investors are often unable to buy securities on the primary market because the company and its investment bankers want to sell all the available securities in a short period  to meet the required volume. They must focus on marketing the sale to large investors who can buy more securities at once. ✓ When a corporation uses financial markets to raise new funds, the sale of securities is said to be made in the primary market by way of a new issue. Secondary Market ✓ The secondary market includes venues overseen by a regulatory body like the SEC where these previously issued securities are traded between investors. Issuing companies don’t have a part in the secondary market. The New York Stock Exchange (NYSE) and Nasdaq are examples of secondary markets. ✓ The secondary market has two categories: the auction and the dealer markets. The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they’re willing to buy and sell their securities. The NYSE is one such example. People trade through electronic networks in dealer markets. Most small investors trade through dealer markets. ✓ After the securities are sold to the public (institutions and individuals) they are traded in the secondary market between investors. What Is a Primary vs. a Secondary Market? The secondary market has two categories: the auction and the dealer markets. The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they’re willing to buy and sell their securities. The NYSE is one such example. People trade through electronic networks in dealer markets. Most small investors trade through dealer markets. Which Markets Do Firms Use to Raise Capital? Companies that raise equity capital can seek private placements via angel or venture capital investors. However, they’re able to raise the largest amount through an initial public offering (IPO) when shares are listed publicly on the stock market for the first time. Debt capital can be raised through bank loans or securities issued in the bond market. The Bottom Line Capital markets are a very important part of the financial industry. They bring together suppliers of capital and those who seek it for their own purposes. This can include governments that want to fund infrastructure projects, businesses that want to expand, and even individuals who want to buy a home. CAPITAL MARKET, FINANCIAL INSTITUTIONS, AND FINANCIAL MARKETS What is a Financial Market? Financial markets are the meeting place for people, corporations and institutions that either need money or have the money to lend or invest. In a broad context, the financial markets may exist as a vast global network of individuals and financial institutions that may be lenders, borrowers or owners of public companies worldwide. Function of Financial Market Financial markets (bond and stock markets) and financial intermediaries (banks, insurance companies among others) have the basic function of getting people together by moving funds from those who have a surplus of funds to those who have a shortage of funds.  ✓ Those who have savings and are lending the funds the (lender – savers) are at the left and those who must borrow funds to finance their spending (the borrowers – spenders) are at the right. ✓ The principal lender – savers are households, but business enterprises and the government as well as foreigners and their government, sometimes also find themselves with excess funds and so lend them out. ✓ The most important borrower-spenders are businesses and the government (particularly the material government) but households and foreigners also borrow to finance their purchase of cars, furniture’s, houses. ✓ The arrows show that funds flow from lender-savers to borrower-spenders, both directly and indirectly, while funds flow from lenders to borrowers indirectly through financial intermediaries such as banks or directly through financial markets, such as Philippine Stock Exchange. What Financial Markets Do? ✓ Raise Capital o Financial markets are an important source of capital for individuals who wish to buy homes or cars, or even to make credit-card purchases. ✓ Commercial Transactions o As well as long term capital, the financial markets provide the grease that makes many commercial transactions possible. ✓ Price setting o Markets provide price discovery, a way to determine the relative values of different items, based upon the prices at which individuals are willing to buy and sell them. ✓ Asset valuation o Market prices offer the best way to determine the value of a firm or of the firm’s assets, or property. This is important not only to those buying and selling businesses, but also to regulators. ✓ Arbitrage  o Arbitrage is buying a security in one market and simultaneously selling it in another at a higher price, profiting from the temporary difference in prices. ✓ Investing o The stock, bond and money markets provide an opportunity to earn a return on funds that are not needed immediately, and to accumulate assets that will provide income in the future. ✓ Risk Management o Futures, options and other derivative contracts can provide protection against many types of risk, such as the possibility that a foreign currency will lose value against the domestic currency before an export payment is received. Financial Institution ✓ A financial institution (FI) is a company engaged in the business of dealing with financial and monetary transactions such as deposits, loans, investments, and currency exchange. ✓ Financial institutions are vital to a functioning capitalist economy in matching people seeking funds with those who can lend or invest it. ✓ Financial institutions encompass a broad range of business operations within the financial services sector including banks, insurance companies, brokerage firms, and investment dealers. ✓ Financial institutions vary by size, scope, and geography. Understanding Financial Institutions (FIs) ✓ At the most basic level, financial institutions allow people to access the money they need. For example, although banks do many things, their primary role is to take in funds—called deposits—from those with money, pool the deposits, and lend the money to others who need funds. ✓ Banks are intermediaries between depositors (who lend money to the bank) and borrowers (who the bank lends money to). Different types of Financial Institutions ✓ Central Bank o They are the financial institutions responsible for overseeing and managing all other banks. In the Philippines, the central bank is the Bangko Sentral ng Pilipinas which is responsible for conducting monetary policy and supervising and regulating financial institutions. ✓ Retail and Commercial Banks o Traditionally, retail banks offer products to individual consumers while commercial banks worked directly with businesses. ✓ Internet Banks o Offer the same products and services as conventional banks, but they do so through online platforms instead of brick-and-mortar locations. ✓ Credit Unions/Credit Cooperative o A credit union is a type of nonprofit financial institution providing traditional banking services and is created, owned, and operated by its members. o Historically, credit unions used to serve a specific and shared demographic group, also known as the field of membership. ✓ Savings and Loan (S&L) Associations o Savings and loan associations provide individual consumers with checking accounts, personal loans, and home mortgages. Financial institutions are owned by their customers or community. A savings and loan is a type of thrift that is required by law to produce a certain number of loans secured by residential real estate, but the aim of most savings and loans is to lend for residential mortgages. ✓ Investment Banks o Investment banks are financial institutions that provide services and act as an intermediary in complex transactions—for instance, when a startup is preparing for an initial public offering (IPO), or when one company is merging with another. They can also act as a broker or financial advisor for large institutional clients such as pension funds.  o Investment banks help individuals, businesses, and governments raise capital through the issuance of securities. ✓ Brokerage Firms o Brokerage firms assist individuals and institutions in buying and selling securities among available investors. Customers of brokerage firms can place trades of stocks, bonds, mutual funds, exchange-traded funds (ETFs), and some alternative investments. ✓ Insurance Companies o Financial institutions that help individuals transfer the risk of loss are known as insurance companies. Individuals and businesses use insurance companies to protect against financial loss due to death, disability, accidents, property damage, and other misfortunes. ✓ Mortgage Companies o Financial institutions that specialize in originating or funding mortgage loans are mortgage companies. While most mortgage companies serve the individual consumer market, some specialize in lending options for commercial real estate only. o A legal agreement by which a bank or other creditor lends money at interest in exchange for taking title of the debtor's property, with the condition that the conveyance of title becomes void upon the payment of the debt. Financial Institutions – Investment Banking IPO (Initial Public Offering) ✓ This investment banking function, i.e., IPO ✓ It is an initial public offering wherein a company hires an investment bank to issue an IPO. Below are the steps followed by a company for its IPO: ✓ Before the issuance of an IPO, companies hire an investment bank. This bank is chosen based on different criteria like market reputation, industrial experience, quality of research and distribution channels, etc. ✓ Selected banks do underwrite, where it acts as a broker between investors and issuing companies. ✓ The investment bank works out the financial details of the IPO in the underwriting agreement. ✓ Post that company files the registration statement along with the underwriting agreement with SEC. ✓ Post-approval of IPO by SEC underwriter and issuing company decide offer price and several shares be sold. ✓ After issuance, the bank carries out aftermarket stabilization in which that bank analyzes aftermarket stabilization and creates a market for the stock. ✓ The final stage is a transition to market competition. After 25 days, the bank provides an estimate regarding the valuation and earnings of the issuing company. ✓ IPO is one of the major investment banking functions. Investment bank helps a company set everything and list an IPO in a stock exchange ✓ This bank, in return, charges a commission from a company. Merger and Acquisitions These are corporate finances, management, and strategy dealing with purchasing or joining other companies. An investment bank, in return, charges fees for M&A. M&A company hires a bank for mergers and acquisitions. The following steps are taken for M&A by investment banks. ✓ Merger and Acquisitions Steps o There are two types of roles in M & M&A of an investment bank: seller representation and buyer representation. o A critical role in M&A is the valuation of a company. The bank calculates the actual value of a company o Investment bank builds its strategy for M&A of two companies. o The investment bank also does financial provisioning for a company as M & M&A companies will need lots of funds. It helps a company in raising funds for M&A. o The main role is to issue new securities to the market. ✓ Risk Management o Investment banks help a company manage financial risk in terms of currency, loans, liquidity, etc. o This bank helps a company to recognize the loss area. o This credit risk-control credit risk investment spreads out counterparties, and banks choose stock exchanges for trading. o There are different risks like business risk, investment risk, legal & compliance risk, and operational risk, internally controlled by an investment bank. ✓ Research o This equity research investment banking function is one of the most important investment banking functions. This research helps provide a rating to the company to help investors decide on investment. Research reports tell whether to buy, sell, or hold based on a company’s rating. Through this, one can know the worthiness of the company. Research is done by analyzing and comparing various company reports and performance reports. o Investment banks’ primary work is research, and this research are of multiple types like equity research, fixed income research, macroeconomic research, qualitative research, etc. Investment banks share these reports with clients, which helps an investor to generate profit through trading and sales. ✓ Structuring of Derivatives  o Derivatives products offer a high rate of return and a good margin; hence, many risks are involved. Investment banks prepare these derivatives with a strategy based on single and multiple securities. o For this Investment banking function, i.e., structuring derivatives, investment banks need a strong technical team working on such a complex structure of derivatives. ✓ Merchant Banking o This investment banking function is one of the personal activities of the investment bank where the bank also does consultancy for their clients. It acts as a financial engineer for business. They provide consultancy in financial, marketing, legal, and managerial matters. ▪ Raising finance for a client ▪ Broker in Stock exchange ▪ Project management ▪ Money market operations ▪ Leasing service ▪ Portfolio management ✓ Investment Management o This investment banking function is a core job of an investment bank to guide the investor to purchase, manage his portfolio, and trade various securities. Investment banks prepare reports based on company performance, and through this investment bank decides on financial securities. Investment advice is based on the client’s objective, risk appetite, investment amount, and period. o Based on the customer segment, investment management is divided into Private clients, Private wealth management, wealth management. Here, an investment bank manages a portfolio of customers and provides tips to investors on whether to sell stocks, buy stocks, or hold stocks.