Module 8 - Equities PDF

Module 8 - Equities Equity Markets Introduction The basic function of a share market is to organise the trading in corporate securities - principally shares. Main share mkt is ASX ASX: - Formed in 1987 by group of state based exchanges - 1998 it was demutualised and became a listed company (Au...

Module 8 - Equities Equity Markets Introduction The basic function of a share market is to organise the trading in corporate securities - principally shares. Main share mkt is ASX ASX: - Formed in 1987 by group of state based exchanges - 1998 it was demutualised and became a listed company (Australian Stock Exchange Limited) - 2006 merged with the Sydney Futures Exchange and was renamed Australian Securities Exchange One of worlds leading financial market exchanges in terms of interest Facilitates bonds, future, ets, shares No longer open outcry but now electronic Plays role in economy and vital source for capital of firms and investments Role in matching surplus and deficit units Market Capitalisation = Number of shares * value of the share Markets used to be dominated by UK, USA, Germany in 1899 - Now US accounts for over half of top 20 In foreign exchange market, half of all foreign exchange transactions involve the US dollar on one side of the transaction We take questions from US exchange markets We find that Aus market ques and prices are driven by the overnight market in the US and we are influenced by this due to the dominance of the US market. Markets: USA New York Stock Exchange (NYSE) - World’s largest stock exchange - Approximately 2,400 companies listed - Founded 1792 - Known for iconic trading floor National Association of Securities Dealers Automated Quotations (NASDAQ) - Approx. 3,300 companies listed - Electronic exchange - Founded 1971 - World’s first electronic share market - Own company and range of listing and corporate services to help companies raise capital and grow business - NASDAQ helps with IPOs, market capitalisation, investor relations, developing indices Australian Securities Exchange (ASX) Product and services include: Shares, derivatives (Futures, options, warrants), contracts for difference, ETFs, real estate investment trusts Trading platform: ASX Trade (The broker uses this website on behalf of the investor) GICS Industry Group - Global Industry Classification Standard - Framework for how we categorise companies into industry groups (11 sectors) depending on main source of revenue - Energy, consumer discretionary, consumer staples, healthcare, financial etc. - There are 157 sub industries within main 11 industries - Grouped based on business activity; retailers, miners, tech companies - Created by S&P and MSCI in 1999 - Used globally by investors, analysts, researchers to make informed investment decisions Approximately 2,200 companies listed Across world, companies divided into industries. - Industries are standardised way of comparing companies with each other to know who the competitors are Part A. Role of the Share Market The Role of the Share Market Basic function is to organise the trading in corporate securities - Shares Provide platform for publicly listed firms to raise capital by selling shares to investors - Facilitates deficit and surplus units When company issues shares it sells ownerships stake to investors who become entitled to share of company’s profits and assets Allows companies to raise capital quickly and very efficiently Main share market conducted by ASX The ASX: 1) Determines and enforces rules for listed securities and brokers 2) Trades ordinary and preference shares, units in listed trusts, corporate bonds, options, warrants and CFDs As a secondary market: 1) Price Discovery - The share market: - Determines entry and exit values for investors; helps investors monitor their securities - Values the equity of listed companies - Helps determine the price for newly listed securities - Has indices that reveal the general movements of equity values. 2) Aids in Liquidity - Investors can sell shares at any time and receive instant funds for the sale thus enhancing liquidity - Important or investors and economy as it ensures capital is available when and as needed. 3) Facilitates flow of funds through pooling of equity investments. Market Discipline and Corporate Governance Corporate governance refers to process of decision making by a company’s top management and the ways these managers are help responsible for the management of the company - Ensures company is operating in a responsible and effective manner - Includes elements of a company’s structure, the director’s officers, process of making decisions and managing risk, mechanism for ensuring accountability and transparency etc. Corporate Governance is designed to promote sound business practices and protect interest of STKs and SHs and ensures a company’s operates by aligning with financial laws and regulations The market’s assessment of a company’s management is reflected int he share price; - Market discipline occurs when changes in the share rice influence the behaviour of senior management ESG investing Environmental Social Governance - Known as Corporate governance Good corporate governance when company has good system of rules, practices and is well controlled and managed in order to benefit the stakeholders in a company Corporate governance is the relationship between a company’s management, Board, stakeholders, shareholders Corporate governance is crucial to the long term sustainability and success of a company helps build trustworthy relationships with industry personnel and build equity in and outside company. Ensure company has a culture of integrity and behaves ethically. - ENRON: Built on lies, deceit, financial irregularities, incorrect financial statements, accounting fraud, accounting collusion - Causes introduction of new regulations to improve transparency, stability, prevention of future scandals. The Market for Corporate Control A low share price exposes the company’s management to the risk of takeover Competition for corporate control holds boards accountable for their management of a company’s assets and resources When share markets result in the better management of listed companies they contribute to the economy’s efficiency Part D. Emerging Developments Emerging Developments 3 developments have threatened the ASX’s position as the main provider of share providing services in Australia 1) The establishment of Chi-X as an alternative exchange - Japanese owned, London based organisation - Granted licence in 2011 to operate as second Aus mkt - Specialise in providing trading services for wholesale and algorithmic traders - Have contributed to mkt efficiency by lowering transaction costs and improving price discovery - Leading electronic stock exchange operator for instruments like shares, equity globally - Founded 2007 - Claim to provide faster and more efficient trading service through advanced tech and low cost structure - Company uses a multi-lateral trading model or MTF model where investors are able to trade securities with investors directly rather than going through a traditional exchange. - Mainly for institutional and large traders especially Europe 2) The emergence of dark pools - Refers to the increased level of crossings: where a brokers arranges for a share trade to occur privately (Which is reported to the market once completed) - Used to trade very large parcels of shares to avoid negative price consequences - Both ASC and Chi-X offer their version of a dark pool - Private electronic trading platform that allows investors to trade securities without revealing prices to the public - Still anonymous for investor units - Large institutional investors; Pension funds, public unit trusts - Enables trade of enormously large quantities without effecting the price of a security in the public market - Operated by broker dealers - Subject to regulatory oversight - Issues lack of transparency 3) The possibility of increased competition in clearing services - The ASX is currently the sole provider and settle services (Some countries have multiple) - We have CHESS (Clearing House Electronic SubRegister System) to settle transaction on the ASX - Their clearing system has financial infrastructure that facilities settlement of transactions for investors in the financial markets. - Typically transaction: Investor goes to broker, buys shares, money flows to clearing system and then to the new owner of shares. - Clear that the competitive environment is changing, with the potential entry of new clearing houses. Briefly Describe Three Threats to the ASC’s Market Position: Chi-X, dark pools, emerging clearing services Other Developments Recent innovations contributed to share trading volumes: 1) High frequency OR Algorithmic Trading which is a form of computerised trading that executes trades faster than what is manually possible. - Relies on fast computers and efficient trading algorithms to identify arbitrage opportunities and initiate trades to profit from them - Trades are typically for small parcels held for short periods - Whilst profits made by high frequency traders come at the expense of the other traders, an ASIC review concluded this was more than offset by the extra liquidity they were supplied with. - Popular with hedge funds - Arbitrage: price difference between markets - Computer monitors different markets in which shares commonly are listed to identify profits in each market - Increased liquidity & lower trading costs - Contributes massively to volatility - Flash Crash: Crash of DOW Jones Index triggered by a trading algorithm that placed a large sell order too quickly and created knock on effect that caused prices to quickly deflate. Event highlighted potential for unintended consequences no share value arising from changes in technology that interact with share market. To resolve, everyone had to manually reset and recover positions. 2) Contracts for Difference (CFD) a relatively new type of derivative that allows a trader to profit from a share price movement without having ownership of the share. - A CFD is a contract where the seller agrees to pay the buyer the difference between the price of a traded asset (e.g. share) at the start of the contract and it’s value when the trader decides to close out the contract. - They allow investors (including retail investors) to profit form either up or down movements in the price of a share without having ownership of the share - If you buy a share you are in favour of the company, that suggests the seller is not in favour or optimistic. Instead of buying and selling, there is an agreement to pay the difference between the price of the share today and the price of the share in three months. - Instead of buying and selling a contract is locked in. - Contract to benefit from rising from increasing or decreasing prices without actually owning the security Workshop Notes Around 2000 companies on ASX. Listing involves heavy regulatory requirements Investors would read prospectus and decide if that investment was for you. Market Cap = Share price * # of shares outstanding In order to be guaranteed you buy a specific stock, you would have to pay the offer price as this is what owners are willing to sell for The bid price is what buyers are willing to pay but you cant pay this if vendors aren’t willing to accept. Your order won’t get fulfilled if you cant come up with the vendors wanted price unless a vendor is willing to accept this price. Bid - offer range difference is the spread Liquidity refers to ease of which you can convert your asset to cash at a fair price Spread is in a range of basis points. The number of cent spread as a proportion of the market price. Letter of Intent, Bloomberg, Roitus On exchnage products are those securities traded on an organised exchange such as the ASX or the CBOE Australia (Used to be Chi-X) Share ownership in Australia for adults is around 38% of Australian’s Increase in share ownership due to the privatisations of previously government owned companies like Qantas, NIB, CBA ETFs (Exchange Traded Funds) extremely popular in Aus due to ability of investors to have diversification. Systematic risk = Market Risk Unsystematic risk can be eliminated through diversification which is why ETFs have become so popular as it gives investor greater capability to invest in a wide range of companies, regions, asset classes and strategies. An ETF can be bought through one trade that can give investors an instant diversification. Trading and Settlement Arrangements Admission Rules Free Float Profits vs Asset Tests: Company must have minimum level of profits or assets. ASX states companies must have $4million net tangible assets (PPE). Net tangible includes subtracting liabilities. - Working capital test: Add up profits for last 3 years and they need to exceed $1,000,000.00 Once companies become listed they have to abide by ASX’s continuous disclosure obligations e.g. price sensitive announcements. Price sensitive means any information that may have an impact of the company’s stock price to ensure fair and transparent markets. - E.g. company announced large gold discovery to market causing an inflated market price. As soon as they found that gold, the market would have to be informed. If stock is less than 2 cents, they can have a half a cent price change. If over 2 cents, price change is 1 cent Electronic Trading Buyers don’t buy at bid prices as this is what they want to buy it for. They buy at the sellers offer price as this is what will guarantee the deal being transacted. A market order means investor is willing to pay whatever current price is on market A limit order specifies or puts at price ceiling on the order being placed If you want to be sure you get the stock, your bid price will be the same price as what the sellers want. Minimum price step is 1 cent for a share over $2 If an investor sold 1000000 Qantas shares, all other investors start getting concerned and they might have time to withdraw their bid. They might do this as it may develop questions of optimism of the shares or that something may be wrong with the company. LIT order book means you can see all buyers and sellers all sellers DARK ORDER BOOK (DOB) is where people with large qty of stock sell it to prevent instant fall in stock price. Get matched with buyers who cant see sellers as you can get better prices through dark market. Only available to sophisticated investors. Limit orders if not matching with an offer price does not get executed and it remains on the bid list until a vendor is willing to fulfil that price. Limit orders do not always get executed but market orders do. Electronic Settlement CHESS - Clearing house electronic sub register system Share Price Indices Most popular is S&P/ASX200 S&P is responsible for collection of the index Index measures performance of top 200 stocks in terms of market capitalisation S&P = Investable benchmark ETFs exist to try and replicate the performance of the S&P 200. It’s adjusted by market cap Share market indices are price weighted indexes where an average is taken of all stock prices Dow Jones is index of 30 US stocks that is price weighted. Price weighted indexes aren’t very good Share price indices contribute to price discovery by revealing general price movements in share markets against which the performance of Individual shares and active fund managers can be measured Most PSIs are broad (including many shares) and are weighted by value Index Composition Index inclusion of a share is based on: - Market cap - Liquidity - Free float: the percent of shares in company available for trading (some companies have shares locked up) - Measured by the investable weight factor (IWF) for most it is 100% - Shares weight in index is it’s index market capitalisation - market cap * IWF INDEX MARKET CAP = MARKET CAP * INVESTIBLE WEIGHT FACTOR ASX Indices: 500 companies listed, market cap weighted S&P/ASX 200: investable benchmark for Aus equity market, market-cap weighted Indices do not include dividends paid by shares where as accumulation index does and so is an arguably better benchmark mark for investment returns. Constructing Market Indices - Weighting Schemes Market Cap Weighted Index: Weight on each security determined by dividing its market cap by the total market capitalisation of all securities in the index. Return = weighted average returns of each security proportional to market value. E.g. S&P 500/NASDAQ Price-Weighted Index: Weight on each security determined by dividing its price by the sum of all prices of the securities. Add prices and divide by divisor. E.g. DJA, Wall Street journal choose 30 NYSE socks from large, blue chip companies Equally Weighted Index: Assigns equal weight to each security at inception. Computed from simple average returns.