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Companies and Stock Markets
Transcript of Companies and Stock Markets
Private limited companies (LTD)
Public Limited Companies (PLC)
Limited liability: Confines an investor's loss in a business to the amount of capital they invested. If a person invests £100,000 in a company and it goes under (bankruptcy), they will lose only their investment and not more.
Private limited companies (LTD):
Most typical setup for small UK businesses, they cannot offer shares to the public, they can have a maximum of 20 shareholders. Directors and shareholders are often the same people. Often family run. Privately owned
Public Limited Companies (PLC)
Allowed to offer shares to the public to raise funds (with shares issued to a minimum value of £50,000)..share capital. Your shares can be traded on the stock exchange, your company is then listed on the stock exchange.
Find me 3 Privately held companies and 3 publicly traded companies in UK
Privately held: John Lewis, Iceland, Specsavers, Harrods, Poundland...
Public Limited Companies: Shell, HSBC, Unilever, Tesco, BT, Avival, Sainsbury etc...
Why do companies issue shares?
Why issuing shares rather than borrowing money?
The advantage of raising money in this way is that you don't have to pay the money back or pay interest to the investors.
Why raising capital?
Expansion, research and development ('R&D'), it provides new Finance, a way to raise your business' profile, repay debts, An exit for founding investors who want to realise their investment...
What do shares provide?
a mechanism for investors to trade shares, a market valuation for the company, an incentive for staff using shares or share options.
Employee share ownership schemes offer employees a stake in the business, encouraging loyalty and helping you to retain key staff. They also provide an incentive or reward for performance and can help recruitment
What Affects the share price?
Why is it moving?
The financial performance and prospects of the company
The performance and prospects for the industry in which the company operates
Political, general economic, financial and Stockmarket conditions, particularly where the company operates or is listed
The perception of the investors of all the above factors
How to make a return on your shares?
Getting the true value of an ordinary share based on price obtained through market forces, understanding the value of the underlying business, knowing investor sentiment towards the company, analysing company’s recent performance and expected future performance, global
demand for a company’s shares
Why a raise in a share price?
New Director, new management
Increase in particular prices like increase in prices for what the company does
New products and contracts (new iphone?)
Profits / Company is expected to make record profits – more than previously forecast
Fall in interest rates, why?
Company has a lot of bank borrowings, and interest rates have fallen
Investors in the company believe the company is about to be taken over
Fall in share prices
Bad publicity (eg BP responsible for oil spill)
Stock market falling (eg this share usually falls faster and further than average
Government legislation (New legislation will add to costs)
Company Performance, Figures show that trading is bad in the company’s main business area
Takeover rumours turns out to be wrong or takeover approach collapses
Profit Warning, company issues a profits warning
Product range criticised as being out of date or technologically inept
How does it work?
Client A wants to buy and client B wants to sell. Exchange matches orders
Provides a market place in order to trade stocks.
Sets rules to ensure the market operates fairly and efficiently.
To be listed on the exchange means to be accepted for trading
Only the exchange members can trade directly on the exchange: usually investments banks: brokers then pass the money on to their clients. General public needs to place the order with an exchange member
Let's quickly sum up what we've seen
Exemples of Exchanges
London Stock Exchange
The primary stock exchange in the U.K. and the largest in Europe.
Sufficient working capital for at least the next 12 months
At least 25% of the share capital must be in the hands of the public so that the shares can be actively traded and remain reasonably liquid.
The company should have at least three years of accounts.
AIM Alternative Investment Market
A sub-market of the London Stock Exchange that permits smaller companies to participate with greater regulatory flexibility than applies to the main market, including no set requirements for capitalization or the number of shares issued. The Alternative Investment Market is the London Stock Exchange's global market for smaller and growing companies
As of 2010, more than 3,000 international companies have joined the Alternative Investment Market (AIM) since its launch in 1995. AIM seeks to assist smaller and growing companies in raising growth capital. Early stage businesses, venture capital-backed companies and more established businesses may join AIM to help raise the capital necessary for expansion. The FTSE Group maintains three indexes for tracking the AIM: the FTSE AIM UK 50 Index, the FTSE AIM 100 Index and the FTSE AIM All-Share Index. AIM is owned by the London Stock Exchange Group.
NYSE (New York Stock Exchange)
Main listing requirements:
Must have issued at least a million shares of stock worth $100 million in total
Earned more than 10 million dollars in the last 3 years
A computerized system that facilitates trading and provides price quotations on more than 5,000 of the more actively traded over the counter stocks. Created in 1971, the Nasdaq was the world's first electronic stock market. The term "Nasdaq" used to be capitalized "NASDAQ" as an acronym for National Association of Securities Dealers Automated Quotation. The acronym is no longer used and Nasdaq is now a proper noun.The Nasdaq is traditionally home to many high-tech stocks, such as Microsoft, Intel, Dell and Cisco.
What's a market capitalization?
Total market value of a company's outstanding shares
Calculated by multiplying the number of shares by the current market price of one share
The investment community uses this figure to determining a company's size, as opposed to sales or total asset figures. Frequently referred to as "market cap".
If a company has 35 million shares outstanding, each with a market value of $100, what's its 'market cap' ?
What is an Index?
Companies, Stock Markets and Derivative products
A stock index or stock market index is a method of measuring the value of a section of the stock market.
Index is an average share price
It is used as a benchmark
A statistical measure of change in a market. Each index has its own calculation methodology and is usually expressed in terms of a change from a base value. Thus, the percentage change is more important than the actual numeric value.
Indexes over the world
MSCI, The MSCI World is a stock market index of 1,606 'world' stocks. It is maintained by MSCI Inc., formerly Morgan Stanley Capital International, and is often used as a common benchmark for 'world' or 'global' stock funds.
FTSE 100 UK 100 biggest companies
FTSE All Share All shares traded on London Stock Exchange. Covers 750 major Uk industrial, commercial and financial companies
CAC40 What does this stand for? Tracks stocks on the Paris Bourse
"Cotation Assistée en Continu"
DJ Eurostoxx 50 biggest companies on European exchange
Deutscher Aktien Index (DAX) Performance based index in Germany
Hang Seng Index
Nikkei 225 Index for the Tokyo stock market (225 stocks on index)
Which market we all should have chosen to invest on 1st, May 2008?
S&P 500 500 leading US companies from different sectors S and P stands for Standard and Poor and Dow Jones Most widely recognized index. 30 largest publicly traded companies in the US
Introduction to Derivative Products
Derivatives are one of the three main categories of financial instrument:
Debt products (loans, bonds Mortgages)
What is a derivative?
A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying"
Derivatives include a variety of financial contracts such as:
Most of these derivatives trade OTC
Although certain Options could trade in a exchange like Equities (Chicago Mercantile Exchange)
Why Derivatives: A bit of History...
To start we need to go back to the Bible. In Genesis Chapter 29, believed to be about the
year 1700 B.C., Jacob purchased an option costing him seven years of labor that granted him the right to marry Laban's daughter Rachel. His prospective father-in-law, however, reneged, perhaps making this not only the first derivative but the first default on a derivative. Laban required Jacob to marry his older daughter Leah. Jacob married Leah, but because he preferred Rachel, he purchased another option, requiring seven more years of labor, and finally married Rachel, bigamy being allowed in those days. Jacob ended up with two wives, twelve sons, who became the patriarchs of the twelve tribes of Israel, and a lot of domestic friction, which is not surprising. Some argue that Jacob really had forward contracts, which obligated him to the marriages but that does not matter. Jacob did derivatives, one way or the other...
Due to its prime location on Lake Michigan, Chicago was developing as a major center for the storage, sale, and distribution of Midwestern grain. Due to the seasonality of grain, however, Chicago's storage facilities were unable to accommodate the enormous increase in supply that occurred following the harvest. Similarly, its facilities were underutilized in the spring. Chicago spot prices rose and fell drastically. A group of grain traders created the "to-arrive" contract, which permitted farmers to lock in the price and deliver the grain later. This allowed the farmer to store the grain either on the farm or at a storage facility nearby and deliver it to Chicago months later. These to-arrive contracts proved useful as a device for hedging and speculating on price changes. Farmers and traders soon realized that the sale and delivery of the grain itself was not nearly as important as the ability to transfer the price risk associated with the grain. The grain could always be sold and delivered anywhere else at any time. These contracts were eventually standardized around 1865, and in 1925 the first futures clearinghouse was formed. From that point on, futures contracts were pretty much of the form we know them today.
But what are Forwards, Futures, Swaps and Options ?
A forward a tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price.
Futures are contracts to buy or sell an asset on a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves.
Options are contracts that give the owner the right, BUT NOT THE OBLIGATION, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction.
2 types of options:
The buyer of a Call option has a right to buy a certain quantity of the underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right. Similarly, the buyer of a Put option has the right to sell a certain quantity of an underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right.
Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, commodities exchange, stocks or other assets.
Why a future contract?
Other common uses
From another perspective, the farmer and the investor both reduce a risk and acquire a risk when they sign the future contract: the farmer reduces the risk that the price of a cow will fall below the price specified in the contract and acquires the risk that the price of a cow will rise above the price specified in the contract (thereby losing additional income that he could have earned). The investor, on the other hand, acquires the risk that the price of a cow will fall below the price specified in the contract (thereby paying more in the future than he otherwise would have) and reduces the risk that the price of a cow will rise above the price specified in the contract. In this sense, one party is the insurer (risk taker) for one type of risk, and the counter-party is the insurer (risk taker) for another type of risk.
Swaps could be used by banks to protect (or hedge) themselves from interest rates changes.
Employees can be paid with stock options, therefore they own derivatives.
Some insurance contracts are structured as derivatives to protect lenders in case their loans go bad.
Energy companies use futures to lock in oil prices when they think they are high to protect the company. Airlines use futures to lock in oil when it's low, such as Southwest Airlines did, allowing it to pay $10 per barrel long after the cost of oil had risen to $100+ per barrel.
There are even weather derivatives to protect certain types of businesses from hurricanes.
Call Options exemple:
Hedging vs Speculation
Derivatives can be used to acquire risk, rather than to hedge against risk (like our farmer)
Thus, some individuals and institutions will enter into a derivative contract to speculate on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset.
Speculators look to make a profit from price changes. Hedgers look to protect against a price change; they make their buy and sell choices as insurance, not as a way to make a profit, so they choose positions that offset their exposure in another market.
Like the commodity markets were intended to help agricultural producers manage risk and find buyers for their products, the stock and bond markets were intended to create an incentive for investors to finance companies and a way to raise finance for these companies. Speculation emerged in all of these markets almost immediately, but it was not their primary purpose
Let's come back to our farmer: