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Transcript of Financial markets
TYPES OF BONDS
ZERO COUPON BONDS - a bond that makes no coupon payments but is issued at considerable discount to par value. The issue of this bond is inversely related to its maturity period, longer the maturity period, lesser would be the issue price and vice versa. These are called Deep Discount Bonds.
CORPORATE BONDS - bonds that are issued by large corporations and have higher yields because there is a higher risk of a company defaulting as compared to government bonds.
GOVERNMENT BONDS - bonds that are issued by the government in its own currency. They are usually referred to as risk free bonds. Bonds issued by national governments in foreign currencies are called Sovereign Bonds.
CONVERTIBLE BONDS - a bond that can be converted into an equity of the issuing firm on pre specified terms, for the part of the convertible bond that is redeemed, the investor receives equity shares and non converted part remains a
INFLATION INDEXED BONDS - bonds that provide protection against inflation. Designed to cut out risks from inflation.
EXTENDABLE/ RETRACTABLE BONDS - bonds that have no fixed maturity date. The maturity period can be changed according to wants of investor.
FLOATING RATE BONDS - bonds in which interest rate depends on the prevailing interest rates in the market.
PERPETUAL BONDS - bonds that have no maturity period and keep paying interest rate to investors. Investors are not allowed to redeem these bonds, they are treated as equity and not as loans/debt.
OTHER BONDS - asset backed securities, war bonds, municipal bonds, lottery bonds, subordinated bonds and bearer bonds.
BOND PRICES AND INTEREST RATES
Shares represent part-ownership in a business concern. Shareholders, therefore, between them own the company, have a vote in how it's affairs are run and if the company makes profit, they are entitled to a share of it. However, the dividend which shareholders receive is dependent on the
company's profitability and management decisions such as company shares, bonds issued by governments in private companies, units in Collective Investment Schemes, debentures, commercial paper and notes.
TYPES OF SHARES
ISSUING OF SHARES
1) Issue of prospectus- The company issues a prospectus to the public which contains complete information about the financial records of the company. This prospectus is issue to send a message to the public that the company has come to existence and it wants the people to invest in their shares so that it can raise capital
2) Subscription- After the issue of prospectus the investors intending to subscribe share capital into the company would make an application along with the application money and deposit the same with a scheduled as specified in the prospectus. The minimum time period for the company to get its subscription is 120 days and if the company fails to do so then the application money has to be returned within 130 days of the date of issue of prospectus.
3) Allotment- Once the applications are received the shares are issued to the investors. The formal letters are sent to the investors confirming that the shares have been allotted to them.
TRADING OF SHARES
A preference share must satisfy the following two conditions:
I) It shall carry a preferential right as to the payment of dividend at a fixed rate
II) In the event of winding up, there must be a preferential right to the repayment of the paid up capital.
These are two dominant characteristics of preference shares. So preference share may or may not carry such other right as:
(a) A preferential right to any arrears of dividend
(b) A right to share in surplus profits by way of additional dividend
(c) A right to be paid a fixed premium specified in the memorandum
(d) A right to share in surplus assets in the event of a winding up, after all kinds of capital have been repaid.
Preference shares can further be divided into Cumulative, Non-Cumulative, Participating and Non-participating
All shares which are not preference shares are equity shares.
Equity shareholders have the residual rights of the company. They may get higher dividend than preference shareholders if the company is prosperous or get nothing if the business of the company flops. In the winding up, the equity shares are entitled to the entire surplus assets remaining after the payment of the liabilities and the capital of the company; unless the articles confer right on the preference shares a right to participate in the distribution of surplus assets.
THE PROCESS- Shares can be bought either from the primary or secondary market. Primary Market refers to the purchase of shares in an Initial Public Offering (IPO), whereby a company offers its shares to members of the public for the first time. During an IPO, shares are bought through the selling agents or banks of the company issuing the shares. In the secondary market, the purchase and sale of shares is done through the Stock Exchange.
STOCK EXCHANGE-The Stock Exchange is one of the institutions in the Capital markets. It is an organized market in securities (shares, stocks and bonds). On this market, individuals and companies can buy shares of companies through Licensed Dealing Member (Stockbrokers) of the Stock Exchange and hence become part- owners or shareholders of these companies. Similarly, individuals or companies through Stockbrokers can buy stocks and bonds of other companies and the Government, and become lenders to or creditors of these companies or the Government. Any individual or company who at one time or the other lent money or bought shares through the Stock Exchange can also sell back the relevant shares or stocks through the stock Exchange at any time. The Stock Exchange has its rules and regulations which govern it. These rules
and regulations are designed to protect all market participants, including the individual who puts up some funds to invest.
BENEFIT TO COMPANIES-A share issue allows companies to increase the equity base of the company and raise capital without bearing the burden of interest payments associated with borrowed funds. Full disclosure requirements encourage companies to observe good business and management practices and ensure better corporate governance, benefiting not just the firm but the economy as a whole.The public profile of the company is improved thus attracting greater business opportunities
BONDS vs. SHARES
At first glance, the inverse relationship between interest rates and bond prices seems somewhat illogical, but upon closer examination, it makes sense. An easy way to grasp why bond prices move opposite to interest rates is to consider zero-coupon bonds, which don't pay coupons but derive their value from the difference between thepurchase price and the par value paid at maturity.
For instance, if a zero-coupon bond is trading at $950 and has a par value of $1,000 (paid at maturity in one year), the bond's rate of return at the present time is approximately 5.26% ((1000-950) / 950 = 5.26%).
For a person to pay $950 for this bond, he or she must be happy with receiving a 5.26% return. But his or her satisfaction with this return depends on what else is happening in the bond market. Bond investors, like all investors, typically try to get the best return possible. If current interest rates were to rise, giving newly issued bonds a yield of 10%, then the zero-coupon bond yielding 5.26% would not only be less attractive, it wouldn't be in demand at all. Who wants a 5.26% yield when they can get 10%? To attract demand, the price of the pre-existing zero-coupon bond would have to decrease enough to match the same return yielded by prevailing interest rates. In this instance, the bond's price would drop from $950 (which gives a 5.26% yield) to $909 (which gives a 10% yield).
Now that we have an idea of how a bond's price moves in relation to interest-rate changes, it's easy to see why a bond's price would increase if prevailing interest rates were to drop. If rates dropped to 3%, our zero-coupon bond - with its yield of 5.26% - would suddenly look very attractive. More people would buy the bond, which would push the price up until the bond's yield matched the prevailing 3% rate. In this instance, the price of the bond would increase to approximately $970. Given this increase in price, you can see why bond-holders (the investors selling their bonds)benefit from a decrease in prevailing interest rates.
FEATURES OF SHARES
1.Decision making and voting rights-
2.Limited liability- If the company shuts down because of lack of cash or some uncertain events then maximum value at risk is the amount invested by shareholders in the company.
3.Loss absorption of other investors or creditors- In case of liquidation of the company, first of all the efforts are made to pay back the creditors and if there is anything left over then it goes to the shareholders.