Capital Market

• History shows that a strong financial system is a necessary ingredient in a growing and prosperous economy
• Financial System includes


  • Banking institutions
  • Non-banking financial intermediaries
  • Investments and loan associations
• Companies routinely raised funds throughout the world to finance projects all over the world
• At the most fundamental level, well-functioning markets and institutions are based heavily on trust
• Financial institutions are the key intermediaries in financial markets because they transfer funds from savers to individuals, firms and government
• Asset


  Any possession that has value in an exchange
• Types of assets


  • Tangible
  • Intangible
• Tangible asset


  Value depends on particular physical properties (e.g. buildings, land, machinery)
• Intangible asset


  Typical future comes in the form of a claim to future cash
• Issuer of a financial asset

  Entity that agrees to make future cash payments
• Owner of financial assets

  Investor
• Examples of financial assets

  • Bond issued by Philippine government
  • Bond issued by San Miguel Corporation
  • Bond issued by municipality of Palawan
  • Bond issued by government of Japan
  • Automobile loan
  • Home mortgage loan
  • Common stock issued by Ayala Land Corporation
  • Common stock issued by Honda Motor Company
• Bond issued by Philippine government, San Miguel Corporation, municipality of Palawan


  Issuer agrees to pay investor interest until bond matures, then repay amount borrowed
• Japan government bond


  Cash payment known if Japan government does not default, denominated in Japanese Yen
• Automobile loan, home mortgage loan


  Issuer is individual who borrowed funds, investor is entity that lent the funds
• Common stock of Ayala Land Corporation, Honda Corporation


  Entitles investor to receive dividends and a pro rata share of net asset value in case of liquidation
• Debt instrument


  Claims of holder may be a fixed dollar amount or varying/residual amount
• Equity claim


  Obligates issuer to pay holder an amount based on earnings
• Convertible bonds


  Allow investor to convert debt into equity under certain circumstances
• Fixed income instruments


  Debt and preferred stock that pay a fixed dollar amount
• Valuation


  Process of determining the fair value or price of a financial asset
• Present value


  Amount of money today is worth more than the same amount in the future
• Cash flow


  Cash expected to be received each period from investing in a particular financial asset
• Minimum interest rate


  Interest rate available in the market
• Role of financial assets

  • Transfer funds from those with surplus funds to those who need funds to invest in tangible assets
  • Transfer funds in a way that redistributes the risk associated with cash flow generated by tangible assets
• Moneyness


  Financial assets that act as a medium of exchange or settlement of transactions
• Divisibility and denomination


  Minimum size at which a financial asset can be liquidated and exchanged for money
• Reversibility (round-trip-cost)


  Cost of investing in a financial asset and then getting out of it and back into cash again
• Bid-ask spread


  Difference between the price at which a market maker is willing to sell and buy a financial asset
• Term to maturity


  Length of interval until the date when the instrument is scheduled to make its final payment or the owner is entitled to demand liquidation
• Liquidity


  How willing sellers are to lose if they wish to sell immediately vs engaging in a costly and time consuming search
• Convertibility


  Ability to convert a financial asset into another financial asset
• Currency


  Financial assets can be denominated in one or more currencies
• Cash flow and return predictability

  Predictability of return depends on predictability of cash flow, riskiness of asset equates to uncertainty/unpredictability of return
• Complexity


  Combination of two simpler assets requires decomposing into components and pricing each separately
• Tax status


  Government code for taxing income from ownership or sale of financial assets varies
• Role of financial markets

  • Determine price of traded assets and required return
  • Provide liquidity for investors to sell assets
  • Reduce search and information costs of transacting
• Classification of financial markets

  • Debt market
  • Stock market
  • Money market (short-term)
  • Capital market (long-term)
  • Primary market
  • Secondary market
  • Auction
  • Over-the-counter
  • Intermediate market
• Derivative markets


  Contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset
• Explicit cost


  Monetary cost spent to advertise the desire to sell or purchase financial asset