125220_16(T5): Equity Markets

  1. Share Market Overview
    • Markets allow trading of financial assets (securities), in particular, trading of corporate equity (shares or stock).
    • A share represents a residual claim over assets of a company
    • Shares also possess an ownership component (i.e. gives a vote in the control of corporation).
  2. The Corporation
    • Ownership claims are widespread & easily transferable.
    • Owners (shareholders) do not affect day-to-day affairs of company.
    • Shareholder’s liability is limited to the fully paid-up value of the shares - Limited Liability Act 1855 in England
  3. Advantages of corporate form
    • Can obtain large amounts of finance relatively cheaply.
    • Specialised management - CEO & directors can be chosen (due to separation of ownership & control).
    • ‘Perpetual succession’: corporate form is unaffected by changes in management or ownership – shares have unlimited lives (in theory)
    • The corporate form is suited to large-scale operations
  4. Disadvantages of corporate form
    Management (as Agents) may not have strong incentive to act in the interests of the owners (shareholders
  5. The Share market or Equity market
    • Issuance of new share capital (IPO or seasoned)- primary market.
    • Acting as secondary market helping trading of existing shares.
    • Trading & settlements role.
    • Derivative market.
    • Interest rate market.
    • Information role.
    • Regulatory role
  6. 1. Primary Market Role
    • Facilitates efficient & orderly sale of new share issues (IPOs).
    • IPO = when a company lists for the first time = raises equity financing from investing public for first time
    • Shares become listed on exchange & companies receive finance
  7. 2. Secondary Market Role
    • Facilitates trading in existing shares.
    • In most countries done by organised stock exchange
    • No new funds are raised by issuing company.
    • Trading reveals current market price of shares.
    • Buy & sell orders are placed with a (stock) broker.
    • Brokers act as agents (NOT dealers) for buyer/seller
  8. Secondary Market Role-Daily Operations of
    • NZSX part of NZX
    • Centralised, continuous, organised, auction market. Computerised systems - not OTC like FX markets
    • Allows ‘uncertificated’ securities & eliminates need for transfer forms to be signed for security sales
    • Brokers, Stock Exchange & share registries all linked electronically
  9. Market liquidity ratio
    value of share turnover/market capitalisation
  10. Market capitalisation ratio
    no. of listed shares × price
  11. 4. Derivatives
    • NZSX part of NZX provides market for trading share-related derivative products
    • Derivatives serve as a risk management tool and/or as a speculative instrument
    • Derivatives traded on the NZSX include Options, Warrants, ETFs
  12. 5. Interest rate role
    • 2002, push by NZX to trade fixed-interest (debt) instruments as well. i.e. NZDX
    • 2012, demutualization - NZSE limited liability company & name change to NZX with parts NZSX, NZAX & NZDX
    • NZAX (Alternative market) & now 2015 NZT
  13. 6. Information role - - NZSX has listing rules governing information.
    • Requirement for company to release semi- & annual reports, & to release to NZSX all price sensitive info.
    • This is then released to share brokers & then eventually is released into the public domain.
    • Continuous disclosure regime details
  14. Regulatory role
    • Aim to operate an open & efficient market.
    • One aim: to keep investors fully informed of company news
  15. Regulatory role - Example
    • In NZ, Financial Markets Authority: 2014 implementation of Financial Markets Conduct Act
    • Exchanges need rules e.g. If you own more than 5% of a company, it must be disclosed, as must any change in ownership
  16. S2. Compliance & Enforcement
    • Deals with role of market surveillance panel.
    • NZ Markets Disciplinary panel - responsible to NZSX.
    • Role: look at listing requirements, & unusual trades. i.e. price of company unexpectedly increases, Panel can ask company for a report, to see if something is amiss, e.g. insider trading. E.g. the stock Xero March 2015
  17. S3. Costs, Trust Deeds & Directors of Companies.
    Governance issues concerning the rights of shareholders

    • new equity
    • employee shares
    • appointment of directors & fees 
    • disposal & acquisition of assets
    • transactions with related parties
    • voting restrictions.
  18. S4. Takeovers.
    • So long as it was disclosed, institutions could buy whatever percentage of a company they wish.
    • July 2001, NZ has new takeover code. e.g. what % of company owned before having to do formal takeover
  19. S5. Listing & Quotation.
    Minimum of 500 shareholders, with minimum of 25% of the company.
  20. Equity Financing - "Choices between..."
    • Internal equity finance
    • External equity financing
  21. Internal equity finance
    • For starting business, owners of company provide equity funds,
    • As it grows, it may generate positive cash flows & retain funds from operations (profits)
    • There are advantages in using retained earnings (internal funds) as source of finance
  22. External sources of equity financing
    • Venture capitalists & angel investors
    • Initial public offering of shares (IPO) & flotation
  23. Initial Public Offering (IPO) - Ordinary Shares
    • Major source of equity funding
    • Shareholders have voting rights at general meetings & rights to vote on important issues
    • Shareholders may transfer voting rights to a proxy
  24. Initial public offering (cont.) - Paid-up Capital
    • "number of shares actually issued"
    • Shares may be sold ‘fully-paid’ or ‘partly-paid’
    • ‘Partly-paid’ shareholders have contractual obligation to pay remaining amount (the call) to company
    • Shareholder’s liability is limited to extent of fully paid shares
  25. Initial Public Offering - No Liability Companies
    • Used for highly speculative ventures
    • Shares issued as ‘partly-paid’
    • Shareholders may decide not to meet future ‘calls’, in which case shareholders will forfeit ‘partly-paid' shares
  26. Initial Public Offering - Managed funds (Unit Trusts) (indirect finance)
    • Investors purchase units in a trust & so provide funds for managers to invest on their behalf
    • Trustee invests pooled funds
    • Entitled to a portion of the income stream of the trust
    • May be listed on the stock exchange if closed-end or unlisted if open-end
  27. Other External Equity Funding Alternatives
    • Additional Ordinary Shares
    • Preference (Preferred) Shares
    • Quasi-entity
  28. Types of additional ordinary shares
    • Rights issues
    • Placements
    • Takeover issues
    • Dividend Reinvestment schemes
  29. Types of Quasi-entity's
    • Convertible Notes
    • Options
    • Warrants
  30. Additional Ordinary Equity - Rights issue
    • Issue of ordinary shares to existing shareholders
    • Issued pro-rata (e.g. 1:5 means 1 new share for every 5 currently held by existing shareholders
    • Rights issue usually made at a discount to current price
  31. Two types of rights issues
    • Renounceable: shareholder may sell their ‘right’
    • Unrenounceable: may not be sold
  32. Additional Ordinary Equity - (Share) Placements
    • Additional new ordinary shares issued directly to selected investors (typically institutions)
    • Not required to register a prospectus
    • Minimum subscription-different countries different rules ($500,000 to not more than 20 participants)
    • Market price discount cannot be excessive
    • Allows smaller discount & shorter time frame than rights issue
    • Disadvantage of dilution for existing shareholders
  33. Additional Ordinary Equity - Takeovers using equity
    • Takeover company issues extra ordinary shares to the owners of the target to settle the transaction
    • Removes the need for owners of the takeover company to inject further equity for the purchase of the company
  34. Additional Ordinary Equity - Dividend Reinvestment Scheme
    • Shareholders have option to reinvest (convert) dividends into additional ordinary shares
    • Generally issued at a discount to market price
    • No brokerage or stamp duty payable
    • In growth periods it allows companies to pay dividends & pass on tax credits, while increasing equity
    • Schemes may be stopped in low growth periods
  35. Preference (Preferred) Shares
    • Preference shares = hybrid securities (i.e. both debt & equity characteristics) but usually no voting rights
    • Have features such as cumulative, convertible, participating, redeemable (see textbook)
    • Fixed dividend rates - set on issue date- preference shares have set maturity
    • Rank ahead of ordinary shareholders for dividend payment
  36. Quasi-Equity - Convertible Notes
    • Convertible notes are a hybrid instrument— initially begins as a debt instrument issued for a fixed term
    • Interest payments specified in convertible note prospectus as well as possible future share price
    • Gives potential investors right to convert note into ordinary shares at specified future date at determinable price
  37. Convertible note - Conversion price
    • The conversion price is nominated at note issue date — gain is made if share price rises subsequently
    • If share price falls, holder may not exercise conversion option, & take the notes cash value
  38. Convertible note - Interest paid/payments
    • Interest paid on notes is usually lower than straight debt interest
    • Interest payments are tax deductible to the company
  39. Share Options
    • Provide the right but not the obligation to purchase ordinary shares, at a stated price, at a future date
    • Issued by company for period < 5 years
    • Allows companies to raise further equity funds at planned future dates (providing holders exercise the option)
    • Generally have value & may be traded up to maturity date
    • Exercising of option will depend upon exercise price of option relative to market price of share at exercise date
  40. Share Investors
    • General market considerations - e.g. liquidity, market depth, charges, return, efficiency, taxation
    • Market indices - measure of performance of entire market or portion e.g. market cap S&P NZSX 50 (change to S&P in 2015)
    • S&P - Performance, tradable & market indicator indices
  41. Share Investors - (a) Share Index construction
    • Price-weighted e.g. the Dow Jones Industrial Average 30.
    • Market value-weighted base: weighted by mkt. capitalisation of company = share price & no. of shares. e.g. S&P/NZSX 10
  42. Share Investors - b) Capital/gross share indices
    • An accumulation index otherwise known as gross index: calculates capital gain/loss & dividends & bonuses received.
    • A share price index otherwise a capital index: Just reflects capital gains/losses in shares.
  43. International Stock Markets
    • By market capitalisation first it’s U.S.- NYSE, NASDAQ, then U.K., then China- Shanghai, Japan-Tokyo,
    • By equity, it is NY, NASDAQ, London, Tokyo
    • Competition, mergers & computerisation is changing the face of stock markets e.g. SEAQ vs. Paris & CATS system
  44. Overview of major share indices around the world
    • Dow Jones DJIA = USA
    • TSE 300 Composite = Canada
    • S&P 500 Composite
    • SSEC = Shangai
    • NASDAQ
    • AORD = Australia
    • FTSE 100 = London
    • KSII = Korea
    • Nikkei 225 Stock Average
    • JSX = Indonesia
    • TOPIX = Tokyo
    • TWII = Taiwan
    • CAC 40 = France
    • SMSI = Spain
    • DAX 30 = Germany
    • SSMI = Switzerland
    • Hang Seng = Hong Kong
    • AEX = Netherlands
    • Straits Times = Singapore
    • Bel-20 = Belgium
  45. Other Features of international equity listings - Multiple listings for large companies
    • – Many companies listing (raising equity funds) their shares in more than one country (Dual or multiple listing) - e.g. ANZ bank listed in Australia & New Zealand
    • In U.S. Many companies have their shares listed as a ADR-American Depository Receipts & trade on NYSE
    • A depository receipt = security issued by US depository bank & supported by shares held of listed foreign company
  46. Why list in other countries as well as in your local country?
    • Diversify funding - May lower cost of capital for companies
    • Reduced threat of takeover
    • Boost reputation of company
  47. Share-market investment - Investors may take one of two approaches
    • Active investment
    • Passive investment
  48. Taxation of Dividends in NZ
    • Pre-imputation: dividends taxed twice—first at company
    • level (as profits) & then at investor’s marginal rate
    • 1987 - Imputation removed double taxation of dividends
    • Investors receive imputation credit for tax a company pays on dividends
  49. Some Indicators of company performance
    • 1. Capital Structure
    • 2. Liquidity
    • 3. Debt Servicing
    • 4. Profitability
    • 5. Share Price
    • 6. Risk
  50. Examples of Financial Performance Indicators - 1. Capital Structure
    • Proportion of finance (capital) obtained through debt or equity
    • Measured as: Image Upload 1
    • Higher debt levels increase financial risk
  51. Examples of Financial Performance Indicators - 2. Liquidity (for company)
    • 2. Liquidity-for company
    • The ability of a company to meet its short-term financial obligations
    • Common measures incl. current ratio. quick ratio
    • Fails to consider the illiquid nature of certain current assets (e.g. inventory) - quick ratio
    • The higher the current & liquid ratios, the better the liquidity position of the company
  52. Examples of Financial Performance Indicators - 3. Debt-Servicing
    • How effectively the company can meet its debt-related (i.e. interest) obligations:
    • Image Upload 2
    • Ratio should be ">2"
  53. Examples of Financial Performance Indicators - 4. Profitability
    • Image Upload 3
    • Earnings per share (EPS): measures the earnings that are attributable to each ordinary share after abnormal items
  54. Examples of Financial Performance Indicators - 5. Share Price
    • Share price represents the opinion of investors as to present value of future net cash flows of company
    • A important price-based performance indicator is Price to Earnings (P/E)
  55. Example - 5. Share Price - P/E Ratio
    • Share price divided by earnings per share
    • Indicates investor’s valuation of future earnings prospects of the company
    • The higher the P/E the more optimistic the outlook for the future
  56. Risk - Two components to risk (price variability)
    • Systematic
    • Non-systematic
  57. Risk - systematic
    • arises from factors affecting whole market
    • e.g. state of domestic economy & world economy
    • Can be measured by beta
    • Average share that matches market has beta of one
  58. Risk - Non-systematic (unique) risk
    • arises from firm-specific factors
    • example: management competence, labour productivity, financial & operational risks
    • Non-systematic risk can be eliminated by forming a well-diversified portfolio
  59. Pricing of Shares - Share price
    Mainly a function of supply & demand for a share

    • Supply & demand are influenced mainly by information
    • Share price is considered to be present value of future dividend payments to shareholders
    • New information that changes investors’ expectations about future dividends will result in a change in the share price
  60. Pricing of Shares - Cum Dividend (cd) and Ex Dividend (xd)
    • Dividends = payments made to shareholders, expressed as cents per share (cps)
    • Dividends are declared at one date & paid at a later specified date

    • During the period between two dates, shares have future dividend entitlement attached (i.e. Cum Dividend cd)
    • Once dividend is paid, shares are traded Ex Dividend (xd)
  61. Pricing of Shares - "Theoretically the share price will..."
    Fall on the ex-dividend date by the size of the dividend
  62. Bonus Share Issues - Example: if a bonus one-for-four (1:4) issue is made, Cum Bonus (c.b.) Price $10.00 Market Value of 4 c.b. shares 40.00
    • Cum Bonus (c.b.) Price $10.00
    • Market Value of 4 c.b. shares 40.00
    • Theoretical Value of 5 x.b shares 40.00
    • Theoretical Value of 1 x.b share 8.00
  63. Pro-rata Rights Issue formula - ex-rights formula
    Image Upload 4

    • P = cum-rights price of existing shares
    • N = number of existing shares with right to subscribe for new share
    • S = subscription price for new shares
  64. Pro-rata Rights Issue - Example
    Current share price cum rights $2, with 1:4 rights issue priced at $1.80 with ex-date in 14 days

    Cum Rights (c.r) Share Price $2.00
    Market Value of 4 c.r shares 8.00
    Plus new cash from 1:4 Issue 1.80
    Market Value of 5 x.r shares 9.80
    Theoretical Price of 1 share ex-rights 1.96
    Image Upload 5
  65. Pricing the Pro-rata Right Issue - Using textbook formula
    Image Upload 6
Card Set
125220_16(T5): Equity Markets