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).
- 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
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
Disadvantages of corporate form
Management (as Agents) may not have strong incentive to act in the interests of the owners (shareholders
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
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
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
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
Market liquidity ratio
value of share turnover/market capitalisation
Market capitalisation ratio
no. of listed shares × price
- 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
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
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
- Aim to operate an open & efficient market.
- One aim: to keep investors fully informed of company news
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
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
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.
- 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
S5. Listing & Quotation.
Minimum of 500 shareholders, with minimum of 25% of the company.
Equity Financing - "Choices between..."
- Internal equity finance
- External equity financing
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
External sources of equity financing
- Venture capitalists & angel investors
- Initial public offering of shares (IPO) & flotation
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
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
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
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
Other External Equity Funding Alternatives
- Additional Ordinary Shares
- Preference (Preferred) Shares
Types of additional ordinary shares
- Rights issues
- Takeover issues
- Dividend Reinvestment schemes
Types of Quasi-entity's
- Convertible Notes
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
Two types of rights issues
- Renounceable: shareholder may sell their ‘right’
- Unrenounceable: may not be sold
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
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
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
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
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
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
Convertible note - Interest paid/payments
- Interest paid on notes is usually lower than straight debt interest
- Interest payments are tax deductible to the company
- 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
- 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
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
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.
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
Overview of major share indices around the world
- Dow Jones DJIA = USA
- TSE 300 Composite = Canada
- S&P 500 Composite
- SSEC = Shangai
- 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
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
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
Share-market investment - Investors may take one of two approaches
- Active investment
- Passive investment
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
Some Indicators of company performance
- 1. Capital Structure
- 2. Liquidity
- 3. Debt Servicing
- 4. Profitability
- 5. Share Price
- 6. Risk
Examples of Financial Performance Indicators - 1. Capital Structure
- Proportion of finance (capital) obtained through debt or equity
- Measured as:
- Higher debt levels increase financial risk
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
Examples of Financial Performance Indicators - 3. Debt-Servicing
- How effectively the company can meet its debt-related (i.e. interest) obligations:
- Ratio should be ">2"
Examples of Financial Performance Indicators - 4. Profitability
- Earnings per share (EPS): measures the earnings that are attributable to each ordinary share after abnormal items
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)
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
Risk - Two components to risk (price variability)
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
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
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
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)
Pricing of Shares - "Theoretically the share price will..."
Fall on the ex-dividend date by the size of the dividend
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
Pro-rata Rights Issue formula - ex-rights formula
- 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
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
Pricing the Pro-rata Right Issue - Using textbook formula