Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared

Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and PhillipsSlides prepared by Peter Phillips

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Chapter 4

The share marketand the corporation

Websites:www.asic.gov.auwww.asx.com.auwww.nyse.com


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Learning objectives

• Understand the nature of corporations and reasons for public listing

• Consider the origins and purpose of a stock exchange• Discuss the role of primary and secondary markets in

equity financing• Explain the derivatives, managed products and interest

rate market roles of a stock exchange• Explain the electronic trading and settlement systems

for share market transactions

(cont.)


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Learning objectives (cont.)

• Explain the importance of information flows for share market efficiency

• Identify the main regulators of the share market• Explain the structure and purpose of the private equity

market


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Chapter organisation

4.1 The Nature of a Corporation4.2 The Stock Exchange4.3 The Private Equity Market4.4 Summary


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4.1 The nature of a corporation

• Share market– A formal exchange facilitating the issue, buying and selling

of equity securities

• Publicly listed corporation– A company whose shares are quoted and traded on a formal

stock exchange

• Ordinary share– The principal form of equity issued by a corporation, which

bestows a claim to residual cash flows and ownership and voting rights

(cont.)


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4.1 The nature of a corporation (cont.)

• The corporation differs from other business forms

– Ownership claims are widespread and easily transferable

– Owners (shareholders) do not affect the day-to-day affairs of the company

– Shareholders’ liability is limited to: the issue price of shares of a limited liability company any partly paid portion of shares of a no-liability company

(cont.)


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• Advantages of the corporate form

– Can obtain large amounts of finance at a relatively cheap cost

– The liquidity of securities facilitates investor diversification and encourages investment in corporate securities

– Separation of ownership and control facilitates: appointment of specialised management greater effectiveness in the planning and implementation of

strategic decisions

(cont.)


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• Advantages of the corporate form (cont.)

– ‘Perpetual succession’—the corporate form is unaffected by changes in management or ownership

– The corporate form is suited to large-scale operations

(cont.)


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• Disadvantages of the corporate form

– Main disadvantage arises from the separation of ownership and control

Conflict of interest between owners (principals) and managers (agents) known as the agency problem

Management may try to run business for their own benefit, rather than that of shareholders, i.e. maximise shareholder value (share price)

(cont.)


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• Disadvantages of the corporate form (cont.)

– Factors moderating conflict of interest between owners and managers

Investors’ ability to sell shares in a corporation, causing the share price to fall

Dismissal from the board at AGM by shareholders Threat of takeover and loss of employment Use of performance incentives, such as share options More rigorous corporate governance

(cont.)


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• Following the GFC, many corporations were forced to raise additional capital through the stock market

• This was to ‘sure up’ their balance sheets during the tough economic environment that followed the crisis

• The advantage of the corporate form is highlighted by such behaviour

• Smaller firms are not able to access capital as easily and would normally be expected to pay a higher rate of return


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4.2 The stock exchange

• Origins of the modern stock exchange traceable to mid-16th century England

• Principal functions of a modern and efficient stock exchange in a globalised market are the provision of:– markets for a range of financial securities– securities trading system– clearing and settlement system– regulation and monitoring of market integrity– well-informed market

(cont.)


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4.2 The stock exchange (cont.)

• Specifically, the following roles of a stock exchange are considered:– Primary market role– Secondary market role– Managed Product role– Derivative market role– Interest rate market role– Trading and settlement roles– Information role– Regulatory role


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Primary market role

• A stock exchange facilitates the efficient and orderly sale of new financial securities– New floats/Initial public offerings (IPOs)

Initial listing of a corporation on the stock exchange– Rights issue

Issue of additional shares to existing shareholders on a pro-rata basis

– Placements Issue of new shares to selected institutional investors

– Dividend reinvestment plans Reinvestment of dividends into corporation for additional

shares

(cont.)


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Primary market role (cont.)

(cont.)


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Primary market role (cont.)


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Secondary market role

• The stock exchange facilitates trading in existing shares– No new funds are raised by the issuing company– An active, liquid, well-organised secondary market increases

the appeal of buying new shares in the primary market– Market liquidity

Ratio of share turnover to market capitalisation– Market turnover

Number of shares on issue x current share price

(cont.)


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Secondary market role (cont.)


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Managed product role

• The stock exchange provides a market for trading managed products

– Equity-based managed products are professionally managed funds.

– The ‘units’ in these funds are bought and sold on the stock exchange in the same way as shares in corporations.

– Managed products are described as: exchange traded funds (ETFs) real estate investment trusts (REITs) infrastructure funds


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Derivative market role

• The stock exchange provides a market for trading equity-related derivative products

– A derivative is a financial security that derives its price from an underlying commodity (e.g. gold) or financial instrument (e.g. BHP shares)

– Derivative products are described as: exchange-traded contracts

• standardised financial contracts traded on a formal exchange over-the-counter contracts

• non-standardised contracts negotiated between writer and buyer

(cont.)


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Derivative market role (cont.)

• The stock exchange provides a market for trading equity-related derivative products (cont.)

– Derivatives serve as a: risk management tool (hedge) speculative instrument

– Derivatives traded on a stock exchange include: options warrants futures contracts Contracts for difference


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Interest rate market role

• The listing, quotation and trading of typically longer term debt instruments on a stock exchange

– Straight corporate bonds– Floating rate notes (FRNs)– Convertible notes– Preference shares

(cont.)


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Interest rate market role (cont.)

• This role adds value to a debt issue owing to:

– transparency information about price, yield, maturity, credit rating of debt

instruments

– ease of entry electronic trading system facilitates buy and sell orders at

minimum cost and time delay at current market prices

– liquidity quotation on a stock exchange provides access to a wider

market


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Trading and settlement roles

• The Australian Securities Exchange (ASX) uses ASX Trade and ASX Trade24, which are integrated computer-based trading systems to trade all listed securities and derivatives

– Clients’ orders are executed via computer from the broker’s office

– Orders are executed in order of time received and the buy/sell price

(cont.)


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Trading and settlement roles (cont.)

• The ASX uses CHESS (Clearing House Electronic Sub-register System)

– Facilitates the settlement of transactions conducted through ASX Trade

– Settlement of transactions within three days (T + 3)

– Provides an electronic sub-register that records the ownership of listed securities

– A CHESS sponsor is a market participant with access to CHESS, e.g. stockbroker


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Information role• Investor confidence in the ASX relies on informational

efficiency– The current share prices should reflect all information

available in the market, determined by: the speed at which new information flows to the market the speed at which that information is absorbed and reflected in

share prices

• The ASX has a critical role in facilitating the flow of information to the market

• Corporations Act 2001 (Cwlth) requires information materially affecting the share price of a listed company to be immediately given to the ASX

(cont.)


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Information role (cont.)

• Listing rules are stock exchange rules with which a listed entity must comply

• Examples of information disclosures required by ASX listing rules– A change in a company’s financial forecasts– Appointment of a liquidator– Declaration of a dividend– Notice of a takeover bid– Disclosure of directors’ interests


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Regulatory role

• The aim of regulation is to ensure market participants have confidence in the integrity of market operations

• Two main supervisors in Australia

– Australian Securities Exchange (ASX)– Australian Securities and Investments Commission (ASIC)

(cont.)


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Regulatory role (cont.)

• ASX

– Ensures listed companies meet specified limited levels of performance and standards of information disclosure so investors can make informed decisions

Continuous disclosure

– Prescribes appropriate behaviour of broker participants on the exchange

Sanctions include discipline, penalties, loss of licence

(cont.)


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• ASX (cont.)

– Electronic surveillance systems to monitor trading behaviour of market participants

Detect trades that fall outside certain limits Cross-references all trades against information on the relevant

company, directors and associated parties

(cont.)


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• ASIC

– Responsible for the supervision of Corporations Law and markets in Australia (Corporations Act 2001 (Cwlth))

– Responsible for market integrity and consumer protection across the financial system, covering investment, insurance and superannuation products

– Supervises the ASX, addressing potential conflicts of interest as a publicly listed corporation


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4.3 The private equity market• Private equity is an alternative funding source for

companies unable or not wanting to access equity capital though a public issue

• Source of funds– Superannuation funds and life insurance offices

• Use of funds– Startups, business expansion, recovery finance for

distressed companies, management buyouts– Aim is generally to:

improve profitability sufficiently to realise value though an IPO break up business to achieve return on investment


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4.4 Summary• Corporate form of organisation has advantages

(fundraising and management) and disadvantages (separation of ownership and control)

• The stock exchange has a number of market roles– Primary and secondary– Derivative– Interest rate– Trading and settlement– Information– Regulatory

• ASX monitors market participants and ASIC supervises Corporations Law and market integrity

Documents

Copyright 2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared