Security_Analysis_Overview.pdf
- 1. Security Analysis Overview of Financial Market Environment and Conditions
- 2. The Role of Financial Markets and Institutions A financial markets Market with assets (securities, financial instruments) Sell and buy … Transfer of funds… Deficit subjects Surplus subjects Financial Market: a market in which financial assets (securities) such as stocks and bonds can be purchased or sold Financial intermediation – financial savings to investments Payment system Means of manage risk
- 3. Role of Financial Markets Transfer funds from those who have excess funds to those who need funds. Students – student loan Families – mortgages Business – finance they growth Government – finance their expenditures One side supply funds the other side demand funds Earn return but only if fund is available in financial market
- 4. Role of Financial Markets Surplus units – lenders, investors Receive more money than they spend Deficit units – borrowers Spend more money than they receive This relation is formally organized by securities Agreement between lender and borrower Claim on the issuer
- 5. Role of Financial Markets Debt securities Represent debt incurred by issuer – credit, borrowed funds Deficit units issue the securities to surplus units and… …pay interest to surplus unit on a periodic basis (such as every six months) Characteristics: Maturity date Face value Fixed or variable interest rate Equity securities Represent equity or ownership in the issuer – stocks Deficit unites issue the stocks to surplus money… …spend more money than they receive from normal operations
- 8. Role of Financial Markets Debt instruments Bonds, mortgages, mortgage-backed securities Contractual agreement by the borrowers to pay the holder of the instrument fixed amounts at regular intervals until a specific date (maturity day), when a final payment is made. The maturity of a debt instrument is the number of years until that instrument’s expiration date. Debt instrument is Short – terms or Long - term
- 9. Role of Financial Markets Equities Common stocks Which are claims to share in the net income (income after expenses and taxes) and the assets of a business. If you own one share of common stock in a company that has issued one million shares, you are entitled to 1 one-millionth of the firm’s net income and 1 one-millionth of the firm’s assets. Equities often make periodic payments to their holders Dividends They are considered long-term securities because they have no maturity day. Owning stocks means that you own a portion of the firm and thus have the right to vote on issues important to the firm and elect its directors.
- 10. Role of Financial Markets Advantages and disadvantages Debt vs. equities Disadvantages of equities Equity holder is residual claimant Advantages of equities Holders benefit directly from any increases in the corporation’s profitability or asset value
- 11. Type of Financial Markets Money versus Capital Markets Short-Term, < 1 Year High Quality Issuers Debt Only Primary Market Focus Liquidity Market--Low Returns Long-Term, >1Yr Range of Issuer Quality Debt and Equity Secondary Market Focus Financing Investment-- Higher Returns
- 12. Type of Financial Markets Primary versus Secondary Markets New Issue of Securities Exchange of Funds for Financial Claim Funds for Borrower; an IOU (I owe you) for Lender Trading Previously Issued Securities No New Funds for Issuer Provides Liquidity for Seller
- 13. Type of Financial Markets Securities brokers and dealers are crucial to a well-functioning secondary market Brokers Dealers
- 14. Type of Financial Markets Because over-the-counter dealers are in computer contact and know the prices set by one another, the OTC market is very competitive and not very different from a market with an organized exchange. Stock Exchange Visible Marketplace Members Trade Securities Listed New York Stock Exchange NASDAQ (2006) OTC Wired Network of Dealers No Central, Physical Location All Securities Traded off the Exchanges Forex
- 19. How Financial Markets Facilitate Corporate Finance Three segments of finance Corporate finance How much funding to obtain and how to invest a proceeds to expand their operation Investment management Make a decision about form of financing and investing Debt vs. Equity financing or investing Financial markets and institutions Attract fund from investors and channel the funds to corporation Money market – borrow on short term basis Support existing operations Capital market – obtain long term funds Support corporate expansion
- 20. How Financial Markets Facilitate Corporate Finance Source: Madura, J.: Financial Markets and Institutions, 9th Edition
- 25. Securities Traded in Financial Markets Return Expected return from investment Ex post Ex ante Mean of return Risk Uncertainty surrounding the expected return More uncertainty surrounding the expected return more risk Standard deviation or variance Coefficient of variation = expected risk (standard deviation)/ expected return (mean) Amount of liquidity Tax status Normally High return with particular preference of low risk and adequate amount of liquidity
- 32. Securities Traded in Financial Markets Money market securities Only debt securities Capital market securities Bonds Mortgages and Martgage-Backed securities Stocks Derivative securities Speculation Speculation on movement in value of underlying assets without having to purchase those assets Leverage effect Hedging Commodities Foreign currencies
- 33. Money market
- 36. Stocks
- 40. Bond
- 45. Commodity - gold
- 50. Valuation of Securities in Financial Markets Each type of security generates a unique stream of expected cash flows to investors Capital gain, income Each security has a unique level of uncertainty surrounding the expected cash flows Valuation of securities = present value (PV) of its expected cash flows Discounted at a rate that reflects the uncertainity
- 51. Impact of Information on Valuations Source: Madura, J.: Financial Markets and Institutions, 9th Edition
- 52. Financial Market Regulation Many regulations were enacted in response to fraudulent practices before the Great Depression Asymmetric Information Adverse Selection Morale Hazard In financial markets, one party often does not know enough about the other party to make accurate decision Lack of information creates problems in the financial system on two fronts: Before and after transaction
- 53. Financial Market Regulation Adverse selection The problem created by asymmetric information before the transaction occurred. This occurs when the potential borrowers who are the most likely to produce undesirable (adverse) outcome – the bad credit risk – are the ones who most actively seek out a loan and are thus more likely to be selected. Because adverse selection makes it more likely that loans might be made to bad credit risks, lenders may decide not to make any loans even though there are good credit risks in the market place.
- 54. Financial Market Regulation Moral hazard It is the problem created by asymmetric information after the transaction occurred. Moral hazard in financial markets is the risk (hazard) that the borrower might engage in activities that are undesirable (immoral) from the lender’s point of view, because they make it less likely that the loan will be paid back. Because moral hazard lowers the probability that the loan will be repaid, lenders may decide that they would rather not make a loan. Moral hazard leads to conflicts of interest
- 55. Financial Market Regulation Six types of regulations. 1. Restriction on entry 2. Disclosure 3. Restriction on Assets and Activities 4. Deposit insurance 5. Limits on Competition 6. Restriction on Interest Rate Disclosure Incorrect information - poor investment decision Attempt to ensure that businesses disclosure accurate information Disclosure information is available only a small set of investors that have major advantage Goal to provide all investors with aqual access to information Regulatory Response to Financial Scandals 2001 – 2002 Sarbanes-Oxley Act The limited financial disclosure by firms is a major reason why there is much uncertainty surrounding their valuations
- 56. Global Financial Markets Improve of international transfer of funds between surplus and deficit units Some countries have had financial market form a long time but there are also new market of transitive economies – emerging markets Slow develop of financial markets in developing countries Lack of information Low confidence in markets Rare of prosecution Low efficiency of fund channeling
- 57. Perfect market E. Fama 1970’s Characteristic of perfect markets All information about any securities are available You can buy any size of security No existence of transactional costs → financial intermediaries are not necessary Markets are imperfect Information are not perfectly and freely available Surplus unit are not able to identify creditworthiness of borrowers Individual contracts are expensive
- 58. Direct and Indirect Financing
- 59. Role of Financial Institutions Financial institutions Depositary Institutions Non-depository Financial Institutions
- 60. Why are financial intermediaries and indirect finance so important? Transaction Costs Transaction costs, the time and money spent in carrying out financial transactions, are a major problem for people who have excess funds to lend. Financial intermediaries can substantially reduce transaction costs because they have developed expertise in lowering them, and because their large size allow them to take advantage of economies of scale. For example A bank knows how to find a good lawyer to produce loan contract, and this contract can be used over and over again in this loan transactions, thus lowering the legal cost per transaction.
- 61. Why are financial intermediaries and indirect finance so important? Risk Sharing Another benefit made possible by the low transaction costs of financial institutions is that they can help reduce the exposure of investors risk. Financial intermediaries do this through the process known as risk sharing. They create and sell assets with risk characteristics that people are comfortable with. The intermediaries then use the funds they acquire by selling these assets to purchase other assets that may have far more risk. Asset transformation
- 62. Depository Insitutions Accept deposit → provide credit → purchase securities Offer deposit account Repackage funds to provide loans Accept risk Expertise available Diversification
- 63. Commercial Banks $5 Trillion Total Assets Savings Institutions $1.3 Trillion Total Assets Credit Unions $.5 Trillion Total Assets Types of Depository Financial Institutions
- 64. Pension Funds Types of Nondepository Financial Institutions Securities Firms Mutual Funds Financial Companies Insurance Companies
- 65. Nondepository Financial Institutions Focused on capital market Longer-term, higher risk intermediation Less focus on liquidity Less regulation Greater focus on equity investments
- 66. Comparison of Role among Financial Institutions Source: Madura, J.: Financial Markets and Institutions, 9th Edition
- 67. Summary of Institutional Sources and Uses of Funds Source: Madura, J.: Financial Markets and Institutions, 9th Edition
- 68. Consolidation of Financial Institutions Rapid growth of mutual funds and pension funds Increased consolidation of financial institutions via mergers Increased competition between financial Institutions Growth of financial conglomerates
- 69. Typical Structure of a Financial Conglomerate Source: Madura, J.: Financial Markets and Institutions, 9th Edition