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1. Introduction to the Capital Markets
1. What are the capital markets? The capital markets are where securities with a life of ____ are traded(Critical Concept). See Capital vs Money Markets (60.0K) The primary participants in the capital markets are the U.S. Treasury as well as U.S.-sponsored government agencies. The markets consist of organized exchanges and over-the-counter markets. The capital markets are said to be efficient when prices adjust rapidly to new information. Legislation targeted at the capital markets are intended to protect investors from ____ and ____(Critical Concept). The U.S. government, governmental agencies and state and local governments all compete with one another and with corporations for the limited supply of capital in the market.
2. International capital markets. The international capital markets are rapidly increasing in importance. Events that have led to their increasing importance are the fall of the Iron Curtain in the early 1990s; the NAFTA trade agreement between the U.S., Canada, and Mexico; expanding growth in the Pacific Rim countries and the establishment of the European Monetary Union. The new European Central Bank is in charge of monetary policy in Europe and, by 2002, the euro will be the only official currency of European countries in the Euro-zone. Other countries invest more in the U.S. than the U.S. invests in them. Most of the international investment in the U.S. has gone to investment in ____(Critical Concept). A large percentage has also gone to investment in U.S. corporations. See Slide 3 (45.0K)
2. Competition for Funds in the U.S. Capital Markets
1. Government Securities. When the U.S. Treasury needs money to operate, it can sell Treasury securities to finance the shortfall. Over the past few years, our Treasury has had a surplus of funds and has actually been repurchasing outstanding debt. In this case, money in the capital markets is freed up for other sectors of the economy. Federally sponsored agencies, such as the Federal Housing Administration (FHA), also issue securities that aren't directly backed by the U.S. Treasury but they still have a very low default rate. When state and local governments need money, they issue municipal securities that are tax-exempt. See Slide 2 (47.0K) Click on this website for a good tutorial on U.S. Treasury securities.
2. Corporate Securities. In reality, corporations use more bond (debt) financing than they do stock financing. As a result, the market for corporate bonds is actually larger than the stock market. Debt financing is usually cheaper for a firm though it does carry some financial risk.
3. Preferred Stock. Companies who have issued all the corporate debt that they can sometimes issue preferred stock before the sell new issues of common stock. Take a look at this website on preferred stock.
4. Common Stock. Companies seeking new capital for investors issue common stock. Common stock is sold either as a new issue in an initial public offering (IPO) or as a secondary offering. Corporate Securities (57.0K)
5. Retained Earnings and Depreciation. Companies also use retained earnings to finance their operations. About 40% of all corporate capital consists of retained earnings plus depreciation. See Slide 2 (47.0K)
3. Sources of Funds in the Capital Markets
1. The Three-Sector Economy. The U.S. economy is composed of three sectors. Two of these sectors, business and government, are the major users of funds. The third sector, households, is a major supplier of funds. As households receive their paychecks from their employment with businesses and governmental agencies, they save and invest part of it through financial intermediaries. In turn, this money is loaned out to businesses and government to finance their operations. See Slide 4 (45.0K)
2. The Security Markets and the Economy. Through financial intermediaries, the security markets exists to aid in the allocation of capital between the three sectors of the economy. Sources of funds for the economy can be analyzed by viewing Slide 6 (45.0K)
4. The Security Markets
1. Organized Exchanges. Organized exchanges have an actual physical place in which securities are traded. The national exchanges are the New York Stock Exchange, the American Stock Exchange and the NASDAQ. There are also five smaller, but significant, regional exchanges with the Chicago Exchange being the largest of the regionals. The Intermarket Trading System (ITS) is an electronic communication network which links the national and regional markets. The website for the NASDAQ contains a lot of interesting information.
2. The New York Stock Exchange. This NYSE is the largest of all the global exchanges. There is a tremendous amount of liquidity for buyers and sellers due to the number of large companies that trade on the exchange. To be traded on the NYSE, a firm must apply and be approved. There is a listing fee and a stringent set of requirements in order to be listed. Down through history, share prices on the NYSE have been quoted in fractions. The Securities and Exchange Commission has mandated the use of decimals and decimalization is in the process of being phased in. See Slide Organized Stock Exchange (72.0K) . Brokers represent buyers and sellers on the floor of the organized exchanges. Take a look at the website for the NYSE .
3. Over-the-Counter Market. There are many diverse companies trading in the over-the-counter market ranging from very small to very large. See Slide Over-the-Counter Market (59.0K) . Dealers represent buyers and sellers in the OTC market instead of brokers. They actually own the securities they sell rather than act as agents as do the brokers in the organized exchanges. Electronic Communication Networks. Electronic Communication Networks are electronic trading systems that automatically match buy and sell orders at specified prices. They allow securities to be traded after-hours. The largest ECN is Instinet . They trade more in NASDAQ stocks than in NYSE stocks.
4. Are the securities markets efficient? Markets are said to be efficient if stock prices adjust rapidly to new information. The Efficient Markets Hypothesis is stated in three forms. Markets are said to be weak-form efficient if prices reflect historical information. They are semi-strong form efficient if prices reflect public information and strong-form efficient if prices reflect both public and private information. Most financial research indicates, at a minimum, weak form efficiency and some suggests semi-strong form efficiency. This simply means that you can't use publicly available information to make abnormal profits.
5. Market Regulation
1. Regulatory Bodies. The Securities and Exchange Commission (SEC) regulates the organized exchanges. The National Association of Securities Dealers regulates the OTC market. See Regulation of Security the Market (57.0K) The SEC website contains interesting information.
2. Governing Laws. Three major pieces of legislation cover the securities market. They are the Securities Act of 1933, the Securities Exchange Act of 1934 and the Securities Acts Amendments of 1975. The Securities Act of 1933 was enacted after the market crash of 1929. It provided for full disclosure of information to investors whenever a company went public. The Securities Exchange Act of 1934 created the Securities and Exchange Commission as the regulator for the organized exchanges. The Amendments of 1975 gave the SEC the power to supervise the development of a national securities market.