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Chapter Nine
The Capital Markets
Slide 9–3
Capital Markets
The market for securities with an original maturity greater than one year
Firms & investors use the capital markets for long-term investments Firms typically try to match the term of financing with the expected
economic life of the assets acquired – why? What is the cost of doing this?
Investors expect to earn higher rates of return on long term securities than on money market securities
Best known capital market securities: Stocks and bonds
Slide 9–4
Capital Market Participants
Primary issuers of securities: Federal and local governments
Federal government – fund the national debt Provincial & local governments – to fund large
infrastructure projects Corporations
Acquire funds to invest in new capital equipment The decision to issue debt or equity is the capital structure
decision
Largest purchasers of securities: Households - You and me (often in the form of mutual funds or
pension funds)
Slide 9–5
Capital Market Trading
Primary market Any new sale of securities by a firm is done in
the primary market If it is the first time a firm has issued securities in
the public market, is referred to as an IPO (Initial Public Offer)
Secondary market After securities have been sold by a firm in the
primary market, future transactions between investors occurs in the secondary market
Secondary market trading can occur: Over-the-counter (OTC) On organized exchanges (i.e., TSX)
Slide 9–6
Some Stock Exchange History
Toronto Stock Exchange Established in 1861
Membership cost $5.00 Eighteen securities listed for trading Trading hours limited to daily half-hour sessions
1901 Price of a stock exchange seat now cost $12,000 Trading volume 1,000,000 shares per year 100 companies listed Continuous auction trading introduced
1914 The fear of a financial panic following the declaration of WWI
prompted the TSE to cease operations for three months, beginning July 28, 1914 Trading also halted on the NYSE
Slide 9–7
Some Stock Exchange History
1922 – 1926 Canadian firms issue over $700 million of new securities From 1924 to 1929, annual trading volume rises from 1,000,000 shares
per year to 10,000,000 shares per year 1933
The Great Depression exacts a toll. Over 2,000 investment & brokerage firms fail in the U.S. However, no TSE member firm defaults on obligations to clients
1937 The TSE moves to a new facility at 234 Bay Street, the first building in
Toronto to have air conditioning 1955
The price of a TSE membership was $100,000 and 1 billion shares worth $2.6 billion traded
Slide 9–8
Some Stock Exchange History
1977 The TSE launches the world’s first Computer Assisted Trading System
(CATS). The TSE 300 Composite Index is launched 1980
3.3 Billion shares worth $29.5 Billion are traded, accounting for 80% of all equity trading in Canada
1987 The TSE 35 Index is created Annual trading value exceeds $100 Billion
1996 The TSE is the first exchange in North America to introduce decimal
trading All US exchanges forced to adopt decimal trading my April 9, 2001
Slide 9–9
Some Stock Exchange History
1997 The TSE is the largest stock exchange in North America to introduce a
floorless, electronic trading environment. The trading floor is closed.
1999 Barbara Stymiest named President & CEO, the first female head of a
North American exchange The TSE becomes the sole exchange for the trading of senior equities Vancouver Stock Exchange and Alberta Stock Exchange merge to
form Canadian Venture Exchange (CDNX) for trading in junior equities
The Canadian Dealing Network, Winnipeg Stock Exchange and the equities portion of the Montreal Stock Exchange later merge with CDNX
Slide 9–10
Some Stock Exchange History
2000 The TSE becomes a for-profit company on April 3, 2000 Daily trading value tops $15 Billion in May, 2000
2001 TSE acquires the Canadian Venture Exchange. CDNX renamed TSX
Venture Exchange
2002 The TSE 300 Composite Index renamed S&P/TSX Composite Index
May 1, 2002 Iceberg Orders introduced (allows a large order to be broken into many
small orders to hide trading information and prevent moving market prices)
TSX does an IPO
Slide 9–11
Some Stock Exchange History
2003 First quarterly dividend of $0.15 paid
2005 TSX splits stock 2:1 Dividend is increased to $0.25 per share (post split) Launches S&P/TSX Canadian Bond Index Annual trading value more than $1 Trillion, up 29% from
2004 Income Trusts added to the S&P/TSX Composite Index.
Slide 9–12
Rankings of Exchanges by Market Capitalization1- New York Stock Exchange2- Tokyo Stock Exchange3- NASDAQ4- London Stock Exchange5- Euronext 6- Toronto Stock Exchange7- Frankfurt Stock Exchange (Deutsche Börse) 8- Madrid Stock Exchange (BME Spanish Exchanges) 9- Hong Kong Stock Exchange 10-SWX Swiss Exchange
Source: World Federation of Exchanges, as of September 2005.
Slide 9–13
Total Value of Shares Traded, 2004
0.0
2,000,000.0
4,000,000.0
6,000,000.0
8,000,000.0
10,000,000.0
12,000,000.0
14,000,000.0
Amer
ican
SE
Berm
uda S
E
Bueno
s Aire
s SE
Colombia
SE
Lima
SE
Mex
ican
Excha
nge
Nasdaq
NYSE
Santia
go S
E
Sao P
aulo
SE
TSX Gro
up
US
D M
illi
on
s
Source: World Federation of Exchanges Website http://www.world-exchanges.org/WFE/home.Asp
Slide 9–14
Average Daily Trading Value, 2004
Average Daily Turnover (USD Millions)
0.0
10,000.0
20,000.030,000.0
40,000.0
50,000.0
Amer
ican
SE
Berm
uda S
E
Bueno
s Aire
s SE
Colombia
SE
Lima
SE
Mex
ican
Excha
nge
Nasdaq
NYSE
Santia
go S
E
Sao P
aulo
SE
TSX Gro
up
Source: World Federation of Exchanges Website http://www.world-exchanges.org/WFE/home.Asp
Slide 9–15
Average Value of a Trade, 2004
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Amer
ican
SE
Berm
uda S
E
Bueno
s Aire
s SE
Colombia
SE
Lima
SE
Mex
ican
Excha
nge
Nasdaq
NYSE
Santia
go S
E
Sao P
aulo
SE
TSX Gro
up
US
D T
ho
usa
nd
s
Source: World Federation of Exchanges Website http://www.world-exchanges.org/WFE/home.Asp
Slide 9–16
Benefits of Going Public
Access to capital – expand investor base Facilitates growth – use shares as currency Maintain control Enhance reputation – provides greater transparency Create a market for existing shareholders Reward for managers & employees
Slide 9–17
Three Ways to List On the TSX Venture Exchange
Initial Public Offer (IPO) Capital Pool Company (CPC)
In stage one, a shell corporation is created whose business it is to locate a promising asset. Funds are raised for the search and due diligence process.
In stage two, the actual asset is acquired. Known as a Qualifying Transaction.
Reverse Takeover (RTO) A private company “buys” a listed company that has no
substantial business activity
Slide 9–18
What it Costs to Go Public on the TSX Venture Exchange
Cost Initial Public Offer
Capital Pool Company
Reverse Takeover
TSX Venture Fees
$7,500 – 30,000 $12,500 – 40,000 $7,500 – 30,000
Securities Commission Fees
$1,000 – 10,000 $1,000 – 3,000 N/A
Sponsor Fees $30,000 – 50,000 $20,000 – 50,000 $30,000 – 50,000
Legal Fees $75,000 + $75,000 + $100,000 +
Accounting & Auding Fees
$25,000 – 50,000 $25,000 – 50,000 $25,000 – 50,000
Source: TSX Website, “Your Guide to Public Venture Capital”
Slide 9–19
Costs Not Included on the Previous Page
Valuation reports Geological or engineering reports Expert reports Investment dealer fees & commissions on financings Printing costs Transfer agency costs Investor relations fees
Slide 9–20
Want to be listed on the TSX?
You will need:
1. At least 300 investors
2. A minimum of 1 million shares traded publicly, with a market value of $4 million
3. Any shareholder with more than 10% of the stock must provide information on their experience in business
4. A Participating Organization of the TSX must sponsor the company
Slide 9–21
Want to be listed on the NYSE?
You will need at least:
1. 2000 stockholders, each owning at least 100 shares
2. A minimum of 1.1 million shares traded publicly
3. Pretax earnings of $2.5 million at the time of listing
4. $2 million in pretax earning in each of the two prior years
5. A total of $100 million in market value of publicly traded shares
Slide 9–22
Number of Listed Companies Yearly Comparison with NYSE, AMEX, Nasdaq and TSX
Slide 9–23
Canada Bonds
Slide 9–24
Canada Bonds
Issued as Bearer Bonds Registered Bonds
No default risk Very low interest rates
Long bonds yields usually higher than short bond yields due to greater interest rate risk
Canada Savings Bonds Redeemable at face value at any time
Canada Premium Bonds Redeemable at face value yearly on anniversary date
Slide 9–25
Real Return Bonds
First issued in Canada in 1991 Provide a hedge against inflation Issued with a fixed coupon Face value of the bond is grossed up by the change in
the CPI Coupon rate paid on the grossed up face value At maturity, bonds are redeemed at the greater of face
value or grossed-up value
Slide 9–26
Canada STRIPS
STRIPS – separate trading of registered interest and principal securities
Investment dealer strips the coupons from the face value. Each cash flow sold as a separate investment.
Issued in book entry form (no paper security is issued)
Collateralized by the underlying Canada bond and thus have no default risk
Slide 9–27
Figure 2: Interest Rate on Long-Term Canada Bonds and the Inflation Rate, 1976–2001
Canada Bond Interest Rates
Slide 9–28
Compare Long-Term Canada Bonds to 90-Day Treasury Bills
Slide 9–29
Municipal Bonds
1. Issued by local governments
2. Used to finance public interest projects
3. Municipal bonds in the United States are tax-free. To compare a tax-free municipal interest rate with a fully taxable interest rate:
Muni = taxable interest rate (1 marginal tax rate)
4. Two types General obligation bonds – no specific collateral Revenue bonds – backed by cash flows of a specific asset
5. NOT default-free
Slide 9–30
Corporate Bonds
Sold in increments of $1000
Pay interest semi-annually
Can be redeemed anytime the issuer wishes (Call feature)
Degree of risk varies with each bond
Interest rate varies with level of risk
Slide 9–31
Corporate Bond Interest Rates
Slide 9–32
Characteristics of Corporate Bonds
Today, usually sold in registered form. Issuers must report holders of bonds to CRA (Canada Revenue Agency)
Bond Indenture – contract between the issuer and the bond investors. Usually contains restrictive covenants designed to control the actions of management
Call Provisions Higher yield – investors don’t like the call feature Sinking fund – a portion of bond redeemed each year
Conversion into common
Value of the convertible the higher of the bond value or the conversion value
Slide 9–33
Types of Corporate Bonds Secured Bonds
Mortgage bonds – secured against real estate Equipment trust certificates – secured against other assets
Unsecured Bonds Debentures Subordinated debentures
Variable-rate bonds Yield tied to some other market rate
Junk Bonds Michael Milken, Drexel Burnham Lambert discovers an under-serviced
niche in high yield bonds (fallen angels) Milken’s personal income from 1983-1987 > $1 Billion Later fined for insider trading & went to jail for 3 years Drexel files for bankruptcy in 1990 due to losses on junk bond portfolio
Slide 9–34
Debt Ratings
Slide 9–35
Stock
1. Represents ownership in a firm
2. Earn a return in two ways Price of the stock rises
over time Dividends are paid to the
stockholder
3. Stockholders have claim on all assets
4. Right to vote for directors and on certain issues
5. Two types Common stock
Right to vote Receive dividends
Preferred stock Receive a fixed dividend Do not usually vote
Slide 9–36
S&P/TSX Composite
Slide 9–37
30 Stocks in the Dow Jones Industrial Average
Slide 9–38
Dow Jones Industrial Average, 1990-2002
Slide 9–39
Stock Market Indexes
Slide 9–40
Public Issues of Stocks and Bonds
Two principal ways to sell securities to the public Investment bankers Private placement
