Topic 1 Pentru Studenti

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Topic 1. Capital market element of the financial market

1.1 . Concept and structure of the financial market1.2 . Functions and structure of the capital market1.3 . Supply and demand on the capital market1.4 . Securities instrument of the capital market

Bibliography

Legea cu privire la piaa valorilor mobiliare, nr. 199-XIV din 18.11.98, Republicat:Monitorul Oficial nr.183-185/655 din 10.10.2008

Anghelache, G. Piee de capital i burse de valori. Bucureti: Editura Adevrul,

1992. - P. 75-120.

Ciobanu, Gh. Bursele de Valori i tranzaciile la burs. Bucureti: EdituraEconomica, 1997. P.127- 135.

Dragoescu, E.; Dragoescu, A. Piee financiare primare i secundare i operaiuni deburs. - Cluj-Napoca: Editura Humanitas, 1994. P. 19-42.

Madura, J. Financial Markets and Institutions. - USA: Florida Atlantic University,West Publishing Company, 1995. PP. 47-65, 249-273

Mishkin Frederic S. The Economics of Money, Banking and Financial Markets. USA: Columbia University, Addison Wesley Publisher, 2002. - PP. 175-197, 199-219.

, .. . . - : ,2002. C. 33-37, 57-72.

. . : -, 2000. C. 433-501 .

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1.1. Concept and structure of the financial marketAny national economy, regardless of its level of development, is characterized by

the existence and operation of specialized markets, where they meet and set, a free orcontrolled, supply and demand for financial assets, needed for creating resources forincreasing production of goods and services within firms. In financial economics financialassets circuit occurs between bidders set of funds (investors) and set their users to achieve

the only goal: satisfying economic needs, which should be completed with profit.Investors are those who made investments by placing funds for their recovery, and usersare those who mobilize funds to finance their own economic activity. Meanwhile, arelationship arises feedback from initial users of funds to investors by distributing profitsmade from development of financial resources. In a market economy, profit sharing mayhowever be substituted at any risk distribution if unprofitable use of the funds weretransferred. Transactions between the two categories of participants in the financial floware achieved through financial markets.

Financial market is an institution or arrangement to finance the purchase or sale of

goods and services which are called financial assets.The asset is any form of property that is priced (value), achievable through market

exchange. In the nature of the recovery process assets are of two types: real and financial.Real assets consist of tangible assets (tangible assets - land, buildings, supplies of

equipment, stocks of materials, products, etc.), intangible property (intangible assets -patents, trade marks etc.. ) which entered the economic circuit, generate future revenues asprofits, rents, etc..

Financial assets are embodied in the documents (securities or into the account),which establishes (determine) the holder of the entitlements and rights of its futurerevenues from the exploitation of those assets as interest and dividends. Financial assetsaccording to a particular institution (ex. banks) which facilitates recovery by users aregrouped in banking and non banking assets.

Banking assets resulting from banks and similar institutions operations and itscharacterized by lack of trade, future income as interest and high level of safety (low risk).

Non-bank financial assets are derived from investment operations and itscharacterized by marketability, future income as interest, dividends and low safety (highrisk).

Market generally means the place or all means of communication that allows sellersand buyers to inform each other about the nature of existing assets (real, financial) and

prices required or offered for concluding a transaction. From the definition, the firstelement is identifying the nature of asset market.

In economics, a financial market is a mechanism that allows people to easily buyand sell (trade) financial securities (such as stocks and bonds), commodities (such as

precious metals or agricultural goods), and otherfungible items of value at low transactioncosts and at prices that reflect the efficient market hypothesis.

Financial markets have evolved significantly over several hundred years and areundergoing constant innovation to improve liquidity.

Both general markets (where many commodities are traded) and specialized markets

(where only one commodity is traded) exist. Markets work by placing many interestedbuyers and sellers in one "place", thus making it easier for them to find each other. Aneconomy which relies primarily on interactions between buyers and sellers to allocate

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resources is known as a market economy in contrast either to a command economy or to anon-market economy such as a gift economy.

In finance, financial markets facilitate--

The raising ofcapital (in the capital markets);

The transfer ofrisk(in the derivatives markets);

International trade (in the currency markets)

--and are used to match those who wantcapital to those who have it.

DEFINITIONThe term financial markets can be a cause of much confusion.Financial markets could mean:1. organizations that facilitate the trade in financial securities. i.e. Stock exchanges

facilitate the trade in stocks, bonds and warrants.2. the coming together of buyers and sellers to trade financial securities. i.e.stocks

and shares are traded between buyers and sellers in a number of ways including: the use

of stock exchanges; directly between buyers and sellers etc.Def . Financial market includes all relations involving the issuance, circulation,

exchange and storage of money, made directly through its special instruments to support

economic and social activity throughout the capital needed for the operation anddevelopment of production of goods and services or financial market is the mechanism bywhich assets are issued and placed in the economic cycle.

Def . Financial market is the place or all means of communication which facilitatethe sale and purchase of non-bank financial asset at the prices formed on the basis ofdemand-supply and the influence of economic, financial, monetary, psychological and

techniques factors.Specialized literature defines financial market as:

The place where capital owners (for various periods of time) meet people who needsuch capital to perform different activities, for commercial, private or publicpurposes;

Place where capital supply meets capital demand;The entirety of relations and mechanisms through which the disposable and

dispersed capital of the economy are offered to entities soliciting funds;An organized market of capital transfers from those who have a surplus of capital to

these who need capital.

In terms of assets is negotiated and the mechanism by which they are placed in theeconomic cycle, financial market consists of three major sectors, set up as separatemarkets:

1. Banking market.2. Money Market3. Capital market

Piaa financiar3
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Piaa bancar Piaa de capital Piaa monetar

Investitori Piaa secundar Piaa primar Beneficiari

Figura 1.1.1. Structura pieei financiare

According to the anglo-saxon classification, depending on the period of mobilizationof capital,financial marketis divided in:

money market;capital market.According to theEuropean classification capital market is divided in:

Financial marketMoney marketmortgage market.According to the type of the traded assets and mechanisms they are introduced in the

economic circuit, the financial market is divided in:

Capital markets which consist of:

o Stock markets, which provide financing through the issuance of shares or

common stock, and enable the subsequent trading thereof.o Bond markets, which provide financing through the issuance of Bonds, and

enable the subsequent trading thereof. Commodity markets, which facilitate the trading of commodities. Money markets, which provide short term debt financing and investment. Derivatives markets, which provide instruments for the management of

financial risk.o Futures markets, which provide standardized forward contracts for trading

products at some future date; see also forward market. Insurance markets, which facilitate the redistribution of various risks. Foreign exchange markets, which facilitate the trading offoreign exchange.

1.2. FUNCTIONS AND STRUCTURE OF THE CAPITAL MARKET

According to the criteria of importance in an economys market system, the functions of

the capital market are classified into:

Main functions:- attraction of populations savings

- participation of physical persons and legal entities in the share capital of the jointstock companies- facilitating the meeting of capital demand and supply is a specific function for the

notion of market4
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- reorientation and reorganization of national economy sectors- barometer of national and world economies

Auxiliary functions:- facilitation of investment- reduction of financial investments risk- gain of profits on the invested capital from the evolution of financial assets prices

The capital market is the market forsecurities, where companies and governmentscan raise long-term funds. The capital market includes the stock market and the bondmarket. Financial regulators, such as the U.S. Securities and Exchange Commission,oversee the capital markets in their designated countries to ensure that investors are

protected against fraud. The capital markets consist of the primary market, where newissues are distributed to investors, and the secondary market, where existing securities aretraded.

The primary is that part of the capital markets that deals with the issuance of new

securities. Companies, governments or public sector institutions can obtain fundingthrough the sale of a new stock or bond issue. This is typically done through a syndicate ofsecurities dealers.

Features of primary markets are:

This is the market for new long term capital. The primary market is the marketwhere the securities are sold for the first time. Therefore it is also called New Issue Market(NIM). In a primary issue, the securities are issued by the company directly to investors. The company receives the money and issues new security certificates to the

investors. Primary issues are used by companies for the purpose of setting up new business or

for expanding or modernizing the existing business. The primary market performs the crucial function of facilitating capital formation in

the economy. The new issue market does not include certain other sources of new long term

external finance, such as loans from financial institutions. Borrowers in the new issuemarket may be raising capital for converting private capital into public capital; this isknown as going public.

The secondary market is the financial market for trading of securities that have

already been issued in an initial private or public offering. Alternatively, secondarymarketcan refer to the market for any kind of used goods. The market that exists in a newsecurity just after the new issue, is often referred to as the aftermarket. Once a newlyissued stockis listed on a stock exchange, investors and speculators can easily trade on theexchange, as market makers provide bids and offers in the new stock.

In the secondary market, securities are sold by and transferred from one investororspeculatorto another. It is therefore important that the secondary market be highly liquid(originally, the only way to create this liquidity was for investors and speculators to meetat a fixed place regularly; this is how stock exchanges originated).

Secondary marketing is vital to an efficient and modern capital market.Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e., theinvestor's desire not to tie up his or her money for a long period of time, in case the

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investor needs it to deal with unforeseen circumstances) with the capital user's preferenceto be able to use the capital for an extended period of time. For example, a traditional loanallows the borrower to pay back the loan, with interest, over a certain period. For thelength of that period of time, the bulk of the lender's investment is inaccessible to thelender, even in cases of emergencies. Likewise, in an emergency, a partner in a traditional

partnership is only able to access his or her original investment if he or she finds another

investor willing to buy out his or her interest in the partnership. With a securitized loan orequity interest (such as bonds) or tradable stocks, the investor can sell, relatively easily,his or her interest in the investment, particularly if the loan or ownership equity has been

broken into relatively small parts. This selling and buying of small parts of a larger loan orownership interest in a venture is called secondary market trading.

Under traditional lending and partnership arrangements, investors may be less likelyto put their money into long-term investments, and more likely to charge a higher interestrate (or demand a greater share of the profits) if they do. With secondary markets,

however, investors know that they can recoup some of their investment quickly, if their

own circumstances change.

The multitude of the types of traded assets on the capital market, the differentorganization of these markets and diversity of mechanisms of issuance andcommercialization of specific products, brought to market structuring by several criteria.

According to the transaction object (or to the nature of the traded asset):a) Stock market - is the market where common and preferred stocks of

joint stock companies are traded.b) Bond market also called market of debt instruments, is the place

where debt securities of any type (bonds, treasury bonds, etc) are traded.c) Futures market on this market the securities are traded for a future

delivery and payment. The used security is the future contractd) Options market - the market where securities are traded for a future

conditional delivery. The negotiated security is the option contractAccording to the way of financial assets price formation:

a) auction market transactioning is held by a third party, according to theaccumulation in prices on the received orders to bye or sell a certain security;

b) negotiations market the market where purchasers and sellers negotiate betweenthem the price and amount of securities, directly or through a broker/dealer.

According to the moment of completion of transaction:a) spot market (sometimes called cash market or market with cash payments) here

securities are trade with an immediate payment and delivery. immediate isdefined differently on each market and its varies between a day and a week.

b) Fixed-term market the transaction completion, meaning the delivery of securitiesand payment is performed on a future date, fixed in advance.

According to the way of market organization:a) organized stock exchange a market with fixed transaction rules. It functions in an

office with a physical central location where the transactions are generally

performed through auctions.

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b) Over-the-counter a market located in brokers, dealers and securities issuersoffices. Due to the fact that transactions are performed in different transactions thisis a market that uses phone, fax, telex or computer.

According to the duration:a) discontinuous markets the prices formation is generally based on fixing;

b) continuous markets transactions can take place anywhere and at any time.

c) Mixed markets are continuous markets which also host discontinuous transactions.

According to the transactional support:a) free auctions use classical negotiation techniques: verbal and visual

b) auctions through computers use electronic techniques

According to the location of the negotiation ring:a) centralized markets

b) decentralized markets

According to the transaction techniques:a) auctions

b) market makers

According to the market ownership and access of operators:a) private markets most of the markets

b) state markets the markets are considered public institutions, with free access ofoperators.

1.3. SUPPLY AND DEMAND ON THE CAPITAL MARKET

At the issuing entities level, capital demand is generally motivated by two bigcategories of determining factors, which divide it in:

Structural demand, resulted from the need of financing large investments,support of companys development or creation of new businesses, entering newmarkets or in connected domains or new types of activity which imply attractingreimbursable in medium or long terms funds or reimbursable participating in

future profits; Cyclical demand, depending on factors linked to credit limits on money market,

budgetary and payment balances deficits etc, generally resulted from transitoryneeds which imply attraction of supplementary financial resources from mediumand long term.

Demand carriers from altogether the category issuers which implies a veryversatile typology:

Companies borrow money to aid short term or long term cash flows. They alsoborrow to fund modernization or future business expansion.

Governments often find their spending requirements exceed their tax revenues. Tomake up this difference, they need to borrow. Governments also borrow on behalf ofnationalized industries, municipalities, local authorities and other public sector bodies.

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Governments borrow by issuing bonds. Government debt seems to be permanent.Indeed the debt seemingly expands rather than being paid off. One strategy used bygovernments to reduce the value of the debt is to influence inflation.

Municipalities and local authorities may borrow in their own name as well asreceiving funding from national governments. In the UK, this would cover an authoritylike Hampshire County Council.

Public Corporations typically include nationalized industries. These may includethe postal services, railway companies and utility companies.

Many borrowers have difficulty raising money locally. They need to borrowinternationally with the aid ofForeign exchange markets.

Capital supply is provided from the economies of those who have big profits,after they satisfy their consumer need.

These funds can be kept in a liquid form, which is an alternative that does not bringany additional profit, besides that of having those economies immediately and without any

additional costs, or they can be placed directly or indirectly in economic activities, the

money being transformed into financial assets.Many individuals are not aware that they are lenders, but almost everybody does

lend money in many ways. A person lends money when he or she: puts money in a savings account at a bank; contributes to a pension plan; pays premiums to an insurance company; invests in government bonds; or invests in company shares.Companies tend to be borrowers of capital. When companies have surplus cash that

is not needed for a short period of time, they may seek to make money from their cashsurplus by lending it via short term markets called money markets.

There are a few companies that have very strong cash flows. These companies tendto be lenders rather than borrowers. Such companies may decide to return cash to lenders.Alternatively, they may seek to make more money on their cash by lending it (e.g.investing in bonds and stocks.)

Capital demand and supply meeting leads to formation of a new rate or quotation,which is one of the essential forms of distribution of both obtained profits and risksrelated to the stock exchange. A specific peculiarity of the stock exchange implies thatcapital demand and supply meet indirectly on this market through professional

participants.

1.4. Securities instrument of the capital market

Financial instruments are cash, evidence of an ownership interest in an entity, or acontractual right to receive, or deliver, cash or another financial instrument.

A security is a fungible, negotiable instrument representing financial value.

Securities are broadly categorized into debt securities, such as banknotes, bonds anddebentures, and equity securities, e.g. common stocks. The company or other entityissuing the security is called the issuer. What specifically qualifies as a security is

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dependent on the regulatory structure in a country. For example private investment poolsmay have some features of securities, but they may not be registered or regulated as suchif they meet various restrictions.

Securities may be represented by a certificate or, more typically, by an electronicbook entry. Certificates may be bearer, meaning they entitle the holder to rights under thesecurity merely by holding the security, or registered, meaning they entitle the holder to

rights only if he or she appears on a security register maintained by the issuer or anintermediary. They include shares of corporate stock or mutual funds, bonds issued bycorporations or governmental agencies, stock options or other options, limited partnershipunits, and various other formal investment instruments that are negotiable and fungible.

Combining the above methods for categorization, the main instruments can beorganized into a matrix as follows:

Asset Class Instrument Type

Securities Other cash Exchange-

traded

derivatives

OTC derivatives

Debt (Long

Term)

>1 year

Bonds Loans Bond futuresOptions on bond

futures

Interest rate swapsInterest rate caps and

floors

Interest rate optionsExotic instruments

Debt (Short

Term)


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By Type of IssuerIssuers of securities include commercial companies, government agencies, local

authorities and international and supranational organizations (such as the World Bank).Debt securities issued by a government (called government bonds or sovereign bonds)generally carry a lower interest rate than corporate debt issued by commercial companies.Interests in an asset - for example, the flow of royalty payments from intellectual property

- may also be turned into securities.By Type of Holder

Investors in securities may be retail, i.e. members of the public investing other thanby way of business. The greatest part in terms of volume of investment is wholesale, i.e.by financial institutions acting on their own account, or on behalf of clients. Importantinstitutional investors include investment banks, insurance companies,pension funds andother managed funds.

The traditional economic function of the purchase of securities is investment, with

the view to receiving income and/or achieving capital gain. Debt securities generally offer

a higher rate of interest than bank deposits, and equities may offer the prospect of capitalgrowth. Equity investment may also offer control of the business of the issuer. Debtholdings may also offer some measure of control to the investor if the company is afledgling start-up or an old giant undergoing 'restructuring'. In these cases, if interest

payments are missed, the creditors may take control of the company and liquidate it torecover some of their investment.

The last decade has seen an enormous growth in the use of securities as collateral.Purchasing securities with borrowed money secured by other securities is called "buyingon margin." Where A is owed a debt or other obligation by B, A may require B to deliver

property rights in securities to A. These property rights enable A to satisfy its claims in theevent that B becomes insolvent. Collateral arrangements are divided into two broadcategories, namely security interests and outright collateral transfers. Commonly,commercial banks, investment banks and government agencies are significant collateraltakers.

Securities are traditionally divided into debt securities, equities and hybrid.Debt securities may be called debentures, bonds, deposits, notes or commercial

paperdepending on their maturity and certain other characteristics. The holder of a debtsecurity is typically entitled to the payment of principal and interest, together with othercontractual rights under the terms of the issue, such as the right to receive certain

information. Debt securities are generally issued for a fixed term and redeemable by theissuer at the end of that term. Debt securities may be protected by collateral or may beunsecured, and, if they are unsecured, may be contractually "senior" to other unsecureddebt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that isnot senior is "subordinated".

An equity security is a share in the capital stock of a company (typically commonstock, although preferred equity is also a form of capital stock). The holder of an equity isa shareholder, owning a share, or fractional part of the issuer. Unlike debt securities, whichtypically require regular payments (interest) to the holder, equity securities are not entitled

to any payment. In bankruptcy, they share only in the residual interest of the issuer after allobligations have been paid out to creditors. However, equity generally entitles the holderto a pro rata portion of control of the company, meaning that a holder of a majority of the

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http://en.wikipedia.org/wiki/Supranationalhttp://en.wikipedia.org/wiki/World_Bankhttp://en.wikipedia.org/wiki/Government_bondhttp://en.wikipedia.org/wiki/Sovereign_bondhttp://en.wikipedia.org/wiki/Corporate_debthttp://en.wikipedia.org/wiki/Retailhttp://en.wikipedia.org/wiki/Wholesalehttp://en.wikipedia.org/wiki/Institutional_investorshttp://en.wikipedia.org/wiki/Investment_bankhttp://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Pension_fundhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Capital_gainhttp://en.wikipedia.org/wiki/Equity_investmenthttp://en.wikipedia.org/wiki/Buying_on_marginhttp://en.wikipedia.org/wiki/Buying_on_marginhttp://en.wikipedia.org/wiki/Property_righthttp://en.wikipedia.org/wiki/Insolventhttp://en.wikipedia.org/wiki/Debenturehttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Depositshttp://en.wikipedia.org/wiki/Promissory_notehttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Supranationalhttp://en.wikipedia.org/wiki/World_Bankhttp://en.wikipedia.org/wiki/Government_bondhttp://en.wikipedia.org/wiki/Sovereign_bondhttp://en.wikipedia.org/wiki/Corporate_debthttp://en.wikipedia.org/wiki/Retailhttp://en.wikipedia.org/wiki/Wholesalehttp://en.wikipedia.org/wiki/Institutional_investorshttp://en.wikipedia.org/wiki/Investment_bankhttp://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Pension_fundhttp://en.wikipedia.org/wiki/Incomehttp://en.wikipedia.org/wiki/Capital_gainhttp://en.wikipedia.org/wiki/Equity_investmenthttp://en.wikipedia.org/wiki/Buying_on_marginhttp://en.wikipedia.org/wiki/Buying_on_marginhttp://en.wikipedia.org/wiki/Property_righthttp://en.wikipedia.org/wiki/Insolventhttp://en.wikipedia.org/wiki/Debenturehttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Depositshttp://en.wikipedia.org/wiki/Promissory_notehttp://en.wikipedia.org/wiki/Commercial_paperhttp://en.wikipedia.org/wiki/Commercial_paper


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equity is usually entitled to control the issuer. Equity also enjoys the right to profits andcapital gain, whereas holders of debt securities receive only interest and repayment of

principal regardless of how well the issuer performs financially. Furthermore, debtsecurities do not have voting rights outside of bankruptcy. In other words, equity holdersare entitled to the "upside" of the business and to control the business.

Hybrid securities combine some of the characteristics of both debt and equity

securities.

Physical Nature of SecuritiesSecurities that are represented by certificates are called certificated securities. They

may be bearerorregistered.

Bearer securities are completely negotiable and entitle the holder to the rights underthe security (e.g. to payment if it is a debt security, and voting if it is an equity security).They are transferred by delivering the instrument from person to person. In some cases,

transfer is by endorsement, or signing the back of the instrument, and delivery.

In the case ofregistered securities, certificates bearing the name of the holder areissued, but these merely represent the securities. A person does not automatically acquirelegal ownership by having possession of the certificate. Instead, the issuer (or its appointedagent) maintains a register in which details of the holder of the securities are entered andupdated as appropriate. A transfer of registered securities is effected by amending theregister.

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