INTRODUCTION
Capital Markets are markets where long-term instruments are traded e.g. equities, preference shares, debentures etc.
A good example of a Capital Market is the Stock Exchange.
- MAIN FUNCTIONS
The main functions of the Stock Exchange are:
- PRIMARY MARKET – used to raise new finance/issue new securities
- SECONDARY MARKET – trade in second-hand securities. This is where most of the day-to-day activity takes place.
- COMPANY FLOTATION
- SHARE SWAP – securities used as consideration in takeover of other companies
CAPITAL PROVIDERS
The main providers of capital are:
- Pension Funds
- Insurance Companies
- Investment Trusts
- Unit Trusts
- Other Financial Institutions
- Overseas Investors
- Venture Capital Organisations
- Business Expansion Scheme Funds Individuals
- COMPANY FLOTATION
There are many reasons why a company may be floated on the Stock Market (“Going Public”). Chief among these is access to capital.
- Advantages – Shareholders
- Cash for some shares.
- Wider market for remaining shares.
- Shares perceived as less risky.
- Ready share price available.
- Advantages – Company Possibility of new funds.
- Better credit-standing.
- Ability to “swap shares” on a takeover.
- Ability to issue shares more easily at a later date.
- Reduced risk & greater marketability leads to lower cost of capital.
- Extra status.
- Possibility of share options for top employees.
- Disadvantages
- Costs can be quite high.
- Compliance with stringent regulations.
- Dilution of control.
- Additional administration.
- Extra scrutiny of profitability/performance.
- GOING PRIVATE
Some company shareholder(s) take a company from public ownership back to private ownership. This happens when the major shareholder and possibly founder finds compliance with the rules governing public limited companies and reporting to shareholders expensive and time-consuming. Also public ownership also confers a pressure to maintain share price through short-term profits or dividends. Where the major shareholder is also chief executive officer or managing director this can be a disincentive to public ownership.
- EFFICIENT MARKETS
A market is generally regarded as efficient if the following are present:
- Prices immediately reflect all relevant available information
- No individual investor dominates the market Transaction costs are not too high to discourage trading
Are the markets efficient? The Efficient Market Hypothesis (EMH) has been developed to test different levels of efficiency. [Note: Hypothesis is defined as a supposition put forward as a basis for reasoning or investigation.]
The Efficient Market Hypothesis tests three degrees of efficience
- Weak Form Efficiency
Prices reflect the information in past stock prices.
- Semi-strong Form Efficiency
Prices reflect past price information
Plus
All publicly available information.
- Strong Form Efficiency
Prices reflect past price information
Plus
All publicly available information
Plus
Inside information
Most of the research suggests that capital markets are semi-strong-form efficient but not quite strong-form efficient.
