Capital Markets Chap 1

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Capital Markets

EXECUTIVE MBA

Winter Semester 09


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Introduction

Chapter 1

Lecture 1


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Chapter 1Introduction

Learning Objectives

What a Financial Asset is The distinction between Debt & an Equity

instrument The general purpose for determining the price

of an Asset Properties of Financial Assets Principle Economic Functions of Financial

Assets What a Financial Market is & its principle

Economic Functions Different ways to classify Financial Markets What is meant by Derivative Instruments Globalization of financial Markets


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Financial Assets


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Financial Assets An Asset is any possession that has value in

exchange.

Assets can be classified as tangibles orintangibles.

Tangible Assets is one whose value depends onparticular physical properties.

Intangible Asset represents legal claim to

some future benefit. For Financial Instruments, the typical Future

benefit is a claim to future cash.

Issuer Vs Investor


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Debt Vs Equity Claims


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Debt Vs Equity Claims In case of Debt instruments, the claim that the

holder has is a fixed dollar amount.

An Equity claim (Residual Claim) obligates theissuer of the Financial Asset to pay the holderan amount based on earnings, if any, afterholders of debt instruments have been paid.

Hybrid Financial Assets


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The Value of a Financial

Asset Valuation is the process of determining the fair

value or price of Financial Asset The fundamental Principle of valuation is that

the value of any financial Asset is the PresentValue of the cash flow expected

The type of financial Asset, weather debtinstrument or an equity instrument, and thecharacteristics of the issuer determines the

degree of certainty of cash flows expected. Inflation Effect The appropriate interest rate for discounting

the cash flows


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Summary of the process for

valuing a financial Asset Estimate The Cash flow

(Cash flow = interest, principle, dividends, expectedsale price of stock)

Determine the appropriate interest rate for discounting

Minimum interest rate on U.S Treasury Securities

Plus Premium required for perceived risk

Value of Financial Asset = Present Value of ExpectedCash flows


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The role of Financial

Assets The first is to transfer funds from those who

have surplus funds to those who need funds to

invest in tangible Assets. The second function is transferring funds in

such a way as to redistribute the unavoidablerisk associated with the cash flow generatedby tangible Assets among those seeking &

those providing for funds


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Properties of Financial

Assets Moneyness

Divisibility

Reversibility Term to maturity

Liquidity

Convertibility

Currency Cash flow & return predictability

Complexity

Tax status


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Assets Moneyness

Some financial Assets are used as medium of exchangeor in settlement of transactions

DivisibilityRelates to the minimum size at which at which afinancial Asset can be liquidated and exchanged formoney

Reversibility(round-trip cost) Depends on Price volatility & liquidity

Term to maturityThe term to maturity is the length of the interval untilthe date when the instrument is scheduled to make itsfinal payment.

LiquidityLiquidity depends not only on the financial asset but

also on the quantity one wishes to buy & sell.


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Assets Convertibility

An important property of some financial Assets is thatthey are convertible into other financial Assets

CurrencyMost financial Assets are denominated in one currencybut there are dual-currency securities as well.

Cash flow & return predictabilityThe return that an investor will realize by holding afinancial asset depends on a cash flow that is expected

to be received.

Complexity(Convertible Bonds, callable Bonds, Putable Bonds)

Tax StatusGovernmental codes for taxing the income form theownership or sale of financial Assets vary widely.


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Financial Markets


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Financial Markets A financial Market is a market where Financial

Assets are exchanged.


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Role of Financial Markets Price Discovery Process

Liquidity

Reduction of search & information costs


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Role of Financial Markets Price Discovery Process

Interaction of buyers & sellers in a financial Marketdetermines the price of the traded asset

LiquidityFinancial Markets provide a mechanism for an investorto sell financial Asset

Reduction of search & information costsSearch Costs include explicit (advertisement costs) &implicit costs (opportunity costs).

Information Costs are those entailed with assesing theamount & the likelihood of the cash flow expected to begenerated


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Classification of Financial

Markets Type of Claim

(Debt market, Stock Market)

Maturity of Claim(Money Market, Capital Market)

New or Seasoned Issue

(Primary Market, Secondary Market)


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Derivative Instruments


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Derivative Instruments Some Contracts give the contract holder either

the obligation or the choice to buy or sell afinancial asset.

Such contracts derive their value from theprice of the underlying financial asset.Consequently, these contracts are calledDerivative Instruments.

The array of Derivative Instruments includeOptions Contracts, Future Contracts & ForwardContracts.


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Globalization of Financial

Markets Globalization means the integration of

Financial Markets throughout the world into an

international Financial Market.


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Thank you for your Time &Patience

Capital Markets Chap 1

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