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CAPITAL MARKET COMPONENT

OF FINANCIAL MARKET

Theme 1

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Subjects

1.1. Theoretical approaches to financial marketand capital market

1.1.1. The concept and structure of financialmarket

1.1.2. The concept and structure of capitalmarket1.2. Supply and demand on the capital market1.3. The functions of the capital market

1.4. Types of the capital markets1.5. Securities - instruments of the capitalmarket

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A. Obligatory bibliography Legea Republicii Moldova privind piaa valorilor mobiliare.

Nr.199-XIV din 18 noiembrie 1998. Republicat: MonitorulOficial nr.183-185/655 din 10.10.2008.

Law on securities market

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: Editura Economic, 1997, p.127- 135.

Drgoescu E., Drgoescu A. Piee financiare primare isecundare i operaiuni de burs. Cluj-Napoca: Editura

Humanitas, 1994, p. 19-42. Stancu I. Finane. Bucureti: Editura Economic, 1997, 720p.

Hincu Rodica, Munteanu Nina, Roca Marcelina, IordachiV., Baxan T., Conencov O. Bazelefuncionriipieeide

capital. Manual. ASEM, Chiinu 2012 3

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1.1. Theoretical approaches to

financial market and capital market

1.1.1. The concept and structure offinancial market

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Definitions of financial market financial marketrepresents an institution or arrangement,

which facilitates the purchase or sale of goods and services thatare calledfinancial assets;

financial marketincludes all relations concerning the issue,

circulation, exchange and direct storage of money, directlyperformed through its special instruments, in order to support alleconomic and social activities with capital necessary for thefunctioning and development of goods and servicesproduction

financial marketis the place or the whole set ofcommunication means, which facilitate the sale and purchase ofnon-bank financial assets at prices fixed according to supply anddemand and the influence of economic, financial, monetary,psychological and technical factors.

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From the point of view of negotiated assets

and the mechanism by which they are

introduced into the economic circuit, thefinancial market consists ofthree main

sectors, organized as separate markets:

banking market;

money market;

capital market.

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Banking market

is characterized by transactions with non-

negotiable bank assets with high level of

liquidity. Banks act as intermediaries between

the owners of cash availabilities and users of

funds, in base of credit relations.

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Money market

is characterized by transactions with short-

term financial assets made by financial

companies.

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Capital market

is specialized in transactions with medium and

long-term financial assets.

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Since there can not be made a strict

distinction between the capital market and

financial one, these two markets being

interdependent (by including or

supplementing each other),

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Anglo-Saxon concept, financial market

includes:

capital market

money market

insurance market (In some specialized sources)

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The Continental-European concept,

defines the term ofcapital market through

the assembly consisting of:

money market

financial market mortgage market

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In some specialized sources

there are opinions that the financial market

can be identifiedwith the capital market.

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The plural of "financial markets" suggests that in a

market economy, regardless of its level of

development, there exists a system of financial

markets, as:

the system of financial markets in the United

States of America;

the system of financial markets in Canada;

the system of financial markets in Romania.

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The system of financial markets in the United States

of America consists of two or more markets,

according to the adopted criterion.

The first criterion concerns duration of the placement,resulting in:

money markets for trading short-term debt

instruments;

capital markets that allow negotiation of long-termdebt instruments and ownership instruments.

The second criterion respects the nature of tradedassetthat determines the following types of markets:

the stock market, bond market, goods/commoditymarket, currency market, options market, futuresmarket.

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The system of financial markets in Canada does

not respect a certain criteria and contains:

tangible assets markets and financial assetsmarkets;

spot market and futures markets, includingoptions;

money markets;

capital markets;

mortgage markets;

regional and local markets; primary markets;

secondary markets.

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Synthesizing the approaches of the financial

markets components, there can be concluded

the following:

there does not exist a unique system of

financial markets that is unanimously accepted by

all national economies;

the number of financial markets depends onthe degree of development of a market economy;

although a distinction between real assets and

financial assets exists, the financial market, insome countries, also includes mortgage market

and even the real estate market (Canada).

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The financial market embraces two

approaches:

restrictive approach, limiting negotiations

only with non-bank financial assets;

liberal approach, which extends negotiation

also with real assets.

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In the Republic of Moldova, according to

legislation in force, the securities market

(capital market) is a part of non-banking

financial market.

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1.1.2. The concept and structure

of capital market

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In the specialty literature, there are several

definitions of the capital market, such as:

capital marketrepresents the assembly of relationsand mechanisms by which is realised the transfer offunds from those who have a surplus of capital towardsthose who need it, through specific instruments (issuedsecurities) and specific operators (for example,

professional participants of securities market, includingcompanies for financial investment services, etc.);

capital marketrepresents the place or the whole setof communication means that permit the issuance and

negotiation of securities by intermediaries (authorizedpersons) at a regulated price named face value and,respectively, at a market price set according to supplyand demand.

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The elements of the capital market the place of transaction, formed by the whole set of

communication means among operators (OTC market)or among the operators and an institution called thestock exchange;

subject, comprising securities (synonym for financial

assets);

operators, consisted by intermediaries: legal entities(for example, securities companies in Romania);authorized individuals (for example, agents of financial

investment services and stock brokers); specialists(market-makers);

operations, which, in logical comprehension, form aset of activities, called transactions or investment.

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In some specialized sources, the

capital marketis treated like

"is specialized in performing transactions with

financial assets for medium and long-termmaturities."

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.1.

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The structuration of capital market (as

part of the financial market)

Capital

Market

Primary Segment

Secondary Segment

Capital

supply

Capital

demand

Fig

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Primary (capital) market

serves for placement of issued securities on

the internal capital markets, as well as on the

international capital market to attract

financial capital available on the medium andlong term.

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The secondary market.

represents, the modality how to concentrate

in one place, private or institutional investors

who can buy and sell securities with the

guarantee that they have a value and can bereintroduced at any time in circulation.

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The secondary market provides to

operators the following advantages:

- offers information about the product to be

traded;

- information about the product and issuer isdistributed towards investors;

- offers information about the level and

movement of market price.

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Secondary market objectives are:

- investors protection, achieved through

transparency, regulation and supervision of

the market;

- market liquidity and exchange rate stability.

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Economic agents

Financial

Institutions,

including

banks

Capital

Market

HouseholdsPublic

administration

47

5

6

8

3

1

2

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The primary segment and secondary segment

of capital market are interrelated.

Secondary market can not exist without the

primary one and, also, the functioning of

primary market is conditioned by the ability of

the secondary market to achieve the

transferability of securities and their

conversion into cash.

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1.2. Supply and demand on the

capital market

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Movement of funds in the economy

can occur through:

indirect financing -by concentration of

available funds in banks and use of these

resources for crediting the users of funds;

direct financing -through the issuance of

securities by the users of funds.

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Capital transfers can be achieved in

three different ways:

1. Direct transfers of money and securities whena company-issuer (users of funds) sell shares orbonds directly to investors without recourse tointermediaries.

2.Transfers through a dealer(investment house).Dealer serves as an intermediary and facilitatesthe issuance of securities.

3. Transfers by a financial intermediary(bank,

mutual fund, etc.). The intermediary obtainsfunds by issuing its own securities and then usesmoney to buy securities issued by somecompanies.

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The demand of capital comes from several major categories of

economic agents, such as:

State and local authorities whose main motivation for

applying for funding is financing costs of budgetarydeficit, which appear on market by issuing bonds.

State companies that require the available funds forown investment needs in different sectors of theeconomy.

Private business entities, which are calling on thecapital market both within the process of their creationand during the development of business by issuingshares to finance the equity capital, and bonds to

finance the loan capital. Financial companies, including banks, that useinvestors' funds to finance their assets, and theirprimary role is to facilitate the circulation of capital,thus, ensuring the financial market liquidity.

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Exponents of demand are debtors on financialmarket. They can be grouped as follows:

depending on activity(central and localadministration; public and private companies

without financial profile; commercial banks andother financial institutions; central monetaryinstitutions; etc.)

depending on purpose (industry and municipal

economy funding; transport and public servicesfinancing; banks financing; internationalorganisations financing; etc.).

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From the point of view of capital

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From the point of view of capital

needs, demandmay be structuraland

cyclical. Structural demandis determined by the need to finance some

economic activities in different sectors of activity (to supportbusiness development or creation of new businesses, entries onnew markets or into related branches, etc.) and supposes the

raising of funds, which are repayble either on medium and longterm, or in form of participation in future earnings.

Cyclical demandis the effect of insufficiency or unavailability ofinternal resources, excessive restrictions on credits granting,financial needs generated by the budget deficit and balance of

payments. The demand is disturbed by several factors, such as:price fluctuation, interest rate augmentation, non-reimbursementof credits at maturity.

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Supply of capitalcomes from savings, i.e.

everything that remaines at the holders of

income, after they satisfy their consumption

needs

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Natural persons and legal entities who have

such savings, can make real investments

and/orfinancial investments.

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1.3. The functions of the capital

market

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Conditions imposed to capital market:

liquidity,

efficiency,

transparency,

correctness,

adaptability.

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Liquidity

consists of the existence, on the primary

capital market, of a large volume of available

funds (supply) and of the need for direct

financing (demand). On the secondary capitalmarket the liquidity is ensured, partially, by

the existing liquidity on the primary market,

and by the volume of transactions.

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Efficiency

consists in the operational performance at

lower costs of issues on primary market and

the transactions on secondary market.

Note: This condition influences the degree of

the market liquidity.

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Transparency

consists in a direct and prompt ensuring of

correct information to investors

Note: It determinesthe increase of the supply of funds on the

primary market, of the volume of transactions and efficient

functioning of the capital market.

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Correctness

is based on rigorous regulation of capital flows inthe economy, and of transactions performed onthe market.

Note: This condition eliminates the trends of

market manipulation, reduces the risk oftransactions and ensures the fulfilment of theother four conditions.

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Adaptability

indicates the degree of adaptation of

elements of the capital market to economic

and financial conditions in the country where

they are located, as well as to internationalones.

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The functions of the capital market

main functions

and

auxiliary (secondary) functions.

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h i f i f h i l

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The main functions of the capital

market are:

attracting savings of population;

ensuring the participation of legal entities andnatural persons to companies capital;

facilitating the meeting of the demand andsupply of capital;

reorientation of the capital flows and thereorganization of sectors of national economy;

representing a barometer of national economyand the world economy.

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A i h i f h
http://dictionary.sensagent.com/reorganization/en-en/http://dictionary.sensagent.com/reorganization/en-en/

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Attracting the savings of the

population

is subordinated to the need of funds of the economicagents, financial and banking institutions, state andnatural persons. One of the possibilities to satisfy thisneed is the issue of securities on the primary capital

market and, subsequent, sale of the possessedsecurities on the secondary capital market.

Note: Decision of population to invest the excess ofrevenues on the capital market arises from comparingthe return of this investment with the return on othercapital investments, for example, term deposits in bank

accounts, buying currency etc. 48

Ensuring the participation of legal entities and

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Ensuring the participation of legal entities and

natural persons to share capital of joint stock

companies

is represented by distribution of share capitalin form of stock on the capital market.

Note: Persons who bought these titles becomeshareholders and influence the financial

results of joint stock companies by decisionstaken within the General Meeting ofShareholders and Board of Directors.

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F ili i h i f d d

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Facilitating the meeting of demand

and supply of capital

is a function that explains the use of the market s notion.On primary market, the need of funds (creation, increasingof share capital, recourse to loans) of economic, financial,banking societies, state is met with theavailability of funds(available capital).

The secondary capital market, with its two components:the stock exchange and the OTC, facilitates the meet ofsupply of securities in circulation that is proposed byowners, who want to liquidate the investment, with

demand for securities, required by capital owners whowant to become investors or to gain from evolution ofsecurities prices.

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Reorientation of the capital flows and the reorganization of

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f p f g f

sectors of national economyis achieved, practically, through

the following actions specific to the capital market:

reflection of the performance of securitiesissuers related to price that allows investors toabandon e the financial securities of unprofitableissuers and to make investments in profitable

ones, supplying them with funds; underestimation of new enterprises whose

securities are purchased to the detriment ofothers, supplyiung them with funds and bringing

to real value by increasing the equitys prices (eg,computer companies in the U.S.);

facilitation of purchasing of one company byanother one.

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B t f ti l d l b l

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Barometer of national and global

economy.

This function is suggested by the evolution of

financial securities prices, the adoption of a

specific index - the market index - or an

international index and their evolution. The

trend of the index reflects the trend of the

economy.

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The auxiliary functions of the capital

market

investment facilitation;

risk reduction of financial investments;

gains obtaining as a result of capital

investments from price evolution of financial

securities.

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Facilitating investment

is a corollary of the function for the

restructuring of the sectors of national

economy by transformation of funds kept by

legal entities and natural persons intosecurities issued by companies, which carry

out investment programs.

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Reducing the risk from investment in securities

is a relatively recent function of the capital market. It

is achieved by regulation and performing oftransactions with derivatives securities (futures,options, etc.). These transactions allow to change theposition in such a way, as the purchase or sale ofprimary securities that might generate losses to

investor, to be doubled with the purchase or sale ofderivatives on the same security that, depending onprice evolution, would permit the reduction of the riskof loss.

Note: This function specific to the secondary capitalmarket should be valued withprudence not to causestock exchanges crashes and minicrashes

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Facilitation of gain

is a function that occurs at shorter or longer

intervals. This unique purpose - achievement

of the greatest possible gain - is the result of

arbitrage and speculative transactions.

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1.4. Types of capital markets

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The capital market is divided into several

components.The most used criteria to delimit

the components are:

the nature of the issued and traded

securities;

the territorial organization;

the nature of operations.

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Primary

capital

market

Stock

market

Bond

market

Primary

securities

market

Derivativ

es

securitie

s marketSecondar

ycapital

market

OTC

marketStock

Exchang

e

Futures

market

Options

market

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Depending on the nature of securities

bond market.

stock market

options market.

futures market.

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Depending on the territorial

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Depending on the territorial

organization,

decentralized capital market

national capital market regional capital market

international capital market

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Depending on the nature of

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Depending on the nature of

operations

primary capital market

secondary capital market

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Secondary capital market is divided

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Secondary capital market is divided,

usually, in two markets:

institutional market(stock exchange),

negotiations marketor the counter market(Over-

the-counter - OTC). (This market can be also calledan off-exchange market)

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S d it l k t b l l ifi d

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Secondary capital market can be also classifiedaccording to the following differentiation criteria:

continuity of market;

way of communication;

Location of the negotiations floor

wide property of market and access of operators

(in some sources, the institutional solution chosenfor the establishment and operation of secondarycapital markets);

Way of negotiations;

Moment when contracts are executed.

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C i i f k

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Continuity of market:

intermittent markets

continuous markets

mixed markets

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way of communication for the

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way of communication, for the

conclusion of transaction:

open outcry,

Electronic,

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Location of the negotiations floor:

centralized markets.

decentralized markets

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wide property of market and access of operators (in some

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sources, the institutional solution chosen for the

establishment and operation of secondary capital markets):

private markets(according this principle the

major modern markets operate, of Anglo-Saxon

origin),

State markets. mixed markets

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Way of negotiation:

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Way of negotiation:

auction market

negotiation market

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Moment when contracts are

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Moment when contracts are

executed:

spot market (cash market)

forward market(futures market)

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1.5. Securities instruments of

the capital market

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The main ways for obtaining additional

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The main ways for obtaining additional

capital are the following:

increasing of share capital through stock issue;

contracting a loan through a bond issue;

contracting a bank credit.

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In the case when a public recourse is made inorder to obtain financial resources through theissuance of shares or bonds, the issuercompanies fall within the capital marketand the

products offered to investors (shares, bonds, etc.)are called securities.

Note: In the romanian specialized literature, thefollowing notions are met: valori mobiliare, hrtiide valoare, titluri financiare.

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Financial securities have a certain value Therefore in

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Financial securities have a certain value. Therefore, inGerman literature they are called "wertpapier" -"securities".

Financial securities certify the existence of acontractual (guaranteed) relationships between theissuer and the holder and guarantees the rights for itsowners. Therefore, in the Anglo-Saxon literature, they

are called "securities" ("/guarantees").

Financial securities allow the conversion of certaintransferable securities, in their essence, into securities,

by their nature, (i.e. shares). Therefore, in Frenchliterature, financial securities are called "valeursmobilieres".

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A security is defined, according to Law of

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y , g

Moldova on the securities market, no. 199-XIV

of 18.11.98, as

Securities are financial instruments certifying

the proprietary and related thereto personal

non-proprietary rights of one person with

respect to another which may not be exercisedor delegated without presentation of a

specified document or without having an

appropriate entry in the registry of nominativesecurities holders or in the records of a

nominal holder of the securities.

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A definition of securities generally

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A definition of securities, generally

accepted, is:

Securitiesare negotiable instruments issued

in materialized form or evidenced by entries

into account, which provides to its holdersnon-property and property rights on issuer,

according to law and in conditions specific to

their issue.

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The characteristics of securities: negotiability. Reveals the possibility of

transmission of securities to other persons at a

price set on the demand-supply mechanism,

respecting the imperative prescriptions of the

legislation in force; literalness. Respresents the stipulation of the

rights and obligations of securities holders;

formality. Denotes the property rights (ownership

right, dividend or interest right, preemption right)and non-property rights (i.e. voting).

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Securities are, therefore, documents certifying

the status ofowners and/or creditors and

generate effects for holders in accordance

with market characteristics.

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Financial securities that are traded on the capital

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market can be classified according to theprocedure

of creation, into three categories:

primary;

derivatives;

synthetic.

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i fi i l i i

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Primary financial securities

Primary financial securities are issued by users offunds:

to mobilize their own capital (also known asproprietary instruments, engl. equity instruments,

such as, for example, shares); or to attract the borrowed capital (also are called debt

instruments such as, for example, the bonds).

The role of primary securities is dual:

to ensure the mobilization of long-term capital;

to grant rights on the cash income of the issuer.

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i i i i

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Derivative securities

are stock exchange products arising fromcontracts concluded between the issuer(seller) and recipient (buyer) and which give tothe latter rights over some assets of the issuerat a future maturity, according to conditionsstipulated in the contract.

Derivative securities are of two types: futuresand options.

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S h i d

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Synthetic products

result from the combination, by the financial

corporation, of different financial assets and

creation of a new placement instrument.

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International Standards Organization in ISO

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International Standards Organization in ISO

10962, groups securities in two levels:

1

st

level, by nature of legal relations of rightsand obligations called categories;

2nd level, categories according to specific

rights and obligations called groups.

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Categories of securities in accordance with ISO 10962

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Categories of securities in accordance with ISO 10962

Property

instruments

Financial instruments representing property/ownership

relation and interest in an economic unit or a pool of assets

(eg., Shares)

Debt

instruments

Financial instruments that show the money owed by the

issuer to the holder, under specified conditions (eg., Bonds)

Rights Financial instruments that give to the holder the

right/privilege to subscribe or to receive specific assets under

specified conditions

Options Contracts that guarantee to the holder the right to buy or

sell a specific asset at a specified price on or before a fixed

time in the future

Futures Contracts that require the buyer to pay and the seller to

deliver the specific assets at a predetermined price at a fixed

date in the future

Other Financial instruments not falling within the categories

specified above84

On the 2nd level, those 6 categories are detailed on groups of

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securities.

For example, the category of property instruments is divided

into 5 groups:

ordinary shares;

preferred shares;

convertible shares;

certificates of investment funds;

others.

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For the capital market from Republic ofMoldova, grouping of securities is treated

according to the Law on Securities Market, no.

199-XIV of 18.11.98. Accordong to this law,the main components of securities are

shares and bonds.

86

In the Republic of Moldova, the

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p ,

securities are issued inform of:

materialized nominative securities;

dematerialized nominative securities.

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Materialized securities circulate in form ofcertificates that

h h h f d b

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authenticates the rights conferred by securities.

A security certificate must contain: identification dates of the issuer;

type and class of securities, certified by the certificate;

state registration number;

number of securities, authenticated by the certificate;

name, surname (full name) of owner of securities (for nominativesecurities certificates);

the obligation of issuer to ensure the rights of securities holder;

number of the certificate;

stamp of the issuer;

the signature (facsimile of signature) of executive president of theissuer and signature of person that issued the certificate;

other information specified by law/legislation for a specific type ofsecurities.

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Dematerialized nominative securities are issuedin book-entry form in personal accounts of

registered persons, including on digital support.

Note: For dematerialized nominative securities

as a document confirming the rights offered by

the security serves the decision on the issuanceof securities and statement from the register.

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Questions for discussion and case

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Q

studies

Analyzing the structure of capital market inRepublic of Moldova, explain their affiliation toone of the approaches concerning the financialand capital markets structure.

Explain the difference between structural andcyclical demandon capital market from Republicof Moldova on concrete examples.

Develope two schemes, which would represent

the circuit of financial assets on financial andcapital market, according to those twoapproaches: European and Anglo-Saxon.

Theme 1, nou

Documents

Transcript of Theme 1, nou