Chapter Nine The Capital Markets

Chapter Nine

The Capital Markets

Copyright © 2003 Pearson Education, Inc. Slide 9–3

Capital Markets

• Original maturity is greater than one year

• Best known capital market securities:– Stocks and bonds

• Primary issuers of securities:– Federal and local governments

– Corporations

• Who is the largest purchasers of securities?


Purpose of the capital market

• By contrast to money market, firms and government use capital market for long-term investment to reduce the interest rate risk– What is interest rate risk?.

• Why not use money market?


Capital Market Trading

1. Primary market for initial sale (IPO)

2. Secondary market– Over-the-counter (NASDAQ)

– Organized exchanges (i.e., NYSE)


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


Figure 9-1: Number of Listed Companies Yearly Comparison with NYSE, AMEX, and Nasdaq


Capital Market Securities: Bonds

• represent a debt owed by issuer ( what about stocks?)

• Several important characteristics about bonds– Maturity – Interest (coupon) payment– Par value (face value)– Issuers.

• Long-term bonds: T-notes, T-bonds, muniicipal bonds and corporate bonds


Treasury Bonds


Treasury Bond Interest Rates

• No default risk

• Very low interest rates


Figure 9-3: Interest Rate on Treasury Bonds and the Inflation Rate, 1973–2002

Treasury Bond Interest Rates


Compare 20-Year Treasury Bonds to 90-Day Treasury Bills

Figure 9-4: Interest Rates on Treasury Bills and Treasury Bonds, 1973–2002 (January of each year)


What can we learn from those graphs?

1. Short term bond rates are usually lower than long term bonds rates

2. Short term rates are more volatile than long term rates because of expectation of inflation.


Municipal Bonds

1. Issued by local, county, and state governments

2. Used to finance public interest projects

3. Tax-free municipal interest rate = taxable interest rate (1 marginal tax rate)

4. Two types– General obligation bonds

– Revenue bonds

5. NOT default-free


Comparing Revenue and General Obligation Bonds

Figure 9-5: Issuance of Revenue and General Obligation Bonds, 1984–2000 (End of year)


Corporate Bonds

• Face value of $1,000

• Pay interest semi-annually

• Can be redeemed anytime the issuer wishes

• Degree of risk varies with each bond

• Interest rate varies with level of risk


Sample Corporate Bond

Figure 9-2: Sohio/BP Corporate Bond


Figure 9-7: Corporate Bond Interest Rates, 1973–2002 (End of year)


Characteristics of Corporate Bonds

• Registered Bonds replace bearer bonds ( this is where “coupon payment” comes from)

• Restrictive Covenants reflect the agency problem

• Call Provisions – Higher yield– Sinking fund– Alternative opportunities

• Conversion


Types of Corporate Bonds

• Secured Bonds– Mortgage bonds secured by physical assets (for example, real estate)

– Equipment trust certificates secured by tangible non-real estate assets ( for example bonds, stocks etc.)

• Unsecured Bonds– Debentures with indentures

– Subordinated debentures have lower priority claim than debentures

– Variable-rate bonds

• Junk Bonds


Debt Ratings


Trends in the Bond Market

Figure 9-8: Bonds and Stocks Issued, 1983–2000

Chapter Nine The Capital Markets

Documents

capital market

treasury bonds

money market

bonds

securities

long

year

stocks