125220 Topic 7: Capital Markets

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jordan_hs
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125220 Topic 7: Capital Markets
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2015-10-18 22:27:18
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capital markets
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  1. Medium-to-longer Term Debt
    • • Borrowers have a choice between direct finance (supplier of funds lends directly to borrower) & intermediated finance (through a bank)
    • Matching principle:
    • • Firms should match the maturity structure of their assets (that are funded through debt) with maturity structure of their liabilities (their debts).
  2. Intermediated Finance-Term Loans via Banks
    • • Banks offer fixed-term loan generally ranging 3 → 15 years
    • • Typically used to finance capital expenditure (e.g. building equipment)
    • • Interest may be fixed or variable but based on reference or indicator rate e.g. BBSW, LIBOR
    • • Banks charge premium or spread depending on:– The credit rating of borrower– Term of loan, &– Repayment schedule
  3. Mortgage Finance
    • • Type of term loan & mortgage markets are important markets.
    • • A mortgage = form of security for loan registered on land title
    • • The mortgage is discharged when loan is repaid
    • • If mortgagor defaults on loan, mortgagee (lender) is entitled to foreclose on property
    • • Loans can be either residential or commercial
    • • Residential loans - typically granted for periods up to 25 yrs, while commercial loans are for periods up to 10 years.
    • • Variable interest rate loans have dominated, but fixed rates are available for loans with long-terms.
    • • Mortgage loans portfolios → securitisation – non-recourse loans
  4. Traded Long-Term Debt Instruments
    •Government Bonds (Government stock)
    • – Normally issued by tender by NZDMO to highest bidders.
    • –Most ‘stock’ on issue between 1 & 10 years.
    • – Lowest risk NZ issued fixed-interest securities paying a semi-annual interest payment & fixed maturity value.
    • – Par value $1,000,000
  5. Capital Markets-Traded L-T Debt Instruments

    Example 1: Current Govt stock yields in market are paying 7% p.a. An existing Govt bond with face value of $100,000, paying 8% p.a. with semi-annual coupons &
    exactly 4 years to maturity, would be selling in capital markets at a price of:

    Solution: find present value of coupon & principal (face value)


    • P = $103,436.98
  6. Capital Markets - Traded L/T Debt instrument
    Example 1: Using simple formula
    "Bond Price = PV(FV) + PV(Coupon)
    • Present value of face value
    • = $100,000 (1 + 0.035)-8 = $75,941.16

    • Present value of $coupon
    •  
    • =$4,000 X 6.873955
    • =$27,495.82

    • Full Price = $75,941.16 + $27,495.82 
    • Full Price = $103,436.98
  7. Example 2: Current Govt stock yields are paying 8.8% p.a. Existing Govt bond with face value of $100,000, paying 8% p.a. with semi-annual coupons & exactly 4 years to maturity, would be sold in capital markets at a price of:
    • Present value of face value
    • = $100,000 (1 + 0.044)-8
    • = $70,859.16
    • Present value of $coupon
    •  = $26,491.67

    • Full Bond Price
    • = $70,859.16+$26,491.67
    • = $97,350.83
  8. Govt Bonds are issued to
    • • Raise money for capital expenditure e.g. roadworks
    • • Help implement monetary policy
    • • Provide investment vehicles for FIs & super funds
    • • Help balance liquidity & credit available in financial system
    • • In most countries, ordinary government bonds pay semiannual coupons
  9. Kiwibonds
    • Retail stock offered directly to the public. They are available only to New Zealand residents and are denominated in NZD with fixed interest rate paid quarterly.
    • • Most common form of Govt stock held by public.
    • • Disadvantage over govt bonds is their illiquidity
  10. Local Authority Stock (Bonds)
    • • Normally issued on application to general public
    • • E.g. Auckland Council bond AKCO50 maturing 29/9/2019
    • • Also have been issued by way of private placement to institutions. Private placement = round of securities not sold through public offering, offered to select investors
    • • Normally secured by recurring rates on rateable property.
    • • In USA- known as municipal bonds (munis)
    • • Similar to Govt stock except offer higher yield as risk is with local authority- city
  11. SOE Stock
    • • SOE Stock- L/T fixed-interest debt issues by State Owned Enterprises e.g. NZ electricity grid company Transpower announced an offer of a minimum $75 million CPI-indexed bond into market – the
    • first of its kind for NZ – TRPO20 maturing 6/9/2019.
    • • The issue is priced at a coupon of 4.65% & Transpower reserves the right to accept oversubscriptions. The issue date for the transaction is 17 May 2010.
  12. Corporate debt market
    • • Corporations raise funds directly from markets by issuing bonds
    • • Bond markets - important for domestic & international capital markets
    • • Bonds pay regular interest payments (generally semiannual) & par value is repaid at maturity
    • • Issued in primary market usually at face value either to raise extra capital, or to reduce their reliance on bank lending.
    • • Secondary markets are important
    • • Advantages for the investors
  13. Debentures
    A type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer.
  14. Unsecured Notes (capital notes)
    • Short-term unsecured debt generally issued by a company to pay short-term liabilities.
    • Carry more risk than other types of secured corporate debt, because capital note holders have the lowest priority.
    • Has higher yield as it is unsecured (has no collateral)
    • Can be protected by an unsecured note deed.
  15. Example of unsecured note
    • New Zealand Fletcher Building Industries e.g. FBIO60 maturing 15/5/2016 paying 9%.
    • Sky TV Capital Notes SKTO20 maturing 31/3/2021 paying 6.25%
  16. Zero-coupon bonds
    • • Long-term equivalent of money market instruments (discount)
    • • Interest - not paid during its lifetime (at end) but calculation for pricing is done on implied semi-annual payments.
    • • Common in USA & now found in this part of the world.
    • Example - QBE (Oz insurance company) issue 20-year zero coupon senior convertible securities 29/04/2010. It raised Aus $913m at 2.5%
  17. Zero-coupon bonds
    Example: Find the price of a zero-coupon bond that has 4 years to maturity (duration = 4 years) & current market yield is 7% p.a. The price per $100 of face value is: (always assume semi-annual)
    • P = 100/(1.035)8
    • P = 100/131.68
    • P = $75.94
  18. Leasing - borrowing of assets
    • • Lease is financial contract where lessor grants to another party (lessee) the right to use asset for a specified period, in return for rental payments from lessee.
    • • Effectively funding for company instead of having to borrow from bank & purchase asset.
    • • Main providers of lease financing are major banks & large finance companies

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