Capital Markets

Notes OF BBA

 What Are Capital Markets?

Capital markets are venues where savings and investments are channeled between the suppliers who have capital and those who are in need of capital. The entities that have capital include retail and institutional investors while those who seek capital are businesses, governments, and people.

Capital markets are composed of primary and secondary markets. The most common capital markets are the stock market and the bond market.

Capital markets seek to improve transactional efficiencies. These markets bring those who hold capital and those seeking capital together and provide a place where entities can exchange securities.

Understanding Capital Markets

The term capital market broadly defines the place where various entities trade different financial instruments. These venues may include the stock market, the bond market, and the currency and foreign exchange markets. Most markets are concentrated in major financial centers including New York, London, Singapore, and Hong Kong.

  • Capital markets are composed of the suppliers and users of funds. Suppliers include households and the institutions serving them— pension funds, life insurance companies, charitable foundations, and non-financial companies—that generate cash beyond their needs for investment.
  • Users of funds include home and motor vehicle purchasers, non-financial companies, and governments financing infrastructure investment and operating expenses.
  • Capital markets are used to sell financial products such as equities and debt securities. Equities are stocks, which are ownership shares in a company. Debt securities, such as bonds, are interest-bearing IOUs.
  • These markets are divided into two different categories: primary markets—where new equity stock and bond issues are sold to investors—and secondary markets, which trade existing securities. Capital markets are a crucial part of a functioning modern economy because they move money from the people who have it to those who need it for productive use.

 Primary vs. Secondary Markets

Capital markets are composed of primary and secondary markets. The majority of modern primary and secondary markets are computer-based electronic platforms.

  • Primary markets are open to specific investors who buy securities directly from the issuing company. These securities are considered primary offerings or initial public offerings (IPOs). When a company goes public, it sells its stocks and bonds to large-scale and institutional investors such as hedge funds and mutual funds.
  • The secondary market, on the other hand, includes venues overseen by a regulatory body like the Securities and Exchange Commission (SEC) where existing or already-issued securities are traded between investors. Issuing companies do not have a part in the secondary market.

 The Pakistan Stock Exchange is the example of capital market

 Financial Services

Financial companies involved in private rather than public markets are part of the capital market. They include investment banks, private equity.

 Public Markets

Operated by a regulated exchange, capital markets can refer to equity markets in contrast to debt, bond, fixed income, money, derivatives, and commodities markets. Mirroring the corporate finance context, capital markets can also mean equity as well as debt, bond, or fixed income markets.

 What Is a Primary vs. Secondary Market?

New capital is raised via stocks and bonds that are issued and sold to investors in the primary capital market, while traders and investors subsequently buy and sell those securities among one another on the secondary capital market but where no new capital is received by the firm.

  • Investment banks and private equity firms are both involved with placing the shares of companies into the hands of investors and facilitating deals.
  • Investment banks tend to act as middle-man, marketing shares of publicly traded companies to other investors in a sell-side function.
  • Private equity firms, on the other hand, invest their own money in a buy-side fashion in privately held companies.

Methods of issuing new shares

    Offer through prospectus
  1. Offer for sale
  2. Private placement
  3. EIPO
  4. Right issue

 Players of primary market


 In the capital markets, corporations behave as operating businesses that require capital to grow and run their operations. These corporations can vary in industry, size, and geographical location. Careers at corporations that relate to the markets include corporate development, investor relations, and financial planning and analysis (FP&A).

Examples of publicly traded corporations:

  • Amazon
  • Apple
  • Toyota
  1. Institutions (“Buy Side” Fund Managers)

Institutions consist of fund managers, institutional investors, and retail investors. These investment managers provide capital to corporations that need the money to grow and operate their businesses. In return for their capital, corporations issue debt or equity to the institutions in the forms of bond and shares, respectively. The exchange of capital and debt or equity completes the cycle of the two key players in the capital markets.

Examples of top “Buy Side” Firms:

  • Foundation Securities (Private) Limited
  • Shajar Capital Pakistan (Private) Limited
  1. Investment Banks (“Sell Side”)

Acting as an intermediary, investment banks are hired to facilitate deals between corporations and institutions. The job of investment banks is to connect institutional investors with corporions, based on risk and return expectations, and investment styles. Careers in investment banking involve extensive financial modeling and valuation analysis.

Examples of top investment banks:

  • Ammar investment bank limited
  • Atlas investment bank ltd
  1. Public Accounting Firms

Depending on their divisions, public accounting firms can engage in multiple roles in the primary market. These roles include financial reporting, auditing financial statements, taxes, consulting on accounting systems, M&A advisory, and capital raising. Therefore, public accounting firms are usually hired by corporations for their accounting and advisory services.

 Examples of top public accounting firms:

  • Deloitte
  • PwC


Players in Corporate finance -Primary Markeet


Key Players in the Secondary Market

Unlike the primary market, where there is an initial issuance of debt or equity in exchange for capital, the secondary market allows for the sale and trade of issued bonds and shares. The secondary market allows players to enter and exit securities easily, making the market liquid.

    Buyers and Sellers

In the secondary market, fund managers or any investors who wish to purchase securities or debts will have to locate a seller. Transactions are facilitated through a central marketplace, including a stock exchange or Over The Counter (OTC).

  1. Investment Banks

While investment banks facilitate the issuance of bonds and shares in the primary market, they expedite the sales and trading of issued debts and equities between buyers and sellers in the secondary market.

 Investment banks provide equity research coverage on each stock’s upside potential, downside risk, and rationale to help buyers and sellers make a judgment. Moreover, investment banks sell and trade securities on behalf of the clients to maximize their profits.


Secondary Market Notes of BBA


1) What are Bonds?

A bond is a debt instrument that provides a periodic stream of interest payments to investors while repaying the principal sum on a specified maturity date. A bond’s terms and conditions are contained in a legal contract between the buyer and the seller, known as the indenture.

Key Bond Characteristics

Each bond can be characterized by several factors. These include:

  • Face Value
  • Coupon Rate
  • Coupon
  • Maturity
  • Call Provisions
  • Put Provisions
  • Sinking Fund Provisions
    a) Face Value

The face value (also known as the par value) of a bond is the price at which the bond is sold to investors when first issued; it is also the price at which the bond is redeemed at maturity. In the U.S., the face value is usually $1,000 or a multiple of $1,000.

    b) Coupon Rate

The periodic interest payments promised to bond holders are computed as a fixed percentage of the bond’s face value; this percentage is known as the coupon rate.

    c) Coupon

A bond’s coupon is the dollar value of the periodic interest payment promised to bondholders; this equals the coupon rate times the face value of the bond. For example, if a bond issuer promises to pay an annual coupon rate of 5% to bond holders and the face value of the bond is $1,000, the bond holders are being promised a coupon payment of (0.05)($1,000) = $50 per year.

    d) Maturity

A bonds maturity is the length of time until the principal is scheduled to be repaid. In the U.S., a bond’s maturity usually does not exceed 30 years. Occasionally a bond is issued with a much longer maturity; for example, the Walt Disney Company issued a 100-year bond in 1993. There have also been a few instances of bonds with an infinite maturity; these bonds are known as consols. With a consol, interest is paid forever, but the principal is never repaid.

    e) Call Provisions

Many bonds contain a provision that enables the issuer to buy the bond back from the bondholder at a pre-specified price prior to maturity. This price is known as the call price. A bond containing a call provision is said to be callable. This provision enables issuers to reduce their interest costs if rates fall after a bond is issued, since existing bonds can then be replaced with lower yielding bonds. Since a call provision is disadvantageous to the bond holder, the bond will offer a higher yield than an otherwise identical bond with no call provision.

A call provision is known as an embedded option, since it can’t be bought or sold separately from the bond.

    f) Put Provisions

Some bonds contain a provision that enables the buyer to sell the bond back to the issuer at a pre-specified price prior to maturity. This price is known as the put price. A bond containing such a provision is said to be putable. This provision enables bond holders to benefit from rising interest rates since the bond can be sold and the proceeds reinvested at a higher yield than the original bond. Since a put provision is advantageous to the bond holder, the bond will offer a lower yield than an otherwise identical bond with no put provision.

    g) Sinking Fund Provisions

 Some bonds are issued with a provision that requires the issuer to repurchase a fixed percentage of the outstanding bonds each year, regardless of the level of interest rates. A sinking fund reduces the possibility of default; default occurs when a bond issuer is unable to make promised payments in a timely manner. Since a sinking fund reduces credit risk to bond holders, these bonds can be offered with a lower yield than an otherwise identical bond with no sinking fund.


 Traditional Bonds vs. Islamic Bonds Called “Sukuk”

The word Sukuk is an Arabic word which means certificate. These are certificates which are offered by corporations and governments which follow Islamic principles.

  • For instance, Saudi Arabia has issued a new tranche of Sukuk in the year 2017. This was done to provide medium-term financing to the government to meet its debt obligations.
  • The Saudi Arabian government has been cash-strapped given the sudden decline in the price of oil which has led to a catastrophic decline in the revenue of the Saudi state
  • The word “Sukuk” is used to denote the Islamic equivalent of traditional bonds. However, there are many differences between Sukuk and bonds. This is because any lending where interest is involved is strictly prohibited as per Sharia law. Since Sukuk are Sharia -compliant, they are not really debt instruments.
  • To the external world, this may seem like a mere technicality. This is why westerners refer to Sukuk as Islamic bonds. However, Muslims hold the prohibition of interest in very high regard. They believe that all the price inflation in the world is happening because of interest. They also believe that interest is a tool used for creating usury and injustice. In fact, interest is also seen as the sole cause of economic misery and the formation of bubbles. This is the reason why Sukuk has been structured to not include interest.
  • Sukuk are Based on Ownership Instead of Debt

Bonds may or not be backed by a real asset. However, Sukuk always has to be backed by a real asset. This is because the Sukuk contract itself provides transfer of ownership of the asset for a short period from the issuer to the buyer. Sukuk is essentially a repurchase contract wherein the seller of an asset sells the asset at a certain price and then agrees to buy it later at a higher price. Since the loan does not have a fixed interest rate, Sukuk is allowed as per Islamic laws.

 The Underlying Assets are Sharia Compliant

  • Islam also prohibits dealing in or associating with certain types of goods and services. Hence these goods cannot be used as collateral for Sukuk. For instance, liquor companies cannot raise money via Sukuk since the underlying asset is not sharia-compliant. Similarly, pork chops also cannot be used as collateral. The issuer of Sukuk needs to certify that the underlying asset or bundle of assets is Sharia compliant. Also, they need to certify that the proceeds from Sukuk will not be used for any purpose that has been prohibited by Islam.

  The Pricing of Sukuk

A loan is not priced on the basis of collateral. The lender does not intend to liquidate the collateral. This is the reason that loans are priced based on the creditworthiness of the borrower. If the borrower has an AAA+ rating, a lower interest will have to be paid on the loan. On the other hand, if the borrower is likely to default, the interest rate demanded is very high.

This is not the case with Sukuk. The Sukuk is priced depending upon the value of the underlying asset. The creditworthiness of the borrower has very little impact on the pricing of the Sukuk. Also if any capital appreciation happens in the asset during the period that the buyer is holding a Sukuk, such benefit belongs to the buyer. For instance, if Saudi Arabia issues Sukuk backed by its oil and the price of oil doubles, then the profit will belong to the holders of the Sukuk since they are the owners of the asset for that period.

On the other hand, if Russia issues bonds backed by its oil and the price of the oil appreciates significantly, the investors are no better off. This is because they have provided a loan and bore no part of the risks. Hence, they are not entitled to receive appreciation.

  Similarities Between Bonds and Sukuk

  • Bonds and Sukuk are very similar in many ways. Some of the important points have been listed below:
  • Sukuk are also subject to credit rating just like bonds. However, the credit rating is about the stability of the underlying asset and the volatility that the buyer may face. The creditworthiness of the borrower is irrelevant. Hence, a Sukuk sold by the Saudi government or even the local trader will be priced in the same manner if the underlying asset is the same.
  • Sukuk also has a thriving secondary market just like bonds. Buyers need not hold Sukuk up to maturity. These certificates are liquid instruments and can be cashed whenever required. Malaysia has one of the most thriving secondary markets for Sukuk in the world.
  • Sukuk provides a better return on investment as compared to bonds in the western world. This may be because relatively few people issue Sukuk. However, there are a large number of investors who are willing to buy these instruments. The westerners are allowed to invest in Sukuk. However, Islam and Sharia prohibit the Muslims from buying bonds.

Common Stock

 Common stock is an equity instrument that represents a small portion of company ownership. The stockholders enjoy dividends once or twice a year. Not like preferred stocks or bonds, the common stock declares a high dividend. As this type of investment has a high dividend yield, it is also a risky investment. The owner can lose the value of the stocks. Also, if there is any downtime, the common stockholders may not enjoy any dividend, unlike preference shares.

  • As it represents ownership, the stockholders have the rights to elect the board of the directors and voting rights. So, the common stock holders elect the board of the directors of a company.

Characteristics of Common Stock

 One of the most popular features of common stock is that anyone can buy and own it, hold it, and sell it when in profit. Also, if anyone wants, s/he can hold it forever and enjoy the yearly dividend for a lifetime.

  • Common stocks have many unique and popular characteristics; this is why its very popular investment all over the world.
  • Common Stocks Represent Ownership of a Company
  • A piece of stock represents a portion of ownership of a company. That means, when you hold a portion of the company’s total stocks, you are one of the owners of the company.
  • For example, if a company has 1000 shares traded in the market and you hold 100 shares of that company, then you are the owner of one-tenth of that company.

 The Voting Rights of Common Stock Holders

  • As a common stockholder of a company enlisted in the stock market, you have the capability of casting the vote while selecting directors’ board. This privilege gives you the right to select the most efficient person for the company. Sometimes, shareholders express their opinion in the major decision making for the company by voting e.g. mergers & acquisition etc.

 The Value of Common Stocks

  • The value of the common stocks is not concrete. That means the value fluctuates time to time. The value of the common stock is backed by the value of the main company.
  • Capability of Receiving Periodic Dividends
  • The dividend is the most important part of a common stock. The image, capability, or attracting investors vastly depend on the dividend declaration capability. As a common stockholder, you have the rights or capability of receiving the periodic dividend.

 Characteristic of Limited Liability in Common Stocks

  • When it is about the liability of the ownership, you have the limited liability in common stocks. In simple words, the portion you have purchased from the stock market is actually your total liability.
  • For example, you are holding 10 shares of a company which has 100 shares trading in the market. So, if the company goes bankrupt, the maximum amount you can lose is the value of 10 shares.

 Profit and Risks Relation in Common Stocks

  • The profit and risk relation is high in the case of common stock. That means, when the risk is high for a specific stock, the return will be high as well. Conversely, if the risk is low, the possible return will be low as well.

Tax Exemptions (Indirect)

  • It is an indirect characteristic that is dependent on the decision of the government. In some countries, the income from the common stocks is not taxable. So, the money you earn from stock trading or investment is tax exempted.

Claim on Assets

  • If the company goes bankrupt, you get some portion of the asset after paying the company’s payable to the preferred stockholdersof the company.
  • Chances of Losing Everything in the Case of Bankruptcy
  • When it becomes bankrupt, there is a big chance that you do lose everything. That is because the stock price may go to the value at zero. And if there is nothing left after paying the preferred stockholders, you cannot get anything as there is nothing left.

 Right to have Capital Gain

  • When you buy a stock, the price may go up or down. This is one of the primary characteristics of common stocks. In this case, you do have the right to sell the share to others and lock your profit. As there is an appreciation in the capital, it is called capital gain.

 Volatility of Common Stocks

  • As the stock is traded in the market by the traders and investors, different people allocate different value for the same stock. So, the price of the stock becomes very volatile. In the morning you are seeing a price may not be the same price in the evening.

 Uncertain Return

  • There is uncertainty in the return of stock investment as the value is dependent on many factors such as company earning, taxes, industry factors, or macroeconomic factors.

In conclusion

  • Because of its diversified and unique characteristics, the common stock became the most popular instrument among the investors and traders all over the world.

What are Preferred Shares?

  • Preferred shares (also known as preferred stock or preference shares) are securities that represent ownership in a corporation, and that have a priority claim over common shares on the company’s assets and earnings. The shares are more senior than common stock but are more junior relative to bonds in terms of claim on assets. Holders of preferred stock are also prioritized over holders of common stock in dividend payments.

Features of Preferred Shares

  • Preferred shares have a special combination of features that differentiate them from debt or common equity. Although the terms may vary, the following features are common:
  • Preference in assets upon liquidation: The shares provide their holders with priority over common stock holders to claim the company’s assets upon liquidation.
  • Dividend payments: The shares provide dividend payments to shareholders. The payments can be fixed or floating, based on an interest rate.
  • Preference in dividends: Preferred shareholders have a priority in dividend payments over the holders of the common stock.
  • Non-voting: Generally, the shares do not assign voting rights to their holders. However, some preferred shares allow its holders to vote on extraordinary events.
  • Convertibility to common stock: Preferred shares may be converted to a predetermined number of common shares. Some preferred shares specify the date at which the shares can be converted, while others require approval from the board of directors for the conversion.
  • Callability: The shares can be repurchased by the issuer at specified dates.


Features of Preferred Shares

Types of Preferred Stock

 Preferred stock is a very flexible type of security. They can be:

Convertible preferred stock: The shares can be converted to a predetermined number of common shares.

 Cumulative preferred stock: If an issuer of shares misses a dividend payment, the payment will be added to the next dividend payment.

Exchangeable preferred stock: The shares can be exchanged for some other type of security.

Perpetual preferred stock: There is no fixed date on which the shareholders will receive back the invested capital.