Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-1 Chapter 4 The share market and the corporation Websites:

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-2 Learning objectives Understand the nature of corporations and reasons for public listing Consider the origins and purpose of a stock exchange Discuss the role of primary and secondary markets in equity financing Explain the derivatives, managed products and interest rate market roles of a stock exchange Explain the electronic trading and settlement systems for share market transactions (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-3 Learning objectives (cont.) Explain the importance of information flows for share market efficiency Identify the main regulators of the share market Explain the structure and purpose of the private equity market

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-4 Chapter organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 The Private Equity Market 4.4Summary

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation Share market –A formal exchange facilitating the issue, buying and selling of equity securities Publicly listed corporation –A company whose shares are quoted and traded on a formal stock exchange Ordinary share –The principal form of equity issued by a corporation, which bestows a claim to residual cash flows and ownership and voting rights (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) The corporation differs from other business forms –Ownership claims are widespread and easily transferable –Owners (shareholders) do not affect the day-to-day affairs of the company –Shareholders’ liability is limited to:  the issue price of shares of a limited liability company  any partly paid portion of shares of a no-liability company (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) Advantages of the corporate form –Can obtain large amounts of finance at a relatively cheap cost –The liquidity of securities facilitates investor diversification and encourages investment in corporate securities –Separation of ownership and control facilitates:  appointment of specialised management  greater effectiveness in the planning and implementation of strategic decisions (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) Advantages of the corporate form (cont.) –‘Perpetual succession’—the corporate form is unaffected by changes in management or ownership –The corporate form is suited to large-scale operations (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) Disadvantages of the corporate form –Main disadvantage arises from the separation of ownership and control  Conflict of interest between owners (principals) and managers (agents) known as the agency problem  Management may try to run business for their own benefit, rather than that of shareholders, i.e. maximise shareholder value (share price) (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) Disadvantages of the corporate form (cont.) –Factors moderating conflict of interest between owners and managers  Investors’ ability to sell shares in a corporation, causing the share price to fall  Dismissal from the board at AGM by shareholders  Threat of takeover and loss of employment  Use of performance incentives, such as share options  More rigorous corporate governance (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The nature of a corporation (cont.) Following the GFC, many corporations were forced to raise additional capital through the stock market This was to ‘sure up’ their balance sheets during the tough economic environment that followed the crisis The advantage of the corporate form is highlighted by such behaviour Smaller firms are not able to access capital as easily and would normally be expected to pay a higher rate of return

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-12 Chapter organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 The Private Equity Market 4.4Summary

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The stock exchange Origins of the modern stock exchange traceable to mid- 16th century England Principal functions of a modern and efficient stock exchange in a globalised market are the provision of: –markets for a range of financial securities –securities trading system –clearing and settlement system –regulation and monitoring of market integrity –well-informed market (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The stock exchange (cont.) Specifically, the following roles of a stock exchange are considered: –Primary market role –Secondary market role –Managed Product role –Derivative market role –Interest rate market role –Trading and settlement roles –Information role –Regulatory role

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-15 Primary market role A stock exchange facilitates the efficient and orderly sale of new financial securities –New floats/Initial public offerings (IPOs)  Initial listing of a corporation on the stock exchange –Rights issue  Issue of additional shares to existing shareholders on a pro- rata basis –Placements  Issue of new shares to selected institutional investors –Dividend reinvestment plans  Reinvestment of dividends into corporation for additional shares (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-16 Primary market role (cont.) (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-17 Primary market role (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-18 Secondary market role The stock exchange facilitates trading in existing shares –No new funds are raised by the issuing company –An active, liquid, well-organised secondary market increases the appeal of buying new shares in the primary market –Market liquidity  Ratio of share turnover to market capitalisation –Market turnover  Number of shares on issue x current share price (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-19 Secondary market role (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-20 Managed product role The stock exchange provides a market for trading managed products –Equity-based managed products are professionally managed funds. –The ‘units’ in these funds are bought and sold on the stock exchange in the same way as shares in corporations. –Managed products are described as:  exchange traded funds (ETFs)  real estate investment trusts (REITs)  infrastructure funds

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-21 Derivative market role The stock exchange provides a market for trading equity-related derivative products –A derivative is a financial security that derives its price from an underlying commodity (e.g. gold) or financial instrument (e.g. BHP shares) –Derivative products are described as:  exchange-traded contracts standardised financial contracts traded on a formal exchange  over-the-counter contracts non-standardised contracts negotiated between writer and buyer (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-22 Derivative market role (cont.) The stock exchange provides a market for trading equity-related derivative products (cont.) –Derivatives serve as a:  risk management tool (hedge)  speculative instrument –Derivatives traded on a stock exchange include:  options  warrants  futures contracts  Contracts for difference

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-23 Interest rate market role The listing, quotation and trading of typically longer term debt instruments on a stock exchange –Straight corporate bonds –Floating rate notes (FRNs) –Convertible notes –Preference shares (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-24 Interest rate market role (cont.) This role adds value to a debt issue owing to: –transparency  information about price, yield, maturity, credit rating of debt instruments –ease of entry  electronic trading system facilitates buy and sell orders at minimum cost and time delay at current market prices –liquidity  quotation on a stock exchange provides access to a wider market

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-25 Trading and settlement roles The Australian Securities Exchange (ASX) uses ASX Trade and ASX Trade24, which are integrated computer-based trading systems to trade all listed securities and derivatives –Clients’ orders are executed via computer from the broker’s office –Orders are executed in order of time received and the buy/sell price (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-26 Trading and settlement roles (cont.) The ASX uses CHESS (Clearing House Electronic Sub-register System) –Facilitates the settlement of transactions conducted through ASX Trade –Settlement of transactions within three days (T + 3) –Provides an electronic sub-register that records the ownership of listed securities –A CHESS sponsor is a market participant with access to CHESS, e.g. stockbroker

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-27 Information role Investor confidence in the ASX relies on informational efficiency –The current share prices should reflect all information available in the market, determined by:  the speed at which new information flows to the market  the speed at which that information is absorbed and reflected in share prices The ASX has a critical role in facilitating the flow of information to the market Corporations Act 2001 (Cwlth) requires information materially affecting the share price of a listed company to be immediately given to the ASX (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-28 Information role (cont.) Listing rules are stock exchange rules with which a listed entity must comply Examples of information disclosures required by ASX listing rules –A change in a company’s financial forecasts –Appointment of a liquidator –Declaration of a dividend –Notice of a takeover bid –Disclosure of directors’ interests

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-29 Regulatory role The aim of regulation is to ensure market participants have confidence in the integrity of market operations Two main supervisors in Australia –Australian Securities Exchange (ASX) –Australian Securities and Investments Commission (ASIC) (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-30 Regulatory role (cont.) ASX –Ensures listed companies meet specified limited levels of performance and standards of information disclosure so investors can make informed decisions  Continuous disclosure –Prescribes appropriate behaviour of broker participants on the exchange  Sanctions include discipline, penalties, loss of licence (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-31 Regulatory role (cont.) ASX (cont.) –Electronic surveillance systems to monitor trading behaviour of market participants  Detect trades that fall outside certain limits  Cross-references all trades against information on the relevant company, directors and associated parties (cont.)

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-32 Regulatory role (cont.) ASIC –Responsible for the supervision of Corporations Law and markets in Australia (Corporations Act 2001 (Cwlth)) –Responsible for market integrity and consumer protection across the financial system, covering investment, insurance and superannuation products –Supervises the ASX, addressing potential conflicts of interest as a publicly listed corporation

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-33 Chapter organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 The Private Equity Market 4.4Summary

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips The private equity market Private equity is an alternative funding source for companies unable or not wanting to access equity capital though a public issue Source of funds –Superannuation funds and life insurance offices Use of funds –Startups, business expansion, recovery finance for distressed companies, management buyouts –Aim is generally to:  improve profitability sufficiently to realise value though an IPO  break up business to achieve return on investment

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-35 Chapter organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 The Private Equity Market 4.4Summary

Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips Summary Corporate form of organisation has advantages (fundraising and management) and disadvantages (separation of ownership and control) The stock exchange has a number of market roles –Primary and secondary –Derivative –Interest rate –Trading and settlement –Information –Regulatory ASX monitors market participants and ASIC supervises Corporations Law and market integrity