Capital Market

Capital Market overview:
This website introduces you to the fundamentals of capital markets and provides a base foundation upon which growth can be established. Additionally, it helps in clarifying capital capital market terminologies.

This site will help you:

1. Describe capital Markets and its terminology
2. List the various financial instruments or assets classes such as Equities, Fixed Income, Fx and derivatives.
3. Describe the life cycle of a Trade in Primary and Secondary Market.
4. List the role of various participants in trade lifecycle
5. Explain in brief the trade process and functions in Front, Middle and Back Office.

What are Capital Markets?

Markets where financial securities like stocks and bonds are brought and sold to raise capital are called Capital Market.

Why do we need Capital Market?

Capital Market is required for two purposes:

Price Discovery

•    Price is decided by demand and supply through the interactions between buyers and sellers.

                The market price should:

•   Reflect all available information at that point of time
• Adjust quickly to new information that comes in
• Not be manipulated
• Operational Efficiency

            Markets provide operational efficiency through:

•    Trading convenience
•    Adequate liquidity-large number of participants
•    Low cost of trading

Capital markets consist of the primary market and the secondary market.

Financial Instruments.

Financial instruments are the instruments having monetary value or recording a monetary transaction.

1.       Basic assets

a.       Equity

                           i.      Stocks and shares are financial instruments representing ownership interest in a corporation

                          ii.      These equities are issued to raise long term capital by selling ownership stake in corporation

                         iii.      Different types of shares

         1)      Ordinary

         2)      Preferential

         3)      Rights

         4)      ADR/GDR

                        iv.      Decides the value of stocks

         1)      Company financial

         2)      Promoters profile

         3)      Sector profile

         4)      Tax regime

         5)      Political climate

         6)      Energy prices

         7)      Commodity prices

         8)      Interest rates

b.      Fixed Income Securities

                          i.      Bond

         1)      Bond is a loan given by investors to companies, banks, corporations and governments

         2)      These are debt obligations with long-term maturities. Markets and participants  easily transfer the ownership of debt obligations from one party to another through debt instruments

         3)      What is debt instrument?

                         ii.      Coupon payments

         1)      Coupon payments are the annual interest paid on a bond, usually in semi-annual tranches

        a)      Fixed rate bond

  1. The amount of each coupon is fixed at issue and remains same throughout the life of the bond

         b)      Zero coupon bonds

  1. Issued at a discount with a fixed final maturity value, hence, entire return is received as capital gain maturity

        c)       Floating rate bond

  1. Coupon adjusted at reset periods, linked to a benchmark rate, e.g. London Interbank Offered Rate (LIBOR)

  2. LIBOR is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale market or interbank market

       d)      Corporate bonds

 1. A corporate bond is a bond issued by a corporation

       e)      US Treasury Bills, Notes and Bonds

        f)       Municipal Bonds

       g)      Collateralized Mortgage Obligations (CMO)

       h)      Asset Backed Securities (ABS)

        i)        Commercial Paper

c.       FX

d.      Commodities

2.       First level derivatives

a.       Forwards

b.      Futures

c.       Swaps

d.      Options with price derived from underlying basic needs

3.       Second level derivatives

a.       Swaptions

b.      Compound option with price derived from underlying first level derivatives

4.       Third level derivatives

a.       Exotic options with price derived from second level derivative

What are money markets?

As good as cash. Markets for highly liquid instruments that can be quickly converted into cash.

Short term debt instruments with maturity of one year or less.

Generally issued on discount basis-sold at a discounted price to the maturity value and bought back at its maturity value by the issuer.

Usually high-grade securities with little or no risk of default.

Common market instruments.

1.       Treasury Bills (T-Bills)

a.       Issued and granted by the Government

b.      Sold on a discount basis

2.       Commercial Paper

a.       A promissory note sold by corporations

b.      Issued on a discount basis

c.       Sometimes backed by a “letter of credit” from a bank

Interest Rate and Time Value of Money

Here are few sample important definitions and examples:

FV: The value of an asset at a specified date in the future that is equivalent in value to a specified sum today. For EX $1000 invested for 5 years with simple annual interest of 10% would have a future value of $1,500.00.

PV: The current worth of a future sum of money or stream of cash flows given a specified rate of return. The basis is that receiving $1,000 now is worth more than $1,000 five years from now, because if you got the money now, you could invest it and receive an additional return over the five years.

NPV: NPV compares the value of a dollar today to the value of the same dollar in the future, talking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.

IRR: You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth.

YTM: The rate of return anticipated on a bond if it is held until the maturity date. Yield to Maturity (YTM) is considered a long term bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price, par value, coupon interest rate and time to maturity. It is also assumed that all coupons are reinvested at the same rate. Sometimes this is simply referred to as “yields” for short.

Hope you enjoyed learning Capital Market!