Chapter 3
Raising Capital in the Financial Markets
Learning Goals & Objective
1. Identify types of Financial Markets
2. Understand the different types of securities
involved in the markets
3. Understand the three forms of market efficiency
4. Understand financial institutions and markets,
and the role they play in managerial finance.
Financial Institutions & Markets:
Flow of Funds
Financial Institutions & Markets:
Transfer of Funds
Transfer of funds is categorized into direct transfer and
indirect transfer.
Direct transfer Occurs when the borrowers
(demanders) obtain funds directly from the savers
(suppliers) without going through an intermediary.
Indirect transfer Occurs when borrowers (demanders)
obtain savers’ (suppliers) fund by going through an
intermediary, either investment bank or a financial
intermediary.
Financial Institutions & Markets:
Direct Transfer Savers to Borrowers
Direct Transfer
RM
Savers Borrowers
Securities (e.g., shares and bonds)
•Without intervention of investment banker
•e.g: dividend reinvestment plan, purchasing treasury bonds issued
by government, borrow from family, friends
Financial Institutions & Markets:
Indirect transfer - Investment Banks
Indirect Transfer- Investment Banks
RM RM
Investment
Savers Borrowers
Banks
Securities Securities
(e.g., IPOs) (e.g., IPOs)
Investment banks help firms to raise capital by selling securities.
Known as ‘underwriter’.
Other services – provide professional advises on matters related to
corporate restructuring, M&A and etc.
Assist issuance process (size, timing, feature), find buyers
Issuance sold: (1) public offering (2) private placement
E.g: Public purchases (IPOs) of firms through investment bank
Financial Institutions & Markets:
Indirect transfer - Financial Intermediaries
Indirect Transfer -Financial Intermediaries
RM RM
Financial
Savers Borrowers
Intermediaries
Intermediaries Firm’s securities
securities
Financial intermediaries pool savings from savers and use it to loan to
borrowers.
Savers and borrowers do not come into direct contact because financial
intermediaries have a separate contract with savers and borrowers. E.g: With
savers (saving account contract), with borrower (loan contract)
Savers will have a financial claim over financial intermediaries while
financial intermediaries will have a financial claims over the borrowers.
Example (1) Individuals contribute to employees’ pension fund (EPF) which
then being used to invest in stocks and bonds (2) Individuals deposit cash in
bank’s saving account which then being used to issue loan to borrowers.
Financial Institutions & Markets:
Overview of Transfer of Funds
Indirect Transfer
Financial
Intermediaries
Deposits Borrowers
Loans
Commercial Banks
Shares (Households)
Mutual Funds
Savers Premiums
Insurance Companies
(Households) Debts or equity
EPF Pension Funds Firms
Investments
Investment Banks
Direct Transfer
(Debts or equity)
Public Offering vs Private Placement
Public Offerings
- Sales of securities to the public
- Impersonal market (no direct contact with
investor)
- SC registration required
Private Placement
- Sales of securities to a limited number of
investors
- Investors involved in private placements are
usually large banks, mutual funds, insurance
companies and pension funds.
- Face-to-face negotiations
- SC registration not required
Categories of financial markets:
Money Market vs Capital Markets
- Maturity period
Primary Markets vs Secondary Markets
- Originality of issues
Primary Markets vs Secondary Markets
Securitiesare first issued through the primary market in
which will bring cash inflow to the issuer.
The primary market is the only one in which a
corporation or government is directly involved in and
receives the proceeds from the transaction.
Once issued, securities then trade on the secondary
markets such as the Bursa Malaysia. No cash inflow to
the issuer. Price of securities determine by SS and DD
Secondary market important to primary market because
- Provide liquidity
- Guideline in pricing the new issues in primary market.
The Money Market
Market for short-term debt instruments (maturity
periods of one year or less).
T- Bills (Issued by Government)
Certificate of deposits (CDs) (Issued by commercial bank)
Commercial Paper (Issued by large Companies)
Bankers’ Acceptance (Bank draft issued by firm)
The Capital Market
Market for long-term securities (maturity greater
than one year)
T- bonds (issued by Government)
Corporate bond (issued by the firm)
Stocks (issued by the firm)
Mortgages (issued by the bank)
Organized Security Exchanges &
Over the Counter Markets
1) Organized Exchanges
◦ Buyers and sellers meet in one central location to conduct
trades.
◦ Membership restrictive, listed securities, different listing
requirement, consider as auction market
2) Over-the-Counter (OTC)
◦ Securities dealers operate at many different locations
across the country.
◦ Unlisted securities (bonds)
◦ Normally trade through computer network or phone
◦ Dealer post bid and ask price (make a market)
◦ Difference between bid and ask is spread (profit)
The Concept of Efficient Market
Hypothesis (EMH)
In an efficient market, securities prices reflect all
available information.
It will always be correctly priced, i.e no under or
over-valuation.
Continuous market, in which each successive
trade is made at a price close to the previous
price.
In other words, EMH argues that NO one can
consistently outperform the market.
Three Forms of Market Efficiency
1) Strong form of capital market efficiency:
o Current prices reflect all information (historical,
public, private) that can possibly be known to
anyone.
2) Semi-strong form of capital market efficiency:
o Current prices reflect all publicly available
information.
3) Weak form of capital market efficiency:
o Historical pricing trends cannot consistently yield
market-beating returns: no trends are predictable
Three Forms of Market Efficiency
Strong form
Stong Form No investors
All relevant information should be able to
earn abnormal
Semi-strong Form return
All public information
Semi/weak form
Weak Form
Investor cannot
All past
information consistently earn
abnormal return
Implication of EMH for Investors
Future market prices cannot be predicted based on
available information.
Investments in these markets have a zero NPV.
◦ The expected rate of return equals the required
rate of return.
◦ The expected rate of return compensates the
investor for the risk borne.
Abnormally high returns are earned by pure
“chance” or luck.
