CHAPTER 1: SECURITIES TRADED IN FINANCIAL MARKETS

Financial Market is a market where financial instruments (or claims) are exchanged or traded
Financial Instruments are issued by entities to raise funds with a promise to make future cash payments.
Entity that issues financial instrument and makes promise of future payments is called the issuer.
Investor is the holder or person in possession of these instruments.

Issuer
(companies)

Issue financial instrument

Investor
(securities holder)

CLASSIFICATIONS OF FINANCIAL MARKETS

1. Types of financial claims traded
Debt market : obligation to make periodic interest payments
Equity market : interest ownership in a corporation
2. Maturity of claims
Money markets : short term instrument (e.g. commercial paper, certificate of deposit)
Capital markets : intermediate/long term debt and equity securities
3. Those dealings with financial claims
Primary market : newly issued; company receive cash proceeds
Secondary market : exchanging financial claim previously; company doesnt receive any fund
4. Organizational structure
Organized market(auction) : secondary market; highly organized in trading floors
Over the counter(dealer market) : new company or those who fail to get listed in main board
5. Delivery mechanism
Spot market/cash market
Future market
IMPORTANCE OF FINANCIAL MARKETS
Aloe buyers and sellers to determine price of financial claims
Equivalently determine the required rate of return on different type of financial assets
Allow efficient allocation of funds among financial instruments
Provide mechanism for an investor to sell a financial instrument
Allow risk sharing which lower the cost of capital for various issuers
CHARACTERISTICS OF FINANCIAL MARKETS
Meeting different investors needs
Short-term, medium, and long-term securities
Providing source of finance
Governments, municipals, and private firms
Allocation of financial resources
Higher production and economic growth

TYPES OF GOVERNMENTS SECURITIES

1. Federal government securities
To price other financial securities such as debt obligations
Sold through bidding process and normally bought by banks, insurance and pension funds
Can be issued as
(i) Discounted securities
price below par value
difference between face value and issue price = return to investor
(ii) Coupon securities
Issued with stated rate of interest
Redeemed at par value at maturity
2. Municipal government securities
Issued by state or local governments
Basic types: general obligation bonds and revenue bonds
CORPORATE DEBT SECURITIES
Corporate debt securities are debt obligation of a company.
These include:
(i) commercial paper
It is a money market instrument.
It is a short-term unsecured financial instrument issued by well-known high-rated
companies.
(ii) medium-term notes
It is a medium-term financial instrument.
An unsecured, fixed interest rate and investment grade debt security of well-known
companies.
These notes are offered continuously to investors by a sole agent of an issuer
(iii) long-term bonds
It is a long-term corporate (government) debt security.
It has a fixed or variable interest rate and maturity ranging from 5 to 30 years.
(iv) asset-backed securities
Long-term debt securities that are based on underlying pools of assets.
Pool of assets might consist of current receivables such as mortgage payment or
future receivables such as export payments.
CORPORATE EQUITY SECURITIES
Common stocks (or shares) are corporate equity securities.
Holders of equity securities are entitled to the earnings of the companies. These earnings are
distributed in the form of dividends.
A preference stock is another type of a corporate equity security that pays a fixed percentage of
dividends.
KEY INPUTS FOR VALUATION OF CORPORATE EQUITIES
1. Cash flows/returns
2. Time period
3. Measure of risk
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VALUATION MODELS
1. Dividends Growth Model
2. Capital Asset Pricing Model
3. Arbitrage Pricing Model
4. Bonds Yield to Maturity
CONDITIONS TO ENHANCE MARKET EFFICIENCY
Availability of information
No transaction cost, tax or other barriers to trading
Market demand and supply determine stock prices
All participants pursue profit maximization
TYPES OF MARKET EFFICIENCY
1. Weak form
The current price reflects the information contained in all past prices.
2. Semi-strong form
The current price reflects the information contained not only in past prices but all public
information (including financial statements and news reports)
3. Strong form
The current price reflects all information public as well as private.
MALAYSIAN FINANCIAL MARKET
1. Money market
Inter-bank market (Islamic Inter-bank market)
Government securities market
2. Capital market
Stock market
Corporate bond market
3. Islamic capital market
Islamic funds
Sukuk
Islamic forward contracts
4. Derivative market
Future derivative
CAPITAL MARKET
Sources of long-term finance for the Malaysian companies and government.
Refer to stock market and bond market.
Primary market: A company issue shares for the first time to investors- initial public offering (IPO)
Secondary market: Investors buy and sell already issued shares (such as ordinary shares) in the stock
exchange
ISLAMIC CAPITAL MARKET
Follows Shari'ah principles in all financial dealings.
Malaysian Islamic capital market has become an important source of short-and long-term finance for
the companies and government such as Sukuk.
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