CAPITAL MARKET COMPONENT OF FINANCIAL MARKET

Theme 1

Subjects
1.1. Theoretical approaches to financial market and capital market 1.1.1. The concept and structure of financial market 1.1.2. The concept and structure of capital market 1.2. Supply and demand on the capital market 1.3. The functions of the capital market 1.4. Types of the capital markets 1.5. Securities - instruments of the capital market
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A. Obligatory bibliography
Legea Republicii Moldova privind piaa valorilor mobiliare. Nr.199-XIV din 18 noiembrie 1998. Republicat: Monitorul Oficial nr.183-185/655 din 10.10.2008. Law on securities market Anghelache G. Piee de capital i burse de valori. Bucureti: Editura Adevrul, 1992, p. 75-120. Ciobanu Gh. Bursele de Valori i tranzaciile la burs. Bucureti: Editura Economic, 1997, p.127- 135. Drgoescu E., Drgoescu A. Piee financiare primare i secundare i operaiuni de burs. Cluj-Napoca: Editura Humanitas, 1994, p. 19-42. Stancu I. Finane. Bucureti: Editura Economic, 1997, 720 p. Hincu Rodica, Munteanu Nina, Roca Marcelina, Iordachi V., Baxan T., Conencov O. Bazele funcionrii pieei de capital. Manual. ASEM, Chiinu 2012
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1.1. Theoretical approaches to financial market and capital market

1.1.1. The concept and structure of financial market

Definitions of financial market

financial market represents an institution or arrangement, which facilitates the purchase or sale of goods and services that are called financial assets; financial market includes all relations concerning the issue, circulation, exchange and direct storage of money, directly performed through its special instruments, in order to support all economic and social activities with capital necessary for the functioning and development of goods and services production

financial market is the place or the whole set of communication means, which facilitate the sale and purchase of non-bank financial assets at prices fixed according to supply and demand and the influence of economic, financial, monetary, psychological and technical factors.
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 From the point of view of negotiated assets and the mechanism by which they are introduced into the economic circuit, the financial market consists of three main sectors, organized as separate markets: banking market; money market; capital market.

Banking market
is characterized by transactions with nonnegotiable bank assets with high level of liquidity. Banks act as intermediaries between the owners of cash availabilities and users of funds, in base of credit relations.

Money market
is characterized by transactions with shortterm financial assets made by financial companies.

Capital market
is specialized in transactions with medium and long-term financial assets.

 Since there can not be made a strict distinction between the capital market and financial one, these two markets being interdependent (by including or supplementing each other),

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Anglo-Saxon concept, financial market includes:

capital market money market

insurance market (In some specialized sources)

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The Continental-European concept, defines the term of capital market through the assembly consisting of:
money market financial market mortgage market

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In some specialized sources

there are opinions that the financial market can be identified with the capital market.

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The plural of "financial markets" suggests that in a market economy, regardless of its level of development, there exists a system of financial markets, as:

the system of financial markets in the United States of America; the system of financial markets in Canada; the system of financial markets in Romania.

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The system of financial markets in the United States of America consists of two or more markets, according to the adopted criterion.
The first criterion concerns duration of the placement, resulting in: money markets for trading short-term debt instruments; capital markets that allow negotiation of long-term debt instruments and ownership instruments. The second criterion respects the nature of traded asset that determines the following types of markets: the stock market, bond market, goods/commodity market, currency market, options market, futures market.
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The system of financial markets in Canada does not respect a certain criteria and contains:
tangible assets markets and financial assets markets; spot market and futures markets, including options; money markets; capital markets; mortgage markets; regional and local markets; primary markets; secondary markets.
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Synthesizing the approaches of the financial markets components, there can be concluded the following:
there does not exist a unique system of financial markets that is unanimously accepted by all national economies; the number of financial markets depends on the degree of development of a market economy; although a distinction between real assets and financial assets exists, the financial market, in some countries, also includes mortgage market and even the real estate market (Canada).
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The financial market embraces two approaches:

restrictive approach, limiting negotiations only with non-bank financial assets; liberal approach, which extends negotiation also with real assets.

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 In the Republic of Moldova, according to legislation in force, the securities market (capital market) is a part of non-banking financial market.

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1.1.2. The concept and structure of capital market

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In the specialty literature, there are several definitions of the capital market, such as:
capital market represents the assembly of relations and mechanisms by which is realised the transfer of funds from those who have a surplus of capital towards those who need it, through specific instruments (issued securities) and specific operators (for example, professional participants of securities market, including companies for financial investment services, etc.); capital market represents the place or the whole set of communication means that permit the issuance and negotiation of securities by intermediaries (authorized persons) at a regulated price named face value and, respectively, at a market price set according to supply and demand.
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The elements of the capital market

the place of transaction, formed by the whole set of communication means among operators (OTC market) or among the operators and an institution called the stock exchange; subject, comprising securities (synonym for financial assets); operators, consisted by intermediaries: legal entities (for example, securities companies in Romania); authorized individuals (for example, agents of financial investment services and stock brokers); specialists (market-makers); operations, which, in logical comprehension, form a set of activities, called transactions or investment.
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In some specialized sources, the capital market is treated like

"is specialized in performing transactions with financial assets for medium and long-term maturities."

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.1. Fig

The structuration of capital market (as part of the financial market)

Capital Market

Primary Segment Capital supply Capital demand

Secondary Segment

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Primary (capital) market

serves for placement of issued securities on the internal capital markets, as well as on the international capital market to attract financial capital available on the medium and long term.

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The secondary market.

represents, the modality how to concentrate in one place, private or institutional investors who can buy and sell securities with the guarantee that they have a value and can be reintroduced at any time in circulation.

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The secondary market provides to operators the following advantages:

- offers information about the product to be traded; - information about the product and issuer is distributed towards investors; - offers information about the level and movement of market price.

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Secondary market objectives are:

- investors protection, achieved through transparency, regulation and supervision of the market; - market liquidity and exchange rate stability.

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Economic agents
4 7

Financial Institutions, including banks

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Capital Market
1 2

Public administration
3

Households

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 The primary segment and secondary segment of capital market are interrelated. Secondary market can not exist without the primary one and, also, the functioning of primary market is conditioned by the ability of the secondary market to achieve the transferability of securities and their conversion into cash.

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1.2. Supply and demand on the capital market

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Movement of funds in the economy can occur through:

indirect financing -by concentration of available funds in banks and use of these resources for crediting the users of funds; direct financing -through the issuance of securities by the users of funds.

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Capital transfers can be achieved in three different ways:

1. Direct transfers of money and securities when a company-issuer (users of funds) sell shares or bonds directly to investors without recourse to intermediaries. 2.Transfers through a dealer (investment house). Dealer serves as an intermediary and facilitates the issuance of securities. 3. Transfers by a financial intermediary (bank, mutual fund, etc.). The intermediary obtains funds by issuing its own securities and then uses money to buy securities issued by some companies.
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The demand of capital comes from several major categories of economic agents, such as:

State and local authorities whose main motivation for applying for funding is financing costs of budgetary deficit, which appear on market by issuing bonds. State companies that require the available funds for own investment needs in different sectors of the economy. Private business entities, which are calling on the capital market both within the process of their creation and during the development of business by issuing shares to finance the equity capital, and bonds to finance the loan capital. Financial companies, including banks, that use investors' funds to finance their assets, and their primary role is to facilitate the circulation of capital, thus, ensuring the financial market liquidity.
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 Exponents of demand are debtors on financial market. They can be grouped as follows: depending on activity (central and local administration; public and private companies without financial profile; commercial banks and other financial institutions; central monetary institutions; etc.) depending on purpose (industry and municipal economy funding; transport and public services financing; banks financing; international organisations financing; etc.).
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From the point of view of capital needs, demand may be structural and cyclical.
Structural demand is determined by the need to finance some economic activities in different sectors of activity (to support business development or creation of new businesses, entries on new markets or into related branches, etc.) and supposes the raising of funds, which are repayble either on medium and long term, or in form of participation in future earnings.
Cyclical demand is the effect of insufficiency or unavailability of internal resources, excessive restrictions on credits granting, financial needs generated by the budget deficit and balance of payments. The demand is disturbed by several factors, such as: price fluctuation, interest rate augmentation, non-reimbursement of credits at maturity.

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 Supply of capital comes from savings, i.e. everything that remaines at the holders of income, after they satisfy their consumption needs

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 Natural persons and legal entities who have such savings, can make real investments and/or financial investments.

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1.3. The functions of the capital market

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Conditions imposed to capital market:

liquidity, efficiency, transparency, correctness, adaptability.

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Liquidity
consists of the existence, on the primary capital market, of a large volume of available funds (supply) and of the need for direct financing (demand). On the secondary capital market the liquidity is ensured, partially, by the existing liquidity on the primary market, and by the volume of transactions.

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Efficiency
consists in the operational performance at lower costs of issues on primary market and the transactions on secondary market.

Note: This condition influences the degree of the market liquidity.

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Transparency
consists in a direct and prompt ensuring of correct information to investors

Note: It determinesthe increase of the supply of funds on the primary market, of the volume of transactions and efficient functioning of the capital market.

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Correctness
is based on rigorous regulation of capital flows in the economy, and of transactions performed on the market.

Note: This condition eliminates the trends of market manipulation, reduces the risk of transactions and ensures the fulfilment of the other four conditions.
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Adaptability
indicates the degree of adaptation of elements of the capital market to economic and financial conditions in the country where they are located, as well as to international ones.

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The functions of the capital market

main functions and auxiliary (secondary) functions.

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The main functions of the capital market are:

attracting savings of population; ensuring the participation of legal entities and natural persons to companies capital; facilitating the meeting of the demand and supply of capital; reorientation of the capital flows and the reorganization of sectors of national economy; representing a barometer of national economy and the world economy.
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Attracting the savings of the population

is subordinated to the need of funds of the economic agents, financial and banking institutions, state and natural persons. One of the possibilities to satisfy this need is the issue of securities on the primary capital market and, subsequent, sale of the possessed securities on the secondary capital market.

Note: Decision of population to invest the excess of revenues on the capital market arises from comparing the return of this investment with the return on other capital investments, for example, term deposits in bank 48 accounts, buying currency etc.

Ensuring the participation of legal entities and natural persons to share capital of joint stock companies

is represented by distribution of share capital in form of stock on the capital market.

Note: Persons who bought these titles become shareholders and influence the financial results of joint stock companies by decisions taken within the General Meeting of Shareholders and Board of Directors.
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Facilitating the meeting of demand and supply of capital

is a function that explains the use of the market s notion. On primary market, the need of funds (creation, increasing of share capital, recourse to loans) of economic, financial, banking societies, state is met with the availability of funds (available capital).

The secondary capital market, with its two components: the stock exchange and the OTC, facilitates the meet of supply of securities in circulation that is proposed by owners, who want to liquidate the investment, with demand for securities, required by capital owners who want to become investors or to gain from evolution of securities prices.
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Reorientation of the capital flows and the reorganization of sectors of national economy is achieved, practically, through the following actions specific to the capital market:

reflection of the performance of securities issuers related to price that allows investors to abandon e the financial securities of unprofitable issuers and to make investments in profitable ones, supplying them with funds; underestimation of new enterprises whose securities are purchased to the detriment of others, supplyiung them with funds and bringing to real value by increasing the equitys prices (eg, computer companies in the U.S.); facilitation of purchasing of one company by another one.
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Barometer of national and global economy.

This function is suggested by the evolution of financial securities prices, the adoption of a specific index - the market index - or an international index and their evolution. The trend of the index reflects the trend of the economy.

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The auxiliary functions of the capital market

investment facilitation; risk reduction of financial investments; gains obtaining as a result of capital investments from price evolution of financial securities.

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Facilitating investment
is a corollary of the function for the restructuring of the sectors of national economy by transformation of funds kept by legal entities and natural persons into securities issued by companies, which carry out investment programs.

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Reducing the risk from investment in securities

is a relatively recent function of the capital market. It is achieved by regulation and performing of transactions with derivatives securities (futures, options, etc.). These transactions allow to change the position in such a way, as the purchase or sale of primary securities that might generate losses to investor, to be doubled with the purchase or sale of derivatives on the same security that, depending on price evolution, would permit the reduction of the risk of loss.

Note: This function specific to the secondary capital market should be valued with prudence not to cause stock exchanges crashes and minicrashes
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Facilitation of gain
is a function that occurs at shorter or longer intervals. This unique purpose - achievement of the greatest possible gain - is the result of arbitrage and speculative transactions.

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1.4. Types of capital markets

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 The capital market is divided into several components. The most used criteria to delimit the components are: the nature of the issued and traded securities; the territorial organization; the nature of operations.

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Primary capital market

Stock market Bond market

Primary securities market

Derivativ Secondar y capital market Options market es securitie s market

Futures market

Stock Exchang e

OTC market

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Depending on the nature of securities

bond market. stock market options market. futures market.

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Depending on the territorial organization,

decentralized capital market national capital market regional capital market international capital market

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Depending on the nature of operations

primary capital market secondary capital market

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Secondary capital market is divided, usually, in two markets:

institutional market (stock exchange), negotiations market or the counter market (Overthe-counter - OTC). (This market can be also called an off-exchange market)

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 Secondary capital market can be also classified according to the following differentiation criteria: continuity of market; way of communication; Location of the negotiations floor wide property of market and access of operators (in some sources, the institutional solution chosen for the establishment and operation of secondary capital markets); Way of negotiations; Moment when contracts are executed.

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Continuity of market:
intermittent markets continuous markets mixed markets

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way of communication, for the conclusion of transaction:

open outcry, Electronic,

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Location of the negotiations floor:

centralized markets. decentralized markets

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wide property of market and access of operators (in some sources, the institutional solution chosen for the establishment and operation of secondary capital markets):

private markets (according this principle the major modern markets operate, of Anglo-Saxon origin), State markets. mixed markets

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Way of negotiation:
auction market negotiation market

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Moment when contracts are executed:

spot market (cash market) forward market (futures market)

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1.5. Securities instruments of the capital market

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The main ways for obtaining additional capital are the following:

increasing of share capital through stock issue; contracting a loan through a bond issue; contracting a bank credit.

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 In the case when a public recourse is made in order to obtain financial resources through the issuance of shares or bonds, the issuer companies fall within the capital market and the products offered to investors (shares, bonds, etc.) are called securities.

Note: In the romanian specialized literature, the following notions are met: valori mobiliare, hrtii de valoare, titluri financiare.
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 Financial securities have a certain value. Therefore, in German literature they are called "wertpapier" "securities". Financial securities certify the existence of a contractual (guaranteed) relationships between the issuer and the holder and guarantees the rights for its owners. Therefore, in the Anglo-Saxon literature, they are called "securities" ("/guarantees"). Financial securities allow the conversion of certain transferable securities, in their essence, into securities, by their nature, (i.e. shares). Therefore, in French literature, financial securities are called "valeurs mobilieres".
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A security is defined, according to Law of Moldova on the securities market, no. 199-XIV of 18.11.98, as Securities are financial instruments certifying the proprietary and related thereto personal non-proprietary rights of one person with respect to another which may not be exercised or delegated without presentation of a specified document or without having an appropriate entry in the registry of nominative securities holders or in the records of a nominal holder of the securities.
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A definition of securities, generally accepted, is:

Securities are negotiable instruments issued in materialized form or evidenced by entries into account, which provides to its holders non-property and property rights on issuer, according to law and in conditions specific to their issue.

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The characteristics of securities:

negotiability. Reveals the possibility of transmission of securities to other persons at a price set on the demand-supply mechanism, respecting the imperative prescriptions of the legislation in force; literalness. Respresents the stipulation of the rights and obligations of securities holders; formality. Denotes the property rights (ownership right, dividend or interest right, preemption right) and non-property rights (i.e. voting).
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 Securities are, therefore, documents certifying the status of owners and/or creditors and generate effects for holders in accordance with market characteristics.

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Financial securities that are traded on the capital market can be classified according to the procedure of creation, into three categories:

primary; derivatives; synthetic.

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Primary financial securities

Primary financial securities are issued by users of funds:
to mobilize their own capital (also known as proprietary instruments, engl. equity instruments, such as, for example, shares); or to attract the borrowed capital (also are called debt instruments such as, for example, the bonds).

The role of primary securities is dual:

to ensure the mobilization of long-term capital; to grant rights on the cash income of the issuer.
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Derivative securities
are stock exchange products arising from contracts concluded between the issuer (seller) and recipient (buyer) and which give to the latter rights over some assets of the issuer at a future maturity, according to conditions stipulated in the contract.

Derivative securities are of two types: futures and options.

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Synthetic products
result from the combination, by the financial corporation, of different financial assets and creation of a new placement instrument.

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International Standards Organization in ISO 10962, groups securities in two levels:

1st level, by nature of legal relations of rights and obligations called categories; 2nd level, categories according to specific rights and obligations called groups.

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Categories of securities in accordance with ISO 10962

Property instruments Debt instruments Rights Financial instruments representing property/ownership relation and interest in an economic unit or a pool of assets (eg., Shares) Financial instruments that show the money owed by the issuer to the holder, under specified conditions (eg., Bonds) Financial instruments that give to the holder the right/privilege to subscribe or to receive specific assets under specified conditions Contracts that guarantee to the holder the right to buy or sell a specific asset at a specified price on or before a fixed time in the future Contracts that require the buyer to pay and the seller to deliver the specific assets at a predetermined price at a fixed date in the future Financial instruments not falling within the categories specified above 84

Options

Futures

Other

On the 2nd level, those 6 categories are detailed on groups of securities. For example, the category of property instruments is divided into 5 groups:

ordinary shares; preferred shares; convertible shares; certificates of investment funds; others.
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 For the capital market from Republic of Moldova, grouping of securities is treated according to the Law on Securities Market, no. 199-XIV of 18.11.98. Accordong to this law, the main components of securities are shares and bonds.

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In the Republic of Moldova, the securities are issued in form of:

materialized nominative securities; dematerialized nominative securities.

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Materialized securities circulate in form of certificates that authenticates the rights conferred by securities.
A security certificate must contain: identification dates of the issuer; type and class of securities, certified by the certificate; state registration number; number of securities, authenticated by the certificate; name, surname (full name) of owner of securities (for nominative securities certificates); the obligation of issuer to ensure the rights of securities holder; number of the certificate; stamp of the issuer; the signature (facsimile of signature) of executive president of the issuer and signature of person that issued the certificate; other information specified by law/legislation for a specific type of securities.
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 Dematerialized nominative securities are issued in book-entry form in personal accounts of registered persons, including on digital support.

Note: For dematerialized nominative securities as a document confirming the rights offered by the security serves the decision on the issuance of securities and statement from the register.

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Questions for discussion and case studies

Analyzing the structure of capital market in Republic of Moldova, explain their affiliation to one of the approaches concerning the financial and capital markets structure. Explain the difference between structural and cyclical demand on capital market from Republic of Moldova on concrete examples. Develope two schemes, which would represent the circuit of financial assets on financial and capital market, according to those two approaches: European and Anglo-Saxon.
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