Capital Markets

Capital markets involve equity investments. Equity is more risky for an investor than debt, so has higher average returns, though equity investments have a longer-term time horizon than debt. Equity is more risky as the returns are uncertain and it ranks behind debt in liquidation.

Corporate Debt	Debentures – bonds with collateral over assets (floating charge – over changing assets) Unsecured note – bond with no security Transferrable Certificate of Deposit – long-term
Equity	Ownership interest in a company
Government Debt	Treasury bonds (short-term) or bonds (long-term)
Forex	Trading of foreign currencies
Derivatives	Derive value from underlying asset

IPO

Another form of offering is private placement – to specified investors.

Disclosure requirements exist to inform investors about the deal.

Listing Process

Underwriting	Investment bank (or syndicate) acts as broker between issuer and investors (purchase and resell shares), undertaking due diligence
Pricing	IB and issuer decide price and number of shares – often underpricing to generate over-subscription Valuation as PV of future dividends
Disclosure	Issue of prospectus to satisfy disclosure requirements on the shares being offered and company’s financial position
Application	Application to purchase shares by investors – fees held in trust account
Allotment	The offer from prospective shareholders is accepted by the company, shares are allotted and funds transferred to the company’s bank account.
Call by Directors	Director’s call for remaining amounts
Listing of company on stock exchange	Added to stock exchange

Types of Shares

Ordinary	Common shares giving holder right to income and voting
Preference	Priority in dividends but no voting rights – hybrid debt/equity
Convertible note	Converts from debt ($ amount) to equity (no. of shares)

Raising of Additional Equity for Listed Companies

Additional Equity

Rights Issue	Offer to existing shareholders to purchase additional shares at discount price
Placement	Issue of shares to new institutional investors – dilutes share value for existing investors
Dividend Reinvestment Scheme	Dividends are directly reinvested instead of investors receiving them

Types of Share Issues

Not all types of share issues raise capital for the company.
E.g. issue of bonus shares increases share capital but not cash flow.

Rights Issue	Existing holders have the right to purchase additional shares at a discounted price	Increases share capital, but dilutes value of shares
Bonus Issue	Offered at no cost to existing shareholders	•Increase in number of shares, decrease in price •Shares more affordable to new investors, so price may increase •Expectation of profit as dividends must be paid on each share
Share split	Divides number of shares	Like bonus issue, but split in two
Share buyback	Repurchase and cancellation, using cash	Reduces share capital – used when company is undervalued (increases EPS) or to restructure equity
Share option	Right of holder to buy/sell at predetermined price at later date	Offers flexibility to investors

Issue Process

Disclosure	Prospectus is issued to potential investors
Application	Application fees paid by investors and held in Solicitor’s trust account ( may have to be returned if minimum subscription value isn’t reached). Capital account is credited.
Allotment	The offer from prospective shareholders is accepted by the company, shares are allotted and funds transferred to the company’s bank account.
Call by Directors	Director’s call for remaining amounts

Company Valuation

Valuation Methods

Market Capitalisation	Number of shares x Share price
Revenue/earnings multiplier	Industry multiplier applied to revenue or profit
DCF	PV of future cash flow from: Assets Debt + equity
Market/ Book Value	Carrying value – cost less depreciation/impairment
Realisable/ Liquidation Value	Value on fire sale (less than market value)

Pre-money valuation: prior to investment
Post-money valuation: after investment, equals pre-money valuation + value of investment

Private Equity

Limited and General Partners	Limited Partners – Investors in the fund General Partners – Managers of the fund -Receive a management fee (% of committed capital) -Receive carried interest (linked to performance), only after LP hurdle is surpassed
Capital	Committed Capital – Received from LPs Drawdown – CC used to invest in companies on recommendation of GPs (total is paid-in capital)
Measures	Residual Value – difference between market value of investment and purchase price Cumulative Distributions – amounts paid out to LPs
Formulas	Investment Multiple = RV + CD / Paid-in capital (shows profit and gains as a multiple of cost base) Realisation Multiple = CD / Paid-in capital Residual Value Multiple = RV / Paid-in capital Paid-in Capital Multiple = Paid-in Capital / Committed Capital