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Capital Markets

Capital markets sustain capitalism as enterprises draw from them to fund their needs especially anything that requires capital: building a factory, making a working space, funding warehouse storage, investing in transportation, supporting research etc. Capital comes from a variety of sources: pension funds, insurance companies, banks, foundations and universities.

There are two main types of asset classes in capital markets: equity and debt. Equity/Shares are a form of ownership of the company and investors receive a return based on dividends or an appreciation of the stock price. Bond or fixed income investors of a company are not owners but act as lenders to a company for which they get interest payments. As a result, they are considered creditors of the enterprise, they have a claim on the business, and their investment is less risky. If a company falls into bankruptcy, the bondholders will get paid first, and equity holders are paid the last.

Shares (Stocks)

Equity members own a percentage of the corporation based on the current valuation of the organisation (they can be in privately and publicly traded enterprises). Shares can be split into tiers/classes depending on ownership rights. You may hear the terms Class A or B shares, each having different types of rights. The owner receives a stock certificate to officialise ownership, detailing the intricacies of share quantities owned, the ownership rights, the class of stocks, etc.

When the stock market and other capital markets allow investors to buy and sell stocks continuously, it is called providing liquidity. Well-known large enterprises generally have a more liquid stock (lots of buyers and sellers at any one time) compared to small companies.

If the stock price goes up, the valuation of equity assets appreciates and the shareholders become wealthier. Predicting the direction of the stock price, whether it is going to go up or down, requires complex analysis. Highly paid equity analysts spend their career trying to do this with varying levels of success. In essence, it is a judgement call on the future of a company concerning its revenue and profit potential. When a corporation is viewed as highly valuable, i.e. they have done something world changing like when Apple launched the iPhone or Google established search, analysts perceive that the company is building a valuable franchise in the marketplace and the stock price will then appreciate as there will be more buyers than sellers of the stock. If the company is perceived as failing the stock price will fall. Here the stock price at any one moment is the collective judgement of millions of players about the value of the company.

External factors also impact the stock price. For example, interest rate trends influence multiple stock prices simultaneously. Rising interest rates tend to depress stock prices, partly because the cost of borrowing has gone up, and can foreshadow a general tightening of economic activity; and partly because they entice backers to draw away from equity investment and to consider interest-bearing investments. Conversely, falling rates, often lead to higher share prices, because they suggest cheaper borrowing costs.

Stockholders are rewarded in two different ways. Some companies pay significant dividends, offering investors a steady income, while others are focused on appreciating the stock price.

Bonds (Fixed Income)

Bonds/ Fixed Income are types of debt and refer to any investment under which the borrower must regularly make repayments on loan. To illustrate, a loanee returns an established rate of interest rate annually and repays the principal amount on maturity. Bonds can be contrasted with equity securities that create no obligation to pay dividends or any other form of income. They are like loan documents representing an agreement to return money loaned at a given date or dates in the future. While waiting for the payment, one receives interest payments at fixed rates on specified dates. Holders can sell bonds to someone else before they are due. In fact, there is a liquid market for certain types of bonds especially. Corporations have a tax advantage in using bond finance or any other type of debt, as interest payments are considered to be a tax-deductible business expense.

There are also other types of finance that are available for companies, such as bank overdrafts and short-term loans. They can also raise capital with the loans secured against assets like equipment, buildings and inventories.

July 12th, 2017

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