15-the-functioning-of-financial-markets.pdf
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1、CHAPTER 15 THE FUNCTIONING OF FINANCIAL MARKETSby Larry Harris,PhD, CFALEARNING OUTCOMESAfter completing this chapter, you should be able to do the following:a Distinguish between primary and secondary markets;b Explain the role of investment banks in helping issuers raise capital;c Describe primary
2、 market transactions, including public offerings, private placements, and right issues;d Explain the roles of trading venues, including exchanges and alternative trading venues;e Identify characteristics of quote- driven, order- driven, and brokered markets;f Compare long, short, and leveraged posit
3、ions in terms of risk and poten-tial return;g Describe order instructions and types of orders;h Describe clearing and settlement of trades;i Identify types of transaction costs;j Describe market efficiency in terms of operations, information, and allocation.61INTRODUCTIONHave you have ever bought sh
4、ares, bonds, or invested money in a mutual fund? If so, you havewhether you realise it or notbeen served by financial markets. Many investors use financial markets to implement their investment decisions, as reflected by the trillions of financial market transactions each year.Investors buy and trad
5、e securities that are issued by companies and governments that need to raise capital. Markets in which companies and governments sell their securities to investors are known as primary markets. Each type of security has its own primary market. For example, in most countries, there is a primary marke
6、t for shares issued by companies or bonds issued by the sovereign (national) government.Investors also trade securities, such as shares and bonds, as well as contracts, such as futures and options. These trades take place in secondary markets. When trading securities and contracts in secondary marke
7、ts, investors often obtain assistance from trading services providers, such as brokers and dealers. These specialists perform a variety of tasks, which were described in the Structure of the Investment Industry chapter. Well- functioning financial markets are important for economic welfare. Investme
8、nt industry participants must understand how financial markets work; this understand-ing will help them appreciate how the industry connects those who need money with those who have savings and are willing to invest their savings. In this chapter, you will learn how primary and secondary markets ope
9、rate, how investors and traders are served by these markets, and what characterises well- functioning financial markets.PRIMARY SECURITY MARKETSSecondary markets are the main focus of this chapter because most investors buy and sell securities via secondary markets. So, most of the investment indust
10、ry is focused on secondary markets. But, first, we discuss primary markets, which are the markets in which issuers sell their securities to investors. In other words, primary markets are where securities first become available to all investors. Issuers are typically companies and governments; sellin
11、g securities to investors in exchange for cash is a way for these companies and governments to raise money. The main primary market transactions are public offerings, private placements, and rights offerings.2.1 Public OfferingsAs discussed in the Equity Securities chapter, a company that sells secu
12、rities to the public for the first time makes an initial public offering (IPO), sometimes also called a placing or placement. Practitioners say that the company is “going public”. The shares 12Primary Security Markets 2015 CFA Institute. All rights reserved.62offered consist of new shares issued by
13、the company and may also include shares that the founders and other early investors in the company want to sell. The IPO provides founders and other early investors with a means of converting their investments into cash, a process known as monetising. The selling of new shares by a publicly traded c
14、ompany subsequent to its IPO is referred to as a secondary, or seasoned, equity offering. Both initial public and sea-soned offerings occur in the primary market for a particular type of securitiesfor instance, the primary market for corporate bonds. Later, if investors buy and sell this type of sec
15、urities from and to each other, they do so in the secondary market. Note that the issuer only receives additional capital when it issues new securities in the primary market. It will not receive any new capital from the trading of its securities in the secondary market.IssuerIssuerInvestorInvestorEx
16、change/BrokerCash(Capital)Issue New Securities(IPO)Securities (Buyer) orCash (Seller)Cash (Buyer) orSecurities (Seller)PrimaryMarketSecondaryMarketThe issuer receives no cash (capital) in secondary market transactions.Before a public offering, the issuer typically provides detailed information about
17、 its business and inherent risks as well as the proposed uses for the money it hopes to raise. This information is offered in the form of a prospectus to potential investors. Most exchanges and their regulators have detailed rules regarding the format and content of a prospectus.Companies generally
18、contract with investment banks to help them sell their securities to the public. Investment banks play an important role in identifying potential investors and setting the offering pricethat is, the price at which the securities are sold. The role played by investment banks is different, however, de
19、pending on whether it is an underwritten offering or a best efforts offering.The most common offering type for initial public and seasoned offerings is an under-written offering. In an underwritten offering, the investment bank acts as an under-writer. In this role, the investment bank buys the secu
20、rities from the issuer at a price that is negotiated with the issuer, thus guaranteeing that the issuer gets the amount of capital it requires. The securities are then sold at an agreed- on offering price to investors. The objective of the investment bank is not to become a long- term share-holder o
21、f the issuer but to be an intermediary between the issuer and the investors for a fee. Finding investors willing to buy the securities is thus an important aspect of an underwritten offering because it reduces the risk that the investment bank is unable to resell all the securities it bought from th
22、e issuer.In a process called book building, the investment bank identifies investors who are willing to buy the securities. These investors are known in the industry as subscribers. The investment bank tries to build a book of orders from clients or other interested buyers to whom they can resell th
23、e securities.Chapter 15 The Functioning of Financial Markets63In the book building process, the right offering price is particularly important. If there are not enough buyers for all the securities that are for sale, the offering is said to be undersubscribed. If there is more demand than securities
24、 for sale, the offering is said to be oversubscribed. In the case of oversubscription, the securities are often allocated by the investment bank to preferred clients or on a pro rata basis, by which all investors get a set proportion of the shares they ordered.In the case of undersubscription, the i
25、nvestment bank will be left with unsold secu-rities, which not only commits capital for longer than expected but is also risky. If after the public offering, the price of the securities falls below the offering price, the investment bank may face a loss. So, investment banks have a conflict of inter
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