fins2618 W7 (Q's)
. Why is it important to maintain modern and efficient stock exchanges?
· stock exchanges → highly competitive (within home country and international markets) → SE provide market where companies may become listed corporations → corporations listed on SE = principal drivers of economic growth within a country → SE = facilitates efficient access to large amounts of equity funding essential for a corporation → this includes: listing of ordinary shares, hybrid and debt securities. • modern and efficient stock markets, incorporating deep and liquid primary and secondary market → encourages investors to provide investment capital to corporations → if investment capital used wisely → should lead to prosperity, plus increased economic growth → efficiency of a stock market = measure of how quickly new information is absorbed by the market and reflected in changes in share prices.
Outline the regulatory structure and the responsibilities of the main supervisors of market integrity and market participants' behaviour in Australian stock exchanges.
• ASIC has responsibility for supervision of real-time trading in domestic licensed markets → responsible for enforcement of laws against misconduct, and supervision of financial services licence holders → also, maintains integrated surveillance system → breaches of rules enforced by disciplinary panel. • ASX → monitors continuous disclosure through its own compliance subsidiary → may impose penalties, suspend or delist corporation and forward formal report to ASIC for further action. • RBA → monitors licensed clearing and settlement platforms and systems in order to ensure financial stability and reduce systemic risk in financial system.
Most developed or developing countries seek to establish modern and efficient stock exchanges. a. Identify and discuss the five principal functions of a modern and efficient stock exchange.
1. establishment of markets in range of financial securities includes: → primary and secondary markets in equity (ordinary shares) → listed debt securities (preference shares, convertible notes, subordinated debt) → derivatives (options, warrants, futures) 2. provision of securities trading system → most modern and efficient stock exchanges have implemented electronic trading systems e.g. ASX Trade platform → buy/sell orders placed into ASX Trade by authorised brokers → system matches orders and executes trade. 3. operation of a clearing and settlements system → global competitive forces require exchanges to settle stock transactions within T+3 days → this time line may be reduced even further as systems become even more efficient → system used by the ASX = CHESS → CHESS instantaneously records transfer of ownership and facilitates financial settlement of transaction → thus, removing possibility of settlement risk. 4. regulation and monitoring of integrity of exchange's market → efficiency and integrity of the market = important → ASX has own listing rules → exchange monitors behaviour of listed companies and authorised brokers → is able to apply penalties including delisting a company or revoking licence of a broker. 5. provision of well-informed market to secure confidence of all participants → price of a share = function of available information about that stock → changes in current price will be in response to new information coming into the market that will impact the future performance of the listed entity → essential that continuous disclosure of material information advised to the exchange immediately.
11 Woodside Petroleum Limited is considering issuing debentures in the capital markets and having the debt debentures quoted on the fixed interest market of the ASX. a. As the chief financial officer for Woodside you have been invited to explain the issue to a group of investors. Prepare a list and explain the advantages to both Woodside and the potential investor in having the debentures listed.
1. transparency — stock exchange keeps markets informed 2. ease of entry and exit — deep and liquid market using electronic trading (ASX Trade) and settlement systems (CHESS) 3. liquidity — existence of price makers and large pool of investors 4. listing increases corporate image and profile in financial markets 5. receipt of a known income stream, being interest coupons 6. investment option for surplus funds 7. strategic investment option to manage interest rate risk exposures 8. opportunity to diversify an investment portfolio.
a. Using the example of the trading and settlement platforms used by the ASX, explain the process whereby one investor places a buy order for 1000 Rio Tinto Limited shares and another investor places a sell order for 1000 Rio Tinto Limited shares; both orders at market price.
• ASX operates technology based trading platform (ASX Trade) and settlements system (Clearing House Electronic Sub-Register System—CHESS) → combination of ASX Trade and CHESS form basis of ASX's strategy to remain an efficient and competitive international stock exchange. • if stockbrokers receive order to buy RIO shares and another to sell RIO shares → stockbroker initiates buy/sell orders of clients by entering orders into ASX Trade platform i.e. buying and selling of shares is facilitated by a CHESS sponsor such as a stockbroker → • ASX Trade matches buy and sell orders then initiates transaction → • under CHESS arrangements, SH no longer receive and hold a share certificate → instead hold uncertificated securities = electronic record of shareholdings. • current CHESS arrangements require settlement of share transaction to occur in two days (T + 2).
7 Explain the difference between an ETF and an active ETF.
• ETF = exchange traded funds • ETF offered through stock exchange e.g. ASX invest in: → basket of securities listed on the ASX → securities listed on an international stock exchange → foreign currencies → commodities. • investors purchase units in an ETF (units in an ETF bought /sold through stock exchange exactly the same as ordinary shares) → • traditional ETF → investors = diversified portfolio of shares because fund manager seeks to track performance of a benchmark stock exchange index e.g. S&P/ASX200 → funds raised from sale of units in the ETF used to purchase a securities portfolio that replicates specified index e.g. the ETF would hold all or majority of shares included in the S&P/ASX200 index • different to active ETF • active ETF = does not track performance of index instead, tries to outperform that benchmark → manager will use various buy/sell strategies to generate rate of return in excess of benchmark index. • Passive ETFs = like following a recipe to bake a cake. You have a list of ingredients and specific measurements. Similarly, passive ETFs track an index and aim to achieve same returns by holding same or similar securities in same proportions as the index. • Active ETFs = like a chef who creates their own recipe. They have flexibility to experiment with different ingredients. Similarly, active ETF managers have flexibility to make their own investment decisions and use various strategies to outperform benchmark index.
With a CFD it is possible to lose many times the initial investment amount. Explain why this circumstance can arise.
• contract for difference (CFD) = type of financial contract traded on a stock exchange → an agreement between buyer and seller agreeing to exchange difference in value of CFD at the end of the contract → @the end, buyer receives difference if value has increased • difference in value = (valueCFDcontract T1) - (value T0) • CFD may be based on nominated security listed on local or international stock exchange, stock exchange indices, foreign currencies or commodities. • CFD → high level of leverage for investor = control large position with relatively small initial investment → CFD buyer only pays deposit/initial margin i.e. does not pay full value of underlying shares → therefore, may take on larger exposure to market i.e. more of underlying security can be bought or sold because full payment is not required • investor may use CFD to go long in a rising market, or go short in a falling market → if underlying security of CFD rises = profit, but security falls = loss → however, risks associated with leverage = much higher because full gain or loss associated with underlying security will be made when CFD is closed out. • investor might invest $5000 • if there's an adverse price movement = investor might lose this initial investment and, potentially, much more → not out of the question for the investor to lose $20,000 or more under some circumstances → this = direct consequence of leverage involved.
Briefly explain the concept of corporate governance within the context of a corporation. What is the relationship between corporate governance and the so-called agency problem?
• corporate governance → relationships that should exist between SH, BOD and executive management → clear responsibility and reporting structures established → ensure accountability and transparency = integral part of corporate culture → AND to facilitate long-term survival and maximisation of SH value → maximisation = presumes BOD establishes appropriate objectives/policies & management implements strategies to increase value → BOD → must implement policies aligning interests of management with those of SH → corporate gov, in part, to address potential agency problems. • agency theory → potential problems from separation of ownership and control → managers control day-to-day not necessarily act in best interests of SH → e.g. managers maximise own benefits at expense of the SH, such as increasing staff levels for prestige and power, extending management remuneration schemes, increasing sales at expense of profitability and sustainability.
b. Briefly describe the main characteristics of a debenture.
• debenture = corporate bond that pays regular periodic interest payment (coupon) and principal repaid at maturity. • debenture = secured security with fixed and floating charge over assets of issuer. • debenture may be a straight corporate bond that pays a fixed interest coupon or a floating rate notes that pays a variable interest rate based on published reference rate.
An investor with a small amount ($15 000) to invest wants to gain exposure to the commercial property market in Australia. What sort of investment product is appropriate?
• investor can invest in real estate investment trust (REIT). • investors buy units in listed trust → gain access to diversified real estate portfolio that otherwise would not be possible for the average investor e.g., investor may purchase units worth $15 000 in a REIT whereas, with that small amount, the investor could not purchase property directly. • type of property held in a REIT → specified in fund's trust deed and may include industrial, hotel and leisure, retail and office properties. • investors may benefit from both capital gains on property assets plus rental income generated by the properties. • units in listed REIT = much more liquid than underlying property; that is, easier to sell units than sell the property held in the trust.
An investor currently holds shares in Amcor Ltd. The investor is worried about a decline in the price of the shares. What sort of instrument can the investor use to hedge the investment?
• investor can use a put option to hedge investment. • put option → gives investor right but not obligation to sell shares in Amcor at specified price, known as strike price → when price of underlying asset, in this case, share, declines → value of put option increases → because it becomes more likely that holder can the shares for a profit at the higher strike price. This makes the put option an effective tool for hedging against potential losses in a portfolio that includes the underlying shares. • put option → increases in value as price of underlying share declines → therefore, investor who holds both share and an appropriate position in the put options will find their portfolio value is hedged against a decline in the share price.
b. What is meant by the liquidity of the share market? Explain why liquidity in the secondary market is important both to shareholders and to the corporation.
• liquidity in share market = ability of a holder of a security to buy or sell listed securities without unduly disturbing current market price of shares traded. • standard measure of share market liquidity = turnover:market cap • market cap = number of shares on issue * current market price. • liquidity in secondary market for shares → encourages investors to initially purchase new issues by corporations → liquid share market = advantages to investor (shareholder) and corporation because it facilitates raising of long-term capital while providing short-term liquidity to investor. • SH = confident that shares may be quickly sold without incurring capital loss as a direct result of the sale transaction (capital loss/gain may result from other factors such as company performance outcomes).
a. It may be argued that information is the life-blood of an efficient stock market. Explain this proposition. b. Within the context of the ASX, explain the requirements and purpose of continuous reporting. c. Identify, using examples, different pieces of information that are regarded as being material and therefore should be reported to the stock exchange.
• listed corporations raise equity funds and part of their debt funds through issue of securities on a stock exchange → investors purchase these securities because they have confidence in the operation of the primary and secondary markets on the exchange → current price of a security reflects all known information relevant to that stock → stock price changes in response to new information → therefore, efficiency at which information is provided to market and speed at which it is absorbed directly affects pricing of listed securities. • once an entity is aware of any information concerning corporation (that a reasonable person would expect to have a material effect on the price or value of the entity's securities) → the entity must immediately tell the ASX → Corporations Act states: a reasonable person would consider information to be material if it likely influence persons who commonly invest in securities in deciding whether or not to subscribe for, or buy or sell, the securities → the purpose of continuous reporting: ensure market participants are quickly and accurately fully informed so appropriate investment decisions are made. different information to be reported: 1. change in corporation's financial forecasts or expectations 2. appointment of a receiver, manager, liquidator or administrator 3. transaction for which consideration payable or receivable is a significant proportion of written down value of entity's consolidated assets 4. recommendation or declaration of dividend or distribution 5. notice of a takeover bid, or an intention to buy-back issued shares 6. proposal to restructure capital base 7. intention to issue equity options, or vary exercise price on existing options 8. notice of general meetings of SH, including motions to be put to the meeting and corresponding outcomes 9. any change of address of corporate office or share registry 10. change in the chairperson, directors and auditors 11. copies of any documents forwarded to SH 12. disclosure of directors' interests 13. recommendation or decision that a dividend or distribution will not be declared 14. under subscriptions or over subscriptions to an issue 15. copy of financial documents lodged with an overseas stock exchange or other regulator which is available to the public.
The private equity market is an alternative source of equity funding for business. Explain how this market typically operates.
• private equity funding → usually provided to higher risk companies → that often do not have adequate collateral or profit performance to attract investors within normal share market or banking sources of funds. • private equity market funding → usually directed towards: → start-up funds for new companies to allow business to develop products and services → business expansion funds that allow growth of current business operations → recovery finance for companies that are currently experiencing financial difficulty → management buy-out financing where existing company managers seek to buy existing business funded, in part, with private equity. • majority of private equity → provided through funds established for this purpose i.e. funds specialise in seeking out and analysing potential private equity opportunities or targets. • major providers of funds for private equity funds: superannuation funds and life insurance offices → these institutional investors seek to increase overall return on large investment portfolios by including proportion of higher risk investments. • investment horizon of private equity investors = often < 5-7 years. • private equity = limited liquidity = cannot be sold through share market → a principal objective of private equity investors = significantly improve profit performance of company so the company can be listed on stock exchange through IPO → alternatively, investors may seek to break-up company and sell component parts to achieve a return on investment. • private equity funding usually grows in times of sustained economic growth → & in times of economic downturn, new private equity funding may fall significantly.
The 'publicly listed corporation' is viewed as one of the most important innovations in the history of economic and financial development. Outline the advantages and disadvantages of the publicly listed corporation OR Smiles Inclusive Ltd is one of the newest public companies to list on the Australian Securities Exchange. Identify and discuss the rights, roles and responsibilities of Smiles Inclusive's shareholders, board of directors and executive management now that it is a publicly listed company.
• publicly listed corporation → legal entity formed under provisions of Corporation Law of a nation-state → and listed on formal stock exchange. • shares → readily bought and sold in market without directly affecting continuing existence of business. • liability of shareholders for debts of the business → limited to value of shareholding • large amounts of equity funding obtained more easily through access to stock market. • investors may be willing to purchase shares knowing that stock exchange provides active secondary market for future sale of those shares. • SH can reduce risks of share ownership by holding diversified portfolio of share investments. • separation of ownership (SH) and control (managers) means corporation choose specialised personnel to run business → plan and implement strategic decisions more effectively. • corporate form → allows for continuity → death or bankruptcy of a SH does not impact existence • corporate form → almost essential for large-scale undertakings → corporations gain access to larger and wider range of equity and debt sources of funds → cost advantages of large-scale production = further benefit of corporate form of business organisation. • disadvantages → separation of ownership and control = distance between day-to-day managers and SH has increased → nowadays, management rests in hands of technical experts while SH maintain distant presence i.e. little control over operating decisions → conflicts of interest between managers and SH. ---- • smiles required to comply with relevant legislation and listing rules of ASX → SH has right to vote, particularly voting on resolutions put to a general meeting of the company → as owners of a company, SH do not have right to participate in day-to-day → SH elect BOD (determine objectives and policies) → directors = legal responsibility to ensure operation in best interests of SH → BOD appoints executive management group responsible for achieving specified objectives and policies through management of day-to-day financial and operational affairs → reporting structure: SH > BOD > executive management
a. Discuss the secondary market role of a stock exchange and its importance to the corporation. Illustrate your answer by using examples
• secondary market role of share market = provide organised and efficient market where existing listed securities may be bought and sold at current market prices → current market price reflect performance outcomes and forecast prospects within context of relevant industry sector, and domestic/global economies. • efficient share market i.e. secondary market facilitates transfer of ownership amongst investors and enhances liquidity in listed securities. • securities initially issued through primary market may be subsequently traded through stock market as secondary market transaction → secondary market transactions include: range of securities listed on exchange, including ordinary shares, rights issues, preference shares, instalment receipts, debentures and notes. • economic growth derives from primary market investment; however a successful primary market requires support of a deep and liquid secondary market → because active secondary market encourages investors to purchase new securities → because investors = confident they can quickly sell those securities in the future in the SM at the current market price.
Discuss why a strong primary market is important for economic growth within a country and explain how each of the main participants in the primary issue of securities interacts with each other during the share issuance process.
• stock exchange → facilitates flow of funds through: → primary market issue → secondary market trading of existing securities • primary market role of stock exchange = facilitate raising of capital by PLC through issue of new equity based securities to investors → and primary market issue of new equity = source of capital funds for corporation → these funds allow maintenance and growth → also, primary market issues = facilitate process of converting savings to investment → theoretically leading to accumulation of capital capacity, economic growth, increased production and higher levels of employment. • the interaction of main participants in securities issuance process: → corporations occupy central position in the process (receiving funds from issuance of securities) → underwriters and advisors guide corporations through issuance process and funds flow through brokers from individuals, institutions and overseas investors with surplus funds to invest → process facilitated by stock exchange.
Within the context of the above Rio Tinto share transaction, define and provide examples of the following: • uncertificated shares • share contract note • settlement risk • T + 2 business days.
• uncertificated shares = ownership of stock listed on exchange is recorded electronically e.g. ASX no longer issues actual share certificates • share contract note = advice sent from stockbroker to a client confirming full details of a buy or sell transaction that has been carried out by broker on behalf of the client → includes details of the stock, date, number of shares, price per share, fees and charges, total cost and settlement date • settlement risk = probability that one party to a buy/sell transaction will not fulfil contractual obligations e.g. delivery of stock and transfer of ownership may occur, but financial settlement does not eventuate. • T + 2 business days → settlement of a share transaction when transfer of ownership and value occur on the transaction day plus two days.
