CAPITAL MARKET: EQUITY
Islamic funds:
- 200 mutual funds of various categories Shari'ah compliant investment facilities - Operates in Saudi Arabia, the United Arab Emirates, Bahrain, Kuwait, Qatar, Pakistan, Malaysia, Brunei, Singapore, Germany, Ireland, UK, US, Canada, Switzerland and South Africa - Most of Islamic funds are equity funds
In Malaysia, companies are classified as Shari'ah non-compliant securities if they are involved in the following core activities:
- Financial services based on interest - Gambling and gaming - Manufacture or sale of non-halal products or related products - Conventional insurance, entertainment activities that are non-permissible according to shari'ah - Manufacturing or sale of tobacco-based products or related products - Stock broking or share trading in Shari'ah non-compliant securities and other activities deemed non-permissible according to Shari'ah
What Does Equity Market Mean?
- The market in which shares are issued and traded, either through exchanges or over-the-counter markets. - Also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance. - The money received from the sale of shares of ownership in a business is referred to as equity financing.
Financial Sector Master Plan (FSMP)
- launched in March 2001 outlines the medium and long-term strategies for the development of the financial sector.' - objective of the FSMP is to develop a competitive, resilient and dynamic financial system, based on international best practices, which would provide an enabling environment for the long- term economic expansion.
Rights attached to preference shares:
-Before a dividend can be declared on the ordinary shares, any dividend obligation to the preference shares must first be satisfied - The dividend rights are often cumulative - Preference shares may or may not have a fixed liquidation value or par value - Have a claim on liquidation proceeds in the event of a company failure - Have a negotiated fixed dividend amount, either specified as a percentage of par value or as a fixed amount
The other differences between equity and debt financing are
1) Seniority: debt holders have a contract specifying that their claim must be paid in full before payments to equity holders. 2) Tax deductibility: payment to debt holders are viewed as tax-deductible expenses, whereas dividend are viewed as payout of profits, therefore, it is not a tax-deductible expense.
Types of stocks
1. Blue chip - priced high, low volatility, steady stream of dividends, safe investment, little room to appreciate because they are so large 2. Penny - low-priced, speculative, very risky, normally issued by companies with a short and erratic history of revenues and earnings, popular among small speculators 3. Income - pay higher than average dividends, paid by large and established companies with stable earnings such as utilities and telephone companies 4. Value - currently selling at a low price, companies that have good earnings and growth potential but their stock prices do not reflect it 5. Defensive - prices stay stable when the markets declines, issued by industries that naturally do well during recessions, e.g. food and utilities companies 6. Cyclical - move up or down with the business cycle. E.g. housing industry 7. Treasury - a type of stock that has been bought back by the company that issued it, may be because the price is underpriced, set aside for future uses
Main categories of Islamic funds:
1. Equity funds - invest in the shares of joint stock companies and returns are in the form of capital gains and dividends which are distributed on a pro rata basis among investors - neither the principal nor a rate of profit can be guaranteed.
Two types of stock exchange:
1. Physically located and transactions are executed on a trading floor using a method known as open outcry where brokers and traders may submit verbal bids and offers simultaneously (NYSE) 2. A virtual kind where it is equipped with network of computers where trades are conducted electronically through the actions of traders ¢Stock market is often considered the primary indicator of a country's economic strength and development ¢Listing requirements (refer to Bursa Malaysia's website)
Some screening criteria:
1. The capital structure of the investee company must be predominantly equity based (debt less than 33%) 2. The investee company is prohibited from investing in interest-based financial institutions and involve in areas of gambling, alcohol production etc. ¢Equity stocks included in the equity funds need to be compliant with Shari'ah guidelines Decided by Shari'ah boards ¢The most widely used Islamic index to measure Shari'ah compliant investable equities is the Dow Jones Islamic Market indexes
Why do companies go public?
1. To obtain more capital to finance growth - Fast growing companies - Opens to a wider pool of investors - Often perceived as financially stronger and may enjoy better credit rating, enabling to borrow at a favorable interest rates 2. To source long-term capital - Can raise additional capital 3. To allow owners to realize their assets - Floatation allows existing shareholders to release some of their equities as well as raise new capital 4. To make the shares more marketable - Increase liquidity - The market value can be easily determined - Shares can be used as collateral for loans 5. To enable payment of managers by stock options - Incentives to improve performance 6. To facilitate growth by acquisition - Easy to offer own shares for the purpose of acquisition 7. To enhance the company's image - Gives an aura of financial respectability, which may encourage new business contracts 8. To act as a catalyst for the participation of foreign partners - May encourage foreign investment in the company 9. To establish good corporate governance practices - Management is accountable to shareholders who ensure that the company operates in an appropriate manner 10. To boost employee pride Make the employees aware of the company's reputation and encourage them to enhance it
The SC's many regulatory functions include:
1.Supervising exchanges, clearing houses and central depositories; 2.Registering authority for prospectuses of corporations other than unlisted recreational clubs; 3.Approving authority for corporate bond issues; 4.Regulating all matters relating to securities and futures contracts; 5.Regulating the take-over and mergers of companies 6.Regulating all matters relating to unit trust schemes; 7.Licensing and supervising all licensed persons; 8. Encouraging self-regulation; and 9.Ensuring proper conduct of market institutions and licensed persons. ¢Underpinning all these functions is the SC's ultimate responsibility of protecting the investor. ¢ Apart from discharging its regulatory functions, the SC is also obliged by statute to encourage and promote the development of the securities and futures markets in Malaysia.
Privileges and legal rights of ordinary shares
1.Voting privileges ¢Statutory voting Allows using all votes based on the total shares for each of the vacancies for the board of directors ¢Cumulative voting Increases the number of votes that a shareholder can use for a particular candidate, could be apportioned in any way 2.Right to information ¢Reports, audited financial statement, minutes of the meetings of the board of directors, examine the list of shareholders 3.Pre-emptive rights ¢It is the right of existing shareholders to purchase shares of a new issue of the company before they are offered to the public, so that existing shareholders can maintain proportionate ownership of the company ¢Issues subscription rights ( no. of shares and price) 4.Rights to dividends 5.Limited liability ¢Limits the liability of shareholders to the capital they own in the company 6.Residual claim ¢In the case of liquidation...
Rights issue
A company wishing to issue additional new shares A rights issue is an issue of new shares where existing shareholders have pre-emptive rights to subscribe for the shares before other investors
Market-value weighted
A type of index whose individual components are weighted according to their market capitalization, so that larger components carry a larger percentage weighting. A relatively small shift in the price of stock price of a large company will heavily influence the value of the index.
Selling short
A way for investors to make money in a declining stock market by borrowing rather than buying stocks Steps involved: 1.Borrow shares from a broker 2.Sell the borrowed shares, assuming the price of similar shares will drop in a reasonably short period of time 3.Purchase similar shares at a lower price 4.Replace the shares borrowed with the purchased shares
Buying stock on margin
Buying shares but does not pay the full amount. A part of the amount is financed through buying on margin. Must have a margin account with the broker Will need to pay interest on the borrowed amount Investors buy on margin because the financial leverage provided by borrowing money can increase the return on investment But, in a declining market, buying on margin can be a risky strategy
Types of preference shares:
Cumulative preference shares ¢Should there be any shortage of the dividend payment, the arrears are carried forward Non-cumulative preference shares ¢No rights of dividends in arrears Participating preference shares ¢In addition to the stated preferential yearly dividend, the holders possess the right to participate in any further profits after the ordinary shareholders have received their dividends Redeemable preference shares ¢Will be redeemed later by the company Convertible preference shares ¢Allow the holders to exchange for a pre-determined number of the company's ordinary shares
Securities Commission (SC)
Established on 1 March 1993 under the Securities Commission Act 1993, the SC is a self-funding statutory body with investigative and enforcement powers. It reports to the Minister of Finance and its accounts are tabled in Parliament annually.
The cost of an IPO
Extremely expensive - the costs engaging underwriters, attorneys, accountants, printing prospectus, listing fee The most expensive cost is underwriter's discount ¢Underwriters help determine the price of offering, draft prospectus, find potential investors
Reasons why investors invest in shares:
Income from dividends ¢Distribution of profits ¢Depend on dividend policies Capital gain from the appreciation of share value ¢Capital gain is the difference between the purchase price and the selling price ¢"buy low, sell high" ¢What about if the price keeps going down???
Over-the-counter market
Is a network of dealers who buy and sell the stocks of companies that are not listed on the stock exchange Example: NASDAQ Reason: unable to meet stock exchange listing requirements Stock of listed companies can be traded on the OTC market
Market-share weighted index
Price is weighted to the number of shares, rather than their total value. All outstanding shares are included.
Islamic equity fund investors
Main investors are from the Gulf countries
Ordinary shares
Owners of the company, "shareholders", also known as "equity capital" or "equities" Par value (in Malaysia) normally RM1 or RM0.50 ¢The value assigned to a unit of share when it is authorized, and is much less that its expected market value ¢Where to get the market value of a share?
Private Companies
Private limited companies (sdn bhd) can only have a maximum of 50 shareholders. Public individuals can only own shares in a private limited company through a shareholders' agreement with the approval of existing shareholders of the private company
Primary market Listing methods
Public offering ¢Offering the share capital for sale to the public Private placement ¢A private offering made to a limited number of persons
Investing in shares of stock
Represents ownership a share of stock is a financial security issued to raise long-term capital for business growth and expansion The company may issue up to the amount of its authorized capital Main classes of shares are ordinary and preference shares Companies are said to be "going public" when their shares are listed and quoted on the stock exchange
Public offer for sale
Selling the shares to the public A 'large' issue will probably take the form of an offer for sale during the first time issuance (when companies "go public") Shares can be offered to the public either at a fixed price (an agreed price between the company and the lead investment bank) or by tender (invitation to submit chosen offer) ¢Normally all new issues will be sold through an investment bank ¢Prospectus ¢For the tender, after all tenders are received, they will be ranked from the highest downwards and a "striking price" is established. The "striking price" is the price of the last tender which just clears the issue.
Private placement
Shares are offered to clients or other contacts of the investment bank leading the issue, rather than to general public Advantage: the costs of advertising and producing documentation are reduced Disadvantage: ¢Shares being held by a smaller number of more powerful investors ¢The discount on the issue is greater than with public offer (the difference between the price at which the shares are first sold and the price at which they are subsequently traded in the market) Refer to http://www.klse.com.my/website/bm
Bursa Malaysia
The only stock exchange approved by the Minister of Finance under the provisions of the Securities Industry Act 1983 The public trading started in 1960 under the name of Malayan Stock Exchange (MSE) 1963 - known as Stock Exchange of Malaysia (SEM) 1965 - became the Stock Exchange of Malaysia and Singapore (SEMS) 1973 - SEMS split into the Kuala Lumpur Stock Exchange Berhad (KLSEB) and Stock Exchange of Singapore (SES) 1976 - Kuala Lumpur Stock Exchange (KLSE) took over the operation of KLSEB Jan 2004 - KLSE became a public company limited by shares April 2004 - changed its name to Bursa Malaysia In the 1960s, started with only Main Board as the board for company listing 1988 - the establishment of Second Board ¢For smaller firms that do not meet the requirement of the main board August 2009 - combines Main Board and Second Board into a single market known as "main market" October 1997 - the Malaysian Exchange of Securities Dealing and Automated Quotation (MESDAQ) was launched ¢Intended as an avenue for small and medium enterprises in technology related areas to raise capital ¢August 2009 - changed its name to ACE (Access, Certainty, and Efficiency) ¢Provides lower listing requirements and open to companies of all sectors
What Does Pro-Rata Mean?
Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the whole.
Limit order
a request to buy or sell shares at a specified price (the limit) or better
Market order
a request to buy or sell shares at the best price available when the order reaches the marketplace
Equity funds can be divided into
a.Regular income funds ¢Earn profit through dividends paid by investee companies ¢Regular income stream ¢Risk averse investors ¢Example: CIMB Equity Income Fund, RHB Islamic Equity Fund b.Capital gain funds ¢Earn profit through capital gain from frequent sale and purchase of Shari'ah compliant stocks ¢Better return ¢Example: AmIslamic Growth Fund c.Aggressive funds ¢Invest in high risk securities to generate abnormal profits ¢Example: CIMB Aggressive Equity Fund d.Balanced funds ¢Invest in high quality securities with less risk and give the investors a regular income stream based on div and capital gains ¢Example: AmIslamic Balanced Fund e.Ijarah funds Such funds are used to purchase assets for the purpose of leasing. Rentals received are distributed among subscribers. f.Commodity funds Funds used to purchase different commodities for the purpose of resale. g.Murabaha funds closed-end funds, not negotiable in the secondary market. No tangible assets involved. h.Mixed funds The subscription employed in different type of investments.
Capital market is
an arena/ platform in which companies and other institutions that require funds to finance their operations come together with individuals and institutions that have money to invest.
Price-weighted index
an index in which each stock influences the index in proportion to its price per share. Stocks with higher price will be given more weight and will have greater influence over the performance of the index. Example: American Dow Jones Industrial Average
Stop loss order
an order to sell a particular stock at the next available opportunity after the price of the stock reaches a specified amount. To prevent further losses.
Two basic source of financing in the capital markets are
debt and equity. Under debt, it can be in form of bank loans, bonds, supplier credit and leases. Under equity, it can be in form of ordinary shares, preference shares and warrants.
Broad-base index
represents the performance of a whole stock market and by proxy reflects investor sentiment on the state of the economy. Example: KLCI, Hong Kong Hang Seng Index
Equity Market can be split into two main sectors
the primary and secondary market. ¢The primary market is where new issues are first offered. ¢Any subsequent trading takes place in the secondary market.
The presence of capital market is to
to serve public and private sectors' need for financing requirements. In general terms, capital market is a market for trading long term debt instruments (those that mature in more than one year).
Public Companies
¢A higher financial reporting standard is usually expected from them. ¢Public companies (bhd) can have an unlimited amount of shareholders. ¢Public companies (bhd) are required to make their financial information publicly available for the public to access. If they are a public listed company, they would also be required to hold quarterly earning calls and answer any questions that their public shareholders might have for them. ¢Public can freely subscribe to shares of public companies (bhd).
Secondary market
¢After a share has been sold through the primary market, the subsequent trading will take place in the secondary market. ¢Trading among investors ¢Shows liquidity of stocks investment ¢Much larger and much more active than the primary market ¢Where the price discovery occurs and liquidity is created - No additional funds to the company
Trading process
¢Buying and selling of shares are done through brokerage houses that are members of the stock exchange A stockbroker ¢A licensed individual registered with the securities commission ¢An instruction given to broker to buy or sell is actually giving an order ¢Types of orders 1.Market order 2.Limit order 3. Stop loss order
Participants in the equity market
¢In an economic system, there units with excess funds and units with deficits. ¢These units will meet in the capital market to satisfy each other needs. Those who have excess cash will invest or give loans to those who need cash. ¢All these units include households, corporations, financial institutions, government and foreigners ¢Besides the units, there are also intermediaries that act on behalf of the units such as brokers and investment banks
Islamic Capital Market: Equity
¢Islamic financial framework Islamic money market, capital market, forward market, limited foreign exchange ¢Instruments and operating procedures are different Operates in an interest-free environment Different principles ¢Derived from Shari'ah (Islamic Law) ¢Sources are from Holy Quran and Sunnah which condemn riba-based transactions as sinful ¢Basic concept is permissible in Shari'ah ¢Key components of Islamic capital market are Shari'ah-compliant stocks, Islamic funds and Islamic investment certificates known as Sukuk
Stock market indexes
¢Refer to the movement of the prices in a market or a section of a market ¢Each of the indexes tracks the performance of a specific "basket" of stocks considered to represent a particular market ¢Types of stock market indexes: 1.Broad-base index 2.Price-weighted index 3.Market-value weighted or capitalization-weighted index Market-share weighted index
Bond/Debt Trading
¢The bond market (also known as the debt, credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. ¢Nearly all of the bonds trading takes place between broker-dealers in the stock exchange. ¢ However, a small number of bonds are traded in a decentralized, over-the-counter (OTC) market.
What Does Bond/Debt Market Mean?
¢The market for trading debt instruments. ¢In other words, the debt market is platform/ forum where trading of debt instruments take place. Examples of debt instruments include mortgages, promissory notes, bonds, and Certificates of Deposit.
Primary market
¢The new issue market, the market for issuing new securities ¢"public issue", "going public" or "floatation" on the stock exchange ¢When we say that a company is doing an IPO (initial public offering), it means the company is issuing ordinary shares or shares to the public for the first time. ¢The stocks can be purchased through brokerage firms and other parties (some commercial banks and financial institutions) acting as agents for investment banks ¢In IPO, the money flows directly to the company ¢An IPO is a high risk investment and too speculative
Preference shares
¢Typically do not carry voting rights ¢Entitled to receive dividend before payment is made to ordinary shareholders
Why issue preference shares?
¢Unlike interest on debt financing, preference dividends are not tax deductible ¢Issuance of preference shares can actually avoid the threat of bankruptcy that exists with debt financing Unlike interest, unpaid preference dividends are not the liability of the company and unlike debt holders, preference shareholders cannot force a company into liquidation because of unpaid dividends
Stock exchanges
¢corporation which provides a place and facilities for the trading of shares, unit trusts and other investment products. ¢On the stock exchange, investors are represented by brokers ¢Provide facilities for the issuance and redemption of securities and act as the clearing house for each transaction Eliminate the default risk ¢Provide real-time trading information on the listed securities - facilitate price discovery
Capital Market Master Plan
¢launched in February 2001 with the objective of setting the strategic position and future direction for the Malaysian capital market. ¢There was some progress made in the area of the consolidating of the stockbroking industry and the stock exchange, disclosure-based regulation and corporate bond market development.