LESSON 4 – SUMMARY

The Capital Markets Nature and instruments

Features of the shares

Features of the bonds

Primary and secondary markets

Stock Indexes

Special Operations

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CAPITAL MARKETS(1/15)

Are the markets of financial operations with a maturity

of more than one year and where dominate the

securities transactions. The most important securities

are Bonds and Shares.

Shares:

It is a title of ownership of the capital of a company (Public

limited company)

Entitles to the following rights:

To receive dividends if the company decides to distribute its results

( by setting the value to be received by each share) 2

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CAPITAL MARKETS(2/15)

To participate in the general meetings of the company (although

it may be imposed a minimum number of shares to attend) where

they approve the accounts,

decide to distribute dividends, elect corporate bodies and make other

important decisions.

From the point of view of a financial investment, the shares can

offer:

The dividends that are distributed

A capital gain (or loss) through the sale of the share for a price higher

(or lower) than the buying price

The evolution of the share price is mainly influenced by the economic-

financial evolution of the company and its prospects for the future. 3

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CAPITAL MARKETS(3/15)

Bonds

It is a debt security

The issuer, when issues a bond, contracts a loan from whom

buys the bond, at the face value of the bond, with a

particular maturity and paying a certain interest rate.

Comparing with a bank loan, the bond issue may have a lower cost, since the intermediation process is minimized. This justifies the great development of this instrument worldwide and is illustrated in the following example

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CAPITAL MARKETS(4/15)

Bonds (cont.)

Example: bank loan vs. bond loan

Classic operation of credit

Savers Financial Company

(Funds available to invest) Institution (Needing funds)

Who has funds in excess puts them in a FI (eg making a term deposit) and the

FI lends those funds to a company that needs them. The difference between the

interest rate received through the loan and the interest rate paid on the deposit is

a profit margin for the FI. The margin will be higher when the company risk is

higher, in order to compensate for this risk. In fact, even if the company does

not repay the loan to the bank, the latest is still responsible for paying the deposit

whenever the saver wants it back. 5

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CAPITAL MARKETS(5/15)

Bonds (cont.) Bond operation

Savers Company

(funds available to invest) (needing funds)

Financial Institution

In this case, the saver buys the bonds directly to the issuer. This

means that he and the other savers that buy the whole issue are the

ones that carry out the credit risk of the company not repaying the

loan and not the FI. The FI in this case is just a service provider and

not a true agent. The services the FI provides in this case

are essentially the following: Placement of the operation ( by identifying investors interested in

purchasing the bonds and providing them information about the issue);6

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CAPITAL MARKETS(6/15)

Bonds (cont.)

These services usually represent a lower cost than the

intermediation margin that the FI charges for the traditional lending

business.

Imagine that in its traditional business the FI pays 4% on the deposit and charges an interest rate of 7% for the loan (a 3% margin). Now consider that in the case of issuing bonds the cost for the services provided, charged by the FI to the issuer, represent 1% per year. The company could issue the bond loan at a rate of 5% (giving the investor an additional 1% more than what he gets on the bank deposit) and the cost to it would be 6% (5% +1% for the services provided by the FI): 1% less comparing to the rate charged by the FI loan.

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CAPITAL MARKET(7/15)

When buying bonds, instead of depositing in the bank, the

investor gets into a different position of risk taking. It takes

the credit risk of the company, on the bond case, and the

bankruptcy risk of the FI on the deposit case. The existence of

RATINGS helps investors in their decision making process.

For investors the bonds have also other important advantage.

As they are securities, they may be listed and therefore can be

sold before the maturity, in case an investor needs his capital

back or wants to make capital gains when the price of the bond

has increased. Thus, other investors may buy these listed bonds,

so they don’t need to be waiting for new issues.8

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CAPITAL MARKETS(8/15)

Bonds (cont.) Bonds Rating

The rating of a bond is a note or grade that is given based on the

likelihood of the issuer to default, that is, to not be able to pay

the interest and repay the capital. Thus, a higher note reflects an

almost certainty that the issuer will meet his obligations, and the

minimum note means the inverse.

The rating allows investors that barely know the issuer to

identify the risk level of its investment and select the risk

profile that is more adequate to their investment objectives.9

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MERCADOS DE CAPITAIS (9/15)

Bonds Rating (cont.)

Naturally, when the rating is lower the interest rate offered by

the corresponding bonds has to be higher (to compensate for the

higher level of credit risk, otherwise the investors

would only invest in high rated bonds). 

The three most well known rating companies are

Standard & Poor's, Moody's and Fitch.

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CAPITAL MARKETS (10/15)

Primary and Secondary Markets (bonds and

shares)

Primary Market

It is when there is issued a new security (bond issue or the issue

of new shares to increase the capital of the company)

Secondary Market

It is when occurs a transaction of an existing security. Stock

exchanges are the places that promote the quotation and

transaction of the existing securities. 11

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CAPITAL MARKETS(11/15)

The main stock exchange on which the Portuguese shares are listed is the Portuguese NYSE EURONEXT -Lisbon stock exchange that resulted from the merger of the New York Stock Exchange (NYSE), Euronext (which joined Paris, Amsterdam, Brussels and Lisbon) and also LIFFE, the leading derivatives exchange in Europe

Stock Market Index

It is a very useful instrument to evaluate the price evolution or

return of a Bond or Stock Market as a whole. Its computation

uses the price of the most representative securities of a

specific market (in terms of market value and turnover).

Generally its name is associated with a number; that number

indicates the number of shares that compose the index. 12

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CAPITAL MARKETS(12/15)

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Example The Portuguese Stock Index (PSI – 20) had the value of 13,019.40 on 31.12.07 and on 31.12.08 was 6,341.34. Thus, in 2008 the portuguese stock index devalued:

There were, of course, shares that performed better and others that performed worse than the computed devaluation. But the market index seeks to portray the global evolution.

Examples of other Stock index:

S&P500 (EUA); DJIA (EUA); NASDAQ100; CAC40 (France); IBEX35

(Spain); DAX30 (Germany); FTSE100 (United Kingdom); Nikkei

225 (Japan).

51.3%- 100 13,019.4

13,019.4-6,341.34 PSI

CAPITAL MARKETS(13/15)

Total Market Value

The market value of a company: multiplying the number of listed

shares by its price.

Special operations in the Stock Exchange Public Tender Offer (PTO) / takeover bid Initial Public Offering (IPO)

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Example

•EDP ( on 5.01.09)

•# listed shares: 3,656, 537,715

•price: 2.777 €

Market Value

3,656,537,715 x 2.777 = 10,154,205 Th €

CAPITAL MARKETS(14/15)

Special operations in Stock exchange

Public Tender Offer (PTO) / takeover bid

A PTO is when an investor intends to acquire all or a significant

percentage of shares of a listed company. To ensure equal

treatment for all shareholders of that company, it is mandatory

that the investor announces his intention publicly and he cannot

negotiate the purchase direct and privately with only some or

more relevant shareholders.

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CAPITAL MARKETS(15/15)

Special operations in Stock exchange (cont.)

Initial Public Offering (IPO)

To have its stocks listed in a stock exchange, a company has to

fulfill certain requirements. One is to have a minimum

percentage of free-float (the proportion of shares of a company

that are held by investors that are likely to be willing to trade

them in the market. These shares are available to be traded by

the investing public – small shareholders of the company). To

achieve that objective the company can

make an IPO, through which, and once again opened to the

public, the company's initial shareholders sell part of their shares

to other (smaller) investors.

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