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What
is a Capital Market
The Capital market generally comprises financial
institutions, the stock exchange, stock brokers and dealers and traders. Its purpose is to facilitate the flow of savings from businesses and
government and individuals who have, to those who need funds. The market allows owners of funds to purchase equity or securities. A
Security
A Security is a legal certificate which proves that the
person buying the security (the lender) has lent money to the person issuing the
security (the borrower) or has purchased equity in a company. Kinds
of Securities
There are basically two types of
securities: 1. fixed income securities and variable dividend
securities 2. debt and ownership securities.
Owners of securities, i.e. stocks, shares, or equities, become owners in part of
the corporation in which they have invested and have certain rights. Equity
The equity of a company is the value of an enterprise
when the debts it owes are deducted. It
represents the ownership interest in a company held by its shareholders. What
is Common stock
Common shares are securities in
a company which represents the
shareholders part of the ownership in that company. They provide the shareholder with a vote in the management of
the company and a claim on its profits. When
profits are earned a dividend may
be declared and distributed to shareholders. A dividend is an equal share of a
company’s profits if a profit has been made. Since profits will vary as business thrives or as it declines, the size
of dividend payments and their frequency may vary. Indeed in some years no dividends may be declared. Preferred Shares
Preferred shares offer the
shareholder certain rights and privileges not enjoyed by common shares. Preferred shares generally entitle the shareholder to dividends at an
agreed rate. Such dividend payments
must be paid out of earnings before any dividends are paid on the common shares.
Usually, preference shares tend to be cumulative, i.e where the company
is unable to pay preferred dividends in a particular year, the unpaid dividends
will accumulate and must be paid in the future before any dividends can be
distributed to common shareholders. In the event that the company
decides to wind up its affairs, the preferred shares are usually entitled to a
stipulated portion of the net assets of the company and take priority over
common shares. On the other hand,
the preferred shareholder does not usually have a voice in the management of the
company. Convertible
preferred – are a special type of
preferred share. Such shares can be
converted at the option of the holder, and may be exchanged into the company’s
common shares. Participating
preferred shares – are entitled to
share with the common stock after payment of the initial dividend at a
predetermined rate. Redeemable
preferred shares - can be called or redeemed after giving
due notice to the shareholder. A
preferred share which is not redeemable is termed “non-callable” or
“non-redeemable”. The
earnings of shareholders
Common shareholders are entitled to vote at the
company’s annual meetings. They
may elect directors to represent their interests at annual general meetings of
all the company’s shareholders. They
may also receive dividends when they are earned, recommended and declared
payable. Common shareholders
sometimes benefit from bonus dividends which the company does not wish to pay
out as part of the regular annual dividend. Sometimes the dividend may be in the form of additional
shares. This usually happens when
the company is expanding or may also occur where there has been revaluation or
recalculation of the assets of a company. In
the place of a cash dividend, the company issues additional stock to each
shareholder in acknowledgement of his claim to the profits retained in the
business. This is referred to as
stock dividend and is issued in proportion to the number of shares held by each
stockholder. Very often this will
result in an increase in the market value of the stock. Who
participates in the capital market
1. Owners of capital – individual investors,
businesses, commercial houses, government, insurance companies, commercial banks
and charitable organizations. 2.
Seekers of capital
– Individuals buying houses, those acquiring mortgage loans, borrowers who
wish to expand businesses, companies wishing to purchase equipment, Governments
who wish to finance major capital project. What
is a Stock Exchange or Securities Exchange?
A stock exchange or securities
exchange is a marketplace where stocks offered for sale are listed and
exchanged. Typically, the exchange
is made up of a Board of Governors generally selected by the members, which is
chosen to represent the interests of seat holders. The Board then employs an executive officer, to manage the
Exchange. The Exchange usually assigns a number of seats to brokers. Persons eligible to be brokers may purchase seats in the Exchange.
In the Caribbean, there are security exchanges in Barbados, Jamaica and
Trinidad & Tobago. Brokers are specialist investors
who bring buyers and sellers together, by matching the price of
securities buyers want to pay, with the prices sellers are asking. They then charge a fee for performing this transaction.
In developed exchanges they work for investment houses. Their employees are known as traders and they trade on the
floor of the Exchange. Traders may
trade on behalf of their clients or for the account of their own investment
house or own dealers. A Bull Market
Is a market in
which the buyers dominate A Bear Market
Is a market in which the sellers dominate Types
of Business Organizations
Businesses
may also be organized as sole proprietorship, a partnership or corporation.
A Single proprietor own his own business.
His personal assets are not held distinct from those of his business. Many very small businesses operate as sole proprietors.
A sole proprietor is legally liable for the debts of the business and his personal assets can be disposed of by law to meet his creditors. A Partnership is made up of two people or more.
Like a sole proprietor the personal assets of the partners can be claimed
by creditors. However, it is a
simple arrangement which many small businesses prefer because there is no need to comply
with tax and other obligations of a company. However, the survival of partnerships tend to depend a great deal on the
ability of the partners to work together. A Corporation is a legal entity established to do
business under the Companies Act of Barbados. A corporation is separate from the shareholders which comprise it, and
has its own legal person. It is
required to have its own name and a registered office. Not all businesses
are organized as corporations. A
corporation – is a more enduring arrangement than either a partnership or a
sole proprietorship. It permits
financial savings to be pooled together. It
allows the management of a company to be different from its ownership. It is a separate legal entity and each shareholder is only liable for the
sum of money which he paid for his shares. This is referred to a limited
liability. While shareholders may
dispose of their shares in a company the corporation still continues, as it has
a legal permanence. This permits it
to contract long term liabilities, and to invest in research and development,
the benefits of which accrue far into the future. It permits it to plan for changes in its management and to strategise
for the long term future of the company beyond the lives of its directors
or its management. Capitalizing
the Corporation
1. Companies obtain capital by the sale of shares.
The initial capital of a corporation must be in the form of common shares
but a company may issue other types of shares e.g. preferred shares after
incorporation. Companies may also
issue long term debt, e.g. debenture issues and other types of debt instruments. 2. A company’s retained earnings also constitute
part of its capital. Investors look
to retained earnings of the company as an indication of its financial strength.
Common shares are securities which show the individual’s ownership in
the corporation and his rights and privileges. Preferred shares give the
owners the right to a set rate of dividends to be paid from the profits or
earnings of the company, before the dividend is paid to common shareholders.
What are Government Securities?
Government Securities are
investment instruments that are issued by the Government. There are
various types of securities, the main ones being Savings Bonds, Treasury Notes
and Debentures. They are issued by the Central Bank of Barbados which acts
as the agent for the Government. What are Savings Bonds?
A Savings Bond is a
five-year security issued at a discount, which offers an individual an
opportunity to set aside some savings for a period of five years on which they
can presently earn interest. Issued at discount means that an individual,
say John Brown, pays $93 dollars for a hundred dollar value savings bond.
On maturity, after the five-year period, John Brown receives $100, which means
that he has gained $7 dollars worth of interest/income. If he is desirous
John Brown can take his 100 dollars and reinvest it and so doing he can earn
further interest. Savings Bonds are issued in denominations/amounts
ranging from $50 to $5,000. The maximum which an individual can hold in
any one issue of Bonds is $50,000. What happens if a person
wishes to have their funds, perhaps because of an emergency, before the bond has
matured (five years)? They can do so simply by
exchanging their bond certificates for cash. They would receive the amount
paid in, plus any interest that has accumulated to date, bearing in mind that
interest is added at six-month intervals. So that in the case of John
Brown, after a year he could cash in his Savings Bond certificate for $93 plus
any interest earned to date. The value of the Bond at various time
intervals is noted at the back of the Bond certificate for the benefit of those
wishing to cash in their bonds before maturity. How can one acquire Savings Bonds?
Simply visit your Commercial Bank and ask for an application form
for Savings Bonds.
Complete this application form, ask for help from your commercial bank if
necessary, and make the relevant payment to the Bank in exchange for a Bond
Certificate.
Similarly, upon maturity of the bond you can return your certificate to your
commercial bank for cash or to purchase more securities. Note: Savings Bonds are
issued at various, though not fixed, times of the year. What are Treasury Notes?
Treasury Notes are fixed
Income securities. These are securities on which you receive a fixed rate
of interest, until the security matures. Your purchase of securities
must be from $1000 and up, in multiplies of $1000. Treasury Notes can be
issued for a period ranging from a year to ten years with no limit on the
maximum amount that an individual can purchase (except that it exceeds the total
amount of Treasury Notes on offer). Government may, for example, offer a
three-year Treasury Note at 7.5% interest per year or a seven-year Treasury Note
at 8% per annum. In the case of our potential investor John Brown, who
wishes to invest $1000, he would pay $1000 for a $1000 Treasury Note with a
guarantee that he would be paid 7.5% interest per year (for the three-year Note)
in two installments each year (every six months) of the life of the Note.
How can one acquire a Treasury Note?
Application forms are available from the Central Bank of
Barbados, Accountant General’s Office and the Commercial Banks.
Make the relevant payment to the Bank in exchange for a Treasury Note
Certificate. Similarly, upon maturity you can return your certificate to the
Central Bank to be cashed or to purchase more securities. What are Debentures?
Debentures are fixed Income
securities with all the same features as Treasury Notes but with a longer
investment life of 11 years or more. The acquisition of a Debenture
is the same as for a Treasury Note. |