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Financial Markets & InstitutionsFinancial Markets & Institutions

(Course Code: FIN-)(Course Code: FIN-)

IntroductionIntroduction

An investor can invest his surplus funds in different investment alternatives like shares, stocks, bonds,debentures depending upon the investment environment, availability of fund, expected rate of returnconsidering the risk factors involve therein. The ultimate objective of an investor is to learn how toconstruct an optimal portfolio of investments. In order to accomplish, an investor will have to be awareof the various investment alternatives available and be able to make estimates of the returns he expects toget from the individual securities in the portfolio as well as their risk. Securities are marketable financialinstruments that bestow on their owners the right to make specific claims on particular assets. Anindividual security provides evident of either creditor ship or ownership depending on whether it is a

 bond or stock respectively.Investment ategories

!asically investments involve two categories vi"., real assets and financial assets. #eal assets includethose assets which are tangible, material things like furniture$s, land, building, ornaments, automobilesetc. %inancial assets, on the other hand, include pieces of paper representing an indirect claim to realassets held by individuals or firms or any corporate body. !eing pieces of paper, financial assetsrepresent debt or e&uity commitments in the form of I owe you 'I()* or stock certificates.+i&uidity being one of the special interest to investors distinguishes real assets from financial assets.(bviously, real assets are less li&uid than financial assets as because the former are more heterogeneousand yield benefits only in cooperation with other productive factors. oreover, returns on real assets arefre&uently more difficult to measure accurately. -owever, our principal concern in analy"ing investmentis more concern with financial assets rather than real assets. Investors in securities always have analternative to direct investing. Indirect investing refers to buying and selling of shares of investmentcompanies that, in turn, hold portfolios of securities. Investors purchasing shares of a particular portfoliomanaged by an investment company are purchasing an ownership interest in that portfolio of securitiesand are entitled to a prorate share of the dividends, interest, and capital gains generated by the portfolio.A direct investor, however, have the following investment categoriesi. /overnment securities,ii. orporate bonds,iii. orporate common stocks,iv. 0referred stocks and

v. 1erived securitiesInvestments in the above assets may, further, be categori"ed according to their source of issuance and thenature of the buyer$s commitment as debt instruments and equities. To this end, investments in securitiescan also be classified on the basis of income or return they earn each year of their life as  fixed income

 securities and variable income securities. %ixed income securities are those which have a defined limitedmoney claim. The money received from those investments will never exceed this promised claim,although they can fall short of promise in the case of default. 2ariable income securities, on the other hand, have a residual claim to the earnings of a company. These claimants are entitled to whatever is leftafter all the other security holders have exercised their claims to the firm$s earnings. 3hile thestockholder$s claim to the earnings is residual, it is also unlimited in amount. If the firm proves to be ahuge success, the stockholders may reap huge gains, while the bondholders receive only their fixed

claim.

Organizing Financial AssetsOrganizing Financial AssetsInvestment covers a wide range of activities. It refers to investing money in common stocks, bonds,certificates of deposits, or mutual funds. Some rationale investors choose others paper assets such as

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warrants, puts and calls, futures contracts, and convertible securities. (ur main concern is to focus on thefinancial assets, financial claims on the issuers of the securities. There are two apathies in investingindividuals$ fund which is the commitment of the same to one or more assets that will be held over somefuture time period as the desires of the fund holders. (ne of the investment avenues is the directinvestment. It is defined as the investors would buy or sell securities themselves with the help given bythe brokerage houses. The other avenue of investing called indirect investment refers to the buying and

selling of shares of investment companies. Investors can invest in a portfolio of securities through buyingthe shares of a financial intermediary that invest in various types of securities on behalf of itsshareholders. Indirect investment, therefore, is a very important alternative for all categories of investors.Investors, on the other hand, can invest in financial markets choosing the best alternative from a widevariety of assets. ajor types of financial assets can be categori"ed as

  %inancial Assets

1irect investing Indirect investing  'utual funds*

oney market apital market 1erivative instruments instruments instruments

 

%ixed income 4&uity  Instruments instruments

Direct investingDirect investing

oney market Treasury billsTreasury notes

Treasury bondsommercial papers4urodollars depositommercial papers

!ankers$ acceptances#epurchase agreements

4urodollar certificates of deposit 5egotiable certificates of deposits

apital market%ixed income

Treasuries1ebentures

Income bondall futures

0otable bondorporate bondortgage bond

onvertible bondSinking fund

4&uities 0referred stockommon stock 

 5onmarketableoney market deposits

Savings depositsertificates of deposits

/overnment savings bonds

1erivatives market(ptions 'puts and calls*

3arrants

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%utures contractsIndirect investingIndirect investing

4&uities

AnnuitiesInsurance policies

)nit investment trusts(pen7end investment companies

losed7end investment companies

Debt InstrumentsDebt Instruments1ebt instruments include all types of fixed7income securities promising the investors that they willreceive specific cash flows at specific times in the future. Securities generating one cash flow are knownas pre7discount securities or "ero7coupon securities. (n the other hand, it may involve multiple cashflows. If all the cash flows are of the same si"e, they are generally referred to as coupon payments. Thedate beyond which the investors will no longer receive cash flows known as maturity date. (n this dateinvestors will receive the principal along with the last coupon payment. Although these cash flows are

 promised, they may not be received due to the risk associated with such investments. %inancial assetsissued by government, firms, and individuals often take the form of I()s calling for fixed periodic

 payments, termed as interest and the repayment of the amount borrowed, termed as principal. 1ebtinstruments represent money loaned rather than ownership to the investors. Deposits and Contracts

urrency, in real sense, is a government I(). oney and savings accounts referred to as demand andtime deposits are loans to banks and other like financial institutions. 1emand and savings and other timedeposits cannot e withdrawn without notice, although financial institutions provide this advantage to thedeposit holders. Savings accounts draw interest, and some forms like certificates of deposits '1s* havespecific maturities. 1s pay higher interest than normal saving accounts do.Government Securities

/overnment securities are those securities which are issued by the government to finance deficit in budget when revenues fall short of expenditures. /overnment securities are all most invariably bondissues of various types. These bonds are issued by the government at all levels. !ecause it can print

money, the securities of the government are not subject to default. The government securities are riskless,default free and earn a fixed rate of interest income. !eing issued by the government debt securities differ in &uality, yield, and maturity. In the national and international financial market, we usually find thefollowing governments securitiesTreasury Bills: Treasury bills are short7term notes that mature in three months, six months, nine monthsand maximum one year from the date of issue. These securities can be redeemed only at maturity.Treasury bills can be easily sold in the money market at prices that reflect prevailing interest rate and ona discount basis before maturity. The discount to the investors is the difference between the less7than7face7value price they pay and face value they receive at the bills maturity.Certificate of Indebtness or Treasury Certificate: ertificate of indebtness differs from Treasury bills

 because they are issued at par value and pay fixed interest rates. These fixed interest rates are called

coupon rates. 4very bond issue of this type promises to pay a coupon rate of interest that is printed on the bond and never changes. The bond investor collects this interest income by tearing perforated coupon slipoff the edge of the certificate and cashing the coupons at the banks and post offices or other governmentapproved authorities. Treasury certificate matures within one year from the date of issue.Treasury Notes: Treasury notes are similar to the treasury certificate accept with regard to time of maturity. 5otes typically have a maturity of one to ten years when they are newly issued. +ike treasurycertificate, however, they are sold at face value in the money market and pay fixed coupon interest

 payments each year of their life.Treasury Bonds: Treasury bonds make up the smallest segment of the government debts. !onds differ from notes and certificates with respect to maturity8 bonds mature and repay their face value within a

 period from ten to thirty years from the date of issue. Some bond issues are callable or redeemable prior 

to maturity. Private Issues

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0rivate debt securities are issued by corporations and:or both financial and nonfinancial institutionswhich run the spectrum in &uality and yield. The categories of these types of securities are furnished

 belowCorporate Bonds:  3hen corporations go to the capital markets to obtain money for all corporate

 purposes, the single most important sources of funds is through the sale of debt securities. It is a long7term written promise to pay under seal a certain sum of money at a certain time for specific rate of 

interest. !ondholders have the right to receive fixed rate of interest payment before any dividends may bedistributed to the e&uity owners. In addition, the bondholders have what is termed a fixed claim on theassets of the firm. This means that when the bonds mature, , or in the event of li&uidation of the firm, the

 bondholders are entitled to receive a stated amount and this claim has priority over any of the claim of the e&uity owners.orporate bond is long7term debt securities issued by corporations help to finance their operations. It issimilar to other kinds of fixed7income securities in that it promises to make specific payments atspecified times and provides legal remedies in the event of default. 1ifferent names are often used for thesame type of bond, and occasionally the same name will be used for different bonds. -owever, thefollowing types of bonds are available in the financial market

 Debentures: 1ebentures are general obligations of the issuing corporation and thus represent unsecuredcredit. Their claim is fixed but based only on the firm$s ability to generate cash flow. To protect the

holders of such bonds, the indenture will usually limit the future issuance of secured debt as well as anyadditional unsecured debt.

 Income bond:  All interest on bonds must be paid before any dividends are distributed to theshareholders. Income bond is a security on which interest is paid only if earnings are sufficient. These areinfre&uently sold to raise new capital because of the residual nature of interest payments. In some income

 bonds, the interest payment must be approved and declared by the board of directors as much the sameway as dividends are paid on preferred stocks. If the interest on bond is not paid, it may be cumulativeand payable at a later time. Income bonds are still debt instruments but they are closely related to stock inthe essential characteristic of interest payment.

 Mortgage bond: ortgage bond represents debt which is secured by the pledge of subject security. Incase of default, the bondholder is entitled to obtain the property and to sell it to offset his claims on thefirm.

 Equipment trust certificate/bond: Any way in which the principal of a bond issue is secured through the pledge of e&uipment. The title to the property or machinery usually remains in the hands of the trusteeuntil the debt is repaid. The corporation receives the title to the e&uipment only when all scheduled

 payments are made. 4ach six month after the purchase of e&uipment, a principal and interest paymentwould be paid to the trustee. The trustee in turn would retire some of the e&uipment trust certificates and

 pay the interest on the outstanding debts.Convertible bond: The convertible bond provides the holder with an option to exchange his bond for a

 predetermined number of common shares at any time period to maturity. The convertible bonds offer the promise of sharing the capital growth. If the stocks increase in value, the bonds also will increase. If thestock remains at the same price, the bonds will still provide a good yield.Callable bond:  The callable bond gives the issuing firm to retire the bonds at a stated call price. The call

option usually becomes operative after a stated period of call protection which is usually either five or tenyears after originally issuance. The call price usually begins at a value close to the sum of the principal plus one annual interest payment and steadily declines to the value of the principal at maturity. The promise to redeem bonds at maturity can be altered or modified by what is called call future providingthe benefit for the issuer.

 Potable bond: A potable bond gives holder the option to exchange his bond for cash e&ual to the facevalue of the same.

 Registered bond:  (ne other safeguard might be indicated in the indenture which assures the basicsecurity of the bond. A bond may be registered to protect the owners from loss. 3hen the bond principalis registered the name and address of the bondholders are recorded with the issuing company. Theregistration of the principal does not guarantee that the bondholder will receive principal repayment atmaturity, but it does provide him with protection from loss should the bond certificate be lost or 

destroyed.

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Collateral trust bond: Some bond issues pledge stocks or bonds as additional security for the money borrowed. This type of bond is referred to as collateral trust bond. The collateral is usually the personal property of the corporation that is issuing the bond. Sining fund: A sinking fund is a specific type of security issued for the benefit of the investors. A partof the principal of debt is paid each year reducing the amount outstanding at maturity. Sinking fundoperates by having the corporation transmit cash to the trustee who can then purchase bonds in the open

market. Receiver!s certificates: #eceivers certificates are debt instruments that arise out of reorgani"ation. 3hena corporation in reorgani"ation needs capital, the receivers or the trustees have the power to raiseadditional funds. The securities issued are known as receivers$ certificates and the principal value of these claims takes precedence over any other debt outstanding. This priority places them in a superior 

 position with respect to other debt. "ond indenture:  The special promises that are made to the bondholder are set forth in the bondindenture. It is an agreement between corporation issuing the bonds and a corporate trustee, usually acommercial bank or trust company who represents the bondholder. The usual items that are found in the

 bond indenture are the authori"ation of the issue, the exact wording of the bond, the interest or couponrate, the trustee$s certificate, the registration and endorsement, the property pledged as security if any,and the agreements, restrictions and remedies of the trustee.Commercial Papers: ommercial paper is an unsecured short7term promissory note issued by bothfinancial and nonfinancial companies. These securities are issued to supplement bank credit and are sold

 by companies of prime credit standing. "aners #cceptance: !anker$s acceptance are time draft drawn on and accepted by a bank which hasagreed to do so for an importer or a holder of merchandise, thus substituting bank credit for commercialcredit. Such instruments are widely used in foreign trade. The buyer of the goods may issue a written

 promise to the seller to pay a certain amount within a short period of time the maturity of which is lessthan one year. This written promise offering liability to both the bank and the buyer of the goods istermed as banker$s acceptance.Certificates of Deposits: ertificates of deposit '1s* are special type of interest7bearing deposit atcommercial banks or savings and loan associations. +arge corporate time deposits in commercial banksare often of certain minimum amounts for a specified time period. )nlike time deposits, these certificatesof deposit are negotiable.

 Eurodollar Certificates of Deposits: In the world of international trade and finance, large short7termcertificates of deposit denominated in dollars and issued by banks outside the )nited States are known as4urodollar certificates of deposit 'henceforth 4uro 1s*. 4uro 1s are negotiable.

 Eurodollar Deposits: 1ollar7denominated time deposits in commercial banks outside )nited States arecommonly known as 4urodollar deposits. 4urodollar deposits cannot be traded and thus they are notnegotiable.

 Repurc$ase #greements: A money market instrument may be traded between two investors. The seller of such instrument may agree to repurchase it for a agreed7on price at a later date. This agreement is likea collaterali"ed loan from buyer to seller.

!uity Instruments!uity InstrumentsInvestment media representing an ownership position is the e&uity investment in which the investor is anowner of the firm and is thus entitled to a residual share of profits. 4&uity instruments differ from fixedincome securities in that their returns are not contractual. #eturns can be much better or much worse thanthose from a bond. The e&uity ownership, however, arises out of the indirect e&uity investment and directe&uity investment. !efore going to describe the direct and indirect e&uity investment, we need to identifythe components of e&uities.Components of !uities

apital structure refers to long7term sources of financing for a firm. It is consisted of long7tern debt ande&uities. Shareholders$ e&uity is a residual item that is not fixed. It is the difference between the assetsand all other liabilities of a firm which is found as

  Assets < +iabilities = 4&uity-owever, the e&uities of a firm are comprised of the following components

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i. Common stoc": The amount of money paid by the owners of the organi"ation measured as the product of par value 'face value* and number of shares outstanding.

ii. #referred stoc": The amount which is measured by the par value of any shares outstanding promising to pay a fixed rate of return in the form of fixed dividend.

iii. $urplus: The excess amount above each share of stock$s par value paid by the shareholders.iv% !uity reserves: #epresenting any fund for contingencies, providing a reserve for dividend

expected, and a sinking fund to retire stock or debt in the future.v% &ndistributed profit: The net earnings after tax that is retained in the business rather thandistributing to the shareholders as dividends

vi% $ubordinated debentures: +ong7term debt carrying a convertible feature. The holders of themhave the right to exchange their debt for shares of stock.

vii% !uity commitment notes: 1ebt security repayable only from the sale of stock.viii% 'inority interest in consolidated debentures: The holdings of ownership shares of other 

 business enterprises.

Direct !uity InvestmentTwo major direct e&uity investments are common stocks and preferred stocks. 3hen investing directly,investors can choose money market securities, capital market securities or the securities in the derivatives

market that include options and financial futures contracts. -owever, the followings are major directe&uity investmentsCommon stoc: ommon stock may be defined as the residual ownership of a corporation, which isentitled to all assets and earnings after the other limited claims have been paid and which has the basicvoting control. In short, common stock is the fundamental ownership e&uity. The investor in commonstock thus occupies a position directly comparable to that of the owner of a firm or a factory. ommonstock bears the main burden of the risk of the enterprise and also receives the lion$s share of theadvantages of success. ommon stock has no maturity date rather its life is limited by the length of timestated in the corporate charter.ommon stock represents the ownership interest of corporations. Among other things, the holders of common stock elect the board of directors, have a right to the earnings of the firm after all expenses andobligations have been paid, also run the risk of receiving nothing if earnings are insufficient to cover allobligations. -olders of common stock receive a return in the form of the distribution of corporateincome like dividends and capital appreciation. ommon stockholders have only a residual claim againstthe income and assets of the firm. Thus, the potential for gain is greater for holders of common stock thanthat for debt holders whose gain is fixed. In contrary, the risk for the e&uity owners is correspondinglygreater since they have last claim to the firm$s income and assets. -owever, the characteristics of common stock can be summari"ed as the following manner

• It normally has control of the corporation and will exercise that control in its own interest.• It has unlimited ownership rights to the remaining gains from the business after other security

holders have received their contractual payments.• It bears the principal ha"ards of the business.• ommon stock may be sold by its holder to any willing buyer.• The earnings on the common stockholder$s e&uity may be unstable.• 1ividends may fluctuate. It must depend on earnings, cash position, surplus position, expansion

needs, debt situation and management policy.• ommon stock prices fluctuate extensively.• ommon stocks in general are a price7level hedge. That is, they tend to earn, pay dividends and

 bring market prices at levels which are vaguely related to the general commodity price level.• 1ividends are normally less than the earnings on the common stockholders$ e&uity.• ommon stockholders have voting power to vote for the board of directors and for against major 

issues of the corporation.• ommon stockholders have pre7emptive right to subscribe to any new issue of stock so that they

can maintain their previous fraction of the total number of shares sold.• 0ar value common stock just like preferred stock can be par or no par.

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The market value of common stock is the variable of concern to investors. The aggregate market value of a corporation which is calculated by multiplying the market price per share of the stock by the number of shares outstanding determines the total value of the firm as estimated in the market place. 1ividends arethe cash payments which are distributed to the common shareholders by the corporation. -owever, thefollowings are the types of dividend concerned

@  Dividend %ield: It is the amount of dividend per share divided by market price of the same. Thisincome component of a stock$s return is stated on a percentage basis.

@  Dividend pa%out ratio &D/P ratio': It refers to the ratio of dividends to earnings. It indicates the percentage of a firm$s earnings paid out in cash to its shareholders.

@  Retention ratio: It is the complement of payout ratio indicating the percentage of firm$s currentearnings retained by it for reinvestment purposes.

 Preferred stoc: 0referred stock is a hybrid sorts between a fixed and variable income security. It is ane&uity security with an intermediate claim between bondholders and stockholders on a firm$s assets andearnings. In the event of li&uidation, preferred stockholders have a claim on available assets before thecommon stockholders. In addition preferred stockholders get their stated dividends before commonstockholders receive any dividends. any issues of preferred stock are callable at a stated redemption

 price. 0referred stocks are usually perpetual securities having no maturity date, although there are

exceptions to the general rule. -owever, following are the special features of preferred stock• Some preferred stockholders have voting rights and some preferred stockholders do not have thisright and voice in the management.

• 0referred stockholders have pre7emptive right to subscribe to additional issues of common stock  but non7voting preferred stock have no pre7emptive right.

• ost preferred stock have par value. In this case, the shares$ cash dividend rights are usuallystated at a percentage of par values.

• ash dividends are the most significant aspect of preferred stock in which the stockholdersshould get more gain from dividends than from capital appreciation.

0referred stocks can be categori"ed as follows• Cumulative preferred stoc": -olders of cumulative preferred stocks are entitled to a dividend

whether the firm earn profit or not. If the corporation misses a preferred dividend or any part of the ones, it is not lost but must be made up in a later year before any cash dividends can be paidthe common stockholders.

• Non(cumulative preferred stoc": -olders of non7cumulative preferred stocks are entitled to adividend if firm earn profit. If the corporation does not earn any profit, the dividend is lost to the

 preferred stockholders.• #articipating preferred stoc"s: 0articipating preferred stock is somewhat uncommon which is

entitled to a stated rate dividend: interest and a share of earnings available to be paid to thecommon stock holders. The holders of participating preferred stocks are entitled to receive extradividends when earnings permit.

• Convertible preferred stoc"s: At the option of the holders, convertible preferred stocks may beconverted into another security 'generally firm$s common stock* on stated terms.

• Trust preferred stoc"s: These types of stocks are structured so that their dividend payments aretreated as tax7deductible interest by the issuer.

• Ad)ustable(rate preferred stoc"s: Adjustable7rate preferred stocks have the cash dividends thatfluctuate from &uarter to &uarter in accordance with the current market interest rates. Thesestocks are created to make cash dividend yield on preferred stock fluctuate with marketconditions and thus be more competitive with bond investments.

• 'oney mar"et preferred stoc"s: oney market preferred stocks have finite life that expiresvery soon after they are used7 some issues mature even after seven weeks. They typically offer alarge denomination because they are targeted at large corporate investors.

 Stoc Dividends: Instead of and sometimes in addition to cash dividends, investors can receive dividendin the form of stock. (ften firms pay stock dividends as a replacement for or a supplement to the

 payment of cash dividends. A stock dividend is a payment of stock to existing owners.

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 Stoc Splits: Stock splits have similar effect upon a firm$s share price as do stock dividends. Stock splitsare commonly used to lower the market price of the firm$s stock. To enhance the trading activity high7

 priced firms often believe to lower the price of the same. Stoc Repurc$ases: Stock repurchases refer to the firm buying its own stock. #epurchased stock iscalled treasury stock. A corporation can repurchase its shares in one of the following ways open market

 purchase, private negotiated transactions or a tender offer.

%rom the above discussion, we may conclude that preferred stock possesses some characteristics similar to bonds and some to common stock. -owever, the different characteristics of common stock, preferredstock and bond are summari"ed in the following Table.

Table:  Features and Characteristics of Different Securities.

Aspects Common stoc" #referred stoc" Bonds

laim on income0riorityAmount

+ast#esidual

Second%ixed

%irst%ixed

laim on assets0riorityAmount

+ast#esidual

Second%ixed

%irst%ixed

laim 1iscretionary 1iscretionary andatoryaturity 0erpetual 0erpetual %ixed

Derived $ecuritiesDerived $ecuritiesSecurities deriving part or all of their value from an underlying asset are termed as derivative securities.In addition to common stock investments, it is also possible to invest in e&uity7derivative securities,which are securities that have a claim on the common stock of a firm. The securities we term derivedsecurities include such financial assets as options, warrants, and futures contracts. All or part of their value is derived from the value of another security. As for example, the value of a call option is derivedfrom the value of the common stock against which the call option is written8 the value of a commodityfutures contract is derived from the value of the commodity which must be delivered in the future.

(ption: An option is the right to buy or sell common stock at a specified price for a stated period of time.(ption instruments include warrants and puts and calls.• A warrant is an option issued by a corporation giving the holder the right to ac&uire a firm$s

common stock from the company at a specified price within a designated time period. Thewarrant does not constitute ownership of the stock only the option to buy the stock.

• A call option is similar to a warrant because it is an option to buy the common stock of acompany within a certain period at a specified price called the striking price. )nlike warrant it isnot issued by the company rather than by another investor willing to assume the other side of thetransaction.

• A put option is the right to sell a given stock at a specified price during a designated time period.)utures contract: A futures contract is an agreement providing for the future exchange of a particular asset at a currently determined market price. The seller contracts to deliver the asset at a specifieddelivery date in exchange for a specified amount of cash from the buyer.Indirect !uity Investment

Indirect e&uity investment re&uires less supervision than does a direct investment. These investments

involve a commitment of funds to an institution of some sort that in return manages the investment for 

the investor. Special types of indirect investments are given below

 #nnuities

)nder some circumstances, employees are permitted to have certain portions of their salaries withheld by

their employers for investment in variable annuities. The amount invested in the variable annuities is not

taxable until it is withdrawn. Investor of such scheme may withdraw during retirement when he is in a

lower tax bracket. It is also a device for deferring the payment of income taxes. The organi"ationmanaging the annuity invests the proceeds of all participants in the plan of a portfolio.

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 Insurance policies

+ike insurance policy is another name of indirect investment when the policy is purchased from a mutual

insurance company, the insured becomes an owner of the company.

 Mutual funds

utual funds, the popular name for open7end7investment companies sell and redeem their own shares.

(wners of funds shares can sell them back to the company any time they choose. The mutual fund islegally obligated to redeem them .Investors purchase new shares and redeem their existing shares at the

net asset value '5A2*. The 5A2 of an investment company share is computed by calculating the total

market value of the securities in the portfolio minus any trade payables and dividing by the number of the

fund$s shares currently outstanding.

*nit investment trusts

It is an investment company that owns a fixed set of securities for the life of the company referring that

the investment company rarely alters the composition of its portfolio during the life of the company.

(pen+end investment companies

An investment company which is ready to purchase its own shares at or near their net asset value iscalled an open7end investment company. ommonly known as mutual funds, these companies also

continuously offer new shares to the public for a price at or near their net asset value. The number of 

share outstanding of these types of company$s changes on a daily basis as their capitali"ation is open.

Close+end investment companies

A close

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Investor$s #eturn through Indirect InvestmentInvestor$s #eturn through Indirect Investment

Investor   holds shares in 

which is a

0ortfolio of Assets

Financial MarketsFinancial Markets

In the economic sense, investment means the commitment of funds to capital assets. Accordingly theinvestors are users of funds which they own or ac&uire in the market. Investors supply the funds byac&uiring debt and e&uity instruments with their savings and they also transfer these instruments amongeach other. In this connection investment market includes the markets for funds both short and long term.A market is a mechanism that brings buyer and seller together to aid in the transfer of goods and services.It is not a physical location where physical commodities are found ready to be bought and sold. #ather itis a process by which buyer and seller can communicate regarding the relevant aspects of the transaction.So financial market is a mechanism that brings buyer and seller of financial assets together for fixing the

 price of a particular security. )nder such mechanism, those who establish and administer the market do

not own the assets. They provide a physical location or an electronic system allowing potential buyersand sellers to interact. They provide necessary information and logistic support to transfer the ownershipof the securities being traded.

C*aracteristic of a mar"et

Individuals enter into the securities markets to buy or sell their securities at a price justified by the prevailing supply and demand. An efficient market is that where the participants must have timely andaccurate information on the volume and prices of past transactions and on all currently outstanding bidsand offers. A good security market possesses the following characteristic

D Investors will be able to get accurate and &uick information necessary for the securitytransactions.

D A market should operate in a position where the ability to buy or sell an asset at fixed price is

not substantially different from the price for prior transaction, assuming no new information is available.D A market should ensure the price continuity meaning that prices do not change much from one

transaction to the next unless substantial new information becomes available. A continuous marketwithout large price changes between trades is a characteristic of a li&uid market.

D The buyers and sellers trade at prices above and below the current market price.D An efficient or good market is one in which the transaction cost is minimum i.e., the market

should be internally efficient.D A market should reflect all the information available regarding the supply and demand factors

in the market. This condition is refers to as external or informational efficiency.

Nature of $ecurities 'ar"ets

The prime objective of a firm is to achieve the highest value for the shareholders. The firm$s managementshould examine sufficiently the process by which a firm$s market value is determined, in particular, theimportant role of financial markets in the process. The determination of share price is a combination of 

Investment company’s funds

Capital gain or

loss

Dividends and/or

interest

Income

EF

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+ole of $ecurities 'ar"ets

%or rapid economic development both direct and indirect financing should be considered complementary.4fficient and effective operation of securities market is re&uired to meet at least two basic re&uirements.%irst one is to support industriali"ation through savings mobili"ation, investment fund allocation andmaturity transformation. Second one is to be safety and efficiency in discharging the above role. In a

developing country like !angladesh such conditions do not prevail due to the prevalence of informalcredit markets. The recent development towards privati"ation seeks the need of efficient capital markets.It performs various functions in the process of economic development. The securities markets provide

 both savers and users with a broad spectrum of investment choices that can increase the level of bothsavings and investment. Securities markets can attract the investors as it offers higher return to theinvestment portfolio. This investment portfolio easily can draw more savers in the investment processthat in turn involves institutions like brokerage house, investment banking, money investing firms etc.)nder the scheme of %oreign 1irect Investment '%1I*, securities markets attract external sources in thecapital market. 4ntrepreneurs are supposed to be provided capital procuring other factors of productionthat would ensure full7employment and create more productive capacity in the economy. A securitiesmarket can achieve this type of objective. Securities markets can augment the growth8 development andstability of a country$s financial structure increase the allocation of savings, allocation of existing real

wealth and ensure the distribution of income. In economic development of a country the problem ismainly two7fold vi"., increase or creation of domestic savings and transformation of more funds toinvestment. Securities markets can ensure efficient allocation of savings to productive investment by thecreation:development of money and capital market.In the economic sense, capital formation is the change in the stock of the capital goods represented by

 producers$ durable e&uipment, and business inventories. In modern capitalistic economy, capitalformation would be impossible without a market or group of markets for the transfer of savings to thoseseeking funds for investment in economic goods and services. In this connection, a variety of instrumentsrepresenting money and claims to money are employed. Savers provide the funds and in return expect toreceive dividends, interest, or rent and the investors offer the hope of income and price appreciation. Inthe financial sense, a securities market is the market for instruments representing longer7term funds. It isconsisted of institutions and mechanism whereby intermediate7term funds and long7term funds are

 pooled and made available to business, government, and individuals, and where outstanding instrumentsare transferred. (n the other hand, money market focuses on debt instruments only with maturitiesranging from one day to one year. It is engage in purchasing and selling of new instruments rather thantrading in outstanding claims. In financial terminology, the investment market includes the markets for funds both short and long term. !oth long term and short term segment of investment market includes the

 primary sale and purchase of and secondary transactions in instruments. !usiness firms invest capital inamounts that are beyond their capacity to save in any reasonable period of time.Securities market plays a crucial role for the proper functioning of capitalistic economy. They serve tochannel funds from savers to borrowers. Another important function that the securities market does is theallocative function by channeling funds to those who can make best use of them. The existence of thesecondary market ensures the purchasers of the primary securities that they can &uickly sell their 

securities. Since there are no guarantees in the financial market, sales may involve losses. Such a lossmay be much preferred to having no cash at all if the securities cannot be sold readily.

Classification of $ecurities

!efore analy"ing securities, it is essential for financial analysts, economists, business policymakers,security investors, academicians to study and develop an understanding of different classes of securities.1epending upon a wide variety of considerations, securities can be categori"ed into four broad groupsvi"8

i. !ond,ii. ommon stock,iii. 0referred stock and

iv. 1erivative securities.!onds are fixed income securities with a fixed maturity. There is a specified date at which time the firmmust pay all liabilities it owes to the bondholders who do typically have the fixed claim on the income of 

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the firm. In addition, bondholders have fixed claim on the assets of the firm. ore specifically, when the bonds mature or in the event of li&uidation of the firm, the bondholders are entitled to receive their  principal having a priority over any of the claims of the e&uity owners.4&uity shares or common stocks called to be perpetual lie on the other side of the securities spectrum.ommon stocks or e&uities have no maturity period. They exist as long as the corporation exists.ommon stockholders have the residual claim against the income and assets of the firm.

0referred stock basically called the hybrid security lies somewhere between those of common stock and bonds. +ike bondholders, the holders of preferred stock have a fixed claim on the income of thecorporation. (n the other hand, like common stock preferred stock is a perpetual liability of the firm.1erivative securities include warrants, options, futures contracts. 0art, if not all, of their value is derivedfrom the value of another security.$ecurities 'ar"ets Distinguis*ed

Investment defined as the changes in capital stocks. In the economic sense, capital formation is thechange in the stock of the capital goods. According to the views of capitalistic economy, capitalformation or accumulation of capital for investment and industrial development of an economy would, nodoubt, be meaningless without an organi"ed market or group of markets. In this connection, it is sine7&ua7non to transfer the savings from surplus unit to those seeking funds for investment in economic

goods and services for the rapid economic development and emancipation. To make effective thistransfer, a variety of instruments representing money and claims to money are employed. Savers providethe funds and expect to get a reasonable return. )sers of the funds are supposed to get income, priceappreciation, or both.

Capital Maret 

In the financial sense, the capital market is the market for the instruments representing long7term fundsre&uirement of the corporation. It consists of a sprawling complex of institutions and mechanismwhereby intermediate7term funds and long7term funds are pooled and made available to business,government, and individuals. In this mechanism outstanding instruments collecting the funds aretransferable.

C*aracteristics of Capital 'ar"etThe characteristics of the capital market and its elements may be classified and measured in varieties of ways. There are a number of submarkets having distinguished features and independent rates of yield.-owever, the capital markets assume the following characteristics

@ 1ebt and e&uities instruments traded in the capital markets are intermediate or longer7term inmaturity.@ The scope of the market is very wide.@ The supply of the new funds comes from the same sectors although it is funneled within themarkets through financial institutions.@ The demand for the capital market instruments comes from five categories like individuals andhouseholds, business and financial corporation, central government, local government, and foreigngovernment.@ )nder the auspice of capital markets, both negotiated and open markets are widely used.@ Transactions in open markets influence the prices and yields of longer7term instruments

immediately.@ +on7term instruments in the open market are transferred among the investors in the over7the7counter market and organi"ed exchanges rather than the raising of new funds in the primary markets.

Capital 'ar"et Instruments

The major instruments traded in the capital markets are medium and longer7term in maturity arediscussed below

@ /overnment securities with maturity of more than one year. They are marketable and their yields vary with changing credit and capital market conditions

@ +onger7term debt owned by the government.@ 0rivately owned longer7term debt that is sponsored by the government.@ +ong7term debt of local government.

@ +ong7term corporate bonds including corporate mortgage debt.@ ommon stock, preferred stock@ ortgage including residential, commercial, and industrial lien.

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 Mone% maret  It focuses on debt instruments only the maturities of which range from one day to one year. It alsoinvolves a complex of instruments dominated by the central bank as agent of the government andcommercial banks. It purchases and sells new instruments rather than trading in outstanding claims.

C*aracteristics of  'oney 'ar"etoney market is not the uni&ue place or mechanism where short term debt instruments are traded among

the investors rather there are several locations where direct transactions take place between borrowersand lenders. )nder an efficient system to handle any amount and volume of transactions at any time,regional submarkets are also linked together with the centrally organi"ed market. -owever, the basiccharacteristics of money markets are given below

@ Short7term securities with maturity of less than one year are traded in the money market@ entral and regional short7term markets create a national short7tern interest rate structure.@ They also create a national short7term credit.@ Idle funds are transferred through the intermediaries from all over the country to the central open

market.@ %unds are largely transferred on a wholesale basis, although the large institutions deal directly

with each other.@ The whole role of the institutions involved in the money market is controlled by the monetary

and credit system of the country.@ The major participants in the money markets are the central banks and commercial banks.

'oney 'ar"et Instruments

oney market instruments are summari"ed below@ Treasury bills@ !ankers$ acceptance@ ommercial paper @ ertificates of deposits71s@ 5egotiable 1s

Any firm distinction between money and capital markets is some what arbitrary. Suppliers of funds maydirect them to one or both the market and users of fund may draw funds from either market. %urthermore,funds flow back and forth between two. Any institution serves both the market. #ates of interest or fundac&uisition costs are interrelated with changes in the general demand and supply of funds.

#rimary 'ar"et

0rimary market is a security market where new securities are being sold for the first time. It is a marketwhere new issues of common stock, preferred stock or bonds are sold by government or firms to ac&uirenew capital. A primary market is one in which a borrower issues new securities in exchange for cashfrom an investor. 3hen securities are initially offered to the public, they are said to be to be sold in the

 primary market. 0rimary markets are those in which the sellers of the securities are also the issuers of thesecurities i.e. the issuing firms are the sellers of the securities. If the existing corporations issue additionalshares, these would be sold in what is called the primary market. A primary issue occurs when the issuer gets the proceeds from an initial public offering 'I0(* of stocks or bonds. An intermediary that finds outthe buyers for I0(s is termed as investment banker.

 5ew treasury bills, stocks, or bonds all take place in the primary markets. The issuers of these securitiesreceive cash from the buyers of these new securities, who in turn receive financial claims that previouslydid not exist.

Functions of Investment Ban"er

An investment banker is defined as firm or a financial intermediary speciali"ing in the sale of newsecurities to the public investors. %or doing so an investment banker performs a wide variety of functions.The typical functions done by an investment banker are, however, summari"ed below

 #dvisor% )unctions: An investment banker serves a potential security issuer in an advisory capacity. Ithelps the issuing firm analy"e its financing needs and suggests different ways of raising funds. !eing anunderwriter, an investment banker may function as an adviser in mergers, ac&uisitions, and financingoperations. The investment banker reaching an agreement with the issuer is called originator or managingunderwriter who subse&uently coordinates two temporary groups. An number of investment bankers

 being the members of underwriting syndicate, the first group, pool their money and share theunderwriting risk. The second group known as selling group is generally made up of brokerage firmsagreed to sell the primary issues to the investors.

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 #dministration )unctions:  The investment banker shares with the issuer the responsibility of conforming to the securities laws involving preparing the registration statement and prospectus. TheSecurities and 4xchange ommission 'S4* re&uires that most primary issues should be accompanied bya registration statement disclosing information that should allow potential investors to assess the &ualityof the new issue. The information that must be published in registration statements is set by law. After filing the registration statement with the Securities and 4xchange ommission, there is usually only a

 brief waiting period until the new issue may be offered for sale.*nder,riting )unctions: )nderwriting refers to the guarantee by investment banker that the issuer of the new securities will receive s certain amount cash for them. The managing underwriter forms anunderwriting syndicate the members of which literally buy the securities from the issuing firm on the dayof the offering. 3hen the securities are actually sold to the public, they are sold either by members of theunderwriting syndicate or by members of the selling group. The members of the selling group are broker7dealer firms buying the securities from the underwriters and in turn resell them to their customers.

 Distribution )unctions: Investment bankers distribute the new issues to investors in several ways vi".,i* )nderwriting7by which they buy the issues and then sell them to the public investors. They

also bring together issuer and investors as an intermediary.ii* 0rivate placement7 meaning that investment banker finds one buy 'typically large institution*

for an entire issue and arrange for direct sale from the issuer to this large investor.iii* !est7efforts basis7 where the investment banker may agree to distribute new issues assuming

no financial responsibility if all the securities can not be sold. The commission or compensation for the investment banker for best7efforts offerings are typically more than for adirect placement but less than for a fully underwriting public offering.

 Pricing )unctions:  The investment bankers must stabili"e the pricing of a new issue during thedistribution period to prevent it from drifting downward. The underwriting manager supports the price by

 placing orders to buy the newly issued security at a specified price in a secondary market where the newsecurities are trading.Floatation Costs

The underwriter offering the highest net cash proceeds for the I0(s gets the deal. Investment bankersmake profits by selling I0(s at price above what they paid for them. The difference between the buyingand selling prices is called the spread. The spread in a security issue is typically divided into three partsThe management fee, the underwriting fee, and the selling concession. These are explained below  The originator or the managing underwriter keeps a certain point for originating and managing

the syndicate.  The entire underwriting group earns a specific percentage of the total profit.  The members of the selling group earn the remaining portion of the total profit.

The precise composition of these fees may vary from offering to offering but the general rule of thumb is6F percent, 6F percent and ?F percent respectively to originator, investment bankers and selling group. Incase where the originator sells to the ultimate buyers without the involvement of other parties, hereceives the total spread.

Ne, Issue &nder,riting #rocess- #rimary Offering of $ecurities

After giving advice investment bankers purchase initial public offerings from the issuer to resell them tothe investing public as &uickly as possible by making an underwriting syndicate comprised of brokeragehouses commonly known as investment bankers. At their capacity investment bankers help create newissues, advise I0( clients, handle administrative tasks, under write the new issues, and distribute thesecurities to the investing public.

Isuuer

  H

(riginating investment banker 

  HInvestmen

t!anker 

Investment

!anker 

Investment

!anker 

Investment

!anker 

Investment

!anker )nderwriting Syndicate

  H

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Selling /roup  H

Investing 0ublic

  Figure:  IPO floatation Issuer 

• Sells securities to the underwriters(riginating investment banker 

• Advises issuer • %orms syndicate• !uys securities from issuer • #esells securities to public or selling group

Investment banker • !uys securities from issuer • #esells securities to public or selling group

Selling group• Sells securities to the investors

$easoned and &nseasoned #ublic Offering

0rimary issues of securities commonly known as initial public offerings 'I0(s* are sold by the firmknown as issuer to the investors through the investment bankers. 3hen the issuer is selling the securitiesin the primary market, these are known as initial public offerings. Such type of securities can becategori"ed into two groups vi"., seasoned issues and unseasoned issues.

 Seasoned Issues: Sales of common stocks of a publicly traded company are called seasoned issues.!roadly speaking an offering of seasoned issues would involve the issuance of additional shares of existing companies having common stocks outstanding. A seasoned public offering is a new offering of securities by a firm that has already issued securities to the public. Three types of seasoned issues are

available in the field of I0(s as followsi.  Primary seasoned offerin! It refers to the offering of new issues of securities by a firm that has

already done an initial public offering. The principal object of such offering is to raise newcapital for the firm.

ii. Secondary seasoned offerin! Also known as secondary placement, a secondary public offeringrefers to the purchase of the securities by the underwriters directly from the firm$s founder,other prepublic owners, and other post7public holders of the securities not from the firm. The

 principal objective of secondary seasoned offering is to cash out the firm.iii. Combined seasoned offerin! It is partly primary and partly secondary seasoned issue which is

generally used to both raise new capital for the firm and to cash out some of the prepublicowners.

*nseasoned Issues: Initial public offerings which are being offered to the public for the first time areknown as unseasoned issues. There is no established market price for them rather is negotiated betweenthe investment bankers and the issuing firm.

$econdary 'ar"ets

0rimary issues of securities occur relatively infre&uently. 3hen an investor buys a security, the seller isanother investor. Such trade occurs in what are called secondary markets. 3hen investment bankersunderwrite I0(s in the primary markets, the issuers receive the cash proceeds. In the secondary marketsone investor sell securities to another investor and the issuing firm is not involved. The secondary marketis an effective mechanism existing for the resale of the new issues. The secondary market gives investorsthe means to trade existing securities. The securities continue to trade between investors in a marketcalled secondary market. In secondary markets issuer no longer receive any cash proceeds. The

secondary markets perform a wide variety of activities like@ A secondary market brings the investors together so that transaction can be made immediately at

a price that varies little from transaction to transaction.

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Est arket 6nd arket 9rd arket ;th arket

@ A secondary market gives investors he means to trade existing securities.@ A secondary market continues to maintain the marketability of the tradable assets.@ arket fixes the price of the security by the transaction that flow from the investors$ demand and

supply preferences.@ A secondary market makes the transaction price public which helps investors making better 

decisions.

@ A secondary market stimulates new financing encouraging the investors to invest in I0(s.@ !eing a self7regulatory organi"ation, a secondary market regulate and monitor the activities of 

members, employees, listed firms. A secondary market also exists for trading of common stock, preferred stock, bonds, debentures, warrants, options, and futures contracts. -owever, thestructure of the secondary market is given below

Secondary arketsType of securities arkets

4&uities• (rgani"ed stock exchanges• (ver7the7counter market

• Third market• %ourth market

!onds• (rgani"ed exchanges 'a relatively small amount*• (ver7the7counter market

0uts and calls   • (rgani"ed stock exchange

#attern of $econdary 'ar"et

Secondary markets may be categori"ed into four groups as i* first market called organi"ed stock exchanges, ii* second market termed as over7the7counter '(T* market, iii* third market and iv* fourthmarket. There position and status are given in the following manner

(rgani-ed E.c$anges

In the secondary markets individual investor can sell securities to another investor without the presenceand involvement of the firm that issued the securities. Such type of secondary trading takes place on theorgani"ed stock exchanges.$e (C Maret 

In past times securities were traded over7the7counter of banks or in the offices of security dealers. Todayover7the7counter trades occur in brokers$ offices, dealers$ offices, homes, over the phone, electrically, andany place or even any transport whole over the country and in foreign countries. The over7the7counter '(T* market includes trading in all securities not listed on one of the exchanges. It also includes tradingin listed stocks referring to as third market. Though unlisted securities trading market, (T is one themost modern and efficient securities market in the world. (T market is not physically located market inany one place. It consists of a number of broker7dealers throughout the country who are linked together through an e7mail or electronic communications network. Any security can be traded on the (T marketas long as a registered dealer is willing to make a market in the security. The (T market competes withinvestment bankers and organi"ed exchanges as (T dealers can operate as both a primary and asecondary market.

Secondar arkets

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Thirdmarket

The (T  market

%ourthmarket

#isk7free securities, government and corporate bonds, common stocks etc. are traded in over7the7counter market. orporate bonds are preferably traded in the (T market because organi"ed exchanges prefer totrade stocks of corporations instead of their bonds as the commissions of common stock are higher. The(T broker7dealers are organi"ed as sole proprietorships, some as partnerships, and many ascorporations. -owever, the broker7dealers in the (T market can be categori"ed as follows

• (T house7 An (T house is speciali"ed in (T issues and rarely belongs to an exchange.• Investment banking house7 An investment banking house is speciali"ed in I0(s and may

diversify by acting as dealer in both listed and (T securities.• ommercial bank7 A commercial bank may be an (T dealer or broker when it trades securities.• Stock exchange member house7 It can work as (T broker or dealer having a separate

department specifically formed to carry on trading in (T market.• !ond house7 A bond house may deal in government and autonomous bond issues trading in (T.

$ird and )ourt$ Marets

The secondary markets can occasionally be categori"ed into four parts. The first market representsorgani"ed exchanges where listed securities are traded. Second market is the over7the7counter marketwhere the unlisted securities are traded. The third market represents over7the7counter trading of securitieswhich are listed on an exchange while the fourth market represents direct trading between two investors

 bypassing the activities usually done by the brokerage firms.$e $ird Maret: The third market is an (T marketing stocks associated with an exchange. Althoughmost transactions in listed stocks take place on an exchange, a brokerage firm without being a member of an exchange can make a market in a listed stock. A number of broker7dealers who are not members of 1haka Stock 4xchange '1S4* can make markets in stocks of 1S4 listed firms. The (T dealers makingup the third market provide minimal services for their clients7only execution of buy7sell orders andrecord keeping. They are always ready to execute large trades at much lower commissions. The successor failure of the third market depends on whether the (T market in these stocks is as good as theexchange market and whether the relative cost of the (T transaction compares favorably with the cost

on the exchange. $e )ourt$ Maret: The method of reducing commission costs in the security transactions sometimeswould be the complete elimination of broker7dealer firm as a middleman. 3hen one investor sellssecurity directly to another investor without a broker7dealer as middleman, they are said to be trading inthe fourth market. In all most all cases, both parties involved in each transaction of fourth market areinstitutions. 1irect investor7to7investor trades occur through a communications network between block traders. A block is a single transaction involving EF,FFF or more shares. The participants of fourth market

 bypass the normal dealer system. -owever, the organi"er of the fourth market collects only a smallcommission for helping to arrange block transaction.

Figure:  Diaram of the orani"ed exchane# O$C market# and the third and fourth market.

.i!uidity in t*e $econdary 'ar"et

+i&uidity is the ability or power of an asset to be converted into cash or near cash at the time needed

without loss. +i&uid asset is a readily marketable asset with a relatively stable price that is reversible.0erfectly marketable assets are called perfectly li&uid assets. 3henever sold they suffer no price decline.ost securities have more moneyness than real asset but are not perfectly li&uid assets like cash. That is,

(rgani"ed

exchange

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securities are more li&uid than real asset but less li&uid than cash and demand deposits at a bank.Investors pay a slightly higher price, called a li&uidity premium for assets that are more li&uid. Illi&uidasset, on the other hand, are the assets that con not be sold &uickly unless the seller incurs significantexecution costs that include the following components

0rice concession the seller must grant to the buyer to execute a &uick sale.

The bid7asked spread, the si"e of which varies inversely with the li&uidity of the subject security. The compensation re&uired to find the other party of the transaction. ommissions of the brokerage firms. Taxes.

In fine, li&uidity of an asset is the ability to buy or sell the same &uickly without causing any significantchange in its price. +i&uidity varies inversely with the costs incurred when buying and selling. +i&uidityof a security increases as the volume of trading in it increases.)eatures of a liquid maret 

1ealer and broker work together to create a li&uid market as their work is easier and their cost of doing business is less in li&uid markets. -owever, the followings are the &ualities that a li&uid market must possess

• 1epth7 being the position where buy and sell orders exist both above and below the price atwhich the security is trading. A market without depth is called a shallow market.

• !readth7being a position where buy and sell orders exist in volume. arkets lacking the volumeof orders needed to provide li&uidity are called thin markets.

• #esiliency7where new orders pour in immediately in response to price changes caused bytemporary order imbalances. A speedy price discovery process is essential for resilient.

 "roers and Dealers

The trading activities done by the investors are executed by a security firm acting either a broker or adealer. A firm acting in a brokerage capacity serves as an agent for investors by finding anther investor to

take the other side of the transaction. %or doing this job, the broker is compensated by a commission. A broker in the securities markets is an intermediary representing buyers and sellers in securitiestransactions.A dealer, on the other hand, may take positions in various securities. A dealer may buy or:and sellsecurities for its own account. If the dealer has a long position i. e., owns the stock and the stock declinesin price, the dealer losses money. (n the other hand, if the dealer has a short position in a stock, he hastemporarily sold more stocks than it owns. )nder this circumstance, if the stock increases in price, thedealer will loss money if covers its short position through purchasing stock in the market prices higher than the dealer originally sold the stock for. The difference between bid price and ask price is thecompensation 'profit:loss* for the dealer. !id price refers to the price that dealer wishes to pay to theseller of the securities and ask prices is the price at which he will sell a security. 1ealers are calledmarket makers as they will sell or buy the securities for their own account in order to balance customers$orders. If a party of the transaction is not available, the dealer will become the second party to constitutethe transaction. A vast majority of the securities firms act as both brokers and dealers.

Types of Bro"er

embership in the organi"ed stock exchange are fre&uently referred to as seats, though tradingisconducted without chairs. !eing an investor an individual will fill out a form disclosing informationabout his personal income and finances. An investor will deal with a broker who will probably be hisconnection with the market for the same time. The broker will provide the investor with informationabout the company he is interested in, about general economic trends, and about other investments of interest. -owever, the brokers are categori"ed as underCommission "roer: The vast majority of the seats of an organi"ed stock exchange are owned by the

commission brokers. They are he agents on the exchange floor who buy and sell securities for the clientsof brokerage houses. They act like employees of a brokerage house. They communicate via telephone

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with brokerage, receive transactions from the brokerages that employ their services and they send back confirmation messages. They may also act dealers and seek profits by trading for their own account.)loor "roer: %loor broker execute orders for commission brokers having more orders than they canhandle. %rom the brokerage house, orders of the clients will be phoned to floor of the exchange to a

 person called a floor broker. %loor brokers basically buy an sell securities on the floor of the exchange.They are free7lance members of the exchange and help prevent backlogs of orders, and allow many firms

to operate with fewer exchange memberships than would be needed without their services.%loor Trader %loor traders are sometime called as registered traders. They differ from floor brokers asthey trade primarily for their own accounts. They are speculators searching the exchange floor for 

 profitable buying and selling opportunities. They trade free of commission as they deal for their ownaccounts. They can buy and sell the same security on the same day in order to profit from pricemovements.

 Specialists:  The floor brokers purchase securities from a person called a specialist. Specialists areassigned to posts on the trading floor where they make a market in one or more stocks assigned to them

 by the exchange. These market makers act as both a dealer and a broker in the stocks assigned to them.As a broker, they execute orders for other brokers for commission and as a dealer, they buy and sellshares of their assigned stock for their own accounts. The specialists keep an investor in one or more

stocks and buy and sell out of that inventory. They publici"e prices at which they are willing to buy astock and prices at which they are willing to sell. Specialists must accept the obligation to maintain a fair and orderly market for their assigned stocks.

Distinction bet,een primary mar"et and secondary mar"et:

#rimary mar"et $ub)ect $econdary mar"et

i. Seller of the securities is the issuer of the securities

-older:issuer 

i. Seller of the securities is theholder of the security

ii. 0rimary securities are typically callinitial public offerings 'I0(s*

 5ame ii. Secondary securities areoutstanding securities

iii. 0rimary issues of securities occur relative infre&uently

%re&uency iii. Secondary securities occur fre&uently

iv. 0rimary securities previously didnot exist in the market

4xistences iv. Secondary securities areoutstanding

v. /ain from secondary transaction isnot possible in the primary market

/ains v. Investor can gain from thesecondary market

vi. (riginal issuer remains unaffecteddue to the price the changes

4ffects vi. Investors will be affected by the price changes

 According to their operation, the securities markets are categori"ed as primary market and secondarymarket. 4ach of these markets can further be divided into money market and capital market on the basis

of economic unit issuing the securities. The following Table considers each of the major segments of thesecurities markets and the functions they perform.

A 0rimary capital market instruments say I0(s of shares,stocks etc.

! 0rimary money market instruments say I0(s of T7bills,  Figure ( Sement of securities market  Secondary capital market instruments say shares and stocks outstanding

6F

apitalapitalmarketmarket

oneyoneymarketmarket

0rimary0rimarymarketmarket

SecondarySecondarymarketmarket

  AA   !!

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Trading $ystems in $toc" /c*anges-Trading ArrangementTrading $ystems in $toc" /c*anges-Trading Arrangement

Investors give orders to the broker or dealer to execute their transactions in the securities markets with aview to managing their portfolios. 3hen an investor places an order with a broker:dealer, there are anumber of arrangements from which he can choose. These arrangements include the type of orders

 placed, the cost of executing the trade, and the method of paying for the transaction. It is important tounderstand the different types of orders placed and executed in the securities markets.

Trading $ystem

Trading system in the organi"ed stock exchange is the floor trading under which trading took placethrough an open outcry system on the trading floor. In floor trading buyers and sellers transact businessface to face using a variety of signals. 5ow7a7days this trading system is abolished by a new one calledscreen7based trading system introducing a fully automated computeri"ed mode of trading. The screen7

 based trading systems are of two typesi0 1uote driven s%stem: !eing the market maker, dealer in a particular security inputs two7way

&uotes. (ne is for buying 'bid price* and the other is for selling 'offer:ask price*. Investors then placetheir orders on the basis of the bid7ask &uotes.

ii0 (rder driven s%stem: )nder this system investors can place their buy orders or sell orderswhich are then fed into the system.

Several orders are discussed below Maret (rder: The market order being the most fre&uent types of order is an order to buy or sell a stock at the best current market price. It indicates that the investor is willing to buy or sell at the best pricecurrently prevails in the stock exchanges. -ence, a market buy order is what the investor wills to pay thelowest price available, a market sell order, on the other hand, indicates that the investor is willing to sellthe security at the highest bid price currently available. A market order provides immediate li&uidity for investor willing to accept the prevailing market price. arket orders are used if the investors want totrade a small &uantity of stock &uickly in the hope that the price of whose will not change the currentmarket price substantially.

 2imit (rder: A limit order indicates that the investor specifies the price at which he will buy or sellsecurities. So, a limit buy order specifies the maximum price the investor wants to pay for some expectedsecurities. A limit sell order, on the other hand, stipulates the minimum price at which an investor wantsto sell some &uantity of securities. The order shall be executed only if the broker obtains the desired

 price. A limit order may either be day order or open order. A limit day order exists until the end of thecurrent trading day. A limit open order is good until cancelled.

 Stop (rder: Stop order is an order that specifies a certain price at which a market order takes effect.Sometimes called stop loss order is executed to protect an investor$s existing profit or to limit losses.ore specifically, a stop7loss7order is an order by which an investor instructs his broker to sell certainnumber of securities if the price goes down to whatever level the former specifies.

 Stop 2imit (rder: It is an order specifying both the stop price and the limit price at which the investor wants to buy or sell securities. The investor will take the risk of no trade if the security price will notreach the limit price. A stop limit order to buy is the reverse of a stop limit order to sell. As soon as the

stock price reaches the stop level, the order to buy will be executed at the limit level or better indicatingthat below the limit price the order will not be executed. Da% (rder: It is an order that remains effective only for a day it is brought to the floor. The majority of orders are day orders. If not executed it is cancelled.Good+till+cancelled (rder: It is an order that remains effective indefinitely. It is known as open order since the investors are willing to wait until the price reaches some limit the set.)ill or ill (rder: It is an order that must be executed immediately. !eing unexecuted such an order iscancelled.An order is round lot that indicates EFF shares or multiple of EFF shares. (n the other hand, an odd lot isany number of shares between E and CC.

Clearing #roceduresClearing #rocedures

Securities are traded on the daily basis. !ut the settlement dare includes three business or working daysafter the trade day. 0urchaser becomes the legal owner of the securities he bought on the settlement dateon which the seller gives them up. At that day both the buyer and seller settle with the brokerage firm.

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ost of the customers allow their brokerage firm to keep their securities in the name of the brokeragefirm. The client receives a monthly statement showing his cash position, securities held, any funds

 borrowed from the brokerage and so on.

Cas* flo,s bet,een t*e firm and financial mar"etsCas* flo,s bet,een t*e firm and financial mar"ets

• To raise capital a firm sells debt and e&uity to investors in the financial markets through

financing decisions.• The funds raised by the firm is invested in the investment activities of the firm called investment

decision or capital budgeting.• The invested funds generate cash for the firm through its operation.• ash is paid to the debtors for using external funds as the cost of debt like interest if any.• ash is paid to the government as taxes.• ash is paid to the e&uity holders as dividends.• #etained cash flows are invested in the firm sometimes by distributing stock dividend or bonus

shares to the existing e&uity holders that also increases capital. 

Appendi/

+egulations of $toc" /c*anges- $ecurities and /c*ange Commission+egulations of $toc" /c*anges- $ecurities and /c*ange Commission

In mixed economies like !angladesh, the major part of domestic savings takes place in the private sector.The domestic saving rate is positively related to the level of income and its growth rate. To raise thesaving rate one must understand the savings preferences and motives of the non7 corporate sector of thecountry. 4conomic history of some developing countries suggests that, in the evolution of the financialstructure, the non7corporate sector prefers to hold more than fifty per cent of its financial saving in theform of saving and fixed deposits.Securities markets in !angladesh were established in EC>; while the formal trading began in EC>?. Their 

activities are being controlled and regulated by their Article of Association along with other governmentregulations subject to amendment from time to time. The apital Issue Act, EC>;, however, is one of the pieces of legislation governing the stock exchange in the country. onse&uently upon, with the spirit of the nationali"ation and sociali"ation motive of the government, the then only securities market in!angladesh, the 1haka Stock 4xchange +td. suspended its trading and other administrative activities inECE after the independence of the country. +ater on in EC? it resumed its activities with nine listedcompanies after the changes of the government policies. Activities of the securities markets improvedsince ECB> and gained momentum from early ECCE4fficient and effective operation of securities market is re&uired to meet at least two basic re&uirements.%irst one is to support industriali"ation through savings mobili"ation, investment fund allocation andmaturity transformation. Second one is to be safety and efficiency in discharging the above role. In adeveloping country like !angladesh such conditions do not prevail due to the prevalence of informal

credit markets. The recent development towards privati"ation seeks the need of efficient capital markets.It performs various functions in the process of economic development. In economic development of acountry like !angladesh, the practices, and the supervision of issuers, market and intermediaries arevested upon regulatory authority. The !oard of S4 is the policymaking and overseeing body and theregulatory functions are taken care of by hairman and members.All the components of securities markets should be concerned with the investor protection. It is essentialto say that the legal protection of investors in a country is an important determinant of the developmentof its financial markets. 3here laws are protective of outside investors and enforced, investors arewilling to finance firms, and financial markets are both boarder and more valuable. eeping this view inmind, the government of !angladesh has set up Securities and 4xchange ommission 'henceforth S4*on June B, ECC9 under the Securities and 4xchange ommission Act, ECC9. Securities and 4xchangeommission is an independent, &uasi7judicial agency of the government, the mission of which is to

administer laws in the securities field and to protect investors and the public in securities transactions.onsistent with the over all policies, S4 is supposed to act as a central regulatory agency performing

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wide range of functions covering the entire capital market including the proper issue of capital, theestablishment of fair trading.

$cenario of $ecurities 'ar"ets in Banglades*

The securities market of !angladesh started functioning with the reactivation of 1haka Stock 4xchangeand Investment orporation of !angladesh I!, the largest investment banker and underwriter, in EC?.

Subse&uently, in ECBFs, 5ational redit +imited and !angladesh ommerce and Investment +td. alsostarted functioning in securities market activities in !angladesh.1S4 is the largest organi"ed exchange at present in !angladesh. After her independence in ECE, the then existing securities market 'The 1hakaStock 4xchange* was abolished by the decision of the government. All the listed companies wereconverted into sector corporations. The controls were vested with government. 5ew industrial policy wasformulated that deterred the growth of new companies. !ut subse&uently, it was found that the publiclyowned enterprises increasingly became losing concerns. 0rivate enterprises became to grow in EC? andthey started functioning side by side with the public sector enterprises. As a result of the revamping of the

 private sector, 1haka Stock 4xchange resumed in EC? with C listed companies. )nder denationali"ation policy in ECB6, the government returned some of the jute and cotton mills to their previous owners. Thedimension of privati"ation spirit results in the development of stock exchange. In ECBFs, two privateinvestment companies vi"., 5ational redit +td. and !angladesh ommerce and Investment +td. were

 permitted to function in the securities market activities along with 1haka Stock 4xchange and Investmentorporation of !angladesh. At present 5ational redit +td. and !angladesh ommerce and Investment+td. do not function in the capital market. -owever, the securities markets in the country are developingits operation in all respect and the second securities market in hittagong started operation in ECC>. (ther individual firms came forward to help investors to take part in the stock exchange activities. -owever, inthe context of 1haka Stock 4xchange, and hittagong Stock 4xchange are involved in bringing together the buyers and sellers of securities as per provisions of the Securities and 4xchange ommission 'S4for short*, !angladesh. These two secondary markets take the responsibilities to meet the demands of 

 buyers and sellers of the market by setting transactions. They have no authority to fix the price of thesecurities8 rather they confirm the transactions in the market. !oth the exchanges are conducted byomputeri"ed Automated Trading System and are self7regulated.4ach stock exchange establishes listing re&uirements, approves, suspends or removes listing privileges of companies, monitors listed companies in compliance with regulatory provisions and permits dual listing.In order to protect the interest of the investors government has established Securities and 4xchangeommission on Bth  June ECC9 the main functions of which are to develop and regulate markets andensure proper issuance of securities. This ommission acts as a entral #egulatory Agency that guidesthe entire capital market. Thus, a lot of policies and regulations were framed by the government throughthe ommission to protect and enhance the securities markets helping channeli"e savings of differentinvestment opportunities. !ut now7a7days the dual authority of !angladesh !ank and Securities and4xchange ommission could jeopardi"e the development and function of erchant !anking policy.

Trends of $ecurities 'ar"ets in Banglades*

Securities markets in !angladesh were established about ;B years back in EC>;. !ut formal trading began

in EC>?. Their activities are controlled and regulated by their Article of Association along with other government regulation subject to amendment from time to time. The apital Issue Act, EC>;, however, isone of the pieces of legislation governing the stock exchange in the country. The then only securitiesmarket in !angladesh, the 1haka Stock 4xchange +td. suspended its trading and other administrativeactivities in ECE after the independence of the country. +ater on in EC? it resumed its activities with thechanges of government policies. Activities of the securities markets improved since ECB> and gainedmomentum from early ECCE, which would be shown in the findings of the study in a later section. As on9Fth June, 6FFF there were 69C listed securities with 1haka Stock 4xchange while there were only E9Bsecurities in ECCE. +isted securities comprised shares of 6EC companies, EF mutual funds and EFdebentures. 1uring %K ECCC76FFF, EE securities got listed with 1S4, the issued capital of which was Tk.6,F;?.> million. At the same date the total number of tradable securities in 1S4 was Tk. ?B>.?C millionwith total issued capital of Tk. 9F,>E million. In this year the number of tradable securities was

increased by 6>.>6L and the total issued capital increased by ?.9CL. Total market capitali"ation as on9Fth June 6FFF of all listed securities in 1S4 amounted to Tk. >;,FF; million as compared to Tk.>F,;B.;E million as on 9Fth June ECCC with an increase in market capitali"ation of ?.;6>LMAnnual

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#eport of S4, ECCC76FFFN. The present market capitali"ation is roughly 6L of /ross 1omestic 0roduct'/10* of the country. In ECCC76FFF turnover of shares and debentures recorded a decrease of ;L to Tk.6.?F billion as against Tk. &