Capital Markets and Financial Assets

Financial market: the market where entities that need capital (governments, corporations) raise funds.

This is classified into two types

• Capital market (capital market): a market where financial assets are issued and traded for raising long-term capital

• Money market (money maeket): a market where financial assets are issued and traded for raising short-term capital

Here in financial management class, even if it’s not quite a perfect capital market,

we’re told we’ll lay down assumptions that come close to it.

1. A market where transaction costs can be minimized (securities transaction tax, various taxes, trading commissions, information-gathering costs, etc.)

​2. Makes securities as liquid as possible.

3. Functions so that when information that can affect securities price formation arises, it is immediately transmitted to investors​

​<Ah…. for perfect capital market, let me just copy-paste.>

It refers to a market where there are no obstructive factors whatsoever in terms of transaction costs, taxes, divisibility and marketability of assets, regulations, etc. in the capital market. Also, it’s a market that satisfies the assumption that perfect competition exists in the goods and capital markets, it is efficient in terms of information, and all individuals are rational beings seeking to maximize their expected utility.

[Korean encyclopedia] Perfect market (Maeil Business, MK.com)

So we keep going​

Issuing market (issuing market)

a market where entities that need funds issue securities to raise funds

Corporations, public institutions, local governments, nations, etc. raise funds by issuing stocks or bonds through the issuing market

(Also called primary market. — the meaning of this word will become clear in a moment.)

1. Makes it easier to raise outside capital at low interest costs.

2. By activating IPOs, it reduces the ownership stake of majority shareholders and promotes the separation of ownership and management, increasing managerial efficiency.

3. Allows investors who invested in stocks to get a cut of the company’s profits, and also weigh in on how it’s run.​

Issuing institution: acts on behalf of the issuer between the issuer and investors (in our country, securities firms or investment trust companies do this)​

The most important thing these guys do is underwriting, and there are 2 methods of underwriting.

1. Stand-by underwriting: the issuer issues the securities to be sold, and whatever securities remain unsold are picked up by these guys — an underwriting fee and a sales fee are charged.

2. Firm commitment underwriting: the issuing institution underwrites all the securities issued by the issuer in its own name, and then sells them to investors under the issuing institution’s responsibility — no fee is charged; instead, they profit from the spread between the underwriting price and the sales price.

The securities firms and investment trust companies that underwrite usually

band together to form a syndicate (syndicate), jointly participate in the issuance of the securities, and thereby disperse the associated risk.

That’s how the issuer and the issuing institution work,

and investors are classified into institutional investors and individual investors.

Institutional investors include securities firms, banks, investment trust companies, insurance companies, etc.

Reckon individual investors’d be ants and fire-ants and whatnot? (joke)

Secondary market: a market where already-issued securities are traded, which is why it’s called the secondary market (now the term primary market makes sense)

1. Makes issued securities liquid, which helps issuers raise funds smoothly

2. Securities investors compete freely, driving fair price discovery

3. Allows information to be reflected in securities prices more quickly and efficiently.

4. Provides investors with opportunities to form various portfolios, and gives them the opportunity to disperse risk — same thing

5. Helps predict the prices of newly issued securities

Security market — stock market & bond market

Stock: a certificate representing the rights of a shareholder who invested capital in a stock company; the rights here include the right to claim dividends, the right to claim residual asset distribution, voting rights, etc.

• Right to claim dividends: a right (claim) over the profits realized as a result of the company’s business activities; dividends are usually paid once a year.

• Right to claim residual asset distribution: if the company is dissolved, shareholders have the right to participate in the distribution of residual assets in proportion to their shareholding (in most such cases, liabilities exceed the size of assets, so situations in which this right can actually be exercised are rare)

• Voting rights​: the right of a shareholder to participate in the shareholders’ meeting and express their will on major agenda items (one voting right per share)

Common stock (common stock)

stock that includes all the general rights — right to claim dividends, right to claim residual asset distribution, voting rights, etc.

Preferred stock (preffered stock)

takes precedence over common stock in terms of dividends or the distribution of residual assets. However, no voting rights.

cf. Preferred stocks also come as cumulative preferred stocks, where unpaid dividends accumulate when dividends cannot be paid, and non-cumulative preferred stocks, where they do not accumulate,

and there are also participating preferred stocks that can participate in additional profits beyond the promised dividend, and non-participating preferred stocks that cannot participate — stuff like that, apparently.

Par value stock (par value stock)

the face amount of the issued stock is indicated at a predetermined amount. In our country, issuance of such par value stocks is disallowed, but even in the US where par value stocks exist, they are not common.

Because par value doesn’t really represent substantive value, but rather only the historical value at the time the company was founded.

In other words, it’s pretty much safe to say it has almost no meaning at all.

Non-voting stock (non-voting stock)

common stock, but apparently there are also kinds without voting rights.

Instead, they say the priority for profit distribution is lower than preferred stock but higher than common stock.

In our country, the number of non-voting stocks cannot exceed 1/4 of a company’s total issued shares. To prevent a small number of voting-rights shareholders from just taking over the company.

Bond: a type of security, a promissory certificate related to debt that indicates conditions such as the payment of a certain amount of interest and the repayment of the principal.

• Classification of bonds by issuer

1. Corporate bonds: bonds issued by corporations. The greater a company’s credit risk, the greater its cost of raising funds, right??? Which for us means we can buy them cheaply.

2. Government and public bonds: issued by the state or local governments, to cover fiscal deficits or to raise funds for carrying out public projects. Such bonds are regarded as risk-free assets (under the assumption that the state can’t go bankrupt).

3. Special bonds: bonds issued by special corporations established under special laws.

Korea Development Bank — Industrial Finance Bonds, Bank of Korea — Monetary Stabilization Bonds, public enterprises’ — Housing Corporation Bonds, Investment Development Bonds, Electricity Bonds, etc.

• Classification by method of interest payment

1. Coupon bond: a bond that pays interest at regular intervals and, at maturity, repays an amount equal to the face value.

2. Discount bond: issued with the total amount of interest to be paid deducted (discounted) from the face value in advance, with the face value being repaid at maturity. ex. Monetary Stabilization Bonds

3. Compound bond: a bond where no interest is paid until the bond’s maturity, and the interest that should have been paid each period is all paid at maturity along with the face value.

4. Permanent bond: a bond where the principal corresponding to the face value is not repaid, but the interest amount is paid perpetually at regular intervals.

• Classification by principal repayment method

1. Callable bond: a bond where the issuer has the right to repay the principal before maturity. Generally, the price paid upon early redemption (call price) is higher than the face value, and the earlier it is redeemed, the higher it becomes.

<The guy who issued this bond, when the interest rate drops, intends to pay the call price to redeem early and then reissue bonds at the lower interest rate. >

2. Lump-sum repayment bond: just the general form of a bond, one that is repaid in a lump sum at maturity.

• A few more

1. Guaranteed corporate bond vs unguaranteed corporate bond

: in the case of corporate bonds, they can be split into those with a guarantee and those without.

A guarantee means there’s a third party that guarantees the payment of principal and interest, and they guarantee it on behalf of the issuer,

usually banks or securities firms have acted as guarantors, but apparently since the 1990s this has been disappearing to a large extent.

2. Secured corporate bond vs unsecured corporate bond

: Corporate bonds may also have collateral or not.

A secured corporate bond is a bond for which collateral is required at the time of issuance,

there are mortgage bonds (mortgage bond) where the company’s real estate serves as collateral,

and collateral bonds (collateral bond) where securities serve as collateral.

3. Convertible securities (convertible securities) — include convertible bonds and convertible preferred stocks.

: A convertible bond, while it is a bond, is a bond with a right attached such that the investor can convert it into common stock if they wish.

Convertible preferred stock is also preferred stock but can be converted into common stock if the investor wishes.

Generally, the interest rate on convertible bonds is lower than on ordinary bonds because of the conversion right.

It’s good for companies because they can raise funds at a low interest rate, and if the conversion right is exercised, they don’t have to repay principal and interest, which is also good.

(They say you also need to be cautious because the control of existing shareholders gets diluted.)

4. Preemptive right/subscription right bond (preemptive right/subion right bond)

: a bond that grants the holder the right to purchase the company’s new shares

And also, in this case, even if the right to purchase new shares is exercised, the bond does not disappear and continues to exist as is (different in character from a convertible bond).

That is, it just grants the right to purchase new shares at a set price and quantity within a certain period!

Such bonds are widely used as an inducement to lure investors into buying the bonds, by attaching this kind of right to bonds issued by growth companies with high future stock price upside.

Beneficiary certificates (beneficiary certificates)

a right certificate issued by an investment trust company

An investment trust company invests funds collected from investors into securities on the investors’ behalf, and distributes the resulting profits to the investors;

in this process, they say you can think of it as one of the securities issued through a contract between the investment trust company and the investors regarding the proxy investment and profit distribution~~

• Types of investment trusts

1. Contract-type investment trust

: In our country, most investment trusts are run as contract-type, apparently,

this is run by parties — the truster, the trustee, and the beneficiary — composed under a trust contract,

here the truster is: the investment trust company that issues beneficiary certificates and manages the assets, i.e., the founder of the investment trust,

the trustee is: a (licensed) bank that safekeeps and manages the entrusted assets, and these guys slap on a fee to earn their keep~

the beneficiary is: the person entitled to receive the profits, you can think of them as the investor.

Contract-type trusts come, depending on the trust’s method of operation, in unit-type and fund-type,

unit-type is operated at a fixed amount scale set per unit, and additional inflows into the set unit are prohibited, so redemption is impossible during the contract period.. T_T T_T

fund-type allows inflows, so redemption is possible if the investor wishes! That’s the biggest difference, apparently.

2. Corporate-type investment trust

: is what is commonly called a mutual fund (mutual fund). In this one, legal personhood is granted to the set-up fund, and the fund is operated as an independent company form.

Investors become shareholders of the company established by the fund’s setup, and they receive the profits generated from the management of the trust property in the form of dividends.

This is classified into closed-end and open-end,

closed-end: investors can’t withdraw their investment funds! So redemption requests are impossible, and you have to recover your investment funds by selling the corporate-type shares you hold on the securities market! That is, closed-end ones are listed on the securities market.

open-end: you can withdraw your investment funds at any time. So there’s no reason for it to be listed and traded on the stock market, hence No listing. That is, entry and exit are free, and that fund’s set-up amount changes from time to time.