EQUITY MARKET

 It is one of the key sectors of financial markets where long- term financial instruments are traded.
 The purpose of equity instruments issued by corporation is to raise funds for the firms.
 The provider of the funds is granted a residual claim of the company’s income and become one of
the owners of the firm.
 For market participants, equity securities means holding wealth as well as a source of new finance.

Purpose of Equity
 As an important source of external equity financing;
 Perform a financing role from internally generated funds (retained earnings);
 Perform an institutional role as a means of ownership.
Considerations as to when to use equity instruments as source of funding
 The degree of availability of internal financing within total financing needs of the firm;
 To cost of available alternative financing sources;
 Current market price of the firm’s equity shares which determines the return of equity investments.

Debt VS Equity
 Tax incentives
 Cost of distress- leveraging
 Agency Conflicts (Owner vs Creditor)
 Signaling Effect- the company which issue equity to finance operation , provide signals to the
market, that current share selling price is high and company is overvalued
Equity Instruments
1. Common Share
2. Preferred Shares
3. Derivatives

Common Shares Preferred Shares

Voting Rights  X
Dividends Not Guaranteed Fixed
Risk High Moderate
Reward High Moderate

 Preferred shares- a hybrid instrument since investor is entitled to receive a fixed contractual amount
of dividends and this make this similar to debt. ; a fixed income instrument
Private Equity
 Companies that are not trading publicly. The form of equity investment is made through private
placement.
Sources of Private Equity Investments:
1. Venture capital funds- receive capital from wealthy individual or institutional investors, willing
to maintain the investments for a long- term period (5-10 years).
2. Private Equity funds- pool resources of their partners to fund most often new business startups.
It usually take over the business, manage them and control the restructuring, charge annual fee
for managing the fund.
3. Leverage buyouts- company equity purchases by individual or institutional investors, which
are financed by a minor portion of share capital and a major portion of debt, provided by banks
or other financial intermediaries.
Primary Equity Market
1. Private placements- securities that are sold directly to investors and are not registered to SEC.
2. Public Market
Initial Public Offering (IPO) - means issuing public equity; when a company is engaged in
offering of shares and is included in a listing on a stock exchange for the first time.
Secondary Public Offering (SPO) or Seasoned Equity Offering (SEO)- Company is already
listed and issuing additional shares

 Processed of Going Public

 Advantage and Disadvantage of IPOs
 Several Problems in IPO market
 Spinning- if an investment bank allocates shares from an IPO to corporate
executives with the expectations to get future contracts from the same company.
 Laddering- broker encourage investors to place the first day bids for the share that
are above the offer price to help build the price upward.
 Excessive commission
EQUITY MARKET TRANSACTIONS
1. Bid- ask spread
a. Bid price- buyer’s price
b. Ask price- Seller’s price

2. Placing order
a. Market Order- an order to buy or sell a security immediately at the best obtainable price.
b. Limit order- an order to buy or sell a security at a specified price or better
i. Buy- limit order (stop buy order) - purchase price should take place only if the
price is at or below a specified level.
ii. Sell- limit order (stop loss order) – specifies a minimum selling price such that the
trade should not take place
iii. Market-if-touched order- as soon as trade in the market happens at the specified
price, the order becomes a market order.
iv. Stop order- it involves selling of shares after the price has fallen to a specified
level, after the price has risen to a level.
 c. Based on length of time
i. Fill- or- kill order- is to be cancelled if it cannot be executed immediately
ii. Open order, or good- till- cancelled order- remain in force until it is specifically
cancelled by the investor.

3. Margin Trading/ Buying on Margins- investors can borrow cash to buy securities and use the
securities themselves as collateral.
In order to purchase shares on margin, investors have to create an account with a broker,
which is called the margin account. The initial deposit of cash is called initial margin.
a. Margin Deposit- the amount of cash or securities that must be deposited as guarantee on
future positions. The margin is a returnable deposit.
b. Maintenance margin requirement- the minimum margin that an investor must keep on
deposit in a margin account at all times.
c. Broker call rate/ Call money rate- the broker charges the borrowing investor the call money
rate plus the service charge.
d. Margin Calls- broker informing the investor to transfer additional cash to be put to the
investor’s margin account. If the investor fails to put up the additional cash, the broker has
the authority to sell the securities from the investors account.

No of Shares 100
Share price 60.00 50.00 40.00
Value 6,000.00

Initial Margin 50% 3,000.00 2,000.00 1,000.00

Borrowings 50% 3,000.00 3,000.00 3,000.00
Total 6,000.00 5,000.00 4,000.00

Maintenance Margin 30% 1,800.00 40% 25%

Margin call
1,200.00

* The use of borrowed funds for investments into shares can magnify the returns on the
investment. However, when borrowed funds are used, ay losses are also magnified.
4. Short- selling- investor place an order to sell a security that is not owned by the investor at the time
of the sale. Investor sells the stock short (or short the stock) when they expect decline of the stock
price.
STOCK VALUATION METHODS
Investors conduct valuations of stocks when making their investment decisions. They consider investing in
undervalued stocks and selling their holdings of stocks that they consider to be overvalued.
1. Fundamental Analysis relies on fundamental financial characteristics (such as earnings) of the
firm and its corresponding industry that are expected to influence stock values.
a. Price- Earnings Method
 based on expected rather than recent earnings of all publicly traded competitors

b. Dividend Discount Model

 c. Adjusted Discount Model
From the investor’s perspective, the value of the stock is equal to (1) the present value of the
future dividends to be received over the investment horizon plus (2) the present value of the
forecasted price at which the stock will be sold at the end of the investment horizon.

The estimated fair value is compared to the market price to determine if the stock is fairly
priced in the market, cheap ( a market price below the estimated fair value), or rich (a market
price above the estimated fair value)

2. Technical Analysis relies on stock price trends to determine stock values.

Assumptions:
 The market price of securities (such as shares and bonds) is determined by supply and
demand.
 Supply and demand are determined by numerous rational and irrational factors.
These include both objective and subjective factors.
 Apart from minor fluctuations the prices of individual securities, and the level
of the market as a whole, tend to move in trends which persist for significant periods
of time.
 Trends change in reaction to shifts in supply and demand. These shifts in supply and
demand can be detected in the action of the market itself.

a. Price Charts- are made for each day or other chosen time interval with the help of a vertical line.
The top indicates the highest price reached and the bottom show the lowest price.
 Price channels (Trend channels) can be horizontal, upward or downward sloping.
Price channels are often interpreted in terms of the bounds providing limits to the extent
of variation of share prices, such that share prices tend to remain within the bounds.
b. Dow Theory
One of the oldest technical tools, aimed to forecast the future direction of the overall stock
market.
• Based on the belief that market movements are analogous to movements of the sea. It sees three
simultaneous movements in the market:
o Ripples – Daily and Weekly fluctuations.
o Waves – Secondary movements.
o Tides – Primary trends.

c. Elliot Wave Theory

The theory sees markets as moving in cycles.
• Analysis of the Elliot cycles is based on waves. Each cycle has eight waves. Five waves carry
the market up and three waves carry it down.
• The pattern of waves entails a succession of support and resistance levels, similarly, to Dow
Theory.
-This theory assumes that markets are driven by investor
psychology.
*Peso- Cost Averaging Method