Global Financial Securities

Company Formation and Features and Benefits of Shares

• Shares can be issued in either registered or bearer form.

• More common for companies to issue on a non certificated basis,
with an electronic record of ownership being sufficient.
• Many businesses, both large and small, are set up as companies.
• UK, a Memorandum of Association confirming the intent to form a
company and Articles of Association setting out the relationship
between the company and its owners are required to be lodged with
the Registrar of Companies at Companies House.
• In the US, Articles of Incorporation or a Certificate of Incorporation
need to be lodged with the relevant Secretary of State office.
• Companies are usually established as either private companies or
public companies.
• All listed companies are public companies, but not all public
companies are listed on a stock exchange.
• UK public companies have ‘plc’ in their names while UK private
companies have the word ‘limited’ or ‘ltd’.
• The global bank HSBC Holdings is a plc and is listed on a number of
worldwide stock exchanges including the London Stock Exchange
(LSE), New York Stock Exchange (NYSE), Hong Kong Exchanges and
Clearing (HKEX), Paris Stock Exchange (Euronext) and the Bermuda
Stock Exchange (BSX). In contrast, Virgin Holdings, the business
empire of Richard Branson, is a plc, but is not listed.
 Ordinary Shares and Common Stock
• As the owners of the company, it is the shareholders who vote yes or
no to each resolution put forward by the company directors at
company meetings.
• Preference shares are a hybrid security with elements of both debt
and equity.
• Preferred stock also tends to have credit ratings and ranks above
equities in the capital structure.
Normally, preference shares:
• are non-voting, except in certain circumstances such as when their
dividends have not been paid
• pay a fixed dividend each year, the amount being set when they are
first issued and which has to be paid before dividends on ordinary
shares can be paid, and
• rank ahead of ordinary shares in terms of being paid back if the
company is wound up.
In relation to rights on receiving dividends, preference shares may be
cumulative, non-cumulative and/ or participating.
 Benefits of Owning Shares
Dividends
• A dividend is the return that an investor gets for providing the risk
capital for a business.
• A fall in dividend payments can lead to a negative reaction among
shareholders and a general fall in the willingness to hold the
company’s shares, or to provide additional capital.
Capital Gains
• Capital gains can be made on shares if their prices increase over time.
Shareholder Benefits
• Some companies provide perks to shareholders, such as a telecoms
company offering its shareholders a discounted price on their mobile
phones or a shipping company offering cheap ferry tickets.
Right to Subscribe for New Shares
• Pre-emption rights give existing shareholders in companies the right
to subscribe for new shares.
• And in many cases they receive some compensation if they decide
not to do so.
• A rights issue is one method by which a company can raise additional
capital, complying with pre-emptive rights, with existing shareholders
having the right to subscribe for new shares.
 Right to Vote
• The right to vote on proposed dividends and other matters, such as
the appointment, or reappointment, of directors.
• The votes are normally allocated on the basis of one share = one vote.
• The individual shareholder can attend the company meeting and
vote.
• Voting by proxy.
• For example, Alphabet, the holding company for Google, has different
classes of shares that allow its founders to control the direction of the
company without owning a majority of the shares.
• In practice, most shares these days are held in electronic form in
stockbrokers’ or investment managers’ nominee accounts operated by
nominee companies.
• These companies are used solely for holding and administering shares and
other investments.
• The nominee company does not trade, and so is described as ‘bankruptcy
remote’ as the chances of it going into liquidation are low.
• It is the nominee’s name that appears on the record of ownership of the
shares and so, if the shareholder wishes to vote, they will need to arrange
for the operator of the nominee account to vote on their behalf.
 The Risks of Owning Shares
• The issuing company, including its management team, the industry it is in,
and even the country or countries it operates in, contribute to determining
the level of risk associated with holding any given shares.
Price and Market Risk
• Price risk is the risk that share prices in general might fall.
• Market-wide falls in equity prices occur, unfortunately, on a fairly frequent
basis.
• In 2008, the
• NASDAQ had its worst ever fall, declining by 40.54% over the year, the Dow
Jones Industrial Average (DJIA) fell 33.84%, and the FTSE 100 tumbled 31%
in the largest annual drop seen since its launch in 1984.
• More recently, in the first part of 2020, equity markets worldwide fell
as they reacted to the coronavirus (COVID-19) pandemic.
• Price risk varies between companies: volatile shares, such as those in
companies highly exposed to global economic trends tend to exhibit
more price risk than ‘defensive’ shares, such as those of utility
companies.
 Liquidity Risk
• Liquidity risk is the risk that shares may be difficult to sell at a
reasonable price.
• ‘thinly traded’ companies – smaller companies or those that do not
have much trading activity.
Issuer Risk
• This is the risk that the issuer collapses and the ordinary shares
become worthless.
• Shares in new companies which have not yet managed to report
profits may have a substantial issuer risk.
 Foreign Exchange Risk
• This is the risk that currency price movements will have a negative
effect on the value of an investment.
• Currency movements can, therefore, wipe out or reduce a gain, but
equally can enhance a gain if the currency movement is in the
opposite direction.
 Corporate Actions
• A corporate action occurs when a company does something that
affects its share capital or its bonds.
• A mandatory corporate action - payment of dividends
• A mandatory corporate action with options – Rights issue
• A voluntary corporate action - that requires the shareholder to make
a decision. Example - takeover bid
 Bonds
• Bonds are roughly equally split between government and corporate
bonds.
• Government bonds are issued by national governments and by
supranational agencies such as the European Investment Bank and
the World Bank.
• Corporate bonds are issued by companies.
• Bonds are commonly referred to as loan stock, debt or (in the case of
those which pay fixed income) fixed-interest securities.
• The feature that distinguishes a bond from most loans is that a bond
is tradeable.
 Advantages
• for fixed interest bonds, a regular and certain flow of income
• for most bonds, a fixed maturity date (but there are bonds which
have no redemption date, and others which may be repaid on either
of two dates or between two dates – some at the investor’s option
and some at the issuer’s option)
• a range of income yields to suit different investment and tax
situations, and
• the relative security of capital for more highly rated bonds.
 Disadvantages
• the real value of the income flow is eroded by the effects of inflation
• bonds carry elements of risk
Risks
• Bonds generally have default risk and price risk.
• Price (or market) risk - open to the effect of movements in general
interest rates.
• Government bond has price risk or market risk only when the coupon
rate of interest differs markedly from market rates.
 Other risks
• Early redemption
• Seniority risk
• Inflation risk
• Liquidity risk
• Exchange rate risk
 Bonds Debentures

Definition Bonds are debt financial instruments Debentures are debt financial
issued by large corporations, financial instruments issued by private
institutions and government agencies companies, but any collaterals or
that are backed up by collaterals or physical assets do not back them up.
physical assets.
Owner The owner of a bond is called a The owner of a debenture is called a
bondholder. debenture holder.
Collateral Bonds get secured by the collateral or Debentures do not get secured by the
physical assets of the issuing company. collateral or physical assets of the
issuing company. Lenders purchase
these instruments solely based on the
reputation of the issuing company.
Tenure Bonds are long term investments and Debentures are generally short to
their tenure is generally higher than medium term investments and their
debentures. tenure is usually lower than bonds.
 Bonds Debentures

Issuer Large corporations, financial Private companies generally issue

institutions and government agencies debentures for their immediate capital
issue these bonds for their long term requirements.
capital requirements.

Rate of Interest The bonds carry a fixed or floating The debentures carry a fixed or
interest rate that is generally lower floating interest rate that is generally
than debentures because they are higher than bonds because they are
more stable in terms of repayment, less stable in terms of repayment, and
and they get backed by collateral of they are also not backed by collateral.
the issuing company.
Priority During If the company is on the verge of If the company is on the verge of
Liquidation liquidation, the bondholders are given liquidation, the debenture holders are
priority over debenture holders for given second priority over bondholders
repayment of capital and interest for repayment of capital and interest
amount. amount.
 Bonds Debentures

Payment The payment of interest for bonds is The payment of interest for bonds is
Structure on an accrual basis. The issuing done on a periodical basis and
company pays this amount on a depends on the company’s
monthly, half-yearly or yearly basis and performance.
this payment is not dependent on the
performance of a company.

Risk Bonds are less riskier than debentures Debentures are riskier than bonds
because they have the security of the because they do not have the security
physical assets of the issuing company. of the physical assets of the issuing
company.
 Government Bonds
• Governments issue bonds to finance their spending and investment
plans and to bridge the gap between their actual spending and the
tax and other forms of income that they receive.
• Issuance of bonds is high when tax revenues are significantly lower
than government spending.
• Western governments are major borrowers of money, so the volume
of government bonds in issue is very large and forms a major part of
the investment portfolio of many institutional investors
 US
• The US government bond market is the largest and most liquid in the
world.
• Generally known as Treasuries and there are four main marketable
types, namely: Treasury bills, Treasury notes, Treasury bonds and
Treasury inflation-protected securities.
 Treasury bills
• A money market instrument used to finance the government’s short-
term borrowing needs.
• They have maturities of less than a year and are typically issued with
maturities of 28 days, 91 days and 182 days.
• They are zero coupon instruments that pay no interest and instead
are issued at a discount to their maturity value.
• Once issued, they trade in the secondary market and are priced on a
yield-to-maturity basis.
Treasury notes - conventional government bonds that have a fixed
coupon and redemption date.
• They have maturity dates ranging from more than one year, to not
more than ten years from their issue date.
• Commonly issued with maturities of two, five and ten years.
Treasury bonds – again conventional government bonds, but with
maturities of more than ten years from their issue date, most
commonly issued with maturities of 30 years.
Treasury inflation-protected securities – these are index-linked bonds
and are referred to as TIPS.
• The principal value of the bond is adjusted regularly, based on
movements in the consumer price index (CPI) to account for the
impact of inflation.
• Interest payments are paid half-yearly and, unlike the UK version, the
coupon remains constant but is paid on the changing principal value.
• US Treasuries have been issued in book entry form since 1986 – that
is, entry on the bond register and transfers can only take place
electronically and no physical bond certificates are issued. Interest is
paid on a semi-annual basis.
 UK
• UK government bonds are known as gilts.
• The bonds are issued on behalf of the government by the Debt
Management Office (DMO).
• Conventional government bonds are instruments that carry a fixed
coupon and a single repayment date, such as 0.129% Treasury Gilt
2029.
• Index-linked bonds are bonds where the coupon and the redemption
amount are increased by the amount of inflation over the life of the
bond; they are similar to the US TIPS.
UK government stocks are classified into the following:
• zero–three years remaining: ultra short-dated
• three–seven years remaining: short-dated
• seven–15 years remaining: medium-dated
• 15 years and over remaining: long-dated.
In 2005, the DMO issued new gilts with redemption dates 50 years later
for the first time.
 Germany
• The main types of German government bonds are Bunds, Schatz and
Bobls.
• Bunds are longer-term instruments; Schatz are issued with two-year
maturities; Bobls are issued with five-year maturities.
• Bunds are issued with maturities of between eight and 30 years, but
the most common maturity is ten years.
• Bund market is large and liquid, and the yield on Bunds sets the
benchmark for other European government bonds.
• Settlement of international trades follows the practice in the
eurobond market and is for T+2 settlement, that is two business days
later.
• All settlement takes place electronically by book entry. Interest on
Bunds is paid on an annual basis.
 China
• China has the third largest bond market in the world
• From 2019, the country’s onshore bonds were included in the
Bloomberg Barclays Global Aggregate Index, which portfolio
managers around the world use as a benchmark.
• Sovereign government bonds are issued by the Ministry of Finance
and typically have maturities between three months and 50 years.
• local government bonds that are issued by provincial and local
governments, which typically have maturities of between one and ten
years
 Japan
• The Japanese government bond market is one of the largest in the
world and its bonds are usually referred to as JGBs.
• Short-term bonds.
• Medium-term bonds
• Long-term bonds.
• Super-long-term bonds.
• Individual investor bonds.
• Inflation-indexed bonds.
• Fixed-rate coupon-bearing bonds: 2, 5, 10, 20, 30 and 40 years.
• Inflation-indexed bonds: ten years.
• Floating-rate bonds: 15 years.
• JGBs for retail investors: three, five and ten years.
 Corporate Bonds
• A corporate bond is a bond that is issued by a company, as the name
suggests.
• Only companies with high credit ratings can issue bonds with a
maturity greater than ten years at an acceptable cost.
• Most corporate bonds are listed on stock exchanges, but the majority
of trading in most developed markets takes place in the over-the-
counter (OTC) market – that is directly between market
counterparties.
 Bond Security
• a third-party guarantee – for example, a guarantee by a bank that, if
the issuer defaults, the bank will repay the bondholders.
• The greater the security offered, the lower the cost of borrowing
should be.
• The security offered may be fixed or floating. Fixed security implies
that specific assets (eg, a building) of the company are charged as
security for the loan.
• A floating charge means that the general assets of the company are
offered as security for the loan; this might include cash at the bank,
trade debtors or stock.
• Zero Coupon Bonds (ZCBs)
• Convertible Bonds
 Asset-Backed Securities (ABSs)
• These are bundled securities, so called because they are marketable
securities that result from the bundling or packaging together of a set
of non-marketable assets.
• The largest market is for mortgage-backed securities, which became
known worldwide as a result of the sub-prime collapse in the US.
• Eventually the appetite for bonds with lower credit quality and the
potential for greater returns grew, and banks started to issue
mortgage bonds backed by sub-prime loans.
• This process spread, with banks using them to finance their
mortgage-lending, generally issuing bonds representing ownership of
a pool of mortgages with sound credit quality.
 Covered Bonds
• A variation on ABSs is covered bonds which are widely used in
Europe.
• They remain on the issuer’s balance sheet.
• The asset pool must provide sufficient collateral to cover bondholder
claims throughout the whole term of the covered bond.
• Bondholders must have priority claim on the cover asset pool in case
of default of the issuer.
 Domestic and Foreign Bonds
• A domestic bond is issued by a domestic issuer into the domestic
market, for example, a UK company issuing bonds, denominated in
sterling, to UK investors.
• Examples of a foreign bond are a German company issuing a sterling
bond to UK investors or a US dollar bond issued in the US by a non-US
company.
 Yields
• Yields are a measure of the returns to be earned on bonds.
• The interest paid on a bond as a percentage of its market price is
referred to as the flat, or running, yield.
• The investor may also either make a capital gain or a loss on the bond
if they hold it until redemption.
 Other Financial Assets
Cash Deposits: Cash deposits comprise accounts held with banks or
other savings institutions.
• They are held by a wide variety of depositors – from retail investors
through to companies, governments and financial institutions.
• The return simply comprises interest income with no potential for
capital growth.
• The amount invested (the capital) is repaid in full at the end of the
investment term.
• TDS on deposits by deposit takers
• Islamic savings accounts - ‘Islamic finance’ or ‘Shariah compliant’.
• paying or receiving interest should be avoided and that where
possible, risk should be shared.
• Liquidity, savings vehicle, relative safety not exposed to market
volatility.
• Inflation reduces the real return that is being earned on cash deposits
and often the after-tax return can be negative.
• During periods of low global interest rates, charges on money market
accounts or funds can result in negative or flat returns.
When cash is deposited overseas, depositors should also consider the
following:
• The costs of currency conversion and the potential exchange rate risks
• The creditworthiness of the banking system.
• tax treatment of interest applied to the deposit.
• Cryptocurrencies - type of digital currency or asset that can be
traded, stored and transferred electronically.
 Money Markets
• Wholesale or institutional markets for cash and are characterised by
the issue, trading and redemption of short-dated negotiable
securities.
• Maturity of up to one year, though three months or less is more
typical.
• Issued at a discount to their face value to save on the administration
associated with registration and the payment of interest.
• High minimum subscription and therefore tends to be more suitable
for institutional investors.
• Certificates of deposit (CDs) – these are issued by banks in return for
deposited money: think of them as tradeable deposit accounts, as
they can be bought and sold in the same way as shares.
• Commercial Paper is issued by large companies to meet their short-
term borrowing needs.
 Property
Property as an asset class is unique in its dis tinguishing features:
• Each individual property is unique in terms of location, structure and
design.
• Valuation is subjective
• Property is subject to complex legal considerations and high
transaction costs upon transfer.
• It is relatively illiquid and diversification is made difficult.
 Foreign Exchange (FX)
• The FX market refers to the trading of one currency for another. It is
by far the largest market in the world.
• Historically, currencies were backed by gold (as money had ‘intrinsic
value’)
• fixing all currencies against the US dollar and making the dollar
convertible to gold at a fixed rate of US$35 per ounce.
• Trading of foreign currencies is always done in pairs.
• These are currency pairs when one currency is bought and the other
is sold and the prices at which these take place make up the exchange
rate.
• Currency Quotes - When currencies are quoted, the first currency is
the base currency and the second is the counter or quote currency.
• The forex market is an over-the-counter (OTC) market, ie, one where
brokers and dealers negotiate directly with one another.
 FX Transactions
Spot transactions – the spot rate is the rate quoted by a bank for the
exchange of one currency for another with immediate effect.
• The currencies actually change hands and arrive in recipients’ bank
accounts – two business days after the transaction date (T+2).
Forward transactions – in this type of transaction, money does not
actually change hands until some agreed future date. The duration of
the trade can be a few days, months or years.
Futures – foreign currency futures are standardized versions of forward
transactions that are traded on derivatives exchanges in standard sizes
and maturity dates. The average contract length is roughly three
months.
Swaps – a common type of forward trans action is the currency swap.
In a currency swap, two parties exchange currencies for a certain length
of time and agree to reverse the transaction at a later date.