On the world's financial markets and stock exchanges. Part 7
The main purpose of the lecture is to understand the basic functioning of the securities market and the structure of the allocation of the main instruments.
1. The securities market
1.1. Characteristics of a securities market
The securities market is a part of the financial market (apart from bank loans), where securities are bought and sold. The purpose of a securities market is to ensure a fuller and faster transfer of savings into investments at a price that suits both the buyer and the seller. Brokers, investment dealers and brokers act as intermediaries on the securities market. Short-term debt instruments - mainly treasury bills - are traded on the money market. The fundamental principles of the securities market are:
- Liquidity, i.e. the market should be characterised by frequent transactions, a small gap between the seller's price and the buyer's price and little price variation from one transaction to the next;
- Efficiency (transaction costs have to be taken into account: accounting commissions, registration fees, etc.);
- informativeness (information about the concluded transactions should be quickly available in all the information channels);
- reliability (possible errors of brokers and the market as a whole must be compensated for).
The securities market can be divided into two main parts: the primary market and the secondary market.
The primary market serves the preparation and placement (issue) of new issues of securities, i.e. the sale of new issues of securities to their first owners, the primary investors.
The secondary market is where securities previously placed on the primary market are traded. The secondary market, which is realised through the activities of special market institutions - stock exchanges - is called the exchange market.
The secondary market, operating outside stock exchanges, is called the over-the-counter market.
1.2. Primary placement of securities. Methods of offering.
There are usually two ways to conduct an initial public offering of securities: a direct placement and an offering via intermediaries.
In a direct placement of securities, emission transactions are carried out with the help of transactions concluded directly between the issuer and the investor. In this case, the issuer itself organises the initial placement of securities and sells the securities of the new issue to investors. Examples include offerings of government securities as well as central bank securities, which are made on a regular basis.
However, for most issuers, market placements are not their core business, so they usually resort to placements through intermediaries who are professional stock market participants.
Depending on the status of the issuer, the type of securities and the purpose of the issue, different forms of IPOs are possible.
The main forms of an initial public offering are:
- An auction sale - takes place in the form of open or closed auctions for a relatively narrow circle of so-called primary investors (e.g. professional stock market participants). Only those primary investors who meet the requirements set by the issuer are allowed to participate in private auctions.
- An open auction involves the sale of securities, such as shares in a public company, to a wide range of investors, including legal entities and individuals. An open sale can take place over a fairly long period of time (from a few weeks to a few months) to anyone who wants it and on the same terms. The placement of securities in the form of an open sale is usually carried out with the participation of intermediaries - dealers or brokers who are professional participants in the securities market.
- individual (private) placement - takes place when the entire issue is purchased by one or a preknown group of investors (usually large institutional investors) on pre-agreed terms with the issuer, including the issue volume, selling price, interest rate, maturity terms and conditions, etc.
The primary and secondary securities markets are closely linked. Uninterrupted, active operation of the secondary market ensures the liquidity of securities and thereby contributes to the successful placement of new issues on the primary market. In turn, the placement of new issues of securities leads to new "instruments" on the secondary stock market, which contributes to its activity.
The stock market is implemented through the activities of a special institution of the stock market - the stock exchange.
The stock exchange is a legal entity entity established to provide professional participants of the securities market with necessary conditions for trading in securities and regulation of their activities.
The stock exchange may be established by legal entities or individuals (members of the stock exchange) in the form of an open joint stock company (OJSC). This JSC must be registered under the applicable law and have a license for the right to perform its functions. The requirements for the members of a stock exchange are determined by the applicable laws of the country as well as the rules of the particular stock exchange. The composition of stock exchanges varies significantly from country to country. For example, in the USA and Great Britain, stock exchange members are individuals, in Japan - only legal entities, in Germany and Italy - individuals and legal entities.
A stock exchange (exchange market) is a scientifically, informationally and technically organised securities market, which operates on the basis of the following basic principles
- registration (listing) of securities accepted for quotation on a stock exchange after verification of the quality and reliability of the securities carried out on the principles of auditing;
- quotation of securities, i.e. establishment of uniform market prices (rates) for purchase and sale of securities of the same issuer and their publication for the information of all interested parties;
- publicity of transactions made on the exchange. This is facilitated by a single place (trading room) and time (trading session) of transactions, as well as open publication of information on transactions in the media;
- Fair competition between market participants, which implies a prohibition on interpreting and transferring so-called insider information, i.e. information that is accessible to a limited number of people in an organisation (insiders) due to their official position and the use of which puts them in a more advantageous position compared to other market participants;
- access to trading on an exchange only for exchange members who are professional participants of the stock market and have a "seat", i.e. the right to trade on the exchange.
2. Main types of securities markets
The OTC market is characterised by the following features:
- the large number and diversity of market participants;
- lack of a single exchange rate for identical securities;
- different place and time of transactions;
- the lack of a single centre organising the trade and developing its methodology;
- the lower quality of the securities traded on it.
The OTC and exchange-traded markets are closely linked. This connection is conditioned by:
- Firstly, the common pool of investors;
- Second, mostly the same composition of professional market participants;
- Thirdly, unity of conjuncture.
Various stock (market or stock exchange) indices are used to reflect price trends on the stock market. They are calculated on the basis of a certain list of securities as specially weighted values of ratios of current values of securities rates to some basic values.
Indices have been devised to allow investors to see trends and speeds in the stock market. Investors forecast the further behaviour of the market on the basis of indexes. Therefore, the stock index is the main indicator, which evaluates the general state of the securities market. The index is calculated on the basis of shares of leading companies, the number of which can reach 100 or more, depending on the index.
3. Stock indices
A sharp change in the share price of one company may be due to internal success or problems of this company and not relate to the general state of the stock market in general. But if the share price of most of the leading companies changes at the same time, it can mean that the change affects the whole stock market and economy of the country. Such a change will be reflected in the value of the stock index. Thus, a change in the index can be an important signal to investors.
The best-known and most used indices are
Dow Jones Industrial Average index is the most popular and most well-known stock index. It is the world's first stock index calculated as an average of stock prices - it was first calculated by Charles Dow on May 26, 1896. Since October of that year, the DJIA has been published regularly in The Wall Street Journal. Initially it was calculated on the basis of quotations of 12 stocks. Currently, the index is comprised of stocks of 30 companies, all of which are leaders in their industries, including Citigroup, General Motors, Intel and others.
The Standart & Poors Index is a stock index for shares of 500 companies that is calculated and published by the Standart and Poors Corporation. This index reflects changes in the market value of U.S. companies and is used to evaluate the U.S. domestic stock market. U.S. domestic stock market.
The Nasdaq index is an over-the-counter market index published by the National Association of Securities Dealers and based on its quotations. The NASDAQ Composite Index is constructed based on the weighted market value of stocks of issuers specialising in high technology. This means that each company's security affects the index in proportion to the market value of the company. During a trading session, the market value of more than 5,000 companies is calculated.
Financial Times Stock Exchange Index - a capitalisation-weighted index of share prices of the 100 largest UK companies with the highest market value traded on the London Stock Exchange. The index includes companies such as CADBURY SCHWEPPES, ROYAL DUTCH SHELL, ROLLS-ROYCE GROUP
The DAX Index is Germany's leading stock index, calculated on the basis of share prices traded on the Frankfurt Stock Exchange. The index is comprised of the shares of 30 leading German companies. The index was introduced in 1988 and is a weighted average of returns of a number of companies representing a significant sector of the German economy (automakers - BMW, VOLKSWAGEN, DAIMLERCHRYSLER; banking sector - DEUTSCHE BANK, COMMERZBANK, etc.). The index is calculated from a specific reference date (currently 30 December 1987). The DAX is recalculated at one minute intervals.
The MICEX Index has been calculated since 1997 and is the second most important index in Russia. It includes shares of 19 companies traded on the MICEX Stock Exchange.
MICEX 10 Index is a price index calculated as an arithmetic average of prices of the 10 most liquid shares.
Indices are calculated as the ratio of the total market capitalization of shares included in the index calculation list to the total market capitalization at the initial date, multiplied by the index value at the initial date and by a correction factor. Market capitalisation is calculated based on share price data and the number of shares issued by the issuer, taking into account the free float.
4. Classification of securities
Now let's go directly to instruments, which are covered by complex financial analysis.
An option is a contract that gives the right to buy or sell a certain commodity at a set price for a certain period of time.
An option is a bilateral agreement to transfer the right to buy or sell a specific asset at a specific price up to and/or on a specific future date.
Currency option is a contract for the right to buy or sell a consignment of currency at an agreed upon date and price. When buying an option, the buyer pays the seller a specified premium (option price).
According to the Civil Code of the Russian Federation (article 142), a security is a document, certifying in compliance with the established form and mandatory details, the property rights, the exercise and transfer of which are possible only upon presentation of the security.
In the economic literature, there are quite a few different definitions of a security. The most accurate are the definitions that emphasise that these are documents that are title deeds or rights to receive income, also that they are documents that confirm the rights to real assets .
In order to fully characterise a category such as a security, it is necessary to examine its main inherent features:
- A security evidences ownership of capital. It is a type of security that includes shares (ordinary or preference shares);
- a security reflects a loan relationship between the investor (the person who bought the security) and the issuer (the person who issued the securities). Such securities include bonds, bills of exchange (promissory notes or bills of exchange), etc;
- a security gives the right to receive a certain income from the issuer;
- Securities in the form of shares entitle the holder to participate in the management of a joint stock company;
- Securities give the right to receive a share in the assets of the issuer in the event of liquidation of the company.
One of the essential properties of a security is its ability to be traded on the stock market. Securities circulate freely or with certain restrictions on the market, ensuring the flow of capital from one issuer to another, as well as earning income from the increase in exchange value, etc. Securities can serve as collateral for obtaining credit, securing the fulfilment of obligations, and be the object of other civil relations.
It is the ability to circulate that distinguishes a security from other financial documents. For example, a loan contract is strictly individual and cannot be resold.
Electronic securities markets emerged later than exchanges - with the advent of modern means of communication and informatics. Nowadays, turnover is comparable to that of stock exchanges. There were several such systems in Russia, but now only the Russian exchange system works.
The government uses three main ways to raise funds:
- The first way is by collecting taxes on profits or revenues earned by the nation.
- The second way is by borrowing the savings of the nation's population or on the international market.
- The third way is by selling assets that the government currently has.
The term "money markets" is used to describe the market for debt instruments with a maturity of less than one year (and usually significantly less than one year). Usually, transactions in such products are conducted between banks and professional short-term money managers mainly in the over-the-counter market rather than through a formal exchange.
There are four main instruments in this market:
- treasury bills;
- bills of exchange (commercial bills);
- commercial papers;
- certificates of deposit.
A bill of exchange is a debt instrument, but it pays neither interest nor a coupon rate. It simply has a face value that will be paid on the maturity date, which is often three months from the issuance date of the bill of exchange (discount).
Transferable bills of exchange (commercial bills)
These are promissory notes that are issued by companies as a debt instrument in payment for goods or services.
Commercial paper is similar to a promissory note, although the promissory note is an independent instrument, while commercial paper is issued as part of a financing program (i.e. as soon as one issue expires, another is issued). In fact, commercial paper is an alternative to a short-term bank loan.
Certificates of deposit.
A certificate of deposit is a certificate that confirms the placement of a deposit with the issuer and is tradable, similar to a savings book issued by a bank when a deposit is made into an individual bank account. The issuance of a certificate of deposit in this form makes it transferable. It is issued at a fixed rate of interest, which means that the issuer commits to repay the instrument at its face value plus an amount of interest at a specific time in the future.
5. Segments of the stock market
Securities market instruments can be divided into three main categories of investment products:
- instruments entitling another instrument.
A bond is a debt issuance security reflecting a borrowing relationship between an investor and the issuer. Investors who purchase bonds are creditors.
Issuers, i.e., businesses, banks and governments that issue bonds, are the borrowers. Bonds, as a financial instrument, are currently very widespread. It is estimated that the global bond market amounts to more than $36 trillion. And surpasses the stock market in terms of volume.
Three countries (USA, Japan, Germany) account for more than 70% of the global bond market. The market for debt financial instruments is developing at a rapid pace. Over the last four years it has grown by more than 30 %.
The main question when buying these securities is what is the purpose of the loan? But investors should also ask themselves the following questions:
- Will the funds generate sufficient income to pay interest and repay the principal at a fixed time within the repayment schedule?
- What assets will be provided as collateral for the loan?
- Does the borrower have the right to use these assets as collateral (i.e. are they not collateral for any other loan)?
- How has the company performed over the last three financial years?
- What is the ratio of current debt to equity before and after the loan in question?
- How much could the company's annual profits be reduced so that it would be able to continue servicing the debt?
- How much loss could the company sustain and still be able to service the principal on the proposed loan?
- Is the system for protecting non-shareholders, i.e. creditors, sufficiently effective?
Issuers issue a variety of types and kinds of bonds, each with its own specific characteristics. Therefore, an investor should know the properties of each type of bonds well enough to make an informed decision when buying particular bonds. Bonds are divided into mortgage-backed and non-collateralised bonds according to the method of securing the bonds with specific assets of the company.
Mortgaged (secured) bonds are issued by a company against specific assets of the company (buildings, machinery, equipment, etc.).
Unsecured bonds are direct debentures of a company which are not secured by any collateral. Depending on the type of collateral, there are several types of mortgage bonds. Mortgage bonds are bonds issued against land or real estate. They are the most secure because they do not lose in value over time. Therefore, by mortgaging real estate, a company can raise finance for an amount close to the value of the collateral.
Under variable (floating) bonds, machinery, equipment and materials are pledged as collateral. The term 'variable' (floating) collateral emphasises that the value of the property is subject to much greater fluctuations than land and real estate. Securities bonds are secured by stocks, bonds and other securities that are owned by the issuer. The value of the collateral is determined by the market price of these securities. Depending on the quality of the pledged securities, the amount for which the bonds can be issued is determined.
As stated earlier, unsecured bonds or debentures are not secured by any collateral. Claims of unsecured bondholders are generally enforceable along with claims of other creditors. The actual collateral for these bonds is the company's general solvency. Typically, unsecured bonds are issued by large and well-known companies with a high rating and good credit history. The name of these companies already serves as a guarantee of repayment.
Most securities companies and investment banks are active in the bond market. This is not surprising, since more than 90% of the value of securities around the world is in the form of bonds. Bonds are securities-based loan agreements in which there is no single lender, but rather a number of lenders lending their funds to a single borrower. A special feature of most bonds is that they offer a coupon with a fixed interest rate, which gives a known annual rate of return in advance. Since loan agreements have a fixed term, most bonds will be redeemable or term bonds, which means that there will be a set repayment date (to repay the principal)
For most states, the shortest period of time for which they raise funds is 3 months. The next one is the short-term loan market or bonds, which usually represent one to five years of borrowing, these instruments are only attractive to a small circle of professional investment institutions and are of no interest to private individuals.
Bonds are bought by:
- Banks - 50% of the asset
- Pension funds
- Insurance companies
- Mutual funds
Like many other securities, a bond can yield income in two ways:
- Firstly, in the form of the interest rate (coupon) on the loan, which in most cases is a fixed annual amount payable either semi-annually or once at the end of the year.
- Secondly, it is possible to achieve a capital gain which is expressed as the difference between the purchase price of the bond and the price at which the investor sells the bond (which can be the redemption amount of the dated bond) or a discount.
A specific feature that must be taken into account when determining the potential yield on a bond is that interest rates (the main component of bond valuation) and bond prices change in opposite directions. Hence, the general rule is that bond prices rise as interest rates fall and fall as interest rates rise. Long-term bonds are more sensitive than short-term bonds.
Depending on the yield method, a distinction is made between coupon and discount bonds (coupon-and-zero-coupon-bonds).Discount bonds are called zero-coupon bonds, i.e. no interest is paid on them and the bondholder earns income by selling the bond at a discount, i.e. at a price below par. Depending on how the coupon rate is determined, a distinction is made between bonds with a fixed and floating (variable) coupon rate.
Coupon bonds can be issued with a fixed interest rate, the yield on which is paid constantly at a constant rate throughout the life of the bond.
A fixed interest rate is possible in a stable economy when price and interest rate fluctuations are negligible. In an environment of high and sharply fluctuating interest rates, setting a fixed nominal yield is fraught with high risk for the issuer. If interest rates fall, the issuer must pay investors the income at the rate fixed when the bonds are issued.
Therefore, to avoid interest rate risk, issuers have resorted to issuing floating-rate bonds. This type of bond became common in the US in the early 1980s, when interest rates were quite high and had a tendency to change. In these circumstances, companies preferred to issue bonds with a floating interest rate tied to some indicator that reflects the real situation in the financial market. Typically in the US, floating-rate obligations are linked to the yield on three-month Treasury bills. When such bonds are issued, the interest rate is set for the first three months and then every three months thereafter the rate is adjusted according to the treasury bill yield. The real interest rate on a particular company's bonds is made up of two components:
- interest rates on treasury bills
- additional risk premium
A special kind of bonds are income bonds. A firm is only obliged to pay interest on these bonds to their owners if it makes a profit. If there is no profit, no interest is paid. Income bonds can be both simple and cumulative. With simple bonds, the unpaid income from previous years does not have to be refunded by the company in subsequent periods, even if there is a sufficiently large profit. For cumulative bonds, interest income not paid due to lack of profit is accumulated and paid in subsequent years.
Index-linked bonds are issued to protect the investor against depreciation of the bonds due to inflation, exchange rate movements, etc. Therefore, a distinctive feature of index-linked bonds is that the coupon and par value of the bond is adjusted by a special coefficient reflecting the change in the relevant indicator (inflation rate, exchange rate movements, etc.). Index-linked bonds first appeared in the 1970s in the United Kingdom. These years were characterised by a volatile economy and relatively high inflation. In order to protect investors' funds from depreciation, the British government issued index-linked bonds where the amount of coupon payments and the face value of the bond was adjusted according to the rate of inflation.
In Russia, index-linked bonds were issued by some companies in order to alleviate currency risk. By buying a bond with rubles, an investor assumes the risk of devaluation of the national currency. By holding the bond to maturity, he will receive an amount in roubles equal to its face value at maturity. If the exchange rate of the dollar rises substantially during this time, the real yield for the investor may be negative. Therefore, in order to have a successful bond offering, companies must offer a financial instrument that protects ruble bondholders from ruble depreciation compared to the dollar.
Callable bonds .
By issuing bonds with a fixed coupon rate for a long period of time, the issuer bears the interest rate risk associated with lower interest rates in the future. In order to insure themselves against losses on fixed coupon payments in a falling interest rate environment, companies resort to early redemption of their bonds. The right of early redemption means that the company can redeem the bonds before the official maturity date. In order to carry out such operations, the terms and conditions of the bond issue must stipulate a company's right to call or callability. Russian legislation allows early redemption of bonds. However, unlike in Western countries, early redemption of bonds in Russia is possible only at the request of bondholders.
Bonds with partial early redemption.
By issuing bonds with a single maturity, the issuer would have to raise a significant amount of money on the maturity date to pay investors the nominal value of all bonds being redeemed. In order to reduce the lump-sum repayment burden, companies have resorted to issuing bonds that are redeemed gradually over a period of time. In this case, the company would redeem a part of the face value of the bond simultaneously with the coupon payment.
Some companies believe that currencies in international markets are more attractive to investors than the currencies they work with in the domestic bond market. Accordingly, they may issue bonds in a foreign market in that country's currency. Each country in which such issues take place tends to assign national names to such issues. The three main countries include:
- The US, where non-US issuers issue dollar-denominated bonds called Yankee bonds;
- Japan, where non-Japanese issuer's non-non-dollar bonds are called "Samurai";
- Great Britain, where sterling bonds of non-British issuers are called "Bulldogs".
Various types of bonds are traded on world markets. Two groups can mainly be distinguished among them: foreign bonds and Eurobonds.
A foreign bond is a bond issued by a foreign company in another country's market in that country's currency. The most attractive markets for issuers are the US, UK and Japanese markets, where enormous financial resources are concentrated. If an issuer from another country wants to raise capital in the US market, it issues bonds in US dollars, registers a prospectus under US law and places the bonds in the US market.
Eurobonds are bonds that are simultaneously placed on the markets of several European countries. The Eurobond market developed in the 60s and 70s and has gained popularity among both issuers and investors. A distinctive feature of the Eurobond market is that issuers are reliable borrowers whose reputation and creditworthiness are beyond doubt.
The issuance of government securities is aimed at achieving the following objectives:
- To cover permanent government budget deficits;
- To cover short-term cash gaps in the budget due to uneven tax revenues and expenditures;
- Raising resources to implement large-scale projects;
- Raising resources to cover earmarked expenditures of the government;
- Raising funds to repay debts on other government securities;
A distinction is therefore made depending on the purpose of the issue:
- Debt securities to cover permanent government budget deficits going from year to year. Generally, medium- and long-term securities are issued precisely for this purpose and service systematic government debt.
- Securities to cover temporary budget deficits (cash gaps) that arise due to a certain cyclicality of tax receipts and permanent budget expenditures.
- Targeted bonds issued for specific projects. For example.
In the UK, the government has been issuing transport bonds, generating resources to nationalise transport.
In Japan, government issues of construction bonds for large-scale road-building programmes have been widely practiced.
In Russia, high-speed rail bonds can be seen as such securities, which were issued under the guarantee of the Russian government, with proceeds from the sale of these bonds being used to finance the construction of the Moscow-St. Petersburg railway line.
Securities intended to cover public debt by enterprises and organisations.
These types of securities were quite widely used in Russia under conditions of systematic non-payments, when enterprises did not pay into the budget and the government could not pay off state orders. To solve this problem, the RF Ministry of Finance in 1994-1996 issued treasury bonds, executed under the state order and financed at the expense of the federal budget. The state in the stock market acts not only as the largest issuer, accumulating funds from private corporate investors to cover general government expenditures, but also as the largest operator of the stock market.
Russian government securities include:
- Government short-term obligations (GKOs);
- Government long-term liabilities (GDO);
- Domestic currency loan bonds (DVVZ);
- Gold certificates;
- Short-term obligations (KOs);
- Federal loan bonds (OFZ);
- State Savings Loan Bonds (SSBs).
- 1991 State Republican Domestic Loan (RSFSR) 30-Year Bonds (GDO);
The bondholders receive an annual coupon of 15% of the face value of the bond once a year on a non-cash basis. The Main Territorial Departments of the Central Bank are responsible for servicing the loan and trading the bonds. Bonds are traded exclusively among legal entities.
On the first demand of investors, the CB institutions sell the bonds to those who want to buy them and buy them back from those who want to sell them at the quotations announced by the CB. Quotations are issued once a week on Tuesdays and are fixed for the whole week. The buying and selling technique for bonds of all classes is the same.
Government short-term bonds (GKO).
- maturity of 3 months, 6 months and 1 year (no annual bonds are currently issued);
- bonds are coupon-free, i.e. the yield is the difference between the purchase and redemption price;
- the bonds are issued in the form of separate issues (tranches);
- the owners of the bonds can be both legal entities and individuals, including non-residents;
- the bonds are registered;
- the form of issue is paperless.
Federal loan bonds with a variable coupon (OFZ-PC);
State Savings Loan Bonds (SSBs).
In September 1995, the Russian financial market saw the appearance of Government Savings Loan Bonds (GSSB) issued in accordance with a Presidential Decree
- documentary (paper) issue;
- relatively low par value (100 thousand and 500 thousand rubles);
- the bearer nature of these securities.
Federal loan bonds with a fixed income (OFZ-PD).
The bonds were issued on June 6, 1996 to cover the compensation of Russian citizens born before 1916 and deposited with the Savings Bank of the Russian Federation. A total of 12 tranches will be issued for a total amount of 3.8 trillion roubles. The circulation term of OFZ-PDs is the longest - 3 years. Coupon income will be paid annually, with the yield on the first coupon set at 20% per annum.
Types of corporate bonds are listed in descending order of rank, i.e. priority of interest and principal payments
Corporate borrowers can issue the following types of bonds
secured or mortgage-backed bonds;
The collateral is usually just land or buildings. In other words, this is property that can be used as fixed collateral for the bond and which the company plans to use over a long period of time (for example, ten to twenty-five years). Since this instrument is a 'top quality' debt instrument, it requires the company to use its profits for each year (or its capital) to pay for this type of bond before other creditors' claims are satisfied.
Unsecured bonds will only be issued where the company has (or will have as a result of the loan) assets which will be sufficient to repay the principal amount borrowed. Since this type of loan is unsecured, the holders of such bonds will stand on par with other unsecured liabilities (trade payables) in the event of the company's failure to meet its financial obligations. Consequently, if the company defaults, it may be that insufficient funds will remain to repay the principal upon liquidation.
Convertible secured or unsecured bonds Convertible unsecured bonds are similar to those described above, the only difference being that these bonds can be converted into equity instruments at some point in the future.
The best known (if not the only) example of a corporate convertible bond issue is the convertible bonds of JSC Oil Company LUKoil.
The purpose of the issue was to attract investments for technical upgrading of the JSC's subsidiaries and repayment of their debts to the federal budget.
From the perspective of the issuing company, the conversion can be seen as an advantage because it can no longer worry about repayment of the loan. However, since conversion only occurs when the yield on the equity instruments is equal to or higher than that on the bonds, it will mean that the company will have to pay a dividend on these new shares that will be higher than the current interest rate on the bonds.
6. Types of risks
When operating in the securities market, an investor assumes a certain type of risk:
- Assumed risk
It is the expectation of an event that may occur or a certain outcome of a known event. For example, when an investor buys a security, he only assumes that the security will rise in value and probably also bring him income (otherwise, why would he make such an investment?).
- Market risk
Market risk (systemic or undiversified risk) is the minimum level of risk for a broad group of securities.
- Specific risk
Specific risk (non-systemic or diversifiable risk) is caused by events unique to the company or issuer, such as management errors, new contracts, new products, mergers and acquisitions, etc.
In order to distribute the concepts of risk and expected return it will suffice to review in general terms the concept of risk and return in relation to investments. Essentially, the relationship between risk and return is assessed as follows: The higher the risk, the higher the expected return should be. Consequently, with low risk one can expect a low return. Closely related to risk are the following concepts:
As markets have evolved, a way of measuring risk has been adopted - the volatility of prices of investment products. Essentially, volatility is a measure of how violent price movements have been in the sense of rapid price movements in short periods of time. The more volatile the price, the more likely it is to make a profit or loss in a short period of time.
As already mentioned, liquidity is the degree to which it is easy to buy and sell assets or exchange them for cash. The greater the overall investor interest in a security, the greater the likely volume of transactions in that security, and this should give investors greater confidence that they can find an appropriate counterparty willing to transact in the opposite direction at a reasonable price.
In markets where market makers operate, it is their responsibility, along with the results of arbitrage activity, to encourage and ensure market liquidity. Accordingly, when buying a security, knowing how easy it is to sell is just as important as being able to buy it at a low price. Professional investors are more inclined to haggle when buying than to try to negotiate a better price when selling.
A portfolio may consist of a single security or a combination of securities. Such a portfolio may contain ordinary shares, preference shares, short-term fixed-income securities, bonds, unsecured obligations, warrants and even derivatives. The mix or specialisation depends on the investor's view of the market, their risk tolerance and expected return.
Ideally, a portfolio should consist of securities from a wide range of sectors. Modern portfolio theory was formulated by Harry Markowitz in a paper published in 1952. A naive version of diversification is the advice to "not put all your eggs in one basket". In portfolio investment terms, this means that a single event can have a negative impact on the entire portfolio. Therefore, investing in different securities or investments will reduce the overall risk of the portfolio so that no single investment will have a drastic overall impact.
US research shows that 7-10 securities are in principle sufficient to achieve an acceptable level of diversification that eliminates 70-80% of specific risk. In reality, the number of securities required may be even lower because the choice of securities for these studies was random. Many professional portfolios (for investment funds, pension funds and insurance companies) often contain 50, 100 or more securities.
The structure of the portfolio depends entirely on the investment requirements of the beneficiary (beneficiary) of the portfolio. The approach to portfolio construction and investment advice is shaped by the needs, objectives and requirements of the beneficiary.
With any portfolio there will almost certainly be a need for a certain amount of money to be deposited. This serves two purposes:
- If the client urgently needs funds, his investment manager will not need to sell securities, especially if the market situation is not very favourable at the moment, and
- If the manager finds a security that he would particularly like to buy (perhaps a new issue), again he will not have to sell other securities.
Then, as a kind of protective mechanism, the portfolio is likely to include bonds. This will be a low-risk part of the portfolio, which will also generate income and perhaps a small capital gain over the long term.
Larger portfolios may also contain real estate (i.e. buildings) as, with the exception of the late 1980s and early 1990s, property prices in capital markets have steadily increased. This asset can generate some income (i.e. rents) as well as medium to long-term capital appreciation.
Moving up the risk scale, the next part of the portfolio might consist of equity securities (ordinary shares). There could be a number of different companies from different sectors, which should provide a varied mix of quality securities which offer long-term returns, and riskier stocks issued for company recovery and new equity issues.
Overall, although the outcome depends largely on the client's objectives, a typical portfolio might consist of the following investments:
- Cash on deposit 4%
- Fixed income bonds (including convertible bonds) 20%
- Real estate (buildings) 10%
- Shares of domestic companies 40%
- Shares of foreign companies 26%
7. Legal basis of securities
It must be remembered that holders of debt instruments do not normally have the right to vote at company meetings on matters that affect the company, but they do have the right to vote where their rights are affected. In addition, the rights of security holders include:
- Receiving notice (or confirmation) of the amount of principal and the terms of that loan;
- to receive fixed (or floating) interest on the principal amount;
- receipt of an agreed repayment amount (usually the same as the principal) on the repayment date (unless repayment has been made earlier under the terms of the agreement);
- the right to demand early repayment from the company if the value of the company's assets has fallen below the agreed level (i.e. the assets securing the loan).
The holders of the debt instruments have only one obligation to the company, which is that they must provide the company with an amount equal to the amount of the loan agreement.
7.1.Transfer of ownership of securities.
- Purchase and sale
In most transactions, title to securities is transferred under a sale and purchase agreement, whereby one party (the seller) undertakes to transfer the ownership of the asset (the goods) to the other party (the buyer), and the buyer undertakes to accept the goods and pay a sum of money (the price) for them.
The contract usually stipulates the price per share. Assuming that it is not the shares themselves that are transferred, but the rights to the shares, it would be more appropriate to state the price of the contract, since it is the rights to which the shares give their holder that are traded, and not the securities.
In a contract of exchange, each party undertakes to transfer to the other party one good in exchange for another. The rules of sale and purchase apply to a contract of exchange. At the same time, each party is considered the seller of the goods, which it undertakes to transfer (article 567 of the Civil Code), and the buyer of the goods, which it undertakes to accept in exchange. The advantage of this type of contract is that there is no need for counter cash flows. However, this is only possible if the packages of securities intended to be exchanged are recognised as being of equal value. If this is not the case, one of the parties will pay the additional amount stipulated in the contract.
With the adoption of the new Civil Code of the Russian Federation, the execution of a gift agreement now differs significantly from the previously accepted form. Article 574 of the Civil Code establishes a simple written form for the gift of movable property, which includes securities. Previously, in almost all cases the contract had to be verified by a notary, but now this is not required. The deed of gift and/or transfer order may be presented by either the donor or the giver. The donation agreement must specify the amount of securities that the donor transfers to the giver.
- Transfer of ownership rights as a result of an inheritance
When resolving issues of securities inheritance, the registrar shall amend the register on the basis of the following primary documents:
- a notarised certificate of the right to inherit;
- The decision of a court.
Application or death certificate is not a basis for making changes in the register.
However, sometimes there are cases where non-standard actions of the registrar are required. This is relevant if:
- the shareholder has no will and no heirs;
- the shareholder's heirs have not made any securities claims