The Corporate Debt Market - Assignment Example

Equity and Debt Markets Student’s Name Institutional Affiliation Question 1 Introduction Equity market, which is also known as the stock market, is one that is used for trading of equity instruments (Landry, 2010). One example of equity instrument is the stock shares such as those traded in stock exchange markets in different parts of the world. Stocks are securities based on the claims of earnings or assets of a given corporation. The following paper intends to discuss various options of debt and equity options available for companies in funding their operations. Equity Market Financing a business or countries’ budgets through equity is instrumental in ensuring that funds are acquired without incurring debt. It is critical to note that purchasing equity instruments helps those who buy stock gain direct ownership of the business, based on some shares they have bought. Therefore, individuals, government or groups that buy equity instruments have the right to vote and make decisions on the issues regarding the business (Livermore & Smitten, 2013). In addition, shareholders have the right to claim the future earnings of the enterprise, which plays a critical part in solving financial challenges that either the country or individual owners may be facing during financial or economic crisis. To the average person, equity markets are known much more compared to the debt market. Equity markets are necessary for economic activity since they influence both consumer and investment spending decisions (Livermore & Smitten, 2013). The shares’ price is used to determine the amount of funds that a company can raise in selling newly issued stock. In this connection, it determines the number of goods that can be purchased by a given company and, therefore, the volume of the company’s production. Corporate Debt Market The debt market involves trading using instruments of debt. Debt instruments refer to assets that need a fixed type of payment to the holder. There are several types of debt markets, one being the corporate debt market, which is also known as the corporate bond (Landry, 2010). The corporate debt market is a debt instrument that is issued by a corporation and then sold to investors. The backing to the bond issued is based on the payment ability of the firm, which is determined by its future operations. However, in some instance the company’s assets are used as collateral for the bonds issued. Further, corporate bonds are considered to be of higher risk compared to the government bonds. Based on this reality, the interest rates are always higher, including those issued for top-flight credit quality companies (Landry, 2010). The bonds issued are usually in blocks such as $1,000 in par value. Each block has a fixed or standard coupon of payment structure. In some instances, call provisions are included to allow for early repayment if there is any change of the prevailing rates. A firm can issue corporate bonds to get funds to finance its operations, which is instrumental in cautioning financial position of a company. Selling corporate bonds also helps a company to gain trust and confidence from the public, which is useful in improving production and general performance. Government Debt Market The government debt market refers to bonds issued by the national government, accompanied by a promise of paying periodic interests as well as the face value on the maturity date (Livermore & Smitten, 2013). It is important to note that the value of country’s currency dominates the government debt market. There are many risks involved when trading in government bonds such as the credit risk (Landry, 2010). Based on the value of the country’s currency, government bonds are taken as approximations of the theoretical risk-free bond since it is assumed that the government can impose taxation measures or create additional money in order to save the bond at maturity. However, in some instances, government defaults in control of currency debts, thus affecting the market value of bonds issued. On the other hand, the county’s currency value may change tremendously compared to the holders’ reference currency. If the currency is usually unstable, the bondholders are forced to take high risks while trading. Issuing of government bonds plays an instrumental role in offering alternative sources of funds for financing government projects. Foreign Exchange Market Foreign exchange market, also known as forex market refers to the market where currencies are traded (Landry, 2010). Globally, foreign exchange market is the biggest and the most liquidated type of financial market. The largest share of the forex market is in Britain with more than 40 percent of a transactions taking place in London. Foreign exchange market is important in determining both national and international investments. It is crucial in supporting exports and imports of a country or region, which is helpful in gaining access to resources and the creation of additional demand of services and goods (Livermore & Smitten, 2013). Further, failure to trade in different markets means that the prospects of a company are limited, and the global economic growth can be affected. Derivatives Market Derivatives refer to financial instruments or contracts that get their value from other variables. Therefore, the value of derivative instruments depends on the assets in question. The assets involved in derivative markets include commodity, index, equity, currency or bond. Some example of derivatives involves Futures, Forwards, Swaps and Options (Landry, 2010). Derivatives are important when high risks in the market are involved. Therefore, derivative is best applied if one wants to manage risk by transferring the risk associated with a given asset to the third party. However, the third party must be willing to take the risk involved. To simplify the risk, derivatives are divided into three, including credit, liquidity, and market risks. Credit risk, also known as default risk comes in when one of the parties involved does not fulfill the responsibility under the contract, which is referred to as a default (Landry, 2010). Liquidity risk is a financial risk based on uncertain cash crunch. If an institution’s credit rating fall or faces unexpected and sudden cash outflows, it may lose its liquidity. This can also happen if some events lead to counter-parties, avoiding trading with or even lending to the company. Finally, market risks are based on various factors such as fluctuation of prices of the underlying assets. However, market risk is divided into four categories including Currency Risk, Equity Risk, Commodity Risk and Interest rate risk. It is important to note that application of derivatives varies from one sector to another. For examples bank use derivative in hedging against risks that can negatively influence their functions and earnings such as market risk and interest rate risk (Landry, 2010). On the other hand, in the agricultural sector, farmers can use derivatives in locking the prices of farm produce to ensure the protection of their harvest. Therefore, the role played by derivatives in economic performance is crucial due to the high volatility of the market. Question Two A corporation refers to a company or group of people that are authorized and recognized by law to act as the single entity in running a business. Various countries have different corporation laws that guide the establishment of corporations (Landry, 2010). Corporations have a number of equity and debt funding alternatives, which this section intends to discuss including describing two equity funding and one debt funding strategies that can be used by a corporation in funding its long-term financial needs. There are several alternatives and techniques applied by corporations in sourcing for funds. However, the common elements involve the use of debt and equity instruments in raising the capital needed (Livermore & Smitten, 2013). Equity and debt instruments also come in different categories. However, the common equity instrument is the selling of shares in stock markets. Investors are always searching for any promising companies to invest their money. A corporation can sell its shares to investors in order to get capital, which can be used in other firm’s operations. On the other hand, foreign exchange business is also another alternative that a corporation can source its capital. The most common form of debt market is the corporate debt market, which involves selling of bonds to potential investors. It must, however, be underlined that there are factors that determine trust investors have on the corporation, including the type of management, future prospects and previous financial performance (Livermore & Smitten, 2013). Debt and Equity Instruments as Sources of Funding As noted above corporations use debt and equity instruments to fund their operations (Markham et al., 2011). The two forms of funding are based on the investors’ confidence in the company. However, equity instruments provide the opportunity for capital gains based on the appreciation and investors bear risks of losing if the corporation’s share price drops (Landry, 2010). Selling of companies shares depend on the asset value of the company. The valuation of the property determines the volume of shares that are going to be floated in the stock market. Based on the number of shares available, the price of a single package of shares is determined, and investors are invited to put their money. The repayment agreement is determined based on the profit made by the firm. If the corporation is making good profits, the investors are also likely to make good earnings depending on the interest rates (Livermore & Smitten, 2013). However, investors have the right of ownership, based on the percentage of shares held. Corporations also provide for warrants in buying of stock (Landry, 2010). Provision of permits means that an investor is only expected to buy common shares at a specific price and time. Corporations use this strategy to dictate the volumes of earnings expected from the investors (Markham et al., 2011). The approach is also used to avoid speculations and unhealthy competition. Conclusion Conclusively, the corporate debt market is a source of capital for corporations, which involves selling of bonds. As debt instruments, issuance of bonds includes an agreement between the company as a borrower and an investor as a lender. An investor buys a bond, which is issued by the firm expecting to be paid later. The repayment of money to the investors comes with interest. Therefore, investors are keen on the interest rate involved and the performance of the corporation, which determines the amount to be received in future. References Landry, D. (2010). The layman's guide to trading stocks. Los Angeles, Calif: Stilwell & Co. Pub. Group. Livermore, J. L., & Smitten, R. (2013). How to trade in stocks: His own words: the Jesse Livermore secret trading formula for understanding timing, money management and emotional control. Markham, J. W., Gabilondo, J., Hazen, T. L., & Markham, J. W. (2011). Corporate finance: Debt, equity, and derivative markets and their intermediaries. St. Paul, MN: Thomson/West. Read More