A Major Role in Financing Investors - Case Study Example

Capital markets London Stock Exchange and how it facilitates an exchange of funds among all participants’ members of the market In any capital market, the participants are the individual investors, corporations and the government who are engaged in buying and selling of securities. Capital markets are the major providers of long term financing. They offer a range of products, just to mention but a few, equity instruments, derivatives, insurance instruments and bonds. The role of the capital market is to facilitate an exchange of funds among all member participants. By doing so, members present themselves with having surplus funds or a deficit of the same. As a result, trading is effected where the surplus funds are invested in the markets through buying of assets, and the deficit is counteracted when investors sell their assets. The London Stock Exchange (LSE) has played a major role in financing investors. The financing from an exchange in the recent decade has been viewed to be more effective compared to other financial institutions. The process applied in extending credit is much easier to undertake. A number of factors have been seen to enhance this process. These include the growing competition, fluctuating interest rates, deregulation and advanced technology that have resulted in the efficiency of operations of the LSE. LSE is among the largest trading market internationally serving 3000 companies in 70 different countries. Integrity, market knowledge and a lot of expertise have been a platform for LSE. It is a leader in providing of services that facilitate raising of capital amongst its participants. It is also among the leading stock exchanges in equity trading. LSE offers both real and virtual stock exchanges. Virtual stock exchange allows its investors to trade online while the real exchange is done offline. Advertently, this allows all manner of investors to trade in this stock exchange. The technological advances allow participants in this market to have the opportunity to trade locally and internationally. The LSE group has in the past decade offered high performance trading platforms, market softwares e.g. sets, crests, for assessment of assets as well as post trading services for its participants (Alexander, 2008, 281; Alexander, 2010, 137). Main markets works together with the LSE and the financial authorities in regulation of trades with big corporations. These are companies who are not only looking for ways of raising capital but also in having a reputation in their liquidity shares profile and international position. It has a combined market capitalisation of £3.7 trillion. This market serves over 1400 companies. It opens avenues for different sectors and geographical dimensions. Moreover, this market facilitates exchange of funds by creating ways for capital growth (Great Britain: Competition Commission, 2005, 19). This is by allowing companies to investment in assets that offer returns. Furthermore, the main markets is also engaged in creating a market for companies shares; substantiating the economic value for these shares in the market; and further allowing companies to make acquisitions from the listing. The LSE has also enhanced the companies trading here in to gain a public profile as well as their status with its customers and suppliers. The LSE lists companies as standard and premiums. Companies under the standards category have to meet requirements laid down by the European Union. Those companies in the premium section have to be over and above these standards. These enjoy increased investor confidence thus they are super active in raising funds and trading in the LSE. Owing to the looming economic conditions, the companies have been experiencing a downfall in profits and rise in debts. The main market has helped curb this by injecting capital to pay off debts and further growth for these companies. LSE has opened avenues for small growing companies by creation of Alternative Investment Markets (AIM). Since its launch in 1995, AIM serves over 3000 companies internationally. This enhances companies that intend to raise capital at the early stages in achieving their goals. LSE has helped over 2300 companies to raise over $28 billion of capital from 1995. LSE has done so through regulation, coordination and further promoting AIM in serving the small growing companies. Undoubtedly, these companies have been able to survive in the industry through further participations on long term financing through the LSE. Once a company has reached a certain growth, it is allowed to transfer its shares to the main market for increase in trading of its securities. The private investor docket incorporates the individuals of the country. These, however, make small investments but in the long run help companies in getting liquid cash easily (Maurice & Alan, 2005). London International Financial Futures and Options Exchange (LIFFE) is another point of exchange from the LSE that delivers an electronic trading platform international for all financial centers. The London clearance house has been developed to offer clearing services to its members for a range of equities and cash assets worldwide and domestically. In collaboration with the LSE, the London clearance house creates avenues in serving members in the market in trading of securities. The launch of Order book for Retail Bonds (ORB) about a year ago by the LSE has created avenues for private investors in providing a range and number of bonds being traded. This is an electronic platform for trading of securities for the private sector. It has had a significance growth in shares traded in this market. Growth in the number of participants in this market has also been witnessed. A rise from 59 bonds to 142 corporate, government and international bonds has been recorded for the one year of ORB operations. This has been a success in facilitating exchange of funds among the private sectors. Inflation multiplier, index linked are just but a few to be mentioned of corporate bonds traded in this sector (Alexandra, 2010, 142). The LSE creates benchmarks that ease the comparison for institutional investors’ portfolio of assets with that of the industry. Indices have been adopted in this case. An example is the FTSE all share index that is used by all investors in the market. The overall goal for corporates is to increase shareholders’ wealth. This has been made possible through LSE trading and monitoring of stock and other assets movement. It enables company to invest their surplus cash more effectively and further borrow funds to increase their business operations. Eventually they are able to earn high profits. A portfolio mix of assets in an enabling environment full of expert advisors and technological advance offers opportunities for useful measures in funds investment. Right or Privilege Issues This is another way to raise shares in a company by issuing new shares to the existing shareholders in accordance to their proportionate holding and with respect to their pre-emption rights (Bastian, 2010, 29). The price at which the rights are offered is usually at a discount. This price is lower than the existing market share price of the company. If the shareholders for any reasons, opts not to take the rights issues, he/she stands to have the value of his/her holding in the firm diluted. Rights issues are issued for a number of reasons by companies. These include strengthening the balance sheet balances, expansion purposes and as a security on its own. For a company that is having a bad position, it may use the balance sheet offers to strengthen its position. This is however, not advisable for stockholders to invest in as the profits of these companies are already at a downfall. The rights are usually sold by the company on before of the existing shareholders, if the right holders have not agreed to take up the rights. This is a practice done in many money markets. The companies offering rights issues do so to raise funds for expansion of business and growth strategies hence, to reassure its stockholders, they do so through investment institutions e.g. a bank. For companies experiencing debt payoffs turmoil, they are able to issue the rights to acquire funds to clear the debts. This is specifically so when a company is not in a position to borrow money elsewhere. Advantages 1. The right holders can sell some rights and exercise the remaining part. This should be undertaken to an extent where the right holders maintain the value of a holding without any further expenses. 2. The rights holders are presented with more shares at a lower cost. This issues them the right to purchase more shares in the future at price lower than the existing market price. To be more precise, the shareholder has an opportunity to increase his securities in form of stock in the offering company at a discounted price. 3. The shareholders are presented with the rights to trade the right shares until the date the new shares are purchased. This trading is more the same as for normal shares. The rights so presented have a value to the shareholders. Disadvantages 1. The dilution of the value of the shareholding often is a limitation to the stockholder who does not exercise their rights. This is because the discount lowers the current market value of the shares to the exercisable price (Juan, 2011, 89). Hence it dilutes the value of the shares. 2. To a company with balance sheet issues, the stockholders may not really know what transpired for the weakness in the financial position of such an organisation. As a result, rights are issued by companies that are facing collapse, presenting a huge risk to stockholders (Rupert & Simon, 2006, 195). 3. A right issue has always been attractive to so many investors. This is hardly a good offer if the intention of the funds being sought is to no good in increasing earnings of the company. A discounted price is attractive but the stockholder need be extra careful before exercising his rights, or overall reject the offer. Cost of internal equity The illustration below can be solved with following formula: Cost of internal equity (ke) = [(next years dividend per share/ (current market price per share - flotation costs)] + growth rate of dividends. Dividend growth is 10% of 1.18=0.12 Next year’s dividends will be 1.18 + 0.12 = 1.30 Floatation costs in this case equals 12% of 41 = £4.92 [(1.30/ (41 - 4.92)] + .10 = .14 or 14% Common stock sells for £41; The dividends paid last year were £1.18; Flotation costs 12% of the market price on issuing these stocks; The dividends and earnings per share stands at a 10% growth rate; The internal cost of equity is the equilibrium rate of return for stockholders. This investment is made from retained earnings of a company. They have proposition that the cost of internal equity is zero. Inadvertently, this view from analysts and managers is not true as indicated by the example above. Funds generated from the firm as profits can either be paid out as dividends or retained in the business for reinvestment. If the firm pays dividend and the stockholders investment them individual, this mode has been seen to be more expensive. As a matter of fact the stockholders prefer to retain the earnings in the firm to reinvest them for higher gains on a risk adjusted basis. Undoubtedly the cost of raising internal equity is cheaper than external equity. This is because external equity requires issuance costs for the sale of new stocks. There are different valuation methods to determine the cost of internal equity. These are, just to mention, dividend valuation model, realized investor yield, capital asset pricing model (CAPM) that applies a constant dividend growth rate as in the example above, and variations in growth of dividends (Charles et al, 2008, 406; Alexandra and John, 2005, 291). In the illustration above the cost of internal is high depicting that much of the retained earnings are reinvested since ke is higher than the dividend growth rate of 10%. Bibliography Alexandra, R. & John, F., (2005), Art of M and A financing and refinancing, New York, McGraw-Hill Professional. Charles, M., James R. & William J., (2008), Contemporary Financial Management (11e), Columbia, Cengage Learning. http://www.londonstockexchange.com/companies-and-advisors/aim/aim/aim.htm Retrieved on 10/12/2011 Maurice, O. & Alan, M., (2005), Global capital markets: integration, crisis, and growth, Cambridge, Cambridge University Press. Alexander, D., (2010), How the City Really Works: The Definitive Guide to Money and Investing in Londons Square Mile (3e), Germany, Kogan Page Publishers. Alexander, D., (2008), How to Understand the Financial Pages: A Guide to Money and the Jargon, Germany, Kogan Page Publishers. Great Britain: Competition Commission, (2005), Deutsche Bèrse AG, Euronext NV and London Stock Exchange Plc: A Report on the Proposed Acquisition of London Stock Exchange Plc by Deutsche Bèrse AG Or Euronext, London, The Stationery Office. Bastian, B., (2010), Rights Issue Related Discounts in France, Germany, Switzerland, and the United Kingdom: Various Empirical Approaches, London, GRIN Verlag. Rupert, P. & Simon B., (2006), Raising venture capital, Chichester, John Wiley & Sons. Juan, R., (2011), Handbook of Corporate Equity Derivatives and Equity Capital Markets, Chichester, John Wiley and Sons. Read More