CHAPTER 1
Types of firms
- When setting up a firm there are many legal structures that can used: sole proprietorship to limited liabilities
corporations
- The choice depends on the countries incorporations legal system
Corporate organizations in the financial industry
1. Mutual funds: mutual organization, the investors are also shareholder (customers are shareholders)
2. Banks: typically listed corporations (limited liability companies) but some are cooperatives or credit unions
3. Insurance: can be limited liability companies or mutual organization
4. Hedge funds and private equity fund: limited partnerships, with general partnerships and limited partners
The Corporation
- Legal entity in its own right. Has right and obligations under the relevant legal system
- The owner are shareholder, their liability is limited to the amount they have invested to buy the shares
- Has governance structure: shareholders appoint a board of directions to represent their interest, and the board
appoint a management team headed by a ceo
The choice of legal structure has important important
- Risk for the different parties • tax • conflict of interest • possibility to raise capital • survival of business
Financial statements
- Accounting reports issues periodically to present past performance and a snapshot of the first assets and the
financing of those assets
- Regulations generally require publicly listed companies to file their annual financial statements with listing
authorities; they must send an annual report together with their financial statement to their shareholders.
- Must be verified by the auditor
- Investors, financial analysts, managers and other interested parties such as creditors rely on financial statements to
obtain reliable information about a corporation
Accounting Standards
- Language of financial statements
- GAAP: generally accepted accounting principles
- IFPS: international financial reporting standards
- US GAAP: in the US only (companies who want to issue securities is the US have to convert to GAAP)
Role of auditors
- Must check that the financial statement present a true picture of the finances of the company, must sign off the
statements by providing a statement to the shareholders
- Problem: conflict of interest
Types of financial statements
1. Balance sheets(Statement of Financial Position)
a. Lists the firm's assets and liabilities and shareholders equity
b. Provides a snapshot of the firm's financial position at a given point in time (what the firm owns, assets, and
owes, liability)
c. Two sides of the sheet must balance
d. Asset = Liabilities + stockholders equity, → If we owe more than we own, we have negative equity
2. Income statement
a. Lists the firm's revenues and expenses over a period of time, last line shows the net income (aka profits or
earnings)
3. Cash flow statement
a. How much cash the firm has generated, how the cash has been allocated during the set period
b. It's important → need to pay bills and maintain opentation and is the source of any return of investments
4. Statement of changes in shareholders equity
Shareholders equity (capital)
The difference between assets and liabilities constitutes the shareholders equity aka book value of equity
An accounting measure of the networth of the firm
Main components:
1. Share (equity) capital (money invested directly by shareholders in exchange for shares of the company)
, 2. Retained earning (reinvestment of profits)
Market Value Vs BookValue
1. Book value of equity
a. Net worth from an accounting perspective
b. Asset - liabilities = Equity
c. True value of assets may be different from book value: many valuable assets are not captured on the
balance sheets, eg. reputation, quality
2. Market Capitalization (market value of equity)
a. Market price per share times number of shares
b. Does not depends on historical costs of assets
Funding the Business
Funds come from 2 sources
1. Equity (capital) → shares/stocks
a. Sourcing money from 3F’s: family, friends, fools, by issuing shares (stock)
b. Later on, we can raise money from financial investors (generally angel investors, venture capital, private
equity)
c. Once business is large, it gets listed as IPO and raise money from the general public (retail investors)
2. Debt (liabilities) → loans, bonds, notes, leases
a. We can borrow money from suppliers (payables & trade credit), banks (loans), finance companies (leases)
and investors (bonds, notes, private placements)
EBITDA
- Financial analysts often compute a firm's earnings before interest, taxes, depreciation and amortization aka EBITDA
- Because depreciation and amortization are not cash flows (non-cash expense) this subtotal reflects the cash a firm
has earned from operations
- This measure is frequently used in debt covenants
EPS
- Earnings per share: net income reported on a per-share basis
- EPS = net income / shares outstanding
Functions of Financial Market
- Channeling funds, efficiency, price determination, risk sharing, liquidity, financial stability, information aggression and
coordination
Asias Financial Markets
1. No transaction efficiency: fragmented markets, lack of information
2. Information asymmetry: reliability of information, timeliness and accuracy of information
3. Legal (uncertainty)and weak regulators
These affect price efficiency
The Players
1. Sources of funds (investors): institutionals, (quasi)Sovereigns, banks & FIs, Corporations, HNWI, Public
2. User of funds (Issuers): SSAs→ supras, sovereigns, agencies, banks, corporations, SPVs
3. Intermediaries: investment bankers, primary dealers/traders, brokers, credit and liquidity enhancers
4. Other actors: regulators, service providers, rating agencies
Classification of financial Markets
1. Primary vs Secondary
a. Primary: raising money/capital for the first time
b. Secondary: selling securities onto another investor
2. Debt vs Equity
a. Debt
, i. Legally binding, No voting rights, Requires repayment of principal and interest, Interest is
tax-deductible, Covenants can be restrictive, Money Market, loan market, DCM
b. Equity
i. Ownership, Voting rights on common stock, Dividends on common stock are optional, Dividends are
paid from after-tax profits
ii. All cumulative preferred dividends must be paid before dividends paid on common stock
3. Securities and Capital Markets
a. Security: Negotiable, tradeable, finance instruments
i. Include equity services (stocks/shares) and debt securities (bonds/notes)
b. Capital markets: where securities are traded and where firms can raise capital (either equity capital or debt
capital)
i. Include Equity capital markets (ECM) and Debt capital markets (DCM)
c. Foreign Exchange (FX): market for trading currencies
i. The largest and most liquid of all markets, is not a capital market since participants don't raise
capital
4. Exchanges vs OTC
a. Exchange: one centralized location
i. 2 types: stock exchanced or derivalive exacnhes
ii. Can be auction markets or dealer markets
b. Over the counter : Not localized
i. Dealer markets, eg. bond market
5. Domestic vs International
6. Public vs Private
a. Public: General public (individuals
b. Public issues
i. Targeted at the general public
ii. Subject to regulatory control
iii. Typically underwritten by an investment bank
iv. Typically require: registration/filing, disclosure/due diligence, rating, prior approval form
c. Private: Sophisticated investors (institutions)
d. Private issues
i. Exempted from registration requirements
ii. Lower standards of disclosure and due diligence as investors are deemed sophisticated
iii. Generally no need for underwriting
Market Organization
1. Direct search
2. Brokered search
a. Price determined by supply/demand
3. Dealer market
a. Price determined by market makers (traders/dealers) based on supply/demand, their existing position, their
view on the market
4. Auction market
a. All bids and offers entered into system, price determined at equilibrium point or higher bid
Some Misunderstanding
1. Trading vs listing : financial instrument can be listed on an exchange
a. To list a security or financial instrument on an exchange, the firm need to meet the listing requirements and
rules of that particular exchange
b. But not necessarily trade on that exchange
c. Trading as to do with supply and demand for that particular instrument
d. A stock can be listed on an exchange but very rarely trade on it if there is no or limited liquidity
e. Some financial instrument ONLY trade on exchanges
i. Eg. Futures are exchange specific financial instruments
f. Other can be traded on exchange or OTC
Current issues related to market organization
- The advent of electronic trading
- Demutualization
- Dark pools and private exchanges
- Advent of high frequency trading (HFT)
, - Regulators push to OTC onto exchanges
Somestic, Euro, Foreign Markets
- To determine if a securities issue is domestic, foreign or ero, we need to check three key variables
- What currency is the security issued in?
- Where is the security placed? (where are the investors)
- Where is the issuer?
1. Domestic issues: placed with investors in the country of the currency and the issuer is also from the country of the
currency
a. HK lands issues a HKD bond placed to HK investors
2. Foreign issues: places with investors in the country of the currency but the issuer is from a different country
a. HK land issues USD bond to US investors
3. Euro Issues : places with investors outside the country of the currency , it doesn't matter where the issuer is from
a. HK Land issues a EUR denominated bond to HK investors
Internal vs. External Classification
1. Internal (national) Market
a. Domestic market: issuers domiciled in the country
b. Foreign market: issuers not domiciled in the country (Eg. Yankee market in the US)
2. External (international, offshore, euromarket) Market
a. Securities offered simultaneously to investors in a number of countries and issues outside the jurisdiction of
a single country
Types of firms
- When setting up a firm there are many legal structures that can used: sole proprietorship to limited liabilities
corporations
- The choice depends on the countries incorporations legal system
Corporate organizations in the financial industry
1. Mutual funds: mutual organization, the investors are also shareholder (customers are shareholders)
2. Banks: typically listed corporations (limited liability companies) but some are cooperatives or credit unions
3. Insurance: can be limited liability companies or mutual organization
4. Hedge funds and private equity fund: limited partnerships, with general partnerships and limited partners
The Corporation
- Legal entity in its own right. Has right and obligations under the relevant legal system
- The owner are shareholder, their liability is limited to the amount they have invested to buy the shares
- Has governance structure: shareholders appoint a board of directions to represent their interest, and the board
appoint a management team headed by a ceo
The choice of legal structure has important important
- Risk for the different parties • tax • conflict of interest • possibility to raise capital • survival of business
Financial statements
- Accounting reports issues periodically to present past performance and a snapshot of the first assets and the
financing of those assets
- Regulations generally require publicly listed companies to file their annual financial statements with listing
authorities; they must send an annual report together with their financial statement to their shareholders.
- Must be verified by the auditor
- Investors, financial analysts, managers and other interested parties such as creditors rely on financial statements to
obtain reliable information about a corporation
Accounting Standards
- Language of financial statements
- GAAP: generally accepted accounting principles
- IFPS: international financial reporting standards
- US GAAP: in the US only (companies who want to issue securities is the US have to convert to GAAP)
Role of auditors
- Must check that the financial statement present a true picture of the finances of the company, must sign off the
statements by providing a statement to the shareholders
- Problem: conflict of interest
Types of financial statements
1. Balance sheets(Statement of Financial Position)
a. Lists the firm's assets and liabilities and shareholders equity
b. Provides a snapshot of the firm's financial position at a given point in time (what the firm owns, assets, and
owes, liability)
c. Two sides of the sheet must balance
d. Asset = Liabilities + stockholders equity, → If we owe more than we own, we have negative equity
2. Income statement
a. Lists the firm's revenues and expenses over a period of time, last line shows the net income (aka profits or
earnings)
3. Cash flow statement
a. How much cash the firm has generated, how the cash has been allocated during the set period
b. It's important → need to pay bills and maintain opentation and is the source of any return of investments
4. Statement of changes in shareholders equity
Shareholders equity (capital)
The difference between assets and liabilities constitutes the shareholders equity aka book value of equity
An accounting measure of the networth of the firm
Main components:
1. Share (equity) capital (money invested directly by shareholders in exchange for shares of the company)
, 2. Retained earning (reinvestment of profits)
Market Value Vs BookValue
1. Book value of equity
a. Net worth from an accounting perspective
b. Asset - liabilities = Equity
c. True value of assets may be different from book value: many valuable assets are not captured on the
balance sheets, eg. reputation, quality
2. Market Capitalization (market value of equity)
a. Market price per share times number of shares
b. Does not depends on historical costs of assets
Funding the Business
Funds come from 2 sources
1. Equity (capital) → shares/stocks
a. Sourcing money from 3F’s: family, friends, fools, by issuing shares (stock)
b. Later on, we can raise money from financial investors (generally angel investors, venture capital, private
equity)
c. Once business is large, it gets listed as IPO and raise money from the general public (retail investors)
2. Debt (liabilities) → loans, bonds, notes, leases
a. We can borrow money from suppliers (payables & trade credit), banks (loans), finance companies (leases)
and investors (bonds, notes, private placements)
EBITDA
- Financial analysts often compute a firm's earnings before interest, taxes, depreciation and amortization aka EBITDA
- Because depreciation and amortization are not cash flows (non-cash expense) this subtotal reflects the cash a firm
has earned from operations
- This measure is frequently used in debt covenants
EPS
- Earnings per share: net income reported on a per-share basis
- EPS = net income / shares outstanding
Functions of Financial Market
- Channeling funds, efficiency, price determination, risk sharing, liquidity, financial stability, information aggression and
coordination
Asias Financial Markets
1. No transaction efficiency: fragmented markets, lack of information
2. Information asymmetry: reliability of information, timeliness and accuracy of information
3. Legal (uncertainty)and weak regulators
These affect price efficiency
The Players
1. Sources of funds (investors): institutionals, (quasi)Sovereigns, banks & FIs, Corporations, HNWI, Public
2. User of funds (Issuers): SSAs→ supras, sovereigns, agencies, banks, corporations, SPVs
3. Intermediaries: investment bankers, primary dealers/traders, brokers, credit and liquidity enhancers
4. Other actors: regulators, service providers, rating agencies
Classification of financial Markets
1. Primary vs Secondary
a. Primary: raising money/capital for the first time
b. Secondary: selling securities onto another investor
2. Debt vs Equity
a. Debt
, i. Legally binding, No voting rights, Requires repayment of principal and interest, Interest is
tax-deductible, Covenants can be restrictive, Money Market, loan market, DCM
b. Equity
i. Ownership, Voting rights on common stock, Dividends on common stock are optional, Dividends are
paid from after-tax profits
ii. All cumulative preferred dividends must be paid before dividends paid on common stock
3. Securities and Capital Markets
a. Security: Negotiable, tradeable, finance instruments
i. Include equity services (stocks/shares) and debt securities (bonds/notes)
b. Capital markets: where securities are traded and where firms can raise capital (either equity capital or debt
capital)
i. Include Equity capital markets (ECM) and Debt capital markets (DCM)
c. Foreign Exchange (FX): market for trading currencies
i. The largest and most liquid of all markets, is not a capital market since participants don't raise
capital
4. Exchanges vs OTC
a. Exchange: one centralized location
i. 2 types: stock exchanced or derivalive exacnhes
ii. Can be auction markets or dealer markets
b. Over the counter : Not localized
i. Dealer markets, eg. bond market
5. Domestic vs International
6. Public vs Private
a. Public: General public (individuals
b. Public issues
i. Targeted at the general public
ii. Subject to regulatory control
iii. Typically underwritten by an investment bank
iv. Typically require: registration/filing, disclosure/due diligence, rating, prior approval form
c. Private: Sophisticated investors (institutions)
d. Private issues
i. Exempted from registration requirements
ii. Lower standards of disclosure and due diligence as investors are deemed sophisticated
iii. Generally no need for underwriting
Market Organization
1. Direct search
2. Brokered search
a. Price determined by supply/demand
3. Dealer market
a. Price determined by market makers (traders/dealers) based on supply/demand, their existing position, their
view on the market
4. Auction market
a. All bids and offers entered into system, price determined at equilibrium point or higher bid
Some Misunderstanding
1. Trading vs listing : financial instrument can be listed on an exchange
a. To list a security or financial instrument on an exchange, the firm need to meet the listing requirements and
rules of that particular exchange
b. But not necessarily trade on that exchange
c. Trading as to do with supply and demand for that particular instrument
d. A stock can be listed on an exchange but very rarely trade on it if there is no or limited liquidity
e. Some financial instrument ONLY trade on exchanges
i. Eg. Futures are exchange specific financial instruments
f. Other can be traded on exchange or OTC
Current issues related to market organization
- The advent of electronic trading
- Demutualization
- Dark pools and private exchanges
- Advent of high frequency trading (HFT)
, - Regulators push to OTC onto exchanges
Somestic, Euro, Foreign Markets
- To determine if a securities issue is domestic, foreign or ero, we need to check three key variables
- What currency is the security issued in?
- Where is the security placed? (where are the investors)
- Where is the issuer?
1. Domestic issues: placed with investors in the country of the currency and the issuer is also from the country of the
currency
a. HK lands issues a HKD bond placed to HK investors
2. Foreign issues: places with investors in the country of the currency but the issuer is from a different country
a. HK land issues USD bond to US investors
3. Euro Issues : places with investors outside the country of the currency , it doesn't matter where the issuer is from
a. HK Land issues a EUR denominated bond to HK investors
Internal vs. External Classification
1. Internal (national) Market
a. Domestic market: issuers domiciled in the country
b. Foreign market: issuers not domiciled in the country (Eg. Yankee market in the US)
2. External (international, offshore, euromarket) Market
a. Securities offered simultaneously to investors in a number of countries and issues outside the jurisdiction of
a single country
