1. Chapter 4

• The Share Market

and the Corporation

Websites:

www.asic.gov.au

www.asx.com.au

www.nyse.com

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 2. Learning Objectives

Understand the nature of corporations and reasons for public listing

Discuss the role of primary and secondary markets in equity financing

Explain the derivatives and interest rate roles of a stock exchange

Understand the electronic trading and settlement systems for share market transactions

Explain the importance of information flows for share market efficiency

Identify the main regulators of the share market

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 3. Chapter Organisation

4.1The Nature of a Corporation

4.2The Stock Exchange

4.3Summary

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 4. 4.1 The Nature of aCorporation

Share market

• A formal exchange facilitating the issue, buying and selling of equity securities

Publicly listed corporation

• A company whose shares are quoted and traded on a formal stock exchange (SX)

Ordinary share

• The principal form of equity issued by a corporation, which bestows a claim to residual cash flows and ownership and voting rights

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 5. 4.1 The Nature of aCorporation (cont.)

The corporation differs from other business forms

• Ownership claims are widespread and easily transferable

• Owners (shareholders) do not affect the day-to-day affairs of the company

• Shareholders liability is limited to

• • T heissue price of shares of a limited liability company

• • Any partly paid portion of shares of a no-liability company

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 6. 4.1 The Nature of aCorporation (cont.)

Advantages ofthecorporate form

• Can obtain large amounts of finance for a relatively cheap cost

• The liquidity of securities facilitates investor diversification and encourages investment in corporate securities

• Separation of ownership and control facilitates

• • Appointment of s pecialised management

• • Greater effectiveness in the planning and implementation of strategic decisions

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 7. 4.1 The Nature of aCorporation (cont.)

Advantages ofthecorporate form(cont.)

• Perpetual successionthe corporate form is unaffected by changes in management or ownership

• The corporate form is suited to large-scale operations

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 8. 4.1 The Nature of aCorporation (cont.)

Disadvantages of the corporate form

• Maindisadvantage arises due to the separation of ownership and control

• • Conflict of interest between owners (principals) and managers (agents) known as the agency problem

• • Management maytry to run business for their own benefit, rather than that of shareholders, i.e. maximise shareholder value (share price)

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 9. 4.1 The Nature of aCorporation (cont.)

Disadvantages of the corporate form (cont.)

• Factors moderating conflict of interest between owners and managers

• • Investors ability to sell shares in a corporation, causing the share price to fall

• • Dismissal from the board at AGM by shareholders

• • Threat of takeover and loss of employment

• • Use of performance incentives, such as share options

• • More rigorous corporate governance

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 10. Chapter Organisation

4.1 The Nature of a Corporation

4.2 The Stock Exchange

4.3 Summary

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 11. 4.2 The Stock Exchange (SX)

Primary market role

Secondary market role

Derivative market role

Interest rate market role

Trading and settlement roles

Information role

Regulatory role

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 12. Primary market role

The SX f acilitates the efficient and orderly sale of newfinancial securities

• New floats/initial public offerings (IPOs)

• • Initial listing of a corporation on the SX

• Rights issue

• • Issue of additional shares to existing shareholders on a pro-rata basis

• Placements

• • Issue of new shares to selected institutional investors

• Dividend reinvestment plans

• • Reinvestment of dividends into corporation for additional shares

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 13. Primary market role (cont.) Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 14. Primary market role (cont.) Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 15. Secondary market role

The SX f acilitates trading in existing shares

• No new funds are raised by the issuing company

• An active, liquid, well-organised secondary market increases the appeal of buying new shares in the primary market

• Market liquidity

• • Ratio of share turnover to market capitalisation

• Market turnover

• • Number of shares on issue x current share price

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 16. Secondary market role (cont.) Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 17. Derivative market role

TheSX provide s a m arket for tradingequity -related derivative products

• A derivative is a financial security that derives its price from an underlying commodity (e.g. gold) or financial instrument (e.g. Fosters shares)

• Derivative products are described as

• • Exchange-traded contracts

• • • Standardised financial contracts traded on a formal exchange

• • Over-the-counter contracts

• • • Non-standardised contracts negotiated between writer and buyer

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 18. Derivative market role (cont.)

TheSX provide s a m arket for tradingequity -related derivative products (cont.)

• Derivatives serve asa

• • R isk management tool(hedge)

• • S peculative instrument

• Derivatives traded onaSX include

• • Options

• • Warrants

• • Futures contracts

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 19. Interest rate market role

The listing, quotation and trading of typically longer-term debt instruments on a SX

• Straight corporate bonds

• Floating rate notes (FRNs)

• Convertible notes

• Preference shares

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 20. Interest rate market role (cont.)

This role adds value to a debt issue due to

• Transparency

• • Information about price, yield, maturity, credit rating of debt instruments

• Ease of entry

• • Electronic trading system facilitates buy and sell orders at minimum cost and time delay at current market prices

• Liquidity

• • Quotation on a SX provides access to a wider market

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 21. Trading and settlement roles

The ASX uses CLICK XT, an integrated computer-based trading system to trade all listed securities

• Clients orders are executed via computer from the brokers office

• Orders are executed in orderof timerecei ved and the buy/sell price

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 22. Trading and settlement roles (cont.)

The ASX usesCHESS (Clearing House Electronic Sub - register System)

• Facilitates the settlement of transactions conducted through CLICK XT

• S ettlementof t ransactions within 3 days(T + 3)

• Provides an electronic sub-register that records the ownership of listed securities

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 23. Trading and settlement roles (cont.)

CDI( CHESS Depositary Interest)

• Electronic depositary receipts issued by the ASX representing uncertificated (scriptless) securities

• • CUFS (CHESS Unit Foreign Securities) for equity securities

• • DI (Depositary Interest) for debt and bearer securities

• Overcomes problems of countries not recognisinguncertificatedholdings or the electronic transfer of legal title

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 24. Information role

Investor confidence in the Australian Stock Exchange (ASX) relies on informational efficiency

• The current share prices should reflect all information available in the market

The ASX has a critical role in facilitating the flow of information to the market

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 25. Information role (cont.)

Listing rules are SX rules with which a listed entity must comply

Examples of information disclosures required by ASX listing rules

• A change in a companys financial forecasts

• Appointment of a liquidator

• Declaration of a dividend

• Notice of a takeover bid

• Disclosure of directors interests

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 26. Regulatory role

The aim of r egulationis to ensure market participants have confidence in the integrity of market operations

Two main supervisors in Australia

• Australian Stock Exchange ( ASX )

• Australian Securities and Investment Commission( ASIC )

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 27. Regulatory role (cont.)

ASX

• Ensures listed companies meet specified limited levels of performance and standards of information disclosureso investors can make informed decisions

• • Continuous disclosure

• Prescribes appropriate behaviour of broker participants on the exchange

• • Sanctions include discipline, penalties, loss of licence

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 28. Regulatory role (cont.)

ASX(cont.)

• Electronic surveillance systems to monitor trading behaviour of market participants

• • Detect tradesthat fall outside certain limits

• • C ross-references all trades against information on the relevant company, directors and associated parties

• The National Guarantee Fund (NFG) compensates investors in the event of failure or misconduct by a stockbroker

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 29. Regulatory role (cont.)

ASIC

• Responsible for the supervision of Corporations Law and markets in Australia ( Corporations Act 2001(Cwlth))

• Responsible for market integrity and consumer protection across the financial system , covering investment, insurance and superannuation products

• Supervises the ASX, addressing the potential conflict of interests as a publicly listed corporation

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 30. Chapter Organisation

4.1 The Nature of a Corporation

4.2 The Stock Exchange

4.3Summary

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4- 31. 4.3 Summary

Corporate form of organisation has advantages (fundraising and management) and disadvantage of separation of ownership and control

The SX has a number of market roles

• Primary and secondary

• Derivative

• Interest rate

• Trading and settlement

• Information

• Regulatory

ASX monitors market participants and ASIC supervises Corporations Law and market integrity

Copyright2007 McGraw-Hill Australia Pty LtdPPTs t/aMcGraths Financial Institutions, Instruments and Markets 5eby Viney Slides prepared by Anthony Stanger 4-