Capital Markets: Basic Terms

A financial market consists of primary and secondary markets. A primary market is where new securities are initially placed and distributed. A secondary market is where securities are bought and sold after initial distribution.

The most tradable financial instruments on the financial markets are shares and bonds.

Shares are certificates of ownership that represent a shareholder's share in a joint stock company's equity. Equity is defined as capital permanently used in business which does not have to be paid out unless the enterprise is in liquidation. The term is often used to mean the shareholders' ownership.

Some types of shares are: common, preferred, and employee shares.

Common shares confer voting rights at the Stockholders' Annual General Meeting (AGM) and a dividend, if the company makes a profit and the AGM decides a dividend is to be paid.

 Preferred shares do not confer voting rights at the AGM, but have priority when it comes to dividend payments. Companies typically issue preferred shares when they want additional financing, but not new owners able to take part in decision-making. We distinguish:

• Cumulative shares, which confer the right to accumulate unpaid dividends, as well as priority over common shareholders with regard to dividend payments;
• Participating shares, which grant the right to certain priority dividends, as well as common shareholder dividends; and
• Participating-cumulative shares, which combines the rights of both types.

Bonds are typically long-term debtor securities, with a maturity of at least a year, bought on the market by investors looking for income in the form of interest. They are sold by issuers looking for financing. Issuers may be the state (state bonds), cities (municipal bonds), or enterprises (corporate bonds). Bonds are extremely attractive securities, since they form the basis for acquiring interest at known time intervals, while the resources invested in the purchase may, depending on the type of bond, be returned on maturity, or in installments together with the interest.

Capital markets also deal in other forms of security, including options, futures, forwards, warranties, etc.

An Option is a contract that grants the holder the right, without obligation, to buy (call option) or sell (put option) a specified amount of financial instruments at a pre-negotiated price during a defined period of time. We distinguish the purchase or sale of financial instruments on maturity (European option) from sale both before and on maturity (American option).

Forwards and futures are sales contracts at a future, specified date and a given price. They are typically used to protect from the market risk of price or exchange rate instability.

All these instruments are traded on capital markets and are therefore called: capital market instruments.

The total market value of securities is their market capitalization. It is the product of a security's market price and the total number of securities.

Each security has a nominal and a market value. The nominal (par) value is the value a security is issued at, i.e. the value written on it and specified at the time of issue. The security's real value is, however, usually different from its nominal value. The market value is the value as determined on the financial market.

If a share's market value is higher than its nominal value, the investor has achieved a positive financial result, known as "aggio" in finance. The opposite case is termed "disaggio."

Besides capital income, people invest in securities to secure the dividend obtainable for a given security. The dividend is that part of a company's net profit that is distributed to shareholders. We distinguish dividends paid in money from dividends in shares (where additional shares with a specific market value are apportioned instead of money payments).

When the dividend's value is expressed as a percentage, it is called the dividend yield and represents the ratio of the current annual dividend per share and the current market price. It is used as a measure of the investor's current yield based on dividend. Large companies tend to have higher dividend yield, while smaller ones, focused on accelerated development, tend to have a lower yield.

Another important measure of the benefit derived from investment in securities is Earnings Per Share (EPS), which is an indicator based on the ratio of a joint-stock company's net profit minus dividends to preferred shares and the total number of common shares.

Finally, two specific options for issuing securities should be mentioned: underwriting and IPO (initial public offering). The first is underwriting - guaranteed purchase whereby an underwriter agrees to purchase the securities, if no one else does, and so contracts to purchase unsold securities issued on the primary market at an agreed price. Another method is to buy a guarantee of all or part of the securities issue and then sell it himself. An IPO is the first public offer of shares of all categories of enterprises.