Paper outline
Introduction
Stock exchange purpose
Stock exchange securities
Features of the securities
Direct Cost in buying and selling securities
Securities rating
Making an investment decision in securities
Security to be purchased
Conclusion
Reference List
Stock Exchanges
Introduction
Stock exchange can be defined as a market agent that facilitates the exchange of different types of financial instruments between companies and investors. In most economies, stock exchanges are established to facilitate the exchange of shares between companies and investors. Stock exchange can assume a central position from which securities can be traded. It can also be virtual to be accessed from anywhere without physical travel to a central location. In many countries,stock exchanges operate under a single umbrella that is regulated by the capital markets authorities.
Stock exchange purpose
Stock exchange is a very vital component of in any given economy. Stock exchange’s importance relates to investment since its focus is mainly in the investment of securities. Primarily, stock exchanges enable the purchase and sale of stocks in the capital market (Melicher, & Norton, 2011). It offers a central place from where companies can reach out to potential buyers. This reduces costs that companies would have otherwise incurred locating investors. Stock exchange also contributes towards economic growth of countries (Melicher, & Norton, 2011). The study by Atlanta Federal Reserve Bank revealed that stock exchanges play an important role of improving the allocation and distribution of resource thereby increasing productivity. The increased productivity within the economy results to economic growth and development (Baier, Dwayer, & Tamura, 2003).
Stock exchange also facilitates the accumulation of capital for companies. Capital-intensive firms use stock exchange to raise capital during their start-up (Melicher, & Norton, 2011). Furthermore, companies issue their stocks in the stock exchange, and through purchase by the investors, they raise capital to undertake various projects. International corporations also use stock exchange to provide capital to small national companies in order to acquire equity share in them. This enables small companies to acquire capital that could have been raised (Melicher, & Norton, 2011).
Stock exchange also plays a crucial role during global financial crisis and economic like the one witnessed from the year 2007 to 2010. During such times, many emerging markets and developed nations used stock exchange to save banks that were worst hit by the crisis (Melicher, & Norton, 2011). The stock exchanges facilitated equity financing by government of the banks and companies that suffered solvency and liquidity problem. Additionally, a stock exchange facilitates the mobilization of investment savings for investors. It enables investors to invest the money that they would have deposited in bank accounts or consumed. If the investors buy these stocks over a long time, then considerable investment will have been made as opposed to bank deposits (Melicher, & Norton, 2011).
Stock exchange is also good indicators for forecasting the state of the economy in the future. It acts as a source of information to be used by economy experts and governments department to predict economic growth trends. Stock exchange statistics on share prices and values of other instruments traded in the capital market can be a sign of economic boom, recession, or financial crisis (Melicher, & Norton, 2011). In addition to the above functions, stock exchange plays a vital role in enhancing good corporate governance of publicly listed companies. Companies are compelled to develop and improve management and efficiency in order to attract investors. Investors access information on company performance from stock exchange or stock agents before making an investment decision. Companies with a good corporate governance and stock performance attract investors. Finally, the governments also use stock exchange to raise capital. Governments issue bonds and other securities to the public through stock exchanges. This is aimed to raise capital that is later used to finance various development projects within the country. The projects usually financed by this capital include road construction, housing, and other infrastructural development projects (Melicher, & Norton, 2011).
Stock exchange securities
There are two categories of securities traded in stock exchanges. These instruments are equities and bonds. Equities are the most popularly traded securities in stock exchanges. Types of equities traded include stocks and shares, bonuses, and rights issues. In most cases, corporate companies and governments offer the bonds (Melicher, & Norton, 2011).
The Australian Securities Exchange (ASX) was established to facilitate the regulation and control of trade of securities in Australia. The ASX provides a market for companies and investors in Australia and the rest of the world seeking to invest in different financial securities. Some of the common instruments offered in the ASX are equities (preference shares and ordinary shares) and convertible bonds. Ordinary shares are the most traded securities in the ASX (Australian Securities Exchange, 2012).
There are over 2000 companies listed in the ASX. These companies are public companies operating in Australia (Australian Securities Exchange, 2012). Panoramic Resources Limited is a public company that trades in ordinary shares on the ASX. The company operates in the mining industry in Australia. The company is engaged in the mining of nickel and gold in Western Australia, Savannah, and Kambalda. It is also engaged in mineral exploration activities in Australia, the United States, Canada and Scandinavian countries. Panoramic Resources Limited is ranked in the top 200 companies by ASX with no bank debt (Panoramic Resources Ltd, 2012). Panoramic Resources Ltd code on the ASX is PAN.
Ramsay Health Care operates in health care industry. The hospital was started in the year 1964 and has developed to become a leading medical health provider in Australia (Ramsay Health Care, 2012). Globally, it operates in France, United Kingdom, and Indonesia. Ramsey Health Care provides quality medical care ranging from surgery to psychiatric care and rehabilitation (Ramsay Health Care, 2012). Ramsay Health Care issues preferential Share in the ASX. The company’s ASX code is RHCPA.
Galaxy Resources Limited issues convertible notes in the ASX. Galaxy Resources Ltd also operates is the mining industry in Australia. Primarily, the company deals with lithium mining and processing to produce spodumene concentrate and tantalum as a by-product (Galaxy Resources Limited, 2012). The company is also involved in lithium mining and processing in Argentina, Canada, and China. Galaxy Resources Ltd ASX code is GXY (Galaxy Resources Limited, 2012).
Features of the securities
Preference shares and convertible notes are categorized as interest rate securities. Interest rate securities are also referred to as hybrid securities. Preference shares have some features that resemble ordinary shares and debentures (Chandra, 2008). Preference shares are characterised with a stable rate of dividends. In this case, the dividend payments to preference shareholders are independent of the company profitability. Preference share does not carry voting rights in the election of company boards. Preference shares also carry a cumulative characteristic. In this case, the companies are required to pay any skipped dividends prior to paying dividends to ordinary shareholders (Chandra, 2008). In most cases, preference share tend not to have maturity dates, and just like ordinary shares, they remain outstanding indefinitely. According to Kieso, Weygandt, and Warfield (2010, p. 782), preference shares are issued by companies as a preference over debt because of a high debt-to-equity ratio. There are different types of preference that can be issued by companies in the stock exchange. According to ASX, these types of preference share include reset preference shares, step up preference shares, and stepped up preference shares.
Convertible note is a financial security that has a fixed rate of interest that can be converted to equity shares at a specified time in future (Australian Securities Exchange, 2012). It is a form of investor loan to companies and carries definitive maturity date and interest rate. Convertible notes have debt features meaning the investor of the notes can hold it until maturity where he or she can collect the principal amount plus interest (Jarnagin, 2008). Furthermore, the investor can choose to convert the note to common equities in the company. The rate of conversion is usually determined at the time of issue of the convertible notes (Jarnagin, 2008).
Companies also issue ordinary shares to raise money to be used by the company. Ordinary shareholders have a residual claim on the company profits and assets. In this case, shareholders are entitled to dividends after the company has paid all expenses related to creditors, government taxes, bondholders, and preference shareholders (Pandey, 1995). Furthermore, ordinary shares carry limited liability. Ordinary shareholders share the residual capital that remain after the company is wound up and the company expenses have been paid to creditors, bondholders, and preference shareholders. Ordinary shares carry voting rights in the election of company boards since ordinary shareholders are principal owners of the company (Pandey, 1995). Finally, ordinary shares carry pre-emptive rights in that the shareholder has a right to be offered shares in proportion to their shareholding in the company before new shares can be offered to public (Pandey, 1995).
Direct Cost in buying and selling securities
There are direct costs that investors and businesses incur when trading in securities. These costs vary from one stock exchange market to another. Stockbrokers are the most common stock exchange intermediaries that a majority of investors use when buying securities (Liaw, 2007). Other intermediaries in the exchange of securities include brokerage houses and advisors. Investors have to pay commission on the services that are offered by brokers when purchasing these securities. The volume of trade determines costs whereby, when the volume of purchase of securities is high, the dealer costs in stock exchanges become low. Bank commissions are also incurred directly by investors who use banks as intermediaries in the selling and buying of securities. Companies use banks as receivers during rights issues and initial public offering (IPO). In this situation, the sellers of the securities incur direct cost in the selling of their securities. There are numerous costs incurred by buyers and sellers. However, commissions are the notable direct costs in the buying and purchase of securities (Liaw, 2007).
Securities rating
There are high chances that investors can lose in events that the companies they have invested in go bankrupt. However, the degree of loss to the investor greatly depends on the security type. The degree of loss to an investor is rated from the highest risk to the minimal risk.
Ordinary shares are the most risky securities that the shareholder can invest in a company. Ordinary shareholders are owners of the company and thus have limited liability tied to the unpaid amount of capital (Pandey, 1995). When the company is bankrupt and is to be closed, ordinary shareholders receive their payments after everyone else with a stake in the company. When a company is wound down due to bankruptcy, creditors, the government, bondholders, and the preference shareholders are paid first before ordinary shareholders. The ordinary shareholders can incur total capital loss in case the available capita after the sale of company assets is only enough to pay the company creditors and preference shareholders (Pandey, 1995). Furthermore, ordinary shareholders are not always guaranteed of dividend payments at the end of the year since it is not certain whether companies are going to make a profit or not (Gomez, 2008).
Preference shares are the second most risk securities. Preference shareholders come in between ordinary shareholders and bondholders. Therefore, the investor may lose his investment in case the available capital upon liquidation of the company is only enough to pay company creditors and bondholders. Additionally, the company may choose to redeem the preference shares at its own option during times of turmoil hence compromising investor interests in the business. On the other hand, convertible notes are less risky as compared to the other two instruments. Convertible notes investor in a company is like a creditor of the company (Gomez, 2008). When a company is wound down, the company is required to pay creditors first before paying other investors such as the preference shareholders and common stockholders. The only time the investor can lose his investment in convertible notes is when, at liquidation, the investor has already converted his shares to common equity (Gomez, 2008).
Making an investment decision in securities
An investor need to consider various factors when choosing where to invest. According to Klosowski (1999), a number of factors should be considered before deciding where to invest. Firstly, the investor needs to determine the safety of investing of a certain instrument by analysing the market, interest rate, and financial risks associated with the security. Furthermore, investors should determine the rate of return on investment for every security. For instance, investment returns like dividends, interest rates, and security appreciation need to be determined (Klosowski, 1999). Thirdly, the marketability of the instrument should be assessed to determine availability of market in which one can sell his or her investment in case it is necessary to do so. An investor needs to analyse the volatility of the securities market to determine whether to invest in shares or interest rates securities. Lastly, the tax implication for any instrument should be evaluated to check the impact on the ultimate yield from the investment (Klosowski, 1999).
Security to be purchased
With 5000 Australian dollars, convertible notes would be purchased. With all risk factors considered, the convertible notes holders are not bound to lose their investment in a company. Investors in convertible notes are company creditors, and in case of bankruptcy, they are not affected. On the other hand, preference shareholders have fixed rates of return, but in case the company fails to meet its credit obligation, shareholders can lose their investment. Ordinary shares purchase is a risky investment, hence less attractive.
Conclusion
There are many financial securities that an investor can to buys. Before any decision is made about which security to purchase, investors should first analyse the pros and cons of every instrument. The essence of all these is to select a financial security that guarantee return on investment and the one that is less risky.
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