Topic 2.

Capital market instruments

 Topic 2. Capital market’ financial
instruments

2.2. Debt financial instruments and their evaluation

2.2.1. Debt financial instruments on the capital market
2.2.2. Evaluation of debt securities.
2.3. The issuance of equities and bonds

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 2.2.1. Debt financial instruments on the
capital market
Bonds are medium and long-term debt obligations issued by corporations and
government units.
Proceeds from a bond issue are used to raise funds to support long-term
operations of the issuer (e.g., for capital expenditure projects).
In return for the investor’s funds, bond issuers promise to pay (to return) a
specified amount in the future on the maturity of the bond (the face value) plus
periodically (usually once or twice per year) to pay coupon interest on the
borrowed funds.
If the terms of the repayment are not met by the bond issuer, the bond holder
(investor) has a claim on the assets of the bond issuer.
Bond markets are markets in which bonds are issued and traded.
They are used to assist in the transfer of funds from individuals, corporations
and government units with excess funds to financial and non-financial
corporations and government bodies in need of long-term debt funding.
Bond markets are traditionally classified into three types: Treasury notes
and bonds; municipal bonds, and corporate bonds. Government units and
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financial corporations are the major bond security issuers.
 2.2.1. Debt financial instruments on the
capital market
The main bonds characteristics are:
• Face value (par value, nominal or maturity value) is the principal amount of a
debt that is repaid.
• Maturity is the time period until the bonds face value is repaid.
• Coupon rate is a rate of interest that is paid periodically to the investor; it
is
usually calculated as a percentage of the bonds face value.
• Bond discount is the difference between the face value and the selling price
for zero coupon bonds.
• Yield to maturity is rate of return earned on a bond held until maturity.
• Bond risks are risks, that issuers won’t be able to make interest or principal
payments in term.
• Indenture is document which details the legal obligation of the corporation to
the bonds holders and lists all the terms and conditions of the bond.
• Only consols (perpetual bonds), are government bonds didn’t have maturity
date.
• Debt ratings, assigned by the Moody’s, Standard & Poor’s, Fitch are important
indicators of bond’s default risk
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 2.2.1. Debt financial instruments on the
capital market
According to the Law on joint-stock companies, in the Republic of Moldova
bond is a “financial certificate of loan which certifies that the bondholder is
entitled to receive from the issuer its nominal value or nominal value and afferent
interest in the amount and within the deadline set by the decision on bond issue”.
Bondholders act as company creditors and have a pre-emptive right versus the
shareholders.
The company is entitled to place only insured bonds.
The nominal value of all placed bonds of the company shall not exceed the
amount of its statutory capital.

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 2.2.1. Debt financial instruments on the
capital market
In international practice, debt financial instruments can be classified according
to the following criteria:
1) According to the way of presentation there are:
- bonds in the form of paper document;
- bonds registered in electronic form or book-entry bonds.
2) According to the bondholder’s identification:
- registered bonds: bonds registered on the name of the exact owner;
- bearer bonds: securities which confer ownership and are payable to whomever
holds the physical certificate, with no register of owners.

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 2.2.1. Debt financial instruments on the
capital market
3) According to the methods of coupon rate calculation:
- conventional bonds (plain vanilla bonds) pay a fixed rate of interest and
coupon
payment that does not change during the bond’s life;
- floating rate bonds (floating rate notes, FRNs) - notes which coupon rate
includes
two parts: a reference rate, like London Interbank Offered Rate (LIBOR- is the
benchmark interest rate at which major global banks lend to one another) and
spread,
typically constant and expresses in basis points;
- participating bonds are debt obligation which entitles the holder to receive a
guaranteed fixed rate plus extra coupon payments in dependence of the corporation's
net profit;
- accrual bonds are fixed-interest bonds that are issued at their face value and
repaid at the end of the maturity period together with the accrued interest;
- zero coupon bonds are debt securities that don't imply coupon payments, but are
traded at discount, rendering profit at maturity when the bonds are redeemed for
their
full face value;
- inflation-linked bonds or index-linked bonds are fixed-income securities in
which
the interest and nominal value are periodically adjusted for inflation or specified
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indexes.
 2.2.1. Debt financial instruments on the
capital market
4. From the point of view of the country of origin:
- domestic bonds: bonds issued locally by a domestic company, usually in local
currency;
- foreign bonds: securities issued on local markets by a foreign borrower, usually
denominated in local currency;
- Eurobonds: are international bonds aimed at international investors and typically
denominated in a currency other than that of the country in which they are issued.
A Eurobond is a debt instrument that's denominated in a currency other than
the
home currency of the country or market in which it is issued. Eurobonds are
frequently
grouped together by the currency in which they are denominated, such as eurodollar.
Since
Eurobonds are issued in an external currency, they're often called external bonds.
Eurobonds are important because they help organizations raise capital while having
the
flexibility to issue them in another currency.
5. According to the level of securitization:
- secured bonds, which represent debt collateralized by assets or another income
stream;
- unsecured bonds, are securities only secured by the bond issuer's good credit
standing.
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 2.2.1. Debt financial instruments on the
capital market
6) According to the embedded contingency provisions:
- convertible bonds is a type of debt that give the bondholders the right to
exchange their bonds for a specified amount of common shares. Convertible
bonds facilitate investors financial protection and give them opportunity to
become shareholders if the issuer company will succeed;
- callable (redeemable) bonds give the issuer the right to buy back the bonds
before the maturity at a defined call price. To compensate investor’s losses, the
call price usually exceeds the face value;
- putable bonds are bonds that give the bondholders right to demand early
repayment of the principal at a fixed price, allowing in changed market reinvest
capital in more favourable assets.

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 2.2.1. Debt financial instruments on the
capital market
7. According to the type of issuer:
- corporate bonds, are bonds issued by the non-financial and financial
companies in order to raise financing for a variety of reasons. Corporate bonds are
sometimes listed and traded on exchanges and Electronic Communication
Networks (ECNs). However, the vast majority of trading volume happens in
decentralized, dealer-based, over-the-counter markets;
- municipal bonds: negotiable bonds, issued by territorial administrative bodies
in
order to finance regional or local socio-economic objectives;
- Government bonds: are state securities represented credit instruments issued by
central public authorities in order to attract resources for covering the budgetary
deficit, infrastructure investments, Treasury needs etc.;
- supranational bonds issued by the international financial institutions, such as
World Bank, European Investment Bank etc.

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 2.2.1. Debt financial instruments on the
capital market
Government securities are government debt issuances used to fund daily
operations,
and special infrastructure and military projects.
They guarantee the full repayment of invested principal at the maturity of the
security
and often pay periodic coupon or interest payments.
Government securities are considered to be risk-free as they have the backing of
the
government that issued them.
• Government securities are usually issued for two different reasons. The primary
reason that most government securities are issued is to raise funds for
government
expenditures. The federal government issues treasury securities to cover
shortfalls
(deficits) in its annual budget. Additionally, cities will often issue bonds
for
construction of schools, libraries, stadiums, and other public infrastructure
programs.
• A central bank of a country, will sell debt securities for another reason: to
control the
supply of money in an economy. If the central bank wants to slow the growth
rate of
money in the economy, it will sell government securities. This means that it is
sucking
up dollars from the economy and replacing them with government securities,
which
results in a slowing of the rate of growth in the money supply. Slowing the
rate of
money's growth in an economy will help keep inflation under control.

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 2.2.1. Debt financial instruments on the
capital market
Examples of Government Securities:
Savings Bonds. Savings bonds offer fixed interest rates over the term of the
product.
Should an investor hold a savings bond until its maturity they receive the face
value of
the bond plus any accrued interest based on the fixed interest rate. Once
purchased, a
savings bond cannot be redeemed for the first 12 months it is held. Also, redeeming
a
bond within the first five years means the owner will forfeit the months of accrued
interest.
T-Bills. Treasury bills (T-Bills) have typical maturities of 4, 8, 13, 26, and 52
weeks.
These short-term government securities pay a higher interest rate return as the
maturity
terms lengthen.
Treasury Notes. Treasury notes (T-Notes) have two, three, five, or 10-year
maturities
making them intermediate-term bonds. These notes pay a fixed-rate coupon or
interest
payment semiannually and will usually have $1,000 face values. Two and three-year
notes have $5,000 face values.
Treasury Bonds. Treasury bonds (T-Bonds) have maturities of between 10 and 30
years. These investments have $1,000 face values and pay semiannual interest
returns.

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The government uses these bonds to fund deficits in the budget.
 2.2.1. Debt financial instruments on the
capital market
The National Bank of Moldova (NBM), acting as the fiscal agent of the Ministry
of
Finance, is in charge of the management of primary and interbank secondary market
of state
securities (SS) issued in book-entry form on the domestic market.
In this capacity, the NBM is authorised to organise and to conduct the activity
of
selling, recording and redemption of SS issued by the Ministry of Finance of the
Republic
of Moldova.
The NBM carries out these attributions in compliance with the Fiscal Agent
Agreement
concluded between the Ministry of Finance of the Republic of Moldova and the
National
Bank of Moldova.
In collaboration with the Ministry of Finance, the NBM has set and applies the
regulation
of activities and operations on the primary market of SS and has worked out a
number of
measures aimed at creating all relevant conditions for the development of the SS
market in a
transparent and regulated issuance environment and the maintenance of an
appropriate level
of liquidity.
Two types of SS are issued in the internal market of Moldova:
• Treasury Bills – state securities with different circulation terms up to one
year;
• Government Bonds – state securities with the maturity over one year.

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2.2.1. Debt financial instruments on the
capital market

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 2.2.2. Evaluation of debt securities

Within the analysis of debt securities, a whole set of characteristics is

applied,
but the most frequently used indicators in the bonds evaluation are indicators for
estimation of the bonds value and bonds yields.
Current value of bonds, as well as of shares, is the present value (PV) of
expected future cash flows (FV), which comprise discounted expected coupon
payments until the maturity date and the final payment of face value (formula
12.4.).
The discount rate for bonds valuation can comprise: real risk-free rate,
expected inflation and premium that reflects bond-specific characteristics such as
default risk, call risk etc.
n
Coupon payments Face value
Bond value = 
t 1 (1  r ) t

(1  r ) n
(12.5.),

where: n – number of periods;

r– discount rate

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 2.2.2. Evaluation of debt securities

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 2.2.2. Evaluation of debt securities

Problem 1:
What is value of bond with face value 200 m.u., 8%
coupon rate and 2 years maturity, if discount rate is 6%?

Problem 2:
A Microgates Industries company’s zero-coupon bond’s
face value is 500 m.u., it’s maturity is 3 years, the discount
rate is 7%. What is value of this security?

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2.2.3. Estimation of debt securities yield

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2.2.3. Estimation of debt securities yield

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2.2.3. Estimation of debt securities yield

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 2.2.3. Estimation of debt securities yield

Yield on a Zero-Coupon Bond

Given the current price (or issue price (present value)) of a zero-coupon
bond (denoted as P), its face value (also called maturity value) of FV and
total number of n coupon payments, we can find out its yield to maturity
using the following equation:

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 Evaluation of debt securities and shares
yield
Problem 4. Calculate the total yield on the shares if for the first year the
dividend
was 50 monetary units, the second - 55 monetary units, for the third and fourth -
45
monetary units.
The share was purchased at the price of 150 monetary units, sold after 4 years for
the price of – 160 monetary units

Problem 5. Calculate the final yield on the shares, if during the ownership period,
the dividend payments amounted 4 monetary units, the share was bought at the rate
of 92 (points), the estimated selling price in 70 days will be 101 points, face
value
of shares – 200 monetary units.

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 2.3. The issuance of equities and bonds

The issuance (issue) of securities is viewed both as a whole number of

securities
of an issuer, which belong to a class and have the same initial and final placement
term, and as all actions (operations) established by law and undertaken by the
issuer for securities placement .
Issuance of securities is advantageous for issuer because it does not require,
in a specified period, the repayment of money invested by shareholders and / or
interest payments for bank loans.
The main purpose of issuance of the primary securities consists of transforming
of the available and dispersed financial resources from an economy into forward
capital, accessible to issuers, designed for investment or transformation into debt
capital.

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 2.3. The issuance of equities and bonds
The issuance of securities can be classified according to the following criteria :
- the moment of issue:
• issuance upon the foundation of the company - the first issue (only of the
shares) performed by joint stock company. Shares issued upon the company's
foundation are entirely placed among the founders, by closed issuance.
• additional issue - all issues (both of shares and of bonds) made for capital
increase during the joint stock company’ activity.

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 2.3. The issuance of equities and bonds
- type of subscription:
• closed issuance (without public issuance) - involves the securities’ placing
within a limited circle of investors, whose list is approved by the issuer’s
statute.
The closed issuance of shares is performed for the following purposes:
- Establishment of company;
- Capital increase (through additional issuance of shares);
- Restructuring of securities issuance (as a result of increase in nominal value);
- Converting, splitting or consolidation of (previously placed) securities.
• open issuance (public issuance or public offer ) involves the placement of
securities among the potential investors, the drawing of the public offering
prospectus and the ensuring of free and equal access to information that prospectus
contains.
The securities’ issue through public offer is made at the shares’ placement of
additional stock for an indeterminate number of persons, in order to increase
capital
and place bonds.
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 2.3. The issuance of equities and bonds
- type of securities’ restructuring from issuances previously recorded:
• issuance at capital modification by the shares’ denomination – the
restructure of
previous issuance by reducing or increasing the nominal value of shares;
• issuance at introduction of amendments concerning to the rights conferred by
shares
- the restructure of previously issuance by placing of shares with other
properties, for
example, with new rights;
• issuance at the consolidation of shares - carried by replacement of all
securities,
from a class, with a smaller number of securities, by the proportional reduction in
the
number of securities of all owners. At shares consolidation, their nominal value is
increased proportionately;
• issuance at shares’ split (division) or conversion - the restructure of
previously
issuance of issuer’ securities of certain class, carried by replacement of all
outstanding
securities from a class, with a greater number of securities, by the proportional
increase
in the number of securities of all owners. At shares split, their nominal value is
reduced
proportionately;
• issuance at the reorganization of the company and other cases provided by law -
the
restructuring of the previously issuance of securities in cases of merger,
acquisition,
takeover of companies, etc.
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 2.3. The issuance of equities and bonds
There are three ways to launch the issued securities on the market:
• Traditional underwriting or firm commitment. In a firm commitment,
an underwriter (intermediar) acts as a dealer and assumes responsibility for
any unsold
inventory (security). A firm commitment is where the investment banking firm
(acts as
underwriter, intermediar) agrees to buys the securities from the issuer at a
set price.
For taking on this risk through a firm commitment, the intermediar profits from
a
negotiated spread between the purchase price from the issuer and the public
offering
price to the public.
A firm commitment sale method contrasts with the best efforts, where an
underwriter
does not guarantee the full sale of an issue at the issuer's desired price.
• Best efforts. The term best efforts refers to an agreement made by a service
provider to
do whatever it takes to fulfill the requirements of a contract. In finance,
an underwriter makes a best efforts or good faith promise to the issuer to sell
as much
of their securities offering as possible.
• Shelf registration. A shelf offering/ shelf registration is a Securities and
Exchange
Commission (SEC) provision that allows an equity issuer (such as a corporation)
to
register a new issue of securities without having to sell the entire issue at
once.
The issuer can instead sell portions of the issue over a three-year period without
re-

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registering the security or incurring penalties
 2.3. The issuance of equities and bonds

The realization of issuance of primary securities through initial public

offering
(IPO) consists of several stages:
1) choice of consultants and intermediaries;
2) preliminary meeting with leading officers of the intermediary company
and preparing the issue prospectus;
3) recording the conditions of offer to market surveillance authority;
4) diligent taking of commitments by intermediary company;
5) trading of primary securities on informal market ("gray market"),
stabilization and introduction of securities at the stock exchange.

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 2.3. The issuance of equities and bonds
1. The choice of consultants and intermediaries
The first step to enter on the market consist in contracting of the services of
a
consulting and brokerage firms (in our example, an investment bank) to sell
(distribute) the securities.
Investment banks have a central role in the development/drafting/elaboration of
the offering prospectus and can provide assistance in selecting of other involved
firms of professional services.
2. Preliminary meeting with most important employees of the intermediary
company/firm/corporation and preparing the issue prospectus.
The "official" start of the process is given by convocation a meeting with leading
employees of the company, which will remain the "working group".
The preliminary meeting is the first step in elaboration of the issue prospectus.
This is a document that contain the all necessary information as investors,
knowingly, can make rational decisions.

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 2.3. The issuance of equities and bonds
3. Recording of offer’s conditions to market supervisory authority.
Once the preliminary prospectus is reviewed and accepted by all members of
working group, it will be submitted, together with other documents (for example, a
statement from auditors) according to law, to the supervisory authority on the
capital market.
The Market Authority only accepts preliminary prospectus and confirms that the
all legal requirements are satisfied.
The authority for market supervisory doesn’t states that this JSC is well
managed, it will be successful or that the shares will increase in value.
Conversely, rejection of prospectus, as it is submitted, does not mean a
disapproval of the issuer or of the shares. It's just a sign that from a particular
reason, all information required by law weren’t provided.
Once the documentation is accepted, the preliminary prospectus (red herring)
are cancelled, and its amended form - final prospectus - can be used to request the
orders from public investors.

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 2.3. The issuance of equities and bonds

4. Diligent assumption of commitments by the intermediary firm/company.

The investment bank will take a very careful investigation of all important
aspects of the deal during the period between the preliminary meeting and
submission to market authority the registration application, accomplished by the
preliminary prospectus (approx. 50-60 days).
5. The trading of primary securities on informal market ("gray market"),
stabilization and introduction of the securities at the stock exchange.
It often creates an informal market that anticipates the transactions themselves
because the time elapsed between the publication of the preliminary prospectus and
the start of official trading is high.

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 2.3. The issuance of equities and bonds

Consultants and intermediaries responsibilities during IPO stages:

In the initial stage of the primary issue of shares, the investment bank grants
the
advises necessary to determine the opportunity of launch the issuance (the
situation/position of issuer, market and sector) and analyze how the shares will be
distributed.
For launching and selling securities on the capital market, investment banks are
undergoing three stages:
• initiation (preparing) of the securities’ issuance (origination);
• underwriting the issuance of securities (guaranteeing);
• securities sales and distribution (sales and distribution).

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 2.3. The issuance of equities and bonds

When is initiate a new issuance, the investment bank can advise the issuer
regarding
the project feasibility and determine the amount of money what shall be attracted.
The investment bank decide what type of financing is required/necessary (as
shares or
bonds), defines the characteristics of securities what will be issued (maturity,
coupon
rate, dividends etc.) and propose the date at which the sale to be made, so that,
the
issuer benefit from lowest financing cost.
Once the issuances’ decision is taken, the investment bank helps the issuer to
prepare the necessary documents.
The most important document in the process of shares’ issuance, submitted to the
supervisory authority of the capital market is the registration statement.
The statement contains detailed information about the financial situation of the
issuer, sector/area/field of activity, experience and structure of management, the
project
for which the funds will be used and characteristics of the securities what will be
issued.
After approval by the supervisory authority of the capital market, a part of the
registration statement, called prospectus, is multiplied and distributed to all
potential
investors.
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 2.3. The issuance of equities and bonds

Subscription (taking risks) is the process by which investment bank

undertakes/is committed to purchase new securities at a certain price.
Risk exists between the moment at which the investment bank buys securities
from the issuer and when they are sold to the public.
The risk consist in that the securities can be sold at a lower price than that
the
bank offered for them.
The risk of unexpected changes in price due to changes in market conditions can,
sometimes, be substantial.

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 2.3. The issuance of equities and bonds

Sale and distribution of securities.

Once the investment bank bought the securities, it must resell them to investors.
The biggest problem of the banking syndicate (organized similarly to those that
are activating on debt securities market) is to as soon sell the securities at the
proposed price.
From this sale, investment banks gain the difference (underwriting spreads)
between the paid price for these securities and the price at which the securities
are
resold to the public.
If the securities aren’t sold in a few days, the selling syndicate is dissolved
and
its members sell securities at prices they can get.
If a negotiated offer, practiced/used in most cases, the distribution of
securities
may be made by various methods: guaranteed placement method, best execution
method, the method "all or none" .

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End