MONASH

BUSINESS
SCHOOL

BFC5926
Financial Institutions and Markets

Seminar 7:
Equity Markets

Reading list: Topic 6

Learning objectives
• Discuss the role and operations of the stock
exchange
• Identify the different types of equity securities
and their alternatives
• Explain the different capital raising techniques
• Contrast the different share indices

2
Lecture outline
1. Role & development of the stock exchange
2. Stock trading techniques
3. Equity raisings
4. Share indices

3
Role & development
of the
stock exchange

4
Role of the stock exchange
• Organised market place for the primary and
secondary trading of securities:
– Primary trading (new shares via initial public offerings
(IPOs) or seasoned equity offerings (SEOs)).
– Secondary trading (existing shares - the bulk of the
business)
• Monitoring the behaviour of its listed
companies as well as the brokers that conduct
the trading.

5
Stock exchange & the economy
Stock exchanges:
– Assist companies in raising capital (primary market)
– Provide liquidity for listed securities (secondary
market)
– Encourage savings mobilisation(Flow of Fund)
– Serve as pricing mechanism
– Enhance corporate governance
– Improve market practice & settlement(Efficiency)
– Act as a barometer for the economy

6
Stock exchange history

• In Latin based languages, the word for stock

exchange is “bourse" - from “bursa” - meaning a
bag or purse. A purse was sometimes displayed to
signal where merchants met.
• Coffee shops became the trading venue in 1600
London and the London Stock Exchange can trace
its origins to one such shop.
• Today, computers can link potential buyers and
sellers, so no specific physical trading location is
required.

7
Australian Securities Exchange
• The Australian Securities Exchange (ASX - formerly the
Australian Stock Exchange) is the main primary and
secondary trading market for equity securities as well
as for debt instruments, options, and other derivatives.
• Futures and option contracts on interest rates, equities,
commodities, and foreign exchange traded on its
subsidiary, the Sydney Futures Exchange.

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Steps in a transaction
• Trading – matching the buy and sells orders
and so execute transactions
• Clearing – updating share ownership records of
the seller and buyer
• Settlement – exchanging money for the shares.
Settlement must be completed in T+2 (the
trade date plus 2 business days.

9
ASX listings and market cap
• At of March 2018, the ASX had 2,282 listed entities of
which 136 were foreign incorporated (mainly New Zealand,
Pacific Islands and some Chinese firms).

• Its market capitalisation (the sum of the shares listed times

their market prices) of AUD 1,847.8 billion (March 2018) is
characterised by a high concentration of financials and
basic material firms.

• The top 20 largest firms together account for more than

half of it. Institutional and foreign ownership is similarly
important at around 40-47 per cent.

10
Top 10 ASX firms - market cap.
Code Company Sector Market Cap Weight(%)
CBA Commonwealth Bank Financials 128,148,000,000 14.41
BHP BHP Group Limited Materials 100,836,000,000 11.34
CSL CSL Limited Health Care 83,869,700,000 9.43
ANZ ANZ Banking Group Limited Financials 70,184,600,000 7.89
NAB National Aust. Bank Financials 66,853,200,000 7.52
MQG Macquarie Group Limited Financials 36,982,600,000 4.16
IAG Insurance Australia Financials 16,177,300,000 1.82
BXB Brambles Limited Industrials 16,174,200,000 1.82
COL Coles Group Consumer Staples 15,660,300,000 1.76
AMC Amcor Limited Materials 15,345,400,000 1.73

Source: https://www.asx20list.com/ (ASX20 List, 1 Jan 2019)

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Stock exchanges by mkt. cap.

Source: Austrade, 2017

12
ASX listing principles
1. Listing & quotation principle: must satisfy minimum
standards of quality, size, operations, disclosure, and
investor interest.
2. Regulatory principles: registered companies must
operate to highest standard of integrity, accountability,
responsibility.
3. Trading & settlement principles: an orderly market place
and settlement certain.
4. Market information principle: advise market in timely
manner on info that may affect value of securities (i.e.
continuous disclosure).

13
ASX listings & governance
• Corporate governance concerns the rights and
responsibilities of the stakeholders in a firm and
how these are shared between them.
• ASX listed companies should follow the ASX
Corporate Governance Council’s Principles of Good
Corporate Governance and Best Practice
Recommendations and its 10 core principles.
• Annual reports must explain the reasons for any
non-compliance (If not, why not)

14
Share ownership
• An ASX survey estimated that 6.48 million
people or 36% of the adult population owned
shares in 2014. This compares to 38% in 2012
and 43% in 2010.
• Some 26% held shares directly while another
10% did so via managed funds.
• These figures do NOT include any indirect
holdings via superannuation funds. Most
Australian are in super funds.

15
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Trading techniques
• Prior to computers, stock exchanges followed a range
of trading practices.
• The simplest is a “call market.” Here an exchange
official read out each listed company’s name and then
trading commenced in its shares. When the trading had
finished, the next name was read and the process
continued until all companies were called. The market
then closed for the day or sometimes had a new call
conducted after lunch.
• Exchanges nowadays use “continuous” trading.

17
Other trading techniques
• Most exchanges use a “pure auction” system where
people indicate their desire to buy or sell and at what
price. Others then respond.
• These orders can be centralised via computer or
organised by specific areas or posts on a physical
trading floor (NYSE and TSE).
• Another alternative is a dealer based system where
dealers make bid and ask quotes to the market (like
NASD OTC).
• A further variation is that of the specialist dealer who
is given the market making responsibility for specific
shares (like NYSE).

18
At market versus limit order
• A sale or purchase order “at market” means you
will pay the ask price or receive the bid price in
terms of the bid-ask spread.
• With a limit order, you set the specific price at
which the shares will be bought or sold.
• A “stop loss” order is a sale exercised as an “at
market” order once the share price drops below a
specified price.
• The “bid-ask spread” size reflects the share’s
market liquidity and level of uncertainty.

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At market versus limit order

Limit @ $60 $60

Market ?

$50

Market ?

Limit @ $40 $40

20
Effective
bid-ask
spreads

Source: ASIC (2017), Equity

market data for the quarter
ending December 2016.

Note: ASX 200 shares are more

liquid than the rest of the
index.

21
High-frequency trading
• High frequency trading (HFT) utilises computer-
generated (algorithmic) programs to trade in a fraction
(micro) of second.
• So to improve reaction speed, such traders place their
computers next to the ASX mainframes. They also
obtain the ASX announcements and Bloomberg/Reuters
data directly and so can trade immediately on this
information.
• Besides any arbitrage opportunities, these programs
look for potential trading patterns and then move to
profit from them. As super computers make decisions in
less than a second, they may front trade against other
traders.

22
Stock lending and shorting
• Long term investors may “lend” their shares to others in
return for fees (0.4 to 1.0% + any dividends).
• The “borrowers” sometimes wish the shares so that they
can support certain corporate actions – vote them.
• Others need the shares to settle trades or other
administrative reasons
• A major portion of these “borrowers” sell these shares
(shorting them). They hope to repay the lender later with
shares purchased at a lower price.

23
Shorting
• Shorting often receives bad press. Some blame it for the
sharp decline in prices during the GFC.
• Shorting does increase share turnover and so liquidity,
but sometimes is thought to involve market
manipulation.
• Greater disclosure of stock lending, shorting and margin
lending as well as trading halts after major short term
declines are under consideration.
• With a long position, the most you can lose is your
investment. With a short position the potential loss is
almost unlimited.

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Shorting P&L Diagram

Short position

Unlimited loss

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Product % short position
SYRAH RESOURCES ORDINARY 21.00947035
DOMINO PIZZA ENTERPR ORDINARY 17.45517497

Short JB HI-FI LIMITED ORDINARY

GALAXY RESOURCES ORDINARY
16.95381817
14.62460865

position
HEALTHSCOPE LIMITED. ORDINARY 14.00555663
VOCUS GROUP LTD ORDINARY 12.09084574
INDEPENDENCE GROUP ORDINARY 11.84754359

report
NANOSONICS LIMITED ORDINARY 11.31825538
MYER HOLDINGS LTD ORDINARY 11.06522174
MAYNE PHARMA LTD ORDINARY 11.039469
RETAIL FOOD GROUP ORDINARY 10.96668805
HT&E LIMITED ORDINARY 10.76458606
OROCOBRE LIMITED ORDINARY 10.25909499
Source: ASIC, 3 April 2018 APN OUTDOOR GRP ORDINARY 10.09582713
NEWS CORP.. B VOTING CDI 9.89657084
The percentage is the number of AUSTRALIAN AGRICULT. ORDINARY 9.81019794
shares shorted divided by the
FLIGHT CENTRE TRAVEL ORDINARY 9.34848299
total number of shares
ARDENT LEISURE GROUP STAPLED SECURITIES 8.70445017
outstanding.
PILBARA MIN LTD ORDINARY 8.68997876
BWX LIMITED ORDINARY 8.42128253
HARVEY NORMAN ORDINARY 8.41311649
QUINTIS LTD ORDINARY 8.38522612
METCASH LIMITED ORDINARY 8.00205679
TASSAL GROUP LIMITED ORDINARY 7.90641782

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Equity raisings
• Listed companies typically do so by issuing:
– Ordinary shares
– Preference shares
• They are issued through
– Initial public offerings
– Rights issues
– Private placements
– Share purchase plans
– Dividend reinvestment plans

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Ordinary shares
Shareholder rights and benefits include:
• Voting and participating at meetings,
• Receiving reports and information,
• Dividends and dividend reinvestment plans,
• Entitlements to further issues of shares,
• Further privatisations and sales of large holdings,
• Share buy-backs.
The USA uses the words stockholders and common
stock rather than shares.

29
A share certificate

Many countries have replaced share certificates with electronic entry

systems, but the USA still uses them.

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Preference shares
• Preference shareholders typically have preference in
the respect to any dividends paid and in any return of
capital when the firm is liquidated.
• Their dividend is normally fixed, like a debt coupon,
at the same rate regardless of the firm’s
performance.
• There is often a set maturity date.
• Preference shareholders generally do not have the
right to vote but can attend the firm’s annual general
meeting (AGM).

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Initial public offering (IPOs)
• An IPO is where a company seeks to raise capital from
the public by selling new shares for listing on the ASX.
• These raisings done via a prospectus registered with
ASIC under the Corporations Act.
• The prospectus explains the terms of its issue as well
as details the issuer’s background, its financials and
management so that investors can decide whether or
not to invest.

32
Financials
versus
others

Source: Reserve Bank of

Australia (2017), Chart
Pack, August

33
IPO & the underwriters
• Most IPO utilise an underwriter (typically a
stockbroker or investment bank) who in
return for a fee effectively guarantee that all
the shares are sold and will typically help
stabilise its trading market initially after the
issue.
• Underwriters will normally offset their risk by
sub-underwriting part of the issue to other
banks, brokers, institution and
superannuation funds(Syndicate).
34
Underwriter risk
• The underwriting process may involve lengthy
delays while the legal aspects and selling
groups are arranged.
• In the meantime, the market conditions might
change significantly.
• To minimise their risks, underwriters typically
include an “out clause” in their contracts which
allow them to “walk away” from the deal
without penalty under certain conditions.

35
Pricing the issue

• The underwriter will help the company

decide on the final price to sell its shares.
• The company would like as high a price as
possible, but the underwriters (given that
they buy any leftovers) would like as low a
price as possible.
• A fair price can also be determined via book-
building.

36
IPO book building
• With book building, the underwriters first talk to
potential institutional investors about their
views on the price and their purchase
intentions (the initial demand for shares).
• From this, as well as the degree of retail investor
interest, the company and underwriter agree on
the final offer price.
• In recent years, the retail price is then set based
on what the institutional investors will pay,
sometimes with a slight discount.

37
IPOs & green shoes
• Many underwriters now add a clause which
allows them to purchase more shares that the
issuer initially agreed should the demand
exceed supply.
• The USA’s Green Shoe Company was the first
to agree to this clause.
• It is known more formally as an “over-
allotment” provision and is important when
substantial over subscriptions are expected.

38
Seasoned equity offerings
• Once a firm has had an IPO and is listed on the
stock exchange, it may need to raise additional
equity capital.
• These issues are known as seasoned equity
offerings or SEOs. SEOs may also be conducted
by existing shareholders and so not involve
new shares.
• They may be held like an IPO with a public
issue or via other means.

39
Rights Offer
• A traditional rights or entitlement issue
involves raising additional equity capital from
the existing shareholders.
• The price is normally set at a discount to the
then market price (10 to 20%) and offered to
shareholders on a pro-rata basis: (e.g. a 1 for
10 rights issue means 10 rights buys 1 share).
• Where the entitlement is renounceable, they
can be resold to other investors. Their value
reflects the difference between the
subscription price and the share’s then market
value.

40
Rights Offer Example
You are a shareholder in S3 Limited. S3 Limited’s shares
are trading in the market at $3.45. S3 Ltd today
announced a rights offer which provides you with a
right to subscribe for one new share at $2.90 for each
three shares that you hold. What is the value of one
right to purchase shares in S3 Ltd’s offer?

R = n*(P-S) / n+1
= (3*(3.45-2.9))/(3+1)
= $0.4125

41
Private placements
• These involve selling new securities to a few institutional
investors (no more than 20), but not necessarily existing
shareholders. This requires only memorandum of
information rather than a full prospectus.
• Investment bankers do this quickly, usually at a fixed price
on a “best efforts” basis.
• The shares are sold generally at slightly less than the market
price (2.5%-7.5%).
• ASX listed firms are limited an annual limit of 15% of the
shares outstanding in any one year

42
Share purchase plans
• Listed companies wishing large private
placements greater than 15% can do so via a
Jumbo placement, but this must be tied to a
share purchase scheme for other shareholders.
• These schemes may allow existing shareholders
to purchase more shares, typically $5,000 to
$15,000, at a similar price.
• They are designed for small shareholders

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Dividend reinvestment plans
• Dividend reinvestment plans (DRPs) allow
shareholders to use their cash dividends to purchase
additional shares in their company.
• These transactions involve no brokerage fees and
sometimes priced at a slight discount (2.5%-5 %)
from the then market price.
• These plans are popular with small investors and
some 15% - 50% dividends are reinvested into new
shares.
• Firms vary their use of DRPs in line with their needs
for capital.
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ASX market indexes
• The All Ordinaries index is one of the ASX key indices
and represents approximately the 500 largest
companies listed on the ASX.
• Market capitalisation is the only eligibility
requirement of constituents, as liquidity is not
considered, with the exception of foreign domiciled
companies.
• Despite some 2,000 listed firms, the All Ordinaries still
covers around 95% of the ASX’s total market
capitalisation.

46
S&P/ASX 200 index by industry

47
Other Major Share Indices
• MSCI AC Asia Pacific (ex Japan)
• Dow Jones Industrial Average
• USA’s S&P 500 Index
• Nasdaq Composite Index
• Chinese indices
– SSE Composite Index (Shanghai SE)
– SZSE Component Index (Shenzhen SE)

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Review of learning objectives

 Discuss the role and operations of the stock

exchange
 Identify the different types of equity securities
and their alternatives
 Explain the different capital raising techniques
 Contrast the different share indices

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