Question for week - 1

Q. "Right issue is just a part of dividend policy of an organization." Do you agree with the statement. Justify.

FIM 4th Year (Unit 1)

Unit 1: Introduction (LH 10)

1.       Financial assets

1.1.    Overview

1.2.    Concept

2.       Debt vs equity instrument

3.       The price of financial assets and risk

4.       Financial assets vs tangible assets

5.       Financial Market

5.1.    Concept

5.2.    Role

5.3.    Classification

5.4.    Market participant

6.       Globalization of financial market

7.       Motivation for foreign market and Euromarkets

8.       Justification for regulation

9.       Forms of regulation

10.   Financial Innovation

10.1.  Categorization of financial innovation

10.2.  Motivation for financial innovation

Financial assets

A financial asset is a tangible liquid asset that derives value because of a contractual claim of what it represents. Stocks, bonds, bank deposits and the like are all examples of financial assets. Unlike land, property, commodities or other tangible physical assets, financial assets do not necessarily have physical worth.

A financial asset is an asset whose value comes from a contractual claim. These assets are frequently traded. Financial assets include the following items:

§  Cash

§  Equity of another entity

§  A contractual right to receive cash or similar from another entity or a potentially favourable exchange of financial assets or liabilities with another entity

§  A contract probably to be settled in the entity's own equity and that is a non-derivative under which the entity may receive a variable amount of its own equity instruments, or a derivative that probably will be settled other than through the exchange of cash or similar for a fixed amount of the entity's equity.

Examples of financial assets are cash, investments in the bonds and equity issued by other entities, receivables, and derivative financial assets.

Debt vs Equity instruments

Debt Instruments

Debt investments tend to be less risky than equity investments but usually offer a lower but more consistent return. They are less volatile than common stocks, with fewer highs and lows than the stock market. The bond and mortgage market historically experiences fewer price changes, for better or worse, than stocks. Also, should a corporation be liquidated, bondholders are paid first. Mortgage investments, like other debt instruments, come with stated interest rates and are backed up by real estate collateral.

Examples of debt instruments are; T-bill, Certificate of deposit, commercial paper, banker’s acceptance, Repo and reverse, other money market instrument

Equity Investments

Fortunes can be made or lost with equity investments. Any stock market can be volatile, with rapid changes in share values. Often, these wide price swings are not based on the solidity of the organization backing them up but by political, social or governmental issues in the home country of the corporation. Equity investments are a classic example of taking on higher risk of loss in return for potentially higher reward.

Example: Common stock, preferred stock.

Common Stock

The type of security that serves as an evidences of proportionate ownership, imparts proportionate voting rights and gives the holder the unlimited proportionate claim on the assets and income of the firm (after the claims of the lender and other obligations are satisfied). The original capital of the common stock is never paid back (redeemable) and is lost if the firm goes to the insolvency. Common stock has a par value, usually Rs 100 in Nepal and generally issued at the par value, however some provision can let firm to sell the common stock at premium as well. For example, NTC in Nepal. In bad year common stock holders may receive very little or no dividends at all. But in good year there is no limit on their dividend, unless government impose some legal constraints. For example, Unilever Nepal distributed 990% dividend on year 2071/72

Preferred Stock

Preferred stock is the source of long term financing under which the investor are entitled to get fixed amount of interest every year. Preferred stock, also called preference share has the hybrid characteristics of equity share and bond. Preference share is discretionary which means failure to pay the interest to the holder of the preference share will not result to default to firm’s obligation or insolvency of the company. From the point of investor preference share is more risker security than bond but less risker security than equity share because

      Firms are more likely to omit preference dividend than to fail to pay interest to bond holder.

      Bond have priority over preference share in case of insolvency.

      Preference share have priority over equity share in case of dividend and insolvency, both.

Types of Preferred Stock

There are following types of preferred stock in practice

aCumulative and Non-Cumulative Preferred Stock: If the dividend of the preferred stock accumulates for next year in the event of firm’s net loss then these type of preferred stock is called cumulative preferred stock.

On the other hand, if the dividend is not carried forward to next year in the event of such loss then these type of preferred stock is called non-cumulative preference share. The dividend of that particular year doesn’t need to be paid further and is lost forever. Investor will have low priority on these type of preferred stock.

bRedeemable and Non-redeemable preferred stock: Preferred stock having maturity date and the firm will buy back those preferred stock at the end of the maturity is called redeemable preferred stock. Some preferred stock might have feature to be redeemed before the maturity date as well. These features are mentioned at the time of issue.

If the preferred stock has the feature that there is no maturity date and the firm will not buy back those issued preferred stock, then it is known as non-redeemable preferred stock. Non-redeemable preferred stock till the existence of the company.

cConvertible and Non-convertible preferred stock: If the preferred stock have the provision of transformation into equity share, after certain period, then these type of preference share is called convertible preferred stock. These terms and conditions are mentioned at the time of issue. For example, the 7% convertible preference share issued by Everest Bank, Nepal.

On the other hand, if the preferred stock does not have such feature to convert into equity share then these type of preferred stock is called non-convertible preferred stock. They remain preferred stock throughout their life span.

Advantage and Dis-advantage of Preferred stock

From the point of shareholder (investor) there are following advantage and dis-advantage of preferred stock.

Advantage
Preferred stock have fixed rate of return, so one can plan according to it for further investment and other purpose.
The preferred stock holders have priority over earning and assets to the common stockholder. They have full claim on the earning and assets of the company.
In some instances, dividend received from preference share can be used for tax exemption purpose. (subject to change)
Chances of higher capital gain with regards to debenture.

Dis-advantages
With regard to common stock, preferred stock have limited return.
The holder doesn’t have voting right and they can neither be director of company nor take part in AGM/SGM of the company. (AGM – Annual General Meeting, SGM – Special General Meeting.
They usually do not have legal right to claim on dividend.
Priority will be given to the bond/debenture holder in the instances of liquidation.

Valuation of Financial Assets

Stock Valuation methods

Stock valuation can be made on two different approaches. The first one is based on the fundamental analysis of the firms based on financial statements, also called intrinsic value. The other one is dictated by how much one investor is willing to pay for a particular share and at what price the other investor is ready to sell. (based on demand and supply) the value determined by this method is called market value. The value from both of this approaches changes over time as the way an investor analyse the financial statement differs and the investor’s confidence may increase or decrease for that particular share.

A stock can be valued on following ways;

         I.            Discounted cash flow analysis: on this method the future cash flow from the company is estimated and is discounted to the present day. The estimated value of the company can be calculated which can be compared to the current market capitalization and it is determined whether it’s worthy to buy or not.

       II.            Dividend discount model: Dividend discount model gives estimation of intrinsic value of a stock. If price doesn’t equal intrinsic value, the rate of return will differ from equilibrium return based on the stock’s risk. The actual return will depend on the rate at which the stock price is predicted to revert to its intrinsic value.

              

Where,  is the expected dividend to be received at the end of the year

 is the expected sales price and ‘k’ is the expected rate of return

There are two further model based on the growth rate of the dividend.

a.       Zero Growth Model: This model assumes that the rate of dividend doesn’t increases and the company pays same amount (percent) of dividend every year, so the growth of the dividend is zero. Here,

Intrinsic value of common stock,

                Where, k is the required rate of return.

b.       Constant growth model: This model assumes that the company’s dividend will increases at a constant rate. On this situation the value of common stock at present can be calculated as;

Dividend in Present year =

Expected dividend in year 1 ( ) =

Expected dividend in year 2 ( ) =

Value of Share,                 

Where, ‘g’ is the growth rate of the dividend and ‘k’ is the required rate of return on equity.

     III.            Earnings per share (EPS): It is the net income available to common shareholder of the company divided by the number of share outstanding.

EPS =   

    IV.            Price earnings ratio: Also known as P/E ratio, which can be calculated by dividing the market price by the earning per share. This ratio indicates that how much money an investor is willing to pay for that firm’s share price when that firm earns one rupees. This ratio is calculated in times.

PE Ratio =

Question: Bentex Corporation just paid dividend of ¥ 5 a share, the dividend is expected to be same for indefinitely. Investors required a 10% rate of return, what is the intrinsic value of common stock today?                                                                                                                                                         (Ans: ¥ 50)

Bond valuation method

The fundamental principle of the bond valuation is that; the bond value is equal to the present value of expected future cash flow. This technique helps to determine the fair value of the bond at that particular time. The basic approach of bond valuation says to calculate the discounted cash flow generated by the bond (or the interest) and the bond price at the maturity. Since, the amount generated by the bond is generally known in advance and the price of the bond is also known in advance, so when all of these figure is discounted with the expected rate of return the actual value of the bond can be found. However, the expected rate of return might be different according to person to person’s risk bearing capacity.

The valuation of bond involves following steps;

·         Estimated the expected cash flow,

·         Determine the appropriate rate of return (k)

·         Calculate the present value of the expected cash flows by using the appropriate rate of return

                                Value of Bond =

OR,                          

Practice Question: BMW Motors’ bond have 10 years remaining of maturity. The bond has £1000 par value and 8% coupon interest rate paid annually. The bond has a yield to maturity of 9%. What is the price of this bond?                                                                                                                                    (Ans: 935.82)

Question: A bond issued at the face value of $1000 yield 8% annual interest. The interest is paid once at the end of the year. The bond has the maturity of 5 years. The expected rate of return of the investor is 6%. What is the price of this bond?

Valuation of zero coupon bond.

Zero coupon bond doesn’t yield any interest hence they are sold at discounted price. The intrinsic value of the bond can be calculated by using following formula;

Value of Bond

Or,         

Question: Calculate the present value of 5 years bond with face value Rs. 1000 and expected rate of return of 8%

Different types of risks associated with financial assets

1. Economic Risk: It is related with the economic cycle and macroeconomic situation of a country, a region or the world. These factors can have significant influence on price of the financial assets. For example: the price drop of crude oil.

2. Inflation risk: Inflation is generally defined as the rate at which prices increase in an economy on a specified time and is closely monitored by central banks. Based on historical analysis, inflation risk, especially high inflation, is particularly relevant in emerging economies. Indeed, high inflation is generally not good for an economy. It typically causes

i) its currency to depreciate (lose its value vs. other currencies) and

ii) reduces the real return of investments and financial instruments (especially bonds) Currency depreciation may cause financial losses to a foreign investor. The value of the investor’s investment will mechanically decrease when converted in his/her domestic currency. Also, high inflation typically causes the real returns of investments to decrease. The real return of a financial instrument can be approximated as its actual (or nominal) return less inflation. While inflation risk impacts most asset classes, it is particularly acute for fixed-rate products.

3. Country risk and transfer risk: Country and transfer risk refer to very specific risks that might happen when investors invest in a foreign country. For example, investors might lend money to a solvent foreign debtor and not be able to collect the proceeds of their investments in their domestic country because of capital controls. In that scenario, investors will be “stuck” with their investments in the foreign country and not be able to transfer them home.

4. Exchange rate risk: Exchange rate risk needs to be factored in whenever an investor holds financial instruments in a foreign currency that is different from his/her domestic currency. Depending on exchange rates movements, an investment in a foreign currency may generate profits, when the foreign currency appreciates, or entail losses, when the foreign currency depreciates.

5. Liquidity risk: Liquidity refers to the ability to buy and sell any type of asset quickly without impacting its market price. Therefore, lack of liquidity may prevent an investor from selling financial instruments at market prices, possibly causing him/her to sell instruments at a substantial discount to fair price. A lack of liquidity due to market supply and demand arises when the supply or the demand for a financial instrument at a certain price is extremely low. Under those circumstances, purchase or sell orders may either not be carried out immediately, and/or only partly (partial execution) and/or at unfavourable conditions.

6. Psychological risk: Psychological risk is related to irrational factors that may affect the overall evolution of asset prices. For example, unsubstantiated rumours may cause important drops in the share price or the bond price of a company, although the economic fundamentals (financials, profitability, growth prospects) of that company are sound.

7. Credit risk: Credit risk occurs each time a party lends money to another party. When investors lend money to an issuer, for example by purchasing debt-related instruments credit-risk refers to the inability of a debtor to honour the payment. This inability is called “default” and investors may lose part or all of the capital they lent.

8. Interest rate: Interest rate risk is the fluctuations in interest rates, whether short-term or long-term rates, may have substantial adverse consequences on the prices of financial instruments.

9. Issuer risk, or clearing and settlement system risk: In case of insolvency of the issuer of financial instruments, or of the clearing and settlement system on which those instruments are negotiated, an investor may lose part or all of his investment.

Financial Market / Security Market (Concept)

Financial market or the security market is the place which facilitate to buy and sell financial assets. It helps to mobilize the fund from saver to users. The financial instruments can be bought and sold through these organised (stock exchange) or over-the-counter (OTC) market. This market may or may not have physical location. The function of financial market is the exchange of one financial assets with another. The major participants of the financial market are the investor and the user of the fund.

In other words, a security market can be defined as a mechanism of bringing the buyer and seller of financial assets together in order to facilitate trading. Financial market plays an important role in mobilizing saving and channelling them into productive investment for economic development of the country. It assists the capital formation and economic growth of the country.

Classification of Financial Market

Financial market can be classified into different categories under different consideration. They are;

         i.            On the basis of economic function,

a.       Primary Market

b.       Secondary Market

       ii.            On the basis of maturity of claim,

a.       Capital Market

b.       Money Market

     iii.            On the basis of physical location,

a.       Organised Market

b.       Over-the-counter (OTC) Market

     iv.            On the basis of trading time

a.       Continuous Market

b.       Call Market

Primary and Secondary Market

Primary market is the market where new securities are issued to the public by the government and corporation. Secondary market is the place (real or virtual) to trade for those securities issued in primary and secondary market. Both stock exchange and over-the-counter (OTC) market are secondary market. In primary market securities are issued for the first time through IPO – Initial Public Offering and FPO – Further Public Offering. Generally, issue managers are appointed to sell those securities. The role of secondary market is to provide liquidity to the security investors. The purchase and sell of security in secondary is done through security broker. There are currently 50 brokerage firm operating in Nepal.

Money Market and Capital Market

Money Market

Money markets are the markets for highly liquid, short term, debt securities. 3/6/9 month and one-year Treasury bill, commercial paper, certificate of deposit, fixed deposit will the tenure of one year or less maturity period, repo and reverse are the example (or instrument) of money market. From those examples it is clear that the instruments of money market have maturity period of less than one year. Money market is used to rise fund for short period like financing current assets, overdraft financing, inventory financing etc.

Capital Market

Capital market are the market for long term securities. The securities which are issued and traded in capital market is called capital market instrument. They have the life span of more than one year. The examples of capital market instrument are; common stock, preferred stock, debenture, bond, treasury note, mutual fund unit, credit union’s saving fund unit etc. capital market consist both primary and secondary market. The instrument of capital market is used to finance long term projects, fixed assets, long term investment etc.

Organised Market and OTC Market

The secondary market may be organised or unorganised. Nepal stock exchange is the only organised stock exchange of Nepal. The other example, round the globe are, New York Stock Exchange (NYSE), London Stock Exchange (LSE), Tokyo Stock Exchange, Euronext of Euro zone, Bombay Stock Exchange of India etc. On the other hand, if the security of the public company could not meet the requirement to be listed in organised stock exchange or by some reasons if the security of the listed company gets de-listed from stock exchange then the security of these company could be purchased (or sold) from over-the-counter market. In Nepal, a trading desk has been established in Nepse to promote trading in OTC market. To trade the securities in OTC market one doesn’t need the medium of share broker, rather an investor can directly buy or sell securities from that trading desk. Recently, the commission to be paid on OTC transaction has been reduced by about 90% to motivate the OTC market activities. Moreover, a security which has been listed in organised market cannot be traded via OTC market.

Continuous and call market

This classification of financial market has been done on the basis of trading time. A continuous market is a type of secondary market in which prices are determined continuously with the demand and supply of the securities, with in the trading hour. The excess supply of securities will decrease the price of the securities and vice versa. So in a continuous market, the prime of a certain security can fluctuate many time with in a day. A call market is a type of secondary market, in which trading is permitted only at certain time. This means, at a certain time of the day call market holds an auction for a particular security and this auction will determine the price of that security.

Financial Market participant

1.       Banks

The bank plays an important role in financial market. There are there types of bank in practice in Nepal. Commercial bank, Development Bank and Finance companies are those three types. There are currently 28 commercial bank in Nepal. The banking activities are governed by the central Bank of Nepal (NRB). The number of listed securities of banking industry occupy almost 70% in Nepal Stock Exchange.

2.       Assets Management Companies (or Investment Companies)

The core business of asset management companies includes portfolio management and investment advisory services. They also work in securities and financial analysis as well as the acceptance and transmission of orders dealing with financial instruments.

3.       Insurance Companies

Insurance companies helps to mitigate different types of risk associated with the financial sector. So, they have an important role in the financial system. By insuring a large number of people, insurance companies can operate profitably and at the same time pay for claims that may arise. Insurance companies use statistical analysis to project what their actual losses will be within a given class. They know that not all insured individuals will suffer losses at the same time or at all.

4.       Brokerages

A brokerage acts as an intermediary between buyers and sellers to facilitate securities transactions. Brokerage companies are compensated via commission after the transaction has been successfully completed.

5.       Mutual Fund

An open-end or close-end fund operated by a professional company, which rise money from shareholder and invest in the group of assets in accordance with their stated set of objectives.

6.       Saving and Loan Association

S&Ls emerged largely in response to the exclusivity of commercial banks. Savings and loans typically offered lower borrowing rates than commercial banks and higher interest rates on deposits; the narrower profit margin was a by-product of the fact that such S&Ls were privately or mutually owned.

7.       Credit Unions

Credit unions are another alternative to regular commercial banks. Credit unions are almost always organized as not-for-profit cooperatives. Like S&Ls, credit unions typically offer higher rates on deposits and charge lower rates on loans in comparison to commercial banks.

Justification for regulation

Regulation of financial institution is the form of governmental monitoring that restrict these institutions’ activities in various areas of lending, borrowing and funding. The financial institutions have the social role of the economy so the regulation is needed to protect and promote the various dimension of the economy. If the financial market is kept unregulated, it will not produce particular goods or service in an efficient manner and at the lowest possible cost.

Securities board of Nepal (SEBON) is the regulator of capital market of Nepal, whereas Nepal Rastra Bank is the regulator for the money market. Through monetary policy, NRB tries to regulate the Bank and Financial Institutions of Nepal. It also regulates the money exchange centre to minimize the malpractices in the market. SEBON regulates all the merchant bank, brokerage firm, stock exchange, Central Depository Service and Clearing Company (CDSC), credit rating company, mutual funds etc. for the fair practices of the investor’s money. Regulators makes the constant watch o the activities of these companies, so that the risk associated can be minimised. The importance of regulators is increasing day by day, since the economy has suffered from various crashes in past. Barrings Bank UK, Societ Generale Bank of France, USB of Switzerland are the major example of previous crashes. Some of them were closed forever and other managed to overcome those problems but suffered a huge loss.

Please, follow following article from University of Warwick, UK on justification for regulation.

Regulation of financial institutions is the form of governmental monitoring that

It can be generalised on following;

·         To prevent issuers of securities from defrauding investors by concealing relevant information.

·         To promote competition and fairness in the trading of financial securities.

·         To promote the stability of financial institutions

·         To restrict the activities of foreign concerns in domestic markets and institutions

·         To control the level of economic activity.

Forms of regulation in Nepal

Securities Board Nepal is the apex body to regulate the capital market of Nepal. It was established on 26^th May 1993. The objective of SEBON is to protect and promote the interest of the investor. The ‘Securities exchange act – 2063’ has facilitate the legal right and duties to SEBON. It facilitates the investor with legal compliances and rights. SEBON is responsible to monitor and regulate the capital market of Nepal. It regulates both primary market activities and secondary market activities. There are various regulations and guidelines to regulate the market. It helps to encourage the investor’s confidence and in the event of malpractices it can also ask for penalty and fine with concern parties. SEBON is empowered to issue guidelines and directives to the participant of the capital market, such as, stock exchange, CDS, credit rating company, brokerage firm, mutual fund, merchant banks, portfolio managers, stock dealer etc.

Nepal Stock Exchange on the other hand is the first line regulator of the capital market. At present, it is the only stock exchange of the country, so, it is the sole organization for the operation of secondary market of the country. Nepse works under the directions of the Board. It is empowered with to issue security listing bylaws and other related bylaws.

The prevailing legislation of Nepal on the field of capital market are;

·         Securities exchange act – 2063

·         Securities exchange regulation

·         Mutual fund regulation

·         Stock exchange regulation

·         Merchant banking regulation

·         Security listing bylaws

·         CDS regulation

·         Credit rating regulation

·         Security issue guidelines etc.

Other related Acts

·         NRB act

·         BAFIA act

·         Insurance act

·         Company act

·         Technology transfer act etc.

Hierarchy of the legislation

1.       Constitution

2.       Acts

3.       Regulations

4.       Bylaws

5.       Guidelines

6.       Directives

Globalization of Financial Market

Over recent decades, there has been a steady increase in cross-border financial flows around the world. First, various financial institutions including banks and institutional investors have expanded their activities geographically. In this process, they acted as an intermediary to channel funds from lenders to borrowers across national borders. Second, the more mature securities markets have gained a clear cross-border orientation. In many instances, newly issued securities are designed and offered to the public in such a way as to maximize their appeal to international investors.

These developments reflected the progressive dismantling of controls on cross-border financial flows as well as the liberalization of national financial markets more generally.

In the process of developing globalization of financial markets seen over recent decades, both technological advances and financial innovation played a key role. In the past few decades, information systems have become able to compute and store more data more rapidly. Telecommunications networks have extended their ramifications and augmented their capacity while more reliable data exchange protocols have made it possible to connect computing machines in more efficient ways. As a result, cross-border financial deals have become both easier and more secure, effectively lowering the barrier constituted by distance, be it determined by geography or other factors. Moreover, particularly over the last two decades, financial markets have become breeding ground for a wide array of rapidly evolving financial products, often described generically as "derivative" instruments. These products make it possible for borrowers and lenders to customize their risk exposures as well as adjust them over time. With derivative products, borrowers and lenders can therefore mitigate some of the problems associated with asymmetries of information in financial markets, which are particularly acute in the international context.

 

How financial markets become global?

Global markets are markets in which the law of one price applies, in the sense that it would be possible to buy or sell products for the same price irrespective of geographical location and local circumstances. When products are purchased and sold outside national boundaries, price differentials may remain as long as there are costs specifically associated with cross-border exchange as opposed to exchange within national boundaries. Hence, the process of internationalization of financial markets is only a step towards global financial markets. This distinction between globalization and internationalization seems to apply to financial markets as well as to markets for goods and non- financial services. Over recent decades, financial markets have gained a clear cross-border orientation but, overall, it can be argued that they are still not truly global.

(Reference: https://www.ecb.europa.eu)

Bonds and Debenture

Debenture

Debenture: A debenture is a medium to long-term debt format that is used by large companies to borrow money. Debentures are the most common form of long-term loans that can be taken by a company. Debentures are usually loans that are repayable on a fixed date, but some debentures are irredeemable securities (these are sometimes called perpetual debentures).

Most debentures pay a fixed rate of interest. It is required that this interest is paid prior to dividends being paid to shareholders. Furthermore, most debentures are secured on the borrower’s assets, although some are not (these can be known as naked or unsecured debentures).

Types of Debenture
Redeemable and Non-redeemable: If the debenture is issued with the certain maturity date and the firm will buy back those debentures at the end of the maturity is called redeemable debenture. If there is no maturity date mentioned on the debenture and the firm will not buy back those issued debentures, then it is known as non-redeemable debenture. Non-redeemable preferred stock, non-redeemable debenture also exists till the existence of the company.

        Convertible and Non-convertible: Debenture having feature of converting to equity share are termed as convertible debentures, whereas debenture with nothing mentioned like that of conversion are termed as non-convertible debentures. All these terms are mentioned at the time of issue.
     
     Secured and Non-secured: If the debentures are backed up by some kind of physical assets and in the event of insolvency of the firm, those backed up assets is sold and debenture holder are paid then this kind of debenture is called secured debenture. However, if the debentures are issued without backing up any security (physical assets) then these kind of debenture are unsecured debenture. Unsecured debentures are also called as naked debenture. Unsecured debentures are riskier then secured debenture, however they yield more interest than secured ones.

Bond

Bond is a debt instrument in which a government or company promises to pay back an amount of money that it has borrowed and to pay interest for the borrowed money. The rate of the interest is mentioned at the time of issue. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer. Among all financial instrument bond is regarded as the safest instrument for investment purpose, that’s why the interest yield by bond is minimum with comparison to other instruments.

Types of Bond

         i.            Government Bond and Corporate Bond: The bond issued by the corporate sector are corporate bond and the bond issued by the government (either federal or central government) is known as government bond. Government bond are treated as the risk free return. They help to determine the interest rate in the market.  Corporate bonds are ranked a bit riskier than government bond and hence, they yield slightly more interest rate than government bond.

       ii.            Face value bond Zero coupon bond: Bonds issued at the face value are called face value bond they yield the coupon rate of cash flow, whereas, the bonds with zero coupon rate and hence, they yield no interest through-out their life span are called zero coupon bond. However, zero coupon bond are issued at the discounted rate and bought back at the face value. The capital gain during this period is treated as the return of the bond.

Putting Bond: The bond having the feature with the option to the investor to continue the bond or not to continue the bond is called putting bond. Unlike other bond, at the maturity period putting bond holder gets the option to continue their bond or not. The general fundamental from the investor side is that if the current market rate is higher than the coupon rate of bond they will dis-continue the holding of the bond, whereas if the market rate is lower than the coupon rate of bond they will continue their holding of the bond.

Motivation for foreign market and Euromarkets

The Euro market is a large market comprising many member nations of EU and facilitates the free movement of goods and services, in other words efficient trade mechanisms such as low tariffs, quotas etc. are put in place and have a centralized monetary policy with most of them using a common currency - Euro. The euro market acts as a major source for international trade.

·          Limited fund availability in internal market: when there is the situation of limited capital is available in the home country and the firm requires much more capital that can be generated from the home country, they have to go a foreign market to fund their project. This also means, the mobilization of fund from saver to investor travels from the territory of one nation to another.

·         Reduced cost of fund: The high volume of the fund can be collected when a firm crosses the territory of the country. The cost compared to the volume of fund will be very low on such situations.

·         Diversifying funding source: when fund is collected from a country only, the funding source gets higher concentration, however, if the funding can be made from foreign market then the source of the fund can be diversified, this eventually reduces the chances of default of the creditor.

Role of Financial Market

Financial Market have following basic role;

          i.             Saving Mobilization: Financial Market helps to mobilize the saving or the excess amount from the saver, such as house hold, business firm, public sector, local government etc. to the investor so that they can utilize it to fund project of large scale.

         ii.            Price Determination: The financial market provides space for buyer and seller of financial instruments. This space helps to determine the fair price of the instrument.

       iii.            Reduces the cost of transaction: The another economic function of a financial market is that it reduces the cost of transacting. There are two costs associated with transacting search cost and information cost.

Financial Innovation

Financial Innovation provides a global forum for exchanging innovative research findings across all fields in financial research in the era of electronic business. It seeks to promote interactions among researchers, policy-makers and practitioners and foster research ideas on financial innovation in terms of new financial instruments as well as new financial technologies, markets, and institutions. It emphasizes emerging financial products, processes, and services that are enabled by the introduction of interruptive technologies.

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