CIMA BA1 Syllabus D. The Financial Context Of Business - Financial Markets - Notes ^{5 / 9}

Financial Markets are

1. Money Markets

   For short-term finance (up to 12 months)

   - treasury bills, forwards and futures
   - issued by governments, financial institutions and large corporations
   - are very liquid and considered extraordinarily safe (therefore LOW Return)

2. Capital Markets

   For long-term finance (bonds and equity)

   - is an ideal environment for the creation of strategies that can result in raising long-term funds for bond issues or even mortgages.

In London, the money markets are active in all the major currencies, and the term 'eurocurrency market' is used for the money market for wholesale lending and deposits of currencies outside their country of origin.

The money market's products:

1. Bills of exchange

   When a business has made a large sale (eg more than £75,000) a legal document can be drawn up and signed by the customer confirming their obligation to pay in the near future (up to 180 days ahead) - this is called a bill of exchange.

   This document can then be sold by a business to a bank or a discount house if the business needs to raise short-term finance.

2. Commercial paper

   Similar to a bill of exchange except that commercial paper is signed by the company confirming its obligation to pay the buyers of the 'bill' in the near future (up to 270 days ahead).

   Commercial paper is unsecured and can only be issued by companies with a good credit rating.

3. Bank Bills

   Similar to commercial paper/bill of exchange, except that bill is signed by the company's bank, guaranteeing (accepting) payment to the buyers of the 'bill' in the near future.

   This can be sold to banks or discount houses at a higher price because of the bank's guarantee to pay. 

   This is also called an acceptance credit.

   Note. If a government issues bills, these are called Treasury Bills; like other bills these are bought at a discount to their face value; they do not pay interest.

Illustration (Bills of exchange)

A bill of exchange confirms that a customer owes £100,000 and is due to pay in 90 days. 

If this is sold to a discount house for £95,000, a firm has raised this Finance 90 days early, at a cost of £5,000.

• Assuming 360 days in a year, this is an annual interest cost in percentage terms of:

  5,000 / 100,000 x  360 / 90 = 20%

The Capital market's products:

1. Shares

   Share capital might be in the form of ordinary shares (equity) or preference shares. 

   Bear in mind that only the ordinary shareholders are owners of the company, and preference shares are comparatively rare.

   Shares are bought (and sold) on organised stock markets, such as the London Stock Exchange.

2. Bonds (Debentures, loan stock)

   Bonds are (normally) fixed interest securities issued by companies that are listed on the stock market.

3. Commodities

   - such as precious metals

Other types of bond

• Eurobonds

  Bonds sold outside the jurisdiction of the country in whose currency the bond is denominated and are often used by large companies to raise debt finance in a range of different currencies.

• Convertible bonds

  The bond holder has the right to convert the bond into shares in the future. 

  This type of bond, which combines aspects of both debt and equity finance, is sometimes referred to as mezzanine finance

• Gilts

  Bonds issued by the government are called gilt-edged securities or gilts (being very low risk) or Treasury Bonds.