STUDY UNIT 2.3: FINANCING
Evaluation criteria:
Determine financing needs of business enterprise by choosing most appropriate source(s)
of financing i.e. long-, medium- and short-term financing needs.
Motivate choice between different sources of finance by discussing factors of risk, returns
and control.
Explain relationship between long and short-term financing.
Calculate and evaluate appropriate ratios for analysis to support choices of financing
instruments.
Calculate various investors’ ratios and indicate how these are affected by changes to
capital structure of organisation.
Analyse creditworthiness of organisation (credit risk) from point of view of institution that
lends money to other organisations.
Discuss functioning of share markets.
Discuss listing requirements of JSE Securities Exchange and to determine if specific
company complies with requirements or not. If there is not compliance, you must give
advice about how it can be accomplished.
Introduction:
Financial manager must consider various finance categories, debt and equity mix, and
cost.
Financial instruments must appeal to investors for funding.
Finance can be supplied from various sources with terms and conditions to meet investor
needs and risk / return relationships.
Financial markets:
In market, sellers sell goods, buyers purchase, and transactions are concluded with agreed
terms.
Financial assets are traded in well-developed markets.
Classification of financial markets:
Money and capital markets:
Created in Effie (Trial)
, Money market is primarily used for short-term finance, consisting of groups
of interested parties borrowing and lending.
It is not physically located and is primarily operated by merchant banks,
commercial banks, non-bank financial institutions, and large corporations.
Capital market, on other hand, is used for long-term finance, such as JSE.
Primary and secondary markets:
Primary market is for new finance issues, while secondary market trades
already issued securities.
While secondary market indicates marketability and value of securities, it's
not finance source but provides information for organizations seeking to
raise finance in primary market.
Formal and over-the-counter (OTC) markets:
Formal markets, like exchanges, are highly regulated, specialized in narrow
range of instruments, and accessible to small investors.
OTC markets, which began as OTC markets, allow parties to innovate and
trade standardised instruments efficiently.
In South Africa, formal exchanges include JSE Equity Market, JSE Derivatives
Market, and JSE Debt Market.
Standardised instruments like currencies can trade efficiently on OTC markets.
Spot and derivative markets:
Derivative instruments are traded at agreed price, while spot markets involve
immediate trading.
Primary purpose of derivatives market is to manage risk, but its flexibility,
leverage, and low cost also encourage investors.
Derivative contracts can be exchange traded or non-exchange traded.
Exchange traded derivatives are standardized contracts traded on physical
exchanges, while non-exchange traded derivatives are non-standardized and
not traded on physical exchange.
Examples include forward contracts, forward rate agreements, and swaps.
Created in Effie (Trial)
, Interaction between market classifications:
Classifications of markets are not mutually exclusive.
For instance, selling 1,000 MTN shares could be classified into capital,
secondary, spot, and formal markets.
Buyer receives shares, MTN isn't involved, and transaction is electronically
processed.
Johannesburg Stock Exchange:
Johannesburg Stock Exchange (JSE) was founded in 1887 by Benjamin Woollan to
provide market place for transactions of shares in mining and financial companies
formed after discovery of gold on Witwatersrand.
As of 2017, A2X went live, making it South Africa's second stock exchange.
JSE is governed by Act of Parliament, Financial Markets Act, 2012, and its own rules
and directives.
Trading on JSE was in form of auction involving brokers, with prices recorded on
price board.
In 1996, JSE introduced electronic share trading, known as JET system.
In 1999, JSE introduced STRATE project (Share Transactions Totally Electronic), which
allows transactions to be settled and traded electronically.
By February 2002, all JSE counters had moved to STRATE, resulting in
dematerialisation of share certificates and creation of Central Securities Depositary
that holds electronic equity certificates.
Main types of securities listed on JSE are ordinary shares, preference shares,
warrants, futures, and options.
Futures and options are traded on JSE Derivatives Market (SAFEX), which is division
of JSE.
Ordinary shares represent ownership of companies and are by far most important
securities listed on JSE.
Warrants represent options on ordinary shares of listed companies and are often
issued by banks such as Standard Bank and Deutsche Bank who have hedged their
positions by buying underlying shares.
JSE Debt Market lists corporate, parastatal, municipal, and government bonds.
Created in Effie (Trial)
, Its role is to ensure a liquid market, fair and equal treatment for investors, and
proper and timely disclosure.
Performance of JSE in raising primary capital has been variable, with number of
listed companies falling dramatically in recent years as companies have gone
private and minority shareholders have been bought out, mainly via a scheme of
arrangement.
Listed companies have undertaken major share buy-backs, giving back capital to
shareholders.
However, there are disadvantages to listing on JSE, including increased disclosure
requirements and reporting standards, increased accountability to shareholders,
financial information becoming available to competitors and potential competitors,
management time being issue, increased attention on company, costs of listing,
annual fees, and increased responsibilities on directors and corporate governance.
Directors must adhere to various legislation, including King IV Code on Corporate
Governance, JSE's listing requirements, Companies Act 71 of 2008, and Financial
Markets Act 19 of 2012.
Companies must raise equity capital on JSE or have secondary market for investors
to trade in shares to expand business operations.
JSE operates two markets:
Main Board and
AltX.
Main Board requires subscribed capital of at least R25 million, 25 million shares in
issue, satisfactory audited profit history for past three years, 20% public ownership
of each equity share, and minimum number of public shareholders.
Companies must also comply with international financial reporting standards, price-
sensitive information reporting, related party transactions, working capital reports,
corporate governance, and appointment of sponsor.
Delisting from Main Board requires fair value and approval from non-controlling
shareholders.
Alternative Exchange – AltX:
Alternative Exchange (AltX) was established in 2003 by JSE to make listing for small
to medium-sized companies less burdensome.
Created in Effie (Trial)
Evaluation criteria:
Determine financing needs of business enterprise by choosing most appropriate source(s)
of financing i.e. long-, medium- and short-term financing needs.
Motivate choice between different sources of finance by discussing factors of risk, returns
and control.
Explain relationship between long and short-term financing.
Calculate and evaluate appropriate ratios for analysis to support choices of financing
instruments.
Calculate various investors’ ratios and indicate how these are affected by changes to
capital structure of organisation.
Analyse creditworthiness of organisation (credit risk) from point of view of institution that
lends money to other organisations.
Discuss functioning of share markets.
Discuss listing requirements of JSE Securities Exchange and to determine if specific
company complies with requirements or not. If there is not compliance, you must give
advice about how it can be accomplished.
Introduction:
Financial manager must consider various finance categories, debt and equity mix, and
cost.
Financial instruments must appeal to investors for funding.
Finance can be supplied from various sources with terms and conditions to meet investor
needs and risk / return relationships.
Financial markets:
In market, sellers sell goods, buyers purchase, and transactions are concluded with agreed
terms.
Financial assets are traded in well-developed markets.
Classification of financial markets:
Money and capital markets:
Created in Effie (Trial)
, Money market is primarily used for short-term finance, consisting of groups
of interested parties borrowing and lending.
It is not physically located and is primarily operated by merchant banks,
commercial banks, non-bank financial institutions, and large corporations.
Capital market, on other hand, is used for long-term finance, such as JSE.
Primary and secondary markets:
Primary market is for new finance issues, while secondary market trades
already issued securities.
While secondary market indicates marketability and value of securities, it's
not finance source but provides information for organizations seeking to
raise finance in primary market.
Formal and over-the-counter (OTC) markets:
Formal markets, like exchanges, are highly regulated, specialized in narrow
range of instruments, and accessible to small investors.
OTC markets, which began as OTC markets, allow parties to innovate and
trade standardised instruments efficiently.
In South Africa, formal exchanges include JSE Equity Market, JSE Derivatives
Market, and JSE Debt Market.
Standardised instruments like currencies can trade efficiently on OTC markets.
Spot and derivative markets:
Derivative instruments are traded at agreed price, while spot markets involve
immediate trading.
Primary purpose of derivatives market is to manage risk, but its flexibility,
leverage, and low cost also encourage investors.
Derivative contracts can be exchange traded or non-exchange traded.
Exchange traded derivatives are standardized contracts traded on physical
exchanges, while non-exchange traded derivatives are non-standardized and
not traded on physical exchange.
Examples include forward contracts, forward rate agreements, and swaps.
Created in Effie (Trial)
, Interaction between market classifications:
Classifications of markets are not mutually exclusive.
For instance, selling 1,000 MTN shares could be classified into capital,
secondary, spot, and formal markets.
Buyer receives shares, MTN isn't involved, and transaction is electronically
processed.
Johannesburg Stock Exchange:
Johannesburg Stock Exchange (JSE) was founded in 1887 by Benjamin Woollan to
provide market place for transactions of shares in mining and financial companies
formed after discovery of gold on Witwatersrand.
As of 2017, A2X went live, making it South Africa's second stock exchange.
JSE is governed by Act of Parliament, Financial Markets Act, 2012, and its own rules
and directives.
Trading on JSE was in form of auction involving brokers, with prices recorded on
price board.
In 1996, JSE introduced electronic share trading, known as JET system.
In 1999, JSE introduced STRATE project (Share Transactions Totally Electronic), which
allows transactions to be settled and traded electronically.
By February 2002, all JSE counters had moved to STRATE, resulting in
dematerialisation of share certificates and creation of Central Securities Depositary
that holds electronic equity certificates.
Main types of securities listed on JSE are ordinary shares, preference shares,
warrants, futures, and options.
Futures and options are traded on JSE Derivatives Market (SAFEX), which is division
of JSE.
Ordinary shares represent ownership of companies and are by far most important
securities listed on JSE.
Warrants represent options on ordinary shares of listed companies and are often
issued by banks such as Standard Bank and Deutsche Bank who have hedged their
positions by buying underlying shares.
JSE Debt Market lists corporate, parastatal, municipal, and government bonds.
Created in Effie (Trial)
, Its role is to ensure a liquid market, fair and equal treatment for investors, and
proper and timely disclosure.
Performance of JSE in raising primary capital has been variable, with number of
listed companies falling dramatically in recent years as companies have gone
private and minority shareholders have been bought out, mainly via a scheme of
arrangement.
Listed companies have undertaken major share buy-backs, giving back capital to
shareholders.
However, there are disadvantages to listing on JSE, including increased disclosure
requirements and reporting standards, increased accountability to shareholders,
financial information becoming available to competitors and potential competitors,
management time being issue, increased attention on company, costs of listing,
annual fees, and increased responsibilities on directors and corporate governance.
Directors must adhere to various legislation, including King IV Code on Corporate
Governance, JSE's listing requirements, Companies Act 71 of 2008, and Financial
Markets Act 19 of 2012.
Companies must raise equity capital on JSE or have secondary market for investors
to trade in shares to expand business operations.
JSE operates two markets:
Main Board and
AltX.
Main Board requires subscribed capital of at least R25 million, 25 million shares in
issue, satisfactory audited profit history for past three years, 20% public ownership
of each equity share, and minimum number of public shareholders.
Companies must also comply with international financial reporting standards, price-
sensitive information reporting, related party transactions, working capital reports,
corporate governance, and appointment of sponsor.
Delisting from Main Board requires fair value and approval from non-controlling
shareholders.
Alternative Exchange – AltX:
Alternative Exchange (AltX) was established in 2003 by JSE to make listing for small
to medium-sized companies less burdensome.
Created in Effie (Trial)
