In this course, participants will learn about how different markets around the world can interact to create value for, and effectively manage the risk of, corporations and their stakeholders. This is part of a Specialization in corporate finance created in partnership between the University of Melbourne and Bank of New York Mellon (BNY Mellon).
2.2 Price Discovery and Fair Value (A level playing field)
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来自 The University of Melbourne 的课程
全球资本市场的作用
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从本节课中
Market Functions and the Key Players
This week we discuss the value added by financial markets to corporate development and economic growth. We cover the key roles of price discovery, flow of funds, efficient capital allocation, portfolio diversification and corporate governance. Introducing the influential participants in financial markets, we discuss how they contribute to the efficiency of those markets. We stress the important empirical result that countries with more developed and efficient financial markets experience faster economic growth and development.
与讲师见面
Paul KofmanDean, Faculty of Business and Economics
Sidney Myer Chair of Commerce
Sean PinderAssociate Professor
Faculty of Business and Economics
The second role of capital markets we'll discuss is price discovery.
The discovery of a fair and transparent value for
the assets traded on that market.
We'll distinguish between the primary markets,
where the assets are first issued, and the secondary markets,
where the assets subsequently get traded for investors to sell onto new investors.
So, first, the primary market, for example, for the equity market.
The diagram that you see below indicates that the price is discovered
where aggregate demand meets aggregate supply.
Aggregate supply in the primary market for equity is fixed.
For example, Kellogg's corporation issued 420 million shares.
It was up to the investment banks assisting Kellogg's in
issuing the shares for the first time to the public, in raising investor demand,
in raising investor interest in the shares of Kellogg's.
What that means in terms of this diagram is to push the demand curve
that you see in this diagram here, to push that up as much as they possibly
could to then find the highest possible issue price
to deliver the highest possible funds to Kellogg's corporation.
Now consider the secondary market of price discovery.
Again, the price is discovered where aggregate demand meets aggregate supply,
but the situation is somewhat different here in the sense that
there is a kink in the supply curve.
So, ultimately, no more shares can be traded
than the shares that are actually listed for trade on the New York Stock Exchange.
That's where the kink occurs, but, beyond that, to the left, smaller quantities
can be offered by the first time investors that bought the shares in the primary
market to new investors that now are also interested in buying shares in Kellogg's.
And again, demand meets supply
tells us where the share price is currently located.
So equity price discovery occurs on equity exchanges
like the New York Stock Exchange, but, of course, we're none the wiser.
We now know that the price is established where demand meets supply, but
what is driving demand or supply for the shares in Kellogg's?
Well, that would depend on the financial position of Kellogg's Corporation.
So the role of the equity market is not just to provide a meeting place for
investors, owners of the shares of Kellogg's corporation, so that they
can trade those shares, but it is also to provide them with all relevant information
that will determine their amount or their supply of the shares in that corporation.
And all that information would include relevant information regarding
the financial performance and the outlook of listed companies like Kellogg's.
The securities regulator, for example, the Securities Exchange Commission in the US,
would impose strict requirements on companies to provide that
information to the public at a timely fashion.
So here's a graph of what happened on the secondary market,
where Kellogg's shares were traded for the past two decades or so.
The blue line indicates how the price evolved over time, and
you can see that there are some sharp turns in that price level.
You can also see in the shaded background on this graph the volume of shares,
the number, the quantity of shares traded on a particular day.
Trading volume enhances price discovery.
We see in the graph that trading volume increase substantially
In the last decade or so.
The more transactions occur, the more investors are on the marketplace,
the more they exchange information about the true value of Kellogg's shares,
the intrinsic value, the underlying value determined by the financial position,
and the earnings outlooks of that company.
The more accurate,
the more transparent, the more focused the price discovery will be.
Keep in mind that on an exchange like the New York Stock Exchange,
there are the headline shares, say, the Dow Jones shares, but
there are many companies, in fact, listed on the exchange,
which are not nearly as visible to the public.
So of 1,867 listed companies, maybe the top 500 trade very frequently,
as represented in the Standard and Poor's 500 index.
The market capitalization of the exchange at large is $16.6 trillion.
The highest market capitalization listed on the exchange is $418 billion,
but the smallest market capitalization is just $2.5 million.
Shares in these small market capitalization companies,
do in fact not change very frequently, sometimes not for days.
In some cases, not for weeks.
It is very problematic for
an investor in those small capitalization companies to get the level of price
discovery that they would have confidence represents a fair and transparent price.
All the problems that arise in the absence of markets could
be present for stocks that are not very liquidly traded,
so turnover, or volume, are good indicators
of the quality of real-time competitive price discovery on those markets.
So now we know that it takes volume, it takes transactions,
to lead to fair and transparent price discovery.
Let's take a closer look at what an efficient market really entails.
In an efficient market, major news announcements like takeovers
would be reflected in the share price almost instantaneously, and
,if the company abides by the rules set by the securities regulator,
there would be no leakage of that information.
Leakage in the sense that some people would have access to that information
prior to the public announcement.
So the example here in the graph illustrates what happened.
When Kellogg's announced that it would buy Pringles from its competitor Proctor and
Gamble.
On the 15th of February 2012,
we see a very sharp increase in the price level from
about $50 to $53 for a share of Kellogg's.
So the company took this news as a surprise, the sudden jump in the price
level for Kellogg's, as a surprise that was positive to the corporation.
A good outcome for Kellogg's future earning prospects.
Then there's a second time at which this particular takeover had
an impact on prices when Kellogg's announced that its purchase of
Pringles shares had been completed on the 31st of May 2012 a few months later, and
there we see that the price suddenly drops from just over $50 to just $48.
Clearly, the market wasn't taking the news so good anymore.
The important point of this graph are these sharp price increases,
and price declines in the shares.
That truly indicate a surprising announcement to the market,
rather than a slow buildup of the price, leading up to the announcement
by Kellogg's that it was going to take over Pringles.
So it truly comes as a surprise, and
the market instantaneously adjusts its demand and supply for the shares of
Kellogg's, thereby instantaneously adjusting the price level of the shares.
So now we've seen how price discovery works in the equity market,
how does it work for the over the counter, different trading platform, debt markets?
Well, debt is issued at coupon rates that would make the issue price,
the price that the corporation receives,
equal to the face value that needs to be repaid at maturity.
So we would call that issue at par.
So rather than prices that are being discovered,
the price in this instance is actually the coupon rate that is being discovered,
the return that investors require to invest in bonds of Kellogg's Corporation.
So if we take a look at the graph here, what is indicated here
are the current outstanding bonds issued by Kellogg's corporation,
the same as you've seen before, but now we've given here in
terms of the bars, the years to maturity, the maturation of the bond issue.
So for the bond issued in 2001, we see that that had 30 years to maturity,
and it was issued, the blue line, at a coupon rate of 7.45%.
We can see that overtime, the coupon rate that Kellogg's had to
pay to the bond investors was decreasing.
We see it go down to a very low level, below 1%,
for the bonds issued in 2013.
Now take a look at the bonds that were issued
to finance the acquisition of Pringles, the two bond issues that occurred in 2012.
The first bond issue, with the longer maturity of ten years to maturity,
maturing in 2022, had a coupon rate of just over 2%.
The much shorter bonds that was issued simultaneously,
with just three years to maturity, had a coupon rate,
was able to be issued at a coupon rate of just over 1%.
So the first lesson we derive here is that the longer the maturity,
apparently the higher the coupon rate required.
Now that's true in this instance, but
it doesn't turn out to be a general conclusion.
It is possible that these rates are in fact inverted.
So how do bond dealers discover these market clearing coupon rates,
also known as the market yield at issue of the bond?
Keep in mind that these are wholesale markets.
So does everything I just mentioned about volume bring us many market participants
to market as you possibly can, to get fair and transparent price discovery,
would that still work at an over the counter, dealer-driven market?
Well, as it turns out, it does.
So while this is a wholesale market where large quantities,
large amounts of bonds are being traded, it is also a closed market.
So while this is a telephone market where dealers call around to
assess investor interest, they would still be able to get
a good picture of aggregate demand for a particular bond issue.
So in that sense, over the counter debt markets could be as efficient
as the floor traded New York Stock Exchange.
A bit more on price discovery in the debt markets.
Keep in mind the each bond yield is specific to that particular bond,
to its risk, and the risk would be assessed by the rating agencies,
the maturity, the life of the bond.
Keep in mind that for equity, that's irrelevant, all shares are listed forever,
and the coupons that are attached to that particular bond issue.
But markets, debt markets, bond markets and money markets,
would aggregate that information, that issue-specific information, for
pricing reference, for broad rating classes of corporate bonds.
We'll discuss a little later what these ratings really mean.
But AAA, AA, and
A would be highly rated, highly softened, highly liquid corporations.
And we would rate them against treasury bonds, the truly risk-free debt market.
The government, after all, can always ensure that it's able to repay it's debt.
But consider the case here in the graph where
we give indicative coupon rates on issue over treasury bond rates.
The treasury bond rates for increasing maturities of the bond issues
show that the coupon rates, the yields are going up with maturity.
So for the two year treasury bond issue,
treasury only has to pay a coupon of 0.5% whereas for
the 20 year body issue, treasury would have to pay 2.25%.
Now, for increasing riskiness,
you can see that the green line, red line, blue line, for
corporate bonds issued, would have a substantial risk premium.
So let's take the 20-year bond issued for
a AAA corporation, indicated by the green line.
Keep in mind or remember that treasury, the government,
was able to issue bonds with 20 years maturity at 2.25% per annum.
A AAA rated corporation, which is, in fact, highly solvent, and
therefore, highly likely to be able to repay all its debt obligations,
even for a 20-year bond issue, the AAA corporation,
would in comparison, have to pay 3.25% per annum.
That's a difference of a full 100 basis points, one percentage point,
for the fact that that corporation still has, albeit minute,
probability of not being able to repay in full its debt obligation.
And then you can see that for lower rated companies than a AAA, the AA or
the A that the rates increase further.
So to gap between the green line and the purple line,
indicates the risk premium that the corporation a AAA
rated corporation would have to pay over treasury coupon rates.
Moving to the next market, what determines the price of a currency?
On the foreign exchange market, just as on the equity market and
debt market, demand and supply for the asset determines the price.
So what changes exchange rates?
Again, it's the changes in demand and supply.
But what are those?
So, what changes to demand for a particular currency could be
changes in the changes in the trade or the capital flows,
the imports of grains from China into the US to produce cereals.
It could also be a change in foreign direct investment.
Chinese investors, investing heavily in corporations in Australia,
and paying for those investments in Australian dollars.
Tourism, an obvious one, but it's also things like relative inflation.
The intrinsic value of the two currencies involved in an exchange rate.
On to relative interest rates.
If it's attractive to invest at higher interest rates, in say China,
than US investors might want to exchange their low interest US dollars,
for high interest Chinese yuans.
So in the graphics here, you can see the US dollar, Euro,
exchange rate, the red line, and the US dollar, Chinese yuan, exchange rate.
They actually look quite similar over that same timeframe.
But be careful, when you're looking at graphs like these, keep in mind,
the notions of fixed exchange rates, managed exchange rates,
and floating exchange rates.
Floating exchange rates, the currency values, are truly determined by markets.
For the managed exchange rates, like the US dollar, Chinese yuan,
we actually see that the monetarial authorities of China would intervene in
the marketi to control the price movements in their currencyi visa vis the US dollar.
And we can easily illustrate thati on the righthand side in
the graphi where we indicate the volatilityi
the typical price movements in the exchange rate in percentage per annum.
We do that for the US dollar, Euro, and you can see that over the timeframe for
which I've taken the exchange rate, the typical price
variation in the US dollar, Euro is about 6 to 7% per annum.
Compare that to the typical variability in the US dollar, Chinese yuan.
And you immediately notice that, hey that currency seems
to have much lower variation in its rate, against the US dollar.
It must be the case that the monetary authorities are doing something
to control price variations, to control market movements.
Because you can see from the blue line, that the typical volatility in the US
dollar, Chinese Yuan, is just about 1% per annum.
Moving on to the commodity markets, and
price discovery on those markets, we've already discussed in the first
module that commodity price discovery is more complicated.
Mostly because there is no such thing As a unique arabica coffee bean.
It depends on quality, it depends on location,
it depends on transportation costs and the like.
So while unique commodity price discovery remains problematic,
there are of course benchmark prices.
And we've seen that for our Kellogg's case,
where Kellogg's can easily Take as benchmark prices the wheat price
versus the corn price as the main ingredients too in cereal manufacturing.
So close substitutes would have closely tracking prices.
If there are different wheat prices and there are many They would still be linked
to this price, as it would be discovered on the Chicago markets, the blue line.
And then our final markets, the derivatives markets.
How does price discovery occur on those markets?
Just as with the markets we've just discussed, which we would label as spot
markets, cash markets, where assets are exchanged Right now.
For derivatives as it's on exchange in some state in the future.
So what we're talking about in terms of price discovery for derivatives markets is
really future demand meets future supply for those assets.
That would give us future price discovery.
Also, known as, the forward or the futures price, involved in a transaction.
So what we could do, and I've illustrated that in this graphic here,
is that we give future prices, for future exchange dates, settlements dates.
So you can see that what I've done here is to take a settlement
date of the contract in May 2015, July 2015,
September 2015, etc., up all the way, up to March 2017.
So future point in time, for which we would like to lock in a futures price.
So this is done for the corn futures prices,
as they are traded on the Chicago Board of Trade.
What you can see is,
the volume of transactions, as indicated by the red bars.
And that tells you immediately, that most of the action,
most of the transactions, demand and supply resulting in a transaction,
occurs for nearby maturities, nearby future dates.
The further into the future,
we want to discover prices, the less transactions that usually occurr.
That should tell you something about the accuracy of
the price signal you get from those markets.
So, whereas, there is a lot of trade for nearby maturities,
the first two bars, the May 2015 and the July 2015,
delivery contracts, there are very few transactions for
those contracts, that happen in nine months time, up to two years time.
So the price signals, as they are indicated by the blue line,
defutes prices for these dates of delivery.
Not as reliable, for the long maturities, as they would be for the short maturities.
So are there perhaps other ways to discover prices?
It's great that we can intersect demand, aggregate demand for
an asset, with aggregate supply for an asset, and
it will tell us where the price is, but ultimately,
we need to know what is driving demand, what is causing supply to change.
So some of the factors that we would, therefore,
have to inspect, include the expected return on the asset.
If the expected return on the asset increases,
investors would be more interested.
Demand would increase.
But at the same time, a higher expected return,
imposes a higher cost on the corporation issuing the asset.
Thereby, making it less attractive for them to issue in the market,
and, therefore, they would like to reduce the supply of the asset.
But it's not just the expectation of the return that any investor hopes to make, it
is also the risk around that return, the likelihood that an expected return will
actually occur, which will have an impact on the likelihood of investor interest.
The higher the risk, the less interested the investor would be,
unless they're compensated for an even higher expected return.
We've seen for the exchange rates, that price discovery depends on
things like interest rates, relative interest rates, and
relative inflation rates, for the countries whose currencies are involved.
Interest rates, inflation, directly relate to the notion of time,
value of money, that we discussed in the first course.
And opportunity costs, very important for the price discovery,
in the foreign exchange market.
But there are other things that are important, as well.
Things like the scarcity of the asset.
Hugely oversubscribed IPOs for Internet companies, for example.
Oversubscribed, where demand manifold,
outstripped the supply of shares, available to the market.
But it could also be in the commodity markets,
where a failed harvest means that there is no supply of corn.
And demands can only be satisfied by driving up prices dramatically.
It could be an underlying shift in investor wealth.
Take, as an example, the increased contributions that
countries around the world see flow into superannuation funds.
Those pension funds, as they're also known,
would invest the cash that is flowing into those funds, into risky assets.
That means a shift in the demand curve for those assets.
It could be a capacity of the market, there could be liquidity constraints.
We will talk about liquidity constraint, in quite some detail, in the next module.
And last, but certainly not least, there's the risk of regulatory and
political intervention.
Always a major risk, that would mean that investors are less inclined to
invest in assets, in those particular markets.
