Course Overview
A portion of the larger capital market where financial institutions and businesses transact in financial instruments and raise cash for businesses is called the equity capital market. Debt markets are less risky than equity capital markets, which could result in higher returns.
Instruments Traded in the Equity Capital Market
Selling a portion of a claim or right to a company's assets in return for cash is one way to obtain equity capital. The worth of the company's equity capital is thus determined by the value of its present assets and business. The equities capital market offers trading in the following instruments:
Common shares
Shares of common stock are used to indicate ownership capital, and holders receive dividend payments from the company's earnings. The company's earnings and assets are subject to a residual claim by common shareholders. They can only make a profit sharing claim after preferred shareholders and bondholders have been compensated.
The following calculation gives the earnings available to common shareholders (EAS):
Earnings Available to Shareholders (EAS) = Profit after Tax – Preferred Dividend
Note: Profit after Tax = Operating profits (/Earnings before Interest and Tax) – Tax
Preferred shares
Due to the fact that they include elements of debentures and common equity stock, preferred shares are a hybrid security. Because they have a fixed/stated dividend rate, a claim to the company's revenue and assets prior to equity, no claim to the company's residual income or assets, and no voting rights for shareholders, they are similar to debentures.
Benefits of Capital Raising on the Equity Capital Market
The benefits of raising funds on the equity market for a business include:
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1. Reduction of credit risk:
Less debt must be raised by the company, the bigger the share of equity in its capital structure. Credit risk is decreased as a result.
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2. Greater flexibility:
Greater operational flexibility is possible for the company with a lower debt to equity ratio. Due to the fact that shareholders stand to gain more if the firm makes a significant profit (in the form of higher dividends) and suffer smaller losses if the company does poorly, they are less risk-averse than debt holders. (because of limited liability).
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3. Signaling Effect:
Equity issuance is another evidence of a successful business.
