Financial Markets

Teacher: Sellamuthu Prabakaran

Student: Juan David Burbano Benavides

1) Characteristics of Corporate Bonds

Choice 
The range of corporate bonds issued each year allows investors to tailor a bond portfolio
around specific needs. Investors should, however, consider that each issuer has its own
unique risk profile.
Secondary market 
An active secondary market exists for many corporate bonds, which creates liquidity for
investors. Investors need to remember that some issues can be thinly traded, which may
impact pricing and may pose a challenge when selling.
New issues 
Customers are able to access new issue corporate bonds through the CorporateNotes ProgramSM. Each
week a limited number of new issue corporate bonds are available for purchase at par, in
minimum denominations of $1,000, without additional trading concessions.
Ratings 
Most corporate bonds are rated by at least one of the major rating agencies. Fidelity offers
both investment grade and non-investment grade bonds, which are classified according to
their rating. When considering an investment in corporate bonds, remember that higher
potential returns are typically associated with greater risk.
Yields 
Corporate bonds are among the highest yielding fixed income securities. In fact,
the yield differential overTreasuries may be great enough to outpace inflation over the long
term. Because interest is fully taxable, buyers should evaluate their tax situations before
investing.

Size of Market.  The corporate bond market is generally large and liquid; in 2009 daily trading
volume was an estimated $16.8 billion and total issuance was over $900 billion. The total market
value of outstanding corporate bonds in the United States at the end of 2009 was approximately
$6.9 trillion. A variety of investors participate in the corporate bond market, including individuals who
invest in corporate bonds through direct ownership and/or through mutual funds; insurance
companies; pension funds and other institutional investors.
Trading Venues. The vast majority of corporate bond transactions, even those involving
exchangelisted issues, take place in the over-the-counter (OTC) market. This market does not have
a central location, but rather is made up of brokers and dealers from around the country who trade
debt securities over the phone or electronically. Market participants are increasingly using electronic
transaction systems to assist in the trade execution process. Some bonds trade in the centralized
environments of the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX),
but the bond trading volume on the exchanges is relatively small.
Bonds are traded on both a principal and agency basis.  When a broker buys or sells bonds from
their firms’ inventory – or on a principal basis – clients do not pay an outright commission, but
instead pay a markup that is built into the price quoted for the bond. If a broker has to go out into
the market to find a particular bond for a customer, a commission may be charged. Commission
rates and markups vary based on the type of bond and size of the transaction.
2) Types of Corporate Bonds

The range of corporate bonds issued each year allows investors to tailor a bond portfolio
around their specific needs. The various types of corporate bonds offer different risk levels, as
well as varying yields andpayment schedules.
Fixed-rate coupons 
The most common form of corporate bond is one that has a stated coupon that remains fixed
throughout the bond’s life. It represents the annual interest rate, usually paid in two
installments every six months, although some bonds pay annually, quarterly, or monthly. The
payment amount is calculated as a percentage of the par value, regardless of the purchase
price or current market value. With corporate bonds, one bond represents $1,000 par value,
so a 5% fixed-rate coupon will pay $50 per bond annually ($1,000 × 5%). The payment cycle is
not necessarily aligned to the calendar year; it begins on the "Dated Date," which is either on
or soon after the bond’s issue date, and ends on the bond’s maturity date, when the final
coupon and return of principal payment are paid.
Investment grade vs. non-investment grade (high yield) 
Corporate bonds are generally rated by one or more of the three primary ratings
agencies: Standard & Poor’s, Moody’s, and Fitch. These firms base their ratings on the bond
issuer’s financial health and likely ability to make interest payments and return the
bondholders’ principal. Rated bonds fall into one of two categories: investment grade or non-
investment grade (also known as high yield). Investment grade bonds are considered to be
lower risk and, therefore, generally pay lower interest rates than non-investment grade
bonds, though some are more highly rated than others within the category. Non-investment
grade bonds are considered to be higher risk or speculative investments. The
higher yield reflects an increased risk of default. A company’s financial health can change, and
when it does, its bonds’ ratings may change as well. So an investment grade bond could
become non-investment grade over time and vice versa.
Zero-coupon 
Zero-coupon corporate bonds are issued at a discount from face value (par), with the full
value, including imputed interest, paid at maturity. Interest is taxable, even though no actual
payments are made. Prices ofzero-coupon bonds tend to be more volatile than bonds that
make regular interest payments.
Floating-rate* 
The coupon on a floating-rate corporate bond changes in relationship to a predetermined
benchmark, such as the spread above the yield on a six-month Treasury or the price of a
commodity. This reset can occur multiple times per year. The coupon and benchmark can also
have an inverse relationship.
Variable- and adjustable-rate* 
Variable- and adjustable-rate corporate bonds are similar to floating-rate bonds, except that
coupons are tied to a long-term interest rate benchmark and are typically only reset annually.
Callable and puttable 
The issuer of a callable corporate bond maintains the right to redeem the security on a set
date prior to maturity and pay back the bond’s owner either par (full) value or a percentage of
par value. The call schedule lists the precise call dates of when an issuer may choose to pay
back the bonds and the price at which they will do so. The callable price is generally expressed
as a percent of par value, but other all-price quotation methods exist.
With a puttable security, or put option, the investor has the right to put the security back to
the issuer, again at a set date or a trigger event prior to maturity. A common example is the
“survivor’s option,” whereby if the owner of the bond dies, the heirs have the ability to put
back the bond to the issuer and typically receive par value in return.
Step-up* 
Step-up corporate bonds pay a fixed rate of interest until the call date, at which time the
coupon increases if the bond is not called.
Step-down* 
Interest on step-down securities is paid at a fixed rate until the call date, at which time the
coupon decreases if the bond is not called.
Convertible Bonds* 
Convertible bonds can be exchanged for a specified amount of the common stock of the
issuing company, although provisions generally restrict when a conversion can take place.
While these bonds offer the potential for appreciation of the underlying security, prices may
be susceptible to stock market fluctuations.

3) Evidence on the Efficient Market Hypothesis

A market theory that evolved from a 1960's Ph.D. dissertation by Eugene Fama, the
efficient market hypothesis states that at any given time and in a liquid market, security
prices fully reflect all available information. The EMH exists in various degrees: weak,
semi-strong and strong, which addresses the inclusion of non-public information in market
prices. This theory contends that since markets are efficient and current prices reflect all
information, attempts to outperform the market are essentially a game of chance rather
than one of skill.

The weak form of EMH assumes that current stock prices fully reflect all currently
available security market information. It contends that past price and volume data have
no relationship with the future direction of security prices. It concludes that excess returns
cannot be achieved using technical analysis.

The semi-strong form of EMH assumes that current stock prices adjust rapidly to the
release of all new public information. It contends that security prices have factored in
available market and non-market public information. It concludes that excess returns
cannot be achieved using fundamental analysis.

The strong form of EMH assumes that current stock prices fully reflect all public and
private information. It contends that market, non-market and inside information is all
factored into security prices and that no one has monopolistic access to relevant
information. It assumes a perfect market and concludes that excess returns are impossible
to achieve consistently.
What is the 'Efficient Market Hypothesis - EMH'?

The efficient market hypothesis (EMH) is an investment theory that states it is impossible
to "beat the market" because stock market efficiency causes existing share prices to
always incorporate and reflect all relevant information. According to the
EMH, stocks always trade at their fair value on stock exchanges, making it impossible for
investors to either purchaseundervalued stocks or sell stocks for inflated prices. As such, it
should be impossible to outperform the overall market through expert stock selection
or market timing, and the only way an investor can possibly obtain higher returns is by
purchasing riskier investments.

What EMH Means for Investors

Proponents of the EMH conclude that, because of the randomness of the market,
investors could do better by investing in a low-cost, passive portfolio. Data compiled by
Morningstar Inc. through its June 2015 Active/Passive Barometer study supports the
conclusion. Morningstar compared active managers’ returns in all categories against a
composite made of related index funds and exchange-traded funds (ETFs). The study
found that year-over-year, only two groups of active managers successfully
outperformed passive funds more than 50% of the time. These were U.S. small growth
funds and diversified emerging markets funds.

In all of the other categories, including U.S. large blend, U.S. large value and U.S.
large growth, among others, investors would have fared better by investing in low-cost
index funds or ETFs. While a percentage of active managers do outperform passive
funds at some point, the challenge for investors is being able to identify which ones will
do so. Less than 25% of the top-performing active managers are able to consistently
outperform their passive manager counterparts.

An important debate among stock market investors is whether the market is efficient - that is,
whether it reflects all the information made available to market participants at any given time.
The efficient market hypothesis (EMH) maintains that all stocks are perfectly priced according
to their inherent investment properties, the knowledge of which all market participants
possess equally. At first glance, it may be easy to see a number of deficiencies in the efficient
market theory, created in the 1970s by Eugene Fama. At the same time, however, it's
important to explore its relevancy in the modern investing environment.

• This equation tells us that current prices in a financial market will be set so that the
optimal forecast of a security’s return using all available information equals the
security’s equilibrium return.
 • Financial economists state it more simply: A security’s price fully reflects all available
information in an
efficient market.

Financial theories are subjective. In other words, there are no proven laws in finance, but
rather ideas that try to explain how the market works. Here we'll take a look at where the
efficient market theory has fallen short in terms of explaining the stock market's behavior.

EMH Tenets and Problems with EMH

First, the efficient market hypothesis assumes that all investors perceive all available
information in precisely the same manner. The numerous methods for analyzing
and valuing stocks pose some problems for the validity of the EMH. If one investor looks
for undervalued market opportunities while another investor evaluates a stock on the
basis of its growth potential, these two investors will already have arrived at a different
assessment of the stock's fair market value. Therefore, one argument against the EMH
points out that, since investors value stocks differently, it is impossible to ascertain what a
stock should be worth under an efficient market.

Secondly, under the efficient market hypothesis, no single investor is ever able to attain
greater profitability than another with the same amount of invested funds: their equal
possession of information means they can only achieve identical returns. But consider the
wide range of investment returns attained by the entire universe of investors, investment
fundsand so forth. If no investor had any clear advantage over another, would there be a
range of yearly returns in the mutual fund industry from significant losses to 50% profits, or
more? According to the EMH, if one investor is profitable, it means the entire universe of
investors is profitable. In reality, this is not necessarily the case.

Thirdly (and closely related to the second point), under the efficient market hypothesis, no
investor should ever be able to beat the market, or the average annual returns that all
investors and funds are able to achieve using their best efforts. (For more reading on beating
the market, see the frequently asked question What does it mean when people say they "beat
the market"? How do they know they've done so?) This would naturally imply, as many market
experts often maintain, that the absolute best investment strategy is simply to place all of
one's investment funds into an index fund, which would increase or decrease according to the
overall level of corporate profitability or losses. There are, however, many examples of
investors who have consistently beat the market - you need look no further than Warren
Buffett to find an example of someone who's managed to beat the averages year after year.
(To learn more about Warren Buffett and his style of investing, see Warren Buffett: How He
Does It and The Greatest Investors.)
Qualifying the EMH
Eugene Fama never imagined that his efficient market would be 100% efficient all the time. Of
course, it's impossible for the market to attain full efficiency all the time, as it takes time for
stock prices to respond to new information released into the investment community. The
efficient hypothesis, however, does not give a strict definition of how much time prices need
to revert to fair value. Moreover, under an efficient market, random events are entirely
acceptable but will always be ironed out as prices revert to the norm.

It is important to ask, however, whether EMH undermines itself in its allowance for random
occurrences or environmental eventualities. There is no doubt that such eventualities must be
considered under market efficiency but, by definition, true efficiency accounts for those
factors immediately. In other words, prices should respond nearly instantaneously with the
release of new information that can be expected to affect a stock's investment characteristics.
So, if the EMH allows for inefficiencies, it may have to admit that absolute market efficiency is
impossible.

Increasing Market Efficiency?

Although it is relatively easy to pour cold water on the efficient market hypothesis, its
relevance may actually be growing. With the rise of computerized systems to analyze stock
investments, trades and corporations, investments are becoming increasingly automated on
the basis of strict mathematical or fundamental analytical methods. Given the right power and
speed, some computers can immediately process any and all available information, and even
translate such analysis into an immediate trade execution.

Despite the increasing use of computers, however, most decision-making is still done by
human beings and is therefore subject to human error. Even at an institutional level, the use
of analytical machines is anything but universal. While the success of stock market investing is
based mostly on the skill of individual or institutional investors, people will continually search
for the surefire method of achieving greater returns than the market averages.

Conclusion
It's safe to say the market is not going to achieve perfect efficiency anytime soon. For greater
efficiency to occur, the following criteria must be met: (1) universal access to high-speed and
advanced systems of pricing analysis, (2) a universally accepted analysis system of pricing
stocks, (3) an absolute absence of human emotion in investment decision-making, (4) the
willingness of all investors to accept that their returns or losses will be exactly identical to all
other market participants. It is hard to imagine even one of these criteria of market efficiency
ever being met.
4) How valuable are Published reports by investments Advisers?

• Not very much if EMH holds true

But if we want to see another point of view, suppose that you have just read in
the "heard on the street" column of the Wall Street Journal that investment
advisers are predicting a boom in oil stocks because an oil shortage is
developing. Should you proceed to withdraw all your hard-earned savings from
the bank and invest it in oil stocks?
 
Efficient markets tell us that when purchasing a security, we cannot expect to
earn an abnormally high return, a return greater than the equilibrium return.
Information in newspapers and in the published reports of investment adviser is
readily available to many market participants and is already reflected in market
prices. So acting on this information will not yield abnormally high returns, on
average. How valuable then are published reports of investment advisers? The
answer is "not very". 
The implication of efficient markets theory that published reports of investment
advisers are not valuable indicates that their published recommendations
cannot help us outperform the general market. Many studies shed light on
whether investment advisers and mutual funds (some of which charge steep
sales commissions to people who purchase them) beat the market. One
common test that has been performed is to take buy and sell recommendations
from a group of advisers or mutual funds and compare the performance of the
resulting selection of sticks with the market as a whole. Sometimes the advisers'
choices have even been compared to a group of stocks chosen by putting a copy
of the financial page of the newspaper on a dartboard and throwing darts. The
Wall Street Journal, for example, has a regular feature called :Investment
Dartboard", which compares how well stocks picked by investment advisers do
relative to stocks picked by thrown darts. Do the advisers win? to their
embarrassment, on average they do not. The dartboard or the overall market
does just as well even when the comparison includes only advisers who have
been successful in the past in predicting the stock market. 
In studies of mutual funds performance, mutual funds are separated into groups
according to whether they had the highest or lowest profits in a chosen period.
When their performance is compared to a subsequent period, the mutual funds
that did well in the first period do not beat the market in the second. 
 
The conclusion form the study of investment advisers and mutual funds
performance is this: Having performed well in the past does not indicate that an
investment adviser or a mutual fund will perform well in the future. This is not
pleasing news to investment advisers, but it is exactly what the theory of
efficient markets predicts. IT says that some advisers will be lucky and some will
be unlucky. Being lucky does not mean that a forecaster has the ability to beat
the market.
 
• Information in newspapers and in the published reports of investment advisers is
readily available to many market participants and is already reflected in market
prices
• So acting on this information will not yield abnormally high returns, on average
• The empirical evidence for the most part confirms that recommendations from
investment advisers cannot help us outperform the general market
5) Should you be skeptical of Hot Tips?

– YES. The EMH indicates that you should be skeptical of hot tips since, if the
stock market is efficient, it has already priced the hot tip stock so that its
expected return will equal the equilibrium return.
– Thus, the hot tip is not particularly valuable and will not enable you to earn
an abnormally high return.
– As soon as the information hits the street, the unexploited profit
opportunity it creates will be quickly eliminated.
– The stock’s price will already reflect the information, and you should expect
to realize only the equilibrium return.

6) Do stock prices always rise when there is Good News?

– NO. In an efficient market, stock prices will respond to announcements

only when the information being announced is new and unexpected.
– So, if good news was expected (or as good as expected), there will be no
stock price response.
– And, if good news was unexpected (or not as good as expected), there will
be a stock price response.

News is something that affects stock prices. Whether you’re a long-term investor or a
short term investor, it’s important to review the news headlines periodically. There may
be positive news, negative news or news to which market may not react at all. One
has to be smart enough to decode the news and quickly grasp whether it will affect his
stocks in anyway and if yes, the degree to which the news can have an impact.

News which is considered as positive tends to have a positive effect on stock markets
and one can see share prices rising soon after the news come out in the open.
Positive news — such as a joint venture agreement, securing of new orders, healthy
 sales numbers, , discovery of huge oil reserves in a country, excellent financial results
of acompany etc— should send a stock up. Stock prices react slowly but steadily to
positive news.

Negative news  has more far reaching effect on stock prices and investor sentiment
than positive news. Stock prices react very heavily to negative news that it may
seriously stop average people from wanting to buy stocks.
The sentiment of the market is also an important factor. In a largely negative
atmosphere, the slightest bit of worrisome news is enough to send a stock tumbling.
‘GOOD’ BAD NEWS..
There are some news which might seem negative at first but it isn’t actually negative.
For example, firing of CEO or top officials. This may sound very negative at first, but it
does show that the company’s board of directors was bold enough to take drastic
actions to help the company in the long run. Another example is lay-offs in a company.
This is usually good for the company and its stock price because expenses will be
reduced significantly and quickly. This should help increase earnings right away. It is
not always a major warning sign; it could just be a reaction to a slower economy. It is
one of the quickest ways a company can cut expenses if sales have not been meeting
expectations.

The news has a direct impact on the market. It can change a bad day into a good one
or a good day into a bad one. The relationship between the news and the market can
be highly unpredictable by the best analysts. The next headline can turn out to be a
boon or a bust.
 Good news will have a positive impact on stock prices
 Stock prices reacts to negative news quickly than it would react to a positive
news.
 The good news locally can be overshadowed by the negative news across the
globe.
 In a negative atmosphere, the slightest bit of worrisome news is enough to send
a stock tumbling. The opposite is also true. To an extend, news effects largely depend
on the reigning sentiment rather than the actual significance of the news.
 Just because the news is bad doesn’t mean the stock market will have a bad
day.
 News about the following affects stock markets: Crude Oil prices, IIP, Inflation,
Unemployment, government policies, political unrest, draught or monsoon, company
results, Global cues, FII activities, mergers and acquisitions , insider trading, bonus
dividends and stock buy backs, stock splits, rights issue, inclusion or exclusion from
indexes, change or death of top officials, loss of customers or break through deals,
changes in demand and supply, fluctuations in prices of raw materials, war, terrorist
attacks, joint ventures, rumors , new interventions etc…..

7) Efficient Markets Prescription for the Investors.

– Investors should not try to outguess the market by constantly buying and
selling securities. This process does nothing but incur commissions costs on
each trade.
– Instead, the investor should pursue a “buy and hold” strategy—purchase
stocks and hold them for long periods of time. This will lead to the same
returns, on average, but the investor’s net profits will be higher because
fewer brokerage commissions will have to be paid.
– It is frequently a sensible strategy for a small investor, whose costs of
managing a portfolio may be high relative to its size, to buy into a mutual
fund rather than individual stocks. Because the EMH indicates that no
mutual fund can consistently outperform the market, an investor should
not buy into one that has high management fees or that pays sales
commissions to brokers but rather should purchase a no-load (commission-
free) mutual fund that has low management fees.

Bibliography

 http://www.investopedia.com/university/bonds/bonds2.asp
 https://www.thestreet.com/story/229151/1/bonds-primer-what-bonds-
have-in-common.html
 http://europe.pimco.com/EN/Education/Pages/CorporateBonds.aspx
 https://www.boundless.com/accounting/textbooks/boundless-accounting-
textbook/reporting-of-long-term-liabilities-11/overview-of-bonds-
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 http://www.hjsims.com/resources-and-tools/bond-basics/corporate-bond-
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