What is Listed Security?
Listed securities are Financial Instruments (Stocks, Bonds, Derivatives, etc) which trade in an exchange. Securities which doesn’t trade in exchange trades via “Over The counter market”, also known as OTC securities. OTC is a dealer market.
Types of Listed Securities
Different types of securities that trade in an exchange and listing procedure
#1 – Stocks
When a private company has been operating for a few years and wants to raise more capital from the market then they sell their own and make them public via listing their shares in exchange. Each exchange has specific rules like minimum stockholder’s equity, minimum share price, a minimum number of shareholders and the minimum number of profitable years as a private held company.
ABC is a private company that is planning to raise more capital from the market by listing its shares in the Stock exchange. What are the advantages and steps?
There are a few ways to raise capital. If ABC plans to take a loan from the bank then it will have to pay interest to the bank even if it doesn’t earn a profit. So taking a loan is a fixed liability for ABC. So instead of taking a loan from the bank if ABC can make its company public by selling of percentage of the owner’s ownership then that will help ABC to raise money as well as it will not have fixed liability to pay interest every year. When you make your company public, then it depends on the company’s management whether they want to pay dividends or not.
Steps to List Shares
Step 1: Decide an Underwriter who will help the private company to get it listed as a public company, as underwriters have licenses to help in the listing process
Step 2: Underwriters will decide the share price by judging the economic condition and by calculating the future earning the power of the company
Step 3: Several Legal procedures will be met and the date will be decided for the listing
Step 4: The first day when the shares will be traded in exchange is called the “Initial Public Offering”. It is done in the primary market
Step 5: From the next day, shares are already in the hands of investors and they start trading shares among themselves in the secondary market
XYZ Company has 10 Million Authorised shares, 800,000 Issued Shares, and 50,000 Treasury shares. How many shares are outstanding in the market?
Getting authorization to list shares in the market is costly, there are lots of legal works and fees that a company will have to pay. So say a company wants to Issue 1,000 shares in the market now, they will still get authorization of say 1,000,000 shares. Every time before issuing shares they don’t want to go to the tedious process of getting authorization first.
So here company XYZ has got Authorisation for 10 million Shares, out of which it has issued 800,000. Out of the issued shares all shares are not traded in the market, few shares are bought back and are kept in treasury for future corporate action needs. So here 50,000 shares are kept in treasury. So outstanding shares in the market are
Outstanding Shares = Issued Shares – Treasury Shares
- = 800,000 – 50,000
- = 750,000
750,000 shares are trading in the market.
The shares price for EFG Company is $50 and there are 1 million outstanding shares in the market. Calculate the market capitalization?
Market Capital = Share Price * Outstanding Shares
- = $50 * 1,000,000
- = 50,000,000
So listed securities help us to calculate the value of the company in the market.
#2 – Bonds
Bonds are also an important way to raise capital for companies. There are several types of bonds having different maturities, coupon rates, options, and face-value. When a company issues Bond, it is a liability for the company and it will have to pay the coupon whether the company earns a profit or not.
Getting a bond listed in exchange helps investors to get the liquidity they want from any investment.
ABC Company plans to raise $50 million by issuing bonds of Face value $1 million. With Coupon rate of 5%. Maturity 10 years. So for this ABC will have to Issue 50 Bonds in the market with Face Value of $1 million each. Each year ABC will have to pay interest of 5% * $1 million * 50 = 2.5 million
So any investor who has bought the bond will have to wait for 10 years to get his money back. So the Secondary market helps investors to get the liquidity as they can exchange securities in the secondary market.
A bond “XYZ” is giving Coupon rate of 5%, the interest rate in the market rose to 8%. What will happen to the price of the Bond in the secondary market?
As the bond is listed security so its price keeps on changing. So if in the market similar bonds are paying a Coupon rate of 8% and bond “XYZ” is paying coupon 5%, so the demand for the bond in the secondary market will fall as no one will be willing to buy it and its price will fall.
So the secondary market helps in determining the correct price of a listed security.
#3 – Derivatives
Derivatives are securities that derive their value from an underlying security. There are several types of derivatives like Options, Swaps in finance, Forwards and Futures. Options and Futures are mostly exchange-traded.
ABC Company is trading at $5, what will happen to the call option if the price of ABC Company increases to $10. The strike price of the call option is $8
Soln: Call Options are listed securities. They are right to buy. So whoever buys the call option will have the right to buy ABC stock at $8. So ABC is trading in the market at $10 and whoever buys the option will get the share at $8, so obviously the price of the option will increase.
As the options are listed, so trading is done and its price changes with the underlying stock
Advantages of Listed Securities
Some of the advantages of Listed security are as follows.
- Listing of securities helps incorrect pricing of the securities
- The secondary market provides liquidity to the security which is beneficial for investors
- When a company gets listed and becomes public, there are lots of disclosures that the company does on a quarterly or event basis. So it helps in mitigating frauds
- It helps to provide a transparent market to all investors
Disadvantages of Listed Securities
Some of the advantages of Listed security are as follows.
- Unnecessary panics can cause huge fall in share prices
- Anyone with money power can play with the price of a listed security
- Making a company public actually takes control out of the previous owner which in turn delays decision making and good opportunities can be missed
Listed securities are the backbone of the financial market. The exchange plays the most important part in giving liquidity to securities which were earlier illiquid. The exchange acts as a bridge between the buyer and seller of financial products.
This has been a guide to what is listed security and its definition. Here we discuss the top 3 types of securities that trade in exchange along with examples, advantages, and disadvantages. You can learn more about financing from the following articles –