The bond and stock markets are some of the avenues that individuals and companies use to raise funds. In these markets, different products are traded. The discussion below examines how these markets function and how firms can use them to generate funding to finance their operations.
Products and functionality of the stock market
Providing an avenue for the sale and purchase of securities is the main f unction of the stock market. Essentially, this market serves as the meeting point for buyers and sellers of the various securities that are traded (Parameswaran, 2011). Enabling firms to raise funds and creating opportunities for investment are other important functions that the stock market performs. Different stock markets allow for trading in different products. The main products include the stocks that listed companies have issued and such derivatives as futures, options and forwards (Parameswaran, 2011). Pooled investment products are yet another item traded on the stock market.
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Products and functionality of the bond market
The bond market is a platform where debt and debt securities are traded (Parameswaran, 2011). Firms use this market to raise funds through the issuance of new debt. There exists a secondary market in the bond market. In this market, debt securities that have already been issued are bought and sold. Corporate and government bonds are the main products that are traded on the bond market (Parameswaran, 2011). Other products include municipal bonds, agency bonds, collateralized debt obligations and mortgage-backed bonds.
Using stock market to raise initial and subsequent funding
In the discussion above, enabling firms to raise funding has been identified as one of the primary functions of the stock market. A company can use the stock market to generate initial funding. Moreover, the stock market providers the company with a platform for raising subsequent funding. To raise initial funding, a firm simply invites the public to purchase its shares through an initial public offering (IPO) (Brigham & Houston, 2015). Through an IPO, the company cedes some of its shares in exchange for cash from investors. To raise subsequent funding, a firm may issue more shares (Brigham & Houston, 2015). While the subsequent issue of shares enables the company to raise additional funding, the share issue dilutes the value of the shares that existing shareholders own. Alternatively, instead of conducting a subsequent share issue, a company may issue stock options after it has conducted an IPO. The stock options are debt securities that serve as vital sources of financing for companies.
Using bond market to generate funding
In simple terms, a bond is a promise that a firm makes that it will repay a debt to investors (Parameswaran, 2011). This definition sheds light on how a firm can use the bond market to generate funding. The company simply issues bonds to investors in exchange for cash. Upon the maturity of the bonds, the company is expected to repay the debt. It is worth noting that the bond market is a preferred source of funding because of the lower rates of interest (Mehta, 2016).
The more expensive option
As they raise funding through the stock and bond markets, firms incur expenses. Before selecting the option to use, firms need to critically examine each and determine the one that is least costly. Generating funding through the stock market appears to be the more expensive option. This is because firms incur various costs when they issue shares. For example, the process of conducting an IPO is costly. A company needs to engage the services of legal experts and accountants (Gregoriou, 2011). Furthermore, a firm launching an IPO has to work with investment bankers whose services tend to be very costly. Generating funds through the stock market also presents some indirect costs. For example, to ensure that it stock prices remain high, a firm needs to go great lengths to maintain profitability. That raising funds through the stock market is the most expensive option does not mean that firms do not incur any costs when they opt for the bond market. There are also costs that are associated with raising funds through this market.
References
Brigham, E. F. & Houston, J. F. (2011). Fundamentals of Financial Management. Boston:Cengage Learning.
Gregoriou, G. N. (2011). Initial Public Offerings (IPO): An International Perspective of IPOs. Amsterdam: Elsevier.
Mehta, S. (2016). Corporate Prefer to Raise Funds from Bond Market: India Ratings. Retrieved7 th January 2018 from https://economictimes.indiatimes.com/markets/bonds/corporate-prefer-to-raise-funds-from-bond-market-india-ratings/articleshow/54657936.cms
Parameswaran, S. (2011). Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives. Hoboken, NJ: Wiley.
