What is the Equity Market?
The Equity Market also known as the Stock Market is a place where buyers and sellers go to trade stocks, derivatives, and other securities. All prices are marked at their current value that the market gives them. A company’s balance sheet is Assets = Debt + Equity (Debt is also known as Liabilities) Companies can raise money by debt (see bond market post) or equity. When an investor buys stock they are buying ownership of the company. Companies make money on stocks the first time the trade them. Most stocks bought are in secondary markets. Investors can sell stock any time they want (investors can also short stocks, but that is outside the scope of this post.) Some stocks pay their owners dividends which is payments per share at a given a stated point in time and the company is responsible to pay. Usually stocks that do not pay dividends are growing and would rather keep the money so they can buy other projects.
Stock is not what the company is worth, but how much investors think it is worth. Based on future projects, business cycle, how many shares are being held by the company, and so on.
How is Equity used in Project Finance?
So equity is used by usually having a number of equity investors which are called sponsors. These equity investor’s returns are not based on the balance sheet, because of the allocation of risk. Equity investors lose if the project does not generate any cash.
What Companies do with Stock?
Companies issue stock through an underwriter at an investment bank. These writers create a value for the stock when it is first issued. Facebook is going through this now and there is a lot of talk about how to value Facebook? It is very hard to put a price on the company. Sometimes companies buy back stocks which has the ability to increase the stock price. Stock also has voting power for companies based on how much percent of the company you own. The bigger the percentage the more influence you have. This is useful when voting on a CEO and so on.
A major risk is if a company goes bankrupt then the stock becomes worthless and an investor stands to lose all of the money they have put into the company. Another risk is fraud. Any signs of fraud will make the stock worthless overnight. It will create a surplus of the company’s stock that no one wants. With stocks you only lose what you put in.
Picture From: http://www.flickr.com/photos/cascade_of_rant/5893302541/
Here is a YouTube video about Project Fiance by http://www.cse.org.uk. It does a great job breaking down how to raise money for a project (in this example energy). I will provide more information about the equity market in my next post. It also breaks down what risks are involved in all of the financing parties. I will also try to find some other great videos in the future to post in my blog. Watch the video and let me know if you have any questions.
Video From: http://www.youtube.com/watch?v=DDmzf84YBx0
The Bond Market
The Bond Market is a place where organizations such as corporations, municipalities, and other entities go to either raise money or buy and sell bonds. The Bond Market is a very complicated market that is used a lot in investments such as Project Finance.
So how does The Bond Market affect Project Finance?
Sometimes the investor or investors in the project need to raise more capital so they will issue debt that will be back in a number of years with interest. Very basic example of it being used in project finance.
What types of bonds are issued?
Some types of bonds are coupon bonds and zero coupon bonds. Coupon bonds pay an amount of the bond with stated payment dates such as semiannually or annually with the full amount paid back at the maturity of the bond. An example is a $1000 bond that pays a semiannual coupon of 6% will result in a payment twice a year for $30 (6%/2). Notice how the two $30 payments equal $60. These are fixed payments. Zero coupon bonds do not give out payments they only pay the amount back at the maturity of the bond. Sometimes investors will choose to sell their bond before maturity, because of changes in their investment horizon or risk for example. Also some bonds have an option for the issuer of the debt to buy back the bond at given time.
Two major ones, credit risk and interest rate risk. Credit risk is a rating given to bonds by credit rating agencies such as Moody’s, Standard and Poor’s, A.M. Best, and Fitch. These companies have different ratings that they give out for example with Moody’s a rating of Aaa(highest grade)-Baa3 is an investment grade meaning the entity has the ability to pay back the loan with a low interest rate. Ba1 – C is a junk bond and is very risky with a high interest rate. These ratings help determine the price of bonds. Now, interest rate risk, this means the change in the value of the bond over its life due to the interest rate changing. As interest rates rise bond prices fall because bonds become more risky and as interest rates fall bond prices rise because of the likely hood of bonds being paid back. This is a very important relationship to understand in the bond market. Notice Aaa has a low interest rate which means investors will pay more and C have a high interest rate meaning investors will pay a lot less.
Next time I will talk about bonds convexity and duration and how that affects investors, when I deicide to cover The Bond Market again.
Again these are very simple examples of The Bond Market. It is important in Project Finance, because it allows more capital to be generated for projects around the world.
Here are some links to look at The Bond Market:
How does engineering and construction work in project finance?
During the construction of a project the team building is responsible for the project risk. This is stated in a contact between the engineering team and the owner or owners of the project. The contact includes losses during construction, the set date that the project is to be finished, the budget, and other aspects within the scope of the contact. This is a way of spreading the risk to other parties.
The most common contact is called the Engineering, Procurement and Construction Contact (EPC Contract), which entails all of the aspects listed above stated by the owner or owners. This contract can be used domestically or globally. These contacts are very complex.
Attached at the bottom is a link that will give you an example of an EPC Contract.
Construction and the contacts involved makeup a very important in the investment process for Project Finance. If contacts are not in place and if risk is solely on the shoulders of the owner or owners then Project Finance would be inefficient. The engineering team could take their time building the project, create a useless budget, and even damage the project before it is used. Contacts like the EPC create a legally binding contact that rests the risk on the construction team who has the ability to prevent such losses as stated above.
Overall the separation of risk at every part in Project Finance allows the investor or investors to worry about how much return they will they will make. This makes Project Finance a great investment.
The Many Catoptric Losses in 2011
Currently the Asian markets are having a hard time setting up projects due to large unexpected catoptric events in 2011. Some of these events are the Australian and Tai Floods along with earthquakes in New Zealand and Japan. These events have killed many people and also destroyed infrastructure in these countries. These events are affecting every party involved in Project Finance. Losses are in the hundreds of billions. In these markets are a lot of risk and every party who is involved with controlling their risk (during their part of the project) wants coverage from these catoptric risks. Now every party is taking a step back and trying to understand how to predict these natural disasters more accurately. It just goes to show how important risk management and a firm understanding of risk.
Information from Willis Re 1st View January 1st 2012
Here are your typical project finance investors as provided by : Investors & Project Finance Providers http://www.projectfinancedirectory.com/
United States Investors:
New York, CIT Group
Washington, Delphos International
Washington, Emerging Markets Partnership
Washington, International Finance Corporation
To name a few
These firms invest in projects not just in the United States but, all over the world. Some these firms are private equity, government agencies, secured lending, and so on.
Cairo, Egypt, African Export Important Bank
London, United Kingdom, Barclays Capital
Luxembourg, Luxembourg, European Investment Bank
Sandton, South Africa, Industrial Development Corporation
To name a few
These firms also invest in projects all around the world. Some of these firms are investment banks, financial assistance, government entities, and so on.
As listed above most of these firms in American and internationally act the same by providing their clients with a wide variety of products that suit their investment horizon. A big majority of investors in Project Finance are massive banks and groups listed above. These groups do not just focus on Project Finance but other investments as well. This makes these banks more risk averse and brings together large amounts of single investors to support infrastructure.
For more information please us the link above.
Here is the article -> http://www.economist.com/node/21543113
This week I interviewed Dr. Donald Wargo an Economics professor at Temple University. Dr. Wargo’s field of study is in Development Economics. The article I choose to interview him about was from The Economist called “Booming Mongolia: Mine all, Mine.”
1. What do think about the mining of natural resources in Mongolia?
Dr. Wargo: “The exploitation of natural resources in countries has been generally unhelpful in the country with natural resources. Oil in Ecuador, Diamond mining in South Africa, the exploitation of natural resources in Iceland. It has all been exploitative. The mining company comes in, they have their own workers (not citizens), ship the resources out and keep profits for themselves and give the government a spilt of the proceeds. It is highly unusually that this type of mining will help the local people. If the government is corrupt it keeps the money and if it isn’t then it builds beautiful buildings for itself instead of income distribution to citizens. Ecuador, the company that mined the oil their created a lot of waste in the jungle, which is another problem.”
2. It said in the article that the town of Ulaanbaatar is now booming with all types of investors, stores, and services. Do think that this kind of growth will generate a need for more projects such as power plants, roads, bridges, and so on?
Dr. Wargo: “No once the resources are gone the companies will leave. Ulaanbaatar is a populated town because it is in the middle of Mongolia where all of the main roads meet. However, outside the city is mountainous. Most people in Mongolia are nomadic and will have little need for the mining companies coming in.”
3. How will this mining help Mongolia’s Gross National Product (GDP)?
Dr. Wargo: By definition it will improve their GDP because their government’s revenue increases. The real question is will it help the local people? No.
4. As of May 03, 2011 Moody’s rated Mongolia a rating of B1 (see link below.)Do you think that the mines will bring Mongolia’s credit rating up?
Dr. Wargo: Yes, it will increase their credit rating. It will increase the revenues of the government and their ability to pay back debt.
It is very important to understand what really motivates growth. I still believe that project finance helps people. However, in this example it can hurt people. If the mining company’s would hire the Mongolia’s and give some of their profit back to the community (not just government.) Then this will cause positive growth.
Just remember that project finance does help people and is very important to the world economy.