6.6 Reading the nancial press

involved in so doing. The rate of return which they required was the cost of capital.

The fact that consumers were ultimately prepared to pay a price for the goods pro-

duced by the real capital assets nanced by investors indicated that their welfare

gain from the goods produced just matched the sacrice of the providers of nance.

No netbenets could result to society by changing either the volume of investment

or its composition.

This happy situation is not the outcome if people buy assets just because the price

is rising (or sell just because the price is falling). In these circumstances the return to

investors could settle anywhere, and where it settles the cost of capital also settles.

For example, take the case where a company’s share price rises on the rumour of

some new product development and where, even when the rumour subsides, the

price goes on rising because investors are impressed by its recent capital appreci-

ation. Perhaps its price before the rumour was £2 and the dividend payment was

8p per share. The dividend yield was 4 per cent and this was the cost (in terms of

dividend per pound raised) of raising new capital by issuing new shares. Suppose

that after a few weeks’ buying the price settles at £3. If the rm now decides to

raise new capital by issuing new shares, the cost (in dividend per pound raised) is

now 8/300 or 2.66 per cent. In the circumstances, the rm may be encouraged to

expand, though there is no indication that the benets to society from the output

that it produces have increased. Furthermore, the rm’s enhanced share price makes

it easier for it to make a bid for other rms (by issuing some of its own shares to

shareholders of the target rm). There are resource allocation arguments in favour

of takeovers. For example, a poorly performing rm, if correctly valued, will have

a low share price and will be a target for more efcient rms which will bring

their more efcient management to the poorly performing rm. But where a rm

is valued as the result of a bubble, its price is no longer an indication of superior

performance. We cannot then expect that benets will follow if it takes over a rm

which is priced more cheaply – but correctly.

6.6Reading the nancial press

Bond prices and yields are reported in the Financial Timeson the page headed

‘Market Data’. This page has tables which show current prices and yields and recent

price changesfor UK government bonds, corporate bonds, bonds issued in ‘emerging

markets’, bond futures and options, and ‘benchmark bonds’ from a variety of countries.

Benchmark bonds are bonds of a specied maturity selected from the whole range

of government bonds which enable markets to make international comparisons

of yields. All developed countries have a ten-year benchmark bond and many also

have a ve-, fteen- and twenty-year bond. Commentary on recent developments

in bond prices appears on the ‘Capital Markets and Commodities’ pages. Box 6.8

(earlier) and Box 6.9 contain an example of commentary. Box 6.10 reproduces the

table containing a selection of UK government bond data from the Financial Times

of Thursday 18 May 2006. (On weekdays, the FTpublishes information for only a

subset of bonds; the full list appears on a Saturday.)

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Chapter 6 • The capital markets

Box 6.9

Share prices fall