6.1The importance of capital markets

Like short-term borrowing, long-term borrowing can be done in a number of ways.

In this chapter we focus on two common sources of long-term funds – equities, or

ordinary company shares, and xed-interest bonds. We look at the characteristics of

these instruments in more detail in the next section. Most long-term borrowing in

any economy is carried out by government and rms. The only long-term borrow-

ing in which households engage is when they take out a mortgage loan to buy a

house, and although these loans typically have an initial maturity of 20–25 years, the

majority are repaid within eight years when borrowers sell, move house, and take out

a new mortgage. Table 6.1 shows the netamount (new issues minus redemptions)

raised by government and rms in sterling capital markets in 2004 and 2005. The

table shows two things of interest. The rst is the dominance of xed-interest securities

(‘bonds’) compared with shares in the nancing of rms. Indeed, in both years,

rms have reduced the number of shares outstanding by buying back some of their

earlier issues. The second is that the UK government is a very large borrower, also

borrowing by the issue of bonds. It is not always easy to remember the importance

of bond nance when the media pay so much attention to what is happening in

share markets and so little to what is happening in the much larger bond markets.

What the table does not show is that while the funds raised by rms may look large,

they are in fact a very small proportion of rms’ capital requirements each year.

More than half of the net investment carried out by UK rms is regularly nanced

by internal funds, that is, by ‘ploughing back’ a substantial fraction of prots. In

addition to this, rms borrow from banks: the proportion of investment nanced by

new issues of securities is rarely more than 20 per cent.

Given that rms raise so little capital from them directly, it is tempting to argue

that the behaviour of capital markets is of little importance. However, we must rstly

remember that rms using internal funds, if they are performing the calculations

correctly, should be taking the level of yields on alternative nancial assets as an

indication of the opportunity cost of using these funds. Secondly, we must remember

that when rms do make new issues of securities in order to raise new funds for

investment, they have to issue those securities on terms which make them attractive

Table 6.1

Net amounts raised in sterling capital markets, 2004–05, £m Firms1Government2 SharesBondsCommercial PaperBonds

2004	789	63,746	4,845	49,651
2005	4,504	87,699	8,963	50,025

¹Funds raised by all rms (UK and overseas) on the London Stock Exchange and Alternative

Investment Market.

²Data for nancial years 2003/04 and 2004/05

Source: ONS, Financial Statistics,March 2006, Tables 1.2c, 6.2b and 6.2c

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