Multitech Business School

3: Capital Markets

CHAPTER: 3

CAPITAL MARKETS

These are markets for long-term capital. They are distinguished from money markets, which are markets for trading short-term financial instruments and short-term borrowing and lending. Short-term markets are those markets where capital is borrowed and lent for a short term i.e. ranging from as overnight to about a year and sometimes longer e.g. certificates of deposit, negotiable instruments issued by a bank. They form part of money markets for short-term borrowing and lending. Sources of short term capital mainly include: trade credit Bank overdrafts and bank loans Hire purchase

Long-term capital is on the other hand invested or lent and borrowed for a period of five years or more. Money markets include primary markets, which are approved institutions that buy and sell bills of exchange and other short-term finance to one another. Sources of long term capital include: Ploughing back of profits The issue of dentures The issue of preference or ordinary shares Borrowing from one of a number of special institutions like Insurance companies, Building societies, Trust saving banks.

Borrowers in a capital market Private individuals: borrow money to purchase fixed assets like buildings e.g. through building societies The government: may borrow through guilt edged securities Limited companies: these are the main borrowers; they borrow by issuing paper securities e.g. debentures, and shares.

CAPITAL MARKETS AND THE STOCK EXCHANGE The ownership of financial rights in business is bought and sold like any property. The market for such rights is called capital market. It provides the bulk of the long-term finance for commerce and industry. This capital market is sub-divided into the new issues market (primary) and the stock exchange (secondary). The new issues market involves the sale new shares to investors while the stock exchange is market for already owned stocks and shares. By : Ambrose Tubenawe 0772467417

Multitech Business School Common Terms used in stock exchange A. Securities:

3: Capital Markets

In simplest terms, securities include shares and debentures. Shares are both ordinary shares and preference shares of public limited companies. Securities are dealt with on the stock exchange. B. Speculation: This refers to the process of anticipation /expectations of share movements by stockjobbers according to expert judgement based on the study of several stock exchange variables as to make decisions when to buy or sell stocks. Compare this with gambling. Speculation differs from gambling in that jobbers will make a decision to buy or sell shares after a careful evaluation of variables such as the companys performance, the general economic atmosphere and the political economy C. Underwriting This is the act of guaranteeing the sum total be raised on issue of shares to the public in circumstances where the success of the public capital issue is not certain. Usually a company arranges with a finance house or broker to underwrite an issue by taking up an agreed portion which he is resold to the public later. D. Blue-chips This term refers to equity shares that have had good track record i.e. first class securities of very sound large-scale international companies. E. Bonds This is a loan security issued by government or company that carries a fixed rate of interest. Note that company bonds are also called debentures. F. Portfolio: this a collection of various securities held by one investor or institution. Stock: a bond issued by a government of local authority signifying a debt. G. Cum cap, ex cap Cum (cumulative), implies sale of shares together with the right to receive bonus shares by the buyer when they due for distribution. Ex cap (excluding), the seller retains the right to receive the bonus shares by the buyer when they are distributed even though he has disposed off the relevant shares. H. Ex div , Cum div This where shares are sold with no right to receive dividends by the buyer f the shares. By : Ambrose Tubenawe 0772467417

Multitech Business School Cum div

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This implies that sale of share together with the right to receive dividends by the buyer I. Guilt-edged securities

These are highly safe (in terms of interest payments and capital redemption), fixed interest securities usually offered by government and public corporations. J. Issuing house This is a finance organisation e.g. a bank, which, specialises in the handling of new capital issues on behalf of public companies. It requires a sound reputation for expertise, integrity nation wide and hence serves to provide assurance that a new issue will be readily subscribed irrespective of the changing financial and economic conditions in the country. K. Market value Market value refers to the price of shares on the stock exchange, according to valuation of specific shares or loan interest as appearing in the official list. It represents the presents the price of a share in terms of the nominal price. For that matter it fluctuates based on financial and economic conditions and the state of particular organisational any one particular time relevant to the nominal value, reserves profit earnings, dividend rates and dividend cover. L. Par value: This refers to the nominal value book value of each share unit issued by a company and upon which dividend is declared. It represents the fixed unit price shown in the Memorandum of Association and Articles, of Association on registration. This remains at this irrespective of market influences except at insolvence or reconstruction. M. Quoted companies: these are companies whose shares are bought and sold on a stock exchange,
Examples of quoted companies on Uganda securities exchange COMPANY

1. 2. 3. 4. 5. 6. 7.

BATU (British American Tobacco Uganda) BOBU (Bank Of Baroda Uganda) DFCU (Development Finance Company Of Uganda) EABL (East Africa African Breweries ) KA (Kenya Airways) KCB(Kenya Commercial Bank) NIC(National Insurance Corporation)

8. NVL (The New Vision Printing and Publishing Co. Limited )

9. SBU (Stanbic Bank Uganda 10. UCL (Uganda Clays)

By : Ambrose Tubenawe 0772467417

Multitech Business School

3: Capital Markets

THE STOCK EXCHANGE This is a market for where already issued share, stocks and securities are bought and sold. Stocks are fixed interest loans comprising of government bonds. Securities concerned are securities of joint stock companies, the central government and the local authorities. The stock exchange of Uganda is known as the Uganda Securities Exchange. It is responsible for the companies listed on this market. 1. Established for the purpose of assisting, regulating and controlling business of buying, selling and dealing in securities 2. Provides a market for the trading of securities to individuals and organizations seeking to invest their saving or excess funds through the purchase of securities 3. Provides a physical location for buying and selling securities that have been listed for trading on that exchange 4. Establishes rules for fair trading practices and regulates the trading activities of its members according to those rules 5. The exchange assures that no investor will have an undue advantage over other market participants. This means that orders are executed and transactions are settled in the fastest possible way 6. Investor make informed and intelligent decision about the particular stock based on information; Listed companies must disclose information in timely, complete and accurate manner to the Exchange and the public on a regular basis. Required information include stock price, corporate conditions and developments dividend, mergers and joint ventures, and management changes etc Functions of the Uganda Securities Exchange 1) Liquidity: Securities of any sort would not be attractive to hold unless they could be turned into cash. The Stock Exchange provides such a ready means of converting investments into liquid form. 2) Transferability Title to any quoted security is transferable speedily and cheaply. This makes it possible for investors to take advantage of more investment opportunities. 3) Pricing: The existence of active market for securities means that price can be set on them whether they are actually being offered for sell or not. 4) Advice: Companies seeking capital are advised at all stages especially on new issues. By : Ambrose Tubenawe 0772467417

Multitech Business School 5) Conduct:

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Investors are protected by rules and the discipline enforced on the market. 6) Marketability: Investors are more willing to buy stock and share if they sell them easily should they wish to do so. It is easier on the stock exchange than to raise funds privately by contacting investors individually. 7) Take-overs: It is common to issue shares to finance a take-over. A take-over by means of share exchange is possible with a recognisable market value. Reasons for floatation Floatation is the process of making shares available on the stock exchange. It is sometimes referred to as going public or obtaining a listing. The reasons for obtaining a listing are: 1) To raise capital: This enables existing shareholders to raise substantial capital by issuing shares to the public for a calculated price par share. The company expands and grows without the interest burden associated with debt capital. 2) Improved debt to equity ratio: This improves the overall financial position of the company by injection of substantial equity funds. 3) Mergers a merger scheme based on exchange of shares appeals mo0re to the shareholders when shares they receive are listed since such are marketable. 4) Market valuation: Shareholders and potential investors are able to check the value of their investments daily by referring to price list of quoted companies as published in the media. 5) Prestige and status: Going public will raise the level of awareness of the company and its products in both the investing community and the public at large. 6) Liquidity The portfolio of quoted shares is generally regarded as being a highly liquid asset since shares may be sold through with the least amount of time and inconvenience. By : Ambrose Tubenawe 0772467417

Multitech Business School 7)Avenue for investment:

3: Capital Markets

Quoted a shares offer the investing public particularly institutional investors, an attractive avenue for investing their excess cash.

8) Transferability: Quoted shares must always be easily transferable. Qualification for listing A Company intending to apply for a listing on the Uganda securities exchange, must conform to the listing rules and regulations as stipulated in the listing manual. Some them are: a) a company must have paid up capital of at least Ug. Shs. 500 million for the first tier and Ug. Shs. 150 million for the second tier. b) At least 25% of the issued equity capital, for which a quotation is being sought, must be offered to the public, whose value must be at least Ug. Shs. 500 million for the first tier and Ug. Shs. 150 million for the second tier. c) The Memorandum and Articles of Association of the company worth the requirements of the securities of the securities exchange whether or not required by law. d) Assure the securities exchange that the spread of share holders existing at the close of an offer is sufficiently wide to justify the listing (approximately 300 shareholders for tier two and 1000 for tier one). e) A company should have a good track record an audited accounts immediately proceeding application for listing f) The company should be engaged in substantially the same business and management, and share control throughout the last three years before the application.

g) The securities which listing is sought must be freely transferable, subject to any restriction that may be imposed by written law. Have only one class of voting shares, which shall be offered at the exchange. h) The name history and description of the companys interests and activities. i) j) k) l) Forecast earnings and dividends. Details of share capital, and borrowing powers of the company. The basic requirements are amplified in the securities exchange listing manuals. E.t.c

By : Ambrose Tubenawe 0772467417

Multitech Business School

3: Capital Markets

MEMBERSHIP OF A STOCK EXCHANGE Only members are allowed to buy and sell shares at a stock exchange. These members constitute the market. Any member of the public wishing to buy or sell shares must do so through a member of the stock exchange. The members chose a council among them selves that runs the affairs of the exchange. Each member pays a fee which covers the expenses incurred in running of the exchange. Member of stock exchange may be rokers or jobbers. The Floatation Team Brokers These are middlemen who connect the investing public to the stock exchange market. Members of the public can only buy shares on the market if brokers are party to the transactions. They give technical information and advice to the members of the public on maters pertaining to shares available e.g. the companies present owners, the earnings share, dividend cover dividend yield etc they earn a commission known as a brokerage, fixed on the par value of shares sold. They endeavour to acquire shares on behalf of their clients at the cheapest price or if selling, sell them at a highest price usually on retail. Jobbers They are not middlemen but rather principals in their own right who buy and sell securities in their names and on whole sale basis. They in most cases buy shares from companies or institutional investors on wholesale basis and sell them to brokers. They earn profit known as a turn, the difference between the buying price of the shares and their selling price of the same shares or securities. Types of jobbers This classification indicates the role played by a jobber in a given transaction. Bull This is a speculator who buys stocks of shares in expectation for a rise their prices. They buy when prices are low and expect them to rise in future. They earn a profit known as a turn. Bear This is a speculator who buys stock of shares in expectation for a fall in prices. They speculate to sell when prices are high again in the hope that prices will soon fall, and buy them at a cheaper price and deliver them to potential buyers at a highly price. Stag: This is a speculator who buys newly issued shared whose prices are low priced (since they have not gained reputation), and sell them when their prices rise. By : Ambrose Tubenawe 0772467417

Multitech Business School FACTORS AFFECTING SHARE PRICES

3: Capital Markets

A Companys share prices quoted on the stock exchange are known as its market price i.e. the price at which its shares are dealt in on the market. Such are determined by a number of factors some of which are: a) Demand and Supply; when more people are buying a certain stock, the price of that stock increases and when more people are selling the stock, the price of that particular stock falls. b) The companys goodwill; Positive news about a company can increase buying interest in the market while a negative information about it can ruin the prospect of buying share in that company hence lowering the prices.. c) Policy on dividends; a company whose dividend policy indicates higher returns that are stable will have a higher share price and vice versa. d) Earning Per Share - Earning per share is the profit that the company made per share on the last quarter. It is mandatory for every public company to publish the quarterly report that states the earning per share of the company. This is perhaps the most important factor for deciding the health of any company and they influence the buying tendency in the market resulting in the increase in the prices of the shares. e) Its profitability; if profits have been good and are expected to be buoyant, share prices are likely to be high as many people will try to acquire them. Poor profits will encourage shareholders to sell them off something that puts down share prices. f) Political stability: the prospect of change of government often makes the stock exchange very unstable and thus bringing the share prices down in case of political instability ad the reverse is true. g) Government policy: policies that lead to increase in profits lead increased profitability of companies and man investors will to instruct their brokers to buy shares for them their rising the demand of shares and consequently rising the share prices. h) Possibility of a merger with another company may lead to optimism and higher share prices if the proposed merger is perceived to be economically beneficial. STEPS IN PURCHASE/SELL OF SHARES a) A member of the public wishing to buy/sell shares approaches a registered broker. b) The broker inquires from other brokers if they have any client who wishes to /buy sell the particular type of shares. Upon finding one, he will haggle for the price and finally agree at one. c) Writing a contract note: after the buying /selling broker has agreed on a price he writes out a contract note which he sends to his client. It has the following information; the price of the shares, brokerage (commission), amount of stamp duty, fee for registering the name of the new shareholder in case of purchase payable to By : Ambrose Tubenawe 0772467417

Multitech Business School

3: Capital Markets

d) e) f) g)

the company and details of the shares to be bought/sold and the day on which the broker will pay the net amount owing (i.e. when selling shares). The selling broker makes out a stock transfer form and share certificate to the buying broker to be given to the new owner after payment. The buyer pays the buying broker The buying broker pays the selling broker The selling broker deducts his commission and tax on capital gain if any on the sale of shares and pays the balance to the seller.

What role do capital markets play in an economy/country? Capital markets have an important role to play in stimulating economic development. The following are some of the examples: 1. Capital markets help mobilise domestic savings, hence facilitating the reallocation of financial resources from dormant to more productive activities. 2. Capital markets provide an avenue for the divestiture of State Owned Enterprises (SOEs), whereby shares in these companies may be sold through the stock exchange (USE), allowing members of the public to participate in the ownership of these companies. The privatisation of SOEs through a stock exchange helps to broaden the asset base by providing a means through which ordinary citizens can acquire a share in the countrys assets. 3. Companies have the opportunity to raise long-term finance through equity and debt financing (issuing shares and bonds respectively). 4. Members of the public are given an opportunity to buy shares or bonds, providing them with an alternative method of investing their savings. 5. Capital raised through the issue of shares, bonds or other instruments, can be invested by the company to expand production, invest in more efficient productive processes and improve competitiveness. 6. Increased investment by companies will lead to employment expansion, income generation, and with a larger percentage of the population earning incomes, savings and consumption will increase resulting in a cycle of increased investment, increased production, enhanced economic growth and wealth creation. 7. Through full disclosure requirements, companies are encouraged to observe better accounting and management practices, hence leading to greater transparency in the business sector and lower incidences of corruption. This will lead to good corporate governance. 8. Capital markets enhance the inflow of international capital when international investors participate in debt and equity instruments.

HOW DO COMPANIES BENEFIT FROM CAPITAL MARKETS? A share issue allows companies to increase the equity base of the company and raise capital without bearing the burden of interest payments associated with borrowed funds. By : Ambrose Tubenawe 0772467417

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Full disclosure requirements of a listing on the Exchange encourage companies to observe good business and management practices and ensure better corporate governance, benefiting not just the firm but the economy as a whole. The public profile of the company is improved thus attracting greater business opportunities. HOW DO INDIVIDUALS BENEFIT FROM CAPITAL MARKETS? Capital markets provide an additional investment option through the purchase of securities. Individuals are given the opportunity to diversify their investment risk. Capital markets also provide a savings avenue. Assists in future planning especially in participating in long term debt instruments Business ownership through shareholding in enterprises.

Source of income through capital gains and dividend payments FACTORS AFFECTING CAPITAL MARKET PERFORMANCE 1. The value of shares is determined by demand and supply during trading. If there are more buyers than sellers, the price of the shares will tend to rise, and the reverse happens if sellers are more than buyers. In other words, the price falls. 2. The performance of a company will depend on a variety of factors, including the type of industry, the performance of the economy, and whether the company is affected by external factors such as world prices. 3. Government policy will also affect the performance of companies ,as will movements in economic indicators. If bank interest rates on deposits are high, this may encourage the holding of savings in banks as opposed to investment on the Exchange. This would then result in less demand for shares and a decrease in the share price. The opposite would occur where interest rates on bank deposits were low with investors preferring to invest their savings on the Exchange, hence increasing the demand for shares and pushing up share prices. By : Ambrose Tubenawe 0772467417

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Multitech Business School

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4. Other factors include the lack of knowledge and the low levels of savings, which translate into lack of liquidity in the market. 5. Inflation rates affect investment decisions. The longer the investment time frame, the more important inflation will be in determining the real value of the investment at the end of the term. Where inflation rates are high, generally sound and low risk investments such as fixed interest bank deposits may be subject to real losses because the interest rates may be lower than the inflation rate and the original capital will not be growing at the same rate as inflation.

By : Ambrose Tubenawe 0772467417

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