CHAPTER THREE SECURITY MARKET prepared .

. The proposed systems-based approach to industry classification Within a sector there is a pattern to how firms organize. Firms provide products and services to customers and “depend upon” (Parnas, 1972: p. 1058) their suppliers to provide inputs. The dependency relationship begins with the sector’s final customers who depend upon the firms in the sector to collectively provide products and services that fulfill their needs. They purchase these products and services from customer service providers: air transportation services from airlines, health care from hospitals, and consumer products from retailers. The customer service providers, in turn, depend upon other firms for complementary services, products to sell, and tools and equipment to use in service M. Dalziel / Research Policy 36 (2007) 1559–1574 1563 Fig. 1. Sector structure. provision. Airlines depend upon aircraft manufacturers, hospitals upon laboratory service providers, and retailers on a variety of product manufacturers. These firms, in turn, depend upon other firms for subsystem and component products, and for complementary services, tools, and equipment. The pattern is one of recursive hierarchical dependency where the chains of dependency correspond, in many cases, to global supply chains.3 Fig. 1 illustrates the systems-based structure of a sector. It identifies eight sector roles and distinguishes between service and manufacturing subsectors, and between central and complementary firms. Solid lines indicate the key dependency relationships. The importance of the dependency relation for the decomposition of a system was identified by Parnas (Baldwin and Clark, 2000). In his award-winning article entitled “On the criteria to be used in decomposing systems into modules”, Parnas (1972)identifies dependency as the most suitable criterion for decomposing a system in a manner that preserves the structure of the problem the system is addressing. When a sector is understood as a system that addresses individual and organizational needs, the dependency criterion can be used to disaggregate sectors into subsectors, industry groups, and industries where aggregates that are positioned further 3 I thank an anonymous reviewer for helping me to articulate this point. up the system hierarchy depend upon lower level aggregates. A classification system that captures this pattern of hierarchical dependency begins by identifying the fundamental individual and organizational needs that define vertical sectors such as transportation, health care, and communications. As these needs are broadly defined, it will likely be possible to classify most business establishments in vertical sectors, a claim that is partially addressed in Section 5. The remaining business establishments will be classified in horizontal sectors that address economy-wide needs for materials, manufactured products, and services, respectively. The second step involves distinguishing between business establishments that provide

1. Security Market Chapter 3

2. Why Do We Invest? By investing a portion of your income you allow money to grow and work for you. Various avenues where money can be invested, are broadly classified into some groups, known as ‘Asset Class’. Stocks or Equity shares are most popular class of assets. Investment is necessary to support your financial needs when you do not earn money.

3. Why to invest in Securities? Con’t 6

4. Three important considerations for any product The degree of important of three components varies from person to person. How to choose a Security for investment? 7

5. Reward Risk Low Low High High Risk – Reward Relationship 8

6. Market is a place where things are bought and sold. Securities market is a market where securities are bought and sold. There are various participants / agents / entities and products in the securities market. Securities Market is part of Capital Market. What is Securities Market? 9

7. FINANCIAL MARKET Financial Markets are the centers or arrangements that provide facilities for buying and selling of financial claims. Efficient transfer of resources from those having idle resources to others who have a pressing need for them is achieved through financial markets. Stated formally, financial markets provide channels for allocation of savings to investment. 10

8. Securities The definition of ‘Securities’ as per the Securities Contracts Regulation Act (SCRA), includes instruments such as shares, bonds, stocks or other marketable securities of similar nature in or of any incorporate company or body corporate, government securities, derivatives of securities, units of collective investment scheme, interest and rights in Securities, security receipt or any other instruments so declared by the Central Government. 11

9. STRUCTURE OF THE SECURITIES MARKET Securities Market Equity Market Debt Market Derivatives Market Gov. Securities Market Corporate Debt Market Money Market Options Market Future Market 12

10. Who regulates the Securities Market? The responsibility for regulating the securities market is shared by Department of Economic Affairs (DEA), Department of Company Affairs (DCA), Reserve Bank of the country and Securities and Exchange Board . 13

11. Why does Securities Market need Regulators ? The absence of conditions of perfect competition in the securities market makes the role of the Regulator extremely important. The regulator ensures that the market participants behave in a desired manner so that securities market continues to be a major source of finance for corporate and government and the interest of investors are protected. 14

12. what is THE role of regulators ? protecting the interests of investors in securities. promoting the development of the securities market Regulating the business in stock exchanges and any other securities markets Prohibiting fraudulent and unfair trade practices 15

13. Participants Who are the participants in the Securities Market? The securities market essentially has three categories of participants, namely, the issuers of securities, B. investors in securities and C. the intermediaries, such as merchant bankers, brokers etc. 16

14. Why is Securities Market essential? Provide opportunity for entrepreneurs to raise capital for business. For investors, stock markets provide a way to invest money and exit when they want.

15. Financial Markets and Instruments Financial securities are traded in Financial markets. Financial market: ‘place’ where supply and demand of financial assets meet. Financial instruments (assets, securities): claim to future cash-flows. Role of financial markets: provide investment opportunity for agents with surplus (buy securities); provide financing opportunity to agents with need of capital (issue securities). Hence financial markets permit to redistribute wealth and consumption over time. 18

16. CON ‘t these markets provide liquidity for buying/selling information through prices risk-sharing among buyers/sellers financials instruments (fin assets, securities) - financial institutions (intermediaries) 19

17. Financial market is of two types : Financial Market FINANCIAL MARKETS MONEY MARKET CAPITAL MARKET 20

18. MONEY MARKET 21

19. Money Market Money market is a mechanism that deals with the lending of short term funds (less than one year) A segment of the financial market in which financial instrument with high liquidity and very short maturities are traded. 22

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21. Capital Market Meaning: Capital markets  are financial markets for the buying and selling of long-term debt or equity. A capital market is a market for securities from where business enterprises and governments can raise long-term funds. Definition: Capital markets are defined as markets in which money is provided for periods longer than a year. 24

22. The market where investment instruments like bonds and equities are traded is known as the capital market. The primal role of this market is to make investment from investors who have surplus funds to the ones who are running a deficit The different types of financial instruments that are traded in the capital markets are: > equity instruments > insurance instruments, > foreign exchange instruments, > hybrid instruments CAPITAL MARKET 25

23. Difference between Capital market & Money market   Money Market Capital Market Definition Is a component of the financial markets where short-term borrowing takes place Is a component of financial markets where long-term borrowing takes place Maturity Period Lasts anywhere from 1 hour to 90 days. Lasts for more than one year and can also include life-time of a company. Credit Instruments Certificate of deposit, Repurchase agreements, Commercial paper, Eurodollar deposit, Treasury bills, Money funds, Foreign Exchange Swaps, short-lived mortgage and asset-backed securities. Stocks, Shares, Debentures, bonds, Securities of the Government. 26

24. Purpose of Loan Short-term credit required for small investments . (Current Assets) Long-term credit required to establish business, expand business or purchase fixed assets. (Fixed Assets) Basic Role Liquidity adjustment Putting capital to work Institutions Central banks, Commercial banks, Acceptance houses, Nonbank financial institutions, Bill brokers, etc. Stock exchanges, Commercial banks and Nonbank institutions, such as Insurance Companies, Mortgage Banks, Building Societies, etc. Risk Risk is small Risk is greater Market Regulation Commercial banks are closely regulated to prevent occurrence of a liquidity crisis. Institutions are regulated to keep them from defrauding customers. Relation with Central Bank Closely related to the central banks of the country. Indirectly related with central banks and feels fluctuations depending on the policies of central banks. 27

25. BASIC FUNCTIONS OF CAPITAL MARKETS CAPITAL FORMATION LIQUIDITY CREATION RISK MANAGEMENT 28

26. Capital Formation CMs facilitate the flow of funds from suppliers to demanders. By this way it provides increases in savings and investments into profitable areas. Provides capital accu m ulation. Convestrs small savings to large investments. 29

27. Liquidity Creation Liquidity is the ability to buy or sell a security at any time you want. This function increase the demand for the securities in both primary and secondary markets. 30

28. Risk Management Security markets permit investors to reduce risk through diversification and hedging. Diversification: Investing into more than one securities by this way we can reduce the risk.. By combining negatively correlated assets into the a portfolio (losses in some investments are offset by gains in others), we can reduce the total risk. Hedging: Individual and institutional investors use derivatives such as futures, options, forwards and swaps to hedge looses. The risks that can be hedged with them are; Foreign exchange ris k, Interest rate ris k, Commodity risk and Equity risk Is there any derivative market in Ethiopia ? 31

29. Functions of capital market 32

30. Primary Market It is that market in which shares, debentures and other securities are sold for the first time for collecting long-term capital . This market is concerned with new issues. Therefore, the primary market is also called NEW ISSUE MARKET. In this market, the flow of funds is from savers to borrowers (industries), hence, it helps directly in the capital formation of the country. Primary market provides opportunity to issuers of securities; Government as well as corporates, to raise resources to meet their requirements of investment and/or discharge some obligation . 34

31. Features of Primary Market It Is Related With New Issues It Has No Particular Place It Has Various Methods Of Float Capital It comes before Secondary Market 35

32. Secondary Market The secondary market is that market in which the buying and selling of the previously issued securities is done. The transactions of the secondary market are generally done through the medium of stock exchange. The chief purpose of the secondary market is to create liquidity in securities.

33. Secondary market Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets. 37

34. Features of Secondary Market It Creates Liquidity It Comes After Primary Market It Has A Particular Place It Encourage New Investments Aids in financing the industry Ensures safe & fair Dealing 38

35. Functions of Secondary Markets Provides regular information about the value of security. Helps to observe prices of bonds and their interest rates. Offers to investors liquidity for their assets. Secondary markets bring together many interested parties. It keeps the cost of transactions low 39

36. Primary and Secondary Market 40

37. Dated Government Securities 41 Dated Government securities are longer term securities and carry a fixed or floating coupon (interest rate) paid on the face value, payable at fixed time periods (usually half-yearly). The tenor of dated securities can be from 1 year to 30 years. The nomenclature of a typical dated fixed coupon Government security has the following features - coupon, name of the issuer, maturity and face value.

38. Types of Dated Securities 42 Fixed Rate Bonds These are bonds on which the coupon rate is fixed for the entire life of the bond. Most Government bonds are issued as fixed rate bonds. Floating Rate Bonds Floating Rate bonds are securities which do not have a fixed coupon rate and the coupon is re-set at pre-announced intervals based on a specified methodology. The coupon is re-set at predetermined intervals (say, every six months or one year) by adding a spread over a base rate . Zero Coupon Bonds Zero coupon bonds are bonds with no coupon payments. Like Treasury Bills, they are issued at a discount to face value.

39. Types of Dated Securities 43 Bonds with Call/ Put Options Bonds can also be issued with features of optionality wherein the issuer can have the option to buyback (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. The Government has the right to buyback the bond (call option) at par value (equal to the face value) while the investor has the right to sell the bond (put option) to the Government at par value at the time.

40. Types of Dated Securities Special Securities In addition to Treasury Bills and dated securities issued by the Government under the market borrowing programme, the Government issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation, etc. as compensation to these companies in lieu of cash subsidies. STRIPS (Separate Trading of Registered Interest and Principal of Securities) STRIPS are instruments wherein each cash flow of the fixed coupon security is converted into a separate tradable Zero Coupon Bond and traded. For example, when ETB 100 of the 8.24% is stripped, each cash flow of coupon (ETB 4.12 each half year) will become coupon STRIP and the principal payment (ETB.100 at maturity) will become a principal STRIP. These cash flows are traded separately as independent securities in the secondary market. 44

41. Auction vs dealer market A uction market trades  directly between a buyer and a seller . A dealer market uses a middleman or “market maker. Auction markets  serve to connect buyers and sellers in the most efficient manner possible .  45

42. Famous Secondary Markets worldwide New York Stock Exchange NASDAQ The London Stock Exchange The Tokyo Stock Exchange Shanghai Stock Exchange 46

43. New York Stock Exchange Founded on March 8, 1817 Location New York City U.S. Currency US $ Largest stock exchange in the world by dollar volume or market capitalization Second largest by number of companies The NYSE is an auction market that uses specialists (designated market makers), where an individual are typically buying and selling between one another 47

44. NASDAQ Is an American stock exchange National Association of security Dealer Automated Quotation Nasdaq is an online global marketplace for buying and trading securities—the world's first electronic exchange. It is the largest electronic screen based equity security trading market in united states and fourth largest market capitalization in the world Founded in 1971 by the National Assocation of Securities Dealers (NASD) the Nasdaq is a dealer market  with many market makers in competition with one another. Where the market participants are not buying and deleing to one another directly but through the dealer. 48

45. The London Stock Exchange Located in the city of London, United Kingdom and founded in 1801 London Stock Exchange is the fourth largest exchange in the world after New York Sock Exchange, NASDAQ and Tokyo stock exchange. It is the largest exchange in Europe 49

46. The Tokyo Stock Exchange founded in may 1878 Tokyo Stock Exchange is the largest stock exchange in Japan, headquarter in its capital city of Tokyo It is the third largest stock market in the world 50

47. Shanghai Stock Exchange Shanghai Stock Exchange was reestablished November 1990 and began December 1990. The Shanghai Stock Exchange (SSE) is the largest stock exchange in mainland China.  Today the ninth largest stock exchange in the world Stocks, funds, bonds, and derivatives are all traded on the exchange. 51

48. Indirect vs. Direct Finance Indirect finance Borrowers and lenders meet through a financial intermediary (e.g. bank) Loan is a liability for borrower, and asset for a bank Direct finance Borrowers sell securities directly to lenders e.g. corporate and Treasury bonds 52

49. Role of Financial Intermediaries Financial intermediaries play at least one of the four economic functions : Providing maturity intermediation Risk reduction via diversification Reducing costs of contracting and information processing Providing a payments mechanism 54

50. Maturity intermediation:by issuing its own financial claims the commercial bank in essence transforms a longer-term asset into a shorter –term one by giving the borrower a loan for length of time sought and the investors/depositor a financial asset for the desired investment horizon.This is called maturity intermediation. 55 Providing maturity intermediation

51. This economic function of financial intermediaries-transforming more risky assets into less risky ones-is called diversification. Even though individual investors can do it on their own,they may not be able to d o it as cost effectively as a financial intermediary, depending on the amount of funds they want to invest. Attaining cost effective diversification in order to reduce risk by purchasing the financial assets of a financial intermediary is an important economic benefit for financial markets. 56 II. Risk reduction via diversification

52. III. Reducing the cost of contracting and information processing. Investors purchasing financial assets must develop skills necessary to evaluate an investment. In addition to the opportunity cost of time to process the information about the financial asset, the cost of this information must also be considered. All these costs are information processing costs. The costs of writing loan contracts are referred to as contracting costs . Another dimension to contracting costs is the cost of enforcing terms of loan agreement. So that, economies of scale can be realized in contracting and processing information because of amount of funds managed by financial intermediaries.The lower costs increase to the benefit of investor who purchases asset and the issuer of financial assets. 57

53. IV. Providing Payment Mechanism. The previous three economic functions may not be immediately obvious. This last one should be. Most transactions made today are not with cash. Payments are made using checks, credit cards, debit cards and electronic transfers of funds. Financial intermediaries provide these methods for making payments. 58

54. Role of Depositories Depositories are institutions which hold your securities (Shares, bonds, debentures, Mutual Fund Units etc.) in electronic form. They are responsible and accountable for safe-keeping of your securities and keep a record of your holdings and transactions in securities. Depository interacts with its clients or investors through its agents, called Depository Participants (DP). To avail the services provided by a Depository, one needs to open Depository account, also known as Demat account, with any DP.

55. Investment is not gambling. You need to put your effort for your money to work for you. You must know - what you are investing in? who you are dealing with? where to go for help? Do not believe in rumours / market tips. Dot take it. Don’t give it. Market timing is impossible for small investor. Remember 60

56. "An investment in knowledge pays the best interest." Benjamin Franklin

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58. Assignment Individual Assignment download any paper related to Financial Market or Financial Asset make and made Article review by including criticism. 64

59. 2. Group Assignment Make a group of maximum 5 no and make Group 1: Industry Analysis Group 2: Company Analysis Group 3: Technical Analysis and Efficient Market Theory. 65

60. Weekend Program Group Name Title Mesfin Admasu Industry Analysis Mesfin Tesfaye Betelihem Desta Selamawit Temesgen Kalkidan Adane Amir Ayub Industry Analysis Seid Mohamed Abdulhafin Adem Mohamed Safi 66

61. Weekend Program Group Name Title Alem Kebede Company Analysis Robel Abate Daniel Negussie ?? Zerihun ?? Yibza Teshome Technical Analysis and Efficient Market Theory. ?? Tadess Tsegaw Solomon Tolera Yared ?? Zarihun 67

62. Weekend Program Group Name Title 68

63. Evening Program Group Name Title 69

64. Evening Program Group Name Title 70