Capital Market – SS2 Economics Lesson Note (Third Term)

Capital Market is a market for medium and long-term loans. The capital market serves the needs of industries and the commercial sectors. It comprises all institutions which are concerned with either the supply of or demand for long-term loans. The capital market provides a system by which money for investment is distributed to institutions which require funds for their further growth.

Behavioural objectives

By the end of the lesson, students should be able to:

1. define the capital market and state its functions;
2. distinguish between the primary and the secondary securities market;
3. explain how the stock exchange operates;
4. state the functions and participants of the stock exchange and the instruments traded there;
5. list examples of development banks in Nigeria and state their functions.

Functions of the capital market

1. It helps to provide long-term loans to investors.
2. It helps to mobilise savings for investment purposes.
3. It helps to enhance the growth and development of merchant banks.
4. It allows the general public to participate in the running of the economy.

What is the primary or first-tier securities market?

A primary market is a market where new securities (shares, stock, bonds, etc.) are either bought or sold. That is a market where securities are traded for the first time. The operators in this market are the issuing houses such as stockbrokers, merchant banks, commercial banks, mortgage banks, insurance companies, the Central Bank of Nigeria and the government. Investors pass on their resources to some of these institutions for investment purposes.

Thus, these financial institutions effectively play the role of financial intermediation by mobilising the savings of investors and investing them. The Securities and Exchange Commission sits at the apex of the primary market, regulating the issues of public companies and all private companies with foreign participation.

What is the secondary or second-tier securities market?

A secondary market is a market in which the buying and selling of existing securities of companies take place. It came into existence to complement the efforts of the Stock Exchange market towards funds mobilisation for investment. The second-tier securities market is an appendage of the Stock Exchange and therefore serves to assist it. The major participants in this market are stockbrokers and banks such as acceptance houses, investment banks, issuing houses, etc. The mode of operation in this market is similar to that of the first-tier securities market but less restricted.

The centre of activities for the secondary market is the Stock Exchange, which provides a market in which holders of existing quoted shares wishing to sell such shares can make contact with individuals and institutions who are interested in buying them. Hence the secondary market is dominated by the Stock Exchange, which provides a forum for trading in securities. Such a forum is necessary since many of the buyers of new securities will eventually resell them.

What is the stock exchange?

Capital serves as the nucleus of any functional business unit. The need to source for this factor becomes a major focus of the finance manager. Registered companies or limited liability companies need funds in large volume, so they must source for funds. A market which provides an answer to this is the stock exchange market.

The Stock Exchange is a highly organised market where investors can buy and sell existing securities such as shares, debentures and stock. The Stock Exchange serves as a medium through which companies raise capital for growth and development. The stock exchange market ensures that every transaction must follow prescribed sets of rules and regulations, which are complex.

The Lagos Stock Exchange, which is an essential part of the capital market, was established in 1960 through an Act of Parliament, with branches in Abuja and Port Harcourt. All public limited liability companies are quoted on the stock exchange.

How the stock exchange operates

A transaction at the stock exchange is facilitated by brokers and jobbers. Only members are permitted to trade directly at the exchange. The actual dealers (participants) in securities are the jobbers, who tend to specialise in particular types of stocks, while the brokers act as agents for potential buyers. A broker working on behalf of a client will approach the jobber with the intention of knowing the price.

The jobber will then quote two prices: a higher price as the selling price and a lower price as the buying price. The difference is the jobber’s turn. When the broker signifies his intention to buy, the necessary documents will be prepared.

The shares of well-known companies are known as blue chips, while gilt-edged refers to government stocks. Prices of shares are quoted cum-div or ex-div. Cum-div denotes a price at which the holders of such shares have the right to receive the next dividend payable, while ex-div denotes a price at which the holder of such shares has no right to receive the next dividend.

Two documents are prepared to speed up transactions: the contract note and the transfer note.

A contract note is a document sent by a stockbroker to his client to confirm a purchase or sale made on his behalf, while a transfer note is used to transfer ownership of shares.

Functions of the stock exchange

1. The Stock Exchange market serves as an avenue for raising capital for business growth.
2. It provides employment opportunities for a vast number of people, e.g. brokers, jobbers, clerks and others.
3. Information which informs business decisions is made available to foreign and local investors through the stock exchange.
4. The Stock Exchange provides a yardstick for measuring the performance of quoted companies.
5. The Stock Exchange provides an avenue for the public to invest their idle funds by subscribing for shares.
6. Dividends that accrue to shareholders serve as income and help to improve their living standards.

Participants in the stock exchange

The following are the participants in the stock exchange:

1. Public limited liability companies, e.g. Dunlop Nig. Plc, Access Bank Plc, First Bank of Nigeria Plc, Zenith Bank, Guinness Nigeria Plc, UTC Nigeria Plc, Longman Nigeria Plc, etc.
2. Brokers
3. Jobbers
4. Speculators (bull, bear and stag)
5. Government
6. Issuing houses

Instruments traded in the stock exchange market

The instruments used in the stock exchange market are shares, stock and debentures.

1. Shares and stock: Stocks and shares are securities purchased by individuals, which are evidence of contributing part of the total capital used in running an existing industry. Shareholders and stockholders are entitled to dividends.
2. Debenture: In financing a business, the owner’s fund (equity) can be supplemented with debt. A debenture is a debt instrument which entitles the owner to a series of cash flows known as interest. A debenture holder is a creditor to a business, unlike the shareholders.

What is a development bank?

A development bank is a financial institution set up purposely to offer medium and long-term loans meant for development. It provides loans for projects in the areas of agriculture, commerce and industry.

Examples of development banks in Nigeria

1. BOI: Bank of Industry
2. NARDB: Nigerian Agricultural and Rural Development Bank
3. FMBN: Federal Mortgage Bank of Nigeria
4. UDB: Urban Development Bank
5. NEB: Nigerian Education Bank
6. NEXIM: Nigerian Export and Import Bank
7. NACB: Nigeria Agricultural and Co-operative Bank

Functions of development banks

1. Provision of long-term loans for capital projects.
2. Implementation of government industrial development policies.
3. Supervision of projects.
4. They advise both the government and industrialists.
5. They underwrite securities issues.
6. They contribute to manpower development and provision of technical support.
7. They conduct extensive studies on the industrial sector, e.g. feasibility studies.
8. They monitor and enhance general economic development activities.
9. They research industrial development.

Evaluation

1. Define the capital market.
2. Distinguish between the primary and the secondary securities market.
3. State four functions of the stock exchange.
4. What is a debenture, and how does a debenture holder differ from a shareholder?
5. List four development banks in Nigeria and state two functions of development banks.

Assignment

1. A government treasury bill is a form of debt instrument which falls due for repayment after _____. (a) 3 months (b) 9 months (c) 2 years (d) 5 years (e) 10 or more years
2. A stockholder partakes of the profits of a limited liability business by receiving _____. (a) shares (b) profits (c) wages and salaries (d) dividends (e) gifts
3. A debenture holder is entitled to payments in the form of _____. (a) allowance (b) interest (c) salary (d) donation
4. Long-term loans can be secured from _____. (a) commercial banks (b) discount houses (c) development banks (d) acceptance houses
5. In the capital market, money can only be borrowed for _____. (a) long-term (b) short-term (c) capital projects (d) public utilities