Presentations_on_Ethiopian_Capital_Market_Related_Focused_Research.pdf

How Do Stock Markets
Work?
As Presented by Asnake E.
Asnake E. Jul - Aug, 2019

Contents
• Historical Background
• Definition of Terms
• The Financial Market
• The Benefits of Financial Markets
• Stock Exchanges
• Problems of Stock Exchange
• Stock Market Indexes
• Bull and Bear Markets, and Short Selling
• Stock Exchanges: USA Example
• Stock Exchanges: Africa’s Experience
• Pre-requisites for Establishing a Stock Exchange Market
1

Contents (Cont’d)
• Pre-requisites for Establishing a Stock Exchange Market
• How Does the Economy Affect the Stock Market?
• Role of Stock Markets
• Types of Stocks/Shares
• How are Stock Prices Determined?
• Buying and Selling Shares
• Trade Dates vs. Settlement Dates
• Stock Market Crashes
• How Do Investors benefit-Capital gain & Dividends
• Analyzing Stocks
• Approaches to Stock Market Investing
• Financing the Stock Exchange
2

Historical background
• Antwerp was the commercial center of Belgium, And it is generally accepted that they had
the world’s first stock market system in the 1500s.
• The first-ever publicly-traded stock was the Dutch East India Company (VOC), which began
trading in the Early 1600s. The Amsterdam Stock Exchange was the world’s first official
(formal) stock exchange. When it began trading the VOC’s freely transferable securities,
including bonds and shares of stock.
• The first major stock exchange was the London Stock Exchange, which opened in 1698.
• The New York Stock Exchange officially opened for trading in 1817, although the founders
first began trading securities in New York under the Buttonwood Agreement which was
signed in 1792.
3

Definition of Terms
 The stock market is an organized market for buying and selling stocks and other
financial instruments known as securities on specific locations called stock exchanges.
 Stock exchanges are secondary markets, where existing owners of shares can
transact with potential buyers.
 Stocks, or shares of a company, represent ownership equity in the firm, which give
shareholders voting rights as well as a residual claim on corporate earnings in the
form of capital gains and dividends.
4

The Financial Market
 The four main financial markets are the share or equity market, the fixed
interest or bond market, foreign exchange market, and the derivatives market.
5

The Benefits of Financial Markets
 Promote private sector development,
 Liquidity function: financial markets enable security holders to easily convert their
investment in securities into cash at the prevailing market price,
 Helps mobilize local savings and makes resources available for local decision making,
 Increases remittances and facilitate their use: Instead of depositing their money in
the banks, the diaspora community can invest their money in corporate bonds and
share,
 Leads to improved corporate governance and promotion of specialized financial
institutions and services,
6

The Benefits of Financial Markets
(Cont’d)
 Help in resource allocation: in a market economy, issues of securities help raise
capital for projects whose outputs are in the highest demand by society, and those
enterprises which are most capable of raising productivity,
 Allow deconcentration of ownership- by allowing the middle class and the poor to own
shares of companies,
 Improve accounting and auditing standards,
 Promote efficient financial system, and
 Rewards sound economic policies and create tools to conduct monetary policy.
7

Stock Exchanges
 stock markets are part of the larger financial markets
 Stock Markets trades are conducted on stock exchanges. Companies that need
to raise capital and satisfy specific requirements must be listed in order for
their stocks to be traded at these exchanges. The capital raised through the
sale of the company's stock, giving a portion of its ownership to investors in
exchange for cash, is called equity financing.
 Brokers and dealers handle stock exchange transactions. These professionals
facilitate the transactions of financial assets. Brokers execute trades behalf of
clients and receive commissions and fees in exchange for matching buyers and
sellers. Dealers have their own inventories of securities and trade from their
own portfolios. They earn income by selling financial instruments at prices that
are greater than the prices the dealers have paid for them. Dealers and
brokers may act purely as agents of their clients or trade as owners of
inventory of financial assets.
8

Stock Exchanges (Cont’d)
 Some stocks can be bought and sold outside of stock exchanges.
Stocks traded outside of stock exchanges are referred as unlisted,
or over-the-counter (OTC) stocks. These stocks are usually traded by
telephone or by computer. Buyers and sellers of these OTC stocks
commonly trade through a dealer, or “market maker”, who specifically
deals with the stock.
9

Stock Exchanges (Cont’d)
 As a financial infrastructure, a good stock exchange market performs basic
functions including serving as: a source for financing new investments; a
mechanism for mobilizing savings; a key platform for investment diversification and
efficient use of capital through a market for corporate control; a mechanism for
monitoring investments through information dissemination.
 Exchanges also act as the clearinghouse for each transaction, meaning that they
collect and deliver the shares, and guarantee payment to the seller of a security.
This eliminates the risk to an individual buyer or seller that the counter party could
default on the transaction.
 For the average person to get access to these exchanges, they would need a
stockbroker. This stockbroker acts as the middleman between the buyer and the
seller.
10

Problems of Stock Exchange
Listing
 Significant costs associated with listing on an exchange, such as listing fees and
higher costs associated with compliance and reporting.
 Burdensome regulations, which may constrict a company's ability to do
business.
 The short-term focus of most investors, which forces companies to try and beat
their quarterly earnings estimates rather than taking a long-term approach to
their corporate strategy.
11

Stock Market Indexes
 The term “stock market” often refers to one of the major stock market indexes, such as
the Dow Jones Industrial Average or the S&P 500. Because it’s hard to track every
single stock, these indexes include a section of the stock market and their performance
is viewed as representative of the entire market.
 Such indices are usually market capitalization weighted, with the weights reflecting the
contribution of the stock to the index.
 In addition to individual stocks, many investors are concerned with stock indices (also
called indexes). Indices represent aggregated prices of a number of different stocks,
and the movement of an index is the net effect of the movements of each individual
component. When people talk about the stock market, they often are actually referring
to one of the major indices such as the Dow Jones Industrial Average (DJIA) or the S&P
500.The DJIA is a price-weighted index of 30 large American corporations. In addition
to the DJIA, other widely watched indices in the U.S. and internationally include:
▪ S&P 500 (USA)
▪ Nasdaq Composite (USA)
▪ TSX Composite (Canada)
▪ FTSE Index (UK)
12

Bull and Bear Markets, and Short
Selling
 Bull market is used to refer to a stock market in which the price of stocks is
generally rising.
 The Bull market is when everything in the economy is great, people are finding
jobs, gross domestic product (GDP) is growing, and stocks are rising. Things are
just plain rosy! Picking stocks during a bull market is easier because everything is
going up.
● Optimistic outlook, investor confidence
● Prices rising or expected to rise
● Can apply to anything that is traded
13

Bull and Bear Markets, and Short
Selling (Cont’d)
 Bear Markets :characterize the attitude of investors who believes that a
particular security or market is headed downward.
 A bear market exists when stock prices are overall declining in price
 Investors can still profit even in bear markets through short selling. Short selling
is the practice of borrowing stock that the investor does not hold from a
brokerage firm which does own shares of the stock. The investor then sells the
borrowed stock shares in the secondary market and receives the money from
that sale of stock. If the stock price declines as the investor hopes, then the
investor can realize a profit by purchasing a sufficient number of shares to
return to the broker the number of shares they borrowed at a total price less
than what they received for selling shares of the stock earlier at a higher price.
If investors believe the economy is growing, then they will invest in stocks.
14

Stock Exchanges: USA Experience
 The New York Stock Exchange (NYSE) is a physical exchange, with a hybrid
market for placing orders electronically from any location as well as on the trading
floor (the open outcry system). Orders executed on the trading floor enter by way
of exchange members and flow down to a floor broker, who submits the order
electronically to the floor trading post for the Designated Market Maker("DMM") for
that stock to trade the order. NYSE has 2,800 listed companies-including the largest
US companies like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and
Wal-mart
 The NASDAQ is an electronic exchange, where all of the trading is done over a
computer network. The process is similar to the New York Stock Exchange. One or
more NASDAQ market makers will always provide a bid and ask price at which they
will always purchase or sell 'their' stock. NASDAQ is a virtual market called an
“over the counter (OTC) market. It has no central location or floor brokers. Trading
is done through a computer and telecommunications network of dealers. NASDAQ
has about 4,000 listed companies-and most of the technology companies-including
Microsoft, Cisco, Intel, Dell and Oracle
15

Stock Exchanges: Africa’s
Experience
 Twenty nine of the 54 African countries have stock markets representing the
capital markets of 38 African countries.
 In the northern part of Africa, Morocco has established the Casablanca Stock
Exchange as early as 1929, while Egypt founded the Egyptian Exchange in
1883.
 Similarly South Africa, Nigeria, Namibia, and Zimbabwe have their own vibrant
stock exchanges.
16

Pre-requisites for Establishing a
Stock Exchange Market
 Contractual saving institutions- pension funds and life insurance;
 The accounting and audit infrastructure;
 The legal and governance structure;
 The independent regulatory and supervisory infrastructure (this can be established upon
setting up the market);
 Macroeconomic stability;
 Adequacy and independence of the judicial system;
 Security;
 Good corporate governance;
 Business environment-suitability of the country in terms of ease of doing business, starting
business, employing workers;
 Potential investor base;
 Potential issuer base;
 Financial literacy; and
 Technological factors
17

How Does the Economy Affect
the Stock Market?
 When the overall economy is robust and growing, people become optimistic
about prospects for business and the stock market goes up.
 Likewise, when investment interest rates fall, the stock market generally rises.
 When interest rates rise, the market goes down as the investors are gaining
higher yield on other investments such as bonds and even bank deposits.
 When the overall economy is in decline, investors lose confidence and the stock
market goes down.
18

Role of Stock Markets
 When properly managed and run, stock exchanges play important positive roles
in national economies. By providing places for buyers and sellers to trade
stocks and other securities, stock markets ideally encourage investment,
enabling corporations to obtain funds and expand their businesses.
 Corporations usually issue new securities in what is known as the primary
market, with the help of investment banks. Investment banks generally buy the
initial issue of stocks from corporations at negotiated prices and then makes the
stocks available for investors in an initial public offering (IPO).
 Stock exchanges also protect investors by upholding rules and regulations that
ensure buyers are treated fairly and receive exactly what they pay for.
19

Types of Stocks/Shares
 Common Stock
● The most basic form of ownership that a corporation issues.
● It designates that you own a fraction of the company.
● The value of a common stock is directly influenced by the successes and failures of the issuing company.
● It may or may not pay a dividend, which is the portion of the company's profits paid out to its shareholders.
● Voting rights are attached to common stock
 Preferred Stock
● They receive their dividends before common stock owners.
● If the company goes out of business, preferred stockholders are paid back the money they invested before
the common stockholders.
● For these reasons, preferred stock is generally less risky than common stock.
● The main drawback of preferred stock is that it cannot benefit as much from company profits because it
only pays a fixed dividend.
● No voting rights are attached to preferred stock
20

How are Stock Prices Determined?
➢ Stock prices are determined by supply and demand based on investor expectations
▪ If a company is expected to be profitable in the future, demand for its shares rises
and the price rises
▪ When a company’s future look les-than-profitable, demand decreases and the price
falls.
➢ Supply and demand are governed by numerous factors, both rational and irrational
(including psychological factors). The variance in supply and demand is usually due to
investor sentiment in regard to that company.
➢ The prices of shares on a stock market can be set in a number of ways, but most the
most common way is through an auction process where buyers and sellers place bids and
offers to buy or sell.
➢ The overall market is made up of millions of investors and traders, who may have
differing ideas about the value of a specific stock and thus the price at which they are
willing to buy or sell it. The thousands of transactions that occur as these investors and
traders convert their intentions to actions by buying and/or selling a stock cause minute-
by-minute gyrations in it over the course of a trading day.
21

Buying and Selling Shares
 when you buy a share of stock on the stock market, you are not buying it from
the company, you are buying it from some other existing shareholder. Likewise,
when you sell your shares, you do not sell them back to the company – rather
you sell them to some other investor.
 A potential buyer bids a specific price for a stock, and a potential seller asks a
specific price for the same stock.
22

Trade Dates vs. Settlement Dates
Trade dates are relevant for tax purposes because they can lock in a taxable gain or
loss for a given tax year. The trade date is the actual date of the trade. Settlement
dates are a bit trickier. In the US, a sale of a stock doesn’t settle until three days
after the trade date.
23

Stock Market Crashes
 A stock market crash is often defined as a sharp dip in share
prices of stocks listed on the stock exchanges.
 Various economic factors lead to crashes. A reason for stock market crashes is
also due to panic and investing public's loss of confidence.
 Often, stock market crashes end speculative economic bubbles.
 As the crash in 1987 (the Black Monday), when the Dow Jones Industrial
Average plummeted 22.6 percent—the largest-ever one-day fall in the United
States.
24

How Do Investors benefit-Capital
gain & Dividends
➢ Capital Gains.
▪ A profit made when selling stock at a higher price than they paid for it. Most people buy stock to
make money from capital gains.
▪ The increase in the price of shares beats inflation and savings' deposits.
▪ For example, if you buy 100 shares of Company XYZ at Br. 200.00 a share (a total Br.20,000
investment) and sold it for Br. 250.00 a share (Br. 25,000), you’ve realized a capital gain of Br.
50.00 a share, or Br. 5,000.00.
▪ Ethiopian tax law requires 30% capital gain tax.
 Dividends
▪ Dividends are the distribution of profits from a company to the shareholders.
▪ Investors buy stock for the dividend payments.
▪ For example, if Company XYZ declares an annual dividend of Br. 10.00 a share and you own 100
shares, you’ll earn Br. 1000.00 a year, or, Br. 250.00 paid each quarter.
▪ Ethiopian tax law requires 10% tax on dividends. In Ethiopia dividends face double taxation as
the amounts come from the after tax earnings of the company and that the recipient also pay
10% dividend tax
25

Analyzing Stocks
➢ Stock market capitalization or Market Cap: is the total value of all the
outstanding shares of the stock. A higher market capitalization usually indicates
a company that is more well-established and financially sound
➢ EPS (Earning per Share): which reflects the company’s profits as divided among
all of its outstanding shares of stock
➢ Price to Earnings (P/E) Ratio: The ratio of a company’s stock price in relation to
its EPS. A higher P/E ratio indicates that investors are willing to pay higher
prices per share for the company’s stock because they expect the company to
grow and the stock price to rise.
➢ Other financial Ratios. including
▪ Debt to Equity
▪ Return on Equity (ROE)
▪ Return on assets (ROA)
26

Approaches to Stock Market
Investing
➢ Value Investing: Value investors typically invest in well-established
companies that have shown steady profitability over a long period of time.
➢ Growth Investing: Growth investors seek out companies with exceptionally
high growth potential, hoping to realize maximum appreciation in share
price. They are usually less concerned with dividend income and are more
willing to risk investing in relatively young companies.
27

Financing the Stock Exchange
Stock exchanges raise revenue for their working capital and other needs
through the following:
➢ transaction fees paid by members for each order executed
➢ Fees paid by firms when their securities are originally listed
➢ Annual fee by firms
➢ Entrance fees from new members
➢ Sale of historic trading and market information
28

How Do Stock Markets
Work-Arguments For and
Against Stock Markets

Advocating for Stock Markets
 Stock Markets are generally perceived to help economic growth through three of their
functions: raising national savings; efficiently allocating investment resources, and making
the best use of existing resources.
 On the other hand, advocates like to point out that stock markets use more accurate market
data and provide better return to investors through equity financing as opposed to debt
financing.
 Advocates assert that the substantial development of stock markets as necessary conditions
for financial liberalization and economic growth in emerging economies.
 Stock markets play an essential role in growing industries that ultimately affect the
economy through transferring available funds from units that have excess funds (savings)
to those who are suffering from funds deficit (borrowings).
 Moreover, if an emerging economy is experiencing foreign exchange constraint, foreign
portfolio inflows could alleviate the foreign currency crunch, allowing further economic
growth.
1

Discounting the Importance of
Stock MarketsMrkets
 Economists who had investigated the performance of stock markets in some emerging
economies tend to discount the role of stock market development to economic growth.
 Detractors believe that stock markets do not influence domestic savings as both gross
domestic savings and the share of the financial assets of the household sector had been
shown to stagnate in emerging economies where the stock market boomed.
 Detractors are also not enthusiastic about foreign private inflows either. They argue that
foreign portfolio inflows can be harmful because they are inherently volatile.
2

• Financial market prices do not accurately reflect the underlying fundamentals when
speculative bubbles emerge in the market.
• Financial market liquidity may negatively influence corporate governance. Since investors
can easily sell their securities holdings in more liquid financial markets, their commitment
and incentive to exert corporate control may be weaken.
• Generates perverse incentives, rewarding managers for their success in financial engineering
rather than creating new wealth through organic growth.
• Moreover, because the stock market undervalues long-term investment, managers are not
encouraged to undertake long-term investments since their activities are judged by the
performance of a company’s financial assets, which may harm long run prospects of
companies.
3
Critics on Financial Markets

How the Stock Markets
Work-Stock Market
Players and IPO

Stock Market Players
Market participants include
▪ individual retail investors,
▪ institutional investors such as mutual funds, banks, insurance companies and hedge funds
▪ Investment banks: handle the initial public offering (IPO) of stock that occurs when a
company first decides to become a publicly-traded company by offering stock shares
▪ publicly traded corporations trading in their own shares.
▪ Stockbrokers: who may or may no t also be acting as financial advisors, buy and sell stocks
for their clients, who may be either institutional investors or individual retail investors.
▪ In case of our country, Idirs might also be participants of the stock market
1

What is an IPO?
 The primary market is where securities are created (by means of an Initial Public
Offering (IPO)) while, in the secondary market, investors trade previously-issued
securities (traded stocks) without the involvement of the issuing-companies. The secondary
market is what people are referring to when they talk about the stock market. It is
important to understand that the trading of a company's stock does not directly involve that
company.
2

What is an IPO? (Cont’d)
 Corporations usually issue new securities in what is known as the primary market, with the
help of investment banks. Investment banks generally buy the initial issue of stocks from
corporations at negotiated prices and then makes the stocks available for investors in
an initial public offering (IPO).
 To issue stocks, firms generally go to investments banks that
▪ Put together a prospectus with information for potential investors,
▪ Help determine the market price of the offering,
▪ And issue the stocks in the primary market, where they are purchased.
➢ Shares offered in IPOs are most commonly purchased by large institutional investors such
as pension funds or mutual fund companies.
3

It is a source of pride, an opportunity for business growth, and a serious legal responsibility.
Great way to get growth money for expansion.
Downside – give up control
4

 Example The Facebook IPO raised around $16 billion: $7billion for the company and the
other $9 billion or some earlier investors to sell some, or all, of their shares.
5

Is Ethiopia Ready for a
Stock Market?

Contents
• Historical Background
• Previous Attempts to open a stock market in Ethiopia
• Present Status
• Opportunities for Establishing Market for Ethiopia
• Support for Stock Market for Ethiopia
• Against Stock Market for Ethiopia
• Criteria to Establish Capital Markets
• To make the Capital Market Successful
• Benefits of a Stock Market for Ethiopia
• Challenges of Establishing Stock Markets for Ethiopia
• Conclusion: Is Ethiopia Ready for a Stock Market?
1

Historical Background
• History tells that share market has existed in Ethiopia during the Imperial regime.
• Before the nationalization of private property in 1975, there had existed a rudimentary share
market in Ethiopia. Share dealing was handled by the National Bank of Ethiopia, department of
Share Exchange and later the bank allowed other financial institutions and few private share
dealers known under the name of “Share Dealing Group”.
• The Addis Ababa Share Dealing Group was abolished by the Dergue in 1974
2

Previous Attempts to Open a
Stock Market in Ethiopia
 Ethiopia is the only country of the world's 15 most populous countries which does not have
a stock exchange
 In 1995, the National Bank of Ethiopia (NBE) undertook a study on the Feasibility of
Establishing of Securities Exchange Market in Ethiopia and also prepared a draft securities
and exchange proclamation which are awaiting government endorsement.
 In 2008, the NBE launched a capital market infrastructural development study by
international consultants under the Financial Sector Capacity Building Project. The study
included capital market infrastructure development in Ethiopia. This initiative was financed
by the World Bank (WB) based on the potential interest of the government of Ethiopia.
 Technical studies for the establishment of the Addis Ababa Stock Exchange were done by
Ernst and Young 20 years ago
3

 Currently in Ethiopia, the Government Treasury bill which is the primary government bond is
serving in the capital market within the country-it is the primary market .
 The $1 billion with its debut Eurobond with a term of 10 years and coupon of 6.625 percent
debt that Ethiopia raised can also be considered Ethiopia's participation in the international
capital market.
 Bond of Abay Renaissance Dam issued by the government can also be considered in the
primary market.
 And there are also share companies established issuing shares.
 However, there are no secondary markets for the above securities as the holders can't sell
them before their maturity dates.
4
Present Status

 A World Bank team was due to arrive in Addis Ababa in December 2019 to provide technical
help to develop the capital market;
 The stock exchange will be a critical component of building domestic savings and capacity in
Ethiopia’s private sector so that Ethiopians can take charge of their future;
 The World Bank has pledged $1.2bn to supporting financial sector growth in Ethiopia;
 The country's adoption of IFRS and auditing standards are also sighted to support the
establishment of the stock market in the country;
5
Opportunities for Establishing
Market for Ethiopia

 The privatization efforts going on would help with the supply problems, particularly if a public
offering of shares is used as the method of privatization;
 The existence of many profitable companies, which can potentially benefit from floating shares
to the public;
 The existence of institutions like the country’s pension fund, insurance companies, credit
unions, etc., with large sums of money. If allowed to invest, they would boost the demand for
securities;
 The gradual improvements of the incentive packages in the successive investment
proclamations help attract new investors including Ethiopians with foreign passports.
6
Opportunities for Establishing
Market for Ethiopia(Cont’d)

 Ethiopia’s attachment to the global economy,
 The country’s large economy compared to those of smaller African countries that have
developed their own stock markets,
 Presence of indigenous companies ready to be listed in a stock exchange,
 The World Bank’s offer of technical assistance for establishing a stock market, and
 Ethiopia’s imminent membership in the World Trade Organization.
7
Support for Stock Market for
Ethiopia

 Given the present stage of its economic development and weak institutional infrastructures,
Ethiopia can benefit more by using the bank-led financial model (contrary to the stock market
model) as its prime financial system rather than sharing the meager savings to both systems.
 Ethiopia’s weak financial infrastructure-accounting and auditing practices, standards;
 Lack of regulatory institutions;
 Non-existence of reliable accounting information;
 Absence of financial media;
 Shortage of trained manpower, and
 Shortfall of technological infrastructure.
8
Against Stock Market for
Ethiopia

 Thee existence of many private companies and individual firms. Those firms should be free
from government influence. Individuals should have the right to buy and sell their own
properties without the pressure of official authorities.
 Land and house should not be in the hands of the government. On this aspect, in Ethiopia
almost all land are under the control of the government. The changing of these policies is vital
to any privatization process.
 Infrastructure such as communication lines, information exchange ways etc. should be
accessible.
 Political stability on the country is important for foreign investors.
 All economic sectors such as trading, industry, service, agriculture must be out of the
government hand. Individuals, in any one of the economic sectors, have an ultimate
contribution to the economic development.
 Small scale firms must be established and encouraged since those firms are the backbone of
the economy.
 Government policy, particularly to economic construction, is a very dominant and important to
the improvement of infrastructure.
9
Criteria to Establish Capital
Markets

 Ethiopia should have to continue to reinforce institutional strengthening, better operational
and financial performance,
 Get some robust internationally recognized mentors,
 Consider capital market as a cheap package of funding and also as the debt and then
increase effective public debt management,
 Increasing diplomatic relations to integrate for trade, foreign direct investment and
technology transfer,
 Developing the most capable professional, regulatory, well-informed consumers and
investors in the capital market,
 Promoting international accounting standards and adherence to sound corporate
governance,
 Adopting International best practices that promote good governance frameworks,
transparency and accountability,
10
To make the Capital Market
Successful

 The Government of Ethiopia should show its commitment in setting clear policies and strategies
on capital markets as such markets could be one source of finance for the government's long
range projects,
 The 1960's Commercial Code of Ethiopia should be revised to reflect the current business
dynamics. It has to also incorporate relevant provisions with regard to stock exchanges and
corporate governance in line with internationally recognized corporate governance principles like
that of the principles of Organization of Economic Cooperation and Development (OECD),
 The role the media plays in promoting the stock exchange market is highly recognized.
Therefore, the country's media should do more in giving more coverage for business and
financial matters,
 Regulation is also needed to protect investors by ensuring that only well run businesses with a
good track record and management can offer shares to the public, contrary to many unregulated
initial public offers that have happened,
11
To make the Capital Market
Successful (Cont’d)

 In summary, For an efficient market to operate consider the following:
 Legal structure, regulation, accounting and auditing standards, macroeconomic stability,
technological infrastructure, number of companies, institutional investors, financial sector
development, public awareness of the stock market, public trust, economic growth, inflation,
FDI, domestic savings and corporate governance.
12
To Make the Capital Market
Successful (Cont’d)

 A stock exchange enables enterprises to raise capital to create growth, jobs and fight
poverty through issuing shares (equity) to long-term investors who are ready to share
the business risks.
 It provides a transparent and efficient market for raising hundreds of millions of long-
term debt, including bonds for housing and infrastructure, as in neighboring Kenya.
 It would amplify efforts by Ethiopia’s Government and banks to finance the ongoing
giant growth potential.
 A regulated stock exchange encourages savings and help investors channel these into
the most productive enterprises, boosting market size and efficiency.
 It boosts transparency by requiring companies to publish audited trading information
promptly and widely, sharing similar information benefits with smaller investors as
the Ethiopian Commodity Exchange (ECX) brings to farmers – any by encouraging
professional analysts.
13
Benefits of a Stock Market for
Ethiopia

 An exchange listing means ready liquidity for shares held by the company's shareholders.
 It enables the company to raise additional funds by issuing more shares.
 Having publicly traded shares makes it easier to set up stock options plans that are necessary
to attract talented employees.
 Listed companies have greater visibility in the marketplace; analyst coverage and demand
from institutional investors can drive up the share price.
 Listed shares can be used as currency by the company to make acquisitions in which part or
all of the consideration is paid in stock.
 But let’s not forget about diversification, which is another important benefit of investing in the
stock market that is overlooked by many.
14
Ethiopia (Cont’d)

 Ethiopia would be the most attractive investment destination in Africa, if it had a stock
market and one could invest in Ethiopian businesses as cheaply as people are now investing
through private transactions.
 A capital market with greater breadth and depth will be able to attract domestic savings.
 Small investors would be wooed to pool their savings and invest in capital market
instruments as they provide greater returns particularly in the long run. The domestic
savings mobilized in turn will be channelized into investment, paving the way for greater
and quicker capital formation.
15
Ethiopia (Cont’d)

 Providing long term finance which the banks are not doing.
 Meeting the growing need for domestic resource to finance investment.
 Providing market place and thereby enhancing the transferability, liquidity and
proprietary value of existing securities.
 Curing the excess reserve and liquidity positions of the banks.
 Enabling the National Bank of Ethiopia to enforce monetary and financial policy
objectives through indirect and open market instruments.
 Encouraging the creation of institutional savers and investors.
 Diversifying the financial market and increasing competition.
16
Ethiopia (Cont’d)

 Motivating companies to go public and widen their ownership bases.
 Enhancing information flow and corporate management, accounting and control.
 Assisting individuals, households, business firms and the financial institutions to diversify
their income and investment portfolios.
 Facilitating future privatization.
 The stock exchange will benefit Ethiopia by serving as governing instrument.
 Making exit easier for minority shareholders from underperforming or oppressing
companies.
 Cope with inflation. As the inflation rate is higher than the return from savings and
government bonds, investors look for alternative investments such as equity investments.
17
Ethiopia (Cont’d)

 Problems with the supply and demand for securities at least initially.
 Lack of awareness and willingness among Ethiopian policymakers.
 Short track record of the share companies in the country to attract buyers for their securities.
 Reluctance of a number of the companies in the country to go public and freely float their securities.
 Lack of separation of ownership and management of most of the share companies in the country.
 Lack of financial and investment experience and conservative attitude towards money of most members
of the business community.
 Little experience of mangers of companies in corporate portfolio management and underdevelopment of
the accounting and auditing professions.
 More attention of the investment regime and practice of the country to direct investment than portfolio
investment through company securities.
18
Challenges of Establishing Stock
Markets for Ethiopia

 Non-issuance of shares other than ordinary shares by the share companies, including the banking,
insurance and microfinance companies that could take the lead in the issuance and trading of
securities.
 Low level of the income and saving of most individuals and households to establish dependable
demand for securities.
 Fragility of the macro and political situation of the country to attract investment and enable
sufficient supply and demand for securities.
 Lack of capacity of the financial regulator (the NBE) to provide strong supervisory framework for a
securities market.
 Failure of the tax regime of the country to encourage creation of securities market.
19
Markets for Ethiopia (Cont’d)

 Need to set up a regulatory institution.
 We need to have stock brokerage firms and investment banks.
 Stock traders have to be trained and the local accounting and auditing firms have to build their capacity.
 Financial media has to be established. The financial media has to be established or the existing ones should
extend their financial news coverage.
20

 In The absence of interest of the government to facilitate the emergence and coalescence of Stock
market, the current stoke brokerage in out of the counter (OTC) market unfolds, and much work
is bound to be required in the future to Address the problems associated with such dealer
markets. Even worse, the present unregulated market for stock exchange in the OTC market may
Severely affect public confidence up to a level which can be counterproductive against future
pursuits toward a strong, reliable and efficient stock market. This indeed impedes the
development of stock market and dwarfs down its role in the Ethiopian economy unless prudent
Regulation is put in place.
21

You have seen the opportunities, the arguments for and against, the benefits and
the challenges of stock markets for Ethiopia and you are also living Ethiopia’s
economic and political present.
Is Ethiopia ready? It is up to you to decide!!
22
Conclusion: Is Ethiopia Ready for
a Stock Market?

Is Ethiopia Ready for a Stock
Market?-Ethiopia’s 1960
Commercial Code

 An important component of the legal and regulatory framework is required to
assure the provision of adequate information such as the requirement of
information disclosure, prohibition of improper trading practices – insider
trading, fraud, market Manipulation and minority protection against coercive
takeover bids and expropriation.
 impartial investigative press is one of the requirements of stock market.
 If the government lacks the ability, or the will, to create or enforce laws that
protect small investors, then insider dealing and price manipulation is likely to
be common.
1
Background

Background (Cont’d)
 When it comes to Ethiopia, there is no institutional, legal and policy framework
for any capital market activity in the country as financial markets are not yet
established in Ethiopia.
 And there is no system of civil courts where securities cases can be prosecuted
by a dedicated governmental authority.
 Because of the lack tight regulations we have recent experiences of failed IPOs
our country.
2

Evaluation of the Commercial
Code 1960
 The 1960 Commercial Code considers shares of companies as tradable financial
security instruments irrespective of the existence of structured stock market in
Ethiopia.
 The Commercial Code clearly enables a shareholder to withdraw from the company
by selling shares at the average price on the stock exchange over the last six
months. If the shares are not quoted on the stock exchange, the shares are sold at
a price proportionate to the company’s assets shown in the balance sheet of the last
financial year.
3

Code 1960 (Cont’d)
The shortcomings of the Code:
 The provisions requiring minimum capitals (Br 50,000) and memberships (5) for the
formation of share companies are inappropriate and unnecessary. These requirements
not only discourage new pools of resources and investments but also contravene
international best practices.
 The share company provisions have loopholes in the requirements of initial offering of
shares to the public.
 The share company law provisions are not supplemented by other legislation.
 The share company law provides regulatory and supervisory powers solely to the
Ministry of Trade. It also failed to mandate sufficient powers to the Ministry for
regulating public companies from their incorporation to ongoing operations and
corporate governance.
4

The shortcomings of the Code (Cont’d):
 The modes, materiality and accuracy of information disclosed to shareholders
meeting are deficient and inadequate.
 Before shareholders pass resolutions, the share company law failed to require full
disclosure of the rules and procedures governing the holdings of corporate assets in
the capital markets inter alia, mergers and extraordinary transactions.
 There are instances where boards, managements and controlling shareholders may
participate and involve in activities that adversely affect the interests of the
company and minority shareholders.
5

The shortcomings of the Code (Cont’d):
 The share company law provisions failed to clearly articulate the minimum
standards of companies ‘disclosure of all relevant and reliable financial and non
financial information timely and regularly standards. Moreover, the share company
law provisions had loopholes to require auditors to apply established accounting and
auditing rules and standards. It also failed to require independently audited financial
reports.
 The share company law also failed to provide boards and auditors liability of failures
to observe the sated accounting, auditing and financial reporting.
6

The Latest
Revision of the 1960 Commercial Code is underway by the Ministry of Justice.
7

How the Stock Markets
Work-Ethical Investment

Ethical Investment
 Ethical investing is often termed ESG: Environmental, Social and Governance.
 Environmental criteria looks at how a company performs as a steward of the natural
environment.
 Social criteria examines how a company manages relationships with its employees,
suppliers, customers and the communities where it operates.
 Governance deals with a company’s leadership, executive pay, audits and internal
controls, and shareholder rights.
1

Ethical Investment Decisions
 In ethical investment decisions relate the following key issues with the ESG:
1. What is the effect on investment performance?
How much investment performance do you give up by being ethical? E.g. Energy
is generally negative in ethical screens and so investment managers who couldn’t
invest in oil companies stocks (the ethical managers) outperformed those who
could (everyone else). In the other direction, there are funds that exclude only
tobacco, and these funds over the last 10 years have generally underperformed
the world index as tobacco stocks rocketed up.
2. How are the stocks chosen?
3. What are the fees? If you are going to invest ethically, you should pick an
investment manager charging fees (for his/her investment management services)
that also would be considered ethical!
2

Ethical Investment Decisions
 The problem with positive ethical investing is finding a company that is good
quality, cheap and will positively benefit society is incredibly difficult – it is rare to
find two of those qualities and so getting all three together is next to impossible.
 Would this be possible to decide ethically in investing in Ethiopian companies?
As there are no qualitative information published by businesses on their
environment, social etc. impact, it would be difficult to evaluate companies on
their ESG aspects.
3

Stock Markets - What is in
it for Us?

Contents
 So Why Should We Care about the Stock market?
 How do You Invest in the Stock Market?
 Benjamin Graham’s* 14 Investment Points
 Peter Lynch’s* Ten Golden Rules of Investing
 Sir John’s* 16 Rules for Investment Success
1

So Why Should We Care about the Stock
market?
Benefits of the stock market for individuals
 We can invest
 Career opportunities- there are many vacancies that we can compete for including investment
managers, stock analysis, other professional advisory, auditors, accountants
Why Invest in Stocks?
 Earn regular income – dividend payments
 Buy low, sell high…hopefully ☺
● Sell at higher price than you bought?-Capital gain
● Sell at lower price than you bought?-Capital loss
● When do you reap the benefits?
 To gain influence at a company.
 To outflank inflation.
 To save for retirement and other long-term financial objectives
2

Why Would You Sell Shares of Stock?
 To make a profit - capital gain.
 The stock represents too much risk.
 You are worried about the company.
 You need the money.
 You like another stock better.
3
So Why Should We Care about the
Stock market? (Cont’d)

How do You Invest in the Stock
Market?
 You can purchase individual stocks through a brokerage account. The broker acts as
the middleman between you and the stock exchanges.
 The reality is that investing in the stock market carries risk, but when approached in a
disciplined manner, it is one of the most efficient ways to build up one's net worth.
 Individuals use the stock market because the returns, on average, outpace those of
other investments, such as bonds or commodities. Stock market investing is an
excellent way to make sure your investments do better than inflation.
4

Benjamin Graham’s* 14 Investment
Points
 Be an investor, not a speculator.
 Know the asking price.
 Search the market for bargains.
 Determine if the stock is undervalued.
 Regard corporate figures with suspicion.
 Don’t stress out.
 Don’t sweat the math
 Diversify among stocks and bonds.
5

Benjamin Graham’s* 14 Investment
Points (Cont’d)
 Diversify among stocks.
 When in doubt, stick to quality.
 Use dividends as a clue for success.
 Defend your shareholder rights.
 Be patient.
 Think for yourself
* Benjamin Graham (1894-1976), called the father of value investing. His popular book “The
Intelligent Investor’’ is worth reading.
6

Peter Lynch’s* Ten Golden Rules
of Investing
 Don’t be intimidated by experts (ex spurts).
 Look in your own backyard.
 Don’t buy something you can’t illustrate with a crayon.
 Make sure you have the stomach for stocks.
 Avoid hot stocks in hot industries.
 Owning stocks is like having children. Do not have more than you can handle.
7

Peter Lynch’s* Ten Golden Rules
of Investing (Cont’d)
 Don’t even try to predict the future.
 Avoid weekend worrying. Do not get scared out of good stocks. Own your mind.
 Never invest in a company without first understanding its finances.
 Do not expect too much, too soon. Think long-term.
* Peter Lynch is and American Investor, mutual fund manager and philanthropist.
8

Sir John’s* 16 Rules for Investment
Success
 Invest for maximum total real return including taxes and inflation.
 Invest. Don’t trade or speculate.
 Remain flexible and open-minded about types of investments. No one kind of
investment is always best.
 Buy at a low price. Buy what others are despondently selling. Then sell what others
are despondently buying.
 Search for bargains among quality stocks.
 Buy value not market trends or economic value.
 Diversify. There is safety in numbers.
9

Success (Cont’d)
 Do your homework. Do not take the word of experts. Investigate before you
invest.
 Aggressively monitor your investments.
 Don’t panic. Sometimes you won’t have everything sold as the market crashes.
Once the market has crashed, don’t sell unless you find another more attractive
undervalued stock to buy.
 Learn from your mistakes, but do not dwell on them.
 Begin with prayer, you will think more clearly.
10

Success (Cont’d)
 Outperforming the market is a difficult task, you must outthink the managers of the
largest institutions.
 Success is a process of continually seeking answers to new questions.
 There is no free lunch. Do not invest on sentiment. Never invest in an IPO. Never
invest on a tip. Run the numbers and research the quality of management.
 Do not be fearful or negative too often. For 100 years optimists have carried the day
in U.S. Stocks.
* Sir John Templeton was a legendary investor and mutual find manager.
11

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