Types of Financial Markets and Their Roles

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By: Site Engineer, Staff

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FINANCIAL MARKETS

There are several instruments available through which funds can be raised in the money market. The use of the instrument varies from country to country and often depends on the development of the economy.

The instruments used in the Nigerian money market are as follows:

1. Certificates of Deposit

A Certificate of Deposit is a receipt from a bank for deposit of funds for a specified period of time at a specified interest rate. It is an inter-bank. Debt instrument and serves as a means for channeling commercial banks’ cash surpluses to merchant banks that are the main issuers of the instrument, there are two types of Certificates of Deposit: Negotiable Certificates of Deposit (NCD) and Non-Negotiable Certificates of Deposit (NNCD).

  • A Negotiable Certificate of Deposit (NCD) is a promise by a bank to pay the principal and interest at the maturity of the deposit. It is a negotiable instrument, which has a maturity range of 3 and 36 months.
  • Non-Negotiable Certificates of Deposit (NNCD) have features of a time deposit receipt. As they are not negotiable, they are normally held to maturity. The maturity range is also between 3 and 36 months.

2. Treasury Securities

These are short-term obligations of the federal government to pay the bearer a fixed sum of money after a specified number of days from the date of issue. The Central Bank of Nigeria auctions the instruments for the Treasury at a discount through competitive and non-competitive bidding. The two treasury securities in Nigeria are Treasury Bill and Treasury Certificates.

(a)        Treasury Bills are 91 days discount obligations of the federal government. The return of the bill is the difference between the face value and the purchased value of the instruments.

(b)        Treasury Certificate is Federal Government obligations that have maturities of one or two years. The instrument was introduced in Nigeria in 1968 to bridge the maturity gap between the short tenure treasury bills and the long-tenured development stocks. The Treasury Certificates are similar to Treasury Bills in all respects except that they have longer maturities and consequently higher returns. They are also issued on a discount basis.

Both the Treasury Bill and Certificates are considered part of the liquid assets of banks in the computation of their liquidity ratio.

3. Bankers Acceptance

A banker’s acceptance is a bill of exchange of draft accepted by the drawee bank specifying that a certain amount will be paid after a specified period of time. The drawee bank accepts the draft by writing on the draft the word “accepted” with the appropriate authorized signature across the face of the draft. By the acceptance, the drawee bank acknowledges its obligation to honor the draft on the due date. With the acceptance, the payee at a fine rate of discount can discount the bill of exchange or drat. The instrument becomes a desirable credit instrument since it is now the obligation or the liability of a bank. The drawee bank is paid a fee for endorsing its acceptance on the draft. The maturity period ranges between 30 days and 270 days. The most common maturities are 90 and 180 days.

4. Eligible Development Stocks

Investment in Federal Government of Nigeria Development loan stocks and state government development bonds and stocks less than 3 years maturity is regarded as liquid assets of a bank in the computation of its liquidity ratio. A secondary market exists for the securities as they are quoted on Nigerian stock exchange. New issues of these investments are really capital instruments; thus, they can be regarded as long term debt instruments.

5. Commercial Paper

A commercial paper is a short-term unsecured promissory note issued by a company at a discount to an interested investor for cash for a specified maturity period. The inventors in the commercial paper are usually high net worth individuals, institutional investors such as pension funds, insurance companies, banker, etc. Commercial papers have a maturity range of 30 days and 270 days.

Commercial papers are categorized into two classes:

  • Dealer Papers, and
  • Directly Placed Papers.

Dealer papers are commercial notes placed with investors through a dealer, which may be a back, short notes placed directly with investors by the company issuing the promissory notes.

6. Bank Deposit

This is the placement of funds by an investor/depositor with a bank at an agreed rate of interest. There are various types of bank deposits and they are differentiated by their maturities:

(a)        Call Deposit: This is a deposit of funds made with no specified maturity period. Either the bank or the depositor can terminate the arrangement by giving the other party due notice based on the agreed notice period. The recall notice can be 24 hours, 7 days, 1 month, etc. The rate of interest applicable on the deposit is normally agreed upon between the bank and the call depositor.

(b)       Fixed Deposit: This is a deposit of fund with a bank for a fixed period of time at a specified rate of interest, which could be fixed, or floating. In the case of a floating rate deposit, the interest rate will be linked to a base rate which could be the prime lending rate of the bank or the Central Bank of Nigeria minimum Rediscounting Rate. The maturity of the deposit can vary from a few days to any number of years. The deposit may or may not be certified with a deposit receipt or certificate.

The main components of the Siberian money market are the discount market and the inter-bank markets.

The Discount Market: This is the market, which trades instruments eligible for rediscount at the central bank of the country. The discount houses and other members of the money market association of Nigeria organize the market. The instruments being traded in the market currently are limited to Treasury Securities.

The Inter-Bank Market: This is the market between banks, which trades the temporary surpluses, and deficits of the banking system.

The Capital Market

The Capital Market is the market for long-term funds. The instruments or securities traded in the capital market are called Capital Market Instruments. However, the capital market has both securities based segment (the stock market i.e., the stock exchange) and non-security base segment (the market for long-term loans).

Capital Market instruments can be categorized into three major groups:

Debt Instruments

The debt instrument is long-term loans raised by a company or government or government parastatal for which interest is paid and at a fixed rate. A debt instrument has a nominal value, which is the debt owed by the issuer, and interest is paid at a stated coupon rate on this amount.

For example, if a company issues 12% loan stock, the coupon rate will be 12% of the nominal value of the stock, so that N1,000 stock will receive N120.00 interest.

Debt instruments issued by a company are usually evidenced in the form of debentures. Debt instruments issued by the government can also be in the form of bonds. In Nigeria, Federal Government debt instruments are evidenced in the form of Federal Government loan stock. Whatever the form the debt instruments take, it is an evidence of indebtedness of the issue specifying the rights of the holder and the duties of the issuer. Debt instruments are, usually redeemable.

First-Tier Securities Market and Second-Tier Securities Market

To encourage small and medium private enterprises (with greater emphasis on indigenous business) to seek quotation without necessarily lowering the standard of listing requirements the Nigerian Stock Exchange established the second-tier securities market (SSM) in 1985. The listings quoted on (SSM) are groomed to seek full listing later. Below are the distinguishing factors between the two.

First-Tier Securities Market (Main List)

  1. Companies must be public companies
  2. Application for listing must be sponsored by one of the dealing members of the exchange.
  3. Date of the latest audited report must not be more than nine month
  4. Not less than 25% of the issued capital must be made available to the public
  5. The company must have five years trading record
  6. Annual quotation free is based on the share capital of the company
  7. The amount that can be raised is limitless depending on the borrowing powers of the company
  8. The number of shareholders must not be less than 300
  9. Companies are required to submit a quarterly, half-yearly and annual statement of account

Second-Tier Securities Market (SSM)

  1. Companies must be public companies
  2. Application for listing must be sponsored by one of the dealing members of the exchange.
  3. Date of the latest audited report must not be more than nine month
  4. Not less than 10% of the equity capital must be made available to the public.
  5. The company must have three years trading record.
  6. A flat annual charge of N5,000 is payable as quotation fee.
  7. The amount that can be raised cannot currently exceed N20 million
  8. The number of shareholders must not be less than 100.
  9. Companies are required to submit an only half-yearly and annual statement of account.

Stock Brokers

Stockbrokers are key operators in the stock market. They are members of the stock exchange who buy and sell securities on behalf of the investing public. Stockbrokers are required at all times to obey the rules and regulations set for dealing members on the stock exchange. Apart from acting as key operators in the secondary market, stockbrokers also sponsor issues to the stock exchange for listing; underwrite and handle primary distribution of securities, and provide investment/management advisory services.

Stock Market Operators

The principal active operators on the Nigeria stock market include the stock exchange, stockbrokers, investment advisers, issuing houses and registrars.

The Nigerian Stock Exchange

The stock exchange is a market place where listed securities (such as; bonds, debentures, stocks, and shares) of varying types are bought and sold. The Nigerian Stock Exchange is the center point of the Nigerian capital market.

It provides a mechanism for mobilizing private and public savings and making such funds available for productive purposes. The exchange assists in the allocation of the nation’s capital resources among numerous competing alternative use, therefore, serving as an aid in the financing industry. The exchange also aids in the determination of prices of securities by matching buy and selling order.

The exchange also provides a means for trading in existing securities, thus, making the securities marketable. This encourages investors to invest in listed securities. The stock exchange also represents an ideal setting for smart and daring speculators to make a fortune with relatively little effort in terms of contributing anything of substance to national output; but also a remarkably easy means for the unwary to lose a fortune through false judgment.

The exchange also assists in transmitting information of price and trading volume to the public. As a means of protecting investors, the exchange causes the release of such information on listed companies, particularly as regards financial condition. The exchange also protects security owners through regulations designed to eliminate dishonest and irregular practices in the brokerage business.

The ownership of the Nigerian Stock Exchange (NSE) is vested in its members. There are two types of membership:

  • Ordinary, and
  • Dealing with members.

An ordinary member (institution or individual) of the NSE is a member who has, in accordance with the Articles of the Exchange, taken up qualifying shares of the issued share capital of the exchange and has been admitted into the register of members.

A dealing member (referred to as a stockbroker) is a person or institution who in addition to being an ordinary member, is licensed to buy and sell securities on the trading floor of the exchange on behalf of the investing public

The NSE is a self-regulatory organization in the capital market: The Securities Exchange Commission (SEC) Degree of 1988 provides that SEC can delegate part of its functions to the exchange.

The instruments traded on the NSE include:

  • Federal Government Development loan stock and state revenue bonds;
  • Commercial and industrial loan or debenture stocks; and
  • Ordinary shares.

The NSE provides a two-tier market structure, consisting of the followings:

(a) The official list or first-tier securities market which covers the vast majority of securities, and

(b) The second-tier securities market.

Listing on the Nigerian Stock Exchange

Listing is the admission of a company’s capital or market instructions to the trading floors of the stock exchange.

Before its admission, the company must have complied with the listing requirements as embodied in the Stock Exchange Green Book.

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