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CERTIFIED SECURITIES AND INVESTMENT
ANALYSTS
PART ONE
SECTION ONE STUDY KIT
FINANCIAL INSTITUTIONS AND MARKETS
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TABLE OF CONTENTS
CHAPTER ONE:
Financial markets in Kenya ………………………………………………………………………………4
Role and types of financial markets
The flow of funds in financial system
Financial innovation and the flow of funds
The concept of financial intermediation and disintermediation
Characteristics of a good market
The organic theory of financial markets
Definitive approaches to financial markets
Decimal pricing
Organization of securities markets
Automation of stock exchanges
CHAPTER TWO:
Marketing financial services ……………………………………………………………………..…….33
The financial services environment and consumer
Identifying and targeting financial prospects
Development and management of financial products
Traditional channels of distribution and technology driven delivery channels
Pricing financial services
Building financial consumers relationships, Consumer retention and loyalty
Benchmarking and Investor education
CHAPTER THREE:
Raising capital on the primary market …………………………………………………………………41
Initial public offerings (IPOs)
Bond issue
Municipal bond issues
Corporate stock issues
Private placements
Global primary financial markets
CHAPTER FOUR:
Foreign exchange markets ………………………………………………………………………………51
Types of foreign exchange markets
Membership and participation
Types of orders
Exchange market makers
Trading systems
Innovation for competition
CHAPTER FIVE:
Financial market institutions…………………………………………………………………………….56
Operations of money markets
Commercial banks and other deposit taking institutions
Savings and loans associations and co-operatives
Foreign exchange bureaus
Unit trusts and mutual funds
Insurance and brokerage firms
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Pension funds/schemes
Investment companies
Investment banks and brokerage houses
Micro finance institutions
Effect of syndication by commercial banks on the capital markets
Capital market regulators
CHAPTER SIX:
Trading on the secondary market………………………………………………………………….…...65
Importance of secondary markets
Trading systems
Secondary bond and equity markets
Challenges on the stock exchange
Financial futures and options markets
Classification of secondary markets
Global secondary financial markets
CHAPTER SEVEN:
Efficient market hypothesis……………………………………………………………………………77
Need for market efficiency
Types of market efficiency
Test of efficiency in the capital markets
Behavioural finance
Implication of efficient markets
Efficient market concepts and its anomalies
CHAPTER EIGHT:
Efficiency, stability and government intervention……………………………………………….…….87
Liquidity crisis
Factors affecting market stability
Bank runs and panics
Financial deepening
Financial liberation
CHAPTER NINE:
Secondary market indices…………………………………………………………………………….…97
Introduction to computing and usage of indices
Differentiating factors in constructing markets indices
Stock market indices
Market capitalization
Benchmarking using indices
CHAPTER TEN:
Informal finance………………………………………………………………………………………112
Sources of informal finance
Features of informal finance
Informal investment organizations
Challenges of informal finance
CHAPTER ELEVEN:
Professional values and ethics………………………………………………………………………116
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TOPIC ONE
FINANCIAL MARKET IN KENYA
A market can be defined as an organizational device, which brings together buyers and sellers. A
financial market is a market which financial assets (securities) such as stocks and bonds can be
purchased or sold. It brings together the parties willing to trade in a commodity, which
constitutes fluids. The respective parties in financial markets are known as demanders of funds
(borrowers) and suppliers of fluids (lenders) who come together to trade so as to meet financial
needs. The level of economic development of any country will be affected by the ability of the
financial markets to move surplus funds from certain economic units, which constitutes
individuals and corporate bodies to other economic units in need of additional funds.
Financial market can be divided into three categories: –
a) Capital and money markets.
b) Primary and secondary markets
c) Organized and over — the counter markets.
Financial Markets
Financial markets provide a forum in which suppliers of funds and demanders of funds can
transact business directly. Whereas the loans and investments of intermediaries are made without
the direct knowledge of the suppliers of funds (savers), suppliers in the financial markets know
where their funds are being lent or invested. It is important to understand the following
distinctions in the market.
Role of financial system and markets
1. Distribution of financial resources of the most productive units i.e. savings are transferred
to economic units that have channel of alternative investments (link between buyer and
seller)
2. Allocations of saving to real investment.
3. Achieving real output in the economy by mobilizing capital for investment
4. Enable companies to make short term and long term investment and increase liquidity of
shares.
5. Provision of investment advice to individuals through financial experts
6. Enable companies to raise short term and long term capital/funds
7. Means of pricing of securities e.g. NSE index shares indicate changes in share prices.
8. Provide investment opportunities i.e. savers can hold financial instruments for
investments made.
Primary and secondary market
Primary financial markets are those markets where there is transfer of new financial instruments.
Financial instruments constitute assets, which are used in the financial markets. They consists of
cash, shares and debt capital both long term and short-term e.g. commercial paper.
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The primary financial markets trade is for securities which have not been issued e.g. if a
company wants to make an issue of ordinary share capital issue of commercial paper, issues of
preference shares, debentures etc, offers and purchase will be through the primary etc.
Secondary markets — the secondary financial markets are for already issued securities. After a
thorough issue of new securities in the primary market later trading of the securities will take
place in secondary market e.g. if a company is to make public issue of ordinary share capital the
issue will take place in primary market. If the initial purchasers wish to dispose off the shares,
trading will take place in the secondary market. The only distinction between primary and
secondary markets is the form of security being traded but there is no physical separation of the
markets.
Capital and money markets
This classification is based on the maturity of financial instruments. The capital market is a
financial market for long-term securities. The securities traded in these markets include shares
and bonds.
The money market is market for short-term securities. The securities traded in these markets
include promissory notes, commercial paper, treasury bills and certificates of deposits while
capital market is regulated by capital authority; the money market is regulated by central banks.
Organized and over- counter markets
An organized market is a market which is a specified place of security trading, defined rules,
regulations and procedures for security trading. Only listed securities trade in organized market,
where exchange is through licensed brokers who are members of exchange
Conducted by accountants, auctioneers, estate agents and lawyers who were engaged in other
areas of specializations.
In 1951 an estate agent (Francis Drummond) established the first stock broking firm. He then
approached the finance minister of Kenya with an idea of setting up a stock exchange in East
Africa. in 1953 he too approached London Stock Exchange Officer and London accepted to
recognize the setting up of Nairobi Stock Exchange as an oversee stock exchange. The major
reorganization emerged in 1954 when stockbrokers emerged and registered the NSE as a
voluntary association under society‘s Act. It was registered as a limited liability company.
Stock exchange terms
1. Broker
Is an agent who buys and sells securities in the Market on behalf of his client on a commission
basis. He also gives advice to his client and at times manages the portfolio for his client. In
connection with the new issue, a broker will advise on price to be charged, will submit the
necessary documents to the quotation department the stock exchange and the capital market
authority. He may be involved in arranging for funds or for the purchase of shares and may
underwrite the issue (assure the company that shares are sold if not broker will buy them).
2. Jobber:
He is a dealer. He is not an agent but a principal who buys and sells securities in his own name.
His profit is referred to as Jobber‘s turn. Since they are experts in the markets, they are not
allowed to deal with general public but only with brokers or other jobbers to avoid exploitation
of individual investors. A Jobber will quote two prices for a share.
The bid price-which is the price at which he is willing to buy securities
Offer price-price at which he is willing to sell the shares.
The difference between offer price and the bid price is called spread price = Ask price – Bid
price. A Jobber will take stocks in his books (also called along sale) when brokers have
predominantly selling orders, and will also sell short (Short sale) when brokers are engaged in
