Dive into the institutions and challenges facing developing and emerging economies relating to their financial sector development.
Introduction- Defining the Capital Market
This course is made possible through the generous financial support of the Arab Gulf Program for Development (AGFUND). _For more information visit the Global Platform on Financial Inclusion _
Module Objectives By the end of this module, you should be able to: Understand the differences between Capital Market and other financial markets. Understand important policy issues in government regulation. Understand the major institutions that are essential in a Capital Market.
Capital Market Development Nearly every country in the world has turned its attention in recent years to Capital Market Development.
Capitalist principles and free market economic theory have become favored tools, even in countries with a long history of socialism and nationalized industries.
A market can be located at a physical location, such as a stock exchange.
A market can exist without a physical location, such as an exchange that is run entirely over the internet, such as NASDAQ in the United States and most over-the-counter markets.
Market Forces and Market Products
Although we refer generally to the Capital Market, we must understand that the Capital Market consists of numerous segments.
Much of that activity occurs on formal stock exchanges, but much of it occurs through over-the-counter transactions and through private investment agreements.
An equity investor receives an economic return only through which of the following Select all that apply
A common misconception among many people is that a capital market principally is located within a stock exchange. As we will see, that is not true.
There is an enormous amount of capital market activity that takes place outside the confines of a stock exchange.
A stock exchange is an important component of a capital market, but it is only one component, and deals with only a limited aspect of the entire capital market.
Market Products: Financial Instruments
Not all stocks are equal, just as not all refrigerators are equal. Buyer interest will depend on differences in quality and pricing.
How do buyers (investors) know the quality of the financial instruments? That is perhaps the most difficult issue facing the capital market. If buyers are not confident that they know the quality of what they are purchasing, they will put their funds into alternatives, such as real estate, gold, jewelry, and bank funds. Much of the entire infrastructure that has been developed for the capital market has been motivated by the problem of providing adequate and accurate information to investors.
Primary and Secondary Markets and Regulation
Primary Market This is the offering of securities by the company to the public.
It could be an** initial public offering**, called an IPO, or an offering of additional securities by a company that already has listed securities.
In either case, the primary market refers to the first issuance of securities to the buyers from the company.
** Secondary Market:** After the issuer has sold securities to the public, anyone interested in purchasing shares will buy them through the secondary market.
The most visible secondary market is the stock exchange. The over-the-counter market is also a secondary market.
A company sells its shares to the public through **underwriters **and other agents. Once those shares are sold, any subsequent trading in those shares takes place on the exchange.
How does a company sell its shares to the public?
Of course, all companies want to see their share price go up, as that indicates public confidence in its future.
Rising share prices also facilitate the giving of stock options and stock bonuses to employees and the ability to sell shares in the future to raise more capital.
The impetus for modernization in most countries was the fact that governments decided to embark on a program to de-nationalize government-owned businesses. In most countries the process was referred to as privatization.
In some countries, such as Vietnam, the process was called equitization.
Whatever the term, the goal was the same, to reduce state ownership of parastatals and State-Owned Enterprises (“SOEs”) through the sale of equity interests to the public and major investors.
**5 Basic Steps of Privatization: ** Creation of a supervisory authority with responsibility for oversight of the issuance and trading of securities. 2. Creation of a stock exchange to facilitate secondary trading in the securities of the privatized State-Owned Enterprises (SOEs). 3. Adoption of new laws and regulations for the issuance and trading of securities. 4. Adoption of licensing standards and examination procedures for market intermediaries, including brokers, dealers, and investment advisers. 5. Development of public education programs to make the public aware of investment opportunities and the process for buying and selling securities.
When share prices rise or fall, who is affected?
Participants in a Capital Market
An efficient capital market provides opportunities for companies and investors to be brought together to match their respective interests.
One would think that with so many different types of potential buyers and sellers there would be a lively capital market. That is not the case in many countries.
The principal investors in a capital market are: Individuals 2. Unit Trusts 3. Pension Plans 4. Insurance Companies 5. Foreign Mutual Funds 6. Investment Firms 7. Other Joint-Stock Companies or Corporations 8. Merchant Banks 9. Commercial Bank Trust Departments 10. Employee Benefit Plans
Which of the following are examples of principal investors in a capital market? Select all that apply.
What two basic participants does the capital market attempt to bring together?
Determining Capital Market Success
Why Do Some Capital Markets Succeed Better Than Others? Before answering this question, we need to know what we mean by a capital market succeeding. What we mean by that term is that there is: (A) An active and substantial flow of equity and debt investment capital into business enterprises from private and institutional investors, and (B) An active secondary market for the trading of those investment securities. In fact, (A) cannot exist without (B), and vice versa, which is why the development of both primary and secondary markets is so important.
Let us assume that Country A and Country B have identical laws and regulations. Why is the capital market more successful in Country A?
Three factors stand out as critically important: Public Confidence Efficiency Corporate Governance
There may be other factors affecting the relative performance of capital markets in different countries. Economic policies, political stability, and regional concerns all play a role.
Securities bought and sold in the monetary market are in small denominations and are available to many individuals.
What factors are essential for a successful capital market? Select all that apply.
Government’s Interest and Role in Capital Market Development
Module Objectives By the end of this module, you should be able to: Understand the importance of permitting companies to develop through free market economic principles. Understand the continuing trend towards privatization. Consider the role of government in facilitating free market economics. Understand the importance of government regulators understanding the broad scope of subjects applicable to regulation of the capital market. Analyze principal issues involved in drafting securities statutes. Examine the relationship between the Central Bank and the capital market. Consider major issues in creating a securities supervisory authority.
Analysis of differing economic models in recent years indicates the importance of Capital Market Development to the domestic economy.
This is in contrast to the loss or stagnation of economies that rely principally on government ownership of the means of production and distribution of goods and services.
To understand how the market operates requires considerable study and expertise.
It also requires being alert to the appropriate role of government; both as to what government can do and what government should refrain from doing.
** Complete this sentence below. ** One of the roles of government in free market economics is to...
Free Market Principles
Impact upon business enterprises Individuals who have the freedom to own their own businesses and enjoy the full benefit of business profits are more highly motivated to make those businesses succeed than individuals who have no investment stake or interest in profits.
The trend to free market economies Governments throughout the world now recognize that domestic economic growth depends in large measure on moving enterprise capital into private hands. This permits business to tap into the entrepreneurial skills of its population. As the domestic population begins to realize that they have a stake in business growth, this will encourage a shift from savings to investment that is so vital in the capital raising process.
Governments are under pressure to privatize in order to raise revenue, eliminate costly business operations, boost public investment opportunities, and increase productivity of goods and services.
Governments are under pressure to privatize in order to:
Resources that exist in many countries include: mineral and other natural deposits of productive ores; large fertile tracts of land for food production; large labor pools of motivated men and women; experience in enterprise development, as witnessed by the enormous informal markets that exist in towns and cities; untapped sources of foreign capital through tourism and local business development.
These resources are best utilized by the private market through well planned and supervised capital market development.
The principal goal for government policy-makers and regulators is to facilitate the development of existing resources.
Resources that exist in many developing countries include… Select all that apply.
Government's Role in the Free Market
Government’s role in developing a free market economy can be described as one of facilitation.
Government facilitates capital market development by… adopting sound fiscal policies for itself, creating institutions that effectively regulate and promote the capital market, and by enacting laws that appropriately balance business growth and investor protection.
If government does its job well, the free market will develop and take its natural course.
This is what the famous economist Adam Smith meant when he referred to the “invisible hand” that leads to greater efficiencies and utilization of resources and labor.
Balancing of Business and Investor Interests Government regulation can be so rigorous, and so dominated by a desire to protect against company abuse, that it becomes far too costly and time-consuming for companies to comply with the demands.
As a result, companies will avoid reaching out to the public and bringing them in as investors in their enterprises.
There needs to be a balancing of interests. Companies cannot be permitted to engage in fraudulent securities offerings, but at the same time the standards must be realistic for local conditions and not unduly burdensome.
Balancing must occur in two different ways: Select two.
Companies will avoid reaching out to the public and bringing them in as investors in their enterprises due to rigorous government regulation.
Government’s Role in the Capital Market
Training and Education on the Capital Market The task of acquiring the broad range of knowledge about the capital market appears daunting. Much of it is quite technical.
Knowledge and the ability to analyze what is important for the domestic economy have to be in place.
The government's role should primarily be to create statutes for the regulation of emerging stock exchanges.
When a government is developing a capital market what is the first and most basic role?
Regulation of the Capital Market
The Central Bank plays a key role in regulating interest rates, the public float of currency, and overall monetary policy.
Capital Market Supervising Agency The Capital Market Supervising Agency is a principal government institution affecting the capital market.
Most countries have established such an agency, whether called the Securities Exchange Commission, Securities Commission, Capital Market Authority, or any other title.
**Responsibilities of Capital Market Supervising Agencies ** Other responsibilities often include public education, interpretive advice to lawyers and other inquirers, regulation of offerings by local government units such as towns and municipalities, developing exemptions from registration for limited forms of offerings, establishing uniform accounting standards for publicly-held companies, regulating foreign investment in domestic companies, and advising the Ministry of Finance and other government officials on the progress of the securities market.
The securities statute creating the agency will often prescribe the principal agency commissioners.
What are the principal government institutions affecting the capital market?
When agency regulators are politically motivated, the public is more confident in the capital market.
Summary, Key Points and Glossary of Terms
The histories of capital markets differ from country to country. However, all capital markets share in common basic infrastructure, including statutes, regulations, and fundamental institutions.
To understand the capital market is to understand its purpose, how it differs from the monetary market, its participants, and the basic infrastructure that exists to put it all together.
The purpose of the infrastructure is to facilitate the trading of financial instruments, which is at the heart and soul of the capital market.
The capital market exists in order for enterprises to raise funds, for investors to place their funds into investment opportunities, and for investors to buy and sell their securities to others.
Full disclosure is the sine qua non of every capital market. Many of the laws and regulations exist for the purpose of assuring that that policy is met.
Both history and economic principles have proven that free market economies produce greater goods, services, and wealth than do government-controlled economies.
Many countries are in the process of moving away from government control of major businesses and industries, and this trend will undoubtedly lead to increased economic growth.
However, the free market cannot be entirely “free” from any government regulation. There are important protections that must be preserved for investors and to assure fair trade and competition.
Government’s role is to balance business and investor concerns to facilitate the growth of the free market.
All we can ask of government officials is that they educate themselves as well as possible and give their best effort to develop principles, policies, and programs that, in their best judgment, maximize business and investor opportunities.
Introduction to Capital Market Development: Quiz
It was really great and very to understand the concepts.
This is very comprehensive and good for a capital markets regulation student like me.