Prepared by: Mr.

Noah Njapau
For Distance Learning Division (NIPA)
2020 ©

UNIT 3 DESCRIBING THE SECURITIES

MARKETS
Introduction
Welcome to Unit 3! This unit will discuss the role of financial markets in
investments and the importance of Finaicial Marketsa and also the types and
role of brokers.

Aim
The aim of this unit is to give you an over view of the components of the
financial markets and different markets and securities that are traded on each individual
market.

Discussion
Discuss the procedures of listing a company on the Lusaka Securities
Exchange commission.

3.1 ROLE AND IMPORTANCE OF FINANCIAL MARKETS AND HOW SECURITIES

ARE TRADED
A financial market is a market where financial assets are traded. Furthermore, financial
markets can be divided into segments, there are a wide variety of markets that serve
differing needs.
The money market deals in short-term assets with maturities of less than one and can
be quickly transformed into money. These are mostly used to solve short-term obligation.
Examples of money market securities are outlined in Unit 1 under short term securities.
Capital Markets/Securities market deals with the raising of new capital and the
trading of existing shares and bond, these are long term securities with maturities of not
less than a year to 30 years outlined in Unit 1.2 under long securities;
The Foreign Exchange Market is where differing currencies are traded for one
another.
Derivatives Market is where future obligations to buy/sell, or options to buy/sell,
underlying financial assets are traded. These are discussed later in this unit, Where we
discuss about different types of derivatives.
Functions of financial markets
➢ Financial markets provide price information about the financial assets traded on
them.
➢ They also provide liquidity for investors.
➢ Financial markets help reduce costs of buying and selling comprising;
➢ Search costs-contacting a broker/trader to notify intention of trading, plus the
implicit cost of the investors’ time;
➢ Information costs-incurred when assessing the relative merits of investment;
➢ Commissions and fees charged by the traders, together with their spreads (bid
and offer prices)
Financial markets are often divided into two; primary markets and secondary markets.

3.2 Primary Markets and Secondary Markets

All securities are first traded in the primary market, and the secondary market
provides liquidity for these securities.
Primary Market is where corporate and government entities can raise capital
and where the first transactions with the new issued securities are performed. If a
company’s share is traded in the primary market for the first time this is referred to as
an initial public offering (IPO).
Investment banks play an important role in the primary market:
➢ Usually handle issues in the primary market;
 ➢ Among other things, act as underwriter of a new issue, guaranteeing the proceeds
to the issuer.

Secondary Market is where previously issued securities are traded among investors.
Generally, individual investors do not have access to secondary markets.
Besides primary and secondary structures of financial markets, other structures may
include the following:
Types of secondary market places:
1. Organized security exchanges
2. Over-the-counter markets
3. Alternative trading system.
An organized security exchange provides the facility for the members to trade
securities, and only exchange members may trade there. The members include brokerage
firms, which offer their services to individual investors, charging commissions for
executing trades on their behalf. Other exchange members by or sell
The operations of the secondary market largely depend on market makers. A market
maker is an institutional investor broker or dealer that will quote bid-offer prices on
securities; in so doing, the market-maker is prepared to take long and short positions in
the securities.

3.3 Exchanges and over the counter (OTC) markets

Stock markets around the world have undergone significant changes since the 1960s.
Stock Exchanges for example have been heavily influenced by the introduction of new
technology. Good examples are stock exchanges in London, Paris and Frankfurt that are
now screen based, replacing the trading-floor environment. (Finance and Financial
Markets (2010) by Keith Pilbeam, 3rd Edition).
Another change in recent years has been regulatory changes such as London’s ‘’Big Bang’’
in 1986 and regulatory changes in the USA following a number of scandals during the
‘’bubble era’’ of 1997-2000. In addition, the markets are increasingly dominated by
institutional investors such as; pension funds, unit trusts/mutual funds, investment
companies and trusts, insurance companies etc. (Finance and Financial Markets (2010)
by Keith Pilbeam, 3rd Edition).

In exchanges, buyers and sellers (through their brokers) meet in one central location to
conduct trade e.g. New York Stock Exchange and American Stock Exchange.
In over the counter markets, dealers at different locations have an inventory of securities,
and are ready to buy and sell these securities ‘over the counter’ to anyone willing to
accept their price. Because of the technological links among dealers about prices, OTC
markets are competitive and not very different from organized exchanges.
They use security brokers (Discussed in later in this unit) to act as intermediaries for
them. The broker delivers and orders received from investors in securities to a market
place, where these orders are executed. Finally, clearing and settlement processes ensure
that both sides to these transactions honor their commitment.

3.4 Over-The-Counter
An over-the-counter (OTC) market is a decentralized market in which market participants
trade stocks, commodities, currencies or other instruments directly between two parties
and without a central exchange or broker. Over-the-counter markets do not have physical
locations; instead, trading is conducted electronically. This is very different from an
auction market system. In an OTC market, dealers act as market-makers by quoting
prices at which they will buy and sell a security, currency, or other financial products. A
trade can be executed between two participants in an OTC market without others being
aware of the price at which the transaction was completed. In general, OTC markets are
typically less transparent than exchanges and are also subject to fewer regulations.
Because of this liquidity in the OTC market may come at a premium.

Brokerage Firms
A brokerage company’s main duty is to act as a middleman that connects buyers and
sellers to facilitate a transaction. Brokerage companies typically receive compensation by
means of a commission (either a flat fee or a percentage of the amount of the transaction)
once the transaction has successfully completed. For example, when a trade order for a
stock is executed, an investor pays a transaction fee for the brokerage company's efforts
to complete the trade.

Types of Brokers
Discount broker, who executes only trades in the secondary market.
Full-Service Broker, who provides a wide range of additional services to clients such
advice to buy or sell
An Online Broker is a brokerage firm that allows investors to execute trades
electronically using Internet.

3.5 Types of orders

Market Order vs. Limit Order
The two major types of orders that every investor should know are the market order and
the limit order.
Market Order is the most basic type of trade. It is an order to buy or sell immediately
at the current price. Typically, if you are going to buy a stock, then you will pay a price
at or near the posted ask. If you are going to sell a stock, you will receive a price at or
near the posted bid.
Market orders are popular among individual investors who want to buy or sell a stock
without delay. The advantage of using market orders is you are guaranteed to get the
trade filled; Although the investor doesn't know the exact price at which the stock will be
bought or sold, market orders on stocks that trade over tens of thousands of shares per
day will likely be executed close to the bid and ask prices.
limit order, sometimes referred to as a pending order, allows investors to buy and sell
securities at a certain price in the future. This type of order is used to execute a trade if
the price reaches the pre-defined level; the order will not be filled if price does not reach
this level. In effect, a limit order sets the maximum or minimum price at which you are
willing to buy or sell.
For example, if you wanted to buy a stock at $10, you could enter a limit order for this
amount. This means that you would not pay a penny over $10 for that particular stock.
However, it is still possible that you buy it for less than the $10 per share specified in the
order.

There are four types of limit orders:

➢ Buy Limit: an order to purchase a security at or below a specified price. Limit
orders must be placed on the correct side of the market to ensure they will
accomplish the task of improving price. For a buy limit order, this means placing
the order at or below the current market bid.
➢ Sell Limit: an order to sell a security at or above a specified price. To ensure
improved price, the order must be placed at or above the current market ask.
➢ Buy Stop: an order to buy a security at a price above the current market bid.
A stop order to buy becomes active only after a specified price level has been
reached (known as the stop level). Buy stop are orders placed above the market
and sell stop orders placed below the market (the opposite of buy and sell limit
orders, respectively). Once a stop level has been reached, the order will be
immediately converted into a market or limit order.
➢ Sell Stop: an order to sell a security at a price below the current market ask. Like
the buy stop, A stop order to sell becomes active only after a specified price level
has been reached.

3.6 Investor Protection

In Zambia, the Lusaka Stock Exchange (LUSE) has been the only stock exchange market
not until 2013 when another stock exchange market called Bonds and Derivative
Exchange (BODEX) market was launched. At the time of writing (2014) BODEX was still
in its infancy. The operations of the Lusaka Stock Exchange (LUSE) are governed by the
Securities Act (No. 38) of Cap 354 of the Laws of Zambia. The implementation of the
Securities Act is the role of the Securities and Exchange Commission (SEC) Zambia.
Each security on the (Lusaka Stock Exchange) LUSE is assigned an International Security
Identification Number (ISIN) which identifies each security uniquely. This is one of the
features of a modern stock exchange. LUSE became the sole financial securities
numbering agency in Zambia on 16th June, 2003 by partnering with the Association of
National Numbering Agencies (ANNA) and assigns International Security Identification
Numbers (ISIN) (Source: www.luse.co.zm).
The Securities Act requires that all registered securities be traded on a recognized and
regulated stock exchange therefore trading takes place on LUSE. Shares traded on LUSE
are divided into two categories:
a) Listed Companies-This is a company which has a presence on the top tier of the LUSE,
‘’listed tier’’. The listed tier is composed of public limited companies (Plcs) that have met
the LUSE listing requirements, and have had their listings approved by the LUSE Listing
committee and the full LUSE board and have paid the listing fee commensurate with the
market value of their issued capital.
As at 31 December, 2019, LUSE had 27 listed companies (Source: www.luse.co.zm):

3.7 Efficient Markets

In an efficient market, security prices are current and fair to all traders.
Operational Efficiency: trades are processed quickly and accurately
Informational Efficiency: securities trade at their fair value
Weak-form efficient markets - current prices reflect the price history and trading
volume of the stock. Thus, charting and other technical strategies would be useless if
markets are truly weak-form efficient.
The weak-form EMH assumes that current stock prices fully reflect all security market
information, including the historical sequence of prices, rates of return, trading volume
data, and other market generated information, such as odd-lot transactions and
transactions by market makers. Because it assumes that current market prices already
reflect all past returns and any other security market information, this hypothesis implies
that past rates of return and other historical market data should have no relationship with
future rates of return (that is, rates of return should be independent). Therefore, this
hypothesis contends that you should gain little from using any trading rule which indicates
that you should buy or sell a security based on past rates of return or any other past
security market data.

Semi-strong-form efficient markets - current prices already reflect all available

public information including history.
The semistrong-form EMH asserts that security prices adjust rapidly to the release of all
public information; that is, current security prices fully reflect all public information. The
semistrong hypothesis encompasses the weak-form hypothesis, because all the market
information considered by the weak-form hypothesis, such as stock prices, rates of return,
and trading volume, is public. Notably, public information also includes all nonmarket
information, such as earnings and dividend announcements, price-to-earnings (P/E)
ratios, dividend-yield (D/P) ratios, price-book value (P/BV) ratios, stock splits, news about
the economy, and political news. This hypothesis implies that investors who base their
decisions on any important new information after it is public should not derive above-
average risk-adjusted profits from their transactions, considering the cost of trading
because the security price should immediately reflect all such new public information.
Strong-form efficient markets - current prices reflect all publicly available
information, including history and private information. The strong-form EMH contends
that stock prices fully reflect all information from public and private sources. This means
that no group of investors has monopolistic access to information relevant to the
formation of prices. Therefore, this hypothesis contends that no group of investors should
be able to consistently derive above-average risk-adjusted rates of return. The strong-
form EMH encompasses both the weak-form and the semi strong-form EMH. Further, the
strong-form EMH extends the assumption of efficient markets, in which prices adjust
rapidly to the release of new public information, to assume perfect markets, in which all
information is cost-free and available to everyone at the same time.
 Summary
This unit has been able to discuss the following:
1. financial Markets;
2. The type and role of brokers;
3. Investment protection;

Activity
1) What is the difference between money markets and capital markets?
2) What is the role of the securities exchange commission?
What is meant by the term IPO?