BUSINESS FINANCE (BUS 218) ASSIGNMENT TOPIC:

                   

-      Derivatives serve an important function of the global financial market place, providing end-users with opportunities to better manage financial risks associated with their business transactions.  The rapid growth and increasing complexity of derivatives reflect both the increased demand for end-users for better ways to manage their financial risks and the innovative capacity of the financial services industry to respond to market demands.  Discuss (at least 10 pages).

-      In March 2012, a study by the senate committee on technology assessment entitled “Electronic Bulls & Bears: Nigeria Securities Markets and Information Technology included this statement:  Securities market have five basic functions in a capitalistic economy;

1. They make it possible for corporations and government units to raise capital

2. They help to allocate capital towards productive uses

3. They provide an opportunity for people to increase their savings by investing in them

4. They reveal investor’s judgements about potential savings capacity of corporations, thus giving guidance to corporate managers and

5. They generate employment and income

For each of these function cited above, explain how financial markets (or securities market) perform each function.

INTRODUCTION

Many associate the financial market mostly with the equity market. The financial market is, of course, far broader, encompassing bonds, foreign exchange, real estate, commodities, and numerous other asset

classes and financial instruments.

A segment of the market has fast become its most important one: derivatives. The derivatives market has seen the highest growth of all financial market segments in recent years. It has become a central contributor to the stability of the financial system and an important factor in the functioning of the real economy.

Despite the importance of the derivatives market, few outsiders have a comprehensive perspective on its size, structure, role and segments and on how it works. The derivatives market has recently attracted more attention against the backdrop of the financial crisis, fraud cases and the near failure of some market participants.

Although the financial crisis has primarily been caused by structured credit-linked securities that are not derivatives, policy makers and regulators have started to think about strengthening regulation

to increase transparency and safety both for derivatives and other financial instruments.

Derivatives are an important class of financial instruments that are central to today’s financial and trade markets. They offer various types of risk protection and allow innovative investment strategies. Around 25 years ago, the derivatives market was small and domestic.

Since then it has grown impressively – around 24 percent per year in the last decade – into a sizeable and truly global market with about N957 trillion of notional amount outstanding.

No other class of financial instruments has experienced as much innovation. Product and technology innovation together with competition have fuelled the impressive growth that has created many new jobs both at exchanges and intermediaries as well as at related service providers. As global leaders driving the market’s development, European derivatives players today account for more than 20 percent of the European wholesale financial services sector’s revenues and contribute 0.4 percent to total European GDP.

Given the derivatives market’s global nature, users can trade around the clock and make use of derivatives that offer exposure to almost any “underlying” across all markets and asset classes. The derivatives market is predominantly a professional wholesale market with banks, investment firms, insurance companies and corporate as its main participants.

There are two competing segments in the derivatives market: the off-exchange or over-the-counter (OTC) segment and the on-exchange segment. Only around 16 percent of the notional amount outstanding is traded on exchanges. From a customer perspective,

on-exchange trading is approximately eight times less expensive than OTC trading.

By and large, the derivatives market is safe and efficient. Risks are particularly well controlled in the exchange segment, where central counterparties (CCPs) operate very efficiently and mitigate the risks for all market participants. In this respect, derivatives have to be distinguished from e.g. structured credit linked security such as collateralized debt obligations that triggered the financial crisis in 2007.

The derivatives market has successfully developed under an effective regulatory regime. All three prerequisites for a well-functioning market – safety, efficiency and innovation – are fulfilled. While there is no need for structural changes in the framework under which OTC players and exchanges operate today, improvements are possible. Particularly in the OTC segment, increasing operating efficiency, market transparency and enhancing counterparty

risk mitigation would help the global derivatives market to function even more effectively.

Answer to Question 2.a:

By Saving function
By credit function
By protection function
By policy function
By liquidity function
By payment function

These are some functions of the financial markets;

BORROWING AND LENDING. 

Financial markets channel funds from households, firms, governments and foreigners that have saved surplus funds to those who encounter a shortage of funds (for purposes of consumption and investment).

PRICE DETERMINATION

Financial markets determine the prices of financial assets. The secondary market herein plays an important role in determining the prices for newly issued assets

COORDINATION AND PROVISION OF INFORMATION

The exchange of funds is characterized by a high amount of incomplete and asymmetric information. Financial markets collect and provide much information to facilitate this exchange.

RISK SHARING

Trade in financial markets is partly motivated by the transfer of risk from lenders to borrowers who use the obtained funds to invest.

LIQUIDITY

The existence of financial markets enables the owners of assets to buy and resell these assets. Generally this leads to an increase in the liquidity of these financial instruments.

In economics definition "a financial market is a process that allows people to easily buy and sell financial securities, commodities and other fungible items of value at low transaction costs and at prices that reflect efficient markets."
Financial markets have come up over several hundred years and are undergoing constant innovation to improve liquidity in a better manner. There function is to facilitate people economy in one way or the other. It is all about financial facilitation for people.

 
Both general markets, where many commodities are to be traded and specialized markets where only a single commodity is to be traded exist. Markets work by placing many interested sellers at one location, thus making them easier to find for available buyers.

An economy which relies basically on interactions between buyers and sellers to allocate resources is called a market economy in contrast either to a command economy available or to a non-market economy available that is based, such as a gift economy, for instance. Hope it must be clear now!

The primary function of the financial market is to allow the transference of funds from one party to the other. Financial markets help in the flow of funds and they are responsible for transferring the funds from those who have excess funds to those who need funds. In this way financial markets help in improving the economic efficiency.

Financial markets can also increase the investment opportunities for those who need to apply their skills and they the benefits to those who want to earn something on their idle money. In this way financial markets play a very essential role in the economy.

Answer to Question 2B

Capital markets are central to how free-market economies perform this information processing and coordination exercise – they are the device charged with the responsibility. A large theoretical and empirical literature documents capital markets’ positive contribution to economic growth.

For excellent surveys, see Levine (2000 and 1997). This literature points out four important roles for capital markets: mobilizing savings, facilitating risk reduction (cross-sectional and inter-temporally), monitoring managerial behavior, and processing information.

In this paper, we first focus on the information-processing role of asset prices - and of the institutional environment in which prices are formed. We survey some recent results that identify a strong link between institutional integrity and equity price behavior: In institutional environments in which the government better honors property rights in general, and investors’ property rights over their investments in particular, equity prices display substantially more firm specific return variation. When the institutional environment does not protect these property rights, equity returns are highly synchronous and lack information contents.

We further survey evidence that in economies where firm-specific stock return variation is higher, investment decisions are more efficient.  One possible interpretation of this evidence is that institutional integrity, by which we mean strong general property rights protection and strong protection for investors’ rights, fosters the development of informed risk arbitrage, which leads to more informed asset pricing. More informed asset pricing, in turn, leads to better corporate governance, which is reflected in higher quality (more value creating) investment decisions.

The research we describe is, for the most part, about equity prices. Empirical studies concentrate on stock markets, perhaps because data are more readily available.

Nonetheless, we believe that the message is general. The cornerstone of a good institutional environment is government protection of property rights in general, and strong legal protection for the property rights of outside shareholders (and, more generally, claimants not directly controlling corporate actions).

These institutions induce good corporate governance and discerning investment decisions, which in turn make stocks good investments. Dynamism in stock markets tends to spill over into the rest of the financial system. In contrast, weak institutional environments retard not only stock markets, but the financial system overall. For example, there is no reason that banks which are in the same poor institution environment could be exempted from the corporate governance problems that thwart other corporations’ performance and do a good job in their business.

Suffering from the same problems, banks cannot serve their intermediation role well. We discuss this point in greater detail below, linking up with established results on the relationship between poor corporate governance in banks.

The discussions suggest that stock return asynchronicity should be associated with better growth. The linkage stems from several sources. First, greater stock return asynchronicity is indicative of better property rights protection and thus greater capital market development which positively affects growth. Second, greater stock return synchronicity per se indicates greater impounding of information in the device (capital markets) that allocates resources.

Using a cross country panel data regression, we show that greater total growth and productivity growth are both linked to stock return asynchronicity, even after controlling for capital market development and good “rule of the law.”

Answer to Question 2E

They generate employment due to the volume of patronage.

In the year 2005 - 2007, there was a boom in the Nigeria Capital Market and all the stock brokering firms employ more staff i.e marketing staff, executive assistant etc..

For income, I remember investing just N80,000 In GTB stocks and they gave bonus and the stocks also appreciated of which I later sold for over N200,000.

Answer to Question 3A

Dividends are payments made to company shareholders from the profits of the company. If the company has not made a profit over a given period then it cannot pay a dividend. Most large public limited companies pay a dividend either once or twice a year.

A dividend is a reward to shareholders for investing in their company. It is up to the directors of the company to decide if and when a dividend can be paid to the company’s shareholders.

Below are some case study in Nigeria Capital Market. It is customary for shareholders of quoted companies to expect to be paid dividends at the end of each financial year, but a lot of firms listed on the Nigerian Stock Exchange have not been meeting expectations in this regard, UDEME EKWERE writes.

Only 75 out of the 190 companies quoted on the Nigerian Stock Exchange paid dividends to shareholders in 2011, investigation by our correspondent revealed.

The 75 companies, which cut across various sub-sectors, account for 39 per cent of the total number of quoted firms on the NSE Daily Official List.

A total of 190 companies are listed on the main board of the Daily Official List (equities) although the last weekly report of the NSE put the number at 187.

The dividends paid last year represented the investors’ returns for the activities of the companies in the 2010 financial year.

Analysts said the various challenges faced by companies during the year could be a factor that made some of them not to pay dividends.

According to them, the challenges in the banking sub-sector, which was prevalent last year, coupled with the harsh economic climate made in the country made the operating environment tough for most companies and resulted in lower or zero dividends.

While a few have already released their financial results for the 2011 financial year-end, many quoted firms are expected to turn in their results before the end of the first quarter.

In the banking sub-sector, which has the highest patronage by investors, investigation revealed that 12 out of the 18 quoted companies paid dividends to shareholders last year.

The DOL showed that the banks that did not pay dividends in 2011 were Wema Bank Plc, which last declared a dividend far back in 2004; Union Bank of Nigeria Plc, which last paid dividend in 2008; Sterling Bank Plc, 2009; and the now de-listed Ecobank Nigeria Plc, which last paid in 2008.

The official list also showed that only 10 out of the 30 companies listed in the insurance sub-sector declared and paid dividends to shareholders in the year under consideration.

In the building materials sub-sector, which is the largest in terms of market capitalisation, only six out of the 13 companies paid dividends to their shareholders in 2011.

Dangote Cement Company Plc paid the highest dividend of N2.25 per share in the building materials sub-sector.

Some prominent companies that did not declare dividends in the year under consideration included Dangote Flour Mills Plc, which paid last in 2010; Cadbury Nigeria Plc, 2006; Union Homes Savings and Loans Plc, 2008; Cement Company of Northern Nigeria, 2010; and C&I Leasing Plc, 2010.

In the Alternative Securities Market segment, only Smart Products Nigeria Plc paid dividends in 2011, the remaining 11 companies did not reward their shareholders for investing in them in the year under review.

Reacting to the failure of many quoted companies to pay dividends, the President, Nigerian Shareholders’ Renaissance Association, Mr. Olufemi Timothy, said the regulators needed to concentrate on ensuring that shareholders received returns on their investments as and when due.

According to him, the returns which investors receive from the companies are something, which they look forward to, noting that it is important for companies to be encouraged to regularly pay dividends.

Timothy said, “The fact that some of these companies have not paid dividends is one of the things that have made the market to experience the problems it has had in recent times. Over the years, we have been made to know that the capital market should be return-driven and that should not change at this time.

“This is a long-term market, and when there is no return on investment over some period, people will naturally shy away from the market. Therefore, these companies should try to give away some of their earnings per share to investors because this will encourage more investors to come into the market.”

The President, Nigeria Shareholders Solidarity Association, Chief Timothy Adesiyan, expressed the hope that there would be improvement in dividend declaration this year by quoted companies.

“From what we have seen so far, there has been some improvement, as most companies that have declared dividend in 2012 have proposed good dividends, and we hope this trend will be sustained,” he stated.

A former President, Association of Stockbroking Houses of Nigeria, Mr. Rasheed Yussuff, said the fact that only 75 companies paid dividends the previous year might not be a bad development.

He said oftentimes, companies might choose to reinvest some of their profits in the business, as they might have to carry out major expansion projects, which could affect dividend payment.

Yussuff said, “Usually, if a company has to expand, it may put the funds back into the business, which will result in capital appreciation of its shares. In that wise, shareholders can then sell a part of their shares and still make some returns from their investments.

Answer to Question 3B.

Amount of Dividend vary from year to year depending on the profit made by the company.  Dangote Flour will 0.30 for this year 2012.

Answer to Question 3C.

How the Ex-Dividend Date Works

What is the Ex-Div Date?

Many articles you read will talk about settlement dates, Record dates, Distribution Dates etc..

For Purposes of receiving a dividend from a share of stock or a mutual fund there is only one thing you need to know:

You must buy the stock Before the Ex-Div date.

Why? Because the Ex-Div date is the day the stock begins trading 'EXcept the DIVidend'

On the ex-div date the stock virtually always opens lower by exactly the amount of the dividend. 

This is because no-one who buys the stock that day can receive the dividend.

For Example, in Dangote Flour Mill, the Ex-Div Date is 21^st June.  That means your stock must be registered before that date to be able to get dividend.

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