DEPARTMENT OF INSURANCE AND ACTUARIAL SCIENCE

RISK MANAGEMENT AND INSURANCE

COURSE: FINANCIAL MARKETS, INSTITUTIONS & REGULATIONS

COURSE CODE: CIN4117

NAMES STUDENT NUMBER

NOTHABO NKALA N0165902A

AMANDA GUMPO N0164817E

SURVIVAL N MPABANGA N0164935J

QUESTION: STOCK MARKETS

OVERVIEW OF STOCK MARKETS

According to Chen, 2008, the term stock market refers to the collection of stock exchanges where regular
activities of buying, selling, and issuance of shares of publicly-held companies take place. Such financial
activities are conducted through institutionalized formal exchanges or over-the-counter (OTC)
marketplaces which operate under a defined set of regulations. There can be multiple stock trading venues
in a country or a region which allow transactions in stocks and other forms of securities. Though it is
called a stock market other financial securities like exchange traded funds (ETF), corporate bonds and
derivatives based on stocks, commodities, currencies, and bonds are also traded in the stock markets.

Generally, the value of equity tradable on the stock markets is affected by the financial performance of the
company however there are other factors that can have a significance on the trading value of equity in the
stock market. According to (Steelman et al. 2015) , other factors that affect the value of share are the
general industry performance, government interference, the leadership of the company as well as the
general perception of the company on the economy.

Since the stock market brings together hundreds of thousands of market participants who wish to buy and
sell shares, one is assured of a fair price. Investors get the company shares which they can expect to hold
for their preferred duration, in anticipation of rising in share price and any potential income in the form of
dividend payments. The stock exchange acts as a facilitator for this capital raising process and receives a
fee for its services from the company and its financial partners, ( McGraw-Hill,2014).

Stock markets ensures fair pricing practices and transparency in transactions, the modern day computer-
aided stock markets operate electronically providing a secure and regulated environment where market
participants can transact in shares and other eligible financial instruments with confidence with zero- to
low-operational risk, (Cox , 1985). Operating under the defined rules as stated by the regulator, the stock
markets act as primary markets and as secondary markets.

PRIMARY MARKETS

Primary markets through the IPO process are markets where companies issue shares to the public for the
first time. It is through the Initial Public Offering (IPO) process which is in most cases facilitated by an
investment bank that private companies become public corporations and get listed on stock exchanges for
potential investors to access the stocks, this is according to Breadly et al, 2001. The key function of this
market is to facilitate capital growth by providing a platform for an issue of new shares by corporates. In
most cases, primary markets trade in common stock.

The Initial Public Offering (IPO) popularly known as “going public” is when a previously unlisted
company sells new or existing securities to the public for the first time, (Cremades, 2016). It is therefore
the process where private companies become public corporations and get listed on the stock exchange thus
broadening its investor base however at the expense of ownership. According to Saunders (2016),
undergoing an IPO is a clear indication that a company is pushing for growth and development and that it
deems itself to be competitive enough to be tradable in the stock exchange.

Usually the IPO process is facilitated by an investment bank, the investment bank can perform either buy
the whole issue for resale or underwrites the issue for a fee. Once the issuing firm and the investment bank
have agreed on the details of the stock issue, the investment bank must get SEC approval in accordance
with the Securities and Exchange Act of 1934. The process starts with the preparation of the registration
statement to be filed with the Stock Exchange Commission (SEC). The registration statement includes
information on the nature of the issuer’s business, the key provisions and features of the security to be
issued, the risks involved with the security, and background on the management. The focus of the
registration statement is on full information disclosure about the firm and the securities issued to the
public at large.

Simultaneously, the issuer and its investment bank prepare a preliminary version of the public offering’s
prospectus called the red herring prospectus. The red herring prospectus is similar to the registration
statement but is distributed to potential equity buyers. It is a preliminary version of the official or final
prospectus that will be printed upon SEC registration of the issue and makes up the bulk of the registration
statement. Firms use the feedback provided from the distribution of the red herring prospectus to help set
the price on the new shares so as to ensure the sale of the full issue. After submission of the registration
statement, the SEC has 20 days to request additional information or changes to the registration statement.
It generally takes about 20 days for the SEC to declare whether or not a registration statement is effective,
this is according to Saunders, (2016).

Once the SEC is satisfied with the registration statement, it registers the issue. At this point, the issuer
along with its investment bankers finalizes the selling price on the shares, prints the official prospectus
describing the issue, and sends it to all potential buyers of the issue, thus the shares can be sold. However,
firsttime issuers can sometimes wait up to several months for SEC registration, especially if the SEC
keeps requesting additional information and revised red herring prospectuses. However, with an
investment bank that knows the process very well, companies can generally obtain registration in a few
days.

Also facilitated by primary market is a seasonal offering, this refers to additional equity that is issued by a
company already trading on the stock exchange. The new issue goes through the primary market, an
example of a seasonal offering is a right issue. A rights issue is a pro rata based issue of shares to prevent
dilution of equity in a company. The number of shares held by a shareholder will determine the additional
that they can get, for example, a company may offer a right issue of share at 1 share for every 100 shares
held. This entails that all investors holding less than 100shares are excluded from the issue and for every
shareholder holding more than 100 shares they can get additional shares at a discount.

SECONDARY MARKETS

Popularly known as the stock exchange, secondary stock markets are platforms where listed companies
trade, it consists of buyers and sellers. When a transaction occurs in a secondary stock market, funds are
exchanged, usually with the help of a securities broker or firm acting as an intermediary between the
buyer and the seller of the stock. The original issuer of the stock is not involved in this transfer of stocks
or funds.

The stock exchange shoulders the responsibility of ensuring price transparency, liquidity, price discovery
and fair dealings in such trading activities, (Saunders, 2016). As almost all major stock markets across the
globe now operate electronically, the exchange maintains trading systems that efficiently manage the buy
and sell orders from various market participants. They perform the price matching function to facilitate
trade execution at a price fair to both buyers and sellers.

Zimbabwe Stock exchange [ZSE]

The origins of the Zimbabwe Stock Exchange date back to the arrival of the Pioneer Column in 1896. The
true forerunner to the ZSE of today was founded in Bulawayo in January 1946, shortly after the end of the
Second World War. In December 1951, second floor opened in Harare (then known as Salisbury), and
trading between the two cities was conducted via telephone.
Several years later, stakeholders agreed that legislation was required in order was required in order to
protect the rights and obligations of all concerned and in January 1974, the Zimbabwe Stock Exchange
Act (then called the Rhodesia Stock Exchange Act) was passed into law, consolidating the two exchanges.
In order to meet legal requirements, anew exchange came into being, although trading continued
uninterrupted.

In order to keep abreast with the moving times, the Zimbabwe Stock Exchange adopted an electronic
system in December 2009. The bourse launched an electronic trading board in December 2009 becoming
the third country African country to move from a manual system and paving the way for investors to have
access to real time data. In March 2013, the ZSE also managed to launch was part of the company’s
revitalisation program after marginal decline of business during the period of the economic meltdown
between 2007 and 2008.

On July 2015, the ZSE migrated to an online trading platform through its launch of the Automated
Trading System (ATS) which replaced the traditional open-outcry manual based trading.

The Automated Trading System (ATS) is designed to match buy and sell orders placed by securities
dealing firms. During trading hours, buy and sell orders are entered into a central electronic order book by
securities dealing firms using terminals located at their premises. These orders are matched within the
ATS under the supervision of the Exchange and execution prices are determined.

The ATS maintains an order book for each security, divided into bids and offers. Prices are determined
and trades are effected according to specific rules depending on order parameters. Information regarding
all executed trades are electronically communicated to all investment dealers. If an order cannot be
matched, it is registered in the order book.

The ATS can be used to trade different types of financial instruments such as equities (Ordinary &
Preference Shares), corporate debentures & bonds and government securities all from the same terminal.
A financial instrument admitted on the Main Market, Secondary Market, or on the Debt Market can be
traded either by continuous matching of buy and sell orders or by an auction pricing procedure following a
period during which the orders have been accumulated.
MARKETS & BOARDS

The Exchange operates three types of markets: the Main Market, the Secondary Market, and the Debt
Market. The Main Market and Secondary Market comprise the following boards, namely:

Equity Board – for the trading of listed ordinary shares, preference shares and other securities. Trading
unit will be in multiples of 100 subject to a minimum of 100, except for ETFs where the trading unit will
be one. Securities denominated in local and foreign currencies will be traded on this board.

Odd Lot Board – for the trading of listed ordinary shares, preference shares and other securities. Trading
unit will be one subject to a maximum of 99. Securities denominated in local and foreign currencies will
be traded on this board.

Special Terms Boards – for undertaking specific types of trades, during business hours of the Exchange
as and when the need arises based on market requirements. It consists of All or None Board, Crossing
Board and Buy-In Board.

TRADING IN SECURITIES ON THE EQUITY BOARD

Trading in securities on the equity board is divided into different sessions with the following operating
hours:

Sessions Time

Pre-Opening 9am to 10 am

Opening 10am
 Continuous 10am to 3pm

Closing 3pm

Post Close 3pm to 3:30pm

Transmission of Orders

Only securities listed on ZSE shall be traded through the ATS.

Order Input

Clients place their orders with the securities dealing firms. Upon receipt of orders, the time of receipt of
the orders is immediately recorded by the ZSEATS authorised users together with other particulars of the
orders. The orders are entered by ZSEATS authorised users in the ATS through their trading terminals
which are then transmitted directly to the ATS for validation, execution and processing.

For order input on the Equity Board, orders should be expressed in multiples of 100. Example: Upon
receipt of a buy/sell order of 10648 shares the order will be broken down in the following manner: 10600
will have to be posted to the equity board and the remaining 48 will have to be posted to the odd lot board.

Clients may also place orders using web based functionality provided in the ZSEATS system. Where this
facility is required, the client must first make the following arrangements through his stockbroker /
securities dealing firm:
The securities dealing firm will request the Exchange to issue a web based terminal to one of its client. If
approved, the Exchange will ask the Securities dealing firm to deposit a fee for the services applied for.
The ZSE Market Administrator will issue the terminal applied for along with the username and password)
to the security dealing firm concerned.

The security dealing firm in turn will deliver the security information (username and password to the
applicant customer. All orders input by ZSEATS authorised users are validated at the order entry level.
Once the order is accepted by the system, it is automatically time stamped and an order ID is allocated
which is used for all future references to the order. If the order fails validation, it is rejected with the
appropriate comment.

Order entry instructions include:

● Security code
● Client account number and Custodian code
● Buy or sell indicator
● Volume
● Price
● Type of order
● Order attributes
The price input is the unit price of a security. Orders input into the ATS are anonymously displayed to the
market. The Exchange may also specify the type of orders (buy orders only or sell orders only) that a
securities dealing firm can enter into the ATS. Following instructions received from CSD that an
investment dealer has not enough fund for settlement purposes, the securities dealing firm will be allowed
to enter sell orders only.

Types of Orders
There are two types of orders that can be placed in the ATS:

a) Market orders

b) Limit orders

Market Orders

A market order is defined as an order to buy or sell a security at the best price or prices prevailing in the
market at that point in time. No price is specified for this type of order, but volume must be indicated.
Price is given the highest priority in the system. Thus, market orders have priority of execution over limit
orders. Market orders cannot be amended.

Limit Orders

This type of order specifies the maximum buying price or the minimum selling price. The volume of the
order must be indicated. The ATS will attempt to match the order until either the entire volume is matched
or no further matching is possible within the limit price.

Order Attributes

Limit orders can have the following attributes:

a) Qualifiers

b) Time in force

c) Disclosed/Hidden quantity

a) Order Qualifiers
Order qualifiers modify the execution conditions of an order based on volume, time and price constraints.

No Qualifiers

Orders will be executed at the specified or better price. If a partial execution occurs the remaining volume
will be registered in the order book.

Fill or Kill (FOK)

Requires the immediate purchase or sale of a specified quantity, at a given price or better. If the whole
order cannot be filled immediately, it is cancelled. These orders do not get registered in the order book.
FOK orders cannot be entered during pre-opening session.

Immediate or Cancel (IOC)

IOC requires the immediate purchase or sale for the whole or part of the specified quantity at the specified
or better price. If no immediate execution occurs the order is cancelled. If the order is partly executed, the
remainder is immediately cancelled.IOC orders cannot be entered during pre-opening session.

b) Time in Force

Time in force limits the lifetime of an order in the order book. If an order does not indicate a time
condition, it is only valid for the Exchange day on which it was input.

Good Till Cancelled (GTC)

This order remains valid till cancelled 30 calendar days from the day on which it was input. The order is
automatically cancelled by the system on the expiry date. GTC orders cannot have Disclosed/Hidden
Quantity and Minimum Fill attributes.

Good Till Day (GTD)

This order remains valid for a fixed number of days. If it is not executed within the validity period, it will
expire at the end of the final day and be automatically deleted from the list of pending orders. GTD orders
cannot have Disclosed/Hidden Quantity and Minimum Fill attributes.

Day Order

This order is valid until the close of the trading day. It is automatically cancelled at the end of the trading
day.

c) Disclosed/ Hidden Quantity

The order size is revealed at the disclosed quantity and not at the full order quantity. The disclosed
quantity will cause execution to occur in blocks of disclosed quantity. The hidden quantity will not be
visible to the market. Disclosed quantity should be in multiples of 100 securities.

When the disclosed quantity is matched, a new order with the same initial volume is generated
automatically. This order will be given a new time stamp. The process will continue until the entire hidden
quantity is matched or the order is cancelled or expired. Disclosed quantity shall be equal to or greater
than 25% of the order size. Disclosed quantity attribute is not valid for FOK or IOC orders. Disclosed
quantity attribute is only valid for Day orders.
Trading Unit

The trading unit for each security is established by the Exchange and is in multiples of 100 securities.

Minimum Fill

Minimum Fill order shall match with the orders in opposite queue by accumulating their volumes. If
accumulated volume fulfils counter order condition then they will match otherwise opposite queue will be
traversed until exhausted. The MF shall fill one to many orders in the system.

Let’s assume that four sell limit orders are placed at different prices. Order A (Volume 700 @10.15),
Order B (Volume 300 @ 10.28), Order C (Volume 500 @ 10.42) and Order D (Volume 2500 @ 10.50).
Now someone places a BUY MF Order E (Volume 1500 @ 10.50), three trades shall occur in this case.
One trade between Order A and Order E (Volume 700 @ 10.15), second trade between Order B and Order
E (Volume 300 @ 10.28) and third trade between Order C and Order E (Volume 500 @ 10.42). Order D
shall remain in the order book.

BUY SELL
E. 1500 @ 10.50 MF 1500 A. 700 @ 10.15

B. 300 @ 10.28

C. 500 @ 10.42

D. 2500 @ 10.50
Result : Following three trades shall occur:
 1. E & A (Volume 700 @10.15)

2. E & B (Volume 300 @ 10.28)

3. E & C (Volume 500 @10.42)

Stock Market Indexes

A stock market index is the composite value of a group of secondary market–traded stocks. Movements in
a stock market index provide investors with information on movements of a broader range of secondary
market securities. Stock market indexes around the world are powerful indicators for global and country-
specific economies. In the United States the S&P 500, Dow Jones Industrial Average, and
Nasdaq Composite are the three most broadly followed indexes by both the media and investors. In
addition to these three indexes there are approximately 5000 others, that make up the U.S. equity market.

The Dow Jones Industrial Average

(DJIA) is one of the oldest, most well-known, and most frequently used indexes in the world. It includes
the stocks of 30 of the largest and most influential companies in the United States. The DJIA is a price-
weighted index. It was originally computed by totaling the per-share price of the stocks of each company
in the index and dividing this sum by the number of companies. The DJIA represents about a quarter of
the value of the entire U.S. stock market, but a percent change in the Dow should not be interpreted as a
definite indication that the entire market has dropped by the same percent. This is because of the Dow's
price-weighted function.

The basic problem is that a $1 change in the price of a $120 stock in the index will have a greater effect
on the DJIA than a $1 change in the price of a $20 stock, although the higher-priced stock may have
changed by only 0.8% and the other by 5%. A change in the Dow represents changes in investors'
expectations of the earnings and risks of the large companies included in the index. Because the general
attitude toward large-cap stocks often differs from the attitude toward small-cap stocks, international
stocks, or technology stocks, the Dow should not be used to represent sentiment in other areas of the
marketplace.

The NASDAQ Composite Index

Most investors know that the NASDAQ is the exchange on which technology stocks are traded. The
NASDAQ Composite Index is a market-capitalization-weighted index of all the stocks traded on the
NASDAQ stock exchange. This index includes some companies that are not based in the United States.
Known for being heavily tech weighted, this index includes several subsectors across the tech market
including software, biotech, semiconductors, and more. Although this index is known for its large portion
of technology stocks, it does include some securities from other countries as well. Investors will also find
securities from a variety of sectors as well, including financials, industrials, insurance, and transportation
stocks, among others.

The Nasdaq Composite includes large and small firms, but unlike the Dow and the S&P 500, it also
includes many speculative companies with small market capitalizations. Consequently, its movement
generally indicates the performance of the technology industry as well as investors' attitudes toward more
speculative stocks.

The Standard & Poor’s 500 Index.

The Standard & Poor’s 500 Index (known commonly as the S&P 500) is an index with 500 of the top
companies in the U.S. Stocks are chosen for the index primarily by capitalization but the constituent
committee also considers other factors including liquidity, public float, sector classification, financial
viability, and trading history.

The S&P 500 Index represents approximately 80% of the total value of the U.S. stock market the S&P 500
Index gives a good indication of movement in the U.S. market as a whole. Indexes are usually market
weighted or price weighted. The S&P 500 Index is a market weighted index (also referred to
as capitalization weighted).   In other words, if the total market value of all 500 companies in the S&P 500
drops by 10%, the value of the index also drops by 10%.

MARKET PARTICIPANTS

Stock Exchanges

They are approved by the regulators to provide a sale and purchase of securities by “open cry” on behalf
of brokers and investors. Examples of securities include equities, bonds and derivatives. Their main
function is to provide clearing house facilities for netting of payments and securities delivery. Such
clearing houses guarantee all payments and deliveries (Saunders, 2016).

Stock Brokers

Stock brokers only that are approved by the capital market regulators buy and sell stocks for their clients
either institutional investors or individual retail investors. They act as intermediates. They help build up
order book, price discovery, and are responsible for a contract being honored and for their services brokers
earn a fee known as brokerage (Saunders, 2016).

Investment banks
Investment banks handle the Initial Public Offering (IPO) of stock that occurs when a company first
decides to become a publicly traded company by offering stock share. An Initial Public Offering (IPO) is
the first sale of stocks issued by a company to the public (Saunders, 2016).

Prior to an IPO, a company is considered a private company, usually with a small number of investors
(founders, friends, families, and business investors such as venture capitalists or angel investors). They
arrange raising of funds through equity and debt route and assist companies in completing various for-
malities like filing of the prescribed document and other compliances with the Regulator and Regulators
(Saunders, 2016).

They advise the issuing company on book building, pricing of issue, arranging registrars, bankers to the
issue and other support services.

Investors

These are the stock holders or the shareholders, they own shares that are listed and are entitled to receive
dividends (Saunders).

Transfer agents

Responsible for the recording of share ownership changes and they also provide the listed companies with
a list of its security holders. For example maybe a holder of preference stock would want to convert to
common stock thus, transfer agents change the ownership. They also cancel or issue certificates and
distribute dividends (Chen, 2008).

MARKET EFFICIENCY

This is the speed with which financial security prices adjust to unexpected news pertaining to interest rates
or a stock specific characteristics (Saunders 2016). For example an unexpected increase in dividends.

It is also a market where there are large numbers of rational, profit maximizers, actively competing with
each other and trying to predict with each other and trying to predict the future market values of individual
securities and where important current information is almost freely available to all participants.

ASSUMPTIONS
It assumes that financial securities are always priced correctly.

Also, it believes that information is already available.

There is no undervaluation and over valuation of prices.

There are three ways which are used to measure the degree of stock market efficiency:

WEAK FORM MARKET EFFICIENCY

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 exchange specialists (Saunders, 2016).

Empirical research on weak form market efficiency generally confirms that markets are weak form
efficient because historical price information is the easiest type of information to acquire about a stock
(Islam S, 2005).

The hypothesis assumes that current market prices already reflect all past returns and any security market
information, the hypothesis implies that past rates of return and other historical market data should have
no relationship with future rates of return. Therefore this hypothesis contends that one should gain little
from using any trading rule that decides whether to buy or sell a security based on past security market
data (Malkiel, 2003).

SEMI STRONG FORM MARKET EFFICIENCY

Asserts that security prices adjust rapidly to the release of all public information, that is current security
prices fully reflect all public information.

The semi-strong 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.
Public information, such as earnings and dividend announcements, price to earnings ratio, dividend yield,
stock splits, news about the economy and political news. Investors cannot earn more than the required
return by trading on public news release (Mensah, 2003).

The semi-strong market implies that investors who base their decision on any important new information
after the public should not derive above average risk adjusted profits from their transactions considering
the cost of trading because the security price already reflects all such new public information (Fama,
1965). For example the government announced on 29 June 2007 that all prices were to be reverted to those
prevailing in 19 June. The stock market plunged a massive 37% in 2 weeks. Retail and wholesale
companies were heavily heat by these price slashes and the resulted effect on the stock exchange was
unavailable. The most affected stocks included OK, Truworths, Edgars and Red Star.

STRONG MARKET EFFICIENCY

The strong form of market efficiency states that stock prices fully reflect all information about the firm,
both public and private sources. This means that no group of investors has monopolistic access to
information relevant to the formation of prices (Saunders, 2016).

With this form, learning about private information about a firm does not increase the earnings from those
required thus, In strong form, there is no set of information that allows investors to make more than the
fair (required) rate of return on a stock (Saunders, 2016).

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 market in which prices adjusts rapidly to the release
of new information, to assume perfect markets in which all information is cost free and available to
everyone every time (Fama, 1970).
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