1. The rationale behind establishing stock markets in developing countries.

The stock market can be described as the collaboration of markets and exchanges in which one
can regularly buy, sell and issue shares of companies that are publicly held. The exchanges may
occur in institutionalized formal organizations or over the counter market places operating under
a predetermined set of regulations. These committed market places facilitate the meetings,
interactions and transactions of stock buyers and sellers. They also ensure transparency of
transactions. Normally, the number of market participants is huge, which makes sure that the
stocks are traded at a fair price. They also ensure transparency of transactions.Some of the
functions of a stock market are;

 Fair dealing in securities transactions: based on the standard rules of demand and supply.
 Efficient price discovery: help in deciding the appropriate price of security.
 Maintaining liquidity: since it gives opportunity for any one qualified and willing to trade
the stocks.
 Security and Validity of transactions: ensuring compliance with the necessary rules and
regulations.
 Investor protection: especially those investing small amounts and have a limited financial
knowledge.

The primary reason behind establishing a well-organized stock market in developing countries is
economic development by making maximum mobilization of obtainable financial resources in
the country. But in order to attain this expected economic growth the stock market established
must be an “efficient stock exchange”. Results expected from efficient stock exchanges are:

 Allocation efficiency: The destination of the mobilized funds must be where they can be
most effectively used.
 Pricing efficiency: Those who provide funds to the market would be involved in a fair
game, the share price must reflect all past and forecasted information regarding the stock.
 Second period efficiency: the operation of the currently established stock exchange
should not be expected to cause predictable changes in the wealth distribution of the next
period. Only a single class of investors shouldn’t be able to maintain a position where
they can gain continuous above average returns.

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  It should satisfy its social and political goals set by public that established it.
 Operational efficiency: operation costs should be minimized to the possible extent.

Stock markets also support the growth of individual listed companies by their role of liquidity
provision. Firms can mobilize capital at a lower capital cost and risk is shared widely in the stock
exchanges. They can also help firms to undertake illiquid long term projects. On the other hand,
they facilitate efficient corporate governance and control for the listed companies since they
pressure their managements to be disciplined.

The stocks by themselves are attractive investments, since they generally earn higher returns than
depositing in banks. This is because there is more risk involved with the stocks in relation to
bank saving deposits. In addition, they give investors to the opportunity of diversification across
different industry areas which improves the trade of between risk and return. They also give the
public (especially the poor ones) opportunities to buy shares of listed companies and be part-
owners of profitable enterprises, which in turn reduces huge income imbalances. Educations
given to the investing public through brokerage community, investment advisors, security
analysts and financial journalists are other benefits of stock markets to the public.

Furthermore, establishment of stock markets assists projects whose outputs (products) are hugely
demanded by the society, and already existing companies to increase their productivity. Listed
companies will shift from relying solely on loans, government grants or subsidies and retained
earnings for their financing needs to add the possibility of accessing funds through stock
issuance.

2. Does liberalizing the banking sector support establishment of stock market in

Ethiopia? Why?

Yes, and my justification is as follows.

The term financial liberalization encompasses a whole combination of actions like autonomy of
central bank from the government, complete lack of restrictions of finance to move into and out
of the economy indicating the currency’s full convertibility; neglecting of all priority sector
lending targets; complete freedom of banks to perform their activities without government
interference and full freedom for foreign ownership. It is the reversal of the control of state over
finance.

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Although it has been argued that banks and stock markets are competing industries, recent
studies show that banks can actually support stock markets. Banks may have a comparative
advantage of assessing credit quality, especially when the stock market is new. In this case, when
banks grant and renew loans, it might be a positive signal for outside investors about the
borrowing firm especially it doesn’t have former reputations. Thus, banks may serve as
information sources about the trustworthiness of a certain investment, which reduces information
cost.

A study undertaken by Jess K. and Y. Lee in 2012 about the impact of financial liberalization on
stock market liquidity in China shows that there is a positive and significant liquidity impact
associated with the reforms made by the Chinese government which included liberalization of
the banking sector. The study showed an improvement in capital allocation efficiency of China’s
equity market, and financial stability by reducing vulnerability.

One reason how bank liberalization supports the stock markets may be by opening the banking
system for foreign investors, and allowing more domestic participants to invest in the banking
sector. When foreign investors are allowed to enter the banking industry and more investors are
given the option of being part-owners of banks, the stock market would have more participants.
The more the participants of a certain market are, the price of the stocks will be a better
representative of the listed banks that issue them. In this way, the banks would also gain more
resources and their role of information provision for the stock markets. Whenever big companies
such as banks are open for foreign and domestic investment there needs to be a well-organized
market that supports the sale of their shares, and that handles the numerous participants that
would be willing to invest in those companies. If a developing country like Ethiopia develops a
method to handle the influences of the highly developed and rich countries through ownership of
the country’s major companies, then liberalizing the banking sector would be a huge step
towards stock market establishment.

According to businessethiopia’s report of March 21, 2019, the Ethiopian Parliament has passed
the Continental Free Trade Area (AfCFTA) by officially beginning the process of financial
sector liberalization. This passing makes the country to open the financial market especially the
banking sector at least for African banks, because opening the financial sector is one of the five
requirements by the parties of AfCFTA under service sector linearization. This shows that

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movements towards liberalization could require the opening of a stock market. Thus, I believe
banking liberalization supports the establishment of stock markets.

3. Evaluation of the investment policy of Zemen Bank.

The investment policy of a certain company is a statement that shows the company’s inclination
towards a certain trend whenever a question of investment brings itself to the table. This trend
can be evaluated by reviewing the performance and growth it has brought in the consecutive
years after the company has followed to decide using that policy. Some essays also suggest that
investment evaluation can be done by relating the company’s performance with that of other
companies within the industry.

Zemen bank’s financial report for 2018 shows that the bank’s average annual earnings per share
for the last five years was 33.7%, which shows that the bank’s performance is slightly above
related companies. The amount of cash earned by the bank in forex inflows is $374 Million. It
provided loans of Birr 1 Billion to its customers, and this provision has increased by 25% from
the preceding year. The revenue of the bank has increased by 15% from the previous year. The
amount of deposit has also increased by 28% from the previous year.

According to the director’s report for the fiscal year 2017/2018, the lion’s share of the bank’s
performance are given to lending and international activities, which caused the bank’s gross
revenue to reach to Birr 1,136 million, its profit after tax to be birr 227 million and earning per
share to be 28.7%. The bank’s return on average equity has reached 18% and return on average
assets reached to 2.4%. The average return on assets of the preceding five years has been above
that of private banks.

When we look at the bank’s loan portfolio (composition of loans and advances); most (25.6% of)
loan goes to the manufacturing sector, Import sector follows by 15.2%, then Export sector by
14.5%, and Domestic Trade and Services (11.1%). The remaining (33.6%) falls under the
category of other loans and advances. The director reports that the bank has a prudent loan
management practice that was able to maintain a non performing loan of 3.78%, which is below
the maximum regulatory requirement of 5 percent. Total loans and advances to customers have
been 3.26 billion in June 30, 2016, 3. 2.99 billion in June 30, 2017, 4.99 billion in June 30, 2018.

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The bank’s Statement of Cash Flows shows that the company has also purchased additional
Equity investments for Birr 632,000. The other investment outflows have been purchase of
investment securities for Birr 386 million, purchase of property, plant and equipment for Birr
13.9 million , purchase of property, plant and equipment for Birr 336.8 million and acquiring
properties for birr 3.07 million.