MONEY AND CAPITAL MARKETS – TERM PAPER

TOPIC: EQUITY

GROUP 4
Names Index Number

EMMANUEL ANYAVI-AGYEPONG 10195153

CECILIA EDNA ODOOM 10638402

ABIGAIL OSAFO 10633860

THELMA FAFA-GYIMAH 10640214

LECTURER: PROF. JOSHUA ABOR

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 Table of Contents
Executive Summary ........................................................................................................................ 1

Introduction ..................................................................................................................................... 1

Trading of Equity ............................................................................................................................ 2

The Stock Exchange ....................................................................................................................... 3

The Ghana Stock Exchange ............................................................................................................ 3

Rules governing their operations includes; ..................................................................................... 5

Dealings on the Ghana Stock Exchange ......................................................................................... 5

Valuation of Equities ...................................................................................................................... 5

Ghana Stock Exchange Market Indices .......................................................................................... 7

Challenges facing the Ghana Stock Exchange................................................................................ 8

Factors affecting stock prices.......................................................................................................... 8

Stock market efficiency ................................................................................................................ 10

Regulation of the stock trading ..................................................................................................... 10

Roles of Stock Market in the Economy ........................................................................................ 10

Promoting stock market development .......................................................................................... 11

Globalization of stock markets ..................................................................................................... 12

Conclusion .................................................................................................................................... 12

References ..................................................................................................................................... 13

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Executive Summary

This piece was to examine the equity market. The write up is made of introduction which involve
the meanings of equity and how to become an equity holder. Also, it discusses the trading of equity
which could be done on the primary, secondary, organized market or over the counter. It also gives
a general overview of the stock exchange including Ghana Stock Exchange with it rules and
regulations, challenges of the GSE, ways of valuing stocks and some importance of the stock
exchange to the country.

Introduction

Every firm has its own capital structure or ways of financing its activities. Many firms have resort
to using a mixed of debt and equity in financing its operations. Equity which is mostly refer to as
shares represents partial ownership in a firm. Firms that seek to acquire long term capital to grow
their businesses issues shares on the primary market which is eventually traded on the secondary
market. Shareholders appoint management to oversee to the operations of the company and board
of directors are also appointed to make sure these managers will work in the best interest of the
shareholders in maximizing shareholders value. This outlook essentially identifies the interests of
the shareholders with their wealth position in the stock. According to this view, the firm’s
manager’s acts as agents of the shareholders, operating the firm as the shareholders would if they
were managers themselves. Problems however arise from this relationship because the interests of
the agent-managers are not the same as those of the principal shareholders. For example, managers
may overspend on fancy office furnishings- paid for out of the pockets of the shareholders- but the
benefits are only enjoyed by the managers.

Equity holders are the real owners of a company and in times of default, debt holders typically
receive fixed nominal returns and are also compensated first. On the other hand, equity holders
explicitly receive a return that is tied to the earnings stream of the firm or the investment project
being financed. Therefore, equity holders receive income that is much less certain, in both amount

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and timing than debt holders. Simply put, financial instruments such as stocks and bonds are claims
on the returns stream generated by the real assets. For example, owners of bonds issued by a
corporation are entitled to receive their promised payments before the stockholders receive
payments on their investments. This is to say that a shareholder is a part owner of a company. The
purchase of any real asset is funded by capital raised through some combination of equity and debt,
alternatively referred to as stocks and bonds. In North America they are referred to as stocks but
in Ghana they are referred to as shares. Returns to shareholders come in the form of dividends and
capital gains which arises when the current price of a share is higher than the initial share price.
As owners of a corporation, shareholders have privileges and responsibilities conferred upon them
by owning the shares.

Trading of Equity

Equity instruments can be traded on; The primary market, secondary market, Organised market
(e.g. Stock Exchange) and Over-the-counter.

The Primary Market

Market for the sale of new stocks and bonds to the public for the first time. A key example is an
initial public offering (IPO). Primary market is facilitated by underwriters comprising investment
banks. Investment banks (or underwriters) set an initial price range for a given stock and oversee
its sale to investors. Securities traded in the primary equity markets are either issued through a
public offering or a private placement.

Public Offering and Private Placement

In the public offering, the general public is targeted. This is known as Initial Public Offerings, i.e.
first times the offering of shares to the public takes place in a primary market. A private placement
on the other hand, is when the issue of shares is targeted at a few people. The issuing firm contacts

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a few institutional investors to buy the shares. Thus, share issue is not open to the general investing
public.

The Secondary Market

This is the market for the trading of already issued stock. It consists of both debt and equity stock.
Secondary market may be organised market (the stock exchange) or over-the-counter market.

The Stock Exchange

A stock exchange was formed purposely to provide a platform for trading of securities. The stock
market has centralized system or an electronic platform through which members trade in shares on
behalf of their clients. Stock exchanges are useful for trading in shares that are issued as a result
of an IPO and secondary offering. Usually, a stock exchange operates as a non-profit corporation
with the aim of promoting the financial interest of its members. Members on the stock exchange
hold memberships or seats on the exchange. There are rules formulated to govern trading activity
on the exchange and members are oblige to abide by them. Only members of the exchange or
license dealing members are giving the opportunity to trade on the exchange. In this regard it is
referred as a self-regulating entity. In that sense, members have monopoly position, because all
orders to buy or sell securities on a given exchange must flow through an exchange member.

The Ghana Stock Exchange

In July 1989 the GSE was established as a private company limited by guarantee under the
company’s code of 1963 as a private company limited. However, trading at the GSE started in
November 1990 after its council was inaugurated the same day. The GSE became a public
company limited by guarantee in 1994. The current listing of equities on the exchange is 42 from
37 companies and two corporate bonds. The GSE in 1994 was adjudged the best index performing

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stock market among all emerging markets with a gain of 124.3 percent in its index level. It
currently lists 42 equities from 37 companies and 2 corporate bonds. It serves as the secondary
market for trading publicly issued shares and is a self-regulatory body. Recently, the composite
index increased from 13 points or 0.53% to 2422 on Tuesday March 26 from 2409 in the previous
trading session. Historically, the Ghana Stock Market Composite GSE-CI reached an all-time high
of 3489.21 in April of 2018 and a record low of 940.04 in December of 2011.

Ghana Stock Market Composite GSE-CI

The GSE was set up as defined in Act 384 with some of the objectives mentioned below;

i. Regulation of the dealings of members with their clients and other members.
ii. Co- operating with the associations of stockbrokers and stock exchanges in other countries.
iii. Obtaining and making available information and facilities which are likely to be useful to
its members and their clients.

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Rules governing their operations includes;

 Membership rules
 Listing rules
 Rules on Takeovers
 Securities Clearing and Settlement House Rules
 Continuous Trading Rules

Dealings on the Ghana Stock Exchange

Share trading on the Ghana Stock Exchange is carried out by stock brokerage firms on behalf of
their clients. The stock brokerage firms are known as Licensed Dealing Members (LDMs). They
trade remotely via an electronic trading platform. The regulations of the GSE ensure that investors
are treated fairly and that trading is regulated by them as well as the Securities and Exchange
Commission. These regulations are imposed to prevent unfair or unethical trading practices on the
stock exchanges. Regulations also attempts to prevent insider trading, that is, the use of inside
information by investors. In recent times barriers to international stock trading has been
minimized, thus allowing investors to trade with foreign investors. Consequently, stock markets
have become more globally integrated. This results from the reduction in transaction cost,
information costs, and exchange rate risk.

Valuation of Equities

There are certain basic principles that guide the valuation of equity. For all assets, one can analyze
the value of a share stock as the present value of all future cash flows from the security. The value
of a share of preferred or ordinary (common) stock equals the present value of the dividends the

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stock will pay over the infinite future. We will now take in turns how these two types of stocks are
valued.

A preferred stock is usually issued with a stated par value, for example GHC 100. Their dividends
represent a percentage of the par value. In many respects the dividends paid on preference shares
are similar to the coupon payments made on a corporate bond. Preferred stock may be analyzed as
perpetuity- bond that makes interest payment of fixed amount forever and never returns its
principal. The value or price of a share of preferred stock equals the present value of all cash flows
that will come from the stock. The price of the preferred share is equal to the dividend payment
from the preferred share divided by the discount rate appropriate to the preferred share. Using the
formula, the obligated payments are known, because the dividend is given by the par value and the
dividend rate on the shares.

Holders of ordinary shares commit their funds and assume the last- place claim on the value of the
firm in hopes of securing substantial profits. While a firm exists, the only cash flows that come
from a share of common stock are cash dividends. These cash flows are risky. The perceived
riskiness of shares is reflected in the rate of return required by stock holders, which is the discount
rate applied to the firm’s dividend stream. The dividend valuation model is used to value common
stocks. This method says that, the price of a share of stock equals the present value for all future
dividends to be paid by a share. The constant growth model can as well be used even when
dividends are not constant.

There are two major models used in valuing stocks. These are:

1. Price Earnings Model: This is a relatively simple method of valuing a stock. This method
assumes that the growth in future years will be similar to that of the industry.

Value per share = (Expected earnings per share) x (Mean industry PE ratio)

Dividend Valuation Model: This model suggests that the price of a share should reflect the present
value of the shares’ future dividends. This model is underlined by three assumptions:

i. Zero growth

Zero growth assumed that dividend will remain same into perpetuity.

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 ii. Constant Growth

This model assumes that dividend is expected to grow at a constant rate forever. In a classic
application of the growing perpetuity idea, Myron Gordon showed that if a company’s
dividends grew at the rate of g% each year, then the share price would be given by:

D1
P 
r  g

iii. Multiple Growths

With this, dividend payment assumes a different growth rate. It grows over a given number of
years and then assumes the constant growth.

Ghana Stock Exchange Market Indices

The two market indices, the GSE Composite Index and the GSE Financial Stock Index which are
used to measure the performance of the market. Data shows that remarkable upward movements
have been recorded. As at 31st October 2016, the total volume of trade stood at 604,542 with a
GSE Composite index of 1728.37. Market Capitalization for the same day stood at GHC 52,385.55
million. On Tuesday, 1st November 2016, Market Capitalization was GHC 52,383.20 million. That
day the volume of trade and the GSE composite index were 93,813 and 1,727.95 respectively.
Again, on November 2, volume of trade was 510,137, GSE Composite Index 1713.18 and a market
Capitalization of GHC 51,898.38million. Between November 1st and November 2nd, the GSE
composite index rose by 14.77 and the GSE Financial Stock index rose from 1,636.46 to 1,615.27,
a difference of 21.19.

Furthermore, small and medium scale enterprises that could not be listed on the stock exchange
due to the fact that they could not meet the requirements for listing have been provided with an
alternative market for raising capital. Most at times these enterprises have future growth potentials
and as such the GSE decided to set up the Ghana Alternative Market (GAX) in 2012 with the focus
of helping SMEs to raise long term capital on the market.

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Challenges facing the Ghana Stock Exchange

A few of the numerous challenges facing the Ghana Stock Exchange are discussed below.

• Macroeconomic Instabilities

• Poor saving habit among Ghanaian and underdeveloped banking system

• Illiteracy and low awareness of the stock market and its operations

• poor fiscal policy management

Factors affecting stock prices

A stock price is the cost of purchasing a security (share) on an exchange.

Inflation. When prices go up it slows sales and reduces profit of businesses because consumers
will not buy as they used to buy due to price increment. When profit goes down, the firm is unable
to pay dividend. Investors will not demand the shares of the company. This will negatively affect
the value of the share.

Interest rates. When interest rates are high companies have to pay more to borrow money. This
eats into their profit. If firms are unable to make up for the lost profit share prices will drop since
it will send a signal that the company is not doing well. On the other hand, if interest rates decline
it signals cheaper cost of borrowing. Hence the company will spend less of its profit paying interest
rates. With this they will be able to retain more profit to pay dividend and engage in a positive
NPV projects. This will send a positive signal to investors that the company is doing well. Hence,
they will demand more of the shares of the company. This will lead to a rise in the firms share
price.

Firms-specific factors

Dividend policy changes. When a company reduces dividend, it pays to its shareholders. It sends
a negative signal to investors that the company isn’t doing very well. The market reacts very

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quickly to dividend changes. Hence investors will start selling their shares. This will immediately
force the prices of the shares to drop because of excess supply in the system. On the other hand,
when dividend goes up, the shares of that particular firm becomes attractive to investors. Hence
there will be more demand for that particular share. This will make the price to increase. Also,
investors need to avoid company who increase their dividend to make their shares look attractive
but may not be making profit.

Acquisition. When some firms realise that they are about to be acquired. They sell the most
attractive asset of the company to avoid the hostile takeover and make it unattractive. When this
happens the share, prices start falling since most investors will not be interested in the company
again. And they will be selling their shares.

Also, on the other hand when two companies merge it brings about economics of scale. Hence
more profit. The two firms coming together become attractive to investors and they tend to demand
more of the company’s shares. This will lead to an increase in the share price.

Market related factors

Market related factors also affect share prices. Among these factors are investor sentiments.
Investor sentiments are the mood of investors. The mood of investors can cause prices to go up or
down. The general direction of the market can affect the price of the share

Bullish market. A strong share market where stock prices are rising and there is a high investor
confidence, economic boom economic expansion. With this market investor are very confident
and optimistic about the market. They buy more shares and are sure of a high return.

Bearish Market. This is a weak market where share prices are falling, investor sentiments are
low. There is economic recession and investors are not too sure about the economy.

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Stock market efficiency

Stock market efficiency indicates how share prices reflect available information. There are three
forms of Market Efficiency

 Weak Form – this form assumes that share prices reflect past or historical stock trading
information. Investor cannot fully rely on this information because it may misguide them
in their decisions.

 Semi-strong Form – advocates that share prices reflect all publicly available information;
which includes both market and non-market information. Analyst also cannot fully rely on
this information. To get the best from this information, analysts or investors should also
consider other information to make the best from it.

 Strong Form – this form suggests that share prices fully reflect all information both public
and private. This means all information weather it’s publicly available or known to insiders.
It is interesting to know that there is no market that is strongly efficient in the world.

Regulation of the stock trading

Regulation ensures that investors are treated just. The Ghana stock exchange regulates the Ghana
stock market so as to ensure there is no insider trading or rigging in the exchange.

In Ghana the stock market is also regulated by the Securities and Exchange Commission. These
regulations are to prevent unfair practices during trading.

Roles of Stock Market in the Economy

Stock markets developments are necessary for the growth of any economy. Sound economic
environment, a well-developed banking sector, high institutional quality and strong shareholder
protection are important preconditions for the efficient functioning of the stock markets. This is

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very crucial to every economy since the market facilitates the mobilization of long-term capital.
The importance of the stock market in the economy is outlined below.

 They provide a ready market. They provide an opportunity and a ready market for
speculators and investors. Since it helps investors who purchase shares in the primary
market to off late these shares on the stock exchange.
 They provide a quoting market price. The pricing mechanism and the continuous
quoting of market prices provide adequate information to investors regarding the value of
their investments. The stock exchange provides an efficient means of determining the
market price of various equities available.
 They serve as an economic barometer. The stock exchange has been seen as a reliable to
measuring a country’s economic condition. The fluctuations in macroeconomic conditions
are been reflected in the share prices.
 Safeguarding activities for investors. The stock market ensures the safeguarding of
activities for shareholders and this enables them to make a fair judgement of the shares.

Promoting stock market development

Even though today the stock market is not doing too well and are facing some infrastructural
challenges, they have also made a lot of impact in the financing of large companies. Hence, we
need to promote the development of the stock market.

• Demutualization of the stock exchange

• Strengthening regulation and supervision

• Attracting private capital inflows

• Increasing Stock Exchange Automation

• Globalisation of stock markets

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Globalization of stock markets
Globalization has caused barriers between countries to be removed and reduced causing our
financial market to grow at a faster pace. Local Firms that need funds can tap into foreign markets
and local investors can also purchase foreign stocks. This helps the local firms to attract capital.
Large privatization programs have helped Ghana attract a lot of foreign investors. Placement of
shares on the international market is done through an investment bank or a syndicate. The issue of
illiquidity diminishes when a firm get listed on a stock exchange. This also gives opportunity to
foreign companies to diversify their shareholding base. Also, the SEC regulations may not permit
some firms for trading on a foreign stock exchange market. Firms that intend doing so thus need
to be abreast with such regulations. Some foreign firms use American Depository Receipts (ADRs)
to raise capital in the US markets. International mutual funds are foreign investment companies
that issue their own shares and invest the funds in a diversified portfolio.

Conclusion

There are primary and secondary markets for shares. In Ghana, the secondary market where shares
are traded is called the Ghana Stock Exchange which was established in July 1989 by the
company’s code of 1963. Although there are several challenges facing the GSE, it has over the
years served as a catalyst for economic growth and development. The GSE promote economic
growth by ensuring the efficient allocation of capital resources in the economy. Due to the critical
role the GSE plays in the development of Ghana, it calls for policy makers to formulate policies
that will foster the smooth operation of the GSE. Government is therefore advised to tailor policies
that will ensure a sustainable growth in the GSE as well as promote its efficiency in fostering
economic progress.

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References

Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of
financial economics, 49(3), 283-306.

Liu, J., Nissim, D., & Thomas, J. (2002). Equity valuation using multiples. Journal of
Accounting Research, 40(1), 135-172.

Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management. Cengage

Learning.

De Bondt, W. F., & Thaler, R. (1985). Does the stock market overreact?. The Journal of finance,
40(3), 793-805.

https://gse.com.gh/overview/

https://gse.com.gh/rules-and-regulations/

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