Explain the functions of the stock exchange ad discuss the challenges affecting

the functioning of stock exchange in Africa.

Stock Exchange is an organized market for the trading of stocks, bonds and other securities. It
provides a mechanism through which companies can raise capital for expansion purposes by selling
and issuing securities (stocks and bonds). According to Avadhani (2002), Stock Exchange means any
body or individuals whether incorporated or not, constituted for the purpose of assisting, regulating or
controlling the business of buying, selling or dealing in securities; it is an association of member
brokers for the purpose of self-regulation and protecting the interests of its members. Stock exchanges
are the most perfect type of market for securities whether of government, semi-government bodies or
other public bodies as well as for shares and debentures issued by the joint-stock companies.

Functions of Stock Exchange

The economy of the world relies on the stock exchanges to facilitate trade in the stocks of companies
by connecting people who seek money with those who can provide it. While the typical role of the
stock market as a centre of trading in securities is the raising of funds for investment in long term
assets to the investing public, there are other roles that can be summarized as follows:

 Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more rational allocation of
resources because funds, which could have been consumed or kept in unused deposits with banks, are
mobilized and redirected to promote commerce and industry.

 Redistribution of wealth
By giving many people a chance to buy shares of listed companies and therefore become part-owners
of profitable enterprises, the stock market helps to reduce large income inequalities because many
people get a chance to share in the profits of businesses that were set up by other people.

 Creating investment opportunities for small investors

As opposed to other businesses that require a huge capital outlay, investing in shares is open to both
large and small investors because a person buys the number of shares that he can afford. Therefore the
stock exchange provides an extra source of income to small savers.
  Raising Government capital for development projects
The Government and even local authorities may decide to borrow money in order to finance huge
infrastructure projects by selling another category of shares known as bonds. These bonds can be
raised through the stock exchange whereby members of the public buy them. When the Government
or the local authority gets this alternative source of funds, it no longer has the need to overtax the
people in order to finance development.

 Control on company management

The role of the stock exchange is also to monitor the market to ensure that it is working efficiently,
fairly and transparently. Over the decades, the stock exchange has been raising requirements for new
corporations seeking listing. These requirements relate to the submission of all financial information
regarding companies whose securities are sold on the stock exchange. Such requirements exercise a
control on a company management and keep its malpractice in check.

 Barometer of the Economy

At the stock exchange, shares rise and fall depending, largely, on market forces. Share prices tend to
rise or remain stable when companies and the economy in general show sign of stability. Therefore,
the movement of share prices can be an indicator of the general trend in the economy.

The challenges affecting the functioning of stock exchange in Africa

The African stock market is becoming increasingly sophisticated in pricing, isolating and
transferring risk. Tools such as derivatives and securitization contribute to this process but
pose their own risk. The failure of accounting and regulation to keep abreast of development
introduces more risk with occasionally spectacular consequences.
 Macroeconomic Factors
Macroeconomic risks include inflation risk, interest rate risk, low reserve and thin financial
market which all together affect the performance of a stock market. Macroeconomic policy
has a great impact on the performance of the stock market. In 1996, the Zimbabwe stock
market which accounted for an overall performance of 86.5%. However, in 1997 its
performance decreased by more than 50% in the wake of dramatic government farm and to
pay $ 240 million in pensions to veterans of Zimbabwe independence war.
For the last two decades, the growth rate of real per capita output for Africa has been
negative, while other regions have been showing strong positive growth rates. For example,
while between the 1970s and 1990s East Asia and South Asia moved from an average growth
rate of 4.6 percent and 0.7 percent to 6.4 percent and 3.3 percent, respectively, Sub-Saharan
Africa’s growth rate declined from 0.5 percent in the 1970s to -0.4 percent in the 1990s.
 Corporate Governance
Coup d’états is quite famous in African history. It appears that constitutional rule are present
there and politicians are manipulating constitutions to either seek longer terms in office or
perpetuate their stay. Thus, there is a lack of good corporate governance in the countries. In
the absence of corporate governance, there is inappropriate policy taken by the government
and regulatory frameworks. Moreover, there is no control of corruption, capacity building,
and there is an ineffective, inefficient, no transparent and accountable system for mobilizing
and allocating public as well as private resources.

 High unemployment
In Africa, there is abundance of unskilled labour and this may lead to decline of the working
class. The growth in demand for skilled labour does not match the decline of unskilled and
semi-skilled jobs. The labour market is shifting towards more skilled workers, professionals
and managers. A labour survey in South Africa found that there is more demand for managers
in the public sector, especially local government and particular services sectors
Unemployment is stubbornly high and inching upward. In South Africa the expanded
unemployment rate is estimated to be as high as 40% with the official rate at approximately
29%. The fact that the labour market is biased against those with less skill is reflected in the
higher average pay increases for skilled persons.
 Trade Development
Many African countries are faced with a multiplicity of challenges that prevent them from
participating in the global economy and reaping the benefits of increased globalization.
Africa is the most fragmented continent. Fourteen countries are landlocked, accounting for
30% of Africa’s population. The roots of the problem lie in chronic constraints to
competitiveness including, poor infrastructure, small and fragmented markets, undeveloped
financial markets, weak systems to facilitate trade, weaknesses in key institutions, and the
lack of adequate human resources.
 Political Risk
Political instability, institutional incapacity and social unrest inhibit foreign capital inflows.
These in turn lower investment appetites and have a negative impact for economic
opportunities and investment climate.
Perceptions of political risk arising from particular events, such as those related to the recent
elections in Kenya which generate market volatility and discourage investment. Africa is seen
as a region of high political risk, and significant risk premium are demanded by equity
investors, lenders and insurers.
 Currency fluctuation risk
The global economic slowdown in world growth may affect African exports of agricultural
products, minerals and hydrocarbons. Africa’s dependence on natural resource exports has
made many countries vulnerable to commodity price shocks that are outside their control.
Sudden increases in export revenues or import costs can cause currency instability and budget
uncertainty. Furthermore, there is strong evidence that currency depreciation has negative
effect on the performance of the African stock market.
 Crisis of International Confidence
Many countries in sub-Saharan Africa enjoyed robust economic growth in recent years.
However, the food and fuel price shocks of 2007-08 that preceded the current global financial
crisis weakened the external position of net importers of food and fuel, caused inflation to
accelerate, and dampened growth prospects.
A research done by IMF shows that in the past a 1 percentage point slowdown in global
growth has led to an estimated ½ percentage point slowdown in sub-Saharan African
countries. But the effects may be more pronounced this time because the tightening of global
credit compounds the impact of the slowdown, exacerbating risks for trade finance and other
capital flows.