DEBRE MARKOS UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
MBA REGULAR PROGRAM
Year of Study: 1st Year 2nd Semester
Course Title: Financial Institutions and Investment Management
Course Code: MBA 612 Credit Hour: 2
Term paper on Securities Marketing and Trading
By: Section A
1. Atinkut Azanaw
GSR/266/13
2. Awoke Sinlew
GSR/267/13
3. Beletu Mulie
GSR/269/13
4. Tigabu Amera
GSR/270/13
5. Alemnesh Mulugeta
GSR/258/13
6. Abay Alemu
GSR/251/13
Submitted to: Bizualem L. (Asst Prof)
Submission Date: March 2021
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Table of Contents
Contents
Page
List of Figures .....................................................................................Ошибка! Закладка не определена.
Introduction ................................................................................................................................................... 2
1.
Securities ............................................................................................................................................... 3
1.2.1. Equity securities .......................................................................................................................... 4
1.2.2. Debt Securities ............................................................................................................................ 5
1.2.3. Derivatives .................................................................................................................................. 5
2.
Financial Markets .................................................................................................................................. 6
2.1.
Definitions of Financial Markets .................................................................................................. 6
2.2.
Functions of Financial Markets ..................................................................................................... 6
2.3.
Major Participants in the Financial Markets ................................................................................. 8
2.4.
Types of Financial Market ............................................................................................................. 9
Primary Market ......................................................................................................................... 9
2.4.1.
2.4.1.1.
Secondary Market ................................................................................................................... 10
2.4.2.
2.4.2.1.
2.5.
Functions of Primary Market .......................................................................................... 10
Functions of Secondary Market ...................................................................................... 10
Money Market ............................................................................................................................. 11
2.5.1.
Characteristics of Money Market ........................................................................................ 11
2.5.2.
Securities Traded in Money Markets .................................................................................. 11
2.6.
Capital Market ............................................................................................................................ 13
2.6.1.
Characteristics of Capital Markets ...................................................................................... 13
2.6.2.
Securities Traded in the Capital Markets ............................................................................ 13
Conclusion .................................................................................................................................................. 15
References ................................................................................................................................................... 15
1
Introduction
Any economic system must combine inputs (land and other natural resources, labor and
management skill, and capital equipment) to produce output (goods and services). Economics
deals with scarce resources. One of the branches of economics is financial economics. Financial
economics deals with the financial system. A financial system is a system that enables
lenders/savers and borrowers/users to exchange funds. Lenders are those who have extra to give
and borrowers are those people or institutions who spend more than they received.
The financial system is complex, comprising many different types of government and privatesector financial institutions all of which are regulated by the government (Mishkin& Eakins,
2012). Financial system consists of financial instruments, financial services, financial markets,
and financial institutions. The financial sector in Ethiopia consists of formal, semi-formal, and
informal institutions. Financial instruments are also called financial assets/claims that whatever
the company issues to the public to raise capital. Financial services are services that ensure the
smooth flow of financial activities in the economy. Financial markets are places where financial
instruments such as stock and bonds are traded/exchanged. It has different classifications based
on different criteria.
This paper will give due emphasis to the financial securities and financial market. A financial
security is a type of financial instrument that is issued by corporations or governments in order to
generate capital. It has different classifications. Besides financial markets are a place where these
securities arebought and sold. There are difreent components of financial markets. Therefore, in
the following section financial security and markets meaning, classification and basic features
will be discussed.
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1. Securities
Based on physical existence, an asset can be classified into tangible and intangible. Unlike
tangible assets, intangible assets lack physical existence. Securities are one example of a nontangible asset. Securities are financial instruments/ financial assets that can be traded. Securities
markets are where financial assets are traded between parties. In other words, securities are
investments that allow you to own things without physical holding. They serve two functions.
First, they help companies to raise funds by making the initial sale of their stock to the public.
Second, they provide a place where investors can trade already issued stock.
Broadly speaking, securities can be categorized into marketable and non-marketable securities.
Marketable instruments are easily bought and sold in public markets. They are liquid financial
instruments that can be quickly converted into cash at a reasonable price. These securities
include common stock and money market instruments. The return on these types of securities is
low because marketable securities are highly liquid and are considered safe investments.
Marketable securities have a short maturity period of usually less than a year.
Non-marketable securities are liquid and are difficult to buy and sell because they are not traded
in secondary markets. Why they are illiquid because they are not easily transferred to new
ownership and are not easily converted into cash. The risk associated with non-marketable
securities is low. The primary reason for issuing security with non-marketable status is to ensure
stable ownership of these securities. It includes complex derivatives, government bonds, and
saving deposits, which are exchanged through a private transaction or over the counter/OTC
market using the internet.
Securities can be
Equity securities –provide partial ownership, includes stocks and
Debt securities –represent an obligation for repayment, includes bonds and banknotes and
Derivatives – which includes options, forwards, and futures and the basis on underlying
asset
Hybrid securities- which are a combination of debt and equity.
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1.2.1. Equity securities
Equity refers to a share of ownership in a company (which is possessed by the shareholder).
When you buy shares, you own part of a company. Equity securities usually generate regular
earnings for shareholders in the form of dividends. Equity security does, however, rise and fall in
value in accord with the financial markets and the company’s fortunes.
Equity
Security
Common
stock
Preferred
stock
Equity security can be common stock and preferred stock (Mishkin & Eakins, 2012). Common
stock represents shares of ownership in a corporation and is the type of stock in which most
people invest. Common shares represent a claim on profits (dividends) and confer voting rights.
Common stockholders are last in line when it comes to company assets, which means they will
be paid out after creditors, bondholders, and preferred shareholders. They receive dividends
according to the company’s profits. The return fluctuates with changes in market conditions. For
example, If the company profits, the investor profits as well, but if the company loses money, the
stock also loses money.
Preferred stock is considered less volatile/risk than common stock but has less profit. If investors
purchase preferred shares, they have the right to obtain regular dividends from the company. It
means that their return is predicated. Preferred stock investors have no right to involve and vote
in the company issues. However, they have a greater claim to the company’s assets. In preferred
stock, investors paid dividends before common stockholders. Preferred shares can be converted
to common shares, but common shareholders don't have this benefit.
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1.2.2. Debt Securities
They are known as fixed-income securities; these are better known as bonds. A debt security is a
type of financial asset that is created when one party lends money to another (Madura, 2015.
When you are buying these securities, you're lending money to a company. For example, when
you are buying the Great Ethiopian Renaissance Dam bond, you are lending money to the
government. Unlike equity securities, debt securities require the borrower to repay the principal
borrowed plus the interest rate.
They can be issued by an individual, company, or government and sold to another party for a
certain amount. Bonds, such as government bonds, corporate bonds, and municipal bonds are all
examples of debt securities. They all are agreements made between two parties for an amount to
be borrowed and paid back – with interest – at a predetermined time.
Generally, debt security has a maturity date, rate of interest, and fixed amount. For example,
while purchasing bonds investors do not get any right to participate in the firm’s decisionmaking. Instead, they repaid the principal and interest of their investment. Compared with
stocks, debt securities, bonds are less risky. It is because the borrower is legally obliged to make
payments.
1.2.3. Derivatives
Derivative securities are financial instruments whose value depends on other variables/assets
(Madura, 2015). The variables can be stocks, bonds, currencies, interest rates, and commodities.
Why investors enter into derivatives is because to earn profit by speculating the value of the
underlying asset in the future. It is achieved by price fluctuations. Derivatives are the agreement
between risk averter (one who avoids risk) and risk-taker (one who expects extra gain from
market fluctuations).
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There are four main types of derivative securities: futures, forwards, options, and swaps.

Forwards and Futures- both are the same; they are financial contracts that depicted a
predecided quantity at a fixed price on a fixed date. The main difference is that forward
traded on an exchange whereas futures are customized contracts and are not traded
anywhere. Futures are traded over the counter/OTC markets.

Options- there are two options: call and put. In a call option, you have the right but not
the obligation to buy a certain quantity at a given price. However, in a put option, you
have the right but not the obligation to sell a certain quantity at a given price.

Swaps- there are interest rate swap, foreign exchange swap, and commodity swap.
The main benefits of derivative trading are: it helps to hedge risk; it is used to set underlying
asset prices; it yields a higher return. Some of its limitations are: it is difficult to understand; it
may result in huge loss/volatility. So, those who enter derivative markets are advisable to have
ample experience in stock markets.
2. Financial Markets
2.1.
Definitions of Financial Markets
As claimed by Madura (2015), “A financial market is a market in which financial assets
(securities) such as stocks and bonds can be purchased or sold” (p. 3). It is a component of the
financial system, and it is a place where financial instruments are traded. Stocks are securities
that investors buy shares from a given corporation. Bond is when savers provide a loan to an
entity for a fixed time, at a fixed interest rate. Financial markets, therefore, facilitate the flow of
funds and thereby allow financing and investing by households, firms, and government agencies.
2.2.
Functions of Financial Markets
Financial markets transfer funds from those who have excess/surplus funds to those who need
funds/deficit. To illustrate, financial markets enable college students to obtain education loans,
families to obtain mortgages, businesses to finance their growth, and governments to finance
many of their projects. Consequently, financial markets play a significant role in the economy.
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Without financial markets, capital could not be allocated efficiently, and economic activity such
as commerce & trade, and investment would be greatly diminished. According to Madura
(2015), some of the basic roles of financial markets are the following.

Accommodating financial needs- financial markets help to decide how much funding to
obtain, what types of securities to issue, and when financing operations. It serves as the
mechanism whereby corporations (acting as deficit units) can obtain funds from investors
(acting as surplus units).

Accommodating investment needs- Another key role of financial markets is
accommodating surplus units who want to invest in either debt or equity securities.
Investment management involves decisions by investors regarding how to invest their
funds. The financial markets offer investors access to a wide variety of investment
opportunities.

Determining market price- The prices of financial instruments are determined by the
market forces i.e., demand and supply in the market. So the financial market provides the
vehicle by which the prices are set for both financial assets which are issued newly and
for the existing stock of the financial assets.

Raising capital- Financial markets raise required funds/capitals/ by enabling
participants/borrowers/ by issuing securities. Financial markets attract funds from
investors and channel them to corporations—they thus allow corporations to finance their
operations and achieve growth

Playing intermediary roles- financial markets plays some intermediary roles. For
instance, it facilitates the transfer of an asset from lenders and borrowers. It enhances
income by making lenders earn interest or dividends from their investment.

Facilitating economic development- financial market facilitates saving mobilization; it
supports entrepreneurship growth by providing necessary resources. It also boots
industrial development in a country and this raised standard of living.
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In short, the following figure shows the basic functions of financial markets.
Figure 1: Functions of Financial Markets
Lower cost of
Transaction
Capital
formation
Fund
Mobilizing
Invests funds
Functions of
Financial
Markets
2.3.
Major Participants in the Financial Markets
The major financial market participants are those who have surplus funds and those who have a
shortage of funds. So, the following parties are involved in the financial markets.

Supply-side Vs. Demand-side
A market participant may either be coming from the supply side. Supply sides are a surplus unit
that has an extra to give. It includes those institutions that receive more than they spend. They
are called savers/lenders. The demand sides are those who have a deficit of funds. It includes
those institutions or peoples who spend more than they receive. They are called users or
borrowers.

Investor Vs. Speculator
Investors- An investor is any party that invests. Investors are people and companies that
regularly purchase equity or debt securities for financial gain.
Less frequently the term is
applied to parties who purchase real estate, currency, commodity derivatives, personal property,
or other assets. Investors may be corporations, individuals, and local and international
governments
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Speculators- they attempt to predict price changes and extract profit from the price moves in an
asset. They are beyond investors. Speculation involves the buying, holding, and selling of stocks,
bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable instrument
to profit from fluctuations in its price as opposed to buying it for use or income via methods such
as dividends or interest. Speculators may be: corporations or individuals

Institutional Vs. Retail
An institutional investor is an investor, such as a bank, insurance company, retirement fund,
hedge fund, or mutual fund that is financially sophisticated and makes large investments. It is
often held in very large portfolios of investments. Because of their sophistication, institutional
investors may often participate in private placements of securities, in which certain aspects of the
securities laws may be inapplicable. A retail investor is an individual investor possessing shares
of a given security.
2.4.
Types of Financial Market
There are different bases to classify the financial market. For example, based on security types, it
is classified as money market and capital market. Based on market levels, the financial market is
classified as a primary and a secondary market.
2.4.1. Primary Market
A primary market is also known as the new issue/ new market. It is because in the primary
market new issues/securities are sold to initial buyers (Madura, 2015). The primary market
refers to the market where securities are created. Simply put, the primary market is the market
where the newly started company issued shares to the public for the first time through IPO
(initial public offering). Moreover, primary market issues include an initial public offering (IPO),
a private placement, a rights issue, and a preferred allotment.
The transactions in primary markets exist between issuers and investors, while secondary market
transactions exist among investors. Unlike the secondary markets, the primary markets supply
funds to companies to expand their business and diversify riks. Besides, in the primary market
securities are sold only once; but, in the secondary market, securities are traded multiple times.
In the primary market prices are fixed and set by companies; in the secondary market prices
fluctuated depends on supply and demand forces.
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2.4.1.1.Functions of Primary Market

New issue offer- The primary market organizes offers of a new issue that had not been
traded on any other exchange earlier.

Underwriting services- underwriting is a situation where investors take risks in
investment /loans by writing their name below the total risks. Underwriters earn a
commission /premium while the issuers raise their capital.

Distribution of new issue- It invites the public at large to buy a new issue and provides
detailed information on the company, issue, and involved underwriters
2.4.2.
Secondary Market
A secondary market is a financial market where previously issued securities are bought and sold
(Madura, 2015). It is known as after-market. Purchasing is undertaken indirectly. In other words,
securities that have already passed through the new issue market are traded in this market. It
means that investors can freely buy and sell shares without the intervention of the issuing
company.
Generally, a secondary market is a market where second-hand securities are sold. The
instruments traded in a secondary market consist of fixed income instruments, variable income
instruments, and hybrid instruments. In Ethiopia, there is no any secondary market securities
trading.
2.4.2.1.Functions of Secondary Market
Ahaduzzaman (2020) listed out the major importance of secondary markets. Some of these are:
Provides regular information about the value of a security.
Helps to observe the prices of bonds and their interest rates.
Offers to investor’s liquidity for their assets.
Secondary markets bring together many interested parties.
It keeps the cost of transactions low
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2.5.
Money Market
As mentioned by Mishkin and Eakins (2012), when we say money market, money or currency is
not traded rather short-term and highly liquid securities that are close to being money is traded.
In the money market short-term securities like treasury bills, commercial papers, certificates of
deposits, etc. Besides, money market securities are debt securities with a maturity of one
year or less (Madura, 2015). It is unsecured debt and used to raise emergency funds. To
illustrate, if an organization fails to pay a salary for its workers, it may issue 1 million worth of
commercial papers.
Money market securities are commonly purchased by households, corporations (including
financial institutions), and government agencies that have funds available for a short-term period.
Because money market securities have a short-term maturity and are sold in the secondary
market, they provide liquidity to investors (Madura, 2015). Market markets do not exist
physically; the transactions are performed over a virtual network, i.e. fax, internet, or phone.
2.5.1.
Characteristics of Money Market
Money markets have three basic characteristics in common (Mishkin & Eakins, 2012). These
are:

They are usually sold in large denominations.

They have low risk.

They are highly liquid

Their maturity is less than one year; short-term nature.
2.5.2.
Securities Traded in Money Markets
Hereunder, common types of money market instruments (Madura, 2015) are discussed.
2.5.2.1. Treasury Bills
When government faces a shortage of funds, it issues Treasury bills to borrow funds to finance
its projects. For instance, in the US, T-bills are issued with 4-week, 13-week, and 26-week
maturities every week. T-bills are considered as risk-free. It is a highly liquid instrument- at any
time the holder can transfer it. Moreover, T-bills are purchased based on an auction. Unlike other
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money markets, investors do not receive interest payments. Investors paid face value at maturity
period. For example, T-bills are auctioned and you bought below face value 100 (99.50). Then
you hold it until maturity. Finally, you received a face value, 100. It means you bought at 99.50
and get 100 at maturity.
In Ethiopia, Treasury bills and government bonds are the only securities issued to finance
government expenditures (NBE, 2019/20). For example, NBE sold Birr 234.84 billion T-bills in
2019/20. Treasury bills were formerly issued in paper form but now due to changes in
technology, it maintained electronically.
2.5.2.2. Commercial Papers
Mishkin and Serletis (2011) claimed that commercial bills/ commercial papers/CP refer to an
unsecured short-term debt instrument issued by reputed financial and non-financial corporations.
Why they are unsecured is because they are unreliable and have no collaterals. They are a
popular instrument for financing the working capital requirement of companies. They help
companies to get immediate funds for operations. CP maturity is less than 1 year.
To illustrate, assume you have used 900 Birr worth of services in a restaurant. Then you gave a
2,000 Birr note to the waiter; unfortunately, the waiter did not get change. He can then give you
a stamped paper that allows you either to refund 1,100 birrs or to use services from any branches
of the restaurant for up to a month.
2.5.2.3. Certificate of Deposits
A certificate of deposit/CD is a form of commercial instrument issued by a bank to a depositor
(Mishkin & Serletis, 2011). It is a way of earning interest on the money you saved by looking
over some time. It is similar to a saving account. Unlike CD, in a saving account, you will
withdraw money at any time you need. It is because CD is a contract between a bank and
depositor for a fixed time. As far as you abide by the contract, in CD, you will get a higher
interest rate than a saving account.
For example, you may buy CD at a certain price, then interest will compound annually. Then
when it is mature, you will earn principal plus interest. But, if you try to take out money before
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maturity dates, there will be a penalty. It has low risk (since it is issued by big financial
institutions) and low return investment. It is safer than stocks and bonds instruments.
2.5.2.4. Bankers
Acceptance
It is a document promising future payment which is guaranteed by a commercial bank. A bank
agrees to pay a particular amount at a specified future date (usually 1-6 months). It is similar to a
treasury bill; but, T-bills are provided by a central bank (NBE). The banker’s acceptance
specifies 3 things: the amount of money, the person to which the payment due, and the maturity
date. Basically, it is a short-term credit investment that is traded in secondary markets. Whenever
necessary, the holder has the option to sell for those who wait for the maturity date.
This instrument is used to finance exports, imports, and other transactions in goods. For example,
a company buys raw material from suppliers. As a result a bank issue bankers' acceptance and
payment for the purchase. Finally, the company pays its short-term debt plus interest to the bank.
2.6.
Capital Market
Capital markets facilitate the sale of long-term securities like bonds, stocks, mortgages, by deficit
units to surplus units (Mishkin & Eakins, 2012). Capital market securities are commonly issued
to finance the purchase of capital assets, such as buildings, equipment, or machinery.
2.6.1. Characteristics of Capital Market
Capital market is a market for borrowing and lending of long-term finance that is for a period of
more than one year.Some of its features are:

Capital market is a market for trading of long term securities.

Capital market is a link between borrower and lender.

They includes primary market and secondary market

They provide liquidity to the investors, that investors can sell their share at any time.

They have lower transaction costs due to their high volume of transactions.

They encourage new investment.
2.6.2.
Securities Traded in the Capital Market
There are three types of securities that are traded in capital markets; these are bonds, mortgages,
and stocks (Mishkin & Eakins, 2012).
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2.6.2.1.
Bonds
Bonds are long-term debt securities issued by government agencies, and corporations to finance
their operations. They provide a return to investors in the form of the interest income (coupon
payments) every six months. Since bonds represent debt, they specify the amount and timing of
interest plus principal payments to investors/ purchasers. At maturity, investors holding the debt
securities are paid the principal. Bonds commonly have maturities of between 10 and 20 years.
In Ethiopia, the bond market is available. For instance, as we know Ethiopian government issued
Great Renaissance Dam bonds for organizations and peoples. This is done to collect enough
funds for the construction of projects.
2.6.2.2.
Mortgages
Mortgages are long-term debt obligations created to finance the purchase of the real estate.
Mortgages are loans given to buy a house. Residential mortgages are obtained by individuals
and families to purchase homes. Financial institutions serve as lenders by providing residential
mortgages in their role as financial intermediaries. Before granting mortgages, they assess the
likelihood that the borrower will repay the loan based on certain criteria such as the borrower’s
income level relative to the value of the home. Here, the home serves as collateral if the
borrower is not able to make the mortgage payments.
2.6.2.3.
Stocks
Stocks (or equity securities) represent partial ownership in the corporations or companies that
issue. They are categorized under capital market securities because they have no known maturity
date and therefore serve as a long-term source of funds. Investors who purchase stocks in the
primary market can sell the stocks to other investors at any time in the secondary market. For
example, an investor who bought a share in Abay bank can sell to another investor. When some
corporations distributed profits to shareholders in a form of a dividend, others reinvest it to the
company.
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Conclusion
Investment is an activity undertaken with the hope of income generation in the future. Securities
are investment alternatives. Investors may spend their funds in different securities such as debt
security, equity security, and derivative market. Such securities are traded in financial markets.
Financial markets can be primary or secondary markets and money or capital markets. Common
money market instruments that have short maturities include bankers acceptances, treasury bills,
commercial papers, and certificates of deposits. Conversely, securities traded in capital markets
have long maturity dates. They include bonds, mortgages, and stocks. Different stakeholders can
participate in financial markets. All in all, securities and financial markets are two sides of the
same coin/investment.
References
Ahaduzzaman, M. (2020). Basic Functions of the Secondary Market | BBALectures. BBA
Lectures. https://www.bbalectures.com/basic-functions-of-the-secondary-market/
Madura, J. (2015). Financial Markets and Institutions (11th ed.). Cengage Learning.
Mishkin, F. S., & Eakins, S. G. (2012).Financial Markets and Instruments (7th ed.). PrenticeHall.
Mishkin, F. S., & Serletis, A. (2011). The economics of money, banking, and financial markets.
Toronto: Pearson Addison Wesley.
National Bank of Ethiopia. ( NBE) (2019/20) Annual Report.
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