The Stock Exchange: A Comprehensive Study Guide

The Stock Exchange is a highly organized financial market where existing securities (such as shares, stocks, bonds, and debentures) are bought and sold. It serves as a vital pillar of the financial system, facilitating capital formation, investment, and economic growth. In Nigeria, the primary platform is the Nigerian Exchange Group (NGX), formerly known as the Nigerian Stock Exchange (NSE).

1. Importance and Functions of the Stock Exchange

The stock exchange plays several crucial roles in an economy for individuals, corporate bodies, and governments:

• Mobilization of Savings: It provides a platform where idle funds from surplus economic units (savers/investors) are channeled into productive sectors of the economy.
• Barometer of the Economy: The performance of stock indices reflects the overall economic health of a nation. Rising prices indicate economic prosperity, while declining trends may signal recession.
• Provides Liquidity to Investments: Investors can easily convert their securities into cash by selling them on the floor of the exchange.
• Facilitates Capital Formation: It assists companies and governments in raising long-term capital for expansion and infrastructure development.
• Valuation of Securities: The market forces of demand and supply determine the fair value of listed securities daily.
• Protection of Investors: Through strict regulations, disclosure requirements, and code of conduct for members, it safeguards investors against fraud and manipulation.

2. Types of Securities Traded

Securities are financial instruments representing ownership, a creditor relationship, or rights to ownership. The main types include:

• Shares: The individual units of ownership in a company's share capital. Shareholders are owners of the company.
• Stocks: A collection of shares bundled together into a single fund, usually expressed in monetary value (e.g., £100 stock) rather than individual units.
• Preference Shares: These shares carry a fixed rate of dividend paid before any dividend is paid to ordinary shareholders. In the event of liquidation, preference shareholders are paid before ordinary shareholders. Types include:
  • Cumulative Preference Shares: Arrears of unpaid dividends accumulate and must be paid in future profitable years before ordinary dividends.
  • Participating Preference Shares: Entitled to a fixed dividend plus an extra share of profits under specified conditions.
  • Redeemable Preference Shares: Can be bought back by the company after a specified period.
• Ordinary Shares (Equity): These are the actual risk-bearers of the business. They have no fixed rate of dividend and are paid last. However, they possess voting rights and benefit most from high profits (via capital growth and higher dividends).
• Debentures: Long-term loans raised by a company. Debenture holders are creditors, not owners, and receive a fixed interest rate regardless of whether the company makes a profit or loss. They may be secured (backed by company assets) or unsecured.
• Gilt-Edged Securities: Government bonds and treasury stocks which carry virtually zero risk of default because they are backed by the federal government.

3. Procedure of Transactions and Speculations

Trading on the floor of the stock exchange is conducted through highly specialized intermediaries:

• Stockbrokers: Licensed professionals who act as agents. They buy and sell securities on behalf of the public and receive a commission called brokerage.
• Jobbers: Independent dealers who buy and sell securities on their own behalf (principals). They do not deal directly with the public, only with brokers. Their profit is called the Jobber's Turn (the difference between their buying and selling price).

Market Speculators

Speculators buy and sell securities hoping to profit from price fluctuations. The main types of speculators are:

• Bulls: Optimistic speculators who buy securities now in anticipation of a future price rise, intending to sell them later at a higher price to make a profit.
• Bears: Pessimistic speculators who sell securities now (sometimes which they do not yet own) in anticipation of a price fall, hoping to buy them back later at a lower price.
• Stags: Speculators who apply for large quantities of new shares in a primary issue (IPO) hoping that the shares will be oversubscribed and open at a premium, allowing them to sell quickly for an immediate profit.
• Lame Ducks: Speculators (usually Bears) who are unable to meet their financial obligations or contracts when the market moves against their predictions.

4. The Second-Tier Securities Market (SSM)

Established in Nigeria in April 1985, the SSM is a market designed specifically to provide small and medium-sized enterprises (SMEs) with access to long-term capital which they otherwise could not access on the First-Tier (Main) market due to stringent listing requirements.

Listing Requirements of the SSM vs First-Tier Market

• Number of Shareholders: SSM requires a minimum of 100 shareholders (compared to 500 for the First-Tier).
• Equity Offered to Public: A minimum of 10% of equity must be offered to the public (compared to 25% for the First-Tier).
• Trading Record: SSM requires a minimum of 3 years of audited trading history (compared to 5 years for the First-Tier).
• Capital Requirements: The minimum share capital required is substantially lower for SSM companies.

Advantages of the SSM

• Provides expansion capital for young, growing indigenous companies.
• Encourages financial discipline and better corporate governance among small businesses.
• Offers an exit route and valuation mechanism for original founders.
• Acts as a stepping stone to full listing on the Main Board of the exchange.