BUSINESS WORLD Understanding Capital Market Operations in Sierra Leone Posted by on Dec 4, 2008, 18:52

This article is meant to educate the general public on the operations of the Capital Market, with particular reference to the Sierra Leone Stock Exchange.  Dr. Jalloh is currently the Officer-in-Charge of the Sierra Leone Stock Exchange , an institution that is being set up to expedite the mobilization of adequate  financial resources to support economic growth in Sierra Leone.  The article, which is written in the form of questions and answers, is intended to provide an in-depth understanding of the operations of a Stock Exchange. The author intends to publish a series of such questions and answers with a view to create public awareness on the role of the Stock Exchange in economic development.  In this article, you will get the answers for some of your major concerns regarding the Stock Exchange.

What is a Financial Market?

At any point in time, we have people that have money that they don’t want to spend but rather save for future uses. This set of people choose to save because they have more than what they needed to spend for the time being. On the other hand, there are people that want to spend money to undertake some economic activities but don’t have the required amount of financial resources.

Though some do have some money, it may not be enough to fully finance the intended activity. For instance, an individual may want to start a small private business but lacks enough money to finance the business. In that case he/she may need additional financial resources to fully finance his/her business. The Government for instance would like to construct of a well equipped modern Hospital or construct a well paved high way linking Sierra Leone to neighbouring countries like Guinea and Liberia but may not have enough economic resources to finance the projects.  As a result, the Government may want to quickly access additional financial resources through borrowing from the general public.

In another example, a university student may want to pay his/her college fees but may not have adequate funds to do so and may look for an opportunity to borrow.  A company may also want to build a new factory to increase its production owing to the increasing demand for its products but may not have additional funds to finance the building of the factory.

Thus the management of the company may want to access additional funds by taking a loan from some where.  In all these cases, it will be practically difficult to easily identify someone or a set of people that can easily afford to lend the Government, the student, the businessman and the company the amount of money they respectively needed to execute their intended expenditures.  As a result, most economies around the world therefore rely principally upon the market system to carry out the complex task of allocating scarce resources.

By definition, a market is a place or a mechanism through which buyers and sellers exchange goods and services using a generally accepted medium of Exchange (i.e. Money). Thus, just like any other market, the Financial Market is a specialized market that is responsible for channelling financial resources from the surplus units ( savers ) to the deficit units ( those who needed  additional funds) to carry out some form of economic activities.

The Financial Market therefore constitute of all financial institutions that receive financial resources from the surplus units of the economy in the form of savings and transfer them to the deficits units through lending activities. This role of transferring financial resources from the surplus units to the deficit units is what is referred to as financial intermediation.

Thus, a Financial Market comprises of all institutions that play the role of financial intermediation. These set of institutions are therefore referred to as financial intermediaries.  The businessman who needed some additional money to start his business, the Government that needed more funds to undertake developmental projects, the student that needed a loan to pay his/her college fees,  and the company that needed more finances to expand its operation will all find the financial Market a useful avenue to access additional funding.

What kind of Institutions that Makes up the Financial Market?

The Financial Market is made up of all those institutions that perform the role of financial intermediation. That is, the Financial Market constituted of all institutions that mobilise financial resources from the surplus units to the deficits units through acting as intermediaries.  To be more precise, these institutions include Commercial Banks, The Central Bank, Insurance Companies, Discount Houses, Savings Banks, Development Banks, Cooperative Banks, Micro Finance Institutions, Rural Credit Markets, Community Banks, Mortgage Finance Banks and the Capital Market.

What is meant by a Capital Market?

A Capital market is that constituent of the Financial Market that facilitates the mobilization of long-term investment capital for the financing of business enterprises as well as Government long term investment projects. In other words, the term Capital Market refers to a specialized financial institution that provides a channel for the borrowing and lending of long-term funds (i.e over one year). It is a well organized financial institution that facilitates the transfer of financial resources from those that have surplus funds (savers) to those that needed the use of theses funds (i.e. Government and private sector businesses) to undertake long-term investment. Thus the Capital Market offers an opportunity for both private business people and Government to mobilize huge amounts of financial resources from the general public through the sale of financial securities.

Is the Money Market the same thing as the Capital Market?

The answer is no. The Money Market is quite different from the Capital Market in the sense that, unlike the Capital Market, one cannot raise long-term capital from the Money Market.  The existence of money markets facilitate trading in short-term debt instruments to meet short-term needs of large users of funds such as governments, banks and similar institutions. Government treasury bills and similar securities, as well as company commercial bills, are examples of instruments traded in the money market. A wide range of financial institutions, including merchant banks, commercial banks, the central bank and other dealers operate in the money market. Public as well as private sector operators make use of various financial instruments to raise and invest short term funds which, if need be, can be quickly liquidated to satisfy short-term needs. In short, whilst the Money Market traded in short-term financial instruments ( i.e.  Less than one year), the Capital Market traded in long-term financial instruments (longer than one year).

What is a Stock Exchange?

A Stock Exchange is actually a component of the Capital Market. The Capital Market is divided into two areas; the Primary Market and the Secondary Market. The Primary Market deals with the trading of new securities. When a company issues securities for the first time (i.e. IPO) , they are traded in the Primary Market through the help of issuing houses , Dealing /Brokerage Firms ,  Investment Bankers and or Underwriters. The acronym IPO stands for Initial Public Offering, which means the first time a company is offering securities to the general public for subscription.  The amount of money raised in the Primary market goes directly to the Issuing Company/Firm to finance its operations. 

Once the securities (shares) of a company are in the hands the general public, they can be traded in the Secondary Market to enhance liquidity amongst holders of such financial securities. Thus, the Secondary Market facilitates the buying and selling of securities that are already in the hands of the general public (investors). Here, the term investor is used to refer to an individual or an institution that buys the securities (Shares) of a Company with the intent of making some financial returns.

The Stock Exchange therefore is an organized financial platform that deals in transactions involving the buying and selling of financial securities in the Secondary Market. In short, the Stock Exchange does the work of a Secondary Market by facilitating a formal trading arrangement for financial securities.

Who are the Main actors in a Stock Exchange?

The main actors in a well organized Stock Exchange include the Dealers/Stockbrokerage Firms, Company Registrars, Issuing Houses, Mutual Fund Managers, Investment Bankers, the Security and Exchange Commission (which regulates the activities of the Exchange), the Central Security Clearing and Settlement (CSCS) system, and the Investing Public.

Who is a Stockbroker/Dealer?

A stockbroker is a licensed member of a Stock Exchange that buys and sells financial securities for their clients/customers. That is, a Stockbroker is an agent that simply buys or sells securities on the behalf of an investor. This simply means that a Stockbroker executes trade on the instruction of his/her customer. Because he/she is trading on the behalf of someone (the investor), he/she gets his/her compensation by levying some form of tax ( i.e  a commission ) from the proceeds of the trade.   On the other hand, a Dealer buys and sells financial securities on his/her own account.  In other words, a Dealer enters the market as a buyer or seller of securities using his/her own financial resources.

Thus, his/her compensation depends on the outcome of the trade. If he/she can buy at a lower price and sells at a higher price, then he/she will make a capital gain. If the reverse holds, then he/she is liable to make a capital loss which he/she has to bear up alone.  In some cases, an individual/institution can act in the capacity of  a Stockbroker as well as a Dealer in securities . In this case, the institution or individual is referred to as a Dealer-Broker.  In a Dealer-Broker setting, the individual can buy or sell securities for him/her self or for some other person with the hope of making a commission.

How can a Company benefit from the Stock Exchange?

Owners of companies/businesses always want to see their operations grow as the demand for their products/services increase. Sometimes, it may be very difficult to raise additional finances to support expansions in the company’s operations. Bank loans may be very expensive, short-term and limited in supply. With the Stock Exchange, a company can raise a huge amount of long-term capital by issuing financial securities tradable at the floor of the Exchange.

For instance, if a company issues 1,000,000 (one million) shares at the price of Le 1,000.00 (one thousand Leones) per share; the company will be able to mobilize Le 1,000,000,000.00 (one billion leones) upon selling all its shares.  If the issue price is increased to say Le 5,000.00 per share, then the company will mobilize Le 5,000,000,000.00 (five billion leones) upon selling the 1,000,000 (one million) shares to the public.  This amount can be easily raised by the company to finance its projects through the Stock Exchange without much stress. Alternatively, if a company chooses to raise this amount from a Commercial Bank, it would be required to provide some form of collateral security that may not be easy to get. It may also required a long process of bureaucratic measures that may be time consuming and costly. But with the Stock Exchange, raising capital is less costly and less time consuming. A company will not be required to provide any form of collateral security to raise capital from the Stock Exchange.    

However, any company that wants its securities to be traded on the floor of the SLSE must be listed on the Exchange.  A lot of benefits can be derived from being a listed company on the Sierra Leone Stock Exchange. Once a company is being listed on the Sierra Leone Stock Exchange, additional financing is easier to raise through subsequent issuing of securities. The credibility of both investors and potential creditors can be enhanced because of the high standards that must be met and maintained by listed companies. There is increased visibility of the company through the comprehensive disclosure of information on the public and publishing of trading statistics by the Sierra Leone Stock Exchange. The Exchange creates a market place where the securities of all listed companies can be bought and sold.  This in turn increases the demand for securities and adds to the value and acceptance of the securities because the purchaser knows that there is a ready market for shares.

How can an investor make money in the Stock Exchange?

As an investor, you cannot buy and sell financial securities directly from the Stock Exchange. If you have money that you wanted to invest in the Stock Exchange, you first need to approach a licensed Stockbroker who has the right to buy and sell securities on the floor of the Exchange. Once you get a licensed Stockbroker, you will instruct him/her to buy for you the shares of any company that you wish to invest in. If for example you want to buy the Shares of Rokel Commercial Bank, or Sierra Leone Brewery Limited, or Standard Chartered Bank, you only need to instruct your Stockbroker(s) to buy for you a given quantity of these shares. If for example you buy the 1,000 Shares of say Standard Chartered Bank at Le200 .00 (two hundred Leones) per share, then you will spend the sum of Le 200,000 .00 (two hundred thousand Leones) to get the 1,000 Shares.

Now suppose that the price of the Shares that you originally bought for Le 200.00 went up to Le 500.00 per share after holding them for three months.  In that case, the investor makes a profit of Le 300.00 for each share that is now sold at the new price of Le 500.00.  Since the person bought 1,000 shares, his/her total profit will be Le 300,000 (three hundred thousand leones) . However, if he/she had decided to keep his/her money under his/her bed for three months, he/she would not have been able to make the Le300, 000.00 profit that was realized by buying the Shares at Le 200.00 and selling them later at Le 500.00.  Now, suppose he/she had plenty of money and was able to buy 2,000, 000  (two million ) Shares,  his/her profit would have been  Le 300 .00  X   2,000,000  =  Le600, 000,000 ( Six hundred million leones )  after selling the Shares at Le500 .00 each. The quantum of profit generated from the buying and selling of Shares depends on both the shares price appreciation over time and the volume of shares traded.  The more one invests on shares that rapidly appreciate with time, the more the profit that accrues to the investor. 

Thus, buying the Shares of companies whose share prices appreciate with time will result in investors making huge capital gains.  Again, if one decided not to sell his/her shares for the time being; he/she can also receive annual dividend payments and bonuses distributed to shareholders of the company. In any case, one stands to benefit from the decision to invest money in the Stock Exchange through the purchase of companies’ securities. However, it should be noted that when share prices fall, investors are likely to make a loss if they decided to sell their shares.  To avoid making a loss when share prices are falling, it is advisable for shareholders to continue holding their shares until prices start to rise again.

If one intends to buy Shares from Companies in Sierra Leone, who should be contacted?

Presently, we have two major licensed financial institutions that are in the business of buying and selling Shares for clients in Sierra Leone. If you want to buy or sell your shares, you can either Contact Mr. Jacob Kanu of First Discount House Limited (FDHL), 17 Wallace Johnson Street, Freetown (Tel : +232 22 228244 ) , or Mr. Daniel Thomas of Capital Discount House Limited (FDH),  15 Lamina Sankoh Street, Freetown  ( Tel: +232 22  226225 ).