March 6, 2022

The ideal way of making profits at the stock exchange is to buy at the bottom of the market (lowest M.P.S) and sell at the top of the market (highest M.P.S). The greatest problem however is that no one can be sure when the market is at its bottom or at its top (prices are lowest and highest). Systems have been developed to indicate when shares should be purchased and when they should be sold. These systems are Dow Theory and Hatch system. 1. Dow Theory This theory depends on profiting of secondary movement of prices of a chart. The principal objective is to discover when there is a change in the primary movement. This is determined by the behaviour of secondary movement but tertiary movements are ignored. e.g. in a bull market, the rise of prices is greater than the fall of prices. In a bear market the opposite is the case i.e. the fall is greater than the rise In a bear market, the volume of the business being done at a certain stage can also be used to interpret the state of the market. Basically, it is maintained that if the volume increases along with rising prices, the signs are bullish and if the volume increases with falling prices, they are bearish. 2. Hatch System This is an automatic system based on the assumption that when investors sell at a certain % age below the top of the market and buys at a certain percent above the market bottom, they are doing as well as can reasonably be expected. This system can be applied to an index of a group of shares or shares of dividends companies egg Dow Jones and Nasdaq index of America.

Stock Exchange Index is a measure of relative changes in prices of stocks from one period to another index. Nairobi Stock Exchange 20 – share Index (20 companies) (Daily basis) Stanchart Index – From 25 most active companies in a given period (weekly basis) Computation of price index. Uses of Stock Exchange Index 1. To gauge price (wealth movement in the stock market) 2. To assess overall returns in the market portfolio 3. To assess performance of specific portfolio using SEI as a benchmark. 4. May be used to predict future stock prices 5. Assist in examining and identifying the factors that underlie the price movements. Limitations/Drawback of NSE index 1. The 20 companies sample whose share prices are used to compute the index are not true representatives. 2. The base year of 1996 is too far in the past 3. New companies are not included in the index yet other firms have been suspended/deregistered e.g. ATH, KFB etc. 4. Dormant firms – Some of the 20 firms used are dormant or have very small price changes. 5. Thinness of the market – small changes in the active shares tend to be significantly magnified in the index 6. The weights used and the method of computation of index may not give a truly representative index.

The activities in NSE are normally low due to several factors that may come into play. These include the following among others: 1. Few Listed companies 2. Economy is made up of small firms which are family owned or sole proprietorship. 3. Level of awareness among the population is low 4. Few instruments traded 5. Low dividend payout to those already holding shares

All sorts of influences affect share prices. These influences include: 1. The recent profit record of the company especially the recent dividend paid to shareholders and the prospects of their growth and stability. 2. The growth prospects of the industry in which the company operates. 3. The publication of a company’s financial results i.e. Balance Sheet and profit and loss statement. 4. The general economic conditions situations e.g. boom and recession e.g. during boom, firms would have high profits hence rise in prices. 5. Change in company’s management e.g. entry and exit of prominent corporate personalities. 6. Change on Government economic policy e.g. spending, taxes, monetary policy etc. These changes influence investors’ expectations. 7. Rumour and announcements of impending political changes e.g. General elections and new president will cause anxiety and uncertainty and adversely affect share prices. 8. Rumours and announcement of mergers and take-over bids. If the shareholders are offered generous terms/prices in a take-over, share prices could rise. 9. Industrial relations e.g. strikes and policies of other firms. 10. Foreign political developments where the economy heavily depends on world trade. 11. Changes in the rate of interest on Government securities such as Treasury Bills may make investors switch to them. Exchange rates will also encourage or discourage foreign investment in shares. 12. Announcement of good news e.g. that a major oil field has been struck or a major new investment has been undertaken. The NPV of such investment would be reflected in share prices. 13. The views of experts e.g. articles by well-known financial writers can persuade people to buy shares hence pushing the prices up. 14. Institutional buyers such as insurance companies can influence share prices by their actions. 15. The value of assets and the earnings from utilization of such assets will also influence share prices

1. Economic conditions of the country and other non-economic factors e.g. unfavorable climatic conditions and diseases which may lead to low productivity and poor earnings. 2. State of management of the company e.g. are the B.O.D. and key management personnel of repute? They should be trusted and run the company honestly and successfully. 3. Nature of the product dealt in and its market share e.g. is the product vulnerable to weather conditions? Is it subject to restrictions? 4. Marketability of the shares – how fast or slowly can the shares of the firm be sold? 5. Diversification i.e. does the company have a variety of operations e.g. multi-products so that if one line of business declines, the other increases and the overall position is profitable. 6. Company’s trading partners (local and abroad) and its competitors. 7. Prospects of growth of the firm due to expected growth in demand of products of the firm.

1. Income in form of dividends When you have shares of a company you become a part-owner of that company and therefore you will be entitled to get a share of the profit of the company which come in form of dividends. Furthermore, dividends attract a very low withholding tax of 5% only. 2. Profits from Capital Appreciation Shares prices change with time, and therefore when prices of given shares appreciate, shareholders could take advantage of this increase and sell their shares at a profit. Capital gains are not taxed in Kenya. 3. Share Certificate can be used as Collateral Share certificate represents a certain amount of assets of the company in which a shareholder has invested. Therefore this certificate is a valuable property which is acceptable to many banks and financial institutions as security, or collateral against which an investor can get a loan. 4. Shares are easily transferable The process of acquiring or selling shares is fairly simple, inexpensive and swift and therefore an investor can liquidate shares at any moment to suit his convenience. 5. Availability of Investment Advice Although the stock market may appear complex and remote to many people. Positive advice and guidance could be provided by the stockbrokers and other investment advisors. Therefore, an investor can still benefit from trading in shares even though he may not be having the technical expertise relevant to the stock market. 6. Participating in Company Decisions By buying shares and therefore becoming a part-owner in an enterprise, a shareholder gets the right to participate in making decisions about how the company is managed. Shareholders elect the directors at the Company’s Annual. General meetings, whereby the voting power is determined by the number of shares an investor holds since the general rules is that one share is equal to one vote.

1. Raising Capital for Businesses The Stock Exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public. 2. Mobilising 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 idle deposits with banks are mobilized and redirected to promote commerce and industry. 3. Redistribution of Wealth By giving a wide spectrum of people a chance to buy shares 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 business that were set up by other people. 4. Improving Corporate Governance By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of the shareholder. It is evident that generally, public companies tend to have better management records than private companies. 5. Creates Investment Opportunities for Small investors As opposed to other business that requires huge capital outlay, investing in shares is open to both the large and small investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides an extra source of income to small savers. 6. Government Raises Capital for Development Projects The Government and even local authorities like municipalities may decide to borrow money in order to finance huge infrastructural projects such as sewerage and water treatment works or housing estates 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 Municipal Council gets this alternative source of funds, it no longer has the need to overtax the people in order to finance development. 7. Barometer of the Economy At the Stock Exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability. Therefore their movement of share prices can be an indicator of the general trend in the economy.

The basic function of a stock exchange is the raising of funds for investment in long-term assets. While this basic function is extremely important and is the engine through which stock exchanges are driven, there are also other quite important functions. 1. The mobilization of savings for investment in productive enterprises as an alternative to putting savings in bank deposits, purchase of real estate and outright consumption. 2. The growth of related financial services sector e.g. insurance, pension and provident fund schemes which nature the spirit of savings. 3. The check against flight of capital which takes place because of local inflation and currency depreciation. 4. Encouragement of the divorcement of the owners of capital from the managers of capital; a very important process because owners of capital may not necessarily have the expertise to manage capital investment efficiently. 5. Encouragement of higher standards of accounting, resource management and public disclosure which in turn affords greater efficiency in the process of capital growth. 6. Facilitation of equity financing as opposed to debt financing. Debt financing has been the undoing of many enterprises in both developed and developing countries especially in recessionary periods. 7. Improvement of access to finance for new and smaller companies. This is futuristic in most developing countries because venture capital is mostly unavailable, an unfortunate situation. 8. Encouragement of public floatation of private companies which in turn allows greater growth and increase of the supply of assets available for long term investment. There are many other less general benefits which stock exchanges afford to individuals, corporate organizations and even the government. The government for example could raise long term finance locally by issuing various types of bond through the stock exchange and thus be less inclined to foreign borrowing. Stock exchanges, especially in developing countries have not always played the full role in economic development.

Stock exchange (also known as stock markets) are special “market places” where already held stocks and bonds are bought and sold. They are, in effect, a financial institution, which provides the facilities and regulations needed to carry out such transactions quickly, conveniently and lawfully. Stock exchange are developed along with, and are an essential part of the free enterprises system. (No stock exchanges exist in the communist world outside Hong Kong and Macao – which have special status, and Taiwan which is also claimed by China). The need for this kind of market came about as a result of two major characteristics of joint stock company (Public Limited company), shares. 1. First of all, these shares are irredeemable, meaning that once it has sold them, the company can never be compelled by the shareholder to take back its shares and give back a cash refund, unless and until the company is winding up and liquidates. 2. The second characteristic is that these shares are, however, very transferable and can be bought and resold by other individuals and organizations, freely, the only requirement being the filling and signing of a document known as a share transfer form by the previous shareholder. The document will then facilitate the updating of the issuing companies’ shareholders register. These two characteristics of joint company shares brought about the necessity for an organized and centralized place where organizations and private individuals with money to spare (investors), and satisfy their individual needs. Stock exchanges were the result emerging to provide a continuous auction market for securities, with the laws of supply and demand determining the prices.

These are institutions which mediate or link between the savers and investors. There are numerous financial intermediaries in Kenya and include the following. 1. Commercial Banks. They act as intermediary between savers and users (investment) of funds. 2. Savings and Credit Associations These are firms that take the funds of many savers and then give the money as a loan in form of mortgage and to other types of borrowers. They provide credit analysis services. 3. Credit Unions These are cooperative associations whose members have a common bond e.g. employee of the same company. The savings of the member are loaned only to the members at a very low interest rate e.g. SACCOS charge p.m. interest on outstanding balance of loan. 4. Pension Funds These are retirement schemes or plans funded by firms or government agencies for their workers. They are administered mainly by the trust department of commercial banks or life insurance companies. Examples of pension funds are NSSF, NHIF and other registered pension funds of individual firms. 5. Life Insurance Companies These are firms that take savings in form of annual premium from individuals and them invest, these funds in securities such as shares, bonds or in real assets. Savers will receive annuities in future. 6. Brokers These are people who facilitate the exchange of securities by linking the buyer and the seller. They act on behalf of members of public who are buying and selling shares of quoted companies. 7. Investment Bankers These are institutions that buy new issue of securities for resale to other investors. They perform the following functions: 1. Giving advice to the investors 2. Giving advice to firms which want to invest 3. Valuation of firms which need to merge 4. Giving defensive tactics in case of forced takeover 5. Underwriting of securities.

1. Organised Exchange and Over the Counter (OTC) market This is where the buying and selling of securities is done but buyers and sellers are not present but only the agents (brokers) internet. This system is called “open outcry”. 2. Over the Counter Market (OTC) Provides an opportunity for unlisted/unquoted firms to sell their security. OTC is usually organized by the dealers or stock brokers who buy securities themselves and then sell them. They maintain a reasonable balance between demand and supply and observe price movements to determine profit margins on sale. Trading may be done through telephones, computer networks, fax etc. The dealers/participants set the trading rules. OTC specializes in securities such as corporate bonds, equity securities, Treasury bonds etc. OTC is underdeveloped in Kenya. Features of OTC Markets 1. Prices are relatively low 2. Usually deal with new securities of firms 3. Is composed of small and closely held firms.

These are markets that deal with securities that have been issued for the first time. The money flows directly from transferor (saver of money) to transferee (investing person). They facilitate capital formation. Economic Advantage of Primary Markets 1. Raising capital for business. 2. Mobilising savings 3. Government can raise capital through sale of Treasury bonds 4. Open market operation to effect monetary policy of the government i.e. control of excess liquidity in the economy 5. It is a vehicle for direct foreign investment. Economic Advantage/Role of Secondary Markets in the Economy 1. It gives people a chance to buy shares hence distribution of wealth in economy. 2. Enable investors realize their investments through disposal of securities. 3. Increases diversification of investments 4. Improves corporate governance through separation of ownership and management. This increases higher standards of accounting, resource management and transparency. 5. Privatisation of parastatals e.g. Kenya Airways. This gives individuals a chance for ownership in large companies. 6. Parameter for health economy and companies 7. Provides investment opportunities for companies and small investors.