The Africas Economy and Internatoinal Financial Markets - Case Study Example

PART A capital market is a place for trading of securities either debt or equity, and also a market for the organizations and the government as well to raise long term finance. The capital market generally comprise of stock and the bond market which are controlled by the financial regulators of particular economy in order to ensure and safeguard the interests of the investors. The capital markets serve numerous functions such as extending a well balanced transfer function, facilitating organizations to access a large amount of local and international investors, keeping integrity, diversity and competition as key drivers of the financial systems. Capital markets also provide important market indications on current market adversities and opportunities along with future expectations as well. All the above functions mentioned above, help in establishing a congenial working capital environment in a market of a particular economy. Apart from the above, an important function of capital markets also comprise of facilitating an exchange of funds among all participants’ members of the market. The primeval role of capital market is to encourage and receive excessive funds from investors and make it available to those who actually require them or are operating in a deficit. Taking example of the African capital market which is a live example of a developing economy has witnessed a rapid international investment growth since the past decades. Capital markets of the country of Africa possess the capability and the potential to meet up its permanent capital requirements especially of the private sector. The market ensures the effectiveness and sustainable funding on account of the projects handled by government, banks, corporations etc only due to the exchange of funds as and when required by the members of the market. Currently, the African capital market is able to fulfill the exchange fund function in the past years only due to the constant improvisations in: A proper exchange, clearing and settlement system which has been consistently upgraded over the years has facilitated the fund transfer and making credit available for all easily and conveniently. A proper and effective legal system exists that helps in enforcing contracts on time. This enhances the efficiency of the entire system of the capital market of the economy. Sound information is made available regarding the capital and funding details and also the future needs and requirements of the various organizations that require certain amount of capital in the near future. The African market has ensured from a period of time that corporate governance would be executed in such a manner that investors would be entrusted and confidence will ne instilled in them in regard to the security and safeguard of their funds. Considering the past decades since 1980, African capital market has been working towards reforming and strengthening the monetary systems along with continuous expansion of the capital markets for better mobilization of funds and other resources and then allocate or transfer them to the most productive and growing sectors within the economy. The Africa’s economy has implemented significant changes in the form of policy amendments catering towards the privatization programs resulting in reduction of public debt, enhancement and developments in incentive plans and increased efficiencies in the privatization of individual entities. Capital can be accessed in the most fruitful manner by subscribing shares to the general public. Africa has certainly experienced a rapid advancement in the capital market, almost over 15 years that is from 1990 till date, due to the advent of the rising privatization and liberalization within the economy, there has been recorded a significant change in the attitudes of the African government towards the role of the private sector. With the emergence of eighteen stock exchanges by the international monetary organizations, the financial environment has taken a complete swing. To facilitate exchange of funds in Africa, many countries have adopted reformed legal and regulatory systems. The countries in Africa have been provided with immense guidance from the financial expert bodies such as the IFC (International Finance Corporation) and World Bank. The economy is also benefitted on account of low inflation rates and stability in currency fluctuations. Africa in some ways is not linked to many other international capital markets which instead of being a disadvantage turned to be an advantage, as such kind of autonomy and self reliance have attracted numerous international investors who want to take minimum risks especially in those times when the developed economies face the maximum brunt of financial shocks or crisis (Kibuthu 2005). Though African capital market emerged as a weak capital market in the past decades, yet the return on investment in the country is steadily budding and gradually increasing making transfer of funds more attractive (Ziorklui 2001). The African stock markets are continually developing and expanding with passage of time as: A wide variety of securities are extended or floated in the market for wide accessibility among members. There is a wide flow of foreign direct investment in the established companies as well as those which are newly introduced. The capital is floated in the market in those sectors which are highly productive or in growth phase. The distribution of funds in appropriate sectors helps in redistributing the economies wealth in the best possible manner. Enhanced corporate governance help in introducing high levels of transparency in the capital market system. CRITICISM Though it is true that exchange of funds is an integral function of a capital market but still in practical terms there are members in a market which are not in tandem with others. Participants of the society vary in degree of market potency in regard to the information they contribute towards a transaction along with the acquiring of control and creditworthiness. For instance, if USA economy is considered, there is a wide gap that exists within the minority communities who have apprehensions regarding the information which is floated for the total amount of funds within the economy. The capital markets are also criticized on the grounds that they do not produce enough credit instruments or means for safeguarding the economic welfare or development specifically related to the minority sections of the economy. The current system prevailing in the capital market of USA tends to enhance and aggravate the inequality of income distribution rather than bridging the gap which further results in higher deliberation of capital in only specific chosen investments. PART 2 RIGHTS AND PRIVELEGE ISSUE A rights issue or a privilege issue is a unique way or amenity extended by the organization to its shareholders whereby a company has the right to sell off its new shares to the existing shareholders for the prime objective of raising required capital for the firm (Gregoriou 2006). A right issue is an integral source of raising capital through equity funding especially for those companies which are publicly listed. On a legal front, rights issue must be initiated before the offer is made to the general public at large as existing shareholders carry the preemption right that the ‘right of first refusal’ As the name depicts, it’s a privilege given to the existing shareholders for purchasing shares in proportion to the current shareholding in the company. The extra shares which are emanated with the rights issue are generally based on a pro-rata basis to the stockholders, for instance on every five shares that each shareholders possesses, two rights share may be offered (Gregoriou 2006), The price at which the rights shares are offered to the shareholders are generally quoted at a discounted value in respect to the current market price which serves to be a major attraction for the shareholders to buy shares at a lesser value. The low price also serves to be safeguard in case the market price of share drips before the issue process is completed (Temple 2001). As if the market price of shares fall even below the price at which the rights shares are issued, the task would be a failure as shareholders would have an option to buy shares at a lower price in comparison to the offers made through a right new issue. However the shareholders, who do not intend to purchase the rights issue, can sell the shares in the stock market or to new shareholders. The rights issue does involve issue cost which is comparatively low to other sources of raising funds as costs of subscription, commission or advertising are avoided (Case 2008). Frequent issue of rights share can actually create a negative impact on the company image, moreover rights issue may not be fruitful option for unlisted companies. Advantages of Right Issue 1. Increased Exposure In accordance with the name itself, rights issue gives the shareholders, the privilege to buy new shares at a discounted value on a pre defined future date. The shareholders are benefitted in form of increased exposure to the new stock at a low price. 2. Added Value to the Shares Stockholders of such stock acquisition mode have the option to trade the new issue shares in the same way as the ordinary shares are traded till the maturity date at which the new shares can be bought, thus the rights issued to the stockholders carry a weighted value. 3. Cost Advantage Another advantage is that, the stockholders have rights to sell some of the shares and use the remaining. The stockholders have an added advantage, to sell just that portion of the rights that can cover the cost of exercising those shares that are unsold. The total value of a holding shares amount can be maintained without adding any extra expense to the total cost (Temple 2001). Disadvantages of Right Issue 1. Dilution of the Share Value The greatest drawback that the right issue holds is the dilution of the value of each share due to the result of the increased number of the total amount of shares released. 2. Window Dressing of Accounts Generally the stockholders are highly attracted towards the concept of buying rights issue with low priced shares but it is not certain that it is a profitable deal for the stockholders. For instance, if the right issue is made by a highly geared company that intends to make its balance sheet stronger is a negative sign rather than a constructive notion. For such organizations, profit tends to be low and future profits are diluted (Temple 2001). 3. Lack of preemptive Rights Stockholders, who do not carry the preemptive rights, are confronted with the maximum risk of investment dilution as they do not carry any transferable rights or right to sell shares to new shareholders (Gregoriou 2006). 3 COST OF INTERNAL EQUITY Expected EPS $2.75 Payout ratio 100% Current stock price $41.00 g 10.00% F 12.00% D1 $1.18 The equation derived from the above mentioned data is: rs = D1/P0 + g re = D1/(P0 ´ (1 - F)) + g rs = 1.18/41 + 0.10 = 12.87% re = 1.18/(41 * (1-0.12)) + 0.10 = 12.84% An organization’s internal equity comprise of its retained earnings. The rate of return which is inescapable by the equity shareholders is actually in the opportunity costs that are incurred on the retained earnings. The investor’s main objective behind endowing in an organization is to earn a reasonable expected rate of dividend and desired capital gains from the invested amount (Pandey 2006). The calculated rate of return in the above calculations clearly signify that the organization must be in such a condition so as to earn a return on the retained funds that equals up to the total cost of equity capital. The organization must be able to earn a rate of return on retained funds equal to re to make certain the dividend growth rate and the price of the share. If the firm earns a rate less than 12.84%, its market price of the share will fall. As far as the cost of equity is concerned, there is a marginal difference between the costs incurred when floatation cost are excluded from the same. REFERENCES Gregoriou, Greg N., 2006. Initial Public Offerings: An International Perspective. Amsterdam: Butterworth-Heinemann, Temple. P., 2001. First Steps in Shares. Harlow, UK: Pearson Education Kibuthu.W.G., 2005. Capital Markets in Emerging Economies A Case Study Of The Nairobi Stock Exchange. [Accessed on 14th Dec, 2011]. Available at http://repository01.lib.tufts.edu:8080/fedora/get/tufts:UA015.012.DO.00089/bdef:TuftsPDF/getPDF Ziorklui. S. Q., 2001. Capital Market Development and Growth in Sub-Saharan Africa: The Case of Tanzania. African Economic Policy Discussion Paper 79. [Accessed on 14th Dec, 2011]. Available at http://pdf.usaid.gov/pdf_docs/PNACK910.pdf Case.A., 2008. Rights Issues: Is the Time Right? Dealmonitor. Issue 44, September, 2004. Pandey.I.M., 2006. “Financial Management”. Vikas Publishing: India Read More