Category Archives: FINANCIAL CONCEPTS

GLOSSARY OF INVESTMENT AND MARKET TERMS OF THE NSE

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The Nigerian Stock Exchange  (NSE)​  has provided this information as an educational service to investors. The information provided is not a  legal interpretation of regulator policy. Investors who have questions about the meaning or application of any of the Information provided should consult with a certified and licensed stock broker, investment advisor or financial advisor.

Admitted to trading’ – The official term for when a security is listed and tradable; same as ‘admitted to the Daily Official List’.

Analyst – A financial professional who has expertise in evaluating investments and puts together “buy”, “sell” or “hold” recommendations for securities. They may be also known as a “financial analyst” or a “security analyst”. Analysts are typically employed by broking firms, investment advisors or mutual funds. They do the leg work for brokers, preparing the research they use for trading. Analysts usually specialize in specific industries or sectors to allow for comprehensive and specialized research capacity.

Ask price – See Bid/Ask prices.

Asset – There are multiple definitions of an asset: 1. Something valuable that an individual or entity owns, benefits from or has use of, in generating income. 2. An item with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. 3. Property (not only real estate) owned by a person or company, regarded as having value and available to meet debts, commitments or legacies.

Asset allocation – An investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon (timeline). The three main asset classes—equities, fixed-income and cash/cash equivalents—have different levels of risk and return, and each will behave differently over time. Asset allocation is the single most important thing an investor should practice.

Auditor – An individual who is qualified to perform financial and accounting audits. An auditor is appointed to examine, correct and verify the accuracy of records and financial accounts, and to form an opinion about the authenticity and correctness of such records, by verifying the accuracy and reliability of the recorded transactions from the evidence available. They are expected to perform an unbiased evaluation. An auditor can be an internal employee or an external consultant.

Bid/Ask prices – The “bid” is the highest price a buyer will pay to buy a share of stock from at any given time. The “ask” is the lowest price at which the seller will sell the stock. The bid price is almost always lower than the ask price. This information is only seen by brokers and investors who have access to a trading screen. These prices fluctuate throughout a trading day as shares are bought and sold.

Bonds – Debt investments in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, states and federal governments to finance a variety of projects and activities. Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash/cash equivalents. The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (principal) are to be returned (maturity date). Interest is usually paid every six months (semi-annually) and in some cases, annually. The main categories of bonds are corporate bonds, federal bonds and state bonds, notes and bills, commonly referred to as “Treasuries”. Two features of a bond—credit quality and duration—are the principal determinants of a bond’s interest rate. Bond maturities range from a 90-day treasury bill (T-bill) to a 30+ year government bond; corporate and states are typically in the three (3) to 10-year range.

Bonus issue (or scrip issue or stock split or capitalization issue) – A corporate action in which a company’s existing shares are divided into multiple shares. The issue of shares to shareholders is in proportion to their existing holdings. A company may decide to distribute such shares as an alternative to increasing the dividend payout. Although the number of shares outstanding increases by a specific multiple, the total naira value of the shares remains the same. In this process, fractions of shares may arise; they are often aggregated and sold, after which a cash payment, in respect of the fraction sold, is made to the appropriate shareholder.

Book building – The process by which an underwriter attempts to determine at what price to offer an IPO based on demand from institutional investors. An underwriter “builds a book” by accepting orders from fund managers indicating the number of shares they desire and the price they are willing to pay.

Broker (or stock broker or dealing clerk) – An individual that executes buy and sell orders submitted by an investor. They are the only persons permitted to transact business on the floor of the stock exchange or in the OTC market. A broker must be employed by a dealing member, and must pass both the Chartered Institute of Stockbrokers Exam and the Nigerian Stock Exchange Authorised Clerkship Exam to be licensed to trade on the NSE floor. Stock brokers provide advice and make recommendations to their clients, but must have a client instruction before executing a trade behalf of that client. They usually charge a commission for the service they render their clients.

Broker-Dealer (or dealing member) – Company or individual that is both a broker and a dealer.

Capital stock – Shares authorized by a firm’s charter and having par value, stated value or no par value. Capital stock is any of various shares of ownership in a business. They include common stock of various classes and any preference stock that is outstanding. If a firm has only a single class of capital stock outstanding, the terms common stock and capital stock are often used interchangeably. The number and the value of issued shares are usually shown, together with the number of shares authorized, in the capital accounts section of the balance sheet.

Central Securities Depository (CSD) – A specialist institution or financial institution that holds securities such as shares in a physical (certificated) or dematerialized (existing solely as electronic records) so that ownership can be easily transferred via a book entry rather than physically. A CSD may provide other services such as electronic clearing and settlement of securities, as well as services such as securities borrowing and lending. See CSCS.

Clearing and settlement – The clearing and settlement of market transactions are described as follows: a. Clearing relates to identifying the obligations of both parties on either side of a transaction. b. Settlement is when the final transfer of securities and funds occur.

Clearing house (or central counter party clearing house) – A financial institution that helps facilitate trading done in futures markets. A clearing house acts as a third party to futures and options contracts – i.e., as a buyer to every clearing member seller, and a seller to every clearing member buyer. While clearing houses are responsible for settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery, and reporting trading data, their prime responsibility is to provide efficiency and stability to the financial markets they operate in. Clearing houses benefit both parties in a transaction, because they bear most of the credit risk. If two individuals deal with one another directly, the buyer bears the credit risk of the seller, and vice versa. When a clearing house is used, the credit risk that is held against both buyer and seller is held by the house.

Closed-end fund (or closed-end investment or closed-end company) – A collective investment with a limited number of shares. It is a publicly traded investment company that raises a prescribed amount of capital only once through an initial public offering (IPO). The shares are listed and traded on an exchange. Stocks of a closed-end fund represent an interest in a specialized portfolio of securities. The portfolio is managed by an investment adviser. The securities in the portfolio typically concentrate on a specific industry, geographic market or sector. The stock price of the fund fluctuates with the changing values of the securities in the fund’s holding, and as shares of the fund are bought and sold.

Common stock – See Stock.

Corporate bond (or corporate loan or corporate note or debenture) – A bond issued by a company. It is a bond that the company sells to “borrow” money in order to expand its business. The company promises to pay the investor (the lender) back on a future maturity date and pay interest in the meantime. There are different kinds of corporate bonds. In some cases, repayment may be secured by specific assets (e.g., cash, securities, real estate or equipment) which can be seized if the company fails to pay interest or return the original principal when the bond matures. Others that are not secured (debentures) are merely a promise to pay the investor back, as documented in an agreement called an indenture. Corporate bonds do not give investors an ownership interest in the issuing company, but they often have added features, including giving investors the option to convert their bonds into the company’s stock, or the company may have the right to buy back the bonds before they mature in order to refinance their debt. Typically, globally, there are five main classes of issuers of corporate bonds:

  1. public utilities;
  2. transportation companies;
  3. industrial corporations;
  4. financial services companies; and
  5. conglomerates.

Coupon – The interest rate stated on a bond when it’s issued. The coupon is typically paid semi-annually. This is also referred to as the “coupon rate” or “coupon
percent rate”.

Central Securities Clearing System Plc (CSCS) – CSCS is licensed by the SEC as a central securities depository (CSD). A CSD facilitates the delivery (transfer from seller to buyer) and settlement (payment) of traded securities. The CSCS enables securities transactions to be processed electronically. The company’s primary functions include:

  • Central depository for electronic share certificates of companies listed on the Exchange
  • Sub-registry for all listed securities (in conjunction with registrars of listed companies)
  • Issuer of central securities identification numbers to shareholders
  • Custodianship (in conjunction with custodians of local and foreign instruments)

CSCS offers investors online account access to view their securities portfolios. Investors must first select a broker before an account can be opened with the CSCS.

Custodian – Agent, such as a bank, a trust company or other organization, which holds and safeguards an individual’s, a mutual fund’s, or an investment company’s assets for them. They have the legal responsibility for their customers’ securities, which implies management and safekeeping. Custodians usually charge a fee for the service they provide.

Data vendor – Firms that provide data to financial market operators and investors. Distributed data is collected from an exchange’s live feeds, broker and dealer desks, and regulatory bodies. The types of data offered varies by vendor and most typically, covers information about entities (companies) and instruments (shares, bonds, etc.) which companies might issue.

Dealer – An individual or firm that buys and sells securities or “takes positions” for itself, or for its own account. Securities bought for the firm’s own account may be sold to clients or other firms, or become a part of the firm’s holdings.

Dealing member – Institution (stock broking firm) that is licensed by The Nigerian Stock Exchange and charges a fee or commission to buy or sell securities listed on the NSE’s platform (the exchange) on behalf of investors. The institution must be incorporated and registered under the Companies and Allied Matters Act, and must meet specific requirements set by the NSE to receive a dealing member license. As foreign investors are legally qualified to participate in the ownership of Nigerian stock broking firms, dealing members can also enter into any form of partnership with foreign stock broking firms.

Debenture – A medium- to long-term debt instrument used by large companies to borrow money. The term may be used interchangeably with bond, loan or note. A debenture is generally freely transferable by the holder who has no rights to vote in the company’s general meetings of shareholders, but who may have separate meetings; or votes, for example, on changes to the rights attached to the debentures. The interest paid to holders is a charge against profit in the company’s financial statements. A debenture may be convertible into equity shares of the issuing company after a predetermined period of time; it may also be non-convertible, and would usually carry a higher interest rate than a convertible debenture.

Debt security – A debt instrument that can be bought or sold between two parties and has basic terms defined, such as amount borrowed (nominal or notional amount), interest rate, and maturity/renewal date. Debt securities include government bonds, corporate bonds, certificates of deposit (CD), state and local bonds, collateralized securities (such as CDOs, CMOs, GNMAs) and zero-coupon securities. Most debt securities are traded over-the-counter. Debt securities get their measure of safety by having a principal amount that is returned to the lender (investor) at the maturity date or upon the sale of the security. They are typically classified and grouped by their level of default risk, the type of issuer and their income payment cycles.

Delisting – The removal of a listed security from the exchange on which it trades. Stock may be removed from an exchange because the company for which the stock is issued may (1) voluntarily or involuntarily not be in compliance with the listing requirements of the exchange; (2) choose, with the approval of its shareholders, to voluntarily delist; or (3) be acquired by another company. Delisting of a debt product such as a bond occurs on the maturity date (day of repayment) of the principal (loan amount) to investors.

Dematerialization – Indicates the conversion of shares/securities from a physical certificate to an electronic form. This allows for paperless trading via state-of-the-art technology, and these transactions of shares are done electronically, without relying on the traditional route of share certificates and transfer deeds. Electronic share certificates offer potential investors a way to get around the time-consuming task of transferring shares in their names; it also bypasses problems like delays in processing, bad deliveries via post or other conventional sources.

Demutualization – The process by which a member-owned organization (a mutual) changes its legal structure to a stock company. A mutual is a company created to provide a specific service at a low cost to benefit its members. Traditionally, a mutual raises capital from its members in order to provide them services, while a stock company raises capital from shareholders and other financial sources in order to provide services to its customers. Depending on the organization’s profit structure, a mutual may redistribute some profits to its members, whereas a stock company distributes profits to equity or debt investors. In a mutual, the legal roles of customer and owner are joined (members), and in a stock company the roles are distinctively divided. In demutualization, ownership of the company is separated from the exclusive right to use the services provided by the company.

Derivatives – A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties, and its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indices. Most derivatives are characterized by high leverage. Futures contracts, forward contracts, options and swaps are the most common types of derivatives.

Dividend – A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the naira amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield.

Dividend per share (DPS) – The the sum of declared dividends for every ordinary share issued. Dividend per share (DPS) is the total dividends paid out over an entire year (including interim dividends but not including special dividends) divided by the number of outstanding ordinary shares issued.

Earnings per share (EPS) – The portion of a company’s profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company’s profitability. It is calculated by dividing the net earnings (income or turnover) by the number of outstanding shares. EPS = Net Earnings / Outstanding Shares

End-to-End (or E2E or E-to-E) – A business term used to refer to an entire process, specifically the beginning and end points of a method or service. The theory embraces the concept of eliminating as many middle steps as possible to optimize performance and efficiency in any process. E2E trading automation takes the entire trade lifecycle into consideration. The concept refers to a fully automated (technology-driven) trade lifecycle to increase speed, reduce costs and improve efficiency.

Equity – The meaning is dependent on the context in which the term is used:

  1. A stock (share) or any other security representing an ownership interest. See Stock
  2. On a company’s balance sheet, the amount of funds contributed by the owners (the stockholders) plus the retained earnings (or losses). See Shareholders equity
  3. In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokering firm
  4. In the context of real estate, the difference between the current market value of the property and the amount the owner still owes on the mortgage, if applicable. It is the amount that the owner would receive after selling a property and paying off a mortgage
  5. In terms of investment strategies, equity (stocks) is one of the principal asset classes; the other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio

Ex-Dividend – A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be given ex-dividend status if a person has been confirmed by the company to receive the dividend payment. The person who owns the security on the ex-dividend date is awarded the payment, regardless of who currently holds the stock. See Dividend.

Ex-Dividend date – The day on and after which the right to receive a current dividend is not transferred from seller to buyer. After the ex-date is declared, the stock will usually drop in price by the amount of the expected dividend.

Ex-Rights – Shares that are trading but which no longer have rights attached because they have either expired, been transferred to another investor, or been exercised. Ex-rights shares are worth less than shares which are not yet ex-rights because they do not give a shareholder access to a rights offering. Renounceable rights may trade separately, allowing a shareholder to choose sell his or her rights, rather than exercise them. See Rights.

Ex-Rights date – The date when a buyer of common stock is no longer entitled to the rights that had been declared for the security.

Exchange traded fund (ETF) – A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. An ETF experiences price changes throughout the day as it is bought and sold, just like a stock. For this reason, it does not have its net asset value (NAV) calculated every day like a mutual fund. ETFs provide the diversification of an index fund, as well as the ability to sell short, buy on margin, and purchase as little as one share. Their expense ratios are lower than those of the average mutual fund, and brokers’ commissions (fees) for buying and selling ETFs are similar to the commissions investors pay for buying and selling stocks.

Exchange traded note (ETN) – A type of senior (unsubordinated) unsecured debt security designed to track the total return of an underlying market index or other benchmark, minus investor fees. An ETN allows investors to buy an obligation, similar to a forward contract, which is traded on an Exchange. The purpose of ETNs is to create a type of security that combines both the aspects of bonds and ETFs. ETNs are similar to ETFs as they are listed on an Exchange and can be bought and sold throughout the trading day. ETNs may be linked to a wide variety of assets, including indices and/or single reference assets based on a variety of products such as commodity futures (e.g., industrial metals, power and petroleum), foreign currencies and equities (grouped by such categories as economic sector, strategy or geographic location). The issuer of an ETN is obligated to deliver the asset performance (less fees) in cash upon early repurchase or maturity . Investors can also hold the debt security until maturity, at which time the issuer will give the investor a cash amount that would be equal to the principal amount (subject to the day’s index factor). The creditworthiness of an ETN itself is not rated, but is based instead on the creditworthiness of the issuer, making the issuer’s credit rating an important consideration for ETN investors.

Exchange traded product (ETP) – A type of security that is derivatively-priced and which trades intra-day on a national securities exchange. ETPs are priced, where the value is derived from another investment instrument such as a commodity, currency, share price or interest rate. Generally, ETPs are benchmarked to stocks, commodities, indices or they can be actively managed funds. See Exchange traded funds and Exchange traded notes.

Financial adviser – See Investment adviser.

Foreign investor – Any investor who participates financially in a country other than the investor’s own. This can happen on any scale, from a foreign national buying securities to a major corporation buying out a company based in a foreign country.

Foreign portfolio investment (FPI) – Foreign portfolio investment typically involves short-term positions in financial assets of international markets, and is similar to investing in domestic securities. FPI allows investors to take part in the profitability of firms operating abroad without having to directly manage their operations. This type of investment is relatively liquid, depending on the volatility of the market invested in. Foreign portfolio investment differs from foreign direct investment (FDI), in which a company fully controls a foreign firm.

Growth stock – A stock which typically does not pay a dividend, as the company declares its choice to reinvest earnings in capital projects. In the US, for example, most technology companies are segmented as growth stocks. Currently in Nigeria, a company with a 5-year average dividend payout of < 30% of earnings is classified as a growth stock.

Income stock – A stock that pays regular dividends, and offers a high yield that may generate the majority of overall returns. Income stocks may require a lower level of ongoing capital investment, thus, profits can be directed back to investors on a regular basis. In the US, income stocks are most commonly companies operating within real estate (e.g., real estate investment trusts—REITs), energy sectors, utilities, natural resources and financial institutions. Currently in Nigeria, a company with a 5-year average dividend payout of = 30% of earnings is classified as an income stock.

Index – A way of measuring the value of a section of the stock market. An index is an imaginary portfolio of securities representing a particular market or a portion of the market. It is used by investors and financial managers to describe the market, and to compare the return on specific investments. Each index has its own calculation methodology – computed from the prices of selected stocks. As an index is a mathematical construct, it may not be invested in directly, so it may be used to construct index mutual funds and ETFs whose portfolios mirror the components of the index.

Indices (or indexes) – The plural of Index.

Institutional investor – A non-bank entity with large amounts to invest, such as investment companies, mutual funds, insurance companies, pension funds, investment banks and endowment funds. They usually trade securities in large share quantities or large monetary amounts. Investment adviser (or investment advisor or financial adviser or financial advisor) – Institutions or individuals in the business of providing advice to others about investment securities, for a fee. This service is usually a supplementary service of a stock broking or issuing house business. Investment advisers are registered by the statutory regulatory agency, the Securities and Exchange Commission (SEC) of Nigeria.

Investment bank – An individual or institution which acts as an underwriter or agent for corporations and municipalities issuing securities. Investment banks also have a large role in facilitating mergers and acquisitions, private equity placements, and corporate restructuring. Unlike traditional banks, investment banks do not accept deposits from or provide loans to individuals. The two main lines of business in investment banking are (1) trading securities for cash or for other securities (i.e., facilitating transactions, market-making) or the promotion of securities (i.e., underwriting, research, etc.), known as the “sell side”; and (2) dealing with pension funds, mutual funds, hedge funds and the investing public (i.e., consumers of the products and services of the sell-side), known as the “buy side”.

Investment fund – Collective funds managed by an investment trust company (a company established with the purpose of investing in other companies) or a management team. Collect investments include unit trusts and closed end funds. See Unit trust, Closed-end fund.

Investment product (or security or investment instrument) – An instrument (contract) that can be assigned a value and traded. It represents ownership (stocks), a debt agreement (bonds) or the rights to ownership (derivatives). The purpose of owning an investment product (security) is usually to get your money back, or to get more money in the form of interest, capital appreciation or both . The two main types of securities are equity and debt. Examples of investment products include notes, stocks, preference stock, bonds, debentures, options, futures, swaps, rights, warrants, or virtually any other financial asset.

Investor – Person or entity that purchases assets with the objective of receiving a financial return. The assets an investor may buy vary widely, but include stocks, bonds, real estate, commodities and collectibles (e. g., art). The portfolio of an investor commonly includes a variety of assets that balance the rewards and risks of each investment. See Private investor, Institutional investor, Professional investor, Foreign investor.

Issuer– A legal entity that develops, registers and sells securities for the purpose of financing its operations. Issuers may be corporations, domestic or foreign governments, or investment trusts. Issuers are legally responsible for the obligations of the issue, and for reporting financial conditions, material developments and any other operational activities, as required by the regulations. The most common types of securities issued are common and preference stocks, bonds, notes, debentures, bills and derivatives.

Issuing house – A financial institution that engages in finding capital for established companies, for private firms wishing to convert to public companies, or for governments, by issuing shares on their behalf. They are responsible for packaging new issues for subscription and for bringing them to the market, including assembling the team for a new issue, e.g., solicitors, registrars, brokers, etc., preparing the prospectus, and successfully working with the broker to obtain approval from the exchange to list the issue. An issuing house may also be a dealing member, but cannot play the role of issuing house and broker for the same issue.

Listing – The process whereby a security is admitted to a trading in a market or on a board of a stock exchange. Upon listing, the security becomes tradable. All exchanges have specific requirements which issuers must satisfy in order for their securities to be listed and remain listed. There are different ways a security can be admitted to trade on an exchange:

  1. Initial Public Offering (IPO) – The first sale of a security by a company to the public. When the securities are listed on a public exchange such as the NSE, the money paid by investors for the newly issued equities goes directly to the issuer. An IPO allows an issuer to tap a wide pool of investors that provide capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors. IPOs usually involve one or more investment banks (i.e., underwriters) with whom the issuer enters into a contractual agreement to sell its securities to the public. Public offerings are sold to both institutional investors and retail clients of underwriters. IPOs also involve one or more law firms specializing in securities law
  2. Secondary Offering – A subsequent listing of securities already in issue. This can be new securities for public sale from a company that has already done an IPO. It is known as a Listing by Introduction. In many cases, this type of offering is made by companies looking to refinance or raise capital for growth. This type of listing increases outstanding shares, and spreads a company’s market capitalization (value) over a greater number of shares. It also dilutes the positions of shareholders owning previously issued shares. Another type of secondary listing is the sale of securities owned by major shareholders in a company. They may choose to sell all or a large portion of their holdings. This is known as a Placement. In such cases, the offering is triggered by founders of a business (or the original financiers) wanting to decrease their positions in a company. This kind of offering does not increase the number of outstanding shares. It usually happens gradually to ensure no negative effects on the price of the equity, and it does not dilute the positions of shareholders owning previously issued shares
  3. Merger/Acquisition – A company may be listed as a result of a merger with or an acquisition by an already listed company

Liquidity – The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets.

Market capitalization (or market cap) – The total market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s outstanding shares by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to sales or total asset figures.

Market intermediary – A business entity that acts as the middleman between two parties in a financial transaction. Commercial banks and other financial institutions, such as investment bank, broker-dealers, mutual funds and pension funds, are all examples of intermediaries. Market intermediaries offer a number of services to the buy side and the sell side, and charge investors advisory fees, broking commissions, proprietary trading fees, etc. while providing other benefits such as safety, liquidity and economies of scale.

Market maker – A broker-dealer firm that accepts the risk of holding a certain quantity of a particular security, in order to facilitate trading in that security. Each market maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of securities. If these prices are met, they will immediately buy for or sell from their own accounts. This process takes place in mere seconds. Market makers are very important for maintaining liquidity and efficiency for the securities they make markets in. Market makers are required to maintain a strict separation of the market-making side and the brokerage side of their business, to prevent their brokers from recommending a specific security simply because the firm makes a market in that security. A market maker makes money by buying stock at a lower rice than the price at which they sell it, or selling the stock at a higher price than they buy it back. Ordinarily they can make money in rising or falling markets, by taking advantage of the difference between “bid” and “offer” prices. There are different types of market makers:

  1. Supplementary market maker – In the Nigerian capital market, supplementary market makers encourage competition among equity market makers, and further enhance the market maker liquidity provision. A supplemental market maker is required to provide a quote for securities in which they make markets for 60% of the trading day
  2. Liquidity provider – Serve the same purpose as market makers, primarily for the secondary debt (bond) market.

Market operator – Professional intermediaries that offer specialized capital market services in various forms, including buying and selling securities, providing investment advice, making a market, auditing accounts of companies who have raised capital from the market, providing legal advice to investors and issuers, managing investment portfolios, and underwriting securities, among others.

Market participant – In finance, market participants are investors that regularly purchase equity and debt securities, either coming from the supply side (supplying excess money in the form of investments) or from the demand side (demanding excess money in the form of borrowed equity). These investors are categorized into (a) investor versus speculator, and (b) institutional versus retail. The term may be used loosely to include all investors in the market.

Market trend – The general direction of a market – typically up/rising (bullish), down/falling (bearish) or steady. Trends can vary in length from short, to intermediate, to long term.

Markets – A stock exchange has the ability to trade different investment products (securities). As a result, a stock exchange can create different markets in which different securities trade. These markets are usually an electronic platform that can accommodate the rules for trading a specific security. The Nigerian Stock Exchange currently lists three (3) types of products on three (3) boards—equities (stock, preference stock, structured products), bonds (corporate, federal and state/local) and ETFs—that are traded on three (3) different boards.

Mutual fund (or memorandum quotation) – A professionally managed type of collective investment scheme that pools money from many investors and invests typically in investment securities (stocks, bonds, short-term money market instruments, other mutual funds, other securities, and/or commodities). A mutual fund is usually an open-ended fund and has a fund manager that trades (buys and sells) the fund’s investments in accordance with the fund’s investment objective. A fund’s investment objectives (and or its names) define the type of investments in which the fund invests. In return for one’s investment, shareholders receive an equity position in the fund, and in effect, in each of the fund’s underlying securities. A fund’s net asset value (NAV) is calculated every day. While funds offer a choice of liquidity and convenience, they charge fees and often require a minimum investment. A contractual investment advisory fee is charged for the management of the fund’s investments, along with other fees. Some of the more significant (in terms of amount) are a transfer agent expense, custodian expense, legal/audit expense, fund accounting expense, registration expense, board of directors/trustees expense, etc. Shareholders are free to sell their shares at any time, although the price of a share of the fund will fluctuate daily, depending upon the performance of the securities held.

Net asset value (NAV) – Used to calculate the ‘per share’ Naira amount of a fund. NAV represents the fund’s market price. It is derived by taking the total value of all the securities in the fund (or portfolio) minus any liabilities divided by the number of shares outstanding. NAV = Total Value of Securities -Liabilities / Shares Outstanding Nominal value (or face value or par value or notional amount) – The value of a security that is set by the company issuing it; unrelated to market value. For stocks it is the original cost of the stocks; for bonds it is the amount paid to the holder at maturity.

Open-ended fund – A collective investment scheme with an unlimited number of shares. There are no restrictions on the amount of shares the fund may issue. It can issue and redeem shares at any time since investors purchase shares from the fund itself than from existing shareholders. If demand is high, the fund will continue to issue shares — there is no limit to the fund size, and the price of the units does not rise and fall in response to demand. Open-end funds also buy back shares when investors wish to sell. The value at which shares are bought or sold is directly linked to the fund’s Net Asset Value (NAV). Shares in open-ended funds are purchased from the fund itself or one of its agents; they are not traded on exchanges.

Outstanding shares – Stock currently held by investors, including restricted shares owned by the company’s officers and insiders, as well as those held by the public. Shares that have been repurchased (bought back) by the company are not considered outstanding stock.

Portfolio – A portfolio may contain a combination of investments, including bank accounts, bonds, stocks, deeds and businesses. Any investment instrument that is likely to retain its value and/or produce a return can be included in an investment portfolio. Types of instruments vary based on individual circumstances and investment goals. Portfolios are constructed based on an investor’s budget and short- and long-term goals. Different types of investment instruments offer different rates of return and carry their own unique degree of risk.

Portfolio manager – Institutions that manage the investment portfolios of clients. They receive funds to be invested in securities, most often, of their own choice. They are required to exercise discretion in the best interest of their clients, and to provide their clients periodic statements, clearly detailing all investment positions.

Preference stock (or preference shares or preferred stock or preferred shares) – A special equity security that has properties of both an equity (potential appreciation) and a debt instrument (fixed dividends)—a hybrid instrument. They provide a class of ownership in a corporation that has a higher claim on the assets (in the event of liquidation) and earnings than common stock, but are subordinate to bonds. Preference stock generally has a dividend that must be paid out before dividends to common shareholders and the shares usually do not have voting rights. Precise details about the structure of preference stock are specific to each company and are stated in a Certificate of Designation. Although they may be convertible into common stock, they are rated by credit rating companies, and are callable at the option of the corporation. Preference stocks offer the issuer an attractive alternative and cost-effective form of financing—e.g., a company can defer dividends by going into arrears without much of a penalty or risk to their credit rating; they are also useful as a means of preventing hostile takeovers.

Price-to-earnings ratio (or P/E ratio or P/E) – The relationship between the stock price and the company’s earnings. It is a measure of the price paid for a share, relative to the annual net income or profit earned by the company (per share). The P/E is a financial ratio used for valuation: a higher P/E means investors are paying more for each unit of net income, so the stock is, technically, more expensive. P/E is calculated as stock price divided by annual earnings per share typically the net income of the company for the most recent 12-month period divided by the number of shares issued). P/E = Stock Price / EPS Private investor (or retail investor or individual investor) – An individual (not a corporation, partnership, proprietorship or any other entity whatsoever) who purchases securities for himself or herself—specifically for his/her personal investment portfolio—is not registered with any securities agency, regulatory or self-regulatory body, and is not in any way engaged in providing investment services.

Professional investor (or broker-dealer) – A corporation, partnership, proprietorship or any other entity whatsoever that purchases securities for the entity’s investment portfolio; or a natural person registered with any securities agency, regulatory or self-regulatory body, and is engaged in providing investment services.

Real Estate Investment Trust (REIT) – A security that sells like a stock and invests in real estate directly, either through properties or mortgages. There are three types of REITs:

  1. Equity REITs: Invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties’ rents
  2. Mortgage REITs: Deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans
  3. Hybrid REITs: Combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages

Receiving agent – Banks and stock broking firms appointed by the issuing houses to serve as centers for the distribution of offer application forms, as well as for the receipt of subscription monies, on behalf of an issuing house. Receiving agents charge a fee for the service they offer.

Receiving bank – Banks designated by an issuer to receive proceeds.

Registrar – An institution, usually a bank or a trust company that is responsible for keeping records of shareholders and bondholders. They ensure that the amount of shares outstanding in the market matches the amount of shares authorized by the company. For bonds, the registrar also makes sure that the company’s obligation from a bond issue is certified as being an actual legal obligation. They perform corporate actions for the companies they represent, arrange general and extraordinary meetings, distribute annual reports and notices of shareholders’ meetings, and verify/reconcile investors’ claims with the depository of the CSCS.

Reporting accountants – Accounting firms which provide independent assessments of issuer accounts. They also examine and review forecasts, and prepare the issuer’s statement of indebtedness, among other things.

Return on assets (ROA) – An indicator of how profitable a company is relative to its total assets. ROA tells investors how much profit a company generated for each N1 in assets. It measures how effectively a company is converting the money it has to invest (shareholders’ capital plus short and long-term borrowed funds) into net income. It is considered the most stringent test of return to shareholders. Companies such as telecommunication providers, car manufacturers and railroads are very asset intensive, meaning they require big, expensive machinery or equipment to generate a profit. It a company has no debt, the ROA and ROE figures will be the same. ROA is a company’s annual earnings divided by its total assets. It is expressed as a percentage. Sometimes this is referred to as “return on investment”. ROA = Net Income / Total Assets

Return on equity (ROE) – The amount of net income returned as a percentage of shareholder equity. Return on equity measures a company’s profitability by revealing how much profit a company generates with the money shareholders have invested. More simply, it shows how well a company uses investment funds to generate earnings growth; how efficiently it uses its assets to produce earnings. ROE is expressed as a percentage. It may be more meaningful to look at ROE over a period of five years rather than one year. ROE = Net Income / Shareholder Equity Reverse stock split – A reduction in the number of a company’s shares outstanding that increases the par value of its stock or earnings per share (EPS).

Rights (or subscription rights or share purchase rights) – When a company wants to raise additional capital, it may give stockholders entitlement to purchase new shares at a predetermined price (normally less than the current market price) in proportion to the number of shares already owned. Rights are issued only for a short period of time, after which they expire. Failure to exercise or sell rights is an actual loss to the stockholder. Rights are a basic form of derivatives.

Risk – The chance that an investment’s actual return will be different than the expected return. With all investments there is an element of risk, desirable or undesirable. The basic definition for investment risk is deviation from an expected outcome. This can be either positive or negative.

Scrip issue – See Bonus issue.

Securities and Exchange Commission (SEC) – The SEC of Nigeria is the statutory regulatory agency of the Nigerian capital market. The SEC is a government agency mandated to regulate and develop the Nigerian capital market. The SEC derives its powers from the Investment and Securities Act (ISA). Visit http://www.sec.gov.ng for more information.

Security – See Investment product.

Securities lending – The act of loaning a stock, derivative, other security to an investor or firm. Securities lending requires the borrower to put up collateral, whether cash, security or a letter of credit, which the borrower is obliged to return at the end of the agreed upon loan period. When a security is loaned, the title and the ownership are temporarily transferred to the borrower. Borrowers looking to borrow a security would do this through a securities lending agent after entering into a global securities lending agreement (GSLA). The securities lending agent would, in turn, have a securities lending authorization agreement (SLAA) with the owner of the security before it can be loaned out. During the loan period, corporate actions, dividend payments, etc. are
retained by the owner.

Share price – The Naira value of a single share (stock) of a company’s tradable stocks.

Share value – See Nominal value.

Shareholders’ equity (or share capital or stockholders’ equity or book value) – The net worth of a company. It is derived by taking the company’s total assets and subtracting the total liabilities. Another way to calculate shareholder equity is share capital plus retained earnings minus treasury shares. It represents the amount by which a company is financed through common and preferred shares. The shareholders’ equity number is usually located on a company’s balance sheet.

Short selling – The sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is motivated by the belief that a security’s price will decline, enabling it to be bought back at a lower price to make a profit. Short selling may be prompted by speculation, or by the desire to hedge the downside risk of a long position in the same security or a related one. Since the risk of loss on a short sale is theoretically infinite, short selling should only be used by experienced traders who are familiar with the inherent risks associated with this type of transaction.

Solicitor – Law firm which represents an issue or the issuer. In practice, two solicitors are required for a public issue of securities—one solicitor for the issuer and one for the issue. On the issuer (the company) side, the solicitor ensures the Memorandum and Articles are in compliance with the legal requirements of a public company and also ensures the company, based on authorized capital, can accommodate the issue being proposed.

Stock (or common stock or share) – A type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings. There are two main types of stock:

  1. Common stock usually entitles the owner to vote at shareholders’ meetings and to receive dividends
  2. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than common shares

Stock broker (or stockbroker) – See Broker.

Stock exchange (or securities exchange or bourse) – Organized and regulated financial market where securities (stocks, bonds, notes, options, etc.) are bought and sold at prices governed by the forces of demand and supply. Stock exchanges serve as (1) primary markets where corporations, governments, municipalities, and other incorporated bodies can raise capital by channeling savings of the investors into productive ventures; and (2) secondary markets where investors can sell their securities to other investors for cash, thus reducing the risk of investment, and maintaining liquidity in the system. Stock exchanges impose stringent rules, listing requirements, and statutory requirements that are binding on all listed and trading parties.

Stock split – See Bonus shares.

Structured products – A pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, indices, commodities, debt issuance, options and/or foreign currencies. They are specially created to meet specific needs that cannot be met from standard financial instruments available in the market. They are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security, such as a bond, and replacing the usual payment features (e.g., periodic coupons and final principal) with non-traditional payoffs derived from the performance of one or more underlying assets, not from the issuer’s own cash flow. Structured products can be used as an alternative to a direct investment, as part of the asset allocation process to reduce risk exposure of a portfolio, or to utilize a current market trend.

Subscription period – The span of time during with investors may by a new issue of securities. Subscription periods have definitive end dates, after which the rights to subscribe will expire.

Ticker – The meaning is dependent on the context in which the term is used.

  1. Ticker Symbol – Specific codes used to identify publicly traded equities (or companies)
  2. Stock Market Ticker – Appears on any electronic surface. Relays stock market data, including stock prices, net change, updates to key indices, and more. Information is provided in real time or with a slight delay

Trustee – A firm which participates in debt and collective investment schemes, including unit trusts. They protect the interest of investors by monitoring and ensuring the terms of a trust deed are fulfilled.

Underwriter – A business entity that effects the issuance and distribution securities from a company or other issuing body to the public. An underwriter plays a role in determining the offer price of a security, buys them from the issuer, and sells them to investors. For a commission, underwriters takes on an insurer-like role in that they may be forced to sell the securities for less than they paid for them, or retain the securities themselves if they cannot sell all of the securities at the specified offering price.

Unit trust – A collective investment scheme that pools money from investors to invest in a portfolio of assets to achieve the investment objectives of the unit trust. Investments in the trust are made by buying units in the trust. The investment fund is set up under a trust deed. The price of each unit is based on the market value of the underlying assets that the unit trust has invested in. The number of units investors receive depends on the amount of their investment less any sales charge they are required to pay. Investors are effectively the beneficiaries under the trust.

Whistle blowing – The act of reporting insider knowledge of illegal activities that occur in an organization that is publicly owned (listed on a securities exchange). A whistle blower can be an employee, investor, supplier, contractor, client or any individual who somehow becomes aware of illegal activities taking place in a business, either by witnessing the activity or by being told about it. Whistle blowing can typically by done anonymously, and whistle blowers are almost always protected from retaliation under various programs of securities exchanges or their regulators. The NSE’s X-Whistle (whistle blowing program) aims to rid the market of infractions and misconduct.

 

 

 

Volatility: How Advisors Can Help Clients Stomach It

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Investment advisors are a combination of money managers, financial educators, and counselors. It’s this last role of counselor that becomes important as market volatility ramps up. Learning to handle customer’s investing fears and anxieties makes the financial advisor a better advocate for their client.

To keep volatility at bay, the advisor can educate the client about market returns and history, the importance of asset diversification, and how to manage the expected anxieties that accompany market declines.

Be Proactive, Not Reactive

Set the stage early to cope with the inevitable market drops. The investment education and collaboration starts when the client walks through the door. Prepare the client by including a risk tolerance and risk capacity quiz and conversation. These tools inform the advisor about how a client might react to the normal ups and downs in asset values. The risk conversations smooth the way to create the client portfolio.

Next, the advisor can include a conversation about investment asset characteristics as part of their educator role. When the client understands historical market returns, they are better equipped to cope with volatility. (For more, see: How to Be a Top Financial Advisor.)

Finally, let clients understand that market volatility is expected and occurs periodically along with changes in the business cycle, global occurrences, and national economic events.

Set Up the Portfolio to Minimize Volatility

The knowledge of how each asset class has performed in the past is an important tool when setting up the initial portfolio. The proper setup helps clients deal with market volatility over the long term. The more risk-averse investor – such as a client at the tail end of their earning years – will weight bonds more heavily than stocks, for example. Whereas the aggressive individual – such as a saver closer to the beginning of their career – holds a larger percent in riskier equities.

Gus Sauter, senior consultant to Vanguard Group, Inc., told The Wall Street Journal that “one of the most common mistakes investors make is not thinking holistically about their portfolio.”

In other words, think of the big picture, not how each specific holding or account is performing. (For more, see: Financial Advisors Need to Seek Out this Group NOW.)

With a broadly diversified portfolio, when emerging market stocks fall, U.S. equities may remain stable while bonds advance. Less correlated investment assets lead to greater diversification which tempers portfolio volatility.

When stock funds are soaring, a diversified portfolio won’t go up as much, but conversely, neither will it fall as low during a market correction.

Control the Mind; Control the Money

All the preparation won’t help if the investor panics at the first sign of market volatility. The advisor needs to be prepared for those phone calls after a big market drop to talk the client off the figurative ledge.

Many investors want to sell, after a big market decline and get out of the market altogether. The advisor must be prepared for some hand holding and refresher education. (For more, see: Money Habits of the Millennials.)

Research studies show that investors’ portfolios typically perform worse than the overall market due to mental money mistakes. If the investor jumps out of the market at the first sign of a decline, then he or she is selling at the bottom. The flip side of this behavior is when an investor gets swept up in market euphoria and buys back in as stocks trend toward their highs. This counterproductive trading activity causes the investor to buy at the highs and sells at the lows. The advisors job is to make sure this doesn’t happen by being available for hand holding and education.

DALBAR, Inc.’s 20th Annual Quantitative Analysis of Investor Behavior 2014 Advisor Edition not only confirms this, but reveals the gap to be especially wide. Over the past 30 years, the S&P 500 returned 11.11% per year while individual investors have averaged only 3.69%.

Trading too often yields subpar investment returns. Not only does buying and selling at inopportune times create lower returns, so does excessive trading which increases commissions and reduces profits.

Volatility Equals Opportunities

An often overlooked benefit of market volatility is the opportunity to invest additional funds during market dips. By keeping some cash on the sidelines, when the inevitable market decline occurs, the advisor can invest the clients’ money at bargain prices. Similar to buying on sale. (For more, see: How to Help Clients Spooked by Volatility.)

The Bottom Line

The best advisors remain in touch with their clients during market ups and downs and shepherd them through the investing landscape with a combination of education and support. (For related reading, see: How Financial Advisors Can Adjust to Robo-Advisors.)

FOREX RATE DETERMINATION IN NIGERIA

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Foreign Exchange Management Before 1986

Before 1986, importers and exporters of non-oil commodities were required to get appropriate licences from the Federal Ministry of Commerce before they could participate in the foreign exchange market. Generally, import procedures followed the international standard of opening of letters of credit (L/Cs) and subsequent confirmation by correspondent banks abroad. The use of Form ‘M’ was introduced in 1979 when the Comprehensive Import Supervision Scheme (CISS) was put in place to guard against sharp import practices. The authorization of foreign exchange disbursement was a shared responsibility between the Federal Ministry of Finance and the CBN. The Federal Ministry of Finance had responsibility for public sector applications, while the Bank allocated foreign exchange in respect of private sector applications.
Increased emphasis was placed on export promotion as a means of reducing pressure on the external sector. The government introduced a number of incentives to boost non-oil exports. These included arrangements for setting up export free zones, concessions to exporters to retain 25 per cent of their export proceeds, the liberalisation of export and import licensing procedures and the provision for the establishment of an export credit guarantee and insurance scheme. Exchange control was discarded on September 26, 1986 in order to evolve an exchange rate mechanism that would better reflect the underlining macroeconomic realities.

Foreign Exchange Management Since 1986

The Second-tier Foreign Exchange Market (SFEM) came into being on September 26, 1986 when the determination of the Naira exchange rate was made to reflect market forces. The modalities for the management of the Foreign Exchange Market have changed substantially since the introduction of SFEM, in line with the principles of the Structural Adjustment Programme (SAP) which emphasise the market-oriented approach to price determination.

Within the basic framework of market determination of the Naira exchange rate, various methods were applied and some adjustments carried out to fine-tune the system. A transitory dual exchange rate system (first and second-tier) was adopted in September, 1986. On 2nd July 1987, the first and second-tier markets were merged into an enlarged Foreign Exchange Market (FEM). Various pricing methods, such as marginal, weighted average and Dutch system, were adopted. With the introduction of the SFEM, the Federal Ministry of Finance had its allocative powers transferred to the CBN, but it retained approving powers on public sector transactions.

The constant fine-tuning of the market culminated in the complete floating of the naira on March 5, 1992 when the system of pre-determined quotas was discontinued. The unabating pressure on the foreign exchange market resulted in the policy reversal in 1994. The reversal of policy in 1995 to that of “guided deregulation” necessitated the institution of the Autonomous Foreign Exchange Market (AFEM). Apart from the institution of an appropriate mechanism for exchange rate determination, other measures increasingly applied in managing Nigeria’s foreign exchange resources included demand management and supply side policies. The CBN and the government have actively fostered the development of institutions such as the Nigerian Export Promotion Council (NEPC) and the Nigerian Export-Import Bank (NEXIM) in the drive to earn more foreign exchange.

The AFEM metamorphosed into a daily, two-way quote Inter-Bank Foreign Exchange Market (IFEM) on October 25, 1999. The IFEM is expected to broaden and deepen the foreign exchange market on daily basis and discourage speculative activities.

The Foreign Exchange Market in Nigeria

 

 

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The evolution of the foreign exchange market in Nigeria up to its present state was influenced by a number of factors such as the changing pattern of international trade, institutional changes in the economy and structural shifts in production. Before the establishment of the Central Bank of Nigeria (CBN) in 1958 and the enactment of the Exchange Control Act of 1962, foreign exchange was earned by the private sector and held in balances abroad by commercial banks which acted as agents for local exporters. During this period, agricultural exports contributed the bulk of foreign exchange receipts. The fact that the Nigerian pound was tied to the British pound sterling at par, with easy convertibility, delayed the development of an active foreign exchange market. However, with the establishment of the CBN and the subsequent centralisation of foreign exchange authority in the Bank, the need to develop a local foreign exchange market became paramount.

The increased export of crude oil in the early 1970s, following the sharp rise in its prices, enhanced official foreign exchange receipts. The foreign exchange market experienced a boom during this period and the management of foreign exchange resources became necessary to ensure that shortages did not arise. However, it was not until 1982 that comprehensive exchange controls were applied as a result of the foreign exchange crisis that set in that year. The increasing demand for foreign exchange at a time when the supply was shrinking encouraged the development of a flourishing parallel market for foreign exchange.

The exchange control system was unable to evolve an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance. This led to the introduction of the Second-tier Foreign Exchange Market (SFEM) in September, 1986. Under SFEM, the determination of the Naira exchange rate and allocation of foreign exchange were based on market forces. To enlarge the scope of the Foreign Exchange Market Bureaux de Change were introduced in 1989 for dealing in privately sourced foreign exchange.

As a result of volatility in rates, further reforms were introduced in the Foreign Exchange Market in 1994. These included the formal pegging of the naira exchange rate, the centralisation of foreign exchange in the CBN, the restriction of Bureaux de Change to buy foreign exchange as agents of the CBN, the reaffirmation of the illegality of the parallel market and the discontinuation of open accounts and bills for collection as means of payments sectors.

The Foreign Exchange Market was liberalised in 1995 with the introduction of an Autonomous Foreign Exchange Market (AFEM) for the sale of foreign exchange to end-users by the CBN through selected authorised dealers at market determined exchange rate. In addition, Bureaux de Change were once more accorded the status of authorized buyers and sellers of foreign exchange. The Foreign Exchange Market was further liberalized in October, 1999 with the introduction of an Inter-bank Foreign Exchange Market (IFEM).

Structure of Nigeria’s Foreign Exchange Market

The Nigerian foreign exchange market has witnessed tremendous changes. The Second-tier Foreign Exchange Market (SFEM) was introduced in September, 1986, the unified official market in 1987, the autonomous Foreign Exchange Market (AFEM) in 1995, and the Inter-bank Foreign Exchange Market (IFEM) in 1999.

Bureaux de Change were licensed in 1989 to accord access to small users of foreign exchange and enlarge the officially recognised foreign exchange market. Exchange rates in the Bureaux de Change are market determined. A parallel market for foreign exchange has been in existence since the exchange control era. It has been established that scarcity in the official sector and bureaucratic procedures necessitated the growth and development of the parallel market.

The Foreign Exchange (FX) market is the largest market by transaction volume within the Nigerian financial markets landscape. The Nigerian official FX market consists of three (3) dealing segments:

  • ▪ The Central Bank of Nigeria (CBN) Auctions – Primary Market
  • ▪ OTC Dealing – Secondary Market
  • ▪ Bureau-de-Change – Cash Market

While the CBN remains the single largest supplier to the market and therefore leads market direction, the OTC market is the critical market with many suppliers and market makers. Various products are offered in the Nigerian FX market including Spot, Forwards, Swaps and Options. The USD/Naira ($/N) currency pair is the most traded in the market, however, Market Makers also deal some crosses including, Canadian Dollars (CAD), Swiss Francs (CHF), Euros (EUR), Pound Sterling (GBP), Japanese Yen (JPY) and South African Rand (ZAR).

 

THE STRUCTURE OF THE NIGERIAN FINANCIAL SYSTEM

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WHAT IS FINANCIAL SYSTEM?

A financial system is a conglomerate of various markets, instruments, operators, and institutions that interact within an economy to provide financial services such as resource mobilization and allocation, financial intermediation and facilitation of foreign exchange transactions to exchange foreign trade.
Financial system in a market economy is comprised of:

Money and non-monetary claims (served debt and equity).
Places, institutions or communication systems that provide a market where financial claims can be bought and sold.
Specialists such as brokers and underwriters who aid in the direct transfer of funds from surplus to deficit units.
A wide variety of intermediaries that provide attractive indirect routes for the transfer of funds surplus to deficit units.
Households, business firms and government unit that generate financial surpluses and deficits.
THE DEVELOPMENT AND STRUCTURE OF THE NIGERIAN FINANCIAL SYSTEM
The Nigerian financial system comprises the regulatory/ supervisory authority, banks and non-bank financial institutions. The regulatory/supervisory authorities are the Central Bank of Nigeria (CBN) at the apex, the Nigerian Deposit Insurance Corporation (NDIC), Security and Exchange Commission (SEC), the Federal Ministry of Finance (FMF), the Nigerian Supervisory Board (NISB), and the Federal Mortgage Bank of Nigeria (FMBN).
The CBN is a major regulator and supervisor in the money market, with the NDIC playing a complementary role. The CBN exclusively regulates the activities of finance companies and promotes the establishment of development banks. The National Board for Community banks, while the final granting of licence is the CBN’s responsibility.
The SEC is the Apex regulator/ supervisor in the capital market, with NSE as self-regulatory institution. The FMF and the CBN share control over Bureaux de change while the NISB is the regulatory authority in the insurance sector. The FMBN regulates mortgage financial business in Nigeria (CBN, 1990).
Developmentally, the Nigeria financial system has witnessed a rapid growth in the last two decades. This could be seen from the widespread establishment of many financial institutions. The growth can be claimed to due to the oil boom and the awareness of the importance of money by Nigerians.
One of the characteristics of the Nigerian financial system is the dominant role the Federal and State Government play in the financial intermediation directly or indirectly. There are a number of government parastatals which the government often lend money to. The state and federal governments also borrow money from the financial system. The governments are also involved in the financial intermediation indirectly through ownership of banks or financial institutions.
Though Nigeria has one of the most modern financial institutions today, there are some worrying features about the system. Nigeria still has an undiversified and unspecialised banking system. The merchant banks are supposed to provide wholesale banking while commercial banks are supposed to provide retail banking. The only exceptions are the development banks and insurance companies. Others perform the same functions. The difference only lies in the quality of service. The co-operative Banks are supposed to operate essentially for the Co-operative Societies but they compete with commercial Banks for all normal banking services. There is no noticeable line of difference between the commercial and merchant banks. They both lend to individuals, corporate bodies and the government. Again, the structure of the financial institutions is such that concentration is in the urban areas despite the rural banking scheme.

Nigeria rules out cutting oil production in isolation of OPEC

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Nigeria said wednesday it would not cut oil production outside the framework of the Organisation of Petroleum Exporting Countries (OPEC), even as nose diving crude prices caused by a global supply glut have ravaged its revenue.

US crude oil prices fell below $30 a barrel on Tuesday, prompting Nigeria, an OPEC member country, to call for an emergency meeting to address collapsing prices that have drained the coffers of Africa’s largest economy.

Minister of State for Petroleum, Dr. Ibe Kachikwu, said in Abu Dhabi on Tuesday that he expected an extraordinary meeting of the global oil cartel in “early March” to discuss the continued plunge in prices.

His push for an emergency meeting was however opposed by the United Arab Emirates, which like Saudi Arabia has resisted calls for production cuts by the oil cartel in order to retain market share.

But until the meeting is formally confirmed, Nigeria can do little in response to the collapsing price of crude, said the Nigerian National Petroleum Corporation’s (NNPC) head of marketing, Mr. Mele Kolo Kyari.

“Nigeria cannot stop the prices of crude from going down,” he told AFP in Abuja.

“The easiest thing to do is to control production but Nigeria can only do that through the OPEC framework and the last OPEC meeting did not agree to cut down production.

“So influencing the price through production is now out of the question.”

Saudi-led Gulf exporters within OPEC have so far refused to cut production to curb sliding prices, seeking to protect their market share despite a heavy blow to their revenues.

But as OPEC ponders an emergency meeting, oil prices rallied yesterday as positive Chinese trade data and an unexpected draw in weekly US crude oil inventories gave investors reasons to buy crude futures.

Brent crude, the global benchmark, was up 63 cents at $31.49 a barrel, while US West Texas Intermediate crude (WTI) was up 69 cents at $31.13 a barrel.

“The API inventory data triggered a profit-taking wave, that’s the main reason for this uptick,” said Hans van Cleef, senior energy economist at ABN Amro in Amsterdam.

“But the overall sentiment is still negative, meaning downside risk is still greater than upside potential.”

US crude stocks fell unexpectedly last week, data from industry group, the American Petroleum Institute (API), showed on Tuesday.
China reported exports dipped just 1.4 per cent in US dollar terms in December, compared to forecasts of an eight per cent drop, positively surprising world markets.

The world’s second-biggest oil consumer has also been taking advantage of the oil price rout to stock reserves, increase exports of refined products, and may be set to overtake the United States as the world’s largest importer. But the bearish outlook for oil remains.
The potential for an emergency OPEC meeting also weakened yesterday when Iran’s oil minister was reported to have said he had not received any request for such gathering.

Plunging oil prices coupled with the Central Bank of Nigeria’s (CBN) decision to stop dollar sales to Bureau de Change (BDC) operators in the retail segment of the foreign exchange market continued to take its toll on the naira as the local currency fell N295 to the dollar in Lagos and sold at N305 to the dollar in Kano.

The naira has fallen precipitously since Monday when the CBN cut forex sale to BDC operators.

Sources said since the announcement, some black market operators started hoarding dollars in anticipation that the naira would fall further.

This, according to the source, has led to scarcity of the greenback in the parallel market.

 

CAPITAL ASSET PRICING MODEL FOR ASSET VALUATION

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In finance, the capital asset pricing model (CAPM) is a mathematical model used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset’s non-diversifiable risk.

The model takes into account the asset’s sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. CAPM “suggests that an investor’s cost of equity capital is determined by beta”.[1]:2 Despite its empirical flaws[2] and the existence of more modern approaches to asset pricing and portfolio selection (such as arbitrage pricing theory and Merton’s portfolio problem), the CAPM still remains popular due to its simplicity and utility in a variety of situations.

The CAPM was introduced by Jack Treynor (1961, 1962),[3] William F. Sharpe (1964), John Lintner (1965a,b) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton Miller jointly received the 1990 Nobel Memorial Prize in Economics for this contribution to the field of financial economics. Fischer Black (1972) developed another version of CAPM, called Black CAPM or zero-beta CAPM, that does not assume the existence of a riskless asset. This version was more robust against empirical testing and was influential in the widespread adoption of the CAPM.

The CAPM is a model for pricing an individual security or portfolio. For individual securities, we make use of the security market line (SML) and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The SML enables us to calculate the reward-to-risk ratio for any security in relation to that of the overall market. Therefore, when the expected rate of return for any security is deflated by its beta coefficient, the reward-to-risk ratio for any individual security in the market is equal to the market reward-to-risk ratio, thus:

\frac {E(R_i)- R_f}{\beta_{i}}  = E(R_m) - R_f

The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation and solving for E(R_i)~~, we obtain the capital asset pricing model (CAPM).

E(R_i) = R_f + \beta_{i}(E(R_m) - R_f)\,

where:

  • E(R_i)~~ is the expected return on the capital asset
  • R_f~ is the risk-free rate of interest such as interest arising from government bonds
  • \beta_{i}~~ (the beta) is the sensitivity of the expected excess asset returns to the expected excess market returns, or also \beta_{i} = \frac {\mathrm{Cov}(R_i,R_m)}{\mathrm{Var}(R_m)},
  • E(R_m)~ is the expected return of the market
  • E(R_m)-R_f~ is sometimes known as the market premium (the difference between the expected market rate of return and the risk-free rate of return).
  • E(R_i)-R_f~ is also known as the risk premium

Restated, in terms of risk premium, we find that:

E(R_i) - R_f = \beta_{i}(E(R_m) - R_f)\,

which states that the individual risk premium equals the market premium times β.

Note 1: the expect

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.

The relationship between β and required return is plotted on the securities market line (SML), which shows expected return as a function of β. The intercept is the nominal risk-free rate available for the market, while the slope is the market premium, E(Rm)− Rf. The securities market line can be regarded as representing a single-factor model of the asset price, where Beta is exposure to changes in value of the Market. The equation of the SML is thus:

 \mathrm{SML}: E(R_i)= R_f+\beta_i (E(R_M) - R_f).~

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security’s expected return versus risk is plotted above the SML, it is undervalued since the investor can expect a greater return for the inherent risk. And a security plotted below the SML is overvalued since the investor would be accepting less return for the amount of risk assumed.

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.

The relationship between β and required return is plotted on the securities market line (SML), which shows expected return as a function of β. The intercept is the nominal risk-free rate available for the market, while the slope is the market premium, E(Rm)− Rf. The securities market line can be regarded as representing a single-factor model of the asset price, where Beta is exposure to changes in value of the Market. The equation of the SML is thus:

 \mathrm{SML}: E(R_i)= R_f+\beta_i (E(R_M) - R_f).~

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security’s expected return versus risk is plotted above the SML, it is undervalued since the investor can expect a greater return for the inherent risk. And a security plotted below the SML is overvalued since the investor would be accepting less return for the amount of risk assumed.

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.

The relationship between β and required return is plotted on the securities market line (SML), which shows expected return as a function of β. The intercept is the nominal risk-free rate available for the market, while the slope is the market premium, E(Rm)− Rf. The securities market line can be regarded as representing a single-factor model of the asset price, where Beta is exposure to changes in value of the Market. The equation of the SML is thus:

 \mathrm{SML}: E(R_i)= R_f+\beta_i (E(R_M) - R_f).~

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security’s expected return versus risk is plotted above the SML, it is undervalued since the investor can expect a greater return for the inherent risk. And a security plotted below the SML is overvalued since the investor would be accepting less return for the amount of risk assumed.

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.

The relationship between β and required return is plotted on the securities market line (SML), which shows expected return as a function of β. The intercept is the nominal risk-free rate available for the market, while the slope is the market premium, E(Rm)− Rf. The securities market line can be regarded as representing a single-factor model of the asset price, where Beta is exposure to changes in value of the Market. The equation of the SML is thus:

 \mathrm{SML}: E(R_i)= R_f+\beta_i (E(R_M) - R_f).~

It is a useful tool in determining if an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security’s expected return versus risk is plotted above the SML, it is undervalued since the investor can expect a greater return for the inherent risk. And a security plotted below the SML is overvalued since the investor would be accepting less return for the amount of risk assumed.

Once the expected/required rate of return E(R_i) is calculated using CAPM, we can compare this required rate of return to the asset’s estimated rate of return over a specific investment horizon to determine whether it would be an appropriate investment. To make this comparison, you need an independent estimate of the return outlook for the security based on either fundamental or technical analysis techniques, including P/E, M/B etc.

Assuming that the CAPM is correct, an asset is correctly priced when its estimated price is the same as the present value of future cash flows of the asset, discounted at the rate suggested by CAPM. If the estimated price is higher than the CAPM valuation, then the asset is undervalued (and overvalued when the estimated price is below the CAPM valuation).[4] When the asset does not lie on the SML, this could also suggest mis-pricing. Since the expected return of the asset at time t is E(R_t)=\frac{E(P_{t+1})-P_t}{P_t}, a higher expected return than what CAPM suggests indicates that P_t is too low (the asset is currently undervalued), assuming that at time t+1 the asset returns to the CAPM suggested price.[5]

The asset price P_0 using CAPM, sometimes called the certainty equivalent pricing formula, is a linear relationship given by

P_0 = \frac{1}{1 + R_f} \left[E(P_T) - \frac{\mathrm{Cov}(P_T,R_M)(E(R_M) - R_f)}{\mathrm{Var}(R_M)}\right]

where P_T is the payoff of the asset or portfolio.[4]

Assumptions of CAPM

All investors:[6]

  1. Aim to maximize economic utilities (Asset quantities are given and fixed).
  2. Are rational and risk-averse.
  3. Are broadly diversified across a range of investments.
  4. Are price takers, i.e., they cannot influence prices.
  5. Can lend and borrow unlimited amounts under the risk free rate of interest.
  6. Trade without transaction or taxation costs.
  7. Deal with securities that are all highly divisible into small parcels (All assets are perfectly divisible and liquid).
  8. Have homogeneous expectations.
  9. Assume all information is available at the same time to all investors.

Problems of CAPM

In their 2004 review, Fama and French argue that “the failure of the CAPM in empirical tests implies that most applications of the model are invalid”.[2]

  • The model assumes that the variance of returns is an adequate measurement of risk. This would be implied by the assumption that returns are normally distributed, or indeed are distributed in any two-parameter way, but for general return distributions other risk measures (like coherent risk measures) will reflect the active and potential shareholders’ preferences more adequately. Indeed, risk in financial investments is not variance in itself, rather it is the probability of losing: it is asymmetric in nature. Barclays Wealth have published some research on asset allocation with non-normal returns which shows that investors with very low risk tolerances should hold more cash than CAPM suggests.[7]
  • The model assumes that all active and potential shareholders have access to the same information and agree about the risk and expected return of all assets (homogeneous expectations assumption).[citation needed]
  • The model assumes that the probability beliefs of active and potential shareholders match the true distribution of returns. A different possibility is that active and potential shareholders’ expectations are biased, causing market prices to be informationally inefficient. This possibility is studied in the field of behavioral finance, which uses psychological assumptions to provide alternatives to the CAPM such as the overconfidence-based asset pricing model of Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam (2001).[8]
  • The model does not appear to adequately explain the variation in stock returns. Empirical studies show that low beta stocks may offer higher returns than the model would predict. Some data to this effect was presented as early as a 1969 conference in Buffalo, New York in a paper by Fischer Black, Michael Jensen, and Myron Scholes. Either that fact is itself rational (which saves the efficient-market hypothesis but makes CAPM wrong), or it is irrational (which saves CAPM, but makes the EMH wrong – indeed, this possibility makes volatility arbitrage a strategy for reliably beating the market).{H deSilva, CFA Institutes Conference Proceedings Quarterly, March 2012:46-55}{Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly. Malcolm Baker, Brendan Bradley, and Jeffrey Wurgler. people.stern.nyu.edu/jwurgler/papers/faj-benchmarks.pdf }
  • The model assumes that given a certain expected return, active and potential shareholders will prefer lower risk (lower variance) to higher risk and conversely given a certain level of risk will prefer higher returns to lower ones. It does not allow for active and potential shareholders who will accept lower returns for higher risk. Casino gamblers pay to take on more risk, and it is possible that some stock traders will pay for risk as well.[citation needed]
  • The model assumes that there are no taxes or transaction costs, although this assumption may be relaxed with more complicated versions of the model.[citation needed]
  • The market portfolio consists of all assets in all markets, where each asset is weighted by its market capitalization. This assumes no preference between markets and assets for individual active and potential shareholders, and that active and potential shareholders choose assets solely as a function of their risk-return profile. It also assumes that all assets are infinitely divisible as to the amount which may be held or transacted.[citation needed]
  • The market portfolio should in theory include all types of assets that are held by anyone as an investment (including works of art, real estate, human capital…) In practice, such a market portfolio is unobservable and people usually substitute a stock index as a proxy for the true market portfolio. Unfortunately, it has been shown that this substitution is not innocuous and can lead to false inferences as to the validity of the CAPM, and it has been said that due to the inobservability of the true market portfolio, the CAPM might not be empirically testable. This was presented in greater depth in a paper by Richard Roll in 1977, and is generally referred to as Roll’s critique.[9]
  • The model assumes economic agents optimise over a short-term horizon, and in fact investors with longer-term outlooks would optimally choose long-term inflation-linked bonds instead of short-term rates as this would be more risk-free asset to such an agent.[10][11]
  • The model assumes just two dates, so that there is no opportunity to consume and rebalance portfolios repeatedly over time. The basic insights of the model are extended and generalized in the intertemporal CAPM (ICAPM) of Robert Merton,[12] and the consumption CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein.[13]
  • CAPM assumes that all active and potential shareholders will consider all of their assets and optimize one portfolio. This is in sharp contradiction with portfolios that are held by individual shareholders: humans tend to have fragmented portfolios or, rather, multiple portfolios: for each goal one portfolio — see behavioral portfolio theory[14] and Maslowian portfolio theory.[15]
  • Empirical tests show market anomalies like the size and value effect that cannot be explained by the CAPM.[16] For details see the Fama–French three-factor model.[17]
  • Roger Dayala[18] illustrates that even within its own narrow assumption set the CAPM is either circular or irrational, and therefore fundamentally flawed. The circularity refers to the price of total risk being a function of the price of covariance risk only (and vice versa). The irrationality refers to the CAPM proclaimed ‘revision of prices’ resulting in identical discount rates for the (lower) amount of covariance risk only as for the (higher) amount of total risk (i.e. identical returns for different amounts of risk).

 

COST OF EQUITY

 

 

index

In finance, the cost of equity is the return (often expressed as a rate of return) a firm theoretically pays to its equity investors, i.e., shareholders, to compensate for the risk they undertake by investing their capital. Firms need to acquire capital from others to operate and grow. Individuals and organizations who are willing to provide their funds to others naturally desire to be rewarded. Just as landlords seek rents on their property, capital providers seek returns on their funds, which must be commensurate with the risk undertaken.

Firms obtain capital from two kinds of sources: lenders and equity investors. From the perspective of capital providers, lenders seek to be rewarded with interest and equity investors seek dividends and/or appreciation in the value of their investment (capital gain). From a firm’s perspective, they must pay for the capital it obtains from others, which is called its cost of capital. Such costs are separated into a firm’s cost of debt and cost of equity and attributed to these two kinds of capital sources.

While a firm’s present cost of debt is relatively easy to determine from observation of interest rates in the capital markets, its current cost of equity is unobservable and must be estimated. Finance theory and practice offers various models for estimating a particular firm’s cost of equity such as the capital asset pricing model, or CAPM. Another method is derived from the Gordon Model, which is a discounted cash flow model based on dividend returns and eventual capital return from the sale of the investment. Another simple method is the Bond Yield Plus Risk Premium (BYPRP), where a subjective risk premium is added to the firm’s long-term debt interest rate. Moreover, a firm’s overall cost of capital, which consists of the two types of capital costs, can be estimated using the weighted average cost of capital model.

According to finance theory, as a firm’s risk increases/decreases, its cost of capital increases/decreases. This theory is linked to observation of human behavior and logic: capital providers expect reward for offering their funds to others. Such providers are usually rational and prudent preferring safety over risk. They naturally require an extra reward as an incentive to place their capital in a riskier investment instead of a safer one. If an investment’s risk increases, capital providers demand higher returns or they will place their capital elsewhere.

Knowing a firm’s cost of capital is needed in order to make better decisions. Managers make capital budgeting decisions while capital providers make decisions about lending and investment. Such decisions can be made after quantitative analysis that typically uses a firm’s cost of capital as a model input.

 

FINANCIAL MODELLING

Financial modeling is the task of building an abstract representation (a model) of a real world financial situation.[1] This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or portfolio of a business, project, or any other investment. Financial modeling is a general term that means different things to different users; the reference usually relates either to accounting and corporate finance applications, or to quantitative finance applications. While there has been some debate in the industry as to the nature of financial modeling—whether it is a tradecraft, such as welding, or a science—the task of financial modeling has been gaining acceptance and rigor over the years.[2] Typically, financial modeling is understood to mean an exercise in either asset pricing or corporate finance, of a quantitative nature. In other words, financial modelling is about translating a set of hypotheses about the behavior of markets or agents into numerical predictions; for example, a firm’s decisions about investments (the firm will invest 20% of assets), or investment returns (returns on “stock A” will, on average, be 10% higher than the market’s returns).

In corporate finance, investment banking, and the accounting profession financial modeling is largely synonymous with financial statement forecasting. This usually involves the preparation of detailed company specific models used for decision making purposes[1] and financial analysis.

Applications include:

To generalize[citation needed] as to the nature of these models: firstly, as they are built around financial statements, calculations and outputs are monthly, quarterly or annual; secondly, the inputs take the form of “assumptions”, where the analyst specifies the values that will apply in each period for external / global variables (exchange rates, tax percentage, etc…; may be thought of as the model parameters), and for internal / company specific variables (wages, unit costs, etc.…). Correspondingly, both characteristics are reflected (at least implicitly) in the mathematical form of these models: firstly, the models are in discrete time; secondly, they are deterministic. For discussion of the issues that may arise, see below; for discussion as to more sophisticated approaches sometimes employed, see Corporate finance# Quantifying uncertainty.

Modelers are sometimes referred to (tongue in cheek) as “number crunchers”, and are often designated “financial analyst“. Typically, the modeler will have completed an MBA or MSF with (optional) coursework in “financial modeling”.[citation needed] Accounting qualifications and finance certifications such as the CIIA and CFA generally do not provide direct or explicit training in modeling.[citation needed] At the same time, numerous commercial training courses are offered, both through universities and privately.

Although purpose built software does exist, the vast proportion of the market is spreadsheet-based; this is largely since the models are almost always company specific. Also, analysts will each have their own criteria and methods for financial modeling.[4] Microsoft Excel now has by far the dominant position, having overtaken Lotus 1-2-3 in the 1990s. Spreadsheet-based modelling can have its own problems,[5] and several standardizations and “best practices” have been proposed.[6] “Spreadsheet risk” is increasingly studied and managed.[6]

One critique here, is that model outputs, i.e. line items, often incorporate “unrealistic implicit assumptions” and “internal inconsistencies”.[7] (For example, a forecast for growth in revenue but without corresponding increases in working capital, fixed assets and the associated financing, may imbed unrealistic assumptions about asset turnover, leverage and / or equity financing.) What is required, but often lacking, is that all key elements are explicitly and consistently forecasted. Related to this, is that modellers often additionally “fail to identify crucial assumptions” relating to inputs, “and to explore what can go wrong”.[8] Here, in general, modellers “use point values and simple arithmetic instead of probability distributions and statistical measures”[9] — i.e., as mentioned, the problems are treated as deterministic in nature — and thus calculate a single value for the asset or project, but without providing information on the range, variance and sensitivity of outcomes.[10] Other critiques discuss the lack of adequate spreads

heet design skills,[11] and of basic computer programming concepts.[12] More serious criticism, in fact, relates to the nature of budgeting itself, and its impact on the organization.[13][14]

The Financial Modeling World Championships, known as ModelOff, have been held since 2012. ModelOff is a global online financial modeling competition which culminates in a Live Finals Event for top competitors. From 2012-2014 the Live Finals were held in New York City and in 2015 they will be held in London.[15]

In quantitative finance, financial modeling entails the development of a sophisticated mathematical model.[citation needed] Models here deal with asset prices, market movements, portfolio returns and the like. A key distinction[citation needed] is between models of the financial situation of a large, complex firm or “quantitative financial management”, models of the returns of different stocks or “quantitative asset pricing”, models of the price or returns of derivative securities or “financial engineering” and models of the firm’s financial decisions or “quantitative corporate finance”.

Applications include:

These problems are often stochastic and continuous in nature, and models here thus require complex algorithms, entailing computer simulation, advanced numerical methods (such as numerical differential equations, numerical linear algebra, dynamic programming) and/or the development of optimization models. The general nature of these problems is discussed under Mathematical finance, while specific techniques are listed under Outline of finance# Mathematical tools. For further discussion here see also: Financial models with long-tailed distributions and volatility clustering; Brownian model of financial markets; Martingale pricing; Extreme value theory; Historical simulation (finance).

Modellers are generally referred to as “quants” (quantitative analysts), and typically have advanced (Ph.D. level) backgrounds in quantitative disciplines such as physics, engineering, computer science, mathematics or operations research. Alternatively, or in addition to their quantitative background, they complete a finance masters with a quantitative orientation,[16] such as the Master of Quantitative Finance, or the more specialized Master of Computational Finance or Master of Financial Engineering; the CQF is increasingly common.

Although spreadsheets are widely used here also (almost always requiring extensive VBA), custom C++ or numerical analysis software such as MATLAB is often preferred,[16] particularly where stability or speed is a concern. MATLAB is the tool of choice for doing economics research[citation needed] because of its intuitive programming, graphical and debugging tools, but C++/Fortran are preferred for conceptually simple but high computational-cost applications where MATLAB is too slow. Additionally, for many (of the standard) derivative and portfolio applications, commercial software is available, and the choice as to whether the model is to be developed in-house, or whether existing products are to be deployed, will depend on the problem in question.[16]

The complexity of these models may result in incorrect pricing or hedging or both. This Model risk is the subject of ongoing research by finance academics, and is a topic of great, and growing, interest in the risk management arena.[17]

Criticism of the discipline (often preceding the financial crisis of 2007–08 by several years) emphasizes the differences between the mathematical and physical sciences and finance, and the resultant caution to be applied by modelers, and by traders and risk managers using their models. Notable here are Emanuel Derman and Paul Wilmott, authors of the Financial Modelers’ Manifesto. Some go further and question whether mathematical- and statistical modeling may be applied to finance at all, at least with the assumptions usually made (for options; for portfolios). In fact, these may go so far as to question the “empirical and scientific validity… of modern financial theory“.[18] Notable here are Nassim Taleb and Benoit Mandelbrot.[19] See also Mathematical finance #Criticism and Financial economics #Challenges and criticism.