KENYA FINANCIAL SYSTEM Financial markets are broadly classified into 2: 1. 2.

Capital Markets Money Markets

e.g. commercial banks, SACCOS, foreign exchange market, merchant banks etc. Capital markets are sub-divided into 2: a) Security markets e.g stock exchange dealing with instruments such as shares, debentures etc. b) Non-security/instrument market e.g mortgage, capital leases, security market is sub-divided into 2. Primary market Secondary market

CAPITAL MARKET These are markets for long term funds with maturity period of more than one year. E.g of Financial instruments used here are debentures, terms, loans, bonds, warrants, preference shares, ordinary shares etc. The capital market serves as a way of allocating the available capital to the most efficient users. Capital market financial institution includes: 1. Stock exchange 2. Development bank 3. Hire purchase companies 4. Building societies 5. Leasing firms

Capital Market Instruments For issuing long-term funds. They include: a) Common share/ordinary share b) Preference share c) Debentures d) Treasury Municipal bonds e) Warrants & Convertible
Page 1 of 6

f) Terms loans g) Mortgages

Functions of Capital Markets are: a) b) c) d) e) f) Providing long term funds which are necessary for investment decisions. Provide advice to investors as to which investments are viable. Long term investments are made liquid, as the transfer between shareholders is facilitated. Facilitates the international capital inflow. Facilitating the liquidation and marketing of a long term Acting as a channel through which foreign investments find their way into the

market. Money/discount markets Are discount and acceptance financial institutions This is a market for S.T funds maturing in one year. Money market works through financial institutions. It facilitates transfer of capital between savers and users. The transfer can be direct (from saver to investor) and indirectly through an intermediary). Foreign exchange market is also part of money market. The money market or discount market is the market for short term loans.

Financial Instruments in Money market include:

These are instruments used to raise short-term funds from the market. They include (A) Treasury Bills These are government securities issued to: (i) Cover government deficit (j) Finance maturity debts (k) Control inflation These are usually sold on auction system at a discount which depends on the value and it maximum period.
Page 2 of 6

Yield in Treasury bills = face value market value x 360 Face value No of days maturity

Main features. 1 .Maturity period is usually 1 year or less. If the period is more than one year, then it is a treasury bond. In Kenya we have Treasury bill of 28 days (I month), 91 days (3months) and 182 days (6 months). 2 .Treasury Bills, in Kenya are denominated in terms of 50,000, 100,000, 1,000,000 20,000,000 shillings etc. 3 .The yield on treasury bills is determined by the market forces through competitive bidding. 4. Increase from the T.Bs is usually taxed at normal tax rate on interest on the part of the receiver. 5. They are usually risk-free securities because they are guaranteed by the government. (B) Certificate Of Deposits These are certificates issued by a bank or non banking financial institution indicating that a specified sum of money has been deposited there in: The certificate bears the maturity date and a specified interest rate and can be issued in any denomination. They can be issued in bearer or non-bearer from: (a) Bearer>. Any one who bears the certificate has a right to the money even if it has no name. (b) Non bearer> has a name on it of the person to whom the money belongs i.e. depositor and may not be transferable. Tile interest rate on these is usually paid after maturity and the finds deposited can be withdrawn before maturity but at a penalty. Page 3 of 6

Types of certificate of deposits: (a) Normal CD Issued by commercial banks (b) Euro dollar CD Dominated in US dollars/or foreign currency & issued by banks. (c) Yankee CD Denominated in US dollars and issued by a foreign bank having a branch in the US. (d) Thrift CD issued by a non - banking financial institution. (C) Commercial Papers Consist of promissory notes issued by financially stable companies and sold to investors in the market. They usually have a maturity period of less than one year and mainly sold on discount basis, which has the effect of increasing the effective rate of interest. Effect yield: = face value market value x 360 Face value Illustration: A company sells 120 days commercial paper with par value of shs. 10,000 but at shs. 9.700 compute the effective yield on the paper 10000-9700 x 360/120 =9.3% 9700 No of days maturity

- They can be discounted before maturity. - They are negotiable due to the credit worthiness of the issuing co. (D) Bankers Acceptances These are bills of exchange drawn in and accepted by the bank Usually, a banks customer under an agreement with the bank draws a bill on the bank and the bank accept it. The bill becomes a bankers acceptance. The bank charges acceptance commission and the drawer will have a two name bill, i.e. his own and that of bank. This makes the bill a highly negotiable
Page 4 of 6

instrument. Main features: (i) Highly required because they can be discounted at any time especially by the accepting bank. (ii) Usually sold on discounted basis (iii) usually unsecured. (iv) Mainly used to finance international transaction/trade due to the fact that there my not be enough trust between the parties. (v) Usually have a maturity period of less than one year, mostly 6 months or 3 months.
(E) Inter-Bank Overnight Loans: - This arises from the central banks requirement that Commercial Banks hold a specified level of liquidity everyday. Commercial banks to meet at the clearing house (which is managed by the Kenya Bankers Association) and the bank with insufficient funds to borrow from those with excess and the one with deficit to approach these with excess and negotiable terms of the loan. Lending Banks instructs clearing house through a cheque or telephone to transfer some of its deposits to the borrowing bank. Since these loans are authorized the borrowing bank serves on order the following day transferring ownership back to the lending bank. Incase of illiquidties, the bank can borrow from central bank. - These are usually un-secured loans. (F)Re-Purchase Agreements - Government security dealers may use repurchase agreements to increase their level of liquidity. Re-purchase agreement is a sale of short-term government security by the dealer to the investor where the dealer agrees to re-purchase the securities at a specified future time. - The investor receives a specified yield while holding the security. - The maturity period may be fixed or left open in which case either the borrower or lender can terminate the agreement at any time. Most re-purchase agreements are overnight although once for as long as 6 months can be made.

Page 5 of 6

These instruments are sold by commercial banks, merchant banks, discounting houses, acceptance houses, and government. Primary Markets These are markets that deal with securities that have been issued for the first time. The money flows directly from transferor (saver of money) to transferee (investing person). They facilitate capital formation. Economic Advantage of Primary Markets 1. 2. 3. 4. 5. Raising capital for business. Mobilising savings Government can raise capital through sale of Treasury bonds Open market operation to effect monetary policy of the government i.e control of excess liquidity in the economy It is a vehicle for direct foreign investment.

Economic Advantage/Role of Secondary Markets in the Economy 1. 2. 3. 4. It gives people a chance to buy shares hence distribution of wealth in Enable investors realize their investments through disposal of securities. Increases diversification of investments Improves corporate governance through separation of ownership and management. This increases higher standards of accounting, resource management and transparency. 5. 6. 7. Privatisation of parastatals e.g. Kenya Airways. This gives individuals a chance for ownership in large companies. Parameter for health economy and companies Provides investment opportunities for companies and small investors. economy.

Page 6 of 6