Develop Understanding of The Ethiopian Financial System Updated
Develop Understanding of The Ethiopian Financial System Updated
The Participants in the Financial Markets and the Roles of Banks and
Financial Institutions
The Financial Markets in Ethiopia
• A financial market is a market in which financial assets are traded.
• In addition to enabling exchange of previously issued financial assets,
financial markets facilitate borrowing and lending by facilitating the
sale by newly issued financial assets.
• The examples of Financial Markets in Ethiopia
1. Bond market
2. Derivatives Markets
3. Money market
4. Foreign Exchange Markets
1. Bond Markets
• A bond is a debt investment in which an investor loans money to an entity (corporate
or governmental), which borrows the funds for a defined period of time at a fixed
interest rate.
• Bonds are used by companies, municipalities, states and foreign governments to
finance a variety of projects and activities.
• Bonds can be bought and sold by investors on credit markets around the world.
• This market is alternatively referred to as the debt, credit or fixed-income market.
• It is much larger in nominal terms that the world's stock markets.
The main categories of bonds are;
Corporate bonds,
Municipal bonds, and
Treasury bonds, notes and bills, which are collectively referred to as simply
"Treasuries."
2. Derivatives Markets
• The derivative is named so for a reason: its value is derived from its
underlying asset or assets.
• A derivative is a contract, but in this case the contract price is
determined by the market price of the core asset.
• The derivatives market adds yet another layer of complexity and is
therefore not ideal for inexperienced traders looking to speculate.
However, it can be used quite effectively as part of a risk management
program.
•In practice, it is a contract between two parties that specifies conditions
(especially the dates, resulting values and definitions of the underlying
variables, the parties' contractual obligations, and the notional amount)
under which payments are to be made between the parties.
Cont.
•The most common underlying assets include: commodities, stocks,
bonds, interest rates and currencies.
•There are two groups of derivative contracts,
•the privately traded Over-the-counter (OTC) derivatives such as
swaps that do not go through an exchange or other intermediary and
•exchange-traded derivatives (ETD) that are traded through
specialized derivatives exchanges or other exchanges.
•Derivatives may broadly be categorized as "lock" or "option" products.
•Lock products (such as swaps, futures, or forwards) obligate the
contractual parties to the terms over the life of the contract.
• Option products (such as interest rate caps) provide the buyer the right,
but not the obligation to enter the contract under the terms specified.
Common derivative contract types
Some of the common variants of derivative contracts are as follows:
1. Forwards: A tailored contract between two parties, where payment takes
place at a specific time in the future at today's pre-determined price.
2. Futures: are contracts to buy or sell an asset on or before a future date at
a price specified today.
• A futures contract differs from a forward contract in that the futures
contract is a standardized contract written by a clearing house that
operates an exchange where the contract can be bought and sold; the
forward contract is a non-standardized contract written by the parties
themselves.
Cont.
3. Options are contracts that give the owner the right, but not the obligation, to
buy (in the case of a call option) or sell (in the case of a put option) an asset.
• The price at which the sale takes place is known as the strike price, and is
specified at the time the parties enter into the option.
• The option contract also specifies a maturity date.
• Options are of two types: call option and put option.
• The buyer of a Call option has a right to buy a certain quantity of the
underlying asset, at a specified price on or before a given date in the future,
he however has no obligation whatsoever to carry out this right.
• Similarly, the buyer of a Put option has the right to sell a certain quantity of
an underlying asset, at a specified price on or before a given date in the
future, he however has no obligation whatsoever to carry out this right.
Cont.
4. Swaps are contracts to exchange cash (flows) on or before a specified future date
based on the underlying value of currencies exchange rates, bonds/interest rates,
commodities exchange, stocks or other assets.
Another term which is commonly associated to Swap is Swaption which is basically an
option on the forward Swap.
Swaps can basically be categorized into two types:
Interest rate swap: These basically necessitate swapping only interest associated
cash flows in the same currency, between two parties.
Currency swap: In this kind of swapping, the cash flow between the two parties
includes both principal and interest. Also, the money which is being swapped is in
different currency for both parties.
Derivatives are used by investors for the following:
Hedge or mitigate risk in the underlying, by entering into a derivative contract
whose value moves in the opposite direction to their underlying position and
cancels part or all of it out.
Create option ability where the value of the derivative is linked to a specific
condition or event (e.g. the underlying reaching a specific price level).
Obtain exposure to the underlying where it is not possible to trade in the
underlying (e.g., weather derivatives).
Cont.
Provide leverage (or gearing), such that a small movement in the
underlying value can cause a large difference in the value of the
derivative.
Speculate and make a profit if the value of the underlying asset
moves the way they expect (e.g., moves in a given direction, stays in
or out of a specified range, reaches a certain level).
3. Money Market
•The money market is a segment of the financial market in which financial
instruments with high liquidity and very short maturities are traded.
•The money market is used by participants as a means for borrowing and
lending in the short term, from several days to just under a year.
•Money market investments are also called cash investments because of
their short maturities.
•The money market is typically seen as a safe place to put money due the
highly liquid nature of the securities and short maturities.
•Because they are extremely conservative, money market securities offer
significantly lower returns than most other securities.
Cont.
•However, there are risks in the money market that any investor needs to be aware of,
including the risk of default on securities such as commercial paper.
Money market securities consist of
Negotiable certificates of deposit (CDs)
Banker’s acceptances,
Treasury bills,
Commercial paper,
Municipal notes,
Birr euro dollars,
Federal funds and repurchase agreements (repos).
Bills of exchange
Promissory notes
4. Foreign Exchange Markets
Financial markets serve six basic purposes. These purposes are briefly listed below:
• Borrowing and Lending: Financial markets permit the transfer of funds (purchasing power)
from one agent to another for either investment or consumption purposes.
Price Determination: Financial markets provide vehicles by which prices are set both for
newly issued financial assets and for the existing stock of financial assets.
Information Aggregation and Coordination: Financial markets act as collectors and
aggregators of information about financial asset values and the flow of funds from lenders to
borrowers.
Risk Sharing: Financial markets allow a transfer of risk from those who undertake
investments to those who provide funds for those investments.
Liquidity: Financial markets provide the holders of financial assets with a chance to resell or
liquidate these assets.
Efficiency: Financial markets reduce transaction costs and information costs.
The Impacts of Financial markets in Ethiopia
Treasury bills
• Treasury bills are short-term securities issued by the NBE. The
Treasury sells bills at regularly scheduled auctions to refinance
manageable Trading issues. It also helps to finance current federal
deficits. They further sell bills on an irregular basis to smooth out the
uneven flow of revenues from corporate and individual tax receipts.
•The Treasury bill market is the only active primary market in the
country. Tenders are offered periodically by the Central Bank. The
government offers 28‐day, 91 day and 182‐day bills
Cont.
Commercial Paper
•Commercial paper is a short-term unsecured promissory note issued by corporations and
foreign governments.
•It is a low-cost alternative to bank loans, for many large, credits worthy issuers. Issuers
are able to efficiently raise large amounts of funds quickly and without expensive Securities
and Exchange Commission (SEC) registration.
•They sell paper, either directly or through independent dealers.
Bill of Exchange
•A written order from one person (the payer) to another, signed by the person giving it,
requiring the person to whom it is addressed to pay on demand or at some fixed future date,
a certain sum of money, to either the person identified as payee or to any person presenting
the bill of exchange.
Cont.
Promissory Note
•A promissory note is a negotiable instrument by which one party makes a promise to pay
certain amount of money to the other party on some future date or on demand by following
the agreed terms and conditions.
•The terms associated with this commercial instrument include principal amount, interest
rate, parties to the note, date, terms of payment, maturity date and sometimes rights of the
payee in case of default.
•A promissory note is a commercial document so must be drafted in professional format. It
must be signed by both the parties
Government Bills
•A public or private bill prepared, introduced, and sponsored in the legislature by a member
of the government.
LO 4- Key Factors that Influence the Ethiopian
Economy
1. The Role and Impact of global market Situation and
Federal and Regional State governments’ action on the
economy
•Globalization of markets; many more markets are becoming attractive for companies,
with most future market growth occurring in emerging economies while Europe in
particular will be losing relative share
•Different demographic trends in Europe versus other parts of the world are further
reinforcing these changes
•Globalization of value chains; activities across the value chain are getting dispersed
across locations and companies, forcing locations to prove their attractiveness for each
individual activity rather than the bundle of activities across the value chain
Cont.
•Changes in the innovation process, i.e. the perceived advantages of
open models of innovation, support the dispersion of innovative
activities across institutions while they reinforce the importance of
geographic proximity
•Changes in management practices, i.e. the focus on core activities
and competences, support the dispersion of activities across institutions
while they reinforce the importance of geographic proximity
Cont.
•Globalization of companies; multinational companies are increasingly
‘orchestrators’ that connect activities around the world to serve markets around the
word
•This also leads to an increasing number of multinational companies that have their
roots in emerging economies
•Globalization of knowledge; standardized knowledge is increasingly available
everywhere around the globe.
•The changes in the global economy erode the benefits that Ethiopia can derive
from an economic policy focused on creating a solid general context and prudently
managing the county’s natural resources.
The Impact of change in the domestic interest Rates on different
sectors of the economy
•Domestic interest rates directly affect rates of return on domestic currency deposits in
the foreign exchange markets.
• A decrease in a country’s money supply causes interest rates to rise, rates of return
on domestic currency deposits to rise, and the domestic currency to appreciate.
The Impact of Changes in Consumer activity on the
Ethiopian Economy
1. In order to fulfill its objectives the Financial Intelligence Centre "the Centre"
collects, processes, analyses and interprets information disclosed to it in terms of
various statutory reporting obligations.
The Centre then uses this information to inform and advise law enforcement
authorities, supervisory bodies, the South African Revenue Service and the
intelligence services and to cooperate with these bodies in the performance of
their functions.
2. The Centre also monitors compliance with the FIC Act and gives guidance to
accountable institutions, supervisory bodies and others.
Cont.