Kingdom Of Saudi Arabia Capital Market Authority

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Kingdom of Saudi ArabiaCapital Market AuthorityFinancial Investmentsand Stock Markets

IntroductionWhen the career life of an individual begins, a continuous income begins with it. This income is spenton basic needs and over time it will increase. Subsequently, the ability to save and place these savings ininvestments will generate more revenues and maintain the purchasing power of the individual’s moneywhich might fall back with the increase in prices.This is where the need for how to place these savings in investment vehicles increases to help theindividual in achieving his life objectives.

Unit One: Introductionments which include tangible and financial assetsthat bring him greater revenues and income andThe cycle of one’s life starts by completing his edu-guarantee that his money purchasing power will becation and entering the work stage where he receives revenue or an incomefrom his work in the form ofsalary or wage. It is normal fora person to split his incomebetween consumption andmaintained and will not fall back when the pricesIncome is return fromrise. Tangible investment assets include real estate,work and propertylands, goods and others. Financial assets, on theowned by an indi-other hand, include deposits in banks, mutual funds,vidual.stocks, bonds, foreign currency and others. Theseinvestments generate more revenues added to thesaving. Usually, an individual spends most of his in-individual’s income which he in turn utilizes to sup-come on his consumption needs such as food, cloth-port any future, accommodation, a car, educational, health andentertainment services etc. After meeting thoseworkneeds, the remainder is accumulated and saved. AtPurchasing power is the capacityof income and money to buy andown goods and services. If pricesIncomethe beginning of acareer, the incomesavingis usually low. Overincrease, the individual’s ability totime, the incomebuy decreases. Thus, money andimproves and therevenues lose part of their value.individual graduallyConsumptionWealth: Financial assets (stocks, bonds,deposits in banks, etc)begins to increasehis savings and employ them in various areas in or-Wealth:Tangibleassets (real estate,gold, goods,.etc)An individual diversifies his investments and balanceder to increase his income more and more.them to ensure achieving his objectives. His shortterm goal (up to one year) can be buying a car, anapartment or starting a small family. In mediumterm (one year up to five years), goals might changeinto starting a family, raising children well, educat-As the individual’s savings increase, his wealth startsto grow. Wealth is defined as the accumulated savings. The individual seeks to place wealth in invest2

investments in financial and tangible assets that havealready been mentioned previously. This conceptcan be reflected by the saying: “Do not put all youreggs in one basket”.ing them and starting a private business or a smallenterprise which could increase the individual’s income. In the long term, things could change intoplanning for post retirement to ensure a decent lifefor him and his family and to leave adequate inheritance for those left behind after his death.Unit Two: The Financial MarketMembers of the society can be economically classified into two groups: Individual investors and savers.Individual investors are those who have the desireto create companies and institutions, and establish different projects, but they may not have thesufficient funds to do so. Individual savers, on theother hand, are those who have the money, but donot have the desire, knowledge or ability to investit by themselves. Usually, savers belong to differentclasses of society such as workers, employees andretirees who can save part of their income. Investors tend to use their saved funds to help them toestablish companies.A person should employ his wealth to achievehis goals through appropriate investments that goin line with the capital he has to secure the highest possible return for himself .In investment, it isknown that the higher risk, the higher the returnsand profits. On the other hand, the lower the risk,the lower the returns and profits. However, individuals handle risk differently. Some risk their moneyin hope for making high and quick profits while others tend to avoid risk and prefer safety and cautionin their investments. In addition, individuals differ intheir ability of being patient and waiting to experience lower returns, increasing risks or losses thatmay happen in the short term.To reduce investmentrisks as much as possible, one should diversify hisThey divide corporate capital into stakes or portionswhere each portion is known as a share. They offerthese shares for sale as each saver buys a numberof those shares within the limits of his savings. Thismakes him a shareholder and a participant in thecompany’s capital. Therefore, he becomes a part of3

vided into stock markets, bond markets and currency markets. Stocks are ownership instruments to apart of the issuer’scapital, while bonds are con-sidered debt instruments on the entity that issuedthem. When you purchase a stock, you become aparticipant or a shareholder in the company. On theother hand, if you purchase a bond, you become acreditor to this company. Savers purchase stocks forits management and decisions according to his staketwo reasons: first, to obtain part of the profits gen-in the company’s capital. In other cases, investorserated by the company. This is known as not wish to share the management and decisionSecond, the prices of these stocks may go up due tomaking of the company with the savers. Therefore,higher demand as a result of the company’s growththey tend to get the savers’ money through bor-and the increase in its earnings. Thus, the value ofrowing, then dividing what they need of their corpo-stocks owned by the investor increases. This israte funds into portions, known as bonds or sukuk.known as the capital gain.Savers buy these bonds within the limits of whatthey want and how much savings they have. In fact,they do this in anticipation for returns from holdingthese bonds, and then redeeming their value whentheir maturity is due.2-1 DefinitionsThe Financial Market: a market where securities aretraded (sold and bought).Securities include: stocks, bonds and also currencyStocks are bought and sold on the market in a regu-trading. According to this, financial markets are di-lated and legal manner so dealers do not lose their4

rights. Usually, all these operations are made throughThe Primary Market: a market where stocks arefinancial brokerage firms that are authorized by aissued, that is when a company is established andmarket regulator, which is the Capital Market Au-offers its stocks to the dealers for the first time, orthority (CMA) in the Kingdom of Saudi Arabia.when the capital of an existing company is raised.When these stocks are listed in the market, the firstThere are various types of stocks which are tradedbuyer of the stock can sell it on a trading market,on the market.There are stocks that give their hold-which is known as the secondary market. In otherer the right to attend the general assembly of thewords, stocks are first issued and sold in the pri-company and express his opinion on the way themary market, and then traded (bought and sold) incompany is managed.the secondary market.There are also bonus stocks: they are free sharesgranted to the owners of ordinary stocks in orderto increase what they own in the company and toincrease the company’s capital as well.2-2 Functions of Financial Market:Financial markets in general, and stock markets inparticular, have great importance given their multiple functions in serving the national economy.TheseAs for preferred stocks, they give their owner theright and priority to obtain his rights from the include the following: Saving Encouragement:There are two main types of stock markets: the primary market and the secondary providing fields toemploy or invest funds, especially for thosewhom their income is higher than their expenses, and do not have enough time to pay at-Stocks of new and existing companies, that aim toraise their capital, are offered for subscription throughlocal banks in the kingdom. The total number ofoffered stocks, their ratio to company capital, stockprice, subscription maximum limit, and duration aredetermined in an IPO. , Savers take interest in IPOsto buy shares on the primary market for the profitsthey expect to generate from selling stocks on thesecondary market eventually.tention to investment projects they want tostart. Therefore, investing in the stock marketprovides good investment opportunities thatencourage savers to increase their savings, takeadvantage of investment opportunities in themarket and provide adequate capital for com5

panies to make investments and sustain their2-3 Characteristics of Financial Markets:business.In general, financial markets have a number of distinct characteristics that distinguish them from other traditional markets like commodity or real estatemarkets and others. The sale and purchase in traditional markets is available for goods and servicesin a physical tangible way plus they give benefits tothose who consume them. In securities markets,however, there is no need to have tangible Sukukor securities etc because the operations are carried out through computer networks. Furthermore,securities like bonds and stocks are not consumedby themselves but rather used to get returns andprofits generated from investments. Daily transactions in financial markets are enormous comparedto other markets . They can exceed billions in financial markets, while they cannot go beyond millions inother markets. The law sometimes requires dealersin the securities market to buy and sell through a financial broker. In traditional markets, however, thereis no obligation to use the services of a broker. Risk mitigation:investing in the stock marketreduces the risks of losing savings and money ifthe saver himself invested them in other areaswhere he does not have enough experience. Inaddition, one of the investment risks, inadequateliquidity, can be eliminated because the investorcan sell his shares easily and quickly. He can alsoliquidate them whenever money is needed. Increase economic growth;financing projectsand investments listed in the stock market contributes to producing more goods and servicesand supporting economic growth. This leadsto an increase in career opportunities for jobseekers.In addition, selecting shares of stocks in specificprojects and companies contributes to steering themoney and savings towards more feasible and profitable projects.Wealth: Financial assets (stocks, bonds,deposits in banks, etc).Stock market6Wealth: Tangible assets (real estate,gold, goods,.etc)

they made and other information affecting thepurchasing and selling decisions. Moreover, dealers should have the ability to obtain proper analyses of the received information to help in judgingthe right price for the stocks or bonds . Sellersand buyers should not have – due to their high financial capacity - the ability to influence the rightmarket prices upwards or downwards or imposerestrictions on the freedom of selling and pur-2-4 Efficiency of Financial Marketschasing for any trader at anytime.The efficiency of financial markets means that theprice of a security (stock or bond) is determinedaccording to all the available information about2-5 Basic Concepts: Nominal Value, BookValue and Market Value :the economy, sectors and companies issuing thatAn investor wanted to establish a plastic com-security. Financial markets are efficient if the pric-pany. After studying the project’s cost, he foundes of stocks and traded securities are determinedout that the company’s capital must be ten mil-correctly. The right price of a security, whether itlion Riyals. Since he does not have this amount,was a stock or a bond, is the one that reflects allhe turned to the savers’ money to participatethe available information in a timely manner aboutin co-founding the company. Due to the largethat security. In order to say that a financial mar-amount of capital required, he divided it into mil-ket is efficient, it must have several features. Forlion shares. Each is worth 10 Riyals.The ten Riyalsexample, all the important information to judgein this case are known as the share nominal valuea stock or bond and determine their right price. Because the expected profitability of the projectshould be available for all dealers. A good exampleis high, a growing number of savers accepted toof this, is the information about companies andcontribute to this project and purchase the is-their profitability, changes in management or thesued stocks. The required capital was raised andthe company was established. At the end of theinformation about competitors, the contracts7

first year, the company have generated a profit ofmaking provisions and reserves to face any emer-two million Riyals, i.e. two Riyals profit per sharegencies. If the distribution is not made, the valueof the company’s shares. The corporate manage-of the company assets in this case will be twelvement met to decide one of the following options:million Riyals. This includes plots, buildings, ma-Distribute profits to shareholders, distribute partchinery, equipment, production supplies availableof the profits and keep the remaining, or do notin the company, its money in treasury and in bankdistribute the profits of this year at all. Of course,accounts, etc . When the company’s assets in-when the decision is to keep the profit or partcrease to twelve million Riyals, the book value ofof it, the retained earnings are used in financinga single share becomes twelve Riyals. (12 millionthe company’s expansions and investments or inRiyals one million stocks 12 Riyals).Nominal Value: The share value when the company is established.Book Value: What shareholders expect to receive if the company were liquidated. The book value can becalculated by dividing the company’s assets by the number of shares.Provisions: Amounts of profit that are retained or cut off from the company’s revenue to be disposed of inone of the specific aspects of actual expenditures (such as buying new machinery or plots to expand thecompany) or for potential emergency expenditures (such as fire, higher production costs, or decreasedcompany earnings).Earnings Per Share: Profits that are allocated to each share. It is not conditional that earnings should bein cash. They can be bonus shares distributed to shareholders. These profits, or even bonus shares, mayalso not be distributed, but rather reinvested and consequently the market value of the company’s sharesincreases.Total Return on Stock: return on the stock plus capital gain.8

Market value: the value of the share in the market. It isspread between its parties easily and simply. Theaffected by the supply ( the number of stocks availablemost important news to be published about theseto investors) and the demand ( the number of stocksmarkets is the performance indexes which we willinvestors wish to buy). The investor can know the marketdefine its concept then review some of the interna-value of a share through the Saudi Stock Exchangetional and regional indexes as the following:(Tadawul) website in addition to other means of massmedia.Market Capitalization: it is calculated by multiplying thenumber of a company’s stocks by the current marketprice of the stock.The company has evolved, the work expanded andthe number of costumers has increased. At the endof the second year, its stocks were floated in an IPOin the stock market at a price of fifteen Riyals. Dueto the good reputation of the company, the market3-1 Stock Market Index :price of the stock has risen to twenty five Riyals onA number that summarizes the price movement ofthe first tradingall stocks listed in a market and usually representsDay. In other words, the market value of each sharethe average of those prices. Stocks are not equal inrose by ten Riyals from the offering price.their percentage representation of the index. Representing a company’s stock depends on its weightin the market measured by the market value of theUnit Three: InternationalStock Marketscompany divided by the market value of all listedcompanies in the market. Stock prices rise and fallNewspaper and media headlines are full of newsdue to supply and demand. When the demand forabout international stock markets. As they say: thesome corporate stock exceeds the supply, the priceworld has become globalized where the news isof this stock rises and subsequently the market in9

dex increases with the percentage represented byA country has created a stock market; three companies offered their stocks for initial sale in each casefor a price of 100 Riyals per stock. For clarificationpurposes, the index of the stock market prices (inthis case) is calculated by taking the (simple) averageof the prices. That is done by adding up the pricesof all the three stocks (100 100 100) then dividingthem by the number of companies that issued them(3) to get the index in what is known as the baseyear (beginning year) and it is 100.this stock in the index.3-2 The Importance of the Index:The stock market index reflects the condition ofthe national economy in general and the economicperformance of listed companies in the market inparticular. If the demand for the companies’ production increased due to the economic boost, then theWith the start of trading in stocks and with the endof the first period, the share price of the first company rose to 120 Riyals while the share price of thesecond company fell to 95 Riyals. The share priceof the third company remained unchanged (100 Riyals). By repeating the calculation of the index valueby taking the (simple) average of the new prices, weget [ (120 95 100)/3] 315/3 105 ; which meansthat the index has risen by 5 points at the end of thefirst trading period.sales and earnings of these companies are expectedto increase as well as their dividends to shareholders, which in turn pushes the prices of their stocksup and the whole market index. In this case, themarket index turns green. However, if the performance in the market declines, the indicator changesits color to red.3-3 Some of the Global Indexes:The rate of change in the index (Market Return) iscalculated according to the following rule :Rate of change [(current index value – previousindex value ) previous index value] 100%In the example above, the calculations are as follows:Rate of change (105 - 100) 100 100% 5%Which means that the stock prices in this marketincreased by 5% between the two periods.It should be noted that this is a simplified calculationmethod intended for clarification purposes But, theactually applied method is different as better statistical and mathematical methods are used.Global financial markets have two types of indexes: General indexes that measure the market situation in general, and sector indexes thatmeasure the market situation according to a particular sector such as banking, industrial, agricultural, communications and other sectors. In thefollowing points we address the most importantinternational and regional indexes.10

3-3-1 U.S. Market Indexes: DOW Jones: is a major index3-3-2 European Market Indexes : United Kingdom :that consistsof four sub-indexes and the most famous ofFinancial Times 100: (FT-100) this index in-which is the Dow Jones Industrial Average.cludes the 100 most important UK compa-The value of the index is calculated based onnies’ stocks in the London market, repre-the stocks of the thirty largest industrial com-senting 70% of the total capital of registeredpanies in the United States of America.companies. Standard and Poor’s 500 (S&P 500): It com- Franceprises the stocks of the leading five hundredCAC 40: this index includes the stocks of thecompanies in several areas, including: manufac-forty most important French companies inturing, transportation, utilities, money, bank-Paris market. Germanying, insurance, technology and services. Thesecompanies represent approximately 80% ofDAX: this index contains the stocks of the 30the market value of shares traded on the Newmost significant companies, representing 70%York Stock Exchange.of the market value of the companies regis- NASDAQ: is the largest among all U.S. indexes.tered in Frankfurt market.It contains the stocks of 3,200 companies,mostly technological.3-3-3 Asian Market Indexes : - JapanNikkei Index : contains the stocks of 225 com11

Unit Four: The Saudi Stock Exchangepanies, representing about 70% of the marketvalue of the companies registered in the TokyoStock Exchange. Other Asian Indexes :4-1 Historical Background1. South Korea: KCS IndexThe Saudi stock exchange is one of the newly es-2. Hong Kong : HANG SENG Indextablished emerging markets. Market dealing began3. Malaysia: KLSE Indexwhen the first joint-stock company (the Arab Auto-4. China : Shanghai Indexmobile) in the Kingdom of Saudi Arabia was established in 1354H (1953).3-3-4 Arab Market Indexes:Arab stock market are emerging markets due tothe great potential of economic growth in Arabcountries. The Saudi stock exchange is consideredthe most significant market in all Arab countries.It represents about one third of the capital valueof all Arab markets combined. In addition to SaudiArabia, there is a number of other important Arabfinancial markets such as : The United Arab Emirates: (Dubai and AbuStock trading started in the Saudi market in a direct and immediate way between sellers and buyers.With the continuous growth, an electronic system,known as “Tadawul”, was launched in 1422H (2002). The system allows registering, trading, clearing andsettling shares immediately. It is directly linked toSaudi commercial banks, and receives orders of selling and buying stocks. Then, it executes transactionsand transfers shares ownership in an automatedDhabi markets ). Oman: MSMEgypt: CMAMorocco: MASI Kuwait: KSE Bahrain: BSE Qatar: CBQ12

“TASI” is an index which summarizes and measuresand accurate way. In 1424H (2004), the Capital Market Law (CML) approval of the financial market hascame out and the major features was to establishthe Capital Market Authority to assume the functions of regulating the market, develop it, organizethe issuance of securities, control it, protect investors, achieve justice, efficiency, transparency, regulate and control the disclosure of information andothers. The system also includes the establishmentof a market for trading securities under the name of“The Saudi Capital Market ”.the level of performance in the Saudi stock market.Its name consists of the first initials of the Englishname “Tadawul All Share Index (TASI)”. The Index iscalculated as the weighted average of stock prices ofthe companies operating in the market.A number of factors and variables effect the priceof traded stocks on the market. They include domestic economic conditions, economic growth, aswell as the problems the economy may suffer fromlike inflation and unemployment. The profitability of“Tadawul” is an electronic system that is char-joint-stock companies and current developmentsacterized with efficiency in stock dealing andtrading (selling and buying) in the Saudi global stock markets also effect it as well as the4-2 Characteristics of the FinancialMarket:ture and government expenditure on services anddomestic economic policies in terms of expendiprojects in addition to the amount of money andliquidity in the economy.The companies listed in theThe Saudi stock market is new compared to theSaudi stock market are distributed to the followingmarkets of developed countries such as the U.S.,fifteen sectors:Japan, or the EU countries. It is characterized by thesmall number of listed companies in the market given the large size of the Saudi economy. The volumeof transactions in the market is considered relativelylimited compared to the number of issued stocks.This can be defined as a tight market, which leads tolarge fluctuations in stock prices.13

Industrial InvestmentPertochimecalIndustriesBanking and Financial ServicesAgriculture &Food IndustriesEnergy & UtilitiesCommunicationsMulti-InvestmentReal EstatedevelopmentHotels andTourismdue to the limitations in trading stocks, especiallythose of major companies, because governmentowned stocks cannot be traded. There is anotherreason that constricts the amount of traded stocksand keeps potential investors away from these companies which is that some major owners control aInsuranceBuilding andConstructionMedia and PublishingRetailsubstantial ownership stake in companies. The largest ten Saudi companies account for about 60 – 70%Cementof market size measured by any of the usual criteria:volume, trading, or profits.TransportIt is expected that the view on the Saudi stock mar-Each sector has an index that measures the perfor-ket remains positive and optimistic in the continu-mance by tracking the prices of companies’ stocksous improvement of the performance of the Saudiin that sector.The general index, known as “TASI”, iseconomy at the macro level, and the application ofused to measure the overall performance of the en-all necessary legislations to ensure the regulation oftire market and it is a weighted average of the stockwork in the market, increase the number of com-prices of the companies in operating the market.panies, increase the market capital and the application of the recent government actions to maintainAs previously stated, the Saudi market is charac-stability.terized by being “tight” and “limited” compared toother similar emerging markets (127 companies atthe end of 2008, compared to about 350-400 companies in similar emerging markets).Note that the number of companies has been growing since the inception of the Capital Market Authority (CMA) in 1424H. The market has a “tight” base14

Unit Five: Financial InvestmentStrategies:5-1 Types of Financial Investments:There are three aspects for savings investment:stocks, bonds and mutual funds.There are a lot of financial and real investment op- Stocks: investing in stocks is characterized by aportunities for savers. Some prefer the financial in-high rate of return in the long term with a highvestment by putting all of his savings in bank de-chance of risk, which means that the investorposits, some prefer owning stocks and bonds whilemay sustain some loss in his invested capital.others prefer real investment in lands, real estate Bonds: it is known that private companies needor private projects. In the following parts, we willfinancing and therefore sell bonds to savers toexplain the fundamental factors that affect savers’obtain the required funds. Deferring to this tooldecisions to invest in a particular area of the abovein the Kingdom for the time being is limited.with focus on financial investment.The government also resorts to issuing bondsThe most important factor is the expected returnto finance projects such as building schools, uni-on investment. Although the return on investmentversities, hospitals, constructing roads, buildinghas many concepts which will be addressed in duebridges, power plants and other public proj-course, it is agreed that it is the difference betweenects. Although the government resources comethe value of savings before investment and theirfrom oil and fees, sometimes it may have to is-value after a certain period of investment in specificsue bonds in order to secure additional funding.areas. Mutual Funds: these funds pool savings througha Muniment of title with equal values similar tostocks. They are called investment units. Investors tend to buy stocks of these funds to usesome of the advantages that these funds havefrom the long experience in managing investment. In addition, these funds have the abilityto diversify their investments, hence, reducingthe risks because of the funds availability. In15

5-2 The Financial Investment StrategyIn general, a strategy is defined as a long term planto achieve a specific vision and objectives. Any planning for the future begins by analyzing the presentsituation and determining the vision and objectives,then determining the best way to achieve that vision and objectives. Financial investment objectivesdiffer from one person to another. The maximumvestors entrust the entity that manages theirprofit may be the goal of a specific investor, whilemutual funds to take decisions on their behalf.the absence of risk might be the most importantIn general, the return on these stocks tend toobjective for another, and adequate liquidity couldbe more secure with a return of more than thebe the objective of a third investor. Therefore, thebond’s and less than the stock’s return .investor should have the knowledge and skills thathelp him reach his objectives.The most important factor that drives investors toinvesting in a particular type of securities is searching for an investment that generates a high returnElements of the Financial Investment Strategyand have a degree of risk which the investor cantolerate.A sound financial investment strategy requires determining the following elements: The areas of investments in mutual funds are diverseaccording to the purposes of establishing the fund. Inthe first place, there are mutual funds in some sectorsof the market, IPOs or real estate.These funds have animportant role in supporting the capital market in theObjectives.Financial potential available to the investor.Time frame necessary to achieve the objectives.Expected return on investment.Alternatives: any other available investment ar-Kingdom with the extra funding and expertise theyeas in which the return on investment can beoffer to the market.achieved.16

The following are considerations that must be taken Fa