What is a Stock Exchange?
It is a platform where people can sell or buy different securities such as stocks, bonds, derivatives or options, futures, etc. Moreover, the shares of the company which is to be traded in any stock exchange should be listed on that particular exchange. So, for example, if you want to purchase shares of any company, then that company should be listed on the stock exchange. Or else you won’t be able to make the transaction. Therefore, any company willing to lists its shares and arrange for public subscription enters the primary market through Initial Public Offering (IPO). Thru IPO the company invites the public to subscribe to its shares and become shareholders of the company. Stock exchange helps to trade for securities. Further, it also helps to determine the prices of shares based on demand and supply.
The capital market has two active divisions:
- What is a Stock Exchange?
- How does a Stock Exchange Work?
- Functions of Stock Exchange
- Final words
- Primary Market
- Secondary Market
The primary market involves the issue of new securities. Whereas the secondary market deals with the buying and selling of those securities already listed and having public shareholding. The secondary market is also known loosely as the stock market or stock exchange where routine trading takes place.
How does a Stock Exchange Work?
In the stock exchange, all the transactions happen amongst the shareholders and not with the company directly. Suppose if a trader wants to trade in any particular stock, then he will have to buy the shares through a stock exchange platform. So, the trader will not purchase the shares from the company directly. But he will buy from the other shareholders who want to sell their securities floating in the market. A stock exchange provides the facility of buying and selling any commodity, bonds, options, etc. All the transaction recording takes place digitally and therefore is a seamless process without any obstacle.
These stock exchanges charge their fees for each trade and that is their primary source of income. Additionally, some of the stock exchanges have their certifications and courses through which they earn income. The other source of their income is the Membership Fee. All the trades can take place through an authorized member of that particular stock exchange. All these members are called the Brokers. And they earn brokerage from their clients for all the trades taking place thru them.
Steps involved in the trade of Securities
Selection of a Broker/Sub-broker
First and foremost, the trader/ investor needs to select a registered broker because the transactions can be done through a broker/sub-broker only. The broker could be an individual, company, bank, or any institution registered under that country’s securities commission or regulator, to conduct the trading of securities.
Dematerialized or Demat Account
Trading in electronic form is the standard practice now. Hence, an investor/trade needs to open a D-mat account to trade in securities which will be held in his account in electronic form. A broker can help you in opening the same with any of the depositories.
You can place the orders online on your own or you can instruct the broker offline about the transaction. The broker would issue a confirmation slip once the order is executed.
Execution of the order
The broker carries out the execution of the order. He then issues a contract note within 24 hours specifying all the details of the transaction made, including brokerage charges and money payable or receivable from the client.
Settlement of funds
The last step involves the actual transfer of securities and settlement of funds between the buyer and seller. As agreed upon, either on the spot settlement is done or forward settlement takes place on some future date through the selected broker.
The stock exchange plays a crucial role in reducing the risks and speculations related to the securities market. Each exchange authorities have their own set of rules and system for smooth working and timely settlement of funds. Stock Exchange works as a clearinghouse for all transactions related to the transfer of securities and funds between the brokers. Brokers in turn carry out the settlement with their clients.
Functions of Stock Exchange
Ease of Marketability
Stock exchanges have their own rules that everyone needs to follow to carry out trade in a fair manner. It ensures the safety of the transactions which take place in a huge amount daily. Otherwise, the investors will be skeptical and won’t feel comfortable transacting in securities on the exchange. The stock exchange regulates the flow of transactions thereby making the marketability of shares quite easier. One can divest and reinvest conveniently in this ongoing market.
The main function of any stock exchange is to provide liquidity to its traders and investors as they know that they can convert their securities into cash anytime without any hassle. The sale of securities can be made with a single notification. So, the liquidity is enhanced with the availability of more cash.
Valuation of Securities
Securities of different companies can be valued at current market prices. These prices and their performance can further be tracked/compared via various indexes. Price determination and fluctuation take place in line with the demand and supply situation of the security/stock.
The legal framework ensures the safety of transactions. In the US, the Securities and Exchange Commission (SEC) does the job of governing and regulating the stock exchanges. In India, the Securities and Exchange Board of India (SEBI) does this job of governing and regulating.
The virtual medium of stock exchange improves the quality of transactions. It leads to smooth functioning of securities market. Investors are encouraged to invest considering the benefits it offers.
Stock exchanges are an important means to raise initial capital through an IPO.
Work as an Intermediary
One thing that is very important to note is that stock exchanges themselves don’t buy or sell securities on anyone’s behalf but only provide a market-place/platform to carry out trade smoothly. The exchange also has a uniform system of payment and settlement which makes it all the more hassle-free and reduces the risk of price movements in any share. They have their own integrated management information system in which all the necessary information is entered related to a particular trade. This helps the exchanges to keep a record of all the transactions taking place and to regulate it properly.
Platform for all
A stock exchange is a place for all kinds of participants like hedgers, investors, speculators or traders, etc. All these participants operate as per their interests. For example, a speculator will only trade in shares to influence the price movements in stocks whereas an investor will invest in stocks for long-term investment. Many people make investments in the stock market with little financial knowledge without being fully aware of the mechanism of how it works. Stock exchange protects the investors from financial losses and ensures a fair medium of trade. They also regularly conducts Investor Awareness and Educational Exercises.
Stock exchanges are not only the market-place for traders to buy or sell any security but also act as the barometer of the economy. It means that generally, the stock exchange works concerning the happenings in the economy. For example, if a construction company has won a contract its shares will automatically go up and thus lead to a rise in its share price. Simultaneously if the economy is performing well that means that more and more people will be willing to invest in the stock market. So if a stock exchange is not performing well, it automatically means that people are skeptical about the economy and the economic conditions may not be good.
Along with all these advantages that any investor enjoys, there are certain drawbacks that no one can escape from.
There are certain costs in the process of listing any stock over the stock exchange which may be quite high for companies having a smaller capital base.
Apart from this, there are various types of rules and regulations that traders need to follow that sometimes it becomes difficult or burdensome to freely carry out trade.
Stock exchanges are the most prevalent medium for the day to day trading and making transactions in today’s world as inclination towards the stock market is significantly increasing. It is becoming crucial to regulate these exchanges properly to ensure smooth and timely completion of transactions while protecting everyone’s interest. Some of the biggest stock exchanges are the New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange, etc.