WHAT IS STOCK EXCHANGE, AND HOW DOES IT FUNCTION?

The stock exchange is where the stocks and securities are traded; it is a well-regulated platform that allows buyers and sellers to stock a safe passage through capital market participation and economic growth. This article deals with the conceptual understanding of the stock exchange and its functions.
Estimated Reading Time: 10 minutes

Introduction

Economic dependency over the stock exchange can be measured by knowing its prime role; it is the secondary zone of the capital market that performs various functions in regulating and preparing the country’s money market performance channelizing it for economic growth. It is a specialized marketplace that facilitates the exchange of stocks and securities bought into the capital market. It is a platform that orients the performance of stocks and securities that the companies trade; it acts as an investments handler and a business moderator. It is the primary source of fund for companies participating in stock trading and a helping hand for the governments at the time of inflation; it also boosts business expansions and diversification for the economy’s growth.

The concept traces its roots back to medieval France and the Low lands, where agricultural goods were traded for cash or debt. The Venetian moneylenders of Europe where the pioneer of stock exchanges who traded debts to individual investors and gained profits from their businesses. While tracing its root in Indian markets, the English East Indian companies created by the sea voyagers who were at a high risk of trading focused on generating high returns and provide dividends to the stockholders; they were the first corporation to introduce joint-stock companies. In 1773, it formed the world’s most powerful stock exchange; “The New York Stock Exchange” still holds international prestige in the global trading market. 

While discussing the roles and functions of the stock exchange concerning India, the Bombay Stock Exchange and India’s National Stock Exchange play a vital role in regulating and monitoring the stock exchange market’s actions, contributing to its growth rate. It has played a requisite role in leading economic and trading activities and helps channelise and mobilize every individual’s funds and investments. It requires healthy and revitalizing rules and regulations for its proper functioning as it has a strong influence on economic growth. The Indian legislature has enacted various laws and policies for its administration by imposing its regulatory power. Besides regulatory motion, the legislature also gave importance to protection for all the parties involved in the stock exchange market’s realm. 

What Is Stock Exchange?

According to Hastings, “Stock exchange or securities market comprises all the places where buyers and sellers of stocks and bonds or their representatives undertake transactions involving the sale of securities.”

As per Indian law, it is defined as follows;

Stock exchange means—

(a) anybody of individuals, whether incorporated or not, constituted before corporatisation and demutualisation under sections 4A and 4B, or

(b) a body corporate incorporated under the Companies Act, 1956 (1 of 1956) whether under a scheme of corporatisation and demutualisation or otherwise, to assist, regulate or controlling the business of buying, selling or dealing in securities.”

As per the Indian legislation, the following securities are traded in the stock market.

  1. Share, scripts, debentures, bonds, and other marketable securities
  2. Government securities
  3. Rights and interests vested in the traded securities.

Farlex Financial Dictionary defines it as follows;

“A physical or electronic place, where stocks, bonds, and/or derivatives in listed companies are bought and sold.”

A stock exchange is also called a bourse or simply an exchange.”

It is irrefutable that almost every individual holds the stock as their substantial investment directly or indirectly through one or more financial institutions; to facilitate such a process of buying and selling of stocks, there is a high need for a well-established staging one such is the stock exchange. It is generally a body of individuals incorporated to work for the benefit of the stock tradings; it is either physical or in an electronic medium where stocks, securities and bonds are traded in both primary and secondary market on neutral grounds.

Derek Honeygold has rightly stated as follows; “Stock exchange can be described as the place where a marriage of convenience is enacted between those who wish to raise capital, such as companies, governments and local authorities, and those who wish to invest- largely households through the medium of institutions acting upon their behalf“.

As stated above, stock exchange participants can be private companies, non-profit, or publicly traded companies or companies that trade on the floor; and the investor can be anyone around who wish to invest. It provides a well-regulated platform and persons like stockbrokers and other intermediaries to meet the participating investors’ demands. They cause to interfere with every matter relating to the stock exchange through its profound functions.

Objectives and Purpose of Stock Exchange

  1. Generate capital investments and funds for business enterprises 
  2. Create a credible platform for investors to mobilizing their income
  3. Perform their market duties in a legal and a well-regulated manner
  4. Create opportunities for business enterprises in expanding and diversifying their ideologies.
  5. Promote economic growth and support the increase of Gross Domestic Product of the country
  6. Protect the stock market participants from fraudulent activities and provide them with fair dealings with companies
  7. Ensure transparency and security in the procedures and promote appropriate market operations
  8. Ensure free transferability of securities which form the essential basis for corporate functioning
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Members and Institutions Associated in Stock Exchange Functions

  1. Stockholder: A stockholder is any company or an individual that purchases stocks of any listed company and hols at least one share in the organisation’s capital. There are also called shareholders. They form an ownership relationship with the company and acquire their stake through profit sharing, called dividends. 
  2. Brokers: The brokers are the intermediaries who bridge the investors with other beneficiaries within the stock exchange market; they act as a link between the buyers and sellers of stocks and also plays a prime role in executing the process for which they receive brokerage or commission. They act on behalf of the investors or stock issuers in both the primary and secondary markets during the stock exchange. They are considered market makers who play a pivotal role in smooth functioning and stock exchange facilitation. Stock exchange brokers can be categorized into foreign broker, industrial group, local bodies, subsidiary of stock exchange, or any financial institutions and banks.
  3. Investors: Investors are persons or entities who participate in the stock exchange by investing their financial instruments to profit. They form the prime party of the stock exchange market who possess certain rights and duties and commit to rely upon their financial instruments for returns to fulfill financial objectives like long-term financial stability, retirement savings, funding for personal protection and usage. Market investors include individual investors, retail investors, institutional investors generating and storing funds in other financial institutions, and publicly traded corporations trading in their shares.
  4. Depositaries: Depositaries are institutional facilities associated with the stock exchange, which helps store and safeguard market participants’ deposit. They accept and maintain currency deposits, stocks, assets and bonds of the investors and provide dividends. A depository can be an organization, bank, or institution that holds stocks or securities and helps in trading them in the stock exchange market and returning them when requested.
  5. Listed companies: Listed companies are the companies or corporations or institutions that list their stocks or shares in the stock exchange market to attract investors and elevate capital for running their business. They are the issuers in the trading process who share their profits with the stakeholders and perform relevant activities concerning other market regulations. 
  6. Other members: Other members refer to the Secondary stakeholders who perform the inside duties of the stock exchange; they generally perform administrative works such are, process tradings and dealing, implement rules and regulation, assist in audit and research and other such financial and legal matters. They have significant influence over the performance of other essential stakeholders in the stock exchange.

Functions of Stock Exchange

It performs profound functions, and those functions are the mirror of their object and purpose, which they are instilled with to serve in the capital market. The functions of the stock exchange reflect its importance in the economy, thus making it an indispensable part; below are some of the functions performed by the stock exchange:

  1. Capital generator for business: The primary function of the stock exchange is to act as a capital generator for the business entities; they intake investments and disperse the same to the stock listed companies as their source of fund to run their chores. Stock exchange deals with a large amount of money supplied to the corporations in the desired manner.
  2. Economic booster: The stock exchange market is the index of economic growth and development; since the country’s development on a global scale usually measured with its economic growth, price market stability is often measured; these price trends are reflected primarily through the stock exchange market which deals with most of the country’s wealth; thus stock exchange has a pivotal role in boosting economic growth.
  3. Investment boosting: Investments play a prominent role in stock exchanges; they are the power source for its functioning, investment and the stock exchange being mutually dependent. This factor imposes an essential duty upon the stock exchange to perform its activities effectively, which in turn boost further investments
  4. Distribution of securities: Established companies or institutions those wish to raise capital for business through stock trading are facilitated with it through the distribution of securities made by the stock exchange; they facilitate the companies to sell securities in the market
  5. Company management: the private corporate system cannot function effectively without the existence of the stock exchanges made in the economy; the functions of the stock exchange have a significant influence on the company management; they regulate the flow of capital within the management.
  6. Investor protection: The stock exchange’s fundamental function is to protect investors’ interests with adequate security from the market’s fraudulent actions. Its functions of regulating the stocks and securities should provide necessary protection guidelines in trading matters. 
  7. Investor education: Investor education is one of the prime function of the stock exchange to widen the stock market participation; it educates the investors on stock trading through various avenues like mass media, print media etc., 
  8. Channelizing savings: Stock exchange creates an ideal platform for channelizing savings by providing a profitable and desirable area for investments; by ensuring a promising and equitable investment strategy, the stock market functions to channelise the savings of the nation efficiently.
  9. Fair market price or value determination: The price values in stock exchanges are determined through the forces of demand and supply; it imposes a prime function upon the stock exchange to fix fair market price to facilitate proper bargains and free-market trading and competition
  10. Optimum resource allocation: Stock exchange acts as an ideal tool for the effective and optimum utilization of a nation’s financial resources. It has to enable a reasonable mechanism in optimum allocation of resource 
  11.  Liquidity: Liquidity is a factor that interprets the efficiency of any exchange concerning sale and purchase and the accessibility and price values of stocks; it deals with the resilience of the market and indicate the response of the investors in trading. The stock exchange performs this function of displaying the liquidity of the market.
  12. Domicile of business information: Stock exchange serves as an information hub for the market participants; they disseminate the required information and financial data of the participating company to facilitate wise market tradings
  13. Pricing securities: Setting the price of the stocks and securities are the fundamental functions of the stock exchange; to ensure free competition on the open market, providing a fair price is mandatory as it reflects the actual worth of the securities traded.
  14. Evaluation of securities: An important stock exchange function is to ensure fair price dealing by evaluating the traded securities; through a fair scrutinization and assessment of the intrinsic value (asset value of the company) of the company and the past trends and market position, it has to ensure a proper trading floor for the investors
  15. Speculation: The stock market should provide healthy speculation through technical and scientific knowledge to encourage the investors to invest more and yield more profits; belief plays a dominant role in the functioning of the stock exchange. It forms the base of investments and tradings
  16. Industrial development: It performs an ideal objective of boosting the economy through supporting industrial development. Mobilizing the capital into the economy boosts the expansion and diversification of industries.
  17. Financing government: It also has an essential function of assisting the government at the time of financial crisis by dealing with government stocks and securities 
  18. Seasoning of securities: Stock market as a vital function of managing the stocks and securities through a seasoned floor of market players; such as brokers, dealers, speculators, market educators, portfolio managers, depositaries etc., their work is to ensure seamless functioning of the stock trading
  19. Marketing stocks: The listed stocks in the capital market are marketed by the stock exchange through a various mechanism to boost the trading of stock and generation of capital for the listed company. The marketing process involves mass media promotions, flyers, dissemination of stock data and price value.
  20. Public debt platform: The stock exchange acts as a platform for facilitating public debts; it creates schemes and policies as per the government regulations to promote socio-economic growth. Public debts refer to the servicing of capital market to the government securities, which includes banking institutions, provident funds, pension funds etc., 
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Conclusion

Stock exchange acquires an important place in the economy’s functioning. It is taught with social, political and economic benefits by acting as a barometer of the economy’s state. By the growth of companies and by the liberalization of market participation, it has grown to a peak in mobilizing various investment activities. It has developed to be a citadel of the capital market, where smaller to giant corporations are involved in trading and business. Its strategies of forming capital for business has made it an ideal meeting place for buyers and sellers with the fair and accessible competition. With all such roles played, the stock market has become an apple’s eye that is expected to perform all its functions effectively. Its effective functioning is highly responsible for the healthy primary and secondary capital market as an enormous amount of capital flow is diverted into it.

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