A stock exchange is an institution which provides a platform for buying and selling of existing securities. As a market, the stock exchange facilitates the exchange of a security (shares, debentures etc.) into money and vice versa. Stock exchanges help companies raise finance, provide liquidity and safety of investment to the investors and enhance the credit worthiness of individual companies.
Meaning Of Stock Exchange
According to Securities Contracts (Regulation) Act 1956, stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying and selling or dealing in securities.
Functions Of A Stock Exchange
The efficient functioning of a stock exchange creates a conducive climate for an active and growing primary market for new issues. An active and healthy secondary market in existing securities leads to positive environment among investors. The following are some of the important functions of a stock exchange –
- Providing Liquidity and Marketability to Existing Securities
The basic function of a stock exchange is the creation of a continuous market where securities are bought and sold. It gives investors the chance to disinvest and reinvest. This provides both liquidity and easy marketability to already existing securities in the market.
- Pricing of Securities
Share prices on a stock exchange are determined by the forces of demand and supply. A stock exchange is a mechanism of constant valuation through which the prices of securities are determined. Such a valuation provides important instant information to both buyers and sellers in the market.
- Safety of Transaction
The membership of a stock exchange is well-regulated and its dealings are well-defined according to the existing legal framework. This ensures that the investing public gets a safe and fair deal on the market.
- Contributes to Economic Growth
A stock exchange is a market in which existing securities are resold or traded. Through this process of disinvestment and reinvestment savings get channelized into their most productive investment avenues. This leads to capital formation and economic growth.
- Spreading of Equity Cult
The stock exchange can play a vital role in ensuring wider share ownership by regulating new issues, better trading practices and taking effective steps in educating the public about investments.
- Providing Scope for Speculation
The stock exchange provides sufficient scope within the provisions of law for speculative activity in a restricted and controlled manner. It is generally accepted that a certain degree of healthy speculation is necessary to ensure liquidity and price continuity in the stock market.
History Of The Stock Market In India
The history of the stock market in India goes back to the end of the eighteenth century when long-term negotiable securities were first issued. In 1850 the companies Act was introduced for the first time bringing with it the feature of limited liability and generating investor interest in corporate securities.
The first stock exchange in India was set-up in 1875 as The Native Share and Stock Brokers Association in Bombay. Today it is known as the Bombay Stock Exchange (BSE).
This was followed by the development of exchanges in Ahmedabad (1894), Calcutta(1908) and Madras(1937). It is interesting to note that stock exchanges were first set up in major centres of trade and commerce.
Until the early 1990s, the Indian secondary market comprised regional stock exchanges with BSE heading the list. After the reforms of 1991, the Indian secondary market acquired a three-tier form. This consists of –
Trading Procedure On A Stock Exchange
Till a few years ago trading on a stock exchange took place through a public outcry or auction system. This has been replaced by an online screen based electronic trading system as almost all exchanges have become electronic.
Trading has, therefore, shifted from the stock market floor to the brokers’ office where trades are executed through a computer. Brokers are members of a stock exchange through whom trading of securities is done.
Brokers may be individuals, partnership firms or corporate bodies. They are the intermediaries between the buyers and sellers.
Earlier these members owned, controlled and managed the exchanges. The ownership and management of stock exchanges by brokers often led to a conflict of interest between the brokers and their clients. This led to ‘demutualisation’ of stock exchanges.
Demutualisation separates the ownership and control of stock exchanges from the trading rights of members. This reduces the conflict of interest between the exchange and the brokers and the chances of brokers using stock exchanges for personal gains.
A company’s securities can be traded on a stock exchange only if they are listed or quoted on it. Companies have to fulfil a stringent set of requirements to get their securities listed on a stock exchange. This ensures that the interest of the shareholders is adequately looked after.
Transactions on a stock exchange may be carried out on either cash basis or a carry over basis. The carry over basis is also called badla and is a unique feature of Indian stock markets, particularly the BSE.
A stock exchange year is divided into periods called ‘accounts’ which vary from a fortnight to a month. All transactions made during one account are to be settled by payment for purchases and by delivery of share certificates in the case of sales on notified days of the clearing programme of a given stock exchange.
A share certificate is proof of ownership of securities by an individual. Purchase and sale transactions in securities involved the exchange of money in return for the share certificate. This led to problems of theft, forgery, transfer delays and time involved in paperwork. To eliminate these problems an electronic book entry form of holding and transferring securities has been introduced. This is referred to as ‘dematerialization of securities’.
Stock Market Index
A stock market index is a barometer of market behaviour.
- It measures overall market sentiment through a set of stocks that are representative of the market.
- It reflects market direction and indicates day-to-day fluctuations in stock prices.
- An ideal index must represent changes in the prices of securities and reflect price movements of typical shares for better market representation.
- In the Indian markets the BSE, SENSEX and NSE, NIFTY are important indices.
Some important global stock market indices are –
- Dow Jones Industrial Average is among the oldest quoted stock market index in the US.
- NASDAQ Composite Index is the market capitalisation weightage of prices for stocks listed in the NASDAQ stock market.
- S and P 500 Index is made up of 500 biggest publicly traded companies in the US. The S and P 500 is often treated as a proxy for the US stock market.
- FTSE 100 consists of the largest 100 companies by full market value listed on the London Stock Exchange. The FTSE 100 is the benchmark index of the European market.
SENSEX — The Bombay Stock Exchange Sensitive Index
The SENSEX is the benchmark index of the BSE. Since the BSE has been the leading exchange of the Indian secondary market, the SENSEX has been an important indicator of the Indian stock market. It is the most frequently used indicator while reporting on the state of the market. An index has just one job: to capture the price movement. So a stock index will reflect the price movements of shares while a bond index captures the manner in which bond prices go up or down. If the SENSEX rises, it indicates the market is doing well. Since stocks are supposed to reflect what companies expect to earn in the future, a rising index indicates that investors expect better earnings from companies. It is also a measure of the state of the Indian economy. If Indian companies are expected to do well, obviously the economy should do well too.
The SENSEX, launched in 1986 is made up of 30 of the most actively traded stocks in the market. In fact, they account for half the BSE’s market capitalisation. They represent 13 sectors of the economy and are leaders in their respective industries.
Some Common Stock Market Terms
- BOURSES is another word for the stock market.
- BULLS and BEARS – The term does not refer to animals but to market sentiment of the investors.
- A Bullish phase refers to a period of optimism and
- A Bearish phase to a period of pessimism on the Bourses.
- BADLA – This refers to a carry forward system of settlement, particularly at the BSE. It is a facility that allows the postponement of the delivery or payment of a transaction from one settlement period to another.
- ODD LOT TRADING – Trading in multiples of 100 stocks or less.
- PENNY STOCKS – These are securities that have no value on the stock exchange but whose trading contributes to speculation.
Bibliography : NCERT – Business Studies