Stock exchange

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The New York Stock Exchange on Wall Street in New York City, the world's largest stock exchange per total market capitalization of its listed companies.[1]

A stock exchange is a form of exchange which provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends. Securities traded on a stock exchange include stock issued by companies, unit trusts, derivatives, pooled investment products and bonds. Stock exchanges often function as "continuous auction" markets, with buyers and sellers consummating transactions at a central location, such as the floor of the exchange.[2]

To be able to trade a security on a certain stock exchange, it must be listed there. Usually, there is a central location at least for record keeping, but trade is increasingly less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of increased speed and reduced cost of transactions. Trade on an exchange is by members only.

The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets are driven by various factors that, as in all free markets, affect the price of stocks (see stock valuation).

There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

In recent years, various other trading venues, such as electronic communications networks, alternative trading systems and "dark pools" have taken much of the trading activity away from traditional stock exchanges.[3]

History[edit]

Among many other things, the Code of Hammurabi recorded interest-bearing loans.

The idea of debt dates back to the ancient world, as evidenced for example by ancient Mesopotamian clay tablets recording interest-bearing loans. There is little consensus among scholars as to when corporate stock was first traded. Some see the key event as the Dutch East India Company's founding in 1602, while others point to earlier developments. Economist Ulrike Malmendier of the University of California at Berkeley argues that a share market existed as far back as ancient Rome.

In the Roman Republic, which existed for centuries before the Empire was founded, there were societates publicanorum, organizations of contractors or leaseholders who performed temple-building and other services for the government. One such service was the feeding of geese on the Capitoline Hill as a reward to the birds after their honking warned of a Gallic invasion in 390 B.C. Participants in such organizations had partes or shares, a concept mentioned various times by the statesman and orator Cicero. In one speech, Cicero mentions "shares that had a very high price at the time." Such evidence, in Malmendier's view, suggests the instruments were tradable, with fluctuating values based on an organization's success. The societas declined into obscurity in the time of the emperors, as most of their services were taken over by direct agents of the state.

Tradable bonds as a commonly used type of security were a more recent innovation, spearheaded by the Italian city-states of the late medieval and early Renaissance periods.

In 1171, the authorities of the Republic of Venice, concerned about their war-depleted treasury, drew a forced loan from the citizenry. Such debt, known as prestiti, paid 5 percent interest per year and had an indefinite maturity date. Initially regarded with suspicion, it came to be seen as a valuable investment that could be bought and sold. The bond market had begun.

From 1262 to 1379, Venice never missed an interest payment, solidifying the credibility of the new instruments. Other Italian city-states such as Florence and Genoa became bond issuers as well, often as a means of paying for warfare. Bonds were traded widely in Italy and beyond, a business facilitated by bankers such as the Medicis.

War between Venice and Genoa resulted in suspension of prestiti interest payments in the early 1380s, and when the market was restored, it was at a lower interest rate. Venice's bonds traded at steep discounts for decades thereafter. Other blows to financial stability resulted from the Hundred Years War, which caused monarchs of France and England to default on debts to Italian banks, and the Black Death, which ravaged much of Europe. Still, the idea of debt as a tradable investment endured.

As with bonds, the concept of stock developed gradually. Some scholars place its origins as far back as ancient Rome. Partnership agreements dividing ownership into shares date back at least to the 13th century, again with Italian city-states in the vanguard. Such arrangements, however, typically extended only to a handful of people and were of limited duration, as with shipping partnerships that applied only to a single sea voyage.

House Ter Beurze in Bruges, Belgium.

The forefront of commercial innovation eventually shifted from Italy to northern Europe. The Hanseatic League, an alliance of mercantile cities such as Bruges and Antwerp, operated counting houses to expedite trade.

By the late 1500s, English merchants were experimenting with joint-stock companies intended to operate on an ongoing basis; one such was the Muscovy Company, which sought to wrest trade with Russia away from Hanseatic dominance.

The next big step occurred in the Netherlands. In 1602, the Dutch East India Company was formed as a joint-stock company based in six locations with shares that were readily tradable. The stock market had begun, but since stocks were not allowed to be traded with multiple addresses for a company, the stocks were redesignated as coming just from Amsterdam.

A bond issued by the Dutch East India Company, dating from 7 November 1623, for the amount of 2,400 florins.

The Dutch East India Company, formed to build up the spice trade, operated as a colonial ruler in what's now Indonesia and beyond, a purview that included conducting military operations against wishes of the exploited natives and competing colonial powers. Control of the company was held tightly by its directors, with ordinary shareholders not having much influence on management or even access to the company's accounting statements.

However, shareholders were rewarded well for their investment. The company paid an average dividend of over 16 percent per year from 1602 to 1650. Financial innovation in Amsterdam took many forms. In 1609, investors led by one Isaac Le Maire formed history's first bear syndicate, but their coordinated trading had only a modest impact in driving down share prices, which tended to be robust throughout the 17th century. By the 1620s, the company was expanding its securities issuance with the first use of corporate bonds.

The Dutch West India Company was formed in 1621, bringing a new issuer to the burgeoning securities market. Amsterdam's growth as a financial center survived the tulip mania of the 1630s, in which contracts for the delivery of flower bulbs soared wildly and then crashed. New techniques and instruments proliferated for securities as well as commodities, including options, repos and margin trading.[4]

Joseph de la Vega, also known as Joseph Penso de la Vega and by other variations of his name, was an Amsterdam trader from a Spanish Jewish family and a prolific writer as well as a successful businessman in 17th-century Amsterdam. His 1688 book Confusion of Confusions explained the workings of the city's stock market. It was the earliest book about stock trading, taking the form of a dialogue between a merchant, a shareholder and a philosopher, the book described a market that was sophisticated but also prone to excesses, and de la Vega offered advice to his readers on such topics as the unpredictability of market shifts and the importance of patience in investment.

The year that de la Vega published also brought an event that helped spread financial techniques and talent from Amsterdam to London. This was the "glorious revolution," in which Dutch ruler William of Orange also ascended to England's throne. William sought to modernize England's finances to pay for its wars, and thus the kingdom's first government bonds were issued in 1693 and the Bank of England was set up the following year. Soon thereafter, English joint-stock companies began going public.

London's first stockbrokers, however, were barred from the old commercial center known as the Royal Exchange, reportedly because of their rude manners. Instead, the new trade was conducted from coffee houses along Exchange Alley. By 1698, a broker named John Castaing, operating out of Jonathan's Coffee House, was posting regular lists of stock and commodity prices. Those lists mark the beginning of the London Stock Exchange.

One of history's greatest financial bubbles occurred in the next few decades. At the center of it were the South Sea Company, set up in 1711 to conduct English trade with South America, and the Mississippi Company, focused on commerce with France's Louisiana colony and touted by transplanted Scottish financier John Law, who was acting in effect as France's central banker. Investors snapped up shares in both, and whatever else was available. In 1720, at the height of the mania, there was even an offering of "a company for carrying out an undertaking of great advantage, but nobody to know what it is."

By the end of that same year, share prices were collapsing, as it became clear that expectations of imminent wealth from the Americas were overblown. In London, Parliament passed the Bubble Act, which stated that only royally chartered companies could issue public shares. In Paris, Law was stripped of office and fled the country. Stock trading was more limited and subdued in subsequent decades. Yet the market survived, and by the 1790s shares were being traded in the young United States.

Role of stock exchanges[edit]

a floor

Stock exchanges have multiple roles in the economy. This may include the following:[5]

Raising capital for businesses[edit]

A stock exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public.[6]

Common forms of capital raising[edit]

Besides the borrowing capacity provided to an individual or firm by the banking system, in the form of credit or a loan, there are four common forms of capital raising used by companies and entrepreneurs. Most of these available options might be achieved, directly or indirectly, through a stock exchange.

Going public[edit]

Capital intensive companies, particularly high tech companies, always need to raise high volumes of capital in their early stages. For this reason, the public market provided by the stock exchanges has been one of the most important funding sources for many capital intensive startups. After the 1990s and early-2000s hi-tech listed companies' boom and bust in the world's major stock exchanges, it has been much more demanding for the high-tech entrepreneur to take his/her company public, unless either the company already has products in the market and is generating sales and earnings, or the company has completed advanced promising clinical trials, earned potentially profitable patents or conducted market research which demonstrated very positive outcomes. This is quite different from the situation of the 1990s to early-2000s period, when a number of companies (particularly Internet boom and biotechnology companies) went public in the most prominent stock exchanges around the world, in the total absence of sales, earnings and any well-documented promising outcome. Anyway, every year a number of companies, including unknown highly speculative and financially unpredictable hi-tech startups, are listed for the first time in all the major stock exchanges – there are even specialized entry markets for these kind of companies or stock indexes tracking their performance (examples include the Alternext, CAC Small, SDAX, TecDAX, or most of the third market companies).

Limited partnerships[edit]

A number of companies have also raised significant amounts of capital through R&D limited partnerships. Tax law changes that were enacted in 1987 in the United States changed the tax deductibility of investments in R&D limited partnerships. In order for a partnership to be of interest to investors today, the cash on cash return must be high enough to entice investors. As a result, R&D limited partnerships are not a viable means of raising money for most companies, specially hi-tech startups.

Venture capital[edit]

A third usual source of capital for startup companies has been venture capital. This source remains largely available today, but the maximum statistical amount that the venture company firms in aggregate will invest in any one company is not limitless (it was approximately $15 million in 2001 for a biotechnology company).[7] At those level, venture capital firms typically become tapped-out because the financial risk to any one partnership becomes too great.

Corporate partners[edit]

A fourth alternative source of cash for a private company is a corporate partner, usually an established multinational company, which provides capital for the smaller company in return for marketing rights, patent rights, or equity. Corporate partnerships have been used successfully in a large number of cases.

Mobilizing savings for investment[edit]

When people draw their savings and invest in shares (through an IPO or the issuance of new company shares of an already listed company), it usually leads to rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to help companies' management boards finance their organizations. This may promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels of firms. Sometimes it is very difficult for the stock investor to determine whether or not the allocation of those funds is in good faith and will be able to generate long-term company growth, without examination of a company's internal auditing.

Facilitating company growth[edit]

Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase their market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.

Profit sharing[edit]

Both casual and professional stock investors, as large as institutional investors or as small as an ordinary middle-class family, through dividends and stock price increases that may result in capital gains, share in the wealth of profitable businesses. Unprofitable and troubled businesses may result in capital losses for shareholders.

Corporate governance[edit]

By having a wide and varied scope of owners, companies generally tend to improve management standards and efficiency to satisfy the demands of these shareholders, and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors).

Despite this claim, some well-documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some public companies. The dot-com bubble in the late 1990s, and the subprime mortgage crisis in 2007–08, are classical examples of corporate mismanagement. Companies like Pets.com (2000), Enron Corporation (2001), One.Tel (2001), Sunbeam (2001), Webvan (2001), Adelphia (2002), MCI WorldCom (2002), Parmalat (2003), American International Group (2008), Bear Stearns (2008), Lehman Brothers (2008), General Motors (2009) and Satyam Computer Services (2009) were among the most widely scrutinized by the media.

However, when poor financial, ethical or managerial records are known by the stock investors, the stock and the company tend to lose value. In the stock exchanges, shareholders of underperforming firms are often penalized by significant share price decline, and they tend as well to dismiss incompetent management teams.

Creating investment opportunities for small investors[edit]

As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.

Government capital-raising for development projects[edit]

Governments at various levels may decide to borrow money to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need, in the short term, to directly tax citizens to finance development—though by securing such bonds with the full faith and credit of the government instead of with collateral, the government must eventually tax citizens or otherwise raise additional funds to make any regular coupon payments and refund the principal when the bonds mature.

Barometer of the economy[edit]

At the stock exchange, share prices rise and fall depending, largely, on economics forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.

Major stock exchanges[edit]

Major stock exchanges (top 21 by market capitalization), as at 31 May 2014 (Monthly reports, World Federation of Exchanges)

Rank Exchange Economy Head­quarters Market cap
(USD bn)
Trade volume
(USD bn)
Time zone Δ DST Open
(local)
Close
(local)
Lunch
(local)
Open
(UTC)
Close
(UTC)
1 New York Stock Exchange  United States New York 18,917 12,693 EST/EDT −5 Mar–Nov 09:30 16:00 No 14:30 21:00
2 NASDAQ  United States New York 6,456 8,914 EST/EDT −5 Mar–Nov 09:30 16:00 No 14:30 21:00
3 Tokyo Stock Exchange  Japan Tokyo 4,373 2,866 JST +9 09:00 15:00 11:30–12:30 00:00 06:00
5 London Stock Exchange Group  United Kingdom
 Italy
London 3,396 1,890 GMT/BST +0 Mar–Oct 08:00 16:30 No 08:00 16:30
4 Euronext  France
 Netherlands
 Belgium
 Portugal
Amsterdam 3,802 1,900 CET/CEST +1 Mar–Oct 09:00 17:30 No 08:00 16:30
6 Hong Kong Stock Exchange  Hong Kong Hong Kong 3,046 913 HKT +8 09:15 16:00 12:00–13:00 01:15 08:00
7 Shanghai Stock Exchange  China Shanghai 2,379 2,176 CST +8 09:30 15:00 11:30–13:00 01:30 07:00
8 Toronto Stock Exchange  Canada Toronto 2,218 1,121 EST/EDT −5 Mar–Nov 09:30 16:00 No 14:30 21:00
9 Frankfurt Stock Exchange  Germany Frankfurt 1,985 1,101 CET/CEST +1 Mar–Oct 08:00 (Eurex)
8:00 (floor)
9:00 (Xetra)
22:00 (Eurex)
20:00 (floor)
17:30 (Xetra)
No 07:00 21:00
11 Australian Securities Exchange  Australia Sydney 1,465 800 AEST/AEDT +10 Oct–Apr 09:50 16:12 No 23:50 06:12
13 Bombay Stock Exchange  India Mumbai 1,399 93 IST +5.5 09:15 15:30 No 03:45 10:00
14 National Stock Exchange of India  India Mumbai 1,396 442 IST +5.5 09:15 15:30 No 03:45 10:00
10 SIX Swiss Exchange   Switzerland Zurich 1,630 502 CET/CEST +1 Mar–Oct 09:00 17:30 No 08:00 16:30
17 BM&F Bovespa  Brazil São Paulo 1,047 751 BRT/BRST −3 Oct–Feb 10:00 17:30 No 13:00 20:00
15 Korea Exchange  South Korea Seoul 1,296 1,297 KST +9 09:00 15:00 No 00:00 06:00
12 Shenzhen Stock Exchange  China Shenzhen 1,457 2,007 CST +8 09:30 15:00 11:30–13:00 01:30 07:00
16 BME Spanish Exchanges  Spain Madrid 1,195 731 CET/CEST +1 Mar–Oct 09:00 17:30 No 08:00 16:30
18 JSE Limited  South Africa Johannesburg 1,007 287 CAT +2 09:00 17:00 No 07:00 15:00
21 Moscow Exchange  Russia Moscow 693 300 MSK +4 10:00 18:45 No 06:00 14:45
20 Singapore Exchange  Singapore Singapore 807 215 SST +8 09:00 17:00 No 01:00 09:00
19 Taiwan Stock Exchange  Taiwan Taipei 865 572 CST +8 09:00 13:30 No 01:00 05:30

Listing requirements[edit]

Listing requirements are the set of conditions imposed by a given stock exchange upon companies that want to be listed on that exchange. Such conditions sometimes include minimum number of shares outstanding, minimum market capitalization, and minimum annual income.

Requirements by stock exchange[edit]

Companies must meet an exchange's requirements to have their stocks and shares listed and traded there, but requirements vary by stock exchange:

  • New York Stock Exchange: To be listed on the New York Stock Exchange (NYSE) a company must have issued at least a million shares of stock worth $100 million and must have earned more than $10 million over the last three years.[8]
  • NASDAQ Stock Exchange: To be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years.[9]
  • London Stock Exchange: The main market of the London Stock Exchange has requirements for a minimum market capitalization (£700,000), three years of audited financial statements, minimum public float (25 per cent) and sufficient working capital for at least 12 months from the date of listing.
  • Bombay Stock Exchange: Bombay Stock Exchange (BSE) has requirements for a minimum market capitalization of INR250 million (US$4.2 million) and minimum public float equivalent to INR100 million (US$1.7 million).[10]

Ownership[edit]

Stock exchanges originated as mutual organizations, owned by its member stock brokers. There has been a recent trend for stock exchanges to demutualize, where the members sell their shares in an initial public offering. In this way the mutual organization becomes a corporation, with shares that are listed on a stock exchange. Examples are Australian Securities Exchange (1998), Euronext (merged with New York Stock Exchange), NASDAQ (2002), Bursa Malaysia (2004), the New York Stock Exchange (2005), Bolsas y Mercados Españoles, and the São Paulo Stock Exchange (2007). The Shenzhen and Shanghai stock exchanges can been characterized as quasi-state institutions insofar as they were created by government bodies in China and their leading personnel are directly appointed by the China Securities Regulatory Commission. Another example is Tashkent republican stock exchange (Uzbekistan) established in 1994, three years after collapse of Soviet Union, mainly owned by state but has a form of a public corporation (joint stock company). According to an Uzbek government decision (March 2012) 25 percent minus one share of Tashkent stock exchange is expected to be sold to Korea Exchange(KRX)in 2014.<www.uzse.uz>

Other types of exchanges[edit]

In the 19th century, exchanges were opened to trade forward contracts on commodities. Exchange traded forward contracts are called futures contracts. These commodity exchanges later started offering future contracts on other products, such as interest rates and shares, as well as options contracts. They are now generally known as futures exchanges.

See also[edit]

Lists:

References[edit]

  1. ^ "Market highlights for first half-year 2010". World Federation of Exchanges. Retrieved June 1, 2013. 
  2. ^ Lemke and Lins, Soft Dollars and Other Trading Activities, §2:3 (Thomson West, 2013-2014 ed.).
  3. ^ Lemke and Lins, Soft Dollars and Other Trading Activities, §§2:25 - 2:30 (Thomson West, 2013-2014 ed.).
  4. ^ "PhD thesis – The world's first stock exchange". Retrieved 1 October 2011. 
  5. ^ Diamond, Peter A. (1967). "The Role of a Stock Market in a General Equilibrium Model with Technological Uncertainty". American Economic Review 57 (4): 759–776. JSTOR 1815367. 
  6. ^ Gilson, Ronald J.; Black, Bernard S. (1998). "Venture Capital and the Structure of Capital Markets: Banks Versus Stock Markets". Journal of Financial Economics 47: 243–277. doi:10.2139/ssrn.46909. 
  7. ^ STRATEGIC IMPLICATIONS OF ALTERNATIVE SOURCES OF CAPITAL FOR PRIVATE BIOTECHNOLOGY COMPANIE
  8. ^ http://www.nyse.com/Frameset.html?displayPage=/listed/1022540125610.html
  9. ^ NASDAQ Corporate -NASDAQ Listing Information
  10. ^ About Us

External links[edit]