Functions of stock exchange

Fuctions of Stock Exchange Meaning, Advantages, Disadvantages

Table of Contents:-

Functions of Stock Exchange

The functions of the stock exchange are as follows:

Functions of stock exchange

1. Ensuring Liquidity of Capital

Stock exchanges provide a marketplace where shares and stocks can be easily converted into cash. This ensures a readily available market for buyers and sellers, allowing those needing immediate cash to sell their holdings.

2. Maintaining a Continuous Market for Securities

Stock exchanges offer a consistent market for securities. Once listed, deposits continue to be traded on the sales, irrespective of changes in ownership. This ensures a regular need for trading in securities.

3. Evaluation of Securities

Investors can assess the value of their holdings by examining the prices quoted for securities on different exchanges. Securities are quoted based on the free market’s demand and supply dynamics, allowing investors to evaluate their investments.

4. Mobilizing Surplus Savings

Stock exchanges offer a ready market for various securities, making it easy for investors to invest their savings in shares, bonds, etc. Without this facility, many individuals looking to invest their savings would lack avenues.

5. Facilitating the Raising of New Capital

Both new and existing companies require capital for their activities. Stock exchanges are crucial in helping new companies raise money for the first time, while existing companies can increase their wealth for expansion and diversification.

6. Ensuring Safety in Dealings

Transactions on stock exchanges are governed by well-defined rules and regulations outlined in the Securities Contract (Regulation) Act, 1956. This ensures that transactions are not manipulated and every contract follows the prescribed procedure, instilling confidence in the contracting parties.

7. Listing of Securities

Only listed securities are available on stock exchanges. Companies seeking to list their securities must apply to the exchange authorities, and listing is granted only after a thorough examination of the company’s capital structure, management, and prospects.

8. Platform for Public Debt

The government’s increasing role in economic development requires substantial funds. Stock exchanges provide a platform for raising public debts and serve as organized markets for government securities traded through brokers.

9. Clearing House of Business Information

Companies listing securities with exchanges must provide financial statements, annual reports, and other reports, ensuring maximum publicity of corporate operations. The economic and other information provided at stock exchanges aids companies in decision making regarding their policies.

Advantages of Stock Exchange

The advantages of a stock exchange are as follows:

1. Providing a Continuous Market

This is the most essential function of an organized security exchange. A continuous market ensures a series of continuous security prices. Price changes resulting from trades tend to be smaller than in the absence of organized markets because of the relatively large sales volume in each security, quick execution of trading orders, and a narrow range between the asked and offered prices. The result is a reduction in price volatility.

2. Establishing and Publicizing Fair Security Prices

An organized exchange allows security prices to be determined by competitive forces rather than negotiations off the exchange floor, where bargaining advantages might come into play.

3. Economies of Scale

One of the advantages of a stock exchange is that it enjoys economies of scale due to the significant amount of money flowing through it. This helps keep costs low, making buying and selling stocks less expensive. A stock exchange can leverage millions of transactions to spread the fixed costs of setting up and maintaining orderly and secure trading, whether conducted electronically or on the exchange floor. The larger the stock exchange, the more cost-effective it becomes to trade individual stocks.

4. Investor Protection

Stock exchanges require listed companies to adhere to strict regulatory requirements regarding financial reporting, corporate governance, and disclosure. In the U.S., the regulatory agency is the Securities and Exchange Commission. Investors gain access to all relevant information about the listed companies, enabling them to make informed decisions about whether to buy or sell shares.

5. Secure Clearing

A stock exchange provides a safe and reliable clearing mechanism.

Disadvantages of Stock Exchange

The disadvantages of the stock exchange are as follows:

1. Rampant Speculation

Indian stock exchanges have witnessed periods of unprecedented booms and crashes. While the economy has been experiencing a generally 4-5% growth rate, share prices have exhibited high volatility, indicating rampant speculative activities. This needs to reflect a very healthy state of affairs.

2. Insider Trading

Unlike speculation, insider trading is widespread in Indian stock exchanges. Insider trading involves operating on price-sensitive information that is not available to the public. It constitutes trading from a position of privilege about price-sensitive information.

3. Oligopolistic Structure

The Indian stock market cannot be considered competitive. It is highly dominated by large financial and institutional brokers and operators, thus exhibiting an oligopolistic structure.

4. Limited Forward Trading

Three types of transactions can be undertaken at stock exchanges: spot delivery, hand delivery, and forward delivery. However, trading in shares for clearing or forward trading was banned in India in 1969, adversely affecting share prices.

5. Outdated Share Trading System

The share trading system followed in Indian stock exchanges is outdated and inefficient compared to international standards. Major problem areas include settlement periods, margin systems, and the carry-forward (badly) system.

6. Lack of a Single Market

Due to the inability of various stock exchanges to function cohesively, the growth in business in any one trade or region has yet to be transmitted to other sales. The disjointed inter-market operations have increased costs and risks for investors in smaller towns.

7. Problem of Interface between the Primary and Secondary Markets

The recent upsurge of the primary market has created severe problems in interfacing with the secondary market, i.e., the stock exchanges. The stock exchanges still, by and large, continue with the same old infrastructure and ways of functioning that suited the narrow base of the capital market in the past but are now out of tune with the fast-paced market and the desired work tempo.

8. Inadequacy of Investor Service

It is commonly felt that exchanges, particularly the smaller ones, have been unable to service their investors adequately. They have made only a limited contribution to the spread of the equity cult in their region.

Meaning of Stock Exchange

The stock exchange, also known as the secondary market, is a crucial component of the capital market. It serves as an organized marketplace for the buying and selling industrial and financial securities. This venue provides a convenient space where trading in securities occurs systematically, following specific rules and regulations.

In the primary market, securities or financial instruments are initially issued, and investors acquire these directly from issuers. This can include corporations issuing shares through an initial public offering (IPO), private placement, or direct acquisition from the government, as in the case of treasuries. Subsequently, after the initial issuance, investors can purchase these securities from other investors in the secondary market.

Definition of Stock Exchange

According to Pyle, “Security exchanges are market places where securities that have been listed thereon may be bought and sold for either investment or speculation”. Stock exchanges facilitate trading in securities for both genuine investors and speculators.

According to Securities Contract (Regulation) Act, 1956, “Stock exchange means anybody or individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling in securities”.

According to Husband and Dockeray, “Securities or stock exchanges are privately organized markets which are used to facilitate trading in securities”. As per this definition, the stock exchanges are the organized places where securities are purchased and sold.

Difference between Primary Market and Stock Exchange

Following are the differences between primary market and stock exchange:

Basis of DifferencePrimary MarketStock Exchange
IssuesThe primary market deals exclusively with new or fresh issues. Issues are considered new or fresh when introduced by an existing company or a new one.Deals in existing securities.
LocationNo fixed geographical location is required.Requires a fixed location for trading securities.
Transfer of SecuritiesSecurities are created and transferred from corporate to investors for the first time.Securities are transferred from one investor to another through the stock exchange mechanism
EntryAll companies can enter the NIM and make fresh securities issues.Listing is mandatory for securities to enter the portals of stock exchanges for trading.
AdministrationLacks a tangible administrative setup.It has a well-defined administrative setup that facilitates trading in securities.
RegulationSubject to regulations, primarily from external entities such as SEBI, stock exchanges, the Companies Act, etc.Subject to regulations from both within and outside the stock exchange framework.
AimCreating long-term instruments for borrowing.Providing liquidity through marketability of those instruments.
Price MovementMovement in stock prices in the secondary market influences the pricing of new issues.Both macro and micro factors influence the movement of stock prices.
DepthDepends on number and the volume of issue.The depth depends on the activities of the primary market as it brings more corporate entities and instruments to the forefront to raise funds.
Art of good investmentThe primary market refers to the art that comes directly from the artists’ studio to the gallery and is sold by the dealer to the collector.The secondary market refers to art offered for sale by the artist, a collector, or another dealer who wishes to sell it.

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