As per Securities Contract Act, 1956 a stock exchange is an “association, organisation or body of individuals whether incorporated or not, established for the purpose of assisting, regulating and controlling the business in buying, selling and dealing in securities. Therefore stock exchange is a place where securities issued by companies are listed and traded.
The leading stock exchanges in the world are:-
New York stock exchange:
- Established in 1792 is the world’s foremost stock exchange.
- Open bid and offers are managed on the trading floor is managed by exchange members
- It is the largest exchange in the world by market capitalization
- Established in 1971 is known for its in-depth and advanced technology;
- Lists more than 4000 securities.
- It is the second-largest exchange in the world by market capitalization.
London Stock Exchange:
- Established in 1801;
- The London Stock Exchange is Europe’s leading stock exchange and is owned by the London Stock Exchange Group plc.
Bombay Stock exchange
- Established in 1875 and is the oldest stock exchange in Asia.
- The index is widely popular as SENSEX is important index in the development of Indian capital market.
- It is the third largest in the world and largest in Asia.
- Founded in the year 2013.
Shanghai Stock Exchange
- Founded in 1990.
- Fifth largest in the world but still not entirely open to foreign investors due to restrictions imposed by Chinese authorities
How the value of an index is determined?
Market capitalization (market cap) is the total market value of the shares outstanding of a publicly traded company; in other words,
Market cap = Number of shares outstanding * Market Value of a share
Index Value = Index value of previous day * Market capitalisation of current day/Market of next day capitalisation of previous day
So the total value of market capitalisation is computed by adding up the total value market cap of the traded shares in the particular index.
Index value can be computed based on price weighted method also instead of market cap weigh method. However, most indexes use the market capitalisation method for computation of index value.
In order to understand the working of stock exchanges we need to understand various participants in the capital markets
- Investor: – For any capital market to be successful it should be able to attract the funds from investors. They are the lifeline of any capital markets. A market is termed as bullish when the investor sentiments are positive i.e, when there is sufficient fund inflow into the market.
- Stock Exchange: – Stock Exchange is the place where buying and selling of securities happens. It helps in raising funds for the businesses and maximising shareholders wealth. The performance of stock exchange reflects the state of a country’s economy.
- Clearing House: – Clearing house is an exchange associated body which provide various services such as clearance and settlement of trades, guarantee of contracts, and management of the risk of its members.
- Depositories: – Depositories are organisations which hold securities of an investor in electronic form. In India, normally the T+ 2 day is the settlement date i.e. 2 days from the transaction or purchase date. So after 2 days from the purchase date the securities will be held with the depository which charges a minimal fee for its services.
How does a stock exchange function (a step by step analysis)?
- Client has to open an account with a member of a stock exchange. They charge brokerage for their services.
- Client needs to infuse funds into the demat linked account to invest or trade in securities.
- Once the fund is added, the client can start buying and selling in securities.
A clearing house acts a medium of transaction between a buyer and a seller. The clearing house becomes the buyer for all the sellers and seller for all the buyers. So a share can be bought and sold at any point of time. So margins are levied for all transactions depending upon the type of instrument in order to reduce the risk of the clearing house.
- The value of a share fluctuates depends upon its demand on a particular day in the market. Investors tend to invest in a share depending on its growth prospects and dividend policy.
- The client can deal in securities on intraday basis (buying and selling in the same day) or can be held on short term or long term basis.