The issue of what is a stock exchange and how to figure out its specific features has long been haunting the minds of eager future investors who want to invest in really worthwhile things. The article will help you understand the main nuances, explain the functions of stock exchanges and how they function. The most striking examples will be listed here, too!
Stocks were first traded in Amsterdam in the 17th century, with the Dutch East India Company being the first publicly traded company. The first stock exchange was established in Amsterdam in 1611. Let’s start with the stock exchange definition. In simple words, it is a special market where the participants in financial processes can purchase or sell various securities, including bonds, shares of EFT exchange-traded funds, and so on. The market itself is an instrument in the act of trading. The most common types of stock exchange include e-trading, auctions, over-the-counter (OTC), and electronic communication networks markets.
How does it work?
First and foremost, the role of the stock exchange is to bring corporations and government together with the investor. Furthermore, it guarantees liquidity — the number of sellers and buyers at a well-established exchange is sufficient for a fast and uninterrupted flow of offers and transactions.
Once a company has completed its initial public offering, it becomes available on the stock exchange in the primary market. After public shareholders purchase securities, they can offer them on the secondary market. It is important that the exchange monitors the flow of orders for each type of stock, as well as the supply and demand, and the optimal prices are thus determined by the market, i.e., by the balance between supply and demand.
How can it affect economic processes?
As we have already pointed out, the main stock exchange meaning and purpose lies in the development of the economy. Let’s break down the three main ways in which it usually contributes:
- Substantial capital raising: any firm that undertakes an initial public offering or regularly issues new shares can raise funds for expansion projects or to finance certain operations.
- Better corporate financial management: companies that present their shares on the biggest stock exchanges in the world are required to follow specific standards (set by financial reporting regulators). All this reduces the risks of fraud and money laundering, because company managers and the cash pool are under constant public control. The more honest and transparent all the processes are, the higher the share price.
- Improving economic efficiency: instead of people just putting their savings in a piggy bank, they have the opportunity to invest it (= fuel economic processes), and then receive additional income.
In addition, another crucial function of stock exchange is maintaining liquidity. After analyzing the information provided, it allows investors to determine the most appropriate value, taking into account supply and demand in a particular period of time.
The brightest examples
The very first exchange that has survived to this day and continues to operate actively is the NYSE, founded in 1792. The decision to create it was made by 24 brokers and traders.
Nevertheless, besides the NYSE (New York Stock Exchange), there are numerous other biggest stock markets in the world. For instance:
- LSE — London Stock Exchange (established in 1801, United Kingdom) with a market capitalization of £2.66 billion;
- Nasdaq (established in 1971, United States of America) with a market capitalization of $10.93 trillion;
- SSE — Shanghai Stock Exchange (established in 1990, China) with a market capitalization of $5.01 trillion.
The above-mentioned major exchanges only list shares of companies that publish their financial statements quarterly or yearly and meet special pre-tax income and publicly held shares requirements. Firms that have been found to be in serious legal violations or have reported incorrect financial data in the last 3-5 years (depending on the requirements of a specific exchange) are not eligible to apply for listing their shares.
To crown it all, a stock exchange is a special market for selling & purchasing financial instruments. As a rule, the whole trading procedure of the stock exchange begins with the purchase of shares in the primary market and continues with their sale in the secondary market. Only those companies that strictly follow the requirements and conduct their business honestly are allowed to present their securities, and the transparency of financial transactions affects the value of shares.