Functions of stock exchange
Stock exchanges play a pivotal role in the economic landscape, serving as:
- Economic indicators: They reflect the overall health of an economy, tracking fluctuations in share prices.
- Security valuation: They facilitate the valuation of securities based on market supply and demand, aiding investors, creditors, and governments.
- Transactional safety: They ensure secure transactions by listing securities only after rigorous verification of companies' financial health and adherence to regulatory standards.
- Economic growth catalysts: They provide a platform for capital formation through continuous disinvestment and reinvestment, fostering economic growth.
- Public awareness and education: They disseminate information about equity investments and encourage participation through new issue offerings.
- Market liquidity: They ensure a vibrant market for buying and selling securities, offering investors confidence in the liquidity of their investments.
- Efficient capital allocation: They enable profitable companies to raise capital, promoting efficient allocation of resources.
- Investment and savings incentives: They offer attractive investment options with potential for higher returns compared to traditional assets like gold and silver.
Benefits of listing with a stock exchange
Listing on a stock exchange offers several key advantages for companies, investors, and the public. Here’s a breakdown of its benefits:
Increased value
Listing enhances a company’s credibility and perceived value. It provides a platform for the company to expand its shareholder base, fostering a positive reputation and potentially increasing its market worth.
Access to capital
Companies listed on a stock exchange can access capital more readily by issuing shares. This avenue often proves more cost-effective, allowing companies to sustain operations and fuel growth through funds raised from the public.
Collateral value
Listed securities are widely accepted as collateral by lenders. This increases a company’s ability to secure credit quickly and efficiently, as listed entities are generally viewed as more trustworthy.
Liquidity
Listing improves liquidity, enabling shareholders to buy or sell shares easily. It offers shareholders marketability, allowing them to track their investments’ value and to capitalise on value appreciation.
Fair price
Listed securities reflect fair market prices, influenced by supply and demand and disclosed transparently. This ensures investors can trade at rates aligned with the true market value, enhancing trust in the investment process.
Purpose of stock exchanges
The stock market is a network of exchanges and brokerage firms where people buy and sell shares of publicly traded companies. Companies issue shares to generate capital for business expansion and development. To become publicly listed, a company must register with the Securities and Exchange Commission (SEC) and consistently report its financial results to maintain transparency with investors.
- Raising capital
Companies can secure funding for growth and operations through initial public offerings (IPOs) or the issuance of new shares. This provides businesses with opportunities to finance expansion projects.
- Corporate governance
Publicly listed companies are mandated to adhere to strict reporting standards, including regular publication of financial statements. This transparency ensures that management decisions align with the interests of shareholders and supports efficient corporate governance.
- Economic efficiency
Stock exchanges promote economic efficiency by encouraging the productive use of idle capital. Investors channel funds into businesses, stimulating economic growth. Additionally, stock exchanges enhance liquidity, enabling investors to buy or sell securities with ease. By providing real-time price information, they also help establish fair market values through supply and demand dynamics.
Investment methods
As an investor, you can invest in the stock market in India in one of the following ways:
- Through the primary market: A primary market is where stocks and bonds are issued and sold for the first time. It acts as a platform where companies can create and list their initial public offerings (IPO), and retail investors can acquire the floated stocks.
- Through the secondary market: A secondary market is one where you can buy and sell securities already listed on the stock exchange. It is a trading platform where investors can trade previously issued securities among themselves without the issuing company getting involved in the trade. Depending on the type of stocks trading, secondary markets can be further subdivided into Auction and Dealer markets.
Major stock exchanges in India
Major stock exchanges in India include BSE and NSE, handling vast trading volumes.
1. Bombay Stock Exchange (BSE)
The BSE was established in 1875 and remains the oldest stock exchange in Asia. Located in Dalal Street, Mumbai, BSE is the world’s 9th largest stock exchange. In 2015, the BSE clocked a median trade speed of 6 microseconds, becoming the fastest stock exchange in the world. As of 8th May 2024, BSE’s estimated market capitalisation stands at Rs. 43,024,731.39 crore ($5.15 trillion). Over 5,000 companies are listed on the BSE. This stock exchange is known for the Sensex Index, which is a benchmark index tracking 30 of the most well-established and financially sound companies on the BSE.
2. National Stock Exchange (NSE)
Incorporated in 1992 and opened in 1994, NSE is a leading financial exchange in India with headquarters in Mumbai. It is famous for being the first Indian exchange to implement electronic or screen-based trading in the country. NSE provides a crucial platform for trading various financial instruments, including equities, derivatives, and currency futures. The estimated market capitalisation of the National Stock Exchange surpassed $4 trillion (Rs. 334.72 trillion) in January 2024. NSE also pioneered index-based trading in India with the launch of its flagship index, the NIFTY 50, which tracks 50 stocks from 13 sectors of the economy, serving as a major benchmark for the Indian equity market.
Pros and cons of stock exchanges
Stock exchanges offer growth and income opportunities but also involve market risks and volatility.
Pros of stock exchanges
- Prestige for companies
Listing on an established stock exchange, such as the NYSE or LSE, enhances a company’s credibility and prestige. It signals trustworthiness to investors.
- Fundraising opportunities
Public listing enables companies to raise significant funds by selling shares, which can then be reinvested into their growth and development.
- Regulation and security
Stock exchanges are heavily regulated, reducing the risk of counterparty default, unlike over-the-counter (OTC) trading methods.
- Accessibility for traders
The advent of online brokerage platforms has made it simpler for individual investors to access stock exchanges, participate in trades, and potentially profit from short-term market movements.
Cons of stock exchanges
While investing in the stock market can be rewarding, it also comes with certain drawbacks that investors must be aware of:
- Market volatility
Stock prices can fluctuate drastically due to economic events, global news, or company-specific developments, making it risky in the short term.
- Emotional investing
Sudden market drops can trigger panic selling, leading to losses driven by fear rather than strategy.
- Requires research and time
To make informed decisions, investors need to consistently track market trends and company performance.
- Unpredictable returns
Unlike fixed-income instruments, stock investments do not guarantee steady returns and can underperform during market downturns.
- Exposure to fraud or mismanagement
There is always a risk of investing in companies that may face internal issues or governance failures.
Conclusion
Stock exchanges play a vital role in shaping the economic development of a country by facilitating capital formation and liquidity. They help companies raise funds for expansion and growth while offering investors opportunities to grow their wealth with stocks for intraday trading and long-term trading. Stock exchanges also help serve as barometers of a country’s economic health by communicating market sentiments and trends via index movements.
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