What is Stock Exchange? Functions, Characteristics, Advantages

  • Post last modified:23/11/2021
  • Reading time:9 mins read

What is Stock Exchange?

The stock exchange is the term commonly used for a secondary market, which provides a place where different types of existing securities such as shares, debentures and bonds, government securities can be bought and sold on a regular basis.

A stock exchange is generally organized as an association, a society or a company with a limited number of members. It is open only to these members who act as brokers for the buyers and sellers.

The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‘Stock Exchange’ as anybody of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.


Functions of Stock Exchange

The functions of stock exchange can be as follow:

  1. Provides Ready and Continuous Market
  2. Provides Information About Prices and Sales
  3. Provides Safety to Dealings and Investment
  4. Evaluation of Securities
  5. Mobilizes Savings
  6. Healthy Speculation
  7. Mobility of Funds
  8. Stock Exchange Helps Capital Formation
  9. Liquidity in Stock Exchange
  10. Economic Barometer
  11. Control on Companies
  12. Attracts Foreign Capital
  13. Monetary and Fiscal Policies
  14. Proper Canalization of Capital
  15. Regulation of Company Management
  16. Barometer of Business Progress

Provides Ready and Continuous Market

By providing a place where listed securities can be bought and sold regularly and conveniently, a stock exchange ensures a ready and continuous market for various shares, debentures, bonds and government securities. This lends a high degree of liquidity to holdings in these securities as the investor can en-cash their holdings as and when they want.

Provides Information About Prices and Sales

A stock exchange maintains a complete record of all transactions taking place in different securities every day and supplies regular information on their prices and sales volumes to the press and other media. This enables the investors in taking quick decisions on the purchase and sale of securities in which they are interested.

Not only that, such information helps them in ascertaining the trend in prices and the worth of their holdings. This enables them to seek bank loans if required.

Provides Safety to Dealings and Investment

Transactions on the stock exchange are conducted only amongst its members with adequate transparency and in strict conformity to its rules and regulations which include the procedure and timings of delivery and payment to be followed.

This provides a high degree of safety to dealings at the stock exchange. There is little risk of loss on account of non-payment or non-delivery. Securities and Exchange Board of India (SEBI) also regulates the business in stock exchanges in India and the working of the stockbrokers.

Evaluation of Securities

In the stock exchange, the prices of securities clearly indicate the performance of the companies. It integrates the demand and supply of securities in an effective manner. It also clearly indicates the stability of companies. Thus, investors are in a better position to take stock of the position and invest according to their requirements.

Mobilizes Savings

The savings of the public are mobilized through mutual funds, investments trusts and various other securities. Even those who cannot afford to invest in huge amounts of securities are provided opportunities by mutual funds and investment trusts.

Healthy Speculation

The stock exchange encourages healthy speculation and provides opportunities for shrewd businessmen to speculate and reap rich profits from fluctuations in security prices. The price of security is based on supply and demand position. It creates a healthy trend in the market. Any artificial scarcity is prevented due to the rules and regulations of the market.

Mobility of Funds

The stock exchange enables both the investors and the companies to sell or buy securities and thereby enable the availability of funds. By this, the money market also is strengthened as even short-term funds are available. The banks also provide funds for dealing in the stock exchanges.

Stock Exchange Helps Capital Formation

The stock exchange plays an active role in the capital formation in the country. Companies are able to raise funds either by issuing more shares through rights shares or bonus shares. But when a company wants to go in for diversification, they can issue the shares and raise more funds. Thus, they are able to generate more capital and this promotes economic growth in the country.

Liquidity in Stock Exchange

Institutions like banks can invest their idle funds in the stock exchange and earn profit even within a short period. When the necessity arises, these securities can be immediately sold for raising funds. Thus, it is the stock exchange that provides opportunities for converting securities into cash within short notice.

Economic Barometer

The most important function of a stock exchange is that it acts as an economic indicator of conditions prevailing in the country.

A politically and economically strong government will have an upward trend in the stock market, whereas an unstable government with heavy borrowings from other countries will have a downward trend in the stock market. So, every government will adopt policies in such a manner that the stock exchange remains dynamic.

Control on Companies

One of the major functions of the stock exchange is that it has control over companies. The companies listing their securities in the stock exchange have to submit their annual report and audited balance sheets to the stock exchange. Thus, only genuine companies can function and have the shares transacted. If not, such companies will be blacklisted and they will find it difficult to raise their capital.

Attracts Foreign Capital

Due to its dynamism and higher return on capital, the stock exchange is capable of attracting more foreign funds. Due to this, the exchange rate of the currency will improve when there is more trade undertaken by the government.

Monetary and Fiscal Policies

The monetary policy and the fiscal policy of the government have to be favourable to businessmen and producers. If they are not so, then through the stock exchange the government may indicate and accordingly suitable steps can be taken.

Proper Canalization of Capital

Stock exchange directs the flow of savings into the most productive and profitable channels.

Regulation of Company Management

The companies, which want to get their securities listed in the stock exchange, should have to follow certain rules and fulfil certain conditions. Thus stock exchanges safeguard the interest of the investing public and also regulate company management.

Barometer of Business Progress

Stock exchanges function as a barometer of the business conditions in the country. Booms and depressions are reflected by the index of prices of various securities maintained by the stock exchange. By analyzing the ups and downs of the market quotations, the causes for the changes in the business climate can be ascertained.


Advantages of Stock Exchanges

The existence of stock exchange is of a vital importance and it has advantages of stock exchanges:

  1. To the Companies
  2. To the Investors
  3. To the Society

To the Companies

  • The companies whose securities have been listed on a stock exchange enjoy a better goodwill and credit-standing than other companies because they are supposed to be financially sound.

  • The market for their securities is enlarged as the investors all over the world become aware of such securities and have an opportunity to invest.

  • As a result of enhanced goodwill and higher demand, the value of their securities increases and their bargaining power in collective ventures, mergers, etc. is enhanced.

  • The companies have the convenience to decide upon the size, price and timing of the issue.

To the Investors

  • The investors enjoy the ready availability of facility and convenience of buying and selling the securities at will and at an opportune time.

  • Because of the assured safety in dealings at the stock exchange the investors are free from any anxiety about the delivery and payment problems.

  • Availability of regular information on prices of securities traded at the stock exchanges helps them in deciding on the timing of their purchase and sale.

  • It becomes easier for them to raise loans from banks against their holdings in securities traded at the stock exchange because banks prefer them as collateral on account of their liquidity and convenient valuation.

To the Society

  • The availability of lucrative avenues of investment and the liquidity thereof induces people to save and invest in long-term securities. This leads to increased capital formation in the country.

  • The facility for convenient purchase and sale of securities at the stock exchange provides support to new issue market. This helps in promotion and expansion of industrial activity, which in turn contributes, to increase in the rate of industrial growth.

  • The Stock exchanges facilitate realization of financial resources to more profitable and growing industrial units where investors can easily increase their investment substantially.

  • The volume of activity at the stock exchanges and the movement of share prices reflect the changing economic health.

  • Since government securities are also traded at the stock exchanges, the government borrowing is highly facilitated. The bonds issued by governments, electricity boards; municipal corporations and public sector undertakings (PSUs) are found to be on offer quite frequently and are generally successful.

Characteristics of Stock Exchange

Following are characteristics of stock exchange:

  1. Association
  2. Mechanism
  3. Organized Market
  4. Market for Old Securities
  5. Deals With Listed Securities
  6. Only the Members Allowed Dealing
  7. Ensures Free Transferability of Securities

Association

Association: The stock market is an association of persons that may be incorporated or not.

Mechanism

Mechanism: It provides a place or mechanism through which industry and government securities may be bought and sold.

Organized Market

Organized market: It is an organized market for securities. It allows trading in securities subject to certain regulations.

Market for Old Securities

The market for old securities: It provides the ready market for old securities that have been already issued by the companies to the public. It does not deal in the fresh shares, debentures and bonds to be issued by the companies or government agencies to the public.

In the stock market transactions in old securities of companies are carried on without the involvement of companies.

Deals With Listed Securities

Deals with listed securities: It offers trading facilities only for those securities that are listed by the companies or issuing agencies with the exchange. If a company has not complied with the listing procedure of a stock market then its securities are not allowed to be traded on such a stock market.

Only the Members Allowed Dealing

Only the members allowed dealing: These stock markets allow only their members to transact the business in the market. Outsiders or nonmembers cannot purchase or sell the securities on these stock exchanges.

Membership of a 2 particular stock exchange (say Bombay Stock Exchange or National Stock Exchange or Bangalore Stock Exchange) is acquired by individuals and firms only on payment of the membership fees prescribed by that stock exchange.

Ensures Free Transferability of Securities

Ensures free transferability of securities and securities evaluation: Stock exchange provides a mechanism for the free transfer of industrial securities and also makes continuous evaluation of securities traded in the market.


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