Economics of Financial Markets What are the purpose and functions of stock exchanges as financial intermediaries? Financial intermediaries are institutions such as building societies, banks, stock exchanges and insurance companies. They all act as an intermediary between people, institutions or countries that may have high incomes, profits or surpluses and those that have lower incomes, losses and deficits. Some major stock exchanges around the world are: the New York stock exchange (NYSE), NASDAQ, American (AMEX), London (LSE), Toronto (TSE), Bombay (BSE), Australian (ASX) and lastly the Tokyo stock exchange (TSE)
One of the main purposes of the stock exchange is to provide a platform for the new born companies and existing ones to raise money through the issuing of shares, this takes place in the primary market. The primary exists because of the symbiotic relationship it shares with the secondary market. The liquidity of exchange is very attractive for investors to buy and sell securities at any given time. There is strong evidence to say that the stock exchange and the economy of the country support each other.
The stock market shows the strength of the economy and the stage of development. Therefore it’s important for stock exchanges to compete for investors’ funds and hence acquiring a large amount of investors which as a result means a more important economy but also being vulnerable to ‘‘the butterfly effect’’ or the famous saying ‘‘when America sneezes, the rest of the world catches a cold’’. In a large reputable stock exchange, companies willing to enter must meet the NYSE Euronext requirements.
Additionally, the stock market must have two qualities: deep market and broad market. Deep market absorbs transaction of high magnitudes, able to maintain its share price with no relation to the large quantity of shares being sold. This is also achieved due to the dark pool trading adopted the LSE. The broad market refers to the variety of shares of different industries that are listed in the stock market. For example, in London we have the London Stock exchange were the most common and popular index is the top 100 companies, FTS 100.
There are overall 10 indices in the LSE. The stock exchange market acts as the clearing house of transactions; they collect the shares and deliver them to the buyer. It also provides a guarantee of payment to the issuer for the shares. This gives buyers the security to sell their shares to sellers and vice versa, that has never met and will probably never meet. Commissions and administrative fees are incurred in the amount of profit the seller makes from the shares sold. In America “the average investor will lose 2. 5% to the wall street croupiers” John C.
In my opinion this is a small amount to pay to eliminate the risk of default payment. However others may argue that “over 50 years the impact of the annual fee is enormous” as stated by the chief executive of The Vanguard Group. As we are aware, the greater the size of a company the higher the level of economies of scale which is achieved. In this stock market, the costs of hiring a lawyer, researchers, accountants etc, is passed on to investors. Due to operational efficiency which the stock market has the cost is reduced, as a result the cost of transaction is minimised.
If we were to do this all alone for each transaction we made, the cost would overflow the minute profits which are gained from the holding of bonds or shares. Stock exchange provides liquidity of securities; they provide the secondary market with a high demand for their shares at a reasonable price, the same share that were sold in the primary market. This is what makes the stock market so competitive. If I was to invest in bonds I would have to wait for this to mature, sell at lower face value or even pay a fee because of the contract I entered. Therefore funds are always disposable I this market.
The provision of information on prices and quantities are well appreciated by speculators and invertors. Yields on shares of a company are helpful to guide invertors on the profitability of those shares. Which give the company the advantage of new risen capital and therefore the more they earn in shares the more they are able to invest in the growth of the company. This then results in the increase in prices of shares as the output has increased. The London stock exchange lists about 3. 600 companies from 60 countries, some which are also listed in the NYSE.
With this number, investors have everything at the tip of their fingers. This takes us to the important fact that the stock exchange acts as a bridge for investors to the company’s profits. Less time, paper work and stress is used to become a part owner of an important company, because of this intermediary. However if we were to go straight into the company to buy these shares, we would have to be very knowledgeable about the company and have the time to travel there, hold meetings and so on. As part owners of a company through the holding of ordinary shares, investors gain political and economic rights.
They are able to vote in share holders meeting and the right to receive dividends, liquidity, rights issues and more, respectively. Because of these rights, the founder of the company gets less power every time new shareholders come into the company, but they gain more capital. Long term funds for companies are raised in the stock exchange, as well at low interest rates if compared to other intermediaries. Statistics show that LSE “in 2008 made 55 million trades involving 2. 2 trillion pounds”, the money that goes through the stock market is immense.
For big projects such as infrastructure, it is extremely important to have the option of long term borrowing and for low interest rates. Euromarkets is a good for lending large sums of money at low interest rates, “the European investment bank lends nearly €70bn a year for projects across Europe”. The stock market must be able to compete with the Euromarkets to keep the standard high and a high volume of trade. Moving on, the broad of the market means that investors have a variety of industries that they can invest into and therefore, diversity their portfolios. The diversification also means risk is spread.
It’s always favourable that one invests into different sectors, so that if one if affected, we still have the other and the losses are bearable. To restrict the risk of mismanagement, public companies that join the stock exchange must make their annual reviews transparent for the public. This is a great feature that helps the investors to keep track of the company’s progress as well as their losses. Lastly, the stock market is a good indicator of the economic social mood. As people invest money on the stock, companies are able to benefit from this and as a result are able to expand their company.
The growth equals more people being employed, more labour increase the level out output. Overall it leads to an increase in the GDP. If the shares price listed on the LSE are high, it means that the economy of the UK is rising and people are positive about the future. London is highly dependable on services, after World War II industrialisation took place and this resulted in London becoming more dependable on this sector rather than producing tangible goods. There are many regulatory bodies in each of the countries in which the stock exchanges are based.
Further on, I will look in more detail at the motives for the existence of such regulators and the rules that stock markets must follow. Before the 1980’s financial intermediaries were highly supervised and regulates. UK competition and credit control 1971 meant that the quantity that could be lead to clients was no longer capped. Also in the USA Abortion of regulation Q in 1982 was a great opportunity for banks to compete on the interest rate they could pay on deposits. Risk Deregulation gained momentum in Europe around the mid 80’s.
The results of this meant freedom on the commission’s fees and market entry. Asymmetry of information Systemic markets Trust is a public good How does London Stock Exchange fulfil its purpose and function? Depth broad allocative efficient x3 ass
References http://www. barrypopik. com/index. php/new_york_city/entry/when_wall_street_sneezes_the_rest_of_the_world_catches_pneum onia_when_ameri/ John C. Financial times- Money, Nov 6 2010, Natalie graham , page 13 http://www. articlesbase. com/investing-articles/function-and-purpose-of-stock-market-582881. html