What Is A Stock Exchange And What Does It Do?

Summary: The financial world is dominated by the role of the stock exchange in a national economy. National and global markets influence politics, social policy and the lives of millions - often directly. Therefore, this section seeks to explore the role of markets in our lives and of other factors in stock markets.

A stock exchange is an organised market for buying and selling financial instruments known as securities, which usually includes equities, bonds, options, and futures. For the average man on the street, just equities and bonds will be of interest.

Most of the options and futures trades carried out will be on behalf of big businesses or fund management groups, both trying to lower or offset risks.

Where is the money?

At the very core, a financial market is all about raising capital. For this reason, they are known as 'capital markets'. Entrepreneurs growing a business might need new funds to help them grow and they wish to find borrowers or investors. Large companies want to make purchases of other large companies and they need large amounts of money to complete the transaction. Both are in need of capital and the stock exchange is the best place to find large amounts of money.

Most capital markets have a specific location where their trades are completed. For the stock of a company to be traded at these exchanges, it must be listed, and to be listed, the company must satisfy certain requirements. These are generally termed as 'Listing Rules'.

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Originally, around two hundred years ago, the first markets were literally gatherings of business people, bankers and traders in one location. Now of course, most trades are virtual and the actual location of a financial market is a very large room containing lots of computer servers. In fact, most exchanges have a number of large rooms in different locations holding lots of servers to ensure that the market is not dependent on one computer location.

In the shadows

However, not all stocks are bought and sold at a specific site. Such securities are referred to as unlisted. Many of these are traded OTC or 'over-the-counter'. This, in effect means that the trade is carried out by computer or telephone. OTC is very prevalent in the derivatives and CFDs markets, which are the mainstay of investment banks and hedge funds.

Many of the algorithic funds that now operate conduct a very high percentage of their trades 'off market'. Since they trade in very quantities - often with each other - this is an unusual and mostly unregulated area of financial markets. These 'off market' markets are known as dark pools.

The major OTC market in the USA is the Nasdaq Stock Market (previously the National Association of Securities Dealers Automated Quotation [NASDAQ] system). The European Association of Securities Dealers Automated Quotation system (EASDAQ) is the major OTC market for the European Union (EU).

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Most of the world’s industrialized nations have one or more stock exchanges. Among the largest are those in London, Paris, Milan, Hong Kong, Toronto and Tokyo.

As finance has globalised, financial markets have had to follow. It is now commonplace for an investment fund or a large corporation to purchase large blocks of shares in a company quoted in another country. These purchases were rare as recently as the 1970s.

This has meant that financial markets have had to become much more homogenised if they are to attract foreign capital. This means that in most major markets, English speakers are very well represented. It also means that companies looking to raise money are as likely to spend time meeting potential investors in New York or London as they are in their home country.

For more background information, please visit the following pages:

What Is An Efficient Capital Market?

Stock Exchanges And National Economies

Investment Insitutions On The Stock Exchange

Executing A Trade On The Stock Exchange

Why Are There So Many Stock Exchange Scandals?

Stock Exchange Regulations - The Sarbanes Oxley Act

Investment In The Stock Exchange

Learn About The Important Role Of Stock Rating Agencies

How Big Should Stock Market Bonuses Be?