Saturday, 1 July 2017
CASE 475 - The stock market
The stock market refers to the collection of markets and exchanges where the issuing and trading of equities (stocks of publicly held companies), bonds and other sorts of securities takes place, either through formal exchanges or over-the-counter markets. Also known as the equity market, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership.
In 12th-century France, the courretiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. A common misbelief is that, in late 13th-century Bruges, commodity traders gathered inside the house of a man called Van der Beurze, and in 1409 they became the "Brugse Beurse", institutionalizing what had been, until then, an informal meeting, but actually, the family Van der Beurze had a building in Antwerp where those gatherings occurred; the Van der Beurze had Antwerp, as most of the merchants of that period, as their primary place for trading. The idea quickly spread around Flanders and neighboring countries and "Beurzen" soon opened in Ghent and Rotterdam.
In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city-states not ruled by a duke but a council of influential citizens. Italian companies were also the first to issue shares. Companies in England and the Low Countries followed in the 16th century.
Birth of formal stock markets
See also: Economic history of the Dutch Republic, Financial history of the Dutch Republic, and Dutch East India Company One of the oldest known stock certificates, issued by the VOC chamber of Enkhuizen, dated 9 Sep 1606. A 17th-century engraving depicting the Amsterdam Stock Exchange (Amsterdam's old bourse, a.k.a. Beurs van Hendrick de Keyser in Dutch), built by Hendrick de Keyser (c. 1612). The Amsterdam Stock Exchange was the world's first official (formal) stock exchange when it began trading the VOC's freely transferable securities, including bonds and shares of stock. Courtyard of the Amsterdam Stock Exchange (Beurs van Hendrick de Keyser) by Emanuel de Witte, 1653. The Amsterdam Stock Exchange is said to have been the first stock exchange to introduce continuous trade in the early 17th century. The process of buying and selling the VOC's shares, on the Amsterdam Stock Exchange, became the basis of the world's first official (formal) stock market. Established in 1875, the Bombay Stock Exchange is Asia's first stock exchange.
In the 17th and 18th centuries, the Dutch pioneering several financial innovations that helped lay the foundations of modern financial system. While the Italian city-states produced the first transferable government bonds, they did not develop the other ingredient necessary to produce a fully fledged capital market: corporate shareholders. In the early 1600s the Dutch East India Company (VOC) became the first company in history to issue bonds and shares of stock to the general public. As Edward Stringham (2015) notes, "companies with transferable shares date back to classical Rome, but these were usually not enduring endeavors and no considerable secondary market existed (Neal, 1997, p. 61)." The Dutch East India Company (founded in the year of 1602) was also the first joint-stock company to get a fixed capital stock and as a result, continuous trade in company stock occurred on the Amsterdam Exchange. Soon thereafter, a lively trade in various derivatives, among which options and repos, emerged on the Amsterdam market. Dutch traders also pioneered short selling – a practice which was banned by the Dutch authorities as early as 1610. There are now stock markets in virtually every developed and most developing economies, with the world's largest markets being in the United States, United Kingdom, Japan, India, China, Canada, Germany (Frankfurt Stock Exchange), France, South Korea and the Netherlands.
How Does the Stock Market Work?
The stock market can be split into two main sections: the primary market and the secondary market. The primary market is where new issues are first sold through initial public offerings (IPOs). Institutional investors typically purchase most of these shares from investment banks; the worth of the company "going public" and the amount of shares being issued determine the opening stock price of the IPO. All subsequent trading goes on in the secondary market, where participants include both institutional and individual investors. (A company uses money raised from its IPO to grow, but once its stock starts trading, it does not receive funds from the buying and selling of its shares). Stocks of larger companies are usually traded through exchanges, entities that bring together buyers and sellers in an organized manner where stocks are listed and traded (although today, most stock market trades are executed electronically, and even the stocks themselves are almost always held in electronic form, not as physical certificates). Such exchanges exist in major cities all over the world, including London and Tokyo. In terms of market capitalization, the two biggest stock exchanges in the United States are the New York Stock Exchange (NYSE), founded in 1792 and located on Wall Street (which colloquially is often used as synonym for the NYSE), and the Nasdaq, founded in 1971. The Nasdaq originally featured over-the-counter (OTC) securities, but today it lists all types of stocks. Stocks can be listed on either exchange if they meet the listing criteria, but in general technology firms tend to be listed on the Nasdaq. The NYSE is still the largest and, arguably, most powerful stock exchange in the world. The Nasdaq has more companies listed, but the NYSE has a market capitalization that is larger than Tokyo, London and the Nasdaq combined. Who Regulates the Stock Market?
The Securities and Exchange Commission (SEC) is the regulatory body charged with overseeing the U.S. stock markets. A federal agency that is independent of the political party in power, the SEC states its "mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." (Learn more about it in Policing The Securities Market: An Overview Of The SEC.)
Two general types of securities are most frequently traded on stock markets: over-the-counter (OTC) and listed securities. Listed securities are those stocks traded on exchanges. These securities need to meet the reporting regulations of the SEC as well as the requirements of the exchanges on which they are listed. Over-the-counter securities are traded directly between parties, usually via a dealer network, and are not listed on any exchange, although these securities may be listed on pink sheets. Pink sheet securities often do not meet the requirements for being listed on an exchange and tend to have low float, such as closely held companies or thinly-traded stocks. Companies in bankruptcy are typically listed here, as are penny stocks, loosely defined as those that trade below $5 a share. OTC securities do not need to comply with SEC reporting requirements, so finding credible information on them can be difficult. The lack of information makes investing in pink sheet securities similar to investing in private companies. The number of stocks that exchanges handle daily is called volume. Market makers are required to buy and sell stocks that don’t interest other investors. Read reviews of stock brokers.
Who Works on the Stock Market?
There are many different players associated with the stock market, including stockbrokers, traders, stock analysts, portfolio managers and investment bankers. Each has a unique role, but many of the roles are intertwined and depend on each other to make the market run effectively. Stockbrokers, also known as registered representatives in the U.S., are the licensed professionals who buy and sell securities on behalf of investors. The brokers act as intermediaries between the stock exchanges and the investors by buying and selling stocks on the investors' behalf. Stock analysts perform research and rate the securities as buy, sell or hold. This research gets disseminated to clients and interested parties to decide whether to buy or sell the stock. Portfolio managers are professionals who invest portfolios, collections of securities, for clients. These managers get recommendations from analysts and make buy/sell decisions for the portfolio. Mutual fund companies, hedge funds and pension plans use portfolio managers to make decisions and set the investment strategies for the money they hold. Investment bankers represent companies in various capacities such as private companies that want to go public via an IPO or companies that are involved with pending mergers and acquisitions.
The Performance Indicators
If you want to know how the stock market is performing, you can consult an index of stocks for the whole market or for a segment of the market. Indexes are used to measure changes in the overall stock market. There are many different indexes, each made up of a different pool of stocks (though there may be overlap among them). In the U.S., examples of indexes include the Dow Jones Industrial Average, NASDAQ Composite Index, Russell 2000, and Standard and Poor’s 500 (S&P 500). The Dow Jones Industrial Average (DJIA) is perhaps the best-known. The Dow is comprised of the 30 largest companies in the U.S., and the daily Dow shows how their stocks perform on a given day. The Dow average is a price–weighted average, meaning its number is based on the price of the stocks. The S&P 500 is comprised of the 500 largest capitalization stocks traded in the U.S. These two indexes are the most followed measurements of the U.S. stock market, and as such, the most generally accepted representatives of the American overall economy. However, there are many other indexes that represent mid- and small-sized U.S. companies, such as the Russell 2000. (For more on indexes and their function, check out The History Of Stock Market Indexes.)
Why is the Stock Market Important?
The stock market allows companies to raise money by offering stock shares and corporate bonds. It lets investors participate in the financial achievements of the companies, making money through the dividends (essentially, cuts of the company's profits) the shares pay out and by selling appreciated stocks at a profit, or capital gain. (Of course, the downside is that investors can lose money if the share price falls or depreciates, and the investor has to sell the stocks at a loss.) In the U.S., the indexes that measure the value of stocks are widely followed and are a critical data source used to gage the current state of the American economy. As a financial barometer, the stock market has become an integral and influential part of decision-making for everyone from the average family to the wealthiest executive.