Stock Exchanges

Trading to the Public

Stock exchanges are where company shares and other securities are traded to the public. Every company that wants to sell shares to the public must be listed on a stock exchange.

Most countries have a stock exchange. Some of the largest are the New York Stock Exchange, the London Stock Exchange (LSE) and the Tokyo Stock Exchange. In the UK there are two main exchanges. The LSE is the Senior Market for established businesses. The Alternative Investment Market (AIM) is the Junior Market for businesses less than three years old.

To ensure fair trading and accurate information for investors, stock exchanges impose strict rules and regulations on those listing and trading.

 

Main points about Stock Exchanges:

Stock exchanges are organised markets where securities are bought and sold. They are known as public markets as they are the places where securities are traded to the public.
Securities traded on an exchange include shares, bonds, unit trusts, derivatives (futures and options) and other investment products.
When a company wishes to raise capital by selling shares in the company to members of the public (rather than to family or private organisations), it does so on a stock exchange. This is known as floating, listing or going public.
The initial offering of stocks of bonds to investors is known as the primary market. Stock exchanges also provide a secondary market where investors can sell their securities to other investors for cash, thus reducing the risk of their investment.
Unlike public shares, stock such as bonds and derivatives do not have to be issued or traded via an exchange, they can be traded direct or 'over the counter'. However to issue bonds in the first place a company must be listed on a stock exchange and publicly owned.
Almost all stock exchanges are 'auction exchanges' where buyers enter competitive bids to purchase.
Prices are governed by the forces of demand and supply. For example, if lots of people are interested in buying a limited amount of shares, the price will rise. Hence prices on stock exchanges are changing all the time throughout the trading day.
 London Stock Exchange (LSE) is one of the most important financial markets in the City of London. In the UK, all major public companies are listed on it.
 The Alternative Investment Market (AIM) is the London Stock Exchange’s international market for smaller growing companies, including early stage, venture capital backed businesses as well as more established companies seeking growth capital. 
Other exchanges are run online for smaller companies with a market capitalisation (total share value) too small to list on the main exchanges or where there is only a small float of shares that are freely traded. 
Most stock exchanges are now businesses in their own right. The LSE is a public company registered as a business on the LSE (i.e. on itself).
Stock exchanges are keen to attract companies that want to list with them and investors that want to invest in these companies.
The greater the volume of companies listed and shares traded, the more liquidity the market will have, making it more attractive to new investors.
To be successful, a stock exchange needs to be seen as impartial and to provide a level playing field to all those listing or investing.
To attract investors it is also important to have companies of good quality. If listed companies were to go bust regularly no one would want to use the exchange to buy securities.
To be able to trade a security on a stock exchange a company must be listed there. To be listed, companies must meet an exchange's requirements (see Shares for more information).
Stock exchanges cannot guarantee that the companies listed with them will do well, but they must ensure investors have as much accurate and up-to-date information as possible.
Both LSE and AIM require a professional adviser to help a company list. They are called a nominated adviser on the LSE and on AIM they are known as a nomad.
Companies have to provide a detailed financial prospectus when listing and once listed must continue to provide financial information.
Stock exchanges also need to ensure investors are operating on a level playing field and not getting an unfair advantage over each other.
The regulation of stock exchanges is an enormously complicated area. The principal market watchdog in the UK is the Financial Services Authority (FSA).
If something peculiar happens, such as a lot of shares being bought for no known reason, the FSA will investigate to find out if people are using inside information.
Stock exchanges are also places where takeovers happen as companies buy each other’s shares (for more information see Mergers and Acquisitions).
Trades in the older exchanges are conducted on the floor (called the 'trading floor') of the exchange itself, by shouting orders and instructions (open outcry system). On modern exchanges, trades are conducted over the telephone or online.
In 1986 the LSE changed from using a trading floor to computerised trading. The British government forced the LSE to radically change its rules, in a process known as the 'Big Bang'. To find out more about this see the section on Brokers.
 
 

The London Stock Exchange and its Importance in the Economy

Stock exchanges are very big businesses. The New York Stock Exchange has a market value of $9.57 trillion, the Tokyo Stock Exchange a market value of $3.10 trillion and the London Stock Exchange (LSE) a market value of $2.20 trillion.

The LSE grew out of trade conducted in coffee houses along Change Alley in London in the late 1600s. It soon grew to be one of the City’s most important financial institutions. In 1801, members had to subscribe and obey its regulations and the modern Stock Exchange was born.

For many years the LSE was owned by the brokers as a private members club. This stopped in 1986, when the government changed the rules: foreign competitors were allowed into the market and the Exchange became a private limited company.

In 1991 the Exchange's role as the UK’s listing authority was transferred from the HM Treasury to the Financial Service Authority (FSA), and LSE shareholders voted to become a public limited company. The London Stock Exchange plc now lists over 3,000 British and overseas companies. It lies at the heart of the global financial community and as such plays a very important role in the economy.

The LSE provides companies with the facility to raise capital for expansion through selling shares to the investing public. This allows capital that would otherwise be held in banks accounts to be put to use to invest in stocks and shares to help companies grow and develop, expand their product lines and move into new areas of product development.

Stock exchanges also provide a place where companies can increase their market share or expand into new areas by acquiring other companies or business assets. A takeover bid or a merger agreement through the stock market is one of the most common ways for a company to grow (for more information on this see the section on Mergers and Acquisitions).

Stock exchanges also allow investors, both big and small, to share in the wealth generated by profitable companies through dividends paid to shareholders or by income generated by selling the shares if stock prices increase. However, unprofitable and troubled businesses can result in capital losses for shareholders.

The stock exchange is also seen as an indicator for the wider state of the economy. The demand for shares and share prices can be affected by a number of different things. Some of these are internal to the company itself, such as the share bonuses and dividends paid, the development of new products or markets, company finances and growth.

Others are factors which are beyond the control of the firm and include raw material prices, demand for products, political factors, government policy, world events, economic trends, inflation, investor confidence and the performance of the industry or sector that the company is part of, as the stocks of companies operating within the same industry tend to move in line with each other.

As share prices rise and fall depending, largely, on market forces of supply and demand, movements of share prices and, in particular, stock indexes are seen as indicators of general trends in the economy.

Although the stock market can give many false signals, share prices do tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression or financial crisis can lead to a stock market crash.

For this reason the FTSE 100 (Financial Times-Stock Exchange 100 Share Index) is watched very closely by economists. The FTSE 100 tracks the 100 'biggest' companies listed on the London Stock Exchange (i.e. those which have the most market capitalisation - the highest total share value).

The index is calculated in real time, with prices updated every 15 seconds. Each quarter, the FTSE evaluates the companies tracked on the index and makes any necessary changes to ensure that it represents the most highly capitalised companies. As such the FTSE 100 Index is considered an important indicator of the health of the wider market.