A stock exchange facilitates the trading of stocks, bonds and other securities in an organized manner. The exchange also helps in the issuance and redemption of securities. Shares issued by a company, bonds, unit trusts, derivatives, pooled investment products are the different types of securities that trade on a stock exchange.
For a security to be traded on a particular stock exchange, it must first be listed there. For example, if a company wants its shares to be traded on the New York Stock Exchange, it must first list its shares on the exchange. Trades on an exchange are carried out by members only.
A stock or a bond offering to investors is initially done in the primary market. After this, the stocks or bonds are traded on the secondary market. Not all stock issuances, however, done through organized stock exchanges. Subsequently, these stocks also do not trade on an organized stock exchange. This type of trading is called off exchange or over-the-counter. Significant amount of trading activity takes place over-the-counter. Generally, derivatives and bonds are traded this way.
But stock exchanges are generally seen as a better alternative to the over-the-counter market for a number of reasons. First, stock exchanges bring a large number of investors together, resulting in greater liquidity and therefore making it possible to obtain better prices. The second major reason why stock exchange is superior to the over-the-counter market is that an exchange is able to obtain and publish the prices at which the trades have occurred or are being offered. Thus exchanges provide investors with an important source of information, which is generally not available on the over-the-counter market. Finally, exchanges have set rules and procedures to ensure that all parties involved live up to their commitments.
Most of the well-known global companies are listed on stock exchanges.
The modern securities market has been developed over many centuries. Trading in debt can be traced back to the ancient world. The evidence for debt trading could be found in ancient Mesopotamian clay tablets, which recorded interest-bearing loans. However, there is still debate on when trading in corporate stock began. Most historians say the founding of Dutch East India Company in 1602 was the first time corporate stock was traded. However, some like economist Ulrike Malmendier of the University of California at Berkeley argue that a stock market existed even in ancient Rome.
The Roman Republic, which preceded the Roman Empire, had societates publicanorum. These were basically organizations of contractors or leaseholders who provided services such as temple-building to the government. Members in such organizations had partes or shares. This concept has been mentioned several times by the statesman and orator Cicero. In of his speeches, Cicero mentioned “shares that had a very high price at time.” According to University of California’s Malmendier, this suggests that partes were tradable instruments just like shares today. The idea of societates went into decline in the Roman empire, as the services provided by these organizations in the Roman Republic were taken over by direct agents of the state.
Trading in bonds can be traced to the Italian city-states of the medieval and early Renaissance periods. The origin of the bond market can be traced back to the 12th century, when the authorities of cash-strapped Republic of Venice forced citizens to buy bonds. These bonds were called prestiti. The bonds paid 5% interest and had indefinite maturity. Citizens initially saw the instrument with suspicion, but later saw them as investment products that could be traded.
Between 1262 and 1379, the Republic of Venice did not miss a single interest payment. This boosted the credibility of the instruments. Soon, a number of other Italian city-states began issuing bonds. Most of the bonds were issued to raise money for paying for wars.
In early 1380s, a war between the Italian city states of Venice and Genoa led to the suspension of interest payments on prestiti. When the bond market was later restored, Venice’s bonds traded at a very steep discount to their face value.
The idea of stock, just like bonds, evolved gradually. As mentioned before, some scholars say trading in stocks existed even in ancient Rome.
The idea of stock trading evolved in the sixteenth century, when British merchants first began experimenting with joint stock companies. One of the early companies was called the Muscovy Company. The company was set up to extract trade with Russia away from Hanseatic dominance. Then in 1602, the Dutch East India Company was formed as a joint-stock company. Shares of the Dutch East India Company were offered to general public and could be traded.
The Dutch East India Company was created to boost the spice trade with Asia. The company was held by directors. Ordinary shareholders did not wield much influence on the management. In fact, they did not even have access to the company’s financial statements. But, shareholders did receive handsome rewards for their risk taking. Between 1602 and 1650, the Dutch East India Company paid an average annual dividend of 16%. Amsterdam had become a hub of financial innovation in the early 17th century.
In 1621, the Dutch West India Company was formed, bringing a fresh issuer to Amsterdam’s fast growing securities market. Despite the Tulip Mania in the 1630s, Amsterdam flourished as a financial center.
The workings of Amsterdam’s stock market have been very well explained by Joseph de la Vega, also known as Joseph Penso de la Vega, in his 1688 book Confusion of Confusions. Vega, himself a trader, explained how the stock market worked. Vega noted in his book that the stock market in Amsterdam at that time was sophisticated. However, it was also prone to bubbles.
In the late 17th century, Amsterdam’s financial innovation and talent spread to London after the Dutch ruler William of Orange ascended to England’s throne. Williams wanted to modernize England’s finances in order to pay for its wars. This led to the issuance of the first ever government bonds in 1693. The following year, the Bank of England was set up. Shortly after that, English joint stock companies started going public. The idea of stock market had well and truly spread.
Stockbrokers in London were initially not allowed to conduct trade from the Royal Exchange, which was the old commercial center. London stockbrokers began trading from coffee houses along Exchange Alley. The origins of the London Stock Exchange can be traced back to these coffee houses.
Just like the stock market today, the stock market back in the seventeenth and eighteenth centuries was prone to bubbles. In fact, one of biggest financial bubbles in the history of stock market took place in early eighteenth century. The bubble involved the South Sea Company, which was formed in 1711 to conduct English trade with South America, and the Mississippi Company, which focused on trade with France’s Louisiana colony. Mississippi Company was promoted by John Law, a Scottish financier. The bubble reached its peak in 1720. Once the share price in both companies began falling sharply, ordinary investors realized that the promise of wealth from Americas was overblown.
Following the South Sea Company bubble, the Bubble Act was passed in London. The Bubble Act stated that only royally chartered companies could issue shares to public. Meanwhile, in Paris, John Law was stripped of office. Law eventually fled from France.
The bubbles resulted in stock trading becoming more limited. However, the idea survived and spread to the U.S. By the 1790s, shares began trading in the U.S.
Role of Stock Exchanges
Stock exchanges play a significant role in the economy.
A stock exchange helps companies in raising capital for expanding their operations. Stock exchanges are particularly important for high tech and capital intensive companies. These companies require significant capital in early stages. However, most of these companies do not have substantial cash flows initially, and therefore raising money through banks or issuing bonds may be difficult. Raising capital through stock issuance is the best alternative for these companies. Since the dotcom bubble burst of 2000s, however, high tech companies have found it difficult to raise capital if they are not generating substantial sales and earnings.
Stock exchange also plays an important role in mobilizing savings for investment. When people tap their savings to invest in shares, it usually results to rational allocation of funds. This is very important for the smooth functioning of an economy. Such mobilization of savings for investment boosts business activity in the country. It is no surprise that people in highly developed countries invest a significant portion of their savings in stocks.
Stock exchange helps ordinary people as well as professional investors in sharing the wealth of a profitable company.
Companies that are traded on stock exchanges also tend to be a lot more efficient. Also, companies trading on stock exchanges have better management records than privately held companies. However, this does not mean that listed companies should not be scrutinized. A number of high-profile cases of corporate mismanagement have involved publicly listed companies. Companies such as Enron, WorldCom and Satyam Computer Services were all listed on stock exchanges.
Stock exchanges also help governments to raise capital to fund infrastructure projects. Generally, governments fund large infrastructure projects through bonds. These bonds can be issued through a stock exchange.
Stock exchanges play a very important role in developing economies. Creation of stock exchanges is in fact seen as a strategy of economic development.
Finally, a stock exchange is a great indicator of the health of an economy. When stock prices are rising or remain stable, it is a signal that the broader economy is robust.
Major Stock Exchanges
NYSE Euronext: The NYSE Euronext is an Euro-American multinational financial services company, operating a number of securities exchange, including the New York City-based New York Stock Exchnge, Euronext and NYSE Arca (previously known as ArcaEx). The NYSE Euronext is the first ever global equities exchange. It was formed after the merger between NYSE Group Inc. and Euronext in 2007. NYSE Euronext is headquarted in New York City. NYSE Euronext’s New York Stock Exchange is by far the world’s largest stock in terms of market capitalization of its listed companies. As of December 31, 2011, the market capitalization of all listed companies on the NYSE totaled $14.242 trillion. Exxon Mobil Corporation, the world’s second largest company in terms of market capitalization, is listed on the New York Stock Exchange. The Euronext is located in Amsterdam, Netherlands and has subsidiaries in Belgium, France, Portugal and the U.K.
NASDAQ OMX: The NASDAQ OMX Group is an American multinational financial services company, owning and operating the NASDAQ stock market in the U.S. The NASDAQ OMX Group also owns and operates eight other stock exchanges in Nordic and Baltic regions and Armenia under the NASDAQ OMX brand. The exchange is headquartered in New York City. It is headed by Robert Greifeld. The NASDAQ stock market in the U.S. is the world’s second largest stock exchange in terms of market capitalization of listed companies behind the New York Stock Exchange. The exchange seeks more trading volume than any other electronic stock exchange. As of January 25, 2011, the total market capitalization of all listed companies on the NASDAQ stock market was $4.5 trillion. NASDAQ was set up in 1971 by the National Association of Securities Dealers (NASD). It has also been credited as the world’s first electronic stock exchange. Apple Inc., the world’s largest company in terms of market capitalization, is listed on the NASDAQ stock market.
Tokyo Stock Exchange: The Tokyo Stock Exchange, also know as TSE or Tosho, is the world’s third largest stock exchange in terms of total market capitalization of its listed companies. The exchange is located in Tokyo, Japan. As of December 31, 2011, the exchange had 2,292 listed companies. The combined market capitalization of the listed companies on the Tokyo Stock Exchange as of December 31, 2011 was $3.3 trillion. The major indices tracking the Tokyo Stock Exchange are the Nikkei 225 Index and the TOPIX. The exchange’s origin can be traced back to the 1870s.
London Stock Exchange: Located in the City of London, one of the world’s major financial centers, the London Stock Exchange is the fourth largest stock exchange in the world. As of December 31, 2011, the LSE had a market capitalization of $3.266 trillion. It is the largest stock exchange in Europe. The London Stock Exchange was set up in 1801. The exchange is located in Paternoster Square in the City of London. It is part of the London Stock Exchange Group. Christopher S. Gibson-Smith is the Chairman of the London Stock Exchange. As of December 2011, the exchange had 2,864 listed companies. The FTSE 100 Index is the major index tracking the London Stock Exchange. Other indexes include the FTSE 250 Index, the FTSE 350 Index, the FTSE SmallCap Index, and the FTSE All-Share Index.
Shanghai Stock Exchange: Shanghai Stock Exchange is one of the two exchanges operating independently in the People’s Republic of China. The exchange is located in the city of Shanghai and is the fifth largest in the world in terms of market capitalization. As of December 31, 2011, the total market capitalization of all listed companies on the Shanghai Stock Exchange was $2.3 trillion. Due to China’s strict capital account controls, the Shanghai Stock Exchange is only partly open to foreign investors. The Shanghai Stock Exchange is a non-profit organization and is overseen by the China Securities Regulatory Commission.
Hong Kong Stock Exchange: Located in Hong Kong, the Hong Kong Stock Exchange is the third largest stock exchange in Asia in terms of market capitalization. It is the sixth largest stock exchange in the world in terms of market capitalization. As of November 30, 2011, the Hong Kong Stock Exchange at 1,477 listed companies. The combined market capitalization of the listed companies as of November 30, 2011 was HK$16,985 trillion. The exchange is owned by the Hong Kong Exchanges and Clearing. The Hang Seng Index in the major index tracking the Hong Kong Stock Exchange. The origin of the Hong Kong Stock Exchange can be traced back to the late 19th century.
Toronto Stock Exchange: Toronto Stock Exchange is North America’s third largest stock exchange in terms of market capitalization behind the New York Stock Exchange and NASDAQ. The Toronto Stock Exchange is the seventh largest exchange in the world in terms of market capitalization. It is based in Canada’s largest city, Toronto. The TMX Group is the owner and operator of the Toronto Stock Exchange. The Toronto Stock Exchange has the highest number of listings of mining and oil & companies in the world. The S&P/TSX Composite and the S&P/TSX 60 are the major indexes tracking the Toronto Stock Exchange.
BM&F Bovespa: BM&F Bovespa (Bolsa de Valores, Mercadorias & Futuros de Sao Paulo) is the world’s 8th largest stock exchange in terms of market capitalization. The exchange is located in Sao Paulo, Brazil. As of December 31, 2011, the total market capitalization of the companies listed on BM&F Bovespa was $1.22 trillion. The exchange was formed after the merger between the Sao Paulo Stock Exchange and the Brazillian Mercantile & Futures Exchange. The merger was completed on May 8, 2008. The Indice Bovespa is the benchmark index of the exchange.
Australian Securities Exchange: The Australian Securities Exchange is the main stock exchange group in Australia. Located in Sydney, the exchange was formed following the merger between Australian Stock Exchange and the Sydney Futures Exchange. The merger was completed in July 2006. As of December 31, 2011, the Australian Securities Exchange was the ninth largest in the world in terms of total market capitalization of its listed companies. The Australian Securities Exchange serves as a market operator, clearing house, payments system facilitator and central securities depository. Some of the major companies listed on the Australian Securities Exchange include mining giants BHP Billiton and Rio Tinto, and financial services companies National Australia Bank and Australia and New Zealand Bank. The S&P/ASX 200 is the major index tracking the Australian Securities Exchange.
Deutsche Borse AG: Frankfurt-based Deutsche Borse AG is one of the world’s largest stock exchanges. As of December 31, 2011, Deutsche Borse was the tenth-largest stock exchange in the world in terms of the total market capitalization of its listed companies.
SIX Swiss Exchange: SIX Swiss Exchange is the main stock exchange in Switzerland. The exchange is based in Zurich. It was the world’s first ever stock exchange to incorporate fully automated trading, clearing and settlement system in 1995. The main index tracking the SIX Swiss Exchange is SMI, the Swiss Market Index. The exchange jointly owns Eurex, which is the world’s largest futures and derivatives exchange.
Shenzhen Stock Exchange: Shenzhen Stock Exchange is one of the two major exchanges in the People’s Republic of China. The exchange is based in the Shenzhen. As of December 31, 2011, the total market capitalization of the listed companies on the Shenzhen Stock Exchange was approximately $1 trillion. It is one of the largest exchanges in Asia. Many of the companies trading on the Shenzhen Stock Exchange are subsidiaries of state-owned companies.
Bolsas Y Mercados Espanoles: Bolsas y Mercados Espanoles is a Spanish company in charge of the organizational aspects of the Spanish stock exchanges and financial markets, including the stock exchanges in Madrid, Barcelona, Bilbao, and Valencia. The IBEX 35 Index is the major index tracking the Spanish stock market.
Bombay Stock Exchange: Mumbai, India-based Bombay Stock Exchange is the oldest stock exchange in Asia. It is also one of the largest stock exchanges in Asia. As of December 31, 2011, the market capitalization of all listed companies on the Bombay Stock Exchange was $1 trillion. This makes the Bombay Stock Exchange the sixth largest stock exchange in the world. As of December 31, 2011, the Bombay Stock Exchange was the 14th largest stock exchange in the world. As of March 31, 2012, there were 5,133 companies listed on the Bombay Stock Exchange. The major index tracking the Bombay Stock Exchange is the BSE SENSEX or BSE 30.
Korea Exchange: Korea Exchange is the only securities exchange operate in South Korea. The exchange is headquartered in Busan. It also has an office for cash markets and market oversight in Seoul.
National Stock Exchange: The National Stock Exchange is one of the two major exchanges in India. The exchange is located in the city of Mumbai. The National Stock Exchange is the 16th largest stock exchange in the world in terms of total market capitalization of its listed companies. The exchange is the largest in India in terms of daily turnover and number of trades for equities and derivatives. As of December 31, 2011, the National Stock Exchange had a market capitalization of $985 billion and a total of 1,646 listed companies. The major index tracking the National Stock Exchange is the S&P CNX Nifty, also called NSE NIFTY. The National Stock Exchange is the second fastest growing stock exchange in the world.
MICEX-RTS: Located in Russia, the MICEX-RTS is the largest stock exchange in Russia. The exchange was formed following a merger between the Moscow Interbank Currency Exchange and the Russian Trading System. The merger was completed on December 19, 2011. Prior to the merger, the Moscow Interbank Currency Exchange and the Russian Trading System were the top exchanges in Russia for two decades. The idea behind the merger was to create a single major stock exchange that would become one of the world’s leading stock exchanges and advance Russia’s plant to transform Moscow into a major international financial center. The MICEX-RTS trades in equities, bonds, derivatives and currencies.
JSE Limited: JSE Limited (previously known as the JSE Securities Exchange and the Johannesburg Stock Exchange) is Africa’s largest stock exchange. Located in Johannesburg, South Africa, the exchange is also one of the world’s largest in terms of market capitalization of its listed companies.
Requirements for Listing on a Stock Exchange
Stock exchanges have a set of terms and conditions for any company that wants to list its shares. These set of conditions, also called listing requirements, include minimum number of shares outstanding, minimum annual income, and minimum market capitalization.
The listing requirements vary by stock exchange. Here are a few examples of listing requirements on some of the major stock exchanges.
New York Stock Exchange: In order list shares on the New York Stock Exchange, a company must issue at least a million shares of stock worth $100 million. The listing company must also have earned over $10 million over the last three years.
NASDAQ Stock Exchange: In order to list shares on the NASDAQ, a company must issue at least 1.25 million shares of stock worth a minimum $70 million. The company’s earnings over the last three years must be over $11 million.
London Stock Exchange: The main market of the London Stock Exchange requires a minimum market capitalization of £700,000, three years of audited financial statements, a public float of at least 25%, and enough working capital for a minimum of 12 months from the date of stock listing.
An initial public offering (IPO) is the initial sale of stock by a company to the general public. Following an IPO, a private company turns into a public company. Companies generally opt for IPOs to raise capital for expanding operations. The first ever IPO was conducted by the Dutch East India Company in 1602.
Stock exchanges began as mutual organizations. Initially stock exchanges were owned by their member stock brokers. However, stock exchanges have demutualized in the recent past, with members selling their shares in initial public offering. As a result, a number of stock exchanges have now become corporation, with listed shares. Some examples are the Australian Stock Exchange, Euronext(which merged with New York Stock Exchange), NASDAQ, the New York Stock Exchange, Bolsas y Mercados Espanoles, and the Sao Paulo Stock Exchange. The Shenzhen and Shanghai stock exchanges can be defined as quasi-state institutions as they were formed by government bodies in China. The exchanges are run by personnel appointed by the China Securities Regulatory Commission.
Increasing competition has forced many exchanges to merge or shut down. This trend is likely to continue. Small scale exchanges have a number of disadvantages, and therefore many of them have merged with or collaborated with bigger exchanges. Increasing competition has even forced big stock exchanges to seek partnership or merge with other exchanges.
Other types of Exchanges
In the 19th century, exchanges began trading forward contracts on commodities. Forward contracts that are traded on organized exchanges are called future contracts. With financial innovation, exchanges began offering future contracts on interest rates, shares and currencies. These contracts are now traded on exchanges called future exchanges.