Role and Functioning of Stock Markets - Coursework Example

?Introduction to Financial Markets: The financial markets comprise of two types of markets: Money market and capital market. Capital markets are alsoknown as long term investment markets. This form of capital markets includes Securities market which further include stock market and bond market. The basic mechanism followed by these markets is to connect the lender of capital with the borrower of capital or people who have excess of funds and want to lend, to users of funds who have a productive opportunity but do not have capital to work with. In such markets exchange of capital occurs through direct financing using securities as a commodity. Moreover, securities markets are further broken down into a primary market and a secondary market. A stock market is a private or public market for the trading of stocks or shares in companies at an agreed upon price. These include securities listed on a stock exchange as well as those traded privately, also known as over the counter securities. A stock market is also known as an equity market (Papadopoulos, 2010). Primary Market and its Role: Primary market is the market in which newly listed companies issue their shares to be traded for the first time, changing hands from the newly listed company to the investors, mostly these first time investors are institutional investors for example pension funds, investment banks, credit unions. This process allows a company, the issuers of stocks, to acquire capital by offering their stocks to investors who in return would supply the capital required. Thereby making primary market that part of capital markets that deals with the issuance of new securities. Privately or Publicly listed Companies, governments or public sector institutions can obtain funding for there projects in this way. Security dealers act as a bridge to link lender to the borrower of the fund. The process of selling new shares is called underwriting. The new stock issue is called an initial public offering (IPO). Dealers earn a commission that is part of the price of the security offering. (Papadopoulos, 2010). Secondary Market and its Role: The secondary market is an organized marketplace for securities. After the initial offering it is through this market that the general public gets the opportunity to be a stakeholder in a company. Licensed broker assist in the buying selling of these securities, along with the exchanges specialized trading system, in accordance with the rules and regulations established by the exchange (Alfaro, Chanda, Kalemi-Ozcan, and Sayek, 2004). When it comes to secondary market, investors in this market purchase securities from other investors in the market, rather than from the issuing company. In any secondary market transaction the cash proceeds go to the investors rather than the entity of which the original securities belonged to. The prices of the securities in this market are determined by the forces of supply and demand, this rule applies to every stock available for trading (Demirguc-Kunt and Levine, 1996). Overview of the functions of Stock Market: There are several functions of stock market that makes it an integral part of the economy. It most important role is the channelling of funds or transferring of capital from investors to users of capital. This role of stock exchanges allows corporations looking to raise capital for enhancing their productive capabilities from investors in the primary market. The secondary market facilitates trade between buyers and sellers of stock and thereby enabling the investors to reach the true price of the stock or commodity. This feature of stock market is known as continuous pricing function. This feature enables interested parties to know at any time, what the price of a stock is. Price quotes can be accessed through financial websites and financial channels. This allows investors to assess the worth of their investment in a particular stock (Kale, Dyer, and Sing, 2002).  Stock market also plays the role of fair pricing. The workings of the stock market enable buyers and sellers of stock, to receive the best price possible for a particular stock.  This fair pricing function is as a result of the competition between the numerous buyers and sellers of stock present in the stock market (Singh, 2012). There are many stock markets in the U.S, but the two most prominent stock markets are the New York Stock Exchange (NYSE) and the NASDAQ. Billions of dollars worth of stock is traded on these markets everyday thereby provide the reason for media attention on these exchanges. Stocks of most of the major U.S corporations are listed on both these markets with the NASDAQ being favoured by technology companies (Beirne, Caporale, Schulze-Ghattas, and Spagnolo, 2010). Stock exchanges of the world differ in the way they run their operations. For instance NASDAQ is an electronic marketplace, which match buy and sells order through a computer system, on the other hand the NYSE has a trading floor with dealers who complete buy and sell orders. Moreover some stock exchanges have both these systems (Rua, and Nunes, 2009). In order to ensure that investors are protected against fraud, stock exchanges require corporations looking to list their shares price on the exchange and release their financial position to the public. Both exchanges also require corporations to meet certain financial requirements. Corporations that are listed but who then fall short of these financial and transparency requirements are usually de-listed from the stock exchange (Park and Ratti, 2008). A stock market provides liquidity to an investor by giving them a chance to sell securities quickly and easily. This makes investing in stocks attractive compared to other investment opportunities. Performance of a stock market in any given day reflects the mood and sentiments of the investors, both foreign and local, of a country. Thus a stock exchange in this way informs about the economic activities, economic well-being and economic health of a country. By efficiently allocating capital or providing a quick access to capital, a stock exchange helps to propel the country’s economic machinery. Stock prices are a reflection of the most attractive investment t opportunity in the market. If share prices are rising, this is means that businesses are investing in enhanced capabilities, which would be a good sign for the country’s gross domestic product, as this action would increase aggregate demand. Moreover share prices are also a function of consumer spending and household wealth Share prices also have an influence on the wealth of households, and thus on how much they spend. Central banks watch the movement of the stock market closely and keep a tap on its operations in order to maintain the smooth functioning of the financial system (Costa, Angelis, and Pass, 2012). Other than the above mentioned functions of stock exchanges, they also perform the role of a clearing house for each transaction carried out in them. Thereby taking guarantee that both parties to the transaction will honour there side of the deal (payment to the seller of the security and collect and deliver the shares to the buyer). In this way there is no risk to a buyer or seller in case any party to the transaction defaults. These activities of the stock exchange propels economic growth as these activities in turn lowers transaction costs and enterprise risk which further helps to increase the production of goods and services, and raise the level of employment. As such, Stock Exchange contributes to increased prosperity in a country (Papadopoulos, 2010). Company Structure The Stock Exchange Limited (“the Company”) can be a private or public company, limited by guarantee. This legal structure is decided by the founding member of the firms (Costa, Angelis, and Pass, 2012). Board Members The Company has a Board of directors (non-executive directors and executive director). Non-executive directors are elected directors, being partners or directors in stockbroker member firms. In addition, there are non-executive directors who represent market interests. The Chief Executive of the Stock Exchange also sits on the main board. The appointment of all directors is subject to prior approval of the Central Bank (Costa, Angelis, and Pass, 2012). Board Committees The Board Committees which is concerned with corporate governance of the Company comprise of (Papadopoulos, 2010): Audit Committee Senior Appointments and Remuneration Committee Investment Committee Securities and Exchange Commission and its role in regulating the Stock Exchange: The principal regulator of securities markets is the Securities and Exchange Commission (SEC), which is an independent statutory body. The SEC is responsible for administering the laws governing the securities markets in the country. It facilitates and encourages the development of these markets. Its different regulatory objectives facilitate the process of keep a check on the investors and companies (Papadopoulos, 2010). SEC tries to ensure that there is fairness in all dealings and all markets are efficient. The institution also provides the required protection to the public members and investors. The measures and regulations of SEC allows the regulators to reduce the cases of frauds, crimes, and any other misconduct in the market or industry. Role and Functioning of Stock Markets: Stock markets are one good source of facilitating the process of transferring the funds and investments from the investors to the companies and organisations. This in turn generate health economic activities and thus enhance the growth and development of the overall economy. With the help of the stock markets, the organisations and companies which are in the need of the funds are able to float their shares in order to generate the required capital. On the other hand the investors can invest their money by evaluating all available information about the companies. The stock markets provide security to both, investors and the companies. Apart from this, the stock markets are helpful in the process of implementing the corporate governance practices. The main factors contributing in this process are the standards related to the disclosure of the information and other regulations regarding the evaluation and monitoring of the organisations listed in the stock exchange. All stock exchanges have worked to promote the activities and practices related to corporate governance (Christiansen and Koldertsova, 2009). According to Demirguc-Kunt and Levine (1996), stock markets facilitate the process of economic growth. The stock exchanges and financial markets are essential in order to make sure that there is proper circulation of money in the economy. All of these factors contribute in improving the economic conditions of the overall world. Alternative Investment market in London: The London stock exchange provides an opportunity for small to raise capital; this is through its alternative Investment market. In this market the capital adequacy ratio is kept low and the regulations are also less stringent. This facilitates smaller companies to raise working capital for their operation. But since the risk involved his higher in this case therefore the provider of capital also seek higher return. In this market the participating companies are (Mallin and Ow-Young, 2012): Early stage businesses Venture Capitalist backed companies Established businesses Objectives of AIMs: Allow smaller companies to obtain public listing at a cost that is not very high. Allow skilled, knowledgeable and experience investors to add riskiness in their portfolio, and simultaneously invest in high return investment opportunity. Give a chance to less well researched shares to grow in price and demand. Since the size of the companies involved in these markets is small, they are subjected to lesser, less stringent regulations than companies listed in the mainstream market. (Colombelli, 2010). The AIM market was originally aimed at UK companies, but today includes overseas companies, ranging from start-ups to mature companies seeking extra funds; the shares in these markets are thinly traded (they are illiquid). Listing in AIM market gives access to the financial resources available in one of the world’s financial hub; London, along with lesser regulations. (Rousseau, 2007). Investing in companies on the Alternative Investment Market should be done by those investors who are well-versed in reading company reports, digging into news releases, and even contacting the companies directly. Other than these individuals AIM companies can also be looked upon by mutual funds, hedge funds and venture capital trusts. An attractive feature of this sort of investment is the relaxation in tax policy which encourages investment in these companies. (Rousseau, 2007). Advantages of AIM-funded capital to companies: It is believed that AIM funded capital have several advantages for the companies. For instance, it allows more flexible and bendable regulations. At the same time, with the help of AIM funded capital, the companies can have access to different and specific international market and can also avail the opportunity of accessing the capital which is available in U.S. The companies using the AIM funded capital are eligible for different tax benefits and can raise the minimum amount of $3MM. Such companies do not have to face any restrictions about the quantity of the issues shares and the percentage of the public shares. Apart from this, there is no requirement of recording the trading activities and of getting approval from the shareholders before making any transaction. Lastly, there is no minimum amount of market capitalisation. Case Study: Overview and analysis of Irish Stock Exchange (ISE): The Irish Stock Exchange (the ISE) is an integral part of Ireland’s financial services industry. This forum allows companies operating in the country to raise capital trough this market. In this market wide range of securities are available. Moreover, it has all those system which allow active and efficient trading to be undertaken. The company was made part of the financial infrastructure of the country in1793 and was initially owned by its founding brokers (O’Donnell and Baur, 2009). Offerings of the exchange: The exchange list specialist fund and debt securities, from all across the world and mostly includes companies who desire to enter the European markets. Thus, this market comes as a great opportunity for them to enter Europe at a lower cost. To act as a centre for Irish companies to raise funds for fuelling their growth and provide trading reports of Irish Government bonds to international market participants. Provide real time and historical market data to participants. This data includes: prices, turnover and ISEQ indices information. Number of listed Companies: 73 Special Features of Irish Market: The Irish Stock Exchange (ISE) offers a real time, web-based Investor Relations (IR) service to companies listed on its equity market. This is a cost-effective and efficient solution that helps to facilitate investors. This service has many complementary tools in it, these include: Content analysis tool for investors Analytical and functional analysis tool for senior executives (O’Donnell and Baur, 2009). Tools for monitoring key market developments Tools for identifying new investment opportunities and maximizing return from there investment. Tools to direct the right information to the right person, so that the message being delivered finds its true utility. ISE operates in three markets: The Irish Stock Exchange is divided into three segments: The Main Securities Market (MSM), is the market for Irish and overseas companies. This market has range of instruments including equities, Irish Government bonds, debt securities, exchange traded funds (ETFs) and investment funds. The second market of ISE is Enterprise Securities Market (ESM), an equity market designed for small to medium sized growth companies. The third and final market of ISE is Global Exchange Market (GEM), a debt market for professional investors (O’Donnell and Baur, 2009). Scams in the stock exchange: The most seen scam in a stock exchange has to do with those investors who own blocks of securities. These investors are approach by mysterious individuals, with an offer to purchase the investors block of shares. However with no such intention in mind these frauds pressurize the investors to go along with the deal as this deal would be a golden opportunity for them to maximize their return for this investment. Those investors who stumble to such an offer end up giving an advance payment to such frauds and after this payment is received by these individuals they disappear in the wind (Papadopoulos, 2010). Conclusion: The stock exchange and other financial markets provide the investors and organizations with several advantages and benefits. These financial markets have important role in the financial stability of the overall financial and economic system. Stock exchanges and the regulatory measures facilitate the process of corporate governance and ensure that all companies and investors indulge in investing and financing activities according to the rules and regulations. As a result there are less chances of any fraud or wrong practices on the part of the investors and the companies. Hence, it is important to make sure that the activities of the financial markets and stock exchanges should be efficient and fair in order to capitalise on all benefits of the stock markets. List of References Alfaro, L., Chanda, A., Kalemi-Ozcan, S., and Sayek, S. (2004). ‘FDI and Economic Growth: the role of financial markets.’ Journal of International Economics, vol. 64, no. 1, pp. 89-112 Beirne, J., Caporale, G., Schulze-Ghattas, M., and Spagnolo, N. (2010). ‘Global and Regional Spillovers in Emerging Stock Markets: a multivariate GARCH-in-mean analysis.’ Emerging Markets Review, vol. 11, no. 3, pp. 250-260. Christiansen, H., and Koldertsova, A. (2009). ‘The Role of Stock Exchange in Corporate Governance.’ Financial Market Trends, Available from http://www.oecd.org/dataoecd/3/36/43169104.pdf [Accessed 6 April 2012] Colombelli, A. (2010). ‘Alternative Investment Market: a way to promote entrepreneurship.’ Journal of Industry, Competition, and Trade, vol. 10, no. 3-4, pp. 253-274. Costa, M., Angelis, L., and Pass, L. (2012). ‘Interdependence and contagion in international stock markets: a latent Markov model approach.’ Mathematical and Statistical Methods for Actuarial Sciences and Finance, pp. 131-138. Demirguc-Kunt, A., and Levine, R. (1996). ‘Stock Markets, Corporate Finance, and Economic Growth: an overview.’ The World Bank Economic Review, vol. 10, no. 2, pp. 223-239. Kale, P., Dyer, J., and Sing, P. (2002). ‘Alliance Capability, Stock Market Response, and Long term Alliance Success: the role of the alliance function.’ Strategic Management Journal, vol. 23, no. 8, pp. 747-767. Mallin, C., and Ow-Young, K. (2012). ‘The UK Alternative Investment Market – ethical dimensions.’ Journal of Business Ethics, vol. 95, pp. 223-239. O’Donnell, D., and Baur, D. (2009). ‘Momentum in the Irish Stock Market.’ Applied Economics Letters, vol. 16, no. 11, pp. 1133-1138. Papadopoulos, P. (2010). 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