Stock Exchange and Its Regulation
A stock exchange is an organized and regulated marketplace that enables buyers and sellers to conduct transactions in existing securities in a quick, efficient, and economical manner. It provides liquidity and marketability for long-term investments by ensuring that securities can be easily bought and sold.
The stock exchange serves as a formal platform that facilitates the free transferability of shares and other securities held by the public. In addition to executing purchase and sale transactions, it plays a crucial role in the continuous valuation of securities through regular trading activities. This ongoing price discovery helps investors assess the fair market value of securities and make informed investment decisions.
Characteristics of a Stock Exchange
- Organized Market A stock exchange is a well-organized market that facilitates the buying and selling of securities in a systematic and regulated manner.
- Dealing in Securities Various types of securities such as shares, debentures, and bonds are traded on the stock exchange.
- Operation Under Rules and Regulations All transactions on a stock exchange are conducted in accordance with the bye-laws of the stock exchange and the guidelines issued by the Securities and Exchange Board of India (SEBI).
- Trading in Listed Securities Only Only securities that are officially listed on the stock exchange are eligible for trading, ensuring transparency and investor protection.
- Transactions Through Authorized Persons Buying and selling of securities on the stock exchange can be carried out only through authorized members or brokers of the stock exchange.
Functions and Objectives of a Stock Exchange
A stock exchange performs several important economic functions and plays a vital role in the efficient functioning of the corporate sector and the economy as a whole.
- Ready Market for Securities The stock exchange provides a ready and continuous market for the purchase and sale of existing (old) securities, ensuring liquidity to investors.
- Continuous Appraisal of Securities Under stock exchange regulations, all transactions are required to be properly recorded and made public. This results in continuous price quotations, which reflect the true market value of securities.
- Protection of Investors Stock exchanges operate under strict rules and regulations. These ensure fair dealing, transparency, and protection of investors’ interests.
- Channelization of Capital into Profitable Ventures The stock exchange facilitates the flow of capital towards profitable and well-performing companies. Investors can easily shift their investments from poorly performing companies to better ones, ensuring efficient allocation of resources.
- Encouragement of Capital Formation By providing wide publicity to securities through price quotations, financial reports, and media coverage, the stock exchange encourages people to invest their savings in industrial and corporate sectors, thereby promoting capital formation in the country.
- Facilities for Speculation The stock exchange provides opportunities for informed and skilled investors to speculate based on market trends and price movements, which also helps in increasing market liquidity.
Importance or Role of a Stock Exchange
A stock exchange plays a vital role in the economic prosperity of society, companies, and investors. Its importance can be studied under the following three broad heads:
A. Role Towards the Community
- Generation of Economic Growth The stock exchange contributes to the economic growth of the country by encouraging investors to channel their savings into productive and income-generating enterprises.
- Facilitation of Marketability of Securities By providing an organized and regulated platform for the buying and selling of securities, the stock exchange enhances the marketability and liquidity of investments.
- Encouragement of Capital Formation Stock exchanges promote capital formation by mobilizing public savings and directing them towards industrial and corporate development.
B. Role Towards Companies
- Enhanced Reputation Companies whose securities are listed on a stock exchange enjoy greater credibility and reputation in the capital and credit markets.
- Wider Market Listing on one or more stock exchanges widens the market for a company’s securities and increases their investor base.
- Higher Market Value Shares traded on a stock exchange generally command higher market prices due to transparency, liquidity, and continuous valuation based on the company’s earning capacity and net asset value.
C. Role Towards Investors
- Fair Dealing Stock exchanges operate under strict rules and regulations, ensuring transparency and fair dealings, thereby protecting investors’ interests.
- Liquidity of Investments Stock exchanges provide liquidity by enabling investors to easily convert their investments into cash through the sale of listed securities.
- Security for Loans Listed securities are widely accepted as reliable collateral, making them eligible for use as security for obtaining loans from financial institutions.
Causes of Price Fluctuations on the Stock Exchange
Prices of securities on the stock exchange fluctuate due to a variety of economic, financial, and psychological factors. The major causes are as follows:
- Earnings of Companies Shares of companies with higher and improving earnings generally experience increased demand, leading to a rise in their market prices compared to companies with lower earnings.
- Actions of Financial Institutions Large-scale buying or selling of securities by domestic and foreign financial institutions significantly influences the prices of securities in the market.
- Bank Rate The bank rate is the rate at which the Reserve Bank of India lends to commercial banks. A decrease in the bank rate increases the availability of funds at lower interest rates, encouraging investment in shares and raising their prices.
- Actions of Underwriters Underwriters may sometimes engage in artificial buying and selling of shares at higher prices, which can lead to a temporary increase in the prices of securities.
- Trade Cycle During periods of economic boom, share prices tend to rise due to higher business activity and investor optimism. Conversely, during periods of recession or depression, share prices generally fall.
- Political Factors Political stability and policies favorable to private enterprise and capital markets often lead to a rise in share prices. In contrast, policies perceived as restrictive or socialist may cause share prices to decline.
- Sympathetic Fluctuations Sometimes, a rise or fall in the prices of shares of a few major companies leads to a general increase or decrease in the prices of shares of other companies, even without direct justification.
- Demand and Supply The basic economic forces of demand and supply play a crucial role. When demand for a security exceeds its supply, its price rises, and when supply exceeds demand, its price falls.
- Speculative Pressure Speculation by bulls (optimistic investors) and bears (pessimistic investors) causes frequent fluctuations in share prices. The interaction between these forces both causes and reflects price movements in the market.
Suggestions for Improvement of Stock Exchange
To strengthen the functioning of the stock exchange and enhance investor confidence, the following measures may be adopted:
- Greater Transparency in Prospectus Strict action should be taken against companies that fail to disclose complete and accurate information in their prospectus as prescribed under SEBI norms.
- Effective Control of Insider Trading Although legal provisions against insider trading exist, their implementation needs to be strengthened. SEBI should adopt stricter surveillance and enforcement mechanisms to curb insider trading practices.
- Introduction of New Financial Instruments To promote capital formation, new and innovative financial instruments should be introduced to cater to the diverse risk and return preferences of different categories of investors.
- Ban on Grey Market Operations Unofficial and unregulated grey market activities should be strictly prohibited. Newspapers and media outlets should also be restrained from publishing unofficial price quotations.
- Streamlining Stock Broking Services While SEBI has prescribed a code of conduct for brokers and sub-brokers, stock broking operations should be further computerized and made more transparent to ensure fair trading practices.
- Coordination Among Stock Exchanges Proper coordination should be ensured among traditional stock exchanges, Over-the-Counter Exchange of India (OTCEI), and the National Stock Exchange (NSE) to safeguard investor interests and improve market efficiency.
- Improvement in Liquidity Measures should be taken to ensure that securities transactions are primarily delivery-based rather than speculative, thereby improving genuine market liquidity and stability.
Frequently Asked Questions (FAQs)
What is a stock exchange?
A stock exchange is an organized and regulated market where existing securities such as shares, debentures, and bonds are bought and sold.
What are the main functions of a stock exchange?
The main functions include providing liquidity, continuous valuation of securities, protection of investors, capital formation, and channelization of funds into profitable ventures.
How does a stock exchange help investors?
A stock exchange ensures fair dealing, provides liquidity to investments, offers continuous price information, and enables the use of listed securities as collateral for loans.
What causes price fluctuations in the stock market?
Price fluctuations are caused by company earnings, demand and supply, bank rate changes, actions of financial institutions, political factors, trade cycles, and speculative activities.
What role does SEBI play in regulating stock exchanges in India?
SEBI regulates stock exchanges by framing rules, preventing insider trading, protecting investor interests, and ensuring transparency and fairness in market operations.
What improvements are suggested for stock exchanges?
Suggested improvements include stricter disclosure norms, better control over insider trading, banning grey markets, introducing new financial instruments, and improving coordination among exchanges.
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