Define Stock Exchanges

Primary market is the market in which new issues of securities are sold by the issuing companies directly to the investors. Secondary market is the market in which securities already issued by companies are subsequently traded among investors. A person with funds for investment in securities may purchase the securities either in the primary market (from the issuing company at the time of a new issue of securities) or from the secondary market (from other investors holding the desired securities). Securities can be purchased in the primary market only at the time of issue of the security by the company, whereas in the secondary market securities can be purchased throughout the year. As a result, trading in a particular security in the primary market is an intermittent event depending upon the frequency of new issues of the security by the company, but trading in that security in the secondary market is continuous. The secondary market where continuous trading in securities takes place is the stock exchange. In this chapter we shall examine the functioning of stock exchanges in the country.

What is a Stock Exchange

The stock exchanges were once physical market places where the agents of buyers and sellers operated through the auction process. These are being replaced with electronic exchanges where buyers and sellers are connected only by computers over a telecommunications network. Auction trading is giving way to “screen-based” trading, where bid prices and offer prices (or ask prices) are displayed on the computer screen. Bid price refers to the price at which an investor is willing to buy the security and offer price refers to the price at which an investor is willing to sell the security. Alternatively, a dealer in securities may declare the bid price and the offer price of a security, suggesting the price at which he is prepared to buy the security (bid price) and also the price at which he is prepared to sell the security (offer price). The bid-offer spread, the difference between the bid price and the offer price constitutes his margin or profit.

Securities of a company first become available on an exchange after the company conducts its Initial Public Offering (IPO). During the IPO, a company sells it securities to an initial set of investors in the primary market. These securities can then be sold and purchased in the stock exchanges. The exchange tracks the flow of orders for each security, and this flow of supply and demand for the security sets the price of the security.

A stock exchange may be defined or described in different ways. A simple description of a stock exchange is as follows: “A centralised market for buying and selling stocks where the price is determined through supply-demand mechanisms”.

A somewhat similar description of a stock exchange is the following: “An organisation that provides a facility for buyers and sellers of listed securities to come together to make trades in these securities”.

In a stock exchange, the trading in listed securities is carried out by qualified members who may act either as agents for customers or as principals for their own accounts.

Stock exchanges may, therefore, be described as “Associations of brokers and dealers in securities who transact business together”.

A more descriptive definition of a stock exchange is: “An organised market place for securities featured by the centralisation of supply and demand for the transaction of orders by member brokers for institutional and individual investors”.

According to the Securities Contracts (Regulation) Act, 1956, which is the main law governing stock exchanges in India, “stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities”.