Functions of Stock Exchanges

Functions of Stock Exchanges

A stock exchange has an important role to fulfil in the economic development of a country. It is essential for the smooth functioning of the private sector corporate economy. In the process of capital formation and in’raising resources for the corporate sector, the stock exchange performs four essential functions.

Firstly, it provides a market place for purchase and sale of securities such as shares, bonds, debentures, etc. Investors desirous of buying securities would be able to buy securities in the primary market only occasionally, that is, at the time of issue of such securities by the company, whereas they would be able to buy securities in the stock exchanges at any time, as trading in stock exchanges is continuous. Similarly, holders of securities who are desirous of selling the securities would be able to sell them only in the stock exchanges, as the issuing companies do not ordinarily buy back the shares. Thus, stock exchanges provide the facility for continuous trading in securities.

Secondly, stock exchanges provide liquidity to the investments in securities, that is, it gives the investors a place to liquidate their holdings. This is essentially the basis for the joint stock enterprise system. Investors would not be interested to invest in corporate securities without the assurance provided by the stock exchanges to the owners of corporate securities that these securities can be sold in the stock exchanges at any time.

Thirdly, the stock exchanges help in the valuation of securities by providing the market quotations of the prices of securities. The market quotations represent the collective judgement on the value of the securities arrived at simultaneously by many sellers and buyers in the market. The value of shares is influenced by macro economic factors as well as micro economic factors, long-term economic trends as well as short-term fluctuations in economic variables. Speculative forces in the securities market also influence share valuations. Market quotations of share prices provide valuable information to prospective investors as well as shareholders regarding the value of shares traded in the stock exchanges.

Fourthly, stock exchanges play the role of a barometer, namely, an indicator of the state of health of the nation’s economy as a whole. The shares of a large number of companies are listed for trading in the important stock exchanges of the country. The market quotations of individual shares represent their current valuation. The trend of price movements in the market is indicated by calculating stock market indices which represent the weighted average of prices of selected shares representing all the important industries. These stock market indices are used to represent the share market as a whole. Their movements and levels are indicative of the economic health of the nation to a great extent because movements of prices of shares are influenced by macro economic factors such as growth of GDP, financial and monetary policies, tax changes, political environment, etc.

The stock exchanges provide the linkage between the savings in the household sector and the investments in the corporate sector. They indirectly help in mobilising savings and channelising them into the corporate sector as securities.