ABC of the Stock Exchange

A stock exchange is a regulated market where buyers and sellers can trade holdings in publicly held companies’ stock.

The intermediary between buyer and seller is a stock broker or someone who arranges for sale based on listed stock prices. The stock market allows buyers and sellers of securities to meet, interact and transact. The market allows for price discovery for shares of corporations and serves as a barometer for the overall economy. Buyers and sellers are assured of a fair price, high degree of liquidity and transparency as market participants compete in the open market economic environment.

Stock markets provide a secured and regulated environment where market participants can transact in shares and other eligible financial instruments with zero to low operational risk. Operating under a defined set of rules as formulated by the operator ( in Bangladesh the operator is the Securities and Exchange Commission), the stock markets act as a secondary market.

A company sells shares to the public. To facilitate the process of selling, a market place is required which is provided by a stock market. A listed company may sell new and additional shares through other offerings at a later stage, such as rights issues or follow on offerings. They may even buy back or delist their shares. Investors own company shares in the expectation that the share value will rise in future or they may get dividends. When investors anticipate a rise in the share value in future, they may buy heavily to sell in future to gain when share price rises in future. This trend of heavy buying is called “Bull” or “Bullish” market. On the other hand when investors anticipate a fall in share price in future, to avoid loss they sell shares at available prices and in future when share prices fall they buy back the shares sold earlier at a low price, thereby gain. This heavy selling trend is called “Bear ” or “Bearish” market. The stock exchange acts as a facilitator for capital raising process and receives a fee for the services render from the company.

The stock exchange ensures price transparency, liquidity, price discovery and fair dealings in trading activities. The exchange guarantees all participants to have access to data for all buying and selling orders thereby helping in the fair and transparent pricing of shares. Traders on the stock market include market makers, investors, traders, speculators and hedgers.

An investor may buy and hold them for long term, while a trader may enter and exit a position within seconds. A market maker provides necessary liquidity in the market while a hedger may trade in derivatives.

Stock exchange is a component of free market economy. The exchange allows companies to raise capital by offering shares and company bonds and allows investors to participate in the financial gain. The exchange is a platform through which savings and investment of individuals are channeled into productive investment opportunities and add to the capital formation and economic growth of the country.

There are a number of players operate in the stock exchange. Stock brokers act as intermediaries between stock exchange and the investors by buying and selling stocks and portfolio managers are professionals who invest portfolios or collections of securities for clients. Investment bankers represent companies in various capacities such as private companies that want to go public via IPO or companies that are involved in pending merger or acquisitions.

The Stock Exchange is a rather remote institution to many people, but it serves several very important functions in the commercial and economic life of the country, including the following.

Capital raising: Although no one can actually raise capital on the stock exchange, it would be impossible to raise long term capital without it. Investors are not prepared to commit their money to a company permanently, but the company needs it permanently. It is only through the stock exchange that this conflict is overcome and investors are able to turn their shares into cash.

Investor protection: The stock exchange offers protection to investors by insisting on the highest standards of behaviour from the members by closely examining companies before allowing a quotation. Without this protection it would be much more difficult for companies or even Government to raise money.

Pension funds and Insurance companies are to offer a better service to their client because of the existence of stock exchange which gives them a profitable outlet for their funds.

Services to the Government: By providing a ready market in gilt edged securities, the stock exchange allows government to implement the various aspects of policy which depend upon sale and purchase of government securities.

The administration of Taxation: The administration of taxation depends in some cases upon stock exchange is levied to a large extent on the profits made by buying and selling shares. The information provided on the contract notes enables the Inland Revenue to ensure that the right amount of tax is being paid. Similarly the valuation of stocks and shares for inheritance tax purposes relies upon their stock exchange valuation.

Indicator of opinion: The stock exchange is an important economic indicator. Stock exchange prices reflect the underlying economic conditions in the country and with particular industries. Low prices reflect pessimism and a grim outlook whereas high prices indicate optimism.

Factors affecting a particular share’s price:

Performance: Much depends on the recent performance of the company that issued the shares. If profits have been good and are expected to be buoyant, the price of the shares is likely to be high, as many people will try to acquire them. Poor profits will encourage shareholders to sell their holdings.

Merger: The possibility of a merger with another company may cause the share price to change and although the price will normally rise, the amount of change will depend on the view that shareholders in general take of the proposed merger.

The development of new products or techniques by a company may lead to optimum and higher share prices. Likewise, new developments by competitors may lead to a fall in the price of the share.

Government Policies aimed at a particular industry may affect share prices of companies in that industry. For example, if restriction are imposed on the hire price of motor vehicle, the share price of car may well fall in price.

General economic atmosphere: This affects all share prices. Sometimes the Government does all it can to persuade to spend money. This will normally mean a period of rising profits and many investors will instruct stockbrokers to b uy shares, causing a general rise in prices. At times Government monetary policy takes steps to reduce spending, thereby causing a fall in share prices.

Political factors may also be important. The prospect of a change in government often makes the stock exchange very jittery. The assassination of JFK has a similar effect on share prices.

Speculation on the Stock Exchange: Speculation means a practice of trying to make a quick profit by anticipating changes in the share prices. There are three ways in which this can be done.

If a share is priced at Tk10 today and you have reason to think that by next week it will be Tk12.5, you could buy 1000 shares for Tk10,000 and if your speculation is correct, you could sell them next week for Tk12500, thereby making a profit of Tk 2500. People who speculate in this way are known as “Bulls”. They may buy shares even if they have no money, hoping to pay at the end of the account out of the proceeds of the sale.

On the other hand, if you own 1000 shares priced at Tk5 today and you think the share price would fall to Tk4 next week, you could sell them today for Tk5000 and if your speculation is correct you could buy back those by Tk4000 next week making a profit of Tk1000. Speculators of this kind are called “Bears.”

It has often happened in the past that newly rapidly, since the price of the share may be low considering the expected dividend that will be paid on it. Accordingly some speculators make a practice of buying new shares, hoping to sell them very quickly at a profit. Such speculators are called ‘stags’.

Stock Exchange is a rule based well regulated institution where companies can raised their necessary capital. Normally companies can borrow from Bank and financial companies, but stock exchange offers the easy way for capital. To conclude it can be said that stock exchange is a very important institution for the economy and business people. Stock exchange acts as an indicator of the economic environment of a country.

The writer is former Director General of Export Promotion Bureau. He can be contacted at hassan.youngconsultants@gmail.com