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Stock Exchange Functions, Objectives, & Types
Updated on 25th Sep, 23 7.7 K Views

Get ready to explore the stock market like never before by delving into their essential functions, underlying objectives, and global diversity. This captivating journey on the stock market for beginners will provide you with the necessary knowledge to navigate this ever-changing realm confidently.

Table of Contents:

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What is Stock Exchange?

A stock exchange is like a market where people can buy and sell different types of investment avenues, such as stocks, bonds, and other financial products.  It acts as a regulated and transparent platform that allows investors to engage in trading. By promoting the exchange of capital, stock exchanges enable companies to secure funds for expansion while offering individuals avenues for investment.

Functions of Stock Exchange

Facilitating Trading

The stock exchange plays a crucial role in enabling the smooth trading of securities. It serves as a meeting ground for individuals looking to buy or sell securities, allowing them to conduct transactions with ease. To maintain a level playing field, the exchange implements comprehensive guidelines and regulations that oversee the process of buying and selling securities to enable fairness, transparency, and efficiency throughout.

Providing Liquidity

They play a crucial role in providing liquidity to the stock market. Liquidity refers to the ease with which securities can be bought or sold without significant fluctuations in their prices.

By stock market analysis, this exchange bring together a large number of buyers and sellers. Stock exchanges also ensure that there is a ready market for securities, which enables investors to convert their investments into cash quickly.

Ensuring Price Discovery

Price discovery refers to the process of ascertaining the fair market value of securities based on forces such as supply and demand. 

Stock exchanges provide a platform where buyers and sellers can express their willingness to buy or sell securities at various prices. Through continuous stock market trading and the matching of buy and sell orders, stock exchanges facilitate the discovery of equilibrium prices for securities.

Promoting Transparency

Transparency plays a key role in stock exchanges by allowing easy access to information about listed companies, such as financial reports, announcements, and corporate actions. This enables investors to make informed decisions based on accurate and timely information, thereby instilling confidence in them.

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Features of Stock Exchange

Some of the features of stock exchange are listed below:

  • Recognition- To receive official approval by the central government.
  • Market for securities – It is a thriving marketplace where government, corporate companies and semi-government companies’ securities can be bought and sold.
  • Regulate Trade of Securities- The exchange does not directly trade bonds and shares; rather, brokers or exchange members handle them on its behalf.
  • Measuring device – It assesses and illustrates the development and security of businesses listed on an exchange index.
  • Operating according to regulations-All security transactions at a stock exchange are governed by its rules and regulations as well as SEBI guidelines.
  • Trading only registered securities – Only listed securities registered with the exchange office can be traded.
  • Transaction- Only through licensed brokers and members is it possible to transact securities.
  • Second-Hand Securities- This refers to bonds or shares issued by a company previously and sold on secondary markets.

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How Stock Exchanges Work?

How Stock Exchanges Work

Stock exchanges function through a series of interconnected processes. Let’s explore the key components:

Listing of Securities

Before securities can be traded on a stock exchange, they need to be listed. Companies interested in listing must meet the specific eligibility criteria set by the exchange, including financial performance, corporate governance standards, and compliance with disclosure requirements. Once listed, securities become available for stock market trading to investors on the exchange.

Trading Mechanism

Stock exchanges employ various trading mechanisms to facilitate the buying and selling of securities. The most common mechanism is an auction-based system, where buyers and sellers place orders indicating the quantity and price at which they are willing to transact. The exchange matches the buy and sells orders based on price and time priority to execute the trades and update the stock market price accordingly.

Clearing and Settlement

After trades are executed, the process of clearing and settlement takes place. Clearing involves verifying the trade details, reconciling the obligations of buyers and sellers, and ensuring the financial and legal integrity of transactions. The settlement involves the actual exchange of securities and funds between the parties involved. Clearinghouses and custodian banks play a crucial role in facilitating these processes.

Regulatory Framework

Stock exchanges operate within a robust regulatory framework to maintain market integrity and protect investors. The regulatory framework includes rules and regulations that govern listing requirements, trading practices, market surveillance, and investor protection. Compliance with these regulations is enforced by regulatory bodies and exchanges themselves to ensure fair and transparent market operations.

Market Makers: Market makers are entities, typically brokerage firms, that provide liquidity to the market by quoting bids and asking prices for specific securities. They stand ready to buy or sell securities at any time, thereby ensuring continuous trading and reducing price volatility. Market makers play a crucial role in maintaining an orderly market and facilitating efficient transactions.

Regulatory Bodies: Regulatory authorities, like the Securities and Exchange Commission (SEC) in the United States and the Financial Conduct Authority (FCA) in the United Kingdom, assume the critical responsibility of overseeing and supervising the activities of stock exchanges. These entities ensure adherence to securities laws, monitor market operations and safeguard the welfare of investors. By upholding market integrity and stability, regulatory bodies play an essential role in maintaining a secure and fair trading environment.

Moreover, stock exchanges contribute to the efficient allocation of resources within the economy. The stock market trading activities on exchanges reflect the collective knowledge of investors, who analyze and evaluate the prospects of different companies. As a result, stock prices mirror the expectations of market participants and provide valuable information about the underlying value and performance of businesses. This information guides decisions regarding the allocation of capital, ensuring that investments flow toward the most promising and efficient companies. This process helps align capital with productive economic activities, leading to improved overall efficiency and productivity.

Objectives of Stock Exchange

The objectives of a stock exchange can be summarized as follows:

  • Facilitate Capital Formation: Stock exchanges provide a platform for companies to raise funds by issuing and selling securities like stocks and bonds to investors. This allows companies to obtain the necessary capital for expansion, research and development, and other important projects.
  • Enable Easy Trading and Liquidity: Stock exchanges serve as a marketplace where investors can conveniently buy and sell securities. They create a regulated and transparent environment that encourages liquidity, allowing investors to convert their investments into cash quickly and efficiently. This liquidity promotes investor participation and improves the efficiency of the stock market.
  • Establish Fairness and Transparency in Pricing: Stock exchanges strive to ensure that securities are priced fairly and transparently. Market prices are determined through open and competitive trading, reflecting the forces of supply and demand. This transparency helps investors access reliable information about the value of securities and make well-informed investment decisions.
  • Safeguard Investors and Build Confidence: Stock exchanges prioritize investor protection and work towards creating a trustworthy market. They establish rules and regulations to govern trading activities, preventing unfair practices and fraudulent behavior. By enforcing compliance and disclosure requirements, stock exchanges enhance investor confidence and maintain market integrity.

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Investment Methods

Investors have two primary ways of investing in stock exchanges:

Primary Market (or Bond Market): This marketplace creates securities by acting as a platform where firms float new stock options and bonds for general public purchase, and where companies first list their shares for trading on an exchange.

Secondary Market (or Stock Market ): It serves as an investor trading platform and acts as a market for trading securities without dealing with companies who issued them directly via brokers. It can further be broken down into the auction market and dealer market.

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Role of Stock Exchanges in the Economy

Stock exchanges are like lively centers of the economy and are all over the stock market news. They create the base for financial markets and make sure that capital markets work well. Think of these exchanges as busy marketplaces, full of energy and chances, where different kinds of investments like stocks, bonds, and other financial products are happily bought and sold. This helps companies to get the money they need to grow and achieve their goals, while investors happily take the opportunity to easily trade these investments, making everyone happy.

Stock exchanges play a significant role in facilitating economic growth by streamlining the process for investors to provide capital to companies. When companies choose to list their stocks on an exchange, they can attract a diverse range of investors, including large corporations, individual investors, and even international entities. 

The infusion of capital enables companies to undertake pivotal initiatives such as business expansion, investment in innovative concepts, and the creation of additional employment opportunities. This active engagement in capital markets fosters a climate of innovation, enhances operational efficiency, and contributes to the comprehensive advancement and augmentation of the overall economy.

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Key Players in a Stock Exchange

Several key players participate in the functioning of a stock exchange. Let’s explore their roles and responsibilities:

Key Players in a Stock Exchange

Stockbrokers: Stockbrokers are licensed professionals who act as intermediaries between investors and the stock exchange. They execute buy and sell orders on behalf of clients and provide investment advice. Stockbrokers play a vital role in facilitating transactions and ensuring compliance with exchange regulations.

Traders: Traders are individuals or entities that buy and sell securities on the stock exchange. They aim to capitalize on short-term price movements and stock market inefficiencies to generate profits. Traders employ various strategies, such as day trading, swing trading, or algorithmic trading, to execute trades and maximize returns.

Famous Stock Exchanges Around the World

Stock exchanges exist globally, serving as centers of financial activity in various countries. Some of the most renowned stock exchanges include the following:

New York Stock Exchange (NYSE): The NYSE, situated in the bustling city of New York, holds the prestigious title of being the largest stock exchange globally when it comes to market capitalization. With a remarkable lineage tracing back to 1792, this exchange has become a hub for a multitude of renowned companies, establishing itself as a powerhouse in the world of finance.

NASDAQ: NASDAQ, which is an electronic exchange situated in the United States, stands out as a prominent marketplace that specializes in technology and companies with a growth-oriented outlook. Renowned for its advanced trading platform, NASDAQ features notable industry giants such as Apple, Amazon, and Microsoft among its prestigious list of listed entities.

London Stock Exchange (LSE): Placed in London, the LSE stands proud as one of the most historic and prominent stock exchanges globally. Renowned for an extensive roster of listed companies, the LSE operates multiple market segments, including the main market and the alternative investment market (AIM). LSE’s reputation as a hub for diverse investment opportunities and its long-standing presence in the financial landscape contribute to its status as one of the world’s oldest and largest stock exchanges.

Tokyo Stock Exchange (TSE): As Japan’s primary stock exchange, the TSE plays a crucial role in the country’s financial markets. It lists major Japanese companies and is known for its technological advancements and efficient stock market trading systems.

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Emerging Trends in Stock Exchange

Stock exchanges continue to evolve to meet the changing needs of market participants. Mentioned below are some emerging trends in the industry:

Digitalization and Blockchain: Stock exchanges are exploring the use of blockchain technology to enhance transparency, security, and efficiency in trading and settlement processes. Blockchain-based platforms can streamline the issuance and trading of securities, reduce intermediaries, and improve liquidity.

Sustainable Investing: Stock exchanges are witnessing a growing interest in sustainable investing with the rise of Environmental, Social, and Governance (ESG) considerations. Exchanges are introducing ESG-focused indices and listing requirements to promote responsible investment practices and support companies with strong sustainability credentials.

Expansion of Derivatives Markets: Stock exchanges are broadening their derivatives markets to present a wider selection of investment and risk management instruments. By introducing fresh derivatives products, such as options and futures, investors are presented with supplementary opportunities for both hedging and speculation.

Conclusion

Stock exchanges are vibrant establishments that hold immense significance in the economy by enabling capital formation, fostering market liquidity, and establishing equitable and transparent trading environments. Developing a comprehensive understanding of the operational mechanisms and prevailing international patterns equips individuals with profound insights into the complexities of stock exchanges. Thus, embracing this invaluable knowledge allows for an enriching exploration into the captivating domain of stock exchanges.

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