Stock exchange Definition and How does it work? By cioreviewindia Team

Stock exchange Definition and How does it work?

cioreviewindia Team | Tuesday, 14 December 2021, 12:01 IST

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Stock exchange Definition and How does it work?The stock exchange is an essential part of the stock market. It is a way through which traders make a transaction of financial instruments. There are rules which all the traders have to follow for the transaction to get successful.

What is a stock exchange?

A stock exchange is a marketplace where buyers and sellers come together to make a transaction of financial securities issued by companies. The financial securities used for transactions mainly include shares and bonds after being issued in the primary market.

You can only trade the risky and non-listed stocks on a reputed stock exchange in an OTC or Over the Counter market. Penny stock is one of the examples of such stock. But these shares are usually not held at a high price in the stock market.

The stock exchange is how companies raise their capital and investors make long-term decisions, including real-time price information. The deal that takes place can be physical or through electronic form.

How does it work?

Generally, the stock exchange works independently as there is no specialist or market makers to regulate it. The trading process in the stock exchange market is mostly order-driven and generally takes place through electronic media.

Electronic limit order book helps in automatically matching the orders with the use of a trading computer. Through the orders, you can check the most suitable order with the match investors’ market order.

The reason why the market is order-driven is that it helps to maintain the transparency in the transaction by displaying all market orders to all.

Brokers play a vital role in how can I buy stocks in US exchange market system, generally, the place of all the orders.

Both retail and institutional traders can enjoy the advantages that come with direct market access or DMA. The investors with the help of stock exchange market brokers can place their orders directly into the trading system using trading terminals.

Contribution of stock exchanges

Stock exchange acts as an agent of the economy by spreading information and facilitating trade. Below are some other ways through which stock exchanges contributes:

Corporate Governance

Companies that are listed on the stock exchange publicly must adhere to reporting standards as set by regulating bodies. The reporting standards state that companies have to control and publicly report their earnings and financial statements to their shareholders.

The actions of company management are being analysed continuously by public scrutiny and directly impact the value of the company. Public reporting helps the management make a decision that benefits the company and its shareholders, thereby confirming efficiency.

Raising Capital

When the company needs funds to carry out an operation or expansion, it raises funds by issuing new shares or through an initial public offering. This offering serves as an avenue medium of the company to increase growth.

Economic Efficiency

Along with maintaining the management efficiency, it also facilitates economic efficiency through proper allocation of the capital. Stock exchanges provide a route for individuals to invest their cash to save these funds. This means the capital so offered will only be used in the economic benefits resulting in a more efficient economy.

Advantages of listing with the stock exchange

Listing with a stock exchange provides many benefits to the company. For example, only those companies who are listed quote their shares under stock exchange. Being listed on a stock exchange is deemed advantageous for companies. Some of the advantages are as under:

•   Gaining capital

One of the potent ways of availing cheap capital for your company is by issuing shares from the stock exchange market to acquire them easily. When companies get listed on the stock exchange, they can generate more capital for the company. The company can use it for keeping itself afloat or running its operation smoothly.

•   Increased value

The stocks that are listed in reputable stock exchanges have a higher value than the others. Companies can cash in its market value in the stock exchange market by increasing their shareholder number. Issuing shares in the stock exchange for the shareholders to invest is an effective way of growing shareholder base, resulting in a rising company’s credibility.

•  Security value

The stock listed in the stock exchange market is easily acceptable as security for extending credit facilities. A listed company makes the process even faster as there is no problem relating to credit requests and are deemed more credible in the market.

•  Fair price

The quoted price represents the real value of particular security listed in a stock exchange. The cost of listed securities set by measuring the supply and demand is shown publicly to all. Thus, investors don’t have to worry about whether they are acquiring it at a fair price or not.

•  Liquidity

When a company lists their shares on stock exchange shareholders can avail advantage of liquidity and also provide them ready marketability. It gives the shareholder the idea of the total value of the investment they are holding.

Besides, it allows sharing transactions with a company and helps them reduce the associated risks. It also increases the earnings the shareholders can get by improving the overall organizational value.

Types of Markets

The investors deal in basically two types of market:

•  Primary market: When a company issues security that has not been listed in the stock exchange before issuing securities, it is basically introduced in the primary market. Issuing an IPO is an example of this type of market. So it is the place where companies enlist their shares for the first time.

•  Secondary market: After a company has issued a new public offering, its shares continue to be traded between investors on the market. These shares now run in the secondary market. Here in this market, the traders can transact the shares without involving brokers. You can further break down this market into the auction market and dealer market.

The bottom line

In stock exchange traders come together to purchase or sell financial instruments through a physical or electronic medium. It provides many advantages to both companies and shareholders. Companies can raise more funds for their capital, and the shareholders have greater value than any other share.

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