Stock Exchange and Share Prices | Economics

In this article we will discuss about the functions of stock exchange.

Meaning of Stock Exchange:

A stock exchange is a market in industrial and financial securities which facilitates the investment of funds and subsequent liquida­tion of such investment. The Securities Contracts (Regulation) Act of 1956 defines a stock exchange as “an association or organisation or body of individuals, whether incorporated or not, established for the purpose of assisting and controlling business in buying, selling and dealing in securi­ties.” Such a market is found in most of the important trading centres of the world, such as in Calcutta, Mumbai, London, New York, Tokyo etc., and they deal in second-hand securities.

Economic Functions and Importance:

A stock exchange performs the following useful economic functions which reveal its importance in the economy of a country:

(i) Continuous market in security:

A stock exchange is a ready and continuous market for buying and selling securities, mostly old and in some cases new shares of the company. By offering a wide choice in securities it promotes investment by the people as well as by the institutions (like UTI, LIC, etc.).

(ii) Ready Market for capital:

The stock exchange provides a market for capital which is already invested. Although the stock exchange is not itself the market for new capital, the advantages which it offers, particularly ready readability of investment are vitally important in stimulating and encour­aging the flow of new capital for industrial and commercial ventures.

(iii) Mobility of Capital:

Regular buying and selling of shares through stock exchange makes capital mobile. In fact, capital would have become less mobile if stock exchanges did not exist at all. Individuals or corporate bodies with funds to invest would be unwilling to do so if difficulty was likely to be experienced afterwards in converting the securities back into money.

(iv) Offering excellent investment opportunity and maintaining liquidity for investment:

The stock exchange provides excellent opportu­nities for investment in securities by both individuals and institutions. Investment in select company shares brings good returns in the form of dividends and in the form of capital appreciation on a regular basis. At the same time, it makes the investment in shares liquid as they can be easily evaluated at the price quoted in the stock exchange and can be easily disposed of through the brokers.

(v) Sale and purchase of securities at their true value:

Stock exchange facilitates the sale and purchase of securities at their true values. The true values of shares necessarily depend on the degree of risk behind the security, on its dividend-earning capacity and on its future possibility. It is said that the true value of a security is what it will fetch. This is really determined by the well-informed dealers operating in the market.

(vi) Safeguarding of the interest of the investors:

The stock exchange safeguards the interest of the investors as the well-known securities are listed in the market and their day-to-day market prices are quoted. The investors can easily evaluate their present holdings with these quoted prices.

Besides, the stock exchange protects their interest through the strict enforcement of rules and regulations. In the absence of organised stock exchanges, the innocent share-investors might have been deceived by the clever and dishonest share-brokers operating in such exchanges.

(vii) Machinery for the settlement of disputes:

The stock exchange offers a machinery for the settlement of disputes among the members and between the members and the clients. The governing body of a stock exchange regulates the dealings of members among themselves as also with their clients by improving necessary regulations.

(viii) Opportunities for speculation:

The stock exchange provides facili­ties to the intelligent speculators to speculate and reap profits from the fluctuations in share prices.

(ix) Control of unhealthy speculation:

A stock exchange controls un­healthy speculation in securities by fixing margin on each transaction or by making arrangement by the clearance of transactions within a stipulated period of time.

(x) Proper functioning of the economy:

The operation in stock exchanges regulates the sentiment and trend of progress of the economy. Prosperous condition of a country is well-reflected in the busy and brisk stock-market transactions. On the other hand, any depressed conditions of the economy make the stock-market sentiment very dull and reduce the volume of transactions in the stock exchanges.

But, the stock exchange does not always perform good functions as stock-market dealings are not always carried out on a rational basis. Un­healthy speculation and gambling (through the adoption of such essential practices like spreading of rumours about the affairs of a company, share- cornering, etc.) sometimes play a considerable part in fixing the market prices of securities. Sometimes the dishonest operators try to rig the market by spreading false rumours about the company concerned and inducing the shareholders to make nervous selling of the shares.

In spite of such limitations, a stock exchange plays a very useful role in the proper functioning of the industrial companies in particular and of the economy in general.

Fluctuations of stock market or factors determining share prices:

Fluctuation of stock-exchange refers to the fluctuation in the prices of shares and securities quoted and transacted through the stock exchanges. There may be general ups and downs affecting the prices of shares and securities quoted and transacted through the stock exchanges. There may be general ups and downs affecting the prices of all securities at the same time or it may be a fluctuation in the price of a particular share or of a group of shares.

Fluctuations in share prices arise due to the following factors:

(i) Present and future economic situation of the country, particularly changes in the industrial atmosphere;

(ii) Trends in the general price level in the country, that is, inflation or deflation in the economy;

(iii) Changes in the government policy relating to taxation, subsidies and expenditure, particularly at the time of the presentation of the budget;

(iv) Changes in the government’s industrial policy relating to expan­sion, restriction and nationalisation of industrial concerns;

(v) Any major political change in the country or sudden death of a national leader;

(vi) Speculative activities of the stock-market operators;

(vii) Major changes in the international affairs and their possible reac­tions on the stock market;

(viii) War or depression in the country;

(ix) Price fluctuation of a particular share due to better working results, prospect of good dividends, prospect of issue of bonus shares, right shares and convertible debentures, possibilities of future expan­sion, reputation and good management of the concern, etc.; and,

(x) Fluctuation due to increase in buyer’s interests, loading or unload­ing of holding by major institutions, nervous sale by operators or investors, and so on.