22. stock exchanges

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Financial Markets and Financial Institutions

The Stock Exchange

The Stock exchange is a trading location where securities are traded, where buying

and selling of securities take place ,and at which the price of listed securities are

determined.

Stock exchanges are formal organizations and legal entities (usualggy joint-stock

companies), approved, licensed and regulated by the Regulator (the Securities and

Exchange Commission SEC) , that are made up of members that use the facilities to

exchange listed securities .

Stocks that are tarded on an exchange are known as listed stocks, and in order to be

classified as listed , the issuing company must apply and satisfy requirments

established by the exchange where listing is sought.

To have the right to trade securities on the floor of the exchange, brockerage firms

must apply for membership and they may buy a seat on the exchange. The cost of the

seat is market determined. Others can trade from their offices if they are electronically

linked to the Exchange trading system.

Member brokers of an exchange trade securities on behalf of their customers in

accordance with the trading rules of the Exchange. While every broker on the fllor has

and operate his own computer and can see all action on his screen, trades/transactions

are displayed on a big screen so everybody can see market activityies real time. 1

Brokers charge commission on transactions , according to the value and the volume of

securities involved. The commission is usally negotiable between investors and

brokers but there are cases where the Stock Exchange fixes a minimum commission

and it is structured in a way that don not allow the commission rate to decline as the

number of securities increase.

Role and Functions of the Stock Exchange

1 On New York Stock Echange there is a different system. For Ecample, each stock is traded at a

specific location on the trading floor called a post . On an exchange the market maker role for a listed

stock is performed by specialist..A member firm may be designated as a specialist for the commonstock of more than one company , but only one specialist is designated for common stock of a given

company. On the exchange there is only one market maker or dealer per stock , known as specialist .

The specialist keeps the limit order book. Designation of who will be specialist for a stock is

determined by the exchange , taking numerous factors into account. Because capital is necessary to

perform as a market maker , one requirment is satisfaction of the minimum capital requirment. As there

is only one specialist for a given stock , there is no competition from other market makers on the

exchange. Dealers provide the opportunity for investors to trade immediately rather than waiting fo rthe

arrival of suficient orders on the other side of the trade. Dealers offer price information to the market

participants. Dealers serve as auctioneers in bringing order and fairness to a market. Dealers buy for

their own account and maintain inventories of securities and their profits come from selling assets at

higher price than they purchaased them.

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The Stock Exchange is a place for trading with sufficient facilities and is a good

pricing machanizm for the securities which are listed on the Exchange. In order to

understand the role and functions of the stock exchange as a secondery market and

how does it operate , the securities market has to be analysed with respect to three

areas of concern

1. Market Infrastructure:

Institutional infrastructure provides the operational basis for the market: brokers ,

investment advisors , stock exchanges , currency exchanges , rating agencies ,

settlement system , registration systems , custodial services , legal advisors , auditors

and accountants.

2. Law enforcement infrastructure:

Regulatory infrastructure centers on the government body or bodies which have the

power and responsibility to supervise the market but also includes self-regulatoryorganizations such as stock exchanges , accounting standards boards and accounting

and auditing professional associations and similar organizations. It also include their

rules and regulatory procedures and facilities such as stock exchange listing and

trading rules or accounting and auditing standards , plus the monitoring and most

important , enforcement of these rules.

3. Regulatory and Legal infrastructure:

Legal infrastructure provides the underpinning to the operational and regulatory

infrastructure. It establishes the framework of property rights, contractual

relationships, forms of incorporation , and rights and responsibilities of participants in

the market. It also specifies the powers and responsibilities of the government

supervisory authority and self-regulatory organizations.

As the Stock Echange, like any other financial intermediary, should be licensed and

be subject to inspection and supervision, the license requirements include that the

trading system and arrangements on the Exchange should be characterized as (FELT),

i.e :

Fair;

Efficient;

Liquid; and

Transparent.

1) Fair: Both small and large investors should have equal access to shares

at comparable prices. Additionally , information flows and transaction

execution should not favour insiders or outsiders

2) Efficient: the trading system must be established in such a way that

paperwork is kept to a minimum, and operations are conducted in the

most direct and simple way with the lowest cost. Time is also an

important factor , including the capacity to settle a trade quickly, rather

than being locked in while cumbersome settlement procedures are

executed.

3) Liquid: a trading system should foster high availability of shares onboth the buy and sell sides. This also implies low transaction costs,

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generated by frequent turnover, which enable market participants to be

active in the market. It helps if a small number of listings do not

dominate the market. volume of trading should be high enough that all

but the largest of market players are unable to move markets

4) Transparent : the true nature of supply and demand should be apparent

to the investor so he is able to judge the parameters within which hemust work when completing his trades. This transparency fosters

liquidity, fairness and efficiency.

Since listed securities on the Exchange cannot be traded outside the Exchange, the

price of traded security reflects the actual demand and supply forces for

such security at a particular time. Therefor, the Stock Exchange is a good

pricing mechanizm for the listed securities.

Automated Order Routing System

The Stock Exchange has a system for routing orders submitted by brokers via

computers directly to the Exchange main computer where the order can be executed.

Fragmented Market:

We mean by fragmented market , one in which some orders for a given stock are

handled differently from other orders.

There are two examples of this fragmented market:

1- the different handling of small orders versus large orders on the same

exchange.2- Stocks that can be bought on several exchanges as well as the over the

counter market.

The Regulator

The Regulator regulates the structure in the stock market , which lead to enhancing

the competition and comprehensive disclosure of market information should be

fostered in order to generate the best prices for investors and the interests of public

investors and should be placed ahead of the brokers.

Trading structure:

In the secondry markets, some market are continuous trading markets which means

that the prices are determined continuosly throughout the trading day as orders are

submited. Others, are call trading market, in which orders are batched or grouped

together for simultaneous execution at the same price. Finally, some stock markets

such as the New York Stock Exchange are mix between the two systems.

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22. stock exchanges

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