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Stock market

From Academic Kids

A stock market is a market for the trading of publicly held company stock and associated financial instruments (including stock options, convertibles and stock index futures).

Contents

Trading

Traditionally, stock markets were open-outcry where trading occurred on the floor of a stock exchange. Most modern stock trading is done in electronic exchanges where buying and selling occurs via online real-time matching of orders placed by buyers and sellers.

Ownership

Many years ago, worldwide, buyers and sellers were individual investors and businessmen. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, investor groups, and banks). The rise of the institutional investor has brought with it an increase of professional diligence which has tended to regulate the market.

The character of markets around the world varies, for example with the majority of the shares in the Japanese market being held by financial companies and industrial corporations, compared with the broader ownership of stock by individuals in the USA or the UK.

History of the Stock Exchange

In 12th Century France the courratier de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers.

In the late 13th Century Bruges commodity traders gathered inside the house of a man called Van der Bourse, and in 1309 they institutionalized this until now informal meeting and became the "Bruges Bourse". The Idea quickly spread around Flanders and neighbouring counties and "Bourses" soon opened in Ghent and Amsterdam.

In the middle of the 13th Century Venice Bankers began to trade with government securities. In 1351 the Venician Government outlawed spreading rumors intended to lower the price of government funds. Pisa, Verona, Genoa and Florence also began trading with government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influental citizens.

In 1602 the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange.

International markets

The first stock exchange to trade continuously was Amsterdam's Beurs, in the early 17th century. The Dutch "pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them" (Murray Sayle, "Japan Goes Dutch," London Review of Books XXIII.7, April 5, 2001).

There are now stock markets in most developed economies, with the world's biggest markets being in the USA, China, Japan, and Europe.

Stock index

Main article: stock market index

The movements of the prices in a market or section of a market are captured in price indices called Stock Market Indices, of which there are many, e.g., the Standard and Poors Indices and the Financial Times Indices. Such indices are usually market-capitalisation weighted.

Derivative instruments

Main article: derivative security

An option is a contract that gives an investor the right to buy or sell a security such as a stock or index at an agreed-upon price during a specified period with no obligation.

A future is a contract that gives an investor the obligation to buy or sell a security at an agreed-upon price during a specified period.

The markets for options and futures are generally somewhat less liquid and more risky than for the underlying stock.

Leverage Strategies

Stock that a trader does not actually own may be traded using short selling and margin buying.

Short selling

In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for the price to fall. The trader eventually buys back the stock, making money if the price fell in the meantime or losing money if it rose. Exiting a short position by buying back the stock is called "covering a short position".

Margin buying

See also: leverage (finance)

In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value. Other rules may include the prohibition of freeriding: putting in an order to buy stocks without paying initially, and then selling them and using part of the proceeds to make the original payment.

Stock Market Regulation in the U.S.

Before 1929, there were few regulations governing trades. In the 1920s there were many abuses in the sale and trading of securities. State blue sky laws were easy to evade by making security sales across state lines. After holding hearings on the abuses Congress passed The Securities Act of 1933. It regulates the interstate sales of securities and made it illegal to sell securities into a state without complying with the state law. It requires companies which want to sell securities publicly to file a registration statement with the Securities & Exchange Commission. The registration statement provides a lot of information about the company and is a matter of public record. The SEC does not approve or disapprove the issue, but lets the statement "become effective" if sufficient required detail is provided, including risk factors. Then the company can begin selling the stock issue, usually through investment bankers.

The next year Congress passed the Securities Exchange Act of 1934 which regulates the secondary market (general-public) trading of securities. Initially it applied only to stock exchanges and their listed companies (as the word "Exchange" in the act's name implies). In the late 1930s it was amended to provide regulation of the over-the-counter (OTC) market (i.e., trades between individuals with no stock exchange involved). In 1964 it was amended to apply to companies traded in the OTC market.

Levels and flows

Main article: equity levels and flows

Issuance of equity and equity-related instruments totaled $505bn worldwide in 2004, a 29.9% increase over the $389bn raised in 2003. Initial public offerings increased nearly 220% with 233 offerings that raised $44 billion.

See also

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