A hub in which shares of companies are issued and traded
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An equity market is a hub in which shares of companies are issued and traded. The market comes in the form of an exchange – which facilitates the trade between buyers and sellers – or over-the-counter (OTC) in which buyers and sellers find each other.
The equity market is also referred to as the stock market and is one of the most important leading indicators of the market economy. It also plays a pivotal role in supporting a market-based economy since it is the bridge between providing capital to companies who require it and providing investments for investors who are seeking a return on their investment.
Understanding Equity Markets
As mentioned, equity markets are the hub that connects buyers and sellers of equities. Equity securities are initially listed on the markets through an initial public offering (IPO) and are subsequently traded among people on the secondary market.
The trading can be done either publicly – which are listed on public exchanges – or privately, where the issuances and trades are initiated through dealers instead of a centralized exchange. The use of dealers in the private market is the defining feature of OTC markets.
History of Equity Markets
Equity markets come with long-entrenched histories, with debt issuances dating back to the 1300s. The first stock market was established in Belgium in 1531. The exchange dealt primarily with promissory notes and bonds, but not with actual stocks.
Throughout the 1600s, the British, Dutch, and French governments gave charters to companies that included ‘East India’ in their monikers. The countries would take stakes in the profits from India and Asia by funding sea voyages that would bring back goods – although it was risky due to the abundance of pirates, poor weather, and faulty navigation.
Instead of bearing all the risk for themselves, ship owners would seek out investors to help fund voyages, and in return, provide investors with a percentage of the profits should the voyage be successful.
They were the earliest forms of limited liability companies (LLCs) that would last a single voyage. Shipowners could send their ships without bearing the risk for themselves, and investors could diversify their risk by investing in multiple different ships and voyages.
The East India companies eventually began paying dividends from the proceeds collected from multiple voyages instead of creating single-time LLCs for each voyage. It was the first form of joint-stock companies in which the companies could demand more capital, build larger fleets, and provide larger returns for investors.
Top Equity Exchanges
Some of the most well-known and largest equity markets are:
Equity markets play an important role in a market-based economy. They provide capital raising, liquidity, and investment options.
These important functions allow our economy to grow continuously, and they are the hallmark of capitalism.
1. Capital Raising
Equity markets facilitate the raising of equity capital. This is important for entrepreneurs who have a business idea but do not have the capital on-hand to start the business themselves.
Banks are debt investors who are unlikely to provide a loan to these businesses without collateral or an abnormally high return. Therefore, it is effective for these entrepreneurs to give up a stake in their business in exchange for the capital provided.
Equity markets allow these businesses to access the deepest pools of capital since they do not have to seek out individual investors – the investors are brought to them through the network of investment banks and financial exchanges.
Equity markets also provide liquidity for the markets. Liquidity refers to the ease of which an asset can be turned into cash. For example, checking accounts are the most liquid, and a painting will be illiquid.
Since equity markets are a centralized hub for buyers and sellers, it is easy to find someone who is willing to buy or sell your equity securities, and you can readily convert your securities to cash.
Equity markets are powerful pricing mechanisms since they reflect the immediate underlying supply and demand from millions of buyers and sellers across the globe. High demand and increased buying activity for stocks cause prices to rise, while low demand and increased selling activity for stocks cause prices to decline.
3. Investment Options
Equity markets provide a slew of investment options for investors. Investors can customize their risk profile and get exposure to different companies and industries by having the option to pick different equity securities.
Equity markets also provide the main alternative to debt investments, which is beneficial for investors with higher risk tolerance.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:
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