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Stock Exchange

A marketplace where securities are bought and sold.

What is a Stock Exchange?

A stock exchange is a marketplace where securities, such as stocks and bonds, are bought and sold. Bonds are typically traded Over-the-Counter (OTC), but some corporate bonds can be traded in stock exchanges. Stock exchanges allow companies to raise capital and investors to make informed decisions using real-time price information. Exchanges can be a physical location or an electronic trading platform. Though people are typically familiar with the image of the trading floor, many exchanges now use electronic trading.

 

Stock Exchange Image

 

Purpose of Stock Exchanges

Stock exchanges act as an agent for the economy by facilitating trade and disseminating information. Below are some of the ways exchanges contribute:

1. Raising Capital: through initial public offerings (IPO) or issuing of new shares, companies are able to raise capital to fund operations and expansion projects. This provides companies with avenues to increase growth.

2. Corporate Governance: companies that are publicly listed on a stock exchange must conform to reporting standards that are set by regulating bodies. This includes having to regularly and publicly report their financial statements and earnings to their shareholders. The actions of a company’s management are constantly under public scrutiny and directly affect the value of the company. This ensures that management will make decisions that benefit the goals of the company and its shareholders, thereby acting efficiently.

3. Economic Efficiency: in addition to encouraging management efficiency, exchanges also facilitate economic efficiency through the allocation of capital. Stock exchanges provide an avenue for individuals to invest their cash as opposed to merely saving these funds. This means that this capital that would otherwise be untouched is utilized towards economic benefits, resulting in a more efficient economy. Coupled with this, exchanges also provide liquidity as it is relatively easy to sell one’s holdings. By providing liquidity and real-time price information of company shares, the stock exchange also encourages an efficient market by allowing investors to actively decide the value of companies through supply and demand.

 

Notable Stock Exchanges

1. New York Stock Exchange (NYSE): founded in 1792, the New York Stock Exchange is by far the largest exchange in the world. As of March 2018, it had a market capitalization of US$23.12 trillion.

2. NASDAQ: founded in 1971, NASDAQ is an American stock exchange and is the second-largest in the world by market capitalization. It had a market capitalization of US$10.93 trillion as of March 2018. Many tech and growth firms choose to be listed on the NASDAQ.

3. Shanghai Stock Exchange (SSE): founded in November 1990, the Shanghai Stock Exchange is the fourth-largest exchange in the world. It had a market capitalization of US$5.01 trillion as of March 2018. There are two types of stocks listed on the SSE, ‘A shares’ and ‘B shares’. A shares are quoted in RMB and have historically had their trade restricted to domestic investors. As of July 2018, China has announced additional plans to allow foreign investors to access A shares through domestic brokerages. B shares are quoted in USD and are open to domestic and foreign investors alike.

 

Listing Requirements

All companies that wish to go public must satisfy certain reporting requirements as outlined by the securities commissions of their respective jurisdictions.

In the United States, the Securities and Exchange Commission dictates that companies must discuss and publish their financial statements as well as other disclosures. These are published in the form of quarterly and annual reports.

On top of these requirements, in order to be listed on an exchange, a company must also satisfy the requirements of the stock exchange they wish to be listed on. Below are some examples of listing requirements by the three aforementioned exchanges. Listing requirements may also differ for initial public offerings (IPO).

  1. New York Stock Exchange (NYSE):
    • Pre-tax income for the past 3 years must be at least US$10,000,000
    • Market capitalization of publicly held shares must be at least US$100,000,000
    • Publicly held shares must be greater than 1,100,000
  2. NASDAQ:
    • Pre-tax income for the past 3 years must be at least US$11,000,000
    • Market capitalization of publicly held shares must be at least US$45,000,000
    • Publicly held shares must be greater than 1,250,000
  3. Shanghai Stock Exchange (SSE):
    • Capital stock must exceed RMB¥50,000,000
    • Publicly issued shares must account for at least 25% of all shares; if the company’s capital stock exceeds RMB¥400,000,000, publicly issued shares must account for at least 10% of all shares
    • No major legal violations in the past three years or fraudulent records in the company’s financial reports

Please note this is not an exhaustive list of the requirements to be listed in each respective stock exchange.

 

Primary Market

When a company issues new securities that did not previously exist on any exchange, it is issuing securities to the primary market. Undergoing an IPO is an example of this. The company offers securities to the investors to raise capital and becomes listed on the stock exchange.

 

Stock Exchange Primary Market

Image from CFI’s Free Introduction to Corporate Finance course.

 

Secondary Market

After a company undergoes an IPO, its shares continue to be traded between investors on the market. This is referred to as the secondary market. The company is no longer involved in any of these transactions. The stock exchange facilitates trade between buyers and sellers in the secondary market.

Stock Exchange Secondary Market

 

Additional Resources

Looking to learn more about finance and stock markets? Corporate Finance Institute offers a range of courses and resources that can help you expand your knowledge and further your career! Check them out below:

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