Functions and Effects of Stock Market

Introduction

Stock exchange is an organized market for buying and selling corporate and other securities. Here, securities are purchased and sold out as per certain well-defined rules and regulations. It provides a convenient and secured mechanism or platform for transactions in different securities. Such securities include shares and debentures issued by public companies which are duly listed at the stock exchange and bonds and debentures issued by government, public corporations and municipal and port trust bodies.

Stock exchanges are indispensable for the smooth and orderly functioning of corporate sector in a free market economy. A stock exchange need not be treated as a place for speculation or a gambling den. It should act as a place for safe and profitable investment, for this, effective control on the working of stock exchange is necessary. This will avoid misuse of this platform for excessive speculation, scams and other undesirable and anti-social activities.

Functions of Stock Exchange:

Continuous and ready market for securities: 
Stock exchange provides a ready and continuous market for purchase and sale of securities. It provides ready outlet for buying and selling of securities. Stock exchange also acts as an outlet/counter for the sale of listed securities.
Facilitates evaluation of securities:
Stock exchange is useful for the evaluation of industrial securities. This enables investors to know the true worth of their holdings at any time. Comparison of companies in the same industry is possible through stock exchange quotations (i.e. price list).
Encourages capital formation: Stock exchange accelerates the process of capital formation. It creates the habit of saving, investing and risk taking among the investing class and converts their savings into profitable investment. It acts as an instrument of capital formation. In addition, it also acts as a channel for right (safe and profitable) investment.

Provides safety and security in dealings: Stock exchange provides safety, security and equity (justice) in dealings as transactions are conducted as per well-defined rules and regulations. The managing body of the exchange keeps control on the members. Fraudulent practices are also checked effectively. Due to various rules and regulations, stock exchange functions as the custodian of funds of genuine investors.
Regulates company management: 
Listed companies have to comply with rules and regulations of concerned stock exchange and work under the vigilance (i.e. supervision) of stock exchange authorities.
Facilitates public borrowing: 
Stock exchange serves as a platform for marketing Government securities. It enables government to raise public debt easily and quickly.
Provides clearing house facility: 
Stock exchange provides a clearing house facility to members. It settles the transactions among the members quickly and with ease. The members have to pay or receive only the net dues (balance amounts) because of the clearing house facility.
Facilitates healthy speculation: 

Healthy speculation, keeps the exchange active. Normal speculation is not dangerous but provides more business to the exchange. However, excessive speculation is undesirable as it is dangerous to investors & the growth of corporate sector.
Serves as Economic Barometer: 
Stock exchange indicates the state of health of companies and the national economy. It acts as a barometer of the economic situation / conditions.
Facilitates Bank Lending: 
Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities. This gives convenience to the owners of securities.

Effect on Economy

Most days the stock market goes unnoticed, quietly ticking up and down. Every so often, however, it climbs or crashes. Suddenly, it's the leading news story. The stock market is one of the gauges of the economy. The health of the stock market has a far-reaching impact, economics professor Jeremy Crimmel says. It affects how much money is being deposited back into the economy and how much confidence consumers have in the stability of their income. Whether an individual has money in the stock market or not, what happens on Wall Street matters. A strong stock market is key to the success of the economy, Crimmel says.

Wealth Effect

When people are making money in their investment accounts and in their 401(k)s, they tend to spend more, said Matthew Tuttle, a money manager with Tuttle Tactical Management and author of "How Harvard and Yale Beat the Market." The spending stimulates economic growth, he said. Conversely, as the market decreases, individuals lose wealth, which often leads to a reduction in spending, said Crimmel, who teaches at La Salle University in Philadelphia. When investors lose money on shares in the stock market, they may be less willing to spend money. This results in a reduction in consumer spending.

Retirement Accounts

Many people rely on retirement accounts that are connected to the stock market, Crimmel said. A sudden drop in the value of these accounts may alter and delay an individual's retirement plans. This can lead to fewer job openings, potentially increasing the level of unemployment. A December 2009 article on the Urban Institute website backs this sentiment, but points out that low stock prices aren't always a bad thing. While low asset levels in retirement accounts can delay retirement, those who still have time before retiring are able to take advantage of bargain stock prices.

Business Investment

One of the ways companies make money is by selling stock, Crimmel said. Companies often use money raised by selling stock to fund expansions of factories, buy new equipment or upgrade computer operating systems. When stock prices are low, companies cannot raise as much money. Not only is a company's stock worth less, there may be fewer buyers. When the stock market is not performing well, investors are less likely to purchase stock, Crimmel added. This leads to fewer funds to use for expansions or improvements. When a company spends less money on improvements, it is infusing less money into the economy.

Bond Market

When stocks are worth less, many investors look to protect their money by investing it where they have a guaranteed return, such as government-issued bonds. As more investors buy bonds, the price of the bonds increase, Crimmel said. As the price of the bond goes up, the interest rates goes down. Lower bond interest rates have a ripple effect on the economy, according to Crimmel. Retirees, for example, often depend on the interest rate payment from government-issued bonds or from CDs from their bank. When the interest rate is lower, these retirees receive less money for their investments. Lower income for retirees results in less spending.

Written by

Amjad Wadood

Agriculture University Peshawar