ROLE OF A STOCK EXCHANGE
A Stock exchange is an exciting place in 2015, many years back it ...
ROLE OF A STOCK EXCHANGE
A Stock exchange is an exciting place in 2015, many years back it was very different. There has been a clear evolution, that’s why we are going to go back, back to the birth of the stock exchange. That’s the year 1602 Amsterdam; this was where the Dutch East India Company was born. The Dutch East India Company did something very simple; they sailed all across Europe down towards the East Indies to trade in spices. These deep sea voyages were dangerous; all the spices were then imported back to Europe.
Birth of a Stock Exchange
This is where it all began; the ships would sail all across under Africa, the coast of Madagascar crossing India into Indonesia. That is a long way off, for the spices they took such a big risk of failing, pirates and who knows what.
This was unprecedented, it was expensive and these are not one or two ships, these are thousands of wooden ships. So there was risk and it was really expensive.
Now this posed an interesting situation, on one side you had amazing spice trade profits, the profits were humongous to say the least and then you had the risk, the risk of pirates, risk of sinking and the biggest risk, it was expensive. It requires lots of capital, so how do you solve such a situation?
The directors of the Dutch East India Company did something crazy, something never done before; they sold a tiny portion, just a small portion, a little sliver or a share of their company to the general public. This was the public got a small ownership of the company. The company itself was able to raise capital, business expanded, flourished and they made even more money.
Perhaps even without realizing it, the shares started to trade hands and that exchange happened in the Amsterdam Stock Exchange and that is the birth of the first stock exchange.
The Stock Market Goes Digital
So tell me what comes to your mind when you hear the word ‘stock exchange’? I know you are probably thinking of the Sensex but what do you imagine, is it something like this?
As technology has evolved so has the stock market. Back then people used to stand in pits with gestures and try to get their shares. So it was face to face and they used to exchange physical shares. But as everything has changed in the world, technology has entered this space as well.
A Stock exchange now looks something like this, server rooms, it’s all digital now.
You get all the buy and sell transactions right here, in digital space
But the question is this, if you have a buy order for every sell order. All you need to do is agree on price. Then how do stocks move up or down?
Well the answer to this is the Market place, the invisible hand said by Adam smith.
The Market Place ‘When the bids start bidding higher and the offers can’t keep up, prices will start to go higher’. For placing any order you should have the software which you will get it when you sign up with the broker and it will look like this.
This is a market watch. We have bank of India from BSE .We have BHEL from NSE. So if you have to buy share of any of these companies, you can simply place an order by selecting that company, clicking buy option and selecting the quantity you need to buy. Your share will reflect in your account.
Stock exchanges take orders every single day and there are stock exchanges in every major city around the world. For example in India we have the NSE and BSE. These exchanges have a combined turnover of $520 billion dollars a month.
The Stock Exchange
Welcome to Dalal street, and that building behind me is the Bombay stock exchange, Asia’s oldest Stock Exchange, and probably one of the fastest too. It started way back in 1875. The question is, what does a stock exchange actually do? A Stock exchange like the BSE basically finds buyers and sellers and matches those orders efficiently. For that to happen, for millions of orders to happen we need something called liquidity.
Liquidity is a fancy way of saying many buyers and many sellers. The abundance of these market participants creates a liquid market. This is exactly what an efficient market needs.
The Open Outcry System
The Bombay stock exchange has a fascinating history, back then trading was very different from what it is now. Wouldn’t you like to know what the open outcry system was? Let’s find out.
This is the trading pit at the Bombay Stock exchange, in rooms similar to this trading pit, a Stock exchange used to function. This system called the open outcry exchange is exactly what stock exchanges were for hundreds of years.
This room used to be filled with brokers, hundreds of them perhaps. A client used to call his broker for a stock he wanted to purchase and the broker who represented him would buy and sell stock using hand gestures, bids and offers. Then, things were not digital as they are now, back then we used to use physical shares similar to this one, real hard copies of companies were being used. But as we all know that everything is online now. You can place an order and in a matter of seconds you could buy shares of a stock that you require. The BSE for example has a response time of 200 microseconds; it also has a capacity of 5 lakh orders a second. The BSE is a little more than this, as I said before a stock exchange is a place to bring buyers and sellers together, so when you put on that buy order it gets matched, digitally in this very building with another seller.
What is the Sensex and Nifty
The job of an index is to track the average movement of the entire exchange. BSE has 5,500 stocks listed on it, so on any given day how would you know if the stock market is up or down? You would have to go through each stock, but even that is pointless because some stocks are heavy weights making lakhs of crores per year like Reliance and we have other companies which we have not heard of. So how do you know if the markets are generally up or generally down?
That is the ticker tape
You will notice some indices there; it tracks all the big stocks.
What the Sensex does is takes the average of all those 30 stocks and gives you an idea of its point up or point down. Just remember that the Sensex is the weighted average of top 30 companies. In quick glance, you can tell whether the market is generally up or down.
So now the question arises, how do you know the size of the company? The term used for that is called Market Capitalization.
The total number of outstanding shares in the company i.e all shares in existence, multiplied by current share price. That is how we calculate the value of the company called Market Capitalization.
Outstanding Shares X Current Share Price = Market Capitalization
So let’s look at an example, many people would think that a price of a company if it’s 150 v/s 150 then they are equal. This is incorrect. Let’s see an example of Geometric software and Karnataka Bank.
Now Both of them are priced about the same, Karnataka bank at 147 and Geometric software at 132 .
You think these are not big companies and perhaps they are of same size but
Geometric market cap calculation is 64,203,729 outstanding shares X 132 = 847 crore Market capitalization.
Karnataka market cap calculation is 181,438,974 outstanding shares X 147 = 2,667 crores Market capitalization.
Stock price is not a reflection of the value of the company; market capitalization is.
In the next lesson, we’re going to go back to our friend Raj. Looks like Raj is ready to issue his IPO. Raj has some important decisions to make now. How does he price his stock? What’s the process to actually issue the IPO? And what role does SEBI have in all of this?