Stock Exchange and New Issue Markets their nature, structure, functioning and limitations

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Stock Exchange and New Issues Markets: Nature, Structure, Functioning, and Limitations

1. Stock Exchange: Nature, Structure, and Functioning

Nature and Structure:

  • Capital Market: The stock market is a crucial segment of the capital market, where long-term securities like stocks and bonds are bought and sold. It helps companies raise capital and provides investors with opportunities to earn returns on their investments.
  • Types of Markets:
    • Organized Stock Exchanges: These are regulated platforms where securities are listed and traded. Examples include the New York Stock Exchange (NYSE) and NASDAQ. They provide transparency, standardization, and regulation.
    • Over-the-Counter (OTC) Market: This is a decentralized market where securities not listed on exchanges are traded. It typically includes smaller companies and involves direct negotiations between buyers and sellers.

Functions:

  • Economic Barometer: Stock exchanges reflect the overall economic health of a country. Rising share prices generally indicate economic growth, while falling prices suggest a downturn. The stock market is often seen as a pulse of the economy, providing insights into economic trends and investor sentiment.
  • Pricing of Securities: The stock market helps determine the value of securities based on supply and demand. Profitable and growth-oriented companies generally have higher valuations due to increased investor interest. This pricing mechanism is crucial for investors, creditors, and governments to assess the worth and potential of securities.
  • Safety of Transactions: Only listed securities are traded on organized exchanges, where companies are vetted for soundness and compliance with regulations. This ensures that transactions are secure and that investors are protected from fraudulent activities.
  • Economic Growth: The stock exchange facilitates the flow of capital to productive enterprises. By buying and selling securities, capital is allocated to companies with promising growth prospects, contributing to overall economic development and capital formation.
  • Spreading Equity Culture: The stock market encourages public participation in ownership securities. It promotes investment through better trading practices, new issues, and investor education, thereby fostering a culture of equity investment.
  • Liquidity: The stock exchange provides a platform for buying and selling securities, ensuring that investments can be quickly converted into cash. This liquidity is crucial for investors who need to access their funds or wish to reallocate their investments.
  • Better Allocation of Capital: Securities of successful and profitable companies are traded at higher prices. This allows these companies to raise fresh capital more easily. Conversely, companies that are struggling may find it harder to attract investment, leading to a more efficient allocation of capital.
  • Promoting Savings and Investment: The stock market offers various investment opportunities that attract savers and encourage them to invest in corporate securities rather than in less productive assets like gold or real estate.

Limitations:

  • Unethical Practices: Issues such as circular trading (where shares are traded among brokers to artificially inflate prices) undermine market integrity and harm investors.
  • Misinformation: Some companies raise funds from investors with promises of high returns but then divert the money to speculative or personal uses, leading to investor losses.
  • Absence of Genuine Investors: A significant portion of trading is done by speculators rather than long-term investors, affecting market stability and integrity.
  • Fake Shares: Fraudulent activities involving forged share certificates can lead to significant losses for investors who unknowingly purchase these fake securities.
  • Insider Trading: The use of non-public information for trading advantages creates an unfair market environment and undermines investor confidence.
  • Unofficial Transactions: Illegal trading activities, such as kerb trading (off-exchange trading) and dabba trading (informal trading), occur outside the regulated exchanges and can disrupt market stability.
  • Price Rigging: Companies may manipulate share prices to make their new issues more attractive, often through secret agreements with brokers, leading to distorted valuations.
  • Thin Trading: Many listed companies have low trading volumes, resulting in poor liquidity and limited market options for investors.
  • Excessive Speculation: Speculative trading can lead to price fluctuations that are unrelated to the underlying fundamentals of the companies, causing instability in the market.
  • Underdeveloped Debt Market: The debt market in India is relatively underdeveloped, with limited activity and liquidity compared to equity markets.
  • Payment Crisis: Speculative trading can lead to a situation where market players are unable to settle transactions due to adverse price movements.
  • Poor Liquidity: While some stocks are highly liquid, many others suffer from low trading volumes, impacting their marketability and value.
  • Inadequate Instruments: The market lacks a diverse range of financial instruments, with a dominance of equities and limited availability of convertible debentures and preference shares.
  • Influence of Financial Institutions: Large players such as mutual funds and insurance companies can significantly influence market prices due to their large trades, sometimes distorting true market values.
  • Domination of Foreign Institutional Investors (FIIs): FIIs play a major role in the market and their large transactions can cause significant price swings, impacting market stability.
  • Odd Lots: Small quantities of shares, or odd lots, often face poor liquidity and lower prices, making them less attractive to investors.
  • Delay in Admitting Securities: The process of listing new securities can be slow, affecting their liquidity and market readiness.
  • Poor Services: Many brokers and sub-brokers provide inadequate services, leading to investor dissatisfaction and potential fraud.
  • Broker Defaults: Excessive speculation can lead to broker defaults, disrupting the market and creating financial instability.

2. New Issues Market: Nature, Structure, and Functioning

Nature and Purpose:

  • Function: The new issues market is designed for raising new capital by corporate enterprises. It allows companies to issue equity shares, preference shares, or debentures to investors. This process is essential for financing expansions, new projects, and general corporate needs.
  • Role: It helps attract fresh investment into the corporate sector, fostering growth and balanced regional development.

Participants:

  • Underwriters: Financial institutions or groups that guarantee the purchase of a specified amount of a new issue, assuming the risk of unsold stock for a fee.
  • Managing Institutions: Organizations like ICICI, LIC, and IDBI that facilitate the issuance of new securities by providing underwriting services and managing the process.
  • Investment Channels: Include term-lending institutions, insurance companies, and international funds, which play a role in supporting and managing new issues.

Process:

  • Origination: Involves evaluating the viability and potential of new projects. This includes assessing technical, financial, and market aspects, ensuring the proposal is sound and investment-worthy.
  • Underwriting: Guarantees the purchase of a new issue, either to sell to the public or for the underwriter's own portfolio. If the issue is not fully subscribed, the underwriter absorbs the unsold stock.
  • Distribution: Involves selling the new issue to the public. Stockbrokers handle public subscriptions, ensuring that shares are distributed and market demand is met.

Methods of Issuing:

  • Public Prospectus: An open invitation to the public to subscribe to new issues, providing detailed information about the company and the issue.
  • Private Placement: Shares are sold privately to a select group of investors rather than the general public. This method is faster and avoids the costs of public offerings.
  • Rights Issue: Existing shareholders are given the opportunity to buy additional shares at a discount to the current market price, allowing them to increase their holdings.

In summary, the stock exchange and new issues market play vital roles in capital formation, economic growth, and providing liquidity. However, they face challenges including unethical practices, market volatility, and regulatory issues.