What is stock exchange?

A stock exchange is a highly organized financial market where bonds, stocks and shares can be bought or sold. The London Stock Exchange is situated in Throgmorton Street within a few yards of the Bank of England, and at the centre of the financial affairs of the City of London. It is a respected and valued nation institution, but it is not alone.

There are independent groups of stock exchanges in other large cities, while members of the Provincial Brokers’ Stock Exchange also carry on business in numerous smaller towns. Stock-market business is world-wide, and New York, Johannesburg, Melbourne, Tokyo, Calcutta, Paris, Amsterdam and Brussels are all famous centres of stock- exchange activity.

The function of a stock exchange is to put those who wish to sell stocks or shares in touch with those who wish to buy, so that investments can change hands in the quickest, cheapest, and fairest manner possible.

Types of Security

A security is a written or printed document acknowledging the investment of money. The investor may merely loan the money in return for interest, or may actually purchase share in the enterprise concerned, in which case the reward to the investor is a share in the profit of the enterprise.

This reward is called a dividend, because the profit is divided among the shareholders. The word ‘securities’ covers all kinds of investment with which the Stock Exchange is concerned. Generally speaking they are ‘existing securities,’ i.e. they have already come into existence at some earlier date.

The Stock Exchange does not itself issue new shares to the public. This function is often performed by specialist institutions called Issuing Houses. For a successful new issue, the Stock Exchange still has vital part to play, for the public will be unwilling to buy the issue unless there is a guarantee that they will be able to sell them again should they wish to do so. Most new issues are therefore announced ‘subject to permission to deal being given by the Stock Exchange Council.’

The main types of security are: (i) Municipal or local- Government loans or bonds; (ii) Government loans or bonds; (iii) Shares; (iv) Debenture; and (v) Stock.

(i) Local Government Loans or Bonds

These are issued by local councils against the general security of the rates. Nearly all are issue to finance capital expenditure which the local authority wishes to afford now, but whose advantage will be enjoyed for several years> for instance, a municipal swimming bath will pay for itself in due course, so that this type of expenditure might justifiably be finance out of borrowing.

The interest and repayments will be paid out of surplus receipts of the enterprises, after operating expenses have been paid. Such investments are very safe, and, although not quite ‘gilt-edged,’ have trustee status. This means that they are so safe that they may be used by lawyers and others acting as executors of will, who are investing trust-moneys on behalf of young person’s not yet old enough to manage their own affairs. This type of investment is authorized by Section 1 of the Trustee Act, 1925.

(ii) Government Loans or Bands

These are documents issued by governments or public authorities in return for loans made to finance expenditures which are not at present to be met by taxation. War Loan’ is an example but similar loans are floated at regular intervals for peacetime purposes such as building power stations, docks and harbours, or road bridges. These securities pay fixed rate of interest throughout their lives, and repayment is guaranteed by the Government.

Such loans by British or commonwealth Governments are called filt-edged securities, because the original gilt- edged securities were recorded in a book that had filt edges.

(iii) Share

These are documents which acknowledge investment in a company. The various classes designed to attract different classes of investor.

(iv) Debentures

Debentures are loans to a company. This type of security is issued to attract the more timid type of investor, because they offer almost as great security as a gilt-edged security. Timid old ladies who have been left money by their husbands traditionally by debentures, which are secure both as to income and capital

The interest rate on a debenture is about 10 percent these days, and after taxation earns about 6 percent for the holder. Payment of this interest is made whether the company is making profits or not, for the money is essentially a loan to the company, not a shareholding in the company.

A simple or naked debenture carries no charge on the assets, but a mortgage debenture carries a mortgage on the assets of the company. This entitles the debenture holders to take over the assets charged and sell them should the provisions as to payment of interest and repayment of principal not be properly observed. A Fixed Debenture is secured on certain fixed assets, which are directly charged with the duty of repaying the debenture holders. It follows that these assets cannot be disposed of in any way by the directors without the permission of the debenture trustees.

These trustees are appointed to represent the debenture holders, since it would be unrealistic to expect timid old ladies to understand what changes were taking place in a company’s affairs. A Floating Debenture is not secured on particular fixed assets, but floats generally over the assets of a company, particularly the current assets.

This type of security is best where a firm deals in huge quantities of valuable stock, but has little plant or machinery, and whose premises are not very valuable. For example, mail-order houses very often operate from premises that are not modern or well placed from the site- value point of view; yet their stocks may be enormously valuable. It would not be sensible to restrict the directors in dealing in such stocks, the sale of which is the source of the profits of the business. Instead, the floating debenture floats over the assets, and only ‘crystallizes’ into solid control when the directors fail to honour their bargain by not paying the interest or repaying the principal.

(v) Stock

Stock used to be shares that had been consolidated into one block. Every share is an individual unit which has been paid for by the share holder. It must be transferred in one piece from one owner to the next.

When shares had been paid for in full, the total number of shares used to be consolidated into stock. This had certain advantages to the firm tying to keep a record of transfers. For instance if 1,000 shares were transferred from Mr. A to Mr. B the share certificate issued to Mr. B needed 1,000 serial numbers written on to it.

This took a great deal of time. If the shares were consolidated into stock, only the monetary value needed to be recorded on the Stock Certificate. These rules have recently changed and there is really no difference between share and stock today.

How a Bargains is Struck

As in any market a deal takes place only when the price is right. If one party thinks the price wrong he will hesitate, and if the other senses this hesitation in any way he will alter the price if he thinks he can still make a profit by doing so, or if he thinks he should cut his losses by selling at once.

If he has quoted a rock-bottom price anyway he will not lower it further. As prices on the Stock Exchange vary with world business activity, the broker and jobbers are continually balancing in their heads the business trends throughout the world. Successes or failure of firms whose shares are being dealt with, or of other firms in the same line of business; wars and rumours of wars; natural disasters; economic crises; government activities restricting or encouraging the flow of raw materials manufactured goods or capital around the world; all these affect the present value of a share on the market.

The floor of the house, to which only brokers and jobbers have access, is shown with some of the main ‘markets’. These markets consist of groups of jobbers, specializing in particular fields, and prepared to buy or sell as required. Outside the Exchange, but of course free to enter at any time, are the stockbrokers operating from their private offices where they are available for advice and help to the general public.

A wishing to sell Rs. 40,000 International Industries’ shares, asks her stockbroker to act for her in selling them at the best possible price. The broker enters the Exchange and proceeds to the Industrial’ market where he approaches one of the jobbers dealing in this type of share. He may not reveal whether he is a buyer or a seller, for this would enable the jobber to vary the price to suit the transaction and make it more profitable to him.

When a bargain has been struck a note is made of it in the “bargain books’ of the jobber and broker. Having agreed to deal at this price a jobber will always honour his bargain, for the proud motto of the Stock Exchange is ‘Dixtum Meum Pactum-My Word is my Bond.’

Turning Fixed Capital into Cash-and Cash into Fixed Capital

When a member of the general public invests his savings by lending them to the mangers of a company, he does not intend that the company shall have the use of his money for ever, for he does not know when fate may knock on his door and present him with problems.

The investment as far as the investor is concerned is a purely temporary one, depending upon his good luck to some extent. If the fates are kind the investment may last for years; if the fates are unkind he, or his her is, may wish to withdraw the investment in cash form just like withdrawing money from a bank.

From the point of view of directors of the firm the matter is quite different. They regard the investment as a permanent one, for the spend the invested money on land and buildings, plant and machinery, transport, and other equipment. They cannot possibly return the money, for they no longer have it. They cannot possibly return the money, for they no lone have it. They have turned it into assets, and in process it has been fixed.’ Fixed capital is capital tied up m fixed asset, which have been purchased for permanent use in the business.

There is no point in the shareholder ringing up the secretary of the company to say that he has decided to reclaim his investment, and will call round for his that he has decided to reclaim his investment, and will call round for his share at 11 o’clock.

The secretary has no way of ‘qualifying’ the fixed assets and will simply point out that the only way for the shareholder to get his money back is to sell the shares for what they will fetch in the market place. This is what the Stock Exchange is: a market where those who wish to sell shares are able to contact those who to buy.

The company whose shares are being bought and sold has little interest in the matter, but it will register the transfer of shares in order to keep its list of shareholders up to date.

The company merely pursues its lawful activities, as laid down in its Memorandum of Association, leaving the specialist dealers on the Stock Exchange to arrange matters when the public wish to buy or sell securities. A company may, however, be interested if a particular buyer is acquiring large blocks of shares, since a take-over may be under consideration.