A stock exchange is one of the most intriguing aspects of the world of finance, where opportunities it creates attract the interest of people and institutions around the world. Familiarize yourself with its characteristics and learn the basic vocabulary. Find out who is involved in market operations, understand the IPO process and discover the variety of financial instruments traded on the exchange.
What is a stock exchange?
A stock exchange is a place where buyers and sellers meet to trade securities. It also provides a platform for companies that want to raise capital through a public share issue. Exchanges facilitate the trading of various financial instruments, such as stocks, ETFs, bonds or futures. Exchanges also provide liquidity by gathering a large number of buyers and sellers.
Primary market
Newly issued securities are sold on the primary market for the first time, directly by the issuer (company). This is the moment when companies raise capital through a public issue of shares as part of an initial public offering (IPO). This is a situation in which a company offers its shares to the public for the first time, thus enabling individual and institutional investors to purchase them directly from the company.
The funds obtained from the sale of newly issued shares can then be used in different ways, for example to expand the scale of operations, finance research and development initiatives or repay existing debts.
Secondary market
Securities previously issued on the primary market are traded on the secondary market, and trade takes place between investors (without the participation of the issuer). It is also a place where shareholders who have purchased shares on the primary market have the opportunity to sell them (at the market price). It is also worth emphasizing that purchase and sale transactions on the secondary market do not generate cash flows to the company that issued them.
Participants of a stock market
From investors, through brokers, to regulatory authorities – each of the entities present to some extent on the stock exchange has its own specific goals and responsibilities related to the capital market. The stock market is a complex, but well-organized ecosystem and understanding how it works is key to navigating it properly. Meet the participants of the stock market:
Individual investors
Individuals who invest their money in the stock market. They can be both experienced investors and beginners who strive to achieve their investment goals. Among them, we can distinguish short and long-term investors, who are distinguished by the adopted investment horizon.
Financial institutions
This is a broad category that includes banks, insurers, investment or pension funds and many other entities. Financial institutions are among the most important participants of the stock exchange market, with significant financial resources and professional expert base.
Issuers
Entities that issue individual financial instruments, such as shares or bonds, in order to raise capital. They are obliged to regularly inform investors about their financial situation, which is intended to maintain market transparency.
Brokerage houses
Organizations licensed to trade on the stock market. Brokers play a key role in the functioning of exchanges, acting as an intermediary between investors and the market. Their main task is to provide investors with access to financial markets and quotations, as well as to enable purchase and sale transactions of securities or other financial instruments. Brokers also act as order executors – they are responsible for carrying out the transaction ordered by the investor on the market, in accordance with applicable regulations.
Some institutions also provide their clients with information and market analysis. Their research teams, with access to a wide range of data and analytics tools, help investors identify investment opportunities.
Brokers also support order settlement processes. After the transaction is completed, they deal with the transfer of securities or cash between the parties and make sure that all formalities and procedures are carried out correctly.
Stock exchanges
Institutions that provide a platform where financial instruments are traded. They are responsible for setting and maintaining appropriate trading standards, overseeing market participants, and ensuring transparency and fairness of transactions.
Supervision authorities
Government entities responsible for monitoring and regulating the stock market. Their main task is to protect investors, as well as to ensure the fairness and stability of the financial system. An example of such authority on the American market is the SEC (Securities and Exchange Commission).
Initial Public Offering (IPO)
Initial Public Offering refers to the process of offering shares of a private corporation to the public for the first time. The stock exchange debut allows companies to raise capital from investors, which can then be used, for example, to finance further development or investments in new projects. In addition, the presence on the stock exchange increases the credibility and prestige of the company, which can attract new customers, business partners and employees.
The IPO process typically includes the following steps:
Preparation: The company and its advisors (i.e. investment banks and legal advisors) are preparing for the IPO. This involves conducting financial audits and preparing the necessary documentation, including the prospectus. This is a document that potential investors can review before making an investment decision, containing details including: finance, business model, risk or prospects for the future.
Selection of underwriters: The company selects investment banks that will underwrite the IPO. Underwriters help determine the price, structure the offering and assist in marketing and selling shares to potential investors.
Regulatory review: The company submits the prospectus and other required documents to the relevant regulatory authority, which then ensures that the company complies with all legal requirements.
Roadshow: The company and its underwriters conduct a roadshow to sell the IPO to potential investors, which includes: presentations, meetings and discussions with investors, fund managers and other interested parties. The aim is to arouse the interest of investors and assess the demand for the company’s shares.
Pricing: Based on the feedback received from investors during the roadshow, the underwriters and the company determine the issue price of the shares. This price is usually set at a level that balances the company’s valuation, market demand and the need to provide an attractive offering.
Distribution: Once an issue price is set, the shares are distributed to institutional and retail investors as well as other interested parties. Everything is supervised and managed by underwriters.
Listing on a stock exchange: After the distribution is completed, the company starts listing its shares on the stock exchange, admitting them to public trading and allowing investors to buy and sell them on the secondary market.
Post-IPO: After the completion of the IPO process, the firm becomes a publicly traded company, which involves the requirement to adapt to current regulations and the obligation to provide periodic financial and operational data.
It should be noted that the IPO process and requirements may vary depending on the jurisdiction and regulatory framework in which the company operates.
Financial instruments available on a stock exchange
Exchanges offer a wide range of financial instruments. In addition to stocks, there are many other assets that investors can invest their capital in. Below are the characteristics of the most popular of them:
- Shares – securities giving their owner the right to participate (co-ownership) in the company that issued them. The entity purchasing the shares is called a shareholder, and with their purchase, they become a co-owner of a given company and acquire a number of rights, including the right to in the distribution of the dividend, which is the profit earned by the company.
- Exchange Traded Funds (ETFs) – a type of security that tracks a sector, index, commodity or other asset. An ETF can track anything from the price of a single commodity or several stocks to a large and diverse group of securities.
- Bonds – debt securities with a specific maturity date, which are issued by, for example, corporations or governments in order to raise capital. Bonds typically pay investors periodic interest over the life of the bond. At maturity, the issuer returns the principal amount to the bondholder (investor).
- Futures – a financial instrument that is a type of contract to buy or sell an underlying instrument at a predetermined price and within a strictly defined period. They are commonly used for commodities and currencies.
- Options – derivative instruments giving the holder the right to buy (call option) or sell (put option) an underlying instrument at a specified price (strike price) within a predetermined period.
The largest stock exchanges in the world
New York Stock Exchange (NYSE)
The New York Stock Exchange (NYSE) is the largest stock exchange in the world by market capitalization of approximately 28 200 billion USD. About 2 300 companies are listed here, including many large international corporations. Known for its global reach, the NYSE attracts companies from around the world. This stock exchange is regulated by the US Securities and Exchange Commission (SEC) and includes leading market indices such as the Dow Jones Industrial Average and the S&P 500.
NASDAQ
NASDAQ is famous for its concentration of technology and innovation companies, where many of the largest companies in the world are listed. It is the first fully electronic exchange, using advanced technology and automated trading systems. With a market capitalization of 22 400 billion USD and approximately 3 600 companies, NASDAQ is the second largest stock exchange in the world.
Shanghai Stock Exchange (SSE)
The Shanghai Stock Exchange is the largest in China and the third largest stock exchange in the world. Since its inception, the SSE has undergone significant reforms and upgrades to comply with international capital market standards. This stock exchange includes over 2 000 purely domestic companies, with a total market capitalization of approximately 8 300 billion USD.
European New Exchange Technology (EURONEXT)
Euronext is a large, global exchange group with exchanges in: Amsterdam, Brussels, Dublin, Lisbon, Milan, Oslo and Paris. The stock exchange plays a key role in supporting liquidity and facilitating securities trading, making it a key element of the European financial landscape. Its range includes over 1 900 companies and its capitalization is approximately 7000 billion USD.
Japan Exchange Group (JPX)
JPX is the largest stock exchange group in Japan, comprising two major exchanges: Tokyo Stock Exchange (TSE) and Osaka Exchange (OSE). Its purpose is to provide appropriate stock excahnge infrastructure enabling investing in financial instruments. Its range covers almost 4 000 companies, which puts it in the first place in the world in this aspect. The total capitalization of companies listed on JPX is approximately 6 200 billion USD.
In conclusion, a stock exchange is a dynamic, complex system that involves numerous participants and regulatory authorities. The framework is divided into primary and secondary markets, allowing for the introduction of new securities and their subsequent trading, respectively. An integral part of this ecosystem is the process of Initial Public Offerings (IPOs), which allows companies to raise capital and attracts new investors. Understanding the intricacies of a stock exchange is crucial for anyone looking to participate in the financial markets. This understanding enables investors to make informed decisions, navigate market trends, and identify potential investment opportunities.