Financial Markets and Financial Institutions

The Stock Exchange

The Stock exchange is a trading location where securities are traded, where buying
and selling of securities take place ,and at which the price of listed securities are
determined.

Stock exchanges are formal organizations and legal entities (usualggy joint-stock
companies), approved, licensed and regulated by the Regulator (the Securities and
Exchange Commission SEC) , that are made up of members that use the facilities to
exchange listed securities .

Stocks that are tarded on an exchange are known as “listed stocks”, and in order to be
classified as listed , the issuing company must apply and satisfy requirments
established by the exchange where listing is sought.

To have the right to trade securities on the floor of the exchange, brockerage firms
must apply for membership and they may buy a seat on the exchange. The cost of the
seat is market determined. Others can trade from their offices if they are electronically
linked to the Exchange trading system.

Member brokers of an exchange trade securities on behalf of their customers in

accordance with the trading rules of the Exchange. While every broker on the fllor has
and operate his own computer and can see all action on his screen, trades/transactions
are displayed on a big screen so everybody can see market activityies real time. 1

Brokers charge commission on transactions , according to the value and the volume of
securities involved. The commission is usally negotiable between investors and
brokers but there are cases where the Stock Exchange fixes a minimum commission
and it is structured in a way that don not allow the commission rate to decline as the
number of securities increase.

Role and Functions of the Stock Exchange

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On New York Stock Echange there is a different system. For Ecample, each stock is traded at a
specific location on the trading floor called a post . On an exchange the market maker role for a listed
stock is performed by specialist..A member firm may be designated as a specialist for the common
stock of more than one company , but only one specialist is designated for common stock of a given
company. On the exchange there is only one market maker or dealer per stock , known as specialist .
The specialist keeps the limit order book. Designation of who will be specialist for a stock is
determined by the exchange , taking numerous factors into account. Because capital is necessary to
perform as a market maker , one requirment is satisfaction of the minimum capital requirment. As there
is only one specialist for a given stock , there is no competition from other market makers on the
exchange. Dealers provide the opportunity for investors to trade immediately rather than waiting fo rthe
arrival of suficient orders on the other side of the trade. Dealers offer price information to the market
participants. Dealers serve as auctioneers in bringing order and fairness to a market. Dealers buy for
their own account and maintain inventories of securities and their profits come from selling assets at
higher price than they purchaased them.

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Financial Markets and Financial Institutions

The Stock Exchange is a place for trading with sufficient facilities and is a good
pricing machanizm for the securities which are listed on the Exchange. In order to
understand the role and functions of the stock exchange as a secondery market and
how does it operate , the securities market has to be analysed with respect to three
areas of concern

1. Market Infrastructure:

Institutional infrastructure provides the operational basis for the market: brokers ,
investment advisors , stock exchanges , currency exchanges , rating agencies ,
settlement system , registration systems , custodial services , legal advisors , auditors
and accountants.

2. Law enforcement infrastructure:

Regulatory infrastructure centers on the government body or bodies which have the
power and responsibility to supervise the market but also includes self-regulatory
organizations such as stock exchanges , accounting standards boards and accounting
and auditing professional associations and similar organizations. It also include their
rules and regulatory procedures and facilities such as stock exchange listing and
trading rules or accounting and auditing standards , plus the monitoring and most
important , enforcement of these rules.

3. Regulatory and Legal infrastructure:

Legal infrastructure provides the underpinning to the operational and regulatory
infrastructure. It establishes the framework of property rights, contractual
relationships, forms of incorporation , and rights and responsibilities of participants in
the market. It also specifies the powers and responsibilities of the government
supervisory authority and self-regulatory organizations.

As the Stock Echange, like any other financial intermediary, should be licensed and
be subject to inspection and supervision, the license requirements include that the
trading system and arrangements on the Exchange should be characterized as (FELT),
i.e :
 Fair;
 Efficient;
 Liquid; and
 Transparent.

1) Fair: Both small and large investors should have equal access to shares
at comparable prices. Additionally , information flows and transaction
execution should not favour insiders or outsiders
2) Efficient: the trading system must be established in such a way that
paperwork is kept to a minimum, and operations are conducted in the
most direct and simple way with the lowest cost. Time is also an
important factor , including the capacity to settle a trade quickly, rather
than being locked in while cumbersome settlement procedures are
executed.
3) Liquid: a trading system should foster high availability of shares on
both the buy and sell sides. This also implies low transaction costs,

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Financial Markets and Financial Institutions

generated by frequent turnover, which enable market participants to be

active in the market. It helps if a small number of listings do not
dominate the market. volume of trading should be high enough that all
but the largest of market players are unable to move markets
4) Transparent : the true nature of supply and demand should be apparent
to the investor so he is able to judge the parameters within which he
must work when completing his trades. This transparency fosters
liquidity, fairness and efficiency.

Since listed securities on the Exchange cannot be traded outside the Exchange, the
price of traded security reflects the actual demand and supply forces for
such security at a particular time. Therefor, the Stock Exchange is a good
pricing mechanizm for the listed securities.

Automated Order Routing System

The Stock Exchange has a system for routing orders submitted by brokers via
computers directly to the Exchange main computer where the order can be executed.

Fragmented Market:
We mean by fragmented market , one in which some orders for a given stock are
handled differently from other orders.

There are two examples of this fragmented market:

1- the different handling of small orders versus large orders on the same
exchange.
2- Stocks that can be bought on several exchanges as well as the over the
counter market.

The Regulator
The Regulator regulates the structure in the stock market , which lead to enhancing
the competition and comprehensive disclosure of market information should be
fostered in order to generate the best prices for investors and the interests of public
investors and should be placed ahead of the brokers.

Trading structure:
In the secondry markets, some market are continuous trading markets which means
that the prices are determined continuosly throughout the trading day as orders are
submited. Others, are call trading market, in which orders are batched or grouped
together for simultaneous execution at the same price. Finally, some stock markets
such as the New York Stock Exchange are mix between the two systems.