Question

1.2 Discuss how, why and where
trading and investment takes
place.

Answer 1

• Stocks, Ior Ishares Iof Ia Icompany, Irepresent Iownership Iequity Iin Ithe Ifirm, Iwhich Igive Ishareholders Ivoting Irights Ias Iwell Ias Ia Iresidual Iclaim Ion Icorporate Iearnings Iin Ithe Iform Iof Icapital Igains Iand Idividends.
• Stock Imarkets Iare Iwhere Iindividual Iand Iinstitutional Iinvestors Icome Itogether Ito Ibuy Iand Isell Ishares Iin Ia Ipublic Ivenue. INowadays Ithese Iexchanges Iexist Ias Ielectronic Imarketplaces.
• Share Iprices Iare Iset Iby Isupply Iand Idemand Iin Ithe Imarket Ias Ibuyers Iand Isellers Iplace Iorders. IOrder Iflow Iand Ibid-ask Ispreads Iare Ioften Imaintained Iby Ispecialists Ior Imarket Imakers Ito Iensure Ian Iorderly Iand Ifair Imarket.

• Stock Iexchanges Iare Isecondary Imarkets, Iwhere Iexisting Iowners Iof Ishares Ican Itransact Iwith Ipotential Ibuyers. IIt Iis Iimportant Ito Iunderstand Ithat Ithe Icorporations Ilisted Ion Istock Imarkets Ido Inot Ibuy Iand Isell Itheir Iown Ishares Ion Ia Iregular Ibasis I(companies Imay Iengage Iin Istock Ibuybacks Ior Iissue Inew Ishares, Ibut Ithese Iare Inot Iday-to-day Ioperations Iand Ioften Ioccur Ioutside Iof Ithe Iframework Iof Ian Iexchange). ISo Iwhen Iyou Ibuy Ia Ishare Iof Istock Ion Ithe Istock Imarket, Iyou Iare Inot Ibuying Iit Ifrom Ithe Icompany, Iyou Iare Ibuying Iit Ifrom Isome Iother Iexisting Ishareholder. ILikewise, Iwhen Iyou Isell Iyour Ishares, Iyou Ido Inot Isell Ithem Iback Ito Ithe Icompany—rather Iyou Isell Ithem Ito Isome Iother Iinvestor.

  The Ifirst Istock Imarkets Iappeared Iin IEurope Iin Ithe I16th Iand I17th Icenturies, Imainly Iin Iport Icities Ior Itrading Ihubs Isuch Ias IAntwerp, IAmsterdam, Iand ILondon.These Iearly Istock Iexchanges, Ihowever, Iwere Imore Iakin Ito Ibond Iexchanges Ias Ithe Ismall Inumber Iof Icompanies Idid Inot Iissue Iequity. IIn Ifact, Imost Iearly Icorporations Iwere Iconsidered Isemi-public Iorganizations Isince Ithey Ihad Ito Ibe Ichartered Iby Itheir Igovernment Iin Iorder Ito Iconduct Ibusiness.

  In Ithe Ilate I18th Icentury, Istock Imarkets Ibegan Iappearing Iin IAmerica, Inotably Ithe INew IYork IStock IExchange I(NYSE), Iwhich Iallowed Ifor Iequity Ishares Ito Itrade. IThe Ihonor Iof Ithe Ifirst Istock Iexchange Iin IAmerica Igoes Ito Ithe IPhiladelphia IStock IExchange I(PHLX), Iwhich Istill Iexists Itoday.The INYSE Iwas Ifounded Iin I1792 Iwith Ithe Isigning Iof Ithe IButtonwood IAgreement Iby I24 INew IYork ICity Istockbrokers Iand Imerchants. IPrior Ito Ithis Iofficial Iincorporation, Itraders Iand Ibrokers Iwould Imeet Iunofficially Iunder Ia Ibuttonwood Itree Ion IWall IStreet Ito Ibuy Iand Isell Ishares.

  The Iadvent Iof Imodern Istock Imarkets Iushered Iin Ian Iage Iof Iregulation Iand Iprofessionalization Ithat Inow Iensures Ibuyers Iand Isellers Iof Ishares Ican Itrust Ithat Itheir Itransactions Iwill Igo Ithrough Iat Ifair Iprices Iand Iwithin Ia Ireasonable Iperiod Iof Itime. IToday, Ithere Iare Imany Istock Iexchanges Iin Ithe IU.S. Iand Ithroughout Ithe Iworld, Imany Iof Iwhich Iare Ilinked Itogether Ielectronically. IThis Iin Iturn Imeans Imarkets Iare Imore Iefficient Iand Imore Iliquid.

  There Ialso Iexists Ia Inumber Iof Iloosely Iregulated Iover-the-counter Iexchanges, Isometimes Iknown Ias Ibulletin Iboards, Ithat Igo Iby Ithe Iacronym IOTCBB. IOTCBB Ishares Itend Ito Ibe Imore Irisky Isince Ithey Ilist Icompanies Ithat Ifail Ito Imeet Ithe Imore Istrict Ilisting Icriteria Iof Ibigger Iexchanges.For Iexample, Ilarger Iexchanges Imay Irequire Ithat Ia Icompany Ihas Ibeen Iin Ioperation Ifor Ia Icertain Iamount Iof Itime Ibefore Ibeing Ilisted, Iand Ithat Iit Imeets Icertain Iconditions Iregarding Icompany Ivalue Iand Iprofitability.In Imost Ideveloped Icountries, Istock Iexchanges Iare Iself-regulatory Iorganizations I(SROs), Inon-governmental Iorganizations Ithat Ihave Ithe Ipower Ito Icreate Iand Ienforce Iindustry Iregulations Iand Istandards.The Ipriority Ifor Istock Iexchanges Iis Ito Iprotect Iinvestors Ithrough Ithe Iestablishment Iof Irules Ithat Ipromote Iethics Iand Iequality. IExamples Iof Isuch ISRO’s Iin Ithe IU.S. Iinclude Iindividual Istock Iexchanges, Ias Iwell Ias Ithe INational IAssociation Iof ISecurities IDealers I(NASD) Iand Ithe IFinancial IIndustry IRegulatory IAuthority I(FINRA).

  How IShare IPrices IAre ISet

  The Iprices Iof Ishares Ion Ia Istock Imarket Ican Ibe Iset Iin Ia Inumber Iof Iways, Ibut Imost Ithe Imost Icommon Iway Iis Ithrough Ian Iauction Iprocess Iwhere Ibuyers Iand Isellers Iplace Ibids Iand Ioffers Ito Ibuy Ior Isell. IA Ibid Iis Ithe Iprice Iat Iwhich Isomebody Iwishes Ito Ibuy, Iand Ian Ioffer I(or Iask) Iis Ithe Iprice Iat Iwhich Isomebody Iwishes Ito Isell. IWhen Ithe Ibid Iand Iask Icoincide, Ia Itrade Iis Imade.

  The Ioverall Imarket Iis Imade Iup Iof Imillions Iof Iinvestors Iand Itraders, Iwho Imay Ihave Idiffering Iideas Iabout Ithe Ivalue Iof Ia Ispecific Istock Iand Ithus Ithe Iprice Iat Iwhich Ithey Iare Iwilling Ito Ibuy Ior Isell Iit. IThe Ithousands Iof Itransactions Ithat Ioccur Ias Ithese Iinvestors Iand Itraders Iconvert Itheir Iintentions Ito Iactions Iby Ibuying Iand/or Iselling Ia Istock Icause Iminute-by-minute Igyrations Iin Iit Iover Ithe Icourse Iof Ia Itrading Iday. IA Istock Iexchange Iprovides Ia Iplatform Iwhere Isuch Itrading Ican Ibe Ieasily Iconducted Iby Imatching Ibuyers Iand Isellers Iof Istocks. IFor Ithe Iaverage Iperson Ito Iget Iaccess Ito Ithese Iexchanges, Ithey Iwould Ineed Ia Istockbroker. IThis Istockbroker Iacts Ias Ithe Imiddleman Ibetween Ithe Ibuyer Iand Ithe Iseller. IGetting Ia Istockbroker Iis Imost Icommonly Iaccomplished Iby Icreating Ian Iaccount Iwith Ia Iwell Iestablished Iretail Ibroker.

  Stock IMarket ISupply Iand IDemand

  The Istock Imarket Ialso Ioffers Ia Ifascinating Iexample Iof Ithe Ilaws Iof Isupply Iand Idemand Iat Iwork Iin Ireal Itime. IFor Ievery Istock Itransaction, Ithere Imust Ibe Ia Ibuyer Iand Ia Iseller. IBecause Iof Ithe Iimmutable Ilaws Iof Isupply Iand Idemand, Iif Ithere Iare Imore Ibuyers Ifor Ia Ispecific Istock Ithan Ithere Iare Isellers Iof Iit, Ithe Istock Iprice Iwill Itrend Iup. IConversely, Iif Ithere Iare Imore Isellers Iof Ithe Istock Ithan Ibuyers, Ithe Iprice Iwill Itrend Idown.

  The Ibid-ask Ior Ibid-offer Ispread—the Idifference Ibetween Ithe Ibid Iprice Ifor Ia Istock Iand Iits Iask Ior Ioffer Iprice—represents Ithe Idifference Ibetween Ithe Ihighest Iprice Ithat Ia Ibuyer Iis Iwilling Ito Ipay Ior Ibid Ifor Ia Istock Iand Ithe Ilowest Iprice Iat Iwhich Ia Iseller Iis Ioffering Ithe Istock. IA Itrade Itransaction Ioccurs Ieither Iwhen Ia Ibuyer Iaccepts Ithe Iask Iprice Ior Ia Iseller Itakes Ithe Ibid Iprice. IIf Ibuyers Ioutnumber Isellers, Ithey Imay Ibe Iwilling Ito Iraise Itheir Ibids Iin Iorder Ito Iacquire Ithe Istock; Isellers Iwill, Itherefore, Iask Ihigher Iprices Ifor Iit, Iratcheting Ithe Iprice Iup. IIf Isellers Ioutnumber Ibuyers, Ithey Imay Ibe Iwilling Ito Iaccept Ilower Ioffers Ifor Ithe Istock, Iwhile Ibuyers Iwill Ialso Ilower Itheir Ibids, Ieffectively Iforcing Ithe Iprice Idown.

  Matching IBuyers Ito ISellers

  Some Istock Imarkets Irely Ion Iprofessional Itraders Ito Imaintain Icontinuous Ibids Iand Ioffers Isince Ia Imotivated Ibuyer Ior Iseller Imay Inot Ifind Ieach Iother Iat Iany Igiven Imoment. IThese Iare Iknown Ias Ispecialists Ior Imarket Imakers. IA Itwo-sided Imarket Iconsists Iof Ithe Ibid Iand Ithe Ioffer, Iand Ithe Ispread Iis Ithe Idifference Iin Iprice Ibetween Ithe Ibid Iand Ithe Ioffer. IThe Imore Inarrow Ithe Iprice Ispread Iand Ithe Ilarger Isize Iof Ithe Ibids Iand Ioffers I(the Iamount Iof Ishares Ion Ieach Iside), Ithe Igreater Ithe Iliquidity Iof Ithe Istock. IMoreover, Iif Ithere Iare Imany Ibuyers Iand Isellers Iat Isequentially Ihigher Iand Ilower Iprices, Ithe Imarket Iis Isaid Ito Ihave Igood Idepth. IStock Imarkets Iof Ihigh Iquality Igenerally Itend Ito Ihave Ismall Ibid-ask Ispreads, Ihigh Iliquidity, Iand Igood Idepth. ILikewise, Iindividual Istocks Iof Ihigh Iquality, Ilarge Icompanies Itend Ito Ihave Ithe Isame Icharacteristics.

  Matching Ibuyers Iand Isellers Iof Istocks Ion Ian Iexchange Iwas Iinitially Idone Imanually, Ibut Iit Iis Inow Iincreasingly Icarried Iout Ithrough Icomputerized Itrading Isystems. IThe Imanual Imethod Iof Itrading Iwas Ibased Ion Ia Isystem Iknown Ias I"open Ioutcry," Iin Iwhich Itraders Iused Iverbal Iand Ihand Isignal Icommunications Ito Ibuy Iand Isell Ilarge Iblocks Iof Istocks Iin Ithe I"trading Ipit" Ior Ithe Ifloor Iof Ian Iexchange.

  However, Ithe Iopen Ioutcry Isystem Ihas Ibeen Isuperseded Iby Ielectronic Itrading Isystems Iat Imost Iexchanges.16 IThese Isystems Ican Imatch Ibuyers Iand Isellers Ifar Imore Iefficiently Iand Irapidly Ithan Ihumans Ican, Iresulting Iin Isignificant Ibenefits Isuch Ias Ilower Itrading Icosts Iand Ifaster Itrade Iexecution.

  Why ITrading I& IInvestment Iis Iimportant

  Stock IMarket ITrends

  The Iprices Iof Iindividual Istocks Iare Idynamic, Igiving Ithe Ientire Istock Imarket Ia Idynamic Iand Ieven Ivolatile Icharacter. IStock Iprices Itend Ito Itrend, Iand Ithese Itrends Ihave Ia Ipsychological Iimpact Ion Iindividuals Iand Ibusinesses. IRising Istock Imarkets, Ior Ibull Imarkets, Ican Icreate Ia Isense Iof Iconfidence Iabout Ithe Idirection Iof Ithe Ieconomy. IAs Iprices Icontinue Ito Irise, Imore Iinvestors Icome Iinto Ithe Imarket, Iwhich Ibuilds Ion Ithe Imomentum. IFalling Istock Imarkets, Ior Ibear Imarkets, Iusually Ihave Ithe Iopposite Ieffect. IPeople Ifeel Ipessimistic Iabout Ithe Ieconomy. IMedia Ireports Iabout Imarket Itrends Ican Icreate Ia Isense Iof Ipanic. IPeople Istart Imoving Ifunds Iaway Ifrom Istocks Iinto Ilow-risk Iassets, Iwhich Ican Idepress Istock Iprices Ieven Ifurther.

  Stock ITrends Iand IConsumer ISpending

  Bull Imarkets Ican Icreate Ia Iwealth Ieffect. IPeople Ifeel Imore Iconfident Ias Itheir Iinvestment Iportfolios Irise Iin Ivalue. IThey Ispend Imore Ion Ibig-ticket Iitems, Isuch Ias Ihomes Iand Icars. IConversely, Ifalling Istock Iprices Icreate Ia Ireverse Iwealth Ieffect. IFalling Iportfolio Ivalues Ican Icreate Iuncertainty Iabout Ithe Ifuture Iof Ithe Ieconomy. IPeople Ihold Iback Ion Itheir Ispending, Iespecially Ion Inonessential Iitems. IThis Islows Idown Ieconomic Igrowth Ibecause Iconsumer Ispending Iis Ia Ikey Icomponent Iof Ithe Igross Idomestic Iproduct.

  Effect Ion IBusiness IInvestment

  Stock Iprices Ican Iaffect Ibusiness Iinvestments. IBusinesses Iare Ilikely Ito Imake Icapital Iinvestments Iwhen Ithey Ifeel Ithat Ithese Iinvestments Iwill Ilead Ito Irising Imarket Ivalues, Isuch Ias Iduring Irising Ior Ibull Imarkets. IManagement Ihas Imore Ioperational Iflexibility Iif Isustained Istock Iprice Iincreases Ilead Ito Iincreased Iconsumer Ispending. IMerger Iand Iacquisition Iactivity Itends Ito Iincrease Iduring Ibull Imarkets Ibecause Icompanies Ican Iuse Istock Ias Icurrency.