Category: Your Money

History of the Stock Exchange

The oldest trading companies were either owned by individuals or were family partnerships. In 1553, a British explorer set up an enterprise to find a North East trade route to China and the Orient. 250 merchants put up 25 pounds each to equip 3 ships for the voyage, thus sharing the cost and any eventual profits. This was the birth of the first modern shareholding enterprise, a ‘joint stock company’ called the ‘Muscovy Company’. The famous East India Company was formed in 1600 and was dominant in trading up to about 1850. The importance of the Dutch empire led to the formation of the United East India Company of the Netherlands in 1602 and the Dutch West India Company in 1621.

Thus, trading began in these companies. Europe’s oldest stock exchange was opened in Amsterdam in 1611. In London, brokers and jobbers (as they were called) met in coffee houses. To regulate the market, New Jonathan’s Coffee House was converted into the ‘Stock Exchange’ in 1773. In 1850, the US had about 250 functioning stock exchanges. However, by 1900, New York was totally dominant due to the introduction of the telegraph and ticker-tape.

The role of the Stock Exchange

Stock Exchanges are important as they provide the regulation of company listings, a price formation mechanism, the supervision of trading, authorization of members, settlement of transactions and publication of trade data and prices. However, the role of the stock exchange is becoming hazy as many listing rules are made by government bodies (like the SEC in the US), settlement is being taken over by separate settlement entities and more and more computerized matching systems outside exchanges are capturing business.

Some of the world’s largest exchanges are – the New York Stock Exchange (NYSE), the London Stock Exchange, Tokyo and the NASDAQ (National Association of Securities Dealers Automated Quotations). Technically, NASDAQ never had an exchange as such and only deal on computer screens. Their shares are actually ‘over the counter’ (OTC) but the companies are much larger than one usually finds with OTC trading. The market value of a stock exchange is the number of shares in existence multiplied by the share price of each. This is also called ‘capitalization’. Share prices go up and down all the time and the capitalization is only that at the moment when calculation is done.

International Equity

Nowadays, it has become common for multinational companies to seek a listing on several foreign stock exchanges. This may be to attract a wider investor market or because the local market is a little small for the ambitions of the company. The result has been a large expansion in primary market issues and secondary market trading in non-domestic equities. Large new equities are now offered on an international basis and similarly, US mutual funds and pension funds have gradually become less parochial and are investing more abroad.

Indices

Share indices are usually based on market capitalization. If the index is of the top 50 companies, say, then ‘top’ means biggest by market capitalization. Sometimes the index is described as ‘weighted’. This simply means that a 1% change in the price of the largest company in the index will have more impact that a 1% change in the price of the smallest. Since the share price is always changing, the ‘top’ shares are not always the same. There is provision for removing some shares and adding others, for example, every quarter.

Modern indices are based on taking the number of shares and multiplying by the price. This gives proper weight to the companies worth the largest capitalization. For example, Standard and Poor’s S&P 500 is an index based on market capitalization. The Dow Jones industrial average, which tracks 30 companies, simply averages the share price using a method known as the ‘constant divisor’. The Dow used to be calculated hourly but is now done every minute.

Stay tuned for next week where I discuss equity markets!

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Some markets are domestic (for example transactions in the local currency and under the control of the local central bank) and some are international (for example, a bond denominated in Japanese yen issued in London). There are also money markets, which are short-term (borrowing/lending of money for 1 year or less), and bond markets, which handle longer-term lending.

The Interbank Market

Banks lend money to one another for different periods of time. The deposit rate offered by one bank to another is called the offer rate. Thus, the interbank rates in London are called LIBOR – London Interbank Offer Rate. As London is a huge international market, LIBOR is the most commonly heard of interbank rate. In other wholesale markets, we may hear terms like ‘LIBOR + ¼’, ‘LIBOR + 35 basis points’ etc. The most common maturity period in the interbank market is 3 months.

Money Market Securities

Common money market instruments are –

Treasury Bills – short-term debt instruments issued by governments

Local Authority/Public Utility Bills – also called Munis in the US, issued by local municipalities etc.

Certificates of Deposit – receipts issued by banks for short term deposits by lenders. The advantage to the lender is that the CD can be sold in the secondary market, if they need the money earlier

Commercial Paper – issued by private corporations looking to raise short-term capital

The Bond Market

In some markets the terms bond and note are both used for medium to long-term securities. The US, for instance, has 2, 5 and 10 year Treasury notes and 30 year Treasury bonds.

There are different types of bonds –

Government bonds – These are the most important and often dominate the bond markets. The bonds are typically issued by a central bank or Ministry of Finance and first sold to specialist dealers from where they are sold in secondary markets.

Mortgage and Asset Backed bonds – In some countries, there is a big market for mortgage bonds. In the US, for example, home mortgages are bundled up and used as the backing security for mortgage bonds. The bundle is called Collateralized Mortgages obligations (CMO) or Collateralized Debt securities/obligations (CDS/CDO) .This technique is called securitization of assets and the bonds are called Asset-Backed securities. In theory, securitization can be applied to any stream of income payments.

Corporate bonds –Of course, they are issued by corporates. There are different varieties for example debentures are bond that must be backed by security like land and buildings. Convertibles are bonds that can be converted at a later point (if so chosen) into equity.

Foreign bonds – These are domestic issues by non-residents – ‘bulldogs’ in the UK, ‘yankees’ in the US, ‘matadors’ in Spain, ‘samurai’ in Tokyo and ‘kangaroo’ bonds in Australia! The bonds are domestic bonds in the local currency, only the issuer is foreign. This is different from international or Eurobonds which are binds issued outside their original -country. For example if a non-US firm seeks dollar funding, they can issue bonds in London as Eurobonds or in the US as ‘yankee’ bonds.

Stay tuned for more next week!

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