`STOCK MARKETS

A stock market / share market is a public market (a loose network of economic transactions
not a physical facility or discrete entity) for the trading of company stock and derivatives at an
agreed price; these are securities listed on a stock exchange as well as those only traded
privately.

The size of the world stock market was estimated at about $36.6 trillion US at the beginning of
October 2008 The total world derivatives market has been estimated at about $791 trillion face
or nominal value, 11 times the size of the entire world economy.

The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual
organization specialized in the business of bringing buyers and sellers of the organizations to a
listing of stocks and securities together. The stock market in the United States is NYSE while in
Canada, it is the Toronto Stock Exchange. Major European examples of stock exchanges include
the London Stock Exchange, Paris Bourse, and the Deutsche Börse. Asian examples include the
Tokyo Stock Exchange, the Hong Kong Stock Exchange,the Bombay Stock Exchange and the
Karachi Stock Exchange. In Latin America, there are such exchanges as the BM&F Bovespa and
the BMV.

Trading

Participants in the stock market range from small individual stock investors to large hedge fund
traders, who can be based anywhere. Their orders usually end up with a professional at a stock
exchange, who executes the order.

Some exchanges are physical locations where transactions are carried out on a trading floor, by a
method known as open outcry. This type of auction is used in stock exchanges and commodity
exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of
stock exchange is a virtual kind, composed of a network of computers where trades are made
electronically via traders.

Actual trades are based on an auction market model where a potential buyer bids a specific price
for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market
means you will accept any ask price or bid price for the stock, respectively.) When the bid and
ask prices match, a sale takes place, on a first-come-first-served basis if there are multiple
bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between buyers and
sellers, thus providing a marketplace (virtual or real). The exchanges provide real-time trading
information on the listed securities, facilitating price discovery.

The New York Stock Exchange is a physical exchange, also referred to as a listed exchange —
only stocks listed with the exchange may be traded. Orders enter by way of exchange members
and flow down to a floor broker, who goes to the floor trading post specialist for that stock to
trade the order. The specialist's job is to match buy and sell orders using open outcry. If a spread
exists, no trade immediately takes place--in this case the specialist should use his/her own
resources (money or stock) to close the difference after his/her judged time. Once a trade has
been made the details are reported on the "tape" and sent back to the brokerage firm, which then
notifies the investor who placed the order. Although there is a significant amount of human
contact in this process, computers play an important role, especially for so-called "program
trading".

The NASDAQ is a virtual listed exchange, where all of the trading is done over a computer
network. The process is similar to the New York Stock Exchange. However, buyers and sellers
are electronically matched. One or more NASDAQ market makers will always provide a bid and
ask price at which they will always purchase or sell 'their' stock.

MARKET PARTICIPANTS

A few decades ago, worldwide, buyers and sellers were individual investors, such as wealthy
businessmen, with long family histories (and emotional ties) to particular corporations. Over
time, markets have become more "institutionalized"; buyers and sellers are largely institutions
(e.g., pension funds, insurance companies, mutual funds, index funds, exchange-traded funds,
hedge funds, investor groups, banks and various other financial institutions). The rise of the
institutional investor has brought with it some improvements in market operations.

Importance of stock market

Function and purpose

The stock market is one of the most important sources for companies to raise money. This
allows businesses to be publicly traded, or raise additional capital for expansion by
selling shares of ownership of the company in a public market. The liquidity that an
exchange provides affords investors the ability to quickly and easily sell securities. This
is an attractive feature of investing in stocks, compared to other less liquid investments
such as real estate.

History has shown that the price of shares and other assets is an important part of the
dynamics of economic activity, and can influence or be an indicator of social mood. An
economy where the stock market is on the rise is considered to be an up and coming economy. In
fact, the stock market is often considered the primary indicator of a country's economic strength
and development. Rising share prices, for instance, tend to be associated with increased business
investment and vice versa. Share prices also affect the wealth of households and their
consumption. Therefore, central banks tend to keep an eye on the control and behavior of the
stock market and, in general, on the smooth operation of financial system functions. Financial
stability is the raison d'être of central banks.
Exchanges also act as the clearinghouse for each transaction, meaning that they collect and
deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to
an individual buyer or seller that the counterparty could default on the transaction.

The smooth functioning of all these activities facilitates economic growth in that lower costs
and enterprise risks promote the production of goods and services as well as employment. In
this way the financial system contributes to increased prosperity.

Relation of the stock market to the modern financial system

The financial systems in most western countries has undergone a remarkable transformation.
One feature of this development is disintermediation. A portion of the funds involved in saving
and financing flows directly to the financial markets instead of being routed via the traditional
bank lending and deposit operations. The general public's heightened interest in investing in the
stock market, either directly or through mutual funds, has been an important component of this
process. Statistics show that in recent decades shares have made up an increasingly large
proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit
accounts and other very liquid assets with little risk made up almost 60 percent of households'
financial wealth, compared to less than 20 percent in the 2000s. The major part of this
adjustment in financial portfolios has gone directly to shares but a good deal now takes the form
of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual
funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving
with a higher risk has been accentuated by new rules for most funds and insurance, permitting a
higher proportion of shares to bonds. Similar tendencies are to be found in other industrialized
countries. In all developed economic systems, such as the European Union, the United States,
Japan and other developed nations, the trend has been the same: saving has moved away from
traditional (government insured) bank deposits to

The behavior of the stock market

From experience we know that investors may 'temporarily' move financial prices away from their
long term aggregate price 'trends'. (Positive or up trends are referred to as bull markets; negative
or down trends are referred to as bear markets.) Over-reactions may occur—so that excessive
optimism (euphoria) may drive prices unduly high or excessive pessimism may drive prices
unduly low. Economists continue to debate whether financial markets are 'generally' efficient.

According to one interpretation of the efficient market hypothesis (EMH), only changes in
fundamental factors, such as the outlook for margins, profits or dividends, ought to affect share
prices beyond the short term, where random 'noise' in the system may prevail. (But this largely
theoretic academic viewpoint—known as 'hard' EMH—also predicts that little or no trading
should take place, contrary to fact, since prices are already at or near equilibrium, having priced
in all public knowledge.) The 'hard' efficient-market hypothesis is sorely tested by such events as
the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percent—the largest-
ever one-day fall in the United States. This event demonstrated that share prices can fall
dramatically even though, to this day, it is impossible to fix a generally agreed upon definite
cause: a thorough search failed to detect any 'reasonable' development that might have accounted
for the crash. (But note that such events are predicted to occur strictly by chance , although very
rarely.) It seems also to be the case more generally that many price movements (beyond that
which are predicted to occur 'randomly') are not occasioned by new information; a study of the
fifty largest one-day share price movements in the United States in the post-war period seems to
confirm this.

However, a 'soft' EMH has emerged which does not require that prices remain at or near
equilibrium, but only that market participants not be able to systematically profit from any
momentary market 'inefficiencies'. Moreover, while EMH predicts that all price movement (in
the absence of change in fundamental information) is random (i.e., non-trending), many studies
have shown a marked tendency for the stock market to trend over time periods of weeks or
longer. Various explanations for such large and apparently non-random price movements have
been promulgated. For instance, some research has shown that changes in estimated risk, and the
use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could
cause financial markets to overreact. But the best explanation seems to be that the distribution of
stock market prices is non-Gaussian (in which case EMH, in any of its current forms, would not
be strictly applicable).

Other research has shown that psychological factors may result in exaggerated (statistically
anomalous) stock price movements (contrary to EMH which assumes such behaviors 'cancel
out'). Psychological research has demonstrated that people are predisposed to 'seeing' patterns,
and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar
shapes in clouds or ink blots.) In the present context this means that a succession of good news
items about a company may lead investors to overreact positively (unjustifiably driving the price
up). A period of good returns also boosts the investor's self-confidence, reducing his
(psychological) risk threshold.

Another phenomenon—also from psychology—that works against an objective assessment is

In one paper the authors draw an analogy with gambling. In normal times the market behaves
like a game of roulette; the probabilities are known and largely independent of the investment
decisions of the different players. In times of market stress, however, the game becomes more
like poker (herding behavior takes over). The players now must give heavy weight to the
psychology of other investors and how they are likely to react psychologically.

The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced
investors rarely get the assistance and support they need. In the period running up to the 1987
crash, less than 1 percent of the analyst's recommendations had been to sell (and even during the
2000 - 2002 bear market, the average did not rise above 5%). In the run up to 2000, the media
amplified the general euphoria, with reports of rapidly rising share prices and the notion that
large sums of money could be quickly earned in the so-called new economy stock market. (And
later amplified the gloom which descended during the 2000 - 2002 bear market, so that by
summer of 2002, predictions of a DOW average below 5000 were quite common.)

Stock market index

The movements of the prices in a market or section of a market are captured in price indices
called stock market indices, of which there are many, e.g., the S&P, the FTSE and the Euronext
indices. Such indices are usually market capitalization weighted, with the weights reflecting the
contribution of the stock to the index. The constituents of the index are reviewed frequently to
include/exclude stocks in order to reflect the changing business environment.

Leveraged strategies

Stock that a trader does not actually own may be traded using short selling; margin buying may
be used to purchase stock with borrowed funds; or, derivatives may be used to control large
blocks of stocks for a much smaller amount of money than would be required by outright
purchase or sale.

Short selling

In short selling, the trader borrows stock (usually from his brokerage which holds its clients'
shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for
the price to fall. The trader eventually buys back the stock, making money if the price fell in the
meantime or losing money if it rose. Exiting a short position by buying back the stock is called
"covering a short position." This strategy may also be used by unscrupulous traders to artificially
lower the price of a stock. Hence most markets either prevent short selling or place restrictions
on when and how a short sale can occur. The practice of naked shorting is illegal in most (but not
all) stock markets.

Margin buying

In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise.
Most industrialized countries have regulations that require that if the borrowing is based on
collateral from other stocks the trader owns outright, it can be a maximum of a certain
percentage of those other stocks' value. In the United States, the margin requirements have been
50% for many years (that is, if you want to make a $1000 investment, you need to put up $500,
and there is often a maintenance margin below the $500). A margin call is made if the total value
of the investor's account cannot support the loss of the trade. (Upon a decline in the value of the
margined securities additional funds may be required to maintain the account's equity, and with
or without notice the margined security or any others within the account may be sold by the
brokerage to protect its loan position. The investor is responsible for any shortfall following such
forced sales.) Regulation of margin requirements (by the Federal Reserve) was implemented
after the Crash of 1929. Before that, speculators typically only needed to put up as little as 10
percent (or even less) of the total investment represented by the stocks purchased. Other rules
may include the prohibition of free-riding: putting in an order to buy stocks without paying
initially (there is normally a three-day grace period for delivery of the stock), but then selling
them (before the three-days are up) and using part of the proceeds to make the original payment
(assuming that the value of the stocks has not declined in the interim).

Investment strategies

One of the many things people always want to know about the stock market is, "How do I make
money investing?" There are many different approaches; two basic methods are classified as
either fundamental analysis or technical analysis. Fundamental analysis refers to analyzing
companies by their financial statements found in SEC Filings, business trends, general economic
conditions, etc. Technical analysis studies price actions in markets through the use of charts and
quantitative techniques to attempt to forecast price trends regardless of the company's financial
prospects. One example of a technical strategy is the Trend following method, used by John W.
Henry and Ed Seykota, which uses price patterns, utilizes strict money management and is also
rooted in risk control and diversification.

Additionally, many choose to invest via the index method. In this method, one holds a weighted
or unweighted portfolio consisting of the entire stock market or some segment of the stock
market (such as the S&P 500 or Wilshire 5000). The principal aim of this strategy is to maximize
diversification, minimize taxes from too frequent trading, and ride the general trend of the stock
market (which, in the U.S., has averaged nearly 10%/year, compounded annually, since World
War II).

Taxation

According to much national or state legislation, a large array of fiscal obligations are taxed for
capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on
the stock market, in particular in the stock exchanges. However, these fiscal obligations may
vary from jurisdiction to jurisdiction because, among other reasons, it could be assumed that
taxation is already incorporated into the stock price through the different taxes companies pay to
the state, or that tax free stock market operations are useful to boost economic growth.

Thus MNC’s can raise new capital by listing their stocks on stock exchange, and they can list on
their home country currency or foreign Exchange.

INTERNATIONALISATION OF STOCK MARKETS

The 1980s gave a major impetus to the international integration of stock markets and the growth
of cross border equity investments have been continuing, with occasional setbacks. The massive
cross border portfolio investments flows very significantly impact the foreign exchange markets.

The important factors which have contributed to the cross-border portfolio investments are the
following

1.Growing realisation by the investors of the importance of diversification of investments.

3. Attractive returns on investments in the emerging markets.

4. The realisation by companies of the benefits of global sourcing of finance.

5. The developments in communication technology that enhanced the ease and efficiency of
conducting transactions.

There has been large portfolio investment flows to the emerging markets and their share in the
global market capitalization has increased substantially.

One of the manifestations of international integration of capital markets is the explosive increase
in cross-listing of equity i.e., listing the equity shares on one or more foreign exchanges, in
addition to the home country stock-exchanges. Although the MNCs predominate the cross listing
scene, non- MNCs have also been cross-listing. In fact, some foreign companies are listed on
virtually all national stock exchanges from developed countries. Many European exchanges have
a large proportion of foreign listings. In fact, the exchanges in Germany and Lexumbourg have
more foreign than domestic listings, while several others like Brussels and Swiss bourses have
substantial foreign listings.

Cross-listings provide several advantages. By expanding the investor base and demand for the
company’s shares, it helps increase share price and liquidity. The global expansion of investor
base would make more people familiar friendly with the company. Cross-listing helps improve
the company’s image and awareness, and possibly the demand for its products.