Functioning of Stock Exchange and Role in Economic Development of a Country

A stock exchange is an entity which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts, derivatives, pooled investment products and bonds.

To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for record keeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks. There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

THE ROLE OF STOCK EXCHANGES

Raising Capital for Businesses

Mobilizing Savings for Investment

Facilitating Company Growth

Profit Sharing

Corporate governance

 Creating investment opportunities for small investors

 Government capital-raising for development projects

 Barometer of the economy

GLOBAL STOCK MARKETS

During the fiscal year 2008-09, the leading stock markets of the world observed negative growth ranging from 50.7 percent (Pakistan) to 2.9 percent (China). Principal stock indices including US S&P 500, UK FTSE 100 and Hong Kong Hang Seng also recorded declines of 31 percent, 41 percent and 23.6 percent respectively during FY09 (See Table 6.1) For Pakistan, a huge number of domestic and external quandaries tested economic buoyancy. Internal and external security concerns received focal importance. The benchmark Karachi Stock Exchange witnessed a sharp hitch in the rising disposition of its leading KSE-100 index. The index underwent a gigantic loss of 41.6 percent, to close at 7,177.6 points on May 15, 2009, during the current fiscal year. In terms of dollar returns, the plunge is all the more magnified by recording a downpour of 50.7 percent.

Table 6.1: Global Stock Indices during June 30, 2008 to May 15, 2009
Sr. No.	Country	Stock Name	Index (Local Currency)		Currency			Market Return
			30-Jun-08	15-May-09	Exchange Rate	30-Jun-08	15-May-09	Local Currency	USD
1	Pakistan	KSE 100	12,289.03	7,177.64	PKR/USD	68.36	80.91	-41.59%	-50.65%
2	India	Sensex 30	13,461.60	12,173.42	INR/USD	42.94	49.40	-9.57%	-21.38%
3	Indonesia	Jakarta Composite	2,349.10	1,750.91	IDR/USD	9260.00	10403.50	-25.46%	-33.66%
4	Taiwan	Taiwan Weighted	7,523.54	6,489.09	TWD/USD	30.35	32.92	-13.75%	-20.48%
5	South Korea	Seoul Composite	1,674.92	1,391.73	KRW/USD	0.26	0.29	-16.91%	-23.85%
6	Hong Kong	Hang Seng	22,102.01	16,790.70	HKD/USD	7.80	7.75	-24.03%	-23.58%
7	Malaysia	KLSE Composite	1,186.57	1,014.21	MYR/USD	3.27	3.55	-14.53%	-21.31%
8	Japan	Nikkei 224	13,481.38	9,265.02	JPY/USD	106.18	94.88	-31.28%	-23.09%
9	Singapore	STRAIT TIMES	2,947.54	2,139.78	SGD/USD	1.36	1.47	-27.40%	-32.72%
10	Sri Lanka	All Shares	2,457.84	1,907.67	LKR/USD	107.70	117.80	-22.38%	-29.04%
11	China	Shanghai Composite	2,736.10	2,645.26	CNY/USD	6.85	6.82	-3.32%	-2.87%
12	Philippines	PSE Composite	2,459.98	2,308.70	PHP/USD	44.87	47.60	-6.15%	-11.52%
13	Australia	All Ordinaries	5,332.90	3,758.90	AUD/USD	1.05	1.33	-29.51%	-44.54%
14	US	S & P 500	1,280.00	882.88	USD/USD	1.00	1.00	-31.03%	-31.03%
15	UK	FTSE 100	5,625.90	4,348.10	GBP/USD	0.50	0.66	-22.71%	-40.91%
16	New Zealand	NZSE 50	3,194.61	2,790.90	NZD/USD	1.31	1.70	-12.64%	-32.53%
Source: Invisor Securities

STOCK EXCHANGE ROLE IN ECONOMIC DEVELOPMENT OF A COUNTRY

Financial markets perform a key function in the form of intermediation by mobilizing savings from a large pool of small savers and channelizing these funds into productive investments by a generally much smaller number of borrowers. Trading in securities enables a match between the differing maturity preferences of lenders and borrowers. Stock markets also potentially endorse broad-basing of ownership of financial assets and the reallocation of funds among corporations and sectors. Moreover, a developed bond market helps in providing liquidity to domestic growth and credit expansion.

Across the world, an extensive transformation towards an equity culture has taken root as conventional bank financing shows a flipside to the emergence of globally interrelated capital markets. Integration proves to be beneficial in the form of a more efficient, liquid and broad securities market; innovative products and services; industrial transformation of markets; cheaper corporate financing; and enhanced risk-return frontiers. However not ignoring the downside, the ensuing globalization of financial services can also exacerbate the too-connected-to-fail problem. Indeed, the ongoing global financial mess has shown how financial innovations have enabled risk transfers that were not fully recognized by financial regulators or by institutions themselves.

The stock markets of Pakistan witnessed a boom during the 1990’s, attributable to a large number of developments, including; first, the process of financial liberalization resulting in a rise and inflow of foreign portfolio investment; second, the process of privatization and the offering of new attractive shares; third, a greater measure of political stability and investor confidence; fourth, improvements in the operational efficiency of stock markets. Nevertheless, the Karachi Stock Exchange (KSE), established soon after independence in September 1947, gathered forceful momentum since 2002. During 2002-2007, even with a few episodes of mayhem down the way, the development in the KSE-100 index and market capitalization has been unparalleled and incredible.

The beginning of the fiscal year 2008 appeared promising for Pakistan’s capital markets regardless of the sub-prime crisis intensifying its grip on financial systems all over the globe. The stock markets in Pakistan posted good gains and the KSE-100 index gained 11.6 percent by mid of April 2008 and reached the highest level of 15,676 points on April 18, 2008 with a gain of 1,747 points over the level of index at the start of the year 2008. Subsequent to this high time, however, the equity market has seen an episode of precipitous decline: the KSE-100 index has fallen by over 62 percent (as on December 31, 2008) since reaching its peak in April 2008. Prices have nose-dived in response to waning macro-economic fundamentals, a worsening law and order situation and international capital flight. Notwithstanding, equity investors have embarked on a fractional recovery of their fortunes with an upsurge in the KSE-100 index of a fine 22.5 percent since the commencement of the calendar year 2009, driven up chiefly by signs of returning economic stability. A timely signing of SBA with the International Monetary Fund (IMF) in November 2008 and a commitment of pledges by Friends of Democratic Pakistan are collectively expected to help out the economy sail through what could be a tumultuous era. It goes without saying that the government's success in managing the economy has, without a doubt, served to build a soothing outcome

Constraints in Development of Stock Markets:    A number of factors have traditionally been responsible for the under development of the equity market in Pakistan. We have already referred to the government policy till recently of keeping interestrates artificially low, thereby leading to a strong preference for debt versus equity financing. Also, the tax system has increased the attractiveness of debt and firms have remained highly leveraged in Pakistan.

Recent Stock Market Development:          The boom witnessed during the 90s in the stock market of Pakistan can be attributed to a large number of factors, including, first, the process of financial liberalization resulting in a rise and inflow of foreign portfolio investment; second, the process of privatization and the offering of new attractive shares; third, a greater measure of political stability and investor confidence; fourth, improvements in the operational efficiency of stock markets. It is of significance to note that the two major measures of the share price index coincided with the induction of popularly elected governments in 1990 and 1993 respectively. More recently, prices have plummeted in response to weakening in the underlying macro economic fundamentals, deteriorating law and order situation and exodus of foreign portfolio capital.