The stock market – origin and benefits

THE stock market (or stock exchange for purposes of this article) to this day is one of the greatest social contracts and institutional creations in economics and most of all, the world of finance. Since its birth in the 1600s, it still is a pivotal part of most nations’ economy and economic growth policy.
As many financial innovations, the stock market was developed by Dutch businessmen and international spice traders in the 1600s. Essentially, this arose from the need to help finance trips from the Netherlands to India to purchase spices for import into the greater part of mineland Europe.
As spices were very important to the Europeans because of things like storage and season of foods, it became a very profitable venture. So to help raise money to purchase ships, security and expand the spice import liners, the “Dutch East Indies Company” (the first ever listed stock on a stock exchange), promised people a share of the profits from the spice trade business in exchange for upfront contribution to their business and this was called purchasing a “share”.
To ensure that cash wasn’t drained from the company, the company also put in a law that the owners of those shares (the “shareholders”) were not permitted to sell the shares back to the company, but to other people, based on a value decided by the marketplace, thus developing the first ever open market for the purchase of shares, the stock market.
In this story of origin one can see the role and features of the stock market, at work. The stock market is simply put, a market that trades in (“exchange of”) capital and works to benefit both companies (wanting to raise capital) and investors (intending to grow their money).
For a company, a stock market is a place where companies can raise financial capital more cheaply than the mainstream options i.e. banks and financial lending institutions. This comes by trading funds for ownership and not for a future interest rate.
When a business acquires a bank loan, it is trading the amount of money it is borrowing now for a promise to pay it back with an extra amount called in interest (also known as debt financing).
However, on the stock market, a company has options to use cheaper debt finance (getting the money for a lower negotiated interest rate because they are not dealing with intermediaries such as banks) called a bond, or they can trade cash for a share in the business’s profits through the purchase of shares on the stock market. In Zambia this is what the companies listed below have done:
• Lafarge Cement Plc
• Standard Chartered Bank Plc
• Zambian breweries
• Zambia National Commercial Bank Plc
Added to this central function, stock markets also allow a company a mechanism for market valuation of their business to give them a true reflection of how much cash their company is worth at any particular moment. At the same time, being listed on the stock market comes with so many regulations and controls that all listed companies are given better credibility in all the business community and the general public. These regulations ensure that best corporate governance practices are adopted by companies listed on the stock market.
On the other side of the equation, stock markets offer investment opportunities for investors. There are two main benefits for those wishing to invest.
The first is an opportunity to fairly invest in a profitable business and reap rewards of such a thriving business through a simple transaction, i.e. buying shares. Similarly, investors also obtain the benefit of easy exit from that company through the same simple transaction of just selling their shares in a company to another person using the stock market.
Another benefit of the stock market is that of asset value and capital gains. Investors can always know how valuable their asset holdings are in the company simply by applying daily market price of their shares in a company.
Simultaneously, if the market is more interested in those shares (due to profitability, business prospects and other reasons) they tend to increase in value and thus their asset base also increases.
In all the above, the stock market’s main roles are facilitation of all such transactions (e.g sale of shares, transfers of dividends), regulation and information communications (e.g. publishing share prices and company information)
The stock exchange as an institution is a company that is given the mandate of serving both these parties (the seller and the buyer) in a transparent, equal and fair manner.
The foregoing ensures the stock market maintains its role as one of the greatest financial innovations of all time.
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