Indian Financial Market: Advantages, Limitations and Speculation of Stock Exchanges (For CBSE, ICSE, IAS, NET, NRA 2022)

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Advantages of Stock Exchanges

Having discussed the functions of stock exchanges, let us look at the advantages which

can be outlined from the point of view of

  • Companies,
  • Investors, and
  • The Society as a whole.
Advantages of Stock Exchanges

To the Companies

  • The companies whose securities have been listed on a stock exchange enjoy a better goodwill and credit-standing than other companies because they are supposed to be financially sound.
  • The market for their securities is enlarged as the investors all over the world become aware of such securities and have an opportunity to invest
  • As a result of enhanced goodwill and higher demand, the value of their securities increases and their bargaining power in collective ventures, mergers, etc. is enhanced.
  • The companies have the convenience to decide upon the size, price and timing of the issue.

To the Investors

  • The investors enjoy the ready availability of facility and convenience of buying and selling the securities at will and at an opportune time.
  • Because of the assured safety in dealings at the stock exchange the investors are free from any anxiety about the delivery and payment problems.
  • Availability of regular information on prices of securities traded at the stock exchanges helps them in deciding on the timing of their purchase and sale.
  • It becomes easier for them to raise loans from banks against their holdings in securities traded at the stock exchange because banks prefer them as collateral on account of their liquidity and convenient valuation.

To the Society

  • The availability of lucrative avenues of investment and the liquidity thereof induces people to save and invest in long-term securities. This leads to increased capital formation in the country.
  • The facility for convenient purchase and sale of securities at the stock exchange provides support to new issue market. This helps in promotion and expansion of industrial activity, which in turn contributes, to increase in the rate of industrial growth.
  • The Stock exchanges facilitate realisation of financial resources to more profitable and growing industrial units where investors can easily increase their investment substantially.
  • The volume of activity at the stock exchanges and the movement of share prices reflect the changing economic health.
  • Since government securities are also traded at the stock exchanges, the government borrowing is highly facilitated. The bonds issued by governments, electricity boards, municipal corporations and public sector undertakings (PSUs) are found to be on offer quite frequently and are generally successful.

Limitations of Stock Exchanges

  • Like any other institutions, the stock exchanges too have their limitations. One of the common evils associated with stock exchange operations is the excessive speculation. speculation implies buying or selling securities to take advantage of price differential at different times. The speculators generally do not take or give delivery and pay or receive full payment. They settle their transactions just by paying the difference in prices. Normally, speculation is considered a healthy practice and is necessary for successful operation of stock exchange activity. But, when it becomes excessive, it leads to wide fluctuations in prices and various malpractices by the vested interests. In the process, genuine investors suffer and are driven out of the market.
  • Another shortcoming of stock exchange operation is that security prices may fluctuate due to unpredictable political, social and economic factors as well as on account of rumours spread by interested parties. This makes it difficult to assess the movement of prices in future and build appropriate strategies for investment in securities. However, these days good amount of vigilance is exercised by stock exchange authorities and SEBI to control activities at the stock exchange and ensure their healthy functioning, about which you will study later.

Speculation in Stock Exchanges

  • The buyers and sellers at the stock exchange undertake two types of operations, one for speculation and the other for investment. Those who buy securities primarily to earn a regular income from such investment and possibly make some long-term gain on account of price rise in future are called investors. They take delivery of the securities and make full payment of the price. Such transactions are called investment transactions.
  • But, when the securities are bought with the sole object of selling them in future at higher prices or these are sold now with the intention of buying at a lower price in future, are called speculation transactions. The main objective of such transactions is to take advantage of price differential at different times. The stock exchange also provides for settlement of such transactions even by receiving or paying, as the case may be, just the difference in prices.
  • For example, Rashmi bought 200 shares of Moser Baer Ltd. at ₹ 210 per share and sold them at ₹ 235 per share. He does not take and give delivery of the shares but settles the transactions by receiving the difference in prices amounting to ₹ 5,000 minus brokerages. In another case, Mohit bought 200 shares of Seshasayee Papers Ltd. at ₹ 87 per share and sold them at ₹ 69 per share. He settles these transactions by simply paying the difference amounting to ₹ 3600 plus brokerage. However, now-a-days stock exchanges have a system of rolling settlement. Such facility is limited only to transactions of purchase and sale made on the same day, as no carry forward is allowed.
  • Though speculation and investment are different in some respects, in practice it is difficult to say who is a genuine investor and who is a pure speculator. Sometimes even a person who has purchased the shares as a long-term investment may suddenly decide to sell to reap the benefit if the price of the share goes up too high or do it to avoid heavy loss if the prices starts declining steeply. But he cannot be called a speculator because his basic intention has been to invest. It is only when a person՚s basic intention is to take advantage of a change in prices, and not to invest, then the transaction may be termed as speculation. In strict technical terms, however, the transaction is regarded as speculative only if it is settled by receiving or paying the difference in prices without involving the delivery of securities. It is so because, in practice, it is quite difficult to ascertain the intention.

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