Role and Function of Stock Markets

Using the Exemplar of London Stock Exchange and Frankfurt Stock Exchange

Term Paper, 2010

16 Pages, Grade: 60%


Table of contents

List of figures

1. Introduction

2. Literature Review
2.1 Scope
2.2 Organisation of Stock Markets as a whole
2.2.1 Role and Structure
2.2.2 Role of Intermediaries
2.2.3 Efficiency
2.2.4 Regulatory

3. Application
3.1 London Stock Exchange versus Frankfurt Stock Exchange
3.1.1 The UK Stock Exchange
3.1.2 The German Stock Exchange
3.2 Conclusion


List of figures

Figure 1 Organisation of Financial Markets

Figure 2 Indirect and direct Finance, Source: Mishkin (2007)

Figure 3 FTSE 100 performance, Source: Bloomberg (2010)

Figure 4 DAX 30 performance, Source: Bloomberg (2010)

1. Introduction

Nowadays it could be assumed that the level of globalisation in the financial sector is very high with participants acting global. The financial markets especially the stock markets allow companies to raise funds by letting the public all around the world to participate. On the other hand investors have the possibility to take part in global- or regional-acting corporations and consequently increase their economical wealth. This work will discuss the role of stock markets as part of the financial system. For that purpose it will analyse the organisation of stock markets including structure, participants, efficiency and regulatory framework with concentrating on the London Stock Exchange (LSE) and the Frankfurt Stock Exchange (FSE). Last but not least it is comparing two main stock markets in Europe, the LSE which is the main stock market for the UK and the FSE which is the main stock market for Germany, by giving some historical and structural data.

2. Literature Review

2.1 Scope

Financial markets transfer funds from people who have access to them, to people who have shortage (demand) like companies. Indeed, well-functioning financial markets are key factor and indicator for countries with high economic growth. On the other hand, bad-functioning financial markets can indicate how poor or rich countries are. Therefore it can be assumed that financial markets directly affect personal wealth and business and consumer behaviour. (Mishkin, 2007:3) For many people the words “financial market” means equity market but it is to mention that the value which is traded in equities is mostly less than in other financial markets. Financial markets can be divided in several subtypes like capital (bond and stock markets), commodity, money, derivatives (future, option and swap markets) and foreign exchange markets. According to Mishkin (2007:17) there are three main markets which deserve particular attention:

- The bond market where interest rates are determined.
- The foreign exchange market where fluctuations in to foreign exchange influences home markets and their interest rates.
- The stock market which effects people’s wealth and firm’s investment decision

The bond market (debt market) and stock market (equity market) are part of the so called capital market.

illustration not visible in this excerpt

Figure 1: Organisation ofFinancial Markets

In general there are two main ways how a corporation can obtain funds in the capital markets. The Debt market is known as the bond market where companies issue debt instruments, such as bonds or mortgages, in which the company pays the holder of the instrument a fixed amount at regular intervals till the maturity date. The other way for the company to raise funds is to issues equity in the stock market where the buyer receives periodic payments (dividends) as long as he holds the shares. Furthermore the buyer of equity can participate from a rise of the share price in the stock market. We will concentrate here on the stock market where companies issue equity to raise long-term funds for financing their activities.

2.2 Organisation of Stock Markets as a whole 2.2.1 Role and Structure

The U.S. stock market is the largest and at this time the most important market for securities in the world. However, foreign stock markets became more and more important for global investors in the U.S.A and abroad. Major stock markets in Europe are the London Stock Exchange, Frankfurt Stock Exchange, Euronext (France, Netherlands, Portugal and Belgium) and the Spanish IBEX.

The purpose of companies (borrower) issuing stocks and selling them to the public (lender or investor) is to raise their funds for financing their spending. A security in the stock market (also called share or financial instrument) is a claim of the issuer’s future income or assets. This means that a stock represents a share of ownership in a company. In addition the stock market share price of a company is also important for the investment decision because the price affects the funds that can be raised by a company by issuing shares to finance the activities. (Mishkin, 2007:5) On the other hand a rising share price increases the value of the stock and therefore the investors’ wealth. In result it can be said that the priorities of lender and borrower are totally different. The lender prefers high return and liquidity and low risk whereas the borrower prefers low costs of borrowing and as high as possible length of loan. (Howells and Bain, 2008:8) The fundamental mechanism at the stock market is pretty easy to understand. If there are more buyer who demand for stocks than seller the share price of a stock will increase. If there are more selling orders than buying orders the share price will decline.

The stock market is distinguished in two sectors. One of them is the primary market which includes just the issue of new securities of a corporation. For this purpose a financial institution sales the new issued shares to the public or it is placing them with a number of institutional firms such as investment funds, pensions and other financial companies. The primary market is not well- known to the public because the new-issued shares are traded secretly behind closing doors. The procedure of underwriting securities is performed by big institutions such as investment banks. The mechanism of underwriting means that the bank is guaranteeing to the issuer a price for his shares and then sells them to the public via the stock market. The advantage for the issuing firm is that it knows the value of funds the issue will raise and the costs the issue will be charged with. On the other hand the underwriter is accepting risks with this agreement. Firstly, there is the danger that the issue is overpriced. Secondly, the markets could fall until the underwriter takes up the new issue. In both cases the underwriter will leave with unsold stock. The procedure to raise funds by adding the number of shares which already are in issue is called rights issue. Rights issue means that the existing shareholders have the priority to buy shares in the new issue or to sell the rights of priority they have on the new issue. (Howells and Bain, 2008:372)

The other part of the stock market is the secondary market where corporations usually don’t participate in the transactions and therefore they do not acquire any new funds. In relation to this there is an exception when the companies buy their own shares back (buy-back shares), in this case companies are intervening on this market which can influence the own share price. In the secondary market shares that have been previously issued are resold. This means that the secondary market makes financial instruments more liquid and it is determining the price of such a financial instrument. (Mishkin, 2007:26) Once the investment firms sell successfully the issue, they try to ensure that there is an active secondary market in the issue. The best- known secondary market is the stock market.

Furthermore, it must be distinguished between well-organized markets and markets which are less organized. Stock exchanges are well-organized markets where transactions can be traded cost-effective, quick and safe. So, it can be assumed that the stock market is a highly well- organized market. An example for a less organized market is the so called over-the-counter (OTC) market in which dealers buy and sell to everyone who is willing to accept their prices. (Mishkin, 2007:27)


Excerpt out of 16 pages


Role and Function of Stock Markets
Using the Exemplar of London Stock Exchange and Frankfurt Stock Exchange
University of Westminster  (Westminster Business School)
MSc Finance and Accounting
Catalog Number
ISBN (eBook)
ISBN (Book)
File size
690 KB
Stock Markets, Role and Function, Regulatory, Intermediaries, Efficiency of Stock Markets, Structure of Stock Markets, Equity Markets, London Stock Exchange, Frankfurt Stock Exchange, FTSE 100, DAX 30
Quote paper
Panagiotis Papadopoulos (Author), 2010, Role and Function of Stock Markets, Munich, GRIN Verlag,


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