Text 9 - The Stock Exchange

Central function of the stock exchange in the economy

Funcion Central del Mercado de valores en la economia
The stock exchange is an organized market, in which supply and demand for securities are brought together. A
differentiation is made between the cash and forward markets. Equities and bonds are traded on the cash
markets. They offer investors the opportunity to take part in the economic progress of corporations. Risks that
arise from price fluctuations in the cash markets are hedged in the options and futures markets through trading in
options and futures contracts so-called derivative financial products.
La bolsa de valores es un mercado organizado, en el que la oferta y la demanda de valores van juntas. Existe una
diferenciacin entre el efectivo y los mercados. Acciones y bonos se negocian en los mercados de contado. Ellos
ofrecen a los inversores la oportunidad de tomar parte en el progreso econmico de las empresas. Los riesgos
que surgen de las fluctuaciones de precios en los mercados de contado se cubren en los mercados de opciones y
futuros a travs de la negociacin de los contratos de opciones y futuros - los llamados productos financieros
derivados.
The stock market fulfills a central function in the economy, bringing together savers and investors (providers of
capital) on the one hand with companies and the state (borrowers) on the other. Without this "mediator", the
capital providers and borrowers would have to negotiate directly, which would generate heavy search and
information costs. Whereas companies and the state often require large sums of long-term capital, most of the
savers and investors want to provide small amounts for relatively shorter time periods. The stock market makes
possible an optimal and efficient reconcilement of interests between these groups. Savers and investors can buy
and sell securities on the exchange at any time, without directly affecting the companies. For this reason, the
stock market is also known as a circulating market (secondary market). It is also an issuers' market in which new
issues can be placed (primary market).
Central functions and responsibilities of a stock market:

Making available cost-effective trading platforms

Bundling of liquidity by concentrating supply and demand
Guaranteeing the fungibility, or interchangeability, as well as the identical structuring of a particular
category of security
Ensuring the greatest possible transparency for investors
Providing information on prices and volume

How Does the Stock Exchange Work?

The stock exchange is not as abstract a concept as it may seem to newcomers. At first, the terminology used by
market participants might be hard to understand. However, the stock exchange is simply a marketplace just like
a street market, if you want where traders offer their goods and where customers buy what they need.
Imagine, on a street market you discover something you have been looking for. You bargain with the seller
what is the object worth, what are you willing to pay and what amount is the seller ready to accept? Once you
have struck a deal, you pay for the product and take your new treasure home.
The stock exchange works in a similar way. There is only one significant difference: you, as the buyer, do not get
in direct contact with the seller. You could compare the scenario with a wholesale market, where the end
customer hardly ever trades with the seller. The producer sells its goods to the wholeseller, who then sells to the
greengrocer, and this is where the end customers buy their greens from.

The stock exchange does not trade itself, in the same way as the operator of a street market is not actually selling
things there. It merely provides the infrastructure. The marketplaces of the Frankfurt Stock Exchange i.e. the
cash market with floor trading in Frankfurt and the fully electronic trading system Xetra rank among the
largest marketplaces worldwide. Trading, however, is conducted by the market participants.
In trading on an electronic platform, brokers do not meet to conduct business. Instead, a computer system
automatically matches buy and sell orders.

Market Participants: Investors and Companies

Market participants include investors (the 'end consumers'), issuers ('the producers') and traders ('the
intermediaries').
Intermediaries
Lead brokers and specialists on the Frankfurt trading floor belong to this group. They match demand and supply
and fix prices. In Xetra trading, Designated Sponsors and Market Makers act as brokers and also provide
binding bid and ask quotes. In addition, banks employ traders who forward the orders of their customers to lead
brokers or enter them into the electronic trading system.
Investors
Private investors without a valid trader's license are not authorized to trade directly on the floor. Access to the
floor is granted to authorized trading participants only. They buy and sell securities on behalf of their clients.
There are private and institutional investors and within each of these two groups, different types of investors and
investment strategies can be found.
Issuers
Just like investors, issuers are not present on the trading floor. This is merely the place where their shares are
traded. However, the first day of admission to the Frankfurt Stock Exchange is an unforgettable experience for
many issuers and a milestone in any company's history. The atmosphere during the first price fixing on the
trading floor is unique. Xetra IPOs can also be observed live on the Internet.
An IPO provides many opportunities for companies seeking capital. Listed companies do not only grow faster,
they also do not react as strongly to economic fluctuations. In principle, an IPO makes sense for companies that
aim for a broader equity basis.
In contrast to debt capital, equity is available for an unlimited period of time and increases the flexibility of a
company. Equity can be used without restrictions for long-term projects, for example to:

Consistently pursue growth strategies,

Strengthen the position in international competition,
Increase awareness in the market and among investors,
Promote the attractiveness as employer.

With a listing on the Frankfurt Stock Exchange, companies keep all these opportunities open for themselves.
Whether or not an IPO turns out successful does not only depend on the company itself, but also on its market
environment. How do stock prices fare at the moment? Which sectors are in the spotlight? No doubt, the stock

market knows trends. Just because everyone is into solar energy today, does not mean that nanotech could not be
all the rage tomorrow. How liquid are the investors? If all conditions are right, you could say there is a window
for an IPO.
Corporate governance Good behavior of listed companies
Investments require confidence in business models, products, markets and, above all, in a companys
management team. That the smaller instances of irregularities and the larger cases of fraud in the financial
markets in the recent past have served to erode such confidence, is only one reason for demanding clear
behavioral guidelines for companies. Another is the increasingly international orientation of both companies and
investors. Globalization demands uniform rules so that it becomes easier to compare companies and their
markets.
Corporate governance describes the good management practices of companies. It deals, more particularly, with
the regulatory framework for executive management and control, issues like the legal and actual allocation of
duties between the supervisory board, the management board and the owners and the remuneration and incentive
systems for these bodies.