Warming Up

1. What is a stock market?

2. Can you name the biggest stock in the world?

3. Why do companies issue shares and sell them on the stock exchange?

Intensive Reading the stock exchange

A market is a place where people meet to buy and sell. Most markets deal in goods that have a practical use — the producers on the one hand, provide a steady supply of the goods traded, and the consumers, on the other, provide a steady demand.

The Stock Exchange deals with a different sort of commodity. The goods on sale, in themselves, have no intrinsic value. Stock and share certificates are evidence of your stake in a company, or, in the case of “Gilts”, that you have lent money to the Government by buying Government stock. They are important documents that should be kept carefully, but they are not “useful” in the sense that foodstuffs or raw materials for industry are.

There is a further complication because, however many shares a company may have in issue, they all belong to somebody. How then can the stock market ensure that there are always shares available to be bought, and buyers available to buy them? How can there be a market at all, if the public all want to buy at the same time?

Stock exchanges in other countries have found different solutions to the problem of providing a continuous and free market in securities, with varying degrees of success.

In Britain, the essential freedom is provided by a special group of Stock Exchange Member Firms, the Jobbers, who constitute a unique feature of the British market system.

In other countries, Brokers attempt to match up buyers and sellers with each other directly. Here, the Jobbers act as stall-holders in the market. At these stalls a Broker can buy or sell for his client whatever quantity of shares he wishes, be it for example, 250, 25,000 or 7,142. There is no need to hunt for a matching amount; the Jobber will provide one, and channelling all deals in this way provides immense flexibility. Unlike Brokers, who are agents for their clients and are paid by commission, Jobbers deal as principals, buying and selling shares at their own risk.

The general level of prices is decided by the investors who use The Stock Exchange; they create the supply and demand to which the Jobbers react by offering prices that they hope will be attractive to an equal number of buyers and sellers. If at one price level there are more buyers than sellers, or vice versa, the Jobbers move their prices until a balance is again reached. If a Jobber were to ignore this vital balance, he would soon find himself unable to buy enough stock to satisfy Brokers who want to buy from him, or indeed find himself buying many more shares than he could sell without incurring a loss. Because Jobbers compete against one another for the Brokers' business no one Jobber can move his prices indefinitely to suit himself without losing some or all of his business to another Jobber.

Nowadays, a Broker does far more than simply carry out his clients' buying and selling orders.

He is also an analyst, a researcher, and an adviser on a whole range of financial topics, for individual savers, for investing institutions and for companies seeking investment.

Even when he is acting in his traditional role, a Broker's responsibility does not end with the transaction on the Trading Floor. He has a responsibility, both to his client and to the Market, to see that the business is properly completed, that shares being sold are delivered to the Broker acting for the new owner, and paid for, and that any benefits due to the buyer are secured on his behalf.

Brokers have research departments which are constantly monitoring the performance of individual companies in countries all over the world, as well as the political and general economic news that may affect a sector of industry as a whole. Investment decisions may well be affected by a client's tax position, and Brokers may not always advise putting money directly into stocks and shares. Brokers therefore become involved in giving guidance on taxation, life assurance, unit trusts, building society and money market investments.

Many Brokers are also involved in corporate finance, working side by side with merchant banks, lawyers and accountants as advisers to companies and local authorities.

The 7,000 stocks and shares officially listed on The Stock Exchange provide an immense choice of possible investments. In addition, dealings are permitted in any security listed anywhere in the world, and in the shares of a great many companies that are not listed at all.

Securities fall into two main categories — “Fixed Interest” and “Equities”.

With FIXED INTEREST stocks, the amount you are due to receive in interest is known in advance. In most cases, the interest is truly “fixed”, and is included in the title of the security, e.g. 7,5% Treasury Stock, which would pay £7.50 interest each year on every £1 00 nominal amount of stock held. There are a few index-linked, or “variable rate” stocks. Here the actual interest can vary, but the amount payable is governed by a set formula, linked to some known index.

At the other end of the scale are EQUITIES, so called because the holders share in the “equity” of the company. Here nothing is fixed — the directors meet to recommend a dividend which is very much dependent on the profits the company has earned. In a bad year, it may be nothing, but if the company does well, so does the shareholder.

The most commonly encountered fixed-interest sub-groups are

Gilt-Edged or “Gilts”: these are fixed interest stocks issued by the Government. Most of them are redeemable at a set date. For example, Exchequer Stock 12% 2013―17 would be repaid at full nominal value at a date, chosen by the Government, not earlier than 2013 and not later than 2017. Since the interest is guaranteed by the Government, these are generally regarded as the most secure of investments, though the market price will still fluctuate in line with prevailing interest rates.

Local Authority and other Public Loans: similar to Gilts, though not guaranteed by the Government, but by some other body, such as a town council or a harbour board. “Yearling Bonds” come in this category. These are initially placed direct with financial institutions, but can be bought by the public through The Stock Exchange.

Debentures and Unsecured Loan Stocks: fixed interest stocks issued by companies. Like Gilts, they are a way of borrowing money, and are usually redeemable at a set date. Debentures are backed by an agreement similar to a mortgage. Trustees are appointed and if the debenture-holders do not receive their interest on time, the trustees can take over some or all of the company's assets and sell them off to repay the loan.

In any winding-up of the company, all loan stockholders must be repaid in full before anything is paid to ordinary shareholders — for that reason, these classes of securities are sometimes called “prior charges”.

Preference Shares come between debentures or loans and equities. They carry a fixed rate of dividend, but this need not be paid if a company's profits are too low to justify this expense. Unless the shares are “cumulative”, once a dividend has been “passed” it is lost forever. Cumulative Preference Shares still qualify for dividends passed in previous years, and until these have been paid up to date no payment can be made to ordinary shareholders.

Ordinary Shares or “equities”: the ordinary shareholders own the company. These shares carry the most risk, but also the best prospects of future growth. Their price is often determined not so much by past results as the expectation of future events. It is the ordinary shareholders who have the right to speak and vote at general meetings of the company, (a right sometimes extended to the holders of preference shares, but only if the dividend is in arrears, and not always then) and they elect the directors to run the business for them.

Options: an option confers the right to buy or sell a fixed number of shares at a specified price within a pre-determined period of time. “Traditional Options” are arranged directly between the two parties concerned, through one of The Stock Exchange Member Firms acting as option dealers, and these are available on practically any security, other than Gilt-Edged, traded on The Stock Exchange. “Traded Options” are available on a more restricted range of securities, but can be bought and sold throughout their period of currency. This is a specialised subject, dealt with in separate literature available from the Information and Press Department of The Stock Exchange.

As soon as you have given your order, your Broker's dealer will start checking on the prices the various Jobbers are “making” in the stock you have chosen.

The price the Jobber makes is a double one, say 100p-103p. In other words, this Jobber is offering to buy this particular share for 100 pence, or to sell it for 103 pence. (Shares are normally quoted in pence per share, until the price reaches £10, after which, the price moves in pounds and fractions of pounds. A few overseas shares, notably South African gold mines, are quoted in U.S. Dollars).

Like other Members of The Stock Exchange, Jobbers do not trade as individuals, but as firms. Different firms of Jobbers compete for the trade in each security, with at least two different firms making prices in every stock.

A Jobber does not know, when approached by a Broker, whether he is going to be asked to buy or sell. The Broker merely asks “What are ABC?” and the Jobber replies “100p to 103p”. The Broker will obtain a similar, but probably not identical, quotation from other Jobbers, before eventually dealing with the one whose price suits him best. A simple note of the bargain is made by each dealer whose verbal agreement is all that is necessary to seal the bargain. There is total trust between Members — reflected in The Stock Exchange's motto “Dictum Meum Pactum” (My Word Is My Bond).

A Jobber who is short of stock may quote a price that is higher than the others. He will therefore attract any sellers, but not buyers, which is what he wants to do, because from his point of view, demand is exceeding supply. In the same way another Jobber in the same stock may feel he has too many of a particular security and be willing to cut his price to attract buyers. By finding the best price in the Market in this way, the Broker arrives at the price which is fairest to all parties, the price at which a willing buyer and a willing seller are prepared to do business with one another.

On the same day that he deals for you, the Broker will send you a Contract Note. This sets out all the details of the transaction — the full title of the security involved, the amount bought and the price. The number of shares, times the price, gives the “consideration”, on which the Broker's commission, and the Transfer Stamp Duty (if applicable) levied by the Government, are based. These, and the other minor charges involved, are all shown on the Contract Note.

If any mistake has been made, now is the time to say so. It is important to hold on to the Contract Note, because it is the only document which gives the price you paid for the shares, and thus may be needed for tax purposes. Also until such time as your share certificate is delivered, which may be six to eight weeks from the day of dealing, (longer in some cases, especially where overseas securities are involved) it is your evidence of ownership. The principle is that, when you buy shares, The Stock Exchange Rules regard you as the owner from the moment that your Broker deals with the Jobber. It does not matter that there is a delay before you receive the share certificate.

Your Contract Note also includes the date by which you are due to pay your Broker. In the case of Government Stocks, this is usually the day after dealing. For company securities, it will normally be two or three weeks later. For overseas stocks, a variety of different times apply, but the appropriate date will always be shown on the Contract Note.