Capital Markets Efficiency

Global Securities Markets

Trading of Global Securities

Securities are traded globally through several large markets and "off-exchanges" through electronic networks, though investors seek to trade where they have legal protections.

Prior to the 2000s, global trading of securities was conducted primarily through major stock exchanges around the world. Today, a large portion of securities trades are conducted privately via "off-exchanges" through electronic private networks. Stock exchanges were originally created in the leading "money-centered" cities of the world, such as London and New York, where institutional and wealthy individual investors were concentrated. Thus, the strength of the local economy and investor interest were two of the most significant factors that drove the need for a stock market in a particular location. However, with private electronic networks now carrying a heavy load of securities trading of bonds and stock, it has become less important to have a local exchange presence. One exception might be China, as these electronic networks do not connect to its Shanghai Stock Exchange because of government restrictions. Therefore, the Chinese government built a connecting network with the Hong Kong Stock Exchange, which is electronically connected to leading global trading centers, in order to permit the trading of Chinese-based public companies via that exchange.

Sophisticated individual investors, as well as institutional investors, also seek to trade in countries that provide strong laws protecting investors’ rights. Thus, global investors are drawn to the capital markets of the United States, Japan, the United Kingdom, and the European Union because of their strong investor protection laws. While developing countries do often have stock exchanges as well, they frequently lack strong investor protection laws. Another factor is the limited trading volume found in developing countries' stock exchanges, forcing them to focus more on domestic companies' capital needs. For large, growing global companies with significant capital funding needs located in these developing regions, the Eurodollar market and U.S. capital markets present the only alternatives to raising large sums via the sale of their bonds or stocks to global investors. In summary, strong local investor protections coupled with highly liquid local exchange markets is the ideal foundation for a successful securities marketplace.

The two largest stock markets in the world are located within a few miles of each other in New York City. They are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (Nasdaq). There are a couple of reasons for this. The first reason is that New York has been a money-centered city for more than 200 years. The second reason is that the Nasdaq focused on entrepreneurial technology companies that were more prevalent in the United States beginning in the 1980s.

In Asia the major stock exchanges are located in Japan, China, India, South Korea, and Taiwan. The major European stock exchanges are located in England, Italy, Germany, Switzerland, Spain, Ireland, and France. Other major global stock exchanges are located in Australia, South Africa, and Brazil.

Most global stock exchanges trade in foreign securities. The NYSE and the Nasdaq, for example, collectively trade many non-U.S. foreign stocks; such trades are allowed if the shares are registered with the U.S. Securities and Exchange Commission (SEC). Some firms choose to tap into overseas securities markets in addition to their domestic financial markets to gain access to new sources of capital for the company and to help facilitate the financing of overseas assets. More importantly, the low cost of raising debt, for example, has attracted U.S. businesses to Japan over the last twenty years due to lower interest rates. Some countries also have investors who are more likely to buy bonds rather than stocks because of conservative investment practices and because there are significant pension systems that limit investing aggressively for long-term retirement needs. Companies in such countries often seek to be traded on foreign exchanges where consumers are more likely to purchase stocks.

Major Global Securities Exchanges

New York Stock Exchange (NYSE) United States New York
National Association of Securities Dealers Automated Quotations (Nasdaq) United States New York
TMX Group Canada Toronto
Japan Exchange Group Japan Tokyo
Hong Kong Stock Exchange China Hong Kong
Shanghai Stock Exchange China Shanghai
Shenzhen Stock Exchange China Shenzhen
Bombay Stock Exchange India Mumbai
National Stock Exchange of India India Mumbai
Korea Exchange South Korea Seoul
Taiwan Stock Exchange Taiwan Taipei
Euronext European Union Amsterdam
London Stock Exchange Group United Kingdom
Deutsche Börse Germany Frankfurt
SIX Swiss Exchange Switzerland Zurich
Nasdaq Nordic Armenia, Nordic and Baltic countries Stockholm
BME Spanish Exchanges Spain Madrid
Australian Securities Exchange Australia Sydney
JSE Limited South Africa Johannesburg
B3 Brazil São Paulo

Numerous stock exchanges around the world trade securities, stocks, and bonds. Some of the largest include the New York Stock Exchange, the Japan Exchange Group, and Euronext.

How Securities Markets Impact the Economy

Securities markets have a significant effect on a country's economy, such as triggering economic collapse or creating higher levels of consumer confidence.

Changes in the valuation of stocks and bonds in securities markets can profoundly affect the economy of the nation in which the securities are traded, as well as global economic conditions. This is because a healthy economy depends in part on consumer and business confidence in prevailing and future economic conditions. For example, it was the U.S. stock market crash in 1929 that triggered the Great Depression, the greatest economic collapse in the history of the modern industrialized world. The Great Depression started in late 1929 and continued throughout the 1930s.

The collapse of the securities markets in the United States and the triggering of the Great Depression had a significant economic impact on the rest of the country. Unemployment soared to record highs as many companies went out of business. People that had assets began to hoard them, not trusting banks to hold cash and not investing in stocks or bonds. The cyclical negative impact led to food and resource shortages, reduced tax revenues for the government to operate with, and overall fiscal decline. Negative news and events in securities markets can have a cumulative impact in that investors become less confident about future financial security, so they are less willing to invest and demand greater returns for any investments they make. This overall siphoning of money out of the economy can have a repetitive negative impact in which negative security impacts leads to bad news, which leads to further securities market declines.

The opposite can also happen, in which a healthy economy leads to higher levels of consumer confidence and greater investment in corporate securities. Corporations use this new money to expand their offerings and raise pay for their current workforce. Their employees, feeling more secure at work, spend more and strengthen the consumer marketplace, which encourages other companies to expand and increase hiring. Overall, what people believe about their short- and long-term economic prospects heavily influences what they think about the securities markets and their willingness to invest at any given time.

Capital Asset Pricing Model

The capital asset pricing model can be used by investors to determine the amount of risk for an individual security.

The capital asset pricing model (CAPM) is based on the economic theory that postulates that the expected return of a securities asset depends on its level of systematic risk. The model provides a method to measure the amount of risk for a given individual security traded in the marketplace. Essentially the CAPM is used in finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital. Thus, an investor can use the CAPM to determine the expected return on a security relative to the risk-free return plus the risk premium of that security. The risk-free investment rate is what a long-term government bond will pay in that securities market.

In building individual investment portfolios, investors can use the CAPM to predict investment risk and price volatility in any given security. Price volatility is risk related to the size of changes in a security's value. This ensures that the security portfolio created is commensurate with the level of risk the investor wants to take.

The CAPM formula calculates the return an investor can expect to receive from an investment in a corporate security in comparison to the risk-free return that could be received from a safe asset class, such as a government bond. The formula is made up of the return, the risk-free rate, the beta, and the risk premium. The return is what the investor expects the asset to generate. The risk-free rate on interest is the rate than can be earned in a market by investing in a safe asset class, like government bonds. The beta (β\beta) is the sensitivity of the expected asset return in relation to the market return.
E(Ri)=Rf+βi(E(Rm)Rf){\rm E}\;({\rm R}_i)=\;{\rm R}_f\;+\beta_i\;({\rm E}\;({\rm R}_m)-{\rm R}_f)
E(Ri)=The Return the Investor Expects the Asset to GenerateRf=The Risk-Free Rate on Interest that Can be Earned in that Market by Investing in a Safe Asset Class Like Government Bondsβi=Theβor Sensitivity of the Expected Asset Return in Relation to the Market ReturnE(Rm)Rf=The Risk Premium\begin{array}{rcl}{\rm E}\;({\rm R}_i)&=&\text{The Return the Investor Expects the Asset to Generate}\\{\rm R}_f&=&\text{The Risk-Free Rate on Interest that Can be Earned in that Market}\\&&\text{ by Investing in a Safe Asset Class Like Government Bonds}\\{\rm\beta}_i&=&\text{The}\;\rm\beta\;\text{or Sensitivity of the Expected Asset Return in Relation to the Market Return}\\\rm E\;({\rm R}_m)-{\rm R}_f&=&\text{The Risk Premium}\end{array}
The CAPM considers three factors. For example, if Widget Inc. issues stock, investors will first want to consider the time value of money. The time value of money is the reward that investors could expect if they purchase stock in Widget Inc. instead of investing in a risk-free asset, such as U.S. government savings bonds. Second, investors will look at the investment class and type of stock that Widget Inc. is offering. Investors will consider the systematic risk of the stock as well as the expected return a portfolio should generate when investing in the same type of stock class, or level of voting rights of shareholders, that Widget Inc. is offering. After all, investors will want to know if Widget Inc. stock is either safer than simply investing in a fund of stocks that are similar to Widget Inc. in terms of size and business field or that Widget Inc. is likely to produce greater returns than its peer stocks. Finally, those considering an investment into Widget Inc. will evaluate the stock by looking at whether its expected return is above or below the security market line. The security market line (SML) is a straight line that positively slopes and shows the relationship between the expected return of an asset class and beta. Beta is the amount of systematic risk, or overall market risk, an asset or portfolio has with respect to the market.

Capital Asset Pricing Model

When making investment decisions, an investor will want to consider the expected rate of return on that asset and its risk with the expected return on a risk-free asset, such as a long-term government bond.
For investors, some securities produce returns that are more sensitive to system-wide market risk than others. For these investments, the gains will correlate more consistently with the returns of the other stocks in the investment portfolio and will, therefore, more heavily influence the portfolio's overall risk. This is because the price of this security will go up and down relative to similar stocks in the portfolio as opposed to being influenced by factors unique to that company. Factors unique to a particular company may be the death of a CEO, which may cause share value to go down, or the success of a new product, which may cause share value to go up. If a commodity, such as a natural resource or an agricultural product, is close to other stocks in a portfolio, any dramatic swings it has will be based more on the stock market as a whole in that industry than on that commodity's individual influencers.