Stock Market

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In the name of Allah, Most Beneficent, Most Merciful

A TERM REPORT ON

Submitted to

Mr. M. Sadiq Shahid Malik Submitted by Muhammad Iqbal MBC-08-04 Allah Dittah MBC-08-11 Muhammad Saeed MBC-08-26 M. Zuhair Altaf MBC-08-36 Usman Shabir MBC-08-61

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Getting practical knowledge is one of the major aims of MBA program. Institute of Management Sciences, City Campus, Bahauddin Zakariya University, Multan has followed policy of assigning different practical assignments to its students so a touch of real working environment can be given to the students apart from classroom studies at widen their perspective. Financial Management is one of the core subjects of MBA (1), which gives an insight into the theoretical concepts and their application in practical world. Therefore study of the subject is imperfect without observing in real working environment. In this context, respectable, instructor Mr. Sadiq Shahid Malik has assigned us to study Working of Stock Market and its application in Pakistan’s stock exchanges.

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Acknowledgement We have the only pearl of our eyes to admire the blessing of the compassionate and omnipotent because the words are bound, knowledge is limited and time is short to express his dignity. All thanks are due only to Almighty ALLAH, most gracious, the most merciful, who gave us the strength and we did this job. Our special praises are for Holy Prophet Muhammad (SAW) who is, for even humanity as a whole. It is a matter of great honor and pleasure for us to express our ineffable gratitude and profound indebtedness to our venerable supervisor Mr. Sadiq Shahid Malik for his kind supervision, valuable suggestions and sympathetic attitude throughout our research. We are much impressed of his intellectual activities, inexhaustible energy to steer forth the student. His sympathetic and sincerest attitude is highly qualified experience. This research report includes analysis of Stock Exchanges of Pakistan. Special Thanks to all of our friends and all those who have helped us in collecting the data.

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TABLE OF CONTENTS

 Stock o Type of Stocks o Stock Derivatives o Share holder o Applications  Stock market o Market participants o History of Stock market o Behavior of Stock market o Crashes o Stock market index o Taxation  Stock Exchange o Role of stock exchange o Ownership o Future of Stock exchange  Stock Broker  Under Writer  IPO (Initial Public Offering)  Stock Markets in Pakistan o Karachi Stock Exchange o Lahore Stock Exchange o Islamabad Stock Exchange  Review of Research Articles  Conclusion  Bibliography

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What is Stock? In business and finance, a share (also referred to as equity share) of stock means a share of ownership in a corporation (company). In the plural, stocks is often used as a synonym for shares especially in the United States, but it is less commonly used that way outside of North America. In the United Kingdom, South Africa, and Australia, stock can also refer to completely different financial instruments such as government bonds or, less commonly, to all kinds of marketable securities.

Types of stocks Stock typically takes the form of shares of either common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend payments before any dividends can be issued to other shareholders. Convertible preferred stock is preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually anytime after a predetermined date. Shares of such stock are called "convertible preferred shares" (or "convertible preference shares" in the UK) Although there is a great deal of commonality between the stocks of different companies, each new equity issue can have legal clauses attached to it that make it dynamically different from the more general cases. Some shares of common stock may be issued without the typical voting rights being included, for instance, or some shares may have special rights unique to them and issued only to certain parties. Note that not all equity shares are the same.

Stock derivatives

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A derivative is any financial asset whose value is derived from the value of some other “underlying” asset. A stock derivative is any financial instrument which has a value that is dependent on the price of the underlying stock. Futures and options are the main types of derivatives on stocks. The underlying security may be a stock index or an individual firm's stock, e.g. single-stock futures. Stock futures are contracts where the buyer is long, i.e., takes on the obligation to buy on the contract maturity date, and the seller is short, i.e., takes on the obligation to sell. Stock index futures are generally not delivered in the usual manner, but by cash settlement. A stock option is a class of option. Specifically, a call option is the right (not obligation) to buy stock in the future at a fixed price and a put option is the right (not obligation) to sell stock in the future at a fixed price. Thus, the value of a stock option changes in reaction to the underlying stock of which it is a derivative. The most popular method of valuing stock options is the Black Scholes model. Apart from call options granted to employees, most stock options are transferable.

Shareholder A shareholder (or stockholder) is an individual or company (including a corporation) that legally owns one or more shares of stock in a joint stock company. Companies listed at the stock market are expected to strive to enhance shareholder value. Shareholders are granted special privileges depending on the class of stock, including the right to vote (usually one vote per share owned) on matters such as elections to the board of directors, the right to share in distributions of the company's income, the right to purchase new shares issued by the company, and the right to a company's assets during a liquidation of the company. However, shareholder's rights to a company's assets are subordinate to the rights of the company's creditors. Shareholders are considered by some to be a partial subset of stakeholders, which may include anyone who has a direct or indirect equity interest in the business entity or someone with even a non-pecuniary interest in a non-profit organization. Thus it might be common to call volunteer contributors to an association stakeholders, even though they are not shareholders. Although directors and officers of a company are bound by fiduciary duties to act in the best interest of the shareholders, the shareholders themselves normally do not have such duties towards each other.

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However, in a few unusual cases, some courts have been willing to imply such a duty between shareholders. For example, in California, USA, majority shareholders of closely held corporations have a duty to not destroy the value of the shares held by minority shareholders. The largest shareholders (in terms of percentages of companies owned) are often mutual funds, and especially passively managed exchange-traded funds.

Application The owners of a company may want additional capital to invest in new projects within the company. They may also simply wish to reduce their holding, freeing up capital for their own private use. By selling shares they can sell part or all of the company to many part-owners. The purchase of one share entitles the owner of that share to literally share in the ownership of the company, a fraction of the decision-making power, and potentially a fraction of the profits, which the company may issue as dividends. In the common case of a publicly traded corporation, where there may be thousands of shareholders, it is impractical to have all of them making the daily decisions required to run a company. Thus, the shareholders will use their shares as votes in the election of members of the board of directors of the company. In a typical case, each share constitutes one vote. Corporations may, however, issue different classes of shares, which may have different voting rights. Owning the majority of the shares allows other shareholders to be out-voted - effective control rests with the majority shareholder (or shareholders acting in concert). In this way the original owners of the company often still have control of the company.

Shareholder rights Although ownership of 50% of shares does result in 50% ownership of a company, it does not give the shareholder the right to use a company's building, equipment, materials, or other property. This is because the company is considered a legal person, thus it owns all its assets itself. This is important in areas such as insurance, which must be in the name of the company and not the main shareholder. In most countries, including the United States, boards of directors and company managers have a fiduciary responsibility to run the company in the interests of its stockholders.

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Even though the board of directors runs the company, the shareholder has some impact on the company's policy, as the shareholders elect the board of directors. Each shareholder typically has a percentage of votes equal to the percentage of shares he or she owns. So as long as the shareholders agree that the management (agent) are performing poorly they can elect a new board of directors which can then hire a new management team. In practice, however, genuinely contested board elections are rare. Board candidates are usually nominated by insiders or by the board of the directors themselves, and a considerable amount of stock is held and voted by insiders. Owning shares does not mean responsibility for liabilities. If a company goes broke and has to default on loans, the shareholders are not liable in any way. However, all money obtained by converting assets into cash will be used to repay loans and other debts first, so that shareholders cannot receive any money unless and until creditors have been paid (most often the shareholders end up with nothing).

Means of financing Financing a company through the sale of stock in a company is known as equity financing. Alternatively, debt financing (for example issuing bonds) can be done to avoid giving up shares of ownership of the company. Unofficial financing known as trade financing usually provides the major part of a company's working capital (day-to-day operational needs).

Trading A stock exchange is an organization that provides a marketplace for either physical or virtual trading shares, bonds and warrants and other financial products where investors (represented by stock brokers) may buy and sell shares of a wide range of companies. A company will usually list its shares by meeting and maintaining the listing requirements of a particular stock exchange. In the United States, through the inter-market quotation system, stocks listed on one exchange can also be bought or sold on several other exchanges, including relatively new so-called ECNs (Electronic Communication Networks like Archipelago or Instinet). In the USA stocks used to be broadly grouped into NYSE-listed and NASDAQlisted stocks. Until a few years ago there was a law that NYSE listed stocks were not allowed to be listed on the NASDAQ or vice versa. Many large non-U.S companies choose to list on a U.S. exchange as well as an exchange in their home country in order to broaden their investor base. These companies have then to ship a certain number of shares to a bank in the US (a certain percentage of their principal) and put it in the safe of the bank. Then the _______________________________________________________________________ _ 8

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bank where they deposited the shares can issue a certain number of so-called American Depositary Shares, short ADS (singular). If someone buys now a certain number of ADSs the bank where the shares are deposited issues an American Depository Receipt (ADR) for the buyer of the ADSs. Likewise, many large U.S. companies list themselves at foreign exchanges to raise capital abroad.

Arbitrage trading Although it makes sense for some companies to raise capital by offering stock on more than one exchange, a keen investor with access to information about such discrepancies could invest in expectation of their eventual convergence, known as an arbitrage trade. In today's era of electronic trading, these discrepancies, if they exist, are both shorter-lived and more quickly acted upon. As such, arbitrage opportunities disappear quickly due to the efficient nature of the market.

Buying There are various methods of buying and financing stocks. The most common means is through a stock broker. Whether they are a full service or discount broker, they arrange the transfer of stock from a seller to a buyer. Most trades are actually done through brokers listed with a stock exchange, such as the New York Stock Exchange. There are many different stock brokers from which to choose, such as full service brokers or discount brokers. The full service brokers usually charge more per trade, but give investment advice or more personal service; the discount brokers offer little or no investment advice but charge less for trades. Another type of broker would be a bank or credit union that may have a deal set up with either a full service or discount broker. There are other ways of buying stock besides through a broker. One way is directly from the company itself. If at least one share is owned, most companies will allow the purchase of shares directly from the company through their investor relations departments. However, the initial share of stock in the company will have to be obtained through a regular stock broker. Another way to buy stock in companies is through Direct Public Offerings which are usually sold by the company itself. A direct public offering is an initial public offering in which the stock is purchased directly from the company, usually without the aid of brokers. When it comes to financing a purchase of stocks there are two ways: purchasing stock with money that is currently in the buyer's ownership, or by buying stock on margin. Buying stock on margin means buying stock with money borrowed against the stocks in the same account. These stocks, or collateral, guarantee _______________________________________________________________________ _ 9

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that the buyer can repay the loan; otherwise, the stockbroker has the right to sell the stock (collateral) to repay the borrowed money. He can sell if the share price drops below the margin requirement, at least 50% of the value of the stocks in the account. Buying on margin works the same way as borrowing money to buy a car or a house, using the car or house as collateral. Moreover, borrowing is not free; the broker usually charges 8-10% interest.

Selling Selling stock is procedurally similar to buying stock. Generally, the investor wants to buy low and sell high, if not in that order (short selling); although a number of reasons may induce an investor to sell at a loss, e.g., to avoid further loss. As with buying a stock, there is a transaction fee for the broker's efforts in arranging the transfer of stock from a seller to a buyer. This fee can be high or low depending on which type of brokerage, full service or discount, handles the transaction. After the transaction has been made, the seller is then entitled to all of the money. An important part of selling is keeping track of the earnings. Importantly, on selling the stock, in jurisdictions that have them, capital gains taxes will have to be paid on the additional proceeds, if any, that are in excess of the cost basis.

Stock Market A stock market, or equity market, is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. Other Definitions of Stock Market • • • • •

A market in which shares of stock are bought and sold. A general term referring to the organized trading of securities in the various market exchanges and the over the counter (OTC) market. The organized trading of stocks, bonds, or other securities, or the place where such trading occurs. An institution that facilitates the buying and selling of stocks. A market for the buying and selling of stocks, such as the New York Stock Exchange.

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• • • • •

•

A location, referred to as ‘market’, where stocks are bought and sold. These can be private or public. The market for trading equities. The display that represents the stock market that railroad shares are traded on. This is a crude representation of a real stock market. Is where a company’s shares are traded. The UK stock market is in London. Is a market for the trading of publicly held company stocks or shares and associated financial instruments (including stock options, convertibles and stock index futures). Traditionally such markets were open-outcry where trading occurred on the floor of an exchange. An infrastructure providing services for raising capital and dealing in shares.

Stock exchange: an exchange where security trading is conducted by professional stockbrokers.

Size of world stock market The size of the world stock market is estimated at about $36.6 trillion US at the beginning of October 2008 The world derivatives market has been estimated at about $480 trillion face or nominal value, 12 times the size of the entire world economy. It must be noted though that the value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Many such relatively illiquid securities are valued as marked to model, rather than an actual market price. The stocks are listed and traded on stock exchanges which are entities a corporation or mutual organization specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. The stock market in the United States includes the trading of all securities listed on the NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, e.g. OTCBB and Pink Sheets. European examples of stock exchanges include the London Stock Exchange. Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes the order. Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of stock exchange is a virtual kind, _______________________________________________________________________ _ 11

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composed of a network of computers where trades are made electronically via traders. Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place on a first come first served basis if there are multiple bidders or askers at a given price. The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide real-time trading information on the listed securities, facilitating price discovery.

The New York Stock Exchange is a physical exchange, also referred to as a listed exchange — only stocks listed with the exchange may be traded. Orders enter by way of exchange members and flow down to a floor broker, who goes to the floor trading post specialist for that stock to trade the order. The specialist's job is to match buy and sell orders using open outcry. If a spread exists, no trade immediately takes place--in this case the specialist should use his/her own resources (money or stock) to close the difference after his/her judged time. Once a trade has been made the details are reported on the "tape" and sent back to the brokerage firm, which then notifies the investor who placed the order. Although there is a significant amount of human contact in this process, computers play an important role, especially for so-called "program trading". The NASDAQ is a virtual listed exchange, where all of the trading is done over a computer network. The process is similar to the New York Stock Exchange. However, buyers and sellers are electronically matched. One or more NASDAQ market makers will always provide a bid and ask price at which they will always purchase or sell 'their' stock

Market participants Many years ago, worldwide, buyers and sellers were individual investors, such as wealthy businessmen, with long family histories (and emotional ties) to particular corporations. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, index funds, exchange traded funds, hedge funds, investor groups, banks and various other financial institutions). The rise of the institutional investor has brought with it some improvements in market operations. Thus, the government was responsible for "fixed" (and exorbitant) fees being markedly _______________________________________________________________________ _ 12

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reduced for the 'small' investor, but only after the large institutions had managed to break the brokers' solid front on fees they then went to 'negotiated' fees, but only for large institutions. However, corporate governance (at least in the West) has been very much adversely affected by the rise of (largely 'absentee') institutional 'owners.

History of stock market Historian Fernand Braudel suggests that in Cairo in the 11th century, Muslim and Jewish merchants had already set up every form of trade association and had knowledge of many methods of credit and payment, disproving the belief that these were originally invented later by Italians. In 12th century France the courratiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. A common misbelief is that in late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurze, and in 1309 they became the "Brugse Beurse", institutionalizing what had been, until then, an informal meeting, but actually, the family Van der Beurze had a building in Antwerp where those gatherings occurred ; the Van der Beurze had Antwerp, as most of the merchants of that period, as their primary place for trading. The idea quickly spread around Flanders and neighboring counties and "Beurzen" soon opened in Ghent and Amsterdam. There are stock markets in virtually every part of the world at this moment. Some of the important stock markets are United States. In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens. The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first

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shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds. The Amsterdam Stock Exchange (or Amsterdam Beurs) is also said to have been the first stock exchange to introduce continuous trade in the early 17th century. The Dutch "pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them" (Murray Sayle, "Japan Goes Dutch", London Review of Books XXIII.7, April 5, 2001). There are now stock markets in virtually every developed and most developing economies, with the world's biggest markets being in the United States, Canada, China (Hongkong), India, UK, Germany, France and Japan.

Function and purpose of stock market The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate. History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. An economy where the stock market is on the rise is considered to be an up coming economy. In fact, the stock market is often considered the primary indicator of a country's economic strength and development. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction. The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity

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The financial system in most western countries has undergone a remarkable transformation. One feature of this development is disintermediation. A portion of the funds involved in saving and financing flows directly to the financial markets instead of being routed via the traditional bank lending and deposit operations. The general public's heightened interest in investing in the stock market, either directly or through mutual funds, has been an important component of this process. Statistics show that in recent decades shares have made up an increasingly large proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid assets with little risk made up almost 60 percent of households' financial wealth, compared to less than 20 percent in the 2000s. The major part of this adjustment in financial portfolios has gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving with a higher risk has been accentuated by new rules for most funds and insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be found in other industrialized countries. In all developed economic systems, such as the European Union, the United States, Japan and other developed nations, the trend has been the same: saving has moved away from traditional (government insured) bank deposits to more risky securities of one sort or another.

The stock market, individual investors, and financial risk Riskier long-term saving requires that an individual possess the ability to manage the associated increased risks. Stock prices fluctuate widely, in marked contrast to the stability of (government insured) bank deposits or bonds. This is something that could affect not only the individual investor or household, but also the economy on a large scale. The following deals with some of the risks of the financial sector in general and the stock market in particular. This is certainly more important now that so many newcomers have entered the stock market, or have acquired other 'risky' investments (such as 'investment' property, i.e., real estate and collectables). With each passing year, the noise level in the stock market rises. Television commentators, financial writers, analysts, and market strategists are all overtaking each other to get investors' attention. At the same time, individual investors, immersed in chat rooms and message boards, are exchanging questionable and often misleading tips. Yet, despite all this available information, investors find it increasingly difficult to profit. Stock prices skyrocket with little reason, then plummet just as quickly, and people who have turned to investing for their children's education and their own retirement become frightened. Sometimes there appears to be no rhyme or reason to the market, only folly. _______________________________________________________________________ _ 15

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The behavior of the stock market From experience we know that investors may temporarily pull financial prices away from their long term trend level. Over-reactions may occur—so that excessive optimism (euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly low According to the efficient market hypothesis (EMH), only changes in fundamental factors, such as profits or dividends, ought to affect share prices. (But this largely theoretic academic viewpoint also predicts that little or no trading should take place—contrary to fact—since prices are already at or near equilibrium, having priced in all public knowledge.) But the efficient-market hypothesis is sorely tested by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percent—the largest-ever one-day fall in the United States. This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a definite cause: a thorough search failed to detect any specific or unexpected development that might account for the crash. It also seems to be the case more generally that many price movements are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period confirms this. Moreover, while the EMH predicts that all price movement (in the absence of change in fundamental information) is random (i.e., non-trending), many studies have shown a marked tendency for the stock market to trend over time periods of weeks or longer. Various explanations for large price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact. Other research has shown that psychological factors may result in exaggerated stock price movements. Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes in clouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor's self-confidence, reducing his (psychological) risk threshold. The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the recent Nasdaq crash, less than 1 percent of the analyst's recommendations had been to sell (and even during the 2000 - 2002 crash, the average did not rise above 5%). The media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so-called new economy stock market. _______________________________________________________________________ _ 16

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Irrational behavior Sometimes the market tends to react irrationally to economic news, even if that news has no real affect on the technical value of securities itself. Therefore, the stock market can be swayed tremendously in either direction by press releases, rumors, euphoria and mass panic. Over the short-term, stocks and other securities can be battered or buoyed by any number of fast market-changing events, making the stock market difficult to predict. Emotions can drive prices up and down. People may not be as rational as they think. Behaviorists argue that investors often behave irrationally when making investment decisions thereby incorrectly pricing securities, which causes market inefficiencies, which, in turn, are opportunities to make money

Crashes A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic. Often, stock market crashes end speculative economic bubbles. There have been famous stock market crashes that have ended in the loss of billions of dollars and wealth destruction on a massive scale. An increasing number of people are involved in the stock market, especially since the social security and retirement plans are being increasingly privatized and linked to stocks and bonds and other elements of the market. There have been a number of famous stock market crashes like the Wall Street Crash of 1929, the stock market crash of 1973–4, the Black Monday of 1987, the Dot-com bubble of 2000. One of the most famous stock market crashes started October 24, 1929 on Black Thursday. The Dow Jones Industrial lost 50% during this stock market crash. It was the beginning of the Great Depression. Another famous crash took place on October 19, 1987 – Black Monday. On Black Monday itself, the Dow Jones fell by 22.6% after completing a 5 year continuous rise in share prices. This event not only shook the USA, but quickly spread across the world. Thus, by the end of October, stock exchanges in Australia lost 41.8%, in Canada lost 22.5%, in Hong Kong lost 45.8%, and in Great Britain lost 26.4%. The names “Black Monday” and “Black Tuesday” are also used for October 28-29, 1929, which followed Terrible Thursday--the starting day of the stock market crash in 1929. The crash in 1987 raised some puzzles-– main news and events did not predict the catastrophe and visible reasons for the collapse were not identified. This event raised questions about many important assumptions of modern economics, namely, the theory of rational human conduct, the theory of market equilibrium and the hypothesis of market efficiency. For some time after the crash, trading in stock exchanges worldwide was halted, _______________________________________________________________________ _ 17

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since the exchange computers did not perform well owing to enormous quantity of trades being received at one time. This halt in trading allowed the Federal Reserve system and central banks of other countries to take measures to control the spreading of worldwide financial crisis. In the United States the SEC introduced several new measures of control into the stock market in an attempt to prevent a re-occurrence of the events of Black Monday. Computer systems were upgraded in the stock exchanges to handle larger trading volumes in a more accurate and controlled manner. The SEC modified the margin requirements in an attempt to lower the volatility of common stocks, stock options and the futures market. The New York Stock Exchange and the Chicago Mercantile Exchange introduced the concept of a circuit breaker.

Stock market index The movements of the prices in a market or section of a market are captured in price indices called stock market indices, of which there are many, e.g., the S&P, the FTSE and the Euronext indices. Such indices are usually market capitalization weighted, with the weights reflecting the contribution of the stock to the index. The constituents of the index are reviewed frequently to include/exclude stocks in order to reflect the changing business environment.

Investment strategies One of the many things people always want to know about the stock market is, "How do I make money investing?" There are many different approaches; two basic methods are classified as either fundamental analysis or technical analysis. Fundamental analysis refers to analyzing companies by their financial statements found in SEC Filings, business trends, general economic conditions, etc. Technical analysis studies price actions in markets through the use of charts and quantitative techniques to attempt to forecast price trends regardless of the company's financial prospects. One example of a technical strategy is the Trend following method, used by John W. Henry and Ed Seykota, which uses price patterns, utilizes strict money management and is also rooted in risk control and diversification. Additionally, many choose to invest via the index method. In this method, one holds a weighted or unweighted portfolio consisting of the entire stock market or some segment of the stock market (such as the S&P 500 or Wilshire 5000). The principal aim of this strategy is to maximize diversification, minimize taxes from too frequent trading, and ride the general trend of the stock market (which, in the U.S., has averaged nearly 10%/year, compounded annually, since World War II).

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According to much national or state legislation, a large array of fiscal obligations is taxed for capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market, in particular in the stock exchanges. However, these fiscal obligations may vary from jurisdiction to jurisdiction because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax free stock market operations are useful to boost economic growth.

Stock exchange A stock exchange, securities exchange or (in Europe) bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets are driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation). There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

The role of stock exchanges Stock exchanges have multiple roles in the economy, this may include the following: _______________________________________________________________________ _ 19

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Raising capital for businesses The Stock Exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public.

Mobilizing savings for investment When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels and firms.

Facilitating company growth Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.

Redistribution of wealth Stocks exchanges do not exist to redistribute wealth. However, both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.

Corporate governance By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors). However, some well-documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some _______________________________________________________________________ _ 20

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public companies. The dot-com bubble in the early 2000s, and the subprime mortgage crisis in 2007-08, are classical examples of corporate mismanagement. Companies like Pets.com (2000), Enron Corporation (2001), One.Tel (2001), Sunbeam (2001), Webvan (2001), Adelphia (2002), MCI WorldCom (2002), Parmalat (2003), Fannie Mae (2008), Freddie Mac (2008), Lehman Brothers (2008), were among the most widely scrutinized by the media.

Creating investment opportunities for small investors As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.

Government capital-raising for development projects Governments at various levels may decide to borrow money in order to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need to directly tax the citizens in order to finance development, although by securing such bonds with the full faith and credit of the government instead of with collateral, the result is that the government must tax the citizens or otherwise raise additional funds to make any regular coupon payments and refund the principal when the bonds mature.

Barometer of the economy At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.

Listing requirements by stock exchanges Listing requirements are the set of conditions imposed by a given stock exchange upon companies that want to be listed on that exchange. Such conditions sometimes include minimum number of shares outstanding, minimum market capitalization, and minimum annual income. _______________________________________________________________________ _ 21

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Companies have to meet the requirements of the exchange in order to have their stocks and shares listed and traded there, but requirements vary by stock exchange: •

NASDAQ Stock Exchange: To be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years.

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New York Stock Exchange: To be listed on the New York Stock Exchange (NYSE), for example, a company must have issued at least a million shares of stock worth $100 million and must have earned more than $10 million over the last three years.

Ownership Stock exchanges originated as mutual organizations, owned by its member stock brokers. There has been a recent trend for stock exchanges to demutualize, where the members sell their shares in an initial public offering. In this way the mutual organization becomes a corporation, with shares that are listed on a stock exchange. Examples are Australian Securities Exchange (1998), Euronext (merged with New York Stock Exchange), NASDAQ (2002), the New York Stock Exchange (2005), Bolsas y Mercados Españoles, and the São Paulo Stock Exchange (2007). The Shenzhen and Shanghai stock exchanges can been characterized as quasi-state institutions insofar as they were created by government bodies in China and their leading personnel are directly appointed by the China Securities Regulatory Commission.

The future of stock exchanges The future of stock trading appears to be electronic, as competition is continually growing between the remaining traditional New York Stock Exchange specialist system against the relatively new, all Electronic Communications Networks, or ECNs. ECNs point to their speedy execution of large block trades, while specialist system proponents cite the role of specialists in maintaining orderly markets, especially under extraordinary conditions or for special types of orders. The ECNs contend that an array of special interests profit at the expense of investors in even the most mundane exchange-directed trades. Machine-based systems, they argue, are much more efficient, because they speed up the execution mechanism and eliminate the need to deal with an intermediary. Historically, the 'market' (which, as noted, encompasses the totality of stock trading on all exchanges) has been slow to respond to technological innovation, _______________________________________________________________________ _ 22

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thus allowing growing pure speculation to continue. Conversion to all-electronic trading could erode/eliminate the trading profits of floor specialists and the NYSE's "upstairs traders", who, like in September and October 2008, earned billions of dollars selling shares they did not have, and days later buying the same amount of shares, but maybe 15 % cheaper, so these shares could be handed to their buyers, therebuy making the market fall deeply. William Lupien, founder of the Instinet trading system and the OptiMark system, has been quoted as saying "I'd definitely say the ECNs are winning... Things happen awfully fast once you reach the tipping point. We're now at the tipping point." One example of improved efficiency of ECNs is the prevention of front running, by which manual Wall Street traders use knowledge of a customer's incoming order to place their own orders so as to benefit from the perceived change to market direction that the introduction of a large order will cause. By executing large trades at lightning speed without manual intervention, ECNs make impossible this illegal practice, for which several NYSE floor brokers were investigated and severely fined in recent years. Under the specialist system, when the market sees a large trade in a name, other buyers are immediately able to look to see how big the trader is in the name, and make inferences about why s/he is selling or buying. All traders who are quick enough are able to use that information to anticipate price movements.

ECNs have changed ordinary stock transaction processing (like brokerage services before them) into a commodity-type business. ECNs could regulate the fairness of initial public offerings (IPOs), oversee Hambrecht's OpenIPO process, or measure the effectiveness of securities research and use transaction fees to subsidize small- and mid-cap research efforts. Some[who?], however, believe the answer will be some combination of the best of technology and "upstairs trading" — in other words, a hybrid model. Trading 25,000 shares of General Electric stock (recent[when?] quote: $34.76; recent[when?] volume: 44,760,300) would be a relatively simple e-commerce transaction; trading 100 shares of Berkshire Hathaway Class A stock (recent quote: $139,700.00; recent volume: 850) may never be. The choice of system should be clear (but always that of the trader), based on the characteristics of the security to be traded. Even with ECNs forming an important part of a national market system, opportunities presumably remain to profit from the spread between the bid and offer price. That is especially true for investment managers that direct huge trading volume, and own a stake in an ECN or specialist firm. For example, in its _______________________________________________________________________ _ 23

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individual stock-brokerage accounts, "Fidelity Investments runs 29% of its undesignated orders in NYSE-listed stocks, and 37% of its undesignated market orders through the Boston Stock Exchange, where an affiliate controls a specialist post."

Stock broker A stock broker or stockbroker is a regulated professional who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors.

Requirements In order to become a stockbroker in the United States, a candidate must pass the General Securities Representative Examination (also known as the "Series 7 exam"). In the UK, brokers are required to pass the SII (Securities and Investment Institute link title) Certificate in Securities, this qualification is achieved by passing two exams: Either Unit 1: FSA Financial regulations or Unit 6 Principles of Financial Regulation for MiFID compliant retail trading, and either Unit 2: Securities, Unit 3: Derivatives or Unit 4: for both Securities and Derivatives. Passing Unit 1 or Unit 6 identifies individuals as having attained FSA Approved Person Status.

Services provided A transaction on a stock exchange must be made between two members of the exchange — an ordinary person may not walk into the New York Stock Exchange (for example), and ask to trade stock. Such an exchange must be done through a broker. There are three types of stock broking service. • • •

Execution-only, which means that the broker will only carry out the client's instructions to buy or sell. Advisory dealing, where the broker advises the client on which shares to buy and sell, but leaves the final decision to the investor. Discretionary dealing, where the stockbroker ascertains the client's investment objectives and then makes all dealing decisions on the client's behalf.

In addition to actually trading stocks for their clients, stock brokers may also offer advice to their clients on which stocks, mutual funds, etc. to buy. _______________________________________________________________________ _ 24

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Underwriter Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage or credit). The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information which was written on a Lloyd's slip created for this purpose. The person involved in underwriting is called underwriter.

Initial public offering Initial public offering (IPO), also referred to simply as a "public offering", is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded. In an IPO, the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market. IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock or shares will do on its initial day of trading and in the near future since there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, and they are therefore subject to additional uncertainty regarding their future value.

Stock Markets in Pakistan There are three stock exchanges in Pakistan. • • •

The Karachi Stock Exchange Islamabad Stock Exchange Lahore Stock Exchange

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Karachi Stock Exchange

Type Location Owner Key people Currency No. of listings MarketCap Volume

Stock Exchange Karachi, Pakistan Karachi Stock Exchange Limited Adnan Afridi, CEO PKR 671 US$ 73 billion US$ 12 billion KSE 100 Index Indexes KSE-30 Index Website www.kse.com.pk

The Karachi Stock Exchange or KSE is a stock exchange located in Karachi, Sindh, Pakistan. Founded in 1947, it is Pakistan's largest and oldest stock exchange, with many Pakistani as well as overseas listings. Its current premises are situated on Stock Exchange Road, in the heart of Karachi's Business District.

Growth The KSE is the biggest and most liquid exchange in Pakistan and in 2002 it was declared as the “Best Performing Stock Market of the World” by “Business Week”. As of December 20, 2007, 671 companies were listed with the market capitalization of Rs. 4364.312 billion (US$ 73 Billion) having listed capital of Rs. 717.3 billion (US$ 12 billion). On December 26, 2007, the KSE 100 Index reached its ever highest value and closed at 14,814.85 points. Foreign buying interest had been very active on the KSE in 2006 and continued in 2007. According to estimates from the State Bank of Pakistan, foreign investment in capital markets total about US$523 Million. According to a research analyst in Pakistan, around 20pc of the total free float in KSE-30 Index is held by foreign participants.

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KSE has seen some fluctuations since the start of 2008. One reason could be that it is the election year in Pakistan, and stocks are expected to remain dull. KSE has set an all time high of 15,000 points, before settling around the 14,000 mark. Karachi stock exchange Board of Directors has recently (2007) announced plans to construct a 40 story high rise KSE building, as a new direction for future investment. Disputes between investors and members of the Exchange are resolved through deliberations of the Arbitration Committee of the Exchange. KSE began with a 50 shares index. As the market grew a representative index was needed. On November 1st, 91 the KSE-100 was introduced and remains to this day the most generally accepted measure of the Exchange. Karachi Stock Exchange 100 Index (KSE-100 Index) is a benchmark used to compare prices overtime, companies with the highest market capitalization are selected. To ensure full market representation, the company with the highest market capitalization from each sector is also included. In 1995 the need was felt for an all share index to reconfirm the KSE-100 and also to provide the basis of index trading in future. On August the 29th, 1995 the KSE all share index was constructed and introduced on September 18, 1995.

Trading System The Karachi Stock Exchange has introduced a state-of-the-art computerized trading system known as Karachi Automated Trading System (KATS) to provide a fair, transparent, efficient and cost effective market for the investors. Currently, the exchange conducts one trading session from Monday to Thursday and two sessions on Friday. The Trading is divided into four distinct segments, each of which has its own clearing and settlement procedure. These are: T+3, Provisionally Listed Companies, spot (T+1) Transactions and Future Contracts.

KSE 100 Index The index was launched in late 1991 with a base of 1,000 points. By 2001, it had grown to 1,770 points. By 2005, it had skyrocketed to 9,989 points. It then reached a peak of 12,285 in February 2007. KSE-100 index touched the highest ever benchmark of 14,814 points on December 26, 2007, a day before the assassination of former Prime Minister Benazir Bhutto, when the index nosedived. The index recovered quickly in 2008, reaching new highs near 15,500 in April. However, by November 22, 2008 during the global financial crisis of 2008 it had fallen to 9,187. _______________________________________________________________________ _ 27

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2008 Karachi Stock Exchange Crisis •

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April 20 : Karachi Stock Exchange achieved a major milestone when KSE-100 Index crossed the psychological level of 15,000 for the first time in its history and peaked 15,737.32 on 20 April, 2008. Moreover, the increase of 7.4 per cent in 2008 made it the best performer among major emerging markets. May 23: Record high inflation in the month of May, 2008 resulted in the unexpected increase in the interest rates by State Bank of Pakistan which eventually resulted in sharp fall in Karachi Stock Exchange. July 17 :Angry investors attacked the Karachi Stock Exchange in protest at plunging Pakistani share prices. July 16 : KSE-100 Index dropped one-third from an all-time high hit in April, 2008 as rising pressure on shaky Pakistan's coalition government to tackle Taliban militants exacerbates concern about the country's economic woes. August 18: KSE 100 Index rose more than 4% after the announcement of the resignation of President Pervez Musharraf but Credit Suisse Group said that Pakistan's Post-Musharraf rally in Stock Exchange will be shortlived because of a rising fiscal deficit and runaway inflation. August 28 :Karachi Stock Exchange set a floor for stock prices to halt a plunge that has wiped out $36.9 billion of market value since April.

Lahore Stock Exchange Lahore Stock Exchange

Type Location Owner Key people Currency No. of listings MarketCap Volume Indexes

Stock Exchange Lahore, Pakistan Lahore Stock Exchange Limited Arif Saeed(Chairman) PKR 671 US$ 73 billion US$ 12 billion. LSE 25 Index

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Introduction Lahore Stock Exchange was established in October 1970 and is the second largest stock exchange in the country with a market share of around 12-16% in terms of daily traded volumes. LSE has 519 companies, spanning 37 sectors of the economy, that are listed on the Exchange with total listed capital of Rs. 555.67 billion having market capitalization of around Rs. 3.64 trillion. LSE has 152 members of whom 81 are corporate and 54 are individual members. Activities of Lahore Stock Exchange (LSE) have increased significantly in all operational areas since its inception. Over the years, LSE has successfully met various challenges and has now emerged, fully geared and positioned to aggressively compete with its fellow Exchanges, contributing towards the growth of Capital Markets in Pakistan.

Islamabad Stock Exchange Islamabad Stock Exchange is one of the three stock exchanges of Pakistan .. Islamabad Stock Exchange is centrally located in Anees Plaza, Fazal ul Haq Road, Islamabad. A new development project is underway to establish a new building for the exchange. The Islamabad stock exchange is going to be shifted to its new home in a few years, as the new Islamabad Stock Exchange is currently under construction in the capital. The ISE has set the highest standards of operational efficiency and is committed to support a climate of confidence and optimism that encourages and promotes trading activity. It also provides for conducive environment to channelize the small investments of the residents of less developed areas. The ISE offers an easy access to both domestic as well as foreign investors and actively encourages the listing of eligible and profitable companies, both large and small to make it an exciting and diverse Exchange. The Exchange is playing a pivotal role for economic growth of the area thereby contributing towards the overall economic prosperity and welfare of the country. At present there are 118 members out of which 104 are corporate bodies including commercial and investment banks, DFIs and brokerage houses. The other 18 Members are individual persons who are well educated, enterprising and progressive minded.

Review of Research article no.1 In the article “Volatility Spillover between the Stock Market and the Foreign Exchange Market in Pakistan” published by Abdul Quyyum and A. R. Kamal the _______________________________________________________________________ _ 29

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volatility spillover between the stock market and the foreign exchange market in Pakistan. They used Engle Granger two step procedures and the volatility spillover is modelled through bivariate EGARCH method. From the article we can conclude that by using Engle Granger in the long run, there is no very much strong relationship or effect of the both markets on each other. But the volatility modeling shows that the stock market and foreign stock markets are dependent each other. The return of one market is effected by the volatility of the other specially volatility of foreign market effects very much on returns of stock exchange. So there is strong relationship between the volatility of two markets. It implies the existence of volatility spillover between the markets in Pakistan.

Review of Research article no.2 In the article ” Bid-ask Spread and Order Size in the Foreign Exchange Market: An Empirical Investigation” published by Liang Ding empirically examines the relationship between order sizes and spreads in the foreign exchange market based on a FX dealer’s quotes. The spread is independent and is of no effect by the order size in the inter-dealer market where as the two are negatively correlated in the customer market. No model could not explain this finding alone so there needs a new mode to explain. Because the positive and negative factors offset each other so this implies spread is independent of order size in the interdealer market., while the negative pattern in the customer market could be due to the dominance of negative factors over positive ones.

Review of Research article no.3 In the article “Does an electronic stock exchange need an upstairs market?” published by Hendrik Bessembinder and Kumar Venkataraman in which they examined the Paris Bourse, whose electronic limit order market closely resembles the downstairs markets envisioned by theorists, to test several theoretical predictions regarding upstairs trading. From the article we can conclude that upstairs brokers lower the risk of adverse selection by certifying block orders as uninformed, upstairs brokers are able to tap into pools of hidden or unexpressed liquidity, traders strategically choose across the upstairs and downstairs markets to minimize expected execution costs, and trades are more

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likely to be routed upstairs if they are large or are in stocks with less overall trading activity.

Conclusion From the report on stock market, we have concluded that the stocks market are important tool for raising capital and if the stock market is performing well, the economy of that country will be in good position. It means the condition of economy of a country can be found from the stock exchange. If the stock exchange is performing well, it means investment is increasing which consequently contributes in the economic conditions. The future of stock trading appears to be electronic, as competition is continually growing between the remaining traditional Stock Exchange specialist system against the relatively new, all Electronic Communications Networks. OTC (overthe-counter) is an emerging market. The changes in the overall economic conditions and foreign stock markets and political situation have an effect on the stock markets of Pakistan. “There is strong relationship between the volatility of foreign market and the volatility of returns in stock market. The returns of one market are affected by the volatility of other market. Particularly the returns of stock market are sensitive to the returns as well as the volatility of foreign exchange market.” As quoted by Abdul Quyyum and A. R. Kamal. Thus stock market is an indicator of economic conditions of a country.

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Bibliography www.Wikipedia.org. www.Jstor.org. www.google.com.pk www.KSE.com.pk www.LSE.com.pk www.ISE.com.pk www.NYSE.com www.SECP.com.pk

Fundamentals of financial management (Brigham & Hoston) _______________________________________________________________________ _ 32

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