Young Investor

How stock exchanges came into being

Adarsh Gopalakrishnan | Updated on November 15, 2017 Published on January 14, 2012

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Markets have come a long way from a few people huddled under a tree haggling and shouting out their buy or sell prices.



There are markets for derivatives, insurance, re-insurance, stocks, bonds, contracts, metals, agriculture, bullion and real estate. Ever wondered how it all began? Read on to find out.

NOT SO PERSONAL

The earliest instances of trading or broking evolved in order to avoid personal losses caused by individual bets on government debt, agricultural debt or risky shipping and trading ventures. The odds of going broke, given the lack of institutions or enforcement led to French monarchy creating the ‘courratiers de change' in the 12{+t}{+h} century. These brokers helped monitor and disburse agricultural debt.

Around the same time, traders in the Benelux region (the Netherlands, Belgium and Luxembourg) gathered in front of an inn owned by the Ter Burze family in Bruges to conduct transactions. The term ‘bourse' finds its origin in this family's name. These traders dealt with bills of exchange for agricultural commodities.

SOWING WILD OATS

Exchanges cropped up in various European cities such as Bruges, Lyons and Amsterdam. Until the 16th century, ‘markets' remained a loose gathering of traders and merchants who dealt in debt or commercial bills.

The idea of ‘equity' or shared ownership of a business did not exist until this point in time. The owner of a venture was personally liable for losses.

For example, if a ship loaded with gold bought on credit was lost at sea, the ship's owner would have to take the losses. He would owe the lenders all that he owned including his turkish bath.

All that changed with the advent of the Dutch, French and British East India companies which had monopolies over trade. This came at a heavy price.

Shipping and trading were expensive exercises and rough weather, pirates, hostile locals, spoilt produce, diseases and battles among the various trading companies hurt the odds of profits.

To get around this, the Dutch East Indies Company became a joint-stock company, the first one to issue stocks to several shareholders, with the idea of sharing profits or losses. Several trading companies such as the British East India Company followed suit.

NOVEL TRAITS

This achieved two powerful goals: First, the companies became a distinct legal entity, separate from those who owned it. Second, it popularised the concept of limited liability.

The owners were personally liable only to the extent of what they invested in it. Arguably, the most important idea that stems from this is of the reduced risk associated with ownership. This allowed individuals to pour their limited capital into several opportunities rather than bet heavily on one toss of a coin.

The idea caught on quite rapidly. Exchanges that traded the stocks of these companies began to crop up across the globe. Most of the exchanges, much like their progenitors, found their origins in coffee shops, public circles or other areas where traders huddled together to transact.

Stock exchanges such as the London Stock Exchange, New York Stock Exchange started out in a coffee shop and under a buttonwood tree respectively. India's Bombay Stock Exchange was founded in 1875 under a banyan tree.

HOW THINGS CHANGE

Organised markets for transacting in stock, bonds and commodities are also seen as an efficient consensus-driven way to arrive at the price of an asset or contract. This is due to the participation of several individuals with varying levels of competence and information. Organised trading also kept the peace by legally making people and organisations stick with their side of the bargain.

Markets have come a long way from a few people huddled under a tree haggling and shouting out their buy or sell prices. Ownership of stocks now straddles countries and competition to control these economic beings is immense.

Stock exchanges are closely watched by governments due to their central role as gatekeepers of hard-earned capital.

Institutions such as the New York Stock Exchange, London Stock Exchange, London Metal Exchange, Bombay Stock Exchange, National Stock Exchange and other bourses across the world today play a central role in putting a price tag on the economy and its assets.

Published on January 14, 2012

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