Stock Exchange: Functions, Trading and Settlement Procedure, Examples

The compilation of these Financial Markets Notes makes students exam preparation simpler and organised.

Stock Exchange

Have you heard of the Bombay Stock Exchange (BSE)? Or perhaps the NSE? Do you closely follow the Sensex? But how much do we actually understand about the stock exchange and its functioning? Let us take a closer look at the meaning, functioning, and importance of the Stock Exchange.

Stock Exchange

The secondary tier of the capital market is what we call the stock market or the stock exchange. The stock exchange is a virtual market where buyers and sellers trade in existing securities. It is a market hosted by an institute or any such government body where shares, stocks, debentures, bonds, futures, options, etc are traded.

A stock exchange is a meeting place for buyers and sellers. These can be brokers, agents, individuals. The price of the commodity is decided by the rules of demand and supply. In India, the most prominent stock exchange is the Bombay Stock Exchange. There are a total of twenty-one stock exchanges in India.

Bombay Stock Exchange

Functions of the Stock Exchange

Liquidity and Marketability: One of the main drawing factors of the stock exchange is that it enables high liquidity. The securities can be sold at a moment’s notice and be converted to cash. It is a continuous market and the investors can divest and reinvest with ease as per their wishes.

Price Determination: In a secondary market, the only way to determine the price of securities in via the rules of supply and demand. A stock exchange enables this process via constant valuation of all the securities. Such prices of shares of various companies can be tracked via the index we call the Sensex.

Safety: The government strictly governs and regulates the stock exchanges. In the case of the BSE, the Securities Board of India is the governing body. All transactions occur within the legal framework. This provides the investor with assurances and a safe place to transact in securities.

Contribution to the Economy: As we know the stock exchange deals in already-issued securities. But these securities are continuously sold and resold and so on. This allows the funds to be mobilized and channelized instead of sitting idle. This boosts the economy.

Spreading of Equity: The stock exchange ensures wider ownership of securities. It actually educates the public about the safety and the benefits of investing in the stock market. It ensures a better quality of transactions and smooth functioning. The idea is to get more public investors and spread the ownership of securities for the benefit of everyone.

Speculation: One often hears that the stock exchange is a speculative market. And while this is true, the speculation is kept within the legal framework. For the stake of liquidity and price determination, a healthy dose of speculative trading is necessary, and the stock exchange provides us with such a platform.

Trading and Settlement Procedure

1. Selecting a Broker or Sub-broker
When a person wishes to trade in the stock market, it cannot do so in his/her individual capacity. The transactions can only occur through a broker or a sub-broker. So according to one’s requirement, a broker must be appointed.

Now such a broker can be an individual or a partnership or a company or a financial institution (like banks). They must be registered under SEBI. Once such a broker is appointed you can buy/sell shares on the stock exchange.

2. Opening a Demat Account
Since the reforms, all securities are now in electronic format. There are no issues of physical shares/securities anymore. So an investor must open a dematerialized account, i.e. a Demat account to hold and trade in such electronic securities.

So you or your broker will open a Demat account with the depository participant. Currently, in India, there are two depository participants, namely Central Depository Services Ltd. (CDSL) and National Depository Services Ltd. (NDSL).

3. Placing Orders
And then the investor will actually place an order to buy or sell shares. The order will be placed with his broker, or the individual can transact online if the broker provides such services. One thing of essential importance is that the order /instructions should be very clear. Example: Buy 100 shares of XYZ Co. for a price of Rs. 140/- or less.

Then the broker will act according to your transactions and place an order for the shares at the price mentioned or an even better price if available. The broker will issue an order confirmation slip to the investor.

4. Execution of the Order
Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the broker must issue a Contract Note. This document contains all the information about the transactions, like the number of shares transacted, the price, date and time of the transaction, brokerage amount, etc.

Contract Note is an important document. In the case of a legal dispute, it is evidence of the transaction. It also contains the Unique Order Code assigned to it by the stock exchange.

5. Settlement
Here the actual securities are transferred from the buyer to the seller. And the funds will also be transferred. Here too the broker will deal with the transfer. There are two types of settlements,

  • On the Spot settlement: Here we exchange the funds immediately and the settlement follows the T+2 pattern. So a transaction occurring on Monday will be settled by Wednesday (by the second working day)
  • Forward Settlement: Simply means both parties have decided the settlement will take place on some future date. It can be T+% or T+9 etc.


Which of the following was Asia’s first stock exchange?
a. Bombay Stock Exchange
b. National Stock Exchange
c. Shanghai Stock Exchange
d. None of the above
The correct option is “a”. Bombay Stock Exchange was established in 1875. It is India’s premier stock exchange and even has a global presence in the world economy. Around more than 5000 national and international companies are listed on the BSE.