The Stock Market (part C)
by
Charles Lamson
The Stock Markets
When most people think about the stock market, they think of New York City's Wall Street, an actual street in South Manhattan that is home to New York's financial district and is also the nation's financial center. But to financial market participants, Wall Street has a much broader connotation that includes many different organized stock exchanges and a nationwide network of brokers and dealers who buy and sell stock over the counter.
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In recent years, the volume and values of stock traded---whether on exchanges or over the counter---have increased dramatically. Large institutional investors, such as pension funds, insurance companies, and mutual funds have come to dominate the market. The institutional investors tend to trade large blocks of stocks. The expanded use of computers to execute trades has accommodated the greater volume of trading and facilitated an increase in program trading by institutional investors. Program trading allows institutional investors to pre-program computers to buy or sell a large number (basket) of stocks.
Investors do not have to put up funds equal to the full value of a stock purchase. Rather, they can purchase stocks on the margin by borrowing. The margin requirement is the percentage of a stock purchase that can be borrowed as opposed to being paid in readily available funds. The current margin requirement, which is set by the Fed, has been 50 percent since 1974 and applies only to initial purchases. buying the margin allows the investor to amplify gains when the stock's price goes up because the investor, in essence, has control over a large number of shares. It is thought that mmargin buying fuels speculation in stock and can be particularly dangerous in a stock market bubble.
The New York Stock Exchange and the National Association of Securities Dealers require member firms to impose a minimum 25 percent maintenance margin requirement on their customer. The maintenance margin requirement is the minimum amount of equity the investor needs in his or her account relative to his or her stock. The maintenance requirement comes into play if the stock has been purchased using borrowed funds and if the stock's value falls so that the investor has less equity than the amount required by the maintenance margin. Many individual brokerage firms set higher margin requirements and vary those requirements depending on the stocks and trading behavior of individual customers.
In a falling stock market, buying on the margin can present problems because losses are also amplified. If the value of a stock falls to less than what is owed, the lender may put in a margin call. This requires the investor to put up more funds. If the investor fails to do so, the stock is sold at a low price, so the lender can recoup part or all of its losses. The selling of the stock to recoup losses puts additional downward pressure on the flagging stock price.
The mid-to-late 1990s also saw unprecedented capital inflows into U.S. markets to purchase U.S. equities. The magnitude of these inflows is dramatic and is part of the ongoing globalization of financial markets. Only life insurance companies and mutual funds purchased more U.S. equities than non-U.S. purchasers. The inflows that many attributed to booming U.S. markets also contributed to those booming markets by increasing the demand for stocks. Without the inflow from abroad, demand for U.S. stocks would have been lower and equity prices not as high. Thus, it is difficult to say whether the inflows are the result of booming stock prices or if the inflows caused stock prices to boom. If foreigners sell U.S. equities or slow purchases, prices of U.S. equities will be lower than what they otherwise would be. It is difficult to say what the future trend will be.
*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED., 2003, MAUREEN BURTON & RAY LOMBRA, PGS. 383-385*
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