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KembaraXtra–Islamic Finance–Islamic Capital Market – Shari’ah Recognition of Joint-Stock Companies and Secondary Market Trading
-Shari’ah recognises joint-stock companies as valid business entities
-A joint-stock company is formed when two or more legal persons participate in a business venture
-Each participant contributes capital to the company
-In return for financial contribution,the company issues share certificates,which represent ownership in the company
-These share certificates confirm the shareholder’s proportionate ownership rights in the company
-Shares issued by a joint-stock company are freely transferable
-Shareholders are allowed to sell their shares at any time
-Sale of shares leads to a transfer of ownership from one shareholder to another
-This transferability enables the existence of an active secondary market
-Shari’ah principles governing equity markets have shown flexibility in accepting modern financial concepts while preserving ethical foundations
-In this regard,the Organisation of Islamic Cooperation Islamic Fiqh Academy has approved the legitimacy of share companies
-In approving joint-stock companies,the Academy accepted two key Western legal concepts:
-Artificial personality:The company is treated as a separate legal entity distinct from its owners
-Limited liability:Shareholders’ financial liability is limited to the amount of capital they invested
-Secondary market trading is important because it provides liquidity
-Liquidity allows investors to buy and sell shares easily without locking in their funds
-An active secondary market increases the appeal and efficiency of equity markets
-From the traditional Islamic perspective,trade is permitted primarily in tangible assets,goods,and services
-However,Shari’ah also allows the trading of shares,as they represent ownership in real assets and productive businesses
-Trading is only permissible if the underlying business activities and financial practices are Shari’ah compliant
-Shari’ah strictly prohibits elements such as:
-Riba (interest)
-Maisir (gambling and games of chance)
-Gharar (excessive uncertainty and ambiguity)
-Key takeaway:Shari’ah recognises joint-stock companies and permits trading of shares in the secondary market,provided the business activities and financial structures comply with Islamic ethical and legal principles,thereby supporting liquidity,ownership transfer,and modern capital market functioning
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KembaraXtra–Islamic Finance–Islamic Capital Market – Types of Islamic Equity
-Islamic finance is founded on the principle of social justice,which promotes fair participation of investors and entrepreneurs in economic activities
-The system requires participants to be willing to share both profits and losses,instead of transferring risk to one party
-Islamic equity encourages engagement in real economic activities such as businesses,construction projects,and joint ventures
-Two of the most widely used Islamic equity-based products are Mudarabah and Musharaka
Mudarabah Products
-Mudarabah is a profit-sharing contract between two parties:the financier (capital provider) and the entrepreneur (manager)
-The entrepreneur is responsible for managing the economic activity,which may include business operations,property construction,or joint ventures
-The financier provides all the capital required to undertake the activity
-If the business generates profit,the profit is shared between the financier and entrepreneur according to a pre-agreed ratio
-If the business incurs losses,the financial loss is borne entirely by the financier
-The entrepreneur does not bear monetary loss because their contribution is their time,effort,and expertise
-The loss of effort and time is considered the entrepreneur’s share of loss
-However,if losses arise due to proven negligence,mismanagement,or misconduct,the entrepreneur may be required to bear financial losses
-This structure ensures fairness while protecting honest entrepreneurship
Example:
-An investor provides capital to an entrepreneur to run a halal business
-If profits are earned,both share profits as agreed
-If the business fails due to market conditions,the investor loses capital,but the entrepreneur loses time and effort
Musharaka Products
-Musharaka is a joint partnership contract involving two or more parties
-All parties contribute capital,and some or all may participate in management
-Profit is shared according to a mutually agreed ratio,which does not have to match capital contribution
-Losses are shared strictly in proportion to capital contribution
-Both investor and entrepreneur bear financial risk,making Musharaka a true risk-sharing model
-This structure closely resembles equity ownership in companies
Example:
-Two partners jointly invest capital to start a manufacturing business
-If the business earns profit,they share it based on agreement
-If losses occur,both partners absorb losses according to how much capital each invested
Key Takeaway
-Mudarabah focuses on capital–management partnership,with financial risk mainly on the financier
-Musharaka focuses on joint ownership and shared financial risk
-Both products reflect Islamic principles of fairness,risk-sharing,and ethical participation in economic activity
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KembaraXtra–Islamic Finance–Islamic Capital Market – Islamic Equity Markets vs Conventional Equity Markets (Notes with Examples)
-Returns are performance-based in Islamic equity markets:Returns depend entirely on how well the company performs financially;profits are earned only if the business generates real income
Example:If a Shari’ah-compliant company earns higher profits,shareholders receive dividends or capital gains;if profits fall,returns decline
-Returns may be interest-linked in conventional equity markets:Conventional firms may rely heavily on interest-based borrowing,allowing shareholders to benefit even when profits are supported by debt
Example:A conventional company may report strong earnings partly due to cheap interest-based loans,rather than operational efficiency
-Islamic equity investing avoids highly leveraged companies:Shari’ah screening restricts excessive debt to ensure investments are not driven by interest
Example:A company with interest-based debt exceeding Shari’ah thresholds is excluded from Islamic portfolios
-Conventional equity markets allow high leverage:Companies can borrow extensively using interest-bearing loans without restriction
Example:A conventional firm may finance expansion primarily through bank loans and bonds with interest
-Risk-sharing is mandatory in Islamic equity markets:Investors must share both profits and losses proportionately with the company
Example:If an Islamic company incurs losses,share prices fall and investors absorb the loss
-Risk transfer exists in conventional markets:Fixed-interest instruments allow investors or lenders to earn income regardless of business performance
Example:Bondholders receive interest payments even if the company is struggling
-Islamic equity markets emphasise ethical screening:Companies involved in haram activities are excluded regardless of profitability
Example:Tobacco,alcohol,and gambling companies are not eligible for Islamic investment
-Conventional markets prioritise profitability:Ethical considerations are optional and profitability remains the primary focus
Example:A highly profitable casino operator may be attractive to conventional investors
-Islamic markets link risk to real assets and productive activity:Investments must be backed by real economic activity and tangible value creation
Example:Manufacturing,healthcare,and technology firms producing real goods and services
-Conventional markets may include speculative exposure:Investments may involve derivatives or financial engineering detached from real assets
Example:Speculative trading in complex derivatives unrelated to physical production
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KembaraXtra–Islamic Finance–Islamic Capital Market – Risk Sharing in the Islamic Equity Market
-Islamic equity markets are based on ownership,not lending,meaning investors become shareholders rather than creditors
-By purchasing Shari’ah-compliant shares,investors own a portion of the company and participate directly in its business outcomes
-Ownership results in shared profits when the company performs well and shared losses when the company performs poorly
-Returns in Islamic equity investing are not guaranteed and depend entirely on real business performance
-This uncertainty of return is essential to Shari’ah as it prevents risk transfer and enforces fairness
-Losses are borne by investors in proportion to their shareholding,ensuring proportional risk-sharing
-Shari’ah screening ensures that risks arise only from halal and productive economic activities,not from interest or speculative activities
-Financial ratio screening limits exposure to interest-based debt,interest income,and excessive receivables
-The prohibition of riba prevents investors from earning fixed returns regardless of business outcomes
-This creates a system where risk cannot be shifted to another party and must be shared collectively
-Shareholders and company management share aligned interests,both benefiting from profits and bearing losses
-This alignment promotes ethical governance,long-term growth,and responsible risk-taking
-Islamic equity markets contribute to financial stability by discouraging excessive leverage and speculation
Notes: Islamic Equity Markets vs Conventional Equity Markets
-In Islamic equity markets,returns are performance-based,while conventional equity markets may involve interest-linked financing structures
-Islamic equity investing avoids companies heavily reliant on debt,whereas conventional equity markets allow high leverage
-Risk-sharing is mandatory in Islamic equity markets,but in conventional markets risk may be transferred through fixed-interest instruments
-Islamic equity markets emphasise ethical screening,while conventional markets prioritise profitability regardless of business nature
-Islamic markets tie risk to real assets and productive activity,whereas conventional markets may include speculative exposures
Link to Musharaka-Style Risk Sharing
-Islamic equity investing closely resembles Musharaka,a joint partnership contract in Islamic finance
-In Musharaka,all partners contribute capital and share profits based on agreement
-Losses in Musharaka are shared strictly according to capital contribution
-Similarly,shareholders in Islamic equity markets contribute capital and share profits and losses proportionally
-Islamic equity markets can therefore be viewed as large-scale Musharaka partnerships
-Both systems embody the Shari’ah principle of justice through equitable risk and reward distribution
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KembaraXtra-Islamic Finance-Islamic Capital Market -Contemporary Stock Trading: The Shifting Face of Worldwide Stock Exchanges
– Over more than two centuries, the New York Stock Exchange (NYSE) dominated stock trading within the United States.
– The growth of the NYSE closely mirrored the simultaneous expansion of the US economy, making it a global financial leader.
– In Europe, the London Stock Exchange (LSE) emerged as the dominant stock exchange for European equity trading.
– As stock markets developed, the NYSE became home to an increasing number of large multinational companies, strengthening its global influence.
– Following the success of the NYSE and LSE, countries such as France and Germany established their own stock exchanges, largely modelled on the structures and practices of these leading exchanges.
– During the 20th century, stock trading expanded further with the rise of new exchanges, most notably NASDAQ.
– NASDAQ became especially attractive to rapidly growing technology companies, which preferred its market structure.
– The technology boom of the 1980s and 1990s significantly increased NASDAQ’s importance and global relevance.
– NASDAQ was the first exchange to implement fully electronic trading, using a network of computers rather than physical trading floors.
– Electronic trading improved efficiency, significantly reducing trading time and transaction costs.
– The growing popularity of NASDAQ, along with the rise of stock exchanges in Asia’s major financial hubs—including Beijing, Malaysia, Hong Kong, and Tokyo—created intense competition for the NYSE.
– To remain competitive, the NYSE pursued strategic integration.
– In 2000, Euronext was formed through the merger of the Brussels, Amsterdam, and Paris stock exchanges.
– In 2007, the NYSE merged with Euronext to form NYSE/Euronext.
– This merger is recognised as the first transatlantic stock exchange, symbolising the globalisation and consolidation of stock markets worldwide.
One-Line Exam Answer
Contemporary stock trading has evolved from nationally dominant exchanges like the NYSE and LSE to globally competitive, electronically driven markets, marked by the rise of NASDAQ, Asian exchanges, and cross-border mergers such as NYSE/Euronext.
– Over more than two centuries, the New York Stock Exchange (NYSE) dominated stock trading within the United States.
– The growth of the NYSE closely mirrored the simultaneous expansion of the US economy, making it a global financial leader.
– In Europe, the London Stock Exchange (LSE) emerged as the dominant stock exchange for European equity trading.
– As stock markets developed, the NYSE became home to an increasing number of large multinational companies, strengthening its global influence.
– Following the success of the NYSE and LSE, countries such as France and Germany established their own stock exchanges, largely modelled on the structures and practices of these leading exchanges.
– During the 20th century, stock trading expanded further with the rise of new exchanges, most notably NASDAQ.
– NASDAQ became especially attractive to rapidly growing technology companies, which preferred its market structure.
– The technology boom of the 1980s and 1990s significantly increased NASDAQ’s importance and global relevance.
– NASDAQ was the first exchange to implement fully electronic trading, using a network of computers rather than physical trading floors.
– Electronic trading improved efficiency, significantly reducing trading time and transaction costs.
– The growing popularity of NASDAQ, along with the rise of stock exchanges in Asia’s major financial hubs—including Beijing, Malaysia, Hong Kong, and Tokyo—created intense competition for the NYSE.
– To remain competitive, the NYSE pursued strategic integration.
– In 2000, Euronext was formed through the merger of the Brussels, Amsterdam, and Paris stock exchanges.
– In 2007, the NYSE merged with Euronext to form NYSE/Euronext.
– This merger is recognised as the first transatlantic stock exchange, symbolising the globalisation and consolidation of stock markets worldwide.
One-Line Exam Answer
Contemporary stock trading has evolved from nationally dominant exchanges like the NYSE and LSE to globally competitive, electronically driven markets, marked by the rise of NASDAQ, Asian exchanges, and cross-border mergers such as NYSE/Euronext.
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KembaraXtra-Islamic Finance-Islamic Capital Market -Objectives of the Stock Market
– Stock markets serve two primary functional purposes: raising capital for companies and creating profit opportunities for investors.
• Providing Capital to Companies
– Stock markets enable companies to raise funds by issuing shares to the public.
– When a company sells shares, it receives capital that can be used for business expansion, investment, and growth.
– Example:
– A company issues shares worth $1 million at $10 per share.
– This results in $10 million of capital raised for the company.
– The share issuance process is usually managed by an investment bank.
– The investment bank charges a standard fee, which is deducted from the total capital raised.
– Stock markets provide an alternative to bank borrowing.
– Companies can raise funds without taking loans and without the burden of interest payments.
– Issuing shares reduces financial pressure compared to debt financing.
• Providing Profit Opportunities to Investors
– Stock markets allow investors to participate in the profits of publicly listed companies.
– Investors benefit from stock ownership in two main ways:
• Dividend Income
– Some companies distribute profits to shareholders in the form of dividends.
– Dividends provide regular income per share owned.
– The total dividend earned depends on the number of shares held.
• Capital Gains
– Investors can earn profits by selling shares at a higher price than the purchase price.
– Example:
– An investor buys a share at $10 per share.
– The investor sells the share later at $15 per share.
– This results in a 50% profit on the original investment.
– Capital gains motivate investors to participate actively in stock markets.
• Overall Importance
– By linking companies needing funds with investors seeking returns, stock markets play a crucial role in economic development.
– They support business growth, investment activity, and wealth creation in the economy.
– Stock markets serve two primary functional purposes: raising capital for companies and creating profit opportunities for investors.
• Providing Capital to Companies
– Stock markets enable companies to raise funds by issuing shares to the public.
– When a company sells shares, it receives capital that can be used for business expansion, investment, and growth.
– Example:
– A company issues shares worth $1 million at $10 per share.
– This results in $10 million of capital raised for the company.
– The share issuance process is usually managed by an investment bank.
– The investment bank charges a standard fee, which is deducted from the total capital raised.
– Stock markets provide an alternative to bank borrowing.
– Companies can raise funds without taking loans and without the burden of interest payments.
– Issuing shares reduces financial pressure compared to debt financing.
• Providing Profit Opportunities to Investors
– Stock markets allow investors to participate in the profits of publicly listed companies.
– Investors benefit from stock ownership in two main ways:
• Dividend Income
– Some companies distribute profits to shareholders in the form of dividends.
– Dividends provide regular income per share owned.
– The total dividend earned depends on the number of shares held.
• Capital Gains
– Investors can earn profits by selling shares at a higher price than the purchase price.
– Example:
– An investor buys a share at $10 per share.
– The investor sells the share later at $15 per share.
– This results in a 50% profit on the original investment.
– Capital gains motivate investors to participate actively in stock markets.
• Overall Importance
– By linking companies needing funds with investors seeking returns, stock markets play a crucial role in economic development.
– They support business growth, investment activity, and wealth creation in the economy.
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•KembaraXtra-Islamic Finance-Islamic Capital Market- Stock Market in the Secondary Market
– In a secondary market system, any public market where existing stocks are bought and sold on a stock exchange is known as the stock market.
– Stocks are also referred to as equities.
– Equities represent fractional ownership in a company, meaning shareholders own a small portion of the firm.
– Stock markets enable investors to buy and sell ownership rights in companies.
– These ownership rights are intangible (invisible) assets, but they carry economic value such as voting rights and dividends.
– Trading in the stock market occurs between investors, not directly with the issuing company.
– The stock market provides liquidity, allowing investors to convert shares into cash easily.
– Efficient functioning of stock markets helps build investor confidence.
– Well-functioning stock markets allow companies to access capital from the public quickly, especially through earlier primary market issuance followed by active secondary trading.
– This efficient flow of funds supports business growth, investment, and expansion.
– Ultimately, active and efficient stock markets contribute to overall economic development by mobilising savings and allocating capital productively.
– In a secondary market system, any public market where existing stocks are bought and sold on a stock exchange is known as the stock market.
– Stocks are also referred to as equities.
– Equities represent fractional ownership in a company, meaning shareholders own a small portion of the firm.
– Stock markets enable investors to buy and sell ownership rights in companies.
– These ownership rights are intangible (invisible) assets, but they carry economic value such as voting rights and dividends.
– Trading in the stock market occurs between investors, not directly with the issuing company.
– The stock market provides liquidity, allowing investors to convert shares into cash easily.
– Efficient functioning of stock markets helps build investor confidence.
– Well-functioning stock markets allow companies to access capital from the public quickly, especially through earlier primary market issuance followed by active secondary trading.
– This efficient flow of funds supports business growth, investment, and expansion.
– Ultimately, active and efficient stock markets contribute to overall economic development by mobilising savings and allocating capital productively.
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KembaraXtra-Islamic Finance-Islamic Capital Market- Comparison of Secondary Markets
• Auction Market
– Operates in the secondary market.
– Trading takes place through competitive bidding and asking by participants.
– Buyers and sellers interact directly with each other.
– Prices are determined by the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
– Convergence of buyers and sellers is required for trading to occur.
– No brokers or dealers are needed to determine prices.
– Participants do not hold inventories of securities.
– No participant uses their own capital to provide liquidity.
– Liquidity is generally high when participation is active.
– Execution is fast once bids and offers match.
– Transparency is high because bids and asks are openly declared.
– Competition exists through simultaneous bids and offers.
– Commonly used for stocks.
– Securities are moderately standardised.
– Not used for IPOs.
– Example: New York Stock Exchange (NYSE).
• Dealer Market
– Operates in the secondary market.
– Trading occurs electronically through dealers.
– Investors trade with dealers, not directly with other investors.
– Prices are set through dealer-quoted bid and ask prices.
– Convergence of buyers and sellers is not required.
– Dealers act as principals in transactions.
– Dealers maintain an inventory of securities.
– Dealers use their own capital to provide liquidity.
– Liquidity is high, as dealers are always ready to trade.
– Execution speed is fast.
– Transparency is high because dealer prices are displayed publicly.
– Competition exists among dealers through price quotations.
– Dealers earn profits through the bid–ask spread.
– Commonly used for bonds, currencies, futures, options, and derivatives.
– Securities are moderately standardised.
– Rarely used for IPOs.
– Example: NASDAQ and foreign exchange markets operated by banks.
• Broker Market
– Operates mainly in the secondary market and sometimes in the primary market.
– Trading is successful only when buyers and sellers are matched as counterparties.
– Brokers act as agents, not principals.
– A dealer may act as a counterparty, but this is not the core feature.
– Convergence of buyers and sellers is required.
– The longer it takes to find a counterparty, the lower the liquidity.
– Brokers do not hold inventory of securities.
– Brokers do not use their own capital.
– Liquidity is moderate to low, depending on market conditions.
– Execution can be slow compared to dealer or exchange markets.
– Transparency is moderate.
– Brokers earn income through commissions.
– Commonly used for IPOs, new bond issues, and customised products.
– Securities are less standardised.
– Historically associated with traditional trading floors like Wall Street.
• Exchange Market
– Operates in the secondary market.
– Trading is carried out through automated electronic systems.
– Orders are matched using an order book mechanism.
– Buyers and sellers trade directly through the exchange platform.
– Trades occur only when prices match; otherwise, the trade is cancelled.
– There is no involvement of brokers or dealer intermediaries in matching trades.
– The exchange provides a centralised marketplace.
– No inventory of securities is held by the exchange.
– No use of own capital by intermediaries.
– Liquidity is very high, the highest among all market types.
– Execution is immediate once prices match.
– Transparency is very high due to visible order books.
– Used mainly for highly standardised securities.
– Common instruments include stocks, bonds, futures, options, and standardised contracts.
– Securities are characterised by contract or lot size, tick size, execution time, delivery terms, and quality standards.
– Example: Electronic stock and commodity exchanges.
• Auction Market
– Operates in the secondary market.
– Trading takes place through competitive bidding and asking by participants.
– Buyers and sellers interact directly with each other.
– Prices are determined by the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
– Convergence of buyers and sellers is required for trading to occur.
– No brokers or dealers are needed to determine prices.
– Participants do not hold inventories of securities.
– No participant uses their own capital to provide liquidity.
– Liquidity is generally high when participation is active.
– Execution is fast once bids and offers match.
– Transparency is high because bids and asks are openly declared.
– Competition exists through simultaneous bids and offers.
– Commonly used for stocks.
– Securities are moderately standardised.
– Not used for IPOs.
– Example: New York Stock Exchange (NYSE).
• Dealer Market
– Operates in the secondary market.
– Trading occurs electronically through dealers.
– Investors trade with dealers, not directly with other investors.
– Prices are set through dealer-quoted bid and ask prices.
– Convergence of buyers and sellers is not required.
– Dealers act as principals in transactions.
– Dealers maintain an inventory of securities.
– Dealers use their own capital to provide liquidity.
– Liquidity is high, as dealers are always ready to trade.
– Execution speed is fast.
– Transparency is high because dealer prices are displayed publicly.
– Competition exists among dealers through price quotations.
– Dealers earn profits through the bid–ask spread.
– Commonly used for bonds, currencies, futures, options, and derivatives.
– Securities are moderately standardised.
– Rarely used for IPOs.
– Example: NASDAQ and foreign exchange markets operated by banks.
• Broker Market
– Operates mainly in the secondary market and sometimes in the primary market.
– Trading is successful only when buyers and sellers are matched as counterparties.
– Brokers act as agents, not principals.
– A dealer may act as a counterparty, but this is not the core feature.
– Convergence of buyers and sellers is required.
– The longer it takes to find a counterparty, the lower the liquidity.
– Brokers do not hold inventory of securities.
– Brokers do not use their own capital.
– Liquidity is moderate to low, depending on market conditions.
– Execution can be slow compared to dealer or exchange markets.
– Transparency is moderate.
– Brokers earn income through commissions.
– Commonly used for IPOs, new bond issues, and customised products.
– Securities are less standardised.
– Historically associated with traditional trading floors like Wall Street.
• Exchange Market
– Operates in the secondary market.
– Trading is carried out through automated electronic systems.
– Orders are matched using an order book mechanism.
– Buyers and sellers trade directly through the exchange platform.
– Trades occur only when prices match; otherwise, the trade is cancelled.
– There is no involvement of brokers or dealer intermediaries in matching trades.
– The exchange provides a centralised marketplace.
– No inventory of securities is held by the exchange.
– No use of own capital by intermediaries.
– Liquidity is very high, the highest among all market types.
– Execution is immediate once prices match.
– Transparency is very high due to visible order books.
– Used mainly for highly standardised securities.
– Common instruments include stocks, bonds, futures, options, and standardised contracts.
– Securities are characterised by contract or lot size, tick size, execution time, delivery terms, and quality standards.
– Example: Electronic stock and commodity exchanges.
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KembaraXtra-Islamic Finance-Islamic Capital Market- Comparison of Types of Secondary Markets
• Auction Market
– Operates in the secondary market.
– Trading takes place through competitive bidding and asking by participants.
– Buyers and sellers interact directly with each other.
– Prices are determined by the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
– Convergence of buyers and sellers is required for trading to occur.
– No brokers or dealers are needed to determine prices.
– Participants do not hold inventories of securities.
– No participant uses their own capital to provide liquidity.
– Liquidity is generally high when participation is active.
– Execution is fast once bids and offers match.
– Transparency is high because bids and asks are openly declared.
– Competition exists through simultaneous bids and offers.
– Commonly used for stocks.
– Securities are moderately standardised.
– Not used for IPOs.
– Example: New York Stock Exchange (NYSE).
• Dealer Market
– Operates in the secondary market.
– Trading occurs electronically through dealers.
– Investors trade with dealers, not directly with other investors.
– Prices are set through dealer-quoted bid and ask prices.
– Convergence of buyers and sellers is not required.
– Dealers act as principals in transactions.
– Dealers maintain an inventory of securities.
– Dealers use their own capital to provide liquidity.
– Liquidity is high, as dealers are always ready to trade.
– Execution speed is fast.
– Transparency is high because dealer prices are displayed publicly.
– Competition exists among dealers through price quotations.
– Dealers earn profits through the bid–ask spread.
– Commonly used for bonds, currencies, futures, options, and derivatives.
– Securities are moderately standardised.
– Rarely used for IPOs.
– Example: NASDAQ and foreign exchange markets operated by banks.
• Broker Market
– Operates mainly in the secondary market and sometimes in the primary market.
– Trading is successful only when buyers and sellers are matched as counterparties.
– Brokers act as agents, not principals.
– A dealer may act as a counterparty, but this is not the core feature.
– Convergence of buyers and sellers is required.
– The longer it takes to find a counterparty, the lower the liquidity.
– Brokers do not hold inventory of securities.
– Brokers do not use their own capital.
– Liquidity is moderate to low, depending on market conditions.
– Execution can be slow compared to dealer or exchange markets.
– Transparency is moderate.
– Brokers earn income through commissions.
– Commonly used for IPOs, new bond issues, and customised products.
– Securities are less standardised.
– Historically associated with traditional trading floors like Wall Street.
• Exchange Market
– Operates in the secondary market.
– Trading is carried out through automated electronic systems.
– Orders are matched using an order book mechanism.
– Buyers and sellers trade directly through the exchange platform.
– Trades occur only when prices match; otherwise, the trade is cancelled.
– There is no involvement of brokers or dealer intermediaries in matching trades.
– The exchange provides a centralised marketplace.
– No inventory of securities is held by the exchange.
– No use of own capital by intermediaries.
– Liquidity is very high, the highest among all market types.
– Execution is immediate once prices match.
– Transparency is very high due to visible order books.
– Used mainly for highly standardised securities.
– Common instruments include stocks, bonds, futures, options, and standardised contracts.
– Securities are characterised by contract or lot size, tick size, execution time, delivery terms, and quality standards.
– Example: Electronic stock and commodity exchanges.
• Auction Market
– Operates in the secondary market.
– Trading takes place through competitive bidding and asking by participants.
– Buyers and sellers interact directly with each other.
– Prices are determined by the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
– Convergence of buyers and sellers is required for trading to occur.
– No brokers or dealers are needed to determine prices.
– Participants do not hold inventories of securities.
– No participant uses their own capital to provide liquidity.
– Liquidity is generally high when participation is active.
– Execution is fast once bids and offers match.
– Transparency is high because bids and asks are openly declared.
– Competition exists through simultaneous bids and offers.
– Commonly used for stocks.
– Securities are moderately standardised.
– Not used for IPOs.
– Example: New York Stock Exchange (NYSE).
• Dealer Market
– Operates in the secondary market.
– Trading occurs electronically through dealers.
– Investors trade with dealers, not directly with other investors.
– Prices are set through dealer-quoted bid and ask prices.
– Convergence of buyers and sellers is not required.
– Dealers act as principals in transactions.
– Dealers maintain an inventory of securities.
– Dealers use their own capital to provide liquidity.
– Liquidity is high, as dealers are always ready to trade.
– Execution speed is fast.
– Transparency is high because dealer prices are displayed publicly.
– Competition exists among dealers through price quotations.
– Dealers earn profits through the bid–ask spread.
– Commonly used for bonds, currencies, futures, options, and derivatives.
– Securities are moderately standardised.
– Rarely used for IPOs.
– Example: NASDAQ and foreign exchange markets operated by banks.
• Broker Market
– Operates mainly in the secondary market and sometimes in the primary market.
– Trading is successful only when buyers and sellers are matched as counterparties.
– Brokers act as agents, not principals.
– A dealer may act as a counterparty, but this is not the core feature.
– Convergence of buyers and sellers is required.
– The longer it takes to find a counterparty, the lower the liquidity.
– Brokers do not hold inventory of securities.
– Brokers do not use their own capital.
– Liquidity is moderate to low, depending on market conditions.
– Execution can be slow compared to dealer or exchange markets.
– Transparency is moderate.
– Brokers earn income through commissions.
– Commonly used for IPOs, new bond issues, and customised products.
– Securities are less standardised.
– Historically associated with traditional trading floors like Wall Street.
• Exchange Market
– Operates in the secondary market.
– Trading is carried out through automated electronic systems.
– Orders are matched using an order book mechanism.
– Buyers and sellers trade directly through the exchange platform.
– Trades occur only when prices match; otherwise, the trade is cancelled.
– There is no involvement of brokers or dealer intermediaries in matching trades.
– The exchange provides a centralised marketplace.
– No inventory of securities is held by the exchange.
– No use of own capital by intermediaries.
– Liquidity is very high, the highest among all market types.
– Execution is immediate once prices match.
– Transparency is very high due to visible order books.
– Used mainly for highly standardised securities.
– Common instruments include stocks, bonds, futures, options, and standardised contracts.
– Securities are characterised by contract or lot size, tick size, execution time, delivery terms, and quality standards.
– Example: Electronic stock and commodity exchanges.
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KembaraXtra-Islamic Finance-Islamic Capital Market-Categories of Secondary Market
Auction Market (Secondary Market Category)
What it is
• An auction market is a type of secondary market where prices are determined through continuous bidding and asking by participants.
• Buyers and sellers announce prices they are comfortable with.
Who trades
• Transactions mainly occur between investors.
• Issuing companies are not involved.
• Business expansion is not the objective of these trades.
How prices are formed
• All participants openly declare their bid and ask prices.
• This makes prices more concrete, transparent, and efficient.
• Market efficiency improves because everyone sees price information.
Price discovery process
• Buyers and sellers come together in the market.
• Buyers submit the highest price they are willing to pay.
• Sellers submit the lowest price they are willing to accept.
• A transaction is completed when bid and ask prices match.
Benefits to investors
• Investors do not need to search for the best price elsewhere.
• A fair and justified price range is automatically discovered.
Example
• The New York Stock Exchange (NYSE) is a well-known auction market.
Dealer Market
Core idea
• Dealer markets do not require buyers and sellers to converge directly.
• Transactions take place electronically through dealers.
How it differs from auction markets
• In auction markets, investors meet each other.
• In dealer markets, investors trade with dealers.
Role of dealers
• Dealers maintain an inventory of securities.
• They are ready to buy or sell at any time.
• Dealers quote:
– a buying price (bid)
– a selling price (ask)
Liquidity and risk
• Dealers use their own capital to hold securities.
• By doing so, they provide liquidity to the market.
• Their capital is exposed to price risk.
How dealers earn profit
• Profit is earned from the spread between buying and selling prices.
Transparency and competition
• Dealer prices are displayed publicly.
• This transparency encourages competition among dealers.
• Competition helps investors get better prices.
Markets where dealer systems dominate
• Currency markets
• Bond markets
• Futures and options
• Other standardised contracts and derivatives
Foreign exchange example
• The foreign exchange market operates mainly as a dealer market.
• Banks and currency exchanges act as dealer intermediaries.
Example
• NASDAQ (New York) is a popular dealer market.
Broker Market
Basic principle
• A broker market works only when a buyer and seller are matched as counterparties.
• Brokers act as agents, not principals.
Counterparty issue and liquidity
• The longer it takes to find a suitable counterparty, the lower the liquidity.
• This makes broker markets generally less liquid than dealer or exchange markets.
Historical background
• Traditional stock markets were brokered.
• Brokers physically searched for counterparties on trading floors.
• This created the classic Wall Street image of traders shouting orders and writing on paper.
Role of brokers
• Brokers search for appropriate buyers or sellers for their clients.
• They do not usually trade using their own capital.
Use in securities markets
• Broker markets are used for many types of securities.
• Particularly important for initial issues.
IPO context
• During an IPO, investment banks broker the issue.
• Their role is to find subscribers for the shares.
Bond and custom products
• Broker markets are suitable for:
– new bond issues
– less liquid securities
– tailored or customised financial products
Exchanges
Market structure
• Exchange markets are mostly automated.
• Trades are executed using order books that match buyers and sellers.
• Stocks are no longer brokered manually.
Price agreement rule
• A trade only occurs if buyer and seller prices match.
• If no agreement is reached, the trade is cancelled.
Role of intermediaries
• There is no involvement of brokers or dealer intermediaries in trade matching.
• Buyers and sellers find counterparties directly through the exchange.
Advantages of automated exchanges
• Centralised trading location
• Faster execution
• Higher transparency
• Lower transaction costs
Types of securities traded
• Standardised securities such as:
– stocks
– bonds
– futures
– options
– other standardised contracts
Key characteristics of exchange-traded securities
• Contract or lot size
• Time required to execute the contract
• Tick size
• Terms of delivery
• Quality specifications
Contract or lot size
• Securities must be traded in minimum quantities.
• Example: stocks traded in lots of 100 shares.
Tick size
• Tick size is the smallest price movement allowed.
• Example: US stock exchanges allow a minimum price change of $0.01.
Contract tick size
• Contract tick size = tick size × lot size.
• Example: $0.01 × 100 shares = $1.
Delivery and quality standards
• Mainly relevant for commodities and derivatives.
• Assets like gold and diamonds are traded based on quality and ratings.
• Physical assets must be in deliverable form.
Liquidity
• Standardisation, automation, and immediate execution make exchange markets highly liquid.
