OTHER FINANCIAL INSTITUTIONS

Trillions of dollars flow through the U.S. banking system each year, providing security and interest income for savers, and a pool of loanable funds for borrowers. Thus, the banking system is an important feature within the larger financial system of the country. There are other important components of the U.S. financial system, however. Some of the key institutions include stock markets, bond markets, mutual funds, and futures exchanges.

Stock Markets

A stock market, or stock exchange, is a mechanism by which stocks are traded. That is, a stock market links buyers and sellers of stocks. Stocks of publicly traded companies are listed on a stock exchange. Some stock markets such as the New York Stock Exchange (NYSE Euronext) still conduct some of their business on a trading floor. Others, such as the Nasdaq Stock Market (Nasdaq OMX), are decentralized networks of investors and stock dealers that communicate and trade stocks through electronic trading systems. Today these exchanges are globally networked.

Recent consolidations of stock markets have resulted in some major changes in the financial services industry. One major change was the merger of the NYSE Group and Euronext N.V. in 2007. The NYSE Group was formed by a merger between the NYSE and the Archipelago exchange. Euronext was the operator of five major European securities exchanges, including stock exchanges in Amsterdam (Netherlands), Brussels (Belgium), Lisbon (Portugal), and Paris (France), and a derivatives exchange in London (United Kingdom). The 2007 “merger of equals” between the NYSE Group and Euronext N.V. created NYSE Euronext. NYSE Euronext was hailed as the world's first global stock exchange. In 2008 NYSE Euronext also purchased the American Stock Exchange (AMEX), thus integrating AMEX into this global securities market. In 2013 NYSE Euronext was purchased by Intercontinental Exchange (ICE).[1] During this same time period Nasdaq purchased several foreign and domestic stock exchanges, including the Boston Stock Exchange (2006) and the Philadelphia Stock Exchange (2007), and exchanges in Sweden, Finland, Denmark, and other countries. Now called Nasdaq OMX, it remains a major player in global securities markets.[2]

On the eve of its takeover by ICE, NYSE Euronext was the largest stock exchange in the world based on its market capitalization. Market capitalization simply refers to the dollar value of stocks listed on a stock exchange at any moment in time. Market capitalization can change when the value of stocks increases during a bull market or decreases during a bear market. It can also change when corporations either leave or join a certain stock exchange. By the close of 2012 market capitalization for the NYSE Euronext (U.S.) was $14.1 trillion, followed by Nasdaq OMX ($4.6 trillion), Tokyo Stock Exchange ($3.5 trillion), London Stock Exchange ($3.4 trillion), and the NYSE Euronext (Europe, $2.8 trillion). The NYSE Euronext (Europe) data covers four stock exchanges: Amsterdam, Brussels, Lisbon, and Paris. Global market capitalization for the world's stock exchanges in 2012 was $54.6 trillion—a $7 trillion jump over the 2011 totals of $47.4 trillion. Rounding out the top 10 stock exchanges in the world were exchanges in Hong Kong (China SAR), Shanghai (China), Toronto (Canada), Frankfurt (Germany), and Sydney (Australia). Trillions of dollars in stock trades take place each year on stock exchanges.[3]

Stock markets are an important type of financial market. First, stock markets raise investment capital for corporations in primary markets. Stock trading in a primary market occurs when a business issues new stocks for sale to investors. The proceeds from the sale of new issues in primary markets enable corporations to build plants, purchase real capital, and attend to other business expenses. A corporation's first issue of stock to investors is called an initial public offering (IPO). Recent IPOs have raised billions of dollars for Facebook ($16.6 billion in 2012), General Motors ($20 billion in 2010), and Visa ($19.7 billion in 2008).[4]

Second, stock markets provide a way for investors to earn profits, called capital gains, in secondary markets. Stock trading in a secondary market involves the purchase and sale of previously issued stocks. The investor earns capital gains when the stock sells for more than its original purchase price. Of course, all investments involve some risk, and an investor can also incur losses, which occur when the selling price of the stock is less than its original purchase price.

Third, stock markets send financial signals to investors, businesses, consumers, and others throughout the economy. The performance of the stock market indicates the level of confidence investors have in specific firms, in specific industries, in different economic sectors, or in the direction of the overall U.S. economy. In fact, economists consider positive or negative trends in the stock market to be a key leading economic indicator, or predictor of future economic activity in the overall economy. The Dow Jones Industrial Average (DJIA), more commonly called the Dow, is one important measurement of stock performance on the New York Stock Exchange. The Dow achieved a series of record-breaking performances during the summer and fall of 2013, and surpassed 16,000 in November

Table 9.4 Composition of the Dow Jones Industrial Average, 1896 and 2013

Source: Dow Jones Indexes, “Dow Jones Industrial Average”; CNN Money, “Dow Jones Industrial Average.”

of that year. The dramatic increase in the Dow signaled investor confidence in the ongoing

U.S. economic recovery.[5] Positive or negative trends can be determined by looking at certain indices of stock performance such as the Dow Jones Industrial Average, or broader indices such as the Standard & Poor's 500. Table 9.4 contrasts the composition of the DJIA in 2013 and 1896.[6] The creation of the Dow is chronicled in the following passage.

ECONOMICS IN HISTORY: Charles H. Dow and the Founding of Two Financial Icons

The Dow Jones Industrial Average is the most recognized stock index in the world. Its founder, Charles H. Dow, was born in Sterling, Connecticut, in 1851. During the 1870s Dow worked as a reporter for several New England newspapers and by the early 1880s had joined a financial news service in New York City. In 1882 Dow and fellow reporter Edward D. Jones formed Dow Jones & Company, which was located on Wall Street. Dow and Jones researched financial news and wrote daily financial bulletins, called flimsies, mainly for financial institutions in the city. The firm’s size and reputation grew during the 1880s. In 1889 its respected bulletins, originally published as the Customer’s Afternoon Letter, were transformed into a financial newspaper called the Wall Street Journal.

Dow was editor of the Wall Street Journal, and thus his articles reached a wide audience. In 1896 Dow developed the Dow Jones Industrial Average (DJIA), an index comprised of 12 prominent manufacturing companies, to track the performance of stocks on the New York Stock Exchange (NYSE). The DJIA followed on the heels of Dow’s first stock index, which tracked mainly railroad companies from 1884 to 1896. Since 1896 the composition and number of companies included in the DJIA has changed significantly. By 1929 the DJIA had grown to 30 companies, the same number as today. Over time additional Dow Jones indexes, including the Dow Jones Transportation Average and the Dow Jones Utility Average, were created to measure the ups and downs of stocks in other industries. The most inclusive of the indexes is the Dow Jones Composite Average.[7]

  • [1] NYSE Euronext, “NYX Statement Regarding EU Decision to Approve Proposed Combination with Intercontinental Exchange,” News Release, June 24, 2013; NYSE Euronext, “NYSE Group and Euronext Announce Merger,” NYSE Group Newsletter 13, no. 3 (June 2006); NYSE Euronext, “New York Stock Exchange,” ; “NYSE Euronext,” Hoovers
  • [2] NASDAQ OMX, “NASDAQ OMX Corporate Timeline,”
  • [3] World Federation of Exchanges (WFE), “Table 1: Domestic Market Capitalization, and Largest Domestic Equity Market Capitalizations at Year-End 2012 and 2011,” 2012 WFE Market Highlights, January 23, 2013
  • [4] Evelyn M. Rusli and Peter Eavis, “Facebook Raises $16 Billion in I.P.O.,” New York Times, May 17, 2012; David Welch, Lee Spears, and Craig Trudell, “GM IPO Raises $20 Billion Selling Common. Preferred,” Bloomberg, November 17, 2010; Katie Benner, “Visa IPO Prices at Record $17.9B,” CNN Money, March 19, 2008
  • [5] CNN, “Dow Jones Industrial Average Fast Facts: Records,” November 27, 2013
  • [6] Dow Jones Indexes, “Dow Jones Industrial Average,”; CNN Money, “Dow Jones Industrial Average,”
  • [7] “Dow Jones Timeline,” Wall Street Journal, 2007 “DJIA Historical Timeline,” Dow Jones Industrial Average Learning Center, 2013
 
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