Personal Finance: Understanding Stock Markets: Deals were done over coffee

One of the best ways to begin to understand the workings of the stock market is to know a little about its history, writes John Andrew.

Until the 16th century, businesses were always either owned by one man or were partnerships with two or more owners. This was fine until a great deal of money was required for risky venture.

If successful, the rewards would be high, but failure would result in the loss of the initial capital. No one individual, or small group of people, would be prepared to lose a great sum of money. However, a solution was found - why not raise capital by selling shares in the enterprise to a large number of investors? If successful, the shareholders would share the rewards. If it failed, they would lose just a little.

In 1553, the world's first joint-stock company, so named because the shares were held jointly, was founded in London. This was the period of the great voyages of discovery and it is appropriate that the first known company to issue shares was established to fund an expedition to find the North-east passage to the Far East.

The route was not found, but contact was made with Ivan the Terrible. The Tsar granted the company, which popularly became known as the Muscovy Company, the monopoly of Anglo-Russian trade. The concession was most lucrative and the shareholders benefited.

Although the shareholders had contributed the capital for the venture, the day-to-day management of the enterprise was in the hands of officers of the company. The shareholders received a dividend based on the profits made. The shares were freely tradable in the open market. The Muscovy Company became the blueprint for all succeeding joint-stock companies.

As more companies came into existence, a market for shares became established. The brokers - the intermediaries acting on behalf of investors - met to buy and sell these in the coffee shops around Threadneedle Street in the City of London. The Stock Exchange was founded nearby in 1773.

Over the past two centuries there have been changes. However, the two main functions remain: to raise money for companies and to provide a marketplace for investors wishing to buy and sell shares or bonds. Last year UK companies raised pounds 56.2bn on the London Stock Exchange and 741.6 billion shares in UK companies changed hands. On average,43,000 transactions worth pounds 2.9bn took place each day.

The London Stock Exchange is also the world's leading international exchange. More international companies are listed and more international equities traded in London than on any other exchange in the world.

If you visit the London Stock Exchange today, the trading floor is empty. Gone is the hustle and bustle of the marketplace. The Exchange's UK market for shares is now screen-based and quote-driven using the Stock Exchange Automated Quotations system - SEAQ for short.

There are dozens of dealing rooms in the City and at other locations staffed by dealers with their eyes glued to computer screens. It is views of one of these dealing rooms that you see on the TV news.

Throughout the day, members of the Exchange called market-makers are obliged to display on SEAQ their buying and selling prices for all shares in which they are registered to deal. These prices are firm. The public may only buy and sell shares through a stockbroker who is a member of the Exchange.

When stockbrokers undertake a deal for a client, this will be transacted at the most advantageous price at the time of the deal. This is possible because SEAQ displays the best bid and offer price for every security quoted and identifies up to four market-markers quoting this price. The deal is executed automatically or by telephone.

Fact File 1997 is available direct from the Exchange. Call 0171-797 1372 for a copy.