Stock markets
What
is a stock market?
- A stock market or equity
market is a market for the trading of company stock (shares) and
derivatives at an agreed price/
- The size of the world stock
market was estimated at about $36.6 trillion USD at the beginning of
October 2008.
What
is a share /stock/equity?
- Shares represent a fraction
of ownership in a business. The common feature of all these is
equity participation. Different classes of shares have different
voting rights.
- Ownership of shares is
documented by a legal document that specifies the amount of shares owned
by the shareholder? And other specifics of the shares, such as the par
value or the class of the shares (if any).
- These days these stock
certificates have been dematerialized. (No physical document!)
Who
is a shareholder?
- A shareholder (or stockholder)
is an individual or company (including a corporation) that legally owns
one or more shares of a company.
- Shareholders are granted
privileges depending on the class of stock, including the right to vote
on matters such as elections to the board of directors, the right to
share in distributions of the company`s income, the right to purchase
new shares issued by the company`s assets during a liquidation of the
company.
- Shareholders vary from
individual stock investors to large hedge fund traders.
Why does a company issue shares to the public?
- A company may want additional
capital to invest in new projects.
- The promoters may simply
wish to reduce their holding, freeing up capital for their own private
use.
- Once a company is listed,
it will be able to issue further shares via a rights issue, thereby
again providing itself with capital for expansion without incurring
any debt.
- Financing a company through
the sale of stock in a company is known as equity financing.
Trading
- The shares of a company
are in general be transferrable from one shareholder to another.
This leads to buying and selling of shares termed as trading.
- Investors usually buy and
sell shares on the exchanges through a stock brokers registered with
the exchange.
- A company may list its
shares on an exchange by meeting and maintaining the listing requirements
of a particular stock exchange.
Share
price determination
- At any given moment, the
price is strictly a result of supply and demand. The supply is the number
of shares offered for sale at any one moment. The demand is the number
of shares investors wish to buy at exactly that same time.
- Actual trades are based
o an auction market model where a potential buyer bids a specific
price for a stock and a potential seller asks a specific price for the
stock. (Buying or selling or selling at market means you will accept
any ask price or bid price for the stock, respectively.) When the bid
and ask prices match, a sale takes place.
Listing
requirements
- The set of conditions imposed
by a given stock exchange upon companies that want to be listed on that
exchange.
- Examples include minimum
number of shares outstanding, minimum market capitalization, and minimum
annual income.
- These requirements vary
from exchange to exchange. Example: Bombay Stock Exchange (BSF) bas
requirements for a minimum market capitalization of Rs.25 Cr and minimum
public float equivalent to RS.10 Cr whereas the London Stock Exchange
has requirements for a minimum market capitalization (£700000).
Ways
of buying and selling share
- Through a stock broker:
They arrange the transfer of stock from a seller to a buyer. Both the
buyer and the seller of the share pay commission known as brokerage
to the broker.
- Directly from the company:
- If at least one share is
owned, most companies will allow the purchase of shares directly from
the company through their investor relations departments.
- A direct public offering
is an initial public offering (IPO) in which the stock is purchased
directly from the company, usually without the aid of brokers.
Leveraged
Strategies
Buying stock on margin means buying
stock with money borrowed against the stocks in the same account. These
stocks, or collateral, guarantee that the buyer can repay the loan;
otherwise, the stockbroker has the right to sell the stock to repay
the borrowed money. The broker usually charges 8-10% interest on margin
sorrowing.
In short selling, the trader borrows
stock (usually from his brokerage) then sells it on the market, hoping
for the price to fall. The trader eventually buys back stock, making
money if the price fell in the meantime and losing if it rose.
When
to invest in a particular stock?
- Fundamental analysis refers
to analyzing companies by their financial statements found in SEC .
Filings, business trends, general economic conditions and the growth
prospects of company`s market segment. A few parameters which are looked
upon include Price to Earnings (PE) Ratio, price to Book Value ratio,
Equity to Debt ratio.
- Technical analysis studies
price actions is markets through the use of charts and quantitative
techniques to attempt to forecast price trends regardless company`s
financial prospects. A few examples include Trend lines, Bollinger Bands,
Oscillators etc.
Stock
Market Index
- The movements of prices
in a market or section of a market are captured in price indices
called stock market indices. Such indices are usually market capitalization
weighted, with the weights reflecting the contribution of stock to the
index. Examples of index include Sensex, Nifty, DJIA, S&P500,
Nikkei etc.
- The constituents of the
index are reviewed frequently to include/exclude stocks in order to
reflect the changing business environment.
Importance
and role of the stock markets
- Raising capital for businesses
- Government capital-rising
for development projects
- Mobilizing savings for
investment
- Facilitating company growth
through acquisitions
- Creating investment opportunities
for small investors
- Barometer of the economy
Stock
markets and the financial risk
Sometimes the market seems to react
irrationally to economic or financial news. This may “temporarily”
move financial prices away from their long term aggregate price “trends”.
(Positive or up trends are reffered to as bull markets; negative or
down trends are reffered to as bear markets). Over-reactions may occur-so
that excessive optimism (euphoria) may drive prices unduly high or excessive
pessimism may drive prices unduly low.
Stock
market Crashes
- A stock market crash is
often defined as a sharp dip in share prices of equities listed on the
stock exchanges. In parallel with various economic factors, a reason
for stock market crashes is also due to panic and investing public`s
loss of confidence. Often, stock market crashes burst speculative economic
bubbles.
- Famous stock market crashes
have lead to the loss of billions of dollars and wealth destruction
on a massive scale