An Introduction To The Stock Market : Part 1

  "When I was young I thought that money was the most important thing in life; now that I am old I know that it is." –Oscar Wilde  

Ever thought of picking up an Economic Times? Well, holding an economic times can be a matter of great pride (and a sense of achievement) for morons like me and you..! But then it is full with financial jargons, isn’t it? And for those unfamiliar with financial terms, the language of an Economic times or of any business newspaper/magazine for that matter can seem foreign and mysterious, making our sincere effort to see through it futile. Every profession or business field has its own set of terms and jargons, the purpose being to convey ideas and concepts quickly. Thus simplifying communication for insiders but making life difficult for the naïve. It can be an embarrassing situation to get placed in an environment where terminology you don’t understand is used frequently and usually taken for granted. So what is the way out? Plausibly, making sense of these jargons is the only way forward..! The world of finance can be monolithic at times to explore and dig dip into. And there is no circumstantial way of beginning a discussion about it. Even though I have a variety of topics and aspects of financial market to choose from, what’s better than the stock market itself to begin what can be a worthy article..!? (Starting from the scratch and we do have a long way to go) What is a stock market? First of all, let me clear that the terms stock market and equity market are same. And you can replace the term ‘equity’ whenever I use it with ‘stock’ for better discernment. As the Investopedia defines it, Stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. The stock market lets investors participate in the financial achievements of the companies whose shares they hold. When companies are profitable, stock market investors make money through the dividends the companies pay out and by selling appreciated stocks at a profit called a capital gain. The downside is that investors can lose money if the companies whose stocks they hold lose money, the stocks’ prices go down and the investor sells the stocks at a loss. What is the meaning of asset and debt in financial terms? Asset: A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are bought to increase the value of a firm or benefit the firm’s operations. You can think of an asset as something that can generate cash flow, regardless of whether it’s a company’s manufacturing equipment or an individual’s rental apartment. Debt: The amount of money borrowed by one party from another. Many corporations/individuals use debt as a method for making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. Bonds, loans and commercial paper are all examples of debt. For example, a company may look to borrow $1 million so they can buy a certain piece of equipment. In this case, the debt of $1 million will need to be paid back (with interest owing) to the creditor at a later date. But, then a question springs up in our mind. What exactly is a stock/equity/share/security? Equity is too broader a term and the purpose of it depends on the context. However in general, you can think of equity as ownership in any asset after all debts associated with that asset are paid off. For example, a car or house with no outstanding debt is considered the owner’s equity because he or she can readily sell the item for cash. Stocks/shares/securities are equity because they represent ownership in a company. And one owning a stock can sell it as and when he wants. The stock market can be split into two major markets:

1. Primary Market: The primary market is where new issues are first sold through Initial Public Offerings (IPO).

Primary market provides opportunity to issuers of securities: Government as well as corporate, to raise resources to meet their requirements of investment. The terms in Italics are what you call jargons and I will explain them as and when they deem appropriate for an explanation: Initial Public Offering (IPO): The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. It is often referred to as going public. Why go public? Going public raises cash, and usually a lot of it. Another advantage is an increased public awareness of the company because IPOs often generate publicity by making their products known to a new group of potential customers. Subsequently this may lead to an increase in market share for the company. Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company’s management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to perform somewhat questionable practices in order to boost earnings. (As happened in The Satyam case- will discuss in the topic “stock market scams in India” in one of my future blogs) As a reason of which globally famous companies like Domino’s Pizza, IKEA, Hallmark Cards are yet to go public.   Capital: Financial assets or the financial value of assets, such as cash. The factories, machinery and equipment owned by a business and used in production. Capital is different from money. Money is used simply to purchase goods and services for consumption. Capital is more durable and is used to generate wealth through investment. Examples of capital include automobiles, patents, software and brand names. All of these things are inputs that can be used to create wealth.

2. Secondary Market:

Secondary market refers to a market where securities/shares are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Provides liquidity to investors. Majority of the trading is done in the secondary market. We all have stared at the above looking TV screen with astonishment and daze. Two horizontal strips full of share prices making their way in and out of the screen. That’s secondary market for you..!! Liquidity: The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets or The ability to convert an asset to cash quickly. It is safer to invest in liquid assets than illiquid ones because it is easier for an investor to get his/her money out of the investment. Keep in mind that you can sell your asset or equity share only if there is an outstanding buyer to purchase it. And degree of easiness in finding a buyer is liquidity. Cash is the most liquid asset whereas Real estate holdings can be one of the least liquid assets. To be continued… (With many more jargons hopefully..!)   ______ About the author: This is Nishant Shah from Ahmedabad. I completed my B.Tech in Mechanical Engineering from NIT, Surat. I would be joining IIM Ahmedabad in June for a Post Graduate Programme in Management. I have interned at ONGC and Inductotherm, and dabbled in Financial Markets at Sharekhan. I have spent two months at IIM Ahmedabad under Prof. Vijaya Sherry Chand, working for the Education Innovations Bank. I am passionate about analysing Cricket and find solace in reading literature. You can find me at financefink.