Stock Exchange
The stock exchange is a regulated and organised financial market where securities such as shares, debentures, and bonds are bought and sold. It provides a platform for companies to raise long-term capital by issuing shares to the public, and for investors to purchase and trade these financial instruments. The stock exchange facilitates the mobilisation of savings and their allocation into productive investments, making it a critical component of the capital market.
Concepts:
- Shares (or stocks): Units of ownership in a company. Shareholders are part-owners and may receive dividends.
- Securities: Tradable financial instruments, including shares, bonds, and derivatives.
- Dividend: A portion of the company’s profit distributed to shareholders.
- Capital gain: The profit earned from selling a share at a higher price than its purchase price.
- Market Capitalisation: The total value of a company’s outstanding shares (Share Price × Number of Shares).
Functions of a Stock Exchange
- Raising Capital for Businesses: Companies can raise equity capital by issuing shares to the public.
- Liquidity Provision: Investors can buy or sell shares at any time, turning securities into cash quickly.
- Price Determination: Prices are determined through the forces of demand and supply.
- Encouraging Savings and Investment: It offers a range of investment opportunities to savers.
- Efficient Resource Allocation: Capital flows to firms that are more efficient and profitable.
- Protection for Investors: Regulated stock exchanges ensure fair trading practices and transparency.
- Indicator of Economic Health: Share price indices reflect business confidence and macroeconomic trends.
Advantages of a Stock Exchange
- Facilitates the mobilisation of funds for productive uses.
- Encourages public participation in ownership of companies.
- Enhances transparency and regulation in financial markets.
- Provides liquidity and price discovery for securities.
- Encourages good governance and disclosure by listed firms.
Disadvantages of a Stock Exchange
- Subject to volatility and speculation, which may cause investor losses.
- Sudden market crashes can impact investor confidence and national economies.
- Encourages short-termism in corporate behaviour due to focus on share prices.
- Requires financial literacy; inexperienced investors may make poor decisions.
- Can be influenced by external factors like politics or global economic shocks.
Step-by-Step Procedure for Buying and Selling Shares
- Open a trading account and a Demat account with a registered stockbroker.
- Deposit funds into your trading account.
- Place an order to buy or sell shares through the stockbroker or online trading platform.
- Matching of orders occurs on the stock exchange platform based on price and quantity.
- Trade is executed and a contract note is issued confirming the transaction.
- Settlement of trade occurs through the clearing house (T+2 days typically).
- Shares are transferred to or from your Demat account and payment is finalised.
Types of Shares Traded
- Ordinary (Equity) Shares: Provide ownership rights, voting rights, and dividends (variable).
- Preference Shares: Fixed dividends and preference over equity shareholders in case of liquidation.
- Deferred Shares: Usually held by founders; dividends paid after all others.
- Bonus Shares: Issued free of charge to existing shareholders from reserves.
- Rights Issue: Existing shareholders are given the right to buy more shares at a discount.
Why People Buy Shares
- To earn dividends as a return on investment.
- To benefit from capital appreciation over time.
- For portfolio diversification and long-term financial goals.
- To exercise ownership rights in the company.
- For speculative purposes aiming at short-term profits.
Yield
Yield refers to the income generated by a share as a percentage of its market price. It is calculated as:
It enables investors to evaluate the return on their investment in relation to the current market value.
Reasons for Fluctuations in Share Prices
- Demand and Supply Forces in the Stock Market.
- Company performance, such as profit results or dividend declarations.
- Macroeconomic indicators like interest rates, inflation, or GDP growth.
- Market sentiment is driven by investor confidence or fear.
- Global events such as geopolitical tensions or financial crises.
- Government policies, including taxation and regulation.
- Technological or sectoral changes impacting specific industries.