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Basics of Stock Market
Financial markets provide their participants with the
most favorable conditions for purchase/sale of financial instruments they have
inside. Their major functions are: guaranteeing liquidity, forming assets
prices within establishing proposition and demand and decreasing of operational
expenses, incurred by the participants of the market.
Financial market comprises variety of instruments, hence its functioning totally depends on
instruments held. Usually it can be classified according to the type of
financial instruments and according to the terms of instruments’ paying-off.
From the point of different types of instruments held the
market can be divided into the one of promissory notes and the one of
securities (stock market).
The first one contains promissory instruments with the right for its owners to
get some fixed amount of money in future and is called the market of promissory
notes, while the latter binds the issuer to pay a certain amount of money
according to the return received after paying-off all the promissory notes and
is called stock market. There are also types of securities referring to both
categories as, e.g., preference shares
and converted bonds. They are also called the instruments with fixed return.
Another classification is due to paying-off terms of
instruments. These are: market of assets with high liquidity (money market) and
market of capital. The first one refers to the market of short-term promissory
notes with assets age up to 12 months. The second one refers to the market of
long-term promissory notes with instruments age surpasses 12 months. This
classification can be referred to the bond market only as its instruments have fixed expiry date,
while the stock market’s not.
Now we are turning to the stock market.
As it was mentioned before, ordinary shares’ purchasers
typically invest their funds into the company-issuer and become its owners.
Their weight in the process of making decisions in the company depends on the
number of shares he/she possesses. Due to the financial experience of the
company, its part in the market and future potential shares can be divided into
several groups.
1. Blue Chips
Shares of large companies with a long record of profit
growth, annual return over $4 billion, large capitalization and constancy in
paying-off dividends are referred to as blue chips.
2. Growth Stocks
Shares of such company grow faster; its managers typically
pursue the policy of reinvestment of revenue into further development and
modernization of the company. These companies rarely pay dividends and in case
they do the dividends are minimal as compared with other companies.
3. Income Stocks
Income stocks are the stocks of companies with high and
stable earnings that pay high dividends to the shareholders. The shares of such
companies usually use mutual funds in the plans for middle-aged and elderly
people.
4. Defensive Stocks
These are the stocks whose prices stay stable when the
market declines, do well during recessions and are able to minimize risks. They
perform perfect when the market turns sour and are in requisition during
economic boom.
These categories are widely spread in mutual funds, thus for
better understanding investment process it is useful to keep in mind this
division.
Shares can be issued both within the country and abroad. In case a
company wants to issue its shares abroad it can use American Depositary
Receipts (ADRs). ADRs are
usually issued by the American banks and point at shareholders’ right to
possess the shares of a foreign company under the asset management of a bank.
Each ADR signals of one or more shares possession.
When operating with shares, aside of purchase/sale ratio profits, you can
also quarterly receive dividends. They depend on: type of share, financial
state of the company, shares category etc.
Ordinary shares do not guarantee paying-off dividends. Dividends of a company depend on its
profitability and spare cash. Dividends differ from each other as they are to
be paid in a different period of time, with the possibility of being higher as
well as lower. There are periods when companies do not pay dividends at all,
mostly when a company is in a financial distress or in case executives decide
to reinvest income into the development of the business. While calculating
acceptable share price, dividends are the key factor.
Price of ordinary share is determined by three main factors:
annual dividends rate, dividends growth rate and discount rate. The latter is
also called a required income rate. The company with the high risks level is
expected to have high required income rate. The higher cash flow the higher
share prices and versus. This interdependence determines assets value. Below we
will touch upon the division of share prices estimating in three possible cases
with regard to dividends.
While purchasing shares, aside of risks and dividends
analysis, it is absolutely important to examine company carefully as for its
profit/loss accounting, balance, cash flows, distribution of profits between
its shareholders, managers’ and executives’ wages etc. Only when you are sure
of all the ins and outs of a company, you can easily buy or sell shares. If you
are not confident of the information, it is more advisable not to hold shares
for a long time (especially before financial accounting published).
Dr. Goldfinger
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Happy Investing & Trading… |