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).



Source by John Goldfinger

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