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Basics of Stock Market
by John Goldfinger
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.
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).
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