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

http://www.financegaes.com

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