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Article #5: What are stocks

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In financial terminology, stock is the exchanges for the same reason. Although
capital raised by a corporation, through it makes sense for some companies to
the issuance and distribution of shares. raise capital by offering stock on more
A shareholder is any person or than one exchange, in today's era of
organization which holds shares, or electronic trading, there is little
fractions of shares, of a corporation's opportunity for private investors to make
stock. The aggregate value of a profit on pricing discrepancies between
corporation's issued shares is its market one stock exchange and another. As such,
capitalization. arbitrage opportunities disappear almost
In the United Kingdom, the word stock has immediately due to the efficient nature
a completely different meaning in of the market.
finance, referring to a bond. It can also Buying There are various methods of
be used more widely to refer to all kinds buying and financing stocks. The most
of marketable securities. common means is through a stock broker.
However, the usage of "share" (as in the Whether they are a full service or
stock issued by a corporation) is the discount broker, they are all doing one
same. thing—arranging the transfer of stock
The owners of a company may want from a seller to a buyer. Most of the
additional capital to invest in new trades are actually done through brokers
projects within the company. They may listed with a stock exchange such as the
also simply wish to reduce their holding, New York Stock Exchange.
freeing up capital for their own private There are many different stock brokers
use. from which to choose such as full service
By selling shares they can sell part or brokers or discount brokers. The full
all of the company to many part-owners. service brokers usually charge more per
The purchase of one share entitles the trade, but give investment advice or more
owner of that share to literally share in personal service; the discount brokers
the ownership of the company a fraction offer little or no investment advice but
of the decision-making power, and charge less for trades. Another type of
potentially a fraction of the profits, broker would be a bank or credit union
which the company may issue as dividends. that may have a deal set up with either a
In the common case of a publicly traded full service or discount broker.
corporation, where there may be thousands There are other ways of buying stock
of shareholders, it is impractical to besides through a broker. One way is
have all of them making the daily directly from the company itself. If at
decisions required to run a company. least one share is owned, most companies
Thus, the shareholders will use their will allow the purchase of shares
shares as votes in the election of directly from the company through their
members of the board of directors of the investor's relations departments.
company. However, the initial share of stock in
In a typical case, each share constitutes the company will have to be obtained
one vote (except in a co-operative through a regular stock broker. Another
society where every member gets one vote way to buy stock in companies is through
regardless of the number of shares he Direct Public Offerings which are usually
holds). Corporations may, however, issue sold by the company itself. A direct
different classes of shares, which may public offering is an initial public
have different voting rights. Owning the offering in which the stock is purchased
majority of the shares allows other directly from the company, usually
shareholders to be out-voted - effective without the aid of brokers.
control rests with the majority When it comes to financing a purchase of
shareholder (or shareholders acting in stocks there are two ways: purchasing
concert). In this way the original owners stock with money that is currently in the
of the company often still have control buyers ownership or by buying stock on
of the company. margin. Buying stock on margin means
Shareholder rights Although owning 51% of buying stock with money borrowed against
shares does mean that you own 51% of the the stocks in the same account. These
company, it does not give you the right stocks, or collateral, guarantee that the
to use a company's building, equipment, buyer can repay the loan; otherwise, the
materials, or other property. This is stockbroker has the right to sell the
because the company is considered a legal stocks (collateral) to repay the borrowed
person, thus it owns all its assets money. He can sell if the share price
itself. This is important in areas such drops below the margin requirement, at
as insurance, which must be in the name least 50 percent of the value of the
of the company and not the main stocks in the account.
shareholder. Buying on margin works the same way as
In most countries, including the United borrowing money to buy a car or a house
States, boards of directors and company using the car or house as collateral.
managers have a fiduciary responsibility Moreover, borrowing is not free; the
to run the company in the interests of broker usually charges 8-10 percent
its stockholders. interes Selling Selling stock is
Nonetheless, as Martin Whitman writes: procedurally similar to buying stock.
"...it can safely be stated that there Generally, the investor wants to buy low
does not exist any publicly traded and sell high, if not in that order
company where management works (short selling); although a number of
exclusively in the best interests of OPMI reasons may induce an investor to sell at
[Outside Passive Minority Investor] a loss.
stockholders. Instead, there are both As with buying a stock, there is a
"communities of interest" and "conflicts transaction fee for the broker's efforts
of interest" between stockholders in arranging the transfer of stock from a
(principal) and management (agent). This seller to a buyer. This fee can be high
conflict is referred to as the principal or low depending on which type of
agent problem. It would be naive to think brokerage, discount or full service,
that any management would forego handles the transaction.
management compensation, and management After the transaction has been made, the
entrenchment, just because some of these seller is then entitled to all of the
management privileges might be perceived money. An important part of selling is
as giving rise to a conflict of interest keeping track of the earnings.
with OPMIs." [Whitman, 2004, 5] Even Importantly, on selling the stock, in
though the board of directors runs the jurisdictions that have them, capital
company, the shareholder has some impact gains taxes will have to be paid on the
on the company's policy, as the additional proceeds, if any, that are in
shareholders elect the board of excess of the cost basis.
directors. Each shareholder typically has Stock Price Fluctuation The price of a
a percentage of votes equal to the stock fluctuates fundamentally due to the
percentage of shares he or she owns. So law of Supply and demand. Like all
as long as the shareholders agree that commodities in the Market, the price of a
the management (agent) are performing stock is directly proportional to the
poorly they can elect a new board of demand. However, there are many factors
directors which can then hire a new on basis of which the demand for a
management team. In practice, however, particular stock may increase or
genuinely contested board elections are decrease. These factors are studied using
rare. Board candidates are usually methods of Fundamental analysis and
nominated by insiders or by the board of Technical analysis to predict the changes
the directors themselves, and a in the stock price.
considerable amount of stock is held and Technology's influence on trading Stock
voted by insiders. trading has evolved tremendously.
Owning shares does not mean Since the very first Initial Public
responsibility for liabilities. If a Offering (IPO) in the 13th
company goes broke and has to default on century,[citation needed] owning shares
loans, the shareholders are not liable in of a company has been a very attractive
any way. However, all money obtained by incentive. Even though the origins of
converting assets into cash will be used stock trading go back to the 13th
to repay loans and other debts first, so century, the market as we know it today
that shareholders cannot receive any did not catch on strongly until the late
money unless and until creditors have 1800s.
been paid (most often the shareholders Co-production between technology and
end up with nothing). society has led the push for effective
Means of financing Financing a company and efficient ways of trading.
through the sale of stock in a company is Technology has allowed the stock market
known as equity financing. Alternatively, to grow tremendously, and all the while
debt financing (for example issuing society has encouraged the growth.
Bonds) can be done to avoid giving up Within seconds of an order for a stock,
shares of ownership of the company. the transaction can now take place. Most
Unofficial financing known as trade of the recent advancements with the
financing usually provides the major part trading have been due to the Internet.
of a company's working capital The Internet has allowed online trading.
(day-to-day operational needs). Trade In contrast to the past where only those
financing is provided by vendors and who could afford the expensive stock
suppliers who sell their products to the brokers, anyone who wishes to be active
company at short-term, unsecured credit in the stock market can now do so at a
terms, usually 30 days. very low cost per transaction.
Equity and debt financing are usually Trading can even be done through
used for longer-term investment projects Computer-Mediated Communication (CMC) use
such as investments in a new factory or a of mobile devices such as handheld
new foreign market. Customer provided computers and cellular phones. These
financing exists when a customer pays for advances in technology have made day
services before they are delivered, e.g. trading possible.
subscriptions and insurance. The stock market has grown so that some
Trading A stock exchange is an argue that it represents a country's
organization that provides a marketplace economy. This growth has been enjoyed
(either physical or virtual) for trading largely to the credibility and reputation
shares, where investors (represented by that the stock market has earned.
stock brokers) may buy and sell shares in Types of shares There are several types
a wide range of companies. A given of shares, including common stock,
company will usually list its shares in preferred stock, treasury stock, and dual
only one exchange by meeting and class shares.
maintaining the listing requirements of Preferred stock, sometimes called
that particular stock exchange. In the preference shares, have priority over
United States, through the inter-market common stock in the distribution of
quotation system, stocks listed on one dividends and assets, and sometime have
exchange can also be bought or sold on enhanced voting rights such as the
several other exchanges, including ability to veto mergers or acquisitions
relatively new internet-only exchanges. or the right of first refusal when new
Stocks are broadly grouped into shares are issued (i.e. the holder of the
NYSE-listed and NASDAQ-listed stocks and preferred stock can buy as much as they
exchanges where NYSE-listed stocks may be want before the stock is offered to
bought are generally not the same group others). A multiple class equity
as the exchanges where NASDAQ-listed structure has several classes of shares
stocks may be bought. Many large foreign (for example Class A, Class B, and Class
companies choose to list on a U.S. C) each with its own advantages and
exchange as well as an exchange in their disadvantages. Treasury stock is shares
home country in order to broaden their that have been bought back from the
investor base. These shares are called public. Treasury Stock is considered
American Depository Receipts (ADRs). issued but not outstanding.
Large U.S. companies also list in foreign






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