Share Market, Main components and Functions of the Stock Market.
What is the Share Market?
The share market is a place where the shares or stocks of companies are bought and sold. It is a financial market where by purchasing shares, investors gain partial ownership of the company. The stock market is also known as a stock exchange.
The main purpose of the stock market is to provide an opportunity to companies to raise capital and give fair chance to the investors to earn profits from their investments. It is a liquid market, where investors can easily buy and sell their shares and get their money.
The stock market has two main components:
Primary Market: It is the market where companies issue shares for the first time through Initial Public Offerings (IPOs) and allows businesses to raise capital for growth and operations. Or we can say that The primary market in the share market is the market where new securities (such as stocks or bonds) are issued for the first time.
Main Characteristics of the Primary Market:
- New Issuances: In the primary market, companies issue fresh shares to the public or institutional investors.
- Raising
Capital: The main purpose of the primary market is to provide a platform to the companies to raise
capital. This capital is used by the company for business expansion, paying off debts, investing in new projects, or
funding research and development.
- Investment Opportunity: Investors purchase shares directly from the issuing company in the primary market . In an IPO, they buy shares at a fixed price determined by the company.
- Pricing
of Securities: The price of the new securities is generally set by the
company in consultation with investment bankers or underwriters and it is based on factors like the company’s financial health, market
demand, and overall market conditions.
- Once-Only Offering: The securities offered in the primary market are available for purchase only during the offering period. Once the securities are sold, they are no longer available in the primary market and are traded in the secondary market.
Types of Transactions in the Primary Market:
- Initial
Public Offering (IPO): When a private company wants to raise the funds, it
issues new shares in the form of an IPO. This is the most common form of
fundraising in the primary market. After the IPO, the shares are listed on
a stock exchange and can be bought and sold in the secondary market.
- Rights
Issue: When a company issues new shares to existing shareholders in
proportion to their holdings, it is known as a rights issue. This is
usually done to raise additional capital without involving new investors.
- Private Placement: In a private placement, a company offers its shares or bonds to a select group of investors, usually institutional investors or a few high-net-worth individuals, rather than the general public.
Importance of the Primary Market:
- Capital
Formation: It plays an important role in the economic development by helping companies and businesses to raise capital for company's essential growth, innovation, and
job creation.
- Opportunities
for Investors: Investors get the opportunity to invest in new businesses at an early stage, which can lead to good returns if the company performs well.
Thus, this market is pivotal for both the company's growth as well as providing investment opportunities to the public.
What is an IPO in the Share Market?
An Initial Public Offering (IPO) is the process by which a private company offers its shares to the public for the first time. For investors, an IPO is the first chance to purchase shares of the company. When the IPO are listed on a stock exchange, it becomes available for trading in the open market.
Key Aspects of an IPO:
- Raising
Capital: A company decides to launch an IPO to
raise capital. The funds generated from the sale of shares in the IPO are
typically used for business expansion, paying off debts, or investing in
new projects.
- Ownership Stake: The company allows outside investors to become partial owners by offering shares to the public. It simply means that the ownership of the company is divided into shares, and the investors can buy and sell these shares on the stock exchange.
Why Do Companies Go Public?
- Raise Capital: When companies need funds to grow, they often turn to public offerings, such as an Initial Public Offering (IPO). The funds raised can be used to expand into new markets, develop innovative products, or increase production capacity. If a company has existing loans or financial liabilities, the funds raised through an IPO can be used to reduce or eliminate debt.
- Enhance Credibility: Public companies often gain more visibility and trust among customers and investors. Being publicly listed signals stability, transparency, and long-term viability to customers, investors, and stakeholders. Regular audits and disclosures required for public companies improve investor confidence, which can lead to easier access to additional funding in the future.
- Liquidity for Shareholders: An IPO provides an opportunity for early investors to sell some of their shares to realize profits. Once shares are listed, they can be freely traded on the stock exchange, giving shareholders the option to sell their shares whenever they choose.
- Attract and Retain Talent: Public companies can offer stock options to attract skilled workers. Stock options or equity compensation as part of the employee benefits package aligns employees’ interests with the company’s performance and motivates them to work towards its success. Stock options are often vested over a period, encouraging employees to stay with the company longer.
Process of an IPO:
1- Pre-IPO Planning: The company and its financial advisors prepare for the IPO, which includes evaluating the company's financial health, setting an appropriate share price, and preparing all required documentation.
2-Filing and Approval: The company submits a prospectus (detailed document outlining business, risks, and financials) and regulatory authorities [such as the Securities and Exchange Commission (SEC) in the U.S. or the SEBI (Securities and Exchange Board of India) in India] review it and approve the offering.
3-Pricing: Underwriters determine the offer price (price per share) and the number of shares to be issued. Pricing is based on the company’s valuation and expected investor demand.
4-Marketing: The company and underwriters put up the IPO to institutional investors to generate interest.
5-Listing: Once shares IPO is launched, the shares are made available to the public. Investors can purchase shares during the offering, and the company raises the capital.
6-Trading Begins: After the IPO, the shares are listed on a stock exchange, and they begin trading in the secondary market, where their price fluctuates based on demand and supply.
Key Terms Related to IPOs
- Underwriter: Investment banks or financial institutions that manage the IPO process, including pricing and selling shares.
- Prospectus: A formal document detailing the company's business, financials, and risks, given to potential investors.
- Offer Price: The price at which shares are sold to investors during the IPO.
- Lock-Up Period: A period (typically 90–180 days) during which insiders and early investors cannot sell their shares after the IPO.
- Oversubscription: When demand for shares exceeds the supply, indicating high investor interest.
Benefits of an IPO:
- Access
to Capital: The company can raise large amounts of funds for company's growth
or reducing debt.
- Increased
Public Profile: Being listed on a stock exchange increases the company’s
visibility, which can help it attract customers, employees, and business
partners.
- Liquidity for Shareholders: Shareholders, including the company’s founders and early investors, can sell their shares, to realize their investment gains.
Opportunities and Risks for Investors:
Opportunities:
- Potential for High Returns: IPOs of promising companies can lead to significant gains. IPOs often offer shares at an attractive price to encourage participation from institutional and retail investors. If the company's market valuation increases after listing, early investors can sell their shares at a good profit.
- Early Access: An IPO provides an opportunity to invest in a company at its earliest public stage, before it potentially grows larger and more valuable. Investing early can be advantageous for long-term investors if the company’s vision and business model is good. If the company grows consistently, its share price may rise significantly over time.
Risks:
- Volatility: Newly listed stocks can experience significant price swings. Since the stock is new to the market, there’s no historical trading pattern to guide investors, which makes the price more susceptible to fluctuations.
- Uncertainty: Limited historical financial data makes it harder to evaluate the company. Investors primarily depend on the company’s IPO prospectus, which may not always provide a complete picture of the company’s challenges or risks.
- Overvaluation: Companies often promote their IPOs heavily to attract investors, creating a buzz that can inflate demand and drive up the initial offer price.
Thus, an IPO plays a significant role for a company to raise funds for company's growth. For investors,
IPOs offer an opportunity to invest in a company at an early stage, although it also comes with risks and uncertainties.
Secondary Market: In this market, already-issued shares are traded among investors.
In the secondary market, the ownership of securities is
transferred between investors, and the company, that issued the securities, does
not receive any proceeds from these transactions.
Key Characteristics of the Secondary Market:
- Trading of Existing Securities: The secondary market is where investors trade securities that were initially issued in the primary market. These are existing shares, and they are bought and sold among investors without involving the issuing company.
- Liquidity: It provides liquidity to investors. In this market, investors can easily buy or sell securities, and convert their investments into cash quickly if needed.
- Price Determination: In the secondary market, the prices of securities are determined by supply and demand. If more investors want to buy a stock, then price of the share will increase. Conversely, if more investors want to sell a stock, the price will fall.
- Stock Exchanges: The secondary market operates through stock exchanges (like the New York Stock Exchange (NYSE), Nasdaq, National Stock Exchange (NSE), and Bombay Stock Exchange (BSE)). These exchanges act as platforms where buyers and sellers come together to trade securities.
- No Capital Raised for the Company: Unlike the primary market, where the issuing company raises capital by selling shares, the company does not receive any capital from transactions in the secondary market. Here, the transactions are among investors.
Types of Secondary Market Transactions:
- Public
Exchanges: These are formal markets like the NSE [National Stock Exchange], BSE [Bombay Stock Exchange], or NYSE [New York Stock Exchange ] where
investors buy and sell shares of listed companies. Trades are regulated by
authorities to ensure fairness and transparency.
- Over-the-Counter
(OTC) Market: This refers to securities traded outside of formal
exchanges, typically through a network of dealers. OTC transactions are
less regulated and occur directly between parties.
Importance of the Secondary Market:
The secondary market plays a major role in the financial systems by offering benefits to both investors and companies. it is given as belows:
1. Provides Liquidity: The secondary market allows investors to buy and sell securities quickly and easily, and convert them into cash whenever needed.
2. Enables Price Discovery: prices of the shares in the secondary market are determined by the forces of supply and demand, hence, it helps to reflect the true value of a company based on its performance, growth potential, and market sentiment.
3. Capital Flow: the secondary market keeps capital circulating in the economy. Investors can reinvest proceeds from selling shares into other company's shares, fostering economic growth.
4. Provides Investment Opportunities: The secondary market gives a big opportunity for investment in options, stocks, bonds, mutual funds and derivatives. Investors can easily diversify their portfolios to manage risk and maximize returns.
5. Enhances Corporate Governance: Companies listed on stock exchanges are subject to regulatory oversight and transparency requirements. This helps to improve accountability and ensures that management decisions align with shareholders’ interests.
6. Encourages Savings and Investment: The secondary market provides a platform for individuals to grow their wealth over time, encouraging savings and long-term investment. It helps the same opportunity to the big institutions to invest and grow their money.
7. Supports Economic Growth: A strong secondary market builds trust in the financial system, attracting investors from both home and abroad and helps companies by ensuring a steady pool of investors and stable share prices.
8. Risk Management: Investors can use the secondary market to reduce risks through tools like futures and options. These help them manage market ups and downs and safeguard their investments.
Thus, the secondary market is essential for the efficient functioning of the financial system. It plays an important role in driving economic growth and nurturing investor confidence by providing liquidity, and offering investment opportunities,
Difference between the primary market and the secondary market in the share market:
| Aspect | Primary Market | Secondary Market |
|---|---|---|
| Definition | Primary market is the market where companies issue shares for the first time (IPO). | Secondary market is the market where existing shares are traded among investors. |
| Purpose | It helps companies to raise capital directly from investors. | It provides liquidity and trading opportunities for investors. |
| Participants | Company and investors (direct transaction). | Investors trading with each other. |
| Nature of Securities | New securities are issued. | Existing securities are bought and sold. |
| Price Determination | Price is set by the company during issuance ( IPO price). | Price is determined by market forces of supply and demand. |
| Intermediaries | Investment banks, underwriters, etc., involved in issuing. | Brokers, dealers, and trading platforms like stock exchanges. |
| Ownership | Investors gain direct ownership in the company for the first time. | Ownership is transferred between investors. |
| Example | Buying shares during an IPO. | Buying or selling shares on the NSE or BSE. |
The primary market helps companies to raise funds for the first time, while the secondary market ensures liquidity and allows investors to trade freely. Both play an important roles in the financial economic system.
Main Functions of the Stock Market:
1. Helps Businesses to Raise Fund: Share market gives the platform to Companies to raise funds by selling shares to the public. This money is used for business growth and new projects.
2. Provides Investment Opportunities: It gives the fair chance to People and organizations also to invest in shares and other securities to grow their money over time. Investors can earn profits through price increases or dividends.
3. Ensures Liquidity: It provides liquidity to investors. The stock market makes it easy to buy and sell shares, allowing investors to quickly turn their investments into cash.
4. Determines Share Prices: Share prices are set based on supply and demand. These prices reflect how well a company is doing and the market’s expectations.
5. Shows Economic Health: The stock market acts as an indicator of the economy. When the stock prices rise, it usually means that the economy is growing, while falling prices may show the obstacles in economic growth.
6. Encourages Saving and Investing : The stock market gives people a way to grow their savings by investing in businesses. It helps them plan for their financial future.
7. Promotes Transparency in Companies: Companies listed on the stock market must share their financial information. This keeps them accountable and ensures they follow good practices.
8. Manages Risk: The stock market offers tools like futures and options which help investors to protect their money from big market changes.
9. Spreads Wealth: Investors, both big and small, can get benefits from profits and dividends, spreading wealth across many people.
Thus, the stock market supports businesses by helping them to raise money and provides people with opportunities to invest and grow their wealth. It’s a key part of a healthy economy.
The share market which is also known as stock market works as a platform where where securities like stocks, bonds, and other financial instruments are bought and sold. It is a key component of the financial system and makes the movement of capital smooth between investors and companies.
Here’s a simple explanation of how it operates:
1. Companies Issue Shares in the Primary Market: Companies that need money for growth or expansion of their company, can sell ownership stakes (shares) to the public through the primary market. This process is called an Initial Public Offering (IPO), and it allows the company to raise capital directly from investors.
2. Shares are Traded in the Secondary Market: After the IPO, these shares are listed on stock exchanges (like NSE, BSE, or NYSE). After then, investors can buy and sell these shares in the secondary market. These types of trading happen between investors, not the company.
3. Role of Stock Exchanges: Stock exchange provides a centralized platform for trading and ensures fair pricing, transparency, and smooth transactions.
- Limit Order: In this type of order, an investor specifies a price at which they want to buy or sell a stock. The order is only executed if the stock reaches that price.
- Stop
Order (Stop-Loss): This is used to limit losses by selling a stock when it
reaches a certain price.
5. Price Determination: Share prices fluctuate based on supply and demand of the stocks. Company performance (profits, growth prospects) , economic conditions (inflation, interest rates) and investor sentiments (confidence or fear in the market) are the main factors to effect demand and supply of the share and price of it.
6. . Role of Investors: There are two types of investors:
- Long-Term Investors: These investors buy shares to hold them for a long period. They aim for long-term growth through capital appreciation by increase in share price and dividends.
- Short-Term Traders: Traders aim to profit from short-term fluctuations in stock prices. They buy and sell shares frequently, sometimes within the same day (intraday trading), or few days.
7. How Investors Make Money: Investors make money by capital gains through getting profit from selling shares at a higher price than the purchase price and by getting dividends.[Some companies share a portion of their profits with shareholders that is called dividend]
8. Market Indices: Stock market indices, such as the Sensex and Nifty in India or the Dow Jones Industrial Average in the U.S., track the performance of a selected group of stocks. These indices give an overall sense of how the stock market is performing.
- Bull
Market: When the stock market is rising, and investors are confident about
the future, it's called a bull market.
- Bear
Market: When the market is falling, and investors are pessimistic about
the future, it’s called a bear market.
9. Stock Market Regulation: The stock market is regulated by authorities like the Securities and Exchange Board of India (SEBI) or the Securities and Exchange Commission (SEC) in the U.S. These regulatory bodies ensure that the market operates transparently, fairly, and securely.
10. How Companies Get Benefits: Companies can raise money by issuing shares in the primary market (IPO). This money can be used for expansion, reducing debt, or other corporate activities. Listing shares on a stock exchange increases a company's visibility and provides access to a wider group of investors.
11. Risk and Reward: Investing in the stock market has the risks also. Share prices can fluctuate and may drop, causing losses for investors. Therefore, it is important for investors to understand their risk tolerance and invest carefully.
In conclusion, the stock market is an important financial
tool that offers opportunities for both companies and investors. With the right
knowledge and understanding, investing in the stock market can be profitable.
Difference between Trading and Investment
Both trading and investing differ significantly in terms of objectives, time horizons, strategies, and risks. Key differences are given below:
1. Time Horizon:
- Definition of Trading: Trading is the act of buying and selling financial instruments like stocks, bonds, commodities, or currencies with the goal of making short-term profits from market price fluctuations. It is generally done for the short-term. Traders look to profit from
short-term price fluctuations in stocks, commodities, or other financial
instruments. They might hold positions for minutes, hours, days, or few weeks.
- Example:
A day trader buys a stock in the morning and sells it by the end of the
day to make a profit from daily price movements.
- Definition of Investment: Investment is the process of allocating money into financial instruments like stocks, mutual funds, real estate, or bonds for long-term growth or income generation. It focuses on the long-term. Investors buy assets
(stocks, bonds, real estate, etc.) with the intention of holding them for
several months, or years to get benefits from
capital appreciation and dividends over time.
- Example:
An investor buys shares in a company, holding them for several years,
expecting the company’s growth and earnings to increase the stock's
value.
2. Objectives:
- Trading aims to make profits from short-term price movements. Traders seeks the opportunity for high volatility and purchase the shares in low price and sell in high. In case of short-selling, they sell high and buy low and get profits.
- Investors wants to build wealth gradually over the long term through capital appreciation, dividends, or interest payments. This is the reason that Investors seek stable growth and income rather than short-term gains.
3. Risk Level:
- Trading involves higher risk due to the volatility of short-term market movements. Traders may experience continuous losses if the market moves against them. They rely on technical analysis and market trends to predict price movements, which can be unpredictable.
- Investing generally involves lower risk because the focus is on holding assets over the long period of time. Investors often buy stocks or bonds from companies or institutions that have a history of stable performance and rapid growth. However, market downturns can affect the value of investments, but not as much as in trading.
4. Strategies:
- Traders rely on technical analysis to make decisions. They use charts, patterns, and indicators to predict the price movement of assets.
- Investors usually buy assets that will grow over time based on strong fundamentals and long-term trends and for this, they use fundamental analysis, focusing on the financial health, earnings growth, dividends, and overall potential of a company or asset.
5. Frequency of Transactions:
- Traders make frequent transactions, buying and selling assets multiple times within a short period (e.g., daily, weekly, monthly).
- Investors make fewer transactions, usually buying assets and holding them for a long period. They make occasional adjustments to their portfolio based on the changing market conditions or life goals. That's why frequency of transaction is very low, in the investment.
6. Capital Allocation:
- Traders often use margin (borrowed funds) to increase their buying power, which can turn up both profits and losses. They often uses leverage (borrowed money).
- Investors mostly use their own capital and do not rely on leverage to the same extent. They focus on building a diversified portfolio for steady long-term growth.
7. Tax Implications:
- In Trading, short-term capital gains (from trading) are taxed at higher rates than long-term gains, so frequent trading can lead to higher tax liabilities.
- Investments get benefits from lower tax rates on long-term capital gains. Investors hold their assets for years and get benefit from a more favorable tax treatment.
8. Market Knowledge:
- Trading needs a trader with a high level of expertise in market timing, technical analysis, and quick decision-making. Traders must aware the market trends, news, and market-moving events to take advantage of short-term opportunities.
- Investors need to understand company fundamentals and economic conditions. They should have strong knowledge of the company, economy, and market fundamentals. They generally take a more patient, long-term approach, focusing on companies or assets that will grow over time.
9. Emotional Involvement:
- Trading can be emotionally intense, as it requires making fast decisions and reacting to quick market fluctuations. That's why emotional Impact is high in trading, due to frequent fluctuations.
- Investing generally involves less emotional stress since investors are focused on long-term gains. However, they may face emotional challenges during market downturns or economic crises.
- Thus, trading focuses on short-term profit from market fluctuations and involves frequent buying and selling, using technical analysis, and typically higher risk while Investing focuses on long-term growth, with a focus on the fundamentals of companies, a lower frequency of transactions, and lower risk over time. Both have their advantages and risks, and the choice between trading and investing depends on individual goals, risk tolerance, time commitment, and market knowledge.
In summary, the share market works as a platform for
buying and selling shares of companies. Investors trade these shares to earn profits through dividends and price
appreciation. The market provides
liquidity, allows businesses to raise capital, and offers investors
opportunities to profit, but it also comes with risks. Through stock exchanges, the market operates transparently, under the regulation of
government authorities, ensuring fair trading practices.
Dr. Swati Gupta
Comments
Post a Comment