The Basic Terms of Stock Market
Many people might say it's good to know about the history of Stocks, Stock Exchange. But personally I don't think you have to, but still if you want to, then you can go through Wikipedia, there are lots of stuffs you can find about history and modern stocks and stock exchanges. In this tutorial I will try to keep everything very simple and try to avoid any complicated definitions so anyone can understand, specially those who are not from commerce or finance background. However before you start reading further I would suggest you to go through Few questions you need to ask yourself before your first step in stock market if you already haven't.
What is Stock or Share?
If you go by definition the word “Share”, then it speaks for itself. In a straight and simple word stock or share means ownership or part of ownership of a company.
How many types of stocks or share are available?
Generally there are two types of shares Common Share and another Preferred or Preference Share.
What is Common or Equity Share?
Equity shares are the most common shares traded in any stock exchange, they are also called common shares. Every company has equity shares except sole owner and partnership farms. Equity shares are distributed between the owners of the company or who purchases those shares. Since equity shares are being traded in stock markets, the chances of price fluctuation are higher. Equity shareholders enjoy right to vote for taking decision about merger, acquisition etc in it's meetings. A company may choose not to pay dividends to equity shareholder every year. Equity shareholders also do not get fixed rate of dividend. Equity shares traded between individuals in a stock market and cannot be sold back to the company, unless the company offers buy back. In one word we can say that equity shares are less secured. An individual can buy and sell equity shares as per their will, there is no time limit or any other condition.
What is Preference Share?
Preference shares are issued by a public company to obtain fund from the banks and investment agencies. Only public companies can issue this type of shares under certain circumstances and government regulation. These shares do not get distributed or traded in stock markets, thus the chances of share price fluctuations are low. Preference shareholders do not get voting right. Shareholders get fixed rate on dividend, as per pre-determined terms. Before distribution among common shareholders, dividends are being distributed between preferred shareholders. If the company gets dissolved, all company premises, machinery and other assets are sold to set off any debt. The money distributed among preferred shareholders first, then rest distributed between equity shareholders. After a certain period of time a preference shareholder can sell his shares back to the company. Preference shareholders cannot sell their shares to any other individuals. In a word preference shares are more secure.
What is Bankruptcy or Insolvency?
When a company faces terrible loss and finds out there is no way to repay debt to its debtors, at that point of time company files for bankruptcy or insolvency in the court of law. The court will review, and declare the company insolvent or bankrupt. The court also assess company assets and set repayment limits. If the company does not have sufficient money, company property will be sold in auction to repay the debt. For an example ABC company has debt of $1000. After assessment the court decides that the company would be liable to pay only $500, in that case the debtors or stock holders cannot claim more than $500 in total. If the company cannot repay the amount then the court can put company assets for auction to repay the debtors.
What type of companies have share or stock?
Every company has shares except ownership companies, ran by a single owner and partnership farms. Except ownership and partnership farms every private limited, limited or privately or publicly held incorporated company has shares.
How many type of Companies are there?
Basically there are four types of companies. Ownership Company which run by single owner, Partnership farm which run by two or more partners, Private Limited or Private company and Limited or Incorporate or public company.
What is Private or Private Limited Company?
A privately held or private limited company has more than one owner or shareholder(not to be confused with partnership company). And a private business can not issue preference shares or it can not collect money from market by issuing equity shares. All shares of the company held privately by the owners. Shares of a private company do not get traded in stock market. Hence the company does not have to declare its classified information such as asset value, income etc to the public.
What is Public or Limited or Incorporate Company?
Public companies are registered under public company act. A public company has more than one owners or shareholder. Depending upon requirement under certain circumstances a public company can issue preference and equity shares. Anyone can purchase equity shares of a public company from a stock exchange. Therefore a public company is obligated to declare its classified information such as net asset values, net yearly income to the public time to time.
Why a company issue shares or stocks?
To collect money for achieving further growth or expansion, a public company can issue shares under some circumstances and government regulation.
Is Public or Limited or Incorporate companies governed by the Government?
Yes all public companies are established under public company act and all companies governed or monitored by the specific department of government. Indian public companies are monitored by Securities and Exchange Board of India (SEBI) and it's an organization of government of India, so does U.S. Securities and Exchange Commission(SEC) is part of US government.
Can a public company can issue only shares?
No, a public company can issue many things such as Shares, Debentures, Dividend, Bonds, IPOs, Mutual Fund and many other things.
What is dividend?
In simple word, a part of company's profit is dividend. For an example Abc.Inc has made $10000 profit, the board of directors decide to share only $1000 as dividend. If the company has sold 100 shares, each share would receive a dividend of $10.
What is Bond?
If you are an Indian then you'll get it in a single word and that is “Fixed Deposit”. Do not worry if you have not understood then I will explain. Bond is a kind of contract issued by public company where the company will be liable to pay certain amount of interest after a certain period of time. For an example you bought secure bond of Google.Inc for $100. In its terms it is mentioned that for 5 years Google will pay you 10% interest per year. That means Google has to pay $150 after that given time, no matter the company makes profit or not during this 5 years. This time being called maturity. So it is a term contract and it is secured and does not depend on market risk. There are insecure bonds as well, however I will discuss about them in later tutorials.
What is Debenture?
Debentures issued by public companies for longer time duration. Debenture is much likely Bonds except the security part. Usually debenture is not secured. In many countries debenture is same as bonds and it's secured depending upon terms.
What is IPO?
The full form of IPO is Initial public offering. When a private company goes public, the company issues IPOs before shares. It is much loan for a longer period of time. In the IPO brochure you can find, how the has company planned everything carefully to repay investor’s money, When the company makes profit it awards you by interest. But it is not secured and it has market risk.
These were the basics of Bonds, Debenture, IPOs and stocks. I did not go in detailed information as it might confuse newbies. If you like to me to explain anything in details feel free to leave comments, and I will write a detailed tutorial later.
Further reading for basics Basic Terms of Investment and Trading, Basic FAQs for the beginners in stock markets, Few preliminary basic terms of Trading and Basic homework for beginners for stock market. Then you need to acquire advance knowledge in How to read Candlestick Chart without any complication, How to calculate support and resistance level, How to read financial report or Balance-sheet, When Why and How stock price changes, and Few things need to care about while trading.