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Introduction to Stock Market and its Participants

A basic understanding of equities and how stocks began trading on the exchanges.

Gopal Kavalireddi
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Through centuries, India has, and continues to be a hotbed of entrepreneurial spirit, with many economically viable ideas experiencing tremendous business success across diversified fields, supporting the trade and industrial activity of India. These businesses need to grow continuously and to fuel that growth, the initial investors of that company need money, also referred to as capital. Normally, capital can be raised as either debt or equity or a mix of both. Markets which support the raising of such forms of capital are called Capital Markets.

Debt as a capital is raised from banks or financial institutions, either as loan or line of credit, at a mutually agreed interest rate, payable over a period of time. The debt is raised either as short term capital or long term capital to support either the working capital requirements or to expand the business through organic/inorganic growth. Irrespective of the business growth, the company has a committed responsibility to repay the principal along with interest.

Equity as a capital is raised by offering portions of the company, in the form of shares to other interested buyers of that business. While the initial investors (also called promoters) offer these shares to other investors highlighting the future prospects of the company, there is no obligation for the promoters to return the capital to the new buyers, incase the business doesn’t perform well. Returns are expected in the form of increase in the share price (capital gains) and dividends, if any, declared by the company.

Stock market is the term used for the buying and selling of the shares of many such companies and the platform that provides these transactional processes is called the Stock Exchange. In India, there are two main stock exchanges: The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), both based out of Mumbai.

BSE, the oldest stock exchange in India as well as in Asia, was established in the late 1800’s but formalized in 1875 (source), to become the largest stock exchange with more than 7000 listed companies. With a current speed of 6 micro seconds (2017), BSE provides an efficient and transparent market for trading in equity, currencies, debt instruments, derivatives, mutual funds. It also has a platform for trading in equities of small-and-medium enterprises (SME). BSE's popular equity index - the S&P BSE SENSEX - is India's most widely tracked stock market benchmark index.

In comparison, NSE (source) is a newly established stock exchange with over 2000 listed companies, and the fourth largest in the world by equity trading volume in 2015, according to World Federation of Exchanges (WFE). It began operations in 1994 and is ranked as the largest stock exchange in India in terms of total and average daily turnover for equity shares every year since 1995.

As is the case with banks and RBI in India, the stock markets do need a regulator to protect the interests of investors and to promote & regulate the development of the securities market. Hence, the Securities and Exchange Board of India (SEBI) was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992 (source). One of the main roles of the SEBI is to continuously monitor the business in the stock exchanges, to prohibit fraudulent and unfair trade practices relating to securities markets.

Till now, we have understood the role of stocks, investors, stock exchanges. But, we need to put the final participant in place – The Stock Broker – who is a member of the stock exchange, and helps complete the transactions between the buyer and seller. A listed dealer/broker has a fiduciary duty to protect the interests of his clients and therefore, cannot engage in transactions or offer financial advice, that provides financial benefits to him. Hence, he provides his services for a fee, which is called the Brokerage.

All of the market participants – companies, brokers and investors - have to be registered with the stock exchange and SEBI to conduct transactions.

 

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Aman commented on April 18th, 2019 at 4:24 PM  
According to you guys what is cheaper for a company to raise capital by equity or debt keeping in mind the risk involved in a business?


Gopal commented on April 18th, 2019 at 5:13 PM  
Cost of equity is always considered more expensive than cost of capital mainly due to the risk involved in securing each type of capital.
Debt capital requires a fixed payment (interest) at periodic intervals (tenure), irrespective of the business performance. Cash flow from operations should be able to address the interest payments. Incase of insolvency or bankruptcy, secured lenders get high preference and will have the first right on the cash from asset liquidation.
Equity capital has no fixed payments, no repayments for the capital raised from shareholders except for expectations of dividends and capital gains coupled with high risk. If a company has excellent business prospects and continues to do well, then the amount of dividends/capital gains could continue to grow steadily, which over a period of time tend be a substantial return on investment. In case the company shuts its operations and declares insolvency then, equity shareholders will the last preferred category and nothing might be left to be paid as their return on investment.


Samika commented on April 22nd, 2019 at 11:54 AM  
Which would you recommend for long-term profits, debt or equity?


Gopal commented on April 24th, 2019 at 8:21 AM  
Long term profits depend on the size of the profit expectations, risk appetite, duration of investments etc. Based on many factors, investments are made.
If comfortable with a 6-7% post tax annualized return, then debt is the best.
If the expectations are for wealth building, then higher risk is essential, which comes from equity only.
If Nifty50 has given a cumulative return of 238% in 10 years, then, in the same time, Nifty IT has given 512%, Nifty Bank has given 493%, PSU Banks have given 66%, while metals have given 49%.
So, selection of the right kind of equity is also essential for wealth building or making large profits.


mohsinkhan commented on May 11th, 2019 at 4:24 AM  
which is best for long time?


tejas commented on May 14th, 2019 at 5:16 PM  
Buy bonds to sleep well,
Buy stocks to eat well.

If you want to get rich, equities are the way to go. If you want to play safe, then debt. Simple stuff.


Ravi kumar commented on December 31st, 2019 at 8:55 AM  
Concise and witty


tejas commented on January 4th, 2020 at 12:15 AM  
We have a wall frame in our office that says that :-)


Ankit Garg commented on May 16th, 2019 at 2:20 PM  
As you mentioned : "Returns are expected in increasing share price". My query is :- If company is making profit, How stock price got increased? Is company allot some profit percentage to stock price, so that stock prices got pumped up.


Gopal commented on May 16th, 2019 at 10:05 PM  
When a company performs well and increases its profit, its Earnings per Share (EPS) increases. As explained in the secondary market terminology, Current Market Price is a function of Price to Earnings (P.E.) ratio and Earnings per Share (EPS) of the Company.
Current Market Price = P.E. X E.P.S. Hence, as EPS increases, with P.E. ratio remaining same, the market price of the stock increases.
EPS on a trailing twelve month (TTM) basis is given across all websites, whereas EPS on a forward earnings basis is estimated based on the expected business performance of the company. Based on that, stock price targets are calculated.


Pratham commented on March 7th, 2020 at 6:42 PM  
Sir I can’t understand this so I felt I’d be the best to approach . (Haven’t started trading yet ) if I swing trade and I happen to hold the shares for more than 2 days and then I happen to sell it do I get the money after two days or at the same time when the transaction takes place ? Thankyou


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