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Stock market basics


Financial markets provide their participants with 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 participants of market.

Financial market comprises variety of instruments, hence its functioning totally depends on instruments held. Usually it can be classified according to type of financial instruments and according to the terms of instruments’ paying-off.

From point of different types of instruments held market can be divided into one of promissory notes and one of security [stock markets]. The first one contains promissory instruments with right for its owners to get some fixed amount of money in future and is called market of promissory notes, while latter binds issuer to pay certain amount of money according to return received after paying-off all promissory notes and is called share market. There are also types of security referring to both category as, e.g., preference shares and converted bonds. They are also called instruments with fixed return.

Another classification is due to paying-off terms of instruments. These are: market of assets with high liquidity [money markets] and market of capital. The first one refers to market of short-term promissory notes with assets age up to I2 months. The second one refers to market of long-term promissory notes with instruments age surpasses I2 months. This classification can be referred to bond market only as its instruments have fixed expiry date, while share market’s not.

Now we're turning to stock market.

As it was mentioned before, ordinary shares’ purchasers typically invest their funds into company-issuer and become its owners. Their weight in process of making decisions in Comp. depends on No. of shares he/she possesses. Due to financial experience of company, its part in market and future potential shares can be divided into several groups.

I. Blue Chips

Shares of large company with 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 policy of reinvestment of revenue into further development and modernization of the company. These Comp. rarely pay dividends and in case they do the dividends are minimal as compared with other companies.

3. Income Stocks

Income shares are the shares of Comp. with high and stable earnings that pay high dividends to shareholders. The shares of such Comp. usually use mutual funds in plans for middle-aged and elderly people.

4. Defensive Stocks

These are stocks whose prices stay stable when market declines, do well during recessions and are able to minimize risks. They perform perfect when market turns sour and are in requisition during economic boom.

These category are widely spread in mutual funds, thus for better understanding investment process it's useful to keep in mind this division.

Shares can be issued both within country and abroad. In case Comp. wants to issue its shares abroad it can use American Depositary Receipts [ADRss]. ADRs are usually issued by American banks and point at shareholders’ right to possess shares of foreign Comp. under asset management of bank. Each ADR signals of one or more shares possession.

When operating with shares, aside of purchase/sale ratio profits, u can also quarterly receive dividends. They depend on: type of share, financial state of company, shares category etc.

Ordinary shares do not guarantee paying-off dividends. Dividends of company depend on its profitability and spare cash. Dividends differ from each other as they're to be paid in different period of time, with possibility of being higher as well as lower. There are periods when Comp. don't pay dividends at all, mostly when Comp. is in a financial distress or in case executives decide to reinvest income into development of business. While calculating acceptable stock price, dividends are 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 required income rate. The Comp. with high risks level is expected to have high required income rate. The higher cash flow higher stock prices and versus. This interdependence determines assets value. Below we will touch upon division of stock prices estimating in three possible cases with regard to dividends.

While purchasing shares, aside of risks and dividends analysis, it's absolutely Imp. to examine Comp. carefully as for its profit/loss Acc. , balance, cash flows, distribution of profits Bet. its shareholders, managers’ and executives’ wages etc. Only when u are sure of all ins and outs of company, u can easily buy or sell shares. If u aren't confident of information, it's more advisable not to hold shares for long time [especially before financial Acc. published].


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