A market where shares are publicly issued and traded is known as a share market. The answer to ‘what is stock market’ is pretty similar to that of a share market. The key difference between share markets and stock markets is that the former only allows one to trade shares. The latter allows you to trade in financial instruments such as derivatives, bonds, mutual funds, as well as the shares of listed companies.
The key factor is that the basic platform offers trading facilities that companies can use to trade stocks in the stock market. On a stock exchange, one can only buy and sell those stocks that are listed on it. Hence, buyers and sellers meet on a stock market. India’s prime stock exchanges are the National Stock Exchange and the Bombay Stock Exchange.
Now that we understand the stock market meaning, one key aspect of stock market basics is that one can trade on one of two market segments. In other words, there are two types of share markets in India. These are primary markets and secondary markets.
A primary share market is a place where a company first gets registered with the goal of raising money and issues a certain amount of shares. The goal of being publicly listed on a primary stock exchange is to raise money. This where a company gets registered to issue a certain amount of shares and raise money. If the company decides to sell its shares for the first time, this is known as an initial public offering.
Once a company’s new securities have been sold in the primary market, they are then traded in the secondary stock market. On the secondary market, investors get the opportunity to exit their investment and sell off their shares. Transactions on the secondary market mostly comprise trades where one investor chooses to buy shares from a separate investor at the prevailing market price.
Based on whatever prices the two parties agree to set or the prevailing market price, one investor will buy shares from another on a secondary market. Typically investors conduct these transactions through a broker or other such intermediary who can facilitate this process. Brokers offer these trading opportunities at different plans.
We cannot discuss stock market basics without addressing the key financial instruments that are traded on it. There are four categories of financial instruments traded on the stock exchange. They are shares, bonds, derivatives, and mutual funds. They are as follows:
A share is a unit denoting equity ownership in a corporation that exists as a financial asset providing equitable distribution for any profits earned. Hence, when you buy shares, you buy a stake in the company whose shares you have bought. This means that if the company becomes profitable over time, shareholders are rewarded with dividends. Traders often choose to sell shares at a price higher than which they purchased them.
A company requires money so they can undertake projects. They pay their investors dividends from the revenue earned on their projects. One way of raising the capital for operations and other company procedures is via bonds. When a company chooses to borrow money from a bank, they take a loan which they repay through periodic interest payments. On a similar note, when a company opts to borrow funds from a variety of investors, this is known as a bond, which is also paid off through timely interest payments. Take the following example as an explanation of how bonds work.
Imagine that your goal is to start a project that will begin to earn money in two years’ time. To undertake this project, you will require some initial amount to get you started. Suppose you acquire the required funds in the form of a loan from a friend and write down the receipt of the loan stating that you owe them ₹1 lakh which you will repay in five years with an interest rate of 5% per annum. Suppose that your friend now holds this receipt. It means that they have just purchased a bond by lending out money to your company. Since you have promised to pay the principal amount at a 5% interest, you do so and finally extinguish your principal repayment by the time the fifth year comes to a close.
One key financial instrument part of share market basics is mutual funds investing. Mutual funds are investments that allow you to indirectly invest in the share market. You can find mutual funds for a variety of financial instruments like equity, debt, or hybrid funds, to name a few. Mutual funds work by pooling money from all the investors that fund them. This aggregate amount is then invested in financial instruments. Mutual funds are handled professionally by a fund manager.
Each mutual fund scheme issues units that are of a certain value similar to a share. When you invest in such funds, you become a unit-holder in that mutual fund scheme. When instruments that are part of that mutual fund scheme earn revenue over time, the unit-holder receives that revenue reflected as the net asset value of the fund or in the form of dividend payouts.
The market value of shares listed on a stock market continues to fluctuate. It is difficult to fix the value of a share at one particular price. This is where derivatives enter the picture. Derivatives are instruments that allow you to trade at a price that has been fixed by you today. To put it simply, you enter into an agreement where you choose to either sell or buy a share or any other instrument at a certain fixed price.
Read more at Financial Instruments Traded on stock Market
Stock market basics include the two types of markets: primary and secondary, as well as the type of instruments traded on it. Use these share market basics as a helpful guide if you try your hand at investing.