Stock

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In financial terminology, stock is the capital raised by a corporation, through the issuance and sale of shares. A shareholder is any person or organization which owns one or more shares of a corporation's stock. The aggregate value of a corporation's issued shares is its market capitalization.

In the United Kingdom, the word stock has a completely different meaning in finance, referring to a bond. It can also be used more widely to refer to all kinds of marketable securities. However, the usage of "share" (as in the stock issued by a corporation) is the same.

History

The first company that issued shares was the Dutch East India Company in the early 17th century (1602).

The innovation of joint ownership made a great deal of Europe's economic growth possible following the middle ages. The technique of pooling capital to finance the building of ships, for example, made the Netherlands a maritime superpower. Before the widespread adoption of the joint-stock corporation, an expensive venture such as building a merchant ship could only be undertaken by governments or by very wealthy individuals or families.

Ownership

The owners of a company may want additional capital to invest in new projects within the company. They may also simply wish to reduce their holding, freeing up capital for their own private use.

By selling shares they can sell part or all of the company to many part-owners. The purchase of one share entitles the owner of that share to literally share in the ownership of the company a fraction of the decision-making power, and potentially a fraction of the profits, which the company may issue as dividends.

In the common case, where there are thousands of shareholders, it is impractical to have all of them making the daily decisions required in the running of a company. Thus, the shareholders will use their shares as votes in the election of members of the board of directors of the company.

Each share constitutes one vote (except in a co-operative society where every member gets one vote regardless of the number of shares they hold). Owning the majority of the shares allows other shareholders to be out-voted - effective control rests with the majority shareholder (or shareholders acting in concert). In this way the original owners of the company often still have control of the company.

Shareholder rights

Although owning 51% of shares does mean that you own 51% of the company, it does not give you the right to use a company's building, equipment, materials, or other property. This is because the company is considered a legal person, thus it owns all its assets itself. This is important in areas such as insurance, which must be in the name of the company and not the main shareholder.

In most countries, including the United States, boards of directors and company managers have a fiduciary responsibility to run the company in the interests of its stockholders. Nonetheless, as Martin Whitman writes:

"...it can safely be stated that there does not exist any publicly traded company where management works exclusively in the best interests of OPMI Passive Minority Investor stockholders. Instead, there are both "communities of interest" and "conflicts of interest" between stockholders (principal) and management (agent). This conflict is referred to as the principal/agent problem. It would be naive to think that any management would forego management compensation, and management entrenchment, just because some of these management privileges might be perceived as giving rise to a conflict of interest with OPMIs." 2004, 5

Even though the board of directors runs the company, the shareholder has some impact on the company's policy, as the shareholders elect the board of directors. Each shareholder typically has a percentage of votes equal to the percentage of shares he or she owns. So as long as the shareholders agree that the management (agent) are performing poorly they can elect a new board of directors which can then hire a new management team. In practice, however, genuinely contested board elections are rare. Board candidates are usually nominated by insiders or by the board of the directors themselves, and a considerable amount of stock is held and voted by insiders.

Owning shares does not mean responsibility for liabilities. If a company goes broke and has to default on loans, the shareholders are not liable in any way. However, all money obtained by converting assets into cash will be used to repay loans and other debts first, so that shareholders cannot receive any money unless and until creditors have been paid (most often the shareholders end up with nothing).

Means of financing

Financing a company through the sale of stock in a company is known as equity financing. Alternatively, debt financing (for example issuing Bonds) can be done to avoid giving up shares of ownership of the company. Unofficial financing known as trade financing usually provides the major part of a company's working capital (day-to-day operational needs). Trade financing is provided by vendors and suppliers who sell their products to the company at short-term, unsecured credit terms, usually 30 days. Equity and debt financing are usually used for longer-term investment projects such as investments in a new factory or a new foreign market. Customer provided financing exists when a customer pays for services before they are delivered, e.g. subscriptions and insurance.

Trading

A stock exchange is an organization that provides a marketplace (either physical or virtual) for trading shares, where investors (represented by stock brokers) may buy and sell shares in a wide range of companies. A given company will usually list its shares in only one exchange by meeting and maintaining the listing requirements of that particular stock exchange. In the United States, through the inter-market quotation system, stocks listed on one exchange can also be bought or sold on several other exchanges, including relatively new internet-only exchanges. Stocks are broadly grouped into NYSE-listed and NASDAQ-listed stocks and exchanges where NYSE-listed stocks may be bought are generally not the same group as the exchanges where NASDAQ-listed stocks may be bought. Many large foreign companies choose to list on a U.S. exchange as well as an exchange in their home country in order to broaden their investor base. These shares are called American Depository Receipts (ADRs). Large U.S. companies also list in foreign exchanges for the same reason. Although it makes sense for some companies to raise capital by offering stock on more than one exchange, in today's era of electronic trading, there is little opportunity for private investors to make profit on pricing discrepancies between one stock exchange and another. As such, arbitrage opportunities disappear almost immediately due to the efficient nature of the market.

Buying

There are various methods of buying and financing stocks. The most common means is through a stock broker. Whether they are a full service or discount broker, they are all doing one thing—arranging the transfer of stock from a seller to a buyer. Most of the trades are actually done through brokers listed with a stock exchange such as the New York Stock Exchange.

There are many different stock brokers from which to choose such as full service brokers or discount brokers. The full service brokers usually charge more per trade, but give investment advice or more personal service; the discount brokers offer little or no investment advice but charge less for trades. Another type of broker would be a bank or credit union that may have a deal set up with either a full service or discount broker.

There are other ways of buying stock besides through a broker. One way is directly from the company itself. If at least one share is owned, most companies will allow the purchase of shares directly from the company through their investor's relations departments. However, the initial share of stock in the company will have to be obtained through a regular stock broker. Another way to buy stock in companies is through Direct Public Offerings which are usually sold by the company itself. A direct public offering is an initial public offering in which the stock is purchased directly from the company, usually without the aid of brokers.

When it comes to financing a purchase of stocks there are two ways: purchasing stock with money that is currently in the buyers ownership or by buying stock on margin. Buying stock on margin means buying stock with money borrowed against the stocks in the same account. These stocks, or collateral, guarantee that the buyer can repay the loan; otherwise, the stockbroker has the right to sell the stocks (collateral) to repay the borrowed money. He can sell if the share price drops below the margin requirement, at least 50 percent of the value of the stocks in the account. Buying on margin works the same way as borrowing money to buy a car or a house using the car or house as collateral. Moreover, borrowing is not free; the broker usually charges 8-10 percent interest.

Selling

Selling stock is procedurally similar to buying stock. Generally, the investor wants to buy low and sell high, if not in that order (short selling); although a number of reasons may induce an investor to sell at a loss.

As with buying a stock, there is a transaction fee for the broker's efforts in arranging the transfer of stock from a seller to a buyer. This fee can be high or low depending on which type of brokerage, discount or full service, handles the transaction.

After the transaction has been made, the seller is then entitled to all of the money. An important part of selling is keeping track of the earnings. Importantly, on selling the stock, in jurisdictions that have them, capital gains taxes will have to be paid on the additional proceeds, if any, that are in excess of the cost basis.

Stock Price Fluctuation

The price of a stock fluctuates fundamentally due to the law of Supply and demand. Like all commodities in the Market, the price of a stock is directly proportional to the demand. However, there are many factors on basis of which the demand for a particular stock may increase or decease. These factors are studied using methods of Fundamental analysis and Technical analysis to predict the changes in the stock price.

Technology's influence on trading

Stock trading has evolved tremendously. Since the very first Initial Public Offering (IPO) in the 13th century, owning shares of a company has been a very attractive incentive. Even though the origins of stock trading go back to the 13th century, the market as we know it today did not catch on strongly until the late 1800s.

Co-production between technology and society has led the push for effective and efficient ways of trading. Technology has allowed the stock market to grow tremendously, and all the while society has encouraged the growth. Within seconds of an order for a stock, the transaction can now take place. Most of the recent advancements with the trading have been due to the Internet. The Internet has allowed online trading. In contrast to the past where only those who could afford the expensive stock brokers, anyone who wishes to be active in the stock market can now do so at a very low cost per transaction. Trading can even be done through Computer-Mediated Communication (CMC) use of mobile devices such as handheld computers and cellular phones. These advances in technology have made day trading possible.

The stock market has grown so that some argue that it represents a country's economy. This growth has been enjoyed largely to the credibility and reputation that the stock market has earned.

Types of shares

There are several types of shares, including common stock, preferred stock, treasury stock, and dual class shares. Preferred stock, sometimes called preference shares, have priority over common stock in the distribution of dividends and assets, and sometime have enhanced voting rights such as the ability to veto mergers or acquisitions or the right of first refusal when new shares are issued (i.e. the holder of the preferred stock can buy as much as they want before the stock is offered to others). A multiple class equity structure has several classes of shares (for example Class A, Class B, and Class C) each with its own advantages and disadvantages. Treasury stock is shares that have been bought back from the public. Treasury Stock is considered issued but not outstanding.

Derivatives

See Equity derivatives

A stock derivative is any financial claim which has a value that is dependent on the price of the underlying stock. Futures and options are the main types of derivatives on stocks. The underlying security may be a stock index or an individual firm's stock, e.g. single-stock futures.

Stock futures are contracts where the buyer, or long, takes on the obligation to buy on the contract maturity date, and the seller, or short takes on the obligation to sell. Stock index futures are generally not delivered in the usual manner, but by cash settlement.

A stock option is a class of option. Specifically, a call option is the right (not obligation) to buy stock in the future at a fixed price and a put option is the right (not obligation) to sell stock in the future at a fixed price. Thus, the value of a stock option changes in reaction to the underlying stock of which it is a derivative. The most popular method of valuing stock options is the Black Scholes model //www.tradingtoday.com/black-scholes.

Apart from call options granted to employees, most stock options are transferable.

References

Whitman, Martin, Third Avenue Value Fund, in Third Avenue Funds Letters to Our Shareholders, Q4, 2004.

External links

The oldest share in the world, issued by the Dutch East India Company VOC, 1606.
''Move Over, Adam Smith: The Visible Hand of Uncle Sam (View as HTML) Report concludes that the U.S. government surreptitiously intervenes in the American stock market
What is Stock?
Stock Market Trivia: History of Stocks
Who Decides Stock Prices?

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