What is a stock market?

>> Friday, April 10, 2009

When you want to start a business, you need cash - To buy equipments, purchase land, construct building, pay out salaries etc. There are primarily two ways to raise this cash.

1. Debt - Taking loans from others, which you will undertake to repay (along with interest) after an agreed period of time and

2. Equity - You can invite someone to become a co-owner/ partner of your business. For becoming a partner, he would of course need to contribute his share of the capital (i.e cash) needed for the business. Unlike a loan there is no fixed repayment for equity. The partner instead has a share of the business and gets his returns in terms of the profits made.

You can raise this equity from people whom you know or from others whom you do not know. Typically its difficult to raise a large amount of cash from your own network of friends/ family. So promoters often come out with something called an IPO - Initial Public Offering. During an IPO, the promoters invite general public to purchase shares of the company.

Thus if Reliance is coming out with an IPO of 1000 shares and you decide to buy 100 shares of Rs. 10 each, then by investing Rs. 1000 (Rs. 10 x 100 shares), you become a part owner of Reliance (you will own a 10% stake i.e 100 shares/ 1000 shares).

What will you do with the shares you own? You can decide to keep it with yourself. As long as you keep it with yourself, you will receive 10% share of the profits, Reliance decides to distribute. You can later decide to sell these shares to some other willing buyer. If things turn good, may be you will be able to sell these shares at Rs. 15 each, thus pocketing a profit of Rs. 5 per share.

How will you know who is a willing buyer? That's where Stock Markets come to the rescue. Stock Markets are like any other markets which bring the buyers and sellers together. Here the commodity traded is shares of companies.

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