What is stock market?

How did the stock market come into being?

It must be understood that most big businesses started up small family enterprises and in a course of time, they grew into financial giants.

The profits of companies like Wal-Mart, Dell Computer and McDonald run into billions of dollars every year. But how many of us know that Wal-Mart started only as a single store business in Arkansas. Dell computers were sold by their maker Michael Dell from his college dormitory. McDonald started up as a small restaurant. All these businesses, starting as non-descript personal enterprises and have blossomed up into largest businesses in the United States.

The secret of their growth lies in the fact that they sold their stock to raise the capital for expansion.

It hardly needs to be mentioned that the companies need money for their expansion program. One way to get the capital is to borrow it from the banks or the venture capitalists. The other way is to sell a part of their business to the general public and use it to fund their growth programs. Since banks or venture capitalists cannot be easily convinced about the profitability of the company, they take the second route of going public.

In order to go public, a company has to get its financial credentials verified by a firm of underwriters such as Goldman Sachs or JP Morgan. The underwriters ensure that the company will grow by going public. The proprietors of the company who own 100% of the business decide to give up with certain part of the business ownership which is sufficient to raise the amount required for their expansion plan.

Let us suppose the company wishes to keep 60% of the company and sells the remaining 40% to the public as stock through the underwriters. This kind of first time sale of company’s stock is called Initial Public Offering. Since the owners own a majority of the stock, they retain their control over the business.

The market where the IPO is issued and sold is called primary market. Once the shares of a company’s stock are purchased by the public, they become its shareholders.

A share represents an investor’s ownership of a company, which entitles him to share its assets, profits and losses. It is created when a business cuts itself into pieces and sells them to investors in exchange for cash.

A few days after the company’s stock is subscribed, it lists itself on the stock exchange where the shares purchased by the general public are bought and sold daily.

The shares of the company are ‘auctioned’ daily at the stock exchange also called the secondary market.

What is a stock exchange and why is it needed?

You are a big company and you want to sell your stock shares. You put up an advertisement in the newspapers and get the customers. Since you are a big company, you can afford to bear the advertisement expenses.

If you are a small company, you can sell it by word of mouth.

In both the cases, you do not have to sell on the daily basis.

This is what happens with a retail share trader. If you buy, say, five shares of a company, it would not be financially viable to pay for advertising their sale. They are not likely to be sold through the word of mouth in view of the limited scope of this practice. Moreover, you cannot buy and sell your shares on the daily basis using this approach. Your investment in the stock of a big company, therefore, becomes a meaningless exercise.

That is why stock exchanges were set up.

A stock exchange facilitates the trading of shares bought from the companies. When a company sells its shares through its IPO, it is called primary market. But when the investors in the company’s stock want to trade their shares, they have to do so in another kind of market. It is called secondary market. A stock exchange provides secondary market to the share traders. The New York Stock Exchange—NYSE--- is an example of such a stock exchange.

A stock exchange is like your neighborhood supermarket that sells all types of food items. The sellers of food items also come there. It is a one stop shop where every body goes to buy different types of food because it is more convenient.

So the NYSE is a supermarket of stocks where every body can buy and sell the stock shares.

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