Questions about shares in Stock Market

• What is a share – Purchasing a share is equivalent to owning a part in the organisation. Suppose an Organisation ABC has 1000 outstanding shares and I as an individual own 150 shares. I have 15% ownership in the organisation. With Ownership in Organisation, An Individual owning share is eligible to the profit as organisation as well as voting rights if attached?

•  Why will an Organisation share its asset and profit with public – Organisation requires money to run it operations or to start on a new opportunity. Suppose my Organisation want to add on infrastructure and requires some capital for the same.

• How does an Organisation gets the money it required – An Organisation can get the required money in two ways. Either by burrowing money in terms of debt (generating bonds is a example of debt) or selling stocks of the organisation. Organisation invites capital investments in terms of public issue of shares.

•  Are stocks a liability or Asset to the Organisation – Stocks are on liabilities side of a company. In broader terms in Accounting. Assets of an Organisation should match the liabilities of the organisation. i.e. Assets = liabilities = debt of the organisation + stocks of the organisation+ other liabilities. This gives value of stock as Assets – debt of instrument – other liabilities

• Where does an organisation sell new stocks – An organisation floats new stock in a primary market. In case organisation sells its equity/stock for first time to the public, a security is created and initial public offer (IPO) is offered in the primary market with an issue price which is offered and number of shares for the stock for public.

• Together with IPO, an already listed Organisation can also gather money from the market in terms of stock by issuing further Public Offering. Difference between IPO and FPO is while IPO are usually offered by an unlisted company in Stock Exchange, FPO is offered by already listed company in the stock exchange. An FPO can be either of fresh issue of shares or an offer for sale. An offer for sale is offered by company, in which organisation sells its share of stocks to public. Also a company can issue right issue or preferential issue.
  

•  Once a price is decided in the Primary market to the allocated shared to public, Investors trades on the shares of a stock in the secondary Market.

•  Once a fresh issue is made to the public, based on the current market price, Market Capitalization is calculated as:  Market Capitalization – Current Market Price * Total Number of shares of Company.This includes Promoters share holding in the Organisation together with public.

• Trading in general happens when a buyer meets a seller for an agreed price and for an agreed quantity. Similarly in stock market, a trade happens when ask Price (price offered by the seller to sell a share) and quantity matches the bid price (price offered by the buyer to buy a share) and bid quantity matches

•  And Last, but not the least, investment in Shares is subjected to market Risk. :)

Understanding Derivatives :Futures and Options

Hi, In this series on financial market, we will learn on concepts in financial market. Concepts on Equity, bond, derivative which will be very useful for beginners in trading.

In this article we will discuss on derivative basic concepts. Derivative is a financial instrument which derives its value from other instruments which are also known as underlying assets. Underlying Assets can be bond, stock, currency, or commodity to name a few.

Stock derivatives derive its value from the stock shares. Movement in equity is responsible for change in derivative pricing. Similarly Currency derivatives derive its value from the movement in derivative market. Similarly we can have derivatives in commodities and other instruments. The basic purpose of derivative is it acts as a basic instrument for handling financial risk and acts as insurance to the financial instrument.

Let us understand an example of derivative. Suppose there is an instrument which depends on interest rate fluctuation or other market condition. So we have an underlying asset.

For trading in any instrument, we require two parties, one who agrees to buy at an agreed price, and another party to sell at an agreed price. This agreement between seller and buyer can be termed as a contract. One buying the contract expects the price to go up from the agreed price. The seller of the contract wants to insure the risk of the underlying asset.

The common types of stock derivatives are as follows: 

1. Future and Forwards - Future and Forwards are contracts deriving value from underlying asset with an obligation for trade on the agreed price and agreed date. Futures are traded on an organized exchange for e.g. NSE; Trading on an organised exchange makes future contracts a better alternate compared to Forwards. 

2. Options - Options are similar to futures with only difference it removes the obligation clause from futures. Instead of obligation, a fee is paid to the option writer (i.e. one selling the contract) by the option holder (i.e. one buying the option).

Understanding future and Options with an example:

Let us assume, there is equity of XYZ Bank currently trading at Rs 1000. Suppose there is future contract of the Bank at RS 1020. Now if I buy a lot of xyz Bank. A lot is the contract size, Suppose 250 shares of ZYZ Bank makes a Lot. Buying a lot of future will cost the buyer 250 * 1020 = RS. 255000.

Instead of buying a future, suppose user buy an option derivative. Option contract can be a put or a call option

Suppose he buy a call option of Rs 1000, you will pay a fee of Rs 50/Share. So the total cost of the contract will be Rs 50*250 = 12500.

Suppose instead of buying a call option, buyer buys a put contact of Rs 1000 with a fee of Rs 40/share, so total cost will be Rs 10000.

Now assume on the expiry date, the sharing is trading at Rs1220, a boom in the price.

The gains/ loss in the three purchases will be:

a.)   Future : (1220 – 1020) * 250 = Rs 50000 Profit

b.)  Option Call :  (1220-1000-50)*250 = Rs 42500 Profit

c.)  Option Put : (40)* 250 = Rs 10000 Loss

Since the buyer of contract do not have obligation for the contract, he will Pay the fee of Rs 10000 as loss in the above example