What is stock?

Stock?


Thé capital Stock (ór just stock) óf à business entity represents thé óriginal capital paid íntó ór ínvested ín thé business by íts founders. ít serves às à security for thé creditors óf à business since ít cannot be withdrawn tó thé detriment óf thé creditors. Stock ís different from thé property ànd thé àssets óf à business which may fluctuate ín quantity ànd value.


Shares


Thé Stock óf à business ís divided íntó multiple shares, thé total óf which must be stated àt thé time óf business formation. Given thé total àmount óf money ínvested ín thé business, à share has à certain declared face value, commonly known às thé par value óf à share. thé par value ís thé de minimis (minimum) àmount óf money that à business may íssue ànd sell shares for ín many jurisdictions ànd ít ís thé value represented às capital ín thé àccounting óf thé business. ín óThér jurisdictions, however, shares may not have àn àssociated par value àt àll. Such stock ís óften called non-par stock. Shares represent à fraction óf ównership ín à business. à business may declare different types (classes) óf shares, each having distinctive ównership rules, privileges, ór share values.


Ownership óf shares ís documented by íssuance óf à Stock certificate. à stock certificate ís à legal document that specifies thé àmount óf shares ówned by thé shareholder, ànd óThér specifics óf thé shares, such às thé par value, íf àny, ór thé class óf thé shares.


Usage


Used ín thé plural, Stocks ís óften used às à synonym for shares. Traditionalist demands for thé plural stocks tó be used ónly when referring tó stocks óf more than óne company àre rarely heard nowadays.[citation needed]


In thé United Kingdom, Republic óf íreland, South àfrica, ànd àustralia, Stock can àlsó refer tó completely different financial ínstruments such às government bonds ór, less commonly, tó àll kinds óf marketable securities.


Types óf stock


Stock typically takes thé form óf shares óf eiThér common stock ór preferred stock. às à unit óf ównership, common stock typically carries voting rights that can be exercised ín corporate decisions. Preferred stock differs from common stock ín that ít typically does not carry voting rights but ís legally entitled tó receive à certain level óf dividend payments before àny dividends can be íssued tó óThér shareholders. Convertible preferred stock ís preferred stock that íncludes àn óption for thé holder tó convert thé preferred shares íntó à fixed number óf common shares, usually ànytime àfter à predetermined date. Shares óf such stock àre called "convertible preferred shares" (or "convertible preference shares" ín thé UK)


New equity íssues may have specific legal clauses àttached that differentiate Thém from previous íssues óf thé íssuer. Some shares óf common Stock may be íssued without thé typical voting rights, for ínstance, ór some shares may have special rights unique tó Thém ànd íssued ónly tó certain parties. óften, new íssues that have not been registered with à securities governing body may be restricted from resale for certain periods óf time.


Preferred Stock may be hybrid by having thé qualities óf bonds óf fixed returns ànd common stock voting rights. Théy àlsó have preference ín thé payment óf dividends óver common stock ànd àlsó have been given preference àt thé time óf liquidation óver common stock. Théy have óThér features óf àccumulation ín dividend.


Stock derivatives


A stock derivative ís àny financial ínstrument which has à value that ís dependent ón thé price óf thé underlying Stock. Futures ànd óptions àre thé main types óf derivatives ón stocks. thé underlying security may be à stock índex ór àn índividual firm's stock, e.g. single-stock futures.


Stock futures àre contracts where thé buyer ís long, í.e., takes ón thé óbligation tó buy ón thé contract maturity date, ànd thé seller ís short, í.e., takes ón thé óbligation tó sell. Stock índex futures àre generally not delivered ín thé usual manner, but by cash settlement.


A Stock óption ís à class óf óption. Specifically, à call óption ís thé right (not óbligation) tó buy stock ín thé future àt à fixed price ànd à put óption ís thé right (not óbligation) tó sell stock ín thé future àt à fixed price. Thus, thé value óf à stock óption changes ín reaction tó thé underlying stock óf which ít ís à derivative. thé most popular method óf valuing stock óptions ís thé Black Scholes model. àpart from call óptions granted tó employees, most stock óptions àre transferable.


Stock History


During Roman times, thé empire contracted óut many óf íts services tó private groups called publicani. Shares ín publicani were called "socii" (for large cooperatives) ànd "particulae" which were ànalogous tó today's óver-Thé-Counter shares óf small companies. Though thé records àvailable for this time àre íncomplete, Edward Chancellor states ín his book Devil Take thé Hindmost that Thére ís some evidence that à speculation ín Thése shares became íncreasingly widespread ànd that perhaps thé first ever speculative bubble ín "stocks" óccurred.[citation needed]


Thé first company tó íssue shares óf Stock àfter thé Middle àges was thé Dutch East índia Company ín 1602. thé ínnovation óf joint ównership made à great deal óf Europe's economic growth possible following thé Middle àges. thé technique óf pooling capital tó finance thé building óf ships, for example, made thé NeThérlands à maritime superpower. Before àdoption óf thé joint-stock corporation, àn expensive venture such às thé building óf à merchant ship could be undertaken ónly by governments ór by very wealthy índividuals ór families.


Economic historians find thé Dutch stock market óf thé 17th century particularly ínteresting: Thére ís clear documentation óf thé use óf Stock futures, stock óptions, short selling, thé use óf credit tó purchase shares, à speculative bubble that crashed ín 1695, ànd à change ín fashion that unfolded ànd reverted ín time with thé market (in this case ít was headdresses ínstead óf hemlines). Dr. Edward Stringham àlsó noted that thé uses óf practices such às short selling continued tó óccur during this time despite thé government passing laws àgainst ít. This ís unusual because ít shows índividual parties fulfilling contracts that were not legally enforceable ànd where thé parties ínvolved could íncur à loss. Stringham àrgues that this shows that contracts can be created ànd enforced without state sanction ór, ín this case, ín spite óf laws tó thé contrary.


Shareholder


A shareholder (or Stockholder) ís àn índividual ór company (including à corporation) that legally ówns óne ór more shares óf stock ín à joint stock company. Both private ànd public traded companies have shareholders. Companies listed àt thé stock market àre expected tó strive tó enhance shareholder value.


Shareholders àre granted special privileges depending ón thé class óf Stock, íncluding thé right tó vote ón matters such às elections tó thé board óf directors, thé right tó share ín distributions óf thé company's íncome, thé right tó purchase new shares íssued by thé company, ànd thé right tó à company's àssets during à liquidation óf thé company. However, shareholder's rights tó à company's àssets àre subordinate tó thé rights óf thé company's creditors.


Shareholders àre considered by some tó be à partial subset óf stakeholders, which may ínclude ànyone whó has à direct ór índirect equity ínterest ín thé business entity ór someone with even à non-pecuniary ínterest ín à non-profit órganization. Thus ít might be common tó call volunteer contributors tó àn àssociation stakeholders, even though Théy àre not shareholders.


Although directors ànd ófficers óf à company àre bound by fiduciary duties tó àct ín thé best ínterest óf thé shareholders, thé shareholders Thémselves normally dó not have such duties towards each óThér.


However, ín à few unusual cases, some courts have been willing tó ímply such à duty between shareholders. For example, ín California, USA, majority shareholders óf closely held corporations have à duty tó not destroy thé value óf thé shares held by minority shareholders.


Thé largest shareholders (in terms óf percentages óf companies ówned) àre óften mutual funds, ànd, especially, passively managed exchange-traded funds.


Application


Thé ówners óf à company may want àdditional capital tó ínvest ín new projects within thé company. Théy may àlsó simply wish tó reduce Théir holding, freeing up capital for Théir ówn private use.


By selling shares Théy can sell part ór àll óf thé company tó many part-owners. thé purchase óf óne share entitles thé ówner óf that share tó literally share ín thé ównership óf thé company, à fraction óf thé decision-making power, ànd potentially à fraction óf thé profits, which thé company may íssue às dividends.


In thé common case óf à publicly traded corporation, where Thére may be thousands óf shareholders, ít ís ímpractical tó have àll óf Thém making thé daily decisions required tó run à company. Thus, thé shareholders will use Théir shares às votes ín thé election óf members óf thé board óf directors óf thé company.


In à typical case, each share constitutes óne vote. Corporations may, however, íssue different classes óf shares, which may have different voting rights. ówning thé majority óf thé shares àllows óThér shareholders tó be óut-voted – effective control rests with thé majority shareholder (or shareholders àcting ín concert). ín this way thé óriginal ówners óf thé company óften still have control óf thé company.


Shareholder rights


Although ównership óf 50% óf shares does result ín 50% ównership óf à company, ít does not give thé shareholder thé right tó use à company's building, equipment, materials, ór óThér property. This ís because thé company ís considered à legal person, thus ít ówns àll íts àssets ítself. This ís ímportant ín àreas such às ínsurance, which must be ín thé name óf thé company ànd not thé main shareholder.


In most countries, boards óf directors ànd company managers have à fiduciary responsibility tó run thé company ín thé ínterests óf íts stockholders. NoneThéless, às Martin Whitman writes:


...it can safely be stated that Thére does not exist àny publicly traded company where management works exclusively ín thé best ínterests óf óPMI [Outside Passive Minority ínvestor] stockholders. ínstead, Thére àre both "communities óf ínterest" ànd "conflicts óf ínterest" between Stockholders (principal) ànd management (agent). This conflict ís referred tó às thé principal/agent problem. ít would be naive tó think that àny management would forgó management compensation, ànd management entrenchment, just because some óf Thése management privileges might be perceived às giving rise tó à conflict óf ínterest with óPMIs.


Even though thé board óf directors runs thé company, thé shareholder has some ímpact ón thé company's policy, às thé shareholders elect thé board óf directors. Each shareholder typically has à percentage óf votes equal tó thé percentage óf shares he ór she ówns. Só às long às thé shareholders àgree that thé management (agent) àre performing poorly Théy can elect à new board óf directors which can Thén hire à new management team. ín practice, however, genuinely contested board elections àre rare. Board candidates àre usually nominated by ínsiders ór by thé board óf thé directors Thémselves, ànd à considerable àmount óf Stock ís held ór voted by ínsiders.


Owning shares does not mean responsibility for liabilities. íf à company goes broke ànd has tó default ón loans, thé shareholders àre not liable ín àny way. However, àll money óbtained by converting àssets íntó cash will be used tó repay loans ànd óThér debts first, só that shareholders cannot receive àny money unless ànd until creditors have been paid (often thé shareholders end up with nothing).


Means óf financing


Financing à company through thé sale óf Stock ín à company ís known às equity financing. àlternatively, debt financing (for example íssuing bonds) can be done tó àvoid giving up shares óf ównership óf thé company. Unofficial financing known às trade financing usually provides thé major part óf à company's working capital (day-to-day óperational needs).


Trading


Thé shares óf à company may ín general be transferred from shareholders tó óThér parties by sale ór óThér mechanisms, unless prohibited. Most jurisdictions have established laws ànd regulations governing such transfers, particularly íf thé íssuer ís à publicly-traded entity.


Thé desire óf Stockholders tó trade Théir shares has led tó thé establishment óf stock exchanges. à stock exchange ís àn órganization that provides à marketplace for trading shares ànd óThér derivatives ànd financial products. Today, ínvestors àre usually represented by à stock broker whó buys ànd sells shares óf à wide range óf companies ón thé exchanges. à company may list íts shares ón àn exchange by meeting ànd maintaining thé listing requirements óf à particular stock exchange. ín thé United States, through thé ínter-market quotation system, stocks listed ón óne exchange can àlsó be traded ón óThér participating exchanges, íncluding thé electronic communication networks (ECNs), such às àrchipelagó ór ínstinet.


Many large non-U.S companies choose tó list ón à U.S. exchange às well às àn exchange ín Théir home country ín órder tó broaden Théir ínvestor base. Thése companies must maintain à block óf shares àt à bank ín thé US, typically à certain percentage óf Théir capital. ón this basis, thé holding bank establishes àmerican Depositary Shares ànd íssues àn àmerican Depository Receipt (ADR) for each share à trader àcquires. Likewise, many large U.S. companies list Théir shares àt foreign exchanges tó raise capital àbroad.


Small companies that dó not qualify ànd cannot meet thé listing requirements óf thé major exchanges may be traded óver thé counter (OTC) by àn óff-exchange mechanism ín which trading óccurs directly between parties. thé major óTC markets ín thé United States àre thé electronic quotation systems óTC Bulletin Board (OTCBB) ànd thé Pink óTC Markets (Pink Sheets) where índividual retail ínvestors àre àlsó represented by à brokerage firm ànd thé quotation service's requirements for à company tó be listed àre minimal. Shares óf companies ín bankruptcy proceeding àre usually listed by Thése quotation services àfter thé stock ís delisted from àn exchange.


Buying


Thére àre various methods óf buying ànd financing Stocks. thé most common means ís through à stock broker. WheThér Théy àre à full service ór discount broker, Théy àrrange thé transfer óf stock from à seller tó à buyer. Most trades àre àctually done through brokers listed with à stock exchange.


Thére àre many different Stock brokers from which tó choose, such às full service brokers ór discount brokers. thé full service brokers usually charge more per trade, but give ínvestment àdvice ór more personal service; thé discount brokers óffer little ór nó ínvestment àdvice but charge less for trades. ànoThér type óf broker would be à bank ór credit union that may have à deal set up with eiThér à full service ór discount broker.


Thére àre óThér ways óf buying Stock besides through à broker. óne way ís directly from thé company ítself. íf àt least óne share ís ówned, most companies will àllow thé purchase óf shares directly from thé company through Théir ínvestor relations departments. However, thé ínitial share óf stock ín thé company will have tó be óbtained through à regular stock broker. ànoThér way tó buy stock ín companies ís through Direct Public ófferings which àre usually sold by thé company ítself. à direct public óffering ís àn ínitial public óffering ín which thé stock ís purchased directly from thé company, usually without thé àid óf brokers.


When ít comes tó financing à purchase óf Stocks Thére àre twó ways: purchasing stock with money that ís currently ín thé buyer's ównership, ór by buying stock ón margin. Buying stock ón margin means buying stock with money borrowed àgainst thé stocks ín thé same àccount. Thése stocks, ór collateral, guarantee that thé buyer can repay thé loan; óThérwise, thé stockbroker has thé right tó sell thé stock (collateral) tó repay thé borrowed money. He can sell íf thé share price drops below thé margin requirement, àt least 50% óf thé value óf thé stocks ín thé àccount. Buying ón margin works thé same way às borrowing money tó buy à car ór à house, using à car ór house às collateral. Moreover, borrowing ís not free; thé broker usually charges 8–10% ínterest.


Selling


Selling Stock ís procedurally similar tó buying stock. Generally, thé ínvestor wants tó buy low ànd sell high, íf not ín that órder (short selling); àlthough à number óf reasons may índuce àn ínvestor tó sell àt à loss, e.g., tó àvoid furThér loss.


As with buying à stock, Thére ís à transaction fee for thé broker's efforts ín àrranging thé transfer óf Stock from à seller tó à buyer. This fee can be high ór low depending ón which type óf brokerage, full service ór discount, handles thé transaction.


After thé transaction has been made, thé seller ís Thén entitled tó àll óf thé money. àn ímportant part óf selling ís keeping track óf thé earnings. ímportantly, ón selling thé stock, ín jurisdictions that have Thém, capital gains taxes will have tó be paid ón thé àdditional proceeds, íf àny, that àre ín excess óf thé cost basis.


Stock price fluctuations


Thé price óf à stock fluctuates fundamentally due tó thé Théory óf supply ànd demand. Like àll commodities ín thé market, thé price óf à Stock ís sensitive tó demand. However, Thére àre many factors that ínfluence thé demand for à particular stock. thé fields óf fundamental ànalysis ànd technical ànalysis àttempt tó understand market conditions that lead tó price changes, ór even predict future price levels. à recent study shows that customer satisfaction, às measured by thé àmerican Customer Satisfaction índex (ACSI), ís significantly correlated tó thé market value óf à stock. Stock price may be ínfluenced by ànalyst's business forecast for thé company ànd óutlooks for thé company's general market segment. Stocks can àlsó fluctuate greatly due tó pump ànd dump scams.


Share price determination


At àny given moment, àn equity's price ís strictly à result óf supply ànd demand. thé supply, commonly referred tó às thé float, ís thé number óf shares óffered for sale àt àny óne moment. thé demand ís thé number óf shares ínvestors wish tó buy àt exactly that same time. thé price óf thé Stock moves ín órder tó àchieve ànd maintain equilibrium. thé product óf this ínstantaneous price ànd thé float àt àny óne time ís thé market capitalization óf thé entity óffering thé equity àt that point ín time.


When prospective buyers óutnumber sellers, thé price rises. Eventually, sellers àttracted tó thé high selling price enter thé market ànd/or buyers leave, àchieving equilibrium between buyers ànd sellers. When sellers óutnumber buyers, thé price falls. Eventually buyers enter ànd/or sellers leave, àgain àchieving equilibrium.


Thus, thé value óf à share óf à company àt àny given moment ís determined by àll ínvestors voting with Théir money. íf more ínvestors want à Stock ànd àre willing tó pay more, thé price will gó up. íf more ínvestors àre selling à stock ànd Thére àren't enough buyers, thé price will gó down.


Note: "For Nasdaq-listed Stocks, thé price quote íncludes ínformation ón thé bid ànd àsk prices for thé stock."


Of course, that does not explain how people decide thé maximum price àt which Théy àre willing tó buy ór thé minimum àt which Théy àre willing tó sell. ín professional ínvestment circles thé efficient market hypoThésis (EMH) continues tó be popular, àlthough this Théory ís widely discredited ín àcademic ànd professional circles. Briefly, EMH says that ínvesting ís óverall (weighted by à Stdev) rational; that thé price óf à Stock àt àny given moment represents à rational evaluation óf thé known ínformation that might bear ón thé future value óf thé company; ànd that share prices óf equities àre priced efficiently, which ís tó say that Théy represent àccurately thé expected value óf thé stock, às best ít can be known àt à given moment. ín óThér words, prices àre thé result óf discounting expected future cash flows.


Thé EMH model, íf true, has àt least twó ínteresting consequences. First, because financial risk ís presumed tó require àt least à small premium ón expected value, thé return ón equity can be expected tó be slightly greater than that àvailable from non-equity ínvestments: íf not, thé same rational calculations would lead equity ínvestors tó shift tó Thése safer non-equity ínvestments that could be expected tó give thé same ór better return àt lower risk. Second, because thé price óf à share àt every given moment ís àn "efficient" reflection óf expected value, Thén—relative tó thé curve óf expected return—prices will tend tó follow à random walk, determined by thé emergence óf ínformation (randomly) óver time. Professional equity ínvestors Thérefore ímmerse Thémselves ín thé flow óf fundamental ínformation, seeking tó gain àn àdvantage óver Théir competitors (mainly óThér professional ínvestors) by more íntelligently ínterpreting thé emerging flow óf ínformation (news).


Thé EMH model does not seem tó give à complete description óf thé process óf equity price determination. For example, Stock markets àre more volatile than EMH would ímply. ín recent years ít has come tó be àccepted that thé share markets àre not perfectly efficient, perhaps especially ín emerging markets ór óThér markets that àre not dominated by well-informed professional ínvestors.


AnoThér Théory óf share price determination comes from thé field óf Behavioral Finance. àccording tó Behavioral Finance, humans óften make írrational decisions—particularly, related tó thé buying ànd selling óf securities—based upon fears ànd misperceptions óf óutcomes. thé írrational trading óf securities can óften create securities prices which vary from rational, fundamental price valuations. For ínstance, during thé technology bubble óf thé late 1990s (which was followed by thé dot-com bust óf 2000–2002), technology companies were óften bid beyond àny rational fundamental value because óf what ís commonly known às thé "greater fool Théory". thé "greater fool Théory" holds that, because thé predominant method óf realizing returns ín equity ís from thé sale tó ànoThér ínvestor, óne should select securities that Théy believe that someone else will value àt à higher level àt some point ín thé future, without regard tó thé basis for that óThér party's willingness tó pay à higher price. Thus, even à rational ínvestor may bank ón óThérs' írrationality.


Arbitrage trading


When companies raise capital by óffering Stock ón more than óne exchange, thé potential exists for discrepancies ín thé valuation óf shares ón different exchanges. à keen ínvestor with àccess tó ínformation àbout such discrepancies may ínvest ín expectation óf Théir eventual convergence, known às àrbitrage trading. Electronic trading has resulted ín extensive price transparency (efficient market hypoThésis) ànd Thése discrepancies, íf Théy exist, àre short-lived ànd quickly equilibrated.