Entering into the stock market without proper knowledge can be dangerous. The financial well being of an investor depends upon how much knowledge and temperament s/he brings into the market. Before you walk into the path of investment in share market, you need to familiarize yourself with the commonly used share market terms. He we have organized 4o common terms and tried to explain their meanings in the simplest way possible. Hope this is helpful for you.
The ownership of the company is divided into several units and sold to the investors. This divided unit of the company is called share. In other words, share is the portion of the company. Investors who purchase the share in the company are called shareholders. Thus, shareholders are the owners of the company. They receive dividends each year based on the company’s financial performance and profit.
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Ordinary or Common Share
Investors who invest in ordinary shares get ownership of the company according to the amount of their investment. They are considered as the owner of the company. As the owner, ordinary shareholders have to bear more risk.
Ordinary shareholders receive the dividend from the earned profits after the distribution to the preferred shareholders. The rate of dividend paid on ordinary shares is not fixed and may fluctuate according to the fluctuation of the company’s earnings. Just because a company makes a profit does not mean that ordinary shareholders receive dividends.
The company does not have to pay dividends on ordinary shares. However, the more profits a company makes, the more likely it is to provide higher dividends to the ordinary shareholders. The company may also distribute bonus shares to the shareholders as dividends.
In case of liquidation of the concerned company, the ordinary shareholders can claim only the remaining amount after paying the amount due to the debenture holders and preference shareholders. For this reason, investing in ordinary shares is considered risky. Only for aggressive investors who are willing to take more risks to get higher returns, securities tools like ordinary shares are considered suitable.
According to the current prevailing system in Nepal, the face value of ordinary shares is usually Rs. 100. Even if the company concerned has to bear a large liability in case of liquidation, the liability of ordinary shareholders is limited to the amount they have invested.
Preference shares are shares issued by the company and distribute dividends at a fixed rate from the profits earned. It is called a preferential share because these shareholders have the prerogative over the ordinary shareholders regarding the dividend to be distributed. Even if such a company goes into liquidation, the shareholders have priority in terms of receiving their investment and accumulated dividends.
For this reason, investing in preferential stocks is considered relatively less risky. However, if the company concerned fails to make a profit in any given year, the preferred shareholders cannot receive dividends at the prescribed rate. On the other hand, no matter how much profit the company earns, the preferred shareholders cannot receive more dividends than the fixed rate. Thus, investing in preferential stocks has less risk and less return.
Preferred shareholders are not allowed to attend the company’s annual general meeting unless they are discussing issues related to their rights. These shares are considered as hybrid security because they feature both ordinary shares and debentures.
Preferential shares are cumulative (to be paid from the next year’s profit with dividend savings when the company is unable to pay dividends at a loss in any given year) or non-cumulative, redeemable (repayable after a certain period of time) or irredeemable (perpetual), convertible (can be converted into ordinary shares after a certain period of time) or non-convertible.
Debentures are securities issued on the condition of paying principal and interest at the prescribed rate and time. Its face value is generally Rs. 1000 in Nepal. Debentures receive interest on their investment at a fixed rate annually or semi-annually. Debtors receive interest before the company pays dividends on ordinary shares and preferred shares. Even if the organization goes into loss, there is no obstacle for the debenture holders to get the fixed interest.
The relationship between the debenture holder and the organization is like that of a lender and a debtor. If the company is unable to pay the interest at the specified rate and time, the debenture holders can take action to send the company to liquidation. Investors who do not want to take risk (risk averter) prefer to invest in debenutre. Debenture holders do not have the opportunity to attend the company’s annual general meeting and the right to vote.
Debentures are secured (secured by company assets or mortgaged) or unsecured, redeemable (repayable after a certain period of time) or irrevocable and convertible (can be converted into ordinary shares after a certain period of time) or non-convertible in nature.
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IPO stands for Initial Public Offering. When a company issues the shares to the investors for the first time, it is known as IPO. After the IPO, the shares of the company are listed in the stock exchange. Investors can trade those shares in the secondary market.
Initial Public Offering (IPO) helps the companies to raise new equity capital. Likewise, it enables the general public to participate in the ownership of the company for the first time.
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FPO, which stands for Follow-On Public Offering, is the issuance of shares to the public by the company which has already issued the IPO. In this case, the company which is already listed in the stock exchange, floats the share to the public.
When a company wishes to raise additional capital from the public, it undergoes FPO. Follow-On Public Offering can be dilutive or non-dilutive.
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Bull Market is a period where the prices of shares of the companies are consistently rising. It refers to the gradual upward movement of the market. In this market phase, investors are highly optimistic towards the economic and companies prospects. Companies generate better than average returns which results in up ward movement of their share price.
Similarly, Bear Market is a period when there is a general decline in the prices of shares. It refers to the downtrend of the stock market. During the bear phase, the investors optimism transforms into fear and pessimism. The economic indicators also fall downward. In this situation, the market price and market index of listed securities are on a downward trend and there is an atmosphere of frustration among investors.
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Suppose, a company has already issued ordinary shares to the public in the past. If it issues ordinary shares again in the future, the existing shareholders get the first right to purchase such shares. As such shares are the first right of the existing shareholders, they are called right shares. Existing shareholders are free to decide whether or not to purchase rights shares. They are entitled to purchase shares in proportion to the number of shares they have previously purchased.
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Dividend / Bonus Share
The dividend is the return given to the shareholders from the profit earned by the company. If such dividend is paid in cash, it is called cash dividend and if it is paid in shares, it is called bonus share or stock dividend. In order to capitalize the company’s savings or reserves, the existing shareholders are thus given additional shares (bonus shares) and the paid-up capital is increased. The amount of dividend is decided by the board of directors.
Blue Chip Share
Blue chip share is the share of the company which has been earning profit for a long time and paying dividends to the investors. They also win the trust of the investors by being aware of the accountability towards the investors. Most of these types of shares have a high price and the dividends are moderate.
Pump and Dump
Pump and Dump is the fraudulent strategy of artificially increasing the price of the securities through incorrect positive rumors. Once, the share price rise to the higher level, the manipulators dump (sell) their shares purchased at a much lower price. After the sale, the share price plummets and the general investors lose huge sum of money. This is an unlawful activity in the stock market.
Volatility in the stock market refers to the deviation in the stock prices in the period of time. The general movement of the market with its ups and downs is the volatility of the market. Thus, volatility refers to the swings in the prices of shares. Sometimes the market prices moves upward while at the other times it falls sharply. Volatility is generally the risk associated with investment in the stock market.
Portfolio refers to the combination of financial assets mainly stocks, bonds, cash and others. Portfolio management is cornerstone to the field of investment. An optimal portfolio generates higher return at a minimum level of risk. Managing Portfolio is essential because it helps in diversification of assets thereby reducing the overall risk.
Margin in stock trading refers to the collateral that the investors/traders should deposit in the brokerage account for the purpose of margin trading. Margin trading is the borrowing of money from the broker for the purchase of shares. This allows the trader to accumulate more shares than if s/he can buy on their own. Buying at margin has possibility of maximum gain due to the use of leverage. However, there is also chances of greater loss.
Averaging Down is an investing strategy in which the investors purchases more shares as the price falls. This helps to reduce the per share cost of the share. Suppose, an investors purchases 100 shares at Rs 500 per share. If the price of that stock falls to Rs 400, s/he buys 100 more shares. This reduces his/her average purchase price to Rs 450 per share. Thus, the average price falls from initial Rs 500 to Rs 450.
Capital gain is the profit from the sale of the capital assets such as stocks, bonds, real estate and others. When an investor sells the assets at a higher price than his/her purchase price, he generates a profit which is known as capital gain. A tax is levied on this gain known as the capital gain tax.
Buying and selling securities within a single day, even within several hours or minutes. Investors with either a serious understanding of the market or a high-risk tolerance track the market all day, buying low and selling high. Generally, speculators engage in day trading.
Short Selling is the process of selling the securities by the investors who don’t possess those securities. In this case, the seller borrowers the securities from the lender (mainly broker) and sells them at current market price. If the market price of those securities declines, the seller later buys at lower price and returns them to the lender. In the meantime, he/she pockets the profit (difference between higher price at which s/he sells and lower buying price).
Thus, short selling is based on the strategy that the market price of the securities will fall in the future. However, if the price continue to surge, then the short seller has to purchase the securities at a higher price which may result in huge loss as well.
A mutual fund is a company that pools money from many small as well as institutional investors and invests in stocks, bonds and other investment securities. It is managed and operated by a portfolio manager. Mutual Funds help the general investors to minimize the risk in investment. As the funds are managed by the professionals, they generate adequate return at lower risks.
Mutual Funds are mainly of two types:
Open End Mutual Fund and Close End Mutual Fund
A warrant is a stock instrument issued in such a way that ordinary shares can be purchased at a specified number and price at a given time. In other words, a warrant is a right given to investors to buy ordinary shares of a company in the future. Generally, warrants are issued along with the bonds to make the issuance of the bonds attractive to the investors.
Investors are free to decide in the future whether to buy ordinary shares using warrant or not. Exercising the warrant turns into ordinary shares, but bonds remain the same. The issuance of a warrant discloses the price to be paid for the purchase of ordinary shares in the future (Exercise Price), the ratio of ordinary shares to be obtained using the warrant (Exercise Ratio) and the expiration date for the use of the warrant.
A securities dealer who buys and sells securities on behalf of a customer is called a stock broker. A stock broker takes buy/sell order from the client and executes the trade. The broker facilitates the trading of securities in the stock market.
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A securities dealer is a person/institutions who buys all or some of the securities issued in the primary market and sells them through the stock market and manages the investment by signing an investment agreement with the customer. A securities dealer buys and sells securities through a customer or securities broker in its own name.
Merchant Bank is an organization that manages the primary issuance of securities, guarantees and collects applications and details for securities trading. Merchant banks usually provide services such as financial advising, fund raising for companies, underwriting during the securities issuance among others.
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A market maker is an institution that buys and sells securities in its own name for the purpose of providing liquidity in the market. It helps to stabilize the highly volatile market. Market Maker are usually large institutions surplus with capital which profit from the price discrepancies in the market.
Share Registrar (RTS)
Share Registrar is a company responsible for keeping records of securities transactions of organized institutions and takes care of all the work related to registering the filings and updating the information of the shareholders. They carry out all logistic arrangement for the conduction of Annual General Meeting (AGM) of the company.
Central Depository System (CDS)
The central depository system of securities is a system that helps the concerned parties to complete the process of purchase and sale record, transfer, etc. in a simple and quick manner. Under this system, securities holders can open an account by depositing their securities just like depositors keep money in a bank. This system eliminates problems like loss of securities, theft and issue of counterfeit shares. It also helps reduce transaction costs.
Underwriting is the agreement between the underwriter and the company willing to issue the shares to the public. If the shares remain unsold in the primary market, the underwriter has to buy the shares as per the agreement. For this, it receives the agreed fee from the issuing company.
Before issuing securities in public, the concerned company should publish the statement known as the ‘Prospectus’. The prospectus discloses the details related to the organization that wants to issue the securities and helps the investors to decide whether to invest in the securities of the related organization based on the given details.
Over Subscription and Under Subscription
During the public offering, when the demand for the issued securities is high i.e investors apply for more shares than the issued quantity, this is known as Over Subscription of share. Similarly, when investors apply for less shares than the issued quantity, it is known as Under Subscription.
The difference between the issue price and the face value is called premium. The issue of securities at a price higher than the face value of the securities is called securities issuance in premium.
Bid and Offer Price
The value of the securities that a potential buyer wants to pay is called the offer price. The purchase and sale of securities is completed after matching the Bid Price and Offer Price marked by the securities brokers on the trading board of the securities market.
Market capitalization is the sum of the market value of all securities listed on the stock exchange market. Market capitalization is obtained by multiplying the number of securities listed in the market and their respective market value.
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The market index is the ratio between today’s total market value of listed securities and the total market value of a given base year. This indicator increases when the value of listed securities increases and decreases when it decreases. In case of Nepal, the NEPSE Index is the market index published by Nepal Stock Exchange.
Earning Per Share
Earnings per share are obtained by dividing the company’s net profit by the total number of shares of the company. Earnings per share provide a significant measure of profit for shareholders of the company. A company with rising earnings per share is considered to be successful in performance while declining earnings per share is considered a sign of a problem.
The total value of the company’s paid-up capital and total reserves is the company’s net worth. Dividing the net worth by the total number of shares of the company gives the net worth per share or the book value of the shares.
Price Sensitive Information
Price sensitive information is the announcement made by the company regarding dividend distribution or bonus share issue, change of management, expansion plan, financial quantities, important agreements with other parties and events directly affecting the price of securities and other information.
The trading of securities by the insiders or person close to the company based on the information which is yet to be released to the general public is known as insider trading. This type of transaction is prohibited by the prevailing system.
Annual General Meeting (AGM)
The annual general meeting is called by the company to inform the shareholders about the work done during the year, achievements, problems and future plans as well as to pass the annual accounts of the company, appoint an auditor and approve other important issues. According to the prevailing rules in Nepal, such a meeting has to be convened within six months of the end of each fiscal year.
A Proxy is a representative of a person who has not been able to attend the annual general meeting of the company in person and has given the right to vote by signing a petition in the prescribed format. A shareholder of any company can only nominate another shareholder of the same company as a representative.
Board of Directors (BOD)
The people who are responsible for managing the entire business of a company, exercising their rights and fulfilling their duties are the directors of the company. The directors of the company are appointed by the founders until the first annual general meeting and then by the general meeting. In order to be the director of any company, one has to take shares as prescribed in the rules of that company.
Annual Report is a yearly financial report published by the company. Annual report includes all the important business activities performed by the company in that year. This report helps the stakeholders (shareholders, regulatory bodies, employees, creditors and others) to analyze the business performance of the organization of that fiscal year. It mainly includes three major statements: Balance Sheet, Income Statement and Cash Flow Statements.