Why does the Stock Market exists? ~ The Finance Magic – Stock Market | Personal Finance

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Why the stock market exists?

“Stock market” the word sounds very interesting. People rarely know the
actual purpose of “Why does the stock market exists?” 

Often beginners tend to invest in the stocks of multiple companies based
on someone’s suggestion, it could be anyone either from your family, friends, local
shopkeeper, building uncle, etc just kidding but it’s a general fact and the
reason behind this is you want to earn some extra income without extra effort
i.e. to generate some handsome returns just from your shareholdings. That’s totally
alright but what we need to understand is the basis of the stock market, the
reason behind the movement of share prices. Many people consider stock market
as a gambling platform because there is always a certain level of risk associated
with it. Now, what are these risks we will be looking at it further in this article.


Let’s understand the entire basis of the stock market with the help of
an example: –

Suppose you have a business idea and for that purpose, you need an
initial capital to invest in the business, now the first source of raising
capital would be utilizing your savings, ask your family or friends to invest
in the business or you can even borrow money from them or you could go for a
bank loan (which will be the costliest way to raise capital as you will be
liable to pay interest on the amount borrowed even if you face losses in the
initial period of your business). So here the problem is solved as you were
able to launch your business and let’s assume you have even started earning
profits.

Two years from now you have a successful business and you are also able
to generate good profits but you are not able to meet the increasing demands of
the consumers and you have no opinions left but to expand your business. In
order to expand the first thing that you need would be the capital, huge
capital (probably much more than your existing business reserves) You start
looking for all possible ways to borrow funds either from banks or private
lenders but you failed to do so. Even if you take an unsecured loan that has a
higher interest rate of somewhere between 10%-14%, you would end up increasing the
debt burden for your company and if things didn’t work out as planned this
might be big business stress which could possibly eat up all your surplus and
make things really difficult to operate.

Since you had a successful business and a healthier balance sheet you
would probably like to raise the required funds through an IPO (Initial Public
Offer). A method where you are not liable to repay back the raised funds and for
this purpose, you approach a merchant banker who would assist you in the entire
fundraising process. The banker will value the business based on which you
could take a call on “how much stake you would like to sell to the general
public?”

(Summarising Para: For the expansion of the business you are
willing to let go some stake in the company, let’s assume 10% of your entire
holding. Now in order to do so, you have to file for an IPO i.e. Initial Public
Offer)

 

What is IPO?

An IPO is a process where the shares of a company are listed on the
stock exchange for the first time and the amount raised through this process
will be directly used by the company for its operational purposes (The
objective of IPO might vary depending upon the companies need. In our case it
was for business expansion.)

All the transactions of buying shares in an IPO is done in the primary
market (where the investor pays money directly to the company and in return get
the shares of that particular company)

Once the shares are listed on the stock exchange the latter buying and
selling of those stocks are done in the secondary market and the company has
nothing to do with profits and losses that investor earns due to increase or
decrease in the share price.

Note: Many of you might have heard about or even applied for IPOs especially
in the current month that is September 2020, we have seen 7 IPO so far and a
few of them in the loop. If the companies are well established and have good
profitability, they tend to enjoy high listing gains.

In simple words, if you have purchased a stock of any company than
technically you are not just buying a unit of share but you are actually
investing in the business of that company and expecting that the company will outperform
in the future. The increase and decrease of share prices totally depend upon
the investor’s expectation about the company’s future performance. You might
have often seen that when a company publishes good quarterly earnings or release
their annual reports, their share prices tend to increase because the investor
is expecting the company will achieve more profitability as compared to its
past quarter or annual earnings,

 

I hope I have done justice to the question of “Why does the Stock Market
exists?”

Last but not the least, since the performance of the stocks is dependent
upon how the company is performing and thus there would always be a certain
level of risk involved on whether the company will survive or not, many a time
business fails and which has a negative impact on its stock. It’s up to our
research and analysis about the company which could help us in achieving good long
term returns in future.

 

Summing up: –

·      
The business needs capital for expansion and hence they come up with an
IPO.

·     By investing in the
shares of the company we are betting on the future performance of the company.

·     Always remember: Never
ever invest on someone’s suggestion, do your own research and analysis.

·       Invest in the
business that has the potential to grow despite all the odds.

 

Happy Investing!

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If you found this article useful then do comment your questions or view
in the comment box below, and share it with all your family members and
friends. Let’s spread financial literacy together.

Check out our popular article: 

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A Complete Guide on Stock Market

 

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Thanks for reading.

The Finance Magic

We’re dedicated to providing you vast investment knowledge, with an emphasis on making you understand the “WHY” in finance. Our aim is to spread financial literacy and show you how magical the world of finance is?



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We're dedicated to providing you vast investment knowledge, with an emphasis on making you understand the "WHY" in finance.
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