What is the stock market?

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What is the stock market?

The stock market as a part of the capital market

The stock market is part of the capital market which brings together the demand and supply of capital. Suppliers of capital are those who are looking for a profitable use for their savings. This group is often represented by financial intermediaries like banks or funds, which make the pooled financial resources available to the capital market. The demand for capital is usually represented by companies or other institutions that need funds to finance investment projects.

Stocks as a means of external financing

Companies requiring additional financial resources have the choice between two main forms of financing on the capital market to fund their projects:

  • Equity-based financing by issuing company shares (stocks)
  • Debt-based financing by issuing debt obligations (bonds)
Both are forms of external financing. That means funds are raised from third parties. But there are significant differences. The owner of a share becomes a shareholder of the corporation by acquiring the stock while the owner of a bond becomes a creditor of the company by acquiring the bond. Another crucial difference is that the shareholder participates in the company's profits, while the owner of a bond receives fixed interest payments (coupons) until the debt is repaid.

 

Distribution of entrepreneurial prosperity

From an economic point of view, share investments are one of the most suitable means of fairly distributing entrepreneurial prosperity within society. Everyone is free to invest in the incorporation that he or she considers to be the most reasonable and promising investment and with a little care and foresight a small stock investment can turn into a considerable fortune.

Quite a few stock corporations that were first listed on the stock exchange just ten years ago for a few cents are now quoted at values of several hundred US- dollars. On the stock exchange there is the opportunity to create the basis for later waelth by the acquisition of suitable shares.

Creating passive income

Of course, not every stock purchase can be a bull's eye, but that is not necessary to create wealth in the long-term because with shares the basis for a steady income can be created.

Making money work for you is the art of investing and shares are a suitable means of achieving this. Those who forgo consumption today, save their funds and invest wisely will be able to profit tomorrow. The stock market offers everyone who understands this basic rule a gigantic pool of investment opportunities and sources that provide one with the knowledge and information he needs to make the right choices.

Opportunities and risks of stock investments

Like everything else in the world, stock trading, despite all this, involves not only opportunities but also risks. Accordingly, investors should always inform themselves and act with caution in their investment decisions.
The most important opportunities and risks at a glance:

Opportunities:

  • High profits
  • Regular dividend payments
  • Passive income
  • Acquisition of a tangible asset with stable value
  • Inflation protection
  • No time limit on participation

Risks:

  • Price losses up to total loss
  • Taxation of profits
  • Dilution of shares by corporate actions
  • Little influence on corporate decisions
  • Political and other external influences on the stock markets

The different types of shares

In line with the issuance of shares, companies can opt for quite different classes of shares, which confer different rights on the shareholder. The most important rights in connection with shareholding are listed below:

  • Voting right
  • Information right
  • Profit participation (dividend payments)
  • Participation in the annual general meeting
Depending on the class of shares, the constellation of rights granted may differ. Here is an overview of the most important types of shares and their special features:
  • Ordinary shares (common stocks) are the most common form of shareholding. They grant all of the previously mentioned rights to their owner.
  • Preferred shares usually have higher profit participation than common stocks of the same company and may grant reduced or no voting rights.
  • Registered shares can be purchased by anyone. However, the respective owner is entered in the share register.
  • Restricted registered shares are registered shares that can only be acquired with the consent of the corporation.

 

Stock exchanges and brokers

With few exceptions, nowadays shares are generally not traded physically but deposited in electronic form with depositaries. Shares are purchased via banks or brokers where investors have their custody accounts. Their trading systems are linked to the stock exchanges via electronic data processing systems, which are then used to process buy and sell orders (securities orders) from market participants.

There are numerous stock exchanges and brokers, and not every stock can be purchased through every broker or stock exchange. Where the particular share can be traded is determined when the share is issued. Therefore the stock market is not a centrally organized institution, but consists of many trading facilities and institutions located in many different places, interconnected via electronic systems. Together with the market participants, they constitute what is commonly understood as the stock market.

 

Regulation of stock markets

The regulation of national stock markets is essentially the responsibility of the respective national institutions, such as the U.S. Securities and Exchange Commission (SEC). Their tasks include the control of trading and compliance with the legal framework with the purpose of protecting shareholders and preventing illegal practices.

Companies wishing to use the U.S. capital market must register with the SEC. Raising funds on the capital market through a share issuance and the associated listing on a U.S. stock exchange is only possible in the context of registration and admission with the SEC.

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