Personal Financial Knowledge Management For You

Investing mistakes by investors

2009-01-07T09:43:00.001-08:00

There are some intelligent actions required any investor to lead his investment to a big success. But, majority of investors are losing there entire money through investments. What is the reason behind such huge failure? Below is the list of 30 common mistakes most of the investors make frequently. As an investor, knowing these mistakes will give you more success.

1. Start investing without any goal or plan.

2. Investing without proper research or study

3. Buying stocks at the time of selling and selling at the time of buying.

4. Short term trading by greed instead of long term investing by patience.

5. Following the actions of big famous investors, FII's (Foreign Institutional Investors) or fund houses

6. Following the public blindly

7. Investing in penny stocks

8. Taking advice from Uncle Sam for investing or taking advises from a wrong, non-qualified adviser.

9. Believing tips, analyst reports blindly

10. Investing on market rumors

11. Greed

12. Not having good understanding on the company, business, before investing in a stock.

13. Ignorance of necessary valuation methods to analyze a stock or analyze performance of a company.

14. Investing without discipline and patience

15. Ignorance of the basics. I.e. meaning of investing, what is a stock, how stock market working etc.

16. Ignorance of factors that capable to lead a market to bear phase or bull phase

17. Buying through IPO's only

18. Unable to evaluate a stock to identify to buy or sell

19. Investing only on hot sectors or companies from a fast booming sector like internet, real estate etc.

20. Marrying stocks with emotional attachment

21. Borrowing money for investing in stocks

22. Using credit cards for investing

23. Being panic when fluctuations happening

24. Monitoring the portfolio multiple times in a day or week

25. Not knowing portfolio diversification

26. Over diversification by 'n' number of stocks

27. Selling good stocks to meet temporary money requirements.

28. Over enthusiasm and expectations

29. Overconfidence

30. Investing only to avoid tax

Hope the above list will help an investor to take a self assessment as well as help to avoid such mistakes in the future. Be an intelligent investor.

Warren Buffett quotes on common sense investing

2009-01-07T09:35:00.001-08:00

No doubt, Warren Buffet is the most intelligent and successful investor today. He made his destiny using common sense. You don't required to have an extra brain to understand this secrets. It is very simple.

Here are some quotes from this legend investor to help anyone to be succeeded... have a look.

1. Buffett on investing on business not in stocks

"Whenever we buy common stocks for Berkshire's insurance companies (leaving aside arbitrage purchases), we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay"

2. Understand the business prior to invest

"Did we foresee thirty years ago what would transpire in the television manufacturing or computer industries? Of course not. Why, then, should Charlie and I now think we can predict the future of other rapidly evolving business? We'll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight?"

3. Don't invest on "franchise" business

"As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: 'Competition may prove hazardous to human wealth"

4. Be a long term investor than a short term trader

"We are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate . . . we do not sell our holdings just because they have appreciated or because we have held them for a long time"

5. How to deal with price volatility

"Charlie and I let our marketable equities tell us by their operating results not by their daily, or even yearly, price quotations whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it"

6. Buy good business when people are fearful

"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they feel elated when stock prices rise and depressed when they fall. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices"

7. He is against short term trading

"Indeed, we believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic"

8. His words against over diversification

"If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantage, conventional diversification makes no sense for you"

Take advantage of your tax deductions

2009-01-04T10:19:00.000-08:00

Taxes are inevitable and it is our social responsibility to pay them. So how about adding a new year resolution to do your homework on various tax deductions available and take full advantage of them.

That way you can save your hard-earned money and avoid paying additional taxes.

I understand taxes are burdensome for all taxpayers. But tax deductions act as a tool to cool all the itching and burning.

Fortunately, there are legally permissible ways to reduce taxes and retain more of your hard-earned money in your piggy bank.

Everyone wants to claim tax deductions and there’s no doubt that saving money in taxes is high on everybody’s list of financial priorities.

But considering the complicated income-tax law, how many people really know about them or take full advantage of them.

Surely, you could be missing a few of them. That’s why it is worthwhile to be aware of the tax deductions which can save your moolah.Let’s look at some commonly overlooked tax deductions.

Home sweet Home

Your home is not only your living shelter but also your tax shelter. If you live in a rental apartment and are a salaried person then you can claim house rent allowance. If not, you can claim deduction of the rent paid in excess of 10% of the total income subject to certain specified limits/ conditions.

If you own your home you can claim the benefit of deduction in respect of the interest paid on loan from a financial institution. Many people often restrict this amount to Rs 1,50,000.

However, it is pertinent to note that this restriction applies only for property considered as self occupied in nature and does not apply in cases where the property is let out or deemed to be let out.

Further, expenses like stamp duty, registration fees and other expenses incurred during transfer of the house property for purchasing a house can be considered for the purpose of determining the benefit of tax deduction in respect of repayment of the loan installment.

Education

Today the cost of education is scorching high which adds to the financial burden.

In this respect, in case you avail of a loan for higher education of your child or your spouse, then you can claim a deduction of the interest paid on such loan.

Health is Wealth

The deduction on medical insurance though of a small quantum of Rs 15,000 is often left out to be claimed. A bonanza is available in the form of an additional deduction of Rs 15,000 towards medical insurance premium paid for your parents.

Further, in case you have paid any amount for the medical treatment of any disabled person dependent on you then again you are entitled to a deduction in the range of Rs.40,000 to Rs.75,000.

Various deductions viz. life insurance premia, deferred annuity, contributions to provident fund, subscription to certain equity shares, tuition fees, house loan repayment, etc are all covered under a single basket of availing deduction upto Rs 1,00,000.

However, one tends to generally forget that all these are restricted under this cap.

At the end of it, just remember what’s one of the most important questions you need to ask every time you pay cash or write a cheque for payment or investment — Can I claim this as a tax deduction?

Do you know how to make 2008 a financial success?

2008-01-05T09:16:00.000-08:00

You were pretty confident about the investments you made at the beginning of 2007. But when the year closed you made nothing much from them.
Be it stocks, mutual funds, real estate or insurance. All or many of your bets fell through.
You bought stocks but at a higher price. The price went up still higher but the uncle next door bought another stock and made stupendous returns on his investments. Or you bought a share on some tip passed on to you by your cousin's uncle's friend's neighbour who got the same piece of information from a shady stock market operator. But the share price plummeted after you bought it.

Or are you the one who bought mutual funds just because your financial advisor promised you the moon? He told you about the past performance of a mutual fund scheme and you bought his logic that mutual fund unit prices move only one way: up, up, up.
Or maybe your insurance agent pushed one policy after another, of companies and various products like ULIPs, money back and endowment plans but forgot to mention the term insurance plan.

Here's the story of our reader Krishna Bhukya, 27, a Delhi-based software consultant, who bought a ULIP policy instead of buying a term insurance as he later realised.

got married in the summer of 2000. By January 2007 we were blessed with a baby girl and with a boy abd were also able to purchase a 2 bed room flat on the outskirts of Delhi. Since I had taken a loan and had dependants now I wanted to buy an insurance policy that would take care of my family in case of any unfortunate event.

I called up my insurance agent and asked him to come out with the best option that would take care of my requirement. He visited my house two days later and advised me to buy a unit linked insurance programme, ULIP. He told me how ULIPs will help me invest as well as take care of my insurance needs.

He explained all the benefits of investing in ULIPs -- the option of not paying annual premiums after three years without any impact on my sum assured, my premiums getting invested into the share market and buying units for me etc. I gave in to his persistent pitch without thinking too much about the pros and cons of such a policy.

Though the stock market has gained stratospheric heights my units are still not fetching me enough returns. This is because the premiums in the first three years that you pay towards your ULIP policy goes towards a bevy of charges like administration costs, mortality charges and lot other things, my insurance agent said like a sage.

He told me that as time goes by these charges will decrease and more of ULIP premiums will go towards investments in the share market thereby increasing my returns. Also, the sum assured on my ULIP policy is Rs 25,00,000 for which I am paying an annual premium of Rs 30,000.
A friend of mine told me that a term insurance plan would have got me the same sum assured at a much lower annual premium. He told me that I could get a sum assured of Rs 25,00,000 by buying a term insurance at an annual premium of not more than Rs 10,000. He told me I could myself invest the remaining amount -- Rs 15,000 I will save if I switched from the ULIP plan to term insurance -- in diversified equity mutual funds and get better returns than ULIPs over a time horizon of 15 years.

When I hired a professional financial consultant he too agreed with my friend and has asked me to stop paying ULIP premiums after three years and buy a term insurance policy immediately.
Now that I have realised my investment/insurance blooper I bought a term insurance plan and feel much happy that I could insure myself at a fraction of a cost and invest the rest of my money into mutual funds.

Moral of the story:

~ Don't take your insurance agent at face value; cross-check whatever s/he says with a couple of professionals before you make a decision.

~ Always seek professional help for making important financial/investment decisions in your life.

~ Study all the advice -- even if it comes from your professional financial advisor -- before you put your hard earned money.

~ Never make any investment be it in stocks, mutual funds, real estate or insurance unless you are pretty certain about what you are doing.

~ And once you board the ship expect the best and be prepared for the worst.

Did you make such mistakes in 2007? What caused you to make these mistakes? How could you have avoided them? Would you like to inform people about such investment bloopers so that they make wiser investment decisions in 2008?

How are you planning investments in 2008 so that the year ends for you on a happy note?

Buy ELSS funds, make money and save tax

2008-01-05T09:05:00.000-08:00

Do you want to 'kill two birds with one stone' through smart investment-cum-tax planning?
If yes, then you should consider investing a part of your investible income in equity linked savings scheme (ELSS) of mutual funds. ELSS is an efficient investment tool that offers the twin-advantage of healthy capital appreciation and reduced tax burden. In our work-a-day life, we exert ourselves utmost to save every penny but are exasperated when taxes eat into our savings.

In order to save on tax, we have the option to invest a maximum of Rs 1,00,000 in various tax saving instruments under Section 80C of the Income Tax Act.

The eligible investments for availing Section 80C benefits include contribution to Provident Fund or Public Provident Fund (PPF), payment towards life insurance premium, investment in pension plans/ specified government infrastructure bonds/ National Savings Certificates (NSC)/ Equity Linked Savings schemes (ELSS) of mutual funds, payment towards principal repayment of housing loan (also any registration fee /stamp duty paid), and payments towards tuition fees for children to any school or college or university or similar institution (only for 2 children).
If you do a cost-benefit analysis of ELSS, PPF and NSC, then you will find that ELSS offers you manifold advantages/ benefits as compared to the other two tax savings instruments.

ELSS has a lock-in of only three years, whereas PPF and NSC have a longer lock-in period of 15 years and six years respectively. PPF and NSC fetch you a return at a compounded annual growth rate (CAGR) of 8 per cent while the average returns over three years in ELSS, which allows investors to participate in the India growth story by investing its money in shares, for the top five schemes as on November 30, 2007 is in the region of 50 per cent.
It would not be out of place at this point to slip in a caveat emptor that in the case of mutual fund investments past performance may not be sustained in future as equity markets are affected by events, global as well as domestic.

The maximum investment an individual can make in PPF under Section 80C is Rs 70,000, whereas it is Rs1,00,000 in the case of NSC and ELSS. When it comes to reaping taxation benefits, ELSS scores over PPF and NSC. As per current tax laws if you invest in ELSS, then dividend and capital gains are tax-free. While interest received in the case of PPF is tax-free, the same is not true in the case of NSC.

How to start an ELSS account?
There are two ways to invest in ELSS.

~ Invest a fixed amount every month through systematic investment plan (SIP) in ELSS and reduce the burden of large investment towards the end of financial year.
~ Invest lump sum at any point of time.

Why SIP route for ELSS?

One of the best ways to invest is to save and invest on a regular basis through SIPs. SIP is a planned investment programme, whereby an investor invests small amounts of his/her savings in mutual funds at regular intervals.

SIP helps an investor take advantage of the fluctuations in the stock markets by rupee cost averaging (in a rising equity market an investor gets fewer MF units but when the market is sliding he/she gets more MF units) and also helps him/ her reap the benefits of compounding.
A SIP in ELSS offers an investor the best combination of investments -- tax-savings and capital appreciation -- available to investors. The minimum investment in an ELSS through the SIP route can be as small as Rs 500.

By investing regularly in ELSS, the problems of wrong timing, wrong stock selection and burden towards the end of financial year is reduced substantially.

Since ELSS has a lock-in of three years, the fund manager does not face any redemption pressure. This is important as the manager has the elbow-room to allow the stocks in his/her portfolio to mature. He/ she is not under undue pressure to sell stocks which are expected to fetch good returns over a two-three year horizon.

In sharp contrast, open-ended schemes can be likened to an expressway which has an exit every 500 meters. So, when investors in an open-ended scheme go for redemption, the fund manager has no choice but to sell stocks which have the potential to grow over a two-three year period.
While choosing ELSS an investor would do well to keep in mind the size, experience, quality and consistency of fund houses over a period of time. If you are building a nest-egg and are conservative, then you should consider channeling your precious resources into ELSS even as you apportion a small part of your savings to PPF and NSC.

The 7-point action plan for investors:

2007-10-26T10:59:00.000-07:00

1. Understand Yourself:

This is the starting point and is especially essential in such times. Start from the beginning - Assess your risk appetite, your time horizon and your financial goals. This will help you to understand if your current portfolio allocation is in line with your particular situation. In bull runs, the assessment of risk appetite gets inflated, while in bear markets, investors underestimate their ability to take on risks. Similarly, if you are investing for your retirement in 20 years as a financial goal, stock market gyrations over the next 3 to 5 years are irrelevant. After assessing these three parameters, look at your earning, saving and hence investment potential. Based on this you will have an idea of your ideal asset allocation...how much money to put in stocks, bank deposits, gold etc. And no better time than times of turmoil to spend a few critical moments evaluating what you have, where it’s located and where the holes in your investment ship may exist.

2. Understand the Risk Reward Equation:

So called safe investment options like Bank deposits, while giving steady returns, lead to erosion of purchasing power due to inflation and taxes both. At 5 % inflation, Rs 1000 today will be worth only Rs 230 in ten-year time. Over the last 27 years, while inflation averaged 7%, 1-year bank deposits, the most popular category, gave before tax returns of 7.5 %. Similarly, what costs Rs 1000 today, at 5% inflation, will cost Rs 1629 in 10 years time.

Stock markets give superior, inflation-adjusted returns, but in the short term they give a roller coaster ride. Hence its critical to understand the nature of each asset class, the type of returns, the risks associated with it and the optimal time horizon for them. If you are asking, “Is this a good time to buy”, you are on the wrong track. The question to ask is, “Will this investment / financial plan help me meet my long term goals?”

3. Understand Markets:

In the short term, stock markets are influenced by sentiments, while in the long run fundamentals are the key determinants. What is certain is that the stock market is a volatile animal, marked by euphoric highs and depressive lows. Indian markets have historically had a decline of 10% or more about once every two years. Even in the greatest bull market we have ever seen, from 2003 to 2007, there have been sharp declines. That's the nature of the market, even in good markets we have declines, and trying to predict its direction over the near term is an exercise in futility. Since 1979, we've had 18 corrections – or drops – of 10% or more. Investors who understand the fundamentals of the market don't panic or pull out when the cyclical declines take place.

4. Understand Long Term:

Over the last 28 years, the Indian stock market has yielded a compounded annualized growth of 20% per annum as reflected in the BSE Index, which has moved from 100 in 1979 to 17,000 in September 2007. Similarly, in 1992, from a market capitalization of Rs 160,000 crore, the Indian markets have moved up multi fold to a market cap of Rs 45 lakh crore in 2007. If in 1992, we knew our money would go up 28 times roughly in the next 15 years, all Indian investors would have put their entire savings in the stock market. However, we are happy in locking our money for 15 years in PPF accounts giving 8% assured returns. What is needed is an understanding that if you invest for the long term, i.e. for 10 years or more, the chance of making a loss is nearly zero, while the upside is many times that of other “safer” investment options. This understanding of what is truly long term is critical for financial health, and will lead to investors having peaceful sleep in times of high volatility

5.Understand Diversification:

Diversification has and always will be the most critical component to investing wisely.
Keep funds equivalent to 6 months of expenses in a liquid fund or savings account. Use insurance to cover the risk of dying young, not as an investment vehicle. And diversify your investments into a wide range of equities, bonds, gold, real estate and other asset classes.

Consider gold and other precious metals. Historically, precious metals such as gold have been considered a ‘safe haven’ in times of economic, financial and geopolitical instability.
After you have covered yourself across the standard asset classes, all you need to do is to re-balance your portfolio on a quarterly basis and hang on tight. The bottom line is to have a well spread out, responsible plan for your investments and know what you own and why you own it.

6. Understand Time and Timing:

Remember that time in the market is important - not timing. Even diversified investment portfolios can lose ground in a bear market. At that time, it’s easy to be tempted to sell all your stocks and funds, and move to cash or bank deposits to wait for better times. All you have to do then, the reasoning goes, is move back into stocks on the day the stock market begins its recovery.

The problem is, nobody knows when that day will be. And if you miss getting back in at the right time, you can lose a huge portion of the upside. If you were investing at the highest point of the Sensex every year since 1979, you would have made around 19.6% compounded annual returns till 2007. On the other hand, if you were a financial wizard and invested at the lowest point of the Sensex every year since 1979, you would have made around 20.2 % compounded annual returns till 2007.

7. Understand SIPs: Invest in Bad Times and Good

One of the best ways to invest regularly is rupee cost averaging through a systematic investment plan or SIP. This involves investing the same amount at consistent intervals, such as once a month or every quarter. With this approach, you don’t have to try to guess which way the financial markets will move - and you won’t be waiting around for the perfect time to buy while the market gallops away. Even though SIPs can’t guarantee a profit or protect against a loss, they help you to take advantage of a down market by ensuring you end up buying more shares or mutual fund units when the price is down.

Market volatility is a fact of life, market decline are natural. By astute financial planning and asset allocation, investors can position themselves to ride out the waves towards financial security and success. This is as relevant in raging bull markets as they are in times of despondency. Following the above 7 Action Plan increases the odds of success manifold for the astute investor.

Mutual Funds

2007-10-05T22:54:00.000-07:00

About Mutual Funds:

What is it about investing that irks you most? Is it the fact that it is time-consuming since it involves researching the market for investment products and then proceeding with the paperwork involved? Or could it be that once you have made your investments, you cannot find the time to monitor them? Like most of us, do you dread a situation wherein you need your money all of a sudden and have no access to it or have to run from pillar to post to get it back?

Do you sometimes hesitate to invest because you are unsure about how well-regulated investment products are? Is your approach to investing constrained by the fact that you possess limited investment capital, which does not allow you to achieve the diversity that you desire?If these are some of the reasons that make you feel disinclined to undertake an investment exercise, consider mutual funds.

This investment vehicle successfully addresses the above concerns and offers other benefits too. Let’s take a look at what exactly a mutual fund is and how it functions. A mutual fund is an entity, which offers a number of investment schemes with different investment objectives. An investor interested in investing in these schemes needs to assess which scheme has an investment objective that matches his, to make his selection from among the available schemes.

Mutual funds are well-structured and closely-regulated entities, which hire investment professionals to invest and manage investors’ funds.

Mutual funds issue units to each investor based on the amount invested. Units of mutual funds are similar to shares issued by companies. For instance, if an investor invests Rs 5,000 in a new scheme of a mutual fund, which is offering units at Rs 10 per unit, he will receive 500 units in the scheme (Rs 5,000 / Rs 10).

The mutual fund invests the money collected from unit-holders on their behalf. Income earned on these investments is distributed by the mutual fund among its investors in proportion to their holding in the scheme. For instance, taking the above example forward, if the scheme issues a total of 1 lakh units and earns a total income of Rs 1 lakh in a particular period, it would have earned Re 1 per unit issued (Rs 1 lakh / 1 lakh units). The investor, who had applied for 500 units, will be entitled to receive Rs 500 (income earned per unit – Re 1 x 500 units).

Choice of investment strategies:

From just two scheme types (equity scheme and debt scheme) offered when the mutual fund industry was conceived more than four decades ago, today, mutual funds offer a plethora of scheme types with different investment strategies. Consider equity schemes. From just one scheme type, there are, today, more than 10 types of schemes, each offering a unique investment strategy. For instance, an index fund invests in stocks forming a stock market index such as the BSE Sensex or NSE Nifty in order to make gains equivalent to appreciation in the index. A sector fund invests in securities of companies belonging to a specific sector (banking, IT, pharma, etc.) in order to make gains when the sector is prospering.

Similarly, in case of debt schemes, from just a single debt scheme-type, presently, there are more than 6 scheme types. Each debt scheme focuses on specific debt securities with specified tenures. For instance, a long-term gilt scheme will invest in government securities with long tenures (exceeding 7-8 years) while a short-term floating rate fund will invest in debt securities with short tenures (1-3 years) whose coupon rates are reset at regular intervals depending on change in prevailing interest rates.

In addition, there are schemes, which combine debt and equity to adopt different investment strategies (balanced funds, MIPs, etc.).

There are also schemes, which invest in other mutual fund schemes (called Fund of Funds).
In other words, mutual funds have been able to envisage different investment strategies that can be adopted by investors, and have created scheme types to cater to each of these strategies

Equity

2007-10-05T22:38:00.000-07:00

About Equity:

Equity is a share in the ownership of a company. It represents a claim on the company''s assets and earnings. As you acquire more stock, your ownership stake in the company increases. The terms share, equity and stock mean the same thing and can be used interchangeably.

Holding a company''s stock means that you are one of the many owners (shareholders) of a company, and, as such, you have a claim (to the extent of your holding) to everything the company owns. Yes, this means that technically, you own a portion of every piece of furniture; every trademark; every contract, etc. of the company. As an owner, you are entitled to your share of the company''s earnings as well as any voting rights attached to the stock.

Another extremely important feature of equity is its limited liability, which means that, as a part-owner of the company, you are not personally liable if the company is not able to pay its debts. In case of other entities such as partnerships, if the partnership goes bankrupt, the partners are personally liable towards the creditors/lenders and they may have to sell off their personal assets like their house, car, furniture, etc., to make good the loss. In case of holding equity shares, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

Characteristics of equity :

Equity is unsecured and a high risk-return investment:

When you invest your money in a debt investment such as a bank deposit, bonds, etc., you are promised a fixed amount of interest on your investment and return of capital. This isn't the case with an equity investment. By becoming an owner, you bear the risk of the company not being successful. However, the rewards for bearing this risk are high. You, as an equity shareholder, are entitled to a share in the profits of the company’s business as well as any appreciation in the perceived value of the shares.

The risks and rewards of investing in equity are clearly apparent from the Bombay Stock Exchange Sensitive Index (BSE Sensex), which is a popular stock market index. This index reflects the movement of the share prices on the stock markets. The Sensex rises and/or falls continuously during trading hours. Rises indicate gains and falls indicate losses. True equity money is unsecured and directly reflects the faith of the investor in the business, its management and the commitment of its principals to it.

Equity remains in perpetual existence:

The perpetual existence of a company implies that the death, disability, retirement or termination of a shareholder, director or officer, will not affect the existence of the company. For an equity shareholder, this is convenient since he does not need to renew/renegotiate the terms of his investment (like in the case of a fixed tenure debt investment). He also has the option to sell his equity holding through the stock exchange if he no longer wants to remain invested in the company.

Limited liability:

Another extremely important feature of equity is its limited liability, which means that, as a part-owner of the company, you are not personally liable if the company is not able to pay its debts. In case of other entities such as partnerships, if the partnership goes bankrupt, the partners are personally liable towards the creditors/lenders and they may have to sell off their personal assets like their house, car, furniture, etc., to make good the loss. In case of holding equity shares, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

Income from equity investing :

Capital appreciation:

Equity shares of companies are listed and traded on a stock exchange (the Bombay Stock Exchange or the National Stock Exchange). The market prices of these shares are continuously moving up or down depending on the interest in the company’s stock, it’s business potential, etc. As an equity shareholder, you can profit/lose from the market price rise/fall. For instance, if you have purchased the equity shares of Company ABC at Rs 25 per share and the market price of the share rises to Rs 30, you can sell the shares at this price to make a profit. This is called ‘capital appreciation’. However, if the market price falls to below Rs 25, you would lose. This loss would be notional till you actually sell at this price and book the loss.

Bonus shares:

When you purchase shares of a company, you become a shareholder of the company. When the company is doing well, it may declare a ‘bonus issue’. This means that the company will issue fresh equity shares to its existing shareholders, for free. As a shareholder, you will be entitled to receive bonus shares in proportion to your holding in the company. For instance, if the company declares a bonus in the ratio of 1:2 (this means it will issue one share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a bonus. When you sell your bonus shares in the stock market, the market price at which you sell your bonus, minus brokerage charges and necessary taxes (Service Tax, Securities Transaction Tax, etc.), will be your profit i.e. capital appreciation. In this case, there will be no cost of purchase since you have received the bonus for free. For instance, if the company declares a ‘bonus issue’ in the ratio of 1:2 (this means it will issue one bonus share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a ‘bonus shares’. The cost of these shares will be nil. In this case, if you sell your bonus shares in the market at say, Rs 35, your capital appreciation will be the entire Rs 35 per share minus brokerage, taxes, etc.

Rights shares:

Another way a company offers benefits to its shareholders is by offering ‘rights shares’. This means that the company will offer fresh equity shares to its existing shareholders at a price, which is lower than the current market price of the share. For instance, if the current market price of the company’s share is Rs 35, it will offer shares at below this price, say Rs 25. As a shareholder, you will be entitled to receive ‘rights shares’ in proportion to your holding in the company. For instance, if the company declares a ‘rights issue’ in the ratio of 1:2 (this means it will issue one share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a ‘rights shares’. This implies that to obtain the ‘rights shares’, you will have to pay Rs 1,250 (50 shares you are entitled to x Rs 25 per share). In this case, if you sell your rights shares in the market at say, Rs 35, your capital appreciation will be Rs 10 per share minus incidental selling costs.

However, if you don’t want to subscribe to the rights offered to you, you can sell your rights entitlements. The price that you receive to sell your rights entitlements will depend on the rights offer price, the current market price and the demand for the company’s shares. For instance, taking the above example forward, if you decide to sell your rights entitlements of 50 shares and you receive Rs 2.50 per share, you will get a total of Rs 125. This will be your profit after deducting incidental selling expenses.

Dividend income:

Companies report their profits earned on a quarterly basis. Based on the quantum of profits, companies declare dividends to distribute a portion of these profits to their shareholders. Dividends are declared as a percentage of the share’s face value. For instance, if a company declares a dividend of 10 per cent and its share has a face value of Rs 10, it implies that it will pay Re 1 per share as dividend (Rs 10 x 10 per cent). As a shareholder, you will be entitled to dividend to the extent of your share holding. For instance, in this case if you hold 500 shares, you will get a dividend of Rs 500 (500 shares x Re 1 per share). However, dividend income is uncertain. Companies don’t declare dividends regularly. Dividends are declared only when there are profits available for distribution.

Reasons for issuing equity :

To expand its business, a company, at some point, needs to raise money. To do this, it can either borrow by taking a loan or raise funds by offering prospective investors a stake in the company --- which is known as issuing stock. A company usually borrows from banks and/or financial institutions. This is called ‘debt financing’.
On the other hand, issuing stock is called ‘equity financing’. While raising loans is used for temporary cash requirements (such as borrowing to fund a project), issuing stock is used to raise funds of a permanent nature. While a lender gets interest for the loan given to the company, an equity shareholder gets a share in the

Stock Market

2007-10-05T22:31:00.000-07:00

The stock market is one of the most important sources for companies to raise money. This allows businesses to go public, or raise additional capital for expansion. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate.

History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. Financial stability is the raison d'être of central banks.
Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction.

The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity.

The term 'the stock market' is a concept for the mechanism that enables the trading of company stocks (collective shares), other securities, and derivatives. Bonds are still traditionally traded in an informal, over-the-counter market known as the bond market. Commodities are traded in commodities markets, and derivatives are traded in a variety of markets (but, like bonds, mostly 'over-the-counter').

The size of the worldwide 'bond market' is estimated at $45 trillion. The size of the 'stock market' is estimated at about $51 trillion. The world derivatives market has been estimated at about $480 trillion 'face' or nominal value, 30 times the size of the U.S. economy…and 12 times the size of the entire world economy. The major U.S. Banks alone are said to account for well over $200 trillion. It must be noted though that the value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. (Many such relatively illiquid securities are valued as marked to model, rather than an actual market price.)

The stocks are listed and traded on stock exchanges which are entities (a corporation or mutual organization) specialized in the business of bringing buyers and sellers of stocks and securities together. The stock market in the United States includes the trading of all securities listed on the NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, the OTCBB, and Pink Sheets. European examples of stock exchanges include the Paris Bourse (now part of Euro next), the London Stock Exchange and the Deutsche Börse.