In this article, we will understand Share Market Working Concept with simple and interesting examples. So Just read this article till the end.
Note – If you want to understand the basics of share market or Share Market Working Concept from zero level then you should start with Part 1. – 📈 Share Market and Related
| So far we have understood…
So far we have understood that the financial market has two parts – money market and capital market . The securities market is a part of the capital market. The securities market has two components – the primary market and the secondary market.
As we know, there are two types of people in the market. One who has extra money and the other who needs money. if you are buying shares of a company, it means we have extra money, obviously only then we are investing.
On the other hand the company which is selling its shares obviously has a shortage of money that is why it is selling its shares. Otherwise why does he sell!
| Now the question may come in your mind that why should he sell his shares when he can take loan from the bank?
The fact is that there are many reasons behind selling shares, which you will understand gradually. Well one of the reasons for this is that if the company takes a loan from the bank and suppose that company sinks, then the bank will sell all its assets and recover the money.
On the other hand, if that company issues shares and then sinks, then the investor’s money will be lost because the company does not have to pay any interest.
| How does the stock market work?
| Example Part 1
Suppose Mukesh opened a shop and he himself invested all the capital in that shop with himself ie Mukesh has 100% equity of that shop.
When 100% equity is held by only one person, then this arrangement is called Proprietorship and that person is Proprietor.
| part 2
Mukesh has to make his business bigger for which he needs some money. To arrange this money, Mukesh gives 50% equity of his shop to his brother Anil. That is, the Fifty-Fifty share got divided between Mukesh and Anil.
This happened that the money needed by Mukesh was fulfilled by Anil but instead Mukesh had to give half of his shop share. In this way now the proprietorship ends and partnership starts.
| part 3
Suppose Mukesh wants to increase his business further, he wants to open many more shops but neither he nor Anil has money now which will be invested in it. If he does not want to take the loan, what will he do now? Obviously he will take money from the market.
There are many private investors in the market who invest money in a company but they do not take interest in return but take a stake in that company. As you must have heard the name of angel investor who invests in a company and in return becomes a partner of that company.
Mukesh converts his company into a private limited company to raise money from similar private investors . The advantage of forming a private limited company is that the company can raise money by selling its shares to a private investor, that is, now Mukesh can also issue shares of his company.
⚫ The second advantage of a private limited company is that now when Mukesh will take a loan from the bank and is unable to repay it, then the bank wants to sell Mukesh’s company’s assets and collect as much money as possible, but they cannot touch Mukesh’s personal property.
Remember one thing here that Mukesh still cannot sell shares to common people. Can only sell to registered private investors. This is because Mukesh’s company is still not a public limited.
By the way, if you want to know the difference between Private and Public Limited, then you can know by clicking here.
| part 4
Let’s assume that Mukesh’s company value is currently Rs 1 lakh. Because both Mukesh and Anil are the sharers of Fifty-Fifty, then according to this, 50 thousand rupees belonged to Mukesh and 50 thousand rupees to Anil. This is called paid-up capital , that is, the capital that both of them have invested in this business so far.
Now both the partners made 1 lakh shares according to their paid-up capital and divided between them i.e. 50 thousand shares belonged to Mukesh and 50 thousand shares belonged to Anil.
⚫ To put it in another way, both of them kept the value of their one share at Re 1. This is 1 rupee, it is called face value i.e. the value of 1 share that both of them kept when its paid up capital is 1 lakh rupees.
Remember one thing here that one lakh shares are divided in both, that’s why the value of one share is 1 rupee, if 10 thousand shares were divided in both, then the value of one share would have been 10 rupees. In this case Mukesh and Anil have made 1 lakh shares, hence the face value is Rs. 1 And both the partners have got 50 – 50 thousand shares in their names.
But if Mukesh and Anil want more money in future then they should have shares to sell as well because someone will give money only when he gets a stake in the company.
⚫ Keeping this in mind, Mukesh and Anil issued 1 lakh extra shares. These extra shares they have issued to sell are called Authorized Shares ; That is, by selling those shares, Mukesh and Anil can raise money.
Since now the face value of a share is Rs 1 so now if Mukesh and Anil sell that entire extra 1 lakh shares, they will get a total of Rs 1 lakh. That is, in the present date, Mukesh and Anil can earn up to Rs 1 lakh by selling this share. This is called Authorized Capital ; That is, the maximum capital that Mukesh and Anil can earn.
| part 5
Let us assume here that it has been 6 months since the shares were issued to Mukesh and Anil and now his company has become worth Rs 2 lakh. This means that now the value of one share has become Rs. 2 Why?
Because the price of a share was Re 1 when your company was worth Rs 1 lakh. But now the company has become 2 lakh rupees and the share is the same, that is, one lakh, obviously the value of one share will be 2 rupees.
The value of this share which became Rs 2, this is called market value; Remember that everything depends on the market value. This means that Mukesh and Anil currently have 1 lakh Authorized Shares. Its value became Rs 2 lakh at the rate of the share at Rs 2. Now he can earn Rs 2 lakh by selling that share.
This means that now if someone buys shares of Mukesh and Anil’s company, then he will get one share for 2 rupees.
Now let’s assume that they both need Rs 1 lakh now. So if they sell 50 thousand shares out of that 1 lakh Authorized Shares, then they will get 1 lakh rupees because now the market value of one share is 2 rupees. That 50 thousand shares a private investor named Nita; and thus he gets 1 lakh rupees.
Now you will remember that both the partners have 50- 50 thousand shares now and now a third person sold another 50 thousand shares to Neeta. This means that now the company has three shareholders. And since all three have 50 – 50 thousand shares, the equity of all three will become 33.3 percent in the company.
Now here you will think that this new partner Nita has come, she has become equal owner of the company. So let me tell you that it is not like that at all. Why is it so?
So you will remember that both Mukesh and Anil had invested 50 – 50 thousand rupees in the initial time, which we called paid up capital. He got 50 thousand shares in exchange for that 50 thousand rupees.
But to buy this 50 thousand shares, Nita had to pay Rs 1 lakh. That is, by paying twice the amount of both of them, she had to buy those 50 thousand shares. So there will always be both the partners in the profit even if his stake in the company is reduced.
If you have understood this much concept, then let me tell you that the shares which have been bought and sold right now have happened in the primary market because the share has been bought directly from the company itself and still common investors are not involved in it.
⚫ The second thing is that till now the company is a private limited only and its limitation is that it can have maximum 50 share holders only. But if Mukesh and Anil need more money then what should they do?
Then he will think of taking money from common people. And to take money from the common people, he has to first convert his private limited company into a public limited company.
When this happens then the real game of share market will start. Because the secondary market is the real stock market. How does this happen and how do we buy shares? The answer to all will be found in the next part of this article.
| Share Market Working Concept Part 2
So, we had understood through an example how a business turns from a Proprietorship to a Partnership and then a Private Limited Company. Private limited company raises money by selling shares to certain people or financial institutions etc. If this company wants, it can remain as a private limited, but it has some limitations such as the company can have a maximum of 200 members.
But if that company becomes a Public Limited Company , then it can sell its shares or make members as many people as it wants, because the limits of Public Limited are not limited.
⚫ Secondly, by converting into a public limited company, the company can sell its shares to the general public i.e. retail investor and can directly collect money from the general public.
Overall, it means that a company as a whole has to become a public limited to be a part of the stock market i.e. secondary securities market. What happens after this happens, let’s understand,
| Working Concept
By the time a company reaches the level where they can become a public limited, the company becomes very large while its stock becomes smaller. For example if suppose we buy one share of Reliance company for Rs 1000 and the market value of Reliance company is 1000 crores now then you are holding only 0.00001 percent share of that company.
⚫ The role of stock exchange increases as soon as it becomes public limited. Why? Because a company will not sell shares by going directly to each and every person. Some platform is needed from where all this work can be done. This is where the platform is provided by the stock exchange.
Once listed on the stock exchange, the company can sell its shares in the market. When the company launches its shares in the market for the first time, it is called IPO i.e. Initial Public Offering. This means that the company is offering its shares to the public for the first time.
If a person buys this share directly from the company, then it is called primary market. We have read about this before. Let us take an example of Mukesh again.
⚫ In that case Mukesh’s company needed more money, so Mukesh made his company public limited and got registered in the stock exchange.
After this Mukesh brought the IPO of his company. How much will be the price of one share and in what quantity it is to be issued, it all depends on Mukesh.
He can issue as many shares as he wants and can also decide the price of the share. Because only he knows how much money he needs.
⚫ But remember one thing that Mukesh cannot issue more shares than Authorized Shares. If Mukesh is not getting as much money according to Authorized Shares as he wants, then he can also increase Authorized Shares. For this, he will have to follow the Companies Act 2013 of the Government of India .
Now when Mukesh has to issue IPO, he will go to the stock exchange. The stock exchange will sell his shares and after taking money from the investor, he will give it to Mukesh.
Mukesh’s work ended here. He got all the money he wanted. Now he can invest that money in the company. Here the primary market ends and the secondary market begins. That is, now the shares, which are floating in the stock market, will start buying and selling among themselves.
| What did all this mean?
This means that now suppose that you want the shares of Reliance company, then you cannot buy it directly because it is a very old company, do not know when it would have brought its IPO, that is why you can buy its shares in the secondary market.
Buying from the secondary market means that you are buying Reliance shares from a person who is already sitting by buying his shares and now he wants to sell.
⚫ Now the question comes that why will he sell when he is sitting on buying. Think of it this way, suppose you have bought Reliance shares for Rs 1000. Now as soon as the market moves up, that is, as soon as the company earns profit or the demand for that share increases in the market, then the price of your 1000 rupees share will also increase, let’s say that 1000 rupees share becomes 1500 rupees.
So obviously you would think that if you are getting 50% return then why not sell it. Just you will sell it for 1500 rupees, you have got 1500 rupees, there will be someone to buy, he will buy it.
⚫ Now again the question comes that why people will buy when its price is now 1500 rupees, then the thing is that when you yourself had bought that share for 1000, then you also bought it thinking that in a few months or a year It will give good returns.
You got a good return, thinking that another person will also buy it thinking that now its price is 1500 rupees but in a few months or years it will definitely become 2000 or more. Because the company will earn profit, then the market value of the share will also increase.
So in the same way, shares are bought and sold in the stock market, but let us know how this happens.
| buying and selling of shares in the stock market
Now this question may also come in your mind that any company will sell with the help of stock exchange but how will you buy and sell it from there.
So let me tell you that the common man can buy and sell shares, for this there comes a concept of DeMAT account. You must have heard its name. Let’s understand it.
| What is Demat Account?
In fact, earlier it used to be that whenever a person bought a share, he would get it printed on paper (ie in physical form). This created many problems like fake transfers, fear of getting damaged or lost etc.
To deal with similar problems and to provide internet-based service, physical securities were replaced electronically. This is called dematerialization . It is called DeMAT ( D-MAT ) in short. Its account is called DeMAT account.
Overall, it means holding shares, bonds, etc. in de-materialised form. You can understand this in simple language in such a way that your shares are not in physical form but in virtual form, as if you open a savings account in a bank and keep money in it, in the same way shares, bonds are in DeMAT account. , debentures etc. are kept.
Where does this DeMAT account open now? The Government of India has maintained a ‘depository‘ of this DeMAT account and this is where this account opens. Now the question comes that what is this depository?
| What is a Depository?
A depository is an institution that holds securities in dematerialized form and allows investors and traders to sell and buy securities.
Because there is another intermediary in the middle who provides you a platform to open DeMAT account. It is called Depository Participants i.e. DP. It acts as an intermediary between the depository and the client.
Currently 276 Depository Participants are registered with NSDL. As you must have heard the name of Zerodha . It is registered with NSDL itself. Similarly, 596 DPs are registered with CSDL. As you must have heard the name of Angel Broking.
So this is a total of 872 DPs, you will have to open an account in any of them. When you open an account in it, your DeMAT account will also be opened and your savings bank account will also be linked with it.
Whenever you buy shares, money will be deducted from your savings account and the shares will be credited to your DeMAT account. You will get to know every day what is the condition of the market right now, whether the market is moving up or down. You can see everything in your trading account, how much you bought shares for now, how much they have become, etc.
| overall Share Market Working Concept
First comes the stock exchange with which the company is listed and they issue their IPO to take money from the market. But since a DeMAT account is required to buy shares and a Demat account is opened by a depository; Which is able to do this with the help of Depository Participants. The stock market works under this system.
On top of all this is SEBI , which monitors everything. This is the organization that stops all the malpractices in the stock market and makes these rules, statutes etc. for everything to run smoothly.
Overall this is Share Market Working Concept ; hope it is understood. In the next article, we will discuss what are the types of shares and what are their features; you can read also any other article like – Bond Market, Derivatives, Insurance, Mutual Fund etc. The links of all will be found below in a sequence-
| Share Market Working Concept Basic Concept Series (BCS)
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Share Market Working Concept Continues…