Sometime in the week before the lockdown, a colleague commented that trading in shares is akin to gambling. I disagreed. Because it isn't. Allow me to retrace (roughly) the conversation that followed.
What are stock exchanges?
A marketplace where shares are traded. The stock exchanges by themselves do not take part in the actual transactions, but they enable them. Sort of like Amazon, but for shares. Companies/representatives put up their shares on the stock exchanges and buyers buy them.
How do stock exchanges make money?
For a long time, I thought that they make a commission on every sale. Not really. Exchanges make money mostly from the sellers (companies/representatives) when they list their shares for sales. They also make money from providing statistical (and other) information to the sales brokers.
Who, now?
The financial equivalent of a real estate agent. You want to buy a share, so you reach out to the agent (can be an individual or a business) and announce your intentions. The agent then buys the share on your behalf on the stock exchange and confirms the sale. Same thing if you are selling shares. P.S.: In India, this interaction between you and the broker happens only through a "de-mat account" which is short for a dematerialised account. You enter some numbers and letters on a piece of software, make the payment, and you have the share showing up in your account. Easy!
But what are shares, actually?
Usually, when a company is formed, it has to have directors who have to mention the percentage of ownership to a central authority. A company (in India, at least) can be formed in three ways:
A one-person company (OPC) where there's one director. They will be responsible for the legality of the company and their personal wealth can be held accountable in the case of the company going bankrupt.
A limited liability partnership (LLP) where there must be a minimum of two directors but their liabilities are limited, in the case of the company going bankrupt.
A private limited company (PVT LTD) is similar to an LLP in that they should have at least two directors but their personal wealth is not held accountable towards the business. Along with that, PVT LTDs have to abide by a lot more rules and regulations.
As usual, please keep in mind that an oversimplification comes at the cost of accuracy. This is a very loose explanation, but it helps put the first foot forward.
So we have a company now. The law requires that you mention clearly how many directors there are, how much money (called capital) has been invested in total to start the company and how much percentage of the company each director has.
OK so far? Good.
But the percentage of ownership by each director is not mentioned in, well, percents; but in terms of "shares held" by each of them. See? The share of the company is held in a number of "share units." Say there are two directors who've put up in total a capital amount of INR 1,00,000.00 with the number of total shares of the company being 10000. Now, in an even split, each director will have 5000 shares each. Or if one director is Mr Moneybags and the other is Dr Smartpants, and their arrangement is that Mr M finances the ideas of Dr S, it might be a say, 75-25 split, giving 7500 shares to Mr M and 2500 to Dr S and so on and so forth.
In time, when the company grows sufficiently large, and there is a need for capital so large that the directors by themselves cannot put in the money, they might "go public" or they might present a huge chunk of their shares for sale on a stock exchange. Here, individuals (or other companies) can buy these shares and put in money into the company in exchange for a very small percentage of ownership in the said company.
With that, we stop here for this post. Tomorrow, a little about a few different types of shares, how the value of shares fluctuate, and a list of the exchanges in India.
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