WHAT IS A CAPITAL MARKET?

Capital market is a place where buyers and sellers indulge in trade (buying/selling) of financial securities
like bonds, stocks, etc. The trading is undertaken by participants such as individuals and institutions.

Capital market trades mostly in long-term securities. The magnitude of a nation’s capital markets is
directly interconnected to the size of its economy

Types of Capital Market

Capital market consists of two types i.e. Primary and Secondary.

1. Primary Market
Primary market is the market for new shares or securities. A primary market is one in which a
company issues new securities in exchange for cash from an investor (buyer).It deals with trade
of new issues of stocks and other securities sold to the investors.

2. Secondary Market
Secondary market deals with the exchange of prevailing or previously-issued securities among
investors. Once new securities have been sold in the primary market, an efficient manner must
exist for their resale. Secondary markets give investors the means to resell/ trade existing
securities. Another important division in the capital market is made on the basis of the nature of
security sold or bought, i.e. stock market and bond market.

STOCK AND COMMODITY EXCHANGE

A stock exchange is a place where shares of different listed companies are bought and sold through the
members of the stock exchange. The major role of the stock exchange is to assist, regulate and control
the trading of shares through different measures. Stock exchanges can also be known as equity markets
or shares markets.

The stock exchange itself does not indulge in trading of shares, but it regulates the trading activities being
done by its members on their own as well as on their clients’ behalf. A Commodity Exchange, on the
other hand, is a place for buying and selling commodities for delivery at a future date. In Pakistan, the
Pakistan Mercantile Exchange (PMEX) is the platform used for trading in commodities.

WHAT ARE SHARES?

A share stands as a unit of possession in a corporation or financial asset.

However, owning shares in a business doesn’t render a shareholder to have direct control over the
business’s day-to-day operations nor makes him entitled to an equal distribution in the profits if they are in
the form of dividends.

Each share signifies a proportionate stake in the equity of a company. You can select from buying large
or small shares to match the amount of money you want to invest. A company's share price can
accelerate or decrease as a result of its own performance or market conditions
HOW SHARES ARE MADE PUBLIC FOR THE FIRST TIME?

Shares are made public through an initial public offering.

Initial Public Offering (IPO)

Initial public offering (IPO) is when a company issues common stock or shares to the public for the first
time. They are often issued by smaller, younger companies seeking capital to increase, but can also be
done by large privately-owned companies looking to become publicly traded.

In an IPO, the issuer gets the assistance of an underwriting firm, which helps in determining what type of
security is to be issued (common or preferred), the most suitable offering price and the proper time to
bring it into the market.

IPOs are a risky investment as it is tough to predict what the share will do on the trading day as well as in
near future because, there is no substantial historical data to analyze the company’s standing.

RETURN ON INVESTMENT IN SHARES

(Dividends & Capital Gains)

As a shareholder, you own a part of company, which entitles you to a potential profit on your investment.
Calculation of Return on Investment (ROI) is the basic part to be understood the definition can be
rewritten to suit the situation relying upon what you add as returns and costs.

Let’s take an example:

A marketer takes the comparison of two products by dividing the gross financial gain that each product
has made by its respective marketing expenses. On the other hand, a financial analyst would compare
the same two products in an entirely different ROI calculation which can go by dividing the net income of
an investment by the total worth of all resources that have been applied in the making and selling of the
product.

In a broader term, ROI is:

“The profitability measure that estimates the performance of a business by dividing the net profit by net
worth”

Making a return on your investment is subjected to on how well the company does - evaluated by its stock
performance - and if the company pays a dividend. Capital appreciation (the stock price rising in value),
and dividends are the two ways you can earn a return as a shareholder.

 Capital Appreciation

Capital appreciation is:

“Certain rise in the value of an asset based on the rise in the market price”

Buy a stock, and when the price escalates, sell the stock for a profit, or hold onto it and hope that it rises
even further over an extended period of time. The amount you make on the stock when you sell it is your
"capital gain" for tax purposes. You can calculate your percentage ROI by taking the sale price and
subtracting the purchase price out of it. You can now divide that total by the purchase price, and then
multiply the amount you receive by 100. What you are getting now is the percentage return on
investment. If the stock price drops, you can sell or hold onto the investment and that’s your choice. But
you will face a capital loss and a negative ROI.

 Dividends

Dividend is:

“A portion of the company’s earnings distributed amongst its class of shareholders decided upon by the
directors.”

Companies distribute a dividend in the form of a quarterly payment paid to shareholders for each share
they own. This provides the investors a stream of income. In order to receive the dividend, you must have
the shares of the company before the ex-dividend status, (The date at which the person has been
confirmed by the company to receive the dividend payment). If you own 100 shares, and the company
pays a Rs.10 dividend, you will receive Rs.1000 annually in dividend income.

RISKS ASSOCIATED WITH INVESTMENT IN SHARES

Shares can be a sound long-term investment but of course there are always risks to be considered as
with any type of investment. These include the following:

1. Volatility
Share values can be volatile and can fall dramatically in price, even to zero.

2. Credit Risk
Owners of ordinary shares are generally the last in the line of creditors if a company fails and
there may be no chance of getting any money back.

3. Unexpected Events
Unexpected events which are outside of your control, such as company specific bad news, a
change in government policy or natural or man-made disaster can seriously affect share prices.

TYPES OF SHARES

Shares can be widely divided into two categories namely, ordinary shares and preference shares.

1. Ordinary Shares
Ordinary shares carry no exceptional or preferred rights. Ordinary shareholders are entitled to
share in the earnings of the company. They can vote at the company’s general meeting as well
as other official meetings. They are also eligible to participate in any dividends or any distribution
of assets on winding up of the company.

2. Preference Shares
Preference shareholders usually get a significance or 'priority' over ordinary shareholders in terms
of payments of dividends or on winding up of the company. There are varying degrees of
preference shares having different rights and characteristics. Holders of preference shares are
entitled to having a fixed periodic income and have restricted voting rights liable to particular
 circumstances or particular resolutions; however this is strictly dependent on the terms of the
shares

WHY DO COMPANIES ISSUE SHARES?

Companies issue shares to raise money from investors who tend to invest their money. This money is
then used by companies for the development and growth of their businesses.

Company issues different types of shares namely; preference shares, ordinary shares, shares without
voting rights or any other shares as are approved under the law. These allow the shareholders a stake in
the company's equity as well as a share in its profits, in the form of dividends, and the aptitude to vote at
general meetings of shareholders

BENEFITS OF INVESTMENT IN SHARES

There are many benefits to investing. Let’s find out how this common form of investment can be an
effective way to make money. Here are some of the benefits of investing in shares.

1. Capital Growth
Selling a share for more than you paid for it is known as Capital Gain. This occurs when an
individual experiences significant rise in share prices and is one of the long term objectives of
investing in shares.

2. Dividends
Dividend is a cash reward given out to shareholders as part of the profit made by the company at
the end of each financial year. The larger the units of the shareholdings one possesses, the more
money one receives.

3. Liquidity
By nature, shares that are listed are a very liquid product and can be bought and sold quickly
over an exchange platform. No hassle of involving a broker or transferee and at a relatively low
cost as compared to other financial products. Trading on an exchange also allows one to sell part
of the share parcels other than redeeming the whole lot.

4. Shareholder Benefits
Some listed shareholder companies from different market sectors including entertainment, retail,
hospitality and financial services offer lavish discounts to shareholders when they buy goods or
services from the companies or their affiliates. However in most scenarios, lots of shares need to
be owned to qualify for such benefits.

MARKET OPERATIONS

How Stock Trades?

An investor first needs to choose a broker through whom he wants to trade with and enter into broker-
client agreement. It is the responsibility of the broker to explain different terms and conditions of the trade
transactions and their implications before entering into an agreement with an investor. This agreement is
mandatory. The features of this agreement that reduce the chances of any dispute on terms and
conditions which relate to placement of order, trade confirmation, brokerage charges by a broker and
delivery of securities and payments.
When an investor has decided to buy shares in a particular company, he contacts his broker. Investor can
place an order to buy a fixed number of shares, or shares up-to a certain value.

For selling, again the investor contacts his broker. The stock broker is obliged to sell at the best price he
can get, but an investor can decide what should be the minimum price he is prepared to accept. Stock
broker assists the investor in buying and selling of shares at best price but in no way he is under any
obligation to supervise the investment or to advice or to make any recommendation to the investor/clients
with respect to the sale/purchase of shares.

Electronic Trading Terminals

Electronic trading terminals use information technology (computers) to bring buyers and sellers together
in a virtual market place, rather than on a trading floor. Electronic trading, either directly with
counterparties or through a broker, has transformed traditional methods of trading through exchanges.
Rather than reaching the exchange and trade from the floor, institutional investors, brokers, and dealers
can trade directly through the Electronic Trading Terminals installed at member’s rooms at Stock
Exchange building or at remote premises of the broker.

Examples of electronic trading terminals in Pakistan are:

 Karachi Automated Trading System (KATS) at KSE

 Trading Workstations (TWS) at LSE
 Ultra Trading System (UTS) at ISE

Entry of Quotes and Orders

Quotes and Orders are entered in the Stock Exchange through the Order Entry Window of the Electronic
Trading Terminals, provided to the brokers, of the exchanges. Following information is required to be
entered into the Order/Quote Entry Windows:

 Type of Order (BUY or SELL)

 Type of Market (Regular, Futures, etc.)
 Type of Order (Market, Limit, Stop loss, etc.)
 Volume or Order (Quantity)
 Symbol of the Security
 Rate (Price to buy or sell)
 Account (assigned account number of a client)

The process continues as long as the incoming order remains executable. If not executed upon entry, an
order is held in the central order book.

Also, it is possible for a single order to generate multiple executions at different points in time. For
example, an order may generate a partial execution upon entry, while the remaining open order remains
in the order book. The open portion may get executed a minute later, an hour later, or even a day later, if
its validity extends beyond the current trading day.

All executions are subject to the restrictions of the Market Order Matching Range. Market orders have the
highest priority for matching. Since the purpose of the market order is to be executed as quickly as
possible at the best possible price, it must be entered without execution restrictions. If several market
orders are booked in the order book, the system takes into account the timestamp of the orders to
establish matching priority. The earliest market order entered receives the highest priority.

In the case of limit orders, orders with the best possible prices (highest price limit for buy orders, lowest
price limit for sell orders) always take precedence in the matching process over other orders with worse
prices. Again, if the limit orders have the same price limit, the criterion used for establishing matching
priority is the order timestamp.

The orders already present in the order book are always executed at their specified limit price. Price
improvements for orders in the order book are only possible during an auction process - opening or
closing auction. Orders going into the order book are always matched at the appropriate prices available
in the order book, up to the specified limit price.

Order Types
Taking up different types of orders allow you to be more precise about how you’d like your broker to carry
on with your trades. Below are some often used, types of orders.

1. Limit Order

An order placed with a brokerage to purchase or sell a set amount of shares at a stated price is
said to be Limit Order.

This is the default order type for all single option, spread and stock orders. Because the limit
order is not the market order therefore, it may not be executed if the price stated by the investor
cannot be met during the tenure in which the order is left open. The limit price for buy orders is
placed below the current market price. The limit price for sell orders is set above the current
market price. Limit orders will be filled at the limit price or better, but are not assured a fill.

2. Market Order

An order which an investor makes through a broker or brokerage service to purchase or sell an
investment straightaway at the best available existing price is said to be Market Order.

Market order assures an execution, but do not guarantee a price or time of execution. It does not
contain restrictions on the buy/sell price as well as the timeframe therefore, is likely to be
executed. The risk of market orders is that you have no control over what the execution price is.

3. Stop Loss

An order that is placed through a broker for the intention of selling a security when it achieves a
certain price is called as Stop Loss Order.

Stop loss order opens or closes a position by buying or selling in case the market rises or falls
respectively. The stop price for buy orders is placed above the current market price whereas for
sell orders, it is placed below the existing market price. A stop order turns into a market order
when the stop price is triggered, so the closing execution price or time of a stop order cannot be
guaranteed. The stop price doesn’t need to be the same as that of the limit price. Same risks of
market orders apply to stop orders.

Stock Market Index

On a very basic level, any stock market index is simply a numerical value that measures the
change in the market. In Pakistan, the main objective for the construction of an index is to track
the performance of the various listed stocks according to their market capitalization. In general, a
capital weighted index is composed of a basket of securities, which captures the change in
market capitalization due to the variation in prices.
 Movements of stock exchange indices are popularly considered as key indicators of the economy
of a country. Stock exchange indices are not only barometers of the economy and public opinion
of the state of economy, but are also used by many technical analysts to forecast and evaluate
market trends and base their opinion on the future direction of the market.

i. KSE 100
KSE-100 is the most recognized index of the KSE, representing almost all sectors of the
KSE and includes the largest companies on the basis of their market capitalization. It
represents approximately 85% of the market capitalization of the Exchange.

ii. KSE 30
The KSE 30 Index was introduced in 2006 and is based on the “Free Float
Methodology”. The index includes only the top 30 most liquid companies listed on
the KSE.

iii. KMI-30 (KSE Meezan Index)

The KMI-30 index was introduced in September 2008 and comprises of 30
Companies that quality the KMI Shariah screening criteria and is weighted by float
adjusted market capitalization. There is a 12% cap on weights of individual
securities, while rebalancing of the Index is done bi-annually.

iv. KSE All Shares

The All Share Index consists of all the companies listed on the KSE.

Market Capitalization
Market capitalization also known as capitalized value of company, is a measurement of economic size
equal to the share price times the number of shares outstanding of a public company. As owning stock
represents owning the company, including all its equity, capitalization could represent the public opinion
of a company's net worth and is a determining factor in stock valuation. Likewise, the capitalization of
stock markets or economic regions may be compared to other economic indicators.

Liquidity
Market liquidity is an investment term that refers to an asset's ability to be easily converted through an act
of buying or selling without causing a significant movement in the price and with minimum loss of value of
the asset. Money, or cash in hand, is the most liquid asset. An act of exchange of a less liquid asset with
a more liquid asset is also called liquidation. Liquidity also refers to a business' ability to meet its payment
obligations, in terms of possessing sufficient liquid assets.

Financing
It is an act of providing funds for business activities, making purchases or investing in capital or money
markets. Financial institutions including banks are in the business of financing as they provide capital to
businesses, consumers and investors to help them realize their investment or consumption aspirations.

Local equity markets provide financing to investors through the following financing arrangements
available under the Securities (Leveraged Markets and Pledging) Rules, 2011:

1. Margin Financing
2. Securities Lending & Borrowing
Transaction Cost
In economics and related disciplines, a transaction cost is a cost incurred in making an economic
exchange. For example, most people, when buying or selling a stock must pay a commission to their
broker; that commission is a transaction cost of doing the stock deal. When rationally evaluating a
potential transaction, it is important to consider transaction costs that might prove significant.

Following costs are incurred while transacting in the local equity markets:

 Brokerage Commission
 FED (16% of brokerage commission)
 Withholding Tax on Sale (.01% of the transaction value)
 Capital Gain Tax (10% & 7.5% on capital gain for holding period of 6 and 12 months respectively)

Central Depository System

Central Depository System (CDS) is an Electronic Book Entry System to record and maintain securities
and to register their transfer. In Central Depository System, ownership will be changed without physical
movements of securities or execution of transfer deeds. The ownership will be transferred as soon as
securities move from one account to another. CDS is purely a settlement vehicle and will not affect the
trading in any manner whatsoever.