Chapter 4

EQUITY MARKET

Introduction
a stock market or (equity market) is private or public market for the trading of
the company stock and derivatives of the company stock at an agreed price. The
expression equity market refers to the market enables the trading of company
stocks (collective share), other security. Participant in stock market range from
small individual stock investor to large huge fund traders, who can be based in
anywhere located. Their orders usually end up with a professional at the stock
exchange, who executes the order. Some exchange is physical location where
transaction are carried out on trading floor, by a method known as open outcry.
This type of auction is used in stock exchanges and commodity exchange where
trader may enter verbal bids and offers simultaneously. The other kind of
exchange is virtual kind, composed of computer net work where trade is made
electronically via traders.

→actual trading are based on an auction market paradigm where a potential

buyer bids a specific price for stock and potential seller ask a specific price for
the stock .(buying or selling at market means you will accepts any ask price or
bid price for the stock, respectively. when the bid and ask price match, a sale
take place on first come first served basis if there are multiple bidder or askers
at given price.

−the purpose of stock exchange is to facilitate the exchange of security between

the buyer and sellers those providing a market place virtual or real. The
exchanges provide real time trading information on the listed securities,
facilitating price discovery.

The role of stock exchanges

1. Raising capital for the businesses

The stock exchange provides a company with a facility to raise capital for the
expansion through selling share to the investing public.

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2. Mobilizing saving for investment

when people draw their saving and invest in shares, it leads to more rational
allocation of resource because funds, which could have been consumed or kept
in idle deposit with banks, are mobilized and redirected to promote business
activity with benefits for several economic sectors such as agricultural,
commerce and industry, resulting in a strong economic growth and higher
productivity levels and firms.

3. Facilitating company growth

companies view acquisitions as an opportunity to expand product lines,

increase distribution channels, increases its market share, or acquire other
necessary business assets. A takeover bid or a merger agreement through the
stock market is one of the simplest and most common ways for a company to
grow by the acquisition or fusion.

4. Redistribution of wealth

stocks exchanges do not exist to redistribute wealth .However both causal and
professional stock investors, through dividends and stock price increases that
may result in capital gains, will share in wealth of profitable businesses.

5. Creating investment opportunity for small investors

As opposed to other businesses that require huge capital outlay, investing in

shares is open to both large and small stock investors because a person buys
the number of shares they can afford. Therefore, the stock exchange provides
the opportunity for the small investors to own shares of the same company as
large investors.

6. Government capital rising for the development projects

Government at various levels may decide to borrow money in order to finance

infrastructure
project such as housing estate, sewage and water treatment works by selling
another category of security known as bonds. This bond can be raised through

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the stock exchange whereby member of the public buy them, thus loaning
money to the government.

6. Barometer of the economy

At the stock exchange, share price rise and falling depending, largely on market
forces. Share price tend to rise or remain stable when company and economy in
general show sign of stability and growth. An economic recession, depression or
financial crises could eventually lead to a stock market crash. Therefore, the
movement of shares prices in general of stock index can be the indicator of the
general trend in the economy.

→Common stock Vs. Preferred stock

There are two classes of stock that the companies offer i.e. common and
preferred. These come with different financial terms and offer different rights in
relation to the governance of the company. Here are the key differences between
these two types of stock and the implication how each type is used.

Common Stock

The holders of the common stock can reap two main benefits from issuing
company. Capital appreciation and dividends. Capital appreciation occurs when
a stock’s value increases over the amount initially paid for it. The stock holder
makes profit when he or she sells the stock at its current market value after
capital appreciation dividend which are taxable payments are paid to company
shareholders from its current earnings. Typically dividend is paid to the stock
holder on a quarterly basis. These payments are usually kept in the form of
cash, but other property or stock can also give as dividends. Common stock
ownership has additional benefit of enabling its holder to vote on company
issues and in the elections of the organization leadership team. Usually, one
share of common stocks equities to one vote.

Preferred Stock

Preferred stock does not offer the same potential for the profit as common stock,
but it is a more stable investment vehicle because it guarantees a regular
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dividend that is not directly tied to the markets like the price of common stock.
This types of stock guarantees dividend which common stock does not. The
price of preferred stock is tied to interest rates levels, and tends to go down if
interest rates go up and to increase if interest rates fall. Preferred stock holder
is a win- win situation over the common stockholders, since the preferred will
receive reimbursement back from their investments from the common stock
holders, especially the company is liquidates or ‘’goes out of business. “Preferred
stock holders however have cons, which include fixed income reimbursements.
This is the set rate of returns which common stock and preferred stock seekers
should explore.

Characteristics of preferred stock

 They look like stocks, behave like bonds.

 Their dividend never changed
 Some preferred shares have special voting rights to approve certain
extraordinary events (such as the issuance of new share or the approval
of the acquisition of the company) or to elect directors, but most
preferred shares provide no voting rights associated with them.
 If the company fails, preferred share holder stands in line before common
shareholders for any proceeds, but behind all creditors and bond holder.
 Companies can postpone paying promised dividends for up to 5 years,
but you have to pay income taxes on the accumulation.
 Since the dividend is based on the original par value, if the stock trade at
the lower price, the current yielding for the new investor is higher. If the
stock trade at higher than par value price, the current yielding for the
new stock purchased is lower.

Common types of preferred stock

There are various types of preferred stocks that are common to many
corporations

 Cumulative preferred stock-if the dividend is not paid, it will

accumulate for future payment.

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  Noncumulative preferred stock-dividend for this type of preferred
stock will not be accumulated if it is unpaid.
 Convertible preferred stock-This type of preferred stock carry the
option of converting in to common stock at the prescribed price.
 Exchangeable preferred stock- this type of preferred stock carries
the option to be exchanged for other security upon certain
condition.
 Participating preferred stock-these types of preferred stock
allows the possibility of additional dividend above the stated
amount under certain Condition.

Expenses, costs and risk in equity market

Trading activity are not free; they have considerable high level of risk,
uncertainty and complexity, especially for unwise and inexperienced stock
traders/investor seeking for an easy way to make money quickly. In addition
stock trader/investor faced several; costs such as commission, taxes, fees to be
paid for the brokerages and other services, like buying and selling order placed
at stock exchange. According to each national or state legislation, a large array
of fiscal obligation must be respected, and taxes are charged by the state over
the transactions, dividends and capital gains.

3. Stock Exchanges

Stock exchanges are formal organizations approved and regulated by the

security and exchange commission (SEC).These exchange are physical locations
and are made up of “members” that uses the exchange facility and system to
exchange or trade listed stocks. Stocks traded on exchange are said to be listed
stocks. To be listed the company must apply and satisfy the requirements
established by the exchange for a minimum capitalization, shareholder equity,
average closing share price, and other criteria. Even after being listed,
exchanges may delist a company stock if it no longer meets the exchange
requirements. The right to trade security or make market in exchange floor is
granted to a firm or individual who becomes a member of exchange by buying a
seat on the exchange.
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The major organized stock exchange market include

 New York stock exchange

 London stock exchange
 Tokyo stock exchange
 Hong Kong stock exchange
 Stockholm stock Exchange
 Brussels stock exchange
 Johannes burg stock exchange

Over the Counter Markets

The majority of securities bought and sold around the globe are traded over the
counter, not on organized exchanges. There is no central location, but only an
electronic communications network. The customer places a buy or sells order
with the broker or dealer that is relayed via telephone, wire or computer
terminal to the dealer or broker with securities to sell or an order to buy. In this
system of electronically linked market makers, brokers and dealers seek the
best possible price, and resulting competition to find the best deal brings
together traders located hundreds or thousands of miles apart. The prices of
actively traded security traded security quickly respond to the changing force of
demand and supply.

The Third Market

The market for securities listed on exchange but traded over the counter is
known as the third market. Broker and dealer firm are not the member of an
organized exchange active in this market. The original purpose of the third
market was to supply large blocks of shares to institutional investors. This
investor engage mainly in block trades, defined as transaction involving 1,000
shares or more .Presumably, block traders posses the technical know how to
make informed investment decision and then carry out transaction without
assistance from the stock exchange. By trading with third market broker and
dealer firms, who in effect, compute directly with specialists on the exchanges,

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the large institutional investor frequently can lower transactions costs and trade
securities faster.

The fourth market; Alternative trading system

it is not necessary for two parties to a transaction (buy and sell stock) to use an
intermediary; that is, the services of a broker or dealer are not required to
execute a trade, The direct trading of Stocks between the buyer and seller of the
stock without the use of a broker is called the fourth market .This market grow
as the same reason as third market because of excessive high minimum
commission.