The role of stock markets

This article was originally published in Postnoon on January 4th, 2013: Co-Author- Purvee Hetamsaria

The Udupi restaurant owner at the corner of the street where Prof. Nicky lived, came and sat across the table in front of her, while she was enjoying the delicious meal. With an eye on the cash counter, which he had handed over to his aide for the time being, he asked her if he could chat with her for a while.

Prof. Nicky (with a wink): Sure Raju, if you make my meal free!

Raju: It’s you shop only madam.

Nicky: I was just joking. Tell me what do you want to talk about?

Raju: My son is doing MBA. He has been telling me to invest my spare money in the stock markets instead of keeping it in Fixed Deposit. I have so many doubts. If I ask him, he gets angry. He says that I think too much. He wants me to go and give my money to a broker, who will take care of everything. Tell me madam, how can I put my hard earned money in something I don’t understand?

Nicky: You are right Raju. You should never put your money into something you don’t understand. While you can take the professional help of a broker or an advisor, you should still know what you are doing. You can ask me all your doubts.

Raju: What is the need of stock markets? Can’t we buy and sell shares from/to the company directly?

Nicky: When a company offers its shares to the Public for the first time, through the exchange, and you buy them, then you are buying directly from the company. This is known as an Initial Public Offering (IPO) and the market is categorized as the Primary Market.

Raju: Oh…so those who bought shares of Bharti Infratel recently, bought it from the company directly?

Nicky: Exactly. Similarly, you can also buy directly from the company during Follow On Public Offering (FPO). A company which is already listed on the exchange but needs more money, can raise more money by selling more shares through a FPO. You can sell your shares directly to the company, if the company comes with a buy back scheme or gets delisted from the exchange.

Raju: But after buying a stock, what if I need the money back? I cannot wait till the company decides to buy back or delist. Can I sell my shares back to the company?

Nicky: No, you cannot do that. You must know that a company is not liable to return the capital that it has raised by way of stock. But, you can sell it to someone else. And that’s why we need the stock exchanges, to facilitate the buying and selling of stocks, to provide liquidity. The market where shares are traded, after getting listed, is known as the secondary market. You can sell your stocks easily in this market. All you need is a demat account.

Raju: A demat account?

Nicky: Yes. But I need to leave now. More on it the next time I come here to eat…

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