Knowledge Centre

Tips For New Investors

What is Capital Market?

The capital market is the market for long-term loans (debentures & bonds) & equity capital. Companies & the government can raise funds for long-term investments via the capital market. The capital market includes the stock market, bond market & primary market. Thus, organized capital markets are able to guarantee sound investment opportunities. The capital market can be contrasted with other financial markets such as the money market which deals in short term liquid assets & futures markets which deal in commodities contracts.

What are the functions of the Capital Market?

Capital market enhances capital formation in the economy & comprises of the followings:

  • Primary Market: Primary Market is a place where new offerings by Companies are made either as an Initial Public Offering (IPO) or Rights Issue.
  • Secondary Market: Secondary Market is a market where securities are traded after being initially offered to the public in the Primary Market &/or listed on the Stock Exchange. Majority of trading is done in this market which comprises of equity market & debt market.

What is Financial Market?

The financial markets are markets which facilitate the raising of funds or the investment of assets, depending on viewpoint. They also facilitate handling of various risks. The financial markets can be divided into different subtypes: Capital market consists of:

  • Stock markets, which facilitates equity investment & buying & selling of shares of stock. Bond markets, which provides financing through the issue of debt contracts & the buying & selling of bonds & debentures.
  • Money markets, which provides short term debt financing & investment.
  • Derivatives markets, which provides instruments for handling of financial risks.
  • Futures markets, which provide standardized contracts for trading assets at a forthcoming date.
  • Insurance markets, which facilitates handling of various risks.
  • Foreign exchange markets.

These markets can be either primary markets or secondary markets.

What is Stock Market?

A stock market is a market for the trading of publicly held company stock & associated financial instruments (including stock options, convertibles & stock index futures). Many years ago, worldwide, buyers & sellers were individual investors & businessmen. These days markets have generally become "institutionalized"; that is, buyers & sellers are largely institutions whether pension funds, insurance companies, mutual funds or banks. This rise of the institutional investor has brought growing professionalism to all aspects of the markets.

What is Money Market?

The money market is a subsection of the fixed income market. We generally think of the term "fixed income" as a synonym of bonds. In reality, a bond is just one type of fixed income security. The difference between the money market & the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs (an abbreviation of the phrase "I owe you") issued by governments, financial institutions & large corporations. These instruments are very liquid & considered extraordinarily safe. Since they are extremely conservative, money market securities offer significantly lower returns than most of the other securities.

Who are the main participants in the capital market?

The capital market framework consists of the following participants:.

  • Stock Exchanges
  • Market intermediaries, such as stock-brokers & Mutual Funds
  • Investors
  • Regulatory institutions (e.g. SEBI)

What are the different types of financial instruments?

The following are the different types of financial instruments:

Debentures: A debenture is the most common form of long-term loan taken by a company. It is usually a loan repayable at a fixed date, although some debentures are irredeemable securities; these are sometimes called perpetual debentures. Most debentures also pay a fixed rate of interest, & this interest must be paid before a dividend is paid to shareholders.

Bonds: A bond is a debt investment with which the investor loans money to an entity (company or government) that borrows the funds for a defined period of time at a specified interest rate.

Preference shares: Preferential shareholders enjoy a preferential right over equity shareholders with regards to:

  • Receipt of dividend
  • Receipt of residual funds after liquidation
However, preferential shareholders do not have voting rights; they are entitled only to a fixed dividend.

Equity shares: Equity shares represent proportionate ownership in a company. Investors who own equity shares in a company are entitled to ownership rights, such as:

  • Share in the profits of the company (in the form of dividends),
  • Share in the residual funds after liquidation / winding up of the company,
  • Selection of directors in the board, etc.

Government securities: The Central Government & the State Governments issue securities periodically for the purpose of raising loans from the public. There are 2 main types of Government securities:

  • Dated Securities: have a maturity period of more than 1 year
  • Treasury Bills: have a maturity period of less than 1 year

How do I buy financial instruments as investment options?

One cannot buy directly from the market or stock exchange. A buyer has to buy stocks or equity through a Stock Broker, who is a registered authority to deal in equities of various companies. In effect a lot many intermediaries might come in between the buyer & seller, as brokers do their business through many sub-brokers & the like.

How risky is the Stock Market?

The general theory goes that the higher the profit, the greater the risk. Since there is scope for high profit in the Stock Market, investing in the Stock Market can be risky. In fact, more than 80% of the people who put money in the market lose it & a majority of the rest is barely able to protect themselves from losses. Only a minuscule minority of investors are able to garner any substantial profits.

If Stock Market is so risky, why are people in it?

It’s due to basic human psychology. Men want profits- big & fast. Not many are deterred by the risks involved. The fact is that investment in the stock markets can give, potentially, the fastest Return on Investment (RoI), as the value of a stock can rise pretty fast, ensuring huge profit for investor. People buy shares in a company for either of two reasons:

  • They have a stake in the company. They are concerned not only in the future growth in stock value but in the worth of the company itself. Their investments are long-term & they don't sell their shares in an impulse.
  • They want quick profit & don't have any stake or interest in the company, but merely want some quick value addition. Most investors belong to this category. Their investments - both buying & selling - are impulsive. Mostly, they don't do any market research & don't follow any sector or company to gain proper knowledge before investing.

How can I achieve success in stock market?

He precept is very easy i.e. saving your investment is the first & most important part. This can be done by ensuring that you do not put your money in a company that does not show solid prospects. Fly- by- nights companies or companies whose shares touch the roof suddenly, need to be avoided. Companies that show a steady prospect are good to invest in. Needless to say, this process involves close acquaintance with market movements & a thorough understanding of the concepts involved.

You should know when to dump your shares especially when they are becoming just junk papers. The second thing is that adequate market knowledge is very important especially when you have invested in the stock market. One should be patient & judiciously responsive to market swings. Of course, luck is also a major factor.

What is the best suggestion for investment?

Undoubtedly, it is “Don't put all your eggs in the same basket”. It is very tempting to make all your investment in the same sector when their stocks are going up, but since market trends are very volatile, you are, at the same time, making yourself extremely vulnerable to lose all your money. Dealing with single sector investment requires razor sharp timing with zero margin of error - a tall order in such a speculative & volatile business.

Hence, it is always advisable to make investments in different companies & in different sectors, so that you can achieve stable portfolio diversification & compensate losses in one sector against profits in another sector.

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