Global Trade Center

Understanding Stock Market Basics before you Trade

Earlier stock market was considered to be a destination for literates. But the interest and buzz among common man regarding the stock market is ever increasing. This is because people have started to realize stock market as a revenue generating source if dealt clearly. Stocks are considered to be the greatest invention in financial instruments. Hence a clear understanding of what a stock is and how it is traded becomes imperative in this scenario.

            Share is the starting point of all. It could be considered as the share in the ownership of the company. In other way it could be considered as the share in the share of the company. Hence a share represents a claim or ownership on the earnings and assets of a company. Hence when you hold more and more stocks (shares) it means that you have a larger claim on the company. But a shareholder will be one among the thousands of shareholders for the company. All the other shareholders have equal claim in the company as you have.

            Earlier if you have a stock then you will be provided with a stock certificate. It is just a piece of paper stating your ownership. But now where everything gets to electronic format stock certificates too have to be in electronic version. It has got a lot of advantages when compared to physical version. First is the ease and security of the certificates when it is traded. Earlier when someone intends to trade he has to be physically present in the stock broker’s office or in the stock market  to trade. But now due to such electronic format you could trade it with a mouse click.

Though it is literally said that you have a call in the ownership of the company it does not mean you can instruct the day to day workings of the company. For example if you are the shareholder of Toyota you cannot call the company and instruct which line of cars you should produce. The ownership is limited to one vote per share in electing the board of directors of the company. Generally the companies into stock market will convene annual general body meeting which invites all of its shareholders. There the company discusses its prospects, future plan and current business. The shareholders have the right to information from the company directors.

            So far we have discussed from the perspective of shareholder. It is equally important to know why the company wants to provide shares. The question is why a company should allow its ownership to get diluted. The simple answer is the need for more money to grow or to sustain in business. A remoter of a company cannot indefinitely release money from his pocket for the business expansion. A point is reached where there is a larger scope for improvement or growth but there is constraint of money. Now the company can go public and issue shares to raise money. Once it obtains the funds it can invest in funds and share the profit with its shareholders

Settling banks” (some 20 in number) do this themselves; others have arrangements with settling banks to do this fro them. By 6:00 P.M., banks that are owed money receive payment out of the same special account.

In 1999, CHIPS handled some 230,000 payments a day, averaging a total of $1.2 trillion. Because of the economies of netting, these payments resulted in only a few billion a day in settlements.

A payment over CHIPS differs in its basic nature from a payment over Fedwire. While payment over Fedwire (like payment in cash) is final, payment over CHIPS (like payment by check) is merely a promise to pay. As with a check, there is a danger that the promise will “bounce”: a bank may be unable to settle at the end of the day. If this happens, all the banks to which it owes money will remain unpaid.

Naturally, there are safeguards. First, the CHIPS system has stringent admission standards. Second, participants set bilateral credit limits on net positions. Third, each bank also has a debit cap on its net position set by CHIPS, based on these bilateral limits
 

The CHIPS computer and the computers of the individual banks keep track continuously of each bank’s net position relative to every other bank. For example, if Chemical has made a total of $11 billion in payments to Bankers Trust, and Bankers Trust has made a total of $13 billion to Chemical, then the net position of Bankers Trust is that it owes Chemical $2 billion. 

At 4:30 P.M., the CHIPS computer sends each participant a summary of its payments for the day and of its final net positions. The summary also indicates the participant’s net position-its net position relative to all other participants. For, example, suppose that in addition to the $2 billion it owes to Chemical, Bankers Trust owes a further $2 billion to Dresdner and is owed $5 billion by Barclays. Then the net position of Bankers Trust is

 -$2 billion – $2 billion + $5 billion = + $1 billion 

That is, Bankers Trust is owed $1 billion. 

On receiving its summary from CHIPS, each bank checks the information against its own records for accuracy. If it has a net debt, it must transfer funds over Fedwire to a special account at
the Fed by 5:30 P.M.

If Fedwire is the electronic equivalent of payment in cash, then the electronic equivalent of payment by check is CHIPS (the Clearing House Interbank Payment System). This system, operated by the New York Clearing House, links some 130 banks with branches in New York City to a central computer. 

Most payments over CHIPS are related to the foreign exchange and Eurodollar markets. For example, suppose a British bank needs to pay a French bank $100 million in U.S. dollars. The British bank executes the payment through its branch in New York-if it has one-or through a New York bank with which it has a deposit. They payment is made to the New York branch of the French bank, if it has one, or to a New York bank at which the Paris bank has a deposit. The London bank sends its instructions to New York via SWIFT (Society for Worldwide Interbank Financial Telecommunications)-a private electronic message transfer system. The payment is made over CHIPS. 

Throughout the day, thousands of payments like this pass from bank to bank. As with the check-clearing process, these payments are netted to minimize the need for final settlement in cash.

An increasing fraction of all transactions now take place on the Internet. There are predictions that business-to-consumer transactions (B2C) on the Internet will soon be in the hundreds of million of dollars and that business-tobusiness transactions (B2B) in the trillions.
Currently, the overwhelming majority of B2C purchases on the Internet are paid for by credit card. This works reasonably well, but there are some problems. The first is secuirty. Hackers can acquire credit card information, either by intercepting communicationbetween consumer and merchant or by gaining access to merchant computers.20 Once they have the information, they can use it by faking e-mail from the owner of the credit card . Credit card fraud is 12 times more common for Internet transactions, and the credit card comapnies consequently charge a larger discount on such transactions. The prinicipal defenses against fraud are encryption of credit card information and better security of merchant computers.
A Second problem is that payment by credit card is not avialable for transactions between consumers (P2P) -for example, to settle purchases in online auctions. Various technologies are being developed to bridge this gap with some form of “online check”. One, called eCheck, is a relatively straightforward electronic version of the paper check. Another, called PayPal, provides consumers with the capability of linking up with the existing credit card and ACH networks to make payments. Yet another technology is planned to link up with existing ATM network.
A third problem with payment by credit card continues is that it is expensive. There is the potential on the Internet for a large volume of quite small transactions involving the sale of information, such as a single song, photograph, news item, or piece of data. The payments involved are likely to be small-from $10 down to 1c or even less. For such transactions, various technologies are being developed to provide some form of “digital cash”.
For the time being, however, the credit card continues to dominate Internet commerce. None of the new digital check or cash technologies have yet caught on. Of course the same network externalities that stand in the way of the smart card are part of the problem here. Consumers do not use the new technologies, because not enough merchants accept them. Merchants do not accept them because not enough consumers use them.

Payment by Fedwire is final: Citi cannot cancel its payment to BankAmerica once it has been executed. It is completely equivalent to payment in physical Fed dollars. In our example, the Fedwire payment is essentially the same as a magical transfer of $50 million in dollar bills from Citi’s vault in New York City to BankAmerica’s in San Fransisco.

Because of its speed and security, virtually all large payments in definitive money are made by Fedwire. UsingFedwire is more expensive than using a check. The cost is about $10 a message, plus the cost of the hookup (a monthly fee and the cost of the dedicated telephone line). Consequently Fedwire is not used for small payments: the average size of a payment is $3.5 million, versus $1,200 for a check and $10 for a cash payment. Most small banks, because they make few large payments, do not find it worthwhile to be connected to Fedwire. If they require this service,they can always get it from their correspondent banks

The methods of payment we have looked at so far have all involved the physical transfer of cash or paper. Modern technology has produced electronic methods of payment that involve no physical transfer at all. 

Online Electronic Payments: Fedwire and CHIPS 

The U.S. payments system includes two online systems of electronic payment-Fedwire andCHIPS-that handle an enormous volume of large payments. 

Fedwire.

Fedwire is a communications network that links the computers of some 7,000 banks to the computers of the Fed. Banks use Fedwire to transfer to one another Fed dollars in the form of deposits at the Fed. For example, if Citibank wishes to pay BankAmerica $50 million, the Fed computer replies, confirming the transfer of $50 million from Citi’s deposit to Bank America’s; BankAmerica is a simultaneously notified that it has received payment. In 1999, Fedwire carried about 400,000 payments each day, with an average daily value of some $1.4 trillion.

The credit card interchange and switch are the basis of a new method of payment very similar in nature to payment by check or giro-the delayed debit card. (The qualifier “delayed” distinguishes this type of debit card from the electronic debit card, to be discussed shortly.)

Unlike the credit card it physically resembles, the delayed debit card involves no credit. Rather than extending the purchaser credit to the end of the month, the issuing bank debits the amount of the purchase from the purchaser’s checking deposit as soon as the slip clears through the interchange. Since the bank extends no credit, the discount charged the retailer is correspondingly lower. 

Notice that the delayed debit card overcomes many of the problems of payment by check or giro. There is no bad-check problem-the transaction is not authorized unless the purchaser has
sufficient funds-and the retailer is guaranteed payment. However, unlike the giro transfer, the delayed debit card can be used for unplanned purchases. While in the United States delayed debit cards are much less popular than credit cards, in Europe the opposite is the case

The “special checks” (traveler’s checks, etc.) provide the convenience of a check to those without deposits. The electronic equivalent of the special check is the prepaid card, commonly used on many campuses to operate copying machines. You buy the card, often from a vending machine, for cash, say $10. You insert the card into the copying machine to make copies, and the cost of the copies is debited from the balance on the card until the $10 is used up. There are other uses of perpaid cards- for example, paying for tickets on the Washington, DC subway system. Prepaid cards are popular in Europe and extremely popular in Japan.
A more sophisticated version is the smart card or “electronic purse or wallet,” which embodies a microchip and can be used as a general rather than a specific means of payment. Users “download” cash from their bank deposits via an ATM machine or a specially adapted phone. Smart cards can be used for payment wherever merchants have the equipment to read them. Unlike credit or debit cards, no vertification is necessary. This saves on telecommunications costs which can be 8c to 15c for a credit /debit card transaction. Consequently smart cards are viable for much smaller transactions-purchase of a newspaper, for example.
Smart cards have been slow to catch on. One reason is again network externalities. Merchants do not find it worthwhile to install readers because few consumers have the card. Consumers do not find it worthwhile to acquire the card because few merchants accept it. Moreover, although the cost to the economy of using cash is substantial, the cost to a consumer of an individual transaction is small. There is therefore little incentive to go to a lot of trouble to avoid it.