Basics of the Securities Market

Table of Contents

Resource and Value

• A resource is anything that has value and can help meet the needs and wants of a person or society. If the resource has monetary or pecuniary value and helps to meet the existing financial needs, then it is called a financial resource.
• An asset is a resource that can generate economic value. Value has been defined in the study titled Foundation of Business Studies.
• Economic value simply measures the benefits that a resource produces to the person or entity that owns this resource, with money being used as the standard of this measurement. Economic value is equivalent to the intrinsic monetary value of a resource. Economic value is different from market value.
• Market value is the value that a buyer is willing to pay for a resource – be it a good or service – and it is principally determined by the laws of demand and supply. As will be explained later, the market value is the basis of open market valuation (OMV) of a company.
• The Limited Liability Partnership (LLP), Private Limited Company (also called Proprietary Limited [or (Pty) Ltd]) and a Public Limited Company are explained in Foundation of Business Studies. Also explained in that study are the concept of the shareholder and dividend, as well as principle of divorce between ownership and control that allows the shareholders to own the company, while the Board of Directors control the company.
• The shareholder owns a stock of the company which is equivalent to the number of shares in the company that (s)he owns. Therefore, stock simply means a portion of a company that a shareholder owns. As will be explained later, a better definition of stock is the proportion of equity in a company that a shareholder owns.
• Stock ownership gives the stockholder or shareholder the right to receive dividends. As stated in Foundation of Business Studies, dividends are the after-tax profit paid to shareholders as annual returns to investors.
• If a person purchases stock of a Public Limited Company so that (s)he can receive dividends, then this shareholder becomes an investor who is said to be engaged in dividend investing. Dividend investment is a strategy to grow wealth by purchasing stock and holding them for a long period. The stocks owned for dividend investment are called dividend stock.
• A person can also purchase stock in order to sell this stock at a later date when its price has gone up, and this is called growth investing. Unlike dividend investing, growth investing does not require the stockholder to hold his stocks for a long period. The stocks owned for growth investing are called growth stock.
• In order for a person to engage in either growth investing or dividend investing, (s)he must purchase the shares of a company. The shares of any public limited company are sold in a specialty market known as the stock market, where also the OMV of the company is realized.
• The OMV of a public limited company is called its market capitalization. This market capitalization is easily calculated by multiplying the value of a single share times the number of shares offered by the company.
• It is important to know that not all shares offered by a company have the same value, and one of the reasons for this is that diluted shares can be floated to the public during a Follow-On Public Offering (FPO). The concept of the FPO and its predecessor – the Initial Public Offering (IPO) – are explained later in this post alongside the concepts of diluted shares and undiluted shares. This allows the reader to know how the FPO and diluted shares affect the value of his/her dividend stocks or growth stocks.

Stock Exchange and Securities Exchange

• As explained in Foundation of Business Studies, the unit of ownership of a publicly traded company (PTC) is called a share. The person who owns this share is called a shareholder or stockholder.
• The shareholder can sell his/her shares for cash in a specialty market called the stock market.
• The facility in the stock market where this exchange of shares for cash, or cash for shares, occur is called a stock exchange. This means that there can be multiple stock exchanges in a stock market. This is the case in the USA where the American stock market is dominated by the New York Stock Exchange (NYSE), the Nasdaq Stock Market, and the Miami International Securities Exchange. However, in Kenya, there is only one stock exchange in the Kenyan stock market i.e the Nairobi Securities Exchange (NSE), formerly, the Nairobi Stock Exchange (1954-2011).
• The stock exchange is an auction market where stock traders and stock brokers buy and sell shares/stocks. It is also called a bourse, a term that can be etymologically traced back to the first debt market in the 13^th Century that was housed in an inn owned by the Van der Beurze family in the Italian town on Bruges.
• The stock exchange keeps a record o all shares traded in its facility, as well as allows a PTC to offer its share the public. The first time that a company offers its shares to the public in a stock exchange is called the initial public offering (IPO). IPO will be discussed later in relation to the primary securities market.
• The IPO allows the company to become a publicly traded company (PTC), and the stock exchange lists this company as one of the stock traders who offer stocks to the public. For this reason, a PTC that is listed in the stock exchange is called a publicly listed company. The PTC can also use the stock exchange to buy back some of the shares it sold to the public, and this is called share repurchase (or stock buyback or share buyback). Therefore, the stock exchange allows share repurchase, as well as share selling by the PTC.
• If other financial assets other than shares/stocks are sold in the stock exchange, then the stock exchange is now called a securities exchange. This means that a stock exchange falls under the category of a security exchange, and is regarded as one type of securities exchange.
• Specialty securities exchanges are named after the financial instrument or financial security that they specialize in trading e.g the Boston Options Exchange (BOX) trades in equity options, and is thus called an options exchange. Most of these speciality securities exchanges deals with derivatives trade. Equity, derivatives, options (a derivative of stocks), and equity options are defined later in this study. For now, the term financial instrument and financial security needs to be defined.
• A financial instrument is a…

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