mechanism of stock trading
TRANSCRIPT
Mechanism of
Stock Trading
A Simple story
This is a storyOf, • How a company/business is formed• Buying and selling of shares• Rising and decline of share prices• Etc...
Company/Business is formed
Meet Siril.
Siril is a farmer. He understood the demand for
coconuts. He had an idea to start a coconut
plantation to meet this demand. So he bought some
land and equipment using a loan. The only problem
was that he lacked enough money to buy coconut
saplings. He had Rs 2,500 but the saplings cost
Rs.5,000. What could he do?
Company/Business is formed
Initial Public Offering
for raising capital
Siril
meets 5 good friends of his
“My friend Nimal, I want 500 rupees from you, But I’m not sure if I could pay it back as a loan. But I can promise you that I will give you a precentage of my harvest to you”
Nimal: “OK friend, I’ll give you the money...”
Initial Public Offering for raising capital
What did Siril do?
He offers his friends a share of his business
Initial Public Offering for raising capital
a Partner or
a Shareholder
The coconut plants grew rapidly
1st year harvest = 100 coconuts
• As Siril paid 50% for the saplings.So he kept 50 coconuts and decided
to share the rest among the friends, 10 per each
• They can use or sell them
Distinction Between Being a Partner and Being a Shareholder
A General Meeting was held by the investors
• They discussed weather they get their coconuts or ask Siril to sell them and give them the money
Decision made: – do the 2nd
• So Siril sold the coconuts and gave his friends the money received
Distinction Between Being a Partner and Being a Shareholder
And also Siril issued a small note saying,
“Siril and Company” “You have one share guaranteeing you,
10% of the company’s profits”
Distinction Between Being a Partner and Being a Shareholder
Trading occurs on Siril’s undervalued Shares
Now Siril’s plantation is very much richer
Production : 500 coconuts
• He sells each for Rs.20 and he got a revenue of Rs.10000/=
Earnings of per share holder = Rs.1000
Siril buys more saplings with his Rs.5000/=• Those plants are also now productive and Siril
now owns a Rs.20000/= revenue creating coconut plantation
Trading occurs on Siril’s undervalued Shares
Sunil, a neighbor of Siril,
sees this and wants to join in (More investors)
Nimal, who’s a share holder of Siril’s company
willing to sell his share
So Sunil likes to pay Rs.500 for the share (Bidding)
But Nimal, not a jerk, knows that this share earns Rs.2000 now (Earnings Per Share)
Trading occurs on Siril’s undervalued Shares
Nimal
asks Rs.2000/= for the share
(Asking)
Sunil agreed and he buys the share for Rs.2000/=
(trading happens)
Trading occurs on Siril’s undervalued Shares
A Bit of a
Bubble
Forms
Oh, What was other share holders
were thinking???
“ Hey, what does Nimal just did? How did he made
money that much quick?We wanna sell too!!!”
Siril’s other neighbors : “We’d like to buy too!!!”
A Bit of a Bubble Forms
Shares are trading...Now share price = Rs.5000/=
It is more than the earnings of Siril’s plantation
(now, shares are over valued)
A Bit of a Bubble Forms
One loyal share holder -> Gayan
Buyers asks for Rs.6000 but he refuse to sell
Why?
He has a fixed income
A Bit of a Bubble Forms
Oh no, Beetles
They destroyed whole one year’s production
Share holders are in troublebecause they used their savings to invest in
A Bit of a Bubble Forms
Bubble bursts
2 share holders, want money, sell their shares to Gayan for Rs.2000/=
(share price declined)
Now Gayan owns 3 shares of Siril’s company
Other share holders also want to sellBut, Gayan don’t need any.
Oh, They are in trouble
Bubble bursts
Jayantha comes in to the sence
He offers Rs.1500 per share
2 share holders sell their shares to Jayantha Rs.1500 each
(share price goes down more and more)
Bubble bursts
Demand is still there
Siril wants to start again
But he don’t have any money...
Bubble bursts
Siril
Issues a
Bond
Due to the tragedy happened,Siril do not want to issue more shares
He don’t wanna get a load either...
........................................
New Idea......
Siril Issues a Bond
Why not sell some of his items?
He selects some crates to sell without actually selling them
(because he needs them back when the production resumed)
Siril Issues a Bond
Call for Nimal from Siril....“Nimal, my good friend, I have an offer for you. I'll sell you my crates, which are worth Rs.5000 total, for a mere Rs.3000 and then buy them back next week for the full Rs.5000.“
Nimal thinks for a while and agrees
Deal is done
Siril Issues a Bond
"But Nimal," Siril adds, "I don't want to run my crates down there and pick them up again. Can I just write up a piece of paper? It'll save my back."
"I don't know - can we call it a
promissory note?" Nimal asks enthusiastically.
"Sure can, but I was thinking more of calling it
a bond or a certificate," says Siril.
Siril Issues a Bond
Insecticide applied -> beetles eliminated
And he pays Nimal as promised and re-own the crates
All are back to normal
Siril Issues a Bond
What
we
learnt?
This story may not explain everything about investing in stocks,
but it does highlight one very important point: ‘the price of Siril's stock followed investors' opinion of the stock's value rather than just the performance of Siril's company.
What we learnt?
Because the stock market is an auction,
There is no set price for a certain stock,
There is a concept that derails most people's trains of thought:
the price paid for a stock is what it's
"worth" until a lower or higher price is offered.
What we learnt?
This fluctuation of worth is good and bad for investors
– because it allows for profit (when you buy an undervalued stock)
– but also makes losses possible (when you pay too much for a stock).
What we learnt?
Learn more about Stock trading
and Colombo Stock Exchange...
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