Shares, Shareholders and the Stock market

The Big 3 S's: Share, Shareholders and the Stock market

By the end of this blog post we will looking at what a stock exchange is and why we need one. But don't worry if that sounds intimidating or confronting, we will start by taking a few steps back and asking what are shares?

Shares are actually a small percentage of ownership of the company. Each share is of equal value and entitles the owner a portion of the profit earned by the company, paid as a dividend. A shareholder is then a person who owns a share in the ownership of a company. To make the decision process easier for a public company with many shareholders, they exercise their control by electing a board of directors to represent their interests.

Shares can be sold for both private and public companies. We will primarily be concerned with public companies. Initially, shares for a public company are sold by the company to investors (normally institutional) to raise capital. This is referred to as the primary market. When these investors decide to sell their shares, without the involvement of the company, it is referred to as the secondary market.

Given the number of companies in each country, and the number of investors, finding another person to buy your share in a company sounds like a chaotic mess! However, we have organised this process into a regulated market, called the stock exchange (in Australia it is called the Australian Stock Exchange or ASX). Stock exchanges in the past have had pits where many traders would stand and yell their orders to facilitators. However, these days almost all stock exchanges are fully electronic, allowing purchase and sale of shares to occur anywhere in the world.

If you are confused about anything I have explained today, try watching this video (Note it is very Australian specific and uses Australian examples and regulations).

The Miracle of Compound Interest

Compound Interest isn't really a miracle, although sometime it can see like that! Last week we discussed simple interest, where the interest is calculated and paid at the end of the time period. This week we will step it up a notch and talk about compounding interest. Compounding is the addition of the interest to the principle before the next interest payment is calculated. This means that the accumulated interest payments in addition to the principle will receive interest for the next payment. This leads to an exponential growth of the loan or deposit. This is the most common type of interest currently used in commercial settings. If you have a savings bank account it will almost certainly be compounded daily for a monthly interest payment.

Frequency of the payments is important for compounding interest. For example; a 5% deposit compounded annually will receive less interest than a 2.5% deposit compounded every 6 months.

To calculate compound interest, use the following formula:

I = P [(1 + r)ⁿ – 1]

 Where:

I= Interest on loan or deposit

P = Principle of loan

R = Rate of Interest per time period

n = number of time periods

P.S. Make sure your Interest rate and time periods are the same duration. Often you may find them quoted in different durations.

Starting Simple

Today we will be 'Starting Simple', by discussing simple interest. While simple interest is not used in many commercial settings anymore, it is important to understand the concept. Interest is the excess charged on a loan to compensate for risk. Simple interest or 'flat rate' interest is only based on the principle so it has a linear relationship with time. More complicated interest types such as compound interest (where interest is charged on interest) will be discussed next week.

To figure out the interest on a loan using simple interest, use the following formula:

Interest = Principle x Rate x Time

Abbreviated to:

I = P x R x T

Where:

I = Interest on loan

P = Principle of the loan

R = Rate of Interest per time period

T = Number of Time periods (Often done annually)