How the Stock Market Works
In order to understand what stocks are and how stock markets
work, we need to dive into history--specifically, the history of
what has come to be known as the corporation, or sometimes the
limited liability company (LLC). Corporations in one form or
another have been around ever since one guy convinced a few
others to pool their resources for mutual benefit.
The first corporate charters were created in Britain as early as
the sixteenth century, but these were generally what we might
think of today as a public corporation owned by the government,
like the postal service.
Privately owned corporations came into being gradually during
the early 19th century in the United States , United Kingdom and
western Europe as the governments of those countries started
allowing anyone to create corporations.
In order for a corporation to do business, it needs to get money
from somewhere. Typically, one or more people contribute an
initial investment to get the company off the ground. These
entrepreneurs may commit some of their own money, but if they
don't have enough, they will need to persuade other people, such
as venture capital investors or banks, to invest in their
business.
They can do this in two ways: by issuing bonds, which are
basically a way of selling debt (or taking out a loan, depending
on your perspective), or by issuing stock, that is, shares in
the ownership of the company.
Long ago stock owners realized that it would be convenient if
there were a central place they could go to trade stock with one
another, and the public stock exchange was born. Eventually,
today's stock markets grew out of these public places.
Stocks
A corporation is generally entitled to create as many shares as
it pleases. Each share is a small piece of ownership. The more
shares you own, the more of the company you own, and the more
control you have over the company's operations. Companies
sometimes issue different classes of shares, which have
different privileges associated with them.
So a corporation creates some shares, and sells them to an
investor for an agreed upon price, the corporation now has
money. In return, the investor has a degree of ownership in the
corporation, and can exercise some control over it. The
corporation can continue to issue new shares, as long as it can
persuade people to buy them. If the company makes a profit, it
may decide to plow the money back into the business or use some
of it to pay dividends on the shares.
Public Markets
How each stock market works is dependent on its internal
organization and government regulation. The NYSE (New York Stock
Exchange) is a non-profit corporation, while the NASDAQ
(National Association of Securities Dealers Automated Quotation)
and the TSE (Toronto Stock Exchange) are for-profit businesses,
earning money by providing trading services.
Most companies that go public have been around for at least a
little while. Going public gives the company an opportunity for
a potentially huge capital infusion, since millions of investors
can now easily purchase shares. It also exposes the corporation
to stricter regulatory control by government regulators.
When a corporation decides to go public, after filing the
necessary paperwork with the government and with the exchange it
has chosen, it makes an initial public offering (IPO). The
company will decide how many shares to issue on the public
market and the price it wants to sell them for. When all the
shares in the IPO are sold, the company can use the proceeds to
invest in the business.
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