Passive vs. Active: Story of stock market and its hypothesis of return Part 1

 

What is stock market ?

Stock : Stock in financial world have different  meaning In case of Financial  instrument Stock or share are ownership of company in proportions you hold

Market :  As per old school theory, market is place were buyer  and seller meet  to fulfill their need and as new school, Market is a arrangement were buyer and seller meet to fulfill their need.

If we combined both ,than stock market is place were buyer and seller meet to trade their stock between each other for cash and transfer of ownership. Or we can say  The stock market is a place where market participants can access any publicly listed company and trade from their point of view, as long as there are other participants who have an opposing point of view.

 

Before diving deep in financial market, Let have brief of financial market, it is divided in two part

i)                    Moneymarket

ii)                   Capital market

Money market :

money market refers to short term financial market ,highly liquid, low risk financial instrument are traded time period of one or less than one year. It acts as a crucial link between borrowers and lenders seeking immediate access to funds.

Instruments Traded:

Treasury bills: Short-term debt securities issued by the government.

Commercialpaper: Unsecured promissory notes issued by corporations.

Certificatesof deposit (CDs): Interest-bearing securities issued by banks.

Federal funds: Overnight loans between banks to manage their reserve requirements.

REPO : Short-term agreements to sell and repurchase securities.

Key Functionalities:

Provides short-term financing: Businesses, governments, and financial institutions can borrow funds to meet their immediate needs.

Manages liquidity: Enables institutions to invest excess funds temporarily and earn interest.

Sets benchmark interest rates: Influences interest rates across other financial markets.

Promotes financial stability: Provides a cushion against unexpected cash flow shocks.

Key factor  Money Market:

High liquidity: Instruments can be easily bought and sold with minimal price fluctuations.

Low risk: Investments are backed by highly creditworthy institutions, minimizing default risk.

Competitive interest rates: Offers relatively good returns compared to traditional savings accounts.

Contributes to economic growth: Facilitates smooth flow of funds and supports business activities.

Participates of  Money Market:

Governments: Manage short-term cash flow needs and issue Treasury bills.

Banks and financial institutions: Borrow and lend funds to manage liquidity and earn interest.

Corporations: Raise short-term funds for inventory purchases, payroll, or other operational needs.

Investment funds and individual investors: Park excess funds for short periods and earn returns.

 

Capital Market :

 A capital market is a financial market where long-term debt or equity-backed securities are bought and sold. In simpler terms, it's where businesses, governments, and individuals can raise capital for their long-term needs, while investors can put their money to work for potential returns over a longer period.

 key points about capital markets:

·         Focus: Unlike money markets which deal with short-term debt instruments (less      than a year), capital markets focus on longer-term investments, typically with      maturities exceeding one year.

·         Instruments: They trade various forms of securities, including:

o        Equity: Ownership shares in a company (stocks).

o       Debt: Loans or bonds issued by companies or governments, promising fixed       interest payments over time.

o       Derivatives: Contracts whose value depends on the underlying asset     (e.g., stocks, bonds, currencies).

·         Roles: They play a crucial role in the economy by:

o     Facilitating capital allocation: Connecting those with capital (suppliers) to those who need it (demand ).

o    Providing investment opportunities: Enabling individuals and institutions to invest their savings for potential growth and income.

o    Supporting economic growth: Fueling business expansion, infrastructure development, and job creation.

Types of Capital Markets:

·         Primary market: Deals with the initial issuance of new securities like stocks or bonds.

·         Secondary market: Provides a platform for trading existing securities among investors. (Next part soon )

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