Quiz 7: Stocks and Other Assets
Stock Exchange is the market place where the buyer and seller trade their stocks. The Stock Exchanges contributes the utmost for the Joint Stock Enterprise to flourish and develop dealing with the securities. The Stock Exchange performs certain functions that help the company in the process of capital formation and in raising resources for the corporate sector. • The Stock Exchange offers purchase and sale of securities such as shares, bonds, debentures etc. • It ensures the free transferability of securities • It provides the association between the savings in the household sector and investment in corporate economy. • It provides a market quotation of the prices of shares and bonds; • It serves as the role of barometer, which reveals the state of health of individual companies and of the nation's economy. • It enables active trading, which helps in liquidity to financial assets. Some Stock Exchanges exist as physical places and few exist through a network of system. Such as the examples of stock exchanges are New York Stock Exchange and NASDAQ (National Association of Securities Dealers Automated Quotation) Stock Exchange. New York Stock Exchange has a physical place and is located at lower Manhattan and NASDAQ Stock Exchange. It has no fixed physical location tangible but works through a network of computers. They differ in manner way of in New York Stock Exchange, since as a place exits the people who want to buy or sell stocks can meet at this place and trade. Whereas in case of NASDAQ, the seller or buyer of stocks need not go to a particular place and search for trade of stocks, it can via net basis make its transactions easily transacted and promptly.
The gains earned by the investors are liable to taxes. The capital gains earned by investors are even liable to taxes, along with dividends; investors should also pay taxes on their realized capital gains. Capital gains are of two forms realized capital gains and implicit capital gains. Realized capital gains is the actual profit earned by investor on selling stocks whereas the Implicit capital gains are the profit which is accrued but not yet realized. The investor is liable to pay taxes on dividends and capital gains earned on the stocks. Therefore, the investors even thou the stock value increase cannot significantly invest in other stock easily to avoid paying capital gains taxes. For instances if Mr. John invested in GENINE Ltd., Stock at a price of $50 and it gradually increased to $80 in two years and rate of return in 10% in the meantime if the OPTIMISTIC Ltd., is issuing Stock at the price of $70 and expected to increase to $120 in coming year and rate of return is 20%. Therefore, if Mr. John wants to invest in OPTIMISTIC Ltd., he will not go for purchasing it because Mr. John has to sell the GENINE Ltd., first and pay taxes on capital gains and then invest in OPTIMISTIC Ltd., and for this, he has to forego an amount for taxes. Therefore the investor (Mr. John) doesn't goes for purchase in OPTIMISTIC Ltd., and this type of holding of investment leads to lock-in-effect for the stock market. This lock-in-effect leads to unhealthy price discrimination of the stocks. Since the stocks are being held, even though it gets less rate of returns, compared to present and holds it for a longer period and on other hand, the other stock, which can have a boom and high rate of returns does not get adequate investors and will suffer a fall in the price. This leads to inefficiency in discovery of the worth of the stocks properly and affect the stock market. Therefore, it is clear that the lock-in effect cause the stock market to be inefficient.
Investments by investors depends on various factors such as on the basis of maturity period, credit-worthiness nature of the instrument or security, variability of the rates of returns, liquidity of an investment, forecasted factors etc. Thus, investments associated with risks along with returns. Therefore, if an investor invests all his savings or surplus only in one type of stocks of a company there is a heavy threat of risks, therefore its considerable to invest in a diversified number of securities so that the risks pertain to those can also be diversified and the investor can easily manage his portfolio and perform well. Because even one investment earns losses then it can be offset by the other investment which earns gains. Diversification is important because for sure there is no possibility for a single class of assets or investment to perform best in all economic environments. Therefore, it is best to go for diversified portfolio, as it is helping in the best way to match the decline securities with the better performing securities. Diversification does not eliminate risk or guaranteed returns of securities, but it just a way to earn potential returns overtime without exposing to higher risks. Mutual Funds are money-managing institutions which are set up for professionally invest the money pooled in from the public. These are managed by AMC Asset Management Companies, which are sponsored by different financial institutions or companies. Therefore, these mutual funds consist of various schemes and each scheme invest in diversified elected number of securities. Therefore, if an investor invests in mutual funds then indirectly it means he has invested in diversified portfolio of securities. Hence, in this way, mutual fund help an investor achieve this diversification goal.