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Management of Finances
Notes When investors acquire stock or other investments on margin, they are increasing the financial
risk of the investment beyond the risk inherent in the security itself. They should increase their
required rate of return accordingly.
Return on margin transaction = (change in investor’s equity – interest – commission)/initial
investor’s equity
Example: Suppose an investor is bullish (optimistic) on Microsoft stock, which is currently
selling at 100 per share. The investor has 10,000 to invest and expects the stock to go up in
price by 30% during the next year. Ignoring any dividends and commissions, the expected rate
of return would thus be 30% if the investor spent only 10,000 to buy 100 shares. If the investor
borrows 10,000 from his broker and invest it in the stock (along with his own 10,000). Assume
that the interest rate is 9% per year.
14.3.3 Role of Stock Exchanges
The stock exchange performs following functions:
1. The stock exchange provided a ready and continuous and permanent market for the
purchase and sale of exiting securities. Securities traded on the exchange are easily
marketable and highly liquid, less risky than other types of investment.
2. Evaluation of securities: It is an open market appraisal based on a compromise between
the opinions of willing buyers and willing sellers.
3. Safety in Dealing: The motto of stock exchange is Dictum Meum Pactum i.e.: “My word is
my Bond”. There is high degree of commercial honor among the member of stock exchange.
To ensure honesty ad integrity in trading on stock exchange, its members are selected
very judiciously. The member is required to observe the rules and regulations of the stock
exchange. The provision of securities contract (regulation) Act provides an element of
safety to the investors.
4. Mobilization of saving: The task of mobilizing savings and directing them into productive
uses is an important function. It inculcates the habit of saving, investing and risk taking
among the members of general public.
5. Canalization of Capital: Through the price quotations, stock exchange helps in canalizing
national saving from less profitable to most profitable sectors of economy. The investors
tend to withdraw their investments from the companies with fewer prospects and invest
in companies whose prospects seem to be better as reflected in their share quotations.
Thus society’s savings are allocated to the promising issues and invested for the maximum
social advantage.
6. Price Stability: The presence of a large number of buyers and seller of securities, demand
for and supply of different securities tend to equalize, thus eliminating the chances of
sudden fluctuations in prices.
7. Economic Barometer: Alfred mashed puts it, “stock exchanges are not merely chief theaters
of business transactions, they are also barometers which indicate the general conditions of
business in a country”. It is the nerve centre of economic health of a nation. It is so
sensitive institution that even a small change in the political, social or economic or
economic environment gets immediately reflected in the dealing on the stock exchange.
8. Facilities for Speculation: The stock exchange provides opportunities to shrewd
businessmen to speculate and rep profits from fluctuations in security prices. Due to
speculation, the supply of securities at different places may be equalized with demand.
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