Page 129 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes Stock Certificate

A stock is represented by a stock certificate. This is a fancy piece of paper that is proof of your
ownership. In today’s computer age, you won’t actually get to see this document because your
brokerage keeps these records electronically, which is also known as holding shares “in street
name”. This is done to make the shares easier to trade. In the past, when a person wanted to sell
his or her shares, that person physically took the certificates down to the brokerage. Now,
trading with a click of the mouse or a phone call makes life easier for everybody.

Limited Liability

Another extremely important feature of stock is its limited liability, which means that, as an
owner of a stock, you are not personally liable if the company is not able to pay its debts. Other
companies such as partnerships are set up so that if the partnership goes bankrupt the creditors
can come after the partners (shareholders) personally and sell off their house, car, furniture, etc.
Owning stock means that, no matter what, the maximum value you can lose is the value of your
investment. Even if a company of which you are a shareholder goes bankrupt, you can never
lose your personal assets.

Risk

It must be emphasized that there are no guarantees when it comes to individual stocks. Some
companies pay out dividends, but many others do not. And there is no obligation to pay out
dividends even for those firms that have traditionally given them. Without dividends, an investor
can make money on a stock only through its appreciation in the open market. On the downside,
any stock may go bankrupt, in which case your investment is worth nothing.
Although risk might sound all negative, there is also a bright side. Taking on greater risk
demands a greater return on your investment. This is the reason why stocks have historically
outperformed other investments such as bonds or savings accounts. Over the long term, an
investment in stocks has historically had an average return of around 10-12%.

How stocks trade?

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide
on a price. Some exchanges are physical locations where transactions are carried out on a trading
floor.
The purpose of a stock market is to facilitate the exchange of securities between buyers and
sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if
you had to call around the neighborhood trying to find a buyer. Really, a stock market is
nothing more than a super-sophisticated farmers’ market linking buyers and sellers.
Before we go on, we should distinguish between the primary market and the secondary market.
The primary market is where securities are created (by means of an IPO) while, in the secondary
market, investors trade previously-issued securities without the involvement of the issuing-
companies. The secondary market is what people are referring to when they talk about the stock
market. It is important to understand that the trading of a company’s stock does not directly
involve that company.

Some common stock markets of the world are as follows:
1. The New York Stock Exchange: The most prestigious exchange in the world is the New
York Stock Exchange (NYSE).

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