INTRODUCTION TO EQUITIES

Introduction to Equities

Companies generate funds for their operations by offering either debt or equity securities. Debt entails borrowing money that must be repaid, generally with interest, whereas equity involves selling ownership shares in the company. When companies issue debt, they are legally obligated to repay both the principal amount and the interest. In contrast, equity securities (shares) do not require repayment, nor do they obligate the company to make regular payments, unlike debt. Shareholders invest in a company's equity with the hope of benefiting from the company’s growth and profitability. They are classified as residual claimants, meaning they are entitled to any leftover value after all debts and obligations have been settled, but they are last in line for any distributions.

Equity Ownership

Equity ownership denotes possessing a stake or interest in a company through the ownership of shares (also referred to as stock). When you possess equity in a company, you become a shareholder and have specific rights and responsibilities associated with your ownership. Equity ownership is a crucial concept in the realm of investing, as it signifies the portion of a company’s value that you hold.

Key Aspects of Equity Ownership

Shares of Stock: Ownership is represented by the number of shares that an investor possesses in a company. Each share reflects a fraction of the company’s ownership. For instance, if a company has 1 million shares outstanding, and you own 10,000 shares, you own 1% of the company.
Rights of Equity Owners: As a shareholder, you hold certain rights, which may vary based on whether you possess common or preferred stock:
Voting Rights: Common shareholders generally have the right to vote on significant company matters, such as the election of the board of directors or major corporate decisions (e. g. , mergers and acquisitions). These votes are typically cast during the company’s annual general meeting (AGM).
Dividends: As an equity owner, you may receive dividends, which are payments distributed by the company to shareholders from its profits. Not all companies issue dividends, but when they do, it is usually proportional to the number of shares owned.
Access to Financial Information: Shareholders have the right to view certain financial statements and reports, such as quarterly earnings reports and annual filings, which aid in understanding the company’s performance.
Liquidation Rights: In the case of liquidation or bankruptcy, equity owners are compensated after debt holders and preferred shareholders. Common shareholders are the last to receive compensation, if at all.

Types of Equity Ownership:

Common Stock: This is the most common type of equity ownership. Common shareholders are entitled to vote on corporate issues and may receive dividends if the company opts to distribute them. The value of common stock often fluctuates with the company’s performance.
Preferred Stock: Preferred shareholders hold a superior claim on the company’s assets and earnings than common shareholders. For instance, preferred shareholders typically receive dividends before common shareholders. However, they usually do not possess voting rights.

Types of Equity Investors:

Individual Investors: Individuals who acquire shares in companies either directly or via investment funds (ETFs, mutual funds). Individual investors might possess small portions of stock, granting them partial ownership in the firm.
Institutional Investors: These consist of large organizations such as mutual funds, pension funds, hedge funds, and insurance firms. Institutional investors generally hold considerable stakes in companies and often have the ability to affect company decisions because of their voting rights.

Dividends and Capital Gains:

Dividends: Equity holders might receive dividends, which are usually distributed quarterly, semi-annually, or annually. These dividends are frequently indicative of a company’s profitability, though not every company distributes dividends. Some reinvest their profits back into the business.
Capital Gains: When the value of a company’s stock appreciates, the worth of the equity ownership rises, potentially providing the shareholder with a profit when the shares are sold.

Risks of Equity Ownership:

Market Risk: Stock prices can be unpredictable and vary due to market situations, company performance, and economic elements. Shareholders risk losing the value of their investment if the company performs poorly or if the overall market declines.
Company-Specific Risk: Equity holders face the risk that poor management choices, competition, legal issues, or bankruptcy concerning a company could cause the value of their investment to drop.
Dilution: If a company issues additional shares (e. g. , during a secondary offering), existing shareholders may encounter dilution, meaning their ownership percentage in the firm diminishes.
Liquidity: Equity ownership in publicly traded companies allows for liquidity, meaning investors can generally buy or sell their shares swiftly in the stock market. However, the liquidity associated with equity ownership can change based on factors such as market conditions and the stock's trading volume. Conversely, privately held companies may offer less liquidity.

Ownership and Control

Ownership vs. Control: Equity ownership differs from control. Holding a large percentage of a company’s shares can grant an investor control over significant decisions, yet most shareholders, particularly in larger companies, may have limited influence. In contrast, institutional investors or founders with substantial holdings usually possess considerable authority over corporate decisions.

Majority vs. Minority Ownership:

Majority Shareholder: This refers to a person or an entity that owns over 50% of a company’s stock. A majority shareholder holds significant sway over the company’s choices, including the election of directors and essential business strategies.
Minority Shareholder: A minority shareholder owns less than 50% of the company’s stock. These shareholders have restricted voting power, but their interests remain significant, especially when corporate choices impact the value of their investment.

Benefits of Equity Ownership

Capital Appreciation: Over the years, the worth of your shares might rise, resulting in possible gains when you sell them. This is the main attraction of investing in stocks.
Dividends: For numerous investors, consistent dividend distributions offer a reliable income source. Firms that have a track record of issuing dividends are frequently viewed as secure investments.
Participation in Company Growth: As an equity stakeholder, you gain from the firm's achievements. If the firm expands and becomes more profitable, the worth of your shares might increase.
Liquidity: Stocks that are publicly traded are liquid, signifying that they can be effortlessly purchased or sold in the stock market.
Diversification: Holding shares in various companies or sectors enables investors to mitigate their risk, lessening the effects of poor performance from any single firm.

Share and Types of Shares

A share represents a unit of ownership in a corporation or financial asset. When you purchase shares of a corporation, you are effectively buying a minor portion of that corporation. When companies gather capital by distributing stock, they generally present different kinds of shares, each with unique rights and benefits for the shareholders. The two primary classifications of shares are common shares and preferred shares. Nevertheless, within these classifications, further distinctions can exist depending on the company’s organization and the rights associated with the shares.

1. Common Shares (Common Stock)

Common shares symbolize ownership in an enterprise and include voting rights and a possible portion in the company’s profits (often as dividends). This is the most common type of equity that individuals invest in.

Key Features:

Voting Rights: Common shareholders possess the right to vote during annual general meetings (AGMs) and special gatherings. They can vote on issues like the election of the board of directors and company policies.
Dividends: Common shareholders may obtain dividends, but these are not assured. The company has the option to reinvest its earnings rather than distributing them to shareholders.
Capital Appreciation: Common shareholders gain from any upswing in the company’s value, which can elevate the stock's price.
Risk: In the situation of bankruptcy, common shareholders are the last to be compensated, following creditors and preferred shareholders. This renders common shares riskier than preferred shares.

Advantages:

Possibility of substantial returns owing to capital gains and dividends.
Capacity to affect company choices via voting rights.

Disadvantages:

Increased risk, particularly if the company does poorly.
Dividends are not guaranteed and may fluctuate or be eliminated.

2. Preferred Shares (Preferred Stock)

Preferred shares are a form of stock that provides shareholders with a superior claim to the company’s assets and earnings compared to common shareholders. While preferred shareholders typically do not have voting rights, they benefit from certain advantages.

Key Features:

Fixed Dividends: Preferred shareholders generally receive fixed, regular dividend payments that take precedence over those of common shareholders. This can render preferred stock appealing for investors seeking income.
Priority in Liquidation: In the event of bankruptcy or liquidation, preferred shareholders are compensated before common shareholders, although after debt holders.
Convertible Preferred Shares: Certain preferred shares are convertible, meaning they can be changed into a set number of common shares at a specific price, offering shareholders the potential for capital appreciation.
Non-Voting: Generally, preferred shareholders lack voting rights in the company's operations, although exceptions may exist if specific conditions (e. g. , unpaid dividends) are satisfied.
Callability: Certain preferred shares are callable, indicating that the company can buy them back at a predetermined price prior to the maturity date.

Advantages:

Increased income due to fixed dividends.
Priority over common stockholders in the event of liquidation.
Less volatile than common stock, as they are more likely to provide a consistent income.

Disadvantages:

Limited or no voting privileges.
The price of preferred stock is typically less prone to significant increases compared to common stock.

3. Class A, Class B, and Other Classifications of Common Shares

Some businesses issue various classes of common shares, such as Class A and Class B shares, which have different voting rights, dividend frameworks, or additional benefits. These classifications allow companies to present various shareholder advantages while maintaining control.

Class A Shares: Usually, Class A shares possess superior voting rights compared to other classes. For instance, each Class A share might carry 10 votes, while Class B shares could hold only one vote or possess no voting rights whatsoever. This arrangement enables founders or major stakeholders to keep control over the company while also raising funds.
Class B Shares: Typically, Class B shares come with reduced voting rights or none at all. They may be issued to employees or the public while ensuring that the company's founders retain voting authority.

Advantages of Multiple Classes:

Founders can maintain control over the company even after it goes public.
Investors can still engage in the company's financial growth, even without voting rights.

Disadvantages of Multiple Classes:

Limited voting power for the majority of shareholders, which may lessen their impact on corporate decisions.
These shares can occasionally be perceived as less appealing due to the lack of equivalent control or influence.

4. Other Specialized Types of Shares

Redeemable (Callable) Shares: These are shares that can be "redeemed" or bought back by the company at a designated price after a specified duration. This category of shares can be either preferred or common.
Convertible Shares: As previously discussed, convertible preferred shares enable the shareholder to switch their preferred shares into common shares at a predetermined price. This provides the opportunity to benefit from the potential upside of common shares.
Growth Shares: These shares are usually provided to employees or management as a form of motivation. Growth shares typically grant investors a stake in a company's appreciation in value without the standard voting rights or a guarantee of dividends.
Non-voting Shares: Some companies offer non-voting shares (whether common or preferred) to generate capital without undermining the control of existing shareholders. These shares confer ownership and may yield dividends, but do not bestow the holder with the ability to vote on corporate issues.

5. Tracking Stocks

A tracking stock is a unique category of stock that is issued by a company to monitor the performance of a specific division or subsidiary. These stocks are associated with the performance of a particular segment of the company, enabling investors to invest in distinct business units without holding shares in the entire corporation. Tracking stocks may not always possess the same rights as other stock types and could have limited or no voting privileges.

Summary of Types of Shares:

Type of Share	Voting Rights	Dividends	Priority in Liquidation	Risk
Common Shares	Yes	Variable	Last (after debt, preferred)	High
Preferred Shares	No	Fixed, Regular	Above common shareholders	Moderate
Class A/B Shares	Varies (A > B)	Variable	Varies	Moderate
Convertible Shares	Varies	Fixed	Same as regular preferred	Moderate
Redeemable Shares	Varies	Fixed	Call by company (usually)	Moderate
Non-voting Shares	No	Variable	Last (after debt, preferred)	Moderate
Tracking Stocks	Varies	Variable	Last (after debt, preferred)	Moderate

Security Markets:

Securities markets denote the venues or systems where financial instruments (like stocks, bonds, and other securities) are traded. These markets play a vital role in the global economy by granting businesses access to capital and presenting investors with chances to purchase, sell, and exchange financial assets. There are two primary categories of securities markets:

1. Primary Market

This is the venue where new securities (stocks or bonds) are introduced and sold for the first time. Companies generate capital in the primary market by offering shares or bonds to investors. For instance, when a company performs an Initial Public Offering (IPO), it presents its shares to the public for the first time, and this takes place in the primary market.

2. Secondary Market

In the secondary market, previously issued securities are traded among investors. Companies do not participate directly in these dealings; instead, investors exchange securities with one another. The most recognized secondary markets are stock exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ.

Types of Securities Traded:

Equities (Stocks): Ownership shares in a company.
Bonds: Debt instruments issued by companies or governments. Bondholders receive periodic interest payments and are repaid the principal at maturity.
Derivatives: Financial contracts with values based on an underlying asset (like options and futures).
Commodities: Basic raw materials or primary agricultural products that are traded (for example, gold, oil, or wheat
Other Securities: Including mutual funds, ETFs (Exchange-Traded Funds), and REITs (Real Estate Investment Trusts).

Key Functions of Securities Markets:

Price Discovery: Securities markets aid in establishing the price of financial instruments via supply and demand.
Liquidity: Markets ensure liquidity, which allows investors to buy and sell securities with relative ease.
Capital Formation: Companies can secure funds by issuing new shares or bonds in the primary market.
Risk Management: Investors can leverage the markets to handle and diversify their financial risks.

Types of Securities Markets:

Exchange-Traded Markets: These are centralized venues where securities are traded systematically. Examples comprise the NYSE and NASDAQ.
Over-the-Counter (OTC) Markets: These are decentralized markets where securities are traded directly between parties, typically through a broker-dealer network. Examples include the OTC Bulletin Board (OTCBB) and the Pink Sheets.

Exchange-Traded Markets

Exchange-Traded Markets denote formal, centralized venues where securities (including stocks, bonds, derivatives, and other financial instruments) are traded. These markets offer a highly regulated and transparent setting for transactions, providing security for both purchasers and sellers. Trades executed on these exchanges follow established rules and regulations, presenting more standardized processes compared to decentralized markets like the Over-the-Counter (OTC) market.

Key Features of Exchange-Traded Markets:

1. Centralized Platform: In an exchange-traded market, all transactions take place via a central exchange (such as the NYSE or NASDAQ), which connects buyers and sellers for various securities.

2. High Regulation: These markets are strictly regulated by governmental bodies (such as the Securities and Exchange Commission (SEC) in the U. S. ) and self-regulatory entities (like FINRA) to assure fairness, transparency, and investor protection.

3. Liquidity: Given that exchange-traded markets are standardized and centralized, they typically provide higher liquidity than OTC markets. This implies that buying or selling securities can occur without significantly impacting the market price.

4. Transparency: Transactions within exchange-traded markets are publicly accessible, with prices and volumes available to all market participants. This transparency fosters market confidence and enables investors to make well-informed choices.

5. Price Discovery: The prices of securities in exchange-traded markets are influenced by supply and demand interactions. The market efficiently uncovers the "true" value of a security at any moment, based on all accessible information.

Major Types of Exchange-Traded Markets:

1. Stock Exchanges: These markets are where shares of publicly traded companies are exchanged. Some of the largest and most recognized stock exchanges include:

New York Stock Exchange (NYSE): Among the largest and oldest exchanges globally, situated in the U. S.
NASDAQ: An electronic exchange that hosts numerous technology firms and growth stocks.
London Stock Exchange (LSE): A significant exchange located in the UK.
Tokyo Stock Exchange (TSE): The primary exchange in Japan.

2. Commodity Exchanges: These exchanges are involved in the buying and selling of physical goods or raw materials, such as gold, oil, agricultural products, and beyond. Examples include:

Chicago Mercantile Exchange (CME)
Commodity Exchange, Inc. (COMEX)

3. Futures Exchanges: These exchanges focus on futures contracts, where parties agree to purchase or sell an asset on a future date at a prearranged price. Key examples encompass:

Chicago Board of Trade (CBOT)
Intercontinental Exchange (ICE)

4. Options Exchanges: These markets allow for the trading of options contracts, which grant buyers the right, but not the obligation, to purchase or sell an underlying asset at a certain price within a defined time frame. Examples include:

Chicago Board Options Exchange (CBOE)

5. Foreign Exchange (Forex) Markets: The foreign exchange market, in which currencies are traded, functions through an exchange or electronically, including platforms like the London International Financial Futures Exchange (LIFFE).

Advantages of Exchange-Traded Markets:

1. Standardization: Securities traded on exchanges must fulfill specific listing criteria and comply with standardized contract terms, ensuring consistency and fairness in transactions.

2. Liquidity: Higher trading volumes and a wide array of participants facilitate the quick buying or selling of securities.

3. Transparency: Markets organized by exchanges provide real-time pricing, trading volumes, and other pertinent data, enabling investors to make decisions based on the latest information.

4. Price Stability: The rivalry between buyers and sellers maintains competitive prices that reflect the market value more closely.

5. Investor Protection: Regulatory agencies enforce guidelines to safeguard investors against fraudulent practices and to maintain fair and orderly trading.

Risks of Exchange-Traded Markets:

1. Market Volatility: Although liquidity contributes to price stability, significant demand shifts or abrupt market news can still lead to notable price swings, particularly in unstable markets.

2. Transaction Costs: Trading on exchanges may incur fees (for instance, brokerage fees), which could diminish overall returns, especially for smaller investors.

3. Overregulation: While protecting investors, regulation may also constrain the flexibility of trading strategies or the variety of securities available on the market.

Examples of Exchange-Traded Instruments:

Stocks: Shares in publicly accessible companies, like Apple (AAPL) or Tesla (TSLA), that are listed on exchanges such as the NYSE or NASDAQ.
Bonds: Government and corporate bonds which can be traded on platforms like the London Stock Exchange or NYSE.
ETFs (Exchange-Traded Funds): Investment vehicles traded on exchanges, providing diversified exposure to stocks, bonds, commodities, or other asset classes.
Futures and Options: Contracts that obtain their value from underlying assets (such as stock indexes, commodities) traded on specific futures or options exchanges.

Participants in Exchange-Traded Markets:

1. Retail Investors: Individual investors who engage in buying and selling securities through brokerage companies or online trading platforms.

2. Institutional Investors: Large organizations such as pension funds, mutual funds, and hedge funds that conduct trades in significant volumes.

3. Market Makers: Financial entities or broker-dealers that supply liquidity by proposing to buy and sell securities at designated prices.

4. Broker-Dealers: Companies or individuals that assist in the buying and selling of securities on behalf of investors.

5. Exchanges: Organized entities that create the framework and regulations for market participants to carry out securities transactions (for example, NYSE, NASDAQ).

The Over-the-Counter (OTC)

The Over-the-Counter (OTC) market is a decentralized financial marketplace where securities, including stocks, bonds, commodities, and derivatives, are exchanged directly between two parties, typically via a broker-dealer network, rather than through a centralized exchange like the NYSE or NASDAQ. OTC markets possess fewer regulations and greater flexibility compared to formal exchanges, enabling a broader variety of instruments to be traded, including those not listed on regulated exchanges.

Key Characteristics of the OTC Market:

1. Decentralized: No centralized exchange exists; trades are performed directly between buyers and sellers, frequently through broker or dealer networks.

2. Less Regulation: Generally, OTC markets face less regulation than formal exchanges. This provides more flexibility but also necessitates that investors remain aware of the associated risks, including limited transparency.

3. Variety of Instruments: The trading of diverse types of securities occurs in OTC markets, encompassing stocks (particularly those of smaller or less-established firms), bonds, derivatives (like options and swaps), and commodities.

4. Private Deals: OTC transactions frequently consist of negotiated agreements between parties, allowing for tailored terms that may not be feasible on an exchange.

Types of OTC Markets:

1. OTC Bulletin Board (OTCBB): An electronic trading service under regulation by the Financial Industry Regulatory Authority (FINRA) for smaller, often less liquid stocks that are not listed on formal exchanges.

2. Pink Sheets: A minimally regulated segment of the OTC market where stocks, often of small or distressed companies, are traded. Such companies may not satisfy the listing standards for formal exchanges.

3. OTC Derivatives: This category includes swaps, forward contracts, and various complex financial products frequently transacted directly between institutions (like banks and investment firms).

Benefits of the OTC Market:

1. Access to Smaller Companies: Investors gain access to smaller or emerging businesses through the OTC market that might not fulfill the stringent listing criteria of major exchanges.

2. Customization: Trades can be tailored to meet the specific preferences of the involved parties, which is particularly significant for derivatives or complex contracts.

3. Flexibility: OTC trading tends to offer more flexibility regarding terms, pricing, and trading hours.

Risks of the OTC Market:

1. Lack of Transparency: As trades are not publicly recorded on an exchange, evaluating pricing, trade volume, and market trends can become more challenging.

2. Liquidity Issues: Numerous OTC securities are less liquid than those traded on major exchanges, complicating the buying or selling of large quantities of an asset without influencing its price.

3. Higher Risk of Fraud: The increased risk of fraudulent schemes or manipulative trading practices may arise due to the lower levels of regulation and transparency present.

Examples of OTC Securities:

OTC Stocks: Shares of smaller enterprises or startups that do not satisfy the qualifications for listing on larger exchanges.
Bonds: Certain corporate and municipal bonds may be traded OTC, particularly those issued by smaller or less-established firms.
Derivatives: Instruments like credit default swaps (CDS) and interest rate swaps are frequently traded in the OTC market.

Participants in the OTC Market:

Market Makers: Broker-dealers that pledge to buy and sell specific securities at designated prices, aiding in maintaining liquidity within the market.
Institutional Investors: Banks, hedge funds, and other major investors may participate in OTC trading to carry out large, tailored trades.
Retail Investors: Individual investors may also engage in OTC trading, though they usually do so indirectly through brokers or online trading platforms.

Regulatory Bodies for OTC Markets:

Even though the OTC market has less regulation compared to formal exchanges, it still functions under some regulatory supervision, particularly for specific types of transactions. In the U. S. , organizations such as:

Financial Industry Regulatory Authority (FINRA): Regulates broker-dealers and provides a degree of oversight to ensure equitable practices.
Securities and Exchange Commission (SEC): Holds authority over certain elements of the OTC market, especially in verifying that companies unveil essential financial information to investors.

Common Types of Market Indexes

Broad Market Indexes: Represent the entire market, such as the KSE-100 Index in Pakistan, which includes 100 companies with high market capitalizations.
Sector Indexes: Monitor specific sectors of the economy, such as the KMI-30 Index, which follows Shariah-compliant stocks.
Style Indexes: Track particular investment styles, such as growth, value, or small-cap stocks.