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To understand what are stocks and how stock
markets work, we need to dive into history--specifically, the
history of what has come to be known as the corporation, or
sometimes the limited liability company . Corporations in one form
or another have been around ever since one guy convinced a few
others to pool their resources for mutual benefit.
The first corporate charters were created in Britain as early as the
sixteenth century, but these were generally what we might think of
today as a public corporation owned by the government, like the
postal service.
Privately owned corporations came into being gradually during the
early 19th century in the United States , United Kingdom and western
Europe as the governments of those countries started allowing anyone
to create corporations.
In order for a corporation to do business, it needs to get money
from somewhere. Typically, one or more people contribute an initial
investment to get the company off the ground. These entrepreneurs
may commit some of their own money, but if they don't have enough,
they will need to persuade other people, such as venture capital
investors or banks, to invest in their business.
They can do this in two ways: by issuing bonds, which are basically
a way of selling debt (or taking out a loan, depending on your
perspective), or by issuing stock, that is, shares in the ownership
of the company.
Long ago stock owners realized that it would be convenient if there
were a central place they could go to trade stock with one another,
and the public stock exchange was born. Eventually, today's stock
markets grew out of these public places.
Stocks
A corporation is generally entitled to create as many shares as it
pleases. Each share is a small piece of ownership. The more shares
you own, the more of the company you own, and the more control you
have over the company's operations. Companies sometimes issue
different classes of shares, which have different privileges
associated with them.
So a corporation creates some shares, and sells them to an investor
for an agreed upon price, the corporation now has money. In return,
the investor has a degree of ownership in the corporation, and can
exercise some control over it. The corporation can continue to issue
new shares, as long as it can persuade people to buy them. If the
company makes a profit, it may plow back the money back into
the company or use some of it to pay dividends on the shares.
Public Markets
How each stock market works is dependent on its internal
organization and government regulation. The NYSE (New York Stock
Exchange) is a non-profit corporation, while the NASDAQ (National
Association of Securities Dealers Automated Quotation) and the
Toronto Stock Exchange are for-profit businesses, earning money by
providing trading services.
Most companies that go public have been around for at least a little
while. Going public gives the company an opportunity for a
potentially huge capital infusion, since millions of investors can
now easily purchase shares. It also exposes the corporation to
stricter regulatory control by government regulators.
When a corporation decides to go public, after filing the necessary
paperwork with the government and with the exchange it has chosen,
it makes an initial public offering (IPO). The company will decide
how many shares to issue on the public market and the price it wants
to sell them for. When all the shares in the IPO are sold, the
company can use the proceeds to invest in the business.
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