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Re: preventing stock plunge

Please help make the Manifesto better, or accept it, and propagate it!

The stock market is an abstraction of the "real market(s)" at best or an elaborate
pyramid scheme at worst.  There are 2 parameters that are important here that
would tie this abstraction to the real world and those are: (1) purchase of stocks
and (2) the dispatch of dividends.  So, if we were to subscribe to any principles
of "conservation" of this or that then how is it that your theory below would
"prevent the stock market plunge"?

PS: "real markets" are not so "real" either but that is a different issue!

Vamsi M.

venugopal wrote:

> ---------------------------------------------------------------------
> Please help make the Manifesto better, or accept it, and propagate it!
> ---------------------------------------------------------------------
> 1. I think the concept of stocks and shares, their impact on the economy  can
> be understood by starting from looking at how a person saves. Traditionally,
> there were not many alternatives other than buying gold, or land. (Of course,
> in the traditional economies, there were cultural practices like a person who
> has earned substantial crop requiring to do some Puja and call all villagers
> for feast and  other charity-oriented acts, which took care of a portion of a
> person's surplus, though not everything was rosy with tradition.)As the
> economy developed, a need arose for heavy investments for industrialization.
> That is how companies started getting formed and they started borrowing from
> banks and financial institutions. Other than borrowing from Banks, which
> requires thorough scrutiny of their records by  the bankers and mutual
> acceptance of the loan terms,  public companies have other option of raising
> resources from the public. It is to sell the  company's shares, by public
> issue (or by giving 'warrants' or rights to existing shareholders),  which in
> effect, increases the equity. The net worth of  a company is  the value of the
> shareholders' ownership and is equal to 'Assets minus Liabilities'. The ratio
> of debt to networth represents the ability of the company to raise resources
> from others in relation to its ownership value. This is called the leverage of
> the company. Bookvalue of stock is the networth per share.
> 2. Now, the share market is just like any other market, say, a vegetable
> market. Buyers want to buy and sellers want to sell and everyday large number
> of transactions take place. There are brokers who act on behalf of buyers or
> sellers and who offer to buy or sell on behalf of the clients. Now, just like
> price of any commodity, there is  demand and supply mechanism operating.
> People have their own notions of value of each share based on their own
> assesments, insights, advertisements and feedback . People make their own
> decisions based on  their assesment of 1. Risk factor 2. Liquidity factor and
> 3. Return, not necessarily in the same order. People consider how easily the
> instrument could be encashed in time of need, upto what period it is
> 'locked-up' and so on. Some who want to give least importance to risk factor
> and highest priority to return may go for high-yielding but risky investment
> options. . Those who want safety first may go for National Savings
> Certificates issued by Post offices.While the supply of financial instruments
> is governed by the need to sell on part of the existing holders for whatever
> reasons, the demand is governed by people's assesments of a particular share
> of a company considering the three factors as above. Now, just like any other
> market, there is a point where the demand curve meets the supply curve and
> that is the equilibrium price of that particular share. Now, suppose, for a
> company, such market price is more than its bookvalue. To take an example,
> suppose the bookvalue is Rs 10 per share, but the market value is Rs 15 per
> share, and suppose the company has a networth of Rs 100 crore. It means the
> company has 10 crore shares. Suppose the company requires purchasing new
> machinery and needs capital. The company can consider issuing another 10 crore
> shares at the rate of Rs 15 per share. If it is able to ensure public
> subscriptions, or sell its shares, it means the assets and networth each has
> risen by Rs 150 crore, while the liabilities remained the same. Thus the
> networth has now become 100 plus 150 i.e. 250 crores. The company has thus
> reduced its 'leverage', which means, in future, it could raise debts from
> financial institutions if need be, relatively more easily. With 20 crore
> shares now, its bookvalue has become 250/20 i.e. Rs 12.50. Thus, by going
> public at the appropriate time, the company has not only raised resources but
> also increased its bookvalue.  Thus, a buoyant financial market, where the
> prices are higher than bookvalues of companies, stimulates growth in the
> economy by attracting investment in certain sectors. Conversely, if the
> financial market is low, it means the market equilibrium price of a company's
> share is lower than its bookvalue. If that happens, company will not feel
> encouraged to go for public issue, even if there is a genuine need for
> acquiring new machinery. If the trend continues, it may lead to a situation,
> where the company may decide to increase the bookvalue per share by buying
> back its shares from the public, by dishing out cash. (Suppose the bookvalue
> now is Rs 10 per share, the company has a networth of Rs 100 crore in our
> example and market value is Rs 5 per share. Company can decide to buy back
> 4crore shares available with public by spending Rs 20crore. Assets and
> networth both reduce by Rs 20 crore. Networth now becomes Rs 80 crore and
> number of shares is now 10 minus 4 i.e. 6 crore, making the bookvalue 80/6
> i.e. Rs 13.33 per share. Thus bookvalue increased from 10 to 13.33, and the
> company has increased its leverage, thereby making it more difficult for being
> able to obtain loans from banks) But the company had to spend cash to achieve
> this, by foregoing any real investment need for new machinery. Another
> alternative that can happen in an economy in such a situation is that big
> companies may find it easier to acquire or take over smaller companies by
> purchasing their shares, without having to invest in new machinery or
> equipment. Both these alternatives have an adverse impact on the overall
> growth of the economy. Thus a market with falling share prices spells problems
> for the performance of the economy. Now it is also true that a well-performing
> economy with reasonably controlled inflaion and low unemployment rate would
> naturally lead to a growing share market. And a poorly performing economy has
> many consequences, with people not earning enough to be able to invest, those
> having some thing to invest not able to find attractive and safe avenues for
> investment, and thus leading to  poor stock market. Thus, it seems like a kind
> of chick-and-egg situation as to which causes which. But, I guess, a sound
> economy is a pre-requisite in the long run for growing stock market.
> 3. The crucial difference between the financial market and any other commodity
> market is that a share is just a document, representing a promise of a
> particular kind of performance. You are 'free' to determine and evaluate the
> likely future performance promises of the company. There is a possibility that
> the promises may be kept and you may get fantastic returns. There is also a
> possibility that you may lose your amount invested, but that is it: you will
> not lose more than what you have invested. Thus you have agreed on taking a
> certain amount of calculated risk.  Of course this is all within the overall
> framework of public disclousures a company has to follow, as per guidelines of
> SEBI. Now, the Stock exchange indices are basically a measure of extent of
> transactions in a particular day by comparing with  cumulative performance.
> Overall changes in the index denote the buoyancy or otherwise of the
> investors. The share market regulator, i.e, SEBI regulates the market by
> controlling certain minimum requirements on part of the brokers, prescribing
> margins, and so on, attempting to influence likely decisions of major players
> like Foreign Institutional Investors, domestic financial institutions like LIC
> and so on. Now, there can be a number of reasons for fluctuations in the
> capital markets, ranging from performance of specific sectors,tax rates,
> fiscal and monetary policies affecting the aggregate savings for investment,
> international business cycles, i.e. fluctuations in growth and recession from
> time to time, with no particular periodicity, Court orders affecting growth of
> particular sectors,  assesment of expectations of various players, global
> financial situation, domestic political situation, and all other factors
> affecting individual assesment of 'return, risk and liquidity' on part of the
> investors.
> I think it is necessary that SEBI  basically ensures that the transactions are
> based on fair degree of transparency and individual companies adhere to basic
> standards and accouting principles, in order to ensure a level playing field
> in the sense that nobody should be in a position to artificially jack up or
> manipulate stock prices and the prices be strictly responding to a number of
> voluntary sellers and voluntary buyers. There is also a great long-term need
> for regulatory organizations like Registrar of Companies to be transparent,
> fair and open in enforcement. Similarly credit-rating agencies need to be
> absolutely professional.  But, other than that, I am not sure if there is a
> need to take any measures to 'prevent a plunge', as plunge is as natural as a
> boom and essentially the stockmarket reflects the condition of the economy in
> the long run, notwithstanding short term fluctuations.
> 4. Now, coming to the query on energy based currency, I am not  clear on how
> such idea could be practically implemented, as lot of theory still needs to be
> sharpened and tools made sophisticated so that it does not make the system
> more cumbersome. Perhaps, what one should aim is to progressively ensure
> greater accountability and enforcement of environmental standards. If law
> enforcement is done rigorously, perhaps the fiscal and monetary policies will
> be better tools to guide the economy. The Capital markets automatically play
> secondary role in influencing investors' decisions. In order to make 'energy
> based currency a reality', many more preparatory jobs will have to be done,
> like first building up a translation of various databases, like, for example,
> the economic survey, or reports of State Domestic Product from rupees to
> energy-units and subject them to detailed scrutiny and interpretation, which
> is not going to be an easy task. Therefore I think it is too premature now to
> think of stockmarkets and energy-units. I hope this meets some of the points
> raised and I welcome others to participate/ add.
> "Komaragiri, Param (Param)** CTR **" wrote:
> > ... relevance of a stock market crash,
> > stock 'points' they frequently say in a market plunge,
> > what exactly happens in a stock trade ? is the value
> > attributed to each stock too virtual? Is it going to whither away
> > when energy based currency if at all becomes a reality?
> > ...
> > How do we ideally prevent a stock plunge to save an economy?
> >
> > Parameswar
> >
> >
> --------------------------------------------------------------------------
> This is the National Debate on System Reform.       debate@indiapolicy.org
> Rules, Procedures, Archives:            http://www.indiapolicy.org/debate/
> -------------------------------------------------------------------------

Vamsi M.

This is the National Debate on System Reform.       debate@indiapolicy.org
Rules, Procedures, Archives:            http://www.indiapolicy.org/debate/