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INTRODUCTION

In world of commerce, apart from money equally revolutionary concept was the concept of limited
liability. Before the industrial revolution economy was self-sufficient village economy. The artisans produced
goods and services on demand. It was industrial revolution, which paved the way for production in anticipation
of demand, and along with it came the economies of large-scale production and to support this was needed
huge finance. Innovative forms of business establishment, incorporating the principle of Limited liability
emerged. Form the highly imaginative world of business, a novel form of business organization viz. Joint Stock
Companies, with the features like limited liability and the separation of ownership and management was born.
Risk is an important and inherent part of any business. Risk cannot be avoided. You can only try to manage
it. This was the best example of risk management by spreading it in small proportions amongst large number
of shareholders. This was achieved by a concept called shares or stock and the need for trading in these stocks
was felt.

2.1 CAPITAL FORMATIONS AND ECONOMIC DEVELOPMENT

Multiplicity of wants and scarcity of means to satisfy these unlimited wants has continued to be the
fundamental of economic problem. Money resources are required to move physical resources. Mobilization
of resources for economic development was and continues to be the major problem with all developing and
developed nations. The capital might be from within the country or outside the country. But one of the
greatest challenges of nations today is creating conditions conducive for capital formation as also for
attracting capital from various countries. A growing economy with vibrant capital and money market with
rules and regulations in place is a of capital formation Prerequisite for attracting capital. Stock market plays
a key role in the entire gamut of financial system.
Having broadly discussed the developments and the basic issues involved, we will now try to review
the Indian Financial System. India has come a long way during the last decade of the 20th Century. With the
path-breaking budget of 91-92 presented by Dr. Man Mohan Sign an era of globalization, liberalization,
decontrol and de-regulation was adhered in. Since then a lot of water has flown from under the bridge and lot
of Development has taken place. The focus all along has been to faster economic development.

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2.2 INDIAN FINANCIAL SYSTEM

The financial system comprises a variety of intermediaries, markets, and instruments. It provides the
principal means by which savings are transformed into investments. Given its role in the allocation of
resources, the efficient functioning of the financial system is critical to a modern economy.

A conceptual Framework of how the financial system works: -

The Financial System

A financial system is a set of institutional arrangements, through which financial surpluses are
mobilized from the units generating surplus income to others in need of them. Financial markets, financial
instruments, financial services and financial institutions constitute the financial system. Financial market
provide channels for allocation of savings to investment, that is how the savings are channelised into
investments thus generating further income, cash or assets. Financial market has two major components

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viz. money market and capital market. Money market refers to the market where borrowers and lenders
exchange short-term funds, to solve their liquidity needs. Money market instruments have low default risk,
maturities under one year and high marketability (liquidity). Low default risk implies that generally the risk
of non-payment of money is low. Maturities under one year imply that all contracts are of maximum one year.
Capital market comprises of institutions and mechanisms through which medium to long term funds are pooled
and made available to business, government and individuals. It facilitates investment in fixed assets. Capital
market consists of securities or stock market. Securities market consists of primary market and secondary
market.
Primary market consists of channel for sale of new securities, while secondary market deals in the
securities already issued. Primary markets involve the following methods of issue.

IPO
Further issue of capital
Rights issue
Offers to public
Bonus issue
Secondary market enables those who already hold securities to adjust their investment in response to
change in their assessment of risk and return, the statement implies that those who already holds the securities
may want to sell them in case if those securities are not paying off, or if he needs to adjust his liquidity or for
any other reason. Secondary market refers to the stock exchanges, a stock exchange provides mechanism to
buy and sell the securities already issues in primary market. There are at present 23 stock exchanges in
India.

2.3 STOCK MARKET

The term ‘the stock market’ is a concept for the mechanism that enables the trading of company
stocks (collective shares) and other securities. The size of the 'stock market' is estimated at about $51 trillion.
The stocks are listed and traded on stock exchanges which are entities specialized in the business of bringing
buyers and sellers of stocks and securities together.
Participants in the stock market range from small individual stock investors to large hedge fund traders,
who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes
the order.
Some exchanges are physical locations where transactions are carried out on a trading floor, by a
method known as open outcry (e.g.: -New York stock exchange). This type of auction is used in stock
exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The
other type of exchange is a virtual kind, composed of a network of computers where trades are made
electronically via traders at computer terminals (e.g. -Nasdaq).

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Actual trades are based on an auction market paradigm where a potential buyer bids a specific price
for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you
will accept any bid price or ask price for the stock.) When the bid and ask prices match, a sale takes place on
a first come first served basis if there are multiple bidders or askers at a given price.
The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers,
thus providing a market place (virtual or real). The exchanges provide real-time trading information on the
listed securities, facilitating price discovery.

Market participants

Many years ago, worldwide, buyers and sellers were individual investors, such as wealthy
businessmen, with long family histories (and emotional ties) to particular corporations. Over time, markets
have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance
companies, mutual funds, hedge funds, investor groups, and banks). The rise of the institutional investor has
brought with it some improvements in market operations.

The First Stock Market

The Dutch started joint stock companies, which let shareholders invest in business ventures and get a
share of their profits - or losses. In 1602,The Dutch East India Company issued the first shares on the
Amsterdam Stock Exchange It was the first company to issue stocks and bonds. Amsterdam Stock Exchange
(or Amsterdam Beurs) is also said to have been the first stock exchange to introduce continuous trade. The
Dutch "pioneered short selling, option trading, debt-equity, merchant banking, unit trusts and other speculative
instruments ". There are now stock markets in virtually every developed and most developing economies, with
the world's biggest markets being in the United States, Canada, China, India, UK, Germany, France and Japan

Importance of stock market


Function and purpose
The stock market is one of the most important sources for companies to raise money. This allows businesses
to go public, or raise additional capital for expansion. The liquidity that an exchange provides affords investors
the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to
other less liquid investments such as real estate.
History has shown that the price of shares and other assets is an important part of the dynamics of
economic activity, and can influence or be an indicator of social mood. Rising share prices, for instance, tend
to be associated with increased business investment and vice versa. Share prices also affect the wealth of
households and their consumption. Therefore, central bank tends to keep an eye on the control

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and behavior of the stock market and, in general, on the smooth operation of financial system functions.
Financial stability is the important outlook of central banks.
Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the
shares, and guarantee payment to the seller of a security. The smooth functioning of all these activities
facilitates economic growth in that lower cost and enterprise risks promote the production of goods and services
as well as employment. In this way the financial system contributes to increased prosperity.

Relation of the stock market to the modern financial system

The financial system in most western countries has undergone a remarkable transformation. One feature
of this development is disintermediation. A portion of the funds involved in saving and financing flows directly
to the financial markets instead of being routed via banks' traditional lending and deposit operations. The
general public's heightened interest in investing in the stock market, either directly or through mutual funds,
has been an important component of this process. Statistics show that in recent decades shares have made up
an increasingly large proportion of households' financial assets in many countries. The major part of this
adjustment in financial portfolios has gone directly to shares.

IMPACT OF STOCK EXCHANGES IN INDIA:

Following are the changes due to the existence of Stock Exchange:


1. Mobilization of savings
The savings of the individuals are easily mobilized in various types of industries. Therefore the
amount of investments in the stock exchange increases.
2. Increase in rate of return on investment
The investors get more rate of return i.e. the market rate and not the normal bank rate, which is
much lower.
3. Availability of funds for growth of industries.
The amount of funds required for the growth of the industries is easily available whereas there was
always shortage of capital.
4. Diversification of industries
Due to the availability of funds the industry becomes financially strong and have scope or
diversification due to which they can become more strongly in the market.
5. Increase in employment
Growth and diversification of industries leads to increase in the amount of work and thus increase
job opportunities for the unemployed.
6. Increase in standard of living
The increased job opportunities and the availability of goods of higher quality have increased the
standard of living of people.

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7. Increase in GDP
Increase in business in overall all industries has automatically leaded to the rise in GDP of the
country and thus its prosperity.
8. Decrease in Trade Deficit.
Due to growth in industries the country is becoming self-sufficient leading to decrease in trade
deficit.

2.4 TRADING IN INDIA: -

The trading on stock exchange in India used to take place through open outcry without use of
information technology for immediate matching or recording of trades. This was time consuming and
inefficient. This imposed limits on trading volumes and efficiency. In order to provide efficiency, liquidity and
transparency, NSE introduced a nationwide online fully automated screen based trading system (SBTS)
where a member can punch into the computer quantities of securities and the prices at which he likes to transact
and the transaction is executed as soon as it finds matching sale or buy order from a counter party. SBTS
electronically matches order on strict time/price priority and hence cuts down on time, cost and risk of error,
as well as on fraud resulting in improved operational efficiency. It allows faster incorporation of price
sensitive information into prevailing prices, thus increasing the information efficiency of markets. It enables
market participants, irrespective of their geographical locations, to trade with one another simultaneously,
improving the depth of liquidity market. It also provides a perfect audit trail, which helps to resolve disputes
by logging in the trade execution process in entirety. Today India can boast that almost 100% trading take
place through electronic order matching. Technology was used to carry the trading platform from the trading
hall of stock exchanges to the premises of brokers. NSE carried the further platform further the PCs at the
residence of Clients through the Internet for Users in geographically vast country like India.

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Conceptual framework

Trading Network

The trading network is depicted in the above figure shows NSE has main computer, which
is connected through very small Aperture Terminal installed at the office. The main computer runs
on falls tolerant STRATUS mainframe computer at the exchange. Brokers have terminals installed
at their premises, which are connected through VASTs/ leased lines/ modems. Investors inform
broker to place an order on behalf of them. The broker enters the order through his PC, which
runs under Windows NT and sends signal to the satellite via VAST/ leased line/ modem. The
signal directed to mainframe computer at NSE
The system also provides complete market information online. The market screens at any
point of time provide information on total order depth in a security, the five best buys and sells
available in the market, the quantity traded in the day security, the high and the low, the last traded
price, etc. investors can also know the fate of the orders almost as soon as they placed with the
trading members. The trading system is normally made available for trading on all days except
Saturdays, Sundays and other holidays.

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BOMBAY STOCK EXCHANGES:
This stock exchanges, Mumbai, popularity known as “BSE” was established in 1875 as “The
native share and stock brokers associations”, as a voluntary non-profit making association.
It has an evolved over the years into its status as the premiere stock exchanges in the country.
It may be noted that the stock exchanges the oldest one in Asia, even older than the Tokyo
Stock Exchanges, which was founded in 1878.
The exchanges, while providing an efficient and transparent market for trading in securities,
upholds the interests of the investors and ensures redressed of their grievances, whether against
the companies or its own members brokers.
It also strives to educate and enlighten the investors by making available necessary informative
inputs and conducting investor’s education programmers.
A governing board comprises of elected directors, 2SEBI nominees, 7 public representatives
and an executive director is the apex body, which decides the policies and regulates the affairs
of the exchanges.
The executive director as the chief executive officer is responsible for the day today
administration of the exchanges. The average daily turnover of the exchange during the year
2000-01 (April-March) was Rs 3984.19 crores and average numbers of daily trades 5.69 Lakhs
However the averages daily turnover of the exchanges during the year 2001-2002 has declined
to Rs. 1224.10 crores and number of average daily trades 5.69 Lakhs.
The average daily turnover of the exchanges during the year 2001-2003 has declined and
number of average daily trades during the period is also decreased.The Ban on all deferral
products like BLESS AND ALBM in the Indian capital markets by SEBI with effect from July
2, 2001, abolition of account period settlements, introduction of compulsory rolling settlements
in all scripts trades on the exchanges.With effect from dec31, 2001 etc. have adversely
impacted the liquidity and consequently there is a considerable decline in the daily turnover at
the exchanges. The average daily turnover of the exchanges present scenario is 110363 (Laces)
and number of average daily trades 1057(laces) 7

NSE NIFTY 50
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The 50 stocks that were most
favored by institutional
investors in the 1960s and
1970s.

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NATIONAL STOCK EXCHANGES:

The NSE was incorporated is now 1992 with an equity capital of Rs 25 crores. The international
securities consultancy (ISC) of Hong Kong has helped in setting up NSE.

ISE has prepared the details business plans and installation of hardware and software system.
The promotion for NSE were financial institutions, insurances companies, banks and SEBI
capital markets Ltd, infrastructure leasing and financial services Ltd and stock holding 28
corporation Ltd.

It has been set up to strengthen the move towards professionalization of the capital market as
well as provide nation wide securities trading facilities to investors. NSE is not an exchange in
the traditional sense where broker own and manage the exchanges.

A two tier administrative set up involving a company board and a governing aboard of the
exchanges is envisaged. NSE is a national market for shares PSU bonds, debentures and
government securities since infrastructure and trading facilities are provided.

Stock Exchange
What is the role of a Stock Exchange in buying and selling shares?
The stock exchanges in India, under the overall supervision of the regulatory
authority, the Securities and Exchange Board of India (SEBI), provide a trading
platform, where buyers and sellers can meet to transact in securities. The
trading platform provided by NSE is an electronic one and there is no need for
buyers and sellers to meet at a physical location to trade. They can trade
through the computerized trading screens available with the NSE trading
members or the internet based trading facility provided by the trading members
of NSE.
What is Demutualisation of stock exchanges?
Demutualisation refers to the legal structure of an exchange whereby the
ownership, the management and the trading rights at the exchange are
segregated from one another.
How is a demutualised exchange different from a mutual exchange?
In a mutual exchange, the three functions of ownership, management and
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trading are concentrated into a single Group. Here, the broker members of the
exchange are both the owners and the traders on the exchange and they
further manage the exchange as well. This at times can lead to conflicts of
interest in decision making. A demutualised exchange, on the other hand, has
all these three functions clearly segregated, i.e. the ownership, management
and trading are in separate hands.

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Issue of Shares
Why do companies need to issue shares to the public?
Most companies are usually started privately by their promoter(s). However, the
promoters' capital and the borrowings from banks and financial institutions may
not be sufficient for setting up or running the business over a long term. So
companies invite the public to contribute towards the equity and issue shares to
individual investors. The way to invite share capital from the public is through a
'Public Issue'. Simply stated, a public issue is an offer to the public to subscribe
To the share capital of a company. Once this is done, the company allots shares
to the applicants as per the prescribed rules and regulations laid down by SEBI.
What are the different kinds of issues?
Primarily, issues can be classified as a Public, Rights or Preferential issues
(also known as private placements). While public and rights issues involve a
detailed procedure, private placements or preferential issues are relatively
simpler. The classification of issues is illustrated below:
Initial Public Offering (IPO) is when an unlisted company makes either a fresh
issue of securities or an offer for sale of its existing securities or both for the first
time to the public. This paves way for listing and trading of the issuer's
securities.
A follow on public offering (Further Issue) is when an already listed
company makes either a fresh issue of securities to the public or an offer for
sale to the public, through an offer document.
Rights Issue is when a listed company which proposes to issue fresh
securities to its existing shareholders as on a record date. The rights are
normally offered in a particular ratio to the number of securities held prior to the
issue. This route is best suited for companies who would like to raise capital
without diluting stake of its existing shareholders.

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A Preferential issue is an issue of shares or of convertible securities by listed
companies to a select group of persons under Section 81 of the Companies 31
Act, 1956 which is neither a rights issue nor a public issue. This is a faster way
for a company to raise equity capital. The issuer company has to comply with
the Companies Act and the requirements contained in
the Chapter pertaining to preferential allotment in SEBI guidelines which interalia
include pricing, disclosures in notice etc.
Classification of Issues
What is meant by Issue price?
The price at which a company's shares are offered initially in the primary
market is called as the Issue price. When they begin to be traded, the
market price may be above or below the issue price.
What is meant by Market Capitalisation?
The market value of a quoted company, which is calculated by multiplying
its current share price (market price) by the number of shares in issue is
called as market capitalization. E.g. Company A has 120 million shares in
issue. The current market price is Rs. 100. The market capitalisation of
company A is Rs. 12000 million.

What is the difference between public issue and private placement?


When an issue is not made to only a select set of people but is open to the
general public and any other investor at large, it is a public issue. But if the
issue is made to a select set of people, it is called private placement. As per
Companies Act, 1956, an issue becomes public if it results in allotment to 50
persons or more. This means an issue can be privately placed where an
allotment is made to less than 50 persons.

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What is an Initial Public Offer (IPO)?


An Initial Public Offer (IPO) is the selling of securities to the public in the
primary market. It is when an unlisted company makes either a fresh issue of
securities or an offer for sale of its existing securities or both for the first time to
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the public. This paves way for listing and trading of the issuer's securities. The
sale of securities can be either through book building or through normal public
issue.
Who decides the price of an issue?
Indian primary market ushered in an era of free pricing in 1992. Following this,
the guidelines have provided that the issuer in consultation with Merchant
Banker shall decide the price. There is no price formula stipulated by SEBI.
SEBI does not play any role in price fixation. The company and merchant
banker are however required to give full disclosures of the parameters which
they had considered while deciding the issue price. There are two types of
issues, one where company and Lead Merchant Banker fix a price (called fixed
price) and other, where the company and the Lead Manager (LM) stipulate a
floor price or a price band and leave it to market forces to determine the final
price (price discovery through book building process).
What does 'price discovery through Book Building Process' mean?
Book Building is basically a process used in IPOs for efficient price discovery. It
is a mechanism where, during the period for which the IPO is open, bids are
collected from investors at various prices, which are above or equal to the floor
price. The offer price is determined after the bid closing date.

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Importance Of Stock Market:

Function and purpose

The stock market is one of the most important sources for companies to raise money. This
allows businesses to be publically traded or raised additionally capital for expansion by selling 33
share of ownership of the company in a public market.
The liquidity that an exchange provides affords investors the ability to quickly and easily sell
securities. This is an attractive feature of investing in stocks, compared to other less liquid
investment such as real estates.

History has shown that the price of shares and other assets is an important part of the dynamic
of economies activity, and can influence or be an indicator of social mood.

An economy where the stock market is on the rise is considered to be an up and coming
economy.

In fact, the stock market is often considered the primary indicators of a country’s economics
strength and development. Rising share prices, for instance, tend to be associated with
increased business investment and vice versa.
Share prices also affect the wealth of household and their consumption.

Therefore, central banks tend to keep an eye on the control and behavior of the stock market
and, in general, on the smooth operation of financial system functions. Financial stability is the
raison d’être of central banks.
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Exchanges also act as the clearinghouses for each transaction, meeting that they collect and
deliver the shares, and guarantee payment to the seller of a securities. This eliminates the risk
to an individual buyers or seller that the counterparty could default on the transaction.
The smooth functioning of all these activities facilities economies growth in that lower costs
enterprise risks promote the production of goods and services as well as employment.

In this way the financial system contribution to increased prosperity. An important aspect of
modern markets, however, including the stock markets, is absolute discretion.

For example, in the USA stock we see more unrestrained acceptance of any firm than in similar
markets. Such as, Chinese firms with no significant value to American society to just name one
segment.

This profit USA banker on Wall Street, as they reap large commissions from the placement,
and the Chinese company which yields funds to invest in china.

Yet accrues no intrinsic value to the long-term stability of the American economy, rather just
short-term profits to American business man and the Chinese; although, when foreign company
has a presence in the new market, there can be benefits to the market’s citizens.

Conversely, there are very few large foreign corporation listed on the Toronto Stock exchange
TSX, Canada’s largest stock exchange. This discretion has insulated Canada to some degree to
worldwide financial condition.

In order for the stock markets to truly facilitate economy’s growth via lower costs and better
employment, great attention must be given to the foreign participants being allowed in.
Relation of the stock market to the modern financial system.
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The financial system in most western countries has undergone a remarkable transformation.
One features of this development is disintermediation. A portion of the funds involved in saving
and financing bank lending and deposit operation.
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The general public’s heightened interest in investing in the stock market, either directly or
through mutual funds, has been an important component of this process. Statistics show that in
recent decades share have made up an increasingly large proportion of household’s financial
assets in many countries.
In the 1970’s, in Sweden, deposit account and other very liquid assets with little risk made up
almost 60 percent of households’ financial wealth, compared to less than 20 percent in the
2000s.

The major part of this adjustment in financial portfolio has directly to shares but a good deal
now take the form of various kinds of institutional investment for groups of individuals, e.g.,
pension funds, mutual funds, hedge funds, insurance investment of premiums, etc.

The trend towards form of saving with a higher risk has been accentuated by new rules for most
funds and insurance, permitting a higher proportion of shares to bonds.

Similar tendencies are to be found in other industrialized countries. In all developed economies
system, such as the European Union, the United State, Japan and other developed nations, the
trend has been the same: saving has moved away from traditional (government insured) bank
deposits to more risky securities of one sort or another.

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The Stock Market, Individual Investors, and Financial Risk:

Riskier long-term saving required that an individual possess the ability to manage the
associated increased risks. Stock prices fluctuated widely, in marked contrast to the stability of
(government insured) bank deposits or bonds.

This something that could affect not only the individual investors or households, but also the
economy on a large scale. The following deals with some of the risks of the financial sectors
in general and the stock market in particular.

This is certainly more important now that so many newcomers have entered the stock market,
or have acquired other ‘risky’ investment (such as ‘investment’ property, i.e., real estate and
collectables.)
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With each passing year, the noise level in the stock market rises. Television commentators,
financial writers, analysis, and market strategies are all over taking each other to get investors
‘attention’.

At the same time, individual investors, immersed in chat rooms and message boards, are
exchanging questionable and often misleading tips.

Yet, despite all this available information, investors find it increasingly difficult to profit. Stock
prices skyrocket with little reasons, then plummet just as quickly.

And people who have turned to investing for their children’s education and their own
retirement become frightened. Sometimes there appears to be no rhyme or reason to the market,
only folly.

This is a quote from the prefaces to a published biography about the long-terms value oriented
stock investors warren Buffett.

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The behavior of the stock market:

From experiences we know that investors may ‘temporarily’ move financial prices away from
their long terms aggregate price ‘trend’ (positive or up trends are referred to as bull markets:
negative or down trends are referred to as bear markets.)

Over-reaction may occur so that excessive optimism (euphoria) may drive prices unduly high
or excessive pessimism may drive unduly low. New theoretical an empirical arguments have
since been put forward against the notion that financial markets are ‘generally’ efficient (i.e.,
in the sense that prices in the aggregate tends to follow a Gaussian distribution.)

(But this largely theoretic academic viewpoint- knows as ‘hard’ EMH- also predicts that little
or no trading should take place, contrary to fact, since prices are already at or near equilibrium,
having priced in all public knowledge.) The ‘hard’ efficient-market hypothesis is sorely tested
by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6
percent—the largest-ever one-day fall in the United States.

This events demonstrated that share prices can fall dramatically even though, to this day, it is
impossible to fix a generally agreed upon definite cause: a thorough search failed to detect any
‘reasonable’ development that might have accounted for the crash. (But note that such events
are predicted to occur strictly by chance, although very rarely.)

It seems also to be the case more generally that many price movements (beyond that which are
predicted to occur ‘randomly’) are not occasioned by new information: a study of the fifty
largest one-day share prices movements in the United States in the post-war period seems to
confirm this.

However, a ‘soft’ EMH has emerged which does not required that prices remain at or near
equilibrium, but only that market participants not be able to systematically profits from any
momentary market ‘inefficiencies’.
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Various explanation for such large and apparently non-random prices movement have been
promulgated. For instance, some research has shown that change in estimated risks, and the
use of certain strategies, such as stop-loss limit and value at Risk limits, theoretically could
cause financial markets to overcorrect.

But the best explanation seems to be that the distribution of stock market prices is non-Gaussian
(in which case EMH, in any of its current forms, would not be strictly applicable.)

Other research has shown that psychological factors may result in exaggerated (statically
anomalous) stock prices movement (contrary to EMH which assumes such behaviors’ cancel
out’).

Psychological research has demonstrated that peoples are predisposed to ‘seeing’ patterns, and
often will perceive a pattern in what is, in fact, just noise, (something like seeing familiar shapes
in clouds or ink blots.)

In the present context this means that a succession of good new items about a company may
lead investors to overreact positively (unjustifiably driving the prices up). A period of good
returns also boosts the investor’s self-confidence, reducing his (psychological) risk threshold.

Another phenomenon—also from psychology—that works against an objective assessment is


group thinking. As social animal, it is now easy to stick to an opinion that differs markedly
from that of a majority of the group.

An example with which one may be familiar is the reluctance to enter a restaurant that is empty;
people generally prefer to have their opinion validated by those of other in the group.

In one paper the authors draw an analogy with gambling. In normal times the market behaves
like a game of roulette; the probabilities are known and largely independent of the investment
decision of the different players.
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In times of market stress, however, the game becomes more like poker (herding behavior takes
over). The players now must give heavy weight to the psychology of other investors and how
they are likely to react psychology.
The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced
investors rarely get the assistance and support they need.

In the period running up to 1987 crash, less than 1 percent of the analysis recommendation had
been to sell (and even during the 2000-2002 bear market, the average did not above 5%).

In the run up to 2000, the media amplified the general euphoria, with reports of rapidly rising
share prices and the notion that large sums of money could be quickly earned in the so called
In the run up to 2000, the media amplified the general euphoria, with reports of rapidly rising
share prices and the notion that large sums of money could be quickly earned in the so called
new economy stock market.

(And later amplified the glom which descended during the 2000-2002 bear market, so that by
summer of 2002, prediction of a DOW average below 5000 were quite common).
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Irrational behavior:
Sometimes the market seems to react irrationally to economic or financial news, even if that
news is likely to have no real effect on the technical value of securities itself.

But this may be more apparent than real, since often such has been anticipated, and a counter
reaction may occurs if the news is better (or worse) than expected.

Therefore, the stock market may be swayed in either by press releases, rumors euphoria and
mass panic; but generally only briefly, as more experienced investors (especially the hedge
funds quickly rally to take advantage of even the slightest, momentary hysteria.

Over the short-term, stock and other securities can be battered or buoyed by any number of
fast market-changing events, making the stock market behavior difficult to predict. Emotion
can drive prices up and down, people are generally not as rational as they think, and the
reasons for buying and selling are generally obscure.
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Behaviorists argue that investors often behave ‘irrationally’ when making investment decision
thereby incorrectly pricing securities. This causes market inefficiencies, which, in turn, are
opportunities, to make money.
However, the whole notion of EMH is that these non-rational reactions to information cancel
out, leaving the prices of stock determined. The Dow Jones industrial Average biggest gain in
one day was 936.42 points or 11 percent, this occurred on October 12, 2008.
Crashes:
Robert shiller’s plot of the S&P composite Real prices, Earning, Dividends, and interest Rates,
from irrational exuberance, 2nd. In the prefaces to this edition, Shiller warns, “The stock market
has not come down to historical levels: the prices-earnings ratio as I defined it in his book is
still, at this writing [2005], in this mid-20s, far higher than the historical average…..people still
place too much confidence in the market and have too strong a belief that paying attention to
the gyration in their investment will someday make them rich, and so they do not make
conservative preparation for possible bad outcomes.”
Price-Earnings ratios as predictors of twenty-year returns based upto the plot by Robert shiller.
The horizontal axis shows the real price-earnings ratio of the S&P composite stock price index
as computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year
mean of inflation-adjusted earning).
The vertical axis shows the geometric average real annual return on investing in the S&P
composite stock prices index, reinvesting dividends, and selling twenty years-did do well when
prices were low relative to earnings at the beginning of the ten years.
Long-term investors would be well advised, individually, to lower their exposer to the stock
market when it is high, as it has been recently, and get into the market when it is low.”

Stock market crash:


A stock market crash is often defined as a sharp dip in share prices of equities listed on the
stock exchanges. In parallel with various economics factors, a reason for stock market crashes
is also due to panic and investing public’s loss of confidence. Often, stock market crashes end
speculative economics bubbles.
There have been famous stock market crashes that have ended in the loss of billions of dollars
and wealth destruction on a massive scale. An increasing number of people are involved in the
stock market, especially since the social security and retirement plans are being increasingly
privatized and linked to stocks and bonds and other elements of the market.
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There have been a number of famous stock market crashes like the Wall Street crashes of 1929,
the stock market crash of 1973-4, the Black Monday of 1987, the Dot-com bubble of 2000, and
the stock market crashes 2008.
One of the most famous stock market crashes started October 24,1929 on Black Thursday. The
Dow Jones industrial lost 50% during this stock market crash. It was the beginning of the Great
depression.
Another famous crash took place on October 19, 1987 --- Black Monday. On Black Monday
itself, the Dow Jones fell by 22.6% after completing a 5 year continuous roses in share prices.
This event not only shook the USA, but quickly spread across the world.
Thus, by the end of October, stock exchanges in Australia lost 41.8%, in Canada lost 22.5%,,
in Hong Kong lost 45.8%, and in Great Britain lost 26.4%. The names, “Black Monday” and
“Black Tuesday” are also used for October 28-29, 1929.
This followed terrible Thursday –the starting day of the stock market crash in 1929. The crash
in 1987 raised some puzzles—main news and events did not predict the catastrophe and visible
reasons for the collapse were not identified.
This event raised question about many important assumptions of modern economics, namely,
the theory of rational human conduct, the theory of market equilibrium and the hypothesis of
market efficiency.
For some time after the crash, trading in stock exchanges worldwide was halted, since the
exchanges computers did not perform well owing to enormous quantity of trades being received
at one time.
This halt in trading allowed the Federal Reserve System and central banks of other countries
to take measures to control the spreading of worldwide financial crisis.
In the United State the SEC introduction several new measures of control into the stock market
in an attempt to prevent a re-occurrence of the events of Black Monday.
Computer systems were upgrades in the stock exchanges to handle larger trading volumes in a
more accurate and controlled manner. The SEC modified the margin requirement in an attempt
to lower the volatility of common stocks, stock option and the futures markets.
The New York Stock Exchanges and the Chicago Mercantile Exchange introduction the
concept of a circuit breaker. The circuit breaker halts trading if the Dow declines a prescribed
number of points for a prescribed amount of time.
 New York Stock Exchange (NYSE) circuit breakers.

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Stock market index

 The movement of the prices in a market or sections of a market are captured in price
indices called stock market indices, of which there are many, e.g., S&P, the FTSE and
the Euro next indices.

 Such indices are usually market capitalization weighted, with the weight reflecting the
contribution of the stock of the index are reviewed frequently to include/exclude stocks
in order to reflects to reflects the changing business environment.

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Leveraged strategies
 Stock that a traders does not actually own may be traded suing short selling; margin
buying may be used to purchase stock with borrowed funds; or, derivatives may be used
to control large blocks of stock for a much smaller of amount of money than would be
required by outright purchases or sale.

Short selling

 In short selling, the traders borrow stock (usually from his brokerage which holds it’s
client’s shares or its own share on account to lend to short sellers) then sells it on the
market, hoping for the price to all.

 The trader eventually buys back the stock, making money if the price fell in the
meantime or losing money if it rose; exiting a short position by buying back the stock
is called “covering a short position”.

 This strategy may also be used by unscrupulous traders to artificially lower the price of
a stock. Hence most markets either prevent short selling or place restriction on when
and how a short sale can occur.

 The practice of naked shorting is illegal in most (but not all) stock markets.\

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Margin buying:

 In margin buying, trader borrows money (at interest)to buy a stock and hopes for it to
rise. Most industrialized countries have regulation that requires that if the borrowing is
based on collateral from other stock the trader owns outright, it can be a maximum of a
certain percentage of those other stocks’ value.

 In the United State, the margin requirements have been 50% for many years (that is, if
you want to make a $100 investment, you need to put up$500, and there is often a
maintenance margin below the $500).

 A margin call is made if the total value of the investor’s account cannot support the loss
of the trade.

 (Upon a decline in the value of the margined securities additional funds may be requires
to maintain the account’s equity, and with or wit out the margined securities or any
others within the account may be sold by the brokers to protect its loan position. This
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investors is responsible for any shortfall following such forced sale).
 Regulation of margin requirement (by the Federal Reserve) was implemented after the
crash of 1929. Before that, speculators typically only needed to put up a little as 10%
(or even less) of the total investment represented by the stocks purchased.

 Other rules may include the prohibition of free-riding: putting in an order to buy stocks
without paying initially (there is normally a three-day grace period for delivery of the
stock.)

 But then selling them (before the three-days are up) and using part of the proceeds to
make the original payment (assuming that the value of the stocks has not declined in
the interim).

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New issuance:

 Global issuance of equity and equity-related instrument totaled $505 billion in 2004, a
29.8% increase over the $389 billion raised in 2003. Initial public offer (IPOs) by US
issuers increased 221% with 233offering that raised $45 billion, and IPOs in Europe,
Middle East and Africa (EMEA) increased by 333% from $9 billion to $39 billion.

Investment strategies:

 One of the many thing people always want to know about the stock market is, “How do
I know money investing?” There are many different approaches; two basic methods
are classified as either fundamental analysis or technical analysis.

 Fundamental analysis refers to analyzing companies by their financial statements


founds in SEC Filing, business trends, general economic conditions, etc.

 Technical analysis studies prices action in market through the use of charts and
quantitative techniques to attempt to forecast prices trends regardless of the company’s
financial prospects.

 One examples of a technical strategy is the Trend following method, used by John W
Henry and risk control and diversification.

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 Additional, many choose to invent via the index method. One holds a weight or
unweight portfolio consisting of the entire stock market or some segment of the stock
market (such as the S&P 500 or Wilshire 5000).

 The principle aim of this strategy is to maximize diversification, minimize taxes from
too frequent trading and ride the general trend of the stock market (which, in the U.S,
has averaged nearly 10% year, compounded annually, since World War II).

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Taxation:

 According to much national or state legislation, large arrays of fiscal obligation are
taxed for capital gains. Taxes are charged by the state over the transactions, dividends
and capital gains on the stock market, in particular in the stock market.

 However, these fiscal obligations may vary from jurisdiction to jurisdiction because,
among other reasons, it could be assumed that taxation is already incorporated into the
stock prices through the different taxes companies pay to the state, or that tax free stock
market operations are useful to boost economic growth.

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