Final project on Capital Market

1. To capitalize the reverses Securities market provides a channel of allocation of

saving to those who have productiveness in them. As a results the savers and
investors are not constrained by their individualities but by the economy’s ability to
invest and save respectively, which inevitably enhance saving and enhancement in
the economy. The national stock exchange of India ltd (NSE) has genesis the report
of the high powered study group on establishment of new stock exchanges, which
recommended promotion of a national stock exchange by financial institution to
provide access to investors from all across the country on an equal footing, based on
the recommendation, NSE was promoted by leading financial institution at the
behest of the government of India and was incorporated in November 1992 as a tax
paying company unlike other stock exchange in the country. 1 To meet the regular
working capital requirements  To diversify the production  To expand an existing
company  To promote a new company 1. Executive Summary The project on
capital study is an attempt to study an overall primary market and secondary market
in India. It’s helped to know and study the parameters opted by all the capital market
and the companies who are operating themselves under the rules and regulation of
capital market. The performance of capital market has registered a significant
upward in recent times right from the beginning capital market attract every person
as it has become common to see car on road every day and being a student of
Finance I learned a lot from this project and it would help me a lot in making my
career. I come to know a lot about Indian as well as international capital market and
how they help there economy. The market for long term securities like Bonds, Equity
stock and Preferred stock is divided into primary and secondary market. The primary
market deals with the new issue of securities. Outstanding securities are traded in
the secondary market or stock exchange. In the secondary market the investor can
sell and buy securities. Stock market predominantly deals in the equity shares debts
instrument like bonds and debenture are also traded in the stock market. Well
regulated and active stock market promotes capital formation. Growth of the primary
market depends on the secondary market. The health of the economy is reflected by
the growth of the stock market. Company raises funds to finance the project to
various methods. The promoters can bring the own money or borrow from the
financial institution or mobilize capital by issuing securities. The funds may be raise
from issue of fresh share at par, or at premium preference shares debentures or
global depository receipts. The main objectives of a capital issue are given below: -
2. 2. Present face of capital market. 2 Structure of capital market.  Concept of
capital market. UNIT- I Introduction:
3. 3. To capitalize the reverses Securities markets provide a channel for allocation of
savings to those who have a productive need for them. As a result, the savers and
investors are not constrained by their individual abilities, but by the economy’s
abilities to invest and save respectively, which inevitably enhances savings and
investment in the economy. 3 To meet the regular working capital requirements 
To diversify the production  To expand an existing company  To promote a new
company CONCEPT OF CAPITAL MARKET The past decade in many ways has
been remarkable for securities market in India. It has grown exponentially as
 measured in terms of amount raised from the market, number stock exchange and
other intermediaries and the number of listed stocks, market capitalization, trading
volumes and turnover on stock exchanges, and investor population. Along with this
growth, the profiles of the investors, issuers and intermediaries have changed
significantly. The market has witnessed several institutional changes resulting in
drastic reduction in transaction cost and sufficient improvement in efficiency,
transparency, liquidity and safety. In a short span of time, Indian derivatives market
has got a place in list of top global exchanges. INTRODUCTION The market for
longterm securities like bonds, equity stocks and preferred stocks is divided into
primary market and secondary market. The primary market deals with the new
issues of securities. Outstanding securities are traded in the secondary market,
which is commonly known as stock market or stock exchange. In the secondary
market, the investors can sell and buy securities. Stock markets predominantly deal
in the equity shares. Debt instruments like bonds and debentures are also traded in
the stock market. Well- regulated and active stock market promotes capital
formation. Growth of the primary market depends on the secondary market. The
health of the economy is reflected by the growth of the stock market. Companies
raise funds to finance their projects through various methods. The promoters can
bring their own money or borrow from the financial institutions or mobilize capital by
issuing securities. The funds may be raised through issue of fresh shares at par or
premium, preference shares, debentures or global depository receipts. The main
objectives of a capital issue are given below:
4. 4. MARKET SEGMENTS The securities market has two interdependent and
inseparable segments: the primary and the secondary market. The primary market
provides the channel for creation of new securities through issuance of financial
instruments by public companies as well as Governments and Government agencies
and bodies whereas the secondary market helps the holders of these financial
instruments to sale for exiting from the investment. The price signals, which
subsume all information about the issuer and his business including associated risk,
generated in the secondary market, help the primary market in allocation of funds.
The primary market issuance is done either through public issues or private
placement. A public issue does not limit any entity in investing while in private
placement, the issuance is done to select people. In terms of the Companies Act,
1956, an issue becomes public if it results in allotment to more than 50 persons. This
means an issue resulting in allotment to less than 50 persons is private placement.
There are two major types of issuers who issue securities. The corporate entities
issue mainly debt and equity instruments (shares, debentures, etc.), while the
governments (central and state governments) issue debt securities (dated securities,
treasury bills). The secondary market enables participants who hold securities to
adjust their holdings in response to changes in their assessment of risk and return.
They also sell securities for cash to meet their liquidity needs. The exchanges do not
provide facility for spot trades in a strict sense. Closest to spot market is the cash
market in exchanges where settlement takes place after some time. Trades taking
place over a trading cycle (one day under rolling settlement) are settled together
after a certain time. All the 23 stock exchanges in the country provide facilities for
trading of corporate securities. Trades executed on NSE only are cleared and settled
by a clearing corporation which provides novation and settlement guarantee. Nearly
100% of the trades in capital market segment are settled through demat delivery.
NSE also provides a formal trading platform for trading of a wide range of debt
 securities including government securities in both retail and wholesale mode. NSE
also provides trading in derivatives of equities, interest rate as well indices. In
derivatives market (F&O market segment of NSE), standardized contracts are traded
for future settlement. These futures can be on a basket of securities like an index or
an individual security. In case of options, securities are traded for conditional future
delivery. There are two types of options – a put option permits the owner to sell a
security to the writer of options at a predetermined price while a call option permits
the owner to purchase a security from the writer of the option at a predetermined
price. These options can also been individual stocks or basket of stocks like index.
Two exchanges, namely NSE and the Stock Exchange, Mumbai (BSE) provide
trading of derivatives of securities. Today the market participants have the flexibility
of choosing from a basket of products like: 4
5. 5. Futures on interest rate products like Notional 91-day T-Bills, 10 year notional
zero. Reforms in the securities market, particularly the establishment and
empowerment of SEBI, market determined allocation of resources, screen based
nation-wide trading, dematerialization and electronic transfer of securities, rolling
settlement and ban ondeferral products, sophisticated risk management and
derivatives trading, have greatly improved the regulatory framework and efficiency of
trading and settlement. Indian market is now comparable to many developed
markets in terms of a number of qualitative parameters. PRODUCTS AND
PARTICIPANTS Financial markets facilitate the reallocation of savings from savers
to entrepreneurs Savings are linked to investments by a variety of intermediaries
through a range of complex financial products called “securities” which is defined in
the Securities Contracts (Regulation) Act, 1956 to include shares, bonds, scrip’s,
stocks or other marketable securities of like nature in or of any incorporate company
or body corporate, government securities, derivatives of securities, units of collective
investment scheme, interest and rights in securities, security receipt or any other
instruments so declared by the central government. It is not that the users and
suppliers of funds meet each other and exchange funds for securities. It is difficult to
accomplish such double coincidence of wants. The amount of funds supplied by the
supplier may not be the amount needed by the user. Similarly, the risk, liquidity and
maturity characteristics of the securities issued by the issuer may not match
preference of the supplier. In such cases, they incur substantial search costs to find
each other. Search costs are minimized by the intermediaries who match and bring
the suppliers and users of funds together. These intermediaries may act as agents to
match the needs of users and suppliers of funds for a commission, help suppliers
and users in creation and sale of securities for a fee or buy the securities issued by
users and in turn, sell their own securities to suppliers to book profit. It is, thus, a
misnomer that securities market disintermediates by establishing a direct
relationship between the savers and the users of funds. The market does not work in
a vacuum; it requires services of a large variety of intermediaries. The
disintermediation in the securities market is in fact an intermediation with a
difference; it is a risk-less intermediation, where the ultimate risks are borne by the
savers and not the intermediaries. A large variety and number of intermediary’s
provide intermediation services in the Indian securities market. The securities market
has essentially three categories of participants, namely the issuers of securities,
investor’s insecurities and the intermediaries and products include equities, bonds
and derivatives. The issuers and investors are the consumers of services rendered
by the intermediaries while the investors are consumers (they subscribe for and
 trade in securities) of securities issued by issuers. DEPENDENCE CAPITAL
MARKET 5 Options on benchmark indices as well as stocks  Futures on
benchmark indices as well as stocks  Bonds issued by both Government and
Companies  Equities 
6. 6. Three main sets of entities depend on securities market. While the corporates and
governments raise resources from the securities market to meet their obligations, the
households invest their savings in the securities. Corporate Sector The 1990s
witnessed emergence of the securities market as a major source of finance for trade
and industry. A growing number of companies are accessing the securities market
rather than depending on loans from FIs/banks. The corporate sector is increasingly
depending on external sources for meeting its funding requirements. There appears
to be growing preference for direct financing (equity and debt) to indirect financing
(bank loan) within the external sources, According to CMIE data, the share of capital
market based instruments in resources raised externally increased to 53% in 1993-
94, but declined thereafter to 33% by 1999-00 and further to 21% in 2001-02. In the
sector-wise shareholding pattern of companies listed on NSE, it is observed that on
an average the promoters hold more than 55% of total shares. Though the non-
promoter holding is about 44%, Indian public held only 17% and the public float
(holding by FIIs, MFs, Indian public) is at best 25%. There is not much difference in
the shareholding pattern of companies in different sectors. Strangely, 63% of shares
in companies in media and entertainment sector are held by private corporate bodies
though the requirement of public offer was relaxed to 10% for them. The promoter
holding is not strikingly high in respect of companies in the IT and telecom sectors
where similar relaxation was granted. Governments Along with increase in fiscal
deficits of the governments, the dependence on market borrowings to finance fiscal
deficits has increased over the years. During the year 1990-91, the state
governments and the central government financed nearly 14% and 18% respectively
of their fiscal deficit by market borrowing. In percentage terms, dependence of the
state government’s on market borrowing did not increase much during the decade
1991-2001. In case of central government, it increased to 77.6% by 2002-03.
Households According to RBI data, household sector accounted for 82.4% of gross
domestic savings during2001-02. They invested 38% of financial savings in deposits,
33% in insurance/provident funds,11% on small savings, and 8% in securities,
including government securities and units of mutual funds during 2001- 02. Thus the
fixed income bearing instruments are the most preferred assets of the household
sector. Their share in total financial savings of the household sector witnessed an
increasing trend in the recent past and is estimated at 82.4% in 2001- 02. In
contrast, the share of financial savings of the household sector in securities (shares,
debentures, public sector bonds and units of UTI and other mutual funds and 6
7. 7. government securities) is estimated to have gone down from 22.9% in 1991-92 to
4.3% in 2000-01, which increased to 8% in 2001-02. Investor Population The Society
for Capital Market Research and Development carries out periodical surveys of
household investors to estimate the number of investors. Their first survey carried
out in 1990 placed the total number of share owners at 90-100 lakh. Their second
survey estimated the number of share owners at around 140-150 lakh as of mid-
1993 CAPITALMARKETATAGLANCE Primary market Stocks available for the first
time are offered through new issue market. The issuer may be new company. These
issues may be of new type or the security used in the past. In the new issue market
 the issuer can be considered as a manufacturer. The issuing houses investment
bankers and brokers act as the channel of distribution for the new issues. They take
the responsibility of selling the stocks to the public. A total of Rs. 2,520,179 million
were raised by the government and corporate sector during 2002-03 as against Rs.
2,269,110 million during the preceding year. Government raised about two third of
the total resources, with central government alone raising nearly Rs.1, 511,260
million. Corporate Securities Average annual capital mobilization from the primary
market, which used to be aboutRs.70 crore in the 1960s and about Rs.90 crore in
the 1970s, increased manifold during the1980s, with the amount raised in 1990-91
being Rs. 4,312 crore. It received a further boostduring the 1990s with the capital
raised by non- government public companies rising sharply to Rs. 26,417 crore in
1994-95. The capital raised which used to be less than 1% of gross domestic saving
(GDS) in the 1970s increased to about 13% in 1992-93. In real terms, the capital
raised increased 4 times between 1990-91 and 1994-95. During 1994-95, the
amount raised through new issues of securities from the securities market accounted
for about four-fifth of the disbursements by FIs. Issuers have shifted focus to other
avenues for raising resources like private placement. There is a preference for
raising resources in the primary market through private placement of debt
instruments. Private placements accounted for about 93% of totalresources
mobilized through domestic issues by the corporate sector during 2002-03. Rapid
dismantling of shackles on institutional investments and deregulation of the economy
are driving growth of this segment. There are several inherent advantages of relying
on private placement route for raising resources. While it is cost and time effective
method of raising funds and can be structured to meet the needs of the
entrepreneurs, it does not require detailed compliance with formalities as required in
public or rights issues. It is believed in some circles that private placement has
crowded out public issues. However, to prevent public issues from being passed on
as private placement, the Companies (Amendment) Act, 2001 considers offer of
securities to more than 50 persons as made to public. Indian market is getting 7
8. 8. integrated with the global market though in a limited way through euro issues.
Since 1992, when they were permitted access, Indian companies have raised about
Rs. 34,264 million through ADRs/GDRs. By the end of March 2003, 502 FIIs were
registered with SEBI. They had net cumulative investments over of US $ 15.8 billion
by the end of March 2003. Their operations influence the market as they do delivery-
based business and their knowledge of market is considered superior. The market is
getting institutionalized as people prefer mutual funds as their investment vehicle,
thanks toevolution of a regulatory framework for mutual funds, tax concessions
offered bygovernment and preference of investors for passive investing. The net
collections by MFs picked up during this decade and increased to Rs. 199,530
million during 1999-00. This declined to Rs. 111,350 million during 2000-01 which
may be attributed to increase in rate of tax on income distributed by debt oriented
mutual funds and lackluster secondary market. The total collection of mutual funds
for 2002-03 has been Rs. 105,378 million. Starting with an asset base of Rs. 250
million in 1964, the total assets under management at the end of March 2003 was
Rs. 794,640 million. The number of households owning units of MFs exceeds the
number of households owning equity and debentures. At the end of financial year
March 2003, according to a SEBI press release 23 million unit holders had invested
in units of MFs, while 16 million individual investors invested in equity and or
debentures. Government Securities The primary issues of the Central Government
 have increased many-fold during thedecade of 1990s from Rs. 89,890 million in
1990-91 to Rs. 1,511,260 million in 2002-03. The issues by state governments
increased by about twelve times from Rs. 25,690 million to Rs.308,530 million during
the same period. The Central Government mobilized Rs. 1,250,000million through
issue of dated securities and Rs. 261,260 million through issue of T-bills. After
meeting repayment liabilities of Rs. 274,200 million for dated securities,
andredemption of T-bills of Rs. 195,880 million, and net market borrowing of Central
Government amounted to Rs. 1,041,180 million for the year 2002-03. The state
government’s collectively raised Rs. 305,830 million during 2002-03 as against Rs.
187,070 million in the preceding year. The net borrowings of State Governments in
2002-03 amounted to Rs. 290,640million. Along with growth of the market, the
investor base has become very wide. Inaddition to banks and insurance companies,
corporates and individual investors are investing in government securities. With
dismantling of control regime, and gradual lowering of the SLR and CRR,
Government is borrowing at near–market rates. The coupons across maturities went
down recently signifying lower interest rates. The weighted average cost of its
borrowing at one stage increased to 13.75% in 1995- 96, which declined to 7.34% in
2002-03. The maturity structure of government debt is also changing. In view of
bunching of redemption liabilities in the medium term, securities with higher
maturities were issued during 2002-03. About 64% of primary issues were raised
through securities with maturities above 5 years and up to 10 years. As a result the
weighted average maturity of dated securities increased to 13.83 years from 6.6
years in 1997-98. 8
9. 9. Relationship between the Primary and Secondary Market 1 . The new issues
market cannot function without the secondary market. The secondary market or the
stock market provides liquidity for the issued securities. The issued securities are
traded in the secondary market offering liquidity to the stocks at affair price. 2. The
stock exchanges through their listing requirements, exercise control over the primary
market. The company seeking for listing on the respective stock exchange has to
comply with all the rules and regulations given by the stock exchange. 3. The
primary market provides a direct link between the prospective investors and the
company. By providing liquidity and safety, the stock markets encourage the public
to subscribe to the new issues. The marketability and the capital appreciation
provided in the stock market are the major factors that attract the investing public
towards the stock market. Thus, it provides an indirect link between the savers and
the company. 4. Even though they are complementary to each other, their functions
and the organizational set up are different from each other. The health of the primary
market depends on the secondary market and vice versa. Functions of Primary
Market The main service functions of the primary market are organization,
underwriting and distribution. Origination deals with the origin of the new issue. The
proposal is analyzed in terms of the nature of the security, the size of the issue, and
timing of the issue and floatation method of the issue. Underwriting contract makes
the share predictable and removes the element of uncertainty in the subscription.
Distribution refers to the lead managers and brokers to the issue. In the new issue
market stocks are offered for the first time. The functions and the organization of the
new issue market are different from the secondary market. In the new issue the lead
managers manage the issue, the under writers assure to take up the unsubscribed
portion according to his commitment for a commission and the bankers take up the
responsibility of the collecting the application form and the money. Advertising
 agencies promote the new issue through advertising. Financial institutions and
underwriter lend term loans to the company. Government agencies regulate the
issue. The new issues are offered through prospectus. The prospectus is drafted
according to SEBI guidelines disclosing the needed information to the investing
public. In the bought out deal banks or accompany buys the promoters shares and
they offer them to the public at a later date. This reduces the cost of raising the fund.
Private placement means placing of the issue with financial institutions. They sell
shares to the investors at a suitable price. Right issue means the allotment of shares
to the previous shareholders at a pro-ratio basis. Book building involves firm
allotment of the instrument to a syndicate created by the lead managers. Thebook
runner manages the issue. Norms are given by the SEBI to price the
issue.Proportionate allotment method is adopted in the allocation of shares. Project
appraisal, disclosure in the 9
10. 10. prospectus and clearance of the prospectus by the stock exchanges protect the
investors in the primary market along with the active role played by the SEBI.
Secondary market The market for long-term securities like bonds, equity stocks and
preferred stocks is divided into primary market and secondary market. The primary
market deals with the new issues of securities. Outstanding securities are traded in
the secondary market, which is commonly known as stock market or stock
exchange. In the secondary market, the investors can sell and buy securities. Stock
markets predominantly deal in the equity shares. Debt instruments like bonds and
debentures are also traded in the stock market. Well-regulated and active stock
market promotes capital formation. Growth of the primary market depends on the
secondary market. The health of the economy is reflected by the growth of the stock
market. Corporate Securities the number of stock exchanges increased from 11 in
1990 to 23 now. All the exchanges are fully computerized and offer 100% on-line
trading. 9,413 companies were available for trading on stock exchanges at the end
of March 2003. The trading platform of the stock exchanges was accessible to 9,519
members from over 358 cities on the same date. The market capitalization grew
tenfold between 1990-91 and 1999-00. It increased by 221% during 1991-92 and by
107% during 1999-00. All India market capitalization is estimated at Rs. 6,319,212
million at the end of March 2003. The market capitalization ratio, which indicates the
size of the market, increased sharply to 57.4% in 1991-92following spurt in share
prices. The ratio further increased to 85% by March 2000. It, however, declined to
55% at the end of March 2001 and to 29% by end March 2003.The trading volumes
on exchanges have been witnessing phenomenal growth during the1990s. The
average daily turnover grew from about Rs.1500 million in 1990 to Rs. 120,000
million in 2000, peaking at over Rs. 200,000 million. One-sided turnover on all stock
exchanges exceeded Rs. 10,000,000 million during 1998-99, Rs. 20,000,000 million
during 1999-00 and approached Rs. 30,000,000 million during 2000-01. However,
the trading volume substantially depleted to Rs.9, 689,541 million in 2002-03. The
turnover ratio, which reflects the volume of trading in relation to the size of the
market, has been increasing by leaps and bounds after the advent of screen based
trading system by the NSE. The turnover ratio for the year 2002-03 increased to 375
but fell substantially due to bad market conditions to 119 during 2001-02 regaining
its position accounted 153.3% in 2002-03. The relative importance of various stock
exchanges in the market has undergone dramatic change during this decade. The
increase in turnover took place mostly at the large big exchanges and it was partly at
the cost of small exchanges that failed to keep pace with the changes. NSE is the
 market leader with more 85% of total turnover (volumes on all segments) in 2002-03.
Top 5 stock exchanges accounted for 99.88% of turnover, while the rest 18
exchange for less than 0.12% during 2002-03. About ten exchanges reported nil
turnovers during the year. Role of the Secondary 10
11. 11. Market when company management has different objectives than its outside
investors, "agency “and "information" problems may result. For example,
management may exert less than optimal effort, may pursue goals that simply
enhance its own power and control, or may squander or divert company resources.
In addition, to the extent that management is better informed than outside investors
about the company's financial situation, this creates an informational asymmetry.
This, in turn, may result in management being unable to convince its outside
investors of the true value of the company as well as of management’s intentions. As
a consequence, management also may find that it is not able to raise as much
capital as it wants or needs to finance new projects, or that management may have
to surrender too much of the value of the firm to raise the capital it wants or needs.
"Governance" refers to the various mechanisms that exist to mitigate these agency
and information problems. These mechanisms are numerous, some involving capital
markets (e.g., facilitation of corporate control via takeover) while others do not, at
least not directly (e.g., the role of the board of directors as a monitoring device).
These major mechanisms will be discussed. We use the term "market-based
governance" to refer to the role of capital markets in alleviating the agency and
information problems, by functioning as an effective conduit for monitoring and
controlling management's sub optimal behavior. Market- based governance may
take different forms. However, generally speaking, such governance takes the form
of facilitating the monitoring of management by outsiders, and aggregating
information —in the form of equilibrium prices (or price discovery)—to help guide
management decisions within the firm. Monitoring and Control As noted, secondary
equity markets serve as a conduit for monitoring and controlling management by
outsiders. First, markets generate information that helps outside investors Evaluate
the quality of past management decisions. Second, the threat of a takeover may
mitigate management inefficiencies. Third, information on stock-market prices
provides for effective incentives for management. And fourth, the rich menu of
contracts provided in the market allows private workouts of financial distress, easing
the transfer of control. • For purposes of our analysis below, we have divided
monitoring into two categories • Market-based monitoring • Non market-based
monitoring. Market-Based Monitoring. 1 Active Shareholders: The secondary equity
market can facilitate effective monitoring by providing the ability to build positions so
as to influence management decisions in situations where a change in corporate
policies could increase a firm's value. II. 2 Financial intermediaries as delegated
monitors: 11
12. 12. Banks closely monitor their business borrowers, and collect information and
scrutinize major investment and financing decisions. In doing so, they can threaten
to withhold financing should management act in a manner contrary to the banks'
interests. Monitoring via business groups in some countries, such as Japan and
Korea, corporate actions are coordinated within a family of interrelated firms, with a
main bank at the center. Firms in the group are interconnected through intricate
vertical and horizontal business relationships and cross-ownership. Members of the
business group, with the lead participation of the main bank, closely monitor the
actions of a member firm's management. The Legal System: The four main
 legislations governing the securities market are: (a) the SEBI Act, 1992which
establishes SEBI to protect investors and develop and regulate securities market;
(b)the Companies Act, 1956, which sets out the code of conduct for the corporate
sector in relation to issue, allotment and transfer of securities, and disclosures to be
made in public issues; (c) the Securities Contracts (Regulation) Act, 1956, which
provides for regulation of transactions in securities through control over stock
exchanges; and (d) the Depositories Act, 1996 which provides for electronic
maintenance and transfer of ownership of demat securities. Government has framed
rules under the SCRA, SEBI Act and the Depositories Act. SEBI has framed
regulations under the SEBI Act and the Depositories Act for registration and
regulation of all market intermediaries, and for prevention of unfair trade practices,
insider trading, etc. Under these Acts, Government and SEBI issue notifications,
guidelines, and circulars which need to be complied with by market participants. The
SROs like stock exchanges have also laid down their rules of game. The
responsibility for regulating the securities market is shared by Department of
Economic Affa irs (DEA), Department of Company Affairs (DCA), Reserve Bank of
India (RBI) and SEBI. The activities of these agencies are coordinated by the High
Level Committee on Capital Markets. Most of the powers under the SCRA are
exercisable by DEA while a few others by SEBI. The powers of the DEA under the
SCRA are also con-currently exercised by SEBI. The powers in respect of the
contracts for sale and purchase of securities, gold related securities, money market
securities and securities derived from these securities and ready forward contracts in
debt securities are exercised concurrently by RBI. The SEBI Act and the
Depositories Act are mostly administered by SEBI. The rules and regulations under
the securities laws are administered by SEBI. The power sunder the Companies Act
relating to issue and transfer of securities and non-payment of dividend are
administered by SEBI in case of listed public companies and public companies
proposing to get their securities listed. The SROs ensure compliance with their own
rules as well as with the rules. The legal system governs both the rights of
management and the rights of investors. The legal system also specifies the
recourse available to investors. Recent research indicates that countries vary in the
level of protection afforded to minority shareholders (LaPorta et al, 1996). Generally,
countries with common-law traditions afford the highest protection, while civil-law
countries, particularly the French civil- law systems, provide the least amount of
protection. Functions of Stock Exchange 12
13. 13. • Maintains active trading: Shares are traded on the stock exchanges, enabling
the investors to buy and sell securities. The prices may vary from transactions to
transaction. • A continuous trading increases the liquidity or marketability of the
shares traded on the stock exchanges. • Fixation of prices: Price is determined by
the transactions that flow from investors ‘demand and suppliers’ preferences.
Usually the traded prices are made known to the public. This helps the investors to
make better decisions. • Ensures safe and fair dealing: The rules, regulations and
by-laws of the stock exchanges’ provide a measure of safety to the investors.
Transactions are conducted under competitive conditions enabling the investors to
get a fair deal. • Aids in financing the industry: A continuous market for shares
provides a favorable climate for raising capital. The negotiability and transferability of
the securities helps the companies to raise long-term funds. When it is easy to trade
the securities, investors are willing to subscribe to the initial public offerings. This
stimulates the capital formation. • Dissemination of information: Stock exchanges
 provide information through their various publications. They publish the share prices
traded on daily basis along with the volume traded. Directory of Corporate
Information is useful for the investors ‘assessment regarding the corporate.
Handouts, handbooks and pamphlets provide information regarding the functioning
of the stock exchanges. • Performance inducer: The prices of stocks reflect the
performance of the traded companies. This makes the corporate more concerned
with its public image and tries to maintain good performance. • Self-regulating
organization: The stock exchanges monitor the integrity of the members, brokers,
listed companies and clients. Continuous internal audit safeguards the investors
against unfair trade practices. It settles the dispute between member brokers,
investors and brokers. Research in Securities Market In order to deepen the
understanding and knowledge about Indian capital market, and to assist in policy-
making, SEBI has been promoting high quality research in capital market. It has set
up an in-house research department, which brings out working papers on a regular
basis. In collaboration with NCAER, SEBI brought out a ‘Survey of Indian Investors’,
which estimates investor population in India and their investment preferences. SEBI
has also tied up with reputed national and international academic and research
institutions for conducting research studies/projects on various issues related to the
capital market. In order to improve market efficiency further and to set international
benchmarks in the securities industry, NSE administers 13
14. 14. a scheme called the NSE Research Initiative with a view to develop an
information base and a better insight into the working of securities market in India.
The objective of this initiative is to foster research, which can support and facilitate.
(a) Stock exchanges to better design market micro-structure. (b) Participants to
frame their strategies in the market place. (c) Regulators to frame regulations. (d)
Policy makers to formulate policies. (e) Expand the horizon of knowledge. The
Initiative has received tremendous response. Testing and Certification The
intermediaries, of all shapes and sizes, who package and sell securities, compete
with one another for the chance to handle investors/issuers’ money. The quality of
their services determines the shape and health of the securities market. In
developed markets and in some of the developing markets, this is ensured through a
system of testing and certification of persons joining market intermediaries in the
securities market. A testing and certification mechanism that has become extremely
popular and is sought after by the candidates as well as employers is a unique on-
line testing and certification programme called National Stock Exchange’s
Certification in Financial Markets (NCFM). It is an on-line fully automated nation-wide
testing and certification system where the entire process from generation of question
paper, invigilation, testing, assessing, scores reporting and certifying is fully
automated - there is absolutely no scope for human intervention. It allow tremendous
flexibility in terms of testing centers, dates and timing and provides easy accessibility
and convenience to candidates as he can be tested at any time and from any
location. It tests practical knowledge and skills, that are required to operate in
financial markets, in a very secure and unbiased manner, and certifies personnel
who have a proper understanding of the market and business and skills to service
different constituents of the market. It offers 9 financial market related modules.
Market Design Corporate Securities: The Disclosure and Investor Protection (DIP)
guidelines prescribe a substantial body of requirements for issuers/intermediaries,
the broad intention being to ensure that all concerned observe high standards of
integrity and fair dealing, comply with all the requirements with due skill, diligence
 and care, and disclose the truth, whole truth and nothing but truth. The guidelines
aim to secure fuller disclosure of relevant information about the issuer and the nature
of the securities to be issued so that investor scan takes informed decisions. For
example, issuers are required to disclose any material ‘risk factors’ and give
justification for pricing in their prospectus. An unlisted company can access the
market up to 5 times its pre-issue net worth only if it has track record of distributable
profits and net worth of Rs. 1 crore in 3 out of last five years. A listed company can
access up to 5 times of its pre-issue net worth. In case a company does not have
track record or wishes to 14
15. 15. rise beyond 5 times of its pre-issue net worth, it can access the market only
through book building with minimum offer of 60% to qualified institutional buyers.
Infrastructure companies are exempt from the requirement of eligibility norms if their
project has been appraised by a public financial institution and not less than 5% of
the project cost is financed by any of the institutions, jointly or severally, by way of
loan and/or subscription to equity. The debt instruments of maturities more than 18
months require credit rating. If the issue size exceeds Rs. 100 crore, two ratings
from different agencies are required. Thus the quality of the issue is demonstrated
by track record/appraisal by approved financial institutions/credit rating/subscription
by QIBs. Thelead merchant banker discharges most of the pre-issue and post- issue
obligations. He satisfies himself about all aspects of offering and adequacy of
disclosures in the offer document. He issues a due diligence certificate stating that
he has examined the prospectus, he finds it in order and that it brings out all the
facts and does not contain anything wrong or misleading. He also takes care of
allotment, refund and dispatch of certificates. The admission to a depository for
dematerialization of securities is a prerequisite for making a public or rights issue or
an offer for sale. The investors, however, have the option of subscribing to securities
in either physical form order materialized form. All new IPOs are compulsorily traded
in dematerialized form. Every public listed company making IPO of any security for
Rs. 10 crore or more is required to do so only in dematerialized form. Government
Securities: The government securities market has witnessed significant
transformation in the 1990s. With giving up of the responsibility of allocating
resourcesfrom securities market, government stopped expropriating seigniorage and
startedborro wing at near - market rates. Government securities are now sold at
market related coupon rates through a system of auctions instead of earlier practice
of issue of securities at very low rates just to reduce the cost of borrowing of the
government. Major reforms initiated in the primary market for government securities
include auction system (uniform price and multiple price method) for primary
issuance of T-bills and central government dated securities, a system of primary
dealers and non-competitive bids to widen investor base and promote retail
participation, issuance of securities across maturities to develop a yield curve from
short to long end and provide benchmarks for rest of the debt market, innovative
instruments like, zero coupon bonds, floating rate bonds, bonds with embedded
derivatives, availability of full range ( 91-day and 382- day) of T-bills, etc. Secondary
Market Corporate Securities: The stock exchanges are the exclusive centers for
trading of securities. Though the area of operation/jurisdiction of an exchange is
specified at the time of its recognition, they have been allowed recently to set up
trading terminals anywhere in the country. The three newly set up exchanges
(OTCEI, NSE and ICSE) were permitted since their inception to have nationwide
 trading. The trading platforms of a few exchanges are now accessible from many
locations. 15
16. 16. Further, with extensive use of information technology, the trading platforms of a
few exchanges are also accessible from anywhere through the Internet and mobile
devices. This made a huge difference in geographically vast country like India.
Exchange Management: Most of the stock exchanges in the country are organized
as “mutual” which was considered beneficial in terms of tax benefits and matters of
compliance. The trading members, who provide brokering services, also own, control
and manage the exchanges. This is not an effective model for self-regulatory
organizations as the regulatory and public interest of the exchange conflicts with
private interests. Effortsare on to demutualise the exchanges whereby ownership,
management and trading membership would be segregated from one another. Two
exchanges viz. OTCEI and NSE are demutualized from inception, where ownership,
management and trading are in the hands of three different sets of people. This
model eliminates conflict of interest and helps the exchange to pursue market
efficiency and investor interest aggressively. Membership: The trading platform of an
exchange is accessible only to brokers. The broker enters into trades in exchanges
either on his own account or on behalf of clients. No stock broker or sub-broker is
allowed to buy, sell or deal in securities, unless he or she holds a certificate of
registration granted by SEBI. A broker/sub-broker complies with the code of conduct
prescribed by SEBI. Over time, a number of brokers - proprietor firms and
partnership firms – have converted themselves into corporates. The standards for
admission of members stress on factors, such as corporate structure, capital
adequacy, track record, education, experience, etc., and reflect a conscious
endeavor to ensure quality broking services. Demat Trading: The Depositories Act,
1996 was passed to prove for the establishment of depositories in securities with the
objective of ensuring free transferability of securities with speed, accuracy and
security by (a) making securities of public limited companies freely transferable
subject to certain exceptions; (b) dematerializing the securities in the depository
mode; and (c) providing for maintenance of ownership records in a book entry form.
In order to streamline both the stages of settlement process, the Act envisages
transfer of ownership of securities electronically by book entry without making the
securities move from person to person. Two depositories, viz. NSDL and CDSL,
have come up to provide instantaneous electronic transfer of securities. At the end of
March 2002, 4,172 and 4,284 companies were connected to NSDL and CDSL
respectively. The number of dematerialized securities increased to 56.5billion at the
end of March 2002. As on the same date, the value of dematerialized securities was
Rs. 4,669 billion and the number of investor accounts was 4,605,588. All actively
traded scraps are held, traded and settled in demat form. Demat settlement
accounts for over 99% of turnover settled by delivery. This has almost eliminated the
bad deliveries and associated problems. The admission 16
17. 17. to a depository for dematerialization of securities has been made a prerequisite
for making a public or rights issue or an offer for sale. It has also been made
compulsory for public listed companies making IPO of any security for Rs. 10 crore
or more to do the same only in dematerialized form. Charges: A stock broker is
required to pay a registration fee of Rs.5, 000 every financial year, if his annual
turnover does not exceed Rs. 1 crore. If the turnover exceeds Rs. 1 crore during any
financial year, he has to pay Rs. 5,000 plus one-hundredth of 1% of the turnover in
excess of Rs.1 crore. After the expiry of five years from the date of initial registration
 as a broker, he has to pay Rs. 5,000 for a block of five financial years. Besides, the
exchanges collect transaction charges from its trading members. NSE levies Rs. 4
per lakh of turnover. The maximum Brokerage a trading member can levy in respect
of securities transactions is 2.5% of the contract price, exclusive of statutory levies
like SEBI turnover fee, service tax and stamp duty. However, brokerage charges as
low as0.15% are also observed in the market Trading Cycle. Risk Management: To
pre-empt market failures and protect investors, the regulator/exchanges have
developed a comprehensive risk management system, which is constantly monitored
and upgraded. It encompasses capital adequacy of members, adequate margin
requirements, limits on exposure and turnover, indemnity insurance, on-line position
monitoring and automatic disablement, etc. They also administer an efficient market
surveillance system to curb excessive volatility, detect and prevent price
manipulations. Exchanges have setup trade/settlement guarantee funds for meeting
shortages arising out of nonfulfillment/partial fulfillment of funds obligations by the
members in a settlement. A clearing corporation assures the counterparty risk of
each member and guarantees financial settlement in respect of trades executed on
NSE. Government Securities: The reforms in the secondary market include Delivery
versusPayment system for settling scrip less SGL transactions to reduce settlement
risks, SGL Account with RBI to enable financial intermediaries to open custody
(Constituent SGL) accounts and facilitate retail transactions in scrip less mode,
enforcement of a trade-for-trade regime, settlement period of T+0 or T+1for all
transactions undertaken directly between SGL participant s and up to T+5 days for
transactions routed through NSE brokers, routingtransactions through brokers of
NSE, OTCEI and BSE, repos in all government securities with settlement through
SGL, liquidity support to PDs to enable them to support primary market and
undertake market making, special fund facility for security settlement, etc. As part of
the ongoing efforts to build debt market infrastructure, two new systems, the
Negotiated Dealing System (NDS) and the Clearing Corporation of India Limited
(CCIL) commenced operations on February 15, 2002. NDS, interlaid, facilitates
screen based negotiated dealing for secondary Market transactions in government
securities and money market instruments, online reporting of transactions in the
instruments available on the NDS and 17
18. 18. dissemination of trade information to the market. Government Securities
(including T-bills), call money, notice/term money, repos in eligible securities,
Commercial Papers and Certificate of Deposits are available for negotiated dealing
through NDS among the members. The CCIL facilitates settlement of transactions in
government securities (both outright and repo) on Delivery versus Payment (DvP-II)
basis which provides for settlement of securities on gross basis and settlement of
funds on net basis simultaneously. It acts as a central counterparty for clearing and
settlement of government securities transactions done on NDS. The relative
importance of various stock exchanges in the market has undergone dramatic
change during this decade. The increase in turnover took place mostly at the large
big exchanges and it was partly at the cost of small exchanges that failed to keep
pace with the changes. NSE is the market leader with over 80% of total turnover
(volumes on all segments) in 2001-02. Top 6 stock exchanges accounted for 99.88%
of turnover, while the rest 17 exchange for less than0.12% during 2002-03 (Table
5.4). About a dozen exchanges reported nil turnovers during the year. Derivatives
Market: Trading in derivatives of securities commenced in June 2000 with the
enactment of enabling legislation in early 2000. Derivatives are formally defined to
 include: (a) a security derived from debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other form of security,
and (b) a contract which derives its value from the prices, or index of prices, or
underlying securities. Derivatives are legal and valid only if such contracts are traded
on a recognized stock exchange, thus precluding OTC derivatives. Derivatives
trading commenced in India in June 2000 after SEBI granted the approval to this
effect in May 2000. SEBI permitted the derivative segment of two stock exchanges,
i.e. NSE and BSE, and their clearing house/corporation to commence trading and
settlement in approved derivative contracts. To begin with, SEBI approved trading in
index futures contracts based on S&P CNX Nifty Index and BSE-30 (Sensex) Index.
This was followed by approval for trading in options based on these two indices and
options on individual securities. The trading in index options commenced in June
2001 and trading in options on individual securities wouldcommence in July 2001
while trading in futures of individual stocks started from November 2001. In June
2003, SEBI/RBI approved the trading on interest rate derivative instruments. The
total exchange traded derivatives witnessed a volume of Rs.4, 423,333 million during
2002- 03 as against Rs. 1,038,480 million during the preceding year. While NSE
accounted for about99.5% of total turnover, BSE accounted for less than 1% in
2002-03. The market witnessed higher volumes from June 2001 with introduction of
index options, and still higher volumes with the introduction of stock options in July
2001. There was a spurt in volumes in November 2001when stock futures were
introduced. It is believed that India is the largest market in the world for stock futures.
18
19. 19. Secondary market 19 Primary market Unit –II Classification of Capital market
20. 20. PRIMARY MARKET The Primary is that part of the capital that deals with the
issuance of new securities. Companies, governments or public sector institutions
can obtain funding through the sale of anew stock or bond issue. This is typically
done through a syndicate of securities dealers. The process of selling new issues to
investors is called underwriting. In the case of a new stock issue, this sale is an initial
(IPO). Dealers earn a commission that is built into the price of the security offering,
though it can be found in the prospectus. The primary market for equity, which
consists of both the ‘initial public offering’ (IPO) market and the ‘seasoned equity
offering’ (SEO) markets, experienced considerable activity in 2005 and2006 (Table
4.1). In 2006, Rs.30, 325 crore of resources were raised on this market, of
whichRs.9, 918 crore were made up by 55 companies which were listed for the first
time (IPOs). The number of IPOs per year has risen steadily from 2002 onwards. A
level of 55 IPOs in the year translates to roughly 4 IPOs every month. The mean IPO
size, which was elevated in 2005, returned to Rs.180 crore, which is similar to the
value prevalent in 2003. 4.3 The primary issuance of debt securities, as per SEBI,
fell to a low of around Rs. 66 crore in 2006, which is one facet of the far-reaching
difficulties of the debt market. Unlike equity securities, debt securities issued at
previous dates are redeemed by companies every year. Hence, a year with allow
issuance of fresh debt securities is a year in which the stock of outstanding debt
securities drops. In addition to resource mobilization by the issuance of debt and
equity securities, one of the most important mechanisms of financing that has been
used by Indian firms is retained earnings, which are also a part of equity financing.
20
21. 21. SECONDARY MARKET: Outstanding securities are traded in the secondary
market, which is commonly known as stock market or stock exchange. In the
secondary market, the investors can sell and buy securities. Stock markets
predominantly deal in the equity shares. Debt instruments like bonds and debentures
are also traded in the stock market. Dematerialization: Indian investor community
has undergone sea changes in the past few years. India now has a very large
investor population and ever increasing volumes of trades. However, this continuous
growth in activities has also increased problems associated with stock trading. Most
of these problems arise due to the intrinsic nature Mutilation or loss of share
certificates in transit. The physical form of holding and trading in securities also acts
as a bottleneck for broking community in capital market operations. The introduction
of NSE and BOLT has increased the reach of capital market manifolds. The increase
in number of investors participating in the capital market has increased the possibility
of being hit by a bad delivery. The cost and time spent by the brokers for rectification
of these bad deliveries tends to be higher with the geographical spread of the clients.
The increase in trade volumes lead to exponential rise in the back office operations
thus limiting the growth potential of the broking members. The inconvenience faced
by investors (in areas that are far flung and away from the main metros) in
settlement of trade also limits the opportunity for such investors, especially in
participating in auction trading. This has made the investors as well as broker wary
of Indian capital market. In this scenario dematerialized trading is certainly a
welcome move. 21 Prevalence of fake certificates in the market.  Possibility of
theft of share certificates.  Possibility of forgery on various documents leading to
bad deliveries, legal disputes etc.  Delay in transfer of shares. of paper based
trading and settlement, like theft or loss of share certificates. This system requires
handling of huge volumes of paper leading to increased costs and inefficiencies.
Risk exposure of the investor also increases due to this trading in paper. Some of
these risks are:
22. 22. What is Dematerialization? Dematerialization or "Demat" is a process whereby
your securities like shares, debentures etc, are converted into electronic data and
stored in computers by a Depository. Securities registered in your name are
surrendered to depository participant (DP) and these are sent to the respective
companies who will cancel them after "Dematerialization" and credit your depository
account with the DP. The securities on Dematerialization appear as balances in your
depository account. These balances are transferable like physical shares. If at a later
date, you wish to have these "demat" securities converted back into paper
certificates; the Depository helps you to do this. Depository: Depository functions like
a securities bank, where the dematerialized physical securities are traded and held
in custody. This facilitates faster, risk free and low cost settlement. Depository is
much like a bank and performs many activities that are similar to a bank. Following
table compares the two. NSDL and CDS At present there are two depositories in
India, National Securities Depository Limited (NSDL) and Central Depository
Services (CDS). NSDL is the first Indian depository; it was inaugurated in November
1996. NSDL was set up with an initial capital of US$28mn, promoted by Industrial
Development Bank of India (IDBI), Unit Trust of India (UTI) and National Stock
Exchange of India Ltd. (NSEIL). Later, State Bank of India (SBI) also became a
shareholder. The other depository is Central Depository Services (CDS). It is still in
the process of linking with the stock exchanges. It has registered around 20 DPs and
 has signed up with 40 companies. It had received a certificate of commencement of
business from Sebi on February 8, 1999.These depositories have appointed different
Depository Participants (DP) for them. An investor can open an account with any of
the depositories’ DP. But transfers arising out of trades on the stock exchanges can
take place only amongst account-holders with NSDL's DPs. 22
23. 23. Savings Trading in dematerialized shares results in substantial savings for the
investors. Following tables gives an idea about these savings. Savings for a person
who buy shares for long term investment (On a purchase of Rs10000) 23
24. 24. How to Rematerialize Shares. During a Rematerialization process, the request
goes from the DP to the R&T agent via NSDL. The R&T Agent, after processing the
request, will print and dispatch the share certificate directly to you. No transfer duty
will be charged to you when you rematerialize your shares. You have the option of
rematerializing your total holdings or part of it. In addition to this, you have the option
to get the certificates in market lot or jumbo lot. If your name has been wrongly spelt
on the certificates given to you after a Remat, you can send it for rectification to the
R&T agent along with the relevant documents. Trading Trading in dematerialized
securities is quite similar to trading in physical securities. The major difference is that
at the time of settlement, instead of delivery/ receipt of securities in the physical
form, it is done through account transfer. An investor cannot trade in dematerialized
securities through his DP. Trading at the stock exchanges can be done only through
a registered trading member (broker) of the stock exchange irrespective of whether
the securities are held in physical or dematerialized form. 24
25. 25. NSDL Charges for DPs NSDL does not charge the investor directly but charges
its DPs, who are free to charge their clients NSDL charges it’s DPs under the
following heads: Transaction Fees: Market Trade: sale - nil; purchase - 5 basis
points (i.e. 0.05% of the value of net receipts to clearing members account) Off
Market Trade: sale - nil; purchase - 10 basis points (i.e. 0.1% of value of securities)
Custody Fees: 3.5 basis points p.a. (i.e. 0.035% p.a. of average value of securities)
Rematerialization: Rs. 10/- per certificate Onetime payment scheme: NSDL has
announced a new scheme under which, if a company makes a one-time payment of
5 basis points (0.05%) of the average market capitalization during the preceding 26
weeks, then NSDL will not charge any custody fees to the DPs for shares of that
company. Future issues by such companies would require a payment of 5 basis
points on the new share capital created. The valuation for new shares will be done at
the issue price. Companies would not be required to pay any additional amount, if
they make a bonus issue. Initial Public Offerings: Credits for public offers can be
directly received into demat account. In the public issue application form of
depository eligible companies, there will be a provision to indicate the manner in
which securities should be allotted to the applicant. All you have to do is to mention
your client account number and the name and identification number of your DP. Any
allotment due to you will be credited into your account. If the applicant is allotted
securities in dematerialized form, but the details regarding the beneficiary account
are incomplete/ wrong, the person will get physical delivery of allotted securities. If
securities are allotted in the dematerialized form, these would be credited to
applicant’s accountancy day between allotment date and listing date, at the
discretion of the company. The issuer company/ their R&T agent will forward the
applicant the allotment advice giving the number of shares allotted in dematerialized
form. Through this you can come to know that you have been allotted shares. An
amendment to the company law requiring all future public issues above Rs100mn to
 compulsorily offer securities in dematerialized form is awaiting legislative approval.
After this all the issues above Rs100mn will require investors to trade only in demat
way. Partly paid up and fully paid up shares in the depository, will be given separate
ISINs (International Securities Identification Number). These are also traded
separately at the stock exchanges. The company issues call notices to the beneficial
holders of securities in the electronic form. The details of such beneficial holders will
be provided to the issuer/ their R&T agent by NSDL. After the call money realization,
issuer/ their R&T agent will electronically convert the partly paid up shares to fully
paid up shares. 25
26. 26. Tax Aspect In case of dematerialized holdings cost of acquisition and period of
holding for calculation of capital gains tax is determined on the basis of First in First
out (FIFO) method. This is as per the amendment to the Income Tax Act. The proof
of the cost of acquisition will remain to be the contract note. Demat Shares: Are They
100% Safe When you buy physical shares from the stock market, you could never
be certain of the validity of the title of shares. There were many reasons- the sellers'
signature did not match, or the certificates were fake, forged or stolen, and so on.
Demat shares are supposed to obviate these problems. Buying shares in the demat
form always guarantees you a good title as soon as the settlement is over. The
biggest attraction of trading in demat shares is that the shares you buy come with a
clean title and immediately after the settlement on the relevant stock exchange. Rule
100 of market regulator SEBI determines whether the shares delivered in a
settlement, are good or not. Under rule 100, the shares that have been transferred
any number of times can still be withdrawn by the company, if a transfer is found to
be invalid for any reason. Market index The S&P CNX Nifty is an index based upon
solid economic research. It was designed not only as barometer of market
movement but also to be a foundation of the new world of financial products based
on the index like index futures, index options and index funds. A trillion calculations
were expended to evolve the rules inside the S&P CNX Nifty index. The results of
this work are remarkably simple:(a) the correct size to use is 50, (b) stocks
considered for the S&P CNX Nifty must be liquid by the’ impact cost’ criterion, (c) the
largest 50 stocks that meet the criterion go into the index. S&PCNX Nifty is a
contrast to the adhoc methods that have gone into index construction in the
preceding years, where indexes were made out of intuition and lacked a scientific
basis. The research that led up to S&P CNX Nifty is well-respected internationally as
a pioneering effort in better understanding how to make a stock market index. The
Nifty is uniquely equipped as an index for the index derivatives market owing to its
(a) low market impact cost and (b) high hedging effectiveness. The good
diversification of Nifty generates low initial margin requirement. Finally, Nifty is
calculated using NSE prices, the most liquid exchange in India, thus making it easier
to do arbitrage for index derivatives. Hedging effectiveness Hedging effectiveness is
a measure of the extent to which an index correlates with a portfolio, whatever the
portfolio may be. Nifty correlates better with all kinds of portfolios in India as
compared to other indexes. This holds good for all kinds of portfolios, not just those
that contain index stocks. Nifty is owned, computed and maintained by India Index
Services &Products Limited (IISL), a company setup by NSE and CRISIL with
technical assistance from Standard &Poor’s. 26
27. 27. Unit –III Instruments & Stock market instruments 27 New issue market
instruments players of capital market
28. 28. Products available in the Secondary and Primary Market New issue market
instruments The term initial public offering (IPO) slipped into everyday speech during
the tech bull market of the late 1990s. Back then, it seemed you couldn't go a day
without hearing about a dozen new dotcom millionaires in Silicon Valley who were
cashing in on their latest IPO. The phenomenon spawned the term siliconaire, which
described the dotcom entrepreneurs in their early 20s and30s who suddenly found
themselves living large on the proceeds from their internet companies 'IPOs. Selling
Stock An initial public offering, or IPO, is the first sale of stock by a company to the
public. A company can raise money by issuing either debtor equity. If the company
has never issued equity to the public, it's known as an IPO. Companies fall into two
broad categories: private and public. A privately held company has fewer
shareholders and its owners don't have to disclose much information about the
company. Anybody can go out and incorporate a company: just put in some money,
file the right legal documents and follow the reporting rules of your jurisdiction. Most
small businesses are privately held. But large companies can be private too. Did you
know that IKEA, Domino's Pizza and Hallmark Cards are all privately held? It usually
isn't possible to buy shares in a private company. You can approach the owners
about investing, but they're not obligated to sell you anything. Public companies, on
the other hand, have sold at least a portion of themselves to the public and trade on
exchange. This is why doing an IPO is also referred to as "going public." Public
companies have thousands of shareholders and are subject to strict rules and
regulations. They must have a board of directors and they must report financial
information every quarter. In the United States, public companies report to the
Securities and Exchange Commission (SEC). In other countries, public companies
are overseen by governing bodies similar to the SEC. From an investor's stand point,
the most exciting thing about a public company is that the stock is traded in the open
marke Trading in the open markets means liquidity. This makes it possible to
implement things like employee stock ownership plans, which help to attract top
talent. 28 As long as there is market demand, a public company can always issue
more stock. Thus, acquisitions are easier to do because stock can be issued as part
of the deal.  Because of the increased scrutiny, public companies can usually get
better rates when they issue debt. t, like any other commodity. If you have the
cash, you can invest. The CEO could hate your guts, but there’s nothing he or she
could do to stop you from buying stock. Going public raises cash, and usually a lot of
it. Being publicly traded also opens many financial doors:
29. 29. A tracking stock is created when a company spins off one of its divisions into a
separate entity through an IPO. 29 Flipping may get you blacklisted from future
offerings.  Lock-up periods prevent insiders from selling their shares for a certain
period of time. The end of the lockup period can put strong downward pressure on a
stock.  An IPO company is difficult to analyze because there isn't a lot of historical
info.  The only way for you to get shares in an IPO is to have a frequently traded
account with one of the investment banks in the underwriting syndicate.  The road
to an IPO consists mainly of putting together the formal documents for the Securities
and Exchange Commission (SEC) and selling the issue to institutional clients. 
Companies hire investment banks to underwrite an IPO.  The process of
underwriting involves raising money from investors by issuing new securities. 
Getting in on a hot IPO is very difficult, if not impossible.  The dotcom boom
lowered the bar for companies to do an IPO. Many startups went public without any
 profits and little more than a business plan.  Going public raises cash and provides
many benefits for a company.  Broadly speaking, companies are either private or
public. Going public means a company is switching from private ownership to public
ownership.  An initial public offering (IPO) is the first sale of stock by a company to
the public. The internet boom changed all this. Firms no longer needed strong
financials and a solid history to go public. Instead, IPOs were done by smaller
startups seeking to expand their businesses. During the cooling off period the
underwriter puts together what is known as the herring. This is an initial prospectus
containing all the information about the company except for the offer price and the
effective, which aren't known at that time. With the red herring in hand, the
underwriter and company attempt to hype and build up interest for the issue. They
go on a roadshow - also known as the "dog and pony show" - where the big
institutional are courted. As the effective date approaches, the underwriter and
company sit down and decide on the price. This isn't an easy decision: it depends on
the company, the success of the road show and, most importantly, current market
conditions. Of course, it's in both parties' interest to get as much as possible. Finally,
the securities are sold on the stock market and the money is collected from
investors.
30. 30. Government securities (G-Secs): These are sovereign (credit risk-free) coupon
bearing instruments which are issued by the Reserve Bank of India on behalf of
Government of 30 Security Receipts: Security receipt means a receipt or other
security, issued by a securitization company or reconstruction company to any
qualified institutional buyer pursuant to a scheme, evidencing the purchase or
acquisition by the holder thereof, of an undivided right, title or interest in the financial
asset involved in securitization.  Participating Preference Share: The right of certain
preference shareholders to participate in profits after a specified fixed dividend
contracted for is paid. Participation right is linked with the quantum of dividend paid
on the equity shares over and above a particular specified level.  Cumulative
Convertible Preference Shares: A type of preference shares where thedivi dend
payable on the same accumulates, if not paid. After a specified date, these shares
will be converted into equity capital of the company.  Cumulative Preference
Shares. A type of preference shares on which dividendaccumul ates if remains
unpaid. All arrears of preference dividend have to be paid out before paying dividend
on equity shares.  Preferred Stock/ Preference shares: Owners of these kind of
shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid
regularly before dividend can be paid in respect of equity share. They also enjoy
priority over the equity shareholders in payment of surplus. But in the event of
liquidation, their claims rank below the claims of the company’s creditors,
bondholders / debenture holders.  Bonus Shares: Shares issued by the companies
to their shareholders free of cost by capitalization of accumulated reserves from the
profits earned in the earlier years.  Rights Issue/ Rights Shares: The issue of new
securities to existing shareholders at a ratio to those already held. Following are
the main financial products/instruments dealt in the secondary market: Equity: The
ownership interest in a company of holders of its common and preferred stock. The
various kinds of equity shares are as follows – Equity Shares: An equity share,
commonly referred to as ordinary share also represents the form of fractional
ownership in which a shareholder, as a fractional owner, undertakes the maximum
entrepreneurial risk associated with a business venture. The holders of such shares
 are members of the company and have voting rights. A company may issue such
shares with differential rights as to voting, payment of dividend, etc.
31. 31. Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No
periodic interest is paid. The difference between the issue price and red Bond: A
negotiable certificate evidencing indebtedness. It is normally unsecured. A debt
security is generally issued by a company, municipality or government agency. A
bond investor lends money to the issuer and in exchange, the issuer promises to
repay the loan amount on specified maturity date. The issuer usually pays the bond
holder periodic interest payments over the life of the loan. The various types of
Bonds are as follows-  Debentures: Bonds issued by a company bearing a fixed
rate of interest usually payable half yearly on specific dates and principal amount
repayable on particular date on redemption of the debentures. Debentures are
normally secured/ charged against the asset of the company infamous of debenture
holder. India, in lieu of the Central Government's market borrowing programme.
These securities have a fixed coupon that is paid on specific dates on half-yearly
basis. Treasury Bills: Short-term (up to 91 days) bearer discount security issued by
the Government as a means of financing its cash requirements. DEBT
INSTRUMENTS To meet the long term and short term needs of finance, firms issue
various kinds of Securities to the public. Securities represent claims on a stream of
income and /or particular assets. Debentures are debt securities, and there is a wide
range of them. Market loans are raised by the government and public sector
institutions through debt securities. Equity shares issued by cooperates are
ownership securities. Preference shares are a hybrid security. It is a mixture of an
ownership security and debt security. DEBENTURES a debenture is a document
which either creates a debt or acknowledges it. Debenture issued by a company is in
the form of a certificate acknowledging indebtedness. The debentures are issued
under the Company's Common Seal. Debentures are one of a series issued to a
number of lenders. The date of repayment is specified in the debentures.
Debentures are issued against a 31 Commercial Paper: A short term promise to
repay a fixed amount that is placed on the market either directly or through a
specialized intermediary. It is usually issued by companies with a high credit
standing in the form of a promissory note redeemable at par to the holder on
maturity and therefore, doesn’t require any guarantee. Commercial paper is a money
market instrument issued normally for tenure of 90 days.  Convertible Bond: A
bond giving the investor the option to convert the bond into equity at a fixed
conversion price. emption price represents the return to the holder. The buyer of
these bonds receives only one payment, at the maturity of the bond.
32. 32. charge on the assets of the Company. Debentures holders have no right to vote
at the meetings of the companies. KINDS OF DEBENTURES (a)Bearer Debentures:
They are registered and are payable to the bearer. They are negotiable instruments
and are transferable by delivery. (b) Registered Debentures: They are payable to the
registered holder whose name appears both on the debentures and in the Register
of Debenture Holders maintained by the company. Registered Debentures can be
transferred but have to be registered again. Registered Debentures are not
negotiable instruments. A registered debenture contains a commitment to pay the
principal sum and interest. It also has a description of the charge and a statement
that it is issued subject to the conditions endorsed therein. (c) Secured Debentures:
Debentures which create a change on the assets of the company which may be
 fixed or floating are known as secured Debentures. The term "bonds" and
"debentures"(secured) are used interchangeably in common parlance. In USA,
BOND is a long term contract which is secured, whereas a debenture is an
unsecured one. (d) Unsecured or Naked Debentures: Debentures which are issued
without any charge on assets are in secured or naked debentures. The holders are
like unsecured creditors and may see the company for the recovery of debt. (e)
Redeemable Debentures: Normally debentures are issued on the condition that they
shall be redeemed after a certain period. They can however, be reissued after
redemption. (f) Perpetual Debentures: When debentures are irredeemable they are
called perpetual. Perpetual Debentures cannot be issued in India at present. (g)
Convertible Debentures: If an option is given to convert debentures into equity
shares at the stated rate of exchange after a specified period, they are called
convertible debentures. Convertible Debentures have become very popular in India.
On conversion the holders cease to be lenders and become owners. 32
33. 33. Debentures are usually issued in a series with a pari passu (at the same rate)
clause which entitles them to be discharged ratably though issued at different times.
New series of debentures cannot rank pari passu with the old series unless the old
series provides so. New debt instruments issued by public limited companies are
participating debentures, convertible debentures with options, third party convertible
debentures convertible debentures redeemable at premiums, debt equity swaps and
zero coupon convertible notes. These are discussed below: (h) Participating
Debentures: They are unsecured corporate debt securities which participate in the
profits of the company. They might find investors if issued by existing dividend
paying companies. (i) Convertible Debentures with options: They are a derivative of
convertible debentures with an embedded option, providing flexibility to the issuer as
well as the investor to exit from the terms of the issue. The coupon rate is specified
at the time of issue. (j) Third Party Convertible Debentures: They are debt with a
warrant allowing the investor to subscribe to the equity of third firm at a preferential
price visa vis the market price. Interest rate on third party convertible debentures is
lower than pure debt on account of the conversion option. (k) Convertible-
Debentures Redeemable at a Premium: Convertible Debentures are issued at face
value with 'a put option entitling investors to sell the bond to the issuer at a premium.
They are basically similar to convertible debentures but embody less risk. (I) Debt-
Equity Swaps: Debt-Equity Swaps are an offer from an issuer of debt to swap it for
equity. The instrument is quite risky for the investor because the anticipated capital
appreciation may not materialise. (m) Deep discount Bonds: They are designed to
meet the long term funds requirements of the issuer and investors who are not
looking for immediate return and can be sold with a long maturity of 25-30 years at a
deep discount on the face value of debentures. IDBI deep discount bonds for Rs 1
lakh repayable after 25 years were sold at a discount price of Rs. 2,700. (n) Zero-
Coupon Convertible Note: 33
34. 34. A zero-coupon convertible note can be converted into shares. If choice is
exercised investors forego all accrued and unpaid interest. The zero-coupon
convertible notes are quite sensitive to changes in interest rates. (o) Secured
Premium Notes (SPN) with Detachable Warrants: SPN which is issued along with a
detachable warrant, is redeemable after a notice period, say four to seven years.
The warrants attached to it ensure the holder the right to apply and get allotted
equity shares; provided the SPN is fully paid. There is a lock-in period for SPN
during which no interest will be paid for an invested amount. The SPN holder has an
 option to sell back the SPN to the company at par value after the lock in period. If the
holder exercises this option, no interest/ premium will be paid on redemption. In case
the SPN holder holds its further, the holder will be repaid the principal amount along
with the additional amount of interest/ premium on redemption in installments as
decided by the company. The conversion of detachable warrants into equity shares
will have to be done within the time limit notified by the company. (p) Floating Rate
Bonds: The rate on the floating Rate Bond is linked to a benchmark interest rate like
the prime rate in USA or LIBOR in Eurocurrency market. The State Bank of India's
floating rate bond was linked to maximum interest on term deposits which was 10
percent. Floating rate is quoted in terms of a margin above or below the bench mark
rate. The-floor rate in the State Bank of India case was 12 per cent. Interest rates
linked to the bench mark ensure that neither the borrower nor the lender suffer from
the changes in interest rates. When rates are fixed, they are likely to be inequitable
to the borrower when interest rates fall subsequently, and the same bonds are likely
to be inequitable to the lender when interest rates rise subsequently. WARRANTS A
warrant is a security issued by a company granting the holder of the warrant the right
to purchase a specified number of, shares at a specified price any time prior to an
expiable date. Warrants may be issued with debentures or equity shares. The
specific rights are set out in the warrant. The main features-of a warrant are number
of shares entitled, expiry date and state price exercise price. Expiry date of warrants,
generally in USA, is 5 to 10 years from the original issue date. The exercise price is
10 to 30 percent above the prevailing market price. The Warrants have a secondary
market. The minimum value of a warrant represents the exchange value between
the current price of the share and the shares purchased at the exercise price.
Warrants have no flotation costs and when they are exercised the firm receives
additional funds at a price lower than the current market, yet about those prevailing
at issue time. New or growing firms and venture capitalists issue warrants. They are
also issued in mergers and acquisitions. Warrants are called sweeteners and have
been issued in the recent past by several companies in India. Debentures issued
with warrants, like convertible debentures, carry lower coupon rates. 34
35. 35. Non-Convertible Debentures (NCDS) With Detachable Equity Warrants The
holder of NCDs with detachable equity warrants is given an option to buy a specific
number of shares from the company at a predetermined price within a definite time-
frame. The warrants attached to NCDs will be issued subject to full payment of NCD
is a value. There is a specific lock-in period after which there detachable option to
apply for equities. If the option to apply for equities is not exercised, the unapplied
portion of shares would be disposed of by the company at its liberty. Zero-Interest
Fully Convertible Debentures (FCDS) The investors in zero-interest fully convertible
debentures will not be paid any interest. However, there is a notified period after
which fully paid FCDs will be automatically and compulsorily converted into shares.
There is a lock-in period up to which no interest will be paid. Conversion is allowed
only for fully paid FCDs. In the event of the company going for rights issue prior to
the allotment of equity resulting from the conversion of equity shares into FCDs,
FCD holders shall be offered securities as may be determined by the company.
Secured Zero-Interest Partly Convertible Debentures (PCDS) With Detachable And
Separately Tradable Warrants: This instrument has two parts; A and B. Part A is
convertible into equity shares at a fixed amount on the date of allotment. Part B is
non-convertible, to be redeemed at par at the end of a specific period from the date
of allotment. Fully Convertible Debentures (FCDS) With Interest (Optional) This
 instrument does not yield interest in the initial period of say, 6 months. After this
period option is given to the holder of FCDs to apply for equity at a "premium" for
which no additional amour it needs to be paid. The option has to be indicated in the
application form itself. However, interest on FCDs is payable at a determined rate
from the date of first conversion to the second final conversion and in lieu of it, equity
shares are issued. OTHER DEBT SECURITIES IN VOGUE ABROAD Income
Bonds: Here interest is paid only when cash flows are adequate. Income Bonds are
like cumulative preference shares on which the fixed dividend is not paid if there is
no profit in a year, but is carried forward and paid in the following year. On Income
Bonds, there is no default if interest is not paid. Unlike dividend on cumulative
preference shares, interest on income bond is tax-deductible. Income Bonds are
issued abroad by companies in reorganization or by firms whose financial situation
does not make it feasible to issue bonds with a fixed interest payment, 35
36. 36. Asset-Backed Securities: Assets-backed securities are a category of marketable
securities that are collateral listed by financial assets such as installment loan
contracts. Asset-backed financing involves a process called securitization.
Securitization is a disintermediation process in which credit from financial
intermediaries is replaced by marketable debentures that can be issued at lower
cost. Financial assets are pooled so that debentures can be sold to third parties to
finance the pool. Repos are the oldest asset-backed security in our country. In USA,
securitization has been undertaken for insured mortgages (Ginnie Mae, 1970),
mortgage backed loans, student loans (Sallie Mae 1973),trade credit receivable
backed bonds (1982), equipment leasing backed bonds (1984), certificatesof
automobile receivable securities (1985) and small business administration loans. M
orerecently, credit card receivables have been securitized. The decade of the
eighties witnessed large expansion of asset backed security financing. Junk Bonds:
Junk Bond is a high risk, high yield bond to finance either a leveraged buyout (LBO),
a merger of a company in financial distress. Coupon rates range from 16 to 25 per
cent. Old line e established companies which were inefficient and. financed
conservatively were objects of takeover and restructuring. To finance such take-
over, high yield bonds were sold. Attractive deals were put together establishing their
feasibility in terms of adequacy of cash flows to meet interest payments. Michael
Milken (the JUNK BOND KING) of Drexel Buraham Lambert was the real developer
of the market. The junk bond market was tarnished by the fines ($ 650 million) levied
in 1989 on the investment banking firm Drexel Burnham Lambert for various
Securities Law violations and thus was forced into bankruptcy in 1990 and the
indictment of Milken in 1990 on charges of fraud $ 600 million fines and penalties. 36
37. 37. Parties involved in tr Process of share trading  Electronic share trading Unit
–IV Trading Procedure ading 37
38. 38. Dematerialization and Electronic Transfer of Securities Traditionally, settlement
system on Indian stock exchanges gave rise to settlement risk due to the time that
elapsed before trades were settled by physical movement of certificates. There were
two aspects: First relating to settlement of trade in stock exchanges by delivery of
shares by the seller and payment by the buyer. The stock exchange aggregated
trades over a period of timeand carried out net settlement through the physical
delivery of securities. The process of phy sically moving the securities from the seller
to his broker to Clearing Corporation to the buyer’s broker and finally to the buyer
took time with the risk of delay somewhere along the chain. The second aspect
 related to transfer of shares in favor of the purchaser by the issuer. This system of
transfer of ownership was grossly inefficient as every transfer involved the physical
movement of paper securities to the issuer for registration, with the change of
ownership being evidenced by an endorsement on the security certificate. In many
cases the process of transfer took much longer than the two months as stipulated in
the Companies Act, and a significant proportion of transactions wound up as bad
delivery due to faulty compliance of paper work. Theft, mutilation of certificates and
other irregularities were rampant, and inaddition the issuer had the right to refuse the
transfer of a security. Thus the buyer did not get good title of the securities after
parting with good money. All this added to the costs and delays in settlement,
restricted liquidity and made investor grievance redressal time-consuming and at
times intractable. To obviate these problems, the Depositories Act, 1996 was passed
to provide for theestablishmen t of depositories in securities with the objective of
ensuring free transferability of securities with speed, accuracy and security by (a)
Making securities of public limited companies freely transferable subject to certain
exceptions (b) Dematerializing the securities in the depository mode (c) Providing for
maintenance of ownership records in a book entry form. A depository holds
securities in dematerialized form. It maintains ownership records of securities and
effects transfer of ownership through book entry. By fiction of law, it is the registered
owner of the securities held with it with the limited purpose of effecting transfer of
ownership at the behest of the owner. The name of the depository appears in the
records of the issuer as registered owner of securities. The name of actual owner
appears in the records of the depository as beneficial owner. The beneficial owner
has all the rights and liabilities associated with the securities. The owner of securities
intending to avail of depository services opens an account with a depository through
a depository participant (DP). The Securities are transferred from one account to
another through book entry only on the instructions of the beneficial owner. In order
to promote dematerialization of securities, NSE joined hands with leading financial
institutions to establish the National Securities Depository Ltd. (NSDL), the first
depository in the country, with the objective of enhancing the efficiency in settlement
systems as also toreduce the menace of fake/forged and stolen securities. 38
39. 39. TRADING PROCEDURE Neat System The NEAT system supports an order
driven market, wherein orders match on the basis of time and price priority. All
quantity fields are in units and prices are quoted in Indian Rupees. The regular lot
size and tick size for various securities traded is notified by the Exchange from time
to time. Market Types The Capital Market system has four types of market. Normal
Market Normal market consists of various book types wherein orders are segregated
as Regular Lot Orders, Special Term Orders, Negotiated Trade Orders and Stop
Loss Orders depending on their order attributes. Odd Lot Market The odd lot market
facility is used for the Limited Physical Market. The main features of the Limited
Physical Market are detailed in a separate section (1.14). RETDEBT Market The
RETDEBT market facility on the NEAT system of capital market segment is used or
transactions in Retail Debt Market session. Trading in Retail Detail Market takes
place in the same manner as in equities (capital market) segment. The main features
of this market are detailed in a separate section (1.15) on RETDEBT market. Auction
Market In the Auction market, auctions are initiated by the Exchange on behalf of
trading members for settlement related reasons. The main features of this market
are detailed in a separate section (1.13) on auction. Entering Orders The trading
member can enter orders in the normal market, odd lot, RETDEBT and auction
 market. A user can place orders in any of the above mentioned markets by invoking
the respective order entry screens. After doing so, the system automatically picks up
information from the last invoked screen (e.g. Market Watch/MBP/OO/SQ and
Security List). 39
40. 40. Price Bands Daily price bands are applicable on securities as below: Daily price
bands of 2% (either way) on securities as specified by the Exchange. Daily price
bands of 5% (either way) on securities as specified by the Exchange. Daily price
bands of 10% (either way) on securities as specified by the Exchange. No price
bands are applicable on: scrips on which derivative products are available or scrip
included in indices on which derivative products are available. In order to prevent
members from entering orders at non-genuine prices in such securities, the
Exchange has fixed operating range of 20% for such securities. Price bands of 20%
(either way) on all remaining scrips (including debentures, warrants, preference
shares etc.). The price bands for the securities in the Limited Physical Market are the
same as those applicable for the securities in the Normal Market. For auction market
the price bands of 20% are applicable. Order Types and Conditions the system
allows the trading members to enter orders with various conditions attached to
themes per their requirements. These conditions are broadly divided into Time
Conditions, Quantity Conditions, Price Conditions and Other Conditions. Several
combinations of the above are allowed thereby providing enormous flexibility to the
users. The order types and conditions are summarized below: A DAY order, as the
name suggests is an order that is valid for the day on which it is entered. If the order
is not executed during the day, the system cancels the order automatically at the end
of the day. By default, the system assumes that all orders entered are Day orders.
Order Modification All orders can be modified in the system till the time they do not
get fully traded and only during market hours. Once an order is modified, the branch
order value limit for the branch gets adjusted automatically. Following is the
corporate hierarchy for performing order modification functionality:• A dealer can
modify only the orders entered by him.• A branch manager can modify his own
orders or orders of any dealer under his branch.• A corporate manager can modify
his own orders or orders of all dealers and branch managers of the trading member
firm. However, the corporate manager/branch manager cannot modify order details
such that itexceeds the branch order value limit set for the day. Order modification
cannot be performed by/for a trading member who is suspended or de-activated by
the Exchange for any reason. A buyback having ‘BUYBACKORD’ in the client
account field cannot be modified to any other client account. Any order modifications
resulting in price or quantity freeze shall not be allowed. The user will receive a
message "CFO Request Rejected' for such modification requests. Order
Cancellation Order cancellation functionality can be performed only for orders which
have not been fully or partially traded (for the untraded part of partially traded orders
only) and only during market hours. Single Order Cancellation Single order
cancellation can be done during trading hours either by selecting the order from the
outstanding order screen or from the function key provided. Order cancellation
functionality is available for all book types. But the user is not allowed to cancel
auction initiation and competitor orders in auction market. Order cancellation 40