Capital market What changes did the Bombay Stock Exchange (BSE) bring about recently in the A group?

The BSE recently announced a reshuffling of the specified or A group to bring some highly volatile B1 scrips into the group. While the BSE had originally planned to replace 26 A group scrips with 26 B1 group scrips, and add one more to make the total number of scrips in the A group 150, it reviewed the decision subsequently and decided to shift only 17 scrips to the A group. With this, the exchange has pruned the specified list to 140 stocks from the original 150. To refresh your memory, A group scrips are those in which carryforward is allowed, and B group (B1 and B2) is where positions cannot be carried forward and you have to take delivery of shares compulsorily after the settlement is over. Why has the A group been reshuffled? The move is aimed at extending carryforward facility to more liquid scrips in the non-specified or cash group. The move will result in greater volatility and increased turnover in the scrips promoted and also the specified group as a whole. Investors can now carry forward their positions in the scrips by paying badla charges, without taking delivery of shares. Which parameters did the BSE use to select the new scrips for the A group? One parameter was market capitalisation. The scrip had to be among the top 300 scrips ranked in terms of market capitalisation. Another was liquidity. This included trading volume, number of trades and trading frequency of the scrip. The average trading turnover in the scrip in the last six months had to be among those of the top 75 per cent among the 300 scrips. The selected scrips also had to form a part of the BSE 500 index. The floating stock in the market had to be adequate. The Index Committee has taken into account parameters such as promoter holding, number of shares, quality of management, and image and background of promoters while deciding on this factor. The selected scrips are expected to offer dematerialisation facility within three months from the date of shifting to the A group. The specified list is subject to review of the Index Committee every quarter. What is an ADR or ADS? A significant portion of public offerings by non-US companies (and here we are more concerned with Indian companies) in the US are in the form of ADRs or American Depository Receipts (also called American Depository Shares or ADS). ADRs are negotiable receipts issued to investors by an authorised depository, normally a US bank or depository, in lieu of shares of the foreign company which

are actually held by the depository. ADRs can be listed and traded in a US-based stock exchange and they help the Indian company to be known in the highly liquid US stock exchanges. ADRs also help the US-based and other foreign investors to have the twin benefits of having a shareholding in a high growth Indian company and the convenience of trading in a highly liquid and well-known stock market. As you probably know, two Indian companies, Infosys and ICICI, have gone in for ADRs. Why do companies go through the depository route? Indian companies are prohibited by law from listing rupee-denominated shares directly in foreign stock markets. Therefore, they issue such shares to a depository which has an office within India. These shares remain in India with a custodian. Against the underlying shares, the depository issues dollar-denominated receipts to foreign investors. Foreign investors can then sell these receipts in the foreign stock exchanges or back to the depository and get delivery of the underlying rupeedenominated shares which can then be sold in the Indian markets. This is generally done if institutional investors with a presence in both India and the US see an arbitrage opportunity arising out of a difference in prices on the US and Indian exchanges. How are ADRs different from GDRs? ADRs are listed on an American stock exchange. The issue process is governed by American laws and Securities and Exchange Commission (SEC), the market regulator, monitors the issue. GDRs or global depository receipts are listed in a stock exchange other than American stock exchanges, say, Luxembourg or London. A listing in America involves adhering to very stringent disclosure and accounting norms. The accounts of the company have to be represented according to US GAAP or generally accepted accounting principles. US GAAP requires representing a combined balance sheet of all group companies, and not just the company which is going for the issue. Typically, a good company can expect its reported profits according to Indian accounting rules to be eroded by 20-30 per cent under US GAAP. Against this, the disclosure requirements for GDR issues are widely thought to be less stringent. An ADR listing also allows the famed American retail investors to partake in the offering and leads to wider interest and better valuations of a company's stock, thus enhancing shareholder value. Also, the Indian company can acquire US companies against issue of shares. The GDR market is mainly an institutional market with lower liquidity. What are the characteristics of an ADR? ADRs are quoted in US dollars and are generally structured so that the number of the foreign company's securities will result in a trading price for each ADR in the range of $10-30. The multiple or fraction that an ADR is of the underlying shares is determined with this price range in mind. The depository receives dividends

directly from the Indian company in rupees and issues dividend cheques to ADR holders in dollars. When an ADR is sold back to the depository, it is considered as cancelled and the stock of ADRs is not replenished. How is an ADR issue done? The company must get its group accounts consolidated and audited according to US GAAP by an independent agency. It also has to appoint a team of legal and compliance experts as well as lead managers and investment bankers to the issue. The teams will then have to prepare the draft prospectus or the registration statement which will be submitted to SEC. SEC reverts with its comments and requirements, and this goes on till SEC is sufficiently satisfied with the information given. Now the draft prospectus is ready to be distributed to prospective investors. Simultaneously, the company will also have to start the application process to list with the particular stock exchange. With the draft prospectus ready, the company can launch its road shows or the selling exercise for getting subscription to the issue. Prospective investors give their price and amount indications to the lead managers to the issue. Based on investor response, the lead managers fix the price of the issue, which is intimated to the SEC and the concerned stock exchange. With their concurrence, the issue is listed. What is meant by arbitration? Arbitration is an alternative dispute resolution mechanism provided by a stock exchange for resolving disputes between the trading members and their clients in respect of trades done on the exchange. This process of resolving a dispute is comparatively faster than other means of redressal. Who can act as arbitrators? The exchange provides a list of eligible persons approved by the Securities and Exchanges Board of India (Sebi) for each of the regional arbitration centres. The persons on the list typically possess expertise in their respective fields including banking, finance, legal (judges) and the capital market(brokers). Who can avail of arbitration on the exchange? Arbitration can be availed by investors who have dealt on the exchange through its trading members and who possess a valid contract not issued by the trading member of the exchange. Arbitration can be availed by investors who have dealt on the exchange through registered sub-brokers of the trading members of NSE and who posses valid sale/purchase note issued by the registered sub-broker. Trading members who have a claim, dispute or difference with another trading member or a constituent can also opt for arbitration. What is the period for filing an application for arbitration? What is the format for applying?

An application for arbitration has to be filed within six months from the date of dispute. The trading member or constituent has to apply with a statement of case, statement of accounts, copies of the member-constituent agreement, copies of the relevant contract notes/purchase notes and bills. A deposit payment and a list of arbitrators selected by the applicant should also be included. What are the other fees, charges, costs to be borne by the parties to the dispute? All fees and charges relating to the appointment of the arbitrator and conduct of arbitration proceedings shall be borne by the parties to the reference equally or in such proportions as may be decided by the arbitrator. Such fees/charges are recovered from the deposits made while filing the arbitration application and balance amount, if any, is refunded to the parties. Is there any appeal provision for arbitration at the exchange? No, there is no appeal provision for arbitration at the exchange. However, the aggrieved party can make an application to the appropriate court to set aside the award given by a sole arbitrator or panel of arbitrators. What are badla & hawala rates? The badla or modified carryforward system is a time-tested system used by the Bombay, Delhi, Calcutta and Ahmedabad stock exchanges. Under this system, the buyer and seller have the option to carry forward their trades to the next settlement without effecting delivery of shares or making payment. Let's talk about the two rates which govern the process: hawala and badla rates. What is the hawala rate? The hawala rate is a making-up price at which buyers and sellers settle their speculative transactions at the end of the settlement on any exchange. It becomes the basis for buy and sell for the investor opting for carryforward during the next settlement. This price is fixed by taking the weighted average of trades in the last half hour of trading on the settlement day for securities in the carryforward list, also known as the A group or specified group. This price is significant because for a speculative buyer or a seller, the hawala rate is the standard rate for settling his trade and for carrying forward business to the next settlement. Say, an investor buys stock of X company at Rs 100 on Monday. By Friday (which in the case of BSE is the settlement day), if Rs 90 is the weighted average price in the last half an hour, the buyer would have to carry forward his trade at this price of Rs 90. He then settles at Rs 90 and enters into a contract at Rs 90 plus badla charges (more about it later) for the next settlement.

Can the stock exchange fix or alter the hawala rate? Normally, stock exchanges do not interfere with the hawala rates. However, there are instances when it has happened and rates have been changed to ensure safety of the markets. This is so because in case the market witnesses a sharp fall during a settlement, the chances of a broker default are extremely high. This is when the exchange administration steps in and raises the hawala rate to avert any possible default. What is badla? Simply put, badla is the price payable by the buyer to carry over his speculative purchases to the next settlement. The system helps traders to carry forward businesses without taking deliveries of stocks purchased. More, the system helps to build large volumes on the exchanges and impart liquidity in stocks. How are badla rates determined? Badla rates are determined by the demand and supply of money in the system. Demand of money in turn, is determined by the net outstanding position, which is the difference between the long purchases and short sales. Before you ask, long purchases are those where the buyer doesn't make payment for his purchases and short sales are those where a seller sells shares he doesn't physically possess. The net of these positions at the end of the settlement is carried forward, and if this figure is large, badla rates will be higher. What are the different types of badlas available at the domestic exchanges? As the settlement is weekly, badla is allowed for one week at a time. Badla charges are normally payable by the buyer to carry forward his business to the next settlement. However, when a company announces the closure of its books for the purpose of determining corporate benefits such as dividend, rights or bonus share entitlement, the company's stock enters a no-delivery period for three to four weeks. Hence in case of book closure badla, badla financing is done for the three to four-week period (two weeks in case of demat stocks and four weeks in case of physical stocks). Also, there are 'undha' badlas where the seller pays charges for carrying over his position. Such badlas arise when there is a substantial oversold position in the market, or when there are more sellers selling without shares in hand than there are buyers who do not make payments. This occurs when market players expect prices to fall and sell speculatively. Do rates differ for the different forms of badla? In theory, badla rates for all forms of carryforward have to be the same. Book closure badla is easier in the case of demat shares as compared to physical shares because in the case of physical shares, transfer of shares along with the attendant problems of bad delivery enhances the risk greatly. As a result, bookclosure badla rates for demat shares are lower as compared to that of shares in physical form.

What does a clearing house do? A clearing house/corporation is an agency which settles trades among brokers. It nets out brokers' positions pertaining to payment of funds and delivery of shares. The clearing house for the Bombay Stock Exchange (BSE) is BOI Shareholding Ltd, a joint venture between the exchange and Bank of India. Individual investors do not come in contact with clearing houses. The National Stock Exchange (NSE) has set up a 100 per cent subsidiary called National Securities Clearing Corporation Ltd. (NSCCL), which handles the clearing functions for the exchange. some of the terms involved: Pay-in/pay-out Pay-in is the day on which brokers deposit shares sold by them and make payments to the clearing house for shares bought during the settlement period. Pay-out is the day when brokers receive shares for which they have made the payment and receive funds for shares sold by them earlier. NSE has a weekly settlement for which trading begins on Wednesday and ends on the subsequent Tuesday. For this settlement, the pay-in is on the Monday of the following week and pay-out is on Wednesday. For BSE, the weekly settlement begins on Monday and ends on Friday. The pay-in for this settlement is on Thursday of the subsequent week and the pay-out, on Saturday. Liquidity Liquidity reflects the quantum of transactions in a particular counter; the larger the volume of trading, the higher the level of liquidity. In the case of highly liquid shares, the spread between the buy and sell quotes is extremely thin because of the larger volumes. Normally, higher liquidity is seen in stocks which have relatively a large capital and larger number of shareholders, as also a large market cap. Reliance Industries, Hindustan Lever, Tata Steel, Telco and Satyam are some of the major high liquid stocks. Illiquid stocks are those in which trades do not take place frequently. Ex-dividend, cum-dividend An ex-dividend quote is the price of a share which does not contain dividend declared by the company (or the share price after the payment of dividend). Hence the new buyer will not be entitled to the dividend amount. The share becomes cum-dividend immediately after the company declares dividend, and it is traded on a dividend containing basis, till the book closure. And similar is the case with bonus shares. Book closure

Book closure is the period during which the company does not entertain transfer of shares. The company announces book closure dates for entitlement of dividend and/or bonus and rights shares, and entitlement of other securities. Bonus shares Bonus shares are equity shares which are given to shareholders free of cost. Bonus shares are created by capitalising the company's reserves. In other words, a portion of the company's reserves is transferred to the equity capital account. A group, B group, B2 group The Bombay Stock Exchange (BSE) and other regional exchanges have classified listed shares into various categories. BSE has three categories: A, B1 and B2, for equities. The A group consists of 150 scrips in which carryforward (badla) facility is provided. In other words, traders or investors can carry forward their transactions from one settlement to another only in the 150 scrips belonging to the A group. B1 and B2 are cash group shares which means carryforward is not allowed. They are also called `non-specified'. The B1 group consists of good quality, high volume scrips while B2 is made up of low-market cap, thinly traded stocks. Circuit filter The circuit filter is the maximum permissible limit (8 per cent in A and B1 stocks, 25 per cent in certain B2 stocks) for fluctuation of the share price - upward or downward - during a trading session.

Demat, a safer way to trade The discomfort among investors for holding share certificates in the physical form is rising. Client (investor) accounts opened with The National Securities Depository Ltd, India's first depository, now stands at 99,000 from a mere 8,000 in March this year. And starting from January 4, 1999, all investors (including retail) will have to settle trades in 12 scrips - BoI, BPCL, BSES, HDFC, ICICI, IDBI, IndusInd Bank, Infosys, L&T, SBI, Wipro and VSNL - compulsorily in the demat form. Another 19 scrips will be added to this list on February 15. Yet, most investors (over two crore of them) are plagued by doubts about the functioning of a depository and the advantages of holding securities in electronic form. What is a depository ? A depository is an organisation where share certificates of a shareholder are held in electronic form. This is done at the request of the shareholder through a depository participant (DP). If an investor wants to use the services offered by a depository, he/she has to open an account with the depository through a DP (more

about him later), much like opening an account with any branch of a bank to utilise its services. In fact, in many ways, a depository is similar to a bank. What is dematerialisation? Dematerialisation (a euphemism for shredding) is a process by which an investor's physical share certificates are taken back by the company/registrar and destroyed. Then an equivalent number of securities are credited in the electronic holdings of that investor. This is done at the request of the investor. An investor will have to first open an account with a DP and then request for dematerialisation of his certificates through the DP so that the dematerialised holdings can be credited into that account. Who is this DP? A DP is your representative in the depository system. Your DP will maintain your securities account balances and intimate to you the status of your holdings from time to time. According to Sebi guidelines, financial institutions, banks, custodians, stock brokers, etc, can become DPs. Why should investors buy/sell shares in the depository mode? Currently, it takes an investor two or three months to get shares registered in his name. Besides, the chances of shares being lost or stolen during transit are real. But when you buy shares which are already in the depository mode, you become the owner of those shares in the depository within a day of the settlement being completed. You don't have to apply to the company to register the shares in your name. The possibility of loss or theft when certificates are posted to the company is eliminated. Will there be a charge for the opening of an account or for every transaction? There will be reasonable charges for the opening of accounts and also for every transaction in the accounts. The depository will publish its charges and the DPs will also have to make their charges known to the market. Thirty three DPs (names can be got from www.nsdl.com) are offering investors various incentives including not charging them anything for opening an account if they sign up before January 4, 1999. How will I know that my DP has updated my account after each transaction? Just like a bank, the depository participant or DP will give you a passbook or a statement of holdings. The statement of holdings will be dispatched to you periodically by the DP. However, the statement of holdings can be sent to you as and when you request it. What happens if I lose my holdings statement or depository passbook? Simple. Inform your DP and obtain a duplicate holdings statement or depository

passbook. Your holdings statement or passbook cannot be used by anybody else for trading in your account. Who will give me the benefits arising out of my holdings, say a bonus or a dividend? When any company announces rights, bonus or dividend, the depository will give all the details of the clients having electronic holdings of that security as of record date/book closure to the registrar. The registrar will then calculate the corporate benefits due to all the shareholders. The disbursement of cash benefits such as dividend/interest will be done by the registrar whereas the distribution of securities entitlements (in case of rights or bonus issue) will be done by the depository based on the information provided by the registrar. Can electronic holdings be converted back into certificates? Yes. If you wish to get back your securities in the physical form, all you have to do is to request your DP for the rematerialisation of the same. Rematerialisation is the term used for converting electronic holdings back into certificates. Your DP will forward your request to the depository after verifying that you have the necessary security balances. The depository will, in turn, intimate the registrar who will print the certificates and despatch them to you.

What is demutualisation? Demutualisation refers to the conversion of an existing non-profit organisation into a for-profit company. In other words, an association that is mutually-owned by members converts itself into an organisation that is owned by shareholders. The company can take different shapes and forms, that is, it could be either a listed or unlisted company which may be closely held or publicly held. Who can demutualise? Is the term restricted only to corporatisation of stock exchanges? No. Any organisation that is a non-profit body (which is not the same as lossmaking), and is not distributing its profits to owner-members, but is retaining the same to develop infrastructure of the organisation, can demutualise. For instance, Australia's life insurer and funds manager AMP recently demutualised, as did Sun Life Assurance, the Canadian insurance firm. Recently, several stock exchanges like the Bombay Stock Exchange, the London Stock Exchange (LSE) and two US stock exchanges, the New York Stock Exchange and Nasdaq, announced that they will demutualise. How is an exchange demutualised?

The exchange values all its assets, including the value of seats, and arrives at a total value. This is then divided into different shares and offered to the public. Later, the shares are listed on the stock exchange itself, and the funds got by selling the shares are distributed among the members of the exchange as payment for their seats. If the company is not being listed, the shares may be offered to the members, not for transfer. Why the need for demutualisation? A corporate structure, which is the goal of demutualisation, provides the management with more flexibility. A company is more nimble and can react faster to changes in the environment as compared to an organisation that is mutuallyowned by members who are worried about themselves. A company can spin off subsidiaries, get into mergers and acquisitions, raise more monies, etc. For instance, the NSE which started out as a corporate body has spun off wholly-owned subsidiaries like the National Securities Clearing Corporation and more recently, NSE.IT, a dedicated info-tech company. But the BSE, which is mutually-owned, was unable to hive off its clearing house into a separate subsidiary. Why do stock exchanges need to demutualise? Technological developments like on-line and internet trading, and increasing competition have forced stock exchanges to re-look at themselves, and adapt and change so as to survive. Exchanges require large investments in infrastructure to keep pace. But the trouble is that their decision-making is often painfully slow and conservative. This is seen from the reluctance of smaller, regional exchanges in India to merge with the larger exchanges, so that they can retain their individual character. This despite the fact that many have no trades in a whole year. Internationally too, it was seen that the members of London's International Petroleum Exchange had voted against demutualising, and had rebuffed an overture for a merger from the New York Mercantile Exchange. With so many obvious benefits, what is the deterrence for demutualisation for exchanges today? The taxation aspect is a major deterrent for many stock exchanges to demutualise. Turning into a corporate structure would result in huge capital gains tax being slapped on them. Hence, stock exchanges are asking for a one-time exemption, as was given by the government to encourage corporatisation of old brokerage houses. If an exchange goes public, what happens to its role as a self-regulatory organisation? The corporate structure by itself does not make any difference, as seen from the

example of the NSE. But a conflict of interest could arise if the boards of the stock exchanges are not independent as also at the time of listing of the demutualised exchange. The conflict would arise due to a clash in the exchange's role as a regulator and its commercial objectives. This issue needs to be looked into by the regulators of the capital markets of the particular country. Here, some cues could be taken from the LSE which, reportedly, has given up some of its functions in preparation for its planned demutualisation. The LSE has given up its role of supervising new company listings to the UK's financial regulator, the Financial Services Authority, which also oversees the regulation of capital markets.

What is a futures contract? A futures contract is an agreement between a buyer and a seller for the purchase and sale of a particular asset at a specific future date. The asset in the case of index futures is an index. It could be the S&P CNX Nifty index or even the BSE-30 sensex. With the passage of time, several more indices are going to be allowed to be traded on the futures markets. In a futures contract, the price at which the asset will change hands in the future is agreed upon at the time of entering into the contract. A futures contract involves an obligation on both the parties to fulfil the terms of the contract. What is the period for which a futures position can be taken? Currently, both the stock exchanges have come out only with three contracts: onemonth, two-month and three-month contracts. Each expires on the last Friday of the respective month. More flexibilities are expected to be introduced as index futures catch up. What are options? Options are contracts which go a step further than futures contracts, in the sense that they provide the buyer of the option the right, without the obligation, to buy or sell a specified asset at an agreed price on or upto a particular date. For acquiring this right, the buyer has to pay a premium to the seller. The seller on the other hand, has the obligation to buy or sell that specified asset at that agreed price. This makes options more of an insurance product, where the downside risk is covered for the payment of a certain fixed premium. So, the loss would be minimised to the extent of the premium paid, like in an insurance product. What are `call' and `put' options? The right to buy is called a `call' option, while the right to sell is called a `put' option. The buyer of the call option can call upon the seller of the option and buy from him the underlying instrument, at any point in time on or before the expiry

date by exercising his option at the agreed price. The seller of the option has to fulfil the obligation on exercise of the option. In a put option, the buyer of the option can exercise his right to sell the underlying instrument to the seller of the option, at the agreed price. What are the assets under which one can exercise options? Right now, the regulator does not allow trading in options. The regulator now proposes to allow trading in option contracts on both indices as well as individual stocks. These products are expected to be introduced by the end of the year. Why do markets need regulators? Regulation is necessary in situations where markets create spillovers called 'externalities'. Why doesn't free pricing lead to the best outcomes? Theoretically, prices are supposed to set everything right in functioning markets. However, reality markets create spillovers and these can be harmful, or could create winners and losers through information asymmetries. However, even economic theorists realise that regulation has a role to play in markets. So, it's important to understand exactly what you're trying to tackle before getting down to frame regulation. What are network externalities? The rapid spread of computing and the internet highlighted an important type of spillover, called network externalities. This happens when one technology or standard, pioneered by one company, gets an edge over others and becomes ubiquitous. A good example is Microsoft's Windows operating systems. The danger involved in this sort of ubiquitousness is that it can be used to lock out competition in related markets. In situations like these, it's clear that the market mechanism doesn't get all the room it needs to operate, because consumers are locked out from getting to sample or use competing products. What kind of problems can arise from information asymmetries? An apparently innocuous thing like an asymmetry of information between parties to a transaction, or incomplete information on the part of the buyer or seller, can lead to entire markets breaking down. A large economics literature, pioneered by George Akerlof and Joseph Stiglitz in the 1970s, has shown how informational quirks can lead to perverse outcomes, even in working markets. Remember that independent auditing or credit rating are all forms of intervention in markets. Does regulation always solve problems it's meant to solve? Not quite. Regulation can go haywire or be ineffective if it's applied without thinking. For example, it is pointless to make a law that says no software company

can sell its operating system to more than 30 per cent of PC buyers. Or to mandate a fixed price for something like oil. These laws will scuttle innovation, drive businesses away and could even encourage parallel markets. It is better to have a loosely defined anti-trust law like the US has, to punish anti-competitive behaviour. The US has specialised regulators for stock markets, electricity and telecommunications. The first market is notoriously sensitive to information glitches, the latter two are prone to things like network effects. What is regulatory capture? This happens when business interests, which the watchdog is supposed to regulate, turn around and begin to exercise influence on regulators. The obvious reason why this happens is corruption. However, there are instances of regulatory capture and failure that can also be due to political interference, poorly drafted legislation, the lack of clarity of mandate and of course, incompetence and oversight. Most of these problems dog regulation in India today.

What links money and stock markets? Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity in the system. This is not entirely correct. Nearly 70 years ago, John Maynard Keynes discovered the link between money and markets. Keynes, himself an aggressive investor in markets, realised that the factor connecting money and stocks was interest rates. People save, Keynes realised, to get returns on their savings. That made bank deposits or bonds (whose returns are linked to interest rates) and stocks (whose returns are linked to capital gains), competitors for people's savings. A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect. This argument has survived econometric tests and practical experience. This is the reason that underlies Wall Street's sighs of relief after Fed chairman Alan Greenspan announced a rate cut earlier this month. Is money supply related to jobs and output? At any point of time, the price level in the economy is determined by the amount of money sloshing around. An increase in the money supply - currency with the public, demand deposits and time deposits - increases prices all round because there are more currency notes chasing the same goods and services. If wages move slower than other prices, higher inflation will drive real wages lower and encourage employers to hire more people. That, in turn, ramps up production and employment. This was the theoretical justification of a long-term trend that showed that higher inflation and employment went together; when infation fell, unemployment increased. This policy of pump priming was followed successfully in the West till the 1970s, when successive boosts in money supply raised inflation

but failed to boost jobs and economies that were reeling from the 1973 oil shock. When are the changes in money supply effective? The debate on whether tweaking money supply could actually affect output and jobs, pit Friedman's Chicago school saying it couldn't, against Samuelson's MIT arguing that it could. After two decades of squabbling and heavy duty number crunching, today's take on why and how money matters is more nuanced than the extreme Chicago or MIT positions of the late 1970s. Changes in monetary policy affect markets, prices and jobs in the short run. However, to be effective, these have to be unanticipated. In other words, monetary policy succeeds only when it surprises players. If everybody anticipates changes, they adjust expectations and holdings to discount the effect of a change in monetary policy, so real effects are discounted away. That's why Greenspan's rate changes have succeeded when they were least expected. What are the levers to regulate money supply? The US Federal Reserve Board uses the interest rate as an instrument to regulate the flow of money between markets and other savings instruments like bonds and deposits. In India, the RBI uses the interest rate, open market operations (OMO), banks' cash reserve ratio (CRR) as well as primary placements of government debt to control the money supply. OMO, primary placements and changes in the CRR are the most popular instruments used. For a variety of reasons, the RBI's bank rate, which was supposed to establish a benchmark interest rate for the entire lending system like the Fed's discount rate, has not really become a popular instrument to tweak the supply of money and its allocation between different assets. Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. The changes in CRR affect the amount of free cash that banks can use to lend. Reducing the amount of money for lending, cuts into overall liquidity, driving interest rates up, lowering inflation and sucking money out of markets. Primary deals in government bonds are a method followed by the RBI to intervene directly in markets. By directly buying new bonds from the government at lower than market rates, the RBI tries to limit the rise in interest rates that higher government borrowings would lead to. Do RBI's policies affect jobs and output? Typically, the RBI follows a least-inflation policy, which means that its money market operations as well as changes in the bank rate are generally designed to minimise the inflationary impact of changes in money supply. Since most people can generally see through this strategy, it limits the impact of the RBI's monetary moves to affect jobs or production. Markets, however, move to the RBI's tune because of the almost inexorable link

between interest rate and capital market yields. In general, the RBI's policies have maximum impact on volatile foreign exchange and stock markets. Jobs and output are affected much later, if trends of high inflation or low liquidity persist for very long. What are MSCI indices? MSCI stands for Morgan Stanley Capital International, which is a leading provider of global indices and benchmark-related products and services to investors worldwide. MSCI indices are a widely-used benchmark by global international portfolio managers. They represent opportunities available to various investors the world over. How many MSCI indices are there? MSCI has 51 country indices and several regional indices. The regional indices are formed by aggregating the country ones. MSCI's equity indices are constructed in a consistent manner across all countries, encompassing 23 developed and 28 emerging markets. The regional indices represent investable areas as determined by global investment managers. These regions are within the developed and emerging markets in addition to spanning both. When are the indices calculated? The MSCI indices are calculated and disseminated once a day, reflecting the closing market value. However, the 15 MSCI European developed market country indices, and the major MSCI European regional indices, are calculated on a realtime basis and updated intra-day every 60 seconds. How are the indices constructed? The construction of MSCI indices is essentially a five-stage process: 1. Define the total market 2. Sort the market by industry groups and target 60 per cent for inclusion 3. Select stocks with good liquidity and free float 4. Avoid cross ownership 5. Apply full market capitalisation weight to each stock Where does India figure? India is represented by the MSCI India Index, which currently comprises 73 Indian companies, covering 24 industries in India with a total market cap of approximately $70 billion. Infosys has the highest weightage of 14 per cent in the index. It is followed by Hindustan Lever with 12 per cent and Reliance with 10 per cent. The MSCI India index is a subset of other global indices like the MSCI Emerging Market Index, which includes various other emerging markets besides India.

What is the MSCI methodology? Currently, MSCI indices include full m-cap of index constituents. But a market capitalization factor (MCF) is applied to reduce the weightage of constituents with free float less than minimum. Zee Telefilms, for example, has an MCF of 0.6x, or 60 per cent of its m-cap, due to its low free float. What is free float? MSCI defines free float as total shares outstanding, excluding shares held by strategic investors such as governments, corporations, controlling shareholders and management, and shares subject to foreign ownership restrictions. What is the likely impact on India? Since the free float in India is quite low, India's weightage in the MSCI Emerging Market Index could show a major decline while the software sector's weightage in the MSCI India Index may go up. There could also be many deletions from the India constituents list. A relatively higher number of deletions are assumed as once 85 per cent of m-cap coverage is reached for a particular sector, the remaining stocks within the sector would be deleted. How are the changes implemented in MSCI's indices? MSCI tries to balance accurate representation of the index with minimising turnover, as it is costly and inconvenient for investment managers. All the changes to MSCI indices are categorised into structural changes and market-driven changes. Structural changes refer to changes from the evolution of the market. For instance, a change in industry composition or regulation. Structural change in a country index can occur only on four dates in a year, i.e. close of the last business day of February, May, August and November. MSCI index additions and deletions are announced two weeks in advance. Market-driven changes are induced by events like new issues, mergers, acquisitions, bankruptcies and other similar corporate events. For instance, new issues may not be automatically included in the index. Care needs to be taken regarding m-cap, float and liquidity. What is options trading? Options are deferred delivery contracts that give the buyer the right, but not the obligation, to buy or sell a specified underlying security at a set price on or before a specified date. Options are entered into between two parties, wherein the buyer receives a privilege for which he pays a fee, called premium, and the seller accepts an obligation for which he receives the fee. The premium is the price negotiated and set when the option is bought or sold. A person who buys the option is said to be `the long' in the option. A person who sells (or writes) an option is said to be `short' in the option.

What are the types of options? There are two types of options: call option and put option. Call option: Selling a call gives traders the right, but not the obligation, to buy a security at a set price at a later date. Put option: Put gives the buyer the right, but not the obligation, to sell a security at a set price at a later date. An example may help to illustrate this. A trader, Ramjibhai, has a call option on company 'A' at Rs 400 by paying a premium of Rs 20. Thus, in this example, if he chooses to exercise the option, the price paid per share, called the strike price, is Rs 420 (Rs 400 plus the Rs 20 premium). Thus, Ramjibhai's loss would be limited to Rs 20 if the price of 'A' drops below Rs 400 on the expiry date and he does not exercise the option. So long as the price does not cross Rs 420, Ramjibhai loses the premium. However, in cases where the share price is between Rs 400 and Rs 420, he can minimise his loss by taking delivery of the underlying shares and selling them at the market price. His loss then is only Rs 5 per share since he has taken delivery of shares at Rs 420 and sold at the prevailing market price of Rs 415. If Ramjibhai doesn't have the money to undertake this transaction, then his losses are Rs 20 per share. Thus, stock options would be akin to buying securities long or selling short. In fact, for a borrower playing on borrowed funds, it would be wiser to invest in stock options than buying deliveries of underlying stocks. The option buyer has the right to exercise his choice but not the obligation, while the option writer or seller has the obligation to meet his commitment but does not enjoy any right in respect of options written. Therefore, option writers are expected to have deep pockets and they will be governed by the Sebi guidelines. The risk in option trading is limited to an initial premium paid by the trader. In case of put and call options, the potential loss is limited to the premia paid. How do you liquidate an option? An option can be liquidated in three ways: a closing buy or sell, abandonment and by exercising. Buying and selling of options are the most common methods of liquidation. An option gives the right to buy or sell an underlying instrument at a set price. Exercise: In general, exercising an option is considered to be the equivalent of buying or selling the underlying instrument for a consideration. Options that are in-the-money are almost certain to be exercised at expiration. Abandonment: An option can be abandoned if the premium left is less than the transaction costs of liquidating the same. We now look at some of the terms involved: Option premium: It is the price paid by the buyer to acquire the right to exercise the option. Strike price or exercise price: The predetermined price upon which the buyer and seller of an option have agreed is the strike price. Each option on an underlying instrument shall have multiple strike prices. Exercise date: It is the date on which the option is actually exercised.

Intrinsic value: It is the difference between the exercise price and the spot price. It cannot be negative. For a call option, it would be spot price minus exercise price while for a put option, it would be exercise price minus the spot value. Time value: It is the amount buyers are willing to pay for the possibility that at some time, prior to expiration, the option may become profitable. This too can be negative. What are preferential allotments? An existing company has three methods available to it for expanding its share capital. The first is through a fresh issue of shares to existing shareholders in proportion to shares held by them (rights or bonus issues). The second method is that of making an open offer or inviting the public in general to subscribe to shares, which is generally known as initial public offer (IPO). The third method is to make a bulk allotment to an individual, individuals, companies, venture capitalists or any other person through a fresh issue of shares. This is known as preferential allotment.This method is distinct from others in the sense that the entire allotment is made to pre-identified people (who may or may not be existing shareholders of the company) at a pre-determined price. Generally, preferential allotments are made to people who wish to take a strategic stake in the company, for instance, venture capitalists, existing shareholders like promoters who wish to enhance their stake in the company, financial institutions, buyers of the company's products or its suppliers. The rationale is to provide a route by which the company can secure the equity participation of those who it feels can be of value as shareholders, but for whom it may be inordinately costly and/or impractical to buy large chunks of shares from the market. How are preferential allotments made? Preferential allotments are made by means of a special resolution that is passed by existing shareholders. This means that three-fourths of the shareholders should agree to the issue of shares on a preferential basis. The number of shares to be issued, their pricing, the consideration for issue of shares and the identities and backgrounds of the persons or companies to whom the shares are proposed to be issued on a preferential basis are taken upfront. Sebi, under its guidelines, has prescribed a minimum pricing formula, under which the preferential allotment can be made. Under this, an average of the highs and lows of the 26 weeks preceding the date on which the board resolves to make the preferential allotment is arrived at and this is the minimum price at which the allotments can be made. Till recently, all preferential allotments were exempted from the applicability of the takeover code. However, the latest amendment has brought preferential allotments of more than 15% of the equity under the ambit of the takeover code, implying that any allotment above this limit will necessitate an open offer to the existing shareholders.

Do Sebi guidelines also stipulate a maximum price for preferential allotments? As of now, there is no limit to the maximum price for the preferential allotments. However, recently, a company was in the news for having made a preferential allotment to a group of brokers at a ridiculously high price for a very small portion of equity. A high price in a preferential allotment results in a benchmark for the market price, facilitating a false market in shares. Sebi is now looking at putting a cap on the maximum price at which such allotments could be made and prescribing the entities to whom they could be made. This will, however, imply regulating for exceptions and interfering with the free functioning of the market. What is the difference between rolling settlement and the prevailing weekly settlement? A rolling settlement is one in which trades outstanding at the end of the day have to be settled (payments made for purchases or deliveries in the case of sale of securities) at the end of the settlement period. In a T+5 rolling settlement, a transaction entered into on Monday for instance, will be settled next Monday when the `pay in' or `pay out' takes place. As opposed to this, in a weekly settlement, the transactions made during any of the five trading days are permitted to be squared up - or purchases offset against sales - during the same settlement period. Only those transactions which are outstanding at the end of the last trading day are required to be settled by payments or deliveries. Internationally, most developed countries follow the rolling settlement system. For instance, both the US and the UK follow a rolling settlement, as also the German stock exchanges. What are the advantages of rolling settlements? In rolling settlements, payments are quicker than in the weekly settlements. Thus, investors benefit from faster turnaround times. For example, in a rolling settlement system, investors would receive the payments on the day after the sale. Currently, in India, in the weekly settlement, sale proceeds of transactions made on the first trading day are available on the 12th day, and on the eighth day if the trade takes place on the last day of the trading cycle. Why do we not practise rolling settlements widely in India? We do have rolling settlements, but it is a separate segment. The trading volumes in this segment are insignificant as compared to those seen in the normal or weekly trading segment. So far, carryforward for scrips in rolling mode was not available but this has now been permitted by Sebi. The National Stock Exchange was the first to introduce rolling settlements in the country. Rolling settlements could not be introduced earlier because India did not have depositories, and rolling settlements necessarily require electronic transfer of funds and demat facilities in respect of securities being traded. This is because handling large volumes of paper

on a daily basis is extremely difficult for the clearing houses of stock exchanges. It is only now that India has adequate facilities for electronic delivery of shares (demat shares), which facilitates trading and clearing large volumes on a daily basis. However, transfer of funds in India still takes two to three days as all banks are not yet connected electronically with all their branches. Why are we talking about rolling settlements now? The finance minister has announced that effective July 2, 2001, all scrips included in the BLESS/ALBM/MCFS and others comprising the BSE 200 index, will have to be traded in rolling settlement mode, compulsorily across all Indian exchanges. This has been done to make it difficult for anyone to manipulate the prices in a scrip and to bring Indian settlement systems and procedures on par with international standards. If by the appointed date in July, any exchange has not put in place the software required to trade the 200 scrips in rolling mode, then those scrips would trade on the exchange only on a spot basis. What are the main drawbacks of rolling settlements? The main drawback is that it results in a drop in liquidity on the bourses. This is because, in India, the cash market has been used as a de facto futures market by speculators and day traders. Rolling settlement forces this segment, which accounts for nearly 80 per cent of exchange volumes, to either square up their positions by the end of the day or pay cash and take delivery of stock. Improving the transparency of the cash market and forcing speculators to move onto the futures market may enhance the liquidity of the futures and options markets while it reduces the liquidity in the cash markets. What is a trading cycle? A trading cycle refers to the number of days on which you are allowed to carry out trading in securities like shares. In India, the trading cycle is five days: Monday to Friday on the Bombay Stock Exchange, and Wednesday to Tuesday on the National Stock Exchange. A settlement is done when you pay for the shares you have bought during the trading days and deliver the shares you have sold. If you have carried out several transactions (buying and selling) and if you do not give delivery, the losses and gains you made are netted out on settlement. A settlement period is the time given to settle the trades and differs with the exchange. The BSE follows the weekly settlement system. It means that a transaction entered into at any time between Monday and Friday is settled on the following Monday. In the past, before the Securities and Exchange Board of India made weekly settlements mandatory, exchanges even had fortnightly settlements. Now there are moves to introduce the T+5 system.

What does T+5 mean? When you say T+5, the `T' stands for the trading day; settlement is carried out after five days. In the case of a T+3 system (seen in the US, UK), transactions outstanding on Monday would be settled on Thursday, and in the case of T+2 (as in Germany), the transactions outstanding on Monday would be settled on Wednesday. What is `carry forward'? The BSE provides the facility of carry forward trades from one weekly settlement to another; this is however confined to the `forward' group of shares. The buyer of shares is permitted to carry forward his purchase position to the next settlement by paying `contango' or `badla' charges. The shortseller - the one who sells shares without possessing them - is also permitted to carry forward his sales position after adjusting the difference between the sale price and a fixed carry-forward price. The traditional badla system permitted carry-forward of trades for one fortnightly settlement to another fortnightly settlement. The revised carry-forward system now prevalent on the BSE has several built-in checks against broker defaults. How does carry-forward act as a hedge? It is permitted in scrips which have high liquidity and is intended to offer a hedge against other investments. An investor in illiquid shares, expecting a decline in the market, can sell short any of the forward scrips and buy them back at a later stage to make good his loss on the illiquid stock. What is a cash settlement? And an auction? In a cash settlement, the buyer is required to take the delivery of shares and the seller is required to give delivery of shares at the end of the settlement period. If the seller fails to deliver, the exchange authorities resort to auction on his behalf, and the resultant loss is payable by the defaulting seller. What is vyaj badla? Vyaj badla is the interest rate for carry-forward trades. These are arrived at through unique transactions which take into account oversold and overbought positions and money supply. What are unlisted securities? Equity shares of companies that have not made a public offering, but are held by the promoters and/or venture capital funds would come under the definition of unlisted securities. Why do we need a market for unlisted securities? At present, there is no organised market for unlisted securities. So it is difficult for, say, a venture fund that has invested in an unlisted company to sell the shares

as is done in the case of companies that are listed on the stock exchanges. Hence, the Over The Counter Exchange of India (OTCEI) is now planning to provide a segment which will permit trading in such securities. How would the unlisted securities trading segment help promoters and other investors? The objective to launch trading in unlisted securities segment is to provide an exit route for investments made by venture capital and private equity funds. Further, it is expected to broadbase the existing informal market in order to make it more liquid and promote organised trading in unlisted securities. It is also expected to act as a preparatory ground for an initial public offering (IPO) that may be planned for some time in the future. What are the salient features of this segment and who can participate in it? By definition, only qualified participants (QPs) can trade in this segment. Corporates including scheduled banks, venture capital funds, private equity funds or mutual funds, Unit Trust of India (UTI), state level institutions and companies wishing to make strategic investments and high net worth individuals can participate in this segment. All QPs need to have a minimum net worth of Rs 2.5 crore. How would this segment help the IPO market in India? The unlisted securities market can act as an ideal launch pad to complement the IPO market in the country. This is because it helps companies not having a track record to still access the stock market platform with limited trading facility to raise funds. This also provides an ideal exit route and opportunity for private equity and venture capital funds, thereby attracting fresh capital through such investment vehicles and at the same time preventing flight of capital. How can entrepreneurs make use of OTCEI's new listing norms to raise money from the public? Any entrepreneur who needs funds for a project has three options today. He can approach a venture capital fund, or go to a bank or financial institution, or raise money through the IPO route. Banks and financial institutions normally hesitate in financing projects if the entrepreneurs lack experience. In the absence of a healthy track record, listing norms of large stock exchanges prohibit entrepreneurs from raising money through the IPO route. The listing norms require that any company planning to raise money through an IPO needs to have a three-year profitability record. This is where the new listing norms of OTCEI come in handy. The exchange has done away with the three-year track record requirement for companies planning an

IPO. This would mean that even inexperienced entrepreneurs can raise money using the IPO route, by approaching OTCEI. What are the norms for listing of such securities? While the OTCEI has done away with the three-year track record criterion for companies planning an IPO, it has laid down stringent norms to ensure that only genuine entrepreneurs raise money from the market. The exchange will set up a high-powered panel of chartered accountants which will do the due diligence of such companies and their projects. Also, marketmaking will be mandatory for a period of 18 months at these counters. Such companies without any track record have to be introduced through a sponsor. According to the Securities and Exchange Board of India (Sebi) norms, all companies which have a paid-up capital of less than Rs 3 crore (excluding premium) have to be listed on the OTCEI. Since infotech companies generally do not require huge capital, it is expected that they would prefer What is venture capital? Venture capital is the capital provided by firms of professionals who invest alongside the management in young, rapidly growing or changing companies that have the potential for high growth. Thus, a venture capitalist (VC) may provide the seed capital for unproven ideas, products, technology-oriented or start-up firms. The VC may also invest in a firm that is unable to raise finance through the conventional means. How is it different from other forms of finance? Venture capitalists finance innovation and ideas that have a potential for high growth, but are unproven. This makes venture capital a high risk, high return investment. In addition to finance, venture capitalists also provide value-added services, and business and managerial support for realising the venture's net potential. What are the types of VCs? Generally, there are three types of organised or institutional venture capital funds: venture capital funds set up by angel investors, that is, high net worth individual investors; venture capital subsidiaries of corporations and private venture capital firms/ funds. Venture capital subsidiaries are established by major corporations, commercial bank holding companies and other financial institutions. The primary institutional source of venture capital is a venture capital firm. Venture capitalists take higher risks by investing in an early-stage company with little or no history, and they expect a higher return for their high-risk equity investment.

Which areas do venture funds prefer to invest in? Different venture groups prefer different types of investments. Some specialise in seed capital and early expansion while others focus on exit financing. Biotechnology, medical services, communications, electronic components and software companies seem to be attracting the most attention from venture firms and are receiving the most financing. In India, the software sector has been attracting a lot of venture finance. Media, health and pharmaceuticals, agribusiness and retailing are the other areas that are favoured by venture firms. How hard is it to raise institutional venture capital? Securing an investment from an institutional venture capital fund is extremely difficult. It is estimated that in the US, only five business plans in 100 are viable investment opportunities and only three in 100 result in successful financing. In fact, the odds could be as low as one in 100. More than half of the proposals to venture capitalists are usually rejected after a 20-30 minute scanning, and 25 per cent are discarded after a lengthier review. The remaining 15 per cent are looked at in more detail, but at least 10 per cent of these are dismissed due to irreconcilable flaws in the management team or the business plan. Another consideration in raising institutional venture capital is the amount of venture capital being sought. Entrepreneurs should emphasize their managerial capability, market attractiveness and cashout potential. What type of returns are expected by venture capitalists? With respect to investing in a business, institutional venture capitalists look for average returns of at least 40 per cent to 50 per cent for start-up funding. Second and later stage funding usually requires at least a 20 per cent to 40 per cent return compounded per annum. Most firms require large portions of equity in exchange for start-up financing. In calculating rates of return, many investment funds end up owning substantial amounts of company stock, which sometimes gives them equity control. The professional investor will look at the value of the company prior to investment and the investor's financial contribution when determining how much equity is necessary for the fund to receive an adequate return on investment. This issue is often the largest financing hurdle for venture funds and owners to work through. What are incubators? Incubators are mostly non-profit entities that provide value added advisory, informational and certain support infrastructure which includes productive office environment, finance and complementary resources. Incubators are mostly promoted by government or professional organisations seeking to develop small enterprises in a particular area. Some times, venture capital funds also have their own incubators and companies also set up in-house incubators. Incubators support the entrepreneur in the pre-venture capital stage, that is, when

he wants to develop the idea to a viable commercial proposition which could be financed and supported by a venture capitalist. What do venture capital firms look for? They look for a strong management team. Each member of the team must have adequate level of skills, commitment and motivation that creates a balance between members in areas such as marketing, finance and operations, research and development, general management, personnel management, and legal and tax issues. Venture capital firms look for a viable idea. They look at factors such as the market for the product or service, why customers will purchase the product, who the ultimate users are, who the competition is, and the projected growth of the industry. The firms also look at the business plan. The plan should concisely describe the nature of the business, the qualifications of the members of the management team, how well the business has performed, and business projections and forecasts. What are Z group stocks? The Bombay Stock Exchange (BSE) recently introduced a new group of shares called the Z group, in addition to the existing A, B1 and B2 groups, to separately classify errant companies. The exchange has so far shifted a total of 293 companies to the Z group from the B2 group. Why are companies being reclassified as Z group companies? The BSE's move to separately classify the companies as Z group companies is part of its "Mission 2000" plan aimed at protecting investor interests. Companies which have not complied with the clauses of the exchange listing agreement and have failed to redress investor complaints are being shifted to the group. The move is aimed at alerting prospective investors against these companies so that they desist from putting their money into stocks of these firms. What is the procedure for selecting Z group companies? As one would imagine, companies are not queuing up to be selected! More seriously, the BSE comes out with the blacklist on the basis of companies' compliance levels. That is, the exchange considers whether the companies are following its rules and regulations as stated in the listing agreement. The compliance involves payment of listing fees, timely announcement of quarterly, half-yearly and annual accounts, announcement of book closures/record dates, submission of some important documents such as annual report, shareholding pattern and so on. Redressal of investor grievances is also an important criterion for the selection of companies. Before actually shifting the companies to the Z group, the exchange sends them notices advising remedial action. If the company

does so in advance of the shifting or even later, it is allowed to stay in its group or shifted back to it, as applicable.