Securities market

Securities Market

The securities market is the market for equity, debt, and derivatives.

The debt market, in turn, may be divided into three parts, viz., the government securities market, the corporate debt market, and the money market.

The derivatives market may divided into two parts, viz., the option market and the futures market.

Financial Market

The transfer of funds between primary lenders and ultimate borrowers takes place through the creation of securities or financial assets.

If the investor deposits the money in the fixed deposit of a commercial bank, the bank issues him a fixed deposit receipt which is a financial asset.

Issue of share certificate by the company is also the example of financial asset.

Financial Market

The commodity being exchanged is a financial asset instead of a physical asset.

The lender of funds (or investor) is the buyer of the asset and the borrower of funds is the seller of the asset (or issuer of the security).

The mechanism or system through which financial assets are created and transferred is known as the financial market.

When the financial assets transferred are corporate securities and government securities, the mechanism of transfer is known as securities market.

Segments of Financial

Market Different types of securities are traded in

the securities market.

These may include ownership securities, debt securities, short-term securities, long-term securities, government securities, non-government or corporate securities.

On the basis of the maturity period of securities traded in the market, the securities market is segmented into money market and capital market.

Money Market

Money market is the market for short-term financial assets with maturities of one year or less.

Treasury bills, commercial papers, certificate of deposits, etc. are the short-term securities traded in the money market.

Money market is the main source of working capital funds for business and industry.

Money Market

The short-term requirements of

borrowers can be met by the creation of

money market securities, which can be

purchased by lenders with short-term

surpluses.

In India, the money market has a

narrow base with limited number of

participants who are mostly financial

institutions.

Capital Market

Capital market is the market segment

where securities with maturities of more

than one year are bought and sold.

Equity shares, preference shares,

debentures and bonds are the long-term

securities traded in the capital market.

The capital market is the source of

long-term funds for business and

industry.

Types of Financial Market

The financial market may be classified

as primary market or secondary market.

Primary Market: The market

mechanism for the buying and selling of

new issues of securities is known as

primary market. This market is also

termed as new issues market because it

deals in new issues of securities.

Types of Financial Market

Secondary Market: It deals with securities which have already been issued and are owned by investors, both individual and institutional.

These may be traded between investors.

The buying and selling of securities already issued and outstanding take place in stock exchanges.

Stock exchanges constitute the secondary market in securities.

Participants in the Financial

Market The major participants are the buyers and

sellers of securities or the investors and the issuers.

Financial intermediaries are the second major class of participants in the financial system.

There are two types of financial intermediaries in the financial system, namely banking financial intermediaries and non-banking financial intermediaries such as insurance companies, housing finance companies, unit trusts and investment companies.


Market

Another group of participants in the

financial system comprises the

individuals and institutions who facilitate

the trading or exchange process in the

system.


Market Stock Exchanges: A stock exchange is an

institution where securities that have already been issued are bought and sold. Presently there are 23 stock exchanges in India, the most important ones being the NSE and BSE.

Listed Securities: Securities that are listed on various stock exchanges and hence eligible for being traded there are called listed securities. Presently about 10000 securities are listed on all the stock exchanges in India put together.


Market

Depositories: A depository is an

institution which dematerializes physical

certificates and effects transfer of

ownership be electronic book entries.

Presently there are two depositories in

India, viz., the National Securities

Depository Limited (NSDL) and the

Central Securities Depository Limited

(CSDL).


Market

Brokers: Brokers are registered

members of the stock exchanges

through whom investors transact. There

are about 10000 brokers in India.

Foreign Institutional Investor (FII):

Institutional investors from abroad who

are registered with SEBI to operate in

the Indian capital market are called

foreign institutional investors.


Market

Merchant Bankers: Firms that specialize

in managing the issue of securities are

called merchant bankers. They have to

be registered with SEBI.

Primary Dealers: Appointed by the RBI,

primary dealers serve as underwriters in

the primary market and as market

makers in the secondary market for

government securities.


Market

Mutual funds: A mutual fund is a vehicle for collective investment. It pools and manages the funds of investors.

Custodians: A custodian looks after the investment back office of a mutual fund. It receives and delivers securities, collects income, distributes dividends, and segregates the assets between schemes.


Market Registrars: Also known as a transfer

agent, a registrar is employed by a company or a mutual fund to handle all investor-related services.

Underwriters: An underwriter agrees to subscribe to a given number of shares in the event the public subscription is inadequate.

Bankers to an Issue: The bankers to an issue collect money on behalf of the company from the applicants.


Market

Debenture Trustees: When debentures

are issued by a company, a debenture

trustee has to be appointed to ensure

that the borrowing firm fulfills its

contractual obligations.

Credit Rating Agencies: A credit rating

agency assigns ratings primarily to debt

securities.

Regulatory Environment

The financial system in a country is subject to a set of regulations in the form of various Acts passed by the legislative bodies.

The regulatory environment may differ from one country to another.

In India, the Ministry of Finance, the RBI, The SEBI, etc. are the major regulatory bodies exercising regulatory control and supervision over the functioning of the financial system in the country.

Regulatory Environment

The securities issued may be traded or

exchanged between investors in

securities markets with the help of

intermediaries, within the regulatory

framework approved by the Government

and other regulatory bodies.

Primary Market / New Issue

Market

New securities are directly issued by the issuing companies to the investors.

All the participants in this process of issuing new shares to investors together constitute the primary market or new issue market.

When a new company is floated, its shares are issued to the public in the primary market as an Initial Public Offer (IPO).

Primary Market / New Issue

Market

The NIM does not have a physical

structure or form.

All the agencies which provide the

facilities and participate in the process of

selling new issues to the investors

constitute the NIM.

Functions of NIM

Origination

Underwriting

Distribution

Origination

Origination is the preliminary work in connection with floatation of a new issue by a company.

It deals with assessing the feasibility of the project, technical, economic and financial, as also making all arrangements for the actual floatation of the issue.

As a part of the origination work, decisions may have to be taken on the following issues:

Origination

Time of floating the issue

Type of issue: The type of issue whether equity, preference, debentures has to be properly analyzed at the time of the origination work.

Price of the issue: The price of the security is determined by the issuer and not by the market. New issues are made either at par or at premium.

The origination function in the NIM is now being carried out by merchant bankers.

Underwriting

Underwriting is the activity of providing

a guarantee to the issuer to ensure

successful marketing of the issue.

An underwriter is an individual or

institution which gives an undertaking to

the stock issuing company to purchase

a specified number of shares of the

company in the event of a shortfall in the

subscription to the new issue.

Underwriting

Underwriting activity in the NIM is

performed by large financial institutions

such as LIC, UTI, IDBI, general

insurance companies, commercial

banks and also by brokers.

Distribution

The distribution function is carried out by brokers, sub-brokers and agents.

New issues have to be publicised by using different mass media, such as newspapers, magazines, television, radio, internet, etc.

New issues are also publicised by mass mailing.

It has become a general practice to distribute prospectus, application forms and other literature regarding new issues among the investing public.

Methods of Floating New

Issues

Public Issue

Rights Issue

Private Placement

Public Issue

It involves sale of securities to members

of the public.

The issuing company makes an offer for

sale to the public directly of a fixed

number of shares at a specific price.

The offer is made through a legal

document called prospectus.

Public issues are mostly underwritten

by strong public financial institutions.

Public Issue

This is the most popular method for

floating securities in the new issue

market.

The company has to incur expenses on

various activities such as

advertisements, printing of prospectus,

bank’s commission, underwriting

commission, agent’s fees, legal charges,

etc.

Rights Issue

The rights issue involves selling of securities to the existing shareholders in proportion to their current holding.

As per Sec.81 of the Companies Act, 1956, when a company issues additional equity capital it has offered first to the existing shareholders on pro rata basis.

It is an inexpensive method of floatation of shares as the offer is made through a formal letter to the existing shareholders.

Private Placement

A private placement is a sale of securities privately by a company to a selected group of investors.

The securities are normally placed, in a private placement, with the institutional investors, mutual funds or other financial institutions.

A formal prospectus is not necessary in the case of private placement.

Underwriting arrangements are also not required in private placement.

This method is useful to small companies.

Principal Steps in Floating a

Public Issue

Pre-issue tasks

Opening and closing of the issue

Post-issue tasks.

Pre-issue Tasks

Drafting and finalisation of the prospectus:

Prospectus is an essential document in a public issue.

The prospectus contains detailed information about the company, its activities, promoters, directors, group companies, capital structure, terms of the present issue, details of the proposed project, details regarding underwriting arrangements, etc.

The draft prospectus has to approved by the Board of Directors of the company.

The draft prospectus has also to be filed with SEBI and the Registrar of companies.

The final prospectus has to be prepared as per the suggestions of SEBI and filed with SEBI and the Registrar of companies.

Pre-issue Tasks

Selecting the intermediaries and

entering into agreements with them:

Merchant Banker

Registrar to an issue

Share transfer agent

Banker to an issue

Pre-issue Tasks

Attending to other formalities:

The prospectus and application forms

have to be printed and despatched to all

intermediaries and brokers for wide

circulation among the investing public.

An initial listing application has to be

filed with the stock exchange where the

issue is proposed to be listed.

Opening and closing of the

issue

The public issue is open for subscription by the public on the pre-announced opening date.

The application forms and application money are received at the branches of the bankers to the issue and forwarded by these bankers to the Registrar to the issue.

Two closing dates are prescribed for the closing of the public issue.

Opening and closing of the

issue

The first of these is the ‘earliest closing date’ which should not be less than three days from the opening date.

If sufficient applications are received by the company, the company may choose to close the issue on the earliest closing date itself.

The other closing date is the final or latest closing date which shall not exceed ten days from the opening date.

Post – issue Tasks

All the application forms received have

to be scrutinised, processed and

tabulated.

When the issue is not fully subscribed

to, it becomes the liability of the

underwriters to subscribe to the shortfall.

When the issue is oversubscribed, the

basis of allotment has to be decided in

consultation with the stock exchange.

Post – issue Tasks

Allotment letters and share certificates

have to be despatched to the allottees.

Refund orders have to be despatched to

the applicants whose applications are

rejected.

Shares have to be listed in the stock

exchange for trading.

Book Building

The usual procedure of a public issue is through the fixed price method where securities are offered for subscription to the public at a fixed price.

An alternative method is now available which is known as the book building process.

SEBI announced guidelines for the book building process, for the first time, in October 1995.

Book Building

Under the book building process, the issue price is not fixed in advance.

It is determined by the offer of potential investors about the price which they are willing to pay for the issue.

The price of the security is determined as the weighted average at which the majority of investors are willing to buy the security.

Under the book building process, the issue price of a security is determined by the demand and supply forces in the capital market.

Role of Primary Market

Primary market is the medium for raising fresh capital in the form of equity and debt.

It mops up resources from the public and makes them available for meeting the long-term capital requirements of corporate business and industry.

The primary market brings together the two principal constituents of the market, namely the investors and the seekers of the capital.

Role of Primary Market

Capital formation takes place in the

primary market.

The economic growth of country is

possible only through the primary

market.

Regulation of Primary

Market The issuer has to engage the services of a number

of intermediaries and comply with complex legal and other formalities.

Investors faces much risk while operating in the primary market.

Investors in the primary market need protection from fraudulent operators.

Up to 1992, the primary market was controlled by the Controller of Capital Issues (CCI) appointed under the Capital Issues Control Act, 1947.

During the period, the pricing of capital issues was regulated by CCI.


Market The Securities and Exchange Board of

India (SEBI) was formed under the SEBI

Act, 1992, with the prime objective of

protecting the interests of investors in

securities as well as for promoting and

regulating the securities market.

All public issues since January 1992 are

governed by the rules, regulations and

guidelines issued by SEBI.


Market SEBI has been instrumental in bringing

greater transparency in capital issues.

It has issued detailed guidelines to standardise disclosure obligations of companies issuing securities.

Companies floating public issues are now required to disclose all relevant information affecting investor’s interests.

SEBI constantly reviews its guidelines to make them more market friendly and investor friendly.

Stock Exchange

Secondary market is the market in which securities already issued by companies are subsequently traded among investors.

The secondary market where continuous trading in securities takes place is the stock exchange.

The stock exchange were once physical market places where the agents of buyers and sellers operated through the auction process.

Stock Exchange

These are being replaced with electronic exchanges where buyers and sellers are connected only by computers over a telecommunications network.

Auction trading is giving way to “screen-based” trading where bid prices and offer prices (or ask prices) are displayed on the computer screen.

Bid price refers to the price at which an investor is willing to buy the security.

Offer price refers to the price at which an investor is willing to sell the security.

Stock Exchange

The bid-offer spread, the difference between the bid price and the offer price constitutes his margin or profit.

“ Stock exchange is a centralized market for buying and selling stocks where the price is determined through supply-demand mechanisms”.

“ Stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities”.

Functions of Stock

Exchanges Maintains active trading: Shares are traded on the

stock exchanges, enabling the investors to buy and sell securities. 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.

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.

Functions of Stock

Exchanges Aids in financing the industry: A continuous

market for shares provides a favourable climate for raising capital.

Dissemination of information: Stock exchanges provide information through their various publications.

Performance inducer: The prices of stocks reflect the performance of the traded companies.

Self-regulating organisation: The stock exchanges monitor the integrity of the members, brokers, listed companies and clients.

Stock Exchanges in India

The origin of the stock exchanges in

India can be traced back to the later half

of 19th century.

An important early event in the

development of the stock market in India

was the formation of the Native Share

and Stock broker’s Association at

Bombay in 1875, the precursor of the

present day Bombay Stock Exchange.


This was followed by the formation of associations/exchanges in Ahmedabad (1894), Calcutta (1908), and Madras (1937).

In order to check development of the stock market, the central government introduced a legislation called the Securities Contracts (Regulation) Act, 1956.

Under this legislation, it is mandatory on the part of a stock exchange to seek governmental recognition.


At present there were 23 stock exchanges recognised by the central government.

They are located at Ahmedabad, Bangalore, Baroda, Bhubaneshwar, Calcutta, Chennai (the Madras Stock Exchange), Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana, Mangalore, Mumbai (The Bombay Stock Exchange), Mumbai (the National Stock Exchange), Mumbai (OTC Exchanges of India), Patna, Pune, and Rajkot.

The Bombay Stock Exchange

(BSE) The BSE is established in 1875.

It is one of the oldest organised exchanges in the world.

The BSE switched from the open outcry system to the screen-based system in 1995 which is called BOLT (BSE On Line Trading)

To begin with, BOLT was a ‘quote-driven’ as well as an ‘order-driven’ system, with jobbers (specialists) feeding two-way quotes and brokers feeding buy or sell orders.

The Bombay Stock Exchange

(BSE)

In October 1996 SEBI permitted BSE to

extend its BOLT network outside

Mumbai.

The capacity of the Tandem hardware

of BOLT is 5, 00,000 trades per day.

In 2002, subsidiary companies of 13

regional exchanges became members

of BSE .

The National Stock Exchange

(NSE) The NSE is inaugurated in 1994.

It seeks to (a) establish a nation-wide trading facility for equities, debt and hybrids,

(b) facilitate equal access to investors across the country,

© impart fairness, efficiency, and transparency to transactions in securities,

(d) shorten settlement cycle, and

(e) meet international securities market standards.


(NSE) The NSE is a national, computerised

exchange.

The NSE has two segments: the Capital Market segment and the Wholesale Debt Market segment.

The capital market segment covers equities, convertible debentures, and retail trade in non-convertible debentures.

The Wholesale debt market segment is a market for a high value transactions in government securities, PSU bonds, commercial papers, and other debt instruments.


(NSE) The trading members in the capital market

segment are connected to the central computer in Mumbai through a satellite link-up, using VSATs (Very Small Aperture Terminals).

NSE is the first exchange in the world to employ the satellite technology.

The NSE has opted for an order-driven system.

When a trade takes place, a trade confirmation slip is printed at the trading member’s work station. It gives details like quantity, price, code number of counterparty, and so on.


(NSE)

Members are required to deliver

securities and cash by a certain day.

The payout day is the following day.

All trades on NSE are guaranteed by

the National Securities Clearing

Corporation (NSCC).

Inter-connected Stock

Exchange of India (ISE)

For the purpose of compete with the NSE

and BSE, the 14 regional stock exchanges

( excluding Calcutta, Delhi, Ahmedabad,

Ludhiana and Pune stock exchanges)

joined together and promoted a new

organisation called Inter-connected Stock

Exchange of India Ltd., (ISE) in 1998.

The ISE was recognised as a stock

exchange by SEBI and it commenced

trading in February, 1999.

Inter-connected Stock

Exchange of India (ISE) The objective of setting up ISE was to

optimally utilize the existing infrastructure and other resources of participating stock exchanges.

The ISE aims to provide cost-effective trading/connectivity to all the members of the participating exchanges on a national level.

The trading settlement and funds transfer operations of the ISE are completely automated.

However, ISE has not succeeded in becoming a competitive market force to BSE and NSE.

Over the Counter Exchange of

India (OTCEI) Over the Counter Exchange of India was

started in 1992 after the role models of NASDAQ ( National Association of Securities Dealers Automated Quotation) and JASDAQ (Japanese Association of Securities Dealers Automated Quotation).

The OTCEI was started with the objective of providing a market for the smaller companies that could not afford the listing fees of the of the large exchanges and did not fulfill the minimum capital requirement for listing.


India (OTCEI) It was sponsored by the country’s premier

financial institutions such as UTI, ICICI,IDBI, SBI Capital Markets , IFCI, GIC and its subsidiaries and canbank Financial services.

The exchange was set up to aid enterprising promoters in raising finance for new projects in a cost effective manner.

It introduced screen based trading for the first time in the Indian stock market.


India (OTCEI)

Trading takes place through a network of computers of over the counter (OTC) dealers located at several places, linked to a central OTC computer using telecommunication links.

It was the first exchange in the country to introduce the practice of market making, that is , dealers in securities providing two-way quotes (bid prices and offer prices of securities)

Regulations of Stock

Exchanges

There are Acts, rules, regulations, by-

laws and guidelines governing the

functioning of secondary markets or

stock exchanges in the country.

There is also a regulator in the form of

the Securities and Exchange Board of

India (SEBI) to oversee and monitor the

functioning of both the primary and

secondary securities market in India.


Exchanges The Securities Contracts (Regulation) Act,

1956, and the rules made under the Act, namely the Securities Contracts (Regulation) Rules, 1957, constitute the main laws governing stock exchanges in India.

This Act provides for the direct and indirect control of virtually all aspects of securities trading and the functioning of stock exchanges.

The provisions of the Securities contracts (Regulation) Act, 1956, were administered by the Central Government.


Exchanges The Securities and Exchange Board of

India was constituted as an interim administrative body in 1988.

SEBI was given a statutory status on 30th

January 1992.

In April 1992, the SEBI Act was passed.

In this Act it is stipulated that it shall be the duty of the Board to protect the interests of investors in the securities market and to promote the development of and to regulate the securities market.


Exchanges The Board plays a dual role, namely a

regulatory role and a developmental role.

The SEBI is constituted with six members, including the chairman of the Board.

Two members are officials of the central government ministries of finance and law.

One member is an official of the RBI

Two members are professionals having experience or special knowledge relating to securities market and are appointed by the central government.


Exchanges The Board is empowered to regulate the

business in stock exchanges, to register and regulate the working of stock market intermediaries.

The Board is also authorised to prevent and prohibit fraudulent and unfair trade practices in the market.

Transparency and equal opportunity to all market participants have been the goals of all developmental and regulatory activities of SEBI.


Exchanges A stock exchange has the power to make

by-laws for the regulation and control of contracts entered into by members.

The Depositories Act, 1996 is another important legislation affecting the functioning of stock exchanges.

The Depositories Act, 1996, was passed to change over to the electronic mode of security transfer through security depositories.

Trading System in Stock

Exchanges Trading System: The system of trading prevailing in

stock exchanges for many years was known as floor trading.

In this system, trading took place through an open outcry system on the trading floor or ring of the exchange during official trading hours.

Floor Trading: In floor trading, buyers and sellers transact business face to face using a variety of signals.

Under this system, an investor desirous of buying a security gets in touch with a broker and places a buy order along with the money to buy the security. Similarly the investor sells his shares.


Exchanges Screen based trading: In the new electronic

stock exchanges, which have a fully automated computerised mode of trading, floor trading is replaced with a new system of trading known as screen-based trading.

In this system the distant participants can trade with each other through the computer network.

The screen-based trading systems are of two types.

1. Quote driven system

2. Order driven system


Exchanges Quote driven system: Under this system, the

market-maker, who is the dealer in a particular security, inputs two-way quotes into the system, that is, his bid price (buying price) and offer price (selling price).

The market participants then place their orders based on the bid-offer quotes.

These are then automatically matched by the system according to certain rules.

Order driven system: Under this system, clients place their buy and sell orders with the brokers.

These are then fed into the system. The buy and sell orders are automatically matched by the system according to predetermined rules.

Types of orders

Market Orders

Limit Orders

Stop Orders

Stop Limit Orders

Day Orders

Week Orders

Month Orders

Open Orders

Fill or Kill Orders

Market Orders

In a market order, the broker is

instructed by the investor to buy or sell a

stated number of shares immediately at

the best prevailing price in the market.

In the case of a buy order, the best

price is the lowest price obtainable.

In the case of a sell order, it is the

highest price obtainable.

Limit Orders

While placing a limit order, the investor specifies in advance the limit price at which he wants the transaction to be carried out.

In the case of a limit order to buy, the investor specifies the maximum price that he will pay for the share; the order has to be executed only at the limit price or a lower price.

In the case of a limit order to sell shares, the investor specifies the minimum price he will accept for the share; the order has to be executed only at the limit price or price higher to it.

Stop Orders

A stop order may be used by an investor to protect a profit or limit a loss.

For a stop order, the investor must specify what is known as a stop price.

If it is a sell order, the stop price must be below the market price prevailing at the time the order is placed.

If it is a buy order, the stop price must be above the market price prevailing at the time of placing order.

Stop Limit Orders

The stop limit order is a special type of

order designed to overcome the

uncertainty of the execution price

associated with a stop order.

The stop limit order gives the investor

the opportunity of specifying a limit price

for executing the stop orders; the

maximum price for a stop buy order and

minimum price for a stop sell order.

Stop Limit Orders

With a stop limit order, the investor

specifies two prices, a stop price and a

limit price.

Day Orders

A day order is an order that is valid only

for the trading day on which the order is

placed.

If the order is not executed by the end

of the day, it is treated as cancelled.

Week order

These are orders that are valid till the

end of the week during which the orders

are placed.

The expire at the close of the trading

session on Friday of the week.

Month orders

These are orders that are valid till the

end of the month during which the

orders are placed.

Month orders expire at the close of the

trading session on the last working day

of the month.

Open Orders

Open orders are orders that remain

valid till they are executed by the

brokers or specifically cancelled by the

investor

Fill or Kill Orders

These orders are also known as FoK

orders.

These orders are meant to be executed

immediately. If not executed

immediately, they are to be treated as

cancelled.

Education

Securities market