Final project on Capital Market

Executive Summary
The project on capital study is an attempt to study an overall primary market and secondary
market in India. It’s helped to know and study the parameters opted by all the capital market and
the companies who are operating themselves under the rules and regulation of capital market.
The performance of capital market has registered a significant upward in recent times right from
the beginning capital market attract every person as it has become common to see car on road
every day and being a student of Finance I learned a lot from this project and it would help me a
lot in making my career. I come to know a lot about Indian as well as international capital market
and how they help there economy. The market for long term securities like Bonds, Equity stock
and Preferred stock is divided into primary and secondary market. The primary market deals
with the new issue of securities. Outstanding securities are traded in the secondary market or
stock exchange. In the secondary market the investor can sell and buy securities.
Stock market predominantly deals in the equity shares debts instrument like bonds and debenture
are also traded in the stock market. Well regulated and active stock market promotes capital
formation. Growth of the primary market depends on the secondary market. The health of the
economy is reflected by the growth of the stock market. Company raises funds to finance the
project to various methods. The promoters can bring the own money or borrow from the
financial institution or mobilize capital by issuing securities. The funds may be raise from issue
of fresh share at par, or at premium preference shares debentures or global depository receipts.
The main objectives of a capital issue are given below: -
 To promote a new company
 To expand an existing company
 To diversify the production
 To meet the regular working capital requirements
 To capitalize the reverses
Securities market provides a channel of allocation of saving to those who have productiveness in
them. As a results the savers and investors are not constrained by their individualities but by the
economy’s ability to invest and save respectively, which inevitably enhance saving and
enhancement in the economy. The national stock exchange of India ltd (NSE) has genesis the
report of the high powered study group on establishment of new stock exchanges, which
recommended promotion of a national stock exchange by financial institution to provide access
to investors from all across the country on an equal footing, based on the recommendation, NSE
was promoted by leading financial institution at the behest of the government of India and was
incorporated in November 1992 as a tax paying company unlike other stock exchange in the
country.
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UNIT- I
Introduction:
 Concept of capital market.
 Structure of capital market.
 Present face of capital market.
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CONCEPT OF CAPITAL MARKET
The past decade in many ways has been remarkable for securities market in India. It has grown
exponentially as measured in terms of amount raised from the market, number stock exchange
and other intermediaries and the number of listed stocks, market capitalization, trading volumes
and turnover on stock exchanges, and investor population.
Along with this growth, the profiles of the investors, issuers and intermediaries have changed
significantly. The market has witnessed several institutional changes resulting in drastic
reduction in transaction cost and sufficient improvement in efficiency, transparency, liquidity
and safety. In a short span of time, Indian derivatives market has got a place in list of top global
exchanges.
INTRODUCTION
The market for longterm securities like bonds, equity stocks and preferred stocks is divided into
primary market and secondary market. The primary market deals with the new issues of
securities. Outstanding securities are traded in the secondary market, which is commonly known
as stock market or stock exchange. In the secondary market, the investors can sell and buy
securities. Stock markets predominantly deal in the equity shares.
Debt instruments like bonds and debentures are also traded in the stock market. Well-
regulated and active stock market promotes capital formation. Growth of the primary market
depends on the secondary market. The health of the economy is reflected by the growth of the
stock market. Companies raise funds to finance their projects through various methods.
The promoters can bring their own money or borrow from the financial institutions or mobilize
capital by issuing securities. The funds may be raised through issue of fresh shares at par or
premium, preference shares, debentures or global depository receipts. The main objectives of a
capital issue are given below:
 To promote a new company
 To expand an existing company
 To diversify the production
 To meet the regular working capital requirements
 To capitalize the reverses
Securities markets provide a channel for allocation of savings to those who have a productive
need for them. As a result, the savers and investors are not constrained by their individual
abilities, but by the economy’s abilities to invest and save respectively, which inevitably
enhances savings and investment in the economy.
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MARKET SEGMENTS
The securities market has two interdependent and inseparable segments: the primary and the
secondary market. The primary market provides the channel for creation of new securities
through issuance of financial instruments by public companies as well as Governments and
Government agencies and bodies whereas the secondary market helps the holders of these
financial instruments to sale for exiting from the investment. The price signals, which subsume
all information about the issuer and his business including associated risk, generated in the
secondary market, help the primary market in allocation of funds. The primary market issuance
is done either through public issues or private placement.
A public issue does not limit any entity in investing while in private placement, the issuance is
done to select people. In terms of the Companies Act, 1956, an issue becomes public if it results
in allotment to more than 50 persons. This means an issue resulting in allotment to less than 50
persons is private placement.
There are two major types of issuers who issue securities. The corporate entities issue
mainly debt and equity instruments (shares, debentures, etc.), while the governments (central and
state governments) issue debt securities (dated securities, treasury bills). The secondary market
enables participants who hold securities to adjust their holdings in response to changes in their
assessment of risk and return. They also sell securities for cash to meet their liquidity needs.
The exchanges do not provide facility for spot trades in a strict sense. Closest to spot market is
the cash market in exchanges where settlement takes place after some time. Trades taking place
over a trading cycle (one day under rolling settlement) are settled together after a certain time.
All the 23 stock exchanges in the country provide facilities for trading of corporate securities.
Trades executed on NSE only are cleared and settled by a clearing corporation which provides
novation and settlement guarantee.
Nearly 100% of the trades in capital market segment are settled through demat delivery. NSE
also provides a formal trading platform for trading of a wide range of debt securities including
government securities in both retail and wholesale mode. NSE also provides trading in
derivatives of equities, interest rate as well indices.
In derivatives market (F&O market segment of NSE), standardized contracts are traded
for future settlement. These futures can be on a basket of securities like an index or an individual
security. In case of options, securities are traded for conditional future delivery. There are two
types of options – a put option permits the owner to sell a security to the writer of options at a
predetermined price while a call option permits the owner to purchase a security from the writer
of the option at a predetermined price. These options can also been individual stocks or basket of
stocks like index. Two exchanges, namely NSE and the Stock Exchange, Mumbai (BSE) provide
trading of derivatives of securities.
Today the market participants have the flexibility of choosing from a basket of products like:
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 Equities
 Bonds issued by both Government and Companies
 Futures on benchmark indices as well as stocks
 Options on benchmark indices as well as stocks
 Futures on interest rate products like Notional 91-day T-Bills, 10 year notional zero.
Reforms in the securities market, particularly the establishment and empowerment of SEBI,
market determined allocation of resources, screen based nation-wide trading, dematerialization
and electronic transfer of securities, rolling settlement and ban ondeferral products, sophisticated
risk management and derivatives trading, have greatly improved the regulatory framework
and efficiency of trading and settlement. Indian market is now comparable to many developed
markets in terms of a number of qualitative parameters.
PRODUCTS AND PARTICIPANTS
Financial markets facilitate the reallocation of savings from savers to entrepreneurs Savings are
linked to investments by a variety of intermediaries through a range of complex financial
products called “securities” which is defined in the Securities Contracts (Regulation) Act, 1956
to include shares, bonds, scrip’s, stocks or other marketable securities of like nature in or of
any incorporate company or body corporate, government securities, derivatives of securities,
units of collective investment scheme, interest and rights in securities, security receipt
or any other instruments so declared by the central government.
It is not that the users and suppliers of funds meet each other and exchange funds for securities. It is
difficult to accomplish such double coincidence of wants. The amount of funds supplied by the
supplier may not be the amount needed by the user. Similarly, the risk, liquidity and maturity
characteristics of the securities issued by the issuer may not match preference of the supplier. In
such cases, they incur substantial search costs to find each other. Search costs are minimized by
the intermediaries who match and bring the suppliers and users of funds together. These
intermediaries may act as agents to match the needs of users and suppliers of funds for a
commission, help suppliers and users in creation and sale of securities for a fee or buy the
securities issued by users and in turn, sell their own securities to suppliers to book profit. It is,
thus, a misnomer that securities market disintermediates by establishing a direct relationship
between the savers and the users of funds.
The market does not work in a vacuum; it requires services of a large variety of intermediaries.
The disintermediation in the securities market is in fact an intermediation with a difference; it is
a risk-less intermediation, where the ultimate risks are borne by the savers and not the
intermediaries. A large variety and number of intermediary’s provide intermediation services
in the Indian securities market. The securities market has essentially three categories of
participants, namely the issuers of securities, investor’s insecurities and the intermediaries and
products include equities, bonds and derivatives. The issuers and investors are the consumers of
services rendered by the intermediaries while the investors are consumers (they subscribe for and
trade in securities) of securities issued by issuers.
DEPENDENCE CAPITAL MARKET
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Three main sets of entities depend on securities market. While the corporates and governments
raise resources from the securities market to meet their obligations, the households invest
their savings in the securities.
Corporate Sector
The 1990s witnessed emergence of the securities market as a major source of finance for trade
and industry. A growing number of companies are accessing the securities market rather than
depending on loans from FIs/banks. The corporate sector is increasingly depending on external
sources for meeting its funding requirements. There appears to be growing preference for direct
financing (equity and debt) to indirect financing (bank loan) within the external sources,
According to CMIE data, the share of capital market based instruments in resources raised
externally increased to 53% in 1993-94, but declined thereafter to 33% by 1999-00 and further to
21% in 2001-02. In the sector-wise shareholding pattern of companies listed on NSE, it is
observed that on an average the promoters hold more than 55% of total shares. Though
the non- promoter holding is about 44%, Indian public held only 17% and the public float
(holding by FIIs, MFs, Indian public) is at best 25%.
There is not much difference in the shareholding pattern of companies in different sectors.
Strangely, 63% of shares in companies in media and entertainment sector are held by private
corporate bodies though the requirement of public offer was relaxed to 10% for them.
The promoter holding is not strikingly high in respect of companies in the IT and telecom sectors
where similar relaxation was granted.
Governments
Along with increase in fiscal deficits of the governments, the dependence on market borrowings
to finance fiscal deficits has increased over the years. During the year 1990-91, the state
governments and the central government financed nearly 14% and 18% respectively of
their fiscal deficit by market borrowing. In percentage terms, dependence of the state
government’s on market borrowing did not increase much during the decade 1991-2001. In case
of central government, it increased to 77.6% by 2002-03.
Households
According to RBI data, household sector accounted for 82.4% of gross domestic savings
during2001-02. They invested 38% of financial savings in deposits, 33% in insurance/provident
funds,11% on small savings, and 8% in securities, including government securities and units of
mutual funds during 2001- 02. Thus the fixed income bearing instruments are the most preferred
assets of the household sector. Their share in total financial savings of the household sector
witnessed an increasing trend in the recent past and is estimated at 82.4% in 2001- 02.
In contrast, the share of financial savings of the household sector in securities (shares,
debentures, public sector bonds and units of UTI and other mutual funds and
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government securities) is estimated to have gone down from 22.9% in 1991-92 to
4.3% in 2000-01, which increased to 8% in 2001-02.
Investor Population
The Society for Capital Market Research and Development carries out periodical
surveys of household investors to estimate the number of investors. Their first
survey carried out in 1990 placed the total number of share owners at 90-100
lakh. Their second survey estimated the number of share owners at around 140-150
lakh as of mid-1993
CAPITALMARKETATAGLANCE
Primary market
Stocks available for the first time are offered through new issue market. The issuer may be new
company. These issues may be of new type or the security used in the past. In the
new issue market the issuer can be considered as a manufacturer. The
issuing houses investment bankers and brokers act as the channel of distribution for the new
issues. They take the responsibility of selling the stocks to the public. A total of Rs. 2,520,179
million were raised by the government and corporate sector during 2002-03 as against
Rs. 2,269,110 million during the preceding year. Government raised about two third
of the total resources, with central government alone raising nearly Rs.1, 511,260
million. Corporate Securities Average annual capital mobilization from the primary
market, which used to be aboutRs.70 crore in the 1960s and about Rs.90 crore in the 1970s,
increased manifold during the1980s, with the amount raised in 1990-91 being Rs. 4,312 crore. It
received a further boostduring the 1990s with the capital raised by non-
government public companies rising sharply to Rs. 26,417 crore in 1994-95. The
capital raised which used to be less than 1% of gross domestic saving (GDS) in the 1970s
increased to about 13% in 1992-93. In real terms, the capital raised increased 4 times
between 1990-91 and 1994-95. During 1994-95, the amount raised through new
issues of securities from the securities market accounted for about four-fifth of the
disbursements by FIs. Issuers have shifted focus to other avenues for raising resources like
private placement.
There is a preference for raising resources in the primary market through private placement of
debt instruments. Private placements accounted for about 93% of totalresources mobilized
through domestic issues by the corporate sector during 2002-03. Rapid dismantling of
shackles on institutional investments and deregulation of the economy are driving
growth of this segment. There are several inherent advantages of relying on private placement
route for raising resources. While it is cost and time effective method of raising funds and can
be structured to meet the needs of the entrepreneurs, it does not require detailed
compliance with formalities as required in public or rights issues. It is believed in some circles
that private placement has crowded out public issues. However, to prevent public
issues from being passed on as private placement, the Companies (Amendment) Act, 2001
considers offer of securities to more than 50 persons as made to public. Indian market is getting
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integrated with the global market though in a limited way through euro issues. Since 1992,
when they were permitted access, Indian companies have raised about Rs. 34,264
million through ADRs/GDRs. By the end of March 2003, 502 FIIs were registered
with SEBI. They had net cumulative investments over of US $ 15.8 billion by the
end of March 2003. Their operations influence the market as they do delivery-based business and
their knowledge of market is considered superior. The market is getting
institutionalized as people prefer mutual funds as their investment vehicle, thanks toevolution of
a regulatory framework for mutual funds, tax concessions offered bygovernment and preference
of investors for passive investing. The net collections by MFs picked up during this
decade and increased to Rs. 199,530 million during 1999-00. This declined to Rs.
111,350 million during 2000-01 which may be attributed to increase in rate of tax on income
distributed by debt oriented mutual funds and lackluster secondary market.
The total collection of mutual funds for 2002-03 has been Rs. 105,378 million. Starting with an
asset base of Rs. 250 million in 1964, the total assets under management at the end
of March 2003 was Rs. 794,640 million. The number of households owning
units of MFs exceeds the number of households owning equity and debentures. At
the end of financial year March 2003, according to a SEBI press release 23 million unit
holders had invested in units of MFs, while 16 million individual investors invested in equity and
or debentures.
Government Securities
The primary issues of the Central Government have increased many-fold during thedecade of
1990s from Rs. 89,890 million in 1990-91 to Rs. 1,511,260 million in 2002-03. The issues by
state governments increased by about twelve times from Rs. 25,690 million to Rs.308,530
million during the same period. The Central Government mobilized Rs. 1,250,000million
through issue of dated securities and Rs. 261,260 million through issue of T-bills.
After meeting repayment liabilities of Rs. 274,200 million for dated securities, andredemption of
T-bills of Rs. 195,880 million, and net market borrowing of Central Government amounted to
Rs. 1,041,180 million for the year 2002-03. The state government’s collectively raised Rs.
305,830 million during 2002-03 as against Rs. 187,070 million in the preceding year. The net
borrowings of State Governments in 2002-03 amounted to Rs. 290,640million. Along with
growth of the market, the investor base has become very wide.
Inaddition to banks and insurance companies, corporates and individual investors are investing
in government securities. With dismantling of control regime, and gradual lowering of the SLR
and CRR, Government is borrowing at near–market rates. The coupons across maturities went
down recently signifying lower interest rates. The weighted average cost of its borrowing at one
stage increased to 13.75% in 1995- 96, which declined to 7.34% in 2002-03. The maturity
structure of government debt is also changing. In view of bunching of redemption liabilities in
the medium term, securities with higher maturities were issued during 2002-03. About 64% of
primary issues were raised through securities with maturities above 5 years and up to 10 years.
As a result the weighted average maturity of dated securities increased to 13.83 years from 6.6
years in 1997-98.
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Relationship between the Primary and Secondary Market
1 . The new issues market cannot function without the secondary market. The secondary
market or the stock market provides liquidity for the issued securities. The issued securities are
traded in the secondary market offering liquidity to the stocks at affair price.
2. The stock exchanges through their listing requirements, exercise control over the primary
market. The company seeking for listing on the respective stock exchange has to comply with all
the rules and regulations given by the stock exchange.
3. The primary market provides a direct link between the prospective investors and the company.
By providing liquidity and safety, the stock markets encourage the public to subscribe to the new
issues. The marketability and the capital appreciation provided in the stock market are the major
factors that attract the investing public towards the stock market. Thus, it provides an indirect
link between the savers and the company.
4. Even though they are complementary to each other, their functions and the organizational set
up are different from each other. The health of the primary market depends on the secondary
market and vice versa.
Functions of Primary Market
The main service functions of the primary market are organization, underwriting and
distribution. Origination deals with the origin of the new issue. The proposal is analyzed in terms
of the nature of the security, the size of the issue, and timing of the issue and floatation method
of the issue. Underwriting contract makes the share predictable and removes the element of
uncertainty in the subscription. Distribution refers to the lead managers and brokers to the issue.
In the new issue market stocks are offered for the first time. The functions and the organization
of the new issue market are different from the secondary market.
In the new issue the lead managers manage the issue, the under writers assure to take up the
unsubscribed portion according to his commitment for a commission and the bankers take up the
responsibility of the collecting the application form and the money. Advertising agencies
promote the new issue through advertising. Financial institutions and underwriter lend term loans
to the company. Government agencies regulate the issue. The new issues are offered through
prospectus. The prospectus is drafted according to SEBI guidelines disclosing the needed
information to the investing public. In the bought out deal banks or accompany buys the
promoters shares and they offer them to the public at a later date. This reduces the cost of raising
the fund. Private placement means placing of the issue with financial institutions. They sell
shares to the investors at a suitable price. Right issue means the allotment of shares to the
previous shareholders at a pro-ratio basis. Book building involves firm allotment of the
instrument to a syndicate created by the lead managers.
Thebook runner manages the issue. Norms are given by the SEBI to price the issue.Proportionate
allotment method is adopted in the allocation of shares. Project appraisal, disclosure in the
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prospectus and clearance of the prospectus by the stock exchanges protect the investors in the
primary market along with the active role played by the SEBI.
Secondary market
The market for long-term securities like bonds, equity stocks and preferred stocks is divided into
primary market and secondary market. The primary market deals with the new issues of
securities. Outstanding securities are traded in the secondary market, which is commonly known
as stock market or stock exchange. In the secondary market, the investors can sell and buy
securities. Stock markets predominantly deal in the equity shares. Debt instruments like bonds
and debentures are also traded in the stock market.
Well-regulated and active stock market promotes capital formation. Growth of the primary
market depends on the secondary market. The health of the economy is reflected by the growth
of the stock market.
Corporate Securities the number of stock exchanges increased from 11 in 1990 to 23 now. All
the exchanges are fully computerized and offer 100% on-line trading. 9,413 companies were
available for trading on stock exchanges at the end of March 2003. The trading platform of the
stock exchanges was accessible to 9,519 members from over 358 cities on the same date. The
market capitalization grew tenfold between 1990-91 and 1999-00. It increased by 221% during
1991-92 and by 107% during 1999-00. All India market capitalization is estimated at Rs.
6,319,212 million at the end of March 2003. The market capitalization ratio, which indicates
the size of the market, increased sharply to 57.4% in 1991-92following spurt in share prices. The
ratio further increased to 85% by March 2000. It, however, declined to 55% at the end of March
2001 and to 29% by end March 2003.The trading volumes on exchanges have been witnessing
phenomenal growth during the1990s. The average daily turnover grew from about Rs.1500
million in 1990 to Rs. 120,000 million in 2000, peaking at over Rs. 200,000 million. One-sided
turnover on all stock exchanges exceeded Rs. 10,000,000 million during 1998-99, Rs.
20,000,000 million during 1999-00 and approached Rs. 30,000,000 million during 2000-01.
However, the trading volume substantially depleted to Rs.9, 689,541 million in 2002-03. The
turnover ratio, which reflects the volume of trading in relation to the size of the market, has been
increasing by leaps and bounds after the advent of screen based trading system by the NSE. The
turnover ratio for the year 2002-03 increased to 375 but fell substantially due to bad market
conditions to 119 during 2001-02 regaining its position accounted 153.3% in 2002-03.
The relative importance of various stock exchanges in the market has undergone dramatic
change during this decade. The increase in turnover took place mostly at the large big exchanges
and it was partly at the cost of small exchanges that failed to keep pace with the changes. NSE is
the market leader with more 85% of total turnover (volumes on all segments) in 2002-03. Top 5
stock exchanges accounted for 99.88% of turnover, while the rest 18 exchange for less than
0.12% during 2002-03. About ten exchanges reported nil turnovers during the year.
Role of the Secondary
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Market when company management has different objectives than its outside investors, "agency
“and "information" problems may result. For example, management may exert less than optimal
effort, may pursue goals that simply enhance its own power and control, or may squander or
divert company resources. In addition, to the extent that management is better informed than
outside investors about the company's financial situation, this creates an informational
asymmetry.
This, in turn, may result in management being unable to convince its outside investors of the true
value of the company as well as of management’s intentions. As a consequence, management
also may find that it is not able to raise as much capital as it wants or needs to finance new
projects, or that management may have to surrender too much of the value of the firm to raise
the capital it wants or needs.
"Governance" refers to the various mechanisms that exist to mitigate these agency and
information problems. These mechanisms are numerous, some involving capital markets (e.g.,
facilitation of corporate control via takeover) while others do not, at least not directly (e.g., the
role of the board of directors as a monitoring device). These major mechanisms will be
discussed. We use the term "market-based governance" to refer to the role of capital markets in
alleviating the agency and information problems, by functioning as an
effective conduit for monitoring and controlling management's sub optimal behavior. Market-
based governance may take different forms. However, generally speaking, such governance takes
the form of facilitating the monitoring of management by outsiders, and aggregating information
—in the form of equilibrium prices (or price discovery)—to help guide management decisions
within the firm.
Monitoring and Control
As noted, secondary equity markets serve as a conduit for monitoring and controlling
management by outsiders. First, markets generate information that helps outside investors
Evaluate the quality of past management decisions. Second, the threat of a takeover may mitigate
management inefficiencies. Third, information on stock-market prices provides for
effective incentives for management.
And fourth, the rich menu of contracts provided in the market allows private workouts of
financial distress, easing the transfer of control.
• For purposes of our analysis below, we have divided monitoring into two categories
• Market-based monitoring
• Non market-based monitoring. Market-Based Monitoring. 1 Active Shareholders: The
secondary equity market can facilitate effective monitoring by providing the ability to
build positions so as to influence management decisions in situations where a change in
corporate policies could increase a firm's value.
II. 2 Financial intermediaries as delegated monitors:
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Banks closely monitor their business borrowers, and collect information and scrutinize major
investment and financing decisions. In doing so, they can threaten to withhold financing should
management act in a manner contrary to the banks' interests. Monitoring via business groups in
some countries, such as Japan and Korea, corporate actions are coordinated within a family of
interrelated firms, with a main bank at the center. Firms in the group are interconnected through
intricate vertical and horizontal business relationships and cross-ownership.
Members of the business group, with the lead participation of the main bank, closely monitor
the actions of a member firm's management.
The Legal System:
The four main legislations governing the securities market are: (a) the SEBI Act, 1992which
establishes SEBI to protect investors and develop and regulate securities market; (b)the
Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to
issue, allotment and transfer of securities, and disclosures to be made in public issues; (c) the
Securities Contracts (Regulation) Act, 1956, which provides for regulation of transactions in
securities through control over stock exchanges; and (d) the Depositories Act, 1996 which
provides for electronic maintenance and transfer of ownership of demat securities. Government
has framed rules under the SCRA, SEBI Act and the Depositories Act. SEBI has
framed regulations under the SEBI Act and the Depositories Act for registration and regulation
of all market intermediaries, and for prevention of unfair trade practices, insider trading, etc.
Under these Acts, Government and SEBI issue notifications, guidelines, and circulars which
need to be complied with by market participants. The SROs like stock exchanges have also laid
down their rules of game.
The responsibility for regulating the securities market is shared by Department of Economic Affa
irs (DEA), Department of Company Affairs (DCA), Reserve Bank of India (RBI) and SEBI.
The activities of these agencies are coordinated by the High Level Committee on Capital
Markets. Most of the powers under the SCRA are exercisable by DEA while a few others by
SEBI. The powers of the DEA under the SCRA are also con-currently exercised by SEBI. The
powers in respect of the contracts for sale and purchase of securities, gold related securities,
money market securities and securities derived from these securities and ready forward contracts
in debt securities are exercised concurrently by RBI. The SEBI Act and the Depositories Act are
mostly administered by SEBI. The rules and regulations under the securities laws are
administered by SEBI. The power sunder the Companies Act relating to issue and transfer of
securities and non-payment of dividend are administered by SEBI in case of listed public
companies and public companies proposing to get their securities listed. The SROs ensure
compliance with their own rules as well as with the rules. The legal system governs both the
rights of management and the rights of investors. The legal system also specifies the recourse
available to investors. Recent research indicates that countries vary in the level of protection
afforded to minority shareholders (LaPorta et al, 1996). Generally, countries with common-law
traditions afford the highest protection, while civil-law countries, particularly the French civil-
law systems, provide the least amount of protection.
Functions of Stock Exchange
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• Maintains active trading: Shares are traded on the stock exchanges, enabling the investors
to buy and sell securities. The prices may vary from transactions to transaction.
• A continuous trading increases the liquidity or marketability of the shares traded on the
stock exchanges.
• Fixation of prices: Price is determined by the transactions that flow from investors
‘demand and suppliers’ preferences. Usually the traded prices are made known to the
public. This helps the investors to make better decisions.
• Ensures safe and fair dealing: The rules, regulations and by-laws of the stock exchanges’
provide a measure of safety to the investors. Transactions are conducted under
competitive conditions enabling the investors to get a fair deal.
• Aids in financing the industry: A continuous market for shares provides a favorable
climate for raising capital. The negotiability and transferability of the securities helps the
companies to raise long-term funds. When it is easy to trade the securities, investors are
willing to subscribe to the initial public offerings. This stimulates the capital formation.
• Dissemination of information: Stock exchanges provide information through their various
publications. They publish the share prices traded on daily basis along with the volume
traded. Directory of Corporate Information is useful for the investors ‘assessment
regarding the corporate. Handouts, handbooks and pamphlets provide information
regarding the functioning of the stock exchanges.
• Performance inducer: The prices of stocks reflect the performance of the traded
companies. This makes the corporate more concerned with its public image and tries to
maintain good performance.
• Self-regulating organization: The stock exchanges monitor the integrity of the members,
brokers, listed companies and clients. Continuous internal audit safeguards the investors
against unfair trade practices. It settles the dispute between member brokers, investors
and brokers.
Research in Securities Market
In order to deepen the understanding and knowledge about Indian capital market, and to assist in
policy-making, SEBI has been promoting high quality research in capital market. It has set up an
in-house research department, which brings out working papers on a regular basis.
In collaboration with NCAER, SEBI brought out a ‘Survey of Indian Investors’, which estimates
investor population in India and their investment preferences. SEBI has also tied up with reputed
national and international academic and research institutions for conducting research
studies/projects on various issues related to the capital market. In order to improve market
efficiency further and to set international benchmarks in the securities industry, NSE administers
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a scheme called the NSE Research Initiative with a view to develop an information base and
a better insight into the working of securities market in India.
The objective of this initiative is to foster research, which can support and facilitate.
(a) Stock exchanges to better design market micro-structure.
(b) Participants to frame their strategies in the market place.
(c) Regulators to frame regulations.
(d) Policy makers to formulate policies.
(e) Expand the horizon of knowledge. The Initiative has received tremendous response.
Testing and Certification
The intermediaries, of all shapes and sizes, who package and sell securities, compete with one
another for the chance to handle investors/issuers’ money. The quality of their services
determines the shape and health of the securities market. In developed markets and in
some of the developing markets, this is ensured through a system of testing and certification of
persons joining market intermediaries in the securities market. A testing and certification
mechanism that has become extremely popular and is sought after by the candidates as well as
employers is a unique on-line testing and certification programme called National Stock
Exchange’s Certification in Financial Markets (NCFM).
It is an on-line fully automated nation-wide testing and certification system where the entire
process from generation of question paper, invigilation, testing, assessing, scores reporting and
certifying is fully automated - there is absolutely no scope for human intervention. It allow
tremendous flexibility in terms of testing centers, dates and timing and provides easy
accessibility and convenience to candidates as he can be tested at any time and from any
location. It tests practical knowledge and skills, that are required to operate in financial markets,
in a very secure and unbiased manner, and certifies personnel who have a proper understanding
of the market and business and skills to service different constituents of the market. It offers 9
financial market related modules.
Market Design
Corporate Securities:
The Disclosure and Investor Protection (DIP) guidelines prescribe a substantial body of requirements for
issuers/intermediaries, the broad intention being to ensure that all concerned observe high standards of
integrity and fair dealing, comply with all the requirements with due skill, diligence and care, and disclose
the truth, whole truth and nothing but truth.
The guidelines aim to secure fuller disclosure of relevant information about the issuer and the nature
of the securities to be issued so that investor scan takes informed decisions. For example, issuers are
required to disclose any material ‘risk factors’ and give justification for pricing in their prospectus. An
unlisted company can access the market up to 5 times its pre-issue net worth only if it has track record
of distributable profits and net worth of Rs. 1 crore in 3 out of last five years. A listed company can
access up to 5 times of its pre-issue net worth. In case a company does not have track record or wishes to
14

rise beyond 5 times of its pre-issue net worth, it can access the market only through
book building with minimum offer of 60% to qualified institutional buyers.
Infrastructure companies are exempt from the requirement of eligibility norms if their project
has been appraised by a public financial institution and not less than 5% of the project cost is
financed by any of the institutions, jointly or severally, by way of loan and/or subscription to
equity. The debt instruments of maturities more than 18 months require credit rating. If the issue
size exceeds Rs. 100 crore, two ratings from different agencies are required. Thus the quality of
the issue is demonstrated by track record/appraisal by approved financial institutions/credit
rating/subscription by QIBs. Thelead merchant banker discharges most of the pre-issue and post-
issue obligations. He satisfies himself about all aspects of offering and adequacy of disclosures
in the offer document. He issues a due diligence certificate stating that he has examined the
prospectus, he finds it in order and that it brings out all the facts and does not contain anything
wrong or misleading.
He also takes care of allotment, refund and dispatch of certificates.
The admission to a depository for dematerialization of securities is a prerequisite for making a
public or rights issue or an offer for sale. The investors, however, have the option of subscribing
to securities in either physical form order materialized form. All new IPOs are compulsorily
traded in dematerialized form. Every public listed company making IPO of any security for Rs.
10 crore or more is required to do so only in dematerialized form.
Government Securities: The government securities market has witnessed significant
transformation in the 1990s. With giving up of the responsibility of allocating
resourcesfrom securities market, government stopped expropriating seigniorage and startedborro
wing at near - market rates. Government securities are now sold at market related coupon rates
through a system of auctions instead of earlier practice of issue of securities at very low rates just
to reduce the cost of borrowing of the government. Major reforms initiated in the primary market
for government securities include auction system (uniform price and multiple price method) for
primary issuance of T-bills and central government dated securities, a system of primary dealers
and non-competitive bids to widen investor base and promote retail participation, issuance of
securities across maturities to develop a yield curve from short to long end and provide
benchmarks for rest of the debt market, innovative instruments like, zero coupon bonds,
floating rate bonds, bonds with embedded derivatives, availability of full range ( 91-day and 382-
day) of T-bills, etc.
Secondary Market
Corporate Securities:
The stock exchanges are the exclusive centers for trading of securities. Though the area of
operation/jurisdiction of an exchange is specified at the time of its recognition, they have been
allowed recently to set up trading terminals anywhere in the country. The three newly set up
exchanges (OTCEI, NSE and ICSE) were permitted since their inception to have nationwide
trading. The trading platforms of a few exchanges are now accessible from many locations.
15

Further, with extensive use of information technology, the trading platforms of a few exchanges
are also accessible from anywhere through the Internet and mobile devices. This made a huge
difference in geographically vast country like India.
Exchange Management:
Most of the stock exchanges in the country are organized as “mutual” which was considered
beneficial in terms of tax benefits and matters of compliance. The trading members,
who provide brokering services, also own, control and manage the exchanges. This is not an
effective model for self-regulatory organizations as the regulatory and public interest of the
exchange conflicts with private interests.
Effortsare on to demutualise the exchanges whereby ownership, management and trading
membership would be segregated from one another. Two exchanges viz. OTCEI and NSE are
demutualized from inception, where ownership, management and trading are in the hands of
three different sets of people. This model eliminates conflict of interest and helps the exchange to
pursue market efficiency and investor interest aggressively.
Membership:
The trading platform of an exchange is accessible only to brokers. The broker enters into trades
in exchanges either on his own account or on behalf of clients. No stock broker or sub-broker is
allowed to buy, sell or deal in securities, unless he or she holds a certificate of registration
granted by SEBI. A broker/sub-broker complies with the code of conduct prescribed by SEBI.
Over time, a number of brokers - proprietor firms and partnership firms – have converted
themselves into corporates. The standards for admission of members stress on factors, such as
corporate structure, capital adequacy, track record, education, experience, etc., and reflect a
conscious endeavor to ensure quality broking services.
Demat Trading:
The Depositories Act, 1996 was passed to prove for the establishment of depositories in
securities with the objective of ensuring free transferability of securities with speed, accuracy
and security by (a) making securities of public limited companies freely transferable subject to
certain exceptions; (b) dematerializing the securities in the depository mode; and (c) providing
for maintenance of ownership records in a book entry form. In order to streamline both the
stages of settlement process, the Act envisages transfer of ownership of securities electronically
by book entry without making the securities move from person to person. Two depositories, viz.
NSDL and CDSL, have come up to provide instantaneous electronic transfer of securities.
At the end of March 2002, 4,172 and 4,284 companies were connected to NSDL and CDSL
respectively. The number of dematerialized securities increased to 56.5billion at the end of
March 2002. As on the same date, the value of dematerialized securities was Rs. 4,669 billion
and the number of investor accounts was 4,605,588. All actively traded scraps are held, traded
and settled in demat form. Demat settlement accounts for over 99% of turnover settled by
delivery. This has almost eliminated the bad deliveries and associated problems. The admission
16

to a depository for dematerialization of securities has been made a prerequisite for making a
public or rights issue or an offer for sale. It has also been made compulsory for public listed
companies making IPO of any security for Rs. 10 crore or more to do the same only in
dematerialized form.
Charges:
A stock broker is required to pay a registration fee of Rs.5, 000 every financial year, if his annual
turnover does not exceed Rs. 1 crore. If the turnover exceeds Rs. 1 crore during any financial
year, he has to pay Rs. 5,000 plus one-hundredth of 1% of the turnover in excess of Rs.1 crore.
After the expiry of five years from the date of initial registration as a broker, he has to pay Rs.
5,000 for a block of five financial years. Besides, the exchanges collect transaction
charges from its trading members. NSE levies Rs. 4 per lakh of turnover. The maximum
Brokerage a trading member can levy in respect of securities transactions is 2.5% of the
contract price, exclusive of statutory levies like SEBI turnover fee, service tax and stamp duty.
However, brokerage charges as low as0.15% are also observed in the market Trading Cycle.
Risk Management:
To pre-empt market failures and protect investors, the regulator/exchanges have developed a
comprehensive risk management system, which is constantly monitored and upgraded. It
encompasses capital adequacy of members, adequate margin requirements, limits on exposure
and turnover, indemnity insurance, on-line position monitoring and automatic disablement, etc.
They also administer an efficient market surveillance system to curb excessive volatility, detect
and prevent price manipulations. Exchanges have setup trade/settlement guarantee funds for
meeting shortages arising out of nonfulfillment/partial fulfillment of funds obligations by the
members in a settlement. A clearing corporation assures the counterparty risk of each member
and guarantees financial settlement in respect of trades executed on NSE.
Government Securities:
The reforms in the secondary market include Delivery versusPayment system for settling scrip
less SGL transactions to reduce settlement risks, SGL Account with RBI to enable financial
intermediaries to open custody (Constituent SGL) accounts and
facilitate retail transactions in scrip less mode, enforcement of a trade-for-trade regime,
settlement period of T+0 or T+1for all transactions undertaken directly between SGL participant
s and up to T+5 days for transactions routed through NSE brokers, routingtransactions
through brokers of NSE, OTCEI and BSE, repos in all government securities with settlement
through SGL, liquidity support to PDs to enable them to support primary market and
undertake market making, special fund facility for security settlement, etc.
As part of the ongoing efforts to build debt market infrastructure, two new systems, the
Negotiated Dealing System (NDS) and the Clearing Corporation of India Limited (CCIL)
commenced operations on February 15, 2002. NDS, interlaid, facilitates screen based negotiated
dealing for secondary Market transactions in government securities and money market
instruments, online reporting of transactions in the instruments available on the NDS and
17

dissemination of trade information to the market. Government Securities (including
T-bills), call money, notice/term money, repos in eligible securities, Commercial
Papers and Certificate of Deposits are available for negotiated dealing through NDS
among the members. The CCIL facilitates settlement of transactions in government securities
(both outright and repo) on Delivery versus Payment (DvP-II) basis which
provides for settlement of securities on gross basis and settlement of funds on net basis
simultaneously. It acts as a central counterparty for clearing and settlement of government
securities transactions done on NDS. The relative importance of various stock exchanges in the
market has undergone dramatic change during this decade. The increase in turnover took place
mostly at the large big exchanges and it was partly at the cost of small exchanges that failed to
keep pace with the changes. NSE is the market leader with over 80% of total turnover (volumes
on all segments) in 2001-02. Top 6 stock exchanges accounted for 99.88% of turnover, while the
rest 17 exchange for less than0.12% during 2002-03 (Table 5.4). About a dozen exchanges
reported nil turnovers during the year.
Derivatives Market:
Trading in derivatives of securities commenced in June 2000 with the enactment of enabling
legislation in early 2000. Derivatives are formally defined to include: (a) a security derived from
debt instrument, share, loan whether secured or unsecured, risk instrument or contract
for differences or any other form of security, and (b) a contract which derives its value from
the prices, or index of prices, or underlying securities. Derivatives are legal and valid only if
such contracts are traded on a recognized stock exchange, thus precluding OTC derivatives.
Derivatives trading commenced in India in June 2000 after SEBI granted the approval to this
effect in May 2000.
SEBI permitted the derivative segment of two stock exchanges, i.e. NSE and BSE, and their
clearing house/corporation to commence trading and settlement in approved derivative contracts.
To begin with, SEBI approved trading in index futures contracts based on S&P CNX Nifty Index
and BSE-30 (Sensex) Index. This was followed by approval for trading in options based on these
two indices and options on individual securities. The trading in index options commenced
in June 2001 and trading in options on individual securities wouldcommence in July 2001 while
trading in futures of individual stocks started from November 2001. In June 2003, SEBI/RBI
approved the trading on interest rate derivative instruments.
The total exchange traded derivatives witnessed a volume of Rs.4, 423,333 million during 2002-
03 as against Rs. 1,038,480 million during the preceding year. While NSE accounted for
about99.5% of total turnover, BSE accounted for less than 1% in 2002-03. The market witnessed
higher volumes from June 2001 with introduction of index options, and still higher volumes with
the introduction of stock options in July 2001. There was a spurt in volumes in November
2001when stock futures were introduced. It is believed that India is the largest market in the
world for stock futures.
18

Unit –II
Classification of Capital market
 Primary market
 Secondary market
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PRIMARY MARKET
The Primary is that part of the capital that deals with the issuance of new securities.
Companies, governments or public sector institutions can obtain funding through the
sale of anew stock or bond issue. This is typically done through a syndicate of
securities dealers. The process of selling new issues to investors is called underwriting. In the
case of a new stock issue, this sale is an initial (IPO). Dealers earn a commission that is built into
the price of the security offering, though it can be found in the prospectus.
The primary market for equity, which consists of both the ‘initial public offering’ (IPO) market
and the ‘seasoned equity offering’ (SEO) markets, experienced considerable activity in 2005
and2006 (Table 4.1). In 2006, Rs.30, 325 crore of resources were raised on this
market, of whichRs.9, 918 crore were made up by 55 companies which were listed
for the first time (IPOs). The number of IPOs per year has risen steadily from 2002 onwards. A
level of 55 IPOs in the year translates to roughly 4 IPOs every month. The mean IPO size, which
was elevated in 2005, returned to Rs.180 crore, which is similar to the value prevalent in 2003.
4.3 The primary issuance of debt securities, as per SEBI, fell to a low of around Rs. 66 crore in
2006, which is one facet of the far-reaching difficulties of the debt market.
Unlike equity securities, debt securities issued at previous dates are redeemed by companies
every year. Hence, a year with allow issuance of fresh debt securities is a year in which
the stock of outstanding debt securities drops. In addition to resource mobilization by the
issuance of debt and equity securities, one of the most important mechanisms of financing
that has been used by Indian firms is retained earnings, which are also a part of equity
financing.
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SECONDARY MARKET:
Outstanding securities are traded in the secondary market, which is commonly known as
stock market or stock exchange. In the secondary market, the investors can sell and buy
securities. Stock markets predominantly deal in the equity shares. Debt instruments like bonds
and debentures are also traded in the stock market.
Dematerialization:
Indian investor community has undergone sea changes in the past few years. India now has a
very large investor population and ever increasing volumes of trades. However, this continuous
growth in activities has also increased problems associated with stock trading. Most of
these problems arise due to the intrinsic nature of paper based trading and settlement, like theft
or loss of share certificates.
This system requires handling of huge volumes of paper leading to increased costs and
inefficiencies. Risk exposure of the investor also increases due to this trading in paper.
Some of these risks are:
 Delay in transfer of shares.
 Possibility of forgery on various documents leading to bad deliveries, legal disputes etc.
 Possibility of theft of share certificates.
 Prevalence of fake certificates in the market.
 Mutilation or loss of share certificates in transit.
The physical form of holding and trading in securities also acts as a bottleneck for broking
community in capital market operations. The introduction of NSE and BOLT has increased the
reach of capital market manifolds. The increase in number of investors participating in the
capital market has increased the possibility of being hit by a bad delivery.
The cost and time spent by the brokers for rectification of these bad deliveries tends to be higher
with the geographical spread of the clients. The increase in trade volumes lead to exponential rise
in the back office operations thus limiting the growth potential of the broking members. The
inconvenience faced by investors (in areas that are far flung and away from the main metros) in
settlement of trade also limits the opportunity for such investors, especially in participating in
auction trading. This has made the investors as well as broker wary of Indian capital market. In
this scenario dematerialized trading is certainly a welcome move.
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What is Dematerialization?
Dematerialization or "Demat" is a process whereby your securities like shares,
debentures etc, are converted into electronic data and stored in computers by a Depository.
Securities registered in your name are surrendered to depository participant (DP) and these are
sent to the respective companies who will cancel them after "Dematerialization" and
credit your depository account with the DP. The securities on Dematerialization appear as
balances in your depository account. These balances are transferable like physical
shares. If at a later date, you wish to have these "demat" securities converted back into
paper certificates; the Depository helps you to do this.
Depository:
Depository functions like a securities bank, where the dematerialized physical
securities are traded and held in custody. This facilitates faster, risk free and low cost
settlement. Depository is much like a bank and performs many activities that are similar to a
bank. Following table compares the two.
NSDL and CDS
At present there are two depositories in India, National Securities Depository Limited (NSDL)
and Central Depository Services (CDS). NSDL is the first Indian depository; it was inaugurated
in November 1996. NSDL was set up with an initial capital of US$28mn, promoted by Industrial
Development Bank of India (IDBI), Unit Trust of India (UTI) and National Stock Exchange
of India Ltd. (NSEIL). Later, State Bank of India (SBI) also became a shareholder.
The other depository is Central Depository Services (CDS). It is still in the process of linking
with the stock exchanges. It has registered around 20 DPs and has signed up with 40 companies.
It had received a certificate of commencement of business from Sebi on February 8, 1999.These
depositories have appointed different Depository Participants (DP) for them. An investor can
open an account with any of the depositories’ DP. But transfers arising out of trades on the stock
exchanges can take place only amongst account-holders with NSDL's DPs.
22

Savings
Trading in dematerialized shares results in substantial savings for the investors. Following tables
gives an idea about these savings. Savings for a person who buy shares for long term investment
(On a purchase of Rs10000)
23

How to Rematerialize Shares.
During a Rematerialization process, the request goes from the DP to the R&T agent via NSDL.
The R&T Agent, after processing the request, will print and dispatch the share certificate directly
to you. No transfer duty will be charged to you when you rematerialize your shares. You have
the option of rematerializing your total holdings or part of it. In addition to this, you have the
option to get the certificates in market lot or jumbo lot. If your name has been wrongly spelt on
the certificates given to you after a Remat, you can send it for rectification to the R&T agent
along with the relevant documents.
Trading
Trading in dematerialized securities is quite similar to trading in physical securities. The
major difference is that at the time of settlement, instead of delivery/ receipt of securities in
the physical form, it is done through account transfer. An investor cannot trade in dematerialized
securities through his DP. Trading at the stock exchanges can be done only through a registered
trading member (broker) of the stock exchange irrespective of whether the securities are held in
physical or dematerialized form.
24

NSDL Charges for DPs
NSDL does not charge the investor directly but charges its DPs, who are free to charge
their clients NSDL charges it’s DPs under the following heads:
Transaction Fees: Market Trade: sale - nil; purchase - 5 basis points (i.e. 0.05% of the value of
net receipts to clearing members account) Off Market Trade: sale - nil; purchase - 10 basis points
(i.e. 0.1% of value of securities)
Custody Fees: 3.5 basis points p.a. (i.e. 0.035% p.a. of average value of securities)
Rematerialization: Rs. 10/- per certificate
Onetime payment scheme: NSDL has announced a new scheme under which, if a company
makes a one-time payment of 5 basis points (0.05%) of the average market
capitalization during the preceding 26 weeks, then NSDL will not charge any custody
fees to the DPs for shares of that company. Future issues by such companies would require a
payment of 5 basis points on the new share capital created. The valuation for new shares will be
done at the issue price. Companies would not be required to pay any additional amount, if they
make a bonus issue.
Initial Public Offerings:
Credits for public offers can be directly received into demat account. In the public issue
application form of depository eligible companies, there will be a provision to indicate the
manner in which securities should be allotted to the applicant. All you have to do is to mention
your client account number and the name and identification number of your DP. Any allotment
due to you will be credited into your account. If the applicant is allotted securities
in dematerialized form, but the details regarding the beneficiary account are incomplete/ wrong,
the person will get physical delivery of allotted securities. If securities are allotted in the
dematerialized form, these would be credited to applicant’s accountancy day between allotment
date and listing date, at the discretion of the company. The issuer company/ their R&T agent will
forward the applicant the allotment advice giving the number of shares allotted in dematerialized
form.
Through this you can come to know that you have been allotted shares. An amendment to the
company law requiring all future public issues above Rs100mn to compulsorily offer securities
in dematerialized form is awaiting legislative approval. After this all the issues above Rs100mn
will require investors to trade only in demat way. Partly paid up and fully paid up
shares in the depository, will be given separate ISINs (International Securities Identification
Number).
These are also traded separately at the stock exchanges. The company issues call notices to the
beneficial holders of securities in the electronic form. The details of such beneficial holders will
be provided to the issuer/ their R&T agent by NSDL. After the call money realization, issuer/
their R&T agent will electronically convert the partly paid up shares to fully paid up shares.
25

Tax Aspect
In case of dematerialized holdings cost of acquisition and period of holding for calculation
of capital gains tax is determined on the basis of First in First out (FIFO) method. This is as per
the amendment to the Income Tax Act. The proof of the cost of acquisition will remain to be the
contract note.
Demat Shares: Are They 100% Safe When you buy physical shares from the stock market, you
could never be certain of the validity of the title of shares. There were many reasons- the sellers'
signature did not match, or the certificates were fake, forged or stolen, and so on. Demat shares
are supposed to obviate these problems. Buying shares in the demat form always guarantees you
a good title as soon as the settlement is over. The biggest attraction of trading in demat shares is
that the shares you buy come with a clean title and immediately after the settlement on the
relevant stock exchange. Rule 100 of market regulator SEBI determines whether the shares
delivered in a settlement, are good or not. Under rule 100, the shares that have been transferred
any number of times can still be withdrawn by the company, if a transfer is found to be invalid
for any reason.
Market index
The S&P CNX Nifty is an index based upon solid economic research. It was designed not only
as barometer of market movement but also to be a foundation of the new world of
financial products based on the index like index futures, index options and index funds.
A trillion calculations were expended to evolve the rules inside the S&P CNX Nifty index. The
results of this work are remarkably simple:(a) the correct size to use is 50, (b) stocks considered
for the S&P CNX Nifty must be liquid by the’ impact cost’ criterion, (c) the largest 50 stocks
that meet the criterion go into the index. S&PCNX Nifty is a contrast to the adhoc methods that
have gone into index construction in the preceding years, where indexes were made out of
intuition and lacked a scientific basis.
The research that led up to S&P CNX Nifty is well-respected internationally as a pioneering
effort in better understanding how to make a stock market index. The Nifty is uniquely equipped
as an index for the index derivatives market owing to its (a) low market impact cost and
(b) high hedging effectiveness. The good diversification of Nifty generates
low initial margin requirement. Finally, Nifty is calculated using NSE prices, the most liquid
exchange in India, thus making it easier to do arbitrage for index derivatives.
Hedging effectiveness
Hedging effectiveness is a measure of the extent to which an index correlates with a
portfolio, whatever the portfolio may be. Nifty correlates better with all kinds of
portfolios in India as compared to other indexes. This holds good for all kinds of portfolios,
not just those that contain index stocks. Nifty is owned, computed and
maintained by India Index Services &Products Limited (IISL), a company setup by
NSE and CRISIL with technical assistance from Standard &Poor’s.
26

Unit –III
Instruments & players of capital market
 New issue market instruments
 Stock market instruments
27

Products available in the Secondary and Primary Market
New issue market instruments
The term initial public offering (IPO) slipped into everyday speech during the tech bull market
of the late 1990s. Back then, it seemed you couldn't go a day without hearing about
a dozen new dotcom millionaires in Silicon Valley who were cashing in on their latest IPO.
The phenomenon spawned the term siliconaire, which described the dotcom
entrepreneurs in their early 20s and30s who suddenly found themselves living large on the
proceeds from their internet companies 'IPOs.
Selling Stock
An initial public offering, or IPO, is the first sale of stock by a company to the public. A
company can raise money by issuing either debtor equity. If the company has never issued equity
to the public, it's known as an IPO. Companies fall into two broad categories: private and public.
A privately held company has fewer shareholders and its owners don't have to disclose much
information about the company. Anybody can go out and incorporate a company: just put in
some money, file the right legal documents and follow the reporting rules of your jurisdiction.
Most small businesses are privately held. But large companies can be private too. Did you know
that IKEA, Domino's Pizza and Hallmark Cards are all privately held? It usually isn't possible to
buy shares in a private company. You can approach the owners about investing, but they're not
obligated to sell you anything. Public companies, on the other hand, have sold at least a portion
of themselves to the public and trade on exchange. This is why doing an IPO is also referred to
as "going public." Public companies have thousands of shareholders and are subject to strict
rules and regulations. They must have a board of directors and they must report financial
information every quarter. In the United States, public companies report to the Securities and
Exchange Commission (SEC). In other countries, public companies are overseen by governing
bodies similar to the SEC. From an investor's stand point, the most exciting thing about a public
company is that the stock is traded in the open market, like any other commodity. If
you have the cash, you can invest. The CEO could hate your guts, but there’s nothing he or she
could do to stop you from buying stock.
Going public raises cash, and usually a lot of it. Being publicly traded also opens many financial
doors:
 Because of the increased scrutiny, public companies can usually get better rates when
they issue debt.
 As long as there is market demand, a public company can always issue more stock. Thus,
acquisitions are easier to do because stock can be issued as part of the deal.
 Trading in the open markets means liquidity. This makes it possible to implement things
like employee stock ownership plans, which help to attract top talent.
28

The internet boom changed all this. Firms no longer needed strong financials and a solid history
to go public. Instead, IPOs were done by smaller startups seeking to expand their businesses.
During the cooling off period the underwriter puts together what is known as the herring. This is
an initial prospectus containing all the information about the company except for the offer price
and the effective, which aren't known at that time. With the red herring in hand, the underwriter
and company attempt to hype and build up interest for the issue. They go on a roadshow - also
known as the "dog and pony show" - where the big institutional are courted. As the effective date
approaches, the underwriter and company sit down and decide on the price. This isn't an easy
decision: it depends on the company, the success of the road show and, most importantly, current
market conditions. Of course, it's in both parties' interest to get as much as possible. Finally, the
securities are sold on the stock market and the money is collected from investors.
 An initial public offering (IPO) is the first sale of stock by a company to the public.
 Broadly speaking, companies are either private or public. Going public means a company
is switching from private ownership to public ownership.
 Going public raises cash and provides many benefits for a company.
 The dotcom boom lowered the bar for companies to do an IPO. Many startups
went public without any profits and little more than a business plan.
 Getting in on a hot IPO is very difficult, if not impossible.
 The process of underwriting involves raising money from investors by issuing new
securities.
 Companies hire investment banks to underwrite an IPO.
 The road to an IPO consists mainly of putting together the formal documents for the
Securities and Exchange Commission (SEC) and selling the issue to institutional clients.
 The only way for you to get shares in an IPO is to have a frequently traded account with
one of the investment banks in the underwriting syndicate.
 An IPO company is difficult to analyze because there isn't a lot of historical info.
 Lock-up periods prevent insiders from selling their shares for a certain period of time.
The end of the lockup period can put strong downward pressure on a stock.
 Flipping may get you blacklisted from future offerings.
 A tracking stock is created when a company spins off one of its divisions into a separate
entity through an IPO.
29

Following are the main financial products/instruments dealt in the secondary
market:
Equity: The ownership interest in a company of holders of its common and preferred stock. The
various kinds of equity shares are as follows – Equity Shares: An equity share, commonly
referred to as ordinary share also represents the form of fractional
ownership in which a shareholder, as a fractional owner, undertakes the maximum
entrepreneurial risk associated with a business venture. The holders of such shares are members
of the company and have voting rights. A company may issue such shares with differential rights
as to voting, payment of dividend, etc.
 Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a
ratio to those already held.
 Bonus Shares: Shares issued by the companies to their shareholders free of cost by
capitalization of accumulated reserves from the profits earned in the earlier years.
 Preferred Stock/ Preference shares: Owners of these kind of shares are entitled to a
fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend
can be paid in respect of equity share. They also enjoy priority over
the equity shareholders in payment of surplus. But in the event of liquidation, their claims
rank below the claims of the company’s creditors, bondholders / debenture holders.
 Cumulative Preference Shares. A type of preference shares on which dividendaccumul
ates if remains unpaid. All arrears of preference dividend have to be paid out before
paying dividend on equity shares.
 Cumulative Convertible Preference Shares: A type of preference shares where thedivi
dend payable on the same accumulates, if not paid. After a specified date, these shares
will be converted into equity capital of the company.
 Participating Preference Share: The right of certain preference shareholders to
participate in profits after a specified fixed dividend contracted for is paid. Participation
right is linked with the quantum of dividend paid on the equity shares over and above a
particular specified level.
 Security Receipts: Security receipt means a receipt or other security, issued by a
securitization company or reconstruction company to any qualified institutional buyer
pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an
undivided right, title or interest in the financial asset involved in securitization.
 Government securities (G-Secs): These are sovereign (credit risk-free) coupon bearing
instruments which are issued by the Reserve Bank of India on behalf of Government of
30

India, in lieu of the Central Government's market borrowing programme. These securities
have a fixed coupon that is paid on specific dates on half-yearly basis.
 Debentures: Bonds issued by a company bearing a fixed rate of interest usually payable
half yearly on specific dates and principal amount repayable on particular date on
redemption of the debentures. Debentures are normally secured/ charged against the asset
of the company infamous of debenture holder.
 Bond: A negotiable certificate evidencing indebtedness. It is normally unsecured. A debt
security is generally issued by a company, municipality or government agency. A bond
investor lends money to the issuer and in exchange, the issuer promises to repay the loan
amount on specified maturity date. The issuer usually pays the bond holder periodic
interest payments over the life of the loan. The various types of Bonds are as follows-
 Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No periodic
interest is paid. The difference between the issue price and redemption price represents
the return to the holder. The buyer of these bonds receives only one payment, at the
maturity of the bond.
 Convertible Bond: A bond giving the investor the option to convert the bond into equity
at a fixed conversion price.
 Commercial Paper: A short term promise to repay a fixed amount that is placed on the
market either directly or through a specialized intermediary. It is usually issued by
companies with a high credit standing in the form of a promissory note redeemable at par
to the holder on maturity and therefore, doesn’t require any guarantee. Commercial paper
is a money market instrument issued normally for tenure of 90 days.
 Treasury Bills: Short-term (up to 91 days) bearer discount security issued by the
Government as a means of financing its cash requirements.
DEBT INSTRUMENTS
To meet the long term and short term needs of finance, firms issue various kinds of Securities to
the public. Securities represent claims on a stream of income and /or particular assets.
Debentures are debt securities, and there is a wide range of them. Market loans are raised by the
government and public sector institutions through debt securities. Equity shares issued by
cooperates are ownership securities. Preference shares are a hybrid security. It is a mixture of an
ownership security and debt security.
DEBENTURES
a debenture is a document which either creates a debt or acknowledges it. Debenture issued by a
company is in the form of a certificate acknowledging indebtedness. The debentures are issued
under the Company's Common Seal. Debentures are one of a series issued to a number of
lenders. The date of repayment is specified in the debentures. Debentures are issued against a
31

charge on the assets of the Company. Debentures holders have no right to vote at the meetings of
the companies.
KINDS OF DEBENTURES
(a)Bearer Debentures:
They are registered and are payable to the bearer. They are negotiable instruments and are
transferable by delivery.
(b) Registered Debentures:
They are payable to the registered holder whose name appears both on the debentures and in the
Register of Debenture Holders maintained by the company. Registered Debentures can be
transferred but have to be registered again. Registered Debentures are not negotiable instruments.
A registered debenture contains a commitment to pay the principal sum and interest. It also has a
description of the charge and a statement that it is issued subject to the conditions endorsed
therein.
(c) Secured Debentures:
Debentures which create a change on the assets of the company which may be fixed or floating
are known as secured Debentures. The term "bonds" and "debentures"(secured) are used
interchangeably in common parlance. In USA, BOND is a long term contract which is secured,
whereas a debenture is an unsecured one.
(d) Unsecured or Naked Debentures:
Debentures which are issued without any charge on assets are in secured or naked debentures.
The holders are like unsecured creditors and may see the company for the recovery of debt.
(e) Redeemable Debentures:
Normally debentures are issued on the condition that they shall be redeemed after a certain
period. They can however, be reissued after redemption.
(f) Perpetual Debentures:
When debentures are irredeemable they are called perpetual. Perpetual Debentures cannot be
issued in India at present.
(g) Convertible Debentures:
If an option is given to convert debentures into equity shares at the stated rate of exchange after a
specified period, they are called convertible debentures. Convertible Debentures have become
very popular in India. On conversion the holders cease to be lenders and become owners.
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Debentures are usually issued in a series with a pari passu (at the same rate) clause which entitles
them to be discharged ratably though issued at different times. New series of debentures cannot
rank pari passu with the old series unless the old series provides so.
New debt instruments issued by public limited companies are participating debentures,
convertible debentures with options, third party convertible debentures convertible debentures
redeemable at premiums, debt equity swaps and zero coupon convertible notes. These are
discussed below:
(h) Participating Debentures:
They are unsecured corporate debt securities which participate in the profits of the company.
They might find investors if issued by existing dividend paying companies.
(i) Convertible Debentures with options:
They are a derivative of convertible debentures with an embedded option, providing flexibility to
the issuer as well as the investor to exit from the terms of the issue. The coupon rate is specified
at the time of issue.
(j) Third Party Convertible Debentures:
They are debt with a warrant allowing the investor to subscribe to the equity of third firm at a
preferential price visa vis the market price. Interest rate on third party convertible debentures is
lower than pure debt on account of the conversion option.
(k) Convertible-Debentures Redeemable at a Premium:
Convertible Debentures are issued at face value with 'a put option entitling investors to sell the
bond to the issuer at a premium. They are basically similar to convertible debentures but embody
less risk.
(I) Debt-Equity Swaps:
Debt-Equity Swaps are an offer from an issuer of debt to swap it for equity. The instrument is
quite risky for the investor because the anticipated capital appreciation may not materialise.
(m) Deep discount Bonds:
They are designed to meet the long term funds requirements of the issuer and investors who are
not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep
discount on the face value of debentures. IDBI deep discount bonds for Rs 1 lakh repayable after
25 years were sold at a discount price of Rs. 2,700.
(n) Zero-Coupon Convertible Note:
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A zero-coupon convertible note can be converted into shares. If choice is exercised investors
forego all accrued and unpaid interest. The zero-coupon convertible notes are quite sensitive to
changes in interest rates.
(o) Secured Premium Notes (SPN) with Detachable Warrants:
SPN which is issued along with a detachable warrant, is redeemable after a notice period, say
four to seven years. The warrants attached to it ensure the holder the right to apply and get
allotted equity shares; provided the SPN is fully paid.
There is a lock-in period for SPN during which no interest will be paid for an invested amount.
The SPN holder has an option to sell back the SPN to the company at par value after the lock in
period. If the holder exercises this option, no interest/ premium will be paid on redemption. In
case the SPN holder holds its further, the holder will be repaid the principal amount along with
the additional amount of interest/ premium on redemption in installments as decided by the
company. The conversion of detachable warrants into equity shares will have to be done within
the time limit notified by the company.
(p) Floating Rate Bonds:
The rate on the floating Rate Bond is linked to a benchmark interest rate like the prime rate in
USA or LIBOR in Eurocurrency market. The State Bank of India's floating rate bond was linked
to maximum interest on term deposits which was 10 percent. Floating rate is quoted in terms of a
margin above or below the bench mark rate. The-floor rate in the State Bank of India case was
12 per cent. Interest rates linked to the bench mark ensure that neither the borrower nor the
lender suffer from the changes in interest rates. When rates are fixed, they are likely to be
inequitable to the borrower when interest rates fall subsequently, and the same bonds are likely
to be inequitable to the lender when interest rates rise subsequently.
WARRANTS
A warrant is a security issued by a company granting the holder of the warrant the right to
purchase a specified number of, shares at a specified price any time prior to an expiable date.
Warrants may be issued with debentures or equity shares. The specific rights are set out in the
warrant. The main features-of a warrant are number of shares entitled, expiry date and state price
exercise price. Expiry date of warrants, generally in USA, is 5 to 10 years from the original issue
date. The exercise price is 10 to 30 percent above the prevailing market price. The Warrants have
a secondary market. The minimum value of a warrant represents the exchange value between the
current price of the share and the shares purchased at the exercise price. Warrants have no
flotation costs and when they are exercised the firm receives additional funds at a price lower
than the current market, yet about those prevailing at issue time. New or growing firms and
venture capitalists issue warrants. They are also issued in mergers and acquisitions. Warrants are
called sweeteners and have been issued in the recent past by several companies in India.
Debentures issued with warrants, like convertible debentures, carry lower coupon rates.
34

Non-Convertible Debentures (NCDS) With Detachable Equity Warrants The holder of
NCDs with detachable equity warrants is given an option to buy a specific number of shares
from the company at a predetermined price within a definite time-frame.
The warrants attached to NCDs will be issued subject to full payment of NCD is a value. There
is a specific lock-in period after which there detachable option to apply for equities. If the option
to apply for equities is not exercised, the unapplied portion of shares would be disposed of by the
company at its liberty.
Zero-Interest Fully Convertible Debentures (FCDS)
The investors in zero-interest fully convertible debentures will not be paid any interest. However,
there is a notified period after which fully paid FCDs will be automatically and compulsorily
converted into shares.
There is a lock-in period up to which no interest will be paid. Conversion is allowed only for
fully paid FCDs. In the event of the company going for rights issue prior to the allotment of
equity resulting from the conversion of equity shares into FCDs, FCD holders shall be offered
securities as may be determined by the company.
Secured Zero-Interest Partly Convertible Debentures (PCDS) With Detachable And
Separately Tradable Warrants:
This instrument has two parts; A and B. Part A is convertible into equity shares at a fixed amount
on the date of allotment. Part B is non-convertible, to be redeemed at par at the end of a specific
period from the date of allotment.
Fully Convertible Debentures (FCDS) With Interest (Optional)
This instrument does not yield interest in the initial period of say, 6 months. After this period
option is given to the holder of FCDs to apply for equity at a "premium" for which no additional
amour it needs to be paid. The option has to be indicated in the application form itself. However,
interest on FCDs is payable at a determined rate from the date of first conversion to the second
final conversion and in lieu of it, equity shares are issued.
OTHER DEBT SECURITIES IN VOGUE ABROAD
Income Bonds:
Here interest is paid only when cash flows are adequate. Income Bonds are like
cumulative preference shares on which the fixed dividend is not paid if there is no profit in a
year, but is carried forward and paid in the following year. On Income Bonds, there is no default
if interest is not paid. Unlike dividend on cumulative preference shares, interest on income bond
is tax-deductible. Income Bonds are issued abroad by companies in reorganization or by firms
whose financial situation does not make it feasible to issue bonds with a fixed interest payment,
35

Asset-Backed Securities:
Assets-backed securities are a category of marketable securities that are collateral listed by
financial assets such as installment loan contracts. Asset-backed financing involves a process
called securitization. Securitization is a disintermediation process in which credit from financial
intermediaries is replaced by marketable debentures that can be issued at lower cost.
Financial assets are pooled so that debentures can be sold to third parties to finance the pool.
Repos are the oldest asset-backed security in our country. In USA, securitization has been
undertaken for insured mortgages (Ginnie Mae, 1970), mortgage backed loans, student loans
(Sallie Mae 1973),trade credit receivable backed bonds (1982), equipment leasing backed bonds
(1984),
certificatesof automobile receivable securities (1985) and small business administration loans. M
orerecently, credit card receivables have been securitized. The decade of the eighties witnessed
large expansion of asset backed security financing.
Junk Bonds:
Junk Bond is a high risk, high yield bond to finance either a leveraged buyout (LBO), a
merger of a company in financial distress. Coupon rates range from 16 to 25 per cent. Old line e
established companies which were inefficient and. financed conservatively were objects of
takeover and restructuring. To finance such take-over, high yield bonds were sold. Attractive
deals were put together establishing their feasibility in terms of adequacy of cash flows to meet
interest payments.
Michael Milken (the JUNK BOND KING) of Drexel Buraham Lambert was the real developer
of the market. The junk bond market was tarnished by the fines ($ 650 million) levied in 1989 on
the investment banking firm Drexel Burnham Lambert for various Securities Law violations and
thus was forced into bankruptcy in 1990 and the indictment of Milken in 1990 on charges of
fraud $ 600 million fines and penalties.
36

Unit –IV
Trading Procedure
 Electronic share trading
 Process of share trading
 Parties involved in trading
37

Dematerialization and Electronic Transfer of Securities
Traditionally, settlement system on Indian stock exchanges gave rise to settlement risk due to the
time that elapsed before trades were settled by physical movement of certificates. There were
two aspects: First relating to settlement of trade in stock exchanges by delivery of shares by the
seller and payment by the buyer. The stock exchange aggregated trades over a period of
timeand carried out net settlement through the physical delivery of securities. The process of phy
sically moving the securities from the seller to his broker to Clearing Corporation to the buyer’s
broker and finally to the buyer took time with the risk of delay somewhere along the chain. The
second aspect related to transfer of shares in favor of the purchaser by the issuer. This system of
transfer of ownership was grossly inefficient as every transfer involved the physical
movement of paper securities to the issuer for registration, with the change of ownership being
evidenced by an endorsement on the security certificate. In many cases the process of transfer
took much longer than the two months as stipulated in the Companies Act, and a significant
proportion of transactions wound up as bad delivery due to faulty compliance of paper work.
Theft, mutilation of certificates and other irregularities were rampant, and inaddition the issuer
had the right to refuse the transfer of a security. Thus the buyer did not get good title of the
securities after parting with good money. All this added to the costs and delays in settlement,
restricted liquidity and made investor grievance redressal time-consuming and at times
intractable.
To obviate these problems, the Depositories Act, 1996 was passed to provide for theestablishmen
t of depositories in securities with the objective of ensuring free transferability of securities with
speed, accuracy and security by
(a) Making securities of public limited companies freely transferable subject to certain
exceptions
(b) Dematerializing the securities in the depository mode
(c) Providing for maintenance of ownership records in a book entry form.
A depository holds securities in dematerialized form. It maintains ownership records of securities
and effects transfer of ownership through book entry. By fiction of law, it is the registered
owner of the securities held with it with the limited purpose of effecting transfer of ownership at
the behest of the owner. The name of the depository appears in the records of the issuer as
registered owner of securities. The name of actual owner appears in the records of the depository
as beneficial owner. The beneficial owner has all the rights and liabilities associated with the
securities. The owner of securities intending to avail of depository services opens an account
with a depository through a depository participant (DP). The Securities are transferred from one
account to another through book entry only on the instructions of the beneficial owner. In order
to promote dematerialization of securities, NSE joined hands with leading financial institutions
to establish the National Securities Depository Ltd. (NSDL), the first depository in the country,
with the objective of enhancing the efficiency in settlement systems as also
toreduce the menace of fake/forged and stolen securities.
38

TRADING PROCEDURE
Neat System
The NEAT system supports an order driven market, wherein orders match on the basis of time
and price priority. All quantity fields are in units and prices are quoted in Indian Rupees. The
regular lot size and tick size for various securities traded is notified by the Exchange from time
to time.
Market Types
The Capital Market system has four types of market.
Normal Market
Normal market consists of various book types wherein orders are segregated as Regular Lot
Orders, Special Term Orders, Negotiated Trade Orders and Stop Loss Orders depending on
their order attributes.
Odd Lot Market
The odd lot market facility is used for the Limited Physical Market. The main features of the
Limited Physical Market are detailed in a separate section (1.14).
RETDEBT Market
The RETDEBT market facility on the NEAT system of capital market segment is used
or transactions in Retail Debt Market session. Trading in Retail Detail Market takes place in the
same manner as in equities (capital market) segment. The main features of this market are
detailed in a separate section (1.15) on RETDEBT market.
Auction Market
In the Auction market, auctions are initiated by the Exchange on behalf of trading members
for settlement related reasons. The main features of this market are detailed in a separate section
(1.13) on auction.
Entering Orders
The trading member can enter orders in the normal market, odd lot, RETDEBT and auction
market. A user can place orders in any of the above mentioned markets by invoking the
respective order entry screens. After doing so, the system automatically picks up information
from the last invoked screen (e.g. Market Watch/MBP/OO/SQ and Security List).
39

Price Bands
Daily price bands are applicable on securities as below: Daily price bands of 2% (either way) on
securities as specified by the Exchange. Daily price bands of 5% (either way) on securities as
specified by the Exchange. Daily price bands of 10% (either way) on securities as specified by
the Exchange. No price bands are applicable on: scrips on which derivative products are
available or scrip included in indices on which derivative products are available. In order to
prevent members from entering orders at non-genuine prices in such securities, the Exchange has
fixed operating range of 20% for such securities. Price bands of 20% (either way) on all
remaining scrips (including debentures, warrants, preference shares etc.). The price bands for the
securities in the Limited Physical Market are the same as those applicable for the securities in the
Normal Market. For auction market the price bands of 20% are applicable. Order Types and
Conditions the system allows the trading members to enter orders with various conditions
attached to themes per their requirements. These conditions are broadly divided into Time
Conditions, Quantity Conditions, Price Conditions and Other Conditions. Several combinations
of the above are allowed thereby providing enormous flexibility to the users. The order types and
conditions are summarized below:
A DAY order, as the name suggests is an order that is valid for the day on which it is entered. If
the order is not executed during the day, the system cancels the order automatically at the end of
the day. By default, the system assumes that all orders entered are Day orders.
Order Modification
All orders can be modified in the system till the time they do not get fully traded and only during
market hours. Once an order is modified, the branch order value limit for the branch gets
adjusted automatically. Following is the corporate hierarchy for performing order modification
functionality:• A dealer can modify only the orders entered by him.• A branch manager can
modify his own orders or orders of any dealer under his branch.• A corporate manager can
modify his own orders or orders of all dealers and branch managers of the trading member firm.
However, the corporate manager/branch manager cannot modify order details such that itexceeds
the branch order value limit set for the day. Order modification cannot be performed by/for a
trading member who is suspended or de-activated by the Exchange for any reason. A buyback
having ‘BUYBACKORD’ in the client account field cannot be modified to any other client
account. Any order modifications resulting in price or quantity freeze shall not be allowed. The
user will receive a message "CFO Request Rejected' for such modification requests.
Order Cancellation
Order cancellation functionality can be performed only for orders which have not
been fully or partially traded (for the untraded part of partially traded orders only) and only
during market hours. Single Order Cancellation Single order cancellation can be done during
trading hours either by selecting the order from the outstanding order screen or from the function
key provided. Order cancellation functionality is available for all book types. But the user is not
allowed to cancel auction initiation and competitor orders in auction market. Order cancellation
40

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