Secondary Market
Chapter-3
Secondary Market
1
Role of Stock Exchange
Role of Stock Exchange
Mobilizing
Savings for
Investment
Corporate
Governance
Maintenance
of Indices
Raising
Capital for
Business
Role of Stock Exchange
Capital
Raising for
Development
Projects of
Government
Facilitating
Company
Growth
(Mergers/
Acquisitions)
Investment
Opportunities
Profit
Sharing with
Investors
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Role of Stock Exchange
• Role of Stock Exchanges are varied and highly important in the
development of economy of a country.
• They measure and control the growth of a country.
• Hub of primary and secondary market.
• They have very important role to play in the economy of the country.
Some of them are listed below.
• 1) Raising capital for businesses
• 2) Mobilizing savings for investment
• They help public to mobilize their savings to invest in high yielding
economic sectors, which results in higher yield, both to the individual and
to the national economy.
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Role of Stock Exchange
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3) Facilitating company growth
They help companies to expand and grow by acquisition or fusion.
4) Profit sharing
They help both casual and professional stock investors, to get their share
in the wealth of profitable businesses.
5) Corporate governance
Stock exchanges impose stringent rules to get listed in them. So listed
public companies have better management records than privately held
companies.
6) Creating investment opportunities for small investors
Small investors can also participate in the growth of large companies, by
buying a small number of shares.
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Role of Stock Exchange
• 7) Government capital raising for development projects
• They help government to rise fund for developmental activities through
the issue of bonds. An investor who buys them will be lending money to
the government, which is more secure, and sometimes enjoys tax benefits
also.
• 8) Barometer of the economy
• They maintain the stock indexes which are the indicators of the general
trend in the economy. They also regulate the stock price fluctuations.
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Stock Exchanges of India (BSE)
• Bombay Stock Exchange Ltd. (BSE Ltd) was established in 1875. One of the
leading exchanges of India.
• It is corporatized and is having broad share holders base and has Deutsche
Bourse and Singapore Exchange, as strategic partners.
• It is an efficient and transparent market for trading in equity, debt
instruments, derivatives, and mutual funds.
• It also has a platform for trading in equities of small-and-medium
enterprises (SME).
• Over the past 139 years, BSE has facilitated the growth of the Indian
corporate sector by providing an efficient capital-raising platform.
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Stock Exchanges of India (BSE)
• More than 5000 companies are listed on BSE, making it the world's top
exchange in terms of listed members.
• The companies listed on BSE Ltd. command a total market capitalization of
USD 1.51 Trillion as of May 2014. (1.94 Trillion April 2017)
• It is also one of the world’s leading exchanges (3rd largest in March 2014)
for Index options trading (Source: World Federation of Exchanges).
• BSE also provides other services to capital market participants, including
risk management, clearing, settlement, market data services, and
education.
• BSE systems and processes are designed to safeguard market integrity,
drive the growth of the Indian capital market, and stimulate innovation
and competition across all market segments.
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Stock Exchanges of India (BSE)
• BSE has On-Line trading System (BOLT). (BSE Online Trading System)
• It a capacity of 8 million orders per day.
• It operates one of the most respected capital market educational
institutes in the country (the BSE Institute Ltd.).
• BSE also provides depository services through its Central Depository
Services Ltd. (CDSL) arm.
• BSE’s popular equity index - the S&P BSE SENSEX – (Formerly SENSEX) is
India's most widely tracked stock market benchmark index.
• It is traded internationally on the EUREX as well as leading exchanges of
the BRCS nations (Brazil, Russia, China and South Africa).
8
Stock Exchanges of India (NSE)
• The National Stock Exchange of India Ltd. (NSE) is a stock exchange was
established in the mid 1990.
• NSE provides a modern, fully automated screen-based trading system,
with over two lakh trading terminals, through which investors in every
nook and corner of India can trade.
• NSE has played a critical role in reforming the Indian securities market
and in bringing unparalleled transparency, efficiency and market integrity.
• NSE has a market capitalization of more than US$1.5 trillion and Number
of securities (equities segment) available for trading are 1600 as on June
2017.Though a number of other exchanges exist.
• NSE and the Bombay Stock Exchange are the two most significant stock
exchanges in India and between them are responsible for the vast majority
of share transactions.
• NSE's flagship index, the S&P CNX Nifty, is used extensively by investors in
India and around the world to take exposure to the Indian equities market.
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Stock Exchanges of India (NSE)
• NSE was mainly set up to bring in transparency in the markets.
• Earlier trading membership was confined to a group of brokers.
• NSE ensured that anyone who was qualified, experienced and met
minimum financial requirements was allowed to trade.
• In this context, NSE was ahead of its times when it separated ownership
and management in the exchange under SEBI's supervision.
• The price information which could earlier be accessed only by a handful of
people could now be seen by a client in a remote location with the same
ease.
• The paper-based settlement was replaced by electronic depository-based
accounts and settlement of trades was always done on time.
• One of the most critical changes was that a robust risk management
system was set in place, so that settlement guarantees could protect
investors against broker defaults.
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MCX-SX
• MCX Stock Exchange Limited (MCX-SXAT) is an Indian Stock Exchange.
• It commenced operations in the Currency Derivatives (CD) segment on
October 7, 2008 under the regulatory framework of SEBI and RBI.
• The Exchange is recognized by SEBI under Section 4 of Securities Contracts
(Regulation) Act, 1956.
• In line with global best practices and regulatory requirements, clearing and
settlement is conducted through a separate clearing corporation, MCX-SXAT
Clearing Corporation Ltd. (MCX-SXAT CCL).
• It has received permission in Trading in new segments such as Equity,
Futures and Options on Equity, Interest Rate Derivatives and Wholesale
Debt Market since Dec 2012
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United Stock Exchange
• The United Stock Exchange of India (USE) is an Indian stock exchange.
• It is the 4th pan India exchange launched for trading financial
instruments in India.
• USE represents the commitment of 21 Indian public sector banks, private
banks, international banks (Standard Chartered) and corporate houses to
build an institution of repute.
• USE launched its operations on 20 Sept 2010.
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The Stock Exchanges of India
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Primary Market in India has registered enormous growth in recent years in
terms of
Number of listed companies
Market Capitalization
Number of Stock Holders
Market Value listed Companies.
The stock exchanges are the exclusive centers for trading of securities
There are 23 recognized Stock Exchanges in the country.
Out of which 14 are Public Limited Companies.
6 are companies limited by guarantee.
3 are voluntary Non Profit Organization.
Most guarantee companies are not-for-profit companies, that is, they do not
distribute their profits to their members but either retain them within the
company or use them for some other purpose. Most such companies need
their articles to be drafted for that particular organization, and this is the main
specialized work to be undertaken.
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The Stock Exchanges of India
• All stock exchanges are managed by a governing body consisting of elected
broker directors, , public representatives and Government and SEBI
nominees.
• Up to 1988 stock exchanges were by and large self regulatory
organizations supervised by Ministry of Finance.
• Their regulations covered almost all areas of their operations.
• However stock Exchanges were not discharging their role properly and
several malpractices had crept into trading.
• This had adversely affected investor’s interest and confidence.
• Several Committees have been established to give recommendation for
reforming the organization of stock exchanges.
• The Securities and Exchange Board of India is the regulator for the
securities market in India. It was established in the year 1988 and given
statutory powers on 12 April 1992 through the SEBI ACT 1992.
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The Stock Exchanges of India(NSE)
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NSE was started by a group of leading Indian financial institutions at the behest of
the Government of India to bring transparency to the Indian market, and has a
diversified shareholding comprising domestic and global investors.
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The domestic investors includes Life Insurance Corporation of India, GIC, State Bank
of India and Infrastructure Development Finance Company (IDFC) Ltd, while the
foreign investors include MS Strategic (Mauritius) Limited, Citigroup Strategic
Holdings Mauritius Limited, Tiger Global Five Holdings and Norwest Venture
Partners X FII-Mauritius.
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It offers trading, clearing and settlement services in equity, debt and equity
derivatives. It is India's largest exchange, globally in cash market trades, in currency
trading and index options.
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As on June 2013, NSE has 1673 VSAT terminals and 2720 lease lines, spread over
more than 2000 cities across India.
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Stock Market Indices
• A stock index or stock market index is a measurement of a section
of the stock market.
• It is computed from the prices of selected stocks (typically a
weighted average).
• It is a tool used by investors and financial managers to describe the
market, and to compare the return on specific investments.
• Stock market indices may be classified in many ways. A 'world' or
'global' stock market index — such as the MSCI World or the S&P
Global 100 — includes stocks from multiple regions.
• Regions may be defined geographically (e.g., Europe, Asia) or by
levels of industrialization or income (e.g., Developed Markets,
Frontier Markets).
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Stock Market Indices
• The values of the grouped stocks are used to calculate the value of
the index.
• Any change in the price of the stocks leads to a change in the index
value.
• An index is thus indicative of the changes in the market.
• Some of the important indices in India are:
• Benchmark indices – BSE Sensex and NSE Nifty.
• Sectoral indices like BSE Bankex and CNX IT.
• Market capitalization-based indices like the BSE Small cap and BSE
Midcap
• Broad-market indices like BSE 100 and BSE 500
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Construction of indices
• An index consists of similar stocks. The stocks are selected on
the basis of market cap and liquidity i.e. volumes traded.
• Once the stocks are selected, the index value is calculated.
• This could be a simple average of the prices of the
components.
• In India, the free-float market capitalization is commonly
used.
• The amount of shares publicly available for trading are used.
18
Construction of indices
• Market-cap weightage
• Market capitalization is the total market value of a company’s stock.
This is calculated by multiplying the share price of a stock with the
total number of stocks floated by the company.
• It thus takes into consideration both the size and the price of the
stock.
• In an index using market-cap weightage, stocks are given weightage
on the basis of their market capitalization in comparison with the
total market-capitalization of the index.
• For example, if stock A has a market capitalization of Rs. 10,000
while the index it is part of has a total m-cap of Rs. 1,00,000, then
its weightage will be 10%.
• Similarly, another stock with a market-cap of Rs. 50,000, will have a
19
weightage of 50%.
Construction of indices
• In India, most indices use free-float market capitalization.
• In this method, instead of using the total shares listed by a
company to calculate market capitalization, only the amount
of shares publicly available for trading are used.
• As a result, free-float market capitalization is a smaller figure
than market capitalization.
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Construction of BSE Sensex
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Securities and Exchange Board of India
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S.E.B.I. should be responsive needs of
Issuers of
Securities
S.E.B.I.
Investors
Market
Intermediaries
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Securities and Exchange Board of India
• SEBI has to be responsive to the needs of three groups, which constitute
the market:
• the issuers of securities
• the investors
• the market intermediaries.
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the basic functions of the Securities and Exchange Board of India are to
i) protect the interests of investors in securities and
ii) promote the development of, and
iii) regulate the securities market
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Securities and Exchange Board of India
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Functions
Functionsof
of S.E.B.I.
S.E.B.I.
Protection
Unfair Trade
Practices
Frauds
Regulation
Business of Stock
Exchange
(Insider trading,
Mergers and
Acquisitions)
Promotion
Investor
Education&
Training of
Intermediaries
Market
Intermediaries
(Registration,
Supervision & Control)
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Securities and Exchange Board of India
(Functions-Details)
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1) Regulation of business of stock exchanges
2) Registration and regulation of market intermediaries.(stock brokers , sub
brokers, underwriters, depositories etc.)
3) Prohibiting fraudulent and unfair trade practices and insider trading relating to
securities market.
4) Promoting investor education and training of intermediaries of securities
market.
5) Regulating substantial acquisition of shares and take over of companies.
6) Calling information , conducting inspection, investigations.
SEBI has the same powers as vested in civil courts.
7) In the interest of investors SEBI has powers to suspend the trading of any
security in recognized stock exchange.
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Securities and Exchange Board of India
(Authority)
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Authority
S.E.B.I.
Stock Exchanges
Financial
Intermediaries
Approval of By
laws of Stock
Exchanges
Registration
Inspection of Books of
Accounts/Call
periodical information
Inspection of Books
of Accounts
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Securities and Exchange Board of India
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SEBI has been vested with the following powers:
to approve by−laws of stock exchanges.
to require the stock exchange to amend their by−laws.
inspect the books of accounts and call for periodical returns from
recognized stock exchanges.
• inspect the books of accounts of a financial intermediaries.
• compel certain companies to list their shares in one or more stock
exchanges.
• registration of brokers.
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Stock Market Organization in India
Stock Market Organization in India
Stock Broking
Brokers/Sub brokers
Registration
Code of Conduct
Responsibilities
Inspection
Penalty
Capital Adequacy
Regulation of
Transaction
Custodial Services
Registration
Responsibilities
Audit
Depository System
Depositories Act
1) Depositories
2) Registration
3)Code of Conduct
4) Rights & Obligations
NSDL, CSDL
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Securities and Exchange Board of India
(Stock Broking)
• Stock Broker is a member of a recognized Stock Exchange who buys , sells
or deals in securities.
• A certificate of registration from SEBI is mandatory for the broker
• SEBI is empowered to impose conditions while granting the certificate.
• Code of Conduct: Fairness , integrity, professional judgment & due
diligence.
• Capital Adequacy Norms for Brokers:
• The Capital Adequacy requirements for brokers consists of two
components:
• 1) Base Minimum Capital 2) Additional Capital related to volume of
business.
• Sub broker acts on behalf of a stock broker as an agent but he is not a
member of stock exchange.
• Certificate of registration from SEBI is required for subbroker.
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Depository System
• Introduction of Depository System has been one of the major reforms of
Indian Stock Market.
• Major problems faced by investors in trading based on physical
transfer/custody of securities were:
• 1) Inordinate delays in transfer of securities.
• 2) Return of share certificates as bad deliveries on account of mismatch of
signatures.
• 3) Delay in receipt or non receipt of securities after allotment.
• 4) Delay in getting duplicate share/debenture certificates
• 5) Inadequate infrastructure in banking and postal services to handle large
volume of applications and storage of share certificates.
• Physical Dealing in Securities had to be completely eliminated , through
scrip less trading
• Transaction in securities takes place by book entry method, without
physical delivery securities.
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Depository System
(Scrip less Trading)
• Transaction in securities takes place by book entry method, without
physical delivery securities.
• Important part of scrip less trading is the dematerialization of share
certificates through depositories.
• All certificates are surrendered to the issuer company (that has issued the
securities) through depositories.(which has entered agreement with the
company).
• On receipt of certificates through depository participants and on the
advice of the depository (with which the company has entered into an
agreement) the certificates are cancelled.
• Depositories name is entered into Register of Members of the company.
• Depository System in India operates within the frame work of Depositories
Act 1996 and SEBI Depositories and Participants Regulation,1996.
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Depository System
(Scrip less Trading)
• Depositories are required to register with SEBI.
• The sponsors of the depositories who act alone or in combination with
others proposing to establish a depository can be
• 1) Public Financial Institution
• 2) Bank
• 3) Foreign Banks (with permission of RBI)
• 4) Recognized Stock Exchange
• 5) Body Corporate engaged in Financial Services ( provided 75% of capital
is held by 1 to 4 above.
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Depositories in India
• There are two depositories in India.
• 1) NSDL 2) CSDL
• NSDL: National Securities Depository Ltd is promoted by NSE (Largest
stock exchange of the country by volume) , IDBI,UTI (largest Mutual Fund
of the country) and some of prominent banks in India.
• It is the largest depository in India.
• Its number of account holders are around 1.31 crores.
• 75% of around 12,000 companies are dematerialized.
• CSDL: Central Securities Depository Ltd is established by BSE and some of
the prominent banks in the country.
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Depositories in India
• Depository Participant: is required to be registered with SEBI. It must
belong to one of the categories
• 1) Public Financial Institution
• 2) Bank 3) Foreign Bank
• 4) State Financial Corporation.
• 5) Clearing Corporation/Clearing House of Stock Exchange.
• 6) Registered Stock Broker (with specified conditions)
• 7) NBFC with specified conditions.
• Should have adequate infrastructure and expertise.
• Should be fit and proper person.
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Depository System
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There are four participants in depository system
1) Depository Participant
2) Investor
3) The issuer company
4) Depository.
Depository is a firm wherein the securities of the investor are held in
electronic form, just as bank holds the money.
• It carries out the transactions of the securities by means of book entry
without any physical movement of securities.
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Depository System
Depository System
Depository
Investor
Depository
Participant
Issuer
Company
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Functions of Depositories
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The functions of securities are as under:
1) Dematerialization:
Conversion of paper securities in to electronic form.
2) Account Transfer:
Transfer of securities from one account to another. (Buyers account to
sellers account.)
• 3) Transfer and Registration: Transfer and registration of securities in the
name of buyer in books of company.
• 4) Corporate Actions: Issue of Bonus shares, splitting of shares etc.
• 5) Pledge of securities: Creating Pledge of securities in favor lender.
Informing it to investor/lender. Cancellation of charge etc.
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Functions of Depositories
• Functions of Depositories
Dematerialization
Account
Transfer
Transfer and
Registration
Depositories
Corporate
Actions
(Bonus/Share
Split)
Pledge of
Securities
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Custodial services
• The provision of efficient custodial services forms important element in
the evolution of matured stock market system.
* The custody business provides a range of security services, including
safekeeping and settlement, reporting, corporate actions, dividends
collection and distribution, proxy voting, tax reclaim services, fund
administration and providing market news and information.
• Foreign banks like, HSBC,CITI, Deutsche and Stan Chart are the major
players in the business. They bring their overseas relationships into the
country. Compared to Indian players, foreign players have the reach.
• Most of the business comes from foreign institutional investors (FIIs) who
have business relations with the international offices of these banks. Most
of these players have strong domestic as well as international businesses.
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Stock Market Trading
• The broad system of cash/normal trading mechanism in Indian Stock
Market is illustrated below with reference to the National Stock Exchange
(NSE) Ltd.
Stock Market Trading in India
Cash/Normal Trading
Wholesale
Debt Market
Segment
Capital Market
(Equity)
Segment
Trading of
Government
Securities.
Derivative Trading
Secondary
Market for
Corporate Debt
Securities
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Stock Market Trading
(Wholesale Debt Market)
• 1) Wholesale Debt Market:
• The WDM segment provides facility for institutional investors to enter into
high value transactions in instruments like PSU Bonds, Units of Mutual
Funds, Corporate bonds etc.
• The players on WDM segments are Trading Members and Participants.
• Trading Members are Corporates , Banks , subsidiaries of banks and
Financial Institutions can become TMs.
• Participants are large players they trade though TMs. They have access to
trading system of NSE. They are responsible for their settlements.
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Trading System:
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It is fully computerized and it is on line.
The system has made trading fast and transparent.
It is screen based with automatic order matching facility.
Orders are matched automatically on the computer, making the system
transparent and fair.
When the order does not find a match it remains in the system and is
displayed to the whole market till a fresh matching order comes in.
If not, earlier order may be modified or cancelled.
Trading system also provides complete on line market information through
various enquiry facilities.
Best buys, Quantity traded in security, high , low and last traded price is
available through various market screens.
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Stock Market Trading
(Capital Market Segment)
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2) Capital Market Segment:
NSE provides efficient and transparent platform for trading of equity ,
preference shares, exchange traded funds etc.
The Trading System is known as National Exchange for Automated Trading
System.(NEAT)
It is On-line , fully automated nationwide , anonymous , order driven screen
based trading system.
Member can punch into the computer quantities of securities and price at
which he would like to transact and transaction is executed as soon as it finds
a matching sale or buy order from the counter party.
It electronically matches order and cuts down on time , cost and risk of error
as well as fraud.
It allows faster incorporation of price sensitive information into prevailing
prices thus increasing informational efficiency of the markets.
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Stock Market Trading
(Trading of Government securities)
• In order to encourage wider participation of all classes of investors
including retail, all over the country , trading Government securities has
been introduced in 2003.
• It is on line , screen based, order driven as in case of equities.
• RBI has permitted Banks and Financial Institutions to transact in G-Secs.
amongst themselves and non bank clients through members of NSE/BSE.
• All Government Securities would be deemed to be listed at issuance.
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Stock Market Trading
(Secondary Market for Corporate Debt Securities)
• Companies issue Debt securities on private placement basis.
• In order to provide greater transparency to such issuances and to protect
interest of investors.
• Every listed company making issue of debt securities on private placement
basis must comply with the following:
• 1) Tenor: At least 365 days.
• 2) Disclosure Norms: As per companies act and SEBI norms.
• 3) Appointment of Intermediaries: In case of debenture issue,
appointment of SEBI registered debenture trustee is necessary.
• 4) Credit Rating: Minimum Investment grade.
• 5) Listing: The issuing company must sign listing agreement with stock
exchange.
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Capital Market Derivatives
• Derivatives Trading was permitted by SEBI in 2001 on BSE & NSE.
• To begin with trading in Index Futures Contracts based on S&P NSE
Nifty and BSE Sensex and Index Options.
• The Derivative is a contract whose value is derived from the value
of underlying (asset). The underlying can be share, commodity ,
interest rate, stock market index.
• The most commonly used derivative contracts are
• Forward Contracts ,
• Futures and
• Options.
• These are instruments of risk management.
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Forward Contracts
• Forward Contract: It is an agreement to buy or sale an asset at a future
date. The agreement is entered today and the price is determined for
future date.
• One of the parties to the contract agrees to buy the underlying asset on a
certain future specified date at a certain specified price.
• The details of contract are decided such as delivery date , price and
quantity are negotiated between the parties bilaterally.
• Forward contract are normally traded outside stock exchanges . These are
popular on Over The Counter(OTC) market.
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Forward Contracts(Salient features)
• 1)These are the bilateral private contracts between two parties and these
are exposed to default risk by counterparty.
• 2) Each contract is customer designed .Hence it is unique in terms of
contract size , asset type, expiration date.
• 3) The contract price is not available in public domain. It gives buyer an
obligation to buy and a seller an obligation to sell an asset.
• 4) The contract has to be settled on expiration date by delivery of asset.
• 5) If party wishes to cancel the contract it has to approach the
counterparty. In such cases high fee/commission is charged.
• 6) It prevents the parties from price fluctuations.
• Asset can be commodity such as grains, precious metals , oil, foreign
currency etc.
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Forward Contracts
• Ex: 1) Suppose ITC wants to buy 500 tons of wheat in Jan 2019.
• It can enter into forward contract. It will fix the price/cost of the raw
material and protect from upward movement of price.
• For the seller the contract will protect from downward movement.
• Ex:2
• Suppose a trader exports goods worth$115,508 to US in Aug2018 and is
expected to get the payment on 30/11/2018
• He is expecting appreciation of rupee by Nov2018. He can enter into
forward sale contract with a bank maturing on 30/11/2018 and fix up the
payment he is to get in rupees.(for a commission)
• Ex:3: Similarly importer who is required to pay in dollars (say $90,545) on
19 Nov 18 can enter into forward buy contract with a bank and reduce
exchange rate fluctuation risk.
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Forward Contract
• 1) These private contracts and are tailor made, say maturing on
30/11/2018 and for $116508.
• 2) These are between individual parties and are not exchange traded.
• 3) Trading is individualized and not centralized.
• 4) They lack liquidity
• 5) These are therefore subject to counter party default.
• 6) These are costly as the commission is high. Risk being high.
• 7) These are exact fit to the transaction.
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Futures
• The futures contracts are designed to over come the defects of forward
contracts.
• Unlike forward contact these are standardized and are exchange traded.
• In order to facilitate liquidity the exchange specifies certain standard
features for the contract. Such as standard quantity , time period (or
expiration date)
• The futures contact can be off set prior to maturity by entering into equal
and opposite transaction.
• Suppose A buys today (3 months) Nov 18 future for 1000 barrels of oil.
After a month if he wants to off set the contract he entered into Nov18
futures sell contract for similar quantity.
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Futures
• Futures are standardized forward contracts. They are standardized in terms
of size , expiration date and all other features.
• There are Currency Futures , Equity Futures, Index Futures, Commodity
Futures etc.
• The period of contract may vary from 1 to 12 months.
• They traded on Stock Exchanges. They are liquid and transparent .
• 1) They are more cost efficient as compared to Forward contracts.
• 2) They are not tailor made. (In earlier example may be one has enter into
sell agreement for $116,700 for 3 months with approximate matching)
• 3) There is no risk of counter party default as these are exchange traded.
• 4) In most of the cases there is no delivery as these are sold before expiry
date.
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Options
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Options: Options are basically different from forward and futures contract.
These are the contracts which give holder a right but not an obligation.
The holder may or may not exercise the option.
There are two types of options
1) Call Option (Option to buy)
2) Put Option (Option to Sell)
The right is to be exercised at the end of specified period called expiration
period.
• American option: Can be exercised any time before expiration date.
• European Option : Can be exercised only at the maturity.
• American options are most popular and are traded on exchanges.
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Parties to Options contract
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There are two parties to options contract.
1) Option Buyer
2) Option Seller (Option writer)
Option Buyer has right ( to buy or sell) but no obligation. He may or may
not exercise option.
But option buyer has to pay commission.
Option seller or writer has obligation to perform in case option buyer
exercises option.
If option buyer does not exercise option the commission paid to
seller/writer is his profit.
If option buyer exercises option seller/writer suffers loss.
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Call Option
Call Option/(Option to Buy)
(Receives
right to
buy/No
Obligation)
Buyer
Seller
(Option Writer)
(Receives
commission/Has
Obligation)
Has only obligation
Has to perform if buyer exercises option
1) Commission is profit
No obligation exercise
1)Will not exercise option to buy
If market price is lower
2) Wii exercise option if market price is higher 2) Will suffer loss. Loss can be
high.
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Call Option
• Example:
• Suppose A has purchased today Call option (to buy) Infy Share for Rs1300
maturing on 30.11.2019
• Infy share today is quoted at 1340 the value of premium is Rs40.
• If after a week Infy is traded at 1340, the buyer will be at par.
• A will not exercise contract and ( if it continues to be traded below 1340
till 30.11.19) instead will buy from the market.
• If he exercises contract, he will be the looser by Rs40.
• Suppose the Share price rises to 1350 the buyer will exercise the contract
and earn profit of Rs10
• ‘A’ may not take the delivery of shares and may sell the contract making
profit of 10.
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Put Option
Put Option (Option to Sell)
(Has right to
sell/No
Obligation)
Buyer
No obligation exercise
1)Will exercise option to sell
If market price is lower
2) Wii not exercise option
if market price is higher
Seller
(Option
writer)
Receives
Commission
Has to perform if buyer exercises option
1) Writer or seller will suffer loss.
2) Commission is the profit.
57
Put Option
• Example: Suppose A has purchased Put option (Option to Sell) TCS share at
2700 on 01.09.19. maturing 31.10.2019
• On 21.09.19, the share is traded at 2550. The premium is 150.
• If the share is traded at 2700 after a week the buyer will be at par.
• The value of the contract will be zero.
• If the share is traded at 2400. He will be in gross profit by Rs300
• Profit will be Rs150 per share net of commission.
• The option buyer will exercise option when market price is lower than
option price.
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Numericals on Options
• 1) A has purchased call option (American) for 100 shares of company X on
21.09.19 at Rs2500. maturing on 30.11.19. On the date of purchase share
was quoted at 2600.Commission charged was Rs50
• On 02.11.19 share price increased to 2700 and on 15.11.19 it was 2750
thereafter share price was fluctuating between 2600 and 2650 till
30.11.19. On 30.11.19 share was quoted at 2600
• Option was exercised on 02.11.19.
• a)Calculate profit earned by purchaser of option.
• b)Calculate loss incurred by option writer.
• c)What would have been the best date for exercising option?
• d)What would have been the profit/loss to option buyer, had it been
European option?
• e)Calculate profit by option seller, if option is not exercised by A.
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Numericals on Options
• Solution-1:
a)Option price : Rs2500 + commission Rs50 = Rs2550.
On 02.11.19 price of share is 2700. Thus profit per share is 2700-2550 = Rs150
per share.
Thus for 100 share profit will be Rs15,000
b) Option writer will be required to purchase shares in the market on 02.11.19
at Rs2700 and sell at the option price of Rs2500 thus incurring loss of Rs200
per share. Thus loss for 100 shares is 20,000. The net loss by option writer is
Rs20,000 less commission 5,000= Rs15,000.
c) Best date is 15.11.2019
d)In case of European option profit will be 2600-2550=Rs50 per share.
i.e.Rs5000
e)Profit by option seller is commission. i.e. Rs5000.
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Numericals on Options
• 2) A has purchased put option (American) for 250 shares of company Y
on 21.09.19 at Rs1400. maturing on 31.12.19. On the date of purchase
share was quoted at Rs1350.Commission charged was Rs20
• On 30.09.16 share price increased to 1400 and on 30.11.19 it was 1200
thereafter share price was fluctuating between Rs1390 and Rs.1410 till
31.12.19.
• a)Calculate profit/loss earned by purchaser of option and option writer if
option is exercised on 30.11.19
• b)If option is not exercised in the month of November, what would have
been the best date for exercising option thereafter?
• c)In case option is European what is profit or loss to the purchaser if
share was quoted at 1410 on 31.12.19
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Numericals on Options
• Solution-2
• a) If option is exercised on 30.11.19, profit per share is Rs200. Thus total
profit is 200X250 i.e. 50,000 less commission Rs5000. Thus Net profit is
Rs45,000.
• b) The option price is 1400-20=1380. Since market price is above this
value, exercising option will result into loss. Thus option should not be
exercised.
• c)Loss will be 1410-1400 i.e. Rs10 per share +Commission.
• Rs2500 + 5000 = Rs7500.
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Numericals on options
• 3) A has purchased call option (American) for 1000 shares of company X
on 11.09.19 at Rs250. maturing on 30.11.19. On the date of purchase
share was quoted at 260.Commission charged was Rs10
• On 02.11.19 share price increased to 270 and on 15.11.19 it was 275
thereafter share price was fluctuating between 260 and 265 till 30.11.19.
On 30.11.19 share was quoted at 260
• Option was exercised on 02.11.19.
• a)Calculate profit earned by purchaser of option.
• b)Calculate loss incurred by option writer.
• c)What would have been the best date for exercising option?
• d)What would have been the profit/loss to option buyer, had it been
European option?
• e)Calculate profit by option seller, if option is not exercised by A.
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Nummerical on options
•
•
•
•
•
•
Solution-3:
a)Option price : Rs250 + commission Rs10 = Rs260.
On 02.11.19 price of share is 270. Thus profit per share is 270-260 = Rs10
per share.
Thus for 1000 share profit will be Rs10,000
b) Option writer will be required to purchase shares in the market on
02.11.19 at Rs270 and sell at the option price of Rs250 thus incurring loss
of Rs20 per share. Thus loss for 1000 shares is 20,000. The net loss by
option writer is Rs20,000 less commission 10,000= Rs10,000.
• c) Best date is 15.11.2019
• d)In case of European option profit will be 260- (250 + 10) =0. No profit.
• e)Profit by option seller is commission. i.e. Rs10,000.
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Stock Market Indices
(Nifty-50)
• A stock market index is a statistical indicator which gives an idea about
how the stock market is performing.
• Stock market indices provide a consolidated view of how the market is
performing. Stock indices are updated constantly throughout the trading
day to provide instant information.
• In India the main indices to be tracked are – The BSE SENSEX and The NSE
NIFTY.
• The NSE S&P CNX Nifty 50 or the NIFTY as it is commonly known, is the
prime index of the National Stock exchange.
• The NIFTY index is made up of 50 different stocks from all the listed
company at the National stock exchange.
• The 50 stocks that made up the NIFTY index are the prime stocks in terms
of market capitalization and daily trading activity.
65
Stock Market Indices
(Nifty-50)
• The NIFTY index at present is owned and managed by the India Index
Services and Products Ltd. (IISL).
• The India Index Services and Products Ltd. (IISL) is joint venture between
the national stock exchange and the CRISIL.
• CRISIL is the first Indian company to specialize for index management. The
company has a license agreement with the Standard & Poor's (S&P), which
is the leading company in the world, in Index management.
• The NIFTY index is used for purposes like benchmarking fund portfolios,
index based derivative trading and managing index funds.
• The 50 stocks selected for NIFTY index are prime companies from different
sectors. These are reviewed and modified from time to time on the basis
of the present market condition , the position of respective companies
and the present market capitalization.
66
Stock Market Indices
(Nifty-50)
• At present the companies in the NIFTY index represent as much as 21
different sectors. The index has a good mix of different sectors and reflects
the overall market condition rightly.
• Moreover, with stocks from different sectors in the index it makes the
NIFTY more stable and it is not greatly influenced by the fall in certain
sector.
• The stocks that make the NIFTY index represent the prime companies in
India and they are leaders in the stock exchange in terms of the trading
volume and the market capitalization.
• These 50 stocks represent the 58.64% of total market capitalization as on
31st March, 2008.
67
Stock Market Indices
(BSE SENSEX-30)
• The prime index of the Bombay Stock Exchange is the BSE 30 that is
popularly known as the Sensex.
• The Sensex is made with highly liquid stocks of 30 largest companies in
terms of market capitalization.
• The Sensex was first constructed in the 1986 on 1st of January with just
30 stocks. Over the years of course these stocks have changed time and
again according to the condition of the market and economy of the
country.
• The selection of the stocks is made on the basis of market capitalization
and liquidity of stocks.
• The BSE index committee decides on which stock to include in the Sensex
and which stock should be removed from the Sensex. This committee is
made up of experts and professionals from the field finance and industry
who are well aware of the Indian stock market scenario.
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Stock Market Indices
(BSE SENSEX-30)
• It is also ensured that the Sensex does not represent few companies or
the sectors. The companies are selected on the basis of market
capitalization and liquidity . Thus only the reputed and large enterprises
are considered. .It is ensured that the Sensex catches the exact pulse of
the industry.
• Another factor that is considered while selecting the stocks is the
diversification of the industries.
• It is ensured that the Sensex has a balanced representation from all the
major sectors. So that debacle in one particular sector can not affect the
Sensex to a great extent.
• Selection of the stocks in this way certainly minimizes the risks of the
investors who invest in the Sensex. In the BSE 30 includes of the leading
companies from different sectors including FMCG, technology, banking,
finance, manufacturing, pharmaceuticals, oil and IT.
• The Sensex is managed and operated by a panel of experts.
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Listing of Securities
• A company, desirous of listing its securities on the Exchange, shall be
required to file an application, in the prescribed form, with the Exchange
before issue of Prospectus by the company.
• The company shall be responsible to follow all the requirements specified
in the Companies Act and the listing norms issued by SEBI from time to
time and such other conditions, requirements and norms that may be in
force from time to time.
• The company may list its securities on the exchange .
• Trading in Government Securities
• Trading shall be allowed in Government Securities, which denote
securities issued by
• the Government of India, State Governments, Port Trusts, Municipal
Corporations and other similar bodies.
• Government Securities shall be deemed to have been admitted to dealings
on the Exchange from the date on which they are issued.
• Transactions in Government Securities shall be carried out and settled in
accordance with the directions issued by the Reserve Bank of India from
time to time.
70
Circuit Breakers
• Stock prices can move up or down due to a number of reasons. For
example – earnings results, government policies, trends in the industry
etc. Such prices movements are reasonable and logical.
• But in some cases, stock prices may move up or down drastically,
accelerated mostly due to fear or greed by speculators and manipulators.
Such movements are harmful for the stock markets.
• In order to control such heavy price fluctuations, stock exchanges have a
system called ‘circuit breakers’, something that works similar to the
electricity circuit breakers that we have at home.
• Circuit breakers were first introduced in the trading system of Indian stock
exchanges back in 1992 at the BSE. There are separate circuit breakers for
the indices and individual stocks.
• These control systems ensure sanity of the stock market and protects
investors. These are also called circuit limits or price bands.
71
Circuit Breakers
• When the volatility of a stock breaks a certain limit as decided by the
exchange, trading in that stock is stopped for some time.
• The limit is fixed as a percentage of the stock’s price by the stock
exchange.
• The rules for circuit breaking are decided by the Securities exchange
Board.
• CIRCUIT LIMITS FOR SENSEX AND NIFTY
• There are 3 circuit limits for indices – 10%, 15% and 20%.
• Circuit filter is applied to Sensex or Nifty whichever is breached first. The
trigger of circuit limits also depends on the time at which it occurs.
• If the market hits the upper or lower circuits, trading is halted and you
cannot place orders until the market re-opens
72
Shares with Differential Voting Rights
• Shares with differential voting rights (DVR shares) are like ordinary equity
shares but with differential voting rights.
• They are listed and traded in the same manner as ordinary equity shares.
• However, they mostly trade at a discount as they provide fewer voting
rights compared to ordinary equity shares.
• Companies generally compensate DVR investors with a higher dividend.
• In India since 2001, issue of DVR shares has been allowed.
• These can be used to thwart hostile takeovers.
• They decouple economic interest and voting rights. Shares with DVR are
mainly targeted at passive investors.
• In most cases, small or retail investors hardly exercise their voting rights,
nor do they have an understanding of corporate affairs to an extent that
they can influence corporate actions.
73
Shares with Differential Voting Rights
•
•
•
•
•
•
•
They invest in shares only for economic returns. Therefore, they give away
their voting rights in favor of those investors who run the company and have
management control.
Thus, this mode offers investors an avenue to acquire shares at lower prices
with prospects of higher dividends in return for surrendering their voting
rights.
The companies issue DVR shares to fund new large projects. This also helps
strategic investors who do not want control but are looking at a reasonably big
investment in a company.
For issue of shares with DVR the company has to satisfy following conditions:
1) It has distributable profits for three financial years preceding the year in
which it was decided to issue such shares.
2) It has not defaulted in filing annual accounts and annual returns for three
financial years immediately preceding the financial year in which it was
decided to issue such shares.
3)
The issue of such shares cannot exceed 25% of the total issued share
capital of the company. (including shares with DVR)
74
Preference Shares Corporate Bonds and
Corporate Debentures
• Preference Shares : Dividends are paid to preference shareholders before
common stock dividends are paid out. In the event of a company
bankruptcy, preferred stock shareholders have a right to be paid from the
proceeds of company assets first.
• Preference shares typically pay a fixed dividend, whereas common stocks
do not. And unlike common shareholders, preference share shareholders
usually do not have voting rights.
• Corporate Bonds: A debt security issued by a corporation and sold to
investors. The backing for the bond is usually the payment ability of the
company, which is typically money to be earned from future operations.
• Debentures: It is an instrument of raising long term debt. Debentures in
India are typically secured by tangible assets.
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Fixed income securities
• Fixed income securities denote debt of the issuer, i.e., they are
an acknowledgment
• or promissory note of money received by the issuer from the
investor.
• Characteristics:
• Fixed maturity period ranging from as low as 91 days to 30
years.
• Specified “coupon” or interest rate.
• Generally issued at a discount to face value and the investor
profits from the difference in the issue and redeemed price.
76
TYPES OF FIXED INCOME SECURITIES
• The types of Fixed Income securities are based on their
issuance. These are issued by
• 1)the government,
• 2) banks or financial institutions or
• 3) the corporate sector.
• Government : Treasury Bills ,Government securities
• Banks/FI : Certificate of Deposits
• Corporates : Commercial Papers, Bonds
77
ADVANTAGES OF FIXED INCOME SECURITIES
• 1. Lower volatility than other asset classes providing stable
returns.
• 2. Higher returns than traditional bank fixed deposits.
• 3. Predictable and stable returns offer hedge against the
volatility and risk of equity investments, and
• 4.Thus help an investor to create a diversified portfolio.
78
DISADVANTAGES OF FIXED INCOME SECURITIES
• 1. Low liquidity: investors‟ money is locked for full
maturity period unless
• the security is traded in the secondary market.
• 2. Not actively traded: this lack of competition
prevents their prices rising very high.
• 3. Sensitivity to market interest rate: Change in market
interest rate changes the yield on held securities.
• Returns on a fixed income security are calculated
differently from other asset classes.
• In most other investments the market value is the
parameter based on which we evaluate returns.
79
Yield
• In case of fixed income securities, return on investment is
denoted by its “yield” which depends on:
• 1. Purchase Price (how much you paid for it initially)
• 2. Coupon (rate of interest you receive periodically)
• 3. Duration (when will the security be redeemed if you wish to
hold it to maturity)
• 4. Market Price (how much will you receive for the security if
you were to sell it)
• The purchase price, coupon rate and duration of a security
cannot change once issued, its market price
• fluctuates with changes in market interest rates, which in turn
affects the yield.
80
CHANGING INTEREST RATES AND
MARKET PRICES
• Rising interest rates make the prices of fixed income securities fall,
whereas when interest rates are falling,
• the market prices of securities rise.
• Suppose, for a 3 year bond, coupon rate of 10%, face value of Rs.
100.
• Let us assume that in the first year, when interest rates are falling,
the market price of the security is
• Rs. 120. Interest income on the bond is Rs. 10 (based on coupon
rate which does not change.)
• The yield in the first year: 10/120*100 = 8.33%.
• In the second year, the market price fell to Rs. 90. With interest
income of Rs. 10,
• the yield is: 10/90*100 = 11.11%.
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TYPES OF BONDS
• 1. Fixed rate bonds: This is a long-term debt paper that carries a
predetermined interest rate.
• These rates do not change during the maturity of the bond
• 2. Floating rate bonds: They come with variable coupons, usually a
spread
• with respect to a reference rate. For example, in India, some floating
bonds
• have a coupon rate of the Mumbai interbank offer rate (MIBOR) + 45 basis
points.
• It means that the coupon amount will change according to the prevailing
MIBOR at the time of coupon payment.
• 3. Zero Coupon Bonds: These bonds do not carry any interest rate; they
are issued
• at a deep discount to their face value and are redeemed at face value.
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Yield To Maturity:
• Yield-To-Maturity (YTM) is the measure of returns accrued by
an investor when his investment is held till maturity.
Therefore, YTM is an indicator of total returns that an investor
would receive at the end of the maturity period. (Rate of
return)
• YTM of an investment however undertakes certain
assumptions which include:
• The investment is held till maturity
• The regular coupons before maturity are reinvested at the
YTM rate.
83
Factors affecting YTM of a bond
• 1.
Coupon rate: Directly proportional to the yield. Higher
coupon rate results in higher interest income provided to the
investor and vice versa.
• 2. Years until maturity: Greater the number of years to
maturity, more coupon payments to the investor and vice versa.
• 3. Bond price: This is indirectly proportional to yield. More
return i.e., yield is accrued by an investor at a lower price and
vice versa.
• 4. Difference between face value and price: On holding the
bond till maturity, the investor receives amount equal to the
face value of the bond. However, the difference between the
face value and the price of the bond is paid by the issuer to the
investor.
84
YTM- continued
• Yield to maturity is the interest rate an investor would earn by reinvesting
every coupon payment from the bond at a constant interest rate until the
bond’s maturity date.
• Therefore the present value of all of these future cash flows equals the
bond’s market price. The method for calculating YTM can then be
represented with the following formula:
85