ICM – Stock
k Brokers' Certiification
Stoc
S ck Bro
B oke
ers''
Certiificat
tion
Study
S
and Refere
R
ence G
Guide
REVISE
ED EDIT
TION
Octo
ober 20110
Insstitute of Capital Marketts © 2010.
Study and Reference Guide
ICM – Stock
k Brokers' Certiification
Sto
ock Bro
oke
ers'
Certtificaation
n Ex
xamiinatiion
Study
S
and Refere
R
ence G
Guide
Revised Edition: Octobber 2010
Study and Reference Guide
ICM – Stock Brokers' Certification
Copyright © 2010
Institute of Capital Markets
Karachi, Pakistan
All rights reserved
This is document is for educational purposes only and the Institute of Capital Markets
(ICM) accepts no responsibility for persons undertaking trading or investments in
whatever form.
While every effort has been made to ensure its accuracy, no responsibility for loss
occasioned to any person acting or refraining from actions as a result of any material in
this publication can be accepted by the ICM or its members.
ICM has prepared its study guides with the best intent for educational reference
purposes only and the documents shall not be considered as an ultimate authority on
the subject or to pass the ICM qualifications. Readers are encouraged to study
additional relevant material and as recommended by ICM.
The ICM's training materials are solely for the purpose of referencing and the matter
provided may not be taken as any empirical theory on the subject which is dynamic and
evolving with latest research and developments. While some of the content has been
taken from third-party sources, their efforts and work on the topic are highly
acknowledged.
For any comments, suggestions and information, you may reach ICM at info@icm.org.pk
3
ICM – Stock Brokers' Certification
TABLE OF CONTENTS
1. Objective of the Examination……………………….……………………………….
2. Target Audience……………………………………………..…………………………….
3. Syllabus Structure …………………………………………..……………………………
4. Exam Specification ……………………………………………………………………….
5. Assessment Structure ………………………………………..…………………………
6. Summary Syllabus ………………………………………………………………………..
7. Recommended Readings ………………………………………………………………
8. Acronyms ……………………………………………………………………………………..
9. Element 1 - Introduction to Markets ……………………………………………..
10. Element 2 - Regulatory Framework …………….…………………………………
11. Element 3 - Primary Market …………………………….....………………………..
12. Element 4 – Secondary Market …..…………………………………………………
13. Element 5 - Clearing, Delivery, Settlement and Depository…………….
14. Element 6 - Stock Brokers and their Clients …………………………………..
15. Element 7 - Commodity Exchange and Derivatives ………….……………
16. Element 8 – Investor Protection …….……..………………………………………
17. Element 9 – Economics And Finance ……..………………………………………
18. Glossary …………………………………………………………………………………………
4
05
05
05
06
06
07
17
19
20
30
35
41
59
88
100
123
133
163
ICM – Stock Brokers' Certification
OBJECTIVE OF THE EXAMINATION
This Certification Exam is specifically designed to meet the minimum qualification needs
of the capital market participants at brokerage houses with client interaction and to
ensure that they are competent to provide buying & selling services to stock market
investors.
TARGET AUDIENCE
This exam is by and large mandated for Brokers, Agents of Brokers, Equity Traders and
Sales Staff of Brokers and Brokerage Firms.
SYLLABUS STRUCTURE
The unit is divided into elements. These are broken down into a series of learning
objectives. Each learning objective begins with one of the following prefixes: know,
understand, be able to calculate and also be able to apply. These words indicate the
different levels of skill to be tested. Learning objectives prefixed:
− know require the candidate to recall information such as facts, rules and
principles
− understand require the candidate to demonstrate comprehension of an issue,
fact, rule or principle
− be able to calculate require the candidate to be able to use formulae to perform
calculations
− be able to apply require the candidate to be able to apply their knowledge to a
given set of circumstances in order to present a clear and detailed explanation of
a situation, rule or principle
5
ICM – Stock Brokers' Certification
EXAMINATION SPECIFICATIONS
Each examination paper is constructed from a specification that determines the
weightings that will be given to each element. The specification is given below.
It is important to note that the numbers quoted may vary slightly from examination to
examination as there is some flexibility to ensure that each examination has a consistent
level of difficulty. However, the number of questions tested in each element will not
change by more than plus or minus 2.
Examination Specification
100 multiple choice questions
Element No.
Elements
1
Introduction to Markets
2
Regulatory Framework
3
Primary Market
4
Secondary Market
5
Clearing, Delivery, Settlement and Depository
6
Stock Brokers and their Clients
7
Commodity Exchange and Derivatives
8
Investor Protection
9
Economics and Finance
Total
Questions
10
10
10
20
10
10
10
10
10
100
ASSESSMENT STRUCTURE
•
•
•
This will be a two-hour examination of 100 Multiple Choice Questions (MCQs).
All questions will carry equal marks.
There will be no negative marking.
6
ICM – Stock Brokers' Certification
SUMMARY OF THE SYLLABUS
7
ICM – Stock Brokers' Certification
ELEMENT 1
Introduction to Markets
On completion, the candidate should:
1.1
know the Products, Participants and Functions of the capital markets
1.2
know the role of the Securities Market and Financial System including:
−
−
−
−
−
−
−
−
−
Stock Exchanges
Stock Brokers
Retail / Commercial banks
Investment Banks
Pension / Mutual funds
Insurance Companies
Fund managers / Asset Management Companies
Custodians
Industry Trade Bodies
1.3
understand the relationship of Securities Market and Economic Development
1.4
know the Investor Population including retail and institutional investors
1.5
understand the role and functions of Primary Market
1.6
understand the role and functions of Secondary Market
8
ICM – Stock Brokers' Certification
ELEMENT 2
Regulatory Framework
On completion, the candidate should:
2.1
understand the scope, core functions and powers of the Securities and Exchange
Commission of Pakistan (SECP) as conferred in SECP Act, 1997
2.2
understand the SECP Regulations, Rules and Procedures, Powers and Functions,
Appeals, Jurisdictions including:
−
−
−
−
Functional responsibility and powers
Approval according body
Power to call for information
Enforcement and investigative powers
2.3
understand the key elements of the Securities and Exchange Ordinance, 1969
2.4
know the Securities and Exchange Rules, 1971
2.5
understand and interpret the SECP Directives to Brokers on Conduct of Business,
Investor Warnings, etc.
2.6
know the sections of the Companies Ordinance, 1984 that are relevant to capital
markets
2.7
know the SECP Code of Corporate Governance 2002 in the light of listing
regulations of stock exchanges
2.8
know the listing regulations of the Karachi, Lahore and Islamabad Stock
Exchanges and should be able to apply the differences in these regulations
2.9
know the Central Depositories Act, 1997 and Regulations
2.10
know the National Clearing Company of Pakistan Limited Regulations
9
ICM – Stock Brokers' Certification
ELEMENT 3
Primary Market
On completion, the candidate should:
3.1
understand the functions and processes of the Primary Market including
−
−
−
−
Issue of Shares
Prospectus/Offering Documents
Pre-Initial Public Offer and Private Placement
Initial Public Offering
3.2
know the general requirements and procedure for companies to list shares on
the Karachi, Lahore and/ or Islamabad Stock Exchanges
3.3
know the requirements for delisting from the stock exchanges
3.4
understand the factors leading to listed companies being suspended or placed on
the Defaulters’ Counter
10
ICM – Stock Brokers' Certification
ELEMENT 4
Secondary Market
On completion, the candidate should:
4.1
know the role and importance of the Stock Exchange
4.2
understand the Stock Trading process through stock exchanges including:
−
−
−
−
−
Electronic Trading Terminals
Entry of Quotes and Orders
Price/Time Priority
Order Types
Transaction and Order Reports
4.3
know the Trading Cycle
4.4
understand the Products available on the stock exchanges including:
− Equity Instrument
− Debt Instrument
4.5
understand the Derivatives/Futures Contracts available on the stock exchanges
including:
− Deliverable Futures contracts
− Cash Settled Futures
− Index Futures contracts
4.6
know the composition and types of the Indexes
4.7
know the process of disseminating and dealing with Corporate Actions and
Announcements
4.8
know the Stock and Market Indicators and Outcomes including:
−
−
−
−
Turnover, growth and distribution
Market Capitalization
Liquidity and Financing
Transaction Costs
11
ICM – Stock Brokers' Certification
ELEMENT 5
Clearing, Delivery, Settlement and Depository
On completion, the candidate should:
5.1
know the role, functions and working of a Clearing House of an Exchange
5.2
know the Risk Management and Types of Risks in Clearing & Settlement
5.3
know the process of Clearing House Deposits and Credit Risk including the
Capital Adequacy requirements and Exposure Limits
5.4
understand the Margin requirements and should be able to calculate
−
−
−
−
−
−
V-a-R (Value-at-Risk) - Market Risk
Impact Cost - Liquidity Risk
Acceptable Collateral to meet Margin Requirements
Haircuts
Mark-to-Market (Variation Margin) & Margin Calls
Special Margins
5.5
know the role and functions of Depository, the book-entry system and its
advantages to the capital market
5.6
know the different services offered by a Depository and Types of Accounts
5.7
understand the working mechanism, benefits, elements and account structure of
Central Depository System (CDS)
5.8
know the maintenance of sub-accounts and participant account in CDS
5.9
understand the functions and process of Settlement including:
−
−
−
−
−
Settlement Cycle
Delivery versus Payment
Institutional Delivery System (IDS)
Pay-in and Pay-out
Settlement of Futures Contracts including Deliverable and Cash Settled
Futures
12
ICM – Stock Brokers' Certification
ELEMENT 6
Stock Brokers and Their Clients
On completion, the candidate should:
6.1
know the Brokers and Agents Registration Rules, 2001 including:
− Brokers Eligibility Requirements
− Broker Registration process with SECP
− Code of Conduct of Brokers including Duty to the Investor and vis-à-vis
other Brokers
6.2
understand the Broker Prohibitions and Restrictions related to:
−
−
−
−
−
−
Clients’ Assets
Confidentiality
Material information
Insiders and Non-public Information
Illegal Trading
Front running
6.3
know the requirements and procedures of Enquiries and Penalties for Offences
related to Brokers
6.4
know the Orders and Appeals procedures of SECP
6.5
know the relevant sections of Anti Money Laundering Ordinance and KYC
requirements
6.6
understand the requirement and working of Universal Identification Number
6.7
know the definition, law, regulation and penalties of Insider Trading while
understanding the meaning of:
− an ‘insider’
− ‘connected person’
− ‘unpublished price sensitive information’
6.8
understand the prohibition on insiders covered by the rules and guidelines
including dealing, communicating and counselling
6.9
know the liability in respect of insider trading and identify the defence to insider
trading
6.10
know the powers available to SECP to prosecute insider trading
13
ICM – Stock Brokers' Certification
ELEMENT 7
Commodity Markets and Products
On completion, the candidate should:
7.1
understand the functioning of a regulated commodities market
7.2
know the National Commodity Exchange Limited and the listed products
7.3
understand the basic features and pricing mechanism of the different types of
contracts traded on the NCEL, including delivery and settlement
7.4
understand the requirements for becoming a broker at the commodities
exchange
7.5
know acts that may lead to suspension or cancellation of registration
14
ICM – Stock Brokers' Certification
ELEMENT 8
Investor Protection
On completion, the candidate should:
8.1
know the requirements of Fair Dealing including:
−
−
−
−
−
−
−
Risks & Rewards of Investing
Best Price
Maintenance of Records
Time Stamps
Recording of Telephone Calls
Account Statements & Contract Notes
Misstatements & Mis-selling/ False Selling
8.2
know the process and handling of Investor Complaints
8.3
know the Investor Protection Fund of stock exchanges
15
ICM – Stock Brokers' Certification
ELEMENT 9
Economics and Finance
On completion, the candidate should:
9.1
know the Taxation laws relevant to capital markets including:
−
−
−
−
9.2
Income Tax
Capital Gain Tax
Capital Value Tax
Corporate Tax
understand and interpret the Financial Statements and conduct basic Financial
Statement Analysis including:
− Revenue and profit growth
− Earnings and Distributions
− Book value and Intrinsic value
9.3
understand and be able to apply basic mathematics and statistics including:
− Mean, Median and Mode
− Dispersion and regression analysis
9.4
understand and be able to apply basic financial mathematics including:
− Time value money, annuities and perpetuities
− Calculations of annuities and perpetuities
− Present & future value of cash flows
9.5
know Principal Factors Affecting Stock Markets & Prices including:
−
−
−
−
−
−
9.6
Business Cycles and its Indicators
Effect of the Business Cycle
Money Markets
Equities Markets
Price/ Earnings & Price/ Book value multiples
Dividend/Capital gain Yield
know the Macroeconomic indicators including:
−
−
−
−
GDP
Money Supply
The Role of State Bank of Pakistan
International/ Regional Economies and Markets
16
ICM – Stock Brokers' Certification
RECOMMENDED READINGS
The next section of this study guide covers a brief extract from some of the below
mentioned documents. Candidates are advised to study the respective documents (in
detail and original) which are available free-to-download from ICM's website and / or
the respective organization's websites.
1. Anti-Money Laundering Act, 2010
2. Anti-Money Laundering Ordinance, 2007
3. Anti-Money Laundering Regulations, 2008
4. Anti-Money Laundering Rules, 2008
5. Bond Automated Trading System (BATS) Regulations, 2009
6. Broker Agents Registration Rules, 2001
7. CDC Act, 1997
8. CDC Regulations
9. Code of Corporate Governance, 2002
10. Directive to Brokers on Conduct of Business 2003
11. Income Tax Ordinance, 2001
12. ISE/ KSE/ LSE Listing Regulations
13. KSE Investor Protection Fund Regulations
14. KSE Cash Settled Future Contract Regulations, 2008
15. KSE Members Default Management Regulations, 2009
16. KSE Deliverable Future Contract Regulations, 2009
17. General Regulations of KSE (Amended), 2009
18. Karachi Automated Trading System (KATS) Regulations, 1998
19. KSE Investor Protection Fund Regulations
20. Margin Trading Regulations, 2004
21. NCCPL Procedure, 2003
22. NCCPL Regulations, 2003
23. NCEL General Regulations, 2007
24. NCEL Commodity Exchange and Futures Contracts Rules, 2005
25. Regulations Governing Over the Counter Market, 2009
26. Regulations Governing System Audit of Brokers of Exchanges, 2004
27. SECP Act, 1997
28. Securities & Exchange Ordinance, 1969
29. Short Selling Regulations, 2002
30. Stock Exchange Members (Inspection of Books and Record) Rules , 2001
31. Securities & Exchange Rules, 1971
32. Voluntary Pension System Rules, 2005
17
ICM – Stock Brokers' Certification
STUDY MATERIAL
18
ICM – Stock Brokers' Certification
ACRONYMS
AMC
CDC
CDS
CGT
CRA
CRR
CSF
CVT
DVP
GDP
GDI
GNP
ICM
IFRS
ISE
KSE
KMI
LSE
MUFAP
NAV
NBFC
NCCPL
NCEL
NCSS
OTC
REIT
RMS
SECP
SBP
SLR
TFC
VPS
Asset Management Company
Central Depository Company of Pakistan Limited
Central Depository System
Capital Gain Tax
Credit Rating Agency
Cash Reserve Ratio
Cash Settled Future Contracts
Capital Value Tax
Delivery-Versus-Payment
Gross Domestic Product
Gross Domestic Income
Gross National Product
Institute of Capital Markets
International Financial Reporting System
Islamabad Stock Exchange (Guarantee) Limited
Karachi Stock Exchange (Guarantee) Limited
Karachi Meezan Index
Lahore Stock Exchange (Guarantee) Limited
Mutual Funds Association of Pakistan
Net Asset Value
Non-Banking and Finance Companies
National Clearing Company of Pakistan Limited
National Commodity Exchange Limited
National Clearing and Settlement System
Over-The-Counter
Real Estate Investment Trust
Risk Management System
Securities & Exchange Commission of Pakistan
State Bank of Pakistan
Statutory Liquidity Ratio
Term Finance Certificates
Voluntary Pension Scheme
19
ICM – Stock Brokers' Certification
ELEMENT 1
Introduction to Markets
On completion, the candidate should:
1.1
know the Products, Participants and Functions of the capital markets
FUNCTION
The basic function of the finance industry is to move money within the financial system
by collecting from one group of people or institutions who have surplus money to invest
and providing this collected money to groups of people or institutions with a need for
money (called a ‘flow of funds’). Money is lent indirectly from one person to another
through a financial ‘intermediary’ (a ‘go between’). This intermediation is the basic
function of a financial institution.
PRODUCTS
Cash Deposits
A cash deposit is held at a financial institution and is either in form of a demand deposit
or term deposit. The demand deposit can be withdrawn at any time, in other words the
deposited amount is available to the account holders on demand. The term deposits are
generally for short to medium term with maturities ranging anywhere from few days to
few years. When a term deposit is purchased, the lender (the customer) understands
that the money can only be withdrawn after the term has ended or by giving a
predetermined number of days notice.
Cash deposits are comparatively safer investments as compared to some securities and
are therefore very appealing to conservative, low-risk profiled investors, with the return
on investment being the prevailing interest rate that is normally much lower than the
rate of inflation. By having the money tied up for fixed period of time (term), investors
generally get a higher rate of returns compared with a demand deposit.
Corporate TFCs
Usually, the corporate TFCs/ bonds are issued by corporations to raise money in order
to finance its business. The term the ‘TFC/Bond’ is usually applied to longer-term debt
instruments, generally with a maturity date falling at least one year after their issue
date. The term "commercial paper" is used for similar instruments but which has a
shorter maturity.
Corporate TFCs/ bonds are often listed on stock exchanges (are called "listed" TFCs/
bonds), and the coupon (i.e. interest payment) is usually taxable. Sometimes this
coupon can be zero, the zero coupon bond also called ‘discount bond’ is bought at a
20
ICM – Stock Brokers' Certification
price below its face value (discount) and the face value is repaid at the maturity date.
Unlike coupon bond a discount bond does not make any interest payments; it just pays
off the face value. Some corporate TFCs/ bonds have an embedded call option that
allows the issuer to redeem the debt before its maturity date. Other bonds, known as
convertible bonds, allow investors to convert the bond into equity.
Government Bonds/Securities
A bond is a debt security or a formal contract where the issuer (borrower) agrees to
repay the holder (lender) the money with an interest rate (coupon) at fixed intervals.
The Bond Market is important to economic activity because it enables the private
businesses/ corporations or the Government to borrow money from the private
individuals or financial intermediaries to finance their activities.
A government bond is simply a contract between the State and investor to repay
borrowed money to the lender who can either be individuals or institutions. Raising
money by government through issuance of bonds and/or borrowing from intermediaries
(banks) is normal for governments especially when the revenue resources are limited.
Equities
Equity Security in law is defined in Securities and Exchange Ordinance, 1969 as:
"Equity security" means any stock or transferable share (preferred or common)
or similar security representing ownership; any security convertible, with or
without consideration, into such a security, or carrying any warrant or right to
subscribe to or purchase such a security; any such warrant or right itself, and
such other security as may be prescribed.
Equity investment generally refers to the buying and holding of shares/securities of
company on a stock market by individuals and funds in anticipation of income from
dividends and capital gain. By buying shares/equities of the company, the investor
becomes part owner of the company. When the investment is made in shares of infant
companies, it is referred to as venture capital investing and is generally understood to
be of higher risk than investment in listed going-concern companies that have a long
proven track record of performance.
Commodities
Commodity is a basic good used in commerce for which there is demand, but which is
supplied without qualitative differentiation across a markets i.e. it is essentially the
same no matter who produces it and that it is interchangeable with other commodities
of the same type. One of the important characteristics of a commodity is that its price is
determined as a function of market and is normally universal and fluctuates on a daily
basis on global supply and demand considerations; examples are petroleum, gold, sugar,
wheat or copper. The commodities can be differentiated from the manufactures by the
21
ICM – Stock Brokers' Certification
simple fact that manufactured products have many aspects of product differentiation,
such as the brand, the user interface, the perceived quality etc.
Generally, Commodities are basic resources and agricultural products such as iron
ore, crude oil, coal, ethanol, salt, coffee beans, sugar, soya beans, aluminium, copper,
rice, wheat, gold, silver, palladium, and platinum. Soft commodities are goods that are
grown, like wheat, maize while hard commodities are the ones that are extracted
through mining. Because these are used in consumption or as raw material therefore
these are sensitive to consumer sentiments. Commodity markets can be highly volatile
and respond very quickly to changes in supply and demand equilibriums. Investors
normally can gain exposure to future changes in commodity markets through the
commodity future market or a commodity Fund.
Foreign Exchange
Trading in Currencies of different countries takes place in Foreign Exchange markets.
These markets are characterized by over-the-counter trading and very low cross-border
restrictions. Regulation is limited since no single exchange rate system exists, as
currencies may operate on both a fixed and floating exchange rate regimes. Financial
institutions such as banks (retail, commercial and central) Hedge funds, Investment
management firms, Retail Foreign and Non-bank Foreign exchange companies and
Money transfer companies participate in this market. The value of currencies is
determined by normal supply and demand principles. Trading undertaken on
speculation by investors also has a considerable impact on the value of currencies.
PARTICIPANTS
Investor
An investor is any party that makes an Investment. However, the term has taken on a
specific meaning in finance to describe the particular types of individual people and
corporate entities that regularly purchase equity or debt securities for financial gain.
Less frequently the term is also applied to parties who purchase real estate, currency,
commodity derivatives, personal property, or other assets.
Equity Investor
In Equities, "Investor" means a person, not being Member, his agent or
representative, who, has purchased or sold any of the securities listed
at the Exchange. [Investors Protection Fund Regulations]
An equity investor is generally involved in buying and holding of shares or stock on
a stock market in anticipation of income from dividends and capital gain as he expects
that the value of the stock will rise. It also refers to an activity of acquisition of equity
participation in a private company or a start-up company; when this investment is in
infant companies. This investment in infant companies is generally understood to be
higher risk than investment in already listed company.
22
ICM – Stock Brokers' Certification
Institutional Investor
An institutional investor is normally a corporate entity, such as a bank, insurance
company, pension fund or mutual fund that is financially sophisticated and makes large
investments, often held in large portfolios of investments. Because of their
sophistication, institutional investors often participate in private placements of
securities, in which certain aspects of the securities laws may be inapplicable.
Retail Investor
A retail investor is an individual investor who has investments in shares of a given
security or units of a fund. Investments are slightly different to savings as these carry
possibilities of growth and accompanying risk. Retail investors in Pakistan can generally
be divided into two categories of share ownership.
− A retail investor holds shares of their securities directly through the issuer or its
transfer agent in their Depository Company account. Some registered
shareholders also have physical copies of their stock certificates.
− An investor in the mutual fund units.
On completion, the candidate should:
1.2
know the role of the Securities Market and Financial System including:
−
−
−
−
−
−
−
−
−
stockbrokers
retail/commercial banks
investment banks
fund managers/asset management companies
pension/mutual funds
insurance companies
stock exchanges
custodians
industry trade bodies
The role of Securities Market and the financial system in an economy have been
introduced under Section 1.3
STOCK BROKERS
A "Broker" means any person engaged in the business of effecting transactions
in securities for the account of others; [Securities and Exchange Ordinance,
1969]
23
ICM – Stock Brokers' Certification
A stock broker or stockbroker is a regulated professional who buys and sells shares and
other securities through market makers or Agency Only Firms on behalf of investors.
Stock broker is a member of the Exchange and is authorized to deal in scrip’s of listed
companies on behalf of their clients/ investors.
Stock broker can be an individual member or a body corporate. To buy and sell shares of
a particular company, an investor has to contact his stock broker. A broker buys and
sells securities on behalf of the investor and charges commission for the services
rendered. The stock broker’s job is to assist clients in meeting their investment
objectives by handling orders for stocks, maintaining account records and providing
information and advisory service.
- Execution-only; which means that the broker will only carry out the client's
instructions to buy or sell.
- Advisory dealing; where the broker advises the client on which shares to buy and
sell, but leaves the final decision to the investor.
- Discretionary dealing; where the stockbroker ascertains the client's investment
objectives and then makes all dealing decisions on the client's behalf.
RETAIL/ COMMERCIAL BANKS
A commercial bank is a type of financial intermediary and a type of bank. It is a bank
that provides checking accounts, savings accounts, and money market accounts and it
accepts time deposits. Commercial banks also function as retail bank. Retail banking
refers to banking in which banking institutions execute transactions directly with
consumers, rather than corporations or other banks. Services offered by commercial
banks include: savings and cheque accounting, mortgages, personal loans, debit cards,
credit cards, and so forth. Most banks offer both commercial and retail banking services.
INVESTMENT BANKS
An investment bank is a financial institution that raises capital, assists in initial sale of
securities in primary market (IPO) trades in securities and arranges and manages
corporate mergers and acquisitions. Investment banks earn profit by raising money
through issuing and selling of securities in the capital markets (both equity and bond)
and as well as providing advice on investments and transactions such as mergers and
acquisitions.
Investment banks offer strategic advisory services for mergers, acquisitions, divesture or
other financial services for clients, such as the trading of fixed income, commodity, and
equity securities including mutual funds.
ASSET MANAGEMENT COMPANIES (AMCs)/ FUND MANAGERS
Asset Management Company provides the professional management of various
securities (shares, bonds etc.) and assets (e.g., mutual funds), to meet specified
24
ICM – Stock Brokers' Certification
investment goals for the benefit of the investors. Investors may be institutions
(insurance companies, pension funds, corporations etc.) or private investors.
PENSION/ MUTUAL FUNDS
A mutual fund is a professionally managed type of Collective Investment Scheme that
pools money from many investors and invests it in stocks, bonds, short-term money
market instruments, and/ or other securities. The mutual fund will have a fund manager
that trades to buy and sell assets from the pooled money on a regular basis.
A pension fund is a pool of assets forming an independent legal entity that are bought
with the contributions to a pension plan for the exclusive purpose of financing pension
plan benefits.
INSURANCE COMPANIES
Insurance is defined as the equitable transfer of the risk of a loss, from one entity to
another, in exchange for payment of a premium, and can be thought of as a guaranteed
small cost (premium) to prevent a large, possibly devastating loss. Insurance companies
perform risk management that is primarily used to hedge against the risk of a contingent
loss. An ‘insurer’ is the company selling the insurance while; an ‘insured’ is the person or
entity buying the insurance. Insurance companies are one of the major institutional
investors in equity and debt markets.
STOCK EXCHANGES
A stock exchange is a corporation or mutual organization which provides "trading"
facilities for stock brokers and traders, to trade stocks and other securities. Stock
exchanges also provide facilities for the issue and redemption of securities as well as
other financial instruments including the payment of income and dividends. The
securities traded on a stock exchange include: shares issued by companies, unit trusts,
pooled investment products and TFCs/bonds. For a security to be able to trade on a
certain stock exchange, it has to be listed at that exchange. Historically there used to be
a central location at least for recordkeeping, but now trade is less and less linked to such
a physical place, as modern markets are electronic networks, which gives the Stock
Exchanges efficiencies and also the advantages of speed and reduced cost of
transactions.
Trade on a not demutualized exchange is done by members only. The initial offering of
stocks and bonds to investors is by definition done in the primary market and
subsequent trading is done in the secondary market. Stock not traded through the stock
exchange is said to be traded off-exchange or over-the-counter (OTC) market. This is
normally the manner that bonds are traded.
CUSTODIAN
Custodian is a trust company, bank or similar financial institution responsible for holding
and safeguarding the securities owned within a mutual fund on behalf of investors. A
25
ICM – Stock Brokers' Certification
mutual fund's custodian may also act as the mutual funds transfer agent, maintaining
records of unit-holder transactions and balances. Since a mutual fund is essentially a
large pool of funds from many different investors, it requires a third-party custodian to
hold and safeguard the securities that are mutually owned by all fund's investors. This
structure mitigates the risk of dishonest activity by separating the fund managers from
the physical/holding of securities and investor records.
INDUSTRY TRADE BODIES
Each segment of financial industry has its own sector specific Associations; like leasing
sector has Leasing Association of Pakistan (LAP) and Commercial Banking has Pakistan
Banks Association (PBA). The Mutual Funds Association of Pakistan (MUFAP) is the
representative trade body of the Asset Management Companies managing Mutual
Funds in Pakistan. The money managed by its members in a wide variety of investment
vehicles including stocks, bonds, money market instruments, government securities and
bank deposits.
These trade bodies try to promote transparency, ethical conduct and growth of
industry. These trade bodies are also policy advocacy mechanisms for each financial
sector they represent. Trade Bodies have invariably been established as Associations
not-for-profit licensed under the Section 42 of the Companies Ordinance 1984.
On completion, the candidate should:
1.3
understand the relationship of Securities Market and Economic Development
The securities markets have experienced significant changes over recent decades, driven
by advances in information and communications technology and widespread reductions
in international barriers to trade and investment. Securities markets are now recognized
to affect growth through various investment channels like direct investments, portfolio
investments, etc., that determine the accumulation and allocation of capital. Countries
with efficient financial systems are able to better harness their long-term growth
potential through efficiency of the system to allocate resources to growth sectors.
Regulations and regulatory enforcement are the foundations of any financial systems.
Regulation is needed to protect investors, promote efficient capital markets, and
enhance investor confidence in the markets. Regulators are expected to balance the
needs of investor protection (which calls for stringent regulations) with the need to
promote market efficiency (which call for minimal interference in markets). The
objectives, as a general rule, of any regulations are to promote the domestic market
that enjoys domestic and international confidence and is competitive.
26
ICM – Stock Brokers' Certification
SECURITIES MARKETS AND ECONOMIC DEVELOPMENT
As a matter of internationally accepted principle, the efficient securities markets are
expected to accelerate economic growth by providing a boost to domestic savings and
increasing the quantity and the quality of investment in a country. Securities markets do
encourage savings by providing individuals with additional financial instruments that
may better meet their investment objective, risk profiles and liquidity restraints. A
better savings mobilization increases the savings rate which eventually leads to higher
investments, greater productivity and thus leads to rising GDP growth rate. The
securities markets also provide an avenue for growing companies to raise capital at
lower cost through public offerings of the shares in the stock market. In addition,
companies in countries with highly developed stock markets are less dependent on bank
financing, which may reduce the risk of a credit crunch in the financial system. Securities
markets, therefore, are able to positively influence economic growth through
encouraging savings amongst individuals and by simultaneously providing avenues for
firm financing.
The securities markets are supposed to ensure through the takeover mechanism that
past investments are also most efficiently used. Theoretically, the threat of takeover is
expected to provide management with an incentive to maximize firm value. The
presumption is that, if management does not maximize firm value, another economic
agent may take control of the firm, replace management and reap the gains from
creating more efficiency in the firm. Thus, a free market in corporate control, by
providing financial discipline, is expected to provide the best guarantee of efficiency in
the use of assets. Similarly, the ability to effect changes in the management of listed
companies is expected to ensure that managerial resources are used efficiently.
Efficient and well-organized securities markets also reduce the costs of acquiring
information. This is effectively, done by generation and dissemination of firm specific
information that is quickly and efficiently reflected in the stock prices. Stock markets are
only efficient if prices of the traded security incorporate all available information quickly
into them. Reducing the costs of acquiring information facilitate and improve the
acquisition of information about investment opportunities and thereby improve
resource allocation in the economy. Stock prices determined in a transparent manner at
Stock Exchanges combined with other publicly available information helps the investor
to make better investment decisions; this ensures better allocation of resources among
corporations and as a result efficiency is rewarded that help growth of the efficient
companies as well as the economy.
Liquid Securities market reduces the downside risk of stock prices and also the costs of
investing in projects that do not pay off for some time. With a liquid market, the
investors do not lose access to their savings and investments because they can easily;
sell their stake (shares) in the company. Liquid securities markets provide ease of
investment thus improve the allocation of capital and enhance prospects for long-term
growth. The illiquid securities markets have adverse effect on the economic growth of
27
ICM – Stock Brokers' Certification
the country as the initial investors get stuck and may not, be able to withdraw their
investments despite bad management of the companies, thus money is locked in
inefficient enterprises.
The absence of a well-developed stock market is of serious disadvantage for any
economy as ease of equity generation is essential for the emergence and growth of
firms. The efficiency of securities markets is a necessity for maintaining the
competitiveness of an economy, especially given the increased international
competition, rapid technological progress, and the increased integration of international
economies and globalization.
On completion, the candidate should:
1.4
know the basics of The Primary Market
The Equity Market, also known as the Stock Market or the Stock Exchange, is the market
where investors can buy shares of listed companies that have already floated their
shares through an IPO.
Primary Market:
When new issues of a security, such as bonds or stock/shares are sold to the initial
buyers by a Company [as in the case of an Initial Public Offering (IPO)] or a government
agency, it is known as a transaction in the Primary Market.
Advantages of Primary Market (as opposed to Secondary Market):
− Shares/Units are, normally, offered at their Face Value
− Tax Credit can be claimed in Pakistan on the invested amount under Section 62
of the Income Tax Ordinance, 2001
Disadvantages of Primary Market (as opposed to Secondary Market):
If the Issue is oversubscribed, the investors will receive shares only if they succeed in the
balloting. Hence, one can, normally, expect to buy only a small quantity of shares
through the Primary Market.
(Further details of Secondary Markets are available in Element 3 of this Study and
Reference Guide)
28
ICM – Stock Brokers' Certification
On completion, the candidate should:
1.5
know the basics of The Secondary Market
Secondary Market
When there is a sale/purchase transaction of securities that have previously been issued
(and thus second hand), between two investors through their Brokers on the Stock
Market, it is known as a transaction in the Secondary Market.
Advantages of Secondary Market (as opposed to Primary Market):
− Subject to availability of a willing seller at the right price, any number of shares
can be bought/sold
Disadvantages of Secondary Market (as opposed to Primary Market):
− Buyer has to pay the Market Price of the share, which is determined on the basis
of demand and supply
− Tax Credit is not available on such transactions
(Further details of Secondary Markets are available in Element 4 of this Study and
Reference Guide)
29
ICM – Stock Brokers' Certification
ELEMENT 2
Regulatory Framework
On completion, the candidate should:
2.1
understand the scope, core functions and powers of the Securities and
Exchange Commission of Pakistan (SECP) as conferred in SECP Act, 1997
Introduction to SECP
The Securities and Exchange Commission of Pakistan (SECP) was set up in pursuance of
the Securities and Exchange Commission of Pakistan Act, 1997 (SECP Act). The Act
provides for the constitution, structure, powers and functions of the SECP and
simultaneously provides the basis for the administrative authority and independence of
the SECP in carrying out its regulatory and statutory responsibilities.
The SECP is the successor organisation of Corporate Law Authority became operational
in its present shape in January 1999 and was initially only concerned with the regulation
of the Corporate Sector and Capital Markets, however, over time; its mandate has
expanded to include supervision and regulation of Insurance Companies, Non-Banking
Finance Companies, REITs and the Private Pension Schemes. The SECP is also entrusted
with the oversight of various external service providers to the corporate and financial
sectors, like Chartered Accountants, Cost and Management Accountants, Credit Rating
Agencies, Corporate Secretaries, Stock and Commodity Brokers and Insurance Surveyors
etc. SECP as the regulator and promoter of the Capital Markets is also one of the
sponsors of the Institute of Capital Markets and Pakistan Institute of Corporate
Governance.
Powers and function of SECP (Commission) can be divided between:
1.
2.
3.
4.
Functional responsibility (power)
Approval according body
Power to call for information
Enforcement and investigative powers
In order to understand the Powers and Functions of SECP candidates are advised to
refer to Section 20 of Part VI (Powers and Functions) of SECP Act 1997.
30
ICM – Stock Brokers' Certification
On completion, the candidate should:
2.2
understand the SECP Regulations, Rules and Procedures, Powers and Functions,
Appeals, Jurisdictions including:
−
−
−
−
Functional responsibility and powers
Approval according body
Power to call for information
Enforcement and investigative powers
To understand the Securities & Exchange Commission of Pakistan (SECP) Rules,
Regulations and Procedures, Powers, Functions, Appeals and Jurisdictions candidates
are advised to refer the Section 29 to 33 of Part VIII (Enforcement and Investigation) of
SECP Act 1997.
On completion, the candidate should:
2.3
understand the key elements of the Securities and Exchange Ordinance, 1969
Candidates are advised to refer the following sections of the Securities and Exchange
Ordinance, 1969
-
Section 2 : Definitions
Section 15A to 15E (Chapter III-A): Insider Trading
Section 16: Credit, pledging and lending of customers’ securities
Section 17: Prohibition of fraudulent acts
Section 18: Prohibition of false statements
Section 18A: Prohibition of making fictitious and multiple applications for new
issues
- Section 19: Maintenance of secrecy
On completion, the candidate should:
2.4
know the relevant sections of Securities and Exchange Rules, 1971
To know the relevant sections of Securities and Exchange Rules, 1971 candidates are
advised to refer the Section 3 and 4 of Securities and Exchange Rules, 1971
31
ICM – Stock Brokers' Certification
On completion, the candidate should:
2.5
understand and interpret the SECP’s Directives to Brokers on Conduct of
Business, Investor Protection, etc.
SECP as a matter of routine, in exercise of its responsibilities and discharging of its
functions issues, instructions to its regulated entities like; stock exchanges and their
members, Central Depository Company, National Clearing Company and other regulated
entities, that are called ‘ Circulars’ or ‘ Directives’ etc. These ‘Circulars/Directives… etc’
issued by the SECP have the force of law as these are issued under enabling provisions
of the law. The circulars and directives etc. issued by SECP can be found on the website
of the SECP (www.secp.gov.pk)
Regulatory directives outline the statutory requirements and provide format of
comprehensive practices as required by regulators. The professionals are expected to
understand these directives and act in the prudent manner accordingly. Also this is the
responsibility of the broking agent to acquaint themselves regularly on the directives.
These directives are usually available on the websites of SECP and stock exchanges soon
after their issuance. The websites of the exchanges are regularly updated in order to
keep abreast the market participants with the regulatory changes taking place.
As envisaged for capital markets development in Pakistan, the three stock exchanges
adjusted their board and management structures, promoted the corporatization of
member brokers and created investor protection funds. SECP has always been issuing
most of the rules that the stock exchanges were required to adopt, like, trade reporting
rules including penalties for insider trading, inspection rules, licensing standards for
traders and agents, listing requirements and guidelines, and model contractual
agreements.
Detailed guidelines on the brokers’ conduct of business are provided in the Third
Schedule of the Brokers and Agents Registration Rules, 2001 and shall be discussed in
detail in Element 6 of this study guide.
On completion, the candidate should:
2.6
know the relevant sections of the Companies Ordinance, 1984 to capital
markets
Companies Ordinance, 1984
To know the sections of the Companies Ordinance, 1984 relevant to capital markets,
candidates are advised to refer to the following sections in the Companies Ordinance
available at ICM's as well as SECP's website.
32
ICM – Stock Brokers' Certification
Part V: Provides information about the Prospectus, Allotment, Issue and Transfer of
Shares and Debentures, Deposits etc.
(Candidates are advised to refer section 52 to 88 of the Companies Ordinance, 1984)
Part VI: Provides information about the ‘Share Capital and Debentures’, their Nature
Numbering and Certificate of Shares.
(Candidates are advised to refer Section 89 to 95A of the Companies Ordinance, 1984)
On completion, the candidate should:
2.7
know the listing regulations of the Karachi, Lahore and Islamabad Stock
Exchanges and should be able to apply these regulations
Listing Regulations of KSE
Candidates are advised to refer to the Listing Regulations of Karachi Stock Exchange
(KSE) available at KSE as well as on ICM’s website.
Listing Regulations of LSE
Candidates are advised to refer to the Listing Regulations of Lahore Stock Exchange (LSE)
available at ICM as well as on the website of LSE.
Listing Regulations of ISE
Candidates are advised to refer to the Listing Regulations of Islamabad Stock Exchange
(ISE) available at ICM as well as on the website of ISE.
On completion, the candidate should:
2.8
know the Central Depositories Act, 1997 and CDC Regulations 2003
For general details, candidates are advised to refer to the Central Depositories Act, 1997
and CDC Regulations 2003, available at ICM's as well as CDC's website.
Specific relevant Sections from CDC Regulations 2003 that need to be specifically
studied are should also be read.
Chapter 6: Establishment and Maintenance of Accounts and Sub-Accounts
Section 6.1A: Establishment of Accounts for the Clearing Company
33
ICM – Stock Brokers' Certification
On completion, the candidate should:
2.9
know the National Clearing Company of Pakistan Limited Regulations
For general details, candidates are advised to refer to the National Clearing Company of
Pakistan Limited (NCCPL) Regulations available at ICM's as well as website of NCCPL.
Specific relevant Sections of NCCPL Regulations 2003 are:
- Section 2.8: Definitions
- Section 3: The NCC System
34
ICM – Stock Brokers' Certification
ELEMENT 3
Primary Market
On completion, the candidate should:
3.1
understand the functions and processes of the Primary Market including
−
−
−
−
Issue of Shares
Prospectus/Offering Documents
Pre-Initial Public Offer and Private Placement
Initial Public Offering
PRIMARY MARKET
The primary market is that part of the capital markets that deals with the issuance of
new securities. Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue.
The process of selling new issues to investors involves underwriting. Underwriting is a
component of mechanics of placing a newly issued security, such as stocks or bonds,
with investors where a syndicate of banks and or brokers underwrite the transaction,
which means they take on the risk of distributing/ selling the securities. Should they not
be able to find enough investors, they will have to hold the undistributed/unsold
securities themselves.
In the case of a new stock issue, this sale is undertaken through an initial public offering
(IPO). Dealers earn a commission that is built into the price of the security offering.
Some important defining features of primary markets are:
− The securities are sold for the first time. Therefore it is also called the new issue
market (NIM).
− In a primary issue, the securities are issued by the company directly to investors.
− The company receives the money and issues new security certificates to the
investors.
− Funds received through primary issue are used by companies for the purpose of
setting up new business or for expanding or modernizing the existing business.
− This is the market for new long term capital.
− The primary market performs the crucial function of facilitating capital formation
in the economy.
− The new issue market does not include certain other sources of new long term
external finance, such as loans from financial institutions. Borrowers in the new
35
ICM – Stock Brokers' Certification
issue market may raise capital for converting private capital into public capital;
this is also known as "going public."
Methods of issuing securities in the market are:
− Initial public offering;
− Rights issue (for existing companies);
− Preferential issue.
PROSPECTUS/ OFFERING DOCUMENT
A prospectus is a legal document that institutions and businesses use to describe the
securities they are offering for participants and buyers. A prospectus commonly
provides investors with material information about mutual funds, stocks, bonds and
other investments, such as a description of the company's business, financial
statements, bio data of officers and directors, detailed information about their
compensation, any litigation that is taking place, a list of material properties and any
other material information. In the context of an individual securities offering, such as an
initial public offering, a prospectus is distributed by underwriters or brokerages to
potential investors.
Candidates are also advised to refer to the Guidelines for the preparation of Prospectus
under Part V of the Companies Ordinance 1984 titled Prospectus, Allotment, Issue and
Transfer of Shares and Debentures, Deposits, etc. (Section 52-66 and 69 are relevant)
PRE-INITIAL PUBLIC OFFER AND PRIVATE PLACEMENT
Pre-Initial Public Offering or simple Pre-IPO is an offering of a company's shares prior to
the firm's initial public offering. Investing in a pre-IPO tends to be risky, because the
planned IPO may for some reason never take place and, in addition, procured shares
from a pre-IPO are not saleable usually for a period of six months from date of public
subscription under sub-section 7 (ii) of Section 6A of listing regulations of the Exchanges.
Private placement is the concept of raising capital via private rather than public
placement of shares. The result is the sale of securities to a relatively small number of
investors. Investors involved in private placements are usually large banks, mutual
funds, insurance companies, pension funds or high net-worth individuals.
Since a private placement is offered to a few selected individuals, the placement does
not have to be registered with the Securities and Exchange Commission of Pakistan. In
many cases detailed financial information is not disclosed and the need for a prospectus
is waived. Since the placements are private rather than public, the average individual
investor is only made aware of the placement usually after it has occurred.
(Word of Caution
In certain cases shares offered in pre-IPO’s are priced substantially lower than the
subscription price in the subsequent IPO, meaning that many analysts who participated
36
ICM – Stock Brokers' Certification
were able to acquire shares at very low prices. The conflict of interest is clear: analysts
are likely to have a personal interest in promoting stocks they own, thus tainting the
independence of their recommendations. Corporations are anxious to have analysts
come on board as shareholders, in part because of the creditability analyst ownership
conveys to the investing public. Analyst ownership may also result in positive
investment recommendations that become a marketing campaign for the firm's stock.)
INITIAL PUBLIC OFFERING
Initial public offering (IPO), also referred to simply as a "public offering" or "flotation," is
when a company issues common stock or shares to the public for the first time. They are
often issued by smaller, younger companies seeking capital to expand, but can also be
done by large privately-owned-companies looking to become publicly traded.
In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it
determine what type of security to issue (common or preferred), best offering price and
time to bring it to market.
An IPO can be a risky investment. For the individual investor, it is tough to predict what
the stock or shares will do on its initial day of trading and in the near future since there
is often little historical data with which to analyse the company. Also, most IPOs are of
companies going through a transitory growth period, and they are therefore subject to
additional uncertainty regarding their future value. However, in order to make money,
calculated risks need to be taken.
It is also defined as the selling of securities to the public in the primary market. It is
when an unlisted company makes either a fresh issue of securities or an offer for sale of
its existing securities or both for the first time to the public. This paves way for listing
and trading of the issuer’s securities. The sale of securities can be either through book
building or through normal public issue.
BOOK BUILDING PROCESS
Book Building is basically a process used in IPOs for efficient price discovery. It is a
mechanism where, during the period for which the IPO is open, bids are collected from
investors at various prices, which are above or equal to the floor price. The offer price is
determined after the bid closing date.
Cut-Off Price
In a Book building issue, the issuer is required to indicate either the price band or a floor
price in the prospectus. The actual discovered issue price can be any price in the price
band or any price above the floor price. This issue price is called “Cut-Off Price”. The
issuer and lead manager decides this after considering the book and the investors’
appetite for the stock.
37
ICM – Stock Brokers' Certification
Floor Price
Floor price in case of book building is the minimum price at which bids can be made.
Price Band
The prospectus may contain either the floor price for the securities or a price band
within which the investors can bid. The cap should not be more than 120% of the floor
price. The price band can also be revised. It is up to the company to decide on the price
or the price band, in consultation with market makers.
Minimum Number of Days
The book should be kept open for at least three days.
RATINGS
It is an important criterion to be considered for an IPO. The grade is nothing but the
rank given to the Issuer by the third party companies like Standard & Poor, Moody’s,
JCR-VIS, PACRA, Etc.
NORMAL PUBLIC ISSUE
In this type of initial public offer/issue of a security, the price at which securities will be
allotted is known in advance to the investor. The demand is known only at the close of
the time for the issue of security. This methodology of normal public offer is less
frequently used these days.
RIGHT ISSUE
Rights Issue is an issue of securities when a listed company which proposes to issue
fresh securities to its existing shareholders as on a record date. The rights are normally
offered in a particular ratio to the number of securities held prior to the right issue. This
route is best suited for companies who would like to raise capital without diluting stake
of its existing shareholders.
PREFERENTIAL ISSUE
A Preferential issue is an issue of securities or of convertible securities by a listed
company to a select group of persons, which is neither a rights issue nor a public issue.
This is a faster way for a company to raise equity capital.
On completion, the candidate should:
3.2
know the general requirements and procedure for companies to list shares on
the Karachi, Lahore and/ or Islamabad Stock Exchanges
Candidates are advised to refer to the following listing regulations of relevant
exchanges; available at ICM's as well as relevant Exchange's website.
38
ICM – Stock Brokers' Certification
- Regulation 3 and 4: Listing of Companies and Securities
- Regulation 5: Undertaking
On completion, the candidate should:
3.3
know the requirements for delisting from the stock exchanges
Candidates are advised to refer to the following listing regulations of relevant
exchanges; available at ICM's as well as relevant Exchange's website.
KSE and LSE Listing Regulations: Section 30
ISE Listing Regulations: Section 32
On completion, the candidate should:
3.4
understand the factors leading to listed companies being suspended or placed
on the Defaulters’ Counter
Generally, a listed company may be de-listed, suspended or placed on the Defaulters’
Counter, under Regulation 32 of Listing Regulations of the Exchanges, for any of the
following reasons:a) If its securities are quoted below 50% of face value for a continuous period of
three years. Provided that if the shares of the company quoted at 50% or above
of their face value then such a rate is maintained for a continuous period of
thirty working days.
b) If it has failed to declare dividend or bonus:i. for five years from the date of declaration of last dividend or bonus; or
ii. in the case of manufacturing companies, for five years from the date of
commencement of production; and
iii. for five years from the date of commencement of business in all other
cases
c) if it has failed to hold its annual general meeting for a continuous period of three
years
d) if it has gone into liquidation either voluntarily or under court order;
e) if it has failed to pay the annual listing fees as prescribed in the regulations
payable to the Exchange for a period of 2 years of penalty imposed under the
regulations or any other dues payable to the Exchange;
39
ICM – Stock Brokers' Certification
f) if it has failed to comply with the requirements of any of these regulations;
i. If the company for any reason whatsoever refuses to join the CDS after its
securities have been declared eligible securities by the CDC.
g) no company which has been de-listed or suspended shall be restored and its
shares re-quoted until it removes the causes of de-listing/suspension and
receives the assent of the Board for the restoration
No company is de-listed or placed on Defaulters’ Counter, under the Listing Regulations,
unless such company has been given an opportunity of being heard.
(For further details, candidates are advised to refer to the listing regulations of relevant
exchanges)
40
ICM – Stock Brokers' Certification
ELEMENT 4
Secondary Market
On completion, the candidate should:
4.1
know the role and importance of the Stock Exchange
As discussed earlier, a stock exchange is a ‘Corporation’ or ‘Mutual’ organization which
provides "trading" facilities for stock brokers and traders, to trade stocks and other
securities. Stock exchanges also provide facilities for the issue and redemption of
securities as well as other financial instruments including the payment of income and
dividends. The securities traded on a stock exchange include shares issued by
companies, unit trusts, pooled/collective investment products and TFCs/bonds.
To be able to trade a security on a certain stock exchange, it has to be listed there.
Usually there is a central location at least for recordkeeping, but now trade is less and
less linked to such a physical place, as modern markets are electronic networks, which
gives them advantages of speed and cost of transactions. Trade on an exchange is by
members only. The initial offering of stocks and bonds to investors is by definition done
in the primary market and subsequent trading is done in the secondary market. A stock
exchange is often the most important component of a capital market. Supply and
demand in stock markets is driven by various factors which, as in all free markets, affect
the price of stocks.
A share/ security not traded on an exchange, usually due to an inability to meet listing
requirements. For such securities, broker/ dealers negotiate directly with one another
over computer networks and by phone, and their activities are monitored by the
Exchange. Over-the-counter (OTC) stocks are usually very risky since they are the stocks
that are not considered large or stable enough to trade on a major exchange. They also
tend to trade infrequently, making the bid-ask spread larger. Also, research about these
stocks is more difficult to obtain as most of them are unlisted.
Role and Importance of a Stock Exchange
Stock exchanges provide a number of services and functions within the financial system;
In short they monitor and provide the marketplace for a corporation looking to raise
funds by going public
Many individuals and companies tend to believe that once funding has been obtained,
their goal is accomplished and the importance of further involvement with the stock
exchange is minimal. On the contrary the importance of the stock exchange lies in the
fact that it allows investors to maintain liquidity for their investments. When a stock is
listed on a major exchange, it allows any shareholder to sell his or her shares almost
41
ICM – Stock Brokers' Certification
instantly. In most cases, immediate small sales are available at or very near the per
share quoted price.
In addition to providing liquidity, stock exchanges also serve as a form of monitoring
agency. In order for a stock to be listed with a particular exchange, it must complete a
series of requirements and SECP filings. Presence on any given exchange indicates that
all qualifying criteria have been met. Ability to qualify for listing on a stock exchange can
signal a certain amount of stability in a company. While it's certainly not a guarantee of
the stock's future performance, it does lend the company some credibility.
Shares that aren't listed on some major exchange are far less liquid, and could involve a
much greater time and/or reduction in price to actually complete the sale. For this
reason, investors pay less for stocks that can't be readily traded on a major stock
exchange.
Because listing requirements vary for each exchange, listing on certain stock exchanges
can be an even greater indicator of the quality of the company. For example, it is
relatively easy for a company to be traded on over-the-counter systems, but it is much
more difficult to qualify for listing with the Karachi Stock Exchange. Sophisticated and
knowledgeable investors are aware of this, and will take it into account when
considering an investment.
On completion, the candidate should:
4.2
understand the Stock Trading process through stock exchanges including:
−
−
−
−
−
Electronic Trading Terminals
Entry of Quotes and Orders
Price/Time Priority
Order Types
Transaction and Order Reports
STOCK TRADING
An investor has first to choose a broker through whom he wants to trade with and enter
into broker-client agreement. It is the responsibility of the broker to explain different
terms and conditions of the trade transactions and their implications before entering
into an agreement with an investor. This agreement is mandatory. The features of this
agreement that reduce the chances of any dispute on terms and conditions which relate
to placement of order, trade confirmation, brokerage charges by a broker and delivery
of securities and payments.
42
ICM – Stock Brokers' Certification
When an investor has decided to buy shares in a particular company, he contacts his
broker. Investor can place an order to buy a fixed number of shares, or shares up-to a
certain value.
For selling, again the investor contacts his broker. The stock broker is obliged to sell at
the best price he can get, but an investor can decide what should be the minimum price
he is prepared to accept. Stock broker assists the investor in buying and selling of shares
at best price but in no way he is under any obligation to supervise the investment or to
advice or to make any recommendation to the investor/ clients with respect to the sale/
purchase of shares.
ELECTRONIC TRADING TERMINALS
Electronic trading terminals use information technology (computers) to bring buyers
and sellers together in a virtual market place, rather than on a trading floor. Electronic
trading, either directly with counterparties or through a broker, has transformed
traditional methods of trading through exchanges. Rather than reaching the exchange
and trade from the floor, institutional investors, brokers, and dealers can trade directly
through the Electronic Trading Terminals installed at member’s rooms at Stock Exchange
building or at remote premises of the broker.
Examples of electronic trading terminals in Pakistan are:
− Karachi Automated Trading System (KATS) at KSE
− Trading Workstations (TWS) at LSE
− Ultra Trading System (UTS) at ISE
PRICE/ TIME PRIORITY
(Candidates are advised to refer to Rule 4 of the Securities & Exchange Rules 1971)
The principle of price/ time priority refers to both orders and quotes. When an order (or
quote) is entered into the system, it is assigned a timestamp. This timestamp is used to
prioritize orders in the book with the same price - the order entered earliest at a given
price limit gets executed first. When a new order (or quote) is entered, the system first
checks the limits of all orders contained in the central order book. If the incoming order
is immediately executable, this means it is capable of being matched against an existing
order(s), one or more transactions are generated. To be immediately executable, the
order must be:
− A market order, where opposite already exist in the central order book;
− An order to buy at a price at or above the lowest offer in the central order book;
− An order to sell at a price at or below the highest bid in the book.
Orders may not necessarily be executed at a single price, but may generate several
partial transactions at different prices. When a large order executes against the total
43
ICM – Stock Brokers' Certification
available quantity at a given price level, the next best price level becomes best. This
process continues as long as the incoming order remains executable. If not executed
upon entry, an order is held in the central order book.
Also, it is possible for a single order to generate multiple executions at different points
in time. For example, an order may generate a partial execution upon entry, while the
remaining open order remains in the order book. The open portion may get executed a
minute later, an hour later, or even a day later, if its validity extends beyond the current
trading day.
All executions are subject to the restrictions of the Market Order Matching Range.
Market orders have the highest priority for matching. Since the purpose of the market
order is to be executed as quickly as possible at the best possible price, it must be
entered without execution restrictions. If several market orders are booked in the order
book, the system takes into account the timestamp of the orders to establish matching
priority. The earliest market order entered receives the highest priority.
In the case of limit orders, orders with the best possible prices (highest price limit for
buy orders, lowest price limit for sell orders) always take precedence in the matching
process over other orders with worse prices. Again, if the limit orders have the same
price limit, the criterion used for establishing matching priority is the order timestamp.
The orders already present in the order book are always executed at their specified limit
price. Price improvements for orders in the order book are only possible during an
auction process - opening or closing auction. Orders going into the order book are
always matched at the appropriate prices available in the order book, up to the
specified limit price.
ORDER TYPES
LIMIT
This is the default order type for all single option, spread and stock orders. The limit
price for buy orders is placed below the current market price. The limit price for sell
orders is placed above the current market price. Limit orders will be filled at the limit
price or better, but are not guaranteed a fill.
MARKET
Market order is used to guarantee an execution, but not guarantee a price or time of
execution. The risk of market orders is that you have no control over what the execution
price is.
STOP LOSS
Stop loss order is used to open or close a position by buying if the market rises or selling
if the market falls. The stop price for buy orders is placed above the current market
price. The stop price for sell orders is placed below the current market price. A stop
order turns into a market order when the stop is triggered, so the final execution price
44
ICM – Stock
k Brokers' Certiification
me of a stop order is nott guaranteed
d. The samee risks of market orders apply to sto
op
or tim
orderrs.
STOP
P LIMIT
Stop limit order is used to open or clo
ose a positioon by buyin
ng if the maarket rises o
or
ng if the maarket falls, but that turns into a limit order when the stop price is
sellin
trigge
ered. Stop liimit orders have a stop
p price and a limit pricee. When the stop price is
trigge
ered, the lim
mit order is activated.
a
Th
he stop pric e for buy orrders is placed above th
he
curre
ent market price.
p
The sttop price forr sell orders is placed below the cu
urrent markeet
price. The stop price does no
ot need to be the same as the limit price. Just aas with a lim
mit
orderr, the stop limit order will
w be filled at
a the limit pprice or bettter, but mayy not be filleed
at all.
TRAN
NSACTION AND
A
ORDER REPORTS
These
e reports are based on the transsactions ma de by the Client on K
KATS (Karach
hi
Automated Trading system). In these re
eports, all ddetails (Clien
nt UIN, Ordeer No., Tickeet
No., Order Type
e (Buy/Sell), Rate, Quantity, Time on which tthe order iss placed an
nd
uted, Date) regarding
r
traades are pre
esent . The eexamples of content incllude:
execu
−
−
−
−
Daily Trad
de Log
Daily Activity Log
Market Su
ummary
Outstanding Orders Log
L
TRA
ANSACTIONS AN
ND ORDER REPOR
RTS: Activity Lo
og Report of K
KATS (Courtesy KSE)
45
ICM – Stock
k Brokers' Certiification
TRANSA
ACTIONS AND ORDER
O
REPORTSS: Market Sum mary Report o
of KATS (Courtesy KKSE)
TRAN
NSACTIONS AND
D ORDER REPORT
TS: KSE-100 Tra
ade Screen of KATS (Courtesy KSEE)
46
ICM – Stock
k Brokers' Certiification
Outstanding
orders log
Terminal Code
E
Exchange
Status
TRANSACTIONS AND OR
RDER REPORTS: Outstanding T
Trades Report of KATS (Courtesyy KSE)
Daily Tradde log
Company
Symbol
Tottal Purchased
Quuantity
Clientt Code
Total Purchase
Amount
Av
verage
Purrchase Rate
ANSACTIONS AN
ND ORDER REPO
ORTS: Trade Logg Report of KA
ATS (Courtesy KSE)
TRA
47
ICM – Stock
k Brokers' Certiification
ed Trading System
S
(UTS):
Unifie
Search Syymbol
feature
Mark
ket Watch
divid
ded into
five pages
p
Heeader labels
Scroll Bar
When coloured
green indicates
real-time increase
in value
When coloured
w indicates
yellow
real-tim
me decrease
in valu
ue
TRANSACTION AND OR
RDER REPORTS: Main Window of Unified Traading System (U
UTS)
Marrket Type
Header row labells
Save current
market summaary
Refresh
R
for up-todate
d information
Print thee current market
summaryy
TRANSACTION AND OR
RDER REPORTS: Market Summary of UTS
48
ICM – Stock
k Brokers' Certiification
TRANSACTION AND OR
RDER REPORTS: Buy Order in Unified
U
Tradingg System
TRANSACTION AND OR
RDER REPORTS: Sell Order of Unified
U
Tradingg System (UTS)
TRANSACTION AND OR
RDER REPORTS: Water Fall Tick
ker of Unified TTrading System
m (UTS)
49
ICM – Stock
k Brokers' Certiification
Heading of all
columns
Accou
unt number
Order sym
mbol
View Buy and Sell
orders
T
Type of Market
TRANSACTION AND OR
RDER REPORTS: Order Book off Unified Tradin
ng System (UTSS)
TRANSACTION AND OR
RDER REPORTS: Remaining Ord
ders of Unifiedd Trading Systeem (UTS)
50
ICM – Stock
k Brokers' Certiification
1. In the ‘S
Symbol’ text box, enter a Symbol, whose detailed
listing you want displayyed. If you ennter a valid syymbol, the
system wouuld automaticaally show the entire trade daata for that
symbol in thhis window.
2. You can choose the Maarket Type, froom this drop ddown menu
to display thhe symbol information for thiis particular maarket only.
In the ‘Sym
mbol’ text box, enter a Symbol, whose detaailed listing
you want ddisplayed. If yyou enter a vvalid symbol, the system
would autom
matically show
w the entire tradde data for thatt symbol in
this window
w.
TRANSACTION AND OR
RDER REPORTS: Symbol Summ
mary of Unified Trading System
m (UTS)
TRANSACTION AND OR
RDER REPORTS: Exchange Statistics of Unified
d Trading System (UTS)
On co
ompletion, the
t candidatte should:
4.3
know the
e Trading Cyycle
TRAD
DING CYCLE
All sttock exchan
nges in the country havve introduceed computeerized tradin
ng system tto
provide a fair, transparent, and efficient market m
mechanism to facilitatee the markeet
nvestors. The
e system be ing operated at KSE is ccalled Karach
hi
particcipants, including the in
Automated Tradiing system (KATS);
(
LSE is called Tradding Worksttations (TWSS) while ISE is
d Ultra.
called
51
ICM – Stock Brokers' Certification
The trading system comprises of various distinct segments, which are:
T + 2 Settlement Systems:
In the T +2 Settlement systems, purchase and sale of securities is netted and the balance
is settled on the second day following the day of trade.
Benefit of T + 2 Settlement Systems:
It reduces the time between execution and settlement of trades, which in turn reduces
the market risk. It also reduces settlement risk, as the settlement cycle is shorter.
Provisionally Listed Counter:
The shares of companies, which are not already listed and which make a minimum
public offering of a specified amount, which is presently Rs. 150 million, trade on this
counter from the date of publication of prospectors/offering document. When the
company completes the process of dispatch/credit of allotted shares to subscriber
through CDC, it is officially listed and placed on the T + 2 counter. Trading on the
provisionally listed counter then comes to an end and all the outstanding transactions
are transferred to the T + 2 counter with effect from the date of official listing.
T + 1/Spot Transactions:
Spot transactions imply delivery upon payment. Normally in spot transactions the trade
is settled within 24 hours.
Futures Contract:
A futures contract involves purchase and sale of securities at some future date (normally
within one calendar month), at a price fixed today. The number and names of
companies to be traded on the Futures counter are determined every six months based
on the eligibility criteria approved by the SECP in this regard and which are notified to
the market participants in advance.
Over-the-Counter (OTC) Market:
In order to encourage enterprising promoters to set up new industries or expand their
existing enterprises by raising finance in a cost – effective way through listing
mechanism with comparatively lesser requirements, an Over- the Counter (OTC) market
has been also made operative. The OTC market operates under the ‘Regulations
Governing Over-the-Counter Market of the Karachi Stock Exchange notified September
17, 2009’.
52
ICM – Stock Brokers' Certification
On completion, the candidate should:
4.4
understand the Products available on the stock exchanges including:
− Equity Instrument
− Debt Instrument
Equity instruments traded on the exchanges are in the form of shares that proves the
ownership interest of common and preferred stock holders in a company. The
ownership interest is represented by shares reflecting the assets and earnings. Equity
instruments traded on the local stock exchanges are:
−
−
−
−
−
−
−
Ordinary Shares
Preference Shares
Shares’ Rights
Deliverable Futures Contracts
Cash Settled Futures Contracts
Stock Index Futures Contracts
Closed-end Mutual Funds
Debt instruments are the written promise to repay a debt. Examples include bills of
exchange, Treasury Bills, TFCs, bonds, notes, CDs, etc.
In order to facilitate the institutions dealing in money markets Karachi Stock Exchange
has introduced Bond Automated Trading System (BATS). Currently, Term Finance
Certificates TFCs have been introduced for trading on the BATS but later Bonds,
Treasury Bills and other debt instruments will also be traded.
On completion, the candidate should:
4.5 understand the Derivatives/Futures Contracts available on the stock exchanges
including:
− Deliverable Futures contracts
− Cash Settled Futures
− Index Futures contracts
FUTURES CONTRACT
A futures contract is a standardized contract, to buy or sell a specified commodity of
standardized quality at a certain date in the future, at a market determined price (the
futures price). The price is determined by the instantaneous equilibrium between the
53
ICM – Stock Brokers' Certification
forces of supply and demand among competing buy and sell orders on the exchange at
the time of the purchase or sale of the contract.
In many cases, the items may be such non-traditional "commodities" as foreign
currencies, commercial or government paper such as bonds, or "baskets" of corporate
equity such as stock indices or other financial instruments. The future date is called the
delivery date or final settlement date. The official price of the futures contract at the
end of a day's trading session on the exchange is called the settlement price for that day
of business on the exchange at a price specified today.
A futures contract gives the holder the obligation to make or take delivery under the
terms of the contract, whereas an option grants the buyer the right, but not the
obligation, to establish a position previously held by the seller of the option. In other
words, the owner of an options contract may exercise the contract, but both parties of a
"futures contract" must fulfil the contract on the settlement date. The seller delivers the
underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is
transferred from the futures trader who sustained a loss to the one who made a profit.
To exit the commitment prior to the settlement date, the holder of a futures position
has to offset his/her position by either selling a long position or buying back (covering) a
short position, effectively closing out the futures position and its contract obligations.
Futures contracts, or simply futures, (but not future or future contracts) are exchange
traded derivatives. The exchange's clearinghouse acts as counterparty on all contracts,
sets margin requirements, and crucially also provides a mechanism for settlement.
DELIVERABLE FUTURES CONTRACT
For deliverable contracts, all bought and sold positions in existence as at the close of
trading in the relevant contract month shall be settled via physical delivery. Deliverable
futures contracts are the forward contracts to buy or sell a certain underlying
instrument with actual delivery of the underlying instrument occurring. Settlement
occurs 30 days after the contract is purchased.
For further details, candidates are advised to refer to the "Regulations Governing
Deliverable Futures Contract" of KSE available at ICM's as well as KSE's website.
CASH SETTLED FUTURES
The Cash Settled Futures Contract is a standardized contract, to buy or sell a certain
underlying instrument at a certain date in the future, at specified price. All settlement
occurs purely on cash basis. Depending on the contract, settlement occurs 30, 60 & 90
days after the contract is purchased.
For further details, candidates are advised to refer to the "Regulations Governing Cash
Settled Futures Contract" of KSE available at ICM's as well as KSE's website.
54
ICM – Stock Brokers' Certification
INDEX FUTURES CONTRACTS
Stock Index Futures are traded in a number of contracts. Each contract is to buy or sell a
fixed value of the index. Stock Index Futures Contract normally occurs 90 days after the
contract is purchased.
For further details, candidates are advised to refer to the "Regulations Governing Index
Futures Contract" of KSE available at ICM as well as on the website of KSE.
On completion, the candidate should:
4.6
know the composition and types of the Indexes
On a very basic level, any stock market index is simply a numerical value that measures
the change in the market. In Pakistan, the main objective for the construction of an
index is to track the performance of the various listed stocks according to their market
capitalization. In general, a capital weighted index is composed of a basket of securities,
which captures the change in market capitalization due to the variation in prices.
Movements of stock exchange indices are popularly considered as key indicators of the
economy of a country. Stock exchange indices are not only barometers of the economy
and public opinion of the state of economy, but are also used by many technical analysts
to forecast and evaluate market trends and base their opinion on the future direction of
the market.
It is often more important for observers of the index to not to take it at face value but to
also explore deeper into the constituents of the index and the policy followed by the
index managers in its maintenance.
KSE 100
KSE-100 is the most recognized index of the KSE, representing almost all sectors of the
KSE and includes the largest companies on the basis of their market capitalization. It
represents approximately 85% of the market capitalization of the Exchange.
For further details, candidates are advised to refer to the Index Brochure of KSE-100
Index of KSE available at ICM as well as on the website of KSE.
KSE 30
The KSE 30 Index was introduced in 2006 and is based on the “Free Float Methodology”.
The index includes only the top 30 most liquid companies listed on the KSE.
For further details, candidates are advised to refer to the Index Brochure of KSE-30
Index of KSE available at ICM as well as on the website of KSE.
55
ICM – Stock Brokers' Certification
KMI-30 (KSE Meezan Index)
The KMI-30 index was introduced in September 2008 and comprises of 30 Companies
that quality the KMI Shariah screening criteria and is weighted by float adjusted market
capitalization. There is a 12% cap on weights of individual securities, while rebalancing
of the Index is done bi-annually. A total return Index based on free float methodology
For further details, candidates are advised to refer to the Index Brochure of KMI-30
Index of KSE available at ICM as well as on the website of KSE.
KSE All Shares
The All Share Index consists of all the companies listed on the KSE.
LSE-25
The Lahore Stock Exchange's LSE-25 index also calculates the performance of stocks
assuming that all rights issues and bonus share issues only increase the listed capital. In
the case of bonuses or rights the prices of the shares are not adjusted as they are in the
case of the LSETRI. However, the LSE-25 assumes that dividends paid out by a
component company are not reinvested. In summary, in the LSE-25, no price
adjustments are made when any component company issues cash dividends.
For further details, candidates are advised to refer to the Index Brochure of LSE-25 Index
of LSE available at ICM's as well as LSE's website.
LSE Total Return Index
The LSE Total Return Index calculates the performance of stocks assuming that all payouts are reinvested in the index on the ex-date. The LSETRI assumes that if a component
company issues bonus shares or announces a rights issue it will increase the listed
capital. Additionally, the LSETRI also assumes that all pay-outs by a component company
are 100% reinvested in the index. Therefore, the LSETRI is adjusted against such payouts announced by any of index constituents on its ex-date allowing the index value to
remain comparable over time.
For further details, candidates are advised to refer to the Index Brochure of LSE-Total
Return Index of LSE available at ICM's as well as LSE's website.
56
ICM – Stock Brokers' Certification
On completion, the candidate should:
4.7 know the Stock and Market Indicators and Outcomes including:
−
−
−
−
Turnover, growth and distribution
Market Capitalization
Liquidity and Financing
Transaction Costs
TURNOVER
In investing context, ‘turnover’ indicates that for how long time, on average, an
individual, a portfolio manager or mutual fund will hold a stock. A high turnover
indicates that stocks are being bought and sold rapidly; a low turnover indicates that
stocks are, on average, being held for longer periods of time.
Turnover matters to investors because every purchase or sale of a stock, whether in an
individual portfolio or a mutual fund, incurs fees. High turnover, also known as churn,
creates higher transaction costs, which lower an investor's overall returns. Investors are
often therefore advised to pay attention to the turnover rates of their portfolios and of
mutual funds in which they invest.
MARKET CAPITALIZATION
Market capitalization also known as capitalized value of company, is a measurement of
economic size equal to the share price times the number of shares outstanding of a
public company. As owning stock represents owning the company, including all its
equity, capitalization could represent the public opinion of a company's net worth and is
a determining factor in stock valuation. Likewise, the capitalization of stock markets or
economic regions may be compared to other economic indicators.
Market capitalization represents the public consensus on the value of a company's
equity. A corporation, including all of its assets, may be freely bought and sold through
purchases and sales of stock, which will determine the price of the company's shares. Its
market capitalization is the share price multiplied by the number of shares in issue,
providing a total value for the company's shares and thus for the company as a whole.
Many companies have a dominant shareholder, which may be a government entity, a
family, or another corporation and this holding is frozen and not traded. Many stock
market indices such as the KSE-100 adjust for these by calculating on a free float basis,
i.e. the market capitalization they use is the value of the publicly tradable part of the
company.
(Note that market capitalization is a market estimate of a company's value, based on
perceived future prospects, economic and monetary conditions. Stock prices can also be
57
ICM – Stock Brokers' Certification
moved by speculation about changes in expectations about profits or about mergers
and acquisitions. Market capitalization is only a rough measure of the true size of a
market.)
LIQUIDITY
Market liquidity is an investment term that refers to an asset's ability to be easily
converted through an act of buying or selling without causing a significant movement in
the price and with minimum loss of value of the asset. Money, or cash in hand, is the
most liquid asset. An act of exchange of a less liquid asset with a more liquid asset is also
called liquidation. Liquidity also refers to a business' ability to meet its payment
obligations, in terms of possessing sufficient liquid assets.
A liquid asset has some or most of the following features. It can be sold rapidly, with
minimal loss of value, any time within market hours. The essential characteristic of a
liquid market is that there are ready and willing buyers and sellers at all times.
An illiquid asset is an asset which is not readily saleable due to uncertainty about its
value or lacking a market in which it is regularly traded. The liquidity of a product can be
measured as how often it is bought and sold; this is known as volume. Often
investments in liquid markets such as the stock exchange or futures markets are
considered to be more liquid than investments such as real estate, based on their ability
to be converted quickly. Some assets with liquid secondary markets may be more
advantageous to own, so buyers are willing to pay a higher price for the asset than for
comparable assets without a liquid secondary market.
TRANSACTION COSTS
In economics and related disciplines, a transaction cost is a cost incurred in making an
economic exchange. For example, most people, when buying or selling a stock must pay
a commission to their broker; that commission is a transaction cost of doing the stock
deal. When rationally evaluating a potential transaction, it is important to consider
transaction costs that might prove significant.
58
ICM – Stock Brokers' Certification
ELEMENT 5
Clearing, Delivery, Settlement and Depository
On completion, the candidate should:
5.1
know the role, functions and working of a Clearing House of an Exchange
A Clearing House is an organization/company affiliated with a Stock exchange through
which brokers, financial institutions, and other parties settle trades. Clearing Company
handles the validation, delivery and settlement of securities transactions undertaken on
the exchange.
Clearing and Settlement is one of the most important aspects in the operation of the
securities business. It is the process of reporting, matching, correcting securities
transaction and the ultimate delivery or receipt of net balances.
National Clearing and Settlement System (NCSS) is a comprehensive system with welldefined procedures under National Clearing and Settlement System Regulations, 2003.
The system provides an electronic system developed to replace the individual Clearing
Houses of Pakistan’s three stock exchanges by a single entity. This system is operated by
National Clearing Company of Pakistan Limited (NCCPL), which has been registered as a
separate legal entity. The operation of NCSS has rapidly gaining acceptance and now
majority of the securities have been inducted into the system for settlement purpose.
NCSS provides stability to the market by capping the systemic risk to a great extent. It
has also improved efficiency of the settlement process by introducing a consolidated
and geographically neutral clearing and settlement system. NCSS, with its
technologically advanced features such as automated ‘Pay and Collect’ functionality, has
introduced transparency and efficiency in the clearing process.
On completion, the candidate should:
5.2
know the Risk Management and Types of Risks in Clearing & Settlement
An efficient settlement system diminishes risks inherent in the settlement system. It
constantly monitors and enhances risk measures to pre-empt market failures. It tracks
the record and performance of members and their net worth. It monitors members’
exposures and collects margins and disables the license of members if the limits are
breached.
There are basically two types of risks involved in the settlement system
59
ICM – Stock Brokers' Certification
1. Counter Party Risk.
2. Systemic Risk.
Counter Party Risk: It arises when a member doesn’t discharge his/her obligations fully
in time or any time thereafter. This leads to two risks – replacement cost risk prior to
settlement and principal risk at the time of settlement.
Replacement cost risk: When one of the parties to the transaction fails to deliver their
obligations, the non-defaulting party tries to replace the original transaction for his
client at current market price. So he loses the profit, that would have accumulated
between the date of original transaction and date of replacement transaction, had the
counter party would not have defaulted, but not the principal because by that time he
has not delivered his obligations. This risk is lessened by reducing time gap between
trading and settlement and by legally binding netting systems.
The Principal Risk: This risk arises when one party delivers obligations and the other
party doesn’t. This risk is rare in current day market scenario wherein the clearing
corporation makes sure that delivery versus payment mechanism works properly.
Clearing corporation acts as a third party to every transaction and delivers the securities
to the buyer upon receiving the funds and transfers funds to the seller upon receiving
the securities.
Liquidity Risk: When one of the parties defaults his/her obligations the other party
looks for replacement. The party has to arrange funds/securities by borrowing these
from other members and their funds/securities may not be available at that point in
time or the cost may be high.
Third Party risk: This arises not because of the defaults by the original parties of the
trade but by a third party for example failure of clearing bank, custodian etc. Allowing
parties to have accounts with multiple clearing banks reduces this risk.
Systemic Risk: This risk arises because of operational risks like errors, frauds and outages
and systemic risk for example failure of one part to deliver obligations may lead to the
failure of other and it may lead to contagion/ domino effect and even to the complete
failure of the settlement system itself.
On completion, the candidate should:
5.3
know the process of Clearing House Deposits and Credit Risk including the
Capital Adequacy requirements and Exposure Limits
Clearing denotes all activities from the time a commitment is made for a transaction
until the transaction is settled. Fast and Efficient Clearing system is a necessity because
60
ICM – Stock Brokers' Certification
the speed of trades is much faster than the cycle time for completing the underlying
transaction.
In its widest sense clearing involves the management of post-trading, pre-settlement
credit exposures, to ensure that trades are settled in accordance with market rules,
even if a buyer or seller should become insolvent prior to settlement. Some of the
salient features in the process of Clearing House Deposits and Credit Risk including the
Capital Adequacy requirements and Exposure Limits include:
− Processes included in clearing are reporting/monitoring, risk margining, netting
of trades to single positions, tax handling and failure handling.
− Presently Stock Exchanges monitor and collect margins on Clearing Member
exposure and mark to market requirements for all NCSS eligible securities.
− Mark-to-market losses are collected in the form of cash.
− Scrip-wise position limit imposed is as follows:
o Market wide position limit: 40% of free-float of each scrip
o Member wide position limit: 10% of free-float of the scrip.
o Client wide position limit: 5% of free-float of the scrip. (Client position
will be universal and determined on UIN basis)
o Member Capital Adequacy: 15 times the Net Capital Balance of member
− Introduction of new Risk Management System (RMS) based on internationally
accepted Value at Risk (VAR) principles with pre-trade verifications.
− Netting of clients’ exposure across different markets, across different Scrips,
across clients and also across different settlement periods is prohibited under
the new RMS.
− On the Ready Market T+2 Settlement System has been implemented
− Comprehensive default regulations have also been implemented.
− Collections of margins by eligible securities as collateral and valuation of such
securities in order to protect both brokers and investors.
61
ICM – Stock Brokers' Certification
On completion, the candidate should:
5.4
understand the Margin requirements and should be able to calculate
−
−
−
−
−
V-a-R (Value-at-Risk) - Market Risk
Impact Cost - Liquidity Risk
Acceptable Collateral to meet Margin Requirements
Haircuts
Mark-to-Market (Variation Margin) & Margin Calls
V-a-R (Value at Risk)
In financial mathematics and financial risk management, Value at Risk (V-a-R) is a widely
used measure of the risk of loss on a specific portfolio of financial assets. For a given
portfolio, probability and time horizon, V-a-R is defined as a threshold value such that
the probability that the mark-to-market loss on the portfolio over the given time
horizon exceeds this value (assuming normal markets and no trading in the portfolio) is
the given probability level.
For example, if a portfolio of stocks has a one-day 5% V-a-R of Rs.1.0 million,
there is a 5% probability that the portfolio will fall in value by more than Rs.1.0
million over a one day period, assuming markets are normal and there is no
trading. Informally, a loss of Rs.1.0 million or more on this portfolio is expected
on 1 day in 20. A loss which exceeds the V-a-R threshold is termed a “V-a-R
break.”
A technique used to estimate the probability of portfolio losses based on the statistical
analysis of historical price trends and volatilities.
V-a-R is commonly used by banks, security firms and companies that are involved in
trading energy and other commodities. V-a-R is able to measure risk while it happens
and is an important consideration when firms make trading or hedging decisions.
One of the most distinguishing characteristic of the new Risk Management System in
Pakistan’s markets is that it has abolished netting at client level, which was applicable
during the previous risk management regime. Under the new regime, exposures are
calculated at client level (based on Universal Identification Number (UIN) and no netting
is allowed between long and short positions of different clients. Exposures calculation
on UIN basis means that netting is allowed in the same scrip and same settlement
period of a single client under the same broker.
The SECP has made it mandatory on the brokers to take margins from their respective
clients in accordance with the rates as prescribed by the Exchange based on Value at
Risk (VaR) Estimates. Regulation 8.4 of the Risk Management Regulations provide that
such prescribed margins shall be the minimum margins that must be taken by the
62
ICM – Stock Brokers' Certification
Member from each of their respective clients while trading/taking exposure on behalf of
such client. The Stock Exchange shall ensure compliance of this requirement through
appropriate procedures including system audit and inspection of records.
Non-compliance of this regulation is punishable under Broker & Agents Registration
Rules, 2001 which provide for a fine of up to Rs.100,000 and even suspension of
registration of the member(s).
IMPACT COST - LIQUIDITY RISK
Liquidity risk is the risk that a given security or asset cannot be traded quickly enough in
the market to prevent a loss (or make the required profit).
Some of the primary reasons of liquidity risks are:
− Widening bid/offer spread
− Making explicit liquidity reserves
− Lengthening holding period for V-a-R calculations
Liquidity risk' arises from situations in which a party interested in trading an asset
cannot do it because nobody in the market wants to trade that asset. Liquidity risk
becomes particularly important to parties who are about to hold or currently hold an
asset, since it affects their ability to trade.
Liquidity risk is financial risk due to uncertain liquidity. An institution might lose liquidity
if its credit rating falls, it experiences sudden unexpected cash outflows, or some other
event causes counterparties to avoid trading with or lending to the institution. A firm is
also exposed to liquidity risk if markets on which it depends are subject to loss of
liquidity. Liquidity risk tends to compound other risks.
HAIRCUTS
A haircut is a percentage that is subtracted from the par-value of the assets that are
being used as collateral. The size of the haircut reflects the perceived risk associated
with the holding of those assets.
For example, Treasury bills (which are seen as fairly safe) might have a haircut
of 1%, while for mutual fund units (which are seen as less safe) the haircut
might be as high as 30%. In other words, a Rs. 1,000 treasury bond will be
accepted as collateral for Rs.990 loan, while Rs. 1,000 mutual fund units might
only allow a loan of Rs.700.
MARK-TO-MARKET (VARIATION MARGIN) & MARGIN CALL
Mark-to-market or fair value accounting refers to the accounting standards of assigning
a value to a position held in a financial instrument based on the current fair market price
for the instrument or for a similar instrument. Fair value accounting has been a part of
US Generally Accepted Accounting Principles (GAAP) since the early 1990s. The use of
63
ICM – Stock Brokers' Certification
fair value measurements has increased steadily over the past decade, primarily in
response to investor demand for relevant and timely financial statements that will aid in
making better informed decisions.
When the margin posted in the margin account is below the minimum margin
requirement, the broker or exchange issues a margin call. The investors now either has
to increase the margin that they have deposited, or they can close out their position.
They can do this by selling the securities, options or futures if they are long and by
buying them back if they are short. If they don't do any of this the broker can sell his
securities to meet the margin call.
The minimum margin requirement, sometimes called the maintenance margin
requirement, is the ratio set for:
(Stock Equity - Leveraged Amount) to Stock Equity were 60%:
Stock Equity: Rs.50 x 1000 = Rs. 50,000
Leveraged Amount or amount borrowed: (Rs.50 x 1000) x (1-60%) = Rs. 20,000
So the maintenance margin requirement uses the above variables to form a ratio that
investor has to abide by in order to keep the account active.
Let's say the maintenance margin requirement is reduced from 60% to 25%. At what
price would the investor be getting a margin call? Let P be the price, so 1000P in our
case is the Stock Equity.
(Stock Equity - Leveraged Amount) divided by Stock Equity = 25%
(1000P – Rs. 20,000) =
1000P
0.25
(1000P – Rs. 20,000) =
250P
P
=
Rs.26.67
So if the stock price drops from Rs.50 to Rs.26.67, investors will be called to add
additional funds to the account to make up for the loss in stock equity.
On completion, the candidate should:
5.5
know the role and functions of Depository, the book-entry system and its
advantages to the capital market
Once the transaction of purchase or sale of security is executed, the same gets
completion on delivery and settlement thereof. If a company has not yet been entered
64
ICM – Stock Brokers' Certification
in the Central Depository System (CDS), the delivery of its shares is performed manually
in physical form, otherwise the same is done electronically through CDS as operated by
a separate company namely Central Depository Company of Pakistan Limited (CDC).
The system of electronic book-entry of securities i.e. CDS has been set up to eliminate
physical maintenance and transfer of securities. This system is in line with the
international best practice and has replaced the manual system of physical handling and
settlement of shares at stock exchanges. Within the CDS, transfer of shares from one
account to another account takes place electronically.
The CDS is managed by the Central Depository Company of Pakistan Limited (CDC),
which has been sponsored by the stock exchanges and leading local and foreign
financial institutions. Established under the Central Depositories Act, 1997, CDC has
emerged from an elementary settlement agency to a full-fledged depository. CDC has
made the trading and settlement of securities in the stock markets transparent, reliable
efficient and secure in eliminating risks.
Following are the core advantages of the CDS:
−
−
−
−
−
−
−
−
Electronic book entry system
Records and transfers securities electronically.
No physical change of hands of securities.
Strict confidentiality
No risk of damaged, lost, forged and duplicate securities.
Simple procedure involved in pledging of securities.
No delays in delivery, settlement and transfer of securities due to speed.
Instantaneous credit of entitlements (Bonus, dividend Paid, Rights, etc.) to
investors.
− Significantly reduces the cost of investors.
On completion, the candidate should:
5.6
know the different services offered by a Depository and Types of Accounts
An investor can use any of the three types of CDC accounts, which are described as
below along with their salient features:
SUB - ACCOUNT
A broker may open, maintain and operate any number of sub-accounts he requires on
behalf of his clients. A specific sub-account is used for keeping securities belonging
individually to that particular client of the broker.
65
ICM – Stock Brokers' Certification
GROUP CLIENT ACCOUNT
This account is used for keeping securities which are beneficially owned by the broker’s
clients who are not willing to utilize the facility of opening separate sub- account. The
broker groups all such clients in their group accounts. The detailed breakup of the
securities held by each client of a group account is maintained by the broker in his back
office.
INVESTOR ACCOUNTS
By opening an investor account with CDC, the client comes with direct contact of CDC.
Such account can only be operated by the relevant account holder. The service of CDC is
efficient, effective and secure.
Out of the above, the most secure and convenient of different account types is the
investor account as the account remains in direct control of the investor. Therefore this
type of account is highly recommended to the investors.
On completion, the candidate should:
5.7
understand the working mechanism, elements and account structure of Central
Depository System (CDS)
Central Depository System (CDS) is an Electronic Book Entry System to record and
maintain securities and to register their transfer. In Central Depository System,
ownership will be changed without physical movements of securities or execution of
transfer deeds. The ownership will be transferred as soon as securities move from one
account to another. CDS is purely a settlement vehicle and will not affect the trading in
any manner whatsoever.
There are three elements of Central depository System.
•
•
•
Account Holders
Issuers/ Registrars
Eligible Pledgee
Account holders
Account Holders are divided into two categories, Account Holders and Participants.
Both, Account Holders and Participants will have direct access to the CDS. Account
Holders will be allowed to have a Main Account and a House Account for their
beneficially owned securities. Participants, however, will be entitled to have client
accounting facilities within the CDS. In addition to Main Account and House Account,
Participants are allowed to have Sub Accounts. In short, Participants can provide
Custody Services to their clients whereas; Account Holders can keep only their
beneficially owned securities in CDS.
66
ICM – Stock Brokers' Certification
All the members of Stock Exchanges, Banks (both Commercial and Investment ), and
DFIs are allowed to open their account as Participants whereas, Corporate Bodies such
as Leasing Companies, Modaraba and Insurance Companies can open their account as
Account Holders.
Issuers / Registrars
The issuers of capital whose securities are converted from physical to electronic book
entry system play a significant role in Central Depository System. They will also have
direct access to the CDS. After a security is declared eligible for the purpose of Central
Depository System, necessary software and CDS connection is provided to that
particular issuer upon signing the Issuers Agreement with CDC. The shares are entered
into CDS only after proper verification by these issuers or their registrar. This process
eliminates the problem of fake/duplicate/lost/stolen share certificates as issuers
thoroughly check them before approving for CDS.
Eligible Pledgee
Any person, company, corporation or institution (on the Board approval in this behalf)
may apply to the CDC for recognition by the CDC for the purpose of admission to the
CDS as an Eligible Pledgee by an application which; is on the most current version of the
relevant Admission Form; and complies with the additional requirements for application
for admission to the CDS.
Upon admitting a person as an Eligible Pledgee, the CDC opens an Eligible Pledgee
Account on behalf of the Eligible Pledgee. The CDC possesses the right to establish
additional Eligible Pledgee Accounts on the behalf of such Eligible Pledgee on request.
An Account Holder or a Participant, acting either on his own behalf or on behalf of his
client, can place securities under pledge to an Eligible Pledgee. In case of pledge through
sub-account prior written authorization from sub-Account Holders/clients is required.
Placing those securities under pledge will result in the securities being flagged as no
longer available for handling until they are released from pledge.
CDS - ACCOUNT STRUCTURE
The Account Holders of CDC are able to settle their transactions within the CDS through
four types of accounts, namely:
Main Account: Each Account Holder in the system is allocated a main account by virtue
of being an Account Holder in the CDS. This account is mainly used as a transit account
for movement of securities. Any security coming in or moving out of an account holder's
family of accounts pass through this account.
House Account: Used for securities owned beneficially by Account Holders.
67
ICM – Stock Brokers' Certification
Sub-account (Client Account): This account is used for keeping securities belonging
individually to each of the clients of an Account Holder. An Account Holder may open
and maintain any number of sub accounts he requires on behalf of his clients.
Cash Account: Each Account Holder in the system who opts to avail the Delivery vs.
Payment (DVP) facility is required to deposit relevant amount to be used for the
settlement of DVP obligations.
CDS - OPERATIONS
The main operations performed in the CDS are as follows:
Deposit of existing and new securities in to the Central Depository System: Once a
security is declared eligible by CDC, the physical certificates of that security are
deposited in the CDS for conversion after which they are available for further transfers
within the system.
The procedure to deposit securities in the CDS:
The Account Holder initiates the Deposit Request by entering the details of share
certificates into the system, and Securities Deposit Form: CDS generates computer
printouts of the transaction. Transfer Deed is executed in favour of 'Central Depository
Company of Pakistan Limited'. Account Holder is then to send the relevant share
certificates, transfer deeds, Securities Deposit Form and the computer printouts to the
relevant registrar. The registrar after verification either approves or rejects the
transaction within five days from the receipt of the documents. Registrar updates CDC
nominee shareholding in the Member's Register, cancels share certificates and transfer
deeds, and returns the relevant documents (other than cancelled share certificates and
transfer deeds) to applicant account holder.
Option of withdrawal of securities in the form of certificates from the depository to
cater the demand of investors who prefer to have physical possession of certificates
with them is also available.
The procedure to withdraw securities from the CDS:
The Account Holder initiates the Withdrawal Request by entering the relevant details
into the system and submits the Securities Withdrawal Form.
CDS generates computer printouts of the transaction.
Account Holder then sends the Securities Withdrawal Form and the computer printouts
to the relevant registrar.
68
ICM – Stock Brokers' Certification
The registrar after verification of the balance either approves or rejects the transaction
within five days from the receipt of the documents.
•
•
•
Update CDC nominee shareholding in the Member's Register.
Prepare share certificate (Jumbo certificate).
Return the relevant documents and share certificates to the applicant.
Free Transfer - Book entry transfer of securities without any associated cash movement.
This is a unilateral transaction in which an Account Holder can deliver securities to any
other Account Holder in Central Depository System. Although the beneficial ownership
of securities changes as securities move from one account to another, there is no stamp
duty involved and the transfer is instantaneous.
Pledge/ Release/ Call - Pledging securities in favour of a lender, which can only be
Released/Called by the lender. This function greatly benefits the financial institutions by
reducing risk of fake share certificates and paperwork.
Corporate Action - In case of Bonus Issues, Rights Entitlements, Sub-Division,
Consolidation and any other action that changes the number of securities held in a
participant's account or involves the determination of entitlement to beneficial owners,
CDC provides relevant details of account holders and sub-account holders to the issuer.
The CDC also provides details for the purpose of Notice of General Meetings and Other
Notices/ Communications.
Delivery Versus Payment - Book entry transfer of ownership of a security in exchange for
payment to settle a transaction. DVP (Delivery Versus Payment) is a bilateral
transaction. The deliverer of the securities initiates the DVP request on CDS specifying
the details of securities and payment.
Upon acceptance by the receiver, the CDS debits deliverer's securities account and
credit receiver's securities account; CDS debits receiver's cash account and credit
deliverer's cash account.
Cash only Movement: Movement of cash from one account to another without any
associated securities movement
On completion, the candidate should:
5.8
know the maintenance of sub-accounts and participant account in CDS
(Participant means Broker under this section)
MAINTENANCE OF SUB-ACCOUNTS
69
ICM – Stock Brokers' Certification
Account Opening
Under section 4(1) of the CDC Act 1997, and CDC Regulation # 6.2, participants can open
Sub-Accounts in CDS on behalf of their clients. Participants are required to ensure that
they are aware of their obligations under the Central Depositories Act 1997 and CDC
Regulations prior to opening of Sub-Accounts.
Eligibility of Sub-Account Holder
Participants should ensure that the prospective Sub-Account Holder meets the eligibility
criteria for opening a Sub-Account:
− The Sub-Account Title for a trust can only be in the name of the trustee.
− A Sole proprietorship/ partnership firm cannot open and maintain Sub-Account
in CDS. However, they can open and maintain a sub account only in the name of
a proprietor or partner(s).
− Minor cannot open an account in CDS. However, minor can become an account
holder along with a Guardian, who will be the beneficial owner till the minor
becomes an adult.
Documents required for opening Sub Account by the Individuals
1. Attested copies of National Identity Card of the applicant.
2. Attested copies of National Identity Card of the Joint Holders and or Nominee(s)
(if applicable)
3. Attested copies of passports of the applicant, Joint Holders and or Nominee(s)
(in case of non-residents)
4. Copy of the letter of authorization from the Account Holder(s) of the person
authorized to trade in the accounts (if other than the account holder).
5. A list of Transaction fee, Commission to be charged by the Broker and other CDC
charges to be levied.
Documents required for opening Sub Account by the Corporates
1. Certified true copy of Board Resolution (specimen provided as per Annexure ‘A’).
2. Certified true copies of Memorandum & Articles of Association.
3. List of authorized signatories.
4. List of nominated persons, allowed to, place orders.
Annexure:
(i) Board Resolution
(ii) Standard Account Opening Form
Guidelines for Opening/ Updating Sub Accounts in CDS
As mentioned above, each Sub Account bears the account opening details as provided
by the Sub-Account holder at the time of opening the Sub-Account. Participant, while
entering the account opening details (registration detail) in CDS, should ensure that the
details being entered are correct and complete in every respect. In the event where
70
ICM – Stock Brokers' Certification
such details are inaccurate or incomplete, the Participant should not enter such
information in the CDS and inform the client accordingly.
A Participant being supplied with a change in the account opening details by the Sub
Account Holder, shall ensure that such a change is reflected in the respective Sub
Account, where allowed. Hence, it is the responsibility of the ‘Participant’ to ensure
that the account opening details of Sub-Account holders are updated and no
discrepancies exist. Any updating requires prior approval from CDC.
For the convenience of the Participants, there is a fourfold Account Setup screen in CDS:
1.
2.
3.
4.
Account Details
Account Holder Details
Joint Account Holder Details
Nominee Details
1. Account Details:
− “Share Holder Category” should be properly selected:
o If the account title is of an individual then category should be selected
as “individual”
o If the account is corporate then shareholder category should be
correctly used in relation with the corporate entity
o If the shareholder category is, “Others” then it is to be ensured that a
“description of other” is properly entered
o “Other Category” should not be entered for individual
o Category of Mutual Fund should be “Mutual Fund”
o Shareholder Category of Public Limited Company or Private Limited
Company should be Joint Stock Company.
It is worth mentioning that after the introduction of Withholding Tax, the importance of
correctly inserting the “Share Holder Category ID” has become more significant and
therefore requires special attention from the Participant.
− “Account Title” should be properly entered as per CNIC; up to 60 characters
can be entered in the textbox (for individuals).
o Using additional identification symbols/prefix/suffix to A/c Title is not
allowed. There is an additional field to be used for entering all back
office codes or other details instead.
o Title account is not allowed to be amended once entered. For any
necessary correction Participant are required to open a new SubAccount or in genuine cases prior written approval for update should
be sought from CDC subject to provision of supporting documents as
evidence.
71
ICM – Stock Brokers' Certification
− “Father/Husband” name field should be properly selected. (By default, it is
Husband’s name), in case of change in marital status prior written approval
to update should be sought from CDC subject to provision of supporting
documents as evidence.
− “Contact Name” should be properly entered.
o Contact person can only be the account holder him/herself (or any of
the joint account holder(s), except for a person in whose name the
Power of Attorney is issued by the account holder(s).
− “Zakat status” should be properly selected, especially in individual account
setup, e.g.
o Title of individual A/c should match with appropriate Zakat Status. In
case of mismatch, the Participant should ask for clarification.
For example an individual account by the title of Justin Dean
should not have ‘Muslim Zakat Payable’ status. It will be “NonMuslim” in such cases.
− “Dividend Mandate” field should be correctly filled (if opted):
o Bank account no. is correctly filled.
o Bank Name, Branch & City is correctly filled.
o Only Common acronyms of Bank(s) are acceptable (e.g. MCB, HBL
etc.)
2. Account Holder Details:
− “Mailing Address” is properly filled: Every address has essential components
like:
o House Number
o Street Number
o Block Number
o Phase Number
o Mohallah Name
o Area Name
o City Name
o Country Name ( Other than Pakistan)
o Post Code/Office
− “Telephone No.” correct telephone number should be entered.
− “Fax No.” should be properly entered.
− “Email address” should be properly entered and provided in appropriate syntax,
(if opt by client).
72
ICM – Stock Brokers' Certification
− “Occupation Code” should be properly entered:
o In case of individual, ensure that the occupation code applicable to
individuals is chosen.
o Please check for Logical Errors like Occupation Code “House Wife “for
Male individual account.
− “Resident Status” should be correctly filled: Change in Residential Status is not
allowed. For any correction/change, opening of a new account is required.
− “Passport details” should be properly entered:
o
o
o
o
Passport No. should be properly filled.
Date of issue should be properly filled.
Place of issue should be properly filled.
Date of expiry should also be entered.
For any necessary correction Participant are required to open a new Sub-Account or in
genuine cases prior written approval for update should be sought from CDC subject to
provision of supporting documents as evidence.
− “CNIC No. /UIN” should be properly entered in new format. Any update in CNIC/
Passport No. /NICOP/registration no. is not allowed. In case of any change, prior
intimation to CDC is required along with certified true copy of relevant
documents. Also, please note that accounts already opened with old NIC must be
regularized.
− “NTN Number” should be correctly entered (if opted).
3. Joint Holder Details:
− Ensure that field of “Joint Account Holder(s)” is properly entered (if applicable).
Subsequent to opening sub account addition, deletion and updation of joint
account holder is not allowed. In case of any change, a new account is required
to be opened.
− Account holder cannot be a joint holder of his/her account.
− Only 3 Joint Holders are allowed in one account.
4.
−
−
−
−
−
Nominee Details (Not to be entered in case of joint account):
Ensure that “Name’ field of Nominee is properly entered.
Ensure that field of “CNIC” is properly filled with CNIC number.
Ensure that in case of foreigner, field of “Passport Number” is properly entered.
Ensure that field of “Place of Issue” is properly entered.
Ensure that field of “Passport Issue Date” is properly entered.
IVR, WEB and SMS Activation
73
ICM – Stock Brokers' Certification
Participants are advised to offer free of cost IVR/ Web and SMS services to their subaccount holders.
While doing so, following fields should be correctly filled out:
−
−
−
−
Mother's Maiden Name (mandatory for IVR activation)
Date of Birth (mandatory for IVR activation)
Mobile Number (mandatory for SMS activation)
Email Address (mandatory for web activation)
Impact of Incorrect Account Opening Details
Incorrect or incomplete account opening details can have serious consequences with
respect to rights and obligations of sub-account holders as well as issuers particularly in
the following matters:
−
−
−
−
−
−
Establishment of ownership of securities
Distribution of entitlement (other offers from the Issuer)
Deduction of Tax and Zakat
Receipt of Statutory notices from the Issuer
Attendance in meeting, personally or by proxy
Reporting to the State Bank of Pakistan for the purpose of declaring the details
of non-resident shareholders on reparable basis
− Directors' Report on Pattern of Shareholding
− Right to succession or transfer/ transmission
− Receipt of accounts and other notices/ information from the Issuer
Maintenance of Relevant Authorities from Sub-Account Holders
Participants should obtain and maintain proper record of authorities/instructions of Sub
Account Holders for:
−
−
−
−
Updating their Account opening details
Change of their authorized signatory(ies)
Handling of securities owned by Sub Accounts
Closure of their Sub Accounts
Filing of Zakat Declaration by Sub-Account Holders
Participants should obtain Zakat declaration from their Clients /Sub Account Holders
(including Joint Account Holders) who are seeking exemption from compulsory
deduction of Zakat from dividends. The Participants should retain Zakat Declaration on
prescribed format (CZ 50) with them and provide a copy to the relevant issuers as and
when required by them.
GUIDANCE FOR SUB-ACCOUNT HOLDERS
Participants should communicate the following to their clients from time to time:
Periodically Checking Account Balance/ Account Activity
74
ICM – Stock Brokers' Certification
Participants should advise their Client to obtain Account Balance Statements and
Account Activity Reports (generated from CDS) on regular basis either from their
Participants or directly through CDC. Account Balance Statement and Account Activity
Reports can be obtained from CDC Customer Support Services by providing a written
request and an attested copy of the CNIC as per CDC’s requirement (In case of nonavailability of attested copy of CNIC, original CNIC can be shown at the time of request
to CDC staff)
Checking Account Opening Details of their Sub-Account in CDS
In order to avoid inconvenience at the time of entitlements, participant should ensure
that the Sub-Account holders have reviewed account opening details of his /her subaccount. To ensure this, participant should provide them with the Account List showing
their account opening details including their Zakat Status and may ask them to sign the
same.
Guideline for filling out Subscription Form
Participants should help their sub account holders in filling out subscription forms
particularly the columns pertaining to participant and Sub-Account numbers in order to
avoid inconvenience for their clients at the time of credit of securities pursuant to right,
new issue or offer for sale. They should also clearly inform their clients that subscription
in CDS is only allowed in subscriber's own account (including joint account).
Advice providing details of Nominee
Participants should guide their client at the time of opening of sub account for providing
nominee relationship to be entered in their registration details. Nominee shall not be
accepted in case of a joint account. Under section 80 of the Companies Ordinance 1984,
nominee can be a spouse, father, mother, sister, brother and off springs (including a
step or an adopted child). Where no nomination has been made, a succession
certification issued by the court shall decide as to the distribution of assets of the
deceased amongst the legal heirs.
Guideline for Pledging of Securities
Where required, participants shall only pledge securities owned by their sub-account
holders directly from the sub accounts in favour of eligible pledge through a pledge
transaction in CDS, provided that proper authorization in this regard has been obtain
from concerned sub-account holders by the Participants. Movements of securities from
Sub-accounts to the house account of a Participant for pledge purpose is strictly
prohibited. Pledge of book-entry securities in favour of an Eligible Pledgee does not
result in change of title, which remain vested in the name of the pledger who enjoy all
rights and benefits that accrue on such securities held by them from time to time.
Guideline for filling out Security Deposit Form (SDF)
Participants should ensure the following before submitting SDF to the Issuer:
75
ICM – Stock Brokers' Certification
− The security submitted for deposit is live in CDS.
− Participants ID, Participant Name, Security Name, Sub Account Number and Title
of Sub Account Number and Title of Sub Account are properly filled out.
− Attached transfer deeds are duly verified.
− Transferee section of the transfer deed are duly signed & stamped by the
Participant on behalf of CDC.
− Share transfer stamp is affixed on every transfer deed.
− Any rectification or overwriting on the form is counter-signed by the authorized
signatory.
− Correct number of securities/units and certificates are filled out in the specified
column of the form.
Important: With the recent amendments in the CDC regulations, deposit of securities
not already registered in the name of the account holder or a sub-account holder
(generally known as “Street Name Shares”) is strictly prohibited. Participants shall
therefore refrain from depositing any street name shares in to the CDS.
Closing Dormant/ Empty Sub-Account
Regarding the course of action to be taken by participants in order to close empty subaccounts of those sub-account holders who are not reachable due to any reason
whatsoever, it is advised that a 7 days’ notice (to be mailed at the last available mailing
address provided by the sub-account holders) should be given to such sub-account
holders. If no response is received within the stipulated time then Sub-Accounts with nil
securities balances may be closed after serving final notice and proper documentation
evidencing such steps shall be kept by the Participant for future reference or queries.
Annual Fee on Sub-Account
The CDC’s tariff structure is approved by the Securities and Exchange Commission of
Pakistan; CDC charges an annual fee of Rs.100 for opening and maintenance of subaccount in the CDS. Participants therefore review all the dormant Sub-accounts and
close the same under notice to the concerned sub-account holders to avoid unnecessary
annual charges.
Transfer of Holding
As per Regulation 15.5.3, Sub-Account Holders may request CDC directly for Transfer of
their holdings from one account to another only in cases where Participant:
a. is suspended
b. its admission in CDS has been terminated
c. its status has been converted to an ordinary Account Holder from a
Participant
Participants should guide the Sub-Account Holders about the following documentation
requirements for transfer of Holdings or may inquire CDC Customer Support for detail:
76
ICM – Stock Brokers' Certification
1. Request Letter duly signed by the Sub-Account Holder (In case of joint holders,
the request also needs to be signed by all the joint holders).
2. Letter of consent from the suspended /terminated/converted Participant duly
signed by the authorized signatory(s), along with the list of securities to be
moved/Account Balance Statement, duly signed by suspended/terminated/
converted Participant.
(Note: Where letter of consent from the suspended/terminated Participant
cannot be obtained due to any reason acceptable to CDC the Sub-Account
Holder will provide the same in writing to CDC, after which CDC shall give notice
to the suspended/terminated participant of its intention to change the
Controlling Account Holder of Such Sub-Account whereby providing seven (7)
Business Days to reply, failing which, CDC may proceed with the request.)
3. Details of the sub account with another Participant where Securities are to be
moved along with the letter of consent to this effect from the receiving
Participant duly signed by the authorized signatory(s).
(Note: Where Book-entry Securities are to be moved to the Investor Account,
consent letter from investor Account Services (IAS) will not be required.)
4. Where recipient Sub-Account or Investor Account is a joint-account, No
Objection Certificate signed by all joint-holders shall also ne furnished at the
time of request.
5. Copies of CNIC of all account holders along with original CNIC. In case of
individual or a certified true copy of board resolution in case of corporate along
with attested true copies of the CNIC (s) of authorized signatory(ies).
(Note: In case of a non-resident Pakistani or foreigner, copy of passport should
be submitted.)
6. Duly Signed ‘Unit Transfer Form”(Four copies),Provided by the Asset
Management Company (AMC) in case where units of open-end mutual funds are
also included in the holding balance
MAINTENANCE OF PARTICIPANT ACCOUNT WITH CDC
Admission Criteria for Investor Account
Person, Company, Corporation or other corporate body that are otherwise eligible to
become a CDS Participant cannot open an Investor Account. Existing Participant also
cannot open an Investor Account in its name.
Note: Members of the stock exchanges cannot become Investor Account Holders. (CDC
circular dated December 6, 2004).
77
ICM – Stock Brokers' Certification
Reconciliation of Records with CDC
According to CDC Regulation 13.6, each Account Holder, for each business day must
verify the activity taking place during that business day related to handling of book entry
securities maintained in his account family and should immediately report (in writing)
any concerns in this regard to CDS latest by the end of the next succeeding business day
enabling CDC to take possible measures on best efforts basis.
Change in Signatory(ies) & Authority(ies)
As prudent measure, Participants are required to intimate to CDC any change in their
authorized signatories as soon as the change takes place at their end. CDC shall however
continue to rely on existing signatories till such time change in authorized signatories is
notified in writing.
Documents required for Change in Authorized Signatory(ies) in case of Individual
Participant
− A Letter Intimating the change in authorized signatories on letterhead. (The
letter must be signed by the authorized signatory (ies) of the account) and by the
member himself.
− Specimen signatures of new signatory (ies) on Signature Card (Signature Card
may be obtained from CDC office). Ensure that the signatory card is duly
stamped and special instructions are clearly mentioned.
Documents required for Change in Authorized Signatory (ies) in case of Corporate
Participant:
Where authorities are delegated by way of Board Resolution (BR)
− Board Resolution specifying the change. The BR should be a certified true copy
on company’s letterhead.
− Specimen signatures of the new signatory (ies) on the Signature Card (Signature
Card may be obtain from CDC office). The Card should bear company’s stamp
and special instruction should be clearly mentioned in conformity with the Board
Resolution.
Where authorities are delegated by way of Power of Attorney (POA)
− Attested copy of Principal Power of Attorney together with an attested copy of
sub power of attorney (as per requirement). The power of attorney should
include CDC specific clauses.
− Specimen signatures of the new signatory(ies) on the Signature Card (Signature
Card may be obtain from CDC office. The Card should bear company’s stamp and
special instructions should be clearly mentioned in line with POA.
Change in Contact Person
78
ICM – Stock Brokers' Certification
In case of change of contact person, the client is required to intimate CDC about the
change of the contact person in writing mentioning the Participant ID. The request letter
nominating a new contact should be duly signed by the authorized signatory (ies). The
participant should always mention the salutation /designation of the contact person as
this information is entered in the CDS.
Note: If the contact person is the authorized signatory then a request for change in
contact person should also be accompanied with change in authorized signatory.
Change in Other Registration Details
In case of change in other registration details like Address, Telephone No., Fax No. Zakat
Status, change in Nominee details etc., the Participant is required to intimate CDC about
such change in writing mentioning the Participant ID. The request letter should be duly
signed by the authorized signatories of the account.
Updating Registration Number in CDS
It is required to enter the Registration Number in CDS for all Sub-Account at the time of
account opening.
Change of CDS User Access Option
Participant/Account Holder is required to send a written intimation to CDC by the
authorized signatory (ies) of the account.
Change of Management
The Clients are required to provide following documents along with the intimation for
change of management in writing:
− Board Resolution along with a covering letter detailing the change and
advising future course of action
− Attested copy of Form 29 (attested by SECP/Registrar Office)
− Specimen Signatures of the new signatory (ies) (if required)
− Name and designation of new contact person (if required)
Change of Company Name
In case of change of company name, the Client will provide a certified true copy of
Certificate of Incorporation upon Change of Name issued by the SECP along-with
covering letter (on company’s letterhead) duly signed by the authorized signatory (ies)
intimating the change. Please make sure that the UIN is updated in National Clearing
Database (NCDB).
Reinstallation of CDS/ Changes in Terminal Details
Reinstallation of CDC is required when the files of CDS at client’s terminal are corrupted,
deleted or corruption occurs in Operating System or failure of hard disk. The clients, in
such cases are required to request CDS reinstallation in writing (on company’s
letterhead ) duly signed by the Authorized Signatory(ies) covering mandatory details like
79
ICM – Stock Brokers' Certification
address, terminal information, contact person details. Please make sure that the
Element ID is mentioned. Clients’ terminal tagged for security reasons. Therefore, in
order to avoid inconvenience, clients are requested to timely update CDC regarding any
changes in MAC/HD address of their Terminals through a letter signed by their
authorized signatory (ies).
Closure of Account Holder Account and Participant Account
As per CDC Regulation 15.10.1, an Account Holder may terminate its admission to CDS
by giving 40 business days’ notice to CDC. In such case, before the expiry of notice
period, the Account Holder should withdraw from CDS or remove from its control the
book entry securities entered in any holdings controlled by such Account Holder and
should close Sub-Accounts under its participant umbrella and inform CDC accordingly. In
this regard, the notice of termination of admission issued by CDC should be complied
with.
It is important to note that in case of Conversion or Transfer of membership new
Member cannot be admitted as Participant in CDS until the previous Participant Account
is terminated in CDS.
Copying of Sub-Accounts & Transfer of Holding
A Facility is available to Participants to copy sub-accounts and transfer securities by
using the “Account Copy” and “Transfer of Holding” option in CDS. This option is made
available to participants only after receiving a standard request duly signed by the
authorized signatory (ies) with certified true copy of notice from relevant Stock
Exchange.
Change of CLI Number
Change in Caller Line Identification CLI numbers should be immediately notified to CDC
by the Elements via written request clearly mentioning the Dialup ID and number to be
replaced duly signed by he authorized signatory (ies). Please note that maximum of 2 CLI
Numbers can be banded with a Dialup ID. (CLI is not for LAN Users)
Termination of Admission of Account Holder into CDS
Chapters 15 of the Central Depository Company of Pakistan Limited Regulations (“The
Regulations”) deals with the events relating to imposition and removal of
Restriction/Suspension and Termination of admission of the Account Holder (Including
Participant) to the CDS.
Causes of Termination of Account Holder Account
Following are the circumstances under which an Account Holder Account can be
terminated:
− Non-Compliance
80
ICM – Stock Brokers' Certification
In the event of Non-Compliance, involuntary Termination of Account Holder,
Account can take place due to the reasons as explained in CDC Regulations
15.1.1.
The Account Holders can also have the account voluntarily terminated by giving notice
of termination under the following scenarios:
− Corporatization
Account holder may give notice for termination to CDC of its admission to
the CDS (Under CDC Regulation 15.10.1.)
In this case admission of the individual Account Holder has to be terminated and
another Account Holder Account has to be opened in the name of Corporate Member.
− Voluntarily Basis
Responsibilities of Account Holders Related to Termination of Account
Following are the responsibilities of the account holder which have to be fulfilled in
case of termination of account:
During Notice Period
Once the Account Holder has been served the notice of termination by CDC, he
should complete the following formalities within 40 business days from the date of
the termination of account:
During Notice Period
Once the Account Holder has been served the notice of termination by CDC, he
should complete the following formalities within 40 business days from the date of
the termination notice:
− Withdraw from CDS or transfer from its control all the accounts in the
account family
− Close all active sub accounts (“C” type accounts) after ensuring that no
entitlements are due to be credited owing to any corporate action
− Ensure that no deposit and / or withdrawal request is in pending position
− Ensure that no security is in pledged position
− Ensure that no future dated intra Account Transaction is in pending position
If the Account Holder fails to complete the above formalities, a fee of Rs.100 per day
would be levied from the day of expiry of the notice period until the formalities are fully
completed.
Post Notice Period
Admission of the account Holder is terminated after expiry of the 40 business days’
notice period and the use of CDS terminal is restricted. In case the Account Holder
wishes to extend the notice period, he may request for an extension in writing, duly
signed by authorized signatories.
81
ICM – Stock Brokers' Certification
Where termination is done pursuant of Corporatization or sale of Stock Exchange
membership, CDS terminal is not removed and access to limited services is provided,
enabling the Account holder to transfer the shareholding to the new account.
CDC refunds the security deposit to the account holder upon completion of all account
closing formalities.
Settlement of Pending Trades of a Suspended Participant
In order to settle the pending trades, the suspended Participant is required to do the
following:
1. Submit a schedule of deliveries (including Inter & Intra account movement and
details of balance Order) duly signed by authorized signatories on the following
format:
a. Name of securities
b. Volume of securities
c. Details of Accounts ( from account & to account)
d. Settlement date
2. Indemnities from the suspended Participant, holding CDC harmless from and
against any losses, damages, costs and expenses incurred or sustained for
allowing movement of sub-account holders’ securities for settlement purpose.
3. Post suspension consent letter from Sub-Account Holders and Joint Account
Holders, if any, from whose sub-accounts the securities are to be moved.
4. Attested copies of CNIC(s) of Sub Account Holders and all joint account holders,
if any
TRANSACTIONS IN CDS
As per section 26 of Central Depository’s Act 1997, it is important to note that with the
exception of conditions specified in Regulation 3.17.1; at least one transaction party in
CDS should be a member of the Stock Exchange.
As per sections 24 of Central Depositories Act 1997, participants should not handle
book–entry securities owned by their sub–account holders without their authority.
As per section 12 of central Depositories Act 1997, participants should not Pledge book
securities owned by their sub account holders without having proper authorization from
them.
82
ICM – Stock Brokers' Certification
Further, pledge of book entry securities is allowed directly from the accounts of
beneficial owners to an eligible Pledge for Pledge purposes or placement of collateral
against loans.
Transfer of Book Entry Securities from clients Sub Account to the House Account of the
Participant are not allowed for pledge or any other purpose
LIST OF FREE DELIVERY TRANSACTION HELD IN CDS
Market Based Transactions
Transfer of Book Entry Securities is allowed only against market-based transaction i.e.
transactions settled through the National Clearing Company of Pakistan Limited and offmarket transaction reported to the Stock Exchanges.
Lending and Borrowing Transactions
Transfer of book Entry Securities is allowed for lending and borrowing transactions till
the implementation of Securities Lending and Borrowing mechanism. All borrowing
transitions and proper documentation evidencing the borrowing and lending is kept by
broker clearly showing the transition parties together with their signatures. A copy is to
be sent to CDC (clearly marked to the Chief Internal Auditor in a sealed envelope) on the
date of transaction.
Gift Transaction (For Blood Relation)
Transfer of Book Entry Securities by way of a gift is allowed amongst family members
only, which include the spouse children, father mother, brother or sister and lineal
ascendant or descendant. All such transactions should be properly document and kept
in record by the Account Holder. A copy of gift deed should be sent to CDC (clearly
marked to the Chief Internal Auditor in a sealed envelope).
Gift Transactions (Other Than Blood Relation)
Gift transactions made on account of natural love and affection under the law shall be
required to be underlined on the relevant Stock Exchange through a broker in the
manner prescribed for an Off Market Transactions, A copy of the gift deed and
confirmation of underlining including the date on which the same was underlined are to
be sent to CDC (clearly marked to the Chief Internal Auditor in a sealed envelope).
In addition to the above referred transactions, securities movement is allowed between
Accounts and Sub-Accounts including transfer to or through CDC’s Investor Accounts for
the below mentioned reasons where proper documentation has to be maintained by
the Account Holders;
i. Securities transactions where title remains the same as that of the Account Holder
or Sub Account Holder
ii. Securities transactions by reason of the transmission of assets to an executor or
beneficiary on the death of Account Holder or Sub account holder
83
ICM – Stock Brokers' Certification
iii. Transfer of securities under a court order or n discharge of a requirement
prescribed by and law for the time being in force:
iv. Securities transactions resulting from the offer for sale of securities.
v. Securities transactions due to privatization of any government owned enterprise
vi. Securities transactions relating to conversion of securities it Global Depository
Receipt GDR(s) and reversal thereof :
vii. Securities transactions where the securities concerned are not listed on any
relevant Stock Exchange.
viii. Securities transactions where the securities concerned are not listed on any
relevant Stock Exchange
ix. Securities transactions resulting from a portfolio transfer, where account title, may
not remain the same, as a result of a merger or restructuring and / or where
underlying foreign investors change custodians/ fund manager/s trustee.
Segregation of Clients Securities
− Participants have to ensure that the securities owned by their clients are kept in
the sub account opened in his / her name.
− Each participant has to ensure that the book entry securities owned by the
participant himself are not kept in any sub accounts maintained by him.
− Participant has to ensure that securities owned by the client of an agent of any
participant should not be kept in the account of the agent.
− Participants should ensure that securities agents of Participants are to be kept in
the Sub Account opened in the name of the agents.
− CDC Regulations do not permit pledging of securities from the Main Account,
therefore, CDC has blocked the authority of pledging securities from CDS Main
Account.
Deposit / Withdrawal Request in CDS
While executing Deposit / Withdrawal Request in CDS, Participants should keep in mind
to enter number of shares/units of securities instead of value.
Timely Sending of Document to Issuers
Participant after executing Deposit/ Withdrawal Requests in CDS should immediately
send the necessary documents to R/TA as delay in doing so creates problem for the
Issuer especially at the time of Book Closure.
Documents required for Deposit of Physical Securities:
− Duly filled Securities Deposit Form
− Duly verified transfer deed with affixed transfer stamp Ensure that transferee
section of deed is duly signed & stamped by authorized signatory (i.e.) of
Participants on behalf of CDC using the rubber stamp in the format given below:
84
ICM – Stock Brokers' Certification
For and on behalf of Central
Depository company of Pakistan
Limited
(only for the purpose of registration of securities in the name of CDC under
Regulation 8.2.1.(C) of the Central Depository Company of Pakistan Limited
Regulations)
Document required for Withdrawal of Book Entry Securities
− Duly filled Securities Withdrawal Form
As per CDC Regulation # 8.3A, if the Registered Transfer Documents are not received by
the Issuer within 30 business days after initiation of a Deposit Request Transaction by
the Account Holder, the Issuers can reject the Deposit Request Transaction initiated by
the Account Holder. In case where the documents are received by the issuer after it has
rejected the Deposit Request Transaction, the issuer shall send them back to the
relevant Account Holder.
Further, if the Registered Transfer Documents are not received by the issuer within 2
business days after the book closure start date, it shall be deemed that the deposit
request was made on the day after the book closure end date.
On completion, the candidate should:
5.9
understand the functions and process of Settlement including:
−
−
−
−
Settlement Cycle
Delivery versus Payment
Institutional Delivery System (IDS)
Settlement of Futures Contracts including Deliverable and Cash Settled
Futures
SETTLEMENT CYCLE
Settlement cycle is an accounting period for the securities traded on the exchange. It is
the process of settling security trades on successive dates so that trades executed today
will have a settlement on day after tomorrow. At present, trading is being done on the
basis of T+2 rolling settlement system which employs that the trading done on Monday
is settled on the 2nd day i.e. on Wednesday. Likewise, trading done on Tuesday will be
settled on Thursday and so on. On settlement day, the obligations of each broker are
calculated and the brokers settle their respective obligations as per the rules and
regulations of the Exchange.
An investor, in case of holding shares in CDC investor account, has to deliver the
securities to the broker immediately upon his getting the ‘order execution confirmation
85
ICM – Stock Brokers' Certification
slip’ or as mutually decided between the investor and the broker. If the investor has
bought securities, he has to pay-in funds to the broker before the settlement day or as
mutually decided between him and his broker. The securities and the funds are paid out
to the broker well before the settlement date. Generally, the retail clients are required
to arrange the funds and deliveries one day prior to settlement date while the sale
proceed and the deliveries from the broker are made available one day after the
settlement date. In case of institutions, deliveries are posted on the NCCS on the
settlement date from the institutions while the payments are received from them on
the next day of the settlement date. Now, with the introduction of Institutional Delivery
System (IDS), the institutions settle their trades directly with the clearing house of the
exchanges.
Settlement Flow in NCSS
Buying Broker
T
Selling Broker
Execution of Trades at the
Stock Exchange
Online trade feed to NCSS
T
Generation of NE Transactions
Netting of trades
Payment orders and Delivery Receive
Money Receive orders and Delivery
order
order
Delivery of NCSS eligible
S
securities (with blocked
Buying Broker
Selling Broker
Unblocking of securities on Payment
Confirmation
T
Payment to NCSS
Collect
Release
86
S
DELIVERY VERSUS PAYMENT (DVP)
DVP is a term of settlement that simply means ‘Delivery versus payment’. On settlement
day Financial Institutions that deals with Brokers pay the respective amount of the
contract when the delivery is being transferred into their participant Account and vice
versa.
INSTITUTIONAL DELIVERY SYSTEM (IDS)
Institutional Delivery System (IDS) provides the facility of recording non-Exchange
transactions between Broker Clearing Member (CM) and non-Broker Clearing Member.
IDS module facilitates a Broker CM and a Non-broker CM to record their Financed and
86
ICM – Stock Brokers' Certification
Regular transactions in settling their exchange transactions directly through the National
Clearing Settlement System (NCSS). Once a transaction is affirmed, the settlement
obligation of the initiating Broker CM is passed onto the affirming Non-broker CM.
SETTLEMENT OF FUTURES CONTRACTS INCLUDING DELIVERABLE AND CASH SETTLED
FUTURES
As discussed above, the Cash Settled Future Contract (CSF) is a standardized 90 days
Contract which will be issued each month on the first trading day following last Friday of
each month each of eligible scrip’s. Each Contract shall expire on the last Friday of the
respective month of the Contract. The final settlement is cash basis, and not on
securities.
Following are some of the key pointers in CSF settlements:
− Any Broker of the Exchange can enter into Cash-Settled Futures Contracts under
these Regulations subject to prior notification in writing and payment of Rs.
250,000/- in cash to the Exchange, as basic deposit.
− The Clearing House/ Clearing Company shall receive payments from Members on
settlement days within the time specified by the Exchange/ Clearing Company. In
case any Member fails to make any payment to the Clearing House / Clearing
Company within the specified time, default proceedings shall be initiated against
that member under relevant Regulations of the Exchange/ Clearing Company.
− There shall be Daily Clearing at the Daily Settlement Price of the day and M-t-M
Losses/Profits shall be settled on in the following manner: Net M-t-M Losses
shall be collected from Members in cash on T+0 settlement bases (by day-end on
trade day) through Clearing House or Clearing Company.
− Net M-t-M Profits shall be disbursed to Members in cash on T+1 settlement basis
through Clearing House / Clearing Company.
Upon closing of Contract, final settlement shall take place on T+1 basis and the resulting
profits or losses, calculated on the basis of “Final Settlement Price” shall be settled in
cash. The payment and collection of profits or losses on final settlement to/from
Brokers shall be carried out by the Clearing Company within the stipulated time and in
the prescribed manner.
87
ICM – Stock Brokers' Certification
ELEMENT 6
Stock Brokers and Their Clients
On completion, the candidate should:
6.1
know the Brokers and Agents Registration Rules, 2001 including:
− Brokers Eligibility Requirements
− Code of Conduct of Brokers including Duty to the Investor and vis-à-vis
other Brokers
BROKER ELIGIBILITY REQUIREMENTS
1. A person shall be eligible for registration as a broker under the Brokers and
Agent Registrations Rules 2001, if he:
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
m)
is a member of the stock exchange;
is not less than twenty-one years of age;
is a citizen of Pakistan;
has at least passed graduation or equivalent examination from an institution
recognized by the Government (the Commission may relax the educational
qualification in suitable cases on merit having regard to the applicant’s
experience)
is not a lunatic or a person of unsound mind;
has not been convicted of an offence involving fraud or breach of trust;
has not been adjudicated as insolvent or has suspended payment or has
compounded with his creditors;
has experience of not less than five years in the business of buying, selling or
dealing in securities;
has not been a partner of a brokerage firm or a director of a brokerage company
which has been convicted of an offence concerning brokerage;
has not defaulted in payment of dues at a clearing house;
has not defaulted in compliance with the provisions of the Ordinance, the Act
and the rules and regulations made there under;
is not in default on settlement of an investor complaint where such complaint
has been adjudicated by a stock exchange or a committee of a stock exchange or
the Commission; and
has complied with the directives of the Commission in respect of business
conduct, dealings with clients and financial prudence
2. The applicant shall remain in compliance with the requirements of sub-rule (1) at
all times and inform the Commission immediately when he is non-compliant with
any of the terms and conditions.
88
ICM – Stock Brokers' Certification
CODE OF CONDUCT
(The Third Schedule of Brokers and Agents Registration Rules, 2001)
GENERAL
1.
Integrity
A broker shall maintain high standards of integrity, promptitude and fairness in
the conduct of all his business.
2.
Exercise of due skill and care
A broker shall act with due skill, care and diligence in the conduct of all his
business.
3.
Manipulation
A broker shall not indulge in manipulative, fraudulent or deceptive transactions
or schemes or spread rumours with a view to distorting market equilibrium or
making personal gains.
4.
Malpractices
A broker shall not create false market either singly or in concert with others or
indulge in any act detrimental to the investors’ interest or which leads to
interference with the fair and smooth functioning of the market. A broker shall
not involve himself in excessive speculative business in the market beyond
reasonable levels not commensurate with his financial soundness.
5.
Compliance with statutory requirements
A broker shall abide by all the provisions of the Act and the rules, regulations
issued by the Commission and the stock exchange from time to time as may be
applicable to him.
DUTY TO INVESTORS
1.
Execution of orders
A broker, in his dealings with the clients and the general investing public, shall
faithfully execute the orders for buying and selling of securities at the best
available market price and not refuse to deal with a small investor merely on the
ground of the volume of business involved. A broker shall promptly inform his
client about the execution or non-execution of an order, and make prompt
payment in respect of securities sold and arrange for prompt delivery of
securities purchased by clients.
2.
Issue of contract note
i. A broker shall not refuse to promptly issue to his clients purchase or sale
notes for all the transactions entered into by him with his clients.
89
ICM – Stock Brokers' Certification
ii. ii. A broker shall not refuse to promptly issue to his clients scrip wise split
purchase or sale notes: Provided that:
a. an agent shall only split the contract notes client-wise and scrip-wise
originally issued to him by the affiliated broker into different
denominations; and
b. an agent shall not match the purchase and sale orders of his clients and
each such order must invariably be routed through a broker of the stock
exchange with whom he is affiliated
3.
Breach of trust
A broker shall not disclose or discuss with any other person or make improper
use of the details of personal investments and other information of a
confidential nature of a client which he comes to know in his business
relationship.
4.
Business and commission
A broker shall not encourage sales or purchases of securities with the sole object
of generating brokerage or commission.
i. A broker shall not furnish false or misleading quotations or give any other
false or misleading advice or information to a client with a view of inducing
him to do business in particular securities and enabling himself to earn
brokerage or commission thereby.
5.
Business through misleading advice
A broker shall not furnish false or misleading quotations or give any other false
or misleading advice or information to a client with a view of inducing him to do
business in particular securities and enabling himself to earn brokerage or
commission thereby.
6.
Business of defaulting clients
A broker shall not deal or transact business knowingly, directly or indirectly or
execute an order for a client who has failed to carry out his commitments in
relation to securities with another broker.
7.
Fairness to clients
A broker, when dealing with a client, shall disclose whether he is acting as a
principal or as an agent and shall ensure at the same time that no conflict of
interest arises between him and the client. In the event of a conflict of interest,
he shall inform the client accordingly and shall not seek to gain a direct or
indirect personal advantage from the situation and shall not consider clients’
interest inferior to his own.
90
ICM – Stock Brokers' Certification
8.
Investment advice
A broker shall not make a recommendation to any client who might be expected
to rely thereon to acquire, dispose of, retain any securities unless he has
reasonable grounds for believing that the recommendation is suitable for such a
client upon the basis of the facts, if disclosed by such a client as to his own
security holdings, financial situation and objectives of such investment. The
broker should seek such information from clients, wherever he feels it is
appropriate to do so.
9.
Competence of broker
A broker should have adequately trained staff and arrangements to render fair,
prompt and competent services to his clients.
BROKER VIS-À-VIS OTHER BROKERS
1.
Conduct of dealings
A broker shall co-operate with the other contracting party in comparing
unmatched transactions. A broker shall not knowingly and wilfully deliver
documents which constitute bad delivery and shall co-operate with other
contracting party for prompt replacement of documents which are declared as
bad delivery.
2.
Protection of clients’ interest
A broker shall extend fullest co-operation to other brokers in protecting the
interests of his clients regarding their rights to dividends, bonus shares, right
shares and any other right related to such securities.
3.
Transactions with brokers
A broker shall carry out his transactions with other brokers and shall comply with
his obligations in completing the settlement of transactions with them.
4.
Advertisement and publicity
A broker shall not advertise his business publicly unless permitted by the stock
exchange.
5.
Inducement of clients
A broker shall not resort to unfair means of inducing clients from other brokers.
6.
False or misleading returns
A broker shall not neglect or fail or refuse to submit the required returns and not
make any false or misleading statement on any returns required to be submitted
to the Board and the stock exchange.
91
ICM – Stock Brokers' Certification
BROKERS VIS-À-VIS COMMISSION AND STOCK EXCHANGE
1.
General conduct
A broker shall not indulge in dishonourable, disgraceful, disorderly or improper
conduct on the stock exchange nor shall he wilfully obstruct the business of the
stock exchange. He shall comply with the rules, bye-laws and regulations of the
stock exchange.
A broker shall faithfully comply with the general or specific directives issued by
the Commission.
2.
Failure to give information
A broker shall not neglect, fail or refuse to submit to the Commission or to the
stock exchange with which he is registered, such books, special returns,
correspondence, documents and papers or any part thereof as may be required.
On completion, the candidate should:
6.2
understand the Broker Prohibitions and Restrictions related to:
−
−
−
−
−
Clients’ Assets
Confidentiality
Material information
Insiders and Non-public Information
Front running
CLIENTS’ ASSETS
The Non-Banking Financial Companies (Establishment and Regulation) Rules, 2003
require a firm to arrange adequate protection for clients’ assets, when the firm is
responsible for them. An essential part of that protection is the proper accounting and
handling of client money and that the NBFC should not “encumber or mortgage or
pledge or transfer clients’ assets deposited with the company as security against any
facility extended to the client, for securing its own (company’s) obligations”.
Please refer “Regulation 75: Segregation of Clients’ Assets by the Brokers” of the
General Regulations of the Exchange as amended August 2009 and “Rule 7-ii: Market
Integrity” of Regulations for Proprietary Trading 2004 as amended September 2009
CONFIDENTIALITY
Please refer “Section 15 (Special Terms & Conditions) of the Account Opening Form
(Form I)” specified under Regulation 74 of the General Regulations of the Exchanges
92
ICM – Stock Brokers' Certification
MATERIAL INFORMATION
Material non-public or insider information is the information about certain aspects of a
company that has not yet been made public but have some impact on the company's
share price. It is illegal for holders of this material insider information to use the
information irrespective of the fact that as to how it was received by them to their
advantage in trading stock, or to provide the information to anyone including family
members or friends so thus they can use it for their benefit.
Getting and using the information to trade to make profit or avoid a possible loss, like
that a company's expected earnings per share for a given period are markedly poorer
than expected, or getting information about developments in an ongoing lawsuit
involving a company before the information is made public are both examples of trading
on and liable for persecution material insider information.
INSIDERS AND NON-PUBLIC INFORMATION
INSIDERS
Defined under Listed Companies (Prohibition of Insiders Trading) Guidelines 2001
"insider" meansi. a person who is a director, chief executive, managing agent, chief accountant,
secretary or auditor of a listed company or the beneficial owner holding directly or
indirectly not less than 10% of the shares of a listed company; or
ii. a person who, is or was connected with the company or is deemed to have been
connected with the company, and who is reasonably expected to have access, by
virtue of such connection, to unpublished price sensitive information in respect of
securities of the company who has received or has had access to such unpublished
price sensitive information;
A person who is either a director, chief executive, managing agent, chief accountant,
secretary or auditor of a listed company or was connected with the company or is
deemed to have been connected with the company, and who is reasonably expected to
have access, by virtue of such connection to unpublished price sensitive information in
respect of securities of the company and who has received or has had access to such
unpublished price sensitive information;
The corporate insider, simply by accepting employment, makes a contract with the
shareholders to put the shareholders' interests before their own, in matters related to
the Corporation. When the insider buys or sells the securities of the company based
upon the company owned information, he is violating his contract with the
shareholders. Trades made by these types of persons (insiders) in the company's
securities, based on material non-public information, are considered to be fraudulent
since the insiders are violating the fiduciary duty that they owe to the shareholders.
93
ICM – Stock Brokers' Certification
For example, illegal insider trading would occur if the chief executive officer of
‘Company A’ learned (prior to a public announcement) that the ‘Company A’ will be
taken over, and informed his brother who, based on that information, bought the shares
in ‘Company A’ knowing that the share price would rise.
NON-PUBLIC INFORMATION
Information about a company, either positive or negative, that will have a material
effect on the stock price when it is released to the public. Insiders, such as corporate
officers and members of the board of directors, are not allowed to trade on material
non-public information until it has been released to the public, since they would have an
unfair advantage over unsuspecting investors. Some examples of important non-public
information are an imminent takeover announcement, a soon-to-be-released earnings
report that is more favourable than most analysts expect, or the sudden resignation of a
key corporate official.
FRONT RUNNING
Front running is the illegal practice of a stock broker executing orders on a security for
its own account while taking advantage of advance knowledge of pending orders from
its customers. When orders previously submitted by its customers will predictably affect
the price of the security, purchasing first for its own account gives the broker an unfair
advantage, since it can expect to close out its position at a profit based on the new price
level. Front running may involve either buying (where the broker buys for their account,
driving up the price before filling customer buy orders) or selling (where the broker sells
for its own account, driving down the price before filling customer sell orders).
For example, suppose a broker receives an order from a customer to buy a large
block of 400,000 shares of some stock, but before placing the order for the
customer the broker buys 200,000 shares of the same stock for his own account
at Rs.100 per share, then afterward places the customer's order for 400,000
shares, driving the price up to Rs. 102 per share and allowing the broker to
immediately sell his shares for, say, Rs. 101.75, generating a significant profit of
Rs.350,000 in just a short time. This Rs. 350,000 is likely to be just a part of the
additional cost to the customer's purchase caused by the broker's self-dealing.
This example uses unusually large numbers to get the point across. It is, however, highly
uncommon for brokers to process buy orders totalling Rs. 40,800,000 in a single
transaction. By front-running, the broker has put his or her own financial interest above
(or in front of) the customer's interest and is thus committing fraud an illegal act.
PROHIBITIONS AND RESTRICTIONS
In order to understand the Prohibition and Restrictions of SECP, Candidates are advised
to refer the following sections of SEC Ordinance, 1969 (Chapter IV: Prohibitions and
Restrictions)
94
ICM – Stock Brokers' Certification
Section 16: Credit, pledging and lending of customers’ securities
Section 17: Prohibition of fraudulent acts
Section 18: Prohibition of false statements
Section 18A: Prohibition of making fictitious and multiple applications for new issues
Section 19: Maintenance of secrecy
Section 20: Prohibitory orders
On completion, the candidate should:
6.3
know the requirements and procedures of:
− Suspension and cancellation of Registration of Brokers
− Enquiries and Penalties for Offences related to Brokers
Under Section 8, 9 & 10 of the Brokers and Agents Registration Rules, 2001
SUSPENSION OF REGISTRATION
Where the Commission is of the opinion that a broker:
a) has failed to remain in compliance with any conditions subject to which
certificate of registration was granted under these rules;
b) has otherwise failed to comply with any requirement of the Act or the Ordinance
or of any rules or direction made or given there under;
c) has contravened the rules and regulations of the stock exchange;
d) has failed to follow any requirement of the code of conduct laid down in the
Third Schedule;
e) has failed to comply with the directives of the Commission in respect of business
conduct, dealings with clients and financial prudence;
f) has failed to furnish any information related to his transactions in securities as
may be required by the Commission;
g) has failed to submit periodical returns as required by the Commission;
h) has furnished wrong or false information;
i) has failed to settle an investor complaint where such complaint had been
adjudicated by a stock exchange or a committee of a stock exchange or the
Commission;
j) has not co-operated in any enquiry or inspection conducted by the Commission;
k) has indulged in manipulating price rigging or cornering activities in a stock
exchange;
l) his financial position has deteriorated to such an extent that the Commission is
of the opinion that his continuance in securities business shall not be in the
interest of investors; and
m) has been suspended by a stock exchange, the Commission may, if it considers
necessary in the public interest so to do, by order in writing:
95
ICM – Stock Brokers' Certification
i.
suspend the registration of a broker for such period as may be specified
in the order; or
n) impose on a broker a fine not exceeding one hundred thousand rupees
o) Provided that an appropriate opportunity of being heard shall be provided to the
broker to clarify his position with regard to suspension of registration.
CANCELLATION OF REGISTRATION
Where the SECP is of the opinion that the cause of suspension of registration under rule
8 continues during the period of such suspension, or a broker whose registration has
been suspended:
a)
b)
c)
d)
has been found guilty of fraud, or convicted of a criminal offence;
has his membership cancelled by a stock exchange; or
has not complied with a directive of the Commission,
the Commission may, if it considers it necessary for the protection of investors
so to do, by order in writing, cancel the registration of the broker: Provided that
no such order shall be made except after giving the broker an opportunity of
being heard.
On completion, the candidate should:
6.4
know the Orders and Appeals procedures of SECP
Candidates are advised to refer to the Orders and Appeals procedures of SECP with the
reference of the Section 21 – 24 of Securities and Exchange Ordinance 1969.
Chapter V: Enquiries, Penalties, Orders and Appeals
On completion, the candidate should:
6.5
know the relevant sections of Anti Money Laundering Ordinance and KYC
requirements
MONEY LAUNDERING
The Anti-Money Laundering Act, 2010 defines:
Offence of money laundering
(1) A person shall be guilty of offence of money laundering, if the person:-
96
ICM – Stock Brokers' Certification
(a) acquires, converts, possesses, uses or transfers property, knowing or
having reason to believe that such property is proceeds of crime; or
(b) conceals or disguises the true nature, origin, location, disposition,
movement or ownership of property, knowing or having reason to
believe that such property is proceeds of crime; or
(c) holds or possesses on behalf of any other person any property knowing
or having reason to believe that such property is proceeds of crime; or
(d) participates in, associates, conspires to commit, attempts to commit,
aids, abets, facilitates, or counsels the commission of the acts specified in
clauses (a), (3) and (c)
Candidates are advised to refer to Anti-Money Laundering Act, 2010 for further details.
On completion, the candidate should:
6.6
understand the requirement and working of Unique Identification Number
To ensure transparency in the equities markets, the use of client codes was made
mandatory and Unique Client Identification Number (UIN) was introduced and
implemented from 1st August 2006. Now UIN and client codes are checked at a pretrade level ensuring that all trades can be tracked to the real investor.
Every Broker Clearing Member shall provide to the NCCPL the Client UIN Registration
details through UIN Registration Screen in NCSS as per the Procedures.
The Broker Clearing Member is responsible for the correctness and completeness of the
Client UIN Registration Details provided to the Clearing Company and entered in UIN
Registration Screen in the UINs Database. The Broker Clearing Member is also required
to obtain from and maintain the documentary evidence of UIN for each of his clients.
Where requested by the NCCPL, a Broker Clearing Member shall provide to it all
required documentary evidence of the UIN of any of his clients entered in the UIN
Registration Screen.
The NCCPL may reject such evidence at its sole discretion for any reason whatsoever.
Notwithstanding acceptance by the Company of any such documentary evidence by the
Broker Clearing Member, the Broker Clearing Member remain responsible for the
correctness and completeness of the Client UIN Registration details provided to NCCPL.
The Broker Clearing Member is responsible for obtaining all necessary authorizations
from his clients for the purposes of creating UINs in the UINs Database.
97
ICM – Stock Brokers' Certification
The UIN Registration Details of Clients of every Broker Clearing Member is accessible by
the Stock Exchange(s) in NCSS as per the transmission mechanism described in the
NCCPL Regulations Procedures.
On completion, the candidate should:
6.7
know the definition, law, regulation and penalties of Insider Trading while
understanding the meaning of:
− an ‘insider’
− ‘connected person’
− ‘unpublished price sensitive information’
INSIDER TRADING
It is the trading of a corporation's stock or other securities (e.g. bonds or stock options)
by individuals with potential access to non-public information about the company. In
certain case, trading by corporate insiders such, key employees may be legal, if this
trading is done in a way that does not take advantage of non-public information.
However, the term is more frequently used to refer to the illegal practice in which an
‘insider’ or a ‘related party’ trades in the securities of a company based on material nonpublic information obtained during the performance of duties or association of the
insider with the corporation, or otherwise in breach of a fiduciary or other relationship
of trust and confidence or through misappropriation of the non-public information from
the company.
For example, illegal insider trading would occur if the chief executive officer of
‘Company A’ learned (prior to a public announcement) that the ‘Company A’ will be
taken over, and informed his brother who, based on that information, bought the shares
in ‘Company A’ knowing that the share price would rise.
CONNECTED PERSON
Listed Companies (Prohibition of Insiders Trading) Guidelines 2001 define connected
person as:
"Connected person" means any person who;
a. is a director, as defined in clause (13) of sub-section (1) of section 2 of the
Companies Ordinance, 1984; or
b. occupies the position as an officer or an employee of the company or holds a
position involving a professional or business relationship between himself and
the company and who may reasonably be expected to have an access to
unpublished price sensitive information in relation to that company;
98
ICM – Stock Brokers' Certification
in other words any person is deemed to be a connected person, if such person is a
company under the same management or group or any subsidiary company; or is an
official or a member of a stock exchange or of a clearing house of that stock exchange,
or any employee of a member of a stock exchange; or is an investment bank, share
transfer agent, registrar to an issue, Trustee of Term Finance Certificates, Investment
Advisor, Investment Company (closed end mutual fund) or an employee thereof, or, is a
member of the Board of Directors of an investment company or a member of the Board
of Directors of the Asset Management of an Investment Scheme (open-end mutual
fund) or is an employee having fiduciary relationship with the company; or is a member
of the Board of Directors, or an employee, of a financial institution as defined in clause
(15A) of the Securities and Exchange Ordinance 1969; or is an official or an employee of
a self-regulatory organization recognized by the Commission; or is a relative of any of
the aforementioned persons; or is a banker of the company.
UNPUBLISHED PRICE SENSITIVE INFORMATION
Unpublished price sensitive information in relation to a listed security means any
information which relates directly or indirectly to matter of a company that is not
generally known or published by such company for general information, but which if
published or known, that information can materially affect the price of securities of that
company in the market. This unpublished price sensitive information includes:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Financial results of the company;
Intended declaration of dividends;
Issue of shares by way of rights, bonus, etc.;
Any major expansion plans or execution of new projects;
Amalgamation, mergers and takeovers;
Disposal of the whole or substantially the whole of the undertaking;
Such other information as may affect the earnings of the company;
Any changes in policies, plans or operations of the company.
On completion, the candidate should:
6.8
understand the prohibition on insiders covered by the rules and guidelines
including dealing, communicating and counselling
6.9 know the liability in respect of insider trading and identify the defence to insider
trading
6.10 know the powers available to SECP to prosecute insider trading
Candidates are advised to refer to the Securities and Exchange Ordinance, 1969 Section
15A to 15E (Chapter III-A: Insider Trading) and Listed Companies (Prohibition of Insiders
Trading) Guidelines 2001.
99
ICM – Stock Brokers' Certification
ELEMENT 7
Commodity Exchange and Derivatives
On completion, the candidate should:
7.1
understand the functioning of a regulated commodities market
INTRODUCTION
Commodity markets (or markets of products) are markets where raw or primary
products are traded (negotiated) or exchanged. These raw commodities are exchanged
or traded on regulated commodities exchanges, in which they are bought and sold in
standardized contracts.
A commodity futures market (or exchange) is, in simple terms, nothing more than a
public marketplace where commodities are contracted for purchase or sale at an agreed
price for delivery at a specified date. The purchases and sales must be made through a
broker who is a member of an organized exchange and under the terms and conditions
of a standardized futures contract. The primary distinction between a futures market
and a market in which actual commodities are bought and sold, either for immediate or
later delivery, is that in the futures market one deals in standardized contractual
agreements only.
These agreements (more formally called futures contracts) provide for delivery of a
specified amount of a particular commodity during a specified future time, but involve
no immediate transfer of ownership of the commodity involved. In other words, one can
buy and sell commodities in a futures market regardless of whether or not one has, or
owns, the particular commodity involved. One may at any time cancel out a previous
sale by an equal offsetting purchase or a previous purchase by an equal offsetting sale. If
done prior to the delivery month the trades cancel out and thus there is no receipt or
delivery of the commodity.
Actually, only a very small percentage, usually less than two percent, of the total futures
contracts that are entered into internationally are ever settled through deliveries. For
the most part they are cancelled out prior to the delivery month in the manner just
described. Followings are some of the major organized commodity exchanges in the
world.
1. Chicago Mercantile Exchange
2. New York Mercantile Exchange
3. London Metal Exchange
100
ICM – Stock Brokers' Certification
PRICING MECHANICS
Commodity Exchanges, like any other exchange, do not determine or establish the
prices at which commodity futures are bought and sold. Prices are determined solely by
supply and demand conditions. If there are more buyers than there are sellers, prices
will be forced up. If there are more sellers than buyers, prices will be forced down.
Buy and sell orders, which originate from all sources and are channelled to the exchange
trading floor for execution, are actually what determine prices. These orders to buy and
sell are translated into actual purchases and sales on the exchange trading floor, and
this must be done by public outcry across the trading ring or through the electronic
trading platform provided by the exchange, through the brokers, to the investors; and
not by private negotiation. The prices at which transactions are made are recorded and
immediately released for distribution over a vast telecommunications network.
Probably the best way to visualize how purchases and sales are made on the floor of a
commodity exchange is to think in terms of what happens at a public auction. The
principle is the same, except in the futures market a two-way auction is continuously
going on during trading hours. This two-way auction is made possible because of the
standardized futures contract, which requires no description of what is being offered at
the time of sale. Also, the two-way auction is made practicable because the inflow of
both buying and selling orders to the exchange floor is normally in sufficient volume to
make buying and selling of equal importance.
The purpose of a commodity exchange is to provide an organized marketplace in which
members can freely buy and sell various commodities in which they have an interest.
The exchange merely provides the facilities and ground rules for its members to trade in
commodity futures and for non-members also to trade by dealing through a member
broker and paying a brokerage commission.
COMMON TERMS USED IN COMMODITY EXCHANGE
Futures Contract
An agreement to purchase or sell a commodity for delivery in the future:
- At a price that is determined at the initiation of the contract
- That obligates each party to the contract to fulfill the contract at a specified date
or time
- Are used to assume or shift price risk
- That may be satisfied by delivery of the commodity or by an offsetting contract
Hedging
Taking a position in a futures market opposite to a position held in the cash market to
minimize the risk of financial loss arising from an adverse price change or a purchase or
101
ICM – Stock Brokers' Certification
sale of futures contract as a temporary substitute for a cash transaction that is supposed
to occur later
Over-the-counter (OTC)
Trading of commodities, contracts or other instruments not listed on any exchange. OTC
transactions can occur electronically or over the telephone.
Speculative Position Limit
It is the maximum buy/sell position that may be held or controlled by one person as
prescribed by an exchange.
Spot market
Spot market is an operation whose delivery takes place immediately either, or with a
minimum delay between the trade and the delivery because of technical constraints.
Market spot normally implies a visual inspection of the goods or a sample of the goods.
The markets of the goods, in addition, require the existence of standards agreed upon,
so that the transactions can be done without an inspection.
Delivery and condition guarantees
In addition, delivery day, method of settlement and delivery point must all be specified.
Typically, trading must end two (or more) business days prior to the delivery day, so that
the routing of the shipment can be finalized via ship or rail, and payment can be settled
when the contract arrives at any delivery point.
Standardization
The contracts have to be of standardized products so that the seller and buyer have
common understanding as to what is being sold or bought. Refined Gold assaying not
less than 995.0 fineness cast in 1 Kg bars bearing serial numbers and identifying stamp
of the Exchange approved Refiner (LBMA approved Refiner) is the standard set by the
National Commodity Exchange Limited (NCEL) as accepted deliveries of 1kg bars. Similar
standardizations criteria have been set for other commodity contracts traded on the
exchange.
ROLE OF A CLEARING HOUSE
A brief explanation of the clearing house (or clearing association) and its function in
futures trading is important for understanding the operation of the futures markets.
Each futures exchange has its own clearing house.
All members of an exchange are required to clear their trades through the clearing
house at the end of each trading session, and to deposit with the clearing house a sum
of money (based on clearinghouse margin requirements) sufficient to cover the
member’s debit balance.
102
ICM – Stock Brokers' Certification
For example, if a member broker reports to the clearing house at the end of the
day total purchases of 100,000 bushels of ‘May wheat’ and total sales of 50,000
bushels of ‘May wheat’ (which may be for himself, his customers, or both), he
would be net long 50,000 bushels of ‘May wheat’. Assuming that this is the
broker’s only position in futures and that the clearing house margin is six rupees
per bushel, this would mean that the broker would be required to have Rs.
300,000 on deposit with the clearing house.
Because all members are required to clear their trades through the clearing house and
must maintain sufficient funds with it to cover their debit balances, the clearing house is
placed in a position of being responsible to all members for the fulfilment of contracts.
For example, Therefore, instead of broker A, who bought 50,000 bushels of May
wheat from broker B being responsible to broker B for fulfilment of his end of the
contract, the clearing house assumes the responsibility. In like manner, the
responsibility of broker B to broker A in connection with this transaction is passed
on to the clearing house, with neither A or B having any further obligation to one
another.
The clearing house becomes the “other party” for all futures trades between exchange
members. This mechanism greatly simplifies futures trading. Considering the huge
volume of individual transactions that are made, it would be virtually impossible to do
business if each party to a trade were obligated to settle directly with each other in
completing their transactions.
For the regulation of Clearing House of the National Commodity Exchange Limited:
please refer Chapter VII of the General Regulation of the Commodity Exchange.
HEDGING THE RISK
Futures’ trading provides a means for those who produce or deal in cash commodities
to hedge, or insure, against unpredictable price changes. There are many kinds of
hedges, and a few examples can adequately explain the principles of hedging.
Take the case of a firm that is in the business of storing and merchandising wheat. By
early June, just ahead of the new crop harvest, the firm’s storage bins will be relatively
empty. As the new crop becomes available in June, July and August, these bins will again
be filled and the wheat will remain in storage throughout the season until it is sold, lotby-lot, to those needing wheat. During the crop movement when the firm’s inventory of
cash wheat is being replenished, these cash wheat purchases (to the extent that they
are in excess of merchandising sales) will be hedged by selling an equivalent amount of
futures short. Then as the cash wheat is sold the hedges will be removed by covering
(with an offsetting purchase) the futures that were previously sold short. In this manner
the storage firm’s inventory of cash wheat will be constantly hedged, avoiding the risk of
103
ICM – Stock Brokers' Certification
a possible price decline – one that could more than wipe out the storage and
merchandising profits necessary for the firm to remain in business.
Another example of hedging might be that of a flour mill which has just made
heavy forward sales of flour, sales that will require substantially more
uncommitted wheat than the mill owns. To hedge these flour sales, the mill will
at the time the flour is sold buy wheat futures equivalent to the amount of
wheat needed to fill its forward flour commitments, and then as the wheat is
acquired to fill these commitments remove the hedges. This will protect the mill
against an advance in the price of wheat between the time it sold the flour and
the time it is able to procure the cash wheat necessary to make the flour.
SPECULATION
Although speculation in commodity futures is sometimes referred to as blind
risk/gambling, this is an inaccurate reference. The generally accepted difference
between gambling and speculation is that in gambling new risks are created which in no
way contribute to the general economic good, whereas in speculation there is an
assumption of risks that exist and that are a necessary part of the economy. Commodity
trading falls into the latter category. Everyone who trades in commodities becomes a
party to an enforceable, legal contract providing for delivery of a cash commodity.
Whether the commodity is finally delivered, or whether the futures contract is
subsequently cancelled by an offsetting purchase or sale, is of no real consequence. The
futures contract is a legitimate contract tied to an actual commodity, and those who
trade in these contracts perform the economic function of establishing a market price
for the commodity.
The primary function of the commodity trader, or speculator, is to assume the risks that
are hedged in the futures market. To a certain extent these hedges offset one another,
but for the most part speculative traders carry the hedging load.
While speculative traders assume the risks that are passed on in the form of hedges, this
does not mean that traders have no choice as to the risks they assume – or that all of
the risks passed on are bad risks. The commodity trader has complete freedom of choice
and at no time is there any reason to assume a risk that he doesn’t think is a good one.
One’s skill in selecting good risks and avoiding poor risks is what determine one’s
success or failure as a commodity trader.
SHORT SELLING
To sell a commodity future short one sells first and then closes out (or covers) this sale
with an offsetting purchase at a later date. One need not have, or own, the particular
commodity involved. The practice of selling short is common in futures markets. Those
who sell short (with the exception of those placing hedges to protect a cash commodity
position) do so in the expectation that prices will decline and that they will be able to
buy later at a profit. A short position in the market is of course just the opposite of a
104
ICM – Stock Brokers' Certification
long position, which involves buying first and closing out (or liquidating) later with an
offsetting sale.
Some find it difficult to understand how short sales are possible, due to the
preconceived idea that one cannot sell something that he doesn’t own. To understand
how one can sell something short one must first understand that it is possible, and
perfectly legal, to sell something that he does not own – providing the sale has certain
attached conditions. One of the conditions is that one agrees to deliver what he sells at
a later date. Another condition is that, if one does not deliver, he will stand any loss that
the buyer may suffer as a result of an advance in price between the time one makes the
sale and the time he cancels out his delivery obligation by means of an offsetting
purchase. When one sells a commodity future short, one always does so under these
conditions. Of course if prices decline during the period one is short one realizes a profit
on the transaction.
If, for example, one sells 5,000 bushels of ‘May wheat’ short at Rs. 500 per bushel
and then later covers this short sale with an offsetting purchase at Rs. 450 per
bushel, the profit is 50 rupees per bushel, or Rs. 250,000, on the 5,000 bushel
contract, less the broker’s commission. In the event wheat prices advance and
one is forced to cover his short sale at Rs. 550, one would have a loss of 250,000,
plus commission.
Short sales in commodities are much simpler than in stocks. When one sells a stock
short he must borrow the stock for immediate delivery against his short sale. This
involves a substantial loan deposit and costs that are not involved when one goes long
on a stock. Also, stock exchange rules prohibit a stock from being sold short in a
declining market unless the short sale is made at a price above the last sale price of the
stock, or in other words on an “uptick.” The short seller in commodities is faced with
none of these restrictions.
DEPOSITING MARGINS
(For the regulation on Depositing Margins of the National Commodity Exchange Limited:
please refer Chapter VIII of the General Regulation of the National Commodity Exchange)
When one establishes a position in a commodity future, either long or short, it is
necessary to deposit with the broker a sufficient amount of money to protect the
position – actually to protect the broker against loss in the event the trade entered into
is unprofitable. This deposit is referred to as the margin. It should not be confused with
the clearinghouse margin required of an exchange member. The margin required of a
customer by a broker is a different margin than that required of the broker by the
clearinghouse. Both margins serve the same purpose, however – they insure that
obligations arising from commitments in commodity futures are fulfilled. There is no
interest charged on the difference between the market value of a futures contract and
the margin deposited to trade in it.
105
ICM – Stock Brokers' Certification
Margins in commodity trading are, in effect, the same as “earnest money” in a real
estate transaction. In a real estate transaction the “earnest money,” margins in the
stock exchanges as deposited by the clients for margin financing or trading accounts. In
the case of a commodity futures contract, just as in the case of a stock future contract
calling for delivery of the shares at a later date, full payment is made upon delivery. But
prior to actual delivery all that is needed is a deposit sufficient to bind the contract. The
amount of margin that one is required to deposit with the broker in order to trade in
commodities is usually 10% or less of the market price of the commodity. Exchange
regulations prescribe the minimum margins that brokers require of customers. These
minimums are changed from time to time, depending on market conditions. Also, it
should be noted that at any given time one broker might require larger margins than
another. The broker is limited only with respect to minimum requirements. If he feels
that adequate protection requires a larger margin than the minimum required by the
exchange regulations, he is free to ask for a larger margin. In this connection, however,
for competitive reasons a broker is somewhat limited in the amount of margin required
from his customers. Consequently, the tendency is for margin requirements among
various brokers to stay pretty close in line.
After making an original margin deposit with a broker, one is obligated to add this
deposit only if (1) he increases the size of his market commitment, or (2) there is a loss
in his existing position due to prices moving in a direction contrary to that which he had
expected. The usual procedure is for the broker to call for additional margin when the
original margin has been reduced (by an adverse price move, usually calculated as of the
close of the market session) to roughly 70 to 75 percent of the margin originally
deposited. The margin call is normally for the amount needed to bring one’s margin
back up to the original requirement.
Assume that a trader has sold 500 bushels of ‘May wheat’ short at Rs. 500 a bushel, and
that the broker has required a Rs. 12,500 margin deposit, i.e. 5% of the amount, on the
transaction. One sells short, naturally, because he expects prices to decline. But suppose
prices go up instead. Each one rupee move in the price of wheat is equal to Rs. 500 on a
500 bushel contract. This means that in the event of a three-rupee advance one would
have a loss of Rs. 1500 in his short position. The margin balance would be reduced to Rs.
11,000 and the broker would probably at this point call for an additional Rs. 1500 to
bring the margin back up to the original requirement. A point that should be made clear
in connection with this example is that unless one closes out his short position on this
three-rupee advance, the Rs. 1500 loss is a paper loss only – one that will be increased
or reduced depending on subsequent market action. If one maintains his short position
and if ‘May wheat’, after going up three rupees, drops back to the selling price of Rs.
500 one will at this point be exactly where he was when he originally went short. There
will be a credit with the broker of Rs. 12,500, the amount of the original margin deposit,
plus the Rs. 1500 that was deposited later.
106
ICM – Stock Brokers' Certification
Let us suppose that after selling ‘May wheat’ short at Rs. 500, prices decline to Rs. 200
where the trader covers his short wheat position with an offsetting purchase. In such an
event one would have a Rs. 150,000 profit on the short sale. The broker would
automatically credit this profit to the account, and with the Rs. 12,500 initially deposited
one would have a total credit of Rs. 162,500. All or any of this credit balance is of course
subject to withdrawal upon request.
On completion, the candidate should:
7.2
know the National Commodity Exchange Limited and Contracts
.
NATIONAL COMMODITY EXCHANGE LIMITED (NCEL)
National Commodities Exchange Limited (NCEL) is first futures commodity market in
Pakistan. It is the only organization in Pakistan to provide a centralized and regulated
place for commodity futures trading and is regulated by Securities and Exchange
Commission of Pakistan (SECP). It has started full trading activities on 11 May 2007.
Shareholders of NCEL are Karachi Stock Exchange, Lahore Stock Exchange, Islamabad
Stock Exchange, Pak Kuwait Investment Company (Pvt) Limited, and Zarai Taraqiati Bank
Ltd and it is regulated by Securities and Exchange Commission of Pakistan under SECP
Act 1997.
NCEL is committed to provide a modern commodity futures trading platform for market
participants to trade in a wide spectrum of commodity derivatives, driven by best global
best practices, professionalism and transparency. Access to NCEL trading platform is
available through the internet for up to the client level. It is the first Exchange in
Pakistan to employ modern risk management techniques based on Value at-Risk with a
pre-trade risk check in real time. The Exchange acts as a central counterparty to both
buyers and sellers through an innovation process and provide clearing and settlement
on a T+0 basis using on-line bank transfer mechanism.
PRODUCTS AND CONTRACTS LISTED AT NCEL
-
100 Tola Gold Futures Contract
50 Tola Gold Futures Contract
10 Tola Gold Futures Contract
3-Month KIBOR Futures Contract
Mini Gold Futures Contract
Gold Futures Contract
IRRI-6 Rice Futures Contract
Palm Olein Futures Contract
107
ICM – Stock Brokers' Certification
SOME SPECIFICATION REGARDING NCEL PRODUCTS TRADING
Deliverable Grade
In fulfillment of each contract, Sellers must deliver refined 10 Tola Gold bars assaying
not less than 999.0 fineness cast. Only deliveries from exchange approved Refiner’s
meeting the ‘Good Delivery’ criteria approved by the Exchange are accepted.
Daily Settlement Price for Gold Related Contracts
The Daily settlement price is the consensus price determined during the closing session.
Exchange can also determine the daily settlement price in the manner and the
conditions described herein or in such other manner as may be determined by the
Exchange from time to time:
•
•
Value Weighted Average Price
Theoretical Futures Price
Theoretical futures price will be calculated as
Future Price = International Spot Price x {e^(r x t)}
where r = linear interpolation of 1, 2 and 3 -month Karachi interbank offer rate (KIBOR)
as disseminated by Reuters, and t = time remaining till maturity. The International Spot
Price will be the mid-price of Gold prevailing in the international spot market, as
displayed on Reuters, at the time of end of daily trading of Gold Futures contract and
converted into local Rupees per Tola units based on average Offer rate of PKR/USD
obtained from five different foreign exchange market dealers or as determined and
notified by the Exchange.
Daily Settlement Price for RBD Palm Oil Future and IRRI-6 Rice Contracts
The Daily settlement price is the consensus price determined during the pre-close
session. Exchange can also determine the daily settlement price in the manner
described here under or in such other manner as may be prescribed by the Exchange:
•
•
•
Value Weighted Average Price
Last Traded Price
Theoretical Futures Price
Final Settlement Price for all products
Final Settlement Price will be determined by the Exchange at the maturity of the
Contract. and will be based on the international spot mid-price of gold, as displayed on
Reuters at the time of expiry of the contract and converted to Rs/ Tola/or any product
related quotations by the average offer rate of PKR/USD obtained from 5 different
moneychangers or as determined and notified by the Exchange.
108
ICM – Stock Brokers' Certification
All Taxes, Freight and all duties/charges etc. up to the point of sale of physical Gold will
have to be fully paid by the Seller to the concerned authority and all documentation
fully complying with Exchange procedures should be completed before delivery of Gold
to the Exchange approved Logistic Agency. After submission and subsequent verification
by the Exchange, matched Buyers will be required to pay freight and taxes incurred by
the Sellers as part of their Final Pay-in Settlement Amount.
Price Fluctuation Maximum price fluctuation is +/-5% of the last trading day’s
settlement price or as determined by the Exchange.
Margin Requirement The amount of margin payable by Brokers in respect of their
outstanding contracts in Gold and other products shall be determined by the Exchange.
Exchange will amend margin requirement whenever necessary or required due to
changes in market conditions and risk management principles. Margins on all open
positions in futures contracts with different maturities shall be on the basis of gross
positions.
(Initial Margin is based on VaR methodology at 99% Confidence Interval over a 1-day
Time Horizon, rounded up to the nearest 0.25%)
Delivery Margin: Delivery margin may be imposed in increments of 5% per day on all
open positions starting at two days prior to expiration, such that delivery margin
payable on last trading day will be 10%. Delivery Margin shall replace the Initial Margin.
However, delivery margin will be applicable only on those open positions for which
intention to make or take delivery would have been received. In other Products like RBD
Palm Oil and IRRI-6 Rice Margins shall be calculated on a gross basis on all open
positions held across different maturities in the same underlying up to the Client Level
without any netting.
Special Margin Exchange reserves the right to impose special margins for short duration
of time during periods of increased or excessive volatility. Special margins will be
computed by increasing the Duties etc. look-ahead period, reducing sample size, or by
changing any other parameters used in the VaR methodology.
Spread Discounts Positions in two offsetting NCEL Futures Contract with different
expirations will be eligible for a spread discount.
Spread Contracts NCEL may list spread contract on the 1st of every month through final
expiration being the 3rd Wednesday of the Month.
109
ICM – Stock Brokers' Certification
On completion, the candidate should:
7.3 understand the basic features and pricing mechanism of the different types of
contracts traded on the NCEL, including delivery and settlement; described in the
regulations governing NCEL
Candidates are advised to refer to the following sections of the National Commodity
Exchange Limited General Regulations 2007
- Chapter IV:
- Chapter IX:
- Chapter X:
Contracts
Clearing and Settlement
Delivery
On completion, the candidate should:
7.4 understand the requirements for becoming a broker at the commodities exchange
Chapter III: Membership of the Exchange of the National Commodity Exchange Limited
General Regulations 2007
MEMBERSHIP OF THE COMMODITY EXCHANGE
3.1 General
Subject to the provisions of the Ordinance and the Companies Ordinance, 1984 the
rights, privileges, duties and responsibilities of a Member shall be in accordance with
these Regulations.
The Board shall have power to establish categories of Membership and to attach
different rights, benefits, obligations and liabilities to each category established. Such
categories may, for example, include:
a) Specific commodity Membership which would authorize the Member to trade,
upon registration as a Broker, only in the specific commodity underlying
Commodity Futures Contracts authorized; or
b) Universal commodity Membership which would entitle the Member to trade,
upon registration as a Broker, in all commodities underlying Future Contracts on
the Exchange.
The Board may, from time to time, determine different fees payable for different
categories of membership and payable for processing applications and for such other
110
ICM – Stock Brokers' Certification
matters as the Board may in its discretion consider appropriate. Subject to these
Regulations, the Rules and the Ordinance, a Member is entitled, after his registration
with the Commission as a Broker, to trade for himself or on behalf of his Clients on or
through the facilities of the Exchange and to enjoy the other rights and benefits from
time to time provided that he may only trade whether for himself or his clients only
after he is registered with the Commission as a Broker.
3.2 Application for Membership
Any person desirous of becoming a Member of the Exchange must first submit an
application to the Exchange. Every application shall be presented to the Exchange which
may accept or refuse such application. In addition to the requirements specified under
the Ordinance and the Rules, the Exchange shall consider the applications of such
candidates who fulfil the following criteria and procedures:
a) Members must be individuals or companies.
b) Every new applicant for Membership shall complete, sign and deliver to the
Exchange an application in writing in such form as the Exchange may from time
to time specify together with letters of reference and recommendation from two
persons providing such information about the applicant as specified by the
Exchange from time to time.
c) Every applicant must specify in his application the category of Membership
under which he seeks to be registered.
d) Every company which applies for Membership must show which individuals are
the legal or beneficial owners of its share capital.
e) In applying for Membership or in applying to change the category of
Membership under which such Member is registered, the applicant shall follow
the procedures determined by the Board from time to time.
f) Every applicant for Membership must fulfil the following minimum requirements
as at the date of making the application in order for his application to be
entertained:
i.
He must be a graduate from a university or college acceptable to the
Board or he must have experience of buying and selling or dealing in
commodities or securities market for at least five years;
ii.
He must be at least 21 years of age and of sound mind;
iii.
He must be a citizen of and resident in Pakistan;
111
ICM – Stock Brokers' Certification
iv.
He must not be insolvent nor must he have compounded with his
creditors;
v.
He must not have been convicted of any offence involving moral
turpitude;
vi.
He must not be in violation of any requirement imposed by any Stock
Exchange or other Commodity Exchange of which he has been or is a
member;
vii.
He must have a National Tax Number;
viii.
He must have a minimum net worth as may be determined by the Board
and approved by the Commission but which shall not be less than Rs.
Twenty Million.
g) Every applicant which is a corporate entity shall have a Chief Executive Officer
who shall satisfy the requirements set forth from 3.2(f) (i) to (vii) above and the
applicant company must satisfy the requirement of 3.2(f) (viii).
h) In addition to the requirements set out in these Regulations, applicants seeking
admission within a specific Membership category shall comply with any
additional requirements applicable to such Membership category as may be
determined by the Board from time to time.
3.6 Notice of Becoming Member
A person is deemed to have become a Member on the date on which notice of approval
of his application is given by the Exchange and conveyed in writing provided that he has
satisfied all the requirements of admission set out in these Regulations.
3.7 Consequence of misrepresentation in the Application
Notwithstanding the provisions of these Regulations, the Board may suspend or cancel
the Membership of a Member at any time, from the date of inception of his
Membership if at the time of his application for Membership, he:
a) made any wilful or material misrepresentation;
b) suppressed any material information required of him;
c) directly or indirectly gave false particulars or information or made a false
d) declaration; or
e) suppressed information that he had been engaging in any activity that might
have been prejudicial to the interest of the Exchange, and had been subject of
112
ICM – Stock Brokers' Certification
any investigation that might bring him into disrepute in the eyes of the general
public
f) Provided that the Board prior to any decision in respect of such suspension or
cancellation, as the case may be, shall give every Member an opportunity of a
hearing.
3.9 Registration with the Commission
Every applicant who has been granted Membership of the Exchange and who is desirous
of acting as a Broker for Clients shall register with the Commission under the Rules.
3.10 Transfer of Memberships
No Member shall assign, sell, transfer, pledge, mortgage or create any trust, charge, lien
or other encumbrance over its rights, benefits or privileges as a Member. The Exchange
shall not be bound or compelled in any way to recognize (even when having notice
thereof) any dealing or disposition made in contravention of this Regulation. Provided
that notwithstanding the foregoing restriction, a Member may apply to the Exchange to
transfer his Membership upon payment of such fee as may be specified by the Board
and the Exchange may, in its discretion, approve such transfer subject to such conditions
(including payment of any fees) that the Board may determine.
3.11 Financial Requirements
The Board shall be entitled to specify minimum capital requirements from time to time
with the approval of the Commission for each category of Membership by reference,
inter alia, to the nature and category of Membership and may in relation to any
particular Member, require that Member to comply with capital requirements higher
than the minimum capital requirements applicable to the category of Membership
under which he is registered.
Every Member shall:
a) comply with the minimum Net Capital Balance requirement as specified by the
Board from time to time with the approval of the Commission
b) maintain a minimum Net Worth of an amount specified by the Board from time
to time with the approval of the Commission but which shall not be less than Rs.
20,000,000 (Rupees twenty million only)
c) Maintain a minimum Net Capital Balance of an amount specified by the Board
from time to time with the approval of the Commission but which shall not be
less than Rs. 2.5 million. Further, the Member shall provide an undertaking that
such minimum Net Capital Balance shall always be kept completely segregated
from the Net Capital Balance required for any Stock Exchange or other
Commodity Exchange of which the Member holds membership
113
ICM – Stock Brokers' Certification
3.13 General Obligations of a Member/Broker
All the existing Members would be required to apply to the Commission for registration
of the Membership within six months of the commencement of the operations of the
Exchange and all the new Members would be required to apply to the Commission for
the registration of the Membership within six months of becoming a Member, except
where the Commission grants an exemption.
The Broker is the primary obligor of the Exchange and would be responsible for all its
own and its Clients liabilities to the Exchange. Brokers shall, at all times, segregate for
each of their clients, all monies, securities and property received to margin and to
guarantee or secure the trades on Commodity Futures Contracts of their Clients,
including for delivery obligations. Brokers shall at all times have and maintain the
necessary administrative and other systems, facilities, resources and expertise to ensure
that;
i.
the management of their own and Clients’ funds is adequate and in accordance
with the requirements set in this chapter relating to the management or
segregation of funds or otherwise;
ii.
an accurate record of their own and Clients’ positions is kept at all times;
iii.
their Clients’ trades, cash balances and any other information relating to their
positions are reported to their Clients in a timely manner; and
iv.
they comply with all financial requirements pertaining to the relevant category
of Membership
Each Broker shall adhere strictly to and be bound by the provisions of these Regulations
and any conditions stipulated in the notice of approval of its Membership given under
these Regulations and shall at all times comply with the decisions, directions,
determinations, findings of fact and/or interpretation of the Board, the Managing
Director and any other person or body of persons in the exercise or performance of any
function, duty, obligation, power, right, privilege or discretion conferred on it by or
pursuant to these Regulations for the purposes of or in connection with the application
and administration thereof.
3.14 Each Broker will ensure that his Clients and Authorized Persons shall adhere to the
provisions of the Ordinance, Rules, Regulations, Articles and any other additional
condition stipulated by the Commission or the Board, from time to time. However the
obligation of the Broker to the Exchange remains notwithstanding any noncompliance
by their Clients and Authorized Persons. The Brokers are the ultimate obligors of the
Exchange and all and any recourse would be made to the Brokers.
114
ICM – Stock Brokers' Certification
3.15 Each Broker must at all times remain in compliance with the applicable
Regulations.
3.16 Each Broker shall provide any information in respect of any of its key employees as
required by the Exchange. Each Broker shall also notify the Exchange in writing
immediately upon any change in the particulars provided to the Exchange regarding any
key personnel or any transfer or termination of employment and reasons thereof, of any
key personnel. The term “key personnel” comprises the following employees of the
Broker:
a) clearing and settlement principals (i.e. the employees responsible for the
clearing and settlement operations of the Broker, by whatever title assigned);
b) trading principals (i.e. the employees responsible for the trading operations of
the Broker, by whatever title assigned);
c) risk management principals (i.e. the employees responsible for the risk
management of the Broker, by whatever title assigned); and
d) such other categories of employees as may from time to time be designated by
the Exchange
3.17 Each Broker shall pay to the Exchange contributions in respect of the Settlement
Guarantee Fund as is determined by the Board from time to time.
3.18 Every Broker will ensure that his Authorized Persons and Clients follow and comply
with all the provisions of the Ordinance, the Rules and these Regulations. Each Broker
shall be liable for all the actions of its Authorized Persons and Clients and shall be liable
to disciplinary action in respect of any act or omission of its Authorized Persons and
Clients in any of the circumstances set out in these Regulations, the Ordinance or the
Rules.
3.19 Each Broker would be an independent entity engaged in clearing and settlement of
transactions entered into on the Exchange and shall indemnify and keep indemnified
the Exchange from and against all harm, loss, damages, and injury suffered or incurred
and all costs, charges and expenses incurred in instituting and/or carrying on and/or
defending any suits, action, litigation, arbitration, disciplinary action, prosecution or any
other legal proceedings suffered or incurred by the Exchange on account of or as a
result of any act of commission or omission or violation in complying with any of the
provisions of the Ordinance, these Regulations or the Rules framed under the Ordinance
or due to any agreement, contract or transaction executed or made in pursuance
thereof or on account of negligence or fraud on the part of any Member of the
Exchange as aforesaid and their Authorized Persons.
115
ICM – Stock Brokers' Certification
3.20 No Member or Broker or any of their Authorized Persons or Clients shall be entitled
to visit or inspect any premises of the Exchange, access whereto is restricted, without
the prior written permission of the Exchange or to require discovery of any information
with respect to any activities of the Exchange or any matter which is or may be in the
nature of a trade secret, mystery of trade, secret process or any other matter which may
relate to the conduct of the business and which in the opinion of the Exchange may not
be expedient in the interest of the Exchange to disclose.
3.21 Obligation to notify the Exchange on the happening of certain events A Member or
Broker shall notify the Exchange in writing immediately upon the happening of any one
or more of the following:
a) the discovery of a failure by it to comply with any of these Regulations or any of
the conditions stipulated in the notice of approval of its Membership given
pursuant to the Ordinance, Rules, Regulations, Articles or any other order or
direction given by the Commission;
b) the passing of any resolutions, the initiation of any proceedings, or the making of
any order which may result in the appointment of a receiver, provisional
liquidator, liquidator or administrator or the winding-up, re-organization,
reconstruction, amalgamation, dissolution or bankruptcy of the Member or
Broker or any of its shareholders, or any change in the existing shareholding
pattern, or the making of any receiving order or
c) arrangement or composition with creditors;
d) the bankruptcy of any of its directors;
e) it becoming aware of any breach of the Ordinance, Rules, Regulations, Articles or
any other order or direction given by the Commission, by any other Member or
Broker;
f) it becoming aware of any matter required to be notified to the Exchange under
these Regulations;
g) the exercise of any disciplinary measure against it by any regulatory or other
chartered or trade body or the refusal, suspension or revocation of any
regulatory license, consent or approval required in connection with its business;
h) attachment of Membership rights by any court or authority; and
i) any other events as the Board may from time to time specify
116
ICM – Stock Brokers' Certification
General Conduct in Business and Trading
3.29 No Broker shall take part in, be concerned with or carry out, either directly or
indirectly, any transaction or activity that has or may have or is intended or calculated to
have the effect of creating an artificial price for a Commodity Futures Contract or for a
commodity which is the subject of a Commodity Futures Contract.
3.30 No Broker shall create or cause to be created or do anything that is intended or
calculated to create a false or misleading appearance of active dealing in Commodity
Futures Contracts or a false or misleading appearance with respect to the market for, or
the price of dealings in, Commodity Futures Contracts.
3.31 No Broker shall, by any fictitious transaction or device, maintain, inflate, depress or
cause fluctuations in the market price of any Commodity Futures Contract.
3.32 No Broker shall buy or sell any Commodity Futures Contract or attempt to do so or
participate in a scheme or plan to do so for the purpose of unduly or improperly
influencing the market price of any Commodity Futures Contract, or for the purpose of
manipulating or attempting to manipulate prices or cornering or attempting to corner
any market of any commodity, or creating a market or other situation including any
action in the cash market which was designed to influence the futures market, and is
detrimental to the Exchange.
3.33 Each Broker shall ensure that all Futures Business conducted by it relating to
Commodity Futures Contracts shall be concluded on or through the facilities of the
Exchange and that all Commodity Futures Contracts are reported and registered with
the Clearing House in such manner as the Board shall from time to time specify, for
clearing by the Clearing House.
3.34 Clearing Privileges
In order to clear trades at the Exchange, a Broker must be granted Clearing Privileges by
the Board. The Board may revoke the said Clearing Privileges at any time. Clearing
Privileges may be granted and retained only if and when the terms and conditions set
forth below have been met.
A Broker must deposit the minimum security deposit amounts for obtaining the clearing
privileges and in such manner as may be determined by the Exchange and any other
requirements that are deemed fit by the Board from time to time. The Board may
impose any other requirement that it deems appropriate.
3.37 Relations with Clients
Every Broker shall enter into an agreement with each of his Clients, before accepting or
placing orders on the Client's behalf. Such agreement shall specify the minimum
conditions to be specified by the Board. Broker shall make the Client aware of the
precise nature of the Broker’s liability for business to be conducted, including any
117
ICM – Stock Brokers' Certification
limitations on that liability and the capacity in which the Broker acts and the Clients'
liability thereon.
The Broker shall make the Client aware of the risk associated with the business in
Futures Trading including any limitations on the liability and the capacity in which the
Broker acts and the Client’s liability thereon by issuing to the Client a copy of the Risk
Disclosure Document as specified by the Exchange at the time of the opening of an
account. The Risk Disclosure Document shall be duly signed by the Client and
maintained and retained by the Broker.
Disciplinary Matters and Violations
3.38 Disciplinary Jurisdiction: The Exchange may exercise any power including but not
limited to expulsion or suspension and/or imposition of any Administrative fine and/or
penalization under censure and/or withdrawal all or any of the Membership rights of a
Member or Broker if he is guilty of any acts of violation mentioned hereunder but not
limited to the same except in cases of non-financial violations where the power rests
with the Board.
3.39 Circumstances giving rise to violations: Any of the following would be deemed a
violation by the Exchange and the Member or Broker participating in the same shall be
deemed a violator:
a) contravening, disobeying, disregarding or wilfully evading of any of these
Regulations or Ordinance, Rules, Articles or the Laws made by the Commission,
or any other order or direction given by the Commission. Or any resolutions,
orders, notices, directions, decisions or rulings of the Board, the directions,
decisions, orders, notices of the Managing Director or any officer of the
Exchange or for any disreputable or fraudulent transactions or dealings or
method of business which the Board of Directors or the Managing Director
deems unbecoming a Member of the Exchange or inconsistent with just and
equitable principles
b) misconduct, un-businesslike conduct or unprofessional conduct as provided
herein
Misconduct:
i. Conduct of business without registration: If without registration as a broker the
member transacts any business on the Exchanges;
ii. Fraud: If he is convicted of a criminal offence or commits fraud or a fraudulent act
which in the opinion of the Board or the Managing Director renders him unfit to be
a Member or Broker;
118
ICM – Stock Brokers' Certification
iii. Improper Conduct: If in the opinion of the Board or the Managing Director he is
guilty of dishonourable or disgraceful or disorderly or improper conduct on the
Exchange or of wilfully obstructing the business of the Exchange, or of coercing,
harassing or influencing by means of bribery, any employee of the Exchange;
iv. Breach of Regulations: If he shields or assists or omits to report any Member or
Broker whom he has known to have committed a breach or evasion of any
Regulation or of any resolution, order, notice or direction hereunder of the Board
or the Managing Director of the Exchange authorized in that behalf;
v. Failure to comply with Resolutions: If he contravenes or refuses or fails to comply
with or abide by any resolution, order, notice, direction, decision or ruling of the
Board or the Managing Director of the Exchange or other person authorized in that
behalf under the Regulations;
vi. Failure to testify or give information: If he neglects or fails or refuses to submit to
the Commission or the Board or the Managing Director or an officer of the
Commission or the Exchange authorized in that behalf, such books,
correspondence, documents and papers or any part thereof as may be required to
be produced or to appear and testify before or cause any of its, attorneys, agents,
authorized representatives or employees to appear and testify before the
Commission or the Board or the Managing Director or officer of the Commission or
the Exchange or other person authorized in that behalf;
vii. Failure to submit Returns: If he neglects or fails or refuses to submit to the Board
or the Managing Director or to the officer so authorized by it, within the time
notified in that behalf special returns in such form as the Exchange may from time
to time specify, together with such other information as it may require whenever
circumstances arise which in the Exchange’s opinion make it desirable that such
special returns or information should be furnished by any or all the Members;
viii. Failure to submit Audited Accounts: If the Broker neglects or fails or refuses to
submit its Audited Accounts to the Exchange within such time as may be specified
by the Exchange and the Commission from time to time;
ix. False or misleading Returns: If the Broker neglects or fails or refuses to submit or
makes any false or misleading statement in his clearing forms or returns required
to be submitted to Exchange under these Regulations;
x. Vexatious complaints: If the Broker or his Authorized person brings before the
Board or the Managing Director or an officer of the Exchange or other person
authorized in that behalf a charge, complaint or suit which in the opinion of the
Exchange is frivolous, vexatious or malicious;
119
ICM – Stock Brokers' Certification
xi. Failure to pay dues and fees: If he fails to pay his subscription, fees, arbitration
charges or any other money which may be due by it or any fine imposed on him.
xii. Call for information; Failure to provide any information, as requested by the
Exchange for any purpose under these Regulations.
Un-businesslike Conduct:
A Broker shall be deemed guilty of un-businesslike conduct for any of the following or
similar acts or omissions namely:
i.
Fictitious Names: If he transacts his own business or the business of his Client in
fictitious names or if he carries on business in the Exchange under fictitious
names;
ii.
Circulation of rumours: If he, in any manner, circulates or causes to be circulated,
any rumours;
iii.
Unwarrantable Business: If he engages in reckless or unwarrantable or unbusinesslike dealings in the market or effects purchases or sales for his Client's
account or for any account in which he is directly or indirectly interested which
purchases or sales are excessive in view of his Client's or his own means and
financial resources or in view of the market for such security;
iv.
Compromise: If he connives at a private failure of another Broker or accepts less
than full and bona fide money payment in settlement of a debit due by a Broker
arising out of a deal in Future Contracts or securities;
v.
Dishonoured Cheque: If he issues to any other Broker or to its Clients or to the
Exchange a cheque which is dishonoured on presentation for whatever reasons;
vi.
Failure to carry out transactions with Clients: If he fails in the opinion of the
Board to carry out its committed transactions with its Clients
Unprofessional Conduct
A Broker shall be deemed guilty of unprofessional conduct for any of the following or
similar acts or omissions namely:
i.
Business for defaulting Clients: If he deals or transacts business directly or
indirectly or executes an order for a Client who has within his knowledge failed
to carry out engagements relating to Future Contracts and is in violation to
another Broker unless such Client shall have made a satisfactory arrangement
with the Broker who is his creditor;
120
ICM – Stock Brokers' Certification
ii.
Business without permission when under suspension: If without the permission
of the Board he does business on his own account or on account of a principal
with or through a Broker during the period he is required by the Board to
suspend business on the exchange;
iii.
Business for or with suspended, expelled and defaulter Brokers: If without the
special permission of the Commission he shares brokerage with or carries on
business or makes any deal for or with any Broker who has been suspended,
expelled or declared a defaulter;
iv.
Business for Employees of other Brokers: If he transacts business directly or
indirectly for or with or executes a deal for an Authorized Person of another
Broker without the written consent of such employing Broker;
v.
Evasion of Margin Requirements: If he wilfully evades or attempts to evade or
assists in evading the margin requirements specified in these Regulations;
vi.
Clearing Fees: If he wilfully evades or attempts to evade or assists in evading the
regulations relating to clearing fees.
vii.
Advertisement: If he advertises for business purposes or issues regularly circular
or other business communication to persons other than his own Clients, without
the inclusion of the Exchange specified disclaimer, as specified by the Exchange
from time to time.
3.41
a) A Broker whose rights are suspended in full or in part for any reason:
i.
shall remain liable for any payments, fees and charges owing or due by
the Broker to the Exchange under these Regulations, as if the suspension
had not occurred;
ii.
subject to these regulations, shall be prohibited from trading in any or all
Markets, handling Client orders and transacting Futures Business on
behalf of a Client, except as may otherwise be permitted by the
Exchange;
iii.
shall be barred from access to and/or using any or all of the Exchange’s
facilities, except as may otherwise be permitted by the Exchange;
iv.
shall remain liable for any agreement, transaction or arrangement in
relation to any Commodity Futures Contracts held by the Broker before
suspension;
121
ICM – Stock Brokers' Certification
v.
shall, in accordance with the directions of the Exchange, instruct and
appoint another Broker to close out any open positions held by the
Broker on its own account or on behalf of its Clients at the date of
suspension or to effect the transfer to another Broker of all open
positions of any Client together with the money or security standing to
the credit of that Client’s account in respect of those open positions and
shall notify the Exchange in writing of such appointment or transfer
immediately; and
vi.
shall remain bound by the Ordinance, Rules, Regulations, Articles or any
other order or direction given by the Commission
b) Where a Broker is required by the Exchange to close out or transfer any open
positions held by the Broker, the Exchange shall be entitled to close out or
transfer, on behalf of the Broker, such open positions. Such Broker shall
indemnify and hold the Exchange harmless in respect of any costs or other
expenses arising by reason of such closing out or transfer and shall indemnify the
Exchange in respect of any loss suffered by the Exchange in respect of such
closing out or transfer.
c) A Broker whose rights are suspended may at any time thereafter apply to the
person or body which imposed the suspension for the lifting of such suspension
by submitting to such person or body such information including any information
as to the financial condition of the Broker as such person or body may require in
order for it to be satisfied that it is proper in all the circumstances to lift the
suspension. Any suspension of a Broker’s rights may be lifted conditionally or
unconditionally by the Exchange.
On completion, the candidate should:
7.5
know acts that may lead to suspension or cancellation of registration
Candidates are advised to refer to the following rules of the Commodity Exchange &
Future Contract Rules 2005.
- Rule 15: Suspension of Registration
- Rule 16: Cancellation of Registration
- Rule 17: Automatic Cancellation of Registration
122
ICM – Stock Brokers' Certification
ELEMENT 8
Investor Protection
On completion, the candidate should:
8.1
know the requirements of Fair Dealing including:
−
−
−
−
−
−
Risks & Rewards of Investing
Maintenance of Records
Time Stamps
Recording of Telephone Calls
Account Statements & Contract Notes
Misstatements & Mis-selling/ False Selling
RISK & REWARD OF INVESTING
People save for different reasons but most of these reasons are common and can be
classified under one of the following;
−
−
−
−
−
their own education/marriages
their children’s education/marriages
the difficult times in their life
their own old age
their heirs to inherit
Ideally, the people want to put their savings in investments that would fetch them the
maximum returns with the minimum risk. However, this is not possible and
rewards/returns have a direct linkage with the risks and the norm of the market is; “The
higher the risk, the higher the reward” or conversely “the lower the risk, the lower the
reward”.
In any case, while balancing the ‘risk/reward’ equation, investors want to earn enough
on their investments to, at least, beat the inflation rate, so that the purchasing power of
their savings are not diminished with the passage of time.
There is a wide array of mutual funds that individually have different degrees of risks
and rewards. An investor can create a portfolio choosing right mutual fund or
combination of fund that match his/ her own risk tolerance and investment goals. When
one chooses a mix of funds with different objectives and strategies, this is also provides
diversification that helps to reduce the risk by spreading the saving among multiple
investments. If one of the fund declines in value, the loss to overall portfolio may be less
because of other investments that may even rise.
123
ICM – Stock Brokers' Certification
MAINTENANCE OF RECORDS
Please refer Rule 8 of Securities & Exchange Rules 1971 and Rule 5 of Stock Exchange
Members (Inspection of Books and Record) Rules, 2001, Section 230 of the Companies
Ordinance 1984.
TIME STAMPS
A timestamp is a sequence of characters, denoting the date and/or time at which a
certain event occurred. In mutual funds industry, time-stamping usually denotes
marking the date and timings at which a particular transaction (sale or redemption) took
place. This data is usually presented in a consistent format, allowing for easy
comparison of two different records and tracking progress over time; the practice of
recording timestamps in a consistent manner along with the actual data is called timestamping.
Timestamps are typically used for logging events, in which case each event in a log is
marked with a timestamp.
Typical time stamp examples may look like:
2009-10-30 T 10:45 UTC
2009-11-09 T 11:20 UTC
Sat Jul 23 02:16:57 2009
RECORDING OF TELEPHONIC CALLS
Brokers are required to maintain the record of telephonic conversation of all the orders
given to equity dealers or front office staff by the clients of the brokerage house; for a
minimum period of 1 year from the date of conversation for clients’ orders.
ACCOUNT STATEMENTS & CONTRACT NOTES
Rule 4: Manner of transaction of member’s business of the Securities & Exchange Rules
1971 describes:
“(4) A member executing an order of a customer shall, within twenty four hours of the
execution of the order, transmit to the customer a confirmation which shall include the
following information, namely:a)
b)
c)
d)
e)
f)
Date on which the order is executed;
Name and number of the securities;
Nature of transaction (spot, ready or forward and also whether bought or sold);
Price;
Commission, if the member is acting as a broker;
Whether the order is executed for the member’s own account or from the
market.”
124
ICM – Stock Brokers' Certification
Section 6.2A & 6.2B of the CDC Regulations updated 2009 describe:
6.2A Participants to send Holding Balance statements to Sub-Account Holders
6.2A.1 Every Participant shall send within 10 days of end of each quarter to all SubAccount Holders maintaining Sub-Accounts under the control of such Participant
Holding Balance statements showing the number of every Book-entry Security entered
in every such Sub-Account as of the end of the preceding quarter. Such Holding Balance
statements shall be generated from the CDS and shall be sent to the Sub-Account
Holders in the manner set out in Regulation 2.6.4 including to the email addresses of the
Sub-Account Holders notified to the Participants by them.
6.2B Participants to send statements to their clients
6.2B.1 Every Participant shall send by the 10th day of every month to each of his clients
whose Book-entry Securities are entered in the Group Account of the Participant a
statement showing the number of every Book-entry Security owned by such client and
standing to the credit of such Group Account as of the end of the preceding month.
Such statements shall be sent in the manner set out in Regulation 2.6.4 of the CDC
Regulations
MISSTATEMENTS & MIS-SELLING/ FALSE SELLING
Section 17 & 18 of the Securities & Exchange Ordinance 1969 prohibits the following
activities:
Section 17 - Prohibition of fraudulent acts, etc.; - No person shall, for the purpose of
inducing, dissuading, effecting, preventing or in any manner influencing or turning to his
advantage, the sale or purchase of any security, directly or indirectly; a) employ any device, scheme or artifice, or engage in any act, practice or course of
business, which operates or is intended or calculated to operate as a fraud or
deceit upon any person; or
b) make any suggestion or statement as a fact of that which he does not believe to
be true; or
c) omit to state or actively conceal a material fact having knowledge or belief of
such fact; or
d) induce any person by deceiving him to do or omit to do anything which he would
not do or omit if he were not so deceived; or
e) do any act or practice or engage in a course of business, or omit to do any act
which operates or would operate as a fraud, deceit or manipulation upon any
person, in particulari. make any fictitious quotation;
ii. create a false and misleading appearance of active trading in any security;
125
ICM – Stock Brokers' Certification
iii. effect any transaction in such security which involves no change in its
beneficial ownership;
iv. enter into an order or orders for the purchase and sale of security which
will ultimately cancel out each other and will not result in any change in the
beneficial ownership of such security;
v. directly or indirectly effect a series of transactions in any security creating
the appearance of active trading therein or of raising of price for the
purpose of inducing its purchase by others or depressing its price for the
purpose of inducing its sale by others;
vi. being a director or an officer of the issuer of a listed equity security or a
beneficial owner of not less than ten per cent of such security who is in
possession of material facts omit to disclose any such facts while buying or
selling such security
Section 18 - Prohibition of false statements, etc.: - No person shall, in any document,
paper, accounts, information or explanation which he is, by or under this Ordinance,
required to furnish, or in any application made under this Ordinance, make any
statement or give any information which he knows or has reasonable cause to believe to
be false or incorrect in any material particular.
On completion, the candidate should:
8.2
know the process and handling of Investor Complaints
The SECP being the apex regulator of the capital markets tries to identify financial
transaction that violate regulations and which could impact the investor confidence or
affect fairness in the markets. Using complaint information the SECP can identify the
weak areas in relevant regulations or in their compliance and make necessary
arrangements for fixing the same.
INVESTOR PROTECTION
Investors’ confidence in the fairness of capital markets is fundamental to the success of
markets in capital foundation. The Karachi Stock Exchange, as frontline regulator and
SECP, as apex regulator of the capital markets deploys a variety of means to get the
investors protected from market abuse and for this purpose has framed various Rules
and Regulations. Investors are offered protection by including good corporate
governance practices in corporate law, having an effective system of resolution of
investors’ complaints, creating awareness among investors of prudent way of dealing in
securities and demonstrating the capacity to detect and punish market abuse through
market surveillance.
126
ICM – Stock Brokers' Certification
THE INVESTOR COMPLAINTS CELL AT KSE
The Karachi Stock Exchange, being the frontline regulator, plays a proactive role.
Securing the interest of small investors and minority shareholders is of prime
importance to the Karachi Stock Exchange. In order to keep a vigilant eye on investors’
issues and to provide a platform to the general public for voicing their concerns, an
Investors’ Complaints Cell within Legal Division of KSE has been set up. This Cell is
responsible for ensuring that grievances/complaints of the general public concerning
investment and trading of securities are heard and redressed, in a quick and efficient
manner. Similar compliant cells are also functioning at the other Exchanges.
Lodging a Complaint with Stock Exchange
It is strongly advised that the concern/problem should first be taken up directly with the
concerned member of Stock Exchange. It is prudent to act promptly. If the Member fails
to redress complainant’s grievance then the investor may lodge a proper complaint
supported by documentary evidences to the Stock Exchange addressed to its Managing
Director. The time required to resolve a dispute varies with the nature and complexity
of each case and the availability of documentary evidences.
In order to enable the Stock Exchange to act upon a complaint and for quick follow-up,
the complaint should necessarily contain all available information for contact purpose,
such as complete postal address, telephone, fax and mobile numbers, and e-mail. In
addition, full details of the complaint are provided by filling the Complaint Form with all
required supporting documents and annexure as mentioned in such form.
On completion, the candidate should:
8.3
know the Investor Protection Fund of stock exchanges
THE INVESTOR PROTECTION FUND
While the investor protection fund and its regulations may vary from exchange to
exchange, following is a brief and general overview of such fund. For details, readers
may review that Investor Protection Fund Regulations of relevant exchanges. Investors’
confidence in the fair dealings at the Exchange is the key to rapid development of the
market.
The Investor Protection fund at KSE was established under “KSE Investor Protection
Fund Regulations” that define investor as “a person, not being member, his agent or
representative who has purchased or sold any of the securities listed at the Exchange”.
The regulation provide for contributions to the fund as follows:
127
ICM – Stock Brokers' Certification
(a) The initial contribution of rupees twenty million by the Exchange out of the
Clearing House Protection Fund.
(b) Allocation of a percentage of Trading Fee as may be determined by the Board
from time to time paid by the members of the Exchange.
The Fund was made available in the situation of default as well as in case of expulsion of
a member due to failure or refusal to abide by or carry out the award of arbitrator(s) or
for non-settlement of investors’ claims as directed by the Board.
ELIGIBILITY OF CLAIMS
All claims of investors arising out of transactions entered into as per Regulations of the
Exchange and approved by the Board/Committee constituted by the Board are eligible
to be considered under these regulations.
PROCEDURE FOR SETTLEMENT OF CLAIMS
In the event of default or expulsion of a Member by the Exchange, in case where the
admitted claims of investors against a Member are more than the amount available for
its satisfaction as per the relevant Regulations, all the claims are paid on pro-rata basis.
The claims still remaining unsatisfied after pro-rata sharing are then paid from the Fund
by utilizing up to aggregate amount of Rs. 25 million in the following order of priority:
(a) Up to Rs. 100,000/- equally among all claimants by utilizing 50% of maximum
allowable contribution i.e. Rs. 12.5 million.
(b) Remaining amount by utilizing balance 50% of maximum allowable contribution
i.e. Rs. 12.5 million plus any unutilized portion of Fund as stated at (a) above. In
case, such amount of Fund is insufficient to satisfy all such claims in full, then
pro-rata distribution are to be made.
MANAGEMENT OF THE FUND
The Management of the Fund vests in the Trustees as provided in the KSE Investors’
Protection Fund Trust Deed.
On completion, the candidate should:
8.4
know the ethical and professional standards of the industry
ETHICS
− Act with integrity, competence, diligence, respect, and in an ethical manner
with the public, clients, prospective clients, employers, employees,
colleagues in the investment profession, and other participants in the global
capital markets.
128
ICM – Stock Brokers' Certification
− Place the integrity of the investment profession and the interests of clients
above their own personal interests.
− Use reasonable care and exercise independent professional judgment when
conducting investment analysis, making investment recommendations,
taking investment actions, and engaging in other professional activities.
− Practice and encourage others to practice in a professional and ethical
manner that will reflect credit on us and the profession.
− Promote the integrity of, and uphold the rules governing, capital markets.
− Maintain and improve their professional competence and strive to maintain
and improve the competence of other investment professionals.
CODE OF PROFESSIONAL CONDUCT
I. PROFESSIONALISM
A. Knowledge of the Law. Market participants must understand and comply with all
applicable laws, rules, and regulations of any government, regulatory organization,
licensing agency, or professional association governing their professional activities. In
the event of conflict, they must comply strictly with the laws, rules and/or regulations
and must not knowingly participate or assist in and must dissociate from any violation of
such laws, rules, or regulations.
B. Independence and Objectivity. Market participants must use reasonable care and
judgment to achieve and maintain independence and objectivity in their professional
activities. Participants must not offer, solicit, or accept any gift, benefit, compensation,
or consideration that reasonably could be expected to compromise their own or
another’s independence and objectivity.
C. Misrepresentation. Market participants must not knowingly make any
misrepresentations relating to investment analysis, recommendations, actions, or other
professional activities.
D. Misconduct. Market participants must not engage in any professional conduct
involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their
professional reputation, integrity, or competence.
II. INTEGRITY OF CAPITAL MARKETS
A. Material Nonpublic Information. Participants who possess material nonpublic
information that could affect the value of an investment must not act or cause others to
act on the information.
129
ICM – Stock Brokers' Certification
B. Market Manipulation. Market participants must not engage in practices that distort
prices or artificially inflate trading volume with the intent to mislead market
participants.
III. DUTIES TO CLIENTS
A. Loyalty, Prudence, and Care. Market participants have a duty of loyalty to their
clients and must act with reasonable care and exercise prudent judgment. Participants
must act for the benefit of their clients and place their clients’ interests before their
employer’s or their own interests. In relationships with clients, Participants must
determine applicable fiduciary duty and must comply with such duty to persons and
interests to whom it is owed.
B. Fair Dealing. Market participants must deal fairly and objectively with all clients when
providing investment analysis, making investment recommendations, taking investment
action, or engaging in other professional activities.
C. Suitability.
1. When Market participants are in an advisory relationship with a client, they must:
a. Make a reasonable inquiry into a client’s or prospective clients’ investment
experience, risk and return objectives, and financial constraints prior to making
any investment recommendation or taking investment action and must reassess
and update this information regularly.
b. Determine that an investment is suitable to the client’s financial situation and
consistent with the client’s written objectives, mandates, and constraints before
making an investment recommendation or taking investment action.
c. Judge the suitability of investments in the context of the client’s total
portfolio.
2. When Market participants are responsible for managing a portfolio to a specific
mandate, strategy, or style, they must only make investment recommendations or take
investment actions that are consistent with the stated objectives and constraints of the
portfolio.
D. Performance Presentation. When communicating investment performance
information, Members or Candidates must make reasonable efforts to ensure that it is
fair, accurate, and complete.
E. Preservation of Confidentiality. Market participants must keep information about
current, former, and prospective clients confidential unless:
1. The information concerns illegal activities on the part of the client or
prospective client.
2. Disclosure is required by law.
130
ICM – Stock Brokers' Certification
3. The client or prospective client permits disclosure of the information.
IV. DUTIES TO EMPLOYERS
A. Loyalty. In matters related to their employment, Market participants must act for the
benefit of their employer and not deprive their employer of the advantage of their skills
and abilities, divulge confidential information, or otherwise cause harm to their
employer.
B. Additional Compensation Arrangements. Market participants must not accept gifts,
benefits, compensation, or consideration that competes with, or might reasonably be
expected to create a conflict of interest with, their employer’s interest unless they
obtain written consent from all parties involved.
C. Responsibilities of Supervisors. Market participants must make reasonable efforts to
detect and prevent violations of applicable laws, rules, regulations, and the Code and
Standards by anyone subject to their supervision or authority.
V. INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTION
A. Diligence and Reasonable Basis. Market participants must:
1. Exercise diligence, independence, and thoroughness in analyzing
investments, making investment recommendations, and taking investment
actions.
2. Have a reasonable and adequate basis, supported by appropriate research
and investigation, for any investment analysis, recommendation, or action.
B. Communication with Clients and Prospective Clients. Participants must:
1. Disclose to clients and prospective clients the basic format and general principles
of the investment processes used to analyse investments, select securities, and
construct portfolios and must promptly disclose any changes that might
materially affect those processes.
2. Use reasonable judgment in identifying which factors are important to their
investment analyses, recommendations, or actions and include those factors in
communications with clients and prospective clients.
3. Distinguish between fact and opinion in the presentation of investment analysis
and recommendations.
131
ICM – Stock Brokers' Certification
C. Record Retention. Participants must develop and maintain appropriate records to
support their investment analysis, recommendations, actions and other investmentrelated communications with clients and prospective clients.
VI. CONFLICTS OF INTEREST
A. Disclosure of Conflicts. Participants must make full and fair disclosure of all matters
that could reasonably be expected to impair their independence and objectivity or
interfere with respective duties to their clients, prospective clients, and employer.
Participants must ensure that such disclosures are prominent, are delivered in plain
language, and communicate the relevant information effectively.
B. Priority of Transactions. Investment transactions for clients and employers must have
priority over investment transactions in which a Member or Candidate is the beneficial
owner.
C. Referral Fees. Participants must disclose to their employer, clients, and prospective
clients, as appropriate, any compensation, consideration, or benefit received from, or
paid to, others for the recommendation of products or services.
132
ICM – Stock Brokers' Certification
ELEMENT 9
ECONOMICS AND FINANCE
On completion, the candidate should:
9.1
know the Taxation laws relevant to capital markets including:
−
−
−
−
Income Tax
Capital Gain Tax
Capital Value Tax
Corporate Tax
INCOME TAX
An income tax is a tax levied on the financial income of people, corporations, or other
legal entities. When the tax is levied on the income of companies, it is often called a
corporate tax, corporate income tax, or profit tax. Income tax for individual is often the
tax on the total income of the individual after allowing for some permitted deductions.
The relevant sections of the Income Tax Ordinance 2001 updated July 2007 pertinent to
individuals investing in stocks and mutual funds are: Section 3, 4, 9, 10, 11, 12, 13, 14,
62, 63, 88A, 114, 115, 116, 149, 150.
CAPITAL GAIN TAX (CGT)
A capital gain is a profit that results from investments into a capital asset, such as
stocks, bonds or real estate, which exceeds the purchase price. It is the difference
between a higher selling price and a lower purchase price, resulting in a financial gain
for the investor.
Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less
than the purchase price.
Most countries impose a tax on capital gains of individuals or corporations, although
relief may be available to reduce or exempt certain capital gains, in relation to holdings
in certain assets such as significant common stock holdings for a predetermined and
specified period. These reductions or exemptions are intended to provide incentives for
long term investments while simultaneously taxing speculations or quick gains.
Capital gains tax is the tax charged on the capital gains.
Pakistan: Changes in Capital Gains Tax regime
In Pakistan the Capital Gains made on the disposal of the securities were exempted from
tax till 30 June 2010. This exemption has now expired and capital gains arising on
disposal of securities have with effect from 1st July 2010 been made chargeable to
133
ICM – Stock Brokers' Certification
capital gains tax by the amendments made in the Income Tax Ordinance 2001, through
Finance Act 2010. In Pakistan Capital Gains Tax on the securities has been linked to the
holding period and the applied rate is dependent on whether the holding period of a
security is;
(i)
(ii)
(iii)
less than six months;
more than six months but less than twelve months and;
more than twelve months.
A schedule of applied rates of Capital Gains Tax has also been announced, the rates
have been legislated to increase gradually over the next five years. The amendment to
the Income Tax Ordinance, 2001 has introduced a new Section 37A in it. Relevant
excerpts of the Section 37A read as:
“Clause 3: TAX ON CAPITAL GAINS ON DISPOSAL OF SECURITIES [Section 37A]
On expiry of exemption on tax on capital gains, capital gains arising on disposal of
securities has been made chargeable to capital gains tax through newly introduced
section 37A:“Securities”
For the purposes of capital gain tax (CGT), “securities” mean share of a public company,
voucher of Pakistan Telecommunication Corporation, Modaraba Certificate, an instrument
of redeemable capital and derivative products.
Date of chargeability of CGT.
Capital gain tax shall be chargeable on capital gain arising from securities disposed off on or
after 1st July 2010.
Charge of CGT according to the holding period
Capital gain tax shall not be chargeable on disposal of securities which are held for a period
of more than one year.
Holding period
Holding period of securities shall be calculated from the date of acquisition (whether before
or after the thirtieth day of June, 2010) to the date of disposal of such security falling after
30th June 2010.
Adjustment of losses
Adjustment of losses on disposal of securities in a tax year shall be adjustable only against
the gain from disposal of any other securities and such loss shall not be carried forward to a
subsequent tax year.
134
ICM – Stock Brokers' Certification
Capital gains – a separate block of income
Capital gains on disposal of securities shall be taxed as a separate block of income and
shall be charged on capital gain arising to securities holders irrespective of taxpayer’s
tax (exemption) status and will be calculated on ‘First in First out (FIFO)’ basis.
Capital Gains Tax Rates
The rate of capital gain tax under section 37A as specified in Division VII of Part I of the First
Schedule to the Income Tax Ordinance, 2001 are as under:-
S. No
(i)
Period
Where holding period of a
security is less than six
months.
Tax Year
2011
2012
2013
2014
2015
Rate of Tax
10%
10%
12.5%
15%
17.5%
(ii)
Where holding period of a
security is more than six
months but less than
twelve months.
2011
2012
2013
2014
2015
2016
7.5%
8%
8.5%
9%
9.5%
10%
(iii)
Where holding period of a
security is more than one
year.
--
0%
…
No loss shall be carried forward to the subsequent tax year.”
Wash Trade
According to the draft rules issued by the FBR, loss suffered on disposal of securities
during the period of a tax year shall be set off against capital gains from disposal of
securities during such period irrespective of the period of holding of such securities in
such tax year. However, No adjustment of loss arising in cases of "Wash sales", "Cross
trade" and "Tax Swap Sale" shall be admissible under the CGT rules. (The terms have
been defined in Glossary)
The securities held for less than one day shall be treated as held for less than six
months. Where contract for the purchase and sale of securities is periodically or
ultimately settled by the actual delivery, the period between the date of acquisition and
135
ICM – Stock Brokers' Certification
date of disposal shall be reckoned as the holding period. In case of derivative products,
the period between the date of entry into contract of purchase or sale and date of exit
from contract of purchase or sale shall be taken as the holding period.
In case of securities not traded on trading platforms (trade over the counter) provided
by the Stock Exchanges, the period between date of acquisition and date of disposal,
shall be taken as the holding period. The method to determine date of acquisition of
various securities disposed of, for the purpose of determination of holding period to be
employed will be "First-In-First-Out" (FIFO).
To determine the cost of acquisition of securities the method to be employed
consistently, at the option of the person holding such securities, shall be either "Moving
Weighted Average Cost method" or "Specific Identification Cost method on FIFO basis".
The profit made on sale of borrowed shares shall be treated as capital gain when such
shares are acquired for their return to Authorized Intermediary. Period intervening
between acquisition and disposal of such borrowed shares shall determine the "holding
period" in which the capital gain or loss falls. "Specific Identification Method" shall be
used to determine the acquisition cost and consideration for disposal of such securities.
Profit made on disposal of shares acquired under Margin Finance Scheme, Margin
Trading Scheme or other Financing or Leverage schemes approved by Securities and
Exchange Commission of Pakistan shall be treated as 'capital gain'. The difference
between cost of acquisition (inclusive of borrowing cost) and consideration received
against disposal of such shares shall determine the quantum of capital gain or loss.
CAPITAL VALUE TAX (CVT)
The Capital Value Tax (CVT) was introduced vide section 7 of the Finance Act, 1989.
After repeated, present application of CVT is such that on the purchase of Modaraba
Certificates or any instrument of redeemable capital, or shares of a public company
listed on stock exchange in Pakistan, a CVT is applied at the rate of 0.02 percent of the
purchase value. In simple terms it can be called a trading tax.
CORPORATE TAX
Corporate tax or company tax refers to a tax imposed on entities that are taxed at the
entity level in a particular jurisdiction. Such taxes may include income and other taxes.
Generally, the taxes are imposed on net taxable income. Net taxable income for
corporate tax is generally financial statement income with modifications, and may be
defined in detail within the system. The tax may have an alternative base, such as
assets, payrolls, or income computed in an alternative manner.
Corporations are also subject to property tax, payroll tax, withholding tax, excise duty,
customs duty and other common taxes, generally in the same manner as other
taxpayers. Corporations may also be taxed on their existence or equity structure. These,
136
ICM – Stock Brokers' Certification
however, are referred to as “corporate tax”. In Pakistan Corporate Tax is levied at the
rate of thirty five percent (35%).
Generally, the income tax is imposed at a specific rate of taxable income as defined
within the system. There is a separate body of law and separate provisions that relates
to corporate taxation. In such cases, the law may apply only to entities and not to
individuals operating a trade. Such laws may differentiate between broad types of
income earned by corporations and tax on such types of income differently.
On completion, the candidate should:
9.2
understand and interpret the Financial Statements and conduct basic Financial
Statement Analysis including:
− Revenue and profit growth
− Earnings and Distributions
− Book value and Intrinsic value
FINANCIAL STATEMENT ANALYSIS (FSA)
Financial statement analysis involves analysing the financial statements and in short it
looks at the health of business of its management, competitiveness, and its markets.
The term is also used to distinguish these analyses from other types of investment
analysis, such as quantitative analysis and technical analysis.
The financial statement analysis is performed on historical and present data, but with
the goal of making financial forecasts. There are several possible objectives for
undertaking this exercise:
−
−
−
−
to conduct a company stock valuation and predict its probable price evolution,
to make a projection on its business performance,
to evaluate its management and make internal business decisions,
to calculate its credit risk
In short, financial statements are means through which companies present their
financial situation to shareholders, creditors and general public. Analysis of a financial
statement means finding out the current position of the company through various tools
like ratio analysis and fund flow analysis. It also involves comparing the company figures
with regard to industry standards or over a period of time.
REVENUE AND PROFIT GROWTH
In business, revenue is income that a company receives from its normal business
activities, usually from the sale of goods and services to customers. Some companies
also receive revenue from interest, dividends or royalties paid to them by other
137
ICM – Stock Brokers' Certification
companies. Revenue may refer to business income in general, or it may, for example,
refer to the amount, received during a period of time, as in "Last year, Company X had
revenue of Rs.32 million." In many countries, revenue is also referred to as turnover.
Profits or net income generally imply total revenue minus total expense in a given
period. In accounting and financial analysis, revenue is often referred to as the "top line"
due to its position on the income statement at the very top. This is to be contrasted with
the "bottom line" which denotes net income.
Revenue is a crucial part of financial analysis. A company’s performance is measured to
the extent to which its asset inflows (revenues) compare with its asset outflows
(expenses). Net Income is the result of this equation, but revenue typically enjoys equal
attention during a standard earnings call. If a company displays solid “top-line growth,”
analysts could view the period’s performance as positive even if earning’s growth, or
“bottom-line growth” is stagnant. Conversely, high income growth would be tainted if a
company failed to produce significant revenue growth. Consistent revenue growth, as
well as income growth, is considered essential for a company's publicly traded stock to
be attractive to investors. Revenue is used as an indication of earnings quality. There are
several financial ratios attached to it, the most important being gross margin and profit
margin.
Price/Sales sometimes used as a substitute for a Price to Earnings ratio when earnings
are negative and the P/E is meaningless. Though a company may have negative
earnings, but in most cases it has positive revenue.
Gross Margin is a calculation of revenue less cost of goods sold, and is used to
determine how well sales cover direct variable costs relating to the production of goods.
Net income/ sales, or profit margin, is calculated by investors to determine how
efficiently a company turns revenues into profits.
EARNINGS AND DISTRIBUTION
Earnings are the amount of profit that a company produces during a specific period,
which is usually defined as a quarter (three calendar months) or a year. Earnings
typically refer to after-tax net income. Ultimately, a business's earnings are the main
determinant of its share price, because earnings and the circumstances relating
to them can indicate whether the business will be profitable and successful in the long
run.
Earnings are perhaps the single most studied number in a company's financial
statements because they show a company's profitability. A business's quarterly and
annual earnings are typically compared to analyst estimates and guidance provided by
the business itself. In most situations, when earnings do not meet either of those
estimates, a business's stock price will tend to drop. On the other hand, when actual
earnings beat estimates by a significant amount, the share price will likely surge.
138
ICM – Stock
k Brokers' Certiification
etained earn
nings refer to
o the portion of net inco
ome which iis retained b
by
In acccounting, re
the corporation
c
rather than
n distributed to its ow
wners as divvidends. Sim
milarly, if th
he
corpo
oration makkes a loss, th
hen that loss is retainedd and called
d by differen
nt names likke
retain
ned losses, accumulate
ed losses or accumula ted deficit. Retained eearnings an
nd
losses are cumulaative from year to year with
w losses ooffsetting eaarnings.
Retained earninggs are reportted in the sh
hareholder'ss equity secttion of the balance sheeet.
Comp
panies with net accumulated lossess may refer tto negative sshareholderrs' equity as a
share
eholders' de
eficit. A com
mplete reporrt of the rettained earnings or retaiined losses is
prese
ented in the Statement of
o retained earnings
e
or SStatement o
of retained lo
osses.
When
n total assetts are greater than totaal liabilities, stockholders have a po
ositive equitty
(posittive book value). Conve
ersely, when total liabiilities are greater than total assets,
stockkholders have a negattive stockho
olders' equ ity (negativve book vaalue) — alsso
some
etimes called stockhold
ders' deficit. A stockhoolders' deficcit does no
ot mean thaat
stockkholders owe
e money to the corporaation as theyy own only its net assets and are no
ot
accou
untable for its
i liabilities.. It means th
hat the valuee of the asseets of the co
ompany musst
rise above its liabilities be
efore the sttockholders hold positive equity value in th
he
comp
pany.
The decision
d
of whether
w
a firrm should re
etain net inccome or have it paid outt as dividend
ds
depends on several factors in
ncluding, but not limitedd to the:
ment of divid
dends; and
− Tax treatm
or reinvestm
ment in the coorporation w
which is calleed retention
n.
− The fundss required fo
Dividend pay-outt ratio is the
e fraction off net incomee that a firm
m pays to its stockholderrs
in divvidends:
BOOK
K VALUE
In accounting, ‘b
book value’ or ‘carrying value’ is thhe value of aan asset acccording to itts
balan
nce sheet acccount balan
nce. For asse
ets, the valuee is based o
on the original cost of th
he
assett less any de
epreciation, amortizatio
on or impairrment costs made again
nst the asseet.
Traditionally, a company's
c
book
b
value is its total assets minu
us intangible assets an
nd
liabiliities. Howevver, in practiice, depending on the ssource of thee calculation
n, book valu
ue
may include goo
odwill, intanggible assets,, or both. W
When intanggible assets and goodwill
e
exccluded, the product
p
is often
o
specified to be "taangible book value". Th
he
are explicitly
term net asset vaalue may reffer to the bo
ook value of a company iin certain co
ountries.
139
ICM – Stock Brokers' Certification
Simply put, the book value is the value at which an asset is carried on a balance sheet.
Calculating the book value is simple; as it equals the cost of an asset minus the
accumulated depreciation. The net asset value of a company is calculated by total assets
minus intangible assets (patents, goodwill) and liabilities.
Book value is the accounting value of a firm and has two main uses:
− It is the total value of the company's assets that shareholders would theoretically
receive if a company was to be liquidated.
− By comparing the company's book value to its market value, the analysts can
determine whether a stock is under- or overpriced with respect to its book value.
In personal finance, the book value of an investment is the price paid for a security or
debt investment. When a stock is sold, the selling price less the book value is the capital
gain (or loss) from the investment.
INTRINSIC VALUE
The intrinsic value refers to the value of a security which is intrinsic to or contained in
the security itself and is also frequently referred to as ‘fundamental value’. It is
ordinarily calculated by summing the future income generated by the asset, and
discounting it to the present value.
Usually, the intrinsic value is the actual value of a company or an asset based on an
underlying perception of its true value including all aspects of the business, in terms of
both tangible and intangible factors. This value may or may not be the same as the
current market value. Investors use a variety of analytical techniques in order to
estimate the intrinsic value of securities in hope of finding investments where the true
value of the investment exceeds its current market value.
On completion, the candidate should:
9.3
understand and be able to apply basic mathematics and statistics including:
− Mean, Median and Mode
− Dispersion and regression analysis
MEAN
Mean is the simple mathematical average of a set of two or more numbers. The mean
for a given set of numbers can be computed in more than one way, including the
arithmetic mean method, which uses the sum of the numbers in the series, and the
geometric mean method. However, all of the primary methods for computing a simple
average of a normal number series produce the same approximate result most of the
time.
140
ICM – Stock Brokers' Certification
For example, if a stock XYZ closed at Rs.50, Rs.51 and Rs.54 over the past
three days, the arithmetic mean would be the sum of those numbers
divided by three, which is Rs.51.67.
In contrast, the geometric mean would be computed as third root of the numbers'
product, or the third root of 137,700, which approximately equals Rs.51.64. While the
two results are not exactly equal, most people consider arithmetic and geometric means
to be equivalent for most practical purposes.
MEDIAN
In statistics, a median is described as the numeric value separating the higher half of a
sample of numbers, from the lower half. The median of a finite list of numbers can be
found by arranging all the observations from lowest value to highest value and picking
the middle one. If there is an even number of observations, then there is no single
middle value; the median is then defined to be the mean of the two middle values.
Median is the midpoint of the range of numbers that are arranged in order of value.
For Example: If there is an even amount of numbers in the series, the median is
found by taking the mean of the two numbers in the middle of the distribution.
50% of the numbers will be above the median and 50% will be below. In this
odd set of numbers--1, 3, 5, 5, 5, 6, 7, 8, 12, 13, and 25--the median would be 6
because half of the other numbers are below it, and half are above
it. Alternatively if you had the following set of numbers—23, 23, 24, 25, 26, 28,
42, and 44--the median would be 25.5 (26+25/2=25.5).
In certain cases, the median can be a good way to determine an approximate average,
especially when dealing with a set of numbers that could otherwise be skewed by
outliers, such as the number 25 in the first set.
STANDARD DEVIATION
A statistic used as a measure of the dispersion or variation in a distribution, equal to the
square root of the arithmetic mean of the squares of the deviations from the arithmetic
mean.
In finance, standard deviation is applied to the annual rate of return of an investment to
measure the investment's volatility (risk).
MODE
Mode is the statistical term referring to the most frequently occurring term in a set of
numbers, if no number is repeated then there is No mode for the set.
For example, in the following set of data--32, 34, 34, 34, 45, 67, 71, 43 --the
mode is 34 because it is the most common number in the set.
141
ICM – Stock
k Brokers' Certiification
TRAL TENDENCY
CENT
A me
easure of cen
ntral tenden
ncy is a meassure that tells us where the middle of a bunch o
of
data lies. The th
hree most common
c
me
easures of ccentral tendency are th
he mean, th
he
median, and the mode.
For th
he data 1, 2,, 3, 4, 5, 5, 6, 7, 8 the me
easures of ceentral tendeency are
Mean
=
Median
=
5
Mode
=
5
DISPEERSION
Dispe
ersion is a term used
d in statistics that reefers to thee location of a set o
of
value
es relative to
o a mean or average
a
leve
el.
In fin
nance, dispersion is used
d to measurre the volatiility of differrent types o
of investmen
nt
strate
egies. Returns that have
e wide dispe
ersions are ggenerally seeen as more rrisky becausse
they have a higher probability of closingg dramaticallly lower thaan the mean
n. In practicee,
stand
dard deviation is the to
ool that is generally uused to measure the d
dispersion o
of
returrns.
REGR
RESSION ANA
ALYSIS
Regre
ession analyysis is the statistical technique thatt identifies tthe relationsship betweeen
two or more quantitative variables: a dependennt variable, whose value is to b
be
prediicted, and an
a independ
dent or exp
planatory vaariable (or variables), about whicch
know
wledge is avaailable. The technique is
i used to fi nd the equaation that reepresents th
he
relatiionship betw
ween the variables. A simple reg ression anaalysis can sh
how that th
he
relatiion between
n an indepen
ndent variab
ble X and a ddependent vvariable Y iss linear, usin
ng
the simple linearr regression equation Y=
= a + bX (wh ere a and b are constan
nts). Multiplle
regre
ession will provide
p
an equation that predict s one variaable from ttwo or morre
indep
pendent variiables, Y= a + bX1+ cX2+ dX
d 3.
Stren
ngths and lim
mitations of the approach
Stren
ngths
− Regre
ession analyysis provid
des an oppportunity to specify hypothesees
conce
erning the nature
n
of effects
e
(actioon theory), as well ass explanatorry
factorrs.
− When
n it is successfully exe
ecuted (wit h a statistiically valid adjustmentt),
regresssion analysis can produ
uce a quantittative estimaate of net efffects.
142
ICM – Stock Brokers' Certification
Limitations
− The technique is demanding because it requires quantitative data relating to
several thousand individuals.
− Implementing the data collection can be time-consuming and expensive.
− Regression analysis is likely to reach the conclusion that there is a strong link
between two variables; whereas the influence of other, more important,
variables may not have been estimated (this error is called "data snooping").
The tool should therefore be used with care.
− Relations between the different explained and explanatory variables are
often circular (X explains Y and Y explains X). In this case, the method is
inapplicable.
−
The observations must present sufficiently contrasted evolutions to allow for
adjustment. For example, if all the observations concern the 30-40 age
groups, it will not be possible to estimate the influence of age on
employment.
On completion, the candidate should:
9.4
understand and be able to apply basic financial mathematics including:
− Time value money, annuities and perpetuities
− Calculations of annuities and perpetuities
− Present & future value of cash flows
TIME VALUE OF MONEY
The concept suggests that money available at the present time is worth more than the
same amount in the future due to its potential earning capacity. This core principle of
finance holds that, provided money can earn interest, any amount of money is worth
more the sooner it is received.
The time value of money is, thus, the value of money figuring in a given amount of
interest earned over a given amount of time. The method of calculating provides
valuation of a likely stream of income in the future, in such a way that the annual
incomes are discounted and then added together, thus providing a lump-sum "present
value" of the entire income stream.
For example, assuming a 5% interest rate, Rs1000 invested today will be worth Rs1050
in one year (Rs100 multiplied by 1.05). Conversely, Rs 100 received one year from
now is only worth Rs 952.4 today (Rs 1000 divided by 1.05), assuming a 5% interest rate
143
ICM – Stock Brokers' Certification
The time value of money, in short represents the interest that might be earned on a
payment received today, if held, earning interest, until that future date.
All the standard calculations derive from the most basic algebraic expression for the
present value of a future sum, "discounted" to the present by an amount equal to the
time value of money.
For example, a sum of FV to be received in one year is discounted (at the
rate of interest r) to give a sum of PV at present:
PV
PV
=
=
FV — r
FV / (1+r).
After studying this material you should be able to
-
Calculate the future value to which money invested at a given interest rate will
grow.
Calculate the present value of a future payment.
Calculate present and future values of streams of cash payments.
Find the interest rate implied by the present or future value.
Understand the difference between real and nominal cash flows and between real
and nominal interest rates.
Compare interest rates quoted over different time intervals—for example, monthly
versus annual rates.
There is nothing complicated about these calculations, but if they are to become second
nature, you should read the material thoroughly, work carefully through the examples. We
are asking you to make an investment now in return for a payoff later.
FUTURE VALUES AND COMPOUND INTEREST
You have Rs.100 invested in a bank account. Suppose banks are currently paying an
interest rate of 6% per year on deposits. So after a year, your account will earn interest
of Rs.6:
Interest
=
interest rate x initial investment
=
0.06 x Rs.100
=
Rs.6
You start the year with Rs.100 and you earn interest of Rs.6, so the value of your
investment will grow to Rs.106 by the end of the year:
Value of investment after 1 year
=
144
Rs.100 + Rs.6 = Rs.106
ICM – Stock Brokers' Certification
Notice that the Rs.100 invested grows by the factor (1 + 0.06) = 1.06. In general, for any
interest rate r, the value of the investment at the end of 1 year is (1 + r) times the initial
investment:
Value after 1 year
=
=
initial investment x (1 + r)
Rs.100 x (1.06) = Rs.106
What if you leave this money in the bank for a second year? Your balance, now Rs106,
will continue to earn interest of 6%. So,
Interest in Year 2
=
0.06 x Rs.106 = Rs.6.36
You start the second year with Rs.106 on which you earn interest of Rs.6.36. So by the
end of the year the value of your account will grow to Rs.106 + Rs.6.36 = Rs.112.36.
In the first year your investment of Rs.100 increases by a factor of 1.06 to Rs106; in the
second year the Rs.106 again increases by a factor of 1.06 to Rs.112.36. Thus the initial
Rs.100 investment grows twice by a factor 1.06:
Value of account after 2 years
=
=
Rs.100 x 1.06 x1.06
Rs.100 x (1.06)2 = Rs.112.36
If you keep your money invested for a third year, your investment multiplies by 1.06
each year for 3 years. By the end of the third year it will total Rs.100 x (1.06)3 =
Rs.119.10.
Clearly for an investment horizon of t years, the original Rs.100 investment will grow to
Rs.100 x (1.06)t. For an interest rate of r and a horizon of t years, the future value of
your investment will be
Future value of Rs.100
=
Rs.100 x (1 + r)t
Notice in our example that your interest income in the first year is Rs.6 (6 percent of
Rs.100), and in the second year it is Rs.6.36 (6 percent of Rs.106). Your income in the
second year is higher because you now earn interest on both the original Rs.100
investment and the Rs.6 of interest earned in the previous year. Earning interest on
interest is called compounding or compound interest. In contrast, if the bank calculated
the interest only on your original investment, you would be paid simple interest.
Table A illustrates the mechanics of compound interest. Obviously, the higher the rate
of interest, the faster your savings will grow. For example, after 10 years Rs. 1,000
invested at 10% will grow to Rs. 1,000 x (1.10)10 = Rs.2,594. If invested at 5%, it will grow
to only Rs. 1,000 x (1.05)10 = Rs. 1,629.
145
ICM – Stock Brokers' Certification
Year
Balance at Start
of Year
Interest Earned during Balance at
Year
End of Year
1
2
3
4
5
Rs.100.00
Rs.106.00
Rs.112,36
Rs.119.10
Rs.126.25
.06 X Rs.100.00 = Rs.6.00
.06X5106.00 = Rs.6.36
.06 X Rs.112.36 = Rs.6.74
.06 x Rs.119.10 = Rs.7.15
.06 x Rs.126.25 =Rs.7.57
Rs.106.00
Rs.112.36
Rs.119.10
Rs.126.25
Rs.133.82
TABLE A: Compound interest
Calculating future values is easy using almost any calculator. If you have the patience,
you can multiply your initial investment by 1 + r (1.06 in our example) once for each year
of your investment. A simpler procedure is to use the power key (the yx key) on your
calculator.
For example, to compute (1.06)10, enter 1.06, press the yx key, enter 10, press =
and discover that the answer is 1.791. (Try this!)
If you don’t have a calculator, you can use a table of future values given in most of the
text books. Check that you can use it to work out the future value of a 10-year
investment at 6%.
First find the row corresponding to 10 years. Now work along that row until you reach
the column for a 6% interest rate. The entry shows that Rs.1 invested for 10 years at 6%
grows to Rs.1.791.
Now try one more example. If you invest Rs.1 for 20 years at 10% and do not withdraw
any money, what will you have at the end? Your answer should be Rs.6.727.
Table B gives futures values for only a small selection of years and interest rates. It
presents the future value of Re.1 investment for a wide range of time periods and
interest rates.
Future value tables are tedious, and as Table B demonstrates, they show future values
only for a limited set of interest rates and time periods. For example, suppose that you
want to calculate future values using an interest rate of 7.835%. The power key on your
calculator will be faster and easier than future value tables. A third alternative is to use a
financial calculator.
The power of compounding is not restricted to money. Foresters try to forecast the
compound growth rate of trees, demographers the compound growth rate of
population. In all these cases, the principle is the same:
146
ICM – Stock Brokers' Certification
Compound growth means that value increases each period by the factor (1 +
growth rate). The value after t periods will equal the initial value times (1 +
growth rate)t. When money is invested at compound interest, the growth rate is
the interest rate.
Number
of Year
1
2
3
4
5
10
20
30
5%
1.050
1.103
1.158
1.216
1.276
1.629
2.653
4.322
Interest Rate
7%
1.070
1.145
1.225
1.311
1.403
1.967
3.370
7.612
6%
1.060
1.124
1.191
1.262
1.338
1.791
3.207
5.743
per Year
8%
1.080
1.166
1.260
1.360
1.469
2.159
4.661
10.063
9%
1.090
1.188
1.295
1.412
1.539
2.367
5.604
13.268
10%
1.100
1.210
1.331
1.464
1.611
2.594
6.727
17.449
TABLE B: Future value of Rs.1
PRESENT VALUES
Money can be invested to earn interest. If you are offered the choice between
Rs.100,000 now and Rs.100,000 at the end of the year, you naturally take the money
now to get a year’s interest. Financial managers make the same point when they say
that money in hand today has a time value or when they quote perhaps the most basic
financial principle:
A Rupee today is worth more than a Rupee tomorrow.
We have seen that Rs.100 invested for 1 year at 6% will grow to a future value of 100 x
1.06 = Rs.106. Let’s turn this around: How much do we need to invest now in order to
produce Rs.106 at the end of the year? Financial managers refer to this as the present
value (PV) of the Rs.106 payoff.
Future value is calculated by multiplying the present investment by 1 plus the interest
rate, .06, or 1.06. To calculate present value, we simply reverse the process and divide
the future value by 1.06:
Present value =
PV
=
future value
1.06
= Rs.106
1.06
= Rs.100
What is the present value of, say, Rs.112.36 to be received 2 years from now? Again we
ask, “How much would we need to invest now to produce Rs.112.36 after 2 years?” The
answer is obviously Rs.100; we’ve already calculated that at 6 percent Rs.100 grows to
Rs.112.36:
147
ICM – Stock Brokers' Certification
Rs.100 x
(1.06)2
=
Rs.112.36
However, if we don’t know, or forgot the answer, we just divide future value by (1.06):
Present value =
PV
=
Rs.112.36
(1.06)2
=
Rs.100
In general, for a future value or payment t periods away, present value is
Present value =
future value after t periods
(1 + r)t
In this context the interest rate r is known as the discount rate and the present value is
often called the discounted value of the future payment. To calculate present value, we
discounted the future value at the interest r.
We repeat the basic procedure:
To work out how much you will have in the future if you invest for t years at an
interest rate r, multiply the initial investment by (1 + r)t. To find the present value
of a future payment, run the process in reverse and divide by (1 + r)t.
Present values are always calculated using compound interest. We calculate present
values we move back along the lines from future to present.
Thus present values decline, other things equal, when future cash payments are
delayed. The longer you have to wait for money, the less it’s worth today. Notice how
very small variations in the interest rate can have a powerful effect on the value of
distant cash flows. At an interest rate of 10%, a payment of Rs.1 in Year 20 is worth
Rs.15 today. If the interest rate increases to 15%, the value of the future payment falls
by about 60% to Rs.06.
The present value formula is sometimes written differently. Instead of dividing the
future payment by (1 + r)t, we could equally well multiply it by 1/(1 + r)t:
PV
=
future payment
(1 + r)t
=
future payment x
1__
(1 + r)t
The expression 1/(1 + r) t is called the discount factor. It measures the present value of
Rs.1 received in year t.
148
ICM – Stock Brokers' Certification
The simplest way to find the discount factor is to use a calculator, but financial
managers sometimes find it convenient to use tables of discount factors. For example,
Table C shows discount factors for a small range of years and interest rates.
Number
of Years
Interest Rate per Year
5%
1
2
3
4
5
10
20
30
.952
.907
.864
.823
.784
.614
.377
.231
6%
.943
.890
.840
.792
.747
.558
.312
.174
7%
.935
.873
.816
.763
.713
.508
.258
.131
8%
.926
.857
.794
.735
.681
.463
.215
.099
9%
.917
.842
.772
.708
.650
.422
.178
.075
10%
.909
.826
.751
.683
.621
.386
.149
.057
TABLE C: Present value of Rs.1
Try using Table C to check our calculations of how much to put aside for that Rs.3,000
computer purchase. If the interest rate is 8%, the present value of Rs.1 paid at the end
of 1 year is Rs.0.926. So the present value of Rs.3,000 is:
PV
=
Rs. 3,000 x
1__
1.08
=
Rs. 3,000 x 0.926 = Rs. 2,778
What if the computer purchase is postponed until the end of 2 years? Table C shows
that the present value of Rs.1 paid at the end of 2 years is Rs.0.857. So the present value
of Rs.3,000 is
PV
=
Rs. 3,000 x
1 ___ =
(1.08)2
Rs. 3,000 x 0.857 = Rs. 2,571
Notice that as you move along the rows in Table C, moving to higher interest rates,
present values decline. As you move down the columns, moving to longer discounting
periods, present values again decline.
MULTIPLE CASH FLOWS
So far, we have considered problems involving only a single cash flow. This is obviously
limiting. Most real-world investments, after all, will involve many cash flows over time.
When there are many payments, you’ll hear business people refer to a stream of cash
flows.
149
ICM – Stock Brokers' Certification
FUTURE VALUE OF MULTIPLE CASH FLOWS
Now suppose you hope to purchase a computer in 2 years and instead of putting aside
one sum in the bank to finance the purchase, you plan to save some amount of money
each year. You might be able to put Rs.1,200 in the bank now, and another Rs.1,400 in 1
year. If you earn an 8% rate of interest, how much will you be able to spend on a
computer in 2 years?
There are two cash inflows into the savings plan. The first cash flow will have 2 years to
earn interest and therefore will grow to Rs.1,200 x (1.08)2 = Rs.1,399.68 while the
second deposit, which comes a year later, will be invested for only 1 year and will grow
to Rs.1,400 x (1.08) = Rs.1,512. After 2 years, then, your total savings will be the sum of
these two amounts, or Rs. 2,911.68.
The total cash available will be the sum of the future values of all three deposits. Notice
that when we save for 3 years, the first two deposits each have an extra year for interest
to compound:
Rs. 1,200 x (1.08)3
Rs. 1,400 x (1.08)2
Rs. 1,000 x (1.08)
Total future value
=
=
=
=
Rs. 1,511.65
Rs. 1,632.96
Rs. 1,080.00
Rs. 4,224.61
We conclude that problems involving multiple cash flows are simple extensions of single
cash-flow analysis.
To find the value at some future date of a stream of cash flows, calculate what each
cash flow will be worth at that future date, and then add up these future values.
As we will now see, a similar adding-up principle works for present value calculations.
PRESENT VALUE OF MULTIPLE CASH FLOWS
When we calculate the present value of a future cash flow, we are asking how much that
cash flow would be worth today. If there is more than one future cash flow, we simply need
to work out what each flow would be worth today and then add these present values.
The present value of a stream of future cash flows is the amount you would have to
invest today to generate that stream.
LEVEL CASH FLOWS: PERPETUITIES AND ANNUITIES
Frequently, you may need to value a stream of equal cash flows. For example, a home
mortgage might require the homeowner to make equal monthly payments for the life of
the loan. For a 30-year loan, this would result in 360 equal payments. A 4-year car loan
might require 48 equal monthly payments. Any such sequence of equally spaced, level
150
ICM – Stock Brokers' Certification
cash flows is called an annuity. If the payment stream lasts forever, it is called
perpetuity.
HOW TO VALUE PERPETUITIES
Some time ago the British government borrowed by issuing perpetuities. Instead of
repaying these loans, the British government pays the investors holding these securities
a fixed annual payment in perpetuity (forever).
The rate of interest on perpetuity is equal to the promised annual payment C divided by
the present value. For example, if perpetuity pays Rs.10 per year and you can buy it for
Rs.100; you will earn 10 percent interest each year on your investment. In general,
Interest rate on a perpetuity
=
Cash Payment
Present Value
r
=
C
PV
We can rearrange this relationship to derive the present value of perpetuity, given the
interest rate r and the cash payment C:
PV of perpetuity
=
C
r
=
cash payment
interest rate
Suppose some worthy person wishes to endow a chair in finance at your university. If
the rate of interest is 10% and the aim is to provide Rs. 100,000 a year forever, the
amount that must be set aside today is
Present value of perpetuity =
C
r
=
Rs.100,000
.10
=
Rs.1,000,000
Two warnings about the perpetuity formula: First, at a quick glance you can easily
confuse the formula with the present value of a single cash payment. A payment of Rs.1
at the end of 1 year has a present value 1/(1 + r). The perpetuity has a value of 1/r.
These are quite different.
Second, the perpetuity formula tells us the value of a regular stream of payments
starting one period from now. Thus our endowment of Rs.1 million would provide the
university with its first payment of Rs. 100,000 one year hence. If the worthy donor
wants to provide the university with an additional payment of Rs. 100,000 up front, he
or she would need to put aside Rs. 1,100,000.
Sometimes you may need to calculate the value of a perpetuity that does not start to
make payments for several years. For example, suppose that our philanthropist decides
to provide Rs. 100,000 a year with the first payment 4 years from now. We know that in
151
ICM – Stock Brokers' Certification
Year 3, this endowment will be an ordinary perpetuity with payments starting at the end
of 1 year. So our perpetuity formula tells us that in Year 3 the endowment will be worth
Rs. 100,000/r. But it is not worth that much now. To find today’s value we need to
multiply by the 3-year discount factor. Thus, the “delayed” perpetuity is worth
1
1
Rs. 100,000 x r x
(1 + r )3
=
Rs. 1,000,000 x
1
= Rs. 751,315
(1.10)3
HOW TO VALUE ANNUITIES
There are two ways to value an annuity, that is, a limited number of cash flows. The
slow way is to value each cash flow separately and add up the present values. The quick
way is to take advantage of the following simplification. Table D shows the cash
payments and values of three investments.
Row 1. The investment shown in the first row provides a perpetual stream of Rs.1
payments starting in Year 1. We have already seen that this perpetuity has a present
value of 1/r.
Row 2. Now look at the investment shown in the second row of Table D. It also provides
perpetual stream of Rs.1 payments, but these payments don’t start until Year 4. This
stream of payments is identical to the delayed perpetuity that we just valued. In Year 3,
the investment will be an ordinary perpetuity with payments starting in 1 year and will
therefore be worth 1/r in Year 3. To find the value today, we simply multiply this figure
by the 3-year discount factor. Thus
PV
=
1
1
1
r * (1 + r )3 = r (1 + r )3
Row 3. Finally, look at the investment shown in the third row of Table D. This provides a
level payment of Rs.1 a year for each of three years. In other words, it is a 3-year
annuity. You can also see that, taken together, the investments in rows 2 and 3 provide
exactly the same cash payments as the investment in row 1. Thus the value of our
annuity (row 3) must be equal to the value of the row 1 perpetuity less the value of the
delayed perpetuity of row 2:
Present value of a 3-year Rs.1 annuity
1
1
= −
r r (1 + r )3
The general formula for the value of an annuity that pays C Rupees a year for each of t
years is
Present value of t-year annuity =
C
152
[ 1r − r (1 +1 r )t ]
ICM – Stock Brokers' Certification
The expression in square brackets shows the present value of a t-year annuity of Rs.1 a
year. It is generally known as the t-year annuity factor. Therefore, another way to write
the value of an annuity is
Present value of t-year annuity = payment x annuity factor
Year:
1. Perpetuity A
1
Rs.1
2
Rs.1
Cash Flow
3
4
Rs.1
Rs.1
5
Rs.1
6….
Rs.1….
Rs.1
Rs.1
Rs.1….
2. Perpetuity B
3.Three-year annuity
Rs.1
Rs.1
Present Value
1
r
1
r (1 + r )3
Rs.1
1
1
−
r r (1 + r )3
Table D: Valuing an annuity
ANNUITIES DUE
The perpetuity and annuity formulas assume that the first payment occurs at the end of
the period. They tell you the value of a stream of cash payments starting one period
hence.
However, streams of cash payments often start immediately.
In general, the present value of an annuity due of t payments of Re.1 a year is the same
as Re.1 plus the present value of an ordinary annuity providing the remaining t – 1
payment. The present value of an annuity due of Rs.1 for t years is therefore
PV annuity due
=
1 + PV ordinary annuity of t – 1 payments
=
1+
[ 1r − r(1 +1r ) ]
t −1
FUTURE VALUE OF AN ANNUITY
You are back in savings mode again. This time you are setting aside Rs. 3,000 at the end
of every year in order to buy a car. If your savings earn interest of 8 percent a year, how
much will they be worth at the end of 4 years? Your first year’s savings will earn interest
for 3 years, the second will earn interest for 2 years, the third will earn interest for 1
year, and the final savings in Year 4 will earn no interest. The sum of the future values of
the four payments is (Rs. 3,000 x 1.083) + (Rs. 3,000 x 1.082) + (Rs. 3,000 x 1.08) +
Rs.3,000 = Rs. 13,518
153
ICM – Stock Brokers' Certification
We are looking here at a level stream of cash flows—an annuity. We have seen that
there is a short-cut formula to calculate the present value of an annuity. So there ought
to be a similar formula for calculating the future value of a level stream of cash flows.
Think first how much your stream of savings is worth today. You are setting aside Rs.
3,000 in each of the next 4 years. The present value of this 4-year annuity is therefore
equal to
PV
=
Rs. 3,000 x 4-year annuity factor
=
Rs. 3,000 x
[ .081 − .08(1 +1 .08) ] =
4
Rs.9,936
Now think how much you would have after 4 years if you invested Rs.9,936 today. Just
4
multiply by (1.08) :
Value at end of Year 4
=
4
Rs. 9,936 x 1.08
=
Rs. 13,518
We calculated the future value of the annuity by first calculating the present value and
then multiplying by (1 + r)t. The general formula for the future value of a stream of cash
flows of Rs.1 a year for each of t years is therefore
Future value of annuity of Rs.1 a year = present value of annuity of Rs.1 a year*(1 + r)t
=
[ 1r − r(1 +1 r) ]
t
t
= (1 + r) – 1
r
If you need to find the future value of just four cash flows as in our example, it is a tossup whether it is quicker to calculate the future value of each cash flow separately or to
use the annuity formula. If you are faced with a stream of 10 or 20 cash flows, there is
no contest.
Remember that all our annuity formulas assume that the first cash flow does not occur
until the end of the first period. If the first cash flow comes immediately, the future
value of the cash-flow stream is greater, since each flow has an extra year to earn
interest. For example, at an interest rate of 8 percent, the future value of an annuity
starting with an immediate payment would be exactly 8 percent greater than the figure
given by our formula.
INFLATION AND THE TIME VALUE OF MONEY
When a bank offers to pay 6 percent on a savings account, it promises to pay interest of
Rs.60 for every Rs. 1,000 you deposit. The bank fixes the number of rupees that it pays,
154
ICM – Stock Brokers' Certification
but it doesn’t provide any assurance of how many those rupees will buy. If the value of
your investment increases by 6 percent, while the prices of goods and services increase
by 10 percent, you actually lose ground in terms of the goods you can buy.
EFFECTIVE ANNUAL INTEREST RATES
Thus far we have used annual interest rates to value a series of annual cash flows. But
interest rates may be quoted for days, months, years, or any convenient interval. How
should we compare rates when they are quoted for different periods, such as monthly
versus annually?
Consider your credit card. Suppose you have to pay interest on any unpaid balances at
the rate of 1 percent per month. What is it going to cost you if you neglect to pay off
your unpaid balance for a year? Don’t be put off because the interest rate is quoted per
month rather than per year.
The important thing is to maintain consistency between the interest rate and the
number of periods. If the interest rate is quoted as a percent per month, then we must
define the number of periods in our future value calculation as the number of months.
So if you borrow Rs.100 from the credit card company at 1 percent per month for 12
months, you will need to repay Rs.100 x (1.01)12 = Rs.112.68. Thus your debt grows
after 1 year to Rs.112.68. Therefore, we can say that the interest rate of 1 percent a
month is equivalent to an effective annual interest rate, or annually compounded rate of
12.68 percent.
In general, the effective annual interest rate is defined as the annual growth rate
allowing for the effect of compounding. Therefore, (1 + annual rate) = (1 + monthly rate)
When comparing interest rates, it is best to use effective annual rates. This compares
interest paid or received over a common period (1 year) and allows for possible
compounding during the period. Unfortunately, short-term rates are sometimes
annualized by multiplying the rate per period by the number of periods in a year. In fact,
truth-in-lending laws in the United States require that rates be annualized in this
manner. Such rates are called annual percentage rates (APRs). The interest rate on your
credit card loan was 1 percent per month. Since there are 12 months in a year, the APR
on the loan is 12 x 1% = 12%.
If the credit card company quotes an APR of 12 percent, how can you find the effective
annual interest rate? The solution is simple:
Step 1. Take the quoted APR and divide by the number of compounding periods in a
year to recover the rate per period actually charged. In our example, the interest was
calculated monthly. So we divide the APR by 12 to obtain the interest rate per month:
155
ICM – Stock Brokers' Certification
Monthly interest rate =
APR
12
=
12%
12
=
1%
Step 2. Now convert to an annually compounded interest rate:
(1 + annual rate) = (1 + monthly rate) 12 = (1 + .01)12 = 1.1268
The annual interest rate is .1268, or 12.68 percent.
On completion, the candidate should:
9.5
know Principal Factors Affecting Stock Markets & Prices including:
−
−
−
−
−
−
Business Cycles and its Indicators
Effect of the Business Cycle
Money Markets
Equities Markets
Price/ Earnings & Price/ Book value multiples
Dividend/Capital gain Yield
BUSINESS CYCLES AND ITS INDICATORS
It is important to understand how business cycles and accompanying economic
indicators impact financial markets, investors and the value of investments. The key to
successful investment is looking at the economic indicators, reading them right, making
judgements and also the right investment decisions.
The term business cycle is the periodic but irregular economy-wide fluctuations/
movements in the economic activity, These fluctuations occur around a long-term
growth trend, and typically involve shifts over time between periods of relatively rapid
economic growth (expansion or boom), and periods of relative stagnation or decline
(contraction or recession).
Despite being termed cycles, most of these fluctuations in economic activity do not
follow a mechanical or predictable periodic pattern i.e. it is not a regular, predictable, or
repeating phenomenon like the swing of the pendulum of a clock. Its timing is random
and, to a large extent, unpredictable.
A business cycle is traditionally identified as a sequence of four phases; i)Contraction (A
slowdown in the pace of economic activity); ii) Trough (The lower turning point of a
business cycle, where a contraction turns into an expansion); iii) Expansion (A speedup
in the pace of economic activity)and lastly; iv) Peak (The upper turning of a business
cycle). These fluctuations are often measured using the growth rate of real gross
156
ICM – Stock Brokers' Certification
domestic product (GDP) and other macroeconomic variables that are termed as
economic indicators.
Economic Indicators are key statistics that reflect as to how the economy of the country
is performing and which way the inflation is heading. Inflation is of importance as it
directly influences the level of interest rates. Stability within the economy can only be
maintained if inflation is kept under control.
An economic indicator (or business indicator) is a statistic about certain aspect of the
overall economy and in combination the economic indicators provide basis for the
analysis of the current economic performance and predictions of future performance of
an economy. One important application of the economic indicators is the study
of business cycles i.e. these characterize the level of economic development and
indicate either economic growth or a decline.
Some of the important macroeconomic indicators
Consumer Price Index (CPI), Current Account Balance, Foreign Currency Reserves, Gross
Domestic Product (GDP), Industrial Production, Unemployment Rate, retail sales, stock
market prices, money supply changes.
The analyses of the trends embodied in these economic indicators suggest, rather fairly,
the direction of the general economy. Gross Domestic Product (GDP) is a strong procyclic indicator and moves in the same direction as the general economy; increase in
GDP suggests that the economy is doing well; decrease when it is doing badly. Similarly
rising unemployment rate indicates that the size of the economy is shrinking.
MONEY MARKET
In finance, the money market is the part of financial market for short-term borrowing
and lending. It provides short-term liquidity funding for the financial system. The money
market is thus where short-term obligations such as Treasury bills, commercial paper
and bankers' acceptances are bought and sold.
The money market trades in short-term financial instruments commonly called "paper."
This contrasts with the capital market for longer-term funding, which is supplied by
bonds and equity.
The core of the money market consists of banks borrowing and lending to each other,
using commercial paper, repurchase agreements and similar instruments (REPO, reverse
REPO). Locally, these instruments are often benchmarked (to i.e. priced by reference to)
the Karachi Interbank Offer Rate (KIBOR) for the appropriate term and currency.
157
ICM – Stock
k Brokers' Certiification
nd
The money marrket playerss/operators normally cconsist of fiinancial insttitutions an
ers in moneyy or credit who
w wish to either borroow or lend. Participantss borrow an
nd
deale
lend for short periods of time
e, typically up
u to thirteeen months.
EQUITY MARKET
T
It is the
t market in
i which shaares are issu
ued and tradded, either tthrough Stock Exchangees
or at over-the-co
ounter. Also known as th
he stock market, it is on
ne of the mo
ost vital areaas
of a market
m
econ
nomy because it gives companies a ccess to cap
pital and invvestors a slicce
of ow
wnership in a companyy with the potential too realize gaains based o
on its futurre
perfo
ormance. In general, the
e term is used for the oorganized traading of sttocks througgh
exchaanges and ovver-the-coun
nter.
TIO
PRICEE/BOOK RAT
The Price/
P
Book Ratio comp
pare a stockk market va lue to the vvalue of total assets lesss
total liabilities (b
book value). This ratio is determinned by divid
ding current price of th
he
stockk by common
n stockholde
er’s equity per
p share (boook value), aadjusted forr stock bonus.
It is also
a called Market-to-Bo
M
ook.
PRICEE/EARNINGSS RATIO
The Price/
P
Earnin
ngs Ratio sh
hows the "m
multiple" of earnings at which a sto
ock sells. It is
deterrmined by dividing current price of the shaare by currrent earninggs per sharre
(adjusted for bon
nus shares). The earninggs per sharee for the P / E ratio is deetermined b
by
dividing earningss for past 12 months by
b the numbber of comm
mon shares outstandingg.
er "multiple"" means inve
estors have higher expeectations forr future grow
wth, and havve
Highe
bid up the stock'ss price. The Formula for Price/Earni ngs Ratio is:
DEND YIELD
DIVID
A financial ratio that showss how much
h a companny pays outt in dividend
ds each yeaar
relatiive to its share price. In
n the absencce of any caapital gains, the dividend yield is th
he
returrn on investm
ment for a sttock. Dividen
nd yield is caalculated as follows:
Dividend yield is a way to measure how
w much cash flow investtors are gettting for fund
ds
invessted in an eq
quity positio
on. Investorss who requiire a stream
m of cash flo
ow from theeir
invesstment portffolio can secure this caash flow by investing in
n stocks payying relatively
high, stable dividend yields.
To be
etter explain
n the concep
pt, a good divvidend yield example is::
158
ICM – Stock
k Brokers' Certiification
If two com
mpanies both pay annu
ual dividendds of Rs.1 peer share, bu
ut ABC
Companyy’s stock is trrading at Rs.20 while XYYZ Companyy’s stock is trrading
at Rs.40, then ABC has
h a dividen
nd yield of 55% while XYYZ is only yieelding
2.5%. Thu
us, assuming
g all other fa
actors are eqquivalent, ann investor lo
ooking
to supplement his or her income would likelyy prefer ABC
C's stock oveer that
of XYZ.
TAL GAIN YIELD
CAPIT
The price
p
appreciation comp
ponent of a security's
s
(suuch as a com
mmon stock)) total return
n.
For stock
s
holdings, the capital gains yield will be the changee in price divided by th
he
origin
nal (purchase) price. Calculated as:
Where:
W
P0 = Original price
p
of the security
s
P1 = Current/SSelling price of the securi
rity
For example, supposee Mr. A purcchased a sh are of XYZ ffor Rs.100 a
and he
later sellss the share for
fo Rs.110. The
Th capital g ains yield foor that investment
would be 10%.
It is important
i
to
o analyse bo
oth the capital gains yi eld and thee total returrn yield of aan
invesstment holdiing. Dividend
ds are not to
o be countedd in a capitaal gains yield
d assessment,
but itt has to be kept in mind that depe
ending on thhe stock, divvidends could comprise a
substtantial portio
on of the tottal return of the stock coompared to capital gains.
On co
ompletion, the
t candidatte should:
9.6
know the
e Macroecon
nomic indicaators includiing:
− Gross Domestic Product
P
(GDP
P)
− Mone
ey Supply
− The Role of State Bank of Pakkistan
Grosss Domestic Product
P
(GD
DP)
The gross
g
domesstic productt (GDP) or gross
g
domesstic income (GDI) is useed as a basic
meassure of coun
ntry's econo
omic performance, andd tells the m
market valu
ue of all finaal
goods and services produced
d within the borders of a nation in a year.
159
ICM – Stock Brokers' Certification
GDP can be defined in three ways, all of which are conceptually identical. First, it is
equal to the total expenditures for all final goods and services produced within the
country in a stipulated period of time (usually a 365-day year).
GDP can also be worked out as the sum of the income generated by production in the
country in the period—that is, compensation of employees, taxes on production and
imports less subsidies, and gross operating surplus (or profits). Thus GDP is a measure of
the total economic activity in a country. It is the sum of the total consumption of
produced goods, Total Investment (Public & Private), Government Expenditure and net
exports of goods and services. Total value of products and services produced within the
territorial boundary of a country.
GDP = consumption + investment + (government spending) + (exports − imports).
Inflation, Savings and Investments
Inflation is the rise in prices of goods and services in the country. We all know that
things seem to cost more every day, but few fully realize just how much that eroding
factor called inflation reduces the purchasing power of the money. Even with relatively
low inflation, one steadily loses buying power of the money that one just holds on to by
keeping it in bank deposit. To stay even, investors must invest at rates of return that at
least match inflation rates. The real rate of return, in terms of buying power of money, is
savings or investments rate of return less the inflation rate.
Nowhere on bank or brokerage statement, there is a report on what inflation is doing to
the real value of your savings and investments. So if your money is stowed in a "safe"
investment, like a savings or money market account, it will never be seen how inflation
is eroding the returns being received on it.
If inflation is at 4 percent per year and the return is 5 percent per year after taxes then
one has managed only a 1 percent gain in real buying power. If after-tax return is only 3
percent, then there is actually a 1 percent loss in the buying power. Inflation occurs
when demand increases relative to the supply available. During periods of economic
growth moderate inflation is expected. However, hyperinflation which is inflation of
100% a year or more is catastrophic for an economy as people lose confidence in the
currency and in the economy. During hyperinflation assets like gold and real estate
usually retain their real value.
Deflation:
It is a decline in the prices of goods and services. Deflation is the opposite of inflation.
When prices are falling due to deflation, economic activity is negatively affected as the
price weakness is usually due to very weak demand factors. Deflation is a significant
aspect of economic depression as economic recession is accompanied by declining
prices and a shrinking economy.
160
ICM – Stock Brokers' Certification
Stagflation:
It is the term used to describe an economy that is growing very slowly accompanied by
high inflation. Normally when the economy is growing slowly the inflation level is low.
How the Central Bank controls inflation?
The Central Bank attempts to control inflation by adjusting the cost of money to
member banks by raising or lowering interest rates. It does this by contracting money
supply by issuing Government bonds. In doing so, the interest rates are also altered. In
general, contracting money supply increases the value of money and increases interest
rates; while increasing of money supply decreases money supply and lowers interest
rates.
Thus if the economy is in a recession, the State Bank will try to stimulate economic
activity by increasing money supply. This increase in money supply can be achieved by
lowering interest rates, making it cheaper to borrow, thereby promoting investment.
Conversely, if the economy is experiencing high inflation and the Central Bank wishes to
reduce inflation, it will contract the money supply. This will increase interest rates,
making it more expensive to borrow, thereby reducing the incentive to invest. This
should decrease the level of economic activity.
THE ROLE OF STATE BANK OF PAKISTAN
The State Bank of Pakistan (SBP) is the central bank of Pakistan. Its constitution was
originally laid down in the State Bank of Pakistan Order 1948, which remained basically
unchanged until January 1, 1974, when the bank was nationalized. The scope of the
Bank’s operations was considerably widened through the State Bank of Pakistan Act
1956, which required the Bank to "regulate the monetary and credit system of Pakistan
and to foster its growth in the national interest with a view to securing monetary
stability and fuller utilisation of the country’s productive resources".
The traditional functions of the SBP may further be classified into two groups;
i) Primary functions
ii) Secondary functions
1. The primary functions include
a. issuance of notes,
b. regulation and supervision of the financial system
c. bankers’ bank
d. lender of the last resort
e. banker to Government and
f. conduct of monetary and credit policy
2. The secondary functions that can also be termed as the agency functions
covers areas like;
161
ICM – Stock Brokers' Certification
a.
b.
c.
d.
management of public debt,
management of foreign exchange, etc.,
advising the government on policy matters and
maintaining close relationships with international financial institutions
The non-traditional or promotional functions, performed by the State Bank include
a)
b)
c)
d)
development of financial framework,
institutionalization of savings and investment,
provision of training facilities to bankers, and
provision of credit to priority sectors
The responsibility of a Central Bank in a developing country goes well beyond the
regulatory duties of managing the monetary policy in order to achieve the macroeconomic goals. The role covers the development of monetary policy and capital
markets, economic growth and promotion of the fuller utilisation of a country’s
resources.
The non-traditional or developmental role of SBP include; i) Development of financial
framework; ii) Institutionalization of savings and investment
Ensuring the stability and soundness of the banking system is a statutory responsibility
of State Bank of Pakistan. SBP’s different banking supervision departments i.e. Banking
Policy and Regulations Department (BP&RD), Banking Surveillance Department (BSD),
Off-Site Supervision and Enforcement Department (OSSED), Financial Markets Strategy
and Conduct Department (FMSCD) and Banking Inspection Department (BID) try to
ensure the soundness of individual banks as well as that of overall banking industry.
There are two Broad Categories of Role of SBP for ensuring the soundness of Financial
System, which are ; i) Regulation of liquidity and; ii) Regulation and Supervision including
the "Prudential Regulations".
Besides providing for credit and risk exposure limits, SBP also prescribe guidelines
relating to classification of short-term and long-term loan facilities, set criteria for
management, prohibit criminal use of banking channels for the purpose of money
laundering
162
ICM – Stock Brokers' Certification
GLOSSARY
A
ALL or NONE
A limit price order that instructs the broker/dealer to buy or sell the whole order at the
stated price or not at all. If there is insufficient supply to meet the quantity requested by
the order then it is cancelled at the close of the market.
ALPHA
Alpha is a measure of selection risk (also known as residual risk) of a mutual fund in
relation to the market. A positive alpha is the extra return awarded to the investor for
taking a risk, instead of accepting the market return. For example, an alpha of 0.4 means
the fund outperformed the market-based return estimate by 0.4 %. -0.6 means a fund's
monthly return was 0.6 % less than would have been predicted from the change in the
market alone. It is thus a measure of performance on a risk-adjusted basis. Alpha takes
the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to
a benchmark index. The excess return of the fund relative to the return of the
benchmark index is a fund's alpha.
AMERICAN DEPOSITARY RECEIPTS
Certificates issued by a U.S. Depositary Bank, representing foreign shares held by the
bank, usually by a branch or correspondent in the country of issue. One ADR may
represent one share or a bundle of shares of a foreign corporation. ADR's carry the same
currency, political and economic risks as the underlying foreign share; the prices of the
two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage.
American Depositary Shares (ADS) are a similar form of certification.
AMERICAN-STYLE OPTION
It is an option contract that can be exercised at any time between the date of purchase
and the date of expiry. Most exchange-traded options are American style.
ANALYST
A professionally qualified and experienced person, normally an employee of a brokerage
firm, an asset management company or an independent research firm who studies
companies, commodities and capital markets, and makes buy and sell recommendations
on stocks, commodities and financial instruments. Most analysts specialize either in a
specific industry, sector or commodity.
ANNUAL REPORT
An Annual Report is the yearly record of a company's financial condition that includes a
description of the firm’s operations, its balance sheet and income statement.
163
ICM – Stock Brokers' Certification
ARBITRAGE
Arbitrage implies profiting from differences in the price of a single security that is traded
on more than one market. The profits are made by taking advantage of certain prices in
different markets by the purchase or sale of any instrument and at the same time taking
an equal and opposite position in a related market to profit from any small price
differential.
ASK
The price at which a broker or dealer is willing to sell a stock, commodity or any other
financial instrument.
AUTOMATIC EXECUTION
Any order that is automatically executed by a computer without any human
intervention based on pre-set terms and conditions.
ASSIGNMENT
Assignment is the receipt of an exercise notice by an option writer that requires him to
sell (in the case of a call) or purchase (in the case of a put) the underlying security at the
specified strike price. Assignment occurs when an option holder exercises his option by
notifying his broker, who then notifies the Clearing System.
AUTOREGRESSIVE
Using past data to predict future movement of market or financial instrument. As a
general application it is using of past data or variable of interest to predict future values
of the same variable.
AVERAGE MATURITY
The average time to maturity of securities held by a mutual fund is called Average
Maturity. Changes in interest rates have greater impact on funds with longer average
life.
B
BACK OFFICE
The clerical or back office operations of a financial intermediary that supports, but do
not include, the trading of stocks and other securities or marketing and sales of mutual
funds and other financial instruments. It includes all communications and settlement of
trades, record keeping and regulatory compliance.
BALANCE OF PAYMENTS
This is a summary of money flowing in and out of a country. If a country is spending
more for imported goods and services than it receives for goods and services it exports,
164
ICM – Stock Brokers' Certification
a deficit results. If the country received more money by selling goods, services and other
payments in foreign markets than it spent on imports and other outgoing payments, it
will result in a surplus.
BASIS POINTS
One hundredth of a percentage usually refers to yield on bonds or to interest rates.
Each percentage point of yield in bonds equals 100 basis points. If a bond yield changes
from 7.25 % to 7.39 %, that's a rise of 14 basis points.
BEAR
An investor who believes a stock or the overall market will decline. A bear market is a
prolonged period of falling stock prices, usually by 20% or more.
BEAR RAID
Bear raid is phenomenon or a situation in which large traders sell positions with the
intention of driving prices down.
BETA
Beta is a measure correlating stock price movement to the movement of an index. Beta
is used to determine the number of contracts required to hedge with stock index futures
or futures options.
BETA (STOCKS)
Beta is a measure of a stock's risk in relation to the market. A BETA of 0.7 for a stock
means that a stock price is likely to move up or down 70 % of the market change; while
a BETA of 1.3 means the stock is likely to move up or down 30 % more than the market.
BETA (MUTUAL FUNDS)
It is the measure of a fund's risk in relation to the market. A BETA of 0.7 for a mutual
fund means that the fund's total return is likely to move up or down 70 % of the market
change; while a BETA of 1.3 means total return is likely to move up or down 30 % more
than the market.
BID
A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for a good. It is
usually referred to simply as the "bid." In bid and ask. Thus it is the price at which a
broker/dealer is willing to buy a stock, commodity or any other financial instrument.
BLANK SALE
“Blank Sale” means “a sale by a party that does not own shares or the sale does not
constitute a sale with pre-existing interest or is a sale by a party that has not entered
into a contractual borrowing arrangement to meet delivery requirements”.
165
ICM – Stock Brokers' Certification
BLOW-OFF TOP
A steep and rapid increase in prices that immediately followed by a steep and rapid drop
in price. This is an indicator seen in charts and used in technical analysis of stock price
and market trends.
BONUS SHARES
The term ‘bonus shares’ means dividend paid to its shareholdings in the form of shares
by a joint stock company from its accumulated profits; the free shares thus issued to
existing shareholders are known as a bonus shares. These bonus shares are issued to the
existing shareholders by the company by converting free reserves or share premium
account to equity capital without taking any consideration from investors. Bonus shares
do not directly affect a company’s performance.
Issue of Bonus shares has following major implications/effects:
1.
2.
3.
4.
5.
6.
Share capital gets increased according to the bonus issue ratio.
Liquidity in the stock increases.
Effective Earnings per share, Book Value and other per share values stand reduced.
Markets take the action usually as a favourable act.
Market price gets adjusted on issue of bonus shares.
Accumulated profits get reduced.
BREAKOUT
Rises in a security’s price above a resistance level (commonly its previous high price) or
drop below a level of support (commonly the former lowest price). A breakout is taken
to signify a continuing move in the same direction. Can be used by technical analysts as
a buy or sell indication.
BROKER
In general a broker is an individual or a firm that matches buyers and sellers for a fee or
a commission.
BUSINESS CYCLE
The business cycle has four phases: Expansion, Peak, Recession and Trough:
These cycles create price changes, which lead to changes in total spending in relation to
the amount of goods and services being produced.
BULL
A market which is on a consistent upward trend is regarded a bull market.
BULL MARKET
A market which is on a consistent upward trend.
166
ICM – Stock Brokers' Certification
BUYOUT
Purchase of a controlling interest of a company's stock. A leveraged buyout is done with
borrowed money.
C
CALL OPTION
An option contract that gives the holder of the option the right (but not the obligation)
to purchase, and obligates the writer to sell, a specified number of shares, commodity
or financial instrument at the given strike price, on or before the expiration date of the
contract.
CAPITAL EXPENDITURES
Amount used during a particular period to acquire or improve long term assets such as
property, plant, or equipment.
CAPITAL GAIN
When a stock, commodity or a financial instrument is sold for a profit, it's the excess of
the net sales price over their net cost that is called Capital Gain.
CAPITAL LOSS
When a stock, commodity or a financial instrument is sold at a loss, it is the excess of
net cost over the net sales price that is called capital loss.
CASH DIVIDEND
A dividend paid in cash to a company's shareholders. The amount is normally based on
profitability and is taxable as income. A cash distribution may include capital gains and
return of capital in addition to the dividend.
CASH AND EQUIVALENTS
The assets that can be converted into liquid cash immediately are regarded as cash
equivalents. Usually this includes bank accounts and marketable securities, such as
government bonds and Bankers Acceptances. Cash equivalents on balance sheets also
include securities (e.g., notes) that mature within ninety days.
CASH FLOW
In investments, it represents earnings before depreciation amortization and non-cash
charges. Sometimes it is called cash earnings. Cash Flow from operations (called Funds
From Operations (FFO) by real estate and other investment trusts, is important because
it indicates the ability to pay dividends.
167
ICM – Stock Brokers' Certification
CASH SETTLED FUTURES
It is a method of settling certain futures or options contracts whereby the seller and the
buyer exchange the difference (profit or loss) in the cash value of the underlying assets
like securities/indices/commodity/etc. At the time of settlement the difference in the
contract value when traded according to a procedure specified in the contact.
CHANGES IN FINANCIAL POSITION
Sources and uses of funds provided from operations which alter a company's cash flow
position.
CHURNING
Excessive trading of a client's account in order to increase the broker's commissions is
called churning.
CIRCUIT BREAKERS
A system of harmonized trading halts and/or price limits on securities and derivative
markets designed to provide a cooling-off period large intraday market movements.
CLOSING PURCHASE
Closing purchase is a transaction in which the purchaser's intention is to reduce or
eliminate a short position in a stock, or in a given series of options.
CLOSING SALE
It is a transaction in which the seller's intention is to reduce or eliminate his long
position in a stock, options or commodity.
COLLECTIVE INVESTMENT SCHEME
Collective Investment Scheme (CIS) is an investment vehicle which allows investors to
pool their assets into a single portfolio in order to gain access to the stock market
generally or to specific markets or sectors. Collective investment scheme includes a
closed-end fund and an open-ended scheme that provides control of the investments to
the company (AMC) pooling and investing the money. The idea behind this is to
maximize the returns by combining resources of the participants and making it possible
to acquire a larger portion of the investment, thus generating more return that is
distributed among the investors.
For small investors, CIS allows access to professional investment management and
spreads the risk of investing in equities and other securities by giving investors a share
of a much larger portfolio than they could invest in on their own. The investors also
benefit from the lower dealing costs that a large fund can command.
COMMON STOCK EQUITY
Value of outstanding common/ordinary shares at par, plus accumulated retained
earnings. It is also called shareholders equity.
168
ICM – Stock Brokers' Certification
CONFIDENCE INDICATOR
Confidence Indicator is a measure of investor’s faith in the economy and the securities
market. A low or deteriorating level of confidence is considered by many technical
analysts as a bearish sign.
CONFIDENCE LEVEL
The degree of assurance that a specified failure rate is not exceeded.
CONFIRMATION
Confirmation is the written statement that follows any "trade" in the financial markets.
Confirmation is issued immediately after a trade is executed. It spells out settlement
date, terms, commission, etc. depending on the nature of trade.
CONSUMER PRICE INDEX (CPI)
This is the indicator of the change in prices of goods and services. Included in the index
are food, transportation, medical care, entertainment and other items purchased by
households and individuals.
CONVERGENCE
The movement of the price of a futures contract toward the price of the underlying cash
commodity. At the start, the contract price is higher because of the time value. But as
the contract nears expiration, the futures price and the cash price converge.
CORNER a MARKET
To purchase enough of the available supply of a commodity or stock so as to be able to
manipulate its price in future.
COUNTERPARTY
Counter party is any one of the participants in a transaction.
COUPON RATE
In bonds, notes or other fixed income securities, the stated percentage rate of interest,
usually paid twice a year.
COVERED CALL
Covered call is primarily a short call option position in which the writer owns the
number of shares of the underlying stock represented by the option contracts. Covered
calls generally limit the risk the writer takes because the stock does not have to be
bought at the market price, if the holder of that option decides to exercise it.
COVERED EMPLOYEE
A person hired to perform services for pay is presumed by law to be a covered
employee
169
ICM – Stock Brokers' Certification
COVERED PERSON
Covered person means persons associated with a broker, but not including an
associated person that has no officers or employees in common with the broker and
where the broker maintains and enforces written policies and procedures reasonably
designed to prevent the broker or any of its controlling persons, officers, or employees
from influencing the activities of research analysts and the content of research reports
prepared by the associated person
CROSS TRADE
Where co-ordinated reshuffle of shares between two related accounts of the same
investor, between two related account of the related investor or between two
membership cards of the same broker is undertaken and share accumulating unrealized
losses are sold to related accounts to realize artificial losses in one account without
actually selling the shareholdings to an outsider and artificial losses so realized in an
account are then used to minimize capital gain tax liability on the capital gains realized
in the same account.
CURRENT ASSETS
Current assets of company are defined as sum total of all Value of cash, accounts
receivable, inventories, marketable securities and other assets that could be converted
into cash in less than 1 year.
CURRENT LIABILITIES
Amount owed for salaries, interest, accounts payable and other debts due within 1 year.
CURRENT RATIO
Indicator of short-term debt paying ability that is determined by dividing current assets
by current liabilities. The higher the current ratio, the more liquid the company is
regarded.
CURRENT YIELD
For bonds or notes, the coupon rate divided by the market price of the bond.
D
DAY ORDER
An order to buy or sell stock that automatically expires if it cannot be executed on the
day it is entered.
170
ICM – Stock Brokers' Certification
DEBT/EQUITY RATIO
Debt/equity ratio is an indicator of financial leverage. The ratio compare assets provided
by creditors to assets provided by shareholders and is determined by dividing long term
debt by common stockholders’ equity.
DECLARATION DATE
The date on which a firm's directors meet and announce the date and amount of the
next dividend.
DEFERRED TAX
It is a non-cash expense or income that provides a source or application of free cash
flow. Deferred tax is an accounting concept (also known as future income taxes),
meaning a future tax liability or asset, resulting from temporary differences or timing
differences between the accounting value of assets and liabilities and their value for tax
purposes.
DEFLATION
Deflation is a decline in prices, where production exceeds demand. Deflation normally
occurs during recessions and leads to a rise in unemployment.
DEPRECIATION
It is a non-cash expense that provides a source of free cash flow. Amount allocated
during the period to amortize the cost of long term assets over the useful life of the
assets.
DERIVATIVE
It is a financial instrument, such as an option, or future, whose value is derived in part
from the value and characteristics of the underlying security. Some of the common
forms of the derivative instruments are forwards, futures, options, swaps etc.
DISTRIBUTIONS
The payments from fund or corporate cash flow that may include dividend from
earnings, capital gains from sale of portfolio holdings and return of capital. Distributions
can be made by cheque or by reinvesting in additional shares/units.
DIVERGENCE
When the price of an asset and an indicator, index or other related asset moves in
opposite directions, this is called divergence. In technical analysis, traders make
transaction decisions by identifying situations of divergence, where the price of a stock
and a set of relevant indicators, such as the money flow index (MFI), are moving in
opposite directions.
171
ICM – Stock Brokers' Certification
DIVIDEND
Dividend is the distribution of a portion of a company's earnings, cash flow or return of
capital to shareholders, in cash or through issuance of additional stocks.
DIVIDEND YIELD (STOCKS)
Dividend Yield represents annual dividend divided by current stock price.
DIVIDEND YIELD (FUNDS)
Dividend Yield (funds) represents return on a share of a mutual fund held over the past
12 months. Assumes fund was purchased 1 year ago. Reflects effect of sales charges (at
current rates), but not ± 98 redemption charges.
DIVIDENDS PER SHARE
Dividends paid for the past 12 months divided by the number of common shares
outstanding, as reported by a company. The number of shares often is determined by a
weighted average of shares outstanding over the reporting period.
DOWNGRADE
It is a classic negative change in ratings for a stock or other rated security of a company
by a credit rating company.
E
EARNINGS
Earnings reflect the amount of profit that a company produces during a specific period.
EARNINGS PER SHARE (EPS)
EPS is also referred to as Primary Earnings per share of common stock. It is computed by
dividing the net income for the past 12 months by the number of common shares
outstanding as reported by a company. The company often uses a weighted average of
shares outstanding over reporting period. It is an important variable to determine the
market value of a share
EARNINGS YIELD
The ratio of Earnings per Share after allowing for tax and interest payments on fixed
interest debt, to the current share price and is the inverse of the Price/Earnings ratio.
It's the Total Twelve Months Earnings divided by number of outstanding shares, divided
by the recent price, multiplied by 100. The end result is shown in percentage.
ENTRY ORDER
An order to enter a position in the market at a specified price.
172
ICM – Stock Brokers' Certification
EQUITY
The value of the common stockholder’s equity in a company as shown on the balance
sheet is called Equity.
EUROPEAN-STYLE OPTION
It is an option contract that can only be exercised on the expiry date only.
EXCHANGE
An exchange is the marketplace in which shares, options and futures, stocks, bonds,
commodities and indices are traded.
EXCHANGE TRADED FUND
An Exchange Traded Fund is an open-end investment instrument issued by an asset
management company that trades on a stock exchange. By investing in the units the
Exchange Traded Fund makes available to small investors to invest in the index or the
commodity. For example, a Tola of gold may cost Rs 35000, but a unit/share in the
Exchange Traded Fund may cost only Rs 5000, making it viable for more people to
invest.
EX-DIVIDEND DATE
The first day of trading when the seller who owned the stock at the start of the day,
rather than the buyer, of a stock will be entitled to the most recently announced
dividend payment. After the ex-date has been declared, the stock will usually drop in
price adjusting for the expected dividend.
EXECUTION
The process of completing an order to buy or sell securities is called the execution of a
trade. Once a trade is executed, it is reported by a Confirmation Report and settlement
(payment and transfer of ownership) occurs usually 2 days after an order is executed
depending on the system of the exchange where it is traded.
EXERCISE
Exercise is to implement the right of the holder of an option to buy (in the case of a call)
or sell (in the case of a put) the underlying security.
EXPENSE RATIO (FUNDS)
Expense Ratio (of funds) is the percentage of the assets that were spent to run a mutual
fund. An expense ratio is determined through an annual calculation, where a fund's
operating expenses are divided by the average value of its assets under management.
173
ICM – Stock Brokers' Certification
F
FOREX
Foreign Currency Exchange
FOREX TRADER
A Person or a firm who buys and sells foreign currencies to make a profit or acts on
behalf of customers to meet their needs of foreign currencies
FUND FAMILY
Asset management companies often offer several funds with different investment
objectives. The investors can move investments between different funds on minimal
cost. The cluster of such funds is called ‘Fund Family”
FUNDS FROM OPERATIONS (FFO)
Used by real estate and other investment trusts to define the cash flow from trust
operations. It is earnings with depreciation and amortization added back. A similar term
increasingly used is Funds Available for Distribution (FAD), which is FFO less capital
investments in trust property and the amortization of mortgages.
FUTURES CONTRACT
Agreement to buy or sell a set number of shares of a specific stock in a designated
future month at a price agreed upon by the buyer and seller. The contracts themselves
are often traded on the futures market. A futures contract differs from an option
because an option is the right to buy or sell, whereas a futures contract is the promise to
actually make a transaction.
G
GOOD TILL CANCELED
Sometimes simply called "GTC", it means an order to buy or sell stock or any tradable
financial instrument that is good until cancelled by the client.
GROSS DOMESTIC PRODUCT (GDP)
Total value of products and services produced within the territorial boundary of a
country
GDP = consumption + investment + (government spending) + (exports − imports).
174
ICM – Stock Brokers' Certification
GROSS NATIONAL PRODUCT (GNP)
GNP is an indicator of national economy that includes GDP, plus any income earned by
residents from overseas investments, minus income earned within the domestic
economy by overseas residents. In other words it is the total value of Goods and
Services produced by all nationals of a country (whether from within or outside the
country)
GNP = GDP + NR (Net income from assets abroad (Net Income Receipts))
GROWTH RATES
This typically represents the compounded annualized rate of growth of a company's
revenues, earnings, dividends and even macro concepts - such as the economy as a
whole
H
HAIRCUTS
In calculating the value of assets for purposes of capital, segregation or margin
requirements, usually a percentage reduction from the stated value (e.g. book value or
market value) to account for possible losses in value that may occur before assets can
be liquidated.
HEAD and SHOULDERS
In technical analysis, a chart formation in which a stock price reaches a peak and then
declines, rises above its former peak and again declines and rises again but not to the
second peak and then again declines. The first and third peaks are shoulders, while the
second peak is the formation's head. Technical analysts generally consider a head and
shoulders formation to be a very bearish indication.
HEDGING
The use of derivatives instruments to protect against price risks. A hedging transaction
has the specific intent of protecting and existing or anticipated physical market
exposure from unexpected or adverse price fluctuations.
In practical terms it is a strategy designed to reduce investment risk using "call" options,
"put" options, "short" selling, or futures contracts. A hedge can help lock in existing
profits. Its purpose is to reduce the potential volatility of a portfolio, by reducing the risk
of loss.
HIGH PRICE
For stocks the highest (intraday) price of a stock over the past 52 weeks, adjusted for
any stock splits. The same applies for commodities and other financial instruments.
175
ICM – Stock Brokers' Certification
HOLDING COMPANY
A holding company is a corporation that owns enough voting stock in another firm to
control management and operations by influencing or electing its board of directors.
I
IMMEDIATE FAMILY MEMBERS
Spouse, parents and grandparents, children and grandchildren, brothers and sisters,
mother in law and father in law, brothers in law and sisters in law, daughters in law and
sons in law. Adopted and step members are also included in immediate family
INDUSTRY
It is a category of business that describes a company's primary line of business. This
usually is determined by the largest contribution towards the revenue of the company.
INFLATION
Inflation is a rise in the general level of prices of goods and services in an economy over
a period of time. When the price level rises, each unit of currency buys fewer goods and
services; consequently, inflation is also erosion in the purchasing power of money. A
chief measure of price inflation is the inflation rate, the annualized percentage change
in a general price index (normally the Consumer Price Index) over time
INITIAL MARGIN REQUIREMENTS
When buying securities on margin, the proportion of the total market value of the
securities that the investor must pay for cash /collateral.
INITIAL PUBLIC OFFERING (IPO)
IPOs are the company's first sale of stock to the public. Securities offered in an IPO are
sometimes those of young, small companies seeking outside equity capital and a public
market for their stock and/or by large privately owned companies looking for a public
market for their shares/stock.
INSIDER INFORMATION
Any information that can have effect on the price of the share of a company and that
has not yet been made public. It is illegal for holders of this information to make trades
based on the information that is not in public knowledge irrespective of the fact that
how this information has been received.
INVENTORY
For companies: Raw materials, items available for sale or in the process of being made
ready for sale. These can be individually valued by several different means, including
cost or current market value, and collectively by FIFO, LIFO or other methods of
176
ICM – Stock Brokers' Certification
valuations. The lower value of alternatives is usually used to preclude overstating
earnings and assets. For security firms the inventory means the securities bought and
held by a broker or dealer for resale.
INVENTORY TURNOVER
The ratio of annual sales to inventory of a company is referred as Inventory Turnover.
Low turnover is in most cases considered an unhealthy sign, indicating excessive stocks
and/or poor sales.
INVESTMENT ADVISORY RELATIONSHIP
A relationship by which a person or organization employed by an individual or mutual
fund to manage assets or provide investment or financial advice is called investment
advisory relationship.
L
LEVERAGE
The use of various financial instruments or borrowed capital, such as margin, to increase
the potential return of an investment is termed as Leverage.
Leverage also refers to the amount of debt used to finance a firm's assets. A firm with
significantly more debt than equity is considered to be highly leveraged.
LIMIT ENTRY ORDER
Limit Entry orders are entry orders to enter the market at a more favourable price.
When buying a stock, the limit entry order will be placed below the current market
price. When placing a limit entry order to sell, the order will be placed above the current
market price.
Limit entry orders are often conducive to strategies pertaining to range-bound markets,
where clients can place orders to buy at the bottom of the range and sell at the top.
LIMIT ORDER
An order to a broker to buy a specified quantity of a security at or below a specified
price or to sell it at or above a specified price (called the limit price). This ensures that a
person will never pay more for the stock than whatever price is set as his/her limit. This
is one of the two most common types of orders, the other being a market order. It is an
opposite of no limit order.
177
ICM – Stock Brokers' Certification
LONG POSITION
It is a position that profits from an increase in price. It occurs when an individual owns
securities or financial instruments. An owner of 1000 shares of stock is said to be "Long
the Stock”.
LOAD FUND
A mutual fund with shares sold at a price including a sales charge--typically 1% to 8% of
the net amount indicated. Some "no-load" funds have distribution fees; these are
typically 0.25%. A "true no-load" fund has neither a sales charge nor load fees. A load
implies that the fund purchaser receives some investment advice or other service
worthy of the charge.
LONG POSITION (OPTIONS)
An options position where a person has executed one or more options trades where the
net result is that he is an "owner" or holder of options (i.e. the number of contracts
bought exceeds the number of contracts sold). The opposite of short.
LONG TERM ASSETS
The value of property, equipment and/or other capital assets less accumulated
depreciation is known as Long Term Assets. These assets are recorded in the books of
accounts of a company, usually on a “cost” basis and thus do not necessarily reflect the
market value of the assets.
LONG TERM DEBT
The loans and obligations with a maturity of longer than one year; usually accompanied
by interest payments are referred to as Long Term Debts.
LONG TERM DEBT/CAPITALIZATION
Long term debt is the indicator of financial leverage which shows long term debt as a
proportion of the capital available. It is determined by dividing long term debt by the
sum of long term debt, preferred stock and common stockholder’s equity.
LONG TERM LIABILITIES
Amount owed for loans, leases, bond repayment and other liabilities due for payment
after 1 year.
LOW PRICE
For stocks the lowest (intraday) price of a stock over the past 52 weeks, adjusted for any
stock splits. The same applies for commodities and other financial instruments.
178
ICM – Stock Brokers' Certification
M
MANAGEMENT/CLOSELY HELD SHARES
Percentage of shares held by persons closely related to a company. Part of these
percentages often is included in Institutional Holdings --sometimes making the
combined total of these percentages at 100%.
MANUAL EXECUTION
It is an order that is entered or executed by a person.
MARGIN
Is a deposit that allows to open a position i.e. a 1% margin gives you the right to open a
Rs.100,000 worth of a position with a Rs. 1,000 deposit.
MARGIN CALL
Margin Call is a requirement by the broker to deposit more funds in order to maintain
an open position. Sometimes a "margin call" means that the position which does not
have sufficient funds on deposit will simply be closed out by the broker. This procedure
allows the client to avoid further losses or a debit account balance.
MARKET ORDER
It is an order to buy or sell at the current market price.
MINI ACCOUNT
It allows an in investor to trade with small -- mini -- lot sizes.
MARGIN ACCOUNT (STOCKS)
It is an account in which stocks can be purchased for a combination of cash and a loan.
The loan in the margin account is collateralized by the stock and, if the value of the
stock drops sufficiently, the owner will be asked to either put in more cash, or sell a
portion of the stock. Margin rules are regulated by the SECP.
MARGIN REQUIREMENT (OPTIONS)
The amount of cash an uncovered (naked) option writer is required to deposit and
maintain to cover his daily position valuation and reasonably foreseeable intra- day
price changes.
MARKET CAPITALIZATION
The total rupee value of all outstanding shares is called Market Capitalization. It is
computed as shares times’ current market price. It is a measure of corporate size.
179
ICM – Stock Brokers' Certification
MARKET MAKER
Market maker is a dealer who makes a market, i.e. quotes bid and offer prices to
counterparties and is prepared to deal at those prices.
MINIMUM PURCHASES
For mutual funds, the amount required to open a new account (Minimum Initial
Purchase) or to deposit into an existing account (Minimum Additional Purchase). These
minima may be lowered for buyers participating in an automatic purchase plan.
MONEY MARKET FUND
A mutual fund that invests only in short term securities, such as banker’s acceptances,
commercial paper, and government securities.
MONEY SUPPLY
This is the total amount of available money and credit in a country. The Central Bank
attempts to control money and credit to create a stable, growing economy.
MOVING AVERAGE
Used in charts and technical analysis, the average of security or commodity prices
constructed in a period as short as a few days or as long as several years and showing
trends for the latest interval. As each new variable is included in calculating the average,
the last variable of the series is deleted.
MUTUAL FUND
Mutual Fund is an open end investment company that pools investor’s money to invest
in a variety of stocks, bonds, or other securities. It issues and redeems shares to meet
demand, and the redemption value per share is the net asset value per share, less in
some cases a redemption fee which represents a rear-end load.
N
NAKED OPTION
The sale of a call or put option with without holding an equal and opposite position in
the underlying instrument is called Naked Option.
NET ASSET VALUE (NAV)
The value of a mutual fund's investments. For a mutual fund, the net asset value per
share usually represents the fund's market price, subject to a possible sales or
redemption charge. It is calculated by dividing the total net asset value of the fund or
company by the number of shares outstanding. Also referred to as "book value per
share". For a closed end fund, the market price may vary significantly from the net asset
value as per demand and supply.
180
ICM – Stock Brokers' Certification
NET INCOME
The company's total earnings, reflecting revenues adjusted for costs of doing business,
depreciation, interest, taxes and other expenses.
NET POSITION
The difference between the open long contracts and open short contracts held by a
trader in any one commodity is called Net Position.
NO LOAD MUTUAL FUND
An open-end investment company, shares of which are sold without a sales and
redemption charge. There can be other distribution charges.
O
OBJECTIVE (MUTUAL FUNDS)
The fund's investment strategy as stated in the prospectus/offering document.
OPTION
Is a contract that grants the buyer the right, but not the obligation, to buy (a call option)
or sell (a put option) commodity or financial security at a specified price on or before a
given date. Investors, not companies, issue options. Investors who purchase call options
bet the stock will be worth more than the price set by the option (the strike price), plus
the price they paid for the option itself. Buyers of put options bet the stock’s price will
go down below the price set by the option.
OTHER CURRENT ASSETS
Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.
OTHER LONG TERM LIABILITIES
The value of leases, future employee benefits, deferred taxes and other obligations not
requiring interest payments that must be paid over a period of more than 1 year.
OTHER SOURCES
Amount of funds generated during the period from operations by sources other than
depreciation or deferred taxes such as funds generated from changes in working capital.
Part of Free Cash Flow calculation.
181
ICM – Stock Brokers' Certification
OUT OF THE MONEY
A call option is out-of-the-money if the strike price is greater than the market price of
the underlying security. A put option is out-of-the-money if the strike price is less than
the market price of the underlying security.
OVERBOUGHT/OVERSOLD INDICATOR
The indicator that attempts to define when prices have moved too far and too fast in
either direction and thus are vulnerable to reaction are referred to as Overbought/
Oversold position.
P
PAYMENT DATE
The date on which a declared stock dividend or a bond interest coupon is scheduled to
be paid is termed as Payment Date.
PHONE SWITCHING
In mutual funds, the ability to transfer shares between funds in the same family by
telephone request. There may be a charge associated with these transfers.
PREFERRED STOCK
A security that shows ownership in a corporation and gives the holder a claim, prior to
the claim of common stockholders, on earnings and also generally on assets in the event
of liquidation are known as Preferred Stock. Mostly preferred stock pays fixed dividend
as a percentage of a par value. This stock does not usually carry voting rights.
PRICES
It is the price of a share of common stock on the date shown. Highs and lows are based
on the highest and lowest intraday trading price.
PRICE/BOOK RATIO
It compares a stock's market value to the value of total assets less total liabilities (book
value). It is determined by dividing current price by common stockholders’ equity per
share (book value), adjusted for stock splits. It also called Market-to-Book.
PRICE/EARNINGS RATIO
Shows the "multiple" of earnings at which a stock sells. It is determined by dividing
current price by current earnings per share. Earnings per share for the P/E ratio are
determined by dividing earnings for past 12 months by the number of common shares
outstanding. Higher "multiple" means investors have higher expectations for future
growth, and have bid up the stock's price. The Price Earnings Ratio is calculated as per
following formulae:
182
ICM – Stock
k Brokers' Certiification
TIO
PRICEE/SALES RAT
Determined by dividing
d
stocck's current price by revvenue per sshare (adjussted for stocck
splitss). Revenue per
p share for the P/S rattio is determ
mined by dividing revenu
ue for past 1
12
montths by numb
ber of sharess outstandingg.
PRIM
MARY MARKET
The first
f
buyer of
o a newly isssued security buys thatt security in
n the primarry market. A
All
subse
equent tradiing of those securities is done in thee secondary market.
PROFFIT MARGIN
Profitt margin is an
a Indicator of being pro
ofitable. It iss determineed by dividing net incom
me
by revenue for th
he same 12-m
month perio
od. Result is shown as a percentage..
PROG
GRAM TRAD
DING
Trade
es based on
n signals fro
om compute
er programss, usually en
ntered direcctly from th
he
trade
er's compute
er to the market's computer system and executeed automatiically.
PROSSPECTUS
Form
mal written document to
t sell secu
urities that describes th
he plan forr a proposeed
busin
ness enterprise, or the faacts concern
ning an existting one, wh
hich an invesstor needs to
o,
make
e an informed decision. Prospectusses are use d by Mutuaal Funds to describe th
he
fund objectives, risks
r
and oth
her essential informatio n.
PUBLLIC APPEARA
ANCE
Public appearancce means an
ny participation by a reesearch analyst in a sem
minar, forum
m
(inclu
uding an inte
eractive electronic forum), or radioo or televisio
on or other interview, iin
which
h the researrch analyst makes a spe
ecific recom
mmendation or providess informatio
on
reaso
onably sufficcient upon which
w
to basse an investm
ment decisio
on about a ssecurity or aan
issuer.
PUT OPTION
O
An op
ption contraact that gives the holderr the right too sell (or "pu
ut"), and plaaces upon th
he
write
er the obligation to purcchase, a specified numbber of sharess of the und
derlying stocck
at the
e given strike price on or before the
e expiration ddate of the ccontract.
183
ICM – Stock Brokers' Certification
Q
QUOTATION
The actual price or the bid or ask price of either cash commodities or futures contracts.
QUICK RATIO
It is an indicator of a company's financial strength (or weakness). It is calculated by
taking current assets less inventories, divided by current liabilities. It also called Acid
Test.
QUIET PERIOD
Quiet period extended from the time a company files a registration document with the
Companies Registrar Office (CRO) at SECP until SECP staff declares the registration
documents “effective”. During that period, the securities and exchange ordinance limits
what information a company and related parties can release to the public
R
RANGE
The difference between the high and low price during a given period is termed as Range.
RETURN
The percentage gain or loss for a mutual fund in a specific time period is referred to as
Return. This number assumes that all distributions are reinvested.
REDEMPTION CHARGE
The commission charged by a mutual fund when redeeming shares. For example, a 2 %
redemption charge (also called a "back end load") on the sale of shares valued at 1000
will result in payment of 980 (or 98 % of the value) to the investor. This charge may
decrease or be eliminated as shares are held for longer time periods.
RELATIVE STRENGTH
A stock's price movement over the past year as compared to a market index ( e.g. KSE
100). Value below 1.0 means the stock shows relative weakness in price movement
(underperformed the market); a value above 1.0 means the stock shows relative
strength over the 1-year period. Equation for Relative Strength: [current stock
price/year-ago stock price] minus (KSE 100 current value – KSE 100 one year ago) .
184
ICM – Stock Brokers' Certification
REMUNERATION
Sum of direct benefits (such as salary, allowances, bonus, and commission) and indirect
benefits (such as insurance, pension plans, vacations) that an employee receives from
an employer
RESEARCH ANALYST
Research analyst means any natural person who is primarily responsible for the
preparation of the content of a research report
RESEARCH REPORT
Research report means a written communication (including an electronic
communication) that includes an analysis of a security or an issuer and provides
information reasonably sufficient upon which to base an investment decision
RETRACEMENT
The price movement in the opposite direction of the previous trend is called
retracement.
RETURN ON ASSETS (ROA)
It is an Indicator of profitability. It is determined by dividing net income for the past 12
months by total assets. Result is shown as a percentage.
RETURN ON EQUITY (ROE)
ROE is the most important indicator of profitability. It is determined by dividing net
income for the past 12 months by common stockholders’ equity. Result is shown as a
percentage.
RIGHTS OFFERING
The issuance of "rights" to existing shareholders allowing them to purchase additional
shares, usually at a discount to market price is known as Rights Offering. Shareholders
who do not exercise these rights dilute their holdings in the company by the offering.
Rights are transferable, allowing the holder to sell them on the open market to others
who may wish to exercise them.
S
SALES CHARGE
The fee charged by a mutual fund when purchasing shares, usually payable as a
commission to a marketing agent, such as a financial advisor, who is thus compensated
for his assistance to a purchaser. It represents the difference, if any, between the shares
purchase price and the share net asset value.
185
ICM – Stock Brokers' Certification
SECONDARY MARKET
A market that provides for the purchase or sale of previously owned securities. Most
trading is done in the secondary market. The Stock Exchanges and the bond markets,
etc., are examples of secondary markets.
SETTLEMENT DATE
It is the date on which payment is made to settle a trade. For stocks traded on
exchanges, settlement is currently 2 business days after the trade (T+2). For mutual
funds, settlement usually occurs the day following the trade. In some regional markets,
foreign shares may require longer period to settle.
SHARES
These are certificates or book entries representing ownership in a corporation or similar
other entity.
SHARE REPURCHASE
It is a programme by which a corporation buys back its own shares in the open market.
It is usually done when shares are undervalued. Since it reduces the number of shares
outstanding and thus increases earnings per share, it tends to elevate the market value
of the remaining shares held by stockholders.
SHORT SALE
"Short Sale" means a sale by a Member, on his Proprietary Account or on Client’s
Account, not owning securities at the time of sale or the sale without constituting a PreExisting Interest but is a sale on Proprietary Account or Client’s Account entered into on
the basis of Prior Contractual Borrowing Arrangement to meet delivery requirements on
the settlement date.
SLIPPAGE
Slippage is the difference between estimated transaction costs and actual transaction
costs. The difference is usually composed of revisions to price difference or spread and
commission costs.
STOCK DIVIDEND/ BONUS SHARES
The payment of a corporate dividend in the form of stock rather than cash is the stock
dividend (also called Bonus shares). It may be additional shares in the company, or it
may be shares in a subsidiary being spun off to shareholders. Stock dividends are often
used to conserve cash needed to operate the business. Unlike a cash dividend, stock
dividends are not taxed until sold.
STOP (-LOSS) ORDER
The order to sell a stock when the price falls to a specified level is known as Stop (Loss)
Order.
186
ICM – Stock Brokers' Certification
STRIKE PRICE
It is the stated price per share for which underlying stock may be purchased (in the case
of a call) or sold (in the case of a put) by the option holder upon exercise of the option
contract.
T
TAX SWAP SALES
Where the investor having realized loss (as in the case of wash sale) on a particular
share does not repurchase the same share but chooses another similar share in the
same sector thus not only minimizing or eliminating altogether CGT liability but also
maintaining the portfolio broadly at the same risk return profile.
TICK INDICATOR
A market indicator based on the number of stocks whose last trade was an uptick or a
downtick. Used as an indicator of market sentiment or psychology to try to predict the
market's trend at a certain point in time and also relevant in context of “Regulations for
Short Selling under Ready Market, 2002”..
TIME VALUE
The portion of the premium that is based on the amount of time remaining until the
expiration date of the option contract, and that the underlying components that
determine the value of the option may change during that time. Time value is generally
equal to the difference between the premium and the intrinsic value.
TRADE
A verbal (or electronic) transaction involving one party buying a security from another
party is called Trade. Once a trade is consummated, it is considered "done" or final.
TRADE DATE
It is the date on which a trade occurs. Trades generally settle (are paid for) 2 business
days after a trade date.
TRADING RANGE
The difference between the high and low prices traded during a period of time; with
commodities, the high/low price limit established by the exchange for a specific
commodity for any one day's trading.
TURNOVER
Mutual Funds: A measure of trading activity during the previous year, expressed as a
percentage of the average total assets of the fund. A turnover ratio of 25 % means that
the value of trades represented one-fourth of the assets of the fund. Finance: The
187
ICM – Stock Brokers' Certification
number of times a given asset, such as inventory, is replaced during the accounting
period, usually a year. Corporate: The ratio of annual sales to net worth, representing
the extent to which a company can grow without outside capital. Markets: The volume
of shares traded as a percentage of total shares listed during a specified period, usually
a day or a year.
V
VARIABLE COSTS
Costs that change as the level of output changes.
VARIANCE
Average value of squared deviations from mean. It is a measure of volatility.
VOLUME
The number of transactions in financial instruments, futures made during a specified
period of time.
W
WALLFLOWER
Stock that has fallen out of favour with investors; tends to have a low P/E.
WANTED FOR CASH
A statement displayed on market tickers which indicates that a bidder will pay cash for
same day settlement of a block of a specified security.
WARRANT
A security entitling the holder to buy a proportionate amount of stock at some specified
future date at a specified price, usually one higher than current market. This "warrant"
is then traded as a security, the price of which reflects the value of the underlying stock.
Warrants are usually issued as a "sweetener" bundled with another class of security to
enhance the marketability of the latter.
WASH SALES
Where capital loss realized on sale of specific share by an investor is preceded or
followed in one month's period by purchase of the same share by the same investor,
thus maintaining the portfolio).
188
ICM – Stock Brokers' Certification
WATCH LIST
A list of securities selected for special surveillance by a brokerage, exchange or
regulatory organization; firms on the list are often takeover targets, companies planning
to issue new securities or stocks showing unusual activity.
WITHDRAWAL PLAN
The ability to establish automatic periodic mutual fund redemptions and have proceeds
mailed directly to the investor.
WRITER
The seller of an option contract is known as a Writer.
Y
YIELD
The percentage annualized rate of return paid on a stock in the form of dividends, or the
interest paid on a bond or a note.
YIELD TO CALL
Yield to call is the percentage rate of return on a TFC/bond or a note, if investor has to
buy and hold the security until the call dates. This yield is valid only if the security is
called prior to maturity. Generally bonds are callable over several years and normally
are called at a slight premium. The calculation of yield to call is based on the coupon
rate, length of time to the call and the market price.
YIELD TO MATURITY
The percentage rate of return paid on a TFC/bond, note or other fixed income security if
it is held to its maturity. The calculation for YTM is based on the coupon rate, length of
time to maturity and market price. It assumes that coupon interest paid over the life of
the bond will be reinvested at the same rate.
Z
ZERO COUPON
The term refers to a debt instrument that does not make coupon payments, but, rather,
is issued at a discount to par and redeemed at par at maturity.
*******
189