B.

COM {FINANCIAL ACCOUNTING}

BCFA-305

SEMESTER -3

Security and portfolio analysis

UNIT-2

Topics covered:

Indian stock market: regulation, organization and function

Market indices and return

Investment alternatives
Indian stock market:
Origin and growth

The National Stock Exchange of India was set up by Government of India on the recommendation of
Pherwani Committee in 1991. Since then there has been lot of changes and the exchange has witnesses
a great height. Actually, the stock exchange in India originated in 1800 and has developed since then in
different stages.

1800-1865: In the initial stages, The East India Company floated shares through a very small group of
brokers. Between the years 1840-1850, there were only half a dozen brokers but in, 1850 the number
rose to about 60 brokers. In 1860, the entire market was attracted with the concept of shares which
lasted till 1865.

1866-1900: This period also saw a drastic change in the history of Stocks and led to the foundation of a
regular market for securities. The Bombay market became the leading and the most organized stock
exchange in India. A number of code of conduct were developed by the brokers during this period.

1901-1913: The share investment grew during this period because of development in the political field.
The industrial enterprises grew after the Swadeshi Movement led by Mahatma Gandhi. Also Calcutta
became a major trading center. New ventures were floated and in 1920 another stock exchange was
established in Madras.

1935-1965: The industrial development planning was done during this period and two more stock
exchanges, one at Hyderabad and another at Delhi was established. Also 12 more stock exchanges were
set up after independence, between the years 1946 and 1990.

There are 24 stock exchanges in India which are as follows:

The Bombay Stock Exchange.
The Ahmedabad Stock Exchanges of India.
Bangalore Stock Exchange.
The Calcutta Stock Exchange Association.
Cochin Stock Exchange.
The Delhi Stock Exchange Association.
The Guwahati Stock Exchange.
Hyderabad Stock Exchange (HSE).
Jaipur Stock Exchange (BE).
Kanara Stock Exchange.
The Ludhiana Stock Exchange Association.
Madras Stock Exchange (MSE).
Madhya Pradesh Stock Exchange.
Magadh Stock Exchange.
Mangalore Stock Exchange.
Pune Stock Exchange.
Saurashtra Kutch, Stock Exchange.
The Uttar Pradesh Stock Exchange Association.
Vadodara Stock Exchange.
Coimbatore Stock Exchange.
Meerut Stock Exchange.
Over the Counter (OTC) Exchange of India.
National Stock Exchange of India (NSE).
Inter-connected Stock Exchange of India (ISE).

ROLE AND FUNCTIONS OF STOCK MARKET

The stock market comprises retail investors, traders, brokers, institutional investors, researchers,
advisors and regulators. For many, the stock market represents an opportunity to create wealth. From
the perspective of a country, stock markets are essential for promoting investing of savings and driving
growth. This article takes a look at various functions of stock markets/exchange.

1. Price discovery: One of the most important functions of stock exchanges is bringing buyers and sellers
together in a single place and facilitating price discovery. The role of stock exchanges is tremendous in
creating a place where the impact of all factors that can affect businesses is incorporated into stock
prices. Since the pricing of securities incorporates all relevant factors, investors, traders, creditors, and
governments need not make repetitive assessments.

2. Promotes investment of savings: For an economy to grow, the citizens’ savings must be deployed in
avenues productive to the economy. A part of this is taken care of by the banking system that provides
loans using deposits. A smooth and trustworthy stock market would encourage citizens to invest in
businesses that can use this capital to produce more, produce better and employ more.

3. Promotes better allocation of capital: Information on companies in the stock market is easier to
obtain as news outlets are likely to cover any events that might affect their market value. The
companies themselves are required to disclose key information. Investors also get access to information
on bulk deals, insider trades, and holdings of institutional investors and promoters.

4. Becoming a medium for foreign investments: In developing countries like India, foreign investments
play a crucial role in promoting new industries and enhancing existing ones. The proceeds can be used
to adopt technological advancements, improve production capacities, hire better talent and enrich the
existing human capital. A stock market that functions smoothly, is regulated against malpractices, and is
transparent can give foreign investors the confidence to invest in the companies of a particular country

5. Driving economic growth and being an economic barometer: As mentioned earlier, a well-functioning
stock market can help draw investments from domestic sources. These investments can be employed to
improve production capacities and can help increase job opportunities. Thus, stock markets can help
drive the economic growth of a country.

6. Liquidity: Liquidation of assets, i.e. converting them into cash, can be a tedious task. Finding a buyer is
difficult, and getting a reasonable bid is even more difficult. But, if the asset in question is a security that
can be traded in the stock market, the situation changes dramatically. Stock markets help connect
buyers and sellers across geographical and socioeconomic boundaries. This makes it a lot simpler to buy
or sell assets.
7. Safe transactions: Companies listed on stock exchanges are regulated and required to meet certain
standards. Also, investors can expect a basic level of information to be available on all companies in the
stock market.

8. Provides scope for speculation: Stock markets provide scope for speculation in a fair and regulated
manner. Healthy speculation can help smoothing changes in asset prices. As situations develop,
speculative activity affects asset prices. The change in asset prices happens in phases instead of
skyrocketing or free-falling prices. Also, speculative trades ensure assets remain liquid.

INDIAN CAPITAL MARKET

In the financial market all those institutions and organizations which provide medium term and
longterm funds to business enterprises and public authorities, constitute the capital market. In
simple words, the market which lends long-term funds is called the capital market. The capital
market is composed of those who demand funds and those who supply funds. Thus, the
borrowers and lenders in the financial market for medium-term and long-term funds constitute
the capital market.

The Indian Capital Market is broadly divided into two categories:

1) The securities market consisting of (a) The gilt-edged market and (b) The industrial securities
market; and

2) The financial institutions (Development Financial Institutions) (DFIs). Thus, the Indian capital
market is composed of (a) The gilt-edged market or the market for government securities and
industrial securities or corporate securities market. (b) Capital market includes Development
Financial Institutions (DFIs) such as IFCI, SFC, LIC, IDBI, UTI, ICICI, etc. They provide medium-
term and long-term funds for business enterprises and public authorities. (c) Apart from the
above, there are financial intermediaries in the capital market such as merchant bankers,
mutual funds, leasing companies, venture capital companies etc. They help in mobilizing savings
and supplying funds to investors.
(1) Gilt- Edged Market: Gilt-edged market is also known as the government securities market. As the
securities are risk free, they are known as gilt-edged i.e. the best quality securities. The investors in the
gilt-edged market are predominantly institutions. They are required by law to invest a certain portion of
their funds in these securities. These institutions include commercial banks, LIC, GIC, and the provident
funds. The transactions in the government securities market are very large. Each transaction may run
into several crores or even hundred crores of rupees. Since June 1992, government securities have been
mostly issued sealed bid auctions. RBI plays a dominant role in the gilt-edged market through its open
market operations. Thus, government securities are the most liquid debt instruments.

(2) The Industrial Securities Market: It is a market of shares, debentures and bonds which can be bought
and sold freely. This market is divided into two categories:

(A) Primary Market: The new issue market called the primary market and (b) old issue market,
commonly known as stock exchange or stock market. It is called the secondary market. The new issue
market is concerned with the raising of new capital in the form of shares, bonds and debentures. Many
public limited companies often raise capital through the primary market for expanding their business. It
may be noted that the new issue market is important because of its impact on economic growth of the
country.

(B) Secondary Market: The stock exchange market or the secondary market is a market of the purchase
and sale of quoted or listed securities. It is a highly organized market for regulating and controlling
business in buying, selling and dealing in securities.

(3) Financial Institutions: We have mentioned that there are special financial institutions which
provided long-term capital to the private sector in the capital market. These institutions are called
Development Financial Institutions.

(4) Financial Intermediaries: The Indian capital market has shown steady improvement after 1951.
During the Five-Year Plans, Capital market has witnessed rapid growth. Both the volume of saving and
investment have shown phenomenal improvement. In fact, in the last two decades, the volume of
capital market transactions has increased substantially. Besides, its functioning has been diversified
indicating the growth of the Indian economy.

PRIMARY MARKET REFORMS IN INDIA:

A number of measures has been taken in India especially since 1991 to develop primary market in India.
These measures are discussed below:

1. Abolition of Controller of Capital Issues: The Capital Issues (Control) Act, 1947 governed capital issues
in India. The capital issues control was administered by the Controller of Capital Issues (CCI). The
Narasimham Committee (1991) had recommended the abolition of CCI and wanted SEBI to protect
investors and take over the regulatory function of CCI. Thus, government replaced the Capital Issues
(Control) Act and abolished the post of CCI. Companies are allowed to approach the capital market
without prior government permission subject to getting their offer documents cleared by SEBI.
 2. Securities and Exchange Board of India (SEBI): SEBI was set up as a non-statutory body in 1988 and
was made a statutory body in January 1992. SEBI has introduced various guidelines for capital issues in
the primary market. They are explained below.

3. Disclosure Standards: Companies are required to disclose all material facts and specific risk factors
associated with their projects. SEBI has also introduced a code of advertisement for public issues for
ensuring fair and truthful disclosures.

4. Freedom of Determine the Par Value of Shares: The requirement to issue shares at a par value of
Rs.10 and Rs.100 was withdrawn. SEBI has allowed the companies to determine the par value of shares
issued by them. SEBI has allowed issues of IPOs through “book building” process.

5. Underwriting Optional: To reduce the cost of issue, underwriting by the issuer is made optional. It is
subject to the condition that if an issue was not underwritten and was not able to collect 90% of the
amount offered to the public, the entire amount collected would be refunded to the investors.

6. FIIs Permitted to Operate in the Indian Market: Foreign institutional investors such as mutual funds
and pension funds are allowed to invest in equity shares as well as in debt market, including dated
government securities and treasury bills.

7. Accessing Global Funds Market: Indian companies are allowed to aces global finance market and
benefit from the lower cost of funds. They have been permitted to raise resources through issue of
American Depository Receipts (ADRs), Global Depository Receipts (GDRs), Foreign Currency Convertible
Bonds (FCCBs) and External Commercial Borrowings (ECBs). Indian companies can list their securities on
foreign stock exchanges through ADR./GDR issues.

8. Intermediaries under the Purview of SEBI: Merchant bankers, and other intermediaries such as
mutual funds including UTI, portfolio managers, registrars to an issue, share transfer agents,
underwriters, debenture trustees, bankers to an issue, custodian of securities, and venture capital funds
have been brought under the purview of SEBI.

9. Credit Rating Agencies: Various credit rating agencies such as Credit Rating Information Services of
India Ltd. (CRISIL – 1988), Investment Information and Credit Rating Agency of India Ltd. (ICRA – 1991).
Cost Analysis and Research Ltd. (CARE – 1993) and so on were set up to meet the emerging needs of
capital market.

SECONDARY MARKET REFORMS

A number of measures have been taken by the government and SEBI for the growth of secondary
capital market in India. The important reforms or measures are explained below.

1. Setting up of National Stock Exchange (NSE): NSE was set up in November 1992 and started its
operations in 1994. It is sponsored by the IDBI and co-sponsored by other development finance
institutions, LIC, GIC, Commercial banks and other financial institutions.
 2. Over the Counter Exchange of India (OTCEI): It was set in 1992. It was promoted by a consortium of
leading financial institutions of India including UTI, ICICI, IDBI, IFCI, LIC and others. It is an electronic
national stock exchange listing an entirely new set of companies which will not be listed on other stock
exchanges.

3. Disclosure and Investor Protection (DIP) Guidelines for New Issues: In order to remove inadequacies
and systematic deficiencies, to protect the interests of investors and for the orderly growth and
development of the securities market, the SEBI has put in place DIP guidelines to govern the new issue
activities. Companies issuing capital in the primary market are now required to disclose all material facts
and specify risk factors with their projects.

4. Screen Based Trading: The Indian stock exchanges were modernized in the 90s, with Computerized
Screen Based Trading System (SBTS). It electronically matches orders on a strict price / time priority. It
cuts down time, cost, risk of error and fraud, and therefore leads to improved operational efficiency.

5. Depository System: A major reform in the Indian Stock Market has been the introduction of
depository system and scrip less trading mechanism since 1996. Before this, the trading system was
based on physical transfer of securities. A depository is an organization which holds the securities of
shareholders in electronic form, transfers securities between account holders, facilitates transfer of
ownership without handling securities and facilitates their safekeeping.

6. Rolling Settlement: Rolling settlement is an important measure to enhance the efficiency and integrity
of the securities market. Under rolling settlement all trades executed on a trading day are settled after
certain days.

7. The National Securities Clearing Corporation Ltd. (NSCL): The NSCL was set up in 1996. It has started
guaranteeing all trades in NSE since July 1996. The NSCL is responsible for post-trade activities of the
NSE. Clearing and settlement of trades and risk management are its central functions.

8. Trading in Central Government Securities:In order to encourage wider participation of all classes of
investors, including retail investors, across the country, trading in government securities has been
introduced from January 2003. Trading in government securities can be carried out through a
nationwide, anonymous, order-driver, screen-based trading system of stock exchanges in the same way
in which trading takes place in equities.

9. Mutual Funds: Emergency of diversified mutual funds is one of the most important development of
Indian capital market. Their main function is to mobilize the savings of general public and invest them in
stock market securities. Mutual funds are an important avenue through which households participate in
the securities market.
 ROLE AND SIGNIFICANCE OF SEBI

SEBI was established as a non-statutory board in 1988 and January 1992, it was accorded statutory
status. The regulatory powers of SEBI were increased in January 1995. It has now become a very
important constituent of the financial regulatory framework in India. The SEBI is under the overall
control of the Finance Ministry.

1. Promotion and Development of Capital Market: One of the important role of SEBI is the promotion
and development of the capital market. It protects the rights and interests of investors, especially the
individual investors. It prevents trading malpractices. Its regulatory measures are meant for the healthy
development of capital markets.

2. Regulatory Role: Another important role of SEBI is the regulation of the security markets in India. The
SEBI can frame or issue rules, regulations, directives, guidelines, norms with respect to primary and
secondary markets.

3. Protection of Interest of Investors: An important role of SEBI is the protection interest of investors in
securities. SEBI has introduced various measures to protect the interests of investors. To ensure no
malpractice takes place in the allotment of share, a representative of SEBI supervises the allotment
process.

4. Investor’s Education: SEBI has a role of educating the investors about the securities market. It issues
advertisements from time to time to enlighten the investors on various issues related to the securities
market and of their rights and remedies.

5. Investor’s Grievances Redressal: SEBI plays another role of redressing the investor’s grievances. SEBI
has introduced an automated complaints handling system to deal with investor complaints. The Investor
Grievances Redressal and Guidance Division of SEBI assists investors who want to make complaints to
SEBI against listed companies.

6. Primary Market Policy: SEBI looks after all the policy matters and regulatory issues with respect to
primary market. It is responsible for vetting of all the prospectuses and letters of offer for public and
right issues, for coordinating with the primary market policy, for registration, regulation and monitoring
of issue related intermediaries.

7. Secondary Market Policy: SEBI is responsible for all policy and regulatory issues for secondary market
and new investment products. It is also responsible for registration and monitoring of members of stock
exchanges, administration of some of the stock exchanges and monitoring of price movements and
insider trading.

8. Institutional Investment Policy: SEBI look after institutional investment policy with respect to
domestic mutual funds and Foreign Institutional Investors (FIIs). It also looks after registration,
regulation and monitoring of FIIs and domestic mutual funds.
9. Facilitates Mobilization of Resources: The SEBI plays an important role in facilitating an efficient
mobilization and allocation of resources through the securities market, stimulating competition and
encouraging innovations.

A stock exchange is an institution which provides a platform for buying and selling of existing securities.
As a market, the stock exchange facilitates the exchange of a security (share, debenture etc.) into money
and vice versa. Stock exchanges help companies raise finance, provide liquidity and safety of investment
to the investors and enhance the credit worthiness of individual companies.

Meaning of Stock Exchange According to Securities Contracts (Regulation) Act 1956, stock exchange
means anybody of individuals, whether incorporated or not, constituted for the purpose of assisting,
regulating or controlling the business of buying and selling or dealing in securities.

Functions of a Stock Exchange the efficient functioning of a stock exchange creates a conducive climate
for an active and growing primary market for new issues. An active and healthy secondary market in
existing securities leads to positive environment among investors. The following are some of the
important functions of a stock exchange.

1. Providing Liquidity and Marketability to Existing Securities: The basic function of a stock exchange is
the creation of a continuous market where securities are bought and sold. It gives investors the chance
to disinvest and reinvest. This provides both liquidity and easy marketability to already existing
securities in the market.

2. Pricing of Securities: Share prices on a stock exchange are determined by the forces of demand and
supply. A stock exchange is a mechanism of constant valuation through which the prices of securities are
determined. Such a valuation provides important instant information to both buyers and sellers in the
market.

3. Safety of Transaction: The membership of a stock exchange is wellregulated and its dealings are well
defined according to the existing legal framework. This ensures that the investing public gets a safe and
fair deal on the market.

4. Contributes to Economic Growth: A stock exchange is a market in which existing securities are resold
or traded. Through this process of disinvestment and reinvestment savings get channelized into their
most productive investment avenues. This leads to capital formation and economic growth.

5. Spreading of Equity Cult: The stock exchange can play a vital role in ensuring wider share ownership
by regulating new issues, better trading practices and taking effective steps in educating the public
about investments.

6. Providing Scope for Speculation: The stock exchange provides sufficient scope within the provisions of
law for speculative activity in a restricted and controlled manner. It is generally accepted that a certain
degree of healthy speculation is necessary to ensure liquidity and price continuity in the stock market.
Trading and settlement procedure

It has been made compulsory to settle all trades within 2 days of the trade date, i.e., on a T+2 basis,
since 2003. Prior to the reforms, securities were bought and sold, i.e., traded and all positions in the
stock exchange were settled on a weekly/fortnightly settlement cycle whether it was delivery of
securities or payment of cash. This system prevailed for a long time as it increased the volume of trading
on the exchange and provided liquidity to the system. However, since trades were to be settled on
specified dates, this gave rise to speculation and price of shares used to rise and fall suddenly due to
trading and defaults by brokers.

1. If an investor wishes to buy or sell any security he has to first approach a registered broker or
sub-broker and enter into an agreement with him. The investor has to sign a broker-client
agreement and a client registration form before placing an order to buy or sell securities. He has
also to provide certain other details and information.

These include: • PAN number (This is mandatory) • Date of birth and address. • Educational
qualification and occupation. • Residential status (Indian/NRI). • Bank account details. •
Depository account details. • Name of any other broker with who registered. • Client code
number in the client registration form. The broker then opens a trading account in the name of
the investor.

2. The investor has to open a ‘demat’ account or ‘beneficial owner’ (BO) account with a depository
participant (DP) for holding and transferring securities in the demat form. He will also have to
open a bank account for cash transactions in the securities market.
3. The investor then places an order with the broker to buy or sell shares. Clear instructions have
tobe given about the number of shares and the price at which the shares should be bought or
sold. The broker will then go ahead with the deal at the above mentioned price or the best price
available. An order confirmation slip is issued to the investor by the broker.
4. The broker then will go on-line and connect to the main stock exchange and match the share
and best price available.
5. When the shares can be bought or sold at the price mentioned, it will be communicated to the
broker’s terminal and the order will be executed electronically. The broker will issue a trade
confirmation slip to the investor.
6. After the trade has been executed, within 24 hours the broker issues a Contract Note. This note
contains details of the number of shares bought or sold, the price, the date and time of deal,
and the brokerage charges. This is an important document as it is legally enforceable and helps
to settle disputes/claims between the investor and the broker. A Unique Order Code number is
assigned to each transaction by the stock exchange and is printed on the contract note.
7. Now, the investor has to deliver the shares sold or pay cash for the shares bought. This should
be done immediately after receiving thcontract note or before the day when the broker shall
make payment or delivery of shares to the exchange. This is called the pay-in day.
8. Cash is paid or securities are delivered on pay-in day, which is before the T+2 day as the deal has
to be settled and finalized on the T+2 day. The settlement cycle is on T+2 day on a rolling
settlement basis, w.e.f. 1 April 2003.
9. On the T+2 day, the exchange will deliver the share or make payment to the other broker. This is
called the pay-out day. The broker then has to make payment to the investor within 24 hours of
the payout day since he has already received payment from the exchange.
10. The broker can make delivery of shares in demat form directly to the investor’s demat account.
The investor has to give details of his demat account and instruct his depository participant to
take delivery of securities directly in his beneficial owner account.

NATIONAL ATIONAL STOCK EXCHANGE OF INDIA (NSE)

The National Stock Exchange is the latest, most modern and technology driven exchange. It was
incorporated in 1992 and was recognised as a stock exchange in April 1993. It started operations in
1994, with trading on the wholesale debt market segment. Subsequently, it launched the capital
market segment in November 1994 as a trading platform for equities and the futures and options
segment in June 2000 for various derivative instruments. NSE has set up a nationwide fully
automated screen based trading system. The NSE was set up by leading financial institutions, banks,
insurance companies and other financial intermediaries. It is managed by professionals, who do not
directly or indirectly trade on the exchange. The trading rights are with the trading members who
offer their services to the investors. The Board of NSE comprises senior executives from promoter
institutions and eminent professionals, without having any representation from trading members.

OBJECTIVES OF NSE

a. Establishing a nationwide trading facility for all types of securities.

b. Ensuring equal access to investors all over the country through an appropriate communication
network.

c. Providing a fair, efficient and transparent securities market using electronic trading system.

d. Enabling shorter settlement cycles and book entry settlements.

e. Meeting international benchmarks and standards.

Within a span of ten years, NSE has been able to achieve its objectives for which it was set up. It has
been playing a leading role as a change agent in transforming the Indian capital market. NSE has
been able to take the stock market to the door step of the investors. It has ensured that technology
has been harnessed to deliver the services to the investors across the country at the lowest cost. It
has provided a nationwide screen based automated trading system with a high degree of
transparency and equal access to investors irrespective of geographical location.
SENSEX — Bombay Stock Exchange Sensitive Index

The SENSEX is the benchmark index of the BSE. Since the BSE has been the leading exchange of the
Indian secondary market, the SENSEX has been an important indicator of the Indian stock market. It
is the most frequently used indicator while reporting on the state of the market. An index has just
one job: to capture the price movement. So a stock index will reflect the price movements of shares
while a bond index captures the manner in which bond prices go up or down. If the SENSEX rises, it
indicates the market is doing well. Since stocks are supposed to reflect what companies expect to
earn in the future, a rising index indicates that investors expect better earnings from companies. It is
also a measure of the state of the Indian economy. If Indian companies are expected to do well,
obviously the economy should do well too. The SENSEX, launched in 1986 is made up of 30 of the
most actively traded stocks in the market. In fact, they account for half the BSE’s market
capitalization. They represent 13 sectors of the economy and are leaders in their respective
industries.

BSE is one such exchange set up as a corporate entity with a broad shareholder base.

It has the following objectives:

(a) To provide an efficient and transparent market for trading in equity, debt instruments,
derivatives, and mutual funds.

(b) To provide a trading platform for equities of small and medium enterprises.

(c) To ensure active trading and safeguard market integrity through an electronically-driven
exchange.

(d) To provide other services to capital market participants, like risk management, clearing,
settlement, market data, and education.

(e) To conform to international standards. Besides having a nation-wide presence, BSE has a global
reach with customers around the world. It has stimulated innovation and competition across all
market segments. It has established a capital market institute, called the BSE Institute Ltd, which
provides education on financial markets and vocational training to a number of people seeking
employment with stock brokers. The exchange has about 5000 companies listed from all over the
country and outside, and has the largest market capitalization in India.