Financial Markets Notes

Course Code: BA4002

Prepared by:

Y Sugandha (Asst. Prof.)

Y Sugandha (Asst. Professor)

 UNIT 3:

Stock Exchange

Stock Exchange market is a vital component of a stock market. It facilitates the

transaction between traders of financial instruments and targeted buyers. A stock
exchange in India adheres to a set of rules and regulations directed by Securities and
Exchange Board of India or SEBI. The said authoritative body functions to protect the
interest of investors and aims to promote the stock market of India.

What is the Stock Exchange?

The stock exchange in India serves as a market where financial instruments like stocks,
bonds and commodities are traded.

It is a platform where buyers and sellers come together to trade financial tools during
specific hours of any business day while adhering to SEBI’s well-defined guidelines.
However, only those companies who are listed in a stock exchange are allowed to trade
in it.

Stocks which are not listed on a reputed stock exchange can still be traded in an ‘Over
The Counter Market’. But such shares would not be held high in esteem in the stock
exchange market.

How Does it Work?

Mostly, a stock exchange in India works independently as no ‘market makers’ or

‘specialists’ are present in them.

The entire process of trading in stock exchange in India is order-driven and is conducted
over an electronic limit order book.

In such a set-up, orders are automatically matched with the help of the trading computer.
It functions to match investors’ market orders with the most suitable limit orders.

The major benefit of such an order-driven market is that it facilitates transparency in

transactions by displaying all market orders publicly.

Brokers play a vital role in the trading system of the stock exchange market, as all orders
are placed through them.

Both institutional investors and retail customers can avail the benefits associated with
direct market access or DMA. By using the trading terminals provided by stock exchange
market brokers, investors can place their orders directly into the trading system.

Benefits of Listing with Stock Exchange

Y Sugandha (Asst. Professor)

Listing with a stock exchange extends special privileges to company securities. For
instance, only listed company shares are quoted on a stock exchange.

Being listed on a reputed stock exchange is deemed beneficial for companies, investors
and the public in general and they tend to benefit in these following ways –

• Increased Value

Only stocks listed with a reputable stock exchange are considered to be higher in value.
Companies can cash in on their market reputation in the stock exchange market by
increasing their number of shareholders. Issuing shares in the market for shareholders to
acquire is a potent way of increasing shareholder base and base, which in turn increases
their credibility.

• Accessing capital

One of the most eXective ways of availing cheap capital for a company is by issuing
company shares in the stock exchange market for shareholders to acquire. Listed
companies can generate comparatively more capital through share issuance owing to
their repute in a stock exchange market and use it to keep their company afloat and its
operations running.

• Collateral value

Almost all lenders accept listed securities as collateral and extend credit facilities
against them. A listed company is more likely to avail a faster approval for their credit
request; as they are deemed more credible in the stock exchange market.

• Liquidity

Listing helps shareholder avail the advantage of liquidity better than other counterparts
and oXers them ready marketability. It allows shareholders to estimate the value of
investment owned by them.

Additionally, it permits share transactions with a company and helps them to even out
the associated risks. It also helps shareholders to improve their earnings from even the
slightest increase in overall organisational value.

• Fair price

The quoted price also tends to represent the real value of a particular security in a stock
exchange in India.

The fact that the prices of listed securities are set as per the forces of demand and supply
and are disclosed publicly, investors are assured to acquire them at a fair price.

Investment Methods

Investors can invest in a stock exchange of India through these two ways –

Y Sugandha (Asst. Professor)

 1. Primary market – This market creates securities and acts as a platform where
firms float their new stock options and bonds for the general public to acquire. It
is where companies enlist their shares for the first time.

2. Secondary market – The secondary market is also known as the stock market; it
acts as a trading platform for investors. Here, investors trade in securities without
involving the companies who issued them in the first place with the help of
brokers. This market is further broken down into – auction market and dealer
market.

Major stock exchanges in India

There are two major types of Stock Exchanges in India, namely the –

Bombay Stock Exchange (BSE): This particular stock exchange was established in 1875
in Mumbai at Dalal Street. It renowned as the oldest stock exchange not just in Asia and
is the ‘World’s 10th largest Stock Exchange’.

The estimated market capitalisation of Bombay Stock Exchange as of April stands at $ 4.9
Trillion and has around 6000 companies publicly listed under it. The performance of BSE
is measured by the Sensex, and it reached its all-time high in June in 2019, when it
touched 40312.07.

National Stock Exchange (NSE): The NSE was established in 1992 in Mumbai and is
accredited as the pioneer among the demutualised electronic stock exchange markets
in India. This stock exchange market was established with the objective to eliminate the
monopolistic impact of the Bombay Stock exchange in the Indian stock market.

The estimated market capitalisation of National Stock Exchange as of March 2016 was
US$ 4.1 trillion and was acclaimed as the 12th largest stock exchange in the world. NIFTY
50 is NSE’s index, and it is extensively used by investors across the globe to gauge the
performance of the Indian capital market.

Here is a list of stock exchanges in India

1. The Bombay Stock Exchange Ltd

• India International Exchange or India INX

• Metropolitan Stock Exchange of India Ltd (was valid up to September 15th, 2019)

• National Stock Exchange of India Ltd.

Y Sugandha (Asst. Professor)

 • NSE IFSC Ltd.

Being a vital part of the Indian stock market, a stock exchange in India tends to influence
the country’s financial sector to a great extent. Their collective performances happen to
be a deciding factor of economic growth.

Also, all major types of stock exchanges are closely integrated with each other; if one
major stock exchange falls, it will have a ripple eXect on all other major exchanges across
the globe.

For example, if the index of Bombay Stock Exchange falls, its eXect will be felt across
stock exchanges like New York Stock Exchange, Tokyo Stock Exchange, Shanghai Stock
Exchange, etc. as well.

History and development

History of Stock Exchange in India (18th Century - 20th Century)

18th Century:

• The history of stock market in India can be traced back to the late 18th century
when the East India Company issued bonds and shares to raise capital for its
operations. This was the first share market in India where securities were
informally traded among merchants in the region.

• The trading floor was under the shade of a sprawling banyan tree opposite the
Town Hall in Mumbai. A few people would meet under this tree to informally trade
in cotton. his was because Mumbai was a busy trading port, and essential
commodities were traded here often.

• The Companies Act was introduced in 1850, following which investors started
showing an interest in corporate securities. The concept of limited liability also put
an appearance around this time.

• By 1875, an organization known as ‘The Native Share and Stock Brokers

Association’ came into being. This was the predecessor of the BSE.

• In 1894, the Ahmedabad Stock Exchange came primarily to enable dealing in the
shares of textile mills in the city.

19th Century:

• During the 19th century, regional stock exchanges were established in major
Indian cities.

• This was because Mumbai was a busy trading port, and essential commodities
were traded here often.

Y Sugandha (Asst. Professor)

 • The Companies Act was introduced in 1850, following which investors started
showing an interest in corporate securities. The concept of limited liability also put
an appearance around this time.

• By 1875, an organization known as ‘The Native Share and Stock Brokers

Association’ came into being. This was the predecessor of the BSE.

• In 1894, the Ahmedabad Stock Exchange came primarily to enable dealing in the
shares of textile mills in the city.

Post-Independence (1947):

After India's independence in 1947, the stock market underwent changes to adapt to the
new economic environment.

When Stock Market Started in India (1950s - 1960s)

• 1950s: Formal stock market trading continued to evolve in India, with several
regional stock exchanges becoming operational. However, the market remained
relatively small and primarily served the needs of British colonial authorities and
their commercial interests.

• 1960s: During this decade, the Indian government introduced the Securities
Contracts (Regulation) Act in 1956, providing the first legal and regulatory
framework for stock exchanges and securities trading in India. This was a
significant step in the development of the Indian stock market.

Who Started Stock Market in India (Late 20th Century)

• Late 20th Century: The late 20th century marked a significant transformation in
the Indian stock market. In 1992, the National Stock Exchange (NSE) was
established, introducing electronic trading and modern technology to the Indian
stock market. It played a vital role in bringing transparency and eXiciency to the
market.

Nifty and Sensex (1990s)

• 1990s: The NSE introduced the Nifty 50 index, providing a benchmark for the
performance of the Indian stock market. The Bombay Stock Exchange's Sensex
(S&P BSE Sensex) also became a prominent stock market index tracking the top
companies listed on the BSE.

Scams in Indian Share Market (1990s - 2000s)

• 1990s: This decade saw the infamous Harshad Mehta scam, which involved
manipulation of the stock market using illegal funds. It raised questions about the
need for regulatory oversight.

Y Sugandha (Asst. Professor)

 • Early 2000s: The Ketan Parekh scam was another significant event in Indian stock
market history. It involved fraudulent trading practices and led to regulatory
changes.

• 2008: The global financial crisis of 2008 had a substantial impact on the history of
Indian stock exchange, causing a significant market correction.

Economic Reforms and Globalization (1991 - 21st Century)

• 1991: India initiated economic liberalization and reforms, attracting foreign

investment, removing trade barriers, and privatizing state-owned enterprises.
These reforms transformed the Indian economy and stock market.

• 21st Century: The Indian stock market continued to grow, attracting both
domestic and international investors. It witnessed periods of bullish trends and
corrections, reflecting economic conditions.

Demutualization and Regulatory Framework (Early 21st Century)

• Early 21st Century: Indian stock exchanges underwent demutualization,

separating ownership and management. This made stock exchanges more
competitive and eXicient.

• Regulatory Framework: The Securities and Exchange Board of India (SEBI),

established in 1988, continued to play a crucial role in regulating and supervising
various aspects of the Indian stock market to ensure transparency and investor
protection. In 2015, SEBI was merged with the Forward Markets Commission
(FMC) to strengthen commodities market regulation, facilitate domestic and
foreign institutional participation, and launch new products.

Online Trading and Technology Advancements (21st Century)

• 21st Century: The proliferation of online trading platforms, enabled by the internet
and technological advancements, made it easier for investors to participate in the
stock market.

Listing

In corporate finance, a listing refers to the company's shares being on the list (or board)
of stock that are publicly listed. Some stock exchanges allow shares of a foreign
company to be listed and may allow dual listing, subject to conditions.

Normally the issuing company is the one that applies for a listing but in some
countries[which?] an exchange can list a company, for instance because its stock is already
being traded via informal channels.

Y Sugandha (Asst. Professor)

Stocks whose market value and/or turnover fall below critical levels may be delisted by
the exchange. Delisting often arises from a merger or takeover, or the company going
private.

Depositaries

1. What is a Depository?

A depository is an organization which holds securities (like shares, debentures, bonds,

government securities, mutual fund units etc.) of investors in electronic form at the
request of the investors through a registered depository participant. It also provides
services related to transactions in securities.

2. What is the minimum net worth required for a depository?

The minimum net worth stipulated by SEBI for a depository is Rs.100 crores.

3. How is a depository similar to a bank?

It can be compared with a bank, which holds the funds for depositors. A bank - depository
analogy is given in the following table:

4. How many Depositories are registered with SEBI?

At present two Depositories viz. National Securities Depository Limited (NSDL) and
Central Depository Services (India) Limited (CDSL) are registered with SEBI.

Y Sugandha (Asst. Professor)

Stock exchange mechanism:

Stock market is a virtual place that allows investors to grow their wealth by purchasing
company shares that are oXered by organisations trying to raise capital. SEBI regulates
all stock market activities and ensures safe and ethical trading practices. The two
depositories manage all investors, brokers and stock exchanges under the guidelines of
SEBI to ensure the free flow of investments and trading.

Stock market has two parts namely, primary and secondary markets. A stock is first
introduced in the primary market when a company launches its Initial Public OXering
(IPO). Companies oXer their equity to the public to collect additional funding for
expansion or any other business plan. Primary investors bid for IPO subscriptions and
buy shares in lots in the primary market.

Such investors put in their money to earn profits by reselling their stocks in the secondary
market. After launching an IPO, the stock is listed on the secondary market and shares
purchased by primary investors are sold to other investors in this market the shares are
then traded between investors based on demand and supply which are influenced by
company performance and market capital.

Y Sugandha (Asst. Professor)

All investors are required to have a DEMAT account to participate in the stock market.
These DEMAT accounts digitally store an investor’s assets and funds with the depository
and allow them to sell those assets when necessary.

Stock exchanges work as a platform for investors to access diXerent shares and other
assets like mutual funds, bonds, etc. Stock exchanges study the market and help
companies and investors understand the market scenario daily.

The performance of a sector and the whole market is represented by separate indices.
Nifty and Sensex are the two broad market indices of the NSE and BSE, respectively.
These indices calculate the market performance of top stocks from all sectors and
produce a value that is representative of the overall market performance.

Trading

Meaning of Trading

Trading is essentially the exchange of goods and services between two entities. In this
context, the entities are investors/traders who are exchanging stocks of diXerent
companies. Stock trading takes place in the stock market. With online trading and
investing, stock markets have become accessible to a larger section of people

History of Trading

Trade has existed for as long as human civilization, i.e., the agricultural revolution. The
form of trading, however, has varied across diXerent societies. Primarily due to isolated
human communities, which did not allow the unification into a single system. In the past,
however, a form of trading that was prevalent across diXerent societies was the barter
system, where services and goods were traded in exchange for other services and goods.

However, the barter system was found inconvenient given the lack of any basic standard
for measuring the value of products. This inconvenience forged the way for money, which
acted as a standard against which the values of all products are measured. This invention
triggered a chain of economic and financial developments such as the introduction of the
credit facility, share trading, etc.

Stock trading came into existence with the formation of joint-stock companies in Europe
and played an instrumental role in European imperialism. Informal stock markets started
mushrooming in various European cities. The first joint-stock company to publically trade
its shares was the Dutch East India Company which released its shares through the
Amsterdam Stock Exchange.

After the success of joint-stock companies in fostering economic development along

with geographical expansion, those were made a mainstay of the financial world. The first
exchange for online trading in India and Asia was the Bombay Stock Exchange which was

Y Sugandha (Asst. Professor)

established in 1875. BSE, along with the National Stock Exchange in India, are the two
main houses where stock market trading takes place.

Types of Trading in Stock Market

Primarily, there are five types of share trading. These are –

1) Day Trading

This form of trade involves purchasing and selling stocks in a single day. A single day in
stock market terms means 9:15 am to 3:30 pm on a weekday (barring market holidays).
In the case of day trading, individuals hold stocks for a few minutes or hours.

A trader involved in such trade needs to close his/her transactions prior to the day’s
market closure. It is popular for capitalizing on small-scale fluctuations in NAV of stocks.

Day trading requires proficiency in market matters, a thorough understanding of market

volatility, and keen sense regarding the up and down in stock values. Therefore, it is
performed mostly by experienced investors or traders.

2) Scalping

It is also known as micro-trading. Scalping and day-trading are both subsets of intraday
trading. Scalping involves reaping small profits repeatedly ranging from a dozen to a
hundred profits in a single market day.

However, every transaction does not yield profits, and in some cases a trader’s gross
losses might exceed the gains. The holding period of securities, in this case, is shorter
compared to day-trading, i.e. individuals hold stocks spanning a maximum of a few
minutes.

This feature allows for the frequency of transactions. Similar to day-trading, scalping
requires market experience, proficiency, awareness of market fluctuations, and prompt
transactions.

3) Swing Trading

This style of stock market trading is used to capitalise on the short-term stock trends and
patterns. Swing trading is used to earn gains from stock within a few days of purchasing
it; ideally one to seven days. Traders technically analyse the stocks to gauge the
movement patterns they are following for proper execution of their investment objectives.

4) Momentum Trading

In case of momentum trading, a trader exploits a stock’s momentum, i.e. a substantial

value movement of stock, either upwards or downwards. A trader tries to capitalise on
such momentum by identifying the stocks that are either breaking out or will break out.

Y Sugandha (Asst. Professor)

In case of upward momentum, the trader sells the stocks he/she is holding, thus yielding
higher than average returns. In case of downward movement, the trader purchases a
considerable volume of stocks to sell when its price increases.

Example:

Mr A holds 7000 shares of S Private Limited at Rs. 50 per share. On 1st April 2019, he sees
the NAV of such shares showing upward momentum. He decides to sell 3000 shares at
Rs. 60 on the first day. After that, He sells the remaining shares at a uniform rate of Rs.
65.

Therefore, his overall profit from the transactions is –

Rs. {(3000 * 60) + (4000 * 65)} – (7000 * 50) or, Rs. 90,000

5) Position Trading

Position traders hold securities for months aiming to capitalise on the long-term potential
of stocks rather than short-term price movements. This style of trade is ideal for
individuals who are not market professionals or regular participants of the market.

Settlement

The process of determining the number of shares that the seller owes and the sum of
money that the buyer owes for each deal is known as Clearing. It also establishes each
party's commitment and evaluates risk.

Further, Settlement is the procedure through which the shares are transferred from the
seller's account to the buyer's account, and the funds are transferred from the buyer to
the seller. These two processes are carried out on T+1 Day.

This is the core clearing and settlement process in a stock exchange. T+1 denotes that
trade-related settlements must be made one day after the conclusion of the transaction.

Entities Involved in the Clearing and Settlement Process

• Depository

While traditionally shares were held in a physical certificate format, today it is mandatory
to hold them in the electronic or dematerialized form. Hence, a DEMAT Account is
mandatory for share transactions. SEBI has created a structure to ensure optimum
performance and maximum control over DEMAT Accounts by creating Depositories –
entities that hold your DEMAT Accounts.

All participants including investors, brokers, and clearing members need to have a
DEMAT Account to trade in the stock exchange.

• Clearing Corporation

Y Sugandha (Asst. Professor)

This is an entity associated with a stock exchange that handles the confirmation,
settlement, and delivery of shares. It acts as a buyer for the seller and a seller for the
buyer. In simpler terms, it facilitates purchase on one end of the transaction and sale on
the other.

It ensures that the settlement cycles are short and consistent while keeping the
transaction risks in check and providing a counter-party risk guarantee.

• Clearing Members and Custodians

The clearing corporation fulfills its role by transferring every trade to a clearing member
or custodian. Their core responsibility is ensuring that the funds and shares are available
on T+1 Day.

They need to have a clearing pool DEMAT Account with a depository for receiving and
sending shares pertaining to the trade.

• Clearing Banks

Since there is a movement of money, SEBI has created a list of 13 clearing banks that aid
in the settlement of funds. Every clearing member must open a clearing account with one
of these banks. If the clearing member is settling a purchase transaction, then it needs to
ensure that the funds are made available in this account before the settlement.

On the other hand, if it is settling a sale transaction, then the funds are received by the
clearing member in the clearing account. Almost all the banks do this clearly including
HDFC Bank, ICICI Bank, SBI, and Axis Bank.

risk management

Managing risks in the stock market is really important. The stock market can be very
unpredictable, and there are many things that can cause problems, like how the market
is doing, the economy, how companies are doing, and even things happening around the
world. That’s why it’s crucial for people who invest in the stock market to have a clear plan
for dealing with these risks. This plan, called risk management, can help them avoid
losing too much money and make the most of their investments.

By using risk management techniques, investors can make smart decisions about where
to put their money and reduce the negative eXects of the stock market going up and
down.

What Is Risk Management In Stock Market ?

Risk management is a fundamental process that plays a crucial role in the realm of stock
market investment. Its purpose is to systematically identify, evaluate, and address
potential risks, thereby safeguarding investment portfolios from unforeseen downturns
and optimising returns.

Y Sugandha (Asst. Professor)

The risk management in stock market process encompasses several key steps:

1. Risk Identification: The initial phase involves an exhaustive examination to pinpoint

potential risks that could impact an investment portfolio. This is accomplished through
various means, including historical data analysis, market research, and expert insights.

2. Risk Assessment: Once potential risks are identified, they undergo a rigorous
assessment. This assessment gauges their likelihood of occurrence and the magnitude
of their potential impact on the investment portfolio. It delves into the severity of the risk
and the probability of its materialisation.

3. Risk Evaluation: Following the assessment, risks are further evaluated based on their
priority and significance. This step determines which risks are of utmost concern and
demand immediate attention and mitigation.

4. Risk Treatment: The final stage of risk management is the implementation of strategies
to mitigate or avert the identified risks. This involves deploying various techniques such
as diversification, hedging, and active portfolio management.

How To Manage Risk In Stock Market – Strategies

1. Diversification: This strategy involves spreading investments across various asset

classes or securities to minimise the impact of market fluctuations on the portfolio.

2. Stop-Loss Orders: Stop-loss orders are used to automatically sell a stock if it reaches
a predetermined price level, limiting potential losses.

3. Hedging: Hedging entails using financial instruments like options or futures contracts
to oXset potential losses. For instance, purchasing put options can protect against stock
price declines.

4. Active Portfolio Management: This strategy involves continuous monitoring and

adjustments to the portfolio based on changing market conditions and data analysis to
make informed investment decisions.

5. Dollar-Cost Averaging: This method involves investing a consistent amount of money

at regular intervals, regardless of market conditions, which can leverage market volatility
to accumulate more shares when prices are low.

6. Fundamental Analysis: Fundamental analysis involves evaluating a company’s

intrinsic value by assessing its financial statements, industry trends, and other relevant
data to identify undervalued stocks with growth potential.

Basics of pricing mechanism

Pricing is determined by the supply and demand of the assets (shares, bonds, debentures
etc.)

Y Sugandha (Asst. Professor)

Player and stock exchange

Regulations of stock exchanges

The Supreme Court recently asked the Securities and Exchange Board of India (SEBI) and
the government to produce the existing regulatory framework to protect investors from
share market volatility.

The stock and securities market in India is regulated by four fundamental laws:

1. The Companies Act, 2013

2. The Securities and Exchange Board of India Act, 1992 (SEBI Act)

3. The Securities Contracts (Regulation) Act, 1956 (SCRA)

4. The Depositories Act, 1996.

Stock markets are components of a Free-Market economy because they enable

democratized access to investor trading and the exchange of capital.

A stock market is a place where shares of publicly traded corporations are exchanged. In
an initial public oXering (IPO), corporations sell shares to the general public on the
primary market to raise money

A stock exchange facilitates stock brokers to trade company stocks and other securities.
A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting
place of the stock buyers and sellers.

India’s premier stock exchanges are the Bombay Stock Exchange and the National Stock
Exchange.

In India, securities regulations have evolved in the face of two diverging trends.

Y Sugandha (Asst. Professor)

 • The first is a drive towards financial market liberalization, which comprises the
removal of financial repressive measures such as direct interest rate restrictions,
forced investment in government assets, administrative pricing of securities, and
so forth.

• Stronger regulation is the second driving force. As financial markets are

characterized by severe knowledge asymmetries that increase moral hazard and,
in extreme circumstances, result in market failure, thus a pressing need for tighter
regulation.

In summary, an unregulated market can entail high systemic risk.

Stock market regulations in India

The Indian stock markets are eXiciently regulated and tracked by The Securities and
Exchange Board of India (SEBI), The Reserve Bank of India, and the Ministry of Finance.
The Ministry of Finance operates via the Department of Economic AXairs (Capital Markets
Division).

The Ministry formulates rules and regulations required for the functioning of the capital
markets. It also develops laws necessary for safeguarding the interests of the investors
in the stock market.

Securities Contracts (Regulation) Act, 1956 (SCRA)

• SCRA is an Act of the Parliament of India enacted to prevent undesirable

exchanges in securities and to control the working of the stock exchange in India

• It provides the legal framework for the regulation of securities contracts in India.

• It also covers the listing and trading of securities, the registration and regulation of
stockbrokers and sub-brokers, and the prohibition of insider trading.

Securities and Exchange Board of India Act, 1992 (SEBI Act)

• The Capital Markets Division of the Department of Economic AXairs sees to the
administration of rules made within the bounds of the SEBI Act of 1992.

• This is the act that established the Securities and Exchange Board of India, or
SEBI, the main authorized regulatory body that regulates Indian stock exchanges.

• The key function of SEBI is to keep the interests of investors/traders protected.

• While trading in the Indian stock market, investors and traders have to execute
trades while abiding by rules, to promote fairness. SEBI monitors the rules.

Depositories Act, 1996

• The Depositories Act, of 1996 regulates the depositories of securities in India.

Y Sugandha (Asst. Professor)

 • It sets out the procedures for the dematerialization and transfer of securities held
in electronic form.

Companies Act, 2013

• This act regulates the incorporation of a company, responsibilities of a company,

directors, and dissolution of a company.

• The act enabled companies to be formed by registration, set out the

responsibilities of the companies, their executive director, and secretaries, and
also provided for the procedures for its winding.

• The amendment to the act was passed in 2020. Ministry of Corporate AXairs
governs this act.

• It also sets out the rules for the issue and transfer of securities by companies.

Role of SEBI in Stock Market Regulations

SEBI regulates Capital Markets through certain measures it takes.

• Protects the interests of traders and investors, thereby, promoting fairness in the
stock exchange.

• regulates how the security markets and stock exchanges function.

• regulates how transfer agents, stock brokers, merchant bankers, etc, function.

• handles the registration activity of new brokers, financial advisors, etc.

• encourages the formation of Self-regulatory Organizations.

• promotes investor learning opportunities.

• makes rules to prevent malpractice.

• manages and controls a ‘complaints’ division

• It regulates mutual funds, both government and private-sector-related.

SEBI can issue directions to those who are associated with the market and has powers to
regulate trading and settlement on stock exchanges.

SEBI has the power to carry out routine inspections of market intermediaries to ensure
compliance with prescribed standards. It also has investigation powers similar to that of
a civil court in terms of summoning persons and obtaining information relevant to its
inquiry.

Safeguards against fraud

Y Sugandha (Asst. Professor)

SEBI notified the Prohibition of Fraudulent and Unfair Trade Practices Regulations in 1995
and the Prohibition of Insider Trading Regulations in 1992 to prevent market manipulation
and insider trading.

• Insider Trading Regulations, 2015 prohibits insider trading in securities listed on

Indian stock exchanges. They prescribe the code of conduct for insiders, the
procedures for disclosures, and the penalties for violations.

Violations of these regulations are ground oXences that can lead to a deemed violation
of the Prevention of Money Laundering Act 2002.

Role of RBI in Stock Market Regulations

The Reserve Bank of India is responsible for regulating the financial activities of the Indian
economy.

• It monitors the capital market and keeps a close tab on the exchange rates.

• The monetary policy designed by the Reserve Bank of India aXects the equity
markets directly.

• It controls the interest rates, which, when lowered, reduces the cost of debt, and
the cost of equity is brought down consecutively.

Role of FIIs,

Foreign Institutional Investors in India greatly influence the Indian stock

market’s dynamics and have contributed immensely to the market's expansion and
advancement. An in-depth examination of FIIs' definition, regulatory environment,
significant determinants of their investment choices, and general significance in India's
financial system is provided in this piece, which also explores the FIIs' diverse eXects on
the country's economy.

What are Foreign Institutional Investors

A foreign institutional investor is someone who puts money into countries outside of their
home country. The Reserve Bank of India (RBI) sets investment limits to keep foreign
institutional investors from investing too much. The Securities and Exchange Board of
India (SEBI) oversees foreign institutional investments in the country.

India's Foreign Institutional Investors Types

In the Indian context, "FIIs" refers to trusts, pension funds, hedge funds, sovereign wealth
funds, international mutual funds, asset management firms, university funds, and
endowments. These groups bring diXerent kinds of money and skills to the Indian stock
market, generally making it more lively.

Regulatory Framework

Y Sugandha (Asst. Professor)

SEBI's regulatory supervision guarantees the appropriate operation and transparency of
Foreign Institutional Investors in India. The RBI establishes investment limitations to
avoid undue market impact and control potential dangers related to significant fund
withdrawals.

A look at the factors that a`ect FII investment decisions:

#1. US Dollar Strengthening:

Many FIIs' assets in developing nations like India have been liquidated due to the recent
strengthening of the US currency and the Federal Reserve's statement that interest rates
will rise by 2023. With this action, investment in US markets will have more liquidity.

#2. Tightening Liquidity and Rising Interest Rates:

FIIs expect stricter monetary policies as central banks, such as the US Federal Reserve
and the Bank of England, slash asset purchases and hike interest rates. This makes them
move money from risky assets, like those in growing countries, to safer markets that have
been around for a while.

#3. Inflation:

The third factor aXecting firm profitability is growing inflation, which central banks
address by raising interest rates. Due to the impact on values, this forces investors—
including FIIs—to reevaluate their holdings in developing economies.

India's FII Inflow Factors:

#1. Global liquidity and macroeconomic circumstances:

FII inflows into developing markets are mostly driven by global liquidity, which is
impacted by the central bank's reduction of short-term interest rates. Companies in
these marketplaces can better mobilise capital when it is easily accessible.

#2. Attractive Economic Conditions and Valuations:

The macroenvironment of developing countries, including robust economic conditions

and appealing values, draws foreign institutional investors. A bigger part of the FII's
financial stock is usually put into countries with strong economies and good values.

FPIs' E`ect on the Indian Stock Markets:

#1. Market Volatility:

FIIs are the primary contributors to stock market volatility. Their investment decisions can
cause fluctuations in the Indian capital market index. A healthy FII flow generally
increases the index, while a decrease in flow has the opposite eXect.

#2. Inflow in Market Instruments:

Y Sugandha (Asst. Professor)

FIIs bring significant funds into the Indian stock market, fostering financial innovation.
This influx of capital contributes to the development of hedging instruments and
improves overall market eXiciency.

#3. Capital Structure and Investment Gaps:

FIIs are crucial in enhancing capital structures and bridging investment gaps in the Indian
economy. Their investments contribute to a healthier inflow of equity capital, supporting
economic growth.

#4. Improvement in Corporate Governance:

By contributing their understanding of a firm's operations, financial analysts and asset

managers constituting FIIs play a role in improving corporate governance standards in
Indian companies.

The Balancing Act and Regulatory Limitations:

To maintain market stability, India, like many other developing countries, limits the total
value of assets and equity shares an FII can hold. For instance, the overall investment
ceiling in India is set at 24% of the paid-up capital for Indian companies and 20% for
public sector banks.

Are you ready to enhance your trading activities and capitalise on the immense potential
of the Indian stock market index?

Are we still dependent on FII flows? Ironically, we are.

Our market has experienced a significant transformation in 2023, a significant reduction

in FII holdings, and a surge in primary market activities. As of December 2023, FII holdings
stand at around 15% of the total market cap of US$4.33 trillion, making it one of the
lowest over a decade. Despite all of these, the market has reached an all-time high,
prompting whether we are decoupled from foreign flows. The surge in domestic retail and
institutional investments, which account for 36% of the market, suggests independence
from foreign influence.

In CY2021 and CY2022, the country saw FII amounts that were much smaller or negative.
FII flows were -16.5 billion USD in CY2022. On the other hand, FIIs have put $20 billion
into the market this year. This positive FII flow, which came after a very negative flow, has
been a big part of the rise in the Sensex and values. With this turn of foreign flows, there
would be more going on in both main markets than there is now.

FII flow dynamics are evolving, shifting towards more stable Foreign Direct Investment
(FDIs) rather than volatile portfolio investments. This transition contributes to long-term
stability rather than the short-term fluctuations associated with portfolio investments.
Looking ahead to CY2024, we can assume that foreign flows will continue, particularly in
the context of changing global interest rates. India has maintained a premium recipient

Y Sugandha (Asst. Professor)

status for foreign flows, ranking as the second-largest recipient in Asia in CY2023,
following Japan and surpassing other emerging markets like Brazil.

MFs and investment bankers

What Are Mutual Funds?

A mutual fund is a pool of money managed by a professional Fund Manager.

It is a trust that collects money from a number of investors who share a common
investment objective and invests the same in equities, bonds, money market instruments
and/or other securities. And the income / gains generated from this collective investment
is distributed proportionately amongst the investors after deducting applicable expenses
and levies, by calculating a scheme’s “Net Asset Value” or NAV. Simply put, the money
pooled in by a large number of investors is what makes up a Mutual Fund.

Here’s a simple way to understand the concept of a Mutual Fund Unit.

Let’s say that there is a box of 12 chocolates costing ₹40. Four friends decide to buy the
same, but they have only ₹10 each and the shopkeeper only sells by the box. So the
friends then decide to pool in ₹10 each and buy the box of 12 chocolates. Now based on
their contribution, they each receive 3 chocolates or 3 units, if equated with Mutual
Funds.
And how do you calculate the cost of one unit? Simply divide the total amount with
the total number of chocolates: 40/12 = 3.33.
So if you were to multiply the number of units (3) with the cost per unit (3.33), you get the
initial investment of ₹10.

This results in each friend being a unit holder in the box of chocolates that is collectively
owned by all of them, with each person being a part owner of the box.

Next, let us understand what is “Net Asset Value” or NAV. Just like an equity share has a
traded price, a mutual fund unit has Net Asset Value per Unit. The NAV is the combined
market value of the shares, bonds and securities held by a fund on any particular day (as
reduced by permitted expenses and charges). NAV per Unit represents the market value
of all the Units in a mutual fund scheme on a given day, net of all expenses and liabilities
plus income accrued, divided by the outstanding number of Units in the scheme.

Stock market indices calculation

The Sensex is an acronym for Sensitive Index and comprises of 30 large and well
established companies. It can be called a cross section of the market, as the companies
are chosen from various sectors. The Sensex is calculated using the free float market
capitalisation method. Free float refers to the shares that are free for trading. All shares
of a company are not free to be traded. Some may be government held, some may be in
the hands of promoters and others may be pledged. Thus, the Sensex represents the free
float market value of its 30 stocks relative to a base period.

Y Sugandha (Asst. Professor)

Now, let us understand the concept of market capitalisation. Market capitalisation is the
combined worth of all the stocks of the diXerent companies in the stock exchange. A
company’s market capitalisation is arrived at by the product of the price of one stock
and the total number of shares issued by the company.

Each company listed on the exchange also has to share free float information with the
exchange on a quarterly basis. The market capitalization is thus multiplied by the free
float factor to arrive at the free float market capitalization. The free float market
capitalization is divided by an index divisor to get the Sensex value, which can be tracked
using a stock market app. The value of the Sensex in the base year is used as a divisor.

Let’s understand this with an example

Suppose the Sensex has two companies A and B. Now, A has 500 shares, 300 of these
are free floating. The price of each share of A is Rs80. B has 1,000 shares, 700 are free
floating. The price of each share of B is Rs100. Market capitalisation of A = 40,000. Market
capitalisation of B = 100,000. Free float of A = 0.60 and free float of B = 0.70. Thus, total
free float market capital of the index = 40,000 x 0.60 + 100,000 x 0.70 = 94,000. Let’s
assume, the base year index was 5,000, so the value of the index will be 94,000 x
100/5,000 =1,880.

The Nifty calculation

Nifty is also calculated in the similar manner like that of the Sensex. Like the Sensex, a
mathematical formula is used to arrive at the calculation. Here is how it is calculated

Market Capitalisation = Equity Capital x Price

Free float market capitalisation = Equity Capital x Price x IWF (Investible Weight Factor, a
factor used to determine the number of shares that are tradeable)

Index Value = Current market value/ Base Market Value x Base Index Value (1000)

How do the Sensex and Nifty di`er?

It is evident from the above explanation that the Sensex and Nifty are calculated similarly.
However, it may be pointed out in this context, that the Nifty is slightly more broad based
as it comprises of 50 stocks. This is as compared to the Sensex that has 30 stocks.

Y Sugandha (Asst. Professor)