STOCK MARKET

UNIT-1

NATURE AND SCOPE OF STOCK MARKETS

Stock markets are a crucial component of the global financial system, offering a platform for
buying and selling shares of publicly traded companies. Their nature and scope encompass
several key aspects:

Nature of Stock Markets

1. Function as Financial Intermediaries: Stock markets facilitate the flow of capital

between investors and companies. They allow companies to raise funds by issuing
shares to the public, and provide investors with the opportunity to buy ownership stakes
in these companies.
2. Marketplace for Securities: Stock markets are essentially marketplaces where
securities, such as stocks, bonds, and derivatives, are bought and sold. They provide a
venue for transactions and price discovery.
3. Regulation and Oversight: Stock markets are regulated by governmental and
independent bodies to ensure fair trading practices, transparency, and investor
protection. In the U.S., for instance, the Securities and Exchange Commission (SEC)
plays a pivotal role.
4. Price Discovery: Prices of stocks and other securities are determined through supply
and demand dynamics in the market. This process of price discovery reflects the
collective sentiment of investors about a company's value.
5. Liquidity Provision: Stock markets provide liquidity, allowing investors to buy and sell
securities quickly and with relative ease. This liquidity helps ensure that prices remain
stable and reflects the true value of securities.
6. Risk Management: Through various financial instruments and derivatives, stock
markets offer mechanisms for managing financial risk. This includes hedging against
potential losses and speculating on price movements.

Scope of Stock Markets

1. Global Reach: Stock markets are global in scope, with major exchanges such as the
New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange (LSE), and
Tokyo Stock Exchange (TSE). Each country typically has its own stock exchange,
contributing to a diverse global market.
2. Variety of Instruments: Beyond equities (stocks), stock markets also deal in a wide
range of financial instruments including bonds, ETFs (exchange-traded funds), mutual
funds, options, and futures. Each of these serves different investment and risk
management purposes.
3. Economic Indicator: Stock markets are often seen as indicators of economic health.
Movements in stock indices, such as the S&P 500 or Dow Jones Industrial Average,
can reflect broader economic trends and investor sentiment.
4. Investment Opportunities: The scope of stock markets extends to providing various
investment opportunities for individuals, institutions, and governments. Investors can

1
 STOCK MARKET
diversify their portfolios, pursue growth, and generate income through dividends and
capital gains.
5. Technological Integration: Modern stock markets are heavily influenced by
technology. Electronic trading systems, algorithmic trading, and high-frequency trading
have transformed how securities are traded, making markets more efficient but also
introducing new types of risks.
6. Market Segments: Within stock markets, there are different segments catering to
various types of companies and investors. For example, there are primary markets for
new issues of securities and secondary markets for trading existing securities.
Additionally, there are different tiers or indices representing companies of varying sizes
and industries.
7. Economic and Social Impact: Stock markets play a significant role in economic
development by enabling companies to raise capital for expansion and innovation. They
also impact social factors, as the performance of stock markets can influence retirement
savings, employment, and overall economic well-being.

INTRODUCTION TO INVESTMENT

Investment refers to the allocation of resources, typically money, into various assets or
ventures with the expectation of generating a return or profit over time. It involves putting
capital to work in a way that aims to grow its value or generate income. Here’s a breakdown of
the key aspects of investment:

1. Basic Definition

 Capital Allocation: Investment involves using money to purchase assets or engage in

activities with the goal of increasing wealth.
 Expectation of Returns: The primary goal is to achieve a financial return, which could
be in the form of income (such as dividends or interest) or capital appreciation (an
increase in the asset's value).

2. Types of Investments

 Financial Investments: Includes buying stocks, bonds, mutual funds, ETFs, and other
financial instruments. These are traded on financial markets and are often chosen for
their potential to provide returns through dividends, interest, or price appreciation.
 Real Estate: Involves purchasing property with the expectation of earning rental income
or capital gains from selling the property at a higher price.
 Business Ventures: Investing in startups or existing businesses with the aim of
achieving profits through business growth and success.
 Commodities: Investing in physical goods like gold, oil, or agricultural products.
Commodities can be a hedge against inflation or market volatility.
 Collectibles and Alternative Investments: Includes art, antiques, rare coins, and
other tangible assets that can appreciate in value over time.

3. Investment Goals

2
 STOCK MARKET
 Growth: Increasing the value of the investment over time, often through capital gains or
appreciation. This is common with investments in stocks or real estate.
 Income: Generating a regular stream of income through dividends, interest, or rental
payments. Bonds and dividend-paying stocks are typical examples.
 Preservation of Capital: Protecting the initial amount invested from loss. This goal is
often pursued through low-risk investments like savings accounts or government bonds.
 Speculation: Taking higher risks with the hope of achieving significant returns. This is
common in trading or investing in volatile assets.

4. Investment Risks

 Market Risk: The possibility of losing money due to market fluctuations. This affects
stocks, real estate, and other market-dependent investments.
 Credit Risk: The risk that a borrower will default on a loan or bond, affecting
investments in bonds and other credit instruments.
 Liquidity Risk: The risk of not being able to sell an investment quickly without
significantly impacting its price. Real estate and certain collectibles can have higher
liquidity risks.
 Inflation Risk: The risk that inflation will erode the purchasing power of returns.
Investments that do not outpace inflation might lose value in real terms.

5. Investment Strategies

 Diversification: Spreading investments across various asset classes or sectors to

reduce risk. A well-diversified portfolio can help manage risk and improve returns.
 Asset Allocation: Deciding how to distribute investments among different asset
classes based on risk tolerance, investment goals, and time horizon.
 Active vs. Passive Investing: Active investing involves frequent trading to outperform
the market, while passive investing aims to match market returns by holding diversified
portfolios for the long term.

6. Investment Time Horizon

 Short-Term: Investments with a timeframe of less than 1-3 years, often with a focus on
liquidity and lower risk.
 Medium-Term: Investments held for 3-10 years, balancing between growth and
stability.
 Long-Term: Investments with a horizon of more than 10 years, typically focusing on
growth and higher risk tolerance.

NEED FOR INVESTMENT

Investment is crucial for various reasons, impacting both individuals and the broader economy.
Here’s a detailed look at why investment is needed:

For Individuals

3
 STOCK MARKET
1. Wealth Building: Investments provide a means to grow your wealth over time. By
putting money into assets that appreciate in value or generate income, individuals can
increase their financial resources and build a more secure future.
2. Retirement Planning: Investments are essential for building a retirement fund. Regular
contributions to retirement accounts, such as 401(k)s or IRAs, can help ensure a
comfortable and financially secure retirement.
3. Income Generation: Investments in dividend-paying stocks, bonds, or rental properties
can provide a steady stream of income, which can supplement earnings or support
financial goals.
4. Inflation Protection: Investing helps protect against inflation, which erodes the
purchasing power of cash over time. Assets like stocks, real estate, and commodities
can potentially outpace inflation and preserve wealth.
5. Achieving Financial Goals: Investments can help achieve specific financial goals,
such as buying a home, funding education, or starting a business. Planning and
investing strategically can make these long-term goals attainable.
6. Risk Management: Diversifying investments across different asset classes helps
manage and mitigate financial risk. By spreading investments, individuals can reduce
the impact of poor performance in any single asset.

For Businesses

1. Capital for Growth: Investments provide businesses with the necessary capital to
expand operations, develop new products, enter new markets, and enhance their
competitive position.
2. Innovation and Development: Investment in research and development (R&D) can
drive innovation, leading to new technologies, improved processes, and better products.
This is crucial for maintaining a competitive edge.
3. Operational Efficiency: Investing in technology, infrastructure, and human resources
can improve operational efficiency, reduce costs, and increase productivity.
4. Market Position: Strategic investments can help businesses gain a stronger market
position, capture market share, and achieve long-term success.
5. Risk Management: Businesses use investments to hedge against various risks, such
as fluctuations in commodity prices or currency exchange rates, through financial
instruments and diversification.

For the Economy

1. Economic Growth: Investments in infrastructure, technology, and businesses

contribute to overall economic growth by creating jobs, increasing productivity, and
fostering innovation.
2. Job Creation: Business investments lead to job creation, which boosts income levels
and consumer spending, further stimulating economic activity.
3. Infrastructure Development: Public and private investments in infrastructure—such as
roads, bridges, and utilities—are essential for supporting economic activities and
improving quality of life.
4. Improving Living Standards: Investments in sectors like healthcare, education, and
housing contribute to improved living standards and social well-being.

4
 STOCK MARKET
5. Encouraging Innovation: Investment in research and development drives
technological advancements and innovation, which can lead to new industries,
products, and services that benefit society as a whole.

For Society

1. Social Impact: Investments in community projects, social enterprises, and non-profit

organizations can address social issues, improve community well-being, and support
sustainable development goals.
2. Environmental Sustainability: Investments in renewable energy, green technologies,
and sustainable practices contribute to environmental protection and the fight against
climate change.
3. Cultural and Recreational Development: Investment in cultural and recreational
facilities, such as museums, parks, and sports venues, enriches society and enhances
quality of life.

SHORT TERM AND LONG TERM INVESTMENT

Short-term and long-term investments serve different purposes and come with their own set
of advantages and disadvantages. Here’s a comparative look at both:

Short-Term Investments

Advantages:

1. Liquidity: Short-term investments are generally more liquid, meaning they can be
quickly converted into cash with minimal loss of value. This is beneficial for meeting
immediate financial needs or taking advantage of opportunities.
2. Lower Risk of Market Fluctuations: Because short-term investments are held for a
shorter period, they are less exposed to long-term market volatility, which can reduce
the risk of large losses.
3. Flexibility: Investors can adjust their portfolios more frequently with short-term
investments, allowing them to respond to changing market conditions or personal
financial goals.
4. Easier to Monitor: The shorter time frame makes it easier to track performance and
make adjustments based on recent developments.

Disadvantages:

1. Lower Returns: Short-term investments typically offer lower returns compared to long-
term investments. This is due to the lower risk and the shorter time frame for potential
growth.
2. Higher Transaction Costs: Frequent buying and selling of short-term investments can
lead to higher transaction costs, which can erode returns.
3. Inflation Risk: Short-term investments may not always keep pace with inflation,
potentially diminishing the real value of returns over time.

5
 STOCK MARKET
4. Limited Growth Potential: The focus on short-term gains means missing out on the
compounding growth that long-term investments can provide.

Long-Term Investments

Advantages:

1. Higher Returns: Long-term investments generally offer higher returns due to the
benefits of compounding and the potential for significant appreciation over time.
2. Compounding Benefits: Reinvested earnings, such as dividends or interest, can
generate additional returns, leading to accelerated growth.
3. Tax Advantages: Many long-term investments benefit from favorable tax treatment,
such as lower capital gains tax rates or tax-deferred growth in retirement accounts.
4. Reduced Transaction Costs: Fewer transactions over time result in lower costs
compared to frequently trading short-term investments.
5. Resilience to Market Fluctuations: Long-term investments can weather market
volatility better, as they have more time to recover from downturns and benefit from
long-term growth trends.

Disadvantages:

1. Reduced Liquidity: Long-term investments are less liquid and may require significant
time or penalties to access funds, making them less suitable for urgent financial needs.
2. Market Risk: While they can recover from market fluctuations, long-term investments
are still subject to market risk and may experience significant downturns before they
rebound.
3. Less Flexibility: Long-term investments are less flexible, as investors are committed to
a specific strategy for a longer period, which can be a disadvantage if personal financial
needs or market conditions change.
4. Longer Time Horizon for Goals: Achieving financial goals with long-term investments
requires patience and discipline, as it may take years or decades to realize the full
benefits.

DEPOSITORIES
Depositories are institutions that hold securities such as stocks, bonds, and other financial
assets in electronic form, simplifying the process of trading, transferring, and managing these
assets. They play a crucial role in modern financial markets by ensuring efficient and secure
transactions. Here’s a detailed look at depositories, their functions, and their significance:

Functions of Depositories

1. Safekeeping of Securities: Depositories hold securities in electronic form, eliminating

the need for physical certificates. This reduces the risk of loss, theft, or damage
associated with physical securities.
2. Facilitating Transactions: Depositories facilitate the transfer of securities between
buyers and sellers. When a transaction occurs, the depository updates its records to
reflect the transfer, ensuring that the process is quick and accurate.

6
 STOCK MARKET
3. Settlement of Trades: Depositories play a central role in the settlement process of
trades. They ensure that the securities are delivered to the buyer’s account and that the
corresponding payment is made to the seller, thereby completing the transaction.
4. Record-Keeping: Depositories maintain detailed records of ownership, transactions,
and balances of securities. This provides transparency and helps in accurate and timely
settlement of trades.
5. Dividend and Interest Payments: Depositories facilitate the payment of dividends and
interest to investors. They ensure that these payments are credited to the appropriate
accounts based on the ownership records.
6. Corporate Actions: Depositories manage corporate actions such as stock splits, bonus
issues, and rights offerings. They ensure that such actions are executed smoothly and
that the changes are accurately reflected in the investors’ accounts.
7. Pledging and Borrowing: Depositories allow investors to pledge their securities as
collateral for loans or other financial transactions. This helps in leveraging investments
and managing liquidity.

Types of Depositories

1. Central Depositories: These are national institutions that operate at the country level.
Examples include:
o Depository Trust Company (DTC) in the United States
o Euroclear and Clearstream in Europe
o National Securities Depository Limited (NSDL) and Central Depository
Services Limited (CDSL) in India
2. Global Depositories: These operate on an international level, handling cross-border
securities transactions. Global Depository Receipts (GDRs) and American Depository
Receipts (ADRs) are examples of instruments facilitated by global depositories.

Advantages of Depositories

1. Enhanced Security: By holding securities in electronic form, depositories reduce the

risks associated with physical certificates, such as loss or theft.
2. Increased Efficiency: Electronic processing speeds up transactions, reducing the time
and cost involved in trading and transferring securities.
3. Simplified Management: Investors can manage their portfolios more easily through a
single electronic account, tracking holdings, transactions, and corporate actions in real-
time.
4. Reduced Errors: Electronic systems minimize manual errors and discrepancies,
leading to more accurate record-keeping and settlement processes.
5. Improved Liquidity: The efficiency and security provided by depositories enhance
market liquidity, making it easier to buy and sell securities.
6. Convenience: Depositories offer convenience through services such as automatic
dividend payments, electronic transfer of securities, and easy access to account
information.

Disadvantages of Depositories

7
 STOCK MARKET
1. Dependency on Technology: Depositories rely heavily on technology, and any system
failures or cybersecurity threats can impact their operations and the security of
investors’ assets.
2. Fees and Charges: Depositories may charge fees for their services, such as account
maintenance, transaction processing, and custody services. These fees can add up for
investors and institutions.
3. Complexity for New Investors: Understanding the depository system and its
processes can be complex for new investors, requiring them to familiarize themselves
with the workings of electronic securities management.

BUY BACK OF SHARES

Buyback of shares, also known as share repurchase, is a corporate action in which a

company buys back its own shares from the marketplace. This can be done through various
methods, and it has several implications for the company and its shareholders. Here’s an in-
depth look at the concept:

Reasons for Share Buybacks

1. Return of Capital to Shareholders: Companies might buy back shares as a way to

return excess capital to shareholders, particularly when they believe their shares are
undervalued or when there are no more attractive investment opportunities available.
2. Increase Earnings per Share (EPS): By reducing the number of shares outstanding,
buybacks can increase the EPS, which might make the company appear more
profitable on a per-share basis.
3. Improve Financial Ratios: Share buybacks can enhance financial metrics like return
on equity (ROE) and return on assets (ROA) by reducing the number of shares
outstanding, which can lead to higher returns on those metrics.
4. Support Share Price: Companies might buy back shares to support or boost their
share price, particularly if they believe the stock is undervalued or to counteract
downward pressure.
5. Utilize Excess Cash: Companies with excess cash and no immediate investment
opportunities may use buybacks as a way to invest in themselves and provide value to
shareholders.
6. Prevent Dilution: Buybacks can offset the dilution of shares caused by stock options or
convertible securities, helping to maintain shareholder value.

Methods of Share Buybacks

1. Open Market Repurchase: The company buys back shares on the open market
through a stock exchange, just like any other investor. This is the most common method
and provides flexibility in terms of the timing and price of repurchases.
2. Tender Offer: The company makes an offer to shareholders to buy back a specified
number of shares at a set price, usually at a premium to the current market price.
Shareholders can choose to tender (sell) their shares at the offered price.

8
 STOCK MARKET
3. Dutch Auction: The company specifies a range of prices at which it is willing to buy
back shares and asks shareholders to submit offers within that range. The company
then selects the lowest price at which it can buy back the desired number of shares.
4. Private Negotiations: The company may negotiate directly with large shareholders or
institutional investors to repurchase shares. This method can be more flexible and
tailored to specific needs.

Advantages of Share Buybacks

1. Increased Shareholder Value: By reducing the number of shares outstanding,

buybacks can increase the value of remaining shares and return value to shareholders.
2. Flexibility: Buybacks can be executed in various ways, providing companies with
flexibility in terms of timing and pricing.
3. Tax Efficiency: In some jurisdictions, capital gains from share price appreciation may
be taxed at a lower rate than dividend income, making buybacks a tax-efficient way to
return capital to shareholders.
4. Signaling Effect: A buyback can signal to the market that the company’s management
believes its shares are undervalued, which can positively impact investor sentiment and
share price.
5. Control Over Capital Structure: Buybacks allow companies to manage their capital
structure by adjusting the proportion of debt and equity.

Disadvantages of Share Buybacks

1. Opportunity Cost: Spending funds on buybacks may mean that the company forgoes
other investment opportunities that could potentially offer higher returns.
2. Impact on Financial Stability: Large-scale buybacks can strain a company’s financial
resources and impact its liquidity or financial stability, especially if financed through
debt.
3. Short-Term Focus: Buybacks may be perceived as a short-term strategy to boost
share prices rather than focusing on long-term growth and value creation.
4. Potential for Misuse: Companies might engage in buybacks to artificially inflate share
prices or meet earnings per share targets, which may not necessarily reflect the
company’s underlying performance.
5. Market Perception: Frequent buybacks can sometimes be viewed negatively if they
are seen as a sign that the company lacks growth opportunities or is unable to invest in
its core business.

TYPES OF INVESTORS
Investors come in various types, each with distinct goals, risk tolerance, investment strategies,
and preferences. Understanding the different types can help tailor investment approaches and
strategies to fit specific needs. Here’s an overview of the main types of investors:

1. Individual Investors

 Retail Investors: Individual investors who buy and sell securities for their personal
accounts. They typically invest in stocks, bonds, mutual funds, and other financial

9
 STOCK MARKET
instruments. Retail investors vary widely in their investment goals, risk tolerance, and
strategies.
 Accredited Investors: Individuals who meet specific income or net worth criteria set by
regulatory bodies (e.g., having a net worth over $1 million or earning over $200,000
annually). They often have access to private investment opportunities and sophisticated
financial products not available to general retail investors.
 Institutional Investors: Organizations that invest on behalf of others. They include:
o Pension Funds: Manage retirement funds for employees and invest in a
diversified portfolio to provide long-term returns.
o Endowments and Foundations: Manage funds for charitable organizations or
educational institutions to support their missions and operations.
o Insurance Companies: Invest premiums received from policyholders to ensure
they can meet future claims and obligations.

2. Professional Investors

 Hedge Funds: Investment funds that use various strategies, including leverage,
derivatives, and short selling, to achieve high returns. Hedge funds are typically open to
accredited or institutional investors and aim to deliver absolute returns regardless of
market conditions.
 Private Equity Investors: Invest in private companies (not publicly traded) or take
public companies private. They focus on long-term value creation through operational
improvements, strategic guidance, and eventual exits via sales or public offerings.
 Venture Capitalists: Provide capital to early-stage, high-growth potential startups in
exchange for equity. They play a crucial role in funding innovation and
entrepreneurship.

3. Types Based on Investment Strategy

 Value Investors: Seek undervalued stocks that they believe are trading below their
intrinsic value. They focus on fundamental analysis and long-term potential. Famous
value investors include Warren Buffett.
 Growth Investors: Look for companies with strong growth prospects, even if their
stocks appear expensive based on traditional valuation metrics. They prioritize revenue
and earnings growth over current valuation.
 Income Investors: Focus on investments that provide regular income, such as
dividend-paying stocks, bonds, and real estate investment trusts (REITs). They are
often interested in steady cash flow rather than capital appreciation.
 Index Investors: Invest in index funds or ETFs that track a specific market index (e.g.,
S&P 500). This strategy aims for broad market exposure and often involves passive
management with lower fees.
 Day Traders: Engage in buying and selling securities within the same trading day to
capitalize on short-term price movements. This approach requires significant time,
attention, and often high-frequency trading strategies.
 Swing Traders: Hold positions for several days to weeks, aiming to profit from short- to
medium-term price movements. They use technical analysis to identify entry and exit
points.

4. Behavioral Types

10
 STOCK MARKET
 Conservative Investors: Prefer low-risk investments and are typically more focused on
preserving capital than achieving high returns. They may invest in bonds, savings
accounts, or other low-risk assets.
 Aggressive Investors: Willing to take higher risks for the potential of higher returns.
They might invest heavily in stocks, startups, or other high-risk, high-reward
opportunities.
 Speculators: Engage in high-risk investments with the hope of substantial short-term
gains. They often use strategies such as options trading, leveraged investments, and
high-frequency trading.

5. Types Based on Time Horizon

 Short-Term Investors: Focus on investments with shorter time horizons, typically less
than a year. They might engage in trading or invest in assets like short-term bonds or
money market funds.
 Long-Term Investors: Invest with a longer time horizon, often several years or
decades. They are typically focused on growth and capital appreciation and may invest
in stocks, mutual funds, or retirement accounts.

CAPITAL MARKET
The capital market is a segment of the financial market where long-term securities are bought
and sold. It provides a platform for companies, governments, and other entities to raise funds
and for investors to invest in these entities' securities. The capital market is crucial for
economic growth and development as it facilitates the allocation of resources, funding of new
projects, and investment opportunities. Here’s an overview of the capital market:

Components of the Capital Market

1. Primary Market:
o Function: The primary market is where new securities are issued and sold for
the first time. It’s a way for companies to raise capital by issuing stocks or
bonds.
o Process: Companies can issue shares through an Initial Public Offering (IPO)
or bonds through a bond issuance. Investment banks often underwrite these
securities, helping to price and sell them to investors.
2. Secondary Market:
o Function: The secondary market is where previously issued securities are
bought and sold among investors. This market provides liquidity and allows
investors to adjust their portfolios.
o Examples: Stock exchanges like the New York Stock Exchange (NYSE) and
NASDAQ, as well as bond trading platforms.

Types of Securities Traded

1. Equities (Stocks):
o Represent ownership in a company. Shareholders may receive dividends and
have voting rights.

11
 STOCK MARKET
Common Stock: Provides ownership and voting rights but is last in line for
o
dividends and claims on assets.
o Preferred Stock: Provides fixed dividends and has a higher claim on assets
than common stock, but typically lacks voting rights.
2. Bonds:
o Represent debt obligations. Issuers pay interest to bondholders and return the
principal at maturity.
o Government Bonds: Issued by governments to fund public projects.
o Corporate Bonds: Issued by companies to raise capital for business expansion
or other needs.
o Municipal Bonds: Issued by local governments or municipalities.
3. Derivatives:
o Financial contracts whose value is derived from the value of an underlying asset
(e.g., stock options, futures contracts).
o Options: Give the holder the right, but not the obligation, to buy or sell an asset
at a specified price.
o Futures: Obligates the holder to buy or sell an asset at a predetermined price at
a future date.
4. Mutual Funds and ETFs (Exchange-Traded Funds):
o Mutual Funds: Pools of funds from multiple investors to invest in a diversified
portfolio of securities.
o ETFs: Similar to mutual funds but trade on stock exchanges like individual
stocks.

PARTICIPANTS OF CAPITAL MARKET

The capital market involves a diverse range of participants, each playing a unique role in the
functioning and efficiency of the market. Here's a detailed overview of the key participants in
the capital market:

1. Issuers

 Companies:
o Public Companies: Firms that issue stocks and bonds to the public to raise
capital for expansion, operations, or other business needs.
o Private Companies: May also issue private placements or equity to raise funds
but typically do so with a smaller group of investors.
 Governments:
o Federal Governments: Issue government bonds to fund public projects,
manage fiscal policy, or refinance existing debt.
o Municipal Governments: Issue municipal bonds to finance local infrastructure
projects such as schools, highways, and utilities.
 Municipalities: Local government entities that issue bonds (e.g., municipal bonds) to
fund community projects and services.

2. Investors

 Retail Investors:

12
 STOCK MARKET
o Individual Investors: Individuals who invest their personal funds in stocks,
bonds, mutual funds, and other securities. They might have varying levels of
investment knowledge and goals.
o Accredited Investors: Individuals who meet specific financial criteria (e.g., high
net worth or income) and have access to investment opportunities not available
to the general public, such as private equity or hedge funds.
 Institutional Investors:
o Pension Funds: Manage retirement savings for employees, investing in a
diversified portfolio to provide long-term returns.
o Mutual Funds: Pool funds from many investors to invest in a diversified portfolio
of securities, offering professional management.
o Insurance Companies: Invest premiums received from policyholders to meet
future claims and obligations, often in bonds and other fixed-income securities.
o Endowments and Foundations: Manage funds for non-profit organizations,
educational institutions, and charitable entities, aiming to support their missions
through investment returns.

3. Intermediaries

 Investment Banks:
o Underwriters: Assist companies and governments in issuing new securities,
setting prices, and selling them to investors.
o Advisors: Provide strategic advice on mergers, acquisitions, and capital raising.
 Brokers:
o Full-Service Brokers: Offer a range of services including investment advice,
research, and trading. They typically cater to individual investors and
institutional clients.
o Discount Brokers: Provide trading services with lower fees and fewer advisory
services, catering to more self-directed investors.
 Dealers:
o Market Makers: Facilitate trading by buying and selling securities, providing
liquidity and ensuring smoother market operations.
o Bond Dealers: Specialize in trading bonds and other fixed-income securities.
 Financial Advisors:
o Certified Financial Planners (CFPs): Offer comprehensive financial planning
and investment advice to individuals and families.
o Investment Advisors: Provide specific investment advice and portfolio
management services.

4. Regulators

 Securities and Exchange Commission (SEC) (U.S.):

o Oversees the securities industry, including stock exchanges, brokers, and
investment advisors, ensuring compliance with laws and protecting investors.
 Financial Conduct Authority (FCA) (U.K.):
o Regulates financial markets and firms in the UK, ensuring that markets operate
fairly and transparently.
 Other National Regulators:

13
 STOCK MARKET
o Each country typically has its own regulatory bodies to oversee capital markets
and enforce financial regulations (e.g., Australian Securities and Investments
Commission (ASIC), Securities and Exchange Board of India (SEBI)).

5. Exchanges and Clearing Houses

 Stock Exchanges:
o New York Stock Exchange (NYSE): One of the largest and oldest stock
exchanges in the world.
o NASDAQ: Known for its high-tech and growth-oriented companies.
o London Stock Exchange (LSE): Major global stock exchange based in the UK.
 Clearing Houses:
o Depository Trust & Clearing Corporation (DTCC): Provides clearing,
settlement, and information services for securities transactions in the U.S.
o European Central Counterparty (EuroCCP): Provides clearing services for
European securities transactions.
 Central Securities Depositories (CSDs):
o Euroclear: Offers securities settlement and safekeeping services in Europe.
o Central Depository Services Limited (CDSL): Provides electronic securities
services in India.

6. Rating Agencies

 Credit Rating Agencies:

o Moody’s, Standard & Poor’s (S&P), and Fitch Ratings: Assess the
creditworthiness of issuers and their securities, providing ratings that help
investors evaluate risk.

Functions and Importance

1. Capital Formation:
o Capital markets enable companies and governments to raise long-term funds for
expansion, development, and infrastructure projects, supporting economic
growth and development.
2. Price Discovery:
o The capital market helps determine the fair value of securities through supply
and demand dynamics. This price discovery mechanism reflects the collective
sentiment and valuation of the market.
3. Liquidity:
o Provides liquidity to investors by allowing them to buy and sell securities easily.
This liquidity is essential for efficient market functioning and investor confidence.
4. Risk Management:
o Allows investors to diversify their portfolios and manage risk through various
financial instruments and securities. Derivatives and other tools can also be
used for hedging and speculating.
5. Economic Indicator:
o The performance of the capital market can serve as an indicator of economic
health. Rising stock prices might signal economic growth, while falling prices
could indicate economic trouble.

14
 STOCK MARKET
6. Investment Opportunities:
o Offers a range of investment options for individuals, institutions, and
governments, catering to different risk profiles and investment goals.

MONEY MARKET
The money market is a crucial financial market segment where short-term borrowing and lending of
funds occur. It facilitates the smooth functioning of the economy by providing a platform for
participants to meet their immediate cash needs and manage liquidity. The participants in the
money market include governments, corporations, financial institutions, and individual investors.
Transactions in the money market typically involve highly liquid and low-risk instruments with
maturities of one year or less.

How Does The Money Market Work?

The money market operates through the interaction of various participants, including governments,
corporations, financial institutions, and individual investors. These participants engage in short-term
borrowing and lending to meet their immediate cash needs and manage liquidity. Here’s a
breakdown of how the money market works:

 Borrowers: Entities needing short-term funds, such as governments or corporations,

approach the money market to meet their immediate financial obligations. They issue
money market instruments to raise funds quickly. These instruments act as a form of
borrowing from investors.
 Money Market Instruments: Borrowers issue various instruments with varying maturities,
interest rates, and credit ratings. These instruments include Treasury bills, commercial
paper, certificates of deposit, and repurchase agreements. These instruments are highly
liquid and considered low risk.
 Investors: Investors with surplus funds seeking short-term investment opportunities turn to
the money market. They purchase money market instruments issued by borrowers. In
return, investors receive interest payments or discounts on the tools, which serve as their
returns on investment.
 Trading and Secondary Market: Money market instruments can be traded on the
secondary market, allowing investors to buy and sell them before maturity. This secondary
market enhances liquidity, as investors can access their funds before the instrument
matures.
 Money Market Funds: Money market funds pool investments from institutional and
individual investors and invest in a diversified portfolio of money market instruments. These
funds allow investors to indirectly participate in the money market while benefiting from
professional management.
 Regulatory Oversight: The money market operates within a regulated environment.
Regulatory bodies monitor and enforce rules and regulations to ensure transparency,
stability, and fair practices. This oversight helps maintain the integrity and reliability of the
money market.
WHO USES THE MONEY MARKET?

15
 STOCK MARKET
Various participants utilize the money market, including governments, corporations, financial
institutions, and individual investors. Let us look at each of these groups and their involvement in
the money market:

 Governments: Governments often play a significant role in the money market. They issue
money market instruments, such as Treasury bills, to finance their short-term funding
requirements. These instruments are considered highly secure, backed by the
government’s creditworthiness.
 Corporations: Large and tiny corporations utilize the money market to meet short-term
funding needs. They issue commercial paper, which represents unsecured promissory
notes, to raise funds for operational expenses, inventory management, or capital
investments.
 Financial Institutions: Banks and other financial institutions actively participate in the
money market. They use money market instruments to manage their liquidity and meet
regulatory requirements. Financial institutions also invest in money market instruments as a
source of income to ensure the stability of their cash positions.
 Individual Investors: Individual investors, including retail investors, also engage with the
money market. They can invest in money market instruments such as Treasury bills,
certificates of deposit, or money market funds offered by banks or investment firms. These
investments provide individuals with a safe and short-term avenue to park their surplus
funds or earn modest returns.
 Money Market Funds: These are investments that pool funds from individual and
institutional investors. Professional investment managers oversee managing these funds,
and they distribute the pooled funds among various money market instruments. Money
market funds provide investors with a convenient way to access the money market and
benefit from diversification.
 Central Banks: They play a crucial role in the money market by conducting monetary
policy operations. They use tools such as open market operations to buy or sell money
market instruments to manage the money supply, influence interest rates, and stabilize
financial markets.
FEATURES OF MONEY MARKET INSTRUMENTS

1. High Liquidity- One of the key features of these financial assets is high liquidity offered by
them. They generate fixed-income for the investor and short term maturity makes them
highly liquid. Owing to this characteristic money market instruments are considered as
close substitutes of money.

2. Secure Investment- These financial instruments are one of the most secure investment
avenues available in the market. Since issuers of money market instruments have a high
credit rating and the returns are fixed beforehand, the risk of losing your invested capital is
minuscule.

3. Fixed returns- Since money market instruments are offered at a discount to the face value,
the amount that the investor gets on maturity is decided in advance. This effectively helps
individuals in choosing the instrument which would suit their needs and investment horizon.

TYPES OF INSTRUMENTS TRADED IN THE MONEY MARKET

16
 STOCK MARKET
1. Treasury bills- are short term borrowing instruments issued by the Government of India.
These are the oldest money market instruments that are still in use. The Treasury bill does
not pay any interest, but are available at a discount of face value at the time of issue.
Treasury Bills can be classified in two ways i.e. based on maturity and bases on type.
These are the safest instruments as they are backed by a government guarantee. The rate
of return, also known as risk-free rate, is low for treasury bills like T-364, T-182 and so on,
as compared to all other instruments.

2. Commercial papers- commercial papers is an unsecured money market instruments

issued in the form of promissory note. It was introduced In India in 1990 with the objectives
of enabling corporate borrowers diversify their sources of short-term borrowing and to
provide an additional investment instrument to investors. Commercial paper is a money-
market security issued (sold) by large corporations to obtain funds to meet short-term debt
obligations and is backed only by an issuing bank or company’s promise to pay the face
value on the maturity date specified on the note.

3. Certificate of Deposit- A certificate of deposit (CD) is issued directly by a commercial

bank, but it can be purchased through brokerage firms. It comes with a maturity date
ranging from three months to five years and can be issued in any denomination. Most CDs
offer a fixed maturity date and interest rate, and they attract a penalty for withdrawing prior
to the time of maturity. Just like a bank’s checking account, a certificate of deposit is
insured by the Federal Deposit Insurance Corporation (FDIC).

4. Banker’s acceptance- a banker’s acceptance is a document that promises future payment

that is guaranteed by the commercial bank. It is considered to be a very safe investment
option and is widely used in foreign trade, bankers acceptance are time drafts which are
accepted and guaranteed by the banks and drawn on a deposit at the bank. The maturity
period of banker’s acceptance can range from 30 to 180 days.

5. Repurchase Agreements- Also known as repos or buybacks, Repurchase Agreements

are a formal agreement between two parties, where one party sells a security to another,
with the promise of buying it back at a later date from the buyer. It is also called a Sell-Buy
transaction. The seller buys the security at a predetermined time and amount which also
includes the interest rate at which the buyer agreed to buy the SECURITY.

FUNCTION OF MONEY MARKET

1. Provides funds– the money market provides short term funds for borrowing at a lower rate
of interest. The private and the public institutions can borrow money from the money
market to finance capital requirements and fund business growth through the system of
finance bills and commercial paper. The govt. can also borrow funds the money market by
issuing treasury bills. However, money market issues money market instruments like
commercial papers, treasury bills and so on and helps in development of trade, industry
and commerce within and outside India.

2. Central Bank Policies- The central bank is responsible for guiding the monetary policy of
a country and taking measures to ensure a healthy financial system. Through the money
market, the central bank can perform its policy-making function efficiently.

17
 STOCK MARKET
3. Helps government- the money market instruments helps the government raise money for
financing government projects for public welfare and infrastructure development. The govt.
can borrow short term funds by issuing treasury bills at low interest rates. On the other
hand, if the government were ton issue paper money or borrow short term funds by issuing
treasury bills at low interest rates. On the other hand, if the govt. were to issue paper
money or borrow from the central bank, it would lead to inflation in the economy.

4. Helps in Financial Mobility- the money market helps in financial mobility by enabling easy
transfer of funds from one sector to the other. Financial mobility is essential for the
development of industry and commerce in the economy.

5. Promote Liquidity and Safety- this is one of the most important functions of money
market, as it provides safety and liquidity of funds. It also encourages saving and
investments. These investments instruments have shorter maturity which means they can
readily be converted to cash. The money market instruments are issues by entities with
good credit score which a=makes them safe investment option.

6. Economy in use of cash- as the money market deals in near-money assets and not
proper money; it helps in economizing the use of cash. It provides a convenient and safe
way of transferring funds from one place to another, there by immensely helps commerce
and industry in India.

MONEY MARKETS VS. CAPITAL MARKETS:

In finance, two key market segments play distinct roles in facilitating the flow of funds and
supporting economic activities: the money market and the capital market. While both markets serve
essential functions, they differ regarding the types of securities traded, their investment horizons,
and the nature of participants. Let’s delve into the dissimilarities between money markets and
capital markets:

Key Differences:

 Securities: Money markets primarily deal with short-term debt instruments, while capital
markets involve long-term securities, including stocks and bonds.
 Maturity: Money market securities have short maturities of one year or less, whereas
capital market securities have longer maturities exceeding one year.
 Risk and Return: Money market instruments are generally lower risk and offer modest
returns, while capital market securities carry varying levels of risk and potential for higher
returns.
 Investment Horizon: Money market investments have a short-term focus, typically from
overnight to one year, whereas capital market investments have a longer-term horizon,
spanning several years or more.
 Participants: Money markets attract many participants, including governments, financial
institutions, corporations, individual investors, and mutual funds. Capital markets involve a
mix.
ADVANTAGES:

 Liquidity: Money market instruments are highly liquid, meaning they can be easily bought
or sold with minimal impact on market value. This allows investors to access their funds
quickly, providing flexibility and ease of cash management.

18
 STOCK MARKET
 Safety: Money market instruments are generally considered low risk. They frequently come
from respectable institutions like governments and reputable businesses, which lowers the
risk of default. This makes money market investments a relatively safe option for preserving
capital.
 Stable Returns: Money market instruments offer stable and predictable returns. They
typically provide interest payments or discounts at maturity, allowing investors to earn a
modest return on their investments. This makes money market investments suitable for
those seeking stability and capital preservation.
 Diversification: Money market instruments provide an opportunity for portfolio
diversification. Investing in various money market instruments with varying maturities and
issuers can spread their risk and reduce exposure to any single entity or maturity date.
 Short-Term Financing: For borrowers, money markets offer a convenient and efficient
source of short-term financing. Governments, corporations, and financial institutions can
issue money market instruments to raise funds quickly and meet their immediate cash flow
needs. This enables them to bridge temporary funding gaps and manage liquidity
effectively.
DISADVANTAGES:

 Lower Returns: While money market investments offer stability, they generally provide
lower returns than other investment options, such as stocks or long-term bonds. The
conservative nature of money market instruments translates to a lower potential for
significant capital appreciation or high yields.
 Inflation Risk: Money market investments may be susceptible to inflation risk. If the
interest rates on money market instruments fail to keep pace with inflation, the real value of
the investment can erode over time. This can impact the purchasing power of the investor’s
funds.
 Limited Growth Potential: Money market investments may not provide significant
opportunities for capital growth. These instruments primarily focus on capital preservation
and short-term liquidity management, making them less suitable for investors seeking
substantial growth or long-term wealth accumulation.
 Regulatory Changes: Money market investments can be subject to regulatory changes,
which may impact their performance and liquidity. Changes in regulations governing money
market funds or the issuers of money market instruments can introduce uncertainties and
affect the attractiveness of these investments.
 Market Conditions: Current market conditions, such as interest rate fluctuations and
market volatility, can have an impact on money market investments. Changes in interest
rates can affect the yields on money market instruments, potentially impacting returns for
investors.
 Limited Investment Options: Money markets provide a narrower range of investment
options than broader financial markets. Investors looking for more diverse investment
opportunities or higher potential returns may need to explore other financial market
segments.

PRIMARY MARKET

The primary market is a part of the capital market. It enables the government, companies, and
other institutions to raise additional funds through the sale of debt and equity-related securities.

19
 STOCK MARKET
For example, primary market securities can be notes, bills, government bonds, corporate
bonds, and stocks of companies.

FUNCTIONS OF THE PRIMARY MARKET

There are three entities involved in the functions of the primary market. It includes a company,
an investor, and an underwriter. Following are the functions of the primary market:
1. New Issue Offer
New issues are issues that have never been traded on other exchanges and are now offered
on a primary market. Setting up a new issue market entails a wide range of responsibilities. For
example, carefully assessing the project’s viability. Financial arrangements are formed for this
purpose and take into consideration promoters’ equity, liquidity ratio, debt-equity ratio, etc.
2. Underwriting
When launching a new issue, underwriting is crucial and necessary. If the firm is unable to sell
the required number of shares, underwriters are in charge of purchasing unsold shares in the
primary market. Financial institutions that take on the role of underwriters can receive
underwriting commissions. Investors analyse underwriters and decide if taking the risk of
investing in the issue is worthwhile. Also, it is quite possible that the underwriter buys the entire
IPO issue and subsequently sells it to the investors.
3. New Issue Distribution
Distribution is yet another very important function. To begin the distribution process, first, a new
prospectus is issued. Next, an announcement is made to invite the general public to subscribe
to the issue. Here, a detailed report of the company and the issue and information regarding
the underwrites is made available for investors to assess and analyse the issue.
.
TYPES OF PRIMARY MARKET ISSUES

1. Public issue
The public issue is one of the most common methods of issuing securities to the public. The
company enters the capital market to raise money from kinds of investors. Here, the securities
are offered for sale to new investors. The new investor becomes the shareholder of the issuing
company. This is called a public issue. The further classification of the public issue is –
2. Initial Public Offer
As the name suggests, it is a fresh issue of equity shares or convertible securities by an
unlisted company. These securities are traded previously or offered for sale to the general
public. After the process of listing, the company’s share is traded on the stock exchange. The
investor can buy and sell securities after listing in the secondary market.
3. Further Public Offer or Follow on Offer or FPO.
When a listed company on the stock exchange announces fresh issues of shares to the
general public. The listed company does this to raise additional funds.
4. Private placement
Private placements mean that when a company offers its securities to a small group of people.
The securities may be bonds, stocks, or other securities. The investors can be either individual
or institution or both.
Comparatively, private placements are more manageable to issue than an IPO. The regulatory
norms are significantly less. Also, it reduces cost and time. The private placement is suitable
for companies that are at early stages (like startups). The company may raise capital through
an investment bank or a hedge fund or ultra-high net worth individuals (HNIs)
5. Preferential issue

20
 STOCK MARKET
The preferential issue is one of the quickest methods for a company to raise capital for their
business. Here, both listed and unlisted companies can issue shares. Usually, these
companies issue shares to a particular group of investors.
It is important to note that the preferential issue is neither a public issue nor a rights issue. In
the preferential allotment, the preference shareholders receive dividends before the ordinary
shareholders receive it.
6. Qualified institutional placement.
Qualified institutional placement is another type of private placement. Here, the listed company
issues equity shares or debentures (partly or wholly convertible) or any other security not
including warrants. These securities are convertible in nature. Qualified institutional buyer (QIB)
purchases these securities.
QIBs are investors who have requisite financial knowledge and expertise to invest in the capital
market. Some of the QIBs are –

7. Rights issue
This is another type of issue in the primary market. Here, the company issues shares to its
existing shareholders by offering them to purchase more. The issue of securities is at a
predetermined price.
In a rights issue, the investors have a choice of buying shares at a discount price within a
specific period. It enhances the control of the existing shareholders of the company. It helps the
company to raise funds without any additional costs.
8. Bonus issue
When a company issues fully paid additional shares to its existing shareholders for free. The
company issues shares from its free reserves or securities premium account. These shares are
a gift for its current shareholders. However, the issuance of bonus shares does not require
fresh capital.

SECONDARY MARKET
A secondary market is a financial market where previously issued financial instruments are
traded. Investors trade in securities that have already been traded in primary market. Instead of
the original issuing identity, investors are freely involved in trading within the secondary
market.

Unlike the primary market, the original issuers of the securities do not participate in the
transactions of secondary market. Instead, the transactions take place between investors,
facilitated by intermediaries such as stock exchanges, brokerage firms, and investment
banks. Secondary markets provide liquidity to investors, allowing them to easily buy and sell
securities based on investing needs and objectives.

TYPES OF SECONDARY MARKETS

Following are the types of secondary markets based on trading mechanisms and the structure
of the market:

21
 STOCK MARKET
 Auction Market: In an auction market, buyers and sellers submit their bids and offers for
securities, and transactions are executed at a mutually agreed-upon price. This price is
typically determined through a process known as an auction, where the highest bid price is
matched with the lowest ask price. Auction markets are characterized by a centralized and
transparent price discovery process. New York Stock Exchange is a type of auction market.
 Dealer Market: In a dealer market, also known as the over-the-counter (OTC) market,
transactions are executed through a network of dealers who act as market makers. These
dealers quote, bid and ask prices for securities and stand ready to buy or sell them. Unlike
auction markets, dealer markets do not have a centralized location or a single price
discovery mechanism. Instead, trades are executed through a decentralized network of
dealers who maintain their own inventory of securities. The NASDAQ Stock Market and the
OTC Markets Group are examples of dealer markets.
 Stock Market: A secondary market where shares of publicly traded companies are bought
and sold. Stock markets can be further divided into large-cap, mid-cap, and small-cap
markets, based on the market capitalization of the listed companies.
 Bond Market: A secondary market where debt securities, such as government and
corporate bonds, are traded. Bond markets can be further classified into government bond
markets, municipal bond markets, and corporate bond markets, depending on the type of
issuer.
 Derivatives Market: A secondary market where financial instruments, such
as options, futures, and swaps, are traded. Derivatives markets can be further divided into
exchange-traded derivatives markets, which operate through centralized exchanges, and
over-the-counter derivatives markets, which operate through a network of dealers.
 Foreign Exchange Market: A secondary market where currencies are bought and sold.
The forex market is primarily an over-the-counter market, with transactions taking place
through a global network of banks, financial institutions, and other participants.

FUNCTIONS OF THE SECONDARY MARKET

The following functions are crucial in a secondary market:

 Liquidity: One of the primary functions of this market is to provide liquidity to investors. By
offering a marketplace for buying and selling securities, it allows investors to easily convert
their investments into cash whenever needed. This liquidity enables investors to manage
their investment portfolios more efficiently and reduces the risk of holding assets that cannot
be easily liquidated.
 Market Efficiency: Secondary markets contribute to the overall efficiency of financial
markets. By enabling the transfer of securities from less to more efficient investors, these
markets promote the optimal allocation of capital. Efficient secondary markets also ensure
that the prices of securities accurately reflect all available information, minimizing the
potential for arbitrage opportunities.
 Price Discovery: The secondary market is essential for determining the market price of
securities. Through the interaction of buyers and sellers, the perceived value of a security is
established based on its supply and demand. This price discovery mechanism helps
investors make informed decisions about their investments and reflects the overall health of
the financial market.

PARTICIPANTS IN THE SECONDARY MARKET

22
 STOCK MARKET
The following players compose a secondary market:

 Stock Exchanges: London Stock Exchange (LSE) and New York Stock Exchange (NYSE)
or types of organized marketplaces where securities are traded. They provide a transparent
and regulated platform for investors to trade securities and ensure that transactions are
executed according to established rules.
 Brokerage Firms: Brokerage firms act as intermediaries between buyers and sellers in the
secondary market. They facilitate transactions by executing trades on behalf of their clients
and may also provide additional services, such as investment advice or research. Brokerage
firms earn revenue through commissions on the trades they execute.
 Market Makers: Market makers are financial institutions that continuously offer to buy and
sell securities at specified prices, thereby ensuring liquidity in the market. By standing ready
to trade, market makers narrow the bid-ask spread and help maintain an orderly and efficient
market.
 Institutional and Retail Investors: Institutional investors, such as mutual funds, insurance
companies, pension funds, as well as retail investors, actively participate in the secondary
market. Their trading activities influence the supply and demand dynamics of the market and
contribute to price discovery.

ADVANTAGES OF SECONDARY MARKET TRANSACTIONS

Secondary market transactions offer several advantages for investors, issuers, and the overall
financial system. Here are some of the key advantages:
1. Liquidity
The secondary market provides liquidity for investors by allowing them to easily buy and sell
previously issued securities. This makes it easier for investors to adjust their portfolios in
response to changing market conditions and allows them to access cash, if needed, quickly.
2. Price discovery
The secondary market facilitates price discovery by allowing investors to trade securities based
on the supply and demand dynamics of the market. This helps to ensure that securities are
priced efficiently and that investors receive fair value for their investments.
3. Transparency
Secondary market transactions are often transparent, with information about the securities, the
issuers, and the trading volume readily available to investors. This helps to ensure that
investors are well-informed and can make informed decisions about their investments.
4. Risk transfer
The secondary market allows investors to transfer risk by buying and selling securities. For
example, an investor who owns a stock and is concerned about a potential market downturn
can sell the stock to another investor, thereby transferring the risk to the new owner.
5. Capital raising
It can also facilitate capital raising by allowing companies to issue new securities to raise funds
from investors. This can be done through follow-on offerings or secondary offerings.

6. Diversification:

23
 STOCK MARKET
It provides investors with a wide range of investment opportunities, which allows them to
diversify their portfolios and potentially earn higher returns.

DISADVANTAGES OF THE SECONDARY MARKET

While there are many advantages to the secondary market, there are also some potential
disadvantages that investors should be aware of.
1. Volatilit
The secondary market can be volatile, with prices of securities fluctuating rapidly in response to
changes in market conditions, investor sentiment, and other factors. This can create
uncertainty and make it difficult for investors to predict the value of their investments.
2. Market manipulation
The secondary market is vulnerable to market manipulation, such as insider trading or other
fraudulent activities, which can distort prices and harm investors.
3. Counterparty risk
In secondary market transactions, investors are exposed to counterparty risk, which is the risk
that the other party to the transaction will not fulfil their obligations. This can be particularly
problematic in over-the-counter (OTC) markets where there is no central clearinghouse to
guarantee trades.
4. Limited access
Some secondary markets may be limited to certain types of investors, such as accredited
investors or institutional investors, which can limit access for individual investors.

5. Regulatory risk
Secondary market transactions are subject to regulation by government authorities, and
changes in regulations can affect the functioning of the market and the value of securities.
6. Price discrepancies
The price of a security on the secondary market may not always accurately reflect its
underlying value or prospects, which can create discrepancies and misalignments between
market prices and fundamental values.

FUNCTIONS OF STOCK EXCHANGE

Following are some of the most important functions that are performed by stock exchange:

1. Role of an Economic Barometer: Stock exchange serves as an economic barometer

that is indicative of the state of the economy. It records all the major and minor changes
in the share prices. It is rightly said to be the pulse of the economy, which reflects the
state of the economy.
2. Valuation of Securities: Stock market helps in the valuation of securities based on the
factors of supply and demand. The securities offered by companies that are profitable
and growth-oriented tend to be valued higher. Valuation of securities helps creditors,
investors and government in performing their respective functions.

24
 STOCK MARKET
3. Transactional Safety: Transactional safety is ensured as the securities that are traded
in the stock exchange are listed, and the listing of securities is done after verifying the
company’s position. All companies listed have to adhere to the rules and regulations as
laid out by the governing body.
4. Contributor to Economic Growth: Stock exchange offers a platform for trading of
securities of the various companies. This process of trading involves continuous
disinvestment and reinvestment, which offers opportunities for capital formation and
subsequently, growth of the economy.
5. Making the public aware of equity investment: Stock exchange helps in providing
information about investing in equity markets and by rolling out new issues to
encourage people to invest in securities.
6. Offers scope for speculation: By permitting healthy speculation of the traded
securities, the stock exchange ensures demand and supply of securities and liquidity.
7. Facilitates liquidity: The most important role of the stock exchange is in ensuring a
ready platform for the sale and purchase of securities. This gives investors the
confidence that the existing investments can be converted into cash, or in other words,
stock exchange offers liquidity in terms of investment.
8. Better Capital Allocation: Profit-making companies will have their shares traded
actively, and so such companies are able to raise fresh capital from the equity market.
Stock market helps in better allocation of capital for the investors so that maximum
profit can be earned.
9. Encourages investment and savings: Stock market serves as an important source of
investment in various securities which offer greater returns. Investing in the stock
market makes for a better investment option than gold and silver.

FEATURES OF STOCK EXCHANGE:

 A market for securities- It is a wholesome market where securities of government,

corporate companies, semi-government companies are bought and sold.
 Second-hand securities- It associates with bonds, shares that have already been
announced by the company once previously.
 Regulate trade in securities- The exchange does not sell and buy bonds and shares
on its own account. The broker or exchange members do the trade on the company’s
behalf.
 Dealings only in registered securities- Only listed securities recorded in the
exchange office can be traded.
 Transaction- Only through authorised brokers and members the transaction for
securities can be made.
 Recognition- It requires to be recognised by the central government.
 Measuring device- It develops and indicates the growth and security of a business in
the index of a stock exchange.
 Operates as per rules– All the security dealings at the stock exchange are controlled
by exchange rules and regulations and SEBI guidelines.

HEDGERS
25
 STOCK MARKET
Hedging is a risk management technique used by traders in the foreign exchange market to
minimize potential losses. It entails opening opposing positions in different currency pairs to
counteract unfavorable price movements. The objective of hedging is to reduce exposure to
market fluctuations and volatility.
Traders achieve this by employing strategies such as utilizing derivatives like options or futures
contracts, or by trading correlated currency pairs. The primary aim of hedging is to protect
capital and promote stability amidst uncertain market conditions.

BASICS OF HEDGING

The basics of hedging can be summarized as follows:

● Risk management: hedging is primarily used as a risk management technique aimed at
minimizing potential losses within the foreign exchange market.
● Offset positions: Hedging in involves taking offsetting positions in different currency
pairs. For example, if a trader holds a long position in one currency pair, they may open a short
position in a correlated pair to mitigate risk.
● Protection against adverse price movements: Hedging serves the purpose of
safeguarding against unfavorable price movements. By maintaining opposing positions,
potential losses in one position can be counterbalanced by gains in the other, effectively
reducing the overall level of risk exposure.
● Hedging instruments: Traders can utilize various instruments to hedge, such as
derivatives like options or futures contracts. These instruments provide flexibility and enable
traders to manage risk more effectively.
● Correlation analysis: Hedging can also involve opening positions in correlated currency
pairs. By trading related pairs, changes in one pair's value can be offset by movements in the
other, providing a level of protection.
● Capital preservation: The ultimate goal of hedging is to safeguard capital and ensure
stability. By reducing risk, traders aim to maintain their trading capital and navigate uncertain
market conditions more effectively.
● Effective risk management: By hedging their positions, traders can better manage risk
exposure and maintain a more controlled approach to their trading activities.
● Protection against unexpected events: Hedging provides protection against unexpected
events such as economic or political crises, ensuring stability in the face of uncertainty.

HOW A HEDGE WORKS

A hedge works through a combination of actions and strategies aimed at mitigating currency
risk. Here's how it functions:
● Identifying the risk: Traders analyze their exposure to currency fluctuations and assess
potential losses.
● Selecting a hedging instrument: Various tools like forward contracts, options, or futures
are considered based on the trader's specific requirements and market conditions.
● Opening opposing positions: Traders take positions that offset the risk of adverse
currency movements, effectively reducing exposure to volatility.

26
 STOCK MARKET
● Locking in exchange rates: By utilizing hedging instruments, traders can establish
predetermined exchange rates for future transactions, shielding themselves from unfavorable
rate fluctuations.
● Balancing the portfolio: Hedging allows for diversification and risk management by
balancing positions and investments across different currency pairs.
● Stabilizing profits: hedges aim to protect profits by minimizing losses caused by adverse
currency movements, providing a level of stability in an unpredictable market.
● Monitoring and adjusting: Traders regularly assess the effectiveness of their hedges and
make necessary adjustments based on market conditions and risk appetite.
By undertaking strategic measures, hedging empowers traders to navigate currency markets
with heightened confidence and control. This risk management strategy effectively mitigates
potential losses, offering a shield against adverse market conditions.

ADVANTAGES OF HEDGING

● Risk mitigation: Hedging in empowers traders to protect their positions from adverse
market movements, effectively reducing the potential for significant losses.
● Capital preservation: Hedging plays a pivotal role in preserving capital by effectively
mitigating the impact of market fluctuations. This risk management strategy offers a crucial
layer of security, shielding against potential downturns in the market.
● Enhanced flexibility: Hedging strategies offer traders the flexibility to adapt to changing
market conditions. They can adjust their positions or hedge different currency pairs based on
market trends.
● Increased trading opportunities: Hedging allows traders to explore more trading
opportunities without the fear of excessive risk. It enables them to take advantage of both
upward and downward market movements.
● Portfolio diversification: Hedging helps diversify a trader's portfolio by offsetting risks in
different currency pairs. This diversification reduces the overall Svulnerability of the portfolio to
a single currency or market.

DISADVANTAGES OF HEDGING

While hedging offers benefits, it also comes with certain disadvantages that traders should be
aware of. These disadvantages include:
● Reduced profit potential: Hedging is primarily focused on risk management, which
means that while it limits losses, it also limits potential profits. The hedging positions may offset
each other, resulting in limited gains.
● Increased complexity: Implementing hedging strategies can be complex and require a
thorough understanding of market dynamics. It may involve using derivatives or correlating
currency pairs, which adds complexity to the trading process.
● Costs and fees: Hedging often involves using derivative instruments such as options or
futures contracts, which may incur additional costs, including fees and commissions. These
expenses can eat into potential profits.
● Psychological impact: Constantly monitoring and managing multiple positions can be
mentally demanding and may create stress or confusion for traders. The added complexity can
impact decision-making and lead to emotional trading.

27
 STOCK MARKET
● Potential over-reliance on hedging: Over-reliance on hedging strategies may lead
traders to neglect other essential aspects of trading, such as technical analysis or fundamental
research. This tunnel vision can limit overall trading performance.

ARBITRATORS
Arbitrators involves settling a legal dispute without going to trial. Going to trial can be expensive
and time-consuming, meaning Arbitrators can be advantageous to many people.

During Arbitrators, a third party listens to both sides of a legal disagreement. With the
documents provided and the oral statements of each person involved, the arbitrator will issue a
resolution. Witnesses will sometimes be called in to provide an oral statement.

Arbitrators can be a great way to avoid legal costs, but careful consideration is required to
determine whether or not Arbitrators is useful for a specific legal case.

TYPES OF ARBITRATON

Arbitrators is most commonly used in the following scenarios:

 Labor disputes
 Business/consumer disputes
 Family law matters

Once an arbitrator has made their decision, the legal outcome is final and cannot be appealed.
Many contracts have a specific Arbitrators clause, meaning that Arbitrators is a requirement.

ADVANTAGES OF ARBITRATORS

There are many advantages to Arbitrators:

 Fairness: Both parties agree to the arbitrator, resulting in a fair outcome, especially
when compared to a traditional legal trial in which neither party has control over the jury
or judge selection. Parties can also agree to choose an arbitrator that has experience in
their specific area of legal dispute.
 Timeliness: A legal resolution through Arbitrators is much quicker than waiting for a
trial date. Arbitrators is less formal and more flexible in terms of scheduling. The
discovery process is a simple phone call, cutting down on much of the traditional trial
process.
 Cost: Arbitrators does not include expert witnesses or require as much legal
preparation. Both parties often split the cost of the arbitrator, meaning the process is
much cheaper.
 Confidentiality: The Arbitrators legal process is more private than a trial.
 Finality: There is a level of finality to the Arbitrators process. Because it cannot be
appealed, both parties can move on following the outcome.
 Agreeableness: Arbitrators often results in an agreeable outcome, as parties are
encouraged to come up with a solution together.
 Simplified Procedures: Legal outcomes are more adaptable to the two parties present
in the dispute. Each party does not have to hire an attorney for representation.

28
 STOCK MARKET
DISADVANTAGES OF ARBITRATORS

There are also some disadvantages of Arbitrators to consider:

 No Appeals: The Arbitrators decision is final. There is no formal appeals process

available. Even if one party feels that the outcome was unfair, unjust, or biased, they
cannot appeal it.
 Cost: While Arbitrators is generally a more cost-efficient legal settlement option, it might
not make sense in cases when minimal money is involved.
 Rules of Evidence: A judge in a traditional court setting has specific regulations to
follow when it comes to accepting evidence. Arbitrators, however, can utilize any
information that is brought to them.
 Lack of Cross-Examination: The Arbitrators process generally includes documents
and not witnesses, voiding the ability to cross-examine.
 Limited Discovery: In the event that Arbitrators is not filed until litigation has already
begun, both parties lose the cost-saving advantage of limited discovery.
 Lack of Consistency: There are no set standards for Arbitrators, making it difficult to
find consistency. It is possible that an arbitrator can be biased, which is sometimes
the case in mandatory Arbitrators contracts.
 Lack of Evidence: Because Arbitrators is not evidence-based, you entrust the
experience of the arbitrator to make the right legal decision.
 Not Public: The level of confidentiality involved in Arbitrators cases could potentially be
disadvantageous to one party. There is also a lack of transparency, which is not the
case in public courtrooms.

SPECULATOR
A speculator investor is an individual or an institution known to frequently handle financial
positions and financial assets with the expectation of making short-term profits from the change
in the price of the investment or purchased assets. They can expect to receive significant or
substantial gains due to the high risk they usually undertake.

Types of Speculators

As you might have already guessed, even the types of speculators differ in terms of the
investments made and the pattern of purchasing or selling assets. They are as follows:

1. Bull Speculator

People who are bull speculators anticipate an increase in the asset’s price. As a result, they will
purchase it to sell it for more money. Bulls stay optimistic about their investment because they
believe that the asset value will increase over time.

2. Bear Speculator

Bears can be known to be the opposite of the first category of speculative individuals we
discussed, the bulls. They invest in the asset price drop as they anticipate it to happen. Bear

29
 STOCK MARKET
speculators benefit by selling a stock when the price is high and then repurchasing it at a lower
price later.

3. Lame Duck

A lame-duck investor and speculator finds themselves in an unforeseen circumstance. These

traders experience unexpected losses due to failure to develop a successful trading strategy.
The phrase can also refer to bulls, although it’s typically used to signify a bear that can’t keep
up his half of the bargain.

4. Stag

Stags are distinct types of financial speculators that anticipate making money from very brief
price movements in the stocks of new companies. Stags tend to be more cautious about profit
and risk analysis than the other people on this list. Instead, they bet on reaping gains when the
asset’s value rises due to increased demand.

EXAMPLES OF SPECULATION
Some of the examples where speculations can be helpful to individuals are as follows:

1. The Speculator in Stock Exchange

Speculative stocks generally refer to those stocks that are characterised by a high level of risk
in the market. When purchasing and selling these stocks, a stock market speculator makes
their decision based on the anticipation of gain or loss in a market by the increase or decline of
stock prices, and if their speculations turn out to be correct, they make a profit.

2. Foreign Exchange Speculations

The foreign exchange rates for currencies are constantly changing in the dynamic market.
Since many currency pairs can be bought and sold, currency speculators frequently trade
money in hopes of earning profit from the changing market.

3. Commodity Market Speculation

Trading in the commodity market is more widespread as compared to stocks or foreign

currencies. The various options available for speculator trading make this market more
prevalent among those who wish to participate in the purchase and sale of assets in the
commodity market.

What is the Difference Between an Investor and Speculator?

Refer to the table below to understand the difference between speculator and investor:

Speculator Investor

30
 STOCK MARKET

Known to take on additional risks Takes risk, but it is less as compared to

speculative individuals

They often participate in the highly volatile They are more concerned with the long-
markets term growth of an asset

They aim to get returns in the shortest They mainly try to seize assets that can
possible time provide slow but steady returns

They are not generally concerned with the They are generally involved in
long-term growth of their purchased businesses and invest in companies
assets

They trade assets in the financial markets They study the long-term growth of the
company before making investment
decisions

How Do Speculators Impact the Market?

Besides looking at their profits and income, speculators are also known to have a significant
impact on the market itself based on their purchase patterns and decisions to buy and sell
assets. There are two powerful ways by which they affect the market, Liquidity and Volatility.
We shall discuss both below:

1. Liquidity

The availability of liquidity is one of the most critical factors that keep these financial markets
growing. Liquidity basically refers to the ability to buy and sell assets on the market. Financial
markets like the stock market have high liquidity, whereas commodities and the forex market
are less liquefiable. This is why making large purchases and sales can drastically alter the
market’s prices.

2. Volatility

When the price of commodities or assets changes for the better or worse, a trader will often
play in the position that is the opposite, usually in the hopes of bringing a balance to the
market, big enough investments can bring about changes in the market that can positively or
negatively affect volatility.

ADVANTAGES OF SPECULATOR
Speculating can often be great for institutions or individuals who are ready to take risks and
earn enormous amounts of profit. Some of its advantages are as follows:

31
 STOCK MARKET
1. Increased Liquidity

Speculators aggressively trade, which drives money into the marketplaces where they are
involved. Nobody wants to perform any transaction in a market that is not active. Due to the
amount of money that is being driven in and out of the markets by speculations, the liquidity of
the market increases with the increase of transactions.

2. Ability to Take Risks

Speculators investors are frequently a reliable source of finance for businesses since they are
more willing to take on risks.

3. Improved Economy

Speculations benefit not only individuals but also the economy as a whole. This is because
speculations provide businesses with the critical finances they need for regular functioning.
This generally leads to better funding for companies, thereby improving the economy’s
condition.

DISADVANTAGES SPECULATOR
Like everything else, speculation is also a topic with disadvantages. They are as follows:

1. High Risk

High risk does generate high rewards. However, it can also bring about the downfall of a
company or an individual. Speculator examples must have an idea of how to go about the
market, or they will incur huge losses.

2. Rapid Escalation of Prices

Stock market speculators generally bid on assets at unreasonable prices. This can lead to the
market being volatile at an unhealthy rate, thereby having long-term effects on the investments
and the market itself.

32
 STOCK MARKET

33
 STOCK MARKET

UNIT-2

TYPES OF EQITY SHARES AND DEBENTURES

AND PREFERENCE SHARE
Equity shares, debentures, and preference shares are fundamental components of a
company's capital structure. Each type of security has distinct characteristics and
serves different purposes in the financial ecosystem. Here's a detailed breakdown:

Equity Shares

Equity shares (also known as common shares or common stock) represent ownership
in a company. Shareholders have voting rights and may receive dividends, but they are
last in line for claims on assets in the event of liquidation. Equity shares can be
classified into various types:

1. Ordinary Shares:
o Features: Represent basic ownership in a company. Shareholders have voting
rights and can participate in company decisions.
o Dividends: Dividends are paid out of the company's profits and are not
guaranteed. They vary based on the company’s performance.
o Risks: Shareholders face the highest risk as they are last in line during
liquidation.
2. Differential Voting Shares:
o Features: Provide shareholders with different voting rights compared to ordinary
shares. They might offer multiple votes per share or fewer votes.
o Purpose: Often issued to founders or key management to retain control while
raising capital.
3. Redeemable Shares:
o Features: Shares that the company can buy back at a predetermined price and
time. They may be redeemed at the option of the company or the shareholder.
o Purpose: Allows companies flexibility in managing their capital structure.
4. Non-Voting Shares:
o Features: Shares that do not provide voting rights. They typically have the same
financial rights as ordinary shares but lack the ability to vote on company
matters.

Preference Shares

Preference shares (or preferred stock) offer a hybrid form of equity that combines
features of both equity and debt. They have priority over common shares in receiving
dividends and in the event of liquidation, but generally do not have voting rights.

1. Cumulative Preference Shares:

34
 STOCK MARKET
o Features: Accumulate unpaid dividends from previous years. If a company skips
a dividend payment, it must make up for it before paying dividends on ordinary
shares.
o Benefit: Provides more security for dividend payments.
2. Non-Cumulative Preference Shares:
o Features: Dividends do not accumulate if missed. Shareholders are only
entitled to dividends declared in the current year.
o Risk: Less secure compared to cumulative preference shares.
3. Participating Preference Shares:
o Features: Allow shareholders to receive additional dividends beyond the fixed
rate if the company performs exceptionally well.
o Benefit: Provides the potential for higher returns in profitable years.
4. Convertible Preference Shares:
o Features: Can be converted into a specified number of equity shares at the
option of the shareholder or upon certain conditions.
o Benefit: Offers potential for capital appreciation.
5. Redeemable Preference Shares:
o Features: The company has the option to buy back the shares at a specified
time and price.
o Purpose: Provides flexibility for the company to manage its capital.
6. Adjustable-Rate Preference Shares:
o Features: Dividends are adjusted periodically based on changes in interest
rates or other benchmarks.
o Benefit: Provides protection against interest rate fluctuations.

Debentures

Debentures are a type of debt instrument used by companies to borrow funds. They
are typically issued for a fixed term and pay interest to holders.

1. Secured Debentures:
o Features: Backed by collateral or assets. In the event of default, debenture
holders have a claim on the secured assets.
o Benefit: Lower risk compared to unsecured debentures due to the presence of
collateral.
2. Unsecured Debentures:
o Features: Not backed by specific assets. They are based on the
creditworthiness of the issuer.
o Risk: Higher risk compared to secured debentures, as they do not have
collateral backing.
3. Convertible Debentures:
o Features: Can be converted into a predetermined number of equity shares at
the option of the debenture holder or based on specific terms.
o Benefit: Offers potential for capital appreciation.
4. Non-Convertible Debentures:
o Features: Cannot be converted into equity shares. They remain a debt
instrument throughout their term.
o Benefit: Provides fixed interest returns without the option to convert.

35
 STOCK MARKET
5. Redeemable Debentures:
o Features: The issuer has the option to repay the principal before the maturity
date at a predetermined price.
o Purpose: Provides flexibility for the issuer to manage its debt.
6. Perpetual Debentures:
o Features: Do not have a fixed maturity date. They pay interest indefinitely.
o Benefit: Provides long-term capital for the issuer, but investors may face
uncertainty regarding the return of principal.

Summary

 Equity Shares: Represent ownership in a company, with various types including

ordinary, differential voting, redeemable, and non-voting shares.
 Preference Shares: Provide fixed income and priority over common shares for
dividends and in liquidation, with types including cumulative, non-cumulative,
participating, convertible, redeemable, and adjustable-rate shares.
 Debentures: Debt instruments with different features, including secured, unsecured,
convertible, non-convertible, redeemable, and perpetual debentures.

MUTUAL FUNDS

Mutual funds are basically investment vehicles that comprise the capital of different investors
who share a mutual financial goal. A fund manager manages the pool of money that is
collected from various investors and invests the money into a variety of investment options
such as company stocks, bonds, and shares. Mutual funds in India are regulated by the
Securities and Exchange Board of India (SEBI), and investing in mutual funds is considered to
be the easiest way through which you can increase your wealth.

TYPES OF MUTUAL FUND

Mutual funds in India are classified into different categories based on certain characteristics
such as asset class, structure, investment objectives, and risk. Here, we will help you
understand in detail the various categories and the kinds of funds under each category.
Based on Asset Class
1. Equity Funds
Equity funds make investments mainly in stocks of companies. Equity funds are the
most preferred investment options among the majority of investors as these offer high
returns and quick growth.
2. Debt Funds
Debt funds chiefly invest in low-risk fixed-income instruments such as government
securities. Since these funds come with a fixed maturity date and interest rate these
are ideal for investors with low-risk appetite.
3. Money Market Funds

36
 STOCK MARKET
Money market funds invest in easily accessible cash and cash equivalent securities
and offer returns as regular dividends. These funds come with relatively lower risk
and are ideal for short term investment.
4. Hybrid or Balanced Funds
Balanced or hybrid funds invest a certain amount of their corpus into equity funds and
the rest in debt funds. Though the risk involved with these funds is relatively high, the
generated returns are equally high.
Based on Structure
1. Open-ended Mutual Funds
Open-ended mutual funds have no constraints as far as the number of units that can
be traded or the time period is concerned. Investors are allowed to trade and exit
from the funds at their own convenience.
2. Closed-ended Mutual Funds
The unit capital that is to be invested in closed-ended mutual funds is fixed and
therefore, it is not possible to sell more than the predetermined number of units. The
maturity tenure of the scheme is fixed.
3. Interval Funds
Interval funds can be bought/exited only at specific intervals as determined by the
company. These are open for investment for a certain period of time only. Usually,
the investors need to stay invested for at least 2 years.
Based on Investment Objectives
1. Growth Funds
Growth funds invest a large portion of their capital into stocks of companies having
above-average growth. The returns offered by these funds are relatively high, but the
risk involved along with is also quite high.
2. Income Funds
The corpus of income funds is invested in a combination of high dividend generating
stocks and government securities. These funds focus to offer regular income and
impressive returns to investors investing for more than two years.
3. Liquid Funds
Similar to income funds, liquid funds also make investments in money market and
debt securities. However, the tenure of these funds usually extends to 91 days and a
maximum amount of Rs.10 lakh can be invested in them.
4. Tax-saving Funds
Equity-Linked Saving Schemes (ELSS) mainly invest in equity and equity-related
instruments and offer dual benefits of tax-saving and wealth generation. These funds,
usually, come with a three-year lock-in period.
5. Aggressive Growth Funds
Aggressive Growth funds carry a relatively high level of risk and are designed to
generate steep monetary returns. Although these funds are prone to market volatility,
they have the potential to deliver impressive returns.
6. Capital Protection Funds

37
 STOCK MARKET
Capital protection funds which chiefly invest in debt securities and partly in equities
aim to protect investors’ capital. The delivered returns are relatively low and the
investors should remain invested for at least 3 years.
7. Pension Funds
Pension funds are great investment options for individuals who wish to save for
retirement. These funds offer regular income and are ideal for meeting contingency
expenses such as a child’s wedding or medical emergencies.
8. Fixed Maturity Funds
Fixed maturity funds make investments in money markets, securities, bonds, etc. and
are closed-ended plans that come with fixed maturity periods. The tenure of these
funds could extend from a month to 5 years.
Based on Risk Profile

1. High-risk Funds
High-risk funds are funds which carry a high level of risk but generate impressive
returns. These funds require active management and their performance must be
reviewed regularly as these are prone to market volatility.
2. Medium-risk Funds
The level of risk associated with medium-risk funds is neither too high, nor too low.
The corpus of medium-risk funds is invested partly in debt and partly in equities. The
average returns offered by these funds range from 9% to 12%.
3. Low-risk Funds
The corpus of low-risk funds is spread across a combination of arbitrage funds, ultra-
short-term funds, and liquid funds. These funds are ideal in times of unexpected
national crisis or when the rupee depreciates in value.
4. Very Low-risk Funds
These funds could be ultra-short-term funds or liquid funds whose maturity extends
from a month to a year. Such funds are virtually risk-free and the returns they offer
are generally around 6% at the best.
Specialised Mutual Funds

1. Index Funds
Index funds invest in an index, and rather than a fund manager managing the fund,
these replicate the performance of the index. The stocks in which investments are
done are similar to that of the corresponding index.
2. Sector Funds
Sector funds are theme-based funds which invest their corpus in a specific sector to
deliver impressive returns. Since these funds invests in a specific sector with a
limited number of stocks, these have a high risk profile.
3. Fund of Funds
Fund of funds invest in a diversified portfolio and the fund manager invests in one
fund that makes investments in several funds rather than investing in various funds
as this helps in achieving diversification of portfolio.
4. Foreign/International Funds

38
 STOCK MARKET
Foreign/international funds make investments in companies located outside the
investor’s country of residence. These funds have the ability to deliver good returns
at times when the Indian stock markets perform well.
5. Global Funds
Global funds primarily invests in markets across the world as well as in the investor’s
home country. Global funds are universal and diverse in approach and carry a high
level of risk due to the currency variations and different policies.
6. Emerging Market Funds
Emerging Market Funds invests in developing markets. These funds are risky
investment options. Since India is also an emerging and dynamic market, these funds
are susceptible to market volatilities.
7. Real Estate Funds
Real estate funds are special share funds which invest in high-quality real estate
directly or through companies which purchase real estates. Though these funds have
high associated risk these offer long-term returns.
8. Market Neutral Funds
Market neutral funds are great options for those investors who want to be safe from
unfavourable market fluctuations while also sustaining healthy returns from their
investment at the same time.
9. Asset Allocation Funds
These funds invest in equity instruments, debt securities, and even gold. These are
highly flexible in nature and can regulate the distribution of funds into equities and
debt instruments.
10. Gift Funds
The investors can gift these funds to their family in order to secure their financial
future. These can be used to pay all portion or a part of down payment or closing
costs. However, these can’t be used to buy an investment property.
11. Exchange-traded Funds
These funds which are sold and purchased on exchanges offer exposure to overseas
stock markets and specialised sectors. These may be traded in real-time and the
prices can increase/decrease many times a day.

OVER THE COUNTER EXCHANGE OF INDIA

The Over-The-Counter (OTC) Exchange of India, also known as OTC India, was a platform for
trading various financial instruments like stocks, bonds, and derivatives. Established in 1990, it
aimed to provide a platform for trading in securities that were not listed on major stock
exchanges like the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE).
OTC India was part of India's broader efforts to enhance the accessibility and liquidity of
financial markets.

Here are some key aspects of OTC India:

1. Purpose: OTC India was designed to offer a trading venue for smaller or less liquid
securities that might not meet the listing requirements of major exchanges.

39
 STOCK MARKET
2. Regulation: The OTC market was regulated by the Securities and Exchange Board of
India (SEBI), which is the primary regulatory authority overseeing securities markets in
India.
3. Instruments Traded: OTC India facilitated trading in various instruments, including
unlisted shares, debentures, and other financial products.
4. Transition and Integration: Over time, the OTC platform in India faced challenges
related to liquidity and transparency. Consequently, many of the functions of OTC India
were absorbed into more established platforms. The NSE and BSE began to offer a
wider range of products and services, making them more comprehensive alternatives.
5. Current Status: As of the latest updates, OTC India is no longer operational as a
distinct exchange. Its activities and the types of securities traded have largely been
integrated into other major exchanges or trading platforms in India.

For the most current information, it's always good to check with the latest updates from SEBI or
major Indian stock exchanges.

NATIONAL STOCK EXCHANGE

The National Stock Exchange of India (NSE) is one of the leading stock exchanges in India
and is known for its robust trading platform and broad range of financial products. Here’s a
detailed overview of NSE:

History and Establishment

 Founded: The NSE was established in 1992.

 Launch: It commenced operations in 1994 with the introduction of its electronic trading
system.

Key Features

 Electronic Trading: NSE was one of the first exchanges in India to adopt fully
automated electronic trading, which has increased efficiency and transparency in
trading.
 Indices: The NSE is well-known for its benchmark index, the Nifty 50, which tracks the
performance of 50 major companies listed on the exchange.
 Products and Services:
o Equities: Stocks of companies listed on the NSE.
o Derivatives: Futures and options contracts on indices and individual stocks.
o Debt Securities: Government and corporate bonds.
o Currency Derivatives: Contracts based on currency pairs.
o Exchange-Traded Funds (ETFs): Investment funds traded on the exchange.

Market Segments

1. Cash Market: This includes the trading of equity shares and other securities for
immediate delivery and settlement.
2. Derivatives Market: This involves trading in futures and options contracts.

40
 STOCK MARKET
3. Currency Derivatives Market: This segment deals with futures and options on
currency pairs.
4. Debt Market: This includes trading in government and corporate bonds.

Regulation and Governance

 Regulator: The Securities and Exchange Board of India (SEBI) is the primary regulator
overseeing the operations of the NSE, ensuring compliance with regulations and
maintaining market integrity.
 Governance: The NSE is managed by a board of directors and operates under a set of
rules and regulations designed to ensure fair trading practices and transparency.

Technological Innovations

 Trading System: NSE's trading system is known for its speed and efficiency, handling
a large volume of trades with low latency.
 NSE India Mobile App: Provides access to market data, trading, and other services on
mobile devices.

International Recognition

 Global Presence: The NSE has garnered recognition on the global stage and is a key
player in emerging markets, often ranked among the top exchanges worldwide in terms
of trading volumes.
 Collaborations: The NSE has formed strategic partnerships and collaborations with
various international exchanges and financial institutions to enhance its global reach.

Social Initiatives

 Financial Literacy: The NSE is involved in promoting financial literacy and investor
education through various programs and initiatives.
 Sustainability: It supports sustainability and corporate social responsibility (CSR)
initiatives in line with global standards.

Recent Developments

 Technological Upgrades: The NSE continues to invest in technology to improve

trading efficiency and security.
 New Products: The exchange regularly introduces new financial products and services
to meet the evolving needs of investors.

For the latest updates, you can visit the official NSE website or consult recent news and
financial reports.

QUALIFIED INDIVIDUALS AND INSTITUTIONAL

BUYERS

41
 STOCK MARKET
In the context of financial markets and securities trading, "qualified individuals" and
"institutional buyers" refer to specific categories of investors who meet certain criteria. These
qualifications often grant them access to a wider range of investment opportunities and may
come with additional regulatory requirements or benefits.

Qualified Individuals

Qualified individuals are typically investors who meet specific financial criteria or possess
certain knowledge that allows them to participate in investment opportunities that are not
available to the general public. In various jurisdictions, these individuals may be referred to as
"accredited investors" or "high-net-worth individuals."

Criteria for Qualified Individuals

1. Financial Criteria:
o Net Worth: Individuals with a high net worth, often defined as having assets
above a certain threshold (e.g., $1 million, excluding primary residence).
o Income: High annual income levels, which may be defined as exceeding a
specific amount (e.g., $200,000 annually for the past two years, or $300,000
with a spouse).
2. Investment Experience:
o Knowledge and Experience: Individuals who have significant investment
experience or knowledge, such as professional experience in the finance
industry.
3. Regulatory Designation:
o Accredited Investor: In the U.S., the Securities and Exchange Commission
(SEC) defines accredited investors based on income, net worth, or professional
qualifications.
o Qualified Investor: In other jurisdictions, similar definitions apply but may vary
in terms of thresholds and criteria.

Access and Benefits

 Private Placements: Qualified individuals can participate in private placements of

securities, which are investment opportunities not registered with regulatory bodies and
often involve higher risk but potentially higher returns.
 Alternative Investments: They may have access to alternative investments like hedge
funds, private equity, or venture capital.
 Fewer Restrictions: They might face fewer regulatory restrictions and have access to
more complex financial products.

Institutional Buyers

Institutional buyers refer to organizations that invest large amounts of capital on behalf of
clients or their own accounts. These entities typically have significant financial resources and
are considered sophisticated investors.

42
 STOCK MARKET
Types of Institutional Buyers

1. Investment Funds:
o Mutual Funds: Pooled investment funds that invest in a diversified portfolio of
securities.
o Hedge Funds: Private investment funds that employ various strategies to
generate high returns.
2. Pension Funds:
o Defined Benefit Plans: Retirement plans where the employer guarantees a
specified payout at retirement.
o Defined Contribution Plans: Retirement plans where the employer and/or
employee contribute funds, which are invested to build retirement savings.
3. Insurance Companies:
o Life Insurance: Companies that invest premiums to generate returns for
policyholders.
o General Insurance: Companies that invest premiums from non-life insurance
policies.
4. Endowments and Foundations:
o University Endowments: Funds held by educational institutions to support their
long-term financial stability.
o Charitable Foundations: Organizations that invest their assets to fund
charitable activities.
5. Sovereign Wealth Funds:
o Government-Owned Investment Funds: Invest surplus national funds, often
derived from natural resources or foreign reserves.
6. Banks and Financial Institutions:
o Commercial Banks: Banks that invest in securities, loans, and other financial
instruments.
o Investment Banks: Banks that assist with capital raising, advisory services, and
trading.

Access and Benefits

 Large-Scale Investments: Institutional buyers can participate in large-scale investment

opportunities and influence market movements.
 Access to Private Placements: They often have access to private placements and
exclusive investment opportunities.
 Regulatory Benefits: Institutions may benefit from regulatory exemptions or simplified
reporting requirements compared to retail investors.

UNDERWRITERS

Underwriters play a crucial role in the financial markets, especially in the issuance of securities
such as stocks and bonds. They are responsible for assessing and managing the risk
associated with underwriting securities offerings. Here’s a detailed overview of their roles and
responsibilities:

43
 STOCK MARKET
Definition and Role of Underwriters

Underwriters are financial institutions or entities that evaluate and assume the risk of issuing
new securities, such as stocks or bonds, on behalf of issuers. They facilitate the process of
bringing new securities to the market and often guarantee the issuer a certain amount of
capital.

Responsibilities

1. Assessment and Pricing:

o Risk Evaluation: Underwriters assess the risk associated with the securities
offering, including the financial health of the issuer and market conditions.
o Pricing: They help determine the appropriate price at which the securities
should be offered to the public, based on market demand and issuer’s
financials.
2. Issuance Process:
o Due Diligence: Underwriters conduct thorough due diligence to ensure that all
relevant information about the issuer is disclosed to potential investors.
o Registration: They assist in preparing and filing the necessary documentation
with regulatory authorities, such as the Securities and Exchange Commission
(SEC) in the U.S., to comply with legal requirements.
3. Distribution:
o Marketing: Underwriters market the new securities to potential investors, which
can include institutional investors, retail investors, and other market participants.
o Sales: They facilitate the sale of the securities and distribute them to the
investors, often through a network of brokers and dealers.
4. Guarantee:
o Underwriting Agreement: In a firm commitment underwriting, the underwriter
agrees to purchase the entire issue of securities from the issuer and then resell
them to the public. This provides the issuer with a guaranteed amount of capital.
o Best Efforts: In a best-efforts underwriting, the underwriter agrees to sell as
many securities as possible but does not guarantee the entire issue.
5. Stabilization:
o Price Stabilization: After the securities are issued, underwriters may engage in
price stabilization activities to prevent the market price from falling below the
offering price.

Types of Underwriters

1. Investment Banks:
o Major Role: Investment banks are the primary underwriters for large securities
offerings. They have the expertise and resources to handle complex
transactions.
o Examples: Goldman Sachs, Morgan Stanley, JP Morgan Chase.
2. Commercial Banks:
o Involvement: Some commercial banks also participate in underwriting,
particularly for bond issues and structured finance products.
3. Specialized Underwriting Firms:

44
 STOCK MARKET
o Niche Areas: These firms might focus on specific types of securities or markets,
such as small-cap stocks or municipal bonds.

Underwriting Process

1. Preliminary Assessment: The underwriter evaluates the issuer’s financial condition,

business model, and market potential.
2. Proposal: They present a proposal outlining the terms of the underwriting agreement,
including the price, number of securities, and fees.
3. Due Diligence: Comprehensive due diligence is conducted to verify the accuracy of the
information disclosed by the issuer.
4. Marketing and Roadshow: The underwriter markets the offering to potential investors
through presentations and meetings.
5. Pricing and Allocation: The final price is set, and the securities are allocated to
investors.
6. Closing: The underwriter purchases the securities from the issuer and sells them to
investors. The issuer receives the proceeds from the sale.

Compensation

 Underwriting Fees: Underwriters are typically compensated through underwriting fees,

which are a percentage of the total amount raised in the offering. This fee is sometimes
structured as a discount on the offering price.
 Spread: The difference between the price at which the underwriters purchase the
securities and the price at which they sell them to investors is known as the
underwriting spread.

45
 STOCK MARKET

UNIT-3

FINANCIAL INTERMEDIARIES
Financial intermediaries are institutions or entities that act as middlemen between parties in
financial transactions, helping to facilitate the flow of funds in the economy. They play a crucial
role in the financial system by channeling funds from savers to borrowers and helping manage
risks. Here’s an overview of various types of financial intermediaries, their roles, and their
functions:

Types of Financial Intermediaries

1. Commercial Banks
o Functions:
 Accept Deposits: Provide a safe place for individuals and businesses to
deposit their funds.
 Provide Loans: Offer various types of loans, including personal loans,
mortgages, and business loans.
 Payment Services: Facilitate payments and transfers through checking
accounts, credit/debit cards, and electronic funds transfers.
 Wealth Management: Offer financial advisory services and investment
products.
2. Investment Banks
o Functions:
 Underwriting: Assist companies and governments in issuing new
securities (stocks and bonds) by underwriting the issue and helping to
price and sell the securities.
 Advisory Services: Provide advisory services for mergers and
acquisitions, restructuring, and other financial strategies.
 Trading: Engage in trading securities and other financial instruments,
both for clients and for their own accounts.
 Market Making: Facilitate trading by buying and selling securities to
provide liquidity.
3. Brokerage Firms
o Functions:
 Buy and Sell Securities: Execute buy and sell orders for stocks, bonds,
and other securities on behalf of clients.
 Investment Advice: Offer investment advice and research to help
clients make informed decisions.
 Portfolio Management: Provide portfolio management services,
including asset allocation and risk management.
4. Mutual Funds
o Functions:
 Pooling Funds: Collect funds from multiple investors to invest in a
diversified portfolio of stocks, bonds, or other securities.
 Professional Management: Offer professional management and
oversight of the investment portfolio.

46
 STOCK MARKET
 Diversification: Provide diversification to reduce risk for investors by
holding a variety of securities.
5. Hedge Funds
o Functions:
 Alternative Investments: Use a wide range of investment strategies,
including leverage, short selling, and derivatives, to achieve high returns.
 Accredited Investors: Typically cater to accredited investors and
institutional clients due to their complex strategies and higher risk
profiles.
 Risk Management: Employ sophisticated risk management techniques
to mitigate potential losses.
6. Private Equity Firms
o Functions:
 Direct Investment: Invest directly in private companies or take public
companies private, often focusing on improving operations and
increasing value.
 Long-Term Investments: Engage in long-term investments with the
goal of generating substantial returns through operational improvements
and eventual exits (e.g., through sales or public offerings).
 Management Expertise: Provide strategic guidance and management
expertise to enhance the performance of portfolio companies.
7. Insurance Companies
o Functions:
 Underwriting Insurance: Provide various types of insurance products,
including life, health, property, and casualty insurance.
 Investment Management: Invest premiums received from policyholders
in a range of financial assets to meet future claims and obligations.
 Risk Pooling: Pool risks from multiple policyholders to provide financial
protection and manage risk.
8. Pension Funds
o Functions:
 Retirement Savings: Manage and invest retirement savings for
employees and retirees, ensuring long-term growth and income.
 Diversification: Invest in a diversified portfolio of assets to balance risk
and return.
 Regulation and Oversight: Operate under strict regulations and
oversight to protect retirees' funds and ensure long-term stability.
9. Central Banks
o Functions:
 Monetary Policy: Implement monetary policy to regulate the money
supply, interest rates, and overall economic stability.
 Banking Supervision: Oversee and regulate commercial banks and
other financial institutions to ensure financial stability and protect
depositors.
 Financial Stability: Act as a lender of last resort to provide liquidity in
times of financial crises.
10. Credit Unions
o Functions:

47
 STOCK MARKET
 Member-Owned: Cooperative financial institutions owned and operated
by their members, offering similar services to commercial banks but
often with a focus on member benefits.
 Savings and Loans: Provide savings accounts, loans, and other
financial services to their members.
 Community Focus: Typically focus on serving the financial needs of a
specific community or group of individuals.

Roles and Functions of Financial Intermediaries

1. Channeling Funds: Facilitate the flow of funds from savers and investors to borrowers
and businesses. They help match those with surplus funds (investors) with those in
need of capital (borrowers).
2. Risk Management: Offer products and services to manage and mitigate financial risks,
such as insurance policies and diversified investment portfolios.
3. Liquidity Provision: Enhance liquidity in the financial system by providing mechanisms
for buying and selling securities and other financial assets.
4. Information Processing: Collect and analyze financial information to help investors
make informed decisions and to assess the creditworthiness of borrowers.
5. Cost Reduction: Reduce transaction costs and information asymmetry by pooling
resources and leveraging economies of scale.
6. Financial Innovation: Develop new financial products and services to meet the
evolving needs of investors and borrowers.

DERIVATIVES
The past decade has witnessed the multiple growths in the volume of international trade
and business due to the wave of globalization and liberalization all over the world. As a
result, the demand for the international money and financial instruments increased
significantly at the global level. In this respect, changes in the interest rates, exchange rates
and stock market prices at the different financial markets have increased the financial risks to
the corporate world. Adverse changes have even threatened the very survival of the business
world. It is, therefore, to manage such risks, the new financial instruments have been
developed in the financial markets, which are also popularly known as financial derivatives.

• The basic purpose of these instruments is to provide commitments to prices for

future dates for giving protection against adverse movements in future prices, in
order to reduce the extent of financial risks. Not only this, they also provide
opportunities to earn profit for those persons who are ready to go for higher risks. In
other words, these instruments, indeed, facilitate to transfer the risk from those who
wish to avoid it to those who are willing to accept the same.

• Today, the financial derivatives have become increasingly popular and most commonly
used in the world of finance. This has grown with so phenomenal speed all over the
world that now it is called as the derivatives revolution. In an estimate, the present
annual trading volume of derivative markets has crossed US $ 30,000 billion,
representing more than 100 times gross domestic product of India.

Meaning of Financial Derivatives

48
 STOCK MARKET
Derivatives are financial instruments whose value is derived from one or more
underlying financial asset. The underlying instrument could be a financial security, a
securities index or some combination of securities and indexes. Derivatives are financial
instruments that have no intrinsic value. They hedge the risk of owning things that are subject
to unexpected price fluctuations, for Example, foreign currencies, stocks and government
bonds.

Features/Characteristics/Nature of Derivatives

The basic features of a derivative can be explained as follows:

1.Contract between two parties: A derivative instrument relates to the future contract
between two parties. It means there must be a contract-binding on the underlying parties and
the same to be fulfilled in future. The future period may be short or long depending upon the
nature of contract, for example, short-term interest rate futures and long-term interest rate
futures contract.

2.Value of Underlying Assets: Normally, the derivative instruments have the value which
derived from the values of other underlying assets, such as agricultural commodities, metals,
financial assets, intangible assets, etc. Value of derivatives depends upon the value of
underlying instrument and which changes as per the changes in the underlying assets and
sometimes, it may be nil or zero. Hence, they are closely related.

3.Specified Obligation: In general, the counter-parties have specified obligation under the
derivative contract. Obviously, the nature of the obligation would be different as per the type of
the instrument of a derivative. For example, the obligation of the counter-parties, under the
different derivatives, such as forward contract, future contract, option contract and swap
contract would be different.

4.Types of Trading: The derivatives contracts can be undertaken directly between the two
parties or through the particular exchange like financial futures contracts. The exchange-traded
derivatives are quite liquid and have low transaction costs in comparison to tailor made
contracts. Examples of exchange traded derivatives are Dow Jons, S&P 500, Nikkei 225,
NIFTY option, S&P junior that are traded on New York Stock Exchange, Tokyo Stock
Exchange, National Stock Exchange, Bombay Stock Exchange and so on.

5.Notional Amount: In general, the financial derivatives are carried off-balance sheet. The
size of the derivative contract depends upon its notional amount. The notional amount is the
amount used to calculate the pay-off. For example, in the option contract, the potential loss and
potential pay-off, both may be different from the value of underlying shares, because the pay-
off of derivative products differs from the pay-off that their estimated amount might suggest.

6.No Physical Delivery: Usually, in derivatives trading, the taking or making of delivery of
underlying assets is not involved; rather underlying transactions are mostly settled by taking
offsetting positions in the derivatives themselves. There is, therefore, no effective limit on the
quantity of claims, which can be traded in respect of underlying assets.

7.Deferred Payment Instrument: Derivatives are also known as deferred delivery or deferred
payment instrument. It means that it is easier to take short or long position in derivatives in
comparison to other assets or securities. Further, it is possible to combine them to match
specific, i.e., they are more easily amenable to financial engineering.

49
 STOCK MARKET
8.Secondary Market Instruments: Derivatives are mostly secondary market instruments and
have little usefulness in mobilizing fresh capital by the corporate world; however, warrants and
convertibles are exception in this respect.

9.Standardized and Customized: Although in the market, the standardized, general and
exchange-traded derivatives are being increasingly evolved, however, still there are so many
privately negotiated customized, Over-the-Counter (OTC) traded derivatives are existence.
They expose the trading parties to operational risk, counter-party risk and legal risk. Further,
there may also be uncertainty about the regulatory status of such derivatives.

10.Off-Balance Sheet: Finally, the derivative instruments, sometimes, because of their off-
balance sheet nature, can be used to clear up the balance sheet. For example, a fund
manager who is restricted from taking particular currency can buy a structured note whose
coupon is tied to the performance of a particular currency pair.

NEED OF DERIVATIVES
Need of financial derivatives arise due to following reasons :

Need Of Derivatives

Management of Risk Efficiency in Trading

Speculation
Price Discover

Price Stabilization

1. Management Of Risk: Financial derivatives allow for the efficient management of financial
risks and can help to ensure that value-enhancing opportunities will not be ignored. Risk
management is not about the elimination of risk rather it is about the management of risk.
Financial derivatives provide a powerful tool for limiting risks that individuals and organizations
face in the ordinary conduct of their businesses. It requires a thorough understanding of the
basic principles that regulate the pricing of financial derivatives. Effective use of derivatives can
save cost and it can increase returns for the organizations.

2. Efficiency in Trading: Financial derivatives allow for free trading of risk components and
that leads to improving market efficiency. Traders can use a position in one or more financial
derivatives as a substitute for a position in the underlying instruments. In many instances,
traders find financial derivatives to be a more attractive instrument that the underlying security.
This is mainly because of the greater amount of liquidity in the market offered by
derivatives as well as the lower transaction costs associated with trading a financial
derivative as compared to the costs of trading the underlying instrument in cash market.

3. Speculation: Financial derivatives are considered to be risky. If not used properly, these can
leads to financial destruction in an organization. However, these instruments act as a powerful
instrument for knowledgeable traders to expose themselves to calculated and well-understood
risky in search of a reward, i.e., profit.

50
 STOCK MARKET
4. Price Discover: Price discovery means revealing information about future cash market
prices through the futures market. Derivatives markets provide a mechanism by which diverse
and scattered opinions of future are collected into one readily discernible number which
provides a consensus of knowledgeable thinking.

5. Price Stabilization: Derivative market helps to keep a stabilizing influence on spot prices by
reducing the short-term fluctuations. In other words, derivative reduces both peak and depths
and leads to price stabilization effect in the cash market for underlying asset.

TYPES OF DERIVATIVES:
Broadly derivatives can be classified in to two categories: Commodity derivatives and
Financial derivatives. In case of commodity derivatives, underlying asset can be commodities
like wheat, gold, silver etc., whereas in case of financial derivatives underlying assets are
stocks, currencies, bonds and other interest rates bearing securities etc. Thus, futures, option
or swaps on gold, sugar, jute, pepper etc are commodity derivatives. While futures, options or
swaps on currencies, gilt-edged securities, stock and share stock market indices etc are
financial derivatives.

Derivatives

Commodity Financial

Basic Instrument Complex Instruments

Forward Futures Options Swaps

Exotic, Swaptions,
and LEAPS, etc.

1. Forwards: A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today’s pre-agreed price. The rupee-
dollar exchange rates is a big forward contract market in India with banks, financial institutions,
corporate and exporters beings the market participants. Forward contracts are generally traded
on OTC.

2. Futures: A future contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Future contracts are special types of forward
contracts in the sense that the former are standardized exchange – traded contracts.

Unlike forward contracts, the counterparty to a futures contract is the clearing corporation on
the appropriate exchange. Futures often are settled in cash or cash equivalents, rather than
requiring physical delivery of the underlying asset. Parties to a futures contract may buy or
write options on futures.

51
 STOCK MARKET
3. Options: An option represents the right (but not the obligation) to buy or sell a security or
other asset during a given time for a specified price (the “strike” price). Options are of two
types:

1) Call Option: It gives the buyer the right but not the obligation to buy a given quantity of the
underlying asset, at a given price on or before a given future date.

2) Put Option: It gives the buyer the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.

4) Swaps: Swaps are private agreements between two parties to exchange cash flows in the
future according to a pre-arranged formula. They can be regarded as portfolios of forward
contracts. Swaps generally are traded OTC through swap dealers, which generally consist of
large financial institution, or other large brokerage houses. There is a recent trend for swap
dealers to mark to market the swap to reduce the risk of counterparty default. The two
commonly used swaps are:

1) Interest Rate Swaps: These entail swapping only the interest- related cash flows between
the parties in the same currency.

2) Currency Swaps: These entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than those in the opposite
direction.

FORWARD CONTRACTS
A forward contract is a customized contract between two entities, where settlement takes place
on a specific date in the future at today’s pre-agreed price. The rupee-dollar exchange rates is
a big forward contract market in India with banks, financial institutions, corporate and exporters
beings the market participants. Forward contracts are generally traded on OTC.

PURPOSE OF FORWARD CONTRACTS

For hedging investments:
One of the most common uses of forward contracts is for hedging investments. When a
company invests in a product that is subject to price volatility, it can use these contracts to lock
in a predetermined price for a future date.
Using open forward contracts:
Open forward contracts, also known as flexible contracts, allow parties involved to change
contract terms during the contract period. This type of contract is ideal when there is
uncertainty about the the delivery date or the quantity of a commodity that might be needed.
With market orders:
When using these contracts with market orders, parties involved agree to buy or sell the
commodity at a future date at the best available market price.
FEATURES OF A FORWARD CONTRACT
Here are some of the essential features of these contracts:
Non-standardized
Unlike futures contracts, these are not regulated by any third-party authority. The terms and
conditions depend solely on the agreement between the two partie
Not regulated
These contracts are not standardized, which means that each contract is customized according
to the needs and requirements of both parties.
Bilateral

52
 STOCK MARKET
This contract is a bilateral agreement between two parties, which means that both parties have
to fulfil their obligations on the date of maturity.
Tailor-made
Since each contract is unique, parties involved can tailor the terms and conditions of the
contract according to their specific needs.
No public disclosure
The price of these contracts is not publicly available, making it difficult for other market
participants to know the price at which the contract was signed.
Settlement on maturity
Unlike futures contracts, which are marked-to-market daily, these contracts are settled on
maturity.
No margin requirement
These contracts do not require any margin payment, so the parties involved do not have to
deposit any upfront payment..
TYPES OF FORWARD CONTRACTS
Following are some of the common types of forward contracts 3:
Closed outright forward
It involves two parties agreeing to exchange currencies at a particular future date by locking in
an exchange rate.
Flexible forward
A flexible forward contract is an agreement between two parties to exchange currencies at a
future date, just like a closed outright forward. However, it allows the parties to exchange funds
before the settlement date, often in parts, as long as the entire amount is settled by the due
date
Long-dated forward
In the long-dated contract, the settlement period extends over more than a year. Most of these
contracts are short-term contracts, which is what differentiates long-dated contracts from the
rest.
Non-deliverable forward
The non-deliverable forward is a type of forward contract that does not involve the physical
exchange of a commodity, asset, or currency. Instead, the parties only exchange the difference
between the contract and spot rates at maturity.
ADVANTAGES OF A FORWARD CONTRACT
Here are some advantages of forward contracts:
Customizable
Commodity forward contracts allow parties to agree on specific terms and conditions that meet
their unique requirements like quantity, price, and delivery date.
Lower international trade-related risks
International trade carries many risks, including currency fluctuations, political risks, and legal
or regulatory environment changes. Forward contract can help businesses mitigate these risks
by providing certainty around the cost of exports.
No upfront hedging costs
Another advantage of commodity forward contracts is that they do not require any upfront costs
for hedging. Unlike options, which require a premium payment, these contracts do not require
businesses to pay anything upfront.
DISADVANTAGES OF FORWARD CONTRACTS
Some of the main disadvantages are:
Non-regularized

53
 STOCK MARKET
One of the major risks or limitations of these contracts is that they are not standardized, and
there is little public information available about the market cap. This lack of regulation can
make it difficult for investors to assess these types of contracts’ risks.
Prone to counterparty risks
Since these contracts are bilateral agreements between two parties, there is always a risk that
one party may default on their obligations.
Possible miscalculation of movement of prices
These contracts are useful for hedging against future price movements. However, they can
also expose companies to risks and potential losses in a highly volatile market. If a company
miscalculates the movement of prices, it may end up locked into an unfavorable contract and
lose out on potential gains.
HOW ARE FORWARD CONTRACTS CALCULATED
Here’s a step-by-step guide to calculating contracts:
Step 1: Determine the currency pair
Before calculating the forward contract, it is essential to determine the two currencies involved
in the transaction.
Step 2: Determine the spot rate
The spot rate refers to the current exchange rate between the two currencies. The system
adjusts the market spot rate when calculating the forward rate.
Step 3: Calculate the forward points
The forward points are usually determined by the difference between interest rates of these
currencies in the pair and time to maturity of the contract.
Step 4: Add the forward points to the spot rate
Once you’ve determined the forward points, add them to the spot rate to calculate the forward
rate.
Step 5: Agree on the total amount and exchange rate
After calculating the forward rate, agree on the total amount of the trade and the exchange
rate.
Step 6: Agree on a binding contract
Once the currencies are paired, the total amount the business wishes to trade and the agreed
exchange rate have been determined; a binding contract is automatically agreed upon.

Forward contracts are an effective tool to manage risks in commodity and currency trading.
They provide businesses with price certainty, customization, and flexibility.

LIMITATIONS OF FORWARD CONTRACTS

Forward contracts are widely used in hedging currency risk as they offer a simple solution to
lock in a future exchange rate. However, they also come with certain limitations that can hinder
their effectiveness in managing currency risk. It is important to be aware of these limitations
and explore alternative hedging strategies such as Quanto options.

Here are some limitations of forward contracts to consider:

1. No flexibility: Once a forward contract is signed, both parties are obligated to fulfill the
terms of the contract, regardless of any changes in circumstances. This lack of flexibility can be
a disadvantage if the market moves in an unexpected direction.

54
 STOCK MARKET
2. Counterparty risk: Forward contracts are bilateral agreements between two parties, and as
such, there is a risk that the counterparty may default on their obligation to deliver the currency
at the agreed-upon rate. This risk can be mitigated by using a reputable counterparty or by
using a clearinghouse to act as an intermediary.
3. Limited availability: Forward contracts are generally only available for major currencies and
for relatively short periods of time. This can be a disadvantage for companies that deal in exotic
currencies or need to hedge currency risk over longer periods.
4. Costly: Forward contracts often require a deposit or margin to be posted, which can tie up
capital and increase the cost of hedging.

FUTURES CONTRACT
A futures contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Futures contract are special types of forward
contracts in the sense that the former are standardized exchange-traded contracts.

Unlike forward contracts, the counterparty to a futures contract is the clearing

corporation on the appropriate exchange. Futures often are settled in cash or cash equivalents,
rather than requiring physical delivery of the underlying asset. Parties of a futures contract may
buy or write options on futures.

Future contracts, while similar to forward contracts, have certain features that make
them more useful for risk management. These include being able to extinguish contract
obligations through offsetting rather than actual delivery of the commodity. In fact, very few
future contracts are ever delivered upon.

Future contracts are traded on organized exchanges in a variety of commodities

(including grains, livestock, bonds and currencies). They are traded by open outcry where
traders and brokers shout bids and offers from a trading pit at designated times and places.
This allows producers, users and processors to establish prices before commodities are
traded. Futures prices are forecasts that can and do change according to a variety of reasons,
such as crop or weather reports.

FEATURES OF FUTURES

55
 STOCK MARKET

Features Of Futures
The features of a futures contract may be specified as
follows:
Features of Futures

Trading on Organized
Exchange
Standardized Contract
Association with Clearing
House
Margin Requirements and Daily
Settlement
Involvement of Regulatory
Authority
Cash Settlement

1) Trading on Organized Exchange: These are traded on an organized exchange like

IMM, LIFFE, NSE, BSE, CBOT, etc.

2) Standardized Contract: These involve standardized contract terms, viz, the underlying
asset, the time of maturity, and the manner of maturity, etc.

3) Association with Clearing House: These are associated with a clearing house to
ensure smooth functioning of the market. Future exchanges have clearing house
arrangements to guarantee the fulfillment of contract obligations.

4) Margin Requirements and Daily Settlement: There are margin requirements and
daily settlement to act as further safeguard. Future positions can be closed easily.

5) Involvement Of Regulatory Authority: These provide for supervision and monitoring

of contract by a regulatory authority.

6) Cash Settlement: Almost ninety per cent future contracts are settled via cash
settlement instead of actual delivery of underlying asset.

RISKS INVOLVED IN FUTURES CONTRACTS

Futures trading is inherently risky and requires that participants, especially brokers, are not
only familiar will all the risks but also possess the skills to manage those risks. Following are
the risks associated with trading futures contracts:

1. Leverage

One of the chief risks associated with futures trading comes from the inherent feature of
leverage. Lack of respect for leverage and the risks associated with it is often the most
common cause for losses in futures trading. Exchange sets margins at levels which are
deemed appropriate for managing risks at clearinghouse level.

2. Interest Rate Risk

56
 STOCK MARKET
The risk that an investment's value will change due to a change in the absolute level of
interest rates. Normally, rise in interest rates during the investment period may result in
reduced prices of the held securities.

3. Liquidity Risk

Liquidity risk is an important factor in trading. Level of liquidity in a contract can impact
the decision to trade or not. Even if a trader arrives at a strong trading view, he may not
be able to execute the strategy due to lack of liquidity. There may not be enough
opposite interest in the market at the right price to initiate a trade. Even if a trade is
executed, there is always a risk that it can become difficult or costly to exit from
positions in illiquid contracts.

4. Settlement and Delivery Risk

All executed trades need to be settled and closed at some point. Daily settlement takes
the form of automatic debits and credits between accounts with any shortfalls being
recovered through margin calls. Brokers are obligated to fulfill all margin calls. Use of
electronic systems with online banking has reduced the risks of failed daily settlements.
However, non-payment of margin calls by clients poses a serious risk for brokers.

5. Operational Risk

Operational risk is a major source of losses for brokers as well as investor complaints.
Errors due to manual mistakes by staff are a major area of risk for all brokers.
Measures like adequate staff training, supervision, internal controls, and documentation
of standard operating procedures and segregation of tasks are essential for running a
brokerage house as well as for reducing instances and impact of operational risks.

CLEARING HOUSE
A clearinghouse is an intermediary that monitors the entire process of selling and purchasing
assets to ensure the parties involved do not undergo any hassle in completing the process. In
short, a clearinghouse assures of the smooth functioning of this sale and purchase network. Its
responsibilities are many, but the motive is only one and that is to ensure the buyer gets the
product right, and the seller receives the payment right without facing any difficulty.

As the name suggests, a clearinghouse clears piles once a transaction completes. Let us
understand how the transaction flows between two parties. The buyer receives the actual
goods from the deemed seller (i.e., the clearinghouse), and the seller receives the
consideration for the goods sold to the supposed buyer (i.e., the clearinghouse).

FUNCTIONS

Being the middle entity between the buyer and seller, a clearinghouse has a huge
responsibility of maintaining a balance in the procedure of selling assets and confirming its
receipt by the other party. When it is there, the buyers and seller hardly have to think of where
they are going wrong. The clearinghouse deal wiuth that. Some of its functions of these entities
include the following. Let us have a look at them, below:

57
 STOCK MARKET

 It guarantees the occurrence of the transaction in the manner planned by the said
parties.
 This guarantee is given by checking the repaying capacity and credibility of the parties
involved. That applies irrespective of whether the parties are natural or artificial
persons.
 It ensures that the system is available during trading hours. That makes sure that the
market is liquid.
 A clearinghouse also provides standardized norms regarding the quality, quantity, price,
minimum ticks, maximum movement of cost within a day, and contract maturity.

IMPORTANCE

When there is a clearinghouse to take care of the transactions and whether the process
complies with the regulations, buyers and sellers know they do not need to worry about
anything. This is what makes these entities such important components in the process.

 Each trader’s basic risk is non-honoring the contract and default risk on the buyer’s
side.
 Clearinghouse eliminates such risks, thereby assuring the financial transaction.
 It is responsible for settlement between the parties, the time limit within which the
transaction should get completed, and monitoring the adequacy of margins placed on
the accounts of each trader.
 Clearinghouse ensures that the variable margin is called for if a trader breaches the
maintenance margin.

BENEFITS

58
 STOCK MARKET
The presence of ta clearinghouse makes carrying out transactions easily, ensuring compliance
of both parties involved with the rules and regulation. Let us have a look at the advantages of
this entity in brief, below:

 Ease of transaction.
 It is a secure way of dealing in a financial transaction at a negligible cost.
 Reduction in human-oriented errors.
 Faster processing of transactions.
 There is no need to search eligible counterparty to the transaction.

DISADVANTAGES

There are very few disadvantages to the clearinghouse. The clearinghouse system has
emerged due to flaws in the earlier physical settlement system. They made the clearinghouse
to advantage the public at large. It can never default due to stringent regulations imposed by
the government. We can better call it the limitations rather than the disadvantages.

 Limited settlement hours since the exchange is not available 24×7.

 A specific quantum of orders is required. So, you cannot trade in odd lots at your
convenience.
 A slower internet connection may delay placing your orders.
 There is a slight risk of default from the sub-brokers to the clearinghouse.

DIFFERENCE BETWEEN FORWARDS AND FUTURES

Basis of Difference Forwards Futures

1) Trading Traded by telephones or telex Traded in a competitive arena

(OTC). (recognized exchange).

2) Size of Contracts Decided between buyer and Standardized in each futures

seller. market.

3) Price of Contract Remains fixed till Maturity. Changes every day.

4) Market to Market Not done. Market to market everyday.

5) Margin No margin required Margins are to be paid by

both buyers and sellers.

6) Counter Party Risk Present. Not Present.

59
 STOCK MARKET

7) Number of contracts There can be any number of Number of contracts in a year

in a year contracts. is fixed.

8) Frequency of 90% of all forward contracts Very few futures contracts are
Delivery are settled by actual delivery. settled by actual delivery.

9) Liquidity No liquidity Highly liquid

10) Nature of Market Over the Counter. Exchange traded.

11) Mode of Delivery Specifically decided. Most of Standardized. Most of the

the contracts result in contracts are cash-settled.
delivery.

12) Transaction Costs Costs are based on bid-ask Include brokerage fees for
spread buy and sell orders.

UNIT-4
STOCK INDICES
Stock indices are benchmarks that track the performance of a group of stocks, representing a
specific portion of the stock market. They provide insights into market trends and the health of
the economy. Here are a few major stock indices:

1. S&P 500: Comprises 500 of the largest publicly traded companies in the U.S. It’s often
seen as a gauge of the overall U.S. stock market.
2. Dow Jones Industrial Average (DJIA): Includes 30 large, publicly traded companies in
the U.S. It’s one of the oldest indices and is often used as a barometer for the overall
market performance.
3. NASDAQ Composite: Includes over 3,000 stocks listed on the NASDAQ Stock
Exchange, with a heavy emphasis on technology and growth stocks.
4. Russell 2000: Tracks 2,000 small-cap U.S. companies, providing a measure of the
performance of smaller, emerging companies.
5. FTSE 100: Represents the 100 largest companies listed on the London Stock
Exchange. It’s a key indicator of the UK stock market’s performance.
6. DAX: The Deutscher Aktienindex (DAX) tracks 30 major German companies listed on
the Frankfurt Stock Exchange.
7. Nikkei 225: A major index in Japan, comprising 225 large, publicly traded companies
on the Tokyo Stock Exchange.

60
 STOCK MARKET
Indices can be price-weighted, market-cap-weighted, or equal-weighted, affecting how they
reflect the market’s movements. They are useful for investors to gauge market performance,
track trends, and make informed decisions.

TYPES OF INDEX
Stock indices come in various types, each designed to measure different segments of the
market or specific investment themes. Here’s an overview of the main types of indices:

1. Price-Weighted Index

 Example: Dow Jones Industrial Average (DJIA)

 Description: In a price-weighted index, the weight of each stock is based on its share
price. Higher-priced stocks have more influence on the index’s performance than lower-
priced stocks.

2. Market-Cap-Weighted Index

 Example: S&P 500, NASDAQ Composite

 Description: This type of index weights companies based on their total market
capitalization (stock price multiplied by the number of shares outstanding). Larger
companies have a bigger impact on the index.

3. Equal-Weighted Index

 Example: S&P 500 Equal Weight Index

 Description: Each stock in the index has the same weight regardless of its market
capitalization or share price. This type of index gives equal importance to each
company.

4. Fundamentally Weighted Index

 Example: FTSE RAFI Index Series

 Description: Stocks are weighted based on fundamental factors such as earnings,
sales, or book value, rather than market price.

5. Sector or Industry Index

 Example: Financial Select Sector SPDR Fund (XLF)

 Description: Tracks performance within a specific sector or industry, such as
technology, healthcare, or finance.

6. Thematic Index

 Example: MSCI ACWI IMI Clean Energy Index

 Description: Focuses on specific investment themes or trends, such as sustainability
or technological innovation.

61
 STOCK MARKET
7. Bond Index

 Example: Bloomberg U.S. Aggregate Bond Index

 Description: Measures the performance of the bond market or specific segments, such
as government or corporate bonds.

8. Commodity Index

 Example: S&P GSCI (Goldman Sachs Commodity Index)

 Description: Tracks the performance of a basket of commodities, such as oil, gold, or
agricultural products.

9. International Index

 Example: MSCI EAFE Index (Europe, Australasia, and Far East)

 Description: Measures the performance of international markets outside the U.S. and
Canada.

10. Regional Index

 Example: EURO STOXX 50 (Eurozone)

 Description: Focuses on a specific geographic region or economic area.

Each type of index serves a different purpose and can be useful for different investment
strategies or analytical needs.

SENSEX AND ITS CALCULATIONS

The Sensex, short for the Sensitive Index, is a major stock market index in India, representing
the performance of 30 large and actively traded companies on the Bombay Stock Exchange
(BSE). It serves as a benchmark for the Indian stock market and reflects the overall health of
the Indian economy.

Calculation of the Sensex

The Sensex is a market-capitalization weighted index. Here’s a step-by-step explanation of

how it’s calculated:

1. Selection of Stocks: The Sensex includes 30 large, well-established, and financially

sound companies listed on the BSE. These companies span various sectors of the
economy.
2. Free-Float Market Capitalization: The index is calculated based on the free-float
market capitalization of these 30 companies. Free-float market capitalization is the
market value of the shares available for trading. It excludes shares held by promoters,
government, or other strategic investors.

62
 STOCK MARKET
3. Base Year and Base Value: The Sensex was introduced with a base year of 1978-79
and a base value of 100. This means that the index value is compared to its value
during this base period.
4. Formula for Calculation:

The Sensex is calculated using the following formula:

Sensex=(Sum of Free-
Float Market Capitalization of the 30 StocksIndex Divisor)×100\text{Sensex} = \left(
\frac{\text{Sum of Free-Float Market Capitalization of the 30 Stocks}}{\text{Index
Divisor}} \right) \times 100Sensex=(Index DivisorSum of Free-
Float Market Capitalization of the 30 Stocks)×100

o Free-Float Market Capitalization: Calculated by multiplying the number of

shares available for trading (free-float) by the current market price of each stock.
o Index Divisor: This is a number used to maintain the continuity of the index and
adjust for stock splits, dividends, and other changes. The divisor is adjusted to
ensure that the changes in the market capitalization of the stocks do not skew
the index value due to corporate actions.
5. Adjustments: The Index Divisor is adjusted to ensure that the index value remains
consistent despite changes such as stock splits, changes in the number of shares, or
the addition/removal of stocks in the index. This helps maintain the integrity of the index
over time.

Example Calculation

Suppose the sum of the free-float market capitalization of the 30 stocks in the Sensex is
₹10,000 crore, and the index divisor is 500. The calculation for the Sensex would be:

Sensex=(10,000 crore500)×100=2,000\text{Sensex} = \left( \frac{10,000 \text{ crore}}{500}

\right) \times 100 = 2,000Sensex=(50010,000 crore)×100=2,000

This means that the Sensex value would be 2,000.

Updates and Rebalancing

 Periodic Reviews: The composition of the Sensex is reviewed periodically, typically

every six months, to ensure it reflects the top-performing companies on the BSE.
 Adjustments: The index is adjusted for corporate actions like mergers, acquisitions,
and other events that might affect the stock prices.

The Sensex provides investors and analysts with a snapshot of the performance of the Indian
stock market, making it a crucial indicator for both domestic and international stakeholders.

TYPES OF CLEARING MEMBERS

In the financial markets, clearing members play a crucial role in facilitating the settlement and
clearing of trades. They act as intermediaries between the trading parties and the

63
 STOCK MARKET
clearinghouse, ensuring that trades are settled efficiently and that the financial obligations of
both parties are met. Here are the main types of clearing members:

1. Individual Clearing Members

 Description: These are individual entities or firms that are members of the
clearinghouse and are directly responsible for clearing and settling trades for
themselves or their clients.
 Roles: They can be trading firms, banks, or other financial institutions that participate
directly in the clearing process.
 Examples: Large investment banks or brokerage firms.

2. General Clearing Members (GCMs)

 Description: General Clearing Members have the capability to clear trades not only for
their own accounts but also on behalf of other trading members (e.g., brokers or smaller
firms).
 Roles: They act as intermediaries in the clearing process, providing clearing services to
other members who may not have direct access to the clearinghouse.
 Examples: Large financial institutions or specialized clearing firms that offer clearing
services to other brokers.

3. Direct Clearing Members (DCMs)

 Description: Direct Clearing Members are entities that clear trades directly with the
clearinghouse for their own trading activities.
 Roles: They do not provide clearing services to other members but are responsible for
their own trades and settlements.
 Examples: Large trading firms or proprietary trading desks within financial institutions.

4. Clearing Brokers

 Description: Clearing Brokers act as intermediaries between their clients and the
clearinghouse. They are responsible for executing and clearing trades on behalf of their
clients.
 Roles: They handle the operational aspects of clearing and settlement for their clients,
including margin requirements and trade confirmations.
 Examples: Brokerage firms that clear trades on behalf of their customers.

5. Settlement Banks

 Description: Settlement Banks are banks that participate in the settlement process by
providing banking services related to the clearing and settlement of trades.
 Roles: They handle the transfer of funds and securities between clearing members and
ensure that financial transactions are properly settled.
 Examples: Major commercial banks with roles in clearing and settlement processes.

6. Self-Clearing Members

64
 STOCK MARKET
 Description: Self-Clearing Members are entities that handle their own clearing and
settlement processes, without relying on third-party clearing services.
 Roles: They manage their own trades and the associated settlement processes directly
with the clearinghouse.
 Examples: Some large financial institutions or trading firms that have the infrastructure
to clear and settle trades internally.

Functions of Clearing Members

 Trade Confirmation: Ensuring that the terms of the trade are confirmed between the
buying and selling parties.
 Margin Management: Handling margin requirements to cover potential losses and
ensuring that sufficient collateral is available.
 Settlement: Facilitating the transfer of funds and securities between the trading parties
to complete the transaction.
 Risk Management: Monitoring and managing risks associated with the clearing and
settlement process to prevent defaults.

Different clearing members play different roles based on their capabilities and the services they
provide, but all are essential in maintaining the integrity and efficiency of the financial markets.

UNIT-5

REGULATORY MECHANISM OF SEBI

The Securities and Exchange Board of India (SEBI) is the regulatory authority responsible for
overseeing and regulating the securities markets in India. Its primary aim is to protect investors'
interests, promote fair and transparent markets, and facilitate the growth of the securities
market. SEBI's regulatory mechanisms encompass various areas, including market regulation,
investor protection, and corporate governance. Here’s a breakdown of its regulatory
framework:

1. Regulation of Market Participants:

 Stock Exchanges: SEBI regulates stock exchanges and ensures that they operate
fairly and transparently. It has the authority to approve and oversee the functioning of
exchanges.
 Brokers and Dealers: SEBI sets guidelines and regulations for brokers, dealers, and
other intermediaries to ensure they operate ethically and transparently.
 Investment Advisors: It regulates and registers investment advisors to ensure they
provide unbiased and accurate advice.

2. Regulation of Financial Products:

 Mutual Funds: SEBI regulates mutual funds and their managers, ensuring that they
operate in the best interests of investors.

65
 STOCK MARKET
 Debentures and Bonds: It oversees the issuance and trading of debentures and
bonds, ensuring compliance with regulations.

3. Investor Protection:

 Disclosure Requirements: SEBI mandates comprehensive disclosure requirements

for listed companies, ensuring transparency in financial reporting and corporate
governance.
 Investor Education: It promotes investor education and awareness to help investors
make informed decisions.
 Complaint Redressal: SEBI provides mechanisms for investors to file complaints and
seek redressal against grievances related to market participants.

4. Regulation of Corporate Governance:

 Corporate Governance Norms: SEBI enforces corporate governance norms for listed
companies to ensure accountability and transparency in management.
 Listing Obligations and Disclosure Requirements (LODR): SEBI’s LODR
regulations mandate that listed companies adhere to stringent disclosure and
governance practices.

5. Market Surveillance and Enforcement:

 Monitoring Market Activities: SEBI monitors trading activities to prevent and detect
market manipulation, insider trading, and other fraudulent practices.
 Investigations and Penalties: SEBI has the authority to investigate and impose
penalties on entities and individuals violating market regulations. It can also refer cases
to enforcement agencies for criminal prosecution.

6. Regulation of New Products and Innovations:

 Approval of New Instruments: SEBI reviews and approves new financial products
and instruments to ensure they meet regulatory standards and do not pose undue risks
to investors.
 Regulatory Sandboxes: SEBI has introduced regulatory sandboxes to encourage
innovation while managing risks associated with new financial technologies and
products.

7. Policy Formulation and Amendments:

 Regulatory Framework: SEBI continuously reviews and updates its regulations to

adapt to changing market conditions and evolving global standards.
 Public Consultations: SEBI often seeks public comments and conducts consultations
before finalizing significant regulatory changes.

Overall, SEBI’s regulatory framework is designed to ensure the integrity and efficiency of the
Indian securities markets, fostering investor confidence and supporting market development.

66
 STOCK MARKET

POWERS AND FUNCTIONS OF SEBI

The Securities and Exchange Board of India (SEBI) is empowered with a broad range of
functions and powers to regulate and oversee the securities markets in India. Its powers and
functions are crucial for maintaining market integrity, protecting investors, and ensuring smooth
market operations. Here’s an overview:

Powers of SEBI

1. Regulatory Powers:
o Issuance of Regulations: SEBI can formulate and issue regulations for the
functioning of various market participants, including stock exchanges, brokers,
and investment advisors.
o Approval of Stock Exchanges: SEBI has the authority to recognize and
approve stock exchanges and set standards for their operations.
o Regulation of Intermediaries: It regulates intermediaries such as brokers,
merchant bankers, and portfolio managers to ensure compliance with market
rules.
2. Enforcement Powers:
o Investigative Powers: SEBI can investigate alleged violations of securities laws
and regulations. It has the authority to summon individuals, inspect records, and
conduct inquiries.
o Imposition of Penalties: SEBI can impose penalties and fines on individuals
and entities for non-compliance with securities laws and regulations.
o Suspension and Cancellation of Registration: It can suspend or cancel the
registration of market participants, including brokers and other intermediaries,
for violations of regulations.
3. Protective Powers:
o Investor Protection Measures: SEBI can take action to protect investors by
ensuring fair practices and transparency in the securities market.
o Redressal Mechanisms: It provides mechanisms for investors to file
complaints and seek redressal against grievances related to market practices.
4. Adjudicatory Powers:
o Adjudication of Disputes: SEBI has the power to adjudicate disputes related
to violations of securities laws and regulations. It can pass orders and directions
in such cases.
5. Rule-making Powers:
o Regulations and Guidelines: SEBI can issue regulations, guidelines, and
circulars to govern the functioning of securities markets and market participants.

Functions of SEBI

1. Regulation and Supervision:

67
 STOCK MARKET
o Market Regulation: SEBI regulates stock exchanges, clearing corporations,
and depositories to ensure smooth and orderly functioning of the securities
markets.
o Surveillance: It monitors trading activities and market trends to detect and
prevent market manipulation, insider trading, and other fraudulent practices.
2. Investor Protection and Education:
o Investor Awareness: SEBI promotes investor education and awareness
through various initiatives and programs.
o Grievance Redressal: It provides a platform for investors to lodge complaints
and seek redressal for issues related to market participants.
3. Promotion of Fair Practices:
o Code of Conduct: SEBI sets and enforces codes of conduct for market
intermediaries to ensure ethical practices.
o Corporate Governance: It mandates corporate governance norms for listed
companies to ensure transparency and accountability.
4. Development and Regulation of Financial Products:
o Approval of Financial Instruments: SEBI reviews and approves new financial
products and instruments to ensure they meet regulatory standards.
o Encouraging Innovation: It fosters innovation in the securities markets while
managing associated risks through regulatory sandboxes and other measures.
5. Policy Formulation:
o Regulatory Framework: SEBI formulates policies and regulations to enhance
market efficiency, protect investors, and ensure fair practices.
o Public Consultations: It often seeks public feedback and conducts
consultations before implementing significant regulatory changes.
6. Research and Analysis:
o Market Research: SEBI conducts research and analysis to understand market
trends, investor behavior, and regulatory impacts.
o Data Collection: It collects and analyzes data related to market activities to
inform policy-making and regulatory actions.

FUNCTIONS AND MECHANISM OF OTCEI

The Over-The-Counter Exchange of India (OTCEI) was an electronic trading platform designed
to facilitate the trading of securities, particularly those of small and medium-sized companies.
While its role has diminished over time with the rise of other trading platforms and exchanges,
it played a significant part in the Indian securities market history.

Functions of OTCEI

1. Trading Platform for Small and Medium Enterprises (SMEs):

o Access to Capital: OTCEI provided a platform for SMEs and companies that
were not able to list on major exchanges like the Bombay Stock Exchange
(BSE) or National Stock Exchange (NSE) due to stringent listing requirements.
This allowed smaller companies to raise capital by listing their shares.
o Liquidity and Marketability: By offering a trading platform, OTCEI helped in
providing liquidity and marketability for the shares of smaller companies.
2. Facilitation of Over-The-Counter Trading:

68
 STOCK MARKET
o Electronic Trading: OTCEI offered an electronic trading mechanism, which
was relatively advanced at the time, allowing for efficient trading of shares.
o Transparency: It aimed to bring transparency to the trading process by
providing a platform where trades could be executed electronically rather than
through traditional methods.
3. Regulation and Compliance:
o Listing Requirements: OTCEI had its own set of listing requirements, designed
to ensure that companies met certain standards before being listed. This was
intended to protect investors by ensuring a baseline level of corporate
governance and financial health.
o Disclosure: Companies listed on OTCEI were required to adhere to disclosure
norms, ensuring that investors had access to relevant information about the
companies they were investing in.
4. Investor Protection:
o Grievance Redressal: OTCEI had mechanisms for addressing investor
grievances and complaints related to trading and settlement processes.

Mechanisms of OTCEI

1. Trading System:
o Electronic Trading Platform: OTCEI utilized an electronic trading system that
allowed for the automatic execution of trades. This system provided a platform
for buyers and sellers to transact without the need for a physical trading floor.
o Order Matching: The system matched buy and sell orders based on price and
time priority, ensuring that trades were executed efficiently and transparently.
2. Listing and Compliance:
o Listing Process: Companies seeking to list on OTCEI had to fulfill certain
criteria related to financial performance, governance, and other factors. The
listing process involved the submission of detailed documents and adherence to
regulatory standards.
o Regulatory Framework: OTCEI operated under a regulatory framework that
included compliance with securities laws and regulations set by the Securities
and Exchange Board of India (SEBI).
3. Settlement and Clearing:
o Settlement Mechanism: OTCEI had a clearing and settlement mechanism to
ensure that trades were settled promptly and accurately. This involved the
transfer of securities and funds between buyers and sellers.
o Depository Services: OTCEI worked with depositories to facilitate the
electronic transfer of securities, reducing the risk associated with physical
certificates.
4. Market Surveillance:
o Monitoring Trades: OTCEI employed surveillance systems to monitor trading
activities, detect irregularities, and ensure that trading was conducted fairly.
o Regulatory Compliance: The exchange conducted regular checks to ensure
that listed companies and market participants adhered to regulatory
requirements and market rules.
5. Investor Education and Support:

69
 STOCK MARKET
o Educational Initiatives: OTCEI undertook efforts to educate investors about
the trading process, investment risks, and the benefits of trading on the OTC
platform.
o Support Services: The exchange provided support services to investors,
including information about listed companies and trading procedures.

70