Chapter 4

Secondary Markets
Introduction
• The secondary market is where securities once issued are bought and
sold between investors.
• The instruments traded in secondary markets include securities issued
in the primary market as well as those that were not issued in the
primary market, such as privately placed debt or equity securities and
derivatives of primary securities created and traded by financial
intermediaries.  
• Transactions in the secondary market do not result in additional
capital to the issuer as funds are only exchanged between investors.
Functions of Secondary Markets
• Liquidity
If an investor wants to sell off equity shares or debentures purchased earlier, it can be done
in the secondary market.
• Price Discovery
Each buy or sell transaction reflects the individual assessment of investors about the
fundamental worth of the security.
• Information Signalling
This information‐signaling function of prices works like a continuous monitor of issuing
companies, and in turn forces issuers to improve profitability and performance.
• Indicating Economic Activity
A market index is generated from market prices of a representative basket of equity shares.
Movements in the index represent the overall market direction.
• Market for Corporate Control
Stock markets function as markets for efficient governance by facilitating changes in
corporate control. If management is inefficient, a company could end up performing below its
potential.
Market Structure
• Stock Exchange - entities which provide infrastructure for trading in securities  
• Members - The trading members of stock exchanges are also called stock brokers; and their
affiliates‐ called sub‐brokers
• Investors - individuals and institutions that buy and sell securities
• Issuers - companies that issue securities
• Trading, Clearing and Settlement - firms that facilitate secondary market activity
• Clearing Corporation - They function as counter‐parties for all trades executed on the exchange
they are affiliated with
• Risk Management - Stock exchanges have risk management systems to insure against the event
that members of the exchange may default on payment or delivery obligations.
• Depositories and Depository Participants -Issuers get their securities admitted to the depositories,
where they are held as electronic entries against investor names, without any paper certificate.
• Custodians - Custodians are institutional intermediaries, who are authorized to hold funds and
securities on behalf of large institutional investors such as banks, insurance companies, mutual
funds, and foreign portfolio investors (FPIs).
• Regulation - authority that oversees activities of all the participants in the market  
Brokers and Client Acquisition
• Brokers and Sub‐brokers

A broker is a member of a recognised stock exchange who is registered with SEBI and permitted to trade on the
screen‐based trading system of stock exchanges.  A sub‐broker is not a member of any recognised stock
exchange but is registered with SEBI through a registered stock broker and is affiliated to the said broker and
enables investors to trade in securities through that broker

Brokers receive a commission for their services, which is known as brokerage. Maximum brokerage chargeable
is fixed by individual stock exchanges.
The responsibilities of a broker include the following:

 Maintain record of client transactions and operate separate trading account for clients and for proprietary
trades.
 Maintain funds of clients in a separate account.
 Issue of contract note to clients within 24hrs of the execution of the order.
 Collect funds or securities from client prior to the pay‐in day in the settlement cycle of the relevant
exchange.
 Make delivery or payment to the client within 24 hrs of pay–out from the stock exchange.
 Appoint compliance officer who will be responsible for monitoring compliance with rules and regulations
applicable to the functions of a broker and for redressal of investor’s grievances.
 Client Acquisition Process

• A trading member has to complete know your customer (KYC) formalities and in‐person verification (IPV)
before opening client accounts.

• Brokers are expected to diligently comply with KYC norms and check all supporting documents. The uniform
KYC norms notified by SEBI applies to stock brokers too apart from depository participants,  mutual funds ,
portfolio managers and other securities market intermediaries. 

• A Unique Client Code (UCC) has to be generated by the broker for each client. The UCC has to be submitted
while placing orders or carrying out trades in the exchange. 
3‐in‐1 Accounts

• The 3‐in‐1 account allows an investor to merge the savings bank, demat and trading accounts.

• A 3‐in‐1 account uses a trading platform as its front end, with the bank and demat account linked in the
background.

• For example, funds can be easily transferred from the bank account to the trading account in case of
purchase of securities and back to the bank account whenever the securities are sold or redeemed.
The advantages of a 3‐in‐1 account are:

 It reduces manual paperwork involving cheques, fund transfers, contract notes, account statements, order
placement and hassles of branch banking transactions.
 More convenient as investor does not need to physically co‐ordinate with the bank, broker and depository
participant.
 It enables efficient trading as the trading platform is linked through the broker’s terminals to the live
market, enabling access to real‐time information on prices and market activity
Power of Attorney
• Power of Attorney (PoA) is a voluntary delegation of power by the
investor to a broker or depository participant (DP) to facilitate the
delivery and receipt of shares and funds to settle the obligations
arising out of a trade or transaction
• Though PoA is not mandatory for opening a trading account with a
broker, it is required when an online 3‐in‐1 account is opened. This is
because PoA is needed for automatic debit from the client’s bank
account upon purchase of shares and automatic debit from the
client’s demat account upon sale of shares.   
Trade Execution
• Trading System
Stock exchanges offer two types of trading systems: open outcry and
online trading.
Under the open outcry system traders gather physically on trading floor
and shout or signal their bid and offer prices.
Online systems allow traders to trade electronically by connecting to
the system without being physically located at the exchange.
The fully automated computerized mode of trading on BSE is known as
BOLT (BSE On Line Trading) and on NSE is called NEAT (National
Exchange Automated Trading) System and on MSEI it is called TWS
(Trader Work Station).
The sequence of trade execution is as
follows:
• Placing of an order to buy or sell with the broker
• Routing of order by broker to trading system
• Display of order on the trading screen
• Matching of order electronically
• Confirmation of trade f. Generation of contract note
• Orders
An order is an instruction to buy or sell a specific quantity of shares in
the stock market. 
An order is complete only if it correctly indicates the name of the listed
company, whether to buy or sell, and the number of shares.
Brokers do not accept orders from unknown investors; it is mandatory
for an order to be identified by the unique client code (UCC) of the
investor.
Each security listed on an exchange has a securities symbol and a
unique International Securities Identification Number (ISIN). The
symbol is usually an abbreviation of the issuing company name.
The ISIN is a unique 12‐digit number that identifies a security in the
depository system.
Types of Orders

 Limit Order - A limit order is placed when an investor wants a trade to get executed only if the desired price
becomes available in the market.
 Market Order- A market order is placed when the investor is willing to accept whatever the current price in
the market is and wants to ensure that the stocks are either bought or sold immediately.
 Immediate or Cancel Order- An Immediate or Cancel (IOC) order allows the user to buy or sell a security as
soon as the order is released into the system, failing which the order is cancelled from the system.
 Stop‐Loss order- Stop‐loss means acting when prices move in the direction opposite to what was desired. 
 Disclosed Quantity Order- A large institutional investor may not want the market to know that they are
placing orders to buy or sell a large quantity of shares.
 Day Orders and GTC Orders- A Day order is valid only until the end of the trading day on which it is placed.
A good till cancelled (GTC) order remains in the system until it is executed.
• Contract Note
A contract note is a confirmation of trades in equity shares completed
on a particular day for and on behalf of a client.  
The broker has to issue a contract note in the prescribed format that
contains details of the trade, settlement, brokerage, securities
transaction tax and service tax information.
The contract note is a proof of transaction for both parties and is
referred to in case of dispute over the transaction.  
Electronic Contract Notes (ECNs) may be sent to a client by email only
on the consent of the client. ECNs are required to be digitally signed,
tamper‐proof and password protected.
• Cost of Trading

All trading transactions on a stock exchange involve costs, in addition to

the price paid for purchasing shares. These additional costs are called
trading costs.
Trading costs can be classified into three categories:
o User charges- Investors pay user charges for using the infrastructure of
brokers, stock exchanges, and depositories.
o Statutory levies- The statutory charges imposed on trading are
securities transaction tax (STT), Goods and Services Tax (GST), stamp
duty and SEBI’s turnover tax.
o Spread and impact cost- Spread and impact cost are not fees that are
directly imposed on investors. These are costs that arise because of
market imperfections or lack of liquidity. The investor pays higher price
for buying and receives a lower price on selling due to these costs.  
Settlement of trade
• Delivery - Settle all trades taking place over a trading cycle (day = T)
on the second working day following the trade (day=T+2).
• Squaring off a trade- Buy or sell a share on a trading day and reverse
their trade before the market closes on the same day.
• Settlement cycle- The period from day T to the completion of all
settlement obligation.
• Volatility - Measure of riskiness in share prices.  
Settlement cycle
Identification and communication of
settlement obligation

Pay-in
Securities pay-in Fund pay-in

Pay‐out
Securities pay-out Fund pay-out
 Margins
Amount of funds that one must deposit with the
clearing corporation in order to cover the risk of non‐
payment of dues or non‐delivery of securities.

Mark to Market Margin

Value at Risk Margin
Extreme Loss Margin computed at the end of each trading
Measure the probability of loss of value day by comparing transaction price
Covering the losses that could occur
in a stock over a period, based on an with the closing price of the share.
outside the coverage of VaR margins.
analysis of historical prices and volatility.
Short Delivery and Payment
• Auction - If a member is not able to pay‐in securities on the settlement day, it
is known as a securities shortage or short delivery. If the shares are delivered
but rejected by the depository for technical reasons, it is a bad delivery. Buyer
has paid good money and needs to receive delivery of shares.   The clearing
corporation conducts an auction session to buy the required shares and deliver
to the buyer.
• Funds Shortage - Members must make sure that they have adequate funds in
their clearing bank accounts. A penal charge on the amount outstanding at the
end of the day has to be paid until full payment has been made. The trading or
clearing facility is withdrawn until the shortages are made up. Repeat
defaulters may be asked to maintain a deposit equal to their cumulative fund's
shortage with the clearing corporation as 'funds shortage collateral'. 
 Corporate
Actions 

Stock benefits Cash benefits

• Record Date - The date on which all those who are on record as
shareholders of a company get the benefit of corporate actions of
that company.
• Cum basis and Ex basis - When a security is traded on cum basis, it
means that it incorporates the benefit of the corporate action in its
price. Once it goes ex‐basis, the buyer no longer has the benefit of the
corporate action.  
• Price Adjustments - The stock exchange carries out adjustments to
traded price on the last day on which a security is traded on cum basis
in the market, after the close of trading hours.
• Circuit breaker - If there is an abnormal percentage change in the
price of a stock, the exchange can suspend trading in that scrip. Such
heavy movement in price is called “hitting the circuit breaker.”
Market Information and Regulation
• Market capitalization - The number of shares outstanding multiplied by
the market price per share.
• Blue‐chip stocks - Represent the largest companies by market cap that
also enjoy a high level of liquidity. less volatile.
• Mid cap stocks - Refer to those companies which enjoy a good level of
liquidity but are medium in terms of size.
•  Small cap stocks - Stocks that are smaller in size and therefore do not
enjoy much liquidity.
• Market Turnover - Indicates how much trading activity took place in it
on a given business day.
• Market Indices - A market index tracks the market movement by using the
prices of a small number of shares chosen as a representative sample.
 Stocks included in an index are also quite liquid, making it possible for
investors to replicate the index at a low cost.Eg Nifty 50,Sensex
• Uses of a stock market index
• Widely reported in the news, financial press and electronic information
media and thus real time data on market movements is easily available to
the investing public.  
• The index value is a leading indicator of overall economic or sector
performance and effectively captures the state of financial markets at a
point of time.
• A representative index serves as a performance benchmark. The returns
earned by equity mutual funds or other investment vehicles are often
compared with the returns on the market index
Disclosures by Listed Companies
• To provide facilities for prompt transfer, registration, sub‐division and
consolidation of securities.
• To give proper notice of closure of transfer books and record dates.
• To forward 6 copies of unabridged Annual Reports, Balance Sheets and Profit and
Loss Accounts to the Exchanges.
• To file shareholding patterns and financial results on a quarterly basis.
• To intimate promptly to the Exchange the happenings which are likely to
materially affect the financial performance of the Company and its stock price.
This includes compliance with regulations on insider trading, and regulations on
takeovers and acquisitions.
• To comply with the conditions of Corporate Governance, etc.  
Risk Management Systems

Capital Margins and

Pay‐in Shortfall Core Settlement
Adequacy Penalties for
Penalties Guarantee Fund
Norms Shortfall/Default

Inspection of Price Monitoring On‐line

Books   and Action Monitoring
Investors have a right to
• Get Unique Client Code (UCC) allotted
• Get a copy of KYC and other documents executed  Get trades executed in only his/her UCC
• Place order on meeting the norms agreed to with the Member  Get best price
• Get Contract note for trades executed
• Know details of charges levied
• Receive funds and securities on time
• Receive statement of accounts from trading member
• Ask for settlement of accounts
• Take up a complaint against member with the exchange
• Take up a complaint against listed company
• File arbitration against member if there is a dispute
• Challenge the arbitration award before court of law
Investors have the obligations to
• Execute Know Your Client (KYC) documents and provide supporting documents
• Understand the voluntary conditions being agreed with the member
• Understand the rights given to the Members
• Read Risk Disclosure Document.
• Understand the product and operational framework and deadlines  Pay margins.
• Pay funds and securities for settlement on time.
• Verify details of trades.
• Verify bank account and DP account for funds and securities movement.
• Review contract notes and statement of account.
• Take up complaint within reasonable time.
• Support complaints with appropriate documents.
• Provide additional information that is called for dispute resolution
• Participate in dispute resolution meetings
Grievance Redressal
Stock exchanges have special cells that deal with the complaints of
investors against members or against listed companies. The BSE has
established a Department of Investors Services (DIS), NSE has an
Investor Services Cell and MSEI has Investors’ Grievances Redressal
Committee (IGRC) to address investor grievances. Investors could lodge
their complaints in the format prescribed by the Exchange along with
the supporting documents.