BBA FIIM

UNIT 1
Meaning, Nature and role of Capital Market
Capital Market is one of the significant aspect of every financial market. Hence it is necessary
to study its correct meaning. Broadly speaking the capital market is a market for financial assets
which have a long or indefinite maturity. Unlike money market instruments the capital market
instruments become mature for the period above one year. It is an institutional arrangement to
borrow and lend money for a longer period of time. It consists of financial institutions like IDBI,
ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business
units and corporate are the borrowers in the capital market. Capital market involves various
instruments which can be used for financial transactions. Capital market provides long term debt
and equity finance for the government and the corporate sector. Capital market can be classified
into primary and secondary markets. The primary market is a market for new shares, where as in
the secondary market the existing securities are traded. Capital market institutions provide rupee
loans, foreign exchange loans, consultancy services and underwriting.

Significance, Role

Like the money market capital market is also very important. It plays a significant role in the
national economy. A developed, dynamic and vibrant capital market can immensely contribute
for speedy economic growth and development.

Let us get acquainted with the important functions and role of the capital market.

Mobilization of Savings: Capital market is an important source for mobilizing idle savings from
the economy. It mobilizes funds from people for further investments in the productive channels
of an economy. In that sense it activate the ideal monetary resources and puts them in proper
investments.

Capital Formation: Capital market helps in capital formation. Capital formation is net addition
to the existing stock of capital in the economy. Through mobilization of ideal resources it
generates savings; the mobilized savings are made available to various segments such as
agriculture, industry, etc. This helps in increasing capital formation.

Provision of Investment Avenue: Capital market raises resources for longer periods of time.
Thus it provides an investment avenue for people who wish to invest resources for a long period
of time. It provides suitable interest rate returns also to investors. Instruments such as bonds,
equities, units of mutual funds, insurance policies, etc. definitely provides diverse investment
avenue for the public.
Speed up Economic Growth and Development: Capital market enhances production and
productivity in the national economy. As it makes funds available for long period of time, the
financial requirements of business houses are met by the capital market. It helps in research and
development. This helps in, increasing production and productivity in economy by generation of
employment and development of infrastructure.

Proper Regulation of Funds: Capital markets not only helps in fund mobilization, but it also
helps in proper allocation of these resources. It can have regulation over the resources so that it
can direct funds in a qualitative manner.

Service Provision: As an important financial set up capital market provides various types of
services. It includes long term and medium term loans to industry, underwriting services,
consultancy services, export finance, etc. These services help the manufacturing sector in a large
spectrum.

Continuous Availability of Funds: Capital market is place where the investment avenue is
continuously available for long term investment. This is a liquid market as it makes fund
available on continues basis. Both buyers and seller can easily buy and sell securities as they are
continuously available. Basically capital market transactions are related to the stock exchanges.
Thus marketability in the capital market becomes easy.

Importance or Functions of Capital Market:

The capital market plays an important role immobilising saving and channel is in them into
productive investments for the development of commerce and industry. As such, the capital
market helps in capital formation and economic growth of the country. We discuss below the
importance of capital market.

The capital market acts as an important link between savers and investors. The savers are lenders
of funds while investors are borrowers of funds. The savers who do not spend all their income
are called. “Surplus units” and the borrowers are known as “deficit units”. The capital market is
the transmission mechanism between surplus units and deficit units. It is a conduit through which
surplus units lend their surplus funds to deficit units.

Funds flow into the capital market from individuals and financial intermediaries which are
absorbed by commerce, industry and government. It thus facilitates the movement of stream of
capital to be used more productively and profitability to increases the national income.

Surplus units buy securities with their surplus funds and deficit units sells securities to raise the
funds they need. Funds flow from lenders to borrowers either directly or indirectly through
financial institutions such as banks, unit trusts, mutual funds, etc. The borrowers issue primary
securities which are purchased by lenders either directly or indirectly through financial
institutions.

The capital market prides incentives to savers in the form of interest or dividend and transfers
funds to investors. Thus it leads to capital formation. In fact, the capital market provides a
market mechanism for those who have savings and to those who need funds for productive
investments. It diverts resources from wasteful and unproductive channels such as gold,
jewellery, real estate, conspicuous consumption, etc. to productive investments.

A well-developed capital market comprising expert banking and non-banking intermediaries

brings stability in the value of stocks and securities. It does so by providing capital to the needy
at reasonable interest rates and helps in minimising speculative activities.

The capital market encourages economic growth. The various institutions which operate in the
capital market give quantities and qualitative direction to the flow of funds and bring rational
allocation of resources. They do so by converting financial assets into productive physical assets.
This leads to the development of commerce and industry through the private and public sector,
thereby inducing economic growth.

In an underdeveloped country where capital is scarce, the absence of a developed capital market
is a greater hindrance to capital formation and economic growth. Even though the people are
poor, yet they do not have any inducements to save. Others who save, they invest their savings in
wasteful and unproductive channels, such as gold, jewellery, real estate, conspicuous
consumption, etc.

Such countries can induce people to save more by establishing banking and non-banking
financial institutions for the existence of a developed capital market. Such a market can go a long
way in providing a link between savers and investors, thereby leading to capital formation and
economic growth.

Reforms of capital market

The Indian capital market has witnessed major reforms in the decade of 1990s and thereafter. It
is on the verge of the growth.

Thus, the Government of India and SEBI has taken a number of measures in order to improve the
working of the Indian stock exchanges and to make it more progressive and vibrant.

The major reforms undertaken in capital market of India includes:-

Establishment of SEBI: The Securities and Exchange Board of India (SEBI) was established in
1988. It got a legal status in 1992. SEBI was primarily set up to regulate the activities of the
merchant banks, to control the operations of mutual funds, to work as a promoter of the stock
exchange activities and to act as a regulatory authority of new issue activities of companies. The
SEBI was set up with the fundamental objective, “to protect the interest of investors in securities
market and for matters connected therewith or incidental thereto.”

The main functions of SEBI are:-

• To regulate the business of the stock market and other securities market.
 • To promote and regulate the self regulatory organizations.
• To prohibit fraudulent and unfair trade practices in securities market.
• To promote awareness among investors and training of intermediaries about safety of
market.
• To prohibit insider trading in securities market.
• To regulate huge acquisition of shares and takeover of companies.

Establishment of Creditors Rating Agencies: Three creditors rating agencies viz. The Credit
Rating Information Services of India Limited (CRISIL – 1988), the Investment Information and
Credit Rating Agency of India Limited (ICRA – 1991) and Credit Analysis and Research
Limited (CARE) were set up in order to assess the financial health of different financial
institutions and agencies related to the stock market activities. It is a guide for the investors also
in evaluating the risk of their investments.

Increasing of Merchant Banking Activities: Many Indian and foreign commercial banks have
set up their merchant banking divisions in the last few years. These divisions provide financial
services such as underwriting facilities, issue organising, consultancy services, etc. It has proved
as a helping hand to factors related to the capital market.

Candid Performance of Indian Economy: In the last few years, Indian economy is growing at
a good speed. It has attracted a huge inflow of Foreign Institutional Investments (FII). The
massive entry of FIIs in the Indian capital market has given good appreciation for the Indian
investors in recent times. Similarly many new companies are emerging on the horizon of the
Indian capital market to raise capital for their expansions.

Rising Electronic Transactions: Due to technological development in the last few years. The
physical transaction with more paper work is reduced. Now paperless transactions are increasing
at a rapid rate. It saves money, time and energy of investors. Thus it has made investing safer and
hassle free encouraging more people to join the capital market.

Growing Mutual Fund Industry: The growing of mutual funds in India has certainly helped
the capital market to grow. Public sector banks, foreign banks, financial institutions and joint
mutual funds between the Indian and foreign firms have launched many new funds. A big
diversification in terms of schemes, maturity, etc. has taken place in mutual funds in India. It has
given a wide choice for the common investors to enter the capital market.

Growing Stock Exchanges: The numbers of various Stock Exchanges in India are increasing.
Initially the BSE was the main exchange, but now after the setting up of the NSE and the
OTCEI, stock exchanges have spread across the country. Recently a new Inter-connected Stock
Exchange of India has joined the existing stock exchanges.

Investor’s Protection: Under the purview of the SEBI the Central Government of India has set
up the Investors Education and Protection Fund (IEPF) in 2001. It works in educating and
guiding investors. It tries to protect the interest of the small investors from frauds and
malpractices in the capital market.
Growth of Derivative Transactions: Since June 2000, the NSE has introduced the derivatives
trading in the equities. In November 2001 it also introduced the future and options transactions.
These innovative products have given variety for the investment leading to the expansion of the
capital market.

Insurance Sector Reforms: Indian insurance sector has also witnessed massive reforms in last
few years. The Insurance Regulatory and Development Authority (IRDA) was set up in 2000. It
paved the entry of the private insurance firms in India. As many insurance companies invest their
money in the capital market, it has expanded.

Commodity Trading: Along with the trading of ordinary securities, the trading in commodities
is also recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of
such transactions is growing at a splendid rate.

Apart from these reforms the setting up of Clearing Corporation of India Limited (CCIL),
Venture Funds, etc., have resulted into the tremendous growth of Indian capital market.

Government Securities Market

The Reserve Bank of India (RBI) defines government securities as “tradable instruments
issued by the Central Government or State Governments.” These securities carry a minimum
risk of default and are sometimes called “risk-free gilt-edged instruments.” The following are
some securities offered by the RBI:

Treasury Bills

These are short-term government securities with maturities of up to one year. They are currently
issued in three different types, that is, the ninety-one day, the one hundred and eighty-two day,
and the three hundred and sixty-four day bills. Since they do not pay interest, the investor’s profit
is the difference between the discounted issue price and the face value. The RBI performs
weekly auctions to issue the treasury bills.

Cash Management Bills

These are short-term securities that are highly flexible since they can be issued when needed.
Their tenure and date of issue are based on the temporary cash needs of the government;
however, the chosen tenure must still be less than 91 days. Like Treasury Bills, they are given at
discounts on the face value via RBI auctions.

Dated Government Securities

These are long-term securities that have either a fixed or floating rate of interest. The investor
benefits from the interest paid (coupon) on each bond. These securities are termed “dated”
because of the explicitly stated date of maturity; for instance, a January 1st, 2019 security will
mature on January 1st of 2019. The RBI sells these securities via auctions. The main investors in
dated securities are primary dealers such as commercial banks and insurance companies.
Examples of dated securities are fixed and floating rate bonds, zero coupon bonds, capital
indexed bonds, and bonds with call or put options.

State Development Loans

These are dated securities that are issued by state governments for purposes of meeting their
budgetary requirements. The RBI facilitates the issuance of these security types via auctions
through the Negotiated Dealing System. These auctions are usually done once every two weeks.
The rates of interest for these securities are determined at the time of auction, though their rates
are often slightly higher than for the Dated Government Securities.

Trading of Securities
Trading securities is a category of securities that includes both debt securities and equity
securities, and which an entity intends to sell in the short term for a profit that it expects to
generate from increases in the price of the securities. This is the most common classification
used for investments in securities.

Trading is usually done through an organized stock exchange, which acts as the intermediary
between a buyer and seller, though it is also possible to directly engage in purchase and sale
transactions with counterparties.

Trading securities are recorded in the balance sheet of the investor at their fair value as of the
balance sheet date. This type of marketable security is always positioned in the balance sheet as a
current asset.

If there is a change in the fair value of such an asset from period to period, this change is
recognized in the income statement as a gain or loss.

Other types of marketable securities are classified as available-for-sale and held-to-maturity.

Stock Exchange and New issues Markets:

Nature, Structure, Functioning and
Limitations
The stock market deals in long-term securities both private and government. It is the most
important component of the capital market. The latter deals in long-term funds of all kinds,
whether raised through open-market securities or through negotiated loans not resulting in
market paper.
Open-market securities are securities (or market paper) that are bought and sold openly in the
market (like marketable goods) and can change hand any number of times. The negotiated loans
have to be negotiated directly (or through a broker) between the borrower and the lender. They
appear only in the account books of the lenders and the borrowers’ promissory notes which are
not salable in the market. The scope and structure of the stock or securities market are shown in
Figure 3.2.

The stock market comprises several distinct markets in securities. The most important distinction
is that between the market for corporate securities and the market for government
securities.Corporate securities are instruments for raising long- term corporate capital from the
public.

The stock market organization provides separate arrangements for the new issues of securities
and for buying and selling of old securities. The former market is known as the ‘new issues
market’ and the latter market as the ‘secondary market’. Both kinds of markets are essential for
servicing corporate borrowers and investors.

The New Issues Market:

The essential function of the new issues market is to arrange for the raising of new capital by
corporate enterprises, whether new or old. This involves attracting new investible resources into
the corporate sector and their allocation among alternative uses and users. Both ways the role is
very important.

How fast the corporate industrial sector grows depends very much on the inflow of resources
into it, apart from its own internal savings. Equally important is the movement of sufficient
venture capital into new fields of manufacturing crucial to the balanced growth of industries in
the economy and in new regions for promoting balanced regional development.
The new issues may take the form of equity shares, preference shares or debentures. The firms
raising funds may be new companies or existing companies planning expansion. The new
companies need not always be entirely new enterprises. They may be private firms already in
business, but ‘going public’ to expand their capital bases. ‘Going public’ means becoming public
limited companies to be entitled to raise funds from the general public in the open market.

For inducing the public to invest their savings in new issues, the services of a network of
specialised institutions (underwriters and stockbrokers) is required. The more highly developed
and efficient this network, the greater will be the inflow of savings into organized industry. Till
the establishment of the Industrial Credit and Investment Corporation of India (ICICI) in 1955,
this kind of underwriting was sorely lacking in India. Instead, a special institutional arrangement,
known as the managing agency system had grown. Now it has become a thing of the past.

The new institutional arrangements for new corporate issues in place of the discredited managing
agency system started, taking shape with the setting up of the ICICI in 1955. Soon after (1956)
the LIC joined hands. The new system has already attained adulthood under the leadership of the
Industrial Development Bank of India (IDBI).

Apart from the ICICI and the other important participants in the new issues market is the major
term- lending institutions such as the UTI, the IFCI, commercial banks. General Insurance
Corporation (GIC) and its subsidiaries, stock brokers, and investment trust. Foreign institutional
funds from the World Bank and its affiliates, International Development Association (IDA) and
International Finance Corporation, are also channeled through the all-India term-lending
institutions (IDBI, ICICI, and IFCI).

Managing successful floatation of new issues involves three distinct services:

(i) Origination,

(ii) Underwriting and

(iii) Distribution of new issues.

The origination requires careful investigation of the viability and prospectus of new projects.
This involves technical evaluation of a proposal from the technical-manufacturing angle, the
availability of technical know- how, land, power, water and essential inputs, location, the
competence of the management, the study of market demand for the product (s), domestic and
foreign, over time, financial estimates of projected costs and returns, the adequacy and structure
of financial arrangements (promoters’ equity, equity from the public, debt-equity ratio, short-
term funds, liquidity ratios, foreign exchange requirement and availability), gestation lags, etc.,
and communication of any deficiencies in the project proposal to the promoters for remedial
measures.

All this requires well-trained and competent staff. A careful scrutiny and approval of a new issue
proposal by well-established financial institutions known for their competence and integrity
improves substantially its acceptability by the investing public and other financial institutions.
This is especially true of issues of totally new enterprises.

Underwriting means guaranteeing, purchase of a stipulated amount of a new issue at a fixed

price. The purchase may be for sale to the public or (for one’s own portfolio or for both the
purposes. If the expected sale to the public does not materialize, the underwriter absorbs the
unsold stock in its own portfolio. The underwriter assumes this risk for commission, known as
underwriter’s commission.

The company bringing out the new issue agrees to bear this extra cost of raising funds, because
thereby it is assured of funds and the task of sale of stock to the public or others is passed on
entirely to underwriters. Mostly, underwriting is done by a group of underwriters, one or more of
whom may act as group leaders. The group (or consortium) underwriting distributes risks of
underwriting among several underwriters and enhances substantially the capacity of the system
to underwrite big issues.

Distribution means sale of stock to the public. The term-lending institutions, the LIC, the UTI
and several other financial institutions^ usually underwrite new issues as direct investments for
their own portfolios. For them, there is no problem of sale of stock to the public. But, under the
law, a part of the new public issue must be offered to the general public. This is placed with
stockbrokers who have a system of inviting subscriptions to new issues from the public.

In normal times it is their distributive capacity which determines the extent of the public
participation in new issues. During periods of stock market boom the demand for new issues
from the public also goes up. New issues of well-known houses and issues underwritten by
strong institutions generally have a good public response.

It is the placing of the issues of small companies that continues to be the Achilles’ heels of the
new issues market. For loosening the grip of monopoly houses on the industrial economy of the
country, it is necessary that new entrepreneurs are encouraged. For this, special efforts need be
stepped up further for promoting small issues.

Broadly speaking, there are three main ways of floating new issues:

(i) By the issue of a prospectus to the public,

(ii) By private placement and

(iii) By the rights issue to the existing shareholders.

What we have described above is the first method. The issue of a public prospectus giving details
about the company, issue, and the underwriters is the last act in the drama and is an open
invitation to the public to subscribe to the issue. Private placement means that the issue is not
offered to the general public for subscription but is placed privately with a few big financiers.
This saves the company the expenses of public placement. It is also faster. Rights issue means
issue of rights (invitations) to the existing shareholders of an old corporation to subscribe to a
part or whole of the new issue in a fixed proportion to their shareholding. Such an issue is always
offered at a certain discount from the going market price of the already-trading shares of the
company.

The discount is in the nature of a bonus to the shareholders. Obviously, a rights issue is open
only to an existing public limited corporation, not to a new one. Old corporations also increase
their capitalisation (paid-up capital) by declaring bonus to their shareholders, which means issue
of new shares to them in a fixed ratio to their shareholdings without charging any price from
them. This is a way of converting a part of accumulated reserves into companies paid- up capital.

The Secondary Market in Old Issues:

This market deals in existing securities. Its main function is to provide liquidity to such
securities. Liquidity of an asset means its easy convertibility into cash at short notice and with
minimal loss of capital value. This liquidity is provided by providing a continuous market for
securities, that is, a market where a security cart be bought or sold at any time during business
hours at small transaction cost and at comparatively small variations from the last quoted price.

This, of course, is true of only ‘active’ securities for which there are always buyers and sellers in
the market. ‘Activeness’ is a property of individual securities, not of the market. The function of
providing liquidity to old stocks is important both for attracting new finance and in other ways. It
encourages prospective investors to invest in securities, old or new, because they know that any
time they want to get out of them into cash, they can go to the market and sell them off.

In the absence of any organized securities market, this will not be easily feasible. So, the
investing public will keep away from securities. Then, the secondary market provides an
opportunity to all concerned to invest in securities and when they like. This opens a way for
continuous inflow of funds into the market.

This is especially important for such investors who do not want to risk their funds by investing in
new ventures, but are perfectly willing to invest in the securities of on-going concerns. On the
other end, there are venturesome investors who invest in new issues in the hope of making
capital gains later when the new concerns have established themselves well.

In a sense, they season new issues and sell them off when the market acceptability of these issues
has improved. With their funds released from sale of their old holdings, they can move into other
new issues coming into the market. Thus, investment into new issues is facilitated greatly by the
operations of the secondary market.

The new investment is influenced in another way too by what is happening in the secondary
market. The latter acts as an important indicator of the investment climate in the economy. When
stock prices of existing securities are rising and the volume of trading activity in the secondary
market goes up, new issues also tend to increase as the new issues market (underwriters,
stockbrokers, and investors) is (are) better prepared and more willing to accept new issues. This
is also a good time for companies to come forward with new issues.

When the secondary market is in doldrums, the new issues market also languishes. The
underwriters are reluctant to underwrite and stockbrokers reluctant to assume the responsibility
of selling new issues to the public. Then, firms are also advised to postpone their new issues for
better times.

There are two segments of the secondary market:

(a) Organized stock exchange,

(b) Over-the-counter market.

The latter deals in such securities as are not ‘listed’ on an organized stock exchange. These are
securities of small companies and have only a limited market. Their prices are determined
through direct negotiation between stock brokers and not through open bidding as is the case
with ‘listed’ securities on a stock exchange. The main action of the stock market is concentrated
on these exchanges. We explain briefly their organization and functioning.

9 Most Important Functions of Stock Exchange/Secondary Market

1. Economic Barometer:

A stock exchange is a reliable barometer to measure the economic condition of a country.

Every major change in country and economy is reflected in the prices of shares. The rise or fall
in the share prices indicates the boom or recession cycle of the economy. Stock exchange is also
known as a pulse of economy or economic mirror which reflects the economic conditions of a
country.

2. Pricing of Securities:

The stock market helps to value the securities on the basis of demand and supply factors. The
securities of profitable and growth oriented companies are valued higher as there is more demand
for such securities. The valuation of securities is useful for investors, government and creditors.
The investors can know the value of their investment, the creditors can value the
creditworthiness and government can impose taxes on value of securities.

3. Safety of Transactions:

In stock market only the listed securities are traded and stock exchange authorities include the
companies names in the trade list only after verifying the soundness of company. The companies
which are listed they also have to operate within the strict rules and regulations. This ensures
safety of dealing through stock exchange.
4. Contributes to Economic Growth:

In stock exchange securities of various companies are bought and sold. This process of
disinvestment and reinvestment helps to invest in most productive investment proposal and this
leads to capital formation and economic growth.

5. Spreading of Equity Cult:

Stock exchange encourages people to invest in ownership securities by regulating new issues,
better trading practices and by educating public about investment.

6. Providing Scope for Speculation:

To ensure liquidity and demand of supply of securities the stock exchange permits healthy
speculation of securities.

7. Liquidity:

The main function of stock market is to provide ready market for sale and purchase of securities.
The presence of stock exchange market gives assurance to investors that their investment can be
converted into cash whenever they want. The investors can invest in long term investment
projects without any hesitation, as because of stock exchange they can convert long term
investment into short term and medium term.

8. Better Allocation of Capital:

The shares of profit making companies are quoted at higher prices and are actively traded so
such companies can easily raise fresh capital from stock market. The general public hesitates to
invest in securities of loss making companies. So stock exchange facilitates allocation of
investor’s fund to profitable channels.

9. Promotes the Habits of Savings and Investment:

The stock market offers attractive opportunities of investment in various securities. These
attractive opportunities encourage people to save more and invest in securities of corporate
sector rather than investing in unproductive assets such as gold, silver, etc.

Limitations

1. Unethical practices: Many unethical practices are rampant in Indian stock markets. Prices of
shares are artificially increased before rights issues by circular trading. Gullible members of
public who buy such shares find the prices of such shares dropping greatly and lose their money.
2. Misinformation: Funds are raised from investors promising investment in projects yielding high
returns. But some promoters divert the money to speculative activities and other personal
purposes. Investors who invest their money in such companies ultimately lose their money.
3. Absence of Genuine Investors: A very small proportion of purchases and sales effected in a
stock exchange are by genuine investors. Speculators constitute a major portion of the market.
Many of the transactions are carried out by speculators who plan to derive profits from short
term fluctuations in prices of securities. This is evident from the fact that majority of the
transactions are of the carry-forward type.
4. Fake shares: Frauds involving forged share certificates are quite common. Investors who buy
shares unfortunately may get such fake certificates. They would not be able to trace the seller
and their entire investment in such fake shares would be a loss.
5. Insider trading: Insider trading is a common occurrence in many stock exchanges. Insiders who
come to know privileged information use it either to buy or sell shares and make a quick profit
at the expense of common shareholders. Though many rules and regulations have been
formulated to curb insider trading, it is a continuing phenomenon.
6. Unofficial transactions: Unofficial markets exist along with the regular stock exchange. Trading
takes place in these unofficial stock exchanges after trading hours of the regular stock exchange.
Unofficial buying and selling transactions are entered into in these unofficial stock exchanges
(kerb trading and dabba trading) even before an issue opens up for subscription. Though trading
in such unofficial stock exchanges are illegal, they continue to exist.
7. Prevalence of Price Rigging: Price rigging is a common evil plaguing the stock markets in India.
Companies which plan to issue securities artificially try to increase the share prices, to make
their issue attractive as well as enable them to price their issue at a high premium. Promoters
enter into a secret agreement with the brokers.
8. Thin trading: Though many companies are listed in stock exchange, many are not traded.
Trading is confined to only around 25% of the shares listed on a stock exchange. Therefore the
investors have restricted choice and many shares lack liquidity.
9. Excessive Speculation: There is excessive speculation in some shares which artificially results in
increasing or decreasing the prices. Increase or fall in prices do not have any relationship with
the fundamental strengths or weakness of the company. Many small investors are unaware of
this fact. They buy shares based on price movements and ultimately suffer losses.
10. Underdeveloped debt market: The debt market in India has not been developed to the required
extent. There is very little liquidity in the debt markets.
11. Payment crisis: Market players indulge in excessive speculation and trading to profit from the
increase and decrease in prices. When movement (increase/decrease) in the security prices is
contrary to their expectations they are not able to settle the transaction (pay cash for securities
bought).
12. Poor liquidity: The main objective of listing shares in a stock exchange is to provide liquidity. But
in India, out of over 6,400 companies which are listed, 90 percent of trading is restricted to only
200 to 250 actively traded scrips. There is high volatility (fluctuations) in case of actively traded
scrips and low liquidity in the others.
13. Inadequate instruments: The markets are dominated by equity. Convertible debenture issues
are very rare. Preference shares which would be preferred by fixed return seeking investors are
almost nonexistent.
14. Influence of Financial Institutions: The equity markets are dominated by large players such as
mutual funds. pension funds and insurance companies. Any purchase of sale by them
significantly influences the market prices as they buy and sell in bulk quantities. The share
prices, therefore do not reflect the fundamentals.
15. Domination of FII’s: Foreign institutional investors have come to play a major role in the Indian
markets. They have pumped in billions of dollars and buy and sell in large quantities. Any entry
(purchase) by FII’s in a particular stock significantly pushes up its prices and any exit (sales)
 results in a steep fall in prices. FII’s invest and take out their money based on global
developments. Any large scale exit by FII’s would trigger a collapse in the Indian markets.
16. Odd lots: Odd lots suffer from poor liquidity. The number of odd lot dealers is very less and odd
lots have to be sold at a lower price.
17. Delay in admitting securities: There is high delay in admitting securities for trading. Sometimes
it goes beyond 60 or even 70 days. Therefore, liquidity of investments is affected.
18. Poor services: The number of brokers is less and many brokers provide very poor service to
investors, There are more than 50,000 sub-brokers and they are totally unregulated. There are
many instances of sub brokers committing fraudulent acts and investors losing money.
19. Broker defaults: Due to excess speculation in specific shares, broker defaults occur. Such
defaults destabilize stock exchanges and results in payment crisis.

Trading of Securities
Trading securities is a category of securities that includes both debt securities and equity
securities, and which an entity intends to sell in the short term for a profit that it expects to
generate from increases in the price of the securities. This is the most common classification
used for investments in securities.

Trading is usually done through an organized stock exchange, which acts as the intermediary
between a buyer and seller, though it is also possible to directly engage in purchase and sale
transactions with counterparties.

Trading securities are recorded in the balance sheet of the investor at their fair value as of the
balance sheet date. This type of marketable security is always positioned in the balance sheet as a
current asset.

If there is a change in the fair value of such an asset from period to period, this change is
recognized in the income statement as a gain or loss.

Other types of marketable securities are classified as available-for-sale and held-to-maturity.

Securities Trading: Types of orders, Margin

Trading
TYPES OF ORDERS

The most common types of orders are market orders, limit orders, and stop-loss orders.

• A market orderis an order to buy or sell a security This type of order guarantees that the order
will be executed, but does not guarantee the execution price. A market order generally will
 execute at or near the current bid (for a sell order) or ask (for a buy order) price. However, it is
important for investors to remember that the last-traded price is not necessarily the price at
which a market order will be executed.
• A limit orderis an order to buy or sell a security at a specific price or better. A buy limit order can
only be executed at the limit price or lower, and a sell limit order can only be executed at the
limit price or higher. Example: An investor wants to purchase shares of ABC stock for no more
than $10. The investor could submit a limit order for this amount and this order will only
execute if the price of ABC stock is $10 or lower.
• A stop order, also referred to as a stop-loss orderis an order to buy or sell a stock once the price
of the stock reaches the specified price, known as the stop price. When the stop price is
reached, a stop order becomes a market order.
• A buy stop orderis entered at a stop price above the current market price. Investors generally
use a buy stop order to limit a loss or protect a profit on a stock that they have sold short. A sell
stop order is entered at a stop price below the current market price. Investors generally use a
sell stop order to limit a loss or protect a profit on a stock they own.

Margin Trading Facility (MTF)

Margin Trading Facility (MTF) is a facility offered to an investor in buying of shares and
securities from the available resources by allowing him to pay a fraction of the total transaction
value called a margin. The margin can be given in the form of cash or shares as collateral
depending upon the availability with the respective investor. In short, it can be termed as
leveraging a position in the market with cash or collateral by the investor. In this transaction the
broker funds the balance amount.

Till last year MTF was allowed against the cash margin not against shares as collateral. Now
Securities Exchange Board of India (SEBI) has relaxed the said criteria vide its circular no.
SCIR/MRD/DP/54/2017 dated June 13, 2017. Investors are now allowed to create a position
under MTF against shares as collateral as well.

SEBI and Exchanges monitor tightly the securities eligible under the MTF and margin required
(through cash or shares as collateral) on such securities are prescribed by them from time to time.
Currently, the securities forming part of Group 1 securities are included in MTF.

Features of MTF:

• Investors who wish to avail the MTF need to undertake by signing/accepting additional Terms
and Conditions. It ensures that investors are completely aware of the risk and rewards of trading
in it.
• Allows investors to create leverage position in securities which are not part of derivatives
segment.
• The positions can be created against the margin amount which can be in the form of cash or
shares as collateral.
• Position can be carried forward up to T+N days (T = means trading day whereas N = means a
number of days the said position can be carried forward). The definition of N varies from broker
to broker.
• Securities allowed under MTF are predefined by SEBI and Exchanges from time to time.
 • Only corporate brokers are allowed to offer MTF as per SEBI regulations.

Benefits for Investors:

• MTF is ideal for investors who are looking for benefit from the price movement in short-term
but not having sufficient cash balance.
• Utilization of securities available in portfolio/demat account (using them as shares as collateral).
• Improve the percentage return on the capital deployed.
• Enhance the buying power of the investors.
• Prudently regulated by the regulator and exchanges.

Regulatory systems for equity Markets

Securities & Exchange Board of India (SEBI)

The Securities & Exchange Board of India (SEBI) Act, 1992 regulates the functioning of SEBI.
SEBI is the apex body governing the Indian stock exchanges.

The primary functions of SEBI are as follows:

Protective Functions

1. It checks Price rigging

2. Prohibits insider trading
3. Prohibits fraudulent and Unfair Trade Practices

Development Functions

1. SEBI promotes training of intermediaries of the securities market.

2. SEBI tries to promote activities of stock exchange by adopting a flexible and adaptable approach

Regulatory Functions

1. SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such
as merchant bankers, brokers, underwriters, etc.
2. These intermediaries have been brought under the regulatory purview and private placement
has been made more restrictive.
3. SEBI registers and regulates the working of stock brokers, sub-brokers, share-transfer agents,
trustees, merchant bankers and all those who are associated with stock exchange in any manner
4. SEBI registers and regulates the working of mutual funds etc.
5. SEBI regulates takeover of the companies
6. SEBI conducts inquiries and audit of stock exchanges.

The participation in the Indian Stock Market of both the domestic or foreign financial
intermediaries are governed by the regulations framed by SEBI. Additionally, Foreign Portfolio
Investors (FPIs) can participate in Indian Stock Market after registering them with an authorized
Depository Participant.

National Stock Exchange of India (NSE)

NSE is responsible for formulating and implementing the rules pertaining to:

• Registration of Members
• Listing of Securities
• Monitoring of Transactions
• Compliance
• Other additional functions related to the above functions

NSE itself is regulated by SEBI and is under regular vigilance for all regulatory compliances.

Stock Exchange

In simple terms, a Stock Market is a platform where people buy and sell stocks, prices of which
are set according to the prevalent demand and supply situation. It is very similar to a marketplace
where traders buy and sell goods, quoting prices on the basis of the demand for the good and the
availability or supply of it.

The term trade, in the context of the bourses, means the transfer of money from the seller to the
buyer in exchange for a security/ share. The price at which the seller sells or the buyer buys is
listed on the stock exchange. You can easily trade through a trading member registered on a
Stock Exchange.

As per National Securities Clearing Corporation Limited “A Trading Member means any person
admitted as a member in any exchange in accordance with the Rules, Bye-laws and Regulations
of that Exchange.”

The Stock Market doesn’t differentiate between any citizen of the country. Outside investments
were only permitted in the 1990s and can take place through either Foreign Direct Investments
(FDIs) or Foreign Portfolio Investments (FPIs). Thus, the Stock Market participants range from
small individual investors to Insurance Companies, Banks, Mutual Fund companies,
Manufacturing companies etc.

However, the rules and regulations formulated by SEBI remain the same for all types of market
participants and everybody is obligated to abide by such rules and mandates.

SEBI Act, 1992

Securities and Exchange Board of India (SEBI) is a regulatory body of the Government of
India. It controls the securities market. It was established on April 12, 1992 under the SEBI Act,
1992. SEBI is headquartered at the Bandra Kurla Complex in Mumbai, India. It has regional
offices in major cities of India such as New Delhi, Kolkata, Chennai, and Ahmedabad. These
cover the North, South, East, and West regions of India. Besides, it has a network of local branch
offices in prominent Indian cities.

Major part of the liberalisation process was the repeal of the Capital Issues (Control) Act, 1947,
in May 1992. With this, Government’s control over issues of capital, pricing of the issues, fixing
of premia and rates of interest on debentures etc. ceased, and the office which administered the
Act was abolished: the market was allowed to allocate resources to competing uses.

However, to ensure effective regulation of the market, Securites and Exchange Board of India
Act, 1992 was enacted to establish SEBI with statutory powers for:

(a) Protecting the interests of investors in securities,

(b) Promoting the development of the securities market, and

(c) Regulating the securities market.

Its regulatory jurisdiction extends over companies listed on Stock Exchanges and companies
intending to get their securities listed on any recognized stock exchange in the issuance of
securities and transfer of securities, in addition to all intermediaries and persons associated with
securities market. SEBI can specify the matters to be disclosed and the standards of disclosure
required for the protection of investors in respect of issues; can issue directions to all
intermediaries and other persons associated with the securities market in the interest of investors
or of orderly development of the securities market; and can conduct enquiries, audits and
inspection of all concerned and adjudicate offences under the Act. In short, it has been given
necessary autonomy and authority to regulate and develop an orderly securities market. All the
intermediaries and persons associated with securities market, viz., brokers and sub-brokers,
underwriters, merchant bankers, bankers to the issue, share transfer agents and registrars to the
issue, depositories, Participants, portfolio managers, debentures trustees, foreign institutional
investors, custodians, venture capital funds, mutual funds, collective investments schemes, credit
rating agencies, etc., shall be registered with SEBI and shall be governed by the SEBI
Regulations pertaining to respective market intermediary.

SEBI plays an important role in regulating all the players operating in the Indian capital markets.
It attempts to protect the interest of investors and aims at developing the capital markets by
enforcing various rules and regulations.

Structure of SEBI

SEBI has a corporate framework comprising of various departments each managed by a

department head. There are about 20+ departments under SEBI. Some of these departments are
corporation finance, economic and policy analysis, debt and hybrid securities, enforcement,
human resources, investment management, commodity derivatives market regulation, legal
affairs, and more.
The hierarchical structure of SEBI consists of the following members:

• The chairman of SEBI is nominated by the Union Government of India.

• Two officers from the Union Finance Ministry will be a part of this structure.
• One member will be appointed from the Reserve Bank of India.
• Five other members will be nominated by the Union Government of India.

Functions of SEBI

• SEBI is primarily set up to protect the interests of investors in the securities market.
• It promotes the development of the securities market and regulates the business.
• SEBI provides a platform for stockbrokers, sub-brokers, portfolio managers, investment advisers,
share transfer agents, bankers, merchant bankers, trustees of trust deeds, registrars,
underwriters, and other associated people to register and regulate work.
• It regulates the operations of depositories, participants, custodians of securities, foreign
portfolio investors, and credit rating agencies.
• It prohibits inner trades in securities, i.e. fraudulent and unfair trade practices related to the
securities market.
• It ensures that investors are educated on the intermediaries of securities markets.
• It monitors substantial acquisitions of shares and take-over of companies.
• SEBI takes care of research and development to ensure the securities market is efficient at all
times.

Authority and Power of SEBI

The SEBI board has three main powers:

1. Quasi-Judicial: SEBI has the authority to deliver judgements related to fraud and other
unethical practices in terms of the securities market. This helps to ensure fairness, transparency,
and accountability in the securities market.

2. Quasi-Executive: SEBI is empowered to implement the regulations and judgements made and
to take legal action against the violators. It is also authorised to inspect Books of accounts and
other documents if it comes across any violation of the regulations.

3. Quasi-Legislative: SEBI reserves the right to frame rules and regulations to protect the
interests of the investors. Some of its regulations consist of insider trading regulations, listing
obligation, and disclosure requirements. These have been formulated to keep malpractices at bay.

Despite the powers, the results of SEBI’s functions still have to go through the Securities
Appellate Tribunal and the Supreme Court of India.

Registration of Intermediaries

The intermediaries and persons associated with securities market shall buy, sell or deal in
securities after obtaining a certificate of registration from SEBI, as required by Section 12:
 1. Stock-broker,
2. Sub- broker,
3. Share transfer agent,
4. Banker to an issue,
5. Trustee of trust deed,
6. Registrar to an issue,
7. Merchant banker,
8. Underwriter,
9. Portfolio manager,

• Investment adviser
• Depository,
• Participant
• Custodian of securities,
• Foreign institutional investor,
• Credit rating agency,
• Collective investment schemes,
• Venture capital funds,
• Mutual fund, and
• Any other intermediary associated with the securities market.

Role of SEBI and working of stock

Exchanges
The Securities and Exchange Board of India (SEBI) is the regulator for the securities market
in India. It was established in 1988 and given statutory powers on 30 January 1992 through the
SEBI Act, 1992.

Initially SEBI was a non statutory body without any statutory power. However, in 1992, the
SEBI was given additional statutory power by the Government of India through an amendment
to the Securities and Exchange Board of India Act, 1992. In April 1988 the SEBI was constituted
as the regulator of capital markets in India under a resolution of the Government of India.

Its main objective was to promote orderly and healthy growth of securities and to provide
protection to the investors.

Role of SEBI

The main objective is to create such an environment which facilitates efficient mobilization and
allocation of resources through the securities market. This environment consists of rules and
regulations, policy framework, practices and infrastructures to meet the needs of three groups
which mainly constitute the market i.e. issuers of securities (companies), the investors and the
market intermediaries.

(i) To the Issuers

SEBI aims to provide a market place to the issuers where they can confidently look forward to
raise the required amount of funds in an easy and efficient manner.

(ii) To the Investors

SEBI aims to protect the right and interest of the investors by providing adequate, accurate and
authentic information on a regular basis.

(iii) To the Intermediaries

In order to enable the intermediaries to provide better service to the investors and the issuers,
SEBI provides a competitive, professionalized and expanding market to them having adequate
and efficient infrastructure.

Stock Exchanges

The secondary tier of the capital market is what we call the stock market or the stock exchange.
The stock exchange is a virtual market where buyers and sellers trade in existing securities. It is a
market hosted by an institute or any such government body where shares, stocks, debentures,
bonds, futures, options etc are traded.

A stock exchange is a meeting place for buyers and sellers. These can be brokers, agents,
individuals. The price of the commodity is decided by the rules of demand and supply. In India,
the most prominent stock exchange is the Bombay Stock Exchange. There are a total of twenty-
one stock exchanges in India.

How Does the Stock Market Work?

If the thought of investing in the stock market scares you, you are not alone. Individuals with
very limited experience in stock investing are either terrified by horror stories of the average
investor losing 50% of their portfolio value – for example, in the two bear markets that have
already occurred in this millennium – or are beguiled by “hot tips” that bear the promise of huge
rewards but seldom pay off. It is not surprising, then, that the pendulum of investment sentiment
is said to swing between fear and greed.

The reality is that investing in the stock market carries risk, but when approached in a disciplined
manner, it is one of the most efficient ways to build up one’s net worth. While the value of one’s
home typically accounts for most of the net worth of the average individual, most of the affluent
and very rich generally have the majority of their wealth invested in stocks. In order to
understand the mechanics of the stock market, let’s begin by delving into the definition of a
stock and its different types.

Functions of the Stock Exchange

Liquidity and Marketability: One of the main drawing factors of the stock exchange is that it
enables high liquidity. The securities can be sold at a moments notice and be converted to cash.
It is a continuous market and the investors can divest and reinvest with ease as per their wishes.

Price Determination: In a secondary market, the only way to determine the price of securities in
via the rules of supply and demand. A stock exchange enables this process via constant valuation
of all the securities. Such prices of shares of various companies can be tracked via the index we
call the Sensex.

Safety: The government strictlt governs and regulates the stock exchanges. In case of the BSE,
the Securities Board of India is the governing body. All the transactions occur within the legal
framework. This provides the investor with assurances and a safe place to transact in securities.

Contribution to the Economy: As we know the stock exchange deals in already issued
securities. But these securities are continuously sold and resold and so on. This allows the funds
to be mobilized and channelised instead of sitting idle. This boosts the economy.

Spreading of Equity: The stock exchange ensures wider ownership of securities. It actually
educates the public about the safety and the benefits of investing in the stock market. It ensures a
better quality of transactions and smooth functioning. The idea is to get more public investors
and spread the ownership of securities for the benefit of everyone.

Speculation: One often hears that the stock exchange is a speculative market. And while this is
true, the speculation is kept within the legal framework. For the stake of liquidity and price
determination, a healthy dose of speculative trading is necessary, and the stock exchange
provides us with such a platform.