Stock Market and Sensex

PREFACE

What are Markets?

A stock market is a market for the trading of company stock/ shares, and derivatives. This includes securities listed on a stock exchange as well as those only traded privately. Market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc.

Primary markets:

The primary market is that part of the capital markets that deals with the issuance of new securities. The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO)

What are the types of issues in primary market?

Primary market Issues can be classified into four types.

Initial Public Offer

Follow on Offer

Rights Issue

Preferential Issue

Introduction to Primary Markets

Most listed companies are usually started privately by their promoter(s). However, the promoters’ capital and the borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a long term. So, companies invite the public to contribute towards the equity and issue shares to individual investors. The way to invite the public to subscribe to the share capital of the company is through a ‘Public Issue’. Once this is done, the company allots shares to the applicants as per the prescribed guidelines laid down by SEBI.

The Primary Market is, hence, the market that provides a channel for the sale of new securities to issuers, which may can be the Government or corporates, to raise resources to meet their fund raising requirements. The securities may be issued at face value, or at a discount/premium and may take a variety of forms such as equity, debt etc. They may be issued in the domestic and/or international market.

Capital market can be defined as a market where long-term funds can be raised. They are a part of the broader financial markets, which include forward markets, swap markets etc. Capital markets can be further sub-divided into equity markets and debt markets, where equity and debt are traded respectively.

Any capital market can be either a primary market or a secondary market. Thus we have primary and secondary markets for both debt and equity. The distinction between primary and secondary market is that in the former, the securities are issued by the original fund-raiser i.e. the company raising the funds, whereas in the latter, the securities are traded among the investors/speculators.

Features of a primary market:

Ÿ         The company issuing the securities gets the funds out of the issue.

Ÿ         In India, only public limited companies can issue equity through primary markets.

Ÿ         The issue of securities to public through the primary market by a company is called its Initial Public Offer (IPO).

Features of a secondary market:

Ÿ         The investors/speculators trade in the securities. The company whose securities are traded does not get any funds from the trading in a secondary market.

Ÿ         In India, only the securities of listed public companies can be traded on a recognized stock-exchange.

Secondary markets provide liquidity to the investors. The market prices in the secondary markets reflect the investor perception of a company’s performance.

The Journey so far…

India , 125 years of experience seem to be a proud milestone. A lot has changed since 1875 when 318 persons became members of what today is called "Bombay Stock Exchange Limited" by paying a princely amount of Re1.

Since then, the stock market in the country has passed through both good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no measure or scale that could precisely measure the various ups and downs in the Indian stock market. Bombay Stock Exchange Limited (BSE) in 1986 came out with a Stock Index that subsequently became the barometer of the Indian Stock Market.

SENSEX, first compiled in 1986 was calculated on a "Market Capitalization-Weighted" methodology of 30 component stocks representing a sample of large, well-established and financially sound companies. The base year of SENSEX is 1978-79. The index is widely reported in both domestic and international markets through print as well as electronic media. SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. From September 2003, the SENSEX is calculated on a free-float market capitalization methodology. The "free-float Market Capitalization-Weighted" methodology is a widely followed index construction methodology on which majority of global equity benchmarks are based.

The growth of equity markets in India has been phenomenal in the decade gone by. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. More recently, the bourses in India witnessed a similar frenzy in the 'TMT' sectors. The SENSEX captured all these happenings in the most judicial manner. One can identify the booms and bust of the Indian equity market through SENSEX.

The launch of SENSEX in 1986 was later followed up in January 1989 by introduction of BSE National Index (Base: 1983-84 = 100). It comprised of 100 stocks listed at five major stock exchanges in India at Mumbai, Calcutta , Delhi, Ahmedabad and Madras. The BSE National Index was renamed as BSE-100 Index from October 14, 1996 and since then it is calculated taking into consideration only the prices of stocks listed at BSE.

All BSE-Indices are reviewed periodically by the "Index Committee" of the Exchange. The Committee frames the broad policy guidelines for the development and maintenance of all BSE indices. Department of BSE Indices of the Exchange carries out the day to day maintenance of all indices and conducts research on development of new indices.

The Stock Exchange, Mumbai is now Bombay Stock Exchange Limited (BSE)… a new name, and an entirely new perspective… a perspective born out of corporatisation and demutualisation. As a corporate entity, our new logo reflects our new mission… smoother, seamless, and efficient, whichever way you look at it.

BSE is Asia's oldest stock exchange…carrying the depth of knowledge of capital markets acquired since its inception in 1875. Located in Mumbai, the financial capital of India, BSE has been the backbone of the country's capital markets

Importance of stock market

Function and purpose

The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate.

History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. Financial stability is the raison d'être of central banks.

Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction.

The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity.

Relation of the stock market to the modern financial system

The financial system in most western countries has undergone a remarkable transformation. One feature of this development is disintermediation. A portion of the funds involved in saving and financing flows directly to the financial markets instead of being routed via banks' traditional lending and deposit operations. The general public's heightened interest in investing in the stock market, either directly or through mutual funds, has been an important component of this process. Statistics show that in recent decades shares have made up an increasingly large proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid assets with little risk made up almost 60 per cent of households' financial wealth, compared to less than 20 per cent in the 2000s. The major part of this adjustment in financial portfolios has gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving with a higher risk has been accentuated by new rules for most funds and insurance, permitting a higher proportion of shares to bonds. 

What are the Sensex & the Nifty?

The Sensex is an "index".

What is an index?

An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.

The Sensex is an indicator of all the major companies of the BSE.

The Nifty is an indicator of all the major companies of the NSE. 

If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.

Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.

The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.

There is an index for the metal stocks. There is an index for the FMCG stocks. There is an index for the automobile stocks and bank stocks etc.

How to calculate BSE SENSEX?

The Sensex has a very important function. The Sensex is supposed to be an indicator of the stocks in the BSE. It is supposed to show whether the stocks are generally going up, or generally going down.

To show this accurately, the Sensex is calculated taking into consideration stock prices of 30 different BSE listed companies. It is calculated using the “free-float market capitalization” method. This is a world wide accepted method as one of the best methods for calculating a stock market index.

Please note: The method used for calculating the Sensex and the 30 companies that are taken into consideration are changed from time to time. This is done to make the Sensex an accurate index and so that it represents the BSE stocks properly.

To really understand how the Sensex is calculated, you simply need to understand what the term “free-float market capitalization” means. (As we said earlier, the Sensex is calculated on basis of the “free-float market capitalization” method)

What is "market capitalization"?

If you were to buy all the shares of a particular company, what is the amount you would have to pay ,that amount is called the “market capitalization”. Market capitalization refers to the total worth of the company in a market scenario where there is equal competition.


Depending on the value of the market cap, the company will either be a “mid-cap” or “large-cap” or “small-cap” company!

What is "free-float market capitalization"?

Many different types of investors hold the shares of a company! The Govt. may hold some of the shares. Some of the shares may be held by the “founders” or “directors” of the company.

Now, only the “open market” shares that are free for trading by anyone, are called the “free-float” shares. When we are calculating the Sensex, we are interested in these “free-float” shares.

A particular company, may have certain shares in the open market and certain shares that are not available for trading in the open market.

According to the BSE, any shares that DO NOT fall under the following criteria, can be considered to be open market shares:

Ÿ         Holdings by founders/directors/ acquirers which has control element

Ÿ         Holdings by persons/ bodies with "controlling interest"

Ÿ         Government holding as promoter/acquirer

Ÿ         Holdings through the FDI Route

Ÿ         Strategic stakes by private corporate bodies/ individuals

Ÿ         Equity held by associate/group companies (cross-holdings)

Ÿ         Equity held by employee welfare trusts

Ÿ         Locked-in shares and shares which would not be sold in the open market in normal course.

Steps to calculate the Sensex

First: Find out the “free-float market cap” of all the 30 companies that make up the Sensex!

Second: Add all the “free-float market cap’s” of all the 30 companies!

Third: Make all this relative to the Sensex base. The value you get is the Sensex value!

Please Note: Every time one of the 30 companies has a “stock split” or a "bonus" etc. appropriate changes are made in the “market cap” calculations.

Now, there is only one question left to be answered, which 30 companies, why those 30 companies, why no other companies?

The 30 companies that make up the Sensex are selected and reviewed from time to time by an “index committee”. This “index committee” is made up of academicians, mutual fund managers, finance journalists, independent governing board members and other participants in the financial markets.

The main criteria for selecting the 30 stocks is as follows:

Market capitalization:

The company should have a market capitalization in the Top 100 market capitalization’s of the BSE. Also the market capitalization of each company should be more than 0.5% of the total market capitalization of the Index.

Trading frequency:

The company to be included should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like share suspension etc.

Number of trades:

The scrip should be among the top 150 companies listed by average number of trades per day for the last one year.

Industry representation:

The companies should be leaders in their industry group.

Listed history:

The companies should have a listing history of at least one year on BSE.

Track record:

In the opinion of the index committee, the company should have an acceptable track record.Having understood all this, you now know how the Sensex is calculated.

NIFTY

The Organisation

The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country.

On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June

Contract Specifications :

Contract Specification for Sensex® Futures contracts

TYPES OF PRODUCTS

Index Futures

A futures contract is a standardized contract to buy or sell a specific security at a future date at an agreed price.

An index future is, as the name suggests, a future on the index i.e. the underlying is the index itself. There is no underlying security or a stock, which is to be delivered to fulfill the obligations as index futures are cash settled. As other derivatives, the contract derives its value from the underlying index. The underlying indices in this case will be the various eligible indices and as permitted by the Regulator from time to time.

Index Options

Options contract give its holder the right, but not the obligation, to buy or sell something on or before a specified date at a stated price. Generally index options are European Style. European Style options are those option contracts that can be exercised only on the expiration date. The underlying indices for index options are the various eligible indices and as permitted by the Regulator from time to time.

Stock Future:

A stock futures contract is a standardized contract to buy or sell a specific stock at a future date at an agreed price. A stock future is, as the name suggests, a future on a stock i.e. the underlying is a stock. The contract derives its value from the underlying stock. Single stock futures are cash settled.

Stock Options

Options on Individual Stocks are options contracts where the underlyings are individual stocks. Based on eligibility criteria and subject to the approval from the regulator, stocks are selected on which options are introduced. These contracts are cash settled and are American style. American Style options are those option contracts that can be exercised on or before the expiration date.

Weekly Options:

Equity Futures & Options were introduced in India having a maximum life of 3 months. These options expire on the last Thursday of the expiring month. There was a need felt in the market for options of shorter maturity. To cater to this need of the market participants BSE launched weekly options on September 13, 2004 on 4 stocks and the BSE Sensex.

Weekly options have the same characteristics as that of the Monthly Stock Options (stocks and indices) except that these options settle on Friday of every week. These options are introduced on Monday of every week and have a maturity of 2 weeks, expiring on Friday of the expiring week.

CONTRACT SPECIFICATIONS

Contract Specification for Index Futures contracts

Top

Contract Specification for Index Options contracts (Monthly & Weekly)

Top

Contract Specifications for Single Stock futures

Contract Specification for Stock Options contracts (Monthly & Weekly Options)

Order Conditions

The derivatives market is order driven i.e. the traders can place only Orders in the system. Following are the Order types allowed for the derivative products. These order types have characteristics similar to ones in the cash market.

Limit Order: An order for buying or selling at a limit price or better, if possible. Any unexecuted portion of the order remains as a pending order till it is matched or its duration expires.

Market Order: An order for buying or selling at the best price prevailing in the market at the time of submission of the order. There are two types of Market orders:

Partial fill rest Kill (PF): execute the available quantity and kill any unexecuted portion.

Partial fill rest Convert (PC): execute the available quantity and convert any unexecuted portion into a limit order at the traded price.

Stop Loss: An order that becomes a limit order only when the market trades at a specified price.

All orders shall have the following attributes:

Ÿ         Order Type (Limit / Market PF/Market PC/ Stop Loss)

Ÿ         The Asset Code, Product Type, Maturity, Call/Put and Strike Price.

Ÿ         Buy/Sell Indicator

Ÿ         Order Quantity

Ÿ         Price

Ÿ         Client Type (Own / Institutional / Normal)

Ÿ         Client Code

Ÿ         Order Retention Type (GFD / GTD / GTC)

Ÿ         Good For Day (GFD) - The lifetime of the order is that trading session.

Ÿ         Good Till Date (GTD) - The life of the order is till the number of days as specified by the Order Retention Period.

Ÿ         Good Till Cancelled (GTC) - The order if not traded will remain in the system till it is cancelled or the series expires, whichever is earlier.

Ÿ         Order Retention Period (in calendar days) This field is enabled only if the value of the previous attribute is GTD. It specifies the number of days the order is to be retained.

Ÿ         Protection Points This is a field relevant in Market Orders and Stop Loss orders. The value enterable will be in absolute underlying points and specifies the band from the touchline price or the trigger price within which the market order or the stop loss order respectively can be traded.

Ÿ         Risk Reducing Orders (Y/N): When the member's collateral falls below 50 lacs then he will be allowed to put only risk reducing orders and he will not be allowed to take any fresh positions. It is not essentially a type of order but a mode into which the member is put into when he violates his collateral limit. A member who has entered the risk-reducing mode will be allowed to put only one risk reducing order at a time.

Ÿ          

The Bombay Stock Exchange in India.

Issue at Face Value:
The nominal value of the share, assigned to it by the issuer, is called the Face Value or Par Value. It is the original cost shown on the share certificate and the extent to which the shareholder is liable to the company. In case of equity shares, the value is generally quite small; for instance Rs 1, Rs 2, Rs 5, Rs 10 etc. Hence, if shares are offered at this value then it is said they are being offered at Face Value or at Par.

Issue at a premium or at a discount:
When shares are offered at more than the Face Value, then it is said that the issue is at a premium. The premium is the amount charged over the Face Value. Conversely, if shares are offered at a price lower than Face Value, then the issue is at a discount. The difference between the Face Value and the Offer Price is the discount.
Initial Public Offer (IPO):
When an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both, for the first time to the public, the issue is called as an Initial Public Offer.

Follow On Public Offer (FPO):
When an already listed company makes either a fresh issue of securities to the public or an offer for sale of existing shares to the public, through an offer document, it is referred to as Follow on Offer (FPO).

Rights Issue:
When a listed company proposes to issue fresh securities to its existing shareholders, as on a record date, it is called as a rights issue. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. This route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders.

A Preferential issue:
A Preferential Issue is an issue of shares or of convertible securities by listed companies to a select group of persons under Section 81 of the Companies Act, 1956, that is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. The issuer company has to comply with the Companies Act and the requirements contained in the chapter, pertaining to preferential allotment in SEBI guidelines, which inter-alia include pricing, disclosures in notice etc.

Who Are The Various Intermediaries In A Public Issue?
The Issuing Company has to appoint various intermediaries for the issue process. The various intermediaries involved are:

Book Running Lead Managers (BRLMs)

Bankers to the Issue

Underwriters

Registrars to the Issue etc.

What Is The Role Of The Intermediaries?
Book Running Lead Managers:

The Company issuing shares appoints the BRLM or the Lead Merchant Bankers. The role of the BRLM can be divided into two parts, viz., Pre Issue and Post Issue. The Pre Issue role includes compliance with the stipulated requirements of the SEBI and other regulatory authorities, completion of formalities for listing on the Stock Exchanges, appointing of various agencies such as advertising agencies, printers, underwriters, registrars, bankers etc.

Post Issue activities include management of escrow accounts, deciding the final issue price, final allotment, ensuring proper dispatch of refunds, allotment letters and ensuring that each agency is carrying out their part properly.
B Bankers to the Issue:
Bankers to the issue, as the name suggests, carry out all the activities of ensuring that the funds are collected and transferred to the Escrow accounts.

Registrars to the Issue:
The Registrar finalizes the list of eligible allottees after deleting invalid applications and ensures that the corporate action for crediting shares to the demat accounts of the applicants is done and the refund orders, where applicable, are sent.

Underwriters to the Issue:
An investment banking firm enters into a contract with the issuer to distribute securities to the investing public. They get an Underwriting Commission for their services. In case of under subscription, they have the obligation to subscribe to the left over portion.

Underwriters to the Issue:
An investment banking firm enters into a contract with the issuer to distribute securities to the investing public. They get an Underwriting Commission for their services. In case of under subscription, they have the obligation to subscribe to the left over portion.

Benefits & Drawbacks of Investing in the Primary Market
Investing in the primary market has its own benefit and drawbacks. Some of the key benefits are:

It is safer to invest in the primary markets than in the secondary markets as the scope for manipulation of price is smaller.

The investor does not have to pay any kind of brokerage or transaction fees or any tax such as service tax, stamp duty and STT.

No need to time the market as all investors will get the shares at the same price.

Some of the major drawbacks are as following:

In case of over subscription, the shares are allotted in proportionate basis. Thus, small investors hardly get any allotment in such a case.

Money is locked for a long time and the shares are allotted after a few days where as in case of purchase from the secondary market the shares are credited within three working days.

Classification of Issue
Procedure of arriving at the issue price:

Fixed Price

Book Building

Fixed Price:
Any IPO can be priced by two methods. Firstly, where the issuing company, in consultation with the BRLM, arrives at a fixed price at which it offers the shares to the public. In the second method, the company and the BRLM fix a floor and cap price for the issue. This range is called the price band. Investors are free to bid at any price in this range. The final price is determined by market forces according to the demand for the issuing company’s shares. This is called the Book Building Process.

Book Building:
In case of a book building IPO, the offer must be open for at least three days. The BRLM declares the issue price before the allotment, which must be completed within 15 days from the closure of the IPO. The shares should get credited to the respective bidders’ de-mat account within two working days from the date of allotment. The refund orders are also dispatched within this time.

Category of investors who can invest in an IPO:
As far as the IPO is concerned, there are three categories of investors.

Qualified Institutional Bidders.

Non-Institutional Investors.

Retail Investors.

Qualified Institutional Investors:
Under this head, financial institutions such as Banks, Mutual funds, Insurance companies, Foreign Institutional investors etc. are permitted to bid for the shares. A mMaximum of 50% of the issue can be kept reserved for investors falling under the QIB category. Out of the 50% shares, 5% are reserved for Mutual Funds.

Non-Institutional Investors:
Under this category, resident Indian individuals, HUFsS, companies, corporate bodies, NRIs, societies and trusts whose application size in terms of value is more than Rs 1 lakh are allowed to bid. At least 15% of the total issue has to be reserved for Non-Institutional Bidders.

Retail Investors:
Under this category, only Individuals, both Resident and NRIs along with HUFs are allowed to bid. At least 35% of the issue has to be reserved for such investors. The size in terms of value should not exceed Rs 1 lakh if one wants to apply under this category.

How are share prices determined?
The share prices, the prices at which the shares trade are determined by supply and demand. If there are more buyers than sellers, then the price will rise and if there are more sellers than buyers it will fall. In turn that supply and demand is determined by a number of other factors including:
General market sentiment

Movements on international markets

Economic events and Government decisions

Company news and performances

Interest rates

Speculation and rumour

1.2 Secondary markets:
The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. In the secondary market, securities are sold by and transferred from one investor or speculator to another.
The secondary market is where you can purchase securities from the seller as opposed to the issuer of such a security. Hence securities that are initially issued in the primary market by companies are traded on the secondary market.
The secondary market comprises of broad segments such as Equity, Debt and Derivatives. Equity shares are the most widely traded form of securities. There are various ways in which equity shares are issued such as IPOs, rights issues and bonuses.

Who Are The Parties To The Transactions?
In the secondary market, there are basically three parties to a transaction. These are buyers, sellers and intermediaries between them.

The first two categories consist of retail investors, high net worth individuals (HNIs), Mutual Fund Houses, Corporates and Institutional Investors, Foreign Institutional Investors etc.
Retail investors are individual investors with limited access to funds. They park their surplus funds in equities to earn returns. Equity investments as an investment option for retail investors are considered to be high risk - high return proposals compared to other investment instruments like fixed deposits and post office schemes.

The term ‘high net worth individual’ or HNI is used to refer to individuals and families that are affluent in their wealth holding and consequently have a higher risk profile. It’s a relative term and its comprehension differs in different financial markets and regions.

Mutual funds pool up money of several investors and invest in various asset classes including equities. These returns are distributed among the investors in proportion of the Mutual Fund units held by them. This investment mode has gained a lot of popularity across the world. It is most suitable for investors who lack the skill and acumen to pick up good stocks.

Foreign Institutional Investors (FIIs) are venture capital funds, pension funds, hedge funds, mutual funds and other institutions registered outside the country of the financial market in which they take an investment exposure.

Mutual Funds and FIIs have gained a lot of importance as market participants as they have huge sums of money in their kitty to manage and are often instrumental in giving direction to the stock markets in the short term. Heavy buying or selling on their part plays a substantial part in market rise and fall.

Intermediaries such as stockbrokers, depositories, depository participants and banks facilitate payment of money in share transactions.

Brokerages are entities registered as members with the concerned stock exchange. In turn you, the investor, would be required to enroll with the broker. Brokers charge commission based fees for the services they offer. Sub brokers appointed by main brokers also offer the same services for a fee.

Depositories hold shares for investors in electronic form. Previously shares were held in physical form meaning that there were paper share certificates for shares held. This new system of holding shares through depositories reduces paper work and time and also does away with risks associated with physical certificates such as bad delivery, fake securities etc. There are two depositories in India, the National Securities Depositories Limited (NSDL) and the Central Depositories Services Limited (CDSL). These two depositories provide service to investors through their agents termed as Depository Participants (DPs). As per SEBI regulations, Banks, Financial Institutions and SEBI registered trading members can become DPs.

How Does The Secondary Market Function?
In order to understand how the secondary markets function we must first be apprised of certain important terms:

Price: - The price of a stock is totally guided by the forces of demand and supply. The share prices of liquid stocks with wide participation keep changing throughout the trading hours They can be tracked continuously on trading screens.

Circuit Filters: - Share prices can swing in a volatile manner on back of news or even due to rigging by operators. It is important to protect the interest of investors and guard them against major losses due to such volatile price movements. So stocks are subjected to an upper and a lower circuit. The price of the stock can move within this range only on a particular trading day There are various slabs like 2%, 5%, 10% and 20% circuit that different stocks are subjected to. The slabs are fixed depending on various factors like share price, retail share holding etc.

Volume: - The term volume refers to the total number of shares traded during the day Volumes can be calculated for a particular stock, an index or even for the entire exchange.

Derivatives (Derivatives Segment Of The Secondary Market)
A derivative is a financial instrument that derives its value from the value of an underlying asset. The underlying asset can be equity, commodities or any other asset. For the purpose of this chapter, we would restrict the scope to Equity derivatives only. Derivatives were introduced in the Indian stock market to enable investors to hedge their investments against adverse volatile price movements. However they are now commonly being used for taking speculative positions
Broadly, Futures and Options are the derivative instruments that are traded on the two main exchanges, BSE and the NSE.
Futures: - To understand the term better, let’s take an example. Nifty is trading at the level of 4000. You can buy or sell a lot of Nifty Fututres. The lot size of Nifty futures is 100. You would be required to pay a margin of 10% of the contract value.
The margin money would work out as follows: -

Transaction value: 4000 × 100 (lot size) = Rs. 4,00,000
Margin Amount: 10% of 4,00,000 = Rs.40,000

The lot size and margin money percentage vary for different scrips and contracts. We took the example of Nifty, which is an index. You can take positions in various stocks which are listed for Futures trade. On NSE, the last Thursday of every month is the expiry date. In our example, if the Nifty is trading at 4300 on the last Thursday of the month and the position is not squared off then the purchaser of the Nifty futures contract at 4000 would be a gainer by Rs.20,000 (200 × lot size100). Similarly seller of Nifty futures contract would stand to lose Rs. 20,000.

Options: Options are hedging/investment instruments, which allow the buyer the right but not the obligation to buy/sell the underlying stock/ index. The buyer of the option incurs a charge for this right, which is referred to as the “premium”. The option writer or seller is the other party to such a contract who earns the premium.

Call Option - Option to buy the stock at a specific price
e.g. Mr. A buys a Nifty Call option with a strike price of 4100 at a premium of Rs.100. Mr. B, the seller of the option earns this premium of Rs.100 taking unlimited risk whereas Mr. A’s risk is limited to the premium amount of Rs.100. If at the expiry date, Nifty is trading at 4350, then Mr. A would exercise his option and earn a net amount of Rs.150. The strike price of the contract is 4100 and at the expiry, the Nifty is at 4350. So he stands gainer by Rs.250 (4350 – 4100). He however has incurred a premium of Rs.100, so his net earnings would be Rs.150 (Rs.250 – Rs.100).
Now, had the Nifty fallen to 3950, then Mr.A would be a loser by only Rs.100, which is the premium amount. His Call option would not exercise and Mr.B would be a gainer by Rs.100.

Put Option - Option to sell the stock at a specified price
e.g. Mr. A buys a Nifty Put option with a strike price of 4100 at a premium of Rs.100. Mr. B, the seller/writer of the option earns this premium of Rs.100 taking unlimited risk whereas Mr. A’s risk is limited to Rs.100. If at the expiry date, Nifty is trading at 3850, then Mr. A would exercise his option and earn a net amount of Rs.150. The strike price of the contract is 4100 and at the expiry, the Nifty is at 3850. So he stands gainer by Rs.250 (4100 - 3850). He however has incurred a premium of Rs.100, so his net earnings would be Rs.150 (Rs.250 – Rs.100).
Now, had the Nifty risen to 4250, then Mr.A would be a loser by only Rs.100, which is the premium amount. His Put option would not exercise and Mr.B would be a gainer by Rs.100.

Spot Mkt Price – It is the price at which the stock is trading in the cash markets.

Strike Price - Specified Price at which the underlying may be purchased or sold when the option is exercised.

Expiry Date - Last date for exercising the option by buyer--- Last Thursday of the relevant month on NSE.

Bonds
The debt segment of secondary market which mainly comprises of bonds.
Bond: - A bond is simply a form of loan borrowed by the government, the municipality or a company. A bond purchaser who plays the role of a lender to such borrower institutions holds in return a negotiable certificate that acknowledges indebtedness of the bond issuer. Such certificates are also termed as bonds. Bonds normally are unsecured. The issuer pays the bond holder periodic interest ranging over the life of the loan.

The secondary market for bonds in India is an over the counter market whereas the market for equities is a system-automated market. The buy orders and sell orders are electronically matched. We shall delve deeper into this in the following chapters.

What Are The Various Types Of Bonds?
Zero Coupon Bond: These are issued at a discount to the face value and at the time of redemption the bond holder is reimbursed with the face value of the bond.

The difference between the issue price and redemption price represents the return to the holder. The holder of such bonds does not enjoy periodic interest payments.

Convertible Bond: These bonds offer the investor the option to convert the bond into equity at a fixed conversion price

Treasury Bills: - T-bills are short-term securities issued by the Government. They mature in one year or less time from their issue date.

2. What are shares?
A share is one of a finite number of equal portions in the capital of a company, entitling the owner to a proportion of distributed, non-reinvested profits known as dividends and to a portion of the value of the company in case of liquidation. Equity is a share in the ownership of a company. It represents a claim on the company’s assets and earnings. As you acquire more stock, your ownership stake in the company increases. The terms share, equity and stock mean the same thing and can be used interchangeably.

Types of shares

Shares can be voting or non-voting, meaning they either do or do not carry the right to vote on the board of directors and corporate policy. Whether this right exists often affects the value of the share. Voting and Non-Voting shares are also known as Class A and B shares.
The most common form of shares is ordinary (equity) shares. One can also buy preference shares, options and partly paid shares.

There are a number of different types of shares such as ordinary or preference shares which have different properties.

Preference shares are those shares in a company with rights in various ways superior to those of ordinary shares; for example, priority to a fixed dividend and priority over ordinary shares in the event of the company being wound up.
When a share is issued, the person applying for it must pay to the company, in cash or equivalent value, the amount of its nominal value together with any premium required by the company. Shares are fully paid when the whole amount has been received by the company.

Shares may also be issued on the basis that only part of their price is to be paid initially, with the remainder being required when called for by the company.

For more experienced investors, derivatives such as options and warrants provide further diversification. However, when the majority of investors invest in shares, they buy ordinary shares.

3. What is a stock exchange?
A stock exchange, share market or bourse is a corporation or mutual organization which provides facilities for stock brokers and traders, to trade company stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there.

The Bombay Stock Exchange Limited, or BSE has a nation-wide reach with a presence in 417 cities and towns of India. Its index, or market indicator is known as the Sensex. It gives a general idea regarding the movement of the stocks; whether they have gone up or have gone down. If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up.

The S&P CNX Nifty, or simply Nifty, is the leading index for large companies on the National Stock Exchange of India. It consists of 50 companies representing 24 sectors of the economy, and representing approximately 47% of the traded value of all stocks on the National Stock Exchange of India

4. Who is a broker?
A stockbroker is person who is licensed to trade in shares. Brokers also have direct access to the sharemarket and can act as your agent in share transactions. For this service they charge a fee. They can also offer additional services like advice on shares, debentures, government bonds and listed property trusts and non-listed investment options (cash management trusts, property and equity trusts.

In addition a stock broker can plan, implement and monitor your investment portfolio, conduct research and help you optimize your returns.