Chapter 2

Introduction to Securities Market

Learning objectives

• Meaning of securities and the function of securities market

• Various kinds of product in securities market
• Structure of securities market
• Activities of the securities market participants
• Various securities market transactions
• Dematerialisation and Rematerialisation of securities

2.1 INTRODUCTION TO SECURITIES & SECURITIES MARKET

What are securities? What is a security market?

- Transferable financial instruments showing - Facilitate buying and selling of
ownership or indebtedness in an entity's securities.
assets.
- Create liquidity by bringing
- Issued by Companies, Government, and together numerous buyers and
Financial Institutions. sellers.

- Types include equity shares, preference - Enable transactions at market

shares, debentures, bonds, etc. prices.

Companies raise money by issuing securities at some cost and Investors invest
their savings in exchange for returns on their investment.
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Constituents of the Securities market

1. Households Direct Finance 1. Business firms

2. Business firms 2. Government
3. Government 3. Households
4. Foreigners 4. Foreigners

The term "securities" has been defined in Section 2(h) of the Securities
Contracts (Regulation) Act,1956(SCRA). Term Securities include various
instruments like shares, bonds, derivatives, government securities, and others
declared by the Central Government

2.2 VARIOUS FINANCIAL INSTRUMENTS / TERMINOLOGY

Foreign currency bonds Equity Share

Foreign currency bonds are issued by Issued by companies to raise

companies in a currency different from money, Equity shares represent
their home country's currency, like Delhi the form of fractional
International Airport Limited issuing USD ownership in the company.
bonds in February 2020.
Investors in these shares bear
Emerging market companies often issue the risk and enjoy the rewards
bonds in USD or stable currencies due to of ownership.
lower interest rates, but this exposes them
to foreign currency risk.
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 Parth Verma The Valuation School
Debenture / bonds / Notes :
Governments and companies raise money by issuing bonds and debentures at a fixed interest rate. The rate depends
upon the credit risk of the company.

A debenture is a type of long-term debt not secured by any collateral. Types include:

1) Fully Convertible: Converts bonds into shares as per decided terms.

2) Partly Convertible: Converts partly into shares, with the remainder redeemed.
3) Non-Convertible: Pure debt instruments without conversion.

Short-term debt instruments are used to raise debt for periods not exceeding one year Examples: T-bills, Commercial
Papers.

External bonds / Masala Bonds Warrants

External bonds, also known as **Euro bonds**, are issued Warrants are
in a currency different from the country of issuance. options granting
investors the right
**Masala bonds**, denominated in Indian rupees (INR), are to purchase the
issued outside India. First issued by the International issuer company's
Finance Corporation in November 2014 and listed on the shares at a
London Stock Exchange. predetermined price
at the maturity.

Indices Mutual fund units

- In the stock market, indices are statistical - Investment pools that gather
measures that track the performance of a group of
money from investors to invest in a
selected stocks.
portfolio reflecting shared
investment goals.
- Market indices track market movements using select
shares, often weighted by market capitalization.
- Units and NAV: Each investor owns
Examples in India include Nifty 50, S&P BSE Sensex,
units in the fund, and their value is
and MSEI's SX40.
determined by the Net Asset Value
(NAV), which changes based on the
- Indices can be broad like Nifty 500 or specific like
fund's portfolio value.
sector-based indices (e.g., banking, IT).
- Open-ended vs. Close-ended: Open-
- They help compare stock returns with other assets,
ended schemes allow investors to
serve as benchmarks, reflect economic performance,
buy/sell units anytime without a
show real-time sentiments, and support index-based
fixed maturity, linked to NAV prices.
financial products like funds and derivatives
 Preference Shares Exchange Traded Funds (ETF)

- Preference shares are shares of a - ETF: Pooled investment vehicle

company's stock with dividends that are tracking indexes, commodities, or
paid out to shareholders before common asset classes.
stock dividends are issued. No voting rights
- Listed and traded in demat form
- It has both debt and equity-like on stock exchanges, reflecting
characteristics. real-time price changes.

- Types: Varieties include cumulative - Offers diversification benefits,

(unpaid dividends carry forward), non- real-time trading, and lower
cumulative (unpaid dividends lapse), expenses due to passive
convertible (partly or fully), etc. management.

Indian Depository Receipts (IDR) ,(GDR), (ADR)

- Depository Receipts (DRs): Represent foreign company shares traded in local markets in local
currency.

- Issuance Process: The Bank receives equity shares, places them in a custodian account, and
issues DRs to overseas investors.

- Sponsored vs. Unsponsored DRs: Sponsored listed on the country's exchanges, and
unsponsored traded in OTC markets with fewer regulations.

- Two-Way Fungibility: DRs can be converted to local shares and vice versa, subject to the
country's regulations.

- IDRs: Indian companies issue IDRs, regulated by SEBI, with specific guidelines like fund
limit, and one-year lock-in, for resident Indian investors.

- Types of DRs: ADRs in the US, IDRs in India, HKDRs in Hong Kong, and GDRs traded in
multiple countries.

- Investor Benefits: Wider investor base for issuing company, global investment opportunities
for investors, no voting rights for DR holders currently under SEBI consideration.

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 Parth Verma The Valuation School

Commodities

- Commodities are uniform goods, like gold bars, that are interchangeable. For instance, a bar of gold
is a commodity, but a piece of gold jewelry isn't, as preferences vary. They're categorized as hard
(mined resources like metals and crude oil) or soft (grown products like grains).

- Investing in commodities can hedge against inflation, protecting the investment's value. Yet, due to
storage costs, many aren't ideal investments.

1. *Precious metals:*

Precious metals like gold and silver are considered investments that preserve the value of money
over time. They have minimal storage costs.

2. *Commodity ETFs:*

A Commodity ETF is an exchange-traded fund that pools investments in physical commodities.

Investors buy units of the fund, and its value closely tracks the underlying commodity prices. Since
storage is managed by the fund, investors have no storage responsibilities.

3. *Managed futures contract:*

Futures contracts involve buying/selling assets at a set price on a future date, allowing investors
to profit from price changes without owning the product.

Managed futures are portfolios of futures contracts managed by professionals, enabling

investors to access commodities without owning them directly.

4. *Warehouse receipts:*

A warehouse receipt is a document proving ownership of goods stored in a warehouse. Many of

these receipts are negotiable, allowing the transfer of ownership of the goods by transferring the
receipts themselves.

REITs / InvITs :
- Stands for Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs).

- REITs: Investors pool money to invest in real estate properties and earn dividends from rents or sales.

- InvITs: Investors pool funds for infrastructure projects like roads or power plants, earning returns from
tolls or lease income.
 Foreign Currency Convertible Bonds (FCCBs) Equity & Convertible Linked
Debentures ( ELD / CLD )
- A FCCB is a type of convertible bond issued in a
currency different than the issuer's domestic - Equity-linked debentures (ELDs) are
currency. floating rate debt instruments whose
interest relies on the returns of the
- Convertibility and Payments: Convertible to equity, underlying equity asset such as S&P
often optionally, with interest and principal Sensex, individual stocks, Nifty 50, or
repayments in foreign currency. Post-conversion any customized basket of individual
dividends paid in Indian Rupees, placing currency risk stocks.
on investors.
- Similarly, CLDs are floating-rate debt
instruments whose interest relies on the
- Governed by RBI guidelines under the Foreign
returns of the underlying commodity
Exchange Management Act (FEMA). asset.

Mortgage backed securities ( MBS ), Asset Backed Securities ( ABS )

- A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') that is
secured by a mortgage or collection of mortgages.

- The mortgages are sold to a group of individuals (investment banks) that securitizes or packages,
the loans together into a security that investors can buy.

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 2.3 STRUCTURE OF SECURITIES MARKET

1. Primary Market
Also known as the new issue market, where issuers raise capital by offering fresh
securities to investors.

2. Secondary Market
This market enables the trading of already-issued securities, allowing investors to buy
or sell existing investments. Provides liquidity.

PRIMARY MARKETS
Methods of Issue of Securities:

1. Initial Public Offer (IPO):

First sale of shares to the public by a

company to raise equity capital.

2. Follow-on Public Offer (FPO):

Additional issuance of shares by a

listed company to the public.

3. Private Placement:

Issuing shares to a limited set of

investors, limited to 50 individuals
under the Companies Act.

4. Qualified Institutional Placements (QIPs)

Private placement of shares by a listed company to Qualified Institutional Buyers (QIBs).

5. Preferential Issue:

Offering shares to a selected group without a public issue or rights/bonus issue.

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 Parth Verma The Valuation School
6. Rights and Bonus Issues:

Providing existing shareholders the right to buy more shares (rights) or issuing free shares
(bonus).

7. Onshore and Offshore Offerings:

Raising capital within or outside the domestic market.

8. Offer for Sale (OFS):

Sale of existing shares by shareholders, not leading to an increase in company capital.

9. Sweat Equity:

Issuing shares to employees, promoters, or technocrats as a reward for their contribution.

10. Employee Stock Option Scheme (ESOPs):

Granting employees the option to buy company shares at a predetermined price after a vesting
period.

SECONDARY MARKET

- Clearing and Settlement:

Post-trading activities involve ascertaining
OTC Exchange Regulated
Markets buyer and seller obligations (clearing) and
settling these obligations by delivering shares
or paying money (settlement).
Here, trades are Securities trading takes
negotiated directly place via stock exchanges, - Risk Management:
between multiple and settlements are In OTC, counterparties manage credit risk; in
exchange-traded markets, clearing
counterparties, settling guaranteed by a clearing corporations mitigate default risk by
securities directly among corporation, acting as a imposing margins like Initial, Peak, and mark-
them. counterparty for both to-market (MTM) margins based on potential
losses.
buyers and sellers.
 2.4 VARIOUS MARKET PARTICIPANTS AND THEIR ACTIVITES

Market Institutional Retails Proxy Advisory

Intermediaries Participants Participants Services Firms

MARKET INTERMEDIARIES

Stock Exchange :

Platforms for securities trading,

like NSE, BSE, and MSEI, where
electronic terminals facilitate
anonymous order matching. Depositories :

Institutions holding securities in

electronic form, like CDSL and NSDL,
accessed via registered Depository
Depository Participants : Participants (DPs).

Agents of depositories providing

dematerialized securities services, and
maintaining investor-level accounts.
Trading Members/Stock Brokers:

Registered members facilitating buy/

sell transactions on stock exchanges,
Authorised Persons: essential for secondary market trades.

Appointed by stock brokers as

agents to reach investors across the
country, replacing sub-brokers as
Custodians :
per SEBI regulations.

Entities safeguarding funds and

securities for institutions, settling
transactions, and tracking corporate
actions.

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 Clearing Corporations :

Ensures trade settlement on stock

exchanges, acting as a counterparty
for all trades, reducing counterparty Clearing banks :
risk for investors.

Intermediaries between clearing

members and clearing corporations,
managing funds for trade
Merchant bankers : settlements.

Registered with SEBI, assist

issuers in accessing the market,
and manage issue processes
Underwriters :
during security offerings.

Primary market intermediaries

committing to buy unsold securities
in public offerings, mitigating risk
for issuers during IPOs or FPOs.

INSTITUTIONAL PARTICIPANTS

Institutional Investors :

Entities like banks, insurance, mutual

funds, etc., making significant
FPIs :
investments.

Overseas entities registered with

Participatory Notes (P-Notes) : SEBI to invest in Indian securities.

Instruments issued by registered FPIs

allowing overseas investors access to Mutual Funds :
Indian markets.

Pooled investment schemes managed

professionally to buy securities on behalf
of investors.

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 Insurance Companies:

Firms primarily insuring assets that

invest in equities, government Pension Funds:
securities, and bonds.

Pooling retirement funds of employees

for stable long-term growth and
Venture Capital Funds: providing a retirement income.

Pooled investment vehicle funding

early-stage enterprises. Private Equity Firms:

pool investor funds to invest in or

acquire companies that are not publicly
Hedge Funds:
traded on a stock exchange.

Pooled investment vehicles deploying

capital across diverse assets,
Alternative Investment Funds (AIFs):
products, and geographies.

Privately pooled investments in various

assets excluding traditional listed
Investment Advisers: equities, fixed income instruments, etc.

Professionals helping investors with

asset allocation and investment
Employee Provident Fund (EPF):
decisions.

Retirement benefit scheme for

National Pension Scheme (NPS): employees managed by EPFO.

Government-sponsored retirement
scheme with various fund options. Family Offices:

Organizations managing wealth and

financial aspects of affluent
Corporate Treasuries: families.
Business entities investing surplus
funds for future opportunities or
obligations.

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 Parth Verma The Valuation School

RETAIL INVESTORS PROXY ADVISORY SERVICES FIRM

Proxy advisors advise investors on voting

matters in companies, assisting them in making
Retail Participants are individual informed decisions about their rights in
investors who trade securities for shareholder meetings or public offers.
personal accounts. HNIs and UHNIs are
high-capacity individual investors. The They help investors analyze proposals and
RBI permits NRIs, PIOs, and QFIs to suggest how to vote, benefiting those who may
directly invest in Indian companies under not track all company announcements or fully
the Automatic Route. evaluate every proposal themselves.
Institutional investors often rely on proxy
advisors for guidance on voting matters.

2.5 KINDS OF TRANSACTIONS

Cash, Tom, and Spot Trades/Transactions: Forward Transaction:

Cash trades settle on the same trading day (T+0) Forward contracts are agreements
in financial markets, although they are less common between two parties to buy or sell an
as most contracts settle between two to three asset in the future at a fixed price
days from the trade date. set at the contract's initiation.

Tom trades settle on the day after the trading day These OTC contracts, such as a farmer
(T+1) and are seen in certain transactions within selling wheat to a miller at a pre-
the Foreign Exchange Market (FX market). decided price six months ahead, are
customizable in terms of quantity,
Spot trades settle on the spot date, typically two quality, settlement mode (cash or
business days after the trade date. Equity markets delivery), and payment conditions.
in India often offer spot trades.
 Futures :

Futures are exchange-traded forward contracts standardized in terms of quantities, quality, and delivery terms,
traded on stock exchanges with settlement guarantees by clearing corporations.

Subject to strict margin requirements, futures are available for various assets like equities, commodities, currencies,
and interest rates.

Options : Swaps :

Options are contracts offering the right, not A swap in the financial markets is a derivative
obligation, to buy (Call) or sell (Put) an underlying contract made between two parties to exchange cash
asset at a predetermined price by a specified date. flows in the future according to a pre-arranged
formula.
Buyers pay a premium for this right, while sellers
receive the premium but have an obligation if the Swaps help market participants manage risks
buyer exercises their right. These contracts can be associated with volatile interest rates, currency
traded in both Over The Counter (OTC) and Exchange- rates, and commodity prices.
Traded Markets.
Example: Two companies, Company A and Company B,
*Example:* You buy a Call option on the Nifty index at agree to an interest rate swap. Company A has a
a strike price of 16,000 expiring in a month, paying a fixed-rate loan while Company B has a floating-rate
premium of ₹200 when the Nifty is at 15,800. If at loan. They agree to exchange interest payments to
expiry, the Nifty is above 16,200, your option is manage their risks. Company A pays a fixed rate,
profitable, allowing you to buy Nifty at 16,000. while Company B pays a variable rate based on an
Otherwise, if the Nifty is below 16,000, the option agreed benchmark. This swap helps both companies
expires worthless, and you lose the premium paid. hedge against interest rate fluctuations.

Trading, Hedging, Arbitrage, Pledging of Shares:

- Trading involves buying or selling assets in anticipation of short-term gains, leveraging on market changes and
can lead to magnified profits or losses.

- Hedging refers to taking a position in financial instruments to counteract potential losses from another
position, limiting both gains and losses.

- Arbitrage is the simultaneous buying and selling of assets in different markets to profit from price
discrepancies, which in an efficient market, tend to be short-lived.

- Pledging of shares involves using securities as collateral to obtain a loan, with the securities held in a
dematerialized account but blocked from other transactions until the loan obligations are fulfilled.

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DEMATERIALISATION AND REMATERIALISATION OF SECURITIES

Dematerialization:

It's the process of converting physical securities into electronic or book entry forms.
Securities lose their distinctive numbers and individual identification in demat form.
SEBI mandates companies to allow investors the choice of holding shares in
dematerialized form during public issues.

Rematerialization:

It's the reverse process of dematerialization. Here, securities held electronically in

book-entry form are converted back into physical certificates on an investor's
request. The securities are allotted distinctive numbers when materialized.

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