UNIT 1

Unit I Investment (7 Hrs)

Overview of Capital Market: Market of securities, Stock
Exchange and New Issue Markets - their nature, structure,
functioning and limitations; Trading of securities: equity and
debentures/ bonds. Securities trading - Types of orders, margin
trading, clearing and settlement procedures. Regularity systems
for equity markets, Type of investors, Aim & Approaches of
Security analysis.

Overview of the capital market

Capital market

• Capital market is a market where buyers and sellers engage in the trade of
financial securities like bonds, stocks, etc. The buying and selling are
undertaken by participants such as individuals and institutions.

• A financial market is the backbone of the economy.

The capital market includes:

a) Primary market - In the primary market, companies sell new stocks and bonds to
the public for the first time, such as with an initial public offering (IPO).

b) Secondary market – In the secondary market, securities are traded by investors.

Functions of capital market

• Helps in the movement of capital from the people who save money to the
people who are in need of it.

• Assists in the financing of long-term projects of the companies.

• Encourage investors to own the range of productive assets

 • Creates liquidity in the market by facilitating the trading of securities in the
secondary market.

Factors affecting Stock market

• Supply and Demand

• Interest rates

• Political factors

• Natural calamities

• Inflation

Stock Exchange & New issue market

Stock Exchange

• The stock exchange is like an organized marketplace that works as a

facilitator of these transactions and enables the buying and selling of shares
and other securities.

• To be precise, it is a platform that conducts the trading of financial

instruments like stocks and derivatives. The activities on this platform in
India are regulated by SEBI. Trading activities in the stock market include
brokering, issuing of shares by companies, etc.

Stock exchanges in India

In India, overall, at present, there are a total of seven recognized stock exchanges
in India, as per SEBI. While BSE & NSE are primarily the two major stock
exchanges

1. BSE
 • BSE (Bombay Stock Exchange) is not only India’s but, in fact, Asia’s first-
ever stock exchange which was established in the year 1875, initially under
the name ‘The Native Share & Stock Broker’s Association. It was founded
by cotton merchant Premchand Roychand, who was also known as the
'cotton king’ and the ‘bullion (gold and silver) king’.

• In the year 1957, it became the first stock exchange in the country to be
granted permanent recognition under the Securities Contract Regulation Act,
of 1956.

• BSE's popular equity index, i.e., the S&P BSE SENSEX, is India's most
widely tracked stock market benchmark index.

NSE

• NSE (National Stock Exchange) was incorporated in the year 1992. It was
recognized as a stock exchange by India’s market regulator SEBI in April
1993, and NSE commenced operations in 1994.

• NSE was established as the first dematerialized electronic exchange in the

country and is considered the first exchange in the country to provide a
modern, fully automated screen-based electronic trading system that offered
easy trading facilities to investors spread across the length and breadth of the
country. NSE's flagship index, the NIFTY 50, which was launched in 1996,
is used extensively by investors in India as well as around the world as a
barometer of the Indian capital market.

Calcutta Stock Exchange Ltd.

• Not many are aware that stockbroking was practiced in Calcutta as early as
1836, although initially the members of the broking profession neither had
any code of conduct for their guidance, nor any permanent place for
congregation. At one time, the brokers had no shelter, and business was
carried on in the open place, which prompted brokers to organize themselves
then in May 1908, an association was formed under the name Calcutta
Stock Exchange Association at 2, China Bazar Street.

• And on June 7, 1923, the association was registered as a limited liability

concern. The Calcutta Stock Exchange (CSE) was later granted permanent
recognition by the Central Government with effect from April 14, 1980,
under the relevant provisions of the Securities Contracts (Regulation)
Act, 1956, with a view to render useful service to investors.

• Since 2013, there has been no trading on the CSE trading platform.

Indian Commodity Exchange Limited

• ICEX (Indian Commodity Exchange Limited) is a SEBI-regulated online

commodity derivative exchange headquartered in Mumbai. It provides a
nationwide trading platform through appointed brokers. ICEX had launched
the world’s first-ever diamond derivatives contracts and aims to provide
futures trading products in India’s all economically relevant commodities.

Metropolitan Stock Exchange of India Ltd.

• MSE offers an electronic, transparent and hi-tech platform for trading in

Capital Market, Futures & Options, Currency Derivatives and Debt
Market segments.

Multi Commodity Exchange of India Ltd.

• The Multi Commodity Exchange of India Limited (MCX), is a commodity
derivatives exchange that facilitates online trading of commodity
derivatives transactions. MCX started operations in November 2003 and
operates under the regulatory framework of SEBI.

• The stock exchange offers trading in commodity derivative contracts across

varied segments including bullion, industrial metals, energy, and
agricultural commodities. It is India’s first exchange to offer commodity
options contracts, bullion index futures, and base metals index futures
contracts.

National Commodity & Derivatives Exchange Ltd.

National Commodity & Derivatives Exchange Limited (NCDEX) is a

leading agricultural commodity exchange in India.

• This exchange has a wide array of permitted commodities aggregating to a

total of 23, including pulses, spices and guar, which are not traded on any
other platforms in the global scenario and are also economically relevant to
India, forming an important component of India’s global trade.

The Regulator

• The regulation, as well as supervision, of the stock markets in India rests in

the hands of SEBI (Securities and Exchange Board of India). Under the
SEBI Act of 1992, SEBI was formed as an independent identity and has the
power to conduct inspections of the stock exchanges. The conducted
inspections thoroughly review the operations of the market as well as look
after the organizational structure along with other aspects of exercising
administrative control.
• The primary roles of SEBI include ensuring a fair as well as an equitable
market for investors, due implementation of the guidelines and directions
issued by SEBI, and checking if the stock exchange and other stock market
participants have complied with all the set conditions.

Traders, Speculators, and Investors

• Stock market participants are classified into three broad categories: -

• Traders, speculators, and investors.

• Traders have a very short time horizon. They square off their positions
within a day or within a week or a month- their time horizon rarely exceeds
a month. They usually work on margin in the derivatives markets(future and
options markets) and hence their positions are highly leveraged. Most traders
rely on technical analysis.

• Speculators have a time horizon that may extend up to six months.

Speculation is based on calculations.

• Investors have a longer time horizon, typically spanning at least one year,
often much longer. Generally, investors do not resort to margin trading and
take fewer risks compared to traders or speculators.

Trading of Securities: Equity Debentures and Bonds

Trading of securities, including equities and debentures/bonds, is an

essential aspect of the global financial markets.
Equity Trading:
Nature:
 Equity trading involves the buying and selling of ownership stakes in
a company, represented by common and preferred stocks.
Investors in equities are shareholders who have ownership rights,
including voting rights and a share in the company's profits.
Functioning:
Equity trading occurs on stock exchanges, where investors buy and
sell shares of publicly traded companies.
Investors can place various types of orders, including market orders
(buy or sell at the current market price) and limit orders (buy or sell at
a specific price or better).
Trades are executed through intermediaries, such as brokers, who
connect buyers and sellers.
Debentures/Bonds Trading:
Parameter Debentures Bonds
Tenure Companies issue debentures for a The tenure of Bonds is generally
short or long term period on the basis longer than debentures.
of their fund requirement.
Issued by Mostly private companies issue Mostly large corporations,
debentures. government agencies, financial
institutions, etc. issue bonds
Interest Rate Debentures offer higher interest rates Bonds offer lower interest rates as
as they are unsecured. Also, the there is repayment stability in
investor relies only on future and also collateral backs
creditworthiness and reputation of the them.
issuer.
Payments The payment of interest on The interest payment on bonds is on
debentures is periodical as per the an accrual basis, i.e. monthly, half-
prospectus. However, this depends on yearly or annually. The performance
the performance of the issuing of the business does not affect these
company. payments.
Risk Debentures are riskier as any Bonds are safer than debentures as
collateral does not back them. It is some form of collateral backs them.
only the reputation of the issuing Also, the issuing party is reviewed
company and the ratings by credit periodically and rated by the credit
rating agencies. agencies.
Convertibilit Issuing company can convert only Bonds cannot be converted into
y convertible and also partially equity shares of the company
convertible debentures into equity
shares on the expiry as specified in
the clause.
Liquidation During liquidation, the debenture During company liquidation,
holders are paid after the Bondholders are given priority over
bondholders. the debenture holders.

OTC Market
An over-the-counter (OTC) market is a decentralized market in which
market participants trade stocks, commodities, currencies, or other
instruments directly between two parties and without a central exchange or
broker.
The Over-The-Counter Exchange of India (OTCEI) is an Indian electronic stock
exchange composed of small- and mid-cap companies. The purpose of the OTCEI
is for smaller companies to raise capital, which they cannot do at the national
exchanges due to their inability to meet the exchange requirements.

Key Differences:
Equities represent ownership, while bonds represent debt.
Equity trading typically takes place on stock exchanges, while bond trading
can occur on exchanges or in the OTC market.
The value of equities fluctuates based on supply and demand, company
performance, and economic factors. Bond prices are influenced by changes
in interest rates and credit risk.
In summary, equity and bond trading are fundamental components of the
financial markets, allowing investors to buy and sell ownership stakes in
companies or invest in debt securities. These markets provide opportunities
for capital allocation and portfolio diversification.
Types of Stock Trade Orders

Market Order
A market order is a trade order to purchase or sell a stock at the current
market price. A key component of a market order is that the individual does
not control the amount paid for the stock purchase or sale. The price is set by
the market. A market order poses a high slippage risk in a fast-moving
market. If a stock is heavily traded, there may be trade orders being
executed ahead of yours, changing the price that you pay. For example,
if an investor places an order to purchase 100 shares, they receive 100 shares
at the stock’s asking price.

Limit Order

A limit order is a trade order to purchase or sell a stock at a specific set price
or better. A limit order prevents investors from potentially purchasing or
selling stocks at a price that they do not want. Therefore, in a limit order, if
the market price is not in line with the limit order price, the order will not
execute. A limit order can be referred to as a buy limit order or a sell limit
order.

A buy limit order is used by a buyer and specifies that the buyer will not
pay more than $x per share, with $x being the limit order set by the buyer.

For example, consider a stock whose price is $11. An investor sets a limit
order to purchase 100 shares at $10. In this scenario, only when the stock
price hits $10 or lower will the trade execute.

A sell limit order is used by a seller and specifies that the seller will not sell
a share under the price of $x per share, with $x being the limit order set by
the seller.
For example, consider a stock whose price is $11. An investor sets a limit
order to sell 100 shares at $12. In this scenario, only when the stock price
hits $12 or higher will the trade execute.

Buying on Margin

Traders can buy shares on margin. This means that traders provide a portion
of the purchase value as a margin and the rest is given by the broker as a
loan to the traders. For example, if the trader has a margin account with
kotaksecurities.com, a trader can get a loan of up to 75 percent of the
purchase value. So, if the trader’s margin account has a balance of Rs.25000,
the trader can buy shares up to Rs.1,00,000.

The percentage margin is equal to equity in the account/market value of the

shares. Suppose a trader pays a margin of Rs.10,000 and purchases shares
worth Rs.25,000, borrowing Rs.15,000 from the broker. The initial
percentage margin is:

Equity in the account/ values of the shares= 10,000/25,000= 40 percent

A rise in the value of the shares augments traders’ equity in the account and
a fall in the value of shares diminishes traders’ equity in the account.
Suppose the value of the shares falls to Rs.20,000. Traders equity in the
account becomes Rs.5,000 and the percentage margin becomes:

5,000/20,000 = 25 percent

If the value of the shares falls below Rs.15,000, traders’ equity in the
account would turn negative. To guard against such a thing, the broker
prescribes a maintenance margin. Should the percentage margin fall below
the maintenance margin, the broker will issue a margin call asking the trader
 to infuse more cash into the margin account. If the trader fails to do so in the
given time, the broker is entitled to sell securities from the account to collect
enough of the loan so that the percentage margin is restored to an acceptable
level.

When traders buy on margin, traders’ upside potential and downside risk are
magnified. For e.g. – suppose a trader deposit Rs.10,000 in a margin account
and buys shares worth Rs.40,000, borrowing Rs.30,000 from the broker. If
the shares appreciate by 25% to Rs. 50,000 trader earn a 100 %
return(Rs.10,000/Rs.10,000),ignoring the cost of borrowing. If the shares
fall by 25 % to Rs. 30,000, traders lose 100%, not counting the borrowing
cost.

Clearing and settlement Procedures

Trading and Settlement Procedure

• Selecting a Broker
 • Opening a Demat Account

• Placing Orders

• Execution of the Order

• Settlement - The actual securities are transferred from the buyer to the seller.
And the funds will also be transferred. There are two types of settlements.

• On the Spot settlement: In this case, the funds are immediately exchanged
and the settlement follows the T+2 pattern. So a transaction occurring on
Monday will be settled by Wednesday (by the second working day)

• Forward Settlement: This simply means both parties have decided the
settlement will take place on some future date. Can be T+% or T+9 etc.

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(when parties inflate prices to achieve higher profits)

2. Prohibits insider trading

3. Prohibits fraudulent and Unfair Trade Practices

Development Functions

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

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

Types of investors

• Individual investors – They are large in number .Each individual will have
comparatively smaller amount of investment . Majority of the individual
investors lack the knowledge and skill required to carry out extensive
analysis of the investment opportunities available in the market.

• Institutional investors - They are institutions that mobilize money from

individuals and other source and invest the same in financial assets .For ex:
Mutual funds , Insurance companies , Banks etc. The institutional investors
have large investible resources as compared to individual investors. In view
of their systematic and scientific approach to investment ,the institutional
investors are better equipped to maximize their return and minimize their
risk.

Aim of Security Analysis

• The aim of security analysis is to identify underpriced and over-priced

securities . A security that is underpriced is worthy of inclusion in the
portfolio of securities . A security that is found over-priced does not deserve
to be included in the portfolio . In analyzing as to whether a security is
correctly priced or not , the risk vs return characteristics of the securities is
studied.

The analysis of securities is the foundation for portfolio construction.

Approaches to security analysis

Fundamental Analysis - It is a method of evaluating the intrinsic value of an asset
and analyzing the factors that could influence its price in the future. Fundamental
Analysis is essential because it provides consistent and reliable information. With
its help, we can evaluate a security's intrinsic value. Fundamental analysis consists
of three main parts: Economic analysis, Industry analysis, Company analysis.

Technical Analysis- Technical analysis is used by traders on all time frames, from
1-minute charts to weekly and monthly charts. A core principle of technical
analysis is that a market's price reflects all relevant information impacting that
market. A technical analyst therefore looks at the history of a security or
commodity's trading pattern rather than external drivers such as economic,
fundamental and news events.

2020-21

1. Define the term Investment. (2)

Ans. Investment is the dedication of money to the purchase of an asset to attain an

increase in value over a period of time. Investment requires a sacrifice of some
present asset, such as time, money, or effort. In finance, the purpose of investing is
to generate a return from the invested asset.

What are the objectives of Investment? (2)

a) To Keep Money Safe - Capital preservation is one of the primary objectives of

investment for people. Some investments help keep hard-earned money safe from
being eroded with time. By parking your funds in these instruments or schemes,
you can ensure that you do not outlive your savings. Fixed deposits, government
bonds, and even an ordinary savings account can help keep your money safe.
b)To Help Money Grow

c)To Earn a Steady Stream of Income

d)To Minimize the Burden of Tax

e)To Save up for Retirement

f)To Meet your Financial Goals

State and explain the characteristics of an investment. (10)

The following are the main characteristics of investments:

1. Return: All investments are characterized by the expectation of a return. In

fact, investments are made with the primary objective of deriving a return. The
return may be received in the form of yield plus capital appreciation. The
difference between the sale price & the purchase price is capital appreciation. The
dividend or interest received from the investment is the yield. Different types of
investments promise different rates of return. The return from an investment
depends upon the nature of the investment, the maturity period & a host of other
factors.

Risk: Risk is inherent in any investment. The risk may relate to the loss of capital,
delay in repayment of capital, nonpayment of interest, or variability of returns.
While some investments like government securities & bank deposits are almost
riskless, others are riskier. The risk of an investment depends on the following
factors.

The longer the maturity period, the longer the risk.

The lower the creditworthiness of the borrower, the higher the risk.
The risk varies with the nature of the investment. Investments in ownership
securities like equity shares carry higher risk compared to investments in debt
instruments like debentures & bonds.

3. Safety: The safety of investment implies the certainty of the return of capital
without loss of money or time. Safety is another factor investors desire for their
investments. Every investor expects to get back his capital on maturity without loss
& without delay.

4. Liquidity: An investment, which is easily saleable, or marketable without loss

of money & without loss of time is said to possess liquidity. Some investments like
company deposits, bank deposits etc. are not marketable. Some investment
instruments like preference shares & debentures are marketable, but there are no
buyers in many cases & hence their liquidity is negligible. Equity shares of
companies listed on stock exchanges are easily marketable through the stock
exchanges.

An investor generally prefers liquidity for his investment, the safety of his funds, a
good return with minimum risk or minimization of risk & maximization of return.

What is a financial market? What is the difference between the primary

market and the secondary market? (10)

• Financial Markets include any place or system that provides buyers and
sellers the means to trade financial instruments, including bonds, equities,
various international currencies, and derivatives. Financial markets facilitate
the interaction between those who need capital with those who have the
capital to invest.

• Financial Markets include any place or system that provides buyers and
sellers the means to trade financial instruments, including bonds, equities,
various international currencies, and derivatives. Financial markets facilitate
the interaction between those who need capital with those who have the
capital to invest.

What was the need to set up SEBI? Explain its organization. (10)

The Securities and Exchange Board of India (SEBI) is the regulator of the
securities market in India. It was established in 1992 and is headquartered in
 Mumbai. SEBI’s role is to protect the interests of investors in securities,
promote the development of the securities market, and regulate the securities
market.

The need for a regulatory body for the securities market was felt after the
stock market scam of 1992. The scam was committed by Harshad Mehta,
who manipulated the stock prices of several companies. This led to a loss of
Rs. 4800 crores to the investors. After the scam was uncovered, it was found
that there were no regulations in place to prevent such manipulation. The
SEBI Act 1992 was enacted to fill this regulatory vacuum.

The SEBI is managed by its members, which consists of the following:

 The chairman is nominated by the Union Government of India.

 Two members, i.e., Officers from the Union Finance Ministry.

 One member from the Reserve Bank of India.

 The remaining five members are nominated by the Union Government of

India, out of them at least three shall be whole-time members.