NISM RA Ch 2 Full PDF

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 th...

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. Parth Verma The Valuation School 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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma The Valuation School  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. Parth Verma I The Valuation School 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. Parth Verma The Valuation School