Stock Exchange

Trimester I2009

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The stock exchange is a highly organized market for the purchase and sale of second hand quoted or listed securities. Stock exchange is a market in which securities are bought and sold and it is an essential component of a developed capital market.

According to the Securities Contracts (Regulation) Act, 1956, “Stock Exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.”

Securities include: Shares, scrips, stocks, bonds, debentures or other marketable securities of

a like nature Government securities

Stock Exchange is an important part of the Capitalistic system of economy. It is indispensable for the smooth functioning of a corporate enterprise.

It provides the necessary mobility to capital and directs the flow of capital into profitable and successful enterprises.

It exerts a powerful and significant influence as a depressant or stimulant of business activity.

It maybe defined as the place or market where securities of joint stock companies and of government or semi government bodies are dealt in.

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Importance: Only an organized securities market can provide sufficient marketability and price

continuity for shares Is only such a market that can provide reasonable measure of safety and fair dealing

in buying and selling of securities. Through the interplay of demand for and supply of securities, properly organized

stock exchange results in a reasonably correct evaluation of securities in terms of their real worth.

Through such evaluation of securities, the stock exchange helps in the orderly flow of savings between different types of investments.

Objective and Role of Stock Exchange: To safeguard the interest of investing public To establish and promote honorable and just practices in securities transactions. To promote, develop and maintain a well regulated market for dealing in

securities. To promote industrial development in the country through efficient resource

mobilization by way of investment in corporate securities. To enable flow of capital into most efficient industries. The market price and

relative yield of a security are the guiding factors. It encourages people to save invest in corporate securities thereby accelerating

capital formation. Raising long term capital: The existence of a stock exchange enable companies

to raise permanent capital.

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Dealings on the Stock exchange are subject to the bye-laws and rules of the Stock Exchange.

Stock exchange dealings in India are regulated by the Securities Contracts (Regulation) Act and the Securities and exchange Board of India (SEBI). There are two important types of trading on the stock exchange namely Ready Delivery and Forward Delivery Contract. Ready Delivery contract, also known as cash trading or cash

transactions, are to be settled either on the same date or within a short period that may extend at best upto seven days. (If the payment and delivery of securities is on the same day or on the next day, it may be called Spot Delivery Contract).

Forward Delivery contracts are discharged on fixed settlement days. They are confined to those securities which are placed on the forward lists.

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Speculation on the Stock Exchange Stock exchange transactions are made either for the purpose of investment

or speculation. Investment transactions are made with the idea of earning a return on the

securities by holding them more or less permanently whereas speculative transactions are made with the intention of making gains by disposing of the securities at favorable prices.

Investment transactions require actual delivery of securities on the part of sellers and the payment of their full price by its buyers.

Speculative transactions does not involve full payment for and taking delivery of the securities that the speculators have contracted to transfer. The transaction can be made by the deposit of a fractional part of the price. The volume of speculative transaction far exceed that of investment transaction on a stock exchange. It is therefore argued that speculation is necessary to ensure sufficient volume and continuity of business in the stock exchange.

There are 23 stock exchanges functioning in India including the OTCEI (Over the Counter Exchange of India) and the National Stock Exchange (NSE). The Bombay Stock exchange established in 1878 is the oldest in Asia. There are over 10,000 companies listed and the number of investors is also one of the largest in the world. Only members and their authorized clerks can enter the trading floor and conduct buying and selling of securities 5

Types of Speculator: Bull: Is a speculator who buys shares in the expectation of selling it at a

higher price.

Bear: Sells securities in the expectation of a fall in their prices in future.

Stag: Neither buys nor sells but applies for subscription to the new issues expecting that he can sell them later at a premium.

Option Dealing: Option is the right to buy or sell a certain quantity of the security at a certain price within a certain time. The option to buy is known as Call Option and the option to sell is know as a Put Option. In an option dealing, the speculator is given the right or option to buy or sell, or both buy and sell as the case maybe on the settlement day or else he will forfeit the option money.

Carry Over (Badla) transaction: This refers to the facility of carry-over of the completion of a forward contract to another / next settlement period any number of times on payment of the badla charge

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Over The Counter Exchange of India The OTCEI was incorporated in 1990 and became fully operational in 1992. The OTCEI is meant primarily to trade securities of the listed companies,

like the other stock exchanges. Yet there is no physical location of the OTCEI, no counters, no trading ring, no stock exchange building.

The OTC markets are fully automated exchanges where transactions are completed through a network of telephones and computers.

Over the Counter basically implies trading across the counter in scrips which are listed on the stock exchange. The minimum issued capital of a company for eligibility for listing on the OTCEI is Rs. 30 lakhs, subject to a minimum public offer of equity shares worth Rs. 20 lakhs. Any company which wants to list its shares on the OTCEI will have to be sponsored by a sponsor.

Features: The OTCEI is a company promoted by Financial Institutions There are many restrictions on listing on the OTCEI. A Company listed on

any other recognized stock exchange in India would not simultaneously be eligible for listing on the OTCEI.

Method of price fixation differs b/w OTCEI and other Exchanges. On the OTCEI the pricing of scrips is regulated while speculation could cause wide price fluctuations on the regular exchanges

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Over The Counter Exchange of India

Features (contd….) The OTC Exchange is a market for spot deals only The settlement takes place daily The OTCEI permits automatic transfer upto 0.5% of a company’s equity

while in other stock exchanges permission of the companies is needed. Spread does not exceed a specific percentage The OTCEI is characterized by a decentralized working

Benefits: Quick payment of money Price transparency Saves the investor from other unscrupulous behavior of the brokers. Simple procedure of buying and selling Facility to sell even odd lots Liquidity even for scrips of small and new companies Facilitates new issues at lower costs Makes raising of capital through issues very easy for small, new and closely held

companies.8

National Stock Exchange (NSE) This was established in 1994 by financial institutions with IDBI as a nodal

agency. The NSE was conceived as a model exchange with a nation wide electronic screen based “scripless” and “floorless” trading system in securities which is both efficient and transparent and offer equal and nation wide access to investors.

NSE operates on the National Exchange for Automated Trading (NEAT), a fully automated screen based trading system which adopts the principle of an order driven market.

The NSE operates in: Wholesale Debt market Capital Market.

Objectives: To establish nation wide trading facility for equities, debts and hybrids. To facilitate equal access to investors across the country. To provide fairness, efficiency and transparency to the securities trading To enable shorter settlement cycles To meet international securities market standard

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National Stock Exchange (NSE)

Features of NSE: The NSE employs a fully automated screen based trading system It has two segments ie the Wholesale Debt market and the Capital

market. There is no trading floor The trading member in the capital market segment are linked

through a satellite link-up while those in the Wholesale Debt market segment are linked through dedicated high speed lines.

The NSE has opted for an order driven system. When a trade takes place, a trade confirmation slip is printed at the

trading member’s workstation. The identity of the trading member is not revealed to others when he

place the order. Therefore, large orders can be placed without influencing the market sentiment.

The automated trading system secures the best price available in the market

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Securities Contracts (Regulation) Act:

Enacted in 1956 and came into force in 1957.

Objectives: The objective of the Act is it prevent undesirable transactions in

securities by regulating the business if dealings in securities and by providing for certain matters connected with transaction in securities.

To empower the RBI to regulate the dealings in and functioning of the stock exchange in India

To promote healthy and orderly development of the stock market To prevent unhealthy speculation and other undesirable activities on

the stock exchange To protect the interest of the investors To provide for reasonable uniformity in respect of the bye-laws and

rules of the different stock exchanges of India.

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Securities Contracts (Regulation) Act:

Main Provisions:

The Act empowers the Central Government or in some cases SEBI pertaining to:

The grant of recognition or withdrawal of recognition to any stock exchange

Approval of the bye-laws and rules of stock exchange Power to direct the stock exchange to make or amend rules and bye-

laws Monitoring the activities and functioning of the stock exchanges by

calling for periodic returns and specific information Power to suspend business of any stock exchange Power to supersede the governing body of any stock exchange on

account of specific reasons Regulation of listing of securities.

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Securities and Exchange Board of India The SEBI was constituted in 1988 by a resolution of GOI and it was made a statutory

body by the Securities and and Exchange Board of India Act, 1992. The Act empowers the Central Government to supersede SEBI if on account of

emergency, SEBI is unable to perform the functions and duties under any provision of the ACT.

Objective: To protect the interests of investors in securities and to promote the development of

and to regulate the securities market for matters connected therewith.

Powers and Functions: Regulates the business in stock exchanges and any other securities market. Registering and regulating the working of stock brokers, sub-brokers etc. Registering and regulating the working of collective investment schemes Promoting and regulating self regulatory organizations Prohibiting fraudulent and unfair trade practices in securities market Promoting investor education and training of intermediaries in securities market Prohibiting insider trading in securities. Regulating substantial acquisition of shares and take-over by companies Conducting inspection and inquiries Levying fees or other charges Conducting research

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Capital Market ReformsThe objective of the reforms was to: Provide for effective control of the stock exchange operations Increase the information flow and disclosures so as to enhance the

transparency Protect the interests of investors Check insider trading Improve the operational efficiency of the stock exchanges Promote healthy development of the capital market.

Important measures of reform and development include: Free Pricing Introduction of book building Electronic Trading Instruments and Market Participants Improvement in Trading, Clearing and Settlement Systems Increased Dematerialization Near Elimination of Counter Party Risk Circuit Breakers / Price Bands Structure of Informational Flows Emphasis on Fair Trading Practices 14

Capital Market Reforms (contd….) Free Pricing: Prior to 1992, raising of capital from the securities

market was regulated by the Capital Issues (Control) Act, 1947 wherein the companies had to obtain approval from the Controller of Capital Issues (CCI) for raising resources. New companies were allowed to issue shares at par while existing companies with reserves could issue shares at a premium based on a prescribed formula.

In 1992, the Capital Issues (Control) Act 1947 was repealed. Since then issuers of securities can raise resources from the market without requiring any consent from an authority either for making the issue or for pricing it. Restrictions on rights and bonus issues have also been removed. However, the issuers need to meet the guidelines of SEBI on disclosure and investor protection.

Introduction of Book Building: The book building mechanism was introduced in 1995 to determine the right price at which the market would clear the issue. This is a method through which an offer price of an IPO is based on investors demand. This gave the investor the choice to raise resources either through this or the fixed price mechanism 15

Capital Market Reforms (contd….) Electronic Trading: Till recently, trading on the stock exchange took place

through an open outcry system. At present, all the stock exchanges have adopted on-online screen based electronic trading, replacing the open outcry system. Electronic trading results in: Transparency, more efficient price discovery and reduction in transaction costs. The screen based trading also offers the advantage of integrating different trading centres all over the country into a single trading platform.

Instruments and Market Participants: In the Indian capital market, traditionally two instruments were traded ie. debt and equity. However, during mid eighties and nineties, a wide range of innovative / hybrid instruments combining both the features of debt and equity were introduced to suit various needs of consumers. Besides, DFIs, PSUs also issued many debt instruments.

Improvement in Trading, Clearing and Settlement Systems: Measures were taken to shorten the settlement cycle through the introduction of rolling settlement system and acceleration of the process of electronic book entry transfer.

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Capital Market Reforms (contd….) Increased Dematerialization: Legislative changes were carried out, for

maintaining ownership records in an electronic book entry form. Under this mode, securities are transferred in a speedy and safe manner. An element of compulsion was introduced by requiring the individual and institutional investors to settle trade compulsorily in dematerialized form in shares of select companies.

Near Elimination of Counter-Party Risk: One of the shortcomings of the clearing and settlement process of the Indian stock markets was the absence of a system to reduce counter party risk. Managing this risk is essential for promoting a safe and efficient market. The risk that the other party in an agreement will default. To provide the necessary funds and ensure timely completion of settlements in cases of failure of member brokers to fulfill their settlement obligations, major stock exchanges have set up Settlement Guarantee Funds. The aggregate corpus of the Fund at the stock exchanges is presently over Rs. 1000 crore. The NSE has set up a clearing corporation which guaranteed settlement of all trades. The clearing corporation therefore assumes the counter party risk involved in all the transactions. All transactions are settled through clearing houses set up by the stock exchanges

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Capital Market Reforms (contd….) Circuit Breakers / Price Bands: To contain abnormal price variations, scrip wise specific daily price bands or

circuit breakers in India were introduced in 1995 whereby the trading automatically got suspended if the prices varied either side beyond 8%further trading was allowed only upto the price band.

Price bands which were originally fixed at 8% were relaxed in January 2000, whereby a further variation of 4% in the scrip beyond 8%, after a cooling off period of 30 minutes, was allowed. This was made applicable in the case of 100 scrips.

In June 2000, for all scrips under compulsory rolling settlement, the price band was relaxed by 8% with half an hour cooling period after the scrip had hit the initial price band of 8%.

Currently, the circuit breakers in place are at 10% with a cooling off period and subsequently 15% and 20%.

Emphasis on Fair Trading Practices: Insider trading has been made a criminal offence punishable in accordance

with the provision under the SEBI Act 1992, prohibiting dealings, communication or counselling in matters related to insider trading. There are separate regulations in place governing substantial acquisition of shares and takeovers of companies. The regulations are aimed at making the takeover process more transparent and to protect the interests of minority shareholders.

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Capital Market Reforms (contd….)

Structure of Informational FlowsSeveral measures were taken to enhance transparency of the companies: A company offering securities in the Indian capital market is required to

make a public disclosure of all relevant information through its offer document.

After a security is issued to the public and subsequently listed on a stock exchange, the stock exchange requires the issuing company to make continuing disclosures under the listing agreement.

In India, all companies are now required to furnish to the stock exchanges and also publish mandated unaudited financial results on quarterly basis.

Companies are required to make decisions regarding dividend, bonus and rights announcements within fifteen minutes of the conclusion of the Board Meeting

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Market Design in Indian Securities Market SEBI is the specialized regulator and is vested with powers to

protect investors interest and to develop and regulate securities market.

Pricing of securities is market determined, either by the issuer through fixed price or by the investors through book building.

Corporates are allowed to issue ADRs/GDRs and raise ECBs. FIIs are allowed to trade in Indian market.

With regards to corporate compliance, there is considerable emphasis on disclosures, accounting standards and corporate governance.

The trading mechanism is screen based trading system, orders are matched on price time priority, transparent, trading platform is accessible from all over the country.

The settlement is done through the clearing house of the exchange or the clearing corporation.

The settlement cycle is rolling settlement on T+2 basis. However, there are provisions where it can be settled by the third day.

Basis of settlement is mostly electronic. Securities are freely transferable and transfers are recorded

electronically. 20