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2. Introduction to Securities Market

Introduction to Securities and Securities Market

Securities are transferrable financial instruments or contracts that show evidence of indebtedness or ownership interest in assets of an incorporated entity. These include equity shares, preference shares, debentures, bonds, and other such instruments. These are issued by companies, financial institutions, or the government. They are purchased by investors who have money to invest. Security ownership allows investors to convert their savings into financial assets which provide a return. On the other hand, security issuance allows borrowers to raise money at a cost. Thus, the objectives of the issuers and the investors are complementary.


Product Definitions/Terminology-

  1. Equity share (also known as ordinary share capital or ordinary shares) is the amount of money that shareholders have invested in a company. It is one of the sources of a company’s capital, along with debt and retained earnings. Equity share capital is represented by shares of stock that can be bought and sold in the stock market. Equity shareholders are the owners of a company and have the right to vote on certain matters, such as electing members of the Board of Directors. They also receive dividends, which are payments made out of the profits of the company. (Regulator:- SEBI & Companies Act)
  2. Debentures (also called bonds or notes) are a form of long-term debt, usually issued by companies to raise capital. They are usually secured against the assets of the company and are repaid in periodic installments with interest. Debentures can be traded on the stock market and provide investors with a regular income. However, they do not carry any voting rights, unlike equity shareholders. (Regulator:- RBI, SEBI & Companies Act)

    Fully convertible debentures (FCDs) are a type of debt instrument that can be exchanged for a fixed number of equity shares of the issuing company at a predetermined price. The conversion is usually done at a predetermined date, usually after a certain period of time. FCDs are a form of hybrid security, as they combine the features of both debt and equity.

    Partly convertible debentures (PCDs) are a type of debt instrument that can be partially converted into equity shares of the issuing company at a predetermined price.

    Non-Convertible Debentures (NCDs) are pure debt instruments without a feature of conversion. The NCDs are repayable/redeemable on maturity.
  3. Foreign currency bonds are bonds issued by a company in a currency that is different from the currency of its home country. For example, in February 2020, Delhi International Airport Limited (an SPV of GMR Infrastructure Ltd) issued USD bonds. (Regulator- Regulators in the respective country of issue).
  4. External bonds / Masala bonds– also referred to as Euro bonds, are bonds issued in a currency that is different from the currency of the country in which it is issued. For example, if a company issues a US dollar-denominated bond in Kuwait, it would be referred to as a Euro bond as the currency of the bond (USD) is different from the currency of the country in which it is issued (Kuwaiti Dinar). (Regulator- Regulators in the respective country of issue).
  5. Warrants and Convertible Warrants- are options that entitle an investor to buy equity shares of the issuer company after a specified time period at a pre-determined price. Only a few companies in Indian Securities Market have issued warrants till now.
  6. Indicies– A market index tracks the market movement by using the prices of a small number of shares chosen as a representative sample. we can call the stock market index a benchmark and it presents the economy of the country and specific sector.
    Common Indicies in India- Nifty 50, Nifty 100, Nifty 500, S&P Sensex, BSE Midcap, etc.
  7. Mutual Funds (MFs) are investment vehicles that pool together the money contributed by investors the fund invests in a portfolio of securities that reflect the common investment objectives of the investors. Each investor’s share is represented by the units issued by the fund. The value of the units, called the Net Asset Value (NAV), changes continuously to reflect changes in the value of the portfolio held by the fund. (Regulator- SEBI & RBI)
    An open-ended scheme offers the investors an option to buy units from the fund at any time and sell the units back to the fund at any time.
    The unit capital of closed-ended funds is fixed and they sell a specific number of units.
  8. Exchange Traded Funds (ETFs) are investment vehicle that invests funds pooled by investors to track an index, a commodity, or a basket of assets. It is similar to an index fund in the sense that its portfolio reflects the index it tracks. But, unlike an index fund, the units of the ETF are listed and traded in Demat form on a stock exchange, and their price changes continuously to reflect changes in the index or commodity prices. (Regulator SEBI & RBI)
  9. Preference Shares- as their name indicates, are a special kind of equity shares that have preference over common/ordinary equity shares at the time of dividend and at the time of repayment of capital in the event of winding up of the company. They have some features of equity and some features of debt instruments.
  10. Depository receipts (DRs) are financial instruments that represent shares of a foreign company. These depositary receipts trade in the local market (in which it is issued) and are denominated in local currency.

    American Depositary Receipts (ADRs): These depositary receipts issued and traded in the U.S.A. are issued by a non-US company. Some of the Indian companies that have issued ADR include Infosys, Wipro, ICICI Bank, and HDFC Bank.

    Indian Depositary Receipts (IDR): DR issued and traded in the Indian market by a non-Indian company is referred to as IDR.

    Hong Kong Depositary Receipts (HKDR): HKDRs refer to a depositary receipt issued by a non-Hong Kong company that is traded in the Hong Kong market.

    Global Depositary Receipts (GDRs): GDRs are preferred to be issued in the European Union member states as the commonality of the regulations makes it easy for the issuing companies to comply with regulations across the region.
  11. Foreign Currency Convertible Bonds (FCCBs):- denominated convertible debt papers issued by companies in international markets. These instruments are to be understood the way convertibles are with the only difference being that they are generally optionally convertible and issued offshore in different denominations under guidelines as defined by the Reserve Bank of India (RBI) from time to time. (Regulator- Foreign Exchange Management Act (FEMA) & RBI)
  12. Equity Linked Debentures (ELDs)- are floating rate debt instruments whose interest is based on the returns of the underlying equity asset such as Nifty 50, S&P Sensex, individual stocks, or any customized basket of individual stocks.
  13. Commodity Linked Debentures (CLDs)– CLDs are floating-rate debt instruments whose interest is based on the returns of the underlying commodity asset.
  14. Mortgage Backed Securities (MBS) and Asset-Backed Securities (ABS): are debt instruments issued by institutions against the receivables and cash flows from financial assets such as home loans (MBS), auto loans, rent receivable, credit card receivables, and others.
  15. REITs/InvITs– Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are investment vehicles that pool money from various investors and invest in revenue-generating real estate projects and infrastructure projects, respectively. In the case of REITs, 80% of the asset should be held in the form of real estate assets. Similarly, for InvITs, the regulation stipulates that 90% of the unit capital should be invested in revenue-generating infrastructure projects. These assets can be held directly or through a special-purpose vehicle (SPV)
  16. Commodities– are largely traded goods that are meant for use in the production of goods or for consumption. Since inflation and prices of commodities are directly related, investing in commodities can help protect the real value of the investment.
  17. Precious metals such as gold and silver are viewed as an investment that can help preserve the real value of money.
  18. Commodity ETFs– A commodity ETF is an exchange-traded fund that invests the pooled investment in a range of physical commodities.
  19. Managed futures contract– Futures contract is a contract to buy or sell an asset at a specified future date at a specific price. Since the price of the contract is pre-determined, the buyer of the contract tends to gain if the price of the product increases in the future (the reverse is also true).
  20. Warehouse receipts– is a document that shows proof of ownership of goods that are stored in a warehouse. Most of these warehouse receipts are negotiable. Thus, the title to the underlying goods can be transferred by simply transferring the receipts.
  21. Structure of Securities Market-

    Primary Market: also called the new issue market, is where issuers raise capital by issuing securities to investors. Fresh securities are issued in this market

    Secondary Market: The secondary market facilitates trades in already-issued securities, thereby enabling investors to exit from an investment or new investors to buy the already existing securities.
  22. Public issue- Securities are issued to the members of the public, and anyone eligible to invest can participate in the issue. This is primarily a retail issue of securities.
  23. Initial Public Offer (IPO)– An initial public offer of shares or IPO is the first sale of a corporate’s common shares to investors at large. The main purpose of an IPO is to raise equity capital for further growth of the business. Eligibility criteria for raising capital from public investors are defined by SEBI in its regulations and include minimum requirements for net tangible assets, profitability, and net worth.
    at least 35% of shares should be allocated to retail investors (investors investing less than or equal to Rs.2,00,000 in the issue) while the utmost 50% can be allocated to qualified institutional investors. Other investors can be issued the balance.
  24. 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 to the public, it is called FPO.
  25. Private Placement- It refers to issuing large quantities of shares to a select set of investors.
    According to the Companies Act 2013, the number of investors to whom shares are issued under
    private placement should not exceed fifty (50).
  26. Qualified Institutional Placements (QIPs)- private placements of shares made by a listed company to certain identified categories of investors known as Qualified Institutional Buyers (QIBs).
  27. Preferential Issue– means an issue of specified securities by a listed issuer to any select person or group of persons on a private placement basis and does not include an offer of specified securities made through a public issue, rights issue, bonus issue, employee stock option scheme, employee stock purchase scheme or qualified institutions placement or an issue of sweat equity shares or depository receipts issued in a country outside India or foreign securities.
  28. Rights and Bonus Issues- Securities are issued to existing shareholders of the company as on a specific cut-off date, enabling them to buy more securities at a specific price (in case of rights) or without any consideration (in case of bonus). Both rights and bonus shares are offered in a particular ratio to the number of securities held by investors as of the record date.
  29. Onshore and Offshore Offerings- If capital is raised from the domestic market, it is called an onshore offering and if capital is raised from investors outside the country, it is termed an offshore offering.
  30. Offer for Sale (OFS)- is a form of share sale where the shares offered in an IPO or FPO are not fresh shares issued by the company, but an offer by existing shareholders to sell shares that have already been allotted to them.
  31. Sweat Equity – Under Sec.54 of the Companies Act, 2013, a company may issue shares to its employees, promoters, technocrats, or others as a reward for their contribution to the company. These shares are referred to as sweat equity.
  32. Employee Stock Option Scheme (ESOPs)– ESOPs are instruments given by a company to its employees that give them the option to buy the shares of the company at a pre-determined price after a period of time (referred to as a vesting period).
  33. Secondary Market- the dealings between investors and the issuers do not come into the picture.
  34. Over-The-Counter Market (OTC Market)– OTC markets are the markets where trades are directly negotiated between two or more counterparties. In this type of market, the securities are traded and settled over the counter among the counterparties directly.
  35. Exchange Traded Markets -trading and settlement are done through the stock exchanges. The trades executed on the exchange are settled through the clearing corporation, which acts as a counterparty and guarantees the settlement of the trades to both buyers and sellers.
  36. Trading– A formal contract to buy/sell securities is termed as trading.
  37. Clearing and Settlement- are post-trading activities that constitute the core part of the equity trade life cycle. Clearing activity is all about ascertaining the net obligations of buyers and sellers for a specific time period. And, settlement is the next step in settling obligations by delivering shares (by the seller) and paying money (by the buyer).
  38. Risk Management– In OTC transactions, counterparties are expected to take care of the credit risk on their own. In the exchange-traded world, the clearing corporation, as defined above, gives a settlement guarantee of trades to the counterparties (all buyers and sellers).
  39. Stock Exchanges– provide a trading platform where buyers and sellers can transact in already issued securities. Stock markets such as NSE, BSE and MSEI are nationwide exchanges. Trading happens on these exchanges through electronic trading terminals which feature anonymous order matching.
  40. Depositories -are institutions that hold securities (like shares, debentures, bonds, government securities, and mutual fund units) of investors in electronic form. two Depositories in India that are registered with SEBI: 1. Central Depository Services Limited (CDSL) & National Securities Depository Limited (NSDL)
  41. Depository Participant- (DP) is an agent of the depository through which it interfaces with the investors and provides depository services. Depository participants enable investors to hold and transact in securities in the dematerialized form.
  42. Trading Members (Broker)– are registered members of a Stock Exchange. They facilitate buy and sell transactions of investors on stock exchanges.
  43. A Sub-Broker is an entity that is not a member of the Stock Exchange but who acts on behalf of a trading member or Stock Broker as an agent for assisting the investors in buying, selling, or dealing in securities through a such trading member or Stock Broker with whom he is associated.
  44. Brokerage- Brokers receive a commission for their services, which is known as brokerage. Maximum brokerage chargeable to customers is fixed by individual stock exchanges.
  45. Authorized Person – An authorized person is any person (individual, partnership firm, LLP, or body corporate), who is appointed by a stock broker or trading member as an agent to reach out to investors scattered across the country.
    SEBI had earlier allowed the spread of sub-brokership as well as Authorised Person’s network to expand the brokers’ network. However, SEBI Board in its meeting held on June 21, 2018, decided that sub-brokers as an intermediary shall cease to exist with effect from April 01, 2019. All existing sub-brokers would migrate to become Authorised Persons (APs) or Trading Members if the sub-brokers meet the eligibility criteria prescribed under Stock Exchange bye-laws and SEBI Regulations and by complying with these Regulations.
  46. Custodians- an entity that is charged with the responsibility of holding funds and securities of its large clients, typically institutions such as banks, insurance companies, and foreign portfolio investors. a custodian also settles transactions in these securities and keeps track of corporate actions on behalf of its clients.
  47. Clearing Corporations – play an important role in safeguarding the interest of investors in the Securities Market. Clearing agencies ensure that members of the Stock Exchange meet their obligations to deliver funds or securities.
  48. Clearing Banks– act as an important intermediary between clearing members and the clearing corporation. Every clearing member needs to maintain an account with the clearing bank.
  49. Merchant Bankers- are entities registered with SEBI and act as issue managers, investment bankers, or lead managers. They help issuer access the security market with the issuance of securities.
    They evaluate the capital needs of issuers, structure an appropriate instrument, get involved in pricing the instrument and manage the entire issue process until the securities are issued and listed on a stock exchange.
  50. Underwriters- are intermediaries in the primary market who undertake to subscribe to any portion of a public offer of securities that may not be bought by investors.
  51. Foreign Portfolio Investors (FPIs)- an entity established or incorporated outside India that proposes to make investments in India. These international investors must register with the regulator – the Securities and Exchange Board of India (SEBI) to participate in the Indian Securities Market.
  52. Participatory Notes (P-Notes or PNs) are instruments issued by SEBI-registered foreign portfolio investors to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator.
  53. Insurance companies’ core business is to ensure assets. Depending on the type of assets that are insured, there are various insurance companies like life insurance and general insurance, etc. These companies have huge corpus and they are one of the most important investors in the Indian economy by investing in equity investments, government securities, and other bonds.
  54. Pension Funds – A fund established to facilitate and organize the investment of the retirement funds contributed by the employees and employers or even only the employees in some cases. The pension fund is a common asset pool meant to generate stable growth over the long term and provides a retirement income for employees.
  55. Venture Capital Funds (VC) -are pools of capital provided by investors to startup companies and small businesses with perceived long-term growth potential. The venture capital funds provide financing to these companies in exchange for equity or an ownership stake in the business. These funds typically focus on high-growth, high-risk investments in exchange for the potential for a high return. Venture capital funds are typically managed by professional investors and are typically structured as limited partnerships.
  56. Private Equity Firms-is a term used to define funding available to companies in the early stages of growth, expansion, or buy-outs. Investee companies may be privately held or publicly traded companies.
  57. Hedge Funds- is an investment vehicle that pools capital from a number of investors and invests that across assets, across products, and across geographies. These fund managers generally have a very wide mandate to generate a return on the invested capital. They hunt for opportunities to make money for their investors wherever possible.
  58. Alternative Investment Funds (AIF)– are funds that invest in non-traditional asset classes such as private equity, venture capital, hedge funds, real estate, commodities, and derivatives. These funds provide investors with more diversified exposure and the potential for higher returns than traditional investments. However, they also come with higher risks and are not suitable for all investors.
  59. Investment advisers work with investors to help them decide on asset allocation and make a choice of investments based on an assessment of their needs, time horizon return expectation, and ability to bear risk. They may also be involved in creating financial plans for investors, where they help investors define their financial goals and propose appropriate saving and investment strategies to meet these goals.
  60. Employee Provident Fund (EPF)- is a scheme that is used to provide retirement benefits in the form of defined benefit schemes to employees of covered organizations. Every employer is obligated to provide 12% of the basic salary as a contribution to the scheme and an equal amount is deducted from the employee’s salary.
  61. National Pension Scheme (NPS)– This is a government-sponsored retirement scheme. Subscribers contribute regularly to the scheme and on maturity, the funds accumulated in the scheme can be used to buy annuity products. Subscribers will also have the option to partially withdraw the funds at maturity.
  62. Family Offices– refers to an organization that handles the wealth of a wealthy family. They typically take care of all aspects of the financial management of the family including investments, estate planning, and tax planning.
  63. Corporate Treasuries– Companies and other business organizations may have surplus funds which they intend to use for potential future opportunities or to meet future obligations. The organizations would gain if these funds are temporarily invested rather than let them be idle in their banks’ current accounts. Large corporates have a separate treasury team that handles such investments of surplus funds.
  64. Retail Participants– include individual investors who buy and sell securities for their personal account, and not for another company or organization. HNIs or High Net-worth Individuals and UHNIs (Ultra High net-worth individuals) are individual investors who invest large sums of money in the market. Reserve Bank of India has also granted general permission to Non-Resident Indians (NRIs), Persons of Indian origin (PIOs), and Qualified Foreign Investors (QFIs) for undertaking direct investments in Indian companies under the Automatic Route.
  65. Proxy Advisory services firms- advise investors in relation to the exercise of their rights in the company including recommendations on public offers or voting recommendations on agenda items. As investors may not be able to track shareholder announcements of all their investee companies or analyze each of the proposals in depth, the service of proxy advisors adds value to them.
  66. Cash trades are the trades where settlement (payment and delivery) occurs on the same trading day (T+0, where 0 defines the time gap in days between trade day and settlement day). we see cash transactions in our normal day-to-day life all the time when we buy groceries, vegetables, and fruits from the market.
  67. Tom trades are the trades where settlement (payment and delivery) occurs on the day next to the trading day (T+1).
  68. Spot trades are the trades where settlement (payment and delivery) occurs on the spot date, which is normally two business days after the trade date (T+2). Equity markets in India offer Spot trades.
  69. Forward contracts are contractual agreements between two parties to buy or sell an underlying asset at a certain future date for a particular price that is decided on the date of the contract. These are Over-the-counter (OTC) contracts.
  70. Futures are standardized exchange-traded forward contracts. They are standardized as to the market lots (traded quantities), quality, and terms of delivery – delivery date, cash settlement or physical delivery, etc. As these contracts are traded and settled on a stock exchange and the clearing corporation provides a settlement guarantee on them.
  71. An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying asset on or before a stated date and at a stated price.

    Call gives the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date.
    Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date.
  72. A swap is an agreement between two parties to exchange one type of asset for another. It is typically used for a variety of reasons, such as to hedge risk, increase liquidity, or raise capital. For example, an interest rate swap is an agreement between two parties to exchange a fixed interest rate payment for a variable rate payment. In this case, one party may be looking to hedge against a potential rise in interest rates, while the other is looking to take advantage of the potential for a lower rate. There are a number of different types of swaps, including currency swaps, credit default swaps, and commodity swaps.
  73. Trading or speculating is an act of purchase or sale of an asset in the expectation of a gain from changes in the price of that asset over a short period of time.
  74. Hedging is an act of taking a position in financial transactions to offset potential losses that may be incurred by another position. A hedge can be constructed from many types of financial instruments, including insurance, forward/futures contracts, swaps, options, etc.
  75. Arbitrage is the simultaneous purchase and sale of an asset in an attempt to profit from discrepancies in its prices in two different markets. Buying a stock in the spot market and simultaneously selling that in the futures market to benefit from the price differential is an example of an arbitrage transaction.
  76. Pledge is an act of taking a loan against securities by the investor. The investor is called a ‘pledgor’ and the entity who is giving the loan against the securities is called a ‘pledgee’. Securities held in a depository account can be pledged/ hypothecated to avail of a loan/credit facility.
  77. Dematerialization is the process of converting securities held in physical form into holdings in book entry (electronic) form.
  78. Rematerialization is the reverse of dematerialization and is the process of converting securities held in electronic form into physical form.

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