Chapter 2: Introduction to Securities Market
| Topic | Description |
|---|---|
| Introduction to Securities and Securities Market | Securities represent ownership (equity) or debt and are fundamental to the financial market. The securities market facilitates the issuance and trading of these financial instruments, enabling companies to raise capital and investors to generate returns. |
| Product Definitions / Terminology | Key terms in the securities market include equity, bonds, derivatives, and mutual funds. Understanding these products is essential for navigating market investments and transactions. |
| Structure of Securities Market | The securities market is divided into the primary market, where new securities are issued, and the secondary market, where existing securities are traded among investors. |
| Various Market Participants and Their Activities | Participants include investors, brokers, dealers, market makers, and regulatory bodies, each playing a specific role in maintaining market efficiency, liquidity, and fairness. |
| Kinds of Transactions | Transactions include buying and selling of securities, short selling, and leveraging through margin. Each type of transaction serves different investment strategies and risk profiles. |
| Dematerialization and Rematerialization of Securities | Dematerialization converts physical certificates into electronic form, while rematerialization reverses this process, allowing for physical certificates if preferred. |
2.1: Introduction to Securities and Securities Market
Imagine a vast financial marketplace where buyers and sellers exchange financial instruments — welcome to the world of securities and securities markets. This section introduces the key building blocks that make capital markets function efficiently.
Securities are financial instruments that represent either ownership (equity) or a creditor relationship (debt). These contracts are issued by companies, financial institutions, or the government to raise capital.
- Equity Shares: Represent ownership in a company, often with voting rights and dividend potential.
- Preference Shares: Offer fixed dividends with priority over equity shareholders.
- Debentures/Bonds: Debt instruments where investors earn interest as creditors of the issuer.
- Investment Avenue: Convert savings into productive financial assets with return potential.
- Fundraising Tool: Issuers raise funds for expansion, development, and operations.
- Transferability: Securities can be easily bought and sold in the market.
🔁 Role of Securities Markets
Securities markets enable efficient capital flow and investment activity by offering a platform for issuing and trading financial instruments.
- Connecting Issuers & Investors: Brings together those who need capital with those who can invest.
- Liquidity Provider: Investors can buy/sell securities anytime, increasing confidence and flexibility.
- Efficient Resource Allocation: Shifts funds from surplus holders to productive uses.
- Diverse Investment Options: Caters to different risk and return profiles.
- Investors: Individuals or institutions that buy securities
- Issuers: Companies or governments raising capital
- Intermediaries: Brokers, dealers, and investment banks
- Regulators: SEBI and other authorities that maintain transparency and fairness
As per Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA), securities include:
- Shares, stocks, bonds, and debentures
- Derivatives (e.g., futures and options)
- Mutual fund units
- Government securities
- Electronic Gold Receipts (declared securities from Dec 2021)
2.2: Product Definitions / Terminology
The securities market offers a wide range of financial products designed for different investment goals, time horizons, and risk appetites. Understanding these products is essential for investors to navigate the market effectively.
1. Equity Shares
Equity shares represent ownership in a company. Shareholders are entitled to a share in the company’s profits and have voting rights. These are traded on stock exchanges and offer potential for capital appreciation.
2. Preference Shares
Preference shareholders receive a fixed dividend before equity shareholders. They have preferential rights during liquidation but usually do not carry voting rights.
3. Debentures and Bonds
These are debt instruments used by companies or governments to raise funds. Investors receive periodic interest payments and the principal at maturity.
- Debentures: Unsecured debt instruments backed only by the issuer’s creditworthiness.
- Bonds: May be secured or unsecured and are typically issued with specific terms.
- Masala Bonds: INR-denominated bonds issued outside India.
- Foreign Currency Bonds: Issued in a currency different from the issuer’s domestic currency.
4. Warrants & Convertible Instruments
Warrants give holders the right to buy shares at a fixed price in the future. Convertible bonds/debentures can be converted into equity shares at a specified time.
5. Mutual Funds & ETFs
- Mutual Funds: Pooled investments managed by professionals, investing in equities, debt, or hybrids.
- Exchange Traded Funds (ETFs): Trade like stocks and track indices or asset baskets, offering intraday liquidity.
6. Hybrid Instruments
- Preference Shares: Exhibit both equity and debt characteristics.
- Convertible Debentures: Debt that can convert into equity.
7. Depository Receipts
- American Depository Receipts (ADRs): Represent shares of foreign companies traded in the US.
- Global Depository Receipts (GDRs): Traded globally and represent foreign equities.
- Indian Depository Receipts (IDRs): Represent foreign company shares traded in India.
8. Structured Products
- Equity Linked Debentures (ELDs): Debt instruments with interest linked to equity performance.
- Commodity Linked Debentures (CLDs): Returns based on commodity index or prices.
9. Securitized Products
- Mortgage Backed Securities (MBS): Backed by home loan receivables.
- Asset Backed Securities (ABS): Based on receivables from loans like car, personal, or credit card debt.
10. REITs and InvITs
- REITs (Real Estate Investment Trusts): Invest in income-generating real estate assets.
- InvITs (Infrastructure Investment Trusts): Focused on income-generating infrastructure projects.
11. Commodities
Commodities are tangible goods like gold, oil, and agricultural produce. Investors can gain exposure through commodity ETFs, futures, and warehouse receipts.
2.3: Structure of Securities Market
The Indian securities market facilitates the efficient allocation of capital and is structured into two major segments — Primary Market and Secondary Market. The design of this structure ensures that savings are channeled into productive investments through regulated and transparent mechanisms.
Primary Market
The primary market, also referred to as the new issue market, is where new securities are created and offered to investors for the first time. It helps issuers raise fresh capital from the public or selected investors.
1. Public Issue
Initial Public Offer (IPO): The first issuance of shares by a company to the public. Companies must meet SEBI criteria including profitability and net worth. Pricing is usually discovered via book-building and allocation is made to different categories like retail, QIBs, and anchor investors.
Follow-on Public Offer (FPO): A listed company issues new shares or offers shares from existing shareholders to raise more capital. This can be for business expansion or reducing debt.
2. Private Placement
Offered to a select group of investors, typically not more than 50, under the Companies Act, 2013. This route is faster and involves less regulatory scrutiny.
- Qualified Institutional Placement (QIP): Offered exclusively to Qualified Institutional Buyers (QIBs) like mutual funds and banks.
- Preferential Allotment: Offered to specific investors with board/shareholder approval.
3. Rights and Bonus Issues
- Rights Issue: Existing shareholders are offered additional shares at a discounted price.
- Bonus Issue: Free shares distributed from the company’s reserves to existing shareholders.
4. Other Instruments
- Offer for Sale (OFS): Promoters or large investors offer shares to the public through the exchange platform.
- ESOPs/Sweat Equity: Shares granted to employees as performance incentives.
- Onshore & Offshore Offerings: Companies raise capital from domestic or international investors depending on their strategy.
Secondary Market
The secondary market deals with the trading of existing securities among investors. It provides liquidity, ensures fair price discovery, and builds investor confidence.
1. Trading Venues
| Market Type | Features |
|---|---|
| Exchange-Traded Market | Regulated trading on platforms like NSE and BSE using electronic systems with transparent processes. |
| Over-the-Counter (OTC) Market | Customized securities traded directly between parties. Less regulation and suitable for complex deals like corporate bonds. |
2. Key Features
- Liquidity: Enables easy entry and exit from investments.
- Price Discovery: Continuous market trades determine the fair price of securities.
- Transparency & Regulation: Ensures investor protection and efficient trade execution.
Post-Trade Activities
After a trade is executed, clearing and settlement ensure its smooth completion. Clearing corporations like NSCCL and ICCL manage this process and guarantee transactions.
- Clearing: Calculates the net obligations of buyers and sellers.
- Settlement: Final transfer of funds and securities between parties.
Risk Management in Exchange-Traded Markets
Clearing corporations enforce risk controls to manage potential defaults using a robust margining system:
- Initial Margin: Collected in advance to mitigate future risk exposure.
- Peak Margin: Highest intraday margin requirement due to volatility.
- Mark-to-Market (MTM) Margin: Adjusted daily to reflect unrealized gains/losses in position value.
2.4: Various Market Participants and Their Activities
The Indian securities market is supported by a network of market participants who play distinct and crucial roles in ensuring smooth and transparent operations. These participants contribute to capital formation, price discovery, liquidity, and market integrity. Let’s explore the key categories of participants and their roles:
1. Issuers
Issuers are entities that raise funds by issuing securities such as shares, debentures, and bonds. These include:
- Corporate Entities: Listed and unlisted companies issuing equity and debt instruments.
- Government Bodies: Central and state governments issuing government securities (G-Secs).
- Financial Institutions: Public financial institutions, development banks, and NBFCs.
2. Investors
Investors provide capital in exchange for returns. They are categorized as:
- Retail Investors: Individual investors with small investment amounts.
- High Net-Worth Individuals (HNIs): Individuals with larger capital and sophisticated investment preferences.
- Institutional Investors: Includes Mutual Funds, Insurance Companies, Pension Funds, Alternate Investment Funds (AIFs), and Foreign Portfolio Investors (FPIs).
3. Intermediaries
These are entities that facilitate transactions and ensure the smooth functioning of markets.
- Stock Brokers: Help investors execute buy and sell orders on stock exchanges.
- Merchant Bankers: Assist companies with IPOs, FPOs, and other fundraising activities.
- Depositories & Depository Participants (DPs): Provide demat account facilities for holding securities in electronic form.
- Clearing Corporations: Responsible for clearing and settlement of trades, managing counterparty risk.
- Registrars & Transfer Agents (RTAs): Maintain records of investors and handle share transfer operations.
- Custodians: Hold securities on behalf of institutional investors.
- Research Analysts & Investment Advisors: Provide investment recommendations based on fundamental and technical analysis.
4. Market Infrastructure Institutions (MIIs)
MIIs are institutions that form the backbone of securities market operations. These include:
- Stock Exchanges: Platforms like NSE and BSE where securities are traded.
- Clearing Corporations: Like NSCCL and ICCL, ensuring guaranteed settlement of trades.
- Depositories: NSDL and CDSL maintain ownership records and enable dematerialization.
5. Regulatory Bodies
These bodies ensure the orderly development and regulation of the market to protect investors and maintain integrity:
- SEBI (Securities and Exchange Board of India): The primary regulator for securities markets.
- RBI (Reserve Bank of India): Regulates money markets and government securities.
- Ministry of Finance: Frames financial sector policies and oversees capital markets.
2.5: Kinds of Transactions
In the securities market, a variety of transactions are executed by investors depending on their strategies, objectives, and market outlook. Understanding the different kinds of transactions is essential to comprehend how securities are traded and how investors participate in the market.
1. Buy/Sell Transactions
The most common type of transaction where investors buy securities to hold and sell them later at a profit. These are executed on the secondary market through stock exchanges.
2. Delivery-Based Transactions
In delivery-based trades, securities are actually delivered to the buyer’s demat account. This is common among long-term investors.
3. Intra-Day Transactions
In these trades, the investor buys and sells the same security on the same trading day. No delivery takes place, and profits/losses are settled at the end of the day.
4. Margin Trading
Investors borrow funds from brokers to buy more securities than they could with their own capital. The margin acts as collateral and enhances potential returns, but also increases risk.
5. Short Selling
Short selling involves selling securities that the investor does not own, with the intention of buying them back later at a lower price. This strategy is used when the investor expects prices to decline.
6. Block Deals and Bulk Deals
- Block Deal: A single transaction of a large number of shares (minimum value ₹5 crore) between two parties, executed through a separate window on the stock exchange.
- Bulk Deal: When an investor trades more than 0.5% of a company’s equity shares in a single or multiple transactions on a single day. These are reported to the exchange.
7. Auction Trades
When a seller fails to deliver the shares on time, exchanges conduct an auction to buy the shares and deliver them to the buyer. This maintains market discipline and trust.
8. Derivative Transactions
These include trading in futures and options contracts, which derive their value from underlying assets like equity shares, indices, or commodities. These are leveraged instruments used for speculation, hedging, or arbitrage.
2.5: Kinds of Transactions
In the securities market, a variety of transactions are executed by investors depending on their strategies, objectives, and market outlook. Understanding the different kinds of transactions is essential to comprehend how securities are traded and how investors participate in the market.
1. Buy/Sell Transactions
The most common type of transaction where investors buy securities to hold and sell them later at a profit. These are executed on the secondary market through stock exchanges.
2. Delivery-Based Transactions
In delivery-based trades, securities are actually delivered to the buyer’s demat account. This is common among long-term investors.
3. Intra-Day Transactions
In these trades, the investor buys and sells the same security on the same trading day. No delivery takes place, and profits/losses are settled at the end of the day.
4. Margin Trading
Investors borrow funds from brokers to buy more securities than they could with their own capital. The margin acts as collateral and enhances potential returns, but also increases risk.
5. Short Selling
Short selling involves selling securities that the investor does not own, with the intention of buying them back later at a lower price. This strategy is used when the investor expects prices to decline.
6. Block Deals and Bulk Deals
- Block Deal: A single transaction of a large number of shares (minimum value ₹5 crore) between two parties, executed through a separate window on the stock exchange.
- Bulk Deal: When an investor trades more than 0.5% of a company’s equity shares in a single or multiple transactions on a single day. These are reported to the exchange.
7. Auction Trades
When a seller fails to deliver the shares on time, exchanges conduct an auction to buy the shares and deliver them to the buyer. This maintains market discipline and trust.
8. Derivative Transactions
These include trading in futures and options contracts, which derive their value from underlying assets like equity shares, indices, or commodities. These are leveraged instruments used for speculation, hedging, or arbitrage.
2.6: Dematerialization and Rematerialization of Securities
The evolution of the Indian securities market has shifted from physical certificates to electronic records. This transformation, known as dematerialization, has greatly enhanced security, efficiency, and investor convenience. Investors also have the option to reverse this process, which is called rematerialization.
1. Dematerialization
Dematerialization is the process of converting physical share certificates into electronic form. The investor must open a Demat Account with a Depository Participant (DP), affiliated with one of the registered depositories in India such as NSDL or CDSL.
- It eliminates problems like theft, forgery, delays, and loss of certificates.
- Securities are held digitally, making trading seamless and safe.
- It is now mandatory for trading listed securities.
2. Rematerialization
Rematerialization is the reverse of dematerialization. It involves converting securities held in electronic form back into physical certificates.
- Investors submit a Remat Request Form (RRF) to their DP.
- The DP forwards the request to the concerned depository and company/issuer.
- Upon approval, the physical certificate is issued and delivered to the investor.
Benefits of Dematerialization
- Safety: Prevents risks of theft, loss, and forgery of physical certificates.
- Convenience: Simplifies transfer and trading of securities through online platforms.
- Reduced Costs: Eliminates handling charges and stamp duties on transfers.
- Faster Settlements: Enhances market efficiency through quicker settlement cycles.
Key Institutions Involved
- Depositories: NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited).
- Depository Participants (DPs): Act as agents between the depositories and the investors.
- Issuer Companies: Facilitate the conversion of physical to electronic shares and vice versa.
