INTRODUCTION TO FINANCIAL

MARKETS
Workbook

NSE Certified Capital Market Professional

(NCCMP)
(A joint certificate course from MAEER's MIT School of Business
and The National Stock Exchange of India Limited)

CHAPTER 1 ...............................................................................................................................6
INTRODUCTION TO FINANCIAL SYSTEM...................................................................................6
MEANING ..............................................................................................................................6
FLOW OF FUNDS IN THE FINANCIAL SYSTEM ......................................................................6
AN OVERVIEW OF FINANCIAL SYSTEM ................................................................................7
FINANCIAL INSTITUTIONS ....................................................................................................7
FINANCIAL MARKETS...........................................................................................................8
FINANCIAL INSTRUMENTS ...................................................................................................9
FINANCIAL SERVICES ........................................................................................................10
REGULATORS ....................................................................................................................10
CHAPTER 2 .............................................................................................................................12
PRIMARY MARKET ..................................................................................................................12
DIFFERENT KINDS OF ISSUES............................................................................................12
PUBLIC ISSUE ....................................................................................................................13
IPO.................................................................................................................................13
FPO................................................................................................................................13
RIGHTS ISSUE ....................................................................................................................14
BONUS ISSUE .....................................................................................................................14
Preferential allotment........................................................................................................14
Qualified institutions placement (QIP).................................................................................14
OFFER DOCUMENTS ..........................................................................................................15
Draft offer document.........................................................................................................15
RED HERRING PROSPECTUS ........................................................................................15
PROSPECTUS .....................................................................................................................15
LETTER OF OFFER .............................................................................................................15
PLACEMENT DOCUMENT ...................................................................................................16
UNDERSTANDING THE OFFER DOCUMENT .......................................................................16
Cover Page .....................................................................................................................16
Risk Factors ....................................................................................................................16
Introduction .....................................................................................................................16
About us .........................................................................................................................17
Financial Statements ........................................................................................................17
Legal and other information...............................................................................................17
Other regulatory and statutory disclosures..........................................................................17
Offering information..........................................................................................................17
Other Information .............................................................................................................18
REGULATION FOR DIFFERENT KINDS OF ISSUES .............................................................18
SEBI (ICDR) Regulations, 2009.........................................................................................18
Issue Requirements .........................................................................................................18
Differential Pricing............................................................................................................20
Contribution of Promoters and lock-in.................................................................................20
General Conditions ..........................................................................................................20
Role of a Lead Merchant Banker .......................................................................................21
Book Building ..................................................................................................................22
Application Supported by Blocked Amount (ASBA)..............................................................22
IPO Grading ....................................................................................................................23

Intermediaries involved in the Issue Process.......................................................................23

Credit Rating ...................................................................................................................23
Demat Issues ..................................................................................................................24
Indian Depository Receipts ...............................................................................................24
FOREIGN CAPITAL ISSUANCE............................................................................................25
Global Depository Receipts (GDRs) ...................................................................................25
American Depository Receipts (ADRs) ...............................................................................26
Foreign Currency Convertible Bonds (FCCBs) ....................................................................26
External Commercial Borrowings .......................................................................................26
Guidelines relating to International Issues...........................................................................27
CONCEPT CLARIFIERS FOR PRIMARY MARKET ................................................................28
CHAPTER 3 .............................................................................................................................32
FINANCIAL MARKETS .............................................................................................................32
FUNCTIONS OF FINANCIAL MARKETS ...............................................................................32
Borrowing and Lending.....................................................................................................32
Price Determination..........................................................................................................32
Information Aggregation and Coordination..........................................................................32
Risk Sharing....................................................................................................................32
Liquidity ..........................................................................................................................33
Efficiency ........................................................................................................................33
TYPES OF FINANCIAL MARKETS........................................................................................33
Securities Markets............................................................................................................33
Money markets ................................................................................................................34
Foreign exchange markets................................................................................................34
Commodity markets .........................................................................................................34
Insurance market .............................................................................................................34
CHAPTER 4 .............................................................................................................................35
SECURITIES MARKET IN INDIA................................................................................................35
DEFINITON OF SECURITIES ................................................................................................35
FUNCTIONS OF SECURITIES MARKET: ..............................................................................35
Mobilization of savings and acceleration of capital formation ................................................35
Promotion of industrial growth ...........................................................................................36
Raising long-term capital ..................................................................................................36
Ready and continuous market ...........................................................................................36
Proper channelization of funds ..........................................................................................36
Provision of a variety of services........................................................................................36
MARKET SEGMENTS IN SECURITIES MARKET...................................................................37
PRIMARY MARKET .........................................................................................................37
Secondary Market............................................................................................................37
HISTORY OF SECURITIES MARKET ....................................................................................38
MARKET PARTICIPANTS IN SECURITIES MARKET .............................................................39
Investors .........................................................................................................................40
Issuers............................................................................................................................40
Intermediaries..................................................................................................................41
Regulators.......................................................................................................................45

COMPONENTS OF SECURITIES MARKET ...........................................................................45

Cash/Equity Markets & Its Products ...................................................................................45
Equity Derivatives Market .................................................................................................47
Debt Market.....................................................................................................................48
Collective Investment Vehicles ..........................................................................................49
Mutual Funds...................................................................................................................50
Advantages of Mutual Funds.............................................................................................51
Structure of Mutual Funds: ................................................................................................52
TYPES OF MFs/SCHEMES ..............................................................................................53
Regulation of Mutual Funds ..............................................................................................54
Index Funds ....................................................................................................................55
Exchange Traded Funds...................................................................................................56
STOCK MARKET INDICATORS ............................................................................................58
Market Capitalisation ........................................................................................................58
Turnover .........................................................................................................................58
Turnover Ratio.................................................................................................................58
Market Capitalisation Ratio ...............................................................................................58
Traded Value Ratio ..........................................................................................................58
Index Movements.............................................................................................................59
INDEX CONSTRUCTION ISSUES .........................................................................................60
REFORMS IN INDIAN SECURITIES MARKETS .....................................................................62
CHAPTER 5 .............................................................................................................................70
MONEY MARKET .....................................................................................................................70
MEANING ............................................................................................................................70
INDIAN MONEY MARKET ....................................................................................................70
PLAYERS IN THE MONEY MARKET ....................................................................................70
ROLE OF RBI IN MONEY MARKET ......................................................................................71
MONEY MARKET INSTRUMENTS ........................................................................................71
Call Money Market ...........................................................................................................71
Term Money Market .........................................................................................................71
Repo Market....................................................................................................................72
CBLO .............................................................................................................................72
T-Bills .............................................................................................................................72
Certificate of Deposits (CDs) .............................................................................................72
Commercial Papers (CPs) ................................................................................................73
Interest Rate Derivatives...................................................................................................73
Link between the money market and Debt Market ...............................................................73
CHAPTER 6 .............................................................................................................................74
FOREX MARKET......................................................................................................................74
MEANING ............................................................................................................................74
PARTICIPANTS IN FX MARKET ...........................................................................................74
PARTICIPANTS IN THE INDIAN FOREX MARKET ................................................................75
Restricted Money Changers (RMC) ...................................................................................75
Full Fledged Money Changers (FFMC)...............................................................................75
Authorised Dealers (AD) ...................................................................................................75
Brokers ...........................................................................................................................75

ISO CODES .........................................................................................................................75

FOREX SPOT TRADING ......................................................................................................76
FOREX DERIVATIVE ...........................................................................................................76
Forward Contract .............................................................................................................76
Non Deliverable Forwards.................................................................................................76
FRAs ..............................................................................................................................77
Swaps.............................................................................................................................77
Option Contracts..............................................................................................................77
Currency Futures .............................................................................................................78
CHAPTER 7 .............................................................................................................................79
COMMODITY DERIVATIVES MARKET ......................................................................................79
MEANING ............................................................................................................................79
EVOLUTION OF COMMODITY DERIVATIVE MARKETS IN INDIA ..........................................79
PRODUCTS IN THE COMMODITY DERIVATIVES MARKETS ................................................80
REGULATION AND LEGAL FRAMEWORK ...........................................................................80
DIFFERENCE BETWEEN COMMODITY AND FINANCIAL DERIVATIVES ...............................81
COMMODITY DERIVATIVES .....................................................................................................81
FINANCIAL DERIVATIVES........................................................................................................81
CHAPTER 8 .............................................................................................................................82
INSURANCE MARKET..............................................................................................................82
MEANING ............................................................................................................................82
CLASSIFICATION OF INSURANCE SECTOR ........................................................................82
INSURANCE INTERMEDIARIES ...........................................................................................82
AGENTS .........................................................................................................................82
Surveyors and Loss Assessors..........................................................................................83
Brokers ...........................................................................................................................83
Third Party Administrators.................................................................................................83
Bancassurance................................................................................................................83
PLAYERS IN INSURANCE INDUSTRY ..................................................................................83
REGULATIONS FOR THE INSURANCE INDUSTRY ..............................................................83
CHAPTER 9 .............................................................................................................................84
CORPORATE ACTIONS ...........................................................................................................84
MEANING ............................................................................................................................84
CLASSIFICATION OF CORPORATE ACTIONS .....................................................................84
TYPES OF CORPORATE ACTIONS ......................................................................................84
Dividends ........................................................................................................................84
Stock Split .......................................................................................................................85
Buy Back.........................................................................................................................86
Mergers and Acquisitions..................................................................................................87
Rights Issues...................................................................................................................87
Bonus Issue ....................................................................................................................87

CHAPTER 10............................................................................................................................88
FINANCIAL STATEMENTS .......................................................................................................88
MEANING ............................................................................................................................88
TYPES OF FINANCIAL STATEMENTS..................................................................................88
Balance Sheet .................................................................................................................88
Profit and Loss Account ....................................................................................................90
Comparative Financial Statements.....................................................................................90
Common Size Statements ................................................................................................91
Ratio Analysis..................................................................................................................91
CHAPTER 11............................................................................................................................97
TIME VALUE OF MONEY..........................................................................................................97
MEANING ............................................................................................................................97
FUTURE VALUE OF A SINGLE CASH FLOW ........................................................................97
PRESENT VALUE OF A SINGLE CASH FLOW .....................................................................99
Present Value of an Annuity ..............................................................................................99
CHAPTER 12..........................................................................................................................101
REGULATORS AND REGULATORY FRAMEWORK.................................................................101
REGULATORS OF INDIAN FINANCIAL SYSTEM ................................................................101
SEBI.............................................................................................................................101
RBI...............................................................................................................................102
FMC .............................................................................................................................102
IRDA.............................................................................................................................102
PFRDA .........................................................................................................................103
REGULATORY FRAMEWORK FOR SECURITIES MARKET ................................................103
Capital Issues (Control) Act, 1947....................................................................................103
SEBI Act, 1992 ..............................................................................................................103
Securities Contracts (Regulation) Act, 1956 ......................................................................103
Depositories Act, 1996....................................................................................................104
Companies Act, 1956 .....................................................................................................104
Prevention of Money Laundering Act, 2002.......................................................................104
Issue of Capital and Disclosure Requirements (ICDR) Regulations 2009 .............................104
Insider Trading...............................................................................................................104
Takeover.......................................................................................................................105
Buy Back.......................................................................................................................106
Regulation for derivatives trading.....................................................................................107

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CHAPTER 1
INTRODUCTION TO FINANCIAL SYSTEM
MEANING
Financial system plays an important role in the economic growth of a country. Financial
system is the system that allows the transfer of money between savers and borrowers. It is a
complex, well-integrated set of sub-systems of financial institutions, markets, instruments and
services which facilitate the transfer and allocation of funds efficiently and effectively.

FLOW OF FUNDS IN THE FINANCIAL SYSTEM

Financial Markets intermediates between the flow of funds belonging to those who save a
part of their income and those who invest in productive assets.
At any point in time in an economy, there are individuals or organizations with excess
amounts of funds, and others with a lack of funds they need for example to consume or to
invest. Exchange between these two groups of agents is settled in financial markets. The first
group is commonly referred to as lenders; the second group is commonly referred to as the
borrowers of funds.
There exist two different forms of exchange in financial markets. The first one is direct
finance, in which lenders and borrowers meet directly to exchange securities. Securities are
claims on the borrowers future income or assets. Common examples are stock, bonds or
foreign exchange. The second type of financial trade occurs with the help of financial
intermediaries and is known as indirect finance. In this scenario borrowers and lenders
never meet directly, but borrowers provide funds to a financial intermediary such as a bank
and those intermediaries independently pass these funds on to lenders.

AN OVERVIEW OF FINANCIAL SYSTEM

The Financial System consists of:
(a) Specialized & Non-Specialized financial institutions,
(b) Organized and Unorganized financial markets
(c) Financial Instruments
(d) Financial services which facilitate transfer of funds and
(e) Regulators
Financial
System
Regulator

Financial
Institutions

Regulators

Intermediaries

Financial
Markets

Non-Intermediaries

Organised

Non Organised

Financial
Instruments

Long Term

Medium Term

Financial Services/
Intermediaries

Short Term

Let us understand the components of financial system.

FINANCIAL INSTITUTIONS
Financial Institutions are business organizations that act as mobilisers and depositories of
savings and as purveyors of credit or finance. These are intermediaries that mobilize savings
and facilitate the allocation of funds in an efficient manner. They also provide various financial
services to the community. Financial Institutions can be classified in various ways:

a) Banking & Non Banking Financial Institutions: The banking institutions are creators
and purveyors of credit while non banking financial institutions are purveyors of credit. In
India, non-banking financial institutions such as development financial institutions (DFIs), and
non-banking financial companies (NBFCs) as well as housing finance companies (HFCs) are
the major institutional purveyors of credit.
b) Term Finance Institutions: Financial institutions like Industrial Development Bank of India
(IDBI), the Small Industries Development Bank of India (SIDBI), and the Industrial Investment
Bank of India (IIBI) can be classified as Term Finance Institutions. These institutions extend
term loans which are long term loans with a maturity of more than 1 year but less than 15
years.
c) Specialised financial Institutions: Financial institutions can be specialized financial
institutions such as the Export Import Bank of India (EXIM), the Tourism Finance Corporation
of India (TFCI), ICICI Venture, the Infrastructure Development Financial Corporation of India
(IFCI) and sectoral financial institutions such as National Bank for Agricultural and Rural
Development (NABARD) and National Housing Bank (NHB).
d) Investment Institutions: Investment institutions such as the public and private sector
mutual funds, Unit Trust of India (UTI), LIC and GIC are also classified as financial
institutions.
e) Intermediaries & Non-Intermediaries: This implies that intermediaries intermediate
between savers and investors; they lend money as well as mobilize savings; their liabilities
are towards the ultimate savers, while their assets are from the investors or borrowers. NoIntermediary institutions do the loan business but their resources are not directly obtained
from the savers. All banking institutions are intermediaries. Many non-bank institutions also
act as intermediaries and when they so they are known as non-banking financial
intermediaries (NBFIs).

FINANCIAL MARKETS
Financial markets are an important component of the financial system. Financial Markets are
markets for exchange of capital and credit. Financial markets are classified in various ways
as follows:
a) Primary & Secondary Market: Primary Market deals in the financial claims or new
securities and therefore they are also known as the new issue markets. On the other
hand, secondary market deals in securities already issued or the new issue market.
(The section on Primary Markets is explained in Chapter 2 and the secondary
market is explained in Chapter 3 under the Securities market).
b) Types of Financial Instruments: Broadly there are two types of financial
instruments debt and capital. Financial markets are classified into various types
according to the different types of instruments that are traded in these types of

markets. These instruments can be both long term and short term in nature. These
markets are classified into: securities market, money market, debt market, foreign
exchange (forex) market, commodities market, insurance market based on the
products which are traded in these markets. These markets are explained in the
later chapters.
c) Organised and Unorganised Market: The financial transactions that take place
outside the well established exchanges or without systematic and orderly structure
or arrangements constitute unorganized markets. For example, the moneylenders,
chit funds, nidhis etc. The organised financial markets come under the direct purview
of financial regulators of the country such as RBI, Ministry of Finance, and SEBI.
d) Over the Counter (OTC) & Exchange Traded Markets: Markets can be classified
as primary or secondary market. There are further two components of the secondary
market i.e. over the counter (OTC) market and the exchange traded market. In the
OTC market, trading occurs via a network of middlemen, called dealers, who carry
inventories of securities to facilitate the buy and sell orders of investors, rather than
providing the order matchmaking service as in the Exchange traded markets where
trading is done as per the predetermined rules and regulations. Many financial
instruments are traded both in over the counter and Exchange traded markets like
currency, commodities, fixed income instruments. However, in some countries, like
India, there are certain instruments like stocks which are traded only on exchanges.

FINANCIAL INSTRUMENTS
A financial instrument is a claim against a person or an institution for payment at a future
date, of the sum of money or periodic payment in form of interest or dividend. Financial
instruments represent shares, debentures etc. These financial instruments are marketable as
they are denominated in small amounts and traded in organised markets. This distinct feature
of financial instruments has enabled people to hold a portfolio of different markets. Different
types of financial instruments are designed to suit the risk and return preferences of different
classes of investors.
Savings and investments are linked through a wide variety of complex financial instruments
known as securities. These securities comprise of shares, bonds, debentures, government
securities, units of collective investment schemes. These financial securities can be primary
or secondary securities. Primary securities are also known as direct securities as they are
directly issued by the ultimate borrowers of funds to the ultimate savers. Examples of primary
or direct securities include equity shares and debentures. Secondary securities are also
referred to as indirect securities as they are issued by the financial intermediaries to the
ultimate savers. Bank deposits, mutual fund units and insurance policies are secondary
securities.
Financial instruments can also be classified according to maturity of claims. Financial
instruments differ in terms of marketability, tenure (short term/medium/long term) liquidity,

returns, risk and transaction cost. Financial instruments help financial markets and financial
intermediaries to perform the important role of channelising funds from lenders and
borrowers.

FINANCIAL SERVICES
Financial services help with borrowing and funding, lending and investing, buying and selling
securities, making and enabling payments and settlements, and managing risk in financial
markets. Thus, the major categories of financial services are funds intermediation, payments
mechanism, provision of liquidity, risk management and financial engineering. The producers
of these financial services are financial intermediaries, such as banks, insurance companies,
mutual funds and stock exchanges. It is through these financial services that the link between
the savers and borrowers is established and this leads to capital formation. The producers of
financial services are financial intermediaries such as banks, insurance companies, mutual
funds and stock exchanges.
Financial intermediaries provide key financial services such as merchant banking, leasing,
credit rating etc. Financial services rendered by financial intermediaries bridge the gap
between the lack of knowledge on the part of investors and the increasing sophistication of
financial instruments and markets. These financial services give the necessary impetus for
the economic growth, industrial expansion etc.

Depositories

Portfolio
Management

Custodials

Financial
Services
Merchant
Banking

Issuing
Guarantees
Credit
Rating
Agencies

FINANCIAL INTERMEDIARIES

REGULATORS
Other than the organizations which are involved in the cycle of savings and investments,
regulators are one important component of financial institutions. Before investors lend money,
they need to be reassured that if it is safe to exchange securities for funds. The financial

10

regulator regulates the conduct of issuers of securities and the intermediaries to protect the
interest of investors in securities and increases their confidence in markets which in turn
helps in the growth and development of financial system. These regulators aim to maintain
the integrity of the financial system and protect the interest of all participants in the market.

11

CHAPTER 2
PRIMARY MARKET
The primary market is a market for new issues i.e. a market for fresh capital. The primary
market provides the channel for sale of new securities. Primary market provides opportunity
to issuers of securities; government as well as corporates, to raise resources to meet their
requirements of investment and/or discharge some obligation.
They may issue the securities at face value, or at a discount/premium and these securities
may take a variety of forms such as equity, debt etc. They may issue the securities in
domestic market and/or international market.
The primary market issuance is done either through public issues or private placement. A
public issue does not limit any entity in investing while in private placement, the issuance is
done to select people. In terms of the Companies Act, 1956, an issue becomes public if it
results in allotment to more than 50 persons. This means an issue resulting in allotment to
less than 50 persons is private placement. There are two major types of issuers who issue
securities. The corporate entities issue mainly debt and equity instruments (shares,
debentures, etc.), while the governments (central and state governments) issue debt
securities (dated securities, treasury bills).
The price signals, which subsume all information about the issuer and his business including
associated risk, generated in the secondary market, help the primary market in allocation of
funds.
The issuers may issue securities in domestic market and international market through ADR /
GDR route.

DIFFERENT KINDS OF ISSUES

Most companies are usually started privately by their promoter(s). However, the promoters
capital and the borrowings from banks and financial institutions may not be sufficient for
setting up or running the business over a long term. So companies invite the public to
contribute towards the equity and issue shares to individual investors. The way to invite share
capital from the public is through a Public Issue. Simply stated, a public issue is an offer to
the public to subscribe to the share capital of a company. Once this is done, the company
allots shares to the applicants as per the prescribed rules and regulations laid down by SEBI.
Issues can be classified as a Public, Rights or preferential issues (also known as private
placements). While public and rights issues involve a detailed procedure, private placements
or preferential issues are relatively simpler. The classification of issues is illustrated below:

12

Issues

Public Issue

IPO

Rights Issue

FPO

Bonus Issue

Private Placement

Preferential Issue

Fresh Issue

Fresh Issue

Offer for Sale

Offer for Sale

Qualified Inst.
Buyers

PUBLIC ISSUE
When an issue / offer of securities is made to new investors for becoming part of
shareholders family of the issue3 it is called a public issue. Public issue can be further
classified into Initial public offer (IPO) and Further public offer (FPO). The significant features
of each type of public issue are illustrated below:

IPO
Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of
securities or an offer for sale of its existing securities or both for the first time to the public.
This paves way for listing and trading of the issuers securities in the Stock Exchanges.
An IPO can either be a fresh issue or an offer for sale i.e. offering of securities by existing
shareholders of the company to the public.

FPO
A Further public offering (FPO) is when an already listed company makes either a fresh issue
of securities to the public or an offer for sale to the public, through an offer document. An offer
for sale in such scenario is allowed only if it is made to satisfy listing or continuous listing
obligations.

13

RIGHTS ISSUE
When an issue of securities is made by an issuer to its shareholders existing as on a
particular date fixed by the issuer (i.e. record date), it is called a rights issue. The rights are
offered in a particular ratio to the number of securities held as on the record date.

BONUS ISSUE
When an issuer makes an issue of securities to its existing shareholders as on a record date,
without any consideration from them, it is called a bonus issue. The shares are issued out of
the Companys free reserve or share premium account in a particular ratio to the number of
securities held on a record date.

PRIVATE PLACEMENT
When an issuer makes an issue of securities to a select group of persons not exceeding 49,
and which is neither a rights issue nor a public issue, it is called a private placement. Private
placement of shares or convertible securities by listed issuer can be of two types:

Preferential allotment
When a listed issuer issues shares or convertible securities, to a select group of persons in
terms of provisions of Chapter XIII of SEBI (ICDR) regulations it is called a preferential
allotment. The issuer is required to comply with various provisions which inter alia include
pricing, disclosures in the notice, lock in etc, in addition to the requirements specified in the
Companies Act.

Qualified institutions placement (QIP)

When a listed issuer issues equity shares or securities convertible in to equity shares to
Qualified Institutions Buyers only in terms of provisions of SEBI Issue of Capital and
Disclosure Requirement (ICDR) Regulations, it is called a QIP.
Usually, the term private placement is used for unlisted companies and the term preferential
issue is used for listed companies. QIP is also for listed companies.

Particulars
a) Public Issues
(I) IPOs
(ii) FPOs

Funds mobilized in Primary Market

2008-09
2007-08
Amount
Amount
No. of issues
No. of issues
(Rs. Cr.)
(Rs. Cr.)
21
2082.35
92
54511
21
2082.35
85
42101.8
0
0
7
11915.8

14

b) Rights Issues
25
c) QIP
2
TOTAL
48
* excluding preferential allotments

12637.16
188.82
14908.33

32
36
160

32518
25525
112554

OFFER DOCUMENTS
Offer document is a document which contains all the relevant information about the company,
promoters, projects, financial details, objects of raising the money, terms of the issue etc and
is used for inviting subscription to the issue being made by the issuer.
Offer Document is called Prospectus in case of a public issue or offer for sale and Letter of
Offer in case of a rights issue.
The terms used for offer documents are defined below.

Draft offer document

Draft offer document is an offer document filed with SEBI for specifying changes, if any, in it,
before it is filed with the Registrar of companies (ROCs). Draft offer document is made
available in public domain including SEBI website, for enabling public to give comments, if
any, on the draft offer document.

RED HERRING PROSPECTUS

Red herring prospectus is an offer document used in case of a book built public issue. It
contains all the relevant details except that of price or number of shares being offered. It is
filed with RoC before the issue opens.

PROSPECTUS
Prospectus is an offer document in case of a public issue, which has all relevant details
including price and number of shares being offered. This document is registered with RoC
before the issue opens in case of a fixed price issue and after the closure of the issue in case
of a book built issue.

LETTER OF OFFER
Letter of offer is an offer document in case of a Rights issue and is filed with Stock exchanges
before the issue opens.

15

Abridged prospectus is an abridged version of offer document in public issue and is issued
along with the application form of a public issue. It contains all the salient features of a
prospectus.
Abridged letter of offer is an abridged version of the letter of offer. It is sent to all the
shareholders along with the application form.
Shelf prospectus is a prospectus which enables an issuer to make a series of issues within
a period of 1 year without the need of filing a fresh prospectus every time. This facility is
available to public sector banks /Public Financial Institutions.

PLACEMENT DOCUMENT
Placement document is an offer document for the purpose of Qualified Institutional
Placement and contains all the relevant and material disclosures.

UNDERSTANDING THE OFFER DOCUMENT

Cover Page
Under this head full contact details of the Issuer Company, lead managers and registrars, the
nature, number, price and amount of instruments offered and issue size, and the particulars
regarding listing. Other details such as Credit Rating, IPO Grading, risks in relation to the first
issue, etc are also disclosed if applicable.

Risk Factors
Under this head the management of the issuer company gives its view on the Internal and
external risks envisaged by the company and the proposals, if any, to address such risks. The
company also makes a note on the forward looking statements. This information is disclosed
in the initial pages of the document and also in the abridged prospectus. It is generally
advised that the investors should go through all the risk factors of the company before making
an investment decision.

Introduction
Under this head a summary of the industry in which the issuer company operates, the
business of the Issuer Company, offering details in brief, summary of consolidated financial
statements and other data relating to general information about the company, the merchant
bankers and their responsibilities, the details of brokers/syndicate members to the Issue,
credit rating (in case of debt issue), debenture trustees (in case of debt issue), monitoring
agency, book building process in brief, IPO Grading in case of First Issue of Equity capital
and details of underwriting Agreements are given. Important details of capital structure,
objects of the offering, funds requirement, funding plan, schedule of implementation, funds

16

deployed, sources of financing of funds already deployed, sources of financing for the
balance fund requirement, interim use of funds, basic terms of issue, basis for issue price, tax
benefits are also covered.

About us
Under this head a review of the details of business of the company, business strategy,
competitive strengths, insurance, industry ]regulation (if applicable), history and corporate
structure, main objects, subsidiary details, management and board of directors,
compensation, corporate governance, related party transactions, exchange rates, currency of
presentation and dividend policy are given.

Financial Statements
Under this head financial statement and restatement as per the requirement of the Guidelines
and differences between any other accounting policies and the Indian Accounting Policies (if
the Company has presented its Financial Statements also as per either US GAAP/IFRS) are
presented.

Legal and other information

Under this head outstanding litigations and material developments, litigations involving the
company, the promoters of the company, its subsidiaries, and group companies are
disclosed. Also material developments since the last balance sheet date, government
approvals/licensing arrangements, investment approvals (FIPB/RBI etc.), technical approvals,
and indebtedness, etc. are disclosed.

Other regulatory and statutory disclosures

Under this head, authority for the Issue, prohibition by SEBI, eligibility of the company to enter
the capital market, disclaimer statement by the issuer and the lead manager, disclaimer in
respect of jurisdiction, distribution of information to investors, disclaimer clause of the stock
exchanges, listing, impersonation, minimum subscription, letters of allotment or refund orders,
consents, expert opinion, changes in the auditors in the last 3 years, expenses of the issue,
fees payable to the intermediaries involved in the issue process, details of all the previous
issues, all outstanding instruments, commission and brokerage on, previous issues,
capitalization of reserves or profits, option to subscribe in the issue, purchase of property,
revaluation of assets, classes of shares, stock market data for equity shares of the company,
promise vis--vis performance in the past issues and mechanism for redressal of investor
grievances is disclosed.

Offering information
Under this head, terms of the Issue, ranking of equity shares, mode of payment of dividend,
face value and issue price, rights of the equity shareholder, market lot, nomination facility to
investor, issue procedure, book building procedure in details along with the process of making

17

an application, signing of underwriting agreement and filing of prospectus with SEBI/ROC,

announcement of statutory advertisement, issuance of confirmation of allocation note("can")
and allotment in the issue, designated date, general instructions, instructions for completing
the bid form, payment instructions, submission of bid form, other instructions, disposal of
application and application moneys, , interest on refund of excess bid amount, basis of
allotment or allocation, method of proportionate allotment, dispatch of refund orders,
communications, undertaking by the company, utilization of issue proceeds, restrictions on
foreign ownership of Indian securities, are disclosed.

Other Information
This covers description of equity shares and terms of the Articles of Association, material
contracts and documents for inspection, declaration, definitions and abbreviations, etc.

REGULATION FOR DIFFERENT KINDS OF ISSUES

SEBI (ICDR) Regulations, 2009
The issues of capital to public by Indian companies are governed by the SEBI (Issue of
Capital and Disclosure Requirements) Regulation, 2009. The regulations provide norms
relating to eligibility for companies issuing securities, pricing of issues, listing requirements,
disclosure norms, lock-in period for promoters contribution, contents of offer documents, preand post-issue obligations, etc. The guidelines apply to all public issues, offers for sale and
rights issues, preferential issues, qualified institutional placement by a listed issuer and issue
of Indian Depository Receipts.

Issue Requirements
Some of the eligibility norms are stated here, however, readers may go through the SEBI
(Issue of Capital & Disclosure Requirements) Regulations 2009 for the detailed provisions.
SEBI has laid down entry norms for entities making a public issue/offer. These entry norms
are different routes available to an issuer for accessing the capital market. An unlisted issuer
making a public issue (i.e. an IPO) has to satisfy the following provisions:
1. Conditions for Initial Public Offer:
a. The issuer should have net tangible assets of at least three crore rupees in each
of the preceding three years (of 12 months each) of which not more than 50% are
held in monetary assets. If more than 50% of the net tangible assets are held in
monetary assets, then the issuer has to make firm commitment to utilize such
excess monetary assets in its business or project .

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b. The issuer should have a track of distributable profits Distributable profits have to
be in terms of section 205 of the Companies Act 1956. in at least three of the
immediately preceding five years.
c. The issuer company should have a net worth of at least one crore rupees in
each of the preceding three full years.
d. The issue size should not exceed 5 times the pre-issue net worth as per the
audited balance sheet of the last financial year.
e. In case of change of name by the issuer company within last one year, at least
fifty per cent of the revenue for the preceding one year should have been earned by
the company from the activity indicated by the new name.
To provide flexibility and also to ensure that genuine companies do not suffer on account of
rigidity or the parameters, SEBI has also provided two other alternative routes to the
companies not satisfying any of the above conditions, for accessing the primary market. They
are as follows:
2. Entry norm II or commonly known as the QIB route
a. The issue shall be made through the book building route, with atleast 50 % to
be mandatory allotted to the Qualified Institutional Buyers (QIBs).
b. The minimum post-issue face value capital of the issuer should be ten crore
rupees; OR there should be a compulsory market making for at least 2 years.
A listed issuer making a Further Public Offer (FPO) has to satisfy the following requirements:
a. If the company has changed its name within the last one year, then atleast 50 % of
the revenue for the preceding 1 year should be from the activity suggested by the
new name.
b. The issue size does not exceed 5 times the pre-issue net worth as per the audited
balance sheet of the last financial year.
In case of listed companies not fulfilling these conditions shall be eligible to make a public
issue by complying with the QIB route or appraisal route for the IPOs.
Pricing in Public Issues
The issuer determines the price of the specified securities in consultation with the lead
merchant banker or through it is determined through the book building process. In case of
debt instruments, the issuer determines the coupon rate and conversion price of the

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convertible debt instruments in consultation with the lead merchant banker or through the
book building process.

Differential Pricing
Additionally, the issuer can offer specified securities at different prices; subject to the
following condition;
(a) the retail individual investors/shareholders or employees of the issuer entitled for
reservation Made under regulation 42 pertaining to Reservation of competitive basis. making
an application of specified securities of value not more than one lakh rupees, are offered
specified securities at a price lower than the price at which net offer is made to other
categories of applicants provided that such difference is not more than ten per cent of the
price at which specified securities are offered to other categories of applicants;
(b) in case of a book built issue, the price of the specified securities offered to an anchor
investor Anchor investor" means a qualified institutional buyer who makes an application for a
value of ten crore rupees or more in a public issue through the book building process in
accordance with the regulations. cannot be lower than the price offered to other applicants;
(c) in case of a composite issue Composite issue means an issue of specified securities by
a listed issuer on public cum-rights basis, wherein the allotment in both public issue and rights
issue is proposed to be made simultaneously., the price of the specified securities offered in
the public issue can be different from the price offered in rights issue and justification for such
price difference shall be given in the offer document.

Contribution of Promoters and lock-in

The promoters minimum contribution varies from case to case. In case of an initial public
offer, the minimum contribution should not be less than twenty percent of the post issue
capital; in case of further public offer, it should be either to the extent of twenty per cent of the
proposed issue size or to the extent of twenty per cent of the post-issue capital; in case of a
composite issue it should be either to the extent of twenty per cent of the proposed issue size
or to the extent of twenty per cent of the post-issue capital excluding the rights issue
component.

General Conditions
An issuer shall not make a public issue or rights issue of specified securities if;
a. the issuer, any of its promoters, promoter group or directors or persons in control of the
issuer are debarred from accessing the capital market by SEBI or if these people are
promoter, director or person in control of any other company which is debarred from
accessing the capital market under the order or directions of SEBI.

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b. if the issuer of convertible debt instruments is amongst the list of willful published by the
RBI or it is in default of payment of interest or repayment of principal amount in respect of
debt instruments issued by it to the public, if any, for a period of more than six months;
c. unless an application is made to one or more recognised stock exchanges for listing of
specified securities on such stock exchanges;
d. unless it has entered into an agreement with a depository for dematerialisation of
specified securities already issued or proposed to be issued;
e. unless all existing partly paid-up equity shares of the issuer have either been fully paid up
or forfeited.
The issuer should appoint one or more merchant bankers, at least one of whom should be a
lead merchant banker. The issuer should also appoint other intermediaries, in consultation
with the lead merchant banker, to carry out the obligations relating to the issue. Where the
issue is managed by more than one merchant banker, the rights, obligations and
responsibilities, relating inter alia to disclosures, allotment, refund and underwriting
obligations, if any, of each merchant banker shall be predetermined and disclosed in the offer
document.

Role of a Lead Merchant Banker

The lead merchant banker plays an important role in the pre-issue obligations of the
company.
He exercises due diligence and satisfies himself about all aspects of offering,
veracity and adequacy of disclosures in the offer document.
Each company issuing securities has to enter into a Memorandum of Understanding
with the lead merchant banker, which specifies their mutual rights, liabilities and
obligations relating to the issue.
In case of under-subscription of an issue, the lead merchant banker responsible for
underwriting arrangements has to invoke underwriting obligations and ensure that
the underwriters pay the amount of devolvement.
The lead merchant banker also ensures that the issuer company has entered into an
agreement with all the depositories for dematerialization of securities along with the
other formalities relating to post-issue obligations viz., allotment, refund and
despatch of certificates. The post issue obligations also involve the lead banker to
take essential follow up steps including follow up with bankers to the issue and Self
Certified Syndicate Banks to get quick estimates of collection.

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Book Building
Book Building is a process of price discovery. The issuer discloses a price band or floor price
before opening of the issue of the securities offered. On the basis of the demand received at
various price levels within the price band, the book running lead manager in close
consultation with the issuer arrives at a price at which the security offered by the issuer, can
be issued
In case of an issuer company makes an issue of 100% of the net offer to public through 100%
book building processi) Not less than 35 % of the net offer to the public shall be available for allocation
to retail individual investors.
ii) Not less than 15 % of the net offer to the public shall be available for allocation
to non institutional investors i.e. investors other than retail individual investors
and qualified institutional buyers.
iii) Not more than 50% of the net offer to the public shall be available for allocation
to Qualified Institutional Buyers; 5 % of which would be allocated to mutual
funds.
In case of fixed price issue the proportionate allotment of securities to the different investor
categories in an fixed price issue is as given below:
a. A minimum of 50% of the net offer of securities to the public shall initially be
made for allotment to retail individual investors, as the case may be.
b. The balance net offer of securities to the public shall be made available for
allotment to individual applicants other than retail individual investors, and other
investors including corporate bodies/institutions irrespective of the number of
securities applied for.

Application Supported by Blocked Amount (ASBA)

To make the public issue process more efficient, SEBI introduced a supplementary process of
applying in public issues through ASBA process. ASBA means Application Supported by
Blocked Amount. ASBA is an application for subscribing to an issue containing an
authorization to block the application money in a bank account. The investor can apply an
issue through ASBA facility. If an investor applies through ASBA, his application money is
debited from the bank account only if his/her application is selected for allotment after the
basis of allotment is finalized, or the issue is withdrawn/failed.ASBA service can by availed of
through the Self Certified Syndicate Banks (SCSB SCSB means a banker to an issue
registered with the SEBI which offers the facility of ASBA.).

22

The ASBA process is available in public issues through the book building route. ASBA coexists with the current process, wherein cheque is used as a mode of payment.

IPO Grading
IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the IPO
or any other security which may be converted into or exchanged with equity shares at a later
date. The grade represents a relative assessment of the fundamentals of that issue in relation
to the other listed equity securities in India. Such grading is generally assigned on a five point
scale with a higher score indicating stronger fundamentals and vice versa.

Intermediaries involved in the Issue Process

Merchant Banker: The merchant banker does the due diligence to prepare the offer
document which contains all the details about the company. They are also responsible for
ensuring compliance with the legal formalities in the entire issue process and also for
marketing the issue.
Registrars to the Issue: These are involved in finalizing the basis of allotment in an issue
and for sending refunds, allotment etc.
Bankers to the Issue: The Bankers to the Issue enables the movement of funds in the issue
process and therefore enable the registrars to finalize the basis of allotment by making clear
funds status available to the registrars.
Underwriters: Underwriters are intermediaries who undertake to subscribe to the securities
offered by the company in case these are not fully subscribed by the public, in case of an
underwritten issue.

Credit Rating
Credit rating is governed by the SEBI (Credit Rating Agencies) Regulations, 1999. The
Regulations cover rating of securities only and not rating of fixed deposits, foreign exchange,
country ratings, real estates etc. CRAs can be promoted by public financial institutions,
scheduled commercial banks, foreign banks operating in India with the approval of RBI,
foreign credit rating agencies recognised in the country of their incorporation, having at least
five years experience in rating, or any company or a body corporate having continuous net
worth of minimum Rs.100 crore for the previous five years. CRAs would be required to have a
minimum net worth of Rs. 5 crore. A CRA cannot rate (i) a security issued by its promoter, (ii)
securities issued by any borrower, subsidiary, an associate promoter of CRA, if there are
common Chairman, Directors and Employees between the CRA or its rating committee and
these entities (iii) a security issued by its associate or subsidiary if the CRA or its rating
committee has a Chairman, Director or Employee who is also a Chairman, Director or
Employee of any such entity.

23

For all public and rights issues of debt securities, an obligation has been cast on the issuer to
disclose in the offer documents all the ratings it has got during the previous 3 years for any of
its listed securities. CRAs would have to carry out periodic reviews of the ratings given during
the lifetime of the rated instrument.

Demat Issues
As per SEBI mandate, all initial public offers should be compulsorily traded in dematerialised
form. The admission to a depository for dematerialisation of securities is a prerequisite for
making a public or rights issue or an offer for sale. The investors would however, have the
option of either subscribing to securities in physical form or dematerialised form. The
Companies Act, 1956 requires that every public listed company making IPO of any security
for Rs.10 crore or more shall issue the same only in dematerialised form.

Indian Depository Receipts

A foreign company can access Indian securities market for raising funds through
issue of Indian Depository Receipts (IDRs).
An IDR is an instrument denominated in Indian Rupees in the form of a depository
receipt created by a Domestic Depository (custodian of securities registered with the
Securities and Exchange Board of India) against the underlying equity of issuing
company to enable foreign companies to raise funds from the Indian securities
Markets.
An issuing company making an issue of IDR is required to satisfy the following:
(a) it should be listed in its home country;
(b) it should not be prohibited to issue securities by any regulatory body;
(c) it should have a track record of compliance with securities market regulations in its home
country.
Conditions for issue of IDR.
An issue of IDR shall be subject to the following conditions:
(a) issue size shall not be less than Rs.50 crore.
(b) procedure to be followed by each class of applicant for applying shall be mentioned in the
prospectus;
(c) minimum application amount shall be twenty thousand rupees;

24

(d) at least 50 %. of the IDR issued shall be allotted to qualified institutional buyers on
proportionate basis.
(e) the balance 50 % is allowed to be allocated among the categories of non-institutional
investors and retail individual investors including employees at the discretion of the issuer and
the manner of allocation shall be disclosed in the prospectus. Allotment to investors within a
category shall be on proportionate basis.
Further, atleast 30% of the said 50%. IDR issued shall be allocated to retail individual
investors and in case of under-subscription in retail individual investor category, spill over to
the extent of under-subscription shall be permitted to other categories.
(f) At any given time, there shall be only one denomination of IDR of the issuing company.

FOREIGN CAPITAL ISSUANCE

Funds can be raised in the primary market from the domestic market as well as from
international markets. After the reforms were initiated in 1991, one of the major policy
changes was allowing Indian companies to raise resources by way of equity issues in the
equity issues in the international markets. Indian companies have raised resources from
international capital markets

Foreign
Capital
Issuance

Global Depository
Receipts (GDRs)

American Depository
Receipts (ADRs)

Foreign Currency
Convertible
Bonds (FCCBs)

External Commercial
Borrowings (ECBs)

Global Depository Receipts (GDRs)

GDRs are essentially equity instruments issued abroad by authorized overseas corporate
bodies against the shares/bonds of Indian companies held with nominated domestic
custodian banks. Global Depository Receipts (GDRs) is defined as a global finance vehicle
that allows an issuer to raise capital simultaneously in two or markets through a global
offering. GDRs may be used in public or private markets inside or outside US. GDR, a
negotiable certificate usually represents companys traded equity/debt. The underlying shares
correspond to the GDRs in a fixed ratio say 1 GDR=10 shares.

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American Depository Receipts (ADRs)

An American Depositary Receipt ("ADR") is a physical certificate evidencing ownership of
American Depositary Shares ("ADSs"). The term is often used to refer to the ADSs
themselves. An American Depositary Share ("ADS") is a U.S. dollar denominated form of
equity ownership in a non-U.S. company. It represents the foreign shares of the company
held on deposit by a custodian bank in the company 's home country and carries the
corporate and economic rights of the foreign shares, subject to the terms specified on the
ADR certificate. One or several ADSs can be represented by a physical ADR certificate. The
terms ADR and ADS are often used interchangeably. ADSs provide U.S. investors with a
convenient way to invest in overseas securities and to trade non-U.S. securities in the U.S.
ADSs are issued by a depository bank, such as JPMorgan Chase Bank. They are traded in
the same manner as shares in U.S. companies, on the New York Stock Exchange (NYSE)
and the American Stock Exchange (AMEX) or quoted on NASDAQ and the over-the-counter
(OTC) market. Although ADSs are U.S. dollar denominated securities and pay dividends in
U.S. dollars, they do not eliminate the currency risk associated with an investment in a nonU.S. company.

Foreign Currency Convertible Bonds (FCCBs)

FCCBs are bonds issued by Indian companies and subscribed to by non-resident in foreign
currency. They carry a fixed interest or coupon rate and are convertible into a certain number
of ordinary shares at a preferred price. They are convertible into ordinary shares of the
issuing company either in whole or in part on the basis of any equity related warrants
attached to the debt instruments. These bonds are listed and traded abroad. Till conversion,
the company has to pay interest in dollars and if the conversion option is not exercised, the
redemption is also made in dollars. Thus, foreign investors prefer convertible bonds whereas
Indian companies prefer to issue GDRs. The interest rate is low but the exchange risk is more
in FCCBs as interest is payable in foreign currency. Hence, only companies with low debt
equity ratios and large forex earnings potential opt for FCCBs. The scheme for issue of
FCCBs and ordinary shares was notified by the government in 1993 to allow companies
easier access to foreign capital markets.

External Commercial Borrowings

ECBs are a key component of Indias overall external debt which includes external
assistance, buyers credit, suppliers credit, NRI deposits, short-term credit and rupee debt.
ECB refer to commercial loans (in the form of bank loans, buyers credit supplier credit,
securitized instruments such as (floating rate notes and fixed rate bonds) availed from nonresident lenders with minimum average maturity of 3 years. It also includes credit from official
export credit agencies and commercial borrowings from the private sector window of
multilateral financing institutions. ECBs can be accessed through two routes viz, the
automatic route and the approval route.

26

Automatic Route: Under the extant policy, ECB for investment in real sector -industrial
sector, especially infrastructure sector-in India, are under Automatic Route, i.e. do not require
RBI/Government approval. In case of doubt as regards eligibility to access Automatic Route,
applicants may take recourse to the Approval Route.
a) Financial institutions dealing exclusively with infrastructure or export finance such as IDFC,
IL&FS, Power Finance Corporation, Power Trading Corporation, IRCON and EXIM Bank are
considered on a case by case basis.
b) Banks and financial institutions which had participated in the textile or steel sector
restructuring package as approved by the Government are also permitted to the extent of
their investment in the package and assessment by RBI based on prudential norms. Any ECB
availed for this purpose so far is deducted from their entitlement.
c) Cases falling outside the purview of the automatic route limits.
d) ECB with minimum average maturity of 5 years by non-banking financial companies
(NBFCs) from multilateral financial institutions, reputable regional financial institutions, official
export credit agencies and international banks to finance import of infrastructure equipment
for leasing to infrastructure projects.
e) Foreign Currency Convertible Bonds (FCCB) by housing finance companies satisfying
the following minimum criteria: (i) the minimum net worth of the financial intermediary during
the previous three years shall not be less than Rs. 500 crore, (ii) a listing on the BSE or NSE,
(iii) minimum size of FCCB is USD 100 million, (iv) the applicant should submit the purpose /
plan of utilization

Guidelines relating to International Issues

ADRs/GDRs are considered to be a part of foreign direct investment (FDI). Therefore, such
issues need to conform to the existing FDI policy and only in areas where FDI is permissible.
Indian companies raising money from ADRs/GDRs through registered exchanges are now
free to access ADR/GDR markets automatically, without the prior approval of Ministry of
Finance, Department of Economic Affairs. Prior permission from the Government of India is
essential for the issue of FCCBs. A company seeking to raise funds abroad through these
instruments should have a consistently good track record of at least three years. The foreign
equity participation directly or indirectly is restricted to 1% of the issued and subscribed
capital of a company.

27

CONCEPT CLARIFIERS FOR PRIMARY MARKET

Face Value of a share/debenture
The nominal or stated amount (in Rs.) assigned to a security by the issuer. For shares, it is
the original cost of the stock shown on the certificate; for bonds, it is the amount paid to the
holder at maturity. It is also known as par value or simply par. For an equity share, the face
value is usually a very small amount (Rs. 5, Rs. 10) and does not have much bearing on the
price of the share, which may quote higher in the market, at Rs. 100 or Rs. 1000 or any other
price. For a debt security, face value is the amount repaid to the investor when the bond
matures (usually, Government securities and corporate bonds have a face value of Rs. 100).
The price at which the security trades depends on the fluctuations in the interest rates in the
economy.
Premium and Discount
Securities are generally issued in denominations of 5, 10 or 100. This is known as the Face
Value or Par Value of the security as discussed earlier. When a security is sold above its face
value, it is said to be issued at a Premium and if it is sold at less than its face value, then it is
said to be issued at a Discount.
Cut-Off Price
In a Book building issue, the issuer is required to indicate either the price band or a floor price
in the prospectus. The actual discovered issue price can be any price in the price band or any
price above the floor price. This issue price is called Cut-Off Price. The issuer and lead
manager decides this after considering the book and the investors appetite for the stock.
Collection Centre means a place where the application for subscribing to the public or rights
issue is collected by the Banker to an Issue on behalf of the issuer company;
Composite Issues means an issue of securities by a listed company on a public cum rights
basis offered through a single offer document wherein the allotment for both public and rights
components of the issue is proposed to be made simultaneously;
Convertible Debt Instrument means an instrument or security which creates or
acknowledges indebtedness and is convertible into equity shares at a later date, at or without
the option of the holder of the instrument or the security of a body corporate, whether
constituting a charge on the assets of the body corporate or not.
Credit Rating Agency means a body corporate registered under Securities and Exchange
Board of India (Credit Rating Agencies) Regulations, 1999;
Lock-in indicates a freeze on the sale of shares for a certain period of time. SEBI guidelines
have stipulated lock-in requirements on shares of promoters mainly to ensure that the

28

promoters or main persons, who are controlling the company, shall continue to hold some
minimum percentage in the company after the public issue.
Listing of securities means admission of securities of an issuer to trading privileges
(dealings) on a stock exchange through a formal agreement. The prime objective of
admission to dealings on the exchange is to provide liquidity and marketability to securities,
as also to provide a mechanism for effective control and supervision of trading.
Listing Agreement: At the time of listing securities of a company on a stock exchange, the
company is required to enter into a listing agreement with the exchange. The listing
agreement specifies the terms and conditions of listing and the disclosures that shall be made
by a company on a continuous basis to the exchange.
Delisting of securities means permanent removal of securities of a listed company from a
stock exchange. As a consequence of delisting, the securities of that company would no
longer be traded at that stock exchange.
Green shoe Option is a price stabilizing mechanism in which shares are issued in excess of
the issue size, by a maximum of 15%. From an investors perspective, an issue with green
shoe option provides more probability of getting shares and also that post listing price may
show relatively more stability as compared to market volatility.
Issue price means the price at which a company's shares are offered initially in the primary
market is called as the Issue price. When they begin to be traded, the market price may be
above or below the issue price.
Market Capitalisation means the market value of a quoted company, which is calculated by
multiplying its current share price (market price) by the number of shares in issue is called as
market capitalization. E.g. Company A has 120 million shares in issue. The current market
price is Rs. 100. The market capitalisation of company A is Rs. 12000 million
In a safety net scheme or a buy back arrangement the issuer company in consultation with
the lead merchant banker discloses in the RHP that if the price of the shares of the company
post listing goes below a certain level the issuer will purchase back a limited number of
shares at a pre specified price from each allottee.
Open book/closed book: In an open book building system the merchant banker along with
the issuer ensures that the demand for the securities is displayed online on the website of the
Stock Exchanges. Here, the investor can be guided by the movements of the bids during the
period in which the bid is kept open. Indian Book building process provides for an open book
system. In the closed book building system, the book is not made public and the bidders will
have to take a call on the price at which they intend to make a bid without having any
information on the bids submitted by other bidders.
Hard underwriting is when an underwriter agrees to buy his commitment before the issue
opens. The underwriter guarantees a fixed amount to the issuer from the issue. Thus, in case

29

the shares are not subscribed by investors, the issue is devolved on underwriters and they
have to bring in the amount by subscribing to the shares. The underwriter bears a risk which
is much higher than soft underwriting.
Soft underwriting is when an underwriter agrees to buy the shares at stage after the issue
the issue is closed. The risk faced by the underwriter as such is reduced to a small window of
time.
Differential pricing: When one category of investors is offered shares at a price different
from the other category it is called differential pricing. An issuer company can allot the shares
to retail individual investors at a discount of maximum 10% to the price at which the shares
are offered to other categories of public.
Basis of Allocation/Basis of Allotment: After the closure of the issue, for example, a book
built public issue, the bids received are aggregated under different categories i.e., firm
allotment, Qualified Institutional Buyers (QIBs), Non Institutional Buyers (NIBs), Retail, etc.
The oversubscription ratios are then calculated for each of the categories as against the
shares reserved for each of the categories in the offer document. Within each of these
categories, the bids are then segregated into different buckets based on the number of
shares applied for. The oversubscription ratio is then applied to the number of shares applied
for and the number of shares to be allotted for applicants in each of the buckets is
determined. Then, the number of successful allotees is determined. This process is followed
in case of proportionate allotment. Thus allotment to each investor is done based on
proportionate basis in both book built and fixed price public issue.
Firm Allotment means allotment on a firm basis in public issues by an issuing company
made to Indian and Multilateral Development Financial Institutions, Indian Mutual Funds,
Foreign Institutional Investors including non-resident Indians and overseas corporate bodies
and permanent/ regular employees of the issuer company.
Networth means aggregate of value of the paid up equity capital and free reserves
(excluding reserves created out of revaluation) reduced by the aggregate value of
accumulated losses and deferred expenditure not written off (including miscellaneous
expenses not written off) as per the audited balance sheet.)
Offer Document means Prospectus in case of a public issue or offer for sale and Letter of
Offer in case of a rights issue.
Offer for Sale means offer of securities by existing shareholder(s) of a company to the public
for subscription, through an offer document.
Preferential Allotment means an issue of capital made by a body corporate in pursuance of
a resolution passed under Sub-section (1A) of Section 81 of the Companies Act, 1956.
Public Issue means an invitation by a company to public to subscribe to the securities
offered through a prospectus;

30

Underwriting means an agreement with or without conditions to subscribe to the securities of

a body corporate when the existing shareholders of such body corporate or the public do not
subscribe to the securities offered to them.
Unlisted Company means a company which is not a listed company.

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CHAPTER 3
FINANCIAL MARKETS
Financial markets are an important component of the financial system. Financial markets are
the centers or arrangements that provide facilities for buying and selling of financial claims
and services. In other words, it is a market for creation and exchange of financial assets.

FUNCTIONS OF FINANCIAL MARKETS

Financial markets play a very pivotal role in allocating resources in an economy. Financial
markets serve six basic functions. These functions are briefly listed below:

Borrowing and Lending

Facilitate the transfer of funds from one entity to another for investment purposes or
immediate use. By transferring of funds its is meant that financial markets channel funds from
households, firms, governments and foreigners that have saved surplus funds to those who
encounter a shortage of funds (for purposes of consumption and investment).

Price Determination
Financial markets provide vehicles by which prices are set both for newly issued financial
assets and for the existing stock of financial assets. Financial markets determine the prices of
financial assets. The secondary market herein plays an important role in determining the
prices for newly issued assets.

Information Aggregation and Coordination

Financial markets act as collectors and aggregators of information about financial asset
values and the flow of funds from lenders to borrowers. The exchange of funds is
characterized by a high amount of incomplete and asymmetric information.

Risk Sharing
Financial markets allow a transfer of risk from those who undertake investments to those who
provide funds for those investments. Trade in financial markets is partly motivated by the
transfer of risk from lenders to borrowers who use the obtained funds to invest.

32

Liquidity
Financial markets provide the holders of financial assets with a chance to resell or liquidate
these assets. The existence of financial markets enables the owners of assets to buy and
resell these assets. Generally this leads to an increase in the liquidity of these financial
instruments. This implies that the investors can readily sell their financial assets through the
mechanism of financial markets.

Efficiency
Financial markets reduce transaction costs and information costs. The facilitation of financial
transactions through financial markets lead to a decrease in informational cost and
transaction costs, which from an economic point of view leads to an increase in efficiency.

TYPES OF FINANCIAL MARKETS

Indian Financial Markets
& Products

Securities
Market

Derivatives

Cash
/Equity

Shares

Debentures

Warrants

Debt

Money
Market

Collective Investment
Vehicles

Cash

Interest
Rate

Forex

Spot

Derivatives

Agro

Index /
Stock

G-secs

Mutual
Fund

Call
Money

Forwards

Index
System

Corporate
Bonds

Index
Funds

Term
Money

NDFs

Currency

T-bills

ETFs

Repos

Swaps

G-Secs

CBLO

Currency

T-Bills

Interest
rate

CPs/CDs

Insurance

Commodity

Non Agro

Life

FRAs

Options

Securities Markets
Securities Market consists of Equity/Cash/Capital Market, Debt Market, Derivatives and Forex
trading (futures and options). Broadly, the securities markets consist of primary markets and
secondary markets. Newly formed (issued) securities are bought or sold in primary markets.
Secondary markets allow investors to sell securities that they hold or buy existing securities.

33

Non-Life/
Life

Money markets
Money market is a market for financial assets that are close substitutes for money. It is a
market overnight to short term funds and instruments having a maturity period of one or less
than one year. Money market provides short term debt financing and investment. The money
market deals primarily in short-term debt securities and investments, such as bankers
acceptances, negotiable certificates of deposit (CDs), repos and Treasury Bills (T-bills),
call/notice money market, commercial papers.

Foreign exchange markets

The foreign exchange market (currency, forex, or FX) is where currency trading takes place. It
is where banks and other official institutions facilitate the buying and selling of foreign
currencies.The forex market (Over the counter), is the largest financial market in the world,
facilitates the trading of the currencies of various nations.

Commodity markets
Commodity Markets facilitate the trading of commodities such as gold, silver and agricultural
goods. The Chicago Mercantile Exchange (CME) and Tokyo Commodity Exchange (TOCOM)
are among the worlds most popular commodity markets.

Insurance market
Insurance markets facilitate the redistribution of various risks. The insurance sector is
involved in the transference of life, property and health-related risks from the policyholder to
the insurance company.
These markets and the different financial instruments traded in these markets are discussed
in the subsequent chapters.

34

CHAPTER 4
SECURITIES MARKET IN INDIA
The securities market in India is an important component of Indian Financial system.

DEFINITON OF SECURITIES
The definition of securities as per the Securities Contracts Regulation Act, 1956 includes
instruments such as:
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities
of a like nature in or of any incorporated company or other body corporate, derivative, units or
any other instrument issued by any collective investment scheme to the investors in such
schemes, security receipt as defined in clause (zg) of section 2 of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, units or
any other such instrument issued to the investors under any mutual fund scheme; i.e. any
certificate or instrument (by whatever name called), issued to an investor by any issuer being
a special purpose distinct entity which possesses any debt or receivable, including mortgage
debt, assigned to such entity, and acknowledging beneficial interest of such investor in such
debt or receivable, including mortgage debt, as the case maybe.
(ii) Government securities, such other instruments as may be declared by the Central
Government to be securities and
(iii) rights or interest in securities;
Thus, securities market deals with all the above financial instruments.

FUNCTIONS OF SECURITIES MARKET:

Securities Markets is a place where buyers and sellers of securities can enter into
transactions to purchase and sell shares, bonds, debentures etc. Further, it performs an
important role of enabling corporates, entrepreneurs to raise resources for their companies
and business ventures through public issues. Transfer of resources from those having idle
resources (investors) to others who have a need for them (corporates) is most efficiently
achieved through the securities market. Stated formally, securities markets provide channels
for reallocation of savings to investments and entrepreneurship.

Mobilization of savings and acceleration of capital formation

In developing countries like India, plagued by the paucity of resources and increasing
demand for investments by industrial organizations and governments, the importance of the
capital market is self evident. In this market, various types of securities help mobilize savings

35

from various sections of the population. The twin features of reasonable return and liquidity in
the stock exchange are definite incentives to the people to invest in securities. This
accelerates the capital formation in the country.

Promotion of industrial growth

The capital market is a central market through which resources are transferred to the
industrial sector of the economy. The existence of such an institution encourages the people
to invest in productive channels rather than in the unproductive sectors like real estate, bullion
etc. Thus, it stimulates industrial growth and economic development of the country by
mobilizing funds for investment in the corporate sector.

Raising long-term capital

The existence of a stock exchange enables companies to raise permanent capital. The
investors cannot commit their funds for a permanent period but companies require funds
permanently. The stock exchange resolves this clash of interests by offering an opportunity to
investors to buy or sell their securities while permanent capital with the company remains
unaffected.

Ready and continuous market

The stock exchange provides a central convenient place where buyers and sellers can easily
purchase and sell securities. The element of easy marketability makes investment in
securities more liquid as compared to other assets.

Proper channelization of funds

An efficient capital market not only creates liquidity through its pricing mechanism but also
functions to allocate resources to the most efficient industries. The prevailing market price of
a security and relative yield are the guiding factors for the people to channelise their funds in
a particular company. This ensures effective utilization of funds in the public interest.

Provision of a variety of services

The financial institutions functioning in the securities market provide a variety of services, the
more important ones being the following :
(i)
grant of long-term and medium-term loans to entrepreneurs to enable them to
establish, expand or modernize business units;
(ii)
provision of underwriting facilities;
(iii)
assistance in the promotion of companies (this function is done by the
developing banks like IDBI);
(iv)
participation in equity capital
(v)
expert advice on management of investment in industrial securities.

36

MARKET SEGMENTS IN SECURITIES MARKET

The securities market has two interdependent and inseparable segments, the new issues
(primary) market and the stock (secondary) market.

PRIMARY MARKET
The primary market provides the channel for creation and sale of new securities, while the
secondary market deals in securities previously issued. The securities issued in the primary
market are issued by public limited companies or by government agencies. The resources in
this kind of market are mobilized either through the public issue or through private placement
route. It is a public issue if anybody and everybody can subscribe for it, whereas if the issue is
made available to a selected group of persons it is termed as private placement. There are
two major types of issuers of securities, the corporate entities who issue mainly debt and
equity instruments and the government (central as well as state) who issue debt securities
(dated securities and treasury bills).

Secondary Market
The secondary market enables participants who hold securities to adjust their holdings in
response to changes in their assessment of risks and returns. Once the new securities are
issued in the primary market they are traded in the stock (secondary) market. The secondary
market operates through two mediums, namely, the over-the-counter (OTC) market and the
exchange-traded market. OTC markets are informal markets where trades are negotiated.
Most of the trades in the government securities are in the OTC market. All the spot trades
where securities are traded for immediate delivery and payment take place in the OTC
market. The other option is to trade using the infrastructure provided by the stock exchanges.
The secondary market is a market in which existing securities are resold or traded. This
market is also known as the stock market. In India, the secondary market consists of
recognised stock exchanges operating under rules, bye laws and regulations of regulators.
According to Securities Contracts (Regulation) Act 1956, a stock exchange is defined as any
body of individuals, whether incorporated or not, constituted before corporatisation and
demutualization or a body corporate incorporated under the Companies Act 1956 whether
under a scheme of corporatisation and demutualization or otherwise for the purpose of
assisting, regulating or controlling the business of buying, selling or dealing in securities.
The exchanges in India follow a systematic settlement period. All the trades taking place over
a trading cycle (day=T) are settled together after a certain time (T+2 day). The trades
executed on exchanges are cleared and settled by a clearing corporation. The clearing
corporation acts as a counterparty and guarantees settlement. A variant of the secondary
market is the forward market, where securities are traded for future delivery and payment. A
variant of the forward market is Futures and Options market. Presently only two exchanges
viz., National Stock Exchange of India Ltd. (NSE) and Bombay Stock Exchange (BSE)
provide trading in the Futures & Options.

37

HISTORY OF SECURITIES MARKET

The securities market in India dates back to the 18th century when the securities of the East
India Company were traded in Mumbai and Kolkata. The brokers used to gather under a
Banyan tree in Mumbai and under a neem tree in Kolkata for the purpose. However the real
beginning came in the 1850s with the introduction of joint stock companies with limited
liability. The 1860s witnessed feverish dealings in securities and reckless speculation. This
brought brokers in Bombay together in July 1875 to form the first formally organised stock
exchange in the country viz. The Stock Exchange, Mumbai. Ahmedabad Stock Exchange in
1894, Calcutta in 1908 and Madras in 1937 and 22 others followed this in the 20th century. In
order to promote the orderly development of the stock market, the central government
introduced a comprehensive legislation called the Securities Contract (Regulation) Act, 1956.
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960s.
However, during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply.
Till the early 1990s, the Indian secondary market comprising of various regional stock
exchanges was plagued with the many problems like uncertainty of execution price, uncertain
delivery and settlement periods, lack of transparency, absence of risk management, herd
mentality of brokers etc.
Emergence of NSE
The National Stock Exchange of India Limited (NSE) was conceptualized at a time when the
industry suffered from extreme infirmities of opacity, inefficiency of processes and poor
infrastructure. It was the time when a section of powerful brokerage firms mostly located in
metropolitan cities dominated the securities industry. NSE wrote for itself the mandate to
create a world-class exchange and use it as an instrument of change for the industry as a
whole through competitive pressure. NSE incorporated in 1992 was given recognition as a
stock exchange in April 1993 and started operation in June 1994 with the following objectives
(a) establish a nationwide trading facility for all types of securities,
(b)ensure equal access to all investors all over the country through an appropriate
communication network,
(c) provide for a fair, efficient and transparent securities market using electronic trading
system,
(d) enable shorter settlement cycles and book entry settlements, and
(e) meet the international benchmarks and standards. Within a short span of time, the above
objectives have been realized and the exchange has played a leading role as a change agent
in transforming the Indian Capital Markets to its present form.
The process of reforms has led to a pace of growth almost unparalleled in the history of any
country. Securities market in India has grown exponentially as measured in terms of amount
raised from the market, number of stock exchanges and other intermediaries, the number of
listed stocks, market capitalisation, trading volumes and turnover on stock exchanges,

38

investor population and price indices. Along with this, the profiles of the investors, issuers and
intermediaries have changed significantly. The market has witnessed fundamental
institutional changes resulting in drastic reduction in transaction costs and significant
improvements in efficiency, transparency and safety. Indian market is now comparable to
many developed markets in terms of a number of parameters, as may be seen from the table
below.
Table: International Comparison: end December 2007
Particulars
No. of listed
Companies
Market
Capitalisation (US
$
Bn.)
Market
Capitalisation
Ratio (%)
Turnover
( US $
Bn.)
Turnover Ratio
(%)

Singapore

Hong
Kong

China

658

472

1,029

1,530

4,887

4,453

2,106

353

1,163

6,226

1,819

157.1

90.25

69.43

274.41

583.89

237.6

200.1

42,613

10,324

6,497

3,363

384

917

7,792

1,108

216.5

270.1

141.6

179.7

122

89.1

180.1

84

USA

UK

Japan

5,130

2,588

3,844

19,947

3,859

149

Germany

India

Note: Market Capitalisation Ratio is computed as a percentage of GNI 2006

There are very few countries that have higher turnover ratio than India. Market Capitalisation
as a percentage of GNP compares favorably even with advanced countries and much better
than emerging markets. In terms of number of companies listed on stock exchanges, India is
second.

MARKET PARTICIPANTS IN SECURITIES MARKET

In every economic system, some units, individuals or institutions, are surplus-generating, who
are called savers, while others are deficit- generating, called spenders. Households are
surplus-generating and corporates and Government are deficit generators. Through the
platform of securities markets, the savings units place their surplus funds in financial claims or
securities at the disposal of the spending community and in turn get benefits like interest,
dividend, capital appreciation, bonus etc. These investors and issuers of financial securities
constitute two important elements of the securities markets. The third critical element of
markets is the intermediaries who act as conduits between the investors and issuers.
Regulatory bodies, which regulate the functioning of the securities markets, constitute another
significant element of securities markets. The process of mobilisation of resources is carried
out under the supervision and overview of the regulators. The regulators develop fair market
practices and regulate the conduct of issuers of securities and the intermediaries. They are
also in charge of protecting the interests of the investors. The regulator ensures a high

39

service standard from the intermediaries and supply of quality securities and non-manipulated
demand for them in the market.
Thus, the four important participants of securities markets are the investors, the
issuers, the intermediaries and regulators.

Market
Participants

Investors

Issuers

Intermediaries

Regulators

Investors
An investor is the backbone of the capital markets of any economy as he is the one lending
his surplus resources for funding the setting up of or expansion of companies, in return for
financial gain.
Investors in Stock Markets can broadly be classified into Retail Investors and Institutional
Investors.
Retail Investors are individual investors who buy and sell securities for their personal
account, and not for another company or organization. This category also includes High
Networth Individuals (HNI) which comprise of people with large personal financial holdings.
Institutional Investors comprise of domestic Financial Institutions, Banks, Insurance
Companies, Mutual Funds and FIIs (Foreign Institutional investor is an entity established or
incorporated outside India that proposes to make investments in India).

Issuers
Both PSUs and private companies tap the securities market to finance capital expansion
activity and growth plans. Even banks, financial institutions raise resources from securities
market. Other important issuers are mutual funds which are important investment
intermediaries which mobilize the savings of the small investors. Funds can rise in the
primary market from the domestic market as well as from international markets. After the
reforms initiated in 1991, one of the major policy change was allowing Indian companies to
raise resources by way of equity issues in the international markets. Indian companies have
raised resources from international capital markets through Global Depository Receipts
(GDRs)/American Depository Receipts (ADRs), Foreign Currency Convertible bonds (FCCBs)
and External Commercial Borrowings (ECBs). GDRs are essentially equity instruments
issued abroad by authorized overseas corporate bodies against the shares/bonds of Indian
companies held with nominated domestic custodian banks. ADRs are negotiable instruments,

40

denominated in dollars and issued by the US Depository Bank. FCCBs are bonds issued by
Indian companies and subscribed to by a non-resident in foreign currency. They carry a fixed
interest or coupon rate and are convertible into a certain number of ordinary shares at a
preferred price. ECBs are commercial loans (in the form of bank loans, buyers, credit,
suppliers credit, securitised instruments (floating rate notes and fixed rate bonds) availed from
any internationally recognised source such as bank, export credit agencies, suppliers of
equipment, foreign collaborators, foreign equity holders and international capital market.
ECBs supplement domestically available resources for expansion of existing capacity as well
as for fresh investment. Indian companies have preferred this route to raise funds as the cost
of borrowing is low in the international markets.

Intermediaries
The term market intermediary is usually used to refer to those who are in the business of
managing individual portfolios, executing orders, dealing in or distributing securities and
providing information relevant to the trading of securities. The market mediators play an
important role on the stock exchange market; they put together the demands of the buyers
with the offers of the security sellers. A large variety and number of intermediaries provide
intermediation services in the Indian securities markets.
Stock Exchanges: The stock exchanges provide a trading platform whereby the buyers and
sellers can meet to transact in securities. The Securities Contract (Regulation) Act, 1956
[SCRA] defines Stock Exchange as 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. Stock exchange could be a regional stock exchange whose
area of operation/jurisdiction is specified at the time of its recognition or national exchanges,
which are permitted to have nationwide trading since inception. Currently, there are 20 stock
exchanges in India.
Stock Exchanges in India
Ahmedabad Stock Exchange Ltd.
MCX Stock Exchange Ltd
Bangalore Stock Exchange Ltd.
National Stock Exchange of India Ltd.
Bhubaneswar Stock Exchange Ltd.
OTC Exchange of India
Bombay Stock Exchange Ltd.
Pune Stock Exchange Ltd.
Calcutta Stock Exchange Association Ltd.,
Uttar Pradesh Stock Exchange Association Ltd.
Cochin Stock Exchange Ltd.
Delhi Stock Exchange Ltd.
Gauhati Stock Exchange Ltd.
Interconnected Stock Exchange of India Ltd.
Jaipur Stock Exchange Ltd.
Ludhiana Stock Exchange Ltd.
Madhya Pradesh Stock Exchange Ltd
Madras Stock Exchange Ltd.

41

Clearing Corporation: A Clearing Corporation is a part of an exchange or a separate entity

and performs three functions, namely, it clears and settles all transactions, i.e. completes the
process of receiving and delivering shares/funds to the buyers and sellers in the market, it
provides financial guarantee for all transactions executed on the exchange and provides risk
management functions. National Securities Clearing Corporation (NSCCL), a 100%
subsidiary of NSE, performs the role of a Clearing Corporation for transactions executed on
the NSE.
Stock Brokers and Subbrokers: Stock Broker means a member of a Stock Exchange and
Sub-broker means any person not being a member of Stock Exchange who acts on behalf of
a Stock broker as an agent or otherwise for assisting the investors in buying, selling or
dealing in securities through such stock brokers.
Depository : A bank or company which holds funds or securities deposited by others, and
where exchanges of these securities take place.
Depository Participant (DP): The Depository provides its services to investors through its
agents called depository participants (DPs). These agents are appointed by the depository
with the approval of SEBI. According to SEBI regulations, amongst others, three categories of
entities, i.e. Banks, Financial Institutions and SEBI registered trading members can become
DPs.
Custodian: A Custodian is basically an organisation, which helps register and safeguard the
securities of its clients. Besides safeguarding securities, a custodian also keeps track of
corporate actions on behalf of its clients:

Maintaining a clients securities account

Collecting the benefits or rights accruing to the client in respect of securities
Keeping the client informed of the actions taken or to be taken by the issue of
securities, having a bearing on the benefits or rights accruing to the client.

Merchant Bankers: Merchant bankers means any person who is engaged in the business of
issue management either by making arrangements regarding selling, buying or subscribing to
securities or acting as a manager, consultant , adviser or rendering corporate advisory
services in relation to such issue management. Merchant Bankers.
Merchant banks are also called investment banks and are most significant institutions in the
financial markets. The merchant banking activity in India is governed by SEBI (Merchant
Bankers) Regulations 1992. Each merchant banker is required to have capital adequacy with
prescribed net worth.
Foreign Institutional Investors: Foreign Institutional Investors means an institution
established or incorporated outside India which proposes to make investment in India in
securities. Currently, entities eligible to invest under the FII route are as follows:

42

a) As FII:
(i) an institution established or incorporated outside India as a pension fund, mutual fund,
investment trust, insurance company or reinsurance company;
(ii) an International or Multilateral Organization or an agency thereof or a Foreign
Governmental Agency, Sovereign Wealth Fund or a Foreign Central Bank;
(iii) an asset management company, investment manager or advisor, bank or institutional
portfolio manager, established or incorporated outside India and proposing to make
investments in India on behalf of broad based funds and its proprietary funds, if any;
(iv) a Trustee of a trust established outside India, and proposing to make investments in India
on behalf of broad based funds and its proprietary funds, if any
(iv) university fund, endowments, foundations or charitable trusts or charitable societies
broad based fund means a fund established or incorporated outside India, which has at least
twenty investor with no single individual investor holding more hat fort-nine percent of the
shares or units of the fund
(b) As Sub-accounts: Sub-accounts means any person resident outside India, on whose
behalf investments are proposed to be made in India by a FII and who is registered as a Subaccount under SEBI (FII) Regulations, 1995.
Mutual Funds: A mutual fund is a company that pools money from many investors and
invests the money in stocks, bonds, short-term money-market instruments, other securities or
assets, or some combination of these investments. Mutual Funds are essentially investment
vehicles where people with similar investment objective come together to pool their money
and then invest accordingly. SEBI defines mutual funds as A fund established in the form of a
trust to raise money through the sale of units to the public or a section of the public under one
or more schemes for investing in securities, including money market instruments or gold or
gold related instruments or real estate assets.
Collective Investment Scheme (CIS): A Collective Investment Scheme (CIS) is any scheme
or arrangement made or offered by any company, which pools the contributions, or payments
made by the investors, and deploys the same.
Venture Capital Funds: Venture Capital Fund (VCF) is a fund established in the form of a
trust or a company including a body corporate having a dedicated pool of capital, raised in the
specified manner and invested in Venture Capital Undertakings (VCUs). VCU is a domestic
company whose shares is not listed on a stock exchange and is engaged in a business for
providing services, production, or manufacture of article. A company or body corporate to
carry on activities as a VCF has to obtain a certificate from SEBI and comply with the
regulations prescribed in the SEBI (Venture Capital Regulations) 1996.
Credit Rating Agency: Credit Rating Agency means a body corporate which is engaged in
or proposes to be engaged in the business of rating of securities offered by way of public or
rights issues.
Debenture Trustee: Debenture Trustee means a trustee of a Trust deed for securing any
issue of debentures of a body corporate.

43

The table below presents an overview of market participants in the Indian securities market.
Market Participants

1
4
2

1
4
2

As on
March 31,
2009
1
4
2

22
2
2
-

19
2
2
-

20
2
2
3

9,443
27,541
996
158
15

9487
44,074
1319
205
15

9628
60,947
1626
232
16

82
17
152
47
30
45
90
78
40
4
0

76
16
155
50
28
35
106
97
40
5
0

71
16
134
51
30
19
132
129
44
5
0

As on March 31
2007

Securities Appellate Tribunal (SAT)

Regulators*
Depositories
Stock Exchanges
With Equities Trading
With Debt Market Segment
With Derivative Trading
With Currency Derivatives
Stock Brokers
Sub-brokers
FIIs
Portfolio Managers
Custodians
Registrars to an issue & Share Transfer
Agents
Primary Dealers
Merchant Bankers
Bankers to an Issue
Debenture Trustees
Underwriters
Venture Capital Funds
Foreign Venture Capital Investors
Mutual Funds
Credit Rating Agencies
Collective Investment Schemes
* DCA, DEA, RBI & SEBI.
Source: SEBI Bulletin.

2008

The market intermediary has a close relationship with the investor with whose protection the
Regulator is primarily tasked. As a consequence a large portion of the regulation of a
securities industry is directed at the market intermediary. Regulations address entry criteria,
capital and prudential requirements, ongoing supervision and discipline of entrants, and the
consequences of default and failure.

44

One of the issue concerning brokers is the need to encourage then to corporatize. Presently,
44% of the brokers are corporates. Corporatisation of their business would help them
compete with global players in capital markets at home and abroad. Corporatisation brings
better standards of governance and better transparency hence increasing the confidence
level of customers.

Regulators
The absence of conditions of perfect competition in the securities market makes the role of
regulator extremely important. The regulator ensures that the market participants behave in a
desired manner so that securities market continues to be a major source of finance for
corporate and government and the interest of investors are protected.
The responsibility for regulating the securities market is shared by Department of Economic
Affairs (DEA), Ministry of Company Affairs (MCA), Reserve Bank of India (RBI) and SEBI.
The activities of these agencies are coordinated by a High Level Committee on Capital
Markets. The orders of SEBI under the securities laws are appellable before a Securities
Appellate Tribunal.
Most of the powers under the SCRA are exercisable by DEA while a few others by SEBI. The
powers of the DEA under the SCRA are also con-currently exercised by SEBI. The powers in
respect of the contracts for sale and purchase of securities, gold related securities, money
market securities and securities derived from these securities and ready forward contracts in
debt securities are exercised concurrently by RBI. The SEBI Act and the Depositories Act are
mostly administered by SEBI. The rules under the securities laws are framed by government
and regulations by SEBI. All these are administered by SEBI. The powers under the
Companies Act relating to issue and transfer of securities and non-payment of dividend are
administered by SEBI in case of listed public companies and public companies proposing to
get their securities listed. The SROs ensure compliance with their own rules as well as with
the rules relevant for them under the securities laws.

COMPONENTS OF SECURITIES MARKET

Securities Market is classified into following markets and different types of instruments are
traded in these markets.

Cash/Equity Markets & Its Products

The equity segment of the stock exchange allows trading in shares, debentures, warrants,
mutual funds and ETFs. These products are explained in detail below.
Shares:
Equity Shares: An equity share, commonly referred to as ordinary share, represents the form
of fractional ownership in a business venture. Equity shareholders collectively own the
company. They bear the risk and enjoy the rewards of ownership. Equity shares are further
classified into:

45

Blue chip shares: Shares of large, well established and financially strong
companies with an impressive record of earnings and dividends
Growth shares: Shares of companies that have a fairly entrenched
position in a growing market and which enjoy an above average rate of
growth as well as profitability
Income shares: Shares of companies that have fairly stable operations,
relatively limited growth opportunities and high dividend payout ratios.
Cyclical Shares: Shares of companies that have a pronounced cyclicality
to their operations.
Speculative Shares: Shares that tend to fluctuate widely because there is
lot speculative trading in them.
Defensive Shares: Shares of companies that are relatively unaffected by
the ups and downs in general business conditions.

Rights Issue/ Rights Shares: The issue of new securities to existing shareholders
at a ratio to those already held, at a price. For e.g. a 2:3 rights issue at Rs. 125,
would entitle a shareholder to receive 2 shares for every 3 shares held at a price of
Rs. 125 per share.
Bonus Shares: Shares issued by the companies to their shareholders free of cost
based on the number of shares the shareholder owns.
Preference shares: Owners of these kinds of shares are entitled to a fixed dividend
or dividend calculated at a fixed rate to be paid regularly before dividend can be paid
in respect of equity share. They also enjoy priority over the equity shareholders in
payment of surplus. But in the event of liquidation, their claims rank below the claims
of the companys creditors, bondholders/debenture holders.
Cumulative Preference Shares: A type of preference shares on which dividend
accumulates if remained unpaid. All arrears of preference dividend have to be paid
out before paying dividend on equity shares.
Cumulative Convertible Preference Shares: A type of preference shares where
the dividend payable on the same accumulates, if not paid. After a specified date,
these shares will be converted into equity capital of the company.
Difference between Equity shareholders and Preferential shareholders:
Equity Shareholders are supposed to be the owners of the company, who therefore, have
right to get dividend, as declared, and a right to vote in the Annual General Meeting for
passing any resolution.
The act defines a preference share as that part of share capital of the Company which
enjoys preferential right as to: (a) payment of dividend at a fixed rate during the life time of the
Company; and (b) the return of capital on winding up of the Company.

46

But Preference shares cannot be traded, unlike equity shares, and are redeemed after a predecided period. Also, Preferential Shareholders do not have voting rights.
Debentures: An instrument for raising long term debt. Debentures in India are typically
secured by tangible assets.
Convertible debentures can be converted at the option of the holder into ordinary shares of
the same company under specified terms and conditions. Thus it has features of both
debenture as well as equity.
Non Convertible debentures are pure debentures without a feature of conversion They are
repayable on maturity. These debentures are issued at a highly discounted issue price.
Partly Convertible debentures have features of convertible and non-convertible debentures.
Warrants: A company may issue equity shares or debentures attached with warrants.
Warrants entitle an investor to buy equity shares after a specified time period at a given price.

Equity Derivatives Market

The derivatives segment allows trading in derivative instruments. Derivative is a product
whose value is derived from the value of one or more basic variables, called bases
(underlying asset, index, or reference rate), in a contractual manner. The underlying asset
can be equity, forex, commodity or any other asset.
There are two types of derivative instruments (futures and options) that are traded on the
Equity Derivative segment of Exchanges.
Index/ Stock Futures: A futures contract is an agreement between two parties to buy or sell
an asset at a certain time in the future at a certain price. Futures contracts are special types
of forward contracts in the sense that the former are standardized exchange-traded contracts.
Futures contracts are available on stocks and indices. At NSE, 4 index future contracts and
more than 150 stocks are available for trading.
Index / Stock Options: Options are of two types - calls and puts. Calls give 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. Puts give 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. At NSE, 4
index option contracts and more than 150 stocks are available for trading.
Currency Derivatives :
Currency derivatives trading was introduced in the Indian financial markets with the launch of
currency futures trading in the USD-INR pair at the NSE on August 29, 2008. Currency

47

futures trading is currently available on three stock exchanges (NSE, BSE (commenced on
October 1, 2008) MCX (commenced on October 7, 2008)

Debt Market
The debt market is one of the most critical components of the financial system of any
economy and acts as the fulcrum of a modern financial system. Debt market consists of
Bond markets, which provide financing through the issuance of Bonds, and enable the
subsequent trading thereof. Instruments like bonds/debentures are traded in this market.
These instruments can be traded in OTC or Exchange traded markets.
The debt market in most developed economies is many times bigger than other financial
markets including equity market. In India, the debt market is broadly divided into two parts- GSec or government securities market /gilt edged market and Corporate Bond Market.
The debt market plays a key role in the efficient mobilisation and allocation of resources in the
economy, financing the development activities of the government, facilitating liquidity
management, framing monetary policy and pricing of non-government securities in financial
markets. Debt market can provide returns commensurate to the risk.
G-Sec Market: The government needs enormous amount of money to perform various
functions such as maintaining law and order, justice, national defense, central banking,
creation of physical infrastructure. The government generates revenue in the form of taxes
and income from ownership of assets. Besides, it borrows extensively from banks financial
institutions and public to finance its expenditure. One of the important sources of borrowing
funds is the government securities market. The government raises short term and long term
funds by issuing securities. These securities do not carry risk as the government guarantees
the payment of interest and the repayment of principal. They are therefore referred to as gilt
edged securities. Government securities are issued by the central government, state
government and semi government authorities. The major investors in this market are banks,
insurance companies, provident funds, state governments, FIIs. Government securities are of
two types- treasury bills and government dated securities. One of the important Dated Govt.
securities consists of zero credit risk (sovereign), Coupon bearing and non coupon (zero)
bearing bonds Longer maturity government debt products are the Government of India
Treasury Bonds (ranging from greater than a year up to 30 years). Treasury bonds issued
have face value of all treasury products, both bonds and bills, is Rs.100 and the maturity of
bonds issued goes from over a year, all the way out to 30 years. All GOI bonds are coupon
bearing bonds, with coupons being paid semiannually. The maturity and the coupon of each
bond are defined at the date.
Corporate Bond Market: Corporate bonds are bonds issued by firms and are issue to meet
needs for expansion, modernization, restructuring operations, mergers and acquisitions. The
corporate debt market is a market wherein debt securities of corporates are issued and
traded therein. The investors in this market are banks, financial institutions, insurance

48

companies, mutual funds, FIIs etc. Corporates adopt either the public offering route or the
private placement route for issuing debentures/bonds.
Other instruments available for trading in the debt segment are T-Bills, Commercial Papers
and Certificate of Deposits.
Regulation of Debt Market: The RBI regulates the government securities market and money
market while the corporate debt market comes under the purview of the SEBI.
Participants in the Debt Market
The participants in the debt market are a small number of large players which has resulted in
the debt market.
Central
& State
Govt.

FIIs

Primary
Dealers

PSUs

Corporates
Players
In
Debt
Market

Banks
HNIs

Mutual
Funds

Provident
Funds

PARTICIPANTS IN DEBT MARKET

Primary and Secondary Segments of Debt Market
In the primary market, new debt issues are floated either through public prospectus, rights
issue or private placement.

Collective Investment Vehicles

A collective investment vehicle is any entity that allows investors to pool their money and
invest the pooled funds, rather than buying securities directly as individuals. The most

49

common types of collective investment vehicles are mutual funds, exchange traded funds,
collective investment schemes and venture capital funds. The Collective Investment Scheme
is well established in many jurisdictions and now serves as an investment vehicle for a wide
range of investment opportunities around the world.
In India, there are three distinct categories of collective investment vehicles in operation
namely, Mutual Funds (MFs), Exchange Traded Funds and Index Funds.

Mutual Funds
A mutual fund is a company that pools money from many investors and invests the money in
stocks, bonds, short-term money-market instruments, other securities or assets, or some
combination of these investments. Mutual Funds are essentially investment vehicles where
people with similar investment objective come together to pool their money and then invest
accordingly.
SEBI defines mutual funds as A fund established in the form of a trust to raise money
through the sale of units to the public or a section of the public under one or more schemes for
investing in securities, including money market instruments or gold or gold related instruments
or real estate assets.
A Mutual Fund will have a fund manager who is responsible for investing the pooled money
into specific securities (usually stocks and bonds). When you invest in a MF, you are buying
shares (or portions) of the MF and become a shareholder of the fund. Mutual Funds (MFs) are
considered a good route to invest and earn returns with reasonable safety.
The basis of a Mutual Fund is a pooling concept. A Mutual Fund is an investment vehicle
that pools the savings of several investors who share a common financial goal. The money
thus collected is then invested in capital market instruments such as shares, debentures and
other securities. The income earned through these investments and the capital appreciation
realised are shared by its unit holders in proportion to the number of units owned by them.

50

Advantages of Mutual Funds

Number of available options: equity funds, debt funds, gilt funds and many others are
available that cater to the different needs of an investor.

Diversification: Mutual funds diversify the risk of the investor by investing in a basket of
various stocks.

Managed by Skilled Professionals: Investors who lacks time, the inclination or the skills
to actively mange their investment risk in individual securities can delegate this role to the
mutual funds which are managed by a team of professional fund managers who manages
them with in-depth research inputs from investment analysts.

Liquidity: When in need of liquidity, the money can be withdrawn or redeemed at the Net
Asset Value related prices anytime, without much reduction in yield (unlike penalty on
premature fixed deposit withdrawal). Some mutual funds however, charge exit loads for
withdrawal within a specified period.

Well Regulated: All investments have to be accounted for & decisions judiciously taken.
SEBI acts as a true watchdog through regulations, designed to protect the investors
interests and impose penalties on the AMCs at fault.

Transparency: Being under a regulatory framework, mutual funds have to disclose their
holdings, investment pattern and all the information relating to the investment strategy,
outlooks of the market and scheme related details to all investors frequently to ensure that
transparency exists in the system.

51

Flexible, Affordable and a Low Cost affair: Mutual Funds provide the benefit of cheap
access to expensive stocks.

Tax benefits: Mutual Funds (MFs) are undoubtedly an important product innovation in the
financial field, as an instrument of raising capital from the wider public for corporate
enterprise growth. Historically MFs originally called unit trusts in the United Kingdom were
invented for the mass of relatively small investors. Investors are issued units, thus for an
investor, investments in MF imply buying shares (or portions) of the MF and becoming the
shareholders of the fund.

Structure of Mutual Funds:

A typical MF in India has the following constituents:
Fund Sponsor - A sponsor is a person who, acting alone or in combination with another
corporate body, establishes a MF. The sponsor should have a sound financial track record of
over five years, have a positive net worth in all the immediately preceding five years and
integrity in all his business transactions.
In case of an existing MF, such fund which is in the form of a trust and the trust deed has
been approved by the Board; the sponsor should contribute at least 40% of the net worth of
the AMC (provided that any person who holds 40 % or more of the net worth of an asset
management company should be deemed to be a sponsor and would be required to fulfill the
eligibility criteria specified in the SEBI regulations).
Trustees - The MF can either be managed by the Board of Trustees, which is a body of
individuals, or by a Trust Company, which is a corporate body. Most of the funds in India are
managed by a Board of Trustees. The trustees are appointed with the approval of SEBI. Two
thirds of trustees are independent persons and are not associated with sponsors or be
associated with them in any manner whatsoever. The trustees, being the primary guardians
of the unit holders funds and assets, have to be persons of high repute and integrity. The
Trustees, however, do not directly manage the portfolio of MF. It is managed by the AMC as
per the defined objectives, in accordance with trust deed and SEBI (MF) Regulations.
Asset Management Company - The AMC, appointed by the sponsor or the Trustees and
approved by SEBI, acts like the investment manager of the Trust. The AMC should have at
least a net worth of Rs. 10 crore. It functions under the supervision of its Board of Directors,
Trustees and the SEBI. In the name of the Trust, AMC fl oats and manages different
investment schemes as per the SEBI Regulations and the Investment Management
agreement signed with the Trustees. The regulations require non-interfering relationship
between the fund sponsors, trustees, custodians and AMC.
Custodians - A custodian is appointed for safe keeping the securities or gold or gold related
instruments or other assets and participating in the clearing system through approved
depository. Custodian also records information on stock splits and other corporate actions. No
custodian in which the sponsor or its associate holds 50 % or more of the voting rights of the

52

share capital of the custodian or where 50 % or more of the directors of the custodian
represent the interest of the sponsor or its associates should act as custodian for a mutual
fund constituted by the same sponsor or any of its associate or subsidiary company.
Registrar and Transfer agent - Registrar and transfer agent maintains record of the unit
holders account. A fund may choose to hire an independent party registered with SEBI to
provide such services or carryout these activities in-house. If the work relating to the transfer
of units is processed in-house, the charges at competitive market rates may be debited to the
scheme. The registrar and transfer agent forms the most vital interface between the unit
holder and mutual fund. Most of the communication between these two parties takes place
through registrar and transfer agent.
Distributors/ Agents - To send their products across the length and breadth of the country,
mutual funds take the services of distributors/agents. Distributors comprise of banks, nonbanking financial companies and other distribution companies.

TYPES OF MFs/SCHEMES
A wide variety of MFs/Schemes caters to different preferences of the investors based on their
financial position, risk tolerance and return expectations.
Funds by Structure/Tenor
Open ended Scheme
An open-ended fund provides the investors with an easy entry and exit option at NAV, which
is declared on a daily basis.
Close ended Scheme
In close-ended funds, the investors have to wait till maturity to redeem their units, however,
an entry and exit is provided through mandatory listing of units on a stock exchange. The
listing is to be done within six months of the close of the subscription.
Assured return schemes
Assures a specific return to the unit holders irrespective of performance of the scheme, which
are fully guaranteed either by the sponsor or AMC.
Interval Fund
This kind of fund combines the features of open-ended and closed-ended schemes, making
the fund open for sale or redemption during pre-determined intervals.

53

Open Ended Scheme

Close Ended Scheme

1) An Open Ended Scheme accepts funds 1) The subscription to a closed ended

from investors by offering its units or shares scheme is kept open only for a limited period
on a continuing basis.
(usually one month to three months)
2) It permits investors to withdraw funds on a 2) It does not allow investors to withdraw
continuing basis under a re-purchase funds as and when they like.
arrangement.
3) Open Ended scheme has no maturity 3) A close ended scheme has a fixed
period.
maturity period (usually five to fifteen years).
4) The open ended schemes are ordinarily 4) The close ended schemes are listed on
not listed.
the secondary market.
5) They offer greater liquidity and relatively 5) They offer lesser liquidity and higher
lower returns.
returns compared to Open Ended Scheme.

Regulation of Mutual Funds

The MFs are regulated under the SEBI (MF) Regulations, 1996. All the MFs have to be
registered with SEBI. The regulations have laid down a detailed procedure for launching of
schemes, disclosures in the offer document, advertisements, listing and repurchase of closeended schemes, offer period, transfer of units, investments, among others.
In addition, RBI also supervises the operations of bank-owned MFs. While SEBI regulates all
market related and investor related activities of the bank/FI-owned funds, any issues
concerning the ownership of the AMCs by banks fall under the regulatory ambit of the RBI.
Further, as the MFs, AMCs and corporate trustees are registered as companies under the
Companies Act 1956, they have to comply with the provisions of the Companies Act. Many
close-ended schemes of the MFs are listed on one or more stock exchanges. Such schemes
are, therefore, subject to the regulations of the concerned stock exchange(s) through the
listing agreement between the fund and the stock exchange. MFs, being Public Trusts are
governed by the Indian Trust Act, 1882, are accountable to the office of the Public Trustee,
which in turn reports to the Charity Commissioner, that enforces provisions of the Indian
Trusts Act.
Constitution of a Mutual Fund, Asset Management Company
A mutual fund is constituted in the form of a trust and the instrument of trust should be in the
form of a deed, duly registered under the provisions of the Indian Registration Act, 908 (16 of
1908), executed by the sponsor in favour of the trustees named in such an instrument. A trust
is appointed with the approval of the Board. The sponsor or, if so authorised by the trust

54

deed, the trustee, would appoint an asset management company, which has been approved
by the Board.
The trustees and the asset management company should with prior approval SEBI enter into
an investment management agreement which should contain clauses necessary for the
purpose of making investments. (Clauses are in the forth schedule chapter III SEBI Mutual
Fund Regulation 1996).

Index Funds
Index funds are those funds which track the performance of an index. This is usually carried
out by either investing in the shares comprising the index or by buying a sample of shares
making up the index or a derivative based on the likely performance of the index. The value of
the fund is linked to the chosen index so that if the index raises so will the value of the fund.
Conversely, if the index falls so will the value of the fund. In the Indian context, the index
funds attempt to copy the performance of the two main indices in the market viz., Nifty 50 or
Sensex. This is done by investing in all the stocks that comprise the index in proportions
equal to the weightage given to those stocks in the index. Unlike a typical MF, index funds do
not actively trade stocks throughout the year. They may at times hold their stocks for the full
year even if there are changes in the composition of index; this reduces transaction costs.
Index funds are considered, particularly, appropriate for conservative long term investors
looking at moderate risk, moderate return arising out of a well-diversified portfolio. Since
index funds are passively managed, the bias of the fund managers in stock selection is
reduced, yet providing returns at par with the index. As of March 2009, there were 35 Index
Funds available.
Index Funds as of March 2009
S.No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16

Scheme Name
JM Nifty Plus Fund - Dividend
JM Nifty Plus Fund - Growth
ICICI Prudential Index Fund - IP - Dividend
Canara Robeco Nifty Index - Dividend
Canara Robeco Nifty Index - Growth
Franklin India Index Fund - NSE Nifty Plan - Growth
ING Nifty Plus Fund - Dividend
ING Nifty Plus Fund - Growth
Tata Index Fund - Nifty Plan - Option A
LIC MF Index Fund - Nifty Plan - Dividend
LIC MF Index Fund - Nifty Plan - Growth
Birla Sun Life Index Fund - Dividend
Birla Sun Life Index Fund - Growth
HDFC Index Fund - Nifty Plan
ICICI Prudential Index Fund
SBI Magnum Index Fund - Dividend

Benchmark
Index
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty

55

17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35

Index Funds as of March 2009

SBI Magnum Index Fund - Growth
Franklin India Index Fund - NSE Nifty Plan - Dividend
UTI Nifty Fund - Dividend
UTI Nifty Fund - Growth
PRINCIPAL Index Fund - Dividend
PRINCIPAL Index Fund - Growth
Benchmark S&P CNX 500 Fund - Dividend
Benchmark S&P CNX 500 Fund - Growth
Franklin India Index Fund - BSE Sensex Plan - Dividend
Franklin India Index Fund - BSE Sensex Plan - Growth
Tata Index Fund - Sensex Plan - Option A
LIC MF Index Fund - Sensex Advantage Plan - Div
LIC MF Index Fund - Sensex Advantage Plan - Growth
LIC MF Index Fund - Sensex Plan - Dividend
LIC MF Index Fund - Sensex Plan - Growth
HDFC Index Fund - Sensex Plan
HDFC Index Fund - Sensex Plus Plan
UTI Master Index Fund - Dividend
UTI Master Index Fund - Growth

S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
S&P Nifty
CNX500
CNX500
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex
BSE Sensex

Exchange Traded Funds

An Exchange Traded Fund (ETF) is a type of Investment Company whose investment
objective is to achieve similar returns as in case of a particular market index. An ETF is
similar to an index fund, but the ETFs can invest in either all of the securities or a
representative sample of securities included in the index. Importantly, the ETFs offer a onestop exposure to a diversified basket of securities that can be traded in real time like an
individual stock. ETFs first came into existence in USA in 1993. Some of the popular ETFs
are: SPDRs (Spiders) based on the S&P 500 Index, QQQs (Cubes) based on the Nasdaq100 Index, iSHARES based on MSCI Indices, TRAHK (Tracks) based on the Hang Seng
Index and DIAMONDs based on Dow Jones Industrial Average (DJIA).
Like index funds, ETFs are also passively managed funds wherein subscription/redemption of
units implies exchange with underlying securities. These being exchange traded, units can be
bought and sold directly on the exchange, hence, cost of distribution is much lower and the
reach is wider. These savings are passed on to the investors in the form of lower costs. The
structure of ETFs is such that it protects long-term investors from inflows and outflows of
short-term investor. ETFs are highly flexible and can be used as a tool for gaining instant
exposure to the equity markets.
The first ETFs in India, based on Nifty 50, were the Nifty Benchmark Exchange Traded
Scheme (Nifty BeES). This was launched by Benchmark Mutual Fund in December 2001. It is
bought and sold like any other stock on NSE. Over the years more and more ETFS have
been introduced. As on October 2008 there were 15 Exchange trade funds in India, out of

56

which 5 are gold exchange traded funds. The various ETFs are detailed below. As on March
2009 there were 12 ETFs in India.
List of Exchange traded Funds in India:
Exchange Traded Funds (ETFs)
1

BANKBEES

Benchmark Asset Management Company Pvt. Ltd.

2
3

JUNIORBEES
UTISUNDER

Benchmark Mutual Fund-Nifty Junior Benchmark ETF

UTI Mutual Fund

4
5
6

LIQUIDBEES
NIFTYBEES
KOTAKPSUBK
PSUBNKBEES

Benchmark Asset Management Company Private Limited

Benchmark Mutual Fund
Kotak Mahindra Mutual Fund
Benchmark Mutual Fund - PSU Bank Benchmark Exchange
Traded Scheme.
Reliance Mutual Fund -Banking Exchange Traded Fund (ETF)

7
8
9

RELBANK
QNIFTY
SHARIABEES

Benchmark Mutual Fund - Shariah Benchmark Exchange Traded

Scheme (ETF)

ICICI SPICE

ICICI SENSEX Exchange Traded Fund

Kotak Sensex ETF

Kotak SENSEX Exchange Traded Fund

10
11
12

Quantum Index Fund -Exchange Traded Fund (ETF)

Gold Exchange Traded Fund

A gold exchange traded fund unit is like mutual fund units whose underlying asset is Gold and
is held in demat form. It is typically an Exchange traded Mutual Fund unit which is listed and
traded on a stock exchange. Every gold ETF unit is representative of a definite quantum of
pure gold and the traded price of the gold unit moves in tandem with the price of the actual
gold metal. The GETF aims at providing returns which closely correspond to the returns
provided by Gold. In India gold ETFs came about in the year 2007, the first being Gold Bees.
This Gold fund was introduced in India by Benchmark Asset Management Company. It offers
investors an innovative, cost-efficient and secure way to access the gold market. As on March
2009 there were 5 Gold ETFs in India.

1 GOLDBEES

GOLD ETFs on NSE

Benchmark Mutual Fund - Gold Benchmark Exchange Traded
Scheme

2 GOLDSHARE UTI Mutual Fund - UTI Gold Exchange Traded Fund

KOTAKGOLD Kotak Mutual Fund - Gold Exchange Traded Fund
3
4 RELGOLD
Reliance Mutual Fund - Gold Exchange Traded Fund
5 QGOLDHALF

Quantum Gold Fund -Exchange Traded Fund (ETF)

57

STOCK MARKET INDICATORS

Market Capitalisation
Market capitalization is defined as value of listed shares on the countrys exchanges. It is
computed using the following formula:
Market Capitalisation= Share price * Number of outstanding shares.
To compute the market capitalization of a particular company, we multiply the number of
shares with the market price of the share. Here the number of shares refers to the issue size
of the stock.
For e.g. Market capitalization of XYZ Company = 10,00,000 (No. of outstanding shares) x 20
(share price) = Rs. 2,00,00,000/-. Thus the market capitalization of XYZ Co. = Rs. 20000000/. Similarly, to compute the market capitalization of companies listed on an Exchange we sum
total the market capitalization of all the companies traded on the Exchange.

Turnover
Turnover for a share is computed by multiplying the traded quantity with the traded price at
which the trade takes place. Similarly, to compute the Turnover of the companies listed at the
Exchange we sum total the traded value of all the companies traded on the Exchange.

Turnover Ratio
The liquidity of the market can be gauged by the turnover ratio which equals the total value of
shares traded/turnover on a countrys stock exchange divided by stock market capitalization.
Turnover Ratio is a widely used measure of trading activity and measures trading relative to
the size of the market. Turnover divided by Market Capitalisation gives the turnover ratio.

Market Capitalisation Ratio

Market Capitalisation Ratio is computed by dividing market capitalization with the GDP of the
country. This ratio has improved significantly in India in recent years. At the end of year
2001,the market capitalization ratio stood at 23.1 and this has significantly increased to
around 65% at end of March 2009.

Traded Value Ratio

Traded value ratio is computed by dividing traded value/turnover by GDP of the country.

58

Index Movements
Through the movement of index, the investors/market participants can gauge market
performance.
Meaning
An index is a number which measures the change in a set of values over a period of time. A
stock index represents the change in value of a set of stocks which constitute the index. More
specifically, a stock index number is the current relative value of a weighted average of the
prices of a pre-defined group of equities. It is a relative value because it is expressed relative
to the weighted average of prices at some arbitrarily chosen starting date or base period. The
starting value or base of the index is usually set to a number such as 100 or 1000. For
example, the base value of the Nifty was set to 1000 on the start date of November 3, 1995.
A good stock market index is one which captures the behavior of the overall equity market. It
should represent the market, it should be well diversified and yet highly liquid. Movements of
the index should represent the returns obtained by "typical" portfolios in the country.
A market index is very important for its use as a barometer for market behavior, as a
benchmark portfolio performance, as an underlying in derivative instruments like index
futures, and in passive fund management by index funds
Economic Significance of Index Movements
How do we interpret index movements? What do these movements mean? They reflect the
changing expectations of the stock market about future dividends of the corporate sector. The
index goes up if the stock market thinks that the prospective dividends in the future will be
better than previously thought. When the prospects of dividends in the future become
pessimistic, the index drops. The ideal index gives us instant readings about how the stock
market perceives the future of corporate sector.
Every stock price moves for two possible reasons:
1. News about the company (e.g. a product launch, or the closure of a factory)
2. News about the country (e.g. budget announcements)
The job of an index is to purely capture the second part, the movements of the stock market
as a whole (i.e. news about the country). This is achieved by averaging. Each stock contains
a mixture of two elements - stock news and index news. When we take an average of returns
on many stocks, the individual stock news tends to cancel out and the only thing left is news
that is common to all stocks. The news that is common to all stocks is news about the
economy. That is what a good index captures. The correct method of averaging is that of
taking a weighted average, giving each stock a weight proportional to its market
capitalization.

59

Example: Suppose an index contains two stocks, A and B. A has a market capitalization of
Rs.1000 crore and B has a market capitalization of Rs.3000 crore. Then we attach a weight of
1/4 to movements in A and 3/4 to movements in B.
INDEX CONSTRUCTION ISSUES
A good index is a trade-off between diversification and liquidity. A well diversified index is
more representative of the market/economy. However there are diminishing returns to
diversification. Going from 10 stocks to 20 stocks gives a sharp reduction in risk. Going from
50 stocks to 100 stocks gives very little reduction in risk. Going beyond 100 stocks gives
almost zero reduction in risk. Hence, there is little to gain by diversifying beyond a point. The
more serious problem lies in the stocks that we take into an index when it is broadened. If the
stock is illiquid, the observed prices yield contaminated information and actually worsen an
index.
Types of indexes
Most of the commonly followed stock market indexes are of the following two types: Market
capitalization weighted index or free float market capitalisation weighted index.
Market Capitalisation Weighted Index
In a market capitalization weighted index, each stock in the index affects the index value in
proportion to the market value of all shares outstanding. A price weighted index is one that
gives a weight to each stock that is proportional to its stock price. Indexes can also be equally
weighted. Recently, major indices in the world like the S&P 500 and the FTSE-100 have
shifted to a new method of index calculation called the "Free float" method. We take a look at
a few methods of index calculation.
Market capitalization weighted index calculation
In the example below we can see that each stock affects the index value in proportion to the
market value of all the outstanding shares. In the present example, the base index = 1000
and the index value works out to be 1002.60

Company
Grasim Inds
Telco
SBI
Wipro

Current Market capitalization

(Rs. Lakh)
1,668,791.10
872,686.30
1,452,587.65
2,675,613.30

Base Market capitalization

(Rs. Lakh)
1,654,247.50
860,018.25
1,465,218.80
2,669,339.55

60

Bajaj
660,887.85
662,559.30
Total
7,330,566.20
7,311,383.40
1. Price weighted index: In a price weighted index each stock is given a weight
proportional to its stock price.
2. Market capitalization weighted index: In this type of index, the equity price is
weighted by the market capitalization of the company (share price * number of
outstanding shares). Hence each constituent stock in the index affects the index
value in proportion to the market value of all the outstanding shares. This index
forms the underlying for a lot of index based products like index funds and index
futures. Table 2.1 gives an example of how market capitalization weighted index is
calculated.
In the market capitalization weighted method,

where:
Current market capitalization = Sum of (current market price * outstanding shares) of all
securities in the index.
Base market capitalization = Sum of (market price * issue size) of all securities as on base
date.
3. Free Float Market Capitalisation Weighted Index: In this type of index, the market
capitalization is calculated as per below mentioned formulae:Free Float Market Cap = Issue Size * Price *

Investible Weight Factor

The free float factor (Investible Weight Factor IWF) for each company in the index is
determined based on the public shareholding of the companies as disclosed in the
shareholding pattern submitted to the stock exchanges by these companies. Free float factor
for each company in the index is updated based on the shareholding pattern submitted on a
quarterly basis by companies to the stock exchanges.
Thus, for calculating Free Float Market Capitalisation of a stock , the free-float method
excludes following categories:

Government holding in the capacity of strategic investor

Shares held by promoters through ADR/GDRs
Strategic stakes by corporate bodies/Individuals (Resident, Non-resident and
Foreign nationals)/H.U.F

61

Investments under FDI category

Equity held by associate/group companies (cross-holdings)

Thus, the Free Float market capitalisation is calculated in the following manner:
Computation of Free Float Market Capitalisation

Issue Size
Company
ABB Ltd.
ACC Ltd.
Ambuja Cement Ltd.
Axis Bank Ltd.
Bharti Airtel Ltd.
TOTAL

(Rs. Lakh)
2,119.08
1,876.90
15,228.09
3,594.42
18,983.25

Price
749.9
829.05
96.9
721.6
802.95

Free Float
MCap*
Investible
Weight
Factor
(Rs. Lakh)
0.48
762767.08
0.54
840263.73
0.54
796825.04
0.58 1504365.41
0.33 5030058.19
8934279.46

*Free Float Market Cap = Issue Size * Price * Investible Weight Factor (free float
factor)
Thus, in the free float market capitalisation method, Index is calculated in the following
manner.
Index =

Free float Current Market Capitalisation

__________________________________
Free Float Base Market Capitalisation

X Base Value

REFORMS IN INDIAN SECURITIES MARKETS

There have been substantial regulatory, structural, institutional and operational changes in
the securities industry. These have been brought in with the objective of improving market
efficiency, enhancing transparency, preventing unfair trade practices and bringing the Indian
market up to the international standards. The following paragraphs list the principal reform
measures undertaken since 1992.
Demutualisation: Historically, brokers owned, controlled and managed the stock exchanges.
In case of disputes, integrity of the exchange suffered. Therefore regulators focused on
reducing the dominance of trading members in the management of stock exchanges and
advised them to reconstitute their governing councils to provide for at least 50% non-broker
representation, management and trading membership would be segregated from one
another. A few exchanges have already initiated demutualisation process. NSE, however,

62

adopted a pure demutualised governance structure where ownership, management and

trading are with three different sets of people. This completely eliminates any conflict of
interest and helped NSE to aggressively pursue policies. As of 2008, there are 19
demutualised stock exchanges in India.
Screen Based Trading: Prior to setting up of NSE, the trading on stock exchanges in India
used to take place through an open outcry system. In the open outcry system, traders shout
and resort to signals on the trading floor of the exchange which consist of several notional
trading posts of different securities. A member (or his representative) wishing to buy or sell a
certain security reaches the trading post where the security is traded. Here he comes in
contact with others interest in transacting in that security. Buyers make their bids and sellers
make their offers and bargains are closed at mutually agreed upon prices. This system did
not allow immediate matching or recording of trades. This was time consuming and imposed
limits on trading.
In order to provide efficiency, liquidity and transparency, NSE introduced a nation-wide online fully-automated screen based trading system (SBTS). The SBTS replaced the trading
ring by the computer screen and distant participants, geographically separated, can trade
simultaneously at high speeds. In this system a member can punch into the computer,
quantities of securities and the prices at which he desires to transact and the transaction is
executed as soon as it finds a matching sale or buy order from a counter party. It allows a
large number of participants, irrespective of their geographical locations, to trade with one
another simultaneously, improving the depth and liquidity of the market. Given the efficiency
and cost effectiveness delivered by the NSEs trading system, it became the leading stock
exchange in the country in its very first year of operation. This forced the other stock
exchanges to adopt SBTS. As a result, open out-cry system has disappeared from India.
Today, India can boast that almost 100% trading takes place through electronic order
matching.
Technology has been harnessed to carry the trading platform to the premises of brokers. NSE
carried the trading platform further to the PCs in the residence of investors through the
internet and to hand-held devises through WAP for convenience of mobile investors. This has
made a huge difference in terms of equal access to investors in a geographically vast country
like India.
Trading and Settlement Cycle: Initially, the trading cycle varied from 14 days for specified
securities to 30 days for others and settlement took another fortnight. The exchanges,
however, continued to have different weekly trading cycles, which enabled shifting of
positions from one exchange to another. Rolling settlement on T+5 basis was introduced in
respect of specified scrips reducing the trading cycle to one day. It was made mandatory for
all exchanges to follow a uniform weekly trading cycle in respect of scrips not under rolling
settlement. All scrips moved to rolling settlement from December 2001. The settlement period
has been reduced progressively from T+5 to T+3 days. Currently T+2 day settlement cycle is
being followed.

63

Depositories Act: The earlier settlement system gave rise to settlement risk. This was due to
the time taken for settlement and due to the physical movement of paper. Further, the transfer
of shares in favour of the purchaser by the company also consumed considerable amount of
time. To obviate these problems, the Depositories Act, 1996 was passed to provide for the
establishment of depositories in securities with the objective of ensuring free transferability of
securities with speed and accuracy. This act brought in changes by (a) making securities of
public limited companies freely transferable subject to certain exceptions; (b) dematerialising
of securities in the depository mode; In order to promote dematerialisation, the regulator has
been promoting settlement in demat form in a phased manner in an ever-increasing number
of securities.
The stamp duty on transfer of demat securities has been waived. There are two depositories
in India, viz. NSDL and CDSL. They have been set up to provide instantaneous electronic
transfer of securities. All actively traded scrips are held, traded and settled in demat form.
Demat settlement accounts for over 99.9% of turnover settled by delivery. This has eliminated
the bad deliveries and associated problems.
To prevent physical certificates from sneaking into circulation, it has been mandatory for all
new securities issued should be compulsorily traded in dematerialised form. The admission to
a depository for dematerialisation of securities has been made a prerequisite for making a
public or rights issue or an offer for sale. It has also been made compulsory for public listed
companies making IPO of any security for Rs. 10 crore or more only in dematerialised form.
Derivatives Trading: To assist market participants to manage risks better through hedging,
speculation and arbitrage, SC(R)A was amended in 1995 to lift the ban on options in
securities. However, trading in derivatives took off much later after the suitable legal and
regulatory framework was out in place. The market presently offers index futures and index
options on the benchmark indices of NSE and BSE and various other indices and single stock
futures and options.
Risk Management: With a view to avoid any kind of market failures, the regulator/exchanges
have developed a comprehensive risk management system. This system is constantly
monitored and upgraded. It encompasses capital adequacy of members, adequate margin
requirements, limits on exposure and turnover, indemnity insurance, on-line position
monitoring and automatic disablement, etc. They also administer an efficient market
surveillance system to detect and prevent price manipulations. The clearing corporation has
also put in place a system which tracks online real time client level portfolio based upfront
margining. Exchanges have set up trade/settlement guarantee funds for meeting shortages
arising out of non-fulfillment/partial fulfillment of funds obligations by the members in a
settlement. As a part of the risk management system, index based market wide circuit
breakers have also been put in place.
The anonymous electronic order book ushered in by the NSE did not permit members to
assess credit risk of the counter-party necessitated some innovation in this area. To address
this concern, NSE had set up the first clearing corporation, viz. National Securities Clearing
Corporation Ltd. (NSCCL), which commenced its operations in April 1996. The NSCCL

64

assured the counterparty risk of each member and guaranteed financial settlement. NSCCL
established a Settlement Guarantee Fund (SGF). The SGF provides a cushion for any
residual risk and operates like a self-insurance mechanism wherein members contribute to
the Fund. In event of failure of a trading member to meet his obligations, the fund is utilized to
the extent required for successful completion of the settlement. This has eliminated counterparty risk of trading on the Exchange.
Investor Protection: The SEBI Act established SEBI with the primary objective of protecting
the interests of investors in securities and empowers it to achieve this objective. SEBI
specifies that critical data should be disclosed in the specified formats regarding all the
concerned market participants. The
Central Government has established a fund called Investor Education and Protection Fund
(IEPF) in October 2001 for the promotion of awareness amongst investors and protection of
the interest of investors.
DEA, DCA, the SEBI and the stock exchanges have set up investor grievance cells for
redressal of investor grievance. The exchanges maintain investor protection funds to take
care of investor claims. The DCA has also set up an investor education and protection fund
for the promotion of investors awareness and protection of interest of investors. All these
agencies and investor associations are organising investor education and awareness
programmes. In January 2003, SEBI launched a nation-wide Securities Market Awareness
Campaign that aims at educating investors about the risks associated with the market as well
as the rights and obligations of investors. The NSE have also taken special measures for
educating the investors, it conducts seminars, workshops and comes out with advertisement
both in print and electronic media to communicate to the investors.
Globalisation: Indian securities market is getting increasingly integrated with the rest of the
world. Indian companies have been permitted to raise resources from abroad through issue of
ADRs, GDRs, FCCBs and ECBs. Further, foreign companies are allowed to tap the domestic
stock markets.
Indian companies are permitted to list their securities on foreign stock exchanges by
sponsoring ADR/GDR issues against block shareholding. NRIs and OCBs are allowed to
invest in Indian companies. FIIs have been permitted to invest in all types of securities,
including government securities. The investments by FIIs enjoy full capital account
convertibility. They can invest in a company under portfolio investment route upto 24% of the
paid up capital of the company. This can be increased up to the sectoral cap/statutory
ceiling, as applicable to the Indian companies concerned, by passing a resolution of its Board
of Directors followed by a special resolution to that effect by its general body. The Indian
Stock Exchanges have been permitted to set up trading terminals abroad. The trading
platform of Indian exchanges is now accessed through the Internet from anywhere in the
world.
RBI permitted two-way fungibility for ADRs/GDRs, which meant that the investors (foreign
institutional or domestic) who hold ADRs/GDRs can cancel them with the depository and sell

65

the underlying shares in the market. The company can then issue fresh ADRs to the extent of
the shares cancelled. Previously, once a company issued ADR/GDR and if the holder wanted
to obtain the underlying equity shares of the Indian Company, then, such ADR/GDR would be
converted into shares of the Indian Company. Once such conversion took place, it was not
possible to reconvert the equity shares into ADR/GDR. The result was, every time a
conversion took place, companies had to seek Government permission to reissue the
depositories.
Foreign investment in stock exchanges
Foreign Investment upto 49% has been allowed, in December, 2006, in infrastructure
companies in the securities markets, viz. stock exchanges, depositories and clearing
corporations, with separate Foreign Direct Investment (FDI) cap of 26% and Foreign
Institutional Investment (FII) cap of 23%.
PAN as the sole identification number
The need for a Unique Identification Number (UIN) for market participants in the securities
markets was felt in the interest of enforcement action. Presently, a person has variety of
identification numbers such as Permanent Account Number (PAN) from CBDT, Depository
Account Numbers from respective depositories, Bank Account Numbers from respective
banks, MAPIN from SEBI, Unique Client Code from Exchanges, Director Identification
Number from MCA, etc. and there is no arrangement to link these numbers.
It was felt that the PAN issued by the CBDT could be a UIN for market participants. A PAN
could identify all participants and the account managers (Depositories, Banks, Exchanges,
Insurance Companies, Pension Fund Managers, Post Offices, and Intermediaries etc.) must
use these numbers. Following a budget announcement to this effect in the budget of 2007-08,
SEBI has declared PAN the sole identification number for all transactions in securities market.
It is an investor friendly measure as he does not have to maintain different identification
numbers for different kinds of transactions/different segments in financial markets.
In the Budget of 2008-09 it was proposed that the requirement of PAN be extended to all
transactions in the financial market subject to suitable threshold exemption limits.
IPO grading
SEBI has made it compulsory for companies coming out with IPOs of equity shares to get
their IPOs graded by at least one credit rating agency registered with SEBI from May 1, 2007.
This measure is intended to provide the investor with an informed and objective opinion
expressed by a professional rating agency after analyzing factors like business and financial
prospects, management quality and corporate governance practices etc. The grading would
be disclosed in the prospectus, abridged prospectus and in every advertisement for IPOs.
New derivative products
The Mini derivative Futures & Options contract was introduced for trading on S&P CNX Nifty
on January 1, 2008 while the long term option contracts on S&P CNX Nifty were introduced
for trading on March 3, 2008. It has been found that globally overall market liquidity and
participation generally increases with introduction of mini contracts.

66

Volatility Index
With rapid changes in volatility in securities market from time to time, a need was felt for an
openly available and quoted measure of market volatility in the form of an index to help
market participants. On January 15, 2008, Securities and Exchange Board of India
recommended Exchange to construct and disseminate the volatility index. Volatility Index is a
measure, of the amount by which an underlying Index is expected to fluctuate, in the near
term, (calculated as annualised volatility, denoted in percentage e.g. 20%) based on the order
book of the underlying index options. On April 08, 2008, NSE launched the Volatility Index,
India VIX, based on the Nifty 50 Index Option prices. From the best bid-ask prices of Nifty 50
Options contracts, a volatility figure (%) is calculated which indicates the expected market
volatility over the next 30 calendar days. The India VIX is a simple but useful tool in
determining the overall volatility of the market
Launch of Securities Lending & Borrowing Scheme
A Securities Lending & Borrowing mechanism allows market participants to take short
positions effectively with less cost. It also provides the holder of idle securities with an
alternative to earn a return on such holdings without risk.
The Exchange launched a Securities Lending & Borrowing Scheme (SLBS) on April 21, 2008.
The Exchange provides automated, screen based, order matching platform to participants to
execute lending and borrowing transactions. Securities available for trading in F&O segment
of the Exchange have been initially permitted to trade in this segment. The SLBS was revised
from December 22, 2008 to increase the trading time & the lending/borrowing period.
Launch of Currency Futures in India
On August 29, 2008, NSE launched trading in currency future contracts for the first time in
India followed by BSE on October 1, 2008 and MCX-SX on October 7, 2008. To start with 12
monthly future contracts on the USD-INR pair have been made available for trading. The
minimum lot size has been kept small at USD 1000 and applicable margins are also
comparably very low due to the less volatile nature of the underlying.
Direct Market Access
During April 2008, Securities & Exchange Board of India (SEBI) allowed the direct market
access (DMA) facility to the institutional investors. DMA allows brokers to offer clients direct
access to the exchange trading system through the brokers infrastructure without manual
intervention by the broker. DMA facility gives clients direct control over orders, help in faster
execution of orders, reduce the risk of errors from manual order entry and lend greater
transparency and liquidity. DMA also leads to lower impact cost for large orders, better audit
trails and better use of hedging and arbitrage opportunities through the use of decision
support tools/algorithms for trading.

67

Cross Margining
Many trading members undertake transactions on both the cash and derivative segments of
an Exchange. They keep separate deposits with the exchange for taking positions in two
different segments. In order to improve the efficiency of the use of the margin capital by
market participants and as in initial step towards cross margining across cash and derivatives
markets SEBI allowed Cross Margining benefit in May 2008.
In December 2008, SEBI extended the cross margin facility across Cash and F&O segment
to all the market participants.
On February 9, 2009, Cross margining was made available for positions across index futures
to stock/stock futures and stock futures to stocks. It is available to all categories of market
participant and benefit is computed on online real time basis.
NSE e-bids
NSE e-bids, NSEs latest offering for credit markets, is an open bidding platform for FIIs to bid
for allotments under the overall FII debt limits. After a one time signup, FIIs can bid for
allotments and get updates of results.
ASBA
To make the existing public issue process more efficient, SEBI introduced a supplementary
process of applying in public issues, viz, the Applications Supported by Blocked Amount
(ASBA) in July 2008. ASBA is an application containing an authorization to block the
application money in the bank account, for subscribing to an issue. If an investor is applying
through ASBA, his application money is debited from the bank account only if his/her
application is selected for allotment after the basis of allotment is finalized, or the issue is
withdrawn/failed .In case of rights issue his application money is debited from the bank
account after the receipt of instruction from the registrars. The ASBA process is available in
all public issues made through the book building route. In September 2008, the ASBA facility
was extended to Rights Issue.
Corporate Bond Markets
The Government and regulators have well recognized that a well developed corporate bond
market is essential for financial system efficiency, stability and overall economic growth. A
well functioning bond market provides for financial diversification and facilitates necessary
financing not only for AAA-rated corporates but also less well known, sub-investment grade
corporates and infrastructure developers. Considering that this market is not well developed
in the country, the Government had set up a High-Level Expert Committee on Corporate
Bonds and Securitisation (Patil Committee) to look in to legal, regulatory, tax and market
design issues in the development of the corporate bond market. The Committee submitted its
report to the Government in December, 2005. The Budget of 2006-07 announced that the
Government has accepted the recommendations of the Report and that steps would be taken
to create a single, unified exchange-traded market for corporate bonds. The measures
already taken in respect of implementation of the recommendations of the Patil Committee

68

include:
(a) Amendment to the Securities Contracts (Regulation) Act, 1956 to include securitized
instruments within the ambit of "securities".
(b) Amendment to the RBI Act to empower RBI to develop and regulate market for Repos in
corporate bonds
(c) Enhancement of limit of FII Investment in corporate debt from US$ 0.5 Bn to US$ 1.5 Bn
and further to US $ 3 Bn
(d) operationalising of trade reporting and trading platforms for corporate bonds at the major
exchanges
(e) Waiver of TDS from corporate bonds traded on exchanges.
CBCS - Corporate Bond Clearing and Settlement
CBCS is a corporate bond reporting and integrated clearing system. The platform supports
trade reporting system where both sides of a corporate bond trade report the deal to the
platform. The deal can then be cleared through a settlement system if required. CBCS fills an
important need in the corporate bond clearing and settlement space. As transaction volumes
rise in the corporate bond market, participants will need to use common clearing and
settlement facilities in order to reduce risks and increase settlement efficiency.

69

CHAPTER 5
MONEY MARKET
MEANING
Money market refers to a mechanism whereby on the one hand borrowers manage to obtain
short term loanable funds and on the other, lenders succeed in getting creditworthy borrowers
for their money. In any money market, commercial banks are the most important lenders.
These banks are however not merely the lenders of money but also create credit. The central
banks role is important as the controller of credit. Money market is not a single market but a
collection of markets for several instruments. It is a wholesale market for short-term debt
instruments.

INDIAN MONEY MARKET

The Indian money market is not an integrated unit. It consists of the organised and
unorganized sector. The organised sector is fairly integrated. Both nationalized and private
sector commercial banks constitute the core of the organised sector. The foreign banks,
cooperative banks, the Reserve bank of India (Indias central bank), finance companies and
mutual funds are some institutions which operate in the organised sector. The unorganized
sector comprises of indigenous bankers, moneylenders and unregulated non-bank financial
intermediaries such as chit funds, nidhis etc.

PLAYERS IN THE MONEY MARKET

RBI
Mutual
Funds

PSUs

Provident
Funds

Discount
&
Finance
House

Players of
Money
Market

State
Govt.

Banks

NBFCs

Corporate
Investors

70

ROLE OF RBI IN MONEY MARKET

RBI is the most important constituent of the money market. The market comes within the
direct purview of RBI Regulations. RBI ensures that liquidity and short term interest rates are
maintained at levels consistent with the monetary policy objectives of maintaining price
stability. Further it ensures an adequate flow of credit to the productive sectors of the
economy.

MONEY MARKET INSTRUMENTS

Some instruments of the Indian money market are explained below. The money market
products are short term products having maturities, typically within a year.

Call Money Market

The call money market is a market for very short term funds. The funds are lent for one day or
from Saturday to Monday (call/overnight money) or for a period upto 14 days (notice money)
in the call/notice market. The call money market is a non-collateralized interbank dealer
market for overnight funds. This market involves credit risk, for there is no collateral.
However, the government has not allowed any important bank in India to fail. Hence, the
credit risk is negligible. The call money market is a highly liquid market with the liquidity being
exceeded only by cash. Call money is required mostly by banks. Commercial banks borrow
money from other banks to maintain a minimum cash balance know as the cash reserve
requirement. The RBI stipulates this from time to time. CRR refers to the cash that banks
have to maintain the Reserve Bank.
The interest rate paid on call loans is called the call rate. It is a highly volatile rate and varies
from day-to-day, hour to hour and sometimes even minute to minute. It is very sensitive to
changes in the demand for and supply of call loans. Till 1973, the call rate was determined by
the market forces of demand and supply but on December 1973 when the call rate touched a
high of 30 percent due to tight credit policy wherein the bank rate was raised and refinance
and rediscount facilities were discontinued. As a result, many banks defaulted and the Indian
Banking Association (IBA) started regulating the call rate by fixing a ceiling from time to time.
From 1989 (May 1), call rates were freed from administrative ceiling. Now the rate is freely
determined by the demand and supply forces in the call money market. NSE Mibor (Mumbai
Interbank Offer Rate) and Reuters Mibor is the reference rate for the call money market.
These rates are determined on a daily basis.

Term Money Market

In the Term Money market, funds lent/borrowed for periods more than 14 days to 1 year. In
India only bench mark is NSE MIBOR and the market is very thin. Some other bench marks
are 91/182/364 days Treasury bills and short term OIS.

71

Repo Market
Repo is money market instrument which helps in collateralised short-term borrowing and
lending through sale/purchase operations in debt instruments. Under a repo transaction,
securities are sold by their holder to an investor with an agreement to repurchase them at a
predetermined rate and date.
Under Reverse Repo transaction, securities are purchased with a simultaneous commitment
to resell at a predetermined rate and date. Borrowing and lending is done by the central bank,
Reserve Bank of India (RBI), as part of the conduct of monetary policy. In many countries, the
policy rate of the central bank is unambiguously defined. In India, there are two distinct rates
at which the central bank borrows and lends the repo rate and the reverse repo rate. These
rates are generally quite far apart; there is a substantial bid-offer spread.

CBLO
Collateralized Borrowing and Lending Obligation (CBLO), a money market instrument
approved by RBI, is a product developed by CCIL for the benefit of the entities who have
either been phased out from inter bank call money market or have been given restricted
participation in terms of ceiling on call borrowing and lending transactions and who do not
have access to the call money market. CBLO is a discounted instrument available in
electronic book entry form for the maturity period ranging from one day to ninety Days (can be
made available up to one year as per RBI guidelines).

T-Bills
Treasury bills are short term instruments issued by the Reserve Bank on behalf of the
government to tide over short term liquidity shortfalls. This instrument is used by the
government to raise short term funds to bridge seasonal or temporary gaps between its
receipts (revenue and capital) and expenditure. They form the most important segment of
money market not only in India, but all over the world. T-bills are repaid at par on maturity. Tbills in India have maturities of 3 months, 6 months and 12 months, and are issued. T-Bills
are negotiable securities, highly liquid as they are of shorter tenure, have an assured yield,
low transaction cost. T-bills are available for a minimum amount of Rs.25,000 and in multiples
thereof. RBI, banks, mutual funds, primary dealers, provident funds, corporates are some of
the participants in the T-Bill market.

Certificate of Deposits (CDs)

The RBI introduced Certificate of Deposits (CDs) in June 1989. CD is a short term,
negotiable instrument, issued at discount and the face value is payable at maturity by the
issuing bank and development financial institutions. CDs are short term deposit instruments
for a period ranging from three months to one year. Further, the minimum amount of a CD is
fixed at Rs.25 Lakh in the denomination of Rs.5 Lakh.

72

Commercial Papers (CPs)

The RBI introduced a scheme of Commercial Papers (CPs) in January 1990. CP is a short
term negotiable money market instrument and is issued by creditworthy corporates, primary
dealers and all India financial institutions in the form of a usance promissory note,
redeemable at par to the holder on maturity. The period of CP is 15 days to 365 days from the
date of issue and is issued at discount.

Interest Rate Derivatives

In July 1999, the RBI laid down guidelines to introduce two money market derivatives: interest
rate swaps and forward rate agreements (FRAs).
Both are over the counter derivatives. These contracts are negotiated between counter
parties and tailored to meet the needs of their contracts. IRS and FRAs are hedging
instruments and give more depth to the money market and also to enable market participants
to hedge interest rate risk arising on account lending or borrowings made at fixed/variable
interest rates.
An interest rate swap (IRS) is a financial contract between two parties, exchanging or
swapping a stream of interest payments for a notional amount during a specified period. Such
contract involves exchange or swapping of a fixed to floating or floating to fixed interest
rate. If participants feel that rates will fall, they could receive fixed and pay floating rates. The
converse is beneficial if interest rates rise.
A forward rate agreement (FRA) is a financial contract between two parties where the
interest at a predetermined rate for a notional principal amount and for a specified period is
exchanged at the market interest rate prevailing at the time of settlement. The market interest
rate is an agreed benchmark/reference rate prevailing on the settlement date. In India, the
NSE Mibor/Reuters/CCIL is used as a reference rate.

Link between the money market and Debt Market

The money market is a market dealing in short-term debt instruments (upto one year) while
the debt market is a market for long-term debt instruments (more than one year). The money
market supports the long term debt market by increasing the liquidity of securities. A
developed money market is a prerequisite for the development of a debt market.

73

CHAPTER 6
FOREX MARKET
MEANING
The foreign exchange market (currency, forex, or FX) is where currency trading takes place.
Presently, the FX market is one of the largest and most liquid financial markets in the world,
and includes trading between large banks, central banks, currency speculators, corporations,
governments, and other financial institutions.
Base Currency / Terms Currency: In foreign exchange markets, the base currency is the
first currency in a currency pair. The second currency is called as the terms currency.
Exchange rates are quoted in per unit of the base currency. E.g. the expression Dollar
Rupee, tells you that the Dollar is being quoted in terms of the Rupee. The Dollar is the base
currency and the Rupee is the terms currency.
Exchange rates are constantly changing, which means that the value of one currency in terms
of the other is constantly in flux. Changes in rates are expressed as strengthening or
weakening of one currency vis--vis the second currency. Changes are also expressed as
appreciation or depreciation of one currency in terms of the second currency. Whenever the
base currency buys more of the terms currency, the base currency has strengthened /
appreciated and the terms currency has weakened / depreciated. Example: If Dollar Rupee
moved from 43.00 to 43.25, it signifies that the Dollar has appreciated and the Rupee has
depreciated.
Geographically, the international foreign exchange market extends from Tokyo and Sydney in
the East through Hong Kong, Singapore, Bahrain, the European centers, London, New York
and to the west coast of the United States. It extends though all the time zones and if effect is
a 24 hour market through the week.
The bulk of the Foreign exchange market is OTC-over the counter i.e. trades are effected on
telephone/telex/swift through electronic dealing systems or intermediate brokers and not on
the floor of an exchange.

PARTICIPANTS IN FX MARKET
1) Non Bank entities i.e. the customers who wish to exchange currencies to meet
contractual obligations i.e. arising out of exports, imports, remittances etc.
2) Commercial Banks which exchange currencies to meet client requirements.
3) Central Banks, which in most of the countries are charged with the responsibility of
maintaining the external value of the currency of the country. Apart from the

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intervention, central banks deal in foreign exchange market for the purpose of
Exchange Rate Management and Reserve Management.
4) Exchange brokers play a very important role in the foreign market.
5) Speculators buying and selling currencies in the hope of profiting from price
movements.

PARTICIPANTS IN THE INDIAN FOREX MARKET

Apart from the users of the market i.e. the customers, other entities/institutions who wish to
deal in the Indian foreign exchange market require registrations.

Restricted Money Changers (RMC)

This is a license issued by RBI which permits them to only buy foreign exchange in the form
of Currency Notes and Travelers Cheque. Normally departmental stores and star hotels
witness heavy movement of foreign tourists obtain these licenses.

Full Fledged Money Changers (FFMC)

This is a license issued by RBI which permits them to buy and sell foreign exchange in the
form of Currency Notes and Travelers cheque. Normally, travel agencies obtain these
licenses to offer single window service to the travel sector.

Authorised Dealers (AD)

This is a license issued by the Reserve Bank of India, generally to Banks and Financial
institutions authorizing to deal in all types of foreign exchange i.e. Imports, Exports,
Remittances, and Travel Sector etc.
After introduction of FEMA in 2000, all the above categories are referred to as Authorised
Persons (AP) by RBI.

Brokers
Brokers wishing to operate in the Indian Foreign exchange Market need to get themselves an
accredited with FEDAI (Foreign Exchange Dealers Association of India).

ISO CODES
Foreign exchange markets are global. To work effectively, standardization of certain elements
is essential. One aspect has been the creation of a standard three letter abbreviation of each
currency. These are created by the International organisation for standardization and are
referred to as ISO codes. The ISO codes of some of the more widely traded currencies are:

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COUNTRY

CURRENCY

ISO CODE

Australia Dollar
Canada Dollar
Europe
Great Britain
India
Japan
Saudi Arabia
Singapore
Switzerland
United States

AUD
CAD
Euro
Pound
Rupee
Yen
Riyal
Dollar
Franc
Dollar

EUR
GBP
INR
JPY
SAR
SGD
CHF
USD

In India, there is an OTC forex market and Exchange traded forex market. OTC market has
two components- Forex Spot and Derivatives. Trading in the currency futures on the USDINR pair was launched on August 29, 2008 at NSE (stock exchange), this marked the
beginning of currency futures in India on Exchanges.

FOREX SPOT TRADING

Foreign exchange spot trading is buying one currency with a different currency for immediate
delivery, rather than for future delivery.
Foreign exchange spot trading is buying one currency with a different currency for immediate
delivery. The standard settlement convention for Foreign Exchange Spot trades is T+2 days,
i.e., two business days from the date of trade execution. An exception is the USD/CAD (US
Canadian Dollars) currency pair which settles T+1. Rates for days other than spot are always
calculated with reference to spot rate.

FOREX DERIVATIVE
Forward Contract
A foreign exchange forward is a contract between two counterparties to exchange one
currency for another on any date after spot. In this transaction, money does not actually
change hands until some agreed upon future date. The duration of the trade can be a few
days, months or years. For most major currencies, three business days or more after deal
date would constitute a forward transaction.

Non Deliverable Forwards

A non-deliverable forward contract is a foreign currency financial derivative instrument. An
NDF differs from a normal foreign currency forward contract in that there is no physical
settlement of two currencies at maturity. Rather, based on the movement of two currencies, a

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net cash settlement will be made by one party to the other. NDFs are commonly used to
hedge local currency risks in emerging markets where local currencies are not freely
convertible, where capital markets are small and undeveloped, and where there are
restrictions on capital movements. Under these conditions, an NDF market might develop in
an offshore financial centre, with contracts settled in major foreign currencies, such as the
U.S. dollar.
There exists a market in forward dollars against rupees in some of the major international
centers. The biggest is probably Singapore. Since actual deliveries of forward rupees cannot
take place in the absence of an offshore rupee market, such forward contracts are known as
NDFs i.e Non deliverable forwards. On maturity of the contract, it is in effect cancelled and
the difference is settled in USD. The participants in the NDF market are speculators and
those who are not permitted to operate in the domestic forward market by exchange control.

FRAs
Forward Rate Agreement (FRA) is an agreement between two parties that determines the
forward interest rate that will apply to an agreed notional principal (loan or deposit amount) for
a specified period. FRAs are basically OTC equivalents of exchange traded short date
interest rate futures, customized to meet specific requirements. FRAs are used more
frequently by banks, for applications such as hedging their interest rate exposures, which
arise from mis-matches in their money market books. FRAs are also used widely for
speculative activities.

Swaps
A forward-type financial derivative contract in which two counterparties agree to exchange
cash flows determined with reference to prices of, say, currencies or interest rates, according
to predetermined rules. At inception, this instrument typically has zero market value, but as
market prices change the swap acquires value.
Interest Rate Swaps: A contract which involves two counter parties to exchange over an
agreed period, two streams of interest payments, each based on a different kind of interest
rate, for a particular notional amount.
Currency Swaps: Currency swap is a contract which commits two counter parties to an
exchange, over an agreed period, two streams of payments in different currencies, each
calculated using a different interest rate, and an exchange, at the end of the period, of the
corresponding principal amounts, at an exchange rate agreed at the start of the contract.

Option Contracts
Options are contracts that give the purchaser of the option the right, but not the obligation, to
buy (a call option) or to sell (a put option) a particular financial instrument or commodity at
a predetermined price (the strike price) within a given time span (American option) or on a
given date (European option). Many options contracts, if exercised, are settled by a cash

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payment rather than by delivery of the underlying assets or commodities to which the contract
relates.
Foreign currency option is an agreement between two parties (the buyer and the seller of the
option) that gives the buyer of the option the right but not obligation to exchange a specified
amount (face value) of one currency for another currency at a nominated foreign exchange
rate on a nominated future date. A foreign currency option usually involves the payment of a
premium a premium (the cost of the option) from the buyer of the option to the seller of the
option. USD-INR currency options were introduced in the Indian market in mid 2003.
The above discussed products trade in the OTC market.

Currency Futures
A futures contract is a standardized contract, traded on an exchange, to buy or sell a certain
underlying asset or an instrument at a certain date in the future, at a specified price. When
the underlying asset is a commodity, e.g. Oil or Wheat, the contract is termed a commodity
futures contract. When the underlying is an exchange rate, the contract is termed a
currency futures contract. In other words, it is a contract to exchange one currency for
another currency at a specified date and a specified rate in the future. Therefore, the buyer
and the seller lock themselves into an exchange rate for a specific value or delivery date.
Both parties of the futures contract must fulfill their obligations on the settlement date.
Currency futures can be cash settled or settled by delivering the respective obligation of the
seller and buyer. All settlements however, unlike in the case of OTC markets, go through the
exchange.

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CHAPTER 7
COMMODITY DERIVATIVES MARKET
MEANING
Commodity markets are markets where raw or primary products are exchanged. These raw
commodities are traded on regulated commodities exchanges, in which they are bought and
sold in standardized contracts. Commodity markets facilitate the trading of commodities such
as gold, silver and agricultural goods.

EVOLUTION OF COMMODITY DERIVATIVE MARKETS IN INDIA

Commodity futures markets have a long history in India. Cotton was the first commodity to
attract futures trading in the country leading to the setting up of the Bombay Cotton Trade
Association Ltd in 1875. The Bombay Cotton Exchange Ltd. was established in 1893
following the widespread discontent amongst leading cotton mill owners and merchants over
the functioning of Bombay Cotton Trade Association.
Subsequently, many exchanges came up in different parts of the country for futures trading in
various commodities. Futures trading in oilseeds started in 1900 with the establishment of the
Gujarati Vyapari Mandali, which carried on futures trade in groundnut, castor seed and cotton.
Futures trading in wheat existed at several places in Punjab and Uttar Pradesh the most
notable of which was the Chamber of Commerce at Hapur, which began futures trading in
wheat in 1913 and served as the price setter in that commodity till the outbreak of the Second
World War in 1939.
Futures trading in bullion began in Mumbai in 1920 and subsequently markets came up in
other centers like Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Calcutta.
Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in raw jute and
jute goods. But organized futures trading in raw jute began only in 1927 with the
establishment of East Indian Jute Association Ltd. These two associations amalgamated in
1945 to form the East India Jute & Hessian Ltd. to conduct organized trading in both raw jute
and jute goods.

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PRODUCTS IN THE COMMODITY DERIVATIVES MARKETS

The products in the commodity derivatives markets can be categorized into Non-Agricultural
Products and Agricultural Products.
Non-Agricultural
Energy (crude oil, natural gas etc.)

Agricultural
Pulses (Chana, moong etc.)

Precious metals (gold, silver)

Base metals (copper, lead etc.)

Grain (Barley, wheat etc.)

Oils and oilseeds (castor oil, cotton seed
and oil)
Spices (cardamom, turmeric etc.)

Ferrous metals (steel, sponge iron etc.)

Polymers (polyethylene, polypropylene, etc.)

Non edible agriculture (raw jute and jute

bags, rubber etc.)
Others (cashew, coffee etc.)

REGULATION AND LEGAL FRAMEWORK

The two important pieces driving the legal and regulatory framework in the commodities
markets are the Essential Commodities Act, 1955 (ECA) and the Forwards Contract
Regulation Act, 1952 (FCRA)
The markets trading the underlying commodities are licensed, regulated and monitored by the
state governments where they are set up.
The overseer of all commodity futures markets, including the national Exchanges, is the
Forward Markets Commission (FMC).
Commodity Exchanges in India
Multi Commodity Exchange of India Ltd., Mumbai
National Commodity & Derivatives Exchange Ltd., Mumbai
National Multi Commodity Exchange of India Limited., Ahmedabad
Ahmedabad Commodity Exchange Ltd., Ahmedabad
Bikaner Commodity Exchange Ltd., Bikaner
Bhatinda Om & Oil Exchange Ltd., Bhatinda
Bombay Commodity Exchange Ltd., Vashi
Bullion Association Limited., Jaipur
Chamber Of Commerce, Hapur
Central India Commercial Exchange Ltd., Gwalior
Cotton Association of India, Mumbai
East India Jute & Hessian Exchange Ltd., Kolkata
First Commodity Exchange of India Ltd., Kochi

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Haryana Commodities Ltd., Sirsa

India Pepper & Spice Trade Association., Kochi
Meerut Agro Commodities Exchange Co. Ltd., Meerut
National Board of Trade, Indore
Rajkot Commodity Exchange Ltd., Rajkot
Rajdhani Oils and Oilseeds Exchange Ltd., Delhi
Surendranagar Cotton oil & Oilseeds Association Ltd., Surendranagar
Spices and Oilseeds Exchange Ltd. Sangli
Vijay Beopar Chamber Ltd., Muzaffarnagar

DIFFERENCE BETWEEN COMMODITY AND FINANCIAL

DERIVATIVES

Commodity Derivatives

Financial Derivatives

Physical Settlement

Cash Settlement

Need for Warehousing

No need for ware housing

Variance in quality is an issue

Variance in quality is not an issue.

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CHAPTER 8
INSURANCE MARKET
MEANING
Insurance may be defined as a social device to reduce or eliminate risk of loss to life and
property. Insurance is a scheme which covers large risks by paying small amount of capital.
Insurance can be defined as a legal contract between two parties whereby one party called
the insurer undertakes to pay a fixed amount of money on the happening of a certain event,
which may be certain or uncertain. The other party called as insured, pays a fixed sum known
as premium. The insurer and the insured are also known as the assuror or underwriter and
the assured respectively. The document which embodies the contract is called the policy
Insurance aids in the growth of modern economy. By promoting safety against personal
losses it not only improves the individuals quality of life but also provides smoothness in the
working of the affairs of business and the industry.

CLASSIFICATION OF INSURANCE SECTOR

The insurance sector can be divided into two branches : life insurance and general (nonlife) insurance.
The Insurance Act, 1938, the first comprehensive legislation governing both life and non-life
branches of insurance were enacted to provide strict state control over the insurance
business. An office of the Controller of Insurance also came into existence.

INSURANCE INTERMEDIARIES
The intermediaries associated with the insurance business are agents and surveyors and loss
assessors, brokers, third party administrators and banks.

AGENTS
Agents are just like the retailers of any consumer product who help in selling and distributing
the product. An agent is a person licensed by the Controller of Insurance to do insurance
business. Agents get the license to sell policies of only Life Insurance Company and one nonlife insurance company at a time.

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Surveyors and Loss Assessors

Surveyors and loss assessors are independent professionals appointed by an insurance
company to assess the loss or damage when a claim is notified under a policy issued by
them. An insurance surveyor must be duly licensed by IRDA which has a laid down code of
conduct for them.

Brokers
Brokers are like agents but they can sell policies of several life and non-life insurance
companies at a time. Insurance brokers are professionals who assess risk on behalf of their
clients, provide advice on mitigation of the said risk, identify the optimal insurance policy
structure, bring together the insurer and the insured, carry out the preparatory work for
entering into the insurance contracts, and facilitate processing where claims arise. The IRDA
has allowed brokers to enter insurance industry.

Third Party Administrators

Third Party Administrators (TPAs) are the middlemen in the healthcare delivery chain, which
links physicians, hospitals, clinics, home health, long term care facilities and pharmacies.
These TPAs serve more than insurer at a time and they get a licensed for a period of three
years and after three years they have to be renewed.

Bancassurance
Bancassurance is insurance companies tying up with banks to sell insurance products.
Bancassurance is an innovative distribution channel in India.

PLAYERS IN INSURANCE INDUSTRY

The insurance industry till August 2000 had only two nationalized players : Life Insurance
Corporation (LIC) and General Insurance Corporation (GIC) and its four subsidiaries. This
sector was finally thrown open to the private sector in 2000. The Insurance Regulatory and
Development Authority (IRDA) was set up in 2000 as an autonomous insurance regulator.
The government has entrusted the IRDA with the responsibility for carrying out the reforms in
this sector.

REGULATIONS FOR THE INSURANCE INDUSTRY

The Indian insurance industry is governed by the Insurance Act 1978, the General Insurance
Business (Nationalization) Act, 1972, Life Insurance Corporation Act, 1956 and Insurance
Regulatory and Development Authority Act, 1999.

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CHAPTER 9
CORPORATE ACTIONS
MEANING
Corporate action events are an integral feature of todays capital markets. They take place
whenever changes are made to the capital structure or financial position of an issuer of a
security that affect any of the securities it has issued.
Corporate actions tend to have a bearing on the price of a security. When a company
announces a corporate action, it is initiating a process that will bring actual change to its
securities either in terms of number of shares increasing in the hands on the shareholders or
a change to the face value of the security or receiving shares of a new company by the
shareholders as in the case of merger or acquisition etc. By understanding these different
types of processes and their effects, an investor can have a clearer picture of what a
corporate action indicates about a company's financial affairs and how that action will
influence the company's share price and performance.
Corporate actions are typically agreed upon by a company's Board of Directors and
authorized by the shareholders. Some examples are dividends, stock splits, rights issues,
bonus issues etc.

CLASSIFICATION OF CORPORATE ACTIONS

Corporate actions are classified in to two main categories Cash and Non-cash corporate
actions. Cash corporate action results in investors getting benefits in form of cash. Examples
of cash corporate actions are payment of interest / dividend. Non cash corporate actions
result in the investors getting benefits in form of securities. Examples of non cash corporate
action are bonus, rights, merger, split etc.

TYPES OF CORPORATE ACTIONS

Dividends
Returns received by investors in equities come in two forms a) growth in the value (market
price) of the share and b) dividends. Dividend is distribution of part of a company's earnings
to shareholders, usually twice a year in the form of a final dividend and an interim dividend.
Dividend is therefore a source of income for the shareholder. Normally, the dividend is
expressed on a 'per share' basis, for instance Rs. 3 per share. This makes it easy to see

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how much of the company's profits are being paid out, and how much are being retained by
the company to plough back into the business. So a company that has earnings per share in
the year of Rs. 6 and pays out Rs. 3 per share as a dividend is passing half of its profits on to
shareholders and retaining the other half. Directors of a company have discretion as to how
much of a dividend to declare or whether they should pay any dividend at all.
Dividend yield gives the relationship between the current price of a stock and the dividend
paid by its issuing company during the last 12 months. It is calculated by aggregating past
year's dividend and dividing it by the current stock price.
Example:
ABC Co.
Share price: Rs. 360
Annual dividend: Rs. 10
Dividend yield: 2.77% (10/360)
Historically, a higher dividend yield has been considered to be desirable among investors. A
high dividend yield is considered to be evidence that a stock is under priced, whereas a low
dividend yield is considered evidence that the stock is overpriced. A note of caution here
though: There have been companies in the past which had a record of high dividend yield,
only to go bust in later years. Dividend yield therefore can be only one of the factors in
determining future performance of a company.

Stock Split
A stock split is a corporate action which splits the existing shares of a particular face value
into smaller denominations so that the number of shares increase, however, the market
capitalization or the value of shares held by the investors post split remains the same as that
before the split.
For e.g. If a company has issued 1,00,00,000 shares with a face value of Rs.10 and the
current market price being Rs. 100, a 2-for-1 stock split would reduce the face value of the
shares to 5 and increase the number of the companys outstanding shares to 2,00,00,000,
(1,00,00,000*(10/5)). Consequently, the share price would also halve to Rs. 50 so that the
market capitalization or the value shares held by an investor remains unchanged. It is the
same thing as exchanging a Rs. 100 note for two Rs. 50 notes; the value remains the same.
Let us see the impact of this on the share holder: - Let's say company ABC is trading at Rs.
40 and has 100 million shares issued, which gives it a market capitalization of Rs. 4000
million (Rs. 40 x 100 million shares). An investor holds 400 shares of the company valued at
Rs. 16,000. The company then decides to implement a 4-for-1 stock split (i.e. a shareholder
holding 1 share, will now hold 4 shares). For each share shareholders currently own, they
receive three additional shares. The investor will therefore hold 1600 shares. So the investor
gains 3 additional shares for each share held. But this does not impact the value of the
shares held by the investor since post split, the price of the stock is also split by 25% (1/4th),
from Rs. 40 to Rs.10, therefore the investor continues to hold Rs.16,000 worth of shares.

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Notice that the market capitalization stays the same - it has increased the amount of stocks
outstanding to 400 million while simultaneously reducing the stock price by 25% to Rs. 10 for
a capitalization of Rs. 4000 million. The true value of the company hasn't changed. An easy
way to determine the new stock price is to divide the previous stock price by the split ratio. In
the case of our example, divide Rs. 40 by 4 and we get the new trading price of Rs. 10. If a
stock were to split 3-for-2, we'd do the same thing: 40/(3/2) = 40/1.5 = Rs. 26.60.
Pre-Split

Post-Split

2-for-1 Split
No. of shares
Share Price
Market Cap.

100 mill.
Rs. 40
Rs. 4000 mill.

200 mill.
Rs. 20
Rs. 4000 mill.

4-for-1
No. of shares
Share Price
Market Cap.

100 mill.
Rs. 40
Rs. 4000 mill.

400 mill.
Rs. 10
Rs. 4000 mill.

Reasons for announcing stock split

If the value of the stock doesn't change, what motivates a company to split its stock? Though
there are no theoretical reasons in financial literature to indicate the need for a stock split,
generally, there are mainly two important reasons. As the price of a security gets higher and
higher, some investors may feel the price is too high for them to buy, or small investors may
feel it is unaffordable. Splitting the stock brings the share price down to a more "attractive"
level. In our earlier example to buy 1 share of company ABC you need Rs. 40 pre-split, but
after the stock split the same number of shares can be bought for Rs.10, making it attractive
for more investors to buy the share. This leads us to the second reason. Splitting a stock may
lead to increase in the stock's liquidity, since more investors are able to afford the share and
the total outstanding shares of the company have also increased in the market.

Buy Back
A buyback can be seen as a method for company to invest in itself by buying shares from
other investors in the market. Buybacks reduce the number of shares outstanding in the
market. Buy back is done by the company with the purpose to improve the liquidity in its
shares and enhance the shareholders wealth. Under the SEBI (Buy Back of Securities)
Regulation, 1998, a company is permitted to buy back its share from:
a) Existing shareholders on a proportionate basis through the offer document.
b) Open market through stock exchanges using book building process.
c) Shareholders holding odd lot shares.
The company has to disclose the pre and post-buyback holding of the promoters. To ensure
completion of the buyback process speedily, the regulations have stipulated time limit for

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each step. For example, in the cases of purchases through stock exchanges, an offer for buy
back should not remain open for more than 30 days. The verification of shares received in
buy back has to be completed within 15 days of the closure of the offer. The payments for
accepted securities has to be made within 7 days of the completion of verification and bought
back shares have to be extinguished within 7 days of the date of the payment.

Mergers and Acquisitions

A merger occurs when two or more companies combine into one while all parties involved
mutually agree to the terms of the merger. The merger usually occurs when one company
surrenders its stock to the other. If a company undergoes a merger, it may indicate to
shareholders that the company has confidence in its ability to take on more responsibilities.
On the other hand, a merger could also indicate a shrinking industry in which smaller
companies are being combined with larger corporations.
In the case of an acquisition, however, a company seeks out and buys a majority stake of a
target company's shares; the shares are not swapped or merged. Acquisitions can often be
friendly but also hostile, meaning that the acquired company does not find it favorable that a
majority of its shares was bought by another entity.

Rights Issues
A company implementing a rights issue is offering additional and/or new shares but only to
already existing shareholders. The existing shareholders are given the right to purchase or
receive these shares before they are offered to the public. A rights issue regularly takes place
in the form of a stock split, and can indicate that existing shareholders are being offered a
chance to take advantage of a promising new development.

Bonus Issue
An offer of free additional shares to existing shareholders. A company may decide to
distribute further shares as an alternative to increasing the dividend payout. Also known as a
scrip issue or capitalization issue. New shares are issued to shareholders in proportion to
their holdings. For example, the company may give one bonus share for every five shares
held.
Conclusion
It is important for an investor to understand the various types of corporate actions in order to
get a clearer picture of how a company's decisions affect the shareholder. The type of action
used can tell the investor a lot about the company, and all actions will change the stock itself
on way or another.

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CHAPTER 10
FINANCIAL STATEMENTS
MEANING
Financial statement consists of Balance Sheet, Profit and Loss Account, Sources and Uses of
Funds Statements, and Auditors Notes to the financial statements. The Balance sheet shows
the financial position of the firm at a particular point of time. The profit and loss account
(Income Statement) shows the financial performance of the firm over a period of time. The
sources and uses of funds statements reflect the flow of funds through the business during a
given period of time.

TYPES OF FINANCIAL STATEMENTS

Balance Sheet
The balance sheet of a company, according to the Companies Act, should be either in
account form or the report form.
Balance Sheet: Account Form
Liabilities
Share Capital
Reserves and Surplus
Secured loans
Unsecured loans
Current liabilities and provisions

Assets
Fixed Assets
Investments
Current Assets, loans and Advances
Miscellaneous expenditure

Liabilities:
Share Capital: Share capital has been divided into equity capital and preference
capital. The share capital represents the contribution of owners of the company.
Equity capital does not have fixed rate of dividend. The preference capital
represents contribution of preference shareholders and has fixed rate of dividend.

Reserves and Surplus: The reserves and surpluses are the profits retained in the
company. The reserves can be divided into revenue reserves and capital reserves.
Revenue reserves represent accumulated retained earnings from the profits of
business operations. Capital reserves are those gained which are not related to
business operations. The premium on issue of shares and gain on revaluation of
assets are examples of the capital reserves.

88

Secured and Unsecured Loans: Secured loans are the borrowings against the
security. They are in the form of debentures, loans from financial institutions and
loans from commercial banks. The unsecured loans are the borrowings without a
specific security. They are fixed deposits, loans and advances from promoters, intercorporate borrowings, and unsecured loans from the banks.

Current Liabilities and Provisions: They are amounts due to the suppliers of goods
and services brought on credit, advances payments received, accrued expenses,
unclaimed dividend, provisions for taxes, dividends, gratuity, pensions, etc.

Assets:

Fixed Assets: These assets are acquired for long-terms and are used for business
operation, but not meant for resale. The land and buildings, plant, machinery,
patents, and copyrights are the fixed assets.

Investments: The investments are the financial securities either for long-term or
short-term. The incomes and gains from the investments are not from the business
operations.

Current Assets, Loans, and Advances: This consists of cash and other resources
which can be converted into cash during the business operation. Current assets are
held for a short-term period. The current assets are cash, debtors, inventories, loans
and advances, and pre-paid expenses.

Miscellaneous Expenditures and Losses: The miscellaneous expenditures represent

certain outlays such as preliminary expenses and pre-operative expenses not written
off. Though loss indicates a decrease in the owners equity, the share capital can not
be reduced with loss. Instead, Share capital and losses are shown separately on the
liabilities side and assets side of the balance sheet.

Balance Sheet: Report Form

I. Sources of Funds
1. Shareholders Funds
(a) Share Capital
(b) Reserves & surplus
2. Loan Funds
(a) Secured loans
(b) Unsecured loans
II. Application of Funds
(i) Fixed Assets

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(ii) Investments
(iii) Current Assets, loans and advances
Less: Current liabilities and provisions
Net current assets
(iv) Miscellaneous expenditure and losses

Profit and Loss Account

Profit and Loss account is the second major statement of financial information. It indicates the
revenues and expenses during particular period of time. The period of time is an accounting
period/year, April-March. The profit and loss account can be presented broadly into two
forms: (i) usual account form and (ii) step form. The accounting report summarizes the
revenue items, the expense items, and the difference between them (net income) for an
accounting period.
Mere statistics/data presented in the different financial statements do not reveal the true
picture of a financial position of a firm. Properly analyzed and interpreted financial statements
can provide valuable insights into a firms performance. To extract the information from the
financial statements, a number of tools are used to analyse such statements. The popular
tools are:
1. Comparative Financial Statements,
2. Common Sized Statements, and
3. Ratio Analysis.
Comparative Financial Statements
This involves putting statements for two periods/organizations in a comparative form and
indicating differences between them in terms of rupees and percentages.
Example 12: Financial statement of XYZ Ltd. for the years 2005 and 2006 are compared as
under:
__________________________________________________________________________
Particulars
Amount (in Rs. Lakh)
Increase/Decrease
2005
2006
Amount_(%)______
Equity Share Capital
15.00
15.00
Debentures
9.00
6.00
(-) 3.00
(-) 33.33
Current Liabilities
10.00
10.50
(+) 0.50 (+) 5.00
Land and Building
13.00
13.00
Investments
8.00
10.00
(+) 2.00 (+) 25.00
Current Assets
13.00
8.50
(-) 4.50
(-) 34.62
__________________________________________________________________________

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Common Size Statements

This involves putting statements for two years/organizations in a comparative form, where the
items appear in percentage to total, rather than in absolute rupee form. This indicates relative
importance of each item in the total and significant changes in the composition of the items.
Example 13: Common size statement of ABC Ltd. for the years 2005 and 2006 is as under:
__________________________________________________________________________
Percentage
Particulars
Amount (in Rs. Lakh)
2005
2006
2005
2006_____
Equity Share Capital
15.00
15.00
44.11
47.62
Debentures
9.00
6.00
26.47
19.05
Current Liabilities
10.00
10.50
29.42
33.33
Land and Building
13.00
13.00
38.23
41.27
Investments
8.00
10.00
23.53
31.75
Current Assets
13.00
8.50
38.24
26.98
__________________________________________________________________________

Ratio Analysis
Financial ratio is a quantitative relationship between two items/variables. Financial ratios can
be broadly classified into three groups: (I) Liquidity ratios, (II) Leverage/Capital structure ratio,
and (III) Profitability ratios.
(I) Liquidity ratios
Liquidity refers to the ability of a firm to meet its financial obligations in the short-term which is
less than a year. Certain ratios which indicate the liquidity of a firm are: (i) Current Ratio, (ii)
Acid Test Ratio, (iii) Turnover Ratios. It is based upon the relationship between current assets
and current liabilities.
(i) Current ratio =

Current. Assets
Current.Liabilities

The current ratio measures the ability of the firm to meet its current liabilities from the current
assets. Higher the current ratio, greater the short-term solvency (i.e. larger is the amount of
rupees available per rupee of liability).
(ii) Acid-test Ratio =

Quick . Assets
Current.Liabilities

Quick assets are defined as current assets excluding inventories and prepaid expenses. The
acid-test ratio is a measurement of firms ability to convert its current assets quickly into cash
in order to meet its current liabilities. Generally speaking 1:1 ratio is considered to be
satisfactory.

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(iii) Turnover Ratios:

Turnover ratios measure how quickly certain current assets are converted into cash or how
efficiently the assets are employed by a firm. The important turnover ratios are:
-Inventory Turnover Ratio,
-Debtors Turnover Ratio,
-Average Collection Period,
-Fixed Assets Turnover and
-Total Assets Turnover
Inventory Turnover Ratio =

Cost of Goods Sold

Average Inventoty

Where, the cost of goods sold means sales minus gross profit. Average Inventory refers to
simple average of opening and closing inventory. The inventory turnover ratio tells the
efficiency of inventory management. Higher the ratio, more the efficient of inventory
management.
Debtors Turnover Ratio =

NetCreditSales
AverageAccounts Re ceivable( Debtors )

The ratio shows how many times accounts receivable (debtors) turns over during the year. If
the figure for net credit sales is not available, then net sales figure is to be used. Higher the
debtors turnover, the greater the efficiency of credit management.
Average Collection Period =

AverageDebtors
AverageDailyCreditSales

Average Collection Period represents the number of days worth credit sales that is locked in
debtors (accounts receivable).
Please note that the Average Collection Period and the Accounts Receivable (Debtors)
Turnover are related as follows:
Average Collection Period =

365 Days
DebtorsTurnover

Fixed Assets turnover ratio measures sales per rupee of investment in fixed assets. In other
words, how efficiently fixed assets are employed. Higher ratio is preferred. It is calculated as
follows:
Fixed Assets turnover ratio =

Net.Sales
NetFixedAssets

Total Assets turnover ratio measures how efficiently all types of assets are employed.

92

Total Assets turnover ratio =

Net.Sales
AverageTotalAssets

(II) Leverage/Capital structure ratios

Long term financial strength or soundness of a firm is measured in terms of its ability to pay
interest regularly or repay principal on due dates or at the time of maturity. Such long term
solvency of a firm can be judged by using leverage or capital structure ratios. Broadly there
are two sets of ratios: First, the ratios based on the relationship between borrowed funds and
owners capital which are computed from the balance sheet. Some such ratios are: Debt to
Equity and Debt to Asset ratios. The second set of ratios which are calculated from Profit and
Loss Account is: The interest coverage ratio and debt service coverage ratio are coverage
ratio for leverage risk.
(i) Debt-Equity ratio reflects relative contributions of creditors and owners to finance the
business.
Debt-Equity ratio =

Debt
Equity

The desirable/ ideal proportion of the two components (high or low ratio) varies from industry
to industry.
(ii) Debt-Asset Ratio: Total debt comprises of long term debt plus current liabilities. The total
assets comprise of permanent capital plus current liabilities.
Debt-Asset Ratio =

Total Debt
Total Assets

The second set or the coverage ratios measure the relationship between proceeds from the
operations of the firm and the claims of outsiders.
(iii) Interest Coverage ratio =

Earnings Before Interest and Taxes

Interest

Higher the interest coverage ratio better is the firms ability to meet its interest burden. The
lenders use this ratio to assess debt servicing capacity of a firm.
(iv)Debt Service Coverage Ratio (DSCR) is a more comprehensive and apt to compute debt
service capacity of a firm. Financial institutions calculate the average DSCR for the period
during which the term loan for the project is repayable. The Debt Service Coverage Ratio is
defined as follows:

Pr ofit.after.tax + Depreciation + OtherNoncashExpenditure + Interest.on.term.loan

Interest on term loan + Re payment of term loan

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(III) Profitability ratios

Profitability and operating/management efficiency of a firm is judged mainly by the following
profitability ratios:
(i) Gross Profit Ratio =

(ii) Net Profit Ratio =

Gross Profit
Net Sales

Net Profit
Net Sales

Some of the profitability ratios related to investments are:

(iii) Return on Total Assets =

Net Income
Average Total Assets

(iv)Return on Capital Employed =

Net Profit
Capital Employed

(Here, Capital Employed = Fixed Assets + Current Assets - Current Liabilities)

Return on Shareholders Equity =

Net Income After Tax

Average Total Shareholders ' Equity or NetWorth

(Net worth includes Shareholders equity capital plus reserves and surplus)
A common (equity) shareholder has only a residual claim on profits and assets of a firm, i.e.,
only after claims of creditors and preference shareholders are fully met, the equity
shareholders receive a distribution of profits or assets on liquidation. A measure of his well
being is reflected by return on equity. There are several other measures to calculate return on
shareholders equity:
(i) Earnings Per Share (EPS): EPS measures the profit available to the equity shareholders
per share, that is, the amount that they can get on every share held. It is calculated by
dividing the profits available to the shareholders by number of outstanding shares. The profits
available to the ordinary shareholders are arrived at by net profits after taxes and preference
dividend.
It indicates the value of equity in the market.
EPS =

Net Profit
Number of Ordinary Shares Outstanding

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(ii) Price-earnings ratios = P/E Ratio =

Market Pr ice per Share

EPS

(iii) Cash Earnings per share (CPS/CEPS):

CPS/CEPS =

Net Pr ofit Pr eference Dividend + Depreciation

Number of Equity Shares

Illustration:
Balance Sheet of ABC Co. Ltd. as on March 31, 2006
(Amount in Rs. Crores)
Liabilities
Share Capital
(1,00,00,000 equity shares
of Rs.10 each)
Reserves & Surplus
Secured Loans
Unsecured Loans
Current Liabilities & Provisions

Total

Amount
16.00

Assets
Fixed Assets (net)

22.00
21.00
25.00
16.00

Current Assets:
Cash & Bank
Debtors
Inventories
Pre-paid expenses
Investments
Total

100

Amount
60.00

23.40
0.20
11.80
10.60
0.80
16.60
100

Profit & Loss Account of ABC Co. Ltd. for the year ending on March 31, 2006:
Particulars
Opening Stock

Amount
13.00

Particulars
Sales (net)

Amount
105.00

Purchases

69.00

Closing Stock

15.00

Wages and Salaries

12.00

Other Mfg. Expenses

10.00

Gross Profit

16.00

Total

120.00

Total

120.00

Administrative and Personnel Expenses

1.50

Gross Profit

16.00

Selling and Distribution Expenses

2.00

Depreciation

2.50

Interest

1.00

Net Profit

9.00

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Total
Income Tax

16.00
4.00

Equity Dividend

3.00

Retained Earning
Total
Market price per equity share - Rs. 20.00

2.00
9.00

Total
Net Profit

16.00
9.00

Total

9.00

Current Ratio = Current Assets / Current Liabilities

= 23.40/16.00 = 1.46
Quick Ratio = Quick Assets / Current Liabilities
=Current Assets-(inventory + prepaid expenses)/Current Liabilities
= [23.40-(10.60+0.8)]/16.00 = 12.00/16.00 = 0.75
Inventory Turnover Ratio = Cost of goods sold/Average Inventory
= (Net Sales-Gross Profit)/ [(opening stock + closing stock)/2]
= (105-16)/ [(15+13)/2] = 89/14 = 6.36
Debtors Turnover Ratio= Net Sales/Average account receivables (Debtors)
=105/11.80 =8.8983
Average Collection period = 365 days / Debtors turnover
= 365 days/8.8983 = 41 days
Fixed Assets Turnover ratio = Net Sales / Net Fixed Assets
= 105/60 = 1.75
Debt to Equity Ratio = Debt/ Equity
= (21.00+25.00)/(16.00+22.00) = 46/38 = 1.21
Gross Profit Ratio = Gross Profit/Net Sales
= 16.00/105.00 = 0.15238 or 15.24%
Net Profit Ratio = Net Profit / Net Sales
= 9/105.00 = 0.0857 or 8.57 %
Return on Shareholders Equity = Net Profit after tax/Net worth
= 5.00/(16.00+22.00) =0.13157 or 13.16

96

CHAPTER 11
TIME VALUE OF MONEY
MEANING
One of the most important principles in all of finance is the relationship between value of a
rupee today and value of rupee in future. This relationship is known as the time value of
money. A rupee today is more valuable than a rupee tomorrow. This is because current
consumption is preferred to future consumption by the individuals, firms can employ capital
productively to earn positive returns and in an inflationary period, rupee today represents
greater purchasing power than a rupee tomorrow. The time value of the money may be
computed in the following circumstances.
(a)
(b)
(c)
(d)

Future value of a single cash flow

Future value of an annuity
Present value of a single cash flow
Present value of an annuity

FUTURE VALUE OF A SINGLE CASH FLOW

For a given present value (PV) of money, future value of money (FV) after a period t for
which compounding is done at an interest rate of r, is given by the equation
FV = PV (1+r)t
This assumes that compounding is done at discrete intervals. However, in case of
continuous compounding, the future value is determined using the formula
FV = PV * ert
Where e is a mathematical function called exponential the value of exponential (e) =
2.7183. The compounding factor is calculated by taking natural logarithm (log to the base of
2.7183).
Example 14: Calculate the value of a deposit of Rs.2,000 made today, 3 years hence if the
interest rate is 10%.
By discrete compounding:
FV = 2,000 * (1+0.10)3 = 2,000 * (1.1)3 = 2,000 * 1.331 = Rs. 2,662
By continuous compounding:
FV = 2,000 * e (0.10 *3) =2,000 * 1.349862 = Rs.2699.72

97

Example 15: Find the value of Rs. 70,000 deposited for a period of 5 years at the end of the
period when the interest is 12% and continuous compounding is done.
Future Value = 70,000*

e ( 0.12*5 )

= Rs. 1,27,548.827.

The future value (FV) of the present sum (PV) after a period t for which compounding is
done m times a year at an interest rate of r, is given by the following equation:
FV = PV (1+(r/m))^mt
Example 16: How much a deposit of Rs. 10,000 will grow at the end of 2 years, if the nominal
rate of interest is 12 % and compounding is done quarterly?

Future value = 10,000 * 1 +

0.12

4*2

= Rs. 12,667.70

Future Value of an Annuity

An annuity is a stream of equal annual cash flows. The future value (FVA) of a uniform cash
flow (CF) made at the end of each period till the time of maturity t for which compounding is
done at the rate r is calculated as follows:
FVA

= CF*(1+r)t-1 + CF*(1+r)t-2 + ... + CF*(1+r)1+CF

(1 + r) t 1

= CF

(1 + r) t 1
is referred as the Future Value Interest Factor for an Annuity
The term
r

(FVIFA). The same can be applied in a variety of contexts. For e.g. to know accumulated
amount after a certain period,; to know how much to save annually to reach the targeted
amount, to know the interest rate etc.
Example 17: Suppose, you deposit Rs.3,000 annually in a bank for 5 years and your deposits
earn a compound interest rate of 10 per cent, what will be value of this series of deposits (an
annuity) at the end of 5 years? Assume that each deposit occurs at the end of the year.
Future value of this annuity is:
=Rs.3000*(1.10)4 + Rs.3000*(1.10)3 + Rs.3000*(1.10)2 + Rs.3000*(1.10) + Rs.3000
=Rs.3000*(1.4641)+Rs.3000*(1.3310)+Rs.3000*(1.2100)+Rs.3000*(1.10)+ Rs.3000
= Rs. 18315.30
Example 18: You want to buy a house after 5 years when it is expected to cost 40 Lakh how
much should you save annually, if your savings earn a compound return of 12%?

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FVIFA t = 5

, r =12%

5
(1 + 0.12) 1
=
=6.353
0.12

The annual savings should be:

4000000/6.353=6,29,623.80
In case of continuous compounding, the future value of annuity is calculated using the
formula: FVA = CF * (ert -1)/r.

PRESENT VALUE OF A SINGLE CASH FLOW

Present value of (PV) of the future sum (FV) to be received after a period t for which
discounting is done at an interest rate of r, is given by the equation
In case of discrete discounting:

PV = FV / (1+r)t

Example: What is the present value of Rs.5,000 payable 3 years hence, if the interest rate is
10 % p.a.
PV
= 5000 / (1.10)3 i.e. = Rs.3756.57
In case of continuous discounting:

PV = FV * e-rt OR PV =

FV
e rt

Example: What is the present value of Rs. 10,000 receivable after 2 years at a discount rate
of 10% under continuous discounting?
Present Value = 10,000/(exp^(0.1*2)) = Rs. 8187.297
Present Value of an Annuity
The present value of annuity is the sum of the present values of all the cash inflows of this
annuity.
Present value of an annuity (in case of discrete discounting)
PVA = FV [{(1+r)t - 1 }/ {r * (1+r)t}]
The term [(1+r)t - 1/ r*(1+r)t] is referred as the Present Value Interest factor for an annuity
(PVIFA).
Example: What is the present value of Rs. 2000/- received at the end of each year for 3
continuous years
= 2000*[1/1.10]+2000*[1/1.10]^2+2000*[1/1.10]^3
= 2000*0.9091+2000*0.8264+2000*0.7513

99

= 1818.181818+1652.892562+1502.629602
= Rs. 4973.704
Example: Assume that you have taken housing loan of Rs.10 Lakh at the interest rate of
Rs.11 percent per annum. What would be you equal annual installment for repayment period
of 15 years?
Loan amount = Installment (A) *PVIFA n=15, r=11%
10,00,000 = A* [(1+r)t - 1/ r*(1+r)t]
10,00,000 = A* [(1.11)^15 - 1/ 0.11(1.11^15]
10,00,000 = A* 7.19087
10,00,000/7.19087 = A
A = Rs. 1,39,065.24
Present value of an annuity (in case of continuous discounting) is calculated as:
PVa = FVa * (1-e-rt)/r

100

CHAPTER 12
REGULATORS AND REGULATORY FRAMEWORK
REGULATORS OF INDIAN FINANCIAL SYSTEM
The regulators of Indian Financial system are as follows:
REGULATORS

SEBI

Corp.
Bond
Market

RBI

Equity/
Derivative

Banking &
Forex
Market

FMC

Fixed
Income
Market

Commodity
Market

IRDAI

PFRDA

Insurance

Pension
Funds

SEBI
Securities and Exchange Board of India (SEBI) looks into the Regulation and supervision of
stock exchanges and mutual funds. The Securities and Exchange Board of India (SEBI) is the
regulatory authority in India established under Section 3 of SEBI Act, 1992.
Role of SEBI :

Protecting the interests of investors in securities.

Promoting the development of the securities market.
Regulating the business in stock exchanges and any other securities markets.
Registering and regulating the working of stock brokers, subbrokers etc.
Promoting and regulating self-regulatory organizations
Prohibiting fraudulent and unfair trade practices
Calling for information from, undertaking inspection, conducting inquiries and audits
of the stock exchanges, intermediaries, selfregulatory organizations, mutual funds
and other persons associated with the securities market.

101

RBI
Reserve Bank of India (RBI) is the central bank of India. It has various roles to play such
as an investment banker to the government, banking regulator, owner and operator of
payments system, depository and bond exchange, regulator and supervisor of currency and
bond market.
Role of RBI

Issuer of currency notes

RBI renders useful service to the government in the capacity of its banker, agent and
advisor.
RBI has been vested with extensive powers to control commercial banking system.
RBI acts as a custodian of the nations foreign exchange reserves.
Exchange stability and price stability.
Credit control.
Financing

FMC
Forward Markets Commission (FMC) looks into the regulation and supervision of commodity
futures trading. It is a statutory body set up in 1953 under the Forward Contracts (Regulation)
Act, 1952
Role of FMC
provides regulatory oversight in order to ensure financial integrity (i.e. to prevent
systematic risk of default by one major operator or group of operators),
market integrity (i.e. to ensure that futures prices are truly aligned with the
prospective demand and supply conditions) and
protects and promotes interest of customers/ non-members

IRDA
Insurance Regulatory and Development Agency (IRDA) looks into the regulation and
supervision of insurance. The IRDA was set up in 2000 as an autonomous insurance
regulator.
Role of IRDA

to regulate, promote and ensure orderly growth of the insurance business.

to facilitate the growth of the market
to integrate insurance markets with domestic financial services market.
synchronizing Indian insurance market with global insurance market.

102

PFRDA
Pension Fund Regulatory and Development Agency (PFRDA) looks into the regulation and
supervision of the New Pension System. PFRDA was established by Government of India on
23rd August, 2003.
Role of PFRDA

to promote old age income security by establishing, developing and regulating

pension funds,
to protect the interests of subscribers to schemes of pension funds and for matters
connected therewith or incidental thereto.

REGULATORY FRAMEWORK FOR SECURITIES MARKET

Capital Issues (Control) Act, 1947
The Act had its origin during the war in 1943 when the objective was to channel resources to
support the war effort. It was retained with some modifications as a means of controlling the
raising of capital by companies and to ensure that national resources were channeled into
proper lines, i.e., for desirable purposes to serve goals and priorities of the government, and
to protect the interests of investors. Under the Act, any firm wishing to issue securities had to
obtain approval from the Central Government, which also determined the amount, type and
price of the issue. As a part of the liberalisation process, the Act was repealed in 1992 paving
way for market determined allocation of resources.

SEBI Act, 1992

The SEBI Act, 1992 was enacted to empower SEBI with statutory powers for (a) protecting
the interests of investors in securities, (b) promoting the development of the securities market,
and (c) regulating the securities market. Its regulatory jurisdiction extends over corporates in
the issuance of capital and transfer of securities, in addition to all intermediaries and persons
associated with securities market. It can conduct enquiries, audits and inspection of all
concerned and adjudicate offences under the Act. It has powers to register and regulate all
market intermediaries and also to penalise them in case of violations of the provisions of the
Act, Rules and Regulations made there under. SEBI has full autonomy and authority to
regulate and develop an orderly securities market.

Securities Contracts (Regulation) Act, 1956

It provides for direct and indirect control of virtually all aspects of securities trading and the
running of stock exchanges and aims to prevent undesirable transactions in securities. It
gives Central Government regulatory jurisdiction over (a) stock exchanges through a process
of recognition and continued supervision, (b) contracts in securities and (c) listing of securities
on stock exchanges. As a condition of recognition, a stock exchange complies with conditions
prescribed by Central Government. Organised trading activity in securities takes place on a
specified recognised stock exchange. The stock exchanges determine their own listing

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regulations which have to conform to the minimum listing criteria set out in the Rules.

Depositories Act, 1996

The Depositories Act, 1996 provides for the establishment of depositories in securities with
the objective of ensuring free transferability of securities with speed, accuracy and security by
(a) making securities of public limited companies freely transferable subject to certain
exceptions; (b) dematerialising the securities in the depository mode; and (c) providing for
maintenance of ownership records in a book entry form. In order to streamline the settlement
process, the Act envisages transfer of ownership of securities electronically by book entry
without making the securities move from person to person. The Act has made the securities
of all public limited companies freely transferable, restricting the companys right to use
discretion in effecting the transfer of securities, and the transfer deed and other procedural
requirements under the Companies Act have been dispensed with.

Companies Act, 1956

It deals with issue, allotment and transfer of securities and various aspects relating to
company management. It provides for standard of disclosure in public issues of capital,
particularly in the fields of company management and projects, information about other listed
companies under the same management, and management perception of risk factors. It also
regulates underwriting, the use of premium and discounts on issues, rights and bonus issues,
payment of interest and dividends, supply of annual report and other information.

Prevention of Money Laundering Act, 2002

The primary objective of the Act is to prevent money-laundering and to provide for
confiscation of property derived from or involved in money-laundering. The term moneylaundering is defined as whoever acquires, owns, possess or transfers any proceeds of
crime; or knowingly enters into any transaction which is related to proceeds of crime either
directly or indirectly or conceals or aids in the concealment of the proceeds or gains of crime
within India or outside India commits the offence of money-laundering. Besides providing
punishment for the offence of money-laundering, the Act also provides other measures for
prevention of Money Laundering. The Act also casts an obligation on the intermediaries,
banking companies etc to furnish information, of such prescribed transactions to the Financial
Intelligence Unit- India, to appoint a principal officer, to maintain certain records etc.

Issue of Capital and Disclosure Requirements (ICDR) Regulations 2009

In August 2009, the SEBI issued Issue of Capital and disclosure requirements (ICDR)
Regulations 2009, replacing the Disclosure and Investor Protection (DIP) Guidelines 2000.
ICDR would govern all disclosure norms regarding issue of securities.

Insider Trading
Insider Trading is considered as an offence and is hence prohibited as per the SEBI
(Prohibition of Insider Trading) Regulations, 1992. The same was amended in the year 2003.

104

The act prohibits an insider from dealing (on his behalf or on behalf of any other person) in
securities of a company listed on any stock exchange, when in possession of any
unpublished price sensitive information. Further, it has also prohibited any insider from
communicating, counseling or procuring directly or indirectly any unpublished price sensitive
information to any person who while in possession of such unpublished price sensitive
information should not deal in securities. Price sensitive information means any information
which is related directly or indirectly to a company and which if published is likely to materially
affect the price of securities of a company. It includes information like periodical financial
results of the company, intended declaration of dividends (both interim and final), issue of
securities or buy-back of securities, any major expansion plans or execution of new projects,
amalgamation, merger or takeovers, disposal of the whole or substantial part of the
undertaking and significant changes in policies, plans or operations of the company. SEBI is
empowered to investigate on the basis of any complaint received from the investors,
intermediaries or any other person on any matter having a bearing on the allegations of
insider trading

Unfair Trade Practices

The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities
Market) Regulations 2003 enable SEBI to investigate into cases of market manipulation and
fraudulent and unfair trade practices. The regulations specifically prohibit fraudulent dealings,
market manipulations, misleading statements to induce sale or purchase of securities, unfair
trade practices relating to securities. When SEBI has reasonable ground to believe that the
transaction
in securities are being dealt within a manner detrimental to the investor or the securities
market in violation of these regulations and when any intermediary has violated the rules and
regulations under the act then it can order to investigate the affairs of such intermediary or
persons associated with the securities market. Based on the report of the investigating officer,
SEBI can initiate action for suspension or cancellation of registration of an intermediary.

Takeover
The restructuring of companies through takeover is governed by SEBI (Substantial
Acquisition of shares and Takeover) Regulations, 1997. These regulations were formulated
so that the process of acquisition and takeovers is carried out in a well-defined and orderly
manner following the fairness and transparency.
In context of this regulation acquirer is defined as a person who directly or indirectly
acquires or agrees to acquire shares or voting rights in the target company or acquires or
agrees to acquires control over the target company, either by himself or with any person
acting in concert with the acquirer. The term control includes right to appoint majority of the
directors or to control the management or policy decisions exercisable by any person or
persons acting individually or in concert, directly or indirectly, including by virtue of their
shareholding or management rights or shareholders agreements or voting agreements or in
any other manner. This implies that where there are two or more persons in control over the

105

target company, the cesser of any one of such persons from such control should not be
deemed to be in control of management.
Certain categories of persons are required to disclose their shareholding and/or control in a
listed company to that company. Such companies, in turn, are required to disclose such
details to the stock exchanges where shares of the company are listed. In case of acquisition
of 5 percent and more share or voting rights of a company, an acquirer would have to
disclose at every stage the aggregate of his shareholding or voting rights in that company to
the company and to the stock exchange where shares of the target company are listed. No
acquirer either by himself or through/with persons acting in concert with him should acquire,
additional shares or voting rights unless such acquirer makes a public announcement to
acquire shares in accordance with the regulations. As per the regulations, the mandatory
public offer is triggered on:

Limit of 15 percent or more but less than 55 percent of the shares or voting rights in a
company.
Limit of 55 percent or more but less than 75 percent of the shares. In a case where the
target company had obtained listing of its shares by making an offer of at least ten
percent of issue size to the public in terms of the relevant clause mentioned in the
Securities Contracts (Regulations) Rules 1957 or in terms of any relaxation granted from
strict enforcement of the said rule, then the limit would be 90 percent instead of 75
percent. Further, if the acquire (holding 55 % more but less than 75 percent) is desirous
of consolidating his holding while ensuring that the public shareholding in the target
company does not fall below the minimum level permitted in the listing agreement, he
may do so only by making a public announcement in accordance with these regulations.

Irrespective of whether or not there has been any acquisition of shares or voting rights in a
company, no acquirer should acquire control over the target company, unless such person
makes a public announcement to acquire shares and acquires such shares in accordance
with the regulations.
The regulations give enough scope for existing shareholders to consolidate and also cover
the scenario of indirect acquisition of control. The applications for takeovers are scrutinized by
the Takeover Panel constituted by the SEBI.

Buy Back
Buy Back is done by the company with the purpose to improve liquidity in its shares and
enhance the shareholders wealth. Under the SEBI (Buy Back of Securities) Regulations,
1998, a company is permitted to buy back its shares or other specified securities by any of
the following methods: From the existing security holders on a proportionate basis through the tender offer
From the open market through (i) book building process (ii) stock exchange
From odd-lot holders.

106

The company has to disclose the pre and post-buy back holding of the promoters. To ensure
completion of the buy back process speedily, the regulations have stipulated time limit for
each step. For example in the cases of purchases through tender offer an offer for buy back
should not remain open for more than 30 days. The company should complete the
verifications of the offers received within 15 days of the closure of the offer and shares or
other specified securities. The payment for accepted securities has to be made within 7 days
of the completion of verification and bought back shares have to be extinguished and
physically destroyed within 7 days of the date of the payment. Further, the company making
an offer for buy back will have to open an escrow account on the same lines as provided in
takeover regulations.

Regulation for derivatives trading

SEBI set up a 24-member committee under the Chairmanship of Dr. L. C. Gupta to develop
the appropriate regulatory framework for derivatives trading in India. On May 11, 1998 SEBI
accepted the recommendations of the committee and approved the phased introduction of
derivatives trading in India beginning with stock index futures.
The provisions in the SC(R)A and the regulatory framework developed hereunder govern
trading in securities. The amendment of the SC(R)A to include derivatives within the ambit of
securities in the SC(R)A made trading in derivatives possible within the framework of that
Act.
1. Any Exchange fulfilling the eligibility criteria as prescribed in the L. C. Gupta
committee report can apply to SEBI for grant of recognition under Section 4 of the
SC(R)A, 1956 to start trading derivatives. The derivatives exchange/segment should
have a separate governing council and representation of trading/clearing members
shall be limited to maximum of 40% of the total members of the governing council.
The exchange would have to regulate the sales practices of its members and would
have to obtain prior approval of SEBI before start of trading in any derivative
contract.
2. The Exchange should have minimum 50 members.
3. The members of an existing segment of the exchange would not automatically
become the members of derivative segment. The members of the derivative
segment would need to fulfill the eligibility conditions as laid down by the L. C. Gupta
committee.
4. The clearing and settlement of derivatives trades would be through a SEBI approved
clearing corporation/house. Clearing corporations/houses complying with the
eligibility conditions as laid down by the committee have to apply to SEBI for grant of
approval.
5. Derivative brokers/dealers and clearing members are required to seek registration

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from SEBI. This is in addition to their registration as brokers of existing stock

exchanges. The minimum networth for clearing members of the derivatives clearing
corporation/house shall be Rs.300 Lakh. The networth of the member shall be
computed as follows:

Capital + Free reserves

Less non-allowable assets viz.,

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)

Fixed assets
Pledged securities
Members card
Non-allowable securities (unlisted securities)
Bad deliveries
Doubtful debts and advances
Prepaid expenses
Intangible assets
30% marketable securities

6. The minimum contract value shall not be less than Rs.2 Lakh. Exchanges have to
submit details of the futures contract they propose to introduce.
7. The initial margin requirement, exposure limits linked to capital adequacy and
margin demands related to the risk of loss on the position will be prescribed by
SEBI/Exchange from time to time.
8. The L. C. Gupta committee report requires strict enforcement of Know your
customer rule and requires that every client shall be registered with the derivatives
broker. The members of the derivatives segment are also required to make their
clients aware of the risks involved in derivatives trading by issuing to the client the
Risk Disclosure Document and obtain a copy of the same duly signed by the client.
9.

The trading members are required to have qualified approved user and sales person
who have passed a certification programme approved by SEBI.

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