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Indian Stock Market: An Overview

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  1. Indian Stock Market: An Overview

  2. Stock Market • Primary Market Secondary Market

  3. Primary Market • IPO vs Seasoned Issues • Pricing of issues • Fixed pricing • Book building • Public offer vs Private placement • Demat issues

  4. Pricing of issues • Companies eligible to make public issue can freely price their equity shares or any security. • Fixed Price • Book Building

  5. Fixed Price • In the fixed-price issue method, the issuer fixes the issue price well before the actual issue. For this very reason, it is cautious and conservative in pricing the issue so that the issue is fully subscribed. Underwriters also do not like the issue to devolve on them and hence favour conservative pricing of the issue. For these practical reasons, the issue price in the case of traditional fixed price method generally errs on the lower side and, therefore, in the investor’s favour.

  6. Book building • Book-building is a process of price discovery used in public offers. The issuer sets a floor price and a band within which the investor is allowed to bid for shares. • The upper price of the band can be a maximum of 1.2 times the floor price. • The investor had to bid for a quantity of shares he wished to subscribe to within this band.

  7. Book building • Bids to remain open for at least 5 days • Only electronic bidding is permitted • Bidding demand is displayed at the end of every day. • The lead manager analyses the demand generated and determines the issue price or cut-off price in consultation with the issuer.

  8. Cut-off price • The cut-off price is the price discovered by the market. It is the price at which the shares are issued to the investors. • Investors bidding at a price below the cut-off price are ignored.

  9. Let’s say a company wants to issue 10,00,000 shares. The floor price for one share of face value, Rs10, is Rs48 and the band is between Rs48 and Rs55. • At Rs55, on the basis of bids received, the investors are ready to buy 2,00,000 shares. So the cut-off price can not be set at Rs55 as only 2 lacs shares will be sold.

  10. So as a next step, the price is lowered to Rs54. At Rs54, investors are ready to buy 4 lacs shares. So if the cut-off price is set at Rs54, 6 lacs shares will be sold. This still leaves 4 lacs shares to be sold.

  11. The price is now lowered to Rs53. At Rs53, investors are ready to buy 4 lacs shares. Now if the cut-off price is set at Rs53, all ten lacs shares will be sold. • Investors who had applied for shares at Rs55 and Rs54 will also be issued shares at Rs53.

  12. Fixed Price vs. Book Building

  13. Book Building • Objective is efficient price discovery. • Asymmetric information between promoter and investors. • Investors always remain in dark.

  14. Private placement • It involves issues of securities to a limited number of subscribers, such as banks, FIs, MFs and high net worth individual. • It is arranged through a merchant banker, an agent of issuers, who brings together the issuers and investor(s). • Securities offered are exempt from public disclosers regulations and registration requirements of the regulatory body. • This market is preferred by small and medium size firms, particularly new entrants who do not have track record of performance.

  15. Private Placement vs Public Issues

  16. DEMATERIALISATION OF SHARES: • Trading in the shares of the Company is compulsory in dematerialized form for all investors. • The Company has, therefore, enlisted its shares with both the depositories, viz, National Securities Depository Limited (NSDL) and Central Depository Services India Limited (CDSL).

  17. What is Dematerialisation? • Dematerialisation is a process by which the physical share certificates of an investor are taken back by the Company and an equivalent number of securities are credited in electronic form at the request of the investor. • An investor will have to first open an account with a Depository Participant so that the dematerialised holdings can be credited into that account. • This is very similar to opening a Bank Account.

  18. What is a Depository? • A Depository (NSDL & CDSL) is an organisation like a Central Bank where the securities of a shareholder are held in the electronic form at the request of the shareholder through the medium of a Depository Participant.

  19. Who is a Depository Participant? • A Depository Participant (DP) is your representative (agent) in the depository system providing the link between the Company and you through the Depository. • While the Depository can be compared to aBank, DP is like a branch of your bank with whom you can have an account. • According to SEBI guidelines, Financial Institutions like banks, stockbrokers etc. can become participants in the depository.

  20. How does the Depository System operate? • The Depository System functions very much like the banking system. • A bank holds funds in accounts whereas a Depository holds securities in accounts for its clients. • A Bank transfers funds between accounts whereas a Depository transfers securities between accounts. • In both systems, the transfer of funds or securities happens without the actual handling of funds or securities.

  21. Secondary Market • Trading • Clearing &Settlement

  22. Trading • Cash Trading • Spot Trading • Forward, future (derivative trading)

  23. TRADING • The NSE trading system called 'National Exchange for Automated Trading' (NEAT) is a fully automated screen based trading system. • It is on line and nationwide trading system. • It adopts the principle of an order driven market.

  24. Trading Mechanism • In this system a member can punch into the computer quantities of securities and prices at which he likes to transact. • The transaction is executed as soon as it finds a matching sale or buy order from a counter party.

  25. Trading Mechanism • A single consolidated order book for each stock displays, on a real time basis, buy and sell orders originating from all over the country. • The book stores only limit orders, which are orders to buy or sell shares at a stated quantity and stated price. • The limit orders are executed only if the price quantity conditions match.

  26. The Limit order book for Titan on the NSE (on 12 April, 2005, at 11.00 A.M.)

  27. One can buy a share by paying Rs237.7 and sell a share at Rs 237.25. • The difference is the bid-ask spread. • There is one potential complication to this simple scenario. • The prices of Rs237.25 and Rs237.7 actually represent commitments to trade up to a specified number of shares. • If somebody wants to buy 150 shares, what will happen?

  28. Limit Orders • Investors may also place limit orders, whereby they specify prices at which they are willing to buy or sell a security.

  29. Limit Orders

  30. Limit-buy Order and Limit-Sale order • Limit-buy Order • If the stock falls below the limit on a limit-buy order then the trade is to be executed. • See the price list of Titan: Somebody has placed a buy order for 25 shares of Titan at Rs237.2 per share. • If price falls to Rs237.2 (from its current level of Rs237.25), then this buy order will be executed. • Limit-Sale order?

  31. What happens if a limit order is placed between the quoted bid and ask prices? • Suppose you have instructed your broker to buy Titan at a price of Rs237.4 or better.

  32. Trading Mechanism • The trading system provides tremendous flexibility to the issuers in terms of kinds of orders that can be placed on the system. • Several time related (Good-till-Cancelled, Good-till-Day, Immediate-or-Cancel), and • Price-related (buy/sell limit and stop-loss orders) conditions can be easily built into an order.

  33. Stop-loss orders • It is an order placed with a broker to sell once the stock reaches a certain price. • A stop-loss is designed to limit an investor's loss on a security position. • Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. • For example, let's say you just purchased ACC at Rs50 per share. Right after buying the stock you enter a stop-loss order for Rs45. This means that if the stock falls below Rs45, your shares will then be sold at the prevailing market price.

  34. Market Timings • Trading on the equities segment takes place on all days of the week (except Saturdays and Sundays and holidays declared by the Exchange in advance). The market timings of the equities segment are:Normal Market Open : 09:55 hoursNormal Market Close : 15:30 hours

  35. Clearing and Settlement Process at NSE • NSE • 1 • DEPOSITORIES 8 NSCCL 9 CLEARING BANK • 6 7 • 10 5 2 3 4 11 • CUSTODIAN / DP

  36. Clearing and settlement Process • 1. Trade details from Exchange to NSCCL • 2. NSCCL notifies the consummated trade details to custodians who • affirm back. Based on the affirmation, NSCCL determines • obligations. • 3. Download of obligation and pay-in advice of funds/ securities. • 4. Instructions to clearing banks to make funds available by pay-in- • time. • 5. Instructions to depositories to make securities available by pay-in- • time.

  37. Clearing and settlement Process • 6. pay-in of securities (NSCCL advises depository to debit pool • account of custodians and credit its account and depository does • it). • 7. pay-in of funds (NSCCL advises Clearing Banks to debit account • of custodians and credit its account and clearing bank does it). • 8. Pay-out of securities (NSCCL advises depository to credit pool • account of custodians and debit its account and depository does • it). • 9. Pay-out of funds (NSCCL advises Clearing Banks to credit • account of custodians and debit its account and Clearing Banks • does it). • 10. Depository informs custodians • 11. Clearing Banks inform custodians

  38. Clearing and settlement Process • Custodians ( for A who is buyer and for B who is seller) • Clearing bank records the following entries: • (for 7) Custodian ( for A) A/C ……Dr • To NSCCL A/C • (for 9) NSCCL A/C ……..Dr • To Custodian (for B) A/C • Depositories record the following entries (shares): • (for 6) Custodian ( for B) A/C ……Dr • To NSCCL A/C • (for 8) NSCCL A/C ……..Dr • To Custodian (for A) A/C

  39. Settlement CycleRolling Settlement • At NSE and BSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2nd working day. • For arriving at the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays and Sundays are excluded. • Typically trades taking place on Monday are settled on Wednesday, Tuesday's trades settled on Thursday and so on.

  40. A tabular representation of the settlement cycle for rolling settlement

  41. Index-based Market-wide Circuit Breakers(w.e. from July 2001) • The index-based market-wide circuit breaker system applies at 3 stages of the index movement, either way viz. at 10%, 15% and 20%. • These circuit breakers when triggered, bring about a coordinated trading halt in all equity and equity derivative markets nationwide. • The market-wide circuit breakers are triggered by movement of either the BSE Sensex or the NSE S&P CNX Nifty, whichever is breached earlier.

  42. Duration of trading halt (in minutes)

  43. Risk ManagementMargin Money • Categorisation of stocks for imposition of margins • The Stocks which have traded atleast 80% of the days for the previous six months shall constitute the Group I and Group II. • Out of the scrips identified above, the scrips having mean impact cost of less than or equal to 1% shall be categorized under Group I and the scrips where the impact cost is more than 1, shall be categorized under Group II. • The remaining stocks shall be classified into Group III.

  44. The impact cost shall be calculated on the 15th of each month on a rolling basis considering the order book snapshots of the previous six months. On the basis of the impact cost so calculated, the scrips shall move from one group to another group from the 1st of the next month. • For securities listed for < 6 months, the trading frequency and the impact cost shall be computed using the entire trading history of the security.

  45. What is impact cost? • What is impact cost? It is the cost of executing a transaction on the stock exchanges. • Suppose you want to buy 150 shares of Titan. • You would be able to buy the first 129 shares at a price of Rs237.7 per share. However, to buy the remaining 21 shares, you have to pay Rs237.9 per share. The higher the number of shares that you want to buy will have an impact on the price of the stock. • This is measured by what is known as the impact cost of the trade.

  46. The average buy price for 150 shares= • (Rs237.7x129 + Rs237.9x21)/150 = Rs237.728 • The average of the best bid and ask price is given by Rs 237.475. • You should ideally expect to buy or sell shares of Titan at this price. • The impact cost of the order is therefore given by: • Impact cost = (237.728 – 237.475)/237.475 • = 0.106%

  47. What does impact cost signify? • It means you incurred a cost of 0.106% to buy 150 shares because of the liquidity conditions in that stock. The more liquid a stock is the lower its impact cost.

  48. Value at Risk Margin

  49. Index VaR • The index VaR would be the higher of the daily Index VaR based on S&P CNX NIFTY or BSE SENSEX. The index VaR would be subject to a minimum of 5%.

  50. Computation VaR • Calculate the daily logarithmic return of share • Ri = In (Pi / Pi-1) • Compute the initial volatility by calculating the standard deviation of returns for the one year period using the formula • SD = σ0 = [ 1/n {Ri – E(Ri)}2 ]