Capital Markets

Capital
M arkets
Capital
M arkets
Dr S GURUSAM Y
Professor and Head
Department of Commerce
University opf Madras
Chennai
Tata McGraw Hill Education Private Limited

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Capital Markets, 2/e

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Contents
Preface................................................................... XV
Chapter 1 Financial Markets
Definition .......................................................................... 1
Location ............................................................................. 1
Role ................................................................................... 2
Functions .......................................................................... 2
Constituents ...................................................................... 3
Financial Instruments ...................................................... 9
Indian Financial Market .................................................. 13
Global Financial Markets ................................................. 18
Review Questions ............................................................. 19
Chapter 2 Capital Market

Money Market .................................................................. 21
Indian Capital Market—Evolution and Growth ............... 23
Constituents of Indian Capital Market ............................. 27
New Financial Institutions .............................................. 29
New Financial Instruments ............................................. 32
Capital Market Doldrums ................................................. 34
Measures of Reactivation .................................................. 36
Measures of Investor Protection ....................................... 37
Recent Initiatives in the Indian Capital Market ............... 38
Indian Capital Market—Major Issues .............................. 40
Rebound in Indian Capital Market ................................... 44
vi Ca pi ta l M arkets
Chapter 3 Capital Market Instruments

Meaning ........................................................................... 47
Types ................................................................................ 47
Preference Shares ........................................................... 47
Equity Shares .................................................................. 49
Non-Voting Equity Shares ................................................ 51
Convertible Cumulative Preference Shares (CCPS) .......... 52
Company Fixed Deposits .................................................. 53
Warrants .......................................................................... 54
Debentures and Bonds ...................................................... 55
Global Debt Instruments .................................................. 59
Chapter 4 Regulation of Indian Capital

M arket
Genesis ............................................................................. 69
The Factors ...................................................................... 69
The Regulatory Framework ............................................ 72
Committees on Regulatory Framework ........................... 87
Chapter 5 D erivatives Market

Meaning of Derivatives ..................................................... 92
Growth of Derivatives Market—Factors ........................... 92
Limitations of Derivatives Market ................................... 93
Functions of Derivatives Market ...................................... 94
Categories of Derivatives .................................................. 95
Forward Contract Vs. Futures Contract ........................ 102
Option Based Derivatives ............................................... 103
Futures and Options—Participants ............................... 105
Benefits of Derivatives .................................................... 109
Risks in Derivatives Market .......................................... 112
Capital Standards for Derivatives .................................. 120
Regulating Derivatives Market ...................................... 120
Advent of Derivatives Market in India ........................... 120
Review Questions ........................................................... 121
Con t en t s vi i
Chapter 6 SEBI— Functions and Working

Genesis ........................................................................... 124
Features of the SEBI Bill ............................................... 124
Objectives ....................................................................... 124
Management .................................................................. 125
Powers and Functions .................................................... 125
Regulatory Role .............................................................. 131
Role and Relevance ......................................................... 131
Chapter 7 Investor Protection

Loss of Confidence of Small Investor—Causes ................ 139
Rights of Investors ......................................................... 141
Facilities by BSE ............................................................ 141
Ombudsman ................................................................... 149
Chapter 8 Insider T rading

Rationale ........................................................................ 157
Insiders—Categories ...................................................... 157
Insider Information ........................................................ 158
Connected Persons ......................................................... 158
Need for Control ............................................................. 159
Prohibition of Insider Trading ........................................ 159
Investigation by SEBI .................................................... 160
Action by Corporates ...................................................... 161
Chapter 9 Stock Exchange

History of Stock Exchanges ............................................ 165
Meaning ......................................................................... 167
Definition ....................................................................... 167
Functions/ Services/ Features/ Role ............................... 168
Stock Exchange and Commodity
Exchange Distinguished ................................................. 174
vi i i Capi tal Mar kets
World’s Stock Exchanges ................................................ 175

Organization Structure .................................................. 179
Mode of Organization ...................................................... 181
Stock Exchange Traders ................................................. 182
Jobbers and Brokers ....................................................... 185
Jobbers Vs. Brokers ........................................................ 186
Weaknesses .................................................................... 186
Regulation of Stock Exchanges ....................................... 189
Steps in Stock Trading ................................................... 192
Mechanics of Settlement ................................................. 194
Systems of Stock Trading ............................................... 196
Specialists ...................................................................... 198
Recent Developments ...................................................... 200
Interconnected Stock Exchange of India (ISE) ................ 203
Indonext ......................................................................... 204
Chapter 10 Indian Stock Exchange

The Bombay Stock Exchange (BSE) ............................... 210
For New Companies ....................................................... 211
For Companies Listed on Other Stock Exchanges .......... 212
For Companies Delisted Already and Seeking Relisting of
this Exchange ................................................................ 213
Safety of market ............................................................. 215
Opportunities for Foreign Investors ............................... 217
Shortages and Objections ............................................... 223
Derivatives Trading ........................................................ 229
Calcutta Stock Exchange ................................................ 230
The National Stock Exchange of India Limited (NSE) ... 233
Chapter 11 Prim ary Market

NIM and Secondary Markets—An Interface ................... 249
Services of NIM .............................................................. 250
NIM Vs. Secondary Market ............................................ 251
Con t en t s ix
Chapter 12 Methods of New Issue

Methods of Marketing Securities .................................... 253
Stock Option or Employees Stock
Option Scheme (ESOP) ................................................... 264
Bought-out Deals Vs. Private Placements ...................... 267
Chapter 13 Intermediaries in New Issues

M arket
Intermediaries in NIM ................................................... 271
Merchant Bankers/Lead Managers ................................ 271
Underwriters .................................................................. 275
Bankers to An Issue ....................................................... 277
Brokers to an Issue ........................................................ 279
Registrars to an Issue and Share Transfer Agents ......... 280
Debenture Trustees ........................................................ 281
Chapter 14 SEBI Guidelines on Primary

M arket
SEBI Guidelines for Listed and Unlisted Companies ...... 287
Chapter 15 Listing
Security Listing ............................................................. 299
Security .......................................................................... 299
Stock Exchange .............................................................. 299
Recognized Stock Exchange ............................................ 299
Legal Provisions ............................................................. 300
Steps ............................................................................... 301
Legal Significance .......................................................... 302
Refusal of Listing ........................................................... 302
SEBI Powers .................................................................. 302
Listing and Corporate Governance ................................. 302
Particulars to be Furnished ........................................... 303
x Ca pi t al Ma rkets
Listing Agreement .......................................................... 304

Stock Exchange Powers .................................................. 305
Listing—Benefits ............................................................ 306
Consequences of Non-listing ........................................... 306
New Entry Norms for Unlisted Companies .................... 306
Listing—Suspension / Withdrawal ................................. 307
Chapter 16 Underwriting
Definition ....................................................................... 309
Types .............................................................................. 309
Mechanics of Underwriting ............................................ 311
Benefits/Functions ......................................................... 311
Indian Scenario .............................................................. 313
Underwriting Agencies ................................................... 313
Obstacles ........................................................................ 314
Underwriter ................................................................... 315
Underwriting Agreement ................................................ 316
SEBI Guidelines ............................................................. 316
Variants of Underwriting ............................................... 318
Grey Market ................................................................... 321
Chapter 17 Book-Building
Concept ........................................................................... 323
Characteristics ............................................................... 323
The Process .................................................................... 325
Allocation Procedure ....................................................... 331
Case I—Initial Public Offer (IPO) Issue ......................... 331
Illustration ..................................................................... 332
Case II—Additional Issue by Listed Company ................ 333
Illustration ..................................................................... 335
Case III—Offer by Unlisted Company ............................ 336
Illustration ..................................................................... 337
Reverse Book-building .................................................... 338
Con t en t s xi
Chapter 18 Over the Counter Exchange of

India (OT CEI)
Genesis ........................................................................... 343
OTCEI Vs. Other Stock Exchanges ................................ 344
Over-the-Counter ............................................................ 345
Need and Objectives ....................................................... 346
Features ......................................................................... 347
Benefits .......................................................................... 351
Securities Traded ............................................................ 353
Players ........................................................................... 354
Members and Dealers ..................................................... 355
Sponsorship .................................................................... 356
Admission of Members—Conditions ............................... 357
Admission of Dealers—Conditions .................................. 358
Registrars and Custodians ............................................. 359
Central Clearing Bank ................................................... 359
Monitoring Agencies ....................................................... 360
Trading Mechanism ....................................................... 360
Settlement Procedure ..................................................... 364
Slow Growth of OTCEI—Causes .................................... 366
Revamping OTCEI ......................................................... 367
Working of NASDAQ ...................................................... 368
Changing Role of OTCEI ................................................ 368
Major Changes in OTCEI Functioning ........................... 369
New Norms .................................................................... 370
Utility of OTCEI’s New Listing Norms to
Entrepreneurs ................................................................ 371
OTCEI MOU with NASSCOM ....................................... 371
Revision in Composite Index ........................................... 372
Clearing and Settlement ................................................. 372
Technology ..................................................................... 373
xi i Cap i tal Mark ets
Chapter 19 Stock Market Index

Meaning ......................................................................... 375
Features ......................................................................... 375
BSE INDEX .................................................................... 378
BSE-SENSEX ................................................................. 379
2. BSE-TECk Index .................................................... 383
3. BSE-PSU Index ...................................................... 386
4. BSE-100 Index ........................................................ 387
5. BL-250 Stock Index ................................................ 388
6. BSE BANKEX ........................................................ 389
7. S&P CNX Nifty ...................................................... 390
S&P CNX Nifty Vs. BSE Sensitive Index ....................... 396
Dow Jones Indices .......................................................... 397
NASDAQ Stock Market Indices ..................................... 398
NASDAQ Index Calculation Description ........................ 402
Other Index Descriptions ................................................ 403
S & P 500 Index ............................................................. 406
1. S&P Global 1200 .................................................... 406
2. S&P Global 1200 Sector Indices ............................. 409
Hang Seng Index ............................................................ 410
DAX Index ...................................................................... 410
Straits Times Index ........................................................ 410
KOSPI ............................................................................ 410
FTSE .............................................................................. 410
MSCI (Morgan Stanley Capital International Inc) Index 411
India Index Services Ltd (IISL) ...................................... 413
Chapter 20 Stock Market T rading

M echanism
Jobbers and Brokers ....................................................... 415
Jobbers Vs Brokers ......................................................... 416
Stock Exchange Dealings ............................................... 416
Speculative Dealings ...................................................... 417
Share Prices—Factors .................................................... 420
Con tent s x i i i
Regulating Speculation ................................................... 423

The Securities Contracts (Regulation) Act ...................... 423
Magin Trading ............................................................... 425
Trading of Securities—Steps ........................................... 430
Margins .......................................................................... 435
Badla System ................................................................. 437
Current Trading System—Problems and Palliatives ...... 440
Chapter 21 D epository Services

Depository ...................................................................... 447
Bank and Depository—Comparison ................................ 448
Depository Participant (DP) ........................................... 448
Depository (Demat) Services ........................................... 448
Services/Functions ......................................................... 450
Demat (Beneficiary) Account .......................................... 455
Dematerialization ........................................................... 459
Electronic Settlement of Trade—Procedure .................... 461
Demat of Debt Instruments ........................................... 462
Safety System for Demat ................................................ 462
Shortcomings of Demat System ..................................... 463
Indian Depository ........................................................... 466
Role of CDSL .................................................................. 466
Constitution ................................................................... 467
Major Tasks ................................................................... 467
Benefits .......................................................................... 467
Role of NSDL .................................................................. 468
Depository Stock Exchanges ........................................... 468
Legal Framework ........................................................... 469
Chapter 22 Speculation
Speculation Vs. Gambling .............................................. 471
Investors Vs. Speculators .............................................. 472
Types of Speculators ....................................................... 473
xi v Cap i tal Mark ets
Chapter 23 On-line Stock T rading

Meaning ......................................................................... 477
Features ......................................................................... 477
Current Scenario ............................................................ 478
Internet Trading—Alternatives ...................................... 478
Internet Trading—Some Issues ...................................... 479
Regulating Internet Stock Trading ................................. 490
IPOs on the Internet—Indian Experience ....................... 492
E-IPO Prospectus ........................................................... 492
E-Commerce Act and Internet Stock Trading ................. 494
Chapter 24 D ebt Market

Advantages ..................................................................... 499
Risks on Debt ................................................................. 500
Issuers Profile ................................................................ 500
Types .............................................................................. 501
Role of Bond Market ....................................................... 502
Price Determination—Factors ........................................ 502
Yield of Bond ................................................................... 503
Yield and Price ............................................................... 503
Secondary Debt Market .................................................. 503
Repos and Normal Buy or Sell ....................................... 504
Broken Period Interest ................................................... 505
Guidelines for Issue of Debt Instruments ....................... 505
Index ---------------------------------------------------------- 515

Preface
Capital Markets serves as an ideal arena for raising long-term
funds needed for trade and industry. It contributes to the
development and growth of the industry and its role is significant
in a developing country like India, where funds are raised by
issuing various types of securities such as equity, bonds, etc.
This book ‘Capital Markets’ has been authored to present in
lucid details the various aspects pertaining to capital markets
such as types, instruments used for raising long-term funds,
intermediaries etc. The book contains 24 chapters.
A notable feature of the book is that it has been written in a
clear and simple language and is student-friendly. The book
contains topics that are relevant and contemporary. Topics such
as SEBI, Derivatives Market, Insider Trading, Listing,
Book-Building, OTCEI, etc are worthy of mention. In addition,
the book also contains topics such as Depository Services,Stock
Market Index,On-line Stock Trading, etc. I have also taken special
care to ensure that all the concepts and ideas on Capital Markets
have been presented exhaustively and in a simple way.
My deep sense of gratitude goes to my mentor and research
guide (late) Dr N Vinayakam, who was my inspiration for this
work. I am indebted to my beloved parents whose blessings were
the source of strength for writing this book. My acknowledgments
are due to my wife and my children for their excellent cooperation
in making this venture successful.
I take this opportunity to express my sincere thanks to
Mr P K Madhavan and his colleagues at M/s Vijay Nicole Imprints
for ensuring the timely completion of this book.
Dr S GURUSAMY
Chapter 1
Financial Markets
A market as defined by economists refesrs to an institution or arrangement

that facilitates the purchase and sale of goods and services, and other
things. A financial market is an institution or an arrangement that facilitates
the exchange of financial instruments, including deposits and loans,
corporate stocks and bonds, government bonds, and more exotic
instruments such as options and futures contracts.
A market wherein financial instruments such as financial claims, assets
and securities are traded is known as a ‘financial market’. Financial market
transactions may take place either at a specific place or location, e.g. stock
exchange, or through other mechanisms such as telephone, telex, or other
electronic media. In financial markets, the price for the use of investible
funds is the interest paid on the funds transacted.
DEFINITION
According to Brigham, Eugene F, “The place where people and
organizations wanting to borrow money are brought together with those
having surplus funds is called a financial market.”
LOCATION
A financial market may or may not have a particular physical existence. For
instance, the New York Stock Exchange (NYSE) is physically located on
Wall Street in New York City. Alternatively, the over-the-counter (OTC)
market for stocks, called the National Association of Securities Dealers
(NASD) has no fixed place of existence. It consists of brokers throughout
the country who track prices via computer and telecommunication lines.
NASD is best known for the newspaper quotes of stock prices it generates
called NASDAQ (National Association of Securities Dealers Automatic
Quotation System).
2 Capi tal Markets
ROLE
One of the important requisites for the accelerated development of an
economy is the existence of a dynamic and a resilient financial market. A
financial market is of great use for a country as it helps the economy in the
following ways:
Mobilization of Savings
Obtaining funds from the savers or ‘surplus’ units such as household
individuals, business firms, public sector units, Central Government, State
Governments, Local Governments, etc is an important role played by
financial markets.
In v e stm e n t
Financial markets play a key role in arranging to invest funds so collected,
in those units which are in need of the same.
National Growth
An important role played by financial markets is that they contribute to a
nation’s growth by ensuring an unfettered flow of surplus funds to deficit
units. The flow of funds for productive purposes ensures growth of
investment and employment.
Entrepreneurship Growth
Financial markets contribute to the development of the entrepreneural
class by making available the necessary financial resources, etc.
Industrial Development
The different components of financial markets help an accelerated growth
of industrial. This contributes to the enhancement of the standard of
living and the society’s well-being.
FUNCTIONS
A financial market renders the following functions:
Intermediary Functions
The intermediary functions of a financial market include the following:
Transfer of resources Financial markets facilitate the transfer of real
economic resources from lenders to ultimate borrowers.
Enhancing income Financial markets allow lenders earn interest/
dividend on their surplus investible funds, thus contributing to the
enhancement of the individual and the national income.
Fi na nci al M ark et s 3
Productive usage of funds Financial markets allow for the productive

use of the funds borrowed, thus enhancing the income and the gross
national production.
Capital formation Financial markets provide a channel through which
new savings flow to aid capital formation of a country.
Price determination Financial markets allow for the determination of
the price of the traded financial asset through the interaction of buyers
and sellers. They provide a signal for the allocation of funds in the economy,
based on the demand and supply, through the mechanism called ‘price
discovery process’.
Sale mechanism Financial markets provide a mechanism for selling of
a financial asset by an investor so as to offer the benefits of marketability
and liquidity of such assets.
Information The activities of the participants in the financial market
result in the generation and the consequent dissemination of information
to the various segments of the market. This results in reduced cost of
transaction of financial assets.
Financial Functions
The financial functions of a financial market include the following:
1. Providing the borrowers with funds so as to enable them to carry
out their investment plans
2. Providing the lenders with earning assets so as to enable them to
earn wealth by deploying the assets in productive ventures
3. Providing liquidity in the market so as to facilitate trading of
funds
CONSTITUENTS
A typical U.S. financial market comprises the following constituents:
1. Primary Market
2. Secondary Market
3. Money Market
4. Capital Market
5. Debt Market
6. Eurobond Market
7. Equity Market
8. Financial Services Market
9. Depository Market
10. Non-depository Market
4 Capi tal Markets
The following Exhibit 1 shows the constituents of a typical financial

market:
Exhi bi t 1 Fi n an ci al M ar ket — Con st i t u en t s
Primary Market
Primary market deals with the issue of new securities. In this market, the
government or the corporate sector issues securities that change hands
from the issuer to the investor. This way, newly issued financial assets are
bought and sold. For instance, if L&T issues new shares, the shares are
sold in the primary market.
Sec ondar y Mar ket
Secondary market deals with existing claims. There is no new flow of
funds for instruments in this market. No fresh capital is made available to
the producers on account of the transactions in the secondary market, as
they deal only in existing securities.
The secondary market renders a very important service to the primary
market by providing a ready market for trading in securities. The volume
and the magnitude of the transactions taking place in the secondary market
influence the activities in the primary market. For instance, if there is an
active trading for the scrips of a particular company, it is possible for that
company to raise additional capital with ease and convenience because of
the goodwill already generated for the scrips.
Existing financial assets of a company are bought and sold in the
secondary market. The existence of a secondary market for a financial
asset enhances its liquidity. For example, if a person buys a share of L&T
in the primary market he can easily sell it for cash because, the shares are
actively traded in the secondary market. All that is required is to inform a
broker about the decision to sell the scrips. The broker, in turn, locates a
buyer and sells the scrips for the client.
The presence of a secondary market helps lower the transaction costs,
as finding buyers and sellers becomes an easy job. In the absence of a
secondary market for a stock, one has to personally locate someone willing
to buy the stock. This would not only take considerable time, but it may
not be possible to locate the buyer who is willing to pay the highest
possible price for the stock. A secondary market is, therefore, that which
allows dealing between buyers and sellers of existing shares which
ultimately serves to enhance the liquidity of corporate stock. This induces
investors to own stock and therefore makes it easier for firms to acquire
funds in the primary market.
Money Market
Meaning Money market is a market where short-term instruments that
mature in a year or earlier are traded.
F e a tur e s
1. Short-term financing Money market facilitates short-term financing
and assures the liquidity of short-term financial assets. Money market
meets the working capital (short-term) requirements of industry, trade and
commerce.
2. Nerve centre Money market acts as the nerve center of all the
operations of the central bank of a country. It reflects the changes in
short-term parameters such as interest rates, monetary policy, availability
of short-term credit, etc.
3. Liquidity adjustment Money market provides a mechanism of liquidity
adjustment between individuals, institutions, and government. It serves
as a medium of exchange between the holders of temporary cash surpluses
and temporary cash deficits. Borrowers are assured that short-term funds
can be quickly obtained and lenders are assured that their short-term
financial assets can be quickly converted into cash.
6 Capi tal Markets
4. Central bank The central bank that is responsible for regulating and
controlling the money supply in an economy conducts most of its
operations in the money market. The central bank, occupying a pivotal
position in the money market is responsible for its promotion and
development. The flow of money and credit in the money market is regulated
and controlled by the central bank through a plethora of qualitative and
quantitative measures.
5. Risk Money market offers a low capital loss (money risk), as
instruments traded are short-term in nature, besides offering a low risk of
default (credit risk). This is because, money market instruments are mostly
in the form of the liabilities of the government, central bank and commercial
banks.
6. Submarkets A developed money market consists of specialized
submarkets such as central banks, commercial banks, cooperative banks,
saving banks, discount houses, acceptance houses, bill market, bullion
market, etc.
Capital Market/Securities Market
Meaning The market where long-term funds are borrowed and lent is
known as a capital market, the primary purpose being directing the flow of
savings into long-term investments (mostly for a period of one year and
above).
F e a tur e s
1. Demand for funds Demand for long-term funds arise from individuals,
institutions, central government, state government, local self government
and the private corporate sector.
2. Instruments Funds are raised through issue of financial instruments
such as shares, debentures and bonds.
3. Supply of funds Individuals (household sector), institutions, banks
and industrial financial institutions are the main sources of supply of
long-term funds.
4. Ideal conduit The capital market acts as an ideal conduit for the
transmission of savings of surplus units to deficit units which demand
long-term funds.
5. Economic growth Capital market plays a significant role in the financial
system by promoting savings and investments, which are vital for the
development and growth of an economy. It accelerates the pace of economic
development. The primary capital market helps government and industrial
concerns in raising funds by facilitating the issue of various kinds of
securities. The secondary market provides liquidity to the outstanding/

existing securities.
6. Price mechanism The price mechanism prevalent in the active capital
market ensures optimal allocation of scarce financial resources to the most
productive sectors of the economy. The system of allocation of funds
works through incentives and penalties. Accordingly, companies that
operate efficiently can sell securities at premium (incentives). Conversely,
companies with poor performance face problems in selling their securities
and may have to issue securities at a discount to raise additional funds or
offer higher rates of interest.
Debt Market
The market where funds are borrowed and lent is known as ‘debt market’.
Arrangements are made in such a way that the borrowers agree to pay the
lender the original amount of the loan (called the principal) plus some
specified amount of interest. The use of debt markets is different for
different people. For instance, individuals use debt markets to borrow
funds to finance purchases such as new cars and houses; corporates use
them for obtaining working capital and new equipment; federal, state, and
local governments use them to acquire funds to finance various public
expenditures. Issue of new funds occurs in the primary debt market, and
purchase and sale of debt instruments in the secondary debt market.
Eurobond Market
A market where bonds are denominated in currency other than that of the
country, in which they are issued, is called ‘Eurobond Market’. Eurobond
market is international in character as for example, a French firm may engage
a German investment banking syndicate to sell dollar-denominated bonds
and so on. A striking characteristic of Eurobonds is that, bulk of these
bonds is denominated in dollars. The multiple-currency bonds are
denominated in a weighted average of many currencies.
Equity Markets
A market where ownership securities are issued and subscribed is known
as ‘equity market’. An example of a secondary equity market for shares is
the Bombay Stock Exchange.
Financial Services Market
A market that comprises participants such as commercial banks etc that
provide various financial services like ATM, credit cards, credit rating,
factoring, leasing, stock-broking etc is known as a ‘financial services market’.
8 Capi tal Markets
Individuals and firms use financial services markets to purchase services

that enhance the working of debt and equity markets.
Depository Market
A depository market consists of depository institutions that accept deposits
from individuals and firms, and use these funds to participate in the debt
market, by giving loans or purchasing other debt instruments such as
Treasury Bills etc. It is a special type of loan market in which depositors
“loan” money to depository institutions, which in turn use the funds to
purchase other financial assets. The major types of depository institutions
are commercial banks, savings and loan associations, mutual savings banks,
and credit unions. A brief description of these is given below:
Commercial banks Commercial banks comprise the largest and most
important depository institutions in a depository market. They have the
largest and most diverse collection of assets among all depository
institutions. Their main source of funds include demand deposits, time
deposits and certificates of deposit.
Sav i ng s a n d l oa n a ss o ci a ti o ns Savings and loan associations
were originally designed as mutual associations, (i.e. owned by depositors)
to convert funds from savings accounts into mortgage loans. The purpose
was to ensure a market for financing housing loans.
Mutual savings banks Mutual savings banks are similar to savings
and loans associations, but are owned cooperatively by members with a
common interest, such as company employees, union members, or
congregation members. Originally they accepted deposits and made
mortgage loans.
Credit unions Credit unions are organized as cooperative depository
institutions, in as much the same way as mutual savings banks. Depositors
are credited upon purchasing shares in the cooperative, which they own
and operate. Like savings and loans associations, credit unions were also
originally restricted by law to accept savings deposits and make consumer
loans.
Non-depository Market
Non-depository market comprises of institutions that do not accept
cheques to liquidate deposits. They carry out various functions in financial
markets, ranging from financial intermediation to selling insurance. A brief
description of the various constituents is given below:
Mutual funds Firms that sell shares to investors and invest the
proceeds in a variety of financial assets are called mutual funds. Owners
of shares receive pro-rata share of the earnings from these assets, minus
management and other fees assessed by the fund. Some mutual funds,
called money market mutual funds, invest in short-term, safe assets such
as U.S. treasury bills and large bank certificates of deposit. Largely, for
historical reasons, money market mutual funds are not considered
depository institutions even though shareholders are often allowed to
write cheques on their accounts. Unlike depository institutions, money
market mutual funds do not promise that the price of a share will stay
constant; but in reality, the price of each share does not fluctuate over
time like prices of stock.
Insurance companies Companies that protect individuals against risk
are called insurance companies. Life insurance companies accept regular
payments from individuals in exchange for contracted payments in the
event of the death of the insured. They hold long-term assets, like long-
term bonds and substantial quantities of commercial real estate. Other
insurance companies, called fire and casualty insurance companies, insure
cars, houses etc against loss from fire, theft, and accident.
Pension funds Funds that are operated by the private and government
employers (including federal, state, and local) and that which provide
retirement income to employees, are called pension funds. Money is
collected by regular contribution from employees, usually via, payroll
deduction. The funds flowing in, are in the nature of fixed deposits. Like
Life insurance companies, these institutions can accurately predict payouts
and hence can hold long-term assets. They hold portfolios consisting
mostly of stocks and bonds. The return on these assets are paid out to
participating individuals when they reach retirement age.
Brokerage firms Brokerage firms bring buyers and sellers of stock
together for the purchase and sale of financial assets. They function as
intermediaries, earning a fee for each transaction. Their main function is to
serve as brokers in the secondary debt and equity markets.
FINANCIAL INSTRUMENTS
The instruments that help in borrowing and lending of money are called
‘financial instruments’. A brief description of some of these instruments
as traded in the U.S. financial market is given below:
Money Market Instruments
The most liquid, short-term debt obligations that are traded in the money
market are called money market instruments. Some of these instruments
are briefly described below:
10 Capi tal Markets
Commercial paper A form of direct short-term finance issued by large,

creditworthy companies is called a Commercial Paper. It is a typical debt
instrument sold by one company to another company or financial institution
to raise immediate funds. It contains a promise to pay back a higher specified
amount at a designated time in the immediate future, say, 30 days. By
issuing Commercial Paper, a corporation avoids the process of applying
for a loan and instead engages in direct finance. To engage in direct finance
effectively, the issuing company must be large and creditworthy enough
to find someone willing to accept its Commercial Paper, which is sold with
the help of brokers. The growing use of Commercial Paper has increased
the competitive pressure on banks, which are finding some of their potential
loan customers turning to the Commercial Paper market.
Certificates of deposit (CDs) These are the debt instruments sold by
banks and other depository institutions. A CD pays the depositor a
specified amount of interest during the term of the certificate, plus the
purchase price of the CD at maturity.
Treasury bills Treasury bills, also called T-bills, are short-term debt
instruments used by the government to obtain funds. They are issued in
3, 6 and 12-month maturities. These instruments do not make regular interest
payments; instead they are sold at a discount. This means that such bills
are sold for an amount that is less than the amount promised by government
at maturity. The difference between the purchase price and the face value
is the return from the T-bill purchase. The advantages of ready market and
zero default risk from the Federal Government makes this instrument very
attractive.
Treasury bonds These are the popular U.S. government securities.
These include Treasury bonds having a maturity of 10 years and T – notes
with a maturity of 1 to 10 years. These bonds also earn implicit interest,
which is the difference between the issue price and maturity value.
Repurchase agreements An agreement by two parties in which the
borrower sells and agrees to buy back a financial instrument, a government
bond, note, or T-bill, is called a repurchase agreement. It is popularly
known as ‘repo’ and is generally used by banks. For instance, if a bank
needs short-term cash today, it can sell some Treasury bills to a firm such
as IBM with the agreement that the bank will repurchase the T-bills in
30 days at a higher price. In effect, this repurchase agreement is a
short-term loan in which the Treasury bills serve as collateral.
Eurodollars US dollars deposited in banks located in countries other
than the U.S. are called ‘Eurodollars’. It is customary for foreign banks and
offshore branches of U.S. banks to hold dollar deposits to service firms
Fi nan ci a l M ark ets 11
engaged in international trade and use it for other purposes as well. US

banks sometimes borrow Eurodollars when they need short-term funds.
Banker’s acceptances An arrangement whereby a bank promises to
pay on a specific date, which is accepted, and guaranteed by another bank
is known as ‘bankers’ acceptance’. It is essentially a letter of credit. It is
similar to a post-dated cheque or a bank draft. However, a banker’s
acceptance is more valuable as a medium of exchange than a standard
cheque. This is because, there is a greater certainty of the acceptance
being honored. The party issuing a banker’s acceptance pays a fee to the
bank for its guarantee. Banker’s acceptances are particularly valuable in
international transactions. It provides a measure of protection for firms in
ensuring due payment by the importers. There is a relatively small
secondary market for banker’s acceptances, which essentially operates as
a scaled-down version of the market for Treasury bills.
Capital Market Instruments
The principal capital market instruments are described below:
Corporate stock An equity instrument that represents ownership of a
share of the assets and earnings of a corporation is called ‘corporate
equity’. A firm undertakes sale of stock when it wishes to mobilize capital
required for taking up new investment projects or for modernization and
expansion projects. The profits earned by a corporation and paid to share-
holders are known as dividends. Unlike interest payments, dividends can
vary with the health of the company. A company would receive money
only when shares or stock are issued by it. Shares are also offered to
underwriters or investment banks that guarantee the firm a certain price
for the issue. The Investment banker then sells the stock to individual
investors, with the assistance of brokers, at what they hope is a higher
price than the guaranteed price. Effectively, the underwriters provide in-
surance to the company issuing the new stock and bear the risk associ-
ated with the low price investors pay for the stock.
When a new issue is in the hands of individual investors, the stock
can be sold and bought by another investor (with the help of a broker) in
a secondary stock market such as the New York Stock Exchange or the
American Stock Exchange. In this connection, funds transferred in the
secondary markets pass between individual buyers and sellers of the
stock rather than to the corporation. Individuals own the majority of stock
in the United States and, pension funds, insurance companies, and mutual
funds own the rest.
12 Capi tal Markets
Corporate bonds A corporate bond is a debt instrument issued by a

corporate entity that contains a promise that the firm will make specified
interest payment, and, a principal amount or the “face value” on the
maturity of the instrument. The original purchaser of a bond buys this
promise from the firm for an up-front amount, known as the price of the
bond. Unlike stockholders, bondholders own no share of profits.
Bondholders are entitled only to the interest payments and the face value
due on maturity. The firm’s “promise” is valuable to the purchaser of the
bond only if the firm does not go bankrupt. This presupposes that only
strong and credible corporations tend to issue bonds.
Corporate bonds, like corporate stock, provide funds to the issuing
firm when sold in the primary market. Like stocks, new bond issues are
underwritten by investment banks, which sell these bonds to individual
investors. When bonds are bought and sold in the secondary bond market
(for example, the New York Bond Exchange), money changes hands among
individual investors, and no funds flow to the corporation that issued the
bond.
Mortgages A debt instrument used to finance the purchase of a home
or other form of real estate where the underlying real estate serves as a
collateral for the loan, is known as a ‘mortgage’. If the borrower defaults,
the lender receives title to the real estate towards payment of the debt. The
two major types of mortgage instruments are fixed-rate and adjustable-
rate mortgages. Each type of mortgage specifies a term (the length of the
mortgage), and a down payment (usually expressed as the fraction of the
house value that must be paid up-front as prepaid interest).
A fixed-rate mortgage specifies an interest rate that is fixed during the
term of the loan, whereas the rate on an Adjustable Rate Mortgage (ARM)
can change (usually every one or three years). An adjustable rate mortgage
also stipulates a margin that reflects the premium above some index of
interest rates (usually one-year U.S. Treasury bills) that will be used to
adjust the interest rate at a specified time during the term. It also stipulates
a cap, which is the maximum amount by which the rate can change at any
adjustment point, and a ceiling and floor, or the maximum and minimum
interest rate.
Co m m e r c i a l l o a n s
Commercial loans are loans obtained by
individuals for intermediate-term purchases such as the purchase of
merchandise etc with credit cards. Commercial loans are essentially credit
lines issued to businesses. There is a less active secondary market for
consumer and commercial loans, making them the least liquid of all capital
market instruments. However, there has been a growing movement to

securitize (convert to marketable securities) some consumer debt.
Municipal bonds State and local governments issue municipal bonds to
obtain long-term funds for financing such projects as highways and
schools. Interest payments these bonds receive are exempt from Federal
income tax (although some state and local governments do collect income
tax on municipal bond interest earnings). This makes municipal bonds an
attractive investment for lenders in high-income tax brackets.
INDIAN FINANCIAL MARKET

The Indian financial market mainly comprises of the money market and
capital market. A brief description of the different contours of the Indian
financial market is presented below:
Indian Money Market
The features of the Indian money market, which is composed of organized
and unorganized markets, are presented below:
Or g a n i ze d m o n e y m a r ke t
a. Constituents The constituents of organised Indian money
market include Reserve Bank of India, State Bank of India and its
subsidiaries, commercial banks, finance corporations, bill market
and bullion market.
b. Principal centers The principal centers of the organized money
markets are Mumbai, Kolkata and Delhi. Mumbai is considered
to be the ‘financial capital’ of India because of the presence of
the head office of Reserve Bank of India and some commercial
banks, leading stock exchanges, well organized market for gilt
edged securities, and bullion market.
c. Banking system The banking system is the most dominant
force in this part of the Indian money market. The banking system
consists of scheduled banks and non-scheduled banks.
Scheduled banks comprise of state cooperative banks and
scheduled commercial banks. Scheduled commercial banks
include both foreign banks and Indian banks. They exist both in
public as well as private sector.
The scheduled banks constitute the largest banking group in
terms of offices/branches, deposits, and advances in India. The
share of non-scheduled banks is very small in terms of the
afore-mentioned banking indicators. Within the scheduled
14 Capi tal Markets
commercial banks, the public sector banks, i.e. State Bank of

India and its subsidiaries, and twenty nationalized banks account
for a major portion of the banking business. State Bank of India is
the largest bank among the public sector banks. Thus, the
government owns the major part of the banking business in India.
d. Rural banking A new category of banks called Regional Rural
Banks (RRBs) primarily sponsored by commercial banks, was
conceived in 1976. They were set up to provide credit for
agricultural purposes, to small entrepreneurs engaged in trade
and industry and other productive activities in rural areas, besides
catering to the needs of weaker sections of the society.
e. RBI The Reserve Bank of India, being the Central Bank in India
occupies the pivotal position in the organized money market.
RBI exercises adequate control over the operations of the
organized money market through various monetary and credit
instruments such as Cash Reserve Ratio (CRR), Statutory
Liquidity Ratio (SLR), Credit Authorization Scheme (CAS), Non-
resident Indian Investment Incentive Scheme, etc.
Unorganized money market The unorganized money market consists
of indigenous bankers and moneylenders. The indigenous bankers and
moneylenders are active in the small towns and villages, and partly in big
cities, where farmers, artisans and, small traders do not have an access to
the modern banks.
The indigenous bankers and moneylenders advance loans against
collateral security and/or to people who are personally known to them.
They are outside the control of the RBI. They charge exorbitant rates of
interest on their advances.
Indian Capital Market
The market where financial securities are bought and sold is known as the
‘capital market’. It is also known as ‘securities market’. The securities are
shares, bonds, debentures, etc. It plays a vital role in facilitating the free
flow of funds from the surplus to deficit units and provides liquidity,
marketability, safety, etc to the investors and accelerates the rate of capital
formation.
A legal instrument that represents either an ownership or a debt claim
is known as a financial security. Ownership securities comprise equity and
preference shares while debt securities include bonds and debentures. A
debt security is used to raise a loan and promises to repay the borrowed
money. The owner of a debt security is a creditor. Following are the features
of Indian capital market:

Type of securities Financial securities may be broadly classified into
government securities and industrial securities. Securities that are issued
by the central government, state governments and local self governments
such as municipalities, autonomous institutions like Port Trusts,
Improvement Trusts, State Electricity Boards, Metropolitan Authorities,
Public Sector Corporations, and other government agencies like IDBI,
IFCI, SFCs, SIDCs, Housing Boards, etc are called government securities.
The government securities market is the most dominant and occupies a
significant position in the Indian capital market.
The instruments for raising funds in the industrial securities market
are bonds, debentures, preference shares and equity shares. The size of
the industrial securities market in India is relatively smaller than that of the
other industrialized countries, because of investment habits, level of
education and industrial structure. Industrial securities are not a popular
mode of investment when it comes to safety and return parameters.
Composition The Indian capital market, like its counterpart, the Indian
money market, is composed of organized and unorganized sectors. The
unorganized sector consists of indigenous bankers and moneylenders.
The organized capital market consists of nonbanking institutions, and
special and development financial institutions. A notable feature of the
Indian capital market has been the dominating presence of development
banks, which besides providing finance also extend other services such
as consultancy, technical know-how, and training.
Role The Indian capital market causes accelerated development of the
economy by undertaking such functions as stimulating the general financial
market conditions, providing risk capital and seed capital, direct
subscription and underwriting of issues, promoting broad-based
entrepreneurship, encouraging new industries, modernizing the existing
industries, encouraging export promotion and import substitution
industries, and promoting backward area and regional development.
Special institutions A number of special institutions of finance,
development and promotion came to be set-up after independence. The
first development bank, the Industrial Finance Corporation of India (IFCI)
was established in 1948. The SFCs Act was passed in the year 1951, in
order to enable the establishment of development institutions at provincial
levels. In 1955, the Industrial Credit and Investment Corporation of India
(ICICI) was established with the main objective of enlarging underwriting
facilities for public issue of capital, foreign currency loans and direct
subscriptions to shares and debentures.
16 Capi tal Markets
After 1960, a number of state governments set up SIDCs to undertake

developmental and promotional function at the state level. The IDBI was
established in 1964, to operate as the central coordinating agency for
industrial financing. Apart from these development banks, other non-
banking institutions, which were set up, included the Unit Trust of India
(UTI), the Life Insurance Corporation of India (LIC), the General Insurance
Corporation (GIC), Investment companies, the financing and the leasing
companies. They all actively participate in the capital market.
For the purpose of directing the growth in rural development, the
National Bank for Agriculture and Rural Development (NABARD) was
established in 1982. To cater to the financial needs of the importers and
exporters for financing international trade, the Export-Import Bank of India
(EXIM Bank) was also established in 1982.
Types of market The securities market is divided into primary or new
issue market and secondary market. The new issues of government and
private corporate sectors are floated in the primary market. New issues
take place through public offer, offer for sale, private placement, and rights
issues in the primary market. Underwriters play a vital role in floating the
new issues. The secondary market provides liquidity to the outstanding
or existing securities. Once the new issues are floated and subscribed by
the public, they are then traded in the secondary market. The securities
market consists of organized stock exchanges and over-the-counter
exchanges. Stock exchange is a place where members, on their own or on
behalf of their clients, buy and sell securities. Stock exchanges are auction
markets. The exchange neither buys nor sells the securities but merely
provides a trading place where members through bids and offers, trade in
securities. In the stock exchange only listed securities, which are permitted
by the governing body of the stock exchange, are traded.
a. National stock exchange (NSE) The National Stock Exchange
works on the standardized system software used all over the
world. It is a state-of-the-art technology. Exchanges around the
world such as Vancouver, Mexico, Istanbul, and Caracas use the
base line software adopted by the NSE. The systems support is
being provided by the TCS (Tata Consultancy Services). The
exchange works with the help of the satellite communication
network. The network is used to link all the national stock
exchanges. The exchange also provides networking around the
globe.
The NSE, through its versatile trading solutions, allows
trading to take place by the brokers and members by simply
sitting in their own offices. This helps the market participants to

take advantage of the support of their back office and facilitates
getting in touch with their constituents. All the options, which
are available on a trading floor or through telephone trades, are
available through the trading software. All the market information
relating to the trading will be available continuously on the screen
at the press of a button. This is possible through the online
updating of information pertaining to the depth of the market, the
types of orders floating into the system, the best buy order value,
the best buy price, all previous trades that have taken place,
outstanding orders of the concerned trading member, etc. The
identity of the trader is concealed.
b. Third market The Over-the-Counter (OTC) market for listed
stock is known as ‘Third Market’. Any exchange-listed security
in the OTC market can be traded in this type of market. Members
of an organized stock exchange can deal in the third market.
Shares traded are the same as those traded on a regular stock
exchange. As prices are fixed through negotiations, dealers have
no responsibility of market-making. Trading takes place even
after the trading hours.
The ‘third market’ had its origin in the U.S., when in 1970, the
New York Stock Exchange permitted non-members of the
exchange to trade in securities without having to pay huge
commissions.
Institutional investors such as investment institutions,
insurance companies, pension funds and mutual funds are the
main customers of the third market. It is possible for these investors
to reduce the cost of transaction so as to obtain better prices.
Transactions take place more rapidly than at the organized
exchanges. Small brokers/dealers, private individuals and small
odd lot customers who are not members of an organized exchange
can also actively take part in the third market. They can buy and
sell the listed stock at negotiated prices. Usually, large stock
transactions are conducted in third market in order to benefit
from lower commissions.
c. Fourth market In the ‘fourth market’ institutions and wealthy
investors who directly buy and sell securities among themselves.
Originated in the US, an essential feature of this type of market is
that buyers and sellers directly deal in securities without the help
of brokers. Only two parties are involved in the transactions as
18 Capi tal Markets
the deals are direct. The market eventually comprises a

communication network among block traders. Direct deal is
facilitated through a negotiated price. Many institutions have
dispensed with brokers and exchanges completely for
transactions in listed stocks.
Transactions are facilitated by computer communications
system which automatically provides quotations and executions.
Under this mechanism, offers made by the parties are recorded in
the system and the transactions are automatically recorded as
two orders are matched. The system then sets up the paper work
for completion. It is also possible for the subscriber to find
partners for a trade and then conduct negotiations by telephone
with the help of this system. ‘Ariel’ is the monitor system that
exists in U.K. The main advantages of the ‘Fourth Market’ are
less commission, better price through direct negotiation, and
rapid execution of the deal.
GLOBAL FINANCIAL MARKETS
Meaning
Financial markets that are integrated and operated worldwide by using
uniform trading practices are known as ‘Global Financial Markets’. Under
the global financial market dispensation, it is possible for firms to raise
funds in international arenas.
F a c to r s
The factors responsible for causing the emergence of global financial
markets are:
1. Deregulation Deregulation or liberalization of markets and the activities
of market participants in key financial centers of the world.
2. Science and technology Technological advances for monitoring
world markets, executing orders, and analyzing financial opportunities.
3. Institutionalization Shift from retailing to increased institutionalization
of investors in financial markets.
4. Competition Global competition which forces governments to
deregulate various aspects of their financial markets.
5. Information flow Free and unrestricted flow of market information
around the world owing to advancement in telecommunication systems.
Classification
Global financial markets may be classified into internal and external markets
as described below:
Internal market Internal market, also called national or domestic market,
is a market where the capital issues and issuers are domiciled within the
boundaries of a particular country.
External market External market, also called foreign market or
international market or Euro market or offshore market, deals with issue of
securities not domiciled in the country but are sold and traded throughout
the world. The rules governing the issuance of foreign securities are
imposed by regulatory authorities where the security is issued.
Accordingly, where an Indian firm wishes to raise capital in the global
market, it has to follow the regulations of Indian authorities. The external
markets are called by different names as: Yankee Market in the U.S., Samurai
Market in Japan, Bulldog Market in UK, Rembrandt Market in Netherlands,
and Matador Market in Spain.
REVIEW QUESTIONS
Section A
1. State the meaning of a financial market
2. How is a financial market defined?
3. Where does a financial market exist?
4. State the financial functions of a financial market
5. What are the constituents of a financial market?
6. What is a capital market?
7. What is a money market?
8. What is a debt market?
9. What is a Eurobond market?
10. What are equity markets?
11. What is a financial services market?
12. What is a depository market?
13. What are pension funds?
14. What are insurance companies?
15. What are financial instruments?
16. What is a commercial paper?
17. What are certificates of deposits?
18. What are repos?
19. What are Eurodollars?
20. What are bankers’ acceptances?
21. What is a corporate equity?
22. What are corporate bonds?
20 Capi tal Markets
23. What are mortgages?

24. What are global financial markets?
Section B
1. Explain the role of a financial market
2. What are the functions of a financial market?
3. State the features of a capital market
4. State the features of a money market
5. What are the various constituents of a non-depository market?
6. Describe briefly the money market instruments
7. Describe briefly the various capital instruments
8. Write a note on the organized money market in India
9. What are the features of Indian capital market?
10. How is a ‘third market’ different from a ‘fourth market’?
11. What are the factors responsible for the emergence and the growth
of global financial markets?
12. How are global financial markets classified? Explain
Secti on C
1. Make a detailed discussion on the financial instruments
2. Discuss the contours of Indian financial market
Chapter 2
Capital Market
Capital market may be defined as a market for borrowing and lending long-
term capital funds required by business enterprises. Capital market is the
market for financial assets that have long or indefinite maturity. Capital
market offers an ideal source of external finance. Capital market forms an
important part of a country’s financial systems too.
Capital market represents all the facilities and the institutional
arrangements for borrowing and lending medium-term and long-term funds.
Like any financial market, capital market is also composed of those who
demand funds (borrowers) and those who supply funds (lenders).
MONEY MARKET
According to the Reserve Bank of India, a money market is a “centre for
dealings, mainly of a short-term character, in monetary assets; it meets the
short-term requirements of the borrowers and provides liquidity or cash to
lenders. It is the place where short-term surplus investible funds at the
disposal of the financial and other institutions, and individuals are bid by
borrowers, again comprising institutions and individuals and also by the
Government”.
C h a r a c te r i s ti c s
Following are the characteristic features of a capital market:
Securities market The dealings in a capital market are done through
the securities like shares, debentures, etc. The capital market is thus called
securities market.
Security prices The price of securities that are dealt with in the
capital market is determined through the general laws of demand and
supply. The equilibrium in demand and supply of securities is brought
about by the prices. The price depends upon a large number of factors
such as the following:
1. Yield on securities
2. Extent of funds available from public savings
22 Capi tal Markets
3. Level of demand for funds

4. Flow of funds from the banking system
5. Price situation in general
6. Attitude towards liquidity on the part of investors
Participants There are many players in the capital market. The par-
ticipants constitute a plethora of institutions, which provide access to
capital market. The capital funds are either directly supplied or arranged
through financial intermediaries. The intermediaries form the edifice of a
capital market. The participants in the capital market include:
1. Financial intermediaries like insurance companies, investment
companies, pension funds, etc
2. Non-financial business enterprises
3. Ultimate economic units like households and Governments
Location It is interesting to note that the capital market is not confined
to certain specific locations, although it is true that parts of the market are
concentrated in certain well-known centers known as Stock Exchanges. It
exists all over the economy, wherever suppliers and users of capital get
together and do business.
Functions
The functions that are performed by the capital market are detailed below:
Allocation function Capital market allows for the channelization of the
savings of innumerable investors into various productive avenues of in-
vestments. Accordingly, the current savings for a period are allocated
amongst the various users and uses. The market attracts new investors
who are willing to make new funds available to business. It also allocates
and rations funds by a system of incentives and penalties.
Liquidity function Capital market provides a means whereby buy-
ers and sellers can exchange securities at mutually satisfactory prices.
This allows better liquidity for the securities that are traded.
Other functions In addition to the functions of funds allocation and

liquidity, capital market also renders the following functions:
1. Indicative function A capital market acts as a barometer showing not
only the progress of a company, but also of the economy as a whole
through price movements of securities.
2. Savings and Investment function Capital market provides a means of
quickly converting long-term investment into liquid funds, thereby
Ca pi ta l Ma rket 23
generating confidence among investors and speeding up the process of

savings and investments.
3. Transfer function Capital market facilitates the transfer of existing
assets, tangible and intangible, among individual economic units or groups.
4. Merger function Capital market encourages voluntary or coercive
take-over mechanism to put the management of inefficient companies into
more competent hands.
INDIAN CAPITAL MARKET—EVOLUTION AND GROWTH
Standing the test of time, the Indian capital market has undergone
phenomenal changes. Since the mid-eighties, a metamorphic transformation
involving multidimensional growth has taken place in an otherwise dormant
Indian financial system. The magnitude of growth could be gauged in
terms of massive jumps in funds mobilization, the turnover on the stock
exchanges, the amount of market capitalization, and the expansion of
investor population. The regulatory framework has been strengthened
and streamlined in order to tackle effectively the problems associated with
the massive growth of the market.
The evolutions in the realm of capital market in India could be broadly
discussed as follows:
Infrastructure Stage
The period between 1947 and 1973 was the period of the development of
infrastructure for capital market. The stage saw the process of strengthening
of capital market through the establishment of a network of development
financial institutions such as IFCI (1948), ICICI (1955), IDBI and UTI (1964),
SFCs (during the fifties and sixties) and SIDCs (during the sixties and early
seventies). A number of important enactments covering the functioning of
different segments of capital market were legislated during this period.
These include: Capital Issues (Control) Act, 1947, Securities Contracts
(Regulation) Act, 1956 and Companies Act, 1956.
Development of an organized indigenous capital market was inhibited
in the initial years owing to a variety of factors as stated below:
1. Insignificant demand for long-term funds owing to weak industrial
base and low savings rate
2. Dependence of many foreign companies upon the London capital
market for raising funds rather than on the Indian capital market
3. Adverse consequences of the managing agency system, which
performed different functions of promotion, management and
underwriting of new capital issues
24 Capi tal Markets
4. Lukewarm interest shown by Indian corporates for mobilizing

capital through the instruments of shares and debentures from
capital market and more reliance of the industry on the bank
credit which offered credit at relatively lower (often subsidized)
rates of interest; and
5. Hazards of administered interest rate structure
N ew Iss ue s Stag e
This stage heralded the enactment of the Foreign Exchange Regulation Act
(FERA) between the period 1973 and 1980. Under this Act, shareholding of
foreign firms in joint ventures was restricted to 40 percent if the companies
wanted to be recognized as Indian companies. This period saw many well-
managed multinational companies offering their equities to the public at a
relatively low price. This encouraged a large number of domestic public
limited companies to come out with the offer of new capital issues for
public subscription. All these culminated in the stock market exhibiting an
upward trend with share prices displaying a high level of buoyancy. This
also created, for the first time, an awareness among the common investors
about the potential of equity investments as a hedge against inflation and
a source of higher earnings compared to the other forms of investments.
The SEBI Stage
This stage of development during the period between 1980 and 1992
brought about rapid changes in the Indian capital market. This period
marked a period of change, signifying the widening and deepening of the
market. Debenture emerged as a powerful instrument of resource
mobilization in the primary market. The public sector bonds, which came
to be introduced since 1985-86, imparted an additional dimension to the
market. The impressive growth witnessed in this stage was responsible
for bringing into existence a number of stock exchanges, phenomenal
increase in the listed companies with a quantum jump in their paid-up
capital and market capitalization. This signified a momentous growth in
the secondary market.
New financial services An important part of development under
this stage was the emergence of SEBI as an effective regulatory body to
set right many ailments afflicting the secondary and the primary markets
and afford a measure of protection to small investors. New financial services
such as credit rating, etc came to be introduced. Several credit rating
institutions such as CRISIL, CARE and ICRA were set up in order to help
investors make a right choice of investment. Similarly, Stock Holding
Corporation of India was set up to provide custodial services; IL&FS was
set up to offer infrastructure financing and leasing services; and TDICI,

RCTC and TFCI were also constituted as specialized financial institutions.
The OTCEI was established to provide screen-based stock exchange
facility to investors. Similarly, mutual funds and venture capital fund/
companies were also set up.
Committees/Working groups An important part of growth during
this period was the constitution of a number of committees in order to
suggest measures to revamp and restructure the working of the secondary
market and cause buoyancy in the primary market so as to instil confidence
in the investing community. These included the following:
a. A Committee on Organization and Management of Stock
Exchange, 1986 under the chairmanship of Mr. G.S. Patel
b. A Working group on the Development of the Capital Market,
1989 under the chairmanship of Dr. Abid Hussain
c. A Study Group for Guidelines Relating to Valuation and New
Instruments, 1991 under the chairmanship of Mr. M.J. Pherwani
d. A High Powered Study Group on Establishment of New Stock
Exchanges, 1991 under the chairmanship Mr. M.J. Pherwani
e. A Committee on Trading in Public Sector Bonds and Units of
Mutual Funds, 1992 under the chairmanship of Mr. S.S. Nadkarni
A number of recommendations of the above committees were
implemented to help streamline the operations of the capital market.
However, this period witnessed one of the worst crises in the Indian capital
market with a major scam in securities breaking out. Large-scale irregularities
in securities transactions that took place in 1992 exposed the loopholes in
the existing systems and procedures of stock trading. This necessitated
the overhauling of the regulatory framework of the capital market for
preventing recurrence of such irregularities in the future. The Securities
and Exchange Board of India (SEBI) which was set up as a regulatory
body of the Indian securities market in 1988 was vested with statutory
powers for regulating capital market only in 1992 after the enactment of the
SEBI Act, 1992. Ever since its inception, SEBI has been focusing its attention
on policy-making, based on wider consultations through the mechanism
of a number of committees to examine the various aspects/segments of the
capital market.
The Structural Transformation
The structural transformation started taking place since1992. Many
technological innovations on par with the developed countries of the
world began to be introduced in the realm of trading operations in the
26 Capi tal Markets
Indian stock market. Some of the significant forces/happenings that were

responsible for the structural transformation were:
1. Financial sector liberalization, adoption of market oriented
approach and opening up of areas to private sector hitherto
reserved for the public sector
2. Computerized on-line trading and setting up of clearing houses/
corporations by most of the stock exchanges
3. Constitution of a depository to facilitate scripless trading
4. Overhauling and strengthening of regulatory structure of stock
exchanges with the establishment of SEBI
5. Permission to Indian companies to raise resources abroad
through the issue of Global Depository Receipts (GDRs) and
Foreign Currency Convertible Bonds (FCCBs) after obtaining
specific approval from the Government of India, since May 1992
6. Disinvestments by Government of its holding in public sector
undertakings commencing from 1992-93
7. Opening up of the market for portfolio investment by foreign
institutional investors and encouraging foreign private
participation in financial services including stock-broking
8. Restructuring of the corporate sector and increasing resort to
mergers and takeovers
9. Abolition of the Capital Issues Control along with setting up of
norms for information disclosure requirements, establishment of
regulations for various market intermediaries, prohibition of
insider trading and fraudulent practices and modernization of
stock exchanges
10. Global recessionary trend and portfolio diversification by the
international fund managers
11. Entry of new institutions like merchant banks, leasing and hire
purchase companies, venture capital funds/companies, etc and
greater participation of banks and financial institutions in capital
market related activities
12. Growth in saving of households backed by changing attitudes
and investing habits towards investment in shares
13. Introduction of innovative financial instruments such as
warrants, cumulative convertible preference shares and a host of
hybrid bonds/debentures
14. Measures initiated by the Government, SEBI and stock exchange
authorities for protecting the interests of investors, i.e. setting up

of investor protection funds at the stock exchanges, restructuring
of various committees on the stock exchanges with larger
participation of public nominees of clearing corporations/houses
on the stock exchanges, making merchant bankers responsible for
the contents of offer documents and laying down the code of
conduct for market intermediaries including brokers/sub-brokers
SEBI issued separate set of guidelines for different categories of
intermediaries such as brokers/sub-brokers, merchant bankers, registrars to
issue, portfolio managers, under writers to issue, mutual funds, bankers to
issue, debenture trustees and venture capital funds/companies. Detailed
guidelines were issued by the SEBI for disclosure and investor protection in
respect of new issues and for regulation of insider trading and prohibition of
fraudulent and unfair trade practices.
CONSTITUENTS OF INDIAN CAPITAL MARKET
The Indian capital market is composed of the following:
1. The gilt-edged market
2. The industrial securities market
The constituents of the Indian Captial Market are shown in Exhibit 2.
Exhibit 2 Consti tuents of Indi an Capi tal Market
Gilt-edged Market
‘Gilt-edged Market’ also known as Government Securities market, is the
market for Government and semi-Government securities. An important
feature of the securities traded in this market is that they are stable in value
28 Capi tal Markets
and are much sought after by banks (as banks are obligated under the
Banking Regulations Act to maintain a proportion of total deposits in
Government securities).
Some of the special features of the gilt-edged market are as follows:
1. Guaranteed return on investments
2. No speculation in securities
3. Institutional based investors which are compelled by law to invest
a portion of their funds in these securities
4. Predominated by such institutions as LIC, GIC, the provident
funds and the commercial banks
5. Heavy volume of transactions necessitating negotiation of each
transaction
Industrial Securities Market
The market for industrial securities is known as ‘Industrial Securities
Market’. It offers an ideal market for corporate securities such as bonds
and equities. Industrial securities market comprises of the following
segments:
1. Primary market
2. Secondary market
Primary Market
Meaning Primary market also known as New Issues Market (NIM) is a

market for raising fresh capital in the form of shares and debentures. Cor-
porate enterprises, which are desirous of raising capital funds through the
issue of securities, approach the primary market. Issuers exchange finan-
cial securities for long-term funds. The primary market allows for the for-
mation of capital in the country and the accelerated industrial and eco-
nomic development.
M odes of r ai s in g c ap ita lFollowing are the popular ways by
which capital funds are raised in the primary market:
1. Public issue Where the securities are issued to the members of the
general public, it takes the form of ‘public issue’. It is the most popular
method of raising long-term funds.
2. Rights issue Where the issue of equity shares of a body corporate is
made to the existing shareholders as a pre-emptive right, it takes the form
of ‘rights issue’. Under this method, additional securities are offered for
subscription to the existing shareholders.
3. Private placement Where the shares of a body corporate are sold to

a group of small investors, it takes the form of ‘private placement’.
The Secondary Market
Meaning A market, which deals in securities that have been already

issued by companies, is known as ‘the secondary market’. It is also called
the stock exchange or the share market.
Importance The importance of the secondary market springs from the

fact that it acts as the basis upon which rests the edifice of the primary
market. In other words, for the efficient growth of the primary market, a
sound secondary market is an essential requirement. This is because the
secondary market offers an important facility of transfer of securities.
Stock Exchanges
The activities of buying and selling of securities in a secondary market are
carried out through the mechanism of stock exchanges. Stock exchanges
form an integral part of the secondary market in India. There are at present
24 stock exchanges in India recognized by the government. They are
located at Mumbai, Calcutta, Delhi, Chennai, Ahmedabad, Bangalore,
Hyderabad, Indore, Pune, Kanpur, Cochin, Ludhiana, Mangalore, Patna,
Guwahati, Bhuwaneshwar, Jaipur, Saurashtra, Surat, Baroda, Coimbatore,
Rajkot and Meerut, and OTC Exchange of India and NSE at Mumbai.
In addition, there is also a ring-less and automated stock market
operating at the national level known as ‘Over the Counter Exchange of
India’ (OTCEI) which has been established to give a major fillip to the
capital market. The Exchange operates through a number of electronically
linked counters at different locations giving rise to a national trading
system. It aims at helping small and start-up companies to overcome the
problems of raising capital through a public issue at exorbitant cost. It also
helps investors to overcome the problems of illiquidity, inaccessibility,
delayed settlement and transfers that are abound with the traditional stock
exchanges.
NEW FINANCIAL INSTITUTIONS
A number of institutions of finance have been established to cater to the
credit requirements of various segments of the industry. A brief outline of
these institutions is presented below:
Venture Fund Institutions
An innovative financing scheme of providing funds for high risk and high
reward projects is called ‘Venture capital financing’. It is a form of equity
30 Capi tal Markets
financing designed specially for funding new and innovative project ideas.
Venture capital funds are instrumental in bringing into force the hi-
technology projects by assisting the research and development projects,
which are eventually converted into commercial production ventures. Many
specialized financial institutions have promoted their own venture capital
funds. These include Risk Capital Foundation of IFCI, Venture Fund of
IDBI, SIDBI, Technology Development and Infrastructure Corporation of
India (TDICI), and others.
Mutual Funds
Financial institutions that provide facilities for channeling savings of a
vast number of small investors into avenues of productive investments
are called ‘Mutual Funds’. A mutual fund company invests the funds
pooled from numerous small savers and thus gives them the benefit of
diversified investment portfolio and a reasonable return.
Through institutionalized mechanism, mutual funds offer collective
investment schemes providing benefits of diversified portfolio and expert
investment advice and management to a large number of investors.
Specialized financial institutions like LIC, UTI, etc besides commercial
banks such as SBI, Canara Bank etc are carrying out the business of
mutual funds. A wide range of benefits such as high return, easy liquidity,
safety and tax benefits to the investors are offered by mutual funds.
Factoring Institutions
An arrangement whereby a financial institution provides financial
accommodation on the basis of assignment/sale of accounts receivables
is known as ‘factoring’. Under this arrangement, the factoring institution
undertakes the task of collecting the book debts for and on behalf of its
clients. The concept of rendering financial services through factoring has
gained strong momentum in the advanced countries, like USA, UK etc.
Based on the recommendations of the Vaghul Committee and Shri
Kalyanasundaram Committee, the RBI initiated several measures to develop
factoring service. Accordingly, RBI along with Government of India, has
notified factoring as an eligible banking activity. Some of the factoring
institutions operating in India are SBI Factors and Commercial Services
Private Limited, a subsidiary of State Bank of India and CanBank Factors
Limited, a subsidiary of Canara Bank.
Credit Rating Institutions
There has been a long-felt need in India for such institutions which would
provide services of evaluating the credit-worthiness of traders and
securities and issue rating grades indicative of the quality and soundness
of credit. The main purpose of credit rating is to provide guidance to
investors/creditors in determining the credit risk associated with a debt
instrument/credit obligation by an independent, professional and an
impartial institution. The credit rating institutions presently operating in
the country include Credit Rating Information and Services India Limited
(CRISIL), Investment Information and Credit Rating Agency of India
Limited (ICRA), Onida Information and Credit Rating Agency of India
Limited (ONICRA), Credit Analysis and Research Limited (CARE), etc.
Over-The-Counter Exchange of India (OTCEI)
The OTCEI was set up by a premier financial institution to allow the trading
of securities across the electronic counters throughout the country. It
addresses some specific problems of both investors and medium-sized
companies. Some of the greatest strengths of OTCEI are transparency of
transactions, quick deals, faster settlements and better liquidity.
National Stock Exchange of India Limited (NSEI)
NSEI was established under the Companies Act, 1956 on November 27,
1992 to function as a model stock exchange. The Exchange aims at providing
the advantage of nation-wide electronic screen based “scripless” and
“floorless” trading system in securities. The institution is expected to
allow for an efficient and transparent system of securities trading.
National Clearance and Depository System (NCDS)
Under the scripless trading system, settlement of transactions relating to
securities takes place through a book entry as against the physical exchange
of securities under the traditional system. The need for scripless trading
was felt on account of the anticipated unprecedented growth on the stock
market, contributing to a steep rise in the number of investors and the
growth of equity cult among the masses. Moreover, the present system of
physical transfer of securities and the registration is slowly becoming an
out-dated practice. The entire scripless trading system comprises the
following three segments:
a. National Trade Comparison and Reporting System which
prescribes the terms and conditions of contract for the securities
market
b. National Clearing System which aims at determining the net
cash and stock liability of each broker on a settlement date
32 Capi tal Markets
c. National Depository System which arranges to provide for the

transfer of ownership of securities in exchange on payment by
book entry on electronic ledgers without any physical movement
of transfer deed
National Securities Depositories Limited (NSDL)
The NSDL was set up in the year 1996 for achieving a time-bound
dematerialization as well as rematerialization of shares in accordance with
the Depositories Act, 1996. The establishment of NSDL is expected to
alleviate the problems of post-trade transactions in the secondary market.
Stock Holding Corporation of India Limited (SHCIL)
Set up on the basis of the recommendations of the Pherwani Committee,
the corporation aims at serving as a central securities depository in respect
of transactions on stock exchanges. The Corporation also takes up the
administration of clearing functions at a national level.
NEW FINANCIAL INSTRUMENTS
Indian capital market also witnessed a phenomenal growth in launching a
variety of new financial instruments. A brief description of some of the
newly introduced financial instruments is presented below:
Commercial Paper (CP)
A form of usance promissory note, which is negotiable by endorsement
and delivery, is known as Commercial Paper.
Certificate of Deposit (CD)
The CD is a document of title, similar to the deposit receipt issued by a
bank. There is no prescribed interest rate on such funds and therefore
banks have the freedom to issue it at a discount or at face value. Being a
bearer document, it is readily negotiable. It is beneficial both to the banker
and the investor.
Secured Premium Notes (SPN) with Attached Warrant
These are the bonds issued with a detachable warrant and are redeemable
after a notified period, say, 4 to 7 years. In the case of fully paid SPNs, the
warrants attached to them facilitate the holder, the right to apply and get
allotted equity shares.
Nonconvertible Debenture (NCD) with Detachable Equity Warrants
The equity warrants attached to this instrument allows its holder to buy a
specific number of shares from the company at a predetermined price
within a definite framework. Warrants are issued where full payment of

NCDs value has been made. Where the option to apply for equities is not
exercised, the company will be at its liberty to dispose off the unapplied
portion of shares.
Zero Coupon Bonds
These are the bonds which bear no interest. In order to compensate the
loss of interest, they are issued at substantial discount from their eventual
maturity values.
Zero Interest Fully Convertible Debentures (FCD)
These instruments carry no interest. They are automatically and
compulsorily converted into shares after the expiry of a specified time
period as may be notified in the terms of issue.
Deep Discount Bonds
The bonds that are issued by corporates at very high discount and matured
at par value are Deep Discount Bonds.
St o c ki n v e s t
An arrangement whereby it is possible for an investor to apply for the
shares without having to pay for them and where the investor could make
payment for shares when allotted to him, through his banker is known as
‘stockinvest’. Under this mechanism, there is only a guarantee of
subscription and a banker makes payment only at the time of making
application for shares.
Equity Shares with Detachable Warrants
The holders of these shares are eligible to apply for a specified number of
shares at a predetermined price in future. Detachable warrants are separately
registered with the stock exchanges and traded separately.
‘Equipref’ Shares
These instruments are issued in two parts, Part A and Part B. Part A is
convertible into equity shares automatically and compulsorily on the date
of allotment without any further act or application by the allottee. Part B
will be redeemed at par/converted into equity shares after a lock-in-period
at the option of the investors.
Preference Shares with Warrants Attached
The holders of these shares are eligible to apply for equity shares for cash
at ‘premium’ at any time in one or more stages between the third and fifth
34 Capi tal Markets
year from the date of allotment.

Euro Issues
The securities that are issued by Indian companies and are traded in
European stock exchange are called ‘Euro Issues’. This has become an
important source of raising finance by Indian companies. Foreign investors
and NRIs are the main subscribers to these securities. The instruments
used as part of Euro Issue include Foreign Currency Convertible Bonds,
European Deposit Receipts, and Global Depository Receipts.
Non-voting Rights Shares
These are the shares that are issued by companies having good track
record, under the relevant provisions of the amended Companies Act.
Other Innovative Instruments
In addition to the above financial instruments that are issued by companies
in India, some of the other major innovative financial instruments floated
by the corporate entities include Money Market Mutual funds, Specialized
Mutual Funds, Nonvoting Shares, Floating Rate and Rating-sensitive
Notes, Commodity Linked bonds, Stripped debt securities, High yield
(junk) bonds, Exchange-traded options, Interest rate futures, Options or
futures contracts, foreign currency futures, Stock index futures, shelf
registration, Discount brokerage, Electronic funds transfer, Leveraged
buyouts, project finance, Secured zero interest Partly Convertible
Debentures (PCDs) with detachable and separately tradable warrants, Fully
Convertible Debentures (FCDs) with interest (optional), etc.
Specialized savings and investment institutions are catering to the
needs of a growing market. The proliferation of financial institutions and
instruments provides the saver with a wider choice of assets depending
upon his perception of risk, liquidity and yield, and has begun to impart a
measure of competition in the field of financial services.
CAPITAL MARKET DOLDRUMS
The developments in the Indian capital market is very typical in the sense
that they were marked by violent fluctuations. For example, amidst market
boom, a crash occurred in the stock market owing to the ‘Securities Scam’
during 1991-92.
The Indian capital market had been quite active during the eighties
and nineties as reflected from the increase in capital issues, the expansion
of the new issues market, the activity in the gilt-edged market and the
growth of industrial securities market. However, many scamy developments

took place in the Indian capital market, which led to the current crisis
afflicting the capital market. For instance, during 1987-88, the stock exchange
literally crashed with the crash of Reliance shares. From 1988-89 onwards,
there was upward swing in the stock market, thanks to excellent
performance by market leaders, industry-friendly policies by successive
governments, such as liberalization of licensing procedures, liberal fiscal
measures, liberal and positive export-import policy and greater scope for
the private sector.
Harshad Factor
The Harshad factor played a crucial role in giving a much needed boost to
the stock market activities. In fact the stock market was booming under the
impact of bulls like Harshad Mehta during 1991-92, who flourished with
huge funds, the origin and magnitude not being known at that time. Later
on, it was found that the reason for the market ‘frenzy’ was created by the
Harshad factor through the manipulation of tremendous amount of funds,
which was made available to some brokers like Harshad Mehta and others.
These brokers along with some banks committed frauds through a new
mechanism known as the Bankers Receipts (BR). According to some rough
estimates, as much as Rs. 4,000 crores were placed at the disposal of the
brokers to play in the stock exchange. Unscrupulous brokers in the stock
exchange who colluded with some bank officials, violating the established
rules and guidelines, siphoned off these enormous sums of money. These
funds were diverted for speculative transactions in the stock market. These
irregularities and frauds came to be popularly called “securities scam”.
Measures of Rejuvenation
Time and again, a number of measures have come to be taken by the
government in order to reactivate and rejuvenate the capital market. Some
of the market-friendly measures introduced in the year 1992-93 budget
were the abolition of wealth tax, the reduction of long-term capital gains to
20 percent, free pricing of capital issues, permission to list the shares of
Public Sector Enterprises (PSEs), etc.
Role of SEBI
The regulation of the capital market was aimed at protecting the interest of
the investor against possible risks and frauds. For this purpose, SEBI
formulated a set of prudential guidelines to protect the interests of the
investor. Permission was given to the SEBI to monitor the functioning of
the securities market and the operations of intermediaries like mutual funds
36 Capi tal Markets
and merchant bankers. Efforts were also made by the SEBI to prohibit
insider trading.
MEASURES OF REACTIVATION
In the interest of the investing public and for the healthy development of
the capital market, following measures have been taken by the SEBI to
streamline and reactivate the stock market in India. These steps aimed at
achieving improved practices and greater transparency in the capital
market:
1. Periodical inspection of stock exchanges
2. Registration of intermediaries (registration being based on
certain eligibility norms such as capital adequacy, infrastructure,
etc) such as the stockbrokers and sub-brokers under the
provisions of the Securities and Exchange Board Act, 1992
3 . Guidelines and regulatory measures for capital issues for the
purpose of ensuring a healthy and efficient functioning of the
market
4. Compulsory requirement for companies to make material
disclosures about the risk factors in their offer documents
5. Mandatory rating of debt instruments
6. Vetting of offer documents to ensure due compliance of the
requirements of listing such as, that all disclosures have been
made by the company in the offer document when the application
for listing of securities is made to the stock exchange
7. Advertisement code for public issues so as to ensure fair and
truthful disclosures
8. Regulating registrars to new issues and share transfer agents
on matters concerning capital adequacy requirements, general
obligations and responsibilities, procedures for inspection and
action in case of default
9. Constitution of a panel in 1998 to suggest measures to revive
the secondary market with focus of attention on the need for
strong regulations, surveillance and investor education and
the need to have adequate insurance cover for the members of
the exchange. The committee made many suggestions to revive
the secondary market. For instance, the panel recommended
that Pension and Provident Funds should be allowed to invest
in the secondary market. For this purpose, some of the
institutions such as mutual funds, etc must be permitted to
float dedicated schemes in which the pension funds and
provident funds could be invested. It was expected that when

these schemes invested the money in the securities market, it
would pave way for the development in the secondary market.
Moreover, pension funds could derive the benefit of the fund
management expertise and experience of the institutions
10. Expansion of the list of scrips eligible for compulsory
dematerialized trading by institutional investors
11. Implementation of the recommendations by the Government to
allow companies to buyback their shares through an amendment
of the Companies Act, 1956
12. Market-making to help simulate liquidity in a larger number of
scrips on the B2 group on the BSE
13. Granting permission to the stock exchanges to expand their
terminals, allowing for an efficient automated and integrated
system of functioning of stock exchanges throughout India
14. Constituting a Committee on Corporate Governance (CCG under
Kumar Mangalam Birla) with a view to focus attention on
enhancing shareholder value, while ensuring sufficient protection
to stakeholders like creditors and suppliers
15. Introducing a new system of dealing called ‘rolling settlement’
and convincing the institutional investors about the benefits of
moving to this mode of settlement
16. Introduction of new and innovative instruments of trade such as
‘derivatives’
MEASURES OF INVESTOR PROTECTION

The SEBI has initiated a number of measures in order to protect the
investors. These include: computerization of stock exchanges, expanding
the realm of dematerialization of shares, prescribing the capital adequacy
for brokers, application of the circuit breaker in stock exchanges in case of
wide fluctuations in prices, introducing and fine tuning the format of
quarterly results and other stringent measures. These measures are
expected to produce positive results in terms of transaction cost,
transparency, and investor confidence.
Towards enhancing and deepening the transparency of operations in
the capital market, the SEBI has taken a host of measures. These included:
introduction of net trading, implementation of the recommendations of the
Kumar Mangalam Birla report on corporate governance, K.B.Chandrasekhar
report on venture capital funds,etc permitting high net worth foreign
individuals and corporates to invest in stock markets under the FII route,
38 Capi tal Markets
allowing domestic mutual funds to manage foreign portfolios and a new

framework for accounting standards so as to accomplish universal
accounting practices.
SCR A
Stock exchanges are subject to Government supervision and control. The
regulation of the functions and working of stock exchanges in India have
been brought under the purview of the Securities Contracts (Regulation)
Act, which was passed in 1956. The regulations require that only those
stock exchanges which have been recognized by the Central Government,
be permitted to function in any notified State or area.
RECENT INITIATIVES IN THE INDIAN CAPITAL MARKET
During 2001-02, several changes were introduced in the settlement practices
in the capital markets, including extension of the rolling settlement on T+5
basis to all scrips. This is to be changed to T+2 rolling settlement system.
The risk management system for the stock exchanges was strengthened in
the aftermath of the irregularities in the securities market. The year also
witnessed major institutional changes for improving corporate governance
practices. The norms for issuance of shares in the primary market were
eased further in order to encourage companies to come out with public
issues. In the derivatives segment, the range of products was extended
further to include index options, stock options, and stock futures.
Primary Market
The Securities and Exchange Board of India (SEBI) amended the SEBI
(Disclosure and Investor Protection) Guidelines, 2000 to provide for the
inclusion of Foreign Venture Capital Investors (FVCIs) and State Industrial
Development Corporations (SIDCs) as Qualified Institutional Buyers (QIBs)
for participating in the book-building process. It also abolished the lock-in
period for the pre-issue share capital of an unlisted company held by
Venture Capital Funds (VCFs) and FVCIs, and removed the restriction of a
minimum issue size of Rs. 25 crores in case of an Initial Public Offer (IPO)
through book-building. The option to allocate the unsubscribed portion
of the fixed price portion in a book-building issue to any category or lapse
altogether was allowed. Buyback norms were relaxed by the Government
and the cooling-off period for a fresh issue of a security after buyback was
reduced to 6 months from 2 years.
Sec ondar y Mar ket
The SEBI extended compulsory rolling settlement on T+5 basis to 414
scrips w.e.f. July 2, 2001 and advised the stock exchanges to introduce
uniform settlement cycle (Monday to Friday) in respect of remaining

securities. Rolling settlement on T+5 basis was extended to all scrips with
effect from January 2, 2002. The settlement cycle was shortened to T+3
effective April 1, 2002. This brings the securities settlement system in
India at par with international standards, in line with the recommendations
of the Report of the Joint Task Force of the Committee on Payments and
Settlement Systems (CPSS) and the International Organization of Securities
Commissions (IOSCO) on securities settlement systems.
Other reforms initiated by the SEBI included banning of all deferral
products, including badla; introduction of a market-wide circuit breaker
system applicable at three stages of the index movements and introduction
of 99 percent value-at-risk (VaR) based margin system for all scrips in the
compulsory rolling settlement with effect from July 2, 2001; and shifting of
the margining system from net basis to gross basis (sales and purchases)
with effect from September 3, 2001. In order to widen the equity derivatives
market, the SEBI permitted introduction of new derivative products. The
stock exchanges, accordingly commenced trading in index options in June
2001, followed by options on select securities in July 2001 and futures on
select securities in November 2001. The FIIs were also permitted to trade
in all exchange-traded derivative contracts subject to position limits
effective February 2002.
Initiatives were also taken to improve standards of corporate
governance, including amendment to listing agreements requiring the
companies to furnish segment-wise details of revenues, results and capital
employed along with quarterly unaudited results, etc. The SEBI issued
norms for speedy redressal of investors’ grievances and prescribed Model
Rules for stock exchanges to be implemented in phases. The SEBI advised
the stock exchanges to amend listing agreements requiring companies to
furnish statements and reports on their Electronic Data Information Filing
and Retrieval (EDIFAR) system.
The disclosure norms for mutual funds were tightened to help investors
take more informed investment decisions. The SEBI decided that mutual
funds should disclose the performance of benchmarks in case of various
types of equity-oriented, debt-oriented and balanced fund schemes while
publishing half-yearly results. Detailed investment and disclosure norms
for employees of Asset Management Companies (AMCs) and Trustee
Companies were laid down in order to avoid any actual or potential conflict
of interests. The SEBI prescribed that all mutual funds should enter into
transactions in Government securities only in dematerialized form. Mutual
funds were allowed to invest in the listed or unlisted securities or units of
40 Capi tal Markets
VCFs within the overall ceiling for such investments. To bring about
uniformity in the calculation of the Net Asset Value (NAV) of mutual fund
schemes, the SEBI issued guidelines for valuation of unlisted equity shares.
With a view to improving the professional standards, certification by the
Association of Mutual Funds of India (AMFI) was made mandatory for
the appointment of agents/ distributors by all mutual funds.
INDIAN CAPITAL MARKET—MAJOR ISSUES
The Indian Capital Market has, over a period of time, undergone rapid
structural transformation. During the last fifty years of 1947 to 1997, it
has evolved itself from a dormant segment of the financial system to a
highly active, dynamic, and volatile segment characterized by institutional
buildup, technological advancement and modernization. With the vast
and varied market reforms unleashed since 1992, primary market has
emerged as a major source of funding for the corporate entities both in
the public and private sectors and the secondary market has modernized
itself through advanced technology and transparent trading practices.
The Development Financial Institutions (DFIs) have also played a crucial
role in meeting long-term credit needs of the industrial sector.
In spite of the fact that the Indian capital market has made a marvellous
dent both in primary as well as secondary markets, there are very many
issues, which require immediate and urgent attention of the authorities
concerned. There are many problems relating to investor protection,
consolidation, integration with other market segments, product innovation
and technology, etc which often come in the way of its efficient functioning.
The major issues confronting the Indian capital market are briefly presented
below:
Investor Protection
Investors constitute the pillars of the capital market. It is imperative that
adequate protection is provided to them. This is of paramount importance.
However, investors have been facing serious problems in view of the
continuing market disturbances arising out of unscrupulous practices
followed by many companies and market intermediaries. Some of the popular
problems that are being faced by investors are as follows:
1. Vanishing companies Certain companies raised funds after taking
advantage of market buoyancy and then desert investors as has happened
in 1985-86. This menace of vanishing companies still haunts investors and
has affected their psyche very much.
2. Lack of commitment The incredibly lack of commitment shown by
financial institutions and underwriters regarding the avoidance of project

appraisal during the post-issue period in relation to mega issues in the
eighties has considerably shaken the confidence of the investors. Inability
of many of the corporates to keep up their promises, which are given at the
time of issue, particularly after removal of capital issues control also
contributes to retardation of Indian capital market.
3. Stock scams Series of share market scams arising out of irregularities
in securities transactions in 1992-93, wrongful disclosures as in 1994-95
and share-switching episode of 1995-96 have all exposed the vulnerability
of the Indian capital market.
4. Malaises like share price rigging and insider trading continue to
afflict the Indian capital market, affecting the investors adversely.
5. L a c k o f n e c e s s a r y p r o f e s s i o n a l e x p e r ti s e and integrity
on the part of merchant bankers and other market intermediaries. In many
cases merchant bankers act hand-in-glove with companies to attract the
gullible investors.
6. Th e de fa ul ts c om mi tted b y so me b ro ke rs in different stock
exchanges have also adversely affected the confidence of investors
causing occasional suspension of trading.
7. M ul ti p l i c i ty o f th e n um b er o f i n v e s to r c o m p l a i n ts with
the SEBI, the Department of Company Affairs (DCA) and the stock
exchange authorities.
As a step towards overcoming many of the woes of investors, it is
essential to pay attention to the following:
a. Coordinated approach to attend to investor complaints
b. Introduction of complete transparency in transactions. Such a
step, under the changed environment, would enable companies
to raise resources from the capital market easily, besides inspiring
the confidence of the investors
c. Evolving a system of dissemination of information to a large
number of investors as possible that influences the valuation of
securities at the earliest. For this purpose, stock exchanges have
to upgrade themselves to play their self-regulatory role more
effectively; the members of stock exchanges should conform to
the just and equitable principles of conduct embodied in
exchanges’ rules
Integration of Stock Exchanges
The sheer size of the Indian capital market in terms of number of stock
exchanges (24) etc requires the immediate attention of the policy
42 Capi tal Markets
formulators. This is essential in the light of the massive expansion of

capital market activities particularly during the eighties and nineties. An
answer for this problem could be found in the issue of consolidation.
Efforts must be made to reduce the number and provide interconnectivity
between all stock exchanges in the country. In this connection, the steps
taken by the NSE are laudable. More than 100 cities and other major stock
exchanges are in the process of extending their trading terminals outside
their places of operation under the umbrella of NSE. Although the vast
size of the country, the regional loyalty of companies, etc might warrant
the size of such a magnitude, it is incumbent on the part of the planners to
stem the stock market of many ailments faced by it.
Efforts must be made on a continuous basis to consolidate and merge
the existing stock exchanges rather than to set up new ones as has
happened in the UK. For example, in the late sixties there were about 20
stock exchanges that got reduced to about half a dozen in 1972 and further
down to a single entity, viz. The London Stock Exchange in 1986. Although,
many new stock markets are being set up in Europe for small fast-growing
companies, such attempts in India in the form of OTCEI have not, however,
been successful.
National Stock Market System
An important issue that needs to be addressed when it comes to tackling
the issue of size and the number of stock exchanges is to have an ‘integrated
stock exchange system’. Accordingly, all the existing stock exchanges in
India will have to be federated to a single entity at the national level. It is
a matter of great satisfaction that recently the Federation of Indian Stock
Exchanges (FISE) has been formed by 12 regional stock exchanges. A
body known as ‘Indian Stock Exchanges Services Corporation’ (ISESC)
has been set up as a central trading system to provide the facility of
interconnectivity. If the efforts of constituting FISE succeed, there will be
three entities with a national stature, viz. NSE, BSE, and ISESC. Such an
arrangement of nation-wide integrated stock marketing would help
enhancing liquidity, improving market efficiency besides reducing
transaction costs.
Efforts must also be made to develop a uniform settlement cycle and
a common clearing system across the bourses. Such a measure will bring
an end to unnecessary speculation at the bourses based on arbitrage
opportunities. Further, there is a pressing need for drawing up a uniform
framework for rules, regulations and byelaws for stock exchanges. In this
connection, SEBI has constituted a Committee under the Chairmanship of
Mr. M.R. Mayya to work out a blueprint in the matter.

Science and Technology
The developments that are taking place in the realm of science and
technology have totally revolutionized the way trading used to be taking
place in stock markets. The availability and the power of computers have
probably made more impact on the securities business than in any other
industry. Adoption of the state-of-art technology by the stock exchanges
in the developed markets has not only changed the functioning of the
stock exchanges but also enabled product innovation in terms of
introduction of trading of options/futures. Technological innovations have
helped bring about the speed in the execution of orders and also to the
efficiency of prudential control. The information technology has facilitated
prudent use of the investment tool. Besides, information technology and
its sophisticated application have come to make all the difference when it
comes to the question of managing risks in the market place.
Derivative Instruments
Derivative instruments help in deepening of the capital markets by
providing for risk hedging and guarded speculation. With a larger size of
market, India commands the advantage of clearing houses/corporations
and depository system, which are essential conditions for introducing
derivatives. Although derivatives trading is considerably more complex to
understand because of the fact that the pay offs and the risks that buyers
and sellers face, and the economic theory that is used for pricing derivatives
are difficult to comprehend than the cash market, it offers an excellent
opportunity for an efficient, profitable, and sound stock trading.
In order to put in place a speedy, efficient and safe payments system
as part of the technological revolution in stock markets, RBI has introduced
the Electronic Fund Transfer System and connect all the important
institutions of the financial sector through VSAT system to improve the
payment arrangements and systems.
With the kind and the quality of human skills possessed by India’s
financial industry, it is quite imperative that there is a need to provide
sound capital foundation for the derivatives market. However, the derivative
trading is not a panacea for all that ails the Indian stock market if the recent
experience of some of corporates and banks abroad is of any indication. It
is to be noted with happiness that the Government of India has successfully
introduced the derivative trading in the stock exchanges.
Integration of Capital Market
44 Capi tal Markets
In order that the capital market thrives well, it is important that it gets itself
integrated with other segments of the financial system. Such an integration
would lead to reduction of speculative movements of funds that may
occur due to arbitrage that market segmentation offers. This in turn will
ensure efficient financial intermediation and optimal resource allocation.
The borderlines between different market segments are fast getting
obliterated in view of the rapid and varied developments taking place in
the realm of capital market. With banks being allowed greater flexibility so
far as their investment activities are concerned, the traditional wall between
banks and securities market is getting eliminated. Moreover, as banks are
increasingly providing long-term loans, they enter capital market to raise
resources through equity capital and subordinated debts. Similarly, the
development financial institutions (DFIs) are also allowed to lend in money
market and borrow in the notice money market segment. The distinction
between the banks and DFIs is getting thinner and the DFIs are facing
increasing competition from the banks so far as long-term funding is
concerned. Banks have also been permitted to diversify into capital market
activities by setting up of mutual funds.
REBOUND IN INDIAN CAPITAL MARKET
Although Indian capital market suffered bruises in the last part of the
nineties owing to the manipulative trade practices of unscrupulous brokers
and other participants, it has been witnessing fine times in the recent past,
thanks to many favorable conditions contributing to it. Some of the factors
that are responsible for this phenomenon are as follows:
1. Strong macroeconomic aggregates
2. Active participation of retail investors with renewed vigor
3. Active FII buying
4. Active Indian Institutional Investor (III) buying
5. Favorable corporate and sovereign ratings by leading credit rating
agencies like S & P, Moody’s, etc
6. Strong foreign exchange reserve position
7. Strong fundamentals of basic and other industrial segments such as
steel, FMCGs, IT, etc
8. Favorable monsoons fuelling adequate demand for goods and
services in the economy
9. Favorable political conditions
10. Forecasts of better prospects in future
REVIEW QUESTIONS
Section A
1. Define the term ‘capital market’?
2. What is a money market?
3. Mention the characteristics of a money market
4. Who are the participants of in a capital market?
5. Where is a capital market located?
6. What are ‘working groups’ associated with the Indian capital
market?
7. What is a ‘Gilt-edged market’?
8. What is industrial securities market?
9. State the components of industrial securities market
10. What is a primary market?
11. What are the different modes by funds are raised in a primary
market?
12. What is a secondary market?
13. State the importance of a secondary market
14. What is a stock exchange?
15. What are venture capital institutions?
16. What are mutual funds?
17. What are factoring institutions?
18. What are credit rating institutions?
19. What is an ‘OTCEI’?
20. Write a note on the National Clearance and depository System
21. What is NSDL?
22. What is a ‘Certificate of Deposit’ (CD)?
23. What are ‘zero coupon bonds’?
24. What are ‘deep discount bonds’?
25. What is a stockinvest?
26. What are ‘equipref’ shares?
27. What are ‘Euro issues’?
28. Write a note on the ‘Harshad Factor’
Section B
1. What are the functions of a capital market?
2. Identify some of the important forces that were responsible for
the structural transformation of the Indian capital market
3. Mention the new financial institutions that have come up in the
Indian capital market.
4. Bring out the measures of rejuvenation and reactivation
46 Capi tal Markets
undertaken by the SEBI in recent times

5. Identify the factors that have caused rebound in the Indian capital
market in the recent past
Secti on C
1. Trace the development and the growth of the Indian capital market
2. Discuss the constituents of the Indian capital market
3. Give an account of the various types of financial instruments
that are used in the Indian capital market
4. What are the recent initiatives taken by the SEBI as part of
revamping the Indian capital market?
5. What are the major issues confronting the Indian capital market?
Discuss
Chapter 3
Capital Market Instruments
The changes that are sweeping across the Indian capital market especially
in the recent past are something phenomenal. It has been experiencing
metamorphic changes in the last decade, thanks to a host of measures of
liberalization, globalization, and privatization that have been initiated by
the Government. Pronounced changes have occurred in the realm of
industrial policy, licensing policy, financial services industry, interest rates,
etc. The competition has become very intense and real in both industrial
sector and financial services industry.
As a result of these changes, the financial services industry has come
to introduce a number of instruments with a view to facilitate borrowing
and lending of money in the capital market.
MEANING
Financial instruments that are used for raising capital resources in the
capital market are known as ‘Capital Market Instruments’.
TYPES
The various capital market instruments used by corporate entities for
raising resources are as follows:
1. Preference shares
2. Equity shares
3. Non-voting equity shares
4. Cumulative convertible preference shares
5. Company fixed deposits
6. Warrants
7. Debentures and Bonds
PREFERENCE SHARES
Meaning
Shares that carry preferential rights in comparison with ordinary shares
are called ‘Preference Shares’. The preferential rights are the rights
48 Capi tal Markets
regarding payment of dividend and the distribution of the assets of the

company in the event of its winding up, in preference to equity shares.
Types
1. Cumulative preference shares Shares where the arrears of dividends
in times of no and/or lean profits can be accumulated and paid in the year
in which the company earns good profits.
2. Non-cumulative preference shares Shares where the carry forward
of the arrears of dividends is not possible.
3. Participating preference shares Shares that enjoy the right to
participate in surplus profits or surplus assets on the liquidation of a
company or in both, if the Articles of Association provides for it.
4. Redeemable preference shares Shares that are to be repaid at
the end of the term of issue, the maximum period of a redemption being 20
years with effect from 1.3.1997 under the Companies Amendment Act,
1996. Since they are repayable, they are similar to debentures. Only fully
paid shares are redeemed. Where redemption is made out of profits, a
Capital Redemption Reserve Account is opened to which a sum equal to
the nominal value of the shares redeemed is transferred. It is treated as
paid-up share capital of the company.
5 . F ul l y c o n v e r ti b l e c um ul a ti v e p r e f e r e n c e s h a r e s Shares
comprise two parts viz., Part A and B. Part A is convertible into equity
shares automatically and compulsorily on the date of allotment. Part B will
be redeemed at par/converted into equity shares after a lock-in period at
the option of the investor, conversion into equity shares taking place after
the lock-in period, at a price, which would be 30 percent lower than the
average market price. The average market price shall be the average of the
monthly high and low price of the shares in a stock exchange over a period
of 6 months including the month in which the conversion takes place.
6 . P r e f e r e n c e s h a r e s wi th w a r r a n ts a tta c h e d The attached
warrants entitle the holder to apply for equity shares for cash, at a
‘premium’, at any time, in one or more stages between the third and fifth
year from the date of allotment. If the warrant holder fails to exercise his
option, the unsubscribed portion will lapse. The holders of warrants would
be entitled to all rights/bonus shares that may be issued by the company.
The preference shares with warrants attached would not be transferred/
sold for a period of 3 years from the date of allotment.
Capi t al Market Instruments 49
EQUITY SHARES
Meaning
Equity shares, also known as ‘ordinary shares’ are the shares held by the
owners of a corporate entity.
F e a tu r e s
Since equity shareholders face greater risks and have no specific preferential
rights, they are given larger share in profits through higher dividends than
those given to preference shareholders, provided the company’s
performance is excellent. Directors declare no dividends in case there are
no profits or the profits do not justify dividend for previous years even
when the company makes substantial profits in subsequent years. Equity
shareholders also enjoy the benefit of ploughing back of undistributed
profits kept as reserves and surplus for the purposes of business expansion.
Often, part of these is distributed to them as bonus shares. Such bonus
shares are entitled to a proportionate or full dividend in the succeeding
year.
A strikingly noteworthy feature of equity shares is that holders of
these shares enjoy substantial rights in the corporate democracy, namely
the rights to approve the company’s annual accounts, declaration of
dividend, enhancement of managerial remuneration in excess of specified
limits and fixing the terms of appointment and election of directors,
appointment of auditors and fixing of their remuneration, amendments to
the Articles and Memorandum of Association, increase of share capital
and issue of further shares or debentures, proposals for mergers and
reconstruction, and any other important proposal on which member’s
approval is required under the Companies Act.
Equity shares in the hands of shareholders are mainly reckoned for
determining the management’s control over the company. Where
shareholders are widely disbursed, it is possible for the management to
retain the control, as it is not possible for all the shareholders to attend the
company’s meeting in full strength. Furthermore, the management group
can bolster its controlling power by acquiring further shares in the open
market or otherwise. Equity shares may also be offered to financial
institutions as part of the private placement exercise. Such a method,
however, is fraught with the danger of takeover attempt by financial
institutions.
Equity shareholders represent proportionate ownership in a company.
They have residual claims on the assets and profits of the company. They
50 Capi tal Markets
have unlimited potential for dividend payments and price appreciation in

comparison to the owners of debentures and preference shares who enjoy
just a fixed assured return in the form of interest and dividend. Higher the
risk, higher the return and vice-versa.
Share certificates either in physical form or in the demat (with the
introduction of depository system in 1996) form are issued as a proof of
ownership of the shares in a company. Demat facilitates electronic trading.
Fully paid equity shares with detachable warrants entitle the warrant holder
to apply for a specified number of shares at a determined price. Detachable
warrants are separately registered with stock exchanges and traded
separately. The company would determine the terms and conditions
relating to the issue of equity against warrants.
Voting rights are granted under the Companies Act (Sections 87 to 89)
wherein each shareholder is eligible for votes proportionate to the number
of shares held or the amount of stock owned. A company cannot issue
shares carrying disproportionate voting rights. Similarly, voting right
cannot be exercised in respect of shares on which the shareholder owes
some money to the company.
Capital
Equity shares are of different types. The maximum value of shares as
specified in the Memorandum of Association of the company is called the
authorized or registered or nominal capital. Issued capital is the nominal
value of shares offered for public subscription. In case shares offered for
public subscription are not taken up, the portion of capital subscribed is
called subscribed capital. This is less than the issued capital. Paid-up
capital is the share capital paid-up by shareowners which is credited as
paid-up on the shares.
Par Value and Book Value
The face value of a share is called its Par value. Although shares can be
sold below the par value, it is possible that shares can be issued below the
par value. The financial institutions that convert their unpaid principal
and interest into equity in sick companies are compelled to do it at a
minimum of Rs.10 because of the par value concept even though the
market price might be much less than Rs.10. Par value can also lead to
unhealthy practices like price rigging by promoters of sick companies to
take market prices above Rs.10 to get their new offers subscribed.
Par value is of use to the regulatory agency and the stock exchange.
It can be used to control the number of shares that can be issued by the
company. The par value of Rs.10 per share serves as a floor price for issue
of shares.
Book value is the intrinsic value of a share that is calculated to reflect
the networth of the shareholders of a corporate entity.
Cash Divid ends
These are dividends paid in cash. A stable payment of cash dividend is
the hallmark of stability of share prices.
Stock Dividends
These are the dividends distributed as shares and issued by capitalizing
reserves. While networth remains the same in the balance sheet, its
distribution between shares and surplus is altered.
NON-VOTING EQUITY SHARES
Consequent to the recommendations of the ‘Abid Hussain Committee’
and subsequent to the amendment to the Companies Act, corporate
managements are permitted to mobilize additional capital without diluting
the interest of existing shareholders with the help of a new instrument
called ‘non-voting equity shares’. Such shares will be entitled to all the
benefits except the right to vote in general meetings. Such non-voting
equity share is being considered as a possible addition to the two classes
of share capital currently in vogue. This class of shares has been included
by an amendment to the Companies Act as a third category of shares.
Corporates will be permitted to issue such shares upto a certain percentage
of the total share capital.
Non-voting equity shares will be entitled to rights and bonus issues
and preferential offer of shares on the same lines as that of ordinary shares.
The objective will be to compensate the sacrifice made for the voting
rights. For this purpose, these shares will carry higher dividend rate than
that of voting shares. If a company fails to pay dividend, non-voting
shareholders will automatically be entitled to voting rights on a prorata
basis until the company resumes paying dividend.
The mechanism of issue of non-voting shares is expected to overcome
such problems as are associated with the voting shares as that the ordinary
investors are more inclined towards high return on capital through sizeable
dividends and capital appreciation through the issue of bonus shares and
the inability of corporates to respond to the investors’ just aspiration for
reasonable dividends. Moreover, there is every need for corporates to
spend huge sums of money on a variety of not-so-useful items including
colorful and costly annual reports. For all these above-mentioned reasons,
52 Capi tal Markets
non-voting equity shares are expected to have a ready and popular market.
In effect, this kind of share is similar to preference shares with regard to
non-voting rights but may get the advantage of higher dividends as well
as appreciation in share values through entitlement to bonus shares which
is not available to preference shares.
CONVERTIBLE CUMULATIVE PREFERENCE SHARES (CCPS)
These are the shares that have the twin advantage of accumulation of
arrears of dividends and the conversion into equity shares. Such shares
would have to be of the face value of Rs.100 each. The shares have to be
listed on one or more stock exchanges in the country. The object of the
issue of CCP shares is to allow for the setting up of new projects, expansion
or diversification of existing projects, normal capital expenditure for
modernization and for meeting working capital requirements.
Following are some of the terms and conditions of the issue of CCP
shares:
• Debt-equity ratio For the purpose of calculation of debt-equity
ratio as may be applicable CCPS are be deemed to be an equity
issue.
• Compulsory conversion The conversion into equity shares
must be for the entire issue of CCP shares and shall be done
between the periods at the end of three years and five years as
may be decided by the company. This implies that the conversion
of the CCP into equity shares would be compulsory at the end of
five years and the aforesaid preference shares would not be
redeemable at any stage.
• Fresh issue The conversion of CCP shares into equity would
be deemed as being one resulting from the process of redemption
of the preference shares out of the proceeds of a fresh issue of
shares made for the purposes of redemption.
• Preference dividend The rate of preference dividend payable
on CCP shares would be 10 percent.
• Guideline ratio The guideline ratio of 1:3 as between preference
shares and equity shares would not be applicable to these shares.
• Arrears of dividend The right to receive arrears of dividend
up to the date of conversion, if any, shall devolve on the holder
of the equity shares on such conversion. The holder of the equity
shares shall be entitled to receive the arrears of dividend as and
when the company makes profit and is able to declare such
dividend.
• Voting right CCPS would have voting rights as applicable to

preference shares under the Companies Act, 1956.
• Quantum The amount of the issue of CCP shares would be to
the extent the company would be offering equity shares to the
public for subscription.
COMPANY FIXED DEPOSITS

Fixed deposits are the attractive source of short-term capital both for the
companies and investors as well. Corporates favor fixed deposits as an ideal
form of working capital mobilization without going through the process of
mortgaging assets and the associated rigmaroles of documentation, etc.
Investors find fixed deposits a simple avenue for investment in popular
companies at attractively reasonable and safe interest rates. Moreover,
investors are relieved of the problem of the hassles of market value fluctuation
to which instruments such as shares and debentures are exposed. There are
no transfer formalities either. In addition, it is quite possible for investors to
have the option of premature repayment after 6 months, although such an
option entails some interest loss.
Re gu latio ns
Since these instruments are unsecured, there is a lot of uncertainty about
the repayment of deposits and regular payment of interest. The issue of
fixed deposits is subject to the provisions of the Companies Act and the
Companies (Acceptance of Deposits) Rules introduced in February 1975.
Some of the important regulations in this regard as follows:
a. Advertisement Issue of an advertisement (with the prescribed
information) as approved by the Board of Directors in dailies
circulating in the state of incorporation.
b. Liquid assets Maintenance of liquid assets equal to 15 percent
(substituted for 10% by Amendment Rules, 1992) of deposits
(maturing during the year ending March 31) in the form of bank
deposits, unencumbered securities of State and Central
Governments or unencumbered approved securities.
c. Disclosure Disclosure in the newspaper advertisement the
quantum of deposits remaining unpaid after maturity. This would
help highlight the defaults, if any, by the company and caution
the depositors.
d. Deemed public company Private company would become a
deemed public company (From June 1998, Section 43A of the
Act) where such a private company, after inviting public deposits
54 Capi tal Markets
through a statutory advertisement, accepts or renews deposits

from the public other than its members, directors or their relatives.
This provision, to a certain extent, enjoins better accountability
on the part of the management and auditors.
e. Default Penalty under the law for default by companies in
repaying deposits as and when they mature for payment where
deposits were accepted in accordance with the Reserve Bank
directions.
f. CLB Empowerment to the Company Law Board to direct
companies to repay deposits, which have not been repaid as per
the terms and conditions governing such deposits, within a time
frame and according to the terms and conditions of the order.
WARRANTS
An option issued by a company whereby the buyer is granted the right to
purchase a number of shares (usually one) of its equity share capital at a
given exercise price during a given period is called a ‘warrant’. Although
trading in warrants are in vogue in the U.S. Stock markets for more than 6
to 7 decades, they are being issued to meet a range of financial requirements
by the Indian corporates.
A security issued by a company, granting its holder the right to
purchase a specified number of shares, at a specified price, any time prior
to an expirable date is known as a ‘warrant’. Warrants may be issued with
either debentures or equity shares. They clearly specify the number of
shares entitled, the expiration date, along with the stated/exercise price.
The expiration date of warrants in USA is generally 5 to 10 years from the
date of issue and the exercise price is 10 to 30 percent above the prevailing
market price. Warrants have a secondary market. The exchange value
between the share at its current price and the shares to be purchased at
the exercise price represents the minimum value of a warrant. They have
no floatation costs and when they are exercised, the firm receives additional
funds at a price lower than the current market, yet higher than those
prevailing at the time of issue. Warrants are issued by new/growing firms
and venture capitalists. They are also issued during mergers and
acquisitions. Warrants in the Indian context are called ‘sweeteners’ and
were issued by a few Indian companies since 1993.
Both warrants and rights entitle a buyer to acquire equity shares of
the issuing company. However, they are different in the sense that warrants
have a life span of three to five years whereas, rights have a life span of
only four to twelve weeks (duration between the opening and closing date
of subscription list). Moreover, rights are normally issued to effect current

financing, and warrants are sold to facilitate future financing. Similarly, the
exercise price of warrant, i.e. the price at which it can be exchanged for
share, is usually above the market price of the share so as to encourage
existing shareholders to purchase it. On the other hand, one warrant buys
one equity share generally, whereas more than one rights may be needed
to buy one share. The detachable warrant attached to each share provides
a right to the warrant holder to apply for additional equity share against
each warrant.
DEBENTURES AND BONDS
A document that either creates a debt or acknowledges it is known as a
debenture. Accordingly, any document that fulfills either of these
conditions is a debenture. A debenture, issued under the common seal of
the company, usually takes the form of a certificate that acknowledges
indebtedness of the company.
A document that shows on the face of it that a company has borrowed
a sum of money from the holder thereof upon certain terms and conditions
is called a debenture. Debentures may be secured by way of fixed or
floating charges on the assets of the company. These are the instruments
that are generally used for raising long-term debt capital.
F e a tu r e s
Following are the features of a debenture:
1. Issue In India, debentures of various kinds are issued by the corporate
bodies, Government, and others as per the provisions of the Companies
Act, 1956 and under the regulations of the SEBI. Section 117 of the
Companies Act prohibits issue of debentures with voting rights. Generally,
they are issued against a charge on the assets of the company but at times
may be issued without any such charge also. Debentures can be issued at
a discount in which case, the relevant particulars are to be filed with the
Registrar of Companies.
2. Negotiability In the case of bearer debentures the terminal value is
payable to its bearer. Such instruments are negotiable and are transferable
by delivery. Registered debentures are payable to the registered holder
whose name appears both on the debenture and in the register of debenture
holders maintained by the company. Further, transfer of such debentures
should be registered. They are not negotiable instruments and contain a
commitment to pay the principal and interest.
56 Capi tal Markets
3. Security Secured debentures create a charge on the assets of the

company. Such a charge may be either fixed or floating. Debentures that
are issued without any charge on assets of the company are called
‘unsecured or naked debentures’.
4. Duration Debentures, which could be redeemed after a certain period
of time are called Redeemable Debentures. There are debentures that are
not to be returned except at the time of winding up of the company. Such
debentures are called Irredeemable Debentures.
5. Convertibility Where the debenture issue gives the option of
conversion into equity shares after the expiry of a certain period of time,
such debentures are called Convertible Debentures. Non-convertible
Debentures, on the other hand, do not have such an exchange facility.
6. Return Debentures have a great advantage in them in that they carry
a regular and reasonable income for the holders. There is a legal obligation
for the company to make payment of interest on debentures whether or
not any profits are earned by it.
7. Claims Debenture holders command a preferential treatment in the
matters of distribution of the final proceeds of the company at the time of
its winding up. Their claims rank prior to the claims of preference and
equity shareholders.
Kinds
Innovative debt instruments that are issued by the public limited companies
in India are described below:
1. Participating debentures
2. Convertible debentures
3. Debt-equity swaps
4. Zero-coupon convertible notes
5. Secured premium notes (SNP) with detachable warrants
6. Non-convertible debentures (NCDs) with detachable equity
warrant
7. Zero-interest fully convertible debentures (FCDs)
8. Secured zero-interest partly convertible debentures (PCDs) with
detachable and separately tradable warrants
9. Fully convertible debentures (FCDs) with interest (optional)
10. Floating rate bonds (FRB)
1. Participating debentures Debentures that are issued by a body

corporate which entitle the holders to participate in its profits are
called ‘Participating Debentures’. These are the unsecured corporate
debt securities. They are popular among existing dividend paying
corporates.
2. Convertible debentures
a. Convertible debentures with options are a derivative of
convertible debentures that give an option to both the issuer, as
well as the investor, to exit from the terms of the issue. The coupon
rate is specified at the time of issue.
b. Third party convertible debentures are debts with a warrant
that allow the investor to subscribe to the equity of a third firm at
a preferential price vis-à-vis market price, the interest rate on the
third party convertible debentures being lower than pure debt on
account of the conversion option.
c. Convertible debentures redeemable at a premium are issued
at face value with a put option entitling investors to sell the bond
to the issuer, at a premium later on. They are basically similar to
convertible debentures but have less risk.
3. Debt-equity swaps They are offered from an issuer of debt to swap
it for equity. The instrument is quite risky for the investor because the
anticipated capital appreciation may not materialize.
4. Zero-coupon convertible note These are debentures that can be
converted into shares and on its conversion the investor forgoes all
accrued and unpaid interest. The zero-coupon convertible notes are
quite sensitive to changes in the interest rates.
5. SPN with detachable warrants These are the Secured Premium
Notes (SPN) with detachable warrants. These are the redeemable
debentures that are issued along with a detachable warrant. The warrant
entitles the holder to apply and get equity shares allotted, provided
the SPN is fully paid. The warrants attached to it assure the holder
such a right. No interest will be paid during the lock-in period for SPN.
The SPN holder has an option to sell back the SPN to the company
at par value after the lock-in period. If this option is exercised by the
holder, no interest/premium will be paid on redemption. The holder
will be repaid the principal and the additional interest/premium amount
in instalments as may be decided by the company. The conversion of
detachable warrant into equity shares will have to be done within the
time limit notified by the company.
58 Capi tal Markets
6. NCDs with detachable equity warrants These are Non-convertible

debentures (NCDs) with detachable equity warrants. These entitle
the holder to buy a specific number of shares from the company at a
pre-determined price within a definite time frame. The warrants
attached to NCDs are issued subject to full payment of the NCDs’
value. The option can be exercised after the specific lock-in period.
The company is at liberty to dispose off the unapplied portion of
shares if the option to apply for equities is not exercised.
7. Zero interest FCDs These are Zero-interest Fully Convertible
Debentures on which no interest will be paid by the issuer during the
lock-in period. However, there is a notified period after which fully
paid FCDs will be automatically and compulsorily converted into
shares. In the event of a company going in for rights issue prior to the
allotment of equity (resulting from the conversion of equity shares
into FCDs), it shall do so only after the FCD holders are offered
securities.
8. Secured zero interest PCDs with detachable and separately tradable
warrants These are Secured Zero Interest Partly Convertible
Debentures with detachable and separately tradable warrants. They
are issued in two parts. Part A is a convertible portion that allows
equity shares to be exchanged for debentures at a fixed amount on
the date of allotment. Part B is a non-convertible portion to be redeemed
at par at the end of a specific period from the date of allotment. Part B
which carries a detachable and separately tradable warrant provides
the warrant holder an option to receive equity shares for every warrant
held, at a price worked out by the company.
9. Fully convertible debentures (FCDs) with interest (Optional) These
are the debentures that will not yield any interest for an initial short
period after which the holder is given an option to apply for equities
at a premium. No additional amount needs to be paid for this. The
option has to be indicated in the application form itself. Interest on
FCDs is payable at a determined rate from the date of first conversion
to the date of second/final conversion and in lieu of it, equity shares
will be issued.
10. Floating rate bonds (FRBs) These are the bonds where the yield
is linked to a benchmark interest rate like the prime rate in USA or
LIBOR in the Euro currency market. For instance, the State Bank of
India’s floating rate bond, issue was linked to the maximum interest
on term deposits that was 10 percent at that time. The floating rate is
quoted in terms of a margin above or below the benchmark rate.
Interest rates linked to the benchmark ensure that neither the borrower
nor the lender suffer from the changes in interest rates. Where interest
rates are fixed, they are likely to be inequitable to the borrower when
interest rates fall and inequitable to the lender when interest rates rise
subsequently.
Shares Vs. Debentures
Shares are different from debentures in the following manner:
1. Shareholder has a proprietary interest in the company, and
debenture holder is only a creditor of the company.
2. Debenture holder is entitled to fixed interest whereas the
shareholder is entitled to dividends depending on and varying
with profits.
3. Shareholders have voting rights whereas debenture holders do
not have voting rights.
4. Debentures may be redeemable whereas shares except preference
shares are not redeemable.
5. Debenture holders get priority over shareholders when assets
are distributed upon winding up.
GLOBAL DEBT INSTRUMENTS

Following are some of the debt instruments that are popular in the
international financial markets:
Income Bonds
Interest income on such bonds is paid only where the corporate
commands adequate cash flows. They resemble cumulative preference
shares in respect of which fixed dividend is paid only if there is profit
earned in a year, but carried forward and paid in the following year. There
is no default on income bonds if interest is not paid. Unlike the dividend
on cumulative preference shares, the interest on income bond is tax
deductible. These bonds are issued by corporates that undergo financial
restructuring.
As se t Bac ked Sec uri ti es
These are a category of marketable securities that are collateralized by
financial assets such as instalment loan contracts. Asset backed
financing involves a disintermediating process called securitization,
whereby credit from financial intermediaries in the form of debentures
are sold to third parties to finance the pool. Repos are the oldest asset
backed security in our country. In USA, securitisation has been
undertaken for the following:
60 Capi tal Markets
• Insured mortgages
• Mortgage backed bonds
• Student loans
• Trade credit receivable backed bonds
• Equipments leasing backed bonds
• Certificates of automobile receivable securities
• Small business administration loans
• Credit and receivable securities
Junk Bonds
Junk bond is a high risk, high yield bond which finances either a Leveraged
Buyout (LBO) or a merger of a company in financial distress. Junk bonds
are popular in the USA and are used primarily for financing takeovers. The
coupon rates range from 16 to 25 percent. Attractive deals were put together
establishing their feasibility in terms of adequacy of cash flows to meet
interest payments. Michael Milken (the junk bond king) of Drexel Burnham
Lambert was the real developer of the market.
Indexed Bonds
These are the bonds whose interest payment and redemption value are
indexed with movements in prices. Indexed bonds protect the investor
from the eroding purchasing power of money because of inflation. For
instance, an inflation-indexed bond implies that the payment of the coupon
and/or the redemption value increases or decreases according to
movements in prices. The bonds are likely to hedge the principal amount
against inflation. Such bonds are designed to provide investors an
effective edge against inflation so as to enhance the credibility of the anti-
inflationary policies of the Government. The yields of an inflation-indexed
bond provide vital information on the expected rate of inflation.
United Kingdom, Australia, and Canada have introduced index linked
government securities as a segmented internal debt management operation
with a view to increase the range of assets available in the system, provide
an inflation hedge to investors, reduce interest costs and pick up direct
signals, and the expected inflation and real rate of interest from the market.
Zero Coupon Bonds (ZCBs)/ Zero Coupon Convertible Debentures
Zero Coupon Bonds first came to be introduced in the U.S. securities
market. Initially, such bonds were issued for high denominations. These
bonds were purchased by large security brokers in large chunks, who
resold them to individual investors, at a slightly higher price in affordable
lots. Such bonds were called ‘Treasury Investment Growth Receipts’
(TIGRs) or ‘Certificate of Accruals on Treasury Securities’ (CATSs) or
ZEROs as their coupon rate is Zero. Moreover, these certificates were sold
to investors at a hefty discount and the difference between the face value
of the certificate and the acquisition cost was the gain. The holders are not
entitled for any interest except the principal sum on maturity.
Advantages Zero Coupon Bonds offer a number of advantages as
shown below:
a. No botheration of periodical interest payment for the issuers.
b. The attraction of conversion of bonds into equity shares at a
premium or at par, the investors usually being rewarded by way
of a low premium on conversion.
c. There is only capital gains tax on the price differential and there
is no tax on accrued income.
d. Possibility of efficient servicing of equity as there is no obligation
to pay interest till maturity and its eventual conversion.
Mahindra & Mahindra came out with the scheme of Zero Coupon
Bonds for the first time in India along with 12.5 percent convertible bonds
for part financing of its modernization and diversification scheme. Similarly,
Deep Discount Bonds were issued by IDBI at Rs.2,000 for a maturity of
Rs.1 lakh after 25 years. These are negotiable instruments transferable by
endorsement and delivery by the transferor. IDBI also offered Option
Bonds which may be either cumulative or non-cumulative bonds where
interest is payable either on maturity or periodically. Redemption is also
offered to attract investors.
Floating Rate Bonds (FRBs)
Bonds that carry the provision for payment of interest at different rates for
different time periods are known as ‘Floating Rate Bonds’. The first floating
rate bond was issued by the SBI in the Indian capital market. The SBI,
while issuing such bonds, adopted a reference rate of highest rate of
interest on fixed deposit of the Bank, provided a minimum floor rate payable
at 12 percent p.a. and attached a call option to the Bank after 5 years to
redeem the bonds earlier than the maturity period of 10 years at a certain
premium. A major highlight of the bonds was the provision to reduce
interest risk and assurance of minimum interest on the investment provided
by the Bank.
Secured Premium Notes (SPNs)
Secured debentures that are redeemable at a premium over the issue price
or face value are called secured premium notes. Such bonds have a lock-in
period during which period no interest will be paid. It entitles the holder to
sell back the bonds to the issuing company at par after the lock-in period.
62 Capi tal Markets
A case in point was the issue made by the TISCO in the year 1992,
where the company wanted to raise money for its modernization program
without expanding its equity excessively in the next few years. The
company made the issue to the existing shareholders on a rights basis
along with the rights issue. The salient features of the TISCO issue were
as follows:
• Face value of each SPN was Rs.300
• No interest was payable during the first three years after allotment
• The redemption started at the end of the fourth year of issue
• Each of the SPN of Rs.300 was repaid in four equal annual
instalments of Rs.75, which comprised of the principal, the interest
and the relevant premium. (Low interest and high premium or
high interest and low premium, at the option to be exercised by
the SPN holder at the end of the third year)
• Warrant attached to each SPN entitled the holder the right to
apply for or seek allotment of one equity share for cash payment
of Rs.80 per share. Such a right was exercisable between first
year and one-and-a-half year after allotment by which time the
SPN would be fully paid up
This instrument tremendously benefited TISCO, as there was no
interest outgo. This helped TISCO to meet the difficulties associated with
the cash generation. In addition, the company was able to borrow at a
cheap rate of 13.65 percent as against 17 to 18 percent offered by most
companies. This enabled the company to start redemption earlier through
the generation of cash flow by the company’s projects. The investors had
the flexibility of tax planning while investing in SPNs. The company was
also equally benefited as it gave more flexibility.
Euro Convertible Bonds
Bonds that give the holders of euro bonds to have the instruments
converted into a wide variety of options such as the call option for the
issuer and the put option for the investor, which makes redemption easy
are called ‘Euro-convertible bonds’. A euro-convertible bond essentially
resembles the Indian convertible debenture but comes with numerous
options attached. Similarly, a euro-convertible bond is an easier instrument
to market than equity. This is because it gives the investor an option to
retain his investment as a pure debt instrument in the event of the price of
the equity share falling below the conversion price or where the investor
is not too sure about the prospects of the company.
P o p ul a r i ty o f c o n v e r ti b l e e ur o b o n ds A convertible bond
issue allows an Indian company far greater flexibility to tap the Euro market
and ensures that the issue has a better market reception than would be
possible for a direct equity issue. Moreover, newly industrialized countries
such as Korea have chosen the convertible bond market as a stepping-
stone to familiarity and acceptance of their industrial companies in the
international market. The convertible bonds offer the following advantages:
a. Protection Euro convertible bonds are favored by international
investors as it offers them the advantage of protection of their
wealth from erosion. This is possible because the conversion is
only an option, which the investors may choose to exercise only
if it works to their benefit. This facility is not available for equity
issues.
b. Liquidity Convertible bond market offers the benefit of the most
liquid secondary market for new issues. Fixed income funds as
well as equity investment managers purchase convertible bonds.
c. Flexibility The feature of flexibility in structuring convertible
bonds allows the company to include some of the best possible
clauses of investors’ protection by incorporating the unusual
features of equity investments. A case in point is the issues made
by the Korean corporate sector, which contained a provision in
the issue of convertible euro bonds. The provision entitled the
holders to ensure the due compliance of the liberalization
measures that had already been announced within a specified
period of time. Such a provision enabled the investor to opt for a
‘put’ option.
d. Attractive investment The issue of convertible debentures
facilitates removal of many of the unattractive features of equity
investment. For investors, convertible bond market makers are
the principal sources of liquidity in their securities.
Bond Issue—Indian Experience
In recent times, all-India financial institutions have come to design and
introduce special and innovative bond instruments exclusively structured
on the investors’ preferences and funds requirement of the issuers. The
emphasis from the issuer’s viewpoint is the resource mobilization and not
risk exposure. Several financial institutions such as the IDBI, the ICICI, etc
are engaged in the sale of such bonds. A brief description of some these
bonds is presented below:
IDBI’s Zero Coupon Bonds, 1996 These bonds are sold at a discount
64 Capi tal Markets
and are paid no interest. It is of great advantage to issuers as it is not

required for them to make periodic interest payment.
IDBI’s Regular Income Bonds, 1996 These were the bonds issued by
the IDBI as 10-year bonds carrying a coupon of 16 percent, payable half-
yearly. The bonds provided an annualized yield equivalent to 16.64 per-
cent. The bonds, which were priced at Rs.5,000 can be redeemed at the end
of every year, after the third year allotment. There was also a call option
that entitled the IDBI to redeem the bonds five years from the date of
allotment.
Retirement Bonds, 1996 The IDBI Retirements Bonds were issued
at a discount. The issue targeted investors who are planning for retire-
ment. Under the scheme, investors get a monthly income for 10 years after
the expiry of a wait period, the wait period being chosen by the investor.
Thereafter, the investors also get a lump sum amount, which is the matu-
rity value of the bond.
IFCI’s Bonds, 1996 These bonds include:
a. Deep Discount Bonds—Issued for a face value of Rs.1 lakh
each.
b. Regular Income and Retirement Bonds—They had a five-
year tenure, a semi-annual yield of 16 percent and a front-
end discount of 4 percent. The bonds had three-year put
option and an early bird incentive of 0.75 percent.
c. Step-up Liquid Bond—The five-year bonds with a put option
every year with a return of 16 percent, 16.25 percent, 16.5
percent, 16.75 percent, and 17 percent at the end of every
year.
d. Growth Bond—An investment of Rs.20,000 per bond under
this scheme entitles investors to a Rs.1 lakh face-value bond
maturing after 10 years. Put options can be exercised at the
end of 5 and 7 years respectively. If exercised, the investor
gets Rs.43,500 after 5 years and Rs.60,000 after a 7 year period.
e. Lakhpati Bond—The maturity period of these bonds varried
from 5 to 10 years, after which the investor gets Rs.1 lakh.
The initial investment required was Rs.20,000 for 10 years
maturity, Rs.23,700 for 9 years, Rs.28,000 for 8 years, Rs.33,000
for 7 years, Rs.39,000 for 6 years and Rs.46,000 for 5 years
maturity.
ICICI’s Bonds, 1997 ICICI came out with as many as five bonds in
March 1997. These are encash bonds, index bonds, regular income bonds,
deep discount bonds, and capital gain bonds. The bonds were aimed at
meeting the diverse needs of all categories of investors, besides contrib-
uting to the widening of the bond market so as to bring the benefits of
these securities to even the smallest investors.
a. Capital gains bond Also called infrastructure bonds
incorporated the capital gains tax relaxations under Section 54EA
of the Income Tax Act announced in the Union Budget for 1997-98.
They are issued for 3 and 7 years maturity. 20 percent rebate was
available under Section 88 of the I.T. Act for investors on the
amount invested in the capital gains bonds upto a maximum of
Rs.70,000. They can avail benefit under Section 88. The annual
interest rate worked out to 13.4 percent while the annual yield
came to 20.7 percent. However, investment through stock-invest
will not qualify for the rebate.
b. Encash bond The five-year encash bonds were issued at a face
value of Rs.2,000 and can be redeemed at par across the country in
200 cities during 8 months in a year after 12 months. The bond had
a step-up interest every year from 12 to 18.5 percent and the
annualized yield at maturity for the bond works out to 15.8 percent.
The encashing facility, however, is available only to the original
bondholders. The bonds not only offer higher return but also help
widen the banking facilities to investors. The secondary market
price of the bonds is likely to be favourably influenced by the
step-up interest that results in an improved YTM every year.
c. Index bond Which gives the investor both the security of the
debt instrument and the potential of the appreciation in the return
on the stock market. Priced at Rs.6,000 the index bond has two
parts:
Part A is a deep discount bond of the face value of Rs. 22,000
issued for a 12 year period. Its calculated yield was 15.26 percent.
It also has a call and a put option attached to it assuring the
investor a return of Rs.9,300 after 6 years option is exercised. Part
B is a detachable index warrant issued for 12 years and priced at
Rs. 2,000. The yield was linked to the BSE SENSEX. The face value
of the bond will appreciate the number of times the SENSEX has
appreciated. The investors’ returns will be treated as capital gains.
Tax Free Bonds The salient features of the tax-free Government of India
66 Capi tal Markets
bonds to be issued from October 1, 2002 are as follows:

a. Interest rate The bonds will carry an interest rate of 7 percent.
b. Tax exemption The bonds will be exempt from Income-tax and
Wealth-tax.
c. Maturity The bonds will have a maturity period of six years.
d. Ceiling The bonds investment will have no ceiling.
e. Tradability The bonds will not be traded in the secondary market.
f. Investors The eligible investors include individuals and Hindu
Undivided families (HUFs). NRIs are not eligible for investing in
these bonds.
g. Issue price Bonds will be issued for a minimum amount of Rs.
1,000 and its multiples.
h. Maturity value The cumulative maturity value of the bond will
be Rs.1,511 at the end of six years.
i. Form of issue The bonds will be both in demat form as well as in
the traditional form of stock certificates. Option once chosen
cannot be changed.
j. Transferability Bonds will not be transferable except by way of
gift to relatives as defined in the Companies Act.
k. Collaterals The bonds cannot be used as collaterals for
obtaining loans from banks, financial institutions and non-banking
financial companies.
l. Nomination A sole holder or a sole surviving holder of the
bond being an individual can make a nomination.
REVIEW QUESTIONS
Section A
1. What are capital market instruments?
2. State the various types of market instruments.
3. What are preference shares?
4. What are equity shares?
5. How is cash dividend different from stock dividend?
6. What are non-voting shares?
7. What are convertible cumulative preference shares?
8. What are company fixed deposits?
9. What are warrants?
10. What is a debenture?
11. What are participating debentures?
12. What are floating rate bonds?
13. What are asset backed securities?

14. What are junk bonds?
15. What are indexed bonds?
Section B
1. Explain briefly the various types of preference shares.
2. State the features of equity shares.
3. State the conditions with regard to the issue of convertible
cumulative preference shares.
4. State the regulations governing the company fixed deposits.
5. What are the features of debentures?
6. Explain briefly the different kinds of debentures
7. How shares different from debentures?
8. How are zero coupon bonds useful?
9. State the features of secured premium notes.
10. What are the various kinds of bonds issued by corporates in
India? Explain.
Secti on C
1. Explain the features of various capital market instruments.
2. Discuss the relevance of global debt instruments bringing out
their features.
3. What are euro convertible bonds? Why are they popular?
Chapter 4
Regulation of
Indian Capital Market
GENESIS
A sound and an efficient capital market provides investors and issuers of
capital an opportunity to spread investment risk and access to various
source of capital. The main advantage of a securities market is that it
enables liquid trading and provides a mechanism for price determination
for a wide range of financial instruments. A well-developed securities
market brings down cost of capital to enterprises in the long run, leading
to economic growth. However, there seems to be no proven path to follow.
The road to the positive outcome of accelerated economic growth is long,
costly, and faltering.
The Indian capital market is relatively young as compared to its western
counterparts, and has grown through the phases of disruptive shocks,
repression and times of prosperity and growth. This uneven path that
securities markets have to traverse is the outcome of the inherent nature
of the market and weakness of its participants’ behavior. The history of
the Indian capital market, beginning with the establishment of Bombay
Stock Exchange is no different, in terms of the shocks, crashes and scams
experienced by other capital markets and the hesitant steps by regulators
to stabilize it. Throughout its existence, the market has witnessed phases
of depression and unbridled competition. Since independence in 1947, the
market was under repressive policies until 1991 when the new economic
policy was unveiled.
THE FACTORS
Many factors were responsible for the introduction of measures of
regulations and control especially after initiation of reform process. Many
of these factors relate to the deficiencies in the Indian capital market.
Following are the kind of problems faced in the capital market in India,
which eventually led to the introduction of regulatory mechanism:
70 Capi tal Markets
1. Lack of adequate instruments Financial instrument are the media

through which trading and investment activities take place. One of
the biggest problems faced by the participants and investors in the
Indian capital market, was the non-availability of sufficient number of
different variety of financial instruments as compared to the capital
markets in advanced countries. The market was predominated by
traditional securities such as equity and preference sharers. Innovative
instruments such as participation certificates, certificates of deposit,
etc were not to be seen so popular.
2. Inadequate financial disclosure Information about market is an
edifice on which a sound capital market structure is built. Further, the
efficiency of capital market is greatly determined by the free flow of
unbiased and reliable market information. The Companies Act 1956,
had a number of norms requiring information disclosure about
companies. However, unfortunately, there was not only a dearth of
adequate market information but also quality and reliable information
for the investors to make right and timely decisions. The offer
documents of issuers hardly contained any useful information for the
investors. Companies often indulged in ‘window dressing’ with bad
accounting practices.
3. Lack of developed secondary market For a capital market to grow,
it is important that there must be available a strong and an agile
secondary market for scrips. Unfortunately, facilities were not
available for active trading of the securities in the secondary market.
Consequently, there was lack of liquidity for the scrips traded. This
greatly hampered the development of the capital market in India.
Moreover, the activities of speculators resulted in volatile share price
movements, jeopardizing the interest of the investors. Many a time,
no market existed for certain newly issued scrips.
4. Insider trading menace The menace of insider trading haunts the
Indian stock market. Insiders are those who have access to confidential
information of a company by virtue of the positions occupied by
them in the said company and thereby, are in a position to manipulate
the share prices to their advantage, with a view to make windfall
profits. They take away substantial business of the exchange stealthily,
thus making huge profits. Their actions cause wide fluctuations in
the prices of the securities, besides undermining the trust of the
investors in the capital market. When the investors find that the stock
market activity is rigged, they simply shy away from the market.
The provisions of the Companies Act (Sections 307 & 308)
Regul ati on of Indi a n Capi tal Market 71
requiring full disclosure by the Board of Directors of the company,

regarding the purchase or sale of securities by any director, statutory
auditor, cost auditor, financial accountant, cost accountant, tax and
management consultant, adviser, solicitors and others prove to be
totally ineffective in controlling such trading. Even the publication of
half-yearly results by listed companies, as required by Clause 41 of
the listing agreement in operation from the beginning of 1987, has not
helped minimize such a practice.
5. Price manipulation A typical characteristic of the Indian capital
market has been the price manipulation of new securities at the time of
fresh issue. Stock market operators indulge in price manipulations in
order to obtain higher premium so as to lure gullible investors to
subscribe to the issues.
6. Abolition of CCI The lifting of the several restrictions and controls
over the capital issues and the abolition of the office of CCI, turned
the conditions completely favorable to the manipulators. Further, the
set of liberalized procedures that came to be introduced thereafter
including the free market pricing of securities by the issuers led to the
practice of price rigging. The stock market quotations nose-dived
even before the subscription lists are closed for the issue, thus leaving
the prospective investors in lurch.
7. Unofficial trading Indian stock market faced the peculiar problem
of unofficial trading in shares prior to listing of new companies. Because
of the stipulation that the shares of new companies are required to be
issued at par; in case of prospective companies having bright future,
the issues are over-subscribed by many times. This gave an
opportunity to the management, underwriters and merchant bankers
to entice the investors. A case in point was the incredible stock market
activity witnessed during the boom, just prior to the unearthing of the
Scam in May 1992.
8. Uncontrolled share broking Yet another significant factor was the
deficiency of the Indian capital market and the resultant lack of control
over the activities of brokers and jobbers. The stock exchanges, instead
of being in a position to exercise their control over the affairs of the
share brokers, allowed themselves to be dictated by the whims of the
unscrupulous brokers who reined in their supremacy on the stock
exchange. This gave rise to a situation of uncontrolled and volatile
fluctuations in the security prices, which besides greatly affecting
the investors’ psychology, further precipitated the share prices. In
fact, there were cases of wiled threats from the broking community of
72 Capi tal Markets
non-cooperation and boycott. In addition, there were unofficial brokers

who commandeered the stock market operations. All these affected
the investors’ confidence thus debilitating the stock market ambience.
9. Lack of institutional support The presence and the active
participation of financial institutions like the UTI, IDBI, and LIC etc in
the stock market contribute in a large measure to the development
and the growth of a stock market. Unfortunately, in India, although
financial institutions were present in large number, there were found
to be highly inadequate in as far as their reach and support was
concerned. They failed to provide their ‘supportive and stabilizing
role’ for the cause of the stock exchange in India. This made the
capital market highly susceptible for many insurmountable problems.
THE REGULATORY FRAMEWORK
Under the SEBI Act

The provisions of the CIC (Capital Issues Control) Act were found to be
inadequate as to allow for the better control over the issues of capital
taking place in the realm of Indian capital market. Further factors such as
the changing industrial environment, spurt in the growth of joint stock
companies, enactment of the Companies Act of 1956, disclosure
requirements of accounting and financial information, listing of securities
for the purpose of their trading in the stock exchanges etc gave rise to a
situation where the existing legislation was found to be grossly inadequate.
Under the circumstances where the Indian stock market faced several
insurmountable problems outlined above, the need for a larger body which
could act as a unifying force in bringing together the scattered legislation
so as to offer better protection to the Indian stock investor was greatly
felt. It was for this purpose, the Securities and Exchange Board of India
(SEBI) was set up on April 12, 1988 as a non-statutory body with the chief
objective of protecting the interest of investors in securities, and for
promoting the development and the regulation of the securities market in
India.
SEBI functions SEBI was constituted to render the following functions:
1. Regulating the business in stock exchanges and any other
securities markets
2. Registering and regulating the working of stockbrokers,
sub-brokers, share transfer agents, bankers to an issue, trustees
of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such
other intermediaries who may be associated with securities

markets in any manner
3. Registering and regulating the working of collective investment
schemes including mutual funds
4. Promoting and regulating self regulatory organizations
5. Prohibiting fraudulent and unfair trade practices relating to
securities market
6. Promoting investors’ education and training of intermediaries of
securities market
7. Prohibiting insider trading in securities
8. Regulating substantial acquisition of shares and take over of
companies
9. Calling for information from undertaking inspection, conducting
inquiries and audits of the stock exchanges and intermediaries,
and self regulatory organizations in the securities market
10. Performing such functions and exercising such powers under
the provisions of Capital Issues Control Act and Securities
Contracts Regulation Act, as may be delegated to it by the Central
Government
11. Levying fees or other charges for carrying out the purposes of
regulation
12. Conducting research for the above purposes
SEBI activities SEBI has identified the following areas for focusing its
attention for the overall growth and the development of the stock market
in India:
1. Registration of brokers
2. Authorization of merchant bankers
3. Control over mutual funds
4. Issue of insider trading regulations
5. Issue of portfolio managers regulations
6. Issue of guidelines for disclosure and investor protection
7. Suveillance
8. Clearing house
Registration of brokersThe foremost activity that was initiated by the
SEBI towards stock exchange reforms was the registration of brokers and
sub-brokers operating on the stock exchange. For this purpose, SEBI
74 Capi tal Markets
issues regulations requiring every stockbroker to make an application for

the grant of a certificate of registration. In order to be eligible to obtain the
certificate of registration, it is incumbent on the part of the prospective
broker that he/she has all the necessary facilities and infrastructure at
his/her command for conducting the trading for the investors.
The broker holding the certificate of registration should abide by the
code of conduct envisaged under the rules of the exchange. Brokers and
sub-brokers are required to make payment of requisite fees on the annual
turnover to the stock exchange concerned.
Authorization of merchant bankers Under section 30, SEBI has the
power to grant authorization to any institution engaged in the business of
merchant banking activity. For this purpose, SEBI issues guidelines and
regulations for merchant bankers for registration with the SEBI. The
intending merchant bankers are expected to fulfill such conditions as the
availability of the necessary infrastructure like adequate office space,
equipment, manpower, etc to discharge their activities, fulfillment of the
capital adequacy norms, professional qualifications as recognized by the
Government, in finance, law or business management, promotion of investor
interest, etc.
The regulations also deal with the matters relating to restriction of
appointment of lead managers depending on the size of the issue,
obligations of lead managers, and code of conduct for merchant bankers.
The regulations require a merchant banker to observe high standards of
integrity and fairness in all his dealings with his clients and other merchant
bankers.
Control over mutual funds With the mushrooming growth of mutual
funds business especially with the entry of commercial banks, other
financial institutions and agencies in a big way, SEBI came out with
guidelines for their regulation. The SEBI’s action was aimed at instilling a
sense of competition, transparency and fair play, and thereby spurs mutual
funds to a greater level of efficiency and investor-friendliness. The
regulations related to investment by mutual funds in both primary and
secondary markets.
Many mutual funds are permitted to operate by separately establishing
Asset Management Companies (AMCs). For this purpose, the AMCs
were required to fulfill such conditions as sound track record, general
reputation and fairness in all their business transactions, the directors to
be persons of high repute and standing having at least 10 years of
professional experience in the relevant fields such as portfolio management,
investment analysis and financial administration, etc, with at least
50 percent of the board of AMC to be independent directors not connected

with the sponsoring organization, and the AMC to have a minimum net
worth of Rs.5 crores.
Regulations also related to the limitations on the investment of funds
by mutual funds. Accordingly, mutual funds are allowed to invest only in
transferable securities and are prohibited from giving term loans for any
purpose. Separate limits are prescribed for investment in any single
company. As a step towards overseeing the working of these funds, SEBI
was given the right to call for any information regarding the operations of
the fund, lay down accounting policies and impose penalties for violating
the guidelines as may be necessary, with the concurrence of the RBI and
the central government.
Insider trading regulations In view of the fact that the actions
of insiders leave a debilitating effect on the functioning of stock exchanges,
SEBI has issued requisite regulations so as to curb such practices. These
provide for various measures including the SEBI’s right to investigate and
inspect the books of account of any insider, and render the act a criminal
offence punishable with fine or imprisonment up to one year. Trading by
insiders is considered harmful because they attempt to deal in the securities
of a company listed on a stock exchange on the basis of any unpublished
price sensitive information. The insiders communicate any unpublished
price sensitive information to any person, with or without his request for
such information, except as required in the ordinary course of business or
they counsel or procure any other person to deal in securities of any
company on the basis of unpublished price sensitive information.
Regulating portfolio managers SEBI seeks to regulate the activities
of portfolio managers too, by means of issuing guidelines thereto. Any
person, who pursuant to a contract or arrangement with a client, advises
or directs or undertakes on behalf of the client, the management or
administration of a portfolio of securities or the funds of the client is called
a ‘portfolio manager’. For the purposes of fair play towards investors,
portfolio managers are required to register themselves with the SEBI. The
capital adequacy limit is fixed at Rs.50 lakhs.
Dis closures a nd in vesto r pro tecti on Guidelines relating to the
issue of shares, debentures, new financial instruments, and bonus shares
are issued to ensure sound disclosure practices and investor protection.
Salient among them are:
1. Par issue All the new companies are permitted to issue shares
to public only at par and where the new company was set up by
an existing company with a five year track record of consistent
76 Capi tal Markets
profitability, it will be free to price its issue, provided the promoter’s

contribution is not less than 50 percent of the equity of the new
company.
2. Draft prospectus A draft prospectus containing the disclosures
will have to be vetted by SEBI, before a public issue is made.
3. Free pricing Existing listed-companies are allowed to raise fresh
capital by freely pricing their further issues, the draft prospectus
being vetted by the SEBI.
4. FCDs As regards the issue of fully convertible debentures
(FCDs), no conversion shall take place beyond 36 months, unless
conversion is made optional with ‘put’ and ‘call’ option.
5. Credit rating Credit rating is made mandatory for FCDs
converting after 18 months. Premium amount on conversion, time
of conversion are predetermined and stated in the prospectus.
These guidelines are also applicable to partially convertible
debentures (PCD) and non-convertible debentures (NCD). In
addition, the non-convertible portions of PCD/NCD are to be
rolled over with or without change in the interest rate.
6. Debenture disclosures Disclosures relating to raising of capital
through debentures should contain, inter alia, the existing and
future equity and long-term debt ratio, servicing behavior on
existing debentures, payment of interest on due dates on term
loans and debentures, certificate from a financial institution or
banker about their no objection to a second or pari passu charge
being created in favor of the trustees to the proposed debenture
issue, etc.
7. Reservation The guidelines provide for reservation in issues
of capital to various categories of persons like employees,
non-resident Indians, financial institutions, mutual funds,
shareholders of group companies and promoter companies.
However, not less than 20 percent of the capital should be offered
to public.
8. Compulsory subscription The guidelines also provide for
compulsory subscription by the promoters of companies. In the
case of new companies established by individual promoter and
entrepreneur, the promoter’s contribution should be at least 25 or
20 percent of the total issued capital, as the case may be,
depending on the size of the issue. In the case of new companies
set up by existing companies with a 5-year track record of
consistent profitability, the promoters should contribute a

minimum of 50 percent of total issued capital.
Surveillance In order that the efficiency and integrity of stock exchanges
is maintained, an effective monitoring and surveillance mechanism must
be put in place. The automation process initiated at the BSE, NSE, OTCEI
and other exchanges has made it possible to put such a monitoring
mechanism in place. There has been a significant increase in the process
of automation contributing to the best reach of the capital market.
SEBI has allowed the expansion of the trading terminals of screen-
based trading systems of stock exchanges to cities with no stock exchanges.
Expansion to cities with stock exchanges has also been permitted, provided
there is an understanding with the local exchange for allowing the
installation of outside terminals within its jurisdiction. The participating
exchange would keep its membership open to the brokers of the other
local exchanges. It will ensure an adequate arrangement for resolving
investor grievances and for timely settlement of arbitration cases arising
out of trades executed on the extended terminals.
The expansion of Bombay On Line Trading (BOLT) system of the
stock exchange, Mumbai, to the trading systems of other exchanges was
subject to such general conditions as ensuring adequate monitoring and
surveillance mechanism, stipulation of usual margins, capital adequacy,
intra-day trading limits fixed for the broker stock exchange, and the
introduction of trade guarantees. The expansion of trading networks will
lead to healthy competition between various stock exchanges with
increased efficiency.
Clearing house SEBI has directed all stock exchanges to set up clearing
house or clearing corporations to provide trade guarantees. This aimed at
reducing counter party risks and thus enabling investors trading through
the exchanges to settle their transactions through a depository. The
National Securities Clearing Corporation Limited (NSCCL) is entrusted
with the task of guaranteeing settlement of trades in the capital market
segment of the NSE. It has made considerable progress in the enhancement
of clearing facilities in other regions by establishing regional clearing
facilities. The setting up of Delhi Regional Clearing House and other
regional clearing facilities of the NSCCL enables the regional relocation of
the settlement facilities. This is bound to increase the efficiency of the
system, thus helping timely settlement of transactions on the NSE.
The parallel to SEBI in USA, is the Securities and Exchange
Commission (SEC), created under Securities Exchange Act, 1934. The SEC
78 Capi tal Markets
has been given the following wide-ranging powers for the purpose of
protecting the investors’ interests:
1. To monitor the working of stock exchanges
2. To insist on the companies for the supply of extensive information
on a regular basis
3. To penalize members of stock exchanges who were found to
violate securities laws
4. To debar the wrong-doers from any activity in the stock market
and impose on them civil penalties and initiate criminal
proceedings
5. To make rules about the manipulative practices
6. To move court for checking insider trading, and
7. To prosecute the company and its directors on its own, even
without receiving complaints by an aggrieved investors in respect
of supplying inadequate, incomplete and incorrect information.
Under the BSCC Act
In January 1926, the Bombay Securities Control (BSCC) Act 1926 was
enacted. The Act provided the government, power to grant recognition to
a stock exchange and/or withdraw recognition as it thought fit. Moreover
the recognized stock exchanges could make rules or any amendment thereof
only after prior approval of the government. Ahmedabad Stock Exchange
got recognition under this Act in 1939.
The BSCC Act 1926, remained in force until the Securities Contract
Regulation Act was promulgated in 1957, but it had no significant effect
on securities trading. One of the major shortcomings of this Act was its
definition of ‘ready delivery contract’. The ambiguity arose due to the lack
of a specified time frame for deliveries. The forward market with its strong
speculative tone thrived on this lacunae. In 1947, the Bombay Forward
Contracts Control Act applying to commodities, mainly cotton and bullion,
was passed. Shares and stock remained outside its purview, due to
objections raised by the stock exchanges. Eventually appropriate Central
legislation; based on the original principles of the Bombay Forward
Contracts Control Act 1947 was enacted in 1952, for commodity markets
and stock exchanges in 1956.
Under the Defence of India Rule
The Defence of India Rule 94-C was promulgated in 1943. It aimed at
countering speculative operations during World War II. The Rule prohibited
stock exchanges from offering facilities for carry-over transactions and
other than ready delivery transactions. It proved to be counter-productive,

since it drove the stock and share business away from regular exchanges
to the street kerbs. The Defence of India Rule 94-C lapsed in September
1946. The government recognized the need to take a wider consensus
before legislating Acts for regulating stock markets. This ended the Central
Government’s first phase of experiments with legislation of the financial
market.
Under the Capital Issues Control Act, 1947
Originally the Control of Capital Issues began in the legistative framework
during the World War II. In 1943, Rule 94-A under the Defence of India
(DOI) Rules was promulgated. It was designated to prevent establishment
of industries, which did not assist in the production of war goods and
mushrooming of small companies, which would not survive in normal
times. It continued to be in force up to 1947 as Capital Issues (Control)
Act.
Its objectives were as follows:
1. To channelize the balanced investment of resources in accordance
with objectives of the Five Year Plan
2. To further the growth of companies with sound capital structure
and to promote a rational and healthy expansion of the corporate
sector in general public interest
3. To direct and distribute public issues of capital in a balanced
manner
4. To regulate bonus issues and to control pricing of issues
5. To regulate the capital organization plans of companies including
mergers and amalgamations necessitating issue of capital
In order to effect the national economic policy in the corporate sector,
various factors like state of the capital market, the volume and nature of
applications coming up for consent, the technical and financial
collaboration required, the criteria for industrial licensing and provisions,
and objectives of company law and stock exchange guidelines were
considered essential. In other words, almost every aspect of the firm’s
activities in the real and financial sector came under its purview, thus
reflecting the repressive policy measures pursued by the government.
Capital issues control was administered by the Controller of Capital Issues
according to Central Government Guidelines, in consultation with the
Capital Issues Advisory Committee.
CIC applied to all companies whether incorporated in India or outside
India, which made an issue of capital, or which offered securities for sale
80 Capi tal Markets
in India. It also applied to companies incorporated in India, which made

an issue outside India. No non-government, i.e. private enterprise could
raise capital in the market without prior consent of the CCI. Consent was
granted usually after complying with time consuming procedures and
rules, it involved detailed scrutiny of documents. There was no incentive
structure to make a trade-off and issue consent letters quickly and
prevent hold ups. Delays often led to cost escalation and consequent
inefficiencies.
The Act covered a wide range of guidelines as pertaining to new
share capital issue, bonus issue, employees stock option, debentures by
public limited companies, rights debentures, cumulative convertible
preference shares, over subscription retention, and a myriad of related
activities.
Pricing o f issues The most important area on which the CCI
influenced the capital market was in determining the level of premium if
any that could be charged, in a public issue. This factor significantly
contributed to under-pricing of the issue and a highly conservative view
of a firm’s future profit earning potential led to issues being made at par
and issues at a premium being an exception rule during the CCI era.
Consequently, the under-pricing influenced public investors to
clamour for allotment, which led to over subscription of issues. CCI used
the parameters of fair value, which were determined by the Net Asset
Value (NAV), the Profit Earning Capacity Value (PECV), and the Market
Value (MV). The NAV was calculated by using the true ‘net worth’ (NW)
of a company after deducting all possible liabilities like contingency
liability, etc.
Since May 29 1992, when the CIC Act was repealed, premium charged
on public issues became market-determined. Though the overall format
described above is maintained, firms today have the freedom to decide
the level of premium it can charge, in consultation with their merchant
bankers and underwriters. This is the free-pricing of issue policy. The
CCI acted as a final check post to ensure that a company obtained all
clearance required from the government, industrial license, letter of intent
under the Industries Development Regulation (IDR) Act 1951, registration
under the Director General of Technical Development, appraisal of project
by financial institution etc before raising capital from the market. Further
over the years, capital issues control was used for regulation of bonus
share issue, capital reorganization plans, including mergers and
acquisitions, capital structure, terms and conditions of capital issue,
fixation of premia on issues of capital by existing companies and foreign
investment in India. It was an all-pervading umbrella institution. The

repeal of the CIC Act changed the nature of the capital market by ushering
in market orientation, a clear departure from the socialistic ideals of the
post-independence era.
Under the Securities Contracts (Regulation) Act, 1956
After independence, the new Constitution of India became effective in
1950. Futures markets and stock exchanges became an exclusive Union
subject under item 48 of the Union list. In 1951, the Gorwala Committee,
with representatives from Bombay, Calcutta and Madras Stock Exchanges,
submitted a report on which a draft bill was prepared. In 1956, the Securities
Contracts (Regulation) Act was enacted.
The Act was passed ‘to prevent undesirable transactions in securities
by regulating the business of dealing therein, by prohibiting options and
by providing for certain other matters connected therewith’. It permitted
only those stock exchanges recognized by the Central Government. The
recognized stock exchanges enjoyed a privileged position, but at the same
time it vested the government with wide ranging powers of supervision
and control over them. The Act provided the following powers:
1. Granting recognition of stock exchanges after application is
made by stock exchanges within the prescribed norms
2. Withdrawal of recognition to a stock in the interest of public
and trade
3. Calling for periodical return or direct enquiries to be made by
every recognized stock exchange
4. Furnishing periodical returns and maintaining records and
books of accounts, and other documents, which they had to
submit to the Central Government. The latter could make enquiries,
if it thought fit in the interest of the public and trade
5. Power to call for Annual Reports by stock exchanges to the
Central Government
6. Power of recognized stock exchanges to make rules restricting
voting right
7. Power of Central Government to direct rules to be made or to
make rules
8. Power of recognized stock exchanges to make byelaws. This
involved the overriding function of trading in securities for the
regulation and control of contracts to listing and trading practices,
hours and settlement of contracts, etc.
82 Capi tal Markets
9. Power of the government to make or amend byelaws of

recognized stock exchanges (this relates to the previous section)
10. Power of the government to supersede governing bodies of
recognized stock exchanges.
11. Power to suspend business of recognized stock exchanges, these
are known as circuit breakers to prevent excess speculation in
any specified scrip
12. Power to deem contracts in notified areas illegal in certain
circumstances
13. Power to declare contracts in notified areas to be void in certain
circumstances
14. Power to prohibit members to acts as principal in certain
circumstances
15. Power to prohibit contracts in certain cases—if the Central
Government is of the opinion that it is necessary to prevent
undesirable speculation in specified securities in any State or
area, it has the power to declare by notification that no person
can enter into contract for the sale or purchase of any security
specified in the notification
16. The Act provided license to dealers in securities in certain areas,
the lack of this license render contracts undertaken by them void
17. Only recognized stock exchanges were permitted to organize or
assist in the activity of entering into or performing contracts in
securities
18. Power to compel listing by public companies. This section
included a right of appeal against refusal by stock exchange to
list securities of public companies
There are altogether 29 sections in the Act, which includes provisions
for penalty and procedures, offences by companies, jurisdictions for trying
the offences, title of dividend and other miscellaneous factors. The rules
among other things provided for recognition of stock exchanges,
submission of periodical returns, annual report by stock exchanges, inquiry
into their activities, their members and requirements for listing of securities.
The rules are statutory and constitute a code of standardized regulations,
which are uniformly applicable for all stock exchanges. In 1985, several
amendments were made to liberalize its impact following the Patel Committee
Report recommendations.
Under the Securities Contracts (Regulation) Rules, 1957

These were the rules framed for facilitating efficient and safe trading at the
stock exchanges. The rules pertain to the following:
1. Procedures to be followed for the recognition of stock exchanges
2. Submission of periodical returns and annual returns by recognized
stock exchanges
3. Inquiry into the affairs of recognized stock exchanges and their
members
4. Requirements for listing of securities
Recognition of stock exchange Stock exchanges, for the purpose of
obtaining recognition, must make an application under Section 3 of the
SCR Act along with a fee of Rs.500. Four copies of rules, including the
Memorandum and Articles of Association, and where the applicant stock
exchange is an incorporated body, byelaws, should also accompany the
application. The government may make enquiries and may seek further
clarifications before granting recognition. Application for renewal should
be made 3 months before the expiry date along with a fee of Rs.200.
Records Every stock exchange should maintain and preserve the
following books of account and documents for a period of 5 years:
1. Minute books of the meetings of members, governing body, any
standing committee of the governing body or general body of
members
2. Register of members
3. Register of authorized clerks
4. Register of authorized remisiers or authorized assistants
5. Record of security deposits
6. Margin deposits books
7. Ledgers
8. Journals
9. Cash book
10. Bank pass books
Annual report Every recognized stock exchange has to furnish the
Central Government/SEBI annually with a report about its activities during
the preceding year which shall, inter alia, contain details of information on
the following matters:
1. Changes in rules and byelaws, if any
2. Change in the composition of governing body
3. Any new committee set up and changes in the composition of
the existing one
84 Capi tal Markets
4. Admissions, readmissions, deaths or resignation of members

5. Disciplinary action against members
6. Nature and number of disputes for arbitration between members
and non-members
7. Defaults
8. Action taken to combat any emergency in trade
9. Securities listed and delisted
10. Securities brought or removed from the forward list
11. Audited balance sheet, and profit and loss account for the
preceding year
Submission of return Periodical returns have to be submitted by the
stock exchange to Central Government/SEBI relating to the following:
1. Official rates for the securities listed thereon
2. Number of shares delivered through the clearing house
3. Making up prices
4. Clearing house programs
5. Number of securities listed and delisted during the previous 3
months
6. Number of securities brought on or removed from the forward list
during the previous 3 months, and
7. Any other matter as may be specified by Central Government/
SEBI
Enquiry The Central Government/SEBI can appoint two or more persons
to enquire into the affairs of the governing body of a recognized stock
exchange or any of its member. The inquiring authority hands over a
statement of issues to the governing body/member who is then given
adequate opportunity to state their case. The inquiring body has to submit
its report to Central Government/SEBI.
Under the Companies Act, 1956
One of the most important laws in the Indian corporate legislation is the
Companies Act 1956, which has far-reaching and all-pervading effect on
the Indian industry. The Companies Act is voluminous and was enacted
with the explicit objective of controlling and regulating every conceivable
facet of the corporate sector. Its inception was in the 19th century in 1850,
when the Act was first promulgated and initiated joint stock company
business in India. The 1850 Act was changed and amended several times
in 1857, 1866, 1882, 1913, 1938, 1942 and in 1949. It was earlier known as the
Indian Companies Act. These amendments were made as and when the
need arose. The 1956 Act was drafted retaining certain sections of the
earlier Act and incorporating a whole new spectrum of legislation that
would correspond to independent India’s socialistic ideals and policies.
The Companies Act of 1956 consists of thirteen parts and fourteen
schedules; part VI has eight chapters while part VII has five chapters.
Important provisions The important provisions as pertaining to the
Indian capital market are detailed below:
1. Part I contains the preliminaries, mostly definition as it relates
to the constitution of the Company Law Board (CLB) consisting
of nine members and its mandate.
2. Part II relates to the incorporation of the companies, its Articles
of Association, and memorandum of association, registration of
companies, etc.
3. Part III is relevant to the capital market as it relates to the
firm’s issue of capital activity, i.e. regarding prospectus allotment,
and other matters relating to issue of shares and debentures.
4. Section 55 to 68 relate to prospectus issue and material
information. Section 62 stipulates that misstatements in
prospectus are subject to civil liabilities in terms of compensation
to persons (aggrieved), who subscribe to an issue in good faith
and sustain any loss. It must be noted that there are sufficient
number of provisons to enable the unscrupulous promoter’s or
officers of the company to evade any indictment. Again Section
63 relates to criminal liability for mis-statements on prospectus.
This phenomenon of entice unwary investors into purchasing
securities of unprofitable firms with dubious credentials is the
driving force behind most financial regulation, since information
asymmetry is ubiquitous in financial markets. Section 68 relates
to penalty for fraudulently inducing persons to invest money.
This section deals with speculation in share and debenture price
in the secondary market.
5. Section 77 relates to purchase by a company of its own shares—
the buy-back provision. While some experts believe in repealing
this clause permitting buy-back, others are in the opinion that
the market is not mature and transparent enough, and this could
lead to further price rigging and manipulations. Buy-back of shares
is legal and a common practice in USA. It is done to reward the
shareholder. The price paid is usually higher than the market rate
86 Capi tal Markets
which is given as an incentive to the shareholders. If firms want

to bring down the paid-up capital to reduce dividend servicing
out flow, this method is undertaken.
6. Part IV relates to share capital and debentures with regard to
type, numbering, certificate of share, share capital, etc. Section
116 in this part provides for penalty for impersonation of
shareholders.
7. Part V refers to registration of charges including mortgages,
etc.
8. Part VI is long and consists of eight chapters. Chapter I is
concerned with general provisions of the company such as
annual returns, meetings, proceedings, proxies, voting at
meetings, accounts with audits, managerial remuneration,
payment of interest and dividends, etc as well as investigation of
the affairs of the company. Chapter II relates to the directors of
the company, constitution of the board of directors, managing
directors, prohibition of contribution to political parties, (this
clause is causing considerable controversy and a lively debate is
in progress presently), remuneration of directors, their powers
and qualification, etc.
9. Part VII relates to winding up and consists of five chapters.
The Companies Bill 1993 intends to make certain significant
changes to ensure transparency, so that firms with poor financial
health and inadequate assets are not passed off as going
concerns. Next Part XIII concerns general matters such as
collection of information and statistics from companies (this needs
higher priority to check the ubiquitous information asymmetry
present in the Indian corporate sector). There are as many as
fourteen schedules.
The Companies Act 1956 is so exhaustive that there are several areas
where the jurisdiction of the Act overlaps with other Act like the SC(R)
Act and even the I(DR) Act. However in 1991, when the structural
adjustment programme was launched, it was realized by political leaders
and policy decision makers of India that Companies Act of 1956 could not
fulfill the functions appropriately under the new policy regime of
liberalization and market orientation. Hence in 1993, the Companies Bill
was drafted to replace the 1956 Act. The bill was amended again in the
year 2000.
COMMITTEES ON REGULATORY FRAMEWORK

A number of committees came to be set up to review the control and
regulatory mechanisms that are in place already and suggest necessary
measures to overhaul the functioning of the stock exchanges, so as to
usher in a strong capital market in India. The salient features of these
committees are presented below:
The G.S. Patel Committee
This was the high-powered committee constituted in May 1984, under the
chairmanship of G.S. Patel. The terms of reference of the G.S. Patel Committee
(GSPC) were:
a. Organizational structure and management of stock exchanges
b. Threshold level of quality for membership of brokers
c. Market mechanism of trading and settlement
d. New issues and listing requirement
e. Investor protection and services
Important recommendations of the Committee were as follows:
1. All stock exchanges to follow a standard model of management
by registering under the Companies Act Section 25, company
limited by guarantee
2. Infusing professionalism into the organizational system through
the non-brokers representation in the stock exchange managing
committee, and the Executive Director and President to have no
direct link with trading activity so as to prevent insider trading
3. Establishing an independent supervisory body modeled on the
SEC of USA to monitor the market. This was the genesis of the
SEBI, which is the regulatory authority today
4. Prescription of minimum educational qualification of XII standard
and certain diploma courses for members
5. Raising the training and qualifying levels for new members and
assistants
6. Members to take insurance cover for loss of documents and acts
of fraud committed by their employees
7. Introducing odd-lot dealing, prohibiting non-bank finance for
‘badia’ dealers and banning all option contracts
8. Checking overtrading, up front margin payment
9. Introduction of provisional listing of new issues to check the
clandestine market and high premium charges caused by the
inordinate delay in listing procedures
10. Cut in underwriters’ commission from 3 percent to 2.5 percent to
reduce issuers cost
88 Capi tal Markets
11. Publication of half yearly unaudited accounts in the media to

keep shareholders and prospective investors informed as a means
of an efficient disclosure practice
The Narasimham Committee
In 1991, pursuing liberalized policies and structural adjustment programme,
the government constituted a high-powered committee on financial sector
reforms with M. Narasimham as chairman. The committee made wide-
ranging recommendations on banking reforms and restructuring of capital
market regulation.
In the capital market, the committee advised greater market orientation
by permitting free pricing of public issues, which until then, was under the
purview of the CCI. To make the primary market independent of government
control, and vest the private sector with the responsibility of primary
market activity, it recommended that merchant bankers be allowed to take
deposits from the public. It became imperative for the lead managers,
underwriters and registrars of the issue to apply due diligence in
consultation with the company concerned in pricing the issue. This was a
step for establishing an incentive structure for allocational efficiency in
the capital market.
The M.J. Pherwani Committee (1991)
This committee was set up to initiate orderly growth of the stock market
and promote investor’s interests. The most important recommendation
was establishing of a National Stock Exchange System, which was
established in 1995, in greater Bombay (much against the objections
forwarded by the BSE). The NSE was created to offer competition to BSE,
which is too gigantic and monolithic, handling almost two thirds of the
country’s primary and secondary market business. Other key
recommendations were:
1. Establishing Central Depository Trust, and evolving electronic
hook-up with regional depositories, upgrading the Stock Holding
Corporation of India
2. Establishing National Clearing and Settlement Corporation for
settlement between regional stock exchanges and Central
Depositories
3. Creating a three-tier stock market system with more floors added
to existing exchanges
4. Active promotion on jobbing or market-making in debt
instruments, or providing separate trading hours
The Malegam Committee (1995)

Important recommendations of the committee were as follows:
1. Disclosing in prospectus the actual project expenditure, sources
of finance expenditure, year-wise break up, residual expenditure,
and details of bridge loans
2. Transparent accounting procedures by making clear statement
in the prospectus on failure to make provisions, for losses in
previous years, and change in accounting policy, financial
disclosures must include accounting ratios such as earnings per
share, return on net worth, and net asset value per share
3. Mandatory disclosure of technology, market, competition, and
managerial competence
4. Disclosures in prospectus to include appraising agency’s report;
forecasts of profit should be supported by an auditor’s certificate
5. The terms ‘promoter’ and ‘promoter’s group’ needs to be defined
precisely
6. Disclosure needs to be of aggregate holding of the promoter’s
group and a list of the persons who constitute the promoter’s
group, and information regarding other venture promoted by the
promoter
7. Other recommendations include disclosure of such information
as stock market data, litigation, defaults and adverse events,
justification for price, technical and financial collaboration
agreements, management’s analysis, capitalization statement,
buy-back and stand-by arrangements, specialized industry
groups, major shareholders, abridged prospectus, advertisement,
rights issue, responsibility for adequacy and authenticity of
disclosure (due diligence), monitoring of use of funds, small
issues, pricing of issues, news items on mergers, etc.
REVIEW QUESTIONS
Section A
1. State the objectives of regulating the Indian capital market.
2. State the objectives of the Capital issues Control Act, 1947.
Section B
1. Trace the genesis of the regulation of Indian capital market.
2. State the functions of SEBI.
3. State the role of Securities Exchange Commission (SEC) of the
US.
90 Capi tal Markets
4. What are the powers vested with the Government under the
Securities Contracts Regulation (SCR) Act, of 1956?
5. What do the rules of the Securities Contracts Regulation (SCR),
1957 prescribe for the safe trading at stock exchanges?
6. How is Indian capital market regulated under the provisions of
the Indian Companies Act, 1956?
7. What were the major recommendations of the G.S. Patel
Committee.
8. State the key recommendations of the M.J. Pherwani Committee?
9. What were the recommendations of the Malegam Committee on
the regulation of Indian capital market?
Secti on C
1. Discuss the factors responsible for the introduction of measures
of regulation and control of the Indian capital market.
2. How is Indian capital market regulated? Bring out clearly the
regulatory framework that has been put in place for this purpose.
3. Give an account of the various committees set up to review the
control and regulatory mechanism of the Indian capital market.
Chapter 5
Derivatives Market
The field of finance has undergone a sweeping change in modern times

thanks to the creation and the widespread use of the ‘derivatives’. Presently,
most major institutional borrowers and investors use derivatives. Similarly,
many act as intermediaries dealing in derivative transactions. Derivatives
are responsible for not only increasing the range of financial products
available but also fostering more precise ways of understanding,
quantifying, and managing financial risk.
Among the several factors that have been responsible for the
development of derivatives, search for higher yields, lower funding costs
and a demand for tools to manage risk are important. Other factors that
have caused broad demand for derivatives include diverse and changing
financial needs of a wide array of users, need for hedging current or future
risks, taking market risk positions, inefficiencies between markets, etc.
Derivatives are financial investments that derive their value from the
underlying financial assets. Derivative contracts are used to unbundle the
price risks embodied in assets and liabilities. Derivatives do not eliminate
risks. They simply divert risks from investors who are risk averse to those
who are risk-neutral. The use of derivative instruments is part of the
growing trend among financial intermediaries like banks to substitute off-
balance sheet activity for traditional lines of business. The exposure to
derivatives by banks have implications not only from the point of capital
adequacy, but also from the point of view of establishing trading norms,
business rules and settlement process. Trading in derivatives differ from
that in equities as most of the derivatives are marked-to-the-market. History
is replete with instances of dangers posed to the financial system on
account of derivatives trading. But it is to be noted that most of the
episodes of losses in derivative markets have arisen due to lack of
transparency and weak internal controls.
An important function of derivatives is the efficient allocation of risks
in the economy. But the ability of derivative instruments to transform risks
can be misused as well. Reportedly, some people have used derivatives to
92 Capi tal Markets
evade investment guidelines, conceal risks from principals, evade taxes,

circumvent regulations, etc. The effect of these misuses on the financial
ability of the system is substantial as evident from recent episodes of Barings
Bank in UK, Daiwa Bank, Sumitomo Corporation in Japan. It is in this context
that the regulatory issues assume much importance. A common viewpoint
among bank regulators is that the presence of derivatives creates a potential
for systematic risk that could wipe out a large portion of capital of banks.
MEANING OF DERIVATIVES
A bilateral contract or payments exchange agreement whose value is
derived from the value of an underlying asset or underlying reference rate
or index is known as ‘derivative’. The scope of derivatives has widened
and includes derivatives transactions covering a broad range of underlying
assets such as interest rates, exchange rates, commodities, equities, and
other indices.
Every derivative transaction can be built up from two simple and
fundamental financial blocks namely forwards and options. Forward-based
transactions include forward contract, swap contract and exchange-traded
futures. Option-based transactions include privately negotiated OTC
options such as caps, floors, collars and options on forward and swap
contracts, and exchange-traded options on futures. It is interesting to
note that many diverse type of derivatives can be created by combining
the building blocks in different ways and by applying these structures to
a wide range of underlying assets, rates, or indices.
In addition to privately negotiated global transactions, derivatives
also include standardized futures and options on futures that are actively
traded on organized exchanges, and securities such as call warrants.
GROWTH OF DERIVATIVES MARKET—FACTORS
The explosive growth in recent times of the derivates market is on account
of the following factors:
Volatility in3 Prices
An important reason for the emergence of derivatives market in the world
has been the sharp volatility noticed in the movement of prices of assets—
securities, currencies, commodities, etc. The forces of demand and supply
determine the market prices. The changes in these forces cause price
volatility. Price changes bring about market adjustments. The imminent
risks that result from such price changes are to be well protected through
a host of instruments and techniques available in the derivatives market.
Deri v ati ves Mar ket 93
Price volatility, for example, was caused by the currency meltdown

experienced in the Southeast Asian countries in 1997. Similarly, the rapid
developments taking place in the realm of telecommunications have also
caused the prices of corporate securities to fluctuate.
Globalization of Markets
The size, the reach, the magnitude and the volume of business operations
have increased manifold thanks to the globalization of markets. Financial
markets came to be affected by the global happenings. Global investors,
global exchanges, global financial institutions started appearing in the
financial markets. Further, globalization has also steadily increased the
competition in operations, thus necessitating different tools to handle.
Technological Advancements
The growth witnessed in the derivatives tools could also be attributed to
the kind and the magnitude of technological breakthroughs in the
communications industry. Advancement achieved in the computer and
satellite technology has helped storage and rapid transmission of
information that provides the right architecture. Such scientific and
technological advancements have impacted in a great way the market
prices to volatility. Derivative instruments help manage the risks arising
from price volatility.
Developments in Financial Theories
The advancements made in the theories of financial management in the
recent past have mainly contributed to the innovation of derivative
products. The theories developed were designed to give the advantage of
better and efficient management of risks arising from asset trading in
markets. Some of the theories of financial management that are worth
noting include option pricing models propounded by Fischer Black and
Martin Scholes in 1973, which are used to determined the value of call and
put options. Similarly, the theory developed by Lewis Edeington on ways
of hedging financial risks with financial futures contributed to the growth
of instruments in the financial market.
LIMITATIONS OF DERIVATIVES MARKET
The derivatives market mechanism is generally fraught with the following
drawbacks:
1. Worldwide, the instruments used in the derivatives such as
options and futures have become more controversial in as far as
its efficacy in handling speculative situation is concerned
94 Capi tal Markets
2. Fortunes are made and lost very quickly

3. Lack of awareness and suspicion about the efficiency of the
tools used in the derivatives market
4. There is a fear of great and insurmountable risks
5. Derivative trading takes place with traders and speculators
indulging in selling what they do not own and buying what they
do not intend to hold, with the only requirement being the ability
to make payment of margin money
6. Potential dangers of defaults by traders who could not keep up
their commitments, thereby creating a situation of loss of
confidence
FUNCTIONS OF DERIVATIVES MARKET
Despite fears of and pitfalls about the efficacy the working of the system
in the derivatives market, there are a number of functions that are
beneficially rendered by the use of derivative instruments as mentioned
below:
Price Discovery
The tools used in a derivatives market such as options, futures, etc are
capable of making a reasonable estimate of a relevant future price that is
expected to continue to prevail for a certain period. Such a mechanism
results from open and competitive trading on the floor of the exchange,
thus reflecting the supply and demand position. This is expected to prevail
in the certain specified future period. The price that is set in this manner is
carried throughout the market by a well-authenticated price reporting
system supported by advancement in telecommunications technology.
This process of establishing equilibrium in the future price of an asset is
known as ‘price discovery function’. A derivatives market is essentially
concerned with anticipating a future price for the asset dealt with. Such a
price discovery mechanism is an important part of an efficient financial
system. Such a price would truly reflect the relative costs of production
and the consumption utilities. The tools help in bringing about equilibrium
between present and future price.
Risk Management
Another important function of a derivatives market is that of managing the
risk exposure resulting from the volatile movements in the price of traded
asset. New instruments such as options and futures are known to be very
effective in minimizing the risk through the arbitrage process arising from
the price movements. Counter party risk is reduced or sometimes
non-existent. Liquidity is added to the market through standardized futures

contracts. To guarantee the due performance of contracts in future, clearing
houses are available which take care of the solvency of the members of
trading. Easy entry and competition provide for low costs and efficient
trading.
Speculative Advantage
The success of derivatives market is built on the edifice of assumed
minimum level of speculative activity of estimating the kind of price to
prevail in future. In fact, speculation is considered a boon to the activities
in a derivatives market. The activities of speculators such as expecting
future prices to go up and indulging in selling spree in order to buy the
asset in the future when prices fall and thus to make a profit, all bring
about speculative advantage. The increased speculative activity therefore,
would bring about better functioning of futures market by allowing for
price discovery and hedging.
CATEGORIES OF DERIVATIVES
The different categories of derivatives that are available to investors and
traders are described below:
Forward-based Derivatives
Forward Contracts
Meaning A contract that obligates one counter party to buy and the
other to sell a specific underlying asset at a specific price, amount and
date in the future is known as a ‘forward contract’. Forward contracts are
the important type of forward-based derivatives. Forward contracts are
the simplest derivatives.
Characteristics Following are the characteristics of forward con-
tract:
1. Uniqueness Separate forward markets exist for a multitude of
underlyings, including the traditional agricultural or physical commodities,
as well as currencies (referred to as foreign exchange forwards) and interest
rates (referred to as forward rate agreements or “FRAs”).
2. Value The change in the value of a forward contract is roughly
proportional to the change in the value of its underlying asset. This
distinguishes forward-based derivatives from option-based derivatives,
which have a different payoff profile.
96 Capi tal Markets
3. Custom-designed Forward contracts are customized with terms and

conditions tailored to fit the particular business, financial, or risk
management objectives of the counter parties.
4. Negotiations Negotiations often take place with respect to contract
size, delivery grade, delivery locations, delivery dates, and credit terms.
Forwards, in other words, are not standardized.
5. Risks Forward contracts create credit exposures. Since the value of
the contract is conveyed only at maturity, the parties are exposed to the
risk of default during the life of the contract. The credit risk is two-sided.
Only the party for whom the contract has a positive mark-to-market value
can suffer a loss; but, since either party can ultimately end up in this
situation, each party must evaluate the credit worthiness of its counter
party. Since these contracts are typically large and the potential credit risk
may be significant, the counter parties to forward contracts are usually
corporations, financial institutions, institutional investors, or government
entities.
Swaps
Meaning
Swaps are transaction that obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment
or settlement dates. A contract whereby two parties agree to exchange
(swap) payments, based on some notional principal amount is known as
‘swap’. Only the payment flows are exchanged and not the principal amount.
Financial Swaps
Financial swaps constitute a funding technique, which permit a borrower
to access one market and then exchange the liability for another type of
liability. Under this arrangement, it is possible for investors to exchange
one type of asset for another type of asset with a preferred income stream.
Parallel Loan
According to the concept of parallel loans, parties based in two different
countries, borrow funds denominated in their respective currencies. The
two parties would lend each other the funds denominated in their own
currencies. This process does not involve any intermediary such as a
bank, etc. This type of loans were not popular as they had many drawbacks;
for example, the default of one party does not automatically release the
other party from his obligations and the two loans were very much
considered as balance sheet items requiring disclosure as per the law, and
that such loans were difficult to arrange as it was difficult to find two
parties with reciprocal needs.
Benefits
SWAPS offer the following benefits:
1. Off-balance sheet transactions
2. No initial exchange of principal but only the future cash flow
payments
3. Lower transaction costs
4. Help borrowers and investors overcome the difficulties posed
by market access
5. Providing opportunities for arbitraging some market imperfections
6. Hedging of interest rate and exchange rate risks
7. Provides for profitable access of markets
Mod e
Swap transactions are normally carried out by telephone, the moment
parties agree on the terms such as the coupon rate, floating rate basis, day
basis, maturity date, rollover dates, the governing law, and documents.
Banks, individuals and financial institutions may carry out trading in swaps.
Characteristics
1. Cash flows The cash flows of a swap are either fixed, or calculated for
each settlement date by multiplying the quantity of the underlying
(notional) principal by specified reference rates or prices. The cash flows
from a swap can be decomposed into equivalent cash flows from a bundle
of simpler forward contracts.
2. Types Depending upon the type of the underlying asset, swaps are
classified into interest rate, currency, commodity, or equity swaps. Except
for currency swaps, the notional principal is used to calculate the payment
stream but not exchanged. Interim payments are generally netted, with the
difference being paid by one party to the other. Interest rate and currency
swaps can also be analyzed in economic terms as back-to-back or parallel
loans. Both of this decomposition has important implications for pricing
and hedging.
3. Bilateral agreement Swaps, like forwards, are bilateral agreements
between sophisticated, institutional participants. Swap agreements are
entered into through private negotiations, which give rise to credit
exposures.
98 Capi tal Markets
4. Risk management Swaps are tailored, like forwards, to meet the specific
risk management needs of the counter parties.
5. Implication Swaps imply pricing relationships and related arbitrage
opportunities among swaps, forwards, and futures contracts and between
derivatives in general, and various cash market instruments.
6. Hedge Swaps also suggest the many ways in which the market risk of
swaps can be hedged. For example, combinations of long and short
positions in Government or corporate securities, exchange-traded interest
rate futures, or forward rate agreements can be used to hedge swap
exposure—and vice versa.
Interest Rate Swaps
Under this arrangement, one party called ‘fixed rate payer’ agrees to
exchange his series of fixed rate interest payments to a party called ‘floating
rate payer’ in exchange for his variable rate interest payments. The fixed
rate payer takes a short position in the forward contract whereas, the
floating rate payer takes a long position in the forward contract.
Accordingly, a fixed rate payer will benefit in a situation where the interest
rate rises or the price of debt instrument falls. Conversely, the floating rate
payer will benefit in a situation where interest rate is higher and the cash
flows are declining because of decline in variable interest rates.
There are three types of interest rate swaps. They are: coupon swaps,
basis swaps, and cross currency swaps.
1. Coupon swaps offer the condition where parties exchange each
other’s fixed and floating interest payments
2. Basis swaps offer the condition where one benchmark is
exchanged for another benchmark under floating rates. This is
very popular for rates like LIBOR, T-bill rate, etc.
3. Cross currency swaps offer the condition where fixed rate flows
in one currency is exchanged for floating rate flows in another
currency
Curre ncy Swaps
Under this arrangement, both the principal amount and the interest on a
loan in one currency are swapped for the principal and the interest payments
on a loan in another currency. The parties to the swap contract generally
hail from two different countries. This allows the counter parties to borrow
easily and cheaply in their home currency. Where both the parties are
interested to borrow the foreign currency at the foreign interest rate, both
the parties would benefit from swaps. This is because, it will not be possible
for a foreign firm to borrow in the foreign currency at rates of interest that
are available to local resident/company.
Under a currency swap, cash flows to be exchanged are determined at
the spot rate at a time when swap is done. Such cash flows are supposed
to remain unaffected by subsequent changes in the exchange rates.
However, failure of the counter party may change the ruling interest rates
for the two currencies on account of change in exchange rate. The net
present value of the net amount to be exchanged determined at ruling
exchange and an interest rate constitutes the amount of risk.
Using Hedge
Hedge technique can be used in a swap. Accordingly, a ‘pay fixed and
receive floating swap,’ may be hedged by making borrowing at the floating
rate and investing in a bond. Similarly, ‘the pay fixed rate sterling interest
and principal, and receive floating price’ can be hedged by borrowing
floating rate dollars, buying pound, investing in pound bond and paying
dollar interest and principal.
Swap Spread
The profit arising from a swap transaction is called ‘swap spread’. Several
factors determine the swap spreads. Such factors include: cost of carry of
the hedging instrument, demand and supply, credit arbitrage, the shape of
yield curve and movement in the treasury market.
A swap spread may be calculated as follows:
[LIBOR + (Treasury coupon rate – Repo rate)] – Treasury yield
Valuing a Swap
A swap is equivalent to a borrowing plus an investment. The value of a
swap is therefore, the difference between the present values of all inflows
and all outflows. A comprehensive discount rate, which encompasses
both the risk-free interest rate and a risk premium, is used for the purpose
of market valuation of a series of cash flows. The need for the valuation of
swaps arises in circumstances where it is necessary to report to
shareholders and also where the contract is terminated prematurely.
The problem of pricing a swap is closely related to swap valuation.
The problem of pricing involves determining the type of rate to be quoted
for the swap, whether fixed rate of interest or floating rate of interest
(LIBOR).
100 Capi tal Markets
Futures Contracts
Meaning A transaction that obligates its owner to buy a specified un-

derlying at a specified price on the contract maturity date or settle the
value for cash is known as ‘futures contract’. The basic form of a futures
contract is similar to that of a forward contract. The payoff, or market risk
profile facing the owner of a futures contract is also similar to that of a
forward contract.
Features Although both forward and futures contracts are similar in

many respects, futures contract has many distinguishing characteristics
as stated below:
1. Standardized The terms and conditions governing futures contract

are well standardized. The contract, besides describing the quantity and
quality of the underlying, specifies the time and place of delivery and the
method of payment. Price is the only variable left to be determined. This
standardization extends to the credit risk of futures.
Credit risk is greatly reduced by marking the contract to market with
frequent settling up of changes in value and by requiring buyers and
sellers alike to post margin as collateral for these settlement payments.
This way contracts of the same maturity act as perfect substitutes. This
process of full standardization results in fungibility, whereby it facilitates
anonymous trading in an active and liquid exchange market.
2. Contractual obligations Contractual obligations under futures
contract are entered into directly with the exchange clearing house and are
generally satisfied through offset—the cancellation of an existing futures
position through the acquisition of an equal but opposite position that
leaves the clearing-house with zero net exposure. The right to offset allows
futures participants to readily cut their losses or take their profits, without
negotiating with counter parties
3. Easy access The anonymous nature of futures trading and the
relatively small contract size make futures contracts accessible to members
of the general public, including retail speculators, who are unable to transact
business in forwards and swaps.
Forward Rate Agreements (FRAs)
Definition According to Apte, “A Forward Rate Agreement (FRA) is
an agreement between two parties in which one of them (the seller of the
FRA) contracts to lend to the other (the buyer), a specified amount of
Deri vati ves Market 101
funds, in a specific currency, for a specified period starting at a specified

future date, at an interest rate fixed at the time of agreement.”
Meaning A forward contract on interest rates is known as a forward
rate agreement. It signifies an agreement between two parties, normally a
bank and a depositor whereby the banker guarantees the
borrower-depositor a fixed rate of interest for a term. Accordingly, the
difference between the agreed rate and the actual rate will be made good
by one party to another.
Characteristics
1. Exchange No principal is exchanged. Only the difference between
fixed interest rate and reference rate on a future date is exchanged.
2. Locking up costs Provides an ideal mechanism for locking up costs
of funds or future stream of income.
3. Interest rate Interest rate is quoted from a certain future date.
4. Principal The principal amount being the reference money is the
basis of the agreement.
5. Buyer The buyer of FRA has to borrow from the cash market, where
the exchange of money is absent.
6. Settlement On the specified future date, the reference rate (MIBOR/
LIBOR) is compared with FRA and settlement is made only for the
difference between the two rates.
Benefits
Interest lock-up Useful device for locking up effective interest costs
where new debt securities are issued and high interest rates are forecasted.
Protection Protection is available against a reduction in the market
value of securities due to rising interest rates. Further, it also protects
against a loss in the market value of fixed rate securities due to rising
interest rates. Similarly, protection is also available for spreads between
fixed rate assets and floating rate liabilities during a period of rising and
falling interest rates. Interest rates decline on future money market
investments is also protected.
FORWARD CONTRACT Vs. FUTURES CONTRACT

The distinguishing characteristics between forward contract and futures
contract are presented below:
Sl. Forward
Characteristics Futures Contract
No. Contract
1. Contract Terms Decided by Standardized contract
buyers and
sellers
2. Contract Price Remains Changes every day
constant till
maturity
3. Marking to Cannot be done Done every day
Market
4. Margin Not needed Margin is to be paid by
Requirements both buyers and sellers
5. Risk of Counter Exists Does not exist
Party
6. Number of No limit on the Number of contracts
Contracts number of limited between 4 and
contracts in a 12 a year
year
7. Hedging Tailor-made Since contract period is
contracts makes limited to a month,
possible perfect hedging not perfect
hedging
8. Liquidity No liquidity Highly liquid
9. Operational Not traded on It is exchange-traded
Mechanism exchange but
traded over the
counter
10. Delivery Delivery is Standardized and cash
specifically delivery of contracts
decided;
contracts usually
result in delivery
OPTION-BASED DERIVATIVES
O ption s
Meaning A derivative transaction that gives the option holder the right
but not the obligation to buy or sell (or settle the value for cash) the
underlying at a price, called the strike price, during a period or on a specific
date in exchange for payment of a premium is known as ‘option’. Underly-
ing refers to any asset that is traded. The price at which the underlying is
traded is called the ‘strike price’ or ‘exercise price’. It is one of the building
blocks of the option contract.
T ype s
Options are basically of two types as described below:
1. Call Option
2. Put Option
Call option A contract that gives its owner the right but not the
obligation to buy an underlying asset-stock or any financial asset, at a
specified price on or before a specified date is known as ‘call option
contract’. The owner makes a profit provided he sells at a higher current
price and buys at a lower future price.
Put option A contract that gives its owner the right but not the
obligation to sell an underlying asset-stock or any financial asset, at a
specified price on or before a specified date is known as ‘put option
contract’. The owner makes a profit provided he buys at a lower current
price and sells at a higher future price. Hence, no option will be exercised
if the future price does not increase.
Characteristics
Options have the following features:
1. The right Both call and put options give the owner the right to buy or
sell some underlying asset without the obligation to perform the contract
on maturity. The buyer’s right exists only up to the time of expiry of the
contract. The owner of the option can choose not to exercise the option
and let it expire.
2. Trading Options are both exchange and counter traded.
3. Position Option buyer assumes ‘long position’ and the option seller
(writer) assumes ‘short position’.
4. Premiums Option premium is payable on the option contract.

5. Types Options may be European option where the option can be
exercised only on maturity date and in the case of American option the
option can be exercised any time before the maturity date. Where the
option is advantageous to exercise, such an option is known as in-the-
money option and where the option is not advantageous to exercise, such
an option is known as out-of-the-money option. Where there is no gain or
loss on the exercise of the option such an option is known as at-the-
money option.
6. Benefits The buyer benefits from favorable movements in the price of
the underlying asset, but is not exposed to corresponding losses.
7. Private options Privately negotiated options exist on a multitude of
underlyings, such as bonds, equities, currencies and commodities, and
even swaps.
8. Structured options Options also can be structured as securities such
as warrants or can be embedded in securities such as certain commodity
or equity-linked bonds with option-like characteristics.
9. Bundling options Options can be bundled to create other option-
based contracts called caps, floors, and collars. Like interest rate swaps,
caps, floors, and collars are generally medium-to long-term transactions.
A notional principal is used to calculate periodic cash flows. The buyer
of the cap pays a premium, normally at inception. At each payment date, the
seller must pay the buyer an amount based on the difference, if positive,
between the reference and strike rate (cap). A cap therefore protects a floating-
rate borrower against a rise in interest rates. A floor contract is the opposite
of a cap in that payment is made only if the difference is negative. A floor
therefore protects a floating-rate investor against a decline in interest rates.
Buying a collar is equivalent to buying a cap and selling a floor.
Swa ptio n s
A swaption (or swap option) is an option on a swap. It gives the buyer the
right, but not the obligation, to enter into a specified swap contract at a
future date. In this case, the asset underlying the option contract is another
derivatives transaction, (i.e. a swap). A borrower can buy protection against
the effect of a general rise in interest rates through the purchase of an
option to enter into an interest rate swap. Swaptions now play an important
role in the management of corporate debt, especially callable debt.
Options on Futures Contracts

Options on futures contracts have similar payoff profiles but differ from
OTC options in that they are fully standardized (including credit terms),
can be cancelled through offset and can be traded by the general public.
The category of derivations is depicted in Exhibit 3.
Exhibit 3 Deri vati ves-Categori es
FUTURES AND OPTIONS—PARTICIPANTS

There are many players in the derivatives market, each one performing a
role depending on the respective goal. For instance, when a trader transacts
in the market for price risk management he is called a hedger, when he
takes an open position in the futures market or if he sells naked options
contracts, he is called speculator and when he enters into simultaneous
contracts to take advantage of mispricing, he is called the arbitrager. Market
makers create liquidity in the market while brokers provide services to
other participants. Fund managers, stockists of goods, processors,
investors, traders and others play an active part in the derivatives market.
The participants in derivatives activity can be divided into two groups,
the end-users and dealers. End-users consist of corporations, government
entities, institutional investors, and financial institutions. Dealers consist
mainly of banks and securities firms with a few insurance companies, and
highly rated corporations having recently joined the ranks. An institution
may participate in derivatives activity both as an end-user and a dealer.
For example, a money-center bank acts as an end-user when it uses
derivatives to take positions as part of its proprietary trading or for hedging
as part of its asset and liability management. It acts as a dealer when it
quotes bids and offers, and commits capital to satisfying customers’

demands for derivatives. Derivatives are used by end-users to lower
funding costs, enhance yields, diversify sources of funding, hedge, and
express market views through position taking.
Derivatives permit end-users and dealers to identify, isolate, and
manage separately the fundamental risks and other characteristics that are
bound together in traditional financial instruments. Desired combinations
of cash flow, interest rate, currency, liquidity, and market source
characteristics can be achieved largely by separable choices, each
independent of the underlying cash market instruments. As a result,
management is able to think and act in terms of fundamental risks. The
place and the role of each of the several participants are discussed below:
Exc han g e s
1. The exchanges play an important part in providing an
infrastructure required for carrying out the dealings on assets
2. There can be a separate exchange for financial assets and non-
financial assets
3. Where trading is based on out-cry system, members of the
exchange come together and transact business during a fixed
trading period and where trading is on-line, exchange provides
the real-time access to information and trading
Clearing House
1. A clearing house acts as a nerve center of contract execution and
completion
2. It helps clear transactions that are executed in derivatives market
3. Besides guaranteeing the due performance of contracts, it also
acts as a counter party to each contract. It ensures the solvency
of members by enforcing strict rules of entry and conduct on
their part
4. Ensures performance of contracts even in volatile market
conditions by means of a good system
Cus tod i an s
1. Custodians require the participants to deposit their securities
before starting trade
2. Custodians ensure a smooth and standardized delivery mechanism
which is an essential prerequisite for the efficient functioning of
the market
3. Custodians help ensure that the prices of assets traded reflect an

equilibrium price
Banks
1. Banks handle large volume of fund movements that take place
between members and the clearing house
2. Banks facilitate daily settlements by carrying out accounting
entries of the members of the exchange and the clearing house
3. Banks help reduce the possibility of misappropriations in dealings
The Regulator
1. The regulator creates confidence among the transacting members
of the exchange
2. The regulator provides a level playing field to the participants by
making rules and regulations
3. The regulator ensures the protection of investors
4. In India, SEBI and the RBI provide the much needed protection
to the members by regulating the working of the different
constituents
5. The approach and the outlook of the regulator, very much affects
the strength and the volume of the market
Market Makers
1. Jobbers are called ‘market makers,’ as they decide the market
price depending upon the demand and supply of the underlying
asset
2. In the case of an out-cry system, jobbing counters are useful, as
they provide information about the price quotations for executing
deals
3. In the case of screen-based trading, they help display on the
screen the best buy and sell rates
4. They are members of the exchange who take part in purchase and
sale transactions by regularly quoting bid-ask rates
5. The difference between bid and ask is known as bid-ask spread,
with spread increasing with the volatility in prices
6. Jobbers provide much needed liquidity to the market
Brokers
1. Brokers perform the task of bringing together the buyers and the
sellers
2. Brokers help all those persons who are not members of the
exchange to conduct the transactions
3. Brokers are responsible for final settlement and delivery

4. Brokers ensure greater participation by non-members which in
turn increases the volume of their trade in the market and provides
the benefits of liquidity and depth to the market
5. Brokers play an important role in the options and futures contracts
Arbitrageurs
1. Arbitrageurs are risk-averse players who enter into such contracts
that can earn riskless profits through the process called ‘arbitrage’
2. Arbitrageurs indulge in buying in one market and simultaneously
selling in another market to earn the riskless profits under the
conditions of imperfect market
3. Arbitrageurs always look for price imperfections in the market
4. Spot and future prices provide opportunities for arbitrage
5. Prevalence of different prices at different contracts provide
opportunities of arbitrage
Spe c ulators
1. Speculators indulgement in the market is shaped by the expected
future prices of the underlying asset
2. Speculators trading is determined by several factors such as
demand and supply, market positions, economic fundamentals,
international events, monsoon behavior, credit policies
enunciated by the central monetary authority of the country, the
fiscal and other policy announcements made by the Government
3. Speculators assume the role of either the bull or the bear
depending upon their perceptions about the price movements
4. Speculators help provide the much needed liquidity and the
volume to the market which helps reducing the costs
5. Speculators provide the wherewithal to hedgers to manage their
risks
He dge rs
1. Hedgers with futures and option contracts provide for locking in
of the future expected price at which to buy or sell
2. Hedgers can enter into futures or option contracts by means of
which price risk exposure is covered
3. Hedgers are traders and exporters who enter into futures contracts
to safeguard their position from falling rates and prices
4. Traders and producers could benefit from a favorable price
movements and hedge their price risk by entering into an option
contract that gives them the right but not the obligation to buy or
sell the asset at specified price
5. Hedgers provide a cost-effective tool in managing price risks
BENEFITS OF DERIVATIVES
The different uses of derivatives for corporate enterprises are discussed
below:
Benefits to Companies
1. Lowering funding costs Derivatives allow corporations to lower
funding costs by taking advantage of differences that exist between capital
markets through arbitrage opportunities or issuance of customized
instruments. Derivatives allow the principle of comparative advantage to
be applied to financing. Where financial markets are segmented nationally
or internationally due to market or regulatory barriers or different
perceptions of credit qualities in various markets, the use of derivatives
has delivered unambiguous cost savings for borrowers and higher yields
for investors.
For instance, it is possible for a borrower to issue debt where it has a
comparative advantage and use a currency swap to obtain funding in its
desired currency at a lower funding cost than a direct financing. Similarly,
a borrower who generates savings in this way is, in effect, using a swap to
exploit an arbitrage between the financial markets involved. Further,
borrowers are able to achieve savings by issuing structured securities
tailored to meet specific investor requirements. Borrowers use swaps to
obtain the borrowing currency and structure they need.
2. D i vers ifyi n g f un d i n g s ourc es By obtaining financing
from one market and then swapping all or part of the cash flows into the
desired currency denominations and rate indices, issuers can diversify
their funding activities across global markets. Placing debt with new
investors may increase liquidity and reduce funding costs for the issuer.
3. In tern atio n al oper atio n s In the case of transnational
corporations, borrowing needs of a particular country or countries may be
too small to be funded cost effectively through the local capital markets.
Such corporations would find the whole task of borrowing in the domestic
market cheaper and then swaping them into the currencies of needed
countries.
4. Hedging the cost It is obvious that volatile interest rates
create uncertainty about the future cost of issuing fixed-rate debt. Delayed
start swaps, or forward swaps, can be used to “lock-in” the general level
of interest rates that exists at the time the funding decision is made. Such
hedging eliminates general market risk. It does not eliminate, however,
specific risk—the risk that an issuer’s funding cost may move out of line
with the funding cost of other borrowers, due to factors related primarily
to the issuer.
5. Managing existing debt or asset portfolios Where a company
wants to change the characteristics of its existing debt portfolio—either
the mix of fixed and floating rate debt or the mix of currency
denominations, interest rate swaps can be used to adjust the ratio of
fixed to floating rate debt, while currency swaps can be used to transform
an obligation in one currency into an obligation in another currency,
thus changing the currency mix of the debt portfolio. Volatile interest
rates may affect the value of a firm’s assets as well as its liabilities. To
protect the firm’s net worth from the interest rate risk, corporate treasuries
increasingly take account of the interest rate sensitivity of both assets
and liabilities in designing hedges. Interest rate swaps can be used to
adjust the average maturity or interest rate sensitivity of a company’s
debt portfolio so that it more closely matches the interest rate sensitivity
of the asset side of the balance sheet, reducing the exposure of the
company’s net worth or market value to interest rate risk.
6. Managing foreign exchange exposures Both importers and
exporters are exposed to exchange rate risk. As a result of this transactional
exposure, an importer’s profit margin can, and often does evaporate, if its
domestic currency weakens sharply before purchases have been paid for.
International firms with overseas operations also face translation exposure
as the value of their overseas assets and liabilities are translated into
domestic currency for accounting purposes. The competitive position of
many domestic producers also is subject to change with major movements
in foreign exchange rates. Currency swaps, and foreign exchange forwards
and options can be used to create hedges of those future cash flows and
reduce the risk.
7. Managing commodity price exposures Volatility in commodity
prices, such as oil or copper, creates significant risk exposures for producers
or firms using these or closely related commodities as inputs. These
exposures can be hedged using commodity forwards, swaps, caps, or
collars.
8. Benefits to government entities Government entities, including
national governments, local governments, state-owned or sponsored
entities, and supranationals such as the World Bank use derivatives for
much the same reasons as non-financial corporations. They use derivatives
in financing activities to diversify their sources of funds and achieve cost

savings through arbitrage of international and national capital market and
issuance of hedged structured securities. Derivatives are also used for
debt management purposes, especially by those governments borrowing
in different currencies. Recently, some government entities have turned to
commodity derivatives to manage oil price risk.
Benefits to Institutional Investors
1. Enhancing yields The earliest use of swaps by institutional
investors involved asset swaps, in which the cash flows from a particular
asset are swapped for other cash flows, possibly denominated in another
currency or based on a different interest rate. Institutional investors use
derivatives to create investments with a higher yield than corresponding
traditional investments. They might do this when securities trade poorly
because of some unattractive feature. In such a case, an investor may
purchase the securities, neutralize the undesirable feature with a suitable
derivatives transaction, and create, for example, a synthetic fixed-rate
investment with a higher yield than comparable fixed-rate instruments of
the same credit quality.
2. Managing exposures Institutional investors have recently begun
to use derivatives, especially interest rate and equity swaps, to manage
their exposure to debt and equity markets, both domestic and international.
The immediate appeal is the ability to quickly and effectively adjust
exposures—between debt and equity or among different equity classes—
without incurring substantial transaction and custodial costs. There is
also potential to enhance yields. The availability of equity swaps on the
major international equity indices allows investors to diversify globally
and adjust their portfolios in a cost-effective manner.
3. Eliminating currency risk Some institutional investors wish to
benefit from investment in or exposure to foreign debt or equity markets
without necessarily incurring foreign exchange risk. A family of swaps
called “quanto” swaps has been designed to meet the growing demands
of investors for investment diversification without currency risk.
4. Managing risk exposures Institutional investors have benefited
from the creation of customized structured securities in which the principal
redemption, coupons, or both are indexed to an underlying. These
structured securities are equivalent to combinations of derivatives and
traditional credit extension instruments, such as bonds, loans, or
deposits. They meet the particular investment needs of the institutional
investors and allow corporations to raise funds at a lower all-in cost.
Corporations, Banks, and Government borrowers that issue these

instruments typically use derivatives to hedge the unwanted risk and
create attractively priced synthetic fixed or floating rate liabilities in the
currency of their choice.
RISKS IN DERIVATIVES MARKET

The risks to end-users and dealers involved in derivatives can be broadly
categorized as market, credit, operational, and legal. These risks are of
the same types that banks and securities firms have to face in their
traditional lines of business, taking deposits and making loans, or
purchasing and financing securities positions. However, sophisticated
risk management system has been developed for managing the derivatives
risks. Some other banking products, such as residential mortgages with
prepayment options, require a similarly sophisticated approach to risk
management.
The assessment and management of the risks associated with
derivatives activities is discussed below:
Market Risk
Meaning
Market risk of derivatives arises from price behavior when market conditions
undergo changes. The dealer or the end-user can manage the risk by
identifying the components of market risk and understanding their
interaction too. The assessment of market risk relies on a mark-to-market
valuation of derivatives and the underlying instruments, which may serve
as hedges. Dealers now typically manage the market risks of their
derivatives activity on the basis of the net or residual exposure of the
overall portfolio. A dealer’s portfolio generally will contain many offsetting
positions, which substantially reduce the overall risk of the portfolio,
leaving a much smaller residual risk to be hedged.
Managing Market Risks

While managing market risk, a dealer must first of all determine properly
the net position of the portfolio. Dealers look beyond the particular
contracts and focus instead, on identifying the fundamental risks they
contain, so that the overall portfolio can be decomposed into underlying
risk factors that can be quantified and managed. The fundamental risks
that must be identified are as follows:
1. Absolute price or rate (or delta) risk This is the exposure to a

change in the value of a transaction or portfolio corresponding to a given
change in the price of an underlying.
2. Convexity (or gamma) risk This is the risk that arises when the
relationship between the price of an underlying and the value of a transaction
or portfolio is not linear. The greater the non-linearity greater the risk.
3. Volatility (or vega) risk This is typically associated with options
and is the exposure to a change in the value of a transaction or portfolio
resulting from a given change in the expected volatility of the price of an
underlying.
4. Time decay (or theta) risk This is typically associated with options
and is the exposure to a change in the value of a transaction or portfolio
arising from the passage of time.
5. Basis (or correlation) risk This is the exposure of a transaction or
portfolio to differences in the price performance of the derivatives it contains
and their hedges.
6. Discount rate (or rho) risk This is the exposure to a change in the
value of a transaction or portfolio corresponding to a change in the rate
used for discounting future cash flows.
Analysis of Market Risks
The market risks of derivative portfolios are best analyzed in terms of the
fundamental risks associated with the two basic types of derivatives. It
may contain: forward-based and option-based derivatives. The market
risks of forward-based derivatives are relatively straightforward since the
dominant risk is absolute price or rate risk. Changes in the price of the
underlying result in proportional changes in the value of the derivative.
Forward-based derivatives generally do not have significant exposure to
convexity (gamma) risk. The simplicity of the market risk profile of these
derivatives makes hedging and monitoring risk easier than for option-
based derivatives. A hedge will consist of a proportional amount of the
underlying (or another forward-based derivative) and this hedge is, for all
intents and purposes, relatively static.
The relationship between the price of an option and the price of its
underlying is not constant, as is the case with forward-based derivatives.
The price sensitivity of an option’s value changes with changes in the
price of the underlying, so that options create exposures to risk of gaps in
prices of the underlying as well as directional movements. Options also
create exposure to volatility risk. Changes in the expected volatility of the
underlying will affect the value of the option, even if the price of the
underlying remains constant. The passage of time also affects the value of
an option because of time decay—the reduction in the likelihood that the

option will end-up in-the-money (or further in-the-money) as the time to
expiration is reduced.
The risks inherent in option-based derivatives are more complex. The
valuation of options is based upon a set of theories and mathematical
models built on foundation first developed in the 1970s. One of the key
contributions was the option valuation model developed by Fisher Black
and Myron Scholes. The Black-Scholes model identifies five factors that
determine the value of many options such as the price of the underlying,
the exercise price of the option, the time of expiration of the option, the
volatility of the price of the underlying, and the discount rate over the life
of the option. These risk factors are considered below:
Market Liquidity Risk
This is typically associated with the possibility that a large transaction in
a particular instrument could have a discernible effect on the price of the
instrument. This market impact increases the cost of hedging. In illiquid
markets, moreover, bid-ask spreads are likely to be larger, further increasing
the cost. A related phenomenon is the risk of an unexpected and sudden
erosion of liquidity, possibly as a result of a sharp price move or jump in
volatility.
By breaking the market risk of a particular product down into its
fundamental elements, however, dealers are able to move beyond product
liquidity to risk liquidity. For example, the interest rate risk of a complicated
U.S. Dollar interest rate swap can be hedged with other swaps, FRAs,
Eurodollar futures contracts, treasury notes, or even bank loans and
deposits. The customized swap may appear to be illiquid, but, if its
component risks are not, then other dealers can effectively acquire the
transaction and hedge it.
Basis or Correlation Risk

When a derivatives transaction is used to hedge another position, changes
in the market value of the combined position result from basis risk. With a
perfect hedge, the value of the combined position remains unchanged for
a change in the price of the underlying. With an imperfect hedge, the
values of the instrument and its hedge are not perfectly correlated. For
example, when similar asset classes are aggregated, so that the risk can be
managed on a portfolio basis, there may be maturity mismatches among
deals or variation in price movements between the net derivatives position
and the corresponding hedge. Correlation risk is an additional element of
market risk that must be measured and managed.

Investing and Funding Risk
Dealers and other participants who manage a portfolio of derivatives
must meet the investing and funding requirements arising from cash
flow mismatches. In addition, participants may be exposed to additional
investing and funding requirements if the agreements they use to
document transactions contain collateral provisions that protect cash
and securities receipts or payments. The magnitude and direction of net
cash positions can be forecast, but will fluctuate with changes in the
market and activity in the portfolios. Transactions can be undertaken in
derivatives and the cash markets to manage investing and funding risks.
Credit Risk
Credit risk is the risk that a loss will be incurred if counter party defaults on
a derivatives contract. The loss due to a default is the cost of replacing the
contract with a new one. The replacement cost at the time of default is
equal to the present value of the expected future cash flows.
1. Credit risk of individual derivatives The credit risk of a derivatives
transaction fluctuates over time with the underlying variables that determine
the value of the contract. In assessing credit risk, the current exposure and
the potential exposure must be considered.
a. Current exposure It simply asks for the current market value of
the derivatives at a given point in time— the cost of replacing the
remaining cash flows at the prices and market interest rates
prevailing when the event of termination occurs. The replacement
cost could be positive or negative, depending on the evolution of
the underlying, since the inception of the transaction. Whenever
the replacement cost is negative, the remaining party incurs no
loss on its counter party defaults.
b. Potential exposure It explains the replacement cost of the
derivatives transaction in the future if the underlying variables
that determine the value of the contract move adversely. Dealers
use Monte Carlo or historical simulation studies or option valuation
models to assess potential exposure. These analysis generally
involve modeling the volatility of the underlying and the effect of
its movements on the value of the derivatives transaction. These
techniques are often used to generate two measures of potential
exposure: “expected” exposure and maximum or “worst case”
exposure.
Expected exposure at any point during the life of the swap is the mean
of all possible replacement costs, where the replacement cost in any
outcome is equal to the market value, if positive, and zero, if negative.
Expected exposure is the best estimate of the present value of the positive
exposure, or credit risk, that is likely to materialize. Hence, expected
exposure is an important measure in derivatives dealer’s capital allocation
and pricing decisions.
It is important to appreciate that counter party defaults in a forward or
swap transaction may not cause a loss. For a credit loss to occur on a
forward or swap transaction, two conditions must coexist—that the counter
party defaults and that the replacement cost of the transaction, (i.e. the
exposure) is positive.
Unlike forwards and swaps, counter party risk in options is one-
sided. The buyer of the option typically pays in full for the option at
contract initiation. The seller, however, is not required to perform until the
option is exercised. This exposes the buyer to credit risk in that the seller
may default prior to fulfilling the commitment under the option.
2. Credit risk of a portfolio In calculating the current replacement
costs for a portfolio of transactions with a counter party, it is important to
know whether netting applies and is enforceable. Master agreements used
for documenting swaps typically provide for netting of close-out values
across all transactions under the contract in the event of default. If a
counter party defaults, application of close-out netting will result in all the
outstanding transactions being terminated and marked to market; the net
(not gross) amount owed under all the transactions would be the
replacement cost for that counter party. If netting applies, the current
credit exposure is simply the sum of the positive and negative mark-to-
market values of the transactions in the portfolio. If netting does not
apply, only the positive mark-to-market transactions should be added in
calculating current exposure because the positive mark-to-market could
not be offset against negative mark to market positions in the event of
default.
The potential exposure for a portfolio of transactions is more difficult
to calculate. While the simplest method is to add the potential exposure of
each transaction in the portfolio, this procedure dramatically overstates,
in most cases, the actual potential exposure. It does not take into account
transactions in the portfolio with offsetting exposures or transactions that
have peak maximum potential exposures that occur at different times. The
potential exposure of a portfolio of transactions with a given counter
party can be analyzed more thoroughly by portfolio-level simulation that
accounts for portfolio effects and provides more accurate measures of

expected and maximum potential exposure than would be obtained by
aggregating exposures on individual transactions.
The overall credit risk of a derivatives portfolio also depends upon
the extent of diversification across specific counter parties and types of
counter parties. For large diversified derivatives portfolios, “worst case”
exposure becomes a less useful measure since it is highly unlikely that all
worst-case outcomes will occur simultaneously. Concentration of the
portfolio with one counter party (or type of counter party) increases credit
risk. This is as true for a derivatives portfolio as it is for a loan book.
3. Managin g credit ris k Dealers adopt various policies and
procedures to manage counter party credit risk. These include internal
controls that ensure that credit risk is assessed prior to entering into
transactions with a given counter party and that credit risk is monitored
over the life of the transaction. Besides, documentation provisions also
help mitigate credit risk and thereby ensure transaction enforceability.
Similarly, credit enhancement structures are also put in place to reduce or
limit the credit exposure of dealing with particular counter parties.
4. Cred it evaluation The credit risk in these derivatives is
addressed generally through counter party credit evaluation and by the
use of risk limits for counter parties. The credit quality of the users of
global derivatives is typically high. For less creditworthy counter parties,
credit enhancement methods such as collateral are often employed.
5. Cre d it expo s ure s Although the measurement of credit
exposures for derivatives transactions is more complicated than the
measurement of exposure for more traditional banking products, the
principles of assuming credit risk and managing these risks remain the
same. For this reason, major dealers typically manage credit exposure on a
consistent and integrated basis across the organization. Specifically, the
evaluation of the credit exposures of derivatives transactions is made on
a comparable basis with those exposures for on-balance-sheet activities,
allowing the dealer to consistently integrate the two activities in the credit
allocation and review process.
Settlement Risk
One aspect of settlement risk results from the fact that few financial
transactions are settled on a same-day basis, or simultaneously. In the
U.S. equity markets, for example, the difference between the trade date and
settlement is at present five days. As a result, one party could suffer a loss
if the price moved in his favor and the counter party refused to exchange
on the settlement date. The largest settlement exposures, however, typically

occur on the settlement day itself when the full value of the security can
be at risk if delivery of the security and delivery of the payment are not
synchronized.
Settlement risk in derivatives is reduced greatly by the widespread
use of the payment netting provisions of master agreements. This reduces
the settlement risk of payments made in the same currency. In addition, for
many derivative transactions (e.g. interest rate swaps), principal amounts
are not exchanged on the maturity date.
Payment netting, however, does not address cross currency settlement
risk. The largest source of settlement risk in payment systems is the
settlement exposure created by foreign currency trades—spot and short-
dated forwards (called “Herstatt” risk after the 1974 failure of the Bankhaus
Herstatt). While derivatives activity would benefit from a reduction of
Herstatt risk, it must be noted that the amounts involved in derivatives are
very small relative to the amounts involved in traditional foreign exchange
activities.
Operational Risk
Operational risk is the risk of losses occurring as a result of inadequate
systems and control, human error, of management failure. Such risks also
exist in securities and credit businesses. The complexity of derivatives,
however, requires special emphasis on maintaining adequate human and
systems controls to validate and monitor the transactions and positions
of dealers. The main types of internal controls, depending upon the level
of derivatives and the sophistication of the institution, may include the
following:
1. Oversight of informed and involved senior management
2. Documentation of policies and procedures, listing approved
activities and establishing limits and exceptions, credit controls
and management reports
3. Independent risk management function (analogues to credit
review and asset/liability committees) that provides senior
management validation of results and utilizations of limits
4. Independent internal audits which verify adherence to the firm’s
policies and procedures
5. A back office with the technology and systems for handling
confirmations, documentation, payments, and accounting
6. A system of independent checks and balances throughout the

transaction process, from front-office initiation of a trade to final
payment settlement
Legal Risk
Legal risk is the risk of loss because a contract cannot be enforced. This
includes risks arising from insufficient documentation, insufficient capacity
or authority of a counter party (ultra vires), uncertain legality and
unenforceability in bankruptcy or insolvency.
Although financial institutions have encountered these legal risks in
their traditional lending and trading businesses, the risk comes in new
forms with derivatives. Legal analysis of derivatives-related disputes,
moreover, often turns on form as well as substance. In the early days of
global derivatives activity, lawyers were presented with a host of issues—
corporate, constitutional, tax, and regulatory that grew out of the fact that
existing laws and regulations had been written before these new
transactions were developed.
Enforceability risk results from the possibility that a derivative contract
with a positive replacement cost might be found to be unenforceable. This
might result from one’s counter party being legally incapable of entering
into the contract, (i.e. ultra vires) or from an entire class of contracts being
declared illegal or unenforceable. Similarly, provisions for netting of
exposures on transactions documented under master agreements offer
obvious benefits to end-users and dealers.
Derivatives and Financial System
Derivatives cause the systemic risk. Such a risk is caused by the following
factors:
1. The size and complexity of derivatives activity
2. The concentration of activity among a relatively small number of
institutions
3. The lack of transparency of risk management activities including
derivatives
4. The apparent illiquidity of customized derivatives interactions
5. Increased settlement risk because of growth of derivatives
6. The credit exposures undertaken by dealers
7. The presence, among large dealers, of unregulated activities
8. The interconnection risk arising from the role played by
derivatives in increasing links among capital markets
CAPITAL STANDARDS FOR DERIVATIVES

The Basle Committee on Banking Supervision published standards for
capital adequacy in 1988. The standards sought to establish a system in
which minimum capital requirements were set for banking firms based on
the risk of bank assets. Many countries including India have adopted the
risk-based capital standards specified in the Basle Accord. The
assignments of minimum capital primarily reflected an assessment of credit
risk or the risk of loss due to counter party default. Consideration of other
types of risk was left to national regulatory authorities or to future
deliberations of the Basle Committee and its subgroups.
REGULATING DERIVATIVES MARKET
The regulatory and supervisory response has so far focused on improving
supervisory oversight and on increasing disclosure. In April 1993, the
Basle Committee sought comments on a consultative paper describing
proposals for incorporating additional types of risks into the original
framework. The G30 report (July 1993) on derivatives was the first attempt
to set out principles for the management of a derivatives trading operation.
In March 1995, the Derivatives Policy Group (DPG), drawn from six U.S.
securities firms produced Framework for Voluntary Oversight, a code for
better disclosure of their Over-The-Counter (OTC) derivatives activities.
In July 1995, a tripartite group of banks, securities and regulators
recommended setting up of a nine-person joint forum representing the
Basle Committee on Banking Supervision, the International Organization
of Securities Commissions (IOSCO) and International Association of
Insurance Supervisors (IAIS) to examine different aspects relating to
derivatives. But an agreement on the financial regulation of derivatives
market has eluded so far.
ADVENT OF DERIVATIVES MARKET IN INDIA
Although India has started the innovations in financial markets very late,
some of the recent measures initiated by the regulatory authorities are
worth mentioning as follows:
Pe rmis sion
Futures trading has been permitted in certain commodity exchanges.
Mumbai Stock Exchange has started futures trading in cottonseed and
cotton under the BOOE and under the East India Cotton Association
(EICA).
Infrastructure
Necessary infrastructure has been created by the National Stock Exchange
(NSE) and the Bombay Stock Exchange (BSE) for trading in stock index
futures, and the commencement of operations in selected scrips.
LERMS
Introduction of the Liberalized Exchange Rate Management System
(LERMS) in the year 1992 for regulating the flow of foreign exchange.
Tarapore Committee
Constitution of a committee by the RBI headed by S.S. Tarapore to go into
the merits of full convertibility on capital accounts.
Interest Rate
RBI has initiated measures for freeing the interest rate structure. Further,
the RBI has envisioned ‘MIBOR’ (Mumbai Inter Bank Offer rate) on the
line of LIBOR as a step towards introducing futures trading in interest
rates and forex.
Badla
Banning of ‘Badla’ transactions in all 23 stock exchanges including the
NSE, DSE and the BSE from July 2001.
Nifty
NSE’s efforts to start trading in index options based on the Nifty (NSE 50)
and certain stocks.
REVIEW QUESTIONS
Section A
1. What are ‘derivatives’?
2. What are ‘forward contracts’?
3. What are ‘swaps’?
4. What is a financial swap?
5. What is meant by ‘parallel loan’?
6. What are ‘currency swaps’?
7. What is ‘swap spread’?
8. How is a swap valued?
9. What are ‘futures contract’?
10. What are ‘Forward Rate Agreements’?
11. Name some of the option based derivatives
12. What are ‘options’? What are its types?
13. What is ‘a call option’?
14. What is ‘a put option’?

15. What are ‘structured options’?
16. What is ‘bundling an option’?
17. What are ‘swaptions’?
18. Identify the various participants in the derivatives market
19. What is ‘liquidity risk’?
20. What is ‘credit risk’?
Section B
1. What are the shortcomings of the derivatives market?
2. What are the features of ‘forward contracts’?
3. What are the features of ‘swaps’?
4. How are swaps beneficial?
5. Explain the modus operandi of swaps.
6. How does the ‘interest rate swaps’ work?
7. What are the features of ‘futures contracts’?
8. State the features of ‘Forward Rate Agreements’?
9. How is a forward contract different from a futures contract?
10. Bring out the features of ‘options’?
11. Explain clearly the role of dealers in the derivatives market.
12. How are derivatives useful for corpoarates?
13. How are derivatives beneficial to institutional investors?
14. What is ‘market risk’? Identify the different kinds of market risk?
15. How could a ‘credit risk’ managed?
16. What is the ‘settlement risk’ attached to the use of derivatives?
17. How is operational risk caused while handling derivatives?
18. State the nature of ‘legal risk’ attached to the use of derivatives?
19. How are derivatives important in the financial system of a
country?
Section C
1. Trace the factors that have caused tremendous growth of
derivatives market around the globe in the recent times.
2. Discuss the various functions of a derivatives market.
3. How are derivatives categorized? Explain.
4. Explain the role of various participants in the derivatives market.
5. Discuss the various advantages of derivatives.
6. Derivatives need to be handled carefully; else they would entail
a huge loss – Elucidate the statement clearly bringing out the
various risks attached to the use of derivative instruments.
7. How is the derivatives market regulated in India? Explain in the
light of the measures initiated by the Government .
Chapter 6
SEBI—Functions and Working
Presence of an efficient securities market is an important requirement for a

country’s march towards industrialization. For, the market offers a
mechanism for efficient mobilization and channeling of savings of the
household sector into productive enterprises. By offering attractive
rewards in the form of returns and capital appreciation, the securities
market encourages thrift and risk taking. It also helps enterprises to raise
money in a cost-effective manner. The emergence of securities market in
India dates back to the eighteenth century, when the Bombay Stock
Exchange was set up in 1887. It was a vital segment of the Indian financial
system.
The securities market came in for a spectacular growth, both in terms
of its ability to mobilize resources and to allocate it with some efficiency in
the nineteenth century. The market came to provide all the support needed
for the growth and development of the corporate sector by facilitating the
raising of long-term capital funds. In fact, the Indian financial system
witnessed an unprecedented growth in terms of the number and the variety
of players. The number of active investors, institutions and intermediaries
increased manifold. The stock exchanges also grew in number. All these
factors necessitated the need for creating an awareness and interest among
the common investors. Moreover, the burgeoning growth of corporate
enterprises ushered in excellent investment opportunities available in the
securities market among the lay savers.
The need for setting up a statutory apex body was felt by the
government to promote an orderly and healthy growth of the securities
market and for investor protection. The body was expected to help sustain
the growth momentum and thereby, crystallize the awareness and interest
into a committed, discerning and growing pool of investors. This was
aimed at protecting investors’ rights and curbing trading malpractices and
structural inadequacies of the market. In countries like the USA and UK,
National Securities Exchange Commission monitors the capital market
operations and safeguards the investors’ interest. Such an agency helped

the healthy growth of the securities market there.
GENESIS
Government of India set up the Securities and Exchange Board of India
(SEBI) on April 12, 1988 on the basis of the recommendations of the high
powered Committee on Stock Exchange Reforms headed by G.S. Patel.
SEBI was given a legal status by the Securities and Exchange Board of
India Ordinance, 1992. The members of the Board of Management of the
SEBI comprised those drawn from professional brokers, financial
consultants, merchant bankers, investors, stock exchange authorities,
finance ministry, etc.
FEATURES OF THE SEBI BILL
The SEBI has been entrusted with a wide range of responsibilities in
regulating the activities of almost all the players in the capital market.
After the abolition of the controller of capital issues, the issuer of capital,
which is the promoter, has come under SEBI’s jurisdiction. The SEBI laid
down certain guidelines for the issuers to ensure investor protection. The
SEBI was expected to regulate mutual funds, merchant bankers, registrars
to issue, share transfer agents, portfolio managers, underwriters, investment
advisors, brokers and sub-brokers. SEBI has also been given certain powers
to regulate the functioning of stock exchanges in India.
OBJECTIVES
SEBI was set up with the following objectives of assisting and facilitating
the mobilization of adequate resources through the securities market and
its efficient allocation, keeping in mind the interests of issuers, investors
and the intermediaries:
Conducive environment SEBI aims at creating a proper and con-
ducive environment required for raising money from the capital market
through the rules, regulations, trade practices, customs and relations among
institutions, brokers, investors and companies. It also aims at endeavor-
ing to restore and safeguard the trust of investors, especially the interest
of the small investors. This is to be achieved by meeting the needs of the
players connected with the securities market such as the investors, the
corporate sector and the intermediaries. SEBI works for creating proper
investment climate to enable corporate sector to float industrial securities
easily, efficiently and at affordable minimum cost.
SEBI— Functi ons and Worki ng 125
Investor education SEBI aims at educating investors so as to make

them aware of their rights in clear and specific terms by providing them
with information. This way, SEBI aims at maintaining liquidity, safety and
profitability of the securities in the market that are crucial for any invest-
ment. A high degree of protection of investor rights and interests is made
possible by providing adequate, accurate and authentic information on a
continuous basis. This way, the market efficiency is also ensured.
Infrastructure SEBI aims at developing a proper infrastructure for fa-
cilitating automatic expansion and growth of business of middlemen like
brokers, jobbers, commercial banks, merchant bankers, mutual funds, etc.
This is aimed at providing efficient service to their constituents, viz. in-
vestors and corporate sector at competitive prices.
Others In addition to the above mentioned objectives, SEBI would
also make efforts to bring about necessary enactments for regulating
business of intermediaries such as mutual funds, NBFCs and chit funds,
etc. SEBI would also work towards creating a framework for more open,
orderly and unprejudiced conduct in relation to takeover and mergers in
the corporate sector so as to ensure fair and equal treatment to all the
security holders.
MANAGEMENT
Under Section 4 of the SEBI Act, the management of SEBI is entrusted
with the Board of Members. The Board consists of a Chairman, two
members from amongst the officials of the Ministries of the Central
Government dealing with Finance and Law, one member from amongst
the officials of the Reserve Bank of India constituted under Section 3 of
the Reserve Bank of India Act, 1934 and two other members appointed
by the Central Government who are professionals having experience or
special knowledge relating to securities market. The Chairman and the
other members of the Board are chosen from amongst the persons of
ability, integrity and standing who have shown capacity in dealing with
problems relating to securities market or have special knowledge or
experience of law, finance, economics, accountancy, administration or in
any other discipline which, in the opinion of the Central Government,
shall be useful to the Board.
POWERS AND FUNCTIONS
Under the SEBI Act
Under Section 11 (1) of the SEBI Act, following are the powers and the
functions of the SEBI, designed to protect and promote the interests of

investors in securities, and thereby allow for the promotion and the
development of the securities market in a regulated manner:
1. Stock exchange regulation SEBI is empowered to regulate the
business in stock exchanges and any other securities market. It works to
prohibit fraudulent and unfair trade practices in securities market. SEBI
performs functions like calling for information, undertaking inspection,
conducting enquiries and audits of the stock exchanges, intermediaries,
and self-regulatory organizations in the securities market.
2. Stock brokers regulation SEBI is empowered to register and
regulate the working of stockbrokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant
bankers, underwriters, portfolio managers, investment advisers and such
other intermediaries who may be associated with securities market in any
manner.
3. CIS regulation SEBI works to regulate the working of Collective
Investment Schemes (CIS), including mutual funds. For this purpose it
promotes and regulates self-regulatory organizations.
4. Investor protection SEBI is empowered to initiate all the steps for
promoting investor education and training of intermediaries in securities
market. For this purpose it would work towards prohibiting insider trading
in securities, besides regulating substantial acquisition of shares and take-
over of companies.
5. Others
a. Performing such functions and exercising such powers under
the provisions of the capital issues (Control) Act, 1947
(Subsequently repealed) and the Securities Contracts
(Regulations) Act. 1956, as may be delegated to it by the Central
Government
b. Levying fees or other charges for carrying out the purposes of
Section 11 of the Act
c. Conducting research for the above purpose
d. Performing such other functions as may be prescribed by the
government
Section 17 of the Act empowers the Central Government to supersede
SEBI and exercise all of the above powers under the following
circumstances:
1. Where on account of grave emergency SEBI is unable to
discharge the functions and duties under any provisions of the
Act
2. Where the SEBI persistently defaults in complying with any

direction issued by the Central Government under the Act
3. Where in the discharge of its functions and duties under the Act
and as a result of such default the financial position of SEBI or its
administration has deteriorated
4. Where the public interest is to be served
Under the SCRA
In addition to the powers that have been granted to be exercised by the
SEBI under its own law, following are the powers granted to it under the
Securities Contracts (Regulation) Act (SCRA):
Information SEBI calls for periodical returns from stock exchanges. It
would also prescribe maintenance of certain documents by the exchanges.
In addition, SEBI calls upon the exchange/any member(s) to furnish
explanation/information relating to the affairs of the exchange/any
member(s) and appoint any person to conduct an inquiry into the affairs
of the governing body of any exchange/any member of the exchange.
Stock exchange regulation SEBI commands the following powers
as relating to the regulation of stock exchanges:
a. Approval of byelaws of the exchange(s) for regulation and control
of contracts
b. Licensing of dealers in securities in certain areas
c. Compel a public company to list its shares
d. Amendment of rules relating to matters specified in Section 3(2)
of the Act
e. Furnishing of annual report by recognized stock exchanges
f. Issuing directions to stock exchanges in general or a stock
exchange in particular to make rules or to amend rules
g. Superseding the governing body of a recognized stock exchange
h. Suspension of business of a recognized stock exchange
i. Prohibit contracts in certain cases
j. Submission of applications for the recognition of stock
exchanges
k. Grant of recognition to stock exchanges
l. Withdrawal of recognition of a stock exchange
m. Making or amending rules or articles of association of a stock
exchange regarding voting rights of members of a stock exchange
at any meeting
n. Issue of notification declaring Section 13 to apply to an area,
consequent upon which contracts issued in that area, otherwise
than between members of a recognized stock exchange or through

or with such members would be illegal
o. Regulation and control of the business of dealing in spot
delivery contracts
p. Hearing appeals submitted by companies against refusal of a
stock exchange to list their securities and
q. Issues of a notification specifying any class of contracts as
contracts to which the SCRA or any provision contained therein
would not apply
Registration of Intermediaries
All intermediaries dealing in securities are compulsorily registered with
the SEBI in accordance with the regulations made under the SEBI Act. The
certificate of registration contains the conditions/rules and regulations
for conduct of business by the security market intermediaries. The SEBI
prescribes regulations for the application form and the manner of making
an application as well as the fee payable. The SEBI can suspend/cancel a
certificate of a registration granted to the intermediaries in accordance
with the regulations made by it in this behalf. An intermediary/person
aggrieved by an order of the SEBI, suspending/canceling registration can
prefer an appeal to the Government. By various regulations notified from
time to time, the SEBI has prescribed the procedure for registration of
various intermediaries associated with the securities market.
Directions from Government
The Government of India can issue directions to the SEBI on questions of
policy in writing from time to time. It is bound to follow and observe such
directions in the exercise of its powers/the performance of its functions.
The Government has absolute discretion to determine whether a question
is one of the policy or not. Its inability to discharge its functions/duties, or
non-compliance to follow and act upon any direction given by the
Government or requirement in the public interest may lead to its
supersession by the Government.
Power to Make Rules
The Government is authorized to make rules for carrying out the purposes
of the SEBI Act. The important matter for which rules may be framed,
include, the additional functions to be performed by it, its constitution,
maintenance of its accounts, manner of inquiry to impose penalty for
defaults, constitution of the Securities Appellate Tribunal (SAT), the forms
of appeal and fee before the SAT, and the form in which reports have to be
submitted to the Government. The Government was also empowered to

frame rules regarding the conditions for certificate of registration for
intermediaries. With effect from 1995, this power was withdrawn from the
Government and rests with the SEBI now.
Power to Make Regulations
To carry out its functions, the SEBI is empowered to make regulations.
Every regulation made by it must have the prior approval of the
Government. All such regulations must be published as notification in the
official gazette. The matters for which regulations may be framed include
(a) the conditions for registration certificate, fee for registration,
cancellation/suspension of registration of intermediaries and (b) matters
relating to issue of capital, transfer of securities and so on.
Penalties
With effect from 1995, the SEBI has been empowered to impose penalties
on different intermediaries for defaults such as the following:
1. Failure to furnish information and return The SEBI can impose
penalties as detailed below:
a. For failure to furnish any document, return, report—not exceeding
Rs. 1,50,000 for each such failure
b. For failure to file any return/furnish any information, books or
documents within the specified time—not exceeding Rs. 50,000
for each day
c. Failure to maintain books of accounts/records—not exceeding
Rs. 10,000 for each day
2. Failure to enter into agreement with clients not to exceed Rs. 5
lakh for every failure
3. Failure to red res s in ves tors ’ grievan c es not to exceed
Rs. 10, 000 for each such failure
4. Defaults in case of mutual funds
a. Default in not obtaining certificate of registration—not to exceed
Rs. 10,000 for each day or Rs. 10 lakhs whichever is higher
b. Default in not complying with the terms and conditions of the
certificate of registration—not to exceed Rs. 10,000 for each day
or Rs. 10 lakhs, whichever is higher
c. Default in failing to make an application for listing of schemes—
not to exceed Rs. 5,000 per day or Rs. 5 lakhs, whichever is higher
d. Default in not despatching unit certificates—not to exceed
Rs. 5,000 for each day of default
e. Default in failing to refund application money—not to exceed

Rs. 1,000 for each day of default and
f. Default in failing to invest collected money not to exceed
Rs. 5 lakhs for each such default
5. Failure by an AMC not to exceed Rs. 5 lakhs for each such failure
6. Default in case of stock brokers
a. For failure to issue contract notes in the form and manner
prescribed by the stock exchange—not to exceed five times the
amount for which the contract note was required to be issued
b. For failure to deliver any security/payment the amount due to the
investor in the manner and within the period specified in the
regulations—not to exceed Rs. 5,000 for each day of default
c. For charging brokerage in excess of that prescribed by the
regulation not to exceed Rs. 5,000 or five times the excess charge,
whichever is higher
7. Penalty for insider trading If an insider (a) deals in securities on
his behalf or on behalf of others on the basis of an unpublished price
sensitive information or (b) communicates any unpublished price sensitive
information except as required in the course of business or under any law,
or (c) counsels or procures for any person to deal in such securities on the
basis of unpublished price sensitive information, he is liable to a penalty
not exceeding Rs. 5 lakhs.
8. Non-disclosure of acquisition of shares and takeovers Failure
to disclose the aggregate of shareholding in a company before acquiring
any shares of that company, and also to make a public announcement for
acquiring shares at a minimum price is liable to penalty not exceeding
Rs. 5 lakhs.
Power to Adjudicate
The SEBI is empowered since 1995, to appoint any of its officers of the rank
of a division chief as the adjudicating officer, to hold an enquiry in the
prescribed manner for determining the amount of penalty on any intermediary.
The quantum of penalty is to be fixed with due regard to (a) the amount of
disproportionate gain or unfair advantage made as a result of the default,
(b) the amount of loss caused to an investor/group of investors as a result
of the default and (c) the repetitive nature of the default.
REGULATORY ROLE
Since its inception in 1992, the SEBI, as a capital market regulator, has been
making tremendous efforts towards achieving its twin objectives of
investor protection and capital market development as mandated by the
SEBI Act. SEBI has initiated a number of policy initiatives. The focus of
attention of SEBI’s activities is as follows:
1. Increasing market transparency through further improvement of
disclosure standards
2. Improving the standards of corporate governance
3. Improving market efficiency by speeding up the process of
dematerialization and introducing rolling settlement in a phased
manner
4. Reduced transaction costs by refining the margin system
5. Enhancing the market safety through an efficient margin system
and stepping up surveillance
ROLE AND RELEVANCE

The role of SEBI in the realm of development and regulation of the securities
market in India is discussed below:
Credible Regulatory Structure
SEBI has been responsible for successfully creating a credible regulatory
structure for the securities market. It acts as a major catalyst for the
development of the securities market in India. For this purpose it brings
about far reaching changes in market practices, introduces the
internationally acclaimed best practices and procedures in the realm of
trading and engages itself in periodical modernization of the market
infrastructure by enforcing regulations taking advantage of technology.
SEBI introduced a package of measures of liberalization, regulation and
development for the healthy promotion of the securities market in India,
keeping in mind the necessity of contributing to the industrial and economic
growth of the country. Some of these measures include the following:
1. Disclosure Introduction of disclosure norms for issuers so as
to ensure the observance of high standards of integrity and fair dealing
thus benefiting the investors.
2. Automation Introduction of automated working procedures
through the computers in all stock exchanges, thus facilitating trading
with the help of terminals of stock exchanges and modernization of market
infrastructure.
3. Depository Creation of the facility of depository by the enactment

of the Depositories Act, 1996 thus providing for the establishment of
depositories in securities with the objective of ensuring free transferability
of securities, its speed, accuracy, and security.
4. Trading Introduction of number of systematic measures thus
enforcing reliable trading mechanism and preventing market failures and
the establishment of settlement guarantee funds in the stock exchanges
thus facilitating a smooth and timely settlement of funds.
5. Others Other measures of establishing a credible securities structure
include shortening of settlement cycles of stock exchanges, modernizing
and strengthening of the surveillance systems in stock exchanges and
SEBI, liberalization of FII policy and simplification of the investment
procedures by the FIIs, and strengthening of the regulations for takeover
to encourage take-over in a fair and transparent manner and to protect the
investors.
Market Surveillance
In order to bring about orderliness in the working of the stock exchanges
all over India, market surveillance is an important key used by the SEBI.
This assumes relevance in the context of the growing incidence of scams
taking place in the capital market. SEBI set up a Market Surveillance Division
as early as in July 1995, with a view to keep a pro-active surveillance on the
activities of the stock exchanges. Following are the focus of attention in
this regard:
1. Policy formulation SEBI has the power to formulate relevant policy
for introduction of surveillance systems and risk containment measures at
the stock exchanges to bring integrity, safety and stability in the Indian
securities markets.
2. Surveillance system SEBI commands the power to oversee the
surveillance activities of the stock exchanges including monitoring of
market movements by them. For this purpose, SEBI establishes
independent surveillance cells in stock exchanges. SEBI also assists in
the formation of Inter-Exchange Market Surveillance Group for prompt,
interactive and effective decision-making on surveillance issues and
coordination between stock exchanges. SEBI oversees the implementation
of Stock Watch System, an on-line automated surveillance system at stock
exchanges. Besides, it also involves in alerting and advising investors
through press releases about the need for a cautious trading in scrips in
ICE (Information, Communications and Electronics industry) and directing
the stock exchanges to closely monitor the trading and other developments
in respect of shares of such companies.
3. Inspection SEBI is empowered to carry out the inspection of the
surveillance cells of the stock exchanges and initiating investigations. It
also carries out the inspection of intermediaries. Inspection is carried out
to gather evidence of alleged violations of securities market such as price
rigging, creation of artificial market, insider trading, public issue related
irregularities and other misconduct.
4. Information SEBI undertakes the preparation of reports and studies
on market movements, which SEBI circulates periodically to the Ministry
of Finance in the Government of India and to securities markets regulators
from other countries. Reporting by stock exchanges through periodic and
event driven reports is also done by the SEBI.
5. Risk containment Risk containment measures in the form of
elaborate margining system and linking of intra-day trading limits and
exposure limits to capital adequacy are also undertaken by the SEBI.
Suspension of trading in scrips to prevent market manipulation and
tightening entry norms for public/right issues is done by the SEBI.
6. Price bands SEBI arranges for the announcement of daily price
bands to curb abnormal price behavior and volatility.
Disclosure Standards
SEBI appointed an expert committee in 1995, under the Chairmanship of
Y. H. Malegam to suggest measures for improving the disclosure standards.
Another committee was appointed under the chairmanship of C. B. Bhave
to recommend measures for improving the continuing disclosure standards
by corporates and timely dissemination of price sensitive information to
the public. On the basis of the recommendations of the above committees,
SEBI initiated such steps as the imposition of a set of entry barriers on
new issues specifying the minimum issue size requirements for companies
that seek listing. A reinforcing step was initiated by the SEBI by issuing
the compendium of SEBI (Disclosure & Investor Protection) Guidelines,
2000 effective from January 27, 2000. This was the consolidation of all the
earlier guidelines encompassing entry norms, lock-in-period, promoters’
contribution, etc. This was done in order to streamline the current procedure
and smoothen out the aberrations in initial public offerings.
Best Governing Practices
Based on the recommendations of the Kumar Mangalam Birla Report,
SEBI put into vigorous practice, the code of corporate governance in
listed companies for the purpose of affording protection to investors

through the mechanism of enhanced standards of corporate management.
To secure corporate governance in companies, the SEBI issued
directives to stock exchanges to amend the listing agreement to include a
new clause (clause 49) on corporate governance to be adhered to, by the
listed companies. The board areas of corporate governance were
composition of board of directors, constitution and functioning of audit
committees, remuneration of directors, disclosure requirements, compliance
report on corporate governance and compliance certificate. Such a measure
was designed to instill investor confidence in the capital market through
better corporate governance.
Building Investor Confidence
SEBI took a number of steps in order to allow for better investor protection
and market development so as to usher in an active primary market. Safety
measures introduced by the SEBI for safeguarding the interests of millions
of investors and also for building their confidence were as follows:
1. Appointment of Compliance Officer
2. Prudent corporate governance norms for all listed companies to
ensure transparency and better disclosure practices
3. Service centers set up by stock exchanges for investors to enable
them to have a forum for recording and counselling their
grievances as well as access to financial and other information of
companies and government policies, rules, regulations, etc
4. Better monitoring and market surveillance systems
5. Directions to stock exchanges to take stern action against
companies not complying with listing agreement
6. Standardization of investor complaints lodged with SEBI against
companies
Global Outlook
Rapid developments in the realm of global financial markets has prompted
the SEBI to initiate steps for the faster integration of the Indian securities
market with the rest of the world. Accordingly, FIIs have been permitted to
invest in all types of securities including government securities. Similarly,
Indian companies have been permitted to raise resources from abroad
through issue of ADRs, GDRs, FCCRs and ECBs. In the same manner,
Indian stock exchanges have been permitted to set up trading terminals
abroad and trading platform of Indian exchanges are now accessed through
internet from anywhere in the world.
As an active and leading member of the International Organization of

Securities Commission (IOSCO), the SEBI has been making all efforts to
harmonize SEBI regulations and guidelines with IOSCO’s principles of
securities’ regulations. This was designed to conform to global standards.
On the basis of the IOSCO’s 30 principles of securities’ regulations, the
SEBI has devised its own principles aimed at protection of investors,
ensuring that markets are fair, efficient and transparent, and reduction of
systematic risk. The eight categories of principles formulated by the SEBI
are as follows:
1. Principles relating to the regulator
2. Principles of self-regulation
3. Principles for the enforcement of securities regulations
4. Principles for cooperation in regulation
5. Principles of issue
6. Principles for market intermediaries
7. Principles for the secondary market
Improving Operational Efficiency
An important requirement for the efficient functioning of the capital market
is the efficient functioning of the market participants. In this regard, SEBI
has undertaken a number of measures aimed at improving the operational
and informational efficiency in the market. This has helped the participants
to carry out transactions in a cost-effective manner by providing full,
relevant, accurate and timely information.
A number of checks and balances have been built up to ensure the
desired level of investor protection, enhance their confidence and avoid
systematic failure of the market. Allowing contestability of the market and
imposing entry criteria for issuers and intermediaries have ensured stability
of the system as a whole. Prudential controls on intermediaries have
facilitated the financial integrity of the market. For instance, code of conduct
for the intermediaries as prescribed in the regulations, capital adequacy
and other norms, a system of monitoring and inspecting their operations
instituted to enforce compliance and initiating disciplinary actions against
the delinquent intermediaries are some of the measures aimed at improving
the operational efficiency of the market participants in the securities market.
SEBI has been making consistent endeavors to promote a market,
which is both efficient and fair, and also protects the interests of investors.
Dematerialization and the rolling settlements are the major steps taken by
the SEBI for improving and modernizing the markets. The dematerialization
system introduced by the SEBI is one of the far-reaching steps. The
process aims at eliminating physical paper and thereby helping in the

reduction of the work on the clearing houses, the registrar to issue and
share transfer agents. It has also helped overcome many of the handicaps
faced under the traditional paper-based system, namely hand delivery
bargains, negotiated trades without price bands, etc.
The system called for elimination or modification of these practices
with a view to improving the market microstructure, provide for increased
transparency, efficient price discovery and curb unhealthy market practices
so as to improve investor confidence. The efforts taken by the players
such as depositories, registrars and share transfer agents in the ‘demat’
system has greatly helped reducing delays and hardships to the investors.
The Rolling Settlement System was introduced by the SEBI in respect
of demat shares in order to enhance the liquidity of the market. This
mechanism has greatly helped integrate Indian markets with the best global
practices and made them more attractive for foreign investors. In fact, the
introduction of rolling settlement proved to be a turning point in the history
of Indian capital market. The system provides many benefits to corporate
entities such as better price realization, decline in speculative activities
leading the share prices to reflect its intrinsic value based on medium-term
and long-term prospects of the company, etc. It has also helped the
exchanges, brokers, fund managers and FIIs in their transactions in
securities.
Screen Based Trading
A landmark development that took place in the history of the SEBI was the
initiative taken by it to constitute the OTCEI (Over The Counter Exchange
of India) in the year 1992 and the National Stock Exchange (NSE) in the
year 1994. The Exchange allowed for transparency in the securities dealings
made possible through the screen-based trading. Under this mechanism,
information regarding quotations for securities, the prices of transactions
and volume of those transactions is made publicly available promptly
after each transaction or quotation.
This electronic form of trading that has gained acceptance
internationally as a highly transparent, cost efficient and faster mode for
executing trades has been greatly contributing to the development of the
Indian securities market. SEBI initiated steps to ensure that all the stock
exchanges in the country introduce electronic trading system and automate
their operations. As a result, the open-outcry system of trading which was
prevalent in the stock exchanges in the country till a few years ago is
being gradually replaced by computerized trading. SEBI has also
contributed to further modernization of the trading system by permitting

internet trading under order routing system in a limited way through
registered stockbrokers on behalf of clients for execution of trades on
recognized stock exchanges.
REVIEW QUESTIONS
Section A
1. Name the committee that recommended the setting up of the
SEBI.
2. State the features of the SEBI bill.
3. How is SEBI managed?
4. State the purpose of regulatory role played by the SEBI.
Section B
1. State the need for setting up the SEBI.
2. What are the objectives of SEBI? Explain.
3. What are the powers vested with the SEBI to regulate stock
exchanges in India?
4. State the powers of the SEBI with regard to action initiated
against. the erring market intermediaries.
5. How is SEBI empowered of adjudication?
6. What are the steps taken by the SEBI to build investor confidence?
7. Evaluate the role of SEBI on improving the operational efficiency
of the Indian capital market.
8. Identify the measures initiated by the SEBI to promote screen
based trading in India.
Section C
1. What are the powers and functions of SEBI? Discuss elaborately.
2. Examine the role and the relevance of the SEBI in the context of
regulating the functions and working of the stock exchanges in
India.
Chapter 7
Investor Protection
The term ‘investor protection’ refers to methods and measures adopted

by a market regulator like the SEBI, SEC, etc. with a view to safeguard the
interest of investor. Investors, especially small investors constitute an
important segment of the Indian stock market. The developments in the
stock market do affect the sentiments of these investors. In turn, the
sentiments of small investors also affect the stock market. Hence, protecting
and promoting their interest is of paramount importance for the efficient
growth of the capital market.
All the stock exchanges in India have put in place adequate measures
of protection for the benefit of small investors. In addition, the government,
regulatory authority, and SEBI have initiated several steps towards
strengthening the position of small investors.
LOSS OF CONFIDENCE OF SMALL INVESTOR—CAUSES

Although small investors (defined by the SEBI, as a person who holds a
small number of shares in different companies, a minimum of hundred
shares of Rs. 10 each for a considerable time, looking for capital appreciation
of his holdings, and disinvests his holdings only when he needs to meet
a huge amount of expenditure for ceremonies like marriage of his children
etc and defined under Section 252 of the Companies Act as a person
holding shares of nominal value of Rs. 20,000 or less in a public company)
are supposed to be protected both by the SEBI and the Companies Act,
keeping in view the need for promoting and developing the regulation of
the securities market, there has been noticed a terrible loss of confidence
in them. This could be attributed to the following factors:
Failing Mutual Funds
Many of the mutual funds in India are in doldrums. The measures of
liberalization and the concerted and conscious efforts of the government
and SEBI to drive the small investor towards mutual funds have met with
little success. Mutual funds have failed to come up to the expectations of
the small investors, since the investors never got a consistent return on
their investments. All these have resulted in the diversion of savings to
other avenues such as bank deposits. A major complaint against the mutual
funds is that they are not delivering the goods as advertised by them. The
security and service offered by the mutual funds are far from satisfactory.
Private P lacement
The private placement route often chosen by the corporate sector with
banks, financial institutions and high net worth individuals, has belied
the hopes of innumerable small investors for an affordable capital market
investment. Many corporate enterprises adopt this route because of the
negligible cost involved in raising the money. To the extent the amount is
raised through private placement, the small investor is denied the
opportunity of subscribing to the issues in the capital market. This
handicap is sought to be removed by an amendment to Section 67 of the
Companies (Amendment) Act, 2000 whereby the issuer is expected to
offer to public a minimum of 50 percent of the issue.
Dematerialization
The recent provisions of the Depositories Act and the regulations of the
SEBI require that the securities are demated and kept with the Depository.
This process has contributed to enormous costs of dematerialization and
safekeeping to investors. The compulsory dematerialization by the
investors before selling their securities has caused considerable
consternation among the small investors.
Lack of Corporate Interest
The amount of regulations regarding listing etc clamped on the issuers by
the SEBI has created hurdles in the way of entrepreneurs tapping the
capital market. Some of the demanding regulations include more and more
disclosure requirements insisted upon by SEBI, the tightening of the clauses
of the listing agreements, code of Corporate Governance, etc. Moreover,
financial institutions and banks do not insist on the company to be a listed
one in order to extend long-term finances.
Delisting by MNCs
Small investors are crippled of their ability and deprived of an opportunity
to make investment of funds in the highly profit making MNCs. This is
because many of the foreign companies operating in India are either
incorporated as wholly owned subsidiaries or indulge in buy-back of the
shares from the public. This process reduces the public float in the capital
Invest or Protect i on 141
market. Further, this has created a roadblock in the development of the

capital market and works against the interest of small investor.
Book-building
The recently introduced ‘book-building’ process is considered to be highly
pernicious for small investors. The mechanism allows for setting the issue
price at unreasonably high levels. This has greatly affected the interest of
common investors. Such a price discovery practice often goes unrealistic
as the market price immediately after the issue nosedives much below the
issue price. Hence, the public is not enamored at all by the fanciful price
fixed by this process.
Takeover and Buy-back
The buy-back mechanism introduced by the Companies Act, 1999, paved
way for promoters acquiring the shares easily and cheaply. This has in
turn reduced the quantum of floating stock in many well-managed
companies in the stock market. The capital market developments are much
in tune with the interest of the promoters than in tune with protecting the
investors’ interests.
RIGHTS OF INVESTORS
1. To receive all benefits/material information declared for the
investors’ by the company
2. To obtain prompt services from the company such as transfers,
subdivisions and consolidation of holdings in the company
3. To subscribe to further issue of capital by the company in the
case of existing equity shareholders
4. To pay a maximum brokerage of 2.5 percent of the contract price
5. To receive the contract note from the broker in the specified
format showing transaction price and brokerage separately
6. To obtain delivery of shares purchased/value of shares sold within
2 days after the payout day
FACILITIES BY BSE
The Bombay Stock Exchange (BSE), Mumbai, is the forerunner and the
pioneer in the realm of providing several facilities for the benefit of investors
as shown below:
Investor’s Service Cell
Protecting the interest of investors dealing in securities is one of the main
objectives of the exchange. In pursuit of this objective, Bombay Stock
Exchange (BSE) set up an Investors’ Services Cell (ISC) in 1986. The

grievances of investors against listed companies and members of the
exchange are redressed by the exchange. The exchange also assists in the
arbitration process both between members and investors. The capital market
can grow, only when the investors’ find it safe for them to invest in the
capital market and only if they are assured that the rules governing the
market are fair and just to all the players in the market.
With a view to ensure speedy and effective resolution of claims,
differences, and disputes between non-members, the exchange has laid
down a set of procedures for arbitration thereof. These procedures are
embodied in the rules, bye-laws and regulations of the exchange, which
have been duly approved by the Government of India/Securities and
Exchange Board of India (SEBI).
Safeguards fo r Investors’
Some of the safeguards that need to be adhered to by the investors’
before trading in the securities market are as follows:
1. Selecting the broker/ sub-broker Investors should deal with only
SEBI registered broker/sub-broker after due diligence. Details of list of
brokers can be procured from the member’s list published by the Exchange
and also from the website of the exchange.
2. Formal agreement An investor is expected to enter into a formal
agreement with the broker before transacting business. For this purpose,
he is advised to scrupulously adhere to the following procedures:
a. Registration Fill in a client registration form with
broker/sub-broker
b. Agreement Enter into broker/sub-broker-client agreement. This
agreement is mandatory for all investors for registering as a client
of a BSE trading member. Before entering into agreement, the
client is expected to carefully read and understand the terms and
conditions of the agreement. Similarly, the agreement shall be
executed on a valid stamp paper of the requisite value. The client
and the member or their representative who has the authority to
sign the agreement shall sign the agreement on all the pages.
Agreement has also to be signed by witnesses too, by giving
their name and address
3. Transacting business The following are to be borne in mind by the
investor before transacting business:
a. Specifying exchange Specify to the broker/sub-broker,
exchange through which your trade is to be executed and maintain
separate account per exchange
b. Contract note Obtain a valid Contract Note (from Broker)/

Confirmation Memo (from sub-broker) within 24 hours of the
execution of the trade. Contract note is a confirmation of trade(s)
done on a particular day for and on behalf of a client in a format
prescribed by the exchange. It establishes a legally enforceable
relationship between the member and client in respect of
settlement of trades executed on the exchange as stated in the
contract note. Contract notes are made in duplicate, and the
member and the client keep one copy each. The client is expected
to sign on the duplicate copy of the contract note for having
received the original
1. Contract Note—Form ‘A’ issued where member is acting
for constituents as brokers and agents
2. Contract Note—Form ‘B’ issued by members dealing with
constituents as principals
3. Confirmation memo—Form ‘C’ issued by registered sub-
brokers acting for clients/constituents as sub-brokers
The investor should ensure that the contract note/confirmation memo
contains such details as SEBI registration number of the member/sub-
broker. Further, such details of trade as, order number, trade number, trade
time, quantity, price, brokerage, settlement number and details of other
levies must also be mentioned. The trade price should be shown separately
from the brokerage charged.
4. Brokerage As stipulated by SEBI, the maximum brokerage that can
be charged is 2.5 percent of the trade value. This maximum brokerage is
inclusive of the brokerage charged by the sub-broker (Sub-brokerage
cannot exceed 1.5 per cent of the trade value). Any additional charges that
the member can charge are service tax @5 percent of the brokerage and
any penalties arising on behalf of the client (investor).
The brokerage and service tax is indicated separately in the contract
note. Signature of authorized representative in the arbitration clause, stating
that the trade is subject to the jurisdiction of Mumbai, must be present on
the face of the contract note.
5. Ensuring settlement Following are the procedures to be followed
by investors for ensuring smooth settlement:
a. Delivery Delivery of securities/payment of money to the broker
is to be ensured immediately upon getting the contract note for
sale/purchase but in any case, before the prescribed pay-in-day.
The Member should pay the money or deliver the securities to

the investor within 48 hours of the payout
b. Demat account Open demat account. Preferably opt for buying
and selling demated securities
c. Depository participant (DP) For delivery of shares from Demat
a/c, give the Depository Participant (DP) ‘Delivery out’
instructions to transfer the same from the beneficiary account to
the pool account of broker through whom shares and securities
have been sold. The details such as the pool account of broker to
which the shares are to be transferred, details of scrip, quantity
etc. As per the requirements of depositories the delivery out
instruction should be given at least 48 hours prior to the cut-off
time for the prescribed securities pay-in
For receiving shares in the Demat account, give the
Depository Participant (DP) ‘Delivery in’ instructions to accept
shares in beneficiary account from the pool account of broker
through whom shares have been purchased
6. Delivery If physical deliveries are received, check the deliveries
received as per good/bad delivery guidelines issued by SEBI. Bad delivery
cases should be sorted out through exchange machinery immediately. All
registration of shares for ownership of physical shares should be executed
by a valid, duly completed and stamped transfer deed.
General Do’s and Don’ts for Investors
1. Not to deal with unregistered intermediaries which might expose
to counter party risk
2. To give clear and unambiguous instructions to broker/sub-broker
3. To keep a record of all instructions issued to the broker/
sub-broker
4. To confirm with the broker/sub-broker whether delivery is in
physical or demat form before selling shares
5. Not to fall prey to promises of unrealistic high returns
6. Not to indulge in speculative trading but to go by the fundamentals
only
7. To trade within the predetermined limits
8. To use the Investors’ Grievance Redressal system of the
exchanges to redress grievances, if any
9. To understand the working of the Investor Service Cell for

complaint against listed companies/brokers, and
10. To preferably trade personally through Internet based trading by
registering with a broker
So lv i n g In v es to r s G r ie v a n ce s —P r o c e s s
BSE has established a full-fledged Investors’ Services Cell (ISC) to redress

investor’s grievances. Since its establishment in 1986, the cell has played
a pivotal role in enhancing and maintaining investors’ faith and confidence
by resolving their grievances either against listed companies or against
Members of the Exchange. The services offered by the ISC are as under:
1. Grievan c es again s t lis ted c ompan ies ISC forwards the
complaints to the respective company and directs them to solve the matter
within 15 days. In spite of the above efforts, if the company fails to resolve
the complaints and the total number of pending complaints against the
company exceeds 25 and are pending for more than 45 days, after issue of
show cause notice for 7 days, the scrip of the company is suspended from
trading till grievances are resolved. ISC also transfers such scrip to ‘Z’
category for non-resolution of investors’ complaints.
Measures ISC takes many other pro-active measures to resolve the

investor’s grievance such as the following:
1. Calling the company representative to the exchange to interact
with investor’s/members to resolve the complaints
2. Calling major registrar and transfer agent to the Exchange to
interact and resolve the grievances of the investor’s and members
of the exchange
3. Issuing monthly press release listing top 25 companies against
whom maximum complaints are pending for resolution. The same
is also released on the website of the exchange
4. Pursuing Mumbai based companies to depute their
representative to the exchange to take the pending list of
complaints and resolve the same immediately
2. Grievances against members
Nature of complaints The nature of complaints received by the exchange
can be broadly classified into the following categories:
a. Non-receipt of delivery of shares/Non- removal of objection/

Non-receipt of sale proceeds of shares/ Non-receipt of dividend/
Non-receipt of Rights, Bonus shares
b. Disputes regarding rate difference
c. Disputes relating to non-settlement of accounts
d. Miscellaneous items
Procedures The complaints are forwarded to the concerned members to
reply/settle the complaints within 7 days from the receipt of the letter. If no
reply is received or reply received is not satisfactory, the matter is placed
before the IGRC (Investor’s Grievance Redressal Committee) headed by a
retired high court judge. IGRC is constituted by the governing board to
resolve the complaints of non-members against members through the
process of reconciliation. The parties are heard and the matter is tried to be
solved amicably or it is referred for arbitration under the rules, bye-laws
and regulations of the exchange.
3. Arbitration The investors complaints referred by IGRC can be against
the (i) active members of the exchange as well as the (ii) defaulter-members
of the exchange. The process of solving the investors complaints through
the arbitration procedure is as mentioned below:
a. Arbitration committee For the purpose of resolution of
grievances between investors and member-brokers, the exchange
has constituted an arbitration committee with the approval of
SEBI. The non-member arbitration panel consists of retired High
Court and City Civil Court Judges, Chartered Accountants,
Company Secretaries, Solicitors and other professionals having
in-depth knowledge of the capital market
b. Filing supporting documents On receiving the direction for
arbitration from the IGRC, the complainant (applicant) files
relevant supporting documents for arbitration. A set of the
arbitration documents is sent to the other party (respondent) for
giving his counter reply
c. Hearing After completion of the formalities, the matter is fixed
for hearing before arbitrators. For claims less than Rs. 10 lakhs,
the applicant has to propose the name of three arbitrators and
the respondent(s) has/have to give consent of or the name of
one of the arbitrators. In case the respondent(s) does/do not
give consent on the arbitrator, the exchange appoints the arbitrator
to adjudicate the matter. For claims above Rs. 10 lakhs, a panel of
three arbitrators, one each to be appointed by the applicant(s)
and respondent(s) and the presiding arbitrator has to be appointed

by the exchange to adjudicate the matter
The date for hearing is fixed and the concerned parties are informed
about the date through notices. After hearing both the parties and taking
the submissions and the documents on record, the arbitrator(s) close the
reference and the award (decision) is given.
4. Appeal If the applicant is not satisfied with the award he can appeal
against the same in the exchange within 15 days of its receipt. The appeal
bench of five arbitrators hears the matter and gives the award. However,
the aggrieved party has to deposit the awarded amount given by the
Arbitral Tribunal with the exchange unless and until the appeal bench
exempts it partly or wholly. If the award is in favor of the applicant, the
active member has to abide by the decision. If he fails to abide by the
award, the Disciplinary Action Committee (DAC) takes necessary action
against him. The award becomes a decree after 3 months from the date on
which it is given and can be executed as a court decree through a competent
court of jurisdiction. The same can be challenged only in the High Court of
Judicature, Mumbai.
5. Arbitration proc ed ure again st defaulter member of the
exchange Any complaint against defaulter-member of the exchange
can directly be filed in arbitration. However, the same has to be filed within
6 months from the date of declaring the member as defaulter by the
exchange. The rest of the process is the same as above.
An award obtained against a defaulter-member is scrutinized by the
Defaulters Committee (DC), a standing committee constituted by the
exchange, to ascertain their genuineness, etc. The awarded amount or
Rs. 10 lakhs whichever is lower is paid from the Customer’s Protection
Fund (CPF). After the approval of the DC and Trustee of CPF, the amount
is distributed to the clients who have obtained the award against
defaulter-member.
Investor’s or Customer’s Protection Fund
BSE is the first exchange to have set up the ‘Stock Exchange Customer’s
Protection Fund’ in the interest of the customers of the defaulter members
of the exchange. This fund was set up on 10th July, 1986 and has been
registered with the Charity Commissioner, Government of Maharashtra as
a Charitable Fund. BSE is the only exchange in India, which offers the
highest compensation of Rs. 10 lakhs in respect of the approved claims of
any investor against the defaulter members of the exchange. The members
at present contribute Rs. 1.50 per Rs. 10 lakhs of turnover. The stock
exchange contributes 2.5 percent of the listing fees collected by it. Also
the entire interest earned by the exchange on 1 percent security deposit
kept with it by the companies making public/rights issues is credited to
the Fund.
Trade Guarantee Fund
In order to introduce a system of guaranteeing settlement of trades and
ensuring that market equilibrium is maintained in case of payment default
by the Members, the Trade Guarantee Fund was constituted and it came
into force with effect from May 12, 1997. The main objectives of the fund
are as given below:
Settlement To guarantee settlement of bona fide transactions of
members of the exchange which form part of the stock exchange settlement
system, so as to ensure timely completion of settlements of contracts and
thereby protect the interest of Investors and the members of the exchange.
Confidence To inculcate confidence in the minds of secondary market
participants generally and global investors’ particularly, to attract larger
number of domestic and international players in the capital market.
Protection To protect the interest of investors’ and to promote the
development of and regulation of the secondary market.
The Fund is managed by the Defaulters’ Committee, which is a
standing Committee constituted by the exchange, the constitution of which
is approved by SEBI.
In ves to r A war ene ss Pr ogr am
Investor awareness programs are being regularly conducted by BSE to
educate the investors and to create awareness among them regarding the
working of the capital market and in particular the working of the stock
exchanges. These programs have been conducted in Gujarat, Kerala, Tamil
Nadu, Uttar Pradesh, Rajasthan, Punjab, Haryana and within Maharashtra.
The investor awareness program covers extensive topics like
Instruments of Investment, Portfolio Approach, Mutual Funds, Tax
Provisions, Trading, Clearing and Settlement, Rolling Settlement, Investors’
Protection Fund, Trade Guarantee Fund, Dematerialization of shares,
information on Debt Market, Investors’ Grievance Redressal system
available with SEBI, BSE and Company Law Board, information on Sensex
and other Indices, workshops and Information on Derivatives, Futures
and Options, etc.
Other Facilities
In addition to the above, the BSE offers the other facilities for the benefit
of the investors:
BSE training institute The institute organizes Investor Education
programs periodically on various subjects like comprehensive program on
Capital Markets, Fundamental Analysis, Technical Analysis, Derivatives,
Index Futures and Options, Debt Market, etc. Further, for the derivatives
market, BSE also conducts the compulsory BCDE certification for members
and their dealers to impart basic minimum knowledge of the derivatives
markets.
BSE’s official website The site serves as the focal point for information
dissemination and updates investors with the latest information on stock
markets on a daily basis through real time updation of statistical data on
market activity, corporate information and results. Educative articles on
various products and processes are also available on the site. BSE regularly
comes out with publication for investor education on various products
and processes like quick reference guide for investors, etc.
OMBUDSMAN
Genesis
The scheme of Ombudsman has been provided for under the SEBI
(Ombudsman) Regulations, 2003 and under subsection 1 of section 11 of
the SEBI Act. The purpose is to redress the grievance of the investors in
securities and for matters connected therewith or incidental thereto.
Definition
According to the SEBI, the term “Ombudsman” means any person
appointed under regulation 3 of the SEBI (Ombudsman) Regulations, 2003
and unless the context otherwise requires, includes Stipendiary
Ombudsman.
“Stipendiary Ombudsman” means a person appointed under
regulation 9 for the purpose of acting as ombudsman in respect of a specific
matter or matters in a specific territorial jurisdiction and for which he may
be paid such expenses, honorarium or sitting fees as may be determined
by the Board from time to time.
Eligibility for Ombudsman
In order to be appointed as an Ombudsman a person shall be:
1. A citizen of India
2. Of high moral integrity
3. Not below the age of 45 years of age, and

4. Either
• A retired District Judge or qualified to be appointed a District
Judge, or
• Having at least ten years experience of service in any
regulatory body, or
• Having special knowledge and experience in law, finance,
corporate matters, economics, management or administration
for a period not less than ten years, or
• An office bearer of investors’ association recognized by the
Board having experience in dealing with matters relating to
investor protection for a period not less than 10 years
Disqualification for Ombudsman
A person shall not be qualified to hold the office of the Ombudsman if he:
1. Is an un-discharged insolvent
2. Has been convicted of an offence involving moral turpitude
3. Has been found to be of unsound mind and stands so declared
by a competent court
4. Has been charge sheeted for any offence including economic
offences, or
5. Has been a whole-time director in the office of an intermediary or
a listed company and a period of at least 3 years has not elapsed
Eligibility for Stipendiary Ombudsman
A person shall be eligible to be appointed as Stipendiary Ombudsman
who:
1. Has held a judicial post or an executive office under the Central
or State Government for at least ten years, or
2. Is having experience of at least ten years in matters relating to
consumer or investor protection, or
3. Has been a legal practitioner in corporate matters for at least 10
years, or
4. Has served for a minimum period of 10 years in any public financial
institution within the meaning of section 4A of the Companies
Act, 1956 (1 of 1956) or a regulatory body
Powers and Functions of Ombudsman
General The Ombudsman shall have the following powers and
functions:
a. To receive complaints specified in regulation 13 against any

intermediary or a listed company or both
b. To consider such complaints and facilitate resolution thereof by
amicable settlement
c. To approve a friendly or amicable settlement of the dispute
between the parties
d. To adjudicate such complaints in the event of failure of settlement
thereof by friendly or amicable settlement
Other powers and functions The Ombudsman shall
a. Draw up an annual budget for his office in consultation with the
Board and shall incur expenditure within and in accordance with
the provisions of the approved budget
b. Submit an annual report to the Board within three months of the
close of each financial year containing general review of activities
of his office, and
c. Furnish from time to time such information to the Board as may
be required by the Board
Procedure for Redressal of Grievance
1. Grounds of complaint A person may lodge a complaint on any
one or more of the following grounds either to the Board or to the
Ombudsman concerned:
a. Non-receipt of refund orders, allotment letters in respect of a
public issue of securities of companies or units of mutual funds
or collective investments schemes
b. Non-receipt of share certificates, unit certificates, debenture
certificates, bonus shares
c. Non-receipt of dividend by shareholders or unit-holders
d. Non-receipt of interest on debentures, redemption amount of
debentures or interest on delayed payment of interest on
debentures
e. Non-receipt of interest on delayed refund of application monies
f. Non-receipt of annual reports or statements pertaining to the
portfolios
g. Non-receipt of redemption amount from a mutual fund or returns
from collective investment scheme
h. Non-transfer of securities by an issuer company, mutual fund,
Collective Investment Management Company or depository
within the stipulated time
i. Non-receipt of letter of offer or consideration in takeover or

buy-back offer or delisting
j. Non-receipt of statement of holding corporate benefits or any
grievances in respect of corporate benefits, etc
k. Any grievance in respect of public, rights or bonus issue of a
listed company
l. Any of the matters covered under section 55A of the Companies
Act, 1956
m. Any grievance in respect of issue or dealing in securities against
an intermediary or a listed company
2. Pr oc ed ure of fi lin g c om plai n t Any person who has a
grievance against a listed company or an intermediary, may himself or
through his authorized representative or any investors association
recognized by the Board, shall make a complaint against a listed company
or an intermediary to the Ombudsman within whose jurisdiction the
registered or corporate office of such listed company or intermediary is
located. The complaint shall be in writing, duly signed by the complainant
or his authorized representative.
However, there shall be no complaint made to the Ombudsman:
a. Where the complainant had, before making a complaint to the
Board or the Ombudsman concerned, made a written
representation to the listed company or the intermediary named
in the complaint and the listed company or the intermediary, as
the case may be, had rejected the complaint or the complainant
had not received any reply within a period of one month after the
listed company or intermediary concerned received his
representation or the complainant is not satisfied with the reply
given to him by the listed company or an intermediary
b. Unless the complaint is made within six months from the date of
the receipt of communication of rejection of his complaint by the
complainant or within seven months after the receipt of complaint
by the listed company or intermediary under clause (a) above
c. If the complaint is in respect of the same subject matter which
was settled through the Office of the Board or Ombudsman
concerned in any previous proceedings, whether or not received
from the same complainant or along with any one or more or
other complainants or any one or more of the parties concerned
with the subject matter
d. If the complaint pertains to the same subject matter for which any
proceedings before the Board or any court, tribunal or arbitrator
or any other forum is pending or a decree or award or a final order

has already been passed by any such competent authority, court,
tribunal, arbitrator or forum
e. If the complaint is in respect of or pertaining to a matter for which
action has been taken by the Board under section 11(4) of the
Act or Chapter VI A of the Act or under subsection (3) of section
12 of the Act or under any other regulations made under the Act
3. Power to call for information For the purpose of carrying out his
duties under these regulations, an Ombudsman may require the listed
company or the intermediary named in the complaint or any other person,
institution or authority to provide any information or furnish certified
copy of any document relating to the subject matter of the complaint
which is or is alleged to be in its or his possession. If the information is not
provided, the ombudsman would draw the inference that the information if
provided or copies if furnished, would be unfavorable to the listed company
or intermediary.
The Ombudsman shall maintain confidentiality of any information or
document coming to his knowledge or possession in the course of
discharging his duties and shall not disclose such information or document
to any person except and as otherwise required by law or with the consent
of the person furnishing such information or document, unless warranted
by compliance with the principles of natural justice and fair play in the
proceedings.
4. Settlement by mutual agreement As soon as it may be practicable
so to do, the Ombudsman shall cause a notice of the receipt of any
complaint along with a copy of the complaint sent to the registered or
corporate office of the listed company or office of the intermediary named
in the complaint, and endeavor to promote a settlement of the complaint
by agreement or mediation between the complainant and the listed company
or intermediary named in the complaint. If any amicable settlement or
friendly agreement is arrived at between the parties, the Ombudsman shall
pass an award in terms of such settlement or agreement within one month
from the date thereof and direct the parties to perform their obligations in
accordance with the terms recorded in the award. For the purpose of
promoting a settlement of the complaint, the Ombudsman may follow such
procedure and take such actions, as he may consider appropriate.
5. Award on adjudication In the event of the matter not being resolved
by mutually acceptable agreement within a period of one month of the
receipt of the complaint or such extended period as may be permitted by
the Ombudsman, he shall, based upon the material placed before him and
after giving opportunity of being heard to the parties, give his award in
writing or pass any other directions or orders as he may consider
appropriate. Ombudsman shall make the award on adjudication within a
period of three months from the date of the filing of the complaint. The
Ombudsman shall send his award to the parties to the adjudication to
perform their obligations under the award.
6. Evidence act not to apply In proceedings before the Ombudsman,
strict rules of evidence under the Evidence Act, shall not apply and the
Ombudsman may determine his own procedure in consistent with the
principles of natural justice. Ombudsman shall decide whether to hold oral
hearings for the presentation of evidence or for oral argument or whether
the proceeding shall be conducted on the basis of documents and other
materials. It shall not be necessary for an investor to be present at the oral
hearing of proceedings under these regulations and the Ombudsman may
proceed on the basis of the documentary evidence submitted before him.
No legal practitioner shall be permitted to represent the defendants or
respondents at the proceedings before the Ombudsman except where a
legal practitioner has been permitted to represent the complainants by the
Ombudsman.
7. Finality of award Subject to the provisions of this regulation, an
award shall be final and binding on the parties and persons claiming under
them respectively. Any party aggrieved by the award on adjudication
may, within one month from the receipt of the award, file a petition before
the Board setting out the grounds for review of the award. The Board may
review an award only if there is substantial miscarriage of justice, or there
is an error apparent on the face of the award.
Where a petition for review of the award under sub-regulation (2) is
filed by a party from whom the amount mentioned in the award is to be
paid to the other party in terms of the award, such petition shall not be
entertained by the Board unless the party filing the petition has deposited
with the Board seventy five percent of the amount mentioned in the award.
The Board may review the award and pass such order, as it may deem
appropriate. The Board shall endeavor to dispose of the matter within a
period of forty-five days of the filing of the petition for review.
The award passed by the Ombudsman shall remain suspended till the
expiry of period of one month for filing review petition or till the review the
Board disposes off petition. The party so directed shall implement the
award within 30 days of receipt of the order of the Board on review or
within such period as may be specified by the Board, in the order disposing
off the review petition. The Board may determine its own procedure
consistent with principles of natural justice in the matter of disposing of
review petition, and may dismiss the petition if it does not satisfy any of
the grounds specified in sub-regulation (3).
8. Cost and interest The Ombudsman or the Board, as the case may
be, shall be entitled to award reasonable compensation along with interest
including future interest till date of satisfaction of the award at a rate,
which may not exceed one percent per month. The Ombudsman in the
case of an award, or the Board in the case of order passed in petition for
review of the award, as the case may be, may determine the cost of the
proceedings in the award and include the same in the award or as the case
may be, in the order. The Ombudsman or the Board may impose cost on
the complainant for filing complaint or any petition for review, which is
frivolous.
9. Non-implementation The award shall be implemented by the party
so directed within one month of receipt of the award from the Ombudsman
or an order of the Board passed in review petition or within such period as
specified in the award or order of the Board. If any person fails to implement
the award or order of the Board passed in the review petition, without
reasonable cause:
a. He shall be deemed to have failed to redress investors’ grievances
and shall be liable to a penalty under section 15C of the Act
b. He shall also be liable for an action under section 11 (4) of the
Act; or suspension or delisting of securities; or being debarred
from accessing the securities market; or being debarred from
dealing in securities; or an action for suspension or cancellation
of certificate of registration; or such other action permissible
which may be deemed appropriate in the facts and circumstances
of the case
Display of the Particulars
Every listed company or intermediary shall display the name and address
of the Ombudsman as specified by the Board, to whom the complaints are
to be made by any aggrieved person in its office premises in such manner
and at such place, so that it is put to notice of the shareholders or investors
or unit holders visiting the office premises of the listed company or
intermediary. The listed company or intermediary in its offer document or
clients agreement shall give full disclosure about the grievance redressal
mechanism through Ombudsman under these regulations. Any failure to
disclose the grievance redressal mechanism through Ombudsman under

sub-regulation (2) or any failure to display the particulars as per sub-
regulation (1) shall attract the penal provisions contained in section 15A
of the Act.
REVIEW QUESTIONS
Section A
1. What does ‘investor protection’ constitute?
2. State the rights of an investor.
3. Write a note on the ‘investor protection fund’ constituted by the
BSE.
4. What do you know of ‘trade guarantee fund’?
5. What do you know of the ‘investor awareness program’ organized
by the BSE?
Section B
1. Analyze the causes for the loss of confidence of small investors.
in the Indian capital market witnessed in the late nineties.
2. What are the facilities offered by the BSE for the protection of
investor interest?
3. State the some of the general do’s and don’ts for investors.
4. Explain the process of solving the grievances of investors as
adopted by the BSE.
5. Explain the working of the ‘ombudsman’ set up by the SEBI for
the protection of investors.
Se ctio n C
1. What are the safeguards offered by the BSE to investors as
regards trading of securities?
2. What are the powers and functions of ombudsman’ set up by the
SEBI for the protection of investors.
3. Outline the procedure involved in the redressal of grievances of
investors.
Chapter 8
Insider Trading
The set of all unhealthy and manipulative dealings and practices indulged
in by persons, who are in better know of internal affairs of the companies
is known as ‘insider trading’. SEBI takes appropriate and necessary steps
to curb and to prohibit such unfair and unethical practices so as to protect
investor interest.
RATIONALE
Although insider trading is the bane of modern stock market trends,
corporates often indulge in them for the following reasons:
1. Benefiting the company through unethical purchase and sale of
the company’s shares by withholding price sensitive information
2. Benefiting the individual indulging in this unethical practice
INSIDERS—CATEGORIES
Insiders are the persons, who have connection with the company in such
a way as to have access to price sensitive information. It includes any
person who is or was connected with the company or is deemed to have
been connected with the company and is reasonably expected to have
access, by virtue of such connection, to unpublished price sensitive
information in respect of securities of the company, or who has received or
has had access to such unpublished price sensitive information.
The various categories of insiders who indulge in manipulative
practices in stock market operations are as follows:
Primary Insiders
These insiders include directors of corporates and stock exchanges,
merchant bankers, registrars, brokers of the company, top executives,
auditors, banks, etc.
Secondary Insiders
These include dealers, agents and other employees having access to price
sensitive information due to their proximity with the company.
INSIDER INFORMATION
For the purpose of describing insider trading, the term ‘insider information’
means any unpublished price sensitive information. This implies any
information which is not yet made known, and which, when accessed will
either directly or indirectly is likely to materially affect the price of securities
of that company in the market. The following unpublished information can
be considered as price sensitive:
1. Financial results (both half-yearly and annual) of the company
2. Intended declaration of dividends (both interim and final)
3. Issue of shares by way of public rights, bonus, etc
4. Any major expansion plans or execution of new projects
5. Amalgamation, mergers and takeovers
6. Disposal of the whole or substantially the whole of the
undertaking
7. Any other information as may affect the earnings of the company
8. Any changes in policies, plans or operations of the company
CONNECTED PERSONS
Connected persons mean and include the following:
1. Director of the company
2. Person deemed to be director of the company
3. Person occupying the position as an officer or an employee of
the company
4. Person holding a position involving a professional or business
relationship between himself and the company and who may
reasonably be expected to have an access to unpublished price
sensitive information relating to that company
De emed Con nected Persons
A person is deemed to be a connected person under the following
circumstances:
Same Man agement
Where the said person is a company under the same management or
group or any subsidiary company thereof.
Me mber
Where the said person is an official or a member of a stock exchange or of
a clearing house of that stock exchange, or a dealer in securities or any
employee of such member or dealer of a stock exchange.
Insi der Tradi ng 159
Merchant Banker
Where the said person is a merchant banker, share transfer agent, registrar
to an issue, debenture trustee, broker, portfolio manager, investment
adviser, sub-broker, investment company or an employee thereof, or is a
member of the Board of Trustees of a Mutual Fund or a member of the
Board of Directors of the Asset Management Company of a Mutual Fund
or is an employee thereof who has a fiduciary relationship with the
company.
BoDs
Where the said person is a member of the Board of Directors or an employee
of a public financial institution.
SR O
Where the said person is an official or an employee of a Self Regulatory
Organization (SRO) recognized or authorized by the board of a regulatory
body.
Relative
Where the said person is a relative of any of the aforementioned persons.
Banker
Where the said person is a banker of the company.
NEED FOR CONTROL
The need for controlling and reining in the insiders arises on account of
the need for protecting the interest of investors. In addition, curbing this
malicious trading practice will help protect and promote the interest and
reputation of the company, besides helping maintenance of confidence in
stock exchange operations and the financial system as a whole.
PROHIBITION OF INSIDER TRADING
SEBI has come out with the following directions regarding the prohibition
of insider trading:
No Dealing
No individual may either on his own behalf or on behalf of any other
person deal in securities of a company listed on any stock exchange on
the basis of any unpublished price sensitive information.
No Communication
No individual can communicate any unpublished price sensitive
information to any person, with or without his request for such information,
except as required in the ordinary course of business or under any law.
No Counsel
No individual can counsel or procure any other person to deal in securities
of any company on the basis of unpublished price sensitive information.
Penalty
A penalty upto Rs. 5 lakhs can be imposed on an insider who indulges in
dealing, communicating or counselling on matters relating to insider trading
discussed above.
INVESTIGATION BY SEBI
Where SEBI suspects that some persons who are close to the company
administration are indulging in insider trading, it may order for an
investigation to inspect the books of accounts, and other records and
documents of an insider by an investigating authority. SEBI may order
investigations on the basis of the complaints received from investors,
intermediaries or any other person on any matter having a bearing on the
allegations of insider trading. It may also initiate investigations suo-moto
upon knowledge or information in its possession to protect the interest of
investors in securities against breach of these regulations. Besides, it is
also possible for the SEBI to appoint a qualified auditor to investigate into
the books of accounts or the affairs of the insider.
Obligations of Insiders
Where an investigation by SEBI has been ordered, the insiders are
obligated to:
Documents Produce to the investigating authority such books,
accounts and other documents in his custody or control, and furnish the
statements and information relating to the transactions in securities market.
Access Allow investigating authority access to his premises and books,
records, documents, etc required for such investigation, and otherwise
cooperate with investigating authority.
SEBI’s Action
SEBI may, on the basis of investigative report, initiate the following actions
towards curbing the menacing practice of insider trading:
1. Criminal prosecution against the insider, and/ or

2. Giving necessary directions to insiders for protecting the interest
of investors and the securities market, and for due compliance
with the provisions of the SEBI Act, Rules and Regulations, the
directions may prohibit dealing in securities in any particular
manner, may prohibit disposal of any of the securities acquired in
violation of these regulations, and may restrain the insider to
communicate or counsel any person to deal in securities
Internal Code
It is a matter of great satisfaction that SEBI has been making efforts to
prohibit insider trading. Following are some of the measures initiated by
the SEBI in this regard:
Financial institutions Encouraging various financial institutions,
professional bodies and other relevant organizations to develop internal
code of conduct as an effective aid. Such a step would have the effect of
ultimately curbing the menace of insider trading leading to price rigging,
market manipulations and other frauds relating to securities.
Stock exchanges Advising stock exchanges, banks and secondary
market institutions to evolve an ‘internal code of conduct’ which should
lay down internal procedures, and checks and balances for avoiding insider
trading.
Internal control SEBI directly writing to banks, financial institutions,
stock exchanges, mutual funds, merchant bankers and other intermediaries,
and professional bodies, such as, the Institute of Chartered Accountants
of India, Institute of Company Secretaries of India, Institute of Cost and
Works Accountants of India and various Chambers of Commerce and
Industry about the desirability of evolving an internal control for the
purpose. These bodies in turn are expected to formulate procedures and
checks and balances for operations by their members and institutions
which would make a meaningful contribution towards ensuring that their
employees or members, who at times are in possession of unpublished
price sensitive information relating to listed companies, do not use such
information for personal gain through trading in the securities of such
companies.
ACTION BY CORPORATES
SEBI has suggested that companies work out and initiate the following
actions in order to prevent the insiders gaining access to unpublished
information:
Type of Information
Corporates shall initiate action to identify the types of information that
could be considered to be price sensitive in relation to the business of the
company and its subsidiaries, and associate companies. The possible
such price sensitive information may include: earnings forecast or material
changes therein, proposals for mergers and acquisitions, significant
changes in investment plans, acquisition or loss of a significant contract,
significant disputes with major suppliers, consumers or sub-contractors,
significant decision affecting the product pricing, profitability, etc.
Type of Employees
Corporates shall initiate action to identify the types of employees and
officers of the company, who are likely to have access to such price sensitive
information.
Type of Controls
Corporates shall initiate action to identify the types of controls that are
put in place in order to handle the price sensitive information specified
above, so as to publish such information wherever possible. This will help
eliminate the non-public character of such information.
Norms
The corporates may prescribe certain norms to be followed by all officers
and employees of the company in dealing with the company’s own shares.
The norms may include: time periods during which time the company
employees and officers are not to deal in the company’s shares, the time
period for the company employees and officers to wait for the price sensitive
information to be made public before dealing in the company’s shares, the
applicability of these norms to representatives of the financial institutions
as well as other directors on the Board of the Company, etc.
Declaration
Corporates may strive to obtain declaration from employees and officers
including transactions done by the relatives of employees and officers as
relating to purchase and sale of the shares of the company.
Handling Information
Corporates may prescribe necessary procedure for handling information
which is likely to affect the price of the securities of other companies in
situations such as mergers, takeovers, etc.
REVIEW QUESTIONS
Section A
1. Define the term ‘insider trading’
2. Why do corporates often indulge in insider trading practices?
3. Who are ‘primary insiders’?
4. Who are ‘secondary insiders’?
5. Who are ‘connected persons’?
6. Who is a ‘deemed connected person’?
Section B
1. How are insiders categorized? Explain.
2. State the some insider information.
3. Why do you think there is an obvious need for controlling insider
treading?
4. State the obligations of insiders while an investigation is ordered
by the SEBI.
5. Mention the ‘internal code’ introduced by the SEBI for controlling
insider trading.
Section C
1. What are the steps initiated by the SEBI to prevent and control
insider trading?
2. How are corporates responsible to prevent insider trading?
Elucidate.
Chapter 9
Stock Exchange
Stock exchanges contribute in a huge measure to the growth and expansion

of national business and to the ultimate benefit and well-being of the
national economy and its people. They provide an ideal conduit through
which enormous amount of capital flows take place through the
interconnected network of financial organizations to all corporate
enterprises in the country. Stock exchanges ensure liquidity and
transferability of financial assets that are dealt with.
Stock exchanges provide an organized marketplace for the investors
to buy and sell securities freely. The market offers perfectly competitive
conditions where a large number of sellers and buyers participate. Further,
stock exchanges provide an auction market in which members of the
exchange participate to ensure continuity of price and liquidity to investors.
The efficient functioning of the stock exchange is responsible for
creating a conducive climate for an active and growing primary market for
new issues. Moreover, an active and a healthy secondary market in existing
securities leads to a better psychology of expectations, thus, considerably
broadening the investment enquiries and thereby, rendering the task of
raising resources by entrepreneurs easier. In fact, good performance and
outlook for equities in the stock exchanges imparts buoyancy to the new
issue market.
HISTORY OF STOCK EXCHANGES
The first organized stock exchange in India is the Bombay Stock Exchange
(BSE), which was established in 1875. But trading in securities used to
take place much earlier in the 18th century, and share quotations were
published in contemporary newspapers. However, dealings were not
regulated by any code of rules, nor any hours of business prescribed nor
was there any committee to supervise the conduct of members of the
exchange. Dealers congregated under some tree in open fields for the
purpose of transacting business.
The advent of western styled business practices in India in the early

18th century commenced with the establishment of the East India
Company’s office in India. Towards the close of the 18th century, the East
India Company naturally dominated business in securities and loan
transactions. Evidence of the existence of trading in stocks of banks and
certain companies is available in price quotations in contemporary
newspapers. By the 1830s, there was a perceptible rise in the volume of
business in loans of corporate stocks and shares. In 1836, the “Englishman”
of Calcutta reported quotations of 4 percent, 5 percent and 6 percent loans
of the East India Company as well as shares of Bank of Bengal. Shares of
banks like the “Corporation Bank”, the “Chartered Mercantile Bank”, the
“Chartered Bank”, the “Oriental Bank”, and the old “Bank of Bombay”
were traded. In 1839, the trading list became broader in Calcutta, where
newspapers gave quotations of banks like the “Union Bank”, the “Agra
Bank” and business ventures like “Bengal Bonded Warehouse”, the
“Docking Company” and “Steam Tug Company”. Between 1840 and 1850,
banks recognized about half-a-dozen brokers and merchants in Bombay.
In 1850, the Companies Act introducing limited liability was enacted and
the era of joint stock enterprises thus began in India.
By the mid-19th century, railways were extended, telegraph was
introduced, and hence communication expanded. Consequently, the
country witnessed rapid development of commercial activity. Internal trade
and commerce gradually improved and broadened. This was followed by
a growth in corresponding demand for Indian goods in Europe. Eventually,
the brokers participated in this general progress and prosperity.
The American Civil War of 1860–65 had widespread impact on the
fledging Indian securities market. The supply of cotton to Europe was
totally stopped, and India, especially Bombay, the cotton belt, became the
major supplier. There was an unlimited demand for Indian cotton. Exports
doubled between 1861–65. The price of cotton shot up as the Civil War
progressed. The bulk of these exports was paid in bullion. The largest flow
was in 1864-65, the last year of the war. The flush of gold bullion spawned
numerous ventures in a wave of speculation. Companies were floated for
every imaginable purpose—banks, financial association, land reclamation,
trading, cotton cleaning, pressing, hotels, shipping, and steamer
companies, etc. Every company that was floated commanded a premium.
Brokerage business became attractive, and in 1860 there were 60
brokers. Their acknowledged leader was Premchand Roychand who was
the first broker to read and speak English. He was a genius and a brilliant
financial strategist. He was called the Napoleon of Finance. But the bubble
St ock Excha ng e 167
burst on 1st of July 1865. Like the South Sea Bubble and Tulip Mania in
Europe, the crash had disastrous effect on Bombay and its environs.
Innumerable companies failed; only a few were left solvent in Bombay.
The share mania left desolation in its wake. Nevertheless, it was responsible
for initiating the process of establishing the Stock Exchange in Bombay.
MEANING
1. A specialized marketplace that facilitates the exchange of
securities that already exist, is known as a Stock Exchange or the
stock market. It is also called a ‘secondary market’ for securities.
It is considered to be sine-quo-non for the primary market.
2. A Stock Exchange represents 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. It serves as a specialist marketplace for facilitating
transactions in existing corporate securities at prices that are
“fair and equitable”.
3. The stock market is the market place where the corporate and the
government securities are traded and exchanged. It regularly
provides sufficient marketability and price continuity to the listed
scrips.
4. A market where industrial securities are bought and sold under a
code of rules and regulations, is known as a stock exchange. Its
chief aim is to facilitate the provision of capital funds to trade,
industry and commerce.
DEFINITION
1. According to Hastings, “Stock exchange or securities market
comprises all the places where buyers and sellers of stocks and
bonds or their representatives undertake transactions involving
the sale of securities”
2. According to Husband and Dockeray, “Securities or stock
exchanges are privately organized markets which are used to
facilitate trading in securities”
3. According to Derek Honeygold, “Stock exchange can be
described as the place where a marriage of convenience is enacted
between those who wish to raise capital, such as companies,
governments and local authorities, and those who wish to
invest—largely households through the medium of institutions
acting upon their behalf”
4. According to Section 2 (3) of the Securities Contract Regulation

Act 1956, “The stock exchange has been defined 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”
Under the said Act, the following securities can be traded at the
stock exchange:
a. Shares, scrips, stocks, bonds, debentures, debenture stocks
or other marketable securities of a like nature in or of any
incorporated company or other body corporate
b. Government securities; and
c. Rights or interests in securities
The stock exchange provides a marketplace for purchase and sale of
securities as stated above. It ensures the free transferability of securities,
which is the essential basis of corporate system. The private corporate
system cannot function efficiently without the existence of stock exchanges
in an economy. The stock market assures the owners of corporate securities
to sell their holdings at any time and thereby provides liquidity. At the
same time those who wish to invest their surplus funds for long-term
capital appreciation or for speculative gain can also buy scrips of their
choice in this market.
FUNCTIONS/ SERVICES/ FEATURES/ ROLE
Stock exchanges have come to occupy an important place in the economy
of any country. Stock exchanges are very sensitive to the political and
economic changes. They are appropriately called the “barometers of the
state of economy” or “the mart of the world” or “business of business”
and so on.
The growth in the number and size of companies has increased the
significance and the role of stock exchanges. As the citadel of capital
market through which the bulk of investment activities are conducted by
individuals and institutional operators, stock exchanges facilitate the
transfer of existing flow of savings into the profitable channels.
Stock exchanges play an important role in the capital formation of an
economy paving way for the industrial and economic development of the
country. It induces the public to save and invest in the corporate sector
that is profitable to them. Companies depend upon stock exchanges for
raising finance. Stock exchanges render very many important services to
the investors and the corporations alike.
Following are some of the functions and services rendered by a stock

exchange:
Ideal Meeting Place
A stock exchange provides an ideal and convenient meeting place and a
common platform for sellers and buyers of securities. It is the nerve center
where open offers and bids for purchase and sale are made under free
competition.
Mobilization of Savings
The stock exchanges perform another important function in an economy,
i.e. mobilization of public savings and channelization of the same for
productive purposes. It helps in the mobilization of savings and surplus
funds of individuals, firms and other institutions. In other words, the
stock market provides an ample opportunity to all the investors, both
individuals and institutions to invest their surplus funds (amount saved
after meeting the expenses from the earnings) into various financial
instruments, and thus, directs its flow towards deficit units (which are
short of funds to meet their productive requirements). In this way, stock
markets assist in capital formation process in the economy. Further, in
case of prosperous and growing industries, the stock prices show a rising
trend and more flow of funds will take place and vice versa.
Providing Safety to Investors
One of the fundamental functions of a stock exchange is to provide
adequate safety to the genuine investors from fraud and manipulation
caused due to activities of speculators, members, brokers, etc. For this
purpose, adequate rules and regulations have been laid down under the
Securities Contract (Regulation) Act, 1956. Further, there are well defined
byelaws, rules and regulations given in the SCRA relating to the listing of
securities, admission of the members, trading mechanism, disclosure of
material information, transparency, delivery, penalties, etc. The Securities
and Exchange Board of India (SEBI) also regulates the working of stock
exchanges with a view to provide safety to investors by periodically issuing
guidelines on matters connected with securities trading.
Distribution of New Securities
A stock exchange helps in the distribution of new securities. Already
established companies, which wish to raise additional capital, may sell
their securities through stock exchange.
Ready Market
An important function of a stock exchange is to provide a continuous,
ready, open and a broad-based market for securities. This way maximum
liquidity, marketability and price uniformity for securities is ensured. It is
possible for the investors to sell their securities at the best-quoted price
and thus, convert their investments into cash, almost immediately and
without much effort.
Liquidity
Liquidity is an important indicator for judging the efficiency of an exchange
as it concerns with sale and purchase of securities, quickly, easily and at
reasonable prices, which is nearer to the previous one. In fact, liquidity is
related with depth, breadth and resiliency of the market. Depth relates to
buy and sell orders around the price at which a share is transacted. Breadth
refers to the adequate volume of orders and response of orders to price
changes in a scrip is called resiliency. The broad indicators of market
liquidity are frequency of sales, narrow spread between bids and offers,
and prompt execution of orders and minimum price changes between
transactions as they occur.
Capital Formation
As an essential adjunct of joint stock enterprise, stock exchange allows
for quick capital formation to take place. This in turn contributes to the
development and promotion of the economy through accelerated industrial
development. Stock exchanges enable people to know the current market
prices of securities. People will invest in those securities that yield higher
returns. Thus, stock exchange facilitates the capital formation in the country
by inducing the public to save and invest.
Speculative Trading
An efficient functioning of stock market motivates investors to save more
and invest in high yielding securities, and thus, promotes those industrial
units that show best productive and financial performance. Speculation
also plays a dominant role in mobilization of savings in an economy. For
instance, healthy speculation on the stock exchanges based on scientific
analysis and expert opinion, not only estimates fair price of the stock but
also provides adequate liquidity. No stock exchange can operate efficiently
merely on the basis of genuine investment, i.e. investment based on actual
(physical) delivery of the scrips. In fact, such investments cannot provide
the requisite volume of business, either to the stock exchange or to the
company. Therefore, the liquidity and the price continuity in the stock
market are possible only if there is a reasonable opportunity for speculative

trading.
Sound Price Setting
Stock exchange, through a plethora of measures of compliance, allows for
a sound and a fair price setting to take place. The prices usually reflect the
real worth of securities. Many factors such as limitless and free competition
in open market, enlightened scientific trading based on accurate knowledge
of present as well as future prospects of demand and supply, free flow of
information, etc contribute for the better price which benefits the investors
ultimately.
Economic Barometer
Stock exchange serves as a barometer of the economy. The price movement
of securities on a stock exchange indicates the state of health not only of
industrial companies but also of the economy of the nation as a whole. For
instance, any impending trends of the business cycles are correctly reflected
on the stock exchange. Similarly, any deep-rooted malaise afflicting the
economy is also reflected in the stock market operations. In fact, the stock
market indices act as precursors for the entrepreneurs to initiate appropriate
measures governing the management of their corporate enterprises. Thus,
they act as a barometer of the business conditions and progress of the
business in the country.
Dissemination of Market Data
Stock exchanges serve as information hub of trade and industry of an
economy. They disseminate information about share prices, volume of
trade—industry wise, scrip wise, etc. In addition, information is also
provided on the financial aspects of the companies whose shares are
traded widely in the stock market. The signals of impending financial or
business booms or distress are first indicated in advance by stock
exchanges very promptly.
Perfect Market Conditions
Perfect market conditions prevail in the stock exchanges. On account of
these reasons, the transaction and the carrying cost are the least. The
activities are much standardized. They are well regulated by institutions
of government. They facilitate a free and limitless competition among the
dealers and the brokers of securities.
Seasoning of Securities
Stock market players such as underwriters, dealers, brokers and speculators
temporarily hold securities issued by new companies. This is called

‘seasoning of securities’. The securities are then released gradually at a
time when the market is prepared to absorb the new issue. This process
ensures a better benchmarking and market for the securities.
Efficient Channeling of Savings
The stock exchange mechanism enables judicious use of national savings
by allowing the flow of savings into the profitable and desirable areas of
investments. It allows corporates to mobilize capital in a free and equitable
manner. For, only those corporate enterprises that satisfy the market tests
of efficiency and profitability could possibly approach the market for capital
funds. Accordingly, a company with good prospects would be able to
raise additional capital, as its share prices would be rising in the market.
Optimal Resource Allocation
Stock exchange serves as an ideal tool of allocating the national savings
to promising issues and thereby, ensures most effective and optimum
allocation and utilization of scarce financial resources in industry and
commerce for maximum social advantage. This is made possible by the
price mechanism under the free competition.
Platform for Public Debt
By serving as an organized market for government securities, stock
exchanges allow for raising huge resources of finance required by the
government for financing its development activities. Stock exchanges act
as platforms for mopping up public debt to execute the schemes of planned
projects. It works as an over-the-counter market, consisting of dealers and
brokers in government securities. Banks, LIC, Provident Fund and Pension
Fund institutions are the chief buyers of government securities.
Clearing House of Business Information
The business information supplied by corporate enterprises is allowed to
be exchanged between investors and the issuers by the stock exchange.
This allows a stock exchange to serve as a clearing house of business
information. Besides, the information provided by corporates by way of
financial statements, annual reports and other reports, etc helps ensure
maximum publicity of corporate operations and working.
Evaluation of Securities
Another important function of the stock exchange is to allow for an
opportunity to determine a reasonable and fair price of various scrips
traded on its floor through the market forces of demand and supply. The
prices of the scrips quoted on the stock exchange change continuously

on the basis of their real (intrinsic) worth along with fundamental and
technical factors. Whereas, the technical factors are concerned with
demand and supply position, market sentiments, rumours, mood, past
trend, etc fundamental factors include the economy, industry and firm
variables.
True Market Mechanism
The stock exchange provides liquidity and price continuity only to listed
securities. Securities that are listed and allowed to be traded on a particular
stock exchange are called listed securities. It is possible that a security
may be listed at more than one stock exchange for the purpose of trading.
A stock exchange assists in determining the stock prices near to their ‘true
and fair’ market worth and prevents from violent and erratic fluctuations in
such prices. It allows for price continuity to prevail in the market which
leads to stability in the market. A stock exchange, thus facilities free market
mechanism providing for marketability, stability and continuity in prices.
Investor Education
An important function of a stock exchange is to widen the share ownership
base especially in developing countries. Stock exchanges play a significant
role in educating the mass through various communication media by
providing information relating to principles and advantages of investing
in shares, debentures, bonds and other avenues. They also educate the
people in selecting the securities and designing their own portfolio. Stock
exchanges have a potential to play a significant role in the Indian economy
where the saving rate is the highest in the world, and the mass of population
is uneducated and living in rural and semi-urban areas. Educating the
public at large about the investment management has been popular in
developed countries too. For example, the stock exchanges like New York
Stock Exchange, London Stock Exchange, Melbourne Stock Exchange,
Sydney Stock Exchange, Toronto Stock Exchange, etc have initiated various
methods like ‘Own Your Share’ ‘Own Your Share of Australia’ ‘Your Brother
and You’ etc to educate the masses and for widening the share ownership
base.
Fair Price Determination
The prices in the stock market are determined by the interplay of the forces
of supply and demand. The two-way auction trading taking place in the
stock exchange facilitates a fair price determination. There is free trading
and free competition in the stock market, which in turn facilitates better
bargains so as to arrive at a fairly attractive price.
Industrial Financing
Stock exchange provides for an ideal ground for the corporate enterprises
to mobilize the capital required for undertaking industrial activities such
as setting up new ventures, expansion and modernization of existing
production units etc at a reasonable cost. If the enterprise happens to be
a company of good standing, then it is possible to obtain an attractive
price for the company’s shares being issued.
Company Regulation
The requirements of ‘listing’ on a stock exchange makes it possible for the
stock exchange to rein in on the corporate enterprises. Listing thus allows
for the quoting and trading of securities of corporate enterprises on the
floor of a stock exchange. Stock exchanges, thus, exercise wholesome
influence on the management and working of companies in public interest.
STOCK EXCHANGE AND COMMODITY EXCHANGE
DISTINGUISHED
The points difference that exist between a stock exchange and a commodity
exchange are furnished below:
Sl.No. Feature Stock Exchange Commodity Exchange
1. Function Providing easy Offering hedging or

marketability price
insurance services and
liquidity to securities
2. Object Object is facilitating Object is facilitating

capital formation goods flow through risk
and making best use reduction
of capital resources
3. Participants Investors and Producers, dealers, traders
speculators and a body of speculators
4. Period of Cash, ready delivery Instant cash dealings
Dealings and dealings for and a settlement period
account for a fortnight of 2 or 3 months for
Futures Market dealings
5. Articles Industrial securities Only durable, graded and

Traded such as stocks and goods having large

bonds, and Government volume of trade, price
securities such as uncertainty and
public debt etc. uncontrolled supply
6. Speculation Speculation ensures Speculation ensures
saleability of assumption and
securities affording a absorption of price risk
broad, ready, liquid and
continuous market of
securities
7. Forward Forward dealings are Standards are to be fixed
Contract simplified as for deliverable grades
securities are fully to facilitate futures
standardized contract
8. Cornering As seller has to deliver Cornering is difficult as
the agreed securities, the seller has option
cornering is easy to deliver standard or other
deliverable goods
9. Price- As regards forward For futures dealings,
Quotation dealings, only one multiple quotations are
quotation is possible possible
WORLD’S STOCK EXCHANGES

The Continental Europe
The world’s stock exchange has its origin in continental Europe with the
inception of the German and Dutch bourses during the Renaissance. The
first stock exchange was established in Hamburg in 1538, which, however,
was concerned with bills transactions. The first actual stock market began
operating in Amsterdam in 1611. The Amsterdam Stock Exchange was
also the first to trade in the shares of public companies including those of
United East India Company. Dutch investors played a dominant role in the
financing of foreign investments in both the public and private sectors.
Amsterdam stock exchange was ranked the third most important stock
market after New York and the London until the Second World War. Another
oldest stock exchange, the Vienna Stock Exchange was founded in 1771,
during the rein of Empress Maria Theresa as a State institution to provide
a market for the state-issued bonds as well as for exchange transactions.
In Italy, the first formal stock exchange was the ‘Milan Stock
Exchange’, which was created in 1808. The most active and most
international of Spanish stock markets, the Bolsa de Madrid, were founded

in 1832. Stock exchanges in the Scandinavia were the Copenhagen Stock
Exchange, the Oslo Stock Exchange founded in 1819, the Stockholm Stock
Exchange founded in 1864 which was internationalized in 1901.
Geneva is the oldest of the 7 stock exchanges in Switzerland that was
founded in 1850, followed by Basle in 1876 and Zurich in 1877.
The London Stock Exchange
The London Stock Exchange is the oldest in the English-speaking world.
The merchant venturers began dealing in stocks and shares during the
17th century, and an informal market dealing in shares in joint venture
trading companies grew up in the coffee houses of Threadneedle Street
during the 18th century as a way of spreading the risk to their backers. The
Council of Associated Stock Exchanges was formed in 1890, with an
amalgam of multifarious stock markets in England. By 1967, they had
grouped themselves into six regional stock exchanges, which finally
became part of the Stock Exchanges of Great Britain and Ireland, with
trading floors in London, Birmingham, Manchester, Liverpool, Glasgow
and Dublin.
North American Stock Exchanges
New York Stock Exchange (NYSE) The New York Stock Exchange
was created in 1817, as an organization of brokers who agreed to meet
regularly at set hours. Trading on the NYSE is conducted on a dealer-to-
dealer basis, without jobbing intermediaries.
American Stock Exchange (AMEX) The American Stock Exchange

was created in 1953, by the second generation of ‘on the curb’ street
traders in stocks and bonds who could not qualify for a listing on the
NYSE. AMEX is based on a central market floor with specialist firms,
which have a commitment to make a market in certain issues.
NASDAQ System
The National Association of Securities Dealers Automated Quotations
System, known as the NASDAQ, is the largest over-the-counter market in
the world. It was started in 1971. It was regarded as the harbinger of the
global stock market of the future. Round-the-clock trading is available to
investors from around the world through a fully computerized system. It is
the third largest trading system in the world after the NYSE and Tokyo
Stock Exchange.
NASDAQ was first developed as an OTC market to help many smaller

companies which were unable to meet the stringent listing requirements
and high listing costs of the major stock exchanges. The National
Association of Securities Dealers regulate it. Apart from dealing between
major institutions, like pension funds and insurance companies, which
normally hold large blocks of shares, it also provides for the private firms
which make block sales by linking their customers together through
computer terminals. This results in lower commission charges and a greater
speed of transactions.
Canadian Exchanges
In terms of market capitalization, Canada is the world’s fourth largest public
equity market. The three major stock exchanges are the Toronto Stock
Exchange, the Montreal Stock Exchange, and the Vancouver Stock
Exchange.
The Stock Exchanges of Japan and
the Pacific Basin
Japan The Tokyo Stock Exchange (TSE) is the world’s largest stock
exchange both in terms of market capitalization and turnover of having
overtaken the NSE in 1987. TSE was set up in 1878, nearly a hundred years
later than the London and New York stock exchanges. The other stock
exchanges are Osaka, Nagoya, Kyoto, Hiroshima, Fukuoka, Niigaatta and
Sapporo. All Japanese stock exchanges comprise three distinct sections.
The first and the largest section comprises of those that deal in listed
shares, the second section handles the newly quoted or unlisted shares,
which might be traded over-the-counter, and the third section comprises
the over-the-counter market.
Hong Kong Other important markets in Asia are those in Hong Kong
and Singapore. The Hong Kong stock exchange was set up in 1914. This
is the least restricted market in the world, having no exchange controls
and no distinction between resident and nonresident investors.
Australia The first stock exchange was founded in Melbourne in 1865.
Sydney in 1871, Brisbane in 1884, Adelaide in 1887, Hobart and Perth in
1891 followed this. All these exchanges now stand amalgamated under the
‘Australian Stock Exchange Ltd.’ (ASX).
Indian Stock Exchanges
Origin and growth Stock market transactions in India first originated

in the later part of the 18th century with the dealings of the stock
transactions of the East India Company. Corporate trading of shares came

into the picture in 1830. The enactment of the Companies Act in 1850,
marked the beginning of the new era in the realm of stock markets in India.
The Act contained many features that were considered significant in as
far as they contributed to the growth and the development of the stock
exchanges across the country. The introduction of limited liability marked
the era of modern joint stock enterprises.
Before World War I
On the eve of the First World War, the Indian Stock Market comprised
three exchanges. During this period, all imports into India ceased and
the Indian manufactures were faced with a boom. As the industrial activ-
ity in Europe centered on producing goods required for the war, the
Indian industries expanded to cater the demand.
Bombay stock exchange The first stock exchange was known as
“The Bombay Stock Exchange” (BSE), which was established in 1887, by
formalizing the deed of association of Native Shares and Stock Brokers
Association. The Association was set up in the year 1875. The Bombay
Stock Exchange made a significant contribution to the growth of the equity
cult and to the development of the Indian capital market.
Ahmedabad stock exchange This was the second stock exchange,
of which came into existence in 1894 under the name of ‘The Ahmedabad
Shares and Stock Brokers Association’. The major factor behind its
establishment was the mushroom growth of cotton textile units in this
region. This exchange was organized practically on the lines of the Bombay
stock exchange.
Calcutta stock exchange This was the third stock exchange to be set
up in India at the beginning of the 19th century. This came into existence
under the name of ‘The Calcutta Stock Exchange Association’ in 1908.
The industries that contributed to its birth were the jute industry of Bengal
and the coal and mining industry of Bihar, Orissa and Bengal.
After World War II
The Second World War also resulted in a sharp boom and mushroom
growth of Indian industries. The boom also resulted in the establishment
of various stock exchanges in the country. During the Second World War,
a few new stock exchanges such as at Hyderabad, Bangalore, Indore, etc
came into existence. Under the provisions of the Securities Contract
(Regulation) Act, 1956 (SCRA) Central Government granted recognition

to establish stock exchanges at Bombay, Ahmedabad, Calcutta, Madras
and Delhi in 1957, and stock exchanges at Hyderabad and Indore in 1958.
Subsequently, 16 more exchanges were given recognition under the
Securities Contract (Regulation) Act. These were Bangalore Stock Exchange
Ltd. in 1963, Cochin Stock Exchange Ltd. in 1979, Uttar Pradesh Stock
Exchange Association Ltd. (Kanpur) in 1982, Pune Stock Exchange Ltd. in
1982, Ludhiana Stock Exchange Association Ltd. in 1983, Gauhati Stock
Exchange Ltd. in 1984, Kanada Stock Exchange Ltd. (Mangalore) in 1985,
Magadh Stock Exchange Association Ltd. (Patna) in 1986, Jaipur Stock
Exchange Ltd. in 1989, Bhubaneshwar Stock Exchange Association Ltd. in
1989, Saurashtra Kutch Stock Exchange Ltd. (Rajkot) in 1989,
Over-the-counter Exchange of India in 1989, Vadodra Stock Exchange Ltd.
(Baroda) in 1990, Coimbatore Stock Exchange Ltd. in 1991, Meerut Stock
Exchange Ltd. in 1991 and National Stock Exchange (Bombay) in 1993.
ORGANIZATION STRUCTURE
The organizational setup of the stock exchange is chiefly guided by its
objectives which include arrangement for listing of companies, control of
trading in securities, settlement and clearance, regulation of members
activities concerning the disputes among members, members and clients
and others, and other services to members and investors. A brief
description of the common organizational structure of a stock exchange is
discussed below:
Governing Board
The governing board is vested with the over-all management of the affairs
of the stock exchange in India. The governing board is also known as the
Board of Governors or Board of Directors or the Managing Committee.
This body comprises of elected and nominated members, and is headed
by a President. This is the highest body/authority to run the affairs of the
exchange and its members. Various departments implement the decisions
made by the governing body. Sometimes, the committee appointed by the
governing board for specific purposes also takes decisions. The Governing
Body consists of President, Vice-President, Executive Director, Elected
Directors, Public Representatives and Nominees of the Government. The
governing body consists of 13 members as stated below:
Six members elected from the members of the stock exchange; one-
third of the elected members shall retire at each annual general meeting
and one member shall be eligible for re-election subject to a maximum of
two consecutive terms.
Three members nominated by the Government or the Board in

accordance with the Act, the government nominees are not subject to
retirement by rotation and they can hold the office till the government
desires.
Three public repres entatives to be nominated by the Board
and one Executive Director to be appointed by the stock exchange. The
public representatives are also appointed for one year and they are also
eligible for re-election. These are nominated by the Board from the various
departments such as Government Departments, Public Financial
Institutions, Investment Institutions, Reserve Bank of India, Educational
Institutions, Industrialists, Professional bodies like Institute of Chartered
Accountants of India, Institute of Cost and Works Accountant and of
India, Institute of Company Secretaries of India, etc. An individual member
is not allowed to be on the governing body of more than one stock exchange.
President and Vice-President The President and Vice-Presi-
dent are elected from amongst the members of the governing body within
10 days after the conclusion of the annual general meeting. No approval is
required for appointment of any person as President or Vice-President
from the Government or Board. The term of these officers is for one year
and they are eligible for re-election but subject to only for two consecu-
tive terms. The President is the Chairman of the Governing Board. He is
responsible for policy aspects and is assisted by the Executive Director in
the implementation of policies. The appointment and other terms and con-
ditions of Executive Director shall be subject to prior approval of the
Board. He would be responsible to implement the directions, guidelines
and orders of the SEBI and will perform his duties as per rules, regulations
and byelaws of that stock exchange. Both the President and Executive
Director have to work in close coordination so that the government guide-
lines and Board’s decisions are implemented effectively. Besides, a num-
ber of Committees and Subcommittees assist the Governing Body in dis-
charging its functions.
The major tasks of the Governing Body are as follows:
1. Making, amending and suspending the operation of the rules,
byelaws and regulations
2. Exercising complete jurisdiction over all members with the power
to admit and expel members
3. Warning, fining and suspending members or their partners,
attorneys, authorized clerks and employees
4. Granting approvals for formation and dissolution of partnership
5. Appointment of authorized clerks and attorneys

6. Enforce attendance and information, adjudicate disputes and
impose penalties
7. Determining the mode and conditions of stock exchange business
and regulating stock exchange trading; and
8. Supervising, directing and controlling all matters and activities
affecting stock exchange
MODE OF ORGANIZATION
In India, stock exchanges are free to establish themselves in any form of
organization, viz. of public limited company, company limited by guarantee,
an association of individuals, non-profit organization, etc. The Securities
Contract (Regulation) Act usually encourages a stock exchange to be
constituted in a limited company form. A brief description of the way the
stock exchanges in India is organized is presented below:
Voluntary Associations
Some of the recognized stock exchanges in India have been constituted as
voluntary non-profit making associations. Examples include Bombay Stock
Exchange, Ahmedabad Stock Exchange and Indore Stock Exchange. This
form usually suits members as they can frame rules, bye-rules and
regulations that suit them. Moreover, membership can be acquired either
by inheritance or through purchase of a card of another member. The new
card of membership can also be purchased direct from the stock exchange
with the approval of the other members. However, at present this form is
not very much popular and even the Government also discourages it.
Public Limited Companies
Exchanges in Calcutta, Delhi, Chennai, Bangalore, Cochin, Kanpur,
Ludhiana, Mangalore and Jaipur are organized as public limited companies.
In this form, the membership is acquired by purchasing the requisite
qualifying shares. However, these shares are not freely transferable as in
the case of a public limited company. The powers of the members are
derived from the Memorandum of Association and Articles of Association
of the company. Further, the liability of the member is limited. However, the
shares can be forfeited if the Governing Board of the stock exchange
cancels the membership of any persons. The stock exchange being a
service unit normally does not declare dividend for the shareholders.
Companies Limited by Guarantee

Stock exchanges in Hyderabad, Magadh, Pune, Bhubaneshwar and
Saurashtra are in the form of companies limited by guarantee. In this form,
there is no share capital. The liability of the members is limited to the extent
of the guaranteed amount mentioned in the Memorandum of Association
and Articles of Association of the company. The membership in this form
can be acquired if the Board of Directors permits the same by passing a
resolution in this respect. Normally each member has one vote in this form
of organization.
Me mbe rship
Only members are allowed to take part in the trading activities of a stock
exchange. Opportunities are usually restricted to persons of high financial
standing with a sufficient knowledge and experience relating to stock
market operations. Members are subject to the rules and regulations of
each of the stock exchanges. Members are also required to make a payment
of cash deposit as margin money. Application for membership has to be
made to the Governing Board of the stock exchange, besides being
recommended by an existing member. Membership of those stock exchanges
that are registered under the Companies Act are governed by the relevant
provisions of the Companies Act.
STOCK EXCHANGE TRADERS
Only the registered members are permitted to carry out trading on the floor
of a stock exchange. However, for reasons of convenience some other
persons are also permitted to enter the premises and transact business on
behalf of the members. They are:
Remis iers
The sub-brokers employed by a member (share-broker) to secure business
are called ‘Remisiers’. As the share brokers are prohibited to get business
by advertisement ,the role of remisiers assumes importance. Remisiers are
not permitted to enter the trading floor for exchange dealings. Remisiers
are those traders who are engaged by the full-fledged members of the BSE
in order to secure business for them. They act as agents of the members.
The members pay them commission on the business procured by them
and for this reason remisiers are best known as “half commission men”.
The remisiers are practically under the same restrictions as their principals.
Authorized Clerks
Authorized clerks are the people who assist a member in transacting
business, especially at times where the volume is heavy. The employees

of a member of a stock exchange are called ‘authorized clerks’. These
clerks or assistants are authorized to transact business on behalf of their
member-employer, but they cannot make any bargain in their own name.
Such persons can sign on behalf of their employers where they are provided
with the power of attorney. They also assist the member in conducting the
exchange transactions. Besides, they are authorized to enter the trading
floors of the stock exchange for carrying out buying and selling of scrips
on behalf of their employers. They cannot buy or sell on their own account.
The number of authorized clerks permitted for each member varies between
exchanges. For instance, in the Bombay Stock Exchange, five authorized
clerks are permitted per member; the Calcutta Exchange allows eight
authorized clerks or member assistants per member, and the Madras
Exchange provides three authorized clerks for a member.
Brokers and Jobbers
In a stock exchange, the actions of brokers and jobbers are interrelated.
Both the broker and the jobber perform important functions. A broker acts
as an expert agent of the ordinary investors who is hardly competent to
deal with skilled jobbers directly. A jobber renders a useful service by
executing orders without delay. The immediate execution of orders helps
make the price fluctuations smooth. He uses his experience and specialized
knowledge to name the price at which a security should pass from one
investor to another. Although there is a clear-cut distinction between
brokers and jobbers in the London Stock Exchange, no such difference
exists between them in India. For instance, brokers are commission agents
who transact business in securities on behalf of non-members; they work
on a commission basis. A broker’s commission on his business is fixed.
A broker serves as a link between the general public and the jobber.
Since a broker acts for a larger number of his non-member clients, he deals
in a wide variety of securities. Brokers are competent to enter into
transactions in an exchange. Brokerage charges are collected for the services
rendered by them. Brokers place orders on behalf of their client-
shareholders, collect the share certificate from the seller-broker and deliver
the same to the buyer-broker. It is the brokers through whom transactions
are dealt in by a stock exchange. Brokers trade in their own account,
besides placing orders on behalf of their clients. The actions of brokers
infuse liquidity in stock exchanges all over the world. Stock broking
business in India is a traditional family business. With the initiation of
economic reforms, international investors and foreign brokerage houses
entered the Indian capital market. A great deal of change has since taken
place in the profile of the market participants. Corporate broking houses
are now common, which is an international norm.
Jobbers are independent dealers in securities. A jobber buys and
sells securities in his own name. He does not deal with non-members
directly, implying that a jobber can either deal with a broker or with another
jobber. He does not work on commission basis, but works for ‘profit’,
which is technically referred to as his ‘turn’. A jobber’s turn on profit is
uncertain. A jobber is a ‘dealer’ in his own right. A jobber is a professional
speculator who usually specializes in a limited number of shares.
A transacting broker approaches a jobber and asks for the price at
which the jobber would be ready to purchase or sell a particular security.
Where the securities are actively traded, the jobber provides a two-way
price, the lower one would be the price at which he would purchase and
the higher one at which he would sell. Otherwise, he offers no quotation.
The difference between the purchase and sale price is his profit or ‘jobber’s
turn’. The broker finalizes/squares up the deal where he is satisfied with
the price.
A jobber does not trade with an inventory of stocks. He merely strikes
a bargain in the expectation that it will be balanced which eventually
involves risk, as sometimes he may not be able to do so for months.
Tarawaniwalas
Tarawaniwalas are dealers in securities in the BSE who transact business
in their own name and on their own behalf as well. Such dealers usually
specialize in one or two securities only. They resemble the jobbers of the
London Exchange in as far as the method of transacting business is
concerned. A typical dealer like the tarawaniwala is not prohibited from
acting as a broker although it might prove objectionable from the point of
view of the public as it gives him a chance to purchase securities from
clients at lower prices or sell his own securities to them at higher prices.
In addition, it is also possible that a tarawaniwala might indulge in a
malpractice of making a false offer and backing out later. In order to prevent
such a practice the Securities Contracts (Regulation) Act of 1956, provides
that a member of a recognized stock exchange can enter into contract in
respect of securities as principal with only a member of a recognized stock
exchange. Where it becomes absolutely essential to have dealings with
any non-member, such dealings can be had only with the express consent
of the authorities of the stock exchange concerned. This is only to afford
a measure of protection to the investors.
Dealers
Dealers are market-makers. They are important intermediaries in the stock
exchange. Dealers buy and sell inventory of stocks. Through this process,
they absorb excessive buying or selling pressures, thereby providing
liquidity and immediacy in the exchange. Such intermediaries are not very
common in the Indian capital market.
JOBBERS AND BROKERS
Jobbers and Brokers are the two categories of dealers found in the London
Stock Exchange.
J ob b e r s
A Jobber is a dealer in securities, while a broker is an agent of a buyer or
seller of securities. Every year a member has to decide and declare in
advance whether he proposes to act as a jobber or a broker. A jobber gives
two quotations as a dealer in securities, lower quotation for buying and
higher one for selling. The difference between the two prices constitutes
his remuneration. This system enables specialization in the dealings and
each jobber specializes in a certain group of securities. It also ensures
smooth and prompt execution of transactions. The double quotation of a
jobber assures fair-trading to investors.
Brokers
The brokers in the London Stock exchange are known as Tarawaniwalas
on the Bombay Stock Exchange. A Tarawaniwala often performs the task
of both a broker and a dealer in securities although strictly speaking,
Tarawaniwalas must act only as dealers in securities. Frequently,
Tarawaniwalas do perform the functions of brokers in order to be broker-
members.
JOBBERS Vs BROKERS
Sl. Feature Jobber Broker

No.
1. Agent Jobber is an independent Broker is merely an
dealer or a merchant agent to buy or sell on
willing to buy and sell behalf of his clients
securities
2. Specialization Jobber is a specialist Broker is a generalist
3. Dealing with Jobber deals only with Broker deals with a
Public brokers and not with jobber on behalf of his
public. No direct sale or clients. He is a
purchase in the market middleman between the
jobber and the real
buyer/seller
4. Price Jobber quotes two prices Broker has to negotiate
Quotation to the broker, one for terms and conditions of
buying and one for sale or purchase and
selling. Sale quotation is safeguard his client’s
higher than the purchase interest. He lives on
quotation commission paid by his
client which is fixed by
the Exchange
5. Margin Jobber’s profit margin is Lower brokerage rate is
fixed by competition fixed by rules; the higher
among themselves as rate by competition. In
dealers. It is narrow practice minimum
when there is keen becomes maximum
competition under keen competition
WEAKNESSES
Although rapid strides have been made in the Indian stock markets, there
are many irritants that continue to afflict the functioning of the stock
exchanges. Following are the principal weaknesses of the Indian stock
exchanges:
Raging Speculation
It is highly characteristic of the Indian stock exchanges that there prevails
a rampant speculative transaction. The continued spell of unprecedented
booms and crashes is a clear testimony for this phenomenon. The Indian
stock market witnesses high volatility taking the unwary investors for a
ride as they do not reflect a very healthy state of affairs. Over-speculative

character and high volatility have made the Indian stock market crises
prone.
Insider Trading Menace
The possibility that the insiders in a stock exchange have an access to
price-sensitive information about the market movements of certain scrips
breaks the ‘Playing field’. This way, equal opportunity of information
access is denied to all the participants in the market.
Neglect of Small Investors
The Indian stock market is often highly dominated by large financial
institutions, big brokers, and operators. The oligopolistic structure does
not leave any advantage to the small investors. The small investor is often
meted out a raw deal, despite the much-proclaimed safeguards built into
the various regulations issued by the SEBI from time to time.
Restrictions on Forward Trading
The ban imposed on the ‘forward trading’ in India in 1969, had a deleterious
effect on share prices. Further, the restrictions placed on dividend
payments by companies as part of the anti-inflationary measures adopted
by the government aggravated the dealings in share market. The limited
facility allowed for carrying forward the delivery contract beyond 14 days
in an informal manner. Under forward trading, the earlier contract is
concluded and a new contract is entered into without any actual delivery.
Only the balance between the contracted price and market price is paid
between the buyer and the seller. This system of forward trading was
useful for providing liquidity and avoiding payment crisis. However,
rampant speculation gave rise to difficulties in the actual physical transfer
of securities resulting in a virtual and inevitably payment crisis.
Bad Trading Practice
There are many obsolete, inefficient and outdated share-trading practices
that are ruling roost in the Indian stock exchanges. Major problem areas
are settlement periods, margin system and carry forward (badla) system.
The settlement period is 14 days in most of the Indian stock exchanges,
whereas most of the countries are moving towards a rolling 3 days
settlement period. The lengthy settlement period encourages the growth
of trading shops outside the stock exchange system, besides increasing
the risk exposure of market participants due to price movements. Avoidance
of margin payment under the margin system is another problem area.
Under the margin system, the members have to maintain with the clearing
house of the stock exchange a deposit, which is a certain percentage of
the value of the security being traded by members. Accordingly, if a member
buys or sells securities marked for margin above the free limit, a specified
amount per share has to be deposited in the clearing house. A major
weakness of the system was that the margin was totally discretionary in
character, with a variation of zero to sometimes 40 percent depending on
nature of shares and timing of trading. This practice often gave rise to
runaway booms. Moreover, under the present settlement and margin system,
there is a strong incentive to collude for the buyer and seller-brokers for
the purpose of avoiding margin payments. Carry forward (or badla) system
was another obnoxious practice followed in the Indian financial system.
The practice caused unprecedented speculation in shares. It allowed a
wholly spurious kind of share trading in which neither the buyer has the
money to pay for the shares at the time of settlement nor the seller has the
shares to deliver, or at least one of the two is spurious. This obviously
constricts the smooth and free functioning of the stock exchanges.
Lack of Integration
In order that the services of a stock market are made use of by a wide
spectrum of investors across the country, close integration among the
various stock exchanges becomes an imperative necessity. Such an
arrangement will also help enhance the cohesive functioning of the stock
exchanges with efficient sharing of information among them. The limited
inter-market operations have resulted in increased costs and risks of
investors in smaller towns. This problem has been further aggravated by
the lack of cohesion among exchanges in terms of legal structure, trading
practices, settlement procedures and jobbing spreads.
Lack of Interface
In India, the kind and the quality of developments taking place in the realm
of new issues market are not adequately matched by the developments in
the secondary markets. For instance, the recent upsurge of the primary
market has created serious problems of interfacing with the secondary
market. The stock exchanges are ill-equipped to handle the great volume
of transactions in the primary market. It therefore, requires that the
secondary market is re-oriented so as to discharge the new responsibilities
efficiently and effectively. This would in turn spur all-round growth in the
capital market, thus making the Indian stock market a real investor-friendly
market.
Inefficient Banking System

The dilatory and inefficient working of the banking system under which
outstation cheques takes very long to be encashed, the difficulty in making
necessary payments in reply to calls or in connection with the subscription
for issues also affect the system. The restrictions imposed by the FERA
on inflow and outflow of foreign exchange and the time consuming
procedures are irritants not only to foreign but also to nonresident Indian
investors, who have grown substantially in recent years. All this militates
against the efficient functioning of the secondary market.
Inadequacy of Investor Service
As regards investor service, it is found to be much wanting especially
among the small stock exchanges. They make a limited contribution to the
spread of the equity cult in their region.
Inadequate Infrastructure
The extent of facilities that are available in the stock exchanges are far from
satisfactory. This results in lower operational flexibility of stock exchanges
and brokers to handle sudden surges in volumes of trading. For instance,
the level of computerization across stock exchanges has been inadequate
resulting in the absence of computer linkages between stock exchanges
and its members. This has hampered the effective inter-market operations,
monitoring of trading and post-trading operations, as well as the free flow
of information on an intra and inter-exchange basis. The inadequate
infrastructure and ineffective trading settlements/pratices have also
resulted in a lack of NRI confidence in the Indian capital markets.
REGULATION OF STOCK EXCHANGES
All stock exchanges were subject to self-regulation till 1956, whereby the
regulation emanated from their own management bodies, i.e. Board of
Governors. Now, Indian stock exchanges are subject to three-tier regulation.
The first level constitutes the authority exercised by the Central
Government under the Indian Constitution and through its Ministry of
Finance (Stock Exchange Division) over the functioning of the stock
exchanges.
The authority, however, is regulated primarily through the Securities
Contract (Regulation) Act, 1956 (SCRA). Further, the Securities and
Exchange Board of India (SEBI) also regulates the stock exchanges in
order to protect the interest of investors and to promote the development
of security markets in India. This constitutes the second-level authority.
The third-level of authority constitutes self-regulation whereby all stock

exchanges have their own separate rules, byelaws and regulations that are
exercised through their Governing Board.
Regulatory Structure
The stock exchange division The Stock Exchange Division of
Ministry of Finance has its Head Office at Delhi and Branch offices at
Bombay and Calcutta. The essential functions of the Division are as follows:
a. Providing linkage between government and stock exchanges
b. Monitoring the operations of the stock exchanges
c. Providing advice to overcome the untoward developments and
crises
d. Ensuring the compliance of listing provisions
e. Ensuring smooth functioning of the stock exchanges and
f. Issuing licenses to brokers and dealers in securities and also in
areas beyond the jurisdiction of recognized stock exchanges
SEBI An apex body called the Securities and Exchange Board of India
(SEBI) has also been constituted besides the above. A Chairman heads
the SEBI. The first chairman of this Board was Dr. S.A. Dave, former
Executive Director of IDBI. Besides, the Central Government is also
empowered to nominate four members that comprise the top management
team of the SEBI. The SEBI issues from time to time various rules, regulations
and guidelines for promoting the development and stabilization of the
securities market in India. A few important among them are as follows:
a. SEBI (Portfolio Managers) Rules and Regulations, 1992
b. SEBI (Stock Brokers and Sub-brokers) Rules and Regulations,
1992
c. SEBI (Insider Trading) Regulations, 1992
d. SEBI (Merchant Bankers) Rules and Regulations, 1992
e. SEBI (Mutual Fund) Regulations, 1993
f. SEBI (Underwriters) Rules and Regulations, 1993
g. SEBI (Registrars to Issue and Share Transfer Agents) Rules and
Regulations, 1993
h. SEBI (Debenture Trustee) Rules and Regulations, 1993
i. SEBI (Bankers to an Issue) Rules and Regulations, 1993
Besides the above, SEBI has also issued guidelines regarding the
following:
1. Free pricing of shares
2. Disclosures and Investors’ protection
3. Registration of Foreign Institutional Investors (FII)

4. Allotment of shares
5. New financial instruments
6. Credit rating of fixed return bearing securities
Departments The major departments of a typical stock exchange in
India are as follows:
a. Listing Department
b. Operations Department
c. Computer and EDP Department
d. Inspection and Audit Department
e. Monitoring Department
f. Investor Service Department
1. Listing department It is an important department of a stock
exchange. Its main function is to list the securities of companies
for trading purposes at the stock exchange. The task of this
department is to examine the prospectus and project of the
company to ensure whether the company fulfills all their
requirements as per existing byelaws of the stock exchange and
guidelines of the government. It also ensures whether the company
has made fair and equitable allotment of shares
2. Operations department The basic objective of this department
is to keep watch on the daily trading and other operations of the
stock exchange. It collects quotations and makes them available
to members by publishing in the evening every day. This
department also looks after the auction of shares and related
matters connected with settlements
3. Computer and EDP department The basic function of this
department is to collect and compile the various data relating to
corporates, quotations of scrips and member-wise and scrip-wise
turnover. Financial results of companies like their net profits,
dividends, bonus, balance sheets, etc are all recorded on the
computer. Further, it builds up a sound management information
system, which is useful to members and investors for making
their investment decisions
4. Inspection and audit department This department is concerned
with carrying out routine audit of the stock exchanges for checking
the accuracy and validity of the accounting records, balance
sheet item, receipts and payments items, and other relevant
registers. The department ensures that all the registers and records
are duly maintained by the stock exchanges as per guidelines of

the SEBI and the Government
5. Monitoring department This department aims at supervising
the activities of the members in the trading ring. Besides, it also
watches the price movements and the trading volume of the
members. The department initiates necessary measures to check
excessive trading and speculative transactions by imposing ad
hoc margin, suspending trading and enquiring into any specific
development
6. Investor service department The basic objective of this
department is to safeguard the interests of investors by rendering
expeditious service to them and by attending to their complaints
against broker-members and their authorized clerks and the listed
companies. The department takes necessary follow-up action
with the members and the companies concerned
STEPS IN STOCK TRADING
Following are the typical steps involved in trading on the National Stock
Exchange:
Client Registration
The buyer approaches the broker and executes a client registration form
wherein all details about the buyer are furnished. This forms the basis for
trading in the exchange through the broker.
Agre e me n t
An agreement between the buyer and the broker as specified by the
exchange concerned is entered into. This agreement is called the client
member agreement.
Order Placing
Buyer places the order in writing with the broker for the purchase of
certain number of scrips at a certain specified price.
Order Confirmation
After collecting the order from the client ,the broker places the order in his
computer system, which is in turn transmitted to the computer system of
the NSE at Mumbai. The order confirmation slip is obtained by the broker
from the exchange.
Trade Confirmation
A trade confirmation slip is generated as soon as the order is matched by the
computer against the price generated by the matching algorithm
(price-time priority). The trade confirmation slip gives details of the trade
executed. The buyer makes payment of necessary margin money to the
broker.
Contract Note
The broker issues a contract note to the buyer in respect of all the orders
that are executed during the day. Such a note spells out the obligations of
the parties concerned, for the buyer to make payment and the broker to
make delivery of scrips. Accordingly, the payment is made and the scrips
are taken delivery by the buyer, which thus concludes the contract.
The steps in stock trading are depicted in Exhibit 4.
Exhibit 4 Steps i n Stock Tradi ng
MECHANICS OF SETTLEMENT
The process of fulfillment of the obligations of the trade by the parties to
the transactions is known as ‘settlement’. This implies payment of funds
to the seller and delivery of securities to the buyer. Although in a traditional
commodity market, a trade is negotiated and settled instantaneously, i.e.
payment is made and goods are taken delivery immediately, settlement of
trade is in a stock market, not instantaneous. For instance, payment for the
purchase and the delivery of shares takes a certain cycle.
T ype s
There are two types of settlement of trade in vogue. They are Rolling
Settlement and Account Period Settlement.
Rolling settlement Under this system of settlement, the trades
executed on a certain day have to be settled after a certain number of days
depending on the nature of settlement cycle practised by the exchange
concerned. Accordingly, where a settlement cycle specified is T+3, it implies
the trades executed on the first day (say a Monday) have to be settled on
the fourth day (on Thursday), i.e. after a gap of 3 days.
Account period system Under this system of settlement, trading
is allowed to continue for a certain agreed period and it is possible for the
investor to buy or sell for a certain number of days, and thereby accumulate
a certain position during the period. At the end of this period, his obligation
in terms of shares purchased or sold and the amount to be paid by him is
worked out and communicated to him. The obligations of a broker are
worked out after netting the trades. The working of the above system of
settlement as practised in the NSE for its equity segment is illustrated
below:
Settlement Cycle at NSE

Day 1 Wednesday Trade cycle commences
Day 7 Tuesday Trade cycle ends
Day 8 Wednesday Obligations worked out and communicated
to brokers
Day 13 Monday Sellers deliver shares sold to the clearing
house
Day 14 Tuesday Purchasers pay amounts for purchases
made
Day 15 Wednesday Sellers get amounts due and buyers get
their shares
As shown above, it is possible for an investor to freely trade in any

pattern that he chooses during a period between a Wednesday and a
Tuesday. After the expiry of this period, the obligation of each broker in
terms of the shares sold/purchased and the money to be paid/received is
worked out and duly communicated to the broker. The broker is expected
to deliver the shares that he has sold on Monday next and pay the amounts
due on Tuesday next.
Counter Party Default
The default committed by either or both the parties to the trading
transaction namely buyer and the seller in honoring their respective
commitments at the end of the settlement period, in a bilateral settlement
process is referred to as ‘counter party default’. In a situation like this, the
buying broker might default in making payment although the seller is
ready to deliver the shares. Similarly, the selling broker might default to
deliver the shares although the buying broker is ready to pay the money.
In such a situation because of the default of one party, the other party
suffers. The counter party default is deleterious in that it would cause
destabilization of the functioning of the stock exchanges thus threatening
the safety and integrity of the market. It is therefore imperative to have a
safety system in place to deal with such situations.
Settlement Guarantee Mechanism
The system, which is devised to eliminate counter party risks, is known as
‘settlement guarantee mechanism’. The National Stock Exchange of India
first introduced the system, which is popular in the developed markets.
This is being adopted in other exchanges as well. According to the system,
settlement of trade is undertaken by a separate legal agency called the
‘Clearing Corporation’. Stock exchanges may set up separate Clearing
Corporation either singularly or jointly. The NSE has a separate fully owned
subsidiary which undertakes this function.
The working of the settlement guarantee mechanism is described
below:
The clearing corporation acts as a counter party in respect of every
trade. It ensures and verifies that the deliveries of money and shares are
made and passes them on to the respective brokers. If one of the brokers
defaults, the Clearing Corporation ensures that the trade is carried out
unhindered by making payment or making delivery of scrips on behalf of
the defaulting broker, who is thereafter dealt with by the Corporation
separately. The mechanism thus, helps both the brokers and thereby their
investors who are assured of prompt settlement irrespective of the
fulfillment of obligations by the other party. Such a function helps minimize

the market risk and thus helps save the integrity and safety of the stock
exchange. The guarantee also covers transactions involving bad deliveries.
In order to perform this function satisfactorily, the clearing corporation
resorts to a variety of risk management techniques like margining, exposure
limits, etc.
Prerequisites For the successful working of the settlement guarantee
system, the following essential requirements are called for:
a. Automated trading and settlement processes
b. Established risk management procedures
c. Well defined settlement schedule
d. All securities to be cleared through the clearing house
e. Multilateral netting (netting across locations, etc.)
f. Funds settlement through clearing banks
g. Clear procedures for post-settlement issues
SYSTEMS OF STOCK TRADING

Trading on a stock exchange takes place either on the basis of the auction
system on a trading floor or a broker-dealer market (which is quote-driven
or dealer-driven). Every one of the worlds stock markets uses one of the
two trading systems or a hybrid of both.
Auction Trading System
This is an order-driven or a custom-driven trading system where customers’
buy and sell orders are matched at a central point. The New York Stock
Exchange (NYSE) is an order-driven auction market. This system allows
the buyer and the seller to find a mutually agreeable price, with no
intervention from the broker-dealers.
The buy and sell orders are automatically matched and in case of any
imbalances, the specialists take up the job of filling in. The specialist is a
single designated market-maker who stands in the market at all times,
adding effectiveness and efficiency into the trading mechanism. 90 percent
of the trading in the NYSE is done this way.
In Indian stock markets other than the BSE, the trading is mainly
order-driven with the buyers and sellers transacting directly with one
another. Although this does have the advantage of giving the investors a
better price, growth of the markets has been hampered by a relatively
high-degree of volatility and liquidity. SEBI has proposed a system of
market-makers on the exchanges at Bombay, Calcutta, Delhi and Chennai.
Any member of these stock exchanges can, with prior approval of SEBI,
take up the charge of becoming a market-maker. Market-makers can make
markets for 500 scrips, which are not included under the BSE National
Index. Each market-maker will be required to acquire at least 30,000 shares
in each of the scrips.
According to Reserve Bank of India guidelines, market- makers would
be in a position to impart liquidity to scrips and reduce volatile movements
in share prices by permitting banks to finance their operations. Banks
have been authorized to determine the amount of working capital
requirements, the margin (existing 50 percent margin on loans to individuals
against shares is not applicable) and credit limits for margin making
requirements. The rate of interest depends on the amount and banks can
stipulate an interest rate subject to a minimum of 16 percent on amount
over Rs. 2 lakhs. Scrips, other than those for which market making is
undertaken may be accepted as collateral.
Dealer Trading System
This is a quote-driven or dealer-driven trading system where dealers
compete to give the customers the best price. This type of trading takes
place through an electronic media with the help of well-networked computer
system. The system runs the trading by trying to find the customer for the
best price available. The National Association of Security Dealers
Automated Quotation System (NASDAQ) is quote-driven, as it is a
computerized network, which serves over the counter.
Dealers who buy and sell a particular security regularly make a market
in that security. The market-makers quote both ‘bid and ask’ prices for
the two sides of the market, both buy and sell continuously. There are
no restrictions on the number of market-makers in a given share.
Competing market-makers are obliged to quote the best and competitive
prices through the system. Market-makers offering the best price are
assigned orders on a rotating basis. The market-makers for most of the
active shares transmit their quotations electronically.
Hybrid Trading
Hybrid trading system is an auction type of trading with bids and offers
being made by open out-cry and at the same time it is a quote-driven
system too. This type of trading system is prevalent in the Bombay Stock
Exchange (BSE). A jobber, unlike the NYSE specialist, does not have to
maintain an orderly and continuous market. Acting on their own behalf
and never as agents, their income was mostly derived from the spread
between the bid and the offer prices by assuming a position in a particular
share. Bombay Stock Exchange has an informal system of jobbers.
Margin Trading
A method of trading on a stock exchange whereby an investor is allowed
to buy securities on credit by making a deposit of a certain amount in the
concerned stock exchange is known as ‘margin trading’. Margin account
or margin trading is much in vogue in the USA. An investor can open a
cash account or a margin account with a member firm. Whereas in the case
of cash account, securities are purchased against cash, the margin account
investors have to apply for permission to buy securities on credit besides
furnishing more information regarding the financial standing. Margin
trading provides a customer with added leverage through the use of
borrowed funds. Such accounts can also be used to procure quick and
easy loans, for short sales, naked call writing and spreads.
When investors buy securities on margin, they buy some shares
against cash payments and borrow from the brokers to pay for additional
shares, using the paid shares as collateral. The margin customer has to
sign a margin agreement, pledging securities as loan collaterals. Before
they lend the clients margined securities, the brokers also ask the customers
to sign a stock-loan consent form. Margins are regulated by the Federal
Reserve, which stipulates 55 percent of margin.
SPECIALISTS
Specialists are market-makers who focus their attention on the maintenance
of prices for the investors to find an appropriate price for their bids.
Specialists contribute for the effective functioning of the stock exchange.
The Specialists firms are mostly the members of the exchange who act as
dealers/brokers in shares. Specialists on the floor of exchange carry out
the dual function of representing the customers on the one hand and
trading on their own account on the other. They buy and sell shares of one
or more companies and thereby, help in maintaining a free and continuous
market in the shares of companies for which they act as specialists.
The specialists are expected to maintain a fair and orderly market for
the securities. In their capacity as brokers, they execute orders on behalf
of other brokers for a commission and as dealers, they trade on their own
accounts, profits and risks. They buy from the public, when other public
bids for purchase are not available and execute the market orders in the
absence of other public offers to sell at or near the last price prior to their
order. Their customers constitute the other members of the exchange. As
specialists they do not transact business directly with the public.
Functions of Specialists
Specialists operating on a stock exchange make a continuous market in
shares assigned to them. Following are the functions of specialists:
1. Acting as brokers on the acceptance of orders for execution from
other members of the exchange
2. Providing a conduit of information for electronically quoting and
recording current bid and ask prices for the shares of companies
assigned to them
3. Acting as dealers and trade on their own accounts when faced
with a liquidity imbalance in the market
4. Providing the two-sided market, by quoting a bid indicating the
price at which shares will be purchased from a seller and an offer
the ask price at which shares will be sold to a buyer
Market-makers
Dealers who are responsible for creating and maintaining a market in a
security are called “market-makers”. In order to carry out the function of
market-making, it is essential that the market-making dealers continuously
engage themselves in the purchase and sale of a particular security on
their own account, and at their own risk and at prices equivalent to the
security’s trading unit. The quotations that are used for this purpose by
the dealers are of two types. They are ‘bid price’ and ‘ask price’. A bid
price is the price at which the dealer will buy a security and an ask price is
that at which a dealer is willing to sell a security. The difference between
bid and ask prices in any quotation is the ‘spread’.
The market-makers are obliged to offer a continuous two-way market
in all their registered securities. Transactions are reported within 90 seconds
of execution. A dealer may take a position in a security by buying for
inventory (long position) or by selling securities that he has not yet
purchased. A quotation, at all times, must include both sides of the market
even though one side may be non-existent.
The Broker-dealer
He is the dealer in the New York Stock Exchange (NSE). The broker-dealers
are registered with SEC. They may buy and sell securities on their own
risk/account, or as an agent, trade on behalf of others. A broker-dealer can
also handle purchase orders and perform the following functions:
1. To sell out of his inventory if he makes a market in a particular
share which a customer wants to buy
2. To act as an agent where he gets the order for a share in which he

does not make a market and buy the same from another market-
maker or from someone else who owns the securities
3. To buy shares on his own account and resell them
The main advantages of the broker-dealer markets are as follows:
a. Provision of instance information to the market-makers regarding
the bid and ask quotations in a particular share
b. Assurance to investors about the best possible execution of
their orders as the traders check with all the market concerned
c. Possibility for traders to gauge market quickly
d. Stimulating market competition
e. Facilitating easy and convenient trading
f. Providing an easy access to the information on the volume, the
indexes of OTC shares, and individual trades
RECENT DEVELOPMENTS
The structure of stock market in India has undergone a vast change due to
the liberalization process initiated by the Government. A number of new
structures have come to be added to the existing structure of the Indian
stock exchange. A brief description of these structures in the Indian stock
market system is presented below:
Over-the-counter Market System
Basically this market is meant for small size companies. The primary
objective of this market was to enable the small start-up companies or
companies in green field ventures to obtain their capital requirements at
the minimum cost. On the basis of the recommendations of the High Powered
Committee on Stock Exchange Reforms (G.S. Patel) and Committee (Abid
Hussain) on Capital Market Reforms, the Over-The-Counter Exchange of
India (OTCEI) was incorporated in October 1990 under the Companies
Act, 1956. Granted recognition under section 4 of the Securities Contract
(Regulation) Act 1956, the OTCEI was promoted by various public financial
institutions like Unit Trust of India (UTI), Industrial Development Bank of
India (IDBI), Industrial Credit and Investment Corporation of India (ICICI),
Industrial Finance Corporation of India (IFCI), Life Insurance Corporation
of India (LIC), General Insurance Corporation of India (GIC), SBI Capital
Market, CanBank Financial Services, etc. Commencing its operations on
September 29, 1992 at Bombay, the OTCEI introduced screen-based
automatic singular trading system. Although companies enjoy the same
status as listed on the other stock exchanges, it is not possible that a

company listed at OTCEI can be listed on other stock exchanges.
National Stock Market System (NSMS)
National stock market system was advocated by the “High Powered Group
on the Establishment of New Stock Exchanges” headed by Shri.M.J.Pherwani
(popularly known as Pherwani Committee). The committee recommended in
June 1991, the following three tier-stock market structure:
• Principal Stock exchanges comprising 5 major stock exchanges
at Bombay, Calcutta, Madras, Delhi and Ahmedabad
• Regional stock exchanges like those in major state capitals
• Additional Trading Floors (ATFs) sponsored or managed by
Principal or Regional stock exchanges
At present the National Stock Market in India comprises the following:
1. National Stock Exchange of India Limited (NSE)
2. Stock Holding Corporation of India Limited (SHCIL)
3. National Clearing and Depository System (NCDS)
4. Securities Trading Corporation of India (STCI)
National Stock Exchange (NSE)
The National Stock Exchange (NSE) was set up for the purpose of providing
a nationwide stock trading facility to investors so as to bring the Indian
financial market in line with international financial market. It started its
operations by the end of 1993. The NSE uses the electronic trading system
and computerized settlement system aimed at extending the facility of
electronic trading to every corner of the country. The exchange has two
separate segments, viz. capital market segment and money market segment.
While the capital market segment is concerned with trading in equity
shares, convertible debentures and debt instruments as nonconvertible
debentures, the money market segment facilitates high value trading in
debts, public sector bonds, mutual fund units, treasury bills, government
securities, call money instruments, etc. The main participants, in this market
are usually banks, financial institutions, and other financial agencies.
Stock Holding Corporation of India Limited (SHCIL)
This Corporation was set up in October 1987, under the Companies Act,
by 7 All India financial institutions viz. IDBI, IFCI, ICICI, LIC, GIC, UTI and
RBI. The range of services that are made available by this institution
includes quick transfer of shares among its member institutions, clearing
services, depository services, support services, management information
services, and development services. This is a board-managed company

and has a whole time Managing Director in charge of the day-to-day
management of the corporation. It has set up regional centers at New
Delhi, Calcutta and Madras. It is providing facilities in the major market
centers in India.
National Clearance and Depository System (NCDS)
This system was created chiefly to help overcome the problem of settlement
and clearance of transactions consequent to enormous workload on the
clearing agencies and share transfer agencies. The problems mainly arose
out of systematic risk like counter party risk, credit risk, bad deliveries,
long delayed delivery, counterfeit scrips, and forged scrips.
Securities Trading Corporation of India (STCI)
The Reserve Bank of India set up Securities Trading Corporation of India
Limited (STCI) in May 1994, under the provisions of the Indian Companies
Act, 1956, jointly with public sector banks and All-India financial
institutions. The main objective of establishing the Corporation was to
foster the development of an active secondary market for Government
securities and bonds issued by public sector undertakings. It had an
authorized and paid-up capital of Rs. 500 crores of which, RBI contributed
50.18 percent. The RBI in December 1997 divested part of its equity in
STCI in favor of the Bank of India, an existing shareholder of the Company.
Corporitization and Demutualization
Of late, efforts are on by the SEBI to corporatize and demutulize the Indian
stock exchanges. For this purpose a Study Group under the Chairmanship
of Justice M.H. Kania has been constituted. The object is to put in place a
common structural model for the Indian stock market system. Accordingly,
stock exchange will have to undergo changes in organizational structure.
Corporitization and Demutualization refer to the process of conversion
of a stock exchange from a not-for-profit entity to a for-profit company.
The process of transition from ‘mutually-owned’ association to a company
‘owned by shareholders’ is called ‘demutualization’. Demutualization
involves the segregation of members’ right into distinct segments, viz.
ownership rights and trading rights. It changes the relationship between
members and the stock exchange. Members, while retaining their trading
rights, acquire ownership rights in the stock exchange, which have a market
value, and they also acquire the benefits of limited liability.
INTERCONNECTED STOCK EXCHANGE OF INDIA (ISE)
Ge n e s i s
Interconnected Stock Exchange of India Limited (ISE) has been promoted
by 15 Regional Stock Exchanges to provide cost-effective trade linkage/
connectivity to all the members of the Participating Exchanges, with the
objective of widening the market for the securities listed on these
exchanges. ISE is a national-level stock exchange which provides trading,
clearing, settlement, risk management and surveillance support to its traders
and dealers.
ISE aims to address the needs of small companies and retail investors,
with the guiding principle of optimizing the existing infrastructure and
harnessing the potential of regional markets, so as to transform them into
a liquid and vibrant market, through the use of state-of-the-art technology
and networking.
The Participating Exchanges of ISE have in all, about 4,500 stock-brokers,
out of which, more than 200 have been currently registered as ‘traders’ on
ISE. In order to leverage its infrastructure and to expand its nationwide
reach, ISE has also appointed around 450 ‘dealers’ across 70 cities other
than the Participating Exchange centers. These dealers are administratively
supported by the regional offices of ISE at Delhi (north), Kolkata (east),
Coimbatore (south) and Nagpur (central), besides Mumbai (west).
ISE has also floated a wholly-owned subsidiary, ISE Securities and
Services Limited (ISS), which has taken up corporate membership of the
National Stock Exchange of India Ltd. (NSE) in the Capital Market Futures
and Options segments and the Stock Exchange, Mumbai, in the Equities
segment, so that the traders and dealers of ISE can access other markets,
in addition to the ISE market and their local markets. ISE thus provides the
investors in smaller cities, a one-stop solution for cost-effective and
efficient trading, and settlement in securities.
With the objective of broadbasing the range of its services, ISE has
started offering the full suite of DP facilities to its traders, dealers and their
clients.
ISE endeavors to consolidate the small, fragmented and less liquid
markets into a national-level, liquid market by using state-of-the-art
infrastructure and support systems.
Objectives /Fe atures
The Interconnected Stock Exchange of India Limited was constituted to
realize the following objectives:
1. Create a single integrated national-level solution with access to

multiple markets for providing high cost-effective service to
millions of investors across the country
2. Create a liquid and vibrant national-level market for all listed
companies in general and small capital companies in particular
3. Optimally utilize the existing infrastructure and other resources
of participating stock exchanges, which are under-utilized now
4. Provide a level playing field to small traders and dealers, by
offering an opportunity to participate in a national-market having
investment-oriented business
5. Reduce transaction cost
6. Provide clearing and settlement facilities to the traders and dealers
across the country at their doorstep in a decentralized mode
7. Spread demat trading across the Country
INDONEXT
Indonext is the proposed common trading platform for regional stock
exchanges. It is planned to be introduced, by the SEBI on the basis of
recommendations by the, ‘Justice Kania Committee on Corporatization
and Demutalization of Stock Exchanges. Indonext is to be set up as the
third National Stock Exchange, on the lines of ‘Euronext’. Indonext is to be
established by merging regional stock exchanges with, the Over-The-
Counter Stock Exchange (OTCEI). The scheme aims at giving a new lease
of life for the regional stock exchanges in India.
Ne e d
The need for setting up Indonext arose, owing to the rapid expansion of
the national and Bombay stock exchanges, into small centers and cities,
and the struggle of regional exchanges to survive of all the national
exchanges, seven of them do not conduct any business at all. Further, the
capital market regulator, SEBI, has permitted companies to cut down their
multiple listings and to eventually delist from the regional bourses. Good
quality stocks started vanishing from the bourses and new stocks are not
being listed, due to lack of initial public offerings. The idea behind Indonext
is, to have a single trading segment.
Features
Indonext seeks to be different from the ISE in the following respects:
1. Exclusive trading Indonext aims at offering exclusive trading in the
case of companies with paid-up capital of Rs 20 lakhs, very small and
medium capital companies.
2. Liquidity Indonext proposes to generate liquidity in the thinly traded

stocks so as to ensure survival of small stock exchanges.
3. Wide trading Trading on Indonext will be open to all members
including NSE, BSE, ISEI, OTCEI and regional exchanges.
4. Trading model Trading segment of all regional exchanges and
OTCEI will be modeled along lines of Euronext, Paris or Amsterdam.
5. Eliminating conflict of interest Indonext seeks to eliminate a
conflict of interest among regional stockbrokers by disallowing
participating exchanges to retain a separate trading platform. Members
will be permitted to trade only on the Indonext platform.
‘S Group’ Companies
The Federation of Indian Stock Exchanges (FISE) representing the regional
stock exchanges, gave the idea of ‘S Group’ Companies. Corporates such
as Alfa Laval, Tata Coffee, Tata Honeywell, Tata Infomedia, Texmaco,
Jindal Strips, Crisil, Godfrey Phillips and Forbes Gokak are among the
2,260 scrips that BSE has agreed to be traded on the Indonext. For this
purpose, agreement is to be worked out between FISE and BSE, to create
a single order book for companies with a paid-up capital of upto Rs. 20
crores. These companies with small capital bases will be called ‘S Group’
companies. Scrips that are traded on BSE ‘A Group,’ would not be included
even if they have a small capital base. Similarly, all ‘Z Group’ scrips at BSE
that have not paid listing fee at the regional stock exchanges, would be
excluded from this group. Once a company is admitted, it cannot come out
of the ‘S Group,’ even if its paid-up capital increases beyond Rs. 20 crores.
Benefits
Indonext offers the advantage of sharing common trading platform,
whereby all the shares listed exclusively in the regional stock exchanges
are placed on a common order book. This would facilitate trading of shares
in all participating exchanges. This would in turn, entail increase of shares
traded and also increase the number of players in this segment.
Members of NSE and BSE would be permitted to trade in Indonext
through limited trading rights, which could be formed at a low entry price.
This would activate the segment with the increase in the number of players,
too. Some of the regional stock exchanges that are set to form a common
trading platform, are the stock exchanges of Madras, Bangalore, Cochin,
Coimbatore, Mangalore and Hyderabad.
REVIEW QUESTIONS
Section A
1. What is a stock exchange?
2. How is a stock exchange defined?
3. Who are ‘remisiers’ on a stock exchange?
4. Who are ‘authorized clerks’ on a stock exchange?
5. Who are ‘brokers’ on a stock exchange?
6. Who are ‘jobbers’ on a stock exchange?
7. Who are ‘tarawaniwalas’ on a stock exchange?
8. Who are ‘dealers’ on a stock exchange?
9. What is ‘settlement cycle’?
10. What is ‘counter party default’?
11. Who is a depository?
12. What is ‘hybrid trading’?
13. What is ‘margin trading’?
14. Who are market makers on a stock exchange?
15. What is allocative efficiency of a stock exchange?
16. What is operational efficiency of a stock exchange?
17. What is ‘NSMS’?
18. What is ‘over-the-counter market system’?
19. What do you know of ‘NSE’?
20. What is ‘corporitization of a stock exchange?
21. What is a ‘demutualized stock exchange?
22. State the objectives of Interconnected Stock Exchange of India
23. What is ‘INDONEXT’?
Section B
1. How is a stock exchange different from a commodity exchange?
2. How are stock exchanges organized in India? Explain.
3. Explain the mode of organization adopted for the Indian stock
exchanges.
4. Who are the traders in a stock exchange?
5. What is the special role played by the SEBI in regulating of stock
exchanges in India?
6. Identify the steps involved in trading on a stock exchange.
7. How does settlement take place on a stock exchange? Explain.
8. State the need for a depository.
9. Analyze the various systems of trading on a stock exchange.
10. How is ‘auction trading system’ different from ‘dealer trading
system’?
11. Who are specialists on a stock exchange? What are their

functions?
12. How does the ‘National Clearance and depository System’
(NCDS) function?
13. Explain the special role of ‘Interconnected Stock Exchange of
India’.
14. Write a note on the trading methodology adopted at the
Interconnected Stock Exchange of India.
15. Write a note on the Indian Public Offering Distribution System
16. State the features of INDONEXT.
17. How is INDONEXT advantageous?
Section C
1. Trace the history of stock exchanges around the world.
2. Give a detailed account of the functions and the role played by
stock exchanges to the general economic development of a nation.
3. Discuss the features of some of the world’s stock exchanges.
4. Trace the history of stock exchanges in India.
5. Analyze the principal weaknesses with which Indian stock
exchanges suffer from?
6. How are Indian stock exchanges regulated? Discuss.
7. Discuss the various forms of measuring the efficiency of a stock
exchange.
8. Capture the recent developments that have taken place in the
realm of Indian stock exchanges.
9. Examine the achievements of Interconnected Stock Exchange of
India.
Chapter 10
Indian Stock Exchange
There are 24 stock exchanges in the country, with 21 of them being regional
in nature. Three others that have been set up in the reforms era, viz.,
National Stock Exchange (NSE), the Over the Counter Exchange of India
Limited (OTCEI), and Interconnected Stock Exchange of India Limited
(ISE) have mandate to nationwide trading network. The ISE has been
promoted by 15 regional stock exchanges in the country and is based at
Mumbai. The ISE provides a member-broker of any of these stock
exchanges an access into the national market segment, which would be in
addition to the local trading segment available at present. The NSE, OTCEI,
ISE, and majority of the regional stock exchanges have adopted the Screen
Based Trading System (SBTS) to provide automated and modern facilities
for trading in a transparent, fair and open manner with access to investors
across the country.
Following are the names of the various stock exchanges in India:
1. The Bombay Stock Exchange
2. The Ahmedabad Stock Exchange Association Ltd
3. Bangalore Stock Exchange Ltd
4. Bhubaneshwar Stock Exchange
5. The Calcutta Stock Exchange Association Ltd
6. The Cochin Stock Exchange Ltd
7. The Delhi Stock Exchange Association Ltd
8. The Guwahati Stock Exchange Ltd
9. The Hyderabad Stock Exchange Ltd
10. The Jaipur Stock Exchange Ltd
11. The Kanara Stock Exchange Ltd
12. The Ludhiana Stock Exchange Association Ltd
13. The Madras stock Exchange Ltd
14. The Madhya Pradesh Stock Exchange Ltd
15. The Magadh Stock Exchange Ltd
16. The Mangalore Stock Exchange Ltd
17. The Pune Stock Exchange Ltd

18. The Saurashtra Kutch Stock Exchange Ltd
19. The Vadodara Stock Exchange Ltd
20. The Coimbatore Stock Exchange
21. The Meerut Stock Exchange Ltd
22. The Over The Counter Exchange of India (OTCEI)
23. The National Stock Exchange of India (NSE)
24. The Interconnected stock Exchange of India Ltd
TH E BOMBAY STOCK EX CHANGE ( BSE)
Genesis
The Bombay Stock Exchange, Mumbai, was originally established in 1875
under the name of “The Native Share and Stockbrokers Association” as a
voluntary non-profit organisation. It is acclaimed as a premier stock
exchange in the country. It is the oldest stock exchange in Asia, much
older than the Tokyo Stock Exchange, which was founded in 1878. The
Exchange while providing an efficient market mechanism also upholds the
interests of the investors and ensures redressal of their grievances, whether
against the companies or its own member-brokers. It also strives to educate
and enlighten the investors by making available necessary informative
inputs.
Management
A Governing Board, comprising of 9 elected directors (one third of them
retire every year by rotation), an Executive Director, 3 Government nominees,
a Reserve Bank of India nominee and 5 public representatives, is the apex
body, which regulates the Exchange and decides its policies. A President,
Vice-President and Honorary Treasurer are annually elected from among
the elected directors by the Governing Board following the election of
directors.
However, as per SEBI Orders issued in March 2001, the elected
directors have been restrained from acting as directors and the Governing
Board presently comprises of only 10 directors, viz., 3 government
nominees, a RBI nominee, 5 public representatives and an Executive
Director. The Executive Director, as the Chief Executive Officer, is
responsible for the day-to-day administration of the Exchange.
BOLT (BSE-ON-LINE-TRADING)
BSE has obtained permission from Securities and Exchange Board of India
(SEBI) for expansion of its BSE-On-Line-Trading (BOLT) network to
In di a n Stock Exchan ge 211
locations outside Mumbai. According to the new arrangements, the

members of the BSE are free to install their own trading terminals at any
place in the country. In order to expand the BOLT network to centers
outside Mumbai and support the smaller regional stock exchanges, the
BSE has admitted subsidiary companies formed by 13 regional stock
exchanges as its members as on November 30, 2001. The members of these
regional stock exchanges work as sub-brokers. The objective is to reach
out to investors in these centers via the members of these Exchanges, and
thus provide them access to the trading facilities in all scrips listed on the
BSE.
Listing of Securities
Listing means admission of securities for the purpose of dealings on a
recognized stock exchange. The securities may be of any public limited
company, Central or State Government, quasi-government and other
financial institutions/corporations, municipalities, etc. The objectives of
listing are:
• Providing liquidity to securities
• Mobilizing savings for economic development
• Protecting interest of investors by ensuring full disclosures
The BSE has a separate Listing Department to grant approval for
listing of securities of companies, in accordance with the provisions of the
Securities Contracts (Regulation) Act, 1956, Securities Contracts
(Regulation) Rules, 1957, Companies Act, 1956, Guidelines issued by SEBI,
and Rules, Bye-laws and Regulations of the Exchange.
A company intending to have its securities listed on the Exchange
has to comply with the listing requirements prescribed by the Exchange.
Some of the requirements are as under:
FOR NEW COMPANI ES
Minimum Capital
New companies can be listed on the Exchange, if their issued and subscribed
equity capital after the public issue is Rs.10 crores. In addition, the issuer
company should have a post-issue net worth (equity capital + free reserves
excluding revaluation reserve) of Rs.20 crores. For new companies in high
technology, (i.e. information technology, internet, e-commerce,
telecommunication, media including advertisement, entertainment etc.) the
following criteria will be applicable regarding the threshold limit:
1. The minimum amount of total income/sales from the main activity,
i.e. the field of information technology, internet, e-commerce,
telecommunication, media including advertisement, entertainment,

etc should be less than 75 percent of the total income during the
two immediately preceding years, as certified by the auditors of
the company
2. The minimum post-issue paid-up equity capital should be Rs.5
crores
3. The minimum market capitalization should be Rs.50 crores. (The
capitalization will be calculated by multiplying the post-issue
subscribed number of equity shares with the issue price)
4. Post-issue net worth (equity capital + free reserves excluding
revaluation reserve) of Rs.20 crores
Minimum Public offer
As per Rule 19(2) (b) of the Securities Contracts (Regulation) Rules, 1957,
securities of a company can be listed on a stock exchange only when at
least 25 percent of each class or kind of securities is offered to the public
for subscription.
In case of IPOs by unlisted companies in the IT and entertainment
sector, at least 10 percent of the securities issued by the company may be
offered to the public subject to the following:
1. Minimum 20 lakh securities are offered to the public (excluding
reservation, firm allotment, and promoters contribution)
2. The minimum size of the offer to the public is 50 crores
For this purpose, the term “offered to the public” means only the
portion offered to the public and does not include reservation of securities
on firm or competitive basis. SEBI may, however, relax this condition on
the basis of recommendations of stock exchange(s), only in respect of a
Government Company defined under Section 617 of the Companies Act,
1956.
FOR COMPANI ES LI STED ON OTHER STOCK EXCHANGES
The companies listed on other stock exchanges and seeking listing on the
BSE are required to fulfill the following criteria:
1. Minimum issued equity capital of Rs. 3 crores
2. Profit track record for at least last three years
3. Minimum net worth of Rs. 20 crores (net worth includes equity
capital and free reserves excluding revaluation reserves)
4. Minimum market capitalization of Rs. 20 crores, based on average
price of last six months
5. Trading for a minimum 50 percent of the total trading days during

the same six months on any stock exchange
6. Minimum average volume traded per day during the last three
complete months should be 1,000 shares and minimum 5 trades
per day
7. 25 percent of the issued capital should be with public (including
body corporates) and minimum 15 shareholders per Rs. 1 lakh of
capital in the public category
8. The company should be agreeable to sign an agreement with
CDSL and NSDL for DEMAT Trading
FOR COMPANI ES DELI STED ALREADY AND SEEKI NG RELI STI NG

OF THI S EX CHANGE
The companies delisted by this Exchange and seeking relisting are required
to make a fresh public offer and comply with the prevailing SEBI’s and
BSE’s guidelines regarding initial public offerings.
Permission to use the Name of the Exchange
The Exchange follows a procedure in terms of which companies desiring
to list their securities offered through public issues, are required to obtain
its prior permission to use the name of the Exchange in their prospectus or
offer for sale documents before filing the same with the concerned office
of the registrar of companies. The Exchange has since last three years
formed a “Listing Committee” to analyze draft prospectus/offer documents
of the companies in respect of their forthcoming public issues of securities
and decide upon the matter of granting them permission to use the name
of “The Stock Exchange, Mumbai” in their prospectus/offer documents.
The committee evaluates the promoters, company, project and several
other factors before taking a decision in this regard.
Submission of Letter of Application
As per Section 73 of the Companies Act, 1956, a company seeking listing
of its securities on the Exchange is required to submit a letter of application,
to all the stock exchanges where it proposes to have its securities listed,
before filing the prospectus with the registrar of companies.
Allotment of Securities
As per listing agreement, a company is required to complete allotment of
securities offered to the public within 30 days of the date of closure of the
subscription list and approach the regional stock exchange, i.e. stock
exchange nearest to its registered office for approval of the basis of
allotment. In case of Book-building issue, allotment shall be made not later

than 15 days from the closure of the issue, failing which, interest at the rate
of 15 percent shall be paid to the investors.
Trading Permission
As per the SEBI guidelines, the issuer company should complete the
formalities for trading at all the stock exchanges where the securities are to
be listed within 7 working days of finalization of basis of allotment.
A company should scrupulously adhere to the time limit for allotment
of all securities and dispatch of allotment letters/share certificates and
refund orders, and for obtaining the listing permissions of all the exchanges
whose names are stated in its prospectus or offer documents. In the event
of listing permission to a company being denied by any stock exchange,
where it had applied for listing of its securities, it cannot proceed with the
allotment of shares. However, the company may file an appeal before the
SEBI under Section 22 of the Securities Contracts (Regulation) Act, 1956.
Security Deposit
The companies making public/rights issues are required to deposit 1 percent
of issue amount with the regional stock exchange before the issue opens.
This amount is liable to be forfeited in the event of the company not
resolving the complaints of investors regarding delay in sending refund
orders/share certificates, non-payment of commission to underwriters,
brokers, etc.
Listing Fees
All companies listed on the Exchange have to pay annual listing fees by
the 30th April of every financial year, to the exchange as per the schedule
of listing fees prescribed from time to time.
Listing Agreement
The companies desirous of getting their securities listed are required to
enter into an agreement with the Exchange called the ‘listing agreement’
and they are required to make certain disclosures and perform certain acts.
As such, the agreement is of great importance and is executed under the
common seal of a company. Under the listing agreement, a company
undertakes, amongst other things, to provide facilities for prompt transfer,
registration, sub-division and consolidation of securities; to give proper
notice of closure of transfer books and record dates, to forward copies of
unabridged Annual Reports and Balance Sheets to the shareholders, to
file distribution schedule with the Exchange annually; to furnish financial
results on a quarterly basis; intimate promptly to the Exchange the

happenings which are likely to materially affect the financial performance
of the company and its stock prices, to comply with the conditions of
Corporate Governance, etc.
The listing department of the Exchange monitors the compliance of the
companies with the provisions of the listing agreement, especially with
regard to timely payment of annual listing fees, submission of quarterly
results, requirement of minimum number of shareholders, etc and takes penal
action against the defaulting companies.
‘Z ’Group
The Exchange has introduced a new category called ‘Z Group’ from July
1999, for companies which have not complied with and are in breach of
provisions of the listing agreement. The BSE has the highest number of
companies under this category among the Stock Exchanges in the country
and in the world.
SAFETY OF MARKET
The BSE has initiated the following measures towards making the trading,
both on-floors and off-floors safer:
Surveillance Department
One of the objectives of the Exchange is to promote and inculcate
honourable and just practices of trade in securities, and to discourage
malpractices. The surveillance function at the Exchange has assumed
greater importance in recent times. The Exchange has accordingly set up a
separate surveillance department to keep a close watch on price movement
of scrips, detect market manipulations like price rigging, etc monitor
abnormal prices and volumes which are not consistent with normal trading
pattern. Besides, the department also monitors the member-brokers’ position
to ensure that defaults do not occur. A general manager, who reports
directly to the Executive Director, heads the department. The surveillance
department monitors exposure of the members on a daily basis. It also
scrutinizes the prices and volumes of the scrips on a daily basis.
Circuit Filters
The limit imposed by a stock exchange for the price of a security to move
within a prescribed band is called ‘circuit filters’. The imposition of circuit
filters on scrips ensures that the price of scrip cannot move upward or
downward beyond the limit set for a day and a settlement. The objective is
to prevent price manipulation. Under this dispensation, the large variation
in the prices as well as the volumes of the scrips is scrutinized and

appropriate actions taken.
The scrips, which reach new high or new low, and companies which
have high turnover, are watched. Similarly, the prices and volumes in the
newly listed scrips are monitored. In case, certain abnormalities are noticed,
then circuit filters are reduced to make it difficult for the price manipulators
to increase or push down the prices of scrip within a short period of time.
The Exchange imposes special margin on the scrips where it is suspected
that there is an attempt to ramp up the prices by creating artificial volumes.
In cases where the abnormal movements continue despite the aforesaid
measures, trading in the scrip is suspended.
As per the guidelines issued by SEBI, the stock exchanges are required
to apply daily circuit filter of 8 percent on scrips quoting above Rs. 20.
However, in respect of scrips quoting below Rs. 20, the exchanges are free
to set their own circuit filters. The Exchange has accordingly prescribed 8
circuit filters for scrips quoting above Rs. 10 but below Rs. 20, and for
scrips quoting upto Rs. 10, daily and weekly circuit filters are 25 percent
and 50 percent respectively. As directed by SEBI, the circuit filter limit is
200 scrips, which are commonly traded and jointly identified by BSE and
NSE scrips, which are under the compulsory rolling settlement, has been
relaxed to 16 percent with effect from July 3, 2000. In this connection, it has
been decided that if scrip touches 8 percent circuit filter band in either
direction, the circuit filter would be relaxed by another 8 percent in that
same direction.
Detailed investigations are conducted in cases where price
manipulation is suspected and disciplinary action is taken against the
members concerned, if warranted. Where any scrip has been suspended
for more than three days, a detailed investigation report is prepared and
sent to SEBI for further investigation/action, if any.
OLRT
With effect from July 15, 1999 the Exchange is using an On-line Real Time
(OLRT) Surveillance System. Under this system, alerts are generated by
the system on-line, in real time, based on certain preset parameters like the
price and volume variation in scrips, members taking unduly large positions
not commensurate with their financial position or having concentrated
position(s) in one or a few scrips, etc.
This system includes databases such as company profile, members’
profile and historical database of turnover and price movement in scrips,
members’ turnover, their pay-in obligations, etc. The system generates
alerts on the basis of preset parameters during the trading hours, and
corrective action based on further investigations is taken in such cases.
Transfer of Ownership
Transfer of ownership of securities, if the same is not delivered in demat
form by the seller, is effected through a date-stamped transfer deed, which
is signed by the buyer and the seller. The duly executed transfer deed
along with the share certificate has to be lodged with the company for
change in the ownership. A nominal duty is payable in the form of stamps
to be affixed on the transfer-deeds. Transfer-deed remains valid for twelve
months or the next book closure following the stamped date whichever
occurs later for transfer of shares in the name of the buyer. However, for
delivery of shares in the market, transfer deed is valid till book closure date
of the company.
Brokerage and Transaction Costs
Brokerage is negotiable. The Exchange has not prescribed any minimum
brokerage. The maximum brokerage is subject to a ceiling of 2.5 percent of
the contract value. However, the average brokerage charged by the
members to the clients is much lower. Typically there are different scales of
brokerages for delivery transaction, trading transaction, etc. The stamp
duty on transfer of securities in physical form is to be paid by the seller but
in practice the buyer while registering the shares in his name pays it. In
case of transfer of shares, the rate is 50 paise for every Rs.100/- or part
thereof on the basis of the amount of consideration, and that for transfer
of debentures the rate of stamp duty varies from state to state, where the
registered office of a company issuing the debentures is located.
OPPORTUNI TI ES FOR FOREI GN I NVESTORS
Following are the opportunities available for foreign investors:
1. Direct investment Foreign companies are now permitted to have a
majority stake in their Indian affiliates except in a few restricted
industries. In certain specific industries, foreigners can even have
holding up to 100 percent.
2. Investment through stock exchanges Foreign Institutional Investors
(FIIs) upon registration with the SEBI and the Reserve Bank of India
are allowed to operate on the Indian stock exchanges subject to the
guidelines issued for the purpose by SEBI. Important guidelines in
this regard are as follows:
Portfolio investment in primary or secondary market of a company
by all registered FIIs, NRIs and OCBs is subject to a ceiling of 30/40
percent of issued share capital. Holding by a single FII, NRI or OCB in

any one company is subject to a ceiling of 10 percent of the total
issued capital. However, in applying the ceiling of 30/40 percent the
following are excluded:
a. Foreign investment under a financial collaboration, which is
permitted up to 51 percent in all priority areas
b. Investment by FII’s through offshore single/regional funds,
GDR’s and euro convertibles
Disinvestment is allowed through a member broker of a stock
exchange. A registered FII is required to buy or sell securities on the
stock exchanges only for delivery. It is not allowed to offset a deal in
the same settlement. It is also not allowed to sell short i.e., sell a
security without having the stock in its portfolio.
3. Investment in euro issues/mutual funds floated overseas Foreign
investors can invest in Euro issues of Indian companies and in India-
specific funds floated abroad.
Broking Business
Foreign brokers upon registration with the SEBI are now allowed to route
the business of their registered FIIs clients through the members of Stock
Exchanges. Guidelines for the purpose have been issued by SEBI.
Asset management compani es/ merchant banki ng Foreign
participation in Asset Management Companies and Merchant Banking
Companies is also permitted.
Trading and Settlement
1.T rading— BOLT The Exchange, which had an open outcry trading
system, had switched over to a fully automated computerized mode of
trading known as BOLT (BSE-On-Line-Trading) system with effect from
March 14, 1995. Through the BOLT system the members can now enter
orders from Trader Work Stations (TWSs) installed in their offices instead
of assembling in the trading ring. This system, which was initially both
order and quote driven, was commissioned on March 14, 1995. However,
the facility of placing of quotes has been removed w.e.f. August 13, 2001 in
view of lack of market interest and to improve system-matching efficiency.
The system, which is now only order driven, facilitates more efficient
processing, automatic order matching and faster execution of orders in a
transparent manner.
2. Scrips group Trading on the BOLT System is conducted from
Monday to Friday between 9:55 a.m. and 3:30 p.m. The scrips traded on
the Exchange have been classified into ‘A’, ‘B1’, ‘B2’, ‘F’ and ‘Z’ groups.
The ‘F’ group represents the debt market (fixed-income securities). The ‘Z’
group was introduced by the Exchange in July 1999 and covers the
companies which have failed to comply with listing requirements and/or
failed to resolve investor complaints or have not made the required
arrangements with both the Depositories, viz., Central Depository Services
(I) Ltd. (CDSL) and National Security Depository Ltd. (NSDL) for
dematerialization of their securities by the specified date, i.e. September
30, 2001.
3. ‘C’ group scrip The Exchange has also the facility to trade in
‘C’ group which covers the odd lot securities in ‘A’, ‘B1’, ‘B2’ and ‘Z’
groups and Rights renunciations in all the groups of scrips in the equity
segment. The Exchange, thus, provides a facility to market participants of
on-line trading in odd lots of securities and Rights renunciations. The
facility not only offers an exit route to investors to dispose of their odd
lots, but also provides them an opportunity to consolidate their securities
into market lots.
4. Exit route scheme The ‘C’ group can also be used by investors
for selling up to 500 shares in physical form in respect of scrips of
companies where trades are to be compulsorily settled by all investors in
demat mode. This scheme of selling physical shares in compulsory demat
scrips is called as Exit Route Scheme. With effect from December 31, 2001,
trading in all securities listed in equity segment of the Exchange takes
place in one market segment, viz., Compulsory Rolling Settlement Segment.
5. P ermi tted securi ti es The Exchange permits trading in the
securities of the companies listed on other stock exchanges under
“Permitted Securities” category, which meet the relevant norms specified
by the Exchange. Accordingly, to begin with the Exchange has permitted
trading in scrips of five companies listed on other Stock Exchanges w.e.f.
April 22, 2002.
6. Closi ng pri ce The closing prices of scrips are computed on
the basis of weighted average price of all trades in the last 15 minutes of
the continuous trading session. However, if there is no trade during the
last 15 minutes, then the last-traded price in the continuous trading session
is taken as the official closing price.
Compulsory Rolling Settlement ( CRS) Segment
With a view to introduce the best international trading practices and to
achieve higher settlement efficiency, as mandated by SEBI, trades in all
the equity shares listed on the Exchange in CRS Segment were to be
settled on T+5 basis w.e.f. December 31, 2001. SEBI has further directed
the Stock Exchanges that trades in all scrips w.e.f. April 1, 2002 should be
settled on T+3 basis. Accordingly, all transactions in all groups of securities
in the equity segment and fixed-income securities listed on the Exchange
are settled on T+3 basis w.e.f. April 1, 2002.
Under a rolling settlement environment, the trades done on a particular
day are settled after a given number of business days, rather than settling
all trades done during a period at the end of an ‘account period.’ A T+3
settlement cycle means that the final settlement of transactions done on a
trade day by exchange of monies and securities occurs on the fifth business
day after the trade day.
The transactions in securities of companies which have made
arrangements for dematerialization of their securities by the stipulated
date are settled only in Demat mode on T+3 on net basis, i.e. buy and sale
positions in the same scrip are netted and the net quantity is to be settled.
However, transactions in securities of companies, which have failed to
make arrangements for dematerialization of their securities (‘Z’ group) are
settled only on trade to trade basis on T+3, i.e. the transactions are settled
on a gross basis and the facility of netting of buy and sale transactions in
a scrip is not available.
I llustration
If one buys and sells 100 shares of a company on the same day, which is
on trade to trade basis, the two positions will not be netted and he will
have to first deliver 100 shares at the time of pay-in of securities and then
receive 100 shares at the time of pay-out of securities on the same day.
Thus, if one fails to deliver the securities sold at the time of pay-in, it will
be treated as a shortage and the position will be auctioned/closed-out. In
other words, the transactions in scrips of companies which are in
compulsory demat are settled in demat mode on T+3 netting basis and the
transactions in scrips of companies, which have not made arrangements
for dematerialization of their securities by the stipulated date or are in ‘Z’
group for other reasons, are settled on trade to trade basis on T+3 either in
demat mode or in physical mode. The settlement of transactions in ‘F’
group securities representing Fixed Income Securities is also on Rolling
Settlement Cycle of T+3 basis.
The Information Systems Department (ISD) of the Exchange generates
the following statements, which can be downloaded by the members in
their back offices on a daily basis:
a. Statement giving details of the daily transactions entered into by

the members
b. Statements giving details of margins payable by the members in
respect of the trades executed by them
The settlement of the trades (money and securities) done by a member
on his own account or on behalf of his individual, corporate or institutional
clients may be either through the member himself or through a SEBI
registered Custodian appointed by him or the respective client. In case the
delivery/payment is to be given or taken by a registered custodian, he has
to confirm the trade done by a member on the BOLT System through 6A-
7A entry. For this purpose, the custodians have been given connectivity
to BOLT System and have also been admitted as members of the clearing
house. In case a registered Custodian does not confirm a transaction, the
liability for pay-in of funds or securities in respect the same devolves on
the concerned member. The introduction of settlement on T+3 basis has
resulted in reduction in settlement risk, besides providing early receipt of
securities and monies to buyers and sellers respectively, and brought
Indian Capital Markets at the international standard of settlements.
Settlement
The trades done by members in all the securities in CRS are now settled by
payment of money and delivery of securities on T+3 basis. All deliveries
of securities are required to be routed through the clearing house, except
for certain off-market transactions, which, although are required to be
reported to the Exchange, may be settled directly between the members
concerned. The scheme of operations in this regard is outlined below:
1. Clearing house The clearing house is an independent company
promoted jointly by Bank of India and the BSE for handling the clearing
and settlement operations of funds and securities on behalf of the
Exchange. For this purpose, the Clearing and Settlement Department of
the Exchange liaises with the clearing house on a day-to-day basis. The
Information Systems Department of the Exchange generates ‘delivery and
receive orders’ for transactions done by the members in A, B1, B2 and F
group scrips after netting purchase and sale transactions in each scrip
whereas delivery and receive orders for ‘C’ and ‘Z’ group scrips are
generated on trade to trade basis, i.e. without netting of purchase and sale
transactions in a scrip.
2. Delivery orders The delivery orders provide information like
scrip, quantity and the name of the receiving member to whom the securities
are to be delivered through the clearing house. The money statement
provides scrip wise/item wise details of payments/receipts for the

settlement. The members in their back offices can download the delivery/
receive orders and money statements. The bank accounts of members
maintained with the eight clearing banks, viz., Bank of India, HDFC Bank
Ltd., Global Trust Bank Ltd., Standard Chartered Bank, Centurion Bank
Ltd., UTI Bank Ltd., ICICI Bank Ltd., and Indusind Bank Ltd., are directly
debited through computerized posting for their settlement and margin
obligations, and credited with receivables on accounts of pay-out dues
and refund of margins. The securities, as per the delivery orders issued by
the Exchange, are required to be delivered by the members in the clearing
house on the day designated for securities pay-in i.e., on T+3 day. In case
of the physical securities, the members have to deliver the securities in
special closed pouches (supplied by the Exchange) along with the relevant
details (distinctive numbers, scrip code, quantity, and receiving member)
on a floppy. The data submitted by the members on floppies is matched
against the master file data on the clearing house computer systems. If
there are no discrepancies, then the clearing house generates a scroll
number and a scroll slip is issued. The members can then submit the
securities at the receiving counter in the clearing house.
3. Auto D .O. faci li ty Instead of issuing Delivery-Out (D.O)
instructions for their delivery obligations in a settlement/auction, a facility
has been made available to the members by automatically generating
Delivery-Out instructions on their behalf from their CM (Clearing Member)
pool a/cs by the clearing house w.e.f. August 10, 2000. This Auto D.O.
facility is available for CRS (normal & auction) and for trade-to-trade
settlements. This facility is, however, not available for delivery of non-pari
passu shares and shares having multiple ISINs. The members wishing to
avail of this facility have to submit an authority letter to the clearing
house. This Auto D.O. facility is currently available only for clearing member
pool accounts/principal accounts maintained by the members with National
Securities Depository Ltd. (NSDL) and Central Depositories Services Ltd.
(CDSL).
4. D emat pay- i n The members can effect demat pay-in either
through CDSL or the NSDL. In case of NSDL, the members are required to
give instructions to their Depository Participant (DP) specifying settlement
number, settlement type, effective pay-in date, quantity, etc. The securities
are transferred to the pool account. The members are required to give
delivery-out instructions so that the securities are considered for pay-in.
As regards CDSL, the members give pay-in instructions to their DP.
The securities are transferred by the DPs to the Clearing Member (CM)
Principal Account. The members are required to give confirmation to their

DP, so that securities are processed towards pay-in obligations.
Alternatively, the members may also effect pay-in from the clients’
beneficiary accounts for which they are required to do break-up on the
front-end software to generate obligations and settlement IDs.
5. Securi ties buy-i n The clearing house arranges and tallies the
securities received against the receiving member-wise report generated
on the pay-in day. This process is called ‘securities pay-in’. Once this
reconciliation is complete, the bank accounts of members with eight clearing
banks having pay-in obligations are debited on the scheduled pay-in day.
This procedure is called ‘pay-in of funds’. Once the pay-in of securities
and funds is complete, the clearing house arranges for payout of securities
and funds. As regards payout of securities, in case of demat securities,
the same are credited in the Pool Account of the members or the client
accounts as per the client details submitted by the members. In case of
physical securities, the receiving members are required to collect the same
from the clearing house on the payout day. The clearing house with the
clearing banks credits the bank accounts of the members having payout of
funds. This process is referred to as payout of funds. In case of rolling
settlements, pay-in and payout of both funds and securities is completed
on the same day.
The settlement schedules are drawn by the Exchange in advance on a
quarterly basis and circulated to the market participants. The settlement
schedules have been strictly adhered to by the Exchange and there has
been generally no case of clubbing of settlements or postponement of
pay-in and payout during the last over six years.
Database on Bad Paper
The Exchange is also maintaining a database of fake/forged, stolen, lost
and duplicate securities in physical form with the clearing house, so that
distinctive numbers submitted by members in case of physical securities
on delivery may be matched against the database to weed out bad paper
from circulation at the time of introduction of such securities in the market.
This database has also been made available to the members so that
delivering and receiving members can check the entry of fake, forged and
stolen shares in the market.
SH ORTAGES AND OBJECTI ONS
Shortages and Consequent Actions
The members download delivery/receive orders based on their netted
positions for transactions entered into by them, during a settlement in ‘A’,
‘B1’, ‘B2’, and ‘F’ group scrips and on trade-to-trade basis i.e., without
netting buy and sell transactions in scrips in ‘C’ & ‘Z’ groups and scrips
in B1 and B2 groups which have been put on trade-to-trade basis as a
surveillance measure.
The seller-members have to deliver the shares in the clearing house
as per the delivery orders downloaded. If a seller-member is unable to
deliver the shares on the pay-in day for any reason, his bank account is
debited at the standard rate (which is equal to the closing price of the scrip
on the day of trading) fixed by the Exchange for the quantity of shares
short-delivered. The clearing house arrives at the shortages in delivery of
various scrips by members on the basis of their delivery obligations and
actual delivery.
The members can download the statement of shortages on T+3 in
rolling settlements. After downloading the shortage details, the members
are expected to verify the same and report discrepancy, if any, to the
clearing House by 1:00 p.m. If no discrepancy is reported within the
stipulated time, the clearing house assumes that the shortage of a member
is in order and proceeds to auction the same. However, in ‘C’ group, i.e.
Odd Lot segment the members are themselves required to report the
shortages to the clearing house.
The Exchange issues an ‘Auction Tender Notice’ to the members
informing them about the names of the scrips, quantity slated for auction
and the date and time of the auction session on the BOLT. The auction for
the undelivered quantities is conducted on T+4 for all the scrips under
compulsory rolling settlements. The auction offers received in batch mode
which are electronically matched with the auction quantities so as to award
the ‘best price’. The members who participate in the auction session can
download the delivery orders on the same day, if their offers are accepted.
The members are required to deliver the shares in the clearing house on
the auction pay-in day, i.e. T+5. Payout of auction shares and funds is also
done on the same day, i.e. T+5. The various auction sessions relating to
shortages, and bad deliveries are conducted during normal trading hours
on BOLT. Thus, it is possible to schedule multiple auction sessions on a
single trading day.
In auction, the highest offer price is allowed up to the close-out rate and
the lowest offer price can be 20 percent below the closing price on a day
prior to day of auction. A member who has failed to deliver the securities of
a particular company on the pay-in day is not allowed to offer the same, in
auction. He can, however, participate in auction of other scrips.
In case no offers are received in auction for a particular scrip, the sale
transaction is closed-out at a close-out price, determined by higher of the
highest price recorded in the scrip from the settlement, in which the
transaction took place up to a day prior to the day of the auction or
20 percent above the closing price on a day prior to the day of auction.
However, in case of the closeout of the shares under objection and
shortages in ‘C’ or ‘Z’ group, 10 percent above the closing prices of the
scrips on the payout day of the respective settlement are considered
instead of 20 percent. Further, if the auction price/close-out price of scrip
is higher than the standard price of the scrip in the settlement in which the
transaction was done, the difference is recovered from the seller who
failed to deliver the scrip. However, in case, auction/closeout price is
lower than standard price, the difference is not given to the seller but is
credited by the Exchange to the Customers Protection Fund. This is to
ensure that the seller does not benefit from his failure to meet his delivery
obligation. Further, if the offeror-member fails to deliver the shares offered
in auction, then the transaction is closed-out as per the normal procedure
and the original selling member pays the difference below the standard
rate and offer rate and the offeror-member pays the difference between the
offer rate and close-out rate.
Self-auction
The ‘Delivery and Receive Orders’ are issued to the members after netting
off their purchase and sale transactions in scrips, where netting of purchase
and sale positions is permitted. It is likely in some circumstances that a
selling client of a member has failed to deliver the shares to him. However,
this did not result in a member’s failure to deliver the shares to the clearing
house, as there was a purchase transaction of some other buying client of
the member in the same scrip, and the same was netted off for the purpose
of settlement. In such a case, the member would require shares so that he
can deliver the same to his buying client, which otherwise would have
taken place from the delivery of shares by the seller. To provide shares to
the members, so that they are in a position to deliver them to their buying
clients in case of internal shortages, the members have been given an
option to submit floppies for conducting self-auction, (i.e. as if they have
defaulted in delivery of shares to the Clearing House). Such floppies are to
be given to the clearing house on the pay-in day.
The internal shortages reported by the members are clubbed with the
normal shortages in a settlement and the clearing house for the combined
shortages conducts the auction. A member after getting delivery of shares
from the clearing house in self-auction credits the shares to the beneficiary
account of his client or hand over the same to him, in case securities
received are in physical form and debits his seller-client with the amount
of difference, if any, between the auction price and original sale price.
Obj ections
When receiving members collect the physical securities from the Clearing
House on the Payout day, the same are required to be checked by them for
good delivery as per the norms prescribed by the SEBI in this regard. If the
receiving member does not consider the securities good delivery, he has
to obtain an arbitration award from the arbitrators and submit the securities
in the Clearing House on the following day of the receipt.
The clearing house returns these securities to the delivering members
on the same day, i.e. (T+4). If a delivering member feels that arbitration
award obtained against him is incorrect, he is required to obtain arbitration
award for invalid objection from the members of the Arbitration Review
Committee. The delivering members are required to rectify/replace the
objections and return the shares to the clearing house on the next day
(T+5) to have the entry against them removed. The Clearing House delivers
the rectified securities to the buyer-members on the same day (T+5). The
buyer-members, if they are not satisfied with the rectification, are required
to obtain arbitration awards for invalid rectification from the Bad Delivery
Cell on T+6 day and submit the shares to the clearing house on the same
day. If a member fails to rectify/replace the objections then the same are
closed-out. This is known as “Objection Cycle” and the entire process
takes 3 days.
The un-rectified and invalid rectification of securities are directly
closed-out by the clearing house instead of first inviting the auction offers
for the same. The shares in physical form returned under objection to the
clearing house are required to be accompanied by an arbitration award
(Chukada) except in certain cases where the receiving members are
permitted to submit securities to the clearing house without ‘Chukada.’
These cases are as follows:
• Transfer Deed is out of date
• Cheques for the dividend adjustment for new shares where
distinctive numbers are given in the Exchange Notice is not
enclosed
• Stamp of the Registrar of Companies is missing
• Details like Distinctive Numbers, Transferors’ Names, etc are not
filled, in the Transfer Deeds
• Delivering broker’s stamp on the reverse of the Transfer Deed is

missing
• Witness stamp or signature on Transfer Deed is missing
• Signature of the transferor is missing
• Death Certificate (in cases where one or more of the transferors
are deceased) is missing
A penalty at the rate of Rs.100/- per Delivery Order is levied on the
delivering member for delivering shares, which are not in order. In the
event of a receiving member misusing the facility of submitting shares
under objection without ‘Chukada,’ a penalty of Rs.500/- per case is
charged and the penalty of Rs.100/- per Delivery Order levied on the
delivering member is refunded to him by debiting the receiving member’s
account.
Book-building
Book-building is basically a capital issuance process used in Initial Public
Offer (IPO), which aids price and demand discovery. It is a process used
for marketing a public offer of equity shares of a company. It is a mechanism
where, during the period for which the book for the IPO is open, bids are
collected from investors at various prices, which are above or equal to the
floor price. The process aims at tapping both wholesale and retail investors.
The offer/issue price is then determined after the bid closing date, based
on certain evaluation criteria.
The Process
The process of book-building as followed at the BSE is described below:
• Book runner The Issuer who is planning an IPO nominates a
lead merchant banker as a ‘book runner’
• Price band The Issuer specifies the number of securities to be
issued and the price band for orders
• Syndicate The Issuer also appoints syndicate members with
whom orders can be placed by the investors
• Placing orders Investors place their order with a syndicate
member who inputs the orders into the ‘electronic book’. This
process is called ‘bidding’ and is similar to open auction. The
book should remain open for a minimum of 5 days. Bids cannot
be entered less than the floor price. The bidder can revise bids
before the issue closes
• Evaluation On the close of the book-building period the ‘book
runner’ evaluates the bids on the basis of the evaluation criteria
which may include Price Aggression, Investor quality of bids, etc.
• Final Price The book runner and the company conclude the
final price at which it is willing to issue the stock
• Quantum The number of shares are fixed, the issue size gets
frozen based on the price per share discovered through the book-
building process. Allocation of securities is made to the successful
bidders
BSE’s Book- building System
The book-building process that is in vogue is explained below:
• BSE offers the book-building services through the book-building
Software that runs on the BSE private network
• This system is one of the largest electronic book-building
networks anywhere spanning over 350 Indian cities through over
7000 Trader Work Stations via leased lines, VSATs and Campus
LANS
• The syndicate member-brokers operate the software through
book-runners of the issue. Through this book, the syndicate
member-brokers on behalf of themselves or their clients’ place
orders
• Bids are placed electronically through syndicate members and
the information is collected on-line real time until the bid date
ends
In order to maintain transparency, the software gives visual graphs
displaying price v/s quantity on the terminals.
I nitial Public Offerings
Corporates may raise capital in the primary market by way of an initial
public offer, rights issue or private placement. An Initial Public Offer (IPO)
is the selling of securities to the public in the primary market. This Initial
Public Offering can be made through the fixed price method, book-building
method or a combination of both.
In case the issuer chooses to issue securities through the book-
building route then as per SEBI guidelines, an issuer company can issue
securities in the following manner:
• 100 percent of the net offer to the public through the book-building
route
• 75 percent of the net offer to the public through the book-building
process and 25 percent through the fixed price portion
Under the 90 percent scheme, this percentage would be 90 and 10
respectively.
DERI VATI VESTRADI NG

The Stock Exchange, Mumbai created history by launching the first
Exchange traded financial derivatives product in India, the Sensex Futures.
Sensex I ndex
An index is an indicator of the broad market. For instance, tracking the
changes in the Sensex enables one to effectively gauge stock market
movements. The BSE 30 Sensex, first compiled in 1986, is a market
capitalization weighted index of 30 scrips. It represents 30 large well-
established and financially sound companies. The Sensex also has the
largest social recall attached with it. It was the first index to be launched by
any Stock Exchange in India and has acquired a unique place in the
collective memory of investors. It facilitates investors to relate to the
market. The most important advantage is that, as one of the oldest and
reliable barometers of the Indian Stock Market, it provides time series data
over a fairly long period of time. The primary consideration in minimizing
changes in the composition of the BSE 30 has been for historical purposes.
However, the structural and market driven changes are taken into
consideration. While an index must represent the current state of an
evolving market, it should concurrently maintain the track record of
changes in the Indian capital markets. The Sensex represents a broad
spectrum of companies in a variety of industries. It represents 14 major
industry groups, which are large enough to be used for effective hedging.
Trading in Sensex Futures
Given the lower cost structure and the overwhelming popularity of the
Sensex, Sensex futures are expected to garner large volumes. The Sensex
futures are expected to become the most liquid contract in the country.
This is because institutional investors in India and abroad, money managers
and small investors use the Sensex, when it comes to describing the mood
of the Indian Stock Markets. Thus is has been observed that the Sensex is
an effective proxy for the Indian stock markets. Higher liquidity in the
product essentially translates to lower impact cost of trading in Sensex
futures. The arbitrage between the futures and the equity market is further
expected to reduce impact cost. Trading in stock index futures is likely to
be pre-dominantly retail driven. Internationally, stock index futures are an
institutional product with 60 percent of the volumes generated from hedging
needs. Immense retail participation to the extent of 80–90 percent is
expected in India based on the following factors:
1. Stock index futures will require lower capital adequacy and margin
requirements as compared to margins on carry forward of
individual scrips.
2. The brokerage costs on index futures will be much lower.
3. Savings in cost is possible through reduced bid-ask spreads
where stocks are traded in packaged forms.
4. The impact cost will be much lower in case of stock index futures
as opposed to dealing in individual scrips.
The market is conditioned to think in terms of the index and therefore,
would prefer to trade in stock index futures. Further, the chances of
manipulation are much lesser.
The stock index futures are expected to be extremely liquid given the
speculative nature of our markets and the overwhelming retail participation
expected to be fairly high. It is poised to become the most liquid contract
in the world in terms of number of contracts traded, if not in terms of
notional value. The advantage to the equity or cash market is in the fact
that they would become less volatile as most of the speculative activity
would shift to stock index futures. The stock index futures market should
ideally have more depth, volumes, and act as a stabilizing factor for the
cash market. However, it is too early to base any conclusions on the
volume or to form any firm trend.
Operators in the Derivatives Market
Operators in a derivatives market include the following:
1. Hedgers Operators, who want to transfer a risk component of
their portfolio.
2. Speculators Operators, who intentionally take the risk from
hedgers in pursuit of profit.
3. Arbitrageurs Operators who operate in the different markets
simultaneously, in pursuit of profit and eliminate mis-pricing.
CALCUTTA STOCK EX CH ANGE

Genesis
The origin of stock broking in India goes back to a time, when shares,
debentures and bonds representing titles to property were first issued on
the condition of transfer from one person to another. The earliest record of
dealings in securities in India is the East India Company’s loan securities.
By 1836, there was a perceptible increase in the volume of business in
Calcutta. The then widely circulated newspaper from Calcutta ‘The English
Man’ contained quotations of 4 percent, 5 percent and 6 percent loans of

the East India Company, with the shares of the Bank of Bengal being
quoted at a considerably high premium over the par value of Rs. 100/-.
Three years later, in 1839, quotations were also found in newspapers
published from Calcutta, of shares of the Union Bank, the Agra Bank and
certain other commercial undertakings like Bengal Bonded Warehouse
Docking Company and Steam Tug Company. The advent of the Companies
Act 1850, and subsequent introduction of the principle of limited liability,
made investments in stocks and shares popular.
In May 1908, an association was formed under the name and style of
the Calcutta Stock Exchange Association at 2, China Bazar Street. On June
7, 1923 the Association was registered as a limited liability concern, with
an authorized capital of Rs. 3 lakhs divided into 300 shares of Rs. 1,000/-
each. The shares were subdivided into 4 shares of Rs. 250/- each in 1959.
The Golden Jubilee of the Association was celebrated in 1938. The Diamond
Jubilee in 1968, and The Platinum Jubilee in 1983.
At the time of incorporation in 1908, the Stock Exchange had 150
members. Today the total membership has risen to more than 900, which
consist of several corporate and institutional members. The Calcutta Stock
Exchange has been granted permanent recognition by the Central
Government with effect from April 14, 1980 under the relevant provisions
of the Securities Contracts (Regulation) Act, 1956, with a view to render
useful service to investors.
In the year 1997, the Calcutta Stock Exchange ushered in a new era by
replacing the old manual trading system with completely computerized
on-line trading and reporting system known as C-STAR (CSE Screen Based
Trading And Reporting). The computerized trading started initially with
101 ‘B’ Group scrips. Subsequently with effect from 7.3.1997 remaining ‘B’
Group and all ‘Permitted Group’ scrips (approx. 3,500) were transferred on
to the C-STAR systems. The exchange finally shifted the entire ‘A’ Group
scrips to the computerized system with effect from April 4, 1997.
Governing Body
The Calcutta Stock Exchange is managed by a Governing Body which
consists of a President, a Vice-President, both elected from the members of
the CSE. From among the 8 elected members of the CSE, 3 are Government
nominees (appointed by SEBI) and 6 are public representatives. The
Executive Director, appointed by the Exchange with SEBI’s approval,
discharges the executive functions. The Governing body is responsible
for policy formulation and for ensuring smooth functioning of the exchange.
Trading, Clearing and Settlement

CSE has an auction type of trading with bids and offers being made by
open outcry. There is no compulsory market-making at CSE but it has an
informal system of jobbers. Communication in the trading ring is either
verbal or through hand signals. Traders within the ring can communicate
with their offices on intercoms provided by the CSE within the trading
ring. The jobbers stand at specific locations in the trading ring called
trading posts. They continuously announce the two-way quotes for the
scrips traded at the post. As there is no prohibition on a jobber acting as
a broker or a broker as a jobber, members are free to do jobbing on any day.
However, an identifiable group emerges which confines its activities to
jobbing alone. The Reuter rare display board and the PTI stocks is used
for the dissemination of information, for showing the current prices of the
important shares in other exchanges and the CSE from time to time. They
also publish scrip-wise volume of trades in the official line.
On striking a deal, traders enter abbreviated details in small ‘souda
books’. At the end of the trading all deal details are transferred to a Souda
sheet and is handed over to the CSE computer division. The clearing
system was introduced in 1944.
I nvestor Protection
The CSE was the pioneer in the forming of an Investor Service Cell in 1986.
Today the cell handles more than 5,000 complaint letters from investors,
on an average per year. The stock exchange has the practice of subjecting
the members to various forms of disciplinary action like warning, reprimand,
censure, fine, withdrawal of all or any of the membership rights. It can
suspend the dealings in securities of errant listed companies or even
delist them, if required. However, such an action is taken only in extreme
cases as it has repercussions on investor’s interest. During 1994-95, 13
companies were delisted. Members can be suspended if they involve
themselves in illegal practices like price rigging, or if they do not submit
adequate information (like financial statements, audit reports, etc.) or if
they are unable to meet the daily margin requirements, etc.
Defaults could arise out of excessive speculation, entering into
commitments beyond one’s financial capacity or a combination of both.
Or it could be a case of intentional evasion of commitment.
Margins
Daily margins are collected in respect of every contract outstanding at the
end of the day. Daily margins are applicable on the gross position of the
member. It is always made on a cash basis. The rate is 20 percent for

specified shares and 5 percent for non-specified shares. There is no
carryover margin at CSE. The third type of margin is the ad hoc margin,
which is collected from individual members who overtrade.
Market I nformation
The availability of prompt and accurate market information is very important
when it comes to removing ‘imperfections’ in the market. Various
programmes aim at making the market related information available to the
investing public through reuter rare display.
PTI Stockscan
Publication of scrip-wise volume of trades in the official line.
M atching transactions The trading period is restricted from 11:00
a.m. to 2:00 p.m. due to the limitations of the existing infrastructure. CSE
has initiated a screen-based trading system. The current settlement period
is 14 days beginning on a Friday and ending two weeks later on Thursday
for the specified group. The settlement period for non-specified shares is
7 days beginning on a Tuesday and ending on Monday the next week.
THE NATI ONAL STOCK EX CHANGE OF I NDI A LI MI TED ( NSE)

Genesis
The National Stock Exchange of India Limited was set up on the basis of
the recommendations of the High Powered Study Group on Establishment
of New Stock Exchanges. On its recognition as a stock exchange under the
Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced
operations in the Wholesale Debt Market (WDM) segment in June 1994.
The Capital Market (Equities) segment commenced operations in November
1994 and operations in Derivatives segment commenced in June 2000.
The National Stock Exchange (NSE) was incorporated in November
1992 with an equity capital of Rs. 25 crores. It was promoted by the
International Securities Consultancy (ISC) of Hong Kong in association
with financial institutions, insurance companies, banks, SBI Capital
Markets Ltd., Infrastructure Leasing and Financial Services Ltd., and Stock
Holding Corporation Ltd. ISC has prepared the detailed business plan,
including the installation of hardware and software systems. It aims at
promoting professionalism in the capital market and providing better
securities trading facilities to investors nationwide. NSE transcends
geographical barriers and overcomes fragmentation by providing a screen-
based trading system instead of the conventional trading ring. This results
in greater depth and liquidity of the market and reduces the transaction
costs.
The NSE is not an exchange in the traditional sense of the term, where
brokers own and manage the exchange. Its two tier administrative set up
involves a company board and a governing board of the exchange. NSE is
a professionally managed national market for shares, PSU bonds, debenture
and government securities with all the necessary infrastructure and trading
facilities.
The Mission
NSE was set up to realize the following objectives:
1. Establishing a nationwide trading facility for equities, debt
instruments and hybrids
2. Ensuring equal access to investors all over the country through
an appropriate communication network
3. Providing a fair, efficient and transparent securities market to
investors using electronic trading systems
4. Enabling shorter settlement cycles and book entry settlements
systems, and
5. Meeting the current international standards of securities markets
The standards set by NSE in terms of market practices and technology
has become industry benchmarks and is being emulated by other market
participants as well. NSE is more than a mere market facilitator. It guides
the industry towards new horizons and greater opportunities.
Trading Mechanism
In order to encourage an institutional market where large volume trades
come up for settlement in jumbo lots, two exclusive additional market
segments, the institutional lot segment and trade-for-trade segment have
been setup. NSE has an order driven system, which allows members to
undertake jobbing in securities of their choice. Several members undertake
jobbing on account of the cease of entry and exit, and narrow margins
which results in improved liquidity and reduced transaction costs.
Settlement
The settlement cycle is completed within eight days from the last day of
the trading cycle. The trading period is a week (Wednesday to Tuesday)
and the settlement of trades takes place in the ensuing week.
Counter Guarantee
NSE’s Clearing Corporation stands guarantee to all trades done in the
cash market on the exchange. The counter guarantee of the Clearing
Corporation ensures that no default, either in payment or delivery takes
place for trades done on NSE.
Price Bands
The price bands are based on the liquidity of a company’s shares as well
as its volatility. The chances for price manipulation are more in the case of
liquid securities. The factors, which determine the measure of liquidity of
a security, are:
1. Frequency of trading
2. Average daily volume of trading
3. Average daily value of trading
4. Average daily number of trades
Listing Requirement
The exchange has also modified two of its listing clauses. The minimum
paid-up capital requirement for initial public offerings has been increased
from Rs.10 crores to Rs. 20 crores. With regard to companies whose shares
are already listed on another exchange, there will now be a requirement of
a minimum market capitalization of Rs. 20 crores (for companies with a
paid-up capital of atleast Rs. 10 crores) or of Rs. 40 crores (for companies
with a paid-up capital of less than Rs. 10 crores). Companies, which have not
paid dividend for at least two of the last three years, will not be required to
have a net worth of at least Rs. 50 crores for seeking listing on the house.
Trading
The National Stock Exchange of India started its trading operations in
debt market segment from June 30, 1994. The NSE has adopted a fully
automated screen-based trading system, which allows trading members to
trade from their offices through a communications network. Price, time and
volume conditions are quite flexible. Securities like the government bonds,
treasury bills, PSU bonds, CPS, floating rate bonds and Unit 64 of UTI are
traded on the exchange. The capital market segment covers the trading
done in convertible/non-convertible debentures and hybrids, both in
equities and retail trade.
W holesale Debt Market
Two distinctive segments representing Wholesale Debt Market (WDM)
and Capital Market have started operations in 1994-95, providing secondary
market trading facilities. WDM is a facility for institutions and corporate

bodies to enter into high value transactions in instruments such as
government securities, treasury bills, PSU bonds, Unit 64 of UTI, CPS and
CDs. Few large investors and a high average trade volume characterize the
segment. The principal participants are banks, corporates and mutual funds.
There are two types of entities on WDM, Trading Members and
Participants. Trading members are the recognized members of NSE. They
can either trade on their own account or on behalf of their clients, including
participants. In the WDM segment of the exchange more than nine
categories of instruments are allowed for trading. The capital market
segment of NSE commenced operations on November 3, 1994 to provide
trading facilities for institutions and retail investors. The exchange has
allowed for trading 1,300 securities of medium and large companies with
nationwide investor bases. Because of the nationwide equal access, such
securities can be traded anywhere in country at the same price.
Electronic Trade Monitoring System
The Stock-Watch system is a computer system designed and programmed
to monitor market activity and identify aberrations from historical patterns.
The algorithm for the NSE system is similar to the one prevalent at NASDAQ
in the United States. However, the trading systems at NASDAQ and NSE
are totally different. The algorithm of NASDAQ has been adapted to NSE’s
trading conditions. The system enables NSE to electronically monitor the
trading patterns, which would lead to a more effective surveillance.
Currently, NSE officials have to manually screen the trading patterns to
ascertain any strange price fluctuations. The electronic track monitoring
system will automatically kick off alerts. It will make the task of surveillance
easier and more effective. There is a great need to enhance information
flow and this will go hand-in-hand with better monitoring of trading patterns
to reduce cases of price manipulation. SEBI will define the kind of
information the stock exchanges need to furnish so as to make their
enforcement job more effective.
Corporate Structure
NSE is one of the first demutualized stock exchanges in the country, where
the ownership and management of the Exchange is completely divorced
from the right to trade on it. Though the impetus for its establishment
came from policy makers in the country, it has been set up as a public
limited company, owned by the leading institutional investors in the
country.
The ownership, management and trading is in the hands of three

different sets of people. NSE is owned by a set of leading financial
institutions, banks, insurance companies and other financial intermediaries
and is managed by professionals, who do not directly or indirectly trade
on the Exchange. This has completely eliminated any conflict of interest
and helped NSE in aggressively pursuing policies and practices within a
public interest framework.
Board
The Board of NSE comprises of senior executives from promoter
institutions, eminent professionals in the fields of law, economics,
accountancy, finance, taxation, etc public representatives, three nominees
of SEBI including a senior official of SEBI and one full time executive of the
Exchange.
Executive Committee
While the Board deals with broad policy issues, decisions relating to
market operations are delegated by the Board to an Executive Committee
(EC) formed under the Articles of Association and Rules. The EC includes
representatives from trading members, the public and the management.
The EC has four broker-members who are nominated by the Board of NSEI
based on their experience in stock market and represent different regions.
The day-to-day management of the Exchange is delegated to the Managing
Director who is supported by a team of professional staff.
Promoters
NSE was promoted by leading financial institutions, banks, insurance
companies and other financial intermediaries such as the following:
• Industrial Development Bank of India
• Industrial Finance Corporation of India Limited
• Life Insurance Corporation of India
• State Bank of India
• ICICI Bank Limited
• Infrastructure Leasing and Financial Services Limited
• Stock Holding Corporation of India Limited
• SBI Capital Markets Limited
• Unit Trust of India
• Bank of Baroda
• Canara Bank
• General Insurance Corporation of India
• National Insurance Company Limited

• The New India Assurance Company Limited
• The Oriental Insurance Company Limited
• United India Insurance Company Limited
• Punjab National Bank
• Oriental Bank of Commerce
• Corporation Bank
• Indian Bank
• Union Bank of India
Committees
The Exchange has constituted various committees to advise it on areas
such as good market practices, settlement procedures, risk containment
systems, etc. Industry professionals, These committees, are manned by
industry trading members, exchange staff as also representatives from the
market regulator.
• Executive Committee
• Committee on Settlement Issues (COSI)
• Dispute Resolution Committee (DRC)
• Committee On Trade Related Issues (COTI)
• Advisory Committee—Listing of securities
Products
NSE has played a catalystic role in bringing about a favorable
transformation in the securities market in terms of microstructure, market
practices and trading volumes. The market has witnessed several
innovations in products and services. NSE offers a wide range of products
and services in the equities, debt and derivative segments of the market as
shown below:
• Indices: Major Indices/Other Indices
• Derivatives—Futures/Options
• Computer to Computer Link (CTCL) facility: Equities/Derivatives
• Internet-based Trading: Equities/Derivatives
• Initial Public Offering (IPO)
• Mutual Funds
• Mutual Fund Service System (MFSS)
• Exchange Traded Funds (ETFs)
• Index Funds
• Working Capital Funding
• Direct Payout to Investors
Debt Market
• References Rates (MIBID/MIBOR)
• Zero-coupon Yield Curve (ZCYC)
• Var for Government Securities
• Constituent SGL Account
Maj or I ndices
The NSE deals with the following major indices:
• S & P CNX Nifty
• CNX Nifty Junior
• S & P CNX 500
• S & P CNX Defty
• CNX Midcap 200
• Other IISL Indices
• CNX IT Sector Index
• CNX FMCG Index
• CNX Millennium Index
• CNX Segment Indices: CNX PSE Index/CNX MNC Index/CNX
IBG Index
• S & P CNX Industry Indices
• Customized Indices
Derivatives
The derivatives that are dealt in include:
• S & P CNX Nifty Futures
• S & P CNX Nifty Options
• Futures on Individual Securities
• Options on Individual Securities
Computer-to-Computer Link ( CTCL) Facility
NSE offers a facility to its trading members by which members can use
their own trading front-end software in order to trade on the NSE trading
system. This facility called Computer-to-Computer Link (CTCL) facility is
available only to trading members of NSE.
Trading Members can use their own software running on any suitable
hardware/software platform of their choice. This software would be a
replacement of the NEAT front-end software that is currently used by
members to trade on the NSE trading system. Members can use software
customized to meet their specialized needs like provision of on-line trade
analysis, risk management tools, integration of back-office operations,
etc. The dealers of the member may trade using the software remotely
through the member’s own private networks, subject to approvals from
Department of Telecommunication, etc as may be required in this regard.
I nternet Based Trading
The Securities and Exchange Board of India (SEBI) approved the report on
Internet Trading brought out by the SEBI Committee on Internet Based
Trading and Services. Internet trading can take place through order routing
systems, which will route client orders to exchange trading systems for
execution. Thus a client sitting in any part of the country would be able to
trade using the internet as a medium through brokers’ internet trading
systems. SEBI-registered brokers can introduce Internet based trading
after obtaining permission from respective stock exchanges. SEBI has
stipulated the minimum conditions to be fulfilled by trading members to
start internet based trading and services.
NSE became the first exchange to grant approval to its members for
providing internet based trading services. In line with SEBI directives,
NSE has issued circulars detailing the requirements and procedures to be
complied with by members desirous of providing internet based trading
and services. Members can procure the internet trading software from
software vendors who are empanelled with NSE or they may develop the
software through their own in-house development team or may procure
the software from other non-empanelled vendors. Members can also avail
of services provided by Application Service Providers(ASP) (which may
inter-alia include providing/maintaining software/hardware/other
infrastructure etc) for providing Internet based trading services subject to
the Application Service Provider being empanelled with the exchange for
providing such services.
Mutual Fund Service System
Mutual Fund Service System (MFSS) is a facility provided by NSE/NSCCL
to the investors for transacting in the dematerialized units of open-ended
schemes of mutual funds. The objective is to provide the investor with a
one-stop shop for transacting in financial products.
While a good number of closed-ended schemes are traded on the
Exchanges, the facilities for transacting in open-ended schemes of the
Mutual Funds are very limited. The entire process of buying and redeeming
open-ended mutual fund scheme units takes place directly between the
individual investor and the Asset Management Company (AMC). The
AMC appoints a number of agents/representatives for the purpose. In
spite of these arrangements, the Mutual Funds have not been able to
effectively cater to the millions of small investors spread across the length
and breadth of the country.The Mutual Funds Services System addresses
the need for a common platform for sale and repurchase of units of schemes
managed by different Funds. The Exchange with its extensive network
covering around 400 cities and towns across the country offers a
mechanism for electronic on-line collection of orders from the market and
the Clearing Corporation acts as a central agency for the clearing and
settlement of all the orders.
Sal i ent features of M F SS
a. Orders for purchase and sale (redemption) of units from investors
are collected using the on-line order collection system of NSE
b. Orders are settled using the Clearing and Settlement system of
NSCCL
c. Orders are settled on order-to-order basis
d. Settlement on rolling basis with orders entered on T-day settled
on T+3 (working days)
e. Settlement to the extent of securities/funds pay-in made by the
participants
f. Securities settlement in dematerialized mode only
g. Transactions are not covered by settlement guarantee
Exchange Traded Funds
An Exchange Traded Fund (ETF) is a mutual fund scheme, which combines
the best features of open-ended and close-ended funds. It usually tracks
an index and trades like a single stock on the stock exchange. It is priced
continually and can be bought or sold throughout the trading day. Buying/
Selling ETFs is as simple as buying/selling any other stock on the exchange
allowing investors to take advantage of intra-day price movements. Thus,
with ETFs, one can benefit, both from, the flexibility of a stock as well as
the diversification and cost efficiency of an index fund. Globally, since
their introduction in the U.S., in 1993, ETFs have grown rapidly with around
U.S. $ 100 Billion in assets as on December 2001. Today, over 60 percent of
trading volumes on the American Stock Exchange (AMEX) are from ETFs.
Currently, more than 120 ETFs are available in US, Europe, Singapore,
Hong Kong, Japan and other countries. Among the popular ones are
SPDRs (Spiders) based on the S&P 500 Index, QQQs (Cubes) based on the
NASDAQ-100 Index, iSHARES based on MSCI Indices and TRAHK
(Tracks) based on the Hang-Seng Index.
I ndex Funds
Index funds today are a source of investment for investors looking at a
long-term, less risky form of investment. The success of index funds
depends on their low volatility and therefore the choice of the index. S&P
CNX Nifty is used by a number of well-known mutual funds in India for
promoting Index Funds. These funds are:
1. India Access Fund Ltd., by UTI, Warburg Dillon Read and Morley
Fund Management. It was launched in November 1997, and is
listed on the London Stock Exchange.
2. UTI Nifty Fund, by Unit Trust of India, is a domestic fund
launched in March 2000 and IDBI Index
I-Nit ’99, by IDBI - Principal Mutual Fund, a domestic fund
launched in July 1999.
3. Franklin India Index Fund, by Templeton Mutual Fund , a
domestic fund launched in June 2000.
4. Franklin India Tax Index Fund, a domestic fund launched in
February 2001 and Pioneer ITI Index Fund, a domestic fund
launched in August 2001.
5. NIFTY BEES, an Exchange Traded Fund on the Nifty, by
Benchmark Mutual Fund, launched in December 2001.
6. Magnum Index Fund, a domestic fund by SBI Mutual Fund,
launched in December 2001.
7. IL&FS Index Fund, a domestic index fund, launched in February
2002.
8. Prudential ICICI Index Fund, a domestic index fund, launched
in February 2002.
Working Capital Funding

This is a facility provided to clearing members in association with the
clearing banks to meet their working capital requirements. Any clearing
bank interested in utilizing this facility has to enter into an agreement with
NSCCL and with the clearing member. The bank is also required to open
clearing accounts with depositories. Clearing member interested in availing
the facility would approach its bank to meet its funding requirements for a
particular settlement. The bank in consultation with NSCCL would extend
the funding to meet its funds pay-in obligation for that settlement against
the securities payout of the member for the same settlement. Funding
amount is determined after applying appropriate haircut to the values of
its securities payout. The securities payout to the extent determined for
funding is given to the bank.
Direct Payout to I nvestors

According to the SEBI directives NSCCL has introduced the facility of
direct payout to clients’ account on both the depositories. It ascertains
from each clearing member, the beneficiary account details of their respective
clients who are due to receive payout of securities. NSCCL has provided
its members with a front-end for creating the file through which the
information is provided to NSCCL. Based on the information received
from members, the Clearing Corporation sends payout instructions to the
depositories, so that the client receives the payout of securities directly to
their accounts on the payout day. The client receives payout to the extent
of instructions received from the respective clearing members. To the
extent of instruction not received, the securities are credited to the CM
pool account of the member.
Reference Rates—FI MMDA-NSE MI BI D MI BOR
A reference rate is an accurate measure of the market price. In the fixed-
income market, it is an interest rate that the market respects and closely
watches. It plays a useful role in a variety of situations. In particular, a call
money reference rate can find the following applications:
1. Traders can make many decisions as offsets compared with the
prevailing reference rate.
2. Derivatives require a clearly defined reference rate as a foundation,
of which the pay-off from the derivative is defined.
3. A variety of contracts can be structured as offsets from the future
levels of a reference rate. The simplest example may be a floating
rate bond that uses an interest rate, which is a given ‘n’ offsets
above a given reference rate.
Apart from its accuracy, such a reference rate needs to have other
qualities. The methodology of collation and computation should be
scientific, should eliminate noise, and resist manipulation. It should form
an unbiased source, be representative of the market, transparent, reliable
and continuously available. Moreover, it should find applicability across
a wide range of products. A reference rate, which embodies all these
qualities, would be widely acceptable to the market as the benchmark rate.
NSE Z ero-coupon Yield Curve ( Z CYC)
With NSE’s strong focus on debt market segment and the long felt need to
create standardized market practices, NSE has embarked upon developing
products that will be used by the market participants to address themselves
to issues relating to this market segment.
In its continuing effort to innovate, the Exchange has developed a

‘Zero-coupon Yield Curve’ (ZCYC) that will help in valuation of sovereign
securities across all maturities irrespective of its liquidity. It aims at creating
uniform valuation standards in the market. The product has been developed
keeping in mind the requirements of the banking industry, financial
institutions, mutual funds, insurance companies, etc that have substantial
investment in sovereign papers. NSE ZCYC aims at improving the Asset
Liability Management of institutions with realistic valuations of portfolio
of sovereign papers. It has been developed keeping in mind the emergence
of a scientific forward curve for the market that will be useful in developing
derivative products and STRIPS in the emerging scenario.
NSE VaR for Government Securities
‘Value-at-Risk (VaR)’ has been widely promoted by regulatory authorities
as a way of monitoring and managing market risk and as a basis for setting
regulatory minimum capital standards. The revised Basle Accord,
implemented in January 1998, makes it mandatory for banks to use VaR as
a basis for determining the amount of regulatory capital, adequate for
covering market risk beyond that required for credit risk. Within the realm
of the fixed-income portfolios of financial sector players, market related
risk has become more relevant and important on account of their trading
activities and market positions.
For players in the Indian financial sector, the need to develop risk
measurement models would prove critical, as regulation progressively
moves from uniform prudential standards to entity-specific risk coverage
requirements. Specifically, the guidelines call for linking of each entity’s
market risk capital charge to the riskiness of its assets as measured by the
chosen VaR model. Accuracy of measurement would prove critical as
regulation would not specify ‘a’ single model for measurement of risk; the
choice of model would be left to market participants who would also be
required to furnish details of back-testing for the chosen VaR model. While
a conservative estimate of risk would lead to very large capital holdings, a
liberal estimate would result in inadequate coverage of loss and excessive
number of model failures historically, which would in turn attract penalties
from the regulator. It would therefore be in the interest of market participants
to develop models that accurately measure the riskiness of their portfolios
and furnish estimates of capital charge that would provide adequate cover.
An important consideration in this context is that setting up of risk
measurement systems by each individual participant for estimating portfolio
risk under alternative models and scenarios would involve significant
costs.
In line with its endeavor to develop market infrastructure, NSE has

taken initiative in developing a VaR system for measuring the market risk
inherent in Government of India (GoI) securities. The NSE-VaR system
builds on the NSE database of daily yield curves—the NSEZCYC is now
well accepted in terms of its conceptual soundness and empirical
performance, and is increasingly being used by market participants as a
basis for valuation of fixed-income instruments. The NSEVaR system
provides measures of VaR using 5 alternative methods—variance-
covariance (normal) and historical simulation methods, together with
weighted normal, weighted historical simulation and the recently developed
extreme value method.
Constituent SGL Account
SGL stands for ‘Subsidiary General Ledger’ account. It is a facility provided
by RBI to large banks and financial institutions to hold their investments
in Government securities and Treasury bills in the electronic book-entry
form. Such institutions can settle their trades for securities held in SGL
through a ‘Delivery-versus-Payments’ (DVP) mechanism, which ensures
movement of funds and securities simultaneously.
As all investors in Government securities do not have an access to
the SGL accounting system, RBI has permitted such investors to hold
their securities in physical stock certificate form. They may also open a
Constituent SGL account with any entity authorized by RBI for this purpose,
and thus avail of the DVP settlement. Such client accounts are referred to
as Constituent SGL accounts. Due to the wholesale nature of the market,
retail investors usually lose their competitive strength due to their physical
holdings. Further, absence of a common settlement agency makes it
difficult for the retail investors to settle these transactions on a bilateral
basis.
To redress the problems faced by retail participants in the market,
NSCCL offers Constituent SGL facility to such participants. RBI has allowed
NSCCL to open SGL and current accounts for this purpose. RBI has also
permitted PFs/Trusts to open their accounts with NSCCL in the year 1998.
Book-building at NSE
The NSE has set up nation-wide network for trading whereby members
can trade remotely from their offices located all over the country. The NSE
trading network spans around 400 cities and towns across India. NSE
offers this infrastructure for conducting on-line IPOs through the Book-
building process. NSE operates a fully automated screen-based bidding
system called NEAT IPO that enables trading members to enter bids directly
from their offices through a sophisticated telecommunication network.Book-

building through the NSE system offers several advantages:
• Nationwide bidding facility in securities
• Fair, efficient and transparent method for collecting bids using
latest electronic trading systems
• Costs involved in the issue are far less than those in a normal IPO
REVI EW QUESTI ONS
Section A
1. How many stock exchanges are there in India? Name them.
2. When was the Bombay Stock Exchange (BSE) set up?
3. How is BSE managed?
4. What are ‘circuit filters’?
5. What do you know of the ‘OLRT surveillance system adopted
by the BSE in order to ensure the safety of securities trading?
6. When was the National Stock Exchange (NSE) established?
7. Who are the promoters of the NSE?
8. State the products offered by the NSE.
9. What do you know of the ‘Mutual Fund Service System’ (MFSS)
of the NSE?
10. What are exchange-traded funds?
11. What is a ‘reference rate’? State its applications.
Section B
1. Explain the concept of ‘BOLT’ as practiced at the BSE
2. What are the opportunities offered by the BSE for foreign
investors?
3. How are scrips grouped in the BSE?
4. What are ‘permitted securities’?
5. Illustrate the working of the ‘rolling settlement system’ followed
by the BSE.
6. Explain the working of the settlement of trades in the BSE.
7. Explain the working of the ‘self-auction’ at the BSE.
8. Write a note on the ‘derivatives trading’ happening at the BSE.
9. State the objectives for which NSE was set up?
10. Explain the trading mechanism adopted by the NSE.
11. How does the ‘electronic trade monitoring system’ of the NSE
work?
12. How does the NSE work for the ‘internet trading’?
13. Explain the ‘direct payout facility’ extended by the NSE to its
clients
14. Write notes on:
a. NSE’s ZCYC
b. NSC’s VaR
Section C
1. Detail the various requirements to be followed by companies
who want to list themselves in the BSE.
2. Discuss the measures adopted by the BSE to ensure safe trading
of securities .
3. What are the guidelines prescribed by the BSE for the foreign
brokers?
4. Explain the mechanism of book building adopted at the BSE.
5. Discuss the working of the Calcutta Stock Exchange.
6. Critically examine the working of the NSE.
Chapter 11
Primary Market
NIM also known as ‘primary market’ is a market, which is characterized by

the presence of a set of all institutions, structures, people, procedures,
services, and practices involved in raising of fresh capital funds by both
new and existing companies.
NIM AND SECONDARY MARKETS—AN INTERFACE
Both the primary and secondary markets are closely interrelated. This is
clear from the following:
Trading
For the purpose of securities to be traded in the secondary market, it is
important that they are first issued in the primary market.
Listing
In order that a corporate entity makes a successful issue of security in the
primary market, it is incumbent that the terms of such an issue carry a
stipulation that the issues are to be listed in a recognized stock exchange
and that an application for this purpose has been made already to the
stock exchange concerned.
Regulation
The activities in the primary market such as the new issues, etc are greatly
influenced by the regulatory norms prescribed by the SEBI and stock
exchanges. The object is to bring about orderliness in the new issues
market.
Marketability
The advantage of marketability provided by the secondary market greatly
helps the subscribers in the primary market. For instance, the positive
trends prevailing in the secondary market immensely help the investors to
off-load their existing holdings so as to subscribe for fresh issues in the
NIM. This liquidity advantage helps in expansion of the NIM.
Prevailing Conditions
The conditions prevailing in the secondary market affect to a very great
extent the successfulness or otherwise of the issue being made in the
NIM. Accordingly, where the conditions are so favorable in the secondary
market that high market prices prevail, the issues made in the primary
market will turn out to be encouraging and successful. Issues would fetch
good premiums.
Survival
The existence and the survival of the secondary market are dependent
upon the efficacy of the NIM as an avenue for fund raising. There could
be no stock exchanges if there is no NIM, in the same manner that there
will be no NIM in the absence of an efficiently functioning stock exchange.
An efficient secondary market is therefore, a sine-qua-non for a growing
primary market.
SERVICES OF NIM
A brief description of the various services rendered by the new issues
market is made below:
The Transfer
An important function rendered by NIM is to allow the transfer of resources
from savers to entrepreneurs who establish new companies. It is also
called the function of ‘origination’. The transfer function is facilitated by
specialist agencies that are engaged in the provision of investigative and
advisory services as specified below:
Investigative services The merchant bankers and other agencies
provide the investigative services. These include technical analysis,
economic analysis, financial analysis and analysis of legal and
environmental aspects of the proposed business. Merchant bankers
provide the above information to investors so as to enable the investors
in making a choice as to the type, quality and quantity of the issue.
Advisory services Various advisory services are made available with
a view to improving the quality of capital issues. The relevant services
include determining the type, the mix, the price, the timing, the size, the
selling strategies, the methods of floatation, and the terms and conditions
of issue of securities.
Pri ma ry Market 251
The Guarantee
It is the function of ‘underwriting’. Underwriting aims at guaranteeing the
subscription of public issue. Underwriters ensure successful subscription
of the issue by undertaking to take up the securities in the event of the
public failing to subscribe the same. It benefits the issuing company, the
investing public and capital market in general. The function of underwriting
is undertaken for a fee.
The Distribution
The function that facilitates the sale of securities to ultimate investors is
called ‘distribution’. The function of distribution is rendered by the
specialized agencies like brokers and dealers in securities. They maintain a
constant and a close link with the issuers and the ultimate investors on the
one hand, and issuers and other agencies of capital market on the other.
NIM Vs. SECONDARY MARKET
NIM is different from the secondary market in the following respects:
Sl.
Feature NIM Secondary Market
No.
1. Issues of NIM deals only with Deals in existing securities
securities new or fresh issue of
securities. Issues are
considered fresh or new
provided such issues are
made for the first time
either by the existing
company or by the new
company
2. Location No fixed geographical Needs a fixed place to
location needed house the secondary
market activities, viz.
trading
3. Transfer of Securities are created Securities are transferred
securities and transferred from from one investor to
corporates to investors another through the stock
for the first time exchange mechanism
4. Entry All companies can enter For the securities to enter
NIM and make fresh the portals of stock
issue of securities exchanges for the purpose
of trading, listing is
mandatory
Sl.
Feature NIM Secondary Market
No.
5. Administration Has no tangible form Has a definite
of administrative administrative set-up that
set-up facilitates trading in
securities
6. Regulation Subject to regulations Subject to regulation
mostly from outside both from within and
the company—SEBI, outside the stock
Stock Exchanges, exchange framework
Companies Act, etc
7. Aim Creating long-term Providing liquidity
instruments for through marketability of
borrowings those instruments.
8. Price Stock price Both macro and micro
Movement movement in factors influence the
secondary market stock price movement
influences pricing of
new issues
9. Depth Depends on number Depth depends upon the
and the volume of activities of the primary
issue market as it brings into
the fore more corporate
entities and more
instruments to raise
funds
REVIEW QUESTIONS
Section A
1. What is a primary market?
Section B
1. Bring out the interface between the primary market and the
secondary market.
2. What are the various services offered by the NIM (New Issues
Market)?
3. How is NIM different from secondary market?
Chapter 12
Methods of New Issue
METHODS OF MARKETING SECURITIES#

Following are the various methods being adopted by corporate entities
for marketing the securities in the New Issues Market:
Pure Prospectus Method
Meaning The method whereby a corporate enterprise mops up capital
funds from the general public by means of an issue of a prospectus, is
called ‘Pure Prospectus Method’. It is the most popular method of making
public issue of securities by corporate enterprises.
Features
1. Exclusive subscription Under this method, the new issues of a
company are offered for exclusive subscription of the general public.
According to the SEBI norms, a minimum of 49 percent of the total issue at
a time is to be offered to public.
2. Issue price Direct offer is made by the issuing company to the general
public to subscribe to the securities at a stated price. The securities may
be issued either at par, of at a discount or at a premium.
3. Underwriting Public issue through the ‘pure prospectus method’ is
usually underwritten. This is to safeguard the interest of the issuer in the
event of an unsatisfactory response from the public.
4. Prospectus A document that contains information relating to
the various aspects of the issuing company, besides other details of the
issue is called a ‘Prospectus’. The document is circulated to the public.
The general details include the company’s name and address of its
registered office, the names and addresses of the company’s promoters,
manager, managing director, directors, company secretary, legal adviser,
auditors, bankers, brokers, etc the date of opening and closing of
subscription list, contents of Articles, the names and addresses of
#
Information sourced from the official website of SEBI, http://www.sebi.gov.in/
underwriters, the amount underwritten and the underwriting commission,

material details regarding the project, i.e. location, plant and machinery,
technology, collaboration, performance guarantee, infrastructure facilities,
etc nature of products, marketing set-up, export potentials and obligations,
past performance and future prospects, management’s perception regarding
risk factor, credit rating obtained from any other recognized rating agency,
a statement regarding the fact that the company will make an application
to specified stock exchange(s) for listing its securities and so on.
Advantages The pure prospectus method offers the following advan-
tages to the issuer and the investors alike:
Benefits to investors The pure prospectus method of marketing the
securities serves as an excellent mode of disclosure of all the information
pertaining to the issue. Besides, it also facilitates satisfactory compliance
with the legal requirements of transparency, etc. It also allows for good
publicity for the issue. The method promotes confidence of investors
through transparency and non discriminatory basis of allotment. It
prevents artificial jacking up of prices as the issue is made public.
Benefits to issuers The pure prospectus method is the most popular
method among the large issuers. In addition, it provides for wide diffusion
of ownership of securities contributing to reduction in the concentration
of economic and social power.
Drawbacks The raising of capital through the pure prospectus method
is fraught with a number of drawbacks as specified below:
High issue costs A major drawback of this method is that it is an expensive
mode of raising funds from the capital market. Costs of various hues are
incurred in mobilizing capital. Such costs as underwriting expenses,
brokerage, administrative costs, publicity costs, legal costs and other
costs are incurred for raising funds. Due to the high cost structure, this
type of marketing of securities is followed only for large issues.
Time consuming The issue of securities through prospectus takes
more time, as it requires the due compliance with various formalities
before an issue could take place. For instance, a lot of work such as
underwriting, etc should be formalized before the printing and the issue
of a prospectus.
Offer for Sale Method
Meaning Where the marketing of securities takes place through
intermediaries, such as issue houses, stockbrokers and others, it is a case
of ‘Offer for Sale Method’.
Methods of New Issue 255
Features Under this method, the sale of securities takes place in two
stages. Accordingly, in the first stage, the issuer company makes an en-
block sale of securities to intermediaries such as the issue houses and
share brokers at an agreed price. Under the second stage, the securities
are re-sold to ultimate investors at a market-related price. The difference
between the purchase price and the issue price constitutes ‘profit’ for the
intermediaries. The intermediaries are responsible for meeting various ex-
penses such as underwriting commission, prospectus cost, advertise-
ment expenses, etc.
The issue is also underwritten to ensure total subscription of the
issue. The biggest advantage of this method is that it saves the issuing
company the hassles involved in selling the shares to the public directly
through prospectus. This method is, however, expensive for the investor
as it involves the offer of securities by issue houses at very high prices.
Private Placement Method
Meaning A method of marketing of securities whereby the issuer makes
the offer of sale to individuals and institutions privately without the issue
of a prospectus is known as ‘Private Placement Method’. This is the most
popular method gaining momentum in recent times among the corporate
enterprises.
Features Under this method, securities are offered directly to large
buyers with the help of share brokers. This method works in a manner
similar to the ‘Offer for Sale Method’ whereby securities are first sold to
intermediaries such as issues houses, etc. They are in turn placed at higher
prices to individuals and institutions. Institutional investors play a sig-
nificant role in the realm of private placing. The expenses relating to place-
ment are borne by such investors.
Advantages Private placement of securities offers the following ad-

vantages:
1. Less expensive as various types of costs associated with the
issue are borne by the issue houses and other intermediaries
2. Less troublesome for the issuer as there is not much of stock
exchange requirements concerning contents of prospectus and
its publicity, etc to be complied with
3. Placement of securities suits the requirements of small companies
4. The method is also resorted to when the stock market is dull and
the public response to the issue is doubtful
Disadvantages The major weaknesses of the private placement of se-

curities are as follows:
1. Concentration of securities in a few hands
2. Creating artificial scarcity for the securities thus jacking up the
prices temporarily and misleading general public
3. Depriving the common investors of an opportunity to subscribe
to the issue, thus affecting their confidence levels
Initial Public Offer (IPO) Method
The public issue made by a corporate entity for the first time in its life is
called ‘Initial Public Offer’ (IPO). Under this method of marketing, securities
are issued to successful applicants on the basis of the orders placed by
them, through their brokers.
When a company whose stock is not publicly traded wants to offer
that stock to the general public, it takes the form of ‘Initial Public Offer’.
The job of selling the stock is entrusted to a popular intermediary, the
underwriter. An underwriter is invariably an investment banking company.
He agrees to pay the issuer a certain price for a minimum number of shares,
and then resells those shares to buyers, who are often the clients of the
underwriting firm. The underwriters charge a fee for their services.
Stocks are issued to the underwriter after the issue of prospectus
which provides details of financial and business information as regards
the issuer. Stocks are then released to the underwriter and the underwriter
releases the stock to the public.
The issuer and the underwriting syndicate jointly determine the price
of a new issue. The approximate price listed in the red herring (the preliminary
prospectus—often with words in red letters which say this is preliminary
and the price is not yet set) may or may not be close to the final issue price.
IPO stock at the release price is usually not available to most of the public.
Good relationship between the broker and the investor is a pre requisite
for the stock being acquired.
Full disclosure of all material information in connection with the offering
of new securities must be made as part of the new offerings. A statement
and preliminary prospectus (also known as a red herring) containing the
following information is to be filed with the Registrar of Companies:
1. A description of the issuer’s business
2. The names and addresses of the key company officers, with
salary and a 5 year business history on each
3. The amount of ownership of the key officers

4. The company’s capitalization and description of how the proceeds
from the offering will be used and
5. Any legal proceedings that the company is involved in
Applications are made by the investors on the advice of their brokers
who are intimated of the share allocation by the issuer. The amount becomes
payable to the issuer through the broker only on final allocation. The
allotment is credited and share certificates delivered to the depository
account of the successful investor.
The essential steps involved in this method of marketing of securities
are as follows:
1. Order Broker receives order from the client and places orders
on behalf of the client with the issuer.
2. Share allocation The issuer finalizes share allocation and
informs the broker regarding the same.
3. The client The broker advises the successful clients of the
share allocation. Clients then submit the application forms for
shares and make payment to the issuer through the broker.
4. Primary issue account The issuer opens a separate escrow
account (primary issue account) for the primary market issue.
The clearing house of the exchange debits the primary issue
account of the broker and credits the issuer’s account.
5. Certificates Certificates are then delivered to investors.
Otherwise depository account may be credited.
The biggest advantage of this method of marketing of securities is
that there is no need for the investors to part with the money even before
the shares are allotted in his favor. Further, the method allows for elimination
of unnecessary hassles involved in making a public issue. Under the
regulations of the SEBI, IPOs can be carried out through the secondary
market and the existing infrastructure of stock exchanges can be used for
this purpose.
Rights Issue Method
Where the shares of an existing company are offered to its existing
shareholders, it takes the form of ‘rights issue’. Under this method, the
existing company issues shares to its existing shareholders in proportion
to the number of shares already held by them.
The relevant guidelines issued by the SEBI in this regard are as follows:
1. Shall be issued only by listed companies
2. Announcement regarding rights issue once made, shall not be
withdrawn and where withdrawn, no security shall be eligible for
listing upto 12 months
3. Underwriting as to rights issue is optional and appointment of
Registrar is compulsory
4. Appointment of category I Merchant Bankers holding a certificate
of registration issued by SEBI shall be compulsory
5. Rights shares shall be issued only in respect of fully paid shares
6. Letter of Offer shall contain disclosures as per SEBI requirements
7. Agreement shall be entered into with the depository for
materialization of securities to be issued
8. Issue shall be kept open for a minimum period of 30 days and for
a maximum period of 60 days
9. A minimum subscription of 90 percent of the issue shall be
received
10. No reservation is allowed for rights issue as regards FCDs and
PCDs
11. A ‘No Complaints Certificate’ is to be filed by the ‘Lead Merchant
Banker’ with the SEBI after 21 days from the date of issue of offer
document
12. Obligatory for a company where increase in subscribed capital is
necessary after two years of its formation or after one year of its
first issue of shares, whichever is earlier (this requirement may be
dispensed with by a special resolution)
Advantages Rights issue offers the following advantages:
Economy Rights issue constitutes the most economical method of
raising fresh capital, as it involves no underwriting and brokerage costs.
Further, the expenses by way of advertisement and administration, etc are
less.
Easy The issue management procedures connected with the rights issue
are easier as only a limited number of applications are to be handled.
Advantage shareholders Issue of rights shares does not involve any
dilution of ownership of existing shareholders. Further, it offers freedom
to shareholders to subscribe or not to subscribe the issue.
Drawbacks The method suffers from the following limitations:

Restrictive The facility of rights issue is available only to existing
companies and not to new companies.
Against society The issue of rights shares runs counter to the overall
societal considerations of diffusion of share ownership for promoting
dispersal of wealth and economic power.
Bonus Issues Method
Where the accumulated reserves and surplus of profits of a company are
converted into paid up capital, it takes the form of issue of ‘bonus shares’.
It merely implies capitalization of existing reserves and surplus of a
company. The issue of bonus shares is subject to certain rules and
regulations. The issue does not in any way affect the resources base of
the enterprise. It saves the company enormously of the hassles of capital
issue.
Issued under Section 205 (3) of the Companies Act, such shares are
governed by the guidelines issued by the SEBI (applicable to listed
companies only) as follows:
SEBI Guidelines
Following are the guidelines pertaining to the issue of bonus shares by a
listed corporate enterprise:
1. Reservation In respect of FCDs and PCDs, bonus shares must be
reserved in proportion to such convertible part of FCDs and PCDs. The
shares so reserved may be issued at the time of conversion(s) of such
debentures on the same terms on which the bonus issues were made.
2. Reserves The bonus issue shall be made out of free reserves built
out of the genuine profits or share premium collected in cash only. Reserves
created by revaluation of fixed assets are not capitalized.
3. Dividend mode The declaration of bonus issue, in lieu of dividend,
is not made.
4. Fully paid The bonus issue is not made unless the partly paid shares,
if any are made fully paid-up.
5. No default The company has not defaulted in payment of interest or
principal in respect of fixed deposits and interest on existing debentures
or principal on redemption thereof and has sufficient reason to believe
that it has not defaulted in respect of the payment of statutory dues of the
employees such as contribution to provident fund, gratuity, bonus, etc.
6. Implementation A company that announces its bonus issue after

the approval of the Board of Directors must implement the proposal within
a period of 6 months from the date of such approval and shall not have the
option of changing the decision.
7. The articles The Articles of Association of the company shall contain
a provision for capitalization of reserves, etc. If there is no such provision
in the Articles, the company shall pass a resolution at its general body
meeting making provisions in the Articles of Associations for capitalization.
8. Resolution Consequent to the issue of bonus shares if the subscribed
and paid-up capital exceeds the authorized share capital, the company at
its general body meeting for increasing the authorized capital shall pass a
resolution.
Rights Issue Vs. Bonus Issue
Bonus issue is different from rights issue in the following respects:
Sl.
Feature Rights Issue Bonus Issue
No.
1. Payment The issue is to be The issue is free
paid for
2. Privilege Confers a privilege Not a privilege issue
on the existing
members
3. Paid-up Shares may be Shares are necessarily to
shares partly paid-up also be fully-paid
4. Minimum Minimum Minimum subscription is
Subscription subscription is not required
required
5. Separate Money is to be No such requirement
Account kept in a separate
bank account
6. Right to Rights issue may No such facility is
Renounce be renounced by a available
member in favour
of a nominee
7. Regulation Regulated by the Regulated by the
provisions of the provisions of the
Companies Act company’s Articles and
and SEBI SEBI guidelines
guidelines
Book-building Method
A method of marketing the shares of a company whereby the quantum
and the price of the securities to be issued will be decided on the basis of
the ‘bids’ received from the prospective shareholders by the lead merchant
bankers is known as ‘book-building method’. Under the book-building
method, share prices are determined on the basis of real demand for the
shares at various price levels in the market. For discovering the price at
which issue should be made, bids are invited from prospective investors
from which the demand at various price levels is noted. The merchant
bankers undertake full responsibility for the issue.
The option of book-building is available to all body corporates, which
are otherwise eligible to make an issue of capital to the public. The initial
minimum size of issue through book-building route was fixed at
Rs. 100 crores. However, beginning from December 9, 1996 issues of any
size will be allowed through the book-building route.
Book-building facility is available as an alternative to firm allotment.
Accordingly, a company can opt for book-building route for the sale of
shares to the extent of the percentage of the issue that can be reserved for
firm allotment as per the prevailing SEBI guidelines. It is therefore possible
either to reserve securities for firm allotment or issue them through the
book-building process.
The book-building process involves the following steps:
1. Appointment of book-runners The first step in the book-
building process is the appointment by the issuer company, of the book-
runner, chosen from one of the lead merchant bankers. The book-runner in
turn forms a syndicate for the book building. A syndicate member should
be a member of National Stock Exchange (NSE) or Over-The-Counter
Exchange of India (OTCEI). Offers of ‘bids’ are to be made by investors to
the syndicate members, who register the demands of investors. The bid
indicates the number of shares demanded and the prices offered. This
information, which is stored in the computer, is accessible to the company
management or to the book-runner. The name of the book-runner is to be
mentioned in the draft prospectus submitted to SEBI.
2. Draftin g prospec tus The draft prospectus containing all
the information except the information regarding the price at which the
securities are offered is to be filed with SEBI as per the prevailing SEBI
guidelines. The offer of securities through this process must separately
be disclosed in the prospectus, under the caption ‘placement portion
category’. Similarly, the extent of shares offered to the pubic shall be
separately shown under the caption ‘net offer to the public’. According to
the latest SEBI guidelines issued in October 1999, the earlier stipulation
that at least 25 percent of the securities were to be issued to the public has
been done away with. This is aimed at enabling companies to offer the
entire public issue through the book-building route.
3. Ci rc ul atin g d r aft pros pec t us A copy of the draft
prospectus filed with SEBI is to be circulated by the book-runner to the
prospective institutional buyers who are eligible for firm allotment and
also to the intermediaries who are eligible to act as underwriters. The
objective is to invite offers for subscribing to the securities. The draft
prospectus to be circulated must indicate the price-band within which the
securities are being offered for subscription.
4. Main tain in g offer record s The book-runner maintains a
record of the offers received. Details such as the name and the number of
securities ordered together with the price at which each institutional buyer
or underwriter is willing to subscribe to securities under the placement
portion must find place in the record. SEBI has the right to inspect such
records.
5. In tima tion abo ut ag greg ate ord e rs The underwriters
and the institutional investors shall give intimation on the aggregate of
the offers received to the book-runner.
6. Bid analysis The bid analysis is carried out by the book-
runner immediately after the closure of the bid offer date. An appropriate
final price is arrived at after a careful evaluation of demands at various
prices and the quantity. The final price is generally fixed reasonably lower
than the possible offer price. This way, the success of the issue is ensured.
The issuer company announces the pay-in-date at the expiry of which
shares are allotted.
7. Man d at ory un d erwr itin g Where it has been decided to
make offer of shares to public under the category of ‘Net Offer to the
Public’, it is incumbent that the entire portion offered to the public is fully
underwritten. In case an issue is made through book-building route, it is
mandatory that the portion of the issue offered to the public be
underwritten. For this purpose, an agreement has to be entered into with
the underwriter by the issuer. The agreement shall specify the number of
securities as well as the price at which the underwriter would subscribe to
the securities. The book-runner may require the underwriter of the net
offer to the public to pay in advance all moneys required to be paid in
respect of their underwriting commitment.
8. Filing with ROC A copy of the prospectus as certified by the SEBI

shall be filed with the Registrar of Companies within two days of the
receipt of the acknowledgement card from the SEBI.
9. Bank accounts The issuer company has to open two separate
accounts for collection of application money, one for the private placement
portion and the other for the public subscription.
10. Collection of completed applications The book-runner collects
from the institutional buyers and the underwriters the application forms
alongwith the application money to the extent of the securities proposed
to be allotted to them or subscribed by them. This is to be done one day
before the opening of the issue to the public.
11. Allotment of securities Allotment for the private placement portion
may be made on the second day from the closure of the issue. The issuer
company, however, has the option to choose one date for both the
placement portion and the public portion. The said date shall be considered
to be the date of allotment for the issue of securities through the book-
building process. The issuer company is permitted to pay interest on the
application moneys till the date of allotment or the deemed date of allotment
provided that payment of interest is uniformly given to all the applicants.
12. Payment schedule and listing The book-runner may require
the underwriters to the ‘net offer to the public’ to pay in advance all
moneys required to be paid in respect of their underwriting commitment
by the eleventh day of the closure of the issue. In that case, the shares
allotted as per the private placement category will become eligible for
being listed. Allotment of securities under the public category is to be
made as per the prevailing statutory requirements.
13. Under-subscription In the case of under-subscription in the ‘net
offer to the public’ category, any spillover to the extent of under-
subscription is to be permitted from the ‘placement portion’ category
subject to the condition that preference is given to the individual investors.
In the case of under-subscription in the placement portion, spillover is to
be permitted from the net offer to the public to the placement portion.
Advantages of Book-building
Book-building process is of immense use in the following ways:
1. Reduction in the duration between allotment and listing
2. Reliable allotment procedure
3. Quick listing in stock exchanges possible
4. No price manipulation as the price is determined on the basis of
the bids received
STOCK OPTION OR EMPLOYEES STOCK OPTION SCHEME (ESOP)

A method of marketing the securities of a company whereby its employees
are encouraged to take up shares and subscribe to it is known as ‘stock
option’. It is a voluntary scheme on the part of the company to encourage
employees’ participation in the company. The scheme also offers an
incentive to the employees to stay in the company. The scheme is
particularly useful in the case of companies whose business activity is
dominantly based on the talent of the employees, as in the case of software
industry. The scheme helps retain their most productive employees in an
industry, which is known for its constant churning of personnel.
SEBI Guidelines
Company whose securities are listed on any stock exchange can introduce
the scheme of employees’ stock option. The offer can be made subject to
the conditions specified below:
1. Issue at discount Issue of stock options at a discount to the
market price would be regarded as another form of employee compensation
and would be treated as such in the financial statements of the company
regardless the quantum of discount on the exercise price of the options.
2. Approval The issue of ESOPs is subject to the approval by the
shareholders through a special resolution.
3. Maximum limit There would be no restriction on the maximum
number of shares to be issued to a single employee. However, in cases of
employees being offered more than 1 percent shares, a specific disclosure
and approval would be necessary in the AGM.
4. Minimum period A minimum period of one year between grant
of options and its vesting has been prescribed. After one year, the company
would determine the period during which the option can be excercised.
5. Superintendence The operation of the ESOP Scheme would
have to be under the superintendence and direction of a Compensation
Committee of the Board of Directors in which there would be a majority of
independent directors.
6. Eligibility ESOP scheme is open to all permanent employees
and to the directors of the company but not to promoters and large
shareholders. The scheme would be applicable to the employees of the
subsidiary or a holding company with the express approval of the
shareholders.
7. Director’s report The Director’s report shall make a disclosure of
the following:
a. Total number of shares as approved by the shareholders

b. The pricing formula adopted
c. Details as to options granted, options vested, options exercised
and options forfeited, extinguishments or modification of options,
money realized by exercise of options, total number of options in
force, employee-wise details of options granted to senior
managerial personnel and to any other employee who receive a
grant in any one year of options amounting to 5 percent or more
of options granted during that year
d. Fully diluted EPS computed in accordance with the IAS
8. IPO SEBI’s stipulations prohibiting initial public offerings by
companies having outstanding options should not apply to ESOP. If any
ESOPs are outstanding at the time of an IPO issue by an unlisted company,
the promoters’ contribution shall be calculated with reference to the
enlarged capital that would arise if all vested options were exercised.
Stock Option Norms for Software Companies
The relevant guidelines issued by the SEBI as regards ‘employees stock
option’ for software companies are as follows:
1. Minimum issue A minimum issue of 10 percent of its paid-up capital
can be made by a software company which has already floated American
Depository Receipts (ADRs) and Global Depository Receipts (GDRs) or a
company which is proposing to float these is entitled to issue ADR/GDR-
linked stock options to its employees. For this purpose, prior permission
from the Department of Economic Affairs is to be obtained.
2. Mode of issue Listed stock options can be issued in foreign currency
convertible bonds and ordinary shares (through depository receipt
mechanism) to the employees of subsidiaries of infotech companies.
3. Permanent employees Indian IT companies can issue ADR/GDR
linked stock options to permanent employees, including Indian and
overseas directors, of their subsidiary companies incorporated in India or
outside.
4. Pricing The pricing provisions of SEBI’s preferential allotment
guidelines would not cover the scheme. The purpose is to enable the
companies to issue stock options to its employees at a discount to the
market price which serves as another form of compensation.
5. Approval Shareholders’ approval through a special resolution is
necessary for issuing the ESOPs. A minimum period of one year between
grant of option and its vesting has been prescribed. After one year, the
company would determine the period in which option can be exercised.
Bought-out Deals
Meaning
A method of marketing of securities of a body corporate whereby the
promoters of an unlisted company make an outright sale of a chunk of
equity shares to a single sponsor or the lead sponsor is known as ‘bought-
out deals’.
Features
1. Parties There are three parties involved in the bought-out deals.
They are promoters of the company, sponsors and co-sponsors who are
generally merchant bankers and investors.
2. Outright sale Under this arrangement, there is an outright sale of a
chunk of equity shares to a single sponsor or the lead sponsor.
3. Syndicate Sponsor forms a syndicate with other merchant bankers
for meeting the resource requirements and for distributing the risk.
4. Sale price The sale price is finalized through negotiations between
the issuing company and the purchaser, the sale being influenced by such
factors as project evaluation, promoters image and reputation, current
market sentiments, prospects of off-loading these shares at a future date,
etc.
5. Fund-based Bought-out deals are in the nature of fund-based activity
where the funds of the merchant bankers get locked in for at least the
prescribed minimum period.
6. Listing The investor-sponsors make a profit, when at a future date,
the shares get listed and higher prices prevail. Listing generally takes
place at a time when the company is performing well in terms of higher
profits and larger cash generations from projects.
7. OTCEI Sale of these shares at Over-the-Counter Exchange of India
(OTCEI) or at a recognized stock exchanges, the time of listing these
securities and off-loading them simultaneously are being generally decided
in advance.
BOUGHT-OUT DEALS VS. PRIVATE PLACEMENTS
Following are the differences between bought-out deals and private

placements:
Sl.
Feature Private Placement Bought-out Deal
No.
1. Trading Listed securities Unlisted securities
Scrips
2. Creating Results in the Securities are simply
Securities creation of additional transferred from promoters
securities for the to sponsors who in turn
buying institutions off-load them to the public
3. Lock-in Five Years 18 months
Period
Benefits
Bought-out deals provide the following benefits:
Speedy sale Bought-out deals offer a mechanism for a speedier sale of
securities at lower costs relating to the issue.
Freedom Bought-out deals offer freedom for promoters to set a realistic
price and convince the sponsor about the same.
Investor protection Bought-out deals facilitate better investor
protection as sponsors are rigorously evaluated and appraised by the
promoters before off-loading the issue.
Quality offer Bought-out deals help enhance the quality of capital
floatation and primary market offerings.
Limitations
Bought-out deals pose the following difficulties for the promoters,
sponsors and investors:
1. Loss of control The apprehensions in the minds of promoters,
particularly of the private or the closely held companies that the sponsors
may usurp control of the company as they own large chunk of the shares
of the company.
2. Loss of sales Bought-out deals pose considerable difficulties in
off-loading the shares in times of unfavorable market conditions. This
results in locking up of investments and entailing losses to sponsors.
3. Wrong appraisal Bought-out deals cause loss to sponsors on
account of wrong appraisal of the project and overestimation of the
potential price of the share.
4. Manipulation Bought-out deals give great scope for manipulation
at the hands of the sponsor through insider trading and rigging.

5. No accountability Bought-out deals pose difficulty of penalizing
the sponsor as there are no SEBI guidelines to regulate offerings by
sponsors.
6. Windfall profits Bought-out deals offer the advantage of windfall
profits by sponsors at the cost of small investors.
7. Loss to investors Where the shares taken up by issue brokers and
a coterie of select clients are being bought back by the promoters at a
pre-fixed higher price after allotment causing loss to investors of the
company.
The different methods used for marketing securities in a new issues
market is shown in Exhibit 5.
Exhibit 5 NIM— Methods of Marketi ng Securi ti es
OTCEI Guidelines
The OTCEI allows for the off-loading of the shares acquired by sponsors
in bought-out deals. The following conditions have been prescribed in
this regard:
1. Minimum post-issue holding of promoters shall be 25 percent with a
lock-in period of five years

2. Sponsor to act as a market-maker for 18 months who has to identify an
additional market maker for such compulsory market-making. The two
market-markers should, between them, hold upto 5 percent of the
equity offered to the public
3. Sponsors to offer two-way quotes based on minimum and maximum
trading prices
4. Freedom to members and dealers to decide the ratio of holdings between
the members, and dealers and the non-members/non-dealers in a
bought-out deal where the members and dealers participate in the
bought-out deal by taking up a minimum 10 percent of the total value
of securities for which the deal is done
5. Initial offer of the bought-out deals should be made on the OTCEI
members and dealers and where the participation from them is not
forthcoming, only then it may be offered to nonmembers/non-dealers
6. Offer of a minimum 25 percent of the post-issue paid-up capital of the
company to the public.
REVIEW QUESTIONS
Section A
1. What is a prospectus?
2. What do you mean by ‘pure prospectus method’ of marketing of
securities?
3. What is ‘offer for sale method’ of marketing of securities?
4. What is an IPO?
5. What is a rights issue?
6. What is a bonus issue?
7. What is ‘ESOP’?
8. How is a bought-out deal different from a private placement?
Section B
1. Mention the features of ‘pure prospectus method’ of marketing
of securities.
2. Specify the advantages and drawbacks of ‘pure prospectus
method’ of marketing of securities?
3. What are the features of ‘private placement’ as a method of
marketing of securities?
4. Bring out the essential steps involved in an IPO.
5. Mention the SEBI guidelines pertaining to making of rights issue.
6. How is rights-issue beneficial?

7. What are the SEBI guidelines pertaining to making of bonus
issue?
8. How is a rights-issue different from a bonus issue?
9. How is book building method of marketing of securities beneficial?
10. State the SEBI guidelines regarding the ESOP.
11. What are ‘bought-out deals’? What are its features?
12. State the limitations of private placement of securities.
13. What are the OTCEI guidelines as regards the bought-out deals?
Section C
1. Discuss the different methods of marketing of securities.
2. Explain the process of book building as an efficient method of
marketing of securities by a corporate enterprise.
Chapter 13
Intermediaries in
New Issues Market
INTERMEDIARIES IN NIM*
Several intermediaries carry out activities of different nature in the new
issues market. The intermediaries include Merchant Bankers/Lead
Managers, Underwriters, Bankers to the issue, Brokers to the issue,
Registrars, Share Transfer Agents, and Debenture Trustees. The legal
framework of operations of these intermediaries as prescribed by the SEBI,
is presented below:
MERCHANT BANKERS/LEAD MANAGERS
Meaning The intermediaries in the stock market who are responsible

for public issues management are known as ‘merchant bankers or lead
managers’.
Category Merchant bankers are categorized as follows:
Category I These are the merchant bankers who carry out such functions
as relating to new issues as determination of security-mix to be issued,
drafting of prospectus, application forms, allotment letters and a host of
other documents, appointment of registrars for handling share applications
and transfers, making arrangements for underwriting, placement of shares,
selection and appointment of brokers and bankers to the issue, publicity
of the issue, etc. Only these merchant bankers are permitted to act as
‘Lead Managers’ to an issue.
Category II These merchant bankers act as consultants, advisers,
portfolio managers and co-managers.
Category III These merchant bankers act as underwriters, advisers and
consultants.
Category IV These merchant bankers act only as advisers or consultants
to an issue.
As per the SEBI guidelines introduced on September 5, 1997, all

categories of merchant bankers below category I would stand abolished.
The guidelines required those merchant bankers who are functioning below
the category I to upgrade themselves to category I. Merchant bankers
currently carrying out underwriting and portfolio management, besides
issue management, would be required to get separate registrations as
portfolio managers, while underwriting could be done without any
additional registration. Further, only body corporates with a net worth of
Rs. 5 crores would be allowed as category I merchant bankers.
Registration—Conditions
Merchant bankers shall compulsorily register with the SEBI in the interest
of investors. Following are the conditions to be satisfied by them before
registration is done by the SEBI:
1. Capital adequacy Merchant bankers have to fulfill the prescribed
minimum capital adequacy norm in terms of its net worth, i.e. paid-up
capital and free reserves.
2. Infrastructure Merchant bankers should have adequate and
necessary infrastructure, such as adequate office space, equipment and
manpower for effective discharge of their duties and responsibilities.
3. Expertise Merchant bankers should employ experts having
professional qualifications in finance, law or business management
competent to handle merchant banking business and who are not involved
in any litigation connected with securities market.
4. Fees Merchant bankers should make a payment of fee as prescribed
by the SEBI.
5. Undertaking Merchant bankers shall undertake to fulfill their
obligations and responsibilities as may be prescribed by the SEBI from
time to time. Further, they should also undertake to adhere to the prescribed
code of conduct.
Role and Responsibilities
SEBI has laid down the following responsibilities for a merchant banker:
1. Contract A merchant banker shall enter into a contract with the
issuing company. The contract invariably specifies their mutual rights,
obligations and liabilities relating to the issue, particularly relating to
disclosures, allotment and refund. A copy of the above contract is to be
submitted to the SEBI at least one month before the opening of the issue
for subscription. The merchant banker has the right not to accept the
appointment as lead manager, if the issuing company is its associate.
Intermedi ari es i n New Issues Market 273
2. Registration A registration certificate has to be obtained by the

merchant banker from the SEBI.
3. Minimum underwriting The merchant banker is duty-bound to
accept on his own or through its associate, a minimum underwriting
obligation of 5 percent of total underwriting commitment or Rs. 25 lakhs,
whichever is less.
4. ‘Due diligence certificate’ The merchant banker has to submit
‘Due Diligence Certificate’ to SEBI at least two weeks before the opening
of the issue for subscription. The certificate has to be given on the basis
of the verification of the contents of the prospectus/letter of offer regarding
the issue and reasonableness of the views expressed therein. For this
purpose, the merchant banker should reasonably be satisfied:
a. That the document contains all details relevant to the issue;
b. That all legal requirements relating to the issue have been fully
complied with; and
c. That all disclosures are true, fair and adequate to enable the
investing public to make a well-informed decision regarding
investment in the proposed issue.
5. Documents submission The merchant banker shall submit to SEBI
various documents containing details such as issue, draft prospectus/
letter of offer and other literature to be circulated to the investors/
shareholders, etc at least two weeks before the date of filing them with the
Registrar of Companies and regional stock exchanges. It has to ensure
that all the modifications and suggestions made by SEBI regarding the
above documents have been duly incorporated.
6. Disclosure to SEBI The merchant banker shall make a disclosure
of the following to the SEBI:
a. Its responsibilities regarding the management of the issue
b. Any change in the information/particulars previously furnished
with SEBI having a bearing on certificate of registration granted
to it
c. Details relating to the breach of capital adequacy norms
d. Names and addresses of the companies whose issues it has
managed or has been associated with, and
e. Information regarding its activities as manager, underwriter,
consultant or adviser to the issue
7. Other duties In addition to the above, the merchant banker has to
fulfill the following obligations too:
a. Continuing to remain fully associated with the issue till the
subscribers have received share/debenture certificates or the
refund of excess application money
b. Not to acquire securities of any company on the basis of

unpublished price sensitive information obtained in the course
of discharge of his professional assignment, whether obtained
from the client or any other person
c. Submit complete particulars with SEBI within 15 days of the
acquisition of securities of the company whose issue the merchant
banker is managing
Code of Conduct
Every merchant banker has to abide by the code of conduct in the course
of performance of his duties. The codes include observance of high
standards of integrity and fairness in its dealings with the client and other
merchant bankers; disclosure to the clients possible sources of conflict of
duties and interest, if any, while accepting the assignment and while
providing the services; provision of all professional services to the client
in a prompt, efficient and cost-effective manner; making available to the
investors true and adequate information relating to the issue without
making any misguided or exaggerated claims, attendant risks relating to
the issue before any investment decisions are taken by them, and copies
of prospectus, memorandum and related documents uncomplete; taking
adequate steps for fair allotment of securities and refund of application
money without delay; adequately dealing with complaints from the
investors; not to practise unfair competition, i.e. not making any statement
or become party to an act which is likely to harm the interest of other
merchant bankers; not divulging to other clients, press or any other party
any confidential information about his client, which has come to his
knowledge; not to be a party to creation of false market, or price rigging or
manipulations, etc.
SEBI’s Role
SEBI is empowered to carry out the inspection of the working of any
merchant banker with a view to protecting the interest of investors and to
ensure better ambience of the capital market. The merchant banker is
duty-bound to extend all assistance and support to the SEBI for carrying
out the inspection. In respect of any merchant banker who fails to comply
with any of the conditions subject to which certificate of registration has
been granted by SEBI, and/or acts in violation of any of the provisions of
the SEBI Act, rules or regulations, the SEBI may suspend the registration
or cancellation of registration.
SEBI may order suspension of Registration under such circumstances

as violation of the provisions of the SEBI Act, rules or regulations, violation
of the conditions of registration, failure to furnish to SEBI the required
information relating to its activities as merchant banker, furnishing wrong,
false or misleading information, failure to submit periodical returns required
by SEBI, defying cooperation in any enquiry/inspection conducted by
SEBI, failure to resolve the complaints of the investors and/or fails to give
a satisfactory reply to SEBI in this regard, indulging in manipulating prices
of securities, or price rigging or cornering activities, etc.
UNDERWRITERS
Meaning
A set of all institutions and agencies that provide a commitment to take up
the issue of securities in the event of a failure of the issue to get full
subscription from the public, are known as ‘underwriters’. They are
compensated for their services by a payment of commission as agreed
upon between the issuing company and the underwriter, and subject to
the ceiling under the Companies Act. Brokers, investment companies,
commercial banks and term lending institutions provide underwriting
services.
Although underwriting of issues is not obligatory, underwriters play
a significant role in the development of the primary market. The issuing
company in consultation with the merchant bankers/lead managers
appoints underwriters. A statement to this effect is also to be incorporated
in the prospectus.
Under the SEBI guidelines, underwriters have the following duties and
responsibilities as regards the public issue:
1. Registration A certificate of registration has to be obtained by the
agencies that wish to carry out underwriting activities from the SEBI. SEBI
grants the certificate of registration on the fulfillment of the following
conditions:
a. Availability of adequate and necessary infrastructure like
sufficient office space, equipment and manpower to effectively
function and discharge his duties
b. Previous experience in underwriting or having a minimum of two
persons with experience in underwriting
c. Meeting capital adequacy requirement of a minimum net worth of
Rs. 20 lakhs
d. That the applicant (director, principal officer or partner) has not

been convicted of any offence involving moral turpitude or found
guilty of any economic offence
e. Undertaking to fulfill obligations under the SEBI Act, rules and
regulations
f. Undertaking to abide by the prescribed code of conduct and
g. Payment of the prescribed fee for grant of registration certificate
and for its renewal, which is Rs. 2 lakhs for the first and the
second years from the initial grant of certificate and Rs. 20,000
per annum subsequently for keeping the certificate in force or for
its renewal. The Certificate of Registration can be suspended by
SEBI in case of failure to pay the fee. Thereupon, the underwriter
ceases to act as underwriter
2. Agreement In order that the issues are taken up by the underwriters,
an agreement has to be entered into between the underwriter and the
issuing company. The agreement should, among others, contain such
details as the period during which the agreement will remain in force, the
amount of underwriting obligation, the maximum period within which the
underwriter will have to subscribe to the offer, after being intimated by or
on behalf of the issuing company, the rate and amount of commission/
brokerage chargeable by the underwriter, within the limits imposed by the
Companies Act, and any other details regarding the arrangements made
by the underwriter for fulfilling the underwriting obligations.
3. Code of conduct An underwriting agency shall follow the
necessary codes of conduct as framed by the SEBI. These include duty
not to derive any other direct or indirect benefit from underwriting the
issue except receiving the underwriting commission at the agreed rate, the
ceiling for which is 5 percent in case of underwriting of shares and 2.5
percent in case of debentures, duty not to take up total underwriting
obligation, at any point of time under all underwriting agreements, exceeding
20 times his net worth, and duty to subscribe for securities under the
agreement within 45 days of the receipt of intimation from the issuing
company.
4. Compliance Underwriters are required to comply with all the
formalities regarding registration with SEBI, agreement with the client
company and general responsibilities. These include ensuring that all
terms and conditions regarding disclosure in the prospectus and its filing
with ROC have been complied with before signing the underwriting
agreement with the issuing company, ensuring that the prospectus is
delivered to ROC within 30 days of the underwriting agreement or within
such an extended time as approved by the underwriter in writing, subject

to the limits within the law, complying with any additional disclosures that
may be made in the interest of investors as stipulated by SEBI/lead
managers, and such disclosure requirements shall not give any right to
the underwriter to avoid or reduce his obligations, unless certified by
SEBI as material in nature and essential for underwriting agreement,
arranging for sub-underwriting but continues to be responsible for any
failure or default on the part of such sub-underwriters, etc.
5. Termination of agreement An underwriter is entitled to terminate
an underwriting agreement at any time before the opening of the issue as
notified in the prospectus under such circumstances as where the issuing
company has made any incorrect representation or statement to the
underwriter, in the application form, in negotiations and correspondence,
and in the prospectus, where a complete breakdown or dislocation of
business has occurred in major financial markets in Mumbai, Calcutta,
New Delhi and Chennai and where any other major disturbance-such as
declaration of war, open and wide insurgency, civil upheaval has taken
place which has adversely affected the major financial markets.
BANKERS TO AN ISSUE
Meaning
Bankers who are engaged in the function of acceptance of applications for
shares and debentures alongwith application money from investors in
respect of issue of securities and also refund of application money to the
applicants to whom securities could not be allotted, are called ‘bankers to
an issue’. They play an important role in the working of the primary market.
The intermediary to act as a banker has the following responsibilities as
ordained by the SEBI:
1. Registration Bankers who are desirous of acting as bankers to an
issue are required to obtain the necessary certificate of registration from
the SEBI. For this purpose, the conditions to be fulfilled include adequacy
of the necessary infrastructure such as office space, equipment,
communication facilities, data processing facilities and manpower to
effectively perform activities relating to the issue, and a stipulation that
the banker or any of its directors is not involved in any litigation connected
with securities market nor they are convicted for any economic offence. If
the applicant is a scheduled bank, the grant of certificate of registration
would serve the interest of investors and the applicant pays the registration
fee.
2. Fees to SEBI Annual registration fee of Rs. 2.5 lakhs for the first
two years is payable to the SEBI by the intending banker and Rs. 1 lakh is
to be paid for the third year. An application for the renewal of the registration
can be made three months before the expiry of registration certificate. The
renewal fees are Rs. 1 lakh annually for the first two years and Rs. 20,000
for the third year.
3. Contract The issuer company has to enter into a contract with the
banker to an issue. The contract shall include detailed information about
the number and addresses of collection centres at which applications and
application money are to be received, the fee for the services and other
terms and conditions of the appointment.
4. Daily statement A daily statement giving the details regarding the
number of applications and the amount of money received from the
investors shall be submitted by the banker to the issuing company/registrar
to an issue.
5. Information to SEBI Information pertaining to such details as to
the profile of the issue, the number of applications and the details of
application money received, the date-wise details of application money
collected and refunds, if any, to the SEBI. Similarly information about any
disciplinary action initiated by the RBI entailing the suspension or
cancellation of the banker is also to be sent to the SEBI.
6. Books and records Books of accounts, records and documents
pertaining to all matters regarding which the banker may be required to
submit details to SEBI shall be maintained by the banker. This is to be
done for a minimum period of three years from the completion of the issue.
7. Code of conduct In addition to the code of conduct prescribed for
the merchant bankers and underwriters, a banker to an issue has to adhere
to the following code of conduct:
a. Not to keep blank application forms bearing broker’s stamp at the
bank premises or at the entrance of the bank
b. Not to accept applications after office hours, or on bank holidays,
or after the date of the closure of the issue
c. Not to act at any time in collusion with other agents in a manner
detrimental to the interest of small investors, and
d. Abide by all acts, rules, regulations, notifications, directions,
circulars, instructions and guidelines issued by the Government,
RBI, Indian Banks Association and SEBI that are relevant to his
operations as banker to an issue.
RBI’s Role
RBI is empowered to carry out the inspection of the bankers to the issue
with a view to protecting the investors’ interest and also promoting
compliance with SEBI Act, rules and regulations. SEBI may order the
suspension of the registration of the banker in such circumstances as the
violation of the provisions of SEBI Act, rules and regulations, failure to
submit the required information, submission of wrong or false information,
failure to resolve investors’ complaints or give satisfactory reply to SEBI,
guilty of misconduct or unprofessional conduct, etc.
BROKERS TO AN ISSUE
Intermediaries that are responsible for procuring the subscription to the
issue from the prospective investors are called ‘brokers to the issue’.
They provide a vital connecting link between the prospective investors
and the issuer. They assist in the speedy subscription of issue by the
public. Appointment of brokers is however not compulsory.
Unless permitted by the stock exchange, the issuing company abides
by the prescribed listing requirements and also undertakes to get its
securities listed on a recognized stock exchange. Moreover, its members
can neither act as managers or brokers to an issue, nor can they make any
preliminary arrangement for floatation of an issue.
The brokers to the issue must have an expert knowledge, professional
competence and integrity in order to be able to carry out the various
functions of an issue. They help the investors make a right choice of the
company for making investments. Consent must be obtained from the
stock exchange broker to act as the brokers to the issuer company. For this
purpose, the approval of stock exchanges is required. Copies of consent
letters of brokers are to be filed with ROC alongwith the copy of prospectus.
The names and addresses of the brokers to the issue are to be disclosed in
the prospectus.
Brokerage has to be paid by the issuer company according to the
provisions in the Companies Act and rules and regulations, the agreement
between the broker and the company, and guidelines prescribed by SEBI.
Maximum brokerage rate, applicable to all types of industrial securities,
whether underwritten or not, is 1.5 percent. The brokers have to meet all
mailing costs, canvassing expenses and all other out-of-pocket expenses
relating to the subscription of the issue out of their brokerage. The maximum
rate of brokerage payable by listed companies on private placement of
capital is 0.5 percent.
REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS

Registrars and transfer agents are of two categories such as category I
which carry on activities of both registrars to an issue and also of share
transfer agents and category II which carry on activities either of a registrar
to an issue or as a share transfer agent.
Functions
Registrars to an issue carry out such functions as keeping a proper record
of applications and moneys received from investors, assisting issuing
companies in determining the basis of allotment of securities as per stock
exchange guidelines and in consultation with stock exchanges, assisting
in the finalization of allotment of securities, and processing and dispatching
of allotment letters, assisting in processing and dispatching refund orders,
share and debenture certificates and other documents related to the capital
issue, functioning as Depository Participants (DPs), etc.
Share Transfer Agents perform such functions as maintaining records
of holders of securities of the company for and on behalf of the company,
handling all matters related to transfer and redemption of securities of the
company and functioning as Depository Participants (DPs).
The role and responsibilities of registrars and share transfer agents are as
follows:
Registration A certificate of registration is to be obtained from the
SEBI. For this purpose, the SEBI considers such factors as their ability to
discharge their duties with efficiency and integrity, the adequacy of
infrastructure and past experience in this line of activity and capital
adequacy. Capital adequacy requirement is net worth of Rs. 6 lakhs for
category I and Rs. 3 lakhs for category II registrars and share transfer
agents. They have to pay an annual fee of Rs. 15,000 and Rs. 10, 000
respectively for initial registration and annual renewal.
Maintenance of records Registrars and share transfer agents shall
show such details as applications received from investors relating to the
issue, rejected applications together with the reasons for rejection, basis
of allotment of securities in consultation with the stock exchanges, terms
and conditions of purchase of securities, allotment of securities, list of
allottees and non-allottees, refund orders, etc and names of transferors
and transferees, and the dates of transfer of securities. Such records and
books are to be preserved for three years from the date of issue. SEBI can
also ask them to file these books and records with it whenever required.
Absorbing code of conduct Registrars and share transfer agents

should adopt those codes of conduct prescribed for merchant bankers
and underwriters. Besides, they should ensure that enquiries from
investors are adequately dealt with and adequate steps are taken for proper
allotment of securities and refund of excess application money as per law
and without delay.
SEBI’s Role
SEBI is empowered to undertake inspection of books of accounts, records
and documents of registrars and share transfer agents. The certificate of
registration issued to registrars and share transfer agents will be suspended
of their registration by the SEBI under such circumstances as violation of
SEBI Act, rules and regulations, violation of SCRA rules and regulations,
and stock exchange bye-laws, rules and regulations, failure to furnish
information to SEBI, furnishing wrong and false information, non-
cooperation in an inspection, investigation or an enquiry, failure to resolve
investor complaints, failure to give satisfactory reply to SEBI regarding
investor complaints, involvement in manipulation, price rigging and
cornering activities, guilty of misconduct, failure to maintain capital
adequacy requirement, etc.
The registration of the registrars and transfer agents will be cancelled
by the SEBI under such circumstances as repeated defaults leading to
suspension of registration certificate, deliberate manipulation, price rigging
and cornering activities adversely affecting the securities market and the
investor interest, violating provisions relating to insider trading and take
over regulations, guilty of fraud, conviction for a criminal offence, and
violating SEBI Act, rules and regulations.
DEBENTURE TRUSTEES
Meaning
Trustees who are appointed to safeguard the interests of debenture
holders are called ‘debenture trustees’. They are to be appointed before
issue of debentures by a company. No person can act as debenture trustee
unless a certificate of registration has been obtained from SEBI for the
purpose.
Eligibility
To be appointed as a debenture trustee, the following are eligible:
1. A scheduled bank carrying on commercial activity; or
2. A public financial institution within the meaning of Section 4-A
of the Companies Act, 1956; or
3. An insurance company; or
4. A body corporate
1. Registration An institution shall be registered with the SEBI to be in
a position to function as a debenture trustee. For this purpose, the institution
concerned shall have an adequate and necessary infrastructure like
adequate office space, equipments and manpower to effectively discharge
his activities, relevant experience of a debenture trustee, professional
qualification for a debenture trustee from an institution recognized by the
government in finance, accountancy, law or business management and
the applicant or any of its director or principal officers has not at any time
been convicted for any offence involving moral turpitude or has been
found guilty of any economic offence.
2. Consent Consent in writing must be given to the body corporate to
act as debenture trustee before the debenture issue.
3. Inspection Debenture trustee shall carry out the inspection of books
of accounts, records, registers of the body corporate and the trust property
to the extent necessary for discharging his obligations.
4. Possession A debenture trustee shall take possession of trust
property in accordance with the provisions of the trust deed and enforce
security in the interest of the debenture holders.
5. Protection of interest A debenture trustee shall carry out any act
as would be necessary for the protection of the interest of and the
resolution of grievances of the debenture holders. He must also ensure
that debenture certificates have been dispatched to the debenture holders
in accordance with the provisions of the Companies Act. Besides, he must
also ensure that interest warrants for interest due on the debentures have
been dispatched to the debenture holders on or before the due dates.
6. Due diligence A debenture trustee should exercise due diligence to
ascertain whether or not the assets of the body corporate which are available
by way of security or otherwise are sufficient or are likely to be or become
sufficient to discharge the claims of debenture holders as and when they
become due. It must also inform the Board immediately of any breach of
trust deed or provision of any law.
7. Meeting A debenture trustee shall call, or cause to be called by the
body corporate, a meeting of the entire debenture holders where a
requisition for the meeting has been made at least one-tenth of the
debenture holders or the happening of any event, which constitutes a
default or which in the opinion of the debenture trustees affects the interest
of the debenture holders.
8. Code of conduct Every debenture trustee shall abide by the
prescribed code of conduct.
9. Maintenance of books of accounts, etc. Subject to the provisions
of any law, every debenture trustee has to keep and maintain proper books
of accounts, records and documents relating to the trusteeship functions
for a period of not less than 5 financial years preceding the current financial
year. Every debenture trustee has to intimate to SEBI, the place where the
books of accounts, records and documents are maintained.
10. Information to SEBI Every debenture trustee shall furnish
information relating to the following to the SEBI:
a. Number and nature of the grievances of debenture holders
received and resolved
b. Copies of the trust deed
c. Non-payment or delayed payment of interest to debenture holders,
if any, in respect of each issue of debentures of a body corporate
d. Details of dispatch and transfer of debenture certificates giving
therein the dates, mode, etc
e. Inspection and Disciplinary Proceedings and
f. Any other particulars or documents that are relevant to debenture
trustee
SEBI’s Role
SEBI is empowered to carry out the inspection of the books of accounts,
other records and documents of the debenture trustee for the purpose of
ensuring that the records and documents which are relevant to debenture
trustees are being maintained in the manner required by the Board, that
the provisions of the Companies Act, 1956, rules and regulations are being
complied with, that there exists any circumstances, which would render
the debenture trustee ineligible for grant of registration or continuance
thereof, that the complaints received from investors, other debenture
trustees are investigated into, and that the interest of the investors is
protected.
SEBI can suspend the certificate of registration granted to a debenture
trustee under the following circumstances:
1. Violation of the provisions of the SEBI Act, rules or regulations
2. Not following the prescribed code of conduct.
3. Failure to furnish information relating to his business as debenture

trustee as required by the Board .
4. Furnishing wrong or false information.
5. Not submitting reports as required by SEBI.
6. Non-cooperation in any enquiry conducted by SEBI.
7. Indulging in manipulating or price rigging or cornering activities.
8. Guilty of misconduct or improper or unbusinesslike or
unprofessional conduct.
9. Failure to pay the fees.
10. Violation of the conditions subject to which the certificate has
been granted and.
11. Failure to fulfill the obligations under the trust deed.
Under the following circumstances, SEBI can cancel the certificate of
registration granted to debenture trustees:
1. Repeated defaults of the type leading to suspension of certificate
2. Indulging in deliberate manipulation or price rigging or cornering
activities affecting the securities market and the investors’
interests.
3. Guilty of fraud, or is convicted of a criminal offence.
4. Violation of any provision of insider trading regulations.
5. Violation of the provisions of Companies Act and the rules made
thereunder, and.
6. Trustee being removed by the debenture holders by a resolution
passed by not less than 75 percent of the debenture holders.
REVIEW QUESTIONS
Section A
1. Who are the intermediaries of the NIM?
2. Who is a merchant banker?
3. Who is a ‘category I merchant banker’?
4. Who are underwriters?
5. Who is a ‘banker to an issue’?
6. Who is a ‘broker to an issue’?
7. Who are debenture trustees?
Section B
1. How are merchant bankers categorized by the SEBI?
2. What are the conditions prescribed by the SEBI for the registration
of merchant bankers?
3. How does the SEBI influence the working of the merchant
bankers?
4. What is the code of conduct prescribed for the merchant bankers?
5. Bring out the role and responsibilities of bankers to the issue?
6. What are the functions of registrars and share transfer agents?
7. What is the role played by the SEBI in governing the working of
debenture trustees?
Section C
1. Discuss the various types of intermediaries working for the NIM.
2. Enumerate and explain the role and responsibilities of merchant
bankers.
3. Write a note on:
a. Role and responsibilities of registrars and share transfer
agents.
b. Role and responsibilities of debenture trustees.
Chapter 14
SEBI Guidelines on
Primary Market
SEBI GUIDELINES FOR LISTED AND UNLISTED COMPANIES
For Companies Issuing New securities

Following are the conditions to be satisfied by the companies that issue
securities offered through an offer document:
As Regards Unlisted Companies
Track record No unlisted company shall make a public issue of any
equity share or any security convertible at a later date into equity share,
unless the company has a track record of distributable profits in terms of
section 205 of Companies Act, for at least three out of the immediately
preceding five years and a pre-issue net worth of not less than Rupees
One crore in three out of preceding five years, with the minimum net worth
to be met during immediately preceding two years.
For the purpose of determining the minimum track record of three
years, at least three audited accounts shall be available comprising not
less than thirty-six months. In case of companies in the information
technology sector, the track record of distributable profits shall be
considered for the purpose of eligibility requirements only if the profits
are emanating from the information technology business or activities.
In the case of partnership firms which have since been converted into
companies, the track record of distributable profits of the firm shall be
considered for the purpose of eligibility requirements if the financial
statements for the respective years pertaining to partnership business
conform to and are revised in a format identical to that required for
companies, and also comply with the following that adequate disclosures
are made in the financial statements similar to that of companies as specified
in Schedule VI of the Companies Act, 1956, and the financial statements
shall be duly certified by a Chartered Accountant stating unequivocally
that the accounts as revised or otherwise and disclosures made are in line
with the provision of Schedule VI of the Companies Act, 1956 and that the
accounting standards of the Institute of Chartered Accountants of India
(ICAI) have been followed, that the financial statements present a true
and fair picture of the firm’s accounts and that the lead merchant banker
shall also confirm that the financial statements furnished on behalf of the
partnership firms are in accordance with accounting standards prescribed
by the ICAI.
In the case of an unlisted company formed out of a division of an
exiting company, the track record of distributable profits of the division
spun off shall be considered for the purpose of eligibility criteria if the
requirements regarding financial statements as specified above for
partnership firms.
Project appraisal An unlisted company which does not satisfy the
above requirement can make a public issue of equity share capital or any
security convertible at a later date into equity share capital, provided a
public financial institution or a scheduled commercial bank has appraised
the project to be financed through the proposed offer to the public and
not less than 10 percent of the project cost is financed by the said
appraising bank or institution by way of loan, equity, participation in the
issue of security in the proposed issue or combination of any of them. The
appraising bank or institution shall bring in the minimum specified
contribution at least one day before the opening of the public issue.
As Regards Listed Companies
1. Filing of offer document No company shall make any public issue
of securities, unless a draft prospectus has been filed with the Board,
through an eligible Merchant Banker, at least 21 days prior to the filing of
prospectus with the Registrar of Companies (ROC). Where the Board
makes any changes within 21 days from the date of submission of draft
Prospectus, the issuer or the Lead Merchant banker shall carry out such
changes in the draft prospectus before filing the prospectus with ROCs.
2. Letter of offer No listed company shall make any issue of security
through a rights issue where the aggregate value of securities, including
premium, if any, exceeds Rs. 50 lakhs, unless the letter of offer is filed with
the Board, through an eligible Merchant Banker, at least 21 days prior to
the filing of the Letter of Offer with Regional Stock Exchange (RSE). Where
the Board makes any changes within 21 days from the date of submission
of the draft Letter of Offer, the issuer or the Lead Merchant banker shall
carry out such changes in the draft offer letter before filing the prospectus
with ROCs.
SEBI Gui del i nes on Pri mary Market 289
3. Companies barred No company shall make an issue of securities if

the company has been prohibited from accessing the capital market under
any order or direction passed by the Board.
4. Application for listing No company shall make any public issue of
securities unless it has made an application for listing of those securities
in the stock exchange(s).
5. Issue of securities in dematerialized form No company shall
make public or rights issue or an offer for sale of securities, unless the
company enters into an agreement with a depository [registered with the
Board under the Securities and Exchange Board of India (Depositories
and Participants) Regulations, 1996] for dematerialization of securities
already issued or proposed to be issued to the public or existing
shareholders; and the company gives an option to subscribers/
shareholders/investors to receive the security certificates or hold securities
in a dematerialized form with a depository.
A listed company shall be eligible to make a public issue of equity
shares or any security convertible at a later date into equity share where
as a result of the proposed issue, the net worth of the company becomes
more than five times the net worth [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 ] prior to the issue, the company shall satisfy the relevant
provisions as specified above.
Public issue by listed companies which has changed its name to
indicate as if it was engaged in the business/activities in information
technology sector during a period of three years prior to filing of offer
document with the Board, shall be eligible to make a public issue of equity
share or securities convertible at a later date into equity share, if it has a
track record of distributable profits in terms of Section 205 of Companies
Act, for at least three out of immediately preceding five years from the
information technology business/activities, and it has a pre-issue net worth
of not less than One Crore in three out of preceding five years, with the
minimum net worth to be met during, the immediately preceding two years.
Exemption from Eligibility Norms
The above provisions of track record and project appraisal shall not be
applicable:
1. In case of a banking company including a Local Area Bank (hereinafter
referred to as Private Sector Banks) set up under sub-section (c) of
Section 5 of the Banking Regulation Act, 1949 and which has received
a licence from the Reserve Bank of India
2. To a corresponding new bank set up under the Banking Companies
(Acquisition and Transfer of Undertaking) Act, 1970 Banking
Companies (Acquisition and Transfer of Undertaking) Act, 1980, State
Bank of India Act 1955, and State Bank of India (Subsidiary Banks)
Act, 1959 (hereinafter referred to as “public sector banks”)
3. To an infrastructure company whose project has been appraised by a
Public Financial Institution or Infrastructure Development Finance
Corporation (IDFC) or Infrastructure Leasing and Financing Services
Ltd. (IL&FS) and not less than 5% of the project cost is financed by
any of the institutions referred to in sub-clause (a), jointly or severally,
irrespective of whether they appraise the project or not, by way of
loan or subscription to equity or a combination of both
4. To rights issue by a listed company
Credit Rating for Debt Instruments
1. No public or rights issue of debt instrument (including convertible
instruments) irrespective of their maturity or conversion period shall
be made unless credit a rating from a credit rating agency is obtained
and disclosed in the offer document
2. Where credit rating is obtained from more than one credit rating
agencies, all the credit rating/s, including the unaccepted credit ratings,
shall be disclosed
3. For a public and rights issue of debt-securities of issue size greater
than or equal to Rs. 100 crores, two ratings from two different credit
rating agencies shall be obtained
4. All the credit ratings obtained during the three years, preceding the
public or rights issue of debt instrument (including convertible
instruments) for any listed security of the issuer company shall be
disclosed in the offer document
Outstanding Warrants or Financial Instruments
No unlisted company shall make a public issue of equity share or any
security convertible at later date into equity share, if there are any
outstanding financial instruments or any other right, which would entitle
the existing promoters or shareholders any option to receive equity share
capital after the initial public offering.
Partly Paid-up Shares

No company shall make a public or rights issue of equity share or any
security convertible at a later date into equity share, unless all the existing
partly paid-up shares have been fully paid or forfeited in a manner specified
above.
On Pricing Issues
The companies eligible to make public issue can freely price their equity
shares or any security convertible at a later date into equity shares in the
following cases:
1. Public/rights issue by listed companies A listed company
whose equity shares are listed on a stock exchange, may freely price its
equity shares and any security convertible into equity at a later date,
offered through a public or rights issue.
2. Public issue by unlisted companies An unlisted company
eligible to make a public issue and desirous of getting its securities listed
on a recognized stock exchange pursuant to a public issue, may freely
price its equity shares or any securities convertible at a later date into
equity shares.
3. Infrastructure company An eligible infrastructure company shall
be free to price its equity shares subject to the compliance with the
disclosure norms as specified by SEBI from time to time.
4. Initial public issue by banks Banks (whether public sector or
private sector) may freely price their issue of equity shares or any securities
convertible at a later date into equity share subject to approval by the
Reserve Bank of India.
5. Differential pricing Any unlisted company or a listed company
making a public issue of equity shares or securities convertible at a later
date into equity shares, may issue such securities to applicants in the firm
allotment category at a price different from the price at which the net offer
to the public (the offer made to the Indian public and does not include firm
allotments or reservations or promoters’ contributions) is made provided
that the price at which the security is being offered to the applicants in firm
allotment category is higher than the price at which securities are offered
to public. A listed company making a composite issue of capital may issue
securities at differential prices in its public and rights issue. In the public
issue, which is a part of a composite issue, differential pricing is also
permissible.
6. Price band Issuer company can mention a price band of 20 percent

(cap in the price band should not be more than 20 percent of the floor
price) in the offer documents filed with the Board and actual price can be
determined at a later date before filing of the offer document with ROCs. If
the Board of Directors has been authorized to determine the offer price
within a specified price band, such a price shall be determined by a
Resolution to be passed by the Board of Directors.
The Lead Merchant Bankers shall ensure that in case of the listed
companies, a 48 hours notice of the meeting of the Board of Directors for
passing resolution for determination of price is given to the regional Stock
Exchange. The final offer document, shall contain only one price and one
set of financial projections, if applicable.
7. Payment of discounts/commissions etc. No payment, direct
or indirect in the nature of a discount, commission, allowance or otherwise
shall be made either by the issuer company or the promoters in any public
issue, to the persons who have received firm allotment in such public
issues.
8. Denomination of shares An eligible company shall be free to
make public or rights issue of equity shares in any denomination determined
by it, in accordance with sub-section (4) of section 13 of the Companies
Act, 1956 and in compliance with the norms as specified by SEBI through
its circular. Companies, which have already issued shares in the
denomination of Rs. 10/- or Rs.100/-, may change the standard denomination
of the shares by splitting or consolidating the existing shares.
The companies proposing to issue shares in any denomination or
changing the standard denomination shall comply with the following:
a. The shares shall not be issued in the denomination of decimal of
a rupee
b. The denomination of the existing shares shall not be altered to a
denomination of decimal of a rupee
c. At any given time, There shall be only one denomination for the
shares of the company
d. The companies seeking to change the standard denomination
may do so after amending the Memorandum and Articles of
Association, if required
e. The company shall adhere to the disclosure and accounting norms
specified by SEBI from time to time
On Promoter’s Contribution and Lock-in Requirements

Promoter’s Contribution
The relevant provisions regarding the promoter’s contribution are as
follows:
1. Pubic issue by unlisted companies In a public issue by an
unlisted company, the promoters shall contribute not less than 20 percent
of the post issue capital.
2. Offers for sale The promoter’s shareholding after offer for sale shall
not be less than 20 percent of the post issue capital.
3. Public issues by listed companies In case of public issues by
listed companies, the promoters shall participate either to the extent of 20
percent of the proposed issue or ensure post-issue shareholding to the
extent of 20 percent of the post-issue capital.
4. Composite issues In case of composite issues of a listed company,
the promoter’s contribution shall at the option of the promoter(s) be either
20 percent of the proposed public issue or 20 percent of the post-issue
capital. Rights issue component of the composite issue shall be excluded
while calculating the post-issue capital.
5. Computation of promoters’ contribution
a. Nonconvertible security Where the promoters of any company
making an issue of securities have acquired equity during the
preceding three years, before filing the offer documents with the
Board, such equity shall not be considered for computation of
promoter’s contribution. This is to be taken note of where the securities
have been acquired for consideration other than cash and revaluation
of assets or capitalization of intangible assets is involved in such
transaction(s) or resulting from a bonus issue, out of revaluation
reserves or reserves without accrual of cash resources.
In case of public issue by unlisted companies, securities which
have been issued to the promoters during the preceding one year, at
a price lower than the price at which equity is being offered to public,
shall not be eligible for computation of promoter’s contribution. The
shares for which the difference between the offer price and the issue
price for these shares is brought in by the promoters shall be
considered eligible subject to issuer company complying with the
applicable provisions of the Companies Act, 1956 (such as passing of
revised resolution by shareholders or issuer’s Board, filing of revised
return of allotment with RoC, etc.)
In respect of companies formed by conversion of partnership

firms, where the partners of the erstwhile partnership firm and the
promoters of the converted company are the same and there is no
change in management, the shares allotted to the promoters during
previous one year out of the funds brought in during that period shall
not be considered eligible for computation of promoters’ contribution
unless such shares have been issued at the same price at which the
public offer is made.
If the partners’ capital existed in the firm for a period of more than
one year on a continuous basis, the shares allotted to promoters
against such capital shall be considered eligible. Such ineligible shares
acquired in pursuance to a scheme of merger or amalgamation
approved by a High Court shall be eligible for computation of
promoters’ contribution.
For the purposes of computing the promoters’ contribution, a
minimum contribution of Rs. 25,000 per application from each individual
and a minimum contribution of Rs.1 lakh from firms and companies
(not being business associates like dealers and distributors), shall be
eligible to be considered towards promoters’ contribution.
No securities forming part of promoters’ contribution shall consist
of any private placement made by solicitation of subscription from
unrelated persons either directly or through any intermediary. The
securities for which a specific written consent has not been obtained
from the respective shareholders for inclusion of their subscription in
the minimum promoters’ contribution subject to lock-in shall not be
eligible for promoters’ contribution.
b. Convertible security In case of any issue of convertible security
by a company, the promoters shall have an option to bring in their
subscription by way of equity or by way of subscription to the
convertible security being offered through the proposed issue so
that the total promoters’ contribution shall not be less than the required
minimum contribution as required.
However, where the conversion price of emerging equity is not
predetermined and the same has not been specified in the offer
document (instead a formula for conversion price is indicated), the
promoters shall not have the said option and shall contribute by
subscribing to the same instrument.
In case of any issue of security convertible in stages either at par
or premium (conversion price being predetermined), the promoters’
contribution in terms of equity share capital shall not be at a price
lower than the weighted average price of the share capital arising out
of conversion. (‘Weights’ means the number of equity shares arising

out of conversion of security into equity at various stages and ‘price’
means the price of equity shares on conversion arrived at after taking
into account predetermined conversion price at various stages).
The promoters’ contribution shall be computed on the basis of
post-issue capital assuming full-proposed conversion of such
convertible security into equity. Where the promoter is contributing
through the same optional convertible security as is being offered to
the public, such contribution shall be eligible as promoters’
contribution only if the promoter(s) undertake in writing to accept full
conversion.
6. Preferential allotment In the case of a listed company, participation
by promoters in the proposed public issue in excess of the required minimum
percentage as required shall attract the pricing provisions of guidelines
on preferential allotment, if the issue price is lower than the price as
determined on the basis of the said preferential allotment guidelines.
7. Promoters’ contribution Promoters shall bring in the full amount
of the promoters’ contribution including premium at least one day prior to
the issue opening date. Where the promoters’ minimum contribution
exceeds Rs. 100 crores, they shall bring in Rs.100 crores before the opening
of the issue and the remaining contribution shall be brought in by the
promoters in advance on pro-rata basis before the calls are made on public.
The company’s board shall pass a resolution allotting the shares or
convertible instruments to promoters against the moneys received. A copy
of the resolution along with a Chartered Accountants’ Certificate certifying
that the promoters’ contribution has been brought in shall be filed with the
Board before opening of the issue. The certificate of the Chartered
Accountants shall also be accompanied by a list of names and addresses
of friends, relatives and associates who have contributed to the promoters’
quota along with the amount of subscription made by each of them.
8. Exemption The requirement of Promoters’ Contribution is exempt
under the following circumstances:
a. In case of public issue of securities by a company which has
been listed on a stock exchange for at least 3 years and has a
track record of dividend payment for at least 3 immediately
preceding years
b. Where the promoters’ participate in the proposed issue to the
extent higher than of the two options available as specified above,
the subscription in excess of such percentage shall attract pricing
guidelines on preferential issue, if the issue price is lower than
the price as determined on the basis of said guidelines on

preferential issue
c. In case of companies where no identifiable promoter or promoter
group exists
d. In case of rights issues promoters shall disclose their existing
shareholding and the extent to which they are participating in the
proposed issue in the offer document
Lock-in Requirements
1. Lock-in of minimum specified promoters’ contribution In
case of any issue of capital to the public the minimum promoters’
contribution shall be locked in for a period of 3 years. The lock-in shall
start from the date of allotment in the proposed public issue and the last
date of the lock-in shall be reckoned as 3 years from the date of
commencement of commercial production. (The last date of the month in
which commercial production in a manufacturing company is expected to
commence as stated in the offer document) or the date of allotment in the
public issue whichever is later.
2. Lock-in of excess promoters’ contribution In case of a public
issue by unlisted company, if the promoters’ contribution in the proposed
issue exceeds the required minimum contribution, such excess contribution
shall also be locked in for a period of 3 years. In case of a public issue by
a listed company, participation by promoters in the proposed public issue
in excess of the required minimum percentage shall also be locked-in for a
period of 3 years as per the lock-in provisions as specified in guidelines on
preferential issue. The excess promoters’ contribution shall not be subject
to lock-in. In case the shortfall in the firm allotment category is met by the
promoter as specified, such subscription shall be locked in for a period of
3 years.
3. Last-in-first The securities that form part of promoters’ contribution,
as specified and issued last to the promoters shall be locked in first for the
specified period. The securities issued to the financial institutions
appearing as promoters, if issued last, shall not be locked-in before the
shares allotted to the other promoters.
4. Ineligibility of lock-in of shares Any security issued to promoters
or other shareholders, out of revaluation of assets or capitalization of
intangible assets, within a period of 3 preceding years from the date of
filing of offer documents with the Board, shall be locked-in for a period of
3 years from the date of allotment of the proposed issue of capital. Any
security to promoters or other shareholders, issued by way of bonus out
of revaluation reserves, within a period of 3 preceding years, shall be

locked-in for a period of 3 years from the date of allotment of the proposed
issue of capital.
In case of unlisted companies, any security issued to promoter or to
any other shareholder, during the preceding one year, at a price lower than
the price at which equity is being offered to public, shall be locked-in for a
period of 3 years from the date of allotment of the proposed issue of
capital.
5. Lock-in of pre-issues of an unlisted company Where an
unlisted company eligible to make a public issue and desirous of getting
its securities listed on a recognized stock exchange pursuant to a public
issue has issued shares to any person within six months prior to the date
of opening of the public issue at a price lower than the price at which
equity is being offered/issued to public, the entire share capital (except
shares issued to venture capitalists and employees of the company) existing
prior to public issue shall be locked in for a period of six months from the
date of trading of the shares on the regional stock exchange.
The lock-in would not apply to the shares (other than shares issued
to promoters, friends, relatives and associates) if the same were issued
more than 6 months prior to the date of opening of the public issue and are
offered under “offer for sale.”
Other Lock-in Requirements
Pledge of securities Locked-in securities held by promoters may be
pledged only with banks or financial institutions as collateral security for
loans granted by such banks or financial institutions, provided the pledge
of shares is one of the terms of sanction of loan.
Inter-se transfer of securities Transfer of locked-in securities
amongst promoters as named in the offer document, can be made subject
to the lock-in being applicable to the transferees for the remaining period
of lock in.
Inscription of nontransferability The securities which are subject
to lock-in shall carry inscription ‘nontransferable’ along with duration of
specified nontransferable period mentioned on the face of the security
certificate.
REVIEW QUESTIONS
Section A
1. What is meant by ‘differential pricing’?
2. What is ‘price band’ with reference to a primary issue?
Section B
1. What are companies that have been granted exemption under
Section 205 of the Companies Act with regard to new issue of
securities?
2. Explain as to how credit rating is made compulsory for companies
issuing debt instruments.
3. Enumerate the relevant SEBI guidelines with regard to pricing of
public issues.
4. State the SEBI guidelines with regard to issue of shares on
different denominations.
5. Bring out the SEBI guidelines with regard to promoters’
contribution with regard to issue of shares.
6. Explain the mode of computation of promoters’ contribution
7. State the circumstances under which requirements of promoters’
contribution is exempt.
8. What are the lock-in requirements with regard to promoters’
contribution?
Section C
1. What are the guidelines issued by the SEBI with regard to the
issue of securities in the primary market?
2. What are the conditions to be satisfied by unlisted companies
that issue securities through an offer document?
3. What are the conditions to be satisfied by listed companies that
issue securities through an offer document?
Chapter 15
Listing
The term ‘listing’ refers to a process or steps or exercise involved in listing

something with some one. Listing means permission to quote shares and
debentures officially on the trading floor of the stock exchange. The listed
shares appear on the official list of securities for the purposes of trading.
SECURITY LISTING
Security listing refers to the steps that are required to register and to place
on record the securities of a corporate entity with the appropriate authority,
the appropriate authority being the recognized stock exchange. Securities
are required to be listed under section 9 of Securities Contract (Regulation)
Act, 1956, hereinafter referred to as SCRA. Listing simply means the
inclusion of any security for the purpose of trading in a recognized stock
exchange.
SECURITY
Securities are those financial instruments that are defined under section
2(h) of SCRA, 1956. Stock exchanges through their byelaws, are authorized
under section 9(m) of SCRA, 1956, to make a provision for listing of
securities on the stock exchange.
STOCK EXCHANGE
According to section 2(i) of the SCRA, ‘Stock Exchange’ means any body
of individuals whether incorporated or not, constituted for the purpose of
assisting, regulating or controlling the business of buying, selling or dealing
in securities. Only a recognized stock exchange has been conferred the
authority to list the securities of a corporate entity.
RECOGNIZED STOCK EXCHANGE
Stock exchanges that are given recognition under section 4 of SCRA,
1956, in response to application made to Central Government under section
3 of the said Act are known as ‘recognized stock exchanges’.
Characteristics
Following are the characteristic features of listing:
Agreement Listing of securities with the stock exchanges is made
possible by means of a ‘Listing Agreement’ between the respective Stock
Exchanges where the securities are to be listed on the one hand and the
corporate entity which offers or issues the securities to the public through
the issue of offer document like prospectus/letter of offer, on the other
hand.
Purpose The purposes that are served by listing with a Stock exchange
are ensuring free transferability of securities so as to facilitate clear
transparency and open disclosure of information relating to the affairs of
the company whose securities are listed. In addition, official quotation
and liquidity in the trading of listed securities is also ensured. Listing
allows for official trading in the Stock Exchange by the registered member/
broker of the stock exchange, which provides an ideal marketplace for
securities.
Restriction A corporate entity is free to have its securities listed in any
number of stock exchanges. It is however, important that the securities are
listed at least on the regional stock exchange. A stock exchange is
considered to be a regional stock exchange provided it is located in the
place where the registered office of the company is situated. In the event
of more than one stock exchange being located in the place or state where
the corporate’s registered office is situated, the stock exchange which is
nearer to the company would be considered as the ‘recognized stock
exchange.’ In case of conflict, as to the regional stock exchange, the decision
of Stock Exchange Division, Ministry of Finance shall be final.
Investor protection Listing is a barometer of performance and
continued good performance of the company. This offers a measure of
protection to the investors.
LEGAL PROVISIONS
The legal provisions relating to the listing of securities are enshrined in
the Securities Contracts (Regulation) Act, 1956 read with the rules made
there under, SEBI Act, 1992 and the Companies Act, 1956. The various
legal and legislative provisions of listing are summarized below:
Section 21 of SCRA
This section prescribes necessary conditions that are required to be
satisfied by the public companies for the purpose of having their securities
listed in the Stock Exchanges.
Li st i n g 301
Section 11 B of SEBI Act

This section empowers SEBI to formulate regulations governing the
working of the listing mechanism. It aims at protecting the interest of
investors in securities, thereby contributing to the development and the
regulation of the securities market.
Section 11 B of the SEBI Act
This section empowers the SEBI to issue directions to intermediaries who
are associated with securities market. This may include stock exchanges
as a regulatory organization for the purpose of protection of interest of
investor and orderly development of securities market. The section also
empowers the SEBI to frame rules for the regulation of listing of securities.
Section 73 of Companies Act
This section requires corporate enterprises to make an application to one
or more recognized stock exchanges seeking permission for dealing with
the securities offered to the public before issue of prospectus.
STEPS
Listing of corporate securities involves the following steps:
Initial Listing
This involves making a simple application by the payment of initial listing
fee as prescribed by the respective stock exchanges. This is done before
the offer of securities to the public and registration of prospectus with the
Registrar of Companies, as required under section 60 of the Companies
Act, 1956.
Final Listing
This involves getting the approval of the recognized stock exchange for
the listing by means of an agreement with the stock exchange.
Registration and Recording
This involves registering and placing on record the corporate securities
openly. This is done for the purpose of trading by the registered members
of the Stock Exchange and for the official quotation/announcement of the
security price, for the benefit of the public who intend dealing with such
securities.
Continued Listing
This step involves making efforts by the corporate enterprise for the
purpose of continuing to remain listed on the stock exchange until it is
delisted from the records of the exchange, either at the option of the
company or at the option of the stock exchange concerned. Listing as
regards further issue of securities will take place as long as the existing
securities remain listed on the stock exchanges.
LEGAL SIGNIFICANCE
Listing is mandatory for a public company, which intends offering its
securities to the public by issue of prospectus and which wishes to provide
trading facilities to the securities being offered to the public. This mandatory
provision is also enforced indirectly by stipulating that any allotment of
securities made in the absence of listing or refusal of listing is held to be
void. Besides, any failure to comply with the section 21 of SCRA attracts
penalty as prescribed under section 23 of the SCRA.
REFUSAL OF LISTING
It is quite possible that the securities of a corporate enterprise are refused
listing by the authorities of the stock exchange. In the event of the decision
of the authorities to refuse listing, it is incumbent on their part to intimate
the company concerned within 15 days, the reasons for refusal. This is
required under section 22 of SCRA. The aggrieved corporate enterprise
may appeal to the Central Government within a prescribed period under
section 73 of the Companies Act, 1956. It is prerogative of the Central
Government either to grant or refuse to grant the permission for listing and
the decision of the Central Government would be informed to the Stock
Exchange concerned, who shall act in conformity with such a decision.
SEBI POWERS
Under section 11 read with section 11B of SEBI Act, SEBI is empowered to
direct the Stock Exchanges from time to time to amend the provisions of
the listing agreement. This may be required for the purpose of regulating
the business in the Stock Exchanges and securities market in the interest
of investors and for promoting orderly development of securities market.
Rule 19 of Securities Contracts (Regulation) Rules, 1957 also prescribes
documents and particulars to be submitted/furnished by a corporate
enterprise to the Stock Exchange for the purpose of listing its securities on
the Stock Exchange.
LISTING AND CORPORATE GOVERNANCE
Listing assumes special significance in the light of the measures that have
been initiated to revamp the functioning and thus shape the culture of
Li st i n g 303
corporate management. The Birla Committee of Corporate Governance

has recommended that SEBI shall issue frequent directions to the Stock
Exchanges, to introduce new listing provisions aimed at securing the
healthy corporate governance of the affairs of the Company, in larger
interest of the stakeholders.
PARTICULARS TO BE FURNISHED
A public company desirous of getting its securities listed on a recognized
stock exchange has to apply for that purpose to the stock exchange and
forward along with its application the following documents and particulars:
1. Copies of Memorandum and Articles of Association and in the
case of a debenture issue, a copy of the trust deed
2. Copies of all prospectuses or statements in lieu of prospectuses
issued by the company at any time
3. Copies of offers for sale and circulars or advertisements offering
any securities for subscription or sale during the last five years
4. Copies of balance sheets and audited accounts for the last five
years, or in the case of new companies, for such shorter period
for which accounts have been made up
5. Statement showing dividends and cash bonuses, if any, paid
during the last ten years (or such shorter period as the company
has been in existence, whether as a private or public company)
and dividends or interest in arrears, if any
6. Certified copies of:
a. Agreements or other documents relating to arrangements
with or between vendors and/or promoters, underwriters
and sub-underwriters, and brokers and sub-workers
b. Agreements with managing agents and secretaries and
treasurers, selling agents, managing directors and technical
directors, and general manager, sales manager, manager or
secretary
c. Every letter, report, balance sheet, valuation contract, court
order or other document, part of which is reproduced or
referred to in any prospectus, offer for sale, circular or
advertisement offering securities for subscription or sale,
during the last five years
d. Letters of consent of the Controller of Capital Issues (now

not required because the office of CCI has been abolished);
and agreements, if any, with the Industrial Finance
Corporation, Industrial Credit and Investment Corporation
and similar bodies
7. Statement containing particulars of the dates of, and parties to
all materials contracts, agreements (including agreements for
technical advice and collaboration), concessions and similar other
documents (except those entered into in the ordinary course of
business carried on or intended to be carried on by the company)
together with a brief description of the terms, subject-matter and
general nature of the documents
8. Statement of brief history of the company since its incorporation,
giving details of its activities including any reorganization,
reconstruction or amalgamation, changes in its capital structure
(authorized, issued and subscribed), and debenture borrowings,
if any
9. Particulars of shares and debentures issued for consideration
other than cash, whether in whole or part, at a premium or
discount, or in pursuance of an option
10. Statement containing particulars of any commission, brokerage,
discount or other special terms including an option for the issue
of any kind of the securities granted to any person
11. Particulars of shares forfeited
12. A list of highest ten holders of each class or kind of securities of
the company as on the date of application along with particulars
as to the number of shares or debentures held by and the address
of each such holder
13. Particulars of shares or debentures for which permission to
deal is applied for, provided that a recognized stock exchange
may, either generally by its byelaws or in any particular case, call
for such further particulars or documents as it deems proper.
Listing agreement will be executed with the company concerned on
the satisfactory fulfillment of the above requirements.
LISTING AGREEMENT
An agreement entered into between a stock exchange and a company,
whereby security listing is proposed is called a ‘listing agreement.’
Li st i n g 305
Features
Following are the features of a listing agreement:
SCRA provisions The agreement contains provisions in accordance
with the rule 19(3) of SCR Rules (SCRR), 1957; the provisions can be
modified, amended or altered from time to time in consonance with the
conditions prevailing in the securities market and the general economy.
SED direction The Stock Exchange Division (SED) of the Ministry of
Finance periodically issues directions to SEBI, to amend the listing
agreement provisions so as to make the listing agreement more compatible
and adaptable to the changing capital market environment.
SEBI powers SEBI is authorized to issue guidelines, orders and
directions to all the recognized stock exchanges, to amend the listing
agreement more in particular reference to the recommendations of Malegam
and Birla Committee. The purpose is to achieve the cherished objectives
of better investor protection and disclosure of more information in the
most transparent manner to the public at large, who are directly or indirectly
associated with the affairs of the company.
SEBI is empowered under rule 19 (7) of SCRR, 1957 to waive or relax
the enforcement of all or any of the listing provisions either on its own
motion or on recommendation of stock exchanges.
Applicability The provisions contained in the listing agreement will be
applicable to the body corporate constituted by an Act of Parliament or
any State Legislature with equal force, besides being applicable to a body
corporate under the Companies Act.
STOCK EXCHANGE POWERS

The stock exchange is empowered under the rule 19(5) of SCRR, 1957, to
suspend or withdraw an admission to dealing in securities of company or
body corporate, for breach or non-compliance with the listing provision
on giving an opportunity of being heard in writing. In an eventuality
where any such withdrawal or suspension exceeds 3 months the corporate
may appeal to the SEBI. The SEBI may either vary or set aside the decision
of the stock exchange. The decision upon being communicated to the
stock exchange shall have to be implemented by the stock exchange
accordingly.
LISTING—BENEFITS
Listed securities command the following advantages:
1. Easy marketability and liquidity that ensures easy raising of
capital
2. High collateral value for bank loans
3. Easy evaluation of the real worth of securities
4. Safeguarding general public interest by ensuring equitable
allotment, easy transfer, disclosure of proper information, etc
5. Availability of tax advantages to listed securities
6. Provision of selling forum for companies to mop up additional
capital in future
7. Higher status and reputation for the company by enjoying the
confidence of the investing public
8. Assurance of genuineness of securities as listing is made after
thorough analysis of a company’s capital structure, the
management pattern and business prospects
9. Provides an assurance of an existence of good faith or an absence
of fraud with regard to the issue of securities
10. Providing activities of quick transfer registration and corporate
information
CONSEQUENCES OF NON-LISTING
Following consequences are to be faced by companies that have not had
their securities listed on one or more recognized stock exchanges:
1. Any allotment of shares or debentures on an application shall be
void
2. Any application money collected is to be refunded without
interest, within eight days after the company becomes liable to
repay it
3. Joint and several liability to every director of the company after
the expiry of the aforesaid eighth day to repay the amount with
interest at prescribed rate
NEW ENTRY NORMS FOR UNLISTED COMPANIES
With reference to the SEBI’s Disclosure and Investor Protection Guidelines,
August 12, 1997 following are the tightened entry norms for unlisted
companies:
Li st i n g 307
1. Dividends should have been paid immediately preceding three

years before public issue
2. Fee pricing of securities possible where the company has shown
net profits in the immediately preceding three years subject to its
fulfilling the existing disclosure requirements
3. Compliance with the entry norms only if the post-issue net worth
becomes more than five times the pre-issue net worth
4. Conversion of partly paid-up shares into fully paid-up or forfeit
the same, before making a public/ rights issue
5. Promoters’ contribution for public issues by unlisted as well as
listed companies will be at 20 percent irrespective of the issue
size
6. Only such securities that provide for lock-in facility can be offered
for promoters contribution for which a specific written consent
has been obtained from the shareholders.
7. Mandatory appointment of a ‘Registrar to an Issue’ for rights
issue.
8. A provision has been made regarding disclosure of the
shareholding of the promoters whose name figure in the paragraph
on ‘Promoters and their Background’
LISTING—SUSPENSION / WITHDRAWAL
The dealings in the securities of a company or body corporate may be
suspended or withdrawn admission to a recognized stock exchange either
for a breach of or non-compliance, with any of the conditions of admission
to dealings or for any other reasons, to be recorded in writing, which in the
opinion of the stock exchange justifies such action.
REVIEW QUESTIONS
Section A
1. What does the term ‘listing’ mean?
2. What is meant by ‘security listing’?
3. How is security defined?
4. How is a stock exchange defined?
5. What are recognized stock exchanges?
6. What is a listing agreement?
Section B
1. What are the characteristic features of listing.
2. State the legal provisions as to listing of securities.
3. What is the legal significance of listing?
4. Specify the powers of the SEBI as to listing of securities.
5. When can listing be refused by a stock exchange?
6. Bring out the association between listing and corporate
governance.
7. State the features of a listing agreement.
8. How is a stock exchange empowered on securities listing?
9. How is listing beneficial?
10. What are the consequences of non-listing?
11. What are the new-entry norms brought out by the SEBI for
unlisted companies?
12. When can listing be suspended or withdrawn?
Section C
1. Outline the steps involved in the listing of securities of a corporate
enterprise.
2. What are the particulars to be furnished to the stock exchange
while making an application for listing of securities by a corporate
enterprise?
Chapter 16
Underwriting
DEFINITION
Underwriting is a guarantee given by the underwriters to take up whole
or part of the issue of securities not subscribed by the public. It is a
marketing technique whereby corporate enterprises are able to sell their
securities to the public and thereby achieve success in the public issue.
The service is utilized by corporates in order to procure the necessary
funds. The agreement between the issuing company and the financial
intermediary, called the underwriter, whereby sale of a certain quantum
of securities is guaranteed for the issuing company, is known as
underwriting agreement. The underwriter works for a commission called
‘underwriting commission’.
According to Gerstenberg, “Underwriting is an agreement entered
into before the shares are brought before the public that in the event of the
public not taking up the whole of them the underwriter will take an allotment
of such part of the shares as the public has not applied for.”
TYPES
A brief description of different types of underwriting is outlined below:
Firm Underwriting
It is an underwriting agreement whereby, the underwriter agrees to take up
a specified number of securities, irrespective of the securities being offered
to the public. It is an agreement for outright purchase of securities, the
underwriter being given a preference in allotment over the general public
in respect of the commitment given by the company issuing the securities.
This is in addition to the shares not taken up by the public. Such an
agreement is designed to create confidence in the minds of investing
public.
Sub-underwriting
When a large issue of securities is made and the underwriting of securities
is contracted out by the main underwriter to other underwriting
intermediaries for a commission, it is known as ‘sub-underwriting’. This
type of underwriting helps the main underwriter minimize the risk of loss of
investment in the event of the issue being unpopular.
Joint Underwriting
When an issue of securities by a company is underwritten by two or more
underwriting intermediaries jointly, it is called ‘joint underwriting’. The
objective is to minimize the risk and share the benefit arising from the
capital issue. Besides, this also helps underwriters with limited resources
to pool them and successfully take up the issue.
Syndicate Underwriting
When a syndicate of underwriters, by means of an agreement, underwrites
the issue of securities collectively, it is known as ‘syndicate underwriting’.
Such an arrangement is worked out in the case of issues that are considered
potentially risky. There will be two types of agreements which will form
part of the syndicate underwriting. They are: agreement between the issuing
company and underwriter, and agreement among the underwriters
themselves stating the terms and conditions.
Un derw ri ti ng 311
MECHANICS OF UNDERWRITING
The working mechanism connected with the underwriting of securities is
depicted in Exhibit 6.
Exhibit 6 Mechani cs of Underwri ti ng
BENEFITS/FUNCTIONS
The financial service of ‘underwriting’ is found advantageous for the
issuers and the public alike. The function and the role of underwriting
firms is given below:
Adequate Funds
Underwriting, being a kind of a guarantee for subscription of a public
issue of securities enables a company to raise the necessary capital funds.
By undertaking to take up the whole issue, or the remaining shares not
subscribed by the public, it helps a company to undertake project
investments with the assurance of adequate capital funds. Underwriting

agreement assures the company of the required funds within a reasonable
or agreed time.
Expert Advice
Underwriters of repute often help the company by providing advice on
matters pertaining to the soundness of the proposed plan etc thus enabling
the company to avoid certain pitfalls. It is therefore, possible for an issuing
company to obtain the benefit of expert advice through underwriting before
entering into an agreement. Further, underwriters supply important
information to the issuing company with regard to investor’s attitude,
market conditions etc and suggest changes in their financial plans too,
wherever necessary.
Enhanced Goodwill
The fact that the issues of securities of a firm are underwritten, would help
the firm achieve a successful subscription of securities by the public. This
is because, intermediaries, of financial integrity and established reputation
usually do the underwriting. Such an activity, therefore, helps enhance
the goodwill of the issuing company. By purchasing securities, either
directly from the company or from the market, they vouchsafe the financial
soundness of the company.
Assurance to Investors
Underwriters, before underwriting the issue, satisfy themselves with the
financial integrity of the issuer-company and viability of the plan. The
underwriting firms assure this way, the soundness of the company. The
investors are, therefore, assured of having low risk when they buy shares
or debentures which have been underwritten by them. Their firm
commitment towards fulfilling their underwriting obligations helps create
confidence in the minds of the investing public about the company.
Better Marketing
Underwriters ensure efficient and successful marketing of the securities
of a firm through their network arrangements with other underwriters and
brokers at national and global level. This promotes a wide geographical
dispersion of securities and facilitates tapping of financial resources for
the company.
Benefits to Buyers
Underwriters are very useful to the buyers of securities due to their ability
to give expert advice regarding the safety of the investment and the
soundness of companies. The information and the expert opinion
published by them in various newspapers and journals are also helpful.
Price Stability
Underwriters provide stability to the price of securities by purchasing and
selling various securities. This ultimately benefits the stock market.
INDIAN SCENARIO
Underwriting, as an important type of financial service, became popular in
the Indian capital market only recently. It made its beginning in 1912 when
M/s.Batliwala and Karni underwrote the shares of the Central India
Spinning and Weaving Co. Ltd. Underwriting, on a substantial scale, started
in the Indian capital market only after World War I. The Tatas started the
first underwriting business in India in 1937, with the setting up of the
‘Investment Corporation of India Ltd’. Not only were there few underwriting
firms operating in India, but also the quantum of underwriting done was
also less.
Underwriting gained momentum and popularity after January 1955,
with the setting up of the Industrial Credit and Investment Corporation of
India (ICICI). Later, other development financial institutions such as the
Life Insurance Corporation of India, Industrial Development Bank of India
(IDBI) and Unit Trust of India (UTI) started taking an active part in the
underwriting of new issues, with IDBI being one of the largest.
UNDERWRITING AGENCIES
The Indian capital market is dominated by several underwriting agencies
such as private firms, banks, financial institutions, etc.
Private Agencies
Some of the important private firms that are involved in underwriting
business are M/s.Place, Siddons and Gough, M/s.Baltiwala and Karni, M/
s.Dalal and Co., M/s.Kothari and Co. and M/s.Wright and Co.
Investment Companies
In addition to private agencies, a number of investment companies and
trusts are also engaged in the underwriting business. These include
Industrial Investment Trusts of Bombay, Birds Investment Ltd., Calcutta,
Devkaran Nanji Investment Co., and Investment Trust of India Ltd.
Commercial Banks
After the nationalization of commercial banks, and with the initiation of
reform measures in the beginning of the nineties, banks started taking a
active part in the underwriting business.
Development Finance Institutions (DFIs)

A number of development finance institutions were established all over
the country in order to spur development and growth in the industrial,
export and agricultural sectors. These institutions provide both direct and
indirect, financial and other type of assistance. Among the indirect
assistance of finance, underwriting constitutes an important segment.
These institutions include the Life Insurance Corporations (LIC), the
Industrial Finance Corporation of India (IFCI), the Industrial Credit and
Investment Corporation (ICICI), the Industrial Development Bank of India
(IDBI), the Unit Trust of India (UTI) and State Financial Corporations
(SFCs). These institutions account for a major share of the underwriting
business in India.
OBSTACLES
Underwriters in India face several debilitating conditions that constitute
obstacle to their progress. Some of the hardships faced by them are as
follows:
Chaotic Capital Market

An essential prerequisite for the development and the promotion of
underwriting is the existence of a well-developed capital market.
Unfortunately, the capital market in India is of recent origin. With the
progress taking place very slowly, even after the implementation of
economic reforms in the beginning of the nineties, a lot of uncertainties
persist. Moreover, the kind of equity culture existing in the capital market
is sluggish, dormant and chaotic. All these factors resulted in the slow
progress of underwriting.
Slow Industrialization
Thanks to many obstacles in the Indian economy, industrial development
has been relatively slow and tardy. There were many legislative and other
measures of control and regulation that were so archaic that they caused
heavy hardship to industrial development. On account of these reasons,
the Indian capital market remained under-developed especially with regard
to underwriting agencies for a long time.
Managing Agency System

The managing agency system, prevalent in the corporate world, was
responsible for the slow growth of the underwriting business in India.
Managing agents who performed the underwriting activity indulged in

the sale of securities of managed companies to their friends.
Bashful Investors
The bashful nature of Indian investors is responsible for the slow progress
of underwriting. Indian investors lack the inclination to make smart
investment in securities. The backward nature of the Indian industry is
responsible for not contributing anything towards the development of
underwriting business.
Lack of Specialized Institutions
For the underwriting service to take place and flourish, it requires the
presence of specialized financial institutions similar to the investment
bankers of USA, or the issue houses of UK. Such specialized institutions
were not available in the Indian capital market, although the banks and
institutions started the underwriting business in a big way very late.
Uns uccess ful Corporates
The inability of the Indian corporates to emerge successful after the public
issue of securities made potential investors lose faith in the activities of
the capital market in India. This also resulted in inadequate capital
formation. The underwriting business thus, did not take off well, since this
made the investments more risky.
UNDERWRITER
The financial services intermediary who arranges for the subscription of
the issue of securities, in the event of the issue not being taken up by the
public, or who firmly guarantees a capital issue, is called ‘the underwriter’.
National financial institutions, commercial banks, merchant bankers,
and members of stock exchanges function as underwriters. The lead
manager, in consultation with the company, arranges the underwriting
service. Several factors are taken into consideration while making the
selection of an underwriter for an issue. The factors include financial
strength, experience in the primary market, past underwriting performance
and defaults, if any, underlying underwriting commitments, the network of
investor clientele of the underwriter and overall reputation of the
underwriter. If any part of the issue is underwritten, the prospectus shall
contain a statement that the underwriters have sufficient resources to
discharge their obligations.
Before accepting the underwriting obligation, the underwriter takes
into consideration factors such as the company’s standing and record,
competence of the management, objectives of the issue, project details,

offer price, other terms of the issue, and off-balance sheet liabilities.
UNDERWRITING AGREEMENT
A contract between an underwriter and the company issuing capital with
regard to the commitment for subscription of securities is known as
‘underwriting agreement’. The underwriter agrees to subscribe or procure
subscription to a portion of the capital to be issued, in case the issue is not
fully subscribed, the maximum liability of the underwriter being restricted
to the amount underwritten. The underwriters usually include merchant
bankers or financial institutions such as UTI, and other mutual funds, LIC
or ICICI.
In finalizing underwriting arrangements, both the resources of the
underwriters and the marketing aspects of the issue are kept in mind. The
participation of brokers in underwriting helps in marketing the issue to the
individual investor. Financial institutions consider underwriting proposals
on the basis of the viability of the project for which public issue is being
made.
SEBI GUIDELINES
SEBI has issued detailed guidelines regulating underwriting as a financial
service. Following are the important guidelines:
Optional
Underwriting has been made optional by the SEBI, for issues since October
1994. Accordingly, if an issue has not been underwritten and the firm is
not able to collect 90 percent of the amount offered to the public, the entire
amount collected would be refunded to the investors. However, the
requirement of a minimum of 90 percent subscription will not be applicable
to the exclusive debt issues, provided the issuer makes adequate
disclosures about the alternative sources of finance that have been tied-
up.
Number of Underwriters
The issuers will decide the number of underwriters. For this purpose, the
lead managers must satisfy themselves about the net worth of the
underwriters, and the outstanding commitments, and disclose the same to
SEBI. The underwriting arrangement should be filed with the stock
exchange.
Registration
An important regulation announced by SEBI was the requirement for
underwriting firms to get themselves registered with SEBI. The registration
requires the underwriters to have a minimum net worth of Rs. 20 lakhs.
Obligations
Underwriters are obligated to follow scrupulously the general obligations
and responsibilities, procedures for inspection and disciplinary
proceedings in case of default. The underwriting obligations, at any point
of time, should not exceed 20 times an underwriters net worth.
Sub-underwriting
As a step towards diversifying the risk, the underwriter can off-load a
portion of the obligations to other underwriters. For this purpose,
underwriters can arrange for sub-underwriting on their own. In order to
ensure transparency in the operations of underwriters, an agreement is
entered into with each body corporate on whose behalf the underwriting
is undertaken. The agreement stipulates details such as the period within
which the underwriter shall subscribe to the issue after being asked, the
precise commission payable and details of arrangements made by the
underwriter for fulfilling the underwriting obligations.
Underwriting Commission
The payment of underwriting commission depends on the amount of
obligation devolving on the underwriter. Underwriting commission is
payable by the issuer-corporation on the basis of the commission rates
prescribed by SEBI. They are the maximum ceiling rates and are negotiable.
No underwriting commission is payable on amounts taken up by promoters,
employees, directors and their friends, and business associates.
Underwriting commission is to be paid within 15 days of finalization of
allotment. However, it is payable only when the entire portion has been
subscribed.
The relevant rates of underwriting commission are as follows:
1. In respect of equity shares, the commission is 2.5 percent on
both the amount devolving on underwriter, and on the amount
subscribed by the public
2 . In respect of preference, convertible and non-convertible
debentures
• For underwriting upto Rs. 5 lakhs, the commission is
2.5 percent for the amount devolving on underwriter and
1.5 percent on the amount subscribed by the public
• For underwriting exceeding Rs. 5 lakhs, the commission is 2

percent for the amount devolving on underwriter and 1
percent on the amount subscribed by the public
VARIANTS OF UNDERWRITING
There are variants of the underwriting business, which have evolved owing
to the series of changes that have taken place in the control and regulatory
ambience of the capital market in India.
Offer for Sale
Offer for sale takes place when a company arranges to obtain money from
private sources, by making the issue of securities fully to them. The private
sources include issue houses and merchant bankers. Issue is generally
made below the par value, which is then sold to the public. In such an
eventuality, the company issues a ‘statement in lieu of prospectus’ instead
of a regular prospectus. A statement in lieu of prospectus with information
to be disclosed according to Schedule III of the Companies Act
(Sec. 70(1)) should be filed with ROC three days before allotment of shares
or debentures.
Bought-out Deals (BODs)
Meaning An arrangement, whereby the entire equity or related security
is bought in full or in lots, with the intention of off-loading it later in the
market is called ‘bought-out deal’.
Features
a. Arrangement The arrangement takes place between the
merchant banker/sponsor and the company, the shares being
held by the sponsor until they are ready for public participation
b. No retailing BODs eliminate retailing, thereby saving time and
cost. They are the cheapest and quickest source of finance for
small and medium companies
c. Fund-based activity BODs convert a fee-based activity into a
fund-based activity for merchant bankers
d. Wholesale activity The capital raised from public, which is a
retail activity, is rendered into a wholesale activity by the
guidelines issued by SEBI in 1994, for reservation of issues without
lock-in periods
e. Reserved portions From the reserved category for institutional
investors, lead managers can take a stake upto 5 percent of the
post-issue equity. The reserved portion of the issue need not be

underwritten. The public offer is 25 percent of the issue and
underwriting is optional
Ad vantages
a. Efficient appraisal of the project by the merchant bankers before
the funds are invested
b. Appropriate avenue to price the securities of companies
c. Helpful in raising funds upfront and thus saving the cost of
raising funds through a public issue
d. Helpful to entrepreneurs who are not confident enough of tapping
the capital market directly
e. Measure of assurance and safety to the investor since the project
is appraised by a merchant banker
f. Benefits of larger participation of FIs, merchant bankers and FIIs
and consequent higher credibility
g. Handsome gains for the merchant banker if proper issue and
prices are selected
Private Placement
Definition The direct sale of securities by a company to institutional
investors is called private placement. It is another variant of underwriting.
Private placement assumes that the offerees are limited and few, and have
sufficient knowledge and experience to evaluate the merits and risk of
investment.
Private placement facility is available for both listed and unlisted
companies with a good track record of sales and profit. In the case of listed
companies, private placements take into account their trading volumes,
the level of floating stock and the purpose for which additional funds are
being raised.
Features
a. No prospectus In private placement no prospectus is issued
b. Instrument covered Private placement covers shares, preference
shares and debentures
c. Issuers The issuers could be public limited companies or private
limited companies
d. Investors Investors include Unit Trust of India, Life Insurance
Corporation, General Insurance Corporation, State Finance
Corporations, and Pension and Insurance Funds. Investors have

sufficient knowledge and experience to be capable of evaluating
the merits and risks of the investment
e. Intermediaries The intermediaries are credit rating agencies,
trustees (e.g. ICICI) and financial advisors such as merchant
banks. The financial intermediary plays a vital role in preparing
an offer memorandum, and negotiating with investors
f. Negotiation By dealing with a limited number of institutional
investors, the credit rating agents or trustees like ICICI can
negotiate a loan directly tailored to suit the issuer’s needs
g. Popular instrument The most widely used instrument in private
placement is nonconvertible debenture, which is preferred by
institutional investors because it gives stable and assured yield.
The debentures are generally held until maturity
h. Market size The private placement market is as big as the market
for public issue through prospectus and rights combined
Rationale Many factors contributed to the need for the development
of opportunities for privately placing the securities. Some of these factors
are as follows:
a. Capital market conditions The conditions that were prevailing
in the Indian capital market with regard to pricing, listing and
trading conditions made it difficult for corporates to raise capital
for new projects. The cost of raising capital in terms of publicity
and brokerage, which has always been prohibitive, along with
uncertainties, has prompted companies to look for private
placement opportunities for public subscription. Activity in the
institutionalized private placement market has been quite intense,
with most public sector enterprises, financial institutions and
corporations meeting their requirement through private equity
funding
b. FIs resources A huge pool of savings with Financial
Institutions (FIs) such as banks, including rural banks, insurance
companies, provident funds, trusts and foreign private equity
funds, made it possible for the growth of private placements
c. Preferences The preferences of institutional investors, details
of the company, promoters, management, project to be
undertaken, pricing norms, and projections also played an
important part in the development of the private placement market
Ad vantages
a. Popular mode Private placement has obvious advantages of
speed, low cost, confidentiality, and accommodates smaller debt
financing than is possible in a public issue
b. Quick access Private placement offers access to capital more
quickly than the public issue
c. Secrecy Confidentiality is ensured in private placement,
especially for private limited companies and closely held public
limited companies, which do not want to make public issues for
fear of takeover, wealth tax hassles and institutional interference
d. Influence Private placement is not influenced by the prevailing
bull or bear phases in the stock markets
GREY MARKET
When securities are not sold through prospectus, it is a case of ‘grey
market placement’. In the grey market, trading takes place in securities
much before official listing. The modus operandi in grey market is
soliciting through post or print media, or door-to-door, and interested
parties to purchase shares in private placement. While shares of new
companies are sold at par or at nominal premium, in the case of shares of
existing and profit making companies, premium could be very high. The
brochure that normally accompanies the application presents a rosy
picture and does not convey the gestation period or risks involved. The
grey market exists with the active connivance of promoters. They sell
shares out of their quota and profit from any premium collected.
REVIEW QUESTIONS
Section A
1. Define the term ‘underwriting’
2. What is meant by ‘firm underwriting’?
3. What is ‘sub-underwriting’?
4. What is ‘joint underwriting’? How is it different from ‘syndicate
underwriting’?
5. Who is an underwriter?
6. What is an underwriting agreement?
7. What is ‘offer for sale’?
8. What are ‘bought-out deals’?
9. What is ‘private placement’?
Section B
1. How is underwriting classified? Explain.
2. Explain the mechanics of underwriting of securities of a corporate
enterprise.
3. State the advantages of underwriting of securities.
4. State the underwriting agencies operating in India.
5. What are the obstacles to the business of underwriting in India?
6. State the relevant rates of underwriting commission as applicable
to underwriting firms in India.
7. What are the features of ‘bought-out deals’?
8. State the benefits of ‘bought-out deals’
9. Bring out the features of private placement.
10. What is the rationale for the development of private placement in
India?
11. What is ‘grey market’? How is it significant?
Section C
1. Examine the business underwriting in the Indian scenario.
2. What are the SEBI guidelines relating to the business of
underwriting in India?
3. Discuss the variants of underwriting.
Chapter 17
Book-Building
C ON C E P T
Book-building is a process by which corporates determine the demand
and the price of a proposed issue of securities through public bidding.
The objective is to determine the quantum of the issue on the basis of the
price book-built. Once the price and the quantum of issue has been
determined by the issuer, the issue may either be offered under the private
placement or the public offer category, or both, as per the requirement of
the SEBI regulations.
CHARACTERISTICS
Tendering Process
Book-building involves inviting subscriptions to a public offer of securities,
essentially through a tendering process. Eligible investors are required to
place their bids for the number of shares to be issued and the price at
which they are willing to invest, with the lead manager running the book.
At the end of the cut-off period, the lead manager determines the response
to the issue in terms of the quantum of shares and the highest price at
which demand is sufficient to match the size of the issue.
Floor Price
Floor price is the minimum price set by the lead manager in consultation
with the issuer. This is the price at which the issue is open for subscription.
Investors are free to place a bid at any price higher than the floor price.
Price Band
The range of price (the highest and the lowest price) at which offer for the
subscription of securities is made is known as ‘price band’. Investors are
free to bid any price within the price band.
Bid
The investor can place a bid with the authorized lead manager-merchant
banker. In the case of equity shares, usually several brokers in the stock
exchange are also authorized by the lead manager. The investor fills up a
bid-cum-application form, which gives a choice to bid for upto three optional
prices. The price and demand options submitted by the bidder are treated
as optional demands and are not cumulated.
Allotment
The lead manager, in consultation with the issuer, decides the price at
which the issue will be subscribed and proceeds to allot shares to investors
who have bid at or above the fixed price. All investors are allotted shares
at the same fixed price. For any allottee, therefore, the price would be equal
to or less than the price bid.
Participants
Generally, all investors, including individuals, eligible to invest in a particular
issue of securities can participate in the book-building process. However,
if the issue is restricted to qualified institutional investors, as in the case
of government securities, then, only those eligible can participate.
Book -Bu i l di n g 325
THE PROCESS
The process of book-building is depicted in Exhibit 7.
Exhibit 7 Process of Book-bui ldi ng
The procedures relating to the book-building process depend on the level

at which it is to be taken up by a corporate entity. According to the SEBI,
there are two options available to a company, either 75 percent or
100 percent book-building process. Each of these methods is discussed
briefly below:
75 Percent Book-building
The 75 percent book-building option of securities is offered on a ‘firm
basis’, where a minimum of 25 percent of the securities is offered to the
public. The following steps are involved in this process:
1. Eligibility All corporates eligible for public shares are also eligible
for raising capital through the book-building process.
2. Earmarking securities Where a decision is taken by a corporate to
issue shares through the book-building process, the securities to be used
should be separately earmarked as the ‘placement portion category’ in the
prospectus. The balance securities must be stated as ‘net offer to the
public’ category.
3. Draft prospectus A draft prospectus containing all the information
except price of the issue must be filed with the SEBI. Although no precise
mention is made, a ‘price band’ indicating the price range within which
securities are being offered for subscription should be indicated. The
prospectus is to be filed with the ROC within two days of the issue price
being finalized.
4. Appointment of book runner The issuing company appoints a
merchant banker as the book runner, which should be mentioned in the
prospectus. The book runner circulates a copy of the draft prospectus
among the institutional buyers who are eligible for firm allotment and to
the intermediaries who are eligible to act as underwriters, inviting them to
subscribe to the issue of securities. The book runner maintains a record of
the names and number of securities ordered by intermediary buyers and
the price at which they are willing to subscribe the issue under the
placement portion.
The book runner collects information about the subscriptions received
from underwriters and other intermediaries. After a stipulated time period,
the book runner aggregates the subscriptions so received. The underwriters
are required to make a payment of the total amount for the subscription of
issues.
The book runner collects payments from underwriters and institutional
buyers a day prior to opening of the issue to the public, which includes
application money for all the applications through which securities were
subscribed by them.
5. Price setting Based on the data collected from intermediaries
relating to the total orders received, the issuing company and the book
runner set an appropriate price of the issue for offer to the public. The
issue price is determined on the basis of ‘bids’ received through members
of the syndicate formed under the lead book runner. This would be the
issue price for both the private placement and the public category. The
number of securities to be issued is decided on the basis of amount and
the issue price. This can be expressed as:
Number of securities = Amount of issue ÷ Price per security
6. Underwriting The members of the syndicate fully underwrite the
offer to the extent that it is not offered to promoters, permanent employees
and shareholders. For this purpose, the syndicate members enter into an
underwriting agreement. The agreement specifies the quantum and price
of shares that would be underwritten for book-building. Underwriting is
mandatory for issues that are earmarked as ‘net offer to the public’. The
underwriters maintain a record of the subscriptions received by them for
the issue in the placement portion and forward these records to the book
runner. In the event of the underwriters not being in a position to take up
the shares as committed, the book runners have to subscribe to the
issue committed for by the underwriters.
7. Bank account The issuer company opens two accounts, one for
collection of the application money towards the private placement portion,
and the other for the offer of the 25 percent of the total issue made to the
public.
8. Allotment All those intermediaries who have offered their bid price
at and above the now determined issue price, will become eligible for
allotment of securities. Once the eligibility is decided, intimation has to
be sent to them for the subscription and payment. Although the allotment
in the private placement category has to be made two days prior to the
date of closure of the issue, the issuer may choose to allot securities
under the book-building process for both private placement and public
offer category on the same day. The allotment of securities under the
public offer category should be made in accordance with the relevant
guidelines.
In the event of under-subscription to the public offer category, orders
in the private placement category can be utilized to fill public subscription.
While doing so, preference should be given to individual investors.
Similarly, when there is deficient subscription to the private placement
category, a spillover is allowed from the public offer category. Interest is
payable by the issuer for the period between the date of closure of the
issue and date of allotment.
9. Listing When all the committed money has been collected from the
underwriters by the 11th day of issue closure, the shares allotted in the
private placement category become eligible for listing. The securities issued
under the public offer category are also eligible for listing. However,
securities offered on-line over the internet are not listed.
10. Inspection SEBI serves as the chief regulator supervising the book-
building process. It has the powers to carry out inspection of books and
records maintained by intermediaries such as the book runner, the
underwriter and others.
100 Percent Book-building
It is an option of book-building process whereby 100 percent of the
securities is offered on a ‘firm basis’ or is reserved for promoters, permanent
employees of the issuer company. It may also be offered to shareholders
either on a competitive basis or on a firm allotment basis. The required
minimum issue of capital is Rs. 25 crores. Following are the procedures
connected with the 100 percent book-building process:
1. Conditions It is possible for an issuer to make a public issue through
the 100 percent book-building process by fulfilling the following conditions:
a. The minimum capital to be raised must be Rs. 25 crores
b. Reservation or firm allotment to promoters can be made only
according to the guidelines of the SEBI, i.e. to permanent
employees of the issuer company, and in the case of new
companies, to the permanent employees of the promoting company
c. Allotment can also be made either on a competitive basis or on
firm allotment basis to the shareholders of the promoting
companies in the case of a new company, or to the shareholders
of group companies in the case of existing companies
d. Eligible merchant bankers shall be appointed as the lead book
runners and their names shall be mentioned in the draft
prospectus to be filed with the SEBI
2. Lead book runner An essential requirement for a 100 percent book-
building process is the appointment of a lead book runner by the issuer.
The book runner is primarily responsible for book-building in order to
determine the appropriate price and quantum of issue. For this purpose, a
syndicate is formed. SEBI-registered underwriters and other eligible merchant
bankers are appointed by the book runner as members of the syndicate. In
the event of any undersubscription of issue, the lead merchant bankers
have to fill the shortfall. The book runners are responsible for incorporating
any changes in the draft prospectus that might be suggested by SEBI.
In addition, they are also responsible for maintenance of records

relating to the book-building process, which may be inspected by SEBI to
examine the modalities of book-building adopted by the company.
3. Draft prospectus The lead book runner files a draft prospectus with
SEBI. This document contains all the required disclosures, such as the
total size of the issue etc in accordance with SEBI norms. The information
about the issue price and the quantum issue need not be mentioned. Any
modifications are intimated to the company by SEBI within a period of 21
days after the receipt of the draft prospectus.
4. Essential disclosures The following information should be
disclosed in the draft prospectus before being filed with SEBI:
a. Details of the members of the ‘syndicate’ formed by the lead
book runner for the purpose of bidding for the issue
b. Details of registrars and bankers to the issue
c. Details of basis of ascertainment of issue price by the issuer and
the book runners
d. Details of accounting ratios, such as preissue EPS, P/E, average
return on net worth etc for three years including a comparison
with industry average. The ratios have to be computed after
giving due effect to the consequent increase of capital on account
of compulsory outstanding conversions
e. Details of NAV per share based on the last balance sheet
5. Advertisement The issuer, after obtaining the revised prospectus
from SEBI, advertises in leading newspapers. The advertisement contains
all the requisite features of the final offer document as specified under the
provisions (Section 2A) of the Companies Act. It is incumbent on the part
of the issuing company to offer at least 10 percent of the total issue to the
public.
6. Stockbrokers SEBI-registered stockbrokers are appointed for
placing orders with the company by the stock exchange that would act as
collection centers for the applications. These brokers must be capable of
taking up the issue in the event of failure on the part of their clients to
honor their commitment. The issuer pays commission for their services.
7. Bidding process The members of the syndicate bid for the securities
to be issued by the issuer. Following are the procedures connected with
the bidding:
a. Advertisement regarding the bidding, containing information
about the date of opening and closing of the bidding (minimum 5
days of opening), names and addresses of the syndicate members,

bidding terminals and the method of bidding are given
b. Bidding takes place on-line electronically by members present at
the designated centers
c. The number of collection centers and bidding centers shall be
according to the guidelines of SEBI
d. Individuals and institutions who are not members of the
syndicate can bid through the syndicate memberse
e. Bidding shall be done in the prescribed form wherein information
about the investor, price and quantum of securities etc are to be
furnished
f. The serial number of the bidding form shall be system generated
and stamped automatically
g. The bidding form shall be made out in duplicate, signed by the
investor and countersigned by the book runner/syndicate
member
8. Allotment process Following are the procedures for the allotment
of securities:
a. A minimum of 15 percent of the issue shall be reserved for
allotment to individual investors to a maximum of 10 tradeable
lots through the syndicate member
b. A minimum of 10 percent of the issue shall be reserved for
allotment to individual investors who have not participated in
the book-building process
c. Allotment to individual investors shall be on the basis of a
proportionate allotment system
d. In the event of under-subscription of issues reserved for individual
investors, the issuer company may make allotment in any manner
as it deems fit
e. Allotment to other categories of investors shall be decided by
the book runner on the basis of prior commitment, investor quality,
price quoted, etc
f. Allotment shall be made within a period of 15 days from the date
of final closure of the issue. Failure to do so will entail the company
to pay interest @ 15 percent p.a. to the investors (issue must be
open for a period of at least 21 days)
9. Refund The broker shall refund the amounts received from

unsuccessful applicants within 3 days of the receipt of the allocation. The
details of the amount received from successful applicants shall be furnished
to the stock exchange in electronic medium.
10. Certificate Once all the formalities for subscription and allotment
are completed, the registrars to the issue post the share certificate to the
applicants, or arrange to have the shares demated by a depository.
ALLOCATION PROCEDURE
The allocation procedure relating to an issue of a firm that wishes to follow
the ‘book-building’ route is as follows:
CASE I—INITIAL PUBLIC OFFER (IPO) ISSUE
In the case of a company going in for an IPO and availing the book-building
facility, the allocation to individual investors applying through the syndicate
members shall be with reference to the post-issue capital. The allocation to
individual investors not applying through the syndicate members shall be
with reference to the issue size offered to the public through the prospectus.
The allocation procedure in the case of an IPO is as follows:
1. Calculate initial promoters’ contribution:
= Initial post-issue capital × 20% (Minimum)
2. Calculate the quantum of book-building:
= Initial post-issue capital – Initial promoters’ contribution
3. Calculate allocation to individual investors applying through
syndicate (fixed):
4. Calculate allocation to institutional investors (fixed):
= Initial post-issue capital – [Initial promoters’ contribution +
Allocation to individual investors pplying through syndicate]
5. Calculate allocation to individual investors NOT applying through
syndicate (fixed):
6. Calculate new post-issue size:
= Initial post-issue capital + Allocation to individual investors
NOT applying through syndicate
7. Calculate New allocation to individual investors applying through

syndicate (fixed):
= New post-issue capital × 15% (Minimum)
8. Find the excess contribution to be brought in by the promoter:
= New allocation to individual investors applying through
syndicate (fixed) – Old allocation to individual investors applying
through syndicate
9. Find new allocation to institutional investors (fixed):
= Initial post-issue capital – [Initial promoters’ contribution +
New allocation to individual investors applying through
syndicate]
10. Find the deficiency contribution to be brought in by the promoter:
= Fixed allocation – New allocation
11. Calculate total promoters’ contribution:
= Initial contribution + Excess of individual investors + Deficiency
of institutional investors
12. Calculate individual investors allocation:
= Minimum allocation to individual investors applying through
syndicate + Minimum allocation to individual investors applying
through syndicate
13. Calculate total issue size:
= Total promoters’ contribution + Total allocation to individual
investors + Allocation to institutional investors
ILLUSTRATION
From the following information, set out the calculations to show the
quantum of book-building, the total promoters’ contribution and the total
allocation to individual investors:
• Initial post-issue capital Rs. 100 Crores
• Minimum promoters’ contribution 20%
• Minimum allocation to individual investors applying through
syndicate 15%
• Minimum allocation to individual investors not applying
through syndicate 8%
Solution
Quantum of book-building, promoters’ contribution and individual
investors contribution
1. Initial post-issue size = Rs. 100 Crores
2. Initial promoters’ contribution = Rs. 100 Crores × 20% =
Rs. 20 Crores
3. Calculate the quantum of book-building = Rs. 100 Crores – Rs. 20
Crores = Rs. 80 Crores
4. Fixed allocation to individual investors applying through
syndicate = Rs. 100 Crores × 15% = Rs. 15 Crores
5. Fixed allocation to institutional investors = Rs. 100 Crores –
[Rs. 20 Crores + Rs. 15 Crores] = Rs. 65 Crores
6. Fixed allocation to individual investors applying NOT through
syndicate = Rs. 100 Crores × 8% = Rs. 8 Crores
7. New post-issue size = Rs. 100 Crores + Rs. 8 Crores = Rs. 108
Crores
8. New (fixed) allocation to individual investors applying through
syndicate = Rs. 108 Crores × 15% (Minimum) = Rs. 16.2 Crores
9. Excess contribution to be brought in by the promoter = Rs. 16.2
Crores – Rs. 15 Crores = Rs. 1.2 Crores
10. NEW (fixed) allocation to institutional investors = Rs. 100 Crores
– [Rs. 20 Crores + Rs. 16.2 Crores] = Rs. 63.8 Crores
11. Deficiency contribution to be brought in by the promoter
Rs. 65 Crores – Rs. 63.8 Crores = Rs. 1.2 Crores
12. Total promoters’ contribution = Rs. 20 Crores + Rs. 1.2 Crores +
Rs. 1.2 Crores = Rs. 22.4 Crores
13. Total individual investors allocation = Rs. 15 Crores + Rs. 8 Crores
= Rs. 23 Crores
14. New total issue size = Rs. 22.4 Crores + Rs. 23 Crores + Rs. 65
Crores = Rs. 110.4 Crores
CASE II—ADDITIONAL ISSUE BY LISTED COMPANY
In the case of a listed company going in for an additional issue of capital,
and availing the book-building facility, the allocation to individual investors
applying through the syndicate members shall be with reference to the
proposed issue. The allocation to individual investors not applying through
syndicate members shall be with reference to the issue size offered to the
public through the prospectus. The allocation procedure in case of an
additional issue by a listed company is as follows:
1. Calculate promoters’ contribution:

= Proposed issue × 20% (Minimum)
= Proposed issue – Promoters’ contribution
syndicate (fixed):
= Proposed issue – [Promoters’ contribution + Allocation to
individual investors applying through syndicate]
syndicate (fixed):
= Quantum of book-building × 10% (Minimum)
6. Calculate New additional issue size:
= Proposed issue + Allocation to individual investors applying
NOT through syndicate
7. Calculate New (fixed) allocation to individual investors applying
through syndicate:
= New additional issue size × 15% (Minimum)
8. Find the excess contribution to be brought in by the promoter:
= New allocation to individual investors applying through
syndicate (fixed) – Old allocation to individual investors applying
through syndicate
9. Find New allocation to institutional investors (fixed):
= Proposed issue – [Promoters’ contribution + New allocation
to individual investors applying through syndicate]
10. Find the deficiency contribution to be brought in by the promoter:
= Fixed allocation – New allocation
11. Calculate Total promoters’ contribution:
= First contribution + Excess of individual investors + Deficiency
of institutional investors
12. Calculate total individual investors allocation:
syndicate + Minimum allocation to individual investors applying
through syndicate
13. Calculate total additional issue size:

ILLUSTRATION
quantum of book-building, the total promoters’ contribution and the total
• Additional issue proposed Rs. 100 Crores
syndicate 15%
• Minimum allocation to individual investors not applying through
syndicate 10%
Solution
Quantum of book-building, promoters’ contribution and individual
investors contribution
1. Proposed issue = Rs. 50 Crores
2. Promoters’ contribution = Rs. 50 Crores × 20% (Minimum) =
Rs. 10 Crores
3. Quantum of book-building = Rs. 50 Crores – Rs. 10 Crores =
Rs. 40 Crores
4. Allocation to individual investors applying through syndicate
(fixed) = Rs. 50 Crores × 15% (Minimum) = Rs. 7.5 Crores
5. Allocation to institutional investors (fixed) = Rs. 50 Crores
– [10 Crores + Rs. 7.5 Crores] = Rs. 32.5 Crores
6. Allocation to individual investors NOT applying through
syndicate (fixed) = Rs. 40 Crores × 10% (Minimum) = Rs. 4 Crores
7. New additional issue size = Rs. 50 Crores + Rs. 4 Crores
= Rs. 54 Crores
8. New allocation to individual investors applying through syndicate
(fixed) = Rs. 54 Crores × 15% (Minimum) = Rs. 8.1Crores
9. Find the excess contribution to be brought in by the promoter
= Rs. 8.1Crores – Rs. 7.5 Crores = Rs. 0.6 Crores
10. New allocation to institutional investors (fixed) = Rs. 50 Crores
– [Rs. 10 Crores + Rs. 8.1 Crores] = Rs. 31.9 Crores
11. Find the deficiency contribution to be brought in by the promoter

= Rs. 32.5 Crores – Rs. 31.9 Crores
= Rs. 0.6 Crores
12. Total promoters’ contribution = Rs. 10 Crores + Rs. 0.6 Crores
+ Rs. 0.6 Crores = Rs. 11.2 Crores
13. Total individual investors allocation = Rs. 7.5 Crores
14. Total additional issue size = Rs. 11.2 Crores + Rs. 11.5 Crores
CASE III—OFFER BY UNLISTED COMPANY
In the case of an unlisted company going in for an offer of sale, and
availing the book-building facility, the allocation to individual investors
applying through the syndicate members shall be with reference to the
post-issue capital. The allocation to individual investors not applying
through syndicate members shall be with reference to the issue size offered
to the public through the prospectus. The allocation procedure in the case
of an offer for sale by an unlisted company is as follows:
1. Calculate Total promoters’ contribution:
= Proposed issue – Promoters’ contribution
syndicate (fixed):
syndicate (fixed):
= Quantum of book-building × 10% (Minimum)
= Proposed issue – [Promoters’ contribution + Allocation to
individual investors applying through syndicate + Allocation to
individual investors NOT applying through syndicate]
6. Calculate total individual investors allocation:
syndicate + Minimum allocation to
individual investors applying through syndicate
7. Calculate total issue size:

ILLUSTRATION
quantum of book-building, total promoters’ contribution and the total
• Issue proposed Rs. 100 Crores
syndicate 15%
• Minimum allocation to individual investors not applying through
syndicate 10%
Solution
Quantum of book-building, promoter’s contribution & individual investors
contribution
1. Proposed issue size = Rs. 100 Crores
2. Total promoters’ contribution = Rs. 100 Crores × 20% (Minimum)
= Rs. 20 Crores
3. Quantum of book-building = Rs. 100 Crores – Rs. 20 Crores
= Rs. 80 Crores
4. Allocation to individual investors applying through syndicate
(fixed) = Rs. 100 Crores × 15% (Minimum)
= Rs. 15 Crores
5. Allocation to individual investors NOT applying through
syndicate (fixed)
= Rs. 80 Crores × 10% (Minimum) = Rs. 8 Crores
6. Allocation to institutional investors (fixed)
= Rs. 100 Crores – [Rs. 20 Crores + Rs. 15 Crores
+ Rs. 8 Crores] = Rs. 57 Crores
7. Total individual investors allocation = Rs. 15 Crores + Rs. 8 Crores
= Rs. 23 Crores
8. Total issue size = Rs. 20 Crores + Rs. 57 Crores + Rs. 23 Crores
= Rs. 100 Crores
Normal Public Issue Vs. Book-Building Process
Issue of securities through book-building process differs from the public
issue in the following respects:
Feature Normal Public Issue Book-building Process

Pricing The investor knows in The investor does not
advance the price at know in advance the price
which the securities are at which securities will be
offered. offered. Only an
indicative price range is
known.
Demand Demand for the securities Demand for the securities
offered is known only offered can be known
after the closure of the everyday as the book is
issue. built.
Payment Payment is made at the Payment only after
time of subscription allocation.
wherein refund is given
after allocation.
REVERSE BOOK-BUILDING
Meaning
The process, By which the exit price of the shares of a corporate entity is
determined, is called, ‘reverse book-building’. This happens where a firm
exits from the stock market through the delisting process.
Reverse book-building allows shareholders to tender their shares at a
price of their choice and the acquirer the freedom to accept or reject the
offer.
Recently there was a move by the Hewlett Packard (HP) to get its
Indian subsidiary ‘Digital Globalsoft’ delisted through reverse book-
building.
Features/Benefits
1. Offer from shareholders Reverse book-building essentially
involves generating offers from the seller (shareholders) who have no
indication of the buyer’s intention on the price that the buyer is willing to
pay for the strategic value of the company.
2. Exit price Reverse book-building is used as a method of arriving at
the exit price for delisting of shares. The exit price will be determined on
the basis of the average of weekly highs and lows of either 26 weeks or 52
weeks. Such a price will be the minimum offer price.
3. Fair price Reverse book-building process is expected to provide a

transparent, fair, and reasonable mechanism for pricing of shares and
ensure investor participation in the whole process of delisting.
4. Reasonable pricing Reverse book-building process is expected to
provide a transparent, fair, and reasonable mechanism for pricing of shares
and ensure investor participation in the whole process of delisting.
5. Viable solutions It focuses on viable solutions for determining
“fair price” to the shareholders in the case of outright acquisition of 100
percent equity stake by multinational or domestic promoters/persons in
control of the company to gain full control over the Indian companies.
Mec han is m
The reverse book-building process as required under the SEBI guidelines
will utilize the trading system network of the stock exchanges now being
used in the Initial Public Offerings (IPOs). The acquirer determines the
floor price of the offer based on the average prices for 26 weeks proceeding
the date of public announcement. Shareholders are then allowed to tender
their shares at or above the floor price. Once the reverse book-building
process is completed the final price will be determined as the price at
which the maximum shares are tendered. While this provides the
shareholder an opportunity to determine the price, the acquirer has the
right to accept or reject the price so discovered. In case, the acquirer
accepts the price, all shareholders who bid at or below the discovered
price, will receive the discovered price for their holdings.
Criticisms
Despite many advantages claimed by the reverse book-building process,
it is criticized on the following grounds:
1. Manipulations The process of reverse book-buildings is prone to
manipulation, as it would operate on a restricted audience, as against an
IPO, which is open to the general public. The possibility of getting a fair
price for shareholders in the reverse book-building process is limited, as
this process is subject to manipulation in the hands of more experienced
and savvy shareholders.
2. Low participation Moreover, the participation of the small
shareholders (or the public) will be extremely low as their understanding
of the process is imperfect.
3. Price indication Any open offer delisting should indicate the price
that the buyer is willing to pay.
4. No fair price Under the rising market conditions, the floor exit price,
which is based on the 26-week average, may not truly be reflective of the
current market price. Hence, such a price will not serve as a useful
benchmark for the investor.
5. Non-acceptance Although the shareholders command the flexibility
of tendering their shares at any price, they also run the risk of their shares
not getting accepted if the acquirer finds the price unattractive.
6. False price There is a bigger risk of speculators spreading false
information in the market and thereby increasing the share price to
unrealistic levels and selling the stock back to small investors. This would
prove highly detrimental to the interest of the investors especially when
share prices come down after the delisting is over.
Sugges tions
Only a combination of “independent investment valuation” and “stock
price” can serve to improve the valuation in a voluntary open offer
transaction. In a voluntary open offer, one criterion for evaluating the fair
price can be the market price (based on the average of 52-week highs and
lows, instead of the 26 weeks now being considered) of the company
To avoid the vagaries of the market the company can appoint an
‘independent valuer’ to arrive at fair price for the stock (just as in acquisition
deal) impounding the premium for control. Further, the valuation report
must be available for inspection to the non-promoter shareholders. The
fair exit price can be arrived at on basis of the higher of these two criteria.
In order to avoid the risk non-acceptance of the shares by the acquirer,
it is essential that the shareholder gets some indication about the level at
which the acquirer is willing to buy out the shares. This is to avoid making
the process a fruitless exercise.
Although this is still imperfect mechanism for arriving at the fair price,
there is a possibility that the shareholders may have less reason to complain.
REVIEW QUESTIONS
Section A
1. What do you mean by ‘book-building’?
2. What is ‘floor piece’?
3. What is ‘price band’?
4. Who is a ‘book-runner’ in a book-building process?
5. What is a ‘draft prospectus’?
6. What is ‘reverse book-building’?
Section B
1. Explain briefly the features of ‘book-building’.
2. How is price discovered in a book-building process?.
3. What are the conditions to be satisfied for the 100 % book-
building process?.
4. Explain the bidding process involved in book-building of
securities.
5. Explain the allotment process pertaining to book-building of
securities.
6. How is a book-building issue different from a normal issue?
7. Explain the mechanism of reverse book-building.
8. State the benefits of reverse book-building.
9. State the criticisms leveled against the reverse book-building.
Section C
1. Explain and illustrate the entire book-building process.
2. Illustrate as to how the shares are allocated to the bidders in the
case of an IPO.
3. Illustrate as to how the shares are allocated to the bidders in the
case of an additional issue by an existing company .
4. How are shares allocated under a book-building process in respect
of shares offered by an unlisted company?
Chapter 18
Over the Counter Exchange of

India (OTCEI)*
GENESIS
OTCEI was incorporated in October 1990 under the Companies Act, 1956
and is recognized as a stock exchange under Section 4 of the Securities
Contracts (Regulation) Act, 1956. A consortium of premier financial
institutions including UTI, ICICI, IDBI, IFCI, LIC, SBI Capital Markets Ltd,
GIC and its subsidiaries and Canbank Financial Services Ltd promoted it.
OTCEI is a recognized stock exchange under the Securities Contract
(Regulation) Act and became operational in 1992. It is the first stock
exchange in India which introduced state-of-the-art screen-based
automated ringless trading system. Companies listed on OTCEI enjoy the
same listing status as available to companies listed on any other recognized
stock exchange in the country. However, the companies listed on OTCEI
cannot be listed/traded on any other stock exchange in India.
The Exchange was set up to aid enterprising promoters in raising
finance for new projects in a cost-effective manner and to provide investors
with a transparent and efficient mode of trading. Modeled along the lines
of the NASDAQ market of USA, OTCEI introduced many novel concepts
to the Indian capital markets such as screen-based nationwide trading,
sponsorship of companies, market making, scripless trading, etc.
Over-the-counter Exchange of India is primarily meant for small size
companies and small investors. The exchange has the merits of
transparency, fast settlements and potential to reach the nook and corner
of the country that could make it as the premier niche exchange in India.
Investors benefit due to cleaner deals and easier reach and small companies
have a safer route to the stock market.
The Dave Committee on Over-the-counter Exchange of India (OTCEI)
recommended relaxation of the maximum size of the issues that may be
*
Discussed with reference to stock exchanges other than BSE and NSE.
listed on OTCEI, relaxation in listing criteria and a shift from a rolling (T+3)
settlement to five-day account period settlement being followed by other
stock exchanges. These and most of the other recommendations of the
Committee for making OTCEI more effective and viable have been accepted
by SEBI and are being implemented.
OTCEI Vs. OTHER STOCK EXCHANGES

OTCEI is different from the regular stock exchange in the following ways:
Sl. Traditional Stock

Feature OTCEI
No. Exchanges
1 Formation Organization Association formed by
promoted by financial brokers of the exchange
institutions
2 Number Only one stock Twenty-two stock
exchange called the exchanges exist
OTCEI exists with a independently in the
nationwide reach country (including NSE)
3 Listing Companies with Companies with equity
equity share capital share capital of Rs.3
between Rs.30 lakhs crores and above are
and Rs.25 crores are allowed listing
allowed to be listed
4 Coverage Decentralized Centralized exchange
exchange with a with members operating
nation-wide network at a single location
(except BSE)
5 Transferable Share certificate is not Ordinarily share
Document a transferable certificate acts as a
document. Counter transferable document
Receipt (CR) was the
transferable document
earlier which has since
been discontinued
6 Computer Screen-based trading Trading is done in a
Usage with computer trading hall/ring by
network public outcry (except
BSE)
7 Transfer Mode Securities are Securities are transferred
transferred through by transferring share
‘counter receipts’ certificates through
demating
Over the Counter Exchange of Indi a (OTCEI) 345
Sl. Traditional Stock

Feature OTCEI
No. Exchanges
8 Transparency Spot deals with full Speculative activities
transparency obstruct transparency
9 Settlement Daily settlement Weekly or fortnightly
system settlement
10 Price Quotes Market-makers are Jobbers may or may not
obliged to offer two- offer two-way quotes
way quotes
11 Transfer Automatic transfer Transfer takes place with
upto 0.5 percent of the permission of the
to Capital equity capital of the company
company
12 Spreads OTCEI has laid down There is no restriction on
that market spreads spreads volatile
would not exceed a
specified percentage
13 Free Pricing SEBI guidelines As per SEBI guidelines,
permit free pricing of free pricing of Equity of
issues without a track new company shares is
record also under not permitted
certain conditions
‘OVER-THE-COUNTER’
The term over-the-counter is a way of trading securities otherwise than on
an organized stock exchange. Trading of securities is carried out by the
brokers, dealers scattered over different locations and regions, with the
help of a communication network including telephone, telegraphs, tele-
typewriters, telex, fax and computers. Communication network links every
dealer-broker, helps arrive at the prices and allows investors to select
among the competing market-makers. A market-maker is one who offers
two-way prices (a buy rate and a sell rate) at which the member-dealer is
willing to buy or sell a standard quantity of scrips that will be continuously
quoted for a specified period. Thus, over-the-counter (OTC) market is
envisaged as a floorless securities trading system equipped with electronic
or computer network through which nationally and internationally scattered
buyers and sellers can conduct business more efficiently and economically.
NEED AND OBJECTIVES

The setting up of the OTCEI was conceived as a method by which the
ailments facing the working of the traditional stock exchanges at present
could be overcome. Stock exchanges function as a single door market in
which the securities of companies engaged in different industries and
trades of varied sizes are listed with identical qualifying criteria, and are
traded simultaneously in the same trading hall. This creates a situation
where only the big and important companies receive all the attention, with
the large bulk of companies, particularly the new and small companies
remaining unnoticed. This creates a situation of unlisted/non-traded
companies that greatly jeopardizes liquidity of small scrips.
Small investors all over the country are faced with the problems of
access, liquidity, delays in payment and delivery, and uncertainty regarding
prices at which their shares are bought or sold. Prohibitive issue costs,
restricted access to the markets and administered pricing of their shares
are the main problems faced by companies. This meant India lacked a
stock market option for small and medium companies given the BSE and
NSE entry threshold of Rs.10 crores-equity base. Similarly small, start-up
companies in India had the problems of raising capital through a public
issue at exorbitant costs and delays in realization of proceeds. Moreover,
many companies, which are doing well, were unable to grow to their potential
because of their inhibition to go public to raise adequate capital. All such
mid-cap companies have benefited from the establishment of OTCEI. The
OTC Exchange has been set up as an answer to these problems of
companies and investors, the two critical players in the capital markets.
The OTCEI aims at creating a stock exchange that will:
1. Facilitate small companies to raise funds from the capital market
in a cost-effective manner, as it does not involve any flotation
costs
2. Provide a convenient and an efficient avenue of capital market
investments for small investors
3. Strengthen investors’ confidence in the financial market by
offering them the two-way best prices to the investors
4. Ensure transparency, redress investors’ complaints and unify
the country’s securities market to cover even those places which
do not have a stock exchange
5. Provide liquidity advantage to the securities traded
6. Promote organized trading in Unlisted Securities
7. Broad base the existing informal market in order to make it more
liquid
8. Provide a source of valuation for securities traded and

9. Act as a launch pad to an IPO
FEATURES
The salient features of OTCEI are as follows:
Nation-wide Trading
OTCEI has a nation-wide network. By listing on the OTCEI, securities of a
company can be traded across the country through centers that are located
in different cities. Counters opened at different locations are interlinked
by computer-based communication system. A public notice is given as to
the availability of counters where trading takes place. Facilities for trading
will be available at the counters of the sponsors and the market-makers
who are notified by the OTCEI. Companies have an unique benefit of
nationwide listing and trading of the scrips by simply listing at only one
exchange, the OTC Exchange.
Compulsory Investor Registration
Every investor is expected to obtain ‘Invest OTC Card’ for buying and
selling securities on OTCEI by making an application at any of the counters
of OTCEI. In fact, the share application form includes the necessary details
to be filled in for obtaining ‘Invest OTC Card’. The purpose of the investor
registration is to facilitate computerized trading. It also provides greater
safety of operations to the investors.
Ringless Trading
Trading does not take place on any specific floor of an exchange. The
members and dealers open counters at various places, which offer investors
to connect locations for the purchase and sale of the listed securities.
OTCEI does not have any trading ring/hall. Dealers quote, query and
transact business through a central OTC computer connected with
computers that are located at different centers/counters spread across the
country.
The network of on-line computers allows market participants to execute
trades from their offices and provides all relevant information on their
screens, creating a fair market. Trading takes places through a network of
computers (screen based) of OTC dealers located at several places within
the same city and even across cities. These computers allow dealers to
quote, query and transact through a central OTC computer using
telecommunication links. Investors can walk into any of the counters of
members and dealers, and see the quote display on the screen, decide to
deal and conclude the transaction.
Transparent Computerized Trading

The entire trading at OTCEI is done in a transparent and speedy manner
through computers. This makes the market more disciplined. The
confirmation that the investor receives through the computer, gives the
exact date, time, price of the deal and brokerage charged. The system also
ensures that transactions are done at the best prevailing quotes in the
market. The investors’ interest is fully protected in this regard.
Exclusive Listing
Companies listed at OTCEI are not listed on other stock exchanges.
However, of late, following the liberalized approach of the RBI, companies
that have been already listed in other stock exchanges are also allowed
trading on the OTCEI. The companies sponsored by members of OTCEI
are listed.
Closeness to Investors
There are a large number of inter-connected counters throughout the
country. Facility for trading is available at the counters of the sponsors.
The addresses of Additional Market-makers and dealers are provided in
the application attached to the offer for sale. This way, OTCEI is considered
to be closer to investors.
Authorized Dealers
Only those members and dealers who are authorized and approved by the
OTCEI can deal on it.
Price Display
In a traditional stock exchange, the investor has no means of verifying the
price at which the broker effected the transaction. Conversely, the OTCEI
continuously displays current security prices on the screens installed at
each of the OTC Exchange counters. This enables investors to make on-
the-spot decisions on purchase or sale of securities.
Greater Liquidity
Since the sponsor and the Additional Market-maker offer two-way quotes,
(i.e. buy and sell quotes) within specified margin, securities can be
purchased and sold at any time. The compulsory market-making by the
sponsor for every security ensures that buy and sell quotes are available
everyday for a period of 3 years after which another market-maker takes
over the price quotation. Unlike other stock exchanges, the OTC Exchange,
through its nationwide reach, facilitates widely dispersed trading across
the country, thus enabling greater liquidity.
Trading for Unlisted Companies

In pursuance of the recommendations of the Dave Committee, the SEBI
has allowed trading of equity shares of all unlisted companies on the
OTCEI to boost the business volume of OTCEI. Such trading provides an
opportunity to make the stocks liquid and tradable. In addition, it also
provides a source of valuation of mutual funds, facilitates inter-institutional
trades and enables placement of these shares with foreign institutional
investors (FIIs) who can now subscribe to the shares of unlisted companies.
Trading in Derivatives
Based on Dave Committee recommendations, instruments like futures and
options, forward contracts on stocks, other forms of forward transactions
and stock lending are allowed to be traded on OTCEI. This aims at
improving OTCEI’s liquidity by providing greater depth.
Instant Execution of Orders
The investors’ orders are executed immediately. If there are no buyers or
sellers on the OTC Exchange, the market-maker deals with the investor.
Ready Information
The compulsory market-maker carries out research on the scrip sponsored
by him and, hence, all vital information pertaining to the company is readily
available.
MoU with NASDAQ
OTCEI has signed a Memorandum of Understanding with NASDAQ, USA,
the second largest stock exchange in the world. The MoU entails mutual
exchange of information, training in various aspects of the capital market,
access to the global market, etc.
Multiproduct Exchange
A lot of innovation has gone into the working of the OTCEI. For instance,
OTCEI introduces new products from time to time for the benefit of the
investors, issuers and intermediaries in the capital market and the nation
at large. OTCEI has also created a national market in its listed segment to
facilitate large corporates to have simultaneous listing on the exchange. It
is pertinent to note that OTCEI currently offers trading in the following
category of securities viz., Listed Equity, Listed Debentures, GOI Securities,
Permitted Equity, Permitted Debentures, Mutual Funds and Bonds of public
sector units.
T ec hnology
OTCEI uses computers, telecommunications and other technologies of
the modern information age in order to bring members/dealers together
electronically, so as to enable them to trade with one another electronically,
rather than on a trading floor in a single location. All the information
needed for trading is available on the OTCEI’s computer screen. To enhance
connectivity for its trading systems, OTCEI has shifted to VSATs (Very
Small Aperture Terminals). The use of modern technology ensures a more
transparent, quick and disciplined trading.
Faster Transfers
The investor have to submit counter receipt at any of the OTCEI counters
for transfer of shares. Shares are automatically transferred in the name of
the investor, if the consolidated holding of the shares is within the limit of
0.5 percent of the issued capital of the company.
OTC trading provides for transfer of shares by Registrars upto a
certain percentage per folio. This results in faster transfers. The concept
of immediate settlement makes it better for the investors. Investors will
trade, not with share certificates but with a different tradable document
called Counter Receipt (CR). However, an investor can always exercise his
right of having the share certificate by surrendering the CR and again
exchanging the share certificate for CR when he wants to trade. A custodian
provides this facility alongwith a settler who will do the signature
verification and CR validation (The Counter Receipt is no longer a tradable
document from 1st March, 1999).
Trading Services
An investor can buy and sell any listed scrip at any of the OTC exchange
counter. The investor can also make an application for services like transfer
of shares, splitting and consolidation of shares, nomination and revocation
of nomination, registering power of attorney, transmission of shares and
change of holder’s name, etc. The parties involved in trading on OTC are
Investor, Counter, Settler, Registrar/Custodian, Company and Bank. The
trading documents mainly involved in OTC exchange transactions are:
Temporary Counter Receipt (TCR), Permanent Counter Receipt (PCR), Sales
Confirmation Slip (SCS), Transfer Deed (TD), Service Application Form
(SAF), Application Acknowledgement Slip (AAS), and Deal Form (DF).
BENEFITS
The OTCEI offers the following benefits:
Benefits to Listed Companies
The benefits that are offered to companies listed with OTCEI are as follows:
1. Negotiability The company can negotiate the issue price with the
sponsors who have to market the issue. It provides an opportunity for fair
pricing of an issue through negotiation with the sponsors.
2. Fixation of premium In consultation with the sponsors, the
company can fix an optimum level of premium on issue with minimum risk
of non-subscription of the issue.
3. Savings in costs Lots of costs associated with public issue of
capital are saved through this mode. It provides an opportunity to
companies to raise funds through capital market instruments at an extremely
low cost as compared to a public issue. The method of sponsors placing
the scrips with members who in turn will offload the scrips to public will
obviate the need for a public issue and its associated costs.
4. No take-over threat OTCEI lists scrips even with 40 percent of the
capital offered for public trading. This limit has now been brought down to
20 percent in the case of closely held companies and new companies. As
a result, the present management of the companies are saved of threats of
takeover if they restrict public offer.
5. Large access Accessing a large pool of captive investor base
through the OTCEI’s computerized network is made possible for companies.
Through nationwide network for servicing of investors, companies listed
on OTC Exchange can have a larger investor base.
6. Other benefits
a. Helpful to small companies
b. Shares of all unlisted companies can now be traded on OTCEI
c. Platform for issuers and first-level investors like financial
institutions, state level financial corporations, Foreign Institutional
Investors, etc.
d. System for defining benchmark for securities
e. Increasing business for the market constituents
f. Easier launch pad for an IPO
Benefits to Investors
The OTCEI offers the following benefits that are otherwise not available
for investors dealing in other stock exchanges. These are as follows:
1. Safety OTCEI’s ringless and scripless electronic trading ensures

safety of transactions of the investor. For instance, every investor in a
OTCEI is given an ‘Invest-OTC-Card’ free. This code is allotted on a
permanent basis and should be used in all OTC transactions and
applications of OTC issues. This card provides for the safety and security
of the investors’ investments. The mechanism offers greater security to
investors as the sponsors investigate into the company and the projects,
before accepting sponsorship thus building up much-needed greater
investor confidence.
2. Transparency OTC screens at every OTC counter display the best
buy/sell prices. The exact trading prices are printed in the trading
documents for confirmations. This protects the investor interest and
thereby minimizes disputes.
3. Liquidity A great advantage of the OTC is that the scrips traded are
liquid. This is because there are at least two market-makers who indulge in
continuous buying and selling. This enables investors to buy and sell the
scrips any time.
4. Appraisal OTC members sponsor each scrip listed in an OTC counter.
The sponsor makes an appraisal of the scrips for investor worthiness.
This ensures quality of investments.
5. Access Every OTC counter serves as a single window to the entire
OTC exchange throughout the country and throughout the world too.
Therefore, buying and selling may be resorted to from any part of the
world. It offers the facility of faster deal settlement for investors across the
counters spread over the entire country.
6. Transfer It is important that OTC shares are transferable within 7
days, where the consolidated holdings of the scrips do not exceed 0.5
percent of the issued capital of the company.
7. Allotment There is not much waiting for the investors when it comes
to allotment of scrips. Allotment is completed in all respects within a matter
of 35 days and trading begins immediately thereafter.
8. Other benefits
a. Derivatives such as futures and options, forward contracts on
stocks, and other forms of forward transactions and stock lending
are allowed on OTCEI
b. Scripless trading makes dealings simpler and easier
c. Market-making system in OTC Exchange gives sufficient
opportunities for the investor to exit
d. Acts as a benchmark to value securities
e. Creating an exit option for illiquid stocks/venture capitalists

f. Shuffling portfolios for the investors
g. Organizing and broad-basing trading in the existing market
Benefits to Financial System
The OTCEI’s role has been laudable in as far as it helps contribute improving
the financial system of India in the following ways:
1. National network of OTCEI operations facilitates the integration
of capital market in the country
2. Boon to closely-held companies as they are encouraged to go
public because scrips can be listed even if only 40 percent of
capital (now a minimum of 20 percent in case of closely held and
new companies) is offered for public trading
3. Facilitates wider dispersal of economic activities by encouraging
small companies and small investors
4. Promoting savings and investments by offering easier avenues
for raising capital
5. Providing over-all stimulation to venture capital activities thereby
promoting entrepreneurship
6. Market-making assistance by the sponsors on the OTCEI that
helps in making an appraised future projections in the issue
documents which in turn helps prospective investors in
determining the usefulness of the issues for investment purposes,
promoting investment environment in general
7. Those members of the OTCEI who did not have multiple
memberships can now have an opportunity to trade in some of
the large capital index stocks
8. Encourage venture capital activities and boost entrepreneurship
9. Spread of stock exchange operations geographically all over India
SECURITIES TRADED
Following are the securities that are traded on the OTCEI:
1. Listed equity (exclusive) These are equity shares of the companies
listed exclusively on the OTCEI. The shares can be bought or sold at
any of the member/dealer’s office all over India. The securities, which
are listed exclusively on the OTCEI, cannot be traded on other stock
exchanges.
2. Listed debt These are the debentures/bonds that are issued through
a public issue or a private placement and are listed on OTCEI. Any
entity holding the entire series of a particular debt instrument can also
offer them for trading on the OTCEI, by appointing an OTCEI member/

dealer to carry out compulsory market-making in those securities.
3. Gilts The securities issued by the Central and State Governments
are called ‘gilts’. Government of India Dated Securities, Treasury Bills
and special securities are traded in this segment. Banks, Foreign
Investors, Foreign Institutional Investors, NBFCs and Provident
Funds can trade in these securities through OTCEI designated
members/dealers. PSU Bonds, Commercial Paper, and Certificates of
Deposit will also be traded in this segment.
4. Permitted securities These are the securities listed on other
exchanges, which are permitted for trading on OTCEI. Securities of
Blue Chip companies like ACC, Reliance Industries Ltd., State Bank of
India, ITC, etc are traded in this segment.
5. Listed mutual funds Listed mutual funds are units of mutual funds
that are listed on OTCEI. Mutual fund units like units of Unit–64,
Monthly Income Plan, and IISFUS ’97 are also listed under this
category.
PLAYERS
Trading in OTCEI, which brings together investors and companies, is
facilitated by members/dealers, registrars and custodians, clearing bank,
settler and the entire set of regulatory and monitoring mechanism. Main
players in the OTC market are as follows:
Investor
Investors constitute the most important players in the OTCEI. They indulge
in purchase and sale of shares. All other players simply support the
investors’ operations to take place in a smooth, efficient and fault-free
manner. For the purpose of trading in the OTCEI, an investor needs ‘Invest
OTC Card’. The card helps buying and selling of shares on OTCEI.
Application for the card can be made either before purchase and sale, at
any of the counters of OTCEI or at the time of applying for new issues on
the OTCEI. The requirements for obtaining Invest OTC Card are mentioned
in the share application form of the listed companies.
Iss uer
The companies that make issue of securities through the mechanism of
OTCEI are the issuers. The securities that are issued through the OTCEI
are categorized as under:
1 . Listed securities These are the shares and debentures of
companies that have been listed on OTCEI and can be bought or sold
at any of the counters of OTCEI anywhere in the country. These

securities cannot be traded on any other stock exchange.
2. Permitted securities These are securities of companies listed
with other stock exchanges but are allowed to be traded as permitted
securities on the counters of OTCEI.
3. Equity shares of unlisted companies Equity shares of all
unlisted companies can be traded on the OTCEI, thus creating a market
for unlisted companies within a proper regulatory framework.
4. Initiated debentures Debentures that are held by an entity holding
a minimum of one lakh debentures of a particular company that wants
trading to take place for these debentures through a member or a
dealer appointed by the entity as a compulsory market-maker in these
debentures.
MEMBERS AND DEALERS
Members and dealers together extend all the support services that are
required by the investors in the OTCEI, whereas members can engage in
sponsorship, dealers cannot.
Functions
The activities that are engaged in by both members and dealers at OTCEI
are as follows:
1. Acting as brokers for buying and selling securities according to
the instructions of the client investor
2. Engaging in trading in securities on their own account at prices
quoted by the market-maker, and
3. Market-making in scrips, i.e. quote two-way prices at which he
commits himself to buy and sell a declared number of securities
Market-Making
The process of offering two-way quotes, i.e. buy as well as sell quotes for
particular scrip, is known as ‘market-making’. Each quote must mention
the value or the quantity of scrip for which the quote is valid. The three
types of market-making in OTCEI are as follows:
1. Compulsory market-making This is to be undertaken by the
sponsor of scrip for a period of 18 months from the date of commencement
of public trading in the specific scrip. Sponsor can assign compulsory
market-making to a member/dealer but in that case, the sponsor would
continue to be responsible in all respects for the satisfactory discharge of
this function.
2. Additional market-making Additional market-making is undertaken

by a dealer/member appointed by the sponsor for a period of at least three
months from the date of commencement of public trading or commencement
of market-making, whichever is applicable. Additional market-maker and
compulsory market maker must hold between themselves upto 5 percent
of the public offer.
3. Voluntary market-making Any counter other than compulsory
and additional market-makers in scrip can do voluntary market-making.
The market-making can be done for a period of at least three months from
the commencement of voluntary market-making. Voluntary market-makers
offer two-way quotes for the same scrip, but if they do not have adequate
saleable stock of at least one market lot or any other quantity specified by
OTCEI, then they may abstain from offering sale quote for the time being.
Whereas members can perform any of the above three roles of market-
making, dealers cannot, however, be compelled to do market-making unless
this function has been assigned to them by the sponsor in that scrip, and
due prior notice in writing has been given to OTCEI in this regard.
4. Graded s ys tem of market-making The Dave Committee
recommended the graded system of market making. According to the
system, the market-making inventory between the compulsory market-
maker and additional market-maker has now been graded. The inventory is
5 percent for companies with market capitalization of less than Rs.5 crores,
2 percent for capitalization between Rs.5 crores and Rs.10 crores, and 1
percent for market capitalization of above Rs.10 crores. More flexibility is
allowed by the OTCEI in the quotes offered by the market-makers whereby
the quotes could be ‘two-way’, increased or decreased within a specific
range ‘band width’, depending on the price of the security.
SPONSORSHIP
The process of screening the companies and their projects before listing
of scrips at OTCEI is known as Sponsorship of scrips. As per the Non-
banking Financial Companies (Reserve Bank) Directions, 1977, institutions
with a minimum net worth of Rs.2.5 crores, and which can carry out the
sponsorship functions are eligible for carrying out the sponsorship
function. Accordingly, institutions such as public financial institutions,
scheduled banks and mutual banks, banking subsidiaries, venture capital
funds, SEBI approved merchant bankers and other non-banking financial
companies are eligible to render this service.
These institutions qualify as members of OTCEI. Finance and leasing

companies were not eligible to become members of OTCEI, but some
relaxations are under consideration regarding their membership. The idea
is to get investors better scrips, besides allowing for better liquidity for
investors by offering them guaranteed exit.
Functions
Following are the functions performed by the sponsors:
1. Appraising the company and its projects for ensuring that the
company’s projects are technologically and financially viable
and that all government regulations have been satisfied, and the
company has adequately arranged for raw materials, infrastructural
inputs, marketing and financial inputs
2. Ascertaining the value of the shares of the company
3. Giving a certificate to OTCEI regarding the investment
worthiness of the company and its projects
4. Ensuring compliance with SEBI guidelines for the issue of
securities
5. Performing compulsory market-making in the issued scrips for
at least eighteen months from the date of commencement of trading
in the scrip
6. Appointing one member or dealer as additional market-maker.
ADMISSION OF MEMBERS—CONDITIONS
According to the SEBI, following are the conditions that should be
satisfied for admission to membership of OTCEI:
1. Institutions eligible for the sponsorship function as mentioned above
are also eligible and can be admitted to membership of OTCEI
2. Members to have a standing and status to carry the confidence of
other members and dealers while recommending the scrips for
investment
3. Members to possess the skill, resources and the capability necessary
for appraising projects, establishing their viability, analyzing
company’s financial position and income earning potential, evaluating
the company’s management, determining marketability of the
company’s products and ensuring that the company/project meets
various governmental regulations
4. Members to be financially sound, having adequate financial resources
to perform the activities of sponsorship and trading
5. Members to have the capacity to invest in scrips and hold on to them
for sufficient period depending on the market requirement, provide
market-making in the scrips for the desired period and to have an

adequate office space to set OTCEI counter for dealings with the
investors
6. Members to have adequate organizational infrastructure to perform
such functions as handling of investments, project appraisal, OTCEI
counter management, and market-making and other trading activities
The OTCEI committee on its part verifies whether the applicants for
membership satisfy all the above conditions or not. On being satisfied,
fresh membership is accepted. All existing members should continue to
meet all the above requirements. On their failure to meet these requirements,
OTCEI committee may cancel their membership after following the due
procedure.
Admission of Members—Fees
Members have to pay one-time non-refundable admission fee of
Rs.20 lakhs. In addition, an annual subscription of Rs.1 lakh is also payable.
OTCEI Committee can change the fee structure.
ADMISSION OF DEALERS—CONDITIONS
OTCEI admits an entity as dealer subject to satisfying the following
conditions:
1. Any corporate body, partnership firm or an individual having a net
worth of Rs.5 lakhs is eligible to become a dealer. In case of a corporate
dealer, at least 40 percent of the share capital of such corporate body
should be held by promoters and in case of individuals, proof of
having tangible liquid assets of Rs.5 lakhs, two independent references
and a reference from a bank regarding the financing standing of the
applicant should be submitted. The individual should at least be a
graduate
2. Dealers to have adequate financial resources to carry on the activities
of trading and market-making
3. Dealers to have adequate knowledge of stock market trading, stock
valuation, share transfer rules and laws governing these activities
4. Dealers to have adequate office space
5. Dealers to have adequate organizational infrastructure to perform
such functions as handling of investments, OTCEI counter
management, and market-making and other trading activities
6. Dealers to have passed the test/interview conducted by OTCEI
Committee for admission.
OTCEI Committee advertises in newspapers inviting applications for

dealership from time to time. Duly filled applications with required
certificates/documents/references, etc are scrutinized. Short listed
candidates are required to appear for computer based test and are
interviewed by the selection panel. Partnership firms and corporate bodies
have to nominate an authorized signatory for test and interview. The
dealership is restricted to the city for which it is granted. Moreover,
dealership is not transferable.
Admission of Dealers—Fees
The fee for dealership is to be paid as specified in the advertisement
inviting applications. A one-time non-refundable admission fee of
Rs.6 lakhs is to be paid by the dealers. In addition, an annual subscription
of Rs.5,000 is also to be paid by them. They may also be required to
deposit an additional security with OTCEI. Rules regarding fee and deposit
can change from time to time.
REGISTRARS AND CUSTODIANS
The registrars and custodians appointed by the OTCEI are required to
carry out the following functions:
• Transferring of shares not exceeding 0.5 percent of equity per
folio
• Maintaining a register of members
• Keeping in custody share certificates of the company
• Maintaining a record of signatures and checking them at the time
of receiving Counter Receipt (CR) and Transfer Deed (TD) for
transferring securities
• Updating the list of members
• Registering power of attorney, transmission and transposition of
shares, and
• Registering nominations, etc.
CENTRAL CLEARING BANK
Central clearing banks are the intermediaries through whom all the counter
deals and settlements are done. These intermediaries perform the following
functions:
• Record keeping of documents generated by counters
• Monitoring the movement of documents
• Keeping a record of signatures of all investors at the counters
• Verification of signatures on counter receipts (CR)
• Checking genuineness of CRs

• Sending confirmations to the counters regarding receipts of CRs
and their validity, etc within the prescribed time limits
• Exchange of CRs for shares before sending them to the Registrar
• Checking applications for splitting, etc.
MONITORING AGENCIES
Monitoring is done by the OTCEI through its own committee, which
monitors the activities of sponsors, members/dealers and overall trading
at OTCEI. In addition, SEBI also frames rules and regulations, and does
monitoring of activities at OTCEI. The Ministry of Finance, Government
of India, also intervenes as and when required.
TRADING MECHANISM
The trading mechanism at OTCEI is entirely different from that of recognized
stock exchanges. It is a ringless security exchange equipped with computers
and electronic equipments instead of a trading hall of conventional stock
exchanges. The dealings will be carried on through counters scattered all
over the country and linked with communication network. The investors,
for the purpose of trading, can choose the price quoted by the market-
makers scattered all over the country. The prices quoted can be viewed on
the computer screens with the push of a button. Every counter at OTCEI
displays these quoted prices continuously at every working day. Having
decided about the price and the market-maker, the investor may proceed
further with the purchase or sale of scrips.
The mechanism of trading followed at OTCEI is different for listed
securities and permitted securities. The trading procedure in respect of
these securities is described below:
For Listed Securities
Trading in listed securities commences three days after the listing and
after due notice to the public and OTCEI counters, i.e. members and dealers.
Trading commences with the compulsory market-maker, additional market-
maker and/or voluntary market-maker offering quotes for the minimum
depth depending on the issue price of the security. In case the issue price
is Rs.50, the market-makers have to give quotes for at least 10 market lots.
In other cases the minimum depth is five market lots.
Counter receipts Shares certificates of listed securities are not
traded on OTCEI. The entire trading takes place through counter receipt
(CR), which creates a tradable document. An investor holding share
certificates has to first convert them into counter receipts before trading in
them. Counter receipts are of three types as shown below:
1. Initial Counter Receipt (ICR) which is issued initially at the
time of primary issues. Sale of ICR is to be accompanied by a
transfer deed properly executed by the seller/transferor so as to
avoid bad delivery
2. Permanent Counter Receipt (PCR) which is issued at the time
of secondary market sale. It is non-transferable though it carries
the investor’s name. This is because it is not entered in the register
of members of the company. A Transfer deed (TD) need not
accompany a sale of PCR
3. Transferred Permanent Counter Receipt (TR-PCR) which is
issued after investor’s service request for transfer of holdings in
his name in the books of the company, has been carried out. A CR
generated after completing the request for transfer of holdings is
a transferred PCR. Sale of transferred PCR should be accompanied
by a transfer deed (TD)
Documents used Following are the main documents that are used in
the course of trading for listed securities on OTCEI:
1. Transfer Deed (TD) Separate TDs are to be executed by both
the transferor and transferee. The seller of transferred PCR signs
the TD as transferor. At the time of service request, the investor
signs TD as transferee. The registrar and the transfer agent of
the company execute the transfer request after matching the two
TDs
2. Sale Confirmation Slip (SCS) Is a receipt issued by the counter
to the seller of CR confirming that the transaction of sale of
securities has been completed
3. Application Acknowledgement Slip (AAS) Is issued by the
concerned counter to the investor requesting for such services
as transfer of shares to his own name, transposition of securities,
recombination i.e., splitting and consolidation of shares etc
conversion of ICR or transferred PCR into share certificate and
converting share certificate back to transferred PCR. Each of the
above service request generates an AAS for the investor.
Steps in Trading
Following are the steps involved in the trading of listed securities on
OTCEI:
1. Issue of CRs Counter Receipt (CR) is issued in lieu of share certificate.
CR is issued at the time of initial public issue or when scrip is purchased at
OTCEI counter. Each CR shall contain such details as the name of the
investor, i.e. buyer, name of the company whose shares have been sold by
the counter, number of shares and the price at which shares are bought,
name, address and telephone number of custodian/settler holding shares,
time and date of transaction, total value of transaction, brokerage charged,
investor’s signature, transaction code—there is a separate code for each
transaction, name and code of issuing counter, name, signature and stamp
of the authorized signatory of the counter.
There is also certification that the transaction is a valid one. The
details and signatures of the buyer are also obtained before issuing CR.
The counter fills up the seller’s details and obtains his signature. CR is
prepared in triplicate—the original for the buyer, one copy for the counter
and the other for the custodian/ settler.
2. Transfer In case of a request of transfer of security in the name
of the investor, Application Acknowledgement Slip (AAS) is also
generated. AAS is also prepared in triplicate—the original for the buyer,
one copy for counter and the other for the custodian/registrar. In addition,
the investor gives to the counter a duly stamped and attested Transfer
Deed (TD). At the end of each day, all TDs with relevant CRs and AASs are
sent to the custodian/settler. The registrar/custodian affects the transfers
and issue the actual share certificate, if required by the investor, in exchange
for the CR. Share certificates are not accepted at the counters, but the
seller surrenders them to custodian/settler in exchange for the CR.
3. Compilation OTCEI compiles and up-dates a manual of all OTCEI
counters alongwith the name, address, signature of the representative
authorized to deal on OTCEI and counter code. A copy of the manual is
sent to all members/dealers.
4. Sellin g s ecurities An investor wanting to sell securities
submits the CR at the counter. After verification of the particulars on the
CR and settlement of price, the deal is put through and the investor is
given Sale Confirmation Slip (SCS). In case the shares have been transferred
in the seller’s name, then he will have to complete and submit a TD before
he gets SCS and a cheque. SCS shall contain such particulars as the name
of the investor/buyer, name of the company whose shares have been
bought by the counter, number of shares and the price at which shares
have been bought by the counter, commission charged, stamp duty, total
value of transaction, name, address and code number of the counter, date
and time of transaction, corresponding CR number, name and signature of
authorized signatory of the counter.
SCS is prepared in triplicate—original for the investor/buyer, a copy

each to the counter and the custodian/settler. At the end of each day, all
CRs, SCSs and relevant TDs are sent to the custodian/settler for updation.
5. Counter details At the end of each day, each counter sends to
OTCEI the details of CRs and SCSs issued by it, and a consolidated
statement showing companywise transactions. Sponsors/companies
periodically send an updated list of shareholders to the registrar. The
counters send to the registrar TDs filled by the sellers. They may not
transfer the scrip in their own name. When those scrips are sold back, the
buyer’s particulars are directly filled up on a separate Transfer Deed and
sent to the custodian/settler who matches the seller’s TD and buyer’s TD
and completes the transaction. Each CR is for the full number of shares
(upto 1,000 shares per CR) purchased by the investor. In case the investor
wants to sell only a part of the holding in a CR, he has first to get the old CR
split and get new CRs and then proceed to transact.
6. Automatic transfer An automatic transfer in favor of transferor’s
name within seven days takes place for transactions involving less than a
certain specified size of holding, which may be 0.5 percent of the company’s
equity or such other limit specified by OTCEI. In case the holding of the
investor exceeds this limit, the counters send the TDs to the companies for
endorsement. Any transaction involving more than 900 shares is reported
to the company on the same day.
7. Consolidated statement After checking its records of CRs issued
by various counters, the custodian/settler issues a consolidated statement
to each counter once in a week to confirm that the CRs accepted by the
counters are valid. The entire process of compilation and matching is
computerized so that daily compilation and quick matching is done without
any difficulty.
For Permitted Securities
In respect of the securities that are listed on other stock exchanges,
permission is granted for the purpose of being traded on OTCEI under
permitted category. This way the benefit of transparent computerized
trading is made available. The trading mechanism is outlined below:
1. Share certificate with a valid TD is the trading document
2. The counters doing market-making in these scrips give two-way
quotes voluntarily, the depth quantity being in multiples of the
market lot for the scrip
3. Counters can give quotes even without having inventory of the

scrip who can also modify or withdraw their quotes strictly before
the deal is struck
4. Selling investors are issued Purchase Confirmation Slips (PCSs)
and the purchasing investors are given Sale Confirmation Slips
(SCSs) by the counters at the time of finalization of the transaction
5. While accepting share certificates, the counter has to ensure
that it is in market lots
6. The counters have to ensure that the share certificates are
accompanied by valid TDs with dates later than the previous
book closure date, the signature of the transferor is genuine, it is
in good condition and meets all the requirements of a good
delivery
7. All delivering brokers have to affix on the reverse of the TD a
rubber stamp giving such details as broker’s name and code
number, name of the exchange, SEBI registration of the delivering
broker and the amount of the transaction
The counter has also to certify that any person other than the final
transferee does not fill the TD.
Bad Delivery
The counters are responsible for defective share certificates and TDs
accepted and introduced by them into the OTCEI system. In case the
shares and TDs are subsequently found defective by the company or its
registrar, the counter originally accepting and introducing the defective
share certificate and/or TD has the responsibility of rectifying the defective
delivery. If an investor suffers a loss due to their negligence, the counters
are liable to compensate the investor.
SETTLEMENT PROCEDURE
A separate system of settlement is adopted for the listed securities and
permitted securities. The procedure is outlined below:
For Listed Securities
OTCEI does not permit short selling or forward buying in listed securities.
All deals get completed after the CRs, SCSs and AASs are confirmed,
matched and issued. The settlement process is based on a rolling T+3
settlement system as explained below:
1. Where transfer of security is not intended, only a list of CR
holders is periodically sent to the company
2. Where transfer of security is intended to take place and the

investor wants that the security to be transferred in his name,
and his name should appear in the list of members in the register
of the company, the un-transferred PCR and duly filled TD is sent
to the custodian/settler who makes a record of signatures. On
T+3 day, the counter prepares a pay-in for the securities
purchased and sends to the registrar with relevant documents.
On T+4 day after confirming the signatures of the seller, a payout
is made for the securities sold. Based on Dave Committee
recommendations, SEBI allowed shifting the settlement system
from the T-3 system to the T-5 system where the pay-in takes
place on the fifth day and the payout on the sixth day.
For Permitted Securities
The salient features of settlement of deals in permitted securities are as
follows:
1. Settlement mechanism has a five-day trading cycle
2. Short-selling and squaring up by the counters is to be completed
within the trading cycle
3. Delivery and payment is on net basis, not on trade basis
4. A transaction generates a single confirmation slip for any value
of transaction
5. Certificates must be delivered to the investors within a fortnight
from the date of purchase of the security
Day-wise Settlement Procedure
The procedure for physical settlement, i.e. delivery and receipt of share
certificate, and payment and receipt of cash procedure is as follows:
1. For T-day (Friday) At the end of five-day trading period each week,
(i.e. Monday to Friday) on Friday, each counter gets a scrip-wise net
position report. Report on net pay-in and net pay-out is prepared.
2. T+d day (Monday) Each counter delivers the share certificates to
transfer agent by Monday of the week following the week in which
transaction has taken place.
3. T+4 day (Tuesday) Transfer agent sends scrip wise and counter-
wise default report to OTCEI. It is a pay-in day.
4. T+5 day (Wednesday) Auction trading session is held for squaring
up the short-sales by the counters. Cash settlement report is prepared
after the auction session is over. Pay-out day, i.e. the sellers are paid for
the securities sold.
5. T+6 day (Thursday) Defaulting counters deliver the share

certificates.
6. T+7 day (Friday) Transfer agent delivers share certificates and cash
clearing status from OTCEI to all receiving counters.
The OTCEI is permitted by the SEBI to undertake weekly netting of
trades in permitted securities segment as in the case of other stock
exchanges. This is expected to remove administrative bottlenecks and
facilitate physical settlement of scrips on a nationwide basis.
SLOW GROWTH OF OTCEI—CAUSES
Despite technical superiority of OTCEI in terms of computerization, speed,
transparency and integrated functioning, the growth of OTCEI operations
has been found to be highly unsatisfactory. Following are some of the
factors that have contributed for the slow growth of business on OTCEI:
1. Crash of BoDs market The primary reason for the slow growth
of the business of the OTCEI was the crash of the Bought-out-Deal
(BoD) market. Large amounts of money stuck in bought-outs
contributed to the liquidity problem on the exchange. Many OTCEI
sponsors are responsible for making a fast buck by listing bought-
outs six to nine months after the deal at very high premium and then
failing to support the scrip.
2. Lack of commitment Only a few sponsors are willing to commit
time, staff and funds for OTCEI operations. Most members and dealers
operate only as brokers and only a limited number takes up the market-
making function. Further, there was a lack of support from the founder
institutions too. SEBI’s insistence for de-linking OTCEI business to
companies with no fund-based activities also contributed to the
shrinkage in the OTCEI operations.
3. Poor settlement system The T+3 trading cycle that was in
operation earlier limits broking operations as it takes a minimum of
three days for the client’s cheque to get encashed, whereas the payment
has to be made on the third day after the trade takes place. Institutional
clients take even seven to eight days to make payment. Market
operators have to commit funds for the intervening period. However,
with the introduction of T+5 trading cycle this problem has been
taken care of to a great extent.
4. Other causes
1. Lack of depth which makes the market susceptible to large swings
on small deals
2. Inadequate funds for market-making
3. Existence of only spot market and lack of short selling and forward
trading has kept many operators away from OTCEI
4. Inefficient software
5. Delay in transfer of shares by registrars
6. Lack of aggressiveness on the part of OTCEI board
7. Limited representation of members and dealers on the policy
making committees of OTCEI
8. Limited awareness about the merits of operations on OTCEI due
to inadequate marketing of the exchange.
REVAMPING OTCEI
A number of measures have been initiated in order to revamp the
functioning of the trading and settlement mechanisms at the OTCEI.
Following are some of these measures:
1. Membership in the National Stock Exchange (NSE) through a
wholly owned subsidiary wherein all those existing brokers who
have cleared their dues with OTCEI will be permitted to act as
sub-brokers with the subsidiary to trade on the NSE order book
2. Total revamp of its market-making mechanism aimed at providing
greater liquidity and an easy exit for investors at all stages whereby
market-makers need to have a minimum net worth of Rs.1 crore
3. Introduction of the concept of an inventory bandwidth, whereby
a market-maker does not get a stock dumped on him during
adverse market conditions. Accordingly, when once a market-
maker’s net inventory reaches 5 percent of the net offer to the
pubic for the scrip, the ‘bid’ side gets disabled and when it falls
to 3 percent, it gets reactivated automatically
4. SEBI allowing the OTCEI to have a ‘free hand’ in increasing the
number of companies under the permitted securities and
debentures category
5. RBI with effect from November, 1997 permitting many market
players to undertake transactions in government securities
through the members of the OTCEI which resulted in an increasing
number of brokers opting to trade through the OTCEI. The OTCEI
trading screens provide for online calculation of yield on
government securities and display the accrued interest portion
of the security price. The trading software allows brokers to
negotiate deals directly on the trading screen. The introduction
of this segment on OTCEI increases both the volume of business
as well as the spread of OTCEI activities
WORKING OF NASDAQ
NASDAQ is the over-the-counter market of USA. Securities that are traded
over the counter are listed on the National Association of Security Dealers
Automatic Quote system (NASDAQ). The quote system of NASDAQ
enables the potential trader to ascertain the person interested in trading at
a certain price. The NASDAQ quote system also serves as an information
source and not as an electronic trading system. Brokers trading for a
customer will take note of the brokers who are interested and at what
prices, and then will directly contact the broker to negotiate a trade. Three
levels of service are available from NASDAQ.
Level III subscribers are given terminals with which to enter bids and
asks. These dealers must be prepared to execute at least a minimum amount
(usually 1,000 shares) at these prices. Level II subscribers are usually
traders who have access to all bids and ask, as well as the name of the firm
making the quote. This allows the traders to determine where to obtain the
best price. Bid quotations are displayed in the descending order and offer
quotations in the ascending order. Level I subscribers simply obtain the
best bid and ask for any stock; these subscribers are normally salespersons
(registered representatives) dealing with customers.
NASDAQ classifies some of the stocks as part of the National market
system (primarily on the basis of trading volume). Stocks designated as
part of the National market system are eligible for short sales and margin
purchases. OTC stocks not listed on the NASDAQ quote system have
bids and offers recorded on paper available once a day; these are called
“pink sheets”. These quotes are not binding and simply give the trader an
idea of who is potentially interested in the stock.
CHANGING ROLE OF OTCEI
By insisting on uniform settlement, OTCEI has realized that brokers will
avoid OTCEI transactions in the absence of business. Speculation is very
important to drive the share prices. An important ingredient of any stock
market is the facility for investors to speculate and also possess the ability
to close out and shift position from one exchange to another so as to take
advantage of price differential at different exchanges. If this facility is
absent, price discovery and price formation will be hampered leading to
low investor interest in capital markets. In view of the emerging trends in
the capital market, a major need has been felt to improve the working of
OTCEI. The Over-the-counter Exchange of India is currently being revived
with help from the National Stock Exchange (NSE).
MAJOR CHANGES IN OTCEI FUNCTIONING

OTCEI has named itself as “The Contemporary and Competitive Exchange”
in its brochures thereby emphasizing its new role in the following
spheres:
1. Weekly Settlement
2. Revamping the Trading System
3. Technology
Weekly Settlement
OTCEI had introduced weekly settlement for the listed segment. This is an
Arbitrage Opportunity involving Saturday-Friday trading. This introduces
a weekly settlement cycle instead of the current rolling settlement on a
T+5 basis (transaction day and five days thereafter). Brokers on the
exchange have long argued that the rolling settlement does not provide
any leeway for speculation and thereafter, the exchange lacks much needed
liquidity. The trading time in operation is Monday-Friday 10–4 p.m.,
Saturday, 1st day of trading 10–1 p.m. All weekly settlements under new
system are successfully completed without default/crisis.
Revamping the Trading System
OTCEI has decided to revamp its trading activity by switching over to
share certificate to attract investor interest. Counter Receipt, as a trading
document, would cease to be a valid trading document. In its place, the
physical shares will be allotted to the logical holders. This move by OTCEI
to shift from CR to share certificate or dematerialization is a fresh initiative
to improve liquidity and bring about price discovery and price formation.
Similarly, a change from the earlier system of Counter Receipts (CR)
(tradable document on the exchange) commenced from March 1, 1999,
when all the counter-receipts ceased to be valid trading documents. OTCEI
has informed all the listed companies to move from CR to share certificates
mode or dematerialization. Companies that choose to dematerialize will
give the option to their shareholders to retain their share certificates.
Changes in the Listed Segment
Major changes have been proposed in the listed segment. The exclusive
quote driven system (market making) will be replaced by the hybrid system.
This would result in a situation where the investor benefits by placing
order directly on the system through any of the broker terminals and not
necessarily through the market-maker.
Changes in the Permitted Segment

In the permitted segment, OTCEI introduced trading in the demat form and
added actively traded and fancied scrips from the regional exchanges.
Around 485 scrips in the permitted segment are being dealt with in the
permitted segment. Also the permitted debt segments with corporate debt
and PSU bonds have been launched.
Trading in Unlisted Segment
Equity shares of companies that have not made a public offering but are
held by promoters and/or venture capital funds would come under the
definition of unlisted securities. At present, there is no organized market
for unlisted securities. Hence, it is difficult for an investor in an unlisted
company to sell the shares as is done in the case of companies that are
listed on the stock exchanges. Hence, the OTCEI is now planning to provide
a segment that will permit trading in such securities.
The objective of launching trading in the unlisted securities segment
is to provide an exit route for investments made by venture capital and
private equity funds. Further it is expected to broad-base the existing
informal market to make it more liquid and promote organized trading in
unlisted securities. It is also expected to act as a preparatory ground for an
initial public offering (IPO) that may be planned for the future.
Salient Features of this Segment
By definition, only qualified participants (QPs) can trade in this segment.
Corporates, including scheduled banks, venture capital funds, private
equity funds or mutual funds, Unit Trust of India (UTI), State level
institutions and companies wishing to make strategic investments and
high net worth individuals can participate in this segment. All QPs need
to have a minimum net worth of Rs.2.5 crores. The unlisted securities
market can act as an ideal launch pad to complement the IPO market in
the country because it helps companies not having a track record to
access the stock market platform to raise funds. It also provides an ideal
exit route for private equity and venture capital funds, thereby attracting
fresh capital and at the same time preventing flight of capital.
NEW NORMS
1. New threshold listing requirements for IPO’s seeking listing on the
OTCEI
2. An arrangement with the NSE for parallel trading of OTCEI listed
securities
3. The appointment of a panel of chartered accountant/audit firms to

undertake a due diligent exercise of companies seeking listing on the
Exchange
4. The constitution of a separate committee for screening companies
prior to listing
5. A complete revamp of the Exchange’s market-making rules to create
greater liquidity for stocks listed on the Exchange to provide better
exit opportunities for the investors at all stages. The new market-
making system has become operational from the second week of
November 1999 and is being integrated with the existing OASIS system
UTILITY OF OTCEI’S NEW LISTING NORMS TO ENTREPRENEURS
Any entrepreneur who needs funds for a project has three options. He can
either approach a venture capital fund, or go to a bank or financial institution
(FI) or raise money through the IPO route. Banks and financial institutions
normally hesitate in financing projects if entrepreneurs lack experience. In
the absence of a healthy track record, listing norms of large stock exchanges
prohibit entrepreneurs from raising money using the IPO route. The listing
norms require that any company planning to raise money through an IPO
needs to have a three-year profitability record.
The OTCEI has done away with the three-year track record
requirement for companies planning an IPO. This would mean that even
inexperienced entrepreneurs could raise money using the IPO route by
approaching OTCEI. However, OTCEI has laid down stringent norms to
ensure that only genuine entrepreneurs raise money from the market. The
exchange will set up a high-powered panel of chartered accountants, which
will do due diligence of such companies and their projects. Also, market-
making will be mandatory for a period of 18 months at these counters.
Such companies without a track record have to be introduced through a
sponsor. According to SEBI norms, all companies that have a paid-up
capital of less than Rs.3 crores (excluding premium) have to be listed on
the OTCEI.
OTCEI MOU WITH NASSCOM
To provide for exchange of ideas and concepts for developing a vibrant
and active market for hi-tech companies in India, NASSCOM and the OTC
Exchange of India have decided to enter into a memorandum of
understanding. According to the MOU, NASSCOM will nominate a
representative on the Screening Committee for listing IT companies on
OTCEI; develop models and methodology for rating promoters and projects
of software companies planning to raise capital through the OTCEI route.
The NASSCOM will arrange and conduct investor education

programmes to generate awareness on investment opportunities and risks
associated with software companies and provide for research and analysis
of the software industry/OTCEI listed software companies for market
information and business development.
The OTCEI has also put in place mechanisms to handhold new IT
entrepreneurs through the entire stock exchange listing and market creation
process. The NASSCOM alongwith OTCEI will from time to time plan and
organize seminars and conferences on topics related to the role and scope
of capital market in the software industry.
The NASSCOM will assist start-up companies listed on the OTCEI
by registering them for NASSCOM membership and providing them with
software industry updates, getting recognition for companies in the
international markets through its ongoing process. It will also hold training
programs for the entrepreneurs on process/quality controls.
REVISION IN COMPOSITE INDEX
OTCEI revised its Composite Index to Market Capitalization with effect
from 23rd July 1997. The earlier OTCEI Composite Index was an unweighted,
simple price index, which comprises all the listed scrips on the exchange.
The new index comprises a basket of 25 scrips having the highest market
capitalization on the exchange. These scrips contribute more than 75 percent
of the total market capitalization of the exchange (as of 15th July 1997) and
represent 17 broad industry groups. The base date for the new index is
10th December 1996 and the base index value is Rs. 100. The index is
expected to reflect the true market sentiments as it gives weightage to
market capitalization. Twenty-five scrips constitute the index. These
include, amongst others, IIS Infotech Ltd., Aryan Pesticides Ltd.,
Renewable Energy Systems Ltd., Maxwell Apparel Ltd., Valecha
Engineering Ltd., Elcot Power Controls Ltd., Bio-chem Synergy Ltd. and
Tribology India Ltd.
CLEARING AND SETTLEMENT
The clearing has been arranged through National Securities Clearing
Corporation Limited (NSCCI). OTCEI has tied up with National Securities
Depositories Limited (NSDL) for demat option. It has also provided for
custodial participation in settlements. Risk containment measures have
also been taken up.
TECHNOLOGY
OTCEI has introduced the latest trading platform Hardware—Fully Fault
Tolerant Stratus Machine. The latest trading software adopted is the
OASIS. The OTCEI plans to update and change its trading software. For
this purpose, it will adopt a modified version of the NSE’s trading software,
for which negotiations have already started with the software vendor.
Facilities support is to be provided by experts like TCS, HCL, Comment,
CMS and CMC. Other measures include trading through VSATs, Modems
and Lease Line. Y2K compliance has been achieved and continuous
upgradation of software is taking place.
Reach
OTCEI has facilities whereby brokers across the country provide ‘at-your-
door’ trading convenience and nationwise quotes.
Safety
The safety measures provided by OTCEI are Settlement Guarantee Fund
(SGF), insurance cover for SGF, capital adequacy norms and margins in
place, insurance cover for members and the establishment of a Contingency
Fund.
Support
OTCEI provides training to brokers. It has Helpdesk and Information
dissemination and the Press. OTCEI Bulletin is being circulated on a regular
basis.
REVIEW QUESTIONS
Section A
1. What is an OTCEI?
2. What do you mean by the term ‘over-the-counter’?
3. What do you mean by the term ‘ringless trading’?
4. Who are the members and dealers at the OTCEI?
5. What is ‘market-making’? What are its kinds?
Section B
1. What are the objectives of OTCEI?
2. State the need for setting up of OTCEI.
3. State the explain the various features of OTCEI.
4. What are the benefits offered by OTCEI trading mechanism?
5. How is the OTCEI beneficial to investors?
6. In what way the OTCEI is beneficial to the financial system of a
country?
7. What are the types of securities that are traded at the OTCEI?
8. What are the functions performed by sponsors of the OITCE?
9. What are the functions carried out by the registrars and custodians
of the OITCE?
10. What are the functions of the central clearing bank of the OITCE?
11. What are the obligations cast on the companies that seek
admission for OTCEI trading?
12. Explain the trading mechanism at the OTCEI.
13. Explain the procedure relating to the settlement at the OTCEI.
14. Outline the steps initiated to revamp the working of the OTCEI
15. Write a note on the working of NASDAQ.
16. How do you see the changing role of the OTCEI?
Section C
1. Trace the origin and the growth of Over-the-counter Exchange of
India.
2. How an OTCEI different from other stock exchanges?
3. Discuss the role played various participants at the OTCEI.
4. Set out the conditions to be satisfied for admission of members
to the OTCEI trading.
5. State the conditions to be satisfied for admission of dealers to
the OTCEI trading.
6. Examine the SEBI guidelines on the registration and the listing
requirements for OTCEI trading.
7. Discuss the various methods of offering securities in the OTCEI
ambience.
8. Analyze the factors that have caused slow growth of the OTCEI.
9. What are the new changes introduced in the realm of OTCEI
trading?
Chapter 19
Stock Market Index
MEANING
An indicator of the trend in the movement of prices of securities that are
dealt with on a stock market on a specified day is called a ‘stock market
index’. The function of a stock market index is to provide a benchmark or
price trend for the investment community. A stock market index captures
the behaviour of the overall equity market.
A stock market index is defined as a statistical indicator that provides
a representation of the value of the securities constituted by it. Indices
often serve as barometers for a given market or industry and benchmarks
against which financial or economic performance is measured.
FEATURES
The following are the features of a stock market index:
1. Index of quality data A stock market index is an independent,
full-service index provider, supplying accurate, reliable and transparent
index data. Indices underlie a variety of financial products in today’s
marketplace such as exchange-traded funds, futures and options
contracts, mutual funds, variable annuity and equity-indexed annuities,
and structured products such as OTC options, swaps, warrants,
equity-linked notes and public/private debt.
2. Index of transparency Stock market indices are maintained
according to a clear, transparent and systematic methodology that is
fully integrated across all types of indices of an index family. This
methodology, together with historical data is open for review and is
made available at no cost to the professional investment community.
3. Index delivery Stock market indices are delivered through a variety
of real-time and end-of-day market data vendors. For instance, the
major indices in the world are published daily in The Wall Street
Journal’s “Money & Investing” section and weekly in the “Market
Week” section of Barron’s, and are disseminated via radio and
television. The Dow Jones Global Indices and the Dow Jones Global
Titans Indices are also published daily in The Wall Street Journal
Europe’s “Global Finance Diary” section. In India, stock market indices
are published in dailies, both financial and non-financial, journals on
money markets and capital markets, etc.
4. Index of future perspectives The ups and downs of an index mean
the changing expectations of the stock market about future dividends
of India’s corporate sector. When the index goes up, it is because 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-to-instant readings about how the stock market
perceives the future of trade and industry.
5. Index of averaging Every stock price moves for two possible
reasons:
a. news about the company (e.g. a product launch, or the closure of
a factory, etc.) or,
b. news about the country (e.g. nuclear bombs, or a budget
announcement, etc.).
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 these two elements, stock news and index news. When an
average of returns on many stocks is taken, the individual stock
news tends to cancel out. On any given day, there would be
good stock-specific news for a few companies and bad stock-
specific news for others. In a good index, these will cancel out,
and the only thing left will be news that is common to all stocks.
This is what the index will capture.
6. Index of portfolio interpretation A typical stock market index gives
an idea of portfolio construction. For instance, it is easy to create a
portfolio which will reliably get the same returns as the index. For
example, if the index goes up by 4 per cent, this portfolio will also go
up by 4 per cent. A stock market index is hence just like other price
index in showing what is happening on the overall indices. The
wholesale price index is a comparable example within context. In
addition, the stock market index is also attainable as a portfolio.
7. Index Types The most important type of market index is the
broad-market index. Generally, a single major index dominates
benchmarking index funds, index derivatives and research
applications. In addition, more specialized indices often find interesting
Stock Market Index 377
applications. In India, there are many type of stock indices, where a

dedicated industry fund uses an industry index as a benchmark.
8. Index of diversification The averaging that takes place in an index
is equivalent to diversification. Diversification cancels out individual
stock fluctuations. From an investment perspective, diversification
reduces risk. From an information perspective, diversification cancels
out stock noise, the bad news about the macro economy. Although it
is possible that a larger number of stocks in an index will give more
diversification, it is not advisable. This is because, 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 certain 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 worsens
an index.
Importance
Stock market indices are significant in the following respects:
1. Leading indicator Traditionally, indices have been used as
information sources. By looking at an index, it is possible to know
how the market is faring. This information aspect also figures in myraid
applications of stock market indices in economic research. This is
particularly valuable when an index reflects on highly up-to-date
information and the portfolio of an investor contains illiquid securities.
In this case, the index is a lead indicator of how the overall portfolio
will fare.
2. Application advantage In recent years, indices have come to the
fore owing to direct applications in finance, in the form of index funds
and index derivatives. Index funds are funds which passively ‘invest
in the index’. Index derivatives allow people to cheaply alter their risk
exposure to an index (called hedging), and to implement forecasts
about index movements (called speculation). Hedging using index
derivatives has become a central part of risk management in the modern
economy and has now became a multi-trillion dollar industry
worldwide, being critically linked up to market indices.
3. Benchmarks Stock market indices serve as a benchmark for
measuring the performance of fund managers. An all-equity fund
should obtain returns like the overall stock market index. A 50:50
debt-equity fund should obtain returns close to those obtained by an
investment of 50 per cent in the index and 50 per cent in fixed income.
A well-specified relationship between an investor and a fund manager
should explicitly define the benchmark against which the fund manager
will be compared, and the exact manner in which the comparison
would be done.
BSE INDEX
BSE Index refers to the Bombay Stock Exchange (BSE) Index. It was
launched by the BSE, the premier Stock Exchange of India. BSE was founded
in the year 1857. BSE occupies a place of prominence in the annals of
Indian stock market.
The growth of equity markets in India has been phenomenal in the
part decade. From the early nineties, the stock market witnessed a heightened
activity in terms of various bull-and-bear runs. The BSE-SENSEX capture
all these happenings in the most judicial manner. One can identify the
booms and bust of the Indian equity market through BSE-SENSEX.
Till the eighties, there was no measure or scale that could precisely
measure the various ups and downs in the Indian stock market. The Stock
Exchange, Mumbai (BSE) in 1986 came out with a Stock Index that
subsequently became the barometer of the Indian Stock Market.
The launch of BSE-SENSEX in 1986 was later followed up in January
1989 by the introduction of BSE National Index (Base: 1983-84 = 100). It
comprised of 100 stocks listed at five major stock exchanges in India at
Mumbai, Kolkatta, Delhi, Ahmedabad and Chennai. The BSE National
Index was renamed as BSE-100 Index from October 14, 1996 and since
then, it is calculated taking into consideration only the prices of stocks
listed at BSE.
With a view to provide a better representation of the increased number
of companies listed, increased market capitalization and the new industry
groups, the Exchange constructed and launched on 27th May, 1994, two
new index series viz., the ‘BSE-200’ and the ‘DOLLEX-200’ indices. Since
then, BSE has come a long way in tuning itself to the varied needs of
investors and market participants. In order to fulfill the need of market
participants for still broader, segment-specific and sector-specific indices,
the Exchange has continuously been increasing the range of its indices.
The launch of BSE-200 Index in 1994 was followed by the launch of
BSE-500 Index and 5 sectoral indices in 1999. In 2001, BSE launched the
BSE-PSU Index, DOLLEX-30 and the country’s first free-float based index
- the BSE-TECk Index taking the family of BSE Indices to thirteen.
The Exchange also disseminates the Price-Earnings Ratio, the Price to

Book Value Ratio and the Dividend Yield Percentage on day-to-day basis
for all its major indices. The values of all BSE indices (except the Dollar
version of indices) are updated every 15 seconds during the market hours
and displayed through the BOLT system, BSE website and news wire
agencies.
All BSE-Indices are reviewed periodically by the “Index Committee”
of the Exchange. The committee frames the broad policy guidelines for the
development and maintenance of all BSE indices. The Index Cell of the
Exchange carries out the day-to-day maintenance of all indices and
conducts research on development of new indices.
Following are the important types of BSE Indices:
1. BSE-SENSEX
The Stock Exchange, Mumbai, started compiling and publishing the
BSE-SENSEX index number of equity prices from 2nd January, 1986. The
base period of BSE-SENSEX is 1978-79. The base value of BSE-SENSEX is
100 points. The purpose is to provide the tread of the equity market as
reflected in the equity share price movement of the basket of shares.
a. Method of Compilation BSE-SENSEX is a “Market Capitalization-
Weighted” index of 30 stocks representing a sample of large,
well-established and financially sound companies. BSE-SENSEX is
calculated using a “Market Capitalization-Weighted” methodology.
As per this methodology, the level of index at any point of time reflects
the total market value of 30 component stocks relative to a base period.
The market capitalization of a company is determined by multiplying
the price of its stock by the number of shares issued by the company.
Statisticians call an index of a set of combined variables (such as price
and number of shares) as composite index. A single indexed number
is used to represent the results of this calculation in order to make the
value easier to work with and track over time. It is much easier to
graph a chart based on indexed values, than one based on actual
values.
The actual total market value of the stocks in the Index during the
base period has been set equal to an indexed value of 100. This is
often indicated by the notation 1978-79=100. The formula used to
calculate the Index is fairly straightforward. However, the calculation
of the adjustments to the Index (commonly called Index maintenance)
is more complex.
The calculation of BSE-SENSEX involves dividing the total market

capitalization of 30 companies in the Index by a number called the
Index Divisor. The Divisor is the only link to the original base period
value of the BSE-SENSEX. It keeps the Index comparable over time
and is the adjustment point for all Index maintenance activities. During
market hours, prices of the index scrips, at which latest trades are
executed, are used by the trading system to calculate BSE-SENSEX
every 15 seconds and disseminated, all-over the country through
BOLT terminals in real time.
b. Maintenance of the Index One of the important aspects of
maintaining continuity with the past is to update the base year
average. The base year value adjustment ensures that additional issue
of capital and other corporate announcements like bonus etc. do not
destroy the value of the index. The beauty of maintenance lies in the
fact that adjustments for corporate actions in the Index should not
per se affect the index values.
The Index Cell of the Exchange does the day-to-day maintenance
of the index within the broad index policy framework set by the Index
Committee. The Index Cell takes special care to ensure that BSE-
SENSEX and all the other BSE indices maintain their benchmark
properties by striking a delicate balance between high turnover in
Index scrips and its representative character. The Index Committee of
the Exchange has experts from different field of finance related to the
capital markets. They include Academicians, Fund-managers from
leading Mutual Funds, Finance - Journalists, Market Participants,
Independent Governing Board members, and Exchange administrators.
c. On-line Computation During market hours, prices of the index
scrips, at which trades are executed, are automatically used by the
trading computer to calculate the BSE-SENSEX every 15 seconds and
continuously updated on all trading workstations connected to the
BSE trading computer in real time.
d. Adjustment The arithmetic calculation involved in calculating BSE-
SENSEX is simple, but problem arises when one of the component
stocks pays a bonus or issues rights shares. If no adjustments were
made, a discontinuity would arise between the current value of the
index and its previous value despite the non-occurrence of any
economic activity of substance. At the Index Cell of the Exchange,
the base value is adjusted, which is used to deflate market capitalization
of the component stocks to arrive at the BSE-SENSEX value.
The Index Cell of the Exchange keeps a close watch on the events
that might affect the index on a regular basis and carries out daily
maintenance of all the thirteen Indices.
Adjustments for Rights Issues When a company, included in the
compilation of the index, issues right shares, the market capitalization
of that company is increased by the number of additional shares
issued based on the theoretical (ex-right) price. An offsetting or
proportionate adjustment is then made to the Base Market
Capitalization (see ‘ Base Market Capitalization Adjustment’ below).
Adjustments for Bonus Issue When a company, included in the
compilation of the index, issues bonus shares, the market capitalization
of that company does not undergo any change. Therefore, there is no
change in the Base Market Capitalization, only the ‘number of shares’
in the formula is updated.
Other Issues Base Market Capitalization Adjustment is required when
new shares are issued by way of conversion of debentures, mergers,
spin-offs etc or when equity is reduced by way of buy-back of shares,
corporate restructuring etc.
e. Base Market Capitalization Adjustment The formula for adjusting
the Base Market Capitalization is as follows:
New Base Market Capitalization = Old Base Market Capitalization ×
[New Market Capitalization ÷ Old Market Capitalization]
To illustrate, suppose a company issues right shares which
increases the market capitalization of the shares of that company by
say, Rs.100 crores. The existing Base Market Capitalization (Old Base
Market Capitalization), say, is Rs. 2450 crores and the aggregate market
capitalization of all the shares included in the index before the right
issue is made is, say Rs.4781 crores. The “New Base Market
Capitalization” will then be Rs. 2501.24 crores. This figure of 2501.24
will be used as the Base Market Capitalization for calculating the
index number from then onwards till the next base change becomes
necessary.
Criteria for Selection and Review
Index Review Frequency The Index Committee meets every quarter
to review the BSE indices. In case of any revision in the Index constituents,
the announcement of the incoming and outgoing scrips is made six weeks
in advance of the actual implementation of change in the index.
Qualification Criteria The general guidelines for selection of
constituent scrips in SENSEX are as follows.
Quantitative Criteria
1. Market capitalization The scrip should figure in the top 100
companies listed by market capitalization. Also market capitalization
of each scrip should be more than 0.5 per cent of the total market
capitalization of the Index i.e. the minimum weight should be 0.5 per
cent. Since the SENSEX is a Market Capitalization-weighted index,
this is one of the primary criteria for scrip selection. (Market
Capitalization would be averaged for the previous six months)
2. Liquidity
 As regards trading frequency, the scrip should have been traded
on each and every trading day for the last one year.Exceptions
can be made for extreme reasons like scrip suspension etc·
 As regards number of trades, the scrip should be among the top
150 companies listed by average number of trades per day for the
last one year
 As regards value of shares traded, the scrip should be among the
top 150 companies listed by the average value of shares traded
per day for the last one year.
3. Continuity Whenever the composition of the index is changed, the
continuity of historical series of index values is re-established by
correlating the value of the revised index to the old index (index before
revision). The back calculation over the last one-year period is carried
out and correlation of the revised index to the old index should not be
less than 0.98. This ensures that the historical continuity of the index
is maintained.
4. Industry representation Scrip selection would take into account a
balanced representation of the listed companies in the universe of
BSE. The index companies should be leaders in their industry group.
5. Listed History The scrip should have a listing history of at least
one year on BSE.
Qualitative Criteria
In the opinion of the Committee, the company should have an acceptable
track record.
The constituents of BSE-SENSEX are as follows:
1. ACC 2. Bajaj Auto
3. BHEL 4. BSES Ltd
5. Castrol 6. Cipla
7. Colgate 8. Dr. Reddy Labs
9. Glaxo 10. Grasim
11. Gujarath Ambuja cements 12. HDFC

13. Hero Honda 14. HINDALCO
15. HLL 16. HPC
17. ICICI bank 18. Infosys
19. ITC 20. Larson & Tubro
21. MTNL 22. Nestle
23. Ranbaxy 24. Reliance
25. Satyam Computers 26. SBI
27. TCS 28. TELCO
29. TISCO 30. RCVL
2. BSE-TECk INDEX
The BSE-TECk is a stock index constituted of companies in the Information
Technology, Media and Telecom sectors. It would track the performance
of TMT sectors through a basket of 21 quality stocks. The BSE-TECk
Index would provide a quality benchmark for the investment community in
the knowledge-based sectors.
‘TECk’ stands for the following:
 ‘T’ - Technology (BSE Sector: Information Technology)
 ‘E’ - Entertainment(BSE Sector: Media & Publishing)
 ‘C’ - Communication (BSE Sector:Telecom)
 ‘k’ - Other Knowledge-based companies not falling in any of the
above three sectors.
The Base Date for BSE TECk Index is 2nd April, 2001. The Base Value for
BSE TECk Index is 1000 points. In other words, the BSE TECk Index was
equal to 1000 on 2nd April 2001.
The technology orientation of the current economy has primarily
marked a paradigm shift from manufacturing-based activities to knowledge-
based activities. In the present economic scenario, tangible assets like
land, plant & machinery are losing their significance to intangibles like
intellectual property, knowledge-base and technology. This has resulted
in the dominance of emerging sectors like Information Technology, Media
and Telecom.
The Need
The TMT sectors have seen heightened activity in the last couple of
years and the stock valuations of the companies in these sectors have
witnessed unprecedented volatility. This led to a strong bull run in the
TMT stocks in 1999 and early 2000. The market subsequently witnessed
the most unexpected sell-off in the stocks of the TMT sectors which led to
huge market capitalization erosion on the bourses and scared away genuine
investors. It was felt that in the absence of a proper benchmark, the
performance of the TMT sectors remained inadequately tracked. In order
to fill this void, the BSE-TECk index was launched as a reliable index for
benchmarking the performance of the TMT sectors.
The launch of BSE-TECk index was justified on rational grounds
which include inter-alia:
a. Globally a lot of investment is being committed to the TMT
sectors. Even in India, the last 2 years have seen a lot of
international and local money flowing into the TMT sectors.
b. The TMT sectors are currently dominating the trading pattern
on the bourses worldwide. In India, the TMT sectors account for
around 68% of the total daily turnover.
c. With a lot of domestic retail money committed to the TMT sectors
and existence of many mutual funds dedicated to one or more of
the TMT sectors in India, a need for a quality benchmark to
track the performance of such funds has been long felt.
d. The global and domestic investment community monitors eagerly.
the performance of the TMT sectors to discern typical trends in
the economy.
e. To provide a ready basket of quality TMT stocks for passive
investors.
f. Reference for Index futures, options and other derivative
products in the times to come.
Me thod ology
Modified Market Capitalization-Weighted (MMCW) method is used for
calculating the BSE TECk Index. It is also called the free-float adjustment
method because it takes into consideration only the free-float (non-
promoter) capital of the company for the purpose of calculation of the
index. It may be noted that currently all other stock market indices in India
take into consideration the entire market capitalization.
Free-float of a company consists of shares readily available in the
market for trading. These are shares held by non-promoters of the company.
The market capitalization of a company is adjusted to reflect the free-float
portion. For e.g. if a company has 35 per cent non-promoter-holding, then
only 35 per cent of the total market capitalization of the company would be
considered for the purpose of calculating the index. SEBI has mandated
submission of shareholding pattern to the exchanges (on a quarterly basis)
by all listed companies in a standardized format.
Free-float for a company Free-float for a company is determined as

per format relating to shareholding pattern stipulated by SEBI and incor-
porated in clause 35 of the Listing Agreement. The format is as follows:
a) Promoters
 Indian
 Foreign
 Persons acting in concert
b) Non-promoters
 Institutions (FI/FII’s)
 Corporate Bodies
 Public
For the purpose of BSE TECk Index calculation, Part B i.e.
‘Non-Promoters’ is taken as Free-Float of the company.
Illustration
Company XYZ
Promoters:
Indian 30%
Foreign 10%
Persons acting in concert 15%
Non-promoters:
Institutions 15%
Corporate bodies 0%
Public 30%
Free-float = B = 45%
BSE-TECk Index Vs. Other BSE Indices
The BSE-TECk Index is the first free-float adjusted index in the country.
Globally most of the index providers have switched to free-float adjusted
indices to better reflect the true buying and selling opportunity in the
market. The free-float adjusted index ignores the locked portion of a
company’s equity and takes into consideration only the freely tradable
portion for the purpose of calculating the index. All other BSE Indices
presently consider the full equity of a company for the purpose of index
calculation irrespective of whether the equity is held by promoters or
non-promoters.
Constructing BSE-TEC k index
The BSE-TECk Index is constructed and maintained as per a laid down
policy detailed in the “Guide to BSE-TECk Index”. The Guide has laid
down a scientific and comprehensive construction and revision
methodology for the TECk Index in order to minimize subjectivity in index
calculation and maintenance.
Determining Weights
The constituent companies in the BSE-TECk index are weighted by their
free-float adjusted market capitalization. For e.g. an Index of two constituent
stocks A and B will have the following weightages in the Index given their
market capitalization and free-float factors as below:
Free-float Free-float
Mkt. Cap. Weightage
Company Adj. Adj.
(Rs. Crs.) (%)
Factor Factor
A 10000 0.25 2500 41.67
B 7000 0.50 3500 58.33
Review of BSE-TEC k Index

The BSE-TECk index would be reviewed in a routine Index Committee
meeting which meets on a quarterly basis.
Global Benchmarks on TMT Sectors
The NASDAQ (US) and TECk MARK (UK) are markets specifically for
technology companies. The NASDAQ composite index is the most widely
tracked technology stock index in the world. The London Stock Exchange
launched in November 1999 a separate market called TECk MARK, to
meet the unique requirements of technology companies. TECk MARK
comprises companies from the main market that share a common attribute,
in this case a commitment to technological innovation.
Prediction
Since the BSE-TECk index represents around 90 per cent of the market
capitalization of the TMT sector universe and includes the sector leaders
as its constituents, this index is expected to act as a trendsetter for the
remaining TMT sector scrips.
3. BSE-PSU INDEX
The Stock Exchange, Mumbai launched “BSE-PSU Index” on Monday,
4th June 2001. The index consists of 34 major Public Sector Undertakings
listed on the Exchange. The BSE-PSU Index is displayed on-line on the
BOLT trading terminals nationwide. The BSE - Public Sector Undertaking
(PSU) Index is a stock index that will track the performance of the listed
PSU stocks on the Exchange. The index is being launched with 34
constituents which are currently part of the BSE-500 Index.
Objec tive
It is an index tracking the performance of listed equity of PSU companies.
It is a suitable benchmark for the Central Government to monitor its wealth
on the bourses.
Index Specifications
The Base Date for the BSE-PSU Index is set as 1st February 1999 when
the BSE-500 was launched. Being a subset of BSE-500, the BSE-PSU Index
is aimed at ensuring a reasonable history of how the Central Government
wealth fluctuates on the bourses. The base value for the BSE-PSU Index
has been set at 1000 to ensure adequacy in terms of Daily Index movement.
The BSE-PSU index has been constituted of listed companies/ institutions/
corporations owned or controlled by the Central Government within the
meaning of Section 619-B of the Companies Act, 1956.
4. BSE-100 INDEX
The BSE-100 Index is also known as ‘BSE National Index’. A need was felt
for a more broad-based index, which can also reflect the movement of
stock prices on a national scale because the BSE Sensitive Index has only
30 scrips. The BSE started compilation and publication of an index series
called “BSE National Index” on 3rd January, 1989.
C ov e r ag e
The equity shares of 100 companies from the “Specified” and the
“Non-specified” list of the five major stock exchanges, viz., Mumbai,
Calcutta, Delhi, Ahmedabad and Madras were selected for the purpose of
compiling the BSE National Index. The criteria for selection were market
activity, due representation to various industry-groups and representation
of trading activity on major stock exchanges.
Base-Year
The financial year 1983-84 was chosen as the base-year. The price stability
during that year and proximity to the index series were the main
consideration for choice of 1983-84 as the base-year.
Method of Compilation
The basic method of compilation is the same as the one used in the case of
the BSE Sensitive Index. However, in the case of BSE National Index, a
distinction is made between “local scrips” for which prices were taken
from only one exchange and “Inter-Exchange scrips” for which an average
of the prices quoted on two or more exchanges were considered for index
compilation.
Redesignation of the BSE-100 National Index
The BSE-100 National Index took prices of certain scrips from other
exchanges or weighed average of some scrips which were popular on
other exchanges in order to reflect market movements at the national level.
However, changes in trading technology, longer trading period and almost
instantaneous availability of information across the country have ensured
that there is little or no difference in prices of the index scrips. Therefore,
the Exchange administration has decided to redesignate the BSE-100
National index as the ‘BSE-100’ index. Since October 14, 1996, the prices of
the BSE are taken to calculate the index.
5. BL-250 STOCK INDEX
BL-250 index is a portfolio of 250 stocks from 48 industry groups, one
diversified group and one miscellaneous group. It has been designed
comprehensively to capture and disseminate the underlying spirit of the
Indian economy. The BL-250 index is formulated and maintained by
Business Line.
It is broad-based and includes stocks of companies in which the
public have a significant stake. The public is defined as both consumers
and investors. Companies tracked by this index are those that have a
significant share in the markets in which they operate and individual and
institutional investors who hold a significant part of equity.
Features
The significant features of the index are as follows:
Weight The index is weighted by market capitalization. Accordingly, a
big price spurt in a stock that has small market capitalization will have only
a small impact on the index.
Wealth index The index is adjusted for dividends, buy-back of equity,
offerings of equity, convertible debt and issue and exercise of warrants. It
is therefore both a full-fledged wealth index and a price index.
Composition It is a composite index of 50 groups of stocks and the
performance of individual industry groups is captured by the composite.
The individual indices are tracked and reported.
Flexibility The index is designed to facilitate the deletion and addition

of stocks. It is therefore immunized against fossilization. The deletion of a
stock of a certain industry is usually followed by the addition of a stock in
the same industry. Accordingly, a cement stock will not be replaced by
sugar stock and vice-versa.
6. BSE BANKEX
BANKEX, is the new entrant in BSE’s current portfolio of 13 indices, and
adds value to BSE’s ability in reflecting both the broad market and specific
sector movements in the Indian equity market.
Indian banking is riding on a major recovery both in terms of strength
and soundness. In the year 2002, return on assets in Indian banking was
higher as compared to many emerging economies and the Moody’s Bank
Financial Strength Index (2002) placed India at 27.5, which is much better
than 16.7 of Korea, 15.8 of Thailand or 12.5 of Japan. India is making
sizeable gains in expanding into consumer credit by tightening credit
administration procedures similar to other rapidly growing countries. Major
policy actions that led to a sharp fall in interest rates have enabled banks
to post a significant rise in operational profits. The enactment of
Securitization Bill offered great opportunities to step up loan recoveries
that could further enhance the scope of greater profitability.
These developments impacted the performance of bank stocks
significantly. Since bank stocks are emerging as a major segment in the
equity markets, BSE considered it important to design an index exclusively
for bank stocks. The index is computed on the basis of the globally
accepted free-float methodology.
Features
A few important features of the BANKEX are given below:
1. BANKEX will track the performance of the leading banking sector
stocks listed on the BSE.
2. BANKEX is based on the free float methodology of index
construction.
3. The base date for BANKEX is 1st January 2002.
4. The base value for BANKEX is 1000 points.
5. BSE has calculated the historical index values of BANKEX since
1st January 2002.
6. 12 stocks which represent 90 per cent of the total market
capitalization of all banking sector stocks listed on BSE are
included in the Index.
7. The Index will be disseminated on a real-time basis through BSE
Online Trading (BOLT) terminals from 23rd June, 2003.
Constitutents of BANKEX Index

Stocks forming part of the BANKEX along with the particulars of their
free-float adjusted market capitalization are listed below.
Andhra Bank Bank of Baroda
Bank of India Canara Bank
Corporation Bank HDFC Bank
ICICI Bank ING Vysya Bank
Oriental Bank of Commerce Punjab National Bank
State Bank of India Union Bank of India
7. S&P CNX NIFTY
S&P CNX Nifty is a stock index diversified into fifty and accounting for
twenty-three sectors of the economy. It is used for a variety of purposes
such as benchmarking fund portfolios, index based derivatives and index
funds. S&P stands for ‘Standard & Poor’ and CNX stands for CRISIL NSE
Index.
Features S&P CNX Nifty index of NSE is characterized by the
following:
1. Launch Equities trading at NSE began in November 1994. In late

1995, NSE became India’s largest equity market platform and was
looking for a market index to utilize this unique information source.
NSE also wanted to have a vehicle for the futures and options market.
NSE approached the economists Dr. Ajay Shah and Dr. Susan Thomas,
who were at CMIE, to do research on methods in index construction.
This work was funded by the USAID FIRE project. This led to the
formation of S&P CNX Nifty.
2. Ownership S&P CNX Nifty is owned and managed by India Index

Services and Products Ltd. (IISL), which is a joint venture between
NSE and CRISIL. IISL has India’s first specialized company focused
upon the index as a core product. IISL have a consulting and licensing
agreement with Standard & Poor’s (S&P), who are world leaders in
the index services. The total traded value of all Nifty stocks is
approximately 70 per cent of the traded value of all stocks on the NSE.
Nifty stocks represent about 59 per cent of the total market
capitalization.
S&P owns the most important index in the world, the S&P 500
index, which is the foundation of the largest index funds and the most
liquid index futures markets in the world. When S&P came to India to
look at market indices, they focused upon the S&P CNX Nifty as
opposed to alternative indices. They now stand behind the S&P CNX
Nifty, as is evidenced by the name “S&P CNX Nifty”. This is a unique
situation; S&P has never endorsed a market index before.
3. Types
a. S&P CNX Defty S&P CNX Defty is S&P CNX Nifty, measured
in dollars. If the S&P CNX Nifty rises by 2% it means that the
Indian stock market rose by 2%, measured in rupees. If the S&P
CNX Defty rises by 2%, it means that the Indian stock market
rose by 2%, measured in dollars. The S&P CNX Defty is calculated
in real time. Data for the S&P CNX Nifty and the dollar—rupee is
absorbed in real time, and used to calculate the S&P CNX Defty
in real time. Realtime currency data is obtained from Knight Ridder.
When there is currency volatility, the S&P CNX Defty is an ideal
device for a foreign investor to know where he stands, even
intraday.
b. CNX Nifty Junior S&P CNX Nifty is the first rung of the largest,
highly liquid stocks in India. CNX Nifty Junior is an index built
out of the next fifty large, liquid stocks in India. It is not as liquid
as the S&P CNX Nifty, which implies that the information in the
CNX Nifty Junior is not as noise-free as that of the S&P CNX
Nifty.
It may be useful to think of the S&P CNX Nifty and the CNX
Nifty Junior as making up the hundred most liquid stocks in
India. S&P CNX Nifty is the front line blue-chips, large and highly
liquid stocks. The CNX Nifty Junior is the second rung of growth
stocks which are not as established as those in the S&P CNX
Nifty. Stocks like Infosys and NIIT, which recently graduated
into the S&P CNX Nifty, were in the CNX Nifty Junior for a long
time prior to this. CNX Nifty Junior can be viewed as an incubator
where young growth stocks are found. As with the S&P CNX
Nifty, stocks in the CNX Nifty Junior are filtered for liquidity, so
they are the most liquid of the stocks excluded from the S&P
CNX Nifty. Buying or selling of the entire CNX Nifty Junior as a
portfolio is feasible.
The maintenance of the S&P CNX Nifty and the CNX Nifty
Junior are synchronized so that the two indices will always be
disjoint sets; i.e. a stock will never appear in both indices at the
same time. Hence, it is always meaningful to pool the S&P CNX
Nifty and the CNX Nifty Junior into a composite hundred stock
indices or portfolio.
S&P CNX Nifty is professionally maintained and is ideal for
derivatives trading.
4. Mechanism S&P CNX Nifty is based upon solid economic research.
A trillion calculations were expended to evolve the rules inside the
S&P CNX Nifty index. The results of this work are remarkably simple:
(a) the correct size to use is fifty, (b) stocks considered for the S&P
CNX Nifty must be liquid by the ‘impact cost’ criterion, (c) the largest
50 stocks that meet the criterion go into the index.
S&P CNX Nifty is a contrast to the ad hoc methods that have
gone into index construction in the preceding years, where indices
were made out of intuition and lacked a scientific basis. The research
that led up to S&P CNX Nifty is well-respected internationally as a
pioneering effort in better understanding how to make a stock market
index.
5. ‘Impact cost’ Market impact cost is the best measure of the liquidity
of a stock. It accurately reflects the costs faced when actually trading
an index. For a stock to qualify for possible inclusion into the S&P
CNX Nifty, it has to reliably have market impact cost of below 1.5 per
cent when doing S&P CNX Nifty trades of half a crore rupees. The
impact cost is not something fixed. It changes, depending upon the
liquidity of the market. Indeed, the time-series of the S&P CNX Nifty
impact cost is one of the best measures of changes in market liquidity
over the years.
6. S&P CNX Nifty trade The index assigns weightages to index
components, and the weight of a stock is proportional to its market
capitalization. This idea can be applied to buying the S&P CNX Nifty.
If one buys all 50 stocks in the S&P CNX Nifty, in correct proportions,
that would be called “an index trade”.
7. Minimum market lot Each purchase would have to be rounded off
to the nearest round lot. Hence, one can’t buy 74 shares of Reliance;
you have to choose either 50 or 100. For example, on 26 October 1998,
the weightage of Reliance in S&P CNX Nifty was 5.91 per cent. This
means that buying Rs.5 million of S&P CNX Nifty involves buying
Rs.2,95,500 of Reliance. The price of Reliance was Rs.115.25 so one
would need 2564 shares of Reliance. However, the market lot of Reliance
is 50, so 2564 is rounded off to 2550.
Therefore, if one has bought Rs.4 million of the S&P CNX Nifty,
with rounding off to the nearest market lot, then the portfolio would
have a 99.99 per cent correlation with the true S&P CNX Nifty. Larger
trade sizes would have an even higher correlation, and smaller trade
sizes would have a lower correlation. This number (99.99) is adequate
for even the most risk averse people; a trade size of Rs.4 million all but
eliminates ‘tracking error’ between the portfolio being traded and the
true S&P CNX Nifty.
8. Index variations A liquid stock, when considered as a good
thermometer, gives accurate data about the true price of the stock,
because it trades actively with a tight spread. The prices observed for
an illiquid stock are like readings from a low quality thermometer,
which reports noisy data about the phenomenon of interest (the true
price of the security).
S&P CNX Nifty is constructed by using ‘fifty best thermometers’
in the country and averages their values. As time passes, better
thermometers become available (in the form of large, liquid stocks
that are not in the S&P CNX Nifty), and it is always be ensured that
S&P CNX Nifty uses the best thermometers possible. Hence, the
weakest thermometer from inside the S&P CNX Nifty is removed and
the new stock into it is accepted.
9. Data used S&P CNX Nifty uses clear, publicly documented rules
for index revision. These rules are applied regularly, to obtain changes
to the index set. For instance, IDBI was once not listed; SBI was once
illiquid; Infosys was once an obscure software startup. The world
changes, and one by one, these stocks have come into the S&P CNX
Nifty. Each change in the S&P CNX Nifty is small, so the continuity of
the index is maintained. Yet, at all times, S&P CNX Nifty represents
the 50 most important liquid stocks in the country the best
thermometers to build an index out of.
10. Composition There are mathematical formulas which ensure that
yesterday’s value and today’s are comparable, even if a change in
composition takes place in-between. Think of an index as a portfolio.
The composition of the portfolio changes, but it is still meaningful to
keep measuring the overnight returns on the portfolio from day to
day. These returns, cumulated up, are the index level. It is part of the
Scientific Index Revision Mechanism. The revision of index is thus
perfectly managed. Further, there are objective, publicly defined rules
which determine when stocks come in and go out of the index. There
isn’t much room for personal judgment here.
11. Closing price The best closing prices of the country are used for
the purpose of calculating the closing price of Nifty. These, in turn,
come from a “call auction” in the last ten minutes. The call auction
yields a single, sharp price out of millions of shares of supply and
demand. NSE has the best surveillance procedures in India. This
ensures that the extent of market manipulation is minimum. For
instance, in NSE, the professional staff of the surveillance department
have no positions on the market. This elimination of conflicts of interest
generates a more honest focus upon eliminating market manipulation.
From the date November 18, 1998 onwards, the NSE ‘official
closing price’ was determined by a call auction, a remarkable market
procedure where a single, sharply defined closing price arises out of
supply and demand of millions of shares. Due to the liquidity and
order flow from numerous market players, manipulation of the closing
price becomes very hard.
NSE is the most liquid exchange in India. Hence, the prices
observed there are the most reliable. NSE has the highest trading
intensity (reducing stale prices) and their bid-ask spreads are the
tightest (reducing bid-ask bounce). This is assisted by the fact that
the NSE tick size is Rs.0.05 for all stocks, which encourages tight
bid-ask spreads.
12. Change in weights When corporate actions take place, the market
capitalization changes and weights are adjusted. Rights issues, public
issues and mergers, all present such problems. Of course, when index-
set changes take place, the portfolio is adjusted and the weights are
modified. This requires elaborate, and consistently- applied policies.
13. Depository All stocks can be dematerialized and traded for electronic
settlement. Of the 50 stocks in the S&P CNX Nifty, institutions are
required (by SEBI) to settle through NSDL for 49 stocks. As of today,
82 per cent of the NSE settlement volume for S&P CNX Nifty stocks is
done through NSDL.
Problems of S&P CNX Nifty
The problem for a S&P CNX Nifty essentially arises in respect of illiquid
stocks. Illiquid stocks do not generally consider the price information as
anything of significance for index compilation. This is because of the
three problems that are associated with it, ‘stale prices’, ‘bid-ask bounce’
and vulnerability to manipulation. Through these problems, an index is
actually worsened when illiquid stocks are put into it. Further, it is quite
possible that a stock may be liquid on one exchange and illiquid on another.
In such an eventuality, it would be difficult to arrive at a workable index.
Illiquid stocks yield bad price data; so the best quality data will come from
the most liquid exchange. In India, the most liquid exchange is the NSE.
The S&P CNX Nifty uses price data from NSE for calculations.
a. Stale prices When one looks at the closing price of an index, it is
supposed to reflect the state of the stock market at a specified time,
say 3.50 P.M. If an illiquid stock is in the index, the last traded price
(LTP) of the stock might be an hour, or a day, or a week old. The index
is supposed to show how the stock market perceives the future of the
corporate sector at the time specified, say 3.50 P.M. When an illiquid
stock injects these ‘stale prices’ into the calculation of an index, it
makes the index staler. It reduces the accuracy with which the index
reflects information.
b. bid-ask bounce Similarly, there is also a problem of ‘bid-ask bounce’.
For instance, a stock trades at bid 1440, ask 1490. If no news appears
for ten minutes and if a buy order first comes in (at Rs.1490) followed
by a sell order (at Rs. 1440), this sequence of events makes it seem
that the stock price has dropped by Rs.50. This is a totally spurious
price movement.
Hence, even when no news is breaking, when a stock price is not
changing, the ‘bid-ask bounce’ is about prices bouncing up and down
between bid and ask. These changes are spurious. This problem is
the greatest with illiquid stocks where the bid-ask spread is wide.
When an index component shows such price changes, it contaminates
the index.
c. Market manipulation The index is a large entity and is intrinsically
harder to manipulate when compared with individual stocks.
Obviously, larger indices are harder to manipulate than smaller indices.
The weak links in an index are the large, illiquid stocks. These are the
‘Achilles’ Heel’ where a manipulator obtains maximum impact upon
the index at minimum cost. Optimal index manipulation consists of
attacking these stocks. This is one more reason why illiquid stocks
should be excluded from a market index; indeed this aspect requires
that the liquidity of a stock in an index should be proportional to its
market capitalization.
S&P CNX NIFTY Vs. BSE SENSITIVE INDEX
Sl. Feature S&P CNX Nifty BSE-SENSEX

1 Number of 50 30
stocks
2 Diversification More diversified index, More vulnerable to
accurately reflecting movements of
overall market conditions individual stocks
3 Risk Less risk Higher risk
4 Liquidity More liquid Less liquid
5 Impact cost Suffers lower market Suffer higher market
impact cost impact cost
6 Price base NSE prices BSE prices

7 Safety Since calculated form a There is a settlement
more liquid market risk because of trading
featuring the safety of on a less liquid
novation at the clearing exchange due to lack of
corporation, high safety novation and lack of a
clearing corporation
8 Index rule Has fully articulated and Procedures are ad hoc
professionally and undocumented, and
implemented rules do not reflect an
governing index revision, awareness of modern
corporate actions, etc; applications of an index
rules are carefully thought
out to dovetail with
operational problems of
index funds and index
arbitrageurs.
9 Hedging Better for randomly Not so
effectiveness selected portfolios in
India.
Sl. Feature S&P CNX Nifty BSE-SENSEX

10 Manipulations Relatively free of It is easier for a
manipulation, because the manipulator to move
index levels are calculated prices at BSE.
from the more liquid
exchange with better
surveillance procedures,
S&P CNX Nifty has a
larger market
capitalization so the
consequence of a given
move in an individual
stock price is smaller and
S&P CNX Nifty
calculation intrinsically
requires liquidity in
proportion to market
capitalization, thus
avoiding weak links which
a manipulator can attack.
11 Research Benefit from research is Owing to the large
possible owing to the long changes in the `BSE
time-series available. sensitive index' in 1996,
the comparable series
available is only for a
limited period.
12 Backing Backed by solid economic Not so
research and three most
respected institutions:
NSE, CRISIL and S&P.
DOW JONES INDICES

‘Dow Jones’ develops, maintains and licenses market indices for investment
products. The Dow Jones Industrial Average and the leading pan-European
indices, are among the more than 3,000 indices which are recognized as the
world’s best known stock indicators.
Dow Jones Index is part of Dow Jones & Company which publishes
The Wall Street Journal and its international and interactive editions,
Barron’s and SmartMoney magazines and other periodicals, the Dow Jones
Newswires, dowjones.com and the Ottaway group of community
newspapers. Dow Jones is a co-owner with Reuters Group of Factiva, and
NBC of the CNBC television operations in Europe and Asia. Dow Jones
also provides news content to CNBC in the U.S.
NASDAQ STOCK MARKET INDICES
Eligible Securities
The following common type securities are eligible for index inclusion in
the NASDAQ. There is no distinction between either the NASDAQ
National Market and The NASDAQ SmallCap Market, and the domestic
US and Non-US securities.
 American Depositary Receipts (ADRs)
 Common Ordinary Shares
 Real Estate Investment Trusts (REITs)
 Shares of Beneficial Interest (SBIs)
 Tracking Stocks
Ineligible Securities
The following issue types are not eligible for inclusion in the indices:
 Convertible debentures
 Preferred stocks
 Rights, warrants, units and other derivative securities
1. NASDAQ-100 Index
Launched in January 1985, the NASDAQ-100 Index represents the largest
non-financial domestic and international issues listed on the NASDAQ
Stock Market based on market capitalization. The NASDAQ-100 Index is
calculated under a modified capitalization-weighted methodology. The
methodology retains in general, the economic attributes of capitalization-
weighting while providing enhanced diversification. NASDAQ reviews
the composition of the NASDAQ-100 Index on a quarterly basis and adjusts
the weightings of Index components using a proprietary algorithm, if certain
pre-established weight distribution requirements are not met.
The NASDAQ-100 Index includes 100 of the largest domestic and
international non-financial companies listed on the NASDAQ Stock Market
based on market capitalization. The Index reflects companies across major
industry groups including computer hardware and software,
telecommunications, retail/wholesale trade and biotechnology. It does not
contain financial companies including investment companies.
Initial Eligibility Criteria
To be eligible for initial inclusion in the NASDAQ-100 Index, a security
must be listed on the NASDAQ Stock Market and meet the following
criteria:
 The security must be listed on the NASDAQ National Market.

 The security must be of a non-financial company.
 The security may not be issued by an issuer currently in
bankruptcy proceedings.
 The security must have average daily trading volume on
NASDAQ of at least 2,00,000 shares.
 If the security is of a foreign issuer, it must have listed options or
be eligible for listed-options trading.
 Only one class of security per issuer is allowed.
 The issuer of the security shall not have entered into a definitive
agreement or other arrangement which would result in the
security no longer being listed on NASDAQ within the next six
months
 The issuer of the security shall not have annual financial
statements with an audit opinion which the auditor or the company
has indicated as cannot be currently relied upon
 The security must have “seasoned” on NASDAQ or any other
recognized market (generally, a company is considered to be
seasoned if it has been listed on a market for at least two years; in
the case of spin-offs, the operating history of the spin-off will be
considered); and
· If the security would otherwise qualify to be in the top 25 per
cent of the securities included in the Index by market capitalization
for the six prior consecutive month ends, then one-year
“seasoning” criteria would apply.
Continued Eligibility Criteria
In addition, to be eligible for continued inclusion in the Index the following
criteria apply:
 The security must be listed on the NASDAQ National Market
 The security must be of a non-financial company
 The security may not be issued by an issuer currently in
bankruptcy proceedings
 The security must have average daily trading volume of at least
2,00,000 shares
 If the security is of a foreign issuer (a foreign issuer is determined
based on its country of incorporation), it must have listed options
or be eligible for listed-options trading
 The security must have an adjusted market capitalization equal
to or exceeding 0.10 per cent of the aggregate adjusted market
capitalization of the Index at each month end. In the event of a
company not meeting this criterion for two consecutive month-

ends, it will be removed from the Index effective after the close of
trade on the third Friday of the following month; and
 The issuer of the security shall not have annual financial
statements with an audit opinion which the auditor or the company
has indicated cannot be currently relied upon.
Securities listed on the NASDAQ Stock Market which meets the above
eligibility criteria are ranked by the market value using closing prices as of
the end of October, and the publicly available total shares outstanding as
of the end of November. Index-eligible securities which are already in the
Index, and which are in the top 150 eligible securities (based on market
value) are retained in the Index provided that such security was ranked in
the top 100 eligible securities as of the previous ranking review. Securities
not meeting such criteria are replaced. The replacement securities chosen
are those Index-eligible securities not currently in the Index which have
the largest market capitalization.
Generally, the list of annual additions and deletions is publicly
announced via a press release in the early part of December. Replacements
are made effective after the close of trade on the third Friday of December.
Moreover, if at any time during the year an Index Security is not traded on
the NASDAQ Stock Market, or is otherwise determined by NASDAQ to
become ineligible for continued inclusion in the Index, the security will be
replaced with the largest market capitalization security not currently in the
Index and meeting the Index eligibility criteria listed above.
2. NASDAQ FINANCIAL-100 Index
The NASDAQ Financial-100 Index includes 100 of the largest domestic
and international financial organizations listed the NASDAQ Stock Market
based on market capitalization. The Index contains bank and savings
institutions and related holding companies, insurance companies, broker
dealers, investment companies and financial services.
3. NASDAQ Composite Index
The NASDAQ Composite Index measures all NASDAQ domestic and
international-based common-type stocks listed on the NASDAQ Stock
Market. Today the NASDAQ Composite includes over 4,000 companies,
more than most other stock market indices. Because it is so broad-based,
the Composite is one of the most widely followed and quoted major market
indices.
4. NASDAQ National Market Composite Index
The NASDAQ National Market Composite Index is a sub-set of the
NASDAQ Composite Index, and consists of all companies included in the

NASDAQ Composite Index which are listed on the NASDAQ National
Market tier of the NASDAQ Stock Market.
5. NASDAQ Bank Index
The NASDAQ Bank Index contains all types of banks and savings
institutions, and related holding companies such as establishments
performing functions closely related to banking, for example, check,
encashing agencies, currency exchanges, safe deposit companies and
corporations for banking abroad.
6. NASDAQ Biotechnology Index
The NASDAQ Biotechnology Index contains companies primarily engaged
in using biomedical research for the discovery or development of novel
treatments or cures for human disease, which also meet other eligibility
criteria. The NASDAQ Biotechnology Index is calculated under a modified
capitalization-weighted methodology.
7. NASDAQ Computer Index
The NASDAQ Computer Index contains computer hardware and software
companies that furnish computer programming and data processing
services and firms that produce computers, office equipment, and electronic
components/accessories.
8. NASDAQ Industrial Index
The NASDAQ Industrial Index contains companies not classified in any
of the other sub-indices, and includes agricultural, mining, construction,
manufacturing, retail/wholesale trade, services, public administration
enterprises, health maintenance organizations and companies that do not
meet the NASDAQ Biotechnology Index criteria.
9. NASDAQ National Market Industrial Index
The NASDAQ National Market Industrial Index is a sub-set of the
NASDAQ Industrial Index, and consists of all companies included in the
NASDAQ Industrial Index which are listed on the NASDAQ National
Market tier of the NASDAQ Stock Market.
10. NASDAQ Insurance Index
The NASDAQ Insurance Index contains all types of insurance companies
including life, health, property, casualty, and brokers, agents, and related
services.
11. NASDAQ Other Finance Index

The NASDAQ Other Finance Index includes credit agencies (except banks
and savings institutions and related holding companies), security and
commodity brokers, exchanges and dealers, real estate, and holding
investments companies.
12. NASDAQ Telecommunications Index
The NASDAQ Telecommunications Index contains all types of
telecommunications companies, including point-to-point communication
services and radio and television broadcast, and companies that
manufacture communication equipment and accessories. On November 1,
1993, the NASDAQ Utility Index was renamed the NASDAQ
Telecommunications Index. The former NASDAQ Utility Index was reset
to a base of 200.00, using a factor of 5.74805.
13. NASDAQ Transportation Index
The NASDAQ Transportation Index contains all types of transportation
companies, including railroads, trucking companies, airlines, pipelines
(except natural gas), and services incidental to transportation, such as
warehousing, travel arrangements, and packing.
14. The KLD-NASDAQ® Social Index SM
The KLD-NASDAQ Social Index is a market-value weighted index reflecting
the performance of the largest NASDAQ listed US corporations in major
sectors of the market, including technology, financial, and
telecommunications. All constituents of the KLD-NASDAQ Social Index
pass KLD Research & Analytics proprietary social and environmental
screens.
NASDAQ INDEX CALCULATION DESCRIPTION
All NASDAQ Indices are market value weighted except the NASDAQ-100
Index which is weighted using a modified market capitalization method.
The representation of each security in the Index is proportional to its last
sale price times the total number of shares outstanding, relative to the
total market value of the respective index.
The formula used for determining the Index values is as follows:
a. Index Level
= [Current Market Value ÷ Adjusted Base Period
Market Value] × Base Value
b. Adjusted Base Period Market Value

= [Current Market Value After Adjustments × Previous Base
Period Market Value] ÷ Current Market Value
Before Adjustments
The level of an Index will only change as a result of price changes
occurring between the opening and closing of the market. Adjustments
for securities being added to or deleted from the NASDAQ Stock Market,
Inc., or capitalization Changes, are adjustments which take place during
the system maintenance process after the market has closed. These
adjustments will result in value changes to the Current Market Value and
Adjusted Base Period Market Value, but will not in and of themselves after
the level of an Index.
Stock splits and stock dividends are likewise adjusted for, during the
system maintenance process. However, the system makes a price
adjustment to account for the increased number of shares with the result
being that the current market value does not change. In the case of cash
dividends, no system adjustment is made. Neither the Current Market
Value nor the Adjusted Base Period Market Value is adjusted to reflect
cash dividends. The index formula relies on market forces to determine the
level of the Index.
OTHER INDEX DESCRIPTIONS
1. AMEX Composite
The Amex Composite Index reflects the aggregate market value of all its
components relative to their aggregate value on December 29, 1995. The
index was developed with a base of 550 as of Dec. 29, 1995. Components of
the index include the common stocks or ADRs of all Amex-listed companies,
REITs, master limited partnerships, and closed-end investment vehicles.
Each component’s market value is determined by multiplying its price by
the number of shares outstanding. The day-to-day price change in each
issue is weighted by its market value (as at the start of the day) as a
percentage of the total market value for all components. Thus, the daily
price change for each company influences that day’s change in the index
in proportion to the company’s market value. The level of the Composite
Index is not altered by stock splits, stock dividends or trading halts, nor is
it affected by new listings, additional issuances, de-listings, or suspensions.
2. Dow Jones Average - 30 Industrial
Prepared and published by Dow Jones & Co. this is one of the oldest and
most widely quoted of all the market indicators. The Dow Jones Industrial
Average is comprised of 30 stocks that are major factors in their respective

industries, and widely held by individuals and institutional investors.
These 30 stocks represent about a fifth of the market value of all U.S.
stocks and about a fourth of the value of stocks listed on the New York
Stock Exchange.
3. Dow Jones Average - 20 Transportation
Prepared and published by Dow Jones & Co., the Dow Jones
Transportation Average represents 20 stocks of the airline, trucking,
railroad, and shipping business.
4. Dow Jones Average - 15 Utilities
Prepared and published by Dow Jones & Co., the Dow Jones Utility index
is geographically representative of the gas and electric utilities industries.
5. FORTUNE 500 Index
Developed by the editors of FORTUNE, this Market Capitalization-
Weighted Index is based on FORTUNE’s 45-year-old list of America’s 500
biggest companies domiciled in the U.S. In addition, the Index is restricted
to publicly listed companies in the FORTUNE 500 List whose shares are
actively traded. Index was set to a base level of 1000.00 at the end of
trading on December 31, 1999 and is being calculated real-time at 15-second
intervals during the trading day.
6. FORTUNE e-50 Index
First published in the Dec. 6, 1999 issue of FORTUNE Magazine, it is
based on a list of the 50 companies that FORTUNE has determined best
capture the scope of the Internet sector.
7. Frank Russell - 3000 Index
Measures the performance of the 3,000 largest U.S. companies based on
total market capitalization, which represents approximately 98 per cent of
the investable U.S. equity market.
Measures the performance of the 2,000 smallest companies in the
Russell- 3000 Index, which represents approximately 8 per cent of the total
market capitalization of the Russell 3000 Index.
Measures the performance of the 1,000 largest companies in the
Russell-3000 Index, which represents approximately 92 per cent of the
total market capitalization of the Russell 3000 Index.
10. Frank Russell - Midcap Index

Measuring the performance of the 800 smallest companies in the
Russell-1000 Index, which represent approximately 35 per cent of the total
market capitalization of the Russell-1000 Index.
11. NYSE Composite Index
In 1966, the NYSE established the NYSE Composite Index to provide a
comprehensive measure of market trends. The indices consist of a
Composite Index of all common stocks listed on the NYSE and four
subgroup indices, Industrial, Transportation, Utility, and Finance. The
indices are basically a measure of the changes in aggregate market value
of NYSE common stocks, adjusted to eliminate the effects of capitalization
changes, new listings and delistings.
12. Philadelphia Semiconductor Index
Created in December 1993, the Philadelphia Semiconductor Index is a price-
weighted index composed of 16 U.S. semiconductor companies primarily
involved in the design, distribution, manufacture, and sale of
semiconductors.
13. S&P 500 Index
Widely regarded as the standard for measuring large-cap U.S. stock market
performance, this popular index includes a representative sample of leading
companies in leading industries. The S&P 500 is used by 97 per cent of
U.S. money managers and pension plan sponsors.
14. S&P Midcap 400 Index
Measuring the performance of the mid-size company segment of the U.S.
market, this index is used by over 95 per cent of U.S. managers and pension
plan sponsors. $20 billion is indexed to the S&P Midcap 400.
15. S&P 100 Index
The Standard & Poor’s 100 Stock Index, known by its ticker symbol OEX,
measures large company U.S. stock market performance. This market
capitalization-weighted index is made up of 100 major, blue chip stocks
across diverse industry groups.
16. Wilshire 5000 Equity Index
The Wilshire 5000 Equity Index measures the performance of all U.S.
headquartered equity securities with readily available price data. Over
7,000 capitalization weighted security returns are used to adjust the index.
S & P 500 INDEX

Standard & Poor’s is a leader in providing highly valued financial data,
analytical research and investment and credit opinions to the global capital
markets. Among the company’s many products are the S&P Global 1200,
the first real time, global equity index, the S&P 500, the premier U.S. portfolio
index, and credit ratings on more than 2,20,000 securities and funds. With
more than 5,000 employees located in 19 countries, Standard & Poor’s is
an integral part of the world’s financial architecture.
The S&P 500 Index consists of 500 stocks chosen for market size,
liquidity, and industry group representation. It is a market-value weighted
index (stock price times number of shares outstanding), with each stock’s
weight in the Index proportionate to its market value. The “500” is one of
the most widely used benchmarks of U.S. equity performance.
Standard & Poor’s, the independent financial research, ratings and
indices leader, has announced the introduction of the S&P Equal Weight
Index (S&P EWI), a new index co-developed with Maryland-based Rydex
Global Advisors. The S&P EWI will have the same constituents as the
S&P 500 and is designed to offer investors an opportunity to invest in the
500 leading U.S. companies represented by the S&P 500 in equal measure.
Standard & Poor’s will begin calculating the index later this month and
daily index values will be published on.
The S&P 500 is designed to reflect the investable US equity universe,
which it achieves through its market capitalization weights and sector-
balanced approach. Standard & Poor’s recognizes that many in the financial
community have been calculating an equal-weighted version of the S&P
500 for both investing and benchmarking for some time. A key reason for
introducing an S&P-calculated equal weight index based on the S&P 500 is
to provide these investors with accurate information and tools that will
enable them to make size, style, and sector decisions relative to the S&P 500.
1. S&P GLOBAL 1200
The S&P Global 1200 sets a new standard for global equity benchmarks.
The S&P Global 1200 combines the features of a broad global portfolio
with sufficient liquidity in the underlying equities, making the index ideally
suited for index-related investment products. The S&P Global 1200 is the
world’s first real-time, free-float weighted index. The S&P Global 1200
covers approximately 70 per cent of global market capitalization.
Building on the success of the S&P 500, the S&P Global 1200 provides
investors with an equivalent global index built and maintained to the same
high standard. With index constituents selected on a global basis, it

supports both regional and sectoral views of asset allocation.
The S&P Global 1200 is comprised of six regional indices: S&P 500,
S&P/TSX 60 (Canada), S&P Latin America 40, S&P/TOPIX 150 (Japan),
S&P Asia Pacific 100, and S&P Europe 350. Constituents for each index are
selected to ensure sectoral and, where applicable, country balance.
Constituent weights are determined by a company’s free-float market
capitalization. Free-float implies removal of corporate cross-holdings,
government ownership, strategic holders, and foreign investment
restrictions.
The component indices are maintained by an index committee made
up of Standard & Poor’s staff worldwide. In the case of two indices, Canada
and Japan, Standard & Poor’s collaborates with two of the World’s leading
exchanges, the Toronto Stock Exchange and the Tokyo Stock Exchange.
Index governance and maintenance for all component indices follow the
same principles that have been successful for the S&P 500. This ensures
high quality constituents with strong fundamentals and liquidity, and low
index turnover.
Defining the S&P Global 1200
The S&P Global 1200 Index is comprised of six distinct, regional, component
indices: US - S&P 500, Canada - S&P/TSX 60, S&P Latin America 40,
Japan - S&P/TOPIX 150, S&P Asia Pacific 100, and the S&P Europe 350.
The S&P Global 1200 represents the opportunity set of investable equities
around the globe. Each regional benchmark is constructed in a manner
similar to the S&P 500 with the addition of a float-adjustment factor. The
size of each region corresponds to its relative size in the global equity
market based on adjusted market value. The S&P Global 1200 is the first
global index to be calculated in real time.
Index Construction and Eligibility
Eligibility Stocks are eligible for the S&P Global 1200 if they meet criteria
for size, liquidity, and sector representation on a regional basis. Each of
the component indices are balanced across country and sector weights in
the region.
Float-Adjusted Market value When calculating index weights,
individual constituents’ shares held by governments, corporations,
strategic partners, or other control groups are excluded from the company’s
shares outstanding. Shares owned by other companies are also excluded
regardless of whether they are index constituents.
In countries with regulated environments, where a foreign investment

limit exists at the sector or company level, the constituent’s weight will
reflect either the foreign investment limit or the percentage float, whichever
is more restrictive.
Liquidity Stocks are ranked according to liquidity measured by dollar
value traded. Value traded and float turnover are also analyzed on a monthly
basis to ensure ample liquidity.
Sector Classification Standard & Poor’s has mapped stocks to the Global
Industry Classification Standard (GICS). The S&P Global 1200 index
provides geographic and economic balance over the 10 GICS market
sectors. These sectors, consistent throughout all the S&P indices, include
Consumer Discretionary, Consumer Staples, Energy, Financials, Health
Care, Industrials, Information Technology, Materials, Telecommunication
Services and Utilities. Standard & Poor’s classifies a stock according to
the source of its largest revenue share.
Fundamental Analysis The financial and operating condition of a
company are rigorously analyzed. Keeping in mind the goal of minimizing
index turnover, the financial stability of index constituents is a major
consideration.
Additions An index addition generally is made only if an index vacancy
is created by an index deletion. Index additions will be made according to
their market size and liquidity, with a view to preserving regional, country,
and sector representation in the index. An Initial Public Offering (IPO) will
be added to the index only when an appropriate vacancy occurs, and
subject to proven liquidity for at least six months. An exception may be
made for extraordinary large global offerings where expected trading volume
justifies inclusion (i.e. privatizations).
Deletions A guiding principle of S&P’s index management is the
minimization of turnover among index constituents. Deletions may occur
due to delistings, bankruptcy, spin-offs or a failure to meet previously
defined criteria for the S&P Global 1200. The most common reason for
deleting a stock from an S&P index is its acquisition by another company.
Revisions to the Float Adjustments
Once a year, the float adjustments will be reviewed. Each company’s
financial statements will be used to update the major shareholders’
ownership.
Quarterly Index Rebalancing

Changes in the number of shares outstanding, driven by corporate events
such as stock dividends, splits, and rights issues will be adjusted on the
ex-date. Share changes of 5 per cent or greater are implemented when they
occur. All share changes of less than 5 per cent are updated on a quarterly
basis (the third Friday of March, June, September, and December or at the
close of the expiry of future contracts). Implementation of new additions,
deletions, and changes to the float adjustment, due to corporate actions,
will be made available at the close of the third Friday in March, June,
September, and December. Generally, index changes, due to rebalancing,
are announced 10 days before the effective date by way of a news release
posted on www.spglobal.com.
Real Time Calculation
The S&P Global 1200 calculation begins as soon as the first quote for any
index constituent is received. The index is calculated until 5:15p.m. EST to
allow for last minute revisions by regional stock exchanges that are the
last to close (U.S., Canada, and Mexico). At the country level, the opening
price is the first trade of any stock, and in the event of a stock not opening
the previous closing price or adjusted price in the region will be used. The
closing index value is calculated using the closing price of each stock in
its primary market.
Exchange Rates and Pricing
WM/Reuters spot rates provided real time by the WM Company. Equity
pricing source is a Reuters real time feed.
Base Date
The S&P Global 1200 was based at December 31, 1997. Base value = 1000.
2. S&P GLOBAL 1200 SECTOR INDICES
Standard & Poor’s offers Sector Indices on the S&P Global 1200 based
upon the Global Industry Classification Standard (GICS). This standard is
jointly maintained by Standard & Poor’s and MSCI. Each stock is classified
into one of 10 sectors, 23 industry groups, 59 industries, and 122
sub-industries according to their largest source of revenue. Standard &
Poor’s and MSCI jointly determine all classifications.
The ten sectors are Consumer Discretionary, Consumer Staples,
Energy, Financials, Health Care, Industrials, Information Technology,
Materials, Telecommunication Services, and Utilities. These indices are
calculated using the same guiding principles that apply to all Standard &
Poor’s Indices.
HANG SENG INDEX

The Hang Seng is the leading index for shares traded on the Hong Kong
Stock Exchange. Started in 1969, the index consists of the 33 largest
companies that trade on the exchange. The index is maintained by a
subsidiary of Hang Seng Bank. It is a capitalization-weighted index, meaning
that the largest firms (based on market value) carry the greatest weight in
the Hang Seng. The index represents approximately 70% of the value of all
stocks traded on the Hong Kong Stock Exchange. The index can be further
divided into four sub-indices: Commerce, Finance, Property, and Utilities.
DAX INDEX
The DAX Index is the most commonly cited benchmark for measuring the
returns posted by stocks on the Frankfurt Stock Exchange. Started in 1984
with a value of 1000, the index is comprised of the 30 largest and most
liquid issues traded on the exchange. It is a performance-based index,
which means that any dividends and other events are rolled into the index’s
final calculation.
STRAITS TIMES INDEX
The Straits Times Index, which is compiled by the newspaper of the same
name, is Singapore’s premier equity index. Started in August of 1998, this
index is comprised of 55 of the exchange’s most valuable firms. It is a
modified value-weighted index, which is complicated in calculation, but
ensures that the largest firms have the greatest impact on the index’s
value. When taken together, the index’s 55 components represent about
60% of the total market value of all issues traded on the Singapore Stock
Exchange.
KOSPI
In South Korea, the main tracking index is the Korean Composite Stock
Price Index or KOSPI for short. Originally started in 1964, the index has
been modified numerous times over the years, taking its current form in
1994. The KOSPI Index is comprised of 200 of the largest and most liquid
issues traded on the Korean Stock Exchange. The index is market
capitalization weighted, meaning that firms with the largest market value
have the greatest influence on the KOSPI’s returns.
FTSE
The Financial Times 100 Index, or FTSE, is the most widely used benchmark
for the performance of equities traded on the London Stock Exchange.
Started in January 1984 with an initial value of 1000, the index contains the
100 largest companies traded on the London Stock Exchange (based on

market capitalization). These stocks represent about 80% of the value of
all issues traded on the exchange. Because it is weighted by market
capitalization, the index’s largest component stocks have the greatest
influence on the FTSE’s value. The index is quite unusual in that it re-
weights its component stocks daily to represent the actual state of the
market. Meanwhile, the index is fully rebalanced (additions and
subtractions) on a quarterly basis.
MSCI (MORGAN STANLEY CAPITAL INTERNATIONAL INC) INDEX
MSCI is the leading international benchmark provider. The information is
provided for informational purposes only, and is not a recommendation to
participate in any particular trading strategy. MSCI is a leading provider of
global indices and benchmark related products and services to investors
worldwide. Morgan Stanley, a global financial services firm and a market
leader in securities, asset management, and credit services, is the majority
shareholder of MSCI, and the Capital Group Companies, Inc., a global
investment management group, is the minority shareholder.
MSCI Equity Indices
MSCI provides global equity indices, which, over the last 30 years, have
become the most widely used international equity benchmarks by
institutional investors. MSCI constructs global equity benchmark indices
that contribute to the investment process by serving as relevant and
accurate performance benchmarks and effective research tools, and as the
basis for various investment vehicles. As such, the MSCI Equity Indices
are designed to fulfill the investment needs of a wide variety of global
institutional market participants. In constructing these indices, MSCI
consistently applies its index construction and maintenance methodology
across 23 developed and 27 emerging markets. This consistent approach
makes it possible to aggregate individual country and industry indices to
create meaningful composite, regional, sector, and industry benchmarks.
Around 2000 organizations worldwide currently use the MSCI international
equity benchmarks. MSCI estimates that over USD 3 trillion are currently
benchmarked to these indices on a worldwide basis.
International Equity Indices
Products include under this category include global, regional and country
equity indices, sector industry group and industry indices, value and
growth indices, small cap equity indices, hedged and GDP-weighted
indices, custom equity indices, and real time equity indices. MSCI Equity
Indices are available in local currency and USD, and with or without
dividends reinvested.
US Equity Indices
In 2003, MSCI launched a new family of US equity indices to provide a
much broader and deeper coverage of the US equity market. The new
index series reflects the full breadth of investment opportunities within
the US equity markets by capitalization size, value and growth investment
styles and sector groups. By design, the MSCI US Equity Indices offer:
 More accurate representation of the US equity market and
segments
 More frequent index reviews
 Robust value and growth style methodology
 Two dimensional, multi-factor
 Float weighted
 Transparent methodology
 More accurate representation of the investment process of size
and style managers via unique buffer rules
Fixed Income Indices
MSCI provides a wide range of fixed income indices for the investment
community, including indices for Sovereign, Investment Grade and High
Yield debt markets, as well as the Interest Rate Swaps market. The MSCI
Fixed Income Indices are unique in their emphasis on trader quotes as the
basis for security pricing, as well as on their use of an industry classification
system based on the Global Industry Classification Standard (GICS ®).
The GICS was developed by MSCI in conjunction with Standard & Poor’s
and is used by MSCI to classify securities in its equity indices. The use of
GICS in the MSCI Fixed Income Indices facilitates analysis across asset
classes.
Hedge Fund Indices and Data Base
Leveraging its unique understanding of the institutional asset management
environment and its expertise in creating and managing global benchmarks,
MSCI has developed a family of hedge fund indices based on a
comprehensive classification system and a growing fund database.
Hedge Invest Index
Launched in 2003, the MSCI® Hedge Invest Index consists of a diverse
sample of hedge funds that represent a broad range of hedge fund strategies
and have weekly liquidity. The index may be licensed for the creation of
index linked financial products.
INDIA INDEX SERVICES LTD (IISL)

India Index Services & Products Ltd. (IISL) is a joint venture between the
National Stock Exchange of India Ltd. (NSE) and the Credit Rating
Information Services of India Limited (CRISIL). IISL has been formed with
the objective of providing a variety of indices and index related services
and products for the capital markets. IISL has a consulting and licensing
agreement with Standard and Poor’s (S&P), the world’s leading provider
of investable equity indices, for co-branding IISL’s equity indices. India
Index Services and Products Ltd (IISL), a joint venture of CRISIL and NSE
has launched the CNX BANK index which will represent the capital market
performance of banking stocks in the country.
CNX Bank Index is an index comprising the most liquid and largest
capitalized banking stocks. It provides investors and market intermediaries
with a benchmark that captures the capital market performance of Indian
banks. The index is a market capitalization weighted index with base date
of January 1, 2000, indexed to a base value of 1000. The index, with 12
stocks from the banking sector, which trade on the National Stock Exchange,
will initially be calculated at the end of the trading day. The banks in the
index are among the most liquid in terms of trading turnover and trading
frequency on the NSE.
REVIEW QUESTIONS
Section A
1. What is a ‘stock market index’?
2. How is a ‘stock market index’ defined?
3. What is ‘SENSEX’?
4. What is ‘BSE-BANKEX’?
5. What is ‘BSE-TECk index’?
6. What does ‘TECk’ stand for?
7. What is ‘BSE-100 National index’?
8. What is ‘BL-250 Stock index’?
9. What do you know of ‘market capitalization-weighted index’?
10. State the constituents of SENSEX.
11. What is ‘S&P CNX Nifty’?
12. What is ‘AMEX Composite’ index?
13. What do you know of ‘FORTUNE-500’ index?
Section B
1. What are the features of a stock market index?

2. How is a stock market index important?
3. Explain how the SENSEX constructed and maintained
4. How is ‘BSE-TECk Index’ constructed? Explain
5. What do you know of the ‘BSE-PSU Index’?
6. How is ‘BSE-100 Index’ constructed? Explain
7. Bring out the features of ‘BSE-BANKEX’?
8. How is ‘S&P CNX Nifty’ compiled and maintained?
9. How is ‘NASDAQ-100’ index constructed?
10. What are the conditions to be fulfilled for inclusion in the
NASDAQ-100 index?
11. Explain how the NASDAQ index is calculated
12. Write a note on the ‘S&P 500’ index
13. What are the services rendered by the IISL (India Index Services
Limited)?
14. Write short notes on:
a. Hang Seng Index
b. KOSPI
c. DAX index
d. Straight Times index
e. FTSE
Section C
1. Give an account of various indices of the Bombay Stock Exchange
(BSE).
2. Explain the broad features of ‘S&P CNX Nifty’?
3. How is ‘S&P CNX Nifty’ different from ‘BSE-SENSEX’?
4. Discuss the various indices constructed and maintained by the
NASDAQ.
Chapter 20
Stock Market Trading Mechanism
The act of buying and selling of securities on a stock exchange is known

as stock market trading.
JOBBERS AND BROKERS
Jobbers and Brokers are the two categories of dealers found in the London
Stock Exchange.
J ob b e r s
A Jobber is a dealer in securities, while a broker is an agent of a buyer or
seller of securities. Every year a member has to decide and declare in
advance whether he proposes to act as a jobber or a broker. A jobber gives
two quotations as a dealer in securities, lower quotation for buying and
higher one for selling. The difference between the two prices constitutes
his remuneration. This system enables specialization in the dealings and
each jobber specializes in a certain group of securities. It also ensures
smooth and prompt execution of transactions. The double quotation of a
jobber assures fair-trading to investors.
Brokers
The brokers in the London Stock exchange are known as Tarawaniwalas
on the Bombay Stock Exchange. A Tarawaniwala often performs the task
of both a broker and a dealer in securities although strictly speaking,
Tarawaniwalas must act only as dealers in securities. Frequently,
Tarawaniwalas do perform the functions of brokers in order to be broker-
members.
JOBBERS Vs BROKERS
Sl. Feature Jobber Broker

No.
1. Agent Jobber is an Broker is merely an agent to
independent dealer or buy or sell on behalf of his
a merchant willing to clients
buy and sell securities
2. Specialization Jobber is a specialist Broker is a generalist
3. Dealing with Jobber deals only with Broker deals with a jobber
Public brokers and not with on behalf of his clients. He
public. No direct sale is a middleman between the
or purchase in the jobber and the real
market buyer/seller
4. Price Jobber quotes two Broker has to negotiate
Quotation prices to the broker, terms and conditions of sale
one for buying and one or purchase and safeguard
for selling. Sale his client’s interest. He
quotation is higher lives on commission paid
than the purchase by his client which is fixed
quotation by the Exchange
5. Margin Jobber’s profit margin Lower brokerage rate is
is fixed by competition fixed by rules; the higher
among themselves as rate by competition. In
dealers. It is narrow practice minimum becomes
when there is keen maximum under keen
competition competition
STOCK EXCHANGE DEALINGS

Type
The type and the nature of dealings on an Indian stock exchange are of
three different categories. They are described as follows:
Spot delivery contract Where in a contract the payment and delivery
of securities take place on the spot, on the same day or on the next day, it
is a case of ‘spot delivery contract’. The sale is said to be complete on the
day of contract. These are essentially cash dealings and are primarily
meant for investors. All listed securities are allowed trading in the spot
market.
Stock Market Trad i ng Mechani sm 417
Ready delivery contract Where settlement—payment and delivery

takes place within a fixed time period of not exceeding 7 days from the date
of contract, it is a case of ‘ready delivery contract’. There is usually hand-
delivery against full payment. All listed securities are allowed trading in
the spot market.
Forward delivery contract Where the settlement—payment and
delivery of securities take place once at the end of every fortnight through
clearing house only, it is case of ‘forward delivery contract’. Such a contract
has carry-over facilities also. Speculators are the main interested parties in
these dealings.
SPECULATIVE DEALINGS
Following are the dealings that are carried out as part of speculative activity:
Option Dealings
The right to buy or sell a certain security within a certain time and at a
certain price is known as ‘option dealing’. An option to buy a security is
known as ‘call option’ and an option to sell a security is known as ‘put
option’. Where in an option, both the right to buy and sell is acquired by
an investor it is a case of ‘double option’ or ‘put and call option’.
A person acquires call option where the price of a security is expected
to rise in future and in such a case, the person will buy the security at a
lower price and sell it at a higher price, thereby making a profit by way of
the difference in price.
A person acquires put option where the price of a security is expected
to fall in future and in such a case, the person will sell the security at a
higher price and buy it at a lower price, thereby making a profit by way of
the difference in price. As the speculator will either buy or sell, or not
exercise the right at all, he will be interested in taking advantage of the
price variations. Option, therefore, is in the nature of a gamble.
Hedging
A mechanism through which loss on a transaction can be minimized is
known as ‘hedging’. It is possible for a bull speculator to hedge himself by
buying a put option (right to sell) where he agrees to purchase the security
from somebody. This would help him offset any loss that he may suffer on
the exercise of the call option. In the similar fashion, a speculator intending
to exercise right to sell (put option) can hedge himself against loss through
a call option.
Margin Trading
The level of deposit of cash or securities that is maintained by an investor-
client with his broker in an account with the broker may be referred to as
‘margin’. Such an arrangement of margin enables the broker to indulge in
buying and selling of securities on behalf of the clients without any
difficulty. Margin offers a measure of cushion to the broker in securities.
The securities acquired by the broker will be used as a margin for securing
prompt collection from the client.
At any point in time, it is required that the client maintains the minimum
amount with the broker. Margin helps in several ways. For instance, it
places a check on excessive speculation by requiring the client to maintain
the margin by making a fresh deposit, besides making the broker’s
investment safe.
The term ‘margin’ is also used with reference to the deposit required
to be maintained by the member-brokers with the clearing house of the
stock exchange. The level of deposit varies with the value and the volume
of security traded by the member. The margin system is prevalent in stock
exchanges such as Bombay, Calcutta, Delhi and Ahmedabad.
Arbitrage
The process whereby a dealer in a security will indulge in buying and
selling activity, to take advantage of the price difference prevailing in
different markets is known as ‘arbitrage’. Accordingly, the speculator will
make purchase of a security in the market where the price is lower and sell
it in the market where the price is higher. The arbitrage process will work
successfully in a situation where there has not been any quick and easy
availability of information relating to conditions prevailing in various
markets. Moreover, the process has to be carried out quickly and without
loss of time. Otherwise, the prices may get equalized, and the chances of a
gain may be eliminated.
Arbitrage may be either domestic or foreign. ‘Domestic arbitrage’ is
one in which a security is carried from one market to another market and
‘foreign arbitrage’ is one in which the security is carried from one country
to another. For foreign arbitrage to take place, it is important that the
currencies of the two countries that are involved should be easily
convertible. In the same way, the profit should be more than the cost of
carrying securities to another country for the purpose of sale.
Arbitrage ultimately helps accomplishing equalization in the price of
security in different markets. This is because, where a security fetches a
higher attractive price in a market, it will be flocked by suppliers/seller of
that particular security, who will offload a large volume of that particular
security. This will ultimately bring down the price of the security and the
concomitant price advantage will vanish. This way, the prices will become
cheaper and will level off with the prices prevailing in other markets.
Wash Sales
A kind of fictitious transaction in which a speculator sells a security and
then buys it at a higher price through another broker is known as ‘wash
sales’. This type of dealing helps a speculator to bring about a misleadingly
higher price. This helps him benefit from further rise in the price of the
security where at that point in time, the broker-speculator will be able to
reap profits by offloading his holdings to the public. The byelaws of a
stock exchange envisage a stiff penalty for such sales activity since it is
considered to be an undesirable activity.
Corn erin g
A kind of speculative activity whereby an individual or group of individuals
holds the entire supply of a particular security or a commodity is called
‘cornering’. Cornering brings about a situation in which it will not be
possible for the bears (short-sellers), who have contracted to sell the
security without actually possessing it, to give delivery to the buyers who
have cornered the market. This will ultimately lead to a situation of dictating
terms to the short-sellers. Such short-sellers are technically known as
‘squeezed-sellers’. This activity is considered to be an undesirable activity.
Rigging the Market
A kind of speculative activity whereby the price of a particular security is
artificially jacked up on account of strong bull movement, causing heavy
spurt in the demand for the security is called ‘rigging the market’. Such a
speculator with his large holdings of shares is able to make a ‘market’ so
as to gradually ‘unload’ his holdings. This is considered to be an
undesirable activity as it interferes with the free and fair interplay of demand
and supply.
Blank Transfers
Where a transfer deed is executed by a person, by merely filling the signature
without in any way filling the other particulars, especially the name of the
transferee, contained in the ‘transfer form’ with a view to facilitate the
transfer to an unlimited number of persons, it takes the form of a blank
transfer. The execution of a blank transfer gives rise to a speculative activity
as it facilitates the carry-over or budla. A budla involves temporary purchase
and sale of securities without involving any registration of transfer. The

transaction enables the parties concerned to evade the payment of stamp
duty. The system of blank transfer however facilitates forward dealing.
There are many drawbacks associated with the system of ‘blank
transfer’. They are as follows:
1. Encourages unhealthy speculation by making securities easily
negotiable
2. Encourages evasion of income-tax, payment of stamp duty on
transfer of shares, etc
3. Encourages the transferee-shareholders to gain control of
management of companies without their name being disclosed
4. Incomplete and misleading nature of the ‘Registers of Members’
of companies which present a false picture of share holdings to
prospective investors
5. Danger of the transferor having to pay the calls in respect of the
uncalled portion long after he has actually sold them
The practice of blank transfer since considered obnoxious and fraught
with deleterious consequences was recommended to be abolished by
various committees such as the Atlay Committee (1924), the Morison
Committee (1937), and the Gorwala Committee (1955).
SHARE PRICES—FACTORS
The price of securities that are traded on a stock exchange is influenced by
very many factors. It is interesting to note that the movement in share
prices is considered to be a broad indicator of the state of affairs of a
company. It is highly characteristic that a combination of many factors
cause changes in the price levels of securities. The price prevailing in a
stock exchange will also affect the yield or return on a security, or the
general expectation about the return on shares in an industry. Following
are the factors influencing the prices of a security in a stock market:
Demand and Supply
A natural force that affects the price level of a security is the interplay of
its demand and supply. Under the conditions of a perfect market, the
forces of supply and demand interact, so as to determine the price of
security. Accordingly, where the supply of a security is abundant and
with slimming demand, its price goes down and vice versa. The demand
and supply position of industrial securities depends on a variety of factors
such as the yield and the general expectation about the yield, etc.
Bank Rate
The price of a security is greatly affected by the easiness with which
funds are made available in the money market, by banks and financial
institutions to investors and brokers to undertake the activities of buying
and selling of securities. The availability and the cost are influenced by
the rate of interest, which is determined by the Bank rate charged by the
central monetary authority of the country, viz. the RBI. Accordingly, where
the bank rate is lower, the demand for funds will be more, thus causing a
spurt in the demand for securities and vice versa.
Market Players
The activities of players in a stock exchange such as underwriters, share
brokers, banks and financial institutions are responsible for causing
fluctuations in share prices, especially of new companies. The market
intermediaries through the large scale buying of securities may attempt to
create an artificial scarcity for securities of some companies, and thereby
jack up the share prices. Similarly, the actions of institutional investors
also stimulate the demand for securities.
Dividend Policy
The extent of price level prevailing for a particular security is greatly
determined by the ability of a company to pay dividends to its shareholders.
The dividend paying ability is dependent upon the financial capacities of
the company. Accordingly, a company that has profitable investment
opportunities with excellent cash flows will be in a better position to pay
dividends periodically. This in turn, determines higher or lower share prices.
It is interesting to note that the dividends act as a signalling device for
share price movements.
Profile of Management
The profile of top management has got a lot to do with the way a company’s
policies are formulated and implemented. Similarly, any change that is
brought about in the board of management of the company will affect the
quality, soundness and the financial stability of the company. Such
changes may lead to positive or negative reactions in the investor
community. This in turn will cause the price determination to take place in
a certain fashion. For instance, the sudden demise of a popular director or
the resignation of an important director may cause plunge in the share
prices.
Trade Cycles
The ups and downs in the economy called ‘trade cycles’ are also
responsible for causing price movements in a particular fashion.
Accordingly, in times of prosperity where there is high order of consumer
and industrial activism, the market looks up. This shores up heightened
activity on the stock exchange leading to higher market prices. The
investors will take part in stock market activities in a large number and with
a lot of enthusiasm. The converse happens in times of depression with
share prices plummeting.
Spec ulation
The activities of speculators such as the bulls and bears cause upward
and downward movement in share prices. They cause fluctuations in
security prices. For instance, the action of bull speculators who start
buying in the expectation of a profit from the upward movement of prices,
causes the price to move upwards naturally. In the same manner, the actions
of the bear speculators will lead to selling pressure, with share prices
coming down. On the other hand, when bulls liquidate their holdings, they
lower the prices on the stock exchange. Similarly, large-scale buying by
bears to meet their short sales will force the security prices upwards.
Thus, speculative pressures engineer price volatility.
Political Factors
The changes and the policies of political leaders at the helm of affairs of a
country vastly determine the price of a security. The stock exchange will
act as a barometer that reflects the changes taking place in the political
arena. Accordingly, positive political change will cause a spur in share
prices and political disturbances will cause prices to tumble. In fact, political
considerations play much greater a role in price movements than any
other factor. This is because politics is chiefly responsible for policy
formulation and implementation in the economy, governing the industrial
development.
Other Factors
In addition to the abovementioned factors, the following factors are also
responsible for causing price variations:
1. The personal health of the head of a Government
2. Weather conditions affecting agricultural production and
consequent demand for basic goods
3. Industrial relations
4. Competitive market conditions

5. Corporate activism such as mergers and amalgamations
6. Conditions of balance of payments
7. The general price levels
8. General market sentiments
REGULATING SPECULATION
Speculators ensure smooth ride in share prices as they take an informal
view of the trends of prices and try to anticipate the future trends on the
basis of price fluctuations. However, the harmful consequences of
speculative activity make it an imminent necessity to control and regulate
it. This is indispensable for the proper and efficient functioning of a stock
exchange. This assumes significance in the context of the need for
continuity, liquidity and smoothness of working of the stock exchange.
It is therefore, essential that the beneficial consequences of
speculation must be allowed to be reaped. It is only the gambling nature of
unfair practices and undesirable activities of speculators that are required
to be curbed. It is for the purpose of ensuring genuine and healthy
speculation, and for curbing unhealthy gambling, proper and adequate
measures of regulation must be put in place.
THE SECURITIES CONTRACTS (REGULATION) ACT
The SCR Act 1956 has given sweeping powers to the Central Government
for the purpose of exercising control and regulation on all stock exchanges
in India. The important provisions of this Act are as follows:
Recognition of Stock Exchanges
An important provision of the Act relates to the functioning of only
recognized stock exchanges in the country. Unrecognized exchanges are,
therefore, illegal. Central Government grants recognition to an exchange
on the fulfillment of such conditions as the compliance with rules and
byelaws of the exchange to ensure fair dealing to the investors and protect
their interests; the exchange is willing to act in accordance with any
condition which the Government may impose on it from time to time; and
it would be in the interest of the trade and the public at large to recognize
the stock exchange. The government has the power either to reject
permission or to withdraw recognition in the interests of the trade or the
general public.
Working of Stock Exchanges

The Central Government has been vested with the following powers under
this Act to require the stock exchanges to:
1. Call for such explanation and information as the Central
Government demands
2. Call for periodical returns about their affairs to the Central
Government
3. Call for submission of a copy of its annual report to the Central
Government
4. Order an enquiry into the affairs of a recognized exchange as and
when it thinks necessary
5. Order a recognized stock exchange to adopt or amend a rule
relating to their administration or constitution
6. Supersede the governing board of a recognized exchange and
order the suspension of business at such an exchange in the
event of an emergency, for a maximum period of 7 days, which
may be extended in the interests of the trade or public
7. Compel certain public companies to comply with the listing
requirements of an exchange and get their securities listed, to
license certain individual dealers in securities who are not
members of recognized exchange, and to prohibit dealings in
certain notified securities with a view to preventing undesirable
speculation in any State or area
8. Regulate and control the business of dealing in spot delivery
contracts in the interest of trade and the public
9. Insist on the maintenance of accounts of members, and their
audit by Chartered Accountants
Regulation of Trading
The Act empowers the Central Government to regulate the working of the
stock exchange as regards the following important matters:
1. Hours of trade at a stock exchange
2. Maintenance of a clearing house for all business transacted at
the exchange
3. Regulation, limitation or abolition of blank transfers and carry-
over facilities
4. Determination and declaration of market rates
5. Regulation of tarawani business
6. Settlement of claims and disputes by arbitration
7. Limitation of business done by individual members

8. Fixation of the scale of brokerage, fines, fees, and penalties and
the margin requirements and
9. Punishment by way of fine or expulsion or suspension for those
members, who contravene these regulations
Curbing Speculative Activity
The governing board of the exchange is empowered to discourage the
practice of blank transfers. The Act requires the registration of the transfer
within 15 days of the date on which dividend becomes due for the transferee
to become entitled to receive dividends. All option dealings and ‘kerb
trading’ are considered illegal. The business transacted by dealers in
securities outside the stock exchanges is known as ‘kerb trading’.
Directorate of Stock Exchanges
The SCR Act provided for the constitution of the Directorate of Stock
Exchanges for the purpose of enforcing and administering the regulatory
provisions of the Act. The Government of India set up the Directorate in
1959. Important functions of the Directorate are as follows:
1. Maintaining a close watch on the activities of the stock markets
in India and their individual members
2. Advising the exchange concerned in order to curb any unhealthy
trends in a recognized stock exchange
3. Taking up matters connected with the control of kerb trading and
prevention of option dealings
4. Ensuring the compliance with the listing requirements of
recognized stock exchanges by corporates
5. Granting licenses to individual dealers in securities in areas
outside the recognized exchanges
6. Acting as an agency of the Government responsible for the
administration and implementation of the reforms contained in
the Securities Contract (Regulation) Act of 1956
7. Serving as a useful link between Government and the leading
stock markets of the country
MARGIN TRADING
Meaning
Where an investor buys securities by borrowing a portion of the
transaction value and using the securities in the portfolio as collateral, it
takes the form of ‘Margin Trading’. An investor who purchases securities
may pay for the securities fully in cash or may borrow a part of the
transaction value from the brokerage firm.
The term ‘margin’ connotes the amount of money or equivalent value
of eligible assets deposited by the investor to borrow money to purchase
more securities than he would have otherwise been able to do so with his
own money, with the expectation that stock prices will rise enabling him to
reap greater profits. In other words, margin implies that part of the transaction
value which the investor must deposit with the broker. It is the investor’s
initial equity in the account with the broker. The loan from the brokerage
firm is secured by the securities that are purchased by the investor.
Conversely, one may also enter into a short sale through a margin account,
i.e. borrow securities from the brokerage firm in order to sell it, hoping that
the price will decline.
Features
Following are the features of margin trading:
1. Enhanced power Margin trading allows for an increase in the
purchasing and selling power of the investor and thereby increases the
possibility of a larger gain if the stock market moves on expected lines. At
the same time, it magnifies the losses too, in case the stock market behaves
contrary to the expectation.
2. Leveraging Margin trading is essentially a form of leverage trading.
Leveraging implies borrowing on the strength of the asset purchased and
using it as a collateral. Such an asset is considered to be far greater in
value than the value of the collateral. The collateral is made up of securities
or other financial assets. Leveraging or borrowing money is to amplify the
gains. Leveraging leads to a doubling of the purchasing power, offering
more flexibility to the investor besides presenting the possibility of
multiplying the return on investment.
3. Margin account An account opened by the investor with the
brokerage firm, which allows the investor to borrow a certain percentage
of the value of his purchases, using his securities as collateral, is known
as ‘margin account’. It implies taking loan from the broker like any other
borrowing-lending, with the investor owing the principal and the interest
to the broker who has lent money through a margin account.
4. Margin value The investor will be entitled for a loan up to 50 percent
of the value of purchase. Only certain assets are considered to be
marginable securities. Accordingly, securities that cannot be purchased
on margin must be purchased in a cash account. These are normally the
securities that trade below a certain minimum price or are highly volatile in
nature with substantial risk to the investor as well as to the broker, if
purchased on margin.
5. Commission Trade commissions as applicable in the case of cash
dealings are also applicable to margin accounts. However, the brokerage
firm charges interest on the margin loans made to the investor. The interest
is a fixed rate stipulated by the authorities plus a markup depending upon
the exposure (debit balance) in the margin account. The interest rate on
the loan varies depending upon the amount borrowed. The cost of margin
trading to the investor thus depends on the prevailing rate of interest for
margin accounts, the amount of loan and the period for which the money
has been borrowed. The broker may charge interest on the outstanding
margin debt at the end of say every month. The interest is normally
compounded on daily basis. As margin debt increases, the interest charges
keep on accumulating.
6. Margin requirements It is essential that the securities purchased
on margin have to appreciate enough in value so as to cover the cost of
borrowing. Margin requirements aim at limiting trade sizes done in margin
accounts. They also prevent the brokerage firm from losing the money
lent to investors. While the margin requirements are fixed by the regulatory
authorities, the individual brokerage firms are free to set their own margin
requirements—often called “house” requirements as long as they are more
stringent than those fixed by the regulatory authorities.
The brokerage firms fix higher margin requirements if the securities in
a margin account are particularly volatile, thinly traded or concentrated in
a single security or single industry. This is done to help ensure that there
are sufficient funds in the customer’s accounts to cover the large ups and
downs in the prices of these securities. Following are the different type of
margins that are imposed:
a. Minimum margin It is the minimum amount of 100 percent of
the purchase price to be deposited by the investor with the
brokerage firm before trading on margin. Many firms, however,
do not insist on a minimum margin and provide finance based on
initial margin.
b. Initial margin It is that portion of the purchase price, which is
deposited by the investor with the broker firm. The Federal
Reserve Board of U.S. has fixed this at 50 percent. Brokerage
firms allow the investors to borrow up to 50 percent of the value
of securities. However, some brokerage firms have set the initial
margin requirements at as high as 67 percent.
c. Maintenance margin It is the minimum level of equity balance

that should be maintained in the account at all times. If the equity
balance in the margin account falls below this level, then the
brokerage firm will insist that the investor deposit. Additional
funds or the firm can sell the securities in the account to bring
down the margin debt. The maintenance margin requirement varies
for different brokerage firms.
7. Margin call When the equity balance in the margin account falls
below the floor acceptable to the broker, he can make a “margin call”. The
floor at which the broker can make the margin call depends upon what is
fixed by the regulatory authorities and the norm followed by the broker.
When the broker makes a margin call, the investor is required to
deposit more cash or securities into his account. If the margin call is not
met, the broker has a right to sell the securities in the margin account to
increase the equity level in the account above the minimum margin
requirement.
If the investor gets a margin call, he will be required to bring in
additional funds before a set time/date. If the security prices continue to
fall and the equity in the account drops further, the broker may sell the
investor out even without waiting till the given time/date. Short sale through
a margin account also works in the similar manner. If the investor expects
the stock prices to decline, he would borrow securities from the brokerage
firm to sell them now and he would purchase the same securities at lower
prices in future and repay the broker. In the process, the investor would
make profit by selling at high prices and purchasing at lower prices.
8. Margin agreement The margin accounts are governed by a margin
agreement signed by the broker and the investor. Accordingly, the
brokerage firm is not even required to make a margin call or notify the
investor that equity in the account has fallen below the minimum
requirement. Securities can simply be sold to meet the shortfall in the
account. The investor, therefore, has to remain vigilant about the account
balances. This is because when the stock market is declining, the value of
the collateral is also declining and so also the value of the securities
purchased with the loan.
Not meeting the margin call means that the broker can offload these
securities in the market to meet the shortfall in the margin account and the
proceeds of the sale go directly to meet the repayment of margin debt. The
losses can get compounded by the fact that the investor loses control
over deciding which stocks should be sold and at what price. The stock
prices may rebound later, but the investors still have to pay principal and
interest for stocks they no longer own. It is therefore better to bring in

additional funds much before the investment has gone bad.
9. Caveats The investors venturing into margin trading need to be
aware of the several of the following risks associated with it:
a. Losing more money In a declining stock market, the losses get
amplified in a margin account, with the potential threat of losing
more money than one had originally invested. If the value of
securities purchased on margin declines, then the investor is
required to provide additional funds to the brokerage firm to
avoid forced sale of those securities or other securities in the
account
b. Meeting deficiency For meeting margin deficiency, the
brokerage firm can sell the securities in the investor’s account at
the current price available in the market. This price may not be
the “best” price at which the investor himself would have
preferred to sell his securities. Further, the investor continues to
remain responsible for any shortfall in the account even after
such a sale
c. No information Generally, the margin trading rules allow the
brokerage firms to liquidate securities in investor accounts
without contacting the investor. Most of firms try to intimate
their investors of the margin call, but they are not required to do
so. This is a source of additional risk.
d. No extension of time When the firm makes a margin call, the
investor is required to respond to it immediately. Normally, one is
not entitled to an extension of time to meet initial margin
requirements, while some firms may allow sometime to meet a
maintenance margin call. The investors will thus have to keep
some extra cash with them, which they can bring in when needed.
Similarly, the brokers need to remain alert.
Indian Scenario
Margin trading is prevalent in most of the markets, which have switched
over to rolling settlement. Since rolling settlement has now been introduced
for a wider range of securities, the pertinent question is whether Indian
markets are ready for margin trading.
In margin trading, both the broker and the investor are well aware of
the credit element involved before hand and the broker can take adequate
precautions, like imposing stricter margin requirements depending upon
the type of securities in which the investment is being made and scrutinising
the credit-worthiness of the investor before the loan is made. Some kind of
lending and borrowing mechanism is a must for enthusing investor interest

in the market. No market can be vibrant and offer sufficient liquidity without
speculators or day traders. The volumes in which day traders operate are
not sustainable if they are to operate strictly with own funds.
The foremost pre-condition for introducing margin trading in India
will be to create widespread investor awareness about margin. Before
investing, the investor needs to fully appreciate the costs and risks of
investing on margin. The Securities and Exchange Commission, the
regulator for securities market in the U.S., has launched an intensive investor
education exercise on its website, focusing on risks and costs associated
with margin trading and several other new products.
TRADING OF SECURITIES—STEPS
Following are the steps involved in the trading of securities at a stock
exchange:
Order Placing
The first and foremost step in the trading of securities is placement of an
order by an investor with the broker concerned either to buy or sell certain
number of scrips at a certain specified price. An order can be placed by
telegram, telephone, letter, fax, etc or in person.
There are various kinds of orders. For instance, where in an order, the
client places a limit on the price of the security; it is a case of ‘limit order’.
Where the order is to be executed by the broker at the best price, such an
order takes the name of ‘Best Rate Order’. An ‘Immediate or Cancel Order’
is one that has to be executed immediately and may have to be cancelled if
the order is not executed immediately. A Limited Discretionary Order allows
the broker to buy and sell within the specified price range and/or within
the given time period as per the best judgment of the broker. Where the
client orders the broker to sell as soon as the price reaches a particular
level, it is a case of ‘Stop Loss Order’. Under the ‘Open Order’, the client
does not fix any price limit or time limit on the execution of the order and
relies on the judgment of the broker.
Order Execution
Brokers execute the orders placed by the clients for the purchase or sale of
scrips. The execution takes place during the trading hours and during the
working days of the exchange. However, the trading after the normal
working hours may also take place and this is termed as ‘kerb trading’.
Entry to the trading floor of the exchange is restricted only to the
identified and regular members of the exchange. Such a member is called a

‘single jobber’ or ‘tarawaniwala’ for a particular scrip. In respect of actively
traded scrips that involve a huge volume of business, there could be more
than one jobber. Jobbers offer two-way quotes for scrips they deal in. This
way, jobbers act as market-makers and provide liquidity to the market. The
order is executed either by auction or negotiation. Settlement of a transaction
takes place by a mutual agreement of the price between the parties
concerned. Such prices are published in the newspaper every day.
Contract Note Preparation
When once an agreement is reached between the parties concerned as
regards price, a contract note is made out between the broker and the
client. Such a note forms the basis of the transactions recorded in the
‘Pucca Sauda Book’ after the execution of the order. Particulars such as
the price, number of scrips, date of transaction, names of parties, brokerage,
etc are found in the note.
Delivery and Clearing
After the preparation of the contract note, delivery of share takes place
through the instrument known as ‘transfer deed’. The transfer deed is
signed by the transferor (seller) and is authenticated by a witness. It
contains the details of the transferee, besides bearing the stamp of the
selling broker. There are different kinds of delivery. For instance, in the
case of ‘spot delivery,’ the transaction is settled by delivery and payment
takes place on the date of the contract or the next day. In the case of ‘hand
delivery’, delivery and payment are completed within 14 days from the
date of contract. Delivery and payment may be completed after 14 days as
specified at the time of the bargain in the case of ‘specified or special
delivery’. Delivery and clearing of security takes place through a clearance
house.
Share Transfer
For the purpose of effecting the transfer in the name of the transferee, the
share certificate and the transfer deed are lodged with the Company. The
parties also pay necessary stamp duty. The company issues the share
certificate bearing a new ledger folio number, transfer number, date and
buyer’s name at the reverse of the certificate. The appropriate authority of
the company endorses these particulars.
Settlement
The procedure adopted for the settlement of transactions varies depending

upon the kind of securities. Following are the procedures involved in the
settlement of transactions:
The steps in stock trading are depicted in Exhibit 8.
Exhibit 8 Steps i n Stock Tradi ng
For Specified Securities

Specified securities consist of actively traded equity shares of established
growth companies commanding a large share of the market capitalization.
Following conditions are to be satisfied for inclusion of shares in the
category of ‘specified securities’:
1. Listing of shares on a recognized stock exchange for a minimum
period of 3 years
2. Minimum issued capital of the company must be Rs. 75 crores
3. Market capitalization of the company is 2-3 times
4. Minimum face value of shares held by the public shall be of the
order of Rs. 4.50 crores
5. The minimum number of shareholders on the dividend paying
list of the company must be 20,000
6. Company should be growth-oriented
7. Company’s shares must have been actively traded during the
previous months
Following are the procedures followed as regards ‘specified
securities’:
Sauda sheets The details of all purchases and sales as recorded in
sauda sheets every day, which are then fed into the computer. The details
are verified in the computer center where the matched transactions are
logged. Unmatched transactions are reverted back to the members for
verification. The computer center is informed of all the settlements.
Issue of advice After verification, the computer center issues to each
member such details as the following:
a. Money settlement slips showing the difference between payables
and receivables
b. The pay slips and receive slips
c. Delivery order and receive orders of shares
d. Carry over margin settlement in case of badla transactions (since
banned)
Clearing The above details are accompanied with the cheques/drafts
and securities certificates as per the delivery order. The clearing house
makes payment and delivers the security certificates to the members on
the payout day, which is the subsequent wednesday.
Non-specified Securities
Securities that are not in the specified list are known as ‘non-specified
list’. In respect of ‘Badla’ (since banned), transaction settlement is not
permitted in the non-specified group. The clearing house handles the
money part. On the pay-in day, members submit only the balance sheet
and the cheques/drafts. Members receive only monetary payments from
the clearing house and themselves handle the actual physical delivery of
securities.
Odd-lot Securities
Odd-lot securities are those, where a single share certificate is of smaller

denomination than the minimum denomination required for regular trading.
They consist of securities of preference shares and odd-lots of shares and
debentures. The members themselves handle both delivery and payment.
The job of verification and matching of transactions alone is done by the
stock exchange. It also issues to the members a statement of all unmatched
transactions entered in the previous settlement period. Members between
themselves do the actual settlement of transactions.
Rolling Settlement
From the year 1998, ‘Rolling Settlement’ is being done in respect of demat
shares. Accordingly, trading in demat shares takes place on the basis of
T+5 rolling settlement on an optional basis. The system allows for the
settlement of each day’s business at the end of the day. The system was
introduced in those exchanges, which are connected to a depository. Rolling
settlement system was first introduced at Bombay Stock Exchange followed
by the National Stock Exchange.
New Settlement System
SEBI had introduced a new T+5 rolling settlement in equity market from
July 2001, and subsequently shortened the settlement cycle to T+3 from
April 2002. After having gained experience of T+3 rolling settlement and
also taking further steps such as introduction of STP, it is now felt
appropriate to further reduce the settlement cycle to T+2, thereby reducing
the risk in the market and to protect the interest of investors.
The shortening of settlement cycle to T+2 needed cooperation,
coordination and active support of various entities and intermediaries in
the market such as stock exchanges, clearing corporations/houses,
depositories and depository participants, FIIs, custodians, fund managers,
brokers, etc. SEBI had held several rounds of consultation with all the
market participants and based on the consensus, decided to introduce
T+2 rolling settlement in Indian equity market from 1st April 2003. The
calendar of events/activities in T+2 rolling settlement would be as follows:
1. Confirmation of the institutional trades by the custodians latest
by 11:00 a.m. on T+1. A provision of an exception window would
be available for late confirmations. The time limit and the additional
charges for the exception window would be decided by the
exchanges
2. The exchanges/Clearing House/Clearing Corporation would
process and download the obligation files to the brokers’ terminals
latest by 1:30 p.m. on T+1

3. DPs shall accept instructions for pay-in of securities by the
investors in physical form atleast upto 4:00 p.m. and in electronic
form by 6:00 p.m. on T+1
4. The depositories would accept the requests from DPs till 8:00
p.m. for ‘same day processing’
5. The depository would permit the downloading of the pay-in files
of securities and funds till 10:30 a.m. on T+2 from the broker pool
accounts
6. The Depository would process the pay-in requests and transfer
the consolidated pay-in files to the Clearing House/Clearing
Corporation by 11:00 a.m. on T+2
7. The Exchanges/Clearing House/Clearing Corporation would
execute the pay-out of securities and funds latest by 1:30 p.m. on
T+2 to the Depositories and the Clearing Banks would in turn
complete the process by 2:00 p.m. on T+2
The various steps to be initiated by the SEBI to ensure smooth
transition into T+2 rolling settlement include:
1. Widening of scope of STP
2. Wider use of electronic fund transfer facility
3. Issue of electronic contract notes
Book Closure
Book closure implies cessation of entries after a specified date. Book
closure aims at enabling the completion of all transfer of securities before
finalization of accounts, so as to determine the beneficiaries of payment of
dividends and the interest. Book closure is declared 21 days in advance.
In order that the interest of the clients is protected, brokers would require
that the claims for transfer is lodged with the company before the book
closure date, so that the transfer claim is accepted. Moreover, fresh transfer
deeds are required on reopening of books. This way the interest of the
buyer will be protected in the case of purchase of securities on the basis of
cum-dividends, cum-bonus and cum-right.
MARGINS
The brokers who trade in securities on the stock exchange are expected to
meet the margin requirements. There are different types of margins. They
are as follows:
Daily Margins
Margins that are collected in cash for every transaction of purchase or

sale outstanding at the end of the day, for scrips in the specified group are
called ‘daily margins’. The margin amount varies depending on the market
position and price movement. For instance, daily margins generally vary
between 5 to 25 percent and to as high as 50 percent in certain scrips.
Carry-over Margin
Margins imposed on the carry-over contracts are known as ‘carry-over
margin’. In respect of transactions that are carried-over from one settlement
period to another, a minimum carry over margin of 3 percent of the making-
up price of net aggregate balance of purchases and sales is payable by
both parties separately. This is compulsory for all stock exchanges. The
margin generally ranges from 5 to 25 percent for purchases in a rising
market and for sales in the falling market.
Ad hoc Margin
Margins that are imposed to ensure that the members do not trade in
excess of their financial resources are known as ‘ad hoc margins’. The aim
is to curb over-trading. Members of BSE having an outstanding position
above Rs. 3 crores have to deposit ad hoc margin at the rate of 10 percent
of the excess business on a continuing basis. An additional ad hoc margin
would be collected from members in case the market of a particular scrip or
securities market in general becomes highly volatile.
Automatic Daily Margins
Margins that are imposed in respect of shares of the market value exceeding
Rs. 50 and in respect of the price rise in scrips taking place by 5 percent in
a day or 10 percent over a settlement period are known as ‘automatic daily
margin’. Automatic daily margin of 50 percent of the price rise on the scrip
is imposed.
Overall Margin
Margins that are imposed in respect of aggregate outstanding sales and
purchase exceeding Rs. 50 lakhs and Rs. 1 crore respectively are called
‘overall margin’. An additional margin of 5 percent and 10 percent is payable.
Additional Volatility Margins (AVM)
These are the margins that are payable to help curb the effects of volatility
in share prices. AVMs came to be prescribed by the SEBI during the first
half of 1998. The AVMs allowed for daily price band reduction from 10
percent to 8 percent. The existing weekly price band of 25 percent was
removed and a graded margin system was put in place in respect of volatile
securities. These AVMs are applicable to all positions in the cash and
carry-forward markets, and are payable on the outstanding buy or sell
positions at the end of each day.
BADLA SYSTEM
Meaning
A system of stock exchange trading that allows the facility of carry forward
of the transaction for the purpose of clearing, from one settlement period
to another is known as ‘badla system’. Badla transactions can be carried
out only in respect of specified categories only. The system allowed the
buyer not to make payment of the entire amount at the time of the purchase
against the security of blank transfer deed and share certificates. Badla
rates were fixed on fortnightly basis depending on the demand and supply
conditions. The greatest advantage of the badla system is that it allows
for the expansion in the market size besides providing excellent liquidity to
the market. The biggest threat of the system is that it encourages mindless
speculation leading to high volatility in stock market prices. The system
was banned by the SEBI since December 1993.
Mec han is m
Badla system involves the following mechanism:
1. Transfer of market position
2. Stock-lending/Short-selling
3. Borrowing/Lending in money market
Transfer of market position In the event of the investor, of the buyer
or the seller, not being in a position to settle the transaction at the end of
a settlement period either by a payment or a receipt or take delivery or give
delivery, it is possible to transfer the position by carrying forward the
transaction from one settlement period to another by reversing the
transaction. The transfer position varies depending on the type of operator.
a. For bull operator In the case of a bull operator, who is
supposed to make purchase of securities but not being in a
position to do so, he can carry forward his purchase position to
the next settlement. This happens by reversing his purchase
position in the current settlement, which implies that he has to
enter into a sale transaction at the make-up price fixed by the
stock exchange. The making-up price is generally the closing
quotation of the share in the current settlement. He is thus,
allowed to pay or receive the difference between the contract
price and this brings to an end his earlier commitment and a new
contract will thus be born.
A fresh purchase position is thus created which will be valid
for the next settlement. Such a position is created in the
expectation of a rise in price in the next settlement. For availing
this facility of carry forward, the bull operator has to pay a charge
known as ‘Contango’ to the financiers.
b. For bear operator In the case of bear operator, who is
supposed to make sale of securities but not being in a position to
do so, it is possible to carry forward the sale position to the next
settlement. This happens by reversing the sales position in the
current settlement, which implies that a purchase transaction has
to be entered into at the make-up price fixed by the stock exchange.
The make up price is generally the closing quotation of the share
in the current settlement. He is thus allowed to receive or pay the
difference between the contract price and this brings to an end
his earlier commitment and a new contract will thus be born.
A fresh sale position is thus created which will be valid for
the next settlement. Such a position is created in the expectation
of a fall in price in the next settlement. For availing this facility of
carry forward, the bear operator has to pay a charge known as
‘backwardation’ to the financiers.
Stock-lending/short-selling The facility by which it is possible for
an operator to sell a security without actually owning it, is called ‘stock-
lending’ or short-selling. Badla transactions facilitate stock-lending for
short-sellers and thus providing for higher investment. In a falling market,
the short-sellers have to purchase to cover their sales position. This activity
checks a fall in security prices. Similarly in a rising market those who have
contracted to purchase, have to sell securities to square their position,
thus arresting further rise in share prices.
Borrowing/lending in money market Under securities lending, the
lenders have to deposit the securities with an approved intermediary under
an agreement for a specified period. The agreement will provide for the
continuance of the beneficial interest including the corporate benefits
with the lender. For this purpose, the SEBI has conditioned that the
approved intermediary shall have a minimum net worth of Rs. 50 crores.
The stock-lending scheme, also called the ‘Securities Lending Scheme’,
was introduced by SEBI in 1997, on the recommendations of B.D. Shah
Committee. The benefits accruing to the lender of securities include
dividends, rights and bonus. Under the scheme, the borrower and the
lender of securities have to enter into separate agreements with an approved

SEBI intermediary, who shall have a minimum net worth of Rs. 50 crores.
The intermediary has to clearly specify the fee payable to the lender and
the amount to be collected by the borrowers in their respective agreements.
Intermediaries, for this purpose, include stock exchange clearing houses,
financial institutions and other similar bodies. The initial registration is for
3 years and the intermediary has to pay a specified fee to SEBI.
The scheme of stock lending was first started in India by the Unit
Trust of India (UTI) in the year 1997 with 3 SEBI approved intermediaries,
such as Stock Holding Corporation of India Ltd. (SHCIL), Deutsche Bank
and Reliance Capital and Financial Consultancy.
Revised Forward Trading System
On account of its large-scale speculation leading to unfettered price
volatility, the ‘Badla System’ was banned in December 1993. However, the
G.S. Patel Committee, having understood the positive advantages of badla
system, came out with an alternative system of trading called ‘Revised
Forward Trading System’. The SEBI, on the basis of the recommendations
of the above committee, introduced a revised carry forward system with
effect from July 28, 1995.
Following are the conditions prescribed for the working of the system:
1. Capital adequacy Prescription of capital adequacy norm of 3 percent
for individual brokers and 6 percent for corporate/institutional brokers,
the calculation being made excludes the membership card of broker and
the SEBI being vested with the right to increase capital adequacy norm if
the circumstances so warrant.
2. Flat margin Recovery of a flat margin of 15 percent marked to market
on weekly basis as against earlier graded margin of 20 to 50 percent of
carry forward position, with higher margins to be imposed if the price of
the scrip goes up and vice versa. In respect of volatile scrips, the margin
requirement can go upto 100 percent.
3. Turnover limit Removal of the limit of 25 percent of the turnover
imposed on carry forward deals by brokers due to implementation of capital
adequacy norms.
4. Self-certification Introduction of self-certification by the brokers
on the status of their settlement.
5. No publication Abolition of the requirement of publishing the carry-
forward position of each broker, scrip-wise before the commencement of
each carry-forward session.
6. Maximum period Allowance of the facility of carry forward of
transactions for a maximum of 90 days, squaring off being permitted only

up to fifth settlement, i.e. 75 days.
7. SEBI permission Stock exchanges to be permitted for carrying out
forward trading/carry forward transactions only after obtaining permission
from SEBI.
8. Facility Requirement of facilities such as screen-based trading,
effective monitoring, surveillance and reporting system, and other
infrastructure requirements for stock exchanges.
The J.R. Varma Committee was set up by the SEBI for the Review of
Revised Carry-forward System, which submitted its recommendations in
July 1997.
Modified Carry-forward System
The Modified Carry-forward System came to be introduced by the SEBI in
October 1997, based on the recommendations of the Varma Committee.
The crucial condition of twin-track system and 90-days limit for settlement
of transactions were retained by the SEBI.
Important features of the ‘modified carry-forward system’ are as
follows:
1. Withdrawal of the prevailing margin requirement of 7.5 percent
on transactions marked for delivery for members doing
carry-forward business
2. Withdrawal of the prevailing margin requirement of 7.5 percent
on transactions marked for delivery for members doing
carry-forward business
3. Continuance of the limit of 90 days for carry-forward transactions
4. Stock exchanges to ensure that no roll-over of transactions takes
place beyond 90 days
5. Enhancement of the over-all carry-forward limit to Rs. 20 crores
per broker per settlement, up from Rs. 7.5 crores
6. Withdrawal of sub-limits for sale and purchase positions and
individual scrips
7. Withdrawal of the limit of Rs. 10 crores for financier, who was
operative at the time, with shares received by Vyaj-badla
financiers continuing to be deposited with the clearing house
CURRENT TRADING SYSTEM—PROBLEMS AND PALLIATIVES
In recent times, the Indian stock market is afflicted with many ailments. It
is the most manipulated or rigged market in the world. Its bull session
and bear slide are regularly organized. The excessive nature of
speculative activity has killed the genuine investors’ interest and made
them lose by making long-term investments with an expectation of capital
appreciation and regular returns. It is a common phenomenon in the
Indian stock market that the ordinary investor comes to grief periodically,
while a few sharks decamp with the contrived windfall.
Proble ms
The current trading system in the Indian stock market is polluted with
money laundering operations, insider trading and price rigging by certain
corporate houses. Following are some of the ailments with which the
Indian stock market suffers:
1. Lack of transparency, accountability and fair play resulting in
suppressed flow of funds
2. Lack of absolute Government intervention
3. Relatively higher cost of credit (interest rates) resulting in lack of
competition
4. Small share of bank credit as a ratio of GDP
5. Lack of limited total capital market exposure of Indian banking
system so as to enhance bank lending to stock market operations
6. Unholy nexus between promoter and broker, and politician and
broker
7. Lack of viability of stock exchanges in India with too many of
them chasing a few of them
8. Lack of adequate efforts at computerization of stock market
operations popular
In order to overcome the aforesaid ailments, measures of reform such
as reorganizing and reducing the number of stock exchanges, providing
SEBI with more powers of regulations to pull up the erring exchanges etc
should be undertaken. The stock markets should be designed in such a
way as to allow for contribution of economic development through orderly
growth of investments. Household investors who account for a whooping
85 percent to savings mobilization, must be given due importance and
must be afforded all protection for their willing .
Palliatives
RBI initiative RBI has introduced guidelines whereby it has fixed the
maximum limit on the all forms of exposure of banks on the stock market
operations to the extent of 5 percent. Accordingly, the ceiling would cover
direct investments by of equity shares, convertible debentures (CDs) and
units of equity-oriented mutual funds, advances against shares and
debentures and guarantees issued on behalf of brokers. These guidelines

have been issued in the light of the recommendations made by the technical
committee of the SEBI. The 5 percent ceiling would be computed in relation
to total advances, including commercial paper (CP) as on March 31, of the
previous year as against the total outstanding domestic credit as on March
of the previous year under the earlier guidelines. Besides, for the purpose
of computing the 5 percent norm, direct investment in equity shares by
banks would be calculated at the price paid by banks at the time of
acquisition of shares. Wherever exposure to stock market in excess of the
5 percent ceiling has already been made, the concerned banks have to
formulate a time bound plan to gradually reduce their exposure to stock
markets in line with the amended guidelines.
a. Revised norms The Reserve Bank of India has recently issued
revised norms for the banks’ exposure in capital market.
Accordingly, banks’ investments in shares and also advances
against shares and other connected exposures should not exceed
5 percent. The ceiling of 5 percent will also apply to total exposure
of a bank to stock market including loans and advances to
individuals, corporates, and stockbrokers and debentures.
However, this will not be applicable to shares and convertible
debentures assigned to banks as collaterals by individuals and
corporates for the purpose of availing bank credit for carrying
out normal trade, production and investment or other development
activities which do not involve stock broking or investment in
capital markets. Similarly, the existing instructions with regard to
advances to individuals and financing of initial public offerings
(IPOs) remain unchanged
b. Rationalized margins The norms relating to the margins on
such advances have been rationalized. Accordingly, the RBI has
proposed an uniform margin of 40 percent against all advances/
guarantees with a minimum cash margin of 20 percent (within the
margin of 40 percent) in respect of guarantees issued by banks
as against the minimum cash margin of 25 percent for issue of
guarantees, 25 percent margin for advances against demat shares,
and 50 percent for advances against physical shares
c. Simplified operations The RBI has come out with a clear policy
on banks’ operations on secondary markets. Accordingly, banks
shall not undertake arbitrage operations themselves, or extend
credit facilities directly or indirectly to stockbrokers for arbitrage
operations in stock exchanges. Similarly, banks shall not undertake
any sale transaction without the shares in their investment

account. The RBI has advised banks to constitute an ‘Investment
Committee’ for taking decisions regarding investments in shares
and advances against shares, so as to avoid any nexus between
banker and stockbrokers. In addition, banks are to constitute a
separate and independent ‘Audit Committee’ for surveillance
and monitoring of investment and advances against shares. The
audit committee will continuously review the total exposure of
the bank to capital market, both fund based and non-fund based
in all forms. It is the responsibility of the audit committee to
ensure that the guidelines issued by the RBI and the Board of the
bank are complied with, and adequate risk management and
internal control systems are in place
Banks have been suitably advised by the RBI to avoid
concentration to a few stock broking entities. Banks shall avoid
concentration to a few stock broking entities. Banks shall fix
within the overall limit of 5 percent, a sub-ceiling for total advances
to all stock brokers and market-makers, both fund based and
non-fund based and to individual stock broking entities, its
associates and interconnected companies.
SEBI initiative The Securities and Exchange Board of India decided to
ban the age-old carry forward (badla) system and introduce options on
individual scrips along with index options, to coincide with the
commencement of the rolling system. Accordingly, all deferral products,
viz. Automated Lending and Borrowing Mechanism (ALBM), Borrowing
and Lending of Securities Scheme (BLESS), Modified Carry Forward
System (MCFS) and Continuous Net System (CNS) would be discontinued.
This calls for compulsory liquidation of all outstanding deferral positions
in the current settlements by September 3, 2001. As many as 414 scrips
were brought under the new system and the remaining stocks with effect
from January 2, 2002. In the interim period, stocks, which will not be under
compulsory rolling settlement, will be traded on the uniform settlement
cycle, Monday to Friday. There will not be any price bands (circuit filters)
on individual stocks in rolling settlements from July 2, 2001. Market wide
index based circuit breakers have been implemented. Similarly, the
recommendations of the Group on Insider Trading have also been
implemented.
In addition to the above measures initiated by the SEBI, the following
have also been suggested:
a. Constitution of a centralized monitoring mechanism to examine
the flow of funds from the banking system to the stock markets
b. Formulation of proper norms regarding transactions of overseas
corporate bodies in the Indian markets
c. Impounding of at least one-third of the hawala profits by the
bourses till their positions are squared up to reduce the risks and
leverage under the carry-forward system
d. Evolving a mechanism of sharing information among the
surveillance departments of exchanges to have a holistic picture
of risk profile and trading by members
e. Review of the system of bank guarantees for meeting capital and
margin requirements with a view to reduce leverage in trading
f. Standardization of composition of settlement guarantee funds
and trade guarantee funds to work as a cushion for the successful
completion of settlements
g. Introduction of unique client identity system to help assess the
risk profile of the brokers/clients’ trading in the market across the
exchanges in light of the dynamic requirements of the exchanges
and particularly in the atmosphere of multiple exchanges and
multiple membership
h. Ensuring the efficient application of the risk management mechanism
by way of margins, exposure limits and carry forward limits
REVIEW QUESTIONS
Section A
1. What is ‘stock market trading mechanism’?
2. Who are ‘jobbers’?
3. Who are ‘brokers’?
4. Who are ‘tarawaniwalas’?
5. What is spot delivery contract?
6. What is ready delivery contract?
7. What is forward delivery contract?
8. What are option dealings?
9. What is hedging?
10. What is margin trading?
11. What is arbitrage?
12. What is ‘wash sales’?
13. What is cornering?
14. What is rigging the market?
15. What is a blank transfer?
16. What is minimum margin?

17. What is initial margin?
18. What is carry-over margin?
19. What is ad-hoc margin?
20. What are daily margins?
21. What is maintenance margin?
22. What is margin call?
23. What are ‘sauda sheets’?
24. What are ‘odd-lot securities’?
25. What are ‘non-specified securities’?
26. What is ‘rolling settlement’?
Section B
1. In what way the jobbers are different from brokers?
2. How are stock exchange dealings classified?
3. Name the different types of speculative dealings
4. How is a ‘domestic arbitrage’ different from a ‘foreign arbitrage’?
5. State the drawbacks of blank transfers.
6. How the working of a stock exchange regulated?
7. What are the functions of the Directorate of Stock Exchanges?
8. Outline the features of margin trading.
9. Explain the different types of margins imposed by a stock exchange
on the stock trading.
10. Specify the type of risks which an investor venturing into margin
trading needs to be aware of.
11. Explain the various steps involved in the trading of securities on
a stock exchange.
12. What are ‘specified securities’? What are the conditions to be
satisfied for inclusion of shares in the category of specified
securities?
13. Bring out the features of a new settlement system introduced by
the SEBI in July 2001.
14. What are the different types of margin requirements to be met by
the brokers on a stock exchange?
15. What are the conditions prescribed for the working of the ‘revised
carry forward system’?
Section C
1. What are the factors that influence the price of a security traded
on a stock exchange?
2. Discuss the various powers granted to the Central Government
to control and regulate the stock exchanges in India under the
provisions of the Securities Contracts (Regulation) Act, 1956.
3. What is ‘badla system’ of stock trading? Explain its mechanism
4. What are the problems encountered in stock market trading?
What are the palliatives announced by the RBI to overcome
such problems?
5. Comment on the role of SEBI in the realm of stock market trading.
Chapter 21
Depository Services
Electronic revolution has brought about a number of changes in the

functioning of Indian capital market. The most revolutionary change that
has been brought into the entire working of the Indian capital market is
the introduction of depository (demat) system. The century old Indian
capital market has been facing quite a lot of trouble in traditional paper-
based settlement of trade causing problems like bad delivery, delayed
transfer etc, until the enactment of depositories Act in 1996.
Dematerialization and depository services have assumed greater
significance consequent to SEBI guidelines which required compulsory
demating of share of all listed companies in India. Further, the number of
agencies, institutions and persons connected with demat environment has
also increased phenomenally.
The depository model in India is a competitive multi-depository
system. Under the system of dematerialization followed in India, the
securities will be cancelled as against the system of immobilization in
which the securities are merely kept in custody.
DEPOSITORY
A depository is an organization which holds securities in electronic book
entries at the request of the shareholder through the medium of a depository
participant. A depository can be compared to a bank. To utilize the services
offered by a depository, the investor is required to open an account called
‘demat account’ with the depository. The demat account is opened through
a depository participant which is very similar to the opening of an account
with any of the branches of a bank in order to utilize the services of that
bank. The objective is to allow for the faster, convenient and easy mode
of affecting the transfer of securities.
BANK AND DEPOSITORY—COMPARISON
Sl.
Feature Bank Depository
No.
Account Holds funds in an Holds securities in an
1.
account account
Transfer Transfers funds Transfers securities
between accounts on between accounts on the
2.
the instruction of the instruction of the account
account holder holder
Handling Facilitates transfers Facilitates transfers
3. without having to without having to handle
handle money securities
Safekeeping Facilitates safekeeping Facilitates safekeeping of
4.
of money securities
Customer Direct contact Contact through
5. contract depository participant
(DP)
DEPOSITORY PARTICIPANT (DP)

A Depository Participant (DP) is an agent of the depository through which
it interfaces with the investor. A DP can offer depository services only
after it gets proper registration from SEBI. A depository can be compared
with a bank, like wise a DP may be compared with a branch of a Bank.
The financial intermediary who arranges to open and maintain demat
account for an investor and who acts as a medium for handling securities
through electronic book entries is called a ‘depository participant’. In India,
the Depository Participants serve as links between the shareholder, the
company and the depository. A Depository Participant is registered with
the National Securities Depository Ltd. (NSDL) and also with Central
Depository Services Ltd. (CDSL). Intimation like change of address, bank
mandate, nomination, request for transmission required to be given to
only depository participant (DP) irrespective of the number of companies
in which shares are held.
DEPOSITORY (DEMAT) SERVICES
Meaning
Financial services relating to holding, maintaining and dealing in securities
in electronic form by a financial intermediary known as depository
participant are called ‘depository or demat services’.
Deposi tory Servi ces 449
Securities are demated by transforming their physical form into

electronic form. An individual can open as many beneficiary accounts
with one or more depository participant as needed. There is no minimum
balance of securities required to be maintained in a demat account. One
can receive shares allotted in IPOs directly in ones demat account. Bonus/
Rights/ Conversion (of Debentures) shares can also be directly credited to
the mat account.
Benefits to Investors
The benefits accruing to investors in holding shares in the electronic form
are manifold. It totally eliminates problems that are normally associated
with physical segment. Following are the benefits in this regard:
1. Faster Transfer Transactions take place much faster in electronic
trading compared to a 30-60 days settlement cycle that usually
takes place in the case of physical transfer of securities; transfer
of shares is effected within a few days after payment is made
2. Elimination of bad deliveries and all risks associated with
physical certificate such as loss, theft, mutilation, forgery, etc.
3. Easy and enhanced liquidity
4. No stamp duty on transfer
5. No postage/courier charges
6. Faster disbursement of corporate benefits like rights, bonus, etc.
7. Facility for creating charge on dematerialized shares for granting
loans and advances against shares.
8. No delay in transfer of securities
9. No follow up with the company regarding the status of the
dispatched certificates
10. Lower interest on loans against demat shares
11. Nomination facility at the time of account opening
12. No loss of share certificate(s) in postal transit
13. Much faster payment on sale of shares
14. No scope for theft/forgery/damage of share certificates
15. Minimum handling of paper
16. Low transaction cost for purchase and sale of securities compared
to physical mode
17. Reduction in paper work
Ne e d
SEBI has made compulsory trading of shares of all the companies listed in
Stock Exchanges in demat form w.e.f. 2nd January 2002. Hence, if an investor
wants to trade in respect of the companies which have connectivity with

NSDL & CSDL, it would require a demat (beneficiary account) opened
with the DP of choice, to hold shares in dematerialised (demat) form and to
undertake scripless trading.
SERVICES/FUNCTIONS
Important services of a depository participant are transferring securities
as per the investor’s instructions without actually handling securities,
through electronic mode, maintaining the account balances of securities
bought and sold by the investor from time to time, furnishing the investor
a statement of holdings similar to a passbook, etc. Depository in a financial
services industry provides the following services:
Account Opening
An investor needs a satisfactory introduction and identification to open a
Demat account with a DP. Every account holder in a bank that offers
depository and demating services can open a Demat account. An investor
has to fill up an Account Opening Form and execute an agreement with
the DP for opening a Demat account.
The investor (investors are called Beneficial owners in Depository
system) intending to hold securities in the electronic form in the Depository
system opens an account with a DP of NSDL. The investor fills up an
account opening form and signs an Agreement. The investor can also open
multiple accounts with same DP as also with different DPs. The DP will
provide the investor a statement of holdings and transactions. In case the
shares are held in joint names then the account is to be opened in the same
order of names. Similarly, separate account needs to be opened for each
combination of names.
Materialization
Holding of securities in physical form is known as ‘materialization’ of
securities. Materialization requires securities that are held in paper form
whereby buying and selling transaction in securities can take place only in
paper mode. In materialization, securities are held by the owner itself and
the Depository, can of course, help hold securities in electronic form.
Dematerialization
The process of transforming paper-form of holding securities into
electronic form is known as ‘dematerialization of securities’. A process by
which the physical certificates of an investor are taken back by the
Company/Registrar and actually destroyed and an equivalent number of

securities are credited in the depository account of that investor is called
dematerialization. Dematerialization allows for easy and faster transaction
in securities.
Dematerialization is the process by which an investor gets his physical
certificates converted into electronic form and reflected in his account
with the DP. For this purpose, the investor just fills in Dematerialization
Request Form available with his DP and submits the share certificates
along with the above form (legend like ‘Surrendered for Dematerialization’
should be written on the face of each certificate before its submission for
Dematerialization).
The beneficial owner’s account will be credited within 15 days and
he will be informed by the DP. If one wishes to convert the electronic
shares back to physical shares at a later stage, it can be done by making an
application for rematerialization through a Rematerialization Request Form
(RRF) available with his DP. The new rematerialized certificates with
new range of certificate number may use existing Folio number or a new
folio number for the certificates.
Rematerialization
The reverse of dematerialization is rematerialization. The process of
converting securities in electronic form to physical form is known as
‘rematerialization of securities’. The investor must fill up a Remat Request
Form (RRF) and give it to the DP. The DP will forward the request to
Depository after verifying that the shareholder has the necessary balances.
Depository in turn will intimate the RTA/Companies. The RTA/Company
will print the certificate and dispatch the same to the investor.
Electronic Trading
Selling of shares held in electronic form is very similar to selling of the
paper form of shares. Instead of signing the transfer deed as seller and
delivering it with share certificates to a broker, one gives to the Depository
Participant, debit instructions for delivering the shares from the client’s
account to the chosen broker’s account. This debit instruction is provided
by the client in time to the Depository Participant (DP) at the designated
collection centres. This debit instruction is verified for signature and
correctness and then acted upon by the DP. The client then receives the
money from the share broker in the same manner as is received now.
For buying shares in the depository system, the client must inform
the broker, the Depository Account Number (Client ID) along with the
Depository Participant ID (DP ID) so that the shares bought by the client
are credited into that account. The payment for the shares in the depository
system can be made in the same way as one pays for the purchase of any
physical shares.
Market Trade and Off Market Trade
Trade done and settled through a stock exchange and clearing corporation
is called ‘Market Trade’. Trades done in private without the involvement
of Stock broker or Stock exchange is called ‘Off Market Trade’. The
investor can buy and sell shares only through a Stock broker and not through
a Depository Participant. However, DP helps in delivering the shares
against a sell transaction or receiving the shares for a buy transaction.
There is absolutely no compulsion for the investor to open demats account
with the same DP as that of his broker.
Corporate Benefit
Corporate benefit is a corporate event. It can be cash corporate benefit like
dividend, interest, etc. or non-cash corporate benefit like rights, bonus
etc. when any corporate event such as rights or bonus or dividend is
announced for a particular security, Depository will give the details of the
clients having the electronic holdings in that security as one of the record
date to the RTA/Company. The RTA/Company will then calculate the
corporate benefit due to all the shareholders. The disbursements of cash
benefits such as dividend/interest will be done by the RTA/Company
directly to the shareholders. Non-cash benefits will be distributed through
Depository by crediting the entitled quantity of shares in to shareholder’s
demat account.
In case of discrepancies in corporate benefits the investor can approach
his DP who in turn will contact the RTA/Company for clarifications
regarding allotment of securities.
Direct Credit of Shares

In the case of public/right issue application forms of depository-eligible
companies, there will be a provision for the investor to indicate the manner
in which the securities need to be allotted. Even in the case of bonus issue
the investor is given an option for getting the shares allotted in physical or
electronic form. The investor must mention his Client ID number and DP
ID Number. SEBI has announced that the shares of all companies going in
for public issue will have to be compulsorily settled in demat form by all
investors. It is, therefore, advantageous for an investor to prefer the
allotment in demat form, so that the shares have higher liquidity.
Voting Rights
Clearing members, clearing corporations and other intermediaries cannot
have voting rights in respect of the shares held in pool account. Further,
the clearing member or clearing corporation is also responsible for
distribution of bonus, rights and other corporate benefits lying in his account
to the investor.
Pled ging
Pleding dematerialized securities is easier and more advantageous as
compared to pledging physical securities. The procedure is:
1. Both borrower (Pledger) as well as the lender (Pledgee) must
have Depository accounts.
2. The pledger must initiate the pledge by submitting to his DP the
details of the securities to be pledged in a standard format.
3. The pledgee should confirm the request through his DP
4. Once this is done, the securities are pledged. All financial
transaction between the pledger and the pledgee are handled
outside the Depository system.
After the borrower has repaid the loan, he can request for a closure of
pledge by instructing his DP in a prescribed format. The lender on receiving
the repayment will instruct his DP to confirm the closure of the pledge. If
the pledgee (lender) agrees, the investor may change the securities offered
in a pledge.
Transmission
In the case of transmission, the claimant will have to fill a Transmission
Request Form (TRF), supported by documents like death certificate,
succession certificate, etc. The DP, after ensuring that the application is
genuine, will transfer securities to the demat account of the claimant. For
this purpose the claimant must have a Depository account. The major
advantage in transmission of dematerialized holdings is that the
transmission formalities for all securities held with a DP can be completed
in a single stage, unlike in the case of share certificates, where the claimant
will have to interact with each RTA/Company.
Transposition
Shares sent for transposition can be dematerialized. In case of
transposition-cum-dematerialization, the investor can get the securities
dematerialized in the same account if the names appearing on the certificates

match with the names in which the demat account has been opened but
are in a different order, by submitting the security certificates along with
the Transposition Form and the Dematerialization Request Form (DRF) to
the DP.
Nomination
Like shares held in physical form, shares held in electronic form also can
be nominated. Nomination can be made only by individuals holding
beneficiary accounts on their own behalf either singly or jointly.
Non-individuals including society, trust, body corporate, partnership firm,
Karta of Hindu Undivided Family, holder of power of attorney cannot
nominate.
Nomination is permitted for accounts with joint holders. But, in case
of death of any of the joint holders, the securities will be transmitted to the
surviving holder(s), only in the event of death of all the joint holders, the
securities will be transmitted to the nominee. Only an individual can be a
nominee. Hence, a nominee shall not be a society, trust, body corporate,
partnership firm, Karta of Hindu Undivided Family or a power-of-attorney
holder.
A minor cannot nominate either directly or through its guardian.
However, a minor can be a nominee. In such a case, the guardian will sign
on behalf of the nominee. In addition, the name and photograph of the
nominee, the name, address and the photograph of the guardian must also
be given. Separate nomination cannot be made for each security.
Nomination can be made demat account wise and not security wise.
Procedure for nomination The investor must fill in and submit to
the DP, the nomination form. The account holder, nominee and two
witnesses must sign this form and the name, address and photograph of
the nominee must also be submitted.
Changing nominee The nomination can be changed anytime by the
account holder by filling up the revised nomination form and submitting
the same to the DP. The account holder, nominee and two witnesses must
sign this form and the name, address and photograph of the nominee must
be submitted. In case of joint holders all joint holders must sign.
Cu s to d y
The act of maintaining the client’s share portfolio in the electronic form
(i.e., as a balance in the Depository account) is designated as custody
service. The additional services the client gets here is a regular statement
of account which shows the client’s various share balances, maintenance

of details on the account like address, bank account number, nomination
etc.
Account Freezing
An investor can freeze/lock his account for any given period of time if he
so desires. During this period no debits can be made to the investor’s
account. It is possible for a client to issue instructions requesting for the
Depository account to be frozen until any further instructions. No debits
will then be allowed to the account. This can be a safe way further ensuring
safety of the client investments especially when there are no transactions
that are likely to occur for a long time.
Single Window Service
The DP enjoys the benefits of a broker-cum-DP wherein the client gets the
benefit of single window service. The broker-DP interface offers clients
the benefit of operating the Depository account at the broker end thus
eliminating multiple agencies and contact points.
Agency Functions
Similar to the brokers who trade on client’s behalf in and outside the stock
exchanges, a Depository Participant is the representative (agent) in the
Depository System. The Depository Participant maintains the securities
account balances and intimation is given to the client on the status of
holdings from time to time. The Depository Participant provides the
facilities and services related to dealing in the Depository.
DEMAT (BENEFICIARY) ACCOUNT

Meaning
A beneficiary account is an account opened by the investor or a broker
with a DP of his choice, to hold shares in dematerialised (demat) form and
undertake scripless trading. The investor must open a demat account with
a Depository Participant (DP). Opening a demat account with DP is similar
to opening an account with bank. The selection of DP is to be done by the
investor based on fee payable, proximity, service levels, etc. An investor
cannot open demat account directly with the Depository. Demat account
opening procedure will normally take a maximum of 5 days.
Features
A demat account possesses the following features:

1. Documents
Following documents are needed for opening a demat account:
a. Demat account opening form duly filled
b. Address proof
c. Photograph
2. Other formalities Once a demat account is opened, the investor
must sign an agreement with the DP. The investor will be allotted account
number known as Client Identity. This ‘Client identity number’ along with
the ‘DP’ identity number forms a unique combination. Both these numbers
should be quoted in all future dealings with the Depositories/DP/RTA/
Companies. However, in case of CDSL there is no DP identity and the
digital client identity itself is a unique number. The investor must collect
forms like Dematerialization Request Form (DRF), Delivery instruction
slips etc from the DP.
3. Demat for partnership firm As a partnership firm is not a legal
entity, demat account cannot be opened in the name of partnership firms.
However, a demat account can be opened in the name of the partners.
4. Demat for Hindu Undivided Family (HUF) Demat account cannot
be opened in the name of HUF. It has to be opened in the name of the
Karta of the HUF.
5. Demat for minor In the case of minor, the depository account should
be opened in the name of minor and the guardian’s name should be
mentioned. The guardian will sign as signatory on behalf of the minor.
6. Number of demat account There is no restriction on the number
of demat accounts that an investor can open. Investor can open any number
of demat accounts with any number of DPs. However, the investor has to
incur cost for each of such account.
7. Different demat accounts The investor must open different demat
accounts for shares held in different combination of names. Alternatively
investor can submit the certificate for demat along with transposition form.
8. Minimum balance There is no minimum balance required to be
maintained in the demat account and an investor can maintain nil balance.
9. Informing DP The investor should inform his DP of any change in
Address, Bank account, Nomination etc., immediately upon change,
thereof.
10. Charges The Depository does not charge any fee directly from the
investors. The Depository charges only the DPs. However the DP is free
to charge its client for the services offered. The charges of the DPs to
investors vary. Generally, the following charges are levied viz. Account
opening, Demat/Remat, Account Maintenance, Custody, Transaction, etc.
11. Account statement The investor is provided with a transaction
statement by his DP at regular intervals. Based on this the investor will
know his security balances. The DP will send a transaction statement once
in a quarter if there are no transactions during the quarter. If there are any
transactions DP will send the statement within fifteen days of the
transaction.
12. Freezing demat account The Depository system provides the
facility to freeze the demat account for any debits or for both debits and
credits. In an account which is “freezed for debits”, no debits will be permitted
from the account, till the time it is defreezed. This is an additional security
feature for the benefit of the investors.
13. Standing instruction The investor can give onetime standing
instruction to his DP to receive all the credits coming to his Depository
account automatically. However, the investor cannot give standing
instruction for any debits in his account.
14. Access to account details A DP cannot access the investor
accounts of any other DP. The DP can access only those investor accounts
serviced by them.
15. Bank account particulars Details of bank account of the client,
including the 9-digit code number of the bank and branch appearing on
the MICR cheques issued by the bank have to be given to the DP at the
time of account opening. Companies use this information for printing them
on dividend/interest warrants, etc. to prevent its misuse. In case client
wishes to change this bank account details, he can do so by submitting the
changes in writing to the DP.
16. Procedure for Closure An investor can close a demat account
by giving an application in the prescribed form. In case there is any balance
in the demat account sought to be closed, the following steps are necessary:
a. Re-materialisation of all securities standing to the credit of the
demat account at the time of making the application for closure
or,
b. Transferring the balance to the credit of another demat account,
with the same participant or with a different participant.
Delivery Instruction Slip (DIS)
To give the delivery instruction to DP one has to fill a form called Delivery
Instruction Slip (DIS). DIS may be compared to cheque book of a bank
account. The following precautions are to be taken in respect of DIS:-
1. Ensure and insist with DP to issue DIS book; do not use loose
slips
2. Ensure that DIS numbers are pre-printed and DP takes
acknowledgement for the DIS booklet issued to investor
3. Ensure that your account number [client id] is pre-stamped
4. If the account is a joint account, all the joint holders have to sign
the instruction slips. Instruction cannot be executed if all joint
holders have not signed
5. Avoid using loose slips
6. Do not leave signed blank DIS with anyone, viz. broker/sub-
broker
7. Keep the DIS book under lock and key when not in use.
8. If only one entry is made in the DIS book, strike out remaining
space to prevent misuse by any one.
9. Investor should personally fill in target account ID and all details
in the DIS.
Benefits to Corporates
It is possible to get securities allotted to in Public Offerings directly in the
electronic form. In the public issue application form there is a provision
to indicate the manner in which an investor wants the securities allotted.
He has to mention the BO ID, the name and ID of the DP on the application
form. Any allotment made will be credited into the BO account.
The concerned company obtains the details of beneficiary holders
and their holdings as on the data of the book closure/record date from
depositories. The payment to the investors will be made by the company
through the ECS (Electronic Clearing Service) facility, wherever available.
Thus, the dividend/interest will be credited to your bank account directly.
Where ECS facility is not available dividend/interest will be given by
issuing warrants on which your bank account details are printed. The bank
account details will be those which you would had mentioned in your
account opening form or changed thereafter. In case of discrepancies in
corporate benefits, one can approach his/her DP or the company/its R&T
Agents.
DEMATERIALIZATION
Meaning
Dematerialization is the process of conversion of shares or other securities
held in physical form into electronic form. The investor must approach
his DP for dematerialization. The investor can demat the shares of any
company that has established connectivity with NSDL or CDSL.
Steps in dematerialization
1. Demat Request Form Investor must submit Demat Request
Form (DRF) and Share Certificate to DP.
2. Checking securities DP will check whether securities are
available for Demat. Investor must deface the Share Certificate
by stamping ‘Surrendered for Dematerialisation’ and DP will
Punch two holes on the name of the Company and will draw two
parallel lines across the face of the Certificate.
3. Entry of request DP Enters the demat requests in their system
to be sent to Depository. DP despatches the physical certificates
along with the DRF to Registrar and Transfer Agents (RTA)/
Company.
4. Recording details Depository records the details of the
Electronic Requests in the system and forwards the request to
Registrar and Transfer Agent (RTA) or Issuer (i.e. the Company,
whose shares are sought to be dematerialized).
5. Verification RTA/Company on receiving the physical
documents and the electronic request verifies and checks them.
Once the RTA/Company finds that the documents are in order,
dematerialization of the concerned securities is electronically
confirmed to the Depository.
6. Account crediting Depository credits the dematerialized
securities to the beneficiary account of the Investor and intimates
the DP electronically. The DP issues a statement of transaction
to the client.
7. Company Identification Once the company is admitted in the
depository system, an ISIN (International Securities Identification
Number) is allotted by the Depository. This number is unique
for each security of the company that is admitted in the Depository.
8. Dematerialization of Shares sent for transfer Shares sent for
transfer can be dematerialized if the company is providing
“Simultaneous Transfer-cum-Dematerialization Scheme.”
Simultaneous Transfer-cum-Dematerialization Scheme
On completion of the process of registration of securities sent for transfer,
the RTA/Company will send an option letter to the investor, providing an

option to dematerialize such securities. The investor may exercise this
option by submitting demat request form together with the option letter to
the DP. Then the company or its RTA would confirm the demat request in
the usual manner. SEBI has made it mandatory for all companies whose
shares are traded compulsorily in demat form in the Stock Exchanges to
offer this facility and has prescribed the procedure therefore.
Certificate Number for Dematerialized Shares
The dematerialized shares are fungible and they do not have any certificate
number or distinctive numbers.
Fungible
Fungible means the dematerialized securities do not have any distinctive
or certificate numbers. It is represented only by the number of securities.
This is called fungible.
Dematerializing odd lot securities
Odd lot share certificates can also be dematerialized. In fact the market lot
in demat mode is one share and an investor can even hold one share in a
company.
Process Time
Dematerialization will normally take about 30 days.
Holdings in Both Demat Form and Physical Form
The investor can dematerialize part of his holdings and hold the balance in
physical mode for the same security.
Distinguishing Partly Paid-up and Fully Paid-up Shares
Partly paid-up shares and fully paid-up shares are identified by separate
ISINs (International Securities Identification Number). These are also
traded separately at the Stock Exchanges. The company issues call notices
to the beneficial holders of partly paid-up securities in the electronic form.
The details of such beneficial holders will be provided to the RTA/Company
by the Depositories. After the call money realization,
RTA/Company will electronically convert the partly paid up shares to fully
paid up shares.
ELECTRONIC SETTLEMENT OF TRADE—PROCEDURE
I. For Selling Dematerialized Securities

The procedure for selling dematerialized securities in stock exchanges is
similar to the procedure for selling physical securities. Instead of delivering
physical securities to the broker, the investor must instruct his/her DP to
debit his/her demat account with the number of securities sold by him/her
and credit broker’s clearing account. Procedure for selling securities is as
follows:
1. Investor sells securities in any of the stock exchanges linked to
Depository through a broker.
2. Investor gives instruction to DP to debit his account and credit
the broker’s (Clearing member pool) account.
3. Before the pay-in day, investor’s broker transfers the securities
to clearing corporation.
4. The broker receives payment from the stock exchange (clearing
corporation).
5. The investor receives payment from the broker for the sale in
the same manner as that is received for a sale in the physical
mode.
II. For Buying Dematerialized Securities
The Procedure for buying dematerialized securities from stock exchanges
is similar to the procedure for buying physical securities. Investor may
give a one-time standing instruction to receive credits in to his/her account
or may give separate instruction each time in the prescribed format.
The transactions relating to purchase of securities are as follows:
1. Investor purchases securities in any of the stock exchanges
connected to Depository through a broker.
2. Broker receives payment from Investors.
3. Broker arranges payment to the clearing corporation.
4. Broker receives credit of securities in clearing account and credit
client’s account.
5. Investor receives shares in his account.
The investor should ensure that the broker transfers the securities
purchased to his account, before the book closure. If the securities remain
in the clearing account of the broker, the company may give corporate
benefit to the broker. Therefore, the investor has to collect benefit from
his broker.
DEMAT OF DEBT INSTRUMENTS

Debt instruments can also be held in demat form. Instruments like Bonds,
Debentures, Commercial Paper, Certificate of Deposit, etc. irrespective

whether these instruments are listed/unlisted/privately placed or even issued
to a single holder can be dematerialised. Commercial paper can also be
kept in demat form. As per RBI Monetary and Credit Policy 2001-2002,
Banking and Financial Institutions, Primary Dealers and Satellite Dealers
are directed to convert their outstanding investment in Commercial Paper
in scrip form, into demat form latest by October, 2001. The above entities
have also been directed to make fresh investment in Commercial Paper
only in demat form w.e.f. June 30, 2001.
Bonds and debentures can also be kept in demat form. In its midterm
review of the monetary and credit policy RBI has mentioned that Banks
and Financial Institutions should make investment in debentures and bonds
only in demat form from October 31st, 2001.
Allocation
Any new instrument can be issued directly in dematerialized form without
recourse to printing of either Letter of Allotment or Certificates. Securities
will be directly credited into the demat account of the investor by the
depositories on receipt of allotment details from RTA/Company. The
investor need not open separate demat account for demat of debt
instruments.
Dematerialization
The procedure for dematerialization of debt instrument is the same as
applicable for equity shares. In order to dematerialize his/her certificates;
an investor will have to first open a debt account with a DP and then
request for the dematerialization certificates by filling up a
Dematerialization Request Form (DRF) which is available with DP and
submitting the same along with the physical certificates. The investor has
to ensure that the certificates handed over to the DP for demat, are marked
“surrendered for dematerialization” on the face of the certificates.
Statement of holdings
A regular single statement of holding will reflect all the holdings in a
particular demat account, irrespective of type of instrument.
SAFETY SYSTEM FOR DEMAT
Demat services in order to be carried out effectively requires the following
safety system to be put in place:
1. Strict norms for becoming a depository participant (DP), net
worth criteria, SEBI approval., etc. are mandatory

2. DP cannot effect any debit or credit in the demat account of the
investor without the valid authorization of the investor
3. Regular reconciliation between DP and Depositories
4. Periodic inspection of Depositories of the office of DP and
Registrar (RTA)
5. All investors have a right to receive their statement of accounts
periodically from the DP
6. In the depository system, the depository holds the investor
accounts on trust. Therefore, if the DP goes bankrupt the creditors
of the DP will have no access to the holdings in the name of the
clients of the DP. These investors can transfer their holdings to
an account held with another DP
7. Compulsory internal audit of operations of DP every quarter by
practising company secretary or chartered accountant
8. Various procedures for back up and safe keeping of data all
levels
SHORTCOMINGS OF DEMAT SYSTEM
Demat system, although greatly facilitates electronic trading of securities
in a scripless environment and is considered as highly beneficial to the
investing community, suffers from various serious shortcomings as
mentioned below:
Hazards of a Bank Account
The demat account has to be treated virtually like a bank account with the
difference being that instead of actual cash there are shares in the account.
If one considers the value of these shares, then, they could be far more
than the amount that one would carry in their bank accounts.
Hazardous Transaction
One of the most important items in the operation of the demat accounts is
the Delivery Instruction Book. Delivery instruction book refers to the
book, which is used to transfer the shares out of the account into some
other account when a transaction takes place. When the shares are sold,
these have to be transferred into the broker’s account. For this purpose,
one needs to sign the delivery instruction book and then give it to the
Depository Participant with whom demat account is maintained.
The participant will then check whether the shares are in the account
and then give approval for the transfer. The process varies slightly when it
comes to an online transaction. In this type of transaction, there is no
need to sign the delivery transaction booklet. Each time when a transaction
takes place, the shares are directly taken out by the broker from the
depository account, which the shareholder maintains with it. This is possible
on account of the fact that the investor has already given the broker, the
right to undertake such transactions by signing an agreement when the
online account is opened.
One can also transfer shares between two demat accounts without
there having to be a market transaction. Such a transaction is called an off
market deal and there is a separate place in the delivery instruction booklet
where such transactions can be put through. It is in this respect there are
possibilities of frauds being committed. For instance, if once delivery book
falls into the wrong hands, then it is possible for the person to transfer the
shares out of the account. This would entail a severe loss to the investor.
Such frauds have been experienced by several investors and one therefore
needs to exercise extreme caution and care especially at times when the
market is booming; as several unscrupulous people are on the prowl to
make a quick buck in the entire process.
To guard against loss on this front, one needs to know that one must
never give blank-signed form in the booklet to anybody. Filling in the
details and crossing out the unused portion is a procedure which has to be
followed so as to ensure that the signed leaf is not misused. Otherwise, it
is tantamount to giving away a blank cheque. More importantly, one must
always keep the booklet under lock and key and should under no
circumstances leave it signed carelessly.
Unauthorized Transactions
In addition, one must always be watchful about the transaction that takes
place in one’s demat account as that will give an indication of any transaction
which might have taken place without the authorization and knowledge of
the owner. A close perusal of the transactions that are printed on the
statements sent periodically by the DP would reveal any discrepancy. There
are two ways in which an unauthorized transaction will be undertaken in a
demat account. It might take place by way of forging the signature of the
person concerned and also when a signed slip falls into the wrong hands.
Hence, extreme care is needed as once the shares have been transferred
out of the account it will be very difficult to trace them and even get them
back. On the whole, one must be very careful with the demat accounts as
one can end up losing quite a bit of money on this front if due diligence is
not undertaken.
DEMAT Costs
Another shortcoming of securities demating is demat costs which are
very important for an investor, as it has a bearing on his overall portfolio
returns. Demat costs, broadly could be segregated as initial and recurring
charges.
Initial charges are the charges by way of account opening charges
and demat charges. Account opening charges typically range between
Rs.100 to Rs.200 and many DPs waive these charges. For demating a
physical share certificate, the charges are normally Rs.3 per certificate for
conversion. In addition, DPs also charge a courier fee Rs.25 to Rs.35 per
request. All these are onetime charges. While the initial charges are more
or less the same, the recurring charges are more crucial.
Recurring charges are Transaction and Custody charges. Transaction
charges are levied on a per transaction basis and as a percentage of a trade
value, or as a flat amount, whichever is higher. The charge is levied
separately for buy and sell transactions with minimum charge riders.
Custody Charges Custody charges are flat charges levied by the DP
as a cost of maintaining client’s records. Here the DP, in addition to an
annual maintenance fee, also charges based on number of companies one
holds. In market parlance, the charges are referred as per ISIN (International
Security Identification Number) per month. So if the client is a typical
small investor with a large portfolio, he or she should ensure that the DP
doesn’t have higher custody charges.
Dangers in Accounting
There can be a case where the shares that one has purchased have not
been deposited in the account. In such an eventuality, necessary check has
to be held with the broker and the exact transaction date is to be obtained
to know whether any such transaction has taken place.
At the same time there have been various instances of a transaction of
sale of shares being executed twice thus resulting in the investor losing
double the shares sold from his account. This is because with a host of
open offers, buybacks and mergers from different companies present in
the market, the investor has to check whether any inward or outward
transactions relate to these deals has taken place.
Conversion Delay
In case the securities under some different name are deposited into the
demat account it could pertain to a merger or amalgamation. In many
cases, it’s the time element which is important; for this can result in quite
a bit of monetary impact.

The time element becomes extremely important when shares are to be
converted into securities from one company to the other at the time of a
merger or an amalgamation or even a takeover. This is because, unless and
until one gets the converted shares in the new or separate entity, it will not
be possible to transact in them in the secondary market. This delay could
mean loss of quite a good opportunity for the investor. At the same time,
one has to take extreme care in case of tendering the shares out of the
account especially in circumstances where they are substituted by some
other securities.
Fake Securities
Another area for concern is the issue of fake securities. According to
reports, there is a probability that some of the companies may have demated
shares, which are more than even their issued capital with the end result
that there could be quite a bit of such shares floating in the market affecting
the investor interest.
INDIAN DEPOSITORY
There are two depositories in India. They are National Securities
Depository Limited (NSDL) and Central Depository Services (India)
Limited (CDSL). NSDL was formed and registered under the companies
Act, 1956. NSDL was promoted by Industrial Development Bank of India
(IDBI), Unit Trust of India (UTI), the largest Mutual Fund in India and
National Stock Exchange (NSE). Some of the prominent banks in the
country also have stake in NSDL. CSDL commenced its operations during
February 1999 and is promoted by Stock Exchange, Mumbai in association
with Bank of Baroda, Bank of India, and State Bank of India and HDFC
Bank.
ROLE OF CDSL
A Depository facilitates holding of securities in the electronic form and
enables securities transactions to be processed by book entry by a
Depository Participant (DP), who as an agent of the depository, offers
Depository services to investors. According to SEBI guidelines, financial
institutions, banks, custodians, stockbrokers, etc. are eligible to act as DPs.
The investor who is known as Beneficial Owner (BO) has to open a demat
account through any DP for dematerialization of his holdings and
transferring securities.
The balances in the investors account recorded and maintained with

CDSL can be obtained through the DP. The DP is required to provide the
investor, at regular intervals, a statement of account which gives the details
of the securities holdings and transactions. The Depository system has
effectively eliminated paper-based certificates which were prone to be
fake, forged, counterfeit resulting in bad deliveries. CDSL offers an efficient
and instantaneous transfer of securities.
CONSTITUTION
CDSL was promoted by The Stock Exchange, Mumbai (BSE) jointly with
leading banks such as State Bank of India, Bank of India, Bank of Baroda,
HDFC Bank, Standard Chartered Bank, Union Bank of India and Centurion
Bank. CDSL was set up with the objective of providing convenient,
dependable and secure depository services at affordable cost to all market
participants.
MAJOR TASKS
Some of the important milestones of CDSL system are:
1. CDSL received the certificate of commencement of business from
SEBI in February, 1999
2. Settlement of trades in the demat mode through BOI Shareholding
Limited, the clearing house of BSE, started in July 1999
3. All leading stock exchanges like the National Stock Exchange,
Calcutta Stock Exchange, Delhi Stock Exchange, The Stock
Exchange, Ahmedabad, etc. have established connectivity with
CDSL
4. As at the end of July 2003, over 4600 issuers have admitted their
securities (equities, bonds, debentures, and commercial papers),
units of mutual funds, certificate of deposits etc. into the CDSL
system
BENEFITS
Con ve n ie nc e
Wide DP Network CDSL has over 200 DPs spread around 114 cities/
towns across the country, offering convenience for an investor to select a
DP based on his location.
On-line DP Services The branches of a DP can also be directly
connected to CDSL thereby providing on-line and efficient Depository
service to investors.
Wide Spectrum of Securities Available for Demat More than
4600 companies have admitted their equity into CDSL. Further, CDSL has
also admitted an entire gamut of debt instruments viz. bonds, debentures,
commercial paper, government securities, certificate of deposits, etc. Thus
an investor can hold almost all his securities in one account with CDSL.
CDSL has kept its tariffs very competitive to provide affordable
Depository services to investors. CDSL also does not collect any custody
fees or ISIN fees from its DPs. A DP, which registers itself with CDSL for
Internet access, can in turn provide demat account holders with access to
their account on the Internet.
Dependability
CDSL’s system is based on centralised database architecture; DPs can
thus provide on-line depository services with to-the-minute status of the
investor’s account. The entire database of investors is stored centrally at
CDSL. If there is any system-related issues at DPs end, the investor is not
affected, as the entire data is available at CDSL. CDSL has made provisions
for contingency terminals, which enables a DP to update transactions, in
case of any system related problems at the DP’s office. Continuous updation
of procedures and processes in tune with evolving market practices is
another hallmark of CDSL’s services.
ROLE OF NSDL
NSDL is National Securities Depository Limited. For a detailed discussion
see Chapter 29 of the book Financial Markets and Institutions.
DEPOSITORY STOCK EXCHANGES
At present the following 10 Stock exchanges are connected to the
Depositories.
1. National Stock Exchange
2. The Stock Exchange, Mumbai
3. Calcutta Stock Exchange
4. Delhi Stock Exchange
5. Ludihana Stock Exchange
6. Bangalore Stock Exchange
7. Over-the-Counter Exchange of India
8. Madras Stock Exchange
9. Inter Connected Stock Exchange
10. Ahmedabad Stock Exchange
LEGAL FRAMEWORK
The legal framework for a Depository system has been laid down in the
following enactments.
1. Securities & Exchange Board of India Act, 1992
2. The Depositories Act, 1996
3. The SEBI (Depositories & Participants) Regulations, 1996
4. Bye-Laws of Depository
5. Business Rules of Depository
6. The Companies Act, 1956
REVIEW QUESTIONS
Section A
1. Who is a depository?
2. Who is a depository participant?
3. Who do you mean by demat services?
4. What is ‘dematerialization’?
5. What is ‘rematerialization’?
6. What is ‘electronic trading of securities’?
7. What do you know of the custody service offered by a
depository?
8. Can an investor freeze the depository account? If yes, how?
9. What is a demat account?
Section B
1. How is a depository different from a banker?
2. How are depository services beneficial?
3. State the need for the introduction of depository services in the
realm of Indian stock trading
4. What are the functions of a depository participant?
5. How do you distinguish between market trade and off market
trade?
6. State the corporate benefits made available under the depository
services
7. How are demated shares pledged? Explain
8. How is a demat account opened? Explain
9. What is a ‘Delivery Instruction Slip’ (DIS)? What are the
precautions to be taken in respect of the use of DIS?
10. Outline the steps in rematerialization of securities

11. What do you know of the ‘simultaneous transfer-cum-
dematerialization scheme’?
12. What are the safety norms that you would put in place to ensure
efficient demat services to clients?
13. What are the various costs associated with the demat services?
Section C
1. How is settlement happening under the electronic scenario?
Explain the process
2. What are the shortcomings of demat system?
3. Comment on the role of Indian depositories.
4. Discuss the role of NSDL and CDSL in the Indian demat scenario
Chapter 22
Speculation
Speculative activity forms an important and an integral part of the working

of the stock exchanges the world over. Speculative activity is prevalent in
the stock exchanges in India too. Speculation consists of buying and selling
commodities or securities or other property, in the hope of a profit from
anticipated changes of value. Speculation is therefore, a risky activity and
a speculator assumes the risks incidental to change in the price of the
commodity under consideration. Speculator is a person who attempts to
make a profit merely out of an anticipated change in price. An important
prerequisite is that his anticipations must come true. Else, there will be an
enormous loss incurred.
SPECULATION Vs. GAMBLING
Speculation and gambling, although perceived as similar, are different in
many ways as shown below:
Feature Speculation Gambling

Legitimacy Involves a legitimate Involves no such intelligent
enterprise of buying and activity, rather it is a reckless
selling property, and blind betting of future
commodities, etc on the without application of mind
basis of an intelligent and intelligence, and without
study and analysis of even possessing resources
market trends, and other necessary to meet the
factors having a bearing commitments
on prices
Risks Speculator merely Gambler creates situation out
assumes existing risks of which risks develop
arising out of natural or artificially. The gambler’s
economic forces. A assumption of risk is based
speculator bears the risk of on reckless or blind
loss on the basis of reason speculation that creates an
and logic. His activity artificial risk of loss
absorbs an existing risk of
price fluctuations
Feature Speculation Gambling

Economic Speculation, if properly Gambling has no such use
Benefits carried out, commands for the community at large
certain economic benefits
Orientation Speculation focuses its Gambling often focuses its
& Focus attention on taking up attention on making people
business dealings that run recklessly after easy and
carry risks and make quick money
profits in a systematic
manner. It does not
encourage people to
engage in a blind and
thoughtless search for
quick and easy gain
Social Speculation is considered Gambling is condemned as
Welfare useful to the producers anti-social and illegal
and others connected with
stock exchanges
Rationality Speculation is based on Gambling is based on blind
knowledge and foresight chance without any rational
regarding anticipated price basis
changes
Agreement Speculators’ agreement is The gambler’s agreement is
not void but enforceable void in law and is not
enforceable
Legality Speculation is a lawful Gambling is an unlawful
activity and is enforceable activity
in a court of law
INVESTORS VS . SPECULATORS
Similar to the fact that speculators are different from gamblers, they also
differ from investors as shown below:
Feature Investors Speculators
Genuineness Investors have a genuine Speculators indulge
intention of buying and in buying and selling
selling securities based on securities for the
the price quotations— purpose of making
selling for the purpose of profits arising from
realizing cash and buying future price
for the purpose of getting movements
an income
Sp ecu l a t i on 473
Feature Investors Speculators

Safety More concerned with the More concerned with
safety of funds invested in the appreciation of
securities his capital and quick
profits
Delivery A genuine investor makes A speculator does not
an immediate settlement make any immediate
after the conclusion of the settlement of the
trade trade, viz. making
payment or receiving
payment, etc
Type Investors can be small There are different
investors and others type of speculators
such as bulls, bears,
etc
In practical terms, there is hardly any difference between a pure

speculator and a pure investor. Every speculator is, to a certain extent, an
investor too. Similarly, even a pure investor would think in terms of
increasing his capital and making quick profits. The difference between
the two is, therefore, a matter of degree.
TYPES OF SPECULATORS
Speculators in a stock market are of different types. They carry their names
depending on their motive of trading in the stock exchange. They are
named after animals as their behavior could be compared best with the
behavior of animals.
Bull
A speculator on the stock exchange who expects a rise in the price of a
certain security is known as a ‘bull’. He is so called because of the tendency
of the bull to throw his victim up in the air. Accordingly, he indulges in
buying the security (without taking actual delivery) in order to sell it in
future at the expected higher price. He is therefore, a potential seller, as
he, having bought a security, must necessarily sell it to reap his profit.
In local stock exchange parlance, a bull is known as a ‘tejiwala’. He
is considered to be an optimist hoping for an increase in the price of a
security and in technical terms he is said to be “on the long side of the
market”.
The share market is said to be ‘bullish’ when it is dominated by an

expectation of a rise in price. In a bullish market, the general atmosphere is
one of optimism. Sometimes, when the purchases made by the speculators
exceed the sales made by them, i.e. there is an over-bought condition in
the market and the bulls begin to spread rumors about a rise in the prices.
This is known as a ‘bull campaign’.
Illustration
1. A speculator asks his broker to buy for him 1000 shares of a
particular company at Rs. 100 each, which he will not have to pay
for it at once
2. He would order his broker to immediately sell the shares at Rs.
120 where the price has risen even before the arrival of the day
fixed for settlement
3. He would make a profit of Rs. 20 per share and thus make a total
profit of Rs. 20,000
4. Where the price does not rise up above the contracted buying
price, then he would incur a loss as he may have to sell much
below the bought price and in such an eventuality he has the
option of terminating the contract and thereby materialize the
loss or carry it forward to the next settlement day by paying
‘contango charge’
5. Thus, the active involvement of a bull speculator spurs up the
stock market activity and a bull pressure is built up, which
automatically causes rise in the price of a security
Bear
A speculator who expects a fall in the price of the security of a company is
known as a ‘bear’. He is called as ‘mandiwala’ in local stock exchange
(BSE) parlance. A bear speculator would aim at taking advantage of an
expected fall in the price, at which time he would sell (give delivery) on a
fixed date, such securities that he may or may not possess. Where the
price of the security goes down much before the date of delivery he would
buy the security at a lower price and sell at a higher price thus making a
profit. Where, however, the price of the security in question rises by the
date of delivery, he would have to buy the shares at a higher price from the
market to deliver (sell) them at a lower price as per the agreement. In such
an eventuality, he would suffer a loss.
The market becomes ‘bearish’ when there is a strong expectation of a
fall in the share prices. Where, the speculative sales made by the bear
Sp ecu l a t i on 475
speculators exceed the purchases made by them, they may spread rumors
to bring the price down. This is known as a ‘bear raid’.
Illustration
1. A speculator asks his broker to sell for him 1000 shares of a
particular company at Rs. 100 each, which he will not have to
deliver at once
2. He would order his broker to immediately buy the shares at
Rs. 80 where the price has come down even before the arrival of
the day fixed for settlement
3. He would make a profit of Rs. 20 per share and thus make a total
profit of Rs. 20,000
4. Where the price does not go down below the contracted selling
price, then he would incur a loss as he may have to buy much
above the sold price and in such an eventuality he has the option
of terminating the contract and materialize the loss or carry it
forward to the next settlement day by paying ‘backwardation
charge’
5. Thus the active involvement of a bear speculator brings down
the stock market activity and a bear pressure is built up which
automatically causes decrease in the price of a security
Lame Duck
Where a speculator finds it difficult to meet his commitments immediately,
he is said to be a ‘lame duck’. Accordingly and as stated above, a bear
speculator may agree to sell a certain security on a fixed date but may find
it difficult to deliver the security as it may not be available in the market at
his expected price.
Stag
A speculator who applies for shares in a new issue like a genuine investor
but with the intention of selling the shares at a later date at a premium is
known as a ‘stag’. He neither buys nor sells securities, but merely applies
for shares of a new company as if he were a genuine investor. He waits for
the price of the scrips to go up immediately after the issue of shares and
this is why he is popularly called the ‘premium-hunter’. His profit is equal
to the difference between the price paid by him and the price at which he
sells his allotment.
Although the stag operates cautiously, it may turn out that he may
also run into the risk of loss where the public response is lukewarm and
that he is not in a position to offload his holdings at a premium and instead

the price rules at a discount. In such a case, the stag may have to sell the
shares at a loss. When the stags begin to sell, the price naturally suffers a
further decline.
REVIEW QUESTIONS
Section A
1. What is a speculation?
2. Who is a ‘stag’?
3. Who is a ‘lame duck’?
Section B
1. How does a speculative activity different from gambling?
2. How are investors different from speculators?
3. Who is a ‘bull’? Illustrate the activity of a bull speculator.
4. Who is a ‘bear’? Illustrate the activity of a bear speculator.
Section C
1. Discuss the different types of speculators on a financial market.
Chapter 23
On-line Stock Trading
The Internet has been the sole evolving tool in the present century, that
affects almost every aspect of everyday life. The uniting force of the
internet, which is changing classic business and economic paradigms,
embodies electronic transformation. Commercial interaction is symbolized
by newer and better methods used in more ingenious ways, than before to
harvest a bumper crop of resultant benefits.
The advent of the internet into the trading of securities has heralded
the growth in the methods of application of the new mode to develop new
models, aimed at encouraging market development in tandem with the rest
of the computer literate world. While some countries do seem to have
incorporated the American method of recognizing the alternative trading
systems on the Internet as additional trading floors and regulating them
separately from the other modes of trading, other countries are for creating
order routing systems to their existent trading systems and regulating
them as another mode of conducting transactions. In India, on-line stock
trading facility is offered by capital market intermediaries like ‘Sharekhan’,
‘Kotak Securities’, ‘ICICI Securities’, etc.
MEANING
Method of trading in securities whereby information about securities,
brokers, dealers, prices, etc are communicated through the official websites
of concerned stock exchanges so as to facilitate buying and selling of
securities, is known as ‘Internet Stock Trading’.
FEATURES
A method of trading in securities whereby, it is possible for the investors
to buy and sell scrips through the internet is called ‘Internet Trading’. It is
also called ‘On-line Trading’. The trading takes place under the ‘Order
Routing System (ORS)’ through registered stockbrokers on behalf of
clients for execution of trades on stock exchanges. The buy/sell orders
can be executed on the investors’ computers by the brokers filter. The
internet trading has been put in place under the auspices of the SEBI.
All the necessary safety and integrity measures are adhered to in the
transactions. For this purpose, the stock exchanges must ensure that the
systems used by brokers have provision for security, reliability and
confidentiality of data through the use of encryption technology. In this
regard, it is incumbent on the part of the brokers to enter into an agreement
with clients spelling out all obligations and rights. The exchanges also are
required to ensure that the brokers have a system-based control on the
trading limits of clients and exposures taken by them. The brokers on the
other hand must set predefined limits on the exposure and turnover of
each client.
CURRENT SCENARIO
At present, conventional securities exchanges are using the internet
primarily as a tool for disseminating a variety of information to the public,
and for advertising their products and services. In this connection, it is to
be noted that stock exchanges in India have already set up their own
websites and provide market information. Even in exchanges around the
world, information on individual security prices, trading volume, contract
terms, trading mechanisms, margin requirements and exchange rules are in
some cases dealt with through a general description, and in other cases
through comprehensive information. Some exchanges’ websites contain a
list of exchange members. Some exchanges provide information on the
listed companies, either in total or in specific market segments. Only a few
exchanges use the Internet to provide access to information filed with the
exchanges by listed companies.
In addition to communicating with the public, exchanges and other
market infrastructure providers are using the internet for communicating
with their members. Exchanges use the Internet as part of their market
infrastructure. It is therefore, possible for an exchange to provide links
between broker-dealers and the exchange for order transmission, trade
execution, and clearance and settlement.
INTERNET TRADING—ALTERNATIVES
Worldwide, internet trading is usually one of the two forms:
Alternative Trading System (ATS)
Alternative Trading System provides investors with additional proprietary
electronic trading facilities for securities that are traded principally on stock
exchanges or other organized markets. ATSs carry out price discovery
functions. In addition, they also serve as order-matching systems, besides
serving as crossing systems using prices already established in organized
markets such as securities exchanges (e.g. closing price).
On-l i ne Stock Tradi ng 479
Order Routing System (ORS)

An effective Order Routing System takes advantage of cutting edge
technology to bring an unprecedented level of efficiency to the order flow
process. It involves the utilization of technology to route orders of the
investors to the brokers reducing any time lag between their order and its
execution on the exchange.
INTERNET TRADING—SOME ISSUES
There are many issues that comprise the on-line trading mechanism called
the ‘Internet Trading’. They are discussed as under:
Examining Alternative Trading System
The feasibility of introducing the alternative trading system for the purpose
of internet trading is examined as follows:
Recognized stock exchanges According to the Securities Contracts
(Regulation) Act, 1956 that deals with regulation and control of contracts
in securities, a contract in securities can be entered and performed only as
per the provisions of SC(R) Act. This implies that the contracts in securities
other than spot delivery contracts have to be done under the auspices of
a Regional Stock Exchange.
Under Section 23 (1) of the SC(R) Act, carrying out the activities of
buying and selling of securities in places other than the (RSE) is considered
unlawful. Accordingly, the following are considered unlawful which attract
punishment:
a. Owning or keeping a place other than that of a RSE which is used
for the purpose of entering into or performing any contracts in
contravention of any of the provisions of this Act; or
b. Managing, controlling, or assisting in keeping any place other
than that of a RSE which is used for the purpose of entering into
or performing any contracts in contravention of any of the
provisions of this Act; or
c. Joining, gathering or assisting in gathering at any place other
than the place of business specified in the byelaws of a RSE, any
person or persons for making bids or offers or for entering into or
performing any contracts in contravention of any of the provisions
of this Act
Therefore, the issue here is whether to treat ATS as an exchange or
Additional Trading Floor (ATF).
Stock Exchange or Recognized Stock Exchange

Section 2(f) of the SC(R) Act, 1956 defines a 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.”
Section 2(f) of the SC(R) Act, defines a Regional Stock Exchange
(RSE) as “a stock exchange that is recognized by the Central Government
or SEBI under Section 4 of the SC(R) Act.”
In order that a stock exchange becomes a RSE, an application in the
prescribed manner has to be made to the Central Government or SEBI. In
addition, a copy of the byelaws of the exchange and the rules by which the
constitution of the stock exchange are to be governed, have to be submitted
to the Central Government or SEBI.
The Central Government or SEBI pursues the application and also
the byelaws and rules of the exchange before deciding and granting
recognition to the applicant stock exchange. The Central Government or
SEBI can require the applicant to satisfy the conditions that it may impose
regarding the rules and regulations of the stock exchange in terms of the
qualifications of members of the exchange, the manner in which contracts
shall be entered into between members of the exchange, the representation
of the Government on the Board of the exchange and the maintenance of
accounts, by the members of the exchange and the audit of such accounts.
SEBI Conditions
According to the SEBI’s press release dated December 10, 1996,
recognition of new stock exchanges would be allowed subject to the
following conditions:
1. That the exchange begins trading only after the introduction of
on-line screen based trading
2. That the exchange makes rules, regulations and byelaws with
adequate provisions for investor protection, with the approval
of SEBI and thereafter strictly follows them
3. That the exchange establishes a clearing house within 6 months
from the date of recognition
If all the conditions are satisfied, SEBI grants recognition to the
exchange subject to such conditions, as it deems appropriate. The Central
Government or SEBI has the power to withdraw recognition granted to an
exchange in the interest of trade or in public interest. In this regard, Section
8 of the SC(R) Act requires periodical reports to be submitted to SEBI by
the RSE.
Additional Trading Floors

Section 13A of the SC(R) Act, 1956, allows a RSE to establish Additional
Trading Floors (ATFs) with prior approval from SEBI. The Act defines the
term ‘trading floor’ as, “a trading ring or trading facility offered by a RSE
outside its area of operation to enable the investors to buy and sell
securities through such trading floor under the regulatory framework of
that stock exchange.” In terms of Section 13, all contracts in securities
within a state where there is a RSE would be void unless the transaction is
between members of such RSE.
Alternative Trading System
ATS provides additional trading facilities to investors in the secondary
markets. In this regard, ATS matches orders to buy or sell stock in specific
quantities at specific prices in private transactions between customers,
who may be brokers, institutions or individuals. ATS are exchange like
entities that trade securities. ATS, which assist in dealing in securities
through order matching or execution of trades, will fall within the ambit of
the definition of “stock exchange” in terms of Section 2(j) of the SC(R)
Act. The trading facility of an ATS, which matches the orders and enables
the investors to buy and sell securities would come within the definition
of a stock exchange or additional trading floor and can be treated as such.
Therefore, an ATS has to comply with such requirements as mentioned in
the law relating to stock exchanges or additional trading floors.
Thus, ATS which provides a mechanism for entering into a contract
in securities, assisting in the execution of contracts, order matching,
recording contracts, adjusting rights or liabilities arising out of securities
contract, will amount to assisting or organizing or entering or the
performance of the contract in securities and, will be treated as a stock
exchange in the eyes of the law. Therefore, any transaction through an
ATS would be within Section 19 and Section 23(1)(e), (f), (i) unless the
ATS takes permission from the Central Government for providing trading
facilities under Section 19 or seeks and procures recognition as RSE
under Section 4 of the SCR Act, in which case all the requirements of
being a stock exchange would also have to be satisfied. Alternatively,
the ATS can be treated as Additional Trading Floors with the approval
of SEBI under Section 13A and brought under the regulatory framework
applicable to a stock exchange for which it seeks to act as a trading floor
or ring.
All or None, Cross and Negotiated Deals

SEBI has banned all negotiated deals in securities including cross deals
and requires that such deals are executed only on the screens of the
exchanges in the price and order matching mechanism of the exchanges.
Similarly, all or none and negotiated deals are banned at present by SEBI
and such transactions could be routed through the ATSs in the guise of
regular orders. Thus, the recognition of ATSs as entities separate from the
RSE would create a route to by-pass the requirements of these circulars.
In the United States, an obligation is cast on the broker to quote a
price to his client that is based on the best price in the nation. However, no
such requirement is prevalent in Indian law and if the ATS were recognized,
the interest of investors would not be safeguarded. In USA there is a
restriction on a broker from undertaking proprietary transactions on their
own account except in case of dealers on the NASDAQ. However, in India
a broker can act as a principal on his own account after fulfilling the
requirements of disclosure and confirmation as specified under Section 15
of the SC(R) Act. Without liquidity or depth, the ATS will be unable to
discharge its function of price discovery, which is an essential function of
a stock exchange. Hence, the investors trading through the ATS may not
be able to avail the best price. Further, without any infrastructure or
mechanisms for clearing and settlement, the ATS will have no mechanism
to enforce the contract.
Kerb Deals
Kerb deals are transactions in securities between members of stock
exchanges carried on after the official close of trading hours on the
exchange. Under the byelaws of the RSE in India, trading after official
trading hours is prohibited. Such trading can come within the ambit of
Section 23(1)(i) of SC(R) Act. In the absence of any regulation, ATS may
become a vehicle for such deals. If the ATS is to be permitted as RSE or
ATS, it is for consideration whether a similar restriction in respect of trading
hours should be imposed. Twenty-four hour trading is prevalent mainly in
International exchanges or commodities exchanges. The above issue arises
in the context of protecting and providing equality and fairness for all. All
the market players should have equal opportunity to hedge, if there is any
material information available after the official closing of trading hours.
Over-The-Counter Contracts
Under section 16(1) of SC(R) Act, no person without permission of Central
Government can enter into any contract for sale or purchase of securities
other than such spot delivery contract or contract for cash or hand delivery
or special delivery in any securities as is permissible under the SC(R) Act
and the rules, byelaws and regulation of a RSE. Therefore, entering into
contracts such as OTC contracts in securities or contracts other than
through RSE or spot delivery are prohibited.
Clearing Houses / Trade Guarantee Fund
All RSEs were required to establish a clearing house or a clearing
corporation by June 30, 1996 in terms of the provisions of the circular of
SEBI. Further all the exchanges were also advised to settle all their
deliveries through the clearing houses. SEBI has also directed all stock
exchanges to set up Trade or Settlement Guarantee Funds. ATS that
provide on-line trade matching will also have to set up a clearing house
and trade guarantee funds.
Price
In India, securities are required to be listed in such RSE whose name is
mentioned in the offer document in terms of Section 73 of the Companies
Act, 1956. Further, securities can be traded in other RSE as permitted
securities. However, there seems to be no restriction of issuing prices
established in main stock exchanges by other stock exchanges. In USA,
ATS are permitted to use the price established in securities exchanges.
Listing of Securities on ATS
Section 73 of the Companies Act, 1956 requires every company intending
to offer shares or debentures to the public for subscription by the issue of
a prospectus, to make an application to one or more of the RSE for
permission for the shares or debentures to be dealt with on that or those
stock exchanges. The stock exchanges are required to grant such
permission within a period of ten weeks of closing the subscription lists,
failing which the company has to repay all the money collected in the
issue within eight days.
Section 21 of the SC(R) Act states that where securities of a body
corporate are listed on a RSE it has to comply with the conditions of the
listing agreement. Thus all issues of securities by issue of a prospectus
are governed by the listing agreement with the stock exchange. Further
Rule 19 of the SC(R), lays down the form of application for listing of
securities with a RSE and also lays down the conditions based on which
the RSE is to make a decision on listing or refusal to list the said securities.
This rule ensures the protection of the right to liquidity of any investor
who invests in the securities listed on the stock exchange. One of these
requirements is the use of a common form of transfer. Besides, it is also

required that the company shall issue to its investors letters of allotment
and right issue receipts for securities deposited with it for registration,
subdivision, exchange or other purposes, issue renewal/consolidation
certificates when required.
The issue, therefore, is that whether the ATS will be a mechanism
only for matching trades and the securities, which are to be traded on the
ATS, and which need to be listed by entering into an agreement with such
companies. If only a trading facility is to be provided without the listing of
those securities being necessary or satisfied, the same may not be in the
interest of investors as the company whose securities are to be traded in
ATS will be under no obligation to give information to ATS which may
affect price of such securities traded in ATS.
U.S. Experience
ATS have been developing outside conventional securities markets and
are now multiplying. They provide investors with additional proprietary
electronic trading facilities for securities that are traded principally on
securities exchanges or other organized markets. Some ATS have price
discovery functions, others serve as matching systems, and still others
serve as crossing systems using prices already established in organized
markets such as securities exchanges (e.g. closing price). Investors using
ATS may be able to lower their transaction costs.
The ATS that currently exist in the United States are closed systems.
However, they are not generally accessible to the public through the
Internet. For emerging ATS, the Internet could be used to increase order
flow by providing new participants with easier access to their trading
systems. In December 1998, the Securities and Exchange Commission
(SEC) introduced a new scheme whereby, it requires an ATS to either
(i) register with the SEC as a national securities exchange in accordance
with the Securities Exchange Act of 1934, or (ii) register as a broker-
dealer and comply with new requirements pursuant to Regulation ATS
and related rules.
In USA, nine ECNs (Electronic Communication Network) operate as
market participants within the NASDAQ network. These alternative trading
systems (ATS) display either one or two-sided quotes, which reflect actual
orders, and provide institutions and market makers with an anonymous
way to enter orders into the marketplace. ECNs foster competition among
market makers, further enhancing the market’s liquidity.
In order to be approved, ECNs must meet three requirements:

1. Each ECN must be a registered broker/dealer and an NASDAQ
member
2. Each ECN must be approved by the SEC as an alternative trading
member (ATS)
3. Each ECN must agree to NASDAQ contractual terms on how to
operate its link into the NASDAQ network
Fundamental to the new structure in the United States, is an expanded
interpretation of the term “exchange” accompanied by exemptions from
the exchange definition that enable ATS to choose their regulatory status
either as an exchange or as a broker-dealer with additional requirements
that address the market-like functions of the ATS. As adopted, regulation
of ATS also includes volume based requirements that provide for increasing
levels of regulatory obligations as ATS’s trading volume rise. This
incremental approach is intended to promote the regulatory goals of the
SEC while preserving the “commercial viability” of the ATS.
Necessity of ATS/ ECN In India
There are some advantages of ATS/ECN such as efficiency in execution
of trade, reduction of costs and execution of trade anytime. Whereas, in
USA the ATS/ECN was developed in stages as under, in India the
situation is different. All the 24 stock exchanges have become electronic,
i.e. they have on-line screen based trading where orders can be matched
automatically. The scale of brokerage and the cost of transactions have
also come down. With effect from 8.10.1999, SEBI has allowed all the
stock exchanges to extend terminals to any place. It is therefore, felt that
there is a need to avoid fragmenting the market so as to ensure that all
should follow the same rules. A broader, deeper market is good for
investors because it increases liquidity and price transparency. The
necessity of permitting ATS as RSE in India should be considered in the
light of above. It may also be necessary to consider whether ATS is to be
allowed for trading only for some limited players such as QIBs. It is also
for consideration whether ATS is to be allowed for securities, which are
not listed in any RSE. Further, the other issue is whether restriction on
trading hours should be removed and the investors should be allowed
to transact and hedge their risk all 24 hours in a day, which is necessary
in case of international market.
Concluding Remarks
In view of the provisions of the SCR Act, especially, Sections 2(f), 13, 13A,
19 and Section 23, an ATS cannot operate without seeking recognition as
a stock exchange or as additional trading floor after satisfying all the legal
requirements therefor. Further, permitting an ATS to function, as a stock
exchange without proper regulation and safeguards will not be in the
interest of general investors or the securities market. The ATS cannot be
used for specialized products like OTC and other contracts, in view of the
1969 notification. Thus, permitting ATS to act as stock exchange in Indian
scenario would require review of some policies and notifications. Further,
in view of the fact that in India all the stock exchanges have electronic on-
line trading facility, the necessity of permitting ATSs/ECNs as RSE should
be considered.
Examining Order Routing System
The feasibility of introducing the Order Routing System (ORS) for Internet
Trading is examined below:
An order routing system is one that directs orders from a client terminal
to the stock exchange terminal or a system which routes matched orders to
the stock exchange terminal or to that of a broker. In light of the above,
policy decisions need to be taken whether:
1. The system should be such that the order is matched at the stock
exchange terminal or at the order routing system
2. The system should merely forward orders received by it to the
exchange’s facility
3. The system should forward orders received by it to broker terminals
Order to be Routed Through a Member?
Section 13 prohibits trading in securities between persons other than the
members of the recognized stock exchanges. The only exception to this
provision is envisaged in Section 18, which permits any person to enter
into transactions in securities on a spot delivery basis, i.e. the delivery of
shares and the consideration pursuant to such a transaction has to be
completed within 48 hours of the transaction being entered into.
According to Section 23(1) the following persons are not eligible for
carrying out trading and hence shall be punishable:
1. Person who is not a member of a RSE or his agent authorized as
such under the rules or byelaws of such stock exchange or not
being a dealer in securities licensed under Section 17 willfully
represents to or induces any person to believe that contracts can
be entered into or performed under this Act through him; or
2. Person who is not a member of a RSE or his agent authorized as

such under the rules or bye-laws of such stock exchange or not
being a dealer in securities licensed under Section 17, canvasses,
advertises or touts in any manner either for himself or on behalf
of any other person for any business connected with contracts
in contravention of any of the provisions of this Act
Further, Section 12 of the SEBI Act, 1992 also bars any person from
dealing in securities unless such a person is registered with SEBI as a
stockbroker. As per the SC(R) Act, contracts in securities other than trades
on a spot-delivery basis have to be entered and performed under the
auspices of a RSE through a member of such RSE. Thus, in case of the
ORS, the order has to be executed on a RSE and through a member of that
RSE.
UK Experience
Similar to the requirement in Section 12 of the SEBI Act, is the provision of
Section 3 of the Financial Services Act 1986, which states that any person
who carries on investment business in the United Kingdom must be
authorized to do so. The definition of “investment business” includes
dealing or arranging deals in, managing or giving advice on investments.
“Authorization” generally involves becoming a member of one of the
recognized Self Regulating Organizations or Recognized Professional
Bodies unless specific exemption is available.
In practice, it is unlikely that an access and/or site provider will be
conducting investment business if it merely acts as a conduit through
which persons or companies gain access to a presence on the internet and
where it has no knowledge of, or control over, the information or service
being provided.
The position under the Act may be less clear if an access and/or site
provider is commercially involved with an investment firm for whom
they are providing access or a site. Access and/or site providers may
need to consider their position under Section 3 of the Act if, for example,
they were to:
1. Provide access and/or an off-the-shelf internet site over which
they had control of what was placed on the site or the nature of
information about investments or investment services provided
2. Have a joint venture arrangement with someone carrying on
investment business—such as a firm providing share dealing
3. Services for whom they had provided access and/or a site
4. Promote an investment service under their own name; or

5. Promote another person’s investment service or put investment
material on the internet
Contract Notes
In India, contract notes are required to be issued to the clients by the
brokers in terms of the byelaws of the stock exchanges introduced pursuant
to the SEBI circular dated 04.02.91. Further, the contract notes to be issued
by brokers to clients in terms of the SEBI circular are at present issued in
writing and delivery is manual or by post. Further, such contract note
should contain price, brokerage, time of execution, provisions regarding
arbitration, etc. When orders are to be issued through the ORS, a system
for issue and delivery of such contract notes through the same medium
may be an issue for consideration while framing the policy.
Confirmation in Writing
Section 15 of the SC(R) Act prohibits members from entering into contracts
as principles with persons other than members unless the consent or
authority is secured, in writing. If the consent is secured in a manner other
than in writing, the confirmation shall be secured within three days from
the date of the contract.
Rule 9 of the SC(R) Rules, 1957, states that all contracts in securities
between members of the RSE shall be confirmed in writing. Even though
the order is routed through the ORS, confirmation in writing would be
required. Thus, in case of routing orders through the ORS, all the above
legal requirements have to be complied with.
Electronic Contract Notes
The Stock Exchange of Singapore (SES) has enhanced its Electronic Trade
Confirmation (ETC) system to include the provision of Electronic Contract
Notes (ECN). Singapore brokers already utilize the ETC system. However,
they need to provide hardcopy contract notes to their clients. The
introduction of electronic broker confirmations makes the SES trade
confirmation system fully automated. As such, brokers no longer have to
send out paper contract notes to their institutional clients.
Margins
The SEBI requires that all members of a RSE have to pay marked to market
margins, special margins, additional volatility margins and carry-forward
margins as may be applicable to them. The stock exchanges also impose
gross exposure margins and net exposure margins. On the introduction of
the ORS, it will become necessary for increased monitoring of transactions

by the RSE for the computation and imposition of these margins.
Data Base
The stock exchanges require that their members maintain databases of
their clients, for which they design client introduction forms and ask the
members to get them filled. In case of an ORS, the responsibility of members
increases greatly. Further, a record of the time when the client places the
order is required to be maintained by the member of the RSE and the same
has to be reflected in the contract note alongwith the time of execution of
the order. This requirement also affects the implementation of the ORS, in
that these requirements would still have to be met by the members.
Jurisdiction
In case of a dispute in respect of an order routed through an ORS, the
question may arise as to which forum will have jurisdiction to resolve the
dispute, i.e. the place from where the order was placed or the place where
the order is executed. If the forum of arbitration is provided in the place
where the order is executed, a client may have to travel a long way. This
may not be in the interests of investors.
Maintenance of Books
Under Rule 15 of the SC(R) Rules, 1957, duplicates of contract notes,
written consent of the clients, members contract book, sauda book, etc
have to be maintained and preserved for a specified period. Thus under
the ORS system, a member has to generate a hard copy of the contract and
preserve duplicate copies as prescribed in the SC(R) Rules and the SEBI
(Stock Brokers and Sub-Brokers) Regulations, 1993.
Security of Information
At present the Indian laws do not envisage the security of internet
information. However, the draft E-commerce Act focuses on this issue and
prescribes the requirements like passwords, net certificates, signatures,
etc which will play an important role on the authenticity of such information,
gathered from the internet. These requirements will also have to be met by
internet traders on the stock exchanges regardless of whether the ORS or
the ATS is adopted in the Indian context.
The NSE and Internet Stock Trading
NSE in one of its brochures states that the exchange plans to introduce
trading of stocks on the internet after obtaining all necessary approvals.
The trading members have to create web pages for retailers to access
them. The members will in turn channelise these orders into the NSE trading
system for order matching. Thus, NSE only seeks to use internet for order
routing, which is permissible subject to the fulfillment of the requirements
stated in this note.
Concluding Remarks
In case of the ORS being adapted to the Indian situation, the possibility
within the existing structure would permit the routing of orders through
the internet to the broker’s terminal, which would then key in the order in
the exchange’s terminal. Thus, the internet can be used as an order routing
system through the registered stock broker on behalf of a known client for
the execution of trades in RSE. Necessary safeguards such as passwords,
etc need to be introduced. However, the laws in respect of physical issue
of contract notes and presentation of documents, etc will be required to be
reviewed.
REGULATING INTERNET STOCK TRADING
Pr os pe c t us
Section 56(1) of the Companies Act, 1956 states that the matter specified
in Part I of Schedule II of the Companies Act, have to be disclosed in a
prospectus to a public issue. Section 56(3) states that no one shall issue
any form of application for securities, unless a memorandum containing
salient features of a prospectus accompanies such form.
Rule 19(2)(b) of the SC(R) Rules provides that at least 25 percent of
each class of securities be offered to the public for subscription through
advertisement in the newspaper for a period not less than two days and
the allotment shall be made fairly and unconditionally.
Section 64 states that any company that allots or agrees to allot shares
with a view to offering them to the public, “any document by which the
offer for sale to the public is made shall, for all purposes, be deemed to be
a prospectus of the company and all enactments and rules of law as to the
contents of the prospectus shall apply to the ...” In view of this, the
disclosures and rules governing prospectuses are applicable to all forms
of advertisements for public subscription in companies.
Further, under Section 69(3) of the Companies Act, the amount payable
on application on each share shall not be less than 5 percent of the nominal
value of the share. Under Section 73(3), all monies received from applicants
for a share shall be kept in a separate bank account maintained with a
scheduled bank.
Section 72(5) of the Companies Act restricts the revocation of an

application till the expiry of five days after the time of opening of
subscription lists. Such revocation is also possible if a person responsible
for the issue of the prospectus issues a public notice to the effect and in
such a situation, the restriction of five days does not apply.
Thus, a company seeking to issue its shares through the internet has
to comply with the provisions relating to the issue of the prospectus,
advertisement, application form accompanying memorandum, minimum
application money, minimum period for which issue is to remain open, etc.
U.S. Experience
The basic rules concerning the registration and issuance of securities is
covered by the 1933 Act. The 1933 Act, not only applies to the Initial
Public Offering (IPO) but also any further issuance of securities. As a
general rule, the 1933 Act requires that any securities must be registered
with the SEC prior to offering the securities to the public. This not only
applies to stocks but also bonds and any other type of security.
A registration statement is to be filed approximately 45 days prior to
the date the company intends to begin selling the securities (the effective
date). Once the registration statement is filed, the communication with
potential investors must be by prospectus only. Between the filing of the
registration statement and the effective date, there may be an ongoing
dialog between the company and the SEC with the object of making changes
in the preliminary prospectus. When the SEC finally approves the
registration statement, the company may begin selling the securities.
Private placements and Small Corporates Offering Registration (SCOR)
offerings are exempt from the filing requirements of the SEC. Although,
SCOR offerings must be registered under the Blue Sky laws with each
state in which it intends to sell the stock, and one short form does need to
be filed with the SEC notifying them of the offering.
The 1934 Act provides the framework under which the company may
communicate non-offering material with investors. The Act also mandates
the filing of periodic reports with the SEC, besides false or misleading
statements. It imposes civil liability for those statements.
The internet and electronic media have opened up the door for the
Internet IPO. In October 1995, the SEC decided that information that can
be delivered in paper under the federal securities laws might be delivered
in electronic format. In May 1996, the SEC made it clear that electronic
distribution of documents would benefit investors and issuers through a
faster and cheaper means of communication. According to the SEC, quick
and broad access to material information was a fundamental concept of
the reporting laws.
Underwriter’s Role
Traditionally, an initial public offering (IPO) is brought out by underwriters.
They draft the prospectus and assist with the filings. They solicit interest
from investors who might be interested in the IPO. They determine the
price at which the shares can be sold. In a true underwriting they purchase
the shares of stock from the company at the offering price (less the
underwriters’ discount). They then sell the stock to investors.
However, with the growing popularity of the internet, many
companies are in a position to go public with an IPO without the
assistance of an underwriter. A case in point was the ‘Spring Street
Brewery IPO’ in which the SEC allowed the offering to proceed as one,
which was made solely through electronic documents. Despite this, it is
still desirable to use an underwriter or a broker/dealer to help market the
IPO securities if you can get one.
The Internet IPO issuer faces liability for false or misleading oral or
written statements in connection with a solicitation to sell stock. In a
traditional IPO the investors purchase their stock from the underwriter
and not from the company. The purpose of e-IPO is to enable investors to
make informed decisions regarding the purchase of the stock by the full
disclosure in the prospectus for the IPO.
IPOS ON THE INTERNET—INDIAN EXPERIENCE
Section 11 of the Securities and Exchange Board of India Act, 1992, imposes
a duty on the SEBI to protect the interests of investors in securities and to
promote the development and to regulate the securities market, by such
measures as it thinks fit. In pursuance of this provision and after Ordinance
No. 9 of 1992 by which the Capital Issues (Control) Act has been repealed,
the Board issued guidelines for disclosure and investor protection
regarding the share issues and other matters pertaining to the protection
of the rights of investors in securities. The Disclosure and Investor
Protection Guidelines and the SEBI (Merchant Bankers) Regulations
provide for the filing of offer documents with SEBI. The observation of
SEBI if given within 21 days has to be included in offer document.
E-IPO PROSPECTUS
The IOSCO has recommended that general antifraud provisions should
apply to all offers and advertisements involving securities or financial
services, regardless of the medium and whether a regulator or SRO is
involved in approving the offer or advertisement.
In India, the offering of securities other than the private placements

has to be done as per SEBI DIP Guidelines. Offering of securities through
internet may amount to soliciting to general public and SEBI guidelines
pertaining to public issue would be applicable. At present, the Indian laws
include within the meaning of the term prospectus; any document by
which the offer for sale to the public is made” by a company which allots
or agrees to allot any shares or debentures. The mode of making such
document public has not been stipulated. Therefore, at present it is possible
to include within the meaning of this term, the publishing of the contents
of a prospectus through the internet. However, Section 66 of the Companies
Act, recognizes newspaper advertisements of a prospectus and states
that such advertisements need not specify the contents of the memorandum
or the signatories thereto, or the number of shares subscribed for by them.
The issue for consideration therefore, is whether the information
contained in a website of a company regarding an IPO would be a
prospectus. Section 2(36) defines a prospectus as “any document
described or issued as a prospectus and includes any notice, circular,
advertisement, or other document inviting deposits from the public or
inviting offers from the public for the subscription or purchase of any
shares or debentures of, a body corporate.” Therefore, the meaning of the
term would need to be amended to include the information contained in
the website before deeming the same to be a prospectus.
Conversely, if the internet is viewed as merely a mode of delivery of
the information contained in a prospectus, then the information on the
internet could be considered to be an advertisement of the prospectus.
If the contents of a website on the internet was to be deemed a
prospectus within the meaning of the term in Section 64, then, any material
a company puts on its website as promotion of an IPO, would be subject
to the provisions of the Companies Act, 1956. The published material
could amount to a violation of the provisions governing the contents of
the prospectus and if the information posted on the website is in the
nature of an advertisement to the prospectus, then the Companies Act,
1956 may be amended to include advertisements being other than newspaper
advertisements. Further, if a company and its officers make false or
misleading statements in order to fraudulently induce investors to purchase
shares then there may be a violation of Section 68 of the Companies Act,
1956.
Under SEBI book-building guidelines, it is specified that bidding shall
be permitted only if an electronically linked transparent facility is used.
Use of internet can be permitted for such bidding subject to safeguards
such as passwords, etc. In case of an offering through the internet, the

question is whether application can be made or entertained through the
electronic media. As stated above, the requirement of the Companies Act
as mentioned below has to be complied with:
1. An application form should contain abridged prospectus
2. Minimum amount has to be paid with the application
3. Money to be kept in separate account till listing permission is
given
4. Investors right to withdraw their application to be protected
5. Collection of money and mandatory collection centers—collection
agent cannot collect money in cash, etc
Even if the issue is fully subscribed the offering on the internet has to
remain open for a minimum of two days as per the provisions of the SC(R)
Act. Besides, the above, a company has to comply with disclosure
requirements as contained in the Disclosure and Investor Protection
Guidelines of SEBI. The merchant banker has to comply with the
requirements in the SEBI (Merchant Bankers) Regulations and observe
due diligence in respect of the offer documents.
E-COMMERCE ACT AND INTERNET STOCK TRADING
The Electronic Commerce Act, 1998 (the Act) seeks to provide legal
infrastructure governing electronic contracting, security and integrity of
electronic transactions, the use of digital signatures and other related
issues.
According to Section 3 of the Act, the purposes of the Act are:
1. To facilitate electronic communications, commerce and filing
2. To establish uniform rules and standards regarding the
authentication and integrity of electronic records
3. To create legal infrastructure for the use of digital records and
signatures
Section 4 of the Act provides that Part II (relating to electronic records
and signatures) or Part IV (relating to electronic contracting) shall not be
applicable to any law requiring writing or signature, inter-alia, in the
following circumstances:
1. The execution of negotiable instrument
2. The creation or enforcement of an indenture, declaration of trust
or Power of Attorney
3. Documents of title for movable or immovable property
The Act recognizes that for certain categories of transactions, hand

written signatures are more appropriate and therefore the same cannot be
dispensed with. Central Government has been authorized to delete or add
any class of transactions for which ‘written’ or ‘signature’ requirement
will continue. In case of internet trading, the requirement of payment by
cheque or other negotiable instrument will continue. Further, under Income
Tax Act payment over Rs. 20,000 has to be through crossed cheque.
Section 4 further provides that the electronic records shall not be
liable to stamp duty. This is on the line of Depository Act. It further provides
that it shall be lawful to transmit and receive records electronically.
Section 5 of the Act provides that parties involved in generating,
receiving, storing or processing electronic records observe the provisions
of Part II or Part IV of the Act. In case of internet trading, the stock exchange
or SEBI may, if deem fit, specify the model agreement to be entered into by
the broker with the client so as to foster uniform practice.
Section 6 seeks to give legal recognition or evidentiary weight to
electronic records and electronic signatures. It provides that electronic
records and signatures shall not be denied legal effect, validity or
enforceability solely on the ground that they are in electronic form. Thus,
electronic records and signatures are sought to be accorded the same
treatment as paper records and signatures. In case of internet trading, this
would facilitate issue of electronic contract note, etc.
Section 7 provides that where any law requires any matters to be in
writing that requirement is met by an electronic record if the matter contained
therein is accessible so as to be usable for subsequent reference. This
provision seeks to legally recognize the use of electronic ‘writings’ through
e-mail, the internet and other electronic records transmitted over networks
in electronic contracting.
Section 8 provides that where any law requires that the record shall
bear a signature that requirement will be met if the identity of the originator
and the method indicate the originator’s approval of the information
contained in electronic record. This section intends to remove any doubt
regarding the enforceability of electronic signatures.
Section 9 requires that if the rule of law requires the record to be
presented or retained in original form an electronic record meets that
requirement if that record is capable of being displayed to the person to
whom it is being presented. It provides that an electronic record will
constitute an original provided that there exists a reliable assurance as to
the integrity of the information.
Section 10 provides that the electronic records and electronic

signatures shall be admitted as evidence in legal proceedings not
withstanding anything contained in the Indian Evidence Act, 1872. It also
lays down the standard for determining evidentiary weight of electronic
records and electronic signatures. The court cannot refuse to admit any
electronic record or electronic signatures into evidence solely on the ground
of its electronic format or on the ground that it is not in original.
Section 11 provides that if any law provides that certain documents,
records or information be retained whether permanently or for a specific
period, that requirement is satisfied by retaining them in the form of electronic
records, if information in the electronic record remains accessible so as to
be usable for subsequent reference, and, is retained in the format in which
it was originally generated or which can be demonstrated to represent
accurately information originally generated. Sub-clause (d) of Section 11
of the Act provides that nothing in this section shall preclude any
department, Ministry or Central Government or State Government or any
statutory corporations from specifying additional requirement for the
retention of electronic record that are subject to its jurisdiction. In case of
internet trading, SEBI or stock exchanges may specify additional
requirement in case of electronic record.
Sections 12 and 13 deal with ‘secure’ electronic records and ‘Secure’
electronic signatures. It provides that the records that qualify as secure
electronic records or signatures are accorded the presumptions set forth
in Section 14. An electronic record or signature is to be deemed secure if
it is possible to verify the integrity of the record or signature through
security procedure. Under Section 14 it is provided that in civil proceedings
the secure electronic signatures affixed to an electronic record the signature
of the person objectively identified as the signer by application of the
applicable qualified security procedures.
Section 15 deals with formation and validity of electronic contracts.
It recognizes electronic records as a means of forming contract. It provides
that offer and acceptance may be accomplished through the use of electronic
exchange. It provides that electronic contracts are enforceable agreements
formed through the use of electronic agents.
Section 16 provides that originator and addressee of the original
record shall make a declaration that they shall not deny legal effect, validity
or enforceability solely on the ground that agreement is in the form of an
electronic record. In case of internet trading, the client or the broker should
make declaration that they shall not deny validity of electronic record or
enforceability.
Section 17 lays down the circumstances when the electronic record

can be deemed to be originated from the originator. This section provides
a framework for attributing electronic records to specific persons.
Section 18 specifies that many electronic transactions may require
acknowledgment of the receipt of electronic records. If an electronic record
is conditional on receipt of acknowledgement, transmission shall be treated
as if it were never sent if no acknowledgement is received. In case of
internet trading such requirement of acknowledgement may be specified.
Section 19 deals with the manner of determining the time and place of
despatch and receipt of an electronic record.
Section 20 deals with the situations in respect of applicable law in
case of dispute. It is provided that it may be decided in accordance with
the rule of law designated by parties as applicable to the substance of
dispute. The above position is similar to Section 28 of the Arbitration and
Conciliation Act, 1996.
Section 21 provides that an electronic record that is signed with
digital signatures shall be treated as a secure electronic record.
Part X of the Act deals with acceptance and use of electronic records
and electronic signatures by governmental entities. This provision
authorizes any department or Ministry to accept electronic filing of
documents and to issue permits, licenses or approvals electronically.
If the Act were given the shape of the law it would pave the way for
reliable electronic contract including the transactions in securities through
internet, which can be enforced. The law will make possible the admissibility
of electronic records and electronic signatures as evidence in legal
proceedings.
Under Section 11, sub-section (d) statutory authorities are not
precluded from specifying the additional requirement for the retention of
electronic records that are subject to its jurisdiction. Therefore, in respect
of retention of electronic records the additional requirement can be specified
by SEBI or the stock exchanges. Further, under Section 18, by law it can be
specified that an electronic record is conditional on receipt of
acknowledgement.
Thus, electronic transmission of any transaction in respect of any
securities requires acknowledgement of receipt of electronic records.
Further under section 4, the requirement of certain paper-based
transactions has not been dispensed with. In other words, the law applicable
such as the execution of negotiated instruments, document for title for
movable properties, declaration of trust or Power of Attorney shall be
continued to be in writing or should contain the signature. Thus, the

enactment of Electronic Commerce Act would pave the way for safe and
secure contracts in securities through electronic medium including internet.
It will also provide the legal framework for validity and enforceability of
electronic documents and signatures. In case of electronic trading
generation of physical papers can be dispensed with. This, however,
requires that certain provisions of SC(R) Rules and SEBI (Stock Brokers
and Sub-Brokers) Regulations, which require retention of certain
documents, issue of contract notes, etc are scrupulously.
REVIEW QUESTIONS
Section A
1. What is ‘on-line stock trading’?
2. What is ‘Alternative Trading System’ (ATS)?
3. What is ‘Order Routing System’ (ORS)?
4. What is a trading floor?
5. What are ‘kerb deals’?
6. What are over-the-counter contracts?
7. What are ‘contract notes’?
Section B
1. What are the features of ‘on-line stock trading’?
2. Explain the working of ‘Alternative Trading System’ (ATS).
3. How is listing of securities done at the ATS?
Section C
1. Discuss the different forms of internet stock trading.
2. Identify and discuss the major issues concerning the internet
stock trading.
3. Bring out the US experience with regard to the working of the
ARS.
4. How is internet stock trading regulated? Elaborate.
5. Examine the Indian experience as regards IPOs on the internet.
6. Evaluate the scope of E-commerce Act on the internet stock
trading.
Chapter 24
Debt Market
A market where fixed income securities of various types and features are
issued and traded is known as a ‘debt market’. Fixed income securities
include securities issued by central and state governments, municipal
corporations, government bodies and commercial bodies such as financial
institutions, banks, public sector units, public limited companies, etc. The
securities are structured in nature.
ADVANTAGES
To Investors
Investment in fixed income securities is advantageous to investors in the
following manner:
Steady income An important advantage of the fixed income securities
is that they ensure steady and constant return by way of interest and
repayment of principal at the maturity of the instrument. Further, investors
are assured of a dependable income.
Safety Fixed income securities are issued by eligible entities of standing
against the moneys borrowed by them from the investors. This guarantees
safety of funds invested on these securities. Moreover, such debt is usually
secured against the assets of the company.
Risk-free Some of the fixed income securities such as government
securities offer a risk-free return on the investors’ moneys. The default on
such securities is zero or near zero. Besides, there is a sovereign guarantee
on those instruments.
To Financial System
Following are the benefits accruing to the Indian financial system on
account of the debt market:
1. Reduction in the borrowing costs thus facilitating mobilization
of resources at reasonable costs
2. Providing greater funding avenues to public and private sector
projects thereby reducing pressure on institutional financing
3. Enhanced resource mobilization by unlocking illiquid retail

investments like gold
4. Development of heterogeneity of market participants
5. Assisting in the development of a reliable yield curve
RISKS ON DEBT
Debt instruments are exposed to the following type of risks:
Default Risk
Default risk also known as credit risk refers to the risk of inability of the
issuer to make prompt payment of the interest and the principal amount.
Interest Rate Risk
The risk emerging from an adverse change in the rate of interest prevalent
in the market so as to affect the yield on the existing instrument is known
as ‘interest rate risk’. An investor would run a risk of having to lose in a
situation where there is a sudden upswing in the prevailing interest rate
scenario where he has already invested his money.
Reinve stment Rate Risk
The risk arising from the probability of a fall in the interest rate resulting in
a lack of options to invest the interest received at regular intervals at
higher rates or comparable rates in the market is known as ‘reinvestment
rate risk’.
Counter-p arty Risk
The risk arising from the failure or the inability of the opposite party to the
contract to deliver either the promised security or the sale value at the time
of settlement is known as ‘counter-party risk’.
Price Risk
The risk arising from the possibility of not being able to receive the expected
market price of the debt instrument, due to an adverse movement in price
is known as ‘price risk’.
ISSUERS PROFILE
Fixed income securities can be issued by almost by any legal entity like
corporate business houses, banks, financial institutions, municipal
corporations, central and state governments, public bodies, statutory
corporations, etc.
Deb t Ma rket 501
TYPES
The type of instruments that are traded in the debt market include the
following:
G ov e rn m en t Sec u ri tie s
Securities of central and state governments include:
• Zero coupon bonds
• Coupon-bearing bonds
• Treasury bills
• STRIPS
Public Sector Bonds
Bonds that are issued by public sector entities such as government
agencies, statutory bodies, public sector bodies, etc include the following:
• Government guaranteed bonds
• Debentures
• PSU bonds
• Commercial paper
Private Sector Bonds
Bonds that are issued by private sector entities such as corporates, banks,
financial institutions, etc include the following:
• Debentures
• Bonds
• Commercial paper
• Floating rate bonds
• Zero coupon bonds
• Intercorporate deposits
• Certificates of deposits
Exhibit 9 shows the profile of debt instruments.

Exhibit 9 Profi le of Debt Instrument
ROLE OF BOND MARKET

Bond market plays an important role in the economic development of a
country in the following manner:
1. Efficient mobilization and allocation of financial and other
resources in the economy
2. Financing the development activities of the government
3. Transmitting signals for the implementation of various monetary
and other policies of the central bank of the country
4. Facilitating the efficient liquidity management in tune with the
overall short-term and long-term objectives of the economic
planning
PRICE DETERMINATION—FACTORS
The price of a bond in the markets is determined by the operation of the
forces of demand and supply. The bond price is influenced by the following
factors:
1. General economic conditions
2. Money market and capital market conditions
3. Political and social conditions
4. Credit quality of the issuer
5. Interest rate prevalent in the market
6. The rates of new issues
Deb t Ma rket 503
YIELD OF BOND
Yield refers to the percentage rate of return paid on a bond in the form of
interest. It is the effective rate of interest paid on a bond or a note. Yield to
Maturity (YTM) is the most popular method of measuring the bond yield.
YTM refers to the percentage rate of return paid on a bond, note or other
fixed income security if the instrument is bought and held till maturity
date. The YTM is calculated on the basis of coupon rate, length of time to
maturity and the market price. It is the IRR of the bond and is identified as
that trial rate of interest at which the issue price of the bond is equated
with the sum of the present value of future cash flows (debt service
payments—interest and the principal) of the bond.
Current yield is the coupon rate divided by the market price and this
gives an approximation of the present yield.
YIELD AND PRICE
Yield and the market price of the bond are inversely related. Accordingly,
a rise in price will decrease the yield and a fall in the bond price will
increase the yield. There will be an immediate and predictable effect on the
price of bonds with every change in the level of interest rate.
Where the prevailing interest rate in the market rises, the price of
outstanding bonds will fall to equate the yield of older bonds in line with
the higher-interest new issues. This happens as there will be few takers for
the lower interest coupon bonds. This results in fall in prices. The price fall
will be to the extent where the same yield is obtained on the older bonds as
is available for the newer bonds. Conversely, where the prevailing interest
rates fall, the price of outstanding bonds will rise until the yield of older
bonds is low enough to match the lower interest rate on the new bond
issue.
On account of such factors as market rate of interest, coupon rate of
interest and the time to maturity, the value of a bond will keep varying
throughout its life and therefore, likely to be either higher or lower than the
original face value.
SECONDARY DEBT MARKET
The market where bonds are bought and sold is known as the ‘secondary
debt market’. Its segments are as follows:
Wholesale Debt Market
This comprises of institutions and agencies such as banks, financial
institutions, RBI, primary dealers, insurance companies, provident funds,
mutual funds, corporate entities, and foreign institutional investors. The

two type of transactions that are executed in a wholesale debt market are
an outright sale or purchase and a repo trade. Stock exchanges offer order-
driven screen based trading facilities for government securities. The trading
activity on the system is however restricted with most trades today being
put through in the brokers’ offices and reported to the exchange through
their electronic system which provides for reporting of ‘Negotiated Deals’
and ‘Cross Deals’.
Settlement The settlement for the various trades is finally carried out
through the SGL account of the RBI except for transfers between the
holders of constituent SGL account in a particular bank or institution like
intra-account transfers of securities held at the banks and CCIL.
As regards broker-intermediated transactions, the settlement
responsibility for the trades in the wholesale market is primarily on the
clients and the broker has no role to play in the same. The member has
only to report the settlement details to the exchange for monitoring
purposes. The exchange reports the trades to RBI regularly and monitors
the settlement of these trades.
Trading modules The GILT permits trading in the wholesale debt
market through the following modules:
a. Order Grabbing System which provides for active interaction
between the market participants in keeping with negotiated deal
structure of the market
b. Negotiated Deal Module which permits the reporting of trades
undertaken by the market participants through the members of
the exchange
c. Cross Deal Module which permits reporting of trades
undertaken by two different market participants through a single
member of the exchange
Retail Debt Market
This comprises of individual investors, small trusts and other legal entities,
besides participants in the wholesale market.
REPOS AND NORMAL BUY OR SELL
An outright buy or sell transaction is one where there is no intended
reversal of the trade at the point of execution of the trade. The buy or sell
transaction is an independent trade and is no way connected with any
other trade at the same or a later point of time.
Deb t Ma rket 505
A repo is ready forward trade transaction where the said trade is

intended to be reversed at a later point of time at a specified rate. The rate
will include the interest component for the period between the two opposite
legs of the transactions. In a repo transaction one participant sells securities
to another with an agreement to purchase them back at a later date. The
trade is called a ‘repo transaction’ from the view point of the seller and it is
called a ‘reverse repo’ from the view point of the buyer.
Repos facilitate creation of liquidity by permitting the seller to avail of
a specific sum of money (value of the repo trade) for a certain period in lieu
of payment of interest by way of the difference between the prices of the
two trades.
Repos and reverse repos are commonly used in the money markets as
instruments for short-term liquidity management. They are also called as a
collateralized lending and borrowing mechanisms. Banks and financial
institutions usually enter into reverse repo transactions to manage their
reserve requirements or manage liquidity.
BROKEN PERIOD INTEREST
The concept of broken period interest or the accrued interest arises where
interest on bonds are received after certain fixed intervals of time by the
holder who enjoys the ownership of the security at a certain point of time.
Therefore, an investor who has sold a bond, which makes half-yearly
interest payments three months after the previous interest payment date,
would not receive the interest due to him for these three months from the
issuer. The interest on these three previous months would be received by
the buyer who has held it for only the next three months but receives
interest for the entire six months as he happens to be holding the security
at the interest payment date.
Therefore, in the case of a transaction in bonds occurring between
the two interest payment dates, the buyer would pay interest to the seller
for the period from the last interest payment date up to the date of the
transaction. The interest, thus calculated, would include the previous
date of interest payment but would not include the trade date.
GUIDELINES FOR ISSUE OF DEBT INSTRUMENTS
Following are the guidelines that must be adhered to, by a listed corporate
enterprise offering convertible/non-convertible debt instruments through
an offer document:
Credit Rating
1. No public or rights issue of debt instruments (including
convertible instruments) in respect of their maturity or conversion
period shall be made unless credit rating from a credit rating
agency has been obtained and disclosed in the offer document
2. In respect of a public/rights issue of debt security greater than or
equal to Rs. 100 crores, two ratings from two different credit
rating agencies shall be obtained and such ratings including the
unaccepted credit ratings, shall be disclosed
3. All the credit ratings obtained during the three years preceding
the public or rights issue of debt instrument (including convertible
instruments) for any listed security of the issuer company shall
be disclosed in the offer document
Deben ture Tru stee
1. Appointment In case of issue of debenture with maturity of more
than 18 months, the issuer shall appoint a debenture trustee. The names of
the debenture trustees must be stated in the offer document.
2. The trust deed A trust deed shall be executed by the issuer
company in favor of the debenture trustees within six months of the closure
of the issue.
3. Trustee powers Trustees to the debenture issue shall be vested
with the requisite powers for protecting the interest of debenture holders
including a right to appoint a nominee director on the Board of the company
in consultation with institutional debenture holders.
4. Certificate The merchant banker shall, alongwith the draft
offer document, file with the Board, certificates from their bankers that the
assets on which security is to be created are free from any encumbrances
and the necessary permissions to mortgage the assets have been obtained
or a No Objection Certificate from the financial institutions or banks for a
second or pari passu charge in cases where assets are encumbered.
5. Trustee duty
a. To ensure that the lead financial institution/investment
institution monitors the progress in respect of debentures
raised for project finance/modernization/expansion/
diversification/normal capital expenditure
b. To ensure that the lead bank for the Company monitors
debentures raised for working capital funds
Deb t Ma rket 507
c. To obtain a certificate from the company’s auditors in respect

of utilization of funds during the implementation period of
projects and in the case of debentures for working capital,
certificate shall be obtained at the end of each accounting
year
d. To ensure that debenture issues by companies belonging to
the groups for financing replenishing funds or acquiring
share holding in other companies are not permitted
e. To supervise the implementation of the conditions regarding
creation of security for the debentures and debenture
redemption reserve
Debenture Redempti on Reserves (DRR)
Creation A company has to create DRR in case of issue of debenture
with maturity of more than 18 months. The issuer shall create DRR in
accordance with the provisions given below:
a. If debentures are issued for project finance DRR can be created
up to the date of commercial production
b. The DRR in respect of debentures issued for project finance may
be created either in equal installments or higher amounts if profits
so permit
c. In the case of partly convertible debentures, DRR shall be created
in respect of nonconvertible portion of debenture issue on the
same lines as applicable for fully nonconvertible debenture issue
d. In respect of convertible issues by new companies, the creation
of DRR shall commence from the year the company earns profits
for the remaining life of debentures
e. Company shall create DRR equivalent to 50 percent of the amount
of debenture issue before debenture redemption commences
f. Draw from a DRR is permissible only after 10 percent of the
debenture liability has actually been redeemed by the company
g. The requirement of creation of a DRR shall not be applicable in
case of issue of debt instruments by infrastructure companies
Treatment DRR shall be treated as a part of general reserve for
consideration of bonus issue proposals and for price fixation related to
post-tax return.
Distribution of Dividends
1. In the of case of new companies, distribution of dividend shall
require approval of the trustees to the issue and the lead
institution, if any
2. In the case of existing companies prior permission of the lead
institution for declaring dividend exceeding 20 percent or as per
the loan covenants is necessary if the company does not comply
with institutional condition regarding interest and debt service
coverage ratio
3. Dividends may be distributed out of profit of particular years
only after transfer of requisite amount to DRR. If residual profits
after transfer to DRR are inadequate to distribute reasonable
dividends, company may distribute dividend out of general
reserve
Redemption
The issuer company shall redeem the debentures as per the offer document.
Creation of Charge
1. The security shall be created within six months from the date of
issue of debentures
2. If for any reasons the company fails to create security within 12
months from the date of issue of debentures, the company shall
be liable to pay 2 percent penal interest to debenture holders
3. If security is not created even after 18 months, a meeting of the
debenture holders shall be called within 21 days to explain the
reasons thereof and the date by which the security shall be created
4. If the issuing company proposes to create a charge for debentures
of maturity of less than 18 months, it shall file with the Registrar
of Companies particulars of charge under the Companies Act
5. Where no charge is to be created on such debentures, the issuer
company shall ensure compliance with the provisions of the
Companies (Acceptance of Deposits) Rules, 1975, as, unsecured
debentures/bonds are treated as “deposits” for purposes of these
rules
6. The proposal to create a charge or otherwise in respect of such
debentures, may be disclosed in the offer document alongwith
its implications
Deb t Ma rket 509
Letter of Option
A letter of option containing disclosures with regard to credit rating,
debenture holder resolution, option for conversion, justification for
conversion price and such other terms which the Board may prescribe
from time to time shall be filed with the Board through an eligible merchant
banker, in the following cases:
Roll over of NCDs and PCDs The nonconvertible portions of
PCD/NCD issued by a listed company, value of which exceeds Rs. 50
lakhs, can be rolled over without change in the interest rate subject to the
following conditions:
a. An option shall be compulsorily given to debenture holders to
redeem the debentures as per the terms of the offer document
b. Roll over shall be done only in cases where debenture holders
have sent their positive consent and not on the basis of the non-
receipt of their negative reply
c. Before roll over of any NCDs or non-convertible portion of the
PCDs, a fresh credit rating shall be obtained within a period of six
months prior to the due date of redemption and communicated to
debenture holders
d. Fresh trust deed shall be executed at the time of such roll over
and fresh security shall be created in respect of such debentures
to be rolled over where the existing trust deed or the security
documents provide for continuance of the security till redemption
of debentures fresh security may not be created
Conversion of instruments into equity capital
a. In case, the convertible portion of any instrument such as PCDs,
FCDs, etc issued by a listed company, value of which exceeds
Rs. 50 lakhs and whose conversion price was not fixed at the time
of issue, holders of such instruments shall be given a compulsory
option of not converting into equity capital
b. Conversion shall be done only in cases where instrument holders
have sent their positive consent and not on the basis of the
nonreceipt of their negative reply
c. Where issues are made and cap price with justification thereon,
is fixed beforehand in respect of any instruments by the issuer
and disclosed to the investors before issue, it will not be
necessary to give option to the instrument holder for converting
the instruments into equity capital within the cap price
d. In cases where an option is to be given to such instrument holders

and if any instrument holder does not exercise the option to
convert the debentures into equity at a price determined in the
general meeting of the shareholders, the company shall redeem
that part of debenture at a price which shall not be less than its
face value, within one month from the last date by which option
is to be exercised. The provisions above shall not apply if such
redemption is to be made in accordance with the terms of the
issue originally stated
Conversion of debentures issued under consent of CCI
a. In case, the value of convertible portion of any instrument such
as PCDs, FCDs, etc issued by a listed company exceeds Rs. 50
Lakhs and where in terms of the consent issued by the Controller
of Capital Issues, the price of conversion of PCDs/FCDs is to
be determined at a later date by the Controller
b. Such price and the timing of conversion shall be determined at a
general meeting of the shareholders subject to the consent of the
holders of PCDs/FCDs; for the conversion, terms shall be
obtained individually and conversion will be given effect to only
if the concerned debenture holders send their positive consent
and not on the basis of non-receipt of their negative reply
c. Such holders of debentures, who do not give such consent, shall
be given an option to get the convertible portion of debentures
redeemed or repurchased by the company at a price, which shall
not be less than face value of the debentures
d. Where the consent from the Controller of Capital Issues stipulates
cap price for conversion of FCDs/ PCDs, the board of the
company may determine the price at which the debentures may
be converted
e. In case of issue of debentures fully or partly convertible made in
the past and where the conversion was to be made at a price to be
determined by the CCI at a later date, the price of conversion and
time of conversion shall be determined by the issuer company in
a meeting of the debenture holders, subject to the following:
1. The decision in the said meeting of debenture holders may
be ratified by the shareholders in their meeting
2. Such conversions shall be optional for acceptance on the
part of individual debenture holders
Deb t Ma rket 511
3. The dissenting debenture holders shall have the right to

continue as debenture holders if the terms of conversions
are not acceptable to them
f. Where issue of PCDs and FCDs is made pursuant to the consent
given by the Controller of Capital Issues and the consent specifies
the timing of conversion but the price of conversion of PCDs/
FCDs is to be determined at a later date, the following shall be
complied with:
1. The consent of the shareholders is to be obtained only for
the purposes of fixing the price of conversion and not for
the pre-poning and postponing the timing of the conversion
approved by CCI
2. The conversion price shall be reasonable (in comparison
with previous conversion price where the terms of the issue
provide for more than one conversion) and the conversion
price shall not exceed the face value of that part of the
convertible debenture, which is to be converted
3. In cases where an option is to be given to the debenture
holders and, if any debenture holder does not exercise the
option to convert the debentures into equity at a price
determined in the general meeting of the shareholders, the
company shall redeem that part of debenture at a price which
shall not be less than its face value within one month from
the last date by which option is to be exercised
g. In cases of issues of debentures fully or partly convertible,
irrespective of value made in the past, where conversion was to
be made at a price to be determined by CCI and the consent order
does not provide for a specific premium or a cap price for
conversion, the draft letter of option to the debenture holders
filed with the Board shall contain justification for the conversion
price
Othe r Re qu ir em en ts
1. No company shall issue FCDs having a conversion period of
more than 36 months, unless conversion is made optional with
“put” and “call” option
2. If the conversion takes place at or after 18 months from the date
of allotment, but before 36 months, any conversion in part or
whole of the debenture shall be optional at the hands of the
debenture holder
3. No issue of debentures by an issuer company shall be made for

acquisition of shares or providing loan to any company belonging
to the same group and this shall not apply to the issue of fully
convertible debentures providing conversion within a period of
18 months
4. Premium amount and time of conversion shall be determined by
the issuer company and disclosed
5. The issuer company can freely determine the interest rate for
debentures
Additional Disclosures
The offer document shall contain the following additional disclosures:
1. Premium amount on conversion, time of conversion
2. In case of PCDs/NCDs, redemption amount, period of maturity,
yield on redemption of the PCDs/NCDs
3. Full information relating to the terms of offer or purchase including
the name(s) of the party offering to purchase the khokhas
(nonconvertible portion of PCDs)
4. The discount at which such offer is made and the effective price
for the investor as a result of such discount
5. The existing and future equity and long-term debt ratio
6. Servicing behavior on existing debentures, payment of due interest
on due dates on term loans and debentures
7. That the certificate from a financial institution or bankers about
their no objection for a second or pari passu charge being created
in favor of the trustees to the proposed debenture issues has
been obtained
REVIEW QUESTIONS
Section A
1. What is a debt market?
2. What is bond yield?
3. What is a wholesale debt market?
4. What is a retail debt market?
5. What is a ‘repo’?
6. What is a ‘reverse repo’?
7. State the concept of ‘broken period interest’
8. Who are debenture trustees?
9. How is ‘debenture redemption reserve’ created?
Deb t Ma rket 513
Section B
1. What are the advantages of a debt market?
2. Bring out the types of risk associated with the debt as a financial
instrument.
3. What are the various types of debt instruments?
4. State the role of debt market in the economic development of a
country.
5. How is the price of a debt instrument determined?
6. Explain the working mechanism of wholesale debt market.
7. What are the SEBI guidelines relating to the issue of debt
instruments by a corporate entity?
Index
A Association of Mutual Funds of India
(AMFI) 40
A cap 104 Association of Securities 177
A floor 104 At-the-money option 104
Abid Hussain Committee 51 Atlay Committee 420
Acceptance 11 Auction markets 16
Account freezing 455 Auction Tender Notice 224
Ad-hoc margins 436 Auction Trading System 196
Additional market-makers 348 Audit Committee 443
Additional market-making 356 Australian Stock Exchange Ltd’
Additional trading Floors 481 (ASX) 177
Additional volatility margins 436 Authorized clerks 182
Adjustable rate mortgage (ARM) 12 Automated Lending and Borrowing
Advisory services 250 Mechanism (ALBM), 443
Ahmedabad Shares and Stock Brokers Automatic daily margin 436
Association 178
Alternative Trading System 478 B
American Civil War 166
American Depository Receipts B.D. Shah Committee 438
(ADRs) 265 B2 group 37
American option 104 Backwardation 438
American Stock Exchange 11, 176 Backwardation charge 475
Amex 176 Bad Delivery 364
Amex Composite Index 403 Badla 39, 433
Application Acknowledgement Slip Badla system 437
361 Bank draft 11
Arbitrage 108, 418 Bank of Bengal 166
Arbitrageurs 108, 230 Bank of Bombay 166
Arbitration 146 Bankers 11
Ariel 18 Bankers Receipts (BR) 35
Ask price 199 Bankers to an issue 277
Asset Backed Securities 59 Banking system 13
Asset Management Companies Banks’ exposure 442
(AMCs) 39, 74 Basle Committee 120
Bear 474
Bear raid 475 BSE-SENSEX 378

Bearer debentures 55 Building Investor Confidence 134
Bearish 474 Bull 473
Bengal Bonded Warehouse 166 Bull operator 437
Best Governing Practices 133 Bulldog Market 19
Best Rate Order 430 Buyouts 34
Bid analysis 262
Bid price 199 C
Bid-ask bounce 395
Bids 261 ‘C’ group scrip 219
Birla Committee of Corporate C-STAR (CSE Screen Based Trading
Governance 303 And Reporting) 231
BL – 250 index 388 Calcutta Stock Exchange 230
Blank transfer 419 Calcutta Stock Exchange Association
Blue Chip companies 354 178, 231
Bolsa de Madrid 176 Call option 103, 417
BOLT (BSE-On-Line-Trading) 218 Call option contract 103
Bombay Forward Contracts Control Campus LANS 228
Act 78 Cancel the certificate of registration
Bombay On Line Trading (BOLT) 77 284
Bombay Securities Control (BSCC) Capital gains bond 65
78 Capital Issues Advisory Committee
Bombay Stock Exchange 7, 165 79
Bond market 502 Capital Issues Control Act 79
Bonds 14 Capital market 6, 21, 69
Bonus Issues Method 259 Capital market instruments 47
Bonus shares 259 Capital Redemption Reserve Account
Book closure 435 48
Book-building 38, 323 Carry-over margin 436
Book-building Method 261 Cash Reserve Ratio (CRR) 14
Book-runner 261 CCIL 504
Bought-out deal 266, 318 Central Bank 14
Broken period interest 505 Central clearing banks 359
Broker 11, 183, 415 Central Depository services Ltd 448
Broker-dealer 199 Central Depository Trust 88
Brokerage firms 9 Certificate of Accruals on Treasury
Brokers and jobbers 183 Securities (CATSs) 61
Brokers to the issue 279 Certificates of Deposit 354
Brokers/ dealers 17 Chartered 166
BSE 37 Chukada 226
BSE BANKEX 389 Circuit breaker 37
BSE National Index 378 Circuit filters 215, 443
BSE SENSEX 65 Clause 49 134
BSE TECk 378 Clearing Corporation 195
BSE-PSU Index 378 Clearing Houses 418, 483
I n d ex 517
Closing prices 219 Counter party default 195

CM (Clearing Member) 222 Counter receipt 350, 359, 360
CNX Nifty Junior 391 Counter-party risk 500
Collar 104 Credit lines 12
Collateral security 14 Credit rating 506
Collective Investment Schemes (CIS) Credit Rating Information and
126 Services India Limit 31
Commercial paper 10 Credit risk 500
Commercial paper market 10 Credit unions 8
Committee on Corporate Governance Cross Deal Module 504
37 Cross Deals 504
Commodity exchange 174 Currency Swaps 98
Commodity linked bonds 34 Customer’s Protection Fund (CPF)
Companies Act in 1850 178 147
Companies formed by conversion of
partnership firm 294 D
Company Fixed Deposits 53
Compensation Committee 264 Daily margins 436
Composite Index to Market Dave Committee 343, 349, 356
Capitalization 372 Dealer Trading System 197
Composite issues 293 Dealers 185
Compulsory market-making 355 Debenture Redemption Reserves 507
Compulsory Rolling Settlement Debenture Trustees 281
(CRS) Segment 219 Debentures 14, 55
Computer-to-Computer Link (CTCL) Debentures and Bonds 55
239 DebtMarket(WDM)7,
Confirmation Memo 143 233,
Confirmation memo - Form ‘C 143 499
Connected Persons 158 Debt portfolio 110
Contact note 431 Debt securities 14
Contango 438 Deemed Connected Persons 158
Contango charge 474 Deep Discount Bonds 33
Contract Note - Form ‘A 143 Default Risk 500
Contract Note - Form ‘B 143 Defaulters committee (DC), 147, 148
Contract notes 488 Defence of India (DOI) 79
Convertible Debentures 56 Defence of India Rule 94-C 78
Copenhagen Stock Exchange 176 Delhi Regional Clearing House 77
Cornering 419 Delivery and Receive Orders 225
Corporate bond 12 Delivery Instruction Slip 457
Corporate equity 11 Delivery out 144, 222
Corporate securities 28 Delivery-versus-Payments 245
Corporate stock 5 Demat account 144, 455
Council of Associated Stock Dematerialization 447, 450
Exchanges 176 Department of Company Affairs
Counter deals 359 (DCA) 41
Department of Economic Affairs 265 Electronic Trade Confirmation (ETC)

Depositories Act, 1996 32, 140 488
Depository 26, 447 Electronic Trading 451
Depository institutions 8 Electronic transmission 497
Depository market 8 Eleventh day 263
Depository Participant (DP) 144, Employees Stock Option Scheme
222, 448 264
Depository Participants (DPs) 280 Empress Maria Theresa 175
Depository services 447 Encash bond 65
Derivative 92 Enforceability risk 119
Derivatives 37, 91 Englishman 166
Derivatives Policy Group (DPG) 120 ‘Equipref’ Shares 33
Derivatives Trading 229 Equity 14
Detachable warrants 50 Equity financing 29
Development Financial Institutions Equity market 7
(DFIs) 15, 40 Equity Shares 49
Differential pricing 291 Escrow account (Primary issue
Director General of Technical account 257
Development 80 Euro Convertible Bonds 62
Directorate of Stock Exchanges 425 Euro currency market 58
Discount houses, acceptance houses, Euro Issues 34
bill market, 6 Euro market 19
Dividends 11 Eurobond Market 7
Docking Company 166 Eurobonds 7
Domestic arbitrage 418 European Deposit Receipts 34
Domestic market 19 European option 104
Double option 417 European Stock Exchange 34
Dow Jones Global Indices 375 Exchange Traded Fund (ETF) 241
Dow Jones Industrial Average 397 Exchange-traded options 34
Draft prospectus 262, 329 Exclusive Listing 348
DRR 507 Exit Route Scheme 219
Due diligence certificate 273 Export-Import Bank of India (EXIM
Bank) 16
E External market 19
E-Commerce Act 494 F

E-IPO 492
East India Company 166, 178 Factoring 30
ECNs (Electronic Communication FCDs 511
Network) 484 Federal Reserve Board of US 427
Electronic book 227 Federation of Indian Stock Exchanges
Electronic Commerce Act 494 (FISE) 42
Electronic Data Information Filing and Fee-based activity 318
Retrieval 39 FII route 37
Electronic Fund Transfer System 43 Financial assets 8
I n d ex 519
Financial capital 13 Gilt-Edged Market 27

Financial instruments 9 Gilts 354
Financial market 1 Global Depository Receipts (GDRs)
Financial risk 91 26, 34, 265
Financial sector liberalization 26 Global Finance Diary 376
Financial security 14 Gorwala Committee 81, 420
Financial services market 7 Government securities 15
Financial swaps 96 Government Securities market 27
Firm allotment 261 Graded margin system 437
Firm Underwriting 309 Graded system of market making 356
Fixed rate payer 98 Green field ventures 200
Fixed-rate 12 Grey market 321
Fixed-rate mortgage 12
Flat margin 439 H
Floating rate bonds 58, 61
Floor price 323 Half commission men 182
Foreign arbitrage 418 Hand delivery 431
Foreign Currency Convertible Bonds Harshad factor 35
(FCCBs) 26, 34 HCL, Comment 373
Foreign market 19 Hedge 98
Foreign Venture Capital Investors Hedgers 108, 230
(FVCIs) 38 Hedging 417
FORTUNE 500 Index 404 House requirements 427
Forward contracts 95 Hybrid trading system 197
Forward dealing 420
Forward delivery contract 417
I
Forward Rate Agreement (FRA) 100 IDBI 16
Frank Russell - 3000 Index 404 Immediate or Cancel Order 430
Fully Fault Tolerant Stratus Machine Implicit interest 10
373 In-the-money option 104
Fund-based activity 266, 318 Income Bonds 59
Fungible 460 Index bond 65
Futures and options 349 Index Committee 379
Futures contracts 100 Index Divisor 380
Index funds 242
G Index options 38
G.S. Patel Committee (GSPC) 87,439 Indexed Bonds 60
Gambling 471 India Index Services Limited 411
General Insurance Corp. of India Indian Money Market 13
(GIC) 200 Indian Stock Exchanges Services
Geneva 176 Corporation (ISES) 42
Gerstenberg 309 Indigenous bankers and moneylenders
Gestation period 321 14
GILT 504 Industrial Credit and Investment
Corporation of India 313
Industrial Development Bank of India Investment Corporation of India Ltd

313 313
Industrial Finance Corporation of Investor Awareness Program 148
India (IFCI) 15 Investor protection 139
Industrial securities 15 Investor Service Cell 232
Industrial Securities Market 28 Investors 472
Information Systems Department Investor’s Grievance Redressal
(ISD) 220, 221 Committee 146
Infrastructure bonds 65 Investor’s or Customer’s Protection
Infrastructure Development Finance Fund 147
Corporation 290 Investors’ Services Cell (ISC) 141,
Infrastructure Leasing and Financing 142, 145
Services Ltd. 290 Invest OTC Card 347
Initial 256 IPOs 492
Initial Counter Receipt 361 IRR 503
Initial listing 301 Irredeemable Debentures 56
Initial margin 427
Initial Public Offer (IPO) 227, 256 J
Initial Public Offering (IPO) 491
Initiated debentures 355 J.R. Varma Committee 440
Insider Information 158 Jobbers 184, 415
Insider trading 70, 157 Joint underwriting 310
Insider Trading Menace 187 Junk Bonds 60
Institute of Chartered Accountants of
India (ICAI) 288
K
Insurance 8 K.B.Chandrasekhar Report on
Integrated stock exchange system 42 Venture Capital Funds 37
Interconnected Stock Exchange of Kerb deals 482
India 203 kerb trading 425, 430
Interest rate risk 500 KLD-NASDAQ Social Index 402
Interest rate swaps 98 Kumar Mangalam Birla Report 37,
Internal market 19 133
International 120
International Association of Insurance L
Supervisors 120
International market 19 Lame duck 475
International Organization of Last-in-first 296
Securities Commission 39, 135 Lead book runner 328
International Securities Consultancy Lead Merchant Banker 258, 288
(ISC) 233 Legal risk 119
Internet 477 Letter of credit 11
Internet Stock Trading 477 Letter of offer 258
Internet Trading 477 Letter of option 509
Investigative services 250 Level I subscribers 368
Investment Committee 443 Level II subscribers 368
Investment companies 313
I n d ex 521
Level III subscribers 368 Memorandum of Association 50

Leveraged Buyout (LBO) 60 Merchant bankers or lead managers
LIBOR 58, 99 271
Life Insurance Corporation of India Mid-cap companies 346
313 Milan Stock Exchange 175
Limit order 430 Minimum Public offer 212
Limited Discretionary Order 430 Model Rules for stock exchanges 39
Listed debt 353 Modified Carry-forward System 440
Listed equity 349, 353 Money market instruments 9
Listed mutual funds 354 Money market m utual funds 9
Listed securities 16 Morison Committee 420
Listing 299 Mortgage 12
Listing agreement 39, 300, 304 Mortgage loans 8
Loan associations 8 Municipal bonds 13
Local Area Bank 289 Mutual associations 8
Lock-in periods 318 Mutual Fund Service System (MFSS)
Lock-in requirements 297 243
London Stock Exchange 176 Mutual Funds 30
Long position 103, 199 Mutual savings banks 8
M N
M.J. Pherwani Committee 88 Napoleon of Finance 166
Maintenance margin 428 Narasimham Committee 88
Malegam Committee 89 NASDAQ 1, 176, 343, 368, 386, 482
Managing agency system 314 NASDAQ Bank Index 401
Mandiwala 474 NASDAQ Biotechnology Index 401
Margin 418, 435 NASDAQ Composite Index 400
Margin account 426 NASDAQ Computer Index 401
Margin agreement 428 NASDAQ Financial-100 Index 400
Margin call 428 NASDAQ Industrial Index 401
Margin Trading 198, 418, 425 NASDAQ National Market
Margining system 39 Composite Index 400
Market Capitalization-Weighted NASDAQ National Market Industrial
I ndex Index 401
379 NASDAQ Telecommunications Index
Market risk 112 402
Market Surveillance 132 NASDAQ Transportation Index 402
Market Surveillance Division 132 NASDAQ-100 Index 398
Market Trade 452 NASSCOM 371
Market- makers 197, 199, 345 National 19, 177
Market-making 355 National Bank for Agriculture 16
Matador market 19 National Clearing and Settlement
Materialization 450 Corporation 88
Maximum brokerage 143 National Depository System 32
National Securities Clearing Open Order 430

Corporation Limited 77, 372 Operational risk 118
National Securities Depositories Option 1, 103
Limited (NSDL) 372, 448 Option dealings 417
National Stock Exchange (NSE)16, Order Execution 430
261, 368 Order Grabbing System 504
National Stock Exchange System 88 Order Placing 430
National Stock Market System 201 Order Routing System (ORS) 477,
Nationalized banks 14 479
Native Shares and Stock Brokers Organization of Securities
Association 178 Commissions (IOSCO) 120
Negotiated Deal Module 504 Organized money market 14
Net Asset Value (NAV) 40, 80 Origination 250
Net offer to the public 262 Oslo Stock Exchange 176
New Issues Market (NIM) 28 OTCEI 343
New York Stock Exchange (NYSE) Out-of-the-money option 104
1, 176, 434 Over the Counter Exchange of India
Next Part XIII 86 (OTCEI) 29, 136, 261
NIM 249 Over-the-Counter (OTC) 1, 120, 345
No Complaints Certificate 258 Over-the-Counter Contracts 482
Non-banking institutions 15 Over-the-Counter Exchanges 16
Non-convertible debenture (NCD) Overall margin 436
32, 56 Ownership securities 14
Non-depository market 8
Non-listing 306 P
Non-scheduled banks 13
Non-specified list 433 Par value 50
Non-specified Securities 433 Par Value and Book Value 50
Non-voting equity shares 51 Parallel loans 96
NSDL 32 Parallel trading 370
NYSE Composite Index 405 Participating debentures 57
Patel Committee Report 82
O Pay-in of funds 223
Pay-in-date 262
OASIS system 371 PCDs 511
Objection Cycle 226 Pension funds 9
Odd-lot securities 434 Permanent Counter Receipt (PCR),
Off-balance sheet activity 91 Sales Confirmatio 350, 361
Off-market transactions 221 Permitted debentures 349
Offshore market 19 Permitted equity 349
Ombudsman 149 Permitted group 231
On Banking Supervision 120 Permitted securities 219
On-line Real Time (OLRT) Pherwani committee 32, 201
Surveillance System 216 Placement portion category 261
On-line Stock Trading 477 Pledging 453
Pool account 223
I n d ex 523
Port Trusts, Improvement Trusts, R

State Electricity 15
Portfolio manager 75 Raging Speculation 186
Post-dated cheque 11 Ready delivery contract 78, 417
Preference shares 14, 47 Recognized Stock Exchange 299, 300,
Preliminary prospectus 256 479
Premium-hunter 475 Red herring 256
Price band 262, 323 Redeemable debentures 56
Price discovery function 94 Regional Rural Banks (RRBs) 14
Price discovery process 3 Regional Stock Exchange (RSE) 288
Price rigging 50 Registrar of Companies (ROC) 288
Price risks 91, 500 Registrars and Custodians 359
Primary debt market 7 Registrars to an Issue 280
Primary Insiders 157 Registration 277
Primary market 4, 28, 249 Reinvestment rate risk 500
Principal centers 13 Rematerialization 451
Private placement 49, 266, 319 Rembrandt market 19
Private Placement Method 255 Remisiers 182
Private Sector Banks 289 Renaissance 175
Procedures 433 Repo 10, 504
Profit Earning Capacity Value (PECV) Repo trade 504, 505
80 Repo transaction 505
Promoters’ contribution 293, 295 Report of the Joint Task Force of the
Proprietary interest 59 Committee on 39
Prospectus 253, 490 Repurchase agreement 10
PSU Bonds, Commercial Paper 354 Reserve Bank of India 14
Public issue by unlisted companies Retirement Bonds 64
293 Reverse book-building 338
Public Offer (IPO) 256 Reverse repo 505
Public sector banks 14 Revised Forward Trading System
Pucca Sauda Book 431 439
Purchase Confirmation Slips (PCSs) Rigging the market 419
364 Rights Issue Method 257
Pure Prospectus Method 253 Rights of Investors 141
Put and call option 417 Rights renunciations 219
Put option 103, 417 Ring-less trading 347
Put option contract 103 Risk Capital Foundation of IFCI,
Venture Fund of IDBI 30
Q Rolling settlement 37, 136, 434
Rolling T+3 settlement system 364
Qualified Institutional Buyers (QIBs) Rural banking 14
38
Qualified participants (QPs) 370 S
S&P 100 Index 405
S&P 500 Index 405, 406
S&P CNX Defty 391 Settlement risk 117, 118

S&P CNX Nifty 390 Settlement Systems (CPSS) 39
S&P Global 1200 406 SFCs Act 15
Sale Confirmation Slip (SCS) 361, Shall be disclosed 506
362 Share mania 167
Salient features 365 Share transfer 431
Samurai market 19 Share transfer agents 280
Sauda sheets 433 Shelf registration 34
Savings and loan associations 8 Short position 103
Schedule VI of the Companies Act, Short selling 438
1956 287 Short-sellers 419
Scheduled banks 13 Shri Kalyanasundaram Committee 30
Scheduled commercial banks 13 SIDCs 16
SCRA 38 Single jobber 431
Screen Based Trading 136 Single Window Service 455
Screen Based Trading System (SBTS) Small Corporates Offering
209 Registration (SCOR) 491
Scripless trading 26 Small investors 139
Scroll slip 222 Souda books 232
SEBI 77, 123 South Sea Bubble 167
Secondary debt market 7, 503 Specialist 196, 198
Secondary Insiders 157 Specified or special delivery 431
Secondary market 4, 5, 29, 251 Specified securities 432
Section 205 287 Speculation 471
Section 205 (3) 259 Speculators 108, 230, 472, 473
Secured debentures 56 Sponsorship 356
Secured Premium Notes (SPN) 57, 61 Spot delivery 431
Securities and Exchange Commission Spot delivery contract 416
(SEC) 77 Spread 199
Securities Appellate Tribunal (SAT) Spring Street Brewery IPO 492
128 Stag 475
Securities Contracts (Regulation) Act, State Bank of India 14
1956 38, 81, 343 State Cooperative Banks 13
Securities Exchange Act, 1934 77 State Financial Corporations 314
Securities Lending Scheme 438 State Industrial Development
Securities market 6, 21 Corporations (SIDCs) 38
Securities pay-in 223 Statement in lieu of prospectus 318
Securities Trading Corporation of Statutory Liquidity Ratio (SLR),
India Ltd 202 Credit Authorizat 14
Security listing 299 Stock Exchange 16, 165, 174, 299
Self-certification 439 Stock Exchange of Singapore (SES)
Sensex 229 488
Sensex futures 229 Stock Exchanges of Great Britain and
Sensex Index 229 Ireland 176
Settlement guarantee mechanism 195 Stock futures 38
I n d ex 525
Stock Holding Corporation of India Tradable Warrants 58

88 Trade Guarantee Fund 148, 483
Stock Market Index 375 Trader Work Stations (TWSs) 218,
Stock option 38, 264 228
Stock scams 41 Transactional exposure 110
Stock-lending 438 Transfer Deed (TD) 359, 361, 419,
Stockholders, bondholders 12 431
Stockinvest 33 Transfer form 419
Stop Loss Order 430 Transferred Permanent Counter
Sub-markets 6 Receipt 361
Sub-underwriting 310, 317 Transmission 453
Subsidiary General Ledger 245 Transnational corporations 109
Suspend the certificate of registration Transposition 453
283 Treasury bills 8, 10
Swap spread 99 Treasury bonds 10
Swaps 96 Treasury Investment Growth
Swaption 104 Receipts’ (TIGRs) 60
Syndicate underwriting 310 Trustee Companies 39
Systemic risk 119 Tulip mania 167
Turn 184
T Twin-track system 440
Two ratings from two different credit
T – notes 10 rating 506
T + 5 434
T+3 39 U
T+3 basis 221
T+3 in Rolling Settlements 224 U.S. Treasury bills 9
T-bills 10 Under-pricing 80
Tarawaniwalas 184, 185, 415, 431 Under-subscription 263
Tax Free Bonds 65 Underlying asset 92
TCS (Tata Consultancy Services) 16 Underwriter 275, 309, 315
TDICI, RCTC and TFCI 25 Underwriting agencies 313
TECK mark 386 Underwriting agreement 309, 312,
Tejiwala 473 316
Temporary Counter Receipt (TCR) Underwriting commission 309, 317
350 Union list 81
The English Man 230 Unit Trust of India 313
The National Stock Exchange of India Unit-64, Monthly Income Plan, and
Limited 233 IISFUS ’97 354
The Native Share and Stockbrokers United East India Company 175
Association 210 Universal Accounting Practices 38
Third Market 17 Unlisted securities 346
Threadneedle Street 176 Unorganized markets 13
TMT sectors 384 Unorganized money market 14
Tokyo Stock Exchange 176, 210 Unsecured or naked debentures 56
V Y
Vaghul Committee 30 Yankee market 19
Valid Contract Note 143 Yield of bond 503
Value-at-Risk (VaR) 244 Yield refers 503
Venture capital financing 29 Yield to Maturity (YTM) 503
Vienna Stock Exchange 175
voluntary market-making 356 Z
VSATs (Very Small Aperture
Terminals) 43, 228, 350, 373 Z category 145
Vyaj-badla 440 Z Group 215
Zero Coupon Bonds 60
W Zero Coupon Yield Curve (ZCYC)
244
Wall Street 1 Zero interest FCDs 58
Warrants 54 Zero-interest Fully Convertible
Wash Sales 419 Debentures 58
Wholesale 233 ZEROs 61
Wholesale debt market 503
World War II 78

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Capital

Tata McGraw Hill Education Private Limited

Capital Markets, 2/e

No part of this publication may be reproduced or distributed in any form or by any

First reprint 2010

This edition can be exported from india by the publishers,

Chapter 2 Capital Market

Chapter 3 Capital Market Instruments

Chapter 4 Regulation of Indian Capital

Chapter 5 D erivatives Market

Chapter 6 SEBI— Functions and Working

Chapter 7 Investor Protection

Chapter 8 Insider T rading

Chapter 9 Stock Exchange

World’s Stock Exchanges ................................................ 175

Chapter 10 Indian Stock Exchange

Chapter 11 Prim ary Market

Chapter 12 Methods of New Issue

Chapter 13 Intermediaries in New Issues

Chapter 14 SEBI Guidelines on Primary

Listing Agreement .......................................................... 304

Chapter 18 Over the Counter Exchange of

Chapter 19 Stock Market Index

Chapter 20 Stock Market T rading

Regulating Speculation ................................................... 423

Chapter 21 D epository Services

Chapter 23 On-line Stock T rading

Chapter 24 D ebt Market

Index ---------------------------------------------------------- 515

A market as defined by economists refesrs to an institution or arrangement

Productive usage of funds Financial markets allow for the productive

The following Exhibit 1 shows the constituents of a typical financial

securities. The secondary market provides liquidity to the outstanding/

Individuals and firms use financial services markets to purchase services

Commercial paper A form of direct short-term finance issued by large,

engaged in international trade and use it for other purposes as well. US

Corporate bonds A corporate bond is a debt instrument issued by a

market instruments. However, there has been a growing movement to

INDIAN FINANCIAL MARKET

commercial banks, the public sector banks, i.e. State Bank of

of Indian capital market:

After 1960, a number of state governments set up SIDCs to undertake

sitting in their own offices. This helps the market participants to

the deals are direct. The market eventually comprises a

23. What are mortgages?

3. Level of demand for funds

Other functions In addition to the functions of funds allocation and

generating confidence among investors and speeding up the process of

4. Lukewarm interest shown by Indian corporates for mobilizing

set up to offer infrastructure financing and leasing services; and TDICI,

Indian stock market. Some of the significant forces/happenings that were

authorities for protecting the interests of investors, i.e. setting up

Meaning Primary market also known as New Issues Market (NIM) is a

3. Private placement Where the shares of a body corporate are sold to

Meaning A market, which deals in securities that have been already

Importance The importance of the secondary market springs from the

c. National Depository System which arranges to provide for the

within a definite framework. Warrants are issued where full payment of

year from the date of allotment.

growth of industrial securities market. However, many scamy developments

provident funds could be invested. It was expected that when

MEASURES OF INVESTOR PROTECTION

allowing domestic mutual funds to manage foreign portfolios and a new

uniform settlement cycle (Monday to Friday) in respect of remaining