FinsSoc Zerodha 1 - Introduction To Stock Markets

ZERODHA
Introduction to
Stock Markets
ZERODHA.COM/VARSITY
TABLE OF CONTENTS
1 The Need to Invest 1

1.1 Why should one invest 1
1.2 Where to invest 3
1.3 Fixed income instruments 5
1.4 Equity 5
1.5 Real estate 6
1.6 Commodity - Bullion 6
1.7 A note on investments 7
1.8 What are the things to know before investing 7
2 Regulators 9
2.1 What is a stock market? 9
2.2 Stock market participants and the need to regulate them 10
2.3 The Regulator 11
3 Financial Intermediaries 15
3.1 Overview 15
3.2 The Stock broker 16
3.3 Depository and Depository Participants 17
3.4 Banks 18
3.5 NSCCL and ICCL 18
4 The IPO Markets - Part 1 21

4.1 Overview 21
4.2 Origin of a business 21
5 The IPO Markets - Part 2 32

5.1 Overview 32
5.2 Why do companies go public 33
5.3 Merchant bankers 34
5.4 IPO sequence of events 35
5.5 What happens after the IPO 36
5.6 Few IPO Jargons 36
5.7 Recent IPO’s in India 37
6 The Stock Markets 40

6.1 Overview 40
6.2 What really is the stock market ? 41
6.3 What moves the stock ? 42
6.4 How does the stock get traded ? 44
6.5 What happens after you own a stock ? 45
6.6 A note on the holding period 45
6.7 How to calculate returns ? 46
6.8 Where do you fit in ? 47
7 The Stock Markets Index 50

7.1 Overview 50
7.2 The Index 51
7.3 Practical uses of the Index 51
7.4 Index construction methodology 53
7.5 Sector specific indices 57
8 Commonly used Jargons 59
9 The Trading Terminal 65

9.1 Overview 65
9.2 The Login Process 66
9.3 The Market Watch 66
9.4 Buying a stock through the trading terminal 69
9.5 The order book and Trade book 71
9.6 The Bid and Ask price 75
9.7 Conclusion 77
10 Clearing and Settlement process 79

10.1 Overview 79
10.2 What happens when you buy a stock 80
10.3 What happens when you sell a stock 82
11 Five corporate actions and its impact on stock prices 84

11.1 Overview 84
11.2 Dividends 85
11.3 Bonus Issue 86
11.4 Stock split 87
11.5 Rights issue 88
11.6 Buyback of shares 88
12 Key Events and Their Impact on Markets 91

12.1 Overview 91
12.2 Monetary policy 92
12.3 Inflation 93
12.4 Index of Industrial Production 94
12.5 Purchasing Manager index 95
12.6 Budget 95
12.7 Corporate Earnings Announcement 96
13 Getting started 99
13.1 So many modules - how are they interrelated 100
C HAP TER 1
1.1 - Why should one Invest?

Before we address the above question, let us understand what would happen if one choose not
to invest. Let us assume you earn Rs.50,000/- per month and you spend Rs.30,000/- towards your
cost of living which includes housing, food, transport, shopping, medical etc. The balance of
Rs.20,000/- is your monthly surplus. For the sake of simplicity, let us just ignore the effect of per-
sonal income tax in this discussion.
1. To drive the point across, let us make few simple assumptions.

2. The employer is kind enough to give you a 10% salary hike every year
3. The cost of living is likely to go up by 8% year on year
4. You are 30 years old and plan to retire at 50. This leaves you with 20 more years to earn
5. You don’t intend to work after you retire
6. Your expenses are fixed and don’t foresee any other expense
7. The balance cash of Rs.20,000/- per month is retained in the form of hard cash
Going by these assumptions, here is how the cash balance will look like in 20 years as per Table
1.1
1 zerodha.com/varsity
Table 1.1 - Total cash balance in twenty years
If one were to analyze these numbers, you would soon realize this is a scary situation to be in.
Years Yearly income Yearly expense Cash retained
1 600,000 360,000 240,000
2 6,60,000 3,88,800 2,71,200
3 7,26,000 4,19,904 3,06,096
4 7,98,600 4,53,496 3,45,104
5 8,78,460 4,89,776 3,88,684
6 9,66,306 5,28,958 4,37,348
7 10,62,937 5,71,275 4,91,662
8 11,69,230 6,16,977 5,52,254
9 12,86,153 6,66,335 6,19,818
10 14,14,769 7,19,642 6,95,127
11 15,56,245 7,77,213 7,79,032
12 17,11,870 8,39,390 8,72,480
13 18,83,057 9,06,541 9,76,516
14 20,71,363 9,79,065 10,92,298
15 22,78,499 10,57,390 12,21,109
16 25,06,349 11,41,981 13,64,368
17 27,56,984 12,33,339 15,23,644
18 30,32,682 13,32,006 17,00,676
19 33,35,950 14,38,567 18,97,383
20 36,69,545 15,53,652 21,15,893
Total Income 17,890,693
Few things are quite startling from the above calculations:
1. After 20 years of hard work you have accumulated Rs.1.7 Crs.

2. Since your expenses are fixed, your lifestyle has not changed over the years, you probably
even suppressed your lifelong aspirations – better home, better car, vacations etc
3. After you retire, assuming the expenses will continue to grow at 8%, Rs.1.7 Crs is good
enough to sail you through roughly for about 8 years of post retirement life. 8th year onwards
you will be in a very tight spot with literally no savings left to back you up.
What would you do after you run out of all the money in 8 years time? How do you fund your life?
Is there a way to ensure that you collect a larger sum at the end of 20 years?
Let’s consider another scenario as per Table 1.2 in the following page where instead of keeping
the cash idle, you choose to invest the cash in an investment option that grows at let’s say 12%
per annum. For example – in the first year you retained Rs.240,000/- which when invested at 12%
per annum for 20 years yields Rs.2,067,063/- at the end of 20th year.
With the decision to invest the surplus cash, your cash balance has increased significantly. The
cash balance has grown to Rs.4.26 Crs from Rs.1.7 Crs. This is a staggering 2.4x times the regular
amount. This translates to you being in a much better situation to deal with your post retirement
life.
Now, going back to the initial question of why invest? There are few compelling reasons for one to
invest..
1. Fight Inflation – By investing one can deal better with the inevitable – growing cost of living –
generally referred to as Inflation
2. Create Wealth – By investing one can aim to have a better corpus by the end of the defined
time period. In the above example the time period was upto retirement but it can be anything
– children’s education, marriage, house purchase, retirement holidays etc
3. To meet life’s financial aspiration
1.2 - Where to invest?

Having figured out the reasons to invest, the next obvious question would be – Where would one
invest, and what are the returns one could expect by investing.
When it comes to investing one has to choose an asset class that suits the individual’s risk and
return temperament.
Table 1.2 - Cash invested at 12% per annum
Retained Cash
Years Yearly income Yearly expense Cash retained
Invested @12%
1 600,000 360,000 240,000 20,67,063
2 6,60,000 3,88,800 2,71,200 20,85,519
3 7,26,000 4,19,904 3,06,096 21,01,668
4 7,98,600 4,53,496 3,45,104 21,15,621
5 8,78,460 4,89,776 3,88,684 21,27,487
6 9,66,306 5,28,958 4,37,348 21,37,368
7 10,62,937 5,71,275 4,91,662 21,45,363
8 11,69,230 6,16,977 5,52,254 21,51,566
9 12,86,153 6,66,335 6,19,818 21,56,069
10 14,14,769 7,19,642 6,95,127 21,58,959
11 15,56,245 7,77,213 7,79,032 21,60,318
12 17,11,870 8,39,390 8,72,480 21,60,228
13 18,83,057 9,06,541 9,76,516 21,58,765
14 20,71,363 9,79,065 10,92,298 21,56,003
15 22,78,499 10,57,390 12,21,109 21,52,012
16 25,06,349 11,41,981 13,64,368 21,46,859
17 27,56,984 12,33,339 15,23,644 21,40,611
18 30,32,682 13,32,006 17,00,676 21,33,328
19 33,35,950 14,38,567 18,97,383 21,25,069
20 36,69,545 15,53,652 21,15,893 21,15,893
TOTAL CASH AFTER 20 YEARS 4,26,95,771
An asset class is a category of investment with particular risk and return characteristics. The fol-
lowing are some of the popular assets class…
1. Fixed income instruments

2. Equity
3. Real estate
4. Commodities (precious metals)
Fixed Income Instruments

These are investable instruments with very limited risk to the principle and the
return is paid as an interest to the investor based on the particular fixed income
instrument. The interest paid, could be quarterly, semi-annual or annual inter-
vals. At the end of the term of deposit, (also known as maturity period) the capital
is returned to the investor.
Typical fixed income investment includes:
1. Fixed deposits offered by banks

2. Bonds issued by the Government of India
3. Bonds issued by Government related agencies such as HUDCO, NHAI etc
4. Bonds issued by corporates
As of June 2014, the typical return from a fixed income instrument varies between 8% and 11%.
Equity
Investment in Equities involves buying shares of publicly listed companies. The
shares are traded both on the Bombay Stock Exchange (BSE), and the Na-
tional Stock Exchange (NSE).
When an investor invests in equity, unlike a fixed income instrument there is no capital guaran-
tee. However as a trade off, the returns from equity investment can be extremely attractive. In-
dian Equities have generated returns close to 14% – 15% CAGR (compound annual growth rate)
over the past 15 years.
Investing in some of the best and well run Indian companies has yielded over 20% CAGR in the
long term. Identifying such investments opportunities requires skill, hard work and patience.
You may also be interested to know that the returns generated over a long term period (above
365 days, also called long term capital gain) are completely exempted from personal income tax.
This is an added attraction to investing in equities.
Real Estate
Real Estate investment involves transacting (buying and selling) commercial and
non commercial land. Typical examples would include transacting in sites, apart-
ments and commercial buildings. There are two sources of income from real es-
tate investments namely – Rental income, and Capital appreciation of the invest-
ment amount.
The transaction procedure can be quite complex involving legal verification of documents. The
cash outlay in real estate investment is usually quite large. There is no official metric to measure
the returns generated by real estate, hence it would be hard to comment on this.
Commodity – Bullion
Investments in gold and silver are considered one of the most popular invest-
ment avenues. Gold and silver over a long-term period has appreciated in value.
Investments in these metals have yielded a CAGR return of approximately 8%
over the last 20 years. There are several ways to invest in gold and silver. One can
choose to invest in the form of jewelry or Exchange Traded Funds (ETF).
Going back to our initial example of investing the surplus cash it would be interesting to see how
much one would have saved by the end of 20 years considering he has the option of investing in
any one – fixed income, equity or bullion.By investing in fixed income at an average rate of 9% per
annum, the corpus would have grown to Rs.3.3 Crs
1. By investing in fixed income at an average rate of 9% per annum, the corpus would have
grown to Rs.3.3 Crs
2. Investing in equities at an average rate of 15% per annum, the corpus would have
grown to Rs.5.4 Crs
3. Investing in bullion at an average rate of 8% per annum, the corpus would have grown to Rs.
3.09 Crs
Clearly, equities tend to give you the best returns especially when you have a multi – year invest-
ment perspective.
A note on investments
Investments optimally should have a strong mix of all asset classes. It is smart to diversify your
investment among the various asset classes. The technique of allocating money across assets
classes is termed as ‘Asset Allocation’.
For instance, a young professional may be able take a higher amount of risk given his age and
years of investment available to him. Typically investor should allocate around 70% of his investa-
ble amount in Equity, 20% in Precious metals, and the rest in Fixed income investments.
Alongside the same rationale, a retired person could invest 80 percent of his saving in fixed in-
come, 10 percent in equity markets and a 10 percent in precious metals. The ratio in which one
allocates investments across asset classes is dependent on the risk appetite of the investor.
1.3 - What are the things to know before investing

Investing is a great option, but before you venture into investments it is good to be aware of the
following…
1. Risk and Return go hand in hand. Higher the risk, higher the return. Lower the risk, lower is
the return.
2. Investment in fixed income is a good option if you want to protect your principal amount. It is
relatively less risky. However you have the risk of losing money when you adjust the return for
inflation. Example – A fixed deposit which gives you 9% when the inflation is 10% means you
are net net losing 1% per annum. Fixed income investment is best suited for ultra risk averse
investors
3. Investment in Equities is a great option. It is known to beat the inflation over long period of
times. Historically equity investment has generated returns close to 14-15%. However, equity
investments can be risky
4. Real Estate investment requires a large outlay of cash and cannot be done with smaller
amounts. Liquidity is another issue with real estate investment – you cannot buy or sell
whenever you want. You always have to wait for the right time and the right buyer or seller to
transact with you.
5. Gold and silver are known to be a relatively safer but the historical return on such investment
has not been very encouraging.
Key takeaways from this chapter
1. Invest to secure your future

2. The corpus that you intend to build at the end of the defined period is sensitive to the rate of
return the investment generates. A small variation to rate can have a big impact on the corpus
3. Choose an instrument that best suits your risk and return appetite
4. Equity should be a part of your investment if you want to beat the inflation in the long run
C HAP TER 2
Regulators
2.1 - What is a stock market?

• Investing in equities is an important investment that we make in order to generate inflation
beating returns.
Just like the way we go to the neighborhood kirana store or a super market to shop for our daily
needs, similarly we go to the stock market to shop (read as transact) for equity investments.
Stock market is where everyone who wants to transact in shares go to. Transact in simple terms
means buying and selling. For all practical purposes, you can’t buy/sell shares of a public com-
pany like Infosys without transacting through the stock markets.
The main purpose of the stock market is to help you facilitate your transactions. So if you are a
buyer of a share, the stock market helps you meet the seller and vice versa.
Now unlike a super market, the stock market does not exist in a brick and mortar form. It exists in
electronic form. You access the market electronically from your computer and go about conduct-
ing your transactions (buying and selling of shares).
Also, it is important to note that you can access the stock market via a registered intermediary
called the stock broker. We will discuss more about the stock brokers at a later point.
There are two main stock exchanges in India that make up the stock markets. They are the Bom-
bay Stock Exchange (BSE) and the National Stock Exchange (NSE). Besides these two exchanges
there are a bunch of other regional stock exchanges like Bangalore Stock Exchange, Madras Stock
Exchange that are more or less getting phased out and don’t really play any meaningful role any-
more.
2.2 - Stock Market Participants and the need to regulate them

Some of the categories of market participants are as follows:
1. Domestic Retail Participants – These are people like you and me transacting in markets
2. NRI’s and OCI – These are people of Indian origin but based outside India
3. Domestic Institutions – These are large corporate entities based in India. Classic example
would be the LIC of India.
4. Domestic Asset Management Companies (AMC) – Typical participants in this category
would be the mutual fund companies such as SBI Mutual Fund, DSP Black Rock, Fidelity
Investments, HDFC AMC etc.
5. Foreign Institutional Investors – Non Indian corporate entities. These could be foreign
asset management companies, hedge funds and other investors.
The Regulator
In India the stock market regulator is called The Securities and Exchange board of India often
referred to as SEBI. The objective of SEBI is to promote the development of stock exchanges, pro-
tect the interest of retail investors, regulate the activities of market participants and financial in-
termediaries. In general SEBI ensures…
6. The stock exchanges (BSE and NSE) conducts its business fairly
7. Stock brokers and sub brokers conduct their business fairly
8. Participants don’t get involved in unfair practices
9. Corporate’s don’t use the markets to unduly benefit themselves (Example – Satyam
Computers)
10. Small retail investors interest are protected
11. Large investors with huge cash pile should not manipulate the markets
12. Overall development of markets
Table 2.1 - Regulators in India
Example of
Entity What do they do? In simpler words
companies
They rate the credit

If a corporate or Govt entity wants to avail
Credit Rating CRISIL, ICRA, worthiness of
loan, CRA checks if the entity is worthy of
Agency (CRA) CARE corporate and
giving a loan
governments
When companies want to raise a loan they

can issue debenture against which they
Debenture Almost all banks Act as a trustee to promise to pay an interest. These
Trustees in India corporate debenture debentures can be subscribed by public. A
Debenture Trustee ensures that the
debenture obligation is honored
Acts like a vault for the shares that you buy.

The depositories hold your shares and
Safekeeping, facilitate exchange of your securities. When
reporting and you buy shares these shares sit in your
Depositories NSDL and CDSL
settlement of clients Depositary account usually referred to as the
securities DEMAT account. This is maintained
electronically by only two companies in
India
Most of the banks You cannot directly interact with NSDL or

Depositary Act as an agent to the
and few stock CDSL. You need to liaison with a DP to open
Participant (DP) two depositories
brokers and maintain you DEMAT account
These are foreign entities with an interest to

Foreign Foreign invest in India. They usually transact in large
Make investments in
Institutional corporate, funds amounts of money, and hence their activity
India
Investors and individuals in the markets have an impact in terms of
market sentiment
Example of
Entity What do they do? In simpler words
companies
If a company plans to raise money by

Help companies raise
Merchant Karvy, Axis Bank, floating an IPO, then merchant bankers are
money in the primary
Bankers Edelweiss Capital the ones who help companies with the IPO
markets
process
An AMC collects money from the public,

Asset HDFC AMC, puts that money in a single account and
Offer Mutual Fund
Management Reliance Capital, then invest that money in markets with an
Schemes
Companies(AMC) SBI Capital objective of making the investments grow
and thereby generate wealth to its investors.
Portfolio
Managers/
They work similar to a mutual fund except in
Religare Wealth Offer PMS schemes
Portfolio a PMS you have to invest a minimum of Rs.
Management,
Management 25,00,000 however there is no such cap in a
Parag Parikh PMS
System mutual fund
(PMS)
Stock Brokers Act as a intermediary Whenever you want to buy or sell shares
Zerodha,
and Sub Brokers between an investor from the stock exchange you have to do so
Sharekhan, ICICI
and the stock through registered stock brokers. A sub
Direct
exchange broker is like an agent to a stock broker
1. Stock market is the place to go to if you want to transact in equities

2. Stock markets exists electronically and can be accessed through a stock broker
3. There are many different kinds of market participants operating in the stock markets
4. Every entity operating in the market has to be regulated and they can operate only within the
framework as prescribed by the regulator
5. SEBI is the regulator of the securities market in India. They set the legal frame work and
regulate all entities interested in operating in the market.
6. Most importantly you need to remember that SEBI is aware of what you are doing and they
can flag you down if you are up to something fishy in the markets!
C HAP TER 3
3.1 - Overview
From the time you access the market – let’s just say, to buy a stock till the time the stocks comes
and hits your DEMAT account, a bunch of corporate entities are actively involved in making this
work for you. These entities play their role quietly behind the scene, always complying with the
rules laid out by SEBI and ensure an effortless and smooth experience for your transactions in the
stock market. These entities are generally referred to as the Financial Intermediaries.
Together, these financial intermediaries, interdependent of one another, create an ecosystem in

which the financial markets exists.
3.2 - The Stock Broker
The stock broker is probably one of the most important financial intermediaries that you
need to know. A stock broker is a corporate entity, registered as a trading member with the stock
exchange and holds a stock broking license. They operate under the guidelines prescribed by
SEBI.
A stock broker is your gateway to stock exchanges. To begin with, you need to open something
called as a ‘Trading Account’ with a broker who meets your requirement. Your requirement could
be as simple as the proximity between the broker’s office and your house.
A trading account lets you carry financial transactions in the market. A trading account is an ac-
count with the broker which lets the investor to buy/sell securities.
The basic services provided by the brokers includes..
1. Give you access to markets and letting you transact

2. Give you margins for trading – We will discuss this point at a later stage
3. Provide support – Dealing support if you have to call and trade. Software support if you have
issues with the trading terminal
4. Issue contract notes for the transactions – A contract note is a written confirmation detailing
the transactions you have carried out during the day
5. Facilitate the fund transfer between your trading and bank account
6. Provide you with a back office login – using which you can see the summary of your account
7. The broker charges a fee for the services that he provides called the ‘brokerage charge’ or
just brokerage. The brokerage rates vary, and its up to you to find a broker who strikes a
balance between the fee he collects versus the services he provides.
3.3 - Depository and Depository Participants
When you buy a property the only way to identify and claim that you actually own the prop-erty is
by producing the property papers. Hence it becomes extremely important to store the property
papers in a safe and secure place.
Likewise when you buy a share (a share represents a part ownership in a company) the only way
to claim your ownership is by producing your share certificate. A share certificate is nothing but a
piece of document entitling you as the owner of the shares in a company.
Before 1996 the share certificate was in paper format however post 1996, the share certificates
were converted to digital form. The process of converting paper format share certificate into digi-
tal format share certificate is called “Dematerialization” often abbreviated as DEMAT.
The share certificate in DEMAT format has to be stored digitally. The storage place for the digital
share certificate is the ‘DEMAT Account’. A Depository is a financial intermediary which offers the
service of Demat account. A DEMAT account in your name will have all the shares in electronic for-
mat you have bought. Think of DEMAT account as a digital vault for your shares.
At present there are only two depositaries offering you DEMAT account services. They are The Na-
tional Securities Depository Limited (NSDL) and Central Depository Services (India) Limited.
There is virtually no difference between the two and both of them operate under strict SEBI regu-
lations.
3.4 - Banks
Banks play a very straight forward role in the market ecosystem. They help in facilitating
the fund transfer from your bank account to your trading account. You may be interested to note
that for a given trading account only one bank account can be interlinked. You cannot transfer
money from a bank account that is not in your name.
3.5 NSCCL and ICCL

NSCCL – National Security Clearing Corporation Ltd and Indian Clearing Corporation are wholly
owned subsidiaries of National Stock Exchange and Bombay Stock Exchange respectively.
The job of the clearing corporation is to ensure guaranteed settlement of your trades/
transactions. For example if you were to buy 1 share of Biocon at Rs.446 per share there must be
someone who has sold that 1 share to you at Rs.446 . For this transaction, you will be debited
Rs.446 from your trading account and someone must be credited that Rs.446 toward the sale of
Biocon. In a typical transaction like this the clearing corporation’s role is to ensure the following:
a) Identify the buyer and seller and match the debit and credit process
b) Ensure no defaults – The clearing corporation also ensures there are no defaults by either
party. For instance the seller after selling the shares should not be in a position to back out
thereby defaulting in his transaction.
For all practical purposes, its ok not to know much about NSCCL or ICCL simply because, you as a
trader or investor would not be interacting with these agencies directly. You just need to be
aware that there are certain professional institutions which are heavily regulated and they work
towards smooth settlement, and efficient clearing activity.
1. The market ecosystem is built by a cluster of financial intermediaries, each offering services
that are unique to the functioning of markets
2. A stock broker is your access to markets, so make sure you choose a broker that matches
your requirements, and services well.
3. A stock broker provides you a trading account which is used for all market related
transactions (buying and selling of financial instruments like shares)
4. A Depository Participant (DP) is a corporate entity that holds the shares in electronic form
against your name in your account. Your account with the DP is called the ‘DEMAT’ account
5. There are only two depositories in India – NSDL and CDSL
6. To open a DEMAT account with one of the depositaries you need to liaison with a Depository
Participant (DP). A DP functions as an agent to the Depository
7. A clearing corporation works towards clearing and settling of trades executed by you.
C HAP TER 4
Table 4.1 - Initial Shareholding Pattern
Name of Share
Sl No No of Shares %Holding
Holder
1 Promoter 2,000,000 40%
2 Angel 1 250,000 5%
3 Angel 2 250,000 5%
Total 2,500,000 50%
The share holding pattern of this company would look something like this..
Please note the balance 50% of the shares totaling 2,500,000 equity shares are retained by the
company. These shares are authorized but not allotted.
Now backed by a good company structure and a healthy seed fund the promoter kick starts his
business operations. He wants to move cautiously, hence he decides to open just one small manu-
facturing unit and one store to retail his product.
SCENE 2 – THE V ENTU RE C APITALIS T
His hard work pays off and the business starts to pick up. At the end of the first two years of opera-
tions, the company starts to break even. The promoter is now no longer a rookie business owner,
instead he is more knowledgeable about his own business and of course more confident.
Backed by his confidence, the promoter now wants to expand his business by adding 1 more
manufacturing unit and few additional retail stores in the city. He chalks out the plan and figures
out that the fresh investment needed for his business expansion is INR 7 Crs.
He is now in a better situation when compared to where he was two years ago. The big difference
is the fact that his business is generating revenues. Healthy inflow of revenue validates the busi-
ness and its offerings. He is now in a situation where he can access reasonably savvy investors for
investing in his business. Let us assume he meets one such professional investor who agrees to
give him 7 Crs for a 14% stake in his company.
The investor who typically invests in such early stage of business is called a Venture Capitalist
(VC) and the money that the business gets at this stage is called Series A funding.
After the company agrees to allot 14% to the VC from the authorized capital the shareholding pat-
tern looks like this:
Table 4.2 - Second stage shareholding pattern
Name of Share
Holder
1 Promoter 2,000,000 40%
2 Angel 1 250,000 5%
3 Angel 2 250,000 5%
4 Venture Capitalist 700,000 14%
Total 3,200,000 64%
Note, the balance 36% of shares is still retained within the company and has not been issued.
Now, with the VC’s money coming into the business, a very interesting development has taken
place. The VC is valuing the entire business at INR 50 Crs by valuing his 14% stake in the com-
pany at INR 7Crs. With the initial valuation of 5Crs, there is a 10 fold increase in the company’s
valuation. This is what a good business plan, validated by a healthy revenue stream can do to
businesses. It works as a perfect recipe for wealth creation.
With the valuations going up, the investments made by the initial investors will have an impact.
The following table summarizes the same…
Table 4.3 - Third stage shareholding pattern
Name of Share Initial Initial Shareholding Valuation Wealth

Sl No
Holder Shareholding Valuation after 2 Yrs after 2 Yrs Created
1 Promoter 40% 2 Crs 40% 20 Crs 10 times
2 Angel 1 5% 25 Lakhs 5% 2.5 Crs 10 times
3 Angel 2 5% 25 Lakhs 5% 2.5 Crs 10 times
Venture
4 0% -NA- 14% 07 Crs -NA-
Capitalist
Total 50% 2.5 Crs 64% 32 Crs
Going forward with our story, the promoter now has the additional capital he requires for the
business. The company gets an additional manufacturing unit and few more retail outlets in the
city as planned. Things are going great; popularity of the product grows, translating into higher
revenues, management team gets more professional thereby increasing the operational effi-
ciency and all this translates to better profits.
SC ENE 3 – THE BA NK ER
Three more years pass by and the company is phenomenally successful. The company decides to
have a retail presence in at least 3 more cities. To back the retail presence across three cities, the
company also plans to increase the production capacity and hire more resources. Whenever a
company plans such expenditure to improve the overall business, the expenditure is called ‘Capi-
tal Expenditure’ or simply ‘CAPEX’.
The management estimates 40Crs towards their Capex requirements. How does the company get
this money or in other words, how can the company fund its Capex requirements?
There are few options with the company to raise the required funds for their Capex…
1. The company has made some profits over the last few years; a part of the Capex requirement
can be funded through the profits. This is also called funding through internal accruals
2. The company can approach another VC and raise another round of VC funding by allotting
shares from the authorized capital – this is called Series B funding
3. The company can approach a bank and seek a loan. The bank would be happy to tender this
loan as the company has been doing fairly well. The loan is also called ‘Debt’
The company decides to exercise all the three options at its disposal to raise the funds for Capex.
It ploughs 15Crs from internal accruals, plans a series B - divests 5% equity for a consideration of
10Crs from another VC and raise 15Crs debt from the banker.
Note, with 10Crs coming in for 5%, the valuation of the company now stands at 200 Crs. Of
course, this may seem a bit exaggerated, but then the whole purpose of this story is drive across
the concept!
The shareholding and valuation look something like this
Table 4.4 - Fourth stage shareholding pattern
Name of Share
Sl No No of Shares %Holding Valuation
Holder
1 Promoter 2,000,000 40% 80 Crs
2 Angel 1 250,000 5% 10 Crs
3 Angel 2 250,000 5% 10 Crs
4 VC Series A 700,000 14% 28 Crs
5 VC Series B 250,000 5% 10 Crs
Note, the company still has 31% of shares not allotted to shareholders which are now being val-
ued at 62 Crs. Also, I would encourage you to think about the wealth that has been created over
the years. This is exactly what happens to entrepreneurs with great business ideas, and with a
highly competent management team.
Classic real world examples of such wealth creation stories would be Infosys, Page Industries, Ei-
cher Motors, Titan industries and in the international space one could think of Google, Facebook,
Twitter, Whats app etc.
SCENE 4 – THE PRIVATE EQUIT Y
Few years pass by and the company’s success continues to shine on. With the growing success of
this 8 year old, 200 Cr Company, the ambitions are also growing. The company decides to raise
the bar and branch out across the country. They also decide to diversify the company by manufac-
turing and retailing fashion accessories, designer cosmetics and perfumes.
The capex requirement for the new ambition is now pegged at 60 Crs. The company does not
want to raise money through debt because of the interest rate burden, also called the finance
charges which would eat away the profits the company generates.
They decide to allot shares from the authorized capital for a Series C funding. They cannot ap-
proach a typical VC because VC funding is usually small and runs into few crores. This is when a
Private Equity (PE) investor comes into the picture.
PE investors are quite savvy. They are highly qualified, and have an excellent professional back-
ground. They invest large amounts of money with the objective of not only providing the capital
for constructive use but also place their own people on the board of the investee company to en-
sure the company steers in the required direction.
Assuming they pick up 15% stake for a consideration of 60Crs, they are now valuing the company
at 400Crs. Let’s have a quick look at the share holding and valuations..
Table 4.5 - Fifth stage shareholding pattern
Name of Share Valuation (in

Holder Crs)
1 Promoter 2,000,000 40% 160
2 Angel 1 250,000 5% 20
3 Angel 2 250,000 5% 20
4 VC Series A 700,000 14% 56
5 VC Series B 250,000 5% 20
6 PE Series C 1,000,000 15% 60
Total 4,450,000 84% 336
Please note, the company has retained back 16% stake which has not been allotted to any share-
holder. This portion is valued at 64 Crs
Usually, when a PE invests, they invest with an objective to fund large capex requirements. Be-
sides they do not invest in the early stage of a business instead they prefer to invest in companies
that already has a revenue stream, and is in operation for a few years. The process of deploying
the PE capital and utilizing the capital for the capex requirements takes up a few years.
SC ENE 5 – THE IPO
5 years after the PE investment, the company has progressed really well. They have successfully
diversified their product portfolio plus they have a presence across all the major cities in the
country. Revenues are good, profitability is stable and the investors are happy. The promoter
however does not want settle in for just this.
The promoter now aspires to go international! He wants his brand to be available across all the
major international cities; he wants at least two outlets in each major city across the world.
This means, the company needs to invest in market research to understand what people like in
other countries, they need to invest in people, and also work towards increasing the manufactur-
ing capacities. Besides they also need to invest into real estate space across the world.
This time around the Capex requirement is huge and the management estimates this at 200 Crs.
The company has few options to fund the Capex requirement.
1. Fund Capex from internal accruals

2. Raise Series D from another PE fund
3. Raise debt from bankers
4. Float a bond (this is another form of raising debt)
5. File for an Initial Public Offer (IPO) by allotting shares from authorized capital
6. A combination of all the above
For sake of convenience, let us assume the company decides to fund the capex partly through in-
ternal accruals and also file for an IPO. When a company files for an IPO, they have to offer their
shares to the general public. The general public will subscribe to the shares (i.e if they want to) by
paying a certain price. Now, because the company is offering the shares for the first time to the
public, it is called the “Initial Public Oﬀer’.
We are now at a very crucial juncture, where a few questions needs to be answered..
1. Why did the company decide to file for an IPO? In general why do companies go public?
2. Why did they not file for the IPO when they were in Series A, B and C situation?
3. What would happen to the existing share holders after the IPO?
4. What do the general public look for before they subscribe to the IPO?
5. How does the IPO process evolve?
6. Who are the financial intermediaries involved in the IPO markets?
7. What happens after the company goes public?
In the following chapter we will address each of the above questions plus more, and we will also
give you more insights to the IPO Market. For now, hopefully you should have developed a sense
of how a successful company evolves before they come out to the public to offer their shares.
The purpose of this chapter is to just give you a sense of completeness when one thinks about an
IPO.
1. Before understanding why companies go public, it is important to understand the origin of

business
2. The people who invest in your business in the pre-revenue stage are called Angel Investors
3. Angel investors take maximum risk. They take in as much risk as the promoter
4. The money that angels give to start the business is called the seed fund
5. Angel’s invest relatively a small amount of capital
6. Valuation of a company simply signifies how much the company is valued at. When one
values the company they consider the company’s assets and liabilities
7. A face value is simply a denominator to indicate how much one share is originally worth
8. Authorized shares of the company is the total number of shares that are available with the
company
9. The shares distributed from the authorized shares are called the issued shares. Issued shares
are always a subset of authorized shares.
10. The shareholding pattern of a company tells us who owns how much stake in the company
11. Venture Capitalists invest at an early stage in business; they do not take as much risk as
Angel investors. The quantum of investments by a VC is usually somewhere in between an
angel and private equity investment
12. The money the company spends on business expansion is called capital expenditure or
capex
13. Series A, B, andC etc are all funding that the company seeks as they start evolving. Usually
higher the series, higher is the investment required.
14. Beyond a certain size, VCs cannot invest, and hence the company seeking investments will
have to approach Private Equity firms
15. PE firms invest large sums of money and they usually invest at a slightly more mature stage
of the business
16. In terms of risk, PE’s have a lower risk appetite as compared to VC or angels
17. Typical PE investors would like to deploy their own people on the board of the investee
company to ensure business moves in the right direction
18. The valuation of the company increases as and when the business , revenues and
profitability increases
19. An IPO is a process by means of which a company can raise fund. The funds raised can be for
any valid reason – for CAPEX, restructuring debt, rewarding shareholders etc
5.1 Why do companies go public?
We closed the previous chapter with few very critical questions. One of which – Why did the com-
pany decide to file for an IPO, and in general why do companies go public?
When a company decides to file for an IPO, invariably the main reason is to raise funds to fuel
their Capex requirement. The promoter has 3 advantages by taking his company public..
1. He is raising funds to meet Capex requirement
2. He is avoiding the need to raise debt which means he does not have to pay finance charges
which translates to better profitability
3. Whenever you buy a share of a company, you are in essence taking the same amount of risk as
the promoter is taking. Needless to say, the proportion of the risk and its impact will depend on
the quantity of shares you hold. Nonetheless, whether you like it or not, when you buy shares
you also buy risk. So when the company goes public, the promoter is actually spreading his risk
amongst a large group of people.
There are other advantages as well in going for an IPO…
1. Provide an exit for early investors - Once the company goes public, the shares of the
company start trading publicly. Any existing shareholder of the company – could be promoters,
angel investors, venture capitalist, PE funds; can use this opportunity to sell their shares in the
open market. By selling their shares, they get an exit on their initial investment in the company.
They can also choose to sell their shares in smaller chunks if they wish.
2. Reward employees –Employees working for the company would have shares allotted to
them as an incentive. This sort of arrangement between the employee and the company is
called the “Employee Stock Option”. The shares are allotted at a discount to the employees.
Once the company goes public, the employees stand a chance to see capital appreciation in
the shares. Few examples where the employee benefited from ESOP would be Google, Infosys,
Twitter, Facebook etc
3. Improve visibility - Going public definitely increases visibility as the company has a status of
being publicly held and traded. There is a greater chance of people’s interest in the company,
consequently creating a positive impact on its growth.
So let’s just build on our fictional business story from the previous chapter a little further and fig-
ure out the IPO details of this company.
If you recollect, the company requires 200 Crs to fund their capex and the management had de-
cided to fund this partly by internal accrual and partly by filing for an IPO.
Do recollect that company still has 16% of authorized capital translating to 800,000 shares which
are not allotted. The last valuation of these shares when the PE firm invested in Series B was
64Crs. The company has progressed really well ever since the PE firm has invested and naturally
the valuation of these shares would have gone up.
For the sake of simplicity, let us assume the company is now valuing the 16% shares anywhere be-
tween 125 Crs to 150 Crs. This translates to a per share value, anywhere between Rs.1562 to
Rs.1875/-…(125Crs/8lakh).
So if the company puts 16% on the block to the public, they are likely to raise anywhere between
125 to 150 Crs. The remainder has to come from internal accruals. So naturally, the more money
they raise, better it is for the company.
5.2 - Merchant Bankers

Having decided to go public, the company must now do a series of things to ensure a successful
initial public offering. The first and foremost step would be to appoint a merchant banker. Mer-
chant bankers are also called Book Running Lead Managers (BRLM)/Lead Manager (LM). The
job of a merchant banker is to assist the company with various aspects of the IPO process includ-
ing…
• Conduct a due diligence on the company filing for an IPO, ensure their legal compliance and
also issue a due diligence certificate
• Should work closely with the company and prepare their listing documents including Draft Red
Herring Prospectus (DRHP). We will discuss this in a bit more detail at a later stage
• Underwrite shares – By underwriting shares, merchant bankers essentially agree to buy all or
part of the IPO shares and resell the same to public
• Help company arrive at the price band for the IPO. A price band is the lower and upper limit of
the share price within which the company will go public. In case of our example, the price band
will be Rs.1562/- and Rs.1875/-
• Help the company with the road shows – This is like a promotional/marketing activity for the
company’s IPO
• Appointment of other intermediaries namely, registrars, bankers, advertising agencies etc. The
Lead manager also makes various marketing strategies for the issue
Once the company partners with the merchant banker, they will work towards taking the com-
pany public.
5.3 - IPO sequence of events

Needless to say each and every step involved in the IPO sequence has to happen under the SEBI
guidelines. In general, the following are the sequence of steps involved.
• Appoint a merchant banker. In case of a large public issue, the company can appoint more
than 1 merchant banker
• Apply to SEBI with a registration statement – The registration statement contains details on
what the company does, why the company plans to go public and the financial health of the
company
• Getting a nod from SEBI – Once SEBI receives the registration statement, SEBI takes a call on
whether to issue a go ahead or a ‘no go’ to the IPO
• DRHP – If the company gets the initial SEBI nod, then the company needs to prepare the DRHP.
A DRHP is a document that gets circulated to the public. Along with a lot of information, DRHP
should contain the following details..
a.The estimated size of the IPO

b.The estimated number of shares being offered to public
c.Why the company wants to go public and how does the company plan to utilize the funds
along with the timeline projection of fund utilization
d.Business description including the revenue model, expenditure details
e.Complete financial statements
f.Management Discussion and Analysis – how the company perceives the future business op-
erations to emerge
g.Risks involved in the business
h.Management details and their background
• Market the IPO – This would involve TV and print advertisements in order to build awareness
about the company and its IPO offering. This process is also called the IPO road show
• Fix the price band – Decide the price band between which the company would like to go pub-
lic. Of course this can’t be way off the general perception. If it is, then the public will not sub-
scribe for the IPO
• Book Building – Once the road show is done and price band fixed the company now has to offi-
cially open the window during which the public can subscribe for shares. For example, if the
price band is between Rs.100 and Rs.120, then the public can actually choose a price they think
is fair enough for the IPO issue. The process of collecting all these price points along with the re-
spective quantities is called Book Building. Book building is perceived as an effective price dis-
covery method
• Closure – After the book building window is closed (generally open for few days) then the price
point at which the issue gets listed is decided. This price point is usually that price at which
maximum bids have been received.
• Listing Day – This is the day when the company actually gets listed on the stock exchange. The
listing price is the price discovered through the book building process.
5.4 - What happens after the IPO?

During the bidding process (also called the date of issue) investors can bid for shares at a particu-
lar price within the specified price band. This whole system around the date of issue where one
bids for shares is referred to as the Primary Market. The moment the stock gets listed and de-
buts on the stock exchange, the stock starts to trade publicly. This is called the secondary mar-
kets.
Once the stock transitions from primary markets to secondary markets, the stock gets traded
daily on the stock exchange. People start buying and selling the stocks regularly.
Why do people trade? Why does the stock price fluctuate? Well, we will answer all these ques-
tions and more in the subsequent chapters.
5.5 Few key IPO jargons

Before we wrap up the chapter on IPO’s let us review few important IPO jargons.
Under Subscription – Let’s say the company wants to offer 100,000 shares to the public. Dur-
ing the book building process it is discovered that only 90,000 bids were received, then the issue
is said to be under subscribed. This is not a great situation to be in as it indicates negative public
sentiment
Over subscription – If there are 200,000 bids for 100,000 shares on offer then the issue is said
to be oversubscribed 2 times (2x)
Green Shoe Option - Part of the underwriting agreement which allows the issuer to author-
ize additional shares (typically 15 percent) to be distributed in the event of over subscription.
This is also called the over allotment option
Fixed Price IPO –Sometimes the companies fix the price of the IPO and do not opt for a price
band. Such issues are called fixed price IPO
Price Band and Cut off price –Price band is a price range between which the stock gets
listed. For example if the price band is between Rs.100 and Rs.130, then the issue can list within
the range. Let’s says it gets listed at 125, then 125 is called the cut off price.
Recent IPO’s in India*

Here is a look at few recent IPO’s in India. With all the background information you now have,
reading Table 5.1 in the following page should be easy
Table 5.1 - Recent IPO’s in India
Issue Price Issue Size Price Band

Sl No Name of Issue BRLM Date of Issue
(INR) (Lakh Shares) (INR)
Edelweiss 115 to 125

Financial 21/04/2014 to
Wonderla 23/04/2014
1 125 Services and 14,500,000
Holidays Limited
ICICI Securities
Limited
03/12/2013 to
Power Grid
SBI, Citi, ICICI, 06/12/2013
2 Coporation of 90 787,053,309 85 to 90
Kotak, UBS
India Ltd
20/05/2013 to 470 to 543

Citi, Morgan 22/05/2013
3 Just Dial Ltd 530 17,493,458
Stanley
165 to 172
13/03/2013 to
SBI, IDFC, JM 1,57,20,262
Repco Homes 15/03/2013
4 172
Finance Limited Financials
01/02/2013 to
195 to 215
V-Mart Retail 05/02/2013
5 210 Anand Rathi 4,496,000
Ltd
*Source : NSE India, as of June 2014
1. Companies go public to raise funds, provide an exit for early investors, reward employees
and gain visibility
2. Merchant banker acts as a key partner with the company during the IPO process
3. SEBI regulates the IPO market and has the final word on whether a company can go public
or not
4. As an investor in the IPO you should read through the DRHP to know everything about the
company
5. Most of the IPOs in India follow a book building process
6.1 - What really is the stock market?
Like we discussed in chapter 2, the stock market is an electronic market place. Buyers and sellers
meet and trade their point of view.
For example, consider the current situation of Infosys. At the time of writing this, Infosys is facing
a succession issue, and most of its senior level management personnel are quitting the company
for internal reasons. It seems like the leadership vacuum is weighing down the company’s reputa-
tion heavily. As a result, the stock price dropped to Rs.3,000 all the way from Rs.3,500. Whenever
there are new reports regarding Infosys management change, the stock prices react to it.
Assume there are two traders – T1 and T2.
T1’s point of view on Infosys - The stock price is likely to go down further because the company
will find it challenging to find a new CEO.
If T1 trades as per his point of view, he should be a seller of the Infosys stock.
T2, however views the same situation in a different light and therefore has a different point of
view – According to him, the stock price of Infosys has over reacted to the succession issue and
soon the company will find a great leader, after whose appointment the stock price will move up-
wards.
If T2 trades as per his point of view, he should be a buyer of the Infosys stock.
So at, Rs.3, 000 T1 will be a seller, and T2 will be a buyer in Infosys.
Now both T1 and T2 will place orders to sell and buy the stocks respectively through their respec-
tive stock brokers. The stock broker, obviously routes it to the stock exchange.
The stock exchange has to ensure that these two orders are matched, and the trade gets exe-
cuted. This is the primary job of the stock market – to create a market place for the buyer and
seller.
The stock market is a place where market participants can access any publicly listed company
and trade from their point of view, as long as there are other participants who have an opposing
point of view. After all, different opinions are what make a market.
6.2 - What moves the stock?
Let us continue with the Infosys example to understand how stocks really move. Imagine you are
a market participant tracking Infosys.
It is 10:00 AM on 11th June 2014 ,and the price of Infosys is 3000. The management makes a state-
ment to the press that they have managed to find a new CEO who is expected to steer the com-
pany to greater heights. They are confident on his capabilities and they are sure that the new CEO
will deliver much more than what is expected out of him.
Two questions –
a.How will the stock price of Infosys react to this news?

b.If you were to place a trade on Infosys, what would it be? Would be a buy or a sell?
The answer to the first question is quite simple, the stock price will move up.
Infosys had a leadership issue, and the company has fixed it. When positive announcements are
made market participants tend to buy the stock at any given price and this cascades into a stock
price rally.
Let me illustrate this further in Table 6.1
Table 6.1 - Trade Flow
What price What does

Last Traded New Last
Sl No Time the seller the buyer
Price Trade Price
wants do?
1 10:00 3000 3002 He buys 3002
2 10:01 3002 3006 He buys 3006
3 10:03 3006 3011 He buys 3011
4 10:05 3011 3016 He buys 3016
Notice, whatever prices the seller wants the buyer is willing to pay for it. This buyer-seller reac-
tion tends to push the share price higher.
So as you can see, the stock price jumped 16 Rupees in a matter of 5 minutes. Though this is a fic-
tional situation, it is a very realistic, and typical behavior of stocks. The stocks price tends to go
up when the news is good or expected to be good.
In this particular case, the stock moves up because of two reasons. One, the leadership issue has
been fixed, and two, there is also an expectation that the new CEO will steer the company to
greater heights.
The answer to the second question is now quite simple; you buy Infosys stocks considering the
fact that there is good news surrounding the stock.
Now, moving forward in the same day, at 12:30 PM ‘The National Association of Software & Serv-
ices company’, popularly abbreviated as NASSCOM makes a statement. For those who are not
aware, NASSCOM is a trade association of Indian IT companies. NASSCOM is considered to be a
very powerful organization and whatever they say has an impact on the IT industry.
The NASSCOM makes a statement stating that the customer’s IT budget seems to have come
down by 15%, and this could have an impact on the industry going forward.
By 12:30 PM let us assume Infosys is trading at 3030. Few questions for you..
a.How does this new information impact Infosys?

b.If you were to initiate a new trade with this information what would it be?
c.What would happen to the other IT stocks in the market?
The answers to the above questions are quite simple. Before we start answering these questions,
let us analyze NASSCOM’s statement in a bit more detail.
NASSCOM says that the customer’s IT budget is likely to shrink by 15%. This means the revenues
and the profits of IT companies are most likely to go down soon. This is not great news for the IT
industry.
Let us now try and answer the above questions..
a.Infosys being a leading IT major in the country will react to this news. The reaction could
be mixed one because earlier during the day there was good news specific to Infosys. How-
ever a 15% decline in revenue is a serious matter and hence Infosys stocks are likely to trade
lower
b.At 3030, if one were to initiate a new trade based on the new information, it would be a
sell on Infosys
c.The information released by NASSCOM is applicable to the entire IT stocks and not just
Infosys. Hence all IT companies are likely to witness a selling pressure.
So as you notice, market participants react to news and events and their reaction translates to
price movements! This is what makes the stocks move.
At this stage you may have a very practical and valid question brewing in your mind. You may be
thinking what if there is no news today about a particular company? Will the stock price stay flat
and not move at all?
Well, the answer is both yes and no, and it really depends on the company in focus.
For example let us assume there is absolutely no news concerning two different companies..
1. Reliance Industries Limited

2. Shree Lakshmi Sugar Mills
As we all know, Reliance is one the largest companies in the country and regardless of whether
there is news or not, market participants would like to buy or sell the company’s shares and there-
fore the price moves constantly.
The second company is a relatively unknown and therefore may not attract market participant’s
attention as there is no news or event surrounding this company. Under such circumstances, the
stock price may not move or even if it does it may be very marginal.
To summarize, the price moves because of expectation of news and events. The news or events
can be directly related to the company, industry or the economy as a whole. For instance the ap-
pointment of Narendra Modi as the Indian Prime Minister was perceived as positive news and
therefore the whole stock market moved.
In some cases there would be no news but still the price could move due to the demand and sup-
ply situation.
6.3 - What happens after you own a stock?

After you buy the shares, the shares will now reside in your DEMAT account. You are now a part
owner of the company, to the extent of your share holding. To give you a perspective, if you own
200 shares of Infosys then you own 0.000035% of Infosys.
By virtue of owning the shares you are entitled to few corporate benefits like dividends, stock
split, bonus, rights issue, voting rights etc. We will explore all these shareholder privileges at a
later stage.
6.4 - How to calculate returns?
Compounded Annual Growth Rate (CAGR) – An absolute return can be misleading if you want to
compare two investments. CAGR helps you answer this question - I bought Infosys at 3030 and
held the stock for 2 years and sold it 3550. At what rate did my investment grow over the last two
years?
CAGR factors in the time component which we had ignored when we computed the absolute re-
turn.
The formula to calculate CAGR is ..
6.5 - Where do you fit in?
Each market participant has his or her own unique style to participate in the market. Their style
evolves as and when they progress and witness market cycles. Their style is also defined by the
kind of risk they are willing to take in the market. Irrespective of what they do, they can be catego-
rized as either a trader or an investor.
A trader is a person who spots an opportunity and initiates the trade with an expectation of prof-
itably exiting the trade at the earliest given opportunity. A trader usually has a short term view on
markets. A trader is alert and on his toes during market hours constantly evaluating opportuni-
ties based on risk and reward. He is unbiased toward going long or going short. We will discuss
what going long or short means at a later stage.
There are different types of traders :
a.Day Trader – A day trader initiates and closes the position during the day. He does not carry for-
ward his positions. He is risk averse and does not like taking overnight risk. For example – He
would buy 100 shares of TCS at 2212 at 9:15AM and sell it at 2220 at 3:20 PM making a profit of
Rs.800/- in this trade. A day trader usually trades 5 to 6 stocks per day.
b.Scalper – A type of a day trader. He usually trades very large quantities of shares and holds the
stock for very less time with an intention to make a small but quick profit. For example – He
would buy 10,000 shares of TCS as 2212 at 9:15 and sell it 2212.1 at 9.16. He ends up making
1000/- profit in this trade. In a typical day, he would have placed many such trades. As you may
have noticed a scalp trader is highly risk averse.
c.Swing Trader – A swing trader holds on to his trade for slightly longer time duration, the dura-
tion can run into anywhere between few days to weeks. He is typically more open to taking
risks. For example – He would buy 100 shares of TCS at 2212 on 12th June 2014 and sell it 2214
on 19th June 2014.
Some of the really successful traders the world has seen are – George Soros, Ed Seykota, Paul Tu-
dor, Micheal Steinhardt, Van K Tharp, Stanley Druckenmiller etc
An investor is a person who buys a stock expecting a significant appreciation in the stock. He is
willing to wait for his investment to evolve. The typical holding period of investors usually runs
into a few years. There are two popular types of investors..
a.Growth Investors – The objective here is to identify companies which are expected to grow sig-
nificantly because of emerging industry and macro trends. A classic example in the Indian con-
text would be buying Hindustan Unilever, Infosys, Gillette India back in 1990s. These companies
witnessed huge growth because of the change in the industry landscape thereby creating mas-
sive wealth for its shareholders.
b.Value Investors – The objective here is to identify good companies irrespective of whether they
are in growth phase or mature phase but beaten down significantly due to the short term mar-
ket sentiment thereby making a great value buy. An example of this in recent times is L&T. Due
to short term negative sentiment; L&T was beaten down significantly around August/
September of 2013. The stock price collapsed to 690 all the way from 1200. At 690 (given its fun-
damentals around Aug 2013), a company like L&T is perceived as cheap, and therefore a great
value pick. Eventually it did pay off, as the stock price scaled back to 1440 around May 2014.
Some of the really famous investors the world has seen – Charlie Munger, Peter Lynch, Benjamin
Graham, Thomas Rowe, Warren Buffett, John C Bogle, John Templeton etc.
So what kind of market participant would you like to be?
1. A stock market is a place where a trader or an investor can transact (buy, sell) in shares
2. A stock market is a place where the buyer and seller meet electronically
3. Different opinions makes a market
4. The stock exchange electronically facilitate the meeting of buyers, and sellers
5. News and events moves the stock prices on a daily basis
6. Demand supply mismatch also makes the stock prices move
7. When you own a stock you get corporate privileges like bonus, dividends, rights etc
8. Holding period is defined as the period during which you hold your shares
9. Use absolute returns when the holding period is 1 year or less. Use CAGR to identify the
growth rate over multiple years
10. Traders, and investors differ on two counts – risk taking ability and the holding period.
C HAP TER 7
7.1 - The Index

Luckily you need not actually track these selected companies individually to get a sense of how
the markets are doing. The important companies are pre packaged, and continuously monitored
to give you this information. This pre packaged market information tool is called the ‘Market In-
dex’.
There are two main market indices in India. The S&P BSE Sensex representing the Bombay stock
exchange and CNX Nifty representing the National Stock exchange.
S&P stands for Standard and Poor’s, a global credit rating agency. S&P has the technical expertise
in constructing the index which they have licensed to the BSE. Hence the index also carries the
S&P tag.
CNX Nifty consists of the largest and most frequently traded stocks within the National Stock Ex-
change. It is maintained by India Index Services & Products Limited (IISL) which is a joint venture
of National Stock Exchange and CRISIL. In fact the term ‘CNX’ stands for CRISIL and NSE.
An ideal index gives us minute by minute reading about how the market participants perceive the
future. The movements in the Index reflect the changing expectations of the market participants.
When the index goes up, it is because the market participants think the future will be better. The
index drops if the market participants perceive the future pessimistically.
7.2 - Practical uses of the Index

Some of the practical uses of Index are discussed below.
Information – The index reflects the general market trend for a period of time. The
index is a broad representation of the country’s state of economy. A stock market
index that is up indicates people are optimistic about the future. Likewise when the
stock market index is down it indicates that people are pessimistic about the fu-
ture.
For example the Nifty value on 1st of January 2014 was 6301 and the value as of 24th June 2014
was 7580. This represents a change of 1279 points in the index of 20.3% increase. This simply
means that during the time period under consideration, the markets have gone up quite signifi-
cantly indicating a strong optimistic economic future.
The time frame for calculating the index can be for any length of time.. For example, the Index at
9:30 AM on 25th June 2014 was at 7,583 but an hour later it moves to 7,565. A drop of 18 points
during this period indicates that the market participants are not too enthusiastic.
Benchmarking – For all the trading or investing activity that one does, a yardstick
to measure the performance is required. Assume over the last 1 year you invested
Rs.100,000/- and generated Rs.20,000 return to make your total corpus Rs.120,000/-
. How do you think you performed? Well on the face of it, a 20% return looks great.
However what if during the same year Nifty moved to 7,800 points from 6,000 points generating a
return on 30%?
Well suddenly it may seem to you, that you have underperformed the market! If not for the Index
you can’t really figure out how you performed in the stock market. You need the index to bench-
mark the performance of a trader or investor. Usually the objective of market participants is to
outperform the Index.
Trading - Trading on the index is probably one of most popular uses of the index. Ma-
jority of the traders in the market trade the index. They take a broader call on the
economy or general state of affairs, and translate that into a trade.
For example imagine this situation. At 10:30 AM the Finance Minister is expected to
deliver his budget speech. An hour before the announcement Nifty index is at 6,600 points. You
expect the budget to be favorable to the nation’s economy. What do you think will happen to the
index? Naturally the index will move up. So in order to trade your point of view, you may want to
buy the index at 6,600. After all, the index is the representation of the broader economy.
So as per your expectation the budget is good and the index moves to 6,900. You can now book
your profits, and exit the trade at a 300 points profit! Trades such as these are possible through
what is known as ‘Derivative’ segment of the markets. We are probably a bit early to explore de-
rivatives, but for now do remember that index trading is possible through the derivative markets.
Portfolio Hedging – Investors usually build a portfolio of securities. A typical portfo-
lio contains 10 – 12 stocks which they would have bought from a long term perspec-
tive. While the stocks are held from a long term perspective they could foresee a pro-
longed adverse movement in the market (2008) which could potentially erode the
capital in the portfolio. In such a situation, investors can use the index to hedge the portfolio. We
will explore this topic in the risk management module.
Table 7.1 - Nifty stocks as per their weightage
Sl No Name of the company Industry Weightage (%)
1 ITC Limited Cigarettes 7.60
2 ICICI Bank Ltd Banks 6.55
3 HDFC Ltd Housing Finance 6.45
4 Reliance Industry Ltd Refineries 6.37
5 Infosys Ltd Computer Software 6.26
6 HDFC Bank Ltd Banks 5.98
7 TCS Ltd Computer Software 5.08
8 L&T Ltd Engineering 4.72
9 Tata Motors Ltd Automobile 3.09
10 SBI Ltd Banks 2.90
11 ONGC Ltd Oil Exploration 2.73
12 Axis Bank Ltd Banks 2.50
13 Sun Pharma Ltd Pharmaceuticals 2.29
14 M&M Ltd Automobiles 2.13
15 HUL Ltd FMCG 1.87
16 Bharti Airtel Ltd Telecom Services 1.70
17 HCL Technologies Ltd Computer software 1.61
18 Tata Steel Ltd Metal -Steel 1.42
19 Kotak Mahindra Bank Ltd Banks 1.40
20 Sesa Sterlite Ltd Mining 1.38
21 Dr.Reddy’s Lab Ltd Pharmaceuticals 1.37
22 Wipro Ltd Computer Software 1.37
23 Maruti Suzuki India Ltd Automobile 1.29
24 Tech Mahindra Ltd Computer Software 1.24
25 Hero Motocorp Ltd Automobile 1.20
26 NTPC Ltd Power 1.15
27 Power Grid Corp Ltd Power 1.13
28 Asian Paints Ltd Paints 1.10
29 Lupin Ltd Pharmaceuticals 1.09
30 Bajaj Auto Ltd Automobile 1.07
31 Hindalco Industries Ltd Metal – Aluminum 0.95
32 Ultratech Cements Ltd Cements 0.95
33 Indusind Bank Ltd Banks 0.94
34 Coal India Ltd Mining 0.93
35 Cipla Ltd Pharmaceuticals 0.89
Electrical
36 BHEL Ltd 0.79
Equipment
37 Grasim Industries Ltd Cements 0.79
38 Gail (India) Ltd Gas 0.78
39 IDFC Ltd Financial Services 0.74
40 Cairn India Ltd Oil Exploration 0.72
41 United Sprits Ltd Distillery 0.70
42 Tata Power Co.Ltd Power 0.68
43 Bank of Baroda Banks 0.63
44 Ambuja Cements Ltd Cements 0.61
45 BPCL Refineries 0.58
46 Punjab National Bank Banks 0.55
47 NMDC Ltd Mining 0.52
48 ACC Ltd Cements 0.50
49 Jindal Steel & Power Steel 0.38
50 DLF Ltd Construction 0.34
As you can see, ITC Ltd has the highest weightage. This means the Nifty index is most sensitive to
price changes in ITC Ltd, and least sensitive to price changes in DLF Ltd.
1. An index acts as a barometer of the whole economy

2. An index going up indicates that the market participants are optimistic
3. An index going down indicates that the market participants are pessimistic
4. There are two main indices in India – The BSE Sensex and NSE’s Nifty
5. Index can be used for a variety of purposes – information, bench marking, trading and
hedging.
6. Index trading is probably the most popular use of the index
7. India follows the free float market capitalization method to construct the index
8. There are sector specific indices which convey the sentiment of specific sectors
C HAP TER 8
The objective of this chapter is to help you learn some of the common market terminologies, and
concepts associated with it.
Bull Market (Bullish) – If you believe that the stock prices are likely to go up then you are
said to be bullish on the stock price. From a broader perspective, if the stock market index is go-
ing up during a particular time period, then it is referred to as the bull market.
Bear Market (Bearish) – If you believe that the stock prices are likely to go down then you
are said to be bearish on the stock price. From a broader perspective, if the stock market index is
going down during a particular time period, then it is referred to as the bear market.
Trend - A term ‘trend’ usually refers to the general market direction, and its associated
strength. For example, if the market is declining fast, the trend is said to be bearish. If the market
is trading flat with no movement then the trend is said to be sideways.
Face value of a stock – Face value (FV) or par value of a stock indicates the fixed denomina-
tion of a share. The face value is important with regard to corporate action. Usually when divi-
dends and stock split are announced they are issued keeping the face value in perspective. For ex-
ample the FV of Infosys is 5, and if they announce an annual dividend of Rs.63 that means the divi-
dend yield is 1260%s (63 divided by 5).
52 week high/low – 52 week high is the highest point at which a stock has traded during the
last 52 weeks (which also marks a year) and likewise 52 week low marks the lowest point at
which the stock has traded during the last 52 weeks. The 52 week high and low gives a sense of
the range within which the stock has traded during the year. Many people believe that if a stock
reaches 52 week high, then it indicates a bullish trend for the foreseeable future. Similarly if a
stock has hits 52 week low, some traders believe that it indicates a bearish trend for a foreseeable
future.
All time high/low – This is similar to the 52 week high and low, with the only difference be-
ing the all time high price is the highest price the stock has ever traded from the time it has been
listed. Similarly, the all time low price is the lowest price at which the stock has ever traded from
the time it has been listed.
Long Position – Long position or going long is simply a reference to the direction of your
trade. For example if you have bought or intend to buy Biocon shares then you are said to be long
on Biocon or planning to go long on Biocon respectively. If you have bought the Nifty Index with
an expectation that the index will trade higher then essentially you have a long position on Nifty.
If you are long on a stock or an index, you are said to be bullish.
Short Position – Going short or simply ‘shorting’ is a term used to describe a transaction car-
ried out in a particular order. This is a slightly tricky concept. To help you understand the concept
shorting, I’d like to narrate a recent incident that happened to me at work.
If you are a gadget enthusiast like me, you would probably know that Xiaomi (Chinese manufac-
tures of Smartphone) recently entered into an exclusive partnership with Flipkart to sell their flag-
ship smart phone model called Mi3 in India. The price of Mi3 was speculated to be around
Rs.14,000/-. If one wished to buy Mi3, he had to be a registered Flipkart user, the phone was not
available for a non registered user, and the registration was open only for a short time. I had
promptly registered to buy the phone, but my colleague Rajesh had not. Though he wanted to
buy the phone, he could not because he had not registered on time.
Out of sheer desperation, Rajesh walked up to me, and made an offer. He said, he is willing to buy
the phone from me at Rs. 16,500/-. Being a trader at heart, I readily agreed to sell him the phone!
In fact I even demanded him to pay me the money right away.
After I pocketed the money, I thought to myself, what have I done?? Look at the situation I’ve put
myself into? I’ve sold a phone to Rajesh, which I don’t own yet!!
But then, it was not a bad deal after all. I agree, I had sold a phone that I dint own. However I
could always buy the phone on Flipkart, and pass on the new unopened box to Rajesh. My only
fear in this transaction was, what if the price of the phone is above Rs.16,500?? In that case I’d
make a loss, and I’d regret entering into this transaction with Rajesh. For example if the phone
was priced at Rs.18,000 my loss would be Rs.1,500 (18,000 – 16,500).
However to my luck, the phone was priced at Rs.14,000/-, I promptly bought it on Flipkart, upon
delivery, I handed over the phone to Rajesh, and in the whole process I made a clean profit of
Rs.2,500/- (16500 – 14000)!
If you look at the sequence of transactions, first I sold the phone (that I dint own) to Rajesh, and
then I bought it later on Flipkart, and delivered the same to Rajesh. Simply put I had sold first,
and bought it later!
This type of transaction is called a ‘Short Trade’.
The concept of shorting is very counter intuitive simply because we are not used to ‘shorting’ in
our day to day activity, unless you have a trader mentality :)
Going back to stock markets, think about this very simple transaction – on day 1 you buy shares
of Wipro at Rs.405, two days later (day 3) the stock moves and you sell your shares at Rs.425. You
made a profit of Rs.20/- on this transaction.
In this transaction your first leg of the trade was to buy Wipro at Rs.405, and the second leg was
to sell Wipro at Rs.425, and you were bullish on the stock.
Going forward, on day 4, the stock is still trading at Rs.425, and you are now bearish on the stock.
You are convinced that the stock will trade lower at Rs.405 in few days time. Now, is there a way
you can profit out of your bearish expectation? Well, you could, and it can be done so by shorting
the stock.
You sell the stock at Rs.425, and 2 days later assuming the stock trades at Rs.405, you buy it back.
If you realize the first leg of the trade was to sell at Rs.425, and the second leg was to buy the
stock at Rs.405. This is always the case with shorting – you first sell at a price you perceive as high
with an intention of buying it back at a lower price at a later point in time.
You have actually executed the same trade as buying at Rs.405 and selling at Rs.425 but in re-
verse order.
An obvious question you may have – How can one sell Wipro shares without owning it. Well you
can do so, just like the way I sold a phone that I did not own.
When you first sell, you are essentially borrowing it from someone else in the market, and when
you buy it back, you actually return the shares back. All this happens in the backend, and the
stock exchange facilitates the process of borrowing, and returning it back.
In fact when you short a stock, it works so seamlessly that you will not even realize that you are
borrowing it from someone else. From your perspective, all you need to know is that when you
are bearish on the stock, you can short the stock, and the exchange takes care of borrowing the
stock on your behalf. When you buy the stocks back, the exchange will ensure the stocks are re-
turned back.
Table 8.1- Long and short positions
Make
You will lose
Position 1st Leg 2nd Leg Expectation money
money if
when
Stock price
Long Buy Sell Bullish Stock goes up
drops
Stock goes Stock price
Short Sell Buy Bearish
down goes up
Square off – Square off is a term used to indicate that you intend to close an existing posi-
tion. If you are long on a stock squaring off the position means to sell the stock. Please remem-
ber, when you are selling the stock to close an existing long position you are not shorting the
stock!
When you are short on the stock, squaring off position means to buy the stock back. Remember
when you buy it back, you are just closing an existing position and you are not going long!
Table 8.2 - Square off positions
When you are Square off position is

Long Sell the stock
Short Buy the stock
Intraday position – Is a trading position you initiate with an expectation to square off the po-
sition within the same day.
OHLC – OHLC stands for open, high, low and close. We will understand more about this in
the technical analysis module. For now, open is the price at which the stock opens for the day,
high is the highest price at which the stock trade during the day, low is the lowest price at which
the stock trades during the day, and the close is the closing price of the stock. For example, the
OHLC of ACC on 17th June 2014 was 1486, 1511, 1467 and 1499.
Volume – Volumes and its impact on the stock prices is an important concept that we will
explore in greater detail in the technical analysis module. Volumes represent the total transac-
tions (both buy and sell put together) for a particular stock on a particular day. For example, on
17th June 2014, the volume on ACC was 5, 33,819 shares.
Market Segment – A market segment is a division within which a certain type of financial in-
strument is traded. Each financial instrument is characterized by its risk and reward parameters.
The exchange operates in three main segments.
a.Capital Market – Capital market segments offers a wide range of tradable securities such as eq-
uity, preference shares, warrants and exchange traded funds. Capital Market segment has sub seg-
ments under which instruments are further classified. For example, common shares of compa-
nies are traded under the equity segment abbreviated as EQ. So if you were to buy or sell shares
of a company you are essentially operating in the capital market segment
b.Futures and Options – Futures and Option, generally referred to as equity derivative segment is
where one would trade leveraged products. We will explore the derivative markets in greater
depth in the derivatives module
c.Whole sale Debt Market – The whole sale debt market deals with fixed income securities. Debt
instruments include government securities, treasury bills, bonds issued by a public sector under-
taking, corporate bonds, corporate debentures etc
C HAP TER 11
11.1 - Overview
Corporate actions are initiatives taken up by a corporate entity that bring in a change to its stock.
There are many types of corporate actions that an entity can choose to initiate. A good under-
standing of these corporate actions gives a clear picture of the company’s financial health, and
also to determine whether to buy or sell a particular stock.
In this chapter, we will be looking into the four most important corporate actions and their im-
pact on stock prices.
A corporate action is initiated by the board of directors, and approved by the company’s share-
holders.
11.2 - Dividends
Dividends are paid by the company to its shareholders. Dividends are paid to
distribute the profits made by the company during the year. Dividends are
paid on a per share basis. For example, during the financial year 2012-13 Info-
sys had declared a dividend of Rs.42 per share. The dividend paid is also ex-
pressed as a percentage of the face value. In the above case, the face value of
Infosys was Rs.5/- and the dividend paid was Rs.42/- hence the dividend payout is said to be
840% (42/5).
It is not mandatory to pay out the dividends every year. If the company feels that instead of pay-
ing dividends to shareholders they are better off utilizing the same cash to fund new project for a
better future, then can do so.
Besides, the dividends need not be paid from the profits alone. If the company has made a loss
during the year but it does hold a healthy cash reserve, then the company can still pay dividends
from its cash reserves.
Sometimes distributing the dividends may be the best way forward for the company. When the
growth opportunities for the company have exhausted and the company holds excess cash, it
would make sense for the company to reward its shareholders thereby repaying the trust the
shareholders hold in the company.
The decision to pay dividend is taken in the Annual General Meeting (AGM) during which the direc-
tors of the company meet. The dividends are not paid right after the announcement. This is be-
cause the shares are traded throughout the year and it would be difficult to identify who gets the
dividend and who doesn’t. The following timeline would help you understand the dividend cycle.
Dividend Declaration Date: This is the date on which the AGM takes place and the company’s
board approves the dividend issue
Record Date: This is the date on which the company decides to review the shareholders register to
list down all the eligible shareholders for the dividend. Usually the time difference between the
dividend declaration date and record date is at least 30 days
Ex Date/Ex Dividend date: The ex dividend date is normally set two business days before the re-
cord date. Only shareholders who own the shares before the ex dividend date are entitled to the
dividend. This is because in India the normal settlement is on T+2 basis. So for all practical pur-
poses if you want to be entitled for dividend you need to ensure you buy the shares before the ex
dividend date.
Dividend Payout Date: This is the day on which the dividends are paid out to shareholders listed in
the register of the company.
Cum Dividend: The shares are said to be cum dividend till the ex dividend date.
When the stock goes ex dividend, usually the stock drops to the extent of dividends paid. For ex-
ample if ITC (trading at Rs. 335) has declared a dividend of Rs.5. On ex date the stock price will
drop to the extent of dividend paid, and as in this case the price of ITC will drop down to Rs.330.
The reason for this price drop is because the amount paid out no longer belongs to the company.
Dividends can be paid anytime during the financial year. If it’s paid during the financial year it is
called the interim dividend. If the dividend is paid at the end of the financial year it is called the
final dividend.
11.3 - Bonus Issue

A bonus issue is a stock dividend, allotted by the company to reward the
shareholders. The bonus shares are issued out of the reserves of the com-
pany. These are free shares that the shareholders receive against shares that
they currently hold. These allotments typically come in a fixed ratio such as,
1:1, 2:1, 3:1 etc.
If the ratio is 2:1 ratio, the existing shareholders get 2 additional shares for every 1 share they
hold at no additional cost. So if a shareholder owns 100 shares then he will be issued an addi-
tional 200 shares, so his total holding will become 300 shares. When the bonus shares are issued,
the number of shares the shareholder holds will increase but the overall value of investment will
remain the same.
To illustrate this kindly refer to Table 11.1 in the following page, let us assume a bonus issue on
different ratios – 1:1, 3:1 and 5:1
Table 11.1 - Bonus Issue
Share price Value of Number of

Bonus No of shares held Share price after Value of Investment
before Bonus Investment shares held
Issue before bonus Bonus issue
issue after Bonus
1:1 100 75 7,500 200 37.5 7500

3:1 30 550 16,500 120 137.5 16,500
5:1 2000 15 30,000 12,000 2.5 30,000
Similar to the dividend issue there is a bonus announcement date, ex bonus date, and record date.
Companies issue bonus shares to encourage retail participation, especially when the price per
share of a company is very high and it becomes tough for new investors to buy shares. By issuing
bonus shares, the number of outstanding shares increases, but the value of each share reduces as
shown in the example above.
11.1 - Stock Split

The word stock split- for the first time sounds weird but this happens on a regular
basis in the markets. What this means is quite obvious – the stocks that you hold
actually are split!
When a stock split is declared by the company the number of shares held increases but the invest-
ment value/market capitalization remains the same similar to bonus issue. The stock is split with
reference to the face value. Suppose the stock’s face value is Rs.10, and there is a 1:1 stock split
then the face value will change to Rs.5. If you owned 1 share before split you would now own 2
shares after the split.
We will illustrate this with an example, refer to Table 11.2 in the following page:
Table 11.2 - Stock Split
No of
Share
shares you Investment
Price No of shares Share Price after Investment value
Split own Value New FV
Old FV before you own after the split after split
Ratio before before split
split split
split
1:1 10 100 900 90,000 5 200 450 90,000
1:5 10 100 900 90,000 2 500 180 90,000
Similar to bonus issue, stock split is usually to encourage more retail participation by reducing
the value per share.
11.2 - Rights Issue

The idea behind a rights issue is to raise fresh capital. However instead of go-
ing public, the company approaches their existing shareholders Think about
the rights issue as a second IPO but for a select group of people (existing
shareholders). The rights issue could be an indication of a promising new de-
velopment in the company. The shareholders can subscribe to the rights issue in the proportion
of their share holding. For example 1:4 rights issue means for every 4 shares a shareholder owns,
he can subscribe to 1 additional share. Needless to say the new shares under the rights issue will
be issued at a lower price than what prevails in the markets.
However, a word of caution – The investor should not be swayed by the discount offered by the
company but they should look beyond that. Rights issue is different from bonus issue as one is
paying money to acquire shares. Hence the shareholder should subscribe only if he or she is com-
pletely convinced about the future of the company. Also, if the market price is below the subscrip-
tion price/right issue price it is obviously cheaper to buy it from the open market.
11.3 Buyback of shares

A buyback can be seen as a method for company to invest in itself by buying
shares from other investors in the market. Buybacks reduce the number of
shares outstanding in the market, however buyback of shares is an important
method of corporate restructuring.
There could be many reasons why corporates choose to buy back shares..
1. Improve the profitability on a per share basis

2. To consolidate their stake in the company
3. To prevent other companies from taking over
4. To show the confidence of the promoters about their company
5. To support the share price from declining in the markets
When a company announces a buy back, it signals the company’s confidence about itself. Hence
this is usually a positive for the share price.
1. Corporate actions has an impact on stock prices

2. Dividends are means of rewarding the shareholders. Dividend is announced as a percentage
of face value
3. If you aspire to get the dividend you need to own the stock before the ex dividend date
4. A bonus issue is a form of stock dividend. This is the company’s way of rewarding the
shareholders with additional shares
5. A stock spilt is done based on the face value. The face value and the stock price changes in
proportion to the change in face value
6. Rights issue is way through which the company raises fresh capital from the existing
shareholders. Subscribe to it only if you think it makes sense
7. Buy back signals a positive outlook of the promoters. This also conveys to the shareholders
that the promoters are optimistic of the company’s prospects.
C HAP TER 12
12.1 - Overview
For a market participant transacting just based on company specific information may not be suffi-
cient. It is also important to understand the events that influence the markets. Various outside
factors, economic and/or non-economic events have a key impact on the performance of stocks
and markets in general.
In this chapter we will try to understand some of these events, and also how the stock market re-
acts to them.
12.2 - Monetary Policy
The monetary policy is a tool with which the Reserve Bank of India (RBI) controls the money sup-
ply by controlling the interest rates. They do this by tweaking the interest rates. RBI is India’s cen-
tral bank. World over every country’s central bank is responsible for setting the interest rates.
While setting the interest rates the RBI has to strike a balance between growth and inflation. In a
nutshell – if the interest rates are high that means the borrowing rates are high (particularly for
corporations). If corporate can’t borrow easily they cannot grow. If corporations don’t grow, the
economy slows down.
On the other hand when the interest rates are low, borrowing becomes easier. This translates to
more money in the hands of the corporations and consumers. With more money there is in-
creased spending which means the sellers tend to increase prices leading to inflation.
In order to strike a balance, the RBI has to consider all the factors and should carefully set a few
key rates. Any imbalance in these rates can lead to an economic chaos. The key RBI rates that you
need to track are as follows:
Repo Rate – Whenever banks want to borrow money they can borrow from the RBI. The rate at
which RBI lends money to other banks is called the repo rate. If repo rate is high that means the
cost of borrowing is high, leading to a slow growth in the economy. Currently, the repo rate in In-
dia is 8%. Markets don’t like the RBI increasing the repo rates.
Reverse repo rate – Reverse Repo rate is the rate at which RBI borrows money from banks. When
banks lend money to RBI they are certain that RBI will not default, and hence they are happier to
lend their money to RBI as opposed to a corporate. However when banks choose to lend money
to the RBI instead of the corporate entity, the supply of money in the banking system reduces. An
increase in reverse repo rate is not great for the economy as it tightens the supply of money. The
reverse repo rate is currently at 7%.
Cash reserve ratio (CRR) – Every bank is mandatorily required to maintain funds with RBI. The
amount that they maintain is dependent on the CRR. If CRR increases then more money is re-
moved from the system, which is again not good for the economy.
The RBI meets every quarter to review the rates. This is a key event that the market watches out
for. The first to react to rate decisions would be interest rate sensitive stocks across various sec-
tors such as – banks, automobile, housing finance, real estate, metals etc.
12.3 - Inflation
Inflation is a sustained increase in the general prices of goods and services. Increasing inflation
erodes the purchasing power of money. All things being equal, if the cost of 1 KG of onion has in-
creased from Rs.15 to Rs.20 then this price increase is attributed to inflation. Inflation is inevita-
ble but a high inflation rate is not desirable as it could lead to economic uneasiness. A high level
of inflation tends to send a bad signal to markets. Governments work towards cutting down the
inflation to a manageable level. Inflation is generally measured using an index. If the index is go-
ing up by certain percentage points then it indicates rising inflation, likewise index falling indi-
cates inflation cooling off.
There are two types of inflation indices – Wholesale Price Index (WPI) and Consumer Price Index
(CPI).
Wholesale Price Index (WPI) – The WPI indicates the movement in prices at the wholesale level. It
captures the price increase or decrease when they are sold between organizations as opposed to
actual consumers. WPI is an easy and convenient method to calculate inflation. However the infla-
tion measured here is at an institutional level and does not necessarily capture the inflation expe-
rienced by the consumer.
As I write this, the WPI inflation for the month of May 2014 stands at 6.01%.
Consumer Price Index (CPI)- The CPI on the other hand captures the effect of the change in prices
at a retail level. As a consumer, CPI inflation is what really matters. The calculation of CPI is quite
detailed as it involves classifying consumption into various categories and sub categories across
urban and rural regions. Each of these categories is made into an index. This means the final CPI
index is a composition of several internal indices.
The computation of CPI is quite rigorous and detailed. It is one of the most critical metrics for
studying the economy. A national statistical agency called the Ministry of Statistics and Pro-
gramme implementation (MOSPI) publishes the CPI numbers around the 2nd week of every
month.
The CPI stands at 8.28% for the month of May 2014. Here is a chart for the inflation for the last
one year in India.
As you can notice, the CPI inflation has kind of cooled off from the peak of 11.16% in November
2013. The RBI’s challenge is to strike a balance between inflation and interest rates. Usually a low
interest rate tends to increase the inflation and a high interest rate tends to arrest the inflation.
12.4 - Index of Industrial Production (IIP)

The Index of Industrial Production (IIP) is a short term indicator of how the industrial sector in
the country is progressing. The data is released every month (along with inflation data) by Minis-
try of Statistics and Programme implementation (MOSPI). As the name suggests, the IIP meas-
ures the production in the Indian industrial sectors keeping a fixed reference point. As of today,
India uses the reference point of 2004-05. The reference point is also called the base year.
Roughly about 15 different industries submit their production data to the ministry, which collates
the data and releases it as an index number. If the IIP is increasing it indicates a vibrant industrial
environment (as the production is going up) and hence a positive sign for the economy and mar-
kets. A decreasing IIP indicates a sluggish production environment, hence a negative sign for the
economy and markets.
To sum up, an upswing in the industrial production is good for the economy and a downswing
rings an alarm. As India is getting more industrialized, the relative importance of the Index of In-
dustrial Production is increasing.
A lower IIP number puts pressure on the RBI to lower the interest rates. The following graph
shows the change in IIP in percentage terms for the last 1 year.
12.5 - Purchasing Managers Index (PMI)
The Purchasing managers index (PMI) is an economic indicator which tries to capture the busi-
ness activity across the manufacturing and service sectors in the country. This is a survey based
indicator where the respondents – usually the purchasing managers indicate their change in busi-
ness perception with respect to the previous month. A separate survey is conducted for the serv-
ice and the manufacturing sectors. The data from the survey is consolidated on to a single index.
Typical areas covered in the survey include factors such as new orders, output, business expecta-
tions and employment amongst others.
The PMI number usually oscillates around 50. A reading above 50 indicates expansion and below
50 indicates a contraction in the economy. And a reading at 50 indicates no change in the econ-
omy.
12.6 - Budget
The Budget is an event during which the Ministry of Finance discusses the country’s finance in de-
tail. The Finance Minister on behalf of the ministry makes a budget presentation to the entire
country. During the budget, major policy announcements and economic reforms are announced
which has an impact on various industries across the markets. Therefore the budget plays a very
important role in the economy
To illustrate this further, one of the expectations for the budget (July 2014) was to increase the du-
ties on cigarette. As expected, during the budget, the Finance Minister raised the duties on ciga-
rette, and hence the prices of cigarettes were also increased. An increased cigarette price has a
few implications:
1. Increased cigarette prices discourage smokers from buying cigarettes (needless to say this is
a debatable) and hence the profitability of the cigarette manufacturing companies such as ITC
decreases. If the profitability decreases then investors may want to sell shares of ITC.
2. If market participants start selling ITC, then the markets will come down because ITC is an
index heavy weight.
In fact as a reaction to the budget announcement ITC traded 3.5% lower for this precise reason.
Budget is an annual event and it is announced during the last week of February. However under
certain special circumstances such as a new government formation the budget announcement
could be delayed.
12.7 - Corporate Earnings Announcement
This is perhaps one of the important events to which the stocks react. The listed companies (trad-
ing on stock exchange) are required to declare their earning numbers once in every quarter, also
called the quarterly earning numbers. During an earnings announcement the corporate gives out
details on various operational activities including..
1. How much revenue the company has generated?

2. How has the company managed its expense?
3. How much money the company paid in terms of taxes and interest charges?
4. What is the profitability during the quarter?
Besides some companies give an overview of what they expect from the upcoming quarters. This
forecast is called the ‘corporate guidance’.
Invariably every quarter the first blue chip company to make the quarterly announcement is Info-
sys Limited. They also give out guidance regularly. Market participants keenly follow what Infosys
has to say in terms of guidance as it has an overall impact on the markets.
The table below gives you an overview of the earning season in India:
Table 12.1 - Quarterly Earnings
Result Announcement
Sl No Months Quarter
1 April to June Quarter 1 (Q1) 1st week of July
2 July to September Quarter 2 (Q2) 1st week of Oct
3 October to December Quarter 3 (Q3) 1st Week of Jan
4 January to March Quarter 4 (Q4) 1st Week of April
Every quarter when the company declares their earnings, the market participants match the earn-
ings with their own expectation of how much the company should have earned. The market par-
ticipant’s expectation is called the ‘street expectation’.
The stock price will react positively if the company’s earnings are better than the street expecta-
tion. On a similar logic, the stock price will react negatively if the actual numbers are below the
street expectation.
If the street expectation and actual numbers match, more often than not the stock price tends to
trade flat with a negative bias. This is mainly owing to fact that the company could not give any
positive surprises.
1. Markets and individual stocks react to events. Market participants should equip themselves
to understand and decipher these events
2. Monetary policy is one of the most important economic event. During the monetary policy,
review actions on repo, reverse repo, CRR etc are initiated
3. Interest rates and inflation are related. Increasing interest rates curbs inflation and vice versa
4. Inflation data is released every month by MOSPI. As a consumer, CPI inflation data is what
you need to track
5. IIP measures the industrial production activity. Increase in IIP cheers the markets and lower
IIP disappoints the market
6. PMI is a survey based business sentiment indicator. The PMI number oscillates around the 50
mark. Above 50 is good news to markets and PMI below 50 is not.
7. The Budget is an important market event where policy announcements and reform initiatives
are taken. Markets and stocks react strongly to budget announcements
8. Corporate earnings are reported every quarter. Stocks react mainly due to the variance in
actual number versus the street

FinsSoc Zerodha 1 - Introduction To Stock Markets

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

FinsSoc Zerodha 1 - Introduction To Stock Markets

Uploaded by

Copyright:

Available Formats

ZERODHA

1 The Need to Invest 1

4 The IPO Markets - Part 1 21

5 The IPO Markets - Part 2 32

6 The Stock Markets 40

7 The Stock Markets Index 50

8 Commonly used Jargons 59

9 The Trading Terminal 65

10 Clearing and Settlement process 79

11 Five corporate actions and its impact on stock prices 84

12 Key Events and Their Impact on Markets 91

1.1 - Why should one Invest?

1. To drive the point across, let us make few simple assumptions.

Years Yearly income Yearly expense Cash retained

1 600,000 360,000 240,000

2 6,60,000 3,88,800 2,71,200

3 7,26,000 4,19,904 3,06,096

4 7,98,600 4,53,496 3,45,104

5 8,78,460 4,89,776 3,88,684

6 9,66,306 5,28,958 4,37,348

7 10,62,937 5,71,275 4,91,662

8 11,69,230 6,16,977 5,52,254

9 12,86,153 6,66,335 6,19,818

10 14,14,769 7,19,642 6,95,127

11 15,56,245 7,77,213 7,79,032

12 17,11,870 8,39,390 8,72,480

13 18,83,057 9,06,541 9,76,516

14 20,71,363 9,79,065 10,92,298

15 22,78,499 10,57,390 12,21,109

16 25,06,349 11,41,981 13,64,368

17 27,56,984 12,33,339 15,23,644

18 30,32,682 13,32,006 17,00,676

19 33,35,950 14,38,567 18,97,383

20 36,69,545 15,53,652 21,15,893

Total Income 17,890,693

1. After 20 years of hard work you have accumulated Rs.1.7 Crs.

1.2 - Where to invest?

1 600,000 360,000 240,000 20,67,063

2 6,60,000 3,88,800 2,71,200 20,85,519

3 7,26,000 4,19,904 3,06,096 21,01,668

4 7,98,600 4,53,496 3,45,104 21,15,621

5 8,78,460 4,89,776 3,88,684 21,27,487

6 9,66,306 5,28,958 4,37,348 21,37,368

7 10,62,937 5,71,275 4,91,662 21,45,363

8 11,69,230 6,16,977 5,52,254 21,51,566

9 12,86,153 6,66,335 6,19,818 21,56,069

10 14,14,769 7,19,642 6,95,127 21,58,959

11 15,56,245 7,77,213 7,79,032 21,60,318

12 17,11,870 8,39,390 8,72,480 21,60,228

13 18,83,057 9,06,541 9,76,516 21,58,765

14 20,71,363 9,79,065 10,92,298 21,56,003

15 22,78,499 10,57,390 12,21,109 21,52,012

16 25,06,349 11,41,981 13,64,368 21,46,859

17 27,56,984 12,33,339 15,23,644 21,40,611

18 30,32,682 13,32,006 17,00,676 21,33,328

19 33,35,950 14,38,567 18,97,383 21,25,069

20 36,69,545 15,53,652 21,15,893 21,15,893

TOTAL CASH AFTER 20 YEARS 4,26,95,771

1. Fixed income instruments

Fixed Income Instruments

Typical fixed income investment includes:

1. Fixed deposits offered by banks