METHODS OF FLOATING NEW ISSUES

The methods by which new issue of shares are floated in the primary market in
India are: -
1. Public Issue
2. Rights issue
3. Private Placement

Public Issue
Public issue involves sale of securities to members of the public. The issuing
company makes an offer for sale to the public directly of a fixed number of
shares at a specific price. The offer is made through a legal document called
Prospectus. Thus, a public issue is an invitation by a company to the public to
subscribe to the securities offered through a prospectus. Public issues are mostly
underwritten by strong public financial institutions. This is the most popular
method for floating securities in the new issue market, but it involves an
elaborate process and consequently it is an expensive method. The company
has to incur expenses on various activities such as advertisements, printing of
prospectus, banks’ commissions, underwriting commissions, agents’ fees, legal
charges, etc.

Rights Issue
The rights issue involves selling of securities to the existing shareholders in
proportion to their current holding. As per Section 81 of the Companies Act,
1956, when a company issues additional equity capital it has to be offered
first to the existing shareholders on a pro-rata basis. However, the
shareholders may forfeit this special right by passing a special resolution and
thereby enable the company to issue additional capital to the public through a
public issue. Rights issue is an inexpensive method of floatation of shares as
the offer is made through a formal letter to the existing shareholders.

Private Placement
A private placement is a sale of securities privately by a company to a selected
group of investors. The securities are normally placed, in a private placement,
with the institutional investors, mutual funds or other financial institutions. The

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terms of the issue are negotiated between the company and the investors. A
formal prospectus is not necessary in the case of private placement.
Underwriting arrangements are also not required in private placement, as the
sale is directly negotiated with the investors. This method is useful to small
companies and closely held companies for issue of new securities, because such
companies are unlikely to get good response from the investing public for their
public issues. They can avoid the expenses of a public issue and also have their
shares sold.

PRINCIPAL STEPS IN FLOATING A PUBLIC ISSUE

In a public issue, investors are allowed to subscribe to the shares being issued
by the company during a specified period ranging from a minimum of 3 days
to a maximum of 10 days. The issue remains open during this period for
subscription by the public. This is the principal activity in the process of a
public issue.

Before the issue is opened for public subscription, several activities/legal

formalities have to be completed. These are the pre-issue steps or obligations.

Similarly, after the issue is closed, several activities are to be carried out to
complete the process of public issue. These activities may be designated as the
post-issue tasks. Thus, we can identify three distinct stages in the successful
completion of a public issue.
1. Pre-issue tasks
2. Opening and Closing of the issue
3. Post-issue tasks

1. Pre-issue tasks
These are the preparatory obligations to be complied with before the actual
opening of the issue: -
(a) Drafting and finalization of the Prospectus
Prospectus is an essential document in a public issue. The Companies Act,
1956 defines a prospectus as: ‘Any document described or issued as a

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prospectus and includes any notice. Circular. Advertisement or other document
inviting deposits from the public or inviting offers from the public for the
subscription or the purchase of any shares in or debentures of a body corporate’.

It is the offer document which contains all the information pertaining to the
company which will be useful to the investors to arrive at a proper decision
regarding investing in the company. It is a communication from the issuer to
the investor. The prospectus contains detailed information about the company,
its activities, promoters, directors, group companies, capital structure, terms of
the present issue, details of proposed project, details regarding underwriting
arrangements, etc. SEBI has issued guidelines regarding the contents of the
prospectus and these have to be complied with by the company.
The draft prospectus has to be approved by the Board of Directors of the
company. The draft prospectus has also to be filed with SEBI and the
Registrar of Companies. The final prospectus has to be prepared as per the
suggestions of SEBI and filed with SEBI and the Registrar of Companies.

(b) Selecting the intermediaries and entering into agreements with them
Several intermediaries are involved in the process of a public issue. These
intermediaries have to be registered with SEBI. Important categories of
intermediaries are the following: -

i. Merchant Banker: Merchant Banker is any person or institution which is

engaged in the business of issue management either as manager, consultant,
adviser, or by rendering corporate advisory service in relation to such issue
management. Merchant bankers play an important role in the process of
managing a public issue. It is the duty of the merchant bankers to ensure
correctness of the information furnished in the prospectus as well as to
ensure compliance with SEBI rules, regulations and guidelines regarding
public issue of securities. Merchant bankers are registered with SEBI in four
categories, with different eligibility criteria for each category.

ii. Registrar to an issue: Registrar to an issue is any person or institution

entrusted with the following functions in connection with a public issue:
(a) Collecting applications from investors
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(b) Keeping a record of applications and monies received from investors
(c) Assisting the stock issuing company in determining the basis of allotment of
securities in consultation with the stock exchange.
(d) Finalizing the list of persons entitled to allotment of securities
(e) Processing and dispatching allotment letters, refund orders, certificates and
other related documents.
iii. Share Transfer Agent: Share Transfer Agent is a person or institution which
maintains the record of holders of securities of a company on behalf of that
company. The share transfer agent is authorized to effect the transfer of
securities as well as the redemption of securities wherever applicable.

iv. Banker to an issue: Banker to an issue is a scheduled bank entrusted with

the following activities in connection with a public issue:
(a) Acceptance of application and application monies
(b) Acceptance of allotment or call monies
(c) Refund of application monies
(d) Payment of dividend or interest warrants
The intermediaries are service providers possessing professional expertise in the
relevant areas of operation. The market regulator, SEBI, regulates the various
intermediaries in the primary market through its regulations for these
intermediaries. SEBI has defined the role of each category of intermediary, the
eligibility criteria for granting registration, their functions and responsibilities,
and the code of conduct to which they are bound.
The stock issuing company has to select the intermediaries such as merchant
banker, registrar to the issue, share transfer agent, banker to the issue,
underwriters, etc. and sign separate agreements with each of them to engage
them for the public issue.

v. Attending to other formalities

The prospectus and application forms have to be printed and despatched to all
intermediaries and brokers for wide circulation among the investing public.
An initial listing application has to be filed with the stock exchange where the

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issue is proposed to be listed. An abridged version of the prospectus along with
the issue opening and closing dates has to be published in newspapers.

2. Opening and Closing of the issue

The public issue is open for subscription by the public on the pre-announced
opening date. The application forms and application monies are received at the
branches of the bankers to the issue and forwarded by these bankers to the
Registrar to the issue. Two closing dates are prescribed for the closing of the
public issue. The first of these is the ‘earliest closing date’ which should not
be less than 3 days from the opening date. If sufficient applications are
received by the company, the company may choose to close the issue on the
earliest closing date itself. The other closing date is the final or latest closing
date which shall not exceed 10 days from the opening date.

3. Post-issue Tasks
After closing of the public issue, several activities are to be carried out to
complete the process of public issue. They are: -
i. All the application forms received have to be scrutinized, processed and
tabulated.
ii. When the issue is not fully subscribed to, it become the liability of the
underwriters to subscribe to the shortfall. The liability of each underwriter has
to be determined.
iii. When the issue is over-subscribed, the basis of allotment has to be decided
in consultation with the stock exchange.
iv. Allotment letters and share certificates have to be despatched to the allotees.
Refund orders have to be despatched to the applicants whose application are
rejected.
v. Shares have to be listed in the stock exchange for trading. For this purpose,
the issuing company has to enter into a listing agreement with the stock
exchange.

BOOK-BUILDING

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Companies may raise capital in the primary market by way of public issue,
rights issue or private placement. A public issue is the selling of securities to the
public in the primary market. The usual procedure of a public issue is through
the fixed price method where securities are offered for subscription to the
public at a fixed price.

An alternative method is now available which is known as the Book building

process. Although book building has been a common practice in most of the
developed countries, the concept is relatively new in India. SEBI announced
guidelines for the book building process, for the first time, in October 1995.

Under the book building process, the issue price is not fixed in advance. It is
determined by the offer of potential investors about the price which they are
willing to pay for the issue. The price of the security is determined as the
weighted average at which the majority of investors are willing to buy the
security. Thus, under the book building process, the issue price of a security is
determined by the demand and supply forces in the capital market.

SEBI guidelines define book building as: ‘A process undertaken by which a

demand for the securities proposed to be issued by a body corporate is elicited
and built up and the price for such securities is assessed for the determination of
the quantum of such securities to be issued by means of a notice, circular,
advertisement, document or information memoranda or offer document’.

Book building is a process of price discovery. It puts in place a pricing

mechanism whereby new securities are valued on the basis of the demand
feedback following a period of marketing. It is an alternative to the existing
system of fixed pricing.

A public issue of securities may be made through the fixed price method, the
book-building method, or a combination of both. In case the issuing company
chooses to issue securities through the book building route, then as per SEBI
guidelines the issuer company can select any of the following methods:
1. 100 percent of the offer to the public through the book building process

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2. Seventy-five percent of the offer to the public through the book building
process and twenty-five percent through the fixed price method at the price
determined through book-building.
3. Ninety percent of the offer to the public through the book building process
and ten percent through the fixed price method.
The issue of the fixed price portion is conducted like a normal public issue after
the book-built portion is issued.

The steps involved in the process of book building may be listed out as follows:

1. The issuer appoints a merchant banker as the lead manager and book runner
to the issue.

2. The book runner forms a syndicate of underwriters. The syndicate consists of

book runner, lead manager, joint lead managers, advisors, co-managers and
underwriting members.

3. A draft prospectus is submitted to SEBI without a price or price band. The

draft prospectus is then circulated among eligible investors with a price band
arrived at by the book runner in consultation with the issuer. Such a prospectus
is known as a Red Herring Prospectus.

4. The book runner conducts awareness campaigns, which include advertising.

Road shows and conferences.

5. Investors place their orders with syndicate members. These members collect
orders from their clients on the amount of securities required by them as well as
the price they are willing to pay.

6. The book runner build up a record known as Book after receiving orders from
members of the syndicate. He maintains detailed records in this regard. The
book is thus built up to the size of the portion to be raised through the book

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building process. When the book runner receives substantial number of orders,
he announces closure of the book. A book should remain open for a minimum
number of 3 working days. The maximum period for which the bidding process
may be allowed is 7 working days.

7. On the basis of the offers received, the book runner and the issuer company
then determine the price at which the securities shall be sold.

8. The book runner finalizes the allocation to syndicate members. Procurement

agreements are signed between issuer and the syndicate members for the
subscription to be procured by them.

9. The final prospectus along with the procurement agreements is then filed
with the Registrar of Companies within 2 days of the determination of the offer
price.

10. The book runner collects from the institutional buyers and the underwriters
the application forms along with the application monies to the extent of the
securities proposed to be allotted to them/subscribed by them.

Book building is a process wherein the issuer of securities asks investors to

bid for the securities at different prices. These bids should be within an
indicative price band decided by the issuer. Here, investors bid for different
quantity of shares at different prices. Considering these bids, issuer
determines the price at which the securities are to be allotted. Thus, the issuer
gets the best possible price for his securities as perceived by the market or
investors.

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ROLE OF PRIMARY MARKET
Primary market is the medium for raising fresh capital in the form of equity
and debt. It mops up resources from the public (investors) and makes them
available for meeting the long-term capital requirements of corporate business
and industry.

The primary market brings together the two principal constituents of the market,
namely the investors and the seekers of capital. The savings or surplus funds
with the investors are converted into productive capital to be used by companies
for productive purposes. Thus, capital formation takes place in the primary
market. The economic growth of a country is possible only through a robust and
vibrant primary market.

In the secondary market, shares already purchased by investors are traded

among other investors. Operations in the secondary market do not result in the
accretion of capital resources of the country, but indirectly promotes savings
and investments by providing liquidity to the investments in securities, i.e. the
investors have the facility to liquidate their investments in securities in the
secondary market.

IPO is an abbreviation of Initial Public Offer. When a company is going for a

process of getting listed on the stock exchange and publicly traded, IPO is the
first public offering, it is the main source of the company in acquiring money
from the general public to finance its projects and the company allots shares to
the investors in return.

FPO is an abbreviation of a Follow-On Public Offer. The process of FPO starts

after an IPO. FPO is a public issue of shares to investors at large by a publicly
listed company. In FPO, the company, already listed on a stock exchange, goes
for a further issue of shares to the general public with a view to diversifying its
equity base. A prospectus is offered by the company.

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There are two types of FPOs: Diluted and Non-diluted.
A Diluted follow-on offering results in the company issuing new shares after the
IPO, which causes the lowering of a company's earnings per share (EPS).
During a Non-diluted follow-on offering, holders of existing, privately-held
shares by the promoters bring previously issued shares to the public market for
sale. Since no new shares are issued, the company's EPS remains unchanged.
Basis of
IPO FPO
distinction
IPO is the first issue of
What does it FPO is the additional issue of
shares made by a
mean? shares made by a company.
company.

The shares issued through

What is the nature The shares issued FPO are either new shares or
of shares offered? through IPO are new. old shares of promoters that
are offered again.

Market forces drive the price

The price of an IPO is
What is the price of an FPO. It depends on the
fixed in a price range with
band? increasing or decreasing
little variations allowed.
number of shares.

What is the status An unlisted company A company already listed

of the company? makes an IPO. makes an FPO.
FPOs are comparatively less
Is there any risk? IPOs are risky.
risky.
Non-diluted follow-on offerings are also called secondary market offerings.

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REGULATION OF PRIMARY MARKET
For companies, raising capital through the primary market is time-consuming
and expensive. The issuer has to engage the services of a number of
intermediaries and comply with complex legal and other formalities. The
investor faces much risk while operating in the primary market. Fraudulent
promoters may try to dupe the investors who opt to invest in a new issue.
Investors in the primary market need protection from such fraudulent
operators.
Up to 1992, the primary market was controlled by the Controller of Capital
Issues (CCI) appointed under the Capital Issues Control Act, 1947. During
that period, the pricing of capital issues was regulated by CCI. The Securities
and Exchange Board of India (SEBI) was formed under the SEBI Act, 1992
with the prime objective of protecting the interests of investors in securities as
well as for promoting and regulating the securities market, in the model of the
Securities and Investment Board (SIB) of UK and the Securities and Exchange
Commission (SEC) of USA. All public issues since January 1992 are
governed by the rules, regulations and guidelines issued by SEBI.

SEBI has been instrumental in bringing greater transparency in capital

issues. It has issued detailed guidelines to standardize disclosure obligations of
companies issuing securities. Companies floating public issues are now
required to disclose all relevant information affecting investors’ interests.
SEBI constantly reviews its guidelines to make them more market-friendly
and investor-friendly.

Successful floatation of a new issue in the primary market requires careful

planning, proper timing and comprehensive marketing efforts. The services of
specialized institutions such as merchant bankers, registrars to the issue,
underwriters, etc. are available to the issuer company to handle the task. There
is effective regulation of SEBI at every stage of a public issue. There are also
regulations to ensure fair practice by the intermediaries in the market.

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STOCK EXCHANGES
Primary market is the market in which new issues of securities are sold by the
issuing companies directly to the investors. Secondary market is the market in
which securities already issued by companies are subsequently traded among
investors.

A person with funds for investment in securities may purchase the securities
either in the primary market (from the issuing company at the time of a new
issue of securities) or from the secondary market (from other investors
holding the desired securities). Securities can be purchased in the primary
market only at the time of issue of the security by the company, whereas in
the secondary market securities can be purchased throughout the year.

As a result, trading in a particular security in the primary market is an

intermittent event depending upon the frequency of new issues of the security
by the company, but trading in that security in the secondary market is
continuous. The secondary market where continuous trading in securities
takes place is the Stock Exchange.
The stock exchanges were once physical market places where the agents of
buyers and sellers operated through the auction process. These are being
replaced with electronic exchanges where buyers and sellers are connected
only by computers over a tele-communications network.

Auction trading is giving way to ‘screen-based’ trading where bid prices and
offer prices (or, ask prices) are displayed on the computer screen. Bid price
refers to the price at which an investor is willing to buy the security and Offer
price refers to the price at which an investor is willing to sell the security.
Alternatively, a dealer in securities may declare the bid price and the offer price
of a security, suggesting the price at which he is prepared to buy the security
(bid price) and also the price at which he is prepared to sell the security (offer
price). The bid-offer spread, the difference between the bid price and the offer
price constitutes the margin or profit.
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According to the Securities Contracts (Regulation) Act,1956, which is the
main law governing stock exchanges in India, “stock exchange means
anybody of individuals, whether incorporated or not, constituted for the purpose
of assisting, regulating or controlling the business of buying, selling or dealing
in securities.”

Stock exchanges play the role of a barometer, namely, an indicator of the

state of health of the nation’s economy as a whole. The trend of price
movements in the market is indicated by calculating stock market indices which
represent the weighted average of prices of selected shares representing all the
important industries. These stock market indices are used to represent the share
market as a whole. Their movements and levels are indicative of the economic
health of the nation to a great extent because movements of prices of shares
are influenced by macro-economic factors such as growth of GDP, financial
and monetary policies, tax changes, political environment, etc.

During the latter half of the 19 th century, shares of companies used to be floated
in India occasionally. There were share brokers in Bombay who assisted in the
floatation of shares of companies. A small group of stock brokers in Bombay
joined together in 1875 to form an association called Native Share and
Stockbrokers Association. The association drew up codes of conduct for
brokerage business and mobilized private funds for investment in the corporate
sector. It was this association which later became the Bombay Stock
Exchange, the oldest stock exchange in Asia. This exchange is now known as
the Mumbai Stock Exchange or BSE.

The high-powered committee on stock exchanges known as Pherwani

Committee recommended, in 1991, the setting up of a new stock exchange as
a model exchange and to function as a national stock exchange. It was
envisaged that the new exchange should be completely automated in terms of
both trading and settlement procedures. On the basis of the recommendations of
the Pherwani committee, a new stock exchange was promoted by the premier
financial institutions of the country, namely IDBI, ICICI, IFCI, all insurance
13
corporations, selected commercial banks and others. The new exchange was
incorporated in 1992 as the National Stock Exchange (NSE). It started
functioning in June 1994.

Both NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) offer
fully computerized screen-based trading facilities to investors. The on-line
trading system of BSE is known as BOLT (BSE's On-line Trading System),
while that of NSE is known as NEAT (National Exchange for Automated
Trading). Both BOLT and NEAT use satellite communication for trading, using
V-SAT.

OVER THE COUNTER EXCHANGE OF INDIA

The traditional trading mechanism (floor trading using open outcry system),
which prevailed in the Indian stock exchanges, resulted in much functional
inefficiency such as absence of liquidity, lack of transparency, undue delay in
settlement of transactions, fraudulent practices, etc.

With the objective of providing more efficient services to investors, the

country’s first electronic stock exchange which facilitates ringless, scripless
trading was set up in 1992 with the name Over the Counter Exchange of
India (OTCEI). It was sponsored by the country’s premier financial institutions
such as UTI, ICICI, IDBI, SBI Capital Markets, IFCI, GIC and its subsidiaries
and Canbank Financial services.

The exchange was set up to aid enterprising promoters in raising finance for
new projects in a cost-effective manner and to provide investors with a
transparent and efficient mode of trading. The OTCEI had many novel features.
It introduced screen-based trading for the first time in the Indian stock market.
Trading takes place through a network of computers of over-the-counter
(OTC) dealers located at several places, linked to a central OTC computer
using telecommunication links. All the activities of the OTC trading process
are fully computerized. Moreover, OTCEI is a national exchange having a
countrywide reach. OTCEI has an exclusive listing of companies, that is, it does
not ordinarily list and trade in companies listed in any other stock exchanges.

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For being listed in OTCEI, the companies have to be sponsored by members of
OTCEI. It was the first exchange in the country to introduce the practice of
market making, that is, dealers in securities providing two-way quotes (bid
prices and offer prices of securities).

LISTING OF SECURITIES
For the securities of a company to be traded on a stock exchange, they have to
be listed in that stock exchange.

Listing is the process of including the securities of a company in the official

list of the stock exchange for the purpose of trading. At the time of issue of
securities, a company has to apply for listing the securities in a recognized stock
exchange. The Securities Contracts Regulation Act and rules, SEBI
guidelines, and the rules and regulations of the exchange prescribe the
statutory requirements to be fulfilled by a company for getting its shares listed
in stock exchange.

Important documents, such as memorandum of association, articles of

association, prospectus, directors’ report, annual accounts, agreement with
underwriters, etc., and detailed information about the company’s activities, its
capital structure, distribution of shares, dividends and bonus shares issued, etc.
have to be submitted to the stock exchange along with the application for
listing.

The stock exchange examines whether the company satisfies the criteria
prescribed for listing. When the stock exchange finds that a company is
eligible for listing its securities at the exchange, the company would be
required to execute a listing agreement with the stock exchange. This listing
agreement contains the obligations and restrictions imposed on the company as
a result of listing. The company is also required to pay the annual listing fees
every year.

The purpose of the listing agreement is to compel the company to keep the
shareholders and investors informed about the various activities which are likely
to affect the share prices of a company. A company whose securities are listed
15
in a stock exchange is obliged to keep the stock exchange fully informed
about all matters affecting the company. Moreover, the company has to
forward copies of its audited annual accounts to the stock exchange as soon as
they are issued.

The securities of a company listed on a stock exchange may be classified into

different groups. For instance, the securities listed on the Bombay Stock
Exchange (BSE) have been classified into A, B1 and B2, based on certain
qualitative and quantitative parameters which include number of trades, value
traded, etc. The F group represents the fixed income securities. The G group
includes government securities for retail investors. The Z group includes
companies which have failed to comply with the listing requirements of the
exchange or have failed to resolve investor complaints or have not made
arrangements with the depositories for dematerialization of their securities.

TRADING SYSTEM IN STOCK EXCHANGES

A stock exchange is a market for trading in securities. But it is not a ordinary
market, it is a market with several peculiar features. In a stock exchange, buyers
and sellers do not directly meet and interact with each other for making their
trades. The investors (buyers and sellers of securities) trade through brokers
who are members of a stock exchange. In stock exchanges, trading
procedures are fully automated and member brokers interact and trade
through a networked computer system.

Trading in a stock exchange takes place in two phases: in the first phase, the
member brokers execute their buy or sell orders on behalf of their clients (or
investors) and, in the second phase, the securities and cash are exchanged.
For the exchange of securities and cash between the traders, the services of
two other agencies are required, namely the clearing house (corporation) of
the stock exchange and the depositories. Further, unlike other ordinary
markets, stock exchanges are markets where the prices of the items traded
(namely securities) fluctuate constantly. This fluctuations in security prices
leads to speculative activities in the stock exchanges.

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Trading System
The system of trading prevailing in stock exchanges for many years was
known as floor trading. In this system, trading took place through an open
outcry system on the trading floor or ring of the exchange during official
trading hours.
In floor trading, buyers and sellers transact business face to face using a variety
of signals. Under this system, an investor desirous of buying a security gets in
touch with a broker and places a buy order along with the money to buy the
security. Similarly, an investor intending to sell a security gets in touch with a
broker, places a sell order and hands over the share certificate to be sold. After
the completion of a transaction at the trading floor between the brokers
acting on behalf of the investors, the buyer investor would receive the share
certificate and the seller investor would receive the cash through their
respective brokers.

In the new electronic stock exchanges, which have a fully automated

computerized mode of trading, floor trading is replaced with a new system of
trading known as screen-based trading. In this new system, the trading ring is
replaced by the computer screen and distant participants can trade with each
other through the computer network. The member brokers can install trading
terminals at any place in the country. A large number of participants,
geographically separated from each other, can trade simultaneously at high
speeds from their respective locations.

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The screen-based trading systems are of two types: -
1. Quote-driven system
2. Order-driven system

Under the quote-driven system, the market-maker, who is the dealer in a

particular security, inputs two-way quotes into the system, that is, his bid
price (buying price) and offer price (selling price). The market participants
then place their orders based on the bid-offer quotes. These are then
automatically matched by the system according to certain rules.

Under the order-driven system, clients place their buy and sell orders with the
brokers. These are then fed into the system. The buy and sell orders are
automatically matched by the system according to pre-determined rules.

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Types of Orders
An investor may place two types of orders, namely market order or limit
order.

Market Orders
In a market order, the broker is instructed by the investor to buy or sell a
stated number of shares immediately at the best prevailing price in the
market. In the case of a buy order, the best price is the lowest price
obtainable; in the case of a sell order, it is the highest price obtainable. When
placing a market order, the investor can be fairly certain that the order will be
executed, but he will be uncertain of the price until after the order is executed.

Limit Orders
While placing a limit order, the investor specifies in advance the limit price at
which he wants the transaction to be carried out. In the case of a limit order to
buy, the investor specifies the maximum price that he will pay for the share;
the order has to be executed only at the limit price or a lower price. In the
case of a limit order to sell shares, the investor specifies the minimum price
he will accept for the share and hence, the order has to be executed only at
the limit price or a price higher to it. Thus, for limit orders to purchase shares,
the investor specifies a ceiling on the price, and for limit orders to sell shares the
investor specifies a floor price.

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In the case of a limit order to buy, the limit price would be below the prevailing
price and in the case of a limit order to sell, the limit price would be above the
prevailing market price. The investor placing limit orders believes that his limit
price will be reached and the order executed within a reasonable period of time.
But the limit order may remain unexecuted.

Settlement
Trading in stock exchanges is carried out in two phases. In the first phase,
the execution of the orders submitted by clients takes place between brokers
acting on behalf of the clients or investors. Buy orders are matched with sell
orders. In the automated system, trading is carried out in an anonymous
environment and the orders are matched by the computer system.

The buyer has to hand over the money and receive the security; the seller on
the other hand has to hand over the security and receive money on account of
the sale of the security. This process of transfer of security and cash is done
in the second phase which is known as the Settlement of the trade.

The settlement process involving delivery of securities and payment of cash is

carried out through a separate agency known as the clearing house which
functions in each stock exchange. The clearing house acts as the counterparty

20
for each trade. Member brokers who sell securities have to deliver the securities
to the clearing house and will receive cash from the clearing house. Similarly,
the member brokers who buy securities will have to pay cash to the clearing
house and receive the securities from the clearing house. The stock exchanges
now follow a settlement procedure known as Compulsory Rolling Settlement
(CRS), as mandated by SEBI.

Under the rolling settlement system, the trades executed on a particular day
are settled after a specified number of business days or working days.
Currently, a T + 2 settlement cycle is adopted by the stock exchanges. This
means that the settlement of transactions done on T, that is, the trade day, has
to be done on the second business day after the trade day. The pay-in and pay-
out of funds and securities has to take place on the second business day after the
day of trade. For example, for an order executed on Tuesday of a week, the
settlement (delivery of security and payment of cash) has to be done on
Thursday. The pay-in and pay-out of funds and securities are marked through
the clearing house.

DEPOSITORIES
The physical form of securities is giving way to electronic form of securities
wherein a security is represented by an entry in a depository account opened
by the investor for the purpose. The transfer of securities on sale of a security is
effected through a debit entry in the depository account of the seller and a credit
entry in the depository account of the buyer. The securities are issued, held
and transferred in dematerialized form or ‘demat mode’. For the demat mode
of shareholding, depositories play the most important role.

A depository can be compared with a bank. A depository holds securities for

investors in electronic form and provide services related to transactions of
securities. A depository interacts with clients through depository participants
(DPs) which are organizations affiliated to a depository. An investor has to
open a demat account with a depository participant to avail depository
services of holding securities and transferring securities.

There are 2 Depositories in India, namely:

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1. National Securities Depository Limited (NSDL)
2. Central Depositories Services Limited (CDSL)

NSDL was India’s first depository which started functioning on November 6,

1996. CDSL was inaugurated on July 15, 1999. The functioning of these
depositories is supervised and regulated by SEBI. Each depository has several
depository participants affiliated to it.

The demat accounts opened by investors with depository participants are

known as beneficiary accounts. When an investor has sold a security through a
member broker, he has to deliver the security through a member broker who, in
turn, has to deliver it to the clearing corporation. The investor has to authorize
his DP to transfer the security from his beneficiary account to the clearing
member’s pool account. Accordingly, the beneficiary account of the investor
would be debited and the pool account of the clearing member would be
credited. The clearing member gives authorization to his DP to deliver the
securities to the clearing corporation.

The process of converting securities held in physical form (certificates) to an

equivalent number of securities in electronic form and crediting the same to the
investor’s demat account is known as Dematerialization. This is done by the
DP on a request from the investor.

Securities in demat form (or electronic form) may again be converted back to
the physical form (certificates), if desired. This process is known as
Rematerialization. At the time of issue of new securities by a company, the
securities allotted to an investor can be directly credited to his demat account.

According to the Depositories Act, 1996, an investor has the option to hold
securities either in physical form or in dematerialized form. But holding
securities in demat form has several advantages. It is safe and convenient to
hold securities in demat form. In demat mode, transfer of securities is
instantaneous and effortless. Much paperwork is done away with in demat
mode.

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MARGIN TRADING
Investors may purchase securities in the stock exchanges either using their
own funds or funds borrowed from banks, brokers, etc. Conservative investors
would prefer to use own funds for trading in securities. Other investors may use
borrowed funds for buying securities when there is a good opportunity to buy
some securities but ready cash may not be available.

Borrowing money from the bank or the broker for purchasing securities is
known as Margin Trading. The investor pays a part of the value of the
securities to be purchased; the balance is provided by the broker or the
banker. The cash paid by the investor is the margin. For example, if an
investor places buy orders for purchase of securities worth Rs. 50,000 and pays
as a cash Rs. 30,000 to the broker, the investor’s margin is 60 percent of the
value of the securities. The balance amount is supplied by the broker.

In margin trading, the investor has to pay interest on the money borrowed to
finance the securities transaction. Thus, profit or gain from the transaction
would be reduced to that extent. Even if there is no gain from the securities
transaction, interest on the borrowed funds has to be paid. Margin trading is
thus a risky venture.

SPECULATION
People who buy and sell securities in the stock exchanges may have different
motivations for doing so. There may be other persons who have a short-term
perspective on their trading activities on the stock exchanges. A person may be
interested in making a quick short-term profit from the fluctuations in the prices
of securities in the stock market. Such a person is known as a speculator.
Speculators are traders who intend to make high returns within a short span
of time, making use of the short-tern fluctuations in security prices.

Speculation involves high amount of risk. The speculators take long position
or short position on the basis of their estimation or speculation about the
future movement of prices. If the prices of securities do not move in the
expected directions within a short time, the speculators suffer losses.

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Long Buy
If a speculator feels that a security is underpriced or that a security which is
correctly priced at the moment is likely to show a rising trend, then he would
like to buy the security for the purpose of selling it at a higher price when the
price rises as anticipated.

The speculator in this case is said to take a long position with respect to that
security. He is not interested in taking delivery of the security, but intends to
sell it off as quickly as possible to gain some profit. Hence, he would not like
to hold his long position for an extended period. He would like the mispricing
to be corrected at the earliest, preferably on the same day. Such kind of a
speculative activity is known as a long buy.

Short Sale
On the contrary, if a speculator estimates that a security is overpriced and its
price is likely to decline shortly, he would like to sell the security at the current
price and buy it sometime later when the price declines so as to deliver the
security sold at the time of settlement of the trade.

Ordinarily, a person sells securities which he owns. Here, the speculator is

selling a security which he does not own or possess in the hope that he would be
able to deliver the security on the due date by buying it at a lower price within a
short period of time. He hopes to gain some profit in the transaction. The
speculator in this case is taking a short position with respect to the security by
engaging in a short sale.

Fundamentally, a short sale is the sale of a security which is not owned by the
seller at the time of the transaction. A short-seller has to cover up his position
or eliminate the deficiency by buying the security sometime in the near future.
He will be able to make a profit out of the short sale transaction only if he is
able to buy the security at a lower price. If the price of a security moves up
against his anticipations, he will suffer a loss.

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TYPES OF SPECULATORS

1. Bull – A trader who expects a rise in the price of securities is known as a

Bull. He, therefore, takes a long position with respect to securities. He engages
in long buy anticipating a rise in prices of securities. The bulls will be able to
make profits only if the price rises as anticipated.
Spreading good rumours about companies with the intention to raise the prices
of shares is known as a Bull Campaign.
When the prices of securities are generally rising in the market, the market is
said to be in a bullish phase

2. Bear – A Bear is a pessimist who expects a decline in the prices of securities.

He, therefore, takes a short position on securities by engaging in short sales. He
attempts to cover up his short position by buying the securities at lower prices
when prices decline.
Spreading unfavourable rumours about companies with the intention of creating
a decline in their share prices is known as a Bear Raid.
When there is a general decline in the prices of securities in the stock market,
the market is said to be Bearish.

3. Lame Duck – A Lame Duck is a bear who has made a short sale but is
unable to meet his commitment to deliver the securities sold by him on account
of rise in prices of securities subsequent to the short sale. He is said to be
struggling like a Lame Duck.

4. Stag – A stag is a trader who applies for shares in the new issues market just
like a genuine investor. A Stag is an optimist like the bull and expects a rise in
the prices of securities that he has applied for.
He anticipates that when the new shares are listed in the stock exchange for
trading, they would be quoted at a premium, that is above their issue price. As
soon as the stag receives the allotment of shares, he would sell them at the stock
exchange at the higher price and make a profit.

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A Stag is said to be a premium hunter. The Stag will, however, suffer a loss if
the prices of the new shares do not rise as anticipated when they are listed for
trading.

STOCK SPLIT
A stock split is generally done to make the stock more affordable for the small
retail investors and increase liquidity. It refers to splitting the face value of the
shares of companies, where in the number of shares of that company increases
but the market cap remains the same. Existing shares split, but the underlying
value remains the same. As the number of shares increases, the price per share
goes down.

 A stock split is when a company divides the existing shares of its stock
into multiple new shares to boost the stock's liquidity.

 Although the number of shares outstanding increases by a specific

multiple, the total dollar value of the shares remains the same compared
to pre-split amounts, because the split does not add any real value.

 The most common split ratios are 2-for-1 or 3-for-1, which means that the
stockholder will have two or three shares, respectively, for every share
held earlier.

REVERSE STOCK SPLIT

 A reverse stock split consolidates the number of existing shares of stock

held by shareholders into fewer, proportionally more valuable, shares.

 A reverse stock split does not directly impact a company's value.

 It does, however, often signal a company in distress since it raises the

value of otherwise low-priced shares.

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  Remaining relevant and avoiding being delisted are the most common
reasons for corporations to pursue this strategy.

 A reverse stock split is also known as a stock consolidation, stock merge,

or share rollback and is the opposite exercise of a stock split, where a
share is divided (split) into multiple parts.

BLOCK DEALS
It is a transaction of a minimum quantity of 500,000 shares or a minimum
value of Rs 5 crore between two parties, wherein they agree to buy or sell
shares at an agreed price among themselves. The deal takes place through a
separate trading window and they happen at the beginning of trading hours for
duration of 35 minutes i.e., from 9.15 am to 9.50 am. Every trade has to result in
delivery.

Rules set by the Securities and Exchange Board of India state that the price of a
share ordered at the window should range within +1% to -1% of the current
market price or the previous day's closing price. Block deals are not visible to
the regular market as they happen in a separate window.

The block deal orders are notified to exchanges and are disclosed on the
bourse's website with details such as name of the company, client, quantity of
shares and the average price at which the deal took place.

BULK DEALS
A bulk deal is a trade where total quantity of shares bought or sold is more than
0.5% of the number of shares of a listed company. Bulk deals happen during
normal trading window provided by the broker. The broker who manages the
bulk deal trade has to provide the details of the transaction to the stock
exchanges whenever they happen. Unlike block deals, bulk deal orders are
visible to everyone.

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Who are the participants in such bulk-block deals?

It is usually deep-pocketed investors like fund houses, foreign institutional

investors, banks, insurance firms and HNIs given the high amount required to
enter into such transactions and the percentage of shares involved.

How do bulk-block deals influence a stock?

Investors often look at bulk and block deals to judge interest of big investors in
a stock. If several deals happen in a stock continuously over a period of time,
it can be viewed as a sign of confidence and stock price may rise in the near
future. But a big institution or investor buying shares through such deals does
not necessarily mean that the stock will rise. Many a time, the large block of
share purchase, which is disclosed to the exchange, could be the last leg of
buying by the large investor, who wants to signal his interest in the stock. In
short, some large HNIs use this as a bait to attract more buyers.

STOCK MARKET QUOTATIONS AND INDICES

In stock exchanges, continuous trading in securities takes place and these trades
occur at different prices. As a result, even on a single day, prices of securities
may fluctuate. On any trading day, four prices can be easily identified,
namely, opening price, closing price, the highest price of the day and the
lowest price of the day. Financial dailies give very detailed price quotations
(opening and closing prices, highest and lowest prices, 52-week high and low
prices, etc.), including the data on volume of daily trading.

In addition to the price quotations of individual securities, stock exchanges

make available stock market indices, which are useful in understanding the
level of prices and the trend of price movements of the market as a whole. A
stock market index acts as the indicator of the performance of the overall
economy or a sector of the economy.

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The Stock Exchange, Mumbai (BSE) came out with a stock index in 1986,
which is known as BSE Sensex. It is an index composed with 30 stocks
representing a sample of large, well-established and financially sound
companies selected from different industry groups. The base year of BSE
Sensex is 1978-79 and the base value is 100.

The stock market indices available at the National Stock Exchange (NSE) are: -
1. S and P CNX Nifty
2. 2. CNX Nifty Junior
3. 3. Sand P CNX 500
4. CNX Midcap 200
5. S and P CNX Defty

S and P CNX Nifty

It is an index calculated with a well-diversified sample of 50 stocks
representing 23 sectors of the economy. The base period selected for Nifty is
the close of prices on November 3, 1995, which marks the completion of one
year of operations of NSE’s capital market segment. The base value of the
index has been set at 1000.

Nifty is managed by India Index Services and Products Ltd (IISL), which
is a joint venture between CRISIL and NSE. The index is known as S and
P index because IISL has consulting and licensing agreement with
Standard and Poor’s (S and P), who are world leaders in index services.

Types of Stock Market Indices

Price-weighted Index:
A price-weighted index is an index reflecting the sum of the prices of the
sample stocks on a certain date in relation to a base date. The price-weighted
index assumes that the investor buys one share of each stock included in the
index.

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Equal-weighted Index:
An equal-weighted index is an index reflecting the simple arithmetic average
of the price relatives of the sample stocks on a certain date in relation to a
base date. An equal-weighted index assumes that the investor invests an
equal amount of money in each stock included in the index.

Value-weighted Index:
A value-weighted index is an index reflecting the aggregate market
capitalization of the sample stocks on a certain date in relation to a base date.
A value-weighted index assumes that the investor allocates money across
various stocks included in the index in such a way that the weights assigned
to various stocks are proportional to their market capitalization.

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Note:-
Price in year ‘t’
Price Relative = ----------------------------------------------------- x 100
Price in Base year

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Stock Market Indices

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A price-weighted index is a type of stock market index in which each
component of the index is weighted according to its current share
price. In price-weighted indices, companies with a high share price have
a greater weight than those with a low share price. Therefore, the price
movements of companies with the highest share price have the largest
impact on the value of the index.

Nowadays, price-weighted indices are less common than other indices.

Instead, the capitalization-weighted index is the most prevalent form of
market indices. The biggest price-weighted indices are the US Dow
Jones Industrial Average (DJIA) and Japan’s Nikkei 225.

Equal weight is a type of weighting that gives the same weight, or importance,
to each stock in a portfolio or index fund, and the smallest companies are
given equal weight to the largest companies in an equal-weight index fund.

Many of the largest and most well-known market indices are either market-
cap-weighted or price-weighted. Market-cap-weighted indices, such as the
Standard & Poor's (S&P) 500, give greater weight to the biggest companies
according to market capitalization. Large-caps such as Apple and Microsoft
are among the biggest holdings in the S&P 500.

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