The capital market is the market for long-term loans (debentures & bonds) and equity capital. Companies and the government can raise funds for long-term investments via the capital market. The capital market includes the stock market, bond market and primary market. Thus, organized capital markets are able to guarantee sound investment opportunities.
The capital market can be contrasted with other financial markets such as the money market which deals in short term liquid assets and futures markets which deal in commodities contracts.
The financial markets are markets which facilitate the raising of funds or the investment of assets, depending on viewpoint. They also facilitate handling of various risks. The financial markets can be divided into different subtypes: Capital markets consists of:
A stock market is a market for the trading of publicly held company stock and associated financial instruments (including stock options, convertibles and stock index futures).
Many years ago, worldwide, buyers and sellers were individual investors and businessmen. These days markets have generally become "institutionalized"; that is, buyers and sellers are largely institutions whether pension funds, insurance companies, mutual funds or banks. This rise of the institutional investor has brought growing professionalism to all aspects of the markets.
The money market is a subsection of the fixed income market. We generally think of the term "fixed income" as a synonym of bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs (an abbreviation of the phrase "I owe you") issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Since they are extremely conservative, money market securities offer significantly lower returns than most of the other securities.
The capital market framework consists of the following participants:
The following are the different types of financial instruments-
One cannot buy directly from the market or stock exchange. A buyer has to buy stocks or equity through a Stock Broker, who is a registered authority to deal in equities of various companies. In effect a lot many intermediaries might come in between the buyer and seller, as brokers do their business through many sub-brokers and the like.
The general theory goes that the higher the profit, the greater the risk. Since there is scope for high profit in the Stock Market, investing in the Stock Market can be risky. In fact, more than 80% of the people who put money in the market lose it and a majority of the rest are barely able to protect themselves from losses. Only a minuscule minority of investors are able to garner any substantive profits.
Basic human psychology. Men want profits- big and fast. Not many are deterred by the risks involved. The fact is that investment in the stock markets can give, potentially, the fastest ROI (Return On Investment), as the value of a stock can rise pretty fast, ensuring huge profit for investor. People buy shares in a company for either of two reasons:
The precept is very easy their investment, saving your investment is the first and most important part. This can be done by ensuring that you do not put your money in a company that does not show solid prospects. Fly- by- nights companies or companies whose shares touch the roof suddenly, need to be avoided. Companies that show a steady prospect are good to invest in. Needless to say, this process involves close acquaintance with market movements and a thorough understanding of the concepts involved. You should know when to dump your shares especially when they are becoming just junk papers.
The second thing is that adequate market knowledge is very important especially when you have invested in the stock market. One should be patient and judiciously responsive to market swings. Of course, luck is also a major factor.
Undoubtedly, it is 'Don't put all your eggs in the same basket'. It is very tempting to make all your investment in the same sector when their stocks are going up, but since market trends are very volatile, you are, at the same time, making yourself extremely vulnerable to lose all your money. Dealing with single sector investment requires razor sharp timing with zero margin for error - a tall order in such a speculative and volatile business. Hence, it is always advisable to make investments in different companies and in different sectors, so that you can achieve stable portfolio diversification and compensate losses in one sector against profits in an another sector.
The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. With Securities Laws (Second Amendment) Act,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:- A
Derivative includes: -
a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security
a contract which derives its value from the prices, or index of prices, of underlying securities
Futures Contract means a legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract.
On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.
However so far delivery against future contracts have not been introduced and the future contract is settled by cash settlement only.
Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchases the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc. Under Securities Contracts (Regulations) Act,1956 options on securities has been defined as "option in securities" means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities;
An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price.Therefore, in the case of American options the buyer has the right to exercise the option at anytime on or before the expiry date. This request for exercise is submitted to the Exchange, which randomly assigns the exercise request to the sellers of the options, who are obligated to settle the terms of the contract within a specified time frame. As in the case of futures contracts, option contracts can also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract.
However so far delivery against option contracts have not been introduced and the option contract, on exercise or expiry, is settled by cash settlement only.
Futures contract based on an index i.e. the underlying asset is the index,are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index. Similarly, the options contracts, which are based on some index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date. An index, in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the whole market are broad based indices and those that represent a particular sector are sectoral indices.
In the beginning futures and options were permitted only on S&P Nifty and BSE Sensex. Subsequently, sectoral indices were also permitted for derivatives trading subject to fulfilling the eligibility criteria. Derivative contracts may be permitted on an index if 80% of the index constituents are individually eligible for derivatives trading. However, no single ineligible stock in the index shall have a weightage of more than 5% in the index. The index is required to fulfill the eligibility criteria even after derivatives trading on the index has begun. If the index does not fulfill the criteria for 3 consecutive months, then derivative contracts on such index would be discontinued. By its very nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these contracts are essentially cash settled on Expiry.
Therefore index options are the European options while stock options are American options.
Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.
With the amendment in the definition of 'securities' under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992.
Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions are-
Derivative products have been introduced in a phased manner starting with Index Futures Contracts in June 2000. Index Options and Stock Options were introduced in June 2001 and July 2001 followed by Stock Futures in November 2001. Sectoral indices were permitted for derivatives trading in December 2002. Interest Rate Futures on a notional bond and T-bill priced off ZCYC have been introduced in June 2003 and exchange traded interest rate futures on a notional bond priced off a basket of Government Securities were permitted for trading in January 2004.
A stock on which stock option and single stock future contracts are proposed to be introduced is required to fulfill the following broad eligibility criteria:-
The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market. In February 2004, the Exchanges were advised to re-align the contracts sizes of existing derivative contracts to Rs. 2 Lakhs. Subsequently, the Exchanges were authorized to align the contracts sizes as and when required in line with the methodology prescribed by SEBI.
Lot size refers to number of underlying securities in one contract. The lot size is determined keeping in mind the minimum contract size requirement at the time of introduction of derivative contracts on a particular underlying. For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares.
The basis for any adjustment for corporate action is such that the value of the position of the market participant on cum and ex-date for corporate action continues to remain the same as far as possible. This will facilitate in retaining the relative status of positions viz. in-the-money, at-the-money and out-of-the-money. Any adjustment for corporate actions is carried out on the last day on which a security is traded on a cum basis in the underlying cash market. Adjustments mean modifications to positions and/or contract specifications as listed below:
The adjustments are carried out on any or all of the above based on the nature of the corporate action. The adjustments for corporate action are carried out on all open, exercised as well as assigned positions. The corporate actions are broadly classified under stock benefits and cash benefits. The various stock benefits declared by the issuer of capital are:
Two type of margins have been specified -
Dr. L.C Gupta Committee had recommended that the level of initial margin required on a position should be related to the risk of loss on the position. The concept of value-at-risk should be used in calculating required level of initial margins. The initial margins should be large enough to cover the one day loss that can be encountered on the position on 99% of the days. The recommendations of the Dr. L.C Gupta Committee have been a guiding principle for SEBI in prescribing the margin computation & collection methodology to the Exchanges. With the introduction of various derivative products in the Indian securities Markets, the margin computation methodology, especially for initial margin, has been modified to address the specific risk characteristics of the product. The margining methodology specified is consistent with the margining system used in developed financial & commodity derivative markets worldwide. The exchanges were given the freedom to either develop their own margin computation system or adapt the systems available internationally to the requirements of SEBI. A portfolio based margining approach which takes an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and Single Stock Futures, has been prescribed. The initial margin requirements are required to be based on the worst case loss of a portfolio of an individual client to cover 99% VaR over a specified time horizon.
The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread Charges) Or Short Option Minimum Charge
The worst scenario loss are required to be computed for a portfolio of a client and is calculated by valuing the portfolio under 16 scenarios of probable changes in the value and the volatility of the Index/ Individual Stocks. The options and futures positions in a client's portfolio are required to be valued by predicting the price and the volatility of the underlying over a specified horizon so that 99% of times the price and volatility so predicted does not exceed the maximum and minimum price or volatility scenario. In this manner initial margin of 99% VaR is achieved. The specified horizon is dependent on the time of collection of mark to market margin by the exchange. The probable change in the price of the underlying over the specified horizon i.e. 'price scan range', in the case of Index futures and Index option contracts are based on three standard deviation (3s ) where 's ' is the volatility estimate of the Index. The volatility estimate 's ', is computed as per the Exponentially Weighted Moving Average methodology. This methodology has been prescribed by SEBI. In case of option and futures on individual stocks the price scan range is based on three and a half standard deviation (3.5 s) where 's' is the daily volatility estimate of individual stock. If the mean value (taking order book snapshots for past six months) of the impact cost, for an order size of Rs. 0.5 million, exceeds 1%, the price scan range would be scaled up by square root three times to cover the close out risk. This means that stocks with impact cost greater than 1% would now have a price scan range of - Sqrt (3) * 3.5s or approx. 6.06s. For stocks with impact cost of 1% or less, the price scan range would remain at 3.5s.
For Index Futures and Stock futures it is specified that a minimum margin of 5% and 7.5% would be charged. This means if for stock futures the 3.5 s value falls below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting the price scan range.
The probable change in the volatility of the underlying i.e. 'volatility scan range' is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks. The volatility scan range is applicable only for option products.
Calendar spreads are offsetting positions in two contracts in the same underlying across different expiry. In a portfolio based margining approach all calendar-spread positions automatically get a margin offset. However, risk arising due to difference in cost of carry or the 'basis risk' needs to be addressed. It is therefore specified that a calendar spread charge would be added to the worst scenario loss for arriving at the initial margin. For computing calendar spread charge, the system first identifies spread positions and then the spread charge which is 0.5% per month on the far leg of the spread with a minimum of 1% and maximum of 3%. Further, in the last three days of the expiry of the near leg of spread, both the legs of the calendar spread would be treated as separate individual positions. In a portfolio of futures and options, the non-linear nature of options make short option positions most risky. Especially, short deep out of the money options, which are highly susceptible to, changes in prices of the underlying. Therefore a short option minimum charge has been specified. The short option minimum charge is 3% and 7.5 % of the notional value of all short Index option and stock option contracts respectively. The short option minimum charge is the initial margin if the sum of the worst -scenario loss and calendar spread charge is lower than the short option minimum charge. To calculate volatility estimates the exchange are required to uses the methodology specified in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures. Further, to calculate the option value the exchanges can use standard option pricing models - Black-Scholes, Binomial, Merton, Adesi-Whaley.
The initial margin is required to be computed on a real time basis and has two components:-
The initial margin so computed is deducted from the available Liquid Networth on a real time basis. At the end of the day NSE sends a client wise file to all the brokers and this margin is debited to clients. Next day the broker is supposed to report the collection of margin. If the margin is short, a penalty is levied and the outstanding position is liable to be squared up at the cost of the investor.
Market wide position limits on Single Stock Derivative Contracts are as follows :
This limit would be applicable on all open positions in all futures and option contracts on a particular underlying stock.
The measures specified by SEBI include:
Remember, Derivatives are tools which can be used for hedging, speculation as well as trading. It is always advisable to take positions in derivatives with caution. Since the trader is required to give only margin, there is a tendency of overtrading which must be avoided. Overtrading may result in failure to pay margin call &/or MTM the outstanding position is liable to be squared up. Before trading it is necessary that the investor should go through the risk disclosure document carefully so that he is aware of the precautions to be taken in derivatives trading
A Mutual Fund is a pool of money that is invested according to a common investment objective by an Asset Management Company (AMC). The AMC offers to invest the money of hundreds of investors according to a certain objective. Investors buy a scheme if it fits in with their investment goals, like getting a regular income now or letting the money accumulate over the long term.
Investors with small portfolios may not have the necessary expertise nor get the required diversification across debt and equity products. For example, for as little as Rs. 1,000, an investor can approach most schemes and get well-diversified portfolios, across product classes and instruments. The money is invested by market experts called Fund Managers.
The Mutual Fund industry is well regulated in India. The market regulator, the Securities and Exchange Board of India (SEBI) has ensured that a repeat of the vanishing companies does not happen here. Therefore, Mutual Funds in India are in the form of a Trust. This means that the money belongs to the investors and is only held in the name of the trust. The investment arm, the AMC, acts as a fee-for investment manager and does not own the money. This does not mean that the investments are risk-free. Investors need to take the risk of volatility or bad management and money can grow or lose value depending on the market and investment decisions. However, sensible Mutual Fund investing is a good way to include equity and debt in individual portfolios to see realistic growth.
Systematic Investment Plan (SIP) is a disciplined way of investing, where you invest fixed amounts at a regular frequency. You often decide to start saving and investing regularly, but get caught up in your day-to-day activities and forget investments. SIP, the time-tested investment approach helps bring in the much-needed discipline, and has shown good results in all the market conditions.
It is a very simple, yet powerful concept. Once you have identified the fund that you want to invest in and the savings required to achieve your goals, all you have to do is to give an ECS instruction to your bank to debit your account directly without the hassle of writing individual cheques. However, you have an option of giving post-dated cheques as well.
To get you into the habit of saving regularly, SIP puts two powerful forces to work for you:
Rupee Cost Averaging
Your average price = Your total Investment / Total No. of Units = 5000/508.333 = Rs. 9.84 What you see from the table is fascinating aspect of Rupee Cost Averaging. It makes you buy fewer units when the price is high and more units when the price is low, thereby bringing down your average cost. Moreover, this gives you the same discipline as investment professionals.
The longer the period of your investment, the more you accumulate, because of the power of compounding which is why it makes sense to start investing early. Illustration: If you invest Rs.1000 per month into a Mutual Fund with an asset allocation of 20% in equity fund and 80% in income fund (a conservative approach), which may possibly generate a return of 13%.
An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO. An IPO is also sometimes known as "going public." Technically, an IPO is the offering to sell but virtually all IPOs result in all the stock offered being sold. IPOs are generally managed by companies that specialize in handling IPOs and have experience in determining what the likely IPO offering price should be. If the IPO manager determines that the stock will not sell at an offering price that is acceptable to the company, the application for an IPO is usually withdrawn until a better time. As soon as all shares of an IPO have been sold, the stock is now tradable through stock exchanges or specialists that trade in the stock and the stock price may go up or down
Basis of Allotment or Basis of Allocation is a document publishes by registrar of an IPO to stock exchanges and IPO investors. This document provides information about final price fixed for an IPO, issue subscription (bidding) information or demand of an IPO and share allocation ratio. The IPO allotment information is categorized by number of shares applied by an applicant. For each such category detail bidding information is provided in this document including number of valid application received, total number of share applied, ratio of the allotment and number of shares allocated to the applicants. Ratio of the allotment is a critical field for IPO's oversubscribed multiple times. This field tells how many applicants will receive single lot of shares among a certain number of applicants. For example, ratio 1:8 means only one out of eight applicant received one lot of shares; ratio value 'FIRM' means all the applicants are eligible to receive certain amount of share.
Corporates may raise capital in the primary market by way of an initial public offer, rights issue or private placement. An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. This Initial Public Offering can be made through the fixed price method, book building method or a combination of both. There are two types of Public Issues
Book Building is essentially a process used by companies raising capital through Public Offerings-either Initial Public Offers (IPOs) or Follow-on Public Offers (FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.
Committee Info. Public Issues: Draft Offer Documents filed with SEBI Public Issues: Red Herring Documents filed with ROC Public Issues: Final Offer Documents filed with ROC Rights Issue: Draft Letters of Offer filed with SEBI Rights Issue: Final Letters of Offer filed with Stock Exchange
The term 'commodity' includes all kinds of goods. FCRA defines 'goods' as 'every kind of movable property other than actionable claims, money and securities'. Futures' trading is organized in such goods or commodities as are permitted by the Central Government. At present, all goods and products of agricultural (including plantation), mineral and fossil origin is allowed for futures trading under the auspices of the commodity exchanges recognized under the FCRA. The national commodity exchanges have been recognized by the Central Government for organizing trading in all permissible commodities which include precious (gold and silver) and non-ferrous metals; cereals and pulses; raw jute and jute goods; sugar, gur, potatoes, coffee, rubber and spices, etc.
Commodity Futures are contracts to buy specific quantity of a particular commodity at a future date. It is similar to the Index futures and Stock futures but the underlying happens to be commodities instead of Stocks and Indices.
Investors in the commodities market fall into the following categories:
The following factors have an impact the commodity prices:
Just as SEBI regulates the stock exchanges, commodity exchanges are regulated by the Forwards Market Commission (FMC), which comes under the purview of the Ministry of Food, Agriculture and Public Distribution
Monday to Friday: 10 am to 11.30 pm (Agri-commodities up to 5 p.m. only) Saturday: 10 am to 2 pm
Yes, but its not compulsory, buyers and sellers intending to take/give delivery should express their intention to the exchange. The exchange will match delivery randomly and assign it accordingly.