chapter

10
Financial Markets
SENSEX — The Bombay Stock
Learning Objectives Exchange Sensitive Index
Have you counted the number of
After studying this chapter, times newspaper headlines in the past
you should be able to: few weeks have been discussing the
SENSEX? It goes up and down all the
time and seems to be a very important
¾¾ explain the meaning of part of business and economic news.
Has that made you wonder what the
Financial Market;
SENSEX actually is?
The SENSEX is the benchmark
index of the BSE. Since the BSE has
¾¾ explain the meaning of been the leading exchange of the
Money Market and describe Indian secondary market, the SENSEX
its major Instruments; has been an important indicator of
the Indian stock market. It is the
most frequently used indicator while
¾¾ explain the nature and reporting on the state of the market.
types of Capital Market; An index has just one job: to capture
the price movement. So a stock index
will reflect the price movements of
shares while a bond index captures the
¾¾ d i s t i n g u i s h b e t w e e n
manner in which bond prices go up or
Money Market and Capital down. If the SENSEX rises, it indicates
Market; the market is doing well. Since stocks
are supposed to reflect what companies
expect to earn in the future, a rising
¾¾ e x p l a i n t h e m e a n i n g index indicates that investors expect
and functions of Stock better earnings from companies. It
Exchange; is also a measure of the state of the
Indian economy. If Indian companies
are expected to do well, obviously the
economy should do well too.
¾¾ describe the functioning of
NSEI and OTCEI; and The SENSEX, launched in 1986
is made up of 30 of the most actively
traded stocks in the market. In fact,
they account for half the BSE’s market
¾¾ describe the role of SEBI in capitalisation. They represent 13 sectors
investor protection. of the economy and are leaders in their
respective industries.

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Introduction sectors – households which save

funds and business firms which
You all know that a business needs
invest these funds. A financial market
finance from the time an entrepreneur
helps to link the savers and the
makes the decision to start it. It needs
investors by mobilizing funds between
finance both for working capital
them. In doing so it performs what is
requirements such as payments for raw known as an allocative function. It
materials and salaries to its employees, allocates or directs funds available for
and fixed capital expenditure such as investment into their most productive
the purchase of machinery or building investment opportunity. When the
or to expand its production capacity. allocative function is performed well,
The above example gives a fair picture two consequences follow:
of how companies need to raise funds • The rate of return offered to
from the capital markets. Idea Cellular households would be higher
decided to enter the Indian capital
• Scarce resources are allocated to
market for its needs of expansion. In
those firms which have the highest
this chapter you will study concepts
productivity for the economy.
like private placement, Initial public
Offer (IPO) and capital markets which There are two major alternative
you come across in the example of mechanisms through which allocation
Idea Cellular. Business can raise of funds can be done: via banks or
these funds from various sources and via financial markets. Households
in different ways through financial can deposit their surplus funds with
markets. This chapter provides a brief banks, who in turn could lend these
description of the mechanism through funds to business firms. Alternately,
which finances are mobilised by a households can buy the shares and
business organisation for both short debentures offered by a business
using financial markets. The process
term and long term requirements. It also
by which allocation of funds is done is
explains the institutional structure and
called financial intermediation. Banks
the regulatory measures for different
and financial markets are competing
financial markets.
intermediaries in the financial system,
and give households a choice of where
Concept of Financial Market
they want to place their savings.
A business is a part of an economic A financial market is a market
system that consists of two main for the creation and exchange of

HOUSEHOLDS BUSINESS FIRMS

BANKS
FINANCIAL MARKETS
SAVERS INVESTORS

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Financial System

financial assets. Financial markets Productive Uses: A financial market

exist wherever a financial transaction facilitates the transfer of savings from
occurs. Financial transactions could savers to investors. It gives savers the
be in the form of creation of financial choice of different investments and
assets such as the initial issue of thus helps to channelise surplus funds
shares and debentures by a firm or the into the most productive use.
purchase and sale of existing financial 2. Facilitating Price Discovery: You
assets like equity shares, debentures all know that the forces of demand
and bonds. and supply help to establish a price
for a commodity or service in the
Functions of Financial Market market. In the financial market, the
Financial markets play an important households are suppliers of funds and
role in the allocation of scarce resources business firms represent the demand.
in an economy by performing the The interaction between them helps
following four important functions. to establish a price for the financial
1. Mobilisation of Savings and asset which is being traded in that
Channeling them into the most particular market.

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3. Providing Liquidity to Financial than one year are traded in the money
Assets: Financial markets facilitate market. Instruments with longer
easy purchase and sale of financial maturity are traded in the capital
assets. In doing so they provide market.
liquidity to financial assets, so that
they can be easily converted into Money Market
cash whenever required. Holders of
assets can readily sell their financial The money market is a market for short
assets through the mechanism of the term funds which deals in monetary
financial market. assets whose period of maturity is
upto one year. These assets are close
4.Reducing the Cost of Transactions:
Financial markets provide valuable substitutes for money. It is a market
information about securities being where low risk, unsecured and short
traded in the market. It helps to save term debt instruments that are highly
time, effort and money that both liquid are issued and actively traded
buyers and sellers of a financial asset everyday. It has no physical location,
would have to otherwise spend to try but is an activity conducted over the
and find each other. The financial telephone and through the internet. It
market is thus, a common platform enables the raising of short-term funds
where buyers and sellers can meet for for meeting the temporary shortages of
fulfillment of their individual needs. cash and obligations and the temporary
Financial markets are classified deployment of excess funds for earning
on the basis of the maturity of returns. The major participants in
financial instruments traded in them. the market are the Reserve Bank of
Instruments with a maturity of less India (RBI), Commercial Banks, Non-

Classification of Financial Markets

FINANCIAL MARKET

MONEY MARKET CAPITAL MARKET

Primary market Secondary Market

Debt Equity Debt Equity

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Banking Finance Companies, State delivery with a fixed maturity period.

Governments, Large Corporate Houses It is issued by large and creditworthy
and Mutual Funds. companies to raise short-term funds
at lower rates of interest than market
Money Market Instruments rates. It usually has a maturity period
of 15 days to one year. The issuance
1. Treasury Bill: A Treasury bill is
of commercial paper is an alternative
basically an instrument of short-term
to bank borrowing for large companies
borrowing by the Government of India
that are generally considered to be
maturing in less than one year. They financially strong. It is sold at a
are also known as Zero Coupon Bonds discount and redeemed at par. The
issued by the Reserve Bank of India original purpose of commercial paper
on behalf of the Central Government was to provide short-terms funds
to meet its short-term requirement for seasonal and working capital
of funds. Treasury bills are issued in needs. For example companies use
the form of a promissory note. They this instrument for purposes such as
are highly liquid and have assured bridge financing.
yield and negligible risk of default.
Example: Suppose a company needs
They are issued at a price which is
long-term finance to buy some
lower than their face value and repaid
machinery. In order to raise the long
at par. The difference between the
term funds in the capital market
price at which the treasury bills are
the company will have to incur
issued and their redemption value is
floatation costs (costs associated with
the interest receivable on them and
floating of an issue are brokerage,
is called discount. Treasury bills are
commission, printing of applications
available for a minimum amount of
and advertising, etc.). Funds raised
` 25,000 and in multiples thereof. through commercial paper are used
Example: Suppose an investor to meet the floatation costs. This is
purchases a 91 days Treasury bill known as Bridge Financing.
with a face value of ` 1,00,000 for 3. Call Money: Call money is short
` 96,000. By holding the bill until the term finance repayable on demand, with
maturity date, the investor receives a maturity period of one day to fifteen
` 1,00,000. The difference of ` 4,000 days, used for inter-bank transactions.
between the proceeds received at Commercial banks have to maintain a
maturity and the amount paid to minimum cash balance known as cash
purchase the bill represents the reserve ratio. The Reserve Bank of India
interest received by him. changes the cash reserve ratio from
2. Commercial Paper: Commercial time to time which in turn affects the
paper is a short-term unsecured amount of funds available to be given
promissory note, negotiable and as loans by commercial banks. Call
transferable by endorsement and money is a method by which banks

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borrow from each other to be able to buyer (drawee) accepts it. On being
maintain the cash reserve ratio. The accepted, the bill becomes a marketable
interest rate paid on call money loans instrument and is called a trade bill.
is known as the call rate. It is a highly These bills can be discounted with a
volatile rate that varies from day-to- bank if the seller needs funds before
day and sometimes even from hour-to- the bill matures. When a trade bill is
hour. There is an inverse relationship accepted by a commercial bank it is
between call rates and other short-term known as a commercial bill.
money market instruments such as
certificates of deposit and commercial Capital Market
paper. A rise in call money rates
makes other sources of finance such The term capital market refers to
as commercial paper and certificates facilities and institutional arrangements
of deposit cheaper in comparison for through which long-term funds,
banks raise funds from these sources. both debt and equity are raised and
invested. It consists of a series of
4. Certificate of Deposit: Certificates
channels through which savings of
of deposit (CD) are unsecured,
the community are made available for
negotiable, short-term instruments
industrial and commercial enterprises
in bearer form, issued by commercial
and for the public in general. It
banks and development financial
directs these savings into their most
institutions. They can be issued
productive use leading to growth and
to individuals, corporations and
development of the economy. The
companies during periods of tight
capital market consists of development
liquidity when the deposit growth of
banks, commercial banks and stock
banks is slow but the demand for
exchanges.
credit is high. They help to mobilise
An ideal capital market is one where
a large amount of money for short
finance is available at reasonable cost.
periods.
The process of economic development
5. Commercial Bill: A commercial is facilitated by the existence of a
bill is a bill of exchange used to finance well functioning capital market. In
the working capital requirements of fact, development of the financial
business firms. It is a short-term, system is seen as a necessary
negotiable, self-liquidating instrument condition for economic growth. It is
which is used to finance the credit essential that financial institutions are
sales of firms. When goods are sold sufficiently developed and that market
on credit, the buyer becomes liable operations are free, fair, competitive
to make payment on a specific date and transparent. The capital market
in future. The seller could wait till should also be efficient in respect of the
the specified date or make use of a information that it delivers, minimise
bill of exchange. The seller (drawer) transaction costs and allocate capital
of the goods draws the bill and the most productively.

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The Capital Market can be divided small savings to subscribe to these

into two parts: a. Primary Market securities. In the money market,
b. Secondary Market transactions entail huge sums of
money as the instruments are quite
Distinction between Capital Market expensive.
and Money Market (iv) Duration: The capital market
The major points of distinction between deals in medium and long term
the two markets are as follows: securities such as equity shares
and debentures. Money market
(i) P articipants: The participants in
instruments have a maximum
the capital market are financial
tenure of one year, and may even
institutions, banks, corporate
be issued for a single day.
entities, foreign investors and
ordinary retail investors from (v) Liquidity: Capital market securities
members of the public. Participation are considered liquid investments
in the money market is by and because they are marketable on
large undertaken by institutional the stock exchanges. However, a
participants such as the RBI, share may not be actively traded,
banks, financial institutions and i.e. it may not easily find a buyer.
finance companies. Individual Money market instruments on
investors although permitted to the other hand, enjoy a higher
transact in the secondary money degree of liquidity as there is
market, do not normally do so. formal arrangement for this. The
Discount Finance House of India
(ii) Instruments: The main instruments (DFHI) has been established for
traded in the capital market are the specific objective of providing
– equity shares, debentures, a ready market for money market
bonds, preference shares etc. The instruments.
main instruments traded in the
(vi) Safety: Capital market instruments
money market are short term debt
are riskier both with respect to
instruments such as T-bills, trade
returns and principal repayment.
bills reports, commercial paper and
Issuing companies may fail to
certificates of deposit.
perform as per projections and
(iii) Investment Outlay: Investment in promoters may defraud investors.
the capital market i.e. securities But the money market is generally
does not necessarily require a huge much safer with a minimum
financial outlay. The value of units risk of default. This is due to the
of securities is generally low i.e. shorter duration of investing and
Rs 10, Rs 100 and so is the case also to financial soundness of the
with minimum trading lot of shares issuers, which primarily are the
which is kept small i.e. 5, 50, 100 government, banks and highly
or so. This helps individuals with rated companies.

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(vii)Expected return: The investment in method of raising funds by public

capital markets generally yield a companies in the primary market.
higher return for investors than the This involves inviting subscription
money markets. The possibility of from the public through issue of
earnings is higher if the securities prospectus. A prospectus makes a
are held for a longer duration. First, direct appeal to investors to raise
there is the scope of earning capital capital, through an advertisement
gains in equity share. Second, in in newspapers and magazines. The
the long run, the prosperity of a issues may be underwritten and also
company is shared by shareholders are required to be listed on at least one
by way of high dividends and stock exchange. The contents of the
bonus issues. prospectus have to be in accordance
with the provisions of the Companies
Primary Market Act and SEBI disclosure and investor
The primary market is also known as protection guidelines.
the new issues market. It deals with 2. Offer for Sale: Under this method
new securities being issued for the securities are not issued directly to the
first time. The essential function of public but are offered for sale through
a primary market is to facilitate the intermediaries like issuing houses or
transfer of investible funds from savers stock brokers. In this case, a company
to entrepreneurs seeking to establish sells securities enbloc at an agreed
new enterprises or to expand existing price to brokers who, in turn, resell
ones through the issue of securities them to the investing public.
for the first time. The investors in
this market are banks, financial 3 . P r i v a t e P l a c e m e n t : Private
institutions, insurance companies, placement is the allotment of securities
mutual funds and individuals. by a company to institutional investors
A company can raise capital and some selected individuals. It
through the primary market in the form helps to raise capital more quickly
of equity shares, preference shares, than a public issue. Access to the
debentures, loans and deposits. Funds primary market can be expensive
raised may be for setting up new on account of various mandatory
projects, expansion, diversification, and non-mandatory expenses. Some
modernisation of existing projects, companies, therefore, cannot afford a
mergers and takeovers etc. public issue and choose to use private
placement.
Methods of Floatation 4. Rights Issue: This is a privilege
There are various methods of floating given to existing shareholders to
new issues in the primary market : subscribe to a new issue of shares
1. Offer through Prospectus: Offer according to the terms and conditions
through prospectus is the most popular of the company. The shareholders are

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offered the ‘right’ to buy new shares than the exchange through which it
in proportion to the number of shares has offered its securities. The lead
they already possess. manager coordinates all the activities
5. e-IPOs: A company proposing to amongst intermediaries connected
issue capital to the public through the with the issue.
on-line system of the stock exchange
has to enter into an agreement with the Secondary Market
stock exchange. This is called an Initial The secondary market is also known
Public Offer (IPO). SEBI registered as the stock market or stock exchange.
brokers have to be appointed for the It is a market for the purchase and
purpose of accepting applications and sale of existing securities. It helps
placing orders with the company. The existing investors to disinvest and fresh
issuer company should also appoint a investors to enter the market. It also
registrar to the issue having electronic provides liquidity and marketability to
connectivity with the exchange. The existing securities. It also contributes
issuer company can apply for listing to economic growth by channelising
of its securities on any exchange other funds towards the most productive

Primary and Secondary Markets — A Comparison

Primary Market Secondary Market

(New Issue Market) (Stock Exchange)

(i) There is sale of securities by new (i) There is trading of existing shares
companies or further (new issues of only.
securities by existing companies to
investors).
(ii) Securities are sold by the company (ii) Ownership of existing securities is
to the investor directly (or through exchanged between investors. The
an intermediary). company is not involved at all.
(iii) The flow of funds is from savers to (iii) Enhances encashability (liquidity)
investors, i.e. the primary market of shares, i.e. the secondary market
directly promotes capital formation. indirectly promotes capital formation.
(iv) Only buying of securities takes place (iv) Both the buying and the selling of
in the primary market, securities securities can take place on the stock
cannot be sold there. exchange.
(v) Prices are determined and decided by (v) Prices are determined by demand and
the management of the company. supply for the security.
(vi) There is no fixed geographical (vi) Located at specified places.
location.

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investments through the process liquidity and safety of investment to

of disinvestment and reinvestment. the investors and enhance the credit
Securities are traded, cleared and worthiness of individual companies.
settled within the regulatory framework
prescribed by SEBI. Advances in Meaning of Stock Exchange
information technology have made According to Securities Contracts
trading through stock exchanges (Regulation) Act 1956, stock exchange
accessible from anywhere in the means any body of individuals, whether
country through trading terminals. incorporated or not, constituted for the
Along with the growth of the primary purpose of assisting, regulating or
market in the country, the secondary controlling the business of buying and
market has also grown significantly selling or dealing in securities.
during the last ten years.
Functions of a Stock Exchange
Stock Exchange
The efficient functioning of a stock
A stock exchange is an institution exchange creates a conducive climate
which provides a platform for buying for an active and growing primary
and selling of existing securities. market for new issues. An active
As a market, the stock exchange and healthy secondary market in
facilitates the exchange of a security existing securities leads to positive
(share, debenture etc.) into money environment among investors. The
and vice versa. Stock exchanges help following are some of the important
companies raise finance, provide functions of a stock exchange.

History of the Stock Market in India

The history of the stock market in India goes back to the end of the eighteenth
century when long-term negotiable securities were first issued. In 1850 the
Companies Act was introduced for the first time bringing with it the feature
of limited liability and generating investor interest in corporate securities. The
first stock exchange in India was set-up in 1875 as The Native Share and Stock
Brokers Association in Bombay. Today it is known as the Bombay Stock Exchange
(BSE). This was followed by the development of exchanges in Ahmedabad (1894),
Calcutta(1908) and Madras(1937). It is interesting to note that stock exchanges
were first set up in major centers of trade and commerce.
Until the early 1990s, the Indian secondary market comprised regional
stock exchanges with BSE heading the list. After the reforms of 1991, the Indian
secondary market acquired a three tier form. This consists of:
• Regional Stock Exchanges
• National Stock Exchange (NSE)
• Over the Counter Exchange of India (OTCEI)

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4. Contributes to Economic Growth:

A stock exchange is a market in
which existing securities are resold
or traded. Through this process of
disinvestment and reinvestment
savings get channelised into their
most productive investment avenues.
This leads to capital formation and
economic growth.
5. Spreading of Equity Cult: The
stock exchange can play a vital role
in ensuring wider share ownership
by regulating new issues, better
trading practices and taking effective
Bombay Stock Exchange steps in educating the public about
investments.
1. Providing Liquidity and Market-
ability to Existing Securities: The 6. Providing Scope for Speculation:
basic function of a stock exchange is the The stock exchange provides sufficient
creation of a continuous market where scope within the provisions of law for
securities are bought and sold. It gives speculative activity in a restricted
investors the chance to disinvest and and controlled manner. It is generally
reinvest. This provides both liquidity accepted that a certain degree of
and easy marketability to already healthy speculation is necessary to
existing securities in the market. ensure liquidity and price continuity
2. Pricing of Securities: Share prices in the stock market.
on a stock exchange are determined
by the forces of demand and supply. Trading and Settlement Procedure
A stock exchange is a mechanism of Trading in securities is now executed
constant valuation through which the through an on-line, screen-based
prices of securities are determined. electronic trading system. Simply
Such a valuation provides important put, all buying and selling of shares
instant information to both buyers and and debentures are done through a
sellers in the market. computer terminal.
3. Safety of Transaction: The There was a time when in the open
membership of a stock exchange is outcry system, securities were bought
well- regulated and its dealings are and sold on the floor of the stock
well defined according to the existing exchange. Under this auction system,
legal framework. This ensures that the deals were struck among brokers,
investing public gets a safe and fair prices were shouted out and the shares
deal on the market. sold to the highest bidder. However,

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now almost all exchanges have gone business hours of the stock exchange.
electronic and trading is done in the The computer in the brokers office is
broker’s office through a computer constantly matching the orders at the
terminal. A stock exchange has its best bid and offer price. Those that are
main computer system with many not matched remain on the screen and
terminals spread across the country. are open for future matching during
Trading in securities is done through the day.
brokers who are members of the stock Electronic trading systems or
exchange. Trading has shifted from the screen-based trading has certain
stock market floor to the brokers office. advantages:
Every broker has to have access to 1. It ensures transparency as it
a computer terminal that is connected allows participants to see the
to the main stock exchange. In this prices of all securities in the
screen-based trading, a member logs market while business is being
on to the site and any information about transacted. They are able to see
the shares (company, member, etc.) he the full market during real time.
wishes to buy or sell and the price is 2. It increases efficiency of
fed into the computer. The software is information being passed on, thus
so designed that the transaction will helping in fixing prices efficiently.
be executed when a matching order is The computer screens display
found from a counter party. The whole information on prices and also
transaction is carried on the computer capital market developments that
screen with both the parties being able influence share prices.
to see the prices of all shares going up 3. It increases the efficiency of
and down at all times during the time operations, since there is reduction
that business is transacted and during in time, cost and risk of error.
4. People from all over the country
and even abroad who wish to
participate in the stock market
can buy or sell securities through
brokers or members without
knowing each other. That is, they
can sit in the broker’s office, log
on to the computer at the same
time and buy or sell securities.
This system has enabled a large
number of participants to trade
with each other, thereby improving
the liquidity of the market.
5. A single trading platform has
Electronic Trading System
been provided as business is

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transacted at the same time in all trades were to be settled on specified

the trading centres. Thus, all the dates, this gave rise to speculation and
trading centres spread all over the price of shares used to rise and fall
country have been brought onto suddenly due to trading and defaults
one trading platform, i.e., the by brokers. A new system, i.e, rolling
stock exchange, on the computer. settlement, was introduced in 2000,
Now, screen-based trading or on-line so that whenever a trade took place it
trading is the only way in which you would be settled after some days. Since
can buy or sell shares. Shares can 2003, all shares have to be covered
be held either in physical form or an under the rolling settlement system
electronic book entry form of holding on a T+2 basis, meaning thereby
and transferring shares can also be that transactions in securities are
adopted. This electronic form is called settled within 2 days after the trade
dematerialised form. date. Since rolling settlement implies
fast movement of shares, it requires
Steps in the Trading and Settlement effective implementation of electronic
Procedure fund transfer and dematerialisation
It has been made compulsory to of shares.
settle all trades within 2 days of The following steps are involved in
the trade date, i.e., on a T+2 basis, the screen-based trading for buying
since 2003. Prior to the reforms, and selling of securities:
securities were bought and sold, i.e., 1. If an investor wishes to buy or sell any
traded and all positions in the stock security he has to first approach a
exchange were settled on a weekly/ registered broker or sub-broker
fortnightly settlement cycle whether it and enter into an agreement
was delivery of securities or payment with him. The investor has to
of cash. This system prevailed for a sign a broker-client agreement
long time as it increased the volume of and a client registration form
trading on the exchange and provided before placing an order to buy
liquidity to the system. However, since or sell securities. He has also to

Project Work
1. Study the website of Mumbai Stock Exchange, i.e., www.bseindia.com and
compile information which you find useful. Discuss it in your class and find out
how it can help you should you decide to invest in the stock market. Prepare
a report on your findings with the help of your teacher.
2. Prepare a report on the role of SEBI in regulating the Indian stock market.
You can get this information on its website namely www.sebi.gov.in. Do you
think something else should be done to increase the number of investors in
the stock market?

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provide certain other details and 4. T he broker then will go on-line

information. These include: and connect to the main stock
• PAN number exchange and match the share and
(This is mandatory) best price available.
5. When the shares can be bought or
• Date of birth and address.
sold at the price mentioned, it will
• Educational qualification and be communicated to the broker’s
occupation. terminal and the order will be
• Residential status (Indian/ executed electronically. The broker
NRI). will issue a trade confirmation slip
to the investor.
• Bank account details.
6. After the trade has been executed,
• Depository account details.
within 24 hours the broker issues
• Name of any other broker with a Contract Note. This note contains
whom registered. details of the number of shares
• Client code number in the bought or sold, the price, the
client registration form. date and time of deal, and the
brokerage charges. This is an
The broker then opens a trading
important document as it is legally
account in the name of the enforceable and helps to settle
investor. disputes/claims between the
2. The investor has to open a ‘demat’ investor and the broker. A Unique
account or ‘beneficial owner’ Order Code number is assigned
(BO) account with a depository to each transaction by the stock
participant (DP) for holding and exchange and is printed on the
transferring securities in the demat contract note.
form. He will also have to open a
7. Now, the investor has to deliver the
bank account for cash transactions
shares sold or pay cash for the
in the securities market.
shares bought. This should be
3. The investor then places an order done immediately after receiving
with the broker to buy or sell
the contract note or before the
shares. Clear instructions have
day when the broker shall make
to be given about the number of
shares and the price at which the payment or delivery of shares to the
shares should be bought or sold. exchange. This is called the pay-in
The broker will then go ahead with day.
the deal at the above mentioned 8. C ash is paid or securities are
price or the best price available. An delivered on pay-in day, which is
order confirmation slip is issued to before the T+2 day as the deal has
the investor by the broker. to be settled and finalised on the

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T+2 day. The settlement cycle is For this, the investor has to open a
on T+2 day on a rolling settlement demat account with an organisation
basis, w.e.f. 1 April 2003. called a depository. In fact, now all
9. O n the T+2 day, the exchange Initial Public Offers (IPOs) are issued
will deliver the share or make in dematerialisation form and more
payment to the other broker. This than 99% of the turnover is settled by
is called the pay-out day. The delivery in the demat form.
broker then has to make payment The Securities and Exchange Board
to the investor within 24 hours of India (SEBI) has made it mandatory
of the pay-out day since he has for the settlement procedures to take
already received payment from the place in demat form in certain select
exchange. securities. Holding shares in demat
form is very convenient as it is just
10. The broker can make delivery like a bank account. Physical shares
of shares in demat form directly can be converted into electronic
to the investor’s demat account. form or electronic holdings can be
The investor has to give details of reconverted into physical certificates
his demat account and instruct (rematerialisation). Dematerialisation
his depository participant to take enables shares to be transferred to
delivery of securities directly in his some other account just like cash
beneficial owner account. and ensures settlement of all trades
through a single account in shares.
Dematerialisation and Depositories These demat securities can even be
pledged or hypothecated to get loans.
All trading in securities is now done
There is no danger of loss, theft or
through computer terminals. Since all forgery of share certificates. It is the
systems are computerised, buying and broker’s responsibility to credit the
selling of securities are settled through investor’s account with the correct
an electronic book entry form. This is number of shares.
mainly done to eliminate problems like
theft, fake/forged transfers, transfer Working of the Demat System
delays and paperwork associated with
share certificates or debentures held 1. A depository participant (DP), either
in physical form. a bank, broker, or financial services
This is a process where securities company, may be identified.
held by the investor in the physical 2. A n account opening form and
form are cancelled and the investor is documentation (PAN card details,
given an electronic entry or number so photograph, power of attorney)
that she/he can hold it as an electronic may be completed.
balance in an account. This process 3. T he physical certificate is to be
of holding securities in an electronic given to the DP along with a
form is called dematerialisation. dematerialisation request form.

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4. If shares are applied in a public In India, there are two depositories.

offer, simple details of DP and National Securities Depositories
demat account are to be given and Limited (NSDL) is the first and largest
the shares on allotment would depository presently operational in
automatically be credited to the India. It was promoted as a joint
demat account. venture of the IDBI, UTI, and the
5. If shares are to be sold through a National Stock Exchange.
broker, the DP is to be instructed to The Central Depository Services
debit the account with the number Limited (CDSL) is the second
of shares. depository to commence operations
and was promoted by the Bombay
6. The broker then gives instruction to
Stock Exchange and the Bank of India.
his DP for delivery of the shares to
Both these national level depositories
the stock exchange.
operate through intermediaries who
7. The broker then receives payment are electronically connected to the
and pay the person for the shares depository and serve as contact points
sold. with the investors and are called
8. A ll these transactions are to be depository participants.
completed within 2 days, i.e., The depository participant (DP)
delivery of shares and payment serves as an intermediary between the
received from the buyer is on a T+2 investor and the Depository (NSDL or
basis, settlement period. CSDL) who is authorised to maintain
the accounts of dematerialised shares.
Depository Financial institutions, banks, clearing
corporations, stock brokers and
Just like a bank keeps money in safe
non-banking finance corporations
custody for customers, a depository
are permitted to become depository
also is like a bank and keeps securities
participants. If the investor is buying
in electronic form on behalf of the
and selling the securities through the
investor. In the depository a securities
broker or the bank or a non-banking
account can be opened, all shares can
finance corporation, it acts as a DP
be deposited, they can be withdrawn/
for the investor and complete the
sold at any time and instruction to
formalities.
deliver or receive shares on behalf
of the investor can be given. It is a
National Stock Exchange of India
technology driven electronic storage
(NSE)
system. It has no paper work relating
to share certificates, transfer, forms, The National Stock Exchange is the
etc. All transactions of the investors are latest, most modern and technology
settled with greater speed, efficiency driven exchange. It was incorporated
and use as all securities are entered in 1992 and was recognised as a stock
in a book entry mode. exchange in April 1993. It started

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operations in 1994, with trading on Objectives of NSE

the wholesale debt market segment.
NSE was set up with the following
Subsequently, it launched the capital
objectives:
market segment in November 1994
as a trading platform for equities and a. Establishing a nationwide trading
the futures and options segment facility for all types of securities.
in June 2000 for various derivative b. Ensuring equal access to investors
instruments. NSE has set up a all over the country through
nationwide fully automated screen an appropriate communication
based trading system. network.
The NSE was set up by leading c. Providing a fair, efficient and
financial institutions, banks, transparent securities market
insurance companies and other using electronic trading system.
financial intermediaries. It is managed d. Enabling shorter settlement cycles
by professionals, who do not directly and book entry settlements.
or indirectly trade on the exchange. e. Meeting international benchmarks
The trading rights are with the trading and standards.
members who offer their services Within a span of ten years, NSE
to the investors. The Board of NSE has been able to achieve its objectives
comprises senior executives from for which it was set up. It has been
promoter institutions and eminent playing a leading role as a change
professionals, without having any agent in transforming the Indian
representation from trading members. capital market. NSE has been able

Stock Market Index

A stock market index is a barometer of market behaviour. It measures overall
market sentiment through a set of stocks that are representative of the market.
It reflects market direction and indicates day-to-day fluctuations in stock prices.
An ideal index must represent changes in the prices of securities and reflect price
movements of typical shares for better market representation. In the Indian markets
the BSE, SENSEX and NSE, NIFTY are important indices. Some important global
stock market indices are:
• Dow Jones Industrial Average is among the oldest quoted stock market index
in the US.
• NASDAQ Composite Index is the market capitalisation weightages of prices for
stocks listed in the NASDAQ stock market.
• S and P 500 Index is made up of 500 biggest publicly traded companies in the
US. The S and P 500 is often treated as a proxy for the US stock market.
• FTSE 100 consists of the largest 100 companies by full market value listed
on the London Stock Exchange. The FTSE 100 is the benchmark index of the
European market.

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to take the stock market to the door (ii) Capital Market Segment: The capital
step of the investors. It has ensured market segment of NSE provides an
that technology has been harnessed efficient and transparent platform
to deliver the services to the investors for trading in equity, preference,
across the country at the lowest cost. debentures, exchange traded
It has provided a nation wide screen funds as well as retail Government
based automated trading system with securities.
a high degree of transparency and
equal access to investors irrespective BSE (Bombay Stock Exchange Ltd.)
of geographical location.
BSE Ltd (formerly known as Bombay
Stock Exchange Ltd) was established
Market Segments of NSE
in 1875 and was Asia’s first Stock
The Exchange provides trading in the Exchange. It was granted permanent
following two segments. recognition under the Securities
(i) Whole Sale Debt Market Segment: Contract (Regulation) Act, 1956. It
This segment provides a trading has contributed to the growth of
platform for a wide range of fixed the corporate sector by providing
income securities that include a platform for raising capital. It is
central government securities, known as BSE Ltd but was established
treasury bills, state development as the Native Share Stock Brokers
loans, bonds issued by public Association in 1875. Even before
sector undertakings, floating the actual legislations were enacted,
rate bonds, zero coupon bonds, BSE Ltd already had a set of Rules
index bonds, commercial paper, and Regulations to ensure an orderly
certificate of deposit, corporate growth of the securities market. As
debentures and mutual funds. discussed earlier, a stock exchange

Some Common Stock Market Terms

You would have often come across the following terms in magazines or newspapers
when you read about the stock market.
BOURSES is another word for the stock market
BULLS and BEARS – The term does not refer to animals but to market sentiment of
the investors. A Bullish phase refers to a period of optimism and a Bearish phase to
a period of perssimism on the Bourses.
BADLA – This refers to a carry forward system of settlement, particularly at the BSE.
It is a facility that allows the postponement of the delivery or payment of a transaction
from one settlement period to another.
ODD LOT TRADING – Trading in multiples of 100 stocks or less.
PENNY STOCKS – These are securities that have no value on the stock exchange but
whose trading contributes to speculation.

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can be set up as a corporate entity Securities and Exchange Board of

with different individuals (who are not India (SEBI)
brokers) as members or shareholders.
The Securities and Exchange Board
BSE is one such exchange set up
of India was established by the
as a corporate entity with a broad
Government of India on 12 April
shareholder base. It has the following 1988 as an interim administrative
objectives: body to promote orderly and healthy
(a) T o p r o v i d e a n e f f i c i e n t a n d growth of securities market and for
transparent market for trading investor protection. It was to function
in equity, debt instruments, under the overall administrative
derivatives, and mutual funds. control of the Ministry of Finance of
(b) To provide a trading platform for the Government of India. The SEBI
equities of small and medium was given a statutory status on 30
enterprises. January 1992 through an ordinance.
The ordinance was later replaced by
(c) To ensure active trading and
an Act of Parliament known as the
safeguard market integrity through
Securities and Exchange Board of
an electronically-driven exchange. India Act, 1992.
(d) To provide other services to capital
market participants, like risk Reasons for the Establishment of
management, clearing, settlement, SEBI
market data, and education. The capital market has witnessed a
(e) To conform to international tremendous growth during 1980’s,
standards. characterised particularly by the
increasing participation of the
Besides having a nation-wide
public. This ever expanding investors
presence, BSE has a global reach with
population and market capitalisation
customers around the world. It has
led to a variety of malpractices on the
stimulated innovation and competition
part of companies, brokers, merchant
across all market segments. It has bankers, investment consultants
established a capital market institute, and others involved in the securities
called the BSE Institute Ltd, which market. The glaring examples of these
provides education on financial malpractices include existence of self
markets and vocational training to a – styled merchant bankers unofficial
number of people seeking employment private placements, rigging of prices,
with stock brokers. The exchange has unofficial premium on new issues,
about 5000 companies listed from non-adherence of provisions of the
all over the country and outside, and Companies Act, violation of rules and
has the largest market capitalisation regulations of stock exchanges and
in India. listing requirements, delay in delivery

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of shares etc. These malpractices and accurate and authentic information

unfair trading practices have eroded and disclosure of information on a
investor confidence and multiplied continuous basis.
investor grievances. The Government • To the intermediaries, it should offer
and the stock exchanges were rather a competitive, professionalised and
helpless in redressing the investor’s expanding market with adequate
problems because of lack of proper and efficient infrastructure so
penal provisions in the existing that they are able to render better
legislation. In view of the above, the service to the investors and issuers.
Government of India decided to set-
up a separate regulatory body known Objectives of SEBI
as Securities and Exchange Board of
India. The overall objective of SEBI is to
protect the interests of investors and
Purpose and Role of SEBI to promote the development of, and
regulate the securities market. This
The basic purpose of SEBI is to may be elaborated as follows:
create an environment to facilitate 1. To regulate stock exchanges and the
efficient mobilisation and allocation securities industry to promote their
of resources through the securities orderly functioning.
markets. It also aims to stimulate
2. To protect the rights and interests of
competition and encourage innovation.
investors, particularly individual
This environment includes rules
investors and to guide and educate
and regulations, institutions and
them.
their interrelationships, instruments,
practices, infrastructure and policy 3. To prevent trading malpractices and
framework. achieve a balance between self
This environment aims at meeting regulation by the securities industry
the needs of the three groups which and its statutory regulation.
basically constitute the market, viz, 4. T o regulate and develop a code
the issuers of securities (Companies), of conduct and fair practices
the investors and the market by intermediaries like brokers,
intermediaries. merchant bankers etc., with a view
• To the issuers, it aims to provide to making them competitive and
a market place in which they can professional.
confidently look forward to raising
finances they need in an easy, fair Functions of SEBI
and efficient manner. Keeping in mind the emerging nature
• To the investors, it should provide of the securities market in India, SEBI
protection of their rights and was entrusted with the twin task of
inte re s t s thro u g h ad equ ate, both regulation and development of the

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securities market. It also has certain Protective Functions

protective functions.
1. Prohibition of fraudulent and unfair
trade practices like making mis-
Regulatory Functions
leading statements, manipulations,
1. Registration of brokers and sub- price rigging etc.
brokers and other players in the
2. C ontrolling insider trading and
market.
imposing penalties for such
2. Registration of collective investment practices.
schemes and Mutual Funds. 3. U ndertaking steps for investor
3. R e g u l a t i o n o f s t o c k b r o k e r s , protection.
portfolio exchanges, underwriters 4. Promotion of fair practices and code
and merchant bankers and the of conduct in securities market.
business in stock exchanges and
any other securities market.
The Organisation Structure of SEBI
4. Regulation of takeover bids by
companies. As SEBI is a statutory body there has
been a considerable expansion in the
5. Calling for information by under-
range and scope of its activities. Each of
taking inspection, conducting the activities of the SEBI now demands
enquiries and audits of stock more careful, closer, co-ordinated
exchanges and intermediaries. and intensive attention to enable it
6. Levying fee or other charges for to attain its objectives. Accordingly,
carrying out the purposes of the SEBI has been restructured and
Act. rationalised in tune with its expanded
7. P erforming and exercising such scope. It has decided its activities into
power under Securities Contracts five operational departments. Each
(Regulation) Act 1956, as may be department is headed by an executive
delegated by the Government of director. Apart from its head office at
India. Mumbai, SEBI has opened regional
offices in Kolkalta, Chennai, and Delhi
Development Functions to attend to investor complaints and
liaise with the issuers, intermediaries
1. Training of intermediaries of the and stock exchanges in the concerned
securities market. region.
2. Conducting research and publishing The SEBI also formed two advisory
information useful to all market committees. They are the Primary
participants. Market Advisory Committee and
3. Undertaking measures to develop the Secondary Market Advisory
the capital markets by adapting a Committee. These committees consist
flexible approach. of the market players, the investors

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associations recognised by the SEBI d. To advise for changes in legal

and the eminent persons in the capital framework to introduce
market. They provide important inputs simplification and transparency
to the SEBI’s policies. in the primary market.
The objectives of the two e. To advise the board in matters
Committees are as follows: relating to the development and
regulation of the secondary market
a. To advise SEBI on matters relating
in the country.
to the regulation of intermediaries
The committees are however non-
for ensuring investors protection
statutory in nature and the SEBI is not
in the primary market.
bound by the advise of the committee.
b. To advise SEBI on issues related to These committees are a part of SEBI’s
the development of primary market constant endeavor to obtain a feedback
in India. from the market players on various
c. To advise SEBI on disclosure issues relating to the regulations and
requirements for companies. development of the market.

Key Terms
Financial Market Money Market Treasury Bills
Commercial Paper Call Money Certificate of Deposit
Commercial Bill Money Market Mutual Fund Capital
Market Primary Market Secondary Market
Stock Exchange SEBI, NSE OTCEI

Summary
Financial Market is a market for creation and exchange of financial assets.
It helps in mobilisation and channelising the savings into most productive
uses. Financial markets also helps in price discovery and provide liquidity to
financial assets.
Money Market is a market for short-term funds. It deals in monetory assets
whose period of maturity is less than one year. The instruments of money market
includes treasury bills, commercial paper, call money, Certificate of deposit,
commercial bills, participation certificates and money market mutual funds.
Capital Market is a place where long-term funds are mobilised by the corporate
undertakings and Government. Capital Market may be devided into primary
market and secondary market. Primary market deals with new securities which

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were not previously tradable to the public. Secondary market is a place where
existing securities are bought and sold.
Stock Exchanges are the organisations which provide a platform for buying
and selling of existing securities. Stock exchanges provide continuous market
for securities, helps in price discovery, widening share ownership and provide
scope for speculation.
Securities and Exchange Board of India was established in 1988 and was
given statutory status through an Act in 1992. The SEBI was set-up to protect
the interests of investors, development and regulation of securities market.

Exercises

Very Short Answer Type

1. What is a Treasury Bill?
2. Name the segments of the National Stock Exchange (NSE).
3. State any two reasons why investing public can expect a safe and fair
deal in the stock market. (Point w.r.t safety of Transactions – Functions
of the Stock Exchange).
4. What is the common name for Beneficiary Owner Account, which is to
be opened by the investors for trading in securities?
5. Name any two details that need to be provided by the investor to the
broker while filling a client registration form.

Short Answer Type

1. What are the functions of Financial Market?
2. “Money Market is essentially a Market for short term funds.” Discuss.
3. Distinguish between Capital Market and Money Market.
4. What are the functions of the Stock Exchange?
5. What are the objectives of SEBI?
6. State the objective of NSE?
7. Name the document prepared in the process of online trading of securities
that is legally enforceable and helps to settle disputes/claims between
the investor and the broker.

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Long Answer Type

1. Explain the various Money Market instruments.
2. Explain the recent Capital Market reforms in India.
3. Explain the objectives and functions of the SEBI.
4. India’s largest domestic investor Life Insurance Corporation of India has
once again come to government’s rescue by subscribing 70% of Hindustan
Aeronautics’ `4,200-crore initial public offering.
a. Which market is being reflected in the above case?
b. State which method of floatation in the above identified market is
being highlighted in the case? (Primary Market)
c. Explain any two other methods of floatation. (Private Placement, Offer
through prospectus, offer for sale).
5. Lalita wants to buy shares of Akbar Enterprises, through her broker
Kushvinder. She has a Demat Account and a bank account for cash
transactions in the securities market. Discuss the subsequent steps
involved in the screen-based trading for buying and selling of securities
in this case.

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