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What is the stock market?

Investing in equities is an important investment that we make to generate inflation-beating returns. This was the conclusion we
drew from the previous chapter. Having said that, how do we go about investing in equities? Clearly, before we dwell further into
this topic, it is essential to understand the ecosystem in which equities operate.
Just like the way we go to the neighborhood Kirana store or a supermarket to shop for our daily needs, similarly, we go to the
stock market to shop (read as transact) for equity investments. The stock market is where everyone who wants to transact in
shares goes to. Transact, in simple terms, means buying and selling. You can’t buy/sell shares of a public company like Infosys
without transacting through the stock markets for all practical purposes

The main purpose of the stock market is to help you facilitate your transactions. So if you are a buyer of a share, the stock
market helps you meet the seller and vice versa.
Now unlike a supermarket, the stock market does not exist in a brick and mortar form. It exists in electronic form. You access the
market electronically from your computer and go about conducting your transactions (buying and selling of shares).
It is also important to note that you can access the stock market via a registered intermediary called the stockbroker. We will
discuss more the stockbrokers at a later point.
There are two main stock exchanges in India that make up the stock markets. They are the Bombay Stock Exchange (BSE) and
the National Stock Exchange (NSE). Besides these two exchanges, there are many other regional stock exchanges like Bangalore
Stock Exchange, Madras Stock Exchange that are more or less getting phased out and don’t really play any meaningful role
anymore.
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The Regulator
In India, the stock market regulator is called The Securities and Exchange Board of India, often referred to as SEBI. The objective of
SEBI is to promote the development of stock exchanges, protect the interest of retail investors, and regulate market participants
and financial intermediaries’ activities.
In general, SEBI ensures:
1) The stock exchanges (BSE and NSE) conducts its business fairly
2) Stockbrokers and sub-brokers conduct their business fairly
3) Participants don’t get involved in unfair practices
4) Corporate’s don’t use the markets to unduly benefit themselves (Example – Satyam Computers)
5) Small retail investors interests are protected
6) Large investors with huge cash pile should not manipulate the markets
7) Overall development of markets

Given the above objectives, it becomes imperative for SEBI to regulate the following entities. All the entities mentioned below are
directly involved in the stock markets. Malpractice by anyone of the following entities can disrupt what is otherwise a harmonious
market in India.
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Participants
The stock market attracts individuals and corporations from diverse backgrounds. Anyone who transacts in the stock market is
called a market participant. The market participant can be classified into various categories. Some of the categories of market
participants are as follows:
1) Domestic Retail Participants – These are people like you and me transacting in markets
2) NRI’s and OCI – These are people of Indian origin but based outside India
3) Domestic Institutions – These are large corporate entities based in India. A classic example would be the LIC of India.
4) Domestic Asset Management Companies (AMC) – Typical participants in this category would be the mutual fund companies
such as SBI Mutual Fund, DSP Black Rock, Fidelity Investments, HDFC AMC, etc.
5) Foreign Institutional Investors – Non-Indian corporate entities. These could be foreign asset management companies,
hedge funds, and other investors.
Now, irrespective of the category of market participant, everyone’s agenda is the same – to make profitable transactions. More
bluntly put – to make money.
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Financial Intermediaries

The market ecosystem is built by a cluster of financial intermediaries, each offering services unique to the functioning of markets.
1) A stockbroker is your access to markets, so make sure you choose a broker that matches your requirements, and services well.
2) A stockbroker provides you with a trading account that is used for all market-related transactions (buying and selling of
financial instruments like shares)
3) A Depository is a corporate entity that holds the shares in electronic form, against your name, in your account. Your account
with the depository is called the ‘DEMAT’ account.
4) There are only two depositories in India – NSDL, and CDSL.
5) To open a DEMAT account with one of the depositaries, you need to liaison with a Depository Participant (DP). A DP functions
as an agent to the Depository
6) A clearing corporation works towards clearing and settling of trades executed by you.
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Why Companies go Public ?

Origin of a Business
Before we jump ahead to seek an answer as to why companies go public, let us spend some time figuring out a more basic
concept –
The origins of a typical business.
1) The Angels
• The people who invest in your business in the pre-revenue stage are called Angel Investors.
• Angel investors take the maximum risk. They take in as much risk as the promoter.
• The money that angels give to start the business is called the seed fund.
• Angel’s invest relatively a small amount of capital
• Valuation of a company simply signifies how much the company is valued at. When one values the company, they consider the
company’s assets and liabilities.
• Face value is simply a denominator to indicate how much one share is originally worth.
• Authorized shares of the company are the total number of shares that are available with the company.
• The shares distributed from the authorized shares are called the issued shares. Issued shares are always a subset of authorized
shares.
• The shareholding pattern of a company tells us who owns how much stake in the company.
2) Venture Capitalists
• Venture Capitalists invest at an early stage in business; they do not risk Angel investors. The quantum of investments by a VC is
usually somewhere in between an angel and private equity investment.
• The money the company spends on business expansion is called capital expenditure or CAPEX
• Series A, B, and C, etc., are all funding that the company seeks as they start evolving. Usually higher the series, the higher is the
investment required.
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Why Companies go Public ?

3) Private Equity
• Beyond a certain size, VCs cannot invest, and hence the company seeking investments will have to approach Private Equity
firms.
• PE firms invest large sums of money, and they usually invest at a slightly more mature stage of the business.
• In terms of risk, PE’s have a lower risk appetite as compared to VC or angels.
• Typical PE investors would like to deploy their own people on the investee company’s board to ensure the business moves in
the right direction.
• The valuation of the company increases as and when the business, revenues, and profitability increases.
4) IPO
• An IPO is a process using which a company can raise funds. The funds raised can be for any valid reason – for CAPEX,
restructuring debt, rewarding shareholders, etc
• For convenience, let us assume the company decides to fund the CAPEX (Capital Expenditure) partly through internal accruals
and files for an IPO.
• When a company files for an IPO, they have to offer their shares to the general public. The general public will subscribe to the
shares (i.e. if they want to) by paying a certain price.
• Now, because the company is offering the shares for the first time to the public, it is called the “Initial Public Offer’.
•Companies go public to raise funds, provide an exit for early investors, reward employees and gain visibility
• Merchant banker acts as a key partner with the company during the IPO process
• SEBI regulates the IPO market and has the final word on whether a company can go public or not
• As an investor in the IPO, you should read through the DRHP to know everything about the company
• Most of the IPOs in India follow a book-building process
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Key points -
1) A stock market is a place where a trader or an investor can transact (buy, sell) in shares
2) A stock market is a place where the buyer and seller meet electronically
3) Different opinions make a market
4)The stock exchange electronically facilitate the meeting of buyers, and sellers
5) News and events move the stock prices on a daily basis
6) Demand supply mismatch also makes the stock prices move
7) When you own a stock you get corporate privileges like a bonus, dividends, rights, etc
8) Holding period is defined as the period during which you hold your shares
9) Use absolute returns when the holding period is 1 year or less. Use CAGR to identify the growth rate over multiple years
10) Traders, and investors differ on two counts – risk-taking ability and the holding period.
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Stock Markets Index

• An index acts as a barometer of the whole economy.
• An index going up indicates that the market participants are optimistic.
• An index going down indicates that the market participants are pessimistic.
• There are two main indices in India – The BSE Sensex 30 and NSE’s Nifty 50
• There are approximately 5,000 listed companies on the Bombay Stock Exchange and about 2,000 listed companies on the
National Stock Exchange.
• An index can be used for a variety of purposes – information, benchmarking, trading and hedging.
• Index trading is probably the most popular use of the index.
• India follows the free-float market capitalization ( product of the total number of shares outstanding in the market and the stock
price.) method to construct the index.
• There are sector-specific indices that convey the sentiment of specific sectors. For example, the Bank Nifty on NSE represents
the mood specific to the banking industry. The CNX IT on NSE represents the behavior of all the IT stocks in the stock markets.
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Market Segment
A market segment is a division within which a certain type of financial instrument is traded. Each financial instrument is
characterized by its risk and reward parameters. The exchange operates in three main segments.

1) Capital Market – Capital market segments offer a wide range of tradable securities such as equity, preference shares, warrants,
and exchange-traded funds. The capital Market segment has sub-segments under which instruments are further classified. For
example, common shares of companies are traded under the equity segment abbreviated as EQ. So if you were to buy or sell
shares of a company you are essentially operating in the capital market segment.
2) Futures and Options – Futures and Options, generally referred to as the equity derivative segment, would trade leveraged
products.
3) Wholesale Debt Market – The wholesale debt market deals with fixed income securities. Debt instruments include government
securities, treasury bills, bonds issued by a public sector undertaking, corporate bonds, corporate debentures, etc.