Basics of Securities

Investment Basics: Savings and investmentThe money what is saved out of earning is called saving which are to meet future expenses. Instead of keeping the saving idle it is advisable to use in to set good return on it in the future is known investment. Inflation- Inflation is the rate at which the cost of living increases and causes money to lose value in other words it will not buy the same amount of a good or a service in future as it does now or did in the past. For example , a person getting a salary of 5 per month after all expenses he plans to save a portion of his salary say !s " per month for future to meet education of his children , marriage other similar things in bank at #$ interest. The annual rate of inflation is %$ and bank interest is #$ per annum it means that the real return you get from your saving is -"$. Investing money will be fruitful only when you get a positive real return in other words the aim of investment should be to provide a return above the inflation rate to ensure that the investment does not decrease in value. A few things one must take into considerations before making the investment 1. &our Investment goals. 2. Time available for working with investments. 3. 'nowledge of investments 4. (vailable funds for investing . (bility to absorb the extant of losses !. )resent financial situation ". !isk tolerance *asic (im of investing is generally to increase the net worth and work towards long term goals. Investing involves risk. For example, earnings generally are not guaranteed and you could loose some of your original investments. *efore you go for investments, consider getting your general financial situation under control first, such as ". (n emergency fund

+. ,ome savings for short term goals -. (de.uate insurance /. 0ontrol over credit use 5. !etirement plan For Investment selection the criteria must be ". !isk +. !eturn -. 1i.uidity and marketability /. 0ost 5. 2iversification #. Taxes %. 3fforts and expertise Types of Investment4 ". Investment in !eal 3state 5old6 7ewellery, 0ommodities etc are known as )hysical assets investment. +. Investment in Fixed deposits with bank, )ost office, Insurance6).).F6 )ension fund or securities market like shares, bonds, debentures etc, is known as financial assets investments. *elow here we have list of different types of investment plans. ". )ublic )rovident Fund 8))F9 +. :ational savings 0ertificate8:,09 -. Fixed deposits with banks8F.2.9 /. !ecurring 2eposit with banks 5. Infrastructure *onds #. Fixed deposit with companies 8:*F0;s9 %. !*I !elief *onds <. )ost office time deposit =. )ost office recurring deposit

" . )ost office monthly Income scheme8>I,9 "". :ational savings scheme 8:,,9 "+. 'isan ?ikas patra "-. >utual fund units "/. ,hares "5. 2ebentures "#. 5overnment securities "%. 0ompany fixed deposits. "<. 5old6,ilver6commodities "=. !eal estate

These are different available investments options most of these belong to 5ovt of India. they are safe and secure investment options because of govt backing but here the reward is low in general the return is between 5-#$ to =-" $ p.a. and there is locking period which differs from option to option. These investments serve the long term purpose only and tax reduction so an investor who has conservative view towards his investment may opt any available option.

:ow we will have a *rief study on ,ecurities. ,ecurities4 the definition of @securities; as per the securities contracts !egulation (ct8,0!(9, "=5#, includes instruments such as shares , bonds, stock or other marketable securities of similar nature in or of any incorporate company or body corporate, government securities, derivatives of securities, units of collective investment scheme , interest and right in securities, security receipt or any other instruments so declared by the central government.

There are different types of ,ecurities and these are ". ,hares +. 5overnment ,ecurities -. 2erivative )roduct

/. Anits of mutual funds etc. are some of the securities investors in the securities market can invest in. #$uit%&Shares&Stocks: Total e.uity capital of a company is divided into e.ual units of small denominations, each called a share. The holders of such shares are members of the company and have voting rights. Thus share represents the form of fractional ownership in a company. ( stock is represented by a stock certificate. In today;s computer age , you won;t actually get to see this document because your brokerage keeps these records electronically , and is known as 2ematerialiBed share commonly known as 23>(T ,hares. Chether you say shares, e.uity or stock, it all means the same thing.

'ebt Instrument2ebt Instruments !epresents a contract whereby one party lends money to another on predetermined terms with regards to rate and periodicity of interest, repayment of principal amount by the borrower to lender. In Indian securities market , the term @*D:2; is used for debt instruments issued by the central and state government and public sector organiBations and the term @2ebenture; is used for instruments issued by private corporate sector.

'ebt v&s #$uit%4 The key differences between e.uity and debt are as follows4 ".2ebt investors are entitles to a contractual set of cash flows 8interest and principal9 whereas e.uity investors have a claim on the residual cash flows of the firm after it has satisfied all other claim and liabilities. +. Interest paid to debt investor represents a tax- deductible expense whereas dividend paid to e.uity investor has to come out of profit after tax. -. 2ebt has a fixed maturity whereas e.uity ordinarily has an infinite life. /. 3.uity investors enEoy the right to control the affairs of the firm whereas debt investors plays a passive role F of courseG they often impose certain restrictions on the way the firm is run to protect the interests. ,ecurities market4

,ecurities markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bond , debentures etc. further, it performs an important role of enabling corporate. 3ntrepreneurs to raise resources for their companies and business ventures through public issues. Transfer of resources from those having idle resources 8investors9 to others who have a need for them 8corporate9 is most efficiently achieved through the securities market. ,tated formally, securities market provides channels for reallocation of savings to investment and entrepreneurship. ,avings are linked to investments by a variety of intermediaries, through a range of financial products called @securities;. (egu)ators of the securities *arket: The absence of conditions of perfect competition in the securities market makes the role of the regulator extremely important. The regulator ensures that the market participants behave in a desired manner so that securities market continues to be a maEor source of finance for corporate and government and the interest of investors are protected. The responsibility for regulating the securities market is shared by 2epartment of 3conomic (ffairs 823(9, !eserve *ank of India 8!*I9, 20( 82epartment of company affairs9 and ,ecurities and exchange board of India 8,3*I9. (egu)ator% bod%- S#BI: The ,ecurities and exchange board of India 8,3*I9 is the regulatory authority in India established under section - of ,3*I act, "==+. ,3*I act, "==+ provides for establishment of securities and exchange board of India 8,3*I9 with statutory power for F a. )rotecting the interest of investors in securities. b. )romoting the development of the securities market. c. !egulating the securities market Its regulatory Eurisdiction extends over corporate in the issuance of capital and transfer of securities, in addition to all intermediaries and person associated with securities market. The ,ecurities exchange board of India 8,3*I9 has been entrusted with the responsibilities of dealing with various matters relating to the capital market. S#BI+s ,rinci,a) task+s are toH!egulate the business in the stock exchange and any other securities market H!egister and regulate the capital market intermediaries 8brokers, merchant bankers, portfolio managers and so on9

H!egister and regulate the working of mutual funds. H)romote and regulate self regulatory organiBations. H)revent fraudulent and unfair trade in securities market. Hpromote investors education and training of intermediaries of securities markets. H)rohibit insider trading in securities. H !egulate substantial ac.uisition of shares and takeover of companies. Hperform such other functions as may be prescribed.

Securities *arket ,artici,ants: The securities market essentially has three categories of participants, namely, the issue of securities, investor in securities and the intermediaries, such as merchant bankers, brokers etc. while the corporate and government raise resources from the securities market to meet their obligations , it is households that invest their savings in the securities market. It is advisable to conduct transactions through an intermediary as he is accountable for its activities. The list of registered intermediaries is available with exchanges, industry associations etc. Segments of securities market: The securities market has two interdependent segments4 the primary 8new issues9 market and the secondary market. )rimary market4 primary market provides the channel for sale of new securities while the secondary market deals in securities previously issued. ,econdary >arket4 ,econdary market refers to a market where securities are traded after being initially offered to the public in the primary market and6or listed on the stock exchange. >aEority of trading is done in the secondary market. ,econdary market comprises of e.uity markets and the debt markets. -rimar% market4 The )rimary market is where securities created 8by means of an I)D9 in other words provide the channel for sale of new securities. )rimary market provides opportunity to issuers of securitiesG 5overnment as well as corporate, to raise resources to meet their re.uirements of investment and 6or discharge some obligation.

0orporate may issue the securities at face value, or at a discount6premium and these securities may take a variety of forms such as e.uity, debt etc. they may issue the securities in domestic market and 6 or International market. .ace /a)ue of a share&debenture4 The nominal or stated amount 8in rs.9 assigned to a security by the issuer. For shares, it is the original cost of the stock shown on the certificateG for bonds, it is the amount paid to the holder at maturity, also known as par value or simply par. For an e.uity share, the face value is usually a very small amount 8rs 5 or rs " 9 and doesn;t have much bearing on the price of the share, which may .uote higher in the market, at rs " or rs " or any other price. For a debt security, face value is amount repaid to the investor when the bond matures8usually, government securities and corporate bonds have a face value of rs " 9. The price at which the security trade depends on the fluctuations in the interest rates in the economy. )remium and discount4 Chen a security is sold above its face value, it is said to be issued at a premium and if it is sold less than its face value then it is said to be issued at a discount. Chy do companies need to issue shares to the publicI >ost companies are usually started privately by their promoters. Jowever, the promoters; capital and the borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a long term. ,o companies invite the public to contribute towards the e.uity and issue shares to individual investors. the way to invite share capital from the public is through a @public issues;. ,imply stated, a public issue is an offer to the public to subscribe to the share capital of a company. Dnce this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid down by ,3*I.

'ifferent kinds of issues: ". I)D8 Initial )ublic offer9 +. )ublic issue by listed company -. !ight issue /. )referential issue ". Initial public offering8I)D9 is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuers securities.

+. )ublic issue by listed company is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public , through an offer document. The procedure for a public issue by a listed company is similar to that of an I)D. 0ompany sends application form similar to I)D to existing share holder to accept the right issue is to the destination of share holder. -. !ight issue involves selling securities in the primary market by issuing right to existing shareholders. Chen a company issues additional e.uity capital, is has to be offered in the first instance to the existing shareholders on a pro rata basis and this enable the company to issue additional capital to public and raise funds. The number of right that a shareholder gets is e.ual to the number of share held by the existing share holder. This is re.uired under section <" of the company;s act "=5#. The shareholder, however, may by a special resolution forfeit this right, partially or fully, to enable the company to issue additional capital to public. /. )referential issue is issue of e.uity by a listed company to selected investors at a price which may or may not be related to the prevailing market price is referred to as preferential issue in the India capital market. )referential issue in India is given mainly to promoters, or friendly investors, towards off the threat of take over.

:ormal )ublic issue and book building process4 In case of Initial public offering 8I)D9 the sale of securities can be either through normal public issue or through book building process. In case of normal public issue the company making issue fixes a price called fixed price whereas in case of book building process the company stipulate a floor price or a price band and leaves it to market forces to determine the final issue price. )rice at which securities will be allotted is not known in case of offer of shares through book building while in case of offer of shares through normal public issues, price is known in advance to investor. Ander book building, investor bid for shares at the floor price or above and after the closure of the book building process the price is determined for allotment of shares. In case of book building, the demand can be known everyday as the book is being built . but in case of the public issue the demand is known at the close of the issue. Issue ,rice:

The price at which a company;s shares are offered initially in the primary market is called as the issue price. Chen they begin to be traded, the market price may be above or below the issue price. 0ut-off ,rice: In a book building issue , the issuer is re.uired to indicate either the price band or a floor price in the prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called Kcut-off priceL. the issuer and lead manager decides this after considering the book and the investors; appetite for the stock. .)oor ,rice: Incase of book building process, floor price is the minimum price at which bids can be made. -rice Band: The prospectus may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than + $.

-ros,ectus: (ny company floating public issues need to provide ade.uate disclosure of information to public, as per guidelines issued by ,3*I. This disclosure includes information like the reason for raising the money, the way money is proposed to be spent, the return expected on the money etc. This information is in the form of KprospectusL which also includes information regarding the siBe of the issues, the current status of the company, its e.uity capital, its current and past performance, the promoters , the proEect, cost of the proEect, means of financing, product and capacity etc. It also contains lot of mandatory information regarding underwriting and statutory compliances. This helps investors to evaluate short term and mong term prospectus of the company.

1ow to know about A))otment of Shares& (efund (s per ,3*I guidelines, the basis of allotment should be completed with "5 days from the issue close date. (s soon as the basis of allotment is completed, within + working days the details of credit to demat account 6 allotment advice and dispatch

of refund order needs to be completed. ,o an investor should know in about "5days time from the closure of issue, whether shares are allotted to him or not. 2isting of securities: 1isting means admission of securities of an issuer to trading privileges8dealings9 on a stock exchange through a formal agreement . the prime obEective of admission to dealings on the exchange is to provide li.uidity and marketability to securities, as also to provide a mechanism for effective control and supervision of trading. Time period for listing of shares4 It would take around - weeks after the closure of the book built issue. *arket ca,ita)i3ation: The market value of a .uoted company, which is calculated by multiplying its current share price8market price9 by the number of shares in issue, is called as market capitaliBation. For example..company omvasusecurities has "# million shares in issue. The current market price is rs " . The market capitaliBation of company omvasusecurities is rs "# million.

.oreign ca,ita) Issuance: Indian companies are permitted to raise foreign currency resources through two main resources. " Issue of foreign currency convertible bonds, more commonly known as KeuroL issues and issue of ordinary shares through depository receipts namely (merican 2epository !eceipt8(2!9 and 5lobal 2epository !eceipt852!9 (n (merican 2epositary !eceipt8K(2!L9 is a physical certificate evidencing ownership of (merican 2epositary shares8K(2,sL9. (n (2, is a A.,. 2ollar denominated form of e.uity ownership in a non- A.,M company. It represents the foreign shares of the company held on deposit by a custodian bank in the company;s home country and carries the corporate and economic rights of the foreign shares, subEect to the terms specified on the (2! certificate. (2,s provide A.,. Investors with a convenient way to invest in overseas securities and to trade non A.,. securities in the A.,. (2,s are issued by a depository bank, such as 7)>organ chase bank. They are traded in the same manner as shares in A.,. companies , on the :ewyork stock exchange8:&,39 and the (merican stock exchange8(>3N9 or .uoted on :(,2(O and the over the counter8DT09 market.

5lobal depository receipts852!s9 is similar to (2!, which can be used to raise capital simultaneously in two or more markets through a global offering. 52!s may be used in public or private markets inside or outside A,.

4he ro)e of the secondar% market: For the general Investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company , secondary e.uity markets serve as a monitoring and control conduit- by facilitating value-enhancing control activities, enabling implementation of incentive based management contracts, and aggregating information 8via price discovery9 that guides management decisions.

'ifference between -rimar% *arket and Secondar% market:

In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. ,econdary market is an e.uity trading venue in which already existing 6 pre-issued securities are traded among investors. ,econdary market could be either auction or dealer market. Chile stock exchange is the part of an auction market, over the counter 8DT09 is a part of dealer market. Stock #5changes: >ost stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. 3xchanges are physical locations, where transactions are carried out on a trading floor. &ou have probably seen a picture of trading floor, on which traders are wildly throwing their arms up , waving , yelling and signaling to each other. This is old practice which is not obsolete. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically which is widely used everywhere now. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, thus reducing the risk. The stock market consists of primary and secondary market. :ew securities are issued in primary market. 3xisting securities are traded in secondary market and they are traded through stock exchanges. 3xchange ,tock 3xchange comprises 8*,3-:,3 and other local exchanges9 0ommodities 3xchanges 0omprises 8>0N, :023N and :c >03I19

Stock e5changes in India: The secondary market in India comprises of +/ stock exchanges, recogniBed by the government under securities contracts 8regulation9 act. Df course the principal bourses are the national stock exchange and *ombay stock exchange, accounting for the bulk of the trading on the Indian stock market. 6ationa) Stock #5change 76S#8: Inaugurated in "==/, the national stock exchange seeks to ". 3stablish a nation wide trading for e.uities, debt and hybrids +. Facilitate e.ual access to investors across the country -. Impart fairness, efficiency and transparency to securities /. ,horten settlement cycle 5. >eet international securities market standards #. It is a ring less, national, computeriBed stock exchange

It has + segments ". 0apital market segment +. Cholesale 2ebt market The 0apital market ,egment covers e.uities, convertible debentures, and retail trade in non-convertible debentures. The wholesale debt market segment is a market for high value transactions in government securities, ),A bonds , commercial paper and other debt instruments. The trading member in the capital market segment is connected to the central computer in >umbai through a satellite link-up, using ?,(Ts 8very small aperture terminals9. The trading members in the wholesale debt market segment are linked, through dedicated high speed lines, to the central computer at >umbai. The :,3 has opted for an order-driven system. Chen an order is placed by a trading member, an order confirmation slip is generated. It gives detail like .uantity, price, and code number of counterparty and so on. In :,3 scripts is known by symbol example Infosys tech. F :,3 ,ymbol- I:FD,&,T0J and its index is nifty.

Bomba% stock e5change7BS#8: *ombay stock 3xchange limited is the oldest stock exchange in (sia with a rich heritage. )opularly known as *,3 it was established as Kthe native share and stock brokers associationL in "<%5. It is the first stock exchange in the country to obtain permanent recognition in "=5# from the government of India under the securities contracts 8regulation9 act, "=5#. The exchange;s pivotal and pre-eminent role in the development of the Indian capital market is widely recogniBed and its index, ,3:,3N, is tracked worldwide. The exchange provides an efficient and transparent market for trading in e.uity, debt instruments and derivatives. In *,3 script is known by code number example Infosys tech. F *,3 0ode- 5 its index is ,ensex. + = and

9ther recogni3ed stock e5changes in india4 There are ++ stock exchanges in India. These were founded at the different time in different places under different laws. Jowever , all of them now been recogniBed and regulated under a single law namely the securities contracts 8!egulations9 (ct, "=5#. :o person is, in principle, allowed to organiBe stock exchanges other then recogniBed ones. Inde5G (n Index is benchmark for measuring the performance of fund managers and is a comprehensive measure of market trends, intended for investors who are concerned with general stock market price movements. (n index comprises stocks that have large li.uidity and market capitaliBation. 3ach stock is given a weightage in the index e.uivalent to its market capitaliBation. It has practical application too in the world of finance. *oth :,3 and *,3 has launched index futures based on the ,P), 0:N :ifty and *,3 sensex respectively . in the global market for index services and their application is a multi- trillion rupees industry.

Sense5: *,3 F - sensex, which is the benchmark index of Indian capital market comprises of - scripts. This is the first index constructed by the *ombay stock exchange sensex measures the floating capitaliBation of its constituents. ,3:,3N is calculated using the Kfree float market capitaliBationL methodology.

(s per this methodology , the level of index at any point of time reflects the free float market value of - component stocks relative to a base period. The market capitaliBation of a company is determined by multiplying the price of its stock by the number of share issued by the company. This market capitaliBation is further multiplied by the free float factor to determine the free-float market capitaliBation. The base period of sensex is "=%<-%= and the base value is " index points. This is often indicated by the notation "=%<-%=Q" . The calculation of sensex involves dividing the free float market capitaliBation of - companies in the index by a number called the index divisor. The divisor is the only link to the original base period value of the ,3:,3N. It keeps the index comparable over time and is adEustment point for all index adEustment arising out of corporate actions, replacements of scripts etc. 2uring market hours, prices of the Indian scripts, at which latest trades are executed, are used by the trading system to calculate ,3:,3N every "5seconds and disseminated in real time.

'efinition of free-f)oat: ,hare holdings held by investors that would not, in the normal course, come into the open market for trading are treated as @controlling6strategic and hence not included in free float. In specific, the following categories of holding are generally excluded from the definition of free float. Jolding by founders6directors6ac.uirers which has control element Joldings by person6bodies with controlling interest 5overnment holding as promoter6ac.uirer Jolding through the F2I route ,trategies stakes by private corporate bodies6individuals 3.uity held by associate 6 group companies8cross-holdings9 3.uity held by employee welfare trusts 1ocked-in shares and shares which would not be sold in the open market in normal course The remaining shareholders would fall under the free float category The closing sensex on any trading day is computed taking the weighted average of all the trades on sensex constituents in the last "5 minutesG the last traded price is taken for computation of the index closure. If sensex constituents has not

traded at all in a day, then its last day closing price is taken for computation of index closure. 6ift%: This is the first index constructed by national stock exchange. Its construction is slightly different form that sensex. (s we have seen however nifty is a step behind. it takes the full capitaliBation of its 5 constituents. Dther important India indices4 ". *,3 small cap index +. *,3 >idcap Index -. 0:N :ifty Eunior /. 0:N >idcap 5. 0:N IT #. *ank nifty

.orm of shares: ". )hysical ,hares +. 2emat )hysical share is represented by a stock certificate, whereas demat ,hares are dematerialiBed shares inform of electronic data stored in computers of electronic depository.

'e,ositor%: ( depository is a securities Kbank,L where dematerialiBed physical securities are held in custody, and form where they can be traded. This facilitates faster, risk free and low cost settlement. ( depository is akin to a bank and performs activities similar in nature. (n analogy between a bank and a depository may be drawn as follows4 ". *anks hold fund in account whereas 2epository hold securities in an account. +. *anks transfer the funds between accounts on the instruction of the account holder whereas in 2epository securities are transferred between accounts on the instruction of account holder. -. *anks Facilitates transfers without having to handle money whereas depository facilitates transfer of ownership.

/. *anks Facilitates safekeeping of money and depository facilitates safekeeping of shares.

'e,ositor% -artici,ant: The depository provides its services to investors through its agents called depository participants 82)s9 These agents are appointed by the depository with the approval of ,3*I. (ccording to ,3*I regulations, amongst others, three categories of entities, i.e. banks, Financial Institutions and ,3*I registered trading members can become 2)s. 'e,ositories in India: (t )resent there are two depositories in India, 02,1 and :,21. 02,1 was promoted by *ombay stock exchange limited8*,39 7ointly with leading banks such as state bank of India , *ank of India, *ank of *aroda, J2F0 *ank , ,tandard 0hartered bank, Anion *ank of India and centurion *ank in "===. :,21 :ational ,ecurities 2epository limited 8:,219 and central depository services 802,9. :,21 was the first Indian depository.. It was inaugurated in :ovember "==#. :,21 was set up with an initial capital of rs "+/ crores, )romoted by Industrial development bank of India8I2*I9, Anit trust of India8ATI9, :ational stock exchange of India limited.8:,3I19 and the state bank of India8,*I9.

'#*A4: 2emat is a commonly used abbreviation of 2ematerialiBation , which is a process whereby securities like shares , debentures are converted from the material 8paper document9 form into electronic 2ata and stored in the computers of an electronic depository. -rocedure for the demateria)i3ation of securities: In order to dematerialiBe physical securities one has to fill in a demat re.uest form 82!F9 which is available with the 2) and submit the same along with physical certificates one wishes to dematerialiBe. ,eparate 2!F has to be filled for each I,I: number. If at a later date you wish to have these Kdemat; ,ecurities converted back into paper certificates, the depository can help to revive the paper shares.

*enefits of 2ematerialiBed shares4 Immediate transfer of securities.

:o stamp duty on transfer of securities 3limination of risks associated with physical certificates such as bad delivery, fake securities etc. !eduction in paperwork involved in a transfer of securities. !eduction in transaction cost 3ase of nomination facility 0hange in address recorded with 2) gets registered electronically with all companies in which investor holds securities eliminating the need to correspond with each of them separately Transmission of securities is done directly by the 2) eliminating correspondence with companies 0onvenient method of consolidation of folios6accounts Jolding Investments in e.uity, debt instruments and 5overnment securities in a single accountG automatic credit into demat account, of shares, arising out of split6consolidation6merger etc. 'e,ositor% -artici,ants 7'-8: The 2epository provides its services to investors through its agents called depository participants 82)s9. These agents are appointed by the depository with the approval of ,3*I. (ccording to ,3*I regulations, amongst others, three categories of entities, i.e. banks, financial institutions and ,3*I registered trading members can become 2)s. >inimum balance of securities in your account with your 2) :o. the depository has not prescribed any minimum balance. &ou can have Bero balance in your account. :hat is ISI6I,I: 8International ,ecurities identification number9 is a uni.ue identification number for a security.

1ow to enter into stock market :h% shou)d one invest in e$uities; 3.uities have the potential to increase in value over time. It also provides your portfolio with the growth necessary to reach your long term investment goals. !esearch studies

have proves that the e.uities have outperformed most other forms of investment in the long term. 3.uities are considered the most challenging and the rewarding, when compared to other investment options. !esearch studies have proved that investment in some shares with a longer tenure of investment have yielded far superior returns than any other investment. Jowever, this doesn;t mean all e.uity investments would guarantee similar high returns. 3.uities are high risk investments. Dne needs to study them carefully before investing. ,ince "== till date, Indian stock market has returned about "%$ to investors on an average in terms of increase in share prices or capital appreciation annually. *esides that, on an average stocks have paid ".5 dividend annually.

9,ening of 'emat account: 2emat refers to a dematerialiBed account. 7ust as you have to open an account with a bank if you want to save your money, make che.ue payment etc, you need to open a demat account if you want to buy or sell stocks. &ou have to approach the 2)s 8remember, they are like bank branches9, to open your demat account. 7ust like a bank passbook or statement the 2) will provide you with periodic statements of holding and transactions. &ou re.uired to submit the documents for opening of your demat account which includes your I2 and address proof with )an card mandatory. 1ow to a,,)% for I-9: 0ompany distributes I)D applications forms in large .uantities. Ce have to fill this form and submit it along with the che.ue622 of the application amount. Dpening Trading account with broker4 ( stock broker or brokerage house is a entity affiliated to a stock market who bridges the gap between an investor and a stock market to buy or sell the stocks and shares. )rocess of buying and selling shares4 Chen you open an account, the 2) will allot a uni.ue *D I2 8*eneficial owner identification9 number, which you need to .uote for all future transactions. If you want to sell your shares, you need to place an order with your broker and give delivery instructions to your 2). The 2) will debit your account with the number of shares sold.

&ou will receive the payment from your broker. If you want to buy shares, inform your broker about your depository account number , so that the shares bought are credited into your account.

'erivatives Dne of the most significant events in the securities markets has been the development and 3xpansion of financial derivatives. The term KderivativesL is used to refer to financial Instruments which derive their value from some underlying assets. The underlying assets could be e.uities 8shares9, debt 8bonds, T-bills, and notes9, currencies, and even indices of these ?arious assets, such as the :ifty 5 Index. 2erivatives derive their names from their respective Anderlying asset. Thus if a derivative;s underlying asset is e.uity, it is called e.uity derivative and so on. 2erivatives can be traded either on a regulated exchange, such as the :,3 or off the 3xchanges, i.e., directly between the different parties, which is called Kover-the-counterL 8DT09 Trading. 8In India only exchange traded e.uity derivatives are permitted under the law.9 The basic purpose of derivatives is to transfer the price risk 8inherent in fluctuations of the asset prices9 from one party to anotherG they facilitate the allocation of risk to those who are willing to take it. In so doing, derivatives help mitigate the risk arising from the future uncertainty of prices. For example, on :ovember ", + = a rice farmer may wish to sell his harvest at a future

date 8say 7anuary ", + " 9 for a pre-determined fixed price to eliminate the risk of change in prices by that date. ,uch a transaction is an example of a derivatives contract. The price of this derivative is driven by the spot price of rice which is the RunderlyingR. 'erivatives in India In India, derivatives markets have been functioning since the nineteenth century, with organiBed trading in cotton through the establishment of the 0otton Trade (ssociation in "<%5. 2erivatives, as exchange traded financial instruments were introduced in India in 7une + .

The :ational ,tock 3xchange 8:,39 is the largest exchange in India in derivatives, trading in

various derivatives contracts. The first contract to be launched on :,3 was the :ifty 5 index futures contract. In a span of one and a half years after the introduction of index futures, index options, stock options and stock futures were also introduced in the derivatives segment for trading. :,3;s e.uity derivatives segment is called the Futures P Dptions ,egment or FPD ,egment. :,3 also trades in 0urrency and Interest !ate Futures contracts under a separate segment.

( series of reforms in the financial markets paved way for the development of exchange-traded e.uity derivatives markets in India. In "==-, the :,3 was established as an electronic, national exchange and it started operations in "==/. It improved the efficiency and transparency of the stock markets by offering a fully automated screen-based trading system with real-time price dissemination. ( report on exchange traded derivatives, by the 1.0. 5upta 0ommittee, set up by the ,ecurities and 3xchange *oard of India 8,3*I9, recommended a phased introduction of derivatives instruments with bi-level regulation 8i.e., self-regulation by exchanges, with ,3*I providing the overall regulatory and supervisory role9. (nother report, by the 7.!. ?arma 0ommittee in "==<, worked out the various operational details such as margining and risk management systems for these instruments. In "===, the ,ecurities 0ontracts 8!egulation9 (ct of "=5#, or ,08!9(, was amended so that derivatives could be declared as KsecuritiesL. This allowed the regulatory framework for trading securities, to be extended to derivatives. The (ct considers derivatives on e.uities to be legal and valid, but only if they are traded on exchanges.

The ,ecurities 0ontracts 8!egulation9 (ct, "=5# defines RderivativesR to include4

". ( security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument, or contract for differences or any other form of security. +. ( contract which derives its value from the prices, or index of prices, of underlying

securities.

(t present, the e.uity derivatives market is the most active derivatives market in India. Trading volumes in e.uity derivatives are, on an average, more than three and a half times the trading volumes in the cash e.uity markets.

4%,es of 'erivatives: There are various types of derivatives traded on exchanges across the world. They range from the very simple to the most complex products. The following are the three basic forms of derivatives, which are the building blocks for many complex derivatives instruments 8the latter are beyond the scope of this book94

S Forwards S Futures S Dptions ". .orwards ( forward contract or simply aforward is a contract between two parties to buy or sell an asset at a certain future date for a certain price that is pre-decided on the date of the contract. The future date is referred to as expiry date and the pre-decided price is referred to as Forward )rice. It may be noted that Forwards are private contracts and their terms are determined by the parties involved. 2. .utures 1ike a forward contract, a futures contract is an agreement between two parties in which the buyer agrees to buy an underlying asset from the seller, at a future date at a price that is agreed upon today. Jowever, unlike a forward contract, a futures contract is not a private

transaction but gets traded on a recogniBed stock exchange. In addition, a futures contract is standardiBed by the exchange. (ll the terms, other than the price, are set by the stock exchange 8rather than by individual parties as in the case of a forward contract9. (ls o, both buyer and seller of the futures contracts are protected against the counter party risk by an entity called the 0learing 0orporation. The 0learing 0orporation provides this guarantee to ensure that the buyer or the seller of a futures contract does not suffer as a result of the counter party defaulting on its obligation. In case one of the parties defaults, the 0learing 0orporation steps in to fulfill the obligation of this party, so that the other party does not suffer due to non-fulfillment of the contract. To be able to guarantee the fulfillment of the obligations under the contract, the 0learing 0orporation holds an amount as a security from both the parties. This amount is called the >argin money and can be in the form of cash or other financial assets. (lso, since the futures contracts are traded on the stock exchanges, the parties have the flexibility of closing out the contract prior to the maturity by s.uaring off the transactions in the market.

3.9,tions 1ike forwards and futures, options are derivative instruments that provide the opportunity to buy or sell an underlying asset on a future date.

(n option is a derivative contract between a buyer and a seller, where one party 8say First )arty9 gives to the other 8say ,econd )arty9 the right, but not the obligation, to buy from 8or sell to9 the First )arty the underlying asset on or before a specific day at an agreed-upon price. In return for granting the option, the party granting the option collects a payment from the other party. This payment collected is called the KpremiumL or price of the option.

The right to buy or sell is held by the Koption buyerL 8also called the option holder9G the party

granting the right is the Koption sellerL or Koption writerL. Anlike forwards and futures contracts, options re.uire a cash payment 8called the premium9 upfront from the option buyer to the option seller. This payment is called option premium or option price. Dptions can be traded either on the stock exchange or in over the counter 8DT09 markets. Dptions traded on the exchanges are backed by the 0learing 0orporation thereby minimiBing the risk arising due to default by the counter parties involved. Dptions traded in the DT0 market however are not backed by the 0learing 0orporation.

There are two types of optionsTcall options and put optionsTwhich are explained below. 0a)) o,tion ( call option is an option granting the right to the buyer of the option to buy the underlying asset on a specific day at an agreed upon price, but not the obligation to do so. It is the seller who grants this right to the buyer of the option. It may be noted that the person who has the right to buy the underlying asset is known as the Kbuyer of the call optionL. The price at which the buyer has the right to buy the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract 8call option strike price in this case9. ,ince the buyer of the call option has the right 8but no obligation9 to buy the underlying asset, he will

exercise his right to buy the underlying asset if and only if the price of the underlying asset in the market is more than the strike price on or before the expiry date of the contract. The buyer of the call option does not have an obligation to buy if he does not want to.

-ut o,tion ( put option is a contract granting the right to the buyer of the option to sell the underlying asset on or before a specific day at an agreed upon price, but not the obligation to do so. It is

the seller who grants this right to the buyer of the option. The person who has the right to sell the underlying asset is known as the Kbuyer of the put optionL. The price at which the buyer has the right to sell the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract 8put option strike price in this case9. ,ince the buyer of the put option has the right 8but not the obligation9 to sell the underlying asset, he will

exercise his right to sell the underlying asset if and only if the price of the underlying asset in the market is less than the strike price on or before the expiry date of the contract. The buyer of the put option does not have the obligation to sell if he does not want to. 'ifference between forwards and futures ".Forwards contracts are )rivately negotiated contracts Traded on an exchange Chereas futures contracts are ,tandardiBed contracts +.Ander Forward contracts ,ettlement dates can be set by the parties Chereas under future contracts there are Fixed settlement dates as declared by the 3xchange. -.Jigh counter party risk under forward contracts and (lmost no counter party risk under future contracts.

9,tions 1ike forwards and futures, options are derivative instruments that provide the opportunity to buy or sell an underlying asset on a future date.

(n option is a derivative contract between a buyer and a seller, where one party 8say First )arty9 gives to the other 8say ,econd )arty9 the right, but not the obligation, to buy from 8or sell to9 the First )arty the underlying asset on or before a specific day at an agreed-upon price. In return for granting the option, the party granting the option collects a payment from the

other party. This payment collected is called the KpremiumL or price of the option.

The right to buy or sell is held by the Koption buyerL 8also called the option holder9G the party granting the right is the Koption sellerL or Koption writerL. Anlike forwards and futures contracts, options re.uire a cash payment 8called the premium9 upfront from the option buyer to the option seller. This payment is called option premium or option price. Dptions can be traded either on the stock exchange or in over the counter 8DT09 markets. Dptions traded on the exchanges are backed by the 0learing 0orporation thereby minimiBing the risk arising due to default by the counter parties involved. Dptions traded in the DT0 market however are not backed by the 0learing 0orporation.

There are two types of optionsTcall options and put optionsTwhich are explained below. 0a)) o,tion ( call option is an option granting the right to the buyer of the option to buy the underlying asset on a specific day at an agreed upon price, but not the obligation to do so. It is the seller who grants this right to the buyer of the option. It may be noted that the person who has the right to buy the underlying asset is known as the Kbuyer of the call optionL. The price at which the buyer has the right to buy the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract 8call option strike price in this case9. ,ince the buyer of the call option has the right 8but no obligation9 to buy the underlying asset, he will

exercise his right to buy the underlying asset if and only if the price of the underlying asset in the market is more than the strike price on or before the expiry date of the contract. The buyer of the call option does not have an obligation to buy if he does not want to.

-ut o,tion ( put option is a contract granting the right to the buyer of the option to sell the underlying asset on or before a specific day at an agreed upon price, but not the obligation to do so. It is the seller who grants this right to the buyer of the option. The person who has the right to sell the underlying asset is known as the Kbuyer of the put optionL. The price at which the buyer has the right to sell the asset is agreed upon at the time of entering the contract. This price is known as the strike price of the contract 8put option strike price in this case9. ,ince the buyer of the put option has the right 8but not the obligation9 to sell the underlying asset, he will exercise his right to sell the underlying asset if and only if the price of the underlying asset in the market is less than the strike price on or before the expiry date of the contract. The buyer of the put option does not have the obligation to sell if he does not want Uto.

I))ustration ,uppose ( has Kbought a call optionL of + shares of Jindustan Anilever 1imited 8J119 at a

strike price of !s +# per share at a premium of !s " . This option gives (, the buyer of the option, the right to buy + +%, + shares of J11 from the seller of the option, on or before (ugust

= 8expiry date of the option9. The seller of the option has the obligation to sell + = 8i.e. whenever asked by the

shares of J11 at !s +# per share on or before (ugust +%, + buyer of the option9.

,uppose instead of buying a call, ( has Ksold a put optionL on " shares at a strike price of !s +

!eliance Industries 8!I19

at a premium of !s <. This option is an obligation to ( to buy

" shares of !eliance Industries 8!I19 at a price of !s + per share on or before (ugust +% 8expiry date of the option9 i.e., as and when asked by the buyer of the put option. It depends on the option buyer as to when he exercises the option. (s stated earlier, the buyer does not have the obligation to exercise the option.

'ifferences between futures and o,tions

". Ander Futures *oth the buyer and the seller are under an obligation to fulfill the contract. Chereas in Dptions The buyer of the option has the right and not an obligation whereas the seller is under obligation to fulfill the contract if and when the buyer exercises his right. +. Ander future The buyer and the seller are subEect to unlimited risk of loss wereas in options The seller is subEected to unlimited risk of losing whereas the buyer has limited potential to lose 8which is the option premium9. -.Ander future The buyer and the seller have potential to make unlimited gain or loss whereas in option The buyer has potential to make unlimited gain while the seller has a potential to make limited gain. Dn the other hand the buyer has a limited loss potential and the seller has an unlimited loss potential.

4ermino)og% of 'erivatives In this section we explain the general terms and concepts related to derivatives.

S,ot ,rice 7S48 ,pot price of an underlying asset is the price that is .uoted for immediate delivery of the asset. For example, at the :,3, the spot price of !eliance 1td. at any given time is the price at which !eliance 1td. shares are being traded at that time in the 0ash >arket ,egment of the :,3. ,pot price is also referred to as cash price sometimes.

.orward ,rice or futures ,rice 7.8 Forward price or futures price is the price that is agreed upon at the date of the contract for the delivery of an asset at a specific future date. These prices are dependent on the spot price, the prevailing interest rate and the expiry date of the contract.

Strike ,rice 8'9 The price at which t he buyer of an option can buy the stock 8in the case of a call option9 or sell the stock 8in the case of a put option9 on or before the expiry date of option contracts is called strike price. It is the price at which the stock will be bought or sold when the option is exercised. ,trike price is used in the case of options onlyG it is not used for futures or forwards.

#5,iration date 8T9 In the case of Futures, Forwards, Index and ,tock Dptions, 3xpiration 2ate is the date on which settlement takes place. It is also called the final settlement date. 4%,es of o,tions Dptions can be divided into two different categories depending upon the primary exercise styles associated with options. These categories are4

#uro,ean 9,tions4 3uropean options are options that can be exercised only on the expiration date. American o,tions4 (merican options are options that can be exercised on any day on or before the expiry date. They can be exercised by the buyer on any day on or before the final settlement date or the expiry date. 0ontract si3e (s futures and options are standardiBed contracts traded on an exchange, they have a fixed contract siBe. Dne contract of a derivatives instrument represents a certain number of shares of the underlying asset. For example, if one contract of *J31 consists of then shares of *J31,

if one buys one futures contract of *J31, then for every !e " increase in *J31;s futures price, the buyer will make a profit of he will lose !s 0ontract /a)ue 0ontract value is notional value of the transaction in case one contract is bought or sold. It is the contract siBe multiplied but the price of the futures. 0ontract value is used to calculate margins etc. for contracts. In the example above if *J31 futures are trading at !s. + contract value would be !s. + *argins In the spot market, the buyer of a stock has to pay the entire transaction amount 8for purchasing the stoc k9 to the seller. For example, if Infosys is trading at !s. + an investor wants to buy " +, , Infosys shares, then he has to pay !s. + N" a share and Q !s. xQ !s. # lacs. the . N " Q !s and for every !e " fall in *J31;s futures price,

to the seller. The settlement will take place on TV+ basisG that is, two days after t he

transaction date.

In a derivatives contract, a person enters into a trade today 8buy or sell9 but the settlement happens on a future date. *ecause of this, there is a high possibility of default by any of the

parties. Futures and option contracts are t raded through exchanges and the counter party risk is taken care of by the clearing corporation. In order to prevent any of the parties from defaulting on his trade commitment, the clearing corporation levies a margin on the buyer as well as seller of the futures and option contracts. This margin is a percentage 8approximately + $9 of the total contract value. Thus, for the aforementioned example, if a person wants to buy " !s / , Infosys futures, then he will have to pay + $ of the contract value of !s +, , Q

as a margin to the clearing corporation. This margin is applicable to both, the buyer

and the seller of a futures contract. *one%ness of an 9,tion K>oneynessL of an option indicates whether an option is worth exercising or not i.e. if the option is exercised by the buyer of the option whether he will receive money or not. K>oneynessL of an option at any given time depends on where the spot price of the underlying is at that point of time relative to the strike price. The premium paid is not taken into consideration while calculating moneyness of an Dption, since the premium once paid is a sunk cost and the profitability from exercising the option does not depend on the siBe of the premium. Therefore, the decision 8of the buyer of the option9 whether to exercise the option or not is not affected by the siBe of the premium. The following three terms are used to define the moneyness of an option.

In-the-mone% o,tion (n option is said to be in-the-money if on exercising the option, it would produce a cash inflow for the buyer. Thus, 0all Dptions are in-the-money when the value of spot price of the underlying exceeds the strike price. Dn the other hand, )ut Dptions are in-the-money when the spot price of the underlying is lower than the strike price. >oneyness of an option should not be confused with the profit and loss arising from holding an option contract. It should be noted that while moneyness of an option does not depend on the premium paid, profit6loss do. Thus a

holder of an in-the-money option need not always make profit as the profitability also depends on the premium paid.

"#

9ut-of-the-mone% o,tion (n out-of-the-money option is an opposite of an in-the-money option. (n option-holder will not exercise the option when it is out-of-the-money. ( 0all option is out-of-the-money when its strike price is greater than the spot price of the underlying and a )ut option is out-of-themoney when the spot price of the underlying is greater than the option;s strike price. At-the-mone% o,tion (n at-the-money-option is one in which the spot price of the underlying is e.ual to the strike price. It is at the stage where with any movement in the spot price of the underlying, the option will either become in-the-money or out-of-the-money.

-artici,ants in the 'erivatives *arket (s e.uity markets developed, different categories of investors started participating in the market. In India, e.uity market participants currently include retail investors, corporate investors, mutual funds, banks, foreign institutional investors etc. 3ach of these investor categories uses the derivatives market to as a part of risk management, investment strategy or speculation.

*ased on the applications that derivatives are put to, these investors can be broadly classified into three groups4

S Jedgers

S ,peculators, and S (rbitrageurs Ce shall now look at each of these categories in detail. 1edgers These investors have a position 8i.e., have bought stocks9 in the underlying market but are worried about a potential loss arising out of a change in the asset price in the future. Jedgers participate in the derivatives market to lock the prices at which they will be able to transact in the future. Thus, they try to avoid price risk through holding a position in the derivatives market. 2ifferent hedgers take different positions in the derivatives market based on their exposure in the underlying market. ( hedger normally takes an opposite position in the derivatives market to what he has in the underlying market. S,ecu)ators ( ,peculator is one who bets on the derivatives market based on his views on the potential movement of the underlying stock price. ,peculators take large, calculated risks as they trade based on anticipated future price movements. They hope to make .uick, large gainsG but may not always be successful. They normally have shorter holding time for their positions as compared to hedgers. If the price of the underlying moves as per their expectation they can make large profits. Jowever, if the price moves in the opposite direction of their assessment, the losses can also be enormous. Arbitrageurs (rbitrageurs attempt to profit from pricing inefficiencies in the market by making simultaneous trades that offset each other and capture a risk-free profit. (n arbitrageur may also seek to make profit in case there is price discrepancy between the stock price in the cash and the derivatives markets.

'erivatives 4rading on 6S#

The FPD segment on :,3 provides trading facilities for the following derivative instruments4

S Index futures, S Index options, S Individual stock futures, and S Individual stock options. (s an investor one can invest in any of these products. (ll these products have different contract specifications. 0learing banks ,ome commercial banks have been designated by the :,001 as 0learing *anks. Financial settlement can take place only through 0learing *anks. (ll the clearing members are re.uired to open a separate bank account with an :,001 designated clearing bank for the FPD segment. The clearing members keep a margin amount in these bank accounts.

Sett)ement of .utures Chen two parties trade a futures contract, both have to deposit margin money which is called the initial margin. Futures contracts have two types of settlement4 8i9 the mark-to-market 8>T>9 settlement which happens on a continuous basis at the end of each day, and 8ii9 the final settlement which happens on the last trading day of the futures contract i.e., the last Thursday of the expiry month.

*ark to market sett)ement To cover for the risk of default by the counterparty for the clearing corporation, the futures contracts are marked-to-market on a daily basis by the exchange. >ark to market settlement is the process of adEusting the margin balance in a futures account each day for the change in the value of the contract from the previous day, based on the daily settlement price of the futures

contracts 8)lease refer to the Tables given below.9. This process helps the clearing corporation in managing the counterparty risk of the future contracts by re.uiring the party incurring a loss due to adverse price movements to part with the loss amount on a daily basis. ,imply put, the party in the loss position pays the clearing corporation the margin money to cover for the shortfall in cash. In extraordinary times, the 3xchange can re.uire a mark to market more fre.uently 8than daily9.

To ensure a fair mark-to-market process, the clearing corporation computes and declares the official price for determining daily gains and losses. This price is called the Ksettlement priceL and represents the closing price of the futures contract. The closing price for any contract of any given day is the weighted average trading price of the contract in the last half hour of trading. .ina) sett)ement for futures (fter the close of trading hours on the expiry day of the futures contracts, :,001 marks all positions of clearing members to the final settlement price and the resulting profit6loss is settled in cash. Final settlement loss is debited and final settlement profit is credited to the relevant clearing bank accounts on the day following the expiry date of the contract. ,uppose the above contract closes on day # 8that is, it expires9 at a price of !s. " / , then on the day of expiry, !s. " would be debited from the seller 8short position holder9 and would be

transferred to the buyer 8long position holder9.

Sett)ement of 9,tions In an options trade, the buyer of the option pays the option price or the option premium. The options seller has to deposit an initial margin with the clearing member as he is exposed to unlimited losses.

There are basically two types of settlement in stock option contracts4 daily premium settlement and final exercise settlement. Dptions being 3uropean style, they cannot be exercised before expiry. 'ai)% ,remium sett)ement *uyer of an option is obligated to pay the premium towards the options purchased by him. ,imilarly, the seller of an option is entitled to receive the premium for the options sold by him. The same person may sell some contracts and buy some contracts as well. The premium payable and the premium receivable are netted to compute the net premium payable or receivable for each client for each options contract at the time of settlement. #5ercise sett)ement :ormally most option buyers and sellers close out their option positions by an offsetting closing transaction but a better understanding of the exercise settlement process can help in making better Eudgment in this regard. ,tock and index options can be exercised only at the end of the contract.

.ina) #5ercise Sett)ement

Dn the day of expiry, all in the money options are exercised by default. (n investor who has a long position in an in-the-money option on the expiry date will receive the exercise settlement value which is the difference between the settlement price and the strike price. ,imilarly, an investor who has a short position in an in-the-money option will have to pay the exercise settlement value.

The final exercise settlement value for each of the in the money options is calculated as follows4

0all Dptions Q 0losing price of the security on the day of expiry F strike price 8if closing price M

strike price, else 9

)ut Dptions Q ,trike price F closing price of the security on the day of expiry 8if closing price W strike price, else 9