Capital Markets

Juhi Sapra Februrary, 2011

Capital Markets
Equity Market Derivatives Market

Debt Market

Forex Market

Capital Market
A market in which individuals and institutions trade financial securities. Organizations/institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. Thus, this type of market is composed of both the primary and secondary markets.

Primary Markets

A market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities. Primary markets are facilitated by underwriting groups, which consist of investment banks that will set a beginning price range for a given security and then oversee its sale directly to investors.

Secondary Markets

A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such NSE and BSE are secondary markets. A newly issued IPO will be considered a primary market trade when the shares are first purchased by investors directly from the underwriting investment bank; After that any shares traded will be on the secondary market, between investors themselves.

In the primary market prices are often set beforehand, whereas in the
secondary market only basic forces like supply and demand determine the price of the security..

Capital Market Constituents

Trading Mechanism

Settlement cycle

Market Indexes

Market Regulation

The BSE & NSE

Most of the trading in the Indian stock market takes place on its two stock exchanges:
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The Bombay Stock Exchange (BSE) The National Stock Exchange (NSE).

The BSE has been in existence since 1875. The NSE, was founded in 1992 and started trading in 1994. Almost all the significant firms of India are listed on both the exchanges. Both exchanges compete for the order flow that leads to reduced costs, market efficiency and innovation. The presence of arbitrageurs keeps the prices on the two stock exchanges within a very tight range.

Trading Mechanism

Trading at both the exchanges takes place through an open electronic limit order
book in which order matching is done by the trading computer. There are no market makers and the entire process is order-driven, This means that market orders placed by investors are automatically matched with the best limit orders. As a result, buyers and sellers remain anonymous. The advantage of an order driven market is that it brings more transparency by displaying all buy and sell orders in the trading system. There is no guarantee that orders will be executed. All orders in the trading system need to be placed through brokers, many of which provide online trading facility to retail customers Institutional investors can also take advantage of the direct market access (DMA) option; they use trading terminals provided by brokers for placing

orders directly into the stock market trading system

Settlement Cycle and Trading Hours

Equity spot markets follow T+2 rolling settlement. This means that any trade taking place on Monday gets settled by Wednesday. Delivery of shares must be made in dematerialized form. Each exchange has its own clearing house, which assumes all settlement risk by serving as a central counterparty. All trading on stock exchanges takes place between 9:00 am and 4:00pm Indian Standard Time from Monday through Friday.

Market Regulation

The overall responsibility of development, regulation and supervision of the stock market rests with the Securities & Exchange Board of India (SEBI)

SEBI was formed in 1992 as an independent authority. Since then, SEBI has consistently tried to lay down market rules in line with the best market practices. It enjoys vast powers of imposing penalties on market participants in case of a breach.

Over The Counter

A security traded in some context other than on a formal exchange. The phrase "over-the-counter" can be used to refer to stocks, debt securities and other financial instrument that trade via a dealer network as opposed to on a centralized exchange. In general, the reason for which a stock is traded over-the-counter is usually because

the company is small, making it unable to meet exchange listing requirements.

Also known as "unlisted stock", these securities are traded by broker-dealers who negotiate directly with one another over computer networks and by phone. Instruments such as bonds do not trade on a formal exchange and are, therefore,

also considered OTC securities.

Most debt instruments are traded by investment banks making markets for specific issues. If an investor wants to buy or sell a bond, he or she must call the bank that makes the market in that bond and asks for quotes

Risk Tolerance

Investment options

Life Insurance Post Office Schemes Equity Shares Mutual Funds Company Deposits Bank Deposits Real Estate Gold and Silver

Equity Market
The market in which shares are issued and traded, either through exchanges or overthe-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance.

Equity Shares

Capital Appreciation Bonus Shares Annual Dividend Right Shares Can be pledged as a security Easy liquidity

Indian Stock Market

The National Stock Exchange is India's largest financial market. Established in 1992, the NSE has developed into a sophisticated, electronic market, which ranks third in the world for transacted volume. The NSE conducts transactions in the wholesale debt, equity and

derivative markets.
Bombay Stock Exchange (BSE) is the first and largest securities market in India and was established in 1875 as the Native Share and Stock Brokers' Association. Based in Mumbai, India, the BSE lists over 6,000 companies and is one of the largest exchanges in the world.

SENSEX

An abbreviation of the Bombay Exchange Sensitive Index (Sensex) - the benchmark index of the Bombay Stock Exchange (BSE). It is composed of 30 of the largest and most actively-traded stocks on the BSE. The index is calculated based on a free-float capitalization method when weighting the effect of a company on the index. This is a variation of the market cap method, but instead of using a company's outstanding shares it uses its float, or shares that are readily

available for trading.

The free-float method, therefore, does not include restricted stocks, such as those held by company insiders that can't be readily sold.

Calculation of Sensex

To find the free-float capitalization of a company, first find its market cap (number of outstanding shares x share price) then multiply its free-float factor. The free-float factor is determined by the percentage of floated shares to outstanding. For example, if a company has a float of 10 million shares and outstanding shares of 12 million, the percent of float to outstanding is 83%. A company with an 83% free float falls in the 80-85% free-float factor, or 0.85, Multiplied by its market cap e.g: $120 million (12 million shares x .$10/share) x 0.85 = $102 million free-float capitalization.

NIFTY

A stock index endorsed by Standard & Poor's and composed of 50 of the largest and most liquid stocks found on the (NSE) of India. The S&P CNX Nifty is computed using a float-adjusted, market capitalization weighted methodology, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period.

The methodology also takes into account constituent changes in the index and corporate actions such as stock splits, rights issuance, etc., without affecting the index value.

Bond Market
The environment in which the issuance and trading of debt securities occurs. The bond market primarily includes government-issued securities and corporate debt securities, and facilitates the transfer of capital from savers to the issuers or organizations requiring capital for government projects, business expansions and ongoing operations.

Bond market
A Market where fixed income securities of various types and features are traded. Participants:

Central and state government Corporates Banks Mutual funds FIIs

Types of Instruments Traded in Debt Market

Market segment
Government Securities

Issuer
Central State

Instruments
Zero coupon bonds, Coupon bearing bonds, floating rate bonds, STRIPS Coupon bearing bonds, floating rate bonds Government guaranteed bonds, debentures

Public sector bonds

Government agencies/statutory bodies

PSU
Private Sector bonds Corporates

PSU bonds taxable/taxfree, debentures, commercial paper

Debentures, Commercial paper, secured premium notes, Zero coupon bonds, Coupon bearing bonds, floating rate bonds

Banks
Financial institutions

Certificate of deposit, debentures, bonds

Certificate of deposit, bonds

Risk associated with debt securities and trading in debt securities

Default /Credit Risk

Price Risk

Interest Rate Risk

Risks

Counterparty Risk

Reinvestment Risk

Debt Market Instruments

Floating rate Bonds: bonds wherein the interest rate is not fixed and is linked to a benchmark rate Zero Interest bonds: carry no periodic interest payments and are sold at a huge discount to face value

Government bonds: In general, fixed-income securities are classified

according to the length of time before maturity. These are the three main categories: Bills - debt securities maturing in less than one year. Notes - debt securities maturing in one to 10 years. Bonds - debt securities maturing in more than 10 years.

STRIPS: Separate Trading of Registered Interest and Principal Securities

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Treasury STRIPS are fixed-income securities sold at a significant discount to face value and offer no interest payments because they mature at par.

Certificate of deposit:
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A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial bank The term of a CD generally ranges from one month to five years.

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Debentures:
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A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital

Commercial paper:
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An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term

liabilities.
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Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates.

Derivative
A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include: stocks, bonds, commodities, currencies, interest rates and market indexes.

What do derivatives do?

Derivatives attempt either to minimize the loss arising from
adverse price movements of the underlying asset

Or maximize the profits arising out of favorable price fluctuation.

Types of Derivatives (UA: Underlying Asset)

Based on the underlying assets derivatives are classified into.

Financial Derivatives (UA: Fin asset) Commodity Derivatives (UA: gold etc) Index Derivative (BSE sensex)

What is Risk? What is a Hedge?

Risk: The concept of risk is simple. It is the potential for change in the price or value of some asset or commodity. The meaning of risk is not restricted just to the potential for loss. There is upside risk and there is downside risk as well

Hedge: To Be cautious or to protect against loss.

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In financial parlance, hedging is the act of reducing uncertainty about future price movements in a commodity, financial security or foreign

currency .
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Thus a hedge is a way of insuring an investment against risk.

Derivative Instruments

Forward Contract Futures Contract Options
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Put Call

Swaps
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Interest Rate

Currency

Futures

A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price.

Futures contracts detail the quality and quantity of the underlying asset; they are
standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.

Futures can be used either to hedge or to speculate on the price movement of the
underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price

movement of corn by going long or short using futures.

Forwards

A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date.

Forward contracts don't have standards and aren't traded on exchanges. A farmer would use a forward contract to "lock-in" a price for his grain for the upcoming fall harvest.

Options

A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon

price (the strike price) during a certain period of time or on a specific

date (exercise date).

Call options give the option to buy at certain price, so the buyer would want the stock to go up. Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

Swaps

The exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed.

Currency Swap: A swap that involves the exchange of principal and interest
in one currency for the same in another currency. Interest Rate Swap: An agreement between two parties where one stream of future interest payments is exchanged for another based on a specified principal amount. It is often an exchange a fixed payment for a floating payment that is linked to an interest rate (most often the LIBOR).

FOREX
The market in which currencies are traded. The forex market is the largest, most liquid market in the world with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world.

Features

There is no central marketplace for foreign exchange Currency trading is conducted electronically OTC, which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange

Open 24/7 Extremely active any time of the day, with price quotes changing constantly.

Spot Market and the Forwards and Futures Markets

Spot market is where currencies are bought and sold according to the current price That price, determined by supply and demand, is a reflection of:
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current interest rates, economic performance, sentiment towards ongoing political situations (local/ international), Perception of the future performance of one currency against another.

Forwards & Futures

Forwards and Futures markets do not trade actual currencies. They deal in contracts that represent:
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Claims to a certain currency type A specific price per unit and A future date for settlement.

Forward contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves. Futures contracts
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Have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.

Reading a Forex quote

When a currency is quoted, it is done in relation to another currency, so that the value of one is reflected through the value of another

The exchange rate between the U.S. dollar (USD) and Japanese yen (JPY) 1 USD=83.5 JPY
USD/JPY=83.5

The currency to the left of the slash is the base currency, while the currency on the right is called the quote currency

Direct Currency Quote vs. Indirect Currency Quote

Direct currency quote: A currency pair in which the domestic currency is the base currency; 1INR=0.0221USD
INR/USD=0.0221

Indirect currency quote: A currency pair where the domestic currency is the quoted currency. 1USD=45.998INR
USD/INR=45.998

Cross Currency

When a currency quote is given without the U.S. dollar as one of its components, this is called a cross currency. The most common cross currency pairs are the EUR/GBP, EUR/CHF and EUR/JPY.

Bid and Ask

When you are trading a currency pair there is a bid price (buy) and an ask price (sell). When buying a currency pair (long), the ask price refers to the amount of quoted currency that has to be paid in order to buy one unit of the base currency.

When selling a currency pair (short), the bid price refers to the amount the market will pay for the quoted currency in relation to the base currency.
USD/CAD = 1.2000/05 Bid = 1.2000 Ask= 1.2005

Currency Quote Overview

USD/CAD = 1.2232/37

Base Currency

Currency to the left (USD)

Quote Currency

Currency to the right (CAD)

Bid Price

1.2232

Price for which the market maker will buy the base currency. Bid is always smaller than ask.
Price for which the market maker will sell the base currency.

Ask Price

1.2237

Thank you!