Introduction to Securities Market

1Securities and the securities market

Securities are transferable financial claims: evidence of a debt owed by the issuer, or of ownership in a company. Issuers (companies, financial institutions, government) raise money at a cost; investors turn savings into financial assets that earn a return. A secondary market lets investors sell to others without affecting the issuer, so a long-term security becomes, in effect, a short-term one for the investor. The market creates liquidity and channels savings into investment.

The financial market has investors (providers of funds), borrowers (seekers of funds), intermediaries and regulators.

Under Section 2(h) of the SCRA, 1956, securities include: shares, bonds, debentures and similar marketable securities of a company or pooled investment vehicle; derivatives; units of collective investment schemes and mutual funds (but not ULIPs); units of pooled investment vehicles; security receipts; securitised debt certificates; government securities; instruments the Central Government declares to be securities; and rights or interests in securities. Electronic Gold Receipts were declared securities in December 2021.

Remember

• Securities definition: SCRA Section 2(h). ULIPs are excluded.

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2Equity, debt and international bonds

Equity shares represent fractional ownership; shareholders bear the risks and enjoy the rewards. Issued by companies; regulated by SEBI, MCA and NCLT.

Debentures, bonds and notes raise debt, secured or unsecured, in rupees or foreign currency. Usage varies by country: "bonds" is the umbrella term in the US, "debentures" in the UK; bonds often mean long-dated government debt (gilts in the UK), and notes shorter maturities. Types: fully convertible, partly convertible (PCDs) and non-convertible (NCDs), which are pure debt redeemed on maturity. Short-term debt (up to one year) includes T-bills (government), commercial paper (highly rated companies) and certificates of deposit (banks).

Domestic bonds are issued at home in the home currency. External bonds are issued abroad in a currency other than the issuer's own:

• Foreign bond: issued in a foreign country in that country's currency (an Indian company issuing dollar bonds in the US). Emerging-market issuers like the lower interest rates, but carry currency risk: if the foreign currency appreciates, repayment costs more in rupees.
• Euro bond: issued in a currency different from that of the country where it is issued (dollar bonds issued in Kuwait). It need not involve Europe or the euro.
• Masala bonds: euro bonds denominated in rupees, first issued by the IFC in November 2014 and listed in London. They shift currency risk to the foreign investor.

Remember

• Foreign bond: foreign country's currency. Euro bond: a third currency. Masala bond: rupee-denominated abroad.

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3Warrants, indices, mutual fund units and ETFs

Warrants give the right, not the obligation, to buy the issuer's shares after a set period at a fixed price.

Indices track the market using a representative sample of shares, usually weighted by market capitalisation, and made of liquid stocks so they can be replicated cheaply. Main Indian indices: Nifty 50 (50 NSE stocks), Sensex (30 BSE stocks) and SX40 (40 MSE stocks), plus broader, market-cap and sector indices. Constituents are reviewed periodically. Uses: comparing asset classes, benchmarking active funds, a barometer of the economy or a sector, a real-time indicator of sentiment, and an underlying for index funds and derivatives.

Mutual fund units represent a share of a pooled portfolio, valued at NAV. Open-ended schemes buy and sell units at NAV-linked prices any time and have no fixed maturity; closed-ended schemes have fixed unit capital and are listed for trading.

ETFs track an index, a commodity such as gold, or a basket. Units are listed and traded at real-time prices. Authorised participants (large brokers and banks) deliver the basket to the sponsor and receive ETF units, which then trade like shares. ETFs combine features of open-ended funds (units can be created) and closed-ended funds (traded on exchange), and have lower expense ratios because they are passive.

Remember

• ETFs: created like open-ended funds, traded like closed-ended funds.

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4Hybrids and structured products

• Preference shares: preference over equity for dividends and repayment on winding up. Like equity: holders are shareholders, dividends come from profit after tax and are not obligatory. Like debt: a fixed dividend rate. They usually carry no voting rights. Cumulative (unpaid dividend carried forward) or non-cumulative (it lapses); may be convertible.
• Convertible debentures: pay interest, then convert into shares. FCD (fully), PCD (part converts, the rest is redeemed) and OCD (holder's option). Terms fixed at issue: conversion date, ratio, price (usually at a discount to market) and proportion converted. The issuer pays a lower coupon and may not have to repay, but existing shareholders are diluted.
• Depository receipts (DRs): represent a foreign company's shares, traded in another country's market and currency. Shares are delivered to a depository (usually a foreign bank), held by its custodian in the home country, and receipts are issued abroad. Sponsored DRs (initiated by the company) can be listed; unsponsored DRs (initiated by investors) trade only OTC. Two-way fungibility allows conversion both ways where rules permit. Types: ADRs (US; for example Infosys, Wipro, ICICI Bank, HDFC Bank), IDRs (a foreign company in India, such as Standard Chartered; one-year lock-in on conversion, for resident Indians only), HKDRs, and GDRs (tradable in more than one country, often in the EU). DR holders get dividends and capital gains but no voting rights.
• FCCBs: foreign-currency convertible bonds issued abroad, usually optionally convertible, under RBI/FEMA rules. Interest and principal are paid in foreign currency; after conversion, dividends are paid in rupees and the currency risk passes to the investor.
• Equity-linked debentures (ELDs): returns linked to an index or shares. Part of the money buys bonds for capital protection and the rest buys options for equity upside. "Capital protected" does not remove credit risk, so ELDs are rated.
• Commodity-linked debentures (CLDs): the same idea, usually linked to gold and silver.
• MBS and ABS: debt backed by home loans (MBS) or auto loans, rents, credit card receivables and so on (ABS). They turn illiquid assets into tradable securities through securitisation.
• REITs and InvITs: trusts that pool money for income-producing real estate or infrastructure. REITs must hold at least 80% in real estate assets; InvITs invest at least 90% in revenue-generating infrastructure. Both must distribute at least 90% of distributable cash flow.

Remember

• Preference shares: preference in dividend and capital, usually no vote.
• REIT 80%, InvIT 90%; distribute 90%.

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5Commodities

Commodities are basic, interchangeable goods: a gold bar is a commodity, gold jewellery is not. Hard commodities are mined or extracted (metals, crude oil); soft commodities are grown (grains, pulses). Commodity prices move with inflation, but storage costs make most of them poor direct investments. Ways to invest:

• Precious metals: long-lasting and cheap to store relative to value.
• Commodity ETFs (most often gold ETFs): the fund handles storage.
• Managed futures: professionally managed portfolios of futures contracts.
• Warehouse receipts: proof of ownership of stored goods, usually negotiable, so title passes by transferring the receipt.

Remember

• Hard = mined; soft = grown.

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6The primary market

The securities market has two linked parts: the primary (new issue) market, where securities are created, and the secondary market, where they trade.

• Public issue: open to anyone eligible.
• IPO: a company's first sale of shares to the public. SEBI sets eligibility (net tangible assets, profits, net worth), timelines, compulsory listing and demat. Allocation: at least 35% to retail (bids up to ₹2 lakh) and at most 50% to QIBs; others get the rest.
• Anchor investors (since 2009): QIBs bidding ₹10 crore or more in a book-built issue; up to 60% of the QIB portion; bidding opens one day before the issue. Their demand signals issue quality.
• FPO: a further public offer by a listed company, as a fresh issue or an offer for sale (often to raise public shareholding).
• Private placement: to a select group, at most 50 investors under the Companies Act, 2013; includes QIPs (listed companies placing shares with QIBs such as banks, mutual funds and financial institutions) and preferential issues (to select persons, with SEBI rules on pricing, disclosure and lock-in).
• Rights issue: existing holders may buy more at a set price; they can exercise, transfer (renounce) or let lapse their rights. Bonus issue: free shares in a set ratio, paid for by moving retained earnings to share capital.
• Onshore vs offshore offerings: raising money at home vs abroad.
• Offer for sale (OFS): existing shareholders sell; no new capital for the company, and proceeds go to the sellers (for example government disinvestment). It is a secondary transaction done through the primary route.
• Sweat equity (Section 54, Companies Act 2013): shares given to employees, promoters or others for their contribution, reducing agency problems.
• ESOPs: options for employees to buy shares at a set price after a vesting period (usually over a year); valuable only if the share price rises above the exercise price.

Remember

• Retail at least 35%; QIBs at most 50%; anchors up to 60% of QIB portion.
• OFS raises no money for the company.

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7The secondary market

The secondary market gives liquidity: investors deal with each other, not with the issuer. An active secondary market supports the primary market.

• OTC market: trades negotiated and settled directly between counterparties, who manage credit risk themselves.
• Exchange-traded market: electronic order matching, with settlement through a clearing corporation that provides novation (buyer to every seller, seller to every buyer) and guarantees settlement.

Clearing works out net obligations; settlement delivers shares and money. To manage default risk, the clearing corporation collects margins: initial (VaR-based), peak and mark-to-market margins.

Remember

• Clearing = work out obligations; settlement = deliver and pay.

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8Market intermediaries

• Stock exchanges: nationwide platforms such as NSE, BSE and MSEI with anonymous electronic matching; they appoint clearing agencies and banks.
• Depositories: hold securities electronically; India has NSDL and CDSL.
• Depository participants (DPs): agents of a depository that serve investors (banks, brokers, custodians, NBFCs, RTAs and others approved by SEBI). The DP keeps investor accounts; the depository keeps company-level accounts.
• Trading members (stock brokers): all exchange trades go through them; can be individuals, firms or companies.
• Authorised persons: agents appointed by brokers with exchange approval, segment by segment. Sub-brokers ceased to exist from 1 April 2019.
• Custodians: hold securities and funds of institutions, settle trades and track corporate actions.
• Clearing corporations: legal counterparty to all exchange trades; guarantee settlement.
• Clearing banks: hold clearing members' accounts for pay-in and pay-out.
• Merchant bankers: SEBI-registered issue managers; assess capital needs, structure and price the issue, and coordinate other intermediaries until listing.
• Underwriters: agree to take up any unsubscribed part of an issue. Hard underwriting is committed at the start; soft underwriting after pricing, often with exit clauses.
• Farmer producer organisations (FPOs): registered collectives of farmers that improve bargaining power, market access, credit and technology, and reduce dependence on middlemen.

Remember

• Hard underwriting: early commitment. Soft: after pricing.

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9Investors: institutional, retail, corporates and proxy advisers

Institutional investors:

• FPIs: foreign entities investing in India, registered with SEBI.
• P-Notes: issued by registered FPIs to overseas investors who want Indian exposure without registering with SEBI.
• Mutual funds: professionally managed, diversified pools.
• Insurance companies: large investors in equity, G-secs and bonds.
• Pension funds: long-term pools for retirement income; among the largest investors.
• Venture capital funds: invest in early-stage firms and bring expertise as well as money.
• Private equity: funds growth, expansion or buyouts; investors are limited partners, managed by the general partner.
• Hedge funds: wide mandates across assets and markets; the name is a misnomer since they need not hedge.
• AIFs (SEBI AIF Regulations 2012, Regulation 2(1)(b)): privately pooled funds not covered by other SEBI fund rules or other regulators. Category I: start-ups, SMEs, social ventures, infrastructure, angel and VC funds. Category II: neither I nor III, no leverage beyond operational needs (PE, real estate, distressed assets). Category III: complex strategies with leverage and derivatives (hedge funds, PIPE funds).
• Investment advisers: help with asset allocation and financial plans.
• Warehouse service providers: storage and related services, often registered with WDRA, issuing negotiable warehouse receipts.
• Quality assayers: test and certify commodity quality; needed for NWRs.
• EPF: employer and employee each contribute 12% of basic salary; run by EPFO, paying a rate set yearly; members have no say in investments.
• NPS: government-sponsored retirement scheme; the corpus buys an annuity at maturity, with partial withdrawal allowed; subscribers choose funds.
• Family offices: manage a wealthy family's finances (single or multi-family).
• Corporate treasuries: invest surplus company funds.

Retail investors trade for themselves; HNIs and UHNIs invest large sums. RBI allows NRIs, PIOs and QFIs to invest directly under the automatic route.

Corporates (processors, manufacturers, importers, exporters) are exposed to commodity prices.

Proxy advisers advise investors, mainly institutions, on how to vote on company resolutions.

Remember

• AIF Cat I: socially desirable sectors. Cat II: no leverage. Cat III: leverage and derivatives.
• P-Notes: exposure without SEBI registration.

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10Kinds of transactions

• Cash trade: settled the same day (T+0).
• Tom trade: settled the next day (T+1).
• Spot trade: settled on the spot date, normally T+2. (Indian equities have moved to T+1.)
• Forward: an OTC, customised agreement to buy or sell later at a price fixed today; both sides are bound, and there is counterparty risk (a farmer selling wheat to a miller in six months).
• Futures: standardised exchange-traded forwards (lot, quality, delivery terms), with clearing corporation guarantee and margins; available on equities, indices, commodities, currencies and interest rates.
• Options: the right but not obligation to buy (call) or sell (put) at the strike price, for a premium; the writer takes the obligation. Traded OTC and on exchanges.

Example A buys a Nifty call at a strike of 11,000 from B for ₹100. At 11,200 on expiry, A exercises and gains 200 − 100 = ₹100; B loses ₹100 net. At 10,800 the option expires worthless and B keeps the ₹100.

• Swaps: exchange of future cash flows by formula, used for interest rate, currency and commodity risk. In an interest rate swap only interest on the notional is exchanged. A floating-rate borrower who pays fixed and receives T-bill plus spread turns the loan into a fixed-rate obligation.

Remember

• Cash T+0, Tom T+1, Spot T+2.

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11Trading, speculation, hedging, arbitrage and pledging

• Trading: short-term (hours to weeks), usually based on technical patterns.
• Speculation: buying or selling to profit from price changes, based on information or a view on fundamentals. Both add liquidity, and both often use leverage. Traders are said to have a higher probability of gains than speculators.
• Hedging: taking a position to offset losses on an existing holding; the aim is to avoid loss, not make profit, so a perfect hedge gives no gain and no loss.
• Arbitrage: simultaneous buying and selling to profit from price differences between markets (buy spot, sell futures). In efficient markets such gaps close quickly.
• Pledging: borrowing against securities. The pledgor (borrower) keeps the shares in their demat account, blocked; the pledgee (lender) can sell them on default after notice.

Remember

• Hedgers avoid losses; speculators seek gains; arbitrageurs exploit price gaps.

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12Dematerialisation and rematerialisation

Dematerialisation converts physical certificates into electronic book entries; demat shares have no distinctive numbers or folio. A company making a public issue must sign agreements with all depositories so investors can hold shares in demat form. Rematerialisation is the reverse: converting electronic holdings back into physical certificates with distinctive numbers, on the investor's request.

Remember

• Demat: physical → electronic. Remat: electronic → physical.