Securities markets — the ground floor

What the securities market is for

A household has savings. A business needs capital. The securities market connects the two in a regulated, institutional way.

The workbook describes the basic arrangement in four moves. The business:

1. Issues securities and raises money from the household through a regulated contract.
2. Lists the securities on a stock exchange so they are liquid — they can be sold when needed.
3. Provides information about its activities and financial performance.
4. And so capital flows from households to business.

Without this market, a household willing to take some risk for higher returns might have to keep all its savings in a bank deposit. With it, the household can choose among equity and fixed income securities of different risk and return. The issuer's objectives and the investor's objectives are complementary — the market satisfies both.

What counts as a "security"

The legal definition sits in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA). It includes:

• Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of an incorporated company, pooled investment vehicle or body corporate
• Derivatives
• Units issued by any collective investment scheme
• Security receipts under the SARFAESI Act, 2002
• Units of a mutual fund scheme
• Units issued by a pooled investment vehicle
• Certificates issued by a special purpose entity holding debt or receivables, including mortgage debt, acknowledging the investor's beneficial interest
• Government securities
• Instruments declared by the Central Government — including onshore rupee bonds of multilateral institutions like the Asian Development Bank and the International Finance Corporation, electronic gold receipts, and zero coupon zero principal instruments
• Rights or interest in securities

One important exclusion: unit linked insurance policies — instruments that combine life cover with investment, issued by an insurer — are not securities.

The SCRA definition of derivatives was amended by the Finance Act 2017. It covers securities derived from a debt instrument, share or loan; contracts that derive value from the prices or index of prices of underlying securities; commodity derivatives; and other instruments the Central Government declares.

What a security really is

A security represents the terms of exchange of money between two parties. Companies, financial institutions and the government issue them; investors buy them.

The issuer sets the terms on which capital is raised. The investor gets claims to rights — which may involve ownership, participation in management, or claims on assets.

Primary and secondary: two halves of one market

The workbook calls them two interdependent and inseparable segments.

That last row is the key idea. An active secondary market promotes the growth of the primary market, because investors know they can liquidate later.

Ways securities are issued in the primary market

The bonus issue rules

• A 1:3 bonus means 1 bonus share for every 3 held.
• Made out of free reserves built from genuine profits.
• Not allowed if the company has defaulted on interest or principal on debt securities or fixed deposits.
• Needs board approval; in some cases shareholder approval too.
• Once announced, it cannot be withdrawn.
• Everyone holding shares on the record date gets the bonus.

The OFS idea

In an OFS, existing shareholders — promoters or large investors — sell shares already allotted to them. Share capital does not increase. The money goes to the offerors, not the company. The Government of India's disinvestment of PSU shares is an example. The workbook's neat summary: an OFS is a secondary market transaction done through the primary market route.

An FPO through an OFS usually happens when a company needs to increase public shareholding to meet regulatory requirements.

The secondary market: two ways to trade

Over-the-counter (OTC) — trades negotiated directly between counterparties, and settled directly between them.

Exchange traded — trading and settlement through the stock exchange. Trades are settled through a clearing corporation, which acts as counterparty and guarantees settlement to both buyers and sellers.

Trading, clearing, settlement

• Trading is a formal contract to buy or sell. Indian exchanges use an electronic order matching system — automatic, speedy, efficient.
• Clearing means working out the net obligations of buyers and sellers for a period.
• Settlement is discharging those obligations — paying money for a buy, delivering securities for a sell.

The exchange passes all trade details to the clearing corporation. The clearing corporation sends an obligation report to trading members and custodians, who must settle within the deadline or pay penalties.

Novation. The clearing corporation becomes buyer to every seller and seller to every buyer. So your counterparty is effectively the clearing corporation, not a stranger — and operational risk is substantially reduced for the investor.

Margins. Guaranteeing every trade exposes the clearing corporation to defaults. It protects itself with margins. The two most prominent:

• Initial (upfront) margin — a percentage of trade value based on Value at Risk.
• Mark-to-market (MTM) margin — the notional loss an open trade has suffered from price movements over a period.

Market infrastructure and intermediaries

A few details the exam likes:

• DPs are appointed by the depository with SEBI approval. Eligible: public financial institutions, scheduled commercial banks, foreign banks operating with RBI approval, state financial corporations, custodians, stock brokers, NBFCs, and RTAs.
• Brokers trading with their own funds do proprietary trades. SEBI requires a base minimum capital deposit and limits gross exposure to a multiple of base capital. Brokers earn brokerage.
• Sub-brokers had to migrate to act as an AP and/or Trading Member under a SEBI circular dated August 3, 2018.

Institutional participants

• Banks — invest in equity and fixed income through treasury operations and subsidiaries, under RBI exposure limits.
• Mutual funds — professionally managed collective schemes.
• Pension funds — pool employer and employee retirement contributions for stable long-term growth.
• Insurance companies — large corpus; among the most important investors in the Indian economy.
• AIFs — privately pooled: Venture Capital, Angel, Private Equity, Debt, Infrastructure, SME, Hedge and Social Venture funds.
• FPIs — entities established outside India; must register with SEBI.
• EPFO — statutory body under the Employees' Provident Funds & Miscellaneous Provisions Act, 1952, under the Ministry of Labour and Employment. It does not invest directly in individual stocks; it invests in debt securities and ETFs.
• NPS — a defined contribution pension scheme regulated by PFRDA, introduced by the Central Government from January 1, 2004. Non-government categories: corporate sector and All Citizens of India.
• Family offices — serve ultra-high net worth households, usually across multiple generations.
• Corporate treasuries — increasingly seen as profit centres; traditionally managers of financial risk and liquidity.

Retail participants

Individuals buying and selling for their own account. Under SEBI ICDR Regulations, 2018, a retail individual investor bids for not more than ₹2 lakh in an IPO or FPO.