4. SECONDARY MARKET

4. SECONDARY MARKET
4.1 Introduction
What is meant by Secondary market?
Secondary market refers to a market where securities are traded after being
initially offered to the public in the primary market and/or listed on the
Stock Exchange. Majority of the trading is done in the secondary market.
Secondary market comprises of equity markets and the debt markets.
What is the role of the Secondary Market?
For the general investor, the secondary market provides an efficient
platform for trading of his securities. For the management of the company,
Secondary equity markets serve as a monitoring and control conduit—by
facilitating value-enhancing control activities, enabling implementation of
incentive-based management contracts, and aggregating information (via
price discovery) that guides management decisions.
What is the difference between the Primary Market and the
Secondary Market?
In the primary market, securities are offered to public for subscription for
the purpose of raising capital or fund. Secondary market is an equity trading
venue in which already existing/pre-issued securities are traded among
investors. Secondary market could be either auction or dealer market. While
stock exchange is the part of an auction market, Over-the-Counter (OTC) is
a part of the dealer market.
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4.1.1Stock Exchange
What is the role of a Stock Exchange in buying and selling
shares?
The stock exchanges in India, under the overall supervision of the regulatory
authority, the Securities and Exchange Board of India (SEBI), provide a
trading platform, where buyers and sellers can meet to transact in
securities. The trading platform provided by NSE is an electronic one and
there is no need for buyers and sellers to meet at a physical location to
trade. They can trade through the computerized trading screens available
with the NSE trading members or the internet based trading facility provided
by the trading members of NSE.
What is Demutualisation of stock exchanges?
Demutualisation refers to the legal structure of an exchange whereby the
ownership, the management and the trading rights at the exchange are
segregated from one another.
How is a demutualised exchange different from a mutual
exchange?
In a mutual exchange, the three functions of ownership, management and
trading are concentrated into a single Group. Here, the broker members of
the exchange are both the owners and the traders on the exchange and
they further manage the exchange as well. This at times can lead to conflicts
of interest in decision making. A demutualised exchange, on the other hand,
has all these three functions clearly segregated, i.e. the ownership,
management and trading are in separate hands.
Currently are there any demutualised stock exchanges in
India?
Currently, two stock exchanges in India, the National Stock Exchange (NSE)
and Over the Counter Exchange of India (OTCEI) are demutualised.
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4.1.2 Stock Trading
What is Screen Based Trading?
The trading on stock exchanges in India used to take place through open
outcry without use of information technology for immediate matching or
recording of trades. This was time consuming and inefficient. This imposed
limits on trading volumes and effic iency. In order to provide efficiency,
liquidity and transparency, NSE introduced a nationwide, on-line, fullyautomated
screen based trading system (SBTS) where a member can punch
into the computer the quantities of a security and the price at which he
would like to transact, and the transaction is executed as soon as a
matching sale or buy order from a counter party is found.
What is NEAT?
NSE is the first exchange in the world to use satellite communication
technology for trading. Its trading system, called National Exchange for
Automated Trading (NEAT), is a state of-the-art client server based
application. At the server end all trading information is stored in an inmemory
database to achieve minimum response time and maximum system
availability for users. It has uptime record of 99.7%. For all trades entered
into NEAT system, there is uniform response time of less than one second.
How to place orders with the broker?
You may go to the broker’s office or place an order on the phone/internet or
as defined in the Model Agreement, which every client needs to enter into
with his or her broker.
How does an investor get access to internet based trading
facility?
There are many brokers of the NSE who provide internet based trading
facility to their clients. Internet based trading enables an investor to buy/sell
securities through internet which can be accessed from a computer at the
investor’s residence or anywhere else where the client can access the
internet. Investors need to get in touch with an NSE broker providing this
service to avail of internet based trading facility.
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What is a Contract Note?
Contract Note is a confirmation of trades done on a particular day on behalf
of the client by a trading member. It imposes a legally enforceable
relationship between the client and the trading member with respect to
purchase/sale and settlement of trades. It also helps to settle
disputes/claims between the investor and the trading member. It is a
prerequisite for filing a complaint or arbitration proceeding against the
trading member in case of a dispute. A valid contract note should be in the
prescribed form, contain the details of trades, stamped with requisite value
and duly signed by the authorized signatory. Contract notes are kept in
duplicate, the trading member and the client should keep one copy each.
After verifying the details contained therein, the client keeps one copy and
returns the second copy to the trading member duly acknowledged by him.
What details are required to be mentioned on the contract
note issued by the stock broker?
A broker has to issue a contract note to clients for all transactions in the
form specified by the stock exchange. The contract note inter-alia should
have following:
§ Name, address and SEBI Registration number of the Member broker.
§ Name of partner/proprietor/Authorised Signatory.
§ Dealing Office Address/Tel. No./Fax no., Code number of the member
given by the Exchange.
§ Contract number, date of issue of contract note, settlement number
and time period for settlement.
§ Constituent (Client) name/Code Number.
§ Order number and order time corresponding to the trades.
§ Trade number and Trade time.
§ Quantity and kind of Security bought/sold by the client.
§ Brokerage and Purchase/Sale rate.
§ Service tax rates, Securities Transaction Tax and any other charges
levied by the broker.
§ Appropriate stamps have to be affixed on the contract note or it is
mentioned that the consolidated stamp duty is paid.
§ Signature of the Stock broker/Authorized Signatory.
What is the maximum brokerage that a broker can charge?
The maximum brokerage that can be charged by a broker from his clients as
commission cannot be more than 2.5% of the value mentioned in the
respective purchase or sale note.
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Why should one trade on a recognized stock exchange only for
buying/selling shares?
An investor does not get any protection if he trades outside a stock
exchange. Trading at the exchange offers investors the best prices
prevailing at the time in the market, lack of any counter-party risk which is
assumed by the clearing corporation, access to investor grievance and
redressal mechanism of stock exchanges, protection upto a prescribed limit,
from the Investor Protection Fund etc.
How to know if the broker or sub broker is registered?
One can confirm it by verifying the registration certificate issued by SEBI. A
broker's registration number begins with the letters ‘INB’ and that of a sub
broker with the letters ‘INS’.
What precautions must one take before investing in the stock
markets?
Here are some useful pointers to bear in mind before you invest in the
markets:
§ Make sure your broker is registered with SEBI and the exchanges and
do not deal with unregistered intermediaries.
§ Ensure that you receive contract notes for all your transactions from
your broker within one working day of execution of the trades.
§ All investments carry risk of some kind. Investors should always
know the risk that they are taking and invest in a manner that
matches their risk tolerance.
§ Do not be misled by market rumours, luring advertisement or ‘hot
tips’ of the day.
§ Take informed decisions by studying the fundamentals of the
company. Find out the business the company is into, its future
prospects, quality of management, past track record etc Sources of
knowing about a company are through annual reports, economic
magazines, databases available with vendors or your financial
advisor.
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§ If your financial advisor or broker advises you to invest in a company
you have never heard of, be cautious. Spend some time checking out
about the company before investing.
§ Do not be attracted by announcements of fantastic results/news
reports, about a company. Do your own research before investing in
any stock.
§ Do not be attracted to stocks based on what an internet website
promotes, unless you have done adequate study of the company.
§ Investing in very low priced stocks or what are known as penny
stocks does not guarantee high returns.
§ Be cautious about stocks which show a sudden spurt in price or
trading activity.
§ Any advise or tip that claims that there are huge returns expected,
especially for acting quickly, may be risky and may to lead to losing
some, most, or all of your money.
What Do’s and Don’ts should an investor bear in mind when
investing in the stock markets?
§ Ensure that the intermediary (broker/sub-broker) has a valid SEBI
registration certificate.
§ Enter into an agreement with your broker/sub-broker setting out
terms and conditions clearly.
§ Ensure that you give all your details in the ‘Know Your Client’ form.
§ Ensure that you read carefully and understand the contents of the
‘Risk Disclosure Document’ and then acknowledge it.
§ Insist on a contract note issued by your broker only, for trades done
each day.
§ Ensure that you receive the contract note from your broker within 24
hours of the transaction.
§ Ensure that the contract note contains details such as the broker’s
name, trade time and number, transaction price, brokerage, service
tax, securities transaction tax etc. and is signed by the Authorised
Signatory of the broker.
§ To cross check genuineness of the transactions, log in to the NSE
website (www.nseindia.com) and go to the trade verification facility
extended by NSE at www.nseindia.com/content/equities/
eq_trdverify.htm.
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§ Issue account payee cheques/demand drafts in the name of your
broker only, as it appears on the contract note/SEBI registration
certificate of the broker.
§ While delivering shares to your broker to meet your obligations,
ensure that the delivery instructions are made only to the designated
account of your broker only.
§ Insist on periodical statement of accounts of funds and securities
from your broker. Cross check and reconcile your accounts promptly
and in case of any discrepancies bring it to the attention of your
broker immediately.
§ Please ensure that you receive payments/deliveries from your broker,
for the transactions entered by you, within one working day of the
payout date.
§ Ensure that you do not undertake deals on behalf of others or trade
on your own name and then issue cheques from a family members ’/
friends’ bank accounts.
§ Similarly, the Demat delivery instruction slip should be from your
own Demat account, not from any other family members’/friends’
accounts.
§ Do not sign blank delivery instruction slip(s) while meeting security
payin obligation.
§ No intermediary in the market can accept deposit assuring fixed
returns. Hence do not give your money as deposit against assurances
of returns.
§ ‘Portfolio Management Services’ could be offered only by
intermediaries having specific approval of SEBI for PMS. Hence, do
not part your funds to unauthorized persons for Portfolio
Management.
§ Delivery Instruction Slip is a very valuable document. Do not leave
signed blank delivery instruction slip with anyone. While meeting pay
in obligation make sure that correct ID of authorised intermediary is
filled in the Delivery Instruction Form.
§ Be cautious while taking funding form authorised intermediaries as
these transactions are not covered under Settlement Guarantee
mechanisms of the exchange.
§ Insist on execution of all orders under unique client code allotted to
you. Do not accept trades executed under some other client code to
your account.
§ When you are authorising someone through ‘Power of Attorney’ for
operation of your DP account, make sure that:
§ your authorization is in favour of registered
intermediary only.
§ authorisation is only for limited purpose of debits and
credits arising out of valid transactions executed
through that intermediary only.
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§ you verify DP statement periodically say every month/
fortnight to ensure that no unauthorised transactions
have taken place in your account.
§ authorization given by you has been properly used for
the purpose for which authorization has been given.
§ in case you find wrong entries please report in writing
to the authorized intermediary.
§ Don’t accept unsigned/duplicate contract note.
§ Don’t accept contract note signed by any unauthorised person.
§ Don’t delay payment/deliveries of securities to broker.
§ In the event of any discrepancies/disputes, please bring them to the
notice of the broker immediately in writing (acknowledged by the
broker) and ensure their prompt rectification.
§ In case of sub-broker disputes, inform the main broker in writing
about the dispute at the earliest and in any case not later than 6
months.
§ If your broker/sub-broker does not resolve your complaints within a
reasonable period (say within 15 days), please bring it to the
attention of the ‘Investor Grievances Cell’ of the NSE.
§ While lodging a complaint with the ‘Investor Grievances Cell’ of the
NSE, it is very important that you submit copies of all relevant
documents like contract notes, proof of payments/delivery of shares
etc. alongwith the complaint. Remember, in the absence of sufficient
documents, resolution of complaints becomes difficult.
§ Familiarise yourself with the rules, regulations and circulars issued by
stock exchanges/SEBI before carrying out any transaction.
4.2 Products in the Secondary Markets
What are the products dealt in the Secondary Markets?
Following are the main financial products/instruments dealt in the Secondary
market which may be divided broadly into Shares and Bonds:
Shares:
Equity Shares: An equity share, commonly referred to as ordinary
share, represents the form of fractional ownership in a business
venture.
Rights Issue/ Rights Shares: The issue of new securities to existing
shareholders at a ratio to those already held, at a price. For e.g. a
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2:3 rights issue at Rs. 125, would entitle a shareholder to receive 2
shares for every 3 shares held at a price of Rs. 125 per share.
Bonus Shares: Shares issued by the companies to their shareholders
free of cost based on the number of shares the shareholder owns.
Preference shares: Owners of these kind of shares are entitled to a
fixed dividend or dividend calculated at a fixed rate to be paid
regularly before dividend can be paid in respect of equity share. They
also enjoy priority over the equity shareholders in payment of
surplus. But in the event of liquidation, their claims rank below the
claims of the company’s creditors, bondholders/debenture holders.
Cumulative Preference Shares: A type of preference shares on which
dividend accumulates if remained unpaid. All arrears of preference
dividend have to be paid out before paying dividend on equity
shares.
Cumulative Convertible Preference Shares: A type of preference
shares where the dividend payable on the same accumulates, if not
paid. After a specified date, these shares will be converted into
equity capital of the company.
Bond: is a negotiable certificate evidencing indebtedness. It is normally
unsecured. A debt security is generally issued by a company, municipality or
government agency. A bond investor lends money to the issuer and in
exchange, the issuer promises to repay the loan amount on a specified
maturity date. The issuer usually pays the bond holder periodic interest
payments over the life of the loan. The various types of Bonds are as
follows:
Zero Coupon Bond: Bond issued at a discount and repaid at a face
value. No periodic interest is paid. The difference between the issue
price and redemption price represents the return to the holder. The
buyer of these bonds receives only one payment, at the maturity of
the bond.
Convertible Bond: A bond giving the investor the option to convert
the bond into equity at a fixed conversion price.
Treasury Bills: Short-term (up to one year) bearer discount security
issued by government as a means of financing their cash
requirements.
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4.2.1Equity Investment
Why should one invest in equities in particular?
When you buy a share of a company you become a shareholder in that
company. Shares are also known as Equities. Equities 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. Research studies have
proved that the equities have outperformed most other forms of
investments in the long term. This may be illustrated with the help of
following examples:
a) Over a 15 year period between 1990 to 2005, Nifty has given an
annualised return of 17%.
b) Mr. Raju invests in Nifty on January 1, 2000 (index value 1592.90).
The Nifty value as of end December 2005 was 2836.55. Holding this
investment over this period Jan 2000 to Dec 2005 he gets a return of
78.07%. Investment in shares of ONGC Ltd for the same period
gave a return of 465.86%, SBI 301.17% and Reliance 281.42%.
Therefore,
§ Equities are considered the most challenging and the rewarding,
when compared to other investment options.
§ Research studies have proved that investme nts in some shares with
a longer tenure of investment have yielded far superior returns than
any other investment.
However, this does not mean all equity investments would guarantee similar
high returns. Equities are high risk investments. One needs to study them
carefully before investing.
What has been the average return on Equities in India?
Since 1990 till date, Indian stock market has returned about 17% to
investors on an average in terms of increase in share prices or capital
appreciation annually. Besides that on average stocks have paid 1.5%
dividend annually. Dividend is a percentage of the face value of a share that
a company returns to its shareholders from its annual profits. Compared to
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most other forms of investments, investing in equity shares offers the
highest rate of return, if invested over a longer duration.
Which are the factors that influence the price of a stock?
Broadly there are two factors: (1) stock specific and (2) market specific. The
stock-specific factor is related to people’s expectations about the company,
its future earnings capacity, financial health and management, level of
technology and marketing skills.
The market specific factor is influenced by the investor’s sentiment towards
the stock market as a whole. This factor depends on the environment rather
than the performance of any particular company. Events favourable to an
economy, political or regulatory environment like high economic growth,
friendly budget, stable government etc. can fuel euphoria in the investors,
resulting in a boom in the market. On the other hand, unfavourable events
like war, economic crisis, communal riots, minority government etc. depress
the market irrespective of certain companies performing well. However, the
effect of market-specific factor is generally short-term. Despite ups and
downs, price of a stock in the long run gets stabilized based on the stockspecific
factors. Therefore, a prudent advice to all investors is to analyse and
invest and not speculate in shares.
What is meant by the terms Growth Stock / Value Stock?
Growth Stocks:
In the investment world we come across terms such as Growth stocks, Value
stocks etc. Companies whose potential for growth in sales and earnings are
excellent, are growing faster than other companies in the market or other
stocks in the same industry are called the Growth Stocks. These companies
usually pay little or no dividends and instead prefer to reinvest their profits
in their business for further expansions.
Value Stocks:
The task here is to look for stocks that have been overlooked by other
investors and which may have a ‘hidden value’. These companies may have
been beaten down in price because of some bad event, or may be in an
industry that's not fancied by most investors. However, even a company
that has seen its stock price decline still has assets to its name - buildings,
real estate, inventories, subsidiaries, and so on. Many of these assets still
have value, yet that value may not be reflected in the stock's price. Value
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investors look to buy stocks that are undervalued, and then hold those
stocks until the rest of the market realizes the real value of the company's
assets. The value investors tend to purchase a company's stock usually
based on relationships between the current market price of the company
and certain business fundamentals. They like P/E ratio being below a certain
absolute limit; dividend yields above a certain absolute limit; Total sales at a
certain level relative to the company's market capitalization, or market value
etc.
How can one acquire equity shares?
You may subscribe to issues made by corporates in the primary market. In
the primary market, resources are mobilised by the corporates through fresh
public issues (IPOs) or through private placements. Alternately, you may
purchase shares from the secondary market. To buy and sell securities you
should approach a SEBI registered trading member (broker) of a recognized
stock exchange.
What is Bid and Ask price?
The ‘Bid’ is the buyer’s price. It is this price that you need to know when you
have to sell a stock. Bid is the rate/price at which there is a ready buyer for
the stock, which you intend to sell.
The ‘Ask’ (or offer) is what you need to know when you're buying i.e. this is
the rate/ price at which there is seller ready to sell his stock. The seller will
sell his stock if he gets the quoted “Ask’ price.
If an investor looks at a computer screen for a quote on the stock of say
XYZ Ltd, it might look something like this:
Bid (Buy side) Ask (Se ll side)
______________________________________________________
Qty. Price (Rs.) Qty. Price (Rs.)
_____________________________________________________________
1000 50.25 50.35 2000
500 50.10 50.40 1000
550 50.05 50.50 1500
2500 50.00 50.55 3000
1300 49.85 50.65 1450
_____________________________________________________________
Total 5850 8950
_____________________________________________________________
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Here, on the left-hand side after the Bid quantity and price, whereas on the
right hand side we find the Ask quantity and prices. The best Buy (Bid) order
is the order with the highest price and therefore sits on the first line of the
Bid side (1000 shares @ Rs. 50.25). The best Sell (Ask) order is the order
with the lowest sell price (2000 shares @ Rs. 50.35). The difference in the
price of the best bid and ask is called as the Bid-Ask spread and often is an
indicator of liquidity in a stock. The narrower the difference the more liquid
or highly traded is the stock.
What is a Portfolio?
A Portfolio is a combination of different investment assets mixed and
matched for the purpose of achieving an investor's goal(s). Items that are
considered a part of your portfolio can include any asset you own-from
shares, debentures, bonds, mutual fund units to items such as gold, art and
even real estate etc. However, for most investors a portfolio has come to
signify an investment in financial instruments like shares, debentures, fixed
deposits, mutual fund units.
What is Diversification?
It is a risk management technique that mixes a wide variety of investments
within a portfolio. It is designed to minimize the impact of any one security
on overall portfolio performance. Diversification is possibly the best way to
reduce the risk in a portfolio.
What are the advantages of having a diversified portfolio?
A good investment portfolio is a mix of a wide range of asset class. Different
securities perform differently at any point in time, so with a mix of asset
types, your entire portfolio does not suffer the impact of a decline of any
one security. When your stocks go down, you may still have the stability of
the bonds in your portfolio. There have been all sorts of academic studies
and formulas that demonstrate why diversification is important, but it's
really just the simple practice of "not putting all your eggs in one basket." If
you spread your investments across various types of assets and markets,
you'll reduce the risk of your entire portfolio getting affected by the adverse
returns of any single asset class.
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4.2.2. Debt Investment
What is a ‘Debt Instrument’?
Debt instrument represents a contract whereby one party lends money to
another on pre-determined terms with regards to rate and periodicity of
interest, repayment of principal amount by the borrower to the lender.
In Indian securities markets, the term ‘bond’ is used for debt instruments
issued by the Central and State governments and public sector organizations
and the term ‘debenture’ is used for instruments issued by private corporate
sector.
What are the features of debt instruments?
Each debt instrument has three features: Maturity, coupon and principal.
Maturity: Maturity of a bond refers to the date, on which the bond
matures, which is the date on which the borrower has agreed to
repay the principal. Term-to-Maturity refers to the number of years
remaining for the bond to mature. The Term-to-Maturity changes
everyday, from date of issue of the bond until its maturity. The term
to maturity of a bond can be calculated on any date, as the distance
between such a date and the date of maturity. It is also called the
term or the tenure of the bond.
Coupon: Coupon refers to the periodic interest payments that are
made by the borrower (who is also the issuer of the bond) to the
lender (the subscriber of the bond). Coupon rate is the rate at which
interest is paid, and is usually represented as a percentage of the par
value of a bond.
Principal: Principal is the amount that has been borrowed, and is also
called the par value or face value of the bond. The coupon is the
product of the principal and the coupon rate.
The name of the bond itself conveys the key features of a bond. For
example, a GS CG2008 11.40% bond refers to a Central Government bond
maturing in the year 2008 and paying a coupon of 11.40%. Since Central
Government bonds have a face value of Rs.100 and normally pay coupon
semi-annually, this bond will pay Rs. 5.70 as six- monthly coupon, until
maturity.
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What is meant by ‘Interest’ payable by a debenture or a bond?
Interest is the amount paid by the borrower (the company) to the lender
(the debenture-holder) for borrowing the amount for a specific period of
time. The interest may be paid annual, semi-annually, quarterly or monthly
and is paid usually on the face value (the value printed on the bond
certificate) of the bond.
What are the Segments in the Debt Market in India?
There are three main segments in the debt markets in India, viz., (1)
Government Securities, (2) Public Sector Units (PSU) bonds, and (3)
Corporate securities.
The market for Government Securities comprises the Centre, State and
State-sponsored securities. In the recent past, local bodies such as
municipalities have also begun to tap the debt markets for funds. Some of
the PSU bonds are tax free, while most bonds including government
securities are not tax-free. Corporate bond markets comprise of commercial
paper and bonds. These bonds typically are structured to suit the
requirements of investors and the issuing corporate, and include a variety of
tailor- made features with respect to interest payments and redemption.
Who are the Participants in the Debt Market?
Given the large size of the trades, Debt market is predominantly a wholesale
market, with dominant institutional investor participation. The investors in
the debt markets are mainly banks, financial institutions, mutual funds,
provident funds, insurance companies and corporates.
Are bonds rated for their credit quality?
Most Bond/Debenture issues are rated by specialised credit rating agencies.
Credit rating agencies in India are CRISIL, CARE, ICRA and Fitch. The yield
on a bond varies inversely with its credit (safety) rating. The safer the
instrument, the lower is the rate of interest offered.
How can one acquire securities in the debt market?
You may subscribe to issues made by the government/corporates in the
primary market. Alternatively, you may purchase the same from the
secondary market through the stock exchanges.