Capital Markets Module

1.1 Market Segments

Securities market is an organized exchange plus over the counter markets in which securities are traded. Securities markets provide a channel for allocation of savings to those who have productive need for them. Securities market has two interdependent segments: 1) Primary market and 2) Secondary market.

1.1.1 Primary Market

Primary market provides an opportunity to the issuers of securities, both Government and corporations, to raise resources to meet their requirements of investment. Securities, in the form of equity or debt. These securities can be issued in domestic /international markets at face value, discount or premium.

The primary market issuance are done through either public issues or private placement. Under Companies Act, 1956, an issue is referred to as public if it results in allotment of securities to 50 investors or more. However, when the issuer makes an issue of securities to a select group of persons, not exceeding 49 and which is neither a rights issue nor a public issue it is called as private placement.

1.1.2 Secondary Market

Secondary market is referred as the market where securities are traded after being offered to public in the primary market. Secondary market comprises of equity, derivatives and debt securities. Secondary market is operated through two mediums, i.e. Over-the-counter (OTC) market and Exchange-Traded market. OTC markets are informal markets where trades are negotiated directly.

1.2 Key Indicators of Securities Market

1.2.1 Index

Index is a statistical indicator that measures changes in the economy. It is a measurement of the value of a section of the stock market and computed from the prices of selected stocks. In case of financial markets, an index is a portfolio of securities that represent a particular market. Each index has its own calculation methodology and usually expressed in terms of a change from a base value. The base value might be as recent as the previous day or many years in the past. Thus, the percentage change is more important than the actual numeric value. Financial indices are created to measure price movement of stocks, bonds, T?bills and other type of financial securities. More specifically, a stock index is created to provide market

participants with the information regarding average share price movement in the market.

Stock market indexes are useful for a variety of reasons. Some of them are:

• They provide a historical comparison of returns on money invested in the stock market against other forms of investments such as gold or debt.
• They can be used as a standard against which to compare the performance of an equity fund.
• In It is a lead indicator of the performance of the overall economy or a sector of the economy
• Stock indexes reflect highly up to date information
• Modern financial applications such as Index Funds, Index Futures, Index Options play an important role in financial investments and risk management

1.2.2 Methodology for Construction of Stock Market Indices

Index can be designed and constructed in various ways. Depending on the methodology, they are classified in the following types:

1) Market capitalization weighted index

Market capitalization weighted index weighted by the market capitalization of each stock in the index. Each stock is given weight according to its market capitalization. So higher the market capitalization of a stock, higher is its weight in the index.

Market capitalization is the market value of the company which is calculated by multiplying total number of outstanding shares by current market price of the company’s stock. For example, company XYZ Ltd. with 2,00,000 shares outstanding and share price of Rs 320 per share will have market capitalization of 2,00,000 x 320 = Rs 6,40,00,000.

A value weighted index assumes that the investors allocates money across various stocks included in the index in such a way that the weights assigned to various stocks are proportional to their market capitalization.

In this the index would be calculated as per the formulae below:

Where,

Current market capitalization = Sum of (Current market price x issue Size)

Base market capitalization = Sum of (Market Price x issue Size) of All Securities as on base date)

2) Free Float market capitalization weighted index.

In this method, the number of equity shares outstanding is multiplied by the price to arrive at market capitalization. This will ensure that each security will influence the index in proportion to its respective market importance. The current market capitalization is compared with the base market capitalization (base value) in order to get the index value at any point of time.

The free float factor, for each company in the index is determined based on the public shareholding of the company as disclosed in the shareholding pattern submitted to the stock exchange by the company. The free float market capitalization is calculated in the following manner:

Free Float Market Capitalization = Issue size x Price x Investible Weight Factor

The index in this case is calculated as per the formulae given below:

3) Price weighted index

An index reflecting the sum of the prices of the sample shares in a certain year or month or week or day with reference to a base year. The price-weighted index assumes that the investor buys one share of each stock included in the index. The value of the index is generated by adding the prices of each of the stocks in the index and dividing them by the total number of stocks. Stocks with a higher price will be given more weight and, therefore will have a greater influence over the performance of the index.

4) Equal weighted index

An index reflecting the simple arithmetic average of the price relatives of the sample shares in a certain year or month or week or day with reference to a base value. An equal-weighted index assumes that the investor invests an equal amount of money in each stock included in the index.

Example:

Assume that stocks X1, X2, and X3 are the constituent sample companies of an index. The base index is 100 and the base date price and current market prices are given below. Compute the current stock index when no change in share representation takes place, dividends or stock splits have not occurred, and no additional shares have been issued. Use market capitalization weighted method, price weighted method, and equal weighted method.

Solution:

i) Market Capitalization Weighted Method:

Market value weighted index = (91,00,00,000 / 24,60,00,000) x 100

= 370

ii) Price weighted method

Market Price Weighted Index = (1250 / 380) x 100 = 329

iii) Equal Weighted Method

Equal Weighted Index = 100 + 201.01 = 301.01

1.2.3 Index Management

Index Maintenance plays a crucial role in ensuring stability of the Index as well as in meeting its objective of being a consistent benchmark of the equity markets. Index construction, management and revision process is done by specialized agencies. All indices at National Stock Exchange are managed by a separate company called as "India Index Services and Product Ltd. (IISL)". IISL has constituted an Index Policy Committee, which is involved in policy and guidelines for managing the IISL Indices. The Index Maintenance Sub-committee takes all decisions on addition/ deletion of companies in any Index.

1.2.4 Major Indices in India

Following are few popular indices in India:

• Nifty 50 Index
• Nifty 100 Index
• Nifty 200 Index
• Nifty 500 Index
• Nifty Bank Index
• India VIX Index
• S&P BSE Sensex
• S&P BSE Midcap
• S&P BSE 100
• S&P BSE 200
• S&P BSE 500

1.3 Products and Participants

1.3.1 Products

Financial markets facilitate reallocation of savings from savers to entrepreneurs. Savings are linked to investments by a variety of intermediaries through a range of complex financial products called "securities". Under the Securities Contracts (Regulation) Act [SC(R)A], 1956, "securities" include

(i) Shares, bonds, scrips, stocks or other marketable securities of like nature in or of any incorporate company or body corporate,

(ii) Government securities,

(iii) Derivatives of securities,

(iv) Units of collective investment scheme,

(v) Interest and rights in securities, and security receipt or any other instruments so declared by the central government. Broadly, securities can be of three types - equities, debt securities and derivatives

1.3.2 Participants

The securities market has essentially three categories of participants (i) the investors, (ii) the issuers, (iii) the intermediaries (Figure 1.1). The Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI), Ministry of Corporate Affairs (MCA) and the Department of Economic Affairs (DEA) of the Ministry of Finance regulate these participants.

Figure 1.1 Market Participants

1.4 Market Segments and their Products

There are many segments to the market and it is totally dependent on the exchange. In India, National stock exchange provides trading in four different segments – Wholesale debt market, Capital Market, Derivatives segment.

1) Whole Sale Debt Market Segment - This segment at NSE commenced its operations in June 1994. It provides the trading platform for wide range of debt securities, which includes State and Central Government securities, T-Bills, PSU Bonds, Corporate debentures, Commercial Papers, Certificate of Deposits etc.

2) Capital Market Segment - This segment at NSE commenced its operations in November 1994. It offers a fully automated screen based trading system, known as the National Exchange for Automated Trading (NEAT) system. Various types of securities e.g. equity shares, warrants, debentures etc. are traded on this system.

3) Derivatives Segment - This segment provides trading in derivatives instruments like index futures, index options, stock options, stock futures, currency and commenced its operations at NSE in June 2000.