UNIT – 4
STOCK EXCHANGE-TERMS USED IN STOCK EXCHANGE
Stock exchange is a specific place where trading of the securities is arranged in an organized method. In simple words, it is a place where shares, debentures and bonds (securities) are purchased and sold. The term securities include equity shares, preferences shares, debentures, government bonds, etc. including mutual funds.
The important features of a stock exchange are as follows
- Stock exchange is a place where buyers and seller meet and decide on a price.
- Stock exchange is a place where stocks or all types of securities are traded.
- Stock exchange is at physical location, where transactions are carried out on a trading floor.
- The purpose of a stock exchange or market is to facilitate the exchange of securities between buyer and sellers, thus reducing the risk.
A stock exchange provides a platform or mechanism to the investors-individuals or institutions. To purchase or sell the securities of the companies, government or semi government institutions. It is like a commodity market where securities are bought and sold. It is an important constituent of capital market.
The stock exchange is also termed as ‘Stock Market’, ‘Share Market’ or ‘Share Bazaar’.
Stock exchange or securities market is like a commodity market where securities are bought and sold.
Let us understand one by one both the markets
- Primary Market : As the diagram suggests here in primary market, new securities for the first and final are floated by issuing companies themselves. Direct contact with the investors at large is established by the companies for selling of the securities in response to the direct appeal made by companies (through electronic media, print media) to investors.
- Secondary Market : As the diagram suggests a stock exchange is the single most important institution in the secondary market for the securities. It is the place where already issued and outstanding shares are bought and sold repeatedly. This is a specific place where trading of second hand or exchanges are traded, cleared and settled through intermediaries as per prescribed regulatory framework.
The company needs to be listed on the stock exchange for the purpose of trading through stock exchange.
In India there are twenty three stock exchanges. All of them are regulated as per Securities Contract (Regulation) Act, 1956 and SEBI Act, 1992. Some stock exchanges are voluntary non-profit associations and some are companies limited by shares and by guarantees. BSE is the oldest stock exchange in India.
Following is the list of twenty three stock exchanges in India.
- The Stock Exchange, Mumbai (BSE).
- The Stock Exchange, Ahmedabad.
- Bangalore Stock Exchange Limited.
- Vadodara Stock Exchange Limited.
- Bhubaneshwar Stock Exchange Association Limited.
- Kolkata Stock Exchange Association Limited.
- Chennai Stock Exchange Limited.
- Cochin Stock Exchange Limited.
- Comibatore Stock Exchange Limited.
- Gauhati Stock Exchange Limited.
- Hyderabad Stock Exchange Limited.
- Madhya Pradesh Stock Exchange Limited.
- Jaipur Stock Exchange Limited.
- Uttar Pradesh Exchange Limited.
- Ludhiana Stock Exchange Limited.
- Mangalore Stock Exchange Limited.
- Delhi Stock Exchange limited.
- Over The Counter Stock Exchange of India(OTCEI)
- Magadh Stock Exchange Association.
- Pune Stock Exchange limited.
- Saurashtra – Kutch Stock Exchange Limited.
- National Stock Exchange (NSE).
- Meerut Stock Exchange.
The Stock Exchange, Mumbai(BSE):
BSE was established in 1875 and is the oldest stock exchange not only in India but also in Asia. It was formed as a voluntary non profit association. Its governing board has nineteen directors of which nine are elected by brokers, five by public representatives, one nominee of Reserve Bank of India and an Executive Director. It has over seven hundred members, majority of whom are individual members. The BSE has the following segments.
1.] Equity Segment:
In this segment only equity securities are traded e.g. Shares.
2.] Debt Segment:
This segment deals with debt securities like debentures, government securities. Bonds etc.
3.] Derivative Segment:
This deals with only derivatives.
National Stock Exchange:
It was set up in 1992 as a public limited company. It is the largest and most modern stock exchange in India. National Stock Exchange is administered by Board of Directors and an Executive Committee. It has eight hundred ninety two members of which majority are corporate members. National Stock Exchange has following segments.
1.] Capital Market Segment (CM):
It deals with equities, convertible debentures, warrants, etc.
2.] Wholesale Debenture Market (WDM) Segment:
It deals with fixed income securities like Government bonds, treasury bills, debentures etc. Only corporates and institutions can participate in this segment.
3.] Futures & Options (F&O) Segment:
This segment deals in derivatives. The regional stock exchanges functions like BSE. The only difference is that the number of members and the volume of trading in regional stock exchange in much lower than BSE.
Commodities future trading was evolved from need of assured continuous supply of seasonal agricultural crops. The concept of organized trading in commodities evolved in Chicago, in 1848. But one can trace its roots in Japan. In Japan merchants used to store Rice in warehouses for future use. To raise cash warehouse holders sold receipts against the stored rice. These were known as “rice tickets”. Eventually, these rice tickets become accepted as a kind of commercial currency. Latter on rules came in to being, to standardize the trading in rice tickets. In 19th century Chicago in United States had emerged as a major commercial hub. So that wheat producers from Mid-west attracted here to sell their produce to dealers & distributors. Due to lack of organized storage facilities, absence of uniform weighing & grading mechanisms producers often confined to the mercy of dealers discretion. These situations lead to need of establishing a common meeting place for farmers and dealers to transact in spot grain to deliver wheat and receive cash in return.
Gradually sellers & buyers started making commitments to exchange the produce for cash in future and thus contract for “futures trading” evolved. Whereby the producer would agree to sell his produce to the buyer at a future delivery date at an agreed upon price. In this way producer was aware of what price he would fetch for his produce and dealer would know about his cost involved, in advance. This kind of agreement proved beneficial to both of them. As if dealer is not interested in taking delivery of the produce, he could sell his contract to someone who needs the same. Similarly producer who not intended to deliver his produce to dealer could pass on the same responsibility to someone else. The price of such contract would dependent on the price movements in the wheat market. Latter on by making some modifications these contracts transformed in to an instrument to protect involved parties against adverse factors such as unexpected price movements and unfavorable climatic factors. This promoted traders entry in futures market, which had no intentions to buy or sell wheat but would purely speculate on price movements in market to earn profit.
Trading of wheat in futures became very profitable which encouraged the entry of other commodities in futures market. This created a platform for establishment of a body to regulate and supervise these contracts. That’s why Chicago Board of Trade (CBOT) was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Agricultural commodities were mostly traded but as long as there are buyers and sellers, any commodity can be traded. In 1872, a group of Manhattan dairy merchants got together to bring chaotic condition in New York market to a system in terms of storage, pricing, and transfer of agricultural products. In 1933, during the Great Depression, the Commodity Exchange, Inc. Was established in New York through the merger of four small exchanges – the National Metal Exchange, the Rubber Exchange of New York, the National Raw Silk Exchange, and the New York Hide Exchange.
The largest commodity exchange in USA is Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are major futures trading exchanges in over twenty countries including Canada, England, India, France, Singapore, Japan, Australia and New Zealand.
The history of organized commodity derivatives in India goes back to the nineteenth century when Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time datives market developed in several commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920).
However many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the market for the underlying commodities, resulting in to banning of commodity options trading and cash settlement of commodities futures after independence in 1952. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. The act prohibited options trading in Goods along with cash settlement of forward trades, rendering a crushing blow to the commodity derivatives market. Under the act only those associations/exchanges, which are granted reorganization from the Government, are allowed to organize forward trading in regulated commodities. The act envisages three tire regulations: (i) Exchange which organizes forward trading in commodities can regulate trading on day-to-day basis; (ii) Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government. (iii) The Central Government- Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution- is the ultimate regulatory authority.
The commodities future market remained dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in a policy, started actively encouraging commodity market. After Liberalization and Globalization in 1990, the Government set up a committee (1993) to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing option trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures’ trading was permitted in all recommended commodities. It is timely decision since internationally the commodity cycle is on upswing and the next decade being touched as the decade of Commodities.
Commodity exchange in India plays an important role where the prices of any commodity are not fixed, in an organized way. Earlier only the buyer of produce and its seller in the market judged upon the prices. Others never had a say.
Today, commodity exchanges are purely speculative in nature. Before discovering the price, they reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. A big difference between a typical auction, where a single auctioneer announces the bids and the Exchange is that people are not only competing to buy but also to sell. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone else’s lower offer. That keeps the market as efficient as possible, and keeps the traders on their toes to make sure no one gets the purchase or sale before they do. Since 2002, the commodities future market in India has experienced an unexpected boom in terms of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which crossed $ 1 trillion mark in 2006. Since 1952 till 2002 commodity datives market was virtually non- existent, except some negligible activities on OTC basis.
In India there are 25 recognized future exchanges, of which there are three national level multi-commodity exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The three exchanges are: National Commodity & Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity Exchange of India Limited (MCX) Mumbai and National Multi- Commodity Exchange of India Limited (NMCEIL) Ahmedabad.There are other regional commodity exchanges situated in different parts of India.
Regulation of stock exchange in India
Stock Exchange is a platform where the trading of securities happens in an organized manner. The securities may be shares or debts. The stock exchange has not been defined under any Act, but the commercial definition is generally accepted. Securities and Exchange Board of India, established in 1992, is the principal regulator of stock exchanges in India.
Share market is the one of the major pillars for the economy of a country. It is very important to control the share market in order to strengthen the economic condition of the country and thereby protect the rights of the investors. Keeping this thing in view, the Capital Issue (Control) Act, 1947 was enforced. But the Act failed to fully control the Share Market. In order to remove its drawbacks, Securities and Exchange Board of India (SEBI) was established in 1992.
The SEBI Act enumerates the powers with respect to regulating the stock exchange. The act has conferred a wide variety of powers to SEBI.
Some of the most important powers of SEBI with respect to regulating the Indian stock market are listed below:
Specifying rules and regulations
SEBI has the authority to specify rules and regulations to control the stock exchange. For example, the timings i.e. opening (9.15 am) and closing (3.30 pm) time of the market has been set by SEBI, and it retains the right to change the timing if required.
Providing licenses to dealers and brokers
Every dealer or broker requires a prior approval and license from SEBI to start distributing securities to investors. It also reserves the right to withhold or cancel the license of brokers and dealers not adhering to guidelines.
Reviewing the performance of various stock exchanges
The regulating body is also responsible for the performances of various stock exchanges and bringing transparency in their functioning.
Controlling mergers, acquisitions and take-overs of the companies
Some companies try to manipulate stocks and buy a majority stake in other companies with an intention of a take-over. SEBI controls and prohibits such movements if it is not in the interest of the company.
Prohibiting unfair trade practices in the market
While SEBI has laid down specific guidelines that promote fair trade practices, many companies occasionally undertake activities that are not healthy for the market. SEBI has the power to prohibit such activities and take action against the parties involved in such a trade. Penalties may range from Rs 25 crores or 3 times the profits made out of such failure, whichever is higher.
Imposition of Penalties in case of violation
A number of acts / activities have been identified and declared to be punishable by SEBI. The same has been mentioned under various sections of the Act.
Stock broker activities
A penalty can be imposed in case a stockbroker defaults or fails in –
Issuing in Contract Note, or
Delivering any security or making payment of an amount due to an investor , or charges an amount of brokerage which is in excess of brokerage specified in the regulations.
The penalty may range from Rs 1 lac per day to Rs 1 crore depending on the type of default or failure.
Insider Trading
A person becomes liable of insider trading if –
Deals of self or others on basis of unpublished / confidential price sensitive information, or
Communicates any unpublished price sensitive information, or
Counsels any person to deal in securities of any corporate on basis of unpublished price sensitive information.
The penalty can be very heavy is such cases going upto Rs 25 crores or thrice the profit made out of such insider trading activity, whichever is higher.
Non Disclosure of acquisition of shares and takeovers
Non Disclosure penalty is applicable if a person fails to –
Disclose his total shareholding in a corporate body before acquiring further shares of the corporate body, or
Makes a public announcement so are to acquire shares at a certain price, or
Makes a public offer by sending an offer letter to the shareholder of the concerned corporate, or
Makes payment of consideration to shareholders who sold their shares pursuant to the offer letter as mentioned earlier.
Online Trading In stock Exchange
In the recent times, trading on stocks has become as simple as shopping online. Investor can do that sitting in a coffee shop using a smart phone. All it needs is a good internet connection, subscription to 3-in-1 account, mobile banking application and sufficient funds in the bank account.
Fortunately, all the hectic paper work has come down to a single click or touch on the mobile screen. Many free and paid mobile and web applications and portals for trading are available on internet.
Stock trading can be financially rewarding if done in the right way. Investing in the stock market involves riding the various ups and downs of the market. Since the introduction of online trading in India, investing has become convenient. Stock market trading is a great alternative when it comes to long-term wealth creation. Although, it might take a while for you to hone your skills.
Online trading involves the trading of securities through an online platform. Online trading portals facilitate the trading of various financial instruments such as equities, mutual funds, and commodities. Angel Broking offers Angel Speed Pro – an online trading platform that helps investors and traders to buy/sell stocks and other financial instruments.
Spot And Future Dealings
The forward rate and spot rate are different prices, or quotes, for different contracts. A spot rate is a contracted price for a transaction that is taking place immediately (it is the price on the spot). A forward rate, on the other hand, is the settlement price of a transaction that will not take place until a predetermined date in the future; it is a forward-looking price. Forward rates typically are calculated based on the spot rate.
Spot Rate
A spot rate, or spot price, represents a contracted price for the purchase or sale of a commodity, security, or currency for immediate delivery and payment on the spot date, which is normally one or two business days after the trade date. The spot rate is the current price of the asset quoted for the immediate settlement of the spot contract. For example, if a wholesale company wants immediate delivery of orange juice in August, it will pay the spot price to the seller and have orange juice delivered within two days. However, if the company needs orange juice to be available at its stores in late December, but believes the commodity will be more expensive during this winter period due to a higher demand than supply, it cannot make a spot purchase for this commodity since the risk of spoilage is high. Since the commodity wouldn't be needed until December, a forward contract would a better fit for the investment.
Forward Rate
Unlike a spot contract, a forward contract, or futures contract, involves an agreement of contract terms on the current date with the delivery and payment at a specified future date. Contrary to a spot rate, a forward rate is used to quote a financial transaction that takes place on a future date and is the settlement price of a forward contract. However, depending on the security being traded, the forward rate can be calculated using the spot rate. Forward rates are calculated from the spot rate and are adjusted for the cost of carry to determine the future interest rate that equates the total return of a longer-term investment with a strategy of rolling over a shorter-term investment.
Advantages Of Future Dealings
Stable Margin Requirements
Margin requirements for most of the commodities and currencies are well-established in the futures market. Thus, a trader knows how much margin he should put up in a contract.
No Time Decay Involved
In options, the value of assets declines over time and severely reduces the profitability for the trader. This is known as time decay. A futures trader does not have to worry about time decay.
High Liquidity
Most of the futures markets offer high liquidity, especially in case of currencies, indexes, and commonly traded commodities. This allows traders to enter and exit the market when they wish to.
Simple Pricing
Unlike the extremely difficult Black-Scholes Model-based options pricing, futures pricing is quite easy to understand. It's usually based on the cost-of-carry model, under which the futures price is determined by adding the cost of carrying to the spot price of the asset.
Protection Against Price Fluctuations
Forward contracts are used as a hedging tool in industries with high level of price fluctuations. For example, farmers use these contracts to protect themselves against the risk of drop in crop prices.
Say for instance a farmer is planting wheat, and she expects to harvest 8,000 bushels of wheat when the crop is ready. Unsure of the prices at the time of harvest, she can sell the entire crop at a fixed price well before the actual harvest, with delivery to be made at a future date such as five months from the date of agreement.
Although the farmer does not get the sale proceeds at the time of the agreement, the transaction offers her protection against any possible fluctuations in currency exchange rates and price drops in the wheat market.
Hedging Against Future Risks
Many people enter into forward contracts for better risk management. Companies often use these contracts to limit risk that may arise from foreign currency exchange.
Let's say for example, a U.S.-based company incurs labor and manufacturing costs in dollars but exports its final products to the European market and receives payment in Euros. The company supplies goods at a lead time of six months, which exposes it to the risk of exchange rate fluctuations. To avoid this risk, the company can use a forward contract to sell its goods at today's exchange rate although the delivery is to be made after six months.
The Disadvantages of Futures Contracts
No Control Over Future Events
One common drawback of investing in futures trading is that you don't have any control over future events. Natural disasters, unexpected weather conditions, political issues, etc. can completely disrupt the estimated demand-supply equilibrium.
Leverage Issues
High leverage can result in rapid fluctuations of futures prices. The prices can go up and down daily or even within minutes.
Expiration Dates
Future contracts involve a certain expiration date. The contracted prices for the given assets can become less attractive as the expiration date comes nearer. Due to this, sometimes, a futures contract may even expire as a worthless investment.
