Meaning – Financial market i s a market for the creation
and exchange of financial assets such as
shares, debentures, bonds and government securities. It is a network of
institutions which provide short, medium and long term funds.
Financial
markets make possible the transfer of money from the investors to the
entrepreneurial borrowers. Actually they bring together the lenders of funds
and borrowers of funds.
Allocation of funds – There are two alternatives through which a llocation of funds can be done –
banks and financial markets. Household savers can dep osit their surplus funds
with banks. Banks then lend these funds to business firms.
Household savers can also invest their savings in financial market directly by purchasing shares and
debentures offered by business firms.
Both banks and financial
markets are competing financial intermediaries.
Functions of financial market
1. Mobilize savings and channelize them into most productive purposes – It offers the investors different investment
avenues and helps to channe lize surplus funds into productive use.
2. Price discovery – Price of any product is determined by the forces of demand and supply. The interaction between
savers(investors) and business firms facilitates the price determination for
the financial assets, which is being traded in a particular market.
3. Providing liquidity – Financial markets provide liquidity to financial assets as they can be converted into cash by selling them
in the market very easily.
4. Reducing cost of transaction – Financial markets provide a common platform
where buyers and sellers meet and
to trade their securities without much cost and time.
Classification of financial
markets
Financial markets are
mainly of two types, Money market (Market for short term funds) and Capital
market (Market for medium an d long term funds)
Money Market – Meaning
Money market is the market
for short term funds. Short term funds are meant for a period of up to one
year. Money market is not usually located at a particular place. It is a term
used to describe all organizations and institutions that deal in short term
debt instruments.
It makes possible the
raising of short term funds for meeting the working capital needs and temporary
deployment of excess funds to get returns.
Features of Money Market
1.
Participants – RBI, Commercial banks,
non-banking finance companies, State governments, large corporate houses and mutual funds.
2.
Instruments – Short term debt instruments are traded.
3. Investment
outlay – Huge sums of
money is being transacted.
4. Duration
– On
They are issued at a price
which is lower than their face value and repaid at par, the difference between
issue price and redemption value is called discount.
It is available for a minimum amount of Rs. 25,000 and in the multiples
thereof.
2.
Commercial Paper (CP) – Issuing commercial paper in
India as a money market instrument
took place in 1989-90. It is an unsecured promissory note issued to the public
with a fixed maturity period ranging from 15 days to 1 year. Since being
unsecured, this is issued by highly reputed corporate entities.
3.
Call Money – This is an important part
of money market where day-to-day surplus
funds of banks and other financial institutions are dealt with. The banks
with surplus funds lend other banks that are facing deficiency. The duration of
call money caries from one day to 15 days and is repayable on demand, either by
the lender or by the buyer. Interest paid on call money is called Call rate.
Call money is a method by
which banks borrow mutually to maintain CRR (Cash Reserve Ratio), CRR is the
minimum balance a commercial bank should maintain with RBI.
4.
Certificate of Deposit (CD)
– It
is an unsecured, negotiable, short term instrument in bearer form, issued by commercial banks and financial institutions
to individuals, corporations and companies. Maturity period 3 months to 12
months. These are issued at a discount and redeemed at par.
5.
Commercial Bill (Trade
Bill) – This
is a bill of exchange used to finance working capital requirements of a business. It is a short period,
negotiable and self-liquidating instrument used to finance credit sales.
On credit sales, the seller
(drawer) draws the bill and the buyer (drawee) accepts it, by putting his
signature on it. On acceptance, the bill becomes a marketable instrument and is
called a trade bill. This bill can be discounted with a bank if the
seller requires funds before maturity. When a trade bill is accepted
(discounting of bills) by a commercial bank, it is known as commercial bill.
1. Participants – Financial institutions, banks, corporate entities, foreign investors and individual investors.
Capital Market – Meaning
Capital market is an
institutional arrangement by which savings are channelized into investment
avenues. It enables the borrowers to raise funds for their purpose. Similarly,
it gives opportunities to the lenders to wisely invest their funds. The
borrowers raise required funds through issue of securities like shares,
debentures, bonds etc. A security means a certificate o f title evidencing
investment made in the capital or debt of any entity.
Features of Capital Market
3.
Small Investment outlay – The value of one unit is
Rs.10, Rs. 100 etc. and they are traded
in lot of 1, 5, 50, 100 etc.
4.
Duration – Medium and long term.
5.
Liquidity – High liquidity as they are marketable in stock exchanges.
6.
High risk – there no much safety of investment and returns.
7.
Expected Return – Normally the return on investment is high than
money market.
Distinction
between Money market and Capital market
Money
Market
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Capital
Market
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1.
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It is a market for short
term instruments
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1.
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It is for medium and long
term instruments
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having a maturity period of less than one
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having maturity period of more than one
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year
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year.
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2.
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It helps to meet the working capital needs.
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2.
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It helps in meeting fixed capital needs.
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3.
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The instruments in money market are Bill
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3.
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The instruments are
equity shares,
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of exchange, treasury bills, certificate of
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preference shares, debentures, bonds etc.
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deposits, commercial papers etc.
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4.
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It is a wholesale market. The instruments
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4.
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It is a retail market where the instruments
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have large face value.
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have small face value.
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5.
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The central bank, commercial banks and
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5.
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Stock exchanges, Merchant banks, Issue
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other financial institutions take part in the
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houses and many financial intermediaries
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market.
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take part in the market.
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6.
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Money market instruments do not have an
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6.
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Capital
market instruments have
both
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active secondary market.
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primary and secondary markets.
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7.
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Money market transactions normally take
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7.
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Capital market transactions normally take
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place over telephone and other ways.
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place at stock exchanges.
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8.The market regulator is the central bank of the country. In India it is RBI. |
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8.
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There is a separate regulator in the capital
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Capital market consists of
two major segments, namely, primary market and secondary market.
Primary
Market (New issue market)
This is the market which
deals in new securities issued by new companies or existing companies.
Therefore, it is also called New Issue Market (NIM). If it is issued by new
companies it is called Initial Public Offerings (IPO s) and if it is issued by existing companies it is called
Seasoned Equity Offerings (SEOs).
The securities offered are equity shares, preference shares, debentures, bonds,
innovative types of securities like deep discount bonds, zero interest bonds
etc.
Methods
of floatation of new issue
1.
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Offer
through prospectus – It is
the most common form of raising capital from the
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primary market. Prospectus is an invitation for
subscription or purchase of shares or
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debentures of a company.
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3.
Private placement – It means the direct sale by
a company of its securities to a limited
number of specified investors. Here the issuing company may appeals to selected investors to subscribe to or purchase the securities either directly
or through brokers. The main advantage of this method is that there is no risk
of uncertainty in raising capital and it is a cost effective method of raising
finance as compared to public issue.
4. Rights issue – It is a method of raising
additional capital from existing shareholders by offering equity shares or debentures on pro-rata basis. This is
known as ‘pre-emptive right’. According to Companies Act, if a public company
wants to issue additional shares, it must first be offered to the existing
shareholders, in proportion to the amount paid up on those shares. When the
issue price is less than market price, the rights have a market value.
5. e-IPOs - In case a company wishes to
issue capital to the public through on-line
system should enter into an agreement with the stock exchange. This method
of new issue is called e-IPOs.
Secondary
Market (Stock Exchange)
Secondary market is the
market for the purchase and sale of second hand or listed securities. Shares,
debentures, bonds etc. which have already been issued by companies or
government are traded in this market. It consists of buyers and sellers of
securities and brokers as intermediaries. The investors can buy and sell
securities only through brokers. Secondary markets are also known as stock
exchanges.
Comparison
between Primary market and secondary market
Primary
market
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Secondary
market
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1.
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It deals with new
securities.
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1.
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It deals with existing
securities.
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2.
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Securities are sold only once.
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2.
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It provides regular and continuous market.
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3.
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It links the issuing company and investors.
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3.
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Transactions are made between investors.
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4.
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Investors can only purchase securities.
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4.
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Investors can purchase and sell securities.
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5.
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It provides capital to the companies.
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5.
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Issuing company has no direct role.
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6.
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It does not have any physical existence.
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6.
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It has physical existence.
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7.
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Prices of securities are determined by the
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7.
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Price is based on demand and supply of
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Co.
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securities.
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8.
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Securities can be sold without listing.
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8.
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Only listed securities can be traded.
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Stock
Exchange
Stock exchange is an organized market where second hand securities are bought and sold. The Securities Contracts (Regulation) Act 1956 defines a stock exchange as “an association organization or body of individuals whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities”.
Online trading in
securities is facilitated through a computer network wherein one can buy or
sell securities just by sitting in front of the broker’s computer. Computer
will match the buyer’s quotation and a deal is struck.
Functions of stock
exchanges
1. Liquidity and marketability
to investment – Secondary market provides a continuous market to the listed securities, so that investors enjoy liquidity
to their investment. They could sell securities with them and buy another.
2.
Pricing of securities – A security is issued in the
market at a price known as the issue price.
Over a period of time, it reaches its true level through the interaction of the
forces of demand and supply in stock exchange.
3.
Safety of transactions – The rules and regulations
ensures safety and fair dealings to investors.
4.
Contributes to economic growth – through capital formation.
5.
Spreading of equity cult
(trend) – Stock
exchanges can take effective measures in
educating public about investments.
6.
Providing scope for
speculation – A
reasonable degree of healthy speculation is
needed to ensure liquidity and price continuity in securities.
7.
Economic barometer – Business conditions like
booms and depressions, important events;
both national and international will affect the stock prices. In this sense we
can say that the stock exchange is an economic barometer (indicator).
Trading and settlement
procedure
Online trading – Trading in securities is now carried out through online, screen based electronic trading system. Buying and
selling of securities are effected through computer terminal.
Shares can be held either
in physical form or in electronic form. In physical form, a share certificate
is issued and it is a proof of ownership of securities. The electronic form is
called the dematerialized form.
When the
securities are bought or sold, it must be settled within 2 days of the trade,
i.e., on a T+2 (Trade +2 days) basis. This system of settlement is called rolling
settlement.
Steps in Trading and
Settlement Procedure (Purchase and Sale of securities)
1. Selection of a broker.
2. Open a Demat account with the Depository
Participant.
3. Placing order for purchase or sale of securities
with the broker.
4. Execution of order through computer terminal.
5. Delivery of contract note
to the investor, which contains details regarding name of security, number of
securities bought or sold, rate at which the deal was made, brokerage etc.
6. Effecting changes in the Demat account.
7. Making/receiving payment of money.
1.
Transparency – It allows the participants
to view the prices of all securities on a real time basis.
2.
Efficient information – Computer screen displays
the capital market developments that
influence the share prices instantly.
3.
Efficient operations – It reduces time, cost and effort.
4.
Wide coverage – People from all over the
world can participate in buying and selling of securities by sitting in front of a computer.
5.
Single platform – All trading centers spread
across the world is brought into a single
online platform.
Dematerialization and
Depository Services
A depository is an
organization where the securities of shareholders are held in electronic form
at the request of the shareholders through the medium of depository participant.
In the depository system, securities are held in depository account, which is
just like holding money in a bank account. It is an electronic record of share
ownership.
The depository system leads
the capital market towards scripless trading through dematerialization of
securities. Dematerialization is a
process by which physical share certificates are converted into electronic form
and credited in the investors account. To trade in dematerialized form, a Demat account is to be opened. The organization
that offers this facility is called Depository Participant (DP).
In India, two
depositories are operating in the market, namely, National Securities
Depository Limited (NSDL) and Central Depository Services Limited (CDSL). Many
share brokers firms and commercial banks act as depository participants.
Process of
dematerialization
1. Investors surrender certificates to DP for
dematerialization.
2. DP informs the depository through electronic
media.
3. DP sends original certificate to the Registrar
for verification and cancellation.
4. Depository sends formal request for
dematerialization to the Registrar.
5. Registrar informs
depository of cancellation of certificates and electronic credit given to the
customer.
6. Depository updates its account and informs the
DP concerned.
National
Stock Exchange (NSE)
Established in 1992 at
Mumbai – set up by LIC, GIC, Commercial banks and other financial institutions
with a paid up capital of Rs.25crores.
Features
and objectives of NSE
1. Nationwide coverage –
satellite linked trading facility – more than 6000 trading terminals in 370
cities.
2. On-line Trading (Electronic
Trading system) – It has adopted a computer based trading system – main
computer at NSE is linked with the computers of trader members through
satellite link.
3. Transparency in dealing –
Screen based trading ensures complete transparency. Investors can verify the
rate at which transactions took place.
4. Matching of orders – The computer itself matches
the buy and sell orders of securities.
5. Trading in dematerialized
form – Trading is carried on dematerialized form and settlement of transactions
are made on rolling settlement basis. Rolling settlement helps traders to
settle the accounts quickly. At present T+2
pattern is followed, which means settlement is made within 2 days from the date
of transaction.
Segments
of NSE
Wholesale debt market
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Capital market segment
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1.
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Debt instruments
like government
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1.
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Retail market.
|
securities, treasury bills, PSU bonds,
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2.
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Shares and debentures of companies
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CPs and CDs are traded.
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are traded.
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2.
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Transactions are wholesale in nature.
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3.
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Listing is provided to companies having
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3.
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It involves high value.
|
minimum
paid up capital
of Rs.10
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4.
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Individual brokers are not permitted.
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crore.
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4.
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About 700 securities are listed.
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Bombay
Stock Exchange (BSE)
Established in the year
1875 – Voluntary non-profit association – oldest in Asia – 1st one recognized by
government – only one that has been granted permanent registration – premier
stock exchange – trendsetter in stock market trading – companies having at
least Rs.10 crores are eligible to be listed in BSE – About 6000 scrips listed – securities are classified into
many groups like group A, B, T and Z. A group contains securities having good
track record and large volume of business – traditionally trading was carried
on outcry system – in 1995 it introduced a screen based trading called BOLT (BSE On-Line Trading). At present
BOLT has a nationwide network.
Securities
and Exchange Board of India (SEBI)
SEBI is the regulatory and
developmental agency of Indian Capital Market, established in 1988 based on the
recommendations of G S Patel Committee. It was made a statutory body under
Securities and Exchange Board of India Act 1992.
Reasons for establishment
of SEBI
During 1980’s the capital
market witnessed a tremendous growth due to increase in investor population.
This hike in market capitalization led to various malpractices by companies, brokers,
merchant bankers, investment consultants, etc. All these made huge losses to
the ordinary investors and they have lost their confidence in this segment.
This made Government of India to constitute a regulatory body known as SEBI.
Common Malpractices in stock market:
a. Self-styled merchant bankers
b. Unofficial private placement
c. Price rigging (artificially inflating prices of
certain shares by a group)
d. Unofficial premium on new issue
e. Non-adherence of provision to Companies Act
f. Violation of rules and regulations of stock
exchanges and listing formalities.
Purpose and Role of SEBI
SEBI was constituted by the
Govt. of India with a view to create a favorable environment for efficient
mobilization and allocation of resources through securities market. This
environment aims at fulfilling the needs of three groups:
a. Issuers – SEBI ensures a market place where the companies can confidently raise finance in easy, fair and efficient
manner.
b. Investors – Provides protection of their rights and interest by providing authentic information.
c. Intermediaries – Offers a competitive professional market by equipping intermediaries to render better services to the
investors and issuers.
Objectives of SEBI
1. Regulatory
functions - To regulate the
securities market and ensure fair practices.
2. Protection of rights - To protect the interest of investors and thereby
attract a steady flow of savings
into capital market.
3. Prevention
of malpractices – To
prevent trading malpractices.
4. Develop a code of conduct - To promote efficient services by brokers,
merchant bankers etc. so as to make
them competitive and professional.
Functions of SEBI
A.
Regulatory functions:
1. Registration of brokers and sub brokers in the
market.
2. Registration of investment schemes and Mutual
Funds.
3. Regulates the functioning of share brokers,
underwriters etc.
4. Regulation of takeover bids by companies.
5. Conducting enquiries and audits of stock
exchanges.
6. Levying fee or other charges as specified by the
Act.
B.
Developmental functions:
1. Promoting investor education and training of
intermediaries.
2. Conduct of research and publication of useful
information.
3. Undertaking measures to develop the capital
market.
C.
Protective functions:
1. Prohibition of fraudulent
and unfair trade practices like misleading statements, manipulations, price
rigging etc.
2. Controlling insider trading
in securities to protect the interest of individual investors. Insider means
the top officials of the company, who can make bulk purchase or sale for making
huge profit on the basis of vital information such as declaration of dividend
on a future date etc.
3. Undertaking steps for investor protection.
4. Promotion of fair practices and code of conduct
in securities market.
Stock Market Indices
Stock market index is a
device, which reflects the relative change in prices of securities in a stock
exchange. The general trend of the market can be measured by studying stock
market index. Eg: BSE Sensex (Sensitive Index), BSE 100, S&P CNX Nifty,
S&P CNX500, CRISIL 500 etc.
BSE Sensex is calculated on weighted average
basis of 30 shares, and Nifty applied in NSE is based on 50 shares.
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