Indian Capital Markets

Since 2003, Indian capital markets have been receiving global attention, especially from sound
investors, due to the improving macroeconomic fundamentals. The presence of a great pool of
skilled labour and the rapid integration with the world economy increased India’s global
competitiveness. No wonder, the global ratings agencies Moody’s and Fitch have awarded India
with investment grade ratings, indicating comparatively lower sovereign risks.
The Securities and Exchange Board of India (SEBI), the regulatory authority for Indian securities
market, was established in 1992 to protect investors and improve the microstructure of capital
markets. In the same year, Controller of Capital Issues (CCI) was abolished, removing its
administrative controls over the pricing of new equity issues. In less than a decade later, the
Indian financial markets acknowledged the use of technology (National Stock Exchange started
online trading in 2000), increasing the trading volumes by many folds and leading to the
emergence of new financial instruments. With this, market activity experienced a sharp surge
and rapid progress was made in further strengthening and streamlining risk management, market
regulation, and supervision.
The securities market is divided into two interdependent segments:

 The primary market provides the channel for creation of funds through issuance of new
securities by companies, governments, or public institutions. In the case of new stock
issue, the sale is known as Initial Public Offering (IPO).
 The secondary market is the financial market where previously issued securities and
financial instruments such as stocks, bonds, options, and futures are traded.

In the recent past, the Indian securities market has seen multi-faceted growth in terms of:
  The products traded in the market,  viz. equities and bonds issued by the government and
companies, futures on benchmark indices as well as stocks, options on benchmark indices
as well as stocks, and futures on interest rate products such as Notional 91-Day T-Bills,
10-Year Notional Zero Coupon Bond, and 6% Notional 10-Year Bond.
 The amount raised from the market, number of stock exchanges and other intermediaries,
the number of listed stocks, market capitalization, trading volumes and turnover on stock
exchanges, and investor population.
 The profiles of the investors, issuers, and intermediaries.

Broad Constituents in the Indian Capital Markets

Fund Raisers are companies that raise funds from domestic and foreign sources, both public and
private. The following sources help companies raise funds:
Fund Providers are the entities that invest in the capital markets. These can be categorized as
domestic and foreign investors, institutional and retail investors. The list includes subscribers to
primary market issues, investors who buy in the secondary market, traders, speculators, FIIs/ sub
accounts, mutual funds, venture capital funds, NRIs, ADR/GDR investors, etc.
Intermediaries are service providers in the market, including stock brokers, sub-brokers,
financiers, merchant bankers, underwriters, depository participants, registrar and transfer agents,
FIIs/ sub accounts, mutual Funds, venture capital funds, portfolio managers, custodians, etc.
Organizations include various entities such as BSE, NSE, other regional stock exchanges, and
the two depositories National Securities Depository Limited (NSDL) and Central Securities
Depository Limited (CSDL).
Market Regulators include the Securities and Exchange Board of India (SEBI), the Reserve
Bank of India (RBI), and the Department of Company Affairs (DCA).
Appellate Authority: The Securities Appellate Tribunal (SAT)
Participants in the Securities Market
SAT, regulators (SEBI, RBI, DCA, DEA), depositories, stock exchanges (with equity trading,
debt market segment, derivative trading), brokers, corporate brokers, sub-brokers, FIIs, portfolio
managers, custodians, share transfer agents, primary dealers, merchant bankers, bankers to an
issue, debenture trustees, underwriters, venture capital funds, foreign venture capital investors,
mutual funds, collective investment schemes.
EQUITY MARKET
History of the Market
With the onset of globalization and the subsequent policy reforms, significant improvements
have been made in the area of securities market in India. Dematerialization of shares was one of
the revolutionary steps that the government implemented. This led to faster and cheaper
transactions, and increased the volumes traded by many folds. The adoption of the market-
oriented economic policies and online trading facility transformed Indian equity markets from a
broker-regulated market to a mass market. This boosted the sentiment of investors in and outside
India and elevated the Indian equity markets to the standards of the major global equity markets.
The 1990s witnessed the emergence of the securities market as a major source of finance for
trade and industry. Equity markets provided the required platform for companies and start-up
businesses to raise money through IPOs, VC, PE, and finance from HNIs. As a result, stock
markets became a people’s market, flooded with primary issues. In the first 11 months of 2007,
the new capital raised in the global public equity markets through IPOs accounted for $107
billion in 382 deals out of the total of $255 billion raised by the four BRIC countries. This was a
sizeable growth from $90 billion raised in 302 deals in 2006. Today, the corporate sector prefers
external sources for meeting its funding requirements rather than acquiring loans from financial
institutions or banks.

Derivative Markets
The emergence of the market for derivative products such as futures and forwards can be traced
back to the willingness of risk-averse economic agents to guard themselves against uncertainties
arising out of price fluctuations in various asset classes. By their very nature, the financial
markets are marked by a very high degree of volatility. Through the use of derivative products, it
is possible to partially or fully transfer price risks by locking in asset prices. However, by locking
in asset prices, derivative products minimize the impact of fluctuations in asset prices on the
profitability and cash flow situation of risk-averse investors. This instrument is used by all
sections of businesses, such as corporates, SMEs, banks, financial institutions, retail investors,
etc. According to the International Swaps and Derivatives Association, more than 90 percent of
the global 500 corporations use derivatives for hedging risks in interest rates, foreign exchange,
and equities. In the over-the-counter (OTC) markets, interest rates (78.5%), foreign exchange
(11.4%), and credit form the major derivatives, whereas in the exchange-traded segment, interest
rates, government debt, equity index, and stock futures form the major chunk of the derivatives.
What are futures contracts?
Futures contracts are standardized derivative instruments. The instrument has an underlying
product (tangible or intangible) and is impacted by the developments witnessed in the underlying
product. The quality and quantity of the underlying asset are standardized. Futures contracts are
transferable in nature. Three broad categories of participants—hedgers, speculators, and
arbitragers—trade in the derivatives market.
  Hedgers face risk associated with the price of an asset. They belong to the business
community dealing with the underlying asset to a future instrument on a regular basis.
They use futures or options markets to reduce or eliminate this risk.
 Speculators have a particular mindset with regard to an asset and bet on future
movements in the asset’s price. Futures and options contracts can give them an extra
leverage due to margining system.
 Arbitragers are in business to take advantage of a discrepancy between prices in two
different markets. For example, when they see the futures price of an asset getting out of
line with the cash price, they will take offsetting positions in the two markets to lock in a
profit.

Important Distinctions
Exchange-Traded Vs. OTC Contracts: A significant bifurcation in the instrument is whether
the derivative is traded on the exchange or over the counter. Exchange-traded contracts are
standardized (futures). It is easy to buy and sell contracts (to reverse positions) and no
negotiation is required. The OTC market is largely a direct market between two parties who
know and trust each other. Most common example for OTC is the forward contract. Forward
contracts are directly negotiated, tailor-made for the needs of the parties, and are often not easily
reversed.
Distinction between Forward and Futures Contracts:

Futures Contracts Forward Contracts

Meaning: A futures contract is a A forward contract is a contractual

contractual agreement between two agreement between two parties to
parties to buy or sell a standardized buy or sell an asset at a future date
quantity and quality of asset on a for a predetermined mutually agreed
specific future date on a futures price while entering into the
exchange. contract. A forward contract is not
traded on an exchange.

Trading place: A futures contract is A forward contract is traded in an

traded on the centralized trading OTC market.
 platform of an exchange.

Transparency in contract The contract price of a forward

price: The contract price of a contract is not transparent, as it is
futures contract is transparent as it is not publicly disclosed.
available on the centralized trading
screen of the exchange.

Valuations of open position and In a forward contract, valuation of

margin requirement: In a futures open position is not calculated on a
contract, valuation of open position daily basis and there is no
is calculated as per the official requirement of MTM on daily basis
closing price on a daily basis and since the settlement of contract is
mark-to-market (MTM) margin only on the maturity date of the
requirement exists. contract.

Liquidity: Liquidity is the measure A forward contract is less liquid due

of frequency of trades that occur in to its customized nature.
a particular futures contract. A
futures contract is more liquid as it
is traded on the exchange.

Counterparty default risk: In In forward contracts, counterparty

futures contracts, the exchange risk is high due to the customized
clearinghouse provides trade nature of the transaction.
guarantee. Therefore, counterparty
risk is almost eliminated.

Regulations: A regulatory authority A forward contract is not regulated

and the exchange regulate a futures by any exchange.
contract.
Benefits of Derivatives

a. Price Risk Management: The derivative instrument is the best way to hedge risk that
arises from its underlying. Suppose, ‘A’ has bought 100 shares of a real estate company
 with a bullish view but, unfortunately, the stock starts showing bearish trends after the
subprime crisis. To avoid loss, ‘A’ can sell the same quantity of futures of the script for
the time period he plans to stay invested in the script. This activity is called hedging. It
helps in risk minimization, profit maximization, and reaching a satisfactory risk-return
trade-off, with the use of a portfolio. The major beneficiaries of the futures instrument
have been mutual funds and other institutional investors.
b. Price Discovery: The new information disseminated in the marketplace is interpreted by
the market participants and immediately reflected in spot and futures prices by triggering
the trading activity in one or both the markets. This process of price adjustment is often
termed as price discovery and is one of the major benefits of trading in futures. Apart
from this, futures help in improving efficiency of the markets.
c. Asset Class: Derivatives, especially futures, offer an exclusive asset class for not only
large investors like corporates and financial institutions but also for retail investors like
high networth individuals. Equity futures offer the advantage of portfolio risk
diversification for all business entities. This is due to the fact that historically it has been
witnessed that there lies an inverse correlation of daily returns in equities as compared to
commodities.
d. High Financial Leverage: Futures offer a great opportunity to invest even with a small
sum of money. It is an instrument that requires only the margin on a contract to be paid in
order to commence trading. This is also called leverage buying/selling.
e. Transparency: Futures instruments are highly transparent because the underlying
product (equity scripts/index) are generally traded across the country or even traded
globally. This reduces the chances of manipulation of prices of those scripts. Secondly,
the regulatory authorities act as watchdogs regarding the day-to-day activities taking
place in the securities markets, taking care of the illegal transactions.
f. Predictable Pricing: Futures trading is useful for the genuine investor class because they
get an idea of the price at which a stock or index would be available at a future point of
time.

EXCHANGE PLATFORM
Domestic Exchanges
Indian equities are traded on two major exchanges: Bombay Stock Exchange Limited (BSE) and
National Stock Exchange of India Limited (NSE).
Bombay Stock Exchange (BSE) 
BSE is the oldest stock exchange in Asia. The extensiveness of the indigenous equity broking
industry in India led to the formation of the Native Share Brokers Association in 1875, which
later became Bombay Stock Exchange Limited (BSE).
BSE is widely recognized due to its pivotal and pre-eminent role in the development of the
Indian capital market.

 In 1995, the trading system transformed from open outcry system to an online screen-
based order-driven trading system.
 The exchange opened up for foreign ownership (foreign institutional investment).
 Allowed Indian companies to raise capital from abroad through ADRs and GDRs.
 Expanded the product range (equities/derivatives/debt).
 Introduced the book building process and brought in transparency in IPO issuance.
 T+2 settlement cycle (payments and settlements).
 Depositories for share custody (dematerialization of shares).
 Internet trading (e-broking).
 Governance of the stock exchanges (demutualization and corporatization of stock
exchanges) and internet trading (e-broking).

BSE has a nation-wide reach with a presence in more than 450 cities and towns of India. BSE
has always been at par with the international standards. It is the first exchange in India and the
second in the world to obtain an ISO 9001:2000 certification. It is also the first exchange in the
country and second in the world to receive Information Security Management System Standard
BS 7799-2-2002 certification for its BSE Online Trading System (BOLT).
Benchmark Indices futures: BSE 30 SENSEX, BSE 100, BSE TECK, BSE Oil and Gas, BSE
Metal, BSE FMCG

http://www.bseindia.com/
National Stock Exchange (NSE)
NSE was recognised as a stock exchange in April 1993 under the Securities Contracts
(Regulation) Act. It commenced its operations in Wholesale Debt Market in June 1994. The
capital market segment commenced its operations in November 1994, whereas the derivative
segment started in 2000. NSE introduced a fully automated trading system called NEAT
(National Exchange for Automated Trading) that operated on a strict price/time priority. This
system enabled efficient trade and the ease with which trade was done. NEAT had lent
considerable depth in the market by enabling large number of members all over the country to
trade simultaneously, narrowing the spreads significantly.
The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12,
2000. The futures contract on NSE is based on S&P CNX Nifty Index. The Futures and Options
trading system of NSE, called NEAT-F&O trading system, provides a fully automated screen
based trading for S&P CNX Nifty futures on a nationwide basis and an online monitoring and
surveillance mechanism. It supports an order-driven market and provides complete transparency
of trading operations.
Benchmark Indices futures: Nifty Midcap 50 futures, S&P CNX Nifty futures, CNX Nifty
Junior, CNX IT futures, CNX 100 futures, Bank Nifty futures
http://nseindia.com/
International Exchanges
Due to increasing globalization, the development at macro and micro levels in international
markets is compulsorily incorporated in the performance of domestic indices and individual
stock performance, directly or indirectly. Therefore, it is important to keep track of international
financial markets for better perspective and intelligent investment.

1. NASDAQ (National Association of Securities Dealers Automated Quotations)

NASDAQ is an American stock exchange. It is an electronic screen-based equity

securities trading market in the US. It was founded in 1971 by the National Association
of Securities Dealers (NASD). However, it is owned and operated by NASDAQ OMX
group, the stock of which was listed on its own stock exchange in 2002. The exchange is
monitored by the Securities and Exchange Commission (SEC), the regulatory authority
for the securities markets in the United States.
NASDAQ is the world leader in the arena of securities trading, with 3,900 companies
(NASDAQ site) being listed. There are four major indices of NASDAQ that are followed
closely by the investor class, internationally.

i. NASDAQ Composite: It is an index of common stocks and similar stocks like

ADRs, tracking stocks and limited partnership interests listed on the NASDAQ
stock market. It is estimated that the total components count of the Index is over
3,000 stocks and it includes stocks of US and non-US companies, which makes it
an international index. It is highly followed in the US and is an indicator of
performance of technology and growth companies. When launched in 1971, the
index was set at a base value of 100 points. Over the years, it saw new highs; for
instance, in July 1995, it closed above 1,000-mark and in March 2000, it touched
5048.62. The decline from this peak signalled the end of the dotcom stock market
bubble. The Index never reached the 2000 level afterwards. It was trading at
1316.12 on November 20, 2008.
ii. NASDAQ 100: It is an Index of 100 of the largest domestic and international non-
financial companies listed on NASDAQ. The component companies’ weight in
the index is based on their market capitalization, with certain rules controlling the
influence of the largest components. The index doesn’t contain financial
companies. However, it includes the companies that are incorporated outside the
US. Both these aspects of NASDAQ 100 differentiate it from S&P 500 and Dow
Jones Industrial Average (DJIA). The index includes companies from the
industrial, technology, biotechnology, healthcare, transportation, media, and
service sectors.
iii. Dow Jones Industrial Average (DJIA): DJIA was formed for the first time by
Charles Henry Dow. He formed a financial company with Edward Jones in 1882,
called Dow Jones & Co. In 1884, they formed the first index including 11 stocks
(two manufacturing companies and nine railroad companies). Today, the index
contains 30 blue-chip industrial companies operating in America. The Dow Jones
Industrial Average is calculated through the simple average, i.e., the sum of the
prices of all stocks divided by the number of stocks (30).
 iv. S&P 500: The S&P 500 Index was introduced by McGraw Hill's Standard and
Poor's unit in 1957 to further improve tracking of American stock market
performance. In 1968, the US Department of Commerce added S&P 500 to its
index of leading economic indicators. S&P 500 is intended to be consisting of the
500 largest publically-traded companies in the US by market capitalization (in
contrast to the FORTUNE 500, which is the largest 500 companies in terms of
sales revenue). The S&P 500 Index comprises about three-fourths of total
American capitalization.

http://www.nasdaq.com/

2. LSE (London Stock Exchange)

The London Stock Exchange was founded in 1801 with British as well as overseas
companies listed on the exchange. The LSE has four core areas:

i. Equity markets: The LSE enables companies from around the world to raise
capital. There are four primary markets; Main Market, Alternative Investment
Market (AIM), Professional Securities Market (PSM), and Specialist Fund Market
(SFM).
ii. Trading services: Highly active market for trading in a range of securities,
including UK and international equities, debt, covered warrants, exchange-traded
funds (ETFs), exchange-traded commodities (ETCs), REITs, fixed interest,
contracts for difference (CFDs), and depositary receipts.
iii. Market data information: The LSE provides real-time prices, news, and other
financial information to the global financial community.
iv. Derivatives: A major contributor to derivatives business is EDX London, created
in 2003 to bring the cash, equity, and derivatives markets closer together. It
combines the strength and liquidity of LSE and equity derivatives technology of
NASDAQ OMX group.
 The exchange offers a range of products in derivatives segment with underlying from
Russian, Nordic, and Baltic markets. Internationally, it offers products with underlying
from Kazakhstan, India, Egypt, and Korea.
http://www.londonstockexchange.com/en-gb/

3. Frankfurt Stock Exchange

It is situated in Frankfurt, Germany. It is owned and operated by Deutsche Börse. The

Frankfurt Stock Exchange has over 90 percent of turnover in the German market and a
big share in the European market. The exchange has a few well-known trading indices of
the exchange, such as DAX, DAXplus, CDAX, DivDAX, LDAX, MDAX, SDAX,
TecDAX, VDAX, and EuroStoxx 50.  
DAX is a blue-chip stock market index consisting of the 30 major German companies
trading on the Frankfurt Stock Exchange. Prices are taken from the electronic Xetra
trading system of the Frankfurt Stock Exchange.
http://deutsche-boerse.com/
REGULATORY AUTHORITY 
There are four main legislations governing the securities market:

a. The SEBI Act, 1992 establishes SEBI to protect investors and develop and regulate the
securities market.
b. The Companies Act, 1956 sets out the code of conduct for the corporate sector in relation
to issue, allotment, and transfer of securities, and disclosures to be made in public issues.
c. The Securities Contracts (Regulation) Act, 1956 provides for regulation of transactions in
securities through control over stock exchanges.
d. The Depositories Act, 1996 provides for electronic maintenance and transfer of
ownership of demat securities.

In India, the responsibility of regulating the securities market is shared by DCA (the Department
of Company Affairs), DEA (the Department of Economic Affairs), RBI (the Reserve bank of
India), and SEBI (the Securities and Exchange Board of India).
The DCA is now called the ministry of company affairs, which is under the ministry of finance.
The ministry is primarily concerned with the administration of the Companies Act, 1956, and
other allied Acts and rules & regulations framed there-under mainly for regulating the
functioning of the corporate sector in accordance with the law. 
The ministry exercises supervision over the three professional bodies, namely Institute of
Chartered Accountants of India (ICAI), Institute of Company Secretaries of India (ICSI), and the
Institute of Cost and Works Accountants of India (ICWAI), which are constituted under three
separate Acts of Parliament for the proper and orderly growth of professions of chartered
accountants, company secretaries, and cost accountants in the country.
http://www.mca.gov.in/
SEBI protects the interests of investors in securities and promotes the development of the
securities market. The board helps in regulating the business of stock exchanges and any other
securities market. SEBI is also responsible for registering and regulating the working of stock
brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars
to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, and such
other intermediaries who may be associated with securities markets in any manner.
The board registers the venture capitalists and collective investments like mutual funds. SEBI
helps in promoting and regulating self regulatory organizations.
http://www.sebi.gov.in
RBI is also known as the banker’s bank. The central bank has some very important objectives
and functions such as:
Objectives

 Maintain price stability and ensure adequate flow of credit to productive sectors.
 Maintain public confidence in the system, protect depositors' interest, and provide cost-
effective banking services to the public.
 Facilitate external trade and payment and promote orderly development and maintenance
of the foreign exchange market in India.
 Give the public adequate quantity of supplies of currency notes and coins in good quality.

 Functions
  Formulate implements and monitor the monetary policy.
 Prescribe broad parameters of banking operations within which the country's banking and
financial system functions.
 Manage the Foreign Exchange Management Act, 1999.
 Issue new currency and coins and exchange/destroy currency and coins not fit for
circulation.
 Perform a wide range of promotional functions to support national objectives.

http://www.rbi.org.in/home.aspx
The DEA is the nodal agency of the Union government to formulate and monitor the country's
economic policies and programmes that have a bearing on domestic and international aspects of
economic management. Apart from forming the Union Budget every year, it has other important
functions like:

i. Formulation and monitoring of macro-economic policies, including issues relating to

fiscal policy and public finance, inflation, public debt management, and the functioning
of capital market, including stock exchanges. In this context, it looks at ways and means
to raise internal resources through taxation, market borrowings, and mobilization of small
savings.
ii. Monitoring and raising of external resources through multilateral and bilateral
development assistance, sovereign borrowings abroad, foreign investments,
and monitoring foreign exchange resources, including balance of payments.
iii. Production of bank notes and coins of various denominations, postal stationery, postal
stamps, cadre management, career planning, and training of the Indian Economic Service
(IES).