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Introduction To Capital Markets - 1. By Prof. Shantanu Gokhale. Investments. Current commitment of money for a period of time - to derive future payments that compensate the investor for The time the funds are committed The expected rate of inflation The uncertainty of the future payments
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Introduction To Capital Markets - 1 By Prof. ShantanuGokhale
Investments • Current commitment of money for a period of time - to derive future payments that compensate the investor for • The time the funds are committed • The expected rate of inflation • The uncertainty of the future payments • Investor can be individual, a government, a pension fund or a company • “Investments” includes investments • by corporations in plant and equipment • by individuals in stocks, bonds, commodities or real estate
Financial Investments • Investment by individuals in stocks and bonds of corporations • Investors enter the securities market and exchange cash for financial instruments • Cash is exchanged between investors, no new capital reaches the corporations • No real investment occurs as result of this activity • Financial assets are claims to income generated by real assets • Financial assets are created and destroyed in the ordinary course of doing business
Real Investments • Occurs when a corporation takes capital and invests it in productive assets • Real investment is channeled in real assets which determines the productive capacity of the economy • Real assets are land , buildings, machines and knowledge necessary to produce goods together with the workers and their skills in operating these resources • Real assets are income generating assets • Real assets are destroyed by accident or by wearing out over time
Clients of the Financial System The Household Sector • Interested in wide array of assets • Differences in risk tolerance creates demand for assets with a variety of risk return combinations Business Sector • Need to raise money to finance their investment in real assets: plant, equipment & technological know how Government Sector • Governments require money to finance their expenditure • Restricted to borrowing - raise funds when tax revenues are not sufficient to cover expenditure • Government cannot sell equity
Stock Market /Capital Market Rationale for a Stock Market • Allows efficient distribution of consumption over time • People save money by postponing consumption • Market provides an avenue to set aside the money and let funds grow over time • Allows idle resources to be put to work • System has surplus units (with lots of income) and deficit units who need the funds • Market allows savings of surplus units to be converted to investments • Enables economic growth and hence creation of jobs • Breakdown of this mechanism is disastrous for the economy
Rationale (continued) • Enables efficient allocation of financial resources among competing users • Price of a Share is a function of future expected earnings • Depends on future investment opportunities and the ability of the firm to turn them into profit • Share price channels funds to companies with prospects and those without prospects do not receive funds • Stock Market provides Liquidity • A mismatch exists between Investors Investment Horizon and Planning Horizon of Project • Market allows people (financers) to come in and get out without affecting the financing of the project • Long Term Projects can be executed • STOCK MARKET HAS LEGITIMATE PURPOSE OTHER THAN THAT OF MAKING MONEY
Types of Capital Markets Primary Markets • Firms requiring capital to fund their growth sell(float) securities • This new issue of securities to the public is referred to as Primary Markets • Stocks are marketed to the public by Investment Bankers/Underwriters to the issue Secondary Markets • Purchase and Sale of already issued securitieswhich takes place at the Exchange
Players in the Market Investors/Hedgers • Markets owe their existence to them • Invest in various assets to reduce overall risk Speculators • In the market for Short Term • Ready to take high risks for high returns • Give Liquidity to the Market Arbitrageurs • Make money if securities are mis priced or when small price differences exist in different markets • Time Period in the market few minutes MARKET REQUIRES ALL OF THEM EACH HAS A ROLE TO PLAY- SYMBIOSIS!!!!!
Market Regulator Securities & Exchange Board of India (SEBI) • Set up in 1988, to create confidence in investors • To create an environment to facilitate the mobilization of adequate resources through the securities market and its efficient allocation • Done by introducing and implementing Rules & Regulations regarding transactions in the market • Caters to Issuers of Securities, Investors, Market Intermediaries • Prohibits fraudulent and unfair trade practices • Regulates substantial acquisition of shares and takeover of companies • Eg. Prior to SEBI, DCM & ESCORTS-Swaraj Paul
Capital Market location - Stock Exchanges Stock Exchanges in India are governed by Securities Contract Regulation Act (SCRA) Most popular Stock Exchanges in India National Stock Exchange (NSE) • Set up by IDBI and other Financial Institutions • No trading floor on this exchange • Trading is screen based Brokers are connected to the exchange by PC terminals • Membership is not a property right, members pay annual subscription fee • Screen based trading with automated order matching • System operates on a price time priority • Matching of orders is done by computers-transparent, objective fair
DEPOSITORY • Depository holds securities of investor in electronic form at the request of the investor through a registered Depository Participant(DP) • Depository is similar to a Bank • Holds securities in an account • Transfers securities between accounts on the instruction of the account holder • Facilitates transfer of ownership, no physical handling involved • Depositories registered with SEBI • NSDL National Securities Depository Ltd. • CDSL Central Depository Services Ltd
Dematerialization • Process by which physical certificates of an investor are converted into electronic form and credited into the investors account with his or her DP Delivery Instruction Slip(DIS) • Slip which instructs DP to deliver the said securities from ones account to the Brokers account • Similar to cheque book of bank account Transaction Statements • Statement giving the list of securities in ones account , typically received every quarter if no transactions or every month
Exercising Orders Bid Price • Price at which a dealer is willing to purchase a security Ask Price • Price at which Dealer will sell a security Market Orders • Instructions to the broker to buy or sell at the best price immediately available Limit Orders • Instructs a broker to buy or sell at a stated price or better • Specifies maximum /minimum investor is willing to accept Stop Order/Stop Loss Order • Used to limit the amount of losses or protect capital gains • can be used to sell securities automatically in case a major decline occurs in market
Market Intermediaries Broker • Buy and Sell securities for earning a commission • Price at which a dealer is willing to purchase a security Market Makers • A brokerage or bank that maintains a firm bid and ask price in a given security by standing ready, willing, and able to buy or sell at publicly quoted prices (called marking to market). • These firms display bid and offer prices for specific numbers of specific securities, and if these prices are met, they will immediately buy for or sell from their own accounts. • Market makers are very important for maintaining liquidity and efficiency for the particular securities that they make markets in
Merchant Banker/Investment Banker • Perform role of middleman, help companies raise(market) new capital/issues • Do all groundwork for new issues and give “Due Diligence” certificate to SEBI Registrar • Collect applications for new issues and computerize them • Make allotments in case of over subscription Underwriters • In case new issues are not fully subscribed, they make good the shortfall by their own subscriptions. eg. Infosys IPO 1993
Market Terminology Index • Statistical Indicator providing a representation of the value of the securities which constitute it. • Indices often serve as barometers for a given market or industry and benchmarks • Financial or economic performance is measured against indices Market Capitalization Weighted Index • Market value of a company is determined by multiplying the price of the stock by the number of shares outstanding • SENSEX represents the total market value of 30 component stocks • SENSEX calculated using Free Float Method • NIFTY calculated using total number of outstanding shares
SENSEX - Scrip selection criteria Listed History • Listing history of at least 3 months at BSE. • Exception if full market capitalization of a newly listed company ranks among top 10 in the list of BSE scrips. • merger/demerger/amalgamation, minimum listing history would not be required Trading Frequency • The scrip should have been traded on each and every trading day in the last three months.
SENSEX Criteria (continued) Final Rank The scrip should figure in the top 100 companies listed by final rank. 75% weightage to the rank on the basis of three-month average full market capitalisation & 25% weightage to the liquidity rank based on three-month average daily turnover & three-month average impact cost.
SENSEX Criteria (continued) Market Capitalization Weightage • The weightage of each scrip in SENSEX based on three-month average free-float market capitalisation should be at least 0.5% of the Index. Industry Representation • Scrip selection would generally take into account a balanced representation of the listed companies on BSE. Track Record • In the opinion of the Committee, the company should have an acceptable track record.
From Indian Express
Insider Information Material information about a company which is known by the company's board of directors, management, and/or employees but not by the public. SEBI forbids trading based on such information. Insider Trading Trading by insiders; or illegal trading by insiders who trade based on insider information • Long Position(Bullish) • Buying/Owning assets for their income and possible price appreciation • Short Position(Bearish) • Investor anticipates price of security will fall. Investor may sell the Security
Short Sale • Investor borrows shares from broker and sells them • Later investor must repurchase the shares in order to replace the shares that were borrowed. This is covering of short position Correction • A reversal of the prevailing trend in price movement for a security. The term is most often used to describe a decline after a period of rising prices. • A correction is often considered beneficial for the long term health of the market • Implies Prices had risen too quickly & the drop puts them back to more realistic levels.