Capital Markets

Section 3 – Secondary Markets

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 Objective
• Components of Secondary Markets
• Stock Exchange Reforms
• Role & Functions of SEBI
• Transaction Flow
• Margins
• Indices

2
•
Secondary Market
This is the market wherein the trading of securities is done after their listing
on the stock exchanges.

• Secondary market consists of both equity as well as debt markets.

• Securities issued by a company for the first time are offered to the public
in the primary market. Once the IPO is done and the stock is listed, they
are traded in the secondary market.

• The main difference between the two is that in the primary market, an
investor gets securities directly from the company through IPOs, while in
the secondary market, one purchases securities from other investors
willing to sell the same.

• Equity shares, bonds, preference shares, treasury bills, debentures,

government securities, etc. are some of the key products available in the
secondary market.

• SEBI is the regulator of both primary and secondary markets.

Introduction to Stock Markets -
https://www.youtube.com/watch?v=QcgRoq_tqec
Secondary Markets - https://www.youtube.com/watch?v=PKWUyZfK_ZQ

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 Functions
• Providing a market place: A stock exchange provides a market place for
purchasing and selling securities in the secondary markets. Investors would be
able to buy and sell securities at any time, as stock exchange provides the
facility for continuous trading in securities like shares, bonds, debentures etc.

• Continuous/active trading: Secondary markets maintain active trading so that

investors can buy or sell immediately at a price that varies little from
transaction to transaction. A continuous trading increases liquidity of the
assets traded in the secondary markets.

• Providing liquidity: An organized stock exchange provides the investors with a

place to liquidate their holdings meaning that securities can be sold in the
stock exchanges at any time.

• Media of asset pricing: Security price is determined by the transaction that

flow from investors’ demand and supply preferences. A secondary market
usually makes their transactions prices public that helps investors make better
decisions.
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 Functions
• Stimulate new financing: If the investors can trade their securities in a liquid
secondary market, they will be encouraged to invest in IPOs that will directly
help the issuing authority to collect new finance.

• Monitoring activities: Being a self-regulated system, a secondary market can

monitor the integrity of members, employees, listed firms, clients, and other
related bodies/persons.

• Provide risk premium: Without an active secondary market, the issuers would
have to provide a much higher rate of return to compensate investors for the
substantial liquidity risk.

• An indicator of the economy: An organized stock plays the role as an

indicator of the state of health of the economy of a nation as a whole.

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 Functions
• Savings-investment linkage: Providing the linkage between savings and
investment, stock exchanges help in mobilizing savings and channelizing
them into the corporate sector as securities.

Furthermore, the prevailing market price of the securities is being determined by

transactions made in the secondary market. New issues of outstanding securities
to be sold in the primary markets are based on the prices and yields in the
secondary market. Hence, the capital costs of the corporations are determined
by investor expectations and perceptions that are reflected in market price
prevailing in the secondary market. In addition to that, non-public IPOs may also
be priced based on the prices and values of comparable stocks or bonds in the
public secondary market.

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 Key Constituents of
Secondary Market
Buyers & Sellers:
• Investors: An investor is any person who commits capital with the expectation
of financial returns. Investors utilize investments in order to grow their money
and/or provide an income during retirement, such as with an annuity. A wide
variety of investment vehicles exist including (but not limited to) stocks, bonds,
commodities, mutual funds, exchange-traded funds (ETFs), options, futures,
foreign exchange, gold, silver, retirement plans and real estate. Investors
typically perform technical and/or fundamental analysis to determine
favourable investment opportunities, and generally prefer to minimize risk
while maximizing returns.

• Speculators: Speculators tend to predict price changes in more volatile

sections of the markets, believing, or speculating, that a high profit will occur
even if market indicators may suggest otherwise. Normally, speculators
operate in a shorter time frame than a traditional investor.

An investor is speculating if he believes that a company that has recently seen a

dramatic downturn, such as a highly negative press event or even a bankruptcy,
will make a quick recovery. The investor's subsequent investment in that
company makes him a speculator.
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 Key Constituents of
Secondary Market
• Arbitrageurs: Arbitrage is the process of exploiting differences in the price of
an asset by simultaneously buying and selling it in two or more different
markets. In the process the arbitrageur pockets a risk free return. Differences
in prices usually occur because of imperfect dissemination of information.

HOW IT WORKS (EXAMPLE):

For example, if Company XYZ's stock trades at INR 500 per share on the NSE and
the equivalent at INR 505 on the BSE, an arbitrageur would purchase the stock for
INR 500 on the NSE and sell it on the BSE for INR 505 -- pocketing the difference of
INR 5 per share.
Theoretically, the prices on both exchanges should be the same at all times,
but arbitrage opportunities arise when they're not. In theory, arbitrage is a riskless
activity because traders are simply buying and selling the same amount of the
same asset at the same time.

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 Buyers & Sellers
• Open a broking account with one or more brokers after completing “KYC”
documentation
o “KYC” – (Know Your Client): Identity proof , address proof ,contact details
and bank account details
o onus is on the broker to check that clients with genuine identity transact
on the exchanges with genuine sources of funds
• Broker gives a Unique Client Code (UCC) by which the exchange recognizes
the client
• Buyers/ Sellers set up Broking account/ Demat Account
• Demat account is set up with a depository participant (DP) (i.e., member of a
Depository organization), usually most brokers are also DPs.
• Demat account holds securities in the “demat” form. Depositories are the
organizations which convert paper securities into the electronic form i.e.,
dematerialize securities.
• DPs provide the customer interface on behalf of the depository organization.

Purchase /sale orders of securities -

• confirmations of trades when executed,
• debit/credit of securities and funds
o all usually happen electronically
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 Transaction Flow
• Client gives order to the broker over recorded phone line, through
email.
• Client may also directly place order over internet on the broker’s
online interface/ portal (e.g., I-Direct) which, in turn, gets connected
with the exchange.
• For a “buy” order, broker checks whether there are sufficient funds in
the client’s account. If yes, broker places order on the on-line system
provided by the exchange.
• For a “sell” order, broker checks whether there are sufficient shares in
the demat account of the client.
• Orders are good for one trading day.
• Institutional clients can access the exchange directly , this facility is
called Direct Market Access (DMA) – this helps them in terms of
speed of execution and better pricing. DMA is offered by the
exchange through a member broker.

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Types of Orders – Market Order
• Orders can be of the following types :
o Market order: It is essentially an instruction to your broker to execute a buy or a sell
immediately at market prices. The market prices could be whatever but you're
instructing your broker to buy or sell. Depending on which hat you're wearing, either
of a buyer or a seller, as long as there are other willing buyers or sellers of the stock
you want to acquire or dispose of, your order should be quickly carried out, or would
be. More of them are quickly carried out. Your buys will always be executed at the
best ask price, and your sells will be executed at the best bid price. If there is no
market at that point of time, it takes the last traded price and remains in the system.

Example:
As an investor you see the price, and you want to buy or sell at as close to that price as
possible. However, someone still needs to “fill” your order for it to go through; just
because you want to buy 50 shares of a stock does not mean that there are 50 people
willing to sell them to you.
For a market order, it is also possible for you to get a different price for each individual
stock you buy. For example, lets say that the “last price” of a stock ABC that you want
to buy is INR 800, and you place a market order for 50 shares.
It could be that there is only 10 shares of that stock for sale left at INR 800, all the other
sellers are trying to sell at INR 820. This means that the first 10 shares you buy will be INR
800, and the next 40 will be at INR 820, giving you an average price of INR 816!

Different types of orders - https://www.youtube.com/watch?v=vENGp8Ivo8E

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 Market order - Example
• At time t = 0, LTP is INR 800 Pre-transaction
• You want to buy 100 shares at Bids Ask /Offer
INR 795
Qty Price Qty Price
• The best offer you get is 50
Shares for INR 803 in case of all 100 795 50 803
or none 50 794 150 804
200 792 200 805
• If the seller is ready to sell
partially, you will buy 50 Shares Post-transaction (partial sale)
at INR 803 and remaining 50
Bids Ask / Offer
shares at INR 804
• LTP then is INR 804. if the case if Qty Price Qty Price
the seller was ready to sell 50 794 100 804
partially 200 792 200 805

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 Types of Orders – Limit Order
o Limit order : It is an order where the user specifies the price at (or better than) which the
trade should be executed.
o When you place a limit order, you're essentially asking your broker to buy a stock at no
more than or sell a stock at no less than a specified price that you set.
• Limit Order to Buy = at or below the market
• Limit Order to Sell = at or above the market
When you are buying, the limit price specifies the highest price you are willing to pay for that
stock; if your limit price is already above the current price, it works like a market order
For example, lets say there is a stock you want to buy, its current price is INR 55. You want to
buy it only if the price falls to INR 50 or below, so you will place a buy-limit order at INR 50.
Your order will stay open, and if the price falls to INR 50, it will execute.
For “Sell” orders, it works in the opposite direction: you specific the minimum price you want
to sell it at. If the market price goes above that price, your order will execute.

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 Lets Explore
• Suppose you decide that you want to buy shares of ABC. At a price
of let's say INR 44.25 when it's currently trading at like say INR44.45.
what order would you place?
• Buy Limit. You would place a limit buy order for INR44.25 which
should get filled if the price drops down to INR44.25 or if the price
drops lower.

• Now once you buy the shares, you might want to sell at say, INR45.
Which order will you place?
• Sell limit order. Your order should fill if the price gets to INR45 or
higher.

• Let's say you want to buy a security for INR10.00 or less. You will only
purchase the security if it trades at INR10.00 or less.
• Buy Limit Order

• Let's say you want to sell a security for INR 20.00 or more.
• Sell Limit Orders
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 Types of Orders – Stop Order
• A “Stop” order is when you want to prevent yourself from losing too much money
on a position, which is why they are also called “Stop Loss” orders. For buying, you
want to make sure you get it before the price goes too high and you miss out, and
for selling you want to sell it before the price drops too low and you lose too much
money.

• Stop loss order: It is an order placed which is kept by the system in suspended
mode and will be visible to the market only when the market price of the relevant
security reaches or crosses a threshold price, which is called as trigger price as
defined by the member. It is used as a tool to limit the loss. A buy stop order is
placed above the market, and a sell stop order is placed below the market (i.e., at
the stop loss price the order gets triggered and gets executed either at market
price on the next tick or at the limit price specified)
• Stop orders work the exact opposite of limit orders, you specify a price and your
order will execute if the price falls below that.
• For buying, you would use a “Stop” order if you are thinking about buying a stock,
but don’t want to buy it until the price starts to go up (momentum buying). In this
case, you would set a “Stop” order above the market price, and as soon as the
market price goes above your stop price, your order will execute.
• For selling, it works as a “loss prevention”, you would set your stop price at the point
where you want to sell it if the price keeps falling, because you think that if it falls
that far, it will continue falling (e.g. Manpasand Beverages – auditor resignation).
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 Lets Explore
Let's assume that you own 100 shares of Company
XYZ stock, for which you have paid INR100 per share. You
are expecting the stock to hit INR112 sometime in the next
month, but you do not want to take a huge loss if
the market turns the other way.
You direct your broker to set a stop-loss order at INR 85. If
the stock goes up, you will realize all of the benefits. If
the stock goes down and touches INR 85,
your broker will automatically place a market order to sell
your shares.
It is important to note that when the stop-loss order is
triggered, it becomes a market order. You will not
necessarily receive INR 85 per share; you will most likely
receive a little more or a little less.

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 Lets Explore
• When you place a stop order, what are you asking??
you are asking to buy a stock once a higher price point is reached. Or to
sell a stock once a lower stock price has been reached.
• Suppose you bought your ABC stock at say, INR 44.25, and expecting
that the stock will go up to INR45.00, however, there is a negative event
that has occurred and you fear that markets will turn around for ABC
stock and you ask your broker to sell at INR 43.75 as you don’t want to
bear too much of loss. What is this order known as and what would you
do??
This is known as Stop Loss Order. You would sell your ABC shares if the
price dropped to INR 43.75
• Stock price of ABC is moving in a range of INR 44.25 and INR 44.50. The
maximum bid price for this stock is INR 44.60. You wish to buy the stock at
INR 44.25, however you do not wish to miss the opportunity to buy if the
stock price breaks the range and move higher. What order would you
use and why?
You will use STOP BUY ORDER, so that you could still be able to buy the
stock if the price breaks the range and is at INR 44.60, even if you could
not it buy at INR 44.25

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 Lets Explore
• Now, lets take an example of Vinod who bought the stocks of a
company XYZ at INR 50 and has placed a sell order at INR 55. But,
suddenly negative rumours on this stock are doing rounds in the market
and Vinod does not want to make a loss of more than 5% on XYZ, if the
stock price starts declining. Which order will he place?
Vinod will place a STOP – LOSS order and enter a STOP PRICE of INR 47.50.
If the price fall below INR 50 and becomes INR 47.50, the STOP – LOSS
order gets triggered and will become a market order.
• Now let’s take an example of Suraj who believes that the price of XYZ will
fall sharply intraday. So, he shorts the shares of XYZ i.e. he first sells the
shares of XYZ at say INR 60 to buy it later during the day at say INR 45. But,
being an old hand he know that prices are volatile and he does not wish
to make a loss of more than 10% on the sale price if the prices go above
INR 60 during a volatile session. Which order will he place?
Suraj will place a STOP LOSS BUY order to buy the stock at any price up to
INR 66.

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 Limit Order Vs Market
Order & Stop Order
Limit Order
You have to specify buying or selling price
Order is submitted when the price level
reaches trigger price
Limit Order
Trade at a price equal to or better than a
certain price. For buy orders, buy at INR X or
lower. For sell orders, sell at INR X or higher
Investors use limit orders to lock in the price
they want because limit orders are
guaranteed to execute (if they execute at
all) at a particular price or better
Market Order
You do not have to specify any price and
order is executed at market price
Order is submitted instantaneously and
executed as well
Stop Order
Trade if price moves beyond the desirable
target. For sell orders, sell if price falls below
INR X. For buy orders, buy if price climbs
above INR X.
The intent of a stop order is to limit losses. If a
stock’s price is moving in a direction opposite
of what the investor would like, a stop order
places a ceiling on potential losses.
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 Lets Explore
• A buy limit order for Bharti Airtel at INR. 410 will buy shares of the company at???
INR 410 or less
• A sell limit order for Infosys when the CMP is 500 will sell shares of the company at???
INR 500 or more
• You call your broker and ask for market price of HDFC Bank, your broker reports to you that the
best bid price is INR 400 and the best offer price is INR 408. What does this mean???
It means that as an investor you would need to pay INR 408 to purchase a share of HDFC Bank
and as a seller you will get INR 400
• If the offer price is good up to 1000 shares, but you want to buy 1500 shares, would the price be
the same for all 1500 shares bought under Market order?
• No
• LTP at T = 0 is INR 500
o What is the best offer? 503
o Break up of 200 shares at various price levels
• 140 at 503 and 60 at 504
o What will be the LTP
• LTP will be 504 in case the seller agrees
for partial sale
• LTP in case of ALL OR NONE scenario : 503

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 Order Queuing and T+2 settlement
• Order queuing:
o Exchange system queues up the orders received online from all across its
“screens” in the “price-time” priority i.e., the highest price “bid” on top.
Among the same price bids, first received on top.

• Once the order is executed ( i.e., “traded”), trade confirmation goes to broker
and in turn to the customer.

• Broker debits client ledger account for the funds required for the purchase
(‘called “pay-in” of funds) and credits securities bought in the client’s demat
account (“pay-out” of securities). The whole cycle is completed in 2 working
days (called rolling T+2 settlement).

• Likewise, broker debits the demat account for the securities in case of ‘sell”
order (“pay in” of shares) and credits client’s ledger account for the funds
received on the sale of the security (“pay-out” of funds).

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1. Trade details from Exchange to NSCCL (real-time and end of day trade fi le).
2. NSCCL notifies the consummated trade details to clearing members/custodians who affirm back.
Based on the affirmation, NSCCL applies multilateral netting and determines obligations.
3. Download of obligation and pay-in advice of funds/securities.
4. Instructions to clearing banks to make funds available by pay-in time.
5. Instructions to depositories to make securities available by pay-in-time.
6. Pay-in of securities (NSCCL advises depository to debit pool account of custodians/CMs and credit its
account and depository does it)
7. Pay-in of funds(NSCCL advises Clearing Banks to debit account of custodians/CMs and credit its
account and clearing bank does it)
8. Pay-out of securities (NSCCL advises depository to credit pool account of custodians/CMs and debit
its account and depository does it)
9. Pay-out of funds (NSCCL advises Clearing Banks to credit account of custodians/CMs and debit its
account and clearing bank does it)
10. Depository informs custodians/CMs through DPs.
11. Clearing Banks inform custodians/CMs 22
23
 Transaction Flow
• Periodically, broker is required to pay the ledger
balance in the client’s ledger account to the client
by way of transfer of funds to the designated bank
account of the client.
• Obligations at the aggregate level for the clients
are settled by the member broker with the
exchange.
• In the event of shortfall of security for any client
o Shares are purchased from the “auction”
o Shares can be borrowed on the exchange from another investor

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 Auction
• In the equity segment, shares can be sold for delivery only if the shares are
available in the demat account of the client. The client needs to transfer the
shares to the Exchanges – BSE or NSE on T+2 days. If the client fails to transfer
the shares within the stipulated time, such transaction results into default of
pay-in obligation and short delivery of shares.
• The buyer of the shares is the rightful acquirer of the shares and the shares
needs to be transferred to his account. Since the seller has defaulted in
delivery of the shares, the exchange would put the undelivered shares for
“Auction”. This Auction will happen on the T+2 day itself.
• In the auction session, people who already have shares in the demat account
can offer their shares. The auction window time is between 2.00 p.m. to 2.45
p.m. Clients of the broker where the default has happened cannot
participate for the auction in the same script. The auction price is taken at the
lowest price offered in the auction. The highest price would be not more than
120% and not less than 80% of the closing price of the T+1 day i.e. the previous
day prior to settlement day. If the shares are offered, the shares are given to
the buyer of the shares on T+3 day. The seller has to pay the price for the
shares offered in the auction, which is generally higher than the market price
prevailing on the day.
• For example above, in an auction of shares of Infosys where the closing price
was 1000, fresh seller can offer to sell 100 shares of Infosys in the Auction
market in the range of 800 to Rs.1200 (+/- 20% above 1000).
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• Auction - https://www.youtube.com/watch?v=hYREyoh8vgE
 Securities Lending and
Borrowing Mechanism (SLBM)
It is a system in which a trader can borrow shares that they do not
already own or can lend the stocks that they own.
An SLB transaction has a rate of interest and a fixed tenure.

Why do traders do it?

Traders borrow stocks to short-sell them in the market.
Short selling means the sale of a stock, the trader does not own.
Short selling can be done by institutional investors and retail investors.
The SLB mechanism in turn allows short sellers to borrow securities for
making delivery.

Only the stocks which are trading on the F&O segment are allowed on
SLB and the contract period for lending can vary between immediate
expiry(1 month) upto 12 months. Usually the maximum liquidity for
borrowing and lending will be for 1 month.
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 Securities Lending and
Borrowing Mechanism (SLBM)
How does SLBM work?
For example, you have a negative view on the price of a stock. You can
borrow shares from SLB and sell them. You can buy them back if and
when the price falls. Your profit is the difference between the selling
price and the buying price, after deducting the interest rate.
Let’s say stock price of Company Z is trading at Rs. 200. You decide to
short sell 100 shares of Z for a total of Rs. 20,000.
Suddenly, disappointing quarterly profits cause the share price of Z to fall
to Rs. 190. You can now buy 100 shares of Z for Rs. 19,000.
You then return the shares of Co. Z to the lender who accepts the return
of the same number of shares lent, regardless of the fact that the shares
prices have fallen.
You retain the Rs. 1,000 difference (minus interest and other costs). You
make a profit.
SLBM - https://www.investopedia.com/terms/s/securitieslending.asp
Short Selling - https://www.youtube.com/watch?v=Z1LctxzEREE
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 Trading System
Order Driven Market:
• An order driven market is a financial market where all buyers and sellers
display the prices at which they wish to buy or sell a particular security, as well
as the quantities of the security desired to be bought or sold.
• The biggest advantage of an order driven market is transparency, since the
entire order book is displayed for investors who wish to access this information.
• Most exchanges charge fees for such information.
• On the other hand, an order driven market may not have the same degree of
liquidity as a quote driven market as the trade is executed when the Best Bid
matches the best offer.

Orders get queued in terms of price and time priority

o Buy orders (called bids) are queued in the decreasing order of the price,
same price orders in time priority
o Sell orders (called offers) are queued in increasing order of price
o When the best bid matches the best offer, trade is executed

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29
 Trading System
Quote Driven Market:

• A quote driven market is an electronic stock exchange system in which prices

are determined from bid and ask quotations made by market makers, dealers
or specialists.

• A quote driven market is more liquid but lacks transparency.

• Market maker offers two way quotes i.e., quotes to the buyers and the sellers.

• These quotes are continuously adjusted reflecting the relative demand/supply

of the scrip

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 Open Positions
• An open position in investing is any trade, established or entered, that has yet
to be closed with an opposing trade.

• An open position can exist following a buy, or long, position or a sell, or short,
position. In either case, the position remains open until an opposing trade
takes place.

• It represents market exposure for the investor.

• It contains risk that can only be eliminated by closing the position.

• Open positions can be held from minutes to years depending on the style and
objective of the investor or trader.

• Portfolios are composed of many open positions.

• The amount of risk entailed with an open position depends on the size of the
position relative to the account size and the holding period. Longer holding
periods entail more risk due to more exposure to unexpected events specific
to the stock, sector or overall market conditions.
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 Open Positions
• The only way to eliminate exposure is to close out the open positions.

• Closing a short position requires buying back the shares, while closing long
positions entails selling the long position.

For example, an investor who owns 500 shares of a certain stock is said to have
an open position in that stock. When the investor sells those 500 shares, the
position is closed. Buy-and-hold investors generally have one or more open
positions at any given time. Short-term traders may execute "round-trip" trades; a
position is opened and closed within a relatively short period of time. Day Traders
may even open and close a position within a few seconds, trying to catch very
small, but frequent, price movements throughout the day.

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 Margins
• Margins are fund balances required from a customer by a broker
(and from a broker by an exchange) to initiate transactions and also
to maintain “open positions”
Initial Margins - https://www.investopedia.com/terms/i/initialmargin.asp

• Margins are the advance funds given by customers to brokers and

brokers to exchanges

• Margins mitigate the risk of default by customers to brokers / brokers

to exchanges

• Refer to Margins document shared separately

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 Why should there be
margins?
Just as we are faced with day to day uncertainties pertaining to weather, health, traffic, etc.
and take steps to minimize the uncertainties, so also in the stock markets, there is uncertainty
in the movement of share prices.
This uncertainty leading to risk is sought to be addressed by margining systems of stock
markets.

Suppose an investor, purchases 1000 shares of ‘xyz’ company at Rs.100/- on July 1, 2017.
Investor has to give the purchase amount of Rs.1,00,000/- (1000 x 100) to his broker on or
before July 2, 2017. Broker, in turn, has to give this money to stock exchange on July 3, 2017.
There is always a small chance that the investor may not be able to bring the required money
by required date. As an advance for buying the shares, investor is required to pay a portion
of the total amount of Rs.1,00,000/- to the broker at the time of placing the buy order.
Stock exchange in turn collects similar amount from the broker upon execution of the order.
This initial token payment is called margin.
Remember, for every buyer there is a seller and if the buyer does not bring the money, seller
may not get his / her money and vice versa.
Therefore, margin is levied on the seller also to ensure that he / she gives the 100 shares sold
to the broker who in turn gives it to the stock exchange.

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 Why should there be
margins?
Margin payments ensure that each investor is serious about buying or selling
shares.

In the above example, assume that margin was 15%. That is investor has to give
Rs.15,000/-(15% of Rs.1,00,000/) to the broker before buying. Now suppose that
investor bought the shares at 11 am on July 1, 2017. Assume that by the end of
the day price of the share falls by Rs.25/-. That is total value of the shares has
come down to Rs.75,000/-. That is buyer has suffered a notional loss of Rs.25,000/-.
In our example buyer has paid Rs.15,000/- as margin but the notional loss,
because of fall in price, is Rs.25,000/-. That is notional loss is more than the margin
given.
In such a situation, the buyer may not want to pay Rs.1,00,000/- for the shares
whose value has come down to Rs.75,000/-. Similarly, if the price has gone up by
Rs.25/-, the seller may not want to give the shares at Rs.1,00,000/-
To ensure that both buyers and sellers fulfill their obligations irrespective of price
movements, notional losses also need to be collected from buyer/ seller by way
of margins.
Prices of shares keep on moving every day. Margins ensure that buyers bring
money and sellers bring shares to complete their obligations even though the
35
prices have moved down or up.
 Types of Margins
Margins in the cash market segment comprise of the following
three types:

1) Value at Risk (VaR) margin - To cover the value at risk for the
trade to be initiated

2) Extreme loss margin - To cover possibilities of extreme loss

situations for the trade to be initiated

3) Mark to Market Margin - Required to maintain an open

position
Types of margins -
https://www.motilaloswal.com/video-detail/4/40/Different-types-
of-margins

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 VaR Margin
VaR is a technique used to estimate the probability of loss of value of an
asset or group of assets (for example a share or a portfolio of a few
shares), based on the statistical analysis of historical price trends and
volatilities.

A VaR statistic has three components:

• a time period,
• a confidence level and
• a loss amount (or loss percentage).

Keep these three parts in mind and identify them in the following
example:

With 99% confidence, what is the maximum value that an asset or

portfolio may loose over the next day”?

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 VaR Margin
Example:
Let us assume that an investor bought 400 shares of XYZ company @ RS 1000 per share. Its
total value today is Rs.4 lakhs. Obviously, we do not know what would be the market value of
these shares next day.

An investor holding these shares may, based on VaR methodology, say that 1-day VaR is
Rs.50000 at the 99% confidence level.
This implies that under normal trading conditions the investor can, with 99%confidence, say
that the value of the shares would not go down by more than Rs.50000 within next 1-day.
Therefore what would be the VaR margin??
12.5%

Why 12.5% ?
In simple terms, it is observed historically that the drop in the price of XYZ company over 1
day period has been less than 12.5% on 99% of the days.

In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss
(in %) that may be faced by an investor for his / her shares (both purchases and sales) on a
single day with a 99% confidence level. The VaR margin is collected on an upfront basis (at
the time of trade).
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 Extreme Loss Margin
• It aims at covering the losses that could occur outside the coverage of
VaR margins.
• It is higher of 1.5 times the standard deviation of daily LN returns of the
stock price in the last six months or 5% of the value of the position
whichever is higher.
• This margin rate is fixed at the beginning of every month, by taking the
price data on a rolling basis for the past six months.

Example:
In the Example given above, the VaR margin rate for shares of XYZ company
was 12.5%.
Suppose that standard deviation of daily LN returns of the security is 2.7%.
Then 1.5 times standard deviation would be 1.5 x 2.7% = 4.05%
Then 5% (which is higher than 4.05%) will be taken as the Extreme Loss margin
rate.
Therefore, the total margin on the security would be 17.5% (12.5% VaR
Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR
margin + extreme loss margin) on a trade of Rs.4 lakhs would be Rs. 70,000.

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 Mark – to – Market
Margin
Mark to market (MTM) is a measure of the fair value of accounts that can change over
time, such as assets and liabilities. Mark to market aims to provide a realistic appraisal
of an institution's or company's current financial situation. It is calculated at the end of
the day on all open positions by comparing transaction price with the closing price of
the share for the day.

Example:
Mr. Dayal purchased 1000 shares of PQR Ltd. @ Rs.100/- at 11 am on July 1, 2017. If
close price of the shares on that day happens to be Rs.85/-, then the buyer faces a
notional loss of Rs.15,000/- on his buy position. In technical terms this loss is called as
MTM loss and is payable by July 2, 2017 (that is next day of the trade) before the
trading begins.
In case price of the share falls further by the end of July 2, 2017 to Rs. 80/-, then buy
position would show a further loss of Rs.5,000/-. This MTM loss is payable by next day.
In case, on a given day, buy and sell quantity in a share are equal, that is net quantity
position is zero, but there could still be a notional loss / gain (due to difference
between the buy and sell values), such notional loss also is considered for calculating
the MTM payable.

MTM Profit/Loss = [(Total Buy Qty X Close price) – Total Buy Value] - [Total Sale Value -
(Total Sale Qty X Close price)]

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Role & Functions of SEBI
o Regulating the business in stock exchanges

o Registering and regulating organizations under its purview

o Prohibiting fraudulent and unfair trade practices relating to the securities

market

o Promoting investors’ education and training of intermediaries of the securities

market

o Prohibiting insider trading in securities

o Regulating substantial acquisition of shares and takeover of companies

o Calling for information from, undertaking inspection, conducting inquiries and

audit of the organizations under its purview

o Calling for information and record from any bank, authority, board or
corporation in respect of any transaction in securities which is under
investigation or inquiry

o Performing functions under the provisions of SCRA

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 Role & Functions of SEBI
• Legal framework
o The Securities Contracts (Regulation) Act, 1956
• As amended by The Securities Laws(Amendment) Act, 2014
o The Securities and Exchange Board of India, 1992
• As amended by The Securities Laws(Amendment) Act, 2014
o The Depositories act,1996
• As amended by The Securities Laws(Amendment) Act, 2014
o Company Law Regulations

• The framework covers

o Powers and Functions of SEBI
o Issuance, listing and corporate actions on securities
o Recognition of stock exchanges
o Regulations for the financial intermediaries under the purview of SEBI
o Ombudsman regulations – Ombudsman is quasi-judicial authority
appointed to redress public complaints regarding deficiency of service

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 Indices
An Index is used to give information about the price movements of products in the financial,
commodities or any other markets. Financial indexes are constructed to measure price
movements of stocks, bonds, T-bills and other forms of investments. Stock market indexes are
meant to capture the overall behaviour of equity markets. A stock market index is created by
selecting a group of stocks that are representative of the whole market or a specified sector
or segment of the market. An Index is calculated with reference to a base period and a base
index value.

Types of Indices
• Broad market indices
• Sectoral indices
• Thematic Indices
• Strategy Indices
• Fixed Income Indices
• Hybrid Indices

https://www.nseindia.com/products/content/equities/indices/indices.htm
http://www.asiaindex.co.in/#

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• Broad Market Indices: These indices are broad-market
indices, consisting of the large, liquid stocks listed on the
Exchange. They serve as a benchmark for measuring the
performance of the stocks or portfolios such as mutual
fund investments.
• Sectoral Indices: Sector-based index are designed to
provide a single value for the aggregate performance
of a number of companies representing a group of
related industries or within a sector of the economy.
• Thematic Indices: Thematic indices are designed to
provide a single value for the aggregate performance
of a number of companies representing a theme.
• Strategy Indices: Strategy indices are designed on the
basis of quantitative models / investment strategies to
provide a single value for the aggregate performance
of a number of companies.

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• Fixed Income Indices: Fixed income index is used to
measure performance of the bond market. The
fixed income indices are useful tool for investors to
measure and compare performance of bond
portfolio. Fixed income indices also used for
introduction of Exchange Traded Funds.
• Hybrid Indices: NIFTY Hybrid Index series seeks to
track the performance of a hybrid portfolio having
pre-defined exposure to equity and fixed income
assets.

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 Uses of Indices
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.

• 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

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