134 || Finance for Everyone 5.1 INTRODUCTION We all know that money doesn’t grow on tre It can grow only when itis saved and invested prudently. While saving means setting aside money for future, investing means putting your money in assets which are likely to earn return. One may invest in physical assets like real estate, gold, and commodities etc,, or buy financial assets such as deposits with banks, saving instruments of post office, insurance schemes, pension funds, provident fund, or securities market instruments such as shares, debentures, and bonds etc, Investment in securities in the securities market is fast becoming popular mode of investment due to promising retum and liquidity. Buying and seling of securities is no'longer a complex mechanism, With evolving technology, it has become much easier and fast ‘Today, itis important to know the important terms pertaining to securities market before one start investing. It will help investor to'understafid markéts and theif fictioning. Further, it will help them to make informal choices. So let us study and understand the important terms pertaining to securities market in this chapter. 5. SECURITIES MARKET ‘The market in which securities are issued, purchased, and transferred among buyers and sellers is called as the securities market. {t has two segments ic. the primary market and secondary (Stock) market. New securities are sold in the primary market. However, sale and purchase of already existing securities is done in the secondary market. The primary market creates new securities which are traded in secondary markets. The securities Bought and sold include shares, debentures, bonds, derivatives, and mutual fund units. On the one hand, the securities market provides medium to corporate organisations to raise capital, by issue of securities, on the other they provide investment, ‘opportunities, and liquidity to investor. 5.3 MEANING OF SECURITY Security is a financial instrument with monetary value which can be ‘bought and sold or traded. Securities are issued by a corporate organization ot a government ntity to raise funds. They allow widespread ownership, easy transfer, dispersion of wealth and simplified investment for investors. It is an opportunity for investors to earn on their money. It allows separation of ownership and management and provides broader source of capital to the issuing company. Securities are one of the key elements in the financial structure of an economy. Issue of securities creates the need for security markets which allows more efficient allocation of resources, provides liquidity and opportunity to get return, This pives a boost to the economic growth of a nation. 5.3.1 Types of Securities As per section 2 of the Securities Contracts (Regulation) Act, 1956, Securities includes (2) Shares, scrips, stocks, bonds, debenturds, debentures stock o* other marketable securities of a like nature in or of any incorporated company or other body corporate (6) Derivativesi \ Stock Market || 135 (c) Units (d) Security receipt (6) Government s uritie (0) Rights or interests in scurities (8) And such other insteuments as miay be dec lared by the Central Government to be securities, From investor's point of view, we can divide securities in four heads () Ownership secure (ii) Debt securities ic,, debentures and bonds (iii) Derivatives, and oo iv) Mutual Fund units. 5.3.1.1 Ownership Securities Ownership seeurities are repre: ing long term funds by 2 eorporate organization. To raise ands a company can issue a unit of ownership called as share, Share represents an equal proportion of a Conipany’s shares capital, ‘The investors who buy these shares are known as shareholders, A company issues a certificate to every shareholder under the common seal of the company certifying that le is the owner of the company shares and how many “shares are held by him. ‘Acompany can issue two types of shares ie (i) Equity shares, and (ii) Preference shares, 5.3.1,1.1 Equity Shares Equity shares constitute the major portion of the share capital of the company. They get no special rights or restrictions, They have the potential to get the highest income but also take the highest tisk. Euity shareholders are the legal owners ofthe busines. They provide the permanent capital to the corporate organization and bear the risk of ownership. When a Company is formed it issued equity shares to the promoters. The first issue of equity shares { (othe public is made for additional capital. This is called as Initial public Offering (1PO), Subsequent issues are called as further issues, Features of Equity Shares * Maturity: Equity shares arenot redeemed during the ie of the organization, Equity sharcholders are paid back ony in the event of winding up ofthe company, * Claim on assets: Equity sharcholders have residual claim on the assets of the business, that is, in the case of liquidation their claim is settled alter ‘meeting all the debt liabilities and Payment to preference sharcholders. Hence, only the remaining balance of assets belongs to thera * Rightto income: Equity shareholders have residual claim on income too. They are pai aid divider out of carnings available to them after. mM Saeed etn all operating cha also after paying dividend to preference ges and financial charges and shareholders, The rate of dividend is not fixed on these136 || Finance for Everyone shar and depends upon the discretion of board of directors, Therefi called ‘variable equity shares are also come securities’, + Right to control: ‘quily shareholders have the right to control the allairs of the business through voting rights. The company’s management, that is, board of directors, are appointed by the equity share-holders in their annual general meeting, Each equity share gets one vote So higher the number of equity shares, an equity sharcholder possess, higher will be his voting tight. Voting rights are accessed by the equity shareholders in the annual general meeting on all important issues pertaining to the busines + Pre-empti right: The pre-emptive right is the right available to equity shareholder to purchase farther shares in proportion to their existing shareholding in case the company is making further issue of fesh equity shares, The pre-eptive right protects the controlling power ofthe existing shareholders. However, a shareholder has the right to decline the“right offer’ or renounce it in favour of some other person. + Limited liability: The liability of the equity shareholder is limited to the value of equity share they have purchased. If the Company makes losses, they are not required to pay for it, so the liability ofan equity sharcholder is different from a sole proprietor or a partner who has unlimited liability. Once a shareholder has paid the issue price of the equity share he is not required to pay anything even at the time of liquidation of the company. ‘To sum up, Equity shares are a high-tisk reward sources of finance. The equity shate-holders share, the risk, return and control of the ownership of the company. 5.3.1.1.2 Preference Shares Preference shares are those ownership securities which have two preferences over the equity shares. These two preferences are: 1. In the case the company declares dividend, they have preference over equity sharcholders to receive dividend first ata pre decided rate 2. In the case of liquidation of the company, the capital of preference shareholders is repaid before anything is paid to the equity sharcholders. Features of Preference Shares Preference shares are of various types. However, there are many features which are common among all types of preference shares. These significant features ate as follows: * Maturity: With effect from March 1997, a company can issue only redeemable preference shares with a maximum maturity period of 20 ycar, even though previously companies have issued itredeemable preference shares too. + Claims on assets: At the time of winding up, preference shares have prior claim on assets than equity shares. After paying all the creditors, the preference sharcholders are returned their capital first. + Right (0 income: Unlike equity shares, preference shares are.entitled to a fixed rate of In’: freedom 5312 Borrowe a specifi agreed For: asthefo source o| source Deb Bonds a Feature oydividend decided at the time of issue of such shares. Dividend is not a compulsory payment like interest on loan. In case the company decides to declare dividend, only then is it paid to preference shareholders. However, in case of cumulative preference shares, the dividend keeps on accumulating if not declared in any year. Further, participative preference shares may participate in the surplus profits after payment of dividend to equity shareholders. + Right (o control: Preference shareholders do not get any voting right and thus do not have any right to control the company. However, preference shareholders can vote on a resolution which directly affects their rights. - + Limited liability: The liability of the preference shareholders is also limited to the value of the \ preference share they have purchased. Once they have paid the full issue price to the company, ~ they have no further lability. = + Hybrid form of security: Preference shares have qualities of both equity and debts. It \ resembles equity shares because dividen‘! is paid out of distributable profits, if declared and is not a compulsory payment. However, the rate of dividend is fixed like interest on a debt security. These shares also do not carry any voting right and ace mostly redeemable like debt. Thus, preference shares are treated as a hybrid security. In brief, preference shares do not dilute owner's control of the company and put no restrain on freedom of the management. However, these shares are costlier than debt sources. : 5.3.1.2 Debt Securities Borrowed capital of an organisation is raised by issue of debt securities. These securities are issued for a specific period against payment of interest at regular interval and the principal is repaid as per the agreed schedule. : For a corporate organisation borrowed sources/debt securities-are riskier than ownership securities as the former securities create legal obligations top: interest and principal. However, they are cheaper source of funds when compared to ownership securities. Foran investor, debt securities are fixed income source with less risk as a company has legal obligation to pay interest on them. ; Debentures and bonds are two popular types of debt securities for raising debt capital by a company. Bonds and debentures have common features Features of Debentures and Bonds + Maturity: Debentures and bonds are used with a fixed maturity schedule. Debentures may be redeemable at fixed date or in instalments by drawing lots. However, a company may issue irredeemnable debentures or perpetual bonds too. + Right tof ncome: Debenture holders/bond holders geta right to receive regular interest payment. i Interest is paid at a fixed percentage of the par value of the debt instrument payable annually or ae semi-annually or quarterly, etc. + Legal Liability: Iti the legal liability of the company to pay interest on due dates and to repay principal on maturity date. + Indenture: An indenture or debenture trust deed is a legal document containing details of theoH eamenee yor Everyone agreement between the company and the debenture trustee who represent the debenture holders, ‘The debenture trustee is generally a bank, financial institution or an insurance company. The debenture trust deed is a detailed document which includes description of debentures, terms | of issue, rights of debenture holders rights of the issuing company and the responsibilities of 1 tmustee, - - 1 * Security : Debentures may be issued as secured of unsecured debentures. In India, debentures p axe usually secured by a charge on the present and future immovable assets of the company. a Debentures may be issued as unsecured debentures wherein no security is provided to debenture 5. holders. Claim on assets: In case of liquidation, debenture holders/bond holders have a claim on assets Prior to that of sharcholder. The realized assets.of the company are first utiliz d to pay the debenture/bond holders before any payment to preference and equity shareholders. However, a Secured debentures will have priority over the utisecured debentures, Control: Debenture holders are creditor and do not ha’ of the company and they ‘do not carry any voting rights 've any control over the management of the company. Call feature: ‘Debentures/bonids may carry call feature in which case the issuing company may redeem the debentures on a certain price before the maturity date. A : r 5.3.1.3 Derivatives @) A derivative isa financial instrument whose value is derived from the value of one or ore underlying ma assels, The most common types of derivatives are futures, options, forwards, and swaps. Derivatives are a discussed in detail in the chapter later sis asp. 5.3.1.4 Mutual Fund Units ae Mutual Fund units are issued by mutual fund companies to investors of mutual fund schemes as per . the amount of money invested by them, Mutual fund schemes are discussed later in the chapter under a separate heading. The securities market has two inseparable and interdependent segments i, the primary market and the stock market. Segments of Securities Market Primary Market Secondary Market ( or ‘ or New Issue Market Stock Market |5.4.1 Primary Market Primary market isa market where new securities are issued. It provades medium for ‘0 fase funds forthe investment opportunities on the one hand, On the other, tis an opportunity for the investors (0 buy new securities. It enables disiabution of securities to a large number of investors and Paves the way fory liquid secondary muarket. Long term capital 1 raised for the businesses by issue of ew securities, therefore, itis also called as new issue market too 5.4.1.1 Types of Issues of Securities in Primary Market Public issues - Types of aa . sue Right issue of Shares in oa — Primary Bonus Issue of Shares Maret ee A company can issue fresh secuntie mary market in sanous ways as captained below (i) Public Issues: for buying the securttes from mvestors by company allots secuntics wo the applicant epulitions of SEAL (Secuntes and In this type of the issue ac Issuing a prospectus. Once the a per the prescribed rules of ¢ Exchange Board of India) Public Issue can of three typ (a) nual Public Offer (IPO. (>) Further Public Offer (FPO) (c) Offer For Sale (OFS) —7 \__ teva Pubic Otter (PO) —, Further Puc Offer (F?0) vy, Otter For Sale (OFS) (2) Initat Publi Offer: When an unlisted company (A company which isnot listed on an xchange) decides to raise funds through sale of secunties for the fist time to the public 's called as intial pudtc offer The company either makes a fresh issue of « “ts extsting securities for sale to the public for the frst time. nfangel investors and venture capitalists 2% an exit stratepy, when a private company seeks to go to public. 1PO not only allow company to reach new investors but also helps in enhancing t the company among suppliers, customers, bankers, and public at large. It also gi chance to own a piece of a corporate organisation _ Some of the popular IRQs in the world are by companies like Sandi Aramco, 4 Saudi Arbian multinational petroleum and natural gas company, Alibaba Group Holding Limited of Chine, Soft Bank Group corporation of Japan, parent company of facebook Meta Platforms, fn India, some of the mega IPOS are of Life Insurance Corporation of India (LIC), Paytrn Ltd., Coal India Ltd., Reliance Power Ltd. etc. (b) Further-Public Offer (KPO} When a listed company (i.¢., which has already issued securities, to the public) decides to come out with a fresh issue of securities and makes an offer for sale to the public, it is called as Further Public offer or Follow-on-Public Offer. In other words, FPO is any issue which comes after [PO. Similar to an 120, an FPO allows the companies to raise additional funds, For the investors the main advantage is that the issue price for an FPO is mostly lower than the prevailing stock market price. This is donc usually to get more and more subscribers to the issue. Another advantage is that they can refer to the past performance of the company on the stock market, Much more data about the management and business practices of the company, financial reports etc, are available to the investor to form an idea about the performance of the company. Google, Facebook, Tesla have used follow-on public offers to raise money. Yes bank Itd, Indian Telecom Industries Ltd, Ruchi Soya Ltd, Engineers India Ltd, Tata steel Itd are some companies in India which have used this method for obtaining funds. Table 5.1: Difference between IPO and FPO. Parameters RO FPO |. Meaning, [PO is the first issue of securities made | FPO is made after [PO to raise funds by by acompany. issue of now additional securities by a company. 2. Company Status | An unlisted company makes an IPO | An altcady listed company makes and and becomes listed, FPO. 4. Nature of Securities | New Securities are issued to the public | Under FPO new securities may offered for the first time, be issued or old shares of existing Shareholders (mostly of company’s Profiioters, directors) may be offered for sale to the public. 4, Priceofthe Security fixe in a price band |The price of see curity in FPO is market _ with slight variations driven. 5. Risk IPOS ae risky. £POs are comparatively less risky.OIGER WERrREs T] Rae °) Offer for sate (OFS Mffer for Sale is a mechanism to sell securities through the stock exchanges for listed companies. Securities Exchange Board of India (SEBI) introduced this mechanism in 2012 to make it easier for promoters of listed companies to cut their holdings and comply with the minimum public shareholders norms by June 2013. Only promoters or shareholders holding more than 10% of the share capital of a company can come up with such an issue. Both retail and institutional investors can buy shares offered for safe. It is important to note that it is available for only the top 200 companies in terms of market capitalization. Further, 2.5% of the shares offered miust be reserved for mutual funds and insurance companies. Aminimum of 10% of the offer is reserved for retail investors. It is mandatory for the company to inform the stock exchanges two banking days prior to OFS. The offer is opened only fora single day. In an OFS, the buyer investor has to provide a bid in order to buy the shares. The Company sets a minimum floor price. Buyer cannot bid below this price.tn-some cases, the seller offers discount to retail investors The process of OFS is also simple and requires minimal paperwork from the investor. InIndia, many government companies have used this mechanism to sell their shares. Oil and Natural Gas Corporation (ONGL) Steet Authority of India Ltd, Coal India Ltd, Hindustan Aeronautics Lid, Indian Railway Catering and Tourism‘comporation (IRCTC) are some examples which used the offer for sale mechanism to meet their disinvestment goals. ‘Table §.2: Difference between Offer for Sale and Initial Public Offering Parameters Initial Public Offering Offer for Sale |. Meaning In an IPO a company raises money by | In offer for sales the shares are sold by selling its securities to the public forthe | existing sharchalders to the public. first time. 2. Seller In IPO, the company sells its shares to | {n OFS promotors ot large shareholders the public. ____ {sell their share to the public. 3. Type of Company | [PO is used by an unlisted company to|Itis made by an already listed company, become listed 4, Applicability | Any unlisted company can go for 1PO. Only top 200 companies based upon market capitalization ae allowed to go for OFS. 5. Time Period ‘An IPO is usualy open for3 to 10 days. | An OFS in open for only one trading day, 6. Increase in Share. | 1PO increases the share capital of a OFS only results in transfer of Capital company duc to issue of new shares, fowmership ftom existing sharcholders to new shareholders — 1, Regulatory A lengthy procedure is required to be | In OFS the process is small and the Compliance. followed for an IPO Issue. regulatory compliance is much ess ; . than IPO. 8. Reservation for 35% of the shares under an 1PO are held {__ Retail Investor for tetal investors. Only 10% of the shares are requifed to be held for retail investors in an OFS.sting sharcholders to buy additional shares in proportion Right [ssue of shares provides a right to the exi i x Both Equity shares and preference shares can be issued to their existing shareholding in the company. vty sh : under this mode of issue of shares. The main features of right issue are as follows. (a) Itgives the existing shareholders a pre-emptive right to buy new shares of a company at a price less than market price. . () The existing sharcholders are also given the right to renounce the offer in favour of any other person, (c) The cost of the issue of right shares is less than the public issuc. (d) Itincrease the share capital of the company. (c) The Offer is provided through notice to the sharefiolders who are required to answer within 15 tr 30 days. © (1) In case a shareholder.does not respond it is presumed that he declined the offer. (2) Ithelps the existing sharcholder to maintain their proportion in thé shareholding of the company Right issue of share is a fast source of raising funds at low cost. For the ‘shareholders it is an opportunity to invest in a company they are already conversant with. One of large right issue has beén made by Reliance industries Ltd in May 2020. It offered 42 crore equity shares of €10 each at a price of 21257 each in the ratio of 1:15. It means that shareholders were allowed to subscribe to one equity share for energy fifteen share held. The price of the share of the reliance industries Ltd. in the security market was over €1400 in the year 2020 . The total amount of right issue made by the company was 53,125 crore (iii) Bonus Issue of Shares; Bonus shares are additional shares issued to the existing shareholders without charging anything. New shares are allotted to shareholder in proportion to their existing holding out of the accumulated profits of the company. In this way, undistributed profits aré capitalized without affecting the cash position of the company. Following are the main features of bonus issue of shares, (a) Bonus shares are issued free to the existing shareholders on prorata basis. (b) They are always fully paid up, (c) Right to renunciation is not available in respect of these shares, (d) Bonus shares do not provide any new funds to the issuing company. (c) Issue of bonus shares is an inexpensive mode of issue of new shares. (f) Bonus issue of shares increases the total number of shares issu teduces the market price of the shares. (8) Shareholders receive dividend on their increased shareholding after bonus issue. ms pe issue helps the company to maintain its liquidity. Shareholders arc kept happy without cling the financial position of the company. Increased number of shares in the hands of the caches Means increased dividend income. They can encash the additional shares received in the market. Over the years ‘many companies have issued bonus shares in India. Some of the blue-chip ed by a company and thus .companies like Infosys, Reliance Industri Wipro, ONGC, L. & T, [1C, HDFC bank and TCS have issued bonus shares to their shareholders Table 5.3: Difference between Right Issue and Bonus Issue Parameter Right Issue Bonus Issue 1. Meaning Right issue of shares provides a right| In bonus shares _ the company’s (o the existing shareholders to purchase | accumulated profits and reserves are additional new shares of the company | converted into share capital and the shares are provide to existing share holders Right shares are issued-for-a price to | Banus shares ate issue fice of cost of the existing shareholders. existing shareholders. 2. Price - 3. Purpose Right shares are issued to raise | Bonus shares do not create additional additional funds for the company funds. They are issued out. of accumulated profits and reserves of the company. 4. Paid up amount | Right issue can be issued as fully paid | Bonus shares are always issued fully up or parily paid up paid up. 5. Right to renounce | Right issue of shares provide a right to | Bonus shares do not carry any right to renounce shares in favour of any other | renounce them to others person (iv) Private Placement: {n private placement securities are not sold to the public but to the pre-selected investors and institutions, In India, the persons to whom the company can make a private placement should not exceed more than 200 persons in the aggregate: Investors invited to participate include banks, other financial institutions, mutual funds, insurance companies and other rch investors. The participants apply through the private placement application form of the company. Then the company should allot the securities within sixty days from the receipt of the application money. No public advertisement of utilization of media, marketing channels or agents can be used to inform about the private placement offer, In India, this way of raising funds have gained importance over the years: As compared to [PO it has few regulatory requirements, Most popular example of private placement is Goldman Sachs approaching Mr. Warren Buffet to offer 5% stake in 2008 in the back drop of sub-prime mortgage crisis. 5.4.2 Secondary Market Secondary market or the stock market is a platform where buyers and sellers meet to trade in securities of listed companies. The shares, which are already issued in the primary market, are bought and sought in the stock market. Stock market consists of stock exchanges which functions as organised market for the sale. and purchase of securities. The stock market makes available the information regarding prices of securities to the buyers and sellers,144 || Finance for Everyone 5.4.2.1. Characteristics of Stock Market Stock market deals in the shares, debentures, bonds and other securities already issued by listed companies and government organisation. (a) Itdoes not buy or sell securities on its own account. Rather, it provides the infrastructure to facilitate trade, ~ ~ (by Security Exchange Board of India regulates the Indian stock market, It protects the interests of » the investors by making rales and regulation forthe operation ofthe market. (@) Tehelps to value the securities on the basis of demand and supply. (a) Woffers attractive opportunities of saving and investment to investors. (c) Stock market is considered important barometer-to gauge the growth of the organisation and _ economic condition of a nation. (0) it provides complete information about the prices and volumes of the securities traded every” day. (@) It provides a ready and continuous market forthe securities, thus, providing high degree. of liquidity to the investor. (h) Transactions are conducted only among the members in stock exchanges for listed securities in a transparent manner. This ensures safety in dealings. (i) Stock market imparts buoyancy to the primary market. 5.4.2.2 Stock Exchanges in India Currently there are seven stock exchanges in India. Table 5.4: List of Indian Stock Exchanges S.No, | Name ‘ Location | Year of Establishment || Bombay Stock Exchange(BSE) Mumbai 1875 2 Calcutta Stock Exchange (CSE) Kolkata 1908 3 | {ndia International Exchange(India [NX) Gandhinagar 2017 4 | Indian Commodity Exchange(ICEX) Navi Mumbai 2017 5 _| Multi Commodity Exchange of India (MCX) Mumbai 2003 6 pee Coreen A Exchange Mumbai 2003 |_7__| National Stock Exchange of India (NSE) Mumbai 1992 B E i ‘iia oatey Stock Exchange and National Stock Exchange are two popular stock exchanges in India. Year 2021, a total of over 7462 companies were listed on these two exchanges, d 5.4.2.3. Stock Market Indices We have seen i vious seni in the previous section that more than seven thousand companies are listed in just tw : ust twooe : Stock exchanges in India. This makes it impossible to monitor the stock market. That is why stock market indices have been developed as indicator of major changes in stock market. These indices are based upon the prices of certain group of securities which are selected on particular criteria like size of the company, type of industry, and market capitalization etc. Any change in the prices of underlying securities impacts the value of the index._Tracking the indices enables investors to make rational investment decisions, SENSEX of Bombay Stock Exchange and NIETY of National Stock Exchange are two popular indices in India which are considered to represent the overall market performance. Some important world indices are Dow Jones (New York Stock Exchange), NASDAQ (Global electronic exchange), and S&P 500 (Standard & Poor's Composite Index) Let us learn more about the two Indian Indices: (i) SENSEX . SENSEX isa bench market index of Bombay Stock Exchange of India, The word SENSEX is a made up of two words Le. Sensitive and Index. A stock market analyst Mr. Deepak Mohan introduced this tem. [twas introduced in 1986 and is the oldest index in India. It is made up from the value of top 30 largest and most frequently traded stocks listed in Bombay Stock. Exchange. It is operated by a joint venture between BSE and standard & Poor’s Dow Jones Indices and thus, is also,known as § & P-BSE Sensex. The Sensex is calculated in Indian rupees and U.S dollars. It reflects the movement in the Indian stock market. If the Sensex increases, it means the prices of the underlying 30 stocks have increased and vice versa. It gives a reflection of the Indian economy and is used to understand the overall trends in stock market. Some of the popular companies included in Sensex are Infosys Ltd., Reliance Industries Ltd., ICICI Bank Ltd. ,HDFC Bank Ltd., Bharti Airtel Ltd., State Bank of India, ITC Ltd, Tata Steel Ltd. and so on. The base year of Sensex Index is 1978-79, The index have grown steadily and have already crossed 58000 points mark in August 2022. $ There are two ways to invest in Sensex. Firstly, an investor can directly buy the stocks of constituent companies of the Sensex in the weightage these companies haye iti Sensex. However, an casy Way is to invest in Sensex through Index Mutual Funds. These. mutual funds invest in the same companies as in the index. So a Sensex based index mutual fund will have the 30 stocks in the same proportion as the Sensex. HDFC Index fund- $ & P BSE Sensex, LIC MF § & P BSE Sensex Indian Fund, and ICICI Pru S & P BSE Sensex Index fund are some of the known mutual Index funds an investor. can invest in. (ii) NIETY NIFTY is a bench mark index of National Stock Exchange. The woid is a blend of two words ic. National stock exchange and fifty. It was first established in 1996 with the name CNX Nifty. In 2015, it was renamed as Nifty 50. Nifty is an index based on’ 50 largest and most liquid companies listed on. national stock exchange of India. These companies belong to different industrial sectors. Nifty is managed by India Index services & products Ltd, (IISL). This company is a joint venture of national stock Exchange and CRISIL. It started its operations on April 22, 1996. NIFETY index is Teconstituted every six months based upon the performance of the company’s stock over the period. On.SOE Ee FOF Veronese this basis companies are added or removed from the list of NIFTY fifty. The Index shows market trends, When NIFTY gocs up, it implies that stock of large companies across industries are moving up and vice-versa. Investors use it to understand market conditions so as to make rational decisions. Further, iCindicates positive economic trends in the country. Some of the companics who have existed in Nifty fora long term are Reliance Industries Ltd, ICICI Bank Ltd,, State Bank of India Ltd, ITC Ltd, HDFC Bank Ltd, Tata Steel Ltd, Infosys Ltd. Bharti Airtel Ltd., Mahindra and Mahindra Ltd., Tata Motors Ltd and so on, The base year of Nitty is 1995 and the base value of is 1000, It has already crossed 17000 marks in August 2022, The base capital for Nifly is €2.06 trillion, Like Sensex an investor can directly invest in the index. In that case he/she will have to buy all the 50 shares in the same proportion as they exist in the index. However, easy route is to buy Nifty index mutual funds, HDFC Index fund Nifty 50, SBI Nifty Index Fund, ICICI Prudential Nifty 50 index fund, Tata Nifty 50 Index fimd are some of the well-known mutual funds to invest in Nifty. Besides Nifty 50, Nifty also have sub-indices based upon industry, market capitalization or asset closes. They are NIFTY Next 50, Nifty SMALL CAP 50, NIFTY FMCG, Nifty Bank, NIFTY IT, NIETY Commodities ete. Table 5.5: Difference between SENSEX and NIFTY P Parameter SENSEX NIFTY 1. Operational Year Tewas frst started on {st January 1986] {t started operations on April 22, + 1996. 2. Full Form Sensex stands for Stock Exchange| Nifty stands for National Stock Sensitive Index Exchange Filly 3. Stock Exchange Ttis a stock market Index for Bombay | {tis a stock market index for National stock exchange stock exchange, 4. Constituent Companies | It is based upon the stock value of 30) It is calculated based upon the stock companies value of 50 companies 5. Base Period The base year for the calculation of] The base year for Nifty is 1995, Sensex is 1978-79 6. Base Value Sensex has base value 100 Nifly has base value 1000. 7. Base Capital Sensex has no base capital defined. | Nifly has a base capital of %2.06 trillion 8. Number of Sectors | Sensex covers companies across 13] Nifly covers companies across 24 sectors sectors and thus is a broader market index 9. Operated by It is opetated by a joint venture] It is operated by a joint venture of between Bombay stock exchange and | National stock exchange and CRISIL S&P Dow Jones Indices called as {ISL.5.5 USEFUL TERMS 10 KNOW BEFORE INVESTING IN THE STOCK MARKET “There are some basic terms each investor should understand before starting investment in stock market. Some of them are explained below: 5.5.1. Business Days tn India normal trading is done in the stock market between 9.15 am to 3.30 pm from Monday to Friday without any lunch or tea break. An investor can buy and sell securities on BSE and NSE at any time between this trading time -period through a brokerage agency. 5.5.1.1 Segments of Stock Market Timingsin India. - - -- India stock market timings is divided into three segments. (i) Pre-opening session (i) Trading session (ii) Post-closing session (i) Pre-Opening Session ‘The pre-opening session starts at 9.00/am and goos tll 9.15 am. During this time orders for purchase and sale for securities are placed. This session is futher divided into three sub sessions. {@) 9.00 am to 9.08 am Order Period: During this period orders for the transaction can be placed when the trading begins. These order entries are given preference and cleared off in the beginning. Order can be cancelled or changed during this time. However, no order can be placed after these eight minutes in. pre-opening timings. (b) 9.08 ani to 9.12am Opening Price Determination Period: Prices of securities are determined during this time period based upon demand and supply. (6) 9.12 am to 9.15 am Transition Period: Thisisa transition period between pre-opening session vtad the normal trading session. No new workis done, In other words, no additional order for transactions can be placed during this time, Also, existing bets already placed between 9.08 ‘am to 9.12 am cannot be revoked as well. It ‘only works as connection window between pre- opening session and trading session. (ii) Trading Session! Normal Session Normal trading in the Indian stock market occurs between 9,30 am to 3.30 pm, Any transactions made during this time follows a bilateral order matching system, wherein price determination is done through demand and supply forces. Bilateral order matching means cach sell order is matched with a buy order that has been placed at the same stock price and vice-versa. During this session orders to buy or sell and modify-or cancel can be placed without any limitation. (iii) Post Closing Session Postelosing session runs from 3.30 pm to 4:pmi. No trading transaction 1s done during this period.Jor Everyone 148 || Fin — I this session can be divided . ¢ ied y this ime-pertoc However, the determination of closing Pre’ is done during this tine-P these 10 minutes closing f the stock prices for the indices Tike all the underlying into two seg (oy 3.30 pm to 3.40 pm = Deter ion of Closing Price: During «determined by calculating the weighted avertey Jed batweon 3.09 pin 10 3:30 pm. The closing PEE Jnted average of the prices prices of securil in which it is tad Nifty, Sensex arc ealculated by taking the welg! securities of the index () 3.40 pm to 4.00 pm — Bids for the following day: Bids for th i placed between 3.40 pm to 4.00 pm. Bids placed during this time period a ‘ven there are adequate numberof buyers and sellers present in the market, In case the closing price is less than ‘opening price next day, investors will gam capita! ga closing price exceeds opening price, bids can be cancelled during the pre-opening session perio «following day's trade-can be re confirmed only tal gain, In case 4 of 9.00 am to 9.08 am. 555.2 Opening and Closing Prices in Stock Market ‘As discussed inthe previous selon, there isa mechanism for caoulting the opening and closing price inthe stock markets in India, (a) Opening price: The opening price isthe price at which fst ring is done in a security in the trading session which stars at 9.15 am. “The opening price is determined inthe pre-opening session window of 9.08 am to 9.(2 am. “The orders are collected first in the window of pre-opening session i. 9.00 am to.9.08 am, The opening price is than determined based onthe principle of demand and supply. Itis the equilibrium price where the maximum trade volume of a security can be executed. Illustration $.L; Suppose following i the information available regarding a security price,{ ts demand and supply , and the maximum tradable quantity at each price. {Security Price (@) | Demand Units Supply Units. | Maximum Tradable Units 107 ~ 500 400 400 108 450 500 450 i 109 300, 600 500 ito 400 150 400 L WW 350 800 350 ee 300 600 300 | In the above case, maximum uni it ¥ its of i fea a eerern vn s of a security can be traded at %109. Hence the opening price of ) The las aStock Market || 149 (b) Closing price: The closing price is the price calculated fora stock after the trading session (9.15 am to 330 pm) is over Its caleulated as the weighted average ofall prices of the security at which iis traded during the last 30 minutes of the trading session ic. between 3.00 pm to 3.30 pm, 2: Suppose following information is give regarding security: Time No.of Units Traded [Price | "3.05 pm 2 110 3.10 pm 5 125 3.12 pm 3 us, 3.20 pm 4 120 3.28 pm 6 BO The weighted average ofthe price a security can be calculated a8! HD, AWB, AWB, yoo WB, p= eW ett el Where weights are the number of shares traded. pe 2x110 + 5x125 + 3x 115 + 4x120 + 6x130 245434446 pe 220 + 625 +345 + 480 +780. =) p- 80 ins e020. . So, the closing price is determined as @122.5, It is the generally used as a benchmark price by the market followers to understand the market performance and to compa re with the previous closing price Ii tobe noted tat losing price is diferent from the Last Trading Price. Last Trading Price is the price at which a security is traded for the last time before the closure of trading session. In our illustration itis €130 at which 6 units ofthe security were traded at 3.28 pm, In case the security is not traded between 3.00 pm to 3.30 pm. Then, whenever, the Security was (raded for the last time becomes the closing price. Suppose last lime, the security was traded at TUS at 2.48 pm. In that case last trading price and the closing price are the same as 2115, Opening price of a security may be different from the closing based upon demand and supply of security inthe pre-opening session price is the weighted average of prices ofa security between 3.00 py ‘The developments after trading hours may induce differences in the Price. Opening price is calculated Window of 9.00 -9.08 am. Closing wt t0 3.30 pm on the previous day, opening and the closing price.150 |, Finance for Everyone 5.5.3 Blue Chip Stocks and Defensive Stacks {hn a security market there ate multiple types of stacks (shares) that can be based upon various factors. Based upon market capitalization, they can cap stocks, mid cap stocks, small cap stoc is of ownership, they are ter preferred stocks. Depending upon the dividend payment they can be growth Based upon risk they can be blue chip and beta stocks. Depending upon defensive and cyclical stock etc. Blue chip stocks and defens: characteristics. Let us know about them ve stocks are popular du (i) Blue Chip Stocks Blue chip stocks are the shares of blue-chip companies. These companies have a long history of stable camings, dividend payment and sound finzncial performance. These Companifs enjoy good Teputat in the snarket and their shares are highly priced in the security market. The term ‘Blue chip’ was first coined by Oliver Gingold ,who use to work in Dow Jones, in 1923 wi ‘nen he noticed that several stocks traded at $200 or more per share: Today, the term is used for high quality stocks/shares. The features of these shares are: (a) Assured Returns: The blue chip companies eam consistent revenue and provide regular - dividend to sharcholders. ) Credit Worthiness: These companies have stable debt equity ratio and « high interest coverage ratio. They meet their financial obligations on time. (c) Risk Factor: Due to stable financial performance and return on equity of blue-chip companies, these are rated high and risk to investor is comparatively less (4) Growth: Blue chip companies show steady growth and proven tack record. Thus, their shares are considered safe and stable. Some of the international blue-chip stocks are of Apple, Mastercard, Coca-Cola, Walman, Microsoft, Johnson and Johnson, American Express, Procter & Gamble and so on.In India the share of Reliance Ltd, Hindustan Unilever Ltd, Infosys Lid. HDFC Bank Ltd. Bharti Airtel Ltd. (TC Ltd, etc. are considered blue chip stocks, (ii) Defensive Stocks Defensive stocks are those shares which provide consistent dividend and have stable earnings even during an economic or market downturn. Defensive stock companies are those companies which offer goods or services that people continue to buy even when the economy is not doing well such as u consumer durable, pharmaceutical, real estate and so on. ‘The features of these shares are: 1 Success History: Defensive stock companies are usually large companies with a success history of regular earings 2. Consistent Dividends: The sharcholders of defensive stocks get regular dividend from their companies,‘s - Stock Market | 154 3 Low Vola: The haste charateristic of defensive took i hats pie sua by the stock market ups and downs Msc mac 4 NoneCyetieal: these sock pertinn clatively the same repaness of he overall evan centnns ia country So they don’t mir the overlleyctes ot the economy sth s tiowth anal revession and theretore they’ are tls Known as non gyetical stocks, Defensive stocks perform better than the market during recession and during bull he auch as the market grows. They’ are the good choice fir investors who wish to play don’t grow as fe in the market Typintemational defensive stocks are Locklhced Martin, Costco, Walmart Feds, Mekesson, Procter and Gamble, General Motors, Coea-Cola and so ont In India, the shares of Hindustan Unilever, Dabur Lid, TCS Ltd, Infosys Ltd, Wipro Ltd, Sun Pharma Ltd and Cipla Ltd are popular defensive stocke 5.5.4 Demat Account and Trading Account To start trading cating, the investor is required to open a Demat account and a trading account with’ stockbroker. The buying and selling of securities in India can only be done through SEBL registered brokers who are members ofthe stock exchange. These brokers provide the facility of opening a demat and trading account, Demat account stores the secutities bought inthe electronic form. A trading account facilitate buying and selling of securities in the stock market. Let us learn miore about them, 1. Demat Account Demat account is essential to get started with online trading as securities are traded in the digital made today. Demat account is known as Dematerialized Account, Dematerialization is the process of converting the physical share certificates into electronic form, Prior to 1996, trading in stocks used to be done physically in stock exehanges. However, introduction of the demat account by SEBI has created case in doing transactions ftom anywhere In India, Depastories such as National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) provide the services of opening free Demat Account. Opening a demat account is a pre-requisite for stack market trading in India. tis also required for applying for shares in an Initial Public oering (IPO) The use of demat account is quite simple, Demat accouat gets linked with the trading account, Trading account gets linked with the bank account of investor, To start trading first money is transferred trom bank account to trading. can place order for the purchase of securities. Once the onder is execurt demat account by the end of be sold too, Account. Then, the investor f t ted the shares are transfered to + Two days where Tis the transaction day. Similarly, the securities can Benefits of Demat Account {a) Safety of Securities: In the demat account seoutiti risk of share getting lost, damaged or stolen as in ease (©) Convenience in Trading: Demat account ean be a electtonie devise like laptop and smart phone ate kept sate electroni lly. There is no of physical share certificate weessed anytime, anywhere through an(c) Convenience in Storage and Transfer: Any large number of securities can be stored in a Demat account. This makes the trading & transfer of securities casily possible. (d) Storage for Various Lavestments: It provides storage and helps in keeping track of all the investments of an investor such as in shares, bonds, mutual funds, exchange traded funds in one place. (e) Reduced Costs: Demat account has taken away the costs OF handling physical certificates, (0 Loan Facilities: Securities maintained in a demat account can be used as collateral to obtain a loan facility from bank (z) Global Investors: Indian stock markets are attracting global investors as easy access is provided to Indian stock markets through a demat account. (h) Increased Liquidity: The demat account has-simplified sale of securities. It has become convenient, and faster to get money in a sale transaction. Thus, it has provided increased liquidity to the securities. . (i) Easy Receipt of Benefits: ‘Dividetids; intetésts, refunds etc are auto-credited. in the demat account. The investors account is easily updated with stock splits, bonus shares, right issues ete. 2. Trading Account Trading account allows a buyer to buy and sell securities through a stockbroker. Trading account is linked to the investor’s bank account. Shares purchased through this account are deposited in demat account and the similarly in a sales transaction the number of shares sold are debited to demat account — and the money is credited to the bank account. Trading Account is an essential tool today for trading in stock market. However, itis important to note that only one trading account can be opened with different brokers. Proof of income, proof of identify and proof of address is tequired to open this account. Benefits of a Trading Account (a) Seamless Transactions: Trading account has made the process of online purchase and sale of securities simple, quick, convenient and seamless. ee (b) One Point Access: Online trading account providing instant access to all the major exchanges ic. Bombay stock exchange, national stock exchange, national commodity and Derivatives exchange, multi commodity exchange etc. via a common plat form. Trading becomes easy. (c) Reliable Information: Experts and professional reports are easily available on the online trading platforms. This helps the investor to make informed decisions, (d) Flexible a Access: Trading accounts can be easily accessed through smatt devices like laptop and smart phones, e (©) Track of (nvestments: Investors can easily keep track of their investments via records of trading account, They can monitor the performance of the stocks throughout the day and then buy and sell at one single platform. (6) Reduced Costs: Online trading account helps in reducing costs of physical trading. Investors can trade in large volume and earn profits quickly. They can also negotiate the brokerroa fs...ned exceutives of online trading, platforms provide customized ny. account client, ‘They can resolve a technical issue with the nd notifications to trading Support to their online iz accounts. Additionally, they can send personalized ales account holders, (h) Better Control: Trading, accounts remove the investors dependence on a broker, Online trading ensures instantaneous transactions. Decisionsmaking att calculation of profitand loss become easy. Thus, investor can exercise better control over his/her investment Table 5.6: Difference between Demat Account and Trading Account E Parameter Dewtheott ‘Trading Account | Ss : —— — 4 | Purpose Demat Account is used Jo keep the'|"Trading Account is used to buy and | | securities bought in the electronic | sell securities in the stock market. | | form | | 2. | Nature Demat account is like a store house | Trading Account shows the record | for the securities bought. of the transactions of buying and . selling securities : | 3. [Need in PO “An investor needs an Demat |Tnvestor who do not wish to sel account if he/she wants to apply | the shares need not open a trading | for securities in an Indian public | account for applying in an [LO { offering (IPO). [4 [Annual Maintenance | Demat account” require annual | Only brokerage charges are to be Charges maintenance charges to be paid paid for operations in a trading | besides the brokerage charges. account. No annual maintenance | SS | charges are required to be paid. 5.555 Delivery Instruction Sp (DIS) Delivery Instruction slip is an important document required ina trading transaction. It is like a cheque for demat account transaction, It is used to facilitate and authorize the sale or transfer of shares from one accouirt to another. DIS is required to instruct the depository participant (Demat account provider) to debit the demat account. -- 2 This signed document is especially important for offline trading. It permits the depository participant to do the transfor on seller’s behalf, However, in an online transaction, the investor can simply give power of attorney to his/her broker to conduct the transaction. In such case no DIS is required, therefore, it is losing its importance. é Some of the important elements of a DIS are: (i) Date (ii) DP ID (iii) Client ID (iv) Name (¥) ISIN (International Securities Identification Number) vi) Security name vii) Quantity viii) Reason for transfer ix) Payment details x) counter party name (person to whom the securities are transferred) (xi) Counter DPID xii) Counter client [D xiii) Execution date (xiv) Signatures. : - DIS is required to be filled very cautiously as it can get rejected by the broker which can lead to fosses. Some stockbrokers have started issuing E-DIS for online transactions where investors can submit154 || Finance for Everyone transfer requests online, How online services for transfer of s transfer. these days depositories NSDL. and CDSL have started providing rities directly from the demat account .So no DIS is required for 5.5.6 Block Deal and Bulk Deal Block deal and bulk deal are big deals in the securities done in a stock market. These deals are keenly watched by big investors (i) Block Deal: {t is a transaction on a stock exchange of a minimum value of €L0 crores between two parties. The ‘ninimum value have been raised from 5 crores to 10 crores by SEBI in 2017. _ Features of a Black Deal . (a) Separate Window: Stock exchanges-are required to provide a separate trading. window, Morning Block Deal window is operated between 8.45 am to 9,00 am. The reference price for execution of block deals in this window is the previous day clasing price of the stock. Afteroon block deal window operates between 2.05 pm to 2.20 pm. The reference price in this window is the volume weighted average market price (VWAP) of the trades executed in the stock in the cask segment between 1.45 pm to 2.00 pm. (b) Segment: Block deal is allowed only in cash segment. (c) Price Range: The order placed can be within + 1% of the applicable reference price in the respective windows as stated in point (a). (d) Disclosure: The stock exchanges are required to disseminate the information on block deals such’as the name. of the scrip, name of the client, quantity of stiares bought/sold, traded price, etc. to the general public on the same day after the market hours. It implies that during the deal, no information is available to outside retail investor about the deal except the parties involved. (6) Matching of Orders: Fra block da tobe exerted, the quantity andthe ate should be exactly the same as the opposite side block deal order. (0) Validity: Block deal order remains valid in the system for 90 seconds only, after which it gets killed if remains unexecuted. Illustration 5.3; (i) Client ABC enters Block Deal order for buying of 6 lakh shares of Beta Ltd @ 85 (ii) Client DEF enters Block Deal order for selling of 6 lakh shares of Beta Ltd @ 85 ‘The quantity and rate are matching block deal will be executed . . Illustration 5.4: (i) Client ABC enters block deal for buying of 10 lakh shares of Alpha Ltd @ 110 (ii) Client DEF enters block deal for selling of 5 lakh shares of Alpha Ltd @ 110 ‘ (iii) Client PQR enters block deal for selling of 5 lakh shares of Alpha Ltd @ 110. mut indi det is giding d for cenly * dow. ce for n this in the in the deals price, deal, ved. Id be t gets Stock Market || 155 ln this case rate is matching but the quantity does not match, So, block deal of buying LO lakh shares does not match with any of the seller. Thus, block deal can't be executed. It is to be noted that a block deal cannot be executed partially. [fit is not executed fully, the order will get cancelled. (g) Delivery: Every block deal trade has to result in delivery. . (h) Participants: Since volume and value of shares are very high normally retail investors do not participate in block deals. | ‘Major participants in these deals are institutional investors including foreign institutional investors, ‘mutual funds, financial institutions, banks, insurance companies, venture capitalists and high net worth, individuals (HNIS). ~ The introduction of block deal by SEBL has proVided transparency terstock market a Bia details about them are available in both BSE and NSE exchanges of India. Investors now can know wi is getting interested in which company It gives a clear idea how these’ deals are influencing the stock prices. (ii) Bulk Deal A bulk deal constitutes all transactions in a scrip on an exchange where the total quantity of shares bought/sold is more than 0.5% of the number of equity shares of the company listed on the exchange. The quantitative limit of 0.5% can be reached through one or more transaction executed during the day in the normal market segment. Features of Bulk Deal (a) Trading Window: Unlike block deal bulk deals happen during normal trading window, No separate window is required. - (b) Trading Hours: Bulk deal can be executed during normal trading hours ic. 9.00 am to 3.30 pm, (©) Visibility: Unlike block deals, Bulk deals ae visible to everyone on the trading window. (d) Disclosure: The broker i required to disclose (othe stock exchange the name ofthe stip, name of the client, quantity of shares bought sold and the trade price immediately upon execution of the trade, S : The stock exchanges are required to disseminate the aforesaid after market hours to the general public. (©) Delivery: Delivery is mandatory in bulk deals. information on the same day 5.5.7 Fac Value and Markel Vole As an investor it is important to understand the concepts of face value and market value of a security. (i) Face Value $ Face value is the price at which a security. is issued by a company through Initial Public Offering. It is fixed by the company at the time of issue of security. [t is also called as par value. A security is shown156 || Finance for Fueryone ————— tificate issued to the security holder. s of the e y and the security cert — at its face value in the books of the company and the security Too bd its 85, Face : Fthe share of Reliance Industries Ltd is @1, of fn For example the face value of the share of Reliance eae alas a the hondof NTPC is €12.5 of Britannia Ltd itis 230, of NHAT (National Highway y of India) it is 21000. inc wer, face There are no fixed criteria for fixing the face value of shares or bonds by a eee value helps in calculation of dividend payment on shares, interest payments on. ond ia warnings Calculation of premium is also made on face value ifthe security is issued at premtum ; per share is also calculated on this (ii) Market Value ee rhe value is hight Market value isthe price at which a particular secusity issraded on a stock exchange. T te value ishighly dependent upon the demand and supply situations in the stock market and keeps on changin8: {is the price at which an investor can buy and sell a security on a stock exchange, The market value of a security can be easily seen on the stock exchange on which it is listed. The market val 14th August2022 of Reliance Industries Ltd. share was %2632, of Tata Sieel Ltd share was €112.80, of Infosys Ltd share was €1593.75. Similarly the market value on 12th August 2022 of NTPC bond was 213.26, of Britannia Ltd was %3662.05 and NHAI bond was <1188.20. High’market value of security of company depicts that investors are optimistic about the company and its future performance. Market value is used to calculate the market capitalization of a company Table 5.7: Difference between Face Value and Market Value S.No. | Parameter Face Value Market Value L_ | Meaning Itis the price at which a company issues its security for the first time. {tis the current price of a security ‘at which it is quoted on a stock exchange. 2 Price Determination Face value is deoided by acompany before issuing the security. Market forces of demand and supply. determines the market value of. security. A security is represented in the balance-sheet of a company and in the security certificate of investor al its face value, Payment of interest/dividend, bonus issues, security premium, stock splits using this value. are based on it. EPS is calculated | - 3. | Stability Face value is fixed it never | Market value keeps on fluctuation changes. depending. upon the — factors : influences the demand and supply of security in the stock exchange. 4. | Utility Market value is the real value of a security at which it can be bought or sold in the market. . Market capitalization of a company, is based upon the market value,5.5.8 Market Capitalization Market capitalization is the market value ofall its outstanding shares. I is calculated by multiplying the market value of a share with the total outstanding number of shares issued by a company. Dlustration $.5: Stippose Market price of the share of Reliance Industries Ld €2650.6. Its outstanding- number of shares ate 6765.99 million. ‘Then the market capitalization of reliance industries is Market Capitalization = 6765.99 * 2650.6 =€1,79,29,873.5 million. 5.5.9 Classification of Stocks based on Market Capitalization Based on market capitalization stocks in the stock market are classed into three categories (i) Large cap stocks: As per SEBI the first 100 companies ranked according to their market capitalization by the stock exchanges are known as large cap companies. Market capitalization ‘of the stocks of these companies tend to be more than %20,000 crores. All popular names such as Reliance industries, TCS, HDFC Bank, Infosys etc. fall under this category. (ii) Mid cap stocks: The companies with rankings 101 to 250 are known as mid cap companies. The market capitalization of the stocks of these companies tend to fall between %5000 crores to €20,000 crores. Bajaj Electrical Ltd, Godrej Industries Ltd, Raymond Ltd, Apollo Tyres Ltd, VIP industries Ltd are some of the known names in this category. (iii) Small eap stocks: The companies which are ranked 251 and below in the stock exchanges are known as smali cap companies. Theit stocks market capitalization tend to fall below 500 crores. : Just Dial Ltd. Hindustan Foods Lid, NIT Ltd, Rallis India Ltd, and Relegate Enterprise Ltd. are ‘some well-known small cap companies. Normally large cap stocks dominate the stock market and are considered stable and less risky. These stocks are considered good choice for long term investors. Mid cap stocks are more volatile and riskier than the large cap stocks. However, they have a growth potential and therefore investors get attracted to these stocks. Small cap stocks are smaller in size. Success of stall cap companies can sky rocket their stock prizes and failure can lead to huge losses. Thus, these stocks are considered risky. Aggressive investors” are found to be more interested in these stocks. 3 It is important for investors to know about the market capitalization of companies. {t helps them to devise long term investment strategy. They can make diversified investment in stocks. It also helps in comparison of the companies in the same market cap group. The market capitalization is an casy and quick method to assess a company’s size-and value for potential investment. 55.10 Bear and Bull Investors in a stock market are often categorized as bulls and bears. A bull is a type of investor who believes that a specific sccurity or an asset or a market is poised to rise in value. Such a speculator is buying or holding a security to earn quick gains in short term as the market is expected to rise. ._2°9 || Finance for Everyone A bear on the other hand is an investor who is pessimistic about the stock markets. He expects the prices to fallin the near future and tries to make profit from a decline in price. 5.5.11 Bull Market and the Bear Market Depending upon the trend in stock market, the market may be classified into a bull market and bear market Abull market is a state in stock market where prices of stocks and indices show an uptrend, Investors belief that the up trend will continue, Bull market as a rise of 20% or more in stock prices from a recent low or 52 weak low. The bull marke is said tobe confined when 50-day moving average of stock or index croses the 200-day _ moving average. This is called as golden cross Bear market is the opposite phase of bull market. In this market state the prices in the stock market continue. to.decline over. a period of time. In other words when a stock prices or index falls 20% or more from a recent peak or 52--week high, itis said to have entered a bear market phase. The phase is confirmed when the 50-day moving average of the stock or index falls below the 200-day moving average. This is also called as death cross. ‘The key indicators of a bull market are tise in stock prices, GDP, and employment rate .In bear market reverse conditions appear ‘The words bull and bear are metaphors of a stock market taken from how a bull and bear attack their opponents, A bull pulls its homs up in the air when it attacks. On the other hand, a bedt puts its paws downwards while attacking its opponent, The great depression of 1929-30 and stock market crash is a wonderful example of bear market. The stock market crashes of 1992, 1994, 2000 and 2008 are examples of bear markets in India. On the other - hand, between April 2003 to January 2008, the Bombay stock exchange was a bull market when during the period it raised from 2900 points to 21000 points. Table 5.8: Bull Market vs. Bear Market S.No | Parameter Bull Market Bear Market 1 _ | Price Trend Stock prices show up trend. Stag pies show down tend. 2. | Trading Type in this large volume of stocks are | In bear market large volume of bought. stocks ar sold 3 | Investors Mood Investor is optimistic with high| Investor is pessimistic with low _ confidence. confidence inthe market. 4 | Economic Situation “| In’ bull market state economy is | In bear market situation ‘economy is generally strengthening. generally weakening s loop (A tise in GDP occurs in a bull| A fall in GDP is seen in a beat ‘market marketStock Market || 159 Parameter Tull Market Bear Market IPOs In bull market there is a general | {n bear market [POs offers tend to increase in {POs offers. | Employment ‘The economy and industries | The economy is sluggish due to | ate flourishing so increase in| which, production gets affected employment opportunity occurs, | This may . cause layoffs and unemployment. _| 8 | Demand and Supply | [n bull market demand for securities | In bear market the supply is higher of Securities is high but supply is low as a result | than the demand leading to. fall in 7 - security prices rise. priges of securities. — 9 | Tavestor’s Position | In bull market, investor takes long In bear market, investor takes short | position and make profit when the | position and make profit if prices prices rise up beyond the contracted | fall beyond the contracted price. | : price. 10 | investments Sought | Equity isa good investment in abull | Securities which are less risky i.e. market as high risk in them brings | bonds and government securities high retums. are preferred in a beat market a investor want to keep their money safe 5.6 RETURN ON INVESTMENT IN SECURITIES We already know that.there are two types of securities most prevalent in the stock market ic. equity or i ownefship securities and debt securities. On. both the types of securities there is a possibility to earn two types of gains ic, : (i) Regular income (ii) Capital gains (i) Regular Income: Dividend and interest are earned regularly by an investor on equity and debt (@) Dividend: Dividend is a reward paid to the share- holders of the company. The profits of the company can be kept in the business as retained earnings and can also be used to pay a retum in the form of dividends to the shareholders. Dividend can be paid in cash or by issue of bonus shares. The rate of dividend is fixed on preference shares. However, on equity it is decided by board of directors and approved by the shareholders in the annual general meeting of the company. Itis to be noted that it isnot obligatory for a company to pay dividends, The companies like to pay dividend as it indicates to the investors that the company is doing well and have, good prospects. The investors’ confidence gets increased in the company.a Stock Market || 159 Bull Market Bear Market 8. No | Parameter 6 | IPOs. In bull market there is a general | In bear market [POs offers tend to LL increase in {POs of rs. deer | 7 | Employment ‘The economy — and industries |'The economy is sluggish duc to are flourishing so increase in| which, production gets affected employment opportunity occurs, | This “may cause layoffs and unemployment. 8 | Demand and Supply | In bull market demand for securities | In bear market the supply is higher of Securities is high but supply is low as a result | than the demand leading to fall in - security prices rise. prices of securities. _- — 9 | Iavestor’s Position | In bull market, investor takes Tong In bear market, investor takes short position and make profit when the position and make profit it prices prices rise up beyond the contracted | fall beyond the contracted price. price. 10 | Investments Sought | Equity isa good investment ina bull | Securities which are, less tisky ie. | market as high risk in them brings bonds and government securities high returns. are prefered in a bear market as investor want to keep their money safe. 5.6 RETURN OW INVESTMENT IN SECURITIES We already know that there are two types of securities most prevalent in the stock market i.e, equity or owneiship securities and debt securities. On. both the types of securities there is a possibility to earn two types of gains ie., (i) Regular income (ii) Capital gains (i) Regular Income: Dividend and interest are eamed regularly by an investor on equity and debt secutities respectively (a) Dividend: Dividend is a reward paid to the share- holders of the company. The profits of the company can be kept in the business as retained earings and can also be used to pay a retum in the form of dividends to the sharcholders. Dividend can be paid in cash or by issue of bonus shares. The rate of dividend is fixed on preference shares. However, on equity it is decided by board of directors and approved by the shareholders in the annual general meeting of the company. tis to be noted that it is not obligatory for a company to pay dividends, ‘The companies like to pay dividend as it indicates to the investors that the company is doing well and have, good prospects. The investors’ confidence gets increased in the company.The payment of dividend is just an appropriation of profits for the company, and it is not an expense. Dividend income is taxable in the hands of the sharehalders. Dividend yield is the rate of dividend paid by a company on its current market price. His calculate Dividend amount per share Dividend Yield Current market price of share In India, the shares of Indian Oil Corporation, Coal India Ltd. RIC Ltd, Hindustan Zine Ltd, Tata Steel Ltd, NDMC Ltd., ONGC Ltd, GAIL India Ltd are considered high dividend yield stocks (b) Interest on debt securities: Interest is the charge paid by the borrower to the lender on the amount borrowed. It is normally expressed as annual percentage. When an investor is depositing money in a savings bank account, he/she is lending money to the bank. And, therefore, bank pays interest on the amount received. Banks also provide loans for various purposes..In that case’ bank charges interest on the amount lent, Thus, the interest is the cost paid for borrowing. Similarly, when organizations issue debt securities like bonds and debentures they are borrowing money and for this they pay interest on the securities issued by them. The rate of interest depends upon the risk. Higher the'risk for the lender, high will be the rate of interest. The key factors affecting interest rates besides the risk of default are inflation rate, liquidity, market conditions and the length of the time for which money is borrowed. (ii) Capital Gains: Besides the regular income received in the form of dividend and interest, there can be gain in the value of the security/asset which can be realised when itis sold. This benefit is called as capital gain, However, there may also occur a capital loss when the value of the security/ capital assets decreases below its cost or purchase at the time of sale. Capital gain/loss is realized only when a security is sold. 3 For example, suppose Ajay purchased 100 shares of Reliance Industries Ltd at 2500 per share one year ago. Today, he sold these shares at €3100 per share. In that case there is a capital gain of €600 per share. However, if today the price of the Reliance Industries share is only €2100, then there is a capital {oss of €400 per share, Capital gain is an income and, therefore, investor is required to pay capital gain tax on this income. The capital gain can be short term and long term based upon the holding period of asset/security and accordingly income tax act has provisions for short term and long-term capital gain tax provisions explained later in the chapter. Besides the above two types of gains a shareholder can get benefits in many other ways besides receiving dividend in cash as explained above. Let us kniow about them too. (a) Issue of Bonus Shares ‘The issue of bonus shares implies payment of dividend in the form of shares instead of cash. New shares are allotted to equity sharcholders in proportion to their existing holdings out of the accumulated profits of the company. In this way, undistributed profits.arc capitalized without affecting the cash position.Stock Market || 161 The Companies Act provides that a company may, if ts articles of association so provide, capitalize its profits by issuing fully paid bonus shares to the members thereby transfering the sums capitalized from the profit and loss account or reserve account to the share capital, Characteristics of Bonus Issue _ The basis characteristics of bonus shares arc as follows: * Bonus shares are shares issued free. + Bonus shares are issued to the existing shareholders on prorate basis. + They are always fully paid up. + Right to renunciation is not available in respect of these shares. Le + Bonus shares do not provide any new funds to the issuing company. . + Bonus shares are not income for income tax purpose. + The issue of bonus shares does not change the shiareholder’s wealth (net worth) in the company. + Bonus shares are not gifts, as they are the capitalization of accumulated: profits and reserves which already belong to the shareholders. ° Purpose of Bonus Issue ‘ The purpose of the bonus issue is not just to give dividend but it may be mi + To signal future profitability and growth prospects, * To expand equity base. + To achieve a desired level of debt-equity ratio. + To make shares more attractive. « To restore the shire prices to an acceptable range of trading. + To increase yield of shareholders. + To bring down the abnormally high rate of cash dividend on existing equity share, + To bring the issued and paid-up capital in line withthe capital employed so as to depict more realistic earning capacity of the company. * To pay bonus to the sharcholders without affecting its liquidity. + To capitalize profits so as to use them permanently in the business. + To make the nominal value and the market value of the shares of the company comparable. + To correct the balance-sheet so as to give a realistic view of the capital structure of the company. ade to achieve the following: As compared to cash dividend bonus issue conserve cash. For shareholders it increases the number of available equity shares in hand without diluting the proportionate ownership. It is seen currently that a lot of companies are making bonus issues in India after-a good-post pandemic performance in financial year 21-22. Infosys, Bharat Petroleum Corporation Ltd. Wipro Ltd, ITC Ltd, and Motherson Sumi Systems Ltd. are 5 Indian companies which have consistently issued bonus shares to their shareholders.162 || Finance for Everyone (b) Stock Splits A stock split an action in which a company sub-dividend its existing shares into shares of smaller denomination. Unlike issue of bonus shares, the total share capital of the company remain the same, Only the nuniber of shares outstanding incceases. A split ratio of 4-for-I of share of 8100 means a shageholder will have four shares of 825 each instead of one share of €100 each aftr the stock spit Purpose of Stock Splits Acompany may choose to split its shares so as to: (}) Lower the trading price of the share in case the share price is high making it pricy for the investor. (ii) InereasBliquidity and marketability ofthe shares by ifereasing the number of shares outstanding. ii) Obtain renewed investor interest which can have a positive impact on the share price A company can also opt for ‘reverse stock split’ which is opposite of the stock split. Under reverse stock split a company feduces the tiuriber of outstanding shares and increases the share price. For example, in reverse {-for-5 split of €10 share, 5 share of €10 each becomes one share of 750. Reverse stock split is undertaken by a company to make share attractive to those investors who perceive more value for a share of higher price. Tata Steel Ltd, Manglam Global Ltd, Variman Global Lid, High Energy Ltd, Hindustan Pods Ltd. ete. are some companies which have announced stock splits in August 2022. (c) Buy Back of Shares ‘The companies Act 2013 permits a company to buy back its own shares or securities. Buy back of shares-help the company to utilize its idle cash, This provides returns to the shareholders in the form of improved financial ratios and a reduced number of outstanding shares in the market, (tinoreases the shareholders’ stake in the company. However, there are certain legal conditions a company must satisfy for buying back its shares. Some of the key provisions areas follows: . Only fully paid up shares can be bought by a company. 2. The buy back may be done only out of company’s free reserves, security premium account or proceeds of issue of afresh issue of shares or other specified securities A company can buy back maximuin upto 25% of the aggregate of paid up capital and free reserves of the company with the approval of the sharcholders. 4, Debt-equity ratio of the company shall not exceed 2:1 after the buyback of shares 5. The buyback should be completed within a period of one year from the date of passing the resolution. Ye = A company cannot issue same kind of shares including right issue of share within a period of 6 months from the date of buy back. . 7. A-company can buy back shares either from the existing shareholder ona proportionate basis, - Wip whi ny of ma ex] tha ret VyStock Market || 163 ne seouritivs issued to employees of of from the open market (stock market) or by purchasing the scours issued (o employ the company under a scheme of stock aption or steal equity » tise sharcholders, whose 8. Company shall within 7 days disburse the consideration ta cash to those sharel securities h e been accepted for buyback 9. Acompany shall extinguish and physically destroy the shares or securities bought back within T days of the completion of the buy back, ; 10. Acompany shall maintain a rogister of the securities bought back and is also reui to 2 4 retum with the registrar of companies within a period of thirty days of the completion of buyback. Alarge number of companies buy back its shares every year: In India, Ballarpur-Chini Mills, Li, Wipto Ltd, Aartidrugs Ltd, Tata Consultancy Services Ltd and Jagran Prakashan Ltd are five companies which have bought their shares back consistently over the past few year. 5.7 RISK IN THE INVESTMENT IN SECURITIES Investor likes to invest in securities to get returns. However, there is risk associated with the brotabiity of getting return. In finance, risk means the possibility that the actual outcome or return on an, a may differ from the expected outcome or return. [t is the variability of the actual retums from the expected retums associated with a security. The greater the variability the riskier is the investment in that security, It measures the potential loss in an investment decision. In general investors seek high retumn for risky investment to compensate themselves for taking cisks Types of Risk L. Systematic risk: [tis a risk which is caused by factors affacting all firms and all securities equally. tis a macro tisk which is unavoidable and non-dliversifable. It arises due to economic, social and political changes. Some of the factors which give tise to this type of risk are as follows: + Market risk: [tis the risk of variability in stock prices duc to changing expectations of the investors. + Tnterest rate risk: This risk is caused by variability of interest rates which normally arises due to change in monetary and credit policy. Changing interest rates create price risk and reinvestment rate risk for investors. Price risk is the possibility of volatility of security prices duc to change in interest rate. If the interest rate is increasing, it will make debt Securities more profitable and the investors of equity may prefer debt which will result in adverse impact on the prices of equity securities. s Further, the change in interest rate will change the rate at which reinv restment may be made by the investor and affects their tetum expectations, The market activity is then affected due to changing perceptions of the investot + Purchasing power risk: power of the inv ’ ‘This risk arises duc to inflation which reduces the purchasing ‘stor. Higher production cost causes increase in the price of the goodsiO” || Finance for Everyone consumed by people. This will penalize an investor's real return from holding an investment. Particularly, fixed income securities like debentures, bonds and preference shares are subject amouint of purchasing power risk as their repayment amounts remain fixed of the inflation rate 2. Unsystematic risk: {t arises due to the influence ofinternal factors peculiar to any firm or industry. The risk is also called as diversifiable tisk or avoidable risk because itcan be controlled and mitigated by an investor. {t is a micro level risk which may be caused by strike, change in management, shortage of power, change in consumer preferences, change in government policy, etc. This risk can be broken down into the following: + Business risk: Business risk of an organization is determined by the types of projects in _ which the investment is made. Business operations of.company.are affected by both internal _ and exterial factors. Internal business risk pertains to the efficiency of the operations. It may be caused by improper product mix, labour strike, lack of managerial skills, shortage of power supply etc. External business risk is caused by change in operation conditions which are not easily controllable by the organization. Examples of such risk are changes in government} policies and laws, change in the price and demand of the product and raw material, change in customer preferences, technological advancements, etc. In short, business risk arises due to change in the business environment which causes variability in the actual returns over the expected fetums. Financial risk: It is Uetermined by the debt-equity mix in the capital structure of an organization. A firm with no debt in the capital structure has no financial risk. Higher the debt component in the total capital, higher will be the fixed interest burden and higher the financial risk. Fixed interest payments will put pressure on cash flows on the one hand and on the other hand the firm will require a higher level of operating profits to cover interest costs, 3 In other words, if there are two firms operating in the same industry and thus have the same level of business risk, one of them may be less financially risky just because it has more equity capital and less debt funds as compared to the other firm. However, it should also be noted here that the cquity shareholders of the firm which have high debt may get the favourable benefit of the finaneial leverage and as a result may get higher carnings per share. 5.8 MANAGEMENT OF RISK {tis clear from the discussion in the previous section that investmentiin securities involves tisk. Different levels of risk occur with investment in different types of securities. For example, investment in fixed deposit is considered a less risky investment, while investment in equity shares is very risky. The casiest and common way is to invest in more than one type of security. There is a famous saying,’ Never put all Cggs in one basket’. It is always better to create a portfolio of different securities, different companies, and different industries. ‘Thus, the risk can be managed through diversification of investment. There are other ways also to mitigate risk in investment in securities, Some of them are now discussed.Stock Market || 165 5.8.1 Stop Loss Stop loss is a type of order to buy or sella security in the stock market when it reaches a particular price point. This is an automated order placed by investor with the broker. IL is designed to limit an investor's loss in a security. Stop loss order may be placed to sell a sccurity if the market price of the security reaches the threshold price called as trigger price. For example, suppose Anun holds 100 equity shares of Reliance Industries Ltd purchased at €2600 per share. He has put the trigger price of 22550. Then as soon as the market price touch base to %2550, the order to sell is triggeréd. This limits the loss of investor to 750, per share. ‘The underlying assumption behind this strategy is that if the prices are falling, it may continue to fall much further. So, the loss is capped with stop loss order. Now suppose the current market price of the share is £2675 and the investor has fixed the trigger price of 2625. In that case; when price falls'and touch %2625, the order to self becomes active. In this case the investor is able to book'a profit or capital gain of €25 (2625-2600) per share and is protected from falling prices. The stop loss order is used by-the investo either to limit their losses or to protect their profits, , 5.8.2 Derivatives Secisrities Contracts (Regulation) Act 1956 has defined derivatives as: - 1. A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security. 2. Acontract which derives its value from the prices, or index of prices, of underlying securities. In simple word a derivative is a financial instrument which has no independent value. [ts value is derived from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, livestock, or anything else. Derivatives serve.as a risk management tool. ‘Derivatives are used to hedge the risks associated with the changing price levels of the underlying assets, For example, suppose ABC Lid manufacturers @ popular potato chip brand for which it requires to buy a large quantity of potato. It has a supplier farmer Ramesh. Say ABC Ltd enters into a contract with Ramesh to buy potatoes at a rate of €1000 per quintal after 4 months. It is possible that due to heavy rainfall the crops of potatoes are destroyed thus the price of potato may be higher in the market. In this case ABC Ltd will stil be paying only 21000 per quintal for potatoes and Ramesh is obliged to sell at this price. On the other hand, it is possible that due to bumper crop a huge production of potato has occurred which has reduced the market price of potato per quintal below &1000. Now Ramesh interests are protected. He will still get 1000 per quintal from ABC Ltd. This contract is a forward contract to buy or sell at a predetermined price ata future date made with the objective of managing risk at the end of both parties. And it is called a derivative. The underlying asset is the potato.166 || Finance for Everyone 5.8.2.1 Types of Derivatives The are mainly four types of derivatives that can easily be traded in the Indian stock market (i) Forward Contracts A forward contract is an agreement between two parties to buyrand sell an underlying asset ona fixed date in future at an agreed price. They are customized egntracts which are settled on a delivery date ‘These types of contracts are not traded on centralized stock exchanges. The example used earlier is an illustration of a forward contract, Forward contracts are mainly used to hedge against the risk of potential loss due to price volatility of the underlying assets, (ii) Future Contract A future contract is a legal agreement to buy/sell an und - ing assct on a fixed date in future at’ Secified price. Unlike forward contracts they are standardized contracts which are traded via a stock exchange. The two concemed parties need not meet each other. The future contract to buy and sell is, entered between the parties through. regular:stockbrokers in an’ stock exchange. In-other words, the buyer and the seller don’t enter into a private agreement, Instead, cach party is in agreement with the exchange. The exchange decides size, format and expiry of these contracts. These contracts are traded in stock exchanges, Let us take an example. Suppose Novembec future contract for the shares of XYZ Ltd are traded at stock exchange today at 71000 per share. Mr. Ajay buys {00 of these future contracts for a total of %1,00,000 for 100 shares. Now in November(last day) the price of share in the stock market may be: (8) Less than 1000 say €950 (ii) more than 1000 say €1100 (ii) Equal to €1,000 In the first case Mr. Ajay is required to buy 100 shares at £1000 per share though the mackét price is 2950_per share. Thus, a loss of %50 per share ic. 25000 on 100 shares will be incurred by investor. However, in’ the second situation the investor will be able to buy shares at 1000 though the prevailing market price is T1100. He will have a profit of 10,000 (100 per share). In third case, there is no profit or no loss. . . Following are the features of a future contract which differentiate it from a forward contract. L. Standardized contracts: Future contracts are standardized contracts where terms and ~~ conditions are set by the exchange in which they are traded. The interested parties can then buy or sell these contracts on stock exchange. Rv Guarantee: The clearing houses guarantee the {ulfilment of transaction Thus, it takes away the default risk at the end of parties. . Margin requirement: Both the parties to a future contract i. buyer and seller are required to deposit the margin money with the exchange which works as collateral to cover the risk of default Daily settlement: Future contracts are subject to daily scttlement. In daily settlement the investors who incur losses pay every day to investors who make profit. The proc until the end of the contract 5. Liquidity: Future ate tea goes on led at exchanges and thus provide liquidity to investors. 6 (ii) O Aopiic underly the epti option, To of optic fa) (b) ee xc €© ®6. Dealing with exchanges: In a future contract both the parties are just dealing with exchange not directly, So the contract can be closed by any party any time on the floor of the exchange (ii) Options A options is a type of contract that gives the buyer the right but not the obligation to buy or sell the underlying asset on a certain dafé at a fixed price. This is a contract which takes sides with the buyer of the option by providing the option. Thus, the buyer of the option pays to the seller called as writer of the option, an amount up front which is called as the option premium. To understand how option trading is done in the market. {t is essential to understand the two types of options which can be traded. (a) The Call Options Call option is an option conteact that gives its holder the tight but not the obligation to buy an asset at an agreed price (called as strike price) on or before a specific future data called as expiry date. The seller tias the obligation to sell. The call option is bought by the option buyer by paying an option premium to the seller of option (also called as option writer) The call option is bought because the bayer expects a rise in the price of underlying asset in the future. For example, Let us pressure tha the current market price ofthe Tata Motors share is €460 per share. Naman expects that the price of this share will go up in the near future. Hence, he buy a call option to buy a share of Tata Motors at strike price of 464 on or before expiry date after a month. Now if after a month, the price of the share of Tata Motors goes up and rises to 467 per share. Mr. Naman will exercise the option to buy. In that case he can buy at %464 and can book a profit of %3 per share by selling it at 467. On the other hand, in case thé price of the share falls to 2460 instead of rising. Mr. Naman will not exercise the option. His loss will only be the amount he paid to the option seller as option premium, : Seller has exactly the opposite position. In case the buyer exercises the option, he will incur a loss of 33 (467- $464). However, suppose he received an option premium of 21.5. So, his net loss will be €1.5. In case buyer does not exercise the option, his gain is equivalent to option premium ic. 1.5 (b) The Put Option: A put option is an option contract that gives the option buyer the right but not the obligation to sell the underlying asset at the set strike price (exercise price) any time before and on the expiry date. This option is bought with the expectation of fall in the price of underlying assets. This option gives the holder a chance to sell at a higher price than the market price in the near future and thereby reduces the risk of the investor. Again, the buyer of the put option is required to pay option premium to the seller. For example, let us again presume that the current market price of the Tata Motor share it 460 per share. Ms. Lavanya expects a fall in the price of shares. Hence, she buys a put option to sell one share of Tata Motors at €458 with expiry date after one month. Now suppose.on expiry date the price of share is 2455. Lavanya will sell the share at 2458 and will make a profit of 33168 || Finance for Cveryone _ se het soll at T458. In. (2458 - £455) However, i the price is €461 she will not and Leen to sell a this case she wll incur a foss equal to the option premium Pa ay 2 scat en the buyer exercises the option to sell at 458, the lier of the opt i at £458 when the market price 'S 4455 only. However, this n of &2 received by him. Incase the option buyer does not asa gain equivalent to the option prengium already On the other hand, W suffers a loss of €3 as he is buying loss is reduced by the option premium exercise the option, the option seller mat received by him. ‘The important terms pertai (a) Sport price: Sport price is the current market price of t ining to an option contract are: / the underlying asset. (b) Strike price: [tis the exercise price at which option buyer decides to buy or sell the ‘underlying assets on or before the specified date. ~~ (c) Option expiry date: [tis the date on which the option expires if'not exercisgd. In India if the offer expires in a month, itis the last Thursday of the month. (d) Option premium: [tis the non-refundable amount paid by the option buyer to the-option’ seller to buy the option. . Option provides the investor not only hedge against the risk but, also an opportunity to trade for any potential movement in the price of underlying assets ‘with a small amount as compared to -astock transaction. (iv) Swaps Swaps are derivatives which refers to exchange of pre agreed cash flows of two financial instruments ‘on specific dates based on the terms of the contract entered into. Swaps can be used to hedge risk of various kinds which includes interest rate risk, currency rate risk and so on. Swaps are not traded-on stock exchanges. Usually the dealings are done through banks. 5.8.3 Hedging Hedging is a risk management strategy which works as an insurance. against possible losses duc to a negative event. For example, buying a car insurance is a hedging strategy against accident, theft etc. Hedging does not prevent the incident from happening. However, it provides a protective cover against the losses in case negative event docs happen. In the stock market hedging helps in limiting the losses that may be incurted by an investor due to unforeseeable variations in the movement of the prices of the securities. Hedging is mainly done through derivatives to take an opposite position in the underlying assct. For example, Ict us presume Ms. Taruna bought 10 shares of Reliance Industries Ltd. at 82600 per share. Now in future the prices may go up and down. Taruna wishes to protect from the loss due to fall in the price of the share. This can be done by her by buying a put option derivative. Letus presume that Taruna bought a put option of selling 10 shares @ %2580 on o before the expiry of one month for this option. She pays a option premium of 82 per share, So jher position is as foltows. ~ (i) Cost of investment in shares 26,000 (i) Option Premium paid (10° 82) %20C tl ry 3. Stock Market || 169 Now let us look into the two possibilities in the price movement of the stock, (a) The price of the Reliance Industries share falls to $2550 per share. In this situation Ms, Taruna will exercise the option and sell 10 shares (@ €2580 per shares. [ler total loss is as follows = . Loss on sale of shares (22600 - £2580) * 10 = 200 Option Premium Paid = 20 Total Loss = %220 In case she would not have taken the option her loss would have been €50 per share i.e., total ~tass %50 x {0 shares = 2500. Thus, hedging reduced loss by®280. (©) ‘Theprice ofthe Reliance Industries share goes up to ¥2625 per share. Inthe situation of upward movement in prices, Taruna need not exercise the put option. Her loss by not exercising is just equal to the option premium she paid i.e: 2 * 10 = 220 However, she’can gain by selling in the market as follows = (@2650 = 2600) x 10 = 500. Her net gain is €480. : Another way of hedging besides derivatives is through diversification as explained in the beginning of this section, Diversification siruply means investing in the variety of securities which are not related o each other. For example an investor an buy stocks ofa hotel company and a pharmaceutical company. So if the tourism industry is impacted by an unforeseen event like Covid 19, the expected loss is mitigated by the hike in the prices of pharmaceutical company stock. Clearly hedging works as loss prevention strategy in case of unanticipated price movetnents and market fluctuations. ; 5.9 TAX ON CAPITAL GAINS When a capital assets sold on profit itis called a‘apital goin. As per ncome tax act 1961 the definition of capital assets as follows: (i) Property of any kind held by an assessee, whether or not connected with his business or profession. Land and building, house property, vehicles, patents, machinery, trademarks, jewelry and securities ace a ow examples of property. (ii) Any securities held by a financial institution of lndia (PI) which has invested in such securities in accordance with SEBI regulation, However, agricultural land, personal goods such as clothes and furniture held for personal use, stock in trade for business are some of the assets which are not considered as capital assets for capital gain tax purposes. Capital gain tax can be divided into two categories i, (i) long term capital gain tax and (ji) short term capital gain tax. The capital gain is long term or short terin, it depends upon the holding period of the capital asset. So let us understand all these aspects,170 || Finance for Everyone — 5.9.1 Holding Period —anjtal asset is Kept bY a” Holding peri is the time pero for which a eapital asst Kept by mt purchase of capital assets and its sale by the investor son0 and wl them ia . as 2020 anc ie 7 Mr Arvind purchased shares of Besannia Industries Ltd. on September 5, a May’ 16, 2022. The holding period of shares is 20 months, LI days. n investor. In other words, it is the time petiod betw 59.2 Short Term and Long Term Capital Asset Different holding period rules exists for different capital assets t term asset. The details are given in the table below: 10 be considered as Jong term and short Table 5.9 Short Term Holding | Long Yerm Holding ‘Type of Capital Asset ay a fr 2 Shares (@quity or preference) listed in a recognized | Not more than 12 More than 12 months stock exchange , units’of mutual funds, other listed months securities like debentures, Government securities, etc. Unlisted shares or an immovable property ike land or| Not more than 24. More than 24 months building or both. months Any other capital asset Not more than 36 | More than 36 months. months Example 1: Mr Raj purchased a house in January 2020 and sold it in December 2021. Then his holding period for & immovable property is less than 24 months so the house. will be considered-short term’ capital asset and he will be charged short term capital gain tax. Example 2: Mr, Akshay purchased 100 shares of Reliance industties Ltd in June 2020, He sold them in July 2021. Now, he has held the shares for more than 12 months So, Shaces are long term capital asset hie will be charged and longterm capital gain Example 3: Mr Amit purchase gold in April 2020 and sold it in July 2022. He has kept the gold for less than 36 months. So he will be charged short term capital gain tax and gold will be considered as short term capital asset. 5.9.3 Long Term and Short Term Capital Gain Long term and short term capital gains occur only when the capital asset is sold on profit ‘The gain which arise on the sale of short term capital assct is called as short term capital gain and the profit on the sale of long term capital asset is termed as long term capital gain.{a) Calculation of Short Term Capital Gain Illustration §,6: Ms, Indu purchased gold swarth &5,00,000 in August 2021 an in July 2022. For making the sale an espenditure of 85000 was incurred as brokerag sold it for %6,40,000 harges. Calculate itst ofall the holding period of gold is less than 36 months and itis sold on profit. So Indu short term capital gain calculated as below: Value of Capital Asset less Cost of Acquisition less Cost of Asset Improvements less Expenses Incurred for Sale Particulars ®) | Sale value of gold %6,40,000 | . Less: Cost incurred on sale 110,000 Net amount received %6,30,000 Less: Cost of gold : 35,00,000 Short term capital gain 11,30,000 (b) Calculation of Long Term Capital Gain Long term capital gain is calculated as follows: LICG = Final Sale Price less Indexed Cost of Acquisition less Indexed Cost of Improvement less Cost of Transfer/ Sale. Where, Index Cost of Acquisition = Cost of Acquisition x (Cost inflation Index of the Year of Sale/ Cost Inflation Index of the Year of Acquisition). Indexed Cost of Improvement = Cost of Improvement x (Cost Inflation Index of the Year of Sale/ Cost Inflation Index of the Year of lmprovement). Indexation adjusts the costs against inflationary rise in the value of the asset. The central government has notified cost inflation index « Tilustration 5.7: Mr. Ram purchased a piece of land in May 2015 for €18,40,000 and sold the same in June 2021 for ¥60,00,000 and incurred a brokerage cost of %6,00,000. Calculate the capital gain to be taxed. The inflation index for 2015-16 is 254. And for 2021-22 it is 317. Solution: Land is an immovable property and the holding period of Ram is more than 24 nionths, ‘Thus, Ram will be taxed for long term capital gain. Long term capital gain can be calculated as under: Particulars @) Sale Value of Land 60,00,000 | Less: Expenses incurred on Sale 600,000. Less: Indexed Cost of Acquisition | 22,96,320 | | Long Term Capital Gain 31,03,6801/2 || Finance for Everyone a a — oe Inflation indes of year of sale Index cost of acc uisition = Cost of Acquisition * 5 index of year of acquisatton qi Inflation index of y Index cost of actuation = 818, 40,000 * a = 22,96,320 = ~ Cantal Gat in India 5.9.4 Long Term Capital Goin Tax Rates ond Short Term Capital Gain Tox Rates in Indi cm capital gains are as follows: ‘The current prevalent rates on short term capital gains and long-te {i) Shot Term Capital Gain Tax The short term capital gain tax depends upon-whether th Whenever &quity shares, units of equity oriented mutual * exchange such transactions liable to security transaction tax STT. equity shares, sale of debentures, bonds and government securities, like gold, land etc., no security transaction tax is paid. e security transaction {ax is applicable or not. funds etc. are sold through a recogrrized stock Howeve:, on sale of shares other than sale of capital asset other than shares The short term capital gain tax is charged as below: \ Tax Rate 15% (plus surcharge and cess as applicable) The gain is added to the total income and tax is charged at normal rate applicable per income tax slab. | S.No. 5 Condition 1. | When security Transaction Tax is paid 2. | When security Transaction tax is not paid Illustration 5.8: Mr Ajay purchase L000 equity shares of ABC Ltd @ 100 per share on 2nd July 2021 and sold them in BSE on Ist October 2021 at the rate of 120 per share. STT is paid. The brokerage paid is €1 per share Calculate the capital gain tax Solution: (i) Holding period: The shares are listed and are hold for less than 12 months. Thus, short term capital gain tax will be applicable (ii) Calculation of short term capital gain tax. Particulars = ®& Sale value of shares 1000 7120 1,20,000 Less: Brokerage paid 1000 x @1 (1000) Less: Cost of shares 1000 x €1000 ~_1,00,000 Short Term Capital Gain - 19000 | Short Term Capital Gain Tax (15%) 2850 mshations 3: Mr. Tarun purchased 1000 debentures of XYZ Ltd at the rate of €250 per debenture on Ist January 2022. He sold them on 30thMay 2022 at €270 per debenture. Calculate the capital gain tax if Tarun is in 30% income tax slab. The brokerage paid is 710,000.Solution: (i) Holding Period: The holding period of debentures is less than 12 months. Therefore, short term capital gain tax is applicable. (i) Calculation of Short Term Capital Gain Tax. [ Particulars — e __ | Sale value of debenture 1000 x 2270 2,10,000 | Less: Broker age paid i oe |_ Less: Cost of debentures 2,50,000 Short term capital gain 10,000 | Tax rate “7 _ 0% | Short term capital gain tax . anne Note: The short term capital gain will be added in the total income of the Tarun and then tax at the Tate of 30% will be charged as he belongs.to this tax rate slabs. (ii) Long Term Capital Gain Tax The long term capital gain tax rates are as follows: S.No. | Condition Tax rate L. ] Sale of listed securities, units of Mutual fund or | 10% only if the long term capital gain exceeds zero coupon bond | 81,00,000 2. | In other cases [20% It is to be noted that if the benefit of indexation is taken the tax rate in first case also becomes 20% Illustration 5.10: Mr. Taksh purchased 10,000 shares of Beta Ltd Listed on BSE on Ist April 2019 at 50 per share. He sold these shares on 10th August 2022 at the rate of &85 per share, brokerage paid is 1% of the sale value. Calculate capital gain tax. Solution: (i) Holding period: As the security is listed and is hold byt Taksh form more than 12 months,the long term capital gain tax will be applicable. (ii) Calculation of long term capital gain tax. Particulars : ® Sale value of shares 10,000 x 85 = 830,000 Less: Brokerage paid [% 85,000 Less: Cost of shares 5,00,000 | Long term capital gain aan 2,65,000 | Tax Rate as capital gain is more than €1,00,000 ‘10% Long term capital gain tax 26,500