Unit 4 Secondary Market

-Twesha Chharia

What are secondary markets?

The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. Alternatively, secondary market can refer to the market for any kind of used goods. Once a newly issued stock is listed on a stock exchange, investors and speculators can easily trade on the exchange, as market makers provide bids and offers in the new stock.

 In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid and transparent. Before electronic means of communications, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly

Post reform Stock market scenario

After initiation of reforms in 1991,the Indian Secondary market now has a three tier form: Regional Stock Exchange National Stock Exchange The Over the counter exchange of India

Organization, Management and Membership of Stock Exchange

Organization forms :Bombay, Ahemdabad, Patna,Indore Voluntary non profit making association Kolkata,Delhi,Bangalore,Cochin,Kanpur,Gu Public limited company wahati,Ludhiana,Mangalore,Chennai Hyderabad,Pune,Rajkot,Magadh National stock exchange Company limited by guarantee A tax paying company incorporated under the Companies Act and promoted by leading financial institutions and banks A company under section 25 of the Companies Act,1956

The Over the Counter Exchange of India

 The regional stock exchanges are managed by a governing body consisting of elected and nominated members. The trading members who provide broking services, own, control and manage the exchange. The governing body is vested with wide ranging powers to elect office bearers, set up committees, admit and expel members, manage properties and finances of the exchange, resolve disputes and conduct day-to-day affairs of the exchange.

 The OCTEI and NSE are de-mutualised exchanges where in the ownership and management of the exchange are separated from the right to trade on exchange. Brokers are members of the stock exchange. They enter trades either on their own Account or on behalf of client. They are given a certificate of registration by SEBI and they have to comply with the prescribed code of Conduct.

 Over a period of time, many brokers with proprietary and partnership firms have converted themselves into corporate entities. Both NSE and OTCEI have laid down strict standards of the admission of members, which relate to capital adequacy, track record, education, experience and so on to ensure quality broking services.

 Stock broker is required to pay an annual registration fee of Rs 5,000 if his turnover per year does not exceed Rs 1 crore. If it does, he has to pay Rs 5,000 plus one hundredth of one per cent of the turnover in excess of Rs 1 crore. Five years from the year of initial registration he has to pay Rs 5,000 for a block of five financial years. The exchange also levies transaction charges

 The brokerage of transactions vary from broker to broker. The maximum brokerage that can be levied is 2.5 per cent of the contract price exclusive of statutory levies such as SEBI turnover fee, service tax, and stamp duty.

Demutualization of Stock Exchanges:

All the stock exchanges in India except the National Stock Exchange are broker owned and broker controlled. In other words, the brokers who trade collectively own and run these exchanges. The ownership and management of the brokers often led to a conflict of interest wherein the interest of brokers was preserved over those of the investors.

 Instances of pricing, rigging, recurring payment crisis on stock exchanges and misuse of official position by office bearers have been unearthed in the last few years. As a result, both rolling settlement and demutualization of stock exchanges was announced to preserve their integrity.

 Demutualization is the process by which any member-owned organization can become a shareholder owed company.

Such a company could either be listed on a stock exchange or be costly held by its shareholders.

 Stock exchanges in India are either section 25 companies under the Companies Act or an association of persons. Hence stock exchanges are exempt from all taxes. Through demutualization, a stock exchange becomes a corporate entity, changing from a nonprofit company to profit making and tax paying company.

 Demutualization separates the ownership and control of stock exchanges from the trading rights of its members. This reduces the conflict of interest between the exchange and the brokers and the chances of brokers using stock exchanges for personal gains. With demutualization stock exchanges have access to more funds for investment in technology mergers with and acquisition of other exchanges and for strategic alliances with other exchanges.

 Members of the stock exchange also benefit by demutualization as their assets become liquid and they get a share of the profit made by the exchange through dividends. Demutualization makes operations of the stock exchange transparent which facilitates better governance.

 There is global trend towards demutualization wherein 17 stock exchanges including NASDAQ and those of Australia, Singapore, Hong Kong, London, and Tokyo have already demutualized and another 15 are in the process of demutualization.

Role of SEBI in regulating Indian Capital Market

1. Power to make rules for controlling stock exchange : SEBI has power to make new rules for controlling stock exchange in India. For example, SEBI fixed the time of trading 9 AM and 5 PM in stock market.

 2. To provide license to dealers and brokers : SEBI has power to provide license to dealers and brokers of capital market. If SEBI sees that any financial product is of capital nature, then SEBI can also control to that product and its dealers.

 3. To Stop fraud in Capital Market : SEBI has many powers for stopping fraud in capital market.

It can ban on the trading of those brokers who are involved in fraudulent and unfair trade practices relating to stock market.
It can impose the penalties on capital market intermediaries if they involve in insider trading.

 4. To Control the Merge, Acquisition and Takeover the companies : Many big companies in India want to create monopoly in capital market. So, these companies buy all other companies or deal of merging. SEBI sees whether this merge or acquisition is for development of business or to harm capital market.

 5. To audit the performance of stock market : SEBI uses his powers to audit the performance of different Indian stock exchange for bringing transparency in the working of stock exchanges.

Stock market index

Stock market indices measures overall market sentiments through a set of stocks that are representative of the market.

Methods for calculating the index

1. Full market capitalisation method: no of shares outstanding X market price of companys share It describe the scrips weightage in the index The share with the highest market capitalisation would have higher weightage and would be the most influential in this type of market.Eg:S&P 500 Index in USA and S&P CNX Nifty in India

 2.Free float market capitalisation method: It is the percentage of shares that are freely available for purchase in the markets. It excludes strategic investment in the company such as stake held by the government, controlling shareholders and their families, companys management, restricted share due to IPO regulations and share locked under employee ownership plan

 Subsequently all BSE indices with the exception of BSE PSU index have adopted the free-float methodology on 11 July 2001.

 Major Advantages of Free-float Methodology A Free-float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the market. Free-float Methodology makes the index more broad-based by reducing the concentration of top few companies in Index.

 Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. Undue influence of company on index is reduced.

Determining Free-float Factors of Companies

BSE determines the Free-float factor for each company based on the detailed information submitted by the companies in the prescribed format.

Free-float factor is a multiple with which the total market capitalization of a company is adjusted to arrive at the Free-float market capitalization.

 Once the Free-float of a company is determined, it is rounded-off to the higher multiple of 5 and each company is categorized into one of the 20 bands given below. A Free-float factor of say 0.55 means that only 55% of the market capitalization of the company will be considered for index calculation. This free float is then multiplied by full market capitalization to arrive at free float capitalization.

% Free-Float >0 5%
>5 10% >10 15% >15 20% >20 25% >25 30% >30 35% >35 40% >40 45% >45 50%

Free-Float Factor 0.05

0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50

% Free-Float >50 55%

>55 60% >60 65% >65 70% >70 75% >75 80% >80 85% >85 90% >90 95% >95 100%

Free-Float Factor 0.55

0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

Credit rating agency

A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued.

Investment banks
Investment banking" refers to financial advisory work. For example, a big corporation might ask for the bank's help if it wants to borrow money in the bond markets, or float itself on the stock market, or buy up another company. In this capacity, the investment bank acts as an impartial adviser - like an accountant - using its expertise to help its client in return for a fee.

 But investment banks also do something else quite different - they deal directly in financial markets for their own account. An investment bank's "markets" division makes money by buying financial assets from one client, and then selling them to another often with a hefty mark-up.

FII investment in India

An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds. The term is used most commonly in India to refer to outside companies investing in the financial markets of India.

 International institutional investors must register with the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs (foreign institutional investors) involves placing limits on FII ownership in Indian companies.

 Foreign Direct Investment in India is permitted as under the following forms of investments: Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets . Through private placements or preferential allotments.

 FDI is not permitted in the following industrial sectors: Arms and ammunition. Atomic Energy. Railway Transport. Coal and lignite. Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.