Equity and Equity-Related Products – NISM Series XA Short Notes (Part 5)
Welcome to Part 5 of the PassNISM short notes series for NISM Series XA – Investment Adviser (Level 1). Equity products form a major portion of the exam and real-world investment advisory. This post covers equity shares, how they are issued, how the secondary market works, valuation methods, and equity-linked instruments tested in the NISM XA exam.
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What is Equity?
Equity represents ownership in a company. When an investor buys equity shares, they become a part-owner (shareholder) of that business. Equity shareholders:
- Share in the company's profits through dividends
- Benefit from capital appreciation when the stock price rises
- Hold voting rights on company decisions (at AGMs)
- Are residual claimants — last to be paid in the event of liquidation, after all creditors and preference shareholders
Equity is considered a high-risk, high-return asset class — it has historically beaten inflation and other asset classes over long investment horizons.
Types of Shares Ordinary (Common / Equity) Shares
The standard form of share capital. Carry full voting rights and are entitled to residual profits after all prior claims are satisfied.
Preference Shares
Holders receive a fixed dividend before ordinary shareholders and have a prior claim on assets during liquidation. However, they usually do not carry voting rights. Types include:
- Cumulative Preference Shares – Unpaid dividends accumulate and must be paid before any equity dividend
- Non-Cumulative Preference Shares – Unpaid dividends lapse if not declared
- Redeemable Preference Shares – Repaid by the company at a future date
- Convertible Preference Shares – Can be converted into equity shares at a specified ratio and time
Differential Voting Rights (DVR) Shares
Equity shares with fewer voting rights but usually a higher dividend. Sometimes used by promoters to raise equity while retaining voting control.
Primary Market – How Shares Are Issued IPO (Initial Public Offering)
The first time a private company sells shares to the public to list on a stock exchange. Capital raised is used for business expansion, debt repayment, or other purposes. IPO price is determined through:
- Book Building Method – Bids are collected within a price band (e.g., ₹90–100); final price set where demand meets supply (cut-off price). Most common method.
- Fixed Price Method – Price is fixed upfront by the company and its investment banker.
FPO (Follow-on Public Offer)
An already-listed company issues additional shares to the public. Can be a fresh issue (new shares, company gets funds) or an offer for sale (existing shareholders sell, company gets no fresh funds).
Rights Issue
Existing shareholders are offered new shares at a discounted price, in proportion to their current holding. They have the right but not the obligation to subscribe. Rights can be traded (renounced) on the exchange during the offer period.
Bonus Issue (Capitalisation Issue)
Free shares issued to existing shareholders by capitalising reserves. The total market capitalisation does not change; the share price adjusts downward proportionally. Example: A 1:1 bonus means one new share for every share held — the price halves, but you hold double the shares.
Stock Split
The company reduces the face value of each share and proportionally increases the number of shares. Similar effect to bonus issue but done differently. Example: A 2:1 split on a ₹10 face value share creates two ₹5 shares for each original share.
Buyback (Share Repurchase)
The company purchases its own shares from the open market or through a tender offer, reducing the number of shares outstanding. This increases EPS and is often done when the management believes the stock is undervalued. SEBI regulates share buybacks.
Private Placement
Shares offered to a select group of institutional or qualified investors without a public offer. Faster process. Includes QIP (Qualified Institutional Placement) — a fast-track fundraising route for listed companies to place shares with qualified institutional buyers (QIBs).
Offer for Sale (OFS)
Promoters or large shareholders sell existing shares through the exchange mechanism (not a new share issuance). No new funds go to the company. Common in government disinvestment programmes.
Secondary Market – Stock Exchanges
The secondary market is where already-issued shares are bought and sold between investors. Price discovery happens here based on demand and supply.
Major Exchanges in India
- NSE (National Stock Exchange) – Largest by trading volume; benchmark index: NIFTY 50 (50 stocks)
- BSE (Bombay Stock Exchange) – Asia's oldest exchange (est. 1875); benchmark: SENSEX (30 stocks)
Market Timings
- Pre-Open Session: 9:00 AM – 9:15 AM (order collection and price discovery)
- Regular Session: 9:15 AM – 3:30 PM
- Post-Close Session: 3:40 PM – 4:00 PM
Settlement
Indian equity markets follow T+1 rolling settlement. Shares and funds are exchanged one trading day after the trade date.
Circuit Breakers
To prevent extreme volatility, market-wide circuit breakers halt trading when NIFTY or SENSEX falls by 10%, 15%, or 20% in a single day.
SEBI Upper and Lower Circuit
Individual stocks have upper and lower circuit limits (5%, 10%, 20%) based on their volatility. If a stock hits the circuit limit, trading is paused or halted.
Equity Valuation Methods Fundamental Analysis
Assesses the intrinsic value of a stock using financial data, business quality, and economic environment. The goal is to find stocks trading below intrinsic value (undervalued) and avoid overvalued ones.
Key Fundamental Metrics
- P/E Ratio – Price / EPS; how much investors pay per rupee of earnings
- P/B Ratio – Price / Book Value; useful for banks and asset-heavy firms
- EV/EBITDA – Enterprise Value / EBITDA; removes effect of different capital structures
- PEG Ratio – P/E / Earnings Growth Rate; P/E adjusted for growth; PEG <1 may signal undervaluation
- Dividend Yield – Annual DPS / Market Price; income from dividends relative to price
Dividend Discount Model (DDM)
Values a stock based on the present value of its expected future dividends.
Gordon Growth Model (Constant Growth DDM):
Intrinsic Value = D1 / (Ke – g)
Where: D1 = Expected dividend next year; Ke = Required return on equity; g = Sustainable dividend growth rate
Applicable only for stable, dividend-paying companies where g < Ke.
Technical Analysis
Uses historical price and volume data to forecast future price movements. Based on the assumption that all known information is already reflected in the price (efficient market).
- Support Level – Price floor where buying interest tends to emerge
- Resistance Level – Price ceiling where selling pressure tends to emerge
- Moving Averages – SMA, EMA to identify trend direction
- RSI (Relative Strength Index) – Momentum indicator; above 70 = overbought, below 30 = oversold
- MACD – Moving Average Convergence Divergence; identifies trend reversals
- Bollinger Bands – Volatility indicator using standard deviation around a moving average
Equity-Related Instruments
| Instrument | Description |
|---|---|
| Convertible Debentures | Debt that converts to equity at a future date; partly or fully convertible |
| Warrants | Right (not obligation) to buy shares at a predetermined price before expiry |
| Equity Futures | Obligation to buy/sell shares or index at a future date at agreed price |
| Equity Options | Right (not obligation) to buy (call) or sell (put) equity at strike price |
| ETFs (Exchange Traded Funds) | Passively track an index; traded on exchange like shares; low cost |
| REITs | Listed instrument giving income from real estate assets; regulated by SEBI |
| InvITs | Infrastructure Investment Trusts; similar to REITs for infrastructure assets |
Equity Taxation in India (Post-Budget 2024)
| Type of Gain | Holding Period | Tax Rate |
|---|---|---|
| Short-Term Capital Gain (STCG) | Less than 12 months | 20% (flat) |
| Long-Term Capital Gain (LTCG) | 12 months or more | 12.5% on gains above ₹1.25 lakh (no indexation) |
| Dividend Income | Any period | Added to total income; taxed at slab rate |
💡 STT (Securities Transaction Tax) is levied on equity transactions on recognised exchanges. LTCG exemption limit raised from ₹1 lakh to ₹1.25 lakh in Budget 2024.
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