NISM Series XV Research Analyst Study Notes: Chapter II - Introduction to Securities Market (Part 2)
This comprehensive study guide covers the second part of Chapter II: Introduction to Securities Market, focusing on the structure of the market, primary market issuance methods, key market participants, types of transactions, and modes of holding securities.
1. Structure of the Market & Issue of New Securities
The securities market is broadly split into two primary segments based on the lifecycle of the securities being traded: the Primary Market (where new capital is raised) and the Secondary Market (where existing securities are traded among investors).
A. The Primary Market
The primary market is the channel through which corporatised entities and governments issue fresh securities to raise capital directly from investors. The source identifies ten major methods used by issuers to offer or issue these securities in the primary market:
- Initial Public Offering (IPO): The first public issuance of shares by an unlisted company to the general investing public.
- Follow-on Public Offer (FPO): An additional public issuance of shares by an already listed company to raise further capital.
- Private Placement: The sale of securities directly to a select group of private investors rather than through a public offering.
- Qualified Institutional Placement (QIP): A regulated private placement mechanism allowing listed companies to raise capital by issuing equities or convertible securities to Qualified Institutional Buyers (QIBs).
- Preferential Issue: An issue of bulk shares to a select group of individuals or partners on a preferential basis, subject to regulatory pricing guidelines.
- Rights Issue: A corporate action where additional shares are offered directly to existing shareholders of the company at a discounted price. This allows existing investors to maintain their proportional ownership.
- Bonus Issue: Also known as an equity dividend, this is an alternative to a traditional cash dividend. Under a bonus issue, additional shares are distributed to existing shareholders by the company without any cash consideration required from them.
- Onshore & Offshore Offerings: Capital-raising exercises targeted at domestic (onshore) or international (offshore) investor bases.
- Offer For Sale (OFS): A mechanism where promoters or existing shareholders dilute their holdings by selling their shares directly to the public through the exchange platform.
- Sweat Equity: Equity shares issued by a company to its directors or employees at a discount or for consideration other than cash, rewarding them for providing intellectual property rights or value additions.
B. The Secondary Market
Once securities are issued in the primary market, they are listed and traded in the secondary market. The secondary market provides liquidity and price discovery for these outstanding securities. According to the source, the secondary market is further divided into two core operational segments:
- Over the Counter Markets (OTC): Unregulated, decentralised markets where financial transactions are customized and negotiated directly between two counter-parties without an exchange acting as an intermediary.
- Exchange Regulated Market: Centralised and highly regulated platforms (such as stock exchanges) where standardized contracts are traded under standardized exchange clearing rules.
2. Four Key Categories of Financial Market Participants
A healthy financial ecosystem requires diverse stakeholders to interact. The source classifies market participants into four distinct groups:
1. Market Intermediaries
These entities provide the structural and operational support required for seamless trade execution, settlement, and record-keeping. They include:
- Stock Exchanges: Platforms facilitating trading activities.
- Depositories & Depository Participants (DPs): Facilities holding securities in electronic formats and their licensed agents.
- Trading Members / Stock Brokers / Sub-Brokers: Registered agents executing buy/sell orders on behalf of investors.
- Authorised Persons: Licensed individuals representing stockbrokers to facilitate trades.
- Custodians: Entities holding and protecting the financial assets of clients.
- Clearing Corporations: Dedicated bodies guaranteeing the clearance and settlement of stock trades.
- Merchant Banks & Underwriters: Professional entities aiding in primary market issuances and managing public offers.
2. Institutional Participants
These are professional, large-scale financial entities that deploy massive pools of capital into the market. They include:
- Foreign Portfolio Investors (FPIs) & P-Note Participants: International funds and proxy investors investing in domestic assets.
- Mutual Funds: Managed pooled investment schemes.
- Insurance Companies & Pension Funds: Long-term capital deployers protecting assets or managing retirement corpuses.
- Venture Capital Funds & Private Equity Firms: Private asset pools funding early-stage or established private businesses.
- Hedge Funds & Alternative Investment Funds (AIFs): Private pooled vehicles classified under three distinct regulatory brackets: Category I, Category II, and Category III.
- Investment Advisors: Registered professionals offering formal investment recommendations.
- Employee Provident Fund (EPF) & National Pension Scheme (NPS): Large state-backed retirement pools.
- Family Offices & Corporate Treasuries: Entities managing private family wealth or excess corporate cash flows.
3. Retail Participants
These are individual retail investors who buy and sell securities for their personal accounts rather than on behalf of organizations.
4. Proxy Advisory Services Firms
Specialized firms providing independent research, analysis, and voting recommendations to institutional shareholders to help them vote on corporate resolutions.
3. Comprehensive Analysis of Kinds of Transactions
Market participants engage in diverse transactions to trade, manage risk, or lock in risk-free profits. The source highlights several key transaction types:
| Transaction Type | Core Mechanism & Regulatory Nature | Strategic Purpose |
|---|---|---|
| Cash, Tom, and Spot Trades | Agreements to carry out a trade at the prevailing market price for settlement on the spot date. The exchange rate used is called the spot exchange rate. | Immediate delivery of assets. |
| Forward Contract | An unregulated, OTC-traded, fully customized contract between two parties to buy/sell an asset at a set price on a future date. | Highly apt for hedging due to its bespoke, non-standardized nature. |
| Futures Contract | Highly regulated, standardized derivative contracts traded on exchanges that obligate parties to transact an asset at a predetermined future date and price, regardless of the spot price at expiration. | Hedging or speculation. Allows investors to gain from price changes without buying the physical product. |
| Options | Derivative financial instruments based on underlying securities (e.g., stocks) that offer the buyer the opportunity (but not obligation) to buy or sell. | Flexible risk management and asymmetric payoff profiles. |
| Swaps | A complex derivative transaction where two counter-parties contractually exchange cash flows of one party's financial instrument for those of the other. | Exchanging payment streams (e.g., fixed vs. floating rates). |
| Trading | The routine buying and selling of financial instruments. | Generating short-to-medium-term financial profits. |
| Hedging | Strategically using financial instruments to offset the risk of adverse price movements in an asset. Done by investing in two negatively correlated securities. | Risk minimization and portfolio protection. |
| Arbitrage | The simultaneous purchase and sale of an identical or similar asset across different markets or in different forms. | Exploiting and profiting from temporary price imbalances. |
| Pledging of Shares | Promoters keeping their equity shares as collateral with financial lenders to raise immediate credit. | Raising capital to meet business or personal requirements without losing ownership. |
4. Modes of Holding Securities
Modern securities markets support two main ways of registering and holding financial securities:
A. Dematerialization (Electronic Form)
With the advent of computer networks and central depository institutions, physical certificates are no longer mandatory.
- Definition: The process of converting physical paper certificates into electronic records.
- Demat Form: The electronic storage and registration of securities.
- Benefits: Facilitates seamless, instantaneous electronic transfer of ownership, eradicates the risk of physical loss, theft, or damage, and significantly lowers transaction costs.
B. Rematerialization (Physical Form)
The reverse process of dematerialization.
- Definition: Re-converting electronic security holdings back into physical paper stock certificates.
- Nature: Rematerialized shares are physical paper stock certificates representing units of corporate ownership. They have largely been replaced globally by electronic book-entry records.
5. Key Takeaways
- Primary vs. Secondary Markets: The primary market facilitates new capital creation via mechanisms like IPOs, FPOs, and Rights Issues. The secondary market offers a regulated framework (or OTC setups) to trade those existing securities.
- Robust Intermediary Network: Depositories, Clearing Corporations, and Stock Brokers form the logistical backbone that makes execution safe and timely.
- Derivative Diversity: Forwards, Futures, Options, and Swaps allow sophisticated players to hedge physical risks, trade volatility, or exploit arbitrage windows across markets.
- Demat Dominance: Electronic holding (Dematerialization) is the modern standard, ensuring speed, transparency, and safety over physical paperwork.
6. Chapter Glossary of Important Terms
- IPO / FPO: Initial Public Offering / Follow-on Public Offer; methods for companies to raise public equity.
- Bonus Issue: The distribution of free additional shares to existing investors as an alternative to cash payouts; also termed an equity dividend.
- OTC Market: Over-the-Counter; a decentralized network of direct trading without exchange supervision.
- Clearing Corporation: An intermediary that guarantees trading settlements.
- Futures Contract: A standardized, exchange-regulated agreement to buy or sell an asset later at a locked-in price.
- Hedging: Minimizing investment risk by placing offsetting positions in negatively correlated assets.
- Arbitrage: Simultanoues buy-and-sell trades designed to pocket risk-free profits from pricing discrepancies.
- Dematerialization: Converting physical share certificates into secure electronic formats (Demat).