UNIT 6 STOCK EXC GES :FUNCTIONS

Objectives
The dojectives of this unit are to:
0 distinguish between primary market and secondary market;
0 highlight various types of traded securities, market players and trading
arrangements which exist in India; and
0 to discuss organisation and functioning of primary and secondary markets for
various types of securities in India.

Structure
6.1 Introduction
6.2 Primary Markets
6.2.1 Principal Steps of a Public Issue
6.2.2 Eligibility for an IPO
6.2.3 Rights Issue
6.2.4 Private Placement
6.2.5 SEBI Guidelines for IPOs
6.3 Secondary Markets
6.4 Stock Exchanges in India
6.4.1 Origin and Growth
6.4.2 Role and Functions
6.4.3 Membership, Organisation and Management
6.4.4 Trading System
6.4.5 Stock Muket Information Systein
6.46 Principal Weak nesses
6.4.7 Directions of Reform
6.5 Summary
6.6 Self Assessment Questions/Exercises
6.7 Further Readings

6.1 INTRODUCTION
Market is a place where buyers and sellers meet and exchange products.
This definition is universal and applies to all markets. In this unit, we will discuss
about the market called capital market. It is a place, where capital of different types
is exchanged. Often individuals like you are lenders or suppliers of capital.
Companies and various other institutions are borrowers or receivers of capital.
The market is organized or divided in two different ways. At a very broad level, the
market is divided into: (a) Short-term Capital Market (money market), and (b)
Long-term capital market (also, called stock market). Another way of classifying
the market is: (a) I~tstitutionalMarket, and (b)Direct Market. As an investor you
can deal with the market in different ways. Let us understand the market from
individual's perspective.

Content Digitized by eGyanKosh, IGNOU

Financial Market: If the surplus money you have can be spared only for a short period, you have to look
Operations and Services for savings of short-duration. Since the amount available is fairly small in such cases,
you have lo look for some institutional support for such savings. In olher words,
individuals don't directly deal with the money market, which specialize in short-term
capital. Often, individuals approach an institution for this purpose. You can save your
short-term surplus in a bank deposit or a mutual fund, which offer money market
schemes.
If the sui-plus money you have can be spared for a long-term, you have to look for
investments of longer duration. Again, you can go to an institution, which offers long-
term products or you can directly participate in the market. That is, you can deposit
your money in a long-term fixed deposit or invest in a mutual funds scheme or directly
buy securities in the market. Whei~you intend to deal with the market on your own,
you can deal with the market in two ways. The markets are accordilzgly classified
into priniary and secortdary ~lrurket.Primary ntarket is one in which the company
approaches investors to raise capital. They can al~proachfor debt capital or equity
capital or combination of both. Dealing in primary market is fairly simple today. Like
fixed deposit opening, you have to take up an application form of the issue and deposit
the amount after filling up the form. Brokers and sub-brokers will normally help you
to get forms and guide you to fill up the forms. What is important is you have to make
sure that investments fit with your objective. Here too, financial dailies and magazines
publish analytical report on prima~ymarket issues for the help of sniall investors.
After your submission of appl~cationforms, if the company accepts the same, you will
get a certificate or credit in your deposito~yAccount. In the event of too many people
applying for the offel; the company may reject some applications. In such cases, you
will get refund of the money that you have paid initially with the application.
Since the price is fixed in primary market, there will be competition for good issues.
The uncertainty of getting allotment forces Inany investors, who are directly willing to
deal with the market, to turn into secondary market. It is a place where an investor
sells to another investor. Since there are large number of sellers and buyers, the
market is dynamic. Securities prices change depending on he demand and supply of
the securities. Secondary market exists for different types of securities like debt,
equity and others. Investmen1 in secondary market has also become easy, [hanks to
developments in information and computing technologies. You have to open an
account with the members of any stock exchanges of your choice. The procedure to
open an account is fairly simple and it is somewhat si~niIarto opening a Savings Bank
Account with a bank. You can place your buying and seIling orders o$er phone and
often you get immediate confirmation of your purchase or sale. Today, it is also
possible for you to buy and sell securities through internet. In this Unit, we will
discuss more on how the stock market is organised and how investors can transact in
buying and selling of securities in the market.

6.2 PRIMARY MARKETS

P ~ - i ~ n a11iarket
ly is the seglnerzt in ~ihiclz~ z e wiss~lesare made whereas secondary
rliarket is the segrnent ill wlzich outstnndir~gissues are traded It is for this reason
that the Priniary Murket i,r also called New Issues Market and tlze Seco~dary
Market is called Stock Market. In the primary market, new issues may be made in
three ways nameIy, public issue, rights issue and private placement. Public Issues
involves sale of securities to members of public, Rights issue involves sale of
securities to the existing shareholdersldebenture holders. Private placement involves
selling securities privately to a selected group of investors. In the primary market,
equity shares, fully convertible debentures (FCD), partially convertible debentures
(PCD), a?d non-convertible debentures (NCD) are the securities commonly issued by

Content Digitized by eGyanKosh, IGNOU

non-government public limited companies. Government companies issue equity Stock Excllnages:
Functions and
shares and bonds. Primary market has become very active in India after the abolition Organisation
of Controller of Capital Issue.
In tlie primary market, issues are made either 'at par' or 'at premium'. Pricing the
new issues is regulated under guidelines on Capital issues or what are also known as
guidelines for disclosure and investors protection issued by the Securities and
Exchange Board of India (SEBI). The SEBI guideline on Disclosure and Investor
Protection is now available in the SEBI website, www.sebi.com. I r ~ i is s a detailed
guideline covering all issues relating to capital offerings. Prior to the promulgation of
the ordinance no.9 of 1992 by which the Capital Issues (Control) Act has been
repealed, the pricillg of the new issues was regulated under the Controllers of Capital
Issues' (CCI) pricing formula.
All issues by a new company has to be made at par and for existing companies tlie
issue price should be justified, as per Malegam Committee recommendations, by
The Earnings Per Share (EPS) for the last three years and comparison of
pre-issue Price to Earnings (PIE) ratio to the P/E ratio of the Indust~y.
e Latest Net Asset Value,
Minimum return on increased networth to maintain pre-issue EPS. A company
may also raise finance from the international markets by issuing GDR's and
ADR' s.

6.2.1 Principal Steps of a Public Issue

The process of a public issue starts with the preparation of a draft prospectus which
gives out details of the company, promoters background, management, terms of the
issue, project details, modes of finalicing, past financial performance, projected
profitability and others. Additionally a Venture Capital Film has to file the details of
the terms subject to which funds are to be raised in the proposed issue in a document
called tlie 'placement memoranduni.'
a) Appoiiltment of Underwriters: Tlle underwriters are appointed who co~iimit
to shoulder the liability and subscribe to the shortfall in-case the issue is under-
subscribed. For this commitment tliey are entitled to a maxi~iiumcommission of
2.5 % on the amount underwritten.
b) Appointment of Bankers: Bankers along with their branch network act as the
collecting agencies and process the funds procured during the public issue. The
Banks provide temporary loans for the period between the issue date and the
date the issue proceeds becomes available after allotment, which is referred to
as a bridge loan.
c) Appointment of Registrars: Registrars process the application forms, tabulate
the amounts collected during the Issue and initiate the allotment procedures.
d) Appointment of the Brokers to the Issue: Recognised members of the
Stock exchanges are appointed as brokers to the issue for marketing the issue.
They are eligible for a maximum brokerage of 1.5%.
e) Filing of Prospectus with the Registrar of Companies: 'The draft
prospectus along with the copies of the agreements entered into with the Lead
Manager, Underwriters, Bankers, Registrars and Brokers to the issue is filed
with the Registrar of Coinpanies of the State where the registered office of the
company is located.
f) Printing and Dispatch of Application forms: The prospectus and application
forms are printed and dispatched to ail the merchant bankers, underwriters,
brokers to the issue.

Content Digitized by eGyanKosh, IGNOU

Financial Market: g) Filing of the Initial Listing Application: A letter is sent to the Stock
Operations and Services exchanges where the issue is proposed to be listed giving the details and stating
the intent of getting the shares listed on the Exchange.
h) Statutory Announcement: An abridged version of the PI-ospectusand the
Issue start and close dates are published in major English dailies and vernacular
newspapers.
i) Processing of Applications: After the close of the Public Issue all the
application fonns are scrutinized, tabulated and then shares are allotted against
these applications.
j) Establishing the Liability of the Underwriter: I11 case the Issue is not F~illy
subscribed to, then the liability for the subscription falls 011 the uirderwriters who
have to subscribe to the shortfall, i n case they have not procured the amount
coininitted by them as per the Underwriting agreement.
k) Allotment of Shares: after the issue is subscribed to the minimum level, the
allotn~entprocedure as prescribed by SEBI is initiated.
I) Listing of the Issue: The shares, after having been allotted, have to be listed
coinpulsorily in the regional stock exchange and optionally at the other stock
exchanges.

6.2.2 Eligibility for an IPO

A11 Indian Company is allowed to make an IPO if:
I) The company has a track record of dividend paying capability for 3 out of the
immediately preceding 5 years;
2) A public financial institution or scheduled comrnel-cia1banks has appraised the
project to be financed through the proposed offer and the appraising agency
participates in the financing of the project to the extent of at least 10% of the
Project cost. Typically a new company has to compulsorily issue shares at par,
while for companies with a track record the shares can be issued at a premium.

6.2.3 Rights Issue

The rights issue involves selling of securities to the existing shareholders in proportion
to their current holding. When a company issues additional equity capital, it has to be
offered in the first instance to the existing shal-eholders on a pro-rata basis as per
Section 81 of tlie Companies Act, 1956. The shareholders may by a special resolutioi~
forfeit this right, partially or fully by aspecial resolution to enable the company to
issue additional:capital to the public or alternatively by passing a simple resolution and
taking the permission of the Central Government. There is no restriction on pricing of
rights issues.

6.2.4 Private PIacement

A private placement results froin the sale of securities by the company to one or few
investors. The issuers are normally the listed public limited companies or closely held
public or private limited companies wliich cannot access the primary market. The
securities are placed normally with the Institutional investors, Mutual funds or other
Financial Institutions. In a number of cases, Indian companies have also offered
shares to promoters under this route. SEBI has issued a separate guideIine for
pricing of such preferential offers.

6.2.5 SEBI Guidelinesfor IPO's

For complete details of SEBI guidelines 011 IPO, you have to visit www.sebi.com,
where you can download the complete guidelines on Disclosure and Investor
Protection Guidelines 2000. The salient features of the guideline are given below:

Content Digitized by eGyanKosh, IGNOU

 P~.omotersshould contribute a minimum of 20% of the total issued capital, if the Stock Exchnages:
Functions and
company is an unlisted one with a three year track record of consistent Organisation
profitability else in all cases the following slab rate apply :
Size of Capital issued (Including Premium) Contribution %
Less than Rs. 100 crores 50%
> 100 crores upto 300 crores 40%
> 300 crores upto 600 crores 30%
> 600 crores 15%
Promoter's contribution is subject to a lock-in period of 3 years.
Net Offer to the ~ e n e ' r a Public
l has to be at least 25% of the Total Issue Size
for listing on a Stock exchange.
Minimum of 50% of the Net offer to the Public has to be reserved for Investors
applying for less than 1000 shares.
In an Issue'of more than Rs. I00 crores the issuer is allowed to place the whole
issue by book-building.
There should be at-least 5 investors for every 1 lakh of equity offered.
Allotment has to be made within 30 days of the closure of the Public Issue and
42 days in case of a Rights issue.
All the listing formalities for a public Issue has to be completed within 70 days
from the date of closure of the subscription list.
Indian development financial institutions and Mutual Fund can be allotted
securities upto 75% of the Issue Amount.
Allotment to categories of FII's and NIII's/OCB's is upto a maximum of
24% which can be further extended to 30% by an application to the RBI
supported by a resolution passed in the General Meeting.
10% individual ceiling for each category: a) Permanent employees,
b) Shareholding of the promoting companies,
Securities issued to the promoter, his group companies by way of firm allotment
and reservation have a lock-in period of 3 years. However shares allotted to
FII's and certain Indian and Multilateral Development Financial Institutions and
Indian Mutual Funds are not subject to Lock-in periods.
The minimum period for which a public issue has to be kept open is 3 working
days and the maximum for which it can be kept open is 10 working days. The
minimum period for a rights issue is 15 working days and the maximum is
60 working days.
A public issue is effected if the issue is able to procure 90% of the Total issue
size within 60 days from the date of earliest closure of the Public Issue. In case
of over-subscription the company may have the right to retain the excess
application money and allot shares more than the proposed issue which is
referred to as the 'green-slzoe' option.
A rights issue has to procure 90% subscription in 60 days of the opening of the
issue.

6.3 SECONDARY MARKET

The secondary market is the segment in which outstanding issues are traded and thus
provide liquidity. Investors, who seek both profitability and liquidity, need both primary
ind secondary markets. There is thus a direct and complementary interface between
the primary and secondary markets. Secondary market exists both for short-term

Content Digitized by eGyanKosh, IGNOU

 Financial Market: (money market) securities and long-telm securities. It exists for debt, equity and a
Operations and Services variety of hybrid securities. While the secondary market activities in money market
securities are conducted over phone or through market makers, the trading is more
organized for long-term securities and conducted through stock exchanges. Buying
and selling securities in secondary market is fairly simple. Investors have to open an
account with a member of stock exchange and then place orders through the
member.
For an orderly functioning of stock market, a set of institutions is required.
The role of these institutions assumes importance in securities marlcet because the
market deals with high value financial.assets. Institutions connected with securities
markets are Stock Exchanges, Members of Stocks Exchanges (popularly called
brokers), Clearing Corporation, Depository www.nsdl.co.in and
www.centraldepository.co~n.Transfer Agents and Securities and Exchange
Board of India (SEBI) www.sebi.gov.in).
Technology has converted stock exchanges into a virtual institution. Earlier, there
was an importance for the physical location of stock exchange because it was a place
where brokers or their assistailts negotiate the prices (outsiders can hear only some
noise but brokers understand the meaning) and enter into transactions on behalf of
their client-investors. Since the telecommunication was very poor in India, one or two
stock exchanges have been opened up in every state to cater the investors of the
region. India is one of the few countries with a large rlulnber of stock exchanges.
Thanks to development in telecommunication and information technology, the physical
constraint was removecl during the last few years. National Stock Exchange today
has its presence everywhere in the country. Bombay Stock Exchange has also
expanded its network. Many other stock exchanges are finding it difficult to
compete with these two principal stock exchanges and trying to come together and
create new business. This new development has improved transparency of
operations and brought down the cost. Today, stockbrokers are operating from
their office through cornputer network and investors can see the price at which the
transactions are settled. Internet based stock broking www.icicidirect.co~nor
www,5paisa.com) allows investors to enter into transactions by themselves
without contacting their brokers directly, Competition has brought down the
brokerage from 2% to around 0.5% and today the brokerage rate in India is
one of the lowest in the world. This transforn~ationhas taken place in a matter
of few months.
Members of stock exchanges, called stock brokers, are intermediaries between
buyers and sellers. Buying and selling securities through members of stock
exchange is beneficial, legally and functionally. Entry of major institutions like ICICI,
Kotak Mahindra, into brokerage services and development in technology
including internet based broking service have irnproved the quality of service.
Many of these brokerage houses offer a number of facilities to the investors at
no extra cost.
Clearing corporation enables the members to settle the transactions entered among
themselves on behalf of their client-investors. It operates something similar to cheque
clearing service offered by RBI for the banks. Earlier when securities were traded in
physical form, a large number of securities have to be exclianged between members
and clearing corporation had a major work on this part. Today, after depository facility
was introduced, the workload of the clearing corporations has come down
significantly. Clearing corporation today facilitates the members lo transfer (or
receive) securities to (or from) depositories and also settle monetary part of the
transactions. It is an institution exclusively serving the brokers.

10

Content Digitized by eGyanKosh, IGNOU

I
Depository service is another major development in the Indian stock market. It Stock Exchnages:
allows investors to hold securities in electronic form (like you are holding cash in your Functions and
Organisation
bank account) and transfers electronically when they sell the shares. The operation is
fairly simple. Investors have to open a depository account with a member of
depository service provider (we have two depository service providers in India
National Securities Depository Ltd. and Central Depository Services (India) Limited).
Investors can give physical securities that they are holding for cancellation (provided
depository facility is available for the securities/company) and convert them in to
electronic holding. A large number of companies have depository holding facility and
SEBI has made it compulsory to trade certain stocks only under depository mode.
When an investor applies for new shares next time in the primary market, helshe can
ask the issuer to credit the depository account in the event of successful allotment.
Any new purchases in the secondary market can also be credited in the depository
account. Investors will get periodical statement on their holding from the member
with whom the depository account is maintained. Many depository participants allow
the investors to see their account through internet. There was some resistance from
retail investors for this change but today everyone started seeing the benefit of this
service. A significant part of volume traded today is settled through depository mode.
Apart from holding the stocks electronically, there are other benefits from depository
services. There is no need to apply for transfer of shares after the purchase of
shares. If an investor buys securities in physical form and desire to transfer the
shares in herthis name, shethe has to fill-up the transfer deed, affix transfer fee
(0.5% of market value of stock) and then send the same to transfer agent. There is a
cost, time and uncertainty involved in the transfer. Under depository mode, the
shares are transferred within a short period of time without any further action from
your side. For more details about depository, visit one of the web sites (http:1/
www.usdl.co.in or http://www.centraldepository.com) of depository service providers
or the members of depository service providers.
Transfer agents maintains the members register of the companies. On the
instructions of tlie company, they transfer the shares from tlie exisling members to
new member. When an investor buys a share in a physical mode and intend to
transfer the share in herthis name, shelhe has to send the transfer deed along with
share certificate to the Transfer Agent. There are many transfer agents like Karvy
Consultants Ltd (http://www.karvy.com) and MCS Ltd. After initial verification, they
will place the shares received for transfer for the approval of company's Board.
The shares are transferred in the name of investors after the approval of the
Board and investor will receive communication to this effect along with share
certificates from the Transfer Agent. Some companies perform this transfer of
shares internally whereas many leading companies have outsourced this service by
appointing one of these transfer agents. The process of verification and other
formalities connected with transfer has been simplified after the introduction of
depository services.
Securities and Exchange Board of India (SEBT) regulates the institutiolis and
intermediaries connected with the securities to protect the interest of investors,
particularly small investors. It is government sponsored but independent body. SEBI
has prescribed detailed regulations and guidelines for various activilies related to
transactions of securities market (See http://www.sebi.gov.in), Regulations are
primarily intended to protect small investors. Despite strong resistance, SEBI is
pushing several reforms connected with securities market. Some of the major
achievements of SEBI so far are bringing transparency in the securities market
operation, speeding up the tech~iologicalprogress and improving disclosure norms.
SEBI is struggling hard to prevent insider trading and price rigging. Since regulation is
a complex task, it will take time to complete the process.

Content Digitized by eGyanKosh, IGNOU

Financial Market: Activity 1
Operations and Services
a) Write brief note on a recent public issue of a company. The note may include the
size of the issue, type of security offered, price, justification of premium,
registrar, banker to issue, underwriter, etc.

b) Visit any one or more of the websites and describe your additional learning on
the identified public issue.

6.4 STOCK EXCHANGES IN INDIA

From scattered and small beginnings in the 19th Century, India's stock market has
risen to great heights. By 1990, we had 19 stock exchanges in the country. There
were around 6,000 listed companies and the investors population stood around 15
milliorl. Ygu might be interested in knowing more about the origin and the growth of
stock market in India. What functions does it perform? What is the form of
organizatio~lof stock exchanges in India? How are these administered? We shall
address these and other questions subsequently.

6.4.1 Origin and Growth

Organizatio~~s and institutions, whether they are economic, social or political, are
products of historical events and exigencies. The events continually replace andlor
reform the existing organizations, so as to make them relevant and operational in
contemporary situations. It is, therefore, useful to briefly acquaint ourselves with the
origin and growth of the stock market in India.
Stock exchanges of India in a rudimentary form originated in 1800 and since that time
have developed through six broad stages.
1800-1865 : The East India Coinpany and few conlmercial banks floated shares
sporadically, through a very small group of brokers. According to a newspaper in
1 850, in Bonibay during 1840-1850 there were only half a dozen recognised brokers.
The year 1850 marked a watershed. ,A wave of company flotations took over the
market ; the number of brokers spurted to 60. The backbone of industrial growth and
the resulting boom in share flotation was the legendary personality of the financial
wodd, Premchand Roychand.
In 1960 the stock market created a unique history. The entire market was gripped by
what is known as 'share mania'. The American Civil War created cotton famine.
Indian cotton manufacturers exploited this situation and exported large quantities of
Content Digitized by eGyanKosh, IGNOU
cotton. The resulting increase in export earnings opened opportunities for share Stock Exchnapes:
investments. New companies started to come up. Excessive speculation and Functions and
Organisation
reckless buying became the order of the day. Th'is mania lasted up 1865. It marks
the end of the first phase in the Indian stock exchange history because with the
cessation of the Civil War, demand for Indian cotton slumped abruptly. The share
became worthless pieces of paper. To be exact, on July 1, 1865 all shares ceased to
exist because all time bargains which had matured could not be fulfilled.
1866-1900 : We find another distinct phase-during 1866-1900. The mania effect
haunted the stock exchange of Bombay during these 25 years. Above everything
else, it led to foundation of a regular market for securities. Since the inarket was
established in Bombay, it soon became and still is the leading and the most organised
stock exchange in India. A number of stock brokers who geared up themselves, set
up a voluntary organisation in 1887, called Native Share and Slockbrokers
Association. The brokers drew up codes of conduct for brokerage business and
mobilized private funds for industrial growth. It also mobilized funds for government
securities (gilt edged securities), especially of the Bombay Port Trust and the Bombay
Municipality. A similar organisation was started at Ahmedabad in 1894.
1901-1913: Political developments gave a big fillip to share investment. The
Swadeshi Movement led by Mahatma Gandhi encouraged the indigeneous trading and
business class to start industrial enterprises. As a result, Calcutta became another
major centre of share trading. The trading was prompted by the coal boom of
1904- 1908. Thus, the third stock exchange was started by Calcutta stock brokers.
During Inter-war years, demand for industrial goods kept increasing due to British
involvement in the World Wars. Existing enterprises in steel and cotton textiles,
woolen textiles, tea and engineering goods expanded and new ventures were floated.
Yet another stock exchange was started at Madras in 1920.
1935-1965: This period can be considered as the period of development of the
existing stock exchanges in India. In this period industrial development planning
played the pivotal role of expanding the industrial and commercial base of the country.
Two more stock exchanges were set up, at Hyderabad in 1943 and at Delhi in 1947.
At the time of Independence seven stock exchanges were functioning located in the
major cities of the country. Between 1946 and 1990, 12 more stock exchanges were
set up trading the shares of 4843 additional listed companies.
There are 24 stock exchanges in the country, 20 of them being regional ones with
L
allocated areas. Three others set up in the reforms era, viz., National Stock Exchange
(NSE) the Over the Counter Exchange of India Limited (OTCEI) and Inter-
connected Stock Exchange of India Limited (ISE) have mandate to nationwide
trading network. The ISE is promoted by 15 regional stock exchanges in the country
and has been set up at Mumbai. The ISE provides a member-broker of any of these
stock exchanges an access into the national market segment, which would be in
addition to the local trading segment available at present. The NSE and OTCEI, ISE
and majority of the regional stock exchanges have adbpted the screen based trading
system (SBTS) to provide automated and modem facilities for trading in a
transparent, fair and open manner with access to inve~torsacross the country. As on
31 March 1999,9,877 companies were listed on the stock exchyges and the market
. capitalization was 5,30,772 crore. The total single sided turnover on all stock
exchanges during 1998-99 was Rs 10,23,381 cr. The following are the names of the
various stock exchanges in India.
1) The Bombay Stock Exchange
2) The Ahmedabad Stock exchange Association
3) Bangalore Stock Exchange
4) The Calcutta Stock Exchange Association
Content Digitized by eGyanKosh, IGNOU
Financial Market: 5) Cochin Stock Exchange
Operations and Services
6) The Delhi Stock Exchange Association
7) The Guwahati Stock Exchange
8) The Hyderabad Stock Exchange
9) Jaipur Stock Exchange
10) Kanara Stock Exchange
1I) The Ludhiana Stock Exchange Association
12) ~ a d r a stock
s Exchange
13) Madliya Pradesh Stock Exchange
14) The Msrgadh Stock Exchange
15) Mangalore Stock Exchange
16) Pune Stock Exchange
17) Saurashtra Kutch Stock Exchange
18) The Uttar Pradesh Stock Exchange Association
19) Vadodara Stock Exchange
20) Coimbutore Stock Exchange
21) Meerut Stock Exchange
22) Over The Counter (OTC) Exchange of India
23) The National Stock Exchange of India
24) Inter-connected Stock Exchange of 1ndia Limited

6,4.2 Role and Functions

The history of stock exchanges in foreign countries as well as in India shows that the
development of joint stock enterprise would never have reached its present stage but
for the facilities which the stock exchanges provided for dealing in securities. Stock
exchanges have a very important function to fulfil in the country's economy. In
Union of Indiavs. Allied International Products Ltd. (1971) 41 Comp Cas 127 (SC) :
(1970) 3 SCC 59411, the Supreme Court of India has enunciated the role of the stock
exchanged in these words:
'A Stock Exchange fulfils a vital function in the economic development of a nation: its
main function is to qualify' capital by enabling a person who has invested money in,
say a factory or a railway, to convert it into cash by disposing off his shares in the
enterprise to someone else. Investment in joint stock companies is attractive to the
public, because the value of the shares is announced day after day in the stock
exchanges, and shares quoted on the exchanges are capable of almost immediate
conversion into money. In modem days a company stands little chance of inducing
the public to subscribe to its capital, uiiless its shares are quoted in an approved stock
exchange. All public companies are anxious to inform the investing public that the
shares of the company will be quoted on the stock exchange.
The stock exchange is really an essential pillar of the private sector corporate
economy. It discharges three essential functions in the process of capital formation
and in raising resources for the corporate sector.
First, the stock exchartge provides a market place for purchase and sale of
securities viz., shares, bonds, debentures etc. It, therefore, ensures the free
transferability of securities which is the essential basis for the joint stock enterprise
Content Digitized by eGyanKosh, IGNOU
 Stock Exchnnges:

) , s 4l WHMI
AMMU , n _ ~ STOCK EXCHANGES
IN INDIA M
Functions and
Organisation

& =
Pmrt Wwr

.
r s~aclc~ebnpn
ad*HWdw.rlW
,p,d WH,y, ANOMAN N I C O M R ISLANOS

Ir*pnabju*
t i Uspower tn+a L1rnl.d 2001
C o p v ~ ~ r j[c)

system. The private sector economy cannot function without the assurance provided
by the stock exchange to the owners of shares and bonds that they can be sold in the
market at any time. At the same time those who wish to invest their surplus funds in
securities for long-term capital appreciation or for speculative gain can also buy
stocks of their choice in.tlie market.
Secondly, the stock exchange provides the linkage between the savings irt the
household sector and the irtvestmerit in corporate economy. It mobilizes savings,
channelises them as securities into those enterprises which are favoured by the
investors on the basis of such criteria as future growth prospects, good returns and
appreciation of prevalence on the Indian scene of such interventionist factors as
industrial licensing, provision of credit to piivate sector by public sector development
banks, price controls and foreign exchange regulations. The stock exchanges
discharge this function by laying down a number of regulations which have to be
complied with while making public issues e.g. offering at least the prescribed
percentage of capital of the public, keeping the subscription list open for a minimum
period of three days, making provisions for receiving applications at least at the
centres where there are recognised stock exchanges, stock exchanges and allotting
the shares against applications on a fair and unconditional basis with the weightage
being given to the applications in lower categories, particularly those applying for
shares worth Rs.500 or Rs.1,000 etc. Members of stock exchanges also assist in the
flotation of new issues by acting as managing brokers/official broker of new issue.
In that capacity, they, i~zteralia, try to sell these issues to investors spread all over
the country. They also act as under-writers to new issues. In this way, the broker
community provides an organic linkage between the primary and the secondary
markets,
Thirdly, by providing a market quotation of the prices of shares and bonds-a sort
of collective judgement simultaneously reached by many buyers and sellers in the
market-the stock exchanges serve the role of a barometer, not only of the state of
health of individual companies, but also of the nation's economy as a whole. It is 15
Content Digitized by eGyanKosh, IGNOU
Financial Market: often not realised that changes in share prices are brought about by a complex set of
Operations and Services factors, all operating on the markets simultaneously. Share values as a whole are
subject to secular trends set by the economic progress of the nation, and governed by
factors like general economic situation, financial and monetary policies, tax changes,
political environment, international economic and financial developments, etc. These -
trends are influenced to some extent by periodical cycles of booms and depressions in
the free market economies. As against these long-lerm trends, the day-to-day prices
are influenced by another variety of factors notably, the buying or selling of major
operators, the buying and selling of shares by the investment financial institutions such
as the U.T.I. or L.I.C. which have in recent years emerged as the largest holders of
corporate securities, speeches and pronouncements by ministers and other
government spokesmen, statements by company chairmen at annual general meetings
and reports of bonus issues or good dividends by companies etc. While these factors,
both long-term and short-term, act as macro influences on the corporate sector and
the level of stock prices as a whole, there is also a set of micro influences relating to
prospects of individual companies such as the reputation of the management, the state
1
of industrial relations in the enterprises, the volu~neof retained earnings and the
related prospects of capitalisation of reserves, etc. which have a bearing on [he level
of prices. In the complex interplay of all these forces, which leads to day-to-day
quotation of prices of all listed securities, speculation plays a crucial role. In the
absence of speculative operations, every purchase by an investor has to be matched
by a sale of the same security by an investor-seller, and this may lead to sharp
fluctuation in prices. With speculative sale and purchases taking place continuously,
actual sale and purchase by investors on a large scale are absorbed by the market
with small changes in prices. There are always some professional operators who are
hoping that the prices would rise. There are others predicting that prices will fall.
Both these groups acting on their respective assumptioil buy or sell continuously in the
market. Their operation helps to bring about all orderly adjustment of prices. Without
these speculative operations, a stock exchange can become a very mechanical thing.
However, excessive speculation endangers market equilibrium and must be
discouraged through appropriate safeguards. The regulatory authorities should
always take necessary precautionary measures to prevent and penalize excessive
speculation and to discipline trading.
A fact which needs to be emphasized is that the stock exchanges in India also serve
the joint sector units as also to some extent public sector enterprises. There is
substantial private participation in the share capital of a number of government
companies such as Balmer Lawrie, Andrew Yule, Gujarat State Fertilizers
Corporation, Gujarat Narniada Fertilizers Corporation, State Bank of India, ICICI,
etc. In recent times some of the Central public sector companies have gone in for
public debentures through the stock exchanges. Also, there are some public sector
companies like VSNL which have made their share capital open for public
subscription.
Another important function that the stock exchanges in India discl~argeis of providing
a market for gilt-edged securities i.e. securities issued by the Central Government,
State government, Municipalities, Improvement Trusts and other public bodies. These
securities are automatically listed on the stock exchanges when they are issued and
transactions in these take place regularly on the stock exchanges.
I
6.4.3 Membership, Organisation and Management
By virtue of the century-old tradition, stock exchange is a highly organized and
smooth functioning network h the world. The membership of stock exchanges
initially comprised of individuals and partnership films. Later on companies were also
allowed to become members. A number of financial institutions are now members of
16
Content Digitized by eGyanKosh, IGNOU
I
Indian stock exchanges. Over the years, stock exchanges have been organized in Stock Exchnages:
Functions and
various forms. For ex;lmple, while the Bombay Stock Excliange (now Mumbai Stock
0rg:misation
Exchange). Ahlnedabad Stock Exchange and M.P. (Indore) Stoclc Exchange were
organised as voluntary lion-profit making association of persons, the Calcutta Stock
Exchange. Delhi Stoclc Exchange, U.P. (Kanpur) Stock Exchange, Ludhiana Stock
Exchange, Cocliin Stock Exchange, Gauhati Stoclc Exchange, Jaipur Stoclc Excliange.
and Kanara (Mangalore) Stoclc Exchange were organised as public limited
companies. Quite a few others have been organised as company lilnited by
guarantee.
Tlie internal governance of every stoclc exchange rests in a governing board
compt-ising members of tlie board and Executive Director/President. Members of the
governing boards include brokers and 11011-brolters. Governing bodies of stock
exclia~igesalso have government nominees. Tlie Executive Director/President is
expecteel to ensure strict compliance by all member:; of tlie excha~igeof rules/by
laws, margin regulations and tracling restriction, etc. Sub.ject to tlie previous approval
of SEBI, under tlie law, governing bodies of stoclc exchanges have wicle powers to
make bye-laws. Govestling bodies can admit, punish, censure and also expel any
member, any partner, any remisier, ant1 authorised clerk and employee. It lias the
power to adjudicate disputes. Above all, it has the power to malce, amencl, suspend
and enforce rules, by-laws, regulations and supervise the entire functioning of a stock
exchange.

6.4.4 Trading System

Trading system differs from exchange to exchange. Tracling system refers to few
things namely: (a) tlie types of trades allowed by the system, (b) order-matching
system, and (c) settlement system. The details of the first two are cliscussed in depth
in Unit 7 (Brolting and Trading in Equity). The scttlelnent system refers to time
recluired to settle tlie transactions. India has cotne tI11.ougha long way in this area.
A decade back, India Sollowed batch processing system (popularly callcd crury-
forward system o r periodic settlement system). Under this batch processilig, trades
of two wceks are clubbed, netted and settled at the encl of another two weeks.
The problem under this system was, speculators can freely buy secul-ities ancl sell
securities or sell securities initially and buy thcm later during the two wcelts period.
A genuine investor lias to wait nearly four weeks to get tlie money for tlie sale
transactions. Tlie trading system was mainly encouraging speculation than
investments. Iliclia moved from this system to Rolling Settlement System and to shrt
with both NSE ancl BSE adopted Tc5. That mciuns speculation is allowed williin a
day but once the day is over, the position at the end of the day has to be settlecl at the
end of trade day plus five days. The rolling settlctnent system was shortened to T+3
and further T+2. India is also moving to T+1 and [nost probably much ahead of other
countries. The rolling settlement brought some discipline in speculation. While it
allows speculation within the clay, it is not possible to carry the spcculation to next
day. Investors get the money on third day frotn the date of sale of securities.

6.4.5 Stock Market Information System

Stock exchange cluotntions and indices published in daily newspapers are the main
source of information on stock exchange trades and turnover. Dailies like Econoniic
Times, Financial Express, Business Standard, Business Line, Times of India and
Hindustan Tiines publish daily cluotations and indices. As for Bombay Stock
Exchange quotations published in Economic Times, information on equity shares,
starting from the first column, is presented in the following order: Co~npany'sname;
previous day's closing price in brackets; all the daily traded prices as published by the
BSE; key financial parameters such as earnings per share (EPS), cash earnings per

Content Digitized by eGyanKosh, IGNOU

Financial Market: share (CPS), cash PIE (price to earnings ratio), Return on Net Worth (RNW) and
Operations and Services Gross Profit Margin (GPM) etc. on different days; P/E; and the high and low prices
in the preceding 5 2 weeks.
The first traded price is the day's opening price. If only one such price is recorded, it
is also the day's closing price. If there are two prices, then the middle quote is either
the high or low price. If there are four prices, then one of the middle quotes is the
day's high and tlie other, the low. If there are 110 transactions in a company's share
on any day, the previous day's closing price is presented in brackets.
The EPS is the average net profit after tax per equity share and the CPS the average
cash profit (after adding back depreciation) per share. The cash P/E is the ratio of
the day's closing price to the cash earnings per share as distinct from the P/E ratio,
which relates price to the net profit per, share. PE values are not printed when
earnings are either nil or negative.
'The RNW is the net profit as a percentage of the net worth and measures the return
earned on the sharehoIders' fund i.e. equity capital plus reserves. The GPM is the
gross profit margin (before depreciation and tax) as a percentage of gross sales and
measures tlie company's profit maixin which is available to absorb depreciation
charges arising from capital expenditure, tax payments, dividend distribution and profit
ploughback. All the figurers are taken from the latest available results (audited/
unaudited) of the company.
The 52-week high and low prices of each share are worked out every day on the
basis of the highest and lowest points scaled during the immediately preceding 52
weeks. The high and low prices are adjusted for bonus and rights issue of equity
shares. If any of the day's traded price is a yearly high or low, the entire line,
including the name of the company, is shown in bold types, with a 'H' attached to the
high value or 'L'attached to the low value. Whenever there is a significant change in
the day's closing value as compared to the previous closing, it is shown in boId types
with a 'plus' or 'minus' sign as the case may be, after the closing value. For
specified shares, a three per cent change and for non-specified shares a 15 per cent
change is treated as significant. Whenever a share goes ex-divided or ex-bonus or
ex-rights, it is ihdicated by notation XD or XB or XR, as the case may be placed next
to its closing price. Symbol of face values other than Rs. 10, are also indicated along
with the names. Since Indian regulations allow stock splits, a number of firms have
face value other than Rs. 10.
For debentures, the information starting from the first column, is presented in the
following order: the nominal rate of interest on the face value, company name, face
value, previous day's closing-price, the day's opening price, Yield To Maturity (YTM)
and yield (both annualized). The yield is nominal interest expressed in percentage
terms of closing value. The YTM adjusts the nomilla1 retum for the maturity period.
frequency of interest payments, manner of priilcipal repayment, redemption pi-emium,
if any, and thereby enables investors to compare different investment options in
debentures on a uniform scale. If there are no quotations for a company's debenture
on a day, the opening price is shown as nil, and the closing price the same as the
previous day's closing.
Besides these quotations share price indices are also published in different dailies.
Bombay Stock Exchange's 30 share 'Sensex' and 100 share 'National' indices are
quite popular. In addition, NSE-50 (Nifty) has also become popular with institutional
and retail investors in recent times. Besides these, there are other indices also which
include The Economic Times Index of Ordinary Share Price, Busi~iessStandard
Index of Ordinary Shares Price and a few others. Reserve Bank of India also
publishes Share Price Index.

Content Digitized by eGyanKosh, IGNOU

Activity 3 Stock Exchnslges:
Functions and
I) Take a look at tlie B o ~ i ~ b aStock
y Exchange quotations published in Economic Organisation
Times and write out hereunder price quotations for five Shares and five
Deben tul-es.

2) Tale a loolc at Economic Times or any other financial daily and compare and
contrast 30-share Sensex and 100-share National Index of Bombay Stock
Exchange and also NSE-50 Index.

3) Write out two sources of stock market information other than a newspaper.

6.4.6 Principal Weaknesses

The Indian stock markets have made rapid developments in the last few years. From
the implementation of dernaterialised securities in the year 1998 to a phased
commencement of rolling settlements from the year 2001, Indian Stock Exchanges
have made advances, which can be compared to the best in the world. India is one of
the few countries at this point where tlie complcte trading syslem is computerized/
automated. Most of the restrictions relating Lo Foreign investments have been
removed. Despite such developments, there are few areas of concern, Most
important oL tlie~nis concentration of liquidity. Though India can claim that it has
second largest number of listed companies in tlie World, the liquidity or trading is
restricted to handful of stocks. About 70% of volume is accounted by 3 to 5 stocks.
About 90% trading is accounted by another 20 stocks, This in turn affects the interest
of several small investors who are generally attracted to market during IYO times.
There is no move from any agencies to improve the liquidity of sinall stocks. The
second major concein is FIIs investments. ~ h o u FIIs ~ h bring capital for the country,
they play critical role in the price movements. Their buying and selling behaviour
affect the stock market significan'tly. The market turns highly volatile the moment FIIs
turn net sellers. In other words, stock market is yet to become important medium of
savings to Indian public. FIIs investment being 'hot money' might create havoc to the
stability of India market if there is a large scale outflow. The third important concern
is 011 insider trading. Though insider trading rule was made a decade ago, there are
very few cases actually booked under this rule. Several international surveys rank
India amongst the top few countries 011 insider trading index. Another general
concern about Indian stock market js quality of financial reporting. Though Indian
companies provide information in their annual report, which is more than the
information provided by companies in the developed markets, the quality of
information is a major concern.

Content Digitized by eGyanKosh, IGNOU

Pinallcia1 Market: 6.4.7 Directions of Reform
Operations and Services
The refolm process is continuing to set right some of the above concerns. SEBI and
stock exchanges are now trying to weed out defrrnct coinpanies by de-listing them.
SEBI has also recenlly initiated a move to connect stock-exchanges in India to
provide additional 1 iquidity of regional stocks. Several steps have been taken to control
risk and improve risk management systems. All members of the stock exchanges are
required to follow strict capital adequacy norms. Until 2001, India has followed
Rolling settlement was introduced in India from July 2,2001 with a Trade Date+ 5
(T+5) system and has since moved to a Ti-2 system from April 1 , 2003. Securities
and Exchange Board of India (SEBI) had formally committed to sliorten the trading
cycle further to T+l .

6.5 SUMMARY
In this unit, we have discussed two segments of Indian securities market namely
primary market or new issues market and secondary market or stoclc market. We
have highlighted recent trends in the primary market and discussed various lypes OF
market players and trading arrangements which exist in the Indian stock market.
Different aspects of the Indian stock market viz., origin and growth, role and
functions, membership, organisation and manage~nent,trading systems, and stock
~narketinformation system have been explained so that you as a student of this
course are able to clearly visualise the environment in which invest~nentand portfolio
management decisions are made. In the next unit we shall focus on the legal frame of
Indian securities market.

6.6 SELF ASSESSMENT QUESTIONS/EXERCISES

1) What are the basic constituents of the securities market?
2) What are the different types of securities markets? What are their role and
functions? I ,

3) What are different categories of players operating in primary and secondary

markets?
1

4) Write a brief note on the hanagement of stock exchanges in India.

5) Briefly discuss recent trends in tlle development of the primary market in India. I
1

6) What is OTCEI and NSE? How are they different from other stock
exchanges ?
7) Critically evaluate stock market indices as indicators of the mood of the market
and health of the economy.

6.7 FURTHER READINGS

I
Bombay Stock Exchange Official Directory, Bombay Stock Exchange, Bombay
Gupta, L.C. 1992, Sfock Exclza~zgeTrading in India-Agenda For Refonl?, Society I
For Capital Market Research and Development, New Del hi. I

SEBI Act and Reg~ifatiorzsoil val-iozts iiztennediaries ~ ~ capital

n d offerirzgs.

Content Digitized by eGyanKosh, IGNOU

s
?.,\
.