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    Add as FriendFinancial Statement and Accounting Practice

    by: sandesh

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    1 : Chapter 2 Stock Markets in India/ Stock Exchanges in India
    2 : In every economic system, some units which may be individual or institutions are surplus-generating, others are deficit-generating. Surplus-generating units are called savers while deficit-generators are called spenders. In our country, at spectral level, households are surplus-generating while corporate and government are deficit generating. The financial assets are also called financial claims or financial securities or paper assets. These financial securities are issued by deficit-generating units in exchange for their savings. It is for this reason that surplus-generating units are called investors while deficit-generating units are called issuers. The third critical element of markets is the intermediaries who act as conduits between the investors and issue. Regulatory bodies, which regulate the functioning of the securities markets, constitute the last but very significant element of securities markets. Thus, there are four important elements of securities markets namely investors issuers, intermediaries and regulators. Now depending upon the nature of the relationship among these element of securities markets, the markets are classified as primary and secondary. Further, depending upon the main securities markets, the markets are classified as short-term and long-term and depending upon the issuers, these are classified government securities or industrial securities. Government securities are also called gilt-edged securities.
    3 : Definition of Capital Market It is a place where people buy and sell financial instruments, be it equity or debt. It is a mechanism to facilitate the exchange of financial assets. Examples of capital market In India - BSE and NSE are the two capital markets. International - NYSE, LSE and TSE are the largest capital markets. Classification Primary market Secondary market It can also be classified on the basis of life span of the asset into: Money market -Less than one year Capital market proper - More than one year.
    4 : PURPOSE STOCK MARKET It helps in the capital formation of the country. It maintains active trading. It increases liquidity of assets. It also helps in price recovery process
    5 : Shortcomings of Stock Markets Scarcity of floating stocks: Financial institutions, banks and insurance companies own 80% of the equity capital in the private sector. Speculation: 85% of the transactions on the NSE and BSE are speculative in nature. Price rigging: Evident in relatively unknown and low quality scrips. Causes short time fluctuations in the prices. Insider trading: Obtaining market sensitive information to make money in the markets. Financing from capital markets; there are two ways a company can raise money from the financial markets: debt and equity.
    6 : Primary or New Issue Market Primary market is the segment in which new issues are made whereas secondary market is the segment in which outstanding issues are traded. It is for this reason that the Primary Market is also called the New Issues Market and the Secondary market is called the Stock Market. In the primary market, new issues may be made in three ways namely, public issue, rights issue and private issue.
    7 : Secondary Market The new issues of securities are made available in the 'primary market'. The securities that are already outstanding and owned by the investors are usually bought and sold through the 'secondary market', which is popularly known as 'stock market'. There are two broad segments of the stock markets (i) The organised stock exchanges (ii) The Over-the-Counter (OTC) market.
    8 : Reasons for Transactions on Secondary Market There are two main reasons why individuals transact in the secondary market: Information Motivated Reasons Liquidity Motivated Reasons The Securities which are traded in the secondary market may be classified as follows: On the basis of issuer, Securities may be classified as Industrial securities Government securities Financial intermediaries securities
    9 : The stock exchange is really an essential pillar of the private sector corporate economy. It discharges essential functions in the process of capital formation and in raising resources for the corporate sector. First, the stock exchange provides a market place for purchase and sale of securities. Secondly, the stock exchange provides the linkage between the savings in the household sector and investment in corporate economy. Thirdly, by providing a market quotation of the prices of shares and bonds.
    10 : Membership, Organization and Management With the rich legacy of more than a century-old tradition, stock exchanges around the world have a highly organized and smoothly functioning network. The membership of stock exchanges initially comprised of individuals and partnership firms. Later on, these were also allowed to become members. A number of financial institutions are now members of Indian exchanges. Over the years, stock exchanges have been organized in various forms.
    11 : The stock exchange rules, bye laws and regulations have identified eight major functional specialization the members. Commission Broker Floor Broker Tataniwala Dealer in non-cleared securities Odd-lot Dealer Budiwalas Security Dealer
    12 : Stock Market Information System Stock exchanges quotations and indices published in daily newspapers are the main source of information of the exchange traders and turnover. The first traded price is the day's opening price. If only one such price is recorded, it is also the day's closing balance. If there are two prices recorded, then the first is the opening and the second the closing price. If there are three prices, then the middle quote is either the high or low price. If there are four prices, then one of the middle prices is the day's high and the other, the low. If there are no 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 the depreciation) per share. The cash P/E is the ratio of the day's closing price to the cash earnings per share distinct form 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.
    13 : Principal Weaknesses of Indian Stock Market Rampant speculation Insider Trading Oligopolistic Limited Forward Trading Outdated share Trading System Lack of a single market Problem of interface between the primary and secondary markets Inadequacy of investor service
    14 : Directions to reform the functioning of stock exchanges The main recommendations of an expert study of trading in shares in the Indian stock exchanges, which was commissioned in 1991 by the Department of Economic Affairs Investment, Ministry of Foreign Government of India Cont….
    15 : Main recommendations made by the expert study are as follows: 1. To introduce a uniform one-week settlement system in all stock exchanges and in all shares in order to unify the market on a national basis and, at the same time, to reduce the risk exposure of market participants to long settlement periods and also to counter the strong tendency towards excessive speculation and exempt the concentration of trading activity in a few shares only. 2. To replace the present margin system, because of its failure to prevent many defaults on several exchanges, by a system of "marketing to the market" on a daily basis (i.e., debiting the losses and credit gains daily to the members having outstanding positions). Cont….
    16 : 3. To do away with the carry forward system which is incompatible with the recommendation of the study and shorten the settlement period, for which the whole rationale will disappear with the adoption of the system "marking to the market" daily, as suggested above. 4. To insist that all the stock exchanges introduce formal market-marking arrangements in the best post manner in order to prevent exploitation of investors by market malpractices, and promote more orderly many all securities. To make the governing bodies of stock exchanges equally representative of the share brokers interest the one hand and the public and the users of stock market services on the other, and strengthen exchange management generally. 6. To introduce in all stock exchanges a well-designed management information system (MIS), capital producing relevant information system which could be used by the authorities for restructuring and regulating the on proper lines.
    17 : Listing of Securities Listing means admission of the securities to dealings on a recognised stock exchange. The securities may be of any public limited company, central or state government, quasi governmental and other financial institutions/corporations, municipalities, etc. The objectives of listing are mainly to: provide liquidity to securities; mobilize savings for economic development; protect interest of investors by ensuring full disclosures. Cont….
    18 : A company intending to have its securities listed on the Exchange has to comply with the listing requirements prescribed by the Exchange. Some of the requirements are as under: Minimum Listing Requirements for new companies Minimum Listing Requirements for companies listed on other stock exchanges Minimum Requirements for companies delisted by this Exchange seeking relisting of this Exchange Permission to use the name of the Exchange in an Issuer Company's prospectus Cont….
    19 : Submission of Letter of Application Allotment of Securities Trading Permission Requirement of 1% Security Payment of Listing Fees Compliance with Listing Agreement Cash Management Services (CMS) - Collection of Listing Fees
    20 : National Stock Exchange of India Ltd. Features NSE is promoted by financial institutions, mutual funds, and financed on a self-sustaining basis through levy of membership fees. The capital outlay of 30 crores of rupees could be financed by admitting 1,000 members with an entry fee of Rs. 10 lakhs each. Fees for corporate and institutional members could be pegged at a higher level of Rs. 25 lakhs. NSE is a company incorporated under the Companies Act of 1956. It is constituted by the Board of Directors (Board) and managed by it. 50% of the Managing Board of the Exchange should comprise of professionals who are not members. These professionals must be from a cross-section of finance and industry, and must actively contribute to ensuring that the stock exchange functions in a balanced and fair manner. Cont….
    21 : It trades on medium sized securities of equity shares and debt instruments. It is a separate ring altogether. For the first time in our country, debt instruments would be traded to become an active part in the secondary market of the nation. NSE made its debut with the debt market. The debt market is predominantly a market in government securities. The Central Government moving over to auctions at market-related rates of interest, the primary market has become active with the well-informed and fine-tuned bidding at the auctions. It has the full support from the National Clearing and Settlement Divisions, SHCIL and the Securities Facilities Support Corporation. It uses modern computer technology for the clearance and settlement procedures. Better transparency system for the securities.
    22 : Over The Counter Exchange of India (OTCEI) The unique features of OTCEI are as under:. Ringless Trading National Network Totally Computerized Exclusives list of Companies Two ways of Making a Public Offer Faster Transfers and Trading without Shares Investor Registration Trading Mechanism
    23 : The benefits which OTC Exchange will offer are: For companies It will provide a method of raising funds through capital market instruments which are priced fairly. In OTC, the company will be able to negotiate the issue price with the sponsors who will market the issue. For Investor Investment in stocks will become easier. For Financial Environment OTC Exchange will help spread the stock exchange operation geographically and integrate capital investment into a national forum.
    24 : Inter-connected Stock Exchange of India Inter-connected Stock Exchange of India Limited (ISE), has been promoted by 15 regional stock exchanges to provide trading linkage/connectivity to all the participating exchanges to widen their market. Thus, ISE is a national level exchange providing trading, clearing, settlement, risk management and surveillance support o the Inter-Connected Market System (ICMS). ISE aims to address the needs of small companies and retail investors with the guiding principle of optimising the infrastructure and harnessing the potential of regional markets to transform these into a liquid and vibrant market through the use of technology and networking. Cont….
    25 : Core objectives of the Inter-connected Stock Exchange include creation of single integrated national level solution with access to multiple markets for providing high quality, low cost services to millions of investors across the country, a liquid and vibrant national level market for all listed companies in general and small capital companies in particular and providing trading, clearing and settlement facilities to the traders and dealers across the country at their doorstep with decentralised support system.
    26 : Demutualisation of Stock Exchanges Demutualisation of exchanges means segregating the ownership from management. This move was necessitated by the fact that brokers in the management of the stock exchange were misusing their position for personal gains. Demutualisation would bring in transparency and prevent conflict of interest in the functioning of the stock exchanges. There would be various benefits of demutualisation, a few of which are narrated herein below: Division of ownership between members and outsiders can lead to a balanced approach, remove conflicts of interest, create greater management accountability, and take into consideration the interest of other players. Cont….
    27 : To cope with competition, stock exchanges require funds. While member owned stock exchanges have limitations in raising funds, publicly owned stock exchanges can tap capital markets. Publicly owned stock exchanges can be more professional when compared to member-owned organisations. This would enhance management flexibility. Further, a company can spin off its subsidiaries, get into mergers and acquisitions, raise funds, etc.
    28 : Money market A money market is a mechanism which makes it possible for borrowers and lenders to come together. Money market is the market in which short-term funds are borrowed and lent. The money market does not deal in cash or money but in trade bills, promissory notes and government papers, which are drawn for short periods. These short-term bills are known as near money. Importance of money market Dealing in bills of exchange and commercial papers Acting as an outlet for the excess short-term funds of commercial banks Cont….
    29 : Dealing in treasury bills and short dated government securities Guiding central banking policies Making central banking policies effective Reduction of disparities in interest rates Influencing the capital market Cont….
    30 : Features of a Developed Money Market Existence of an efficient and effective central bank Well organized commercial banking system Existence of specialized sectors Free flow of funds between the various sub-markets Adequate facilities for transfer of funds Uniformity in interest rates Availability of ample funds Availability of ample short-term credit instruments Sensitiveness to internal and external events Existence of specialized financial institutions Cont….
    31 : Cont…. Features and Weaknesses of the Indian Money Market Existence of unorganized money market Absence of integration Diversity in money rates of interests Seasonal stringency of money Highly volatile call money market Absence of the bill market Absence of well organized banking system Availability of credit investments
    32 : Money Market Instruments Treasury Bills (T-Bills) Central Government Securities (gilt-edged securities) State Government and Public Sector Instruments Municipal Bonds Commercial Paper Certificates of Deposit Bills Rediscounting Call/Notice Money Market Cont….
    33 : Repurchase Agreements (Repos) Inter-bank Participation Bank Deposits Term Money Corporate Debentures and Bonds Bankers Acceptance Commercial Bills Fringe Market
    34 : Composition of the Indian Money Market Indian Money Market Unorganized Banking Sector Sub Markets Organized Banking Sector Call Money Market 364 days treasury Bills market Short-term bills market Certificates of deposits Commercial papers Bills of exchange Treasury Bills Cont….
    35 : Cont…. Central Government Securities (Gilt-edged Securities) The types of Central Government securities that have evolved recently include: Issue of stock through auction ushering new treasury culture enabling development of bidding skills amongst market participants. Issue of stock with pre-announced coupon rates (e.g. fixed rate bonds). Issue of stock with variable coupon rates (e.g. floating rate bonds). Issue of zero coupon bonds (issued at discount). Issue of capital index bonds (to hedge against inflation). Issue of stock in conversion of maturing treasury bill/dated securities (converted stocks).
    36 : State Government/Public Sector/Municipality Issued Securities Municipal Bonds General Obligation Bonds (GOBs) Revenue Bonds (RBs) State Government and Public Sector
    37 : Certificate of Deposit The various features of CDs are as follows: CDs can be subscribed by an individual, as well as by an institution. CDs are money market instruments in the form of Usance Promissory Notes issued at a discount and are negotiable in character. There is a lock-in-period of 15 days, after which they can be sold. The minimum size of the deposit is Rs. 5 lakhs and thereafter in multiples of Rs. 5 lakhs. The rate of interest is determined freely by the parties to the transaction. Cont….
    38 : The instrument is to be stamped according to the rates prescribed by the Indian Stamp Act. Premature closure of CDs is not permitted and buy-back of the CDs is prohibited. The CDs should fall due for payment on a working day. In case, the due date falls on a holiday, the payment is to be made on the previous working day. No advance can be taken against the security of the CDs. There is no limit for investment in CDs by the banks. Due to the negotiable character of the CD, the same could be sold after the lock-in-period, thus enabling the investing bank to create liquidity. This instrument is useful to the corporates for parking their surplus short-term bonds. Cont….
    39 : Rate of Interest on CDs As this instrument is issued at discount, the rate of interest is calculated as rear end rate on the basis of calculations as follows: I = Where I = Rate of Interest R = Discounted value Issue price of CD = Face value × Discounted value 100 X R X No. of Days to Maturity 365 X 100
    40 : Commercial Paper The commercial paper (CP) was introduced into the Indian money market during the year 1990, on the recommendations of the Vaghul Committee. CP is a form of usance promissory note, negotiable by endorsement and delivery. It is issued at a discount determined by the issuer company. The discount varies with the credit rating of the issuer company and the demand and supply position in the money market. Advantages It does not create any lien on assets of the company. Tradability of CP provides investors with exit options. High credit ratings fetch a lower cost of capital. Wide range of maturities provide more flexibility. Cont….
    41 : Disadvantages A high degree of control is exercised on issue of CP. Stand-by credit may become necessary. Its usage is limited to only blue chip companies. Issuance of CP bring down the bank credit limits.
    42 : Call Money Market Call money refers to that transaction which is received or delivered by the participants in the call money market and where the funds are returnable next day. The call money transactions are also referred to as overnight funds.
    43 : Repurchase Agreements (Repos) Repurchase agreements are simply known as 'repos' and arise when one party sells a security to another party with an agreement to buy it back at a specified time and price. Repos are active between commercial banks. Basically it is pledge transaction, with the bank committing itself to buy back the security, therefore, paying back the amount borrowed on pledge at a mutually agreed price after a specified period. This period ranges between one and 14 days. Repo is a risk-free short-term instrument for balancing short-term liquidity needs. Cont….
    44 : Inter-Bank Participation Certificate The minimum period shall be 91 days with maximum of 180 days for IBPC on risk sharing basis and in case of non-risk sharing basis, it is limited to 90 days. The maximum participation in loan under IBPC would be 40% of the amount outstanding or the limit sanctioned, whichever is lower. However, participation should be only in 'standard asset'. Documents to be executed by the borrowers in favour of the issuing banks, which shall include a clause that it should have liberty to shift at its discretion, without notice to the borrower, of a part or portion of the outstanding to another participating bank. Cont….
    45 : Interest rates are determined between issuing bank and the participating bank. The issuing bank and the participating bank have to enter into participation contracts in the prescribed format. IBPCs are not transferable and they cannot be re-deemed before the due date. On the date of maturity, the issuing Bank have to make payment of the IBPC along with agreed rate of interest to the participating bank.
    46 : Bills Rediscounting The formula for arriving at the discounted value of the bills for various unexpired usance period is given below: Discounted Value of the Bill D = Where, D = Discounted value of bills I = Effective rate of interest per annum F = Face value of bills n = Number of days of the usance period Cont….
    47 : Other Money Market Instruments Term Money Corporate Debentures and Bonds Bank Deposits Bankers Acceptance Commercial Bills Fringe Market
    48 : Reasons for Growth of Money Market in India Availability of new and more attractive instruments for investments such as short-term government papers and zero coupon bonds, besides other types of non-SLR instruments. Marketisation of government securities with adoption of auction system for all central government securities, and treasury bills of varying maturities. Increased professionalism in the banking industry with emergence of sophisticated instruments and technology changes, especially with the advent of more number of private sector participants. Cont….
    49 : Emergence of risks of different nature in money markets on account of freeing of interest rates, removal of entry barriers and integration with the international financial markets. The total impact of interest rate deregulation has exposed the banks to greater vulnerability in trying to cope with money market related risks. Stimulation of the government securities market due to decision of the government to borrow at market related rates on the lines suggested by the Narasimham Committee. Taking into consideration the risk factor, there is no doubt that government securities including treasury bills offer a good return to the investor.

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