Q.1) Distinguish between Primary Market and Secondary Market.
Answer:
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Q.2) Name the Leading Stock Exchanges in India and Abroad.
Answer:
Stock Exchanges in India
a) Bombay Stock Exchange(BSE)
b) National Stock Exchange(NSE)
Stock Exchanges Abroad
a) New York Stock Exchange (NYSE)
b) Nasdaq (National Association of Securities Dealers Automated Quotations.)
c) London Stock Exchange
Q.3) What are the functions of Stock Exchanges?
Answer:
A) Liquidity and Marketability of Securities: Stock exchange provides a ready and continuous market for purchase and sale of securities. Investors can at any time sell one and purchase another security, thus giving them marketability.
B) Fair Price Determination: Due to nearly perfect information, active bidding takes place from both sides. This ensures fair price to be determined by demand and supply forces.
C) Sources of Long Term Funds: Corporate, Government and public bodies raise funds from equity markets.
D) Helps in Capital Formation: Stock exchange accelerates the process of capital formation. It creates the habit of saving, investing and risk taking among the investing class and converts their savings into profitable investment. It acts as an instrument of capital formation. In addition, it also acts as a channel for right (safe and profitable) investment.
E) Reflects the General State of the Economy: Stock exchange indicates the state of health of companies and the national economy. It acts as a barometer of the economic situation / conditions.
G) Provides Clearing House Facility: Stock exchange provides a clearing house facility to members. It settles the transactions among the members quickly and with ease. The members have to pay or receive only the net dues (balance amount) because of the clearinghouse facility.
G) Provides Clearing House Facility: Stock exchange provides a clearing house facility to members. It settles the transactions among the members quickly and with ease. The members have to pay or receive only the net dues (balance amount) because of the clearinghouse facility.
Q.4) What is Stock Market Index?
Answer:
✓ A stock index or a stock market index is a list of figures and stocks that are used to indicate the combined value of its constituents.
✓ The stock index is applied as a device for representing the essential features of its constituent stocks.
✓ Stock indices function as an indicator of the general economic scenario of a country.
✓ If, however, there is a plunge noticed in the stock market index, it is indicative of poor economic condition of the companies and therefore, the general economy. my of the country are stable.
✓ If, however, there is a plunge noticed in the stock market index, it is indicative of poor economic condition of the companies and therefore, the general economy.
Stock Market Index answers to the question “how is the market doing? ”A base year is set along with a basket of base shares. Each stock exchange has a flagship index like in India Sensex of BSE and Nifty of NSE and outside India is Dow Jones, FTSE, Nasdaq etc.
Q.5) What do the fluctuations of Index Say?
Answer:
A. Stocks are valued by discounting future earnings of the company; therefore stock indices reflect expectation about future performance of the companies listed in the stock market.
B. When the Index goes up, the market thinks that the future returns will be higher than they are at present and when it goes down, the market thinks that the future returns will be lower than they are at present. The concept behind the Index Stock price are sensitive to the following news:
· Company specific news
· Country specific news (budget, elections, government policies, wars etc.)
On any one day there is some good news and bad news related to specific companies, which offset with each other. This news does not affect the index. However, the country specific news, which is common to all stocks, affects the index.
Q.6) How is the Index calculated?
Answer:
Step 1: Calculate market capitalization (or market cap) of each individual company comprising the index. [Market price per share x Total no. of outstanding shares]
Step 2: Calculate total market capitalization by adding the individual market capitalization of all companies in the Index.
Step3: Computing index of the next day requires the index value and the total market capitalization of the previous day and is computed as follows:
Note: Indices may also be calculated by price weighted method. Here the share price of
constituent companies forms the weights. However almost all equity indices world-wide are calculated using market capitalization weighted method (the one used above).
Q.7) Write short note on Settlement Cycle and Trading Hours.
Answer:
✓ Equity spot markets follow a T+2 rolling settlement. ✓ This means that any trade taking place on Monday gets settled by Wednesday.
✓ All trading on stock exchanges takes place between 9:15 am and 3:30 pm, Indian Standard Time, Monday through Friday. ✓ Delivery of shares must be made in dematerialized form, and each exchange has its own clearing house, which assumes all settlement risk, by serving as a central counterparty. Q.8) What is Clearing Houses?
Answer:
✓ Clearing house is an exchange associated body charged with the function of ensuring the financial integrity of each trade.
✓ Orders are cleared by means of clearinghouse acting as a seller to all the buyers and buyer to all the sellers.
✓ It provides range of services related to the guarantee of contracts, clearing and settlement of trades and management of risk for their members and associated exchanges.
Q.9) What is the role of clearing house?
Answer:
✓ Ensuring adherence to the system and procedures for smooth trading.
✓ Minimizing credit risk by being a counterparty to all trades.
✓ Daily accounting of gains and losses.
✓ Ensuring delivery of payment for assets on maturity dates for all outstanding contracts.
✓ Monitors the maintenance of speculation margins.
Q.10) Write short note on Trading Mechanism.
Answer:
✓ Trading at both the exchanges takes place through an open electronic limit order book, in which order matching is done by the trading computer. ✓ There are no market makers or specialists and the entire process is order-driven, which means that market orders placed by investors are automatically matched with the best limit orders. As a result, buyers and sellers remain anonymous. ✓ The advantage of an order driven market is that it brings more transparency, by displaying all buy and sell orders in the trading system.
✓ However, in the absence executed. of market makers, there is no guarantee that orders will be
✓ All orders in the trading system need to be placed through brokers, many of which provide online trading facility to retail customers.
Q.11) What are the major capital market instruments?
Answer:
a) Debt Instruments
b) Equities (Common stock)
c) Preference Shares
d) Derivatives
Q.12) Write short notes on American Depository Receipts (ADRs).
Answer:
✓ An American depositary receipt (ADR) is a negotiable security that represents securities of a non-US company that trades in the US financial market.
✓ ADRs allow U.S. investors to invest in non-U.S. companies and give non- U.S. companies easier access to the U.S. capital markets. Many non- U.S. issuers use ADRs as a means of raising capital or establishing a trading presence in the U.S.
Benefits to the US Investors
1. One of ADRs’ top advantages is the facilitated diversification into foreign securities.
2. ADRs also allow easy comparison to securities of similar companies as well as access to price and trading information, if listed.
3. Transfer of ADR does not require any stamp duty hence the transfer of underlying shares does not require any stamp duty.
4. The dividends are paid to the holders of ADRs in US dollars.
Q.13) Write short notes on Global Depository Receipts (GDRs).
Answer:
✓ A global depositary receipt(GDR) is similar to an ADR, but is a depositary receipt sold
outside of the United States and outside of the home country of the issuing company. Most GDRs are, regardless of the geographic market, denominated in United States dollars, although some trade in Euros or British sterling.
✓ GDR can be particularly helpful those persons who are not resident of a country in which they want to invest. Because through GDR those persons can invest in the shares of the company without any problem and hence it is a great alternative of investment for them
✓ Prices of GDR are often close to values of related shares, but they are traded and settled separately than the underlying share.
✓ Usually a GDR is denominated in US dollars.
Q.14) Explain Moving Averages.
Answer:
Moving averages are frequently plotted with prices to make buy and sell decisions. The two types of moving averages used by chartists are:
1. Arithmetic Moving Average(AMA)
2. Exponential Moving Average(EMA)
1. Arithmetic Moving Average (AMA): An n period AMA at period it is nothing but the simple average of the last n period prices.
AMA n,t = 1/n[Pt + Pt–1 + ⋯ + Pt–(n–1)
2. Exponential Moving Average (EMA): Unlike AMA, which assigns equal weight of 1/n to each of the n prices used for computing the average, the Exponential Moving Average (EMA) assigns decreasing weights, with the highest weight being assigned to the latest price. The weights decrease exponentially, according to a scheme specified by exponential smoothing constant, also known as the exponent,
EMA=[CP x e]+ [Previous EMA x (1-e)]
CP= Current Closing Price, e= exponent in decimals
Q.15) Write short notes on ‘Stock Lending Scheme’.
Answer:
✓ In stock lending, the legal title of a security is temporarily transferred from a lender to a borrower.
✓ The lender retains all the benefits of ownership, other than the voting rights.
✓ The borrower is entitled to utilize the securities as required but is liable to the lender for all benefits.
✓ A securities lending program is used by the lenders to maximize yields on their portfolio. Borrowers use the securities lending program to avoid settlement failures.
✓ Securities lending provide income opportunities for security holders and creates liquidity to facilitate trading strategies for borrowers. It is particularly attractive for large institutional shareholders as it is an easy way of generating income to offset custody fees and requires little involvement of time
The basic function of merchant bankers is marketing of corporate and other securities.
Answer:
In this process, he performs a number of services concerning various aspects of marketing viz. origination, underwriting, and distribution of securities.
In this process, he performs a number of services concerning various aspects of marketing viz. origination, underwriting, and distribution of securities.
Other activities or services performed by merchant bankers in India include:
✓ Project promotion services
✓ Project Finance
✓ Management and marketing of new issues
✓ Underwriting of new issues
✓ Syndication of new issues
✓ Syndication of credit
✓ Leasing services
✓ Corporate advisory services
✓ Providing venture capital
✓ Operating mutual funds and off shore funds
✓ Investment management or portfolio management services
✓ Bought out deals
✓ Providing assistance for technical and financial collaborations and joint ventures
✓ Management of and dealing in commercial paper
✓ Investment services for non-resident Indians
Q.17) Write short notes on ‘Book Building’.
Answer:
Book building is a technique used for marketing a public offer of equity shares of a company. It is away of raising more funds from the market. After accepting the free pricing mechanism by the SEBI, the book building process has acquired too much significance and has opened anew lead in development of capital market.
A company can use the process of book building to fine tune its price of issue. When a company employs book building mechanism, it does not pre-determine the issue price (in case of equity shares) or interest rate (in case of debentures) and invite subscription to the issue. Instead it starts with an indicative price band (or interest band) which is determined through consultative process with its merchant banker and asks its merchant banker to invite bids from prospective investors at different prices (or different rates). Those who bid are required to pay the full amount. Based on the response received from investors the final price is selected. The merchant banker(called in this case Book Runner) has to manage the entire book building process. Investors who have bid a price equal to or more than the final price selected are given allotment at the final price selected. Those who have bid for a lower price will get their money refunded.
In India, there are two options for book building process. One, 25 per cent of the issue has to be sold at fixed price and 75 per cent is through book building. The other option is to split 25 per cent of offer to the public (small investors) into a fixed price portion of 10 per cent and a reservation in the book built portion amounting to 15 per cent of the issue size. The rest of the book built portion is open to any investor.
The greatest advantage of the book building process is that this allows for price and demand discovery. Secondly, the cost of issue is much less than the other traditional methods of raising capital. In book building, the demand for shares is known before the issue closes. In fact, if there is not much demand the issue may be deferred and can be rescheduled after having realised the temper of the market.
Q.18) Explain the term Buy Back of Securities.
Answer:
Companies are allowed to buy back equity shares or any other security specified by the Union Government. In India Companies are required to extinguish shares bought back within seven days. In USA Companies are allowed to hold bought back shares as treasury stock, which may be reissued. A company buying back shares makes an offer to purchase shares at a specified price. Shareholders accept the offer and surrender their shares.
The following are the management objectives of buying back securities:
(i) To return excess cash to shareholders, in absence of appropriate investment opportunities.
(ii) To give a signal to the market that shares are undervalued.
(iii) To increase promoters holding, as a percentage of total outstanding shares, without additional investment. Thus, buy back is often used as a defence mechanism against potential takeover.
(iv) To change the capital structure.
Q.19) Write short notes on ‘Green Shoe Option’.
Answer:
The green shoe option allows companies to intervene in the market to stabilize share prices during the 30-day stabilization period immediately after listing. This involves purchase of equity shares from the market by the company-appointed agent incase the shares fall below issue price.
Guidelines for exercising green shoe option
· The guidelines require the promoter to lend his shares (not more than 15% of issue size) which is to be used for price stabilisation to be carried out by a stabilising agent (normally merchant banker or book runner) on behalf of the company.
· After making the decision to go public, the company appoints underwriters to find the buyers for their issue. Sometimes, these underwriters also help the corporate in determining the issue price and the kind of equity dilution i.e. how many shares will be made available for the public.
· After making the decision to go public, the company appoints underwriters to find the buyers for their issue. Sometimes, these underwriters also help the corporate in determining the issue price and the kind of equity dilution i.e. how many shares will be made available for the public.
· But with the turbulent times prevailing in the marketplace, it is however quite possible that the IPO undersubscribed and trades below its issue price.
· This is where these underwriters invoke the green shoe option to stabilise the issue.
How green shoe option works
- As said earlier, the entire process of a green shoe option works on over-allotment of shares. For instance, a company plans to issue 1 lakh shares, but to use the green shoe option; it actually issues 1.15 lakh shares, in which case the over-allotment would be 15,000 shares. Please note, the company does not issue any new shares for the over-allotment.
- The 15,000 shares used for the over-allotment are actually borrowed from the promoters with whom the stabilising agent signs a separate agreement. For the subscribers of a public issue, it makes no difference whether the company is allotting shares out of the freshly issued 1 lakh shares or from the 15,000shares borrowed from the promoters.
- Once allotted, a share is just a share for an investor. For the company, however, the situation is totally different. The money received from the over-allotment is required to be kept in a separate bank account (i.e. escrow account)
Role of the stabilising agent
1. The stabilizing agent start its process only after trading in the share starts at the stock exchanges.
2. In case the shares are trading at a price lower than the offer price, the stabilizing agent starts buying the shares by using the money lying in the separate bank account. In this manner, by buying the shares when others are selling, the stabilizing agent tries to put the brakes on falling prices. The shares so bought from the market are handed over to the promoters from whom they were borrowed.
✓ Euro Convertible bonds are quasi-debt securities (unsecured) which can be converted into depository receipts or local shares. any shares.
Q.20 )Write short notes on Euro Convertible Bonds.
Answer:
✓ Euro Convertible bonds are quasi-debt securities (unsecured) which can be converted into depository receipts or local shares.
✓ ECBs offer the investor an minimum lock in period. Option to convert the bond into equity at a fixed price after the
✓ The price of equity shares at the time of conversion will have a premium element. The bonds carry a fixed rate of interest.
✓ These are bearer securities and generally the issue of such bonds may carry two options viz., call option and put option. A call option allows the company to force conversion if the market price of the shares exceeds a particular percentage of the conversion price. A put option allows the investors to get his money back before maturity.
✓ In the case of ECBs, the payment of interest and the redemption of the bonds will be made by the issuer company in US dollars. ECBs issues are listed at London or Luxemburg stock exchanges.
✓ Indian companies which have opted ECBs issue are Jindal Strips, Reliance, Essar Gujarat, Sterlite etc.
✓ Indian companies are increasingly looking at Euro-Convertible bond in place of Global Depository Receipts because GDRs are falling into disfav our among international fund managers.
✓ An issuing company desirous of raising the ECBs is required to obtain prior permission of the Department of Economic Affairs, Ministry of Finance, and Government of India.
✓ The proceeds of ECBs would be permitted only for following purposes:
(i) Import of capital goods.
(ii) Retiring foreign currency debts.
(iii) Capitalising Indian joint venture abroad.
(iv) 25% of total proceedings can be used for working capital and general corporate restructuring.
Q.21) Explain the term “Short Selling”
Answer:
In purchasing stocks, you buy a piece of ownership in the company. The buying and selling of stocks can occur with a stock broker or directly from the company. Brokers are most commonly used. They serve as an intermediary between the investor and the seller and often charge a fee for their services.
In finance short selling (also known as shorting or going short) is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them ("covering").
The short seller borrows shares and immediately sells them. The short seller then expects the price to decrease, when the seller can profit by purchasing the shares to return to the lender.
The procedure:
Because you don't own the stock you're short selling (you borrowed and then sold it), you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short,you'll owe twice the number of shares at half the price.r, you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.
Most of the time, you can hold a short for as long as you want, although interest is charged on margin accounts, so keeping a short sale open for a long time will cost more However, you can be forced to cover if the lender wants the stock you borrowed back. Brokerages can't sell what they don't have, so yours will either have to come up with new shares to borrow, or you'll have to cover. This is known as being called away. It doesn't happen often, but is possible if many investors are short selling a particular security.
Offer for sale is also known as bought out deal (BOD). It is a new method of offering equity shares, debentures etc.,to the public. In this method, instead of dealing directly with the public,a company offers the shares/debentures through a sponsor.ll owe twice the number of shares at half the price.
Q.22) Explain the term “Offer for Sale”
Answer:
Offer for sale is also known as bought out deal (BOD). It is a new method of offering equity shares, debentures etc.,to the public. In this method, instead of dealing directly with the public, a company offers the shares/debentures through a sponsor.
The sponsor may be a commercial bank, merchant banker, an institution or an individual. It is a type of wholesale of equities by a company. A company allots shares to a sponsor at an agreed price between the company and sponsor. The sponsor then passes the consideration money to the company and in turn gets the shares duly transferred to him.
After a specified period as agreed between the company and sponsor, the shares are issued to the public by the sponsor with a premium. After the public offering, the sponsor gets the shares listed in one or more stock exchanges. The holding cost of such shares by the sponsor may be reimbursed by the company or the sponsor may get the profit by issue of shares to the public at premium.
Thus, it enables the company to raise the funds easily and immediately. As per SEBI guidelines, no listed company can go for BOD. A privately held company or an unlisted company can only go for BOD. A small or medium size company which needs money urgently chooses to BOD. It is a low cost method of raising funds. The cost of public issue is around 8% in India. But this method lacks transparency. There will be scope for misuse also. Besides this, it is expensive like the public issue method. One of the most serious short coming of this method is that the securities are sold to the investing public usually at a premium. The margin thus between the amount received by the company and the price paid by the public does not become additional funds of the company, but it is pocketed by the issuing houses or the existing shareholders.
Q.23) Explain the term “Placement Method”
Answer:
1. Yet another method to float new issues of capital is the placing method defined by London Stock Exchange as “sale by an issue house or broker to their own clients of securities which have been previously purchased or subscribed”. Under this method, securities are acquired by the issuing houses, as in offer for sale method, but instead of being subsequently offered to the public, they are placed with the clients of the issuing houses, both individual and institutional investors. Each issuing house has a list of large private and institutional investors who are always prepared to subscribe to any securities which are issued in this manner. Its procedure is the same with the only difference of ultimate investors.
2. In this method, no formal underwriting of the issue is required as the placement itself amounts to underwriting since the issuing houses agree to place the issue with their clients.
3. The main advantage of placing, as a method of issuing new securities, is its relative cheapness.
5. Its weakness arises from the point of view of distribution of securities. As the securities are offered only to a select group of investors, it may lead to the concentration of shares into a few hands who may create artificial scarcity of scrips in times of hectic dealings in such shares in the market. Performances.
5. Its weakness arises from the point of view of distribution of securities. As the securities are offered only to a select group of investors, it may lead to the concentration of shares into a few hands who may create artificial scarcity of scrips in times of hectic dealings in such shares in the market.
Q.24 Explain briefly the advantages of holding securities in ‘Demat’ form rather than in physical form.
Answer:
From an individual investor point of view, the following are important advantages of holding securities in demat form:
• It is speedier and avoids delay in transfers.
• It avoids lot of paper work.
• It saves on stamp duty.
From the issuer-company point of view also, there are significant advantages due to dematting, some of which are:
• Savings in printing certificates, postage expenses.
• Stamp duty waiver.
· Easy monitoring of buying/selling patterns in securities, increasing ability to spot takeover attempts and attempts at price rigging.
Q.25 Explain briefly the terms ESOS and ESPS with reference to the SEBI guidelines
Answer:
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