MODULE –II

Meaning of Money Market:

Money market is a market for short-term funds. We define the short-term as a period of 364
days or less. In other words, the borrowing and repayment take place in 364 days or less. The
manufacturers need two types of finance: finance to meet daily expenses like purchase of raw
material, payment of wages, excise duty, electricity charges etc., and finance to meet capital
expenditure like purchase of machinery, installation of pollution control equipment etc.
The first category of finance is invested in the production process for a short period of time.
The market where such short-time finance is borrowed, and lent is called ‘money market’.
Almost every concern in the financial system, be it a financial institution, business firm, a
corporation, or a government body, has a recurring problem of liquidity management, mainly
because the timing of the expenditures rarely synchronize with that of the receipts.
The most important function of the money market is to bridge this liquidity gap. Thus,
business and finance firms can tide over the mismatches of cash receipts and cash
expenditures by purchasing (or selling) the shortfall (or surplus) of funds in the money
market.
Features of Money Market:
Following are the features of money market:
 Money market has no geographical constraints as that of a stock exchange. The
financial institutions dealing in monetary assets may be spread over a wide
geographical area.
 Even though there are various centers of money market such as Mumbai,
Calcutta, Chennai, etc., they are not separate independent markets but are inter-
linked and interrelated.
 It relates to all dealings in money or monetary assets.
 It is a market purely for short-term funds.
 It is not a single homogeneous market. There are various sub-markets such as Call
money market, Bill market, etc.
 Money market establishes a link between RBI and banks and provides information
of monetary policy and management.
 Transactions can be conducted without the help of brokers.
 Variety of instruments are traded in money market.
Money Market Instruments
 Call and Notice Money Market:
Under call money market, funds are transacted on overnight basis. Under notice
money market funds are transacted for the period between 2 days and 14 days.
The funds lent in the notice money market do not have a specified repayment date
when the deal is made. The lender issues a notice to the borrower 2-3 days before
the funds are to be paid. On receipt of this notice, the borrower will have to repay
 the funds within the given time. Generally, banks rely on the call money market
where they raise funds for a single day. The main participants in the call money
market are commercial banks (excluding RRBs), cooperative banks and primary
dealers. Discount and Finance House of India (DFHI), Non-banking financial
institutions such as LIC, GIC, UTI, NABARD etc. are allowed to participate in
the call money market as lenders.
 Treasury Bills (T-Bills):
Treasury bills are short-term securities issued by RBI on behalf of Government of
India. They are the main instruments of short-term borrowing by the Government.
They are useful in managing short-term liquidity. At present, the Government of
India issues three types of treasury bills through auctions, namely – 91 days, 182-
day and 364-day treasury bills. There are no treasury bills issued by state
governments. With the introduction of the auction system, interest rates on all
types of TBs are being determined by the market forces.
 Commercial Bills:
Commercial bill is a short-term, negotiable, and self-liquidating instrument with
low risk. They are negotiable instruments drawn by a seller on the buyer for the
value of goods delivered by him. Such bills are called trade bills. When trade bills
are accepted by commercial banks, they are called commercial bills. If the seller
gives some time for payment, the bill is payable at future date (i.e. usance bill).
Generally, the maturity period is up to 90 days. During the usance period, if the
seller needs funds, he may approach his bank for discounting the bill. Commercial
banks can provide credit to customers by discounting commercial bills. The banks
can rediscount the commercial bills any number of times during the usance period
of bill and get money.
 Certificates of Deposits (CDs):
CDs are unsecured, negotiable promissory notes issued at a discount to the face
value. They are issued by commercial banks and development financial
institutions. CDs are marketable receipts of funds deposited in a bank for a fixed
period at a specified rate of interest. CDs were introduced in India in June 1989.
The main purpose of the scheme was to enable commercial banks to raise funds
from the market through CDs. According to the original scheme, CDs were issued
in multiples of Rs.25 lakh subject to minimum size of an issue being Rs.1 crore.
They had the maturity period of 3 months to one year. They are freely transferable
but only after the lock in period of 45 days after the date of issue.
 Commercial Papers (CPs):
Commercial Paper (CP) is an unsecured money market instrument issued in the
form of a promissory note with fixed maturity. They indicate the short-term
obligation of an issuer. They are quite safe and highly liquid. They are generally
issued by the leading, nationally reputed, highly rates and credit worthy large
 manufacturing and finance companies is the public as well as private sector. CPs
were introduced in India January 1990. CPs were launched in India with a view to
enable highly rated corporate borrowers to diversify their sources of short-term
borrowings and to provide an additional instrument to investors. RBI has modified
its original scheme to widen the market for CPs. Corporates and primary dealers
(PDs) and all India financial institutions can issue CPs. A corporate can issue CPs
provided they fulfill the following conditions: (a) The tangible net worth of the
company is not less than Rs.4 crore. (b) The company has been sanctioned
working capital limit by banks or all India financial institutions, and (c) The
borrowed account of the company is classified as a standard asset by the financing
institution or bank.
 Repos:
A repo or reverse repo is a transaction in which two parties agree to sell and
repurchase the same security. Under repo, the seller gets immediate funds by
selling specified securities with an agreement to repurchase the same at a mutually
decided future date and price. Similarly, the buyer purchases the securities with an
agreement to resell the same to the seller at an agreed date and price. The repos in
government securities were first introduced in India since December 1992. Since
November 1996, RBI has introduced “Reverse Repos”, i.e., to sell government
securities through auction.
 Discount and Finance House of India (DFHI):
It was set up by RBI in April 1988 with the objective of deepening and activating
money market. It is jointly owned by RBI, public sector banks and all India
financial institutions which have contributed to its paid-up capital. The DFHI
deals in treasury bills, commercial bills, CDs, CPs, short-term deposits, call
money market and government securities. The presence of DFHI as an
intermediary in the money market has helped the corporate entities, banks, and
financial institutions to invest their short-term surpluses in money market
instruments.
 Money Market Mutual Funds (MMMFs):
RBI introduced MMMFs in April 1992 to enable small investors to participate in
the money market. MMMFs mobilizes savings from small investors and invest
them in short-term debt instruments or money market instruments such as call
money, repos, treasury bills, CDs, and CPs. These instruments are forms of debt
that mature in less than a year.
Money Market Institutions
The major participants who supply the funds and demand the same in the money
market are as follows:
 Reserve Bank of India:
 Reserve Bank of India is the regulator over the money market in India. As the
Central Bank, it injects liquidity in the banking system, when it is deficient and
contracts the same in opposite situation.
 Banks:
Commercial Banks and the Co-operative Banks are the major participants in the
Indian money market. They mobilize the savings of the people through acceptance
of deposits and lend it to business houses for their short-term working capital
requirements. While a portion of these deposits is invested in medium and long-
term Government securities and corporate shares and bonds, they provide short-
term funds to the Government by investing in the Treasury Bills. They employ the
short-term surpluses in various money market instruments.
 Discount and Finance House of India Ltd. (DFHI):
DFHI deals both ways in the money market instruments. Hence, it has helped in
the growth of secondary market, as well as those of the money market
instruments.
 Financial and Investment Institutions:
These institutions (e.g., LIC, UTI, GIC, Development Banks, etc.) have been
allowed to participate in the call money market as lenders only.
 Corporates:
Companies create demand for funds from the banking system. They raise short-
term funds directly from the money market by issuing commercial paper.
Moreover, they accept public deposits and indulge in inter corporate deposits and
investments.
 Mutual Funds:
Mutual funds also invest their surplus funds in various money market instruments
for short periods. They are also permitted to participate in the Call Money Market.
Money Market Mutual Funds have been set up specifically for the purpose of
mobilization of short-term funds for investment in money market instruments.

PRIMARY MARKET
Primary Market is a market for new issues and hence it is called new issue market. It deals
with securities which are issued to the public for the first time.
Functions of Primary Market
The main function of the New Issue Market is to facilitate the ‘transfer of resources’ from
savers to users. Conceptually, however, the New Issue Market should not be conceived as a
platform only for the purpose of raising finance for new capital expenditure.
In fact, the facilities of the market are also utilized for selling existing concerns to the public
as going concerns through conversions of existing proprietary enterprises or private
companies into public companies.
It, therefore, becomes imperative at this stage to classify new issues. One classification
suggested by R.F. Henderson (c.f. The New Issue Market & Finance for Industry, 1951),
categorizes new issues into those by:
(a) New companies also called ‘initial issues’ and
(b) Old companies also called ‘further issues.
These bear no relation to the age of the company but are based on the fact whether the
company already has stock exchange listing.
This classification is thus concerned only with the flow of ‘new money’. Another
classification (c.f. Merrett, Howe & New bould “Equity Issues and the London Capital
Market” 1967) distinguishes between flow of funds into the market and flow of “new money”
hence we have ‘new money issues or issues of capital involving newly created share and ‘no
new money issues’ i.e., sale of securities already in existence and sold by their holders.
This is more an “exclusive” classification in that two types of issues are excluded from the
category of new issues.
(a) Bonus/capitalization issues which represent only bookkeeping entries.
(b) Exchange issues: by which shares in one company are/exchanged for securities of
another.
Now, the main function of the New Issue Market, i.e., channeling of investible funds, can be
divided, from the operational standpoint, into a triple-service function:
(a) Origination
(b) Underwriting
(c) Distribution
The institutional setup dealing with these can be said to constitute the New Issue Market
organization.

(a) Origination: Origination refers to the work of investigation and analysis and processing
of new proposals. This in turn may be:

(i) A preliminary investigation undertaken by the sponsors (specialized agencies) of the issue.
This involves a/careful study of the technical, economic, financial and/legal aspects of the
issuing companies to ensure that/it warrants the backing of the issue house.

(ii) Services of an advisory nature which go to improve the quality of capital issues. These
services include/advice on such aspects of capital issues as: determination of the class of
security to be/issued and price of the issue in terms of market conditions; the timing and
magnitude of issues; method of flotation; and technique of selling and so on. The importance
of the specialised services provided by the New Issue Market organisation in this respect can
hardly be over-emphasized. On the thoroughness of investigation and soundness of
judgement of the sponsoring institution depends, to a large extent, the allocative efficiency of
the market. The origination, however, thoroughly done, will not by itself guarantee success of
an issue. A second specialised service i.e., “Underwriting” is often required.

(b) Underwriting: The idea of underwriting originated on account of uncertainties prevailing

in the capital market because of which the success of the issue becomes unpredictable. If the
issue remains undersubscribed, the directors cannot proceed to allot the shares, and must
return money to the applicants if the subscription is below a minimum amount fixed under
the Companies Act. Consequently, the issue and hence the project will fail.

Underwriting entails an agreement whereby a person/organization agrees to take a specified

number of shares or debentures, or a specified amount of stock offered to the public in the
event of the public not subscribing to it, in consideration of a commission the underwriting
commission. If the issue is fully subscribed by the public, there is no liability attaching to the
underwriters; else they must come forth to meet the shortfall to the extent of the under-
subscription.

The underwriters in India may broadly be classified into the following two types:

(i) Institutional Underwriters; (ii) Non-Institutional Underwriting.

Institutional Underwriting in our country has been development oriented. It stands as a major
support to those projects which often fail to catch the eye of investing public. These projects
rank high from the points of view of national importance e.g., steel, fertilizer, and generally
receive higher priority by such underwriters.

Thus, institutional underwriting may be broadly recognized, in the context of development

credit, as playing a decisive role in directing the economic resources of the country towards
desired activities. This does not mean that they are barred entrance in the issue market from
so called glamorous issues to which public can be expected to readily subscribe. They may be
underwriting in such cases, but what is expected of them is their support to projects in the
priority sector. One of the principal advantages they offer is that resource-wise they are
undoubted. They can fulfill their underwriting commitments even in the worst foreseeable
situations.

The public financial institutions namely IDBI, IFCI, ICICI, LIC and UTI, underwrite a
portion of the issued capital. Usually, the underwriting is done in addition to granting term
finance by way of loans on debentures.

These institutions are usually approached when one or more of the following situations
prevail: (i) The issue is so large that broker-underwriting may not be able to cover the entire
issue.

(ii) The gestation period is long enough to act as distinctive

(iii) The project is weak since it is being in a backward area.

(iv) The project is in the priority sector which may not be able to provide an attractive return
on investment.

(v) The project is promoted by technicians.

(vi) The project is new to the market.

The quantum of underwriting assistance varies from institution to institution according to the
commitments of each of them for a particular industry.

However, institutional underwriting suffers from the following two drawbacks:

1. The institutional handling involves procedural delays which sometimes dampen the
initiative of the corporate managers or promoters.

2. The other disadvantage is that the institutions prefer to wait and watch the results to fulfill
their obligations only where they are called upon to meet the deficit caused by under
subscription.

(c) Distribution: The sale of securities to the ultimate investors is referred to as distribution;
it is another specialised job, which can be performed by brokers and dealers in securities who
maintain regular and direct contact with the ultimate investors. The ability of the New Issue
Market to cope with the growing requirements of the expanding corporate sector would
depend on this triple-service function.

There are three ways through which capital is raised in primary market. These are:
- Public issue
- Right Issue
- Private placement
INTIAL PUBLIC OFFERING (IPO)
An IPO is short for an initial public offering. It is when a company initially offers shares
of stocks to the public. It is also called "going public." An IPO is the first time the owners of
the company give up part of their ownership to stockholders. Before that, the company is
privately-owned.
SEBI GUIDELINES FOR IPO

1. An issuer making an initial public offer must fulfill that:

 It has net tangible assets of at least three crore rupees in each of the preceding
three full years (each year of twelve months), of which not more than fifty
percent. are held in monetary assets:
 It has a past record of distributable profits for at least three out of the immediately
preceding five years as per section 205 of the Companies Act, 1956. Thus, it shall
 be a profit-making company. While calculating the distributable profits
extraordinary items shall be excluded in such calculation.
 It must have a net worth of at least one crore rupees in each of the preceding three
full years (each year of twelve months);
 The aggregate of the proposed issue and all previous issues made in the same
financial year in terms of issue size must not exceed five times its pre-issue net
worth calculated as per the audited balance sheet of the preceding financial year.
 If it has changed its name during the last one year, at least fifty percent of the
revenue generated for the preceding one full year has been earned by it from the
activity mentioned by the new name.

2. An issuer not fulfilling any of the conditions prescribed in sub-regulation (1) may
make an initial public offer if:

 The issue is made through the book building process and the issuer promises to
allow at least fifty percent. of the net offer to the public, qualified institutional
buyers and to refund full subscription amount if it fails to make an allotment to the
qualified institutional buyers, or
 At least fifteen percent. Of the cost of the project is contributed by scheduled
commercial banks or public financial institutions, out of which at least ten percent
shall come from the appraisers and the issuer guarantees to allow at least ten
percent of the net offer to the public, to qualified institutional buyers and to refund
full subscription amount if it fails to make the allotment to the qualified
institutional buyers.
 The minimum amount post-issue face value capital of the issuer is ten crore
rupees; or the issuer commits to furnish market-making for at least two years from
the date of listing of the securities, subject to the following:
 the market makers offer to buy and sell quotes for at least of three hundred
specified securities and confirm that the bid-ask spread for their quotes does not,
at any point of time, exceed ten percent.
 The inventory of the market makers, as on the date of allotment of the specified
securities, shall not be less than five percent of the proposed issue.

3. An issuer may make an initial public offer (IPO) of convertible debt instruments
even though he has not undertaken a prior public issue of its equity shares and
further listing thereof.
4. An issuer shall not make an allotment pursuant to a public issue if the number of
prospective allottees is below one thousand.
5. No issuer shall make an initial public offer (IPO) if [as on the date of registering
the prospectus with the Registrar of Companies]
 i) there are any outstanding convertible securities or ii) any other right entitling
any person any option to receive equity shares after the initial public offer:
Provided that the norms of this sub-regulation shall not apply to:

 a public issue brought out during the prevalence of convertible debt instruments
issued through an earlier initial public offer if the conversion price of such
convertible debt instruments was fixed and mentioned in the prospectus of the
earlier issue of convertible debt instruments.
 Outstanding options permitted to employees under an employee stock option
scheme (ESOS) formulated in consonance with the relevant Guidance Note or
Accounting Standards, if any, issued by the Institute of Chartered Accountants of
India (ICAI) in this matter.

6. Subject to provisions of the Companies Act, 1956, equity shares may be offered
for sale to the public if such equity shares have been held by the sellers for a
period of at least one year before the filing of draft offer document with the Board
under the provisions of sub-regulation (1) of regulation 6:

Provided that in the case where the equity shares received on conversion or exchange
of fully paid-up compulsorily convertible securities and depository receipts are being
offered for sale, the holding period of such convertible securities and that of resultant
equity shares together shall be considered for calculation of one-year period
prescribed in this sub-regulation:

7. No issuer shall make an initial public offer without obtaining grading for the initial
public offer from at least one credit rating agency registered with the Board. This has
to be as on the date of registering prospectus or red herring prospectus with the
Registrar of Companies.
METHODS OF ISSUING IPO
According to the Corporate Finance Institute there are five steps in the IPO process.

First, the owners must select a lead investment bank. This beauty contest occurs six months
before the IPO, according to CNBC. Applicant banks submit bids that detail how much the
IPO will raise and the bank's fees. The company selects the bank based on its reputation, the
quality of its research, and its expertise in the company's industry.

The company wants a bank that will sell the shares to as many banks, institutional investors,
or individuals as possible. It is the bank's responsibility to put together the buyers. It selects a
group of banks and investors to spread around the IPO's funding. The group
also diversifies the risk.

Banks charge in between 3% to 7% of the IPO's total sales price.

The process of an investment bank handling an IPO is called underwriting. Once selected, the
company and its investment bank write the underwriting agreement. It details the amount of
money to be raised, the type of securities to be issued, and all fees. Underwriters ensure that
the company successfully issues the IPO and that the shares get sold at a certain price.

The second step is the due diligence and regulatory filings. It occurs three months before the
IPO. This is prepared by the IPO team. It consists of the lead investment banker, lawyers,
accountants, investor relations specialists, public relations professionals, and SEC experts.

The team assembles the financial information required. That includes identifying, then selling
or writing off, unprofitable assets. The team must find areas where the company can
improve cash flow. Some companies also look for new management and a new board of
directors to run the newly public company.

The investment bank files the S-1 registration statement with the SEC. This statement has
detailed information about the offering and company info. The statement includes financial
statements, management background, and any legal problems. It also specifies where the
money is to be used, and who owns any stock before the company goes public. It discusses
the firm's business model, its competition, and its risks. It also describes how the company is
governed and executive compensation.

The SEC will investigate the company. It makes sure all the information submitted is correct
and that all relevant financial data has been disclosed.

The third step is pricing. It depends on the value of the company. It also is affected by the
success of the road shows and the condition of the market and economy.

After the SEC approves the offering, it will work with the company to set a date for the IPO.
The underwriter must put together a prospectus that includes all financial information on the
company. It circulates it to prospective buyers during the roadshow. The prospectus includes
a three-year history of financial statements. Investors submit bids indicating how many shares
they would like to buy.

After that, the company writes transition contracts for vendors. It must also
complete financial statements for submission to auditors.

Three months before the IPO, the board meets and reviews the audit. The company joins
the stock exchange that lists its IPO. In the final month, the company files its prospectus with
the SEC. It also issues a press release announcing the availability of shares to the public. The
day before the IPO, bidding investors find out how many shares they were able to buy. On
the day of the IPO, the CEO and senior managers assemble at either the New York Stock
Exchange or NASDAQ for the first day of trading. They often ring the bell to open the
exchange.
The fourth step is stabilization. It occurs immediately after the IPO. The underwriter creates
a market for the stock after it is issued. It makes sure there are enough buyers to keep the
stock price at a reasonable level. It only lasts for 25 days during the "quiet period."

The fifth step is the transition to market competition. It starts 25 days after the IPO, once the
quiet period ends. The underwriters provide estimates about the company's earnings. That
assists investors as they transition to relying on public information about the company. Six
months after the IPO, inside investors are free to sell their shares.
SECONDARY MARKET
The secondary market is also known as the stock market or stock exchange. It is a market for
the purchase and sale of existing securities. It helps existing investors to disinvest and fresh
investors to enter the market.
It also provides liquidity and marketability to existing securities. It also contributes to
economic growth by channelizing funds towards the most productive investments through the
process of disinvestment and reinvestment.
Securities are traded, cleared, and settled within the regulatory framework prescribed by
SEBI. Advances in information technology have made trading through stock exchanges
accessible from anywhere in the country through trading terminals. Along with the growth of
the primary market in the country, the secondary market has also grown significantly during
the last ten years.
STOCK EXCHANGE
A stock exchange is an institution which provides a platform for buying and selling of
existing securities. As a market, the stock exchange facilitates the exchange of a security
(share, debenture etc.) into money and vice versa. Stock exchanges help companies raise
finance, provide liquidity and safety of investment to the investors, and enhance the credit
worthiness of individual companies.
Meaning of Stock Exchange
According to Securities Contracts (Regulation) Act 1956, stock exchange means anybody of
individuals, whether incorporated or not, constituted for the purpose of assisting, regulating,
or controlling the business of buying and selling or dealing in securities.
Functions of a Stock Exchange
The efficient functioning of a stock exchange creates a conducive climate for an active and
growing primary market for new issues. An active and healthy secondary market in existing
securities leads to positive environment among investors. The following are some of the
important functions of a stock exchange.
 Providing Liquidity and Marketability to Existing Securities:
The basic function of a stock exchange is the creation of a continuous market
where securities are bought and sold. It gives investors the chance to disinvest and
reinvest. This provides both liquidity and easy marketability to already existing
securities in the market.
  Pricing of Securities:
Share prices on a stock exchange are determined by the forces of demand and
supply. A stock exchange is a mechanism of constant valuation through which the
prices of securities are determined. Such a valuation provides important instant
information to both buyers and sellers in the market.
 Safety of Transaction:
The membership of a stock exchange is well regulated, and its dealings are well
defined according to the existing legal framework. This ensures that the investing
public gets a safe and fair deal on the market.
 Contributes to Economic Growth:
A stock exchange is a market in which existing securities are resold or traded.
Through this process of disinvestment and reinvestment savings get channelized
into their most productive investment avenues. This leads to capital formation and
economic growth.
 Spreading of Equity Cult:
The stock exchange can play a vital role in ensuring wider share ownership by
regulating new issues, better trading practices and taking effective steps in
educating the public about investments.
 Providing Scope for Speculation:
The stock exchange provides sufficient scope within the provisions of law for
speculative activity in a restricted and controlled manner. It is generally accepted
that a certain degree of healthy speculation is necessary to ensure liquidity and
price continuity in the stock market.
TRADING MECHANISIM
 Trading in securities is now executed through an on-line, screen-based electronic
trading system. Simply put, all buying and selling of shares and debentures are
done through a computer terminal. There was a time when in the open outcry
system, securities were bought and sold on the floor of the stock exchange.
 Under this auction system, deals were struck among brokers, prices were shouted
out and the shares sold to the highest bidder. However, now almost all exchanges
have gone electronic, and trading is done in the broker’s office through a
computer terminal. A stock exchange has its main computer system with many
terminals spread across the country.
 Trading in securities is done through brokers who are members of the stock
exchange. Trading has shifted from the stock market floor to the broker’s office.
Every broker must have access to a computer terminal that is connected to the
main stock exchange.
 In this screen-based trading, a member logs on to the site and any information
about the shares (company, member, etc.) he wishes to buy or sell, and the price is
fed into the computer. The software is so designed that the transaction will be
executed when a matching order is found from a counter party. The whole
transaction is carried on the computer screen with both the parties being able to
 see the prices of all shares always going up and down during the time that
business is transacted and during business hours of the stock exchange.
 The computer in the broker’s office is constantly matching the orders at the best
bid and offer price. Those that are not matched remain on the screen and are open
for future matching during the day.
Electronic trading systems or screen-based trading has certain advantages:
 It ensures transparency as it allows participants to see the prices of all securities in
the market while business is being transacted. They Electronic Trading System are
able to see the full market during real time.
 It increases efficiency of information being passed on, thus helping in fixing
prices efficiently. The computer screens display information on prices and also
capital market developments that influence share prices.
 It increases the efficiency of operations, since there is reduction in time, cost and
risk of error.
 People from all over the country and even abroad who wish to participate in the
stock market can buy or sell securities through brokers or members without
knowing each other. That is, they can sit in the broker’s office, log on to the
computer at the same time and buy or sell securities. This system has enabled
many participants to trade with each other, thereby improving the liquidity of the
market.
 A single trading platform has been provided as business is transacted at the same
time in all the trading centers.
Thus, all the trading centers spread all over the country have been brought onto one trading
platform, i.e., the stock exchange, on the computer. Now, screen-based trading or on-line
trading is the only way in which you can buy or sell shares. Shares can be held either in
physical form or an electronic book entry form of holding and transferring shares can also be
adopted. This electronic form is called dematerialized form.
ONLINE TRADING
Introduction-
 Online trading in securities refers to the facility of investor being able to place his
own orders using the internet trading platforms offered by the trading members viz.,
the broker.
 The orders so placed by the investor using internet would be routed through the
trading member.
 It is continuously growing and has a huge market potential.
 Online trading started in India in February 2000 when a couple of brokers started
offering an online trading platform for their customers.
Advantages of Online-Trading
 Lower Fees: One of the clearest advantages of online trading is the reduction in
transaction costs and high fees associated with traditional brick-and-mortar brokerage
 firms. Typically, you’ll pay between $5 and $10 to buy and sell stocks and exchange-
traded funds at online discount brokerages.
 More Control and Flexibility: Time is often of the essence when you trade stocks, so
the speed of using online trading portals is a benefit to many investors. With online
trading, you can execute a trade almost immediately.
 Ability to avoid Brokerage: By taking trading into your own hands, you can eliminate
brokerage bias. Bias sometimes occurs when a broker gives financial advice that
benefits the broker — such as in the form of a commission for selling specific mutual
funds and other products. This kind of biased advice can be troublesome for any
investor and might even lead to investment decisions that are good for the broker but
bad for you.
 Access to Online Tools: In the world of online trading, a lower cost does not
necessarily mean a shoddy product. Many of today’s online trading companies offer
customers an impressive suite of tools to help optimize trades. For example, sites such
as Trade King, Interactive Brokers and Motif offer a robust selection of tools designed
to give customers immediate access to valuable information, including interactive
investment performance charts.
 Option to Monitor Investment in Real Time: Many online trading sites offer stock
quotes and trade information that make it easy for people to see how their investments
are doing in real time. Companies such as Scot trade and Trade King, for example,
offer customers access to streaming data. You get real-time quotes, stock market news
and more. For some traders, this one-stop, at-a-glance convenience trumps picking up
the phone and calling a live broker, turning on the television, or even going to a
different website to get market information.
Disadvantages of Online-Trading
 Easier to Invest Too Much Too Fast: Because online trading is so easy — you
basically push a button — there is the risk of making poor investment choices or
overinvesting. The Securities and Exchange Commission warns investors that
although it takes just a nanosecond to make a trade, real investment decisions require
time. Investors who are not used to fast-moving markets can get caught up in the
excitement. Before they know what hit them, they can end up losing a lot of money.
 No Personal Relationship with Brokers: By and large, online traders are on their own.
They don’t have a broker to help them navigate the uncertain waters of the stock
market. From getting help on how to create an investment strategy to understanding
how the results of feedback mechanisms affect the market, online traders are left to
their own devices. For some, this kind of autonomy can be unsettling.
 Addictive Nature: Trading stocks can be like gambling for some people. The trader
speculates on the result of something — such as a company’s performance — and
then bets money that the speculation will be correct. Online traders can experience a
certain high when trading that is like what people experience when gambling,
according to a recent study on excessive trading published in the journal Addictive
Behaviors.
  Internet- Dependent: The nature of online trading means that, ultimately, you’re at the
mercy of your internet connection. If the internet connection is too slow or is
interrupted, you can lose out on a potentially important or lucrative trade.
Process of Online Trading
 Selection of a Broker: The buying and selling of securities can only be done through
SEBI registered brokers who are members of the Stock Exchange. The broker can be
an individual, partnership firms or corporate bodies. So, the first step is to select a
broker who will buy/sell securities on behalf of the investor or speculator.
 Opening Demat Account with Depository: Demat account refer to an account which
an Indian citizen must open with the depository participant (banks or stockbrokers) to
trade in listed securities in electronic form. Second step in trading procedure is to
open a Demat account. The securities are held in the electronic form by a depository.
Depository is an institution or an organization which holds securities. At present in
India there are two depositories: NSDL (National Securities Depository Ltd.) and
CDSL (Central Depository Services Ltd.)
 Placing the Order: After opening the Demat Account, the investor can place the order.
The order can be placed to the broker either (DP) personally or through phone, email,
etc. Investor must place the order very clearly specifying the range of price at which
securities can be bought or sold. e.g., “Buy 100 equity shares of Reliance for not more
than Rs 500 per share.”
 Executing the order: As per the Instructions of the investor, the broker executes the
order i.e., he buys or sells the securities. Broker prepares a contract note for the order
executed. The contract note contains the name and the price of securities, name of
parties and brokerage (commission) charged by him. Contract note is signed by the
broker.
 Settlement: This means actual transfer of securities. This is the last stage in the
trading of securities done by the broker on behalf of their clients. There can be two
types of settlement. a) On the Spot Settlement b) Forward Settlement
Types of Orders
Buy and sell orders placed with members of the stock exchange by the investor. The orders
are of different types:
 Limit orders: Orders are limited by a fixed price. E.g., ‘buy Reliance Petroleum at
Rs.50. Here, the order has clearly indicated the price at which it has to be bought and
the investor is not willing to give more than Rs.50.
 Best rate order: Here, the buyer or seller gives the freedom to the broker to execute
the order at the best possible rate quoted on the date for buying. It may be lowest rate
for buying and highest rate for selling.
 Discretionary order: The investor gives the range of price for purchase and sale. The
broker can use his discretion to buy within the specified limit. Generally, the
approximation price is fixed. The order stands as this ‘buy BRC 100 shares around
Rs.40.
  Stop loss order: the orders are given to limit the loss due to unfavorable price
movement in the market. A particular limit is given for waiting. If the price falls
below the limit, the broker is authorized to sell the shares to prevent further loss. E.g.
Sell BRC limited at Rs.24, stop loss at Rs.22.
Traditional Trading Vs Online Trading
Traditional Trading Online Trading
In offline the investor has no control on his  In online trading mechanism the customer
demat and trading A/C. has full control on his demat and trading
A/C.
It is a time-consuming process. Online trading is time effective
Offline trader needs to open separate Online investors can directly invest into
account IPO’s and mutual Fund
Offline brokers charge a considerable high Online trading is much more profitable as
amount as fees. online brokerage charges less fees
Chances of fraud increases if you have There are no chances of fraud as it is you
offline account. who has complete control over your
transaction.

STEPS IN THE TRADING PROCEDURE

It has been made compulsory to settle all trades within 2 days of the trade date, i.e., on a T+2
basis, since 2003. Prior to the reforms, securities were bought and sold, i.e., traded and all
positions in the stock exchange were settled on a weekly/fortnightly settlement cycle whether
it was delivery of securities or payment of cash. This system prevailed for a long time as it
increased the volume of trading on the exchange and provided liquidity to the system.
However, since trades were to be settled on specified dates, this gave rise to speculation and
price of shares used to rise and fall suddenly due to trading and defaults by brokers.
A new system, i.e., rolling settlement, was introduced in 2000, so that whenever a trade took
place it would be settled after some days. Since 2003, all shares must be covered under the
rolling settlement system on a T+2 basis, meaning thereby that transactions in securities are
settled within 2 days after the trade date.
Since rolling settlement implies fast movement of shares, it requires effective implementation
of electronic fund transfer and dematerialization of shares.
The following steps are involved in the screen-based trading for buying and selling of
securities:
 If an investor wishes to buy or sell any security, he must first approach a registered
broker or sub-broker and enter into an agreement with him. The investor must sign a
broker-client agreement and a client registration form before placing an order to buy
 or sell securities. He has also to provide certain other details and information. These
include:
PAN number (This is mandatory)
Date of birth and address.
Educational qualification and occupation.
Residential status (Indian/NRI).
Bank account details.
Depository account details.
Name of any other broker with whom registered.
Client code number in the client registration form.
 The broker then opens a trading account in the name of the investor.
 The investor must open a ‘demat’ account or ‘beneficial owner’ (BO) account with a
depository participant (DP) for holding and transferring securities in the demat form.
He will also have to open a bank account for cash transactions in the securities
market.
 The investor then places an order with the broker to buy or sell shares. Clear
instructions must be given about the number of shares and the price at which the
shares should be bought or sold. The broker will then go ahead with the deal at the
above-mentioned price or the best price available. An order confirmation slip is issued
to the investor by the broker.
 The broker then will go on-line and connect to the main stock exchange and match the
share and best price available.
 When the shares can be bought or sold at the price mentioned, it will be
communicated to the broker’s terminal and the order will be executed electronically.
The broker will issue a trade confirmation slip to the investor.
 After the trade has been executed, within 24 hours the broker issues a Contract Note.
This note contains details of the number of shares bought or sold, the price, the date
and time of deal, and the brokerage charges. This is an important document as it is
legally enforceable and helps to settle disputes/claims between the investor and the
broker. A Unique Order Code number is assigned to each transaction by the stock
exchange and is printed on the contract note.
 Now, the investor must deliver the shares sold or pay cash for the shares bought. This
should be done immediately after receiving the contract note or before the day when
the broker shall make payment or delivery of shares to the exchange. This is called the
pay-in day.
 Cash is paid or securities are delivered on pay-in day, which is before the T+2 day as
the deal has to be settled and finalised on the T+2 day. The settlement cycle is on T+2
day on a rolling settlement basis, w.e.f. 1 April 2003.
 On the T+2 day, the exchange will deliver the share or make payment to the other
broker. This is called the pay-out day. The broker then must make payment to the
investor within 24 hours of the payout day since he has already received payment
from the exchange.
  The broker can make delivery of shares in demat form directly to the investor’s demat
account. The investor must give details of his demat account and instruct his
depository participant to take delivery of securities directly in his beneficial owner
account.
Dematerialization and Depositories
All trading in securities is now done through computer terminals. Since all systems are
computerized, buying and selling of securities are settled through an electronic book entry
form. This is mainly done to eliminate problems like theft, fake/forged transfers, transfer
delays and paperwork associated with share certificates or debentures held in physical form.
This is a process where securities held by the investor in the physical form are cancelled and
the investor is given an electronic entry or number so that she/he can hold it as an electronic
balance in an account. This process of holding securities in an electronic form is called
dematerialization.
For this, the investor must open a demat account with an organization called a depository.
Working of the Demat System
 A depository participant (DP), either a bank, broker, or financial services
company, may be identified.
 An account opening form and documentation (PAN card details, photograph,
power of attorney) may be completed.
 The physical certificate is to be given to the DP along with a dematerialization
request form.
 If shares are applied in a public offer, simple details of DP and demat account are
to be given and the shares on allotment would automatically be credited to the
demat account.
 If shares are to be sold through a broker, the DP is to be instructed to debit the
account with the number of shares.
 The broker then gives instruction to his DP for delivery of the shares to the stock
exchange.
 The broker then receives payment and pay the person for the shares sold.
 All these transactions are to be completed within 2 days, i.e., delivery of shares
and payment received from the buyer is on a T+2 basis, settlement period.

KINDS OF BROKER
A stockbroker or brokerage is licensed and regulated financial firm that facilitates buying and
selling transactions in various financial instruments for investor clients, institutions and or for
the firm. All financial market transactions must be executed through a broker. Basically, a
broker is responsible for facilitating all stock trades you place. Most brokers allow users to
sign up through online applications. Brokers charge commissions for their services. The type
of broker will determine how expensive and how the commissions are structured.
There are three main types of brokerage firms: Full-service, discount and direct access.
Full-Service Brokers
 These firms charge higher commissions or a percentage of assets. They offer the
largest assortment of diversified financial services and usually assign a licensed
individual broker to each client. These firms tend to have their own investment
banking and research departments that provide their own analyst
recommendations, products, and access to initial public offerings (IPOs). Clients
have the option of calling their personal broker directly to place trades or use
various other platforms including online and mobile.
 Full-service brokers have physical offices and locations. They also offer financial
planning, asset management and banking services. In addition to savings and
checking accounts many full-service brokers provide personal, business and home
loans services. While most full-service brokers provide online access and trading
functions, they tend to charge higher commissions and route orders directly to
their own market makers or through order-fill agreements with other firms. Full-
service broker online platforms tend to have less day trading tools
and indicators as they cater more towards long-term investors.
Discount Brokers
 Discount brokers have narrowed the gap with full-service brokers in terms of
financial products and services providing independent research, mutual fund
access and basic banking products. As the name says, discount brokers have
smaller commissions for trades.
 The platforms tend to have more trading and research tools than the full-service
brokers since they cater to active investors and day traders. Many of the larger
discount brokers provide their own direct-access trading platforms and physical
office locations throughout the country.
Online Brokers
 Online brokers also known as direct-access brokers cater to active day trading
clients with the smallest commissions often priced on a per-share basis, which is
needed when scaling in and out of positions.
 These firms provide direct-access platforms with charting and routing capabilities
with access to electronic communication networks (ECN), market makers,
specialists, dark pools, and multiple exchanges. Speed and access are the top
benefits of direct-access brokers, often allowing for point-and-click executions
and programmable hot-keys.
 Complex stock and options orders can be placed on these platforms. The heavy-
duty platforms often carry a monthly fee composed of software fees and exchange
fees. The software fees can usually be waived or discounted based on the client’s
monthly trading volume.
 Active day traders are best advised to use reputable online/direct-access brokers to
ensure maximum control and flexibility as well as speedy order fills. To keep
 overhead low and pass on the cheaper rates, online brokers usually don’t provide
physical office locations for customers.
REGISTRATION OF BROKERS
Stockbroker is a member of a recognized stock exchange who buys, sells, or deals in
securities. To work as a stockbroker registration with SEBI is mandatory. SEBI is
empowered to impose conditions while granting the certificate of registration.
Registration
 A broker seeking registration with SEBI, must apply through the stock exchange
of which he is member.
 For registering SEBI checks - eligibility of the applicant to become the member of
stock exchange, has the necessary infrastructure to effectively discharge his
duties, experience etc.
 Every registered stockbroker is required to pay annual fee @ Rs. 5,000 for
turnover up to Rs. 1 crore and 0.01% of turnover exceeding Rs. 1 crore. For
calculating turnover underwriting and collection of deposits are not considered for
the purpose of calculating the turnover.
 The authenticity of the annual turnover is to be certified by the stock exchange
concerned.
Capital adequacy norms for brokers: -
An absolute minimum of Rs. 5 lakh as a deposit with the exchange is to be maintained by the
member brokers of the BSE & CSE and Rs. 3.5 lakh for DSE and ASE irrespective of
volume of business. In case of other SE the minimum requirement is Rs. 2 lakhs. The security
deposit kept by the members in the SE forms part of the base minimum capital; 25% of the
base minimum capital is to be maintained in case with the exchange. Another 25% remains in
the form of a long-term fixed deposit with a bank on which the SE is given free lien. The
remaining requirement is being maintained in the form of securities with a 30% margin. The
securities should be in the name of the member and are pledged in favor of SE.