Stock market fundamentals

• What are the basics of financial instruments?

Let us understand the two fundamental types of investments, namely bonds and stocks with an example. Eg. Imagine you want to start your own grocery store. You will need a capital amount to get started. You acquire the requisite funds from a friend and write down a receipt of this loan ' I owe you Rs 1, 00,000 and will repay you the principal loan amount plus 5% interest'. Your friend has just bought a bond (IOU) by lending money to your company.

Thus a bond is a means of investing money by lending money to others. When you invest in bonds, the bond you buy will show the amount of money being borrowed (face value), the interest rate (coupon rate or yield) that the borrower has to pay, the interest payments (coupon payments), and the deadline for paying the money back (maturity dates).

There are several Pro's and Con's to investing in bonds.

Pro's

Ø Bonds give higher interest rates compared to short-term investments.Ø Bonds are less risky when compared to stocks.

Con's

Ø Selling bonds before they're due, may result in a loss, known as a discount.

Ø If the issuer of the bond declares bankruptcy, you may lose your money. Hence you must critically evaluate the credibility of the issuer of the bond, ensuring that he has the capability to repay the bond amount.

Now, let us continue with the same example. To accrue more capital for your new grocery store, you sell half your company to your brother for Rs 50,000. You put this transaction in writing 'my new company will issue 100 shares of stock. My brother will buy 50 shares for Rs 50,000.' Thus, your brother has just bought 50% of the shares of stock of your company.

Thus, to explain stocks:

Stocks, also known as Equities, are shares in a company. It is the certificate of ownership of a corporation. In simple terms, when you invest in a company's stock or buy its shares, you own part of a company. Thus, as a stockholder, you share a portion of the profit the company may make, as well as a portion of the loss a company may take. As the company keeps doing better, your stocks will increase in value and yield higher dividends.

Dividend: A sum of money, determined by a company's directors, paid to shareholders of a corporation out of its earnings.

This example covers the 2 major types of investments: bonds and stocks.

• Rewinding back to the Stock Market Trading history of India

In the earlier days, stockbrokers kept scouting for 'natural' sites to conduct their trading activities, shifting from one set of Banyan trees to another. As the number of brokers kept increasing and the streets kept overflowing, they simply had no choice but to relocate from one place to another.

Finally in 1854, trading in India found a permanent address, Dalal Street, now synonymous with the oldest stock Exchange in Asia, The Bombay Stock Exchange. With a heritage that goes back to over 130 years, BSE was the first stock exchange in the country to be granted permanent recognition under the Securities Contract Regulation Act, 1956. The exchange has played a pioneering role in the development of the Indian Securities Market - one of the oldest in the world. After India gained independence, the BSE formulated a comprehensive set of guidelines adopted by the Indian Capital markets. Even today, the BSE Sensex remains one of the parameters against which the robustness of the Indian Economy and finance is measured.

The trading scenario in India then underwent a paradigm shift in 1993, when NSE or National Stock Exchange was recognized as a Stock Exchange. Within just a few years, trading on both the exchanges shifted from an open outcry system to an automated trading environment.

Today, the Indian Securities market successfully keeps pace with its global counterparts through the use of modern day technology.

• Stock market milestones

1875 BSE established as 'the native Share and Stock Brokers Association'

1956 BSE became the first stock exchange to be recognized under the Securities Contract Act.

1993 NSE recognized as a stock exchange.

2000 Commencement of Internet trading at NSE.

2000 NSE commences derivatives trading (Index futures)

2001 BSE commences derivatives trading

• Primary and Secondary Markets

Primary Market
An Issuer/Company enters the Primary markets to raise capital. They issues new securities in Exchange for cash from an investor (buyer). If the Issuer is selling securities for the first time, these are referred to as Initial Public Offers (IPO's). Summing up, Primary Market is the means by which companies float shares to the general public in an Initial Public Offering to raise capital.

Eg. If the promoters of a private company, say XYZ makes its shares available to investors, company XYZ is said to have entered the primary market.

Secondary Markets
Once new securities have been sold in the Primary Market, an efficient mechanism must exist for their resale, if investors are to view securities as attractive opportunities. Secondary Market transactions are referred to those transactions where one investor buys shares from another investor at the prevailing market price or at whatever price both the buyer and seller agree upon. The Secondary Market or the Stock Exchanges are regulated by the regulatory authority. In India, the Secondary and Primary Markets are governed by the Security and Exchange Board of India (SEBI).

eg. If one of the investors who had invested in the shares of company XYZ sold it to another at an agreed upon price, a Secondary Market transaction is said to have taken place. Normally investors transact in securities using an intermediary such as a broker who facilitates the process.

• Introduction to SEBI

The Government of India established the Securities and Exchange Board of India, the regulatory body of stock markets in 1988. Within a short period of time, SEBI became an autonomous body through the SEBI Act passed in 1992, with defined responsibilities that cover both development & regulation of the market while also giving the board independent powers. Comprehensive regulatory measures introduced by SEBI ensured that end investors benefited from safe and transparent dealings in securities.

• The basic objectives of the Board were identified as:

To protect the interests of investors in securities

To promote the development of Securities Market

To regulate the Securities Market

SEBI has contributed to the improvement of the Securities Market by introducing measures like capitalization requirements, margining and establishment of clearing corporations that reduced the risk of credit.

Today, the board continues on its two-fold mission of integrating the Securities Market at the National level and also diversifying the trading products to increase the number of traders (including banks, financial institutions, insurance companies, Mutual Funds, primary dealers etc) transacting through the Exchanges. In this context the introduction of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 AD has been a real landmark.

What are Stock Exchanges?
A Stock Exchange is a place that provides facilities to stock brokers to trade company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus it is the meeting place of the stock buyers and sellers. India's premier Stock Exchanges are the Bombay Stock Exchange and the National Stock Exchange.