Notes - Investment in Stock Markets

 

Investment in

Stock Markets

 

 

Unit - 1

 

Capital Market – Meaning

            Capital Market in India is a financial market where securities, such as stocks and bonds, are bought and sold. This market helps companies and governments raise funds to finance their operations, as well as providing investors with an opportunity to make returns on their investments. It is regulated by the Securities and Exchange Board of India (SEBI).

 

Capital markets can be divided into two broad categories: primary markets and secondary markets.

 

1.     Primary Markets: These are the markets where new securities are issued and sold for the first time. It is the primary source of capital for companies and governments. Primary markets facilitate long-term capital investments and involve the transfer of ownership of securities from the issuer to the investor.

2.     Secondary Markets: These are markets where previously issued securities are bought and sold among investors. Secondary markets provide liquidity to existing securities by allowing them to be traded among investors. This allows investors to easily exit or enter their positions in the market. Secondary markets are also important for setting the price of securities and providing price discovery.

 

Primary Market

    A primary market is a place where companies bring a new issue of shares for being subscribed by the general public for raising funds to fulfil their long-term capital requirement like expanding the existing business or purchasing new entity. It plays a catalytic role in the mobilisation of savings in the economy.

Various types of an issue made by the corporation are a Public issue, Offer for Sale, Right Issue, Bonus Issue, Issue of IDR, etc.

The company who brings the IPO is known as the issuer, and the process is regarded as a public issue. The process includes many merchant bankers (investment banks) and underwriters through which the shares, debentures, and bonds can directly be sold to the investors. These investment banks and underwriters need to be registered with SEBI (Securities Exchange Board of India).

The public issue is of two types, they are:

• Initial Public Offer (IPO): Public issue made by an unlisted company for the very first time, which after making issue lists its shares on the securities exchange is known as the Initial Public Offer.
• Further Public Offer (FPO): Public issue made by a listed company, for one more time is known as a follow-on offer.

o   The primary market is a financial market in which new securities are issued and sold to investors.

o   It is the financial market in which companies, governments, and other organizations raise money by selling securities to the public for the first time.

o   These securities can be in the form of stocks, bonds, derivatives, or other financial instruments.

o   The primary market is the initial market where securities are offered to the public.

o   This market is used by issuers of securities to raise capital.

o   Companies will typically go through an Initial Public Offering (IPO) process to raise capital for their business.

o   During the IPO process, the company will issue and sell shares of their company to the public.

o   Governments also use the primary market to raise capital by issuing bonds to investors.

o   The primary market is used to raise capital and the secondary market is used to exchange securities.

o   The primary market is an important part of the capital market as it allows companies and governments to raise capital for their operations.

 

Secondary Market

The secondary market is a type of capital market where existing shares, debentures, bonds, options, commercial papers, treasury bills, etc. of the corporates are traded amongst investors. The secondary market can either be an auction market where trading of securities is done through the stock exchange or a dealer market, popularly known as Over The Counter where trading is done without using the platform of the stock exchange.

The securities are firstly offered in the primary market to the general public for a subscription where the company receives the money from the investors and the investors get the securities; thereafter they are listed on the stock exchange for the purpose of trading. These stock exchanges are the secondary market where maximum trading of the company is done. The top two stock exchanges of India are Bombay Stock Exchange and National Stock Exchange.

The Secondary Market in India is a market where existing securities, such as stocks and bonds, are traded between investors. The securities are bought and sold on organized exchanges such as the Bombay Stock Exchange or the National Stock Exchange. The Secondary Market provides a platform for investors to buy or sell securities at a price determined by the demand and supply for the security.

 

o   The secondary market is a financial market where investors buy and sell securities that have already been issued.

o   It is also known as the aftermarket, and is commonly used as a way for investors to buy and sell stocks, bonds, options, and other financial instruments.

o   The secondary market allows for the trading of securities without the issuer having to issue new shares.

o   This market is an important part of the overall capital market because it provides liquidity and price discovery for investors.

o   It also allows investors to access investments that may not be available in the primary market.

o   In the secondary market, securities are typically sold by broker-dealers who act as intermediaries between the buyers and sellers.

o   The prices of securities are determined by the demand and supply of the securities in the market.

Difference between Primary Market & Secondary Market

 

Comparison Chart

BASIS FOR COMPARISON	PRIMARY MARKET	SECONDARY MARKET
Meaning	The market place for new shares is called primary market.	The place where formerly issued securities are traded is known as Secondary Market.
Another name	New Issue Market (NIM)	After Market
Type of Purchasing	Direct	Indirect
Financing	It supplies funds to budding enterprises and also to existing companies for expansion and diversification.	It does not provide funding to companies.
How many times a security can be sold?	Only once	Multiple times
Buying and Selling between	Company and Investors	Investors
Who will gain the amount on the sale of shares?	Company	Investors
Intermediary	Underwriters	Brokers
Price	Fixed price	Fluctuates, depends on the demand and supply force
Organizational difference	Not rooted to any specific spot or geographical location.	It has physical existence.

Key Differences Between Primary Market and Secondary Market

    The points given below are noteworthy, as far as the difference between primary market and secondary market is concerned:

1. The securities are formerly issued in a market known as Primary Market, which is then listed on a recognised stock exchange for trading, which is known as a secondary market.
2. The prices in the primary market are fixed while the prices vary in the secondary market depending upon the demand and supply of the securities traded.
3. Primary market provides financing to new companies and also to old companies for their expansion and diversification. On the contrary, secondary market does not provide financing to companies, as they are not involved in the transaction.
4. At the primary market, the investor can purchase shares directly from the company. Unlike Secondary Market, when investors buy and sell the stocks and bonds among themselves.
5. Investment bankers do the selling of securities in case of Primary Market. Conversely, brokers act as intermediaries while trading is done in the secondary market.
6. In the primary market, security can be sold only once, whereas it can be done an infinite number of times in case of a secondary market.
7. The amount received from the securities are income of the company, but same is the income of investors when it is the case of a secondary market.
8. The primary market is rooted in a particular place and has no geographical presence, as it has no organizational setup. Conversely, the Secondary market is present physically, as stock exchange, which is situated in a particular geographical area.

Functions of Primary Market

The primary market is the financial market where new securities are issued and sold for the first time. It is the source of long-term financing for businesses, governments, and other organizations. It operates by connecting issuers of securities with buyers and investors, and facilitating the issuance of securities.

The primary market provides a number of different services and functions, including the following:

  

1.     New issue offer or origination: This refers to the process of creating and offering a new security for sale to the public. This typically involves issuing securities such as stocks, bonds, or derivatives. It is the first step in the primary market process, as the new securities are made available to the public for the first time.

 

2.     Underwriting services: This refers to the services provided by a financial institution to ensure the successful issuance of a new security and to guarantee that the securities will be sold to the public. The underwriter is responsible for the pricing and distribution of the new securities, as well as providing advice and guidance to the issuer.

 

3.     Distribution of New Issue: This refers to the process of making a new security available to the public. This includes the placement of the new securities in the market through the stock exchange, brokers, and other channels. The distribution of new issue also involves the pricing of the security, as well as the promotion of the security to potential investors.

 

Methods of Marketing Securities in the Primary Market 

Methods of marketing securities in the primary market refer to the ways in which companies and other entities can raise capital from investors by selling newly issued securities. This involves issuing debt instruments (e.g. bonds) and equity shares (e.g. stocks) for sale. Common methods of marketing securities in the primary market include public offerings (IPOs), private placements, and syndicated offerings. Each method has its own advantages and disadvantages that must be taken into consideration before deciding which method is most appropriate for a given situation.

          Marketing securities in the primary market is the process of issuing and selling securities to investors. This is done by the issuing companies, usually through investment banks, to raise capital. When a company needs to raise money, it will issue securities such as stocks, bonds, or other forms of debt. These securities are then sold to investors in the primary market, usually through a public offering. The company receives the money from the investors and in return, the investors receive the securities. The money raised is then used by the company to finance its operations.

1.     Pure prospectus method: This is a method where securities are offered to the public through a prospectus. The prospectus is a legal document that outlines the details of the securities, such as the type of security, the amount being offered, the price of the security, and the risks associated with investing in it.

 

2.     Offer for sale method: This is a method where securities are offered for sale to the public through a broker or dealer. The issuer and the broker or dealer negotiate the terms for the sale, and the broker or dealer acts as an intermediary between the issuer and the public.

 

3.     Private placement method: This is a method where securities are offered to a select group of investors, typically high-net-worth individuals or institutional investors. The issuer and the investors negotiate the terms of the transaction, and the investor is typically required to sign a confidentiality agreement.

 

4.     Electronic Initial Public Offering Method: This is a method where securities are offered for sale to the public through an electronic platform. The issuer and the electronic platform negotiate the terms for the sale, and the electronic platform acts as an intermediary between the issuer and the public.

 

5.     Right issue method: This is a method where existing shareholders of the company are offered additional securities at a discounted price. The shareholders are given the right to buy additional securities in proportion to the number of securities they already hold.

 

6.     Bonus issue method: This is a method where existing shareholders of the company are given additional securities for free. The additional securities are given in proportion to the number of securities the shareholders already hold.

 

7.     Book building method: This is a method where the price of the securities is determined through an auction process. Investors submit bids for the securities at different prices, and the price is determined based on the highest bids.

 

8.     Sweat Equity Method: This is a method where the company issues equity shares to employees in exchange for services provided. The company can issue equity shares in lieu of cash payment or in exchange for services rendered.

 

9.     Stock option method: This is a method where employees are given the right to buy a certain number of shares of the company at a predetermined price. The employees can exercise the options at any time up to the expiration date, and the option price is determined by the company.

 

10.  Bought out deals method: This is a method where the company purchases the shares of another company in order to gain control. The company can purchase the shares directly from the other company or from the marketplace. 

Roles of Primary Market

  

Primary markets play an important role in the functioning of the economy. They provide capital formation, liquidity, diversification of risk, cost reduction and rapid industrial growth. These are essential components of a thriving economy and enable businesses to grow and expand. Through primary markets, businesses can access capital, manage risk and reduce costs, and generate economic growth.

 

1.     Capital Formation: Primary markets are used to raise funds for companies, allowing them to expand their operations, invest in new projects, or launch new products. The money raised in primary markets is used to form capital, which is the lifeblood of businesses.

 

2.     Liquidty: Primary markets provide liquidity to investors. This means that investors can buy and sell easily as there are always willing buyers and sellers. This increases the liquidity of the market and allows investors to buy and sell quickly without having to wait for a long period of time.

 

3.     Diversification of risk: By investing in different stocks and bonds, investors can reduce their risk by diversifying their portfolio. This means that if one stock or bond performs badly, the other investments may make up for the losses.

 

4.     Reduction in cost: By investing in primary markets, investors can avoid the high costs associated with investing in the secondary market. This is because the primary market is less competitive and the costs associated with buying and selling securities are lower.

 

5.     Rapid industrial growth: Primary markets are an important source of capital for companies to invest in new projects and technologies. This investment allows companies to grow and develop, leading to rapid industrial growth. This growth can have a positive impact on the economy as a whole, as new jobs are created and the standard of living improves.

 

Regulation of Primary Market

Primary market regulation is the regulation of the buying and selling of securities or other financial instruments by their issuers. This regulation is important as it helps to ensure fair and orderly markets, protect investors and maintain the integrity of the financial system.

 

1.     Disclosure Requirements: Issuers are required to provide full and accurate disclosure of all information material to the investment decision, such as the issuer's financial condition, business plan and risk factors.

 

2.     Registration Requirements: Issuers must register the offering of securities with the relevant regulatory bodies before they can be sold to the public.

 

3.     Prospectus: A prospectus must be prepared that contains all the necessary information about the offering, including the risks and rewards for investors.

 

4.     Disclosure of Material Information: Issuers must promptly disclose any material information that would affect the value of their securities or the investment decision.

 

5.     Insider Trading Regulations: Trading by insiders, such as company executives and directors, is regulated to prevent them from taking advantage of their knowledge of the company's affairs.

 

6.     Market Manipulation: Regulatory authorities monitor the market for signs of manipulation and take action when necessary.

 

7.     Price Controls: Some jurisdictions impose price controls on certain types of securities to ensure that investors are not taken advantage of by excessive pricing.

Unit - 2

Functions of Stock Exchange

1.     Ensure liquidity of capital: Stock exchanges act as a bridge between buyers and sellers, providing buyers and sellers with access to each other, and making sure that all trades are executed efficiently. This means that when investors want to buy and sell securities, they can do so quickly and easily, which ensures that the capital is not left idle and can be used to generate returns.

 

2.     Price Determination of securities: Stock exchanges provide investors with a transparent marketplace where prices are determined by the forces of supply and demand. With more buyers and sellers, greater liquidity and more active trading, stock prices are more likely to reflect a security’s true market value.

 

3.     Continuous market for securities: Stock exchanges provide a continuous market for listed securities. This ensures that traders have access to a liquid market for their securities at all times, allowing them to buy and sell whenever they choose.

 

4.     Economic Barometer: By tracking the prices of securities, stock exchanges provide investors with an insight into the health of the economy. If prices are rising, this is seen as a sign of economic strength, whereas if they are falling, it might be an indication of a troubled economy.

 

5.     Mobilizing surplus savings: Stock exchanges also help to mobilize surplus savings and channel them into productive investment opportunities. By providing access to these investment opportunities, the stock market allows investors to generate higher returns while also helping to fund the growth of companies.

 

6.     Helpful in rising new capital: Stock exchanges enable companies to raise new capital by issuing new shares. This provides companies with the funds they need to expand their businesses or finance new projects, while also providing investors with a chance to invest in firms with potentially high growth potential.

 

7.     Investor protection: Stock exchanges serve as a platform to provide protection from fraudulent activities to the buyers and sellers of securities. The exchange monitors the activities of listed companies and their investors to ensure fair dealing and compliance with the regulations set by regulatory authorities.

 

8.     Safety in dealings: Stock exchanges assist in providing safety to the securities traded by providing stringent measures to safeguard the capital of the investors. This includes surveillance, monitoring of transactions and timely resolution of disputes through arbitration.

 

9.     Listing of securities: Stock exchanges provide a platform to list securities issued by companies, to facilitate their trading. Companies go through a listing process through the stock exchanges, to be allowed to issue their securities and make it accessible to the public.

 

10.  Platform for public debt: Stock exchanges serve as a public debt platform. Companies can reach out to investors and raise funds through the issuance of debt securities like bonds.

 

11.  Provides information: Stock exchanges collect and disseminate information about listed companies and their securities. This helps investors to make sound and informed decisions about investments.

 

12.  Contribution to economic growth: Stock exchanges provide an avenue to create wealth, invest surplus funds and enable businesses to raise funds for their operations, thereby contributing significantly to the economic growth of the country.

 

13.  Generates employment to intermediaries: Stock exchanges provide employment opportunities to intermediaries such as brokers, financial advisors and market makers etc. These professionals provide valuable advice and assist investors in carrying out transactions in the stock exchange.

 

Listing of Securities

Listing of securities is the process of making a security available for trading on a public exchange. This process involves submitting an application to the relevant stock exchange, providing information about the company and its securities, and meeting applicable listing requirements. Once the listing is complete, the securities become available to the public to buy and sell on the exchange.

 

Types of Listing of Securities

 

1.     Initial Listing: Initial listing is the process of listing a security on a formal exchange for the first time, such as a stock exchange. It involves registering the security with the exchange and providing all the necessary paperwork and information to allow the security to be traded publicly.

 

2.     Listing for Public Issue: When a company goes public, it needs to list its shares on a stock exchange. This is known as a listing for a public issue, and it involves registering the security with the exchange, providing all the necessary paperwork and information, and setting up a public offering for the shares.

 

3.     Listing for Right Issue: A right issue is when existing shareholders are given the right to buy additional shares from the company at a discounted price. The company’s shares must be listed on a stock exchange in order for the right issue to take place, and this is known as a listing for a right issue.

 

4.     Listing Bonus Shares: Companies often issue bonus shares to existing shareholders as a reward for their loyalty. These bonus shares must be listed on a stock exchange in order for them to be traded, and this is known as a listing for bonus shares.

 

5.     Listing for Merger and Amalgamation: When two companies merge, their shares must be listed on a stock exchange in order for the merger to take place. This is known as a listing for a merger and amalgamation, and it involves registering the security with the exchange, providing all the necessary paperwork and information, and setting up a public offering for the shares.

 

Objectives of Listing of Securities

The objective of listing securities is to provide investors with a transparent and reliable platform for trading in securities. Listing enables investors to trade in securities in a well-regulated and orderly manner. It also facilitates liquidity in the market by providing a platform for trading in securities. Listing also helps to ensure that the securities are properly priced and that the investors are provided with the necessary information to make informed decisions.

 

Stock Exchanges in India

 

1.     Bombay Stock Exchange (BSE)

The Bombay Stock Exchange (BSE) is the oldest stock exchange in India, established in 1875. It is the world’s 10th largest stock exchange by market capitalization, and the largest in India. It is based in Mumbai and has a significant presence in the Indian capital market. The BSE has a large number of listings, and offers a wide range of services including trading in equities, derivatives, mutual funds, and more.

 

2.     National Stock Exchange (NSE)

The National Stock Exchange (NSE) was established in 1992 and is India’s largest stock exchange by market capitalization. It is based in Mumbai and is the first exchange in India to offer electronic trading. It offers a wide range of products and services including trading in equities, derivatives, mutual funds, and more.

 

3.     Over-the-Counter Exchange of India (OTCEI):

The Over-the-Counter Exchange of India (OTCEI) is a national stock exchange established in 1992. It provides trading in stocks, mutual funds, and equity derivatives. The exchange provides a platform for small and medium enterprises to raise capital. It also offers services such as depository services, online trading, and depository participant services.

 

4.     Inter-connected Stock Exchange (ISE):

        The Inter-connected Stock Exchange (ISE) is an online stock exchange located in Mumbai. It was established in 2005 and is the first regional exchange in India. It provides a platform for companies to list their shares and for investors to trade them. It provides trading in equities, derivatives, mutual funds, and exchange-traded funds. 

What is Speculation?

Speculation is the buying of an asset or financial instrument with the hope that the price of the asset or financial instrument will increase in the future. Speculative investors tend to make decisions more often based on technical analysis of market price action rather than on fundamental analysis of an asset or security. They also tend to be more active market traders – often seeking to profit from short-term price fluctuations – as opposed to being “buy and hold” investors.

 

Speculation - Meaning

 

Speculation is often frowned upon and derided by many financial experts. However, the truth is that speculators do not deserve the common public perception that casts them as “bad guys.” Speculators aren’t bad guys – they’re helpful guys (and gals).

 

Speculators are the people who create fortunes, nourish ideas, businesses, and economies, and who help create “the next big thing.”  Bill Gates and Steve Jobs were speculators; Warren Buffett is a speculator. Venture capitalists – the people who fund start-ups for new ideas and new businesses – are speculators. In short, speculators are an important and valuable part of the world’s financial markets.

 

Who are the Speculators?

Speculators are people who engage in speculative investments. In other words, a speculator is a person who buys assets, financial instruments, commodities, or currencies with the hope of selling them at a profit on a future date. So they’re not really all that fundamentally different from other market participants who also enter the financial markets looking for financial rewards. Many people point to the main difference between investors and speculators as follows:

 

An investor is concerned with the fundamental value of his investment, whereas a speculator is only concerned with market price movement. In other words, for example, a speculator doesn’t really care if a company is performing well or poorly – only about whether or not he can profit from trading the company’s stock.

Types of Speculators

 

Speculators in a stock market are of different types. They carry their names depending on their motive of trading in the stock exchange. They are named after animals as their behavior could be compared best with the behavior of animals.

 

1.    Bull

A Bull or Tejiwala is an operator who expects a rise in prices of securities in the future. In anticipation of price rise he makes purchases of shares at present and other securities with the intention to sell at higher prices in future. He is called bull because just like a bull tends to throw his victim up in the air, the bull speculator stimulates the price to rise. He is an optimistic speculator.

 

 

 

2.    Bear

        A bear or Mandiwala speculator expects prices to fall in future and sells securities at present with a view to purchase them at lower prices in future. A bear does not have securities at present but sells them at higher prices in anticipation that he will supply them by purchasing at lower prices in future. A bear usually presses its victim down to ground. Similarly the bear speculator tends to force down the prices of securities. A bear is a pessimistic speculator.

 

 

 

3.    Stag

A stag is a cautious speculator in the stock exchange. He applies for shares in new companies and expects to sell them at a premium, if he gets an allotment. He selects those companies whose shares are in more demand and are likely to carry a premium. He sells the shares before being called to pay the allotment money. He is also called a premium hunter.

 

 

 

4.    Lame Duck

When a bear finds it difficult to fulfill his commitment, he is said to be struggling like a lame duck. A bear speculator contracts to sell securities at a later date. On the appointed time he is not able to get the securities as the holders are not willing to part with them. In such situations, he feels concerned. Moreover, the buyer is not willing to carry over the transactions.

Advantages of Speculation

1. Welfare of the economy

Speculators, who are typically willing to take on greater investment risk than the average investor, are more willing to invest in a company, asset, or security that is unproven or whose stock is trading at a very low price, during times or in situations where more conservative investors shy away.

 

Thus, speculators often provide the capital that enables young companies to grow and expand, or that provides price support for assets or industries that have temporarily fallen on financially hard times or out of favor. In such a way, speculators help to support and drive forward the overall economy.

 

2. Market liquidity

Speculators add liquidity to the markets by actively trading. A market without speculators would be an illiquid market, characterized by large spreads between bid and ask prices, and where it might be very difficult for investors to buy or sell investments at a fair market price. The participation of speculators keeps markets fluid and helps facilitate easy exchange between buyers and sellers at all times.

 

3. Risk bearing

The higher risk tolerance of speculators translates to financing for companies being more widely and readily available. Speculators are willing to risk lending money to companies, governments, or business ventures that either lack established credit or that are currently with poor credit rating. Without speculators, the only businesses able to obtain loans would be those large, already established firms with a stellar credit rating.

 

Disadvantages of Speculation

1. Unreasonable prices

Speculation can sometimes push prices beyond reasonable levels, to excessively high or low valuations that do not accurately reflect an asset or security’s true intrinsic value. It means that speculation may lead to price fluctuations that, even though they are merely temporary, can have a long-term impact on the fortunes and stability of a company, an industry, or even a whole economy.

 

For example, some economists and market analysts have argued that extremely high oil prices early in the 21st century – around $100 a barrel – were due more to widespread speculation than to actual supply and demand conditions in the marketplace.

 

2. Economic bubble­s

A related disadvantage to unreasonable prices is that rampant speculation is often connected with economic bubbles, which form due to an unrealistically high rise in prices. A speculative bubble results from demand by speculators initially driving prices higher, which then draws in more speculators, driving prices even higher.

 

The cycle is repeated – rising prices as a result of increased demand from speculators, followed by new buyers attracted by the rapidly rising prices increasing demand further, driving the market to even higher prices – until the bubble bursts and prices dramatically decline.

 

The housing bubble was an example of such a bubble. Real estate investors paid higher and higher prices for real estate, expecting prices to continue rising indefinitely. When the price rise finally stalled out and prices began to fall back toward more realistic, fair market price levels, many investors in real estate found themselves overextended and stuck with properties that were now worth less than what they had paid for them.

 

Speculation in the Stock Market

Stocks that are considered highly risky in the stock market are known as speculative stocks. Speculative stocks offer potentially high returns to compensate for the high risk associated with them. Penny stocks with very low share prices are an example of speculative stocks. Some stock market speculators are day traders who seek to profit from the intraday fluctuations in stock prices that occur within the trading day.

 

As noted above, speculators are important to publicly-traded companies because they are willing to invest in unproven companies, providing those companies with equity funding that enables them to grow and expand their market reach.

 

Speculation in the Currency Market

The foreign currency exchange (forex) market is popular with speculators because of the fact there are constant fluctuations in the exchange rates between currencies, both on an intraday and long-term basis. The currency market also provides frequent trading opportunities due to the many different currency pairs that are available for trading.

 

For example, the exchange rate of the US dollar can be traded relative to more than a dozen other currencies worldwide. Among the most commonly traded currency pairs are EUR/USD (the euro vs. the dollar), GBP/USD (the British pound vs. the dollar), and USD/JPY (the dollar vs. the Japanese yen).

 

Forex trading is also popular with speculators because of the high amount of leverage available, which makes it easy for traders to generate substantial profits using only a small amount of trading capital.

 

Speculation in the Commodity Market

In the commodity markets, speculation is important to control the price volatility of commodities because without speculators, there would be only a very limited number of market participants. Commodities are much less widely traded than stocks.

 

Speculators add significantly more liquidity to the commodity markets, thereby helping to facilitate trading among all the market participants. Speculation in commodity futures is popular because, like forex trading, commodity trading offers traders high amounts of leverage.

 

Speculators also influence prices of commodities in a way that helps to protect against massive price swings by using futures contracts to encourage buyers to stockpile in order to prevent shortages.

 

Speculators, by vastly increasing the number of market participants, also importantly serve to prevent market manipulation. With so many traders holding a variety of trading positions, it is difficult for even the largest participants in the market to successfully manipulate prices or “corner the market” (take control of virtually all the supply of a commodity).

 

 

Unit - 3

 

Stock Index

A stock market index, also known as stock index, is a statistical measure that reflects changes taking place in the market. It’s created by grouping a few similar stocks among the securities listed on the exchange and the selection criteria could be the size of a company, its market capitalization or type of industry.

Change in prices of underlying securities impacts the overall value of the index. If prices rise, the index will rise, and if they go down, so will the index.

 

Needs of Indices

Stock indices are required to know the mood and sentiment prevailing in the market. As an investor, you can identify the market’s pattern by looking at the indices, and use it to decide which stock can prove to be a winning bet.

Stock indices also aid you in identifying trends of a particular sector and take investment decisions accordingly. They also help you to make passive investment, i.e., investing in a portfolio of securities that closely resembles the index. With passive investment, you can cut down on the cost of research and selection process of equities.

 

Types of Indices in Indian Stock Market

Some of the common types of indices in Indian stock market are as follows:

Ø  Benchmark indices like BSE Sensex and NSE Nifty

Ø  Broad-based indices like Nifty 50 and BSE 100

Ø  Market capitalization-based indices such as BSE Midcap and BSE Smallcap

Ø  Sectoral indices such as CNX IT, Nifty FMCG, Nifty Bank Index, S&P BSE Oil and Gas, so on.

 

Sensex

In the stock market parlance, Sensex is a pretty common term. The term Sensex is the brainchild of by stock market expert Deepak Mohoni. A blend of two terms, sensitive and index, Sensex constitutes 30 of the largest and most actively traded stocks on the Bombay Stock Exchange (BSE).

These stocks belong to some of the biggest companies in India, representing various sectors of the economy. BSE Sensex was first published on 1st January 1986 and is often regarded as the pulse of stock markets in India.

 

Calculation of Sensex

The calculation of Sensex is done by the free-flow method. This method takes into account the proportion of shares that can be readily traded.

Then market capitalization of all the 30 companies, whose stocks are traded, is calculated, post which the BSE determines a free-float factor. It helps in determining the free-float market capitalization and then ratio and proportion are used on the base index of 100 to arrive at the value of Sensex. The formula is as follows:

 

Sensex = (Total free float market capitalization/Base market capitalization) X Base Index Value

 

Nifty

Nifty is another widely used term in the stock market. So, what is Nifty? Nifty is the index of the National Stock Exchange (NSE), another popular stock exchange in India. It’s a collection of 50 stocks, and is known as Nifty 50. It’s managed by India Index Services and Products Ltd (IISL).

 

Calculation of Nifty

Just like Sensex, the value of Nifty is calculated through the free-float market capitalization-weighted method. The formula for calculation of Nifty is as follows:

 

Nifty = (Current Market Value / Base Market Capital) X Base Index Value

 

The base index value, in this case, is 1,000.

 

 

 

BSE and NSE

BSE or the Bombay Stock Exchange is Asia’s oldest stock exchange. Established in 1875, BSE has been instrumental in the development of India’s capital markets and enables investors to trade in a range of financial instruments such as equities, derivatives, currencies, and mutual funds.

 

The National Stock Exchange or NSE is another popular stock exchange in India, founded in 1992. Just like the BSE, NSE offers trading and investment in equities, debt, derivatives, and bonds. NSE provided the country’s first automated, screen-based electronic trading system and was instrumental in creation of the National Securities Depository Limited (NSDL) that allows investors to hold and transfer shares electronically.

 

 

Unit - 4

 

Stock Analysis

Stock analysis refers to the method that an investor or trader uses to evaluate and investigate a particular trading instrument, investment sector, or the stock market as a whole. Stock analysis is also called equity analysis or market analysis. Investors or traders make buying or selling decisions based on stock analysis information.

 

Meaning

Stock analysis helps traders to gain an insight into the economy, stock market, or securities. It involves studying the past and present market data and creating a methodology to choose appropriate stocks for trading. Stock analysis also includes the identification of ways of entry into and exit from the investments.

 

Summary

o   Stock analysis is a process followed by traders to evaluate and understand the value of a security or the stock market.

o   Stock analysis follows the idea that analysts can create methodologies to select stocks by studying past and present data.

o   Fundamental analysis and technical analysis are two broad types of stock analysis.

 

Types of Stock Analysis

Stock analysis can be grouped into two broad categories:

 

1. Fundamental Analysis

The fundamental stock analysis method involves the evaluation of a business at a basic financial level. Investors use fundamental analysis to determine whether the current price of a company’s stock reflects the future value of the company.

Fundamental analysis uses different factors such as the current economic environment and finances of the company to estimate its stock value. Different key ratios are also used to determine the financial health and understand the true value of a company’s stock.

 

·       Earnings per share (EPS) – The EPS is useful when companies operating in the same industry need to be compared. A company’s EPS indicates its profitability; hence, traders consider an increasing EPS a good sign. The higher the value of EPS, the more the company shares are worth buying.

·       Price to Earnings ratio (P/E) – The P/E ratio indicates how much investors are willing to pay for the earnings of a company. A higher P/E value could mean an overvalued stock. Or, it could imply that the market is expecting the company to perform extremely well over time. On the other hand, a low P/E value is seen as unfavorable by the market.

·       Price to Earnings to Growth ratio (PEG) – The PEG ratio helps to determine the value of a company’s stock while considering the earnings growth of the company. The PEG ratio, along with the P/E ratio, can help obtain a clearer picture of a company’s stock than the P/E value alone.

·       Price to Book ratio (P/B) – The P/B ratio is used to compare the market value of a company with its book value. It seeks the value that the stock market places on a company’s stock relative to the book value of the company. A company with sound financial health will trade for more than its book value since investors will consider the company’s future growth while pricing the stocks.

·       Return on Equity (ROE) – It measures how effectively a company uses its assets for producing earnings. A high ROE implies that a company squeezes out greater profits with available assets. Hence, with all other things equal, it will be better to invest in high ROE companies in the long run.

·       Dividend Payout Ratio – It measures the percentage of the company’s earnings paid to shareholders or owners. The earnings of the company, which are not passed on to the shareholders, are used to pay off debts, reinvest in business operations, or are retained for future use

2. Technical Analysis

The technical analysis method involves examining data generated through market activities, such as volume and prices. Analysts following such a type of stock analysis use technical indicators and tools like charts and oscillators to identify patterns that can indicate future price trends or direction.

Technical analysts examine the historical trading data of a security and estimate the future move of the security. It is frequently used for forex and commodities. The technical analysis is based on the following assumptions:

The market knows it all. Technical analysis assumes that the market price of a stock reflects all that has or can affect a company. Technical analysts consider that all the factors affecting the company are priced into the security.

Price follows a trend. It implies that once a trend is established, future prices tend to follow the direction of the trend. Such an assumption is the basis of many strategies for technical trading.