Security Analysis and Portfolio Management Lecture Notes

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Security Analysis and Portfolio Management Subject: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT Credits: 4 SYLLABUS Overview of Investment Concept of Investment; Various Investment Alternatives; Application of Investment Alternatives; a Case Study on Investment Alternatives Overview of Risk Management Concept of Risk Management; Analysis of Risk Management; a Case Study on Risk Management Equities in India Basic of Stocks; Different Types of Stocks; National Stock Exchange; Trading of Equities Trading of Securities Introduction to Markets and their Functions; Development of Securities Market in India; SEBI and its Role in Primary and Secondary Market; SEBI and its Functions; a Case Study on OTCBB Analysis and Valuation of Debt and Equity Introduction to Bonds; Embedded Options; Analysis of Bond, Relationship between Price and Yield; a Case Study on Mirage Resorts: Refunding a Bond Issue, Various Models of Stock Valuation, Concept of Credit Rating, Analysis of Credit Rating Framework, Rationales of Rating; Case Study: Aether Systems - Common Stock Valuation; the Variable Growth Model Security Analysis and Valuation: Fundamental and Technical Analysis Stock Prices Change; its Causes; Effect of Macroeconomics Variable on Stock Market; Difference between Technical and Fundamental Analysis; Company Analysis; Basics and usefulness of Technical Analysis; Case Study: Coca Cola. Efficient Market Hypothesis Introduction; Concept of Market Efficiency; Tests of Efficient Market Hypothesis; Case Study: EBay- Stock Market Efficiency. Portfolio Management Introduction to Portfolio Management; Relation between Risk and Return; Optimal Portfolio; Capital Asset Pricing Model; its Valuation and Validity; Case Study: Nations Bank - Valuation: Stock Valuation: the Gordon Growth Model; Portfolio Evaluation; Case Study: Vanguard - Mutual Funds and Taxes. Articles Bonds and Bond Funds; Nate Pile’s Small Cap Classroom; Dangers of Inaction; Bond with the Best; Take your Time to Plan Investment. Suggested Readings: 1. Security Analysis and Portfolio Management by Donald E. Fischer Ronald J. Jordan, Publisher: Prentice-Hall of India 2. Security Analysis And Portfolio Management by V. Gangadhar, Publisher: Anmol Publications 3. Security Analysis And Portfolio Management 6th Edition, by Fischer Donald E and Jordan Ronald J, Publisher: Prentice hall of India 4. Security Analysis And Portfolio Management by S Kevin Publisher: Prentice hall of India SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT COURSE OVERVIEW This course involves the functioning of Indian securities lastly it gives the overview of the various investing options market, study of two decisions: setting the optimal asset- available to the investor and how they are best suited to them. allocation mix (using modern portfolio theory) and analyzing and selecting securities within the asset class and analysis of Course Highlights various investing options available to the Indian investors. • Overview and Functioning of Stock Market Although it focuses primarily on the first of these decision • Overview of Primary and Secondary Market processes, there is also a brief review of security analysis • Corporate Debt Market models, the capital markets, and their historic risk/return • Derivatives Trading and Strategies aspects. The theory and practice of identifying the optimal • Determination of security prices allocation of wealth among the various asset classes is pre- sented. The mathematics underlying the portfolio decision is • Portfolio selection and efficient sets reviewed to give the student a foundation for understanding • The Capital Asset Pricing Model the elements that influence asset-allocation models. • Factor models of security returns The course also presents techniques for quantifying expected • Common stocks and their characteristics risk and expected return for individual asset classes and • Financial analysis of common stocks portfolios; for evaluating portfolio performance; for portfolio • Common stock valuation distribution; for applying the dividend discount model to • Investment management and performance valuation security analysis; and for the use of options, futures, and other investments. • Characteristics of fixed-income securities The objective of this course is to provide the study of end-to- • Bond valuation and analysis end investment decision process. That’s why the course firstly • Portfolio management and Performance evaluation deal with the functioning of stock market plus the options • Investing in Mutual Funds, Equities, Real Estate, Small strategies; secondly it deals with answer the questions like: Savings, Fixed Deposits, Insurance, Bonds and Credit Cards. When to invest, Where to invest and How much to invest and iSECURITY ANALYSIS AND POR TFOLIO MANAGEMENT SAMS SECURITY ANALYSIS AND PORTFOLIO 11.319 MANAGEMENT CONTENT Lesson No. Topic Page No. Lesson Plan v Indian Securities Market Chapter 1 : Indian Financial System & Stock Market Lesson 1 Investment Planning 1 Lesson 2 Introduction to Stock Market 2 Lesson 3 Overview of Indian Financial System 4 Chapter 2: Mechanics of Stock Market Lesson 4 Market Indices 7 Chapter 3 : Clearing & Settlement Lesson 5 13 Chapter 4 : Primary & Secondary Market Lesson 6 Overview of the Primary Market 18 Lesson 7 Functioning of Secondary Market 21 Chapter 5 : Intermediation & Depository Lesson 8 Intermediation - Brokerage Firm 27 Lesson 9 Depository – The Technology Advantage 29 Chapter 6 : Derivatives Lesson 10 Derivatives: Trading, Clearing and Settlement 34 Lesson 11 & Derivatives – Trading Strategies 37 12 Chapter 7 : Corporate Debt Market Lesson 13 42 Lesson 14 A Multi-factor risk model for the Indian Stock 47 Market Portfolio Management Chapter 8 : Introduction to Portfolio Management Lesson 15 51 Chapter 9 : Risk and Return Lesson 16 55 Chapter 10 : Efficient Market Theory Lesson 17 62 ivSECURITY ANALYSIS AND PORTFOLIO MANAGEMENT SAMS SECURITY ANALYSIS AND PORTFOLIO 11.319 MANAGEMENT CONTENT Lesson No. Topic Page No. Lesson 18 Fundamental Analysis 68 Lesson 19 Technical Analysis 72 Chapter 11 : Valuation of Securities Lesson 20 An Introduction to Equity Valuation 80 Lesson 21 DDMs for Valuation of Equities 82 Lesson 22 P/E Approach to Valuation of Equities 87 Lesson 23 Valuation of Options 91 Chapter 12 : Debt Market Lesson 24 Types & Features of Debt Market 97 Lesson 25 Calculation of Bond Yields 106 Lesson 26 Risk in Investing in Bonds 108 Chapter 13 : Portfolio Theory Lesson 27 Harry Markowitz Theory & Capital Market Line 113 Lesson 28 Capital Asset Pricing Model 120 Chapter 14 : Portfolio Selection & Evaluation Lesson 29 Selecting The Best Portfolio 124 Lesson 30 Tutorial 128 Case Study : Pied Piper Advisors 130 Applied Finance Chapter 15 : Investing Options in Indian Market Lesson 31 Concepts of Investing & Investment in Mutual 131 Funds Lesson 32 Investment in Small Saving Schemes 138 Lesson 33 Investment in Equities 143 Lesson 34 Investing in Fixed Deposits 157 Lesson 35 Investment in Insurance 161 Lesson 36 Investment in Bonds 166 Lesson 37 Investment in Real Estate / Housing 170 Lesson 38 Investment in Cash Equivalents 176 Lesson 39 Investment in Credit Cards 179 Lesson 40 Guidelines for Investment Decisions 185 vSECURITY ANAL YSIS AND PORTFOLIO MANAGEMENT UNIT 1 INDIAN SECURITIES MARKET CHAPTER 1 LESSON 1 INDIAN FINANCIAL SYSTEM INVESTMENT PLANNING & STOCK MARKET in the habit of saving sufficient amount every month, then you Introduction to Investment Planning are not ready for investing. The advice is: Investment planning is an alien concept for the Indian popu- lace. For a country, which till now was worried about making Avoid unnecessary or lavish expenses as they add up to your ends, meet this emerging trend is definitely a new experience. savings. A dinner at Copper Chimney or Grand Hyatt can But, the truth is that if only they would have been introduced always be avoided, the pleasures of avoiding it will be far greater to the Art of Managing Money, life could have been so much if the amount is saved and invested. easier. Most of us spend more than half of our lives working Clear all your high interest debts first out of the savings that and saving because money is important, in fact crucial. However, you make. Credit card debts (revolving credits) and loans from most of us spend almost no time planning to make that hard- pawnbrokers typically carry interest rates of between 24-36% earned money work more effectively for us. So, how do you annually. It is foolish to pay off debt by trying to first make plan your financial life? money for that cause out of gambling or investing in stocks What is investment planning? with whatever little money you hold. In fact its prudent to clear Financial planning is nothing but an assessment of your goals a portion of the debt with whatever amounts you have. and the steps you must take to help make them a reality. Notes What you first need to figure out.......... What is it that you want? Is your wish to retire with a sound lump sum amount or do you want a steady monthly income. Is your son’s education or daughters’ marriage worrying you? The key is to figure out your goals. Where is your money going? The most important thing is that you should where your money is going. Zero on your monthly and annual expenses. Why should you invest? You should invest so that your money grows and shields you against rising inflation. If prices rise by four per cent annually it would not be sufficient if your savings only give you a return of three per cent. It leaves you with a deficit of one per cent. The idea is that your rate of return on investments should be greater than the rate of inflation, leaving out with a nice surplus over a period of time. Whether your money is invested in stocks, bonds, mutual funds or certificates of deposit (CD), the end result is to create wealth for retirement, marriage, college fees, vacations, better standard of living or to just pass on the money to the next generation. Also, it’s exciting to review your investment returns and to see how they are accumulating at a faster rate than your salary. When to Invest? The sooner you invest the better it is. By investing into the market right away you allow your investments more time to grow, whereby the concept of compounding interest swells your income by accumulating your earnings and dividends. Considering the unpredictability of the markets, research and history indicates these three golden rules for all investors: 1. Invest early 2. Invest regularly 3. Invest for long term and not for short term There is always a first time for everything so also for investing. To invest you need capital free of any obligation. If you are not 1SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT LESSON 2 INTRODUCTION TO STOCK MARKET and voting in the meetings etc., but they are not liable for the Introducing debts of the company beyond the value that has already been Like several other goods which require a market place for buyer subscribed through the share capital. However certain shares do and sellers to come together; shares too need a bazaar where not carry ownership privileges like voting etc. these shares are they can be sold and bought. The bazaars where shares are sold preferential or non – voting shares. But preference shareholders are either primary market or secondary market. Primary market get assured dividends, if the company makes profit and they refers to the business done through Initial PUBLIC offers would get back their money invested after a specified period of (IPOs), during which shares are offered for the first time to the time. Equity shareholders can only redeem their investment by public or to existing shareholders through rights. The latter is selling the share at the market price. the existing shareholder either on priority or through a private placement when shares are selectively sold to limited number of You can buy equity or preference shares either in primary market investors. New equity shares are initially issued and offered or in secondary market. Depending on the market appeal, shares through the primary market and subsequently they are traded are also called by different names. through the secondary market. The latter consists of network Blue Chip Shares of stock exchanges. Shares of large, financially strong and well – established A Stock Exchange is the actual bazaar that conducts securities companies which have stood up against all odds and which trading. Companies that wish their stock to be bought or sold have a good profitability and dividend track record are called list their shares in the stock exchange and members registered at blue chip shares. The volumes of trading in these stocks are the stock exchange either buy or sell these stocks on behalf of high and they enjoy any time liquidity in the exchange. HLL, their investor clientele the prices of the listed securities keep ITC and Reliance are the example of such shares. changing depending on the demand and supply for that Growth Shares security, almost akin to what happens to the other commodity These are the shares that have out performed others in the products (in their respective markets). industry. Shares of such companies grow at a faster rate than A stock exchange regulate the entire activity of trading to ensure others in terms of sales and profitability. Infosys, Wipro and that trade takes place in transparent manner and that the deals NIIT are the current example of growth shares. These shares once struck are honored. It registers members who have the may be fairly priced or over priced as investors buy these fancied necessary qualification, skills and financial resources to undertake stocks on expectation of even further growth. Sometimes the the trading in securities. Not all the stock bought and sold in expected growth may not take place due to adverse internal and the market pass through the stock exchanges. Shares of those external factors, but generally these stocks give quick returns as companies who have not listed with any stock exchanges can’t compared to the value stocks. be sold through stock exchanges. If an investor wants to sell Value Stocks shares of such companies then ha has to find the buyer Value stocks are those that currently have a low market senti- through his own means. ment and are under priced relative to their intrinsic value. A This is where a stock exchange helps investors. It provides a major advantage is that, it limits the downside risk of the large market place consisting of hundreds of members portfolio – since their prices may not dip further. On the flip representing thousands of buyers and sellers to give a fair side, however, the market may not take cognizance of the valuation of shares and to improve liquidity of the investment. stock’s potential worth for a long time. In which case, the Presently there are 25 Government recognized stock exchanges investors have to hold them for a longer period till its full in various states of India. Of these, National Stock Exchange worth is recognized. (NSE) and Bombay Stock Exchange (BSE) operate all over Defensive Shares India and handle the bulk of business volumes. There is also These stocks are generally neutral to business cycle. These have Interconnected Stock Exchange (ISE) and Over – the - Counter low fluctuations in their prices and are fairly stable. If you expect Exchange (OTC), which operates at more than one location but a downtrend in the economy, it may be a good idea to pick up a their business volumes are not very significant at present. defensive stock, so that your portfolio value may not erode. At Stock Market Glossary present, FMCG and Pharma stocks fall into this category. Let’s take a quick tour of the various stock market terms to Cyclical Shares understand the meaning and their importance: These shares are in commodity companies and their prices Equity Shares depend on the cyclical fluctuations of the economy. If they An equity share in a company is a share in its ownership. Equity economy is doing well, they appreciate otherwise their prices shareholders collectively constitute the ownership of the would fall. Cement, Steel and Petrochemical shares fall under company and enjoy the fruits of the ownership like dividends this category. 2SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT Speculative Shares be rectified by the seller’s broker within a stipulated period. If These shares tend to fluctuate widely in short span of time on the documents are complete and proper, it’s a good delivery and expectations of some major deal in the parent company. For the shares can be sent for transfer in the name of the buyer. example, if market expects a foreign tie – up, a merger or even Transfer and Transmission an acquisition; the prices of these shares rise to dizzy heights Shares, like any other property can change hands by following but may fall equally abruptly, if the expected turn of events do the due process of law. Ownership of shares can be transferred not takes place. from one to another through a sale or gift when accompanied Turn Around Shares by a transfer deed. It can also be transmitted from one person These are the shares of those companies which have large to another by operation of the law in case of the death or accumulated losses but which show signs of recovery or making insolvency from the owner to his legal heirs or creditors. profits. At present, SAIL and Mafatlal Industries are the Settlement examples of such shares. At the end of a trading period, the obligation of each broker is Book Closure and Record date calculated and brokers settle their respective obligations as per Ownership in shares traded in the stock market keeps changing rules, by laws and regulations prescribed. This process is called hands amongst investors through buy and sell transactions. settlement. When corporate benefits like dividend, bonus or rights are Auction announced, it become necessary to identify the owner at that When a broker selling shares default on the delivery, the given point of time so that only such owners can receive the exchange resorts to a mechanism called auction to fulfill its corporate benefits. Problem arises because different buyers often obligation towards the broker buying the shares. In a particular hold shares without sending them for registration to the settlement, if the selling brokers have delivered short, their company. But to receive the benefits, an investor needs to send deliveries are bad or if they have not rectified the company’s them for the registration. To facilitate this registration compa- objections reported against them. The stock exchange purchases nies usually announce the cut – off dates from time to time. the requisite quantity from the market through the auction and Only those members registered in the company’s share register delivers them to the buying party. as on such cut – off dates would alone be entitled to receive the Company Objections corporate benefits. Such cut- off dates is referred to as book When investors send share certificate along with the transfer closure and record dates. deeds to the company for registration, the registration is Cum – Dividend and Ex – Dividend sometimes rejected if the signature differs, shares are fake, When you buy with cum dividend or cum rights or cum bonus, forged or stolen or if there is a court injunction preventing the you are entitled for the dividend, rights or bonus shares for transfer of shares etc. in such cases, the company returns the which the books are about to be closed. shares along with a letter stating its objections. Such cases are When you buy the shares ex dividend or ex bonus or ex rights, identified as company objections. you are not entitled to these benefits but the previous owner Stock Lending would be entitled to them. Irrespective of whether you are It is a mechanism through which seller going short borrows buying cum or ex, the prices you pay for the security would have stocks to meet his obligations. The present stock lending normally got adjusted for the corporate benefits you may or mechanism announced by the SEBI is similar to badla in certain may not immediately receive on shares bought. aspects, but the main difference is that the mutual funds can Stock Market Indices lend stocks, while in badla they cant participate. However, there is These are the numbers that measure the general movement of no provision for a long buyer to obtain funds through the the market. They represent the entire market or the segment stocks lending mechanism. It only provides for the lending of thereof. The two most popular index in Indian market are, securities for a price mainly to short sellers. The lenders of the SENSEX (Sensitive Index) of Bombay Stock Exchange, which scrips earn additional returns by lending his stocks for a reflects the price movement of 30 selected shares on the BSE specified period to those who need them to discharge their and NIFTY of National Stock Exchange, which reflect the price delivery obligations. With the introduction of derivatives in the movement of selected 50 shares on NSE. These shares have market, stock lending would help broad base the market. been selected on the basis of market capitalization and liquidity. Good or Bad Delivery When shares are sold in the stock exchange, the seller delivers the shares along with a transfer deed to the buyer through his broker. Bad delivery refers to the cases where the transfer deed or share certificate may have some problem like being torn, mutilated, overwritten, defaced or spelling mistakes in the name of company or the transferor, erasure or crossing out the characters of the folio numbers, distinctive number range or certificate numbers. Bad delivery can also occur if the transfer deed is improperly stamped. In such cases the delivery needs to 3SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT LESSON 3 OVERVIEW OF INDIAN FINANCIAL SYSTEM Overview of Indian Financial Markets Introduction The organised part of the Indian Financial System can be classified from the point of view of the regulators as: Indian Financial Markets Regulatory Authorities RBI SEBI Commercial Banks Primary Market Forex Markets Secondary market Money Market Debt Market Capital Market Financial Institutions Derivatives Market Primary Dealers Reserve Bank of India (RBI) Commercial banks include public sector banks, private banks Securities Market Non-Securities Market and foreign banks. RBI, under Banking Regulation Act and Negotiable Instrument Act, regulates these banks. Financial Institutions may be of all India level like IDBI, IFCI, ICICI, NABARD or sectoral financial institutions like, EXIM, Primary Market Secondary Market TFCIL etc. IFCI was the first term lending institution to be set up. IDBI is the apex development financial institution set up to provide funds for rapid industrialization in India. In order to boost the disbursement of credit to the agriculture sector, Spot Market Forward Market Agriculture Refinance Corporation was set up by RBI to provide refinance to banks and institutions extending credit to the agriculture sector. Role of Capital Market The participants in Foreign exchange market include banks, 1. It is the indicator of the inherent health of the economy. financial institutions and are regulated by RBI. 2. It is the largest source of funds with long or indefinite Primary dealers are registered participants of the wholesale debt maturity for companies and thereby enhances capital market. They bid at auctions for government debts, treasury formation in the economy. bills, which are then retailed to banks and financial institutions, 3. It offers a number of investment avenues to the investors. which invest in these papers to maintain their Statutory 4. It helps in channelising the savings pool in the economy Liquidity Ratio (SLR). towards investments, which are more efficient and give a better rate of return thereby helping in optimum allocation Securities and Exchange Board of India (SEBI) of capital in the country. SEBI was set up as an autonomous regulatory authority by the Primary Market Government of India in 1988 “To protect the interest of the The primary market is the place where the new offerings by investors in the securities and to promote the development of companies are made either as Initial Public Offer (IPO) or and to regulate the securities market and the matters connected Rights Issue. IPOs are offerings made by the companies for the therewith or incidental thereto”. It is empowered by two acts first time while rights are offerings made to the existing shareholders. Investors who prefer to invest in the primary namely ‘The SEBI Act, 1992 and The Securities Contract issues are called Stags. (Regulation) Act, 1956 to perform the function of protecting investors rights and regulating the capital markets. Secondary Market Secondary market consists of stock exchanges where the buy orders and sell orders are matched in the organised manner/ there are at present 25 recognized stock exchanges in India and are governed by the Securities Contracts (Regulation) Act (SCRA). 4SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT The functions of stock exchange are as follows: securities; financial institutions and Provident fund trust for their SLR requirements and are normally referred to as gilt- 1. It ensures a measure of safety and fair dealing. edged securities. 2. It translates short-term and medium-term investments into • Bonds: It can be of many types like Regular Income, long term funds for companies. Infrastructure, Tax saving or Deep Discount Bonds. These 3. It directs the flow of capital to the area of maximum returns are investment products with fixed coupon rates and a and ensures ample investment for the investor depending on definite period after which they are redeemed. The bonds their risk preference. may be regular income with the coupons being paid at fixed 4. It induces the companies to improve their standard of intervals or cumulative in which interest is paid on performance. redemption. Deep Discount bonds are one, which is issued at a discount at the face value, and the investor is paid the Derivatives Market face value at redemption. It is the market for the financial instrument, which derives their values from the underlying assets like stock, commodity or • Debentures: It may be many types like, Fully convertible currency. Derivatives’ trading has started with Index Futures, debentures (FCDs), Partly convertible debentures (PCDs) followed by Index Option and then Stock Option as per the and non-convertible debentures (NCDs). FCDs are those recommendation of the SEBI appointed L. C. Gupta Commit- whose face value is converted into fixed number of equities tee. at a fixed price. The price of each equity share is received by the way of converting the face value of convertible securities Derivatives market has the following roles: i.e. the debenture is called the conversion price and the 1. Derivatives allow hedging of market risk. number of equity shares exchanable per unit of the 2. It allows for a separate market to be developed for lending convertible security i.e. debenture is called conversion ratio. of funds and securities to the market. Callable debenture is a debenture in which the issuing company 3. It helps in making the underlying cash market more liquid. has the option of redeeming the security before the specified redemption date at a pre-determined price. Puttable debenture 4. It helps in innovations and creations f new financial is one where the holder has the option of getting it redeem products. before the maturity date. PCDs are debentures where a Self-Regulatory Organizations (SROs) portion of the face value is converted into equity shares and SEBI is authorized to promote and regulate SROs. SROs are the NCDs, also called the khoka, are redeemed on maturity practical and efficient tool for regulating various kinds of only. participants in the market. They have bylaws and code of • Public Deposits: Corporates can raise funds from the public conduct to bind their members. in the form of fixed deposits. These deposits are unsecured Currently, the SROs related to the securities market whose and are mainly used for the working capital requirements. regulatory framework is well established and which have actually These unsecured public deposits are governed by the been functioning are the stock exchanges. Other non-registered Companies (Acceptance of Deposits) Amendment Rules SROs are: 1978. Under this rule, public deposits can’t exceed 25% of 1. Association of Merchant Bankers of India (AMBI) the share capital and free reserves and the maximum 2. Association of Mutual Funds of India (AMFI) maturity period is 3 years while the minimum is 6 months. • Certificate of Deposits: These are short term funding Investment Products instruments issued by banks and financial institutions at a Fixed Income discount to the face value. Banks can issue CDs for duration Fixed income products include bank deposits, Government of less than 1 year while FIs can only issue this for more securities, Bonds, Debentures, Commercial papers and Certifi- than 1 year. The issuing bank or financial institution can’t cate of Deposits. Criteria for investment in fixed income repurchase the instruments. CDs have to be issued for a products: minimum of Rs. 5 lakhs with multiples of Rs. 1 lakh 1. Yield to maturity. thereafter. These are generally used by corporates to meet their short-term requirements. 2. Credit rating of the security. • Commercial Papers: These represent short-term 3. Risk preference. promissory notes issued by firms with a high credit rating. For fixed income securities interest is the major decisive factor. The maturity of these varies from 15 days to 1 year, sold at a Credit rating of the securities published periodically helps the discount to the face value and redeemed at the face value. CPs investor in credit risk assessment. can be issued by the companies having minimum net worth • Government Securities: It includes T-Bills (364, 182, 91 & of Rs. 4 crores and needs a mandatory credit rating of P2 14 days), Bonds issued by the Central & State Government, (CRISIL), D2 (Duff & Phelps), PR2 (Credit Analysis & State Financial Institutions, Municipal Bodies, Port Trusts, Research) and A2 (ICRA). The rating should not be more and Electricity Bodies etc. T-Bills are discounted instruments than 2 months old. It can be issued for a minimum amount and these may be traded with a repurchase clause, called of Rs. 25 lakhs and more in multiples of Rs. 5 lakhs. repos. Repos are allowed in 364, 182 and 91 days T-Bills and the minimum repo term is 1 day. The banks purchase these 5SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT Equity Shares An equity share in a company is a share in its ownership. Equity shareholders collectively constitute the ownership of the company and enjoy the fruits of the ownership like dividends and voting in the meetings etc., but they are not liable for the debts of the company beyond the value that has already been subscribed through the share capital. However certain shares do not carry ownership privileges like voting etc. these shares are preferential or non – voting shares. But preference shareholders get assured dividends, if the company makes profit and they would get back their money invested after a specified period of time. Equity shareholders can only redeem their investment by selling the share at the market price. Credit Rating Agencies The major credit rating agencies existing in India are Credit Rating Information Services of India Limited (CRISIL), Indian Credit Rating agency (ICRA), Credit Analysis & Research (CARE). The rating accorded by any rating agency is instrument specific and relates to the debt instrument of any maturity, public deposits and preferential shares. Exercise 1. Explain the term Stock market and what are the various stocks available in the market, depending on the market appeal? 2. What are Ex-divined and Cum-dividend shares? Explain the term Stock Lending and how it is different from Badla system? 3. Explain Indian Financial system from the regulator’s point of view. 4. What are the different markets available in the Indian Financial market system and explain the roles of each of them. Explain the various investment products available in Indian market. Notes 6SECURITY ANAL YSIS AND PORTFOLIO MANAGEMENT CHAPTER 2 MECHANICS OF STOCK MARKET LESSON 4 MARKET INDICES Introduction India Index Services & Products Limited (IISL) is India’s first Shares Prices (P ) Issue size Prices 0 today (P ) specialist company dedicated to providing investors in Indian 1 A 20 4000 45 equity with Indices and Index services. IISL is the joint venture between CRISIL and NSE. IISL has a consulting and licensing B 60 5000 50 agreement with Standard & Poor Corporation, the worlds leading provider of investible equity indices, for co-branding C 145 2000 150 IISL’s equity indices. D 15 10000 15 IISL Indices for Index Derivatives / Index Funds Total 240 21000 260 S&P CNX Nifty It comprises 50 stocks and is a market capitalization weighted Price Weighted Arithmetic Mean Method index. Stocks are selected based on their market capitalization Divide the total of the weightage over base prices for today’s by and liquidity. All stocks in the index should have market the total of weightage of the base prices on base date and capitalization of more than 500 crores and should have traded multiply the out come with the base value to get the result or for 85% of the trading days at an impact cost of less than 1.5%. alternatively divide the total of today’s prices by the total of The low impact cost of S&P CNX Nifty makes it an optimal prices on base date and multiply the outcome with base value to index for derivative trading. get the index value today. S&P CNX Defty It is a dollar denominated index based on S&P CNX Nifty. All Shares P P / 240 P P / 240 0 0 1 1 computations are done using the S&P CNX Nifty index and the A 20 0.0833 45 0.1875 online exchange rates ( vs. Rs.) disseminated by information B 60 0.2500 50 0.2083 vending systems. C 145 0.6042 150 0.6250 CNX Nifty Junior D 15 0.0625 15 0.0625 It comprises 50 midcap stocks and is a market capitalization weighted index. All stocks in the index should have market Total 240 1.0000 260 1.0833 capitalization of more than Rs. 200 crores and should have traded for 85% of the trading days at an impact cost of less Nifty = 1.0833 / 1.0000 1000 = 1083.30 than 2.5%. Alternatively, Index Maintainence Nifty = 260 / 240 1000 = 1083.3 Index maintenance plays a crucial role in ensuring stability of the index as well as in meeting its objective of being a consis- Equi-Weighted Arithmetic Mean Method tent benchmark in the equity markets. IISL has constituted an Divide the individual P by individual P and add all the 1 0 Index Policy Committee, which evolves policies and guidelines outcomes, then divide the sum by the number of stocks for managing the CNX indices. An index maintenance sub included in calculation and finally multiply the outcome with committee takes decision on addition / deletion of companies the base value to find the index today. on any index. Each index has a Replacement Pool comprising companies that meet all criteria for candidacy to that index. All Shares Prices Prices P / P 1 0 replacement of companies in the index comes from this pool, (P ) today (P ) 0 1 which is continuously monitored. A 20 45 2.2500 B 60 50 0.8333 Methods of Computation 1. Price weighted Arithmetic Mean Method. C 145 150 1.0344 2. Equi-weighted Arithmetic Mean Method. D 15 15 1.0000 3. Market Capitalization Weighted Arithmetic Mean Method. Total 240 260 5.1177 Example 1: Let’s say Index comprises of following four Securities on base date, with base value of 1000, as in NSE. Nifty = 5.1177 / 5 1000 = 1023.54 7SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT Market Capitalization Weighted Arithmetic Mean Revised Base Cap = 195000 + -100 (1000 / 1012.82) = 194901.27 Method Divide the total of the weightage over base capitalization for Impact Cost today’s by the total of weightage of the base capitalization on Impact cost represents the cost of executing a transaction in a base date and multiply the out come with the base value to get given stock, for a specific predefined order size, at any given the result or alternatively divide the total of today’s capitaliza- point of time. Impact cost is a practical and realistic measure of tion by the total of capitalization on base date and multiply the market liquidity; it is closer to the true cost of execution faced by outcome with base value to get the index value today. a trader in comparison to the bid-ask spread. It should however be emphasised that: a. Impact cost is separately Shares Prices Issue Capitalization Weightage Prices Capitalization Weightage computed for buy and sell (P ) size at t today at t over Base 0 0 1 (P ) Cap 1 b. Impact cost may vary for different transaction sizes c. Impact cost is dynamic A 20 4000 80000 0.098 45 180000 0.219 and depends on the B 60 5000 300000 0.366 50 250000 0.305 outstanding orders C 145 2000 290000 0.354 150 300000 0.366 d. Where a stock is not sufficiently liquid, a penal D 15 10000 150000 0.183 15 150000 0.183 impact cost is applied Total 240 21000 820000 1.000 260 880000 1.073 In mathematical terms it is the percentage mark up Nifty = 1.073 / 1.000 1000 = 1073.00 observed while buying / selling the desired quantity of a stock with reference to its ideal price (best buy + best sell) / 2. Alternatively, Example 3: Given the order book for a security, the impact cost Nifty = 880000 / 820000 1000 = 1073.00 to buy 1500 shares of the security. Issue Size Change in an Index Security Index value should remain constant even if the issue size and Order Book issue price changes on account of corporate action or change in Buy Buy Price Sell Sell Price composition. Quantity Quantity Index Value (I) = Market Capitalization (M) / Base Capitali- 1000 98 1000 99 zation (B) Initial Index Value (IIV) 2000 97 1500 100 Change in Market Capitalization (DM) = Change in Issue Size 1000 96 1000 101 Issue Price Now, Index should not move with change in issue size. Therefore, To buy 1500 shares I = (M+DM) / B+DB) (IIV) Ideal Price = (98 + 99) / 2 = 98.5 B+DB = (M+DM) (IIV / I) Actual Buy Price = (1000 99 + 500 100) / 1500 = 99.33 B+DB = M (IIV / I) + DM (IIV / I) Impact Cost (for 1500 shares) = (Actual Price – Ideal Price) / New Base Capitalization = Old Base Capitalization + DM Ideal Price 100 (IIV / I) = (99.33-98.5) / 98.5 100 = 0.84% Or, Change in Base Capitalization = DM (IIV / I) Basics of Neat System Example 2: On April 5, the total market cap of S&P CNX The NEAT system is the trading system provided by the Nifty is Rs. 197500 crores and base cap is Rs. 195000 crores. It is exchange to its trading members. The term NEAT is an decided to replace scrip A, a constituent of Nifty having a acronym for ‘National Exchange for Automated Trading’. The market cap of Rs. 1000 crores with scrip B that has a market cap NEAT CM system supports an order driven market. Wherein of Rs. 900 crores with effect from April 6. What is the revised order matched automatically. Order matching is necessary on the base cap of Nifty on April 6? basis of security, its price, time and quantity. IIV = 1000 Basic Trading Terminology M = 197500 Market Phases B = 195000 The system is normally made available for trading on all days DM = -100 except Saturday, Sunday and other holidays. A trading day I = 197500 / 195000 1000 = 1012.8205 typically consists of number of discrete market phases. 8SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT Pre – Open Phase Auction Market The pre – open period is applicable only to normal market. In the auction market, the Exchange on behalf of trading Order matching takes place at the end of the session, based on members for settlement related reasons initiates auctions. There which an opening price is computed and assigned to all trades are three types of participants in this market. of pre – open. Simple Regular lot and Stop Loss orders can be a. Initiator: The party, which initiates the auction process, is entered in this phase. called the Initiator. Opening Phase b. Competitor: The party, which enters orders on the same side In this period, all orders that have been entered during the pre – as of the initiator, is called a competitor. open are matched. During this phase, the trading member can’t c. Solicitor: The party, which enters orders on the opposite side login to the system. as of the initiator, is called a Solicitor. Open Phase Order Types & Conditions The open period indicates the commencement of trading The system allows the trading members to enter orders with activity. During this phase orders are matched in a continuous various conditions attached to them as per their requirements. basis. Several activities, such as order entry, order modification, Members can enter ‘O’ (Open) orders for opening an transac- order cancellations are allowed during this phase. tion on the system and ‘C’ (Close) orders for closing out an existing position in the participant code field in the order entry Close Phase screen. These conditions are broadly divided into the following The close period is applicable only to the normal market. Order categories: matching takes place at the end of the session, based on which the closing price is computed and assigned to all trades of close Time Conditions phase. Simple Regular lot and Stop Loss orders can be entered a. DAY – It is an order which is valid for the day on which it is in this phase. entered. If the order is not executed during the day, the Market Close Phase system cancels the order automatically at the end of the day. When the market closes, trading in all instruments for that b. GTC – A Good Till Cancelled (GTC) order remains in the market comes to an end. A message to this effect is sent to all system until the user cancels it. Consequently, it spans trading members. No further orders are accepted, but the user is trading days, if not traded on the day the order is entered. permitted to perform the activities like enquiries. The exchange notifies the maximum number of days an order can remain in the system. Currently, all GTC orders get SURCON Phase purged on Tuesday; each day counted is a calendar day Surveillance and Control (SURCON) is that period after market including the holidays. The days counted are the inclusive of close during which, the user have enquiry access only. After the the day on which the order is placed and the order is cancelled end of SURCON period, the system processes the data and from the system at the end of the day of the expiry period. prepares the system for the next trading day. When the system start processing data the interactive connection with the trading c. GTD – A Good Till Days (GTD) order allows the user to system is lost and a message to that effect is displayed at the specify the number of days / date till which the order should trader workstation. stay in the system, if not executed. The maximum days allowed by the system are same as in GTC order. At the end Market Types of this days / date, the order is cancelled from the system. The capital market system has four types of markets. They are: Each day /date counted as a calendar day an d inclusive of Normal Markets holidays. The days counted are the inclusive of the day on All orders in the Normal market have to be of regular lot size which the order is placed and the order is cancelled from the or multiples thereof. The normal consists of various book system at the end of the day of the expiry period. types, wherein orders are segregated as Regular Lot orders, d. IOC - An Immediate or Cancel (IOC) order allows a Trading Special Term orders, Negotiated Trade orders and Stop Loss Member to buy or sell a security as soon as the order is orders depending on their attributes. released into the market, failing which the order will be Odd Lot Market removed from the market. Partial match is possible for the An order is called an odd lot order, if the order size is less than order, and the unmatched portion of the order is cancelled regular lot size. In an odd lot market, both the price and immediately. quantity of both the orders (buy & sell) should exactly match Quantity Conditions for trade to take place. a. DQ - An order with a Disclosed Quantity (DQ) condition Spot Market allows the Trading Member to disclose only a part of the Spot orders are similar to the normal market orders except that order quantity to the market. For example, an order of 1000 spot orders have a different settlement period vis-à-vis normal with a disclosed quantity condition of 200 will mean that market. These orders do not have special term attributes 200 is displayed to the market at a time. After this is traded, attached to them. another 200 are automatically released and so on till the full order is executed. The Exchange may set a minimum disclosed quantity criteria from time to time. 9SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT b. MF - Minimum Fill (MF) orders allow the Trading Member find a match, it remains in the system as an outstanding order to specify the minimum quantity by which an order should and is called as passive order. Best sell order is the order with be filled. For example, an order of 1000 units with the lowest price and the best buy order is the order with the minimum fill 200 will require that each trade be for at least highest price. The unmatched orders are queued in the system 200 units. In other words there will be a maximum of 5 in the following priority: trades of 200 each or a single trade of 1000. The Exchange a. By Price – A buy order with a higher price gets a higher may lay down norms of MF from time to time. priority and similarly, a sell order with a lower price gets a c. AON - All or None orders allow a Trading Member to higher priority. impose the condition that only the full order should be b. By Time – If there is more than order at the same price, the matched against. This may be by way of multiple trades. If order entered earlier gets a higher priority. the full order is not matched it will stay in the books till As and when valid orders are received by the system, they are matched or cancelled. first numbered, time stamped, and then scanned for a potential Price Conditions match. This means that each order has a distinctive order a. Limit Price/Order - An order that allows the price to be number and a unique time stamp on it. If a match is not found specified while entering the order into the system. then the orders are stored in the book as per price / time priority. An active buy order matches with the best passive sell b. Market Price/Order - An order to buy or sell securities at order if the price of the passive sell is less than or equal to the the best price obtainable at the time of entering the order. price of the active buy order. Similarly, an active sell order c. Stop Loss (SL) Price/Order - The one that allows the matches with the best passive buy order, if the price of the Trading Member to place an order, which gets activated only passive buy order is greater than or equal to the price of the when the market price of the relevant security reaches or active sell order. crosses a threshold price. Until then the order does not enter Pre – Open Matching the market. A sell order in the Stop Loss book gets triggered The pre – open matching rules applies to the pre – open period when the last traded price in the normal market reaches or for the normal market. During the pre-open period, the system falls below the trigger price of the order. A buy order in the accepts all normal order activity but does not generate trade. Stop Loss book gets triggered when the last traded price in Based on orders carried over from the previous day, any new the normal market reaches or exceeds the trigger price of the order entered for the current trading day and any changes / order. cancellations to these orders, the system computes opening Example: If for stop loss buy order, the trigger is 93.00, the price for each security. All order entry functions available during limit price is 95.00 and the market (last traded) price is 90.00, normal trading hours are also available during pre-open. Orders then this order is released into the system once the market price can be entered, modified, or cancelled. Orders can be limited to reaches or exceeds 93.00. This order is added to the regular lot price orders or market orders. After the pre-opening matching book with time of triggering as the time stamp, as a limit order algorithm is executed, the system will begin the process of of 95.00 opening the market. During the opening process order entry Quantity Freeze function is disabled. Based on the pre-open matching algo- An order results in a quantity freeze, if the quantity is greater rithm, opening prices of the securities are calculated and all than 1% of the security. A quantity freeze is sent to the opening trade occurs at this price only. exchange for approval. The exchange may either approve or Open Phase Matching reject the request for quantity freeze. During this phase, orders are matched on a continuous basis in Price Freeze all book types. Orders are arranged in price / time priority and All limit price orders are checked for certain validations. The trade take place at the passive order price. Order matching takes limit price should be in multiples of tick size and within the place if the best buy price is greater than or equal to the best sell days minimum / maximum price range, otherwise the order is price with the minimum quantity condition being satisfied. If rejected by the system. If an order price lies outside the the combined equity of one or more matching orders on the Operational range but within day’s maximum / minimum opposite side of the regular lot book is equal to or more than range, it results in a price freeze and the order is not accepted as a the quantity of the active order, the active order is completely valid order till the time exchange approves it. traded else it may be partially traded. If after trading, any quantity is left untraded, the order is added to the regular lot Order Matching book with price / time priority. An active order with disclosed Matching Attributes condition tries to maximizes the quantity as possible, regardless Buy and sell orders are matched on the main attribute like Book of the disclosed quantity i.e. a single trade takes place for a Type, Symbol, Series, Quantity and Price. quantity more than the disclosed quantity. If an active order Matching Priority with the disclosed quantity can’t trade its total quantity, it is Before we go into the details of order matching, it is necessary added to the regular lot book with the price / time priority. The to understand the terms “Active” and “Passive” order. An active disclosed order quantity is determined as follows: order is an order entering the system. Once this order does not 10SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT • If the remaining order quantity is less than or equal to the End of Day Report original disclosed quantity, the disclosed order quantity is set Once the trading day ends, the details of trading activities done as equal to remaining order quantity. are generated as reports and downloaded on the user worksta- tion of corporate and branch managers. Following are the • If the remaining order quantity is more than the original repots available at the trader’s workstation: disclosed quantity, the disclosed order quantity is set to the original disclosed quantity. • Market Statistics Report: Commonly called the Bhav Copy Once an order with the disclosed quantity has become a passive in market parlance, this report gives details to all securities order, it trades only in units of the disclosed quantity or less. traded on a particular day. The information given includes Each time the disclosed quantity is replenished, the order is re- price statistics for each security as well as quantity and volume time stamped and added to the regular order book as fresh traded during the day. It also includes the day’s index value order. for S&P CNX Nifty, CNX Junior Nifty, S&P CNX Defty, S&P CNX 500 and CNX Midcap 200. Negotiated Trade Matching • Open Orders Report: This report shows records of all Negotiated trade entries are matched on the basis of the counter outstanding GTC / GTD orders for the day that can take party trading member id entered at the time of the order entry. part in trading on the next trading day. If the counter side entry of the negotiated trade is not entered on the same day then this trade entry is cancelled. All the terms • Order Log: This report gives record of all the orders related to a negotiated trade entry must be identical to the entered, modified or cancelled during the day. corresponding entry made by the counter party. The orders in • Trades Done Report: This report shows the record of all the NT book can be modified / cancelled till the time such alerts the trades executed by the member-trading firm during the is not created. All negotiated trade requires exchange approval. day. Spot Order Matching • Negotiated Deals: A negotiated deal may be defined as a Matching rules for the spot order are similar to that of regular deal at a mutually agreed price and quantity between two lot book. clients of the same broker and two clients of two different brokers. Odd lot Order Matching Odd lot matching takes place only for orders in odd lot book. Exercise There are no partial trades for an odd lot order i.e. each match is 1. What are the methods of computation of index? Which an exact match where the quantity of the passive order is equal method is being followed in NSE and BSE and why? to that of the active order. 2. Let’s say Index comprises of following four Securities on Auction Matching base date, with base value of 1000, as in NSE All auction orders are entered into the Auction order book. The rules for matching of auction are similar to that of the regular Shares Prices Issue size Prices lot. Auction order matching takes place at the end of the (P ) today 0 (P ) solicitor period for the auction only, across orders belonging to 1 Reliance 202 4000000 245 the same auction. All auction trade takes place at the auction price that is calculated as per matching rules. Wipro 600 500000 450 Neat Screen BFL 145 200000 150 SAIL 25 1000000 55 • Ticker: It displays the series, market type, stock symbol, volume and price at which each successive trade takes place on Total 972 5700000 900 the exchange. • Snap Quote: It allows a trading member to get immediate Find the index value today? market information on any desired security. 3. On April 5, the total market cap of S&P CNX Nifty is Rs. • Most Active Securities: It gives a list of securities with the 257500 crores and base cap is Rs. 255000 crores. It is decided highest traded value during the day. to replace scrip A, a constituent of Nifty having a market cap • MBP: ‘Market by price’ displays the best five price points of Rs. 800 crores with scrip B that has a market cap of Rs. available in each security along with the total order quantity at 927 crores with effect from April 6. What is the revised base these 5 prices. cap of Nifty on April 6? • Market Movement: It provides the hourly details of a 4. Given the order book for a security, find the impact cost to particular security like buying order quantity; selling order sell 1500 shares of the security. quantity, high price, low price etc. Order Book • Outstanding Orders: It provides the details of orders that Buy Buy Sell Sell are not traded for a particular security. Quantity Price Quantity Price • Previous Trades: It provides the details of all trades in a 1000 98 1000 99 security for the day. 2000 97 1500 100 1000 96 1000 101 11SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT 5. What are the different order types and conditions used in the NEAT system? 6. Explain the different types of market of the Capital market system? Notes 12SECURITY ANAL YSIS AND PORTFOLIO MANAGEMENT CHAPTER3 CLEARING & SETTLEMENT LESSON 5 Introduction Settlement Cycle The National Securities Clearing Corporation Ltd. (NSCCL), a Real Time Gross Settlement wholly owned subsidiary of NSE, was incorporated in August It involves settlement of trades on real time and involves every 1995. It was set up to bring and sustain confidence in clearing single trade being settled without any netting. This type and settlement of securities; to promote and maintain, short settlement involves the smallest time between the trade and and consistent settlement cycles; to provide counter-party risk settlement. guarantee, and to operate a tight risk containment system. At the end of each trading day, concluded or locked-in trades are NSCCL commenced clearing operations in April 1996. received from NSE by NSCCL. NSCCL determines the Clearing cumulative obligations of each member and electronically Clearing is the process of determination of obligations, after transfers the data to Clearing Members (CMs). All trades which the obligations are discharged by settlement. concluded during a particular trading period are settled together. NSCCL has two categories of clearing members: trading A multilateral netting procedure is adopted to determine the net members and custodians. The trading members can pass on its settlement obligations (delivery/receipt positions) of CMs. obligation to the custodians if the custodian confirms the same NSCCL then allocates or assigns delivery of securities inter se to NSCCL. All the trades whose obligation the trading member the members to arrive at the delivery and receipt obligation of proposes to pass on to the custodian are forwarded to the funds and securities by each member. Settlement is deemed to custodian by NSCCL for their confirmation. The custodian is be complete upon declaration and release of payout of funds required to confirm these trade on T + 1 days basis. and securities. Once, the above activities are completed, NSCCL starts its On the securities pay-in day, delivering members are required to function of Clearing. It uses the concept of multi-lateral netting bring in securities to NSCCL. On pay out day the securities are for determining the obligations of counter parties. Accordingly, delivered to the respective receiving members. Exceptions may a clearing member would have either pay-in or payout obliga- arise because of short delivery of securities by CMs, bad tions for funds and securities separately. Thus, members pay-in deliveries or company objections on the payout day. and payout obligations for funds and securities are determined Auctions latest by T + 1 day and are forwarded to them so that they can Each CM would communicate to NSCCL on the pay-in day the settle their obligations on the settlement day (T+2). securities that the CM would be delivering and those that the Cleared and Non – Cleared Deals CM is unable to deliver. NSCCL identifies short deliveries and NSCCL carries out the clearing and settlement of trades conducts a buying-in auction on the day after the payout day executed in the following sub-segments of the Equities through the NSE trading system. segment: The CM is debited by an amount equivalent to the securities 1. All trades executed in the Book entry / Rolling segment. not delivered and valued at a valuation price (the closing price as announced by NSE on the day previous to the day of the 2. All trades executed in the Limited Physical Market segment. valuation). If the buy-in auction price is more than the valua- NSCCL does not undertake clearing and settlement of deals tion price, the CM is required to make good the difference. All executed in the Trade for Trade sub-segment of the Equities shortages not bought-in are deemed closed out at the highest (Capital Market) segment of the Exchange. Primary responsibil- price between the first day of the trading period till the day of ity of settling these deals rests directly with the members and squaring off or closing price on the auction day plus 20%, the Exchange only monitors the settlement. The parties are whichever is higher. This amount is credited to the receiving required to report settlement of these deals to the Exchange. member’s account on the auction payout day. Clearing Mechanism Bad Delivery Trades in rolling segment are cleared and settled on a netted Bad deliveries (deliveries which are prima facie defective) are basis. Trading and settlement periods are specified by the required to be reported to the clearinghouse within two days Exchange / Clearing Corporation from time to time. Deals from the receipt of documents. The delivering member is executed during a particular trading period are netted at the end required to rectify these within two days. Un-rectified bad of that trading period and settlement obligations for that deliveries are assigned to auction on the next day. In a typical settlement period are computed. A multilateral netting proce- settlement cycle bad deliveries are reported on Friday and are to dure is adopted to determine the net settlement obligations, in be rectified by Monday. Failing which the clearing corporation a rolling settlement, each trading day is considered as a trading conducts an auction buy-in on Wednesday. Like in the case of period and trades executed during the day are netted to obtain short deliveries there is a valuation of debit and a square off in the net obligations for the day. 13SECURITY ANALYSIS AND POR TFOLIO MANAGEMENT the event of unsuccessful auction. Good / Bad delivery norms Risk Management are given by SEBI. A sound risk management system is integral to an efficient clearing and settlement system. NSE introduced for the first Company Objections time in India, risk containment measures that were common Company objections arise when, on lodgment of the securities internationally but were absent from the Indian securities with the company / Share Transfer Agent (STA) for transfer, markets. which are returned due to signature mismatch or for any other Risk containment measures include capital adequacy require- reason for which the transfer of security cannot be effected. The ments of members, monitoring of member performance and original selling CM is normally responsible for rectifying / track record, stringent margin requirements, position limits replacing defective documents to the receiving CM as per pre- based on capital, online monitoring of member positions and notified schedule. The CM on whom company objection is automatic disablement from trading when limits are breached, lodged has an opportunity to withdraw the objection if the etc. objection is not valid or the documents are incomplete (i.e. not as required under guideline No.100 or 109 of SEBI Good/Bad Margins (Equities) delivery guidelines), within 7 days of lodgment against him. If Categorization of Stocks for imposing Margins: the CM is unable to rectify/replace defective documents on or • The Stocks which have traded at least 80% of the days for before 21 days, NSCCL conducts a buying-in auction for the the previous 18 months shall constitute the Group I and non-rectified part of defective document on the next auction Group II. day through the trading system of NSE. All objections, which are not bought-in, are deemed closed out on the auction day at • Out of the scrips identified above, the scrips having mean the closing price on the auction day plus 20%. This amount is impact cost of less than or equal to 1% shall be categorized credited to the receiving member’s account on the auction under Group I and the scrips where the impact cost is more payout day. than 1, shall be categorized under Group II. • The remaining stocks shall be classified into Group III. Rolling Settlement In a rolling settlement, each trading day is considered as a • The impact cost shall be calculated at 15th of each month on trading period and trades executed during the day are settled a rolling basis considering the order book snapshots of the based on the net obligations for the day. previous six months. On the basis of the impact cost so calculated, the scrips shall move from one group to another At NSE, trades in rolling settlement are settled on a T+2 basis group from the 1st of the next month. i.e. on the 2nd working day. For arriving at the settlement day all intervening holidays, which include bank holidays, NSE Daily margins payable by members consists of the following: holidays, Saturdays and Sundays are excluded. Typically trades a. Value at Risk Margin taking place on Monday are settled on Wednesday, Tuesday’s b. Mark to Market Margin trades settled on Thursday and so on. A tabular representation Daily margin, comprising of the sum of VaR margin and mark of the settlement cycle for rolling settlement is given below: to market margin is payable. Value at Risk Margin Activity Day VaR margin is applicable for all securities in rolling settlement. All securities are classified into three groups for the purpose of Trading Rolling Settlement Trading T VaR margin. Clearing Custodial Confirmation T+1 working days For the securities listed in Group I Scrip wise daily volatility Delivery Generation T+1 working days calculated using the exponentially weighted moving average methodology that is used in the index futures market and the Securities and Funds pay in T+2 working days Settlement scrip wise daily VaR would be 3.5 times the volatility so Securities and Funds pay out T+2 working days calculated. Valuation Debit T+2 working days For the securities listed in Group II the VaR margin shall be Auction T+3 working days higher of scrip VaR (3.5 sigma) or three times the index VaR, Post Bad Delivery Reporting T+4 working days Settlement and it shall be scaled up by root 3. Auction settlement T+5 working days For the securities listed in Group III, the VaR margin would be Rectified bad delivery pay-in T+6 working days equal to five times the index VaR and scaled up by root 3. and pay-out Re-bad delivery reporting T+8 working days VaR margin rate for a security constitutes the following: and pickup • Value at Risk (VaR) based margin, which is arrived at, based Close out of re-bad delivery on the methods stated above. The index VaR, for the and funds ay-in & payout T+9 working days purpose, would be the higher of the daily Index VaR based on S&P CNX NIFTY or BSE SENSEX. The index VaR would be subject to a minimum of 5%. 14

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