Indian Economy, 5th edition (67 page)

In the London Stock Exchange he is called a
market-maker
while in the New York Stock Exchange he is called a
specialist.
The Bombay Stock Exchange has made it mandatory for every company with a share capital of over Rs. 3 cr to appoint jobbers or market-makers if it seeks enlistment. Such an arrangement enables investors to buy and sell shares on the stock exchange and thus liquidity increases.

Market –Maker

Functions as an intermediary in the market ready to buy and sell securities. He simultaneously quotes two-way rates—like a jobber basically with the only difference that he quotes two-way rates, for buying and selling at the same time.
8

On the floor of India’s OTCEI (
o
ver the
c
ounter
s
tock Exchange of India Ltd.), only market-makers are allowed to play. In the money market of India, the Discount and Finance House of India (DFHI) is the chief market–maker
9
.

Since he quotes the selling price while buying a particular share, he makes market for that share, hence such a name.

The NASDAQ of the USA is a market– maker’s stock exchange where they are connected by the web-enabled trading terminals.

SEBI

The regulator of Indian stock market, set up under the
Security and Exchange Board of India Act, 1992
(as a non-statutory body set on April 12, 1988 through a Government Resolution in an effort to give the Indian stock market an organised structure) with its head office in Mumbai. Its initial paid-up capital was Rs. 50 crore provided by the promoters—the IDBI, the IFCI and the ICICI.

The Board of SEBI comprises 9 members excluding the
c
hairman—one member each from the Ministries of Finance and Law, one member from the RBI and two other members appointed by the Central Government. It has four full-time members (including the
c
hairman).

Main functions/powers of the Board as per the
SEBI Act, 1992
are:

(i)
Registering and stock exchanges, merchant banks, mutual
f
unds, underwriters, registrars to the issues, Brokers, Sub-brokers, transfer agents and others.

(ii)
Levying various fees and other charges (as 1 per cent of the issue amount of every company issuing shares are kept by it as a caution money in the concerned stock exchange where the company is enlisted).

(iii)
Promoting investor education.

(iv)
Inspection and audit of stock exchanges and various intermediaries.

(v)
Performing other concerned functions as may be prescribed from time to time.

Commodity Trading

Commodity trading happens similar to ‘stocks’ (shares, securities, debentures, bonds) trading in the stock market. However, commodities are actual physical goods such as corn, silver, gold, crude oil, etc. Futures are contracts for commodities that are traded at a futures exchange like the Chicago Board of Trade (CBOT). Futures contracts have expanded beyond just commodities, now there are futures contracts on financial markets like foreign currencies, interest rates, etc.

Commodity Futures serve a great purpose in any economy. As we see in the case of agricultural commodity – their prices play a key role in determining the fortune of the agriculture and food processing industry in India. These prices undergo a
large degree of fluctuation
. Reasons for price fluctuation are crop failure, bad weather, demand-supply imbalance, etc. This fluctuation, in turn, leads to a ‘price risk’. This price risk is largely borne by the farmer and the industries where agricultural commodities are used as raw material. Commodity exchanges are associations that determine and enforce rule, and set procedures for trading of commodities. The main objective of the exchange is to protect the participants from adverse movement in prices by facilitating futures trading in commodities.

If the participants
hedge
themselves against this price risk, then they would be able to insulate themselves against the inherent price fluctuations associated with agricultural commodities. One of the methods of doing this would be by using commodity exchanges as a trading platform. Apart from hedging against price risk, a commodity exchange helps in production and procurement planning as one can buy in small lots. Further as the exchange consists of various informed industry participants,
price discovery
is more efficient and discounts the local and global factors.

Let us take a very simple example to understand how trading on commodity exchanges help industry participants – a farmer who is producing wheat can sell ‘wheat futures’ on a commodity exchange. This will help him lock in a sale price of a specified quantity of wheat at a future date. Hence the farmer would now be able to get an assured price for his produce in future and any decline in the price of wheat would not impact his earnings. On the other hand, a user industry (e.g. a flour mill) could purchase the wheat futures from the exchange. Hence the flour mill would now be able to fix its future purchase cost for a specified quantity of wheat. Therefore, any increase in the price of wheat in future would not impact its cost of production.

However, what needs to be kept in mind is that farmers do not largely operate in the futures market. This is partly due to operational difficulties and lack of knowledge. Though, they observe the price trends emerging from a futures market and then decide what commodity in what proportion to cultivate.

In case of user industries, commodity exchanges help them to plan their production and determine their cost of production. Commodity exchanges are an effective tool to hedge price risk. However, the government needs to improve infrastructure, put in place vigilant governing systems, etc. to encourage trading on these exchanges.

Big money started flowing into commodity futures with the advent of online multi-commodity exchange. The boom, which began when the stock market was sluggish, has surprisingly not waned even after the Sensex crossed 20,000 (by 2004-06). High stakes, long trading hours and comparatively little knowledge about the derivative products have underscored the role of a regulator. The Forward Markets Commission (FMC), which for decades was entrusted with the job to curb forward trades, now has the job to develop and regulate the commodity futures market.

FMC

The Forward Markets Commission (FMC) is a statutory body set up under the
Forward Contracts (Regulation) Act, 1952.
It functions under the administrative control of the Department of Consumer Affairs, Ministry of Consumer Affairs, Food & Public Distribution. Headquartered at Mumbai with one regional office at Kolkata, the Commission comprises a Chairman, and two members. The Commission provides
regulatory oversight
in order to ensure –

(i)
Financial integrity (i.e., to prevent systematic risk of default by one major operator or group of operators);

(ii)
Market integrity (i.e., to ensure that futures prices are truly aligned with the prospective demand and supply conditions), and

(iii)
Protection and promotion of the interest of consumers/non-members.

After assessing the market situation and taking into account the recommendations made by the
Board of Directors of the Commodity Exchange
, the Commission approves the rules and regulations of the
Commodity Exchanges
in accordance with which trading is to be conducted. It accords permission for commencement of trading in different contracts, monitors market conditions continuously and takes remedial measures wherever necessary by imposing various regulatory measures. At present, there are 21 commodity exchanges in India including three
‘national level’
exchanges recognized for conducting futures/forward trading. The three national exchanges are –

1.
Multi-commodity Exchange of India Ltd. (MCX), Mumbai.

2.
National Commodity and Derivatives Exchange Ltd. (NCDEX), Mumbai.

3.
National Multi-commodity Exchange of India Ltd. (NMCE), Ahmedabad.

In US, which has the
largest
commodity futures market, there are separate regulators for equities and commodities. Single regulator exists in China, UK, Australia, Hong Kong and Singapore. Japan has a different model for its derivatives market, with multiple product type based regulators.

Raising Capital in the Primary Market

There are three ways in which a company raises capital in the primary market
—

Public Issue

A public offer is open for all Indian citizens, the most broad-based method of raising capital and the most prestigious, too (The Reliance Industries Ltd. is the biggest company of India in this category).

Rights Issue

Raising capital from the existing shareholders of a company, it means it is a preferential kind of issue restricted to a certain category of the public only.

Private Placement

Raising capital by selling shares to a select group of investors, usually financial institutions (FIs) but may be to individuals also. This is done through a process of direct negotiations (completely opposite to the public issue). The advantage of this route is the substantial saving a share issuing company makes on marketing expenses (but the risk of shifting loyalties of the investors in this route is also the highest!).

Recent times have seen such capital raising by many companies privately placing their shares to the foreign institional investors (FIIs) as a route to source foreign exchange in India, and that too quickly.

Important Terms of Stock
Market

Scrip Share

A share given to the existing shareholders without any charge—also known as
bonus share.

Sweat Share

A share given to the employees of the company without any charge.

Rolling Settlement

An important reform measure started in the Indian stock market in mid-2001 under which all commitments of sale and purchase result into payment/delivery at the end of the ‘X’ days later (where ‘X’ stands for 5 days. Some shares have X as one, two or three days, too). Today, all shares are covered under this provision.

Badla

When the buyers want postponement of the transaction–in Western world called
Contango.

Undha Badla

When the sellers want postponement of the transaction—also known as the
reverse badla
or
backwardation.

Futures

A trading allowed in shares where a future price is quoted for the shares and the payment and delivery takes place on the pre-determined dates.

Depositories

Started in 1996 under which stocks are converted into
‘paperless form’
(dematerialisation of shares shortly known as the ‘demat’). At present, two Public Sector depositaries (Mumbai) are functioning in India set up under the
Depositories Act, 1996
—

(i)
NSDL (National Securities Depositories Ltd.)

(ii)
CDSL (Central Depositories Services Ltd.)

Spread

The difference between the buying and selling prices of a share is called spread. Higher the liquidity of a share lower its spread and vice versa. Also known as Jobber’s
Turn
or
Margin
or
Hair cut.

k
erb Dealings

The transactions of stocks which take place outside the stock exchanges—unofficially and take place after the normal trading hours.

NSCC

The National Securities Clearing Corporation (NSCC), a public sector company set up in 1996 takes the
counter party risk
of all transactions done at the NSE just as an intermediary guarantees all trades.

Demutualisation

A process started (2002) by SEBI under which ownership, management and trading membership was to be segregated from each other. No broker was to be on the Board of Directors or an office-bearer in a stock exchange.

This has been done in the case of all stock exchanges except three regional stock exchanges (RSEs) in India.

Authorised Capital

The limits upto which shares can be issued by a company—also known as the
nominal
or
registered
capital. This is fixed in the Memorandum of Association (MoA) and the
a
rticle of
a
ssociation (AoA) of a company as required by the
Companies Act (Law)
.

Paid-up Capital

The part of the authorised capital of a company that has actually been paid by shareholders. A difference may arise because all shares authorised might not be
issued
or issued shares are only partly paid-up.

Subscribed Capital

The amount actually paid by the shareholders or have been committed by them for contribution.

Issued Capital

The amount which is sought by a company to be raised by issuing shares which cannot exceed the authorised capital of the company.

Greenshoe Option

A provision under which a company issuing shares for the first time is allowed to sell some additional shares to the public—usually 15 per cent, is also known as
over-allotment provision
.
It gets its name from the first company (Green
s
hoe Company, USA) which was allowed such an option.

Penny Stocks

The share which remains low-priced at a stock exchange for a comparatively longer period. Speculators may start hoarding them for hefty margins, this was seen in India in mid-2006. And since such stocks get hoarded, ultimately their market prices increase. The speculators earn profit after offloading (selling) these shares at high prices and others who purchase these shares ultimately might fetch huge losses because price rise of these stocks are unintentional or each intentional manipulation and nothing else.