principles of trading

8/7/2019 PRINCIPLES OF TRADING

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PRINCIPLES OF TRADING & HEDGING WITH INDEX FUTURES

Terminology Spot, future price, contract specifications, contract cycle, expiry date,

settlement date, basis, mark to market, Contract specification for BSE Sensex, Tick

date, types of orders, trading strategies, Hedging Strategies, Initial, Maintenance

Margins, Executing & Clearing, Execution, Matching confirmation, Clearing Mechanism,

Settlement price, Settlement cycle, cash vs. Physical delivery, Open Interest& Trading Volumes

Hedging is minimizing risk as much as possible. There are many different ways of hedging,

depending on the asset in question.

Let's take wheat as an example. The farmer wants to lock in a particular price for wheat. Thefarmer's objective is to remove the uncertainty over what his/her wheat will sell for when it's

time to harvest it. In this case, a futures contract on wheat is a good hedge. A futures contract,as you may know, is an agreement between a buyer and seller which says that the buyer will

buy a specified amount of wheat at a specific price on a set date. In this fashion, the wheatfarmer can eliminate uncertainty over what the wheat will be worth in the future.

Now let's take stock as an example. A common way of hedging stock is to buy options. Astock option contract gives the buyer the right to buy or sell a specific number of shares ofstock on or by an expiration date. A call is a right to buy and a put is a right to sell. Anoptions contract has a buyer and seller. The buyer has the right to buy or sell. The seller hasthe OBLIGATION to deliver/purchase stock. Hedging stock with options is verycomplicating but I will describe a common scenario to you. Many investors buy stock andthen buy put options on the same stock. A put option is a right to sell stock at a specified

price, known as the strike price. Usually, options contracts involve blocks of 100 shares ofstock. Therefore, a common way of hedging stock with put options is for the investor to buy

100 shares of stock. By buying 100 shares of stock, the investor makes a profit only if theprice goes up. This is called going long. Subsequently, the investor can buy a put option on

that same stock. If the price goes down, the investor can exercise the put option and sell theshares of stock under the terms of the put option, effectively canceling out the loss on thelong position.

The above scenarios are examples of hedging. The problem is that hedging is verycomplicated for individual investors. Options contracts are incredibly expensive, running intothe tens of thousands of dollars. An alternative to this is short ETFs. These ETFs go short onsome index, such as the S&P 500. If you buy into this ETF, you can indirectly hedge your

portfolio. Another "hedge" is to have some of your portfolio in fixed income, i.e. bonds. This


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is an "imperfect hedge" for your portfolio. Typically, when stocks go down, bonds go up so ifyou have some of your portfolio in bonds, it is possible to provide a cushion.

y Hedging means to cut down the risk of loss which may occur for asset likestock/commodity over a period of time.

Suppose investor wants to invest in a company X which is expected to perform wellafter six months.Investor will buy shares of company X and also buy shares of profitmaking company Y which is already doing well of the same sector.So that even if thecompany X doesn't perform well after six months ,the profit in company Y shares willreduce the loss of investment in company X.

y DEFINATIONS OF EVERY WORD USED IN STOCK MARKET TO BE KNOWN..............MU STREAD - December 9th, 2007

yy GLOSSARY

1 Basic Capital Market Instrument

2 Regulatory Framework

Security Laws

Taxation

3 Players

Investors

Traders

4 Terminology / Jargon

Mutual Funds

Primary Market

Secondary Market

Indices

Demat

Stock market manipulations

Equity Research

Derivatives ,Options & Futures

Risk &Return

Mergers &Acquisition

A PRIMER TO THE PRIMARY MARKETS

BASIC CAPITALMARKET INSTRUMENTS

1 Stock or share

An ordinary share represents the form of fractional ownership of a company in which a

shareholder, as a fractional owner, undertakes maximum entrepreneurial risk associated with

the business venture... If the business fails to succeed, the claim of the ordinary shareholder on


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the residual amount left comes last after all other stakeholders, such as employees, creditors,

lenders, government, preference shareholders, etc.

2 Preference share

A preference share means a share, which carries a right for a dividend of a fixed amount, or an

amount calculated at a fixed rate, before dividend is distributed to equity shareholders.

However, this right is not like any other debt obligation. This is because if a company is not

making profit it is not liable to pay dividend to preference shareholders, but the company is

required to pay interest to its other creditors. Usually dividend payable on preference shares ifnot paid, is accumulated and paid in subsequent years. Preference shares are also redeemed, in

the event of winding up of a company to the extent of principle value and unpaid dividend

before making any payments to equity shareholders.

3 Cumulative Convertible Preference Share (CCP)

A Cumulative Convertible Preference share has two distinct features mainly the dividend is

accumulated if not paid in a year and the Preference share is convertible into equity shares as

per the terms of the issue of Preference shares.

4 Debenture

A debenture represents the smallest unit of public lending to a company. A debenture holder

receives a fixed stream of interest, unlike the uncertain stream of dividends that a shareholder

receives. Payment of interest is a legal obligation on the part of the company. Also, usually a

debenture is required to be secured against the assets of a company.

5 Convertible debenture

A debenture which is convertible either optionally or compulsorily into equity shares at a later

date (at the time of redemption or the period as specified in the conditions of the debentures) is

called convertible debenture. The price (face value plus premium if any) is determined as per

the conditions mentioned in the debentures.

Statutes &Regulatory Authorities

1 Security Contract Regulation Act (SCRA)

It is a Law passed by Indian Government with a view to prevent undesirable transactions in

securities by regulating the business of dealing therein, by providing for certain other matters

connected therewith. This act is called the Securities Contracts Regulation Act, 1956. It extends

to the whole of India.

2 Securities and Exchange Board of India (SEBI)

SEBI was constituted in the year 1992 under the overall administrative control ofGovernment of

India (Ministry of Finance) for the regulation and orderly functioning of the stock exchanges and

the securities industry to fully protect the rights of the investors, to prevent trading

malpractice's and promote healthy growth of capital markets. It was given a statutory status in

1992 under the SEBI Act.

3 Registrar of companies

The Registrar of Companies is an authority under the Companies Act where all the companies

have to register their Memorandum of association, Articles ofAssociation and all reports such as

annual repots, any mergers, etc.

4 Company Law Board (CLB)

CLB is a statutory body appointed under the Companies Act. It administers various powers

granted to it under the Companies Act for smooth functioning of the companies in the country.

5 Stock Exchange

Stock Exchange is the place where buyers and sellers of stocks meet. The prices of the sharesare decided by demand and supply of the shares. The buyers and sellers are represented by the

brokers. Hence, the stock exchange is an association of individual members called member

brokers (or simply members or brokers), formed for the express purpose of regulating and

facilitating the buying and selling of securities by the public and institutions at large. A stock

exchange in India operates with due recognition from the government under the Securities and

Contracts (Regulations) Act, 1956. The member brokers are essentially the middlemen, who

carry out the desired transactions in securities on behalf of the public (for a commission) or on

their own behalf. Some exchanges are formed and managed by limited companies whose

shareholders may be members of the exchange and thereby have license to offer brokerage

services to members of public. Some exchanges which are formed by limited companies may

have brokers who are not necessarily shareholders of the exchange company also


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6 Broker

A company or an individual who is a member of the stock exchange and acts as a middleman

between the buyer and seller of securities in that market. Broker charges fees for his services.

Currently the brokers have to be registered with Securities and Exchange Board of India in order

to carry out his activities.

Taxation

1 Capital Gain

When an asset is bought, and it is likely to generate benefit for period longer than 1 year, it is

usually capitalized in books of accounts. This is called a Capital asset. When an investor buys a

capital asset i.e. stocks, securities, real estate, gold, etc the gains realized on selling are called

capital gains.

2 Short -Term Capital gain

When an equity investor buys a security and sells within a short period, usually less than one

year, then the gains made are called short-term capital gains. These gains are clubbed with

investor's ordinary income for tax purposes and charged normal tax rate as applicable. For Real

estate consideration trade done within 3 years time is treated as short-term capital gain. The

exact period for reckoning short term or long term gains depends on the accounting and

taxation practices of respective countries.

3 Long-Term Capital gains

The gains realized in the buy-sell of an asset, if the asset is held for more than the short-termperiod, (one year in case of equity/debentures and if real estate then more than 3 years, as per

current Indian laws) are called long term capital gains.

Types of Investors

1 Indian Corporates & Non Corporate Entities

An ordinary share represents the form of fractional ownership of a company in which a

shareholder, as a fractional owner, undertakes maximum entrepreneurial risk associated with

the business venture... If the business fails to succeed, the claim of the ordinary shareholder on

the residual amount left comes last after all other stakeholders, such as employees, creditors,

lenders, government, preference shareholders, etc.

2 Non Resident Indian (NRI)

The definition of Non Resident Indian is given in the Indian Income Tax Act. As per that, an

individual is a non resident Indian if he satisfies one of the following conditions, - He is in India

in the previous year for a period of 182 days or more; or - He is in India for a period of 60 days

or more during the previous year and 365 days or more during 4 year preceding the previous

year.

3 Mutual Fund

A Mutual Fund is a collective savings scheme. An Asset Management Company (AMC)

manages the pool of money. The AMC usually come out with various schemes declaring the type

of investment that will be undertaken on those funds. For example if most of the money is likely

to be invested in interest bearing securities, then the scheme is called Income scheme.

A debenture represents the smallest unit of public lending to a company. A debenture holder

receives a fixed stream of interest, unlike the uncertain stream of dividends that a shareholder

receives. Payment of interest is a legal obligation on the part of the company. Also, usually a

debenture is required to be secured against the assets of a company.

4 Financial institution (FI)

Financial institution is a financial intermediary, which conducts the business of lending and

borrowing of money. FIs are governed by the RBI and Ministry of Finance regulations. E.g.

ICICI, IFCI, HDFC, etc.

5 Foreign Institutional Investor (FII)

Foreign Institutional Investor means an institution or Pension Fund, Mutual Fund, Investment

Trust, Asset Management Company, Bank , Nominee Company and Incorporated /

Institutional Portfolio Manager or their Power ofAttorney holder established or incorporated

outside India which proposes to make investment in India in securities, it also includes domestic


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asset management company or domestic portfolio manager who manages funds raised or

collected or brought from outside India for investment in India on behalf of a sub-account, shall

be deemed to be a Foreign Institutional Investor. Foreign Institutional Investors have been

permitted to invest in Indian securities markets since September 1992 when the Government of

India issued the Guidelines for Foreign Institutional Investment. In November 1995, the SEBI

(Foreign Institutional Investors) Regulations, 1995 have been notified based on the earlier

guidelines There are around 500 FIIs registered in India at present.

6 Overseas Corporate Body (OCB)

Overseas corporate body is a legal entity incorporated outside India, where an NRI holds 60%

or more of its share capital or beneficial interest.

7 Offshore Fund

A fund promoted by a domestic asset management company abroad is called offshore fund.

Offshore funds are usually promoted for investing in one or few specific countries. These are

called country funds.

Types of Traders

1 Bull

In market there are traders/investors who take position i.e. Buy position by buying the shares in

anticipation that price of the particular share will rise in the future. After the share prices rise,they would sell them off for a profit. These traders/investors are known as bulls.

2 Bears

In market there are traders/investors who take position i.e. Sell position by selling the shares in

anticipation that price of the particular share will fall in the future. These traders will buy back

the shares when the prices actually do fall to make a profit. These traders/investors are known

as bears.

3 Stag

Stag is an investor who buys the shares in the primary market from public issue in anticipation

of rise in prices on the listing of the shares on stock exchange. They try to encash the profit

between the issue price and the listing price of the share.

TERMINOLOGY / JARGONS

Mutual Fund Terms

1 Open Ended Scheme

Open-Ended Schemes do not have a fixed maturity and are highly liquid schemes. All

redemptions and fresh investments in this scheme is done directly with the Mutual Fund at net

asset value ("NAV") related prices.

2 Close Ended Schemes

Close-Ended Schemes have fixed maturity period and investment in these schemes is done at

the time of the initial issue and thereafter you can buy or sell the units of the scheme on the

stock exchanges where they are listed. Some close-ended schemes give you an additional

option of selling your units directly to the Mutual Fund through periodic repurchase at NAV

related prices.


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3 Net Asset Value (NAV)

Net Asset Value is the common expression among Mutual Funds and denotes

Net Asset Value (N AV). NAV per Unit is equal to

NAV = Market value of the assets of the scheme - Liabilities/ Units Outstanding

4 Asset Management Company (AMC)

The AMC is the corporate entity, which markets and manages a mutual fund scheme and in

return receives a management fee paid from the fund corpus. SEBI specifies that an AMC must

be a separate entity from the trust, which owns the mutual fund.

5 Front end/entry load and Back end / exit load

These terms are common in Open ended mutual fund schemes. Mutual Funds incur various

expenses during an issue, which are charged to the scheme. Funds may charge these expenses

either fully or partly to the schemes. Such a charge is called a Sales load, Entry load or Front

end load. The maximum sales load that can be charged to a scheme at the time of an initial

public offer is 6 % of the unit capital raised. Similarly when an investor choose to withdraw from

a fund, the value of deductions effected from NAV is called Back end load or Exit load. Back End

loads are imposed since premature withdrawals carry a transaction cost to the AMC. SEBI has

prescribed that total of Front end and Back end loads should not exceed 6% of the NAV of thecorpus.

Primary Market Terms

1Primary Market

Primary market refers to issue of new shares, Debentures, Shares with attached options like

warrants by new as well as existing companies. These shares will be listed on specified stock

exchanges after the completion of allotment and compliance with other prescribed formalities.

2 Public Issue

When an existing company offers its shares in the primary market it is called public issue. Often

IPO and Public issue are used interchangeably.

3 New issue or IPO (Initial Public Offering )

When the company offers its shares to the investors for the first time its called initial public

offering. At the time of IPO the companies' shares are not listed on any stock exchange.

4 Underwriter

Underwriter to issue of capital is the one that agrees to take up securities, which are not fully

subscribed by shareholders in case of a Rights issue or by members of public in case of a publicissue. He makes a commitment to get the issue subscribed either by others or by him. The

underwriter is like an insurance company to the issuer company. The underwriter charges

underwriting fees to the issuer company for his services. He is paid underwriting charges even if

the issue is fully subscribed.

5 Share Certificate Nos

The companies issue physical stock to the shareholder. The certificate carries a number, which

remains in the records of the companies. This is called certificate number. The certificate


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number is different from distinctive numbers of shares. One share certificate would carry

distinctive number of one or more number of shares.

6 Distinctive Numbers)

Distinctive numbers are the numbers given by the company to the shareholder for the shares

held by them. The companies use this for their records.

7 Prospectus

A prospectus is a document that must accompany the application forms of all public issues of

securities, whether ordinary shares, or debentures. Typically, a prospectus contains the terms

and conditions of the issue, along with the specific feature of the security, the purpose for which

the issue is made, the company's track record, the risk inherent in the project for which the

capital is being raised and so on.

8 Face value

Face Value (Par Value) implies the value at which a share is originally recorded in the balancesheet as capital. In India face value is normally Rs 10 or Rs. 100. But now as per relaxation by

SEBI, companies are coming out with issues with different face values e.g. HCL Technologies

(Rs. 4). Zee has split the face value of shares from Rs. 10 to Rs 1.

9 Partly Paid Share

When a company gives the option to investor to apply for the shares on part payment of the

face value then till the remaining amount is paid the share is called partly paid share

10 Dividend

A company from its post tax profit distribute some proportion to shareholders. This income for

the shareholders is called dividend. Currently dividend income is tax free in the hands of

investors, but the company is required to pay dividend tax directly to the Government

Corporate Terms

1 Company

Company is an incorporated association of many persons, which is an artificial person in law,

having a common seal and a perpetual succession. Thus on incorporation, a company becomes

a separate legal entity different from the persons forming it. The liabilities of the members of a

company extend only to the unpaid value of the shares held by them. This is called a limited

liability company. It is possible to form a Company whose liability is limited by guarantee or

even a company with unlimited liability of the shareholders.

2 Distinction between Private limited company and Public limited company

A private limited company is closely held company. It can have minimum 2 and maximum 50

members. There is a restriction on transfer of shares without consent of others. The shares of

private limited company are not listed. There are restrictions on inviting Capital from Members

of public for a private limited company. A public limited company can have more than 50

members. The company can invite public subscription for its shares or debentures. The company

must have minimum 7 members and 3 directors.


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3 Board of Directors

A director includes any person occupying the position of a director by whatever name ( Section

13 of the Companies Act' 88 ). Only an individual can be a director (Section 253). The directors

of the company are collectively referred to as the Board of Directors. An individual director or

any group of directors can exercise their power only after the delegation by the board. The

directors have the direction, superintendence and control of the affairs of the company. Theday-to-day management of the affairs of the company is delegated to the managerial personnel

by the board.

4 Registrar and Share Transfer Agent (R & T Agent)

An R & T agent is an agency appointed by a Public Limited company to carry out the service of

transfer of shares from one member to another, register such transfers in its book of members,

distribute dividend warrants to shareholders, etc.

5Common seal

The company on the share certificate for authentication puts a stamp on the share certificate

known as company seal. The Company seal is also affixed on important agreements and

contracts by the Company

6 Company Secretary

Company Secretary is the member of association of Institute of Company Secretaries of India

who engages himself in the practice of the profession of the Company Secretaries or offers to

perform or perform services in relation to the promotion, forming, incorporation, amalgamation,

reconstruction, reorganization or winding up of companies.

7 Subsidiary companys

A Company is a subsidiary of the other if, but only if, - that other controls the composition of its

board of directors or - where the first mentioned company is an existing company in respect of

which the holders of preference shares issued before the commencement of this act have the

same voting rights in all respects as the holders of equity shares, exercises or controls more

than half of the total voting power of such company; - where the first mentioned company is

any other company, holds more than half in nominal value of its equity share capital or - the

first mentioned company is a subsidiary of any company, which are that others subsidiary.

8 Managing agent

When a company appoints some other company to manage and run the operations on

commission basis the company is called managing agent.

9 Are all public limited companies necessarily listed?

Most Public limited companies can get themselves listed, but it's not necessary that all Public

companies are listed.

10 Meaning of a Company listed on the Stock Exchange

A Company, which comes out with a public issue, has to offer investors the option to trade their

shares i.e. an exit route where they can sell their shares. For this, company has to apply to the

stock exchange to get approval for their shares to be traded on the same. If the stock exchange

approves the company's application then company's shares get listed on the exchange for


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trading. Usually the Stock Exchanges and the company enter into an agreement, which is called

"The Listing Agreement". The listing agreement stipulates obligations of the listed company to

the Members of public as well as shareholders on dissemination of information regarding the

working of the company.

11 Multiple listing

A Company gets its shares listed on more than one exchange for better access of the investors.

This is called multiple listing.

12 Resolution

Any decision of the company has to be taken by consent of members or board of directors. This

is called resolution.

13 General Body meeting

AGeneral Body Meeting is a meeting of the members, as on a record date of the Company.

Every company limited by shares, and every company limited by guarantee and having a sharecapital, shall, within a period of not less than one month nor more than six months from the

date at which the company is entitled to commence business, hold a general meeting of the

members of the company which is General Body meeting.

14 Annual General Meeting (AGM)

The AGM is a meeting called annually of the members to transact routine business such as

approving of accounts, electing directors etc. It also transacts special business such as

enhancing borrowing limits, sale/purchase of undertaking of the Company, etc. Every company

shall in each year hold in addition to any other meetings a general meeting as its annual general

meeting and shall specify the meetings as such in the notice calling it; and not more than fifteen

months shall elapse between the date of one annual general meeting of a company and that of

next.

15 Extraordinary general body meeting

All general body meetings other than annual general body meeting are called Extraordinary

General Body Meeting (EGM). The EGM is called usually to transact urgent business, which

cannot wait till the AGM. There are provisions in the Company's Act whereby the members can

also requisition such meetings

16 Proxy

Any member of a company entitled to attend and vote at meeting of the company is entitled to

appoint another person (whether a member or not) as his proxy to attend and vote instead of

himself; but a proxy so appointed does not have any right to speak at the meeting. Usually theCorporate members send in their representatives as proxies.

Basic Secondary Market Terms

1 Secondary Market

Secondary market is the market where you can buy or sell shares, which are listed on Stock

exchanges.


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2 Brokerage and the maximum Brokerage charged by a Broker

Brokerage is the commision charged by the broker for purchase/sale transaction through him.

The maximum brokerage chargeable, as stipulated by SEBI, is at present 2.5% of the trade

value.

3 Additional charges other than brokerage that can be levied on the investors

Apart from the brokerage the trading member can charge :

Transaction charges payable to Stock exchange for facilitating smooth trading.

Stamp duty payable to various State governments. Investor Protection Fund.

Contingency Fund. Insurance Fund Excise Duty payable to Revenue authorities in the form

ofService Tax.

Penalties arising on behalf of clients (investors) for non compliance of the relevant

requirements.

4 Specified or 'A' group, 'B1' , 'B2', ' F ' and 'Z' Group shares

At (BSE) Bombay Stock Exchange the shares are classified in different categories. 'A' Group is a

category where there is a facility for carry forward (Badla) for a period not exceeding 90 days. It

contains the shares of the companies which have fairly good growth record in terms of dividend

and capital appreciation. The scrips in this group are classified on the basis of equity capital ,market capitalisation, number of years of listing on the exchange, public share holding, floating

stock, trading volume etc. 'B1' Group is a subset of the other listed shares that enjoy higher

market capitalization and liquidity than the rest. 'B2' Group of shares comprises the shares not

covered in the above two categories. 'F' Group represents the debt market ( fixed income

securities ) segment. 'Z' Group category comprises of shares of the companies which does not

comply with the rules and regulations of the Stock Exchange.

5 Security code

For the trading purpose on BOLT (BSE online terminal) all the scrips have been assigned

numeric codes which have to be keyed in at the time of transaction. This is called security code.

6 Scrip symbol

For NSE trading scrips are represented by their symbols depending upon their names. These are

known as scrip symbols.

7 Market lots

When the company issues shares to the public, the face value is decided and the minimum

number of shares to be transacted per single transaction is decided. This minimum number of

shares per lot is known as market lot. This is done to facilitate easy trading of shares on the

stock exchange. Hence for all physical shares traded on the stock exchange, the deliveries are

to be made in market lots only by the seller unless specifically agreed to otherwise. Before

dematerialization minimum lot used to be 50 or 100 shares for Rs. 10 and 5 or 10 shares for Rs.

100 face value. After dematerialization, minimum lot has become one for all shares which aretraded in dematerialized form.

8 Contract Note

Contract note is a confirmation of trade(s) done on a particular day for and on behalf of a client.

A contract note is issued by the broker in the prescribed format and manner, establishing a

legally enforceable relationship between the member and client in respect to the trades stated in

that contract note. Contract notes are made in duplicate, and the member and client both keep

one copy each.


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9 Points to be checked by an investor to check the validity of a contract note

Name and address of the Trading member, SEBI registration number, details of trade like order

no., trade no., trade time, security name, quantity, rate, brokerage, settlement no., details of

other levies, signature of authorized signatory and the arbitration clause stating that the trade is

subject to the jurisdiction of Mumbai must be present on the face of the contract note.

10 Documents an Investor should receive from the broker and when

The Transactions executed by the broker for the clients can be confirmed by the following

methods. Orally by the word of mouth on telephone or personal meeting.

By faxing the details or the Contract Note.

On line ,if the trading is via internet.

The confirmation given will be followed by Contract Note evidencing the transactions executed

within 24 hours of the trade being executed.

11 Book-Closure and Record dates

An important aspect of investing in securities is to understand the purpose and implications of

book closure or record date. Since the security holders of a company keep changing practically

every day, when a company has to distribute benefits in the form of interest, dividends, bonus

shares or rights issues, the company has to ascertain as to who should receive the benefits. For

this purpose, for each benefit to be distributed to the shareholders, a company announces in

advance, a record/book closure date. The benefits are then distributed to those security holders

whose names appear on the register of the company on that date. To receive this benefit from

the company, an investor who has bought the security on a cum-benefit basis must make sure

that the security is sent for registration of his name before the book closure date.

12 Portfolio

The set of all securities held by an investor is called his portfolio. The portfolio may contain just

one security. However, since in general no one puts all the eggs in one basket, it will contain

several securities. Such a portfolio is known as a diversified portfolio.

13 Private Placement

When a company offers its shares to group of investors by passing the right/public issue, to

selected group of investors, then it is called a private placement of shares. There are SEBI

guidelines, which regulate such issues by a listed company.

14 Preferential Issue

When a company offers its shares to selected investors who may be promoters of the company,

associates, shareholders of the Group Company, etc. then the issue is called a preferential

issue. There are SEBI guidelines, which regulate such issues by a listed company.

15 Rights Issue

Whenever an existing company makes a fresh issue of equity capital or convertible debentures,

the existing shareholders or convertible debenture holders have the first right to subscribe to

the issue in proportion to their existing holdings. Only what is not subscribed to by the existing

shareholders can be issued to the public. Thus, an issue offered to the existing shareholders as

their right is known as Rights Issue, as opposed to an issue open to the public at large, in which

case we call it a public issue.


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16 Bonus Issue

When we invest in shares we expect more than just the dividends from the earnings of the

company after paying off the dues of all other stakeholders. The company after distributing the

dividends keeps remaining earnings as reserves. The reserves plus equity capital is called

Networth. When company's reserves are satisfactory, the management by book entry, issuesshares from reserves to shareholders and credits the equity capital by the same amount. This

are called bonus shares. This increases the liquidity of the company's shares as number of

shares increase. The market price of the company's shares usually comes down as per the ratio

in which the shares are issued. Shareholders are benefited as they get more shares but the

returns in real terms accrue only if the company is able to maintain the same growth.

17 Rights Issue

When investor applies for the registration of shares in his/her name, he/she can apply jointly.

That means there will be two/three applicants for the same shares. First holder is entitled to all

rights. But at the time of selling, the approval of all the joint holders is necessary.

18 Calls

Calls are the sums payable on a partly paid share. The Company after having issued partly paid

shares would call upon the shareholders to pay the balance calls as and when they require.

19 Order books

There may be several buy orders and several sell orders at various prices with different

quantities. These orders for buy-sell trades for any share giving the prices and quantities of

shares are arranged in descending orders. This listing of all the orders is called order book.

20 Touchlines

This term is often used when trading on the BOLT( BSE On Line Trading)system. Touchline is

the prices at which buy and sell order can be executed. Hence the best buy and sell price for a

scrip form the touchline.

21 Delivery V/s Payment (DVP)

Delivery v/s payment means exchanging simultaneously for money. Often there is a time lag

between pay in and pay out. The time lag may be of a couple of hours or even. In the absence

of DVD, the buyers have to pay in money and the sellers have to deliver shares ahead of time

and wait for the payout to take place. The time gap between delivery and payment increases

the market risk.

22 ISIN Number

ISIN (International Securities Identification Number) is an identification number given to the

security of an issuer company by the International securities organisation in consultation with

SEBI. These numbers are unique and facilitate international trade.

Margin

1 Definition


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After a buy/sell trade takes place, the prices of the stock may move up or down. This movement

in price may result in profit/loss to the investor. To guard against the possibility of the loss not

being paid by the investor, the margins are collected by the brokers from the investors. On

successful completion of the transaction, the margin is refunded. When a trade takes place, on

the stock exchange, the stock exchange or the clearing house guarantees honoring of the trade

between members/brokers. To secure the trade, the stock exchange asks from the

members/brokers some proportion of total transaction value as a safety deposit, in case the

broker/member defaults in honoring the commitment to the exchange. This is known as margin.

The stock exchange levies different margins as per the situation requirements. Different types of margins are

Gross Exposure Margin

Daily margin

Carry Forward Margin

Special Margin

Mark to Market Margin

Volatility Margin

Concentration Margin

Adhoc Margin

a) Daily margin

A client and a broker is required to deposit/make available margin for open positions either on

the buy side or on the sell side at the end of the day. This is known as daily margin. It is

intended to take care of eventualities that might occur between 2 trading days.

b) Carry forward margin

On exchanges which provides for trading on carry forward basis from one settlement to another

as per the SEBI guidelines an additional margin needs to be paid on positions which are carried

over. The daily margin is refunded at the end of the settlement while the carry forward margin

is collected.

c) Special Margin

In order to curtail heavy, unhealthy transaction positions in particular scrip (normally illiquid,

small cap stocks) Exchange specifies special margin to be paid for both the buy side and the sell

side of the transaction. This is specified in absolute amount to be paid generally in cash form.

d) Mark to Market margin

When a trader takes a buy/sell position and the market price moves against the trade i.e. for a

buy trade price declines and for sell trades price moves up, the trader has to pay the difference

between the trade price and the closing price as a margin. This margin is known as mark to

market margin. This is usually done at the close of the business day

E.g. A trader buys 100 shares ofReliance at Rs. 250 and the price closes at Rs. 245 he has to

pay the difference ofRs. (250-245) i.e. RS. 5 per share totaling RS. 500 as mark to market

margin.

E.g. A trader sells 100 shares ofGujarat Ambuja at Rs. 250/- per share, and the price of

Gujarat Ambuja closes at Rs 260/- then the difference ofRs 10 per share on 100 share totaling

Rs 1000 will be mark to market margin. At the broker level the mark to market profits are notadjusted against mark to market losses.

e) Volatility Margin

In order to control the volatility or very wide fluctuations in the scrip price, SEBI imposes from

time to time a margin, which is called as Volatility Margin. The objective of this margin is to

ensure that in case there is a very wide fluctuation in the price of the scrip, both the buyers and

seller honour their commitments to each other and the integrity of the market is not

endangered. Generally the method adopted to calculate the volatility is by working out the

difference between the highest price and the lowest price over a 45 day transaction cycle and


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comparing it with the lowest price. The margin is accepted in cash or in form of demat shares.

f) Ad-hoc Margin

As prescribed by SEBI Ad-hoc margins are imposed on brokers carrying very large position over

all or in certain illiquid small value stocks.

g) Gross Exposure Margin

The end of the day net outstanding scripwise position results in open exposure between

client/broker and broker/exchange. The total of net open positions is know as gross exposure.

The exchange insists on the broker making certain security available to it in the form of

cash/bank guarantee/shares, etc. to take care of gross exposure. This is known as Gross

exposure margin. Generally, it needs to be paid in advance of the trade.

Why are Margins levied on

1 Buyers

If the buyer fails to honor his commitment of taking delivery by paying cash or by squaring off

the trade, the stock exchange can use the margin taken from the trader to settle his trade so

that the settlement procedure for whole market does not get disrupted. It is a cushion available

for meeting likely losses in case the buyer does not honor his commitment to the market.

2 Sellers

If the seller fails to honor his commitment of giving delivery or by settling the trade at a loss

and paying cash due to loss in a trade, the stock exchange can use the margin taken from the

trader to settle his trade so that the settlement procedure for the whole market does not get

disrupted. Again, it is a cushion available for meeting likely losses in case the seller does not

honor his commitment to the market.

2 T+1 or T+2n

T+1 is the settlement of trade after 1 day of the date of trading.

T+2 is the settlement of trade after 2 days of the date of trading.

3 Rolling Settlement

In a rolling settlement the trade has to be settled on the T+ Nth day. Every day's trades are

netted on a daily basis. Squaring off can be done on the same day otherwise the trades have to

be settled by paying cash or giving security. In India currently T+5 is operational. This is

different from weekly settlement wherein the trades are netted off on a weekly basis and settled

subsequently.

4 Definition

It is a trading mechanism, which allows us to buy shares, even if we do not have the requisite

amount of money, or sell shares if you don't have the deliveries. It is also known as carry

forward trading. Badla charges are known as contango charges. As per the current SEBIregulation one can take either buy or sell position in specified shares in the Bombay Stock

Exchange and carry it forward till 90 days or else the person has to settle the trade by taking

delivery by paying cash or giving delivery if he has sold the shares. In any of trades the

investor/trader has to pay margins as per the stock exchange specification.

Indices


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1 Index

An index is a simple barometer of the underlying scrips in the market. It is statistical average,

simple or weighted average, of a few leading shares in the market. The number so arrived at is

called an index. BSE 30 or SENSEX is such an average of thirty leading shares traded in the

BSE. Some indices may track a large number of shares average whereas some may track

particular industries. This is called a sector specific index.

2 Significance of Index movements

If the share price index today is 5000, with the average share price in 1984-85 taken as 100,it

means that on an average, share prices in the market have gone up by about 50 times since

1984-85. The year for which the average price is assumed to be 100 (in this case, 1984-85) is

known as the base year. The base year keeps on changing with time, when this happens the

indices before and after the introduction of the new base year can not be compared directly. Ups

and downs of an index reflect the changing expectations of the stock market about future

earnings of India's corporate sector. When the index goes up, it is because the stock market

thinks that the prospective earnings will be better than previously thought. When prospects of

earnings in the future become pessimistic, the index drops. The ideal index gives us instant-to-

instant readings about how the stock market perceives the future of India's corporate sector.

Every stock price moves for three possible reasons: - news about the company (e.g. a product

launch, or the closure of a factory) - news about the industry - news about the economy as a

whole including political and sentimental factors. Each stock contains a mixture of these three

elements - stock, industry and economy news. When we take an average of returns on several

stocks, the individual stock news tends to cancel out. On any one day, there would be goodstock-specific news for a few companies and bad stock-specific news for others. In a good

index, these will cancel out, and the only thing left will be news that is common to all stocks.

That is what the index will capture. The current method of averaging is to take a weighted

average, and give each stock a weight proportional to its market capitalization.

3 ICE Stocks or ICE Index

The stocks falling in Information Technology, Telecommunication and Entertainment industries

are referred to as ICE Stocks. The Index based on above stocks is called ICE Index.

4 S&P CNX 500 Equity Index

The S&P CNX 500 Equity Index comprises 500 stocks and is market capitalisation weighted.

Stocks are selected based on their market capitalisation, industry representation, trading

interest and financial performance. However, the overriding need has been to ensure that the

industry weightings in the index dynamically reflect the industry weightings in the market. The

S&P CNX~500 Equity Index currently contains 79 industry groups representing over 73% of

total market capitalisation and over 98% of total turnover making it an optimal market

benchmark.

5 CNX MidCap 200 Index

For the trading purpose on BOLT (BSE online terminal) all the scrips have been assigned

numeric codes which have to be keyed in at the time of transaction. This is called security code.

6 S&P CNX Nifty and CNX Nifty Junior

The CNX MidCap 200 Index comprises 200 companies. The MidCap Universe for this index has

been defined as companies having an average market capitalisation (over the preceding 12

months) between Rs.1.5 billion (US$ 35 million) and Rs. 15 billion (US$ 353 million). The

distribution of industries in the index represents the industry distribution in the MidCap

Universe. The index represents 71% of the total midcap market capitalisation and 72% of its

trading value making it an optimal index for stock market performance of the MidCap segment.

7 NATEX or National Index


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Natex is developed by BSE, which is more broad based index than the sensex. Natex reflects the

price movements of 100 actively traded shares of five major exchanges viz. Bombay, Calcutta,

Delhi, Ahmedabad and Madras.Their base year is 1983. Whether the stock market is depressed

or buoyant is reflected by either the downward or upward movement respectively of this indices.

8 NASDAQ

'Nasdaq' is an acronym of the National Association ofSecurities Dealers. It represents the

indices of Technology stocks listed on New York Stock Exchange.

Demat

1 Meaning of Dematerialized stocks

The dematerialization of physical stock is done on the request of the investor and the

depositories hold it. Since the shares now appear only as an electronic record in the books of

the depository, it is called dematerialized stock.

2 Meaning of Physical stock

The company issues a share certificate to the shareholder as a proof of his holding in the

company. This is known as physical stock since the certificate exists physically.

3 Depository

A depository is the place where shares are "deposited" or withdrawn from. The depository may

hold the share on behalf of the clients in physical form or dematerialized form. All deposits and

withdrawals of shares are accounted by the depository similar to a bank account operation. This

method does away with all the risks and hassles normally associated with paperwork.

Consequently, the cost of transacting in a depository environment is considerably lower as

compared to transacting in physical form.

4 Depository Participant

A depository participant (DP) is an agent of the depository and is authorized to offer depository

services to investors. According to SEBI guidelines, financial institutions, banks, custodians,

stockbrokers, can become depository participants in a depository.

5 NSDL and CDSL

NSDL stands for National Securities Depository Limited. It is promoted by IDBI, UTI and

National Stock Exchange. CDSL stands for Central Depository Services Limited. It is promoted

by Bombay Stock Exchange (BSE), Bank of Baroda, HDFC Bank, State Bank of India and Bank

of India.

6 Rematerialisation ofShares

It is the process through which shares held in electronic form in a depository are converted into

physical form.

Types of Traders

1 Market Maker /Jobber

Market maker is the one who gives two way quotes for a security at any point of time. He can

do this if he has financial strength and the shares to deliver. He is the liquidity provider in the

scrip. A market maker would offer to do transaction on either side as chosen by the counter

party at the prices indicated by the market maker for the quantities offered. The market maker

assumes the price risk, the liquidity risk and the time risk. Price risk means that he may not be

able to cover his position at the same or better price than the price at which he did the original

transaction. Liquidity risk means that he may not be able to liquidate his purchase position and

may have to take deliveries and vice versa. Time risk means that the market maker may have


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to hold the inventory for an unknown period of time and lose the interest on his investments.

E.g. Market maker will give quotes for Satyam as Buy 100 shares at Rs. 5000 and Sell 100

shares at Rs. 5010. To cover for the risk involved, he keeps difference between buy and sell

quote.

2 Tarvaniwala

When a jobber gives two way qoutes and does the transaction, the difference he gets betweenthese two way spread is called Tarvani and the trader is called Ttarvanivala.

3 Arbitrage

A simultaneous buy and sale of an asset to get the benefit of price difference is called arbitrage.

Arbitrage is of different types: price differences between two exchanges, between spot and

futures market etc.

E.g. If on the BSE price ofSBI is Rs.250 and on NSE is Rs.253 one can buy the shares on BSE if

he has the money and sell simultaneously on NSE if he has the shares with him for delivery and

make risk free profit ofRs.3 per share.

4 Arbitrageur

The persons who do arbitrage as a business are called arbitrageurs.

Auction

1 Auction ofStocks

Auction is a mechanism which is used when a member broker selling shares defaults on the

delivery ie. if he has delivered short ( shares fewer than what they have sold) or their deliveries

are bad or if they have not rectified the company's objections reported against them. The

exchange resorts to Auction to fulfil its obligation towards the broker buying the shares.

2 Modus Operandi ofAuction

Investors can ask their broker member to sell their securities in the Auction. However they

should ensure that.

Shares are readily available for delivery (pay-in day of securities for auction is held within 1 or

2 days of auction) and

Shares delivered are good delivery (no opportunity provided for rectification of bad delivery)

Securities not delivered on auction pay-in day or bad delivery of securities delivered in auction

are directly squared off at a price specified by the Exchange/Clearing Corporation.

3 Close out

If the shares could not be bought in the auction i.e. if shares are not offered for sale in the

auction, the transactions are squared up as per SEBI guidelines. As per the guidelines in force,

the transaction is squared up at the highest price from the relevant trading period till the close-

out day or at 20% above the last available trading price whichever is higher.

Nature ofShares


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1 Blue Chip Shares

Shares of large, financially strong and well established companies which have stood up against

all kinds of market conditions and which have good profitability and dividend track records are

referred to as blue chip Shares.

2 Growth Shares

These are shares of companies, which have out-performed others in the Industry, Shares of

such companies grow at a rate faster than others in terms of sales and profitability. E.g.

Infosys, Wipro, Satyam and NIIT are current examples of growth stocks in the Indian IT

industry.

3 Value Stocks

Value stocks are those stocks that currently have a low market sentiment and are underpriced

relative to their intrinsic worth.

4 Defensive Shares

These Shares are generally neutral to business cycles. These shares have low fluctuations in

their prices and are fairly stable.

5 Cyclical Shares

These shares are in commodity companies and their prices depend on cyclical fluctuations of the

economy. If the economy is doing well, they appreciate otherwise, their prices would fall.

6 Turn Around Shares

The shares, which belong to the companies that, have large accumulated losses but which show

signs of recovery or making profits.

STOCK MARKET MANUPILATIONS

Price Manipulative Terms

1 Inside information

Nonpublic knowledge about a corporation possessed by corporate officers, directors, major

stockholders, or others who hold private inside information allowing them to benefit from buying

or selling the stock.

2 Insider trading

When persons aware of private price sensitive information about a company take trading

decisions based on that information, it is known as insider trading. In most countries including

India trading on publicly unknown price sensitive information is illegal and punishable under the

law.

3 Price rigging

When a person or person acting in concert with each other collude to artificially increase or

decrease the prices of a security, that process is called price rigging.

4 Front running

When a person buys ahead of certain information becoming public knowledge on his own behalf

or someone else it is called front running. So when a trader anticipates buying from institutions

(domestic, FII, Mutual Funds) in near future they buy the shares to sell them on later date. This


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is called front running operation done by trader.

5 Circular Trading

When some informed investors indulge in trading between themselves in order to manipulate

price and/or volume traded in the scrip is called circular trading. E.g. A buys 100 shares ofSBI

from B. B sells this shares at higher/lower (negotiated between them) to C. C sells them once

again to A at some higher/lower price. In this trading, actual funds and shares have notchanged owners, but in the process price and volumes get manipulated. This is circular trading.

Research Terms

1 Fundamental Analysis

Investing in Equity shares requires you to know about the company you are investing into, in

some level of depth. Eg.You need to examine the company's line of business, its management

capability, its financial performance, its market share, technological prowess and various

factors. Such a detailed study of corporate performance is called 'Fundamental Analysis'.

2 Technical Analysis

Some experts believe that tracking past prices of equity shares will provide adequate guidance

as to its future path. These experts configure complex charts and mathematical averages of the

price movements to accurately predict its future. This analysis is called 'Technical Analysis'.

3 Rally

Material rise in the price of a share, or a material rise in the share market index, after a period

of stagnancy or a declining trend.

4 Relative Strength

Price wise performance of a share as compared with other shares or the share price index.

5 Dead-Cat Bounce

A deceptive, temporary recovery in share prices.

6 Valuation

Valuation is an exercise to find the intrinsic value of an asset. This helps the investor in making

decisions about when to buy the asset or to sell.

7 Networth

Networth is the sum of paid up equity capital and reserves (the amount of retained earnings for

the past years after paying all stakeholders and distribution of dividend).

8 Book value

Book value of a share is networth divided by number of shares outstanding

9 Profit before tax (PBT)

The residual amount left with the company from the earnings after paying all the dues of

stakeholders i.e. employees, government agencies (excise, sales tax, etc), operating

expenditure, debt obligation, etc is called profit before tax.

10 Earning per share (EPS)

Earning per share is the ratio of net profit to the number of paid up equity shares.

11 What is Cash Earning per share (CEPS)

Cash earning per share ratio is the ratio of sum of profit after tax and depreciation to number ofoutstanding equity shares.

12 Price Earning (P/E) ratio

Price earning ratio is the ratio of market price of the security to the earning per share (EP S) of

the company. This indicates usually, the market perception of the potential of the scrip.

13 Payout Ratio

Payout Ratio is how much percentage of Earnings is distributed as dividend.

It is defined as

Payout Ratio = Dividend per share (DPS) / (EPS) x 100 Earnings Per


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If the payout ratio Share is 40%, it means that 40% of the company's profits after tax have

been distributed as dividend and 60% transferred to reserves. A very high dividend payout may

not be healthy, if the IRR (Internal Rate OfReturn) is higher than the return an investor will get

if he invests the amount of dividend distributed outside

14 Fully Diluted earnings

When a company issues bonus shares or rights shares or comes out with an IPO, the share

capital of the company goes up. In such case, the earnings of the companies are to beconsidered on the enhanced equity capital. When this is done it is called fully diluted earnings.

15 Top Down or Bottoms Up Approach

These terms are used while doing fundamental analysis ofStocks. Top down refers to first find

about the economy, the industry in which the company is operating and then move on to

analyze the company's performance. Bottoms up approach on the other hand assumes that the

impact of economy and the industry is reflected in the fundamentals of the company ,which if

studied carefully , will reveal the potential for appreciation in the scrip.

16 Debt Trap

When highly leveraged company does not perform satisfactorily it falls into debt trap. Servicing

of large debt may not leave the company with any profit or operating cash, which in turn will

lead to further borrowing. Unless there is a dramatic turnaround in the company's profits, the

trap closes on it, forcing liquidation. Countries which borrow heavily, often fall into the trap, and

may have to accept humiliating conditions proposed by lender countries for further

Miscellaneous1 Dividend, Cum-dividend and Ex-Dividend

When an Investor buys a shares with cum-dividend (or cum Bonus or cum rights or other

benefits), he is entitled for the dividend , bonus shares or rights for which the books are to be

closed. When an investor buys the share ex-dividend (ex bonus or ex rights or other benefits),

he is not entitled to these benefits but the previous owner would be entitled to them.

2 Stock Lending

It is a mechanism through which seller going short can borrow stocks to meet his obligations. It

provides for the lending of securities for a price to short sellers. The lender of the scrip earns

additional returns by lending his stocks for a specified period to those who need them to

discharge their delivery obligations.

3 Company Objection

When Investors send share certificates along with the transfer deeds to the company for

registration, the registration is some time rejected if the signature differs, shares are fake,

forged or stolen , or if there is a court injunction preventing the transfer of the shares etc.

4 Deep Discount Bond

A Deep Discount Bond is long term bond where the initial amount invested keeps growing based

on the interest accumulated on the principal amount. For E.g. Bonds where an investment ofRs.

2800 today could yield Rs.100,000 after 30 years.

5 Global Depository Receipt (GDR)

Global Depository Receipt (GDR) are receipts denominated in US Dollar giving the owner the

right to convert the underlying shares by surrendering them to the depository holding the

underlying shares. Depositories are normally big international banks, which receive dividends,

reports, etc. The underlying shares are called depository shares.

GDRs are listed on stock exchanges such as London, Luxembourg, etc. In GDRs only qualified

institutional investors can participate which restricts retail entry decreasing the depth of themarket.

E.g. GDRs ofReliance, ITC etc are listed on London exchange.

6 American Depository Receipt (ADR)

American Depository Receipts (ADR) are depository receipts issued in US. For this, the

companies issuing receipts has to file the prospectus with US regulator Securities and Exchange

Commission for their approval and follow their strict accounting and disclosure procedures.

ADRs increase retail participation. ADRs are listed in stock exchanges in the US. usually

NASDAQ or New York Stock Exchange.

7 Transfer ofShares


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Transfer refers to transfer of ownership of shares from one person to another through a sale or

gift when accompanied by a transfer deed.

8 Transmission ofShares

Transmission refers to transfer of ownership of shares by operation of law in case of death or

insolvency from the owner to his legal heirs or creditors.

9 An Angel investor

Companies or persons providing venture capital for the new start ups, as they are not able to

access the capital markets at that point of time. Often angel investors also help the Promoters

by way of sourcing/assisting in finding managerial personnel, strategizing etc.Pricewise

performance of a share as compared with other shares or the share price index.

10 Arbitrator

When there is a dispute between two or more parties, it is resolved by unbiased persons -

arbitrators - who are familiar with the areas of controversy. This also cuts down on time to

resolve the disputes. All stock market contracts are subject to arbitration.

11 Circuit Filter

To check the excessive volatility of shares, SEBI has come with a set of rules to determine the

fixed price bands for different securities within which they can move within a day. As per SEBI

directive, all securities traded at or above Rs.10/- and below Rs.20/- have a daily price band of

25%, traded below Rs. 10/- have a daily price band of 50%, traded at or above Rs. 20/-

have a daily price band of 8%.

However recently the price band is extended to 12% for 200 active scrips. After the 8% price

band is hit and it doesn't recover from that level for next 30 minutes, the circuit is further

released for 4% more. The previous day's closing price is taken as the base price for calculating

the price. As the closing price on BSE and NSE can be significantly different, this means that the

circuit limit for a shares on BSE and NSE can be different.

12 Investors Protection Fund (IPF)

Investor's Protection Fund was set up by The Stock Exchange in July , 1986 to meet the claims

of investors against defaulter members.

13 Trade Guarantee Fund ( T G F )

The Stock Exchange has constituted a Trade Guarantee Fund to guarantee settlement of

bonafide transactions of members of the exchange inter-se which form part of the Stock

Exchange settlement system, so as to ensure timely completion of settlement of contracts and

thereby protect the interest of investors and the members of the exchange.

14 BIFR

BIFR is Board of Industrial Finance and Reconstruction. The government had set up this board

to rehabilitate the sick companies if possible or to liquidate them. When the networth of a

company is eroded, the company is referred to the BIFR.

15 Venture Capital

Venture capital is basically equity finance in relatively new companies when it is too early to go

to the capital market to raise funds. However, such investment is not exclusively equity

investment. It can also be made in the term of loan finance/convertible debt to ensure a

running yield on the portfolio of venture capitalist. Venture capital financing involves high risk-

return spectrum. Some of the ventures yield very high return compensating the loss from

unsuccessful investments. In brief, Venture capitalists acts as a financial intermediary between

investors looking for high returns and entrepreneurs who need institutional capital as they are

not yet ready /able to go to the public.

Mergers &Acquisitions

1 Merger

Merger involves dissolving of two firms and creating one new entity or continuing of one of the

old entity names.

Mergers represent a very important form of corporate restructuring. Mergers, as used in

financial literature, subsume both absorption and consolidation. Example of absorption :

Hindustan Lever and Ponds merged but the resultant entity remained Hindustan Lever.


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A consolidation involves a combination of two or more firms as a result of which a new firm

comes into being and the existing firms are dissolved. E.g. Hindustan Ciba Geigy and Sandoz

merged to form Novartis

2 Takeover

A takeover involves the acquisition of a certain or entire block of equity capital of a company,

which enables the acquirer to exercise control over the affairs of the company. SEBI has

specified a takeover code, which the acquiring company has to follow so that investor interestsare protected.

3 SWAP RATIO

When two or more companies merge or demerge, a consideration is payable to shareholders of

merged entity. For example, company A is merging into Company B, then company B has to pay

consideration to shareholders of company A. This may be in cash or by shares of the company

B. When the shares are being issued to shareholders of company A, a reasonable ratio is worked

out by valuation experts. This ratio is called swap ratio. Consider following examples:

1. A and B company merge to make company C and shares of company C are given to

shareholders ofA and B based on individual ratio worked out for each company.

E.g. Hindustan Ciba and Sandoz merged to form the new entity Novartis. The ratio in which

the shares of Novartis were issued to Hindustan Ciba and Sandoz is called SWAP RATIO.

2. Company A merges into B and shares of B are given to shareholders ofA on a fixed ratio.

E.g. Times Bank has merged into HDFC Bank. The Swap Ratio decided was 5.75 : 1. ie. for

every 5.75 shares held in Times Bank by it's shareholder 1 Equity share of HDFC Bank wasalloted.

3. A merges into B and shareholders ofA are given shares of C, held as investments by B in a

fixed ratio.

4. Company A divests its one division into separate company and existing shareholders are

given shares in the new company.

E.g. Recently Sterlite Industries has decided to split into 3 units viz. Copper , aluminium and

telecom cables.

4 Employee Stock Option Plan (ESOP)

The companies in order to reward and retain its employees offer them option to buy the shares

of the company. This is known as Employee Stock Option Plan (ESOP). Usually the options are

exercisable at a price lower then the market price. They are regulated by SEBI and have Tax

Implications as prescribed by the act from time to time.

5 Dawn Raid

In takeover attempt an individual or a company instructs brokers to buy all available shares of

the target company at current market prices as soon as stock exchanges open for business on a

particular date. With that as a base the bidder makes an attractive offer to the other

shareholders in order to make a full takeover bid.

Derivatives, Options & Futures

1 Derivatives

Derivatives are hedging instruments to be used against price risk. Securities providing payoffs

that depend on or are contingent on the values of other assets such as a commodity price, bond

and stock price, or market index values. The underlying instrument in any derivative instrument

is the physical asset or a security.

2 Futures

Futures contract is a firm legal commitment between a buyer and a seller in which they agree to

exchange something at a specified price at the end of a designated period. The buyer agrees to

take delivery of something and pay the agreed price and the seller agrees to make delivery for

the agreed consideration.

3 Index

An Index is a representative of a set, and is generally the indicator of status of the set. In a

stock market context, Index is an indicator of the broad market. For instance, by tracking the

changes of the BSE Sensex, NSE Nifty one can effectively gauge market moods in India. Any

Index is an average of its constituents. For example, the BSE Sensex is a weighted average of

prices of 30 select stocks, where the weight is the market capitalization of individual stocks.


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Market capitalization is the product of stock price and number of shares issued by the company.

4 Index futures

Index futures are future contracts where the underlying asset is the Index. This is of great help

when one wants to take a position on market movements. Suppose one feels that the market is

bullish and the Sensex would cross 5,000 points. Instead of buying shares that constitute the

Index one can buy the market by taking a position on the Index future.

5 Difference between the Forward and Future Contracts

Forward contracts are Over the counter (OTC) contracts whose terms are agreed upon by the

counter parties. Whereas Futures are traded on exchanges where the terms are standardized by

the exchange.

6 Options

An option is the right, but not the obligation, in the hands of the holder, to buy or sell an asset

at a particular price on or before a particular date. This is different from futures wherein there is

an obligation on both the buyer and seller to perform the contract.

7 Call and Put Options

A call option gives the holder the right to buy while a put gives him the right to sell the

underlying security / asset.

Risk &Return

1 Systematic risk

Risk in holding securities is generally associated with the possibility that realized returns will beless than the returns that were expected. The source of such disappointment is the failure of

dividends (interest) and/or the appreciation in security price to materialize as expected.

Forces that contribute to variations in returns-price or dividend (interest) - constitute the

elements of risk. Some influences are external to the firm and cannot be controlled, and affect

large number of securities. Other influences are internal to the firm and are controllable to the

large degree.

In Investments, those forces that are uncontrollable, external, and broad in their effect are

called as sources of systematic risk.

Systematic risk refers to that portion of total variability in return caused by factors affecting the

price of all securities. Economic, political, and sociological changes are sources of systematic

risk. Their effect is to cause prices of nearly all-individual common stocks and/or all individual

bonds to move together in the same manner.

For E.g. if the economy is moving towards recession and corporate profits shift downward, stock

prices may decline across the board and nearly all the stocks listed on the BSE move in the

same direction as the BSE Index. This happens due the systematic risk in the market.

2 Unsystematic risk

Unsystematic risk is the portion of total risk that is unique to a firm or industry. Factors such as

management capability, consumer preferences, and labor strikes cause systematic variability of

returns in a firm. Unsystematic factors are largely independent of factors affecting securities

markets in general. Because these factors affect one firm, they must be examined for each firm.

3 Bench marking of returns

For the returns on the stocks we have in our portfolio, some comparison must be there to find

out whether our choice of stocks are giving optimum returns or not. For this purpose we

compare them against some benchmark such as BSE Sensex or CNX Nifty, etc. This is called

benchmarking of returns.

4 BETA

Beta measures non-divesifiable risk. Beta shows how the price of a security responds to marketforces. In effect, the more responsive the price of a security is to changes in the market, the

higher will be its beta. Beta is calculated by relating the returns on a security with the returns

for the market. Market return is measured by the average return of a large sample of stocks,

such as the BSE SENSEX or S&P CNX Nifty. The beta for the overall market is equal to 1 and

other betas are viewed in relation to this value.

Betas can be positive or negative. However, nearly all betas are positive and most betas lie

somewhere between .4 and 1.9.

Investors will find beta helpful in assessing systematic risk and understanding the impact

market movements can have on the returns expected from a share or stock. For e.g., if the


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market is expected to provide a 10 percent rate of return over the next year, a stock having a

beta of having a beta of 1.80 would be expected to experience an increase in return of

approximately 18 percent (1.8*10%) over the same period. This particular stock is much more

volatile than the market as a whole.

5 Stock Co-relations

When the security price moves in some trend which some short of relationship can be

established to the trend of some other security or index then the two are said to co-relate. The

relation is called correlation. The correlation can be positive or negative.

Positive co-relation implies if one of the two moves up, the other will also move up and vice

versa.

Negative co-relation implies if one of the two moves up the other will move down and vice

versa.

Technical Definition- A standardized statistical measure of the dependence of two random

variables, defined as the covariance divided by the standard deviations of two variables.

6 Hedging

Hedgingis a mechanism to reduce investment risk using call options, put options, short selling,

or futures contracts. A hedge can help lock in existing profits. Its purpose is to reduce the

volatility of a portfolio, by reducing the risk of loss. Suppose you have a portfolio and there is a

likelihood of a war, in such an event the value of your portfolio would diminish. You would not

like to sell off your entire portfolio because of tax issues or liquidity problems. The best hedgewould be to sell Index futures. The loss on your portfolio would be covered by the gains on sell

position in Index futures.

Open interest

From Wikipedia, the free encyclopedia

Jump to: navigation, search

Open interest (also known as open contracts oropen commitments) refers to the totalnumber ofderivative contracts, like futures and options, that have not been settled in theimmediately previous time period for a specific underlying security. A large open interestindicates more activity and liquidity for the contract.[1]

For each buyer of a futures contract there must be a seller. From the time the buyer or selleropens the contract until the counter-party closes it, that contract is considered 'open'.

Contents

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y 1 Use of Open Interest in Technical Analysisy 2 The Importance of Open Interesty 3 Benefits of Monitoring Open Interesty 4 Open Interest - A Confirming Indicator


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y 5 Referencesy 6 External links

[edit] Use of Open Interest in Technical Analysis

Many technical analysts believe that a knowledge of open interest can prove useful towardthe end of major market moves. For some option traders, open interest indicates the intensityof trading in a financial instrument. If open interest increases suddenly, it is likely that newinformation about the underlying security has been revealed, which may indicate a near-termrise in the underlying security's volatility. However, neither an increase in volatility nor openinterest necessarily indicate anything about the direction of future price movements. Aleveling off of open interest following a sustained price advance is often an early warning ofthe end to an uptrending or bull market.

Technical analysts view increasing open interest as an indication that new money is flowinginto the marketplace. From this assumption, one could conclude that the present trend will

continue. Analogously, declining open interest implies that the market is liquidating, andsuggests that the prevailing price trend is coming to an end.

However, according to the definition of open interest in this entry, a change in open interestindicates a difference in the number of buyers and sellers of a financial instrument. Likevolatility, it has no directional component, it is just a tally of unsettled contracts.

For example, if trader X buys 2 futures contracts from trader Y(who is the seller), then openinterest rises by 2.

If another trader A buys 2 futures contracts from trader B, then the open interest rises to 4.Now, if trader X unwinds his position and the counter party is either Y or B, then the openinterest in the system will reduce by that quantity.

But if X unwinds his position, and the counter party is a new entrant, say C, then the openinterest will remain unchanged. This is because while X has squared off his position, Cs

position is still open. The level of outstanding positions in the derivatives segment is one ofthe parameters widely tracked by the market.

[edit] The Importance of Open Interest

Open interest is a concept all option traders need to understand. Although it is always one ofthe data fields on most option quote displays - along with bid price, ask price, volume and

implied volatility - many traders ignore open interest. But while it may be less important thanthe option's price, or even current volume, open interest provides useful information thatshould be considered when entering an option position.

First, let's look at exactly what open interest represents. Unlike stock trading, in which thereis a fixed number of shares to be traded, option trading can involve the creation of a newoption contract when a trade is placed. Open interest will tell you the total number of optioncontracts that are currently open - in other words, contracts that have been traded but not yetliquidated by either an offsetting trade or an exercise or assignment.


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For example, say we look at Microsoft and open interest tells us that there have been 81,700options opened for the March 27.5 call option. You may be wondering if that number refers

to options bought or sold. The answer is that you have no way to know for sure how manytransactions have taken place but you do know that there are 81,700 options contracts that

remain open. Since there is 1 bought position and 1 sold position for each of these contracts,there are 81,700 positions that remain bought to 'open' and 81,700 positions that remain sold

to 'open' for the March 27.5 call option. There are always the same number of positions oneither side of the open transactions.

So, when an option is traded with one party opening and one party closing, the open interestremains unchanged. If both parties in the transaction are closing positions then the openinterest decreases accordingly. If both parties are opening positions then the open interestgoes up accordingly.

One way to use open interest is to look at it relative to the volume of contracts traded. Whenthe volume exceeds the existing open interest on a given day, this suggests that trading in thatoption was exceptionally high that day. Open interest can help you determine whether there isunusually high or low volume for any particular option.

Open interest also gives you key information regarding the liquidity of an option. If there isno open interest for an option, there is no secondary market for that option. When optionshave large open interest, it means they have a large number of buyers and sellers, and anactive secondary market will increase the odds of getting option orders filled at good prices.So, all other things being equal, the bigger the open interest, the easier it will be to trade thatoption at a reasonable spread between the bid and ask.[

2]

[edit] Benefits of Monitoring Open Interest

By monitoring the changes in the open interest figures at the end of each trading day, some

conclusions about the days activity can be drawn.

Increasing open interest means that new money is flowing into the marketplace. The resultwill be that the present trend (up, down or sideways) will continue.

Declining open interest means that the market is liquidating and implies that the prevailing

price trend is coming to an end. A knowledge of open interest can prove useful toward theend of major market moves.

A leveling off of open interest following a sustained price advance is often an early warningof the end to an uptrending or bull market.

[edit] Open Interest - A Confirming Indicator

An increase in open interest along with an increase in price is said to confirm an upwardtrend. Similarly, an increase in open interest along with a decrease in price confirms adownward trend. An increase or decrease in prices while open interest remains flat ordeclining may indicate a possible trend reversal.


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The relationship between the prevailing price trend and open interest can be summarized bythe following table:[3][4]

Price Open Interest Interpretation

Rising Rising Market is Strong

Rising Falling Market is WeakeningFalling Rising Market is Weak

Falling Falling Market is Strengthening

[edit] References

1. ^"Open Interest". Financial Dictionary. http://financial-dictionary.thefreedictionary.com/Open+Interest. Retrieved 2010-09-01.

2. ^ Investopedia. "Options Trading Volume And Open Interest". Nasdaq.com.http://www.nasdaq.com/investing/options-trading-volume-open-interest.stm. Retrieved 2010-09-01.

3. ^"Open Interest". TradingPicks.com. http://www.tradingpicks.com/open_interest.htm.Retrieved 2010-09-01.

4. ^ Donna Kline (2001).Fundamentals of the futures market. McGraw-Hill Professional.p. 142,143 of256.http://books.google.co.in/books?id=v3_xmjYiX_QC&lpg=PP1&dq=Fundamentals%20of%20the%20futures%20market%20By%20Donna%20Kline%20open%20interest&pg=PA142#v=

onepage&q=open%20interest&f=false. Retrieved 2010-09-01.

[edit] External links

y Open Interest

In finance, an option is a derivativefinancial instrument that establishes a contract betweentwo parties concerning the buying or selling of an asset at a reference price during a specifiedtime frame. During this time frame, the buyer of the option gains the right, but not theobligation, to engage in some specific transaction on the asset, while the seller incurs theobligation to fulfill the transaction if so requested by the buyer. The price of an option derives

from the value of an underlyingasset (commonly a stock, abond, a currency or a futurescontract) plus a premium based on the time remaining until the expiration of the option. Other

types of options exist, and options can in principle be created for any type of valuable asset.

An option which conveys the right to buy something is called a call; an option which conveys

the right to sell is called a put. The price specified at which the underlying may be traded iscalled the strike price or exercise price. The process of activating an option and therebytrading the underlying at the agreed-upon price is referred to as exercisingit. Most options

have an expiration date. If the option is not exercised by the expiration date, it becomes voidand worthless.

In return for granting the option, called writingthe option, the originator of the optioncollects a payment, thepremium, from the buyer. The writer of an option must make good ondelivering (or receiving) the underlying asset or its cash equivalent, if the option is exercised.


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An option can usually be sold by its original buyer to another party. Many options are createdin standardized form and traded on an anonymous options exchange among the general

public, while otherover-the-counteroptions are customized to the desires of the buyer on anad hoc basis, usually by an investment bank.[1][2]

Contents[hide]

y 1 Option valuationy 2 Contract specificationsy