A securities market moves savers' money to businesses that need it, and lets savers get out whenever they want.
A security is a financial claim you can transfer to someone else. It is one of two things:
Companies, financial institutions and the government issue them. Investors buy them. The investor gets a return. The issuer gets money, at a cost. The words security, instrument and product mean the same thing in this book.
Have spare money. Want a return.
Turns savings into investment
Need money for productive use. Pay a cost for it.
Money flows right. Securities flow left.
This ability to buy and sell easily, close to the market price, is called liquidity.
They buy securities.
They sell (issue) securities.
Provide the pipes that move money and securities.
Keep the market orderly and growing.
"Securities" is defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA).
A unit linked insurance policy mixes life cover with investment and is issued by an insurer. It is not a security under SCRA.
Recent additionDeclared securities by gazette notification on 24 December 2021. An electronic receipt issued against physical gold deposited under SEBI rules.
Every product has a different mix of risk and return. The book gives each one an "ID card": who issues it, who invests, how it is sold, and who regulates it. The regulator is the part most likely to be asked.
A slice of the company. You share its risks and rewards.
You lent money. You get interest and your money back.
Right, not duty, to buy the company's shares later at a fixed price.
You own a slice of a basket someone else manages.
Part loan, part ownership. Preference shares, convertibles, DRs, FCCBs, ELDs, MBS, REITs.
Gold, oil, wheat. Same quality units that can be swapped for each other.
All three are loans. The names overlap, and the book says you cannot draw hard lines. Rough usage:
Debentures can be secured (backed by collateral) or unsecured.
Short-term debt (up to one year) has three instruments:
Issued by the government
Issued by companies with high credit ratings
Issued by banks
Four questions decide the name: Who issues? In which country? In what currency? What is that country's own currency?
Yes: Domestic bond.
No: it is an external bond. Go on.
Yes: Foreign bond. Indian firm sells USD bonds in the US.
No: Euro bond. Indian firm sells yen bonds in Germany (a Euro-yen bond).
That is a Masala bond. Sold outside India, priced in INR.
Two dates to remember: the first masala bond was issued in November 2014 by the International Finance Corporation and listed on the London Stock Exchange. The book's foreign bond example: Delhi International Airport (a GMR company) issued USD bonds in the US in February 2020.
A loan that may turn into shares. Terms are fixed at the time of issue.
Terms fixed at issue: conversion date, ratio (shares per debenture), price (usually below market price), and the portion that converts (for PCDs).
Called "shares", but they behave half like a loan.
Missing: no voting rights, no claim on leftover assets. Cumulative: unpaid dividend carries forward. Non-cumulative: unpaid dividend lapses.
A DR lets people in one country trade shares of a company from another country, in their own currency, on their own exchange.
A company or an investor gives shares to a depository (usually a foreign bank)
The depository keeps the shares with a custodian in the company's home country
The depository issues DRs to investors in the overseas market
The company starts it. Can be listed on an exchange, if listing rules are met.
An investor starts it. Usually not allowed on exchanges. Trades OTC only. Lighter regulation.
| Type | Traded in | Issued by | Book's example |
|---|---|---|---|
| ADR | USA | A non-US company | Infosys, Wipro, ICICI Bank, HDFC Bank |
| IDR | India | A non-Indian company | Standard Chartered Bank |
| HKDR | Hong Kong | A non-Hong Kong company | |
| GDR | More than one country | Any foreign company | Often issued in EU countries, since common rules make compliance easy |
DR holders get dividends and price gains, but no voting rights (SEBI is considering this). Two-way fungibility: shares can be turned into DRs and DRs back into shares, subject to rules.
Foreign Currency Convertible Bond. Usually optionally convertible, issued offshore. Interest and principal in foreign currency. After conversion, dividends are in rupees and the currency risk sits with the investor. Regulated by RBI under FEMA.
Interest depends on an equity index or shares. Most money goes into bonds to protect capital, the rest buys options for equity upside. Capital protection does not remove credit risk, so ELDs are rated.
Same idea as an ELD, linked to a commodity. Mostly gold and silver.
Bonds paid from loan repayments. MBS: home loans. ABS: auto loans, rent, credit card dues. Turns illiquid loans into tradable bonds (securitisation).
Pool of money in a portfolio. Unit value is the NAV.
Open-ended: buy from and sell to the fund anytime. No maturity.
Close-ended: fixed number of units. Must be listed, traded on the exchange.
Tracks an index, a commodity like gold, or a basket. Listed and traded in real time, even one unit. Passive, so lower expense ratio. Like open-ended funds (new units can be created) and like close-ended funds (trades on an exchange).
Trust investing in income-producing real estate. At least 80% of assets in real estate.
Trust investing in income-producing infrastructure. At least 90% of unit capital in such projects.
Both REITs and InvITs must pay out at least 90% of distributable cash flow to unit holders. Both are trusts that issue units and get tax benefits if they meet the rules.
A mutual fund or global asset manager sets up the ETF
A big broker or bank assembles the basket of assets and hands it to the sponsor
The participant gets units in return and sells them in the market
Trade units like ordinary shares
An index tracks the market using a sample of shares. Most big indices are market-cap weighted: bigger companies count for more. Shares are picked for liquidity, free float and market cap, and the list is reviewed from time to time.
50 stocks on NSE
30 stocks on BSE
40 stocks on MSEI
Five uses of an index: compare returns with gold or debt; benchmark for a fund; barometer of the economy or a sector; real-time mood of investors; base for index funds, futures and options.
A commodity is a basic good where every unit is the same, so units can be swapped.
Metals, crude oil
Grains, pulses
Commodities protect against inflation, but storage is costly. So people invest through:
Long life, low storage cost
The fund stores it. Gold ETFs are most common.
Professionals trade futures, not the goods
Proof you own stored goods. Usually negotiable: pass the receipt, pass the ownership.
Two parts that need each other:
Money goes to the issuer. Issuer deals directly with investors. Creates financial assets.
Money goes between investors. The issuer is not involved. Gives liquidity, which encourages people to buy in the primary market.
IPO: first ever sale of shares to the public. Mainly to raise equity for growth.
FPO: an already listed company offers shares to the public again. For growth, to repay debt, or to meet public shareholding rules.
OFS: existing holders sell their shares. No new shares, share capital unchanged, money goes to the sellers. Example: government disinvestment in PSUs.
Up to 50 investors, as per the book (Companies Act, 2013).
QIP: a listed company places shares with Qualified Institutional Buyers (FIs, mutual funds, banks and others).
Preferential issue: a listed company issues to a select person or group. SEBI rules on pricing, disclosure and lock-in apply.
Rights: buy more shares at a set price, in a ratio, as on the record date. Three choices: exercise, transfer to someone, or let lapse.
Bonus: free shares, instead of dividends. Needs enough retained earnings, which move to share capital.
Sweat equity: shares as a reward for contribution. Section 54, Companies Act, 2013. New shares, but raising money is not the goal. It keeps managers working in the owners' interest (the book calls this reducing agency risk).
ESOP: option to buy shares at a set price after a vesting period, usually more than a year. Employee gains only if the price rises above the exercise price.
Onshore = raised from investors in India. Offshore = raised from investors abroad.
Invests up to Rs 2,00,000 in the issue.
A QIB applying for Rs 10 crore or more in a book-built issue. Can get up to 60% of the QIB portion. Bids open one day before the IPO. Introduced in 2009. Strong anchor demand signals a good issue.
SEBI also sets IPO eligibility (net tangible assets, profitability, net worth), requires listing on a nationwide exchange, and requires shares in demat form.
Two ways to trade:
| Over-the-counter (OTC) | Exchange traded | |
|---|---|---|
| How the deal is made | Negotiated directly between the parties | Electronic order matching on the exchange |
| Who settles | The parties themselves | The clearing corporation |
| Default risk | Each party manages it alone | Clearing corporation guarantees settlement |
You place an order through a broker. The exchange matches buyers and sellers.
Work out each party's net dues for the period. The exchange sends trade details to the clearing house, which sends obligation reports to brokers and custodians.
Seller delivers shares. Buyer pays money. Miss the deadline and pay a penalty.
Guaranteeing every trade is risky for the clearing corporation, so it collects margins:
A long list. Sort it by what job each player does, and it is easy to hold.
Merchant bankers: SEBI-registered issue managers or lead managers. Single point of contact for the issuer. Plan the issue, price it, run it until listing, and coordinate other intermediaries.
Underwriters: promise to buy what the public does not. Hard underwriting = committed at the start. Soft = committed after pricing, with an exit clause.
Stock exchanges: NSE, BSE, MSEI (nationwide). Anonymous electronic order matching. Appoint clearing agencies and clearing banks.
Trading members (brokers): every exchange trade must go through one. Can be individuals, firms or companies.
Authorised persons: agents of a broker. Need prior exchange approval, per person and per segment.
Clearing corporation: legal counterparty to all exchange trades. Guarantees settlement. Can be part of the exchange or separate.
Clearing banks: every clearing member keeps an account here for money pay-in and pay-out.
Depositories: hold securities electronically. Two in India: NSDL and CDSL. Keep company-level accounts.
Depository participants (DPs): the depository's agents. Keep investor-level accounts. Appointed by the depository with SEBI approval.
Custodians: hold securities and funds for big institutions, settle their trades, track corporate actions.
Farmer Producer Organisations: farmer collectives (cooperatives, producer companies, societies) for better prices and market access.
Warehouse service providers: storage. Many registered with WDRA. Issue Negotiable Warehouse Receipts (NWRs).
Quality assayers: test and certify quality. Often accredited by WDRA. Their certificates are needed for NWRs.
Who can be a DP: public financial institutions, scheduled commercial banks, RBI-approved foreign banks, state financial corporations, custodians, stockbrokers, clearing corporations, NBFCs, and registrars and share transfer agents.
Set up outside India, invests in India. Must register with SEBI.
Overseas investors who do not register with SEBI. P-Notes are issued to them by SEBI-registered FPIs.
Pool money, fund manager decides. Diversification lowers risk.
Large corpus. Invest in equity, government securities and bonds.
Retirement money from employers and employees. Among the largest investors.
Early-stage firms with long-term potential. Bring expertise as well as money.
Growth, expansion, buy-outs. Includes VC. Investors are limited partners; managers are general partners.
Very wide mandate. The name is a misnomer: they are not necessarily hedged.
Employer pays 12% of basic salary, employee the same. Run by EPFO. Rate set yearly. Employees have no say in investments.
Government-sponsored retirement scheme. Buy an annuity at maturity, partial withdrawal allowed. Choice of funds.
Manage a wealthy family's money, tax, estate, even household payments. Single or multi-family.
Invest a company's spare cash. Small firms mostly use mutual funds.
Start-ups, early-stage, social ventures, SMEs, infrastructure. Includes VC funds and angel funds.
Not I or III. No borrowing except for day-to-day needs. Real estate funds, PE funds, distressed asset funds.
Leverage and derivatives. Hedge funds, PIPE funds.
An AIF is a privately pooled fund not already covered by other SEBI fund rules or by IRDAI, PFRDA or RBI.
Individuals trading for themselves. HNIs and UHNIs invest large sums. RBI lets NRIs, PIOs and QFIs invest directly under the automatic route.
Processors, manufacturers, importers and exporters whose margins depend on commodity prices.
Help investors with asset allocation and financial plans based on needs, horizon and risk.
Tell investors, mostly institutions, how to vote on company proposals.
T is the trade date. The number after it is how many days later money and goods change hands.
Same day. Like buying vegetables at the market.
Next day ("tomorrow"). Some FX deals settle this way.
Normally two business days after the trade. The global default for FX.
The book notes Indian exchanges have moved stocks to a T+1 cycle. For the exam, learn the three definitions above.
A derivative is a contract whose value comes from something else: a share, an index, wheat, an interest rate.
| Forward | Futures | Options | Swaps | |
|---|---|---|---|---|
| What it is | Agree today to buy or sell later at a fixed price | A forward with standard terms | Right, not obligation, to buy (call) or sell (put) | Swap cash flows by a set formula |
| Where | OTC | Exchange | OTC or exchange | OTC |
| Terms | Customised | Standard lot, quality, delivery date | Strike price, expiry | Notional amount, fixed and floating legs |
| Default risk | High. Relies on trust. | Clearing corp guarantees. Strict margins. | Buyer pays premium upfront | Counterparty |
| Book's example | Farmer sells wheat to a miller 6 months ahead | MCX wheat: 10 MT trading unit, physical delivery | Arvind buys a Nifty call from Salim | Borrower turns floating-rate loan into fixed |
Nifty on expiry:
Arvind breaks even at 11,100 (strike plus premium). His loss is capped at the Rs 100 premium. Salim's gain is capped at Rs 100.
Short term: hours, days, weeks. Based on price patterns (technical analysis), assuming history repeats. Book says traders have a higher probability of gains than speculators.
Buy or sell expecting a price change, usually short term. Based on private or insider information, or a view on fundamentals.
Take a position to offset losses on something you already hold. Aim is no gain, no loss. Motive is avoiding loss, not profit.
Buy and sell at the same time in two markets to profit from a price gap. Example: buy in spot, sell in futures. In an efficient market the gap closes fast.
Traders and speculators add liquidity. Both often use borrowed money, which magnifies gains and losses.
Taking a loan against your shares.
Holdings become book entries. Shares lose their distinctive numbers, folio and certificate numbers. One investor's shares cannot be told apart from another's.
On the investor's request, shares come back as certificates with distinctive numbers.
A company making a public issue must sign an agreement with all depositories, so investors can hold shares in demat form.
Tap the card to flip. On a keyboard: space flips, right arrow = got it, left arrow = again.
Scoring works like the real exam: +1 for a right answer, minus 0.25 for a wrong one, 0 for a skip. Skipping is allowed.