Security Market in India: Markets, Instruments and Investment Strategies

India’s Security Market: Facilitating Capital Flow and Resource Allocation #

• Securities are financial instruments issued to raise funds via issue of bonds, debentures, mutual funds etc.
• Security market is a component of the wider financial market where securities can be bought and sold on the basis of demand and supply
• The primary function of the securities market is:

1. To enable the flow of capital from those that have it to those that need it.
2. To help in transfer of resources from those with idle resources to others who have a productive need for them.
3. To provide channels for enhancing savings and investment in the economy.

Distinctions between Debt vs. Equity in the Security Market  #

Various Types of Financial Markets  #

How do Brokers, Jobbers and Market-Makers impact Security Markets Within Financial Markets? #

Essential Terms in Security Markets: From Scrip Shares to Rolling Settlements #

How do Primary and Secondary Markets impact Capital and Liquidity in Security Markets?  #

Initial Public Offering (IPO) Process: Transitioning Companies to Public Trading in Security Markets #

• IPO is the selling of securities to the public in the primary market.
• Through an IPO, an unlisted company can get listed on the stock exchange.
• It is a process by which a privately held company becomes a publicly-traded company by offering its shares to the public for the first time.

Issuers in the Indian Security Market: Organizations Raising Capital through Securities #

• Issuers are organizations that raise money by issuing securities. They issue securities based on their need, their ability to service the securities.
• Some of the common issuers in the Indian Securities Markets are:

What is the significance of Stock Exchanges in Security Markets? #

• A Stock Exchange is a marketplace, where financial securities issued by companies are bought and sold, after they have been issued in the primary market.
• In India BSE and NSE are two main stock exchanges:

Role of Stock Exchanges in Security Markets

• Providing Liquidity and Marketability for the securities which are traded.
• Responsible for evaluation of stock prices- based on demand and supply of stock.
• Safeguards investors- There is a proper checks and balance in the exchange.
• Contributes to Economic Growth.
• Acts as a barometer for a country’s economy.
• Broader range of investment avenues.
• Providing Scope for Speculation within the provisions of law

Commodity Trading in Security Markets #

• Commodity exchanges trade in futures contracts in commodities such as food, energy or metals
• They are risky investments as their market is impacted by uncertainties such as unusual weather, epidemics, and disasters etc.

Spot Exchange Dynamics in Security Markets #

• The spot market is a commodity/security market where goods are sold for cash and delivered immediately or within a short span of time. E.g.- Oil, coal etc.
• Enables trading in a transparent way and better price discovery.
• Trades are completed on spot.
• It eliminates the scope of cartelization.

Foreign Investments in Security Markets: Comparing FDI, FPI, and FII  #

Foreign Direct Investment (FDI) Regulations: Impact on Security Markets and Economic Growth #

• Foreign investment was introduced in 1991 under Foreign Exchange Management Act (FEMA).
• There are two routes for FDI –
• Automatic route: FDI is allowed without prior approval by Government/ RBI.
• Government route: With Govt. approval
• Investment is permitted through government route only in the following cases:

1. An entity situated in a country which shares a land border with India.
2. Where the owner of investment into India is situated in or is a citizen of any such country.
3. Any transfer of ownership of any FDI in an entity in India leading in beneficial ownership falling within the purview of the above restrictions.

• The Foreign Investment Facilitation Portal (FIFP), administered by the Department for Promotion of Industry and Internal Trade (DPIIT) UNDER MINISTRY OF COMMERCE facilitates the single window clearance of applications which are through approval route.

• India (2019-20) received the maximum FDI equity inflow from:

What is the function of Credit Default Swaps (CDS) in transferring Credit Risk within Security Markets? #

CDS is a credit derivative that can be used to transfer credit risk from the investor exposed to the risk (called protection buyer) to an investor willing to take risk (called protection seller). 

How does Securitization transform Financial Assets into Marketable Securities in Security Markets? #

• Securitization is a process by which a company clubs its different financial assets/debts to form a consolidated financial instrument which is issued to investors.
• In return, the investors in those securities get interest.
• This helps them get liquid cash out of assets that otherwise would be stuck on their balance sheets.
• Derivatives are generated by the process of securitization.

Derivatives: Financial Instruments Tied to Underlying Assets in Security Markets #

A derivative is a financial security with a value that is derived from an underlying asset like stocks, bonds, commodities, currencies, interest rates, and market indexes. 

Options: Rights and Obligations in Security Markets #

This contract grants the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. Two types of options:

1. Call option– gives the holder the right to buy a stock
2. Put option– gives the holder the right to sell a stock.

Swap Contracts: Cash Flow Exchanges in Security Markets #

Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific period of time. 

What are Participatory Notes (P-Notes) and their impact on Security Markets? #

• P-notes are Offshore Derivative Instruments (ODIs) issued by registered Foreign Portfolio Investors (FPIs) to overseas investors who wish to be a part of the Indian stock markets without registering themselves directly.
• P-notes have Indian stocks as their underlying assets.
• Though P-note holders have less stringent registration requirements, they have to go through a proper due diligence process of the Securities and Exchange Board of India (SEBI).
• Concerns:

Bonds: Debt Instruments in Security Markets  #

BOND:

• In finance, a bond is an instrument of indebtedness of the bond issuer to the holders.
• The bond is a debt security, under which the issuer owes the holders a debt and (depending on the terms of the bond) is obliged to pay them interest (the coupon) or to repay the principal at a later date, termed the maturity date.
• Bonds are fixed income instruments that represent a loan made by an investor to a borrower.
• These bonds have a maturity date and when that is attained, the issuing company needs to pay back the amount to the investor along with a part of the profit.
• Bond prices are inversely correlated with interest rates: when rates go up, bond prices fall and vice-versa.

Bond Yields: Effective Returns in Security Markets #

• The yield of a bond is the effective rate of return that it earns. But the rate of return is not fixed — it changes with the price of the bond.

What is the significance of Yield Curves in Security Markets? #

• A yield curve is a graphical representation of yields for bonds (with an equal credit rating) over different time horizons. Typically, the term is used for government bonds — which come with the same sovereign guarantee. So the yield curve for US treasuries shows how yields change when the tenure (or the time for which one lends to the government) changes.

What is Yield Inversion and its implications for Security Markets? #

• Yield inversion happens when the yield on a longer tenure bond becomes less than the yield for a shorter tenure bond.
• A yield inversion typically portends a recession. An inverted yield curve shows that investors expect the future growth to fall sharply; in other words, the demand for money would be much lower than what it is today and hence the yields are also lower.

Distinctive Bond Types Across Global Markets  #

Investment Funds: Mutual Funds vs. REITs/InvITs in Security Markets  #

How do Venture Capital Funds impact Security Markets? #

• VCF is an investment fund that manages money from different investors seeking to provide capital in startups and small and medium-size enterprises that have strong growth potential.
• According to SEBI, VCF is a fund established in the form of a trust/company including a body corporate and registered with SEBI. The VCF will have a dedicated pool of capital, raised in the specified manner and invested by following regulations of SEBI.
• The objective of the venture capital financing is to invest in high-risk projects with the anticipation of high returns.

Impact of Social Venture Funds on Security Markets #

• The National Innovation Council, in partnership with the Ministry of Micro, Small and Medium Enterprises (MSME), launched the India Inclusive Innovation Fund (IIIF), an impact investment fund that will invest in ventures catering to the country’s poor.
• The Rs 500-crore fund, which will be registered under market regulator SEBI’s Alternative Investment Fund regulations as a Category –I venture capital fund, will invest in social ventures operating in areas such as healthcare, food, nutrition, agriculture, education and skill development, energy, financial inclusion, water, sanitation and employment generation.

Liquid Alternative Investments in the Security Markets #

Funds which operate similarly to hedge funds but are regulated similarly to mutual funds are available and known as liquid alternative investments. 

ESG (Environmental, Social, and Governance) Funds in the Security Markets #

• It is a kind of mutual fund. Its investing is used synonymously with sustainable investing or socially responsible investing.
• While selecting a stock for investment, the ESG fund shortlists companies that score high on environment, social responsibility and corporate governance, and then looks into financial factors.
• The fund is regulated by Securities and Exchange Board of India (SEBI).
• The first ESG mutual fund was launched by the State Bank of India – SBI Magnum Equity ESG Fund.

VIX- Market Volatility in the Security Markets #

• VIX (Volatility index) is an index used to measure the near term volatility expectations of the markets.
• Volatility signifies the rate and magnitude of change in the stock price or index value.
• India VIX- was launched by National Stock Exchange (NSE) in 2010.
• India VIX indicates the Indian market’s volatility from the investor’s perception.
• Volatility and the value of India VIX move parallel. i.e. a spike in the VIX value means the market is expecting higher volatility in the near future and vice versa.

Depository Receipts in the Security Markets #

• Depository Receipts are negotiable financial instruments issued by a company in a foreign jurisdiction.
• It is a mechanism for raising funds by tapping foreign investors who otherwise may not be able to participate in the domestic market.

Different types of Depository Receipts in the Security Markets  #

Key Concepts in the Security Market #

• SOCIAL STOCK EXCHANGE– A SSE is a platform where social enterprises can raise funds from the public under the regulatory ambit of SEBI.
• OPERATION TWIST– RBI’s simultaneous sales and purchases of government securities, sale of short-term securities to buy long-term government debt instruments, to bring long term yields lower.
• Under this mechanism, the short-term securities are transitioned into long-term securities.
• Operation Twist was first used in 1961 by the US Federal Reserve (central bank) as a way to strengthen the U.S. dollar and stimulate cash flow into the economy.
• Impact– people can avail long-term loans (such as buying houses, cars or financing projects) at lower rates. This will lead to a boost in consumption and spending in the economy which in turn will revive the growth.
• PUBLIC CREDIT REGISTRY–
• PCR is a database of credit information for India that is accessible to all stakeholders.
• Helps banks in credit assessment and pricing and making risk-based provisioning.
• The Y M Deosthalee committee suggested PCR.
• INSIDER TRADING- It is a malpractice where trade of securities is done based on non-public information/confidential information. It is illegal.
• UNDERWRITER- An individual or an institution who undertakes the risk associated with investment/loan in lieu of a premium.
• HEDGING- It is a financial strategy for risk management to offset/minimize/reduce the losses in investments due to adverse price movements.
• DATED SECURITIES – Long term securities or bonds of the government that carries a fixed or floating coupon (interest rate). Securities are issued by the government (centre or state) for mobilizing funds. The interest payment is fixed and is a percentage of the face value of the security. Interest is paid at regular intervals (usually half-yearly). The tenor of dated securities can be up to 30 years. But the most common tenure is five years and ten years.
• GILT EDGED SECURITIES– Government securities are instruments issued by the government to borrow money from the market. They are also known as gilts or gilt edged securities. “Government security” means a security created and issued by the Government. They have zero income default. There is a high rate of return. There is cent per cent liquidity.
• Short term government securities are Treasury bills. They have a maturity of less than one year. There are three main treasury bills in India – 91 day, 182 day and 364 day.
• Long term government securities are known as government bonds or dated securities. They have a maturity period of five years, ten years, fifteen years etc.
• SOVEREIGN BONDS – A sovereign bond is a specific debt instrument issued by the government. They can be denominated in both foreign and domestic currency. Just like other bonds, these also promise to pay the buyer a certain amount of interest for a stipulated number of years and repay the face value on maturity. The Yield of the bonds are dependent on primarily 3 factors:

1. Creditworthiness– the issuing countries’ perceived ability to repay their debts; this can be obtained from rating agencies
2. Country risk– external/internal factors like unrest and wars tend to jeopardize a country’s ability to pay off their debts
3. Exchange rates– in cases where bonds are issued in foreign currency, fluctuations in exchange rate may lead to increased pay out pressure on the issuing government

• REDEEMABLE BOND – A callable bond, also known as a redeemable bond, is a bond that the issuer may redeem before it reaches the stated maturity date. A callable bond allows the issuing company to pay off their debt early.
• SOCIAL IMPACT BONDS – A Social Impact Bond is also called pay-for-success bond or pay-for-success financing. A Social Impact Bond is basically a contract with public sector authority where it pays for better social outcomes. It is a form of outcome-based contracting. It aims at improving social outcomes for a specific group of citizens.

Key Regulators in the Security Markets  #