Chapter 4- What does the Share Market consist of: Exchanges, Indices, SEBI, Types of Markets, Blue Chips and Mid Caps
The Stock Exchange
The Stock Exchange (also called the Stock Market) is the marketplace where Shares and Securities are traded. Securities, as we mentioned before, is the broad term covering Shares/Stock and Debentures/Bonds. So, a Stock Exchange would facilitate purchase and sale of all of these. Unlike other markets, one is not permitted to buy and sell shares directly in the Stock Market – one has to do so through a Stockbroker. The Stockbroker is a licensed member of the Stock Exchange and is authorized to buy and sell shares on our behalf on a commission basis. This commission is called ‘Brokerage’.
Companies have to list their Securities with one or more Stock Exchanges for them to be eligible for trading. At the time of writing, there are 23 Stock Exchanges in the country. However the most popular ones are both in Mumbai, The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
The Stock Exchange, Mumbai, popularly known as “BSE” was established in 1875 as “The Native Share and Stock Brokers Association”. It is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was established in 1878. It is a voluntary non-profit making Association of Persons (AOP) and is currently engaged in the process of converting itself into demutualised and corporate entity. It has evolved over the years into its present status as the premier Stock Exchange in the country. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. of India under the Securities Contracts (Regulation) Act, 1956. Read More…
The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges, which recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country. On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June 2000. Read more…
Market Regulatory Body – SEBI (Securities and Exchange Board of India)
Securities & Exchange Board of India (SEBI) formed under the SEBI Act, 1992 – is the body that is responsible for protecting the interests of investors in securities, promoting the development of, and regulating, the securities market. The SEBI Act came into force on 30th January, 1992 and with its establishment, all public issues are governed by the rules & regulations issued by SEBI.
SEBI was formed to promote fair dealing in issue of securities and to ensure that the capital markets function efficiently, transparently and economically in the better interests of both the issuers and the investors. The promoters of a company should be able to raise funds at a relatively low cost. At the same time, investors must be protected from unethical practices and their rights must be safeguarded so that there is a steady flow of savings into the market. There must be proper regulation and code of conduct and fair practice by intermediaries to make them competitive and professional. Read More…
Stock Exchange Index
A Stock Exchange Index is a number which is calculated using various methods and whose purpose is to reveal the performance of the entire market. A Stock Exchange Index is created by selecting a group of stocks that are representative of the whole market or a specified sector or segment of the market. An Index is calculated with reference to a base period and a base index value. The most widely followed Stock Indices in India are the SENSEX and NIFTY.
The Bombay Stock Exchange, Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market. This was called the SENSEX. The SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. First compiled in 1986, SENSEX is a basket of 30 constituent stocks representing a sample of large, liquid and representative companies. The base year of SENSEX is 1978-79 and the base value is 100.
Due to its wide acceptance amongst the Indian investors; SENSEX is regarded to be the pulse of the Indian stock market. As the oldest index in the country, it provides the time series data over a fairly long period of time (From 1979 onwards). Right from early nineties the stock market witnessed heightened activity in terms of various Bull and Bear runs (explained later). The SENSEX captured all these events in the most judicial manner. One can identify the booms and busts of the Indian stock market through SENSEX.
SENSEX was initially calculated based on the “Full Market Capitalization” methodology but was shifted to the “Free-Float” methodology with effect from September 1, 2003. The “Free-float Market Capitalization” methodology of index construction is regarded as an industry best practice globally. Free-float Methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in Index. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market. It generally excludes promoters’ holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course.
The base period of SENSEX is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time.
The S&P CNX Nifty (called NIFTY for Short) is the Index used to represent the overall performance of the stocks trading at NSE. The NIFTY was designed based upon solid economic research. A trillion calculations were expended to evolve the rules for the Nifty index. The results of this effort were remarkably simple: (a) the correct size to use is 50 (b) stocks considered for the S&P CNX Nifty must be liquid by the `impact cost’ criterion, (c) the largest 50 stocks that meet the criterion go into the index.
The design of the S&P CNX Nifty was a contrast to the adhoc methods that had gone into index construction in the preceding years, where indexes were made out of intuition and lacked a scientific basis. The research that led up to S&P CNX Nifty is well respected internationally as a pioneering effort in better understanding how to make a stock market index.
BULL & BEAR MARKET
A Bull Market is a prolonged period in which investment prices rise faster than their historical average. Bull markets can happen as a result of an economic recovery, an economic boom, or investor psychology. Conversely, a Bear Market is a prolonged period in which investment prices fall, accompanied by widespread pessimism. Bear markets usually occur when the economy is in a recession and unemployment is high, or when inflation is rising quickly.
If the period of falling stock prices is short and immediately follows a period of rising stock prices, it is instead called a correction. Another interesting term (though not used as frequently) is Chicken Market – which just signifies a prolonged period where the market doesn’t move up or down significantly and just hovers around a single value.
Blue Chips are generally the stocks of very large companies with a solid record of stable earnings and/or dividend growth and a reputation for high quality management and/or products. More generally, a Blue Chip is anything of very high quality. Some Indian Blue Chips would be Infosys, Reliance, HDFC, HLL, ITC and ONGC. Some Internationally traded Blue Chips would be Procter & Gamble, Gillette, Pfizer, IBM, Intel and GE. The term blue chip usually refers to a stock, but could in theory apply to any financial asset with potential risk. A blue chip stock is one that entails unusually small risk (risk being a subjective judgment).
To explain Mid Cap we would first need to explain “Market Capitalization”. Market capitalization is calculated by multiplying the current stock price (CMP) with the number of shares outstanding or issued by the company. The definition of mid-cap shares can vary from market to market and from country to country.
In case of India, the National Stock Exchange (NSE) defines the mid-cap universe as stocks whose average six months’ market capitalization is between Rs 75 Crores and Rs 750 Crores. In the US, mid-cap shares are those stocks that have a market capitalization ranging from 1 Billion Dollars to 5 Billion Dollars. In India, these shares would be classified as large-cap shares. Thus, classification of shares into large-cap, mid-cap, small-cap is made on the basis of the relative size of the market in the country. The total market capitalization of US markets is $15 trillion. In India, the market capitalization of listed companies is around $600 Billion.
Large-cap shares have lesser growth potential since the turnover and profits of large companies are already high in the context of that particular market. On the other hand, mid-cap shares are considered an attractive investment avenue because their growth rate should be faster. It is analogous to investing in an emerging market like India compared to a mature market.