Indian Stock Market...

OVERVIEW OF INDIAN STOCK MARKET:

The working of stock exchanges in India started in 1875. BSE is the oldest stock market in India. The history of Indian stock trading starts with 318 persons taking membership in Native Share and Stock Brokers Association, which we now know by the name Bombay Stock Exchange or BSE in short. In 1965, BSE got permanent recognition from the Government of India. National Stock Exchange comes second to BSE in terms of popularity. BSE and NSE represent themselves as synonyms of Indian stock market. The history of Indian stock market is almost the same as the history of BSE.

 The 30 stock sensitive index or Sensex was first compiled in 1986. The Sensex is compiled based on the performance of the stocks of 30 financially sound benchmark companies. In 1990 the BSE crossed the 1000 mark for the first time. It crossed 2000, 3000 and 4000 figures in 1992. The reason for such huge surge in the stock market was the liberal financial policies announced by the then financial minister Dr. Man Mohan Singh.

The up-beat mood of the market was suddenly lost with Harshad Mehta scam. It came to public knowledge that Mr. Mehta, also known as the big-bull of Indian stock market diverted huge funds from banks through fraudulent means. He played with 270 million shares of about 90 companies. Millions of small-scale investors became victims to the fraud as the Sensex fell flat shedding 570 points. To prevent such frauds, the Government formed The Securities and Exchange Board of India, through an Act in 1992. SEBI is the statutory body that controls and regulates the functioning of stock exchanges, brokers, sub-brokers, portfolio managers investment advisors etc. SEBI oblige several rigid measures to protect the interest of investors. Now with the inception of online trading and daily settlements the chances for a fraud is nil, says top officials of SEBI. Sensex crossed the 5000 mark in 1999 and the 6000 mark in 2000. The 7000 mark was crossed in June and the 8000 mark on September 8 in 2005. Many foreign institutional investors (FII) are investing in Indian stock markets on a very large scale. The liberal economic policies pursued by successive Governments attracted foreign institutional investors to a large scale. Experts now believe the sensex can soar past 14000 mark before 2010.
The unpredictable behavior of the market gave it a tag – ‘a volatile market.’ The factors that affected the market in the past were good monsoon, Bharatiya Janatha Party’s rise to power etc. The result of a cricket match between India and Pakistan also affected the movements in Indian stock market. The National Democratic Alliance led by BJP, during 2004 public elections unsuccessfully tried to ride on the market sentiments to power. NDA was voted out of power and the sensex recorded the biggest fall in a day amidst fears that the Congress-Communist coalition would stall economic reforms. Later prime minister Man Mohan Singh’s assurance of ‘reforms with a human face’ cast off the fears and market reacted sharply to touch the highest ever mark of 8500.

India, after United States hosts the largest number of listed companies. Global investors now ardently seek India as their preferred location for investment. Once viewed with skepticism, stock market now appeals to middle class Indians also. Many Indians working in foreign countries now divert their savings to stocks. This recent phenomenon is the result of opening up of online trading and diminished interest rates from banks. The stockbrokers based in India are opening offices in different countries mainly to cater the needs of Non Resident Indians. The time factor also works for the NRIs. They can buy or sell stock online after returning from their work places. The recent incidents that led to growing interest among Indian middle class are the initial public offers announced by Tata Consultancy Services, Maruti Udyog Limited, ONGC and big names like that. Good monsoons always raise the market sentiments. A good monsoon means improved agricultural produce and more spending capacity among rural folk.
The bullish run of the stock market can be associated with a steady growth of around 6% in GDP, the growth of Indian companies to MNCs, large potential of growth in the fields of telecommunication, mass media, education, tourism and IT sectors backed by economic reforms ensure that Indian stock market continues its bull run.

TRADING PATTERN OF THE INDIAN STOCK MARKET:

Indian Stock Exchanges allow trading of securities of only those public limited companies that are listed on the Exchange(s). They are divided into two categories:

1.        Over The Counter Exchange of India (OTCEI):  Traditionally, trading in Stock Exchanges in India followed a conventional style where people used to gather at the Exchange and bids and offers were made by open outcry. This age-old trading mechanism in the Indian stock markets used to create much functional inefficiency. Lacks of liquidity and transparency, long settlement periods are a few examples that adversely affected investors. In order to overcome these inefficiencies, OTCEI was incorporated in 1990 under the Companies Act 1956. OTCEI is the first screen based nationwide stock exchange in India created by Unit Trust of India, Industrial Credit and Investment Corporation of India, Industrial Development Bank of India, SBI Capital Markets, Industrial Finance Corporation of India, General Insurance Corporation and its subsidiaries and Can Bank Financial Services.

      Advantages of OTCEI:

ü  Greater liquidity and lesser risk of intermediary charges due to widely spread trading mechanism across India

ü  The screen-based scrip less trading ensures transparency and accuracy of prices

ü   Faster settlement and transfer process as compared to other exchanges

ü   Shorter allotment procedure (in case of a new issue) than other exchanges

2.        National Stock Exchange:    In order to lift the Indian stock market trading system on par with the international standards. On the basis of the recommendations of high powered Pherwani Committee, the National Stock Exchange was incorporated in 1992 by Industrial Development Bank of India, Industrial Credit and Investment Corporation of India, Industrial Finance Corporation of India, all Insurance Corporations, selected commercial banks and others.NSE provides exposure to investors in two types of markets, namely:   Wholesale debt market and Capital market.

Trading at NSE

• Fully automated screen-based trading mechanism.

• Strictly follows the principle of an order-driven market.

• Trading members are linked through a communication network.

• This network allows them to execute trade from their offices.

• The prices at which the buyer and seller are willing to transact will appear on the screen.
• When the prices match the transaction will be completed, a confirmation slip will be printed at the office of the trading member.

Advantages of trading at NSE

ü  Integrated network for trading in stock market of India

ü  Fully automated screen based system that provides higher degree of transparency

ü  Investors can transact from any part of the country at uniform prices

ü  Greater functional efficiency supported by totally computerized network.

IMPACT OF FII ON INDIAN STOCK MARKET:

The Indian government has established a regulatory framework for three separate investment avenues: foreign direct investment; investment by foreign institutional investors; and investment by foreign venture capital investors. While these investment alternatives have created clear avenues for foreign investment in India, they remain subject to many conditions and restrictions which continue to hamper foreign investment in India.

Foreign direct investment is proven to have well-known positive effect through technology spillovers and stable investments tied to plant and equipment, but portfolio capital is associated more closely with volatility and its capacity to be triggered by both domestic as well as exogenous factors, making it extremely difficult to manage and control. Chakrabarti (2001) has examined in his research that following the Asian crisis and the bust of info-tech bubble internationally in 1998-99 the net FII has declined by US$ 61 million. But there was not much effect on the equity returns. This negative investment would possibly disturb the long-term relationship between FII and the other variables like equity returns, inflation, etc. has marked a regime shift in the determinants of FII after Asian crisis. The study found that in the pre-Asian crisis period any change in FII found to have a positive impact on the equity returns. But in the post-Asian crisis period it was found the reverse relation that change in FII is mainly due to change in equity returns.

FIIs have played a very important role in building up India’s forex reserves, which have enabled a host of economic reforms. FIIs are now important investors in the country’s economic growth despite sluggish domestic sentiment. The Morgan Stanley report notes that FII strongly influence short-term market movements during bear markets. However, the correlation between returns and flows reduces during bull markets as other market participants raise their involvement reducing the influence of FIIs. The correlation between foreign inflows and market returns is high during bear and weakens with strengthening equity prices due to increased participation by other players.

The equity return has a significant and positive impact on the FII. But given the huge volume of investments, foreign investors could play a role of market makers and book their profits, i.e., they can buy financial assets when the prices are declining thereby jacking-up the asset prices and sell when the asset prices are increasing. Hence, there is a possibility of bi-directional relationship between FII and the equity returns.

India opened its doors to foreign institutional investors in September, 1992. This event represents a landmark event since it resulted in effectively globalizing its financial services industry. The decision to open up the Indian financial market to FII portfolio flows was influenced by several factors such as the disarray in India's external finances in 1991 and a disorder in the country's capital market. Aimed primarily at ensuring non-debt creating capital inflows at a time of an extreme balance of payment crisis and at developing and disciplining the nascent capital market, foreign investment funds were welcomed to the country. 

What is Derivative

Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a
Transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying". In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines "derivative" to include-
1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying securities.
DERIVATIVE PRODUCTS
Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps. We take a brief look at various derivatives contracts that have come to be used.
Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today's pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.
Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
Warrants: Options generally have lives of upto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter.
LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years.
Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options.
Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:
Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.
Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.

Risk Minimisation of portfolio........

Taking in to account the past market conditions, each and every individual who was dealing with stock market was very worried . Investor might have invested his savings in the stock market either directly or indirectly.His objective was to minimise his own portfolio risk. Now the qusetions come that " how an individual could minimise his own portfolio risk.
Diversification is the way by which you can minimise your portfolio risk. Investors portfolio has to be diversified. Rather than investing his entire savings in a single company, he must invest small small amounts in different different sectors. One can not predict/forecast future market conditions. So in case rate of return is not as good as you would have wished it may be compensated by heavy profits in some different sector. Your loss can not be compensated untill and unless you have diversified your portfolio. So one must put in his money in different sectors such as IT Sector, Telecom Sector, Pharma Sector , Real Estate Sector etc in order to minimise the portfolio risk.
In case you are investing indirestly in the stock market such as insurance sector, here again one must be acting as aFund Manager. Rather than putting in entire money in one fund say Equity Fund, one must ensure proper debt equity ratio. Taking in to consideration good market conditons no doubt you may put your bulk savings in Equity fund but at the same time must ensure certain savings in debt fund just to secure your money.in this case your ratio may be 85:15 . As soon market conditions get worst you must understand the neccesity of Switching. Switching is just transfering of your money from one fund to another. in this case you must switch from equity fund to debt fund immideately so that your 85% money do not get affected by those adverse market conditions. IIn this case your debt -equity ratio may be 10:90.Again as soon market gets better switch again i.e from debt fund to equity by ensuring some proper debt - equity ratio.Debt funds comprises of many funds such as Protector, preserver etc. Similarly Equity fund comprises of Multiplier, Rich, Balancer, Flexi Growth, etc.Different funda are associated with different NAV which fluctuate in the stock market on daily basis. Again by seeing fund performance of various funds you can mamange your own portfolio and hense can minimise the risk by the way of switching at right time.Thus we can say the way to minimize the portfolio risk is to diversify the portfolio.