ZERODHA

Introduction to
Stock Markets
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 TABLE OF CONTENTS

1 The Need to Invest 1

1.1 Why should one invest 1
1.2 Where to invest 3
1.3 Fixed income instruments 5
1.4 Equity 5
1.5 Real estate 6
1.6 Commodity - Bullion 6
1.7 A note on investments 7
1.8 What are the things to know before investing 7

2 Regulators 9
2.1 What is a stock market? 9
2.2 Stock market participants and the need to regulate them 10
2.3 The Regulator 11

3 Financial Intermediaries 15
3.1 Overview 15
3.2 The Stock broker 16
3.3 Depository and Depository Participants 17
3.4 Banks 18
3.5 NSCCL and ICCL 18

4 The IPO Markets - Part 1 21

4.1 Overview 21
4.2 Origin of a business 21

5 The IPO Markets - Part 2 32

5.1 Overview 32
5.2 Why do companies go public 33
5.3 Merchant bankers 34
5.4 IPO sequence of events 35
5.5 What happens after the IPO 36
5.6 Few IPO Jargons 36
5.7 Recent IPO’s in India 37

6 The Stock Markets 40

6.1 Overview 40
6.2 What really is the stock market ? 41
6.3 What moves the stock ? 42
6.4 How does the stock get traded ? 44
6.5 What happens after you own a stock ? 45
6.6 A note on the holding period 45
6.7 How to calculate returns ? 46
6.8 Where do you fit in ? 47

7 The Stock Markets Index 50

7.1 Overview 50
7.2 The Index 51
7.3 Practical uses of the Index 51
7.4 Index construction methodology 53
7.5 Sector specific indices 57

8 Commonly used Jargons 59

9 The Trading Terminal 65

9.1 Overview 65
9.2 The Login Process 66
9.3 The Market Watch 66
9.4 Buying a stock through the trading terminal 69
9.5 The order book and Trade book 71
9.6 The Bid and Ask price 75
9.7 Conclusion 77

10 Clearing and Settlement process 79

10.1 Overview 79
10.2 What happens when you buy a stock 80
10.3 What happens when you sell a stock 82

11 Five corporate actions and its impact on stock prices 84

11.1 Overview 84
11.2 Dividends 85
11.3 Bonus Issue 86
11.4 Stock split 87
11.5 Rights issue 88
11.6 Buyback of shares 88

12 Key Events and Their Impact on Markets 91

12.1 Overview 91
12.2 Monetary policy 92
12.3 Inflation 93
12.4 Index of Industrial Production 94
12.5 Purchasing Manager index 95
12.6 Budget 95
12.7 Corporate Earnings Announcement 96
13 Getting started 99
13.1 So many modules - how are they interrelated 100
 C H A PT E R 1

The Need to Invest

1.1 - Why should one Invest?

Before we address the above question, let us understand what would happen if one choose not
to invest. Let us assume you earn Rs.50,000/- per month and you spend Rs.30,000/- towards your
cost of living which includes housing, food, transport, shopping, medical etc. The balance of
Rs.20,000/- is your monthly surplus. For the sake of simplicity, let us just ignore the effect of per-
sonal income tax in this discussion.

1. To drive the point across, let us make few simple assumptions.

2. The employer is kind enough to give you a 10% salary hike every year
3. The cost of living is likely to go up by 8% year on year
4. You are 30 years old and plan to retire at 50. This leaves you with 20 more years to earn
5. You don’t intend to work after you retire
6. Your expenses are fixed and don’t foresee any other expense
7. The balance cash of Rs.20,000/- per month is retained in the form of hard cash
Going by these assumptions, here is how the cash balance will look like in 20 years as per Table
1.1

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Table 1.1 - Total cash balance in twenty years
If one were to analyze these numbers, you would soon realize this is a scary situation to be in.

Years Yearly income Yearly expense Cash retained

1 600,000 360,000 240,000

2 6,60,000 3,88,800 2,71,200

3 7,26,000 4,19,904 3,06,096

4 7,98,600 4,53,496 3,45,104

5 8,78,460 4,89,776 3,88,684

6 9,66,306 5,28,958 4,37,348

7 10,62,937 5,71,275 4,91,662

8 11,69,230 6,16,977 5,52,254

9 12,86,153 6,66,335 6,19,818

10 14,14,769 7,19,642 6,95,127

11 15,56,245 7,77,213 7,79,032

12 17,11,870 8,39,390 8,72,480

13 18,83,057 9,06,541 9,76,516

14 20,71,363 9,79,065 10,92,298

15 22,78,499 10,57,390 12,21,109

16 25,06,349 11,41,981 13,64,368

17 27,56,984 12,33,339 15,23,644

18 30,32,682 13,32,006 17,00,676

19 33,35,950 14,38,567 18,97,383

20 36,69,545 15,53,652 21,15,893

Total Income 17,890,693

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Few things are quite startling from the above calculations:

1. After 20 years of hard work you have accumulated Rs.1.7 Crs.

2. Since your expenses are fixed, your lifestyle has not changed over the years, you probably
even suppressed your lifelong aspirations – better home, better car, vacations etc
3. After you retire, assuming the expenses will continue to grow at 8%, Rs.1.7 Crs is good
enough to sail you through roughly for about 8 years of post retirement life. 8th year onwards
you will be in a very tight spot with literally no savings left to back you up.
What would you do after you run out of all the money in 8 years time? How do you fund your life?
Is there a way to ensure that you collect a larger sum at the end of 20 years?

Let’s consider another scenario as per Table 1.2 in the following page where instead of keeping
the cash idle, you choose to invest the cash in an investment option that grows at let’s say 12%
per annum. For example – in the first year you retained Rs.240,000/- which when invested at 12%
per annum for 20 years yields Rs.2,067,063/- at the end of 20th year.

With the decision to invest the surplus cash, your cash balance has increased significantly. The
cash balance has grown to Rs.4.26 Crs from Rs.1.7 Crs. This is a staggering 2.4x times the regular
amount. This translates to you being in a much better situation to deal with your post retirement
life.
Now, going back to the initial question of why invest? There are few compelling reasons for one to
invest..

1. Fight Inflation – By investing one can deal better with the inevitable – growing cost of living –
generally referred to as Inflation
2. Create Wealth – By investing one can aim to have a better corpus by the end of the defined
time period. In the above example the time period was upto retirement but it can be anything
– children’s education, marriage, house purchase, retirement holidays etc
3. To meet life’s financial aspiration

1.2 - Where to invest?

Having figured out the reasons to invest, the next obvious question would be – Where would one
invest, and what are the returns one could expect by investing.

When it comes to investing one has to choose an asset class that suits the individual’s risk and
return temperament.

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Table 1.2 - Cash invested at 12% per annum

Retained Cash
Years Yearly income Yearly expense Cash retained
Invested @12%

1 600,000 360,000 240,000 20,67,063

2 6,60,000 3,88,800 2,71,200 20,85,519

3 7,26,000 4,19,904 3,06,096 21,01,668

4 7,98,600 4,53,496 3,45,104 21,15,621

5 8,78,460 4,89,776 3,88,684 21,27,487

6 9,66,306 5,28,958 4,37,348 21,37,368

7 10,62,937 5,71,275 4,91,662 21,45,363

8 11,69,230 6,16,977 5,52,254 21,51,566

9 12,86,153 6,66,335 6,19,818 21,56,069

10 14,14,769 7,19,642 6,95,127 21,58,959

11 15,56,245 7,77,213 7,79,032 21,60,318

12 17,11,870 8,39,390 8,72,480 21,60,228

13 18,83,057 9,06,541 9,76,516 21,58,765

14 20,71,363 9,79,065 10,92,298 21,56,003

15 22,78,499 10,57,390 12,21,109 21,52,012

16 25,06,349 11,41,981 13,64,368 21,46,859

17 27,56,984 12,33,339 15,23,644 21,40,611

18 30,32,682 13,32,006 17,00,676 21,33,328

19 33,35,950 14,38,567 18,97,383 21,25,069

20 36,69,545 15,53,652 21,15,893 21,15,893

TOTAL CASH AF
FTER 20 YEARS 4,26,95,771

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An asset class is a category of investment with particular risk and return characteristics. The fol-
lowing are some of the popular assets class…

1. Fixed income instruments

2. Equity
3. Real estate
4. Commodities (precious metals)

Fixed Income Instruments

These are investable instruments with very limited risk to the principle and the
return is paid as an interest to the investor based on the particular fixed income
instrument. The interest paid, could be quarterly, semi-annual or annual inter-
vals. At the end of the term of deposit, (also known as maturity period) the capital
is returned to the investor.

Typical fixed income investment includes:

1. Fixed deposits offered by banks

2. Bonds issued by the Government of India
3. Bonds issued by Government related agencies such as HUDCO, NHAI etc
4. Bonds issued by corporates
As of June 2014, the typical return from a fixed income instrument varies between 8% and 11%.

Equity
Investment in Equities involves buying shares of publicly listed companies. The
shares are traded both on the Bombay Stock Exchange (BSE), and the Na-
tional Stock Exchange (NSE).

When an investor invests in equity, unlike a fixed income instrument there is no capital guaran-
tee. However as a trade off, the returns from equity investment can be extremely attractive. In-
dian Equities have generated returns close to 14% – 15% CAGR (compound annual growth rate)
over the past 15 years.

Investing in some of the best and well run Indian companies has yielded over 20% CAGR in the
long term. Identifying such investments opportunities requires skill, hard work and patience.

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