Chapter 4:
STOCK MARKET AND
STOCK SELECTION
Ashel Rebello, Assistant Professor, Dept. of Co 1
mmerce, SAC
Stock markets
Ashel Rebello, Assistant Professor, Dept. of Co 2
mmerce, SAC
What are Securities?
1. Equity Shares
2. Preference Shares
3. Debentures / Bonds
4. Mutual Fund Units
5. Government Securities
6. Others
What are not Securities?
7. Fixed deposit with banks or companies
8. Insurance policies
9. Provident Fund / Public Provident Fund
Ashel Rebello, Assistant Professor, Dept. of Co 3
mmerce, SAC
What is Securities Market?
1. Market is a place where things are bought and sold.
2. Securities market is a market where securities are bought
and sold.
3. There are various participants / agents / entities and
products in the securities market.
4. Securities Market is part of Capital Market.
Ashel Rebello, Assistant Professor, Dept. of Co 4
mmerce, SAC
CAPITAL AND MONEY MARKET
In money market , instruments like T-bills,
certificate of deposit are traded. These are all
instruments of short term nature
In capital market, instruments like equity , bonds
are traded. These are all instrument of long term
nature (more than one year)
Ashel Rebello, Assistant Professor, Dept. of Co 5
mmerce, SAC
Why is Securities Market essential?
1. Provide opportunity for
entrepreneurs to raise
capital for business.
2. For investors, stock
markets provide a way to
invest money and exit
when they want.
Ashel Rebello, Assistant Professor, Dept. of Co 6
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 7
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 8
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 9
mmerce, SAC
What are the different kinds of
issues?
Initial Public Offering (IPO) is when an unlisted company
makes either a fresh issue of securities or an offer for sale
of its existing securities or both for the first time to the
public. This paves way for listing and trading of the issuer’s
securities.
A follow on public offering (Further Issue) is when an
already listed company makes either a fresh issue of
securities to the public or an offer for sale to the public,
through an offer document.
Ashel Rebello, Assistant Professor, Dept. of Co 10
mmerce, SAC
Rights Issue is when a listed company which proposes to
issue fresh securities to its existing shareholders as on a
record date. The rights are normally offered in a particular
ratio to the number of securities held prior to the issue. This
route is best suited for companies who would like to raise
capital without diluting stake of its existing shareholders.
A Preferential issue is an issue of shares or of convertible
securities by listed companies to a select group of persons
under Section 81 of the Companies Act, 1956 which is
neither a rights issue nor a public issue. This is a faster way
for a company to raise equity capital.
Ashel Rebello, Assistant Professor, Dept. of Co 11
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 12
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 13
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 14
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 15
mmerce, SAC
Over-The-Counter OTC market
It is characterized by non-existence of a central
counterparty (CCP), and hence the parties deal directly with
each other.
Since, no CCP is involved, the counterparty settlement risk
is higher.
However, since these are dealt directly between the
counterparties, it can be customized to the needs of the
buyers and sellers.
Some of the popular instruments that are dealt in these OTC
markets are – Foreign exchange (Fx), Forward derivatives,
Swap derivative contracts, etc.
Ashel Rebello, Assistant Professor, Dept. of Co 16
mmerce, SAC
Stock Exchanges
A stock exchange is simply a place where financial
instruments can be bought or sold.
The stock exchanges in India, under the overall supervision
of the regulatory authority, the Securities and Exchange
Board of India (SEBI), provide a trading platform, where
buyers and sellers can meet to transact in securities.
Ashel Rebello, Assistant Professor, Dept. of Co 17
mmerce, SAC
The notable stock exchanges in India are National Stock
Exchange (NSE) and Bombay Stock Exchange (BSE).
The trading platform provided by NSE is an electronic one
and there is no need for buyers and sellers to meet at a
physical location to trade.
They can trade through the computerized trading screens
available with the NSE trading members or the internet
based trading facility provided by the trading members of
NSE.
Ashel Rebello, Assistant Professor, Dept. of Co 18
mmerce, SAC
Stock Exchanges
They began simply as meeting places where investors
gathered to discuss companies and their shares, and to
trade shares
As they became more formal, these meeting places became
the trading floors of exchanges, where traders made deals
face to face.
Today, many of these exchange floors have been replaced by
sophisticated electronic dealing systems run on computer
systems that now operate in major cities throughout the
world.
Ashel Rebello, Assistant Professor, Dept. of Co 19
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 20
mmerce, SAC
Stock Exchanges
A stock exchange is simply a place where
financial instruments can be bought or
sold.
Financial
Instrument
s
Cash Sellers
STOCK EXCHANGE
Buyers
Financial
Instrument
Cash s
Ashel Rebello, Assistant Professor, Dept. of Co 21
mmerce, SAC
Clearing & Settlement:
After a trade is executed, it needs to be settled.
The clearing and settlement mechanism in Indian securities market
has witnessed significant changes and several innovations during
the last decade.
These include use of the state-of-art information technology,
emergence of clearing corporations to assume counterparty risk,
shorter settlement cycle, dematerialization, electronic transfer of
securities and fine-tuned risk management system.
Till January 2002, the stock exchanges in India were following a
system of account period settlement for cash market transactions.
An account period settlement is a settlement where the trades
pertaining to a period stretching over more than one day are settled.
Ashel Rebello, Assistant Professor, Dept. of Co 22
mmerce, SAC
For example, trades for the period Monday to Friday are
settled together.
The obligations for the account period are settled on a net
basis. Instead of the account period settlement,
T+2 rolling settlement was introduced for all securities.
Rolling settlement refers to the settling of trades at a
standard fixed period of days after the execution occurred.
In a rolling settlement, each trading day is considered as a
trading period and trades executed during the day are
settled based on the net obligations for the day.
In the year 2021, the stock exchanges in India (NSE & BSE)
have made a joint statement to reduce this settlement cycle
to T+1 in a phased manner starting February 2022.
Ashel Rebello, Assistant Professor, Dept. of Co 23
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 24
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 25
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 26
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 27
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 28
mmerce, SAC
MARKET PARTICIPANTS
Broker/Dealers: These are primarily members of the stock exchanges
who facility trading on the platform. How we do differentiate ‘brokers’ &
‘dealers’? Dealers are usually those trading members who trade for
themselves (proprietary trades – trades made using own capital); where
as Brokers are those trading members who act as agents for their clients
and trade on behalf of their clients (client trades – trades made using
client’s capital) Examples: Kotak Securities, Zerodha, ICICI Direct, etc.
Merchant Banks/Investment Banks: These banks are unlike traditional
banks. They do not deal with deposits or loans. Instead they facilities
capital raising activities for their clients which include corporations,
government and institutional clients. They help with IPOs, advisory
servicing on Mergers & Acquisitions (M&A), Underwriting services, etc.
Examples: State Street Bank, SBI Capital, Axis Capital Ltd, etc.
Ashel Rebello, Assistant Professor, Dept. of Co 29
mmerce, SAC
Depositories: A depository is like a bank wherein the deposits are
securities (viz. shares, debentures, bonds, government securities,
units etc.) in electronic form. Examples: NSDL & CDSL
Depository Participant (DP): The Depository provides its services
to investors through its agents called depository participants
(DPs). These agents are appointed by the depository with the
approval of SEBI. According to SEBI regulations, amongst others,
three categories of entities, i.e. Banks, Financial Institutions and
SEBI registered trading members can become DPs.
Clearing House: A clearing house is a financial institution that
provides clearing and settlement services for financial and
commodities derivatives and securities transactions.
Ashel Rebello, Assistant Professor, Dept. of Co 30
mmerce, SAC
Custodian: A financial institution that holds customers’
securities for safekeeping to prevent them from being
stolen or lost. The custodian may hold stocks or other
assets in electronic or physical form on behalf of their
customers.
Registrar & Transfer Agent (RTA): Registrar and Transfer
Agents (RTA) are SEBI registered institutions associated with
a company to maintain investors’ records.
Ashel Rebello, Assistant Professor, Dept. of Co 31
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 32
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 33
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 34
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 35
mmerce, SAC
What is Trade Settlement?
In a secondary market, the trading and settlement
procedure begins with the choosing of a broker or sub-
broker and finishes with the settlement of shares. To trade
on the secondary market, you must first open a Demat
account with a broker or bank. You can buy and sell
securities after your account is operational. Your deal is
settled once your order is executed and you receive a
contract note.
Ashel Rebello, Assistant Professor, Dept. of Co 36
mmerce, SAC
Stock selection
Ashel Rebello, Assistant Professor, Dept. of Co 37
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 38
mmerce, SAC
Fundamental Analysis
Fundamental analysis is a method used to identify the true
value of a stock.
1. The current price of a stock may not reflect the
actual value of the stock. The stock may be
overvalued or undervalued in the market.
2. Fundamental analysis helps investors to study
the health of the company, and thus leading to
the actual value of the stock.
3. This is done by using various qualitative and
quantitative factors.
4. The main purpose of this method is to identify
companies that that are fundamentally strong
in order to invest in them for the long term.
Ashel Rebello, Assistant Professor, Dept. of Co 39
mmerce, SAC
Economic Analysis
1. It involves assessing or examining topics or issues from an
economist’s perspective.
2. This allows investors to analyse the market from the big picture to
all the way down to individual stocks.
3. By examining the economic numbers one can determine the current
market strength and have a better idea of what the future holds.
4. Key Economic indicators investors must incorporate while selecting
stocks:
i. Indices (e.g. Nifty, Sensex)
ii. Gross Domestic Product (GDP)
iii. Unemployment rate
iv. Inflation rate
v. Consumer Confidence
vi. Purchase Managers' Index Ashel Rebello, Assistant Professor, Dept. of Co 40
mmerce, SAC
After the analysis of the macro-economy (termed as
Economic Analysis), the next step is to analyse the industry
environment which the firm is operating in.
One should analyse all the factors that give the firm a
competitive advantage in its sector, such as, management
experience, history of performance, growth potential, low
cost of production, brand name etc.
This step of the Industry analysis entails finding out as
much as possible about the industry and the inter-
relationships of the companies operating in the industry.
Ashel Rebello, Assistant Professor, Dept. of Co 41
mmerce, SAC
Company analysis
The next step is to study the company and its products (termed as
Company Analysis). The components that are analysed at the
company level are the following:
◦ 1. Business model: What exactly does the company do? This isn’t as
straightforward as it seems. If a company’s business model is based on selling
fast-food chicken, is it making its money that way? Or is it just coasting on
royalty and franchise fees?
◦ 2. Competitive advantage: A company’s long-term success is driven largely by
its ability to maintain a competitive advantage—and keep it. Powerful
competitive advantages, such as Coca-Cola’s brand name and Microsoft’s
domination of the personal computer operating system, create a moat around
a business allowing it to keep competitors at bay and enjoy growth and profits.
When a company can achieve a competitive advantage, its shareholders can
be well rewarded for decades.
Ashel Rebello, Assistant Professor, Dept. of Co 42
mmerce, SAC
◦ 3. Management & Corporate Governance: One of the important
component to look at is the management composition. Corporate
governance describes the policies in place within an organization
denoting the relationships and responsibilities between
management, directors, and stakeholders. These policies are defined
and determined in the company charter and its bylaws, along with
corporate laws and regulations. You want to do business with a
company that is run ethically, fairly, transparently, and efficiently.
◦ 4. Financial analysis: Financial statements are the medium by which
a company discloses information concerning its financial
performance. Followers of fundamental analysis use quantitative
information gleaned from financial statements to make investment
decisions. The three most important financial statements are income
statements, balance sheets, and cash flow statements.
Ashel Rebello, Assistant Professor, Dept. of Co 43
mmerce, SAC
Technical analysis
Ashel Rebello, Assistant Professor, Dept. of Co 44
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 45
mmerce, SAC
Technical analysis tools are used to scrutinize the ways
supply and demand for a security will affect changes in
price, volume, and implied volatility.
It operates from the assumption that past trading activity
and price changes of a security can be valuable indicators
of the security’s future price movements when paired with
appropriate investing or trading rules.
It is often used to generate short-term trading signals from
various charting tools, but can also help improve the
evaluation of a security’s strength or weakness relative to
the broader market or one of its sectors.
This information helps analysts improve their overall
valuation estimate.
Ashel Rebello, Assistant Professor, Dept. of Co 46
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 47
mmerce, SAC
Stock return and risk
Ashel Rebello, Assistant Professor, Dept. of Co 48
mmerce, SAC
Risk
Risk is usually understood as “exposure to a danger or
hazard”.
In investment decisions, risk is defined as the possibility that
what is actually earned as return could be different from what
is expected to be earned.
For example, consider an investor who buys equity shares
after hearing about the huge returns made by other
investors. He expects to earn at least 50% return within 2
years.
But if equity markets decline during that period, the investor
could end up with negative returns instead.
Ashel Rebello, Assistant Professor, Dept. of Co 49
mmerce, SAC
This deviation between actual and expected returns is the risk in his
investment.
If the return from an investment remains unchanged over time, there
would be no risk.
But there is no investment of that kind in the real world.
Even returns on government saving products change. For example,
consider the Public Provident Fund (PPF), which is a 15-year deposit in
which investors have to put in money at least once every year.
This investment is considered to be government- guaranteed and its
returns are viewed as being very safe.
The rate of return on PPF was 12% in the year 2000. Consider the
changes ever since:
◦ Reduced to 11% in January 2000
◦ Reduced to 9.5% in March 2001
◦ Reduced to 9 % in March 2002
Reduced to 8% in March 2003
Ashel Rebello, Assistant Professor, Dept. of Co 50
mmerce, SAC
There are several types of risk to which investments can be
exposed.
◦ 1. Inflation Risk
◦ 2. Default Risk
◦ 3. Liquidity Risk
◦ 4. Re-investment Risk Chapter
◦ 5. Business Risk
◦ 6. Exchange Rate Risk
◦ 7. Interest rate Risk
◦ 8. Market Risk
◦ 9. Systematic & Unsystematic Risk
Ashel Rebello, Assistant Professor, Dept. of Co 51
mmerce, SAC
Return
Return on investment is a basic computation made to assess how an investment
is performing.
Every investment can be represented as a set of inflows and outflows.
Return is the comparison of the inflow and outflow and therefore the benefit to
the investor from making the investment. Returns can be positive or negative.
A negative return means that the investment has yielded losses rather than
benefits.
Consider these examples:
◦ A plot of land was purchased for Rs.5 lakhs and sold for Rs. 4 lakhs
◦ A debenture was bought for Rs.105 and sold for Rs.130
On basis of a comparison of inflows and outflows, clearly, the first investment
has resulted in a loss, whereas the second has yielded a profit.
The first case represents negative return on investment; the second is an
example of positive return.
Ashel Rebello, Assistant Professor, Dept. of Co 52
mmerce, SAC
Return can be measured in two ways:
1. Comparing amount of inflows and amount of outflows on
an investment in absolute rupee terms.
2. Computing a rate of return by comparing inflows and
outflows.
Consider the following investments:
1. Purchase equity shares for Rs.23,000 and sell at
Rs.28,000
2. Purchase equity shares for Rs.2500 and sell at Rs.3100
Ashel Rebello, Assistant Professor, Dept. of Co 53
mmerce, SAC
Risk-free rate is rate of return from a default-risk free government
security.
Government bonds have less risk as interest rate is known and
the risk of default is very less.
An asset like T-bills, money market funds or bank deposits is
taken as the proxy for risk-free rate.
Such assets have very low or virtually negligible default risk and
interest rate risk.
On the other hand one has to take more risk if he wants to invest
in shares as return is not certain.
However one can expect lower return from Government bond and
higher from shares.
Risk and expected return move one behind the other, the greater
the risk the greater the expected return.
Ashel Rebello, Assistant Professor, Dept. of Co 54
mmerce, SAC
Types of Investors According to ‘Risk-
Return’ Perception
Risk averse investors avoid risk, however, may be ready to
take risk if the return available for taking extra risk is
commensurate or equal.
Risk Seeker investors are ready to take risk even if the
return for taking that risk is not sufficient enough.
Risk Neutral investors require just sufficient return for
taking risk. They want neither extra return for a given risk,
nor ready to take extra risk for a given return.
Ashel Rebello, Assistant Professor, Dept. of Co 55
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 56
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 57
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 58
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 59
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 60
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 61
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 62
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 63
mmerce, SAC
Ashel Rebello, Assistant Professor, Dept. of Co 64
mmerce, SAC