Basic Terminology in Capital Markets
1. What is a Capital Market?
Capital Market enhances capital formation in the economy and comprises of -
- Primary Market
- Secondary Market
- Primary Market is a place where new offerings by Companies are made either as an Initial Public Offering (IPO) or Rights Issue.
- Secondary Market is a market where securities are traded after being initially offered to the public in the Primary Market and/or listed on the Stock Exchange. Majority of trading is done in this market which comprises of equity market and debt market.
2. What is the difference between the primary market and the secondary market?
In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading avenue in which already existing/pre- issued securities are traded amongst investors. Secondary market could be either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
3. What is an IPO?
An IPO or Initial Public Offering is referred to the issue of shares to the public by the promoters of a company for the first time. The shares are made available to the investors at the face value of the share or with a premium as per the perceived market value of the share by the promoters. The IPO can be in the form of a fixed price portion or in the form of Book Building portion.
4. What is book building?
Book Building is a public offer of equity shares of a company. Book building is so called because it refers to the collection of bids from investors, which is based on an price range. The issue price is fixed after the bid closing date.
- How is the book built process done? A company that is planning an initial public offer (IPO) appoints a merchant banker as a book runner. The company issues a prospectus which does not mention the price, but gives other details about the company with regards to issue size, the business the company is in, the promoters and future plans among other disclosures. Then a particular period is fixed as the bid period. The book runner builds an order book, that is, collates the bids from various investors, which shows the demand for the shares. For example, a bidder may quote that he wants 10,000 shares at Rs 500 while another may bid for 15,000 shares at Rs 600. Prospective investors can revise their bids at any time during the bid period.
- On what basis is the final price decided? On closure of the book, the quantum of shares ordered and the respective prices offered are known. The price discovery is a function of demand at various prices, and involves negotiations between those involved in the issue. The book runner and the company conclude the pricing and decide the allocation to each syndicate member.
5. What is an Equity Share?
An Equity share represents a form of ownership. The holder of such a share is a member of the company and has voting rights.
6. What is Dividend?
Dividend is the part of profit distributed by the company among its investors. It is usually declared as a percentage of the paid-up value or face value of the share.
7. What is a Bonus Share?
A share issued by companies to their shareholders for free of cost by capitalization of accumulated reserves from the profits earned in the earlier years.
8. What is Rights Issue?
In a rights issue, a company issues new shares by giving existing shareholders the right to purchase new share in proportion to their existing holding, so as to avoid dilution. Shares are usually offered at a discount, and most investors take up the offer of a rights issue.
9. What is preferential allotment of shares?
A fresh allotment of shares to promoters, their friends and relatives on a preferential basis is called preferential allotment.
10. What is the Face value of a share?
Face value also, called Par value, is the nominal value of the share. The company arrives at this figure on the basis of the total capital issued by it and the number of shares issued in order to raise the capital. While earlier, companies were required to fix the face value of their shares at Rs.10 or multiples of Rs.10 as per the prevailing regulations of the time, now they are free to fix the face value at any amount they desire.
11. What is Issue at Par?
It is when a share is issued at the same price as the face value of the share.
12. What is Issue at Premium?
It is when a share is issued at a price above the face value of the share.
13. What is Issue at Discount?
It is when a share is issued at a price below the face value of the share.
14. What is a Bond?
A Bond is a promissory note issued by a company or government to its lenders. A Bond is evidence of debt on which the issuing company usually promises to pay the bondholder a specified amount of interest at intervals over a specified length of time, and to repay the original loan on the expiration date. A Bond investor lends money to the issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date.
15. What is a Stock Exchange?
A Stock Exchange is a place where the buyer and seller meet to trade in shares in a organized manner. A stock exchange is an entity that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends. Securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. There are at present two recognized national stock exchanges in the country that are governed by the Securities Contract (Regulation) Act, 1956.
16. What is an Index?
An index is a stock-market indicator created as a statistical measure of the performance of an entire market or segment of a market based on a sample of securities from the market. An index is thus a means to evaluate the overall performance of a market or of a segment of the market. Apart from being a general market indicator, indices are used as a benchmark to evaluate individual portfolio performance. Professional money managers will always try to outperform the market, i.e. they will always try to do better than the indices.
For example, if the value of a portfolio moves up by 10% while the index moved up by only 5% then the portfolio is doing better than the market. We have two renowned indices viz. (a) BSE Sensitive (BSE Sensex) (b) S&P Nifty 50 (Nifty). BSE Sensex comprises of 30 large-cap companies. As the name suggests, it is a premier index on the Bombay Stock Exchange (BSE). Nifty comprises of 50 large-cap companies on the National Stock Exchange (NSE).
17. What is S&P CNX Nifty?
S&P CNX NIFTY stands for Standard & Poor’s CRISIL National Stock Exchange’s fifty nicked named Nifty50. The Nifty is a well diversified 50 stock index accounting for 23 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.
The formula for calculating the Nifty = (Sum of free flow market cap of 50 biggest stocks of NSE)*Index Value in 1995/Market Cap Value in 1995.
Note: Base year is 1995 and base value (index value) is 1000.
18. What is Sensex?
The Bombay Stock Exchange SENSEX also referred to as BSE 30 is a free-float market capitalization-weighted index of 30 well-established and financially sound companies listed on Bombay Stock Exchange. The 30 component companies which are some of the largest and most actively traded stocks are representative of various industrial sectors of the Indian economy.
The formula for calculating the SENSEX = (Sum of free flow market cap of 30 biggest stocks of BSE)*Index Value in 1978-79/Market Cap Value in 1978-79.
Note: The base value (index value) of the Sensex is 100 on April 1, 1979, and the base year of BSE-SENSEX is 1978-79.
19. What is Buying and Selling?
There are several types of orders that you dictate to a broker. The most common type, which is a regular Buy or Sell order, is called a Market order. Another type of order is a limit order wherein you ask the broker to trade only, if the price reaches a specific level. In a stop order, you tell the broker to sell your shares, if the price drops to a certain level to prevent significant loss because if it drops to that level it is likely to drop further and your losses are likely to increase.
20. Why some shares are called Blue chips?
The term ‘Blue Chips’ refers to the stock of renowned companies with established and stable businesses. Such companies offer a steady stream of earnings and are preferred by investors because of the stability of their earnings. Blue chip stocks are seen as a less volatile investment than owning shares in companies without blue chip status because blue chips have an institutional status in the economy. Investors may buy blue chip companies to provide steady growth in their portfolios.
21. What do you mean by ‘Market Trades’ and ‘Off Market Trades ‘ ?
Any trade settled through a clearing corporation is termed as a ‘Market Trade ’. These trades are done through stock brokers on a stock exchange. ‘Off Market Trade’ is one which is settling directly between two parties without the involvement of a clearing corporation. The same delivery instruction slip can be used either for market trade or off-market trade by ticking one of the two options.
22. What is a Rolling Settlement?
In a Rolling Settlement trades executed during the day are settled based on the net obligations for the day. In NSE and BSE, the trades pertaining to the rolling settlement are settled on a T+2 day basis, where T stands for the trade day. Hence trades executed on a Monday are typically settled on the following Wednesday (Considering 2 working days from the trade day). The funds and securities pay-in and pay- out are carried out on T+2 day.
23. What is Auction?
The securities are put up for auction by the Exchange on account of non-delivery of securities by the selling trading member to ensure that the buying trading member receives the securities due to him. The non-delivery by the trading member could arise on account of short delivery. The Exchange purchases the requisite quantity in the Auction Market and gives them to the buying trading member.
24. What is meant by a Bullish and Bearish trend?
When the market goes up it is called a bullish trend and when the market goes down it is called a bearish trend.
25. What shares can I buy?
You can buy the shares that are listed on any of the recognized Stock Exchanges.
26. What is day trading?
Day trading refers to buying and selling of securities within the same trading day such that all positions will be closed before the market close of the trading day. In the Indian securities market only retail investors are allowed to day trade.
27. What is meant by taking a Position?
When you act upon a stock and buy into it, you are taking a position. A position is an amount of money committed to an investment in anticipation of favorable price movements. There are two kinds of positions: -
- Long positions are what most people do. When you buy long, that means you are anticipating an upward movement in the price, and that is how you profit. People usually buy stocks at prices expecting to sell them later at higher prices and hence make profits.
- Short positions are the tricky ones. When you buy short, you are anticipating a fall in the price and the fall is the source of your profits. The shares will be sold and when the price falls they will be repurchased and given back and the difference is the where the investor profits. Of course, the investor who borrowed the shares carries the risk of not having the price move as anticipated, in which case he may lose money in repurchasing the stocks.
28. What is Short Selling and Securities Lending & Borrowing?
Short Selling means selling of a stock that the seller does not own at the time of trade. Short selling can be done by borrowing the stock through Clearing Corporation/Clearing House of a stock exchange which is registered as Approved Intermediaries (AIs). Short selling can be done by retail as well as institutional investors. Naked short sale is not permitted in India, all short sales must result in delivery, and information on short sale has to be disclosed to the exchange by end of day by retail investors, and at the time of trade for institutional investors. The Securities Lending and Borrowing mechanism allows short sellers to borrow securities for making delivery. Securities in the F&O segment are eligible for short selling.
29. Why stock prices fluctuate?
Factors Affecting Stock Prices
There are two basic factors that affect the movements of stock prices.
- Fundamental Factors
- Technical Factors
Fundamental Factors
Following are the major Fundamental Factors which are affecting the price of stocks
- Demand and supply
- Market Cap
- Earnings per share (EPS)
- Price/Earnings Ratio (P/E Ratio
Demand and Supply
Demand and Supply is the fundamental factors of economics, which holds good for the equity market as well. The price of stock is directly affected by the trend of stock market trading. When more and more people buy a same stock, the price of that stock increases and when more people are selling the same, the price of that particular stock falls. Normally it is difficult to predict the trend of the market but experts like Indianmoney.com can give you fair idea of the live trend of the market.
News
News is an important factor which affects the stock price. Positive news about a company can increase people’s interest in buying the shares. At the same time a negative press release can ruin the interest of people in buying that same. After all it is the overall performance of the company that matters more than news.
Market Cap
How will you determine the worth of a company…..??? If you think it can be determined from the stock prices, then you are making a huge mistake. It is the market capitalization of the company that is more important when it comes to determining the worth of the company. Market Cap can be calculated by multiplying the stock price with the total number of outstanding stocks in the market and that is the worth of the company.
Earnings per Share (EPS)
Earnings per share are the profit that the company made per share on the last quarter. This is the most important factor for deciding the health of a company. Every public company has to publish the quarterly report that shows the earning per share of the company. High EPS influence the buying tendency in the market resulting in the increase in price of that particular stock.
Price/Earnings Ratio
Price/Earnings ratio also known as P/E ratio helps you to get a fair idea of how a company's share price compares to its earnings. If the price of the share is very less than the earning of the company, the stock is undervalued and it has the potential to rise in the near future. On the other hand, if the price is higher than the actual earning of the company and then the stock is said to be overvalued and the price can fall at any point.
Technical Factors
Things would be easier if only fundamental factors determine stock prices. Technical factors are the mix of external conditions that modify the demand and supply of a company's stock. Some of these indirectly affect fundamentals. (For example, economic growth indirectly contributes to earnings growth).
Following are the major Technical factors affecting stock price: Inflation, Economic Strength of Market and Peers, Substitutes, Incidental Transactions, Trends and Liquidity.
Inflation
Inflation is a huge driver from a technical perspective of stock market. Historically, low inflation had a strong inverse correlation with valuations. On the other hand deflation is generally bad for stocks because it indicates a loss in pricing power for companies.
Economic Strength of Market and Peers
Generally company stocks tend to follow the track of market and with their industry peers. Stock Market specialists say that the combination of overall market and sector movements determines a majority of a stock's movement.
For example, a sudden negative outlook for one oil stock often hurts other oil stocks and drags down the demand for the whole sector as "guilt by association"
Substitutes
Substitutes influence the price of stocks to a great extent. These include corporate bonds, government bonds, commodities, real estate and foreign equities. In any point of time if the investors are finding that the alternatives are giving more returns than equities, probably they will withdraw all the investments from the stock and go for alternatives, this will affect the stock price very badly.
Incidental Transactions
Incidental Transactions include executive insider transactions, which are often driven by portfolio objectives. These are purchases or sales of a stock that are forced by something other than the intrinsic value of the stock. They do impact supply and demand and therefore can move the price.
Trends
A stock always moves according to a short-term trend in the market. On the other hand, a stock that is moving up can gather momentum. Sometimes stocks behave in the opposite way in a trend and do exactly opposite to the market.
Liquidity
Liquidity is a very important factor in determining the price of stocks. Liquidity refers to how much investor interest and attention a specific stock has. Some company’s stocks are highly liquid and therefore highly responsive to material news. Trading volume indicates both liquidity and a function of corporate communications.
Other factors affecting stock prices
Apart from those discussed above, there are many reasons for increase or decrease in price of the share. There are several stock factors affecting share prices. Stock Price does not depend upon one or two factors, but some factors directly influence the share prices. Major factors affecting stock prices can be broadly divided under following categories: