Secondary Market

Introduction

The market where existing securities are traded is referred to as the secondary market or stock market. In a stock market, purchases and sales of securities whether of Government or Semi-Government bodies or other public bodies and also shares and debentures issued by joint stock companies are affected. The securities of government are traded in the stock market as a separate component, called guilt edged market. Government securities are traded outside the trading wing in the form of over the counter sales or purchases. Another component of the stock market deals with trading in shares and debentures of limited companies.

Control over Secondary Market

For the effective functioning of secondary market, proper control must be exercised. At present, control is exercised through the following three important processes:

a) Recognition of Stock Exchanges

b) Listing of Securities

c) Registration of Brokers.

a) Recognition of Stock Exchanges

Stock exchanges are the important ingredient of the capital market. They are the citadel of capital and fortress of finance. They are the theatres of trading in securities and as such they assist and control the buying and selling of securities. Thus, according to Husband and Dockeray “securities or stock exchanges are privately organized markets which are used to facilities trading in securities.” However, at present stock exchanges need not necessarily be privately organized once.

As per the securities Contacts Regulation Act, 1956 a stock exchange has been defined as follows: “It is an association, organization or body of individuals whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.” In brief, stocks exchanges constitute a market where securities issued by the central and state governments, public bodies and joint stock companies are traded.

b. Listing of securities

Listing of securities means that the securities are admitted for trading on a recognized stock exchange. Transactions in the securities of any company cannot be conducted on stock exchanges unless they are listed by them. Hence, listing is the very basis on stock exchange operations. It is the green signal given to selected securities to get the trading privileges of the stock exchange concerned. Securities become eligible for trading only through listing.

Listing is compulsory for those companies which intend to offer shares/debentures to the public for subscription by means of issuing a prospectus. Moreover, the SEBI insists on listing for granting permission to a new issue by a public limited company. Again, financial institutions do insist on listing for underwriting new issues. Thus, listing becomes an unavoidable one today.

The companies which have got their shares/debentures listed in one or more recognized stock exchanges must submit themselves to the various regulatory measures of the stock exchange concerned as well as the SEBI. They must maintain necessary books; documents etc. and disclose any information which the stock exchange may call for.

C. Registration of Brokers.

A broker is none other than a commission agent who transacts business in securities on behalf of his clients who are non-members of a stock exchange. Thus, a non-member can purchase and sell securities only through a broker who is the member of the stock exchange. To deal in securities on recognized stock exchanges, the broker should register his name as a broker with the SEBI. A stock broker must possess the following qualification to register as a broker:

(a) He must be an Indian citizen with 21 years of age.

(b) He should neither be a bankrupt nor compounded with creditors.

(c) He should not have been convicted for any offence, fraud etc.

(d) He should not have engaged in any other business other than that of a broker in securities.

(e) He should not be a defaulter of any stock exchange.

(f) He should have completed 12 std examinations.

Functions of stock exchange

Stock market performs pivotal position in the financial system. It performs several economic functions and renders invaluable service to the investors, and to the economy as a whole

1. Liquidity and marketability of securities

Stock exchanges provide liquidity to securities since securities can be converted to cash at any time according to the discretion of the investor by selling them at the listed prices. They facilitate buying and selling of securities at listed prices by providing continuous marketability to the investors in respect of securities they hold or intend to hold. Thus, they create a ready outlet for dealing in securities

2. Safety of funds

Stock exchanges ensure safety of funds invested because they have to function under strict rules and regulations and bye-laws are meant to ensure safety of investible funds. Over- trading, illegitimate speculation etc. are prevented through carefully designed set of rules. This would strengthen the investor’s confidence and promote larger investment.

3. Supply of long term funds

The securities traded in the stock market are negotiable and transferable in character and as such they can be transferred with minimum of formalities from one hand to another. so, when a security is transacted, one investor is substituted by another, but company is assured of long term availability of funds

4. Flow of capital to profitable ventures

The profitable and popularity of companies are reflected in stock prices. The prices quoted indicate the relative profitability and performance of companies. Funds tend to be attracted towards securities of profitable companies and this facilitates the flow of capital into profitable channels. In the words of husband dockeray ‘’ stock exchanges function like traffic signal, indicating a green light when certain fields offer the necessary inducement to attract and blazing a red light when the outlook for new investment is not attractive

5. Motivation for improved performance

The performance of a company is reflected on the prices quoted in the stock market. These prices are more visible in the eyes of the public. Stock market provides room for this price quotation for these securities listed by it. This public exposure makes a company conscious of its status in the market and it acts as a motivation to improve its performance further

6. Promotion of investment

Stock exchanges mobilize the savings of the public and promote investment through capital formation. But for these Stock exchanges, surplus funds available with individuals and institutions would not have gone for productive and remunerative ventures

7. Reflection of business cycle

The changing business conditions in the economy are immediately reflected on the stock exchanges. Booms and depressions can be identified through the dealings on the Stock exchanges and suitable monetary and fiscal policies can be taken by the government. Thus a Stock market portrays the prevailing economic situation instantly to all concerned so that suitable actions can be taken.

8. Marketing of new issues

If the new issues are listed, they are readily acceptable to the public, since listing presupposes their evaluation by concerned stock exchange authorities. Costs of underwriting such issues would be less. Public response to such new issues would be relatively high. Thus, a stock market helps in the marketing of new issues also

9. Miscellaneous services

Stock exchange supplies securities of different kinds with different maturities and yields. It enables the investors to diversify their risks by a wider portfolio of investment. It also inculcates saving habits among the community and paves the way for capital formation. It guides the investors in choosing securities by supplying the daily quotation of listed securities and by disclosing the trends of dealings on the Stock exchange. It enables companies and the government to raise resources by providing a ready market for their securities.

FEATURES OF SECONDARY MARKET

· The market where securities are traded after they are initially offered in the primary market. Most trading is done in the secondary market.

· In Secondary market share are traded between two investors.

· In secondary market there is no issuing of the fresh securities but trading of the already issued securities

· In secondary market both buying and selling can take place

· It has a special and fixed place known as stock exchange. However, it must be noted that it is not essential that all the buying and selling of securities will be done only through stock exchange. Two individuals can buy or sell them manually. This will also be called a transaction of the secondary market. Generally, most of the transactions are made through the medium of stock exchange.

Example are the New York Stock Exchange (NYSE), Bombay Stock Exchange (BSE),National Stock Exchange NSE, bond markets, over-the-counter markets, residential mortgage loans, governmental guaranteed loans etc.

· The prices of securities in secondary market are determined by demand and supply.

· Only investors do the trading among themselves in secondary market.

· The trading of securities does not take place first. A security can be traded in the secondary market only if issued in the primary market.

· Secondary market creates liquidity, hence, indirectly promotes capital formation.

· It creates liquidity in securities. Liquidity means immediate conversion of securities into cash. This job is performed by the secondary market.

· Secondary market comes after primary market. New securities are first sold in the primary market and thereafter it is the turn of the secondary market.

SEBI Guidelines:

Though badla transactions have the effect of expanding the market and providing liquidity to the market, very often they lead to high speculative activity and larger volatility in the stock market. Hence, it was banned by the SEBI since December 1993. However, it has announced a modified forward trading system which is effective from October 9, 1995. The important features of the revised Forward Trading System are the following:

1. Each individual broker must have a capital adequacy norm of 3 percent and it is 6 percent for each institutional broker. This must be complied with April 1, 1996.

2. The limit of 25 percent of the turnover imposed on carry forward deals has been removed due to the implementation of capital adequacy norms.

3. Transactions can be carried forward for a maximum period of 90 days. But, squaring off is permitted up to a maximum of five settlement only(for each settlement 15 days and altogether 75 days only).Beyond this stipulated period, transactions have to be settle by actual delivery or payment as the case may be.

4. The graded margin of 20 to 50% of carry forward position has been dispensed with. Instead, a flat margin 15% marked to market has been fixed on a weekly basis as recommended by the Patel Committee.

5. This margin foe carry forward transaction can vary according to market sentiments .For example, a higher margin can be insisted upon if the price of the securities goes up and vice versa. In the case of volatile scrips, the margin can go upto 100%.

6. Brokers are allowed self-certification on their status on settlement subject to re-check by the SEBI. There is no monthly audit as recommended by the Patel Committee.

7. There is no need to publish the carry forward position of each broker scrip-wise before the commencement of each carry forward session.

8. Stock exchange can allow carry forward transaction only after getting necessary permission from the SEBI. Permission will be generally granted only if the stock exchange concerned has screen based trading, and other infrastructural facilities.

Meanwhile, the Government of India appointed another committee under the chairmanship of J.S.Varma to go into the question of carry forward system in July 1997. This committee has made the following recommendation:

1. Capital adequacy norms and other prudential safeguards with regard to carry forward s should be strictly enforced.

2. Scrips chosen for carry forward must be having sufficient floating stock.

3. The maximum period of 90 days allowed for carry forwards shall be eliminated.

4. Similarly, the maximum period of 75 days allowed for squaring off shall be eliminated.

5. The limit of 10 corers fixed on the financier funding shall be relaxed.

6. Instead of a flat margin of 15% a uniform margin of 10% of the gross position with a daily marking to market prices shall be maintained.

7. The segregation of carry forward trades and delivery trades shall be abolished.

Principal weaknesses of Indian stock market

While in terms of number of stock exchanges, listed companies, daily turnover, market capitalisation & investor population, the Indian stock market has witnessed growth over the last four decades.

a) Rampant speculation: stock exchanges have witnessed spells of unprecedented booms & crashes. While cost has been experiencing 4-5% rate of growth, share prices have shown high volatility this shows that speculative activities have been rampant. The distinction Keynes made in 1929 in Wall Street journal between speculators operating on the basis of forecasting the psychology market and investor trying to forecast prospective yield of assets over whole life has almost vary in India ‘s market condition.

b) Insider trading: Means operation information which is price sensitive and not available to public. It’s thus trading from a position of privilege in respect of price sensitive information. It is decried because it violates level playing; a state where equal opportunity to information is available to all participants in the market.

c) Oligopolistic: the Indian stock market cannot be truly competitive. Its highly dominated by large financial & institutional big brokers, operators & thus oligopolistic

d) Limited forward trading: there can be three types of transactions undertaken spot delivery, hand delivery & forward delivery. Trading in share for clearing or forward trading was common banned in India in 1969. It had an adverse effect on share prices. The situation was further aggravated in 1974 restrictions put on dividend by companies as part of anti-inflationary measures adopted by Government. From 1974 onwards under a scheme first evolved by BSE & thereafter accepted Calcutta, Delhi, & Ahmedabad, a certain informal type of forward trading was revived. This was done by carrying forward the delivery contract beyond 14 days in an informal manner, by concluding earlier contract and entering into a new contract without actual delivery, but merely payment of balance between country price and market price. This system had been continued for selected securities called cleared securities. A certain volume of forward trade useful for providing liquidity and avoiding payment arises, speculation runs riot and actual price transfer of securities lies far behind, there will inevitably be a payment crisis.

e) Outdated share trading system: This system followed in Indian Stock Exchanges, when matched an international prospectus is thoroughly outdated and inefficient. The major problem areas include settlement period, margin system and carry for (badla) system. Settlement period is 14 days in most Indian Stock Exchanges whereas most countries are moving towards a rolling 3 days. Apart from encouraging rise of shops outside the stock exchange system, such a lengthy settlement period increases the risk to exposed market participants due to price movements. Avoidance of margin payment under margin system is a problem area. Margin system is the deposit which members maintain with clearing house stock exchange. The deposit is a certain percentage of value of security which is being traded by them. Under margin system if a member buys or sells securities marketed for margin above free limit, a spot amount per share has to be deposited in clearing house. Margin trading means that a customer buys a shar3e by paying portion of purchase price. Ex: a customer purchases shares worth 1 lakh market value by paying 60,000, he’s in trade paying a margin of 60%. In this case, the balance is being lent by broker & securities bought are collateral for the loan & have to be left with the broker.

f) Lack of single market: Due to inability of various stock exchanges to function cohesively, the growth in business in any one exchange or region has not been transmitted to other exchanges. The limited inter market operations have resulted in increased costs & risk of investors in smaller towns. This problem is further aggravated by lack of cohesion among exchanges in terms of legal structure, trading practices, settlement procedures & jobbing.

g) Problem of interface between primary & secondary markets: The recent upsurge of primary market has created serious problems of interfacing with secondary market, viz. the stock exchanges which still, by & large, continue with the same old infrastructure & ways of long which suited the very narrow base of capital market in yester years but are totally out of tune with fast market & desired tempo of work at present. Unless secondary market is re-oriented so as to take charge of new responsibilities cast on it by recent developments, this will act as a drag on future preface serious problems while trying to buy or sell scrips.

h) Inadequacy of investor service: it’s commonly felt that smaller exchanges, have been unable to service investors adequately, & have been able to make only limited contribution to spread of equity cult in their region. Level of computerisation across stock exchanges has been inadequate, resulting in lower operational flexibility of stock exchanges & leaving brokers unable to handle sudden surges in volumes. The absence of computer linkage between stock exchanges & its members has hampered effective inter market operations, monitoring of trading & trading operations, as well as free flow of information on an intra & inter-exchange basis. The inadequate structure & ineffective trading practices\ settlements have also resulted in lack of NRI confidence in capital market.

Major Indian corporate today needs to diversify their sources of capital & seek direct recitation of foreign investors. Up gradation of existing stock exchanges has to be viewed as an integral component of increasing globalisation of Indian economy.

Difference between primary and secondary market

BASIS OF DIFFERENCES	PRIMARY MARKET	SECONDARY MARKET
1) ISSUES	Market for new issues of securities	Deals with existing securities
2) LOCATION	No fixed geographical location needed.	Needs a fixed place to house the secondary market activities, viz, trading .
3) TRASFER OF SECURITIES	Securities are created and transferred from corporate to investors for the first time	Securities are transferred from one investor to another through the stock exchange mechanism.
4) ENTRY	All companies can enter NIM and fresh issue of securities.	For the securities to enter the portals of stock exchanges for the purpose of trading, listing is mandatory.
5) ADMINISTRATION	Has no tangible form of administrative set-up	Has a definite administrative set-up that facilitates trading in securities
6) REGULATION	Subject to regulations mostly from outside the company-SEBI, stock exchanges, companies act, etc	Subject to regulation both from within and outside the stock exchange framework.
7) AIM	Creating long-term instruments for borrowings.	Providing liquidity through marketability of those instruments.
8) PRICE MOVEMENT	Stock price movement in secondary market influences pricing of new issue	Both macro and micro factors influence the stock price movement.
9) DEPTH	Depends on number and the volume of issue.	Depth depends upon the activities of the primary market as it brings into the fore more corporate entities and more instruments to raise funds