Tug War Nse and Bse in India

The Tug of War: NSE vs. BSE

STUFFING OF THE PROJECT

1. Introduction 3-16

2. MONETARY POLICY AND STOCK MARKET 17-34

3. NSE VS. BSE 35-46

4. ROLE OF SEBI IN NSE AND BSE 47-80

5. TABLES 81-92

6. References 93

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1. INTRODUCTION

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INTRODUCTION

WHAT IS STOCK?

A stock, also referred to as a share, is commonly a share of ownership in a joint

stock company. The owners and financial brokers of a company may desire

additional capital to invest in new projects within the company. If they were to sell the

company it would represent a loss of control over the company. Also, Stock is

ownership in a company, with each share of stock representing a tiny piece of

ownership. The more shares you own, the more of the company you own. The more

shares you own, the more dividends you earn when the company makes a profit. In

the financial world, ownership is called equity.

There are two primary classes of stock:

1. Preferred Stock typically pays regular dividends and is favored by investors

who want income foremost from their stocks.

2. Common Stock represents ownership of a company and may offer more

rights and privileges than preferred stock.

Investors may purchase stock on the primary or secondary market. A company sells

its stock to the public on the primary market through its initial public offering.

Investors may sell their shares through brokers to other investors on the secondary

market. The secondary market can be structured as an auction market, like the other

exchanges, or a dealer market, like the NSE & BSE. Stock prices can be found

(quotes) in newspapers, on television and the Internet.

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WHY DO COMPANIES ISSUE STOCK?

Businesses issue stock to raise money. They use this money to finance expansions,

pay for equipment, and fund projects, etc. Corporations issue stock when they may

need additional capital to operate successfully. The fancy term for issuing stock to

raise money is equity financing. The money received from investors who buy stocks

is called equity capital. In the world of securities, the word "equity" usually refers to

stocks. The other method of raising money is debt financing, which involves selling

bonds. When companies make profits, they may reward their stockholders with

pieces of their profits, known as dividends. Dividends are an incentive for investors

to hold stocks.

WHAT ARE STOCK EXCHANGES?

Exchanges are the physical locations where stocks are bought and sold. They are

the sisters of the over-the-counter (OTC) market. The OTC refers to a market in

which securities transactions are conducted through a telephone and computer

network connecting dealers in stocks and bonds, rather than on the floor of an

exchange. Together, these two markets form the secondary market. The primary and

secondary markets together make up the stock market. Exchanges are located all

over the world, with the most famous one being the Indian Stock Exchange.

Thousands of stocks are listed on this exchange. When you buy a stock, you will

need to learn which exchange list it. Other than locating a quote in the newspaper,

with online trading and the automation of order systems, there is very little reason to

determine where the stock trades from the customer's viewpoint. The Securities and

Exchange Commission (SEC) regulates stock trading and exchanges. Additional

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regulation is administered by The National Association of Securities Dealers (NASD).

The NASD makes and enforces rules for its members and enforces federal securities

acts and the SEC makes rules for its membership. As you read more about

investing, you will become more familiar with these organizations and their protective

regulations.

ABOUT STOCK MARKET BASICS

Companies are started by individuals or maybe a small circle of people. They pool

their money or obtain loans, raising funds to launch the business. A choice is made

to organize the business as a sole proprietorship where one person or a married

couple owns everything, or as a partnership. Later they may choose to "incorporate".

As a corporation, the owners are not personally responsible or liable for any debts of

the company if the company doesn't succeed. Corporations issue official-looking

sheets of paper that represent ownership of the company. These are called stock

certificates, and each certificate represents a set number of shares. The total

number of shares will vary from one company to another, as each makes its own

choice about how many pieces of ownership to divide the corporation into. One

corporation may have only 2,500 shares, while another may issue over a billion

shares such as IBM and Ford Motor Company. Companies sell stock (pieces of

ownership) to raise money and provide funding for the expansion and growth of the

business. The business founders give up part of their ownership in exchange for this

needed cash. The expectation is that even though the owners have surrendered a

portion of the company to the public, their remaining share of stock will become

increasingly valuable as the business grows. Corporations are not allowed to sell

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shares of stock on the open market without the approval of the Securities and

Exchange Commission (SEC).

The Golden Piggy Bank Page 36 This transition from a privately held corporation to a

publicly traded one is called going public, and this first sale of stock to the public is

called an initial public offering, or IPO. Usually an IPO is sponsored by an investment

bank (the underwriter) such as Merrill Lynch, Salomon-Smith Barney, or Goldman

Sachs. Companies can choose to incorporate, by filling the appropriate papers and

paying a fee, in any state that they choose. This becomes their charter state where

they must maintain an office address. Officers are chosen - president, vice-

president, and secretary-treasurer, and a board of directors may be established. It is

the board of directors' duty to represent the shareholders, who of course at the early

stages of a company's life, are going to be the company founders. Most corporations

stay privately owned although they may elect to sell stock to qualified investors. You

can tell if a company is a corporation by seeing the "Inc." after its name, or other

letters such as LTD or AG if the company is based in a foreign country. According

the U.S. Census Bureau, of the 5,579,177 registered businesses in the United

States, 5,562,799 have less than 500 employees. Of the 16,378 big companies with

over 500 workers, about half are privately owned.

Common Stock - standard shares issued by a corporation. Most stocks traded are

common stock.

Preferred Stock - special class of stock that is issued without voting rights, but

promises a fixed dividend. If a company is forced to liquidate and close its doors,

preferred shareholders stand in line in front of common stock holders, for any

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proceeds available after secured creditors are paid. Most preferred stock trades on

the NYSE at about $25.00 per share.

HOW TO BUY STOCK?

Buying stocks is not as simple as walking into a stockbroker's office and buying

shares like you would a pair of shoes from a store. You are required to open an

account with the brokerage, like opening an account at a bank. Some brokers will

allow you to open an account with very little money. The firm will then hold this

money in an interest earning cash account, awaiting your orders to buy or sell stock,

or other securities such as bonds or mutual funds. When you buy or sell, you pay a

commission which is deducted from your account. When a stock is purchased, the

ownership of the shares may be listed in one of two ways. "Listed" means how the

corporation tracks the ownership of their stock. If you choose to have the stock listed

in your name, you will receive the actual stock certificates. Most investors choose to

have the ownership listed in the broker's name, called "held in street name", with the

broker keeping track of whose trading account the stock actually belongs to. The

benefits are reduced paperwork, consolidated portfolio statements, no concerns

about storing and processing the paper certificates, and the ability to instantly sell

and transfer the shares. Either way, any dividends are credited to your account.

Stocks held in street name are insured up to $500,000 by the federal government

against fraud or financial failure of the brokerage company.

MARKET CAPITALIZATION

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As you become familiar with stock and mutual fund investing, you will encounter the

term "cap", as in small-cap, mid-cap, and large-cap. Cap is short for capitalization.

As a stock market term, the capitalization of a company is found by multiplying the

total number of shares times the current share price. If a company has 500 million

shares trading at $20 a share, its market cap is $10 billion (500,000,000 x $20). This

is the total value of the company's stock, the value that the world of stock market

investors has placed on the company (at least for today, investors are quick to

change their minds). Today, we define a large-cap company as one whose stock is

valued at over $10 billion, a mid-cap from $1 to $10 billion, a small-cap from $250

million to $1 billion, and a company whose stock value is under $250 million as a

micro-cap. Depending on who you listen to or how old your reference is, these

definitions will vary. A related point - don't think a company is big just because it has

a high stock price, or that it is small just because its stock price is low.

WHAT FUELS DEMAND FOR A STOCK?

Wall Street has said for years that the market is efficient, and the price of a stock

represents everything that is known about a company up to that moment. Wrong,

stock prices over-react to news, both good and bad. You would think that if a stock is

fairly valued, that no one would buy at a higher price or sell at a lower price. But how

can anyone truthfully say what fair value is? Sure, you can measure stocks by

earnings, dividend yields, return on invested capital, the company’s growth rate, or

against its industry peers. Some experts say that since safe government bonds sell

at about 20x earnings (at a 5% return), stocks should sell at less than 20x earnings

because of the added risk, and many of course do. The fact is, stocks don't have a

“fair value”, and they never have. The buying and selling, and so the moment’s price,

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is driven by psychological forces (fear of lost opportunity, envy over the killing that a

friend made in the market, good news, bad news) and economic forces (productivity,

inflation, deflation, etc.). It’s what the crowd thinks about all of this that creates

demand or a lack of demand. Whether it’s because of a company’s growth or

“because it’s a big company that pays a regular dividend”, big demand for a stock

comes down to one thing, and only one thing: investors think that they will make

money by buying the stock. Period.

The Beardstown Ladies Investment Club (of Illinois) sold a lot of their books and

received lots of publicity when they reportedly earned 23.4% for 10 years. Turned

out that they didn’t know how to figure percentages, actually earning an annual

average of 9.1% while the S&P 500 averaged 15.3%

WHAT BENEFITS DO INVESTORS GET FROM STOCK OWNERSHIP?

In addition to owning part of a company, you have the potential to receive monetary

benefits when you own stock shares. Owning stock may allows you the opportunity

to earn money on money. Historically, stocks have performed better than most other

investments. This is a testament to the growth of the economy in the United States.

From 1955 to 1994, the average yearly return of a share of stock was approximately

10 percent. This means that if $10,000 were invested in stocks in 1955, and

dividends and capital gains were reinvested instead of kept, this $10,000 would have

been worth about $444,000 by 1994.

Alternatively, by selling shares, they can sell part or all of the company to many part-

owners. The purchase of one share entitles the owner of that share to literally a

share in the ownership of the company, including the right to a fraction of the

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company, a fraction of the decision-making power, and potentially a fraction of the

profits, which the company may issue as dividends. However, the original owners of

the company often still have control of the company, and can use the money paid for

the shares to grow the company. In the common case, where there are thousands of

shareholders, it is impractical to have all of them making the daily decisions required

in the running of a company. Thus, the shareholders will use their shares as votes in

the election of members of the board of directors of the company. However, the

choices are usually nominated by insiders or the board of the directors themselves,

which over time has led to most of the top executives being on each other's boards.

Each share constitutes one vote (except in a co-operative society where every

member gets one vote regardless of the number of shares they hold). Thus, if one

shareholder owns more than half the shares, they can out-vote everyone else, and

thus have control of the company. Financing a company through the sale of stock in

a company is known as equity financing. Alternatively debt financing can be done to

avoid giving up shares of ownership of the company. Shares of stock are usually

traded on a stock exchange, where people and organizations may buy and sell

shares in a wide range of companies. A given company will usually only trade its

shares in one market, and it is said to be quoted, or listed, on that stock exchange.

However, some large, multinational corporations are listed on more than one

exchange. They are referred to as inter-listed shares. There are several types of

shares, including common stock preferred stock, treasury stock, and dual class

shares. Preferred stock, sometimes called preference shares, have priority over

common stock in the distribution of dividends and assets, and sometime have

enhanced voting rights such as the ability to veto mergers or acquisitions. A dual

class equity structure has several classes of shares (for example Class A, Class B,

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and Class C) each with its own advantages and disadvantages. Treasury stocks are

shares that have been bought back from the public. A stock option is the right or

obligation to buy or sell stock in the future at a fixed price. Stock options are often

part of the package of executive compensation offered to key executives. Some

companies extend stock options to all of their employees. This was especially true

during the dot-com boom of the mid- to late- 1990s, in which the major compensation

of many employees was in the increase in value of the stock options they held,

rather than their wages or salary. This is still the major method of compensation for

CEO. The theory behind granting stock options to executives and employees of a

corporation is that, since their financial fortunes are tied to the stock price of the

company, they will be motivated to increase the value of the stock over time. The

first company that issued shares is considered to be the Dutch East India Company

in 1602. In finance a share is a unit of account for various financial instruments

including stocks, mutual funds, limited partnerships, and REIT. In British English, the

usage of the word share alone to refer solely to stocks is so common that it almost

replaces the word stock itself.

HOW DOES THE STOCK MARKET WORK?

For all its apparent complexity, the stock market exists to do two relatively simple

things. One is to allow the sale of pieces of a company (i.e. shares) to investors, and

the second to provide a market place for the ongoing valuation of those shares.

Almost all the action takes place in this second arena, when investors buy and sell

with each other. There are many ways in which an investor can use the stock market

and the huge amount of information that is published by and about companies to try

to make money. The more quickly you intend to make money, the more attention and

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hard work is required. But there are several low-risk, low-maintenance ways of

investing too, so long as you are in for the long haul. These allow you to ignore

almost all that blizzard of news that emerges from the market yet still get superb

long-term returns.

WHY THE STOCK MARKET?

Shares are easily the best way to make your money grow over the very long term.

Those who can manage to regularly put away even small sums year by year in a

broad range of shares and leave it to do its work for a decade or more are likely to

find the performance of their cash has far exceeded the results of other kinds of

savings. This picture would be a lot clearer, of course, if the short-term performance

of the stock market were not so variable. If the value of each and every share rose

every year by 7.5%, which is roughly what it has averaged over the last century or

so, the superiority over savings accounts that pay 2%-4% would be easy to see.

However the fact that some shares double overnight and some halve, and whole

stock markets can rise or fall by 25% in a single year makes us feel seasick, puts

many people off, and obscures the long-term picture. Yet that long-term picture is

astonishingly favorable.

WHY DO PRICES MOVE SO MUCH?

Ultimately the stock market valuation of a company moves in line with the profits and

performance of that enterprise, but rumors, hype, hysteria and gossip play just as big

a role on a day-to-day basis. Stockbrokers say that two factors, greed and fear,

determine the immediate movements of share prices. That is the greed for making a

profit and the fear of making losses. Every share price is a balance between the two.

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For most long-term investors the day-to-day price of a share should not matter too

much so long as the underlying company is performing well. Certainly, many

companies that are well financed and prospering take little notice of day to day

gyrations in their share prices.

BUT WHAT ABOUT RISK?

Shares and risk seem to go hand in hand. Every day there is a story in the papers

about someone who lost an inheritance in the stock markets, or borrowed to buy

shares and now can’t repay the loan. We read articles about profit warnings,

unexpected losses, and various other events that can harm companies and destroy

the savings of those who invest in them. There are also the stories of those who

have been investing, carefully and patiently, yet find after many years saving most of

their profits have been eaten up in charges. Still others, entrusting their money to

financial advisers or fund managers, have been sold investments that were either too

risky, performed poorly, or were in some way inappropriate to their needs. There are

ways around all these problems.

RISK AND REWARD

If you put Rs.10 on a 100-1 outsider at Cheltenham, you know you are taking a risk.

There is a very high chance that you will lose your Rs.10, but then there is a tiny

chance that you will win Rs.1000 if the horse comes in. This trade-offs between risk

and rewards are also intrinsic to investing. The difference with buying shares

compared to backing horses is that nobody can put an exact number on your chance

of losing money on a particular share or how much you might gain. Day traders are

quite willing to bet thousands, sometimes much of it borrowed from specialist

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brokers, to bet on short-term movements in indices or shares. They know they are

taking a big risk. However, investors who invest in a broad range of shares and leave

them to grow for a decade or more are taking a very low risk.

MANAGING SPECIFIC RISKS

There are several types of risk.

One is the risk that a company you have shares in will go bankrupt or

permanently lose most of its value. The antidote to this risk is to spread your

investments over a large number of different shares, perhaps through a fund,

so that such an event will have minimal impact on your finances.

A second risk is that your investments will have performed poorly by the time

you want to sell. This could either be in absolute terms or compared with

savings accounts, the return on gilt-edged stocks or some other place where

you may have put the money instead. One answer to this is to put your money

away for as long as possible so the historical superiority of shares has time to

show itself, and the second is to include some of the competing assets, such

as cash or government bonds, in your investment portfolio.

A third risk, rather a subtle one, is that while you have spread your cash

between different types of assets, they move together in certain

circumstances. For example when inflation is high both savings accounts and

government bonds perform poorly. When interest rates are soaring, shares in

house builders and the value of the home you live in may both fall. The whole

point of a portfolio is to give you a smoother increase in wealth, and it takes

some planning to make sure that happens.

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THINKING ABOUT RISK

We should think about risk whether we want to invest in the stock market or not.

Many of us are running much bigger risks than we think. While many people buy life

insurance in case a family breadwinner dies, few consider how much we may have

at stake from a single event like the collapse of an employer. Bad enough to lose a

job, but what if both breadwinners work for the same firm? What about the company

car and the cheap loan from the employer to help buy an expensive house? Some

people with company share options riding high stop saving altogether. These are an

awful lot of eggs in one basket. Risk, after all, is not confined to the stock market.

HOW TO GET THE BEST FROM STOCK MARKET INVESTING?

There are a few simple rules to make sure that your money works hard for you. We

will come back to them again in more detail in other parts but here they are in brief.

Start investing early in life

Contribute steadily for years, preferably decades

Never forget the importance of dividends, not just their size but their rate of

growth, and make sure you reinvest them

Keep commissions, charges and overheads to a minimum. You want your

money to go into the market, not somebody else’s pocket

Leave the money to do its work, don’t raid it for spending

Don’t put all your investment eggs in one basket

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2. MONETARY POLICY AND STOCK MARKET

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MONETARY POLICY AND STOCK MARKET

Movements in the stock market can have a significant impact on the macro economy

and are therefore likely to be an important factor in the determination of monetary

policy. However, little is known about the magnitude of the Federal Reserve's

reaction to the stock market. One reason is that it is difficult to estimate the policy

reaction because of the simultaneous response of equity prices to interest rate

changes. This paper uses an identification technique based on the

heteroskedasticity of stock market returns to identify the reaction of monetary policy

to the stock market. The results indicate that monetary policy reacts significantly to

stock market movements, with a 5% rise (fall) in the S&P 500 index increasing the

likelihood of a 25 basis point tightening (easing) by about a half. This reaction is

roughly of the magnitude that would be expected from estimates of the impact of

stock market movements on aggregate demand. Thus, it appears that the Federal

Reserve systematically responds to stock price movements only to the extent

warranted by their impact on the macro economy.

EMPIRICAL RESULTS OF MONETARY POLICY

The ultimate objective of monetary policymakers is to promote the health of the

economy, which we do by pursuing our mandated goals of price stability and

maximum sustainable output and employment. However, the effects of our policy

instruments, such as the short-term interest rate, on these goal variables are indirect

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at best. Instead, monetary policy actions have their most direct and immediate

effects on the broader financial markets, including the stock market, government and

corporate bond markets, mortgage markets, markets for consumer credit, foreign

exchange markets, and many others. If all goes as planned, the changes in financial

asset prices and returns induced by the actions of monetary policymakers lead to the

changes in economic behavior that the policy was trying to achieve. Thus,

understanding how monetary policy affects the broader economy necessarily entails

understanding both how policy actions affect key financial markets, as well as how

changes in asset prices and returns in these markets in turn affect the behavior of

households, firms, and other decision makers. Studying these links is an ongoing

enterprise of monetary economists both within and outside the Federal Reserve

System. The link between monetary policy and the stock market is of particular

interest. Stock prices are among the most closely watched asset prices in the

economy and are viewed as being highly sensitive to economic conditions. Stock

prices have also been known to swing rather widely, leading to concerns about

possible "bubbles" or other deviations of stock prices from fundamental values that

may have adverse implications for the economy. It is of great interest, then, to

understand more precisely how monetary policy and the stock market are related.

EXAMPLE

In my talk today, I will report the results of research that I have been studied on this

topic of the Federal Reserve Bank of New York, as well as the findings of some

related work done both within and outside the Federal Reserve System. The views I

will express today, however, are based on the researcher’s views on the Federal

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Open Market Committee (FOMC) or the Board of Governors of the Federal Reserve

System. In my research, I take two questions.

1. First, by how much do changes in monetary policy affect equity prices?

As I focus on changes in monetary policy that are unanticipated by market

participants because anticipated changes in policy should already be discounted by

stock market investors and, hence, are unlikely to affect equity prices at the time

they are announced. I find an effect of moderate size: Monetary policy matters for

the stock market but, on the other hand, it is not one of the major influences on

equity prices.

2. Second question, both more interesting and more difficult, is, why do

changes in monetary policy affect stock prices?

I come up with a rather surprising answer, at least one that was surprising to us. I

find that unanticipated changes in monetary policy affect stock prices not so much by

influencing expected dividends or the risk-free real interest rate, but rather by

affecting the perceived riskiness of stocks. A tightening of monetary policy, for

example, leads investors to view stocks as riskier investments and thus to demand a

higher return to hold stocks. For a given path of expected dividends, a higher

expected return can be achieved only by a fall in the current stock price. As I will

see, this finding has interesting implications for several issues, including the role of

stock prices in transmitting the effects of monetary policy actions to the broader

economy and the potential effectiveness of monetary policy in "pricking" putative

bubbles in the stock market.

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THE EFFECT OF MONETARY POLICY ACTIONS ON THE STOCK MARKET

Normally, the FOMC, the monetary policymaking arm of the Federal Reserve,

announces its interest rate decisions at around 2:15 p.m. following each of its eight

regularly scheduled meetings each year. An air of expectation reigns in financial

markets in the few minutes before to the announcement. If you happen to have

access to a monitor that tracks key market indexes, at 2:15 p.m. on an

announcement day you can watch those indexes quiver as if trying to digest the

information in the rate decision and the FOMC's accompanying statement of

explanation. Then the black line representing each market index moves quickly up or

down, and the markets have priced the FOMC action into the aggregate values of

U.S. equities, bonds, and other assets. On occasion, if economic conditions warrant,

the FOMC may decide to make a change in monetary policy on a day that falls

between regularly scheduled meetings, a so-called intermeeting move. Intermeeting

moves, typically agreed upon during a conference call of the Committee, nearly

always take financial markets by surprise, at least in their precise timing, and they

are often followed by dramatic swings in asset prices.

Even the casual observer can have no doubt, then, that FOMC decisions move asset

prices, including equity prices. Estimating the size and duration of these effects,

however, is not so straightforward. Because traders in equity markets, as in most

other financial markets, are generally highly informed and sophisticated, any policy

decision that is largely anticipated will already be factored into stock prices and will

elicit little reaction when announced. To measure the effects of monetary policy

changes on the stock market, then, we need to have a measure of the portion of a

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given change in monetary policy that the market had not already anticipated before

the FOMC's formal announcement.

Fortunately, the financial markets themselves are a source of useful information

about monetary policy expectations. As you may know, the FOMC implements its

decisions about monetary policy by changing its target for a particular short-term

interest rate, the federal funds rate. The federal funds rate is the rate at which

depository institutions borrow and lend reserves to and from each other overnight;

although the Federal Reserve does not control the federal funds rate directly, it can

do so indirectly by varying the supply of reserves available to be traded in this

market. Since October 1988, financial investors have been able to hedge and

speculate on future values of the federal funds rate by trading contracts in a futures

market, overseen by the Chicago Board of Trade. Investors in this market have a

strong financial incentive to try to guess correctly what the federal funds rate will be,

on average, at various points in the future. The existence of a market in federal funds

futures is a boon not only to investors, such as banks, which want to protect

themselves against changes in the cost of reserves, but also to both policymakers

and researchers, because it allows any observer to infer from the sale prices of

futures contracts the values of the federal funds rate that market participants

anticipate at various future dates. Previous research has shown that participants in

this market collectively do a good job of forecasting future values of the funds rate,

efficiently incorporating available information about likely future monetary policy

actions.

By using data from the federal funds futures market, then, it is possible to estimate

the value at which financial market participants expect the FOMC to set its target for

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the federal funds rate on any given date. By comparing this expected value to what

the FOMC actually did at each date, we can determine the portion of the Fed's

interest rate decision that came as a surprise to financial markets. In our research, it

is considered all the dates of scheduled FOMC meetings plus all the dates on which

the FOMC changed the federal funds rate between meetings, or made intermeeting

moves, for the period May 1989 through December 2002, amounting to a total of 131

observations. For each of these dates, we used the expected value of the federal

funds rate as inferred from the futures market to divide the actual change in the

federal funds rate on that day into the part that was anticipated by the markets and

the part that was unanticipated. So, for example, on November 6, 2002, the Federal

Reserve cut the federal funds rate by 50 basis points. (A basis point equals 1/100 of

a percentage point, so a 50-basis-point cut equals a cut of 1/2 percentage point.)

However, this cut in the federal funds rate was not entirely unexpected; indeed,

according to the federal funds futures market, investors were expecting a cut of

about 31 basis points, on average, from the Fed at that meeting.6 So, of the 50 basis

points that the FOMC lowered its target for the federal funds rate last November 6,

only 19 basis points were a surprise to financial markets and thus should have been

expected to affect asset prices. Note, by the way, that if the Fed had not changed

interest rates at all that day, our method would have treated that action as the

equivalent of a surprise tightening of policy of 31 basis points because the Fed would

have done nothing while the market was expecting an easing of 31 basis points.

To evaluate the effect of monetary policy on the stock market, we looked at how

broad measures of stock prices moved on days on which the Fed made

unanticipated changes to policy. I can illustrate our method by continuing the

example of the Fed's cut in the federal funds rate last November 6. On that day, the

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broad stock market index we used in our study (the value-weighted index

constructed by the Center for Research in Securities Prices at the University of

Chicago) rose in value by 0.96 percentage point. Dividing the 96-basis-point gain in

the stock market by the 19-basis-point downward surprise in the funds rate, we

obtain a value of approximately 5 for the "stock price multiplier" relating policy

changes to stock market changes. If this one day were representative, we would

conclude that each basis point of surprise monetary easing leads to about a 5-basis-

point increase in the value of stocks. Or, choosing magnitudes that might be more

helpful to the intuition, we could just as well say that a surprise cut of 25 basis points

in the federal funds rate should lead the stock market to rise, on the same day, about

1.25 percentage points--about 120 points on the Dow Jones index at its current

value. In fact, applying a formal regression analysis to the full sample from 1989 to

2002, we found a number fairly close to this one, namely, a stock price multiplier for

monetary policy of about 4.7. We also found, as expected, that changes in monetary

policy that were anticipated by the market had small and statistically unimportant

effects on stock prices, presumably because these changes had already been priced

into stocks.

Although a stock price multiplier of about five for unanticipated changes in the

federal funds rate is certainly not negligible, we should appreciate that unexpected

changes in monetary policy account for a tiny portion of the overall variability of the

stock market. Unanticipated movements in the federal funds rate of 20 basis points

or more are relatively rare (we observed only thirteen examples in our fourteen-year

sample). Yet the change of one percent or so in the stock market induced by the

typical 20-basis-point "surprise" in the funds rate is swamped by the overall

variability of stock prices. For example, over the past five years, the broad stock

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market has moved one percent or more on about 40 percent of all trading days.

Thus, news about monetary policy contributes very little to the day-to-day

fluctuations in stock prices.

It explored the empirical results with some care. It is noted, for example, that a few of

the monetary policy changes in the sample were followed by what seemed to be

excessive or otherwise unusual stock market responses. A number of these

responses occurred rather recently, during the Fed's series of rate cuts in 2001. The

Fed's surprise intermitting cuts of 50 basis points each on January 3 and April 18 of

that year were both greeted euphorically by the stock market, with one-day increases

in stock values of 5.3 percent and 4.0 percent, respectively. By contrast, the rate cut

of 50 basis points on March 20, 2001, was received less enthusiastically. Even

though the cut was more or less what the futures market had been anticipating, the

financial press reported that many equity market participants were "disappointed"

that the rate cut hadn't been an even larger 75-basis-point action. In any event, the

market lost more than 2 percent that day.

To ensure that results did not depend on a few unusual observations, or "outliers,"

we re-ran our regression, omitting the days with the most extreme or unusual market

moves. This more conservative analysis led to a smaller estimate of the effect of

policy actions on the stock market, a stock price multiplier of about 2.6 rather than

4.7. However, the effect remains quite sharp in statistical terms. It is considered

other variations as well. For example, we investigated whether the magnitude of the

effect on the stock market of a surprise policy tightening (that is, an increase in

interest rates) differs from that of a surprise easing of comparable size. It does not.

Yet another experiment consisted of asking whether an unanticipated policy change

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has a larger effect if it is thought by the market to signal a longer-lasting change in

policy. We measured the perceived permanence of policy changes by observing the

effects of unanticipated policy changes on the expected federal funds rate three

months in the future, as measured by the futures market. The stock market multiplier

associated with unanticipated policy moves that are perceived to be more permanent

is a bit higher, as would be expected; its value is about 6.

In short, the statistical evidence is strong for a stock price multiplier of monetary

policy of something between 3 and 6, the higher values corresponding to policy

changes that investors perceive to be relatively more permanent. That is, according

to our findings, a surprise easing by the Fed of 25 basis points will typically lead

broad stock indexes to rise from between 3/4 percentage point and 1-1/2 percentage

points. Incidentally, similar results obtain for stock values of industry groups: it is find

almost all industry stock portfolios respond significantly to changes in monetary

policy, with telecommunications, high-tech, and durables goods industry stocks

being the most sensitive to monetary policy news, and energy, utilities, and health

care stocks being the least sensitive. These results can be broadly explained by the

tendency of each industry group to move with the broad market, or (to use the

language of the standard capital asset pricing theory), by their industry "betas."

WHY DOES MONETARY POLICY AFFECT STOCK PRICES?

It is interesting, though perhaps not terribly surprising, to know that Federal Reserve

policy actions affect stock prices. An even more interesting question, though, is, why

does this effect occur? Answering this question will give us some insight into how

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monetary policy affects the economy, as well as the role that the stock market should

play in policy decisions.

A share of stock is a claim on the current and future dividends (or other cash flows,

such as stock buybacks) to be paid by a company. Suppose, for just a moment, that

financial investors do not care about risk. Then only two types of news ought to

affect current stock values: news that affects investor forecasts of current or future

(after-tax) dividends or news that affects forecasts of current or future short-term

interest rates. News that current or future dividends (which I want to think of here as

being measured in real, or inflation-adjusted, terms) are likely to be higher than

previously expected--say, because the company is expecting to be more profitable--

should raise the current stock price. News that current or future short-term interest

rates (also measured in real, or inflation-adjusted, terms) are likely to be higher than

previously expected should depress the stock price.

There are two essentially equivalent ways of understanding why expectations of

higher short-term real interest rates should lower stock prices.

First, to value future dividends, an investor must discount them back to the

present; as higher interest rates make a given future dividend less valuable in

today's dollars, higher interest rates reduce the value of a share of stock.

Second, higher real interest rates make investments other than stocks, such

as bonds, more attractive, raising the required return on stocks and reducing

what investors are willing to pay for them. Under either interpretation,

expectations of higher real interest rates are bad news for stocks.

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So, to reiterate, in a world in which investors do not care about risk, stock prices

should change only with news about current or future dividends or about current or

future real interest rates. However, investors do care about risk, of course. Because

investors care about risk, and because stocks are viewed as relatively risky

investments, investors generally demand a higher average return, relative to other

assets perceived to be safer, to hold stocks. Using long historical averages, one

finds that, in the United States, a diversified portfolio of stocks has paid 5 to 6

percentage points more per year, on average, than has a portfolio of government

bonds. This extra return, known as the risk premium on stocks, or the equity

premium, presumably reflects, in part, the extra compensation that investors demand

to be willing to hold relatively more risky stocks.

Like news about dividends and real interest rates, news that affects the risk premium

on stocks also affects stock prices. For example, news of an impending recession

could raise the risk premium on stocks in two ways. First, the macroeconomic

environment is more volatile than usual during a recession, so stocks themselves

may become riskier investments. Second, the incomes and wealth of financial

investors tend to fall during a downturn, giving them a smaller cushion to support the

lifestyles to which they are accustomed (that is, to make house payments and meet

other obligations). With less discretionary income and wealth to absorb potential

losses, people may become less willing to bear the risks of more volatile financial

investments. For both reasons, the extra return that investors demand to hold stocks

is likely to rise when bad times loom. With expected dividends and the real interest

rate on alternative assets held constant, the expected yield on stocks can rise only

through a decline in the current stock price. Now there is a list of three key factors

that should affect stock prices. First, news that current or future dividends will be

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higher should raise stock prices. Second, news that current or future real short-term

interest rates will be higher should lower stock prices. And third, news that leads

investors to demand a higher risk premium on stocks should lower stock prices.

How does all this relate to the effects of monetary policy on stock prices? According

to our analysis, Fed actions should affect stock prices only to the extent that they

affect investor expectations about dividends, short-term real interest rates, or the

riskiness of stocks. The trick is to determine quantitatively which of these sets of

investor expectations is likely to be most affected when the Fed unexpectedly

changes the federal funds rate. To make this determination, we used a methodology

first applied by the financial economist John Campbell, of Harvard University, and by

Campbell and John Ammer of the Federal Reserve Board staff. Putting the details

aside, we can describe the basic idea as follows. Imagine that the expectations of

stock market investors can be mimicked by a statistical forecasting model that takes

relevant current data as inputs and projects estimated future values of aggregate

dividends, real interest rates, and equity risk premiums as outputs. In principle,

investors could use such a model to make forecasts of these key variables and

hence to estimate what they are willing to pay for stocks. Besides a number of

standard variables that have been shown to be helpful in making forecasts of such

financial variables, suppose we include in the forecasting model our measure of

unanticipated changes in the federal funds rate.13 That is, we use the information

contained in these unanticipated changes in making our forecasts of future

dividends, interest rates, and risk premiums.

Suppose we have run our computer model, made our forecasts, and inferred the

appropriate values for stocks. But then we receive news that the Fed has

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unexpectedly raised the federal funds rate by 25 basis points. Based on our

forecasting model, by how much would that information change our previous

forecasts of future dividends, interest rates, and risk premiums? The answer to this

question clarifies the channel by which monetary policy affects stock prices. If we

were to find, for example, that the news of an unexpected increase in the funds rate

significantly changed the forecast of future dividends but did not much affect the

forecasts of interest rates or risk premiums, then we could conclude that monetary

policy affects stock prices primarily by affecting investor expectations of future

dividends. By contrast, if news of the policy action changed the model forecasts for

real interest rates but did not change our forecasts for the other two variables, we

would decide that unanticipated policy actions affect stock prices primarily by

influencing the interest rates expected by stock investors.

What we actually found when conducting this statistical experiment was quite

interesting. It appears that, for example, an unanticipated tightening of monetary

policy leads to only a modest change in forecasts of future dividends and to still less

of a change in forecasts of future real interest rates (beyond a few quarters).

Quantitatively, according to our methodology, the most important effect of a policy

tightening is on the forecasted risk premium. Specifically, an unanticipated tightening

of monetary policy raises expected risk premiums on stocks for a protracted period.

For a given expected stream of dividend payouts and real interest rates, the risk

premium and hence the return to holding stocks can only rise if the current stock

price falls.

In short, our analysis suggests that an unanticipated monetary tightening lowers

stock prices only to a small extent by lowering investor expectations about future

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dividend payouts, and by still less by raising expected real interest rates. The most

powerful effect of an unanticipated monetary tightening is to increase the perceived

risk premium on stocks, either by increasing the riskiness of stocks, by reducing

people's willingness to bear risk, or both. Reduced willingness of investors to hold

relatively more risky stocks drives down stock prices.

Our analysis does not explain precisely how monetary policy affects risk, but we can

make reasonable conjectures. For example, tighter monetary policy may raise the

riskiness of shares themselves by raising the interest costs and weakening the

balance sheets of publicly owned firms. In the macro economy more generally, by

reducing spending and economic activity, tighter money raises the risks of

unemployment or bankruptcy faced by individual households or firms. In each case,

tighter monetary policy increases risk by reducing financial buffers or otherwise

increasing the vulnerability of individuals or firms to future shocks to the economy.

IMPLICATIONS OF THE RESULTS FOR MONETARY POLICY

So far two principal conclusions from the empirical analysis are discussed:

First, the stock price multiplier of monetary policy is between 3 and 6--in other

words, an unexpected change in the federal funds rate of 25 basis points

leads, on average, to a movement of stock prices in the opposite direction of

between 3/4 percentage point and 1-1/2 percentage points.

Second, the main reason that unanticipated changes in monetary policy affect

stock prices is that they affect the risk premium on stocks. In particular, a

surprise tightening of policy raises the risk premium, lowering current stock

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prices, and a surprise easing lowers the risk premium, raising current stock

prices.

What implications do these results have for our broader understanding and for the

practice of monetary policy? I will briefly discuss two issues: first, the role of the

stock market in the transmission of monetary policy changes to the economy; and

second, the efficacy of monetary policy as a tool for controlling stock market

"bubbles." A long-held element of the conventional wisdom is that the stock market is

an important part of the transmission mechanism for monetary policy. The logic goes

as follows: Easier monetary policy, for example, raises stock prices. Higher stock

prices increase the wealth of households, prompting consumers to spend more--a

result known as the wealth effect. Moreover, high stock prices effectively reduce the

cost of capital for firms, stimulating increased capital investment. Increases in both

types of spending--consumer spending and business spending--tend to stimulate the

economy.

This simple story can be elaborated somewhat in light of our results. It is true, as I

have discussed, that an easier monetary policy raises stock prices, whereas a tighter

policy lowers them. However, easier monetary policy not only raises stock prices; as

we have seen, it also lowers risk premiums, presumably reflecting both a reduction in

economic and financial volatility and an increase in the capacity of financial investors

to bear risk. Thus, our results suggest that easier monetary policy not only allows

consumers to enjoy a capital gain in their stock portfolios today, but it also reduces

the effective amount of economic and financial risk they must face. This reduction in

risk may cause consumers to trim their precautionary saving, that is, to reduce the

amount of income that they put aside to protect themselves against unforeseen

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contingencies. Reduced precautionary saving in turn implies more spending by

households. Thus, the reduction in risk associated with an easing of monetary policy

and the resulting reduction in precautionary saving may amplify the short-run impact

of policy operating through the traditional channel based on increased asset values.

Likewise, reduced risk and volatility may provide an extra kick to capital expenditure

in the short run, as firms are more likely to undertake investments in new structures

or equipment in a more stable macroeconomic environment.

A second issue concerns the role of monetary policy in the management of large

swings in stock values, or "bubbles." In an earlier speech (Bernanke, 2002), I gave a

number of reasons why I believe that using monetary policy--as opposed to

microeconomic, prudential policies--is not a good way to address the problem of

asset-market bubbles. These included the difficulty of identifying bubbles in advance;

the questionable wisdom, in the context of a free-market economy, of setting up the

central bank as the arbiter of asset values; the problem that arises when a bubble

occurs in only one asset class rather than in all asset classes; and other reasons. A

major concern that I have about the bubble-popping strategy, however, is that

attempts to bring down stock prices by a significant amount using monetary policy

are likely to have highly deleterious and unwanted side effects on the broader

economy.

The research described today allows me to address this issue more

concretely. Here I will make just two points.

First, this research suggests that relatively small changes in monetary policy

would not do much to curb a major overvaluation in the stock market. As we

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have seen, a surprise tightening of 25 basis points should be expected to

lower stock prices by only a little more than 1 percent, which, as already

noted, is a trivial movement relative to the overall variability of the stock

market. It would not be appropriate to extrapolate these results to try to

estimate how much tightening would be needed to correct a substantial

putative overvaluation in stock prices, but it seems clear that a light tapping of

the brakes will not be sufficient. What we can say is that the necessary policy

move would have to be quite large--many percentage points on the federal

funds rate--and we would be highly uncertain about its magnitude or its

ultimate effects on stock prices and the economy.

Second, we have seen that monetary tightening reduces stock prices primarily

by increasing the risk premium for holding stocks, as opposed to raising the

real interest rate or lowering expected dividends. The risk premium for stocks

will rise only to the extent that broad macroeconomic risk rises, or that people

experience declines in income and wealth that reduce their ability or

willingness to absorb risk. This evidence supports the proposition that

monetary policy can lower stock values only to the extent that it weakens the

broader economy, and in particular that it makes households considerably

worse off. Indeed, according to our analysis, policy would have to weaken the

general economy quite significantly to obtain a large decline in stock prices.

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3. NSE VS. BSE

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The Bombay Stock Exchange Ltd. (BSE) was established in 1875 and is the

oldest exchange in Asia and was the only exchange for investors in India to tradein

stocks(equity shares) till 1995. In 1995, National Stock Exchange Ltd. (NSE)

promoted by financial institutions was established. Within a short span of time the

NSE with remarkable product innovations, use of technology and professional

management was able to overtake BSE and emerge as a leading stock exchange in

India. NSE introduced avenues for tangible differentiation to set itself apart from

BSE. Major investors shifted their main operations from BSE to NSE to trade and

invest. In 2005, BSE had a market share of 31.11%1 in the cash segment and 0.63%

in the derivatives segment, corresponding to NSE’s 68.39% (cash) and 99.37%

(derivatives) respectively.

In 2005, BSE converted into a corporate entity (earlier an association of

brokers) to compete with NSE operations. The ownership and management of the

BSE were separated from the trading rights. The brokers (associated with BSE) were

skeptical about the restructuring exercise and were worried about the future of BSE.

Would BSE be able to gain its lost pride with its new identity?

BSE

Bombay Stock Exchange Limited (popularly known as "BSE") was the oldest

stock exchange in Asia (Table-1). It was established in 1875 when 318 individuals

contributed Re.1 each and became members to form "The Native Share & Stock

Brokers Association". It was the first stock exchange in India to obtain permanent

recognition in 1956 from the Government of India under the Securities Contracts

(Regulation) Act, 1956.

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BSE a voluntary non-profit association of broker members emerged as a

premier stock exchange after the 1960s. The increased pace of industrialization

caused by the two world wars, protection to domestic industry and government’s

fiscal policies aided the growth of new issues which in turn helped the BSE to

prosper. BSE dominated the Indian capital market with over 60% of the total turnover

of shares traded.

In 1986, the exchange came up with an index called SENSEX, comprising of

30 representative stocks. The stock were selected on the basis of their market

capitalization, number of trades, average value of shares traded per day (as a

percentage of total number of outstanding shares), balanced representation of

industry, leadership position in the industry, continuous dividend paying record and

track record of promoters. This index subsequently proved to be the barometer of the

Indian stock market. Sensex emerged as a prominent brand in the country. Sensex

was scientifically designed and based on globally accepted construction and review

methodology.

The base value of Sensex was 100 taken as on 1978-79.

The carry forward system or badla (Table 2) was a unique selling proposition

of the BSE. Badla provided the facility for carrying forward the transaction from one

settlement to another. It was the postponement of delivery or payment for the

purchase of securities from one settlement period to another. This facility of ‘carry

forward’ provided liquidity and breadth to the market. By bringing in outside money to

fund the carry forward of long positions, badla acted as a bridge between the money

market and the stock market. But this trading was uncontrolled and unregulated and

enhanced market risk. However, with the securities scam outburst in 1992 Securities

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Exchange Board of India (SEBI) (Table 3) took over the control of the stock market

and banned the badla system in 1993.

Until March 1995, BSE had an open outcry system of trading. With the

entrance of NSE the country’s first modern, computerized and professionally

managed stock exchange in 1994, BSE had to change its system of trading and

operations. In 1995, BSE adapted itself to the BSE online Trading System (BOLT),

an electronic trading system through which brokers traded using computers. The

introduction of BOLT helped BSE significantly reduce the spread between buy and

sell orders, better trading in odd lot shares, fixed income instruments and dealings in

the renunciation of rights shares. The surveillance, clearing and settlement functions

of the exchange were ISO 9001:2000 certified.

Following the ban on badla trading, a steep decline was experienced in

volumes in specified groups of stocks. , the system was later revived and resumed in

1996. However, the BSE had to face a serious scam in 2001 in which Ketan Parekh

was involved. He operated through his three broking outfits and 40 satellite brokers

and invested heavily in Information Technology, Communication and Entertainment

(ICE) industry scrips. He operated with badla payments and used funds of NRIs and

new private sector banks (who accepted shares as collateral).The Sensex rose from

the figures of 3378 to 6100. In 2001, due to the sharp fall in the prices of ICE scrips

across the globe and the recession in the global economy resulted in a significant

erosion of market capitalization of stocks on the NASDAQ and at other leading stock

exchanges around the world, the value of the Sensex fell to 3788. This compelled

brokers and banks to ask for their money. Being unable to meet the demand for

payments Ketan Parekh defaulted and the resultant scams now baled to a large

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amount of Rs 1,500-2,000 crores. The after math of this scam led to SEBI banning

badla once again and possibly forever.

In 1999, BSE set up the Central Depository Services India Ltd. (CDSIL) co-

sponsored by the State Bank of India, Bank of India, Bank of Baroda and HDFC

Bank. CDSIL improved the overall functioning of the stock settlement process,

eliminated paperwork that impacted service delivery, shortened the book closure

period and effected immediate payment on sale of shares by investors.

By 2005, the network of BSE spread across 417 cities, with over 800

members and 14,426 terminals. It registered about 1.4 million transactions per day,

and an average daily turnover of about Rs. 25 billion.

Restructuring

In 2005, the BSE was demutualized and was registered as a corporate entity

under the provisions of the Companies Act, 1956. Until 2005 the exchange was an

association of brokers. After demutualization the trading rights and ownership rights

were separated. The Exchange was professionally managed under the overall

direction of the Board of Directors. The Board comprised eminent professionals,

representatives of trading members and the Managing Director of the exchange.

The Board formulated policy issues and exercised overall control. The Managing

Director assisted by a team of professionals who handled the day-to-day operations.

According to experts, BSE was expected to have better commercial

orientation and accountability as a ‘for profit’ company than before. Moreover,

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segregation of ownership and management was expected to encourage greater

confidence among the regulators and the investors, and flexibility in decision-making

would bring about speedy response to emerging business opportunities.

In 2005, BSE along with Federation of Indian Stock Exchanges launched a

national trading platform called BSE Indonext, for small and medium enterprises.

This platform helped SMEs to raise capital and trade through BSE Online Trading

and its website trading system.

NSE

The National Stock Exchange of India Limited (NSE); promoted by leading

financial institutions (Exhibit IV) was incorporated in 1992 as a tax-paying company

(unlike other stock exchanges in the country). NSE was incorporated as a

demutualised stock exchange where the ownership and management were deprived

of the trading rights. A report from High Powered Study Group on Establishment of

New Stock Exchanges instituted financial institutions to promote NSE and provide

equal access to investors across the country (India).

Though the driving force behind its inception was the policy makers in the

country, it was set up as a public limited company and owned by leading institutional

investors in the country. The Board comprised of senior executives from promoter

institutions, eminent professionals in the field of law, economics, accountancy,

finance, taxation, public representatives and nominees of the SEBI (Securities

Exchange Board of India - the regulating body of the Indian capital market).

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In 1993, NSE was recognized as a stock exchange under the Securities

Contracts (Regulation) Act, 1956. The exchange commenced operations in 1994

with the Wholesale Debt Market (WDM) and achieved various milestones (Table -5).

NSE provided fair and transparent services in the securities market to

investors with the help of screen based electronic trading systems. It allowed a

member to feed into the computer the number of securities and the prices at which

he would like to transact; the transaction was executed as soon as matching order

from a counter party was found. This technology-oriented mechanism ensured

transparency, shortened settlement cycles and book entry settlement systems and

thereby matched the global standards of securities markets. The market practices

and technology standards set by NSE later on emerged as benchmark and were

followed by other participants.

In 1996, the exchange came up with an index called NIFTY, comprising of 50

large, liquid and representative stocks representing 24 sectors of the economy and

77% of traded value of all stocks on the NSE. The stocks were selected on the basis

of low impact cost, high liquidity and market capitalization. The base is defined as

1000 as of November 1995. The index was professionally maintained and reviewed

every quarter.

In 1998, NSE commenced Automated Lending and Borrowing Mechanism for

lending and borrowing of securities (ALBM). ALBM was the answer to BSE’s badla.

ALBM facilitated borrowing/lending of securities/funds at market determined rates to

meet immediate settlement requirements or payment obligations at a reasonable

cost and low risk. ALBM was a security lending and borrowing mechanism while

badla a pure financing mechanism.

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NSE members were connected to the exchange from their work stations to

the central computer located at the exchange through a satellite using VSATs (Very

Small Aperture Terminals). By 2005, NSE had installed over 2,829 VSATs in over

345 cities across the country. NSE pioneered commencement of Internet Tradingin

February 2000, which led to the wide popularization of the NSE in the broker

community.

By 2004, NSE was known as the third best exchange across the world

(Exhibit VI). Also, NSE won the Wharton-Infosys Business Transformation Award in

the Organisation-wide Transformation category for the Europe and Asia Pacific

region for harnessing technology to create a world class exchange and bringing a

revolution in the industry as a whole.

In 2004-2005, the NSE had a trading value of Rs.1,140,072 crore from Rs.

1,805 crore in 1994-95. The Futures &Options segment (Box I) had a trading value

of Rs. 2,547,053 crore during 2004-05.

Group Companies

NSDL

In order to solve the problems associated with trading in physical securities,

NSE along with the Industrial Development Bank of India (IDBI) and the Unit Trust of

India (UTI) promoted dematerialisation of securities and set up National Securities

Depository Limited (NSDL)the first depository of India in 1996. NSDL established a

national infrastructure of international standard to handle trading and settlement in

dematerialised form.

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NSCCL

The National Securities Clearing Corporation Ltd. (NSCCL), the first clearing

corporation in India, was incorporated in 1995. NSCCL sustained confidence in

clearing and settlement of securities (equity and derivatives), promoted short and

consistent settlement cycles, provided counter party risk guarantees and operated a

tight risk containment system. It also operated a Subsidiary General Ledger (SGL)for

settling trades in government securities.

These steps brought Indian financial markets at par with international markets.

NSE. IT Ltd.

NSE. IT Ltd. was the 100% subsidiary, information technology arm of NSE.

NSE.IT provided products and services in areas of broker front end and back-ofice,

clearing and settlement, web based training, risk management, treasury

management, asset liability management, banking etc.

IISL

In 1998, Indian Index Services and Products Limited (ISL) was set up by the

joint venture of NSE and CRISIL Ltd. (Credit Rating Information Services of India

Limited).ISL provided variety of indices and index related services and products for

the Indian capital markets.

DotEx International Limited

DotExprovided world class Internet trading platforms to members of NSE to

further provide it to their customers. DotEx provided products in two modules: Equity

Trading Module and F&O Trading Module.

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Competitive Landscape

NSE with approximately 860 stocks listed on its exchange provided stiff

competition to BSE (Exhibit VI) which had around 8,500 stocks listed on its

exchange. According to brokers, a large proportion of BSE's cash market turnover

(Table-6) was contributed by arbitrage opportunities between the NSE and BSE and

from small and medium sized stocks that were not listed on NSE.

Around 50% of BSE's cash market turnover came from the stocks other than

those in the 'A' group. On the other hand top 100 stocks on NSE contributed

approximately 80% of its cash segment turnover.

Investors in India traded without any computerization at the BSE for many

years. The quality of this market was widely considered as poor with respect to

transparency, liquidity and market efficiency. After a serious scam in 1992, Finance

Ministry and SEBI sought reforms in the equity markets with the introduction of

screen based trading and promotion of NSE.

BSE Sensex suffered from hedging effectiveness, higher impact cost and

immense political hiccups. NSE within a short period of time overtook BSE due to its

administrative improvements and les systemic costs which attracted a lot of investors

to NSE.

NSE on the other hand with the help of robust IT infrastructure became

strongly associated with derivatives. NSE has a good global perspective.

International investors and NRIs with an interest to hedging India risk knew about

derivatives and started trading in the NSE.

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Earlier the governing board of BSE was an elected body and therefore its

members were worried about broker sentiments; but with the changes that took

place and with competitive pressures from NSE. Broker members (who earlier were

considered to be roadblocks) no longer questioned the regulatory bodies. The

brokers brought about reforms and greater transparency to sustain the competition

from NSE. While NSE was not exposed to such external pressures. Most members

in NSE unanimously accepted the decisions taken by the top authorities and were

happy to be a part of the country's leading stock exchange.

Technically larger trading volumes and superior bid-ask spread son NSE

attracted a large number of traders. More investors at NSE opened different avenues

of investment- for e.g. derivatives. Due to the regulations at BSE, it merely

concentrated in Mumbai, while the NSE spread along the length and breadth of the

country (8,000 terminals across the country)and invited a large number of potential

audiences to the exchange.

Moreover, SEBI allowed exchanges to set up trading terminals abroad with

the help of Internet trading. Internet trading consisted of two types –order driven

trading system and quote driven trading system. BSE provided both these systems

while NSE provided only the order driven system.

In global stock markets the size of derivative segments is five times larger

than the size of the cash segment. Rajnikant Patel CEO, BSE said, "We will be re-

launching our products to be in the derivatives space".

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The Road Ahead

The restructuring at BSE required the member brokers to of load their

shareholding (i.e.51%) by 2006. The various avenues considered were to offer an

IPO, or enter into strategic relationship or both according to feasibility. Experts

opined that if BSE entered into strategic partnerships with large private sector banks

it would be exposed to a large distribution network and would also be able to

promote new products like derivatives on a large scale.

How and what strategy should BSE adopt to not only preserve its historical

image but also counter the stiff competition from NSE needs to be seen in the future.

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4. ROLE OF SEBI IN NSE AND BSE

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SEBI IN CAPITAL MARKET

Joint Stock Companies: Concept & Evolution

The early history of the accumulation of capital in England is very obscure, especially

as most enterprises were either one-man businesses or simple partnerships, where

all decisions were informal and hardly ever recorded. This was the state of affairs

under the gild system, and the lack of evidence from this quarter increases the

importance of the history of the joint-stock companies, which kept records and

played a large part in the accumulation of capital even before 1720. The concept of

the Corporation was well established in the English Law at about the 14th Century.

The Concept owes its origin to the Earlier Guild system prevalent at theta point of

time. Guilds were built in regard to particular commodity in which they specialized

themselves in order to create monopoly.

The discoveries of the sixteenth and seventeenth centuries had opened new trade

routes all over the world, and the consequent extension of markets offered many

profitable openings for capital to be invested in commercial enterprises. Thus the

way opened for the rapid development of capitalist organization that took place in the

seventeenth and eighteenth centuries.

It was in the 16th and 17th century when the idea of legal unity coupled with the

financial device of joint stock trading bought forth the birth of Business Corporations.

Company form of Business Organization have originated and developed after the

Industrial Revolution. In the year 1844 Joint Stock Companies Act was Enacted

which provided incorporation of companies by way of registration opposed to a

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Special Act or Charter and further differentiating between private partnerships and

joint stock companies. But the concept of limited liability was absent then, it was

brought into existence by Limited liability Act, 1855 but was repealed with Joint stock

Companies Act of 1856. The concept of having limited liability was preserved and

was made compulsory. This was in order to make even small and middle class

investors to contribute to the stock of the Corporation to which they were skeptical in

the absence of limited liability. Thus it can be concluded that Joint Stock Companies

as the name provides are Corporations pooling the fund received from the investor in

a common stock benefits of which is divided between the contributors as in

accordance of their rights so vested.

By the end of Seventeenth Century, share dealings were common and stock broking

was a recognized profession abuse of which legislator sought to regulate as early as

1696.

It is interesting to note that although the invention of preference shares is generally

attributed to Railway boom a century later, certain company’s had already

experimented with different classes of shares or of a loan stock, the distinction

between shares and debentures were not appreciated until much later.

Historical Background of Stock Exchange

As According to the Oxford dictionary of the business world, the stock market also

known as the stock exchange is defined as a place in which stock, shares and other

securities are bought and sold, price being controlled by demand and supply. Stock

markets have developed hand in hand with capitalism. Since the 17th century they

are constantly growing in importance and complexity. The stock market has

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therefore been developed with time to open up opportunities to businesses and

these individuals, and could be traced far back in history. During the second half of

the seventeenth century there existed a considerable volume of securities, both

commercial and gilt-edged, and the need to facilitate their transfer was becoming

evident. At first, Government securities were predominantly short-term, such as

Exchequer Tallies and discounting them with bankers affected liquidation. Similarly,

many company stocks were still relatively short term relating to a particular voyage

or adventure. When an investor wished to realize his share before the completion of

the voyage, this was normally achieved by private negotiation with potential buyers.

Towards the end of seventeenth century an organized market existed for the

purchase and sale of stocks and shares. Brokers were licensed by the Lord Mayor of

the City of London, and carried a silver medal as evidence thereof. These brokers

were entitled to trade in any commodity or commodities within the city. After the

financial crisis of 1696 the Government attempted to regulate the market and in 1697

passed an “Act” to restrain the number and ill practice and stock Jobbers”. This

provided that no person was to act as a broker in commodities or stock and shares

unless licensed by the City of London, and that the total number of brokers so

licensed to be limited to one hundred. Both this Act and Barnard Act of 1733, which

made it illegal to buy stock without immediate payment or to sell it without immediate

delivery were largely uninformed, and both the number of practicing Stockbrokers

and the volume of speculative transactions increased. Up to 1698 the stockbrokers

had congregated in the Royal Exchange, which was the center for all commodity

transactions in the city.

It is clear that the Stock Exchange developed in order to meet two demands. First,

the increased issue of securities of a long-term or permanent nature required a

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market for the purchase and sale of these securities, so that their holders could

liquidate their investments in the short-term. Also the expansion of industry during

the nineteenth century necessitated the discovery of new sources of finance. One of

the sources of such was the Stock Exchange, which has continued ever since to be

an important source of capital for industry.

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Role of Regulatory Body

The role of the Regulatory Authority in a Country depends upon the stages of

development in the Securities Market in that Country. In the Indian Context where

the market is emerging in nature, role of the regulatory body is not only limited to

regulation but to create conditions through exercise of function for the development

of the market.

This will ensure the market development and regulatory measures aiming to create

discipline in the market and ensure high degree of fairness and market integrity.

Thus we can say that SEBI as the Capital Market Regulator in India has twin

objectives i.e. of regulating as well as developing the market.

As indicated earlier, a favourably operating capital market requires good rules and

laws guiding a prospective market player which is now the duty of Regulatory

Authority taking charge of fair market entrance and play. Most countries have treated

this as a priority because the development of a country’s financial market and

institution may contribute substantially to its subsequent economic growth. It’s been

a decade since the Securities and Exchange Board of India (SEBI) started to put in

place the regulatory framework for the capital market and investors have certainly

benefited from the availability of more information and a contemporary secondary

market structure.

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POWERS AND FUNCTIONS OF THE BOARD

Functions of Board

(1) Subject to the provisions of this Act, it shall be the duty of the Board to protect the

interests of investors in securities and to promote the development of, and to

regulate the securities market, by such measures as it thinks fit.

(2) Without prejudice to the generality of the foregoing provisions, the measures

referred to therein may provide for -

(a) Regulating the business in stock exchanges and any other securities markets;

(b) registering and regulating the working of stock brokers, sub-brokers, share

transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue,

merchant bankers, underwriters, portfolio managers, investment advisers and such

other intermediaries who may be associated with securities markets in any manner.

(c) Registering and regulating the working of 1[15][venture capital funds and

collective investment schemes],including mutual funds;

(d)Promoting and regulating self-regulatory organizations;

(e)Prohibiting fraudulent and unfair trade practices relating to securities markets;

(f) Promoting investors' education and training of intermediaries of securities

markets;

(g) Prohibiting insider trading in securities;

1

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(h) Regulating substantial acquisition of shares and take-over of companies;

(i) Calling for information from, undertaking inspection, conducting inquiries and

audits of the stock exchanges, mutual funds, other persons associated with the

securities market] intermediaries and self- regulatory organizations in the securities

market;

(j) Performing such functions and exercising such powers under the provisions of the

Securities Contracts (Regulation) Act, 1956(42 of 1956), as may be delegated to it

by the Central Government;

(k) Levying fees or other charges for carrying out the purposes of this section;

(l) Conducting research for the above purposes;

(m) Performing such other functions as may be prescribed.

(i) The discovery and production of books of account and other documents, at

such place and such time as may be specified by the Board;

(ii) Summoning and enforcing the attendance of persons and examining them

on oath;

(iii) Inspection of any books, registers and other documents of any person

referred to in section 12, at any place;

(iv) Inspection of any book, or register, or other document or record of the

company referred to in sub-section (2A);

(v) issuing commissions for the examination of witnesses or documents.

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(3) Without prejudice to the provisions contained in sub-sections (1), (2), (2A) and (3)

and section 11B, the Board may, by an order, for reasons to be recorded in writing,

in the interests of investors or securities market, take any of the following measures,

either pending investigation or inquiry or on completion of such investigation or

inquiry, namely:-

(a) Suspend the trading of any security in a recognized stock exchange;

(b) Restrain persons from accessing the securities market and prohibit any person

associated with securities market to buy, sell or deal in securities;

(c) Suspend any office-bearer of any stock exchange or self- regulatory organization

from holding such position;

(d) Impound and retain the proceeds or securities in respect of any transaction which

is under investigation;

(e) attach, after passing of an order on an application made for approval by the

Judicial Magistrate of the first class having jurisdiction, for a period not exceeding

one month, one or more bank account or accounts of any intermediary or any person

associated with the securities market in any manner involved in violation of any of

the provisions of this Act, or the rules or the regulations made there under:

Provided that only the bank account or accounts or any transaction entered therein,

so far as it relates to the proceeds actually involved in violation of any of the

provisions of this Act, or the rules or the regulations made there under shall be

allowed to be attached;

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(f) Direct any intermediary or any person associated with the securities market in any

manner not to dispose of or alienate an asset forming part of any transaction which

is under investigation:

Provided that the Board may, without prejudice to the provisions contained in sub-

section (2) or sub-section (2A), take any of the measures specified in clause (d) or

clause (e) or clause (f), in respect of any listed public company or a public company

(not being intermediaries referred to in section 12) which intends to get its securities

listed on any recognized stock exchange where the Board has reasonable grounds

to believe that such company has been indulging in insider trading or fraudulent and

unfair trade practices relating to securities market:

Provided further that the Board shall, either before or after passing such orders, give

an opportunity of hearing to such intermediaries or persons concerned.

Board to regulate or prohibit issue of prospectus, offer document or advertisement

soliciting money for issue of securities.

11A (1) without prejudice to the provisions of the Companies Act, 1956(1 of 1956),

the Board may, for the protection of investors, -

(a) Specify, by regulations –

(i) The matters relating to issue of capital, transfer of securities and other matters

incidental thereto; and

(ii) The manner in which such matters shall be disclosed by the companies;

(b) By general or special orders –

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(i) Prohibit any company from issuing prospectus, any offer document, or

advertisement soliciting money from the public for the issue of securities;

(ii) Specify the conditions subject to which the prospectus, such offer document

or advertisement, if not prohibited, may be issued.

(2) Without prejudice to the provisions of section 21 of the Securities Contracts

(Regulation) Act, 1956(42 of 1956), the Board may specify the requirements for

listing and transfer of securities and other matters incidental thereto."]

Collective Investment Scheme

(1) Any scheme or arrangement which satisfies the conditions referred to in sub-

section (2) shall be a collective investment scheme.

(2) Any scheme or arrangement made or offered by any company under which, ---

(i) the contributions, or payments made by the investors, by whatever name

called, are pooled and utilized solely for the purposes of the scheme or

arrangement;

(ii)The contributions or payments are made to such scheme or arrangement

by the investors with a view to receive profits, income, produce or property,

whether movable or immovable from such scheme or arrangement;

(iii) The property, contribution or investment forming part of scheme or

arrangement, whether identifiable or not, is managed on behalf of the

investors;

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(iv) The investors do not have day to day control over the management and

operation of the scheme or arrangement.

(3) Notwithstanding anything contained in sub-section (2), any scheme or

arrangement –

(i) made or offered by a co-operative society registered under the co-operative

societies Act,1912(2 of 1912) or a society being a society registered or

deemed to be registered under any law relating to cooperative societies for

the time being in force in any state;

(ii)under which deposits are accepted by non-banking financial companies as

defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934(2

of 1934);

(iii) Being a contract of insurance to which the Insurance Act,1938(4 of 1938),

applies;

(iv)providing for any scheme, Pension Scheme or the Insurance Scheme

framed under the Employees Provident Fund and Miscellaneous Provisions

Act, 1952(19 of 1952);

(v) Under which deposits are accepted under section 58A of the Companies

Act, 1956(1 of 1956);

(vi) Under which deposits are accepted by a company declared as a Nidhi or

a mutual benefit society under section 620A of the Companies Act, 1956(1 of

1956);

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(vii)falling within the meaning of Chit business as defined in clause (d) of

section 2 of the Chit Fund Act, 1982(40 of 1982);

(viii) Under which contributions made are in the nature of subscription to a

mutual fund;

Power to issue directions.

11B. Save as otherwise provided in section 11, if after making or causing to be made

an enquiry, the Board is satisfied that it is necessary,-

(i) in the interest of investors, or orderly development of securities market; or

(ii) to prevent the affairs of any intermediary or other persons referred to in

section 12 being conducted in a manner detrimental to the interest of investors or

securities market; or

(iii) to secure the proper management of any such intermediary or person, it

may issue such directions,-

(a) to any person or class of persons referred to in section 12, or associated

with the securities market; or

(b) to any company in respect of matters specified in section 11A, as may be

appropriate in the interests of investors in securities and the securities market.

11C. (1) Where the Board has reasonable ground to believe that –

(a)the transactions in securities are being dealt with in a manner detrimental

to the investors or the securities market; or

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(b)any intermediary or any person associated with the securities market has

violated any of the provisions of this Act or the rules or the regulations made or

directions issued by the Board thereunder,

It may, at any time by order in writing, direct any person (hereafter in this section

referred to as the Investigating Authority) specified in the order to investigate the

affairs of such intermediary or persons associated with the securities market and to

report thereon to the Board.

(2) Without prejudice to the provisions of sections 235 to 241 of the Companies Act,

1956(1 of 1956), it shall be the duty of every manager, managing director, officer and

other employee of the company and every intermediary referred to in section 12 or

every person associated with the securities market to preserve and to produce to the

Investigating Authority or any person authorised by it in this behalf, all the books,

registers, other documents and record of, or relating to, the company or, as the case

may be, of or relating to, the intermediary or such person, which are in their custody

or power.

(3)The Investigating Authority may require any intermediary or any person

associated with securities market in any manner to furnish such information to, or

produce such books, or registers, or other documents, or record before it or any

person authorized by it in this behalf as it may consider necessary if the furnishing of

such information or the production of such books, or registers, or other documents,

or record is relevant or necessary for the purposes of its investigation.

(4) The Investigating Authority may keep in its custody any books, registers, other

documents and record produced under sub-section (2) or sub-section (3) for six

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months and thereafter shall return the same to any intermediary or any person

associated with securities market by whom or on whose behalf the books, registers,

other documents and record are produced:

Provided that the Investigating Authority may call for any book, register, other

document and record if they are needed again:

Provided further that if the person on whose behalf the books, registers, other

documents and record are produced requires certified copies of the books, registers,

other documents and record produced before the Investigating Authority, it shall give

certified copies of such books, registers, other documents and record to such person

or on whose behalf the books, registers, other documents and record were

produced.

(5)Any person, directed to make an investigation under sub-section (1),may examine

on oath, any manager, managing director, officer and other employee of any

intermediary or any person associated with securities market in any manner, in

relation to the affairs of his business and may administer an oath accordingly and for

that purpose may require any of those persons to appear before it personally.

(6)If any person fails without reasonable cause or refuses – (a) to produce to the

Investigating Authority or any person authorised by it in this behalf any book,

register, other document and record which it is his duty under sub-section (2) or sub-

section (3) to produce; or

(b) To furnish any information which is his duty under sub-section (3) to

furnish; or

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(c) to appear before the Investigating Authority personally when required to do

so under sub-section (5) or to answer any question which is put to him by the

Investigating Authority in pursuance of that sub-section; or

(d) to sign the notes of any examination referred to in sub-section (7),

he shall be punishable with imprisonment for a term which may extend to one year,

or with fine, which may extend to one crore rupees, or with both, and also with a

further fine which may extend to five lakh rupees for every day after the first during

which the failure or refusal continues.

(7) Notes of any examination under sub-section (5) shall be taken down in

writing and shall be read over to, or by, and signed by, the person examined, and

may thereafter be used in evidence against him.

(8) Where in the course of investigation, the Investigating Authority has

reasonable ground to believe that the books, registers, other documents and record

of, or relating to, any intermediary or any person associated with securities market in

any manner, may be destroyed, mutilated, altered, falsified or secreted, the

Investigating Authority may make an application to the Judicial Magistrate of the first

class having jurisdiction for an order for the seizure of such books, registers, other

documents and record.

(9) After considering the application and hearing the Investigating Authority, if

necessary, the Magistrate may, by order, authorise the Investigating Authority –

(a) To enter, with such assistance, as may be required, the place or places

where such books, registers, other documents and record are kept;

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(b) To search that place or those places in the manner specified in the order;

and

(c) To seize books, registers, other documents and record, it considers

necessary for the purposes of the investigation:

Provided that the Magistrate shall not authorize seizure of books, registers,

other documents and record, of any listed public company or a public company (not

being the intermediaries specified under section 12) which intends to get its

securities listed on any recognised stock exchange unless such company indulges in

insider trading or market manipulation.

(10) The Investigating Authority shall keep in its custody the books, registers,

other documents and record seized under this section for such period not later than

the conclusion of the investigation as it considers necessary and thereafter shall

return the same to the company or the other body corporate, or, as the case may be,

to the managing director or the manager or any other person, from whose custody or

power they were seized and inform the Magistrate of such return;

Provided that the Investigating Authority may, before returning such books,

registers, other documents and record as aforesaid, place identification marks on

them or any part thereof.

(11) Save as otherwise provided in this section, every search or seizure made

under this section shall be carried out in accordance with the provisions of the Code

of Criminal Procedure, 1973(2 of 1974), relating to searches or seizures made under

that Code.

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Cease and Desist Proceedings

11D. If the Board finds, after causing an inquiry to be made, that any person has

violated, or is likely to violate, any provisions of this Act, or any rules or regulations

made thereunder, it may pass an order requiring such person to cease and desist

from committing or causing such violation:

Provided that the Board shall not pass such order in respect of any listed public

company or a public company (other than the intermediaries specified under section

12) which intends to get its securities listed on any recognized stock exchange

unless the Board has reasonable grounds to believe that such company has

indulged in insider trading or market manipulation.

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Regulatory Framework & Investor Protection.

Every law relating to Securities has its objective of investor protection. As we have

discussed in the earlier part of the paper that, right form vetting of Prospectus to the

all sorts disclosure requirement of the Companies dealing with the public money has

a nexus with the protection of interest of investor who form the part of the paid up

capital of the Company. Investors make the backbone of the every Corporation by

providing the required Finance to the Corporation. Protection of Investor is

accomplished through effective regulation and Efficient and biting Securities Law.

The Regulatory Framework of Country monitoring the securities dealing in the set

market place aims at fair play and of preserving the market integrity which in turn has

its objective of protection of Interest of Investor who contribute their hard earned

money in the common pool of the Business Corporation. We can take the example

of U.S.A. where the Securities Act of 1933 has two basic objectives:

Require that investors receive financial and other significant information

concerning securities being offered for public sale; and · Prohibit deceit,

misrepresentations, and other fraud in the sale of securities.

Further the Preamble of SEBI Act lays down that protection of the interest of investor

is its basic and foremost aim which is to be achieved through its functions of

regulation.

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All the Regulatory Measures and actions starting from the vetting of Prospectus till

the trading of shares in the market are designed and modified time to time in the

Interest of Investor.

The Regulator identifies and prohibits certain types of conduct in the markets and

provides the Commission with disciplinary powers over regulated entities and

persons associated with them.

SEBI and Capital Market

There have been significant reforms in the regulation of the securities market since

1992 in conjunction with overall economic and financial reforms. In 1992, the SEBI

Act was enacted giving statutory status as an apex regulatory body.

Over the last few years, SEBI has announced several far-reaching reforms to

promote the capital Market and protect investor interests. Reforms in the Secondary

market have focused on three main areas: structure and functioning of stock

exchanges, automation of trading and post trade systems, and the introduction of

surveillance and monitoring systems.

Until the early 1990s, the trading and settlement infrastructure of the Indian capital

market was poor. Trading on all stock exchanges was through open outcry,

settlement systems were paper-based, and Market intermediaries were largely

unregulated. The regulatory structure was fragmented and there was neither

comprehensive registration nor an apex body of regulation of the securities market.

Stock exchanges were run as "brokers clubs" as their management was largely

composed of brokers. There was no prohibition on insider trading, or fraudulent and

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unfair trade practices since 1992, there has been intensified market reform, resulting

in a big improvement in securities trading, especially in the secondary market for

equity. The Indian Capital Market has experienced a process of structural

Transformation with operations conducted to standards equivalent to those in the

Capital Market of the developed countries. It was opened for investment for the

Foreign Institutional Investors (FIIs) in 1992 and Indian companies were allowed to

raise resources abroad through Global Depository Receipts (GDRs) and Foreign

Currency convertible Bonds(FCCBs). The Primary and Secondary segment of the

market grew much rapidly, with greater institutionalization and wider participation of

individual investors accompanying this growth. However many problems including

lack of confidence in the stock investment, institutional overlaps and other

governance issues remain as obstacle to the improvement of Indian capital Market

Efficiency.

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SEBI and Primary Market

The fundamental objective of the economic reforms undertaken by the government

since 1991-92 was to bring rapid and sustained improvement in the quality of life of

the people of India. It was with this set of objectives that the government had

undertaken economic reforms since 1991-92. One of the important aspects of this

reform package was to increase the efficiency of the financial system and securities

market so that larger saving could be channeled for productive use reforms in the

public sector. Reforms in the primary market have to be appreciated very well in light

of the regulatory framework in regards to market players involved in the work of

issue. The regulations guidelines and notifications of SEBI have focused right from

vetting of the prospectus to actually reaching the secondary market and have

ensured a fair play ensuring the Protection of the interest of the Investor. Reforms in

the Primary securities market over a decade or so have been of immense help to the

investors. Since the Primary market provides for floating of capital of the Company,

measures regarding market intermediaries, their eligibility criteria and simplification

and streamlining of issue procedure has been the areas of achievement from the

aspect of regulatory framework in India. Disclosure requirement of Company through

its prospectus, market players and all those who play a part in the Primary market

has been appreciated and strengthened with the growing time and need of the Hour.

The focus of these measures was to enhance the level of investor confidence and

inhibit fraud in public offerings. To give effect to these measures, the Guidelines for

Disclosure and Investor Protection were amended.

Further the introduction of Book Building, Regulations of Credit rating agencies, lock

in requirements and Enhancing the Disclosure requirement has been the

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Achievement over a period of more than a decade since SEBI has taken Charge as

a Regulator of the Capital Market in India.

SEBI AND SECONDARY MARKET

A series of re-forms was introduced to improve investor protection, automation of

stock trading, integration of national markets, and efficiency of market operations.

India has seen a tremendous change in the secondary market for equity.

It is ten years since the Securities and Exchange Board of India (SEBI) started to put

in place the regulatory framework for the capital market and investors have certainly

benefited from the availability of more information and a contemporary secondary

market structure. Reforms in the Secondary market include Encouragement to stock

Exchange to act as Self-Regulatory Organisations (SROs) with accountability and

responsibility. Further the Reforms have been in areas of Reconstruction of the

Governing body of the Stock Exchanges, audit of broker book, market makers,

insider trading, code for merger and takeover, grievance redressel by Stock

exchange and function of inspection of and monitoring of Stock Exchange. Market

has been made Infrastructurally sound and modern in terms of transparency and

Efficiency in Light of Investor Protection. In this regard continuous interfaces with

stock Exchanges were kept in regard to various issues as that of Investor Protection,

improvement in intermediary quality and building automodated market Infrastructure.

Introduction of rolling Statements, scrip’s, maintenance of Accounting standards,

warehousing of shares , market making, setting up of Depositories, stringent

disclosure requirement for the Listed Corporates have added to the achievement and

Reforms in the Secondary Market.

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The present regulatory regime for the securities markets established under the SEBI

Act 1992 has led to improvements in standards of investor protection. At the same

time a number of challenges remain and there is a scope for potential further

improvements and greater efficiency in the regulatory system. Some of the

measures that SEBI proposes to take in this direction are mentioned above. As the

changes and reforms brought in by SEBI get bedded in and markets mature, it is

expected that Indian securities markets will take up their rightful role in the Indian

economy. The Capital market has made tremendous progress in terms of institution

building. In a period of three years, we had the elimination of unlimited leverage in

stock trading; the onset of anonymous, electronic trading; the rise of a clearing

corporation which eliminates counter party risk from the exchanges for which it does

clearing, and the onset of depository settlement. These are profound changes in

market mechanisms. They have transformed the lives of investors and of market

intermediaries. They have given us an unprecedented level of market liquidity and

market efficiency. With the rapid expansion in the primary market, there were

concerns raised about the quality of some of the issuers who were able to raise

funds from the market in the period after the repeal of the Capital Issues (Control)

Act, 1947. In response to these concerns, SEBI had strengthened norms for public

issues, raised the standards of disclosure in public issues to enhance the level of

investor protection without seeking to control the freedom of eligible issuers to enter

the market and freely price their issues. But there still may be some grayer areas in

takeover, merger region etc.

SEBI began to put in place regulations a decade ago, starting with its Guidelines for

Disclosure and Investor Protection (primary markets) in 1992. A fairly broad-based

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regulatory framework is now in place, though, going forward, SEBI has to make the

market a friendlier place for investors by plugging the gaps in its performance.

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CAPITAL MARKET DIVISION -Capital Market Reforms

The Indian regulatory and supervisory framework of securities market has been

adequately strengthened through the legislative and administrative measures in the

recent past. The regulatory framework for securities market is consistent with the

best international benchmarks, such as, standards prescribed by International

Organisation of Securities Commissions (IOSCO).

Capital Market Reforms

Extensive Capital Market Reforms were undertaken during the 1990s

encompassing legislative regulatory and institutional reforms. Statutory

market regulator, which was created in 1992, was suitably empowered to

regulate the collective investment schemes and plantation schemes through

an amendment in 1999. Further, the organization strengthening of SEBI and

suitable empowerment through compliance and enforcement powers including

search and seizure powers were given through an amendment in SEBI Act in

2002. Although dematerialisation started in 1997 after the legal foundations

for electronic book keeping were provided and depositories created the

regulator mandated gradually that trading in most of the stocks take place

only in dematerialised form.

Till 2001 India was the only sophisticated market having account period

settlement alongside the derivatives products. From middle of 2001 uniform

rolling settlement and same settlement cycles were prescribed creating a true

spot market.

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After the legal framework for derivatives trading was provided by the

amendment of SCRA in 1999 derivatives trading started in a gradual manner

with stock index futures in June 2000. Later on options and single stock

futures were introduced in 2000-2001 and now India’s derivatives market

turnover is more than the cash market and India is one of the largest single

stock futures markets in the world.

India’s risk management systems have always been very modern and

effective. The VaR based margining system was introduced in mid 2001 and

the risk management systems have withstood huge volatility experienced in

May 2003 and May 2004. This included real time exposure monitoring,

disablement of broker terminals, VaR based marginingetc.

India is one of the few countries to have started the screen based trading of

government securities in January 2003.

In June 2003 the interest rate futures contracts on the screen based trading

platform were introduced.

India is one of the few countries to have started the Straight Through

Processing (STP), which will completely automate the process of order flow

and clearing and settlement on the stock exchanges.

RBI has introduced the Real Time Gross Settlement system (RTGS) in 2004

on experimental basis. RTGS will allow real delivery v/s. payment which is the

international norm recognized by BIS and IOSCO.

To improve the governance mechanism of stock exchanges by mandating

demutualisation and corporatisation of stock exchanges and to protect the

interest of investors in securities market the Securities Laws (Amendment)

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Ordinance was promulgated on 12th October 2004. The Ordinance has since

been replaced by a Bill.

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Sebi, Scams and Reforms

One of the biggest fears that perpetually linger in the minds of Indian investors

remains the possibility of a scam being unearthed, which could end the ongoing

party at its bourses, which has lasted for more than two years now.

The mental wounds inflicted due to the 'Harshad Mehta' and 'Ketan Parikh' scam do

not seem to have healed completely. Hence, when the recent imbroglio

surrounding an individual with over 6,000 (!) demat accounts surfaced, several retail

investors kept their fingers crossed hoping that this would not trigger a mass sell-off.

Fortunately for them, it did not, and the party remains well and truly on. The

Securities Exchange Board of India, which is the designated 'watchdog' of the Indian

capital market initiated an enquiry into this matter and came up with a set of fresh

recommendations.

Securities and Exchange Board of India has often been accused, unfairly and

otherwise, of not being proactive enough. In recent times though, under the

stewardship of Damodaran, it seemed to be getting its act together. Its

promulgations on book-building IPO norms were progressive and has substantially

minimized the practice of frivolous bidding with the objective of leading investors.

It has now proposed some further changes in the primary market system, as it exists.

Let us now proceed to scrutinise the proposals:

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Public issue refunds through Electronic Clearing Scheme: Presently refunds in public

issues are sent only through post/ registered post, which have time and cost

implications for investors.

Progressive use of technology in banking has enhanced the efficiency in clearing

and transfer of funds, which is evidenced in use of ECS mechanism for corporate

dividend payments and routine corporate transactions. It has now been decided to

extend the facility of electronic transfer of funds, viz, ECS to public issue refunds

also.

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The man behind Sebi's makeover - The Capital Markets Crisis

This will ensure faster and hassle free refunds to investors. ECS as a mode of

refunds will initially be available at 15 centers across India where clearing is done by

RBI and may be extended to other centers over a period. Opinion: Given that the

ECS facility has been in place for quite some time, this pronouncement should have

come a lot earlier. Nevertheless, it is a clear case of 'better late than never'.

Introduction of optional grading of IPOs: SEBI Board has granted in principle

approval for introduction of optional "grading" of public issues by unlisted companies

(viz. IPOs) by credit rating agencies registered with SEBI. IPO grading would not be

mandatory. It would be solely at the option of the issuer company. SEBI will not

certify the assessment made by the grading agency.

The grading is intended to be an independent and unbiased opinion of the

concerned agency. The grading would be a one-time exercise and would only focus

on assisting the investor particularly Retail Individual investors, in taking an informed

investment decision.

The cost of IPO grading can be met by stock exchanges or out of the corpus of

Investor Education and Protection Fund. Necessary procedurals aspects would be

finalized by SEBI in consultation with Stock Exchanges.

Opinion: While the intent cannot be faulted, there has to be serious doubt about its

practicality. Equity, by its inherent nature, signifies risk.

To try and capture that into a grading system should, for all practical purposes, be

extremely difficult. Unless of course, what is planned is merely an academic grading

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based on some pre-fixed parameters.

Given that SEBI has washed its hands off being accountable for this grading system,

one wonders whether the grading agency can be held accountable and will need to

indemnify investors relying thereon.

If not, is this then a rap on the knuckles for merchant bankers who do everything

short of grading an issue, even going so far as to justify the price on offer? Or, is this

an attempt to erase the demarcating line between equity and debt. If nothing else,

some comic relief should be on the cards, albeit not for investors who might end

being even more confused than ever.

Rationalising disclosure requirements for further public offers and rights issues:

Presently all companies irrespective of whether they are listed in any stock exchange

or are approaching the markets for the first time with IPOs have to make identical

disclosures in the prospectus/offer document.

In the context of further public offers and Rights Issues, some disclosures in the

document are repetitive, as the same have been periodically disclosed to the

exchanges by the listed companies.

It is now proposed to do away with the repetitive disclosures in case of rights issues

and FPOs by companies, which have a satisfactory track record of filing disclosures

with the stock exchanges, of redressing investors' grievances.

Opinion: Given the amount of irrelevant information that finds its way into every

prospectus, leave alone those of companies making FPO's and rights issues, this is

a welcome pronouncement.

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One question though - how many investors read prospectuses? Clearly, the primary

losers here are the printers while the gainers are corporates. As for the retail investor

- who cares?

Unique Identification Number: The Board decided to resume fresh registrations for

obtaining Unique Identification Number under SEBI (Central Database of Market

Participants) Regulations, 2003 (MAPIN), after considering the recommendations of

the Committee set up by SEBI to examine the issues related to MAPIN.

The registration process will be resumed in a phased manner. To begin with, the cut

off limit for obtaining UIN with biometric impressions for natural persons has been

raised from the existing limit of trade order value of Rs 100,000 to Rs 500,000 or

more. The limit will be reduced progressively.

Agencies capable of providing such facilities in a cost effective manner will be

assigned the responsibility of maintaining the databases. For trade order value of

less than Rs 500,000, option will be available to investors to obtain either the

Permanent Account Number of Income Tax Department or UIN obtained under

MAPIN. Investors in mutual funds would be exempted from the requirement of

obtaining UIN.

Opinion: One of the better decisions made by Damodaran after taking over as SEBI

chief was to halt the treatment of retail investors like history-sheeters, through an ill-

conceived UIN regime.

Alas, that now stands reversed. Indian investors must rank among those with the

maximum forms of identification with the likes of a Income Tax PAN Card, ration

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card, passport and now the UIN all over again.

One cant' help feeling that whereas those who were prima facie held responsible for

the demat imbroglio have been let off with a light rap on the knuckles, while retail

investors have been left to bear the cross yet again.

To conclude, even as FII money pours in like never before, the old Indian

bureaucratic shuffle of two steps-forward and one-backward, sadly continues.

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5. TABLES

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Table I

Milestones of BSE

1840-50 About half a dozen brokers converge under a banyan tree near what is now

called Horniman Circle.

1860-65 An the prevailing share mania, the number of brokers rises to about 250 but

in the aftermath of the price crash they are hard pressed to find a place for their

regular meeting.

1874 The broking community find a place in what is now called Dalal Street to

conduct their dealings in securities without hindrance and an informal association of

sorts comes into being.

July 9, 1875 The Native Share and Stock Broker Association with the aim of

‘protecting the character, status and interests of native share and stock brokers,’ with

3,128 members who pay an entrance fee of one rupee is set up.

1895-1930 The exchange moves into what is now known as the Stock Exchange Old

Building in 1895. With more members and more trading spaces, after repeated

expansion in 1920, 1928 and 1930, BSE is vastly different from the one that existed

in the last quarter of the nineteenth century.

1921 The establishment of a clearing house for settlement of transactions.

1957 The Government accords permanent recognition under the Securities contracts

(Regulation) Act.

Jan .2, 1986 The BSE launches Sensex, first stock indices (with 1978-79 as base

year), comprising 30 highly liquid stocks from specified and non-specified group

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shares listed on the country’s five major stock exchanges – Mumbai, Kolkata, Delhi,

Ahmedabad and Chennai.

July 25, 1990 The Sensex touches the four-figure mark for the first time and closes

at 1,000.97 in the wake of good monsoon and corporate results.

Jan 15, 1992 The benchmark index crosses the 2,000 mark and closes at 2,020.18

following the liberal economic policy initiatives undertaken by the then Finance

Minister Dr. Manmohan Singh.

Feb 29 1992 Market friendly Budget by the Finance Minister, Dr. Manmohan Singh,

leads the Sensex to cross the 3,000 mark.

Mar 30 1992 Sensex, in just 30 days rises by 1,000 points and crosses the 4,000

mark (closed at 4,091.43)on expectation of a liberal export import policy.

Apr 28 1992 The 30-stock index falls by record 570.42 points (12.77%) to close at

3,869.90 due to the exposure of securities scam.

1994 Serial bomb blasts in BSE butit begins to operate as usual despite damages to

the premises.

March 1995 BSE introduces the modified cary forward system (the traditional badla

had been banned since March 1993).

July 1995 All scrips are transferred to BOLT.

Aug 19, 1996 Major reconstitution of Sensex with the board of BSE deciding to

replace 15 stocks from the index with a new one in order to have better

representation of the market in the wake of changed economic environment. For the

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first time, index includes companies from the finance sector such as ICICI, IDBI and

SBI.

1997 Screen based trading commences.

Nov 16, 1998 BSE replaces four scrips from the Sensex with new ones following

investors fancy for software, pharma and multinational stocks, which include Infosys

Technologies, NIT, Novartis and Castrol.

March 1999 CDSL begins operations.

Oct 8, 1999 Sensex croses 5,000 mark.

Feb 11, 2000 Sensex croses 6,000 mark but closes at 5,933.56.

June 2000 BSE becomes the first exchange in the country to introduce trading in

derivatives in the form of index futures on the Bel Wether Sensex.

Sept 1, 2003 In the line with international trends, the BSE decides to move to free-

float methodology for calculation of Sensex from the full market capitalization

methodology.

June 21,2004 Sensex closes above 7,000 for the first time at 7,076.52.

Sept 8,2005 Sensex croses 8,000 mark close sat 8,052.56.

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Table 2

Badla System

Badla was allowed in the specified group of shares of BSE. This specified group was

also known as forward group as one could buy or sell shares in it without physical

delivery. The carry forward session (badla session) was held on every Saturday at

BSE.

A contract for current settlement could be executed in any of the following three

ways:

a) Delivery against a sale contract given and delivery against a purchase contract

received, and payment received/made at the contract rate.

b) Squaring off of transactions wherein a reverse transaction of either buying or

selling of shares squared up with the earlier outstanding position and the difference

in prices settled.

c) A contract in respect of which delivery was given or taken and which was not of

set by an opposite transaction during the settlement period, could be carried forward

to the next settlement period at the making up price, that is, the closing quotation on

the last trading and the difference between the contract rate and the making up price

settled. This postponement of the delivery of or payment for the purchase of

securities from one settlement period to another was referred to as carry forward.

Badla involved four parties: the long buyer – a buy position in a stock without the

capacity to take delivery of the same, the short seller – a sell position without having

the delivery in hand, the financier, and the stock lender.

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If the quantum of delivery sales exceeded the quantum of delivery purchases,

financiers came forward to asist in completing the deal, took delivery in the current

settlement made the delivery in the next settlement to the buyers and, by doing so,

helped in carrying forward the transaction.

The difference between the current settlement rate and the sale rate for the next

settlement which they received was the interest charges.

If the quantum of delivery purchases exceeded the quantum of delivery sales, share

financiers would give delivery in the current settlement to the buyers at the

settlement rate and take the delivery back in the next settlement from the seller at

lower sales rates.

Badla charges were market determined and varied from scrip to scrip and from

settlement to settlement. Badla rates ranged from 15% to 36% on a yearly basis.

SEBI banned badla charges for carry forward sales (short position) if the net carry

forward buy (long) positions exceeded short positions. If the market was overbought

(net long) there would be more demand for funds and the carry forward rates would

be high; the reverse would be true when the market was oversold (net short). An

oversold market would result in high demand for securities and the stock lender

would get returns.

These transactions were completely hedged and stock exchanges guaranteed

settlements and conducted auctions of shares in case of defaults. However, these

guarantees were not available in unofficial or parallel badla markets which existed in

Kolkata and Mumbai.

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Badla or carry forward facility was quite popular, accounting for nearly 90% of the

trade at al stock exchanges.

Source: Bharti Pathak,“Indian Financial System”

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Table-3

SEBI’s role and regulations

SEBI had the duty to protect the interests of investors in securities and to promote

the development and to regulate the securities market through appropriate

measures. These measures provide for:

i. Regulation the business in stock exchanges and any other securities market.

i. Registering and regulating the working of stock brokers, sub-brokers, share

transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue,

merchant bankers, underwriters, portfolio managers, investment advisors, and such

other intermediaries who may be associated with securities market in any manner.

i. Registering and regulating the working of collective investment schemes, including

mutual funds.

iv. Promoting and regulating self-regulatory organizations.

v. Prohibiting fraudulent and unfair trade practices in securities market.

vi. Promoting investor education and trading of securities insecurities market.

vi. Prohibiting insider trading insecurities.

vi. Regulating substantial acquisition of shares and takeover of companies.

ix. Calling for information from, undertaking inspection, conducting inquiries and

audits of the stock exchanges and intermediaries and self regulatory organizations in

the securities market.

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x. Performing such functions and exercising such powers under the provisions of the

Capital Issues (Control) Act, 1947, and the Securities Contracts (Regulations) Act,

1956, as may be delegated to it by the central government.

xi. Levying fees or other charges for carrying out the activities.

xi. Conducting research for the above purpose and

xi. Performing such other functions as maybe prescribed by the government.

Source: Bharti Pathak,“ Indian Financial System”

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Table - 4

Promoters of NSE

Industrial Development Bank of India Limited

Industrial Finance Corporation of India Limited

Life Insurance Corporation of India

State Bank of India

ICICI Bank Limited

IL & FS Trust Company Limited

Stock Holding Corporation of India Limited

SBI Capital Markets Limited

The Administrator of the Specified Undertaking of Unit Trust of India

Bank of Baroda

Canara Bank

General Insurance Corporation of India

National Insurance Company Limited

The New India Assurance Company Limited

The Oriental Insurance Company Limited

United India Insurance Company Limited

Punjab National Bank

Oriental Bank of Commerce

Corporation Bank

Indian Bank

Union Bank of India

Table-5

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Milestones of NSE

1992 Incorporation

1993 Recognition as a stock exchange

1994 Whole sale Debt Market

1995 Became the largest stock exchange in India

1996 Launch of S&P CNX Nifty & set up National Securities Depository Limited, first

depository in India.

1997 Launch of NSE's website: www.nse.co.in

1999 Launch of Automated Lending and Borrowing Mechanism

2000 Commencement of Derivatives Trading

2001 Commencement of Futures & Options on Individual Securities

2002 Launch of Exchange Traded Funds (ETFs)

2003 Commencement of trading in Retail Debt Market

Comparison of NSE and BSE

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BSE NSEMarket capitalization of

listed companies:

Rs. 4,670,227 crore Rs. 3,367,350 crore.

Index value (As on 11th

December 2007):

20,290 6,097

Name: Bombay Stock Exchange National Stock Exchange

What is it?: Indian Stock exchange Indian Stock exchange

Location: Mumbai Mumbai

Established in: 1875 1993

Key people: Rajnikant Patel(CEO) R.H.Patil (Founder, MD)

Claim to fame: Oldest stock exchange in

Asia.

Third largest stock

exchange in the world in

terms of volumes.

Owner: Bombay Stock Exchange

Limited

National Stock Exchange of

India Limited

Main Index: BSE Sensex S & P CNX Nifty

Website: www.bseindia.com www.nse-india.com

Geographical spread: Presence in 417 cities Presence in 1,486 cities

Number of listed

companies:

4,867(Oct 2007) 1,288 (March 2007)

Number of members: 951 (Oct 2007) 1,009 as on March 2007

Number of trader

workstations:

15,151(Oct 2007)

Top trading companies in

volumes in main index (Till

March 2007):

Reliance Industries

Limited, Infosys

Technologies Limited,

Satyam Computer

Services.

Top companies in terms of

market capitalization in

each index (Till March

2007):

Reliance Industries

Limited, Oil and Natural

Gas Corporation, Bharti

Airtel Limited

References

Page 92 of 93


Indian Capital Market: An Empirical Study -

by Rathore, Shirine Rathore

Investment Performance of Equity Shares: a test of

Indian market efficiency – by Hari Om Chaturvedi

www.sebi.gov.in/

www.sharekhan.com

www.5pasia.com

www.nse-india.com

www.bseindia.com

Page 93 of 93

http://www.bseindia.com/

http://www.nse-india.com/

Tug War Nse and Bse in India

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