Important terms (shares and trading): Part 1

In the last few posts I had attempted to introduce to my readers the basic concepts of shares and the stock exchange. In this post, some more commonly used terms– Book Building, Dual Listing and Preferential issue have been taken up for discussion.

Book Building

According to SEBI Guidelines 2000, Book Building means a process undertaken by which demand for the securities proposed to be issued by a body corporate is elicited and built up, and the price for such securities assessed, for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memorandum or offer document.

In case of book building, the investors place their bids at different prices and finally the price at which there is maximum demand is selected. The prospectus generally contains a base price and a maximum price between which the bids are made for the securities. The spread between the base price and the maximum price cannot be more than 20%. For example, of a company issues n number of securities with a base price of Rs 100, the maximum price cannot exceed Rs 120 (Rs 100 + 20% of Rs 100)

Difference between book building and fixed issue:

In case of a fixed issue, the price of the issue is fixed first and then the securities are offered to the investors. However, in case of book building, the price is determined on the basis of the demand.

The demand for securities in case of a fixed is known only at the close of the issue, whereas the demand is know on a regular basis in case of book building.

Dual listing

Dual listing is a process that allows a company to be listed on the stock exchanges of two different countries and hence the shares of the company are traded in both the stock exchanges. Dual listing generally takes place when companies belonging to two different companies enter into an equity alliance. Royal Dutch Shell (UK/ Netherlands) and Unilever (UK / Netherlands) are examples of companies which have their shares .

Dual listing is not allowed in India and it will need major amendments to key corporate laws of the country to allow dual listing. The Foreign Exchange Management Act (FEMA) too would need to be amended because case of a dual listed company, an investor can buy shares in one country and sell it in an overseas market and this would require the Indian rupee to be fully convertible. Also, it should be noted that domestic trading in shares denominated in foreign currency cannot take place without the permission of the Reserve Bank of India. It should be noted that the dual listing was one of the prime reasons for failure of the Bharti-MTN deal in the year 2009.

Preferential issue

A preferential issue is an issue of shares or of convertible securities by listed companies to a select group of persons under. The issuer company has to comply with Section 81 of the Companies Act, 1956 and to the guidelines laid down by SEBI. A preferential issue is neither a rights issue nor a public issue, and is a faster way to issue shares.

I hope that the readers will come up with questions and feedback. In the next post, some other important terms like futures, options and leverage would be taken up.

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The Stock Exchange: An Overview

The stock exchange is often termed as the barometer of the economy. In this post, an attempt has been made to briefly discuss some of the terms related to the stock exchange.

As per the definition given by The Securities Contract (Regulation) Act, 1956 a Stock Exchange is a body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.

The stock exchanges in India are under the overall supervision of the regulatory authority, the Securities and Exchange Board of India (SEBI). These exchanges provide a trading platform, where buyers and sellers can transact in securities. At present there are 21 recognised stock exchanges in India. To see the list of stock exchanges in India, click here.

Thus, to be precise, it is a regulated market for the buyers and sellers of securities.

Demutualised and mutual stock exchange

In a mutual exchange, the functions of ownership, management and trading are concentrated into a single Group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. This at times can lead to conflicts of interest in decision making. A demutualised exchange, on the other hand, has all these three functions clearly segregated, i.e. the ownership, management and trading are in separate hands. NSE is an example of a demutualised stock exchange.

Listing of shares in a stock exchange

The shares of a company can be listed on a particular stock exchange (or exchanges) after fulfilling the conditions laid down by that particular stock exchange. It should be noted that all stock exchanges do not have a unique set of prerequisites for listing.

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BSE and the NSE

The history of the Bombay Stock Exchange (BSE) dates back to the year 1875, when 318 persons who had contributed a sum of Re. 1 each to become a member of the exchange. It is the oldest stock exchange in Asia. The BSE came up with the BSE SENSEX in the year 1986. The base value of the SENSEX is taken as 100 on April 1, 1979, and its base year as 1978-79. In 1995, the BSE successfully moved to electronic trading from the open-cry system of trading. The BSE has the largest number of listed companies in the world. Please click here to know the listing criteria of listing requirements of the BSE. The BSE SENSEX is made up of 30 companies.

The National Stock Exchange (NSE) is a stock exchange located at Mumbai, India. It was incorporated in the year 1992. It is the 9th largest stock exchange in the world by market capitalization and largest in India by daily turnover and number of trades. The index S&P CNX Nifty was launched in the year 1995. The base period for the S&P CNX Nifty index is November 3, 1995. The base value of the index has been taken as 1000. In the year 2000, the NSE became the first exchange in India to started trading of stocks on the Internet. To know the listing criteria of the NSE, click here. The Nifty index is made up of 50 companies.

What is an Index?

An index is a basket of securities that is used to track the changes in the stock market. Securities from various sectors of the industry form a part of the index. Weights are assigned to the securities on parameters like market capitalisation, share price, etc. The securities that form a part of the index are from different sectors; hence they reflect the changes in the entire economy. For example, S&P CNX Nifty is an index that is composed of 50 stocks of various companies belonging to more than 20 different sectors of the economy. An index is revised regularly by varying the companies that form a part of the index. For e.g. if in a particular market scenario, assigning higher weights to petroleum companies can lead to distortion of figures, the weights will be adjusted to depict a more realistic figure.

To illustrate the working of an Index in a Stock exchange, suppose we have an Index named S&P ABC Swifty which indicates the performance of stocks at ABC Stock Exchange. ABC Exchange has in total 100 company’s shares listed on it (from varied sectors of the economy), out of which stocks (and not shares) of 5 companies have been chosen (assume the economy has only 3 notable sectors) to formulate the S&P ABC Swifty. These 5 company stocks are such that they provide an overview of the entire economy.

Now, let’s assume the weights are assigned on the market capitalization of the company.

Company	Market Capitalization (in Rs. Lakhs)	Weight
A	1	0.1%
B	2	0.2.%
C	3	0.3%
D	4	0.4%
E	5	0.5%

Thus total value of S&P ABC Swifty is 5500 points, as of the closing day for, say, 13.05.2011

If the same value falls to, say, 5450 as on the closing day 14.05.2011, we’ll say Swifty has fallen by 0.91% (Bad news for the economy and the investors).

Hope this gives you a rough idea of how the index works. Remember, the actuals are much complex and boggling but you may still draw some parlance with the example.

We hope that the readers were able to understand the basic terms related to the stock exchange. Suggestions, feedback and comments are welcome.

(Co-authored with Dola Halder, B. Com. (Honours), SRCC)

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