Module 1   Introduction to Stock MarketsChapter 2


View chapters →

2.1 What is the stock market?

Investing in equities is an important investment that we make to generate inflation-beating returns. This was the conclusion we drew from the previous chapter. Having said that, how do we go about investing in equities? Clearly, before we dwell further into this topic, it is essential to understand the ecosystem in which equities operate.

Just like the way we go to the neighbourhood Kirana store or a supermarket to shop for our daily needs, similarly, we go to the stock market to shop (read as transact) for equity investments. The stock market is where everyone who wants to transact in shares goes to. Transact, in simple terms, means buying and selling. You can’t buy/sell shares of a public company like Infosys without transacting through the stock markets for all practical purposes.

The main purpose of the stock market is to help you facilitate your transactions. So if you are a buyer of a share, the stock market helps you meet the seller and vice versa.

Now unlike a supermarket, the stock market does not exist in a brick and mortar form. It exists in electronic form. You access the market electronically from your computer and go about conducting your transactions (buying and selling of shares).

It is also important to note that you can access the stock market via a registered intermediary called the stockbroker. We will discuss more the stockbrokers at a later point.

There are two main stock exchanges in India that make up the stock markets. They are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Besides these two exchanges, there are many other regional stock exchanges like Bangalore Stock Exchange, Madras Stock Exchange that are more or less getting phased out and don’t really play any meaningful role anymore.


2.2 Stock Market Participants and the need to regulate them

The stock market attracts individuals and corporations from diverse backgrounds. Anyone who transacts in the stock market is called a market participant. The market participant can be classified into various categories. Some of the categories of market participants are as follows:

  1. Domestic Retail Participants – These are people like you and me transacting in markets
  2. NRI’s and OCI – These are people of Indian origin but based outside India
  3. Domestic Institutions – These are large corporate entities based in India. A classic example would be the LIC of India.
  4. Domestic Asset Management Companies (AMC) – Typical participants in this category would be the mutual fund companies such as SBI Mutual Fund, DSP Black Rock, Fidelity Investments, HDFC AMC, etc.
  5. Foreign Institutional Investors – Non-Indian corporate entities. These could be foreign asset management companies, hedge funds, and other investors.

Now, irrespective of the category of market participant, everyone’s agenda is the same – to make profitable transactions. More bluntly put – to make money.

When money is involved, human emotions in the form of greed and fear run high. One can easily fall prey to these emotions and get involved in unfair practices. India has its fair share of such twisted practices, thanks to Harshad Mehta’s operations and the like.

Given this, the stock markets need someone who can set the game rules (commonly referred to as regulation and compliance) and ensure that people adhere to these regulations and compliance thereby making the markets a level playing field for everyone.

2.3 The Regulator

In India, the stock market regulator is called The Securities and Exchange Board of India, often referred to as SEBI. The objective of SEBI is to promote the development of stock exchanges, protect the interest of retail investors, and regulate market participants and financial intermediaries’ activities. In general, SEBI ensures:

  1. The stock exchanges (BSE and NSE) conducts its business fairly
  2. Stockbrokers and sub-brokers conduct their business fairly
  3. Participants don’t get involved in unfair practices
  4. Corporate’s don’t use the markets to unduly benefit themselves (Example – Satyam Computers)
  5. Small retail investors interests are protected
  6. Large investors with huge cash pile should not manipulate the markets
  7. Overall development of markets

Given the above objectives, it becomes imperative for SEBI to regulate the following entities. All the entities mentioned below are directly involved in the stock markets. Malpractice by anyone of the following entities can disrupt what is otherwise a harmonious market in India.

SEBI has prescribed a set of rules and regulations to each one of these entities. The entity should operate within the legal framework as prescribed by SEBI. The specific rules applicable to a specific entity are made available by SEBI on their website. They are published under the ‘Legal Framework’ section of their site.

Entity Example of companies What do they do? In simpler words
Credit Rating Agency (CRA) CRISIL, ICRA, CARE They rate the creditworthiness of corporate and governments If a corporate or Govt entity wants to avail the loan, CRA checks if the entity is worthy of giving a loan
Debenture Trustees Almost all banks in India Act as a trustee to corporate debenture When companies want to raise a loan, they can issue debenture against which they promise to pay interest. The public can subscribe to these debentures. A Debenture Trustee ensures that the
debenture obligation is honoured
Depositories NSDL and CDSL Safekeeping, reporting and settlement of clients securities Acts like a vault for the shares that you buy. The depositories hold your shares and facilitate the exchange of your securities. When you buy shares these shares sit in your Depositary account usually referred to as the DEMAT account. This is maintained electronically by only two companies in India
Depository Participant (DP) Most of the banks and few stockbrokers Act as an agent to the two depositories You cannot directly interact with NSDL or CDSL. You need to liaison with a DP to open and maintain your DEMAT account
Foreign Institutional Investors Foreign corporate, funds and individuals Make investments in India These are foreign entities with interest to invest in India. They usually transact in large amounts of money, and hence their activity in the markets have an impact in terms of market sentiment
Merchant Bankers Karvy, Axis Bank, Edelweiss Capital Help companies raise money in the primary markets If a company plans to raise money by floating an IPO, then merchant bankers are the ones who help companies with the IPO process
Asset Management Companies
HDFC AMC, Reliance Capital, SBI Capital Offer Mutual Fund Schemes An AMC collects money from the public, puts that money in a single account, and then invests that money in markets intending to make the investments grow and generate wealth.
Portfolio Managers/
Portfolio Management System
Religare Wealth Management, Parag Parikh PMS Offer PMS schemes They work similarly to a mutual fund except in a PMS; you have to invest a minimum of Rs.25,00,000; however, there is no such cap in a mutual fund.
Stock Brokers and Sub Brokers Zerodha, Sharekhan, ICICI Direct Act as an intermediary between an investor and the stock exchange Whenever you want to buy or sell shares from the stock exchange, you have to do so through registered stock brokers. A sub-broker is like an agent to a stockbroker.

Key takeaways from this chapter

  1. The stock market is the place to go to if you want to transact in equities.
  2. Stock markets exist electronically and can be accessed through a stockbroker.
  3. There are many different kinds of market participants operating in the stock markets.
  4. Every entity operating in the market has to be regulated, and they can operate only within the framework as prescribed by the regulator.
  5. SEBI is the regulator of the securities market in India. They set the legal framework and regulate all entities interested in operating in the market.
  6. Most importantly you need to remember that SEBI is aware of what you are doing and they can flag you down if you are upto something fishy in the markets!


View all comments →
  1. akrsrivastava says:

    I dont quite understand whats the role of a depository. All the shares are in electronic form. If I buy a share, it should come into my trading account. If I sell a share it should go from my trading account to the buyer’s trading account. This buying and selling and transfer of shares should be facilitated by the stock exchange, of course electronically. What is the role of a depository here? And to add to that why should I interact with the depository through a DP. All transactions are electronic, why shouldnt the end user interact with the depository directly?
    Similarly, why couldnt I open a trading account directly with NSE. Why should I need a broker/sub broker? Whatever fees/charges that I pay to broker, I can directly pay to the NSE. Sorry Zerodha…nothing against you 🙂

    • Karthik Rangappa says:

      My colleague Venu Madhav says this –

      The depositories has various functions, allowing to hold shares in electronic form is just one of them. A trading account is an account/window through which you execute transactions, after which if the transaction has resulted in an asset creation such asset would be held somewhere. It is electronically held in your demat account. A Demat account, similar to a bank account is a place where your hold your shares in electronic format.

      Some other functions of a DP are:

      a) Dematerialization – The process of converting material shares into electronic format
      b) Transfers & Transmissions – Moving shares from one demat to another
      c) Settlement of securities
      d) Pledging of dematerialised securities
      e) Facilitating Securities Lending & Borrowing

      There are brokerages to assist clients to trade through the Stock Exchange.Its similar to how if you’d like to buy vegetables, you’d go to a shop and not to the farmer 🙂 Imagine there were no brokers and you had to deal with the Exchange directly. How many clients can one Stock Exchange cater to? It’d be a monopoly where you’d have to be happy with what you got. Having intermediaries ensures you get better services and products.

    • vinay says:

      The market participants are necessary to provide better services in this industry. Since there are lot of financial transactions with millions of customer and billions of transactions practically it is not possible to provide services from one entity. So the specific roles and responsibility are allocated to each different entity to expedite the services for the end users, in terms of financial and asset (equity or other instruments ) settlement and also to provide value added services.

    • Balaji Rao says:

      Hi, it is impossible for a stock exchange to handle clients directly. It is only a facilitator. Like we buy our train tickets from IRCTC since it would not be easy for the Railways Dept to cater to everyone’s buying needs, similarly there has to be stockbrokers who do the due-diligence and get the customers and connect them through the mechanism of a stock market. Since a stockbroker also handles various other services and can be accessed easily we need their presence. We pay a fee as brokerage for receiving such services.

      Depositories are those who actually “hold” our shares/securities with them and they are authorized by the govt. A Depository Participant helps the Beneficiaries like you and me to get in and get out our shares by handling our transactions. Only our shares going out and coming is facilitated by Depository Participants while the shares are actually held by the Depositories. Again the problem is volume which just the depositories cannot handle while a DP can handle through their logistics and infrastructure.

    • Vipin P M says:

      Depository is Like a Server Computer ( or Central Bank / Bank HO ) Main Entity .
      DP is like a Client Computer ( or Bank or Branch ) Members ( Brokers ) .
      Your shares are lying in DP A/c ( Demat A/c ) not Trading A/c .
      Demat A/c are using only for depositing shares & securities ( Similar to your Bank A/c , there you are depositing money )
      Trading A/c is window to Buy & Sell Shares ( Like a Cash counter or ATM or CDM ) in Bank .
      We are keeping Funds as Initial margin in Trading a/c , Your trading A/c is linked with demat A/c by a POA for automatic debit & credit securities .
      If you are buying amount debited from Trading A/c , Shares will credited in Demat A/c ( DP A/c ) .
      If you are selling amount will credited to the Trading A/c & Shares will be debited from Demat A/c ( DP A/c ).
      NSE is Stock Exchange .
      Brokers are Members of Exchange .
      Trades are settling by the entity Clearing Corporation ( NSCCL ) Electronic clearing cordinating with Stockexchanges ,Depostorys Members ( Brokers ) ,DPs , Clearing banks , Custodians etc.
      SEBI is the Regulator .
      If SEBI is Regulating brokers the clients are also regulating it is very difficult to regulate retailers .
      Direct membership available for Foreign Institutions .

  2. Suchetha says:

    As the name suggests, a depository is place where things are stored. In the securities market terms, it is an organization where shares, debentures, bonds, mutual funds are held in electronic form. It does so at the investors/client’s request which is made through a registered DP. Apart from the custodial services a depository also facilitates dematerialisation of securities.

    All these services are provided to the client not directly by the depository. It provides these services through its agent referred to as the Depository Participant. These agents ( DP’s) are generally registered with the SEBI. As per the SEBI amongst the others, the three categories of participants who can become a DP are Banks, Financial Institutions and Trading members registered with the SEBI.

    • Jomi says:

      Why is zerodha not a Depository Participant?Most other brokers are.

      • Karthik Rangappa says:

        I guess setting up a DP is on the cards, but not sure about the time line.

      • Venu Madhav says:

        Hi Jomi,
        Initially when we took membership at the Exchanges, our constituent type was of a registered partnership firm. This was because the membership for a partnership firms gets processed faster. As per NSDL & CDSL rules, partnership firms can’t be registered as DP. However we should have our own DP soon.

        • gmish27 says:

          How much (and why) being a DP matters to the retail clients?

          • Karthik Rangappa says:

            DP is an agent to a Depository. When you buy shares, these shares has to be parked at the Depository account. You are permitted to open a depository account only through a DP. Some trading members like Zerodha are DPs as well, it offers a lot of convenience to clients when you have all accounts in 1 place.

  3. Anand says:

    What is the difference between Nsdl&csdl

    • Karthik Rangappa says:

      Both of them are Depositories (in fact there are only 2 depositories in India). No difference between the two.

    • Suchetha says:

      Both NSDL and CDSL are depositories which hold the investors securities in electronic form. The key difference is , NSDL works for the National Stock Exchange and the CDSL works for the Bombay Stock exchange.

  4. Jagmohan Singh Ahluwalia says:

    Portfolio Management System-They work similar to a mutual fund except in a PMS you have to invest a minimum of Rs.25,00,000 however there is no such cap in a mutual fund.What do you mean by “Cap” here???

    • Karthik Rangappa says:

      Cap simply refers to a limit. When investing in MF, you can invest any amount you wish (starting from Rs.500/-) where as in PMS service you need to invest a minimum of Rs.25,00,000/-.

    • Anand Nayak says:

      It basically means a floor not a cap.

  5. suraj says:

    What is the difference between hedge funds and MF? Both of them collect operating capital from individual investors and try to appreciate it by investing in different asset classes, but how do you differentiate them? Are there any hedge funds in the Indian market?
    Thank you!

    • Karthik Rangappa says:

      A main difference is with the regulations. Hedge Funds are largely unregulated however a MF is very tightly regulated. Also, the capital that they collect is referred to as a ‘fund’. There are quite a few hedge funds operating in India, suggest you look at AIF category 3 funds.

    • Anand Nayak says:

      Hedge Funds are usually reserved for large institutional investors, they have a minimum investment requirement wich is even more than that of PMS. Also, unlike mutual funds, hedge funds employ any and every strategy in order to generate alpha (return), like shorting a stock, using leverage and using derivatives.

View all comments →
Post a comment