Introduction to Securities Market: formula sheet

Key formulas

Capital formation chain

Savers (investors) → securities market → issuers → investment in productive assets

Use this to answer questions on the role of the market in capital formation.

Primary vs secondary market

Primary: money goes to the issuer. Secondary: money goes to the selling investor.

A very common test point. The issuer gets no money from secondary trades.

Four groups of participants

Issuers + Investors + Intermediaries + Regulators

Classify any named entity into one of these groups.

Key functions of the market

Capital mobilisation, liquidity, price discovery, risk management, efficient allocation of resources

Know these as a list. Options often mix in functions that do not belong.

IPO vs FPO

IPO = unlisted company, first public offer; FPO = already listed company, further public offer

The test is whether the issuer is already listed.

Fresh issue vs OFS

Fresh issue: money to company; OFS: money to selling shareholders

OFS does not add new shares or fund the company.

Rights entitlement

Shares offered = Existing shares × Rights ratio

For a 1:4 ratio, a holder of 100 shares can apply for 25 new shares.

Rights issue investor

Offered only to existing shareholders as on the record date

It is not an offer to the general public.

Private placement vs QIP

Private placement: select persons; QIP: only QIBs, by a listed company

QIP needs the issuer to be listed.

Book building

Floor price ≤ bid ≤ Cap price (price band)

The final issue price is discovered within the band.

Settlement date under T+1

Settlement day = T + 1 working day

T is the trade day. Holidays and weekends are not counted as working days.

Market capitalisation

Market cap = Share price × Total number of shares outstanding

This is the full market value of the company's equity.

Free-float market capitalisation

Free-float market cap = Share price × Number of free-float shares

Free-float shares exclude promoter and other locked-in or strategic holdings.

Index value (free-float method)

Index = (Current free-float market cap ÷ Base free-float market cap) × Base index value

Indices use a base date and base value. Adjustments (divisor changes) handle corporate actions so the index does not jump artificially.

Order matching rule

Price priority first, then time priority

Higher bids and lower asks get priority. At equal price, the earlier order executes first.

Net obligation

Net obligation = Total buy value − Total sell value (per member, per security or in funds)

Clearing nets obligations so only the net amount or net quantity is settled.

Equity vs debt claim

Equity = ownership (residual claim); Debt = loan (fixed claim)

On winding up, creditors are paid before preference shareholders, who are paid before equity shareholders.

Order of payment on liquidation

Secured creditors → unsecured creditors → preference shareholders → equity shareholders

Use this as a ranking of risk. Equity is the riskiest and has the highest potential return.

Mutual fund NAV per unit

NAV = (Market value of assets − Liabilities) ÷ Number of units outstanding

Units are priced at NAV, not at a market price like a share, for open-ended schemes.

Money market maturity

Money market instruments: maturity up to 1 year

Treasury bills, commercial paper and certificates of deposit are money market instruments.

Derivative value

Value of derivative depends on the underlying asset

Futures create an obligation. Options give the buyer a right, not an obligation.

SEBI's statutory basis

SEBI Act, 1992 → statutory status to SEBI

SEBI existed from 1988 as an administrative body. The 1992 Act made it a statutory regulator.

SEBI's three objectives

Protect investors + Develop the market + Regulate the market

Questions often ask which of these is not an objective.

SEBI's three roles

Quasi-legislative + Quasi-executive + Quasi-judicial

Making regulations, inspecting and registering, and passing orders.

SCRA, 1956

SCRA → stock exchanges, securities contracts, listing

Recognition of exchanges and regulation of trading in securities sit here.

Research analyst registration

Research Analyst → registered with SEBI under SEBI (Research Analysts) Regulations, 2014

Applies to those who publish research reports or give recommendations.

Appeal route

SEBI order → Securities Appellate Tribunal (SAT)

Further appeal goes to the Supreme Court, on the points the law allows.

Quick revision

• Primary market is where securities are issued for the first time; secondary market is where existing securities are traded.
• An IPO is a first public offer by an unlisted company; a rights issue is offered to existing shareholders.
• Exchanges provide the trading platform; clearing corporations guarantee and manage settlement of trades.
• Depositories hold securities in electronic form; depository participants are their agents for investors.
• Brokers execute trades for clients and must be registered with SEBI.
• Equity represents ownership; debt represents a borrowing that carries a promise of interest and repayment.
• Derivatives derive their value from an underlying asset such as a share, index or commodity.
• SEBI was set up to protect investors, develop the securities market and regulate it.
• Mutual fund units represent a share in a pooled portfolio managed by a professional fund manager.
• Read each option fully: many wrong options differ from the right one by a single word.
• Skip a question if you are unsure between two options; wrong answers carry a 25% negative mark.

Common mistakes

• Thinking the issuer receives money when shares trade on the exchange. Fix: Only primary market issues bring money to the issuer. Secondary trades transfer money between investors.
• Treating stock exchanges as issuers or regulators. Fix: Exchanges are market infrastructure that provide a trading platform. They have some rule-making for members, but SEBI is the regulator.
• Saying an FPO is the first public issue of a company. Fix: IPO is the first offer by an unlisted company. FPO comes after listing.
• Thinking the company receives money in an offer for sale. Fix: In an OFS the selling shareholders get the money. Only a fresh issue funds the company.
• Thinking the company receives money when shares are traded on the exchange. Fix: Remember that secondary trades transfer money between investors. Only primary issues raise funds for the issuer.
• Using the word clearing and settlement as if they mean the same thing. Fix: Clearing is working out and netting obligations. Settlement is the actual delivery of securities and payment.
• Treating preference shares as debt Fix: Remember they are share capital. The dividend is paid from profits and is not a legal obligation like interest.
• Thinking debenture holders are owners Fix: Debenture holders are creditors. They get interest and have no ownership or ordinary voting rights.
• Saying SEBI was created by the SEBI Act, 1992 in that year. Fix: Remember SEBI began in 1988 as an administrative body. The 1992 Act gave it statutory powers.
• Assigning stock exchange regulation to the SEBI Act instead of SCRA. Fix: Link SCRA to exchanges and securities contracts. Link the SEBI Act to the regulator and its powers.

Exam tips

• Expect simple classification questions: name an entity and pick its category.
• Always ask who receives the money. This separates primary from secondary questions.
• Learn the functions of the market as a short list and watch for an option that does not belong.
• Remember SEBI is the main securities market regulator, but RBI and the government also have roles.
• Negative marking in this exam is 25% of the marks assigned to a question, so a wrong answer costs 0.25 mark on a 1-mark question. A blind guess among four options has a small positive expected value: 0.25 × 1 − 0.75 × 0.25 = 0.0625, or about 0.06 mark. Eliminating options raises it. With three options left, the expected value is about 0.17 mark. Whether to guess is a risk decision: the expected gain is positive but small, and a single guess can still cost you 0.25 mark.
• Expect definition and difference questions. Learn one-line tests for IPO, FPO, rights, private placement and QIP.
• Watch for words like 'unlisted', 'existing shareholders' and 'QIBs'. They decide the answer.
• For rights ratio questions, divide holding by the base number first, then multiply.