Year: 2020

1. Cash Contracts (Physical Market):

The cash contracts for the purchase or sale of commodities are those which call for payment of the full con­tract price in cash on delivery. Such contracts are made in the cash or physical market. In fact they are also referred to physical contracts in the sense that they deal in actual or physical products.

The cash or physical contracts may be subdivided into two subclasses:

(i) Spot Transactions:

Spot transactions are those cash contracts which involve the payment for the price by buyer and the delivery of the specified grade of goods by sellers immediately. These contracts relate to the purchase or sale of com­modities on spot. The essence of such contracts is the ready delivery and accep­tance of the delivery of the goods sold.

(ii) Forward Contracts:

Forward dealings are those cash contracts made in the cash or physical market which call for the delivery of goods and payment of the price after a specified period on a fixed date. The basic feature common to both the spot contracts and the forward con­tracts is that they are made and settled not necessarily in the premises of the commodity exchange. That is to say, the cash contracts are generally made out­side the exchange.

2. Futures Contracts:

A futures contract is a special type of agreement made strictly under the rules of a commodity which may or may not call for the actual delivery of goods and payment of price in cash on a future date.

A futures contract has been defined “as a contract for the future deliv­ery of some commodity without reference to spe­cific lots, made under the rules of some commer­cial body, in a set form, by which the conditions as to units of amount, the quality and time of deliv­ery are stereotyped, and only the determination of the total amounts and the price is left open to the contracting parties”. 

This definition brings out the following fea­tures of a futures contract:

(i) Such contracts are meant exclusively for future settlement through the exact data of settlement is decided by reference to the wishes of the seller and the estab­lished rules of the commodity exchange.

 (ii) Such contracts do not specify the par­ticular grade of a commodity but impliedly refer to a basic grade called the contract grade accepted as the com­mon grade for all futures dealings.

(iii) The details in respect of the unit of amount, the time of settlement, the qual­ity etc. are mentioned in the rules and regulations and are common to all such contracts. The contracting parties have to decide upon the price at which the contract is to be settled sometime in one of the trading months specified by the exchange.

The meaning of futures will be clear if the fol­lowing basic features of such contracts are referred to:

1. Futures contracts are made only in the ring of the commodity exchanges and not outside the exchanges.
2. Only members of commodity exchange can enter into such a deal. No outsider can become a party to a futures agreement.
3. Such contracts can be made only in multi­ples of a fixed unit of trading specified in the rules of the exchange. No such contracts can be made in fractions of these units.
4. The futures contracts are settled only in the trading months adopted by exchange. Every ex­change specifies 3 to 4 months in a year for settle­ment of such contracts.
5. The time of delivery is not specified in these contracts. It is left to the choice of the seller. The seller may settle the contract on any day of the trad­ing month for which the delivery was fixed.
6. As per rules of the exchange the contract­ing parties have to deposit a certain percentage of the contract price with the exchange as “margin money’ whenever they make a futures contract.
7. Since futures contracts are entered into only under the rules of the commodity exchange con­cerned, all disputes between contracting parties are required to be settled through arbitration by the machinery provided for the purpose.

The futures contracts differ from cash contracts not only in respect of the above features but also in regard to the basic purposes for which they are made. All futures contracts are generally made for the purpose of speculation or hedging. The gen­eral procedure for settlement is the neutralisation of the original contract by an opposite contract on settlement so that only difference between the cur­rent and the contract price is paid.

It is rarely that actual delivery of goods is taken and price paid in settlement of futures contracts. Cash contracts are made for actual purchase and sale of the commodi­ties. Under these contracts the commodity is deliv­ered and the price paid in full, though in some cases price differences may be paid. The futures market is also called the exchange market as against physi­cal market which is another name for cash market.

The futures trading are the most important fea­ture of business activity on the commodity ex­change. In fact, the commodity exchanges are or­ganised mainly for futures contracts. The futures contracts are made for speculative and hedging purposes.

A brokerage provides intermediary services in various areas, e.g., investing, obtaining a loan, or purchasing real estate. A broker is an intermediary who connects a seller and a buyer to facilitate a transaction.

Functions of a Brokerage

The main function of a broker is to solve the client’s problems for a fee. However, there are other broker functions existing today. A brokerage can:

• Execute trades on the financial markets at the expense of the customer and on his behalf.
• Provide information support about the situation on trading platforms, sending notifications about quotes and trading mechanisms.
• Provide information about other market participants, making the correct decision for the client to conduct the transaction.
• Lending to clients for margin transactions.
• Storage and protection of customer data.
• Creating a technical base to make transactions on the exchange.

Certainly, broker companies carry out a broader activity besides mediation. Without a broker, the financial market itself would not exist.

Types of Brokers

Brokers can be one of three types:

1. Online brokers

A new form of digital investment that interacts with the customer on the internet. Online brokerages offer the main advantages speed, availability, and low commissions.

2. Discount brokers

A discount broker is a stockbroker who performs buy and sell orders at a reduced commission rate.

3. Full-service brokers

A full-service brokerage provides a wide range of professional services to customers, such as tax tips, investment advisory, equity researching, etc.

Different Brokerage Specializations

Let’s take a closer look at the main specializations of brokers and their respective features:

1. Stock brokerage

A stockbroker is a professional intermediary on stock or commodity markets who sells and buys assets in the interest of the client on the most favorable terms.

Operations on the exchange market are difficult for outsiders and require a certain number of special approvals and permissions to finalize transactions. It is useful to address professional participants on a stock exchange, such as to brokers.

2. Credit brokerage

Credit brokers are specialists with the necessary information and professional contacts with credit institutions. They provide individual assistance to clients in selecting optimal lending options. They also assist with obtaining the needed financing, its conversion, and repayment, etc.

3. Leasing brokerage

A leasing broker is a specialist who is similar to a credit broker but in the field of leasing equipment. A leasing brokerage’s main clients include legal entities and commercial organizations.

4. Forex brokerage

A forex broker is an intermediary who provides access to the forex currency market. Since the forex market is open only to a certain number of organizations, access to it for individuals is possible only through the mediation of forex brokers.

5. Real estate brokerage

A real estate broker searches for buyers and sellers of real estate, e.g., warehouses, offices, retail, as well as residential properties. A real estate broker receives a certain percentage commission of the real estate transaction.

6. Business brokerage

A business broker offers its services for buying and selling an existing business. They usually deal with a business valuation, take part in negotiations with potential buyers, and generally help in the sale of the business.

7. Insurance brokerage

The main goals of contacting an insurance broker are as follows:

• Mediators draw up insurance policies at a discount.
• It saves time required to fill out an insurance contract.
• It allows searching for better offers from insurers.

Different Charges on Share Trading

Security Transaction Tax (STT)

1. Apart from brokerage, this is the second biggest charge involved while trading in stocks.
2. For delivery trading, STT is charged on both sides (buy & sell) of transactions and is equal to 0.1% of the total transaction price (on each side of trading).
3. For intraday and derivate trading (futures and options), STT is charged only when you sell the stock. For intraday, the STT charge is 0.025% of the total transaction price while selling.
4. For equity Futures, the STT is equal to 0.01% on the sell-side. On the other hand, for equity options trading, STT is equal to 0.05% on sell-side (on premium).

Stamp Duty

Stamp duty is charged uniformly irrespective of the state of residence effective from July 1st, 2020. These new rates are only on the buy-side (and not on both buy and sell-side). Here are the new rates on stamp duty on different types of trades:

Quick Note: Previously, the stamp duty was charged by the state government and hence not similar across all the states in India. A few states charged higher stamp duty, whereas a few of them charges lower duty taxes. Different states charge different stamp duty. Moreover, Stamp duty used to be charged on both sides of transactions while trading ( i.e. buying & selling) and hence are charged on the total turnover. **This rule changed after 1st July, 2020.

Transaction Charges

1. The transaction charges is charged by the stock exchanges and that too on both sides of the trading. This charge is the same for intraday & delivery trading.
2. National stock exchange (NSE) charges a fee of 0.00325% of the total turnover as Transaction charges on Equity and Delivery Trading. On the other hand, Bombay stock exchange (BSE) charges a fee of 0.003% of total turnover as Transaction charges on Equity and Delivery Trading.
3. For Derivatives trading, BSE doesn’t cost any transaction charges. However, on NSE, the Exchange transaction charge is 0.0019% for futures trading and 0.05% of total turnover for Options Trading.

SEBI Turnover Charges

1. SEBI stands for the Securities exchange board of India and it is the security market regulator. SEBI makes the rules and regulations on the exchanges for its proper functioning.
2. SEBI Turnover fee is charged on both sides of the transaction i.e. while buying and selling and is the same for all equity intraday, delivery, futures, and options trading.
3. The SEBI turnover charge is equal to Rs 10 per crore of the total turnover.

Depository Participant (DP) Charges

1. There are two stock depositories in India NSDL(National Securities Depository Limited) and CDSL (Central Depository Services Limited). Whenever you buy a share, it is kept in an electronic form in a depository. For this service, the depositories charge some fixed amount.
2. The depositories don’t charge the traders or investors directory but charge the depository participant. Here, the brokerage firm or your demat account company is the depository participant (DP).
3. DP acts as a linkage between the depository and the investor as the investors cannot directly approach the depository. In short, the depository charges the DP and then the depository participant (DP) charges the investors.
4. For example, while trading with Zerodha, DP charge is equal to ₹13.5 + GST per scrip (irrespective of quantity), on the day, is debited from the trading account, i.e. when stocks are sold. This is charged by the depository and depository participant.

Goods & Service Taxes (GST)

GST is the mandatory tax levied by the government on the services rendered and is equal to 18% of total brokerage and transaction charges.

Capital Gain Taxes

Lastly, Capital gain taxes is the most important tax to understand in this article for the traders and investors. We are not going to cover all the details regarding capital gain taxes in this article, but just a short over.

1. There are two types of Capital gain taxes in India Short-term capital gain tax and Long-term capital gain tax.
2. When you sell a stock before one year of buying, then it is considered as a Short-term. Here a flat 15%of the profit is charged as short-term capital gain tax.
3. When you sell a stock after one year of holding, then it is called the long-term. For the long term capital gain, you have to pay a tax equal to 10% of the gains, if it exceeds Rs 1 lakh.
4. For Intraday Traders, they need to pay taxes on their capital gains which depends on their tax slab. For example, if you’re in the highest tax slab and made some profits while intraday trading, you’ve to pay taxes of 30% on those gains.

1) Selecting a Broker or Sub-broker

When a person wishes to trade in the stock market, it cannot do so in his/her individual capacity. The transactions can only occur through a broker or a sub-broker. So according to one’s requirement, a broker must be appointed.

Now such a broker can be an individual or a partnership or a company or a financial institution (like banks). They must be registered under SEBI. Once such a broker is appointed you can buy/sell shares on the stock exchange.

2) Opening a Demat Account

Since the reforms, all securities are now in electronic format. There are no issues of physical shares/securities anymore. So an investor must open a dematerialized account, i.e. a Demat account to hold and trade in such electronic securities.

So you or your broker will open a Demat account with the depository participant. Currently, in India, there are two depository participants, namely Central Depository Services Ltd. (CDSL) and National Depository Services Ltd. (NDSL).

3) Placing Orders

And then the investor will actually place an order to buy or sell shares. The order will be placed with his broker, or the individual can transact online if the broker provides such services. One thing of essential importance is that the order /instructions should be very clear. Example: Buy 100 shares of XYZ Co. for a price of Rs. 140/- or less.

Then the broker will act according to your transactions and place an order for the shares at the price mentioned or an even better price if available. The broker will issue an order confirmation slip to the investor.

4) Execution of the Order

Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the broker must issue a Contract Note. This document contains all the information about the transactions, like the number of shares transacted, the price, date and time of the transaction, brokerage amount, etc.

Contract Note is an important document. In the case of a legal dispute, it is evidence of the transaction. It also contains the Unique Order Code assigned to it by the stock exchange.

5) Settlement

Here the actual securities are transferred from the buyer to the seller. And the funds will also be transferred. Here too the broker will deal with the transfer. There are two types of settlements,

• On the Spot settlement: Here we exchange the funds immediately and the settlement follows the T+2 pattern. So a transaction occurring on Monday will be settled by Wednesday (by the second working day)
• Forward Settlement: Simply means both parties have decided the settlement will take place on some future date. It can be T+% or T+9 etc.

Participants Involved in the Process

• Clearing Corporation

Clearing corporation is one of the major participants involved in clearing and settlement process in stock market. The responsibility for clearing and settlement of trade executed at the stock exchange lies on the National Securities Clearing Corporation Limited (NSCCL). It is also in charge of risk management and is obligated for meeting all settlement regardless of the member defaults.

• Clearing Members/Custodians

They are another participant in the clearing and settlement process in Indian stock market. When trading members place deals in the stock exchange, the same is moved to NSCCL, which transfers them to the clearing members. The clearing member is in charge of determining the position of share to suit the trade.

• Clearing banks

Clearing banks are responsible for the settlement of funds. There are 13 clearing banks, and each clearing member needs to open a clearing account with either one of them. In case of a pay-out, clearing members receive funds in the clearing account and in case of pay-in they need to make funds available.

• Depositories

There are two depositories in India: National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories hold your Demat account, and clearing members also need to maintain a clearing pool account with them.

Clearing members need to transfer the securities to the clearing pool account they hold with the depositories on the date of settlement.

• Professional Clearing Members

These are special category members appointed by the NSCCL. However, note that they are not allowed to trade, and they can only clear and settle trades executed for their clients. Professional clearing members generally constitute banks, custodians, etc.

Speculation is an important function of the stock exchange. Speculation means purchase or sale of a commodity with a view to earning profit from future price changes.

The word speculation is derived from the Latin word speculare which means to look at from a distance.

Thus all specula­tion represents an attempt on the part of man to peep into the future out of the window of the present. When a speculator anticipates that the price of a commodity is going to rise, he will buy it for selling in future at a profit.

Similarly when the speculator anticipates that the price of commodity is going to fall, he will sell it with a view to buying in the future at lower prices. Thus the speculator anticipates all changes in prices and hopes to earn profits out of it. A speculator is a dealer not in goods but in risks.

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. A person who does not have any influence in the market price but who believes that the price is going to rise or fall independently of his own actions and who buys or sells in an attempt to make profit is a simple or competitive specula­tor.

The competitive speculator, if he is successful, buys cheap and sells dear and thereby makes profit for him-self. But by his actions he shifts goods from points where they are relatively plentiful to others where they are relatively scarce and thereby renders a great service to the society.

When he buys he tends to raise the price conferring a benefit on those from whom he buys; when he sells he tends to lower the price conferring a benefit on those to whom he sells.

By bidding up the price when it is low, he induces other members of the society to consume less and by lowering the price when it is high; he induces other members of the society to consume more. Thus competitive speculation improves upon the distribution of consumption over time.

If there is only one speculator, the whole of the gain from buying cheap and selling dear will be pocketed by him. If there are many speculators they will turn the price against themselves so that their share of the gain becomes relatively small.

If there are enough speculators and if they make cor­rect guesses, the whole of speculative gain might disappear and all the benefits will accrue to con­sumers. This is what is meant by the phrase “per­fect speculation kills itself”.

Speculation should not be confused with gam­bling. Gambling is a bad thing because it involves a sterile transfer of money between individuals, cre­ating no new value. While creating no new value gambling does nevertheless absorb time and re­sources. Gamblers try to make a quick profit by assuming unnecessary risks. They often themselves deliberately create the risks which they bear.

On the other hand a speculator assumes necessary and natural risks. There is a risk in production which must be assumed by somebody if production is to run smoothly. In other words, speculation leads people to take up business dealings which carry risks but it does not encourage people to engage in a blind search from quick and easy gain.

That is why gambling is condemned as anti-social but speculation is considered useful to the producers.

Functions of Speculation:

Speculators perform many important func­tions:

• First, speculators promote stability of prices by reducing the gap between demand and supply. If at a particular point of time, there is an excess supply of a commodity and the price becomes low, the speculator buys it and holds it for sale in the future when the commodity will be in short sup­ply.

Such action reduces the present supply and prevents prices from falling as much as they would have and increases the future supply thus prevent­ing prices from rising then as high as they would otherwise have. Thus, as a result of the functions of the speculators, the range of price fluctuations becomes less.

• Secondly, speculators reduce the risks of pro­duction by enabling manufacturers to buy raw materials in the future at current prices. Modern production organisation involves risks. In primi­tive communities, there were practically no risks because each man produced for himself and con­sumed what he produced.

But in a modern society production is carried on in anticipation of future demand. All types of productive activity involve risks and uncertainty. It is the special functions of the speculators to assume these risks and help to increase production.

• Thirdly, stock exchange speculation performs another social objective. Investment in capital mar­ket is guided by speculation. Since shares can be easily bought and sold, the cause of long-term in­vestment is promoted by the existence of stock markets. Again, if speculators are well informed, the prospects of different classes of industrial es­tablishments will be reflected in the present quota­tions of stock prices.

The ordinary lay investor will thus get a reliable guide in stock market quotations for the proper disposal of his savings. The entre­preneur may also raise fresh capital funds by issu­ing fresh shares through the stock market. Thus stock exchange speculator helps the investor, the manufacturer as well as speculator himself.

Stock Exchange Speculation:

Speculation in shares is an important form of speculation. Security prices change frequently due to the uncertainty of their future yield about which market expectations vary frequently. Security prices also vary owing to the varying liquidity preference of the public. In the stock exchange there are al­ways some speculators who expect that the prices of securities will rise and others who expect that the prices of security will fall.

Those who expect that security prices will rise are known as ‘bulls’ while those who expect that security prices will fall are known as “bears’. If all were bulls and there were no bear’s security prices would go on rising indefi­nitely and there would be no equilibrium level of security prices.

Conversely if all were bears and none was a bull security prices would go on falling down to zero level. But things seldom go on in this way. As prices go on rising, some of those who pre­viously thought prices were too low might be in­duced to revise their expectation? and night be transformed into bears.

Similarly, when prices go on falling, some of those who previously thought that prices were too high might be induced to re­vise their expectations and might be transformed into bulls.

A share market is said to be a bull mar­ket if the bullish sentiment is greater than the bear­ish sentiment and it is said to be a bear market if the bearish sentiment is more powerful than the bullish sentiment. Both bulls and bears are always there in every stock market.

Similar to “futures’ contracts in the commod­ity markets there are dealings in ‘futures’ in the stock market. A speculator in the securities market sells “short’ when he contracts to deliver shares to a buyers at some future date at a price fixed at present. The ‘short seller’ is a bear who expects a fall in the future spot price and who hopes to fulfill his con­tract offer buying shares at the future expected low price.

Just as bears are counter balanced by bulls in the spot market similarly in the futures market the short seller is counter balanced by the “margin buyer’. Margin buying is in effect a contract to de­liver money at a future date in return for shares purchased now. The margin buyer is a bull he ex­pects a future rise in the price of shares and hopes to be able to sell his securities at a profit before the date.

Evils of Speculation:

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. All the benefits of speculation are the benefits of competitive speculation. But we of­ten come across aggressive or monopolistic specu­lation where rich and powerful persons try to ma­nipulate the market price by their own bulk trans­actions so as to extract profits for themselves.

Such profits constitute a form of tribute which they are able to extort from society. Aggressive speculation does not make for an optimum allocation of re­sources—rather it moves society away from such optimum allocation. Instead of reducing price dif­ferences it aggravates such differences and prevents competitive forces from bringing about an equalisation of prices over time and space.

The remedy for monopolistic speculation is as Prof. Lerner suggests, counter speculation. A Govt. agency may fix up appropriate prices and guarantee them to buyers and sellers and may thus make it impossible for any powerful speculator to manipulate prices. Statutory price fixation backed up by governmental resources alone can save soci­ety from the consequences of the predatory activi­ties of aggressive speculation.

Speculation of the type which is beneficial to society is called legitimate speculation; specu­lation by ill-informed persons and by men who try to rig the market is called illegitimate speculation. Legitimate speculation is beneficial to society and as such requires no control. But illegitimate specu­lation is an evil and as such should be suppressed. The remedies suggested are generally inadequate.

One remedy against illegitimate speculation is the passing of legislation prohibiting such action. But there are loopholes in all legislations. It is for this reason that Prof. Taussig said that the most effec­tive remedy is a better moral standard for all in­dustry and an arousal of public opinion against all kinds of gambling.

According to Lord Keynes stock exchange speculation is responsible for much of the insta­bility of the current economic order. If expert speculators are actually engaged in forecasting the future prospects of a concern, they might confer a great benefit to society. As a matter of fact, few speculators have the intelligence, energy to fore­cast correctly the future prospects of a concern.

The wide fluctuations that often take place in security prices are due to conventional valuation of a large number of ignorant individuals. Keynes has aptly said that speculators may do no harm as bubbles on a steady stream of enterprise.

But the position becomes serious when enterprise becomes the bub­ble on a whirlpool of speculation. When the capi­tal development of country becomes a by-product of the activities of a Casino, the job is likely to be ill-done.

Types of Speculators

The speculators are classified into four categories such as

• Bull
• Bear
• Stag
• Lame Duck

1. Bull: A bull is an optimistic speculator. He expects a rise in the price of the securities in which he deals. Therefore, he enters into purchase transactions with a view to sell them at a profit in the future. If his expectation becomes a reality, he shall get the price difference without actually taking delivery of the securities.
2. Dear: A bear is a pessimistic speculator who expects a sharp fall in the prices of certain securities. He enters into selling contracts in certain securities on a future date. If the price of the security falls as he expects he shall get the price difference.
3. Stag: A stag is considered as a cautious investor when compared to the bulls or bears. He is a speculator who simply applies for fresh shares in new companies with the sole object of selling them at a premium or profit as soon as he gets the shares allotted.
4. Lame Duck: When a bear is unable to meet his commitment immediately, he is said to be struggling like a lame duck.

In the stock market, there is always a buyer and a seller. So, when a person buys a certain number of shares, there is another trader who sells the shares. This trade is settled only when the buyer receives the shares and the seller receives the money.

There are three phases in a secondary market transaction:

1. Trading
2. Clearing
3. Settlement

• Trading 

In the stock market, a large number of trades occur simultaneously. The stock exchanges use an electronic order matching system to match ‘buy’ and ‘sell’ orders from different traders. This way, each trade is executed.

For instance, imagine that stock ‘X’ is trading in the stock market.

The buy and sell orders for this stock are as follows:

Here the costliest buy prices are matched against the cheapest available sell prices, and whenever the buy price is less than or equal to the best available sell price a match is done. This of course also depends on the respective quantities available in the market across buys and sells and is known as market depth.

So even if a particular price may result in a match, if there is not enough quantity available at the seller side at that price, the buy order will still not be fully traded.

The market depth is created by brokerages who collect orders from different investors and pass it on to the stock exchanges, most likely to be the two most popular exchanges in India the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). In this process, brokerages act as the intermediary between the investor and the stock exchange.

• Clearing

Once two orders match and a trade is executed, the clearing process takes place. Clearing is the identification of what security is owed to the buyer and how much money is owed to the seller. The entire process is managed by ‘clearing houses’. These are independent entities.

For example, imagine that there are two traders: Ramesh and Suresh.

However, in the real market scenario, traders tend to conduct multiple transactions. As a result, the clearing house identifies all the transactions and the net amount or net securities owed to the trader are calculated.

• Settlement

The next step is to fulfil the financial obligations identified in the clearing step. This involves the transaction settlement for the buyers and sellers.

So once the buyer receives the security and the seller receives the payment, the transaction is settled.

Participants Involved in the Process

• Clearing Corporation

Clearing corporation is one of the major participants involved in clearing and settlement process in stock market. The responsibility for clearing and settlement of trade executed at the stock exchange lies on the National Securities Clearing Corporation Limited (NSCCL). It is also in charge of risk management and is obligated for meeting all settlement regardless of the member defaults.

• Clearing Members/Custodians

They are another participant in the clearing and settlement process in Indian stock market. When trading members place deals in the stock exchange, the same is moved to NSCCL, which transfers them to the clearing members. The clearing member is in charge of determining the position of share to suit the trade.

• Clearing banks

Clearing banks are responsible for the settlement of funds. There are 13 clearing banks, and each clearing member needs to open a clearing account with either one of them. In case of a pay-out, clearing members receive funds in the clearing account and in case of pay-in they need to make funds available.

• Depositories

There are two depositories in India – National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories hold your Demat account, and clearing members also need to maintain a clearing pool account with them.

Clearing members need to transfer the securities to the clearing pool account they hold with the depositories on the date of settlement.

• Professional Clearing Members

These are special category members appointed by the NSCCL. However, note that they are not allowed to trade, and they can only clear and settle trades executed for their clients. Professional clearing members generally constitute banks, custodians, etc.

In India, a Depository Participant (DP) is described as an Agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act. In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the sub section 1A of Section 12 of the SEBI Act. As per the provisions of this Act, a DP can offer depository-related services only after obtaining a certificate of registration from SEBI. As of 2012, there were 288 DPs of NSDL and 563 DPs of CDSL registered with SEBI.

SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers, R&T agents and non-banking finance companies (NBFC), for granting them a certificate of registration to act as DPs. If a stockbroker seeks to act as a DP in more than one depository, he should comply with the specified net worth criterion separately for each such depository. No minimum net worth criterion has been prescribed for other categories of DPs; however, depositories can fix a higher net worth criterion for their DPs.

Basics of Depository

Depository is an institution or a kind of organization which holds securities with it in De-Mat form, in which trading is done among shares, debentures, mutual funds, derivatives, F&O and commodities. The intermediaries perform their actions in variety of securities at Depository on behalf of their clients. These intermediaries are known as Depositories Participants (DPs). Fundamentally, there are two sorts of depositories in India. One is the National Securities Depository Limited (NSDL) and the other is the Central Depository Service (India) Limited (CDSL). Every Depository Participant (DP) needs to be registered under this Depository before it begins its operation or trade in the market.

Demat Account Opening

A demat account is opened on the same lines as that of a Bank Account. Prescribed Account opening forms are available with the DP, needs to be filled in. Standard Agreements are to be signed by the Client and the DP, which details the rights and obligations of both parties. Along with the form the client requires to attach Photographs of Account holder, attested copies of proof of residence and proof of identity needs to be submitted along with the account opening form.

In case of Corporate clients, additional attachments required are true copy of the resolution for Demat a/c opening along with signatories to operate the account and true copy of the Memorandum and Articles of Association is to be attached.

Services provided by Depository

• Dematerialisation (usually known as demat) is converting physical certificates of Securities to electronic form
• Rematerialisation, known as remat, is reverse of demat, i.e. getting physical certificates from the electronic securities
• Transfer of securities, change of beneficial ownership
• Settlement of trades done on exchange connected to the Depository
• Pledging and Unpledging of Securities for loan against shares
• Corporate action benefits directly transfer to the Demat and Bank account of customer

No. of Depository in the country

Currently there are two depositories operational in India.

• National Securities Depository Ltd. – NSDL – Having 2 crores Demat A/c as on 30-06-2020
• Central Depository Services Ltd. – CDSL – Having 2.3 crores Demat A/c as on 30-06-2020

Depositories Act 1996

The definition of depositories under the Depositories Act, 1996 is that a “depository” is a company registered under the Companies Act, 1956. It would be granted a certificate of registration under Section 12 subsection (1A) of Securities and Exchange Board of India Act (SEBI), 1992. Hence the Depository becomes an organization like a central bank.  The main role of Depositories is to dematerialize the securities which mean converting the securities from physical form to electronic form and enabling transactions in electronic form. The depository needs to obtain a certificate of commencement of business from SEBI. At present two Depositories are functioning in India:

• National Securities Depository Limited (NSDL)
• Central Depository Services (India) Limited (CDSL)

Depository Participant (DP)

The Depository Participant is the link between the owner of the securities and the depositors. He is deemed to be an agent of the depository. Accordingly, he is authorized to offer depository services to investors. As per SEBI regulations and Depository Act, a depository cannot interact directly with beneficial owners. He has to deal with its agents called Depository Participant. Neither can the investors directly approach the depository for any services. They have to interact through the DP.

Services provided by a depository

The following services are provided by a depositor through a DP:

1. Opening a Demat Account

The first step is to open a Demat Account. Demat Account is the short form for Dematerialisation Account. It is the process of holding investments like mutual funds, shares, bonds, government securities, etc. It does away with the hassles of maintenance of physical documents.

2. Dematerialization

This process is the conversion of physical shares to electronic shares. When a shareholder uses this facility, the Company takes back the physical shares through the depository system and equal numbers of shares are credited into the shareholder’s account.

3. Rematerialization

This is the exact opposite of Dematerialization. Here physical securities are issued in place of securities in electronic form. 

4. Other services

Pledging Dematerialized shares

Dematerialized shares can be pledged. After the loan is repaid a request can be made through one’s DP to close the pledge through a standard format.

Initial Public Offerings

Public offer credits can be directly received into the Demat account.

Receipt of cash/non-cash benefits

When rights or bonus or dividend is announced by any corporate event for a particular security, the depository will give the details of all the clients having electronic holdings to the registrar as on that date. The registrar will then calculate the benefits due to all the shareholders.

Stock lending and borrowing

Securities in the Demat form can be easily lent/ borrowed. Instructions are to be given to DP through a standard format (which is available with DP).

Transmission of securities

In case there is a need for transmission of securities due to death, lunacy, bankruptcy, insolvency, or by any other lawful means, it is possible through the depository system. The claimant will have to fill in a transmission request form supported by valid documents.

Freezing Account with DP

If at any time one wishes that no transaction should be effected in one’s account, one may advise one’s DP accordingly. DP will freeze the account of the investor until further instructions.

Dematerialization process

1. Appointing DP

The investor chooses a DP of his choice and opens an account with him.  The process will be just like opening an account with a bank. The Investor gets an identification number called Client ID. This is just like the bank account number. This no is the reference point for all transactions with DP. Every investor with the help of a DP has to agree with a depository to get his holding dematerialized. This step is necessary whether an investor already has securities or securities are yet to be issued in a fresh issue.

2. “Demat” Request

The investor makes an application to DP’s in a form called Dematerialisation Request Form is known as DRF.  This form is provided by the DP, the investor hands over his share certificates after cancelling them in writing. The certificates are then surrendered to get dematerialized for Demat. The DP will accept certificates registered only in the investor’s name.

3. Verification and confirmation by Registrar

The depository electronically intimates the issuer or its Registrar of the dematerialization request. The issuer or the Registrar has to verify the security certificates. He also has to verify that the DRF has been made by the person recorded as a member in its Register of Members. Once the Registrar is satisfied, it dematerializes the scrip and updates its record. The Registrar then authorizes electronic credit for that security in the investor’s favour and informs the depository of the same.

4. Crediting the Client’s Account

The investor’s account is credited by DP with the number of shares dematerialized. After this, the investor holds the securities in electronic form. The investor gets the information in the form of a statement.  However, in case, there is a rejection then such credit is not given.

Features of the Depository System in India

1. Securities in dematerialized form

The depository model is more or less similar to holding funds in bank accounts. Transfer of ownership of securities is done through simple account transfer. This method is simpler and avoids cumbersome paperwork.

2. Fungibility

Fungibility means an asset can be interchanged with another asset of a similar type. The dematerialized securities are not identified by share certificate numbers. Hence all securities which are in the same class can be interchanged.

3. Registered and beneficial owner

There are two types of ownership of securities. One is a registered owner and the other is a beneficial owner. For all the dematerialized securities, NSDL is the registered owner but ownership rights, duties and liabilities are with beneficial owners.

4. Easy transferability of shares

The transfer takes place freely through the electronic system and dispenses the procedural formalities related to paperwork.

5. No stamp duty

For the transfer of physical shares, then the stamp duty of 0.5% is payable on the market value of the shares. However, there is no such duty on the electronic form.

6. No risk

Physical certificates have issues like loss in transit, theft, bad deliveries, etc. There is hardly any risk involved in the electronic system as compared to physical certificates.

Commodity market facilitates an exchange of physical goods among residents in a country. Individuals aiming to diversify their portfolio can undertake investments in both perishable and non-perishable products, thereby not only mitigating the risk factor, but also providing a hedge against inflation rates in an economy.

Types of Commodities in the market, available for trading are categorized into the following classes, based on their inherent nature:

Hard commodities:

Precious metals: Gold, platinum, copper, silver, etc.

Energy: Crude oil, Natural gas, gasoline, etc.

Soft commodities:

Agriculture: Soybeans, wheat, rice, coffee, corn, salt, etc.

Livestock and meat: Live cattle, pork, feeder cattle, etc.

As of 2019, some examples of commodities in the market that were most commonly traded in major commodity exchanges in India included crude oil and silver. While crude oil acts as one of the most important energy sources required for virtually every industry, silver is one of the most precious metals other than gold with a steady demand.

As crude oil is not domestically available in abundance, almost 82% of it is imported from OPEC and Middle Eastern countries. Similarly, silver is traded in extensive quantities from countries such as Mexico, Peru, etc.

Investing in the Commodity Market

Commodity trading is managed by four major commodity exchanges in India:

1. Multi Commodity Exchange (MCX)
2. Indian Commodity Exchange (ICEX)
3. National Commodity and Derivatives Exchange (NCDEX)
4. National Multi Commodity Exchange (NMCE)

All activities of such nationwide exchanges come under the regulation of Commodity Derivatives Market Regulation (CDMRD) of Securities and Exchange Board of India, which merged with Forward Market Commission in 2015.

Commodity markets facilitate an exchange of both physical goods and derivative contracts while the physical exchange is undertaken by institutional investors and commodity brokers aiming to realise gains through the resale of the products in the retail sector of the country.

Conversely, a derivative contract does not require a physical store of the goods procured, as individuals can trade commodities online through digitised contracts, making the transaction hassle-free and convenient.

Investors can practice investing in commodity markets through a futures or options contract. While a futures contract dictates individuals to sign a deed stipulating delivery of a product at a later date with respect to a fixed price, an options contract acts as an agreement but not a liability of the same.

Futures contracts

Future derivative trading is most common in the commodity market, wherein sellers sign a futures agreement with brokers/buyers to purchase a stipulated quantity of products at a given price. While a downtrend in the market prices can help sellers realise margin profits, a rising price can help buyers or brokers profit from the transactions.

If such trade is supervised by commodity exchange, it is known as a future derivative contract. Any settlement between two parties without any overseeing exchange is known as over the counter exchange trading.

Both exchange-traded and derivative future contracts are undertaken by two primary classes of investors producers aiming to reduce fluctuations in final good price, and speculators aiming to profit from the volatility of a futures contract.

Options contracts

As of 2017 SEBI regulations, options trading can be practised while investing in top commodities wherein traders enjoy a right but not obligation to purchase/ sell a commodity derivative at a fixed price. Partaking in commodity investment through such agreements help individuals profit from any market fluctuations, as no obligation regarding the purchase or sale of products is imposed on either of the parties, depending upon the type of options contract.

Relationship of the Commodity Market and Stock/Bond Market 

One of the features of a commodity market is that its performance demonstrates an inverse relation with both stock and bond markets, as the bond and stock prices fall when the average price level of goods rise in the economy.

During times of rising aggregate price level or inflation, the prices of commodities traded on respective exchange rises significantly. As extreme inflation has a negative impact on consumers, the government often tries to tackle the situation by increasing the domestic lending rates through a repo rate hike. As the cost of borrowing rises, investors often reduce their speculative demand for stock market investments, making the prices of capital sector plummet.

The bond market is also affected as a result of such a hike in the lending rates levied by scheduled commercial banks, as interests on respective savings tools rise. Consequently, fixed coupon bonds indicate a relatively less profitable investment venture, thereby creating a surplus amount of bonds with reduced demand, causing bond prices to fall.

While bond and stock prices move in the opposite direction as compared to commodity prices, investment in commodities, especially in precious metals and energy sources, tend to generate significant returns for investors.

Traders in a Commodity Market

The commodity markets holds importance for two kinds of individuals based on the commodity market operations they partake in:

Hedgers

Such investors aim to reduce exposure to market volatility by entering into a futures contract with traders. Any change in the price level does not affect the rate at which respective commodities are traded in the market. Most hedgers trade physical goods in the commodities market, as they require the stipulated goods or production or resale purposes.

• Speculators 

Investors aiming to generate substantial profits from trade in the commodity market are termed as speculators. A prediction regarding the direction of movement of market prices are assumed by such individuals before signing a futures contract, and depending upon accuracy of market forecast, positive or negative returns can be realised, subject to spot prices.

Speculators don’t desire physical possession of the goods traded, and hence, opt for a cash settlement to reduce the hassles of physical trading.

Price Determination

The prices of commodity markets are heavily dependent on the market demand and supply of commodities, both domestically and from foreign sources. Speculative news also affects the commodity prices heavily, as socio-economic conditions deeply influence the productive capacity of respective companies.

The factors affecting commodity prices in an economy are discussed below –

• Market demand and supply

Market demand and consequent supply of goods traded on a commodity exchange heavily influence the market price. A rising demand (for any reason) can cause prices to rise in the short run, as supply cannot be increased immediately to compensate for the higher demand in the market. Generally, such a rise in demand can be attributed to a pessimistic performance outlook towards the stock market, thereby causing investors to shift towards relatively safer investment avenues.

• Global scenario 

Global indicators play a crucial role in determining the prices of commodities available internally in a country. For example, any turmoil in the Middle Eastern countries can affect the prices at which crude oil is exported, thereby affecting the prices at which it is traded domestically.

A significant example can be cited in this respect when a supply shock was experienced by all major countries in the world triggered by Iraq-Kuwait tensions in the 1990s.

• External factors

Any condition affecting the total production of stipulated goods traded in an exchange can cause price changes accordingly. For example, a rise in the cost of production can drive up the prices at which a product is sold in the market, consequently affecting the equilibrium rate.

Also, the performance of the stock and bond market has an effect on the prices of commodities, as a negative viewpoint regarding their performances tends to divert investors towards commodity market securities. Individuals often trade in commodity derivatives to compensate for stock market risks, or to safeguard their portfolio from stock market downturns.

• Speculative demand

Demand for derivative investing in commodities online can arise from speculative investors, who aim to realise profits through market price fluctuations. Speculators often make predictions regarding the direction of movement of prices and aim to close the contract before the expiration date to realise capital gains on total gains.

Individuals unwilling to take physical delivery of the goods can opt for cash settlement contracts, whereby upon completion of the tenure of the futures contract, the difference between the price in spot trading and price stated in the futures contract has to be paid.

Depending upon the market assumptions, individuals can assume either a short or a long position in a futures contract. Investors expecting the price to drop in the future can undertake a short position (sell the security at a fixed price on a stipulated date) to realise profits through a fall in the market price. On the other hand, if individuals expect the price of a commodity future contract to rise in the future, they can opt to go long (buy the security at a fixed price on a stipulated date) so as to sell the same at higher prices in the future.

Nonetheless, a futures contract tends to merge with the spot price at which a commodity is trading at a future date, as prices adjust automatically at the expected level.

• Market outlook

Any unforeseen fluctuations in the stock market can cause investors to shift towards commodity trade, as chances of severe fluctuations in prices of certain commodities such as precious metals are low. Hence, commodity market investments are secure in nature and act as a hedge against inflation for risk-averse individuals.

Limitations

• High risk

The commodity market is volatile, as any fluctuations in the productive capacity, demand, or changing social circumstances readily affect the prices. Due to such high volatility, predicting the movement of commodity prices might be challenging, causing investors to lose out substantial returns due to unforeseen market events.

Hence, individuals need to be well-equipped with both the internal working of an economy as well as external factors such as international trade before choosing to trade in commodities. Additionally, the demand and supply patterns should be kept in mind to mitigate the risk further.

• Limited returns:

While stock and bond markets have periodic pay-outs such as dividend yields, coupon payments, etc. commodity investment can only generate capital gains.

While commodity market investments can reap significant returns, substantial expertise is required for the same. Nonetheless, individuals can trade in goods through any established commodity exchange by registering with a commodities broker.