AUTO INDUSTRY

EXECUTIVE SUMMARY

A Capital Market deals in financial assets, excluding coins and currency. The

financial assets comprise of banking accounts, pension funds, provident fund, mutual

fund, insurance policy, shares, debentures, and other securities. The secondary market

is the market where scrips are traded. It is a market place, which provides liquidity to

the scrips issued in the primary market.



All investments are risky, whether in stock, capital market, banking, financial sector,

real estate, bullion, gold etc. The degree of risk however varies on the basis of the

features of the assets, investments instrument, the mode of investment, time frame or

the issuer of the security etc.



Risk can be defined as “Possibility of suffering losses”



“The chance of something happening that will have an impact upon objectives. It is

measured in terms of consequences and likelihood”.



Risk management in a Broking Industry is a new concept in India, since it

poses maximum risk in the financial market, managing it was felt most essential by

the regulatory bodies and exchanges.









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INDEX

Sr. TOPICS Page

No. No.

1. INTRODUCTION TO CAPITAL MARKETS 4

1.1 Financial system

1.2 Capital market scenario

1.3 Capital market

2. WORKING OF A BROKING FIRM 7

2.1 Stock Broker

2.2 Compliance Department

2.3 Registration of Clients

2.4 Registration of Sub-Brokers

2.5 Dealing Department

2.6 Trade

2.7 Settlement Department

3. CENTRAL DEPOSITORY SERVICES LTD DEPARTMENT 12

3.1 Necessity of Demat Accounts

3.2 Account Opening

4. TRANSMISSION & NOMINATION 15

4.1 Transmission

4.2 Nomination

5. DEMATERIALIZATION AND REMATERIALIZATION 16

5.1 Dematerialization

5.2 Rematerialization

6. SETTLEMENT OF TRADES 18

6.1 Off – Market Transaction

6.2 On – Market Transaction

6.3 Inter Depository Transfer

7. RISK MANAGEMENT DEPARTMENT 20

7.1 Risk Management

8. RISK 21

8.1 Systematic Risk

8.2 Unsystematic Risk

8.3 Risk Categories

8.4 Risk & Uncertainty

8.5 Causes of Risk

8.6 Ways to Deal with Risk

8.7 Risk & Return

8.8 Investors Risks

9. RISK INVOLVED IN A BROKING FIRM 30

9.1 Operational Risk

9.2 Market Risk

9.3 Credit Risk





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9.4 Liquidity Risk

9.5 Financial Risk

10. RISK MANAGEMENT 34

11. RISK MANAGEMENT TAKEN BY BSE 40

12. MEAUSRES TAKEN BY SEBI FOR INVESTORS PROTECTION 41

12.1 Recent Developments

13. CONCLUSION 44

14. RECOMMENDATIONS & SUGESTIONS 45

15. BIBIBLIOGRAPHY 47









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1.0| INTRODUCTION TO CAPITAL MARKETS

1.1| FINANCIAL SYSTEM

The financial system of every economy consists of various constituents such as

 Financial Institutions

 Financial Companies

 Financial Markets

 Financial Instruments

 Financial Services

 Financial regulations



The financial market in India comprised of capital market and money market whereas

the financial system of the country comprised of institutions, which operate the financial

markets and the financial instruments with which the financial system is put into operation.



Tax anomy of financial markets can be understood on functional, sectoral and

institutional basis. On a functional basis we can divide financial markets into

 Money market (short term)

 Capital market (long term)

The institutional classification can be made into

 Organized financial market

 Non-Organized financial market



1.2| CAPITAL MARKET SCENARIO

The stock market in India dates back to the 18th century when the East India Company

was ruling the roost in the country and was perhaps the most dominant and powerful

institution and its securities were traded. The securities trading were done in an

unorganized form at Bombay and Calcutta in early 19th century.



The decade of 90’s has witnessed several changes in reformation of capital market.

Automation, transparency,. Strict surveillance, depository system, on line trading, investors

protection, new rules and regulations, etc. are some of the activities which only reflect the

growth of Indian capital market. By any reckoning Indian corporate sector has grown very

significantly in the last couple of decades whether to look at it in terms of public and private

limited companies, their share capitalization, their sales turnover or their contribution to

capital formation with this came the legislation of SEBI to act as a regulatory body to

protect investors





1.3| CAPITAL MARKET

A Capital Market deals in financial assets, excluding coins and currency. The financial

assets comprise of banking accounts, pension funds, PF, MF, insurance policy, shares,

debentures, and other securities. If the stock exchanges are well regulated and function

smoothly, then it is an indication of healthy capital market.





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Stock exchanges provide a good leverage of the capital market and their relationship is

directly proportional. In our country, capital markets are generally also known as

security/stock market. The Indian capital market currently provides excellent investment

opportunities to domestic and foreign investors in both equity and fixed income Segments.

The Indian Capital Markets can be broadly classified into three types of markets.

 Money market

 Primary market

 Secondary market



1.3.1| MONEY MARKET

The money market is part of overall financial system and securities or capital market.

It deals in short term financial assets whish can be readily converted into cash. Money

market is a place for trading in money and short tern financial assets that are as liquid

as money. It provides a platform for short term surplus funds of lenders or investors

and short term requirements of borrowers, the instruments can be traded at low cost

and are highly liquid.



1.3.2| PRIMARY MARKET

Primary market is generally referred to the market of issues or market for new mobilization

of resources by the companies and the government undertakings, for new

projects as also for expansion, modernization, addition, and diversification and up

gradation. Primary market operations include new issues of shares by new and existing

companies, further and right issues to existing share holders, public offers, and issue of

debt instruments such as debentures, bonds, etc. Raising money from capital market is

cheap for the company and involves a low servicing cost. The investors’ benefit by way of

dividend and or capital appreciation.



The following are the market intermediaries associated with the primary market

 Merchant banker/book building lead manager

 Registrar and transfer agent

 Underwriter/broker to the issue

 Advisor to the issue

 Banker to the issue

 Depository

 Depository participant



Defects in Indian Primary Market

 Aggressive pricing and over pricing.

 Price rigging before and during issues.

 Poor, wrong and vague disclosures in offer documents.

 Poor information accessibility.





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 Misleading projections subject to vague assumptions.

 Delay in penal actions against the erring market intermediaries.

 SEBI not assuming any responsibility for disclosure/offer documents.

 Bunching of issues.

 Existence of grey or unofficial market.

 Lack of transparency

 Uninformed and uneducated investors.

 Delay in listing and trading permission.



1.3.3| SECONDARY MARKET

The secondary market is the market where scrips are traded. It is a market place, which

provides liquidity to the scrips issued in the primary market. Thus, the growth of secondary

market is dependent upon primary market. More the number of companies entering the

primary market, the greater is the volume at the secondary market.



Trading activities in the secondary market are done through recognized stock exchanges,

which are 24 in number including Over the Counter Exchange of India, National Stock

Exchange of India, and Inter-connected Stock Exchange of India Secondary market

operations involves buying and selling of securities on the stock exchange through its

members.



The following intermediaries are involved in the secondary marker.

 Broker/member of Stock Exchange- buyer broker and selling broker

 Portfolio manager

 Investment advisor

 Share transfer agent

 Depository

 Depository participant









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2.0| WORKING OF A BROKING FIRM



2.1| STOCK BROKER

According to SEBI Stock Broker is a member of a recognized stock exchange(s) and

is engaged in buying, selling and dealing in securities. In other words broker is an

intermediary who arranges to buy and sell securities on behalf of clients i.e. the buyer

and the seller. A broker can deal in securities only after getting registered with

SEBI.through stock exchanges. The constitution of a broking firm may be a

Proprietary Concern, a Partnership firm or a Corporate.



2.2| COMPLIANCE DEPARTMENT

The functions carried out by Compliance Department are as follows

 Reg. of Sub-Broker

 Reg. Of Client

 Reg. Of Franchisee

 Individual Non Individual

 Limited Company / Partnership / Sole Proprietorship



2.3| REGISTRATION OF CLIENT

Documentation required for individual client as per SEBIs guidelines are as follows



2.3.1| INDIVIDUAL

 Client Registration Application Form.

 Broker Client Agreement on stamp paper of value as applicable in the respective

state.

 Identity Proof like

 Copy of Passport

 Copy of ration card

 Copy of Driving Licenses

 Copy of Voters Identity Card

 Copy of Pan card

 Letter from bank certifying account number and period from

which the same is in operation

 Letter of Running account



2.3.2| NON-INDIVIDUAL



2.3.2.1| Limited Company

 Client Registration Application Form.

 Broker client Agreement on stamp paper.





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 Certified copy of Memorandum and Articles of Association.

 Certified copy of resolution authorizing the company to open account with a Bank

and appointing persons authorized to operate upon said account on behalf of

company.

 Proof of identity in respect of authorized director

 Letter from the bank certifying account number and period from which the

same is in operation.



2.3.2.2| Partnership Firm

 Application Form

 Broker client agreement on stamp paper.

 Partnership Deed

 Partnership letter signed by all the partners authorizing the firm to open account

with a Bank and appoint one or more partners to operate the said account on behalf

of the firm.

 Identity Proof

 Bank Certifying Letter



2.3.2.3| Proprietorship Concern

 Client Registration Application Form

 Broker Client Agreement

 Identity Proof

 Bank Certifying Letter



2.4| REGISTRATION OF SUB-BROKER

SEBI rules for application for registration of Sub Broker

 An application by a sub broker for the grant of a certificate shall be made in Form B

 The Application shall be accompanied by a recommendation letter from a stock

broker of a recognized stock exchange with whom he is to affiliated along with two

references including one from his banker

 The application form shall be submitted to the stock exchange of which the stock

broker with whom he is affiliated as a member.

 The stock exchange on receipt of an application shall verify the information

contained and then shall also certify that the applicant is eligible for registration.



The eligibility criteria is as follows

 The applicant should not be less than 21 years of age

 The applicant has not been convicted to any offence involvingfraud or dishonesty

 The applicant should have at least passed 12th STD





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 The applicant should be fit and proper person



2.5| DEALING DEPARTMENT

Dealing department is a very important department in the broking firm as it carries out

most important activities of Buying and Selling of securities. The people doing dealing are

called as Dealers. He is the person dealing on behalf of the investor, therefore when the

investor wants to trade in some scrip’s he must inform the dealer first and then the dealer

deals in the market.



The following are the activities carried out in a dealing department.

 Buying Selling

 Securities Securities

 Entering Order Order Order

 Orders Modification Cancellation Matching



2.5.1|Entering Order

The trading member can enter orders in the normal market and auction market. When an

order enters the trading system it is an active order, it tries to find out on the other side of

the books if it finds the match, trade is generated. If it does not find a match, the order

becomes a passive order and goes and sits in the order book.



2.5.2|Order Modification

All orders can be modified in the system till the time they do not get fully traded and only

during market hours. Once an order is modified, the branch order values limit for the

branch and get adjusted automatically.



2.5.3|Order Cancellation

Order cancellation functionality can be performed only for orders which have not been fully

or partially traded (for the untraded part of partially traded orders only) and only during

market hours.



2.5.4|Order Matching

The buy and sell orders are matched on book type, symbol, series, quantity and price. The

best sell order is the order with lowest price and best buy order is the order with highest

price. The unmatched orders are queued in the system by the following priority.



By Price - The buy order with the higher price gets a higher priority and similarly a sell

order with a lower price gets a higher priority.

Ex. a) 100 shares @ Rs 35 @time 9.30 am

b) 500 shares @ Rs 35.05 @time 9.43 am

The second order price is greater than the first order price and therefore it is the best

buy order.







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By Time - If there are one or more order at the same price the order entered earlier gets a

higher priority.

Ex. a) 200 shares @Rs 72.75 @time 9.30 am

b) 300 shares @ Rs 72.75 @time 9.33 am

Both orders have same price but they were entered in the system at different times, the

first order was entered before the second order and therefore it is the best sell order.



2.6|TRADE

Trade is the basic activity of dealing of which a buy and sell order match with each other.

This matching of two orders is done automatically in the system. Whenever the trade takes

place the system sends a confirmation message to each of the user involved in the trade.







2.6.1|Trade Modification

The user can use trade modification facility to request for modifying trade to be done

during the day. The user can request the exchange to modify price and quantity. Since

trading is done on line the dealer makes the necessary changes on the request of the

client in his trading term.





2.6.2|Trade Cancellation

The user can use canceling facility for canceling the trades requested. When the request

for the trade cancellation is approved by the exchange, the party to trade receives a

system message confirming the trade cancellation at the workstation of the dealer.



2.7|SETTLEMENT DEPARTMENT

This department performs the back office function ie settling of trades that takes place

every day. This settling is done under “T+2” rolling settlement system.



NSE/BSE provides a platform for trading to its trading members; the National Securities

Clearing Corporation LTD (NSCCL) determines the funds/securities obligation of the

trading members and ensures that trading members meet their obligations. The clearing

banks and depositories provide the necessary interface between the custodians and

clearing members (who clear for the trading members or their own transactions) for

settlement of funds/securities obligation of trading members.



Their core processes

 Placing Order

 Decision to trade Trade execution

 Funds and securities Clearing of trades

 Settlement of trades



The main functions of this department are as follows

 Pay in of funds & securities





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 Pay out of Securities funds



Pay in of Funds and Securities

The members bring in their funds/securities to the NSCCL; they make available required

securities in designated accounts with the depositories by the prescribed pay in time. If

they fail to do so the securities go for Auction.



Pay out of Funds and Securities

After due scrutiny, NSCCL sends electronic instructions to the depositories/clearing banks

to release pay out of securities/funds. This securities/funds reach the members account

respectively, if the member account is showing a debit balance his shares are kept on hold

until he clears them. This settlement is based on rolling system



2.7.1| Rolling Settlement System

Under Rolling settlement all the trades executed on a trading day are settled X days later

this is called “T+X”rolling settlement where “T” is the trade date and “X” is the number of

business days after trade date in which settlement takes place. The rolling settlement has

started in T+5 basis in India, now it is T+2.



Advantages

 Under Rolling Settlement, the investors trading on the preceding or succeeding day

are treated differently. All of them wait for “X” days from the trade date for

settlement.

 The gap between the trade date and the settlement is less under rolling settlement

making both securities and funds easily convertible

 The account period settlement combines the features of cash as well as futures

market and hence distorts price discovery process. In contrast rolling settlement

segregates cash and futures market and thereby removes excessive speculation

that helps in better price discovery.

 There is a scope for both inter-day and intra-day speculation under account period

settlement, which allow large outstanding positions and hence poses greater

settlement risks In contrast, since all open positions under rolling settlement at the

end of a date “T” are closed on the same day and necessarily settled “X” working

days later it limits the outstanding positions and reduces settlement risks.

 Till recently it was possible to shift position from one exchange to another under

account period as they follow different trading cycles. Rolling Settlement took care

of this making trading cycle uniform









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3.0|CENTRAL DEPOSITORY SERVICES LTD (CDSL) DEPARTMENT

The main activities of CDSL Department are as follows CDSL

 Account Transmission Dematerialization Settlement

 Opening & Nomination & Rematerialization of trade

 Just as in a bank, opening an account is the first step that an investor has to do,

here an investor intends to hold scrip’s in D-mat form in a depository form in the

depository system. The Investor can open an account with any DP of NSDL, CDSL.

 An investor can open an account with several DP’s or he may open several

accounts with a single DP in different permutation and combination as per the

holding.



3.1|NECESSITY OF DEMAT ACCOUNTS

SEBI has made it compulsory for trades in almost all listed scrip’s to be settled in a demat

mode. Although trades up to 500 shares was allowed to be settled in physical form for

some time.

 It is safe and convenient way to hold securities compared to holding them in

physical form.

 No stamp duty is levied on transfer of securities held in demat form.

 It eliminates thefts, deface, delays, and subsequent misuse of the certificates

 Change of name, address, registration of power of attorney, deletion of deceased

name etc. can be effected across companies by one single instruction to the DP.

 Each share is a market lots for the purpose of transactions so no odd lot problem.

 Any number of securities can be transferred and delivered with one delivery order.

Therefore paperwork and signing of multiple transfer forms is done away with.

 It facilitates taking advances against securities on low margin and low interest.



3.2|ACCOUNT OPENING

Types of Accounts: -

The purpose for which a depository account is opened determines the nature of

operation of such account.

 Beneficial owner account

 Clearing member account

 Intermediary account





3.2.1|Beneficial owner account

This is an account opened by investors to hold their securities in dematerialized form with

a depository and to settle the transactions of sale and purchase of such securities in book

entry form through the depository system.







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An account holder is legally entitled for all rights and liabilities attached to the securities

(i.e. Equity shares, debentures, government securities etc) held in that account. Therefore

the account is called “beneficial owner account”. A beneficiary account can be in the name

of an individual/corporate or broker himself for the purpose of his personal investments in

demat form. The account is opened with the DP.



3.2.2|Clearing members account

The entities that are authorized to pay in and receive the pay out from a clearing

Corporation / clearing house against trade done by them or on behalf of their clients are

known as clearing members (CMs). All pay in and pay out transactions are carried out

through their accounts.



There are two types of clearing members -

 All members of stock exchanges popularly known as Brokers are clearing members.

 Custodians who are permitted by the stock exchange to act as a clearing member.



Procedure

The clearing member has to first register itself with the depository and obtain a business

partner identification number (CM-BP-ID).

The steps undertaken to open the account are same as those of individuals difference lays

in the type of form the details to be filled in and documents to be submitted.



Checklist for a clearing member account

 Ensure that all compulsory fields in the account opening form have been entered

(except PAN/GIR no and nomination, all other details are compulsory)

 Ensure that a copy of the board resolution for authorized signatories has been

enclosed in case of corporate.

 Ensure that required letter from NSCCL giving CC-ID is enclosed. In case of other

stock exchanges this is not required.

 Ensure CM is informed of standing instruction facility for receipts.

 Ensure CM is informed that in case of delivery to CC instructions either of the joint

holders can sign the instructions.

 If the forms are received at the branch of a DP, ensure that the account opening

form along with required references is dispatched to head office in the proper and

timely manner. If required retain the copy.

 Ensure follow up with head office in case defined deadline in respect of account

opening is not met.



3.2.3|Intermediary account

As per SEBI regulations on stock lending and borrowing, only qualified intermediary can

lend and borrow stocks from clients. These intermediaries borrow from lenders and lends

to borrowers. Intermediaries registered with SEBI as approved intermediary may open an





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intermediary account with a DP of its choice for executing stock lending and borrowing

transactions made through them.



The intermediary account may be opened only after obtaining registration from SEBI under

an approved stock lending scheme and getting the approval of the depository for opening

the account









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4.0|TRANSMISSION AND NOMINATION



4.1|TRANSMISSION

The Companies Act 1956 distinguishes Transmission of shares from transfer of shares.

Transfer of shares relates to a voluntary act of the shareholder while Transmission is

brought about by operation of law. The word “Transmission” means devolution of title to

shares example- devolution by death, succession, inheritance, bankruptcy, and marriage

etc. the persons on whom the shares devolve has to prove his entitlement by submitting

appropriate documents and seek transmission. If the securities are held in the depository

system, documents have to be submitted to the DP. If the securities are held in physical

form, the documents have to be sent to the company for effective transmission.



Check list for DP’s in case of Transmission, if in case securities held jointly

 The surviving holder(s) to have a separate account with any DP

 Ensure all surviving holder(s) sign instruction form

 Ensure that instruction form is accompanied with a copy of notarized death

certificate.

 Verify Signature



In case of securities held singly

 Ensure legal heir(s)/representative(s)have an account with any DP

 Ensure all legal heir(s)/ representatives sign the instruction form

 Ensure that instruction form is accompanied with the following documents

 Copy of notarized death certificate

 Copy of notarized succession certificate

 Certificate or order of court where deceased has not left a will, Or

 Copy of notarized probate or letter of administration



4.2|NOMINATION

The Companies (Amendment) Act 1999 has introduced provisions for nomination in

respect of shares, Debentures, Fixed Deposits etc. Under the provision, a Shareholder,

a Debenture holder, a Bondholder or a Deposit holder can nominate a person in whom

the shares, debentures, bonds or deposits would vest, in the event of original investors

death.



Individuals applying for holding shares/debt securities on their own behalf singly or

jointly with one or two persons can make nomination. If the shares are held jointly, all

the joint holders are required to sign the nomination form. A holder can even nominate a

minor, represented by one of the parents or guardian. Trusts, Societies, Body Corporate,

Partnership Firms, Karats of Hindu Undivided Family, or Power of Attorney holder cannot

be appointed as nominee.







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5.0|DEMATERIALIZATION AND REMATERIALIZATION



5.1|DEMATERIALIZATION

It is the process in which the physical form of holding securities is replaced with electronic

(book-entry) form of holding. The securities held in dematerialized form are fungible. They

do not bear any distinguishable features like distinctive number, certificate number. Once

the shares are dematerialized they lose their identification feature in terms of share

certificate distinctive number and folio numbers. Each security is identified in the

depository system by ISIN (International Securities Identification number) this is a

convenient method for preventing all the problems that occur with physical securities

through dematerialization.



Pre-requisites for dematerialization request

 The registered holder of the securities should make the request

 The request should be made in the prescribed dematerialization request form

 Securities to be dematerialized must be recognized by a Depository as eligible. In

other words only those securities whose ISIN has been activated by a Depository,

can be dematerialized.

 The company/issuer should have established connectivity with any Depository like

NSDL, CDSL, Stock Holding Corporation ltd, only after this connectivity is

established that the securities of the company/issuer are recognized to be “available

for dematerialization”

 The holder of securities should have a beneficiary account in the same name as it

appears on the security certificates to be dematerialized



Procedure for dematerialization

 Client Investor submits the DRF (Demat request form) and physical certificates to

the DP. DP checks whether the securities are available for Demat.

 DP enters the demat request in his system to be sent to the relevant Depository. DP

dispatches the Physical certificates along with the DRF to the R&T agent.

 Depository records the details of the electronic request in the system and forwards

the request to the R&T agent.

 R&T agent, on receiving the physical documents and the electronic request verifies

and checks them. Once the R&T agent is satisfied, dematerialization of the

concerned securities is electronically confirmed to the Depository.



Depository credits the dematerialized securities to the beneficiary account of the investor

and intimates the DP electronically. The DP issues a statement of transaction to the client.









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5.2|REMATERIALIZATION

It is exact reverse of dematerialization. It refers to the process of issuing physical securities

in place of the securities held electronically in book entry form with a depository. Under this

process the depository account of a beneficial owner is debited for the securities sought to

be rematerialized and physical certificates for the equivalent number of securities is/are

issued.



Pre requisite to a rematerialization request

 The beneficial owner of the securities should make the request.

 There should be sufficient balance of securities available in the beneficiary account

to honor the rematerialization request.



Procedure of rematerialization

 The DP should provide rematerialization request forms (RRF) to the clients.

 The client should complete RRF in all respects and submit it to the DP.

 The DP should check RRF for validity, completeness and correctness. In



Particular following points should be checked

 Sufficient balance of shares available in clients account or not

 The name of the client on the RRF is exactly the same as that in the client account

 Details like security type, face value, issuers name and lock in status are filled in

correctly

 The RRF is properly signed or not

 If the RRF is not found in order the DP should return the RRF to the client for

rectification

 If RRF is found in order the DP should accept RRF issue an acknowledgement to

the client.









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6.0|SETTLEMENT OF TRADES

One of the basic services provided by the Depository is to facilitate transfer of securities

from one account to another on the instruction of the account holder.



Transfer of securities from one account to another may be done for any of the following

purposes: -

 Transfer due to a transaction done on a person-to-person basis (an” offmarket”

trade).

 Transfer arising out of transaction done on a stock exchange.

 Transfer arising out of transmission and account closure.



There are four types of transactions, which a DP has to carry out TRANSACTION

 Off-Market

 On-Market

 Inter Depository

 Intra Depository



6.1|OFF-MARKET TRANSACTION

Any trade that is clear and settled without the participation of a clearing corporation and

transfer from one beneficiary account to another due to a trade between them is called Off-

Market Trade.

 DEPOSITORY

 DP 1

 DP 2

 Seller Buyer



6.2|ON-MARKET TRANSACTION

Any transaction for sale or purchase of securities through broker on a stockexchange to be

settled through clearing corporation/clearing house is generally termed as On-Market

Transaction.



The procedure is as follows

 The seller gives delivery instructions to his DP to move securities fromhis account to

his brokers account.

 Securities are transferred from brokers account to CC on the basis of the delivery

out instruction.

 On payout, securities are moved from CC to buying brokers account.

 Buying broker gives instructions and securities move to the buyers account.

6.3|INTER DEPOSITORY TRANSFER

Transfer of securities from an account in one depository to an account in another

depository is termed as an inter depository transfer.





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Pre-requisites given by SEBI (Depository and Participants) regulations, 1996

 Both the depository must be interconnected to enable inter depository transfers

 Inter Depository Transfer can be done only for securities that are available for

dematerialization on both the depositories.

 The account in Depository can be either a clearing account or a beneficiary

account.

 For debiting the clearing account on the beneficiary account with Depository the

form for the inter depository delivery instruction is required to be submitted by the

clearing member/beneficial owner to DP.









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7.0| RISK MANAGEMENT DEPARTMENT

The concept of Risk Department on a broking firm is a new concept in India. The Risk

Management Department is principally concerned with the management of trading and

non-trading risks. It seeks to ensure that all risks, which threaten the business, are

recognized, controlled, and reduced to their feasible economic minimum and not just the

risks that are capable of being insured.



There have been experiments with different risk containment measures in the recent past,

following are some of the measures which are taken by the broking firms.



7.1|RISK DEPARTMENT

 Capital On Line Off-Line Margin Circuit

 Adequacy monitoring monitoring requirement filters



Capital Adequacy Requirement

Every stock exchange has mentioned its own capital requirements, as compared to the

minimum statutory requirements as also those stipulated by other stock exchanges; the

Capital adequacy requirements stipulated by NSE are higher.



Out of total capital provided by a member, Base Minimum Capital (BMC) is utilized towards

taking exposure/turnover only and Additional Base Capital (ABC) is utilized towards margin

payment if not used up for taking exposure/turnover.



On-Line and Off-Line Exposure Monitoring

NSCCL has put in place an online monitoring and surveillance system whereby exposure

of the members is monitored on a real time basis.



Off-Line surveillance activity Consists of inspection and investigations as per regulatory

requirement a minimum of 10% of the active trading members are to be inspected every

year to verify the level of compliance with various rules, bye laws and regulations of the

exchange.



Margin Requirement

The daily margin in rolling settlement comprises of Mark to Market margin (MTM) and

Value at Risk based Margin (VaR). Margins are computed at client level. A member

entering an order needs to enter the client code. Based on this information margin is

computed at the client level which will be payable by the trading member on T+1 basis.





Index based Circuit Filters

An index based market wide circuit breakers system applies at three stages of the index

movement either way at 10%, 15%, and 20%. These circuit breakers bring about a

coordinated trading halt in all equity derivatives market nationwide.









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8.0| RISK

Whether it is driving, or just walking down the street, everyone exposes himself to risk. It is

equally true in the case of investments. Your personality and lifestyle play a big role on

how much risk you are comfortably able to take if you invest in stocks and have no trouble

sleeping at nights because of your investments you are probably taking too much of risk.

All investments are risky, whether in stock, capital market, banking, financial sector, real

estate, bullion, gold etc. The degree of risk however varies on the basis of the features of

the assets, investments instrument, the mode of investment, time frame or the issuer of the

security etc.



Risk can be defined as “Possibility of suffering losses”



“The chance of something happening that will have an impact upon objectives. It is

measured in terms of consequences and likelihood”.



Investopedia has defined risk as “The chance that an investment’s actual return will

be different than expected” this includes the possibility of losing some or all of the

original investments.



When considering any security, the investor is always concerned with the return

expected on the investments and the risks of the investments, i.e. how likely it is that

the return expected will be achieved. There are two types of risks

 Systematic Risks

 Unsystematic Risks



8.1|SYSTEMATIC RISKS

The risks arising out of external and uncontrollable factors, arising out of the market,

nature of industry, the state of the economy and a host of other factors.



This risk influences a large number of assets. It is virtually impossible to protect yourself

against this type of risk. Example, Market Risk, Interest rate risk, Purchasing power risk

etc.



8.2|UNSYSTEMATIC RISK

The risk emerging out of known and controllable factors, internal to the issuer of the

securities or companies. This risk affects a very small number of assets. Sometimes

referred to as “specific risks”. Example Business risk, financial risk, Insolvency risks etc.





8.3|RISK CATEGORIES

Dynamic – Associated with changes in the economy

Static – With or without changes in the economy

Pure – Chance of loss or no loss

Speculative – Chance of loss or gain





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8.4|RISK AND UNCERTAINTY

Risk and uncertainty go together. Risks suggests that the decision maker knows that there

is some possible consequence in an investment decision, but uncertainty involves a

situation, where the outcome is not known to the decision maker. But basically, whether

the outcome is known or not, the investments involve both risk and uncertainty. For our

decision, the word “Risk” is comprises of all elements of variability of return, uncertainty of

the outcome, etc.



The investors and some issuers of securities can control some risks by planning. Others

cannot control and they have to bear the consequence compulsorily.



8.5|CAUSES OF RISKS

These risks are caused by the following factors

 Wrong decision of what to invest in.

 Wrong time of investments.

 Nature of investments.

 Creditworthiness of the issuer.

 Maturity period or the length of the instrument.

 Method of investments, namely, secured by collateral or not.

 Terms of lending such as periodicity of servicing, redemption period, etc.

 Nature of industry in which the company is operating.

 Amount of investment.

 National and International factors, acts of God.



8.6| WAYS TO DEAL WITH RISKS

A. Avoid it

Investor should take those risks, which are bearable. Unnecessary and excessive risks

should be avoided.



B. Retain it

Every Investment posses some inherent risks which are unavoidable; in order to earn

certain returns investor has to retain certain risks.

C. Reduce it

Investor can reduce the risk by taking advice from a knowledgeable persons, analysts etc

before investing in any instruments.

D. Transfer it

Insurance policies are the best way to transfer any risk.

E. Share it

While investing an investor can approach his friends, relatives etc to invest with him and

the risk gets shared among different people.









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Rules of risk to be remembered

 Don’t risk more than you can afford to lose

 Consider the odds

 Don’t risk a lot for a little



8.7|RISK AND RETURN

Every investor invests money to receive returns. The risk/return tradeoff could easily be

called the iron stomach test. Deciding what amount of risk you can take on while allowing

you to get rest at night is an investor’s most important decision.



The risk/return tradeoff is the balance, an investor must decide on between the desires for

the lowest possible risk for the highest possible returns. Remember to keep in mind that

low levels of uncertainty (low risks) are associated with low potential return and high levels

of uncertainty (high risks) are associated with high potential returns. Therefore risks and

return go hand in hand.



RISK/ RETURN TRADEOFF

 Low Risk Higher Risk

 Low Return High Return



8.8| INVESTORS RISKS

Smart investors know how much risk is appropriate for them, and they don't exceed that

level. They realize that risks come in many forms, and there is no way to totally escape

from them whatever measure or precautions they may take.



If you can recognize risks, you can manage them with relatively simple solutions. But too

many investors underestimate the importance of doing this and it's one of the most

important tasks investors should do.





The following are some risks which the investors face.

8.8.1| INFLATION RISK

This is the risk that money you save or earn will lose some of its purchasing power. Even if

your five-year certificate of deposit is guaranteed, the dollars you get back may not buy as

much in five years as they bought when you took them to the bank.



It may make you feel giddy to receive double-digit interest on your money market fund, as

some investors did in the early 1980s. But if inflation is also in double digits, as it was back

then, you're more likely to fall behind economically than get ahead.



From 1970 through 1999, the cost of living in the United States rose at a compound rate of

5.1 percent a year. Many people believed they would be secured if they could retire on a

fixed income of $50,000 a year, which in many cases is adequate today. But at the rate of







Page 23

5.1 percent inflation, after 25 years you will need $173,400 to buy what you can get today

for $50,000. Even if inflation is much more modest, say 3 percent, a person who retires on

$50,000 today at age 55 will require $104,700 at age 80 to buy what $50,000 buys today.



Stated another way, with inflation of 3 percent over 25 years, your $50,000 will be worth

only about $23,300 in today's dollars. At inflation of 5.1 percent, it will be worth only

$13,500.



You may think these numbers are far-fetched and have a hard time relating to them. But it

was amazing to learn that in King County, Washington, per-capita income rose from

$4,834 in 1969 to $40,904 in 1998.



To illustrate how money has lost its purchasing power during last 10 to 15 years, in India a

two wheeler which costed Rs 5000 few years back is available today in the range of Rs

35000 to 60000.Our most popular car Maruti which was priced Rs 50000 initially when it

was introduced in the market today costs Rs 2.5 lacs.



The way to protect yourself against this risk is to own at least some equity assets. For

most investors, that means stock funds. Over the past 75 years, the annual inflation

adjusted return of the Standard & Poor's 500 Index was 8 percent, for small-cap stocks it

was 9 percent, while it was only 0.7 percent for Treasury bills and 1.5 percent for

government bonds.



Most investors ought to have at least 10 percent of their portfolios in assets that can

increase in value, such as stock funds. Studies show that even a 10 percent equity stake

can noticeably increase the returns while at the same time it actually reduces the risk of an

all-fixed-income portfolio.



8.8.2| BUSINESS RISK

This is the risk that you buy stock in a company that fails or has a major unexpected

deterioration in its business. The cure for this risk is basic and simple: diversification.

If you own stock in one or a handful of companies, an unexpected disaster hitting one

of them can do serious damage to your portfolio. But if you own 100 companies, a

disaster in one will have little overall effect.



8.8.3| CREDIT RISK

This is the variation of business risk that affects bond investors. You can buy a bond

issued by a company that can't pay the interest or the principal. It's called a default.

More commonly, the company that issued your bond has an unexpected deterioration

in its business, and its bonds are downgraded by rating services. When this happens,

the market value of the bond falls.



The cure for credit risk is mostly diversification. If you own a single bond and it

winds up being insolvent, you may be in a heap of trouble. But if you own 20 bonds,

as is typical of some bond funds, one or two duds won't spoil your party.





Page 24

8.8.4|MANAGER RISK

Once you determine the proper amount of your portfolio that should be in stocks, you

typically hire a manager to pick them for you. Or you buy a mutual fund, which amounts to

the same thing. You’ll probably pick a manager with a winning personality, persuasive

marketing materials and a track record that's impressive.



There’s just one problem: Very, very few people have been able to successfully pick

market-beating stocks over long periods of time, and even the best track records don't

last forever. By now you might be able to guess the recommended way to overcome this

risk: by practicing the most fundamental investing technique of all, diversification.



Invest in index funds that in turn invest in hundreds or even thousands of stocks. If you

prefer actively managed funds, split your investments among multiple managers. If you're

investing in an actively managed large-cap value fund, choose two of them, run by

different managers. Some mutual funds give you a way to do this in a single package.



Birla Mutual Fund for example, has several funds, which invest in different

sectors of industry and are managed by carefully chosen managers of proven record.

It's a way to get the benefit of several fund managers and diversification.



8.8.5| MARKET RISK

This is the chance that the entire market, either bonds or stocks, goes way up when you

want to buy-or way down when you want to sell. The market is the product of nearly

countless influences and forces, both economic and psychological, both rational and

irrational. In the very long term, it's a relatively safe bet that the market will continue its

upward climb. But nobody can consistently and accurately predict what the market will do

in a week, a month, a year or even a decade.



Over the past century, the U.S. stock market measured by the Dow ]ones Industrial

Average has experienced 19 bear markets in which the index declined more than 20

percent. These figures, by the way, represent bear markets for the highest quality

companies. If you think this is all in the past, remember that the NASDAQ 100 Index

suffered a decline of more than 50 percent last year. And Warren Buffet's Berkshire

Hathaway, a portfolio managed by one of the best in the business, Dropped 50 percent

from March 1999 to March 2000.



If you're an equity investor, you have two ways to protect yourself from bear markets. First,

you can use mechanical market timing, to attempt to get out of stocks before they

experience major losses and to attempt to get back in before they experience major gains.,

this can be a frustrating and imperfect process. But at times it is very successful. Second,

you can have enough fixed-income assets in your portfolio to dampen the volatility of

equities, so your temporary losses won't exceed your risk tolerance. Most investors should

have at least 10 percent of their portfolios in variable assets like equity funds, most should

have at least 10 percent of their assets in fixed income investments like bond funds to

dampen the volatility of their portfolios.





Page 25

Bond investors, including those who invest through bond funds, can protect themselves by

the use of market timing and by investing in short-term bonds, which are less volatile than

bonds with longer maturities.



One form of market risk is paying too much for assets when you invest in them. By using

dollar cost averaging, the practice of routinely investing a fixed amount in an asset every

month or every quarter or every year, you automatically buy more units when prices are

down and fewer when prices are up. Over time, this technique will make your average

price per share of a mutual fund lower than the average of all the prices at which you

bought. This is the technique many investors use when they invest a fixed amount every

month to buy units of mutual fund.





8.8.6| TAX RISK

This is the risk, usually a certainty, that your investment gains will be diminished by income

taxes. Later this year, all mutual fund prospectuses will have to disclose more

fully the theoretical impact of taxes on their returns. This will make returns look smaller,

because the Securities & Exchange Board of India has ordered that prospectuses and

advertisements must mention the impact of tax clearly.



There are plenty of ways to protect you against tax risk, but some of them come at the

expense of good investing principles. Many people bought limited partnerships in the

early 1980s, having been promised substantial tax write-offs from big expected losses.

Then something unexpected happened: Government changed the tax laws subsequently.

The investment losses came as expected, but the tax write-offs

disappeared, as the changed law did not allow this. Without tax breaks, many limited

partnerships didn't have well enough fundamentals to attract any new buyers hence

the investments became duds.



Here are a few of the ways you can save taxes on your investments. Each of them

works, but each has drawbacks that you should understand in advance.

 Buy and hold. If you don't sell, you won't be hit with a capital gain.

 Invest in mutual funds with tax benefits. There are many funds available in the

 market, which allow this. The dividend earned on these investments is also

 tax-free.

 If you're in a high tax bracket, invest in RBI tax-free bonds instead of taxable

 bond funds and taxable money-market funds.

 If you have exhausted all other avenues and still need to reduce taxes, consider

 variable annuities.



8.8.7|EXPENSE RISK

This is the risk that your investment returns will be eroded by paying needlessly high

expenses. Expenses are like anchors being dragged behind a sailboat. They may be

invisible, but they inevitably reduce the speed of the boat. High expenses take many





Page 26

forms, including sales commissions (called loads in mutual funds) and ongoing

expense ratios.



Every investment manager expects and deserves to be paid. But some investment

companies and products charge investors too much. Than you should have a very

good reason.



The best way to control this risk is to inquire about expenses before you invest. Every

investment product involves expenses; don't invest in one until you understand this

element. Here are a few specific suggestions:



 When you buy mutual funds, buy no-load funds. This will save you from one of the

biggest one-time losses your investment can experience.

 If you're a buy-and-hold investor, invest in index funds for their ultra low expenses.

 If you invest in stocks or bonds, choose a reputed brokerage house who charges a

reasonable brokerage. SEBI has these days made it mandatory for brokers to issue

split Contract Notes, which separately give the rate at which the broker has bought

the stock for you and brokerage he has charged you.



8.8.8|EVENT RISK

This is the -risk that some unexpected event will topple the market, or part of it. This

may be an assassination, a natural disaster, a political upheaval or some man-made

crisis that causes investors to suddenly question the future.



This risk also can be very personal, affecting only you and your family: a death, illness,

layoff or a house fire. Unless you keep all your money in government-guaranteed bank

accounts, there is no absolute protection against sudden events. Your best protection may

be the right attitude, that life is uncertain and the uncertainty is part of what makes it worth

living, backed up by an emergency fund that would let you continue living if your income

were interrupted or if your expenses suddenly skyrocketed.



8.8.9|LIQUIDITY RISK

This is the risk that you won't be able to get your money quickly when you need it

without taking a significant investment hit. If you own a small business, selling it for

anything close to what you think it's worth is usually difficult and time consuming. If

your wealth is tied up in raw land and you need to turn it into cash, you may have to

wait months or years to get the price you think you deserve. If you invest in limited

partnerships and need to sell before they expire, you may have to sell at a substantial

loss.



You protect yourself against this risk in two ways: First, by making sure that most of

your investments are in liquid assets that can be sold quickly and inexpensively;

stocks, bonds and mutual funds, gold all qualify. Second, by having an emergency

fund that will let you quickly get your hands on money when you need it, without





Page 27

having to sell an investment you had planned to keep.



8.8.10|FRAUD RISK

This is the risk that you'll simply be defrauded in your investments. This is different

from making a dumb mistake. Fraud deliberately creates victims. To keep yourself from

becoming one of them, deal with reputable investment professionals. Don't make impulsive

decisions about unfamiliar investments; instead, take the time to have somebody

thoroughly check out anything you are considering to buy.



If you're told you must make a decision immediately to take advantage of a opportunity,

there is only one right answer: "I'll pass." If you are offered something promising an

unusually high return, remember that risks and returns always go together. If you can't

identify the risks you are taking in order to seek a high return, leave your checkbook in the

drawer where it belongs.



Finally, follow one of the most basic of all investment rules: Don't invest in something you

don't understand.



8.8.11| EMOTIONAL RISK

This is the risk that your emotions will get out of hand and start dictating your decisions.

Greed and fear are the two biggest forces driving our Stock Markets, and nobody is totally

immune to them. Another form of emotional risk is grandiosity, thinking you know more

than you really do and becoming overconfident in your ability to see into the future.



We sometimes see emotional risk most clearly when investors who are on the sidelines

see others making big gains, and eventually they get so anxious to get some of those

gains for themselves that they just jump into whatever is "hot" in the market. We call this

the "I can't stand it any more" market timing system, and very often it leads people to buy

at close to the peak of a market cycle. We see the converse of this when investors get

increasingly frustrated and exasperated- at-continuing losses, and finally they "Can't stand

it any more" and sell, often at close-of -the bottom of a market cycle.



If investors could follow the old Stock Market saying, "Buy low and sell high," they would

make money. But in both instances, the "I can't stand it anymore" timing system leads

them to do the opposite.



To protect yourself from the risk of grandiosity, be brutally honest about the results of the

investments you have made. Keep a list, if necessary, of the decisions you made

that went wrong. Next time you are sure that you know better than the rest of the

market, pull out the list and study it.

The best protection against emotional risk is a disciplined plan for buying and selling.

Make sure your assets are balanced so you can sleep at night no matter what the

market is doing. If you use market timing, follow a strict discipline, preferably having

somebody else implement it for you - somebody without any emotional charge on

each trade. If you are a buy-and-hold investor, make sure you have enough fixed





Page 28

income in the portfolio to moderate the volatility of equities; and make sure you have

some equities in the portfolio so you won't feel totally left out during bull markets.



Finally, the biggest risk of all: You could run out of money before you run out of

life.



This is the biggest fear of many retirees, that their resources won't last long enough to

support them for life.



There are several good ways to protect you against this risk, but none is foolproof.

You must protect yourself against inflation, which we already discussed briefly. You

must keep your living costs within reasonable bounds. You must start with enough

assets before you stop working. Every year "early" that you retire can impact you

financially in two ways: It gives you one less year of savings and one more year of

future life. Finally, you must invest your assets in a sensible way so your risks are

limited and you have some opportunity for growth.









Page 29

9.0|RISKS INVOLVED IN A BROKING FIRM

The Exchange has been exposed to a large number of risks, which have been inherently

borne by the member brokers for all the times. These risks are as follows





9.1|OPERATIONAL RISKS

Operational risks are very common risks, which are found in every organization.

Operational risks can be defined as “Risk of loss arising due to procedure errors, omission

or failure of internal control system”. Every individual organization faces the risks that their

activities and processes may be disrupted unexpectedly or fail to meet expected

performance level. Strong risk management is an essential part of good corporate

governance and something that helps to protect the shareholders value.



There is also growing recognition of the need to ensure that an effective framework of

management controls and supervision is in place. This view is reflected in the attention

that is being placed on risk management by regulators and testing authorities around the

world.



Management at an operational level often forces on the smooth and efficient running of an

organization Attention is not always given to management of operational risks within the

context of an enterprise-wide view of risks.

Therefore the organization has to face the following risks:

 Direct financial losses, which arise from failing to meet an obligation (ex penalty

interest payments or restitution loss).

 Direct financial losses, attributable to an absence of income (ex, from loss of sales,

transaction fees, direct fees or commission)

 Statutory or regulatory penalties resulting to revocation of licenses.

 Opportunity costs, arising from adverse publicity, being unable to trade or because

of processing delays, backlogs, and poor customer service delivery or poor product

or service quality.



The errors and failures causing risks

Risk category Functional Responsibilities

A. PEOPLE Business line Human errors

Human recourses Internal fraud

Security Staff shortage/sabotage



B. TECHNOLOGY Business line technologies Technology failure

Central infrastructure Outmoded system

Data center maintenance Poor data integrity

C. REGULATORY Compliance Regulator disputes

Finance and accounting Mis stating accounts

Legal Litigations







Page 30

The operational risks found in a broking firm at various departments are as follows

a. COMPLAINCE DEPARTMENT RISKS

In compliance department risks is involved in absence of documents

 Absence of application form

 Absence of different agreements and signs on agreement

 Absence of bank certification

 Absence of identity proof

 Absence of reference letter from chartered accountant

 Absence of undertaking from sub broker that he/she has not been involved in any

criminal offence and no trail is pending against him/her.

 Absence of authorization letter for maintaining account on running basis

 Risk is involved if the client is not introduced by someone



EFFECTS

If the compliance department doesn’t complete all the required documentation the results

could devastating. First of all in the absence of compliance the broker can be suspended

and penalized. This would result in bad publicity, loss of business and credibility, because

no one would like to be associated with a suspended broker. Secondly when compliance is

done the broker is insulated from a probable risk, fraud, and cheating and financial loss at

the entry level itself.



Proper introduction, reference from a chartered accountant, bank statement ensures that

the investor is genuine and has no malafide intentions. It wouldn’t be out of place that

many brokers were cheated by some investors by giving false information and third party

cheques. Since the compliance department had not done their work perfectly the brokers

were on a very weak wicket when they sought legal redressal of their problems.



Similarly the information about the sub broker that he is not involved in any criminal

offence and no trial is pending against him saves the broker from any future risk and

liability.



b. DEALING DEPARTMENT RISKS

 Placing of wrong order i.e. instead of buy order sell order is given.

 Placing of wrong quantity.

 Trading done from wrong account i.e. buying and selling for wrong clients account.

 Trading in wrong scrip ex instead of trading in reliance, trading is done in infosys.

 Entry not made in trade book.



EFFECTS

In all the above-mentioned points the broker suffers financial loss. When instead of buying

the sell order is punched the broker is unable to give delivery of shares resulting in Auction

of the shares and loss to him. It is also observed that in some volatile scrips if the investor





Page 31

misses an opportunity he pressurizes the broker to compensate him. If this is repeated

quite often the investor loses confidence and prefers changing the broker. Thus long-term

relationships are lost leading to financial losses.



c. SETTLEMENT DEPARTMENT RISKS

 Payout of shares to wrong account

 Failure in deciding brokerage slab for a client

 Pay in not done by the client

 Wrong preparation of statement of funds

 Failure in sending confirmation of account opening to the client.

 Failure in sending contracts.

 Failure in preparing bills.

 Failure in preparing pay in and pay out of slips.

 Frauds by the employees.



EFFECTS

Though no department is less important in a broking house, without hesitation it can be

said that the work of settlement department is of utmost responsibility. All the good work

done by different departments can be nullified by an incompetent or casual settlement

department. Wrong payout of shares, wrong payout of funds, failure in preparing bills in

time, failure in preparing pay in and pay out of slips can not only create chaos in a broking

firm, it can result in huge financial losses to the broker. It is on the record that frauds by the

employees have been responsible for many brokers to go bankrupt and close their

business.



d. RISK DEPARTMENT

 Failure in giving limits.

 Giving wrong limits to the client.

 Failure in collecting margins.

 Failure in sending daily reports to Franchisee and sub broker.

 Failure in sending daily reports to management.



EFFECTS

Like settlement department the role of risk department is very important. This concept is

quite new in India and its needs were felt when during last two three years broking houses

suffered huge losses. However the risk department, which is supposed to be managing

risk, is managed by human beings and itself faces many risks. If it does not give enough

limits where it is due and is required it can result in loss to investor or a sub broker leading

to dispute and financial loss.



On the contrary giving wrong limits have the same effect. Failure in collecting margins

attracts two types of risks regulatory and financial. If the margins are not collected





Page 32

according to SEBI guidelines it can result in suspension, termination or financial penalty to

a broking firm. And insufficient collection of margins exposes a broker to financial loss in

case of default.



e. CDSL DEPARTMENT RISKS

 Time period for pay in of shares which is not followed

 Punching error

 Networking problem with the exchange.

 Failure in maintaining records for D-mat and R-mat account



9.2|MARKET RISK

The risk of loss arising from adverse market rate movements e.g. foreign exchange

(transaction, translation, or economic) interest rates, commodity and equity prices are

termed as market risk. Generally this risk occurs due to volatility in scrip’s, which can’t be

controlled.



9.3|CREDIT RISK

It is the risk that the counter party of financial transaction will fail to perform according to

the terms and conditions of the contract, thus causing the other party to suffer a financial

loss. Credit risk is often due to bankruptcy or insolvency of the counter party.



9.4| LIQUIDITY RISK

Market liquidity is the risk that a financial instrument cannot be sold quickly at a price,

which equates to their market value. Liquidity changes over time and rapid changes occur

in highly volatile conditions. Derivative instruments, which are new, and the liquidity of the

market have yet to be fully tested. It must be recognized that many derivatives are OTC

based and liquidity of these products can disappear quickly.



9.5| FINANCIAL RISK

Financial risk means fear of loss of money, which is the biggest risk faced by a broking

firm. Financial risk in respect of broking firm can be of two types firstly loss of income i.e.

brokerage secondly loss of capital.









Page 33

10.0|RISK MANAGEMENT

Risk is defined as “possibility of suffering losses”



This risk in itself is not bad, risk is essential to progress, and failure is often key part

of learning, but we must learn to balance the possible negative consequences of risk

against the potential benefits of its associated opportunities. This is risk management.



Functions of Risk Management are as follows

Identify - Search for and locate risks before they become problems

Analyze - Transform risks data into decision-making information. Evaluate impact,

probability, and time frame, classify risks, and prioritize them

Plan - Translate risk information into decision and mitigating actions (both present and

future) and implement those actions

Track - Monitor risk indicators and mitigation actions

Control - Correct for deviations from the risk mitigation plan.

Communicate - Provide information and feedback internal and external to the project on

the risk activities, current risks, and emerging risks.



10.1|RISK MANAGEMENT IN A BROKING FIRM

Risk management in a Broking Industry is a new concept in India, since it poses maximum

risk in the financial market, managing it was felt most essential by the regulatory bodies

and exchanges. Therefore NSE introduced for the first time in India, risk containment

measures that were common internationally but were absent from the Indian Securities

Market. NSCCL has put in place a comprehensive risk management system, which is

constantly upgraded to pre-empt market failures. These measures were taken to reduce

the brokers’ risks. Whereas SEBI has given some guidelines under Investors Protection to

protect investors risks.



NSE has given the following risk management measures



Margins

NSE has specified Different margins for different instruments like stocks futures and

options etc. Margins depend upon the volatility and market conditions, It vary from

stock to stock and instrument to instrument



Daily margins payable by members consists of the following:

 Value at Risk Margins

 Mark to Market Margins



Daily margin, comprising of the sum of VaR margin and mark to market margin is

payable.



Value at Risk Margin

VaR margin is applicable for all securities in rolling settlement. All securities are





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classified into three groups for the purpose of VaR margin.



The VaR based margin would be rounded off to the next higher integer (For E.g.: if

the VaR based Margin rate is 10. 0 1, it would be rounded off to 11. 00) and capped at

100%.



The VaR margin rate computed as mentioned above will be charged on the net

outstanding position (buy value-sell value) of the respective clients on the respective

securities across all open settlements. The net position at a client level for a member

are arrived at and thereafter, it is grossed across all the clients for a member to

compute gross exposure for margin calculation.



For example, in case of a member, if client A has a buy position of 1000 in a security

and client B has a sell position of 1000 in the same security, the net position of the

member in the security would be taken as 2000. The buy position of client A and sell

position of client B in the same security would not be netted. It would be summed up

to arrive at the member's exposure for the purpose of margin calculation.

VaR margin rate & Security category



Mark-to-Market Margin

Mark to market margin is computed on the basis of mark to market loss of a member.

Mark to market loss is the notional loss which the member would incur in case the

cumulative net outstanding position of the member in all securities, at the end of the

relevant day were closed out at the closing price of the securities as announced at the

end of the day by the NSE. Mark to market margin is calculated by marking each

transaction in scrip to the closing price of the scrip at the end of trading. In case the

security has not been traded on a particular day, the latest available closing price at

the NSE is considered as the closing price.



In the event of the net outstanding position of a member in any security being nil, the

difference between the buy and sell values would be considered as notional loss for

the purpose of calculating the mark to market margin payable.



MTM profit/loss across different securities within the same settlement is set off to

determine the MTM loss for a settlement. Such MTM losses for settlements are

computed at client level.



Upfront margins collection

Members are required to ensure collection of upfront margin from their clients at rates

mentioned below and deposit the same in a separate clients account, in respect of

trades in normal market in which would result in a margin of Rs 50,000 more, after

applying the margin percentages as given from 15%, 30%, 45%.









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Intra-day turnover limit

Members are subject to intra-day trading limits. Gross turnover (buy +sell) intra-day

of the member should not exceed thirty three and one-third (33 1/3) times the base

capital (cash deposit and other deposits in the form of securities or bank guarantees

with NSCCL and NSE).



Members violating the intra-day gross turnover limit at any time on any trading day

are not being permitted to trade forthwith.



Member’s trading facility is restored from the next trading day with a reduced

intraday turnover limit of 20 times the base capital till deposits in the form of

additional deposits (additional base capital) is deposited with NSCCL.



Members are given a maximum of 15 days time from the date of the violation to bring

in the additional capital. Upon members failing to deposit the additional capital within

the stipulated time, the reduced turnover limit of 20 times the base capital would be

applicable for a period of one month from the last date for providing the margin

deposits.



Upon the member violating the reduced intra-day turnover limit, the above-mentioned

provisions apply and the intra-day turnover limit will be further reduced to 15 times.

Upon subsequent violations, the intra-day turnover limit will be further reduced from

15 times to 10 times and then from 10 times to 5 times the base capital. Members are

not permitted to trade if any subsequent violation occurs till the required Additional

deposit is brought in.



Gross Exposure Limits

Members are also subject to gross exposure limits. Gross exposure for a member,

across all securities in rolling settlements, is computed as absolute (buy value - sell

value), i.e. ignoring +ve and -ve signs, across all open settlements. Open settlements

would be all those settlements for which trading has commenced and for which

Settlement payin is not yet completed. The total gross exposure for a member on any

given day would be the sum total of the gross exposure computed across all the

securities in which the member has an open position.



Security-wise Differential Exposure Limits

In case of securities that are traded in the Rolling settlement (Type 'N' and security

series 'EQ'), the GE multiple for each security are as under:

All new securities to be traded on the Exchange shall be subject to exposure multiple

of 2 times.



It is clarified that while computing the gross exposure at any time for a particular

trading day, for the purpose of the above limits, members are required to add the net

outstanding positions of the previous settlement period to the cumulative net

outstanding positions as of that particular trading day until the securities pay-in day







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for the previous settlement period.



Members exceeding the gross exposure limit are not permitted to trade with

immediate effect and are not permitted to do so until the cumulative gross exposure is

reduced to below the gross exposure limits (as defined above or any such lower limits

as applicable to the members) or they increase their limit by providing additional base

capital.



Members who desire to reduce their gross exposure may submit their order entry

requirements as per the prescribed format if members desire to increase their limits,

additional deposits by way of , bank guarantee or Fixed Deposit Receipt CEDR) have

to be submitted to NSCCL. Additional deposits by way of securities in electronic

form ('demat securities') may be deposited as per procedures.



The additional deposits of the member are used first for adjustment against gross

exposure of the member. After such adjustments, the surplus additional deposits, if

any, excluding deposits in the form of securities is utilised for meeting margin

requirements.



Violation Charges

A penalty of Rs.5, 000/- is levied for each violation of gross exposure limit and Intra

Day Turnover limits, which shall be paid by next day. The penalty is debited to the

clearing account of the member. Non-payment of penalty in time will attract penal

interest of 15 basis points per day till the date of payment.



In respect of violation of stipulated limits on more than one occasion on the same day,

each violation would be treated as a separate instance for purpose of calculation of

penalty.



The penalty as indicated above, would be charged to the members irrespective of

whether the member brings in additional capital subsequently.



Additional Base Capital

Members may provide additional margin/collateral deposit (additional base capital) to

NSCCL, over and above their minimum deposit requirements (base capital), towards

margins and/ or exposure / turnover limits.



Members may submit such deposits in any one form or combination of the following

forms:

 Cash

 Fixed Deposit Receipts (FDRs) issued by approved banks and deposited with

Approved Custodians or NSCCL

 Bank Guarantee In favor of NSCCL from approved banks in the specified format.

 Approved securities in demat form deposited with approved Custodians.







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 All Additional Base Capital (ABC) given in the form of cash / FDR (hereinafter

referred to as 'Cash Component) should be at least 30% of the total ABC and Cash

 Margins in respect of every trading member. Incase where non - cash component is

more than 70 % of the total additional base capital, the excess non-cash component

is ignored for the purpose of exposure limits requirements and / or margins

requirements.



Exemption for institutional deals

While computing margins, institutional deals are excluded. Deals executed on behalf

of the following entities are considered as institutional deals:

 Financial Institutions

 SEBI registered FII’s

 Banks

 SEBI registered Mutual Funds



Deals are identified by the use of the participant code in the trades reported on the

NSE.



Deals entered into on behalf of custodial participants i.e. carrying custodial participant

code are considered as institutional deals unless not confirmed by the respective

custodians in which case the deals shall attract margins.

Non-Custodial Institutional Deals are identified by the use of the participant code

`NCIT'. The NCIT' deals will be exempted for margin purposes (However, VaR based

margin which is charged on institutional trades on the net outstanding sale position, in

securities shall be applicable in this case also) and the settlement obligation will

remain with TM clearing member. Non Custodial Institutional deals, which are not

marked as 'NCIT' at the time of order entry, will not be exempted.



All TM clearing members are required to provide details of the contract notes for all

Non-Custodial Institutional Trades through a file upload as per the procedure



Exemption upon delivery of securities

If members deliver securities prior to the securities pay-in day, then the margin

payable by the member will be recomputed after considering the above pay-in of

securities. The margin benefit on account of early pay-in (EPI) of securities shall be

given to the extent of the net delivery position across across all clients of the member.



The EPI would be allocated to clients having net deliverable position, on a random

basis, till such time that the system is developed to provide the EPI benefit on a client

basis. However, members are required to ensure to pass on appropriate early pay-in

benefit of margin/exposure to the relevant client, until the above system is in place.

The value of the advance pay-in made is reduced from the cumulative net outstanding

sale position of the member for the purpose of gross exposure limits.







Page 38

Members may note that early pay-in of securities only up to the working day prior to

the scheduled settlement pay-in day shall be considered for the purpose of early payin

benefits. In case any member makes early pay-in on the scheduled day of pay-in for

the settlement, no benefit will accrue to the member. Such early pay-in shall not be

adjusted against the settlement pay-in obligation and it would be treated as short

delivery. Members are therefore alerted to ensure that no early pay-in is made on the

scheduled day of settlement pay-in



Pay-in of funds securities prior to scheduled pay-in day

The relevant authority may require members to pay-in funds and securities prior to the

scheduled pay-in day for funds and securities. The relevant authority would determine

from time to time, the members who would be required to pay-in funds and securities

prior to the pay-in day. The relevant authority would also determine securities and

funds which would be required to be paid in and the date by which such pay-in shall

be made by the respective member.



The value of such prior pay-in of funds and securities will not be reduced from the

cumulative net position of the member for the purpose of gross exposure reduction.

There will be no margin exemption available for such pay-in of funds and securities.









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11.0|RISK MANAGEMENT TAKEN BY BSE

i. Know your client scheme

Under the procedure the member brokers of the exchange are compulsory required to

obtain detailed information of clients prior to commencement of any transactions with new

clients. A similar procedure is also to be followed for existing clients. This information is to

be made available to the exchange authorities whenever called for. In case the member

brokers fails to furnish the same it is viewed seriously.



ii. Verification of shares at members office

The exchange has outlined the process i.e. in case the transaction in a script with one

particular client in a settlement exceeds Rs 10 lacs then the member are to send the

photocopies of the transfer deeds and the share certificates to the company/ registrar for

verification of the material particulars. The basic idea behind the introduction of this

procedure is to prevent fake/forged/stolen shares from being introduced in the market.



iii. Inspection

The department is carrying out inspection of the member brokers records as regards

compliance of the risk management procedures



iv. Insurance

The exchange presently has in place insurance policies to protect itself in the event of

losses on account of fire, damage to computer systems and a comprehensive policy that

covers risks faced by the exchange, its member brokers and the clearinghouse.

The risks covered under the basic cover of the policy are detailed as below.

 Loss to members on account of infidelity of employees

 Loss of member on account of fake/forged/ stolen shares being introduced by his

clients

 Direct financial losses suffered by the member broker on account of physical loss,

destruction, theft or damage to securities and cash.

 Loss on account of securities lost in transit

 Loss suffered on account of incomplete transaction

 Loss sustained as final receiving member on exchange on account of default of the

introducing member

 Loss on account of errors and omission

 Directors and officials liability cover









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12.0|MEASURES TAKEN BY SEBI FOR INVESTORS PROTECTION

Government of India and SEBI have been stressing upon the need for regulating the

secondary market and bringing transparency in transactions on the floor of stock

exchanges



The steps taken by SEBI to regulate and control the business of stock exchanges and

reduce the risks of investors are as follows

i. Regulation on insider trading with the object to curb it completely and punish the

guilty

ii. Uniform Trading hours at all the stock exchanges in the country to check arbitrage.

iii. Registration of market players- brokers, non member brokers, sub brokers,

registrars to issues, merchant bankers, portfolio managers, underwriters, debenture

trustees, custodians etc so as to have access/inspection of their books, records and

verification of transactions.

iv. Compulsory audit of accounts of all member brokers and registered intermediaries

by practicing chartered accountants.

v. Inspection of Stock exchange operations.

vi. Indirect supervision through stock exchanges in day-to-day business by fixing

margins, imposing curbs, penalties and fines.

vii. Gradual automation to reduce paper work and ensure transparency in transactions

this is now almost complete and all stock exchanges have been computerized.

viii. Brokers contact notes to mention brokerage separately.

ix. Nationwide paperless trading through over the counter exchange of India, National

Stock Exchange, BSE, DSE and other exchanges.

x. Transfers to be affected within two months as per companies act and within one

month as per listing agreement.

xi. Brokers should notify all transaction to the stock exchanges including off the floor

trades.

xii. Uniform good/bad delivery norms.

xiii. Capital adequacy norms prescribed for brokers.

xiv. Brokers to keep clients money in a separate bank account.

xv. Forward trading being banned on stock exchanges

xvi. Stress upon shorter settlement period.

xvii. Dematerialization of securities permitted on a selective basis. By March 2001, about

3500 companies will have compulsory trading in demat mode.

xviii. Stern action against erring brokers, stock exchanges, companies, merchant

bankers, etc.

xix. Regulation for fraudulent trade practices

xx. Total transparency and automation of stock exchanges.

xxi. Effective margin system for smooth settlement.





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xxii. Circuit breaker system to check volatility on the exchanges

xxiii. Introduction of modified carry forward system and automated lending borrowing

mechanism (ALBM).

xxiv. Introduction of Internet trading.

xxv. Derivative trading in index based futures of 30, 60 and 90 days.

xxvi. Practicing prudent governance norms.

xxvii. Stock lending.

xxviii. Abolition of no delivery period in demat scrip’s.



12.1|RECENT DEVELOPMENTS

a. Appointment of administrators to check bad deliveries

b. To get rid of bad deliveries, SEBI has decided to appoint administrator to implement

the signature guarantee and certificate authentication programs. The administrators

appointed by SEBI act on behalf regulator in resolving problems arising out of

signature mismatch

c. Streamlining Investor protection fund

d. The committee set up by SEBI to review the sources and utilization of investor

protection fund of stock exchanges has made following recommendations

e. Funds should be on trust structure and set upon under Indian Trust Act, 1882 with

independent trustees

f. Regular contributions from active member brokers and stock exchanges

g. Fund to be utilized only for investor claims and not broker claims.

h. Trustees to ensure that fund is not deployed in risky instruments or for the benefit of

any member but only in prescribed avenues.

i. Time schedule to be specified while setting investor claims.

j. Service centers for investors

k. SEBI has directed all stock exchanges to constitute service centers for investors to

enable the investors to have a form for recording and counseling of their grievances

as well as access financial and other information of companies on government

policies, rules, regulations, etc.

l. Compliance Officer

m. Each company is required to appoint compliance officer who would be able to verify

rumors and information floating in the market about the company to the stock

exchange. This will reduce motivated rumors about companies, which aids in price

manipulation.

n. Corporate Governance

o. SEBI has prescribed prudent corporate governance norms for all listed companies

to ensure transparency and better disclosure practices.

p. Investor Education







Page 42

q. SEBI has taken steps to educate investors through various awareness programmes

and publications









Page 43

13.0| CONCLUSION

It was found that the working of a broking firm is a very risky job because risk is involved in

each and every activity of the business.



The risk prevailing in the business is recognized therefore an efficient risk management

department is essential in every broking firm.



Capital Market is growing very fast, turnover wise as well as area of operation wise. The

activities have reached through lengths and breadth of the country. All these necessitated

in the introduction of latest technology in the form of advanced software’s.



Efficient staff and technology is the base of broking industry. Broking business is a client-

based business. The recent trends of voluminous increase in investors has also increased

the risk involved in it. There is need of continuous up gradation of internal control

measures Staff in a broking firm is continuous busy and due to which they are

always under stress.









Page 44

14.0|RECOMMENDATIONS & SUGGESTIONS

a) Every Organization should have a risk management policy that is approved by the

board of directors annually.

The policy should outline

 Products Traded

 Parameters for risk activities

 Limit Structure

 Over Limit approval Procedure

 Frequency of review



b) An Organization should have a risk management function that is independent of its

trading staff i.e. personnel responsible for the risk management function should be

separate from trading floor personnel.



c) Ideally an institution should be able to identify the relevant risks and should have

measurement systems in place to conceptualize, Quantify and control these risks

on an institutional level using a common measurement framework.



d) Senior management should regularly evaluate the risk management procedure in

place to ensure they are appropriate and sound.



e) Senior management should also foster and participate in active discussions with the

board of directors, sub brokers, franchisee, staff of risk management function and

investors regarding procedures for measuring and managing risk.



f) Highly qualified staff not only in front office positions such as trading desk,

relationship officer and sales but also all back office functions responsible for risk

management and internal control.



g) An organization should have an integrated management system that controls

market risks and provide comprehensive reports.



h) Risk management or control function should be able to produce a risk management

report that highlights positions, limits and excess on a basis commensurate with

trading activity. This report should be sent to senior management, reviewed, signed

and returned to control staff.



i) A periodical compliance review should be conducted to ensure conformity with the

rules and regulations.







Page 45

j) Auditors should perform a comprehensive review of risk management annually,

emphasizing segregation of duties and validation of data integrity.



k) For avoiding market risk the organization should ensure that they adequately

measure, monitor and control the market risk in their trading activities. the various

methods like mark to mark and value at risk approach can be used for trading

operations. Some more measures which can be used are Delta, Gamma, Vega,

Theta etc



l) Every Organization should have “Know Your Customer” policy and this should be

understood and acknowledged by the trading and sales staff.



m) Every organization should check cash flow statement and balance sheet of last two

years of a client before starting business with him.



n) Taping of trader and dealer telephone lines will facilitate to resolve the disputes and

can be a valuable source of information to auditors, managers and examiners.



o) The designated compliance officer should perform a review of trading Practices

annually.









Page 46

15.0|BIBLIOGRAPHY



Websites

 http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=85&Mode=0

 http://www.productprofitability.com/BaselIILossGivenDefault.htm

 http://www.inductis.com/who_we_are/articleandwhitepaper/basel_II_and_inductis_o

fferings.html

 http://en.wikipedia.org/wiki/Advanced_IRB

 http://www.federalreserve.gov/generalinfo/basel2/DraftNPR/NPR_Memo/NPR_Mem

o_Description.htm

 http://www.bis.org/publ/bcbs118.htm

 http://www.denabank.com





Articles

1. Basel II: Risk Management and Implications For Banking In Emerging Market

Countries

Stanley Fischer, Citigroup

2. The Basel II Accord on Credit Risk Management: The Imperative of Proactive Credit

Disputes Management

Bidemi O. Olowosile

3. Managing Credit Risk: The Challenge for The New Millennium

Dr. Edward I. Altman, Stern School of Business, New York University

4. Risk Management in Banks

R.S. Raghavan









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