NISM RA Chapter 2 — Introduction to the Securities Market, explained simply

This is my note on Chapter 2 of the NISM-Series-XV Research Analyst workbook — “Introduction to the Securities Market.” It’s a big, foundational chapter. It doesn’t ask you to calculate anything; it asks you to know a lot of definitions and how the pieces of the market fit together. I’ve tried to lay it all out in plain language, in the order the workbook builds it, so you can read this once and have the whole map in your head.

What a “security” actually is

A security is a transferable financial claim. It’s a contract that either proves someone owes you money (debt) or gives you an ownership stake in a company (equity). Shares, bonds, debentures, and similar instruments are all securities. Companies, financial institutions, and governments issue them; investors buy them.

The neat trick securities pull off: they let a saver turn spare money into an asset that earns a return, and at the same time let a borrower raise money at a cost. Both sides get what they want. And because there’s a secondary market where you can sell to another investor without touching the issuer, even a “long-term” security becomes something you can exit whenever you like. That’s what liquidity means — the ability to buy and sell easily at close to the market price.

The whole financial market has four kinds of players: investors (who provide funds), borrowers (who seek funds), intermediaries (the plumbing that moves money and securities between them), and regulators (who keep it orderly). Keep those four buckets in mind — the chapter is basically a tour of them.

Legally, the word “securities” is defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA). Under it, “securities” includes shares, scrips, stocks, bonds, debentures; derivatives; units of collective investment schemes and mutual funds; security receipts; government securities; and other instruments the Central Government declares as securities. A useful example: Electronic Gold Receipts were declared securities in December 2021. One thing that is NOT a security: a unit-linked insurance policy (ULIP), because it combines insurance with investment.

The products — a tour of the securities market

This is the heart of the chapter. There are a lot of instruments, so here’s each one in a line or two.

Equity shares represent fractional ownership of a company. Shareholders collectively own the business, bear its risks, and enjoy its rewards. Regulated mainly by SEBI (and the Companies Act / MCA / NCLT).

Debentures, bonds, and notes are all ways to raise debt. Debentures can be secured (backed by collateral) or unsecured. A few terminology notes worth remembering: “bonds” is the umbrella term in the US, “debentures” in the UK; bonds tend to mean government issuers with long maturities (called GILTs in the UK), debentures tend to mean corporates; “notes” usually means shorter or medium maturities. Debentures come in three flavours by conversion: fully convertible (fully turns into shares), partly convertible (part turns into shares, the rest stays debt), and non-convertible (NCDs — pure debt, repaid on maturity).

Short-term debt instruments (under one year) include Treasury Bills (issued by government), Commercial Papers (issued by high-credit-rating companies), and Certificates of Deposit (issued by banks).

Bonds also split into domestic and external. Domestic bonds are issued by a country’s entities, in their home market, in their home currency. External bonds are issued in a foreign market in a different currency — and these divide again into:

• Foreign bonds — issued in a foreign country, in that country’s local currency (e.g. an Indian company issuing USD bonds in the US).
• Euro bonds — issued in a foreign country, in a currency that is NOT that country’s local currency (e.g. an Indian company issuing a Yen-denominated bond in Germany — a “Euro Yen bond”). Note the trap: “Euro bond” does not mean it’s issued in Europe or in euros.

A special case worth knowing: Masala bonds are Euro bonds denominated in Indian rupees, issued outside India. First issued in 2014 by the IFC on the London Stock Exchange. The clever bit: because they’re in rupees, the currency risk sits with the foreign investor, not the Indian issuer — the opposite of a normal foreign-currency bond, where the issuer carries that risk.

Warrants give the holder the right (not the obligation) to buy the issuer’s shares later, at a pre-set price.

Indices track market movement using a representative sample of shares, usually weighted by market capitalisation. India’s most-tracked are the Nifty 50 (NSE, 50 stocks), S&P BSE Sensex (BSE, 30 stocks) and MSEI’s SX40 (40 stocks). Stocks get picked based on liquidity, floating stock, and market-cap size, and the composition is reviewed periodically. Indices are used as benchmarks (to compare a fund’s returns), as a barometer of the economy or a sector, as a real-time read of market sentiment, and as the underlying for index funds and derivatives.

Mutual fund units represent your share of a pooled, professionally managed portfolio. The value of a unit is the NAV (Net Asset Value), which moves with the portfolio. Open-ended schemes let you buy and sell units from the fund anytime with no fixed maturity; closed-ended schemes have a fixed number of units and are traded on the stock exchange.

Exchange Traded Funds (ETFs) are like index funds but their units trade on an exchange in demat form, with prices moving continuously. They blend features of both open- and closed-ended funds, and because they’re passively managed, their expense ratios are usually lower than active mutual funds. Gold ETFs are the most common commodity ETF.

Then come the hybrids / structured products — instruments with a mix of debt and equity features:

• Preference shares — equity that gets preference over ordinary shares for both dividends and repayment if the company winds up. They resemble equity (holders are shareholders, paid a dividend from post-tax profit, dividend isn’t a compulsory obligation) but also debt (fixed dividend rate, paid before ordinary dividends). They usually carry no voting rights. Varieties: cumulative (unpaid dividend carries forward) vs non-cumulative (it lapses), and convertible options.
• Convertible debentures/bonds — debt that converts into equity at a future date; pays a coupon until then. Types: fully convertible (FCD), partly convertible (PCD), and optionally convertible (OCD — holder chooses). The issuer benefits from a lower coupon and not having to repay (shares are issued instead); the downside is dilution of existing shareholders.
• Depository Receipts (DRs) — instruments representing shares of a foreign company, traded in another country’s market in local currency. A company/investor delivers shares to a depository (usually a foreign bank), which issues receipts against them. Sponsored DRs (issuer-initiated) can be exchange-listed; unsponsored DRs (investor-initiated) trade only OTC. Country versions: ADRs (American — US-traded; Infosys, Wipro, ICICI Bank, HDFC Bank have issued them), IDRs (Indian — a foreign company traded in India; Standard Chartered), HKDRs (Hong Kong), and GDRs (Global — tradable in more than one country). DR holders get dividends and price appreciation but no voting rights.
• Foreign Currency Convertible Bonds (FCCBs) — foreign-currency (usually dollar) convertible bonds issued offshore, generally optionally convertible, regulated by RBI under FEMA.
• Equity Linked Debentures (ELDs) — debt whose interest is tied to an equity underlying (like the Nifty). Structured to protect capital while giving some equity upside — but “capital protection” still carries credit risk (the issuer can default).
• Commodity Linked Debentures (CLDs) — same idea as ELDs but linked to a commodity, usually gold or silver.
• Mortgage-Backed / Asset-Backed Securities (MBS/ABS) — debt backed by the cash flows from financial assets like home loans (MBS), auto loans, or credit-card receivables (ABS). This is securitisation: turning illiquid assets into tradable securities.
• REITs and InvITs — trusts that pool money to invest in income-generating real estate (REITs) and infrastructure (InvITs). Key numbers to remember: a REIT must hold at least 80% in real estate assets; an InvIT must invest at least 90% of unit capital in revenue-generating infrastructure; and both must distribute at least 90% of their distributable surplus cash flow to unit holders.

Finally, commodities — basic, homogeneous, interchangeable goods (a gold bar is a commodity; gold jewellery isn’t, because design matters). Hard commodities are mined/extracted (metals, crude oil); soft commodities are grown (grains, pulses). Since most commodities cost a lot to store, you usually invest through: precious metals (gold, silver — long life, low storage cost), commodity ETFs (the fund handles storage), managed futures contracts (a professionally run portfolio of futures), or warehouse receipts (a document proving ownership of stored goods, often negotiable).

How the market is structured: primary vs secondary

The securities market has two inseparable halves.

The primary market (the “new issue market”) is where issuers raise fresh capital by issuing new securities. The main ways to do it:

• Public issue — securities offered to the general public.
• IPO (Initial Public Offer) — a company’s first sale of shares to the public, to raise equity for growth. SEBI sets eligibility (net tangible assets, profitability, net worth) and rules (mandatory listing, demat form). Allocation rules: at least 35% to retail investors (those investing ≤ ₹2,00,000), at most 50% to Qualified Institutional Buyers (QIBs). Anchor investors (introduced 2009) are QIBs applying for ₹10 crore or more; they can get up to 60% of the QIB portion, and bid one day before the IPO opens — their participation signals the quality of the offer.
• FPO (Follow-on Public Offer) — a further issue by an already-listed company.
• Private placement — issuing shares to a select group (max 50 investors under the Companies Act, 2013). Includes QIPs and preferential allotment.
• QIP (Qualified Institutional Placement) — a listed company privately placing shares with QIBs (financial institutions, mutual funds, banks).
• Preferential issue — securities issued to a select group on a private-placement basis.
• Rights and bonus issues — offered to existing shareholders as of a record date. Rights let you buy more at a set price (you can exercise, transfer, or let them lapse); bonus shares are given free out of retained earnings (an amount equal to the bonus shares moves from retained earnings to share capital).
• Onshore vs offshore offerings — raising capital domestically vs from investors abroad.
• Offer for Sale (OFS) — existing shareholders sell already-allotted shares (no new shares, no increase in capital). The government’s PSU disinvestment is a classic example. Note: OFS is a secondary-market transaction done through the primary-market route.
• Sweat equity — shares given to employees/promoters as reward for contribution (Sec. 54, Companies Act 2013).
• ESOPs — options for employees to buy shares at a pre-set price after a vesting period (usually over a year), to align them with the company’s interest.

The secondary market provides liquidity for already-issued securities — here the deals are between investors, and the issuer isn’t involved. It has two segments: the OTC market (trades negotiated directly between counterparties) and exchange-traded markets (through stock exchanges, where a clearing corporation guarantees settlement). Two post-trade activities matter: clearing (working out the net obligations of buyers and sellers) and settlement (actually delivering shares and paying money). The clearing corporation provides “novation” — it becomes buyer to every seller and seller to every buyer, which slashes counterparty risk. To manage its own risk, it charges margins: initial/upfront margin, peak margin, and mark-to-market (MTM) margin.

Who’s who: the market participants

This section is a big list of players. Grouped so it’s easier to hold:

Intermediaries: Stock exchanges (NSE, BSE, MSEI — the trading platform); depositories (hold securities electronically — India has two, CDSL and NSDL); depository participants (the agents through whom you open a demat account); trading members / stock brokers (registered exchange members who execute your trades); authorised persons (agents appointed by brokers — note that sub-brokers were abolished from April 2019 and migrated to this role); custodians (hold funds and securities for big institutional clients); clearing corporations (guarantee settlement); clearing banks (where clearing members hold accounts for pay-in/pay-out); merchant bankers (issue managers / lead managers for new issues); underwriters (agree to buy any unsold portion of a public offer — “hard” underwriting is committed early, “soft” once pricing is set); and Farmer Producer Organizations (collectives that improve farmers’ bargaining power).

Institutional participants: FPIs (foreign portfolio investors, must register with SEBI); P-Note participants (overseas investors accessing India via participatory notes issued by registered FPIs, without registering themselves); mutual funds; insurance companies; pension funds; venture capital funds (early-stage, high-risk); private equity firms; hedge funds (wide mandate — and, the workbook notes, often not actually “hedging” anything); and Alternative Investment Funds (AIFs). Worth memorising the AIF categories: Category I (start-ups, SMEs, social ventures, infrastructure — things government sees as desirable), Category III (complex strategies using leverage and derivatives — hedge funds, PIPE funds), and Category II (everything else that doesn’t use leverage — real estate funds, PE funds, distressed-asset funds). Also here: investment advisers, warehouse service providers, quality assayers, EPF, NPS, family offices, and corporate treasuries.

Retail participants: individual investors buying for their own account, including HNIs and UHNIs. Corporates: processors, manufacturers, importers and exporters whose margins are affected by commodity prices. Proxy advisory firms: advise (usually institutional) investors on how to vote on company resolutions.

Kinds of transactions

The chapter closes with the types of trades:

By settlement timing: Cash trades settle the same day (T+0); Tom trades settle the next day (T+1); Spot trades settle two business days after (though Indian equity markets have moved to a T+1 cycle).

By instrument: Forwards (customised OTC contracts to buy/sell later at a set price — both parties obliged, carry counterparty risk); Futures (standardised, exchange-traded forwards with margins and a settlement guarantee); Options (the right, not the obligation, to buy or sell — a call is the right to buy, a put is the right to sell; the buyer pays a premium, the seller/writer receives it and takes on the obligation); and Swaps (two parties exchanging future cash flows by formula, often to convert a floating interest rate into a fixed one).

And a set of activities worth distinguishing: trading (short-term, based on technical patterns, higher probability of gain), speculating (betting on price changes, often on a view or information — lower probability than trading), hedging (buying an offsetting position to avoid losses — motivated by avoiding loss, not making profit), arbitrage (simultaneously buying and selling the same asset in two markets to profit from a price gap — which, in an efficient market, closes quickly), and pledging (taking a loan against your securities — they stay in your demat account but get blocked; the lender can sell them if you default).

Demat and remat

Finally, the plumbing that makes modern markets work. Dematerialization converts physical securities into electronic (book-entry) form — in demat, your shares carry no distinctive certificate or folio number. Rematerialization is the reverse: converting electronic holdings back into physical certificates with distinctive numbers, on the investor’s request.

How this chapter is tested

A few things I’m keeping in mind, using what I know about the exam:

This chapter carries only about 2 marks, so it’s low weightage — but it’s pure theory and definitions, which means it’s scoreable if you simply know your terms. Don’t over-invest time here, but don’t skip it either.

The questions are recall-based: expect “which of these is a security under SCRA?”, “fully-convertible vs partly-convertible debenture”, “which AIF category is a hedge fund?”, or “what’s the difference between a call and a put?” The workbook even ends with two sample questions of exactly this type (identifying what SCRA covers, and naming a fully convertible debenture).

The traps are in the look-alikes. The exam loves testing the pairs that sound similar: foreign bond vs euro bond, sweat equity vs ESOP, forwards vs futures, hedging vs speculation, REIT (80%) vs InvIT (90%), cash vs tom vs spot. If you can tell each pair apart, you’ll clear most questions from this chapter.

My approach: read it once for the map, then make a one-line flashcard for each instrument and each participant. It’s a memory chapter, not a thinking chapter — so spaced repetition beats deep study here.

Next up: Chapter 3 — the specific terminology of the equity and debt markets. See you in the next note.