Study of Risk Management in Stock Broking Firm

A Project ReportOn “Study of Risk Management in Stock Broking Firm” For “Pune Stock Exchange Securities Limited, Pune” By “Mr. Prasad Dipak Deshmukh” Under the guidance of “Dr. Yashwant Vaishampayan” Submitted to “University of Pune” In partial fulfillment of the requirement for the award of the degree of Master of Business Administration (MBA) 2007-2009 Through Vishwakarma Institute of Management Pune-48. 1 ACKNOWLEDGEMENT It gives me great pleasure to express my sincere gratitude towards all the individuals who have directly or indirectly helped me in completing the project. First of all I am extremely grateful to Mrs. Nihali Mitra, M.D. Pune Stock Exchange Ltd. for providing me an opportunity to work with such an esteemed organization. I feel immense pleasure to thank Mrs. Archana Gorhe, Officiating C.E.O., PSE Securities Ltd. and Ms. Darshana Deshpande, Senior Manager, PSE Securities Ltd. . I would also like to express my sincere thanks to Dr. Sharad L. Joshi, Director, Vishwakarma Institute of Management, Prof. Shailesh Kasande, Executive Director, Vishwakarma Institute of Management and my project guide Dr. Yashwant Vaishampayan for providing valuable guidance and inputs which helped a lot for the completion of project in a true sense. I would also like to thank the whole staff of PSE Securities Ltd., my parents and all my friends for their kind co-operation and support. Prasad Dipak Deshmukh 2 CERTIFICATE This is to certify that Mr. Prasad Dipak Deshmukh has completed the Summer Project Titled “Study of Risk Management in Stock Broking Firm” to my satisfaction and as per the requirements of the two year full-time MBA programme. Project Guide Director Date: 3 INDEX Sr. I Title Executive Summary Page Number 1 II Company Profile 3 III Objectives of the Study 7 IV Research Methodology 8 V Data Analysis 9 VI Findings 60 VII Suggestions and Conclusion 62 VIII Limitations 65 IX Bibliography 66 4 . No. selling or dealing in securities. The study was carried out in PSE Securities Ltd.‟ Risk is the chance of happening of something that may affect the desired results. Indian capital market has got a strong foundation and therefore has gained a confidence of Indian investors as well as Foreign Institutional Investors. regulating or controlling the business of buying. the concept of Risk Management comes into picture. Duration of the Project: 2nd June 2008 to 2nd August 2008. franchisees and investors. 5 . The capital market in India is an emerging market with a great potential.EXECUTIVE SUMMARY Title of the Project: Study of Risk Management in Stock Broking Firm. Therefore. In India there are two Stock Exchanges (National Stock Exchange and Bombay Stock Exchange) through which securities are traded. shows that the project revolves around the risks managed by Stock Brokers while handling their Sub brokers. Pune during the period of 2nd June 2008 to 2nd August 2008. „Study of Risk Management in Stock Broking Firm‟ the title. Stock exchange is a body formed for the purpose of assisting. An investor has to trade in stock market through a registered stock broker.. Risk can be defined as„Risk is the possibility of happening uncertain events. branches. A stock broker is a member of a recognized stock exchange who is permitted to do trades on the floor of the exchange. The risk may cause due to its sub brokers. the brokers are allowed intra day turnover and gross exposure limits. branches. Brokers have to maintain minimum base capital and additional base capital with the exchange. higher the chances of good return and vice versa. risk and return have a direct relationship. To cope up with such events brokers have to collect certain amount of margins and maintain the same with the exchange. every 6 . Also. the risk can be avoided. To manage such risks Value at Risk margin.Risk Management can be defined as„Risk Management is the structured approach towards managing the uncertainties. credit risks. continuous surveillance. financial risks. higher the risk. Further to avoid the unpredictable outcomes arising out of risk. Thus brokers are always exposed to market risks. Thus. In stock broking industry risks are high due to the volatility of the market. Risk and uncertainty go together. Exchanges. Risk can be broadly categorized as Systematic Risks and Unsystematic Risks. Mark to Market margin and extreme loss margin is maintained. reduced or transferred. best possible solution has to be chosen to tackle the risk. However. investor clients etc. However. SEBI and NSCCL have taken steps like KYC.‟ Risk Management involves risk identification and risk assessment. There are uncertainties about payments from clients or from clients to sub brokers and then sub brokers to the broker. mandatory audit etc. liquidity risk and operational risks. The high volatility of the market may cause the clients or sub brokers not to make payments in specified time. Sadashiv Peth. PSE Securities Ltd. COMPANY PROFILE PSE Securities Limited History Pune Stock Exchange Securities Ltd. R.broking firm has Risk Management department. came 7 . 752. is located at Shivleela Chambers. Pune-411030. In PSE Securities Ltd. The company is also a CDSL Depository Participant and it witnessed an increase in the handling of approximately 5600 Beneficiary accounts in the previous year to 8400+ accounts this year. However the management still feels the need to generate more operational income through Brokerage. It commenced Live Trading in the BSE Cash Segment from 15th March 2004 and commenced depository operations with Central Depository Services (I) LTD. are the members of Pune Stock Exchange Ltd. Kumthekar Road. from 16th Dec. member of NSE and BSE and also a Depository Participant of CDSL. is a leading Stock Broking Firm. Founders and Promoters The founders and promoters of PSE Securities Ltd. 2003.. PSE Securities Ltd. there is a surveillance department to deal with the risk management activities. All the members of Pune Stock Exchange Ltd. It was founded in the year 1999 and is a subsidiary company of Pune Stock Exchange Ltd.B. has the largest turnover in the cash market segment in Pune. There are total 152 sub brokers of PSE Securities Ltd.  Motilal Oswal 8 . Arvind R. Shaukat Merchant Mr. Joshi Mr. Rajendra Nahar Chairman & PR Director PR Director PR Director Broker/Member Director Broker/Member Director Nominee Director-Pune Stock Exchange Ltd. only the members of the Pune Stock Exchange Ltd. Board of Directors Dr. According to the Articles of Association of company and SEBI. PSE Securities Ltd. it has to face competition from following organizations. Mahesh Athavale Me. has cash segment membership of the Bombay Stock Exchange and National Stock Exchange and also is a depository participant of Central Depository Services Limited. Sharad L.together and formed PSE Securities Ltd. are the members of Pune Stock Exchange Ltd. which is the parent company can register as sub broker of PSE Securities Ltd. Shailendra Shah Mr. Hence all the present sub brokers of PSE Securities Ltd. Competitors Though the company deals in the cash segment only. Products The main business of the company is to provide a platform for trading in securities market with the help of Stock Broking and Depository Services. Shah Mr. The Net profit for the year was Rs. 7451 Crores (Rs.04 Lacs. The paid up capital is Rs.7. 2885 Crores was delivery turnover and Rs.000 divided into 390 equity shares or Rs. during the year was Rs.000 each. 4556 was non delivery turnover). 401.       India Infoline Sharekhan Anand Rathi Indiabulls Religare Angel Broking Karvy Consultancy Financial Data The Authorized Capital of the company is Rs.06.52 Lacs by way of interest on fixed deposits and short term deployment of funds.80 Lacs of which Rs.00.7. 367. 494.00.000 each. During the Financial Year 2007 – 2008. 2. the total turnover of dealings through BSE and NSE was Rs. 2.32 Lacs has been earned by way of Brokerage and Rs.80. The Profit before Taxes of PSE Securities Ltd.000 divided into 353 equity shares or Rs. 9 .00.00. 67. 10 .Organization Chart New Projects This year the company proposes to issue 25 equity shares to persons other than existing share holders thus increase the number of sub brokers from 152 to 177. In the securities market the liquidity risks. Therefore.OBJECTIVES OF THE STUDY Background The stock prices in Indian capital market change very rapidly. the brokers are always at a risk that investors may not pay in the securities or funds due to increase or decrease in the prices of shares. To find out the risks involved in stock broking firm. which monitors the day to day activities of its sub brokers and investors. To study the measures to reduce the risk. this study is carried out to understand the measures taken to reduce the risks at brokers‟ end and the objectives of the study are as follows. Thus. It results into high volatility in the market. To get familiar with the working of broking firm. Need Therefore. to tackle these situations need for risk management in stock broking firm arises. financial risks and operational risks also create hurdles in the smooth running of broking firm. 11 . To reduce such risks broking firms have risk management or surveillance departments.      Introduction to Capital Market. To understand the concept and types of risk. 12 . » » » » Discussion with Surveillance department officers. the necessary inputs taken were primary as well as secondary. The primary data collection and secondary data collection form an integral part of the study. » » » Books related to risk management and capital market.  Primary Data Primary data is the one which is collected specifically for the purpose of the project. Discussion with employees of the organization.RESEARCH METHODOLOGY During the project. Websites related to risk management and stock market. Discussion with sub brokers. However. it plays a significant role in the project. For this study the secondary data was collected from the following sources. and can be obtained from various people working in the organization. Discussion with manager. For this study the primary data was collected from following sources. It is a data collected by somebody else for their own purposes. Magazines related to the stock market.  Secondary Data Secondary data is the one which is not specifically collected for a certain work. They are explained as below. provident funds and other securities. It is not that the users and suppliers of funds meet each other and exchange funds for securities. bank accounts. debentures. pension funds.DATA ANALYSIS Capital Markets The capital markets deal in financial assets. They provide channels for reallocation of savings to investments and entrepreneurship and thereby decouple these two activities. Transfer of resources from those with idle resources to others who have a productive need for them is perhaps most efficiently achieved through the Capital Markets. In this way. Thus. A capital market deals in financial assets. the Capital market moves the money of investors who have a surplus to the entrepreneurs who needs it with the help of intermediaries. which comprise shares. but by the economy‟s abilities to invest and save respectively. the capital funds comprising of both equity and debt are issued and traded. Capital market is a market for long-term debt and equity shares. The amount of funds supplied by the supplier may not be the amount needed by the user. the savers and investors are not constrained by their individual abilities. As a result. 13 . mutual funds. which inevitably enhances savings and investment in the economy. there are intermediaries who may act as agents to match the needs of users and suppliers of funds for a commission. excluding coins and currency. insurance policies. In this market. It is difficult to accomplish such double coincidence of wants. investor protection and regulations were some of the key activities which reflected the growth of the Indian Capital Market. With the Dematerialization of shares and introduction of SEBI (Securities and Exchange Board of India) Indian Capital market provided protection to its investors. Capital markets are evaluated while judging the performance of any economy. With the liberal policy of India and investments of Foreign Institutional Investors. The tail of Twentieth Century made the Indian Capital Market change drastically. The East India Company was perhaps the most dominant and powerful institution in those days and business in its loan securities used to be transacted in an unorganized for at Bombay and Calcutta in early Nineteenth century. Its history dates back to nearly 200 years ago. Later on the business on corporate stocks and shares in bank and cotton presses took place in Bombay and gradually the number of companies listed increased from 1125 in 1946 to 8593 in 1995. strict surveillance. depository system. Indian Capital Market – An Overview Indian Stock Markets are one of the oldest in Asia. On line trading. Every decision or event related to economy of the country is reflected and influenced by the capital market thus.The capital market in a country is very valuable indicator of its soundness. Indian Market started prospering. the confidence of investors is increased to a great extent. it carries a huge weightage for the economic development of any country. During 1990‟s with the introduction of computers. transparency. In 14 . e. and to protect the interests of investors. the Act was repealed in May 1992 paving way for market determined allocation of resources. It has powers to register and regulate all market intermediaries and also to penalize them in case of violations of the provisions of the Act. 1992 was enacted in establish SEBI with statutory powers for (a) protecting the interests of investors in securities. any firm wishing to issue securities had to obtain approval from the Central Government. SEBI Act. Under the Act. audits and inspection of all concerned and adjudicate offences under the Act. It was retained with some changes as a means of controlling the raising of capital by companies and to ensure that national resources were channeled into proper lines. and (c) regulating the securities market. type and price of the issue. It can conduct enquiries.January 2008 the BSE Sensex touched the 21000 points. To ensure effective regulation of the market. SEBI Act (Securities and Exchange Board of India Act). i. As a part of the liberalization process. Market Segments A) Primary Market 15 .. for desirable purposes to serve goals and priorities of the government. (b) promoting the development of the securities market. SEBI has full autonomy and authority to regulate and develop and orderly securities market. 1992 The Act had its origin during the war in 1943 when the objective was to channel resources to support the war effort. which is the highest up till now. which also determined the amount. This market comprises of equity markets and the debt markets. In this market the securities are offered for subscription for the purpose of raising capital or fund. The entrepreneurs or corporates as well as Government may issue the securities at face value. Stock Exchange 16 . Government as well as corporates. debt etc. For the management of the company. secondary equity markets serve as a monitoring and control conduit-by facilitating valueenhancing control activities. The investors and the company come into direct contact in the primary market. to raise resources to meet their requirements of investment and/or discharge some obligation. (B) Secondary Market Secondary Market refers to a market where securities are traded after being initially offered to public in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market.The primary market provides the channel for sale of new securities. They may issue the securities in domestic and/or international market. Primary market provides opportunity to issuers of securities. and aggregating information (via price discovery) that guides management decisions. For the general investor. or at as discount / premium and these securities may take a variety of forms such as equity. the secondary market provides an efficient platform for trading of securities. enabling implementation of incentive-based management contracts. securities are traded or exchanged in secondary market. to 03:30 P. under this Act. and has witnessed several innovations in products & services viz. clearing and settlement mechanism. trading in securities permitted to be traded would be in normal trading hours (09:55 A. Chennai etc. professionalism of trading members. screen based trading. debentures. 25 crores by leading institutions to provide a modern. securities trading are regulated by the Central Govt. fine-tuned risk management systems. NSE has played a catalytic role in reforming the Indian securities market in terms of microstructure. The market today uses state-of-art information technology to provide an efficient and transparent trading.As seen earlier. market practices and trading volumes. 1956. Under the Securities Contract Regulation Act. The Exchange has brought about unparalleled transparency. National Stock Exchange (NSE) The National Stock Exchange (NSE) is India‟s leading stock exchange covering various cities and towns across the country. major Stock Exchanges are Bombay. bonds etc.M on working days). Delhi. shares. Securities are defined as any monetary claims and include stock. demutualization of stock exchange governance. fully automated screen-based trading system with national reach. As per the Act. and such trading can take place only in Stock Exchanges recognized by the Govt. Of these.M. emergence of clearing corporations to assume counter party risks. At present there are 23 such recognized Stock Exchanges in India. NSE was set up in November 1992 with an equity capital of Rs. market of debt and derivative instruments and intensive use of information technology. safety and market integrity and its index NIFTY has got worldwide recognition. Kolkata. A Stock Exchange is an organized platform where securities are traded or exchanged. IDBI & other 17 . speed & efficiency. Calcutta Stock Exchange (CSE) came into existence. The systems and processes of the Exchange are designed to safeguard market integrity and enhance transparency in operations. Regional Stock Exchanges (RSEs) There are 23 stock exchanges in India. In the year 1908. The surveillance and clearing and settlement functions of the Exchange are ISO 9001:2000 certified. the Ahmedabad Stock Exchange (ASE) was established. It started operation in Wholesale debt market in June 1994 & in equity. is tracked worldwide. The Exchange provides an efficient and transparent market for trading in equity. The BSE On Line Trading System (BOLT) is a proprietary system of the Exchange and is BS 7799-2-2002 certified. Bombay Stock Exchange (BSE) Bombay Stock Exchange Limited is the oldest stock exchange in Asia with a rich heritage. debt instruments and derivatives. 18 . 1956. Among them two are national level stock exchanges namely Bombay Stock Exchange (BSE) and National Stock Exchange of India (NSE). 25 cores set up NSE. when the first RSE. SENSEX. it was established as „The Native Share & Stock Brokers Association‟ in 1875. The Regional Stock Exchanges started clustering from the year 1894. Popularly known as „BSE‟. the second in the series. The Exchange has a nation-wide reach with a presence in 417 cities and towns of India.financial institution with paid equity capital of Rs. The Exchange‟s pivotal and pre-eminent role in the development of the Indian capital market is widely recognized and its index. It is the first stock exchange in country to obtain permanent recognition in 1956 from the Government of India under the Securities Contracts (Regulation) Act. in Nov 1994. The rest 21 are Regional Stock Exchanges (RSE). Ahmedabad.During the early sixties. selling or dealing in securities through such stock broker. unless he or she holds a certificate of registration granted by SEBI. sell or deal in securities. The broker then trades in securities on behalf of its investors. A sub broker may take the form of 19 . a stock broker means a member of a recognized stock exchange. A broker is an intermediary who arranges to buy and sell securities on behalf of clients (the buyer and the seller). 1980s was the turning point and many RSEs were incorporated. No stockbroker is allowed to buy. who is permitted to do trades on the floor of the exchange. No investor can invest in the stock market directly. there were only few recognized RSEs in India namely Calcutta. unless he or she holds a certificate of registration granted by SEBI. He acts on behalf of a stock broker as an agent or otherwise for assisting the investors for buying. Delhi. Madras. they have to register themselves with a registered broker of recognized stock exchange. The number remained unchanged for the next two decades. According to Rule 2 (e) of SEBI (Stock Brokers and Sub brokers) Rules. No sub broker is allowed to buy. sell or deal in securities. 1992. Hyderabad and Indore. The latest is Coimbatore Stock Exchange and Meerut Stock Exchange. Stock Broker The Stock Broker is a member of a recognized stock exchange. Sub broker A Sub broker is a person who intermediates between investors and stock brokers. Presently there are approximately 390 DPs are registered with SEBI. 1. National Securities Depository Limited (NSDL) 2. Stock brokers of the recognized stock exchange are permitted to transact with sub brokers. Depositories in India There are two depositories in India.a sole proprietorship. a partnership firm or a company. A DP can offer depository services only after it gets proper registration from SEBI. The fear of loosing of securities is removed through depository as it facilitates safekeeping of shares. Dematerialization 20 . It also provides services related to transactions in securities. Depository A depository is an organization which holds securities of investor in electronic form at the request of the investor through a registered Depository Participant. Central Depository Services Limited (CDSL) Depository Participant A Depository Participant (DP) is an agent of the depository through which it interfaces with the investor. Depository transfers securities between accounts on the instructions given by the account holder. To avail the services of a depository an investor has to open an account with any of the depository participant of any depository. A Depository can be compared with a bank. like wise a DP may be compared with a branch of a bank. It transfers the ownership of the securities without having to handle the securities. Working of Stock Broking Firm Stock Broker As seen earlier. No stockbroker is allowed to buy.Dematerialization is the process by which physical certificates of an investor are converted to an equivalent number of securities in electronic form and credited to the investor‟s account with his Depository Participant (DP). a Stock Broker means a registered member of a recognized stock exchange. The constitution of a broking firm may be a Proprietary Concern. 1992. According to Rule 2 (e) of SEBI (Stock Brokers and Sub brokers) Rules. unless he or she holds a certificate of registration granted by SEBI. Departments in Stock Broking Firm (A) Central Depository Services Ltd (CDSL) Department CDSL Department Demat Account Opening Dematerialization & Rematerialization Transmission & Nomination Settlement of Trade 21 . a Partnership firm or a Corporate. A broker is an intermediary who arranges to buy and sell securities on behalf of clients (the buyer and the seller). sell or deal in securities. 22 . An investor has to first open an account with the DP in order to hold the securities in a dematerialized form. An investor can open an account with any DP of CDSL or NSDL.   It eliminates thefts. and subsequent misuse of the certificates. registration of power of attorney. can be effected across companies by one single instruction to the DP. deletion of deceased name etc. The CDSL department also converts the physical shares into demat form and also shares in demat form into physical share certificate. Therefore heavy paperwork and headache of signing multiple transfer forms is eliminated. or National Securities Depository Limited. address.   No stamp duty is levied on transfer of securities held in demat form. Change of name. To hold the securities an investor has to open the demat account with any of the DP of either Central Depository Services Ltd. Any number of securities can be transferred and delivered with one delivery order. delays. Importance of Demat Account  Demat account is a safe and convenient way to hold the securities as compared to holding them in physical form. (1) Demat Account Opening The CDSL department performs the basic function of demat account opening. deface. It is mandatory of open a demat account with any of the DP in order to hold the securities in an electronic form.The CDSL department performs the above stated functions. The activities like transmission and nomination and trade settlement are also done at CDSL department. To convert the physical shares certificates in the dematerialized form. address proof. Depository credits the dematerialized securities to the beneficiary account of the investor and intimates the DP electronically. dematerialization of the concerned securities is electronically confirmed to the Depository. an investor has to submit the DRF (Dematerialization Request Form) along with the shares certificate. cheque and two latest photographs. certificate number. Each security is identified in depository system by ISIN (International Securities Identification number). The DP issues a statement of transaction to the client. Shares in demat form do not bear any distinguishable feature like distinctive number. DP enters the DRF in its system and dispatches the Physical certificates along with the DRF to the R&T agent. on receiving the physical documents and the electronic request verifies them. (b) Rematerialization 23 . R&T agent.To open a demat account client has to submit identity proof. statement of bank account. Absence of any of the above document create hurdles in the procedure of demat account opening. Once the R&T agent is satisfied. (2) Dematerialization and Rematerialization (a) Dematerialization Dematerialization is the process in which the physical form of holding securities is replaced with electronic (book-entry) form of holding. PAN Card. and marriage etc. If the securities are held in physical form. R & T agent scrutinizes of shares and after being satisfied a certificate is issued to respective DP which is later passed on to the client. If the securities are held in the depository system. RRF is then entered in the system. the documents have to be sent to the company for effective transmission of shares. The person on whom the shares devolve has to prove his entitlement by submitting appropriate documents and seek transmission. succession. Transfer of shares relates to a voluntary act of the shareholder while Transmission is brought about by the operation of law. inheritance. DP checks all the details of RRF and also verifies that client has a sufficient balance of shares in his account. It refers to the process of converting the shares held in electronic form with a DP into the physical shares certificate.Rematerialization is exactly opposite of dematerialization. The word “Transmission” means devolution of title to shares. DP sends it to the R & T agent for further procedure. documents have to be submitted to the DP. To convert the shares in dematerialized form into physical form. (3) Transmission and Nomination (a) Transmission The Companies Act 1956 distinguishes Transmission of shares from transfer of shares. 24 . Under this process the depository account of a beneficial owner is debited for the securities sought to be rematerialized and physical share certificates for the equivalent number of securities issued. Such kind of transmission takes place due to devolution by death. a client has to submit the RRF (Rematerialization Request Form) with its DP. bankruptcy. Under the provision the security holder can nominate a person in whom the shares. in the event of original investor‟s death. Body Corporate. all the joint holders are required to sign the nomination form. debentures. A holder can even nominate a minor.(b) Nomination The Companies (Amendment) Act 1999 has introduced provisions for nomination in respect of shares. (4) Settlement of Trade 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. Fixed Deposits etc. However. Transfer of securities from one account to another may be done for any of the following purposes. Transfer arising out of transmission and account closure. Debentures. If the shares are held jointly. (B) Compliance Department Compliance Department 25 . or Power of Attorney holder cannot be appointed as nominee. represented by one of the parents or guardian. Kartas‟ of Hindu Undivided Family.    Transfer due to a transaction done on a person-to-person basis. Trusts. Societies. Partnership Firms. Transfer arising out of transaction done on a stock exchange. bonds or deposits would vest. Partnership firm Sole Proprietor The main function of the compliance department is to open a trading account of clients and registration of sub brokers and franchisees. An individual client has to submit identity proof. An application for the grant of certificate shall be made in form B. Of Client Reg. Partnership Firm or Sole Proprietor the documents required are application form. The compliance department has to comply with the rules and regulations of SEBI while opening account of clients and registering the sub brokers. In case of non individuals Joint Stock Company. While registering for sub broker compliance department has to comply with the criteria laid down by the SEBI. PAN card. of Sub Broker Individual Non-individual Joint Stock Co. broker client agreement on stamp paper along with application form. Such account is opened with the registered member broker.Reg. he should not be convicted to any offence involving fraud or dishonesty etc. he should have at least passed HSC exam. application shall be accompanied by a 26 . Such account enables the client to trade in the securities held in the demat account. The applicant should not be less than 21 years of age. a trading account is opened to trade into securities. broker client agreement. As a client has to open demat account to hold the securities. certified copy of resolution to open account. address proof. bank certifying letter whichever is applicable. certified copy of Articles and Memorandum of Association. Generally. buying and selling of securities on behalf of its clients is performed by the Dealing Department.e. The stock exchange on receipt of application shall verify the information contained and then shall also certify that the applicant is eligible for registration.recommendation letter from a stock broker of recognized stock exchange with whom he is affiliated to along with two references including one from his banker. the ODIN software is used for such purposes. (C) Dealing Department Dealing Department Buying Securities Selling Securities Entering Orders Order Modification Order Cancellation Order Matching The most basic and important function of stock broking firm i. The functions carried out at dealing department are explained below in detail. The clients have to inform the dealer to buy or sell securities who then enters the order in the system. Dealer is the person who performs the function of buying and selling of securities of securities for clients. The employees who carry out this function are known as dealers. 27 . quantity and price. If it does not find a match. Order Cancellation Order cancellation functionality can be performed only for orders which have not been fully or partially executed (for the unexecuted part of partially traded orders only) and only during the market hours. series.Entering Order The trading member can enter orders in the normal market during the trading hours. it tries to find out on the other side of the books if it finds the match. The best sell order is the order with lowest price and best buy order is the order with highest price. symbol. the branch order values limit for the branch and get adjusted automatically. the order becomes passive order and appears in the order book. When an order enters the trading system it is an active order. Order Modification All orders can be modified in the system till the time they do not get executed and only during the market hours. Once an order is modified. The unmatched orders are queued in the system by the following priority. (D) Settlement Department Settlement Department 28 . trade is generated. Order Matching The buy and sell orders are matched on book type. The clearing banks and depositories provide the necessary interface between the custodians and clearing members (who clear for trading members or their own transactions) for settlement of funds/securities obligation of trading members. The rolling settlement has started in T+5 bases in India. If they fail to do so the securities go for auction. 29 . now it is T+2. the National Securities Clearing Corporation LTD (NSCCL) determines the funds/securities obligation of the trading members and ensures that trading members meet their obligations. This settling is done under „T+2‟ rolling settlement system. Pay Out Of Securities and Funds NSCCL sends electronic instructions to the depositories/clearing banks to release pay out of securities/funds. they make available required securities in designated accounts with the depositories by the prescribed pay in time. NSE/BSE provides a platform for trading to its trading members. Rolling Settlement 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 working days after trade date in which settlement takes place.e. This settlement is based on rolling system which is T+2 days. settling of trades that takes place every day. These securities/funds reach to the respective members account. Pay In Of Securities and Funds The members bring in their securities/funds to the NSCCL.Pay In Of Securities Pay Out Of Securities Pay In Of Funds Pay Out Of Funds Settlement department performs the back office function i. 90%. and 100%) when the members approach their 30 . The members have to pay Base Minimum Capital and Additional Base Capital. Base minimum capital of the member is taken to determine the member‟s intra-day trading limit and/or gross exposure limit only whereas the amount provided as additional capital is allowed to be utilized towards margin payment if not used up for taking exposure/turnover. in order to keep a continuous check on market risk management department performs the following functions. undertakes on-line monitoring of members‟ positions and exposure with the market collects margins from members and automatically disables members if the limits are breached. The NSCCL ensures that trading members‟ obligations are commensurate with their net worth. It monitors the track record and performance of members and their net worth. Capital Adequacy The stock exchanges mention their own capital adequacy requirements. On-line Monitoring NSCCL has put in place an online monitoring and surveillance system whereby exposure of the members is monitored on a real time basis. 85%. A system of alerts has been built in so that both the member and NSCCL are alerted as per pre-set levels (reaching 70%.(E) Risk Management Department / Surveillance Department Risk Management Department Capital Adequacy On Line Monitoring Off Line Monitoring Margin Requirements Circuit Filters A sound risk management system is integral to an efficient clearing and settlement system. Thus. Margins are computed at client level.based Margin (VaR Margin) and Mark to Market margin (MTM Margin). These breakers are triggered by movement of either S&P CNX Nifty or Sensex whichever is breached earlier. Margin Requirements As per SEBI directive.allowable limits. Generally. and 20%. As an additional measure of safety. It also verifies if investor interests are being compromised in the conduct of business by the members. all stock exchanges have imposed stringent margin requirements as a part of their risk containment measures. Off-line Monitoring 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. if required and take pro-active action. inspection of more members than the regulatory requirement is undertaken every year. These circuit breakers bring about a coordinated trading halt in all equity derivatives market nationwide. bye laws and regulations of the exchange. The daily margin in rolling settlement comprises of Value at Risk . It enables to further check the micro-details of members‟ positions. Circuit Filters An index based market wide circuit breakers system applies at three stages of the index movement either way at 10%. in T+2 rolling settlement. 15%. individual scrip – wise price bands of 20% for all scrips and 10% for scrips for which derivative 31 . Based on this information margin is computed at the client level which will be payable by the trading member on T+1 basis. A member entering an order needs to enter the client code. whether in stock. All investments are risky. risk has evolved along with man. Risk has been encountered primarily in his physical environment. capital market. This risk was mitigated by the discovery of fire. have been imposed. The risk can also be explained as a probability that some event will cause an undesirable outcome on the financial health of your business and/or other business/family goals. later on in his social environment. Risk can be defined as„Risk is the possibility of happening uncertain events. It is an integral part of the evolution of man. financial sector. Whether it is walking on the road or flying in the plane. real 32 . Here also risk is mitigated not eliminated. Risk Risk has been known to man ever since he first faced adversity. Risk exists if there is something you don‟t want to happen – having a chance to happen. banking.‟ Risk is the chance of happening of something that may affect the desired results. With time. From that time to the twenty first century man has faced n number of risks. buying the video game or a bunglow every person is exposed to the risk involved in the situation. The main risk man faced was an attack by animals.products are available or those included in indices on which derivative are available. In the same way risk is involved in the investments also. the degree of risk plays a vital role in any kind of investment. higher is the possibility of better returns and vice versa. Thus. (a) Market Risk This arises out of changes in demand and supply pressures in the markets. time frame or the issuer of the security etc. The market risks also arise due to ups and downs in the prices of securities. investments instrument. The degree of risk however varies on the basis of the features of the assets. arising out of the market. The examples of systematic risk are as follows. However. 33 . Higher the risk. gold etc. and make the market more volatile. nature of the industry and the state of the economy and a host of other factors. the mode of investment. which is not controllable.estate. The economic changes affect the prices of securities to go up or down. Risk Systematic Risk Unsystematic Risk (1) Systematic Risk Systematic risks are out of external and uncontrollable factors. bullion. following the changing flow of information or expectations. The totality of investor perception and subjective factors influence the events in the market which are unpredictable and give rise to risk. the risk and return goes hand in hand. Types of Risk Risks are broadly divided into 2 categories. The examples of unsystematic risk are as follows. These interest rates depend on nature of instruments. input supplies. The element of purchasing power risk is inherent in all investments and cannot be controlled. profits etc. The cost of funds borrowed by companies or stockbrokers depends on interest rates. sales. (b) Financial Risk 34 . maturity of the periods and the creditworthiness of the issuer of securities. policy or strategies of competitors etc. The return expected by investors will change due to change in real value of return. loans etc. bonds. lower margins. wage rises and profit squeezing etc. It is sometimes external to company due to changes in Govt. internal to the issuer of the securities or companies.(b) Interest Rate Risk The return on an investment depends on the interest rate promised on it and changes in market rates of interest from time to time. (c) Purchasing Power Risk Inflation or rise in prices lead to rise in costs of production. income. It may internal due to labour problems. fall in production etc. and strength of competitors. while in turn depend on the market conditions for the product mix.. raw material problems. (a) Business Risk Business risk relates to the variability of the business. stocks. (2) Unsystematic Risk Unsystematic risks emerge out of the known and controllable factors.. higher is the possibility of better returns and lower the risk. may get bankrupt in short span of time. The borrower. adopted by the company. or delay the payments due. may be due to mistakes of management. and their financial position play a big role on how much risk they can comfortably bear. in extreme cases. (c) Default or Insolvency Risk The borrower or issuer of securities may become insolvent or may default. Investors‟ personality. lower is the possibility of better returns. The diagram given below explains the relationship between the risk and return. Return The risk and return go hand in hand. As the risk increases the probability of getting higher returns also increases and vice versa. 35 . lifestyle. Risk vs. Higher the risk. high leverage leading to larger debt servicing problems or short-term liquidity problems due to bad debts. the investor may get no return or negative returns. delayed receivables and fall in current assets or rise in current liabilities. The risk/return tradeoff is the balance. Proper financial planning and other financial adjustments can be used to correct this risk and as such it is controllable. It is important 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. They have a direct relationship.Financial risk relates to the method of financing. such as interest installments or principal repayments. an investor must decide on between the desires for the lowest possible risk for the highest possible returns. In such cases. * Equity * Mutual Funds Rewards * Debentures * Fixed Deposits * Post Office Certificates * Bank Deposits * Insurance Schemes Risk Taken By Investor 36 . whereas there is very high risk in equity.RISK/ RETURN TRADEOFF Returns Low Risk Low Return Higher Risk High Return Risk Different securities have different degrees of risk. Insurance is the safest mode of investment. The below diagram shows the degree of risk contained in various investments. foreign exchange rate. The value of investments may decline over a given time period simply because of 37 . clients etc. The various risks borne by a broker can be classified as under. commodity prices and equity prices.Risks involved in a Stock Broking Firm A stock broker has to deal with various risks while dealing with its sub brokers. These risks arise due to adverse market rate movements i.e. interest rates. Risks in broking firms Market Risks Financial Risks Credit Risks Liquidity Risks Operational Risks (1) Market Risks Market risks are the risks which cause due to the high volatility of market and value of scrips. Due to the high volatility of the market broker is always exposed to the risks. Some assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company). Credit risk is the risk of loss due to a debtor's non-payment of a loan or non fulfillment of terms and conditions of contract. Proper asset allocation and diversification can protect against market risk. Financial risk in respect of broking firm can be of two types firstly loss of income i. It has a risk that it will go out of funds because of non payment by the clients. sub brokers etc. 38 . (4) Liquidity Risk Liquidity risk is a risk which arises from the difficulty of selling an asset and realizing the money of it.economic changes or other events that impact large portions of the market. Credit risk is often due to bankruptcy or insolvency of the counter party which results in non payment of dues. brokerage secondly loss of capital. while other assets are highly illiquid and have high liquidity risk (such as a house). An investment may sometimes need to be sold quickly. (2) Financial Risks Financial risk is the risk that a company will not have adequate cash flow to meet the financial obligations. thus causing the other party to suffer a financial loss. Financial risk means fear of loss of money.e. an insufficient secondary market may prevent the liquidation or limit the funds that can be generated from the asset. Market liquidity is the risk that a financial instrument cannot be sold quickly at a price. (3) Credit Risks Credit risk is the risk that the counter party of financial transaction will fail to perform according to the terms and conditions of the contract. Unfortunately. which equates to their market value. which is the biggest risk faced by a broking firm. Operational Risks 39 . which are found almost in every organization. Such events may cause an organization certain problems like Direct financial losses. it is a very broad concept including fraud risks. In stock broking firms the operational risks are found at various levels of departments. loss of sales.  Direct financial losses. All the organizations face the risks that their activities and processes may be disrupted unexpectedly or fail and this will stop the functioning of organization. attributable to an absence of income (e. direct fees or commission)   Statutory or regulatory penalties resulting to revocation of licenses. penalty interest payments or restitution loss). physical or environmental risks. being unable to trade or because of processing delays. omission or failure of internal control system. which arise from failing to meet an obligation (e. etc. arising from adverse publicity.(5) Operational Risks Operational risks are explained as Risk of loss arising due to procedure errors.‟ An operational risk is a risk arising from execution of a company's business functions. These risks are defined as „The risk of loss resulting from inadequate or failed internal processes. transaction fees. backlogs.g. people and systems or from external events. legal risks. Operational risks are very common risks. They are as follows. Opportunity costs.g. As such. and poor customer service delivery or poor product or service quality. Errors in CDSL department will directly affect the clients and this may cause a bad client broker relationship. If services are not provided properly to the clients. Failures in maintaining records for demat and remat account. Absence of bank certification. Absence of identity proof. it will result in the problems with recording the transaction. Punching error.      Effects CDSL department directly deals with the clients. The errors in entering the details of DRF and RRF will cause problems to security holder. Failure in receipt of transaction slip. Non-compliance of various agreements and forms.      Non-eligibility of the applicant. (b) Compliance Department Following are the risks involved in compliance department.CDSL Department Compliance Department Dealing Department Settlement Department Risk Management Department (a) CDSL Department Following are the risks involved in CDSL department. 40 . If transaction slip is not received. it may mar the reputation of the broker. Absence of reference letter from chartered accountant. Networking problem with the exchange. Wrong entry of DRF and RRF. instead of buy order sell order is given. If the trading is done from wrong client account i. such kinds of events result in loss of money as well as loss of reputation for a broker. If such things happen on regular basis the client may change the broker and it will create problems for broker in the long term. Therefore compliance department must verify all the documents while opening the trading accounts of investors and approving to new sub brokers. B and Mr. if buy order is put from Mr. A in place of Mr.e. Trading in wrong scrip i.e. On the event of non compliance of documents a broker can be penalized or terminated. This will result in the bad publicity and loss of clients. Placing of wrong quantity. B does not give a cheque a broker has to face the loss from is own pocket. 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.e.    Placing of wrong order i. (c) Dealing Department Following are the risks involved in dealing department. buying and selling from wrong clients account. instead of trading in L & T. If a wrong person is appointed as sub broker it may mar the reputation of the broker. Effects Compliance department is responsible for the acceptance to the new clients and sub brokers. Also the compliance department has to verify all the details about person applying for the sub broker ship. Thus.  Effects In all the above cases mentioned a broker has to face financial loss. Trading done from wrong account i. trading is done in ABB 41 .e. Failure in collecting margins. Failure in preparing bills.      Failure in calculating the limits and margins. Failure in sending daily reports to franchisee and sub broker. failure in preparing pay in and pay out of slips can not only create chaos in a broking firm. Failure of client in Pay in of shares or funds. it can result in huge financial losses to the broker and a bad image in the minds of clients. Payout of shares to wrong account. (e) Risk Management Department Following are the risks involved in risk management department.(d) Settlement Department Following are the risks involved in settlement department.         Effects The work of settlement department is of utmost importance and full of responsibility. Failure in deciding brokerage slab for a client. Failure in sending confirmation of account opening to the client. Failure in sending contracts. Wrong payout of shares. wrong payout of funds. 42 . Failures in preparing pay in and pay out slips. Wrong preparation of statement of funds. All the good work done by different departments can be nullified by an incompetent or casual work of settlement department. failure in preparing bills in time. Giving wrong limits to the client. Failure in sending daily reports to management. On the contrary giving wrong limits have the same effect.Effects The risk management department directly comes into contact with sub brokers and franchisees. the risk of losing a job. If the margins are not collected according to SEBI guidelines it can result in financial penalty.the risk of house fire. the risk to the farmer who plants a crop that will have an uncertain yield and be sold at an uncertain price in several months time. and so on. and mitigation of risk using managerial resources. If risk management department 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. a sequence of human activities including: risk assessment. suspension or termination of broker ship. Failure in collecting margins attracts two types of risks regulatory and financial. The complexity of our modern lives and the numerous decisions we are able to take are only made possible by our ability to manage risks . Ways to deal with Risk Ways to deal with Risk Avoid Retain Reduce Transfer 43 . the risk to the investor in the stock market. strategies development to manage it. the risk to the entrepreneur who invests in a business. Risk Management Risk management is a structured approach to managing uncertainty related to a threat. the company can concentrate more on business development without worrying much about the manufacturing process. (c) Reduce the Risk Reduction in risk involves methods that reduce the severity of the loss or the likelihood of the loss from occurring. 44 . All risks that are not avoided or transferred are retained by default. Insurance is one type of risk transfer which uses contracts. This way. while handling the business management itself. Avoidance may seem the answer to all risks. (d) Transfer the Risk Risk transference causes another party to accept the risk. Outsourcing could be an example of risk reduction. but avoiding risks also means losing out on the potential gain that accepting the risk may have allowed. a company may outsource its manufacturing of hard goods to another company. For example.(a) Avoid the Risk Avoidance of risk Includes not performing an activity that could carry risk. (b) Retain the Risk Retention of risk involves accepting the loss when it occurs. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits. This includes risks that are so large that they either cannot be insured against or the premiums would be infeasible. typically by contract or hedging. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. and prioritize them. plan for the management of risk Planning is done according to whether the risk is to be avoided. Evaluate impact.  Analyze the risk Transform the risks data into decision-making information. reduced or transferred. Such transference of risk may include certain cost like insurance premium. current risks.Liability among construction or other contractors is very often transferred this way. Process of Risk Management  Identify the areas of risk Search for and locate the areas where there can be risk before they become the actual problems for the organization. probability and time frame of it and classify the risks.  Communicate Communicate the internal and external information and feedback to the project on the risk activities.  Control Find out any deviations or variance and correct for the same during the execution of risk mitigation plan. 45 .  Plan On the basis of the data evaluated. and emerging risks. retained. SEBI has also suggested certain measures to manage the risks borne by the brokers. This uncertainty leading to risk is sought to be addressed by margining systems by stock markets. National Stock Exchange introduced for the first time in India. which is constantly upgraded to pre-empt market failures. risk management in stock broking firms was felt most essential by the exchanges and its regulatory bodies. 46 . risk containment measures that were common internationally but were absent from the Indian Securities Market. Margins There is a lot of uncertainty in the movement of share prices. Since it poses maximum risk in the financial markets.Measures to reduce the risk Stock broking firm is highly exposed to the financial risks. NSCCL has also put in place a comprehensive risk management system. These measures were taken to reduce the risks at brokers‟ end. Stock exchange in turn collects similar amount from the broker upon execution of the order.1. purchases 1000 shares of „ABC‟ company at Rs. Broker.00. As an advance for buying the shares.100 on July 1. that is. has to give this money to stock exchange on July 3. 2008.000 (1000 x 100) to his broker on or before July 2. in turn. 2008. For every buyer there is a seller and if the buyer does not bring the money. There is always a small chance that the investor may not be able to bring the required money by required date. For the margin purposes. Calculate the daily returns. use „LN‟ (natural log) function in excel. investor is required to pay a certain portion (margin) of the total amount of Rs.00. seller may not get the money. Volatility has different definitions and therefore different people compute it differently. First put down close prices of a share for the last six months in a column of the excel sheet. Margin is levied on the seller also to ensure that he gives the shares sold to the broker who in turn gives it to the stock exchange.Suppose an investor. Investor has to give the purchase amount of Rs. It is important to understand the meaning of volatility a little more closely because it has a major bearing on how margins are computed. Use the formula LN (today‟s close price / yesterday‟s close price) in the next column for 47 . let us compute volatility based on close prices of a share over last 6 months. 2008. Volatility Volatility essentially refers to uncertainty arising out of price changes of shares. Since it is based on historical data let us call it „historical volatility‟. This initial token payment is called margin.1.000 to the broker at the time of placing the buy order. The historical volatility can be easily calculated using an excel sheet. July-08 7-July-08 8. Lower volatility means that a security‟s value may not change as dramatically.41% 1.21% 0.52% -0. Go to the end of the second column (after the last value) and use the excel function „STDEV‟ (available under statistical formulas) to calculate the Standard Deviation of returns computed as above.40% 1.83% -3.20% -0.52% 0.38% -4.63% 0.24% 0.51% 1.59% 1.45% 1.83% 5.20% Date 1-July-08 2-July-08 3-July-08 4-July-08 5-July-08 6.05% 0.80% 1.20% 0.31% -3.51% -5.calculating daily returns for all the days.78% Daily LN returns Closing Daily price of LN shares Returns of Y 2420 2480 2515 2550 2565 2592 2614 2635 2667 2686 2708 2725 2742 2.77% -5.85% 0.82% 0.62% Closing Daily price of LN share Returns of Z 2510 2515 2520 2512 2508 2514 2523 2510 2505 2515 2502 2510 2515 0. The calculated standard deviation expressed as percentage is the „historical volatility‟ of the share for the six months period.40% -0.36% -0.70% -0.32% 0. Closing price of shares of X 2800 2850 2700 2750 2900 2800 2650 2700 2750 2650 2640 2520 2670 1.July-08 9-July-08 10-July-08 11-July-08 12-July-08 13-July-08 48 .20% 0.71% 0. Higher volatility means the price of the security may change dramatically over a short time period in either direction.16% 0.32% -0.38% 0.87% 1.65% 5. 14-July-08 15-July-08 Volatility 2720 2790 1.86% 2.54% 3.85% 2758 2825 0.58% 2.40% 0.62% 2511 2514 -0.16% 0.12% 0.32% Value at Risk Margin (VaR Margin) The most popular and traditional measure of uncertainty/risk is Volatility, while historical volatility tells us how the security price moved in the past, VaR answers the question, „How much is it likely to move over next one day?‟ VaR is computed using exponentially weighted moving average (EWMA) methodology. Based on statistical analysis, 94% weight is given to volatility on „T -1‟ day and 6% weight is given to „T‟ day returns. To compute, volatility for Trading Day (T), first we need to compute day‟s return for T by using LN (close price on T / close price on T-1). Following formula is used to calculate volatility T. Square root of [0.94*(T-1 volatility)*(T-1 volatility) + 0.06*(T LN return)*(T LN return)] To arrive at VaR margin rate, companies are divided into 3 categories based on how regularly their shares trade and on the basis of liquidity (that is, by how much a large buy or sell order changes the price of the scrip, what is technically called as impact cost. Group I consists of shares that are regularly traded (that is, on more than 80% of the trading days in the previous six months) and have high liquidity (that is, impact cost less than 1%). Group II consists of shares that are regularly traded 49 (again, more than 80% of the trading days in the previous six months) but with higher impact cost (that is, more than 1 %). All other shares are classified under Group III. For Group I shares, the VaR margin rate would be higher of  3.5 times volatility or  7.5% of value For Group II shares, the VaR margin rate would be higher of  3.5 times volatility or  3.0 times volatility of index The volatility of index is taken as the higher of the daily Index volatility based on S&P CNX NIFTY or BSE SENSEX. At any point in time, minimum value of volatility of index is taken as 5%. For Group II shares, the number arrived at as above, is multiplied by 1.732051 (that is, square root of 3). The number so obtained is the VaR margin rate. For Group III securities VaR margin rate would be 5.0 times volatility of the Index multiplied by 1.732051 (that is, square root of 3). Mark to Market Margin (MTM Margin) Mark to Market margin is calculated at the end of the day on all open positions by comparing transaction price with the closing price of the share for the day. In the above example a buyer purchased 1000 shares @ Rs.100 at 11 am on July 1, 2008. If close price of the shares on that day happens to be Rs.75, then the buyer faces a notional loss of Rs.25,000 on his buy position. In technical terms this loss is called as MTM loss and is payable by July 2, 2008 (that is next day of the trade). In 50 case price of the share falls further by the end of July 2, 2008 to Rs. 70, then buy position would show a further loss of Rs.5,000. This MTM loss is payable. In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position is zero, but there could still be a notional loss / gain (due to difference between the buy and sell values), such notional loss also is considered for calculating the MTM payable. MTM Profit/Loss = [(Total Buy Qty X Close price) - Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close price)] Extreme Loss Margin The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins. The Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LN returns of the stock price in the last six months or 5% of the value of the position. This margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis for the past six months. According to the example mentioned above, the VaR margin rate for shares of ABC Ltd. was 13%. Suppose the 1.5 times standard deviation of daily LN returns is 3.1%. Then 5% (which is higher than 3.1%) will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR margin + extreme loss margin) on a trade of Rs.10 lakhs would be Rs. 1,80,000. 51 00 times 2.Upfront Margin 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.000 more. 10 lacs or above for more than 10 occasions in the past 4 weeks.00 times 5. In case a member has a margin shortage of Rs. Under Slab Full Exposure 1st level 2nd level 3rd level 4th level Multiple 8.00 times 52 . Groups (Securities Covered) Group I Group II Group III Upfront Margin Rate 15% 30% 45% Failure to pay margins Non-payment of either the whole or part of the margin amount due will be treated as a violation of the Bye Laws of the Clearing Corporation and will attract penal charges @ 0. after applying the margin percentages as given below.50 times 7.09% per day of the amount not paid throughout the period of nonpayment. the gross exposure multiple of the member will be reduced to one level lower at the time of re-activation of their trading terminals as giver.00 times 3. in respect of trades in normal market in which would result in a margin of Rs 50. Upon members failing to deposit the additional capital within the stipulated time. Members violating the intra-day gross turnover limit at any time on any trading day are not being permitted to trade forthwith. Margins based on turnover & Exposure limits (Initial margins) Intra-day turnover limit Members are subject to the intra-day trading limits. advice the exchange to withdraw any or all of the membership rights of the member including the withdrawal of 'trading facilities without any notice.If there is no margin shortage for the next I week of Rs. and such action shall be final and binding on the member. Members are given a maximum of 15 days time from the date of the violation to bring in the additional capital. In the event of withdrawal of trading facilities. forthwith or any time thereafter by NSCCL. the outstanding positions of the member may be closed out. the exposure limits shall be restored to the previous levels. NSCCL may. Gross turnover (buy + sell) intra-day of the member should not exceed the 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). In addition. at its discretion by placing at the Exchange. within such time as it may deem fit. without any notice to the member. the reduced turnover limit 53 . 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. to the extent possible. counter orders in respect of the outstanding position of the member. 10 lacs or more. the above-mentioned provisions apply and the intra-day turnover limit will be further reduced to 15 times. Gross Exposure Limits Members are also subject to gross exposure limits. Gross exposure limit would be: Total Base Capital Up to Rs. across all open settlements. 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.e.5 times the total base capital 8.sell value). Upon subsequent violations. 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. i. Upon the member violating the reduced intra-day 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. across all the securities in rolling settlements.5 crores + 10 times the total base capital in excess of Rs 1 crore 54 . Gross exposure for a member. 1 crore Gross Exposure Limit 8. Open settlements would be all those settlements for which trading has commenced and for which settlement pay in is not yet completed. is computed as the absolute (buy value . ignoring +ve and -ve signs. 1 crore > Rs. Members are not permitted to trade if any subsequent violation occurs till the required additional deposit is brought in. 55 .Or any such lower limits as applicable to the members. bank guarantee. not used towards margins. the GE multiple for each security are as under: Groups (Securities Covered) Group I Group II Group III Covered Multiple 1 time 2 times 5 times All new securities to be traded on the Exchange shall be subject to exposure multiple of 2 times. 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 for the previous settlement period. for the purpose of the above limits. It is clarified that while computing the gross exposure at any time for a particular trading day. FDR or cash with NSCCL and NSE. in the nature of securities. Security-wise Differential Exposure Limits In case of securities that are traded in the Rolling settlement (Type 'N' and security series 'EQ'). The total base capital being the base minimum capital (cash deposit and security deposit) and additional deposits. 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. 5. excluding deposits in the form of securities is utilized for meeting the margin requirements. In respect of violation of stipulated limits on more than one occasion on the same day. The penalty is debited to the clearing account of the member. the surplus additional deposits. Non-payment of penalty in time will attract penal interest of 15 basis points per day till the date of payment.Members who desire to reduce their gross exposure may submit their order entry requirements as per the prescribed format and if members desire to increase their limits additional deposits by way of bank guarantee or Fixed Deposit Receipt (FDR) have to be submitted to NSCCL. Additional Base Capital Members may provide additional margin/collateral deposit (additional base capital) to NSCCL. if any. Violation Charges Members exceeding the gross exposure limit are not permitted to trade with immediate effect (trading terminals are disabled automatically. A penalty of Rs. over and above their minimum deposit requirements (base 56 . each violation would be treated as a separate instance for purpose of calculation of penalty. which shall be paid by next day. The additional deposits of the member are used first for adjustment against gross exposure of the member. The penalty as indicated above would be charged to the members irrespective of whether the member brings in additional capital subsequently.000 is levied for each violation of gross exposure limit and Intra Day Turnover limits. Additional deposits by way of securities in electronic form (demat securities) may be deposited as per procedures. After such adjustments.  Approved securities in demat form deposited with approved Custodians. 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. towards margins and/ or exposure / turnover limits.capital). 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 favour of NSCCL from approved banks in the specified format. Exemption for institutional deals Deals executed on behalf of the following entities are considered as institutional deals:     Financial Institutions SEBI registered FII‟s Banks SEBI registered Mutual Funds 57 . Incase where non . the excess non-cash component is ignored for the purpose of exposure limits requirements and / or margins requirements.cash component is more than 70 % of the total additional base capital. The early pay in would be allocated to clients having net deliverable position. members are required to ensure to pass on 58 . Exemption upon delivery of securities If members deliver the securities prior to the securities pay in day. 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. will not be exempted. Deals are identified by the use of the participant code in the trades reported. Non Custodial Institutional deals.While computing margins.e. The margin benefit on account of early pay in of securities shall be given to the extent of the net delivery position across all clients of the member. which are not marked as 'NCIT' at the time of order entry. VaR based margin which is charged on institutional trades on the net outstanding sale position. till such time that the system is developed to provide the early pay in benefit on a client basis. on a random basis. then the margin payable by the member will be recomputed after considering the above pay in of securities. Non-Custodial Institutional Deals are identified by the use of the participant code `NCIT'. Deals entered into on behalf of custodial participants i. in securities shall be applicable in this case also) and the settlement obligation will remain with TM clearing member. institutional deals are excluded. However. carrying custodial participant code are considered as institutional deals unless not confirmed by the respective custodians in which case the deals shall attract margins. The NCIT' deals will be exempted for margin purposes (However. 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 pay in benefits.appropriate early pay in benefit of margin/exposure to the relevant client. until the above system is in place. The relevant authority would determine from time to time. 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 members. Pay in of funds and 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. In case any member makes early pay in on the scheduled day of pay in for the settlement. Such early pay in shall not be adjusted against the settlement pay in obligation and it would be treated as short delivery. 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 59 . Members are therefore alerted to ensure that no early pay in is made on the scheduled day of settlement pay in. no benefit will accrue to the member. the members who would be required to pay in funds and securities prior to the pay in day. 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.  Surveillance / Inspection Surveillance / Inspection department carries out inspection of the member brokers records and keep a regular check on the activities of member brokers as well as sub brokers as regards the compliance of the risk management procedures.  Insurance The exchange presently has in place insurance policies to protect itself in the event of losses on account of fire. In case the member broker fails to furnish the same. » Loss of member on account of fake / forged / stolen shares being introduced by the clients. it may result in penalties to the member brokers.  Know your client (KYC) According to know your client scheme the member brokers of the exchange are 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. its member brokers and the clearing houses. damage to computer systems and a comprehensive policy that covers risks faced by the exchange. There will be no margin exemption available for such pay in of funds and securities. The risks covered under the basic cover of the policy are detailed as below. 60 .exposure reduction. Measures taken by BSE for risk management Certain steps or measures are taken by BSE towards the reduction of risks of stock brokers. Direct financial losses suffered by the member broker on account of physical loss. » » »  Loss on account of securities lost in transit. Loss suffered on account of incomplete transaction.» » Loss to members on account of fraud by employees. merchant bankers. Measures taken by SEBI The Securities and Exchange Board of India (SEBI) along with Government have been stressing upon the need for strict regulation of secondary market and bringing the transparency on the floor of stock exchanges. registrars to issues. 10 lacs then the member has to send the photocopies of the transfer deeds and the share certificates to the company / registrar for verification of the material particulars. Loss on account of errors and omission. in case the transaction in a script with one particular client in a settlement exceeds Rs. The steps taken by the SEBI and Government in order to regulate and control the activities of stock exchanges and reduce the risk of investors and sock brokers are as follows. The basic idea behind the introduction of this procedure is to prevent the fake / forged / stolen shares from being introduced in the market. 61 . debenture trustees.  Registration of all market players such as brokers.e. underwriters. theft or damage to securities and cash. sub brokers. Verification of shares members’ office The exchange has outlined the process i.  Uniform Trading hours at all the stock exchanges in the country to check the arbitrage. portfolio managers. destruction.  Systematization and computerization in order to reduce the paper work and ensure transparency in transactions. records and verification of transactions.   Mentioning of brokerage separately in broker contract notes.           Uniform good/bad delivery norms.  Regulation on insider trading with the object to curb it completely and punish the guilty. Forward trading being banned on stock exchanges. Brokers have to keep the clients money in a separate bank account.  Compulsory audit of accounts of all member brokers and registered intermediaries by practicing chartered accountants. Capital adequacy norms prescribed for brokers.  Indirect supervision through stock exchanges in day-to-day business by fixing margins. imposing curbs. Recent steps taken by SEBI 62 . Total transparency and automation of stock exchanges. Dematerialization of almost all the securities. penalties and fines etc. Brokers have to notify all transaction to the stock exchanges including off the floor trades. Effective margin system for smooth settlement. Derivative trading in index based futures of 1. Circuit breaker system to check volatility of particular scrip and the exchange. Introduction of Internet and online trading.custodians etc so as to have access/inspection of their books. 2 or 3 months. » » Fund to be utilized only for investor claims and not for broker claims. This will help reduce the encouragement to rumors about companies. The administrators appointed by SEBI act on behalf regulator in resolving problems arising out of signature mismatch. »  Time schedule to be specified while setting investor claims.  Streamlining Investor protection fund The committee set up by SEBI to review the sources and utilization of investor protection fund of stock exchanges has made following recommendations » Funds should be on trust structure and set upon under Indian Trust Act. Trustees to ensure that fund is not deployed in risky instruments or for the benefit of any member but only in prescribed avenues. SEBI has decided to appoint administrator to implement the signature guarantee and certificate authentication programs. which aids in price control and stability. 1882 with independent trustees. » Regular contributions from active member brokers and stock exchanges. Compliance Officer Each company is required to appoint the compliance officer who would be able to verify the rumors and information floating in the market about the company and inform the same to the stock exchanges. Appointment of administrators To get rid of bad deliveries.  Service centers for investors 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 63 . it is emerging as an utmost important practice. Risk may hamper the pre determined outcomes and result into losses. The findings drawn during the project are as follows. reduced or transferred.  To cope up with the situation and reduce the evil effects of it such risks can be avoided. 64 . Due to high volatility of market brokers are always exposed to the risk and they have to suffer heavy financial losses.  Investor Education SEBI has taken steps to educate the investors through various awareness programmes. It is the chance of happening of something that may affect the desired results. etc. regulations.  Risk is the possibility of happening uncertain events. FINDINGS The study of risk management in stock broking firm was really an interesting and informative project. and publications etc. retained. policies. Though the concept of risk management in stock broking firm is a new concept in India. rules.  Corporate Governance SEBI has prescribed the corporate governance norms for all listed companies to ensure transparency and better disclosure practices.grievances as well as access financial and other information of companies on government norms. credit risks.  NSE.  If member delivers the securities prior to the scheduled securities pay in day. The members violating the limits are penalized and not permitted to trade forthwith. liquidity risks and operational risks.  Stock broking firms face the market risks. BSE. to ensure the minimum risk.  To tackle such risks Value at Risk (VaR) Margin. Mark to Market (MTM) Margin. SEBI and NSCCL have taken various steps like KYC.  The technological advancements and infrastructural development have helped broking firms to keep a regular check on its clients and sub brokers. the margin payable by broker is then recomputed and margin is released to the extent of early pay in. inspection. financial risks.  Intra day turnover limit and gross exposure limit are allowed to member brokers against the minimum base capital and additional base capital. Member‟s trading facility is restored from the next trading day with a reduced intra day and gross exposure limit. In extreme cases NSCCL may withdraw the membership rights of member broker. 65 . It has also enabled the exchanges to monitor on line where the correct and immediate position of members is monitored on real time basis. The Indian capital market is very volatile and because of this brokers are always at a risk of non receipt of payments from clients and sub brokers. compulsory audit of accounts etc.  Non payment of margins is treated as violation of the bye laws of NSCCL and attracts penalties. circuit filters. surveillance. Extreme Loss Margin are collected from clients and maintained at the exchange. 66 . franchisees and investors etc. The one important reason behind this can be lack of proper implementation of the rules and regulations.SUGGESTIONS AND CONCLUSION Inspite of strict surveillance and stringent policies towards reducing the risk. Many times strict adherence to the provisions laid down by the exchanges and SEBI is neglected and it results in to losses. Therefore following are the suggestions which would help reduce the risk and losses at exchanges and member brokers.  Every stock broking firm must have a Risk Management or Surveillance Department to keep a strict watch on market and the activities of its sub brokers. brokers have to suffer financial losses. copy of passbook.g.  Also while giving refunds to the broker or sub broker it must be checked that he has maintained a minimum required balance (Minimum Base Capital). There has to be minimum qualification criteria for the member broker.)  Such qualified staff would help in reducing the mistakes and errors as they have a proper understanding of the procedure.  The member brokers and sub brokers must strictly adhere to the limits and gross exposure provided to them and in case of need a specified amount must be deposited first with the exchange.  The clients should be asked to call dealers on the phones only on which the conversation can be recorded. Letter from bank.  All the documents along with applications for client and sub broker must be verified thoroughly and all the requirements (e.  While providing acceptance to the limits it must be scrutinized that broker or sub broker has a required amount of credit in his bank account. clients‟ calls on personal phones should be avoided. a dealer must pass the NCFM or BCFM Dealer‟s module.g. sub broker and franchisee and employees especially dealers. signature. 67 .  The senior officers of broker must visit periodically to its sub brokers and franchisees to keep a check and understand their problems. letter of landlord in case of tenant etc) must be fulfilled. The criteria can be various modules of NCFM or BCFM (e.  In both the cases of acceptance to the limit and refund of capital the margins must be recomputed and increased or decreased immediately. Thus. It helps to reduce the miscommunication and conflicts between client and broker. The activities of risk management or surveillance are the heart of the broking industry and they should be taken care of. with the margin system and use of advanced technology the transparency of market is growing. refund etc. limits. CONCLUSION Working with PSE Securities Ltd. The report should be send to senior management for verification. gross exposure. 68 . they are very volatile and unpredictable too. Risk Management or Surveillance Department should generate a report containing the position. Prices of shares in Indian stock market change very swiftly. Therefore. The brokers are always at a risk that investors may not pay in the securities or funds due to increase or decrease in prices of shares. broking firm is a very risky business and chance of financial losses lies in almost each and every activity of the business. However. for study of risk management in stock broking firm was a great experience. acceptance. which restricted the scope of study. LIMITATIONS During the study certain limitations were faced.Therefore to conclude it can be noted that though the business of stock broking is always exposed to the risk of non receipt of payments or loss of money but such risks can be managed and reduced through strict adherence to the rules and regulation mentioned by exchanges. SEBI and NSCCL.   It was not possible to study certain confidential data. The study was conducted in Pune city only. 69 . deals in the cash segment only and not in the derivatives segment. The PSE Securities Ltd. Those limitations are as follows. This will not only reduce the risk but also help organization run smoothly and grow further.  The data provided by persons cannot be held 100% true.   The time period of 2 months was a very short span to complete the study. that put restrictions on the study. in the absence of which the study could have been better. . Capital Market (Dealers) Module Work Book NSE. pp 3-10 Internet sites 70 . Himilaya Publishing House. Understanding Margins. Bhalla. (2002). Chand and Co. pp 84-95.A Avadhani. Securities Analysis and Portfolio Management. (Oct. 2007). Capital Market (Basic) Module Work Book NSE.K. (Oct. Ltd. Mumbai. Mumbai. pp46-54. » National Stock Exchange. 2007). New Delhi. pp1-24 » National Stock Exchange. pp 151-159 » V. S. Portfolio Analysis and Management. (2006).  Journals or Magazines »  Jointly Published by NSE and BSE.BIBLIOGRAPHY  Books » V. Mumbai. com/terms/v/var. 4:30 p.m.org/wiki/Risk_Management> Assessed on 15th June 2008. » <http://www.asp> Assessed on 12th July 2008.investopedia.m. » <http://punestockexchange.html> Assessed on 6th July 2008. 71 . 6 p.m.com/search/searchresults. 6:30 p.com/mktlive/market_summ/margin.m. 10 a. » <http://www.aspx?q=risk> Assessed on 12th July 2008.m. 4 p. » <http://bseindia.m.investopedia.asp> Assessed on 29th June 2008.com/psescompanyprofile. 5:30 p.ht m> Assessed on 29th June 2008. » <http://www.nseindia.» <http://en.wikipedia.com/home/NSCCL/RiskManagement/equities.