Perfect Competition – Case Study on Stock Exchange

By: Amit ShethGagan Pareek

Sainatth Wagh Samir Daddikar

Perfect CompetitionA perfectly competitive market must meet the following requirements:

• Both buyers and sellers are price takers.• The number of firms is large.• There are no barriers to entry.• The firms' products are identical.• There is complete information.

Examples of Perfect Competition

•Agriculture•Poultry•Stock Market•Fisheries•Forex

Stock Market

Stock market: A stock market is a physical place, sometimes known as a stock exchange, where brokers gather to buy and sell stocks and other securities.The term is also used more broadly to include electronic trading that takes place over computer and telephone lines

Constituents of Stock Market

Stock Market

ParticipantsFor e.g.: BHEL

Investors For e.g.: FII

Intermediaries For e.g.: ICICI direct

Types of Securities

Security Market

Secondary Market

List of Stock Exchanges India

Open Out Cry System In the open outcry system, only eight representatives of a

broker were allowed to go to the Ring and trade. Investors were allowed to watch from the investors’ gallery and

they had to physically visit the broker’s office to place an order. A representative of the broker would then rush to the Ring and execute the trade.

Disadvantages of Open Out Cry:• This was time consuming and inefficient• Imposed limits on trading volumes and efficiency.• Share of Mumbai was 80% , whereas rest part was not able to

participate.

Screen-based trading and Dematerialization

NSE arrived with a fully computerized order book in 1994 called NEAT (National Exchange for Automated Trading).

This enabled it to spread across to various towns and cities in India by setting up terminals connected to the central system through VSAT.

Trading in 1363 securities through 2856 VSAT terminals (servicing 9000 users) spread across 354 cities

Bid & Ask Price

The difference in the price of the best bid and ask is called as the Bid-Ask spread and often is an indicator of liquidity in a stock. The narrower the

difference the more liquid or highly traded is the stock.

Transaction Stages –Micro LevelPay In and Pay Out Period

From outcry to screenplay• 2009 :NSE turnover almost 70% of total stock market • Trade settlement reduced from three weeks to T+15 and now

T+2. • Mumbai shares compare with India reduced from 70% to 40%

, thereby giving large players fare chance.

S.No Day Time Description of activity

1 T Trade Day

By 1.00 pm Confirmation of all trades (including custodial trades).

By 2.30 pm Processing and Downloading of obligation files to brokers/custodians

By 11.00 am Pay- in of securities and funds

By 1.30 pm Pay- out of securities and funds

2 T+1

3 T+2

Harshad Mehta Scam•Harshad Mehta scam was exposed in April 1992 by the journalist Sucheta Dalal.•The amount involved in the scam was around 4000 cr INR.•The scam was a result because of the loopholes in the banking system which were exploited.Following were the causes:•Bank Receipt.•Ready Forward Deal.

Bank ReceiptBank Receipt: As the name suggest, BR acts as the receipt for the money received by the selling bank.• It promises to deliver the securities to the buyer.• In the mean time the seller holds the securities in trust of buyer.•For this operation, banks such as the bank of Karad (BoK) and Metropolitan Co-operative Bank (MCB) came handy which issued Mehta with fake BR or BR without any backing from government.•When Mehta gave this fake receipt for the same the bank would give the money without checking the credentiality of the document.

READY FORWARD DEAL

Drawbacks in Banking System•In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller. This lead to the asymmetric flow of information.•In this settlement process, the buyer and the seller might not even know whom they had traded with, either being know only to the broker.•Since the market prices were made by the brokers they had become market makers. There was no concept of price taker and price maker. Also the concept of ready forward deal was banned after this scam.

Regulatory FrameworkSEBI Act (1992): SEBI has been obligated to protect the interests of the investors in securities and to promote and development of, and to regulate the securities market.Following are the functions : Regulating the business in stock exchanges. Registering and regulating the working of stock brokers.Promoting and regulating self-regulatory organizations.Prohibiting insider trading in securities.Regulating substantial acquisition of shares.Leving fees or other charges for carrying out various activities. Conducting research for various activities.

Depositories Act 1996Why was depository act established?•Introduction of screen based trading•Shortening of trading and settlement cycles•Dematerialisation

Features Of Depository Act 1996

• Making securities of public limited companies freely transferable

• Dematerialising the securities in the depository mode

• Providing maintenance of ownership records in a book entry form.

• Facilitating Screen Based Electronic Trading• Facilitating exchanges to employ risk management

practices to ensure timely settlement of trades.

Demutualisation

• Historically, brokers owned, controlled and managed the stock exchanges.

• Regulators focused on reducing the dominance of trading members in the management of stock exchanges

• NSE adopted a pure demutualised governance structure where ownership, management and trading are with three different sets of people.

Investor Protection

• Investor Education and Protection Fund (IEPF)• SEBI and the stock exchanges have set up

investor grievance cells for redressal of investor grievance.

Ketan Parekh Scam•Scam was detected in March 2001•Sudden crash of 176 points on 1 March 2001 •SEBI ordered for an instant investigation•KP arrested on 30 March 2001• KP charged with defrauding BOI with $30 million

Liquidity CrunchKP used to routes for to solve Liquidity crunchFirst Route

Liquidity Crunch contd..

Second Route• KP used around 16 MMCB branch at Mandvi (Mumbai),

accounts, either directly or through other broker firms, to obtain funds

• KP used his BoI accounts to discount 248 pay orders worth about Rs 24 billion between January and March 2001

• BoI's losses eventually amounted to Rs 1.2 billion• The MMCB pay order issue hit several public sector banks

very hard including big names such as the State Bank of India, Bank of India and the Punjab National Bank.

Loopholes

• The scam opened up the debate over banks funding capital market operations and lending funds against collateral security.

• It also raised questions about the validity of dual control of co-operative banks.

• Analysts pointed out that RBI was inspecting the accounts once in two years, which created ample scope for violation of rules.

Regulatory FrameworkPrevention of Money Laundering Act (2002): which helped in money lending and provided confiscation of property derived from or involved in money lending.

Q) Why do you think the name Money Laundering Act?The term Money Laundering has been defined in Section 3 of the Act asWhosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activityconnected with the proceeds of crime and projecting it as untainted property shall be guilty of offence of money-laundering.

Regulatory FrameworkAs seen above there are some legal implications under the depositionaries act.Following are the legal actions mentioned below:

Rigorous imprisonment . Term Imprisonment for three to seven years. Liable to fine which may extend to five lakh rupees.

Conclusion

• Both buyers and sellers are price takers. ו The number of firms/individuals is large. • There are no barriers to entry. × • The firms' products are identical. • There is complete information. ו Thus under normal circumstances a stock

market nearly resembles a perfectly competitive market structure

Questions??

THANK YOU!!