NISM Series XXI A PMS Short Notes – Chapter 2 & 3: Securities Markets and Investing in Stocks
Welcome to Part 2 of 7 in our complete NISM Series XXI A – Portfolio Management Services (PMS) study series. This post covers Chapter 2: Introduction to Securities Markets and Chapter 3: Investing in Stocks — two of the most important and high-weightage chapters in the NISM XXI A exam syllabus.
If you missed Part 1, read Chapter 1: Investments here →
Table of Contents
- What is a Security?
- Primary Market vs Secondary Market
- Market Participants and Their Roles
- Institutional Participants
- Equity as an Investment
- Diversification of Risk Through Equity
- Risks of Equity Investments
- Equity Research and Stock Selection
- Fundamental Analysis
- Valuation Methods
- Technical Analysis
- Practice Questions
Chapter 2: Introduction to Securities Markets What is a Security?
A security is a financial instrument that represents the terms of exchange of money between two parties. Securities markets provide the institutional structure that channels savings into productive investments, enabling efficient capital flow in the economy.
- Investors buy securities to convert their savings into financial assets that generate returns
- Borrowers (companies, governments) issue securities to raise capital at a reasonable cost
Primary Market vs Secondary Market Primary Market (New Issue Market)
The primary market is where fresh securities are issued for the first time. Companies and governments raise capital by selling new securities directly to investors.
Methods of Issue in Primary Market:
| Method | Description |
|---|---|
| IPO (Initial Public Offering) | First-time sale of shares to the public by a private company |
| FPO (Further Public Offer) | Additional share sale by an already-listed company |
| Rights Issue | Offer to existing shareholders to buy new shares at a discount |
| Private Placement | Selling securities to a select group of investors, not the public |
| Preferential Issue | Allotment of securities to a specific group at a preferential price |
| QIP (Qualified Institutional Placement) | Listed companies raising capital from qualified institutional buyers |
| OFS (Offer for Sale) | Promoters sell existing shares to the public through the exchange |
| ESOP | Employee Stock Ownership Plan — shares issued to employees |
| FCCB | Foreign Currency Convertible Bond — bond that can convert to equity |
| ADR / GDR | American / Global Depository Receipts for foreign market access |
| Anchor Investor | Large institutional investor who subscribes before the public issue |
Secondary Market
The secondary market is where already-issued securities are traded between investors. No new capital is raised here — existing securities simply change hands.
Why Secondary Market Matters:
- Provides liquidity and exit options for primary market investors
- Active secondary market promotes capital formation and encourages primary market participation
- Key segments: OTC (Over-the-Counter) Market and Exchange-Traded Markets
Market Infrastructure Institutions and Intermediaries
The NISM XXI A exam frequently tests knowledge of market participants. Here is a complete, exam-ready breakdown:
| Participant | Role |
|---|---|
| Stock Exchanges | Provide a platform for buying and selling already-issued securities through anonymous electronic order matching |
| Depositories | Hold securities in electronic form. India has two: CDSL and NSDL, both registered with SEBI |
| Depository Participant (DP) | Agent of depository. Enables investors to hold and transact in dematerialised securities |
| Trading Members / Stockbrokers | Registered members of stock exchanges. Facilitate buy/sell transactions for investors |
| Authorised Persons (APs) | Agents of brokers (formerly sub-brokers). Help extend broker services to a wider investor base |
| Custodian | Responsible for safekeeping of funds and securities for large institutional clients (banks, insurance companies, FPIs) |
| Clearing Corporations | Ensure that members meet their obligations to deliver funds or securities. Safeguard investor interests |
| Clearing Bank | Intermediary between clearing members and clearing corporation. Every clearing member maintains an account here |
| Merchant Bankers | SEBI-registered entities acting as issue managers / lead managers for securities issuance |
| Underwriters | Subscribe to any unsold portion of a public issue of securities |
Institutional Participants in Indian Securities Markets
| Institution | Role |
|---|---|
| Mutual Funds | Professionally managed collective investment schemes pooling money from multiple investors |
| Pension Funds | Manage retirement savings contributed by employees and/or employers |
| Insurance Companies | Manage large pools of premium money (life insurance, general insurance) |
| Alternative Investment Funds (AIFs) | Private pooled vehicles: Venture Capital, Angel, PE, Debt, Hedge, Infrastructure, SME, Social Venture Funds |
| Foreign Portfolio Investors (FPIs) | Entities incorporated outside India investing in Indian securities after registering with SEBI |
| Investment Advisers | Help investors decide on asset allocation and security selection based on risk profile and goals |
| EPFO | Statutory body under Employees' Provident Funds Act, 1952 |
| NPS (National Pension System) | Government-launched pension-cum-investment scheme for old-age security |
| Family Office | Ecosystem built by a wealthy family to manage its wealth professionally |
| Corporate Treasuries | Manage financial risks, liquidity, debt, and capital structure of corporations |
Chapter 3: Investing in Stocks Equity as an Investment
When a company issues equity, it is not obligated to repay the amount received from shareholders, nor is it required to make periodic payments. Equity holders have:
- A residual claim on the company's net assets (assets minus all liabilities)
- Voting rights at shareholder meetings
- Income from dividends (if declared) and capital gains from price appreciation
Key NLP Entity for NISM: Equity shareholders are called residual claimants because they receive what is left after all other obligations (debt, preference dividends) are settled.
Diversification of Risk Through Equity
Diversification reduces risk by combining assets that do not move in the same direction at the same time. This is based on the concept of correlation between assets.
- Different business sectors behave differently in economic cycles
- Counter-cyclical (defensive) businesses perform well when others are struggling (e.g., FMCG, pharma)
- Recession-proof businesses maintain stability through downturns
- Some sectors recover faster from recession; others enter recession later
By combining stocks from multiple sectors, a portfolio manager can reduce overall portfolio risk without sacrificing expected returns — this is the essence of the Markowitz diversification principle.
Risks Specific to Equity Investments
| Risk Type | Explanation |
|---|---|
| Market Risk | Fluctuation in equity prices due to broad market dynamics (sentiment, macro events) |
| Sector-Specific Risk | Factors affecting an entire industry/sector (e.g., regulation change for pharma) |
| Company-Specific Risk | Factors unique to a single company (management, product failure, fraud) |
| Liquidity Risk (Impact Cost) | The percentage price movement caused by a particular order size. Higher impact cost = higher liquidity risk |
Preference Shares vs Equity Shares
| Feature | Preference Shares | Equity Shares |
|---|---|---|
| Dividend Priority | Paid first | Paid after preference |
| Liquidation Priority | Rank above equity | Residual claim |
| Voting Rights | Generally absent (unless stated) | Yes — key characteristic |
Equity Research and Stock Selection
Equity research aims to determine the intrinsic value of a stock and compare it with the current market price to make buy, hold, or sell decisions.
Decision Rule (Fundamental Analysis):
- Market Price < Intrinsic Value → Buy (undervalued)
- Market Price > Intrinsic Value → Sell / Do Not Buy (overvalued)
Buy-Side vs Sell-Side Research
| Feature | Sell-Side Research | Buy-Side Research |
|---|---|---|
| Works For | Brokerages, investment banks | Mutual funds, hedge funds, PMS, pension funds |
| Output | Public research reports with Buy/Hold/Sell ratings | Internal reports for portfolio decisions |
| Client | Investors and traders using broker services | Fund's own portfolio |
Stock Analysis Process: Three-Step Approach
- Economic Analysis — Assess macroeconomic conditions (GDP, interest rates, inflation, monetary policy)
- Industry / Sector Analysis — Evaluate the industry's growth stage, competitive dynamics (Porter's 5 Forces), and regulatory environment
- Company Analysis — Deep dive into financials, management quality, competitive moat, and valuation
Industry Life Cycle Stages
| Stage | Characteristics | Investment Implication |
|---|---|---|
| Introduction | High investment, low revenues, high risk | Speculative — high risk, high potential |
| Growth | Rapid revenue growth, expanding markets | Strong investment case for long-term holders |
| Maturity | Stable revenues, intense competition | Moderate risk — focus on dividends |
| Deceleration / Decline | Shrinking market, falling revenues | Cautious — seek exit or value plays |
Porter's Five Forces Model
Michael Porter's framework identifies five forces that determine industry competitiveness and profitability:
- Rivalry Among Existing Competitors
- Threat of New Entrants
- Threat of Substitute Products
- Bargaining Power of Buyers
- Bargaining Power of Suppliers
The stronger these forces collectively, the lower the industry's profitability.
Fundamental Analysis — Estimating Intrinsic Value Discounted Cash Flow (DCF) Model
The most theoretically sound valuation method. It requires three inputs:
- Stream of future cash flows
- Timing of those cash flows
- Discount rate (investor's required rate of return)
Free Cash Flow Models
| Model | Cash Flow Type | Discount Rate Used |
|---|---|---|
| FCFF (Free Cash Flow to Firm) | Cash flows before debt payments — available to all capital providers | WACC (Weighted Average Cost of Capital) |
| FCFE (Free Cash Flow to Equity) | Cash flows available only to equity investors | Cost of Equity (Ke) |
CAPM Formula for Cost of Equity:
Ke = Rf + β × (Rm – Rf)
Where: Ke = Cost of equity Rf = Risk-free rate β = Beta (systematic risk measure) Rm = Expected market return (Rm – Rf) = Market risk premium Asset-Based Valuation
Value of business = Total Assets – Total Liabilities
This method is suitable for asset-heavy businesses or companies in liquidation scenarios.
Relative Valuation (Multiples-Based Approach)
Compare a company's value against similar companies using standardised multiples:
| Multiple | What It Measures |
|---|---|
| P/E Ratio (Price to Earnings) | How much investors pay per rupee of earnings |
| P/B Ratio (Price to Book) | Market value vs book value of equity |
| P/S Ratio (Price to Sales) | Market cap relative to revenue |
| PEG Ratio | P/E adjusted for earnings growth rate |
| EV/EBITDA | Enterprise value relative to operating earnings |
| EVA & MVA | Economic Value Added & Market Value Added |
| EV/Sales | Enterprise value vs total sales |
Technical Analysis — How It Works
Technical analysis assumes that all information that can affect a stock's price is already reflected in its current market price. Rather than analysing company fundamentals, technical analysts study price and volume patterns.
Three Elements of Price Behaviour
- Price History — Past price patterns indicate trends and direction
- Trading Volume — Volume confirms the strength of a price trend
- Time Span — Over time, patterns reflect long-term influencing factors
Core Assumptions of Technical Analysis
- Market price is determined by supply and demand
- Supply and demand are driven by rational AND irrational factors
- Price adjustments are not instantaneous — prices move in trends
- Trends persist for meaningful periods
- Trends change when supply-demand relationships shift
- These shifts can be detected by analysing market data itself
Popular Technical Analysis Tools
- Trend-line Analysis: Draws lines connecting price highs or lows to identify directional trends
- Moving Averages: Smooth out price data to identify the direction of the underlying trend (SMA, EMA)
- Bollinger Band Analysis: Uses standard deviation bands around a moving average to identify overbought/oversold conditions
Practice Questions — Chapters 2 & 3
-
India has how many SEBI-registered depositories?
a) One b) Two c) Three d) Four
✅ Answer: b) Two — CDSL and NSDL
-
Under CAPM, what does Beta measure?
a) Total risk b) Unsystematic risk c) Systematic risk (market sensitivity) d) Liquidity risk
✅ Answer: c) Systematic risk
-
Which approach to stock analysis starts with macroeconomic analysis first?
a) Bottom-up b) Top-down c) Inside-out d) Quantitative
✅ Answer: b) Top-down approach
-
Which market is called the "New Issue Market"?
a) Secondary Market b) Derivatives Market c) Primary Market d) OTC Market
✅ Answer: c) Primary Market
-
FCFF is discounted using which rate?
a) Cost of Equity b) WACC c) Risk-free rate d) Coupon rate
✅ Answer: b) WACC
Key Takeaways — Chapters 2 & 3 at a Glance
- Primary market = New issues | Secondary market = Trading of existing securities
- India has 2 depositories: CDSL and NSDL
- Equity = Ownership + Residual claim + Voting rights
- Impact Cost = Liquidity Risk proxy for equity
- Technical analysis assumes all info is in the price
- Fundamental analysis seeks intrinsic value through DCF, relative, or asset-based methods
- Top-down analysis: Economy → Industry → Company
- Porter's 5 Forces: Rivalry, New Entrants, Substitutes, Buyer Power, Supplier Power
- CAPM: Ke = Rf + β(Rm – Rf)
Internal Links — Continue Your NISM XXI A Preparation
- 📘 ← Part 1: Investments
- 📘 Part 3: Fixed Income Securities & Derivatives →
- 🎯 Free NISM XXI A Mock Test →
- 📄 NISM Study Material PDF →
Tags: NISM Series XXI A, securities markets, primary market secondary market, equity investment, fundamental analysis technical analysis, stock valuation, Porter five forces, CAPM formula, NISM PMS exam, nism study material