PREFACE

In last decade or so, it has observed that there has been a paradigm shift in Indian capital market.
It is not only because of change in application of technology in the payment and settlement
system but also due to change in investment patterns. There are mainly two types of investors i.e.
Institutional and Individual investors. Investment pattern of these investors are considered as
main factor behind the volatility of stock market although there are many other factors.

Above changes made the Indian capital market comparable with the international capital market.
Now, the markets features a developed regulatory mechanism and a modern market
infrastructure with growing market capitalization, market liquidity and mobilization. The
securities and exchange board of India is now widely perceived as a robust institution, a role
model for regulators in emerging market.

These achievements are impressive but, there are several areas where the market still falls short
of international benchmark. In a country of over 1.2 billion people, less then million individual
participates directly or indirectly in the capital market. Therefore, the growth of Indian capital
market happens to contribute to the sustainable development of Indian economy.
 Executive Summary

The study of Indian capital market begins with the introduction of Indian financial system and
this study shows that the capital market is the backbone of Indian economy. The capital market is
important to a country’s economy and social system. It plays the crucial role of raising fund from
individual and institutional investors for both public and private sectors, promoting balance and
stability in the financial system, decreasing dependency on the banking sector, driving the
economy forward and creating job, as well as being an alternative method for savings. A strong
capital market will lessen the impact of economic fluctuation, which can be compounded by the
fast-flowing nature of capital.

The objective of the project is to find the different role of institutional and individual
investors in the capital market in India and to find the relationship between the Sensex
variation with the variation of the investments made by the institutional and individual
investors. India opened its stock markets to foreign investors in September 1992 and has,
since 1993, received considerable amount of portfolio investment from foreigners in the
form of Foreign Institutional Investor’s (FII) investment in equities. While in generally
that portfolio flows benefit to the economies of recipient countries, policy makers worldwide
have been more than a little uneasy about such investments. Portfolio flows-often referred as
“hot money”-are notoriously volatile compared to other types of capital inflows. Investors
are known to pull back portfolio investments at the slightest hint of trouble in the host
country often leading to disastrous consequences to its economy. They have been blamed
for exacerbating small economic problem in a country by making large and concerted
withdrawals at the first sign of economic weakness.
After completing the project, I would r e c o m m e n d that Government should certainly
encourage foreign institutional investment but should keep a check on the volatility factor;
Govt. should also encourage individual investor. Long-term funds should receive priority and
encouraged some of the actions that should take to ensure stability are:
 Strengthening domestic institutional investors

 Operational flexibility to impart stability to the

 Market Knowledge activities and research program

To conclude with I could say that the foreign funds is certainly one of the most important
Cause of volatility in the Indian stock market and has had a considerable influence on it.
Although it would not be fair enough to come to any conclusion as there are a lot of other
factors beyond the scope of the study that effect returns and risks .it is not easy to predict
the nature of the macroeconomic factors and their behavior but it has a great significance on
any economy and its elements. Although generally a positive, relationship has seen between
the stock market returns and the FII inflows. It is not easy to say which one is the cause, and
which is the effect.
 Objective of the Study

 To study about the Indian Capital Market.

 To study the role and impact of Individual and Institutional Investors on Indian Capital
Market.
 How investor’s behavior affect the Indian Capital Market?
 Research Methodology

Information Research

Secondary Data Primary Data

Internet Book Survey of 100

 Chapter 1

Indian Capital Market

1.1 Introduction

Capital markets are like any other markets, but differ in terms of the products traded and their
organization. Capital markets deal with the trading of securities. Capital markets provide avenue
where companies can raise funds to expand on their businesses or establish new ones by issuing
securities owned by the companies. Like businesses in the private sector, Government issue its
securities to raise funds in capital markets to build electricity damn, construct new roads, bridges
by issues.
It is an organized market mechanism for effective and efficient transfer of money capital or
financial resources from the investing class i.e. from
(individual or institutional savers) to the entrepreneur
class (individual engaged in business or services) in the
private or public sectors of the economy.

In a broader sense, According to Goldsmith “The capital

market of a modern economy has two basic functions first
the allocation of savings among users and investment;
second the facilitation of the transfer of existing assets, tangible and intangible among individual
economic units”.

Capital Market is generally consider as the market for long-term funds. It provides long-term
debt and equity finance for the government and the corporate sector. It is a best performing
markets in the world since last few years. It facilitates the transfer of capital i.e. financial assets
from one owner to another.
The rapid growth in Indian capital markets and the spread of “Equity culture” has doubtlessly
strained its infrastructure and regulatory resources. Nevertheless, securities market is a watchdog
as SEBI plays a vital role in redressing investors’ grievances.
Capital Markets are mainly leaded by two major Indian exchanges BSE and NSE, which ranked
16th & 17th among all the exchanges around the world in terms of market capitalization. In terms
of risk and returns the Indian those in industrialized nations. Due to such strong stock exchanges,
there is a strong economic growth and a large inflow of foreign institutional investors (FIIs).

1.2 Structure of Indian Capital Market

Broadly speaking the capital market is classified into two categories. They are the Primary
market (New Issues Market) and the Secondary market (Old (Existing) Issues Market). This
classification is done on the basis of the nature of instrument brought in the market. However, on
the basis of the institutions involved in capital market, it can be classified into various categories
such as the Government Securities market or Gilt-edged market, Industrial Securities market,
Development Financial Institutions (DFIs) and financial intermediaries. All of these components
have specific features to mention. The structure of the Indian capital market has its distinct
features. These different segments of the capital market help to develop the institution of capital
market in many dimensions. The primary market helps to raise fresh capital in the market. In the
secondary market, the buying and selling (trading) of capital market instruments takes place. The
following chart will help us in understanding the organizational structure of the Indian Capital
market.
1) Government Securities Market :

This is also known as the Gilt-edged market. This refers to the market for government and
semi-government securities backed by the Reserve Bank of India (RBI). There is no speculation
in securities. Huge volume of transaction can take place as because it is obligated under Banking
Regulation Act 1949.

2) Industrial Securities Market

New securities INDUSTRIAL Issued Securities

issued SECURITIES Trade
MARKET

PRIMARY MARKET SECONDARY MARKET

This is a market for industrial securities i.e. market for shares and debentures of the existing and
new corporate firms. Buying and selling of such instruments take place in this market. This
market is further classified into two types such as the New Issues Market (Primary) and the Old
(Existing) Issues Market (secondary).In primary market companies, raise fresh capital by issuing
 new shares, bonds, units of mutual funds and debentures. However, in the secondary market
already, existing that is old shares and debentures are traded. This trading takes place through the
registered stock exchanges. In India, we have three prominent stock exchanges. They are the
Bombay Stock Exchange (BSE), the National Stock Exchange (NSE) and Over the Counter
Exchange of India (OTCEI).

i. Primary market
Primary market provides an opportunity to the issuers of securities, both Government and
corporations, to raise funds through issue of securities. The securities may be issued in the
domestic or international markets, at face value, or at a discount (i.e. below their face value) or at
a premium (i.e. above their face value).

ii. Secondary market

Secondary market refers to a market, where securities that are already issued by the Government
or corporations, are traded between buyers and sellers of those securities. The securities traded in
the secondary market could be in the nature of equity, debt, derivatives etc.

3) Development Financial Institutions (DFIs):

This is yet another important segment of Indian capital market. This comprises various
financial institutions. These can be special purpose institutions like IFCI, ICICI, SFCs, IDBI,
IIBI, UTI, etc. These financial institutions provide long term finance for those purposes for
which they are set up.
 ICICI
BANK
SFCI IFCI
BANK
DEVELOPMENT
BANKS

EXIM
NABARD
BANK
SDBI
BANK

4) Financial Intermediaries
The fourth important segment of the Indian capital market is the financial intermediaries. An
institution that acts as the middleman between investors and firms raising funds, often referred to
as financial institutions. Through the process of financial intermediation,
certain assets or liabilities are transformed into different assets or liabilities. As such, financial
intermediaries channel funds from people who have extra money (savers) to those who do not
have enough money to carry out a desired activity (borrowers).
This comprises various merchant banking institutions, mutual funds, leasing finance companies,
venture capital companies and other financial institutions.
These are important institutions and segments in the Indian capital market.
1.3CAPITAL MARKET INSTRUMENTS

1) Equity (instrument of ownership) Equity shares are instruments issued by companies to raise
capital and it represents the title to the ownership of a company. You become an owner of a
company by subscribing to its equity capital (whereby you will be allotted shares) or by buying
its shares from its existing owner(s). As a shareholder, you bear the entrepreneurial risk of the
business venture and are entitled to benefits of ownership like share in the distributed profit
(dividend) etc. The returns earned in equity depend upon the profits made by the company.
Company’s future growth etc.
2. Debt (loan instruments)
A. Corporate debt
I) Debentures are instrument issued by companies to raise debt capital. AsAn investor, you lend
you money to the company, in return for its promise To pay you interest at a fixed rate (usually
payable half yearly on specific Dates) and to repay the loan amount on a specified maturity date
say after5/7/10 years (redemption).Normally specific asset(s) of the company are held (secured)
in favor of Debenture holders. This can be liquidated, if the company is unable to pay
The interest or principal amount. Unlike loans, you can buy or sell these Instruments in the
market.

Types of debentures that are offered are as follows:

 Non-convertible debentures (NCD) – Total amount is redeemed by the Issuer
 Partially convertible debentures (PCD) – Part of it is redeemed and the Remaining is
converted to equity shares as per the specified terms
 Fully convertible debentures (FCD) – Whole value is converted into Equity at a specified
price

II) Bonds are broadly similar to debentures. Companies issue them, Financial institutions,
municipalities or government companies and are Normally not secured by any assets of the
company (unsecured).

Types of bonds
Regular Income Bonds provide a stable source of income at regular, predetermined intervals
-Tax-Saving Bonds offer tax exemption up to a specified amount of investment, depending on
the scheme and the Government notification. Examples are:
-Infrastructure Bonds under Section 88 of the Income Tax Act, 1961 NABARD/
NHAI/RECBonds under Section 54EC of the Income Tax Act, 1961 RBI Tax Relief Bonds

B. Government debt:
• Government securities (G-Secs) are instruments issued by Government of India to raise
money Secs pays interest at fixed rate on specific dates on half-yearly basis. It is available in
wide range of maturity, from short dated (one year) to long dated (up to thirty years). Since it is
Sovereign borrowing, it is free from risk of default (credit risk). You can subscribe to these bonds
through RBI or buy it in stock exchange.

D. Money Market instruments.

• Treasury Bills (T-bills) are short term instruments issued by the Government for its cash
management. It is issued at discount to face Value and has maturity ranging from 14 to 365 days.
Illustratively, a T-bill Issued at Rs. 98.50 matures to Rs. 100 in 91 days, offering an yield of
6.25% p.a.
• Commercial Papers (CPs) are short term unsecured instruments issued By the companies for
their cash management. It is issued at discount to face value and has maturity ranging from 90 to
365 days.

• Certificate of Deposits (CDs) are short term unsecured instruments issued by the banks for
their cash management. It is issued at discount to face value and has maturity ranging from 90 to
365 days.

3. Hybrid instruments (combination of ownership and loan instruments)

• Preferred Stock / Preference shares entitle you to receive dividend at a fixed rate. Importantly,
this dividend had to be paid to you before dividend can be paid to equity shareholders. In the
event of liquidation of the company, your claim to the company’s surplus will be higher than that
of
the equity holders, but however, below the claims of the company’s creditors, bondholders /
debenture holders.
• Cumulative Preference Shares: A type of preference shares on which dividend accumulates
if remains unpaid. All arrears of preference dividend have to be paid out before paying dividend
on equity shares.

• Cumulative Convertible Preference Shares: A type of preference shares where the dividend
payable on the same accumulates, if not paid. After a specified date, these shares will be
converted into equity capital of the company.

• Participating Preference Shares gives you the right to participate in profits of the company
after the specified fixed dividend is paid. Participation right is linked with the quantum of
dividend paid on the equity shares over and above a particular specified level.

4. Mutual Funds

Mutual funds collect money from many investors and invest this corpus in Equity, debt or a
combination of both, in a professional and transparent Manner. In return for your investment,
you receive units of mutual funds, which entitle you to the benefit of the collective return earned
by the fund, after reduction of management fees. Mutual funds offer different schemes to cater to
the needs of the investor are regulated by securities and Exchange board of India (SEBI)

 Types of Mutual Funds

At the fundamental level, there are three types of mutual funds:
 Equity funds (stocks)
 Fixed-income funds (bonds)
 Money market funds

5. Repo / Reverse Repo

A repo agreement is the sale of a security with a commitment to repurchase the same
security as a specified price and on specified date. The difference between the two prices is
effectively the borrowing cost for the party selling the security as part of the first leg of the
transaction.
Reverse repo is purchase of security with a commitment to sell at predetermined price and date.
The difference between the two prices is effectively interest income for the party buying the
security as part of the first leg of the transaction.
A repo transaction for party would mean reverse repo for the second party. As against the call
money market where the lending is totally unsecured, the lending in the repo is backed by a
simultaneous transfer of securities.

6. DERIVATIVES
A derivative is a financial instrument, whose value depends on the values of basic underlying
variable. In the sense, derivatives is a financial instrument that offers return based on the return
of some other underlying asset, i.e the return is derived from another instrument.
Derivative products initially emerged as a hedging device against fluctuations in commodity
prices, and commodity linked derivatives remained the sole form of such products for almost
three hundred years. . It was primarily used by the farmers to protect themselves against
fluctuations in the price of their crops. From the time it was sown to the time it was ready for
harvest, farmers would face price uncertainties. Through the use of simple derivative products, it
was possible for the farmers to partially or fully transfer price risks by locking in asset prices.
From hedging devices, derivatives have grown as major trading tool. Traders may execute their
views on various underlying by going long or short on derivatives of different types.

FINANCIAL DERIVATIVES:
Financial derivatives are financial instruments whose prices are derived from the prices of other
financial instruments. Although financial derivatives have existed for a considerable period of
time, they have become a major force in financial markets only since the early 1970s. In the class
of equity derivatives, futures and options on stock indices have gained more popularity
especially among institutional investors.
TYPES OF DERIVATIVES
1) FORWARDS
A forward contract is an agreement to buy
or sell an asset on a specified date for a
specified price. One of the parties to the
contract assumes a long position and
agrees to buy the underlying asset on a
certain specified future date for a certain
specified price. The other party assumes a
short position and agrees to sell the asset
on the same date for the same price, other
contract details like delivery date, price
and quantity are negotiated bilaterally by
the parties to the contract. The forward
contracts are normally traded outside the
exchange.

2) FUTURES
Futures contract is a standardized transaction taking place on the futures exchange. Futures
market was designed to solve the problems that exist in forward market. A futures contract is an
agreement between two parties, to buy or sell an asset at a certain time in the future at a certain
price, but unlike forward contracts, the futures contracts are standardized and exchange traded To
facilitate liquidity in the futures contracts, the exchange specifies certain standard quantity and
quality of the underlying instrument that can be delivered, and a standard time for such a
settlement. Futures’ exchange has a division or subsidiary called a clearing house that performs
the specific responsibilities of paying and collecting daily gains and losses as well as
guaranteeing performance of one party to other

3) OPTIONS
An option is a contract, or a provision of a contract, that gives one party (the option holder) the
right, but not the obligation, to perform a specified transaction with another party (the option
issuer or option writer) according to the specified terms. The owner of a property might sell
another party an option to purchase the property any time during the next three months at a
specified price. For every buyer of an option there must be a seller.
The seller is often referred to as the writer. As with futures, options are brought into existence by
being traded, if none is traded, none exists; conversely, there is no limit to the number of option
contracts that can be in existence at any time. As with futures, the process of closing out options
positions will cause contracts to cease to exist, diminishing the total number.
Thus an option is the right to buy or sell a specified amount of a financial instrument at a pre-
arranged price on or before a particular date.

4) SWAPS:
Swaps are private agreement between two parties to exchange cash flows in the future according
to a pre-arranged formula. They can be regarded as
portfolio of forward contracts. The two commonly
used Swaps are
i) Interest Rate Swaps: - A interest rate swap entails
swapping only the interest related cash flows
between the parties in the same currency.

ii) Currency Swaps: - A currency swap is a foreign

exchange agreement between two parties to
exchange a given amount of one currency for
another and after a specified period of time, to give back the original amount swapped.
 SIGNIFICANCE, ROLE OR FUNCTION OF
CAPITAL MARKET

Capital Market plays a significant role in the national economy. A developed, dynamic and
vibrant capital market can immensely contribute for speedy economic growth and
development.
Let us get acquainted with the important functions and role of the capital market:
1. Provide Liquidity for Financial Instrument
Capital markets provide liquidity to the Financial Instruments which are traded in the
Secondary Market. It depends on the Mobilization of savings Capital market is an important
source for mobilizing savings from the economy. It mobilizes funds people for further
investments in the productive channels of an economy. In that sense it activates the ideal
monetary resources and puts them in proper investments.

2. Provision of Investment Avenue

Capital market raises resources for longer periods of time. Thus it provides an investment
avenue for people who wish to invest resources for long period of time. It provides suitable
interest rate return also to investors. Instrument such as bonds, mutual Funds, insurance
policies definitely provide a diverse investment avenue for the public.

3. Proper regulation of Funds

Capital market not only helps in fund mobilization, but it also help in proper allocation of their
resources. It can have regulation over the resources so that it can direct funds in a qualitative
manner.

4. Continuous availability of Funds

Capital market is the place where the investment avenue is continuously available for long term
investment. This is a liquid market as it makes fund available on continues basis. Both buyers
and sellers can easily buy and sell securities as they are continuously available.
5. Raise capital for Industry
Capital market helps to raise capital for the industrial sector by investing in various securities
such as shares, debentures which can easily provide finance to industries.

6. Capital Formation
Capital market helps in capital formation. Capital formation is net addition to the existing stock
of capital in the economy. Through mobilization of savings it would generate investment in
various segments such as agriculture, industry etc. this helps in capital Formation.

7. Speed up Economic growth and Development

Capital market provides products and productivity in the national economy. As it makes funds
available for a long period of time, the financial requirements of business houses are met by the
capital market. Thus increase in production and productivity generates employment and
development in infrastructure.
 ROLE OF CAPITAL MARKET IN INDIA’S
INDUSTRIAL GROWTH

1. Mobilization of Savings and Acceleration of Capital Formation.

In developing countries like India plagued by paucity of resources and increasing
demand for investments by industrial organizations and governments, the importance of
the capital market is self-evident.

2. Promotion of Industrial Growth.

The capital market is a central market through which resources are transferred to the
industrial sector of the economy. The existence of such an institution encourages people
to invest in productive channels rather than in the unproductive sectors like real estate,
bullion etc. Thus, it stimulates industrial growth and economic development of the
country by mobilizing funds for investment in the corporate securities.

3. Raising Long-Term Capital.

The existence of a stock exchange enables companies to raise permanent capital. The
investors cannot commit their funds for a permanent period but companies require funds
permanently. The stock exchange resolves this clash of interests by offering an
opportunity to investors to buy or sell their securities while permanent capital with the
company remains unaffected.

4. Ready and Continuous Market.

The stock exchange provides a central convenient place where buyers and sellers can
easily purchase and sell securities. The element of easy marketability makes investment
in securities more liquid as compared to other assets.
5. Proper Channelization of Funds.
An efficient capital market not only creates liquidity through its pricing mechanism but
also functions to allocate resources to the most efficient industries. The prevailing market
price of a security and relative yield are the guiding factors for the people to channelize
their funds in a particular company. This ensures effective utilization of funds in the
public interest.

6. Provision of a Variety of Services.

The financial institutions functioning in the capital market provide a variety of services,
the more important ones being the following:
(I) Grant of long-term and medium-term loans to entrepreneurs to enable them to
establish, expand or modernize business units
(II) Provision of underwriting facilities;
(III) Assistance in the promotion of companies (this function is done by the
development banks like the idbi);
(IV) Participation in equity capital;
(V) Expert advice on management of investment in industrial securities.
 FACTORS CONTRIBUTING TO THE GROWTH OF
CAPITAL MARKET IN INDIA

1. Establishment of development banks and industrial financing institutions.

With a view to providing long-term funds to industry, the government set up the Industrial
Finance Corporation of India (IFCI) in 1948, i.e., soon after Independence. This was
followed by the setting up of a number of other development banks and financial institutions
like the Industrial Credit and Investment Corporation of India (ICICI) in 1955, Industrial
Development Bank of India (lOBI) in 1964, Industrial Reconstruction Corporation of India
(IRCI) in 1971, various State Financial Corporation’s (SFCs) at the State level, Unit Trust of
India (UTI) in 1964, State Industrial Development Corporations, Life Insurance Corporations
of India etc. In addition, 14 major commercial banks were nationalized in 1969.

2. Growing public confidence.

The early post-Liberalizations’ phase witnessed increasing interest in the stock markets. The
small investor who earlier shied away from the securities market and trusted the traditional
modes of investment (deposits in commercial banks and post offices) showed marked
preference in favour of shares and debentures. As a result, public issues of most of the good
companies were over-subscribed many times.

3. Increasing awareness of investment opportunities.

The last few years have witnessed increasing awareness of investment opportunities among
the general public. Business newspapers and financial journals, (The Economic Times, The
Financial Express, Business Line, Business Standard, Business India, Business Today,
Business World, Money Outlook etc.) have made the people increasingly aware of new long-
term investment opportunities in the securities market.
4. Setting up of SEBI.

The Securities and Exchange Board of India (SEBI) was set up in 1988 and was given
statutory recognition in 1992. Among other things, the Board has been mandated to create an
environment which would facilitate mobilization of adequate resources through the securities
market and its efficient allocation.

5. Credit rating agencies.

There are three credit rating agencies operating in India at present CRISIL, ICRA and CARE.
CRISIL (the Credit Rating Information Services of India Limited) was set up in 1988, ICRA
Ltd. (the Investment Information and Credit Rating Agency of India Limited) was set up in
1991 and CARE (Credit Analysis and Research Limited) was set up in 1993.
 Chapter-2

Role of Retail Investors in the Capital Market

2.1 About Retail Investors

2.1.1 Introduction

Retail investors are considered as the backbone of the Indian economy. They play a prominent role in
the capital market along with the foreign institutional investors and domestic financial institutions. Their
contribution towards the capital market especially after the introduction of financial reforms in India
needs to be studies thoroughly. This chapter is an attempt in that direction. The role of regulatory
authorities to safeguard the interests of the retail investors has also been studied.

The entire gamut of securities markets revolves around the three broad components i.e. issuers of the
securities, intermediaries and investors. However, the present study focuses on the investors’
component investor only. There are mainly three categories of investors in markets, viz. retail investors,
institutional investors, and no institutional investors. Other categories of investors include qualified
institutional buyers (QIBs) and non-institutional investors. QIBs comprise the following:

1. Mutual Funds
2. Scheduled Commercial Banks
3. Public Financial Institutions as specified in Section 4(A) of the Companies Act, 1956.
4. Development Financial Institutions
5. Pension and Provident Funds
6. Foreign Institutional Investors
7. Venture Capital Investors
8. Venture Capital Funds
9. State Industrial Development Corporations
10. Insurance Companies.
Non-institutional investors include the following:

1. Hindu Undivided Family (HUF) in the name of Karta

2. Corporate bodies
3. NRIs
4. Scientific Institutions
5. Societies & Trusts.

Investors support the development of economy by mobilizing their surplus resources through the capital
market and other means of investments. The retail investors assume greater significance because the
household savings account 30% of Gross Domestic Savings and it is the prime source of funding. The
retail investors stay for a longer period and this provides the stability to the markets. But, it is deplorable
that the household investors park their savings only 2% to 3% in capital market, and put their major
chunk of money in other class of assets, perhaps because they have burnt their fingers in the market
scams, manipulations and also on account of the higher volatility.

As per RBI data, the retail investors have put in around 3% of their savings in capital market (As per
Economics Times, 2017). There is urgent need to look into the causes and to take remedial actions, if we
expect consistent double-digit growth in GDP. There is need to increase the retail investors’
participation, and this could be done by increasing the financial literacy and awareness, expanding the
number of issues, providing diverse investment options, training and increasing the reach of
intermediaries, enhancing investor protection measures, simplified norms and cost effective services
(Rai, 2010). On the other hand, Kannadhasan (2011) while debating on the growth of retail investors,
states that according to SEBI statistical records, it shows that the Retail investors’ contribution towards
the capital market has increased due to globalisation and the investors’ awareness.

Venkateshwaran (2011) is of the view that the development of the securities market brings in a host of
benefits, including the creation of more complete financial markets, facilitating financial
disintermediation and risk diversification, financing of the government deficit, smooth conduct of the
monetary policy, stabilization of capital inflows and product innovation. There is need to have a
comprehensive data and relevant information from the regulated entities for incorporation in the flow of
funds accounts. Black, (2008) is of the view that policy-makers should view investor education as an
important aspect of fairness and the regulator must “encourage and promote informed investment
decision-making” as one of the main goals. According to her, it is unfair treatment if investors participate
in markets about which they lack the necessary education. Investor education becomes particularly
important with the increasing variety of investment products of greater complexity. In addition, many
retail investors make their investment decisions based on recommendations from brokers. In most of the
cases, these recommendations prove harmful to retail investors. Thus, investors need education about
basic investment theory so that they can understand and assess their advisors’ recommendations. The
retail investors are having a mix of the objectives i.e. regular income, value appreciation, Liquidity or
Marketability and most important safety & security (Kannadhasan 2011).

2.1.2 Who is a retail investor? Who comes under the purview of a retail investor?

In accordance with SEBI (Disclosures of Investor Protection) Guidelines {DIP Guidelines}, a retail
individual investor is defined as the one who applies or bids for securities of or for a value not exceeding
1 lakh as against the earlier limit of 50,000. However, SEBI has since increased the limit for retail
investors to 2 lakh (SEBI Circular, 2010). The word “applies or bids” means the investor can invest in
primary market through an IPO application or in mutual fund or in secondary market by bidding through
a broker/sub-broker. The definition as given in DIP Guidelines appears to be vague, as it does not specify
whether the value is the face value or the offered value including premium. But, for the present study,
the individual investors who hold shares not more than 20 lakh of face value as their investments are
taken into consideration.

2.1.3 Retail Investors: Backbone of Indian Economy

Investors are the backbone of any securities market as they are the prime constituents and the key
players in the financial system. No study about the securities market will be complete without the
mention of investors and shareholders/ stakeholders particularly the retail investors. As discussed in the
previous chapter, both the business houses and government look towards investors for raising money in
order to meet their need for funds for short-term and long-term development projects. A sound and
vibrant industrial system is a prerequisite for strong economy of any country. Investors are providers of
the much-needed finance for a strong economy. Hence, it becomes duty of the market regulator and
other intermediaries to protect the interests of the investors. Retail investors are advised to trade with
abundant caution and with limited amount of capital on which they can take risk. They should trade with
discipline and should know what they are doing in the market (Angel, 2007).

2.1.4 Importance of Retail Investors for Capital Market

There are talks at global level to protect the interests of investors particularly retail investors, because it
is the investors who build the stock market and the economy of any country. Retail investors look for
long-term investment, but on the other hand FIIs, FFIs, QIBs and HNIs play for short-term gains. If the
government and its various agencies are able to look after the interests of retail investors, the corporate
houses and government will be assured of long-term finances for building up the economy. History is
witness to the fact that stock markets of those countries have grown at a much faster pace, which have
taken care of investors, particularly the retail investors. Higher the investors’ confidence, more are the
chances of putting their savings in the productive channels. In other words, the capital formation takes
place at a faster pace where investors’ interest is taken care of. Individual investors have become far
more powerful than anyone gives credit. Bartimoro (2010) states that today 85% Americans invest in
stocks. Collectively, that kind of buying and selling power can move markets. This is the market we wish
for Indian Securities Market.

There is a growing concern about the safety and integrity of capital market at the international
level. The global concern is to make the stock markets safer, transparent and devoid of frauds
and scams. Today, Indian securities market is of one of the most robust and vibrant securities
market in the world. India has latest technology, shortest settlement cycle, paperless transaction
and screen based trading system, better corporate governance norms and faster dissemination of
information.

However, if we look at the participation of retail investors in Indian securities market, the picture
is not at all comparable with global statistics. The retail investors have preferred to stay away
from the securities market and have preferred to invest their hard-earned money in other safer
modes of investment like bank deposits, Insurance products, mutual funds, gold, real estate, etc.
Price manipulation, increased volatility, repeated scams, ineffective corporate governance norms,
etc. have been the main reasons for keeping the retail investors away from the securities market.
A wide investor base is always in the interest of Capital markets. It helps in checking the
volatility, deepening of the markets and reducing the cost of transactions (Neelakantan, 2010).
Thus, there is an urgent need to take care of the interests of retail investors if we wish to have a
strong and robust economy.

2.1.5 Investors and their Expectations

The investors predominantly look forward for following three objectives while investing their hard
earned money:

1. Safety of the invested money,

2. Liquidity of the instruments invested, and
3. Return on the investment.

Once the investors are sure of meeting of above-said three objectives, they invest their money
without worry. Thus, these three factors must be taken care of, if we wish for a robust and
vibrant securities market in the country. The securities instruments are the most rewarding as
well as challenging. The products are complex but offer unmatched returns.
A sound and vibrant securities market ensures that there is a free flow of funds to the corporate
houses and government, and at the same time it ensures that the interest of investors is taken care
of so that there is safety of their investments and they are able to derive handsome returns. There
arises a need to strike a balance between raisers of capital and the interest of investors. Unless
and until, we are able to protect the interest of retail investors, the corporate houses would find it
very difficult to raise money over a very large period of time. But at the same time investors are
advised not to trade in the markets based upon the recommendations of the brokers etc., rather
they should do their own study, if they wish to succeed (Bernstein, 2007). The investors are also
advised to have a long-term horizon in the markets and should not look for quick fixes. Investors
are advised to have a long-term horizon on floor and there are lot of months the investors grind it out
and they will have a few glorious months (Chandra, 2007). The interest of small or retail investors
should properly be taken care of, as the higher the degree of protection to retails investors, higher will
be standard of capital market of an economy as well. It is an indicator of capital market stability and for
economy. A capital market where retail investors’ interest is not duly taken care of can never be said to a
stable one.

2.1.6 Efforts made for the Growth of Retail Investors

SEBI has initiated a number of steps to boost the participation of retail investors. Following factors have
culminated in emergence of retail investors and their greater participation in securities market:

1. Nation- wide access of trading terminals of BSE and NSE,

2. Stronger Corporate Governance norms,
3. Increased participation of retail investors in IPOs,
4. Stipulation of minimum public shareholding,
5. Launch of various schemes by Mutual Funds for retail investors,
6. Introduction of shorter settlement cycle,
7. Demat of shares,
8. Increase in minimum public shareholding, and
9. Application supported by Blocked Amount (ASBA).

The above-said measures have brought retail investor to the forefront of Indian Stock Market and their
contribution can be gauged from the fact that Reliance Industries Limited alone has 35 lakh retail
shareholders or investors and the company has risen to the greater heights due to the large participation
of retail investors.
Many top industrial luminaries like late Mr. Dhiru Bhai Ambani and Late Mr. J.R.D. Tata had
great faith in Indian retail investor, and companies of these luminaries created world class
Business Empire just by motivating the retail investor to invest in their business ideas and
thereafter sharing the wealth with them. They were of the view that true spirit of corporate
democracy comes from participation of retail investor, which in turn leads to the overall growth
of the economy or an enterprise. The small money pooled from millions of investors makes it big
for companies and helps them realize the potential, which is quite evident from the mutual funds
and their collections (assets under management). However, the fact remains that despite above-
said measures initiated by SEBI and by the few of top corporate luminaries, the population of
retail investors has not increased to the desired level.

2.1.7 Foreign Institutional Investors: Impact on Indian Capital Market

In the recent years, Indian Capital Market has witnessed that Foreign Institutional Investors are
becoming major participants in the Stock Markets. They have a global investment perspective
and independent country market evaluating criteria. The basic concern in this context is
generating faith in Indian markets, which requires our market intermediaries to become more
transparent, more informative and encourage greater participation from the institutions and the
individuals. Better-educated and empowered investors play their role in stabilizing the market
which itself generates faith among the investors who are looking forward for better investment
opportunities. These investors too strongly influence the national economy. The growth of
institutional investors in the market is having its own advantages as well as it brings its own
share of problems. The participation by the bigger players in the market causes the market to
deepen and reduce the cost of transactions. Also, the increasing presence of this class of
investors leads to reforms in securities trading and transaction systems, nurturing of securities
brokers, and liquid markets. If we see the number of FII flows into Indian Capital Market, it is
increasing every year with substantial percentage, which has led to globalization of Indian
Securities Market.

Foreign investors in particular bring a very much-required welcome inflow of foreign capital,
but there are always some dangers if certain limits are exceeded. Firstly, the foreign investors are
free and unpredictable and are always on the lookout of profits. FIIs frequently move
investments, and those swings can be expected to bring severe price fluctuations resulting in
increasing volatility and instability. This is the way the FIIs are supplementing volatility in the
Indian market. This is what is happening in current scenario. Increased investment from overseas
is likely to shift control of domestic firms to foreign hands. This shows us how the Indian market
is interdependent on global markets like U.S., Europe and other Asian markets. Any meltdown in
these markets would cause them to sell in Indian markets resulting in sudden downslide and
panic. The sell off by FFIs and FIIs also triggers the sell wave by other investors and that causes
markets meltdown and sudden erosion of investors’ wealth. Rekha and Dutta (2009) are of view
that it is extremely difficult to say what can be the investment behaviour of the FIIs in the equity
markets.

While promoting induction of FIIs in the Indian Capital Market, the interest of retail investors
can never be ignored (Bhatnagar, 2010). Volatility emerging out of investment and disinvestment
by FIIs ultimately affects the financial health of the Retail and Small investors. Markets are
skewed towards the institutional players and that is why retail investors are staying away. The
much hyped NTPC (Indian blue chip PSU with strong fundamentals) could manage only 1.2
times in its follow on offer with retail participation of only 16% with only 80,000 applications
throughout the country (Dalal, 2010). The major challenges for growing the retail investor base
in India is due to lower risk appetite & expectations of the guaranteed returns, lack of
distribution reach in smaller cities, low awareness & confidence, short-term horizon and
regulatory conflicts (Nath, 2010).

2.2 Investment Process and Retail Investors

2.2.1 Process of Investment

A prudent retail investor passes through various stages for taking an investment decision, while
an ill informed retail investor simply ends up with the decision on the basis of rumours, tips,
without any scientific decision-making process and most of the decisions are taken instantly
without any study. It is observed that they are not fully educated and not aware about the
scientific process of investment and various investment avenues. Lack of awareness on the part
of investors, leads to ill informed investment decision and it consequently leads to financial
losses. The globalization of financial markets has made investors’ decisions complex (Bennet
and Selvam, 2011).
Research by behavioural finance experts has shown that investors’ financial decisionmaking is
not always driven by just mental considerations. The investors have revealed more human traits
in investment decision-making such as fear, greediness, risk seeking and aversion, peer group
pressures and pleasure rather than going in a systematic manner.

Psychological and behavioural factors play a vital role in investment decision rather than
fundamental analysis of facts and figures. It is a well-known fact that the ability of human beings
to make complex decisions is limited and emotionally and psychologically biased (Kannadhasan,
2011). Similarly, Tom Bierovic (2007) advises the investors not to get overly excited about
winning trades and do not get overly despondent about losing trades… you should not feel like a
hero after one winning trade and you should not feel like a bum after losing a trade.
2.2.2 Well-informed Investor

A well-informed investor makes his investment decision based upon sound reasoning and after
taking into consideration many parameters. These parameters could be, what should be his
investment objective, why should he invest, when should he invest, what are his investment
options, what care he should take while making investment and what should he do if he has any
grievances (SEBI, Publications on Investor Education).

A well-informed investor trades based on the well-defined parameters and he never invests his
100% money in stocks. He diversifies his portfolio, he always keeps watch over general market
conditions, he never lets his emotions prevail over a rational disciplined approach, he uses right
techniques and he expects the stock to be volatile and there will always be probability that
something may go wrong suddenly (Shamatov, 2009). According to Simha (1998), investment
decision-making in equity shares is a complex business, requiring the detailed study, deep
thinking, consultation with experts and a little luck too. An intelligent investor puts various
questions to self, his peers, market experts, and then tries to find the answers before taking an
investment decision. He makes in depth study before making any investments in any king of
instruments. The various questions and their possible answers differ from person to person, from
time to time and from circumstances to circumstances. This has been better explained in the following
Figure 2.1.

Table 2.1: Investment Questions and Possible Answers of Well Informed and Intelligent
Investor
S. No. Question Possible Answers

a. Why should I invest? (i) to earn returns on idle resources, (ii)

to achieve specified capital in life, and
(iii) to make provision for an uncertain future.
b. What are my investment (i) Better return on investments,
objectives? (ii) Education of kids,
(iii) Building a house,
(iv) Provisions for retirement,
(v) Provisions for ill health, etc.
 c. What are my investment (i) Equity Shares,
options? (ii) Preference Shares
(iii) Bonds and Debentures
(iv) Insurance schemes
(v) Mutual Fund Schemes
(vi) Derivatives, Futures & Options
(vii) Currency Futures
(viii) Gold Traded Funds (ix) Exchange Traded Funds (x)
Commodity Derivatives, etc.
(xi) ADRs, GDRs, FCCBs, IDRs etc.
d. When should I invest? (i) After studying about the stock, company, its
products, and management.
(ii) After analyzing economic conditions.
(iii) After checking ex- cum dividend, ex-cum bonus,
other rights, etc. on the stocks.
(iv) After analyzing overall market conditions etc.
e. What care should I take (i) Obtain written documents regarding investment
while investing? (ii) Read and understand such documents
(iii) Find out the cost & benefits associated with
these
(iv) Assess risk-return profile of the investment
(v) Know liquidity and safety aspect of the
investment
(vi) Seek clarifications about the investment and the
intermediary
(vii) Deal only through a SEBI registered intermediary
(viii) Explore alternate options in case something
wrong goes with the investment, etc.
f. What should I do if I (i) To lodge a complaint with the entity concerned at
have any grievances? the first instance.
(ii) To contact stock exchange grievance cell.
(iii) To lodge on-line complaint to SEBI.
Figure 2.1: Investment Cycle of a Well-informed and Educated Investor
 What care
should I take
while
investing?

What s hould
be my Why should I
investment invest?
objective?
Investment
Decision -
making
Process

What are my
When should I
investment
invest?
options?

What if I have
a grievance?

However, the ultimate objective is to have maximized returns on his investments. Gettess (2012)
is of the view that if the investors can lose money fast in the markets, they can earn it fast too.
The investors are advised to study and answer to all possible questions before venturing out.
Investors should enter into those markets that are more liquid. He further advised the investors
not to expect unrealistic expectations.

2.2.3 Ill-informed Investment Cycle

An ill-informed investor makes his investment decisions based upon tips, rumors, greed,
borrowed money, expectations of quick gains and tips received from others.
Table 2.2: Possible Causes and Reasons for Investment Cycle of an Ill- informed
Investor

S. No. Investment Possible Answers

Question
a. What happens An ill-informed investor always seeks tips from the so-called
if investor market experts and other market players, and based upon
based the tips, he invests his hard earned money, and thereafter
his loses his investments.
decision
on TIPS?
b. What are the An ill-informed investor invests his hard earned money
consequences based upon the rumours and grape-wines. Many
of unscrupulous elements spread rumours about a particular
RUMOURS? stock with ulterior motive to make money, and the innocent
investor gets trapped and thereafter loses his investments.

c. What is the Fear is one such of emotion that causes loss to the innocent
after effect of and ill-informed investor. Fear of losing money in stock
FEAR on markets makes an investor uncomfortable about his
investor? holding, and because of this, he takes ill-timed decisions
causing losses to him.
d. What Investment made by the borrowed money is bound to cause
happens if losses because investor has to pay the interest cost and
investor there would always be pressure upon him to return the
trades on money, thus making ill-timed decisions.
BORROWE
D money?
e. What causes Stock markets give handsome returns as compared to other
expectation of class of assets, but not quick gains, as expected by most of
QUICK? the investors. Expectations of quick gains induce the
investor to make wrong decisions causing loss to him.

f. What GREED Greed is, on the other end, spectrum of fear. Greed of
brings making quick money often burns fingers of the illinformed
to investor. The investor forgets to sell an overpriced share in
Investor? the hope of making more money and greed takes over, and
when prices fall, he is left high and dry.
An ill-informed investor does not study before making any investment decision; rather he invests
based upon the parameters as given in Table 2.2. All these factors enumerated in the table
account for the losses to the ill-informed investor and at the end, he blames everybody else
except himself.
The investment decision of an ill-informed investor can be best explained with the help of the
following figure:

Figure 2.2: Investment Cycle of an Ill-informed Decision

Borrowed
Money

Rumours
Tips

Investment
decision -
making

Fear and
Panic Quick gains

Hope and
Greed

2.3 Retail Investors and Importance of Household Savings

2.3.1 Number of Retail Investors

Now coming on to number of investors, it can be said that the Indian stock market is expanding
in scope, size and scale day-by-day and so is the number of investors. As of now, India has the
highest number of listed companies in the world and has taken over US, but the number of
investors is not at all commensurate with the size of population and the market depth. The
participation by the retail investors in equity market is very low, and immediate corrective
measures are required to be taken. The number of investors in the present market place can very
well be gauged from the number of Demat accounts with both the depositories, NSDL and
CDSL (Most of these account holders have account in both the DPs). However, as per latest
estimates, the investor population with demat accounts is around 32,656,750 which is
enumerated in Table 2.3.

Table 2.3: Number of Investors in Indian Depositories as on June 30, 2012

S. No. Depositories Number of demat

Accounts
1. NSDL 17,305,324

2. CDSL 15,351,426

TOTAL 32,656,750

Source: www.nsdl.co.in & www.cdslindia.com,

2.4 Scams and Retail Investors

World over securities markets have been marred by scams, manipulations, distortions, etc. “I can
calculate the movement of the stars, but not the madness of men” (Faber, 2011). The said quote
is attributed to Sir Isaac Newton who lost in the South Sea Stock crash during the period
December 1718 to December 1721. Indian securities market has witnessed a number of scams
due to the loopholes in the system, and because of these loopholes unscrupulous persons take
undue advantage at the cost of majority of investors. But the tragedy is that it is always the retail
investors that are most adversely affected. Patil (2010) is of the view that each global crisis has
its own initial triggering causes but have the similar underlying problems of economic greed and
reckless risks by the market players.
If we count the number of scams, these will outnumber the count on the fingers, but the painful
memories of Harshad Mehta Scam in 1992, Ketan Parekh Scam in 2001 and UTI fiasco in 1999-
00, plantation companies scams, demat scam and the latest being the Satyam case are still fresh
in our minds, and has eroded the confidence of retail investors in securities market. That is why
even today more and more people rely on safer mode of investment like FDR, Bank Savings,
NSC, etc. and consequently the stock markets’ participation is very low. Bernanke (2009) was
of the view that the challenge faced by regulators is to strike the right balance to strive for the
highest standards of consumer protection without eliminating the beneficial effects of the
responsible innovations on consumer choice and access to credit.

Venugopal (2012) righty states that investors face some more grievances other than listed by
SEBI. These are mainly due to lack of market liquidity in many securities, excessive speculation
in the market, price rigging on many scrips, insider trading by those possessing price sensitive
information, excessive premium charged by some company promoters under the guise of free
pricing norms etc.

The reforms introduced in the year 1990 and afterwards have resulted in sound and vibrant Indian Stock
Market, but at the same time these have also brought many ills with them. A critical look at the
happenings in the past painfully reveals the agony of small investors during the post liberalization era.
They have always been at the receiving end subject to unjustifiable losses and mental torture because of
the systemic failures and the frauds that have occurred in the capital markets in one form or other. The
various stock market intermediaries, Market Regulator and other regulatory organizations have realized
the importance of the stakeholders, shareholders or investors but a lot still, is required to be done. Table
no. 2.6 depicts the top ten frauds that have hit the Indian Securities Market and the quantum of the
amount involved in each of these scams.

Table 2.6: Top Ten Scams in Indian Securities Market

( in mn.)
S. No. Name Year Estimated
Amount
1. Harshad Mehta 1992 45000
2. C.R. Bhansali 1994 12000
3. Cobbler Scam 1995 10000
4. UTI Scam 2000 320
5. Ketan Parekh 2000 10000
6. Dinesh Dalmia (DSQ Software) 2001 6350
7. Sanjay Aggarwal (Home Trade) 2001 6000
8. Uday Goyal (Plantation Scam) 2003 2100
9. IPO Scam 2005 2338
 10. Satyam Scam 2009 80000
Source: Siddarth Singh, Top 10 Scams in India, www. indianblogger.com

2.5 Measures Initiated To Protection Retail Investors

2.5.1 Introduction

Protecting the interests of the investors needs to be the top priority of the market regulator and various
market intermediaries. A well-protected investor feels safe and secure and puts his hard earned money
in securities market. In case the investor does not feel safe, he will not put his money; and the economy
would be deprived of the much-needed finance. It is good to note that the market regulator has realized
this importance and has put in place a system to ensure availability of adequate, up-to-date and correct
information to the investors so as to enable them to take timely and wellinformed investment decisions.
Corporate Governance is also gaining significance, more particularly in the wake of globalization and
privatization. The regulator in order to ensure the protection of Retail Investors has initiated a number of
measures. The various stock market intermediaries, market regulator and other agencies have taken up
the task of protecting this vital segment of the capital market, i.e., retail investor but a lot still required
to be done.

There is increased evidence to suggest that the investor protection is the need of the hour, if India
expects consistent double-digit growth. Integrity of the financial markets and the well-being of the
economic power depends upon the accountability of the corporate houses and the level of the investors’
confidence in various instruments of financial markets. There is a growing concern at the global level to
make the capital market safer, transparent, deeper and vibrant, so as to ensure un-interpreted flow of
the funds to the economic mainstream.

2.5.2 Measures for Protecting the Interests of Retail Investors

SEBI in its various Annual Reports has prescribed the initiation of number of steps for investor protection
in Indian securities market, which are detailed as follows:

2.5.2.1 Enactment of SEBI (DIP) Guidelines

SEBI had issued a number of DIP (Disclosure & Investor Protection) guidelines in the interest of investors.
These guidelines cover the following:

1. Eligibility for issuer Companies,

 2. Cast responsibility on Market Intermediaries, and
3. Observe high standards of integrity and fair dealings.

These guidelines have been replaced with SEBI (ICDR) Regulations, 2009.

2.5.2.2 Introduction of Screen Based Trading

NSE introduced screen Based Trading System in India in 1996 by out placing of open outcry system. This
has been a landmark development in Capital Market of India, which brought transparency, speed and
efficiency in the trading system. At present 100%, trading is done through Screen Based Trading System
(SBTS). Online real time trading through SBTS is fully automated. It has broken the barrier of distance. A
person sitting far away has access to same trading screen as available in the Stock Exchange premises.

2.5.2.3 Reduction in Trading Cycle

Initially trading cycle was from 14-30 days and trades used to take 21-45 days to settle. Later on, SEBI
introduced weekly settlement in Indian Market. To further shorten the settlement cycle in order to
protect the interest of the investors, trading cycle was further reduced to T+5. Today, Two system is
working efficiently and SEBI further aims to bring down to T+1 system in the Indian Market. There is talk
for further reduction of trading cycle in regulator’s mind to T+1 and vision towards T+0.

2.5.2.4 Dematerialization

After dematerialization, the role of company with regard to transfer of shares has been reduced to nil as
shares are electronically transferred through depositories and its various participants.

 It has eliminated tribulations associated with physical shares.

 No delays in transfers and shares are freely transferable.
 It does not attract stamp duty (Indian Depository Act).

2.5.2.5 Introduction of Derivatives

Derivatives have been introduced in index and individual stocks in a phased manner. It assists market
participants to manage the investments better through the mechanism of hedging, arbitrage and risk
mitigation. Two derivative instruments, i.e., futures & options have been introduced in Indian Markets,
which are showing huge trading interest from all categories of investors.

2.5.2.6 Introductions of Risk Management Measures

(i) Capital Adequacy Requirements for Brokers and Sub-brokers

Brokers and sub-brokers under capital adequacy requirements stipulated by SEBI are required to have
adequate paid-up capital at all times to be eligible for trading. Further, they are required to deposit Base
Minimum Capital with the Exchanges, which varies from Exchange to Exchange.

(ii) Adequate Margin Requirements even at Client Level

SEBI has put in place margining system based on Value at Risk (VaR). These margins are calculated based
on risk exposure of particular group of shares. These requirements keep on changing with the
developments taking place in the market.

(iii) Limits on Exposure and Turnover

In order to protect the interests of the investors and to make brokers to honor their obligations, SEBI has
put in place exposure and turnover limits through online position monitoring of brokers and sub-
brokers. This ensures safety and efficiency of the market. If any broker, sub-broker crosses his exposure
limit, the robust trading system software automatically disables his trading terminal. The brokers and the
sub_brokers can set the similar limits for their clients as well. (SEBI Master Circular No CIR/ MRD/ DP/
42/ 2010).

2.5.2.7 Investor Education

SEBI has initiated massive public advertisement campaign for educating investors through print and
electronic media. A large number of Investor Awareness Workshops have been organized to disseminate
investor awareness, strengthening of investor redressal mechanism etc. by SEBI and various market
intermediaries. Ministry of Finance too have initiated the move for investor education and roped in
various statutory and non-statutory bodies in order to spread mass investor awareness at various town
and other smaller places.

2.5.2.8 Setting up of Clearing Corporation/ Clearing House

The leading Exchanges NSE & BSE have set up their respective Clearing Corporations in order to carry out
the functions of clearing of trades efficiently. Settlement risk has been reduced to a considerable extent
due to the establishment of clearing corporations, which have adopted latest technologies and
professional approach.

2.5.2.9 Professional Management and Demutualization of Stock Exchange

This path breaking reform has been introduced in the stock exchange recently. The stock exchanges,
which were earlier owned managed and controlled by the brokers, are now, being managed by
professionals. Moreover, the representation of broker members on the governing board has been
reduced to one-fourth of the total strength of the governing board. Their participation will be further
reduced to nil in a phased manner. The known “Not for Profit” character of the Exchanges have also
changed to the “for profit” character.

2.5.2.10 Regulations to the Protect Investor’ Interest against Takeover, Insider Trading or
Fraudulent Practices etc.

SEBI has framed various regulations pertaining to substantial acquisitions of shares and takeovers,
insider trading and fraudulent practices. Through these regulations, SEBI is empowered to impose a
maximum penalty of Rupees 25 crore for violation of its regulations.

2.5.2.11 High Level of Corporate Governance

SEBI since its inception has been endeavouring to introduce highest level of corporate governance
practices in India through suitable provisions in the listing agreement. Corporate governance essentially
means maximization of stakeholders’ interests, which includes shareholders, society at large. SEBI
through recent amendment in clause 49 of the Listing Agreement has comprehensively defined
framework for corporate governance for listed companies, which has been implemented w.e.f. 31 st
December, 2005 (Listing Agreement pursuant to SC(R)A, 1956).

2.5.2.12 Testing and Certification in Securities Market

In order to create skilled professionals in the Securities market, SEBI introduced testing and certification
of market intermediaries. Any market intermediary (Broker, Sub-broker, and Mutual Fund Agent) who
does not hold certification in financial market is not allowed to operate in market as such. This is a good
international practice, which has been suitably adopted in India. This puts the discipline in the whole
markets.
2.5.2.13 Margin Trading for Improving Liquidity

To improve liquidity in the market, SEBI has initiated steps to introduce margin trading. Trading in the
securities market is done with borrowed resources-funds or securities. The margin trading provides
facility to trade in the market with margin capital and this helps in increasing the liquidity in the markets.
Whenever there is an insufficient flow of demand and supply forces due to lack of funds or securities,
the margin trading enables investors increase their purchasing / selling power and raises the possibility
of increasing their profits.

2.5.2.14 Securities Lending and Borrowing Mechanism (SLBM)

Securities lending and borrowing mechanism provides liquidity and price discovery by offering equal
opportunities of short selling and margin trading to both buyers and sellers. This further ensures non-
failure of delivery and reduction of unsystematic risk. Issues regarding settlement risks are addressed
through borrowing and lending securities by clearing corporations. Clearing corporations can borrow
securities on behalf of members for the purpose of meeting their pay-on obligation, subject to some
conditions. This practice was stopped for a while by SEBI, but has now been restarted.

2.5.2.15 National Institute of Securities Market

National Institute of Securities Market (NISM) is a public trust, established by the Securities and
Exchange Board of India (SEBI). Based in Navi Mumbai, NISM in its ojectives, endeavours to enhance
market quality through educational initiatives. It is an autonomous body governed by its Board of
Governors. An international Advisory Council provides strategic guidance to NISM.

2.5.2.16 Establishment of Office of Ombudsman

SEBI has replicated this concept of Ombudsman in Indian Securities Market, which is also prevalent in
Indian Insurance and Banking Industry. The regulation for capital market Ombudsman has been notified
by SEBI and it is in the process of operationalising this agency for redressal of investor complaints. An
Ombudsman is an official body, appointed by the government or by Parliament, who is charged with
representing the interests of the public by investigating and addressing complaints reported by
individual citizens. The purpose of the office of Ombudsman is to safeguard the rights of citizens by
establishing a supervisory agency independent of the executive.

2.6 Observations of Experts and Role of Regulatory Authorities for Protection of

Retail Investors
All experts and authorities are of the opinion that protection of interest of retail investor is of paramount
importance in the present scenario as this vital segment of stock market has been ignored and is staying
away from the securities market. If the retail investors are brought back, it will result into development
of capital market as a whole, which will have a bearing for better economic growth.

India has a target of achieving double-digit GDP growth in the future, and if large number of retail
investors join the capital market, it would mean that more capital is being employed for productive
purposes in the economy and India can achieve its well-cherished dream of becoming a global economy
by 2020.

Bajpai (2005), former Chairman of SEBI, is of the opinion that with the liberalization and opening up of
different sectors including capital market, the domestic investors have a choice either to invest in India
or outside. Many reforms have been undertaken which include review of entry norms for IPOs,
enhancing quality of issues, upgradation disclosure standards, review of risk management processes, re-
orientation of codes of conduct for all intermediaries and most importantly being the introduction of
corporate governance norms. All these measures were aimed at improving the quality of the market and
making India stand among the best-regulated markets in the world.

Murthi (2005), former Chairman of Infosys, is of the view that all our institutions are as good as our
people. As long as you have crooks in the system, you will come across problems because these crooks
are able to by-pass regulatory mechanism you put in place. He was of the opinion that it is also very
important for us to educate our people to become better quality citizens, and not to allow these crooks
to benefit taking advantage of innocent and ignorant people.

Narayan (2005), President, Tamil Nadu Investor Association says that small investors depend upon
rumours and tips even now, and they really don’t go behind the fundamentals as he/she is not keen to
spend any time to get proper advice. So when his investment decision goes wrong and he blames
everybody except himself. Here is a need to educate these small investors to make prudent decisions.
He, further goes on to say that to make capital market healthy, we need to educate the investors. We
need to have investor awareness programmes and we must have a mechanism of investor protection.
We need to make the small investors a smart investor.

According to Dalal (2010), famous Finance Journalist, Capital Market should be offered early to the
students after they finish their matriculation examination. She further says that she has been receiving
lots of emails from many people wherein they say that they want to understand the basics of capital
market and there are hardly any books on capital market. She advises that BSE should start courses of
three months duration in capital market, and goes on to further add that the single most important
corrective measure is to make market little safer. Education, bringing more people on board, making the
system more accessible, spreading on infrastructure would go a long way in making market safer. At the
same time, we don’t have to get complacent because of having a world class system as most of the
turnover figures in our market are due to foreigners putting in their capital and trading in few scrips or
when you have 6000-7000 scrips where there is no trading.

Parekh (2005), Chairman, HDFC, was of the view that key to greater participation of retail investor is the
investor education. Investors who understand the risk and return possibilities, will be able to make a
more informed decision regarding their assets, and would be prone to a lesser chance of disappointment
from the capital markets. Understanding that one type of investment or a particular asset allocation may
not be appropriate for all investors, and that each investor based on his objective and risk appetite
needs to allocate his savings into specified securities, is important.

Highlighting the role of investor education and protection, Jain (2005), Finance Journalist, New Delhi
says that media’s role is to highlight the grievance , but in a manner in which it remains in focus. So, if
you are doing an investor grievance column, one way is to publish the grievance for a month or so and
later follow this up with action taken on the grievance. That is the only way the authorities will feel
under pressure to take action. The media is the vehicle that has exposed scams like Harshad Mehta
Scam, Ketan Parekh Scam etc. What restricts the media from doing better work is the lack of access to
the information on the entry cases of the scam and that has to do with the fact that our investigating
agencies do not do a good job.

While discussing the safe investing in stocks, Rambhia (2012), finds that investors should trade in low
volatility stocks as these stocks give absolute higher returns over a longer period of time than the high
volatility stocks.
 Chapter 2: Role Of FIIs In Indian Stock Market

“Huge investments are being done by FIIs

(Foreign Institutional Investors) in Indian
companies, But the question is - If India is a
developing country, why do they rely on our services
and invest in India. Do they lack the knowledge about
poverty and social issues in India? Does India has a
false image in International market?”

2.1 Introduction
Reason of above denotation lines, the truth is that they do not be short of acquaintance about the
poverty of India neither there is any false image in the International market. The main reason why
Foreign Institutional Investors put their money in India is because we have the ability to produce goods
and provide services at a lower cost. The scarcity employment opportunities in India has created a
situation where industries can easily hire a well qualified or even an over qualified professional at a
lower cost, usually at a fraction of international wage standards. In developed countries getting good
service from the well qualified professionals can be a significant burden on their budget. So, it staffing
costs affect the profitability and the survival of these foreign companies. If a company does not control
their cost then they will probably not survive, especially because their competitors might already be
outsourcing in India to save costs.

In India, there are so many qualified people, competing for good jobs. Pay scales provided by foreign
companies may be much lower than their domestic rate, but that lower salary will be an excellent one
for people in India due to lower living costs and currency exchange rate. If you post a single job, it is
common to get a list of 100 candidates, each of them almost equally well qualified. As such the scarcity
of employment opportunities brings good competition in the labour force and automatically improves
the the quality and productivity which is highly favorable for foreign corporations.

Labour costs in India rise each year and in some fields like software, people feel that we will no longer
experience a double digit salary increases anymore. This is important to protect the cost benefits and
continue to attract Foreign Institutional Investors to India.

This is the reason that industries like BPO, IT and Manufacturing are steadily rising in India.

There is hardly any big company in the entire world that does not have their presence in India in one way
or the other. Some companies outsource their accounting and others outsource IT and BPO operations.
Regardless of the domestic issues, they get an excellent service for their money
Before liberalization in 1991, India was a self reliant economy with markets depending on Domestic
institutions and investors. FIIs & OCBs were permitted to invest in Indian financial instruments in
September 1992 with restrictions.

India opened its stock markets to foreign investors in September 1992 and since then; considerable
amount of portfolio investment from foreigners in the form of Foreign Institutional Investor’s (FII)
investment in equities is coming in India. This has become one of the main channels of international
portfolio investment in India for foreigners. In order to trade in Indian equity markets, foreign
corporations need to register with the Security Exchange Board of India (SEBI) as Foreign Institutional
Investors (FII). FII’s have been allowed to invest in the Indian securities market since September 1992
when the Guidelines for Foreign Institutional Investment were issued by the Government. The

SEBI Regulations were enforced in November 1995, largely based on these Guidelines. The regulations
require FII’s to register with SEBI and to obtain approval from the

Reserve Bank of India under the Foreign Exchange Regulation Act to buy and sell securities, open foreign
currency and rupee bank accounts, and to remit and repatriate funds. Once SEBI registration has been
obtained, an FII’s does not require any further permission to buy or sell securities or to transfer funds in
and out of the country, subject to payment of applicable tax. Foreign investors, whether registered as
FII’s or not, may also invest in Indian securities outside the country.

2.2 Meaning & Definitions of FII

The term is used most commonly in India to refer to outside companies investing in the financial markets
of India. International institutional investors must register with the Securities and Exchange Board of
India to participate in the market. One of the major market regulations pertaining to FIIs involves placing
limits on FII ownership in Indian companies.

FII’s can be said to include investors or investment funds that are from or registered in a country outside
of the one in which they are currently investing. Institutional investors include hedge funds, insurance
companies, pension funds and mutual funds In other words Foreign Institutional Investor means an
entity established or incorporated outside India that proposes to make investment in India. Positive
tidings about the Indian economy combined with a fast-growing market have made India an attractive

destination for foreign institutional investors. FII investment is usually referred to as Hot Money because
it can leave the country at the same speed at which it comes in.

SEBI’s definition of FII’s presently includes foreign pension funds, mutual funds, charitable
/endowment /university funds etc. as well as asset management companies and other money managers
operating on their behalf.

According to Michael Frenkel and Lukas Menkhoff, “FIIs are beneficial for an economy
under specific institutional conditions. It is defining characteristic of an emerging market that these
conditions are often not met”.
Foreign institutional investors ‘investments are volatile in nature, and they mostly invest in the emerging
markets. They usually keep in mind the potential of a particular market to grow.
Foreign institutional investment is a short-term investment, mostly in the financial markets. FII, given its
short-term nature, can have bidirectional causation with the returns of other domestic financial markets
such as money markets, stock markets, and foreign exchange markets. Hence, understanding the
determinants of FII is very important for any emerging economy as FII exerts a larger impact on the
domestic financial markets in the short run and a real impact in the long run.

2.3 FIIs Investment Avenues

Foreign Institutional Investor invests in different avenue which are as follow: One who propose to invest
their proprietary funds or on behalf of "broad based" funds or of foreign corporate and individuals and
belong to any of the under given categories can be

registered for FIIs.

1. Pension Funds

2. Mutual Funds

3. Investment Trust

4. Insurance or reinsurance companies

5. Endowment Funds

6. University Funds

7. Foundations or Charitable Trusts or Charitable Societies

8. Asset Management Companies

9. Nominee Companies

10.Trustees
11. Bank

Currently entities eligible to invest under FII course are as follows

1. Designated bank.
"Designated bank" means any bank in India, which has been authorized by the Reserve Bank of India
to act as a banker to Foreign Institutional Investors.

2. Domestic custodian
"Domestic custodian" includes any person carrying on the activity of providing custodial services in
respect of securities.
3. Sub-accounts

“Sub-account" includes those institutions, established or incorporated outside India and those
funds, or portfolios, established outside India, whether incorporated or not, on whose behalf
investments are proposed to be made in India by a FIIs.

4. Domestic Entity:
A domestic portfolio manager or a domestic asset management company shall also be eligible to be
registered as FII to manage the funds of sub-accounts. FII’s registered with SEBI fall under the
following categories:
(a) Regular FII’s – Those who are required to invest not less than 70 per cent of their investment in
equity -related instruments and up to 30 per cent in non-equity instruments.

(b) 100 per cent debt-fund FII’s – those who are permitted to invest only in debt instruments.
5. Prohibitions on Investments:
Foreign Institutional Investors are not permitted to invest in equity issued by an Asset Reconstruction
Company. They are also not allowed to invest in any company which is engaged or proposes to
engage in the following activities:

a) Business of chit fund

b) Nidhi Company
c) Agricultural or plantation activities
d) Real estate business or construction of farm houses (real estate business does not include
development of townships, construction of residential or commercial premises, roads or
bridges).

e) Trading in Transferable Development Rights (TDRs).

2.4 The eligibility criteria for FII registration:

As per Regulation 6 of SEBI (FII) Regulations, 1995, Foreign Institutional Investors are required to fulfill
the following conditions to qualify for grant of registration:
1. Applicant should have track record, professional competence, financial soundness, experience,

general reputation of fairness and integrity;

2. The applicant should be regulated by an appropriate foreign regulatory authority in the same
capacity/category where registration is sought from SEBI. Registration with authorities, which are
responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor.
3. The applicant is required to have the permission under the provisions of the Foreign Exchange
Management Act, 1999 from the Reserve Bank of India.
4. Applicant must be legally permitted to invest in securities outside the country or its in-corporation /
establishment.
5. The applicant must be a "fit and proper" person.
6. The applicant has to appoint a local custodian and enter into an agreement with the custodian.
Besides it also has to appoint a designated bank to route its transactions.
7. Payment of registration fee of US $ 5,000.00
2.5 Supporting Documents Requirement:
1. Application in Form A duly signed by the authorised signatory of the applicant.
2. Certified copy of the relevant clauses or articles of the Memorandum and Articles of Association or
the agreement authorizing the applicant to invest on behalf of its clients
3. Audited financial statements and annual reports for the last one year , provided that the period
covered shall not be less than twelve months.
4. A declaration by the applicant with registration number and other particulars in support of its
registration or regulation by a Securities Commission or Self Regulatory Organisation or any other
appropriate regulatory authority with whom the applicant is registered in its home country.
5. A declaration by the applicant that it has entered into a custodian agreement with a domestic
custodian together with particulars of the domestic custodian.
6. A signed declaration statement that appears at the end of the Form.
7. Declaration regarding fit & proper entity.

2.6 Procedure And Grant Of Certificate

1. Where an application is made for grant of certificate under these regulations, the Board shall, as
soon as possible but not later than three months after information called for by it is furnished, if
satisfied that the application is complete in all respects, all particulars sought have been furnished
and the applicant is found to be eligible for the grant of certificate, grant a certificate in form B,
subject to payment of fees in accordance with the Second Schedule.

2. Provided that the Board may exempt from the payment of fees, an applicant such as the World Bank
and other institutions established outside India for providing aid, and which have been granted
privileges and immunities from the payment of tax and duties by the Central Government.
3. A foreign institutional investor holding a certificate shall, at all times, abide by the Code of Conduct
as specified in Third Schedule.
 Chart 2.1 Process of Foreign Institutional Investors Investments
2.7 Requirements of the Foreign Capital
The requirements of foreign investment/ foreign capital arise due to the following reasons:

1. Country Infrastructure:
The development of any economy depends on the available infrastructure in that country. The
infrastructure facilities such as Roads, Railways, sea ports, warehouses banking services and insurance
services are the prominent players. Due to long gestation period naturally individuals will not come
forward to invest in infrastructure industries. Government of India could not able to raise necessary
investments. To fill the gap foreign capital is highly suitable.

2. Industrilisaion:
The need for foreign capital arises due to the policy initiatives of the government to intensify the process
of industrialization. For instance the government of India is gradually opening the sectors to foreign
capital to expand the industrial sector.

3. Risk averse:
Any developing countries suffer from severe scarcity of private investors. The risk problem can be
diverted to the foreign capitalists by allowing them to invest. As we know the Indians are comparatively
risk averse. The same risk can be transferred to foreign investors by allowing their investment where risk
is more.

4. Global imperative:
Globalization is the order of the day. The international agreements between countries are also the
reason for the foreign capital. The multinational companies are expanding their presence to many
countries; while they are entering into the foreign countries they will bring their capital. The principles of
WTO and other regional associations are binding the member countries to allow foreign capital.

5. Comparative advantage:
The variations in the cost of capital like interest rate are also one of the important factors which resulting
in approaching foreign capital. For example; Interest rates are high in India compared with developed
economies. To reduce the cost of capital, companies/ organizations are now looking for foreign capital.
In several countries the interest rates are very low as 1% to 3%, where as in some countries the interest
rates are very high as 8% to 10% per annum.

6. To remove the technological gap:

The developing countries have very low level of technology compared to the developed countries.
However, these developing countries posses a strong urge for industrialization to develop their
economies and to wriggle out of the low level equilibrium trap in which they are caught. This raises the
necessity for importing technology from the advanced countries. That technology usually comes with
foreign capital when it assumes the form of private foreign investment or foreign collaboration.

2.8 Advantages of FII Investments

The advantages of having FII investments can be broadly classified under the following categories.

1. Enhanced flows of Equity Capital:

FII’s are well known for a greater appetite for equity than debt in their asset structure. For example
pension funds in the United Kingdom and United States had 68 per cent and 64 per cent respectively of
their portfolios in equity in 1998. Thus opening up the economy to FII’s is in line with the accepted
preference for non-debt creating foreign inflows over foreign Debt. Furthermore because of these
preferences for equities over bonds, FII’s can help in compressing the yield differential between equity
and bonds and improve corporate capital structures. Further, given the existing savings investment
gap of around 1.6 per cent, FII inflows can also contribute in bridging the investment gap so that
sustained high GDP growth rate of around 8 per cent targeted under the 10th Five year Plan can
materialize.

2. Managing Uncertainty and Controlling Risks:

Institutional investors support financial innovation and development of hedging instruments. Institutions
for example, because of their interest in hedging risks are known to have contributed to the development
of Zero coupon bonds and index futures. FII’s, as professional bodies of asset managers and financial
analysts just not only enhance competition in financial markets but also improve the alignment of asset
prices to fundamentals. Institutions in general and FII’s in particular are known to have good information
and low transaction costs. By aligning asset prices closer to fundamentals, they stabilize markets.
Fundamentals are known to be sluggish in their movements. Thus, if prices are aligned to fundamentals,
they should be as stable as the fundamentals themselves. Furthermore a variety of FII’s with a variety of
risk- return references also help in dampening volatility.

3. Improving Capital Markets:

FII’s as professional bodies of asset managers and financial analysis, enhance competition and
efficiency of financial markets. Equity market development aids economic development by increasing
the availability of riskier long term capital for projects and increasing firm incentives to supply more
information about themselves, FII’s can help in the process of economic development.

4. Improved Corporate Governance:

Good Corporate Governance is essential to overcome the principal agent problem between Shareholder
and Management. Information asymmetries and incomplete contracts between share holders and
management are at the root of the agency costs. Dividend payment, for example is discretionary. Bad
corporate governance makes equity finance a costly option. The large shareholders with leverage to
complement their legal rights and overcome the free rider problems but shareholding beyond say 5 per
cent also lead to exploitation of minority Shareholders. FII’s constitute professional bodies of asset
managers and financial analysts, who by contributing to better understanding of firms
operations improve corporate governance. Among the four models of corporate control - takeover or
market control via equity, leveraged control or market control via debt, direct control via equity and
direct control via debt or relationship banking. The third model which is known as corporate governance
movement has institutional investors at its core. In this third model, Board Representation is
supplemented by direct contacts by institutional investors.

Institutions are known for challenging excessive executive compensation and remove under performing
managers. There is more evidence that institutionalization increases dividend payouts and enhances
productivity growth.

2.9 Disadvantages of FII Investments:

The two common apprehensions about FII inflows are the fear of management takeover and
potential capital outflows.

1. Management Control:
There are domestic laws that effectively prohibit institutional investors form taking management control.
For example, US Law prevents mutual funds from owning more than 5 per cent of a Company’s
stock. According to the International Monetary Fund’s Balance of Payments Manual 5, FDI is
that category of international investment that reflects the objective of obtaining a lasting interest by a
resident of other economy. The lasting interest implies the existence of a long term relationship between
the direct investor and the enterprise.

2. Potential Capital Outflows:

FII inflows are popularly described as ‘hot money’ because of the herding behavior and potential for large
capital outflows. All the FII’s tries to either only buying or only selling at the same time particularly at
times of market stress. Value at Risk models followed by FII’s may destabilize markets by leading to
simultaneous sale by various FII’s as observed in Russia and Long Term Capital Management 1998
(LTCM) crisis. Extrapolative expectations or trend chasing rather than focusing on fundamentals can lead
to destabilization. Movements in the weight age attached to a country by indices such as Morgan Stanley
Country Index (MSCI) or International Finance Corporation (IFC) also leads to mass shift in FII portfolios.

2.10 Facilitation to Foreign Investment in India

Foreign investment can be done through automatic route up to 100 per cent without need for any
approvals in certain sectors which are open for Foreign investment. The investor has to keep the Reserve
Bank of India informed. The sectors not open to foreign investments are retail trade, housing and real
estate, agriculture, lottery and gambling. In certain sectors, there is a maximum prescribed limit on
foreign investment. Some of these are being increased. Prior approval of the government is needed for
those cases which need industrial license and those involving investment beyond the maximum limits.
Such cases are cleared by the Foreign Investment Promotion Board in a transparent, efficient, time-
bound and predictable manner. The department of industrial policy and promotion is the nodal agency
for information and assistance for foreign investors. Their website www.dipp.nic.in has comprehensive
information for foreign investors and gives weekly update on proposals for foreign investment under
consideration. It also gives information on projects available for foreign investors and contains online
applications for clearances

2.12 Impact Of FIIs On Indian Stock Market Performance

India opened doors to foreign institutional investors in September, 1992. This event represents a
landmark event since it resulted in effectively globalizing its financial services industry. Initially, pension
funds, mutual finds, investment trusts, Asset Management Companies, nominee companies and
incorporated/institutional portfolio managers were permitted to invest directly in the Indian stock
markets. Beginning 199697, the group was expanded to include registered university funds, endowment,
foundations, charitable trusts and charitable. Since then, FII flows which form a part of foreign portfolio
investments have been steadily growing in importance in India.

The FIIs are major institutional investors in Indian capital market. Movement in the SENSEX has clearly
been driven by the behavior of foreign institution investors. The presence of foreign institution investor
in the SENSEX companies and their active trading behaviours, their role in determining the share price
movements must be considerable. Indian stock markets are known to be known narrow and shallow in
the sense that there are few companies whose shares are actively traded. Although there are 4700
companies listed with stock exchange.

The BSE SENSEX incorporates only 30 companies, trading on whose shares are seen as indicative f
market activity. This shallowness also means that the FIIs can also affect the behavior of other retail
investors, who tend to follow the FIIs when making their investment decision.

The Indian stock markets are both shallow and narrow and the movement of stocks depends on limited
number of stocks. As FIIs purchases and sells these stocks there is a high degree of volatility in the stock
markets. If any set of development encourages outflow of capital that will increase the vulnerability of
the situation. The high degree of volatility can be attributed to the following reasons:

First, increase in investment by FIIs cause sharp price increase. It would provide additional incentives for
FII investment and this encourages further investment so that there is a tendency for any correction of
price unwaited by price earnings ratios to be delayed. And when the correction begins it would have to
lead by an FII pullout and can take the form of extremely sharp decline in the share prices.

Second, as and when FIIs are attracted to the market by expectations of a price increase that tend to be
automatically realized, the inflow of foreign capital can result in an appreciation of the rupee. This
increases the return earned in foreign exchange, when rupee assets are sold and the revenue converted
into dollars. As a result, the investments turn even more attractive triggering an investment twisting that
would imply a sharper fall when any correction begins.

Third, the growing realization by the FIIs of the power they wield in what are shallow markets,
encourages speculative investment aimed at pushing the market up and choosing an appropriate
moment to exit. This implicit manipulation of the market if resorted to often enough would obviously
imply a substantial increase in volatility.

Finally, in volatile markets, domestic speculators too attempt to manipulate markets in periods of
unusually high prices.

The stock market has also witnessed a growing trend of ‘Institutionalization’ that may be considered as a
consequence of globalization. The number of the institutional investor entities, whose primary purpose
is to invest their own assets or those entrusted to them by others and the most common among them
are the mutual funds and portfolio investors has been growing. Today, large institutions command a
control on the Stock market because they have large funds available with them and they move

continuously from one market to another. In European and Japanese markets, institutions virtually
dominate total trading of stocks there. However, in US, retail investors still remain active participants.

An important feature of the development of stock market in India in the last 17 years has been the
growing participation of Institutional Investors, both Foreign Institutional Investors and the Indian
Mutual Funds since the pension funds are still restricted to fully participate in the stock market
otherwise pension funds are big investors all world over. With the acceleration of reforms in India, the
stock market India opened its stock markets to foreign investors in September 1992 and since then;
considerable amount of portfolio investment from foreigners in the form of Foreign Institutional
Investor’s (FIIs) investment in equities is coming in India. This has become one of the main channels of
international portfolio investment in India for foreigners. In order to trade in Indian equity markets,
foreign corporations need to register with the Security Exchange Board of India (SEBI) as Foreign
Institutional Investors (FIIs). As a part of the reform process, the Government of India opened up the
Indian capital market to global competition and took measures to initiate structural reforms by putting in
place the requisite regulatory and supervisory structure in the form of SEBI. In a move towards current
account convertibility and to increase foreign exchange inflows, Foreign Institutional Investors (FIIs) were
permitted to invest in the tradable Indian securities such as shares, debentures, bonds, mutual fund
units etc. through primary and secondary markets as per guidelines issued by Government of India in
September 1992.

The FII flows to India began in January 1993. The number of foreign institutional investors (FII’s)
registered with the Securities and Exchange Board of India (SEBI) has now increased to 1,042 in June
2007 which was 813 in the beginning of calendar year 2006. The gross FII investments in the country till
June from the time they were allowed to invest in the India equity markets stands at US$ 53.06 billion.
FII’s have raised their holding in 540 companies out of top 1,000 companies on the Bombay Stock
Exchange (BSE) during September-March (2006-07) period. Companies that have gained favor with
foreign investors are mostly from construction, banking and second-line IT companies among others.
CLSA, HSBC, Citigroup and Merrill Lynch have been the most active foreign investors during January 2006
to April 2007. Together they were involved in US$ 4.73 billion worth of trading in shares. Apart from the
four FII’s, many others, including Crown Capital, Fidelity, Goldman Sachs, Morgan Stanley, UBS, T Rowe
Price International, Capital International, have taken a significant exposure to Indian equities Given that
India is one of the fastest growing economies in South Asia, promising a growth of over 6 percent,
second only to China, it would not be a surprise to see increased FII flows to India in the future. FIIs are
now looking at the economy as a whole, with the macro-economic factors also playing their role in
attracting foreign investors. Factors like a strong currency, key reforms in the banking, power and
telecommunications sector, increased consumer spending and stable policies are expected to play a
major role in attracting FIIs to India.

2.13 FIIs Recent Trend

1. Fast GDP growth has made India a preferred destination for foreign investors post the 2008 financial
crisis. In 2010 itself, India attracted nearly US$ 30 billion of net foreign inflows, which was just under
50 per cent of all inflows into emerging Asian markets, excluding China

2. FII Trading Activity - Rising Investments in equity and debt markets –Foreign investors have invested
Rs 6,460 crore (US$1.45 billion) in Indian stock markets in just five trading sessions of July 2011 and
the trend is expected to continue, according to analysts.
3. In the first six months of 2011, overseas investors infused around Rs 17,000 crore (US$3.82 billion)
into the Indian market, including stocks and bonds. In the same period, FIIs made investments of Rs
9,948 crore (US$2.23 billion) in the debt market, with investments in stocks being Rs 2,670 crore
(US$ 599.79 million).
4. FIIs bought equities and debt securities worth Rs 26,004 crore (US$ 5.84 billion) till July 10, 2011,
according to the data available with market regulator Securities and Exchange Board of India (SEBI).
5. The number of FIIs registered with SEBI increased from 1,718 as of December 31, 2010, to 1,730 as
of July, 2011. Moreover, the number of registered sub-accounts has risen from 5,503 in December
31, 2010 to 5,898 currently.
6. International investors increased their stakes in most companies last quarter. FII’s holding was higher
in 26 companies while it remained the same in 50 per cent of the 108 companies for which
shareholding details were available with stock exchanges as on July 13, 2011.
7. FII-supported out performers include Talwalkars Better Value Fitness (TBVF), Lupin, Petronet LNG,
GlenmarkPharma, ING Vysya Bank, MRPL and Castrol India. There is a growing trend of FIIs
increasing their exposure towards consumer staple companies.FIIs have raised holdings in
 companies such as Sintex, Cadila Healthcare, Asian Paints, Lupin and Ranbaxy Labs in the quarter
ended June, 2011.

8. FIIs have raised stakes in private sector lenders such as Kotak Mahindra Bank (0.60 per cent) and
Development Credit Bank (3.39 per cent).
9. For broking companies, FII stake has gone up in India Infoline, from 29.5 per cent to
35.71 per cent. FIIs raised their stake in Gujarat Pipavav Port to 23.09 per cent from
15.74 per cent in the previous quarter

10. FIIs have raised their ownership in India by 170 basis points to 20.4 per cent in 201011, through the

purchase of depository receipts and through market operations. Overall, FIIs hold 25 per cent of
market value of private sector companies and 7.7 per cent in government-owned companies.
11. FIIs purchased a high Rs 110,100 crore (US$ 24.73 billion) worth of shares in 201011. Of the shares

purchased, Rs 61,300 crore (US$ 13.77 billion) was through primary sources and Rs 48,800 crore
(US$ 10.96 billion) from the trading platform of the Bombay Stock Exchange (BSE) and the National
Stock Exchange (NSE).
12. In 2010, FIIs had increased their holdings by 150 bps to 18.7 per cent.

13. The Indian stock market has gained from the flow of FII money so far in July 2011. With lower

inflation numbers reported, and concerns over Greece debt sliding, the risk desire of global investors
has been in favour of emerging markets. Foreign investors infused more money in July in Indian
equities than for the period between January and June.
14. On the back of significant FII inflows, the Indian rupee has resumed its rise against the US dollar. On

July 6, 2011, the rupee closed at 44.48/49 after being as high as

44.3350. This was the highest since May 3, 2011.

2.14 Government Initiatives

1. FIIs are allowed to invest in the primary and secondary capital markets in India through the portfolio
investment scheme (PIS). Under this scheme, FIIs can acquire shares/debentures of Indian
companies through the stock exchanges in India.
2. The ceiling for overall investment for FIIs is 24 per cent of the paid-up capital of the Indian company,
and limit is 20 per cent of the paid-up capital in the case of public sector banks. The ceiling of 24 per
cent for FII investment can be raised up to sectoral cap/statutory ceiling, subject to the approval of
the board and the general body of the company passing a special resolution to that effect.
3. To further increase FII participation in the Indian market, the government and SEBI have taken
several measures:
4. Allowed foreign individuals, corporate and other investors such as hedge funds to register directly as
foreign institutional investors.
5. SEBI has FII investment limit in government securities being increased to US$ 5 billion from US$ 3.2
billion.
6. Institutional investors--including FIIs and their sub-accounts--have been allowed to undertake short-
selling, lending and borrowing of Indian securities from February 1, 2008.
7. SEBI has simplified the registration norms for FIIs and sub-accounts.

8. Significantly, it has allowed investment managers, advisors or institutional portfolio managers in the
NRI category to be registered as FIIs.
9. Consequent to the liberalisation of registration norms, the number of foreign institutional investors
(FIIs) registered with the Securities and Exchange Board of India (SEBI) has increased to 1403 as on
June 27, 2008 as compared with just 1051 FIIs a year back.
10. Simultaneously, the up gradation of India's sovereign ratings combined with the improvement in the

macro-economic situation and growth fundamentals has led to a near tripling of FII investments in
the debt market. Total investment in the country's debt market till November amounted to US$ 1.59
billion as against US$ 487 million in the corresponding period in 2006.
11. Also, with the government raising the investment limit for the FIIs in the Government Securities, the

FIIs are rushing in to buy Government paper. As of 27 June, 2008 FIIs have already invested US$ 3.87
billion in the debt market, as against US$ 2.29 billion in debt at the close of 2007.
12. Earlier in May 2008, SEBI had hiked the investment allocations to FIIs in both government and

corporate debt collectively by US$ 3.5 billion, taking the total investment limit to US$ 8 billion.

13. SEBI has said that it has relaxed the reporting norms for FIIs coming to India. These reporting

guidelines pertain to the lending of securities as part of short-selling. Till now, the FIIs were
supposed to disclose their information on a daily basis. After the relaxation, they need to do it on a
weekly basis.
14. SEBI has allowed FIIs to invest US$25 billion a year in bonds issued by infrastructure companies as

against the previous limit of US$5 billion. FIIs can now invest US$40 billion annually in corporate
bonds.
15. The Policy Guidelines on phase III expansion of private FM radio services, approved by the Cabinet,

have raised the aggregate cap on FII to 26 per cent from the existing 20 per cent. Allowing 26 per
cent will encourage foreign investors to invest as it gives them more leeway to participate actively in
management, according to TarunKatial,
Chief Executive Officer, Reliance Broadcast Network Ltd

2.15 Conclusion
The Foreign Institutional Investors have gained a significant role in Indian Capital Market. Availability of
Foreign Capital depends on many firm specific factors other than economic developments of the
country. Foreign investment refers to investments made by residents of a country in another country’s
financial assets and production processes.

After the opening up of the borders for capital movement, foreign investments in India have grown
enormously.

It affects the productivity factor of the beneficiary or the receiver country and has the potential to
create a ripple effect on the balance of payments of that country. In developing countries like India,
foreign capital helps in increasing the productivity of labor and to build up foreign exchange reserves to
meet the current account deficit. It provides a channel through which these countries can have access to
foreign capital. Foreign institutional investors ‘investments are volatile in nature, and they mostly invest
in the emerging markets. They usually keep in mind the potential of a particular market to
grow

The Indian economy has been one of the fastest growing economies in the world, next only to China.
According to the strong growth rate of GDP, India now ranks 10 th among the largest economies in the
world as per the World Bank Report. Indian economy has experienced the problem of capital in many
instances. While planning to start the steel companies under government control, due to shortage of
resources it has taken the aid of foreign countries. Likewise we have received aid from Russia, Britain
and Germany for establishing Bhiloy, Rourkela and Durgapur steel plants.

In the last decade during 2003-2012, the rises in stock market have been attributed to the
FIIS participation in the Indian Stock Market. But still FIIs are looked with a word of caution and a sense
of worry for market regulators. The foreign institutional investment was increased during the years 2006
and 2007. Later on, due to global financial crisis the investments by FIIs were reduced. FIIs investment
increased during 2008 to 2011.
This study observed that investments by FIIs and the movements of SENSEX are quite closely correlated
in India and FIIs wield significant influence on the movement of SENSEX. There is little doubt that FII
inflows have significantly grown in importance over the last few years.

In the absence of any other substantial form of capital inflows, the potential ill effects of a reduction in
the FII flows into the Indian economy can be severe. From the point of attracting foreign capital,the
initial expectations have not been realised. Investment by FIIs directly in the Indian stock market did not
bring significantly large amount compared to the GDR issues. GDR issues, unlike FII investments, have
the additional advantage of being project specific and thus can contribute directly to productive
investments.FII investments, seem to have influenced the Indian stock market to a considerable extent.