CBSE Class 12 Introducing and Understanding Transaction Cycle

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Chapter 5 Introducing and Understanding

Transaction cycle

Learning Objectives:

After reading this chapter, you should be able:

1. To identify the parties involved in the process of clearing and settlement.

2. To understand the functions of the relevant parties.

3. To understand the procedure of settlement of trades.

4. To know the types of risks that an investor is exposed to.

Your guide engine to learning:

5.1 Introduction

5.2 Transaction Cycle

5.3 Settlement Agencies

5.3.1 National Securities Clearing Corporation Limited (NSCCL)

5.3.2 Clearing Members

5.3.3 Custodians

5.3.4 Clearing Banks

5.3.5 Depositories

5.3.6 Professional Clearing Members (PCM’s)

5.4 Settlement Process

5.5 Risks in Settlement

5.5.1 Counterparty Risk

5.5.1.1 Replacement Cost Risk

5.5.1.2 Principal Risk

5.5.1.3 Liquidity Risk

5.5.1.4 Third Party Risk

5.5.2 System Risk

5.5.2.1 Operational Risk

5.5.2.2 Legal Risk

5.5.2.3 Systemic Risk


5.1 Introduction

Earlier we used to follow account period settlement for settling all the trades in the stock market. Account period in NSE was from Wednesday to the following Tuesday. This means trades done on Wednesday, Thursday, Friday, Monday and Tuesday will be paid-in on Tuesday and paid-out on the following Wednesday.

This was a time consuming process. An investor who had bought the shares will have to wait till the following Wednesday to get the delivery of shares, so he will be unable to reap the benefit of rising prices during the period. Also, the shares being in physical form created a lot of problem for the buyer as they had to be sent to the company or their R&TA (Registrar & Transfer Agent) for getting the ownership changed of the securities. While on BSE, the cycle commenced on Monday and ended on Friday. At the end of this period, the net obligations of all the brokers were calculated and the brokers Introducing and Understanding Transaction Cycle settle their respective obligations as per the rules, bye-laws and regulations of the clearing corporation.

Account period is a system that encourages liquidity in the market because people can buy and sell without having to pay immediately - almost like using a credit card. But the flip side of the system is that the longer it takes between a trade (a buy or sell) and actual settlement, the riskier the system is.

Nowadays, the scenario has totally changed. The clearing and settlement system has become very transparent and therefore, people have also started having faith in the market and its operations. The use of super computers to carry out the trades and to maintain their records has actually made the market operations crystal clear. Apart from the state of art information technology, the latest innovations include: 

- Emergence of clearing corporation to assume counterparty risks; we will be discussing this later in this chapter.

- Replacement of account period settlement by rolling settlement system leading to shorter settlement cycles,

- Dematerialization of securities has been adopted in place of physical securities; we will be discussing this later in this unit.

- Electronic transfer of securities through book entry system; we will be discussing this later in this unit.

- Fine tune risk management system, etc.; we will be discussing this later in this unit.

Though many of these have not been implemented fully as they are yet to reach the masses and penetrate the whole market. 

 


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