Class 12 FMM chapter 3 Notes for Free

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Are you worried about your class 12 Financial Market Management Exam? So, here we have Class 12 FMM chapter 3 notes for free.

So if you are a student of class 12th standard and you are not well prepared for your FMM examination. The notes given are going to be very helpful for you to get prepared for your exams very quickly.

Before starting with our notes we would like to tell you to read these notes very carefully and note them down in your textbook for further examination revision.

This chapter is totally based on three main terms that are Clearing, Settlement, and Legal Framework. We are going to describe all of these terms in a few lines. To understand each and every topic of this chapter you have to read our class 12 FMM chapter 3 notes very sincerely. So, let’s begin with our notes.

What do you mean by Clearing?

Clearing includes the transfer of funds and securities from buyer’s and seller’s accounts to clearing corporations (NSCCL) through their trading members/brokers.

What do you mean by Settlement?

The settlement includes the transfer of funds and securities to the seller and buyer respectively by the clearing corporation (NSCCL).

The legal framework includes all the legal buying and selling of stocks in the share market with the permission of the government. As all the buying and selling of shares in the Stock market is done with the permission of the government.

Terms that you should Remember

Before learning further concepts of this chapter we would like to make you all familiar with some key terms that are used in this chapter. These terms are given below one by one:

  1. Pay-in day: the day on which the broker for trading members makes payment of funds order delivery of securities to the clearing corporation (NSCCL).
  2. Securities pay-in: securities pay-in includes the transfer of shares from the client or company’s Demat account to the clearing corporation (NSCCL).
  3. Funds pay-in: Funds pay-in involves the transfer of funds from the buyer’s Demat account to the clearing corporation (NSCCL).
  4. Pay-out day: The day on which the clearing corporation (NSCCL) transfers funds to the seller’s account and securities to the buyer’s account.
  5. Securities pay-out: Securities pay-out includes the transfer of securities from clearing agencies to the buyer’s Demat account.
  6. Funds Pay-out: Funds pay-out include the transfer of funds from the clearing corporation (NSCCL) to the seller’s account.

What is the Clearing process?

The process includes the transfer of funds and securities from buyer’s and seller’s accounts to clearing corporations (NSCCL) through their trading members/brokers.

NOTE: You should read all the headings of ‘Class 12 FMM chapter 3 notes for free’ very carefully. Please Ignore this note.

What is the Settlement process?

The process involves the transfer of funds and securities to the seller and buyer respectively by the clearing corporation (NSCCL).

What are Settlement Agencies?

Settlement agencies are a part of the stock exchange. They play a vital role in the selling and buying of shares in the share market. There are mainly 5 types of settlement agencies. These are given below:

Clearing Corporation (NSCCL): Clearing Corporation (NSCCL) is an authority in the stock exchange that helps in the transfer of securities and funds between buyer and seller. The main function of a clearing corporation (NSCCL) is to do the pay-in and pay-out of funds and securities among the buyer and the seller.

Clearing Member– The clearing member help in informing the broker or trade member to pay in funds and securities on the behalf of buyer and seller. In some cases, the broker/trading member is the clearing member. The clearing member is the only one who transfers funds and securities to the clearing corporation (NSCCL).

Clearing Bank: While settling any trade the buyer and seller transfer funds and securities to the clearing corporation (NSCCL) and then the clearing corporation (NSCCL) give funds to the seller’s account and Securities to the buyer’s account. In this trade, the funds and securities of the buyer and seller are transferred to the clearing bank account of the buyer and seller. While settling any trade it is very necessary for buyers and sellers to have an account in a clearing bank.

Custodian: custodian is the person who safeguards the legal agreements of securities on the behalf of the buyer. If any person wants to keep any security for a very long time so they used to hire a custodian to safeguard legal agreements of their securities. It is not very necessary to hire any custodian to safeguard the legal agreements of your securities.

Depositories: The Depositories help in the settlement of the dematerialized securities. The depository runs an electronic file to transfer the securities from accounts of the custodians or clearing members to that of the NSCCL. As per the schedule of allocation of securities determined by the NSCCL, the depositories transfer the securities on the pay-out day from the account of the NSCCL to those of the trading members or custodians.

Transaction Cycle

The transaction table which is also known as the transaction table tells us about the main steps that are involved in clearing and settlement of a trade in the Share market.

The Transaction Cycle is the most important topic of Class 12 FMM chapter 3 Notes so, you should read it very carefully.

There are mainly six steps in a transaction cycle. In the further paragraph, we are going to tell you about the steps in the Transaction Cycle.

class 12 FMM chapter 3 notes
Class 12 FMM chapter 3 notes

Steps in Transaction Cycle

  1. The decision of Trade: When the person decides to buy or sell a share in the share market.
  2. Placing Order: Placing orders include instructing the broker to place an order on the behalf of that person.
  3. Trade Execution: when any order found its match then that order is converted into the trade. This process is called trade execution.
  4. Clearing of Trade: the clearing of the trade includes the pay-in of funds from buyers and securities from the seller to the clearing corporation (NSCCL).
  5. Settlement of Trade: after the clearing of trade that trade had to be settled by clearing agencies (NSCCL). In settlement of trade, the clearing corporation (NSCCL) transfers funds to the seller’s account and securities to the buyer’s account.
  6. Funds/Securities: At the end of the Transaction cycle the funds or securities are transferred successfully to the seller and buyer respectively by the clearing corporation (NSCCL) in the share market.

Settlement Cycle

The settlement cycle includes all the major and minor steps that are involved in the settlement process of any trade in the stock market.

The settlement cycle for securities in dematerialised and physical form:-

Settlement cycle for dematerialised securities:

  1. Normal Market: Hindi normal market all the trades are settled on a T+2 basis.
  2. Inter-institutional deals: in this market segment only institutions can trade.

NOTE- Physical securities- Those securities that are in form of documents.
Dematerialised securities – those securities that are in electronic form instead of paper form

Settlement cycle for physical securities:

Limited physical market: In a limited physical market all the settlement is done on a trade for trade basis.

Salient features of Limited physical market
  • If the delivery of any security is done on the name of any street in that case that delivery is considered as bad delivery.
  • If there is the last transfer date in the introduction or after the introduction of trading in a limited physical market. Then this delivery is also considered as bad delivery.
  • Each and every delivery had to be compulsorily attested by the introducing member or delivery member.
  • The buyer of securities had to send it for dematerialisation within three months from the payout date.

Types of Settlements

There are two main types of securities. Their names are given below:

  1. Securities Settlement
  2. Funds Settlement

Securities Settlement

In securities settlement, there are two types of securities first one are materialized securities and the other are physical securities. So, we are telling you about the settlement process of both of these securities.

Settlement of dematerialized securities
  • Securities obligations of the client are downloaded by NSCCL.
  • The Depositories deliver all the securities to the clearing corporation (NSCCL).
  • The client should have an account on depositories participants. Either NSDL or CDSL.
  • In the case of NSDL, the member needs to give instruction to transfer securities to the clearing corporation (NSCCL). On the other hand in the CDSL, the pay-in is done on the basis of a settlement id through in which members have to provide separate balances for each settlement.
  • Now, the client needs to make sure that the settlement number and type are correctly entered to avoid any kind of problem in the future.
  • After making sure that all the details are correct. The Clearing Corporation (NSCCL) transfers securities directly to the client’s account using the ‘direct payout to investor system’.

NOTE: Read all the headings of ‘Class 12 FMM chapter 3 notes for free’ very carefully. Please Ignore this note.

What is the Direct payout to Investor system?

Direct payout to Investor system is a system in which the clearing corporation (NSCCL) directly delivers securities to the client’s account. This call is done on the basis of the details given by the clearing member (broker).

Salient features of payout to Investors
  1. The trading member of broker had to submit a file to the clearing corporation (NSCCL) about the settlement type, settlement number, delivery type etc. So that the payout code sent to the clients account securely. This file should be in a format that is is made by the clearing corporation (NSCCL).
  2. The file is needed to be submitted before 9:30 a.m. on d pay-out day.
  3. After the clearing corporation (NSCCL) received the file so they upload it in their system and respond in form of accepting or reject.
  4. The clearing member or broker had to submit the information of the client in any one of the depositories (CDSL or NSDL).

Settlement of Physical Securities

  1. The security obligations of the client are downloaded by the clearing corporation.
  2. The trading member or custodian delivers securities to the clearing corporation (NSCCL) as pay-in.
  3. The documents should be delivered to the clearing corporation (NSCCL) by the trading member/broker between 9:30 a.m. to 10:30 a.m. on the settlement day.
  4. The member is needed to make sure that all the details such as settlement number and type are correct to avoid any kind of default.
  5. At last the clearing corporation (NSCCL) Transformers securities as payout on pay-out day.

Problems in Securities Settlement

1. Short delivery: If any client makes an order for 100 shares but the trade is started in only 80 or 90 shares in this case that delivery is considered as short delivery.

2. Bad Delivery: If there is any fault in the securities certificate then that delivery is considered as bad delivery. In this case, the client had to report that delivery to the clearing corporation (NSCCL) within two days after delivery. This problem arises only in physical securities.

3. Company Objectives: This problem occurs when the security transfer documents are returned back because of any mistake such as signature mismatch etc.

Funds Settlements

For this fund settlement, the clearing member or broker had to open an account in any one of impaneled banks. The clearing corporation declared 13 main impaneled banks which are- State Bank of India, Axis Bank, Canara Bank, HDFC Bank, etc.

Settlement of Funds
  1. First of all the clearing member had to inform of fund obligations through the daily clearing data download.
  2. The daily fund’s statement data has all the details about debit and credit in the broker’s account
  3. The clearing member of the broker had to make funds available for settlement in their account.
  4. At the time of the fund settlement, the clearing member or broker had to send funds. In case the clearing member does not have adequate fund for a settlement then they use any other account for the deduction of funds for settlement.
  5. The clearing member had to pay in funds before 11:00 a.m. so they had to make funds available in their account.
  6. The funds are credited to the account of the clearing member after 1:30 p.m. on the pay-out day.

Funds Shortage

The shortage of funds in the clearing account of the broker is called Fund shortage. In this case, the trade cannot be settled.

Penalties charged to Clearing Mmener for Fund Shortage

There are some penalties that are to be charged from the clearing member or broker if there is a fund shortage while settling any trade. Some of the penalties charged to the broker are as follows:

  1. Failure to fulfill the fund obligations
  2. Failure to fulfill their securities delivery obligations
  3. Security deposit shortage
  4. Margin shortage

Shortage Handling

In shortage handling, we learn about how the clearing member or the broker handles fund shortages in their account.

If the clearing corporation (NSCCL) notices short delivery to clearing members so they charge an amount that is equivalent to the securities not received. This deducted amount is called a valuation debit.

NOTE: You should read all the headings of ‘Class 12 FMM chapter 3 notes for free’ very carefully. Please Ignore this note.

Valuation Price

The amount which is debited as valuation debit is called ‘Valuation price’. There are two main methods to calculate the valuation price.

  1. The valuation price for short delivery or failure to deliver deals.
  2. The valuation price for bad delivery.
Close-Out Procedure

All shortages not bought-in are deemed closed out at the highest price between the first day of the trading period till the day of squaring off or closing price on the auction day plus 10%/20% (as the case may be). This amount is credited to the receiving member‘s account on the auction payout day. The close-out procedure is done in the following manner for different markets and varies from case to case.

Risks in Settlement

There are two main types of risks in a settlement process.

  1. Counterparty risk
  2. System risk

Counterparty Risk

The risk that arises due to any fault of the buyer or seller. As we all know that the buyer is a counterparty for the seller and the seller is a counterparty for the buyer. There are two types of counterparty risk:

1. Replacement Cost Risk: The replacement cost risk arises when anyone buyer or seller refused to pay in on the pay-in day.

The buyer or seller refused to pay in because in the past time the trade is settled on T+9 days so in this time period the price of that particular security increased or decreased. This leads to gain or loss to anyone buyer or seller.

That is why any one of them refused to pay in on the pay-in day. To resolve this risk the trade is to be settled within T+2 days.

2. Principal Risk: The principal risk arises when any one of the buyers or sellers in but the other counterparty refused to pay in on the pay-in day.

In this case, the counterparty didn’t get their payout even after doing the pay-in. To reduce this risk delivery versus payment mechanism was introduced.

In this mechanism when the pay-in is done to the clearing corporation (NSCCL) then after it the payout is transferred to both counterparties.

System Risk

This system risk is of three subcategories:

1. Operational system risk: The operational system risk occur when there is an operational failure such as errors, frauds, Outage, etc.
2. Legal system risk: The legal system risk arises when law regulations do not allow the enforcement of the settlement.
3. Systemic risk: Systemic risk takes place when one party failed to discharge his obligations.

NOTE: You should read all the headings of ‘Class 12 FMM chapter 3 notes for free’ very carefully. Please Ignore this note.

Risk Management

If you read Class 12 FMM chapter 3 Notes carefully so we are damn sure that all the topics covered in this chapter are crystal clear for you. And if you want to ask any questions from us so tell us in the comment box.

We published this post on Class 12 FMM chapter 3 notes for free that will help you to learn Class 12 FMM chapter 3 notes for free.

For more information, we have provided notes of other chapters of the class 12th FMM book. In the list given below, we provided another Class 12 FMM Chapter 3 Notes so if you want to read another Class 12 FMM Chapter 3 Notes. So, these are given below:

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