Working of Stock Broking Firm

Stock Broker
As seen earlier, According to Rule 2 (e) of SEBI (Stock Brokers and Sub brokers)
Rules, 1992, a Stock Broker means a registered member of a recognized stock exchange. A
broker is an intermediary who arranges to buy and sell securities on behalf of clients (the buyer
and the seller). No stockbroker is allowed to buy, sell or deal in securities, unless he or she holds
a certificate of registration granted by SEBI. The constitution of a broking firm may be a
Proprietary Concern, a Partnership firm or a Corporate.
BUSINESS
Over a period of time RSL has recorded a healthy growing rate both in business volume and
profitability as it only the major players in this line of business. The business thrust has mainly in
the development of business from Financial Institutions, Mutual Funds and Corporate.
OPERATIONS
The operations of the company are broadly organized among the following functions.
1. Research & Analysis
This group is focused on doing stock picks and periodical scrip/ Segment specific research.
They provide the best of analysis in the industry and are valued by both our institutional and
Retail Clients
2. Marketing
This group is focused on tracking potential business opportunity and converting them into
business relationships. Evaluation the need of the clients and tailoring products to the meet
there specific requirements help the company to build lasting relationship.

3. Dealing
Enabling the clients to procure the best rates on their transactions is the core function of this
group.
4. Back office
This group ensures timely delivery of securities traded, operation matters with stock
exchange, statutory compliance, handling tasks like pay-in, pay-out, etc. This section is fully
automated to enable the staff to focus on the technicalities of securities trading and is manned
by professionals having long experience in the field.

Departments in Stock Broking Firm

(A) Central Depository Services Ltd (CDSL) Department

CDSL Department

Demat Account
Opening

Dematerialization &

Transmission

Settlement

Rematerialization

& Nomination

of Trade

(B) Compliance Department

Compliance Department

Reg. Of Client

Individual

Reg. of Sub Broker

Non-individual

Joint Stock Co.

Partnership firm

Sole Proprietor

(C) Dealing Department

Dealing Department

Buying Securities

Selling Securities

Entering

Order

Order

Order

Orders

Modification

Cancellation

Matching

(D) Settlement Department

Settlement Department

Pay In Of

Pay Out Of

Pay In

Pay Out

Securities

Securities

Of Funds

Of Funds

(E) Risk Management Department / Surveillance Department

Risk Management Department

Capital

On Line

Off Line

Margin

Circuit

Adequacy

Monitoring

Monitoring

Requirements

Filters

RISKS INVOLVED IN A STOCK BROKING FIRM

A stock broker has to deal with various risks while dealing with its sub brokers, clients etc. Due
to the high volatility of the market broker is always exposed to the risks. The various risks borne
by a broker can be classified as under.

Risks in broking firms

Market

Financial

Credit

Liquidity

Operational

Risks

Risks

Risks

Risks

Risks

(1) MARKET RISKS

Market risks are the risks which cause due to the high volatility of market and value of scrips.
These risks arise due to adverse market rate movements i.e. foreign exchange rate, interest rates,

commodity prices and equity prices. The value of investments may decline over a given time
period simply because of economic changes or other events that impact large portions of the
market. Proper asset allocation and diversification can protect against market risk.

(2) FINANCIAL RISKS

Financial risk is the risk that a company will not have adequate cash flow to meet the financial
obligations. Financial risk means fear of loss of money, which is the biggest risk faced by a
broking firm. Financial risk in respect of broking firm can be of two types firstly loss of income
i.e. brokerage secondly loss of capital. It has a risk that it will go out of funds because of nonpayment by the clients, sub brokers etc.
(3) CREDIT RISKS
Credit risk is the risk that the counter party of financial transaction will fail to perform according
to the terms and conditions of the contract, thus causing the other party to suffer a financial loss.
Credit risk is the risk of loss due to a debtor's non-payment of a loan or non-fulfilment of terms
and conditions of contract. Credit risk is often due to bankruptcy or insolvency of the counter
party which results in non-payment of dues.
(4) LIQUIDITY RISK
Liquidity risk is a risk which arises from the difficulty of selling an asset and realizing the money
of it. Market liquidity is the risk that a financial instrument cannot be sold quickly at a price,
which equates to their market value.

An investment may sometimes need to be sold quickly. Unfortunately, an insufficient secondary

market may prevent the liquidation or limit the funds that can be generated from the asset. Some
assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company),
while other assets are highly illiquid and have high liquidity risk (such as a house).

(5) OPERATIONAL RISKS

Operational risks are explained as Risk of loss arising due to procedure errors, omission or
failure of internal control system. These risks are defined as The risk of loss resulting from
inadequate or failed internal processes, people and systems or from external events. An
operational risk is a risk arising from execution of a company's business functions. As such, it is
a very broad concept including fraud risks, legal risks, physical or environmental risks, etc.
Operational risks are very common risks, which are found almost in every organization. All the
organizations face the risks that their activities and processes may be disrupted unexpectedly or
fail and this will stop the functioning of organization. Such events may cause an organization
certain problems like

Direct financial losses, which arise from failing to meet an obligation (e.g. penalty
interest payments or restitution loss).

Direct financial losses, attributable to an absence of income (e.g. loss of sales, transaction
fees, direct fees or commission)

Statutory or regulatory penalties resulting to revocation of licenses.

Opportunity costs, arising from adverse publicity, being unable to trade or because of
processing delays, backlogs, and poor customer service delivery or poor product or
service quality.

In stock broking firms the operational risks are found at various levels of departments. They are
as follows.
Operational Risks

CDSL

Compliance

Dealing

Department

Department

Department

Settlement
Department

Risk Management
Department

WAYS TO DEAL WITH RISK

Ways to deal with Risk

Avoid

Retain

Reduce

Transfer

(A) AVOID THE RISK

Avoidance of risk Includes not performing an activity that could carry risk. Avoidance may seem
the answer to all risks, but avoiding risks also means losing out on the potential gain that
accepting the risk may have allowed. Not entering a business to avoid the risk of loss also avoids
the possibility of earning profits.

(B) RETAIN THE RISK

Retention of risk involves accepting the loss when it occurs. Risk retention is a viable strategy
for small risks where the cost of insuring against the risk would be greater over time than the
total losses sustained. All risks that are not avoided or transferred are retained by default. This
includes risks that are so large that they either cannot be insured against or the premiums would
be infeasible.
(C) REDUCE THE RISK
Reduction in risk involves methods that reduce the severity of the loss or the likelihood of the
loss from occurring. Outsourcing could be an example of risk reduction. For example, a
company may outsource its manufacturing of hard goods to another company, while handling the
business management itself. This way, the company can concentrate more on business
development without worrying much about the manufacturing process.
(D) TRANSFER THE RISK
Risk transference causes another party to accept the risk, typically by contract or hedging.
Insurance is one type of risk transfer which uses contracts. Liability among construction or other

contractors is very often transferred this way. Such transference of risk may include certain cost
like insurance premium.

MEASURES TO REDUCE THE RISK

Risk management in a Broking Industry is a new concept in India, since it poses maximum risk
in the financial market, managing it was felt most essential by the regulatory bodies and
exchanges. Therefore NSE introduced for the first time in India, risk containment measures that
were common internationally but were absent from the Indian Securities Market. NSCCL has put
in place a comprehensive risk management system, which is constantly upgraded to preempt
market failures. These measures were taken to reduce the brokers risks.
Whereas SEBI has given some guidelines under Investors Protection to protect investors risks.
NSE has given the following risk management measures
Margins
NSE has specified Different margins for different instruments like stocks futures and options etc.
Margins depend upon the volatility and market conditions, it vary from stock to stock and
instrument to instrument Categorization of stocks for imposition of margins
Margins
There is a lot of uncertainty in the movement of share prices. This uncertainty leading to risk is
sought to be addressed by margining systems by stock markets. Stock exchange in turn collects
similar amount from the broker upon execution of the order. This initial token payment is called
margin.
For every buyer there is a seller and if the buyer does not bring the money, seller may not get the
money. Margin is levied on the seller also to ensure that he gives the shares sold to the broker
who in turn gives it to the stock exchange.

Daily margins payable by members consists of the following:

1. Value at Risk Margins
2. Mark to Market Margins
Daily margin, comprising of the sum of VAR margin and mark to market margin is payable.
Value at Risk Margin
VAR margin is applicable for all securities in rolling settlement. All securities are classified into
three groups for the purpose of VAR margin. The VAR based margin would be rounded off to the
next higher integer (For E.g. If the VAR based Margin rate is 10. 0 1, it would be rounded off to
11. 00) and capped at 100%.
The VAR margin rate computed as mentioned above will be charged on the net outstanding
position (buy value-sell value) of the respective clients on the respective securities across all
open settlements. The net positions at a client level for a member are arrived at and thereafter, it
is grossed across all the clients for a member to compute gross exposure for margin calculation.
For example, in case of a member, if client A has a buy position of 1000 in a security and client
B has a sell position of 1000 in the same security, the net position of the member in the security
would be taken as 2000. The buy position of client A and sell position of client B in the same
security would not be netted. It would be summed up to arrive at the member's exposure for the
purpose of margin calculation. VAR margin rate & Security category
Mark-to-Market Margin
Mark to market margin is computed on the basis of mark to market loss of a member. Mark to
market loss is the notional loss which the member would incur in case the cumulative net
outstanding position of the member in all securities, at the end of the relevant day were closed
out at the closing price of the securities as announced at the end of the day by the NSE. Mark to
market margin is calculated by marking each transaction in scrip to the closing price of the scrip
at the end of trading. In case the security has not been traded on a particular day, the latest
available closing price at the NSE is considered as the closing price.

In the event of the net outstanding position of a member in any security being nil, the difference
between the buy and sell values would be considered as notional loss for the purpose of
calculating the mark to market margin payable.
Extreme Loss Margin
The extreme loss margin aims at covering the losses that could occur outside the coverage of
VAR margins. This margin rate is fixed at the beginning of every month, by taking the price data
on a rolling basis for the past six months.