What Are The Different Kinds Of Transactions In the Stock Market?

We may undertake a few types of transactions in the securities market array for immediate settlement to the distant settlement.

Transaction kinds differ based on transactions in the stock market or outside the stock market (called OTC Trades). A concise explanation of diverse kinds of transactions is mentioned below:

Cash, Tom and Spot Trades/Transactions

Cash Trades:

·       Cash trades are the trades where settlement (payment and delivery) take place on the same trading day (T+0, were 0 terms the time gap in days between trade day and settlement day).

·       Cash trades in Financial Markets are strange as most contracts are settled between two to three days from the date of the trade.

·       On the other hand, we see cash transactions in our everyday day-to-day life when we buy groceries, vegetables, and fruits from the market.

Tom Trades

Tom trades are the trades where settlement (payment and delivery) take place on the day next to the trading day (T+1, where 1 term is the time gap in days between trade and settlement day). Some of the transactions in the Foreign Exchange Market (FX market) settle on a T+1 basis

Spot Trades

·       Spot trades are the trades where settlement (payment and delivery) takes place on the spot date, which is usually two business days after the trade date.

·         Equity markets in India present Spot trades. FX markets worldwide, by default, offer spot transactions in foreign exchange.

 

Forward Transactions

·       Forward contracts are a contractual agreement between two parties to buy or sell an underlying asset at a specific future date for a particular price that is decided on the date of the contract.

·       Both the contracting parties are dedicated and indebted to honour the transaction irrespective of the underlying asset price at the time of settlement. Since forwards were arranged between two parties, the terms and conditions of contracts were customized. These are Over-the-counter (OTC) contracts.

Example:

·       A farmer agrees to sell his produce of barley to a miller, 6 months later, when his crop is ready, at a price that both counterparties are in agreement today.

·       This is an OTC executed forward contract. It can be settled in cash or outcome in the actual delivery of barley.

·       The settlement conditions such as quantity and quality of the product, the price and payment terms, position benchmark in case of cash settlement of the contract, etc., are determined by the counterparties at the time of entering into a contract.

·       These contracts bear counterparty risk if either of the parties in the trade fails to honor his side of the contract.

·       Consequently, these contracts are generally entered between known parties and lean on informal protection mechanisms to ensure that the contract is honoured. In several parts of India, the forward markets in commodities are based on mutual trust and are functional despite the risks involved.

 

Swaps

In the financial markets, a swap is a derivative contract made between two parties to exchange cash flows in the future according to a pre-organized formula. Swaps assist market participants control risks related to volatile interest rates, currency rates, and commodity prices.

Example:

·       On a borrowing, the borrower has to pay a quarterly interest rate, which is definite as the Treasury bill rate on that date plus a spread.

·       This floating rate interest payment means that the actual obligation of the borrower will depend on what the Treasury bill rate would be on the date of each settlement of interest obligation. On the other hand, the borrower prefers to pay a fixed rate of interest.

·       He can utilize the interest rate swap market to get into the following swap order:

·       Every quarter must pay a fixed rate to the swap dealer

·        Receive T-bill plus spread from the swap dealer every quarter

·       The swap in this contract is nothing but that one party pays a fixed rate to the other and receives a floating rate in return.

·       The principal amount on which the interest will be calculated is agreed upon between counterparties (called notional of the trade).

·       Only the interest rate on this amount is exchanged on each settlement date (every quarter) between counterparties.