MARKET MAKING :
Though there are thousand companies listed on the stock exchanges in India only a few of them are being actively traded in the market. Thus the market sentiment was not representative of a wide range of industries or companies, because mostly concentrated on a few scrips. This leads one to conclude that mere listing of securities does not provide liquidity to scrips. A process known as market making was clearly needed to build up liquidity. The market maker by offering a two way quote not only increases the supply of scrips but also triggers of a demand in the scrips. SEBI has taken the view that market making will go a long way in reducing the bane of concentration and thus eliminating the influence of the unbalanced Sensitive Index.
Market-making is aimed at infusing liquidity in securities that are not frequently traded on stock exchanges. A market-maker is responsible for enhancing the demand supply situation in securities such as stocks and futures & options (F&O ). To understand this concept better, it would be helpful to have an idea about the existing screen based electronic trading system. In this system , orders placed by buyers and sellers are matched by a computer system (run by stock exchanges). This system is beneficial for actively-traded stocks, but not for lesser-traded ones. Investors usually ignore thinly-traded stocks despite good fundamentals due to fears that they might not be able to trade more frequently in them. This is where a market maker comes into the picture. The introduction of the market-making facility could be a possible means to infuse liquidity into such shares. In overseas markets, a market-maker is usually a broker or an institution. As a result, there is an incentive for the broker to recommend securities for which he creates a market.
A market-maker usually is responsible for enhancing activity in a few chosen securities. In the process, the market-maker provides both a buy and a sell quote for his chosen securities. He profits from the spread between buy and sell quotes. For example, if the market-maker gives a bid-ask quote of ` 505-500 (which means the market-maker will buy from the market at ` 500 and sell at ` 505), then the profit is ` 5. For illiquid securities, the profit spreads are usually higher (within a regulator-prescribed band) because of the higher risk taken byn the market-maker.
Market-makers are obligated to buy or sell the security at a price and size they have quoted. One may wonder the role of a market- maker in the computerised system , as investors can transact directly without a third party. The market-maker’s role here is to ensure supply of stocks at any given point in time. Market-makers are helpful as they are always ready to buy or sell as long as investors are willing to pay the price quoted by them.