Introduction to capital markets

1. CAPITAL MARKETS

2. The capital market: Introduction
 The capital market is a market which deals in long-
term loans.
 It supplies industry with fixed and working capital
and finances medium-term and long-term borrowings
of the central, state and local governments.
 The capital market deals in ordinary stock, shares and
debentures of corporations, and bonds and securities
of governments.
 The issuing houses underwrite the shares and
debentures of companies and help in selling their new
issues of shares and debentures.
 The demand for funds comes from joint stock
companies for working and fixed capital assets and
inventories and from local, state and central
governments

3.  The capital market functions through the stock
exchange market.
 A stock exchange is a market which facilitates
buying and selling of shares, stocks, bonds,
securities and debentures.
 It is not only a market for old securities and shares
but also for new issues shares and securities.
 In fact, the capital market is related to the supply and
demand for new capital, and the stock exchange
facilitates such transactions.
 Capital markets channel savings and investment
between suppliers of capital such as retail investors
and institutional investors, and users of capital like
businesses, government and individuals.
 Capital markets are vital to the functioning of an
economy, since capital is a critical component for
generating economic output.

4. Functions of Capital Market?
1. Link between Savers and Investors:
 The capital market functions as a link between savers and
investors. It plays an important role in mobilising the
savings and diverting them in productive investment.
2. Encouragement to Saving:
With the development of capital market, the banking and
non-banking institutions provide facilities, which
encourage people to save more
3. Encouragement to Investment:
 The capital market facilitates lending to the businessmen
and the government and thus encourages investment. It
provides facilities through banks and nonbank financial
institutions.

5. 5. Promotes Economic Growth:
 Various institutions of the capital market, like
nonbank financial intermediaries, allocate the
resources rationally in accordance with the
development needs of the country. The proper
allocation of resources results in the expansion of
trade and industry in both public and private sectors
6. Provide insurance against market risk or price risk
through derivative trading and default risk through
investment protection fund.
7. Disseminate information efficiently for enabling
participants to develop an informed opinion about
investment, disinvestment, reinvestment, or holding
a particular financial asset.

6. 8. Stability in Security Prices:
 The process of stabilisation is facilitated by
providing capital to the borrowers at a lower
interest rate and reducing the speculative and
unproductive activities.
9. Enable quick valuation of financial instruments—
both equity and debt.
10. Direct the flow of funds into efficient channels
through investment, disinvestment, and
reinvestment.

7. Benefits to Investors:
 The credit market helps the investors, i.e., those who
have funds to invest in long-term financial assets, in
many ways:
 (a) It brings together the buyers and sellers of
securities and thus ensure the marketability of
investments,
 (b) By advertising security prices, the Stock
Exchange enables the investors to keep track of their
investments and channelize them into most profitable
lines,
 (c) It safeguards the interests of the investors by
compensating them from the Stock Exchange
Compensating Fund in the event of fraud and default.

8. History of Indian capital Market
 The capital market was not well-organized and
developed during the British rule
 In the post-independence era also, the size of the
capital market remained small.
 Public sector undertakings were healthier than private
undertakings
 The Controller of Capital Issues (CCI) closely
supervised and controlled the timing, composition,
interest rates, pricing, allotment, and floatation costs
of new issues
 In the 1950s, Century Textiles, Tata Steel, Bombay
Dyeing, National Rayon, and Kohinoor Mills were the
favourite scrips of speculators
 Financial institutions such as LIC and GIC were the
most important group of investors.

9.  The first mutual fund of India, the Unit Trust of India
(UTI) came into existence in 1964.
 In 1974 restricting the payment of dividend by
companies to 12 per cent of the face value or one-third
of the profits of the companies that can be distributed
as computed under Section 369 of the Companies Act,
whichever was lower.
 1980s witnessed an explosive growth of the securities
market in India,
 Major capital market scams took place in the 1990s. It
was the scam which prompted a reform of the equity
market.
 The Bombay Stock Exchange was subject to
nationwide competition by two new stock
exchanges—the National Stock Exchange, set up in
1994, and the Over the Counter Exchange of India, set
up in 1992.

10.  The National Securities Clearing Corporation
(NSCC) and the National Securities Depository
Limited (NSDL) were set up in April 1995 and
November n1996 respectively for improved
clearing and settlement and dematerialized
trading.
 Foreign institutional investors have emerged as
major players
 Now the capital market is organized, fairly
integrated, mature, more global and modernized

11. Components of Capital Market: Primary Market and
Secondary Market
 1. Primary Market (New Issue Market):
 Primary market is also known as new issue market.
 As in this market securities are sold for the first time,
i.e., new securities are issued from the company.
 Primary capital market directly contributes in capital
formation because in primary market company goes
directly to investors and utilises these funds for
investment in buildings, plants, machinery etc.
 This refers to the long-term flow of funds from the
surplus sector to the government and corporate sector
(through primary issues) and to banks and non-bank
financial intermediaries
 The common securities issued in primary market are
equity shares, debentures, bonds, preference shares
and other innovative securities.

12. Intermediaries in primary market
 There are three categories of participants in the primary market
1. Merchant Banker : A merchant banker should be registered with the SEBI
as per the SEBI (Merchant Bankers) Regulations, 1992 to act as a book
running lead manager (BRLM) to an issue. He perform pre-issue and post-
issue activities
2. Registrar to the Issue : The role of the registrar is to finalize the list of
eligible allottees, ensure crediting of shares to the demat accounts of the
eligible allottees, and dispatch refund orders.
3. Bankers to the Issue: They are appointed in all the mandatory collection
centres, and by the lead merchant banker to carry out activities relating to
collection of application amounts, transfer of this amount to escrow
accounts, and dispatching refund amounts.
4. Underwriters: They will purchase the balance share that not purchased by
the public for fixed amount as fees.
5. Stock brokers:professional trader who buys and sells shares on behalf of
clients.

13.  The fund-raising in the primary market can be
classified as follows:
 Public issue by prospectus
a) Fixed Method
b) Book Building method
 Private placement
 Rights issues
 Preferential issues

15.  Public issue can be further classified into two
types:
1. Initial Public Offerings ( IPO):
 The most important mode of issuing
securities is by issuing prospectus to the
public.
 If the issue has been made for the first time
by a body corporate, it is known as initial
public offer.
 The securities issued by the company for the
first time either after incorporation or on
conversion from private to public.

16. Continued
 The information in the prospectus helps the public to
know about the risk and earning potential of the
company and accordingly they decide whether to
invest or not in that company
 Through IPO company can approach large number of
persons and can approach public at large. Sometimes
companies involve intermediaries such as bankers,
brokers and underwriters to raise capital from general
public
2. Further Public Offerings (FPO) or Seasoned Public
Offerings (SPO) : When an already listed company
makes either a fresh issue of securities to the public or
an offer for sale to the public, it is called a FPO

17. Offer for Sale
 Under this method new securities are offered to
general public but not directly by the company but by
an intermediary who buys whole lot of securities from
the company.
 Generally the intermediaries are the firms of brokers.
 So sale of securities takes place in two steps: first
when the company issues securities to the
intermediary at face value and second when
intermediaries issue securities to general public at
higher price to earn profit.
 Under this method company is saved from the
formalities and complexities of issuing securities
directly to public.

18. (2) Private placement (PP):
 When an issuer makes an issue of securities to a
select group of persons not exceeding 50, and which
is neither a right issue nor a public issue, it is called a
private placement.
 The private placement method is a cost saving
method as company is saved from the expenses of
underwriter fees, manager fees, agents’ commission,
listing of company’s name in stock exchange etc.
 Small and new companies prefer private
placement as they cannot afford to raise from public
issue.

19. Continued
 Under this method the securities are sold by the
company to an intermediary at a fixed price and in
second step intermediaries sell these securities not
to general public but to selected clients at higher
price.
 The issuing company issues prospectus to give
details about its objectives, future prospects so
that reputed clients prefer to buy the security from
intermediary.
 Under this method the intermediaries issue
securities to selected clients such as UTI, LIC,
General Insurance, etc.

20. Apreferential issue
 A preferential issue is an issue of shares or of convertible
securities by listed companies to a select group of persons
 The issue of shares on a preferential basis can be made at a
price not less than the higher of the following:
 i) The average of the weekly high and low of the closing
prices of the related shares quoted on the stock exchange
during the six months preceding the relevant date;
 ii) The average of the weekly high and low of the closing
prices of the related shares quoted on a stock exchange
during the two weeks preceding the relevant date.

21. Qualified Institutional investors
 Qualified Institutional Buyers are those
institutional investors who are generally perceived
to possess expertise to evaluate and invest in the
capital markets.
 QIPs were created to avoid dependency on foreign
resources for raising capital
 Qualified institutional placements (QIPS) are a
way to issue shares to the public without going
through standard regulatory compliance.
 To be allowed to raise capital through a QIP, a firm
must be listed on a stock exchange along with the
minimum shareholding requirements as specified
in their listing agreement.

22. Right Shares
 This is the issue of new shares to existing
shareholders.
 It is called right issue because it is the pre-
emptive right of shareholders that company must
offer them the new issue before subscribing to
outsiders.
 Each shareholder has the right to subscribe to the
new shares in the proportion of shares he already
holds. A right issue is mandatory for companies
under Companies’Act 1956.

23.  The stock exchange does not allow the existing
companies to go for new issue without giving pre-
emptive rights to existing shareholders because if
new issue is directly issued to new subscribers
then the existing equity shareholders may lose
their share in capital and control of company. To
stop this the pre-emptive or right issue is
compulsory for existing company.
 According to the SEBI guidelines, no listed issuer
company shall make any rights issue of securities,
where the aggregate value of such securities,
including premium, if any, exceeds Rs.50 lakh,
unless a draft letter of offer has been filed with the
SEBI, through a merchant banker, at least 30 days
prior to the filing of the letter of offer with the
designated stock exchange.

24. E- IPOs
 It is the new method of issuing securities through
on line system of stock exchange.
 In this company has to appoint registered brokers
for the purpose of accepting applications and
placing orders.
 The company issuing security has to apply for
listing of its securities on any exchange other than
the exchange it has offered its securities earlier.
The manager coordinates the activities through
various intermediaries connected with the issue.

25. Book Building—a New Issue
Mechanism in India
 Methods for Determining the Offer Price
• Fixed Price: In this method the investors’
demand is not taken into account
• Book Building: This method explicitly uses
investors’ demand for shares at various prices as
an important input to arrive at an offer price.
 Book building is a mechanism through which an
offer price for IPOs based on the investors’
demand is determined
 The book building is basically an auction of
shares

26.  The issue of securities through book building can be
done in either of the following two ways:
a) 75 percent book building: It is known as partial book
building . The SEBI allowed 75 per cent of the total
issue allotted for the book built portion; the remaining
25 per cent has to be compulsorily offloaded in the
general market at a fixed price discovered during the
book building process.
b) 100 percent book building : it is known as one-stage
book building. It implies that the entire issue is
completed in a single stage
 The option of 100 per cent book building was available
only to those issuer companies which are to make an
issue of capital of and above 100 crore

27. Difference between Fixed Price and Book
building process

28. Book Building Process
1. Company plans IPO via the book building route
2. Appoints a merchant banker as book runner. He
shall be primarily responsible for the book building.
The lead book runner and co-book runners shall
compulsorily underwrite the issue
3. Issues draft prospectus (containing all mandatory
company disclosures
4. Draft prospectus filled simultaneously with
concerned authority (SEBI)

29. 5. Book runner appoints syndicate members and
registered intermediaries to garner subscription
6. Price discovery begins through the bidding process.
The issuer shall, in consultation with lead book
runner, determine the issue price based on the bids
received.
7. Bidding process shall be only through an
electronically linked transparent bidding facility
provided by recognized stock exchange(s)At close
of bidding, book runner and company decide upon
the allocation and allotment
8. Registering of Prospectus with registrar of
companies
9. Allotment/Allocation in Book Built Issue

30. 2. Secondary Market (Stock Exchange):
 The secondary market is the market for the sale
and purchase of previously issued or second hand
securities.
 In secondary market securities are not directly
issued by the company to investors. The securities
are sold by existing investors to other investors.
 Sometimes the investor is in need of cash and
another investor wants to buy the shares of the
company as he could not get directly from
company. Then both the investors can meet in
secondary market and exchange securities for
cash through intermediary called broker.

31.  In secondary market companies get no
additional capital as securities are bought and
sold between investors only so directly there is
no capital formation but secondary market
indirectly contributes in capital formation by
providing liquidity to securities of the
company.