Blackbook Project- Indian Capital Market

INDIAN CAPITAL MARKET|2014-15

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CHAPTER 1:

INTRODUCTION TO CAPITAL MARKETS

Generally, the personal savings of an entrepreneur along with contributions from

friends and relatives are the source of fund to start new or to expand existing business. This

may not be feasible in case of large projects as the required contribution from the

entrepreneur (promoter) would be very large even after availing term loan; the promoter

may not be able to bring his / her share (equity capital). Thus availability of capital can be a

major constraint in setting up or expanding business on a large scale.

However, instead of depending upon a limited pool of savings of a small circle of

friends and relatives, the promoter has the option of raising money from the public across

the country by selling (issuing) shares of the company. For this purpose, the promoter can

invite investment to his or her venture by issuing offer document which gives full details

about track record, the company, the nature of the project, the business model, the expected

profitability etc.

If you are comfortable with this proposed venture, you may invest and thus become a

shareholder of the company. Through aggregation, even small amounts available with a very

large number of individuals translate into usable capital for corporates. Your small savings

of, say, even ` 5,000 can contribute in setting up, say, a ` 5,000 crore Cement or Steel plant.

This mechanism by which corporates raise money from public is called the primary markets.


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Importantly, when you, as a shareholder, need your money back, you can sell these

shares to other or new investors. Such trades do not reduce or alter the companys capital.

Stock exchanges bring such sellers and buyers together and facilitate trading. Therefore,

companies raising money from public are required to list their shares on the stock exchange.

This mechanism of buying and selling shares through stock exchange is known as the

secondary markets.

As a shareholder, you are part owner of the company and entitled to all the benefits

of ownership, including dividend (companys profit distributed to owners). Over the years if

the company performs well, other investors would like to become owners of this performing

company by buying its shares. This increase in demand for shares leads to increase in its

price. You then have the option of selling your shares at a higher price than at which you

purchased it. You can thus increase your wealth, provided you make the right choice. The

reverse is also true!

Apart from shares, there are many other financial instruments (securities) used for

raising capital. Debentures or bonds are debt instruments that pay interest over their lifetime

and are used by corporates to raise medium or long-term debt capital. If you prefer fixed

income, you may invest in these instruments, which may give you higher rate of interest

than bank fixed deposit, because of the higher risk. Besides, equity and debt, a combination

of these instruments, like convertible debentures, preference shares are also issued to raise

capital.

If you have constraints like time, wherewithal, small amount etc. to invest in the

market directly, Mutual Funds (MFs), which are regulated entities, provide an alternative

avenue. They collect money from many investors and invest the aggregate amount in the

markets in a professional and transparent manner. The returns from these investments net of

management fees are available to you as a MF unit holder.

MFs offer various schemes, like those investing only in equity or debt, index funds,

gold funds, etc. to cater to risk appetite of various investors. Even with very small amounts,

you can invest in MF schemes through monthly systematic investment plans (SIP).

The institutions, players and mechanism that bring suppliers and users of capital

together, is known as capital market. It allows people to do more with their savings by

providing variety of assets thereby enhancing the wealth of investors who make the right

choice. Simultaneously, it enables entrepreneurs to do more with their ideas and talent,

facilitating capital formation.


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Thus capital market mobilizes savings and channelizes it, through securities, into

preferred entrepreneurs.

It is not that the providers of funds meet the user of and exchange funds for

securities. It is because the securities offered by the users may not match the preference of

the providers of funds. There are a large variety of intermediaries who bring the providers

and user of funds together to facilitate the transactions.

The market is supervised by SEBI. It ensures supply of quality securities and non-

manipulated demand for them. It develops best market practices and takes enforcement

actions against the miscreants. It essentially maintains discipline in the market so that the

participants can undertake transaction safely.

1.1 Definition of Capital Market

Capital markets are financial markets for the buying and selling of long-term debt or

equity-backed securities. These markets channel the wealth of savers to those who can put it

to long-term productive use, such as companies or governments making long-term

investments.

1.1.A. Major Objectives of Indian Capital Market

To mobilize resources for investments.

To facilitate buying and selling of securities.

To facilitate the process of efficient price discovery.

To facilitate settlement of transactions in accordance with the predetermined time

schedules.

1.1.B. Reforms in Capital Market of India

The major reform undertaken in capital market of India includes:

Establishment of SEBI:

The Securities and Exchange Board of India (SEBI) was established in 1988. It got a

legal status in 1992. SEBI was primarily set up to regulate the activities of the merchant

banks, to control the operations of mutual funds, to work as a promoter of the stock

exchange activities and to act as a regulatory authority of new issue activities of companies.


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Establishment of Creditors Rating Agencies:

Three creditors rating agencies viz. The Credit Rating Information Services of India

Limited (CRISIL - 1988), the Investment Information and Credit Rating Agency of India

Limited (ICRA - 1991) and Credit Analysis and Research Limited (CARE) were set up in

order to assess the financial health of different financial institutions and agencies related to

the stock market activities. It is a guide for the investors also in evaluating the risk of their

investments.

Increasing of Merchant Banking Activities:

Many Indian and foreign commercial banks have set up their merchant banking

divisions in the last few years. These divisions provide financial services such as

underwriting facilities, issue organizing, consultancy services, etc.

Rising Electronic Transactions:

Due to technological development in the last few years, the physical transaction with

more paper work is reduced. It saves money, time and energy of investors. Thus it has made

investing safer and hassle free encouraging more people to join the capital market.

Growing Mutual Fund Industry:

The growing of mutual funds in India has certainly helped the capital market to

grow. Public sector banks, foreign banks, financial institutions and joint mutual funds

between the Indian and foreign firms have launched many new funds. A big diversification

in terms of schemes, maturity, etc. has taken place in mutual funds in India. It has given a

wide choice for the common investors to enter the capital market.

Growing Stock Exchanges:

The numbers of various Stock Exchanges in India are increasing. Initially the BSE

was the main exchange, but now after the setting up of the NSE and the OTCEI, stock

exchanges have spread across the country. Recently a new Inter-connected Stock Exchange

of India has joined the existing stock exchanges.

Investor's Protection:

Under the purview of the SEBI the Central Government of India has set up the

Investors Education and Protection Fund (IEPF) in 2001. It works in educating and guiding


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investors. It tries to protect the interest of the small investors from frauds and malpractices in

the capital market.

Growth of Derivative Transactions:

Since June 2000, the NSE has introduced the derivatives trading in the equities. In

November 2001 it also introduced the future and options transactions. These innovative

products have given variety for the investment leading to the expansion of the capital

market.

Commodity Trading:

Along with the trading of ordinary securities, the trading in commodities is also

recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such

transactions is growing at a splendid rate.

These reforms have resulted into the tremendous growth of Indian capital market.

1.1.C. Factors Affecting Capital Market in India

A range of factors affects the capital market. Some of the factors that influence capital

market are as follows: -

Performance of domestic Companies: -

The performance of the companies or rather corporate earnings is one of the factors

that have direct impact or effect on capital market in a country. Weak corporate earnings

indicate that the demand for goods and services in the economy is less due to slow growth in

per capita income of people. Because of slow growth in demand there is slow growth in

employment that means slow growth in demand in the near future. Thus weak corporate

earnings indicate average or not so good prospects for the economy as a whole in the near

term. In such a scenario the investors (both domestic as well as foreign) would be wary to

invest in the capital market and thus there is bear market like situation. The opposite case of

it would be robust corporate earnings and its positive impact on the capital market.

Environmental Factors: -

Environmental Factor in Indias context primarily means- Monsoon. In India around

60 % of agricultural production is dependent on monsoon. Thus there is heavy dependence

on monsoon. The major chunk of agricultural production comes from the states of Punjab,

Haryana & Uttar Pradesh. Thus deficient or delayed monsoon in this part of the country


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would directly affect the agricultural output in the country. Apart from monsoon other

natural calamities like Floods, tsunami, drought, earthquake, etc. also have an impact on the

capital market of a country.

Macro Economic Numbers: -

The macroeconomic numbers also influence the capital market. It includes Index of

Industrial Production (IIP) which is released every month, annual Inflation number indicated

by Wholesale Price Index (WPI) which is released every week, Export Import numbers

which are declared every month, Core Industries growth rate (It includes Six Core

infrastructure industries Coal, Crude oil, refining, power, cement and finished steel) which

comes out every month, etc. This macro economic indicators indicate the state of the

economy and the direction in which the economy is headed and therefore impacts the capital

market in India.

Global Cues: -

In this world of globalization various economies are interdependent and

interconnected. An event in one part of the world is bound to affect other parts of the world;

however the magnitude and intensity of impact would vary. Thus capital market in India is

also affected by developments in other parts of the world i.e. U.S., Europe, Japan, etc.

Global cues includes corporate earnings of MNCs, consumer confidence index in developed

countries, jobless claims in developed countries, global growth outlook given by various

agencies like IMF, economic growth of major economies, price of crude oil, credit rating of

various economies given by Moodys, S & P, etc.

Political stability and government policies: -

For any economy to achieve and sustain growth it has to have political stability and

pro- growth government policies. This is because when there is political stability there is

stability and consistency in governments attitude that is communicated through various

government policies. The vice- versa is the case when there is no political stability .So

capital market also reacts to the nature of government, attitude of government, and various

policies of the government.

Growth prospectus of an economy: -

When the national income of the country increases and per capita income of people

increases it is said that the economy is growing. Higher income also means higher


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expenditure and higher savings. This augurs well for the economy as higher expenditure

means higher demand and higher savings means higher investment. Thus when an economy

is growing at a good pace capital market of the country attracts more money from investors,

both from within and outside the country and vice -versa. So we can say that growth

prospects of an economy do have an impact on capital markets.

Investor Sentiment and risk appetite:-

Another factor, which influences capital market, is investor sentiment and their risk

appetite. Even if the investors have the money to invest but if they are not confident about

the returns from their investment, they may stay away from investment for some time. At the

same time if the investors have low risk appetite, which they were having in global and

Indian capital market some four to five months back due to global financial meltdown and

recessionary situation in U.S. & some parts of Europe, they may stay away from investment

and wait for the right time to come.


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CHAPTER 2:

CLASSIFICATION OF CAPITAL MARKET

2.1Primary Market

Companies issue securities from time to time to raise funds in order to meet their

financial requirements for modernization, expansions and diversification programs. These

securities are issued directly to the investors (both individuals as well as institutional)

through the mechanism called primary market or new issue market. The primary market

refers to the set-up, which helps the industry to raise the funds by issuing different types of

securities. This set-up consists of the type

of securities available, financial

institutions and the regulatory

framework. The primary market

discharges the important function of

transfer of savings especially of the

individuals to the companies, the mutual

funds, and the public sector undertakings.

Individuals or other investors with

surplus money invest their savings in

exchange for shares, debentures and other

securities. In the primary market the new

issue of securities are presented in the form of public issues, right issues or private

placement.

Firms that seek financing, exchange their financial liabilities, such as shares and

debentures, in return for the money provided by the financial intermediaries or the investors

directly. These firms then convert these funds into real capital such as plant and machinery

etc. The structure of the capital market where the firms exchange their financial liabilities

for long-term financing is called the primary market. The primary market has two

distinguishing features:


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It is the segment of the capital market where capital formation occurs; and

In order to obtain required financing, new issues of shares, debentures securities

are sold in the primary market. Subsequent trading in these securities occurs in other

segment of the capital market, known as secondary market.

The securities that are often resorted for raising funds are equity shares, preference

shares, bonds, debentures, warrants, cumulative convertible preference shares, zero interest

convertible debentures, etc. Public issues of securities may be made through:

Prospectus,

Offer for sale,

Book building process and

Private placement

The investors directly subscribe the securities offered to public through a prospectus. The

company through different media generally makes wide publicity about the public offer.

2.1.A. Activities in the Primary Market

Appointment of merchant bankers

Collection of money

Pricing of securities being issued

Minimum subscription

Communication/ Marketing of the issue

Listing on the stock exchange(s)

Information on credit risk

Allotment of securities in demat/ physical mode

Making public issues

Record keeping

2.1.B. Function of Primary Market

Organization: Deals with the origin of the new issue. The proposal is analyzed in

terms of the nature of the security, the size of the issued timings of the issue and flotation

method of the issue.


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Underwriting: Underwriting is a kind of guarantee undertaken by an institution or

firm of brokers ensuring the marketability of an issue. it is a method whereby the guarantor

makes a promise to the stock issuing company that he would purchase a certain specific

number of shares in the event of their not being invested by the public.

Distribution: The third function is that of distribution of shares. Distribution means

the function of sale of shares and debentures to the investors. This is performed by brokers

and agents. They maintain regular lists of clients and directly contact them for purchase and

sale of securities.

2.1.C. Role of Primary Market

Capital formation - It provides attractive issue to the potential investors and with

this company can raise capital at lower costs.

Liquidity - As the securities issued in primary market can be immediately sold in

secondary market the rate of liquidity is higher.

Diversification - Many financial intermediaries invest in primary market; therefore

there is less risk if there is failure in investment as the company does not depend on a single

investor. The diversification of investment reduces the overall risk.

Reduction in cost - Prospectus containing all details about the securities are given

to the investors hence reducing the cost is searching and assessing the individual securities.

2.1.D. Features of Primary Market

It is the new issue market for the new long-term capital.

Here company issues the securities directly to the investors and not through any

intermediaries.

On receiving the money from the new issues, the company will issue the security

certificates to the investors.

The amount obtained by the company after the new issues are utilized for expansion

of the present business or for setting up new ventures.

External finance for longer term such as loans from financial institutions is not

included in primary market. There is an option called going public in which the


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borrowers in new issue market raise capital for converting private capital into public

capital.

2.1.E. Types of issues

Primary market Issues can be classified into four types.

Initial Public Offer (IPO):

When an unlisted company makes either a fresh issue of securities or an offer for

sale of its existing securities or both, for the first time to the public, the issue is called as an

Initial Public Offer.

Follow On Public Offer (FPO):

When an already listed company makes either a fresh issue of securities to the public

or an offer for sale of existing shares to the public, through an offer document, it is referred

to as Follow on Offer (FPO).

Rights Issue:

When a listed company proposes to issue fresh securities to its existing shareholders,

as on a record date, it is called as a rights issue. The rights are normally offered in a

particular ratio to the number of securities held prior to the issue. This route is best suited for

companies who would like to raise capital without diluting stake of its existing shareholders.

A Preferential issue:

A Preferential Issue is an issue of shares or of convertible securities by listed

companies to a select group of persons under Section 81 of the Companies Act, 1956, that is

neither a rights issue nor a public issue. This is a faster way for a company to raise equity

capital. The issuer company has to comply with the Companies Act and the requirements

contained in the chapter, pertaining to preferential allotment in SEBI guidelines, which inter-

alia include pricing, disclosures in notice etc.


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2.2 SECONDARY MARKET

Secondary market refers to the network/system for the subsequent sale and purchase

of securities. An investor can apply and get allotted a specified number of securities by the

issuing company in the primary market. However, once allotted the securities can thereafter

be sold and purchased in the secondary market only. An investor who wants to purchase the

securities can buy these securities in the secondary market. The secondary market is market

for subsequent sale/purchase and trading in the securities. A security emerges or takes birth

in the primary market but its subsequent movements take place in secondary market. The

secondary market consists of that portion of the capital market where the previously issued

securities are transacted. The firms do not obtain any new financing from secondary market.

The secondary market provides the life-blood to any financial system in general, and to the

capital market in particular.

The secondary market is represented by the stock exchanges in any capital market.

The stock exchanges provide an organized market place for the investors to trade in the

securities. This may be the most important function of stock exchanges. The stock exchange,

theoretically speaking, is a perfectly competitive market, as a large number of sellers and

buyers participate in it and the information regarding the securities is publicly available to

all the investors. A stock exchange permits the security prices to be determined by the

competitive forces. They are not set by negotiations off the floor, where one party might

have a bargaining advantage. The bidding process flows from the demand and supply

underlying each security. This means that the specific price of a security is determined, more

or less, in the manner of an auction. The stock exchanges provide market in which the

members of the stock exchanges (the share brokers) and the investors participate to ensure

liquidity to the latter.

In India, the secondary market, represented by the stock exchanges network, is more

than 100 years old when in 1875, the first stock exchange started operations in Mumbai.

Gradually, stock exchanges at other places have also been established and at present, there

are 23 stock exchanges operating in India. The secondary market in India got a boost when

the Over the Counter Exchange of India (OTCEI) and the National Stock Exchange (NSE)

were established. Out of the 23 stock exchanges, 20 stock exchanges are operating at

Mumbai (BSE), Kolkata, Chennai, Ahmadabad, Delhi, and Indore. Bangalore, Hyderabad,


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Cochin, Kanpur, Pune, Ludhiana, Guwahati, Mangalore, Patna, Jaipur, Bhubaneswar,

Rajkot, Vadodara and Coimbatore. Besides, there is one ICSE established by 14 Regional

Stock Exchanges. It may be noted that out of 23 stock exchanges, only 2, i.e., the NSE and

the Over the Counter Exchange of India (OTCEI) have been established by the All India

Financial Institutions while other stock exchanges are operating as associations or limited

companies. In order to protect and safeguard the interest of the investors, the operations,

functioning and working of the stock exchanges and their members (i.e., share brokers) are

supervised and regulated by the Securities Contracts (Regulations) Act, 1956 and the SEBI

Act, 1992.

2.2.A. Activities in the Secondary Market

Trading of securities

Risk management

Clearing and settlement of trades

Delivery of securities and funds

2.2.B. Importance of Secondary Market:

Providing liquidity and marketability to existing securities

Pricing of securities

Safety of transaction

Contribution to economic growth

Providing scope for speculation

2.2.C. Role of Secondary Market

For the general investor, the secondary market provides an efficient platform for

trading of his securities. For the management of the company, Secondary equity markets

serve as a monitoring and control conduitby facilitating value-enhancing control

activities, enabling implementation of incentive-based management contracts, and

aggregating information (via price discovery) that guides management decisions.

2.2.D. Products in secondary markets

Equity Shares


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Rights Issue/ Rights Shares

Bonus Shares

Preferred Stock/ Preference shares

Cumulative Preference Shares

Cumulative Convertible Preference Shares

Participating Preference Share

Bond

Zero Coupon Bond

Convertible Bond

Debentures

Commercial Paper

Coupons

Treasury Bills

2.2.E. The OTC Market

Sometimes you'll hear a dealer market referred to as an over-the-counter (OTC)

market. The term originally meant a relatively unorganized system where trading did not

occur at a physical place, as we described above, but rather through dealer networks. The

term was most likely derived from the off-Wall Street trading that boomed during the great

bull market of the 1920s, in which shares were sold "over-the-counter" in stock shops. In

other words, the stocks were not listed on a stock exchange - they were "unlisted".

2.2.F. Third and Fourth Markets

You might also hear the terms "third" and "fourth markets". These don't concern

individual investors because they involve significant volumes of shares to be transacted per

trade. These markets deal with transactions between broker-dealers and large institutions

through over-the-counter electronic networks. The third market comprises OTC transactions

between broker-dealers and large institutions. The fourth market is made up of transactions

that take place between large institutions. The main reason these third and fourth market

transactions occur is to avoid placing these orders through the main exchange, which could

greatly affect the price of the security. Because access to the third and fourth markets is

limited, their activities have little effect on the average investor.


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CHAPTER 3:

PARTICIPANTS OF INDIAN CAPITAL MARKET

There are several major players in the primary market. These include the merchant

bankers, mutual funds, financial institutions, foreign institutional investors (FIIs) and

individual investors. In the secondary market, there are the stock exchanges, stock brokers

(who are members of the stock exchanges), the mutual funds, financial institutions, foreign

institutional investors (FIIs), and individual investors. Registrars and Transfer Agents,

Custodians and Depositories are capital market intermediaries that provide important

infrastructure services for both primary and secondary markets.

I. Custodians

In the earliest phase of capital market reforms, to get over the problems associated

with paper-based securities, large holding by institutions and banks were sought to be

immobilized. Immobilization of securities is done by storing or lodging the physical security

certificates with an organization that acts as a custodian - a securities depository. All

subsequent transactions in such immobilized securities take place through book entries. The

actual owners have the right to withdraw the physical securities from the custodial agent

whenever required by them. In the case of IPO, a jumbo certificate is issued in the name of

the beneficiary owners based on which the depository gives credit to the account of

beneficiary owners. The Stock Holding Corporation of India Limited was set up to act as a

custodian for securities of a large number of banks and institutions who were mainly in the

public sector. Some of the banks and financial institutions also started providing "Custodial"

services to smaller investors for a fee. With the introduction of dematerialisation of

securities there has been a shift in the role and business operations of Custodians. But they


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still remain an important intermediary providing services to the investors who still hold

securities in physical form.

II. Depositories

The depositories are important intermediaries in the securities market that is scrip-

less or moving towards such a state. In India, the Depositories Act defines a depository to

mean "a company formed and registered under the Companies Act, 1956 and which has

been granted a certificate of registration under sub-section (IA) of section 12 of the

Securities and Exchange Board of India Act, 1992." The principal function of a depository is

to dematerialise securities and enable their transactions in book-entry form.

Dematerialisation of securities occurs when securities issued in physical form is destroyed

and an equivalent number of securities are credited into the beneficiary owner's account. In a

depository system, the investors stand to gain by way of lower costs and lower risks of theft

or forgery, etc. They also benefit in terms of efficiency of the process. But the

implementation of the system has to be secure and well governed. All the players have to be

conversant with the rules and regulations as well as with the technology for processing. The

intermediaries in this system have to play strictly by the rules.

A depository established under the Depositories Act can provide any service

connected with recording of allotment of securities or transfer of ownership of securities in

the record of a depository. A depository cannot directly open accounts and provide services

to clients. Any person willing to avail of the services of the depository can do so by entering

into an agreement with the depository through any of its Depository Participants.

The services, functions, rights and obligations of depositories, with special reference

to NSDL are provided in the second section of this Workbook.

III. Depository Participants

A Depository Participant (DP) is described as an agent of the depository. They are

the intermediaries between the depository and the investors. The relationship between the

DPs and the depository is governed by an agreement made between the two under the

depositories Act, 1996. In a strictly legal sense, a DP is an entity who is registered as such

with SEBI under the provisions of the SEBI Act. As per the provisions of this Act, a DP can

offer depository related services only after obtaining a certificate of registration from SEBI.

SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for the


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applicants who are stockbrokers or non-banking finance companies (NBFCs), for granting a

certificate of registration to act as a DP. For R & T Agents a minimum net worth of Rs. 10

crore is prescribed in addition to a grant of certificate of registration by SEBI. If a

stockbroker seeks to act as a DP in more than one depository, he should comply with the

specified net worth criterion separately for each such depository. If an NBFC seeks to act as

a DP on behalf of any other person, it needs to have a networth of Rs. 50 cr. in addition to

the networth specified by any other authority. No minimum net worth criterion has been

prescribed for other categories of DPs. However, depositories can fix a higher net worth

criterion for their DPs. NSDL stipulates a minimum net worth of Rs. 300 Lakh to be eligible

to become a DP as against Rs. 50 lakh prescribed by SEBI (D&P) Regulations, except for R

& T agents and NBFCs, as mentioned above.

IV. Merchant Bankers

Among the important financial intermediaries are the merchant bankers. The services

of merchant bankers have been identified in India with just issue management. It is quite

common to come across reference to merchant banking and financial services as though they

are distinct categories. The services provided by merchant banks depend on their inclination

and resources - technical and financial. Merchant bankers (Category I) are mandated by

SEBI to manage public issues (as lead managers) and open offers in take-overs. These two

activities have major implications for the integrity of the market. They affect investors'

interest and, therefore, transparency has to be ensured. These are also areas where

compliance can be monitored and enforced.

Merchant banks are rendering diverse services and functions. These include

organising and extending finance for investment in projects, assistance in financial

management, raising Eurodollar loans and issue of foreign currency bonds. Different

merchant bankers specialise in different services. However, since they are one of the major

intermediaries between the issuers and the investors, their activities are regulated by:

SEBI (Merchant Bankers) Regulations, 1992.

Guidelines of SEBI and Ministry of Finance.

Companies Act, 1956.

Securities Contracts (Regulation) Act, 1956.


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Merchant banking activities, especially those covering issue and underwriting of

shares and debentures, are regulated by the Merchant Bankers Regulations of Securities and

Exchange Board of India (SEBI). SEBI has made the quality of manpower as one of the

criteria for renewal of merchant banking registration. These skills should not be

concentrated in issue management and underwriting alone. The criteria for authorisation

takes into account several parameters.

These include:

Professional qualification in finance, law or business management,

Infrastructure like adequate office space, equipment and manpower,

Employment of two persons who have the experience to conduct the business of

merchant bankers,

Capital adequacy and

Past track record, experience, general reputation and fairness in all their transactions.

SEBI authorises merchant bankers (Category I) for an initial period of three years, if

they have a minimum net worth of Rs. 5 crore. An initial authorisation fee, an annual fee and

renewal fee is collected by SEBI.

According to SEBI, all issues should be managed by at least one authorised merchant

banker functioning as the sole manager or lead manager. The lead manager should not agree

to manage any issue unless his responsibilities relating to the issue, mainly disclosures,

allotment and refund, are clearly defined. A statement specifying such responsibilities has to

be furnished to SEBI. SEBI prescribes the process of due diligence that a merchant banker

has to complete before a prospectus is cleared. It also insists on submission of all the

documents disclosing the details of account and the clearances obtained from the ROC and

other government agencies for tapping peoples' savings. The responsibilities of lead

manager, underwriting obligations, capital adequacy, due diligence certification, etc., are

laid down in detail by SEBI. The objective is to facilitate the investors to take an informed

decision regarding their investments and not expose them to unknown risks.

V. Registrar

The Registrar finalizes the list of eligible allottees after deleting the invalid

applications and ensures that the corporate action for crediting of shares to the demat

accounts of the applicants is done and the dispatch of refund orders to those applicable are


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sent. The Lead manager coordinates with the Registrar to ensure follow up so that that the

flow of applications from collecting bank branches, processing of the applications and other

matters till the basis of allotment is finalized, dispatch security certificates and refund orders

completed and securities listed.

VI. Bankers to the issue

Bankers to the issue, as the name suggests, carries out all the activities of ensuring

that the funds are collected and transferred to the Escrow accounts. The Lead Merchant

Banker shall ensure that Bankers to the Issue are appointed in all the mandatory collection

centers as specified in DIP Guidelines. The LM also ensures follow-up with bankers to the

issue to get quick estimates of collection and advising the issuer about closure of the issue,

based on the correct figures.

VII. Underwriters

Underwriting is an agreement, entered into by a company with a financial agency, in

order to ensure that the public will subscribe for the entire issue of shares or debentures

made by the company. The financial agency is known as the underwriter and it agrees to buy

that part of the company issues which are not subscribed to by the public in consideration of

a specified underwriting commission. The underwriting agreement, among others, must

provide for the period during which the agreement is in force, the amount of underwriting

obligations, the period within which the underwriter has to subscribe to the issue after being

intimated by the issuer, the amount of commission and details of arrangements, if any, made

by the underwriter for fulfilling the underwriting obligations. The underwriting commission

may not exceed 5 percent on shares and 2.5 percent in case of debentures. Underwriters get

their commission irrespective of whether they have to buy a single security or not.

Types of underwriting

Syndicate Underwriting: - is one in which, two or more agencies or underwriters

jointly underwrite an issue of securities. Such an arrangement is entered into when the total

issue is beyond the resources of one underwriter or when he does not want to block up large

amount of funds in one issue.

Sub-Underwriting:- is one in which an underwriter gets a part of the issue further

underwritten by another agency. This is done to diffuse the risk involved in underwriting.


TYBFM Mithibai 20

The name of every under-writer is mentioned in the prospectus along with the amount of

securities underwritten by him.

Firm Underwriting: - is one in which the underwriters apply for a block of

securities. Under it, the underwriters agree to take up and pay for this block of securities as

ordinary subscribers in addition to their commitment as underwriters. The underwriter need

not take up the whole of the securities underwritten by him. For example, if the underwriter

has underwritten the entire issue of 5 lakh shares offered by a company and has in addition

applied for 1 lakh shares for firm allotment. If the public subscribes to the entire issue, the

underwriter would be allotted 1 lakh shares even though he is not required to take up any of

the shares.

Types of underwriters

Underwriting of capital issues has become very popular due to the development of

the capital market and special financial institutions. The lead taken by public financial

institutions has encouraged banks, insurance companies and stock brokers to underwrite on a

regular basis. The various types of underwriters differ in their approach and attitude towards

underwriting:-

Development banks like IFCI, ICICI and IDBI: - they follow an entirely objective

approach. They stress upon the long-term viability of the enterprise rather than

immediate profitability of the capital issue. They attempt to encourage public

response to new issues of securities.

Institutional investors like LIC and AXIS: - their underwriting policy is governed by

their investment policy.

Financial and development corporations: - they also follow an objective policy while

underwriting capital issues.

Investment and insurance companies and stock-brokers: - they put primary emphasis

on the short term prospects of the issuing company as they cannot afford to block

large amount of money for long periods of time.

To act as an underwriter, a certificate of registration must be obtained from

Securities and Exchange Board of India (SEBI). The certificate is granted by SEBI under the

Securities and Exchanges Board of India (Underwriters) Regulations, 1993. These

regulations deal primarily with issues such as registration, capital adequacy, obligation and


TYBFM Mithibai 21

responsibilities of the underwriters. Under it, an underwriter is required to enter into a valid

agreement with the issuer entity and the said agreement among other things should define

the allocation of duties and responsibilities between him and the issuer entity. These

regulations have been further amended by the Securities and Exchange Board of India

(Underwriters) (Amendment) Regulations, 2006.

VIII.Credit Rating Agencies

The 1990s saw the emergence of a number of rating agencies in the Indian market.

These agencies appraise the performance of issuers of debt instruments like bonds or fixed

deposits.

The rating of an instrument depends on parameters like business risk, market

position, operating efficiency, adequacy of cash flows, financial risk, financial flexibility,

and management and industry environment.

The objective and utility of this exercise is two-fold. From the point of view of the

issuer, by assigning a particular grade to an instrument, the rating agencies enable the issuer

to get the best price. Since all financial markets are based on the principle of risk/reward, the

less risky the profile of the issuer of a debt security, the lower the price at which it can be

issued. Thus, for the issuer, a favorable rating can reduce the cost of borrowed capital. From

the viewpoint of the investor, the grade assigned by the rating agencies depends on the

capacity of the issuer to service the debt. It is based on the past performance as well as an

analysis of the expected cash flows of a company, when viewed on the industry parameters

and performance of the company. Hence, the investor can judge for himself whether he

wants to place his savings in a "safe" instrument and get a lower return or he wants to take a

risk and get a higher return.

The 1990s saw an increase in activity in the primary debt market. Under the SEBI

guidelines all issuers of debt have to get the instruments rated. They also have to

prominently display the ratings in all that marketing literature and advertisements. The

rating agencies have thus become an important part of the institutional framework of the

Indian securities market.


TYBFM Mithibai 22

IX. Collective Investment Schemes

Collective Investment Scheme is a scheme in whatever form, including an open-

ended investment company, in pursuance of which members of the public are invited or

permitted to invest money or other assets in a portfolio, and in terms of which:

Two or more investors contribute money or other assets to and hold a participatory

interest;

The investors share the risk and benefit of investment in proportion to their

participatory interest in a portfolio of a scheme or on any other basis determined in

the deed.

X. Unit Trust

A Unit Trust Scheme is a Fund into which small sums of monies from individual

investors are collected to form a pool for the purpose of investing in stocks, shares and

money market instrument by professional fund managers on behalf of the contributors called

unit holders [subscribers]. By investing in a unit trust scheme, the unit holders enjoy the

benefits of diversification and professional management of their fund at low cost.

The total fund of a unit trust scheme is divided into units of exactly equal monetary

value e.g. If one unit is N1.00, any person investing N100 will get 100 units. Unit Trust

Funds are invested in highly-rated securities on behalf of the unit holders by the

management company.

There are two types of Unit Trust Schemes, viz;

Open-Ended

This is a Fund that continuously creates issues and redeems units after the initial

public offering. The price is based on the Net Asset Value (NAV), which is total asset of the

fund minus liabilities as at date of purchase or redemption.

Closed-Ended

In a ClosedEnded Fund, there is no additional issue of new units or redemption of

units. The Fund is usually listed and traded on the Stock Exchange and its price will be

determined by the market forces of supply and demand. A unit holder who wants to redeem

his unit will therefore have to go through his Stockbroker.


TYBFM Mithibai 23

XI. Venture Capital Funds

It is early stage financing of new and young companies seeking to grow rapidly. It is

defined as a profit seeking venture by an entrepreneur, whose primary objective is to provide

fund not otherwise available to new and growing business venture for the purpose of making

profit in the long term.

For a Venture Capital Fund to exist there must be the presence of the following:-

Risk-Takers, who are prepared to invest in Venture Capital Fund and wait for long

term gains rather than short term profits (Venture Capitalist).

There must be a Venture Capital Company to collect the money from the risk-takers

and offer them shares in return with a promise of high return in future.

There must be a viable business venture whether new or young into which the

Venture Capital Company could invest part of its equity.

There must be an entrepreneur with a good business under taking yearning for

expansion capital.

The process for a Venture Capital activity involves:

Fund raising

Real flow/investment

Monitoring/value enhancement

Exit stage.

XII. Foreign direct investment

Foreign direct investment pertains to international investment in which the investor

obtains a lasting interest in an enterprise in another country. Mostly it takes the form of

buying or constructing a factory in a foreign country or adding improvements to such a

facility in form of property, plants or equipments and thus is generally long term in nature.

XIII.Private equity investment

Private equity investment is one made by foreign investors in Indian Venture Capital

Undertakings (VCU) and Venture Capital Funds (VCF).


TYBFM Mithibai 24

XIV. Foreign portfolio investment

It is a short-term to medium- term investment mostly in the financial markets and is

commonly made through foreign Institutional Investors (FIIs), non resident Indian (NRI)

and persons of Indian origin (PIO).

XV. Foreign Institutional Investors

The term FIIs used to denote an investor, mostly in the form of an institution or

entity which invests money in the financial markets of a country different from the one

where in the institution or the entity is originally incorporated. According to Securities and

Exchange Board of India (SEBI) it is an institution that is a legal entity established or

incorporated outside India proposing to make investments in India only in securities. These

can invest their own funds or invest funds on behalf of their overseas clients registered with

SEBI. The client accounts are known as sub - accounts. A domestic portfolio manager can

also register as FII to manage the funds of the sub-accounts. From the early 1990s, India has

developed a framework through which foreign investors participate in the Indian capital

market.

A foreign investor can either come into India as a FII or as a sub-account. As on

March 31, 2011, there were 1,722 FIIs registered with SEBI and 5,686 sub-accounts

registered with SEBI as on March 31, 2011 Basically FIIs have a huge financial strength and

invest for the purpose of income and capital appreciation. They are no interested in taking

control of a company. Some of the big American mutual funds are fidelity, vanguard,

Merrill lynch, capital research etc.

They are permitted to trade in securities in primary as well as secondary markets and

can trade also in dated government securities, listed equity shares, listed non convertible

debentures/bonds issued by Indian company and schemes of mutual funds but the sale

should be only through recognized stock exchange. These also include domestic asset

management companies or domestic portfolio managers who manage funds raised or

collected or bought from outside India for the purpose of making investment in India on

behalf of foreign corporate or foreign individuals. In the Indian context, foreign institutional

investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the

participation of their overseas clients, who are not interested in participating directly in the

Indian stock market.


TYBFM Mithibai 25

FIIs contribute to the foreign exchange inflow as the funds from multilateral finance

institutions and FDI are insufficient.

It lowers cost of capital, access to cheap global credit.

It supplements domestic savings and investments.

It leads to higher asset prices in the Indian market.

And has also led to considerable amount of reforms in capital market and financial

sector.

XVI. R&T Agents - Registrars to Issue

R&T Agents form an important link between the investors and issuers in the

securities market. A company, whose securities are issued and traded in the market, is

known as the Issuer. The R&T Agent is appointed by the Issuer to act on its behalf to service

the investors in respect of all corporate actions like sending out notices and other

communications to the investors as well as despatch of dividends and other non-cash

benefits. R&T Agents perform an equally important role in the depository system as well.

These are described in detail in the second section of this Workbook.

XVII. Stock Brokers

Stockbrokers are the intermediaries who are allowed to trade in securities on the

exchange of which they are members. They buy and sell on their own behalf as well as on

behalf of their clients. Traditionally in India, partnership firms with unlimited liabilities and

individually owned firms provided brokerage services. There were, therefore, restrictions on

the amount of funds they could raise by way of debt. With increasing volumes in trading as

well as in the number of small investors, lack of adequate capitalisation of these firms

exposed investors to the risks of these firms going bust and the investors would have no

recourse to recovering their dues. With the legal changes being effected in the membership

rules of stock exchanges as well as in the capital gains structure for stock-broking firms, a

number of brokerage firms have converted themselves into corporate entities. In fact, NSE

encouraged the setting up of corporate broking members and has today only 10% of its

members who are not corporate entities.


TYBFM Mithibai 26

XVIII. Mutual Funds

Mutual funds are financial intermediaries, which collect the savings of small

investors and invest them in a diversified portfolio of securities to minimise risk and

maximise returns for their participants. Mutual funds have given a major fillip to the capital

market - both primary as well as secondary. The units of mutual funds, in turn, are also

tradable securities. Their price is determined by their net asset value (NAV) which is

declared periodically.

The operations of the private mutual funds are regulated by SEBI with regard to their

registration, operations, administration and issue as well as trading.

There are various types of mutual funds, depending on whether they are open ended

or close ended and what their end use of funds is. An open-ended fund provides for easy

liquidity and is a perennial fund, as its very name suggests. A closed-ended fund has a

stipulated maturity period, generally five years. A growth fund has a higher percentage of its

corpus invested in equity than in fixed income securities, hence the chances of capital

appreciation (growth) are higher. In growth funds, the dividend accrued, if any, is reinvested

in the fund for the capital appreciation of investments made by the investor.

An Income fund on the other hand invests a larger portion of its corpus in fixed

income securities in order to pay out a portion of its earnings to the investor at regular

intervals. A balanced fund invests equally in fixed income and equity in order to earn a

minimum return to the investors. Some mutual funds are limited to a particular industry;

others invest exclusively in certain kinds of short-term instruments like money market or

government securities. These are called money market funds or liquid funds. To prevent

processes like dividend stripping or to ensure that the funds are available to the managers for

a minimum period so that they can be deployed to at least cover the administrative costs of

the asset management company, mutual funds prescribe an entry load or an exit load for the

investors. If investors want to withdraw their investments earlier than the stipulated period,

an exit load is chargeable. To prevent profligacy, SEBI has prescribed the maximum that can

be charged to the investors by the fund managers.

XIX. The Stock Exchanges

A stock exchange is the marketplace where companies are listed and where the

trading happens. They provide a transparent and safe (risk-free) forum of a market for

investors to transact and invest their funds. There are 23 Stock Exchanges registered with


TYBFM Mithibai 27

SEBI and under its regulation. National Stock Exchange (NSE) and the Bombay Stock

Exchange (BSE) are the pre-dominant ones.

XX. Insurance Companies

Insurance companies receive premium in exchange for insurance policies and use

these funds to purchase a variety of securities. Thus, they invest the proceeds received from

insurance in stocks and bonds.

XXI. Pension funds

Many companies, corporations and government organizations and agencies offer

pension plans to their employers their employers or both periodically contribute funds to

such plans. The funds contributed are invested in securities until they are withdrawn by the

employees upon their retirement.

XXII. Commercial Banks

Commercial banks are those companies which are engage in accepting deposits from

savers and lending it back to deficit groups who are demanding loans and advances in order

to invest business. Commercial banks are a major source of deposits collectors among the all

other kinds of financial institutions. They mobilize their depository funds in many forms for

example, lending to individuals and corporations, invest in stock market and participate

other forms of investment.

XXIII. Saving Banks

Like commercial banks, savings banks also accumulate the scattered savings of the

country and then create investment friendly funds and lastly channelize these funds into

productive investments. Most savings banks are mutual in nature.

XXIV. Credit Unions

Credit union differs from commercial savings banks in that they are not profit

oriented company and restrict their business to the main members only. They use most of

their funds to provide loans to their internal members.


TYBFM Mithibai 28

XXV. Finance Companies

Most finance companies obtain funds by issuing securities and then lend the funds to

individuals and small businesses.

XXVI. Developmental Financial Institutions

DFIs play the significant role as the source of long-term funds mainly for the

corporate firms. They supply fixed capital to the investors for investment in fixed capital

expenditures. They also perform the underwriting functions relating to shares and debentures

of the corporate firms.


TYBFM Mithibai 29

CHAPTER 4:

INSTRUMENTS IN INDIAN CAPITAL MARKET

I. Secured Premium Notes

SPN is a secured debenture redeemable at premium issued along with a detachable

warrant, redeemable after a notice period, say four to seven years. The warrants attached to

SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is

fully paid. There is a lock-in period for SPN during which no interest will be paid for an

invested amount.

II. Deep Discount Bonds

A bond that sells at a significant discount from par value and has no coupon rate or

lower coupon rate than the prevailing rates of fixed-income securities with a similar risk

profile.

They are designed to meet the long term funds requirements of the issuer and

investors who are not looking for immediate return and can be sold with a long maturity of

25-30 years at adept discount on the face value of debentures.


TYBFM Mithibai 30

III. Equity Shares With Detachable Warrants

A warrant is a security issued by company entitling the holder to buy a given number

of shares of stock at a stipulated price during a specified period. These warrants are

separately registered with the stock exchanges and traded separately. Warrants are

frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay

lower interest rates or dividends.

IV. Fully Convertible Debentures With Interest

This is a debt instrument that is fully converted over a specified period into equity

shares. The conversion can be in one or several phases. When the instrument is a pure debt

instrument, interest is paid to the investor. After conversion, interest payments cease on the

portion that is converted. If project finance is raised through an FCD issue, the investor can

earn interest even when the project is under implementation. Once the project is operational,

the investor can participate in the profits through share price appreciation and dividend

payments.

V. Disaster Bonds

Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt

instrument that is usually insurance linked and meant to raise money in case of a

catastrophe.

VI. Mortgage Backed Securities(MBS)

MBS is a type of asset-backed security, basically a debt obligation that represents a

claim on the cash flows from mortgage loans, most commonly on residential property.

Kinds of Mortgage Backed Securities:

Commercial mortgage backed securities: backed by mortgages on commercial

property

Collateralized mortgage obligation: a more complex MBS in which the mortgages are

ordered into tranches by some quality (such as repayment time), with each tranche

sold as a separate security.

Stripped mortgage backed securities: Each mortgage payment is partly used to pay

down the loans principal and partly used to pay the interest on it


TYBFM Mithibai 31

Residential mortgage backed securities: backed by mortgages on residential property

VII.Indian Depository Receipts

As per the definition given in the Companies (Issue of Indian Depository

Receipts) Rules, 2004, IDR is an instrument in the form of a Depository Receipt

created by the Indian depository in India against the underlying equity shares of the

issuing company. In an IDR, foreign companies would issue shares, to an Indian

Depository (say National Security Depository Limited NSDL), which would in turn

issue depository receipts to investors in India. The actual shares underlying the IDRs

would be held by an Overseas Custodian, which shall authorize the Indian Depository

to issue the IDRs. The IDRs would have following features:

Overseas Custodian: It is a foreign bank having branches in India and requires approval

from Finance Ministry for acting as custodian and Indian depository has to be

registered with SEBI.

Approvals for issue of IDRs: IDR issue will require approval from SEBI and

application can be made for this purpose 90 days before the issue opening date.

Listing: These IDRs would be listed on stock exchanges in India and would be freely

transferable.

Eligibility conditions for overseas companies to issue IDRs:

Capital: The overseas company intending to issue IDRs should have paid up capital and

free reserve of at least $100 million.

Sales turnover: It should have an average turnover of $ 500 million during the last three

years.

Profits/dividend: Such company should also have earned profits in the last 5 years and

should have declared dividend of at least 10% each year during this period.

Debt equity ratio: The pre-issue debt equity ratio of such company should not be more

than 2:1.

Extent of issue: The issue during a particular year should not exceed 15% of the paid up

capital plus free reserves.

Redemption: IDRs would not be redeemable into underlying equity shares before one

year from date of issue.

Denomination: IDRs would be denominated in Indian rupees, irrespective of the

denomination of underlying shares.


TYBFM Mithibai 32

Benefits: In addition to other avenues, IDR is an additional investment opportunity for

Indian investors for overseas investment.

VIII. FOREIGN CURRENCY CONVERTIBLE BONDS (FCCBs)

A convertible bond is a mix between a debt and equity instrument. It is a bond

having regular coupon and principal payments, but these bonds also give the bondholder the

option to convert the bond into stock. FCCB is issued in a currency different than the issuer's

domestic currency.

The investors receive the safety of guaranteed payments on the bond and are also

able to take advantage of any large price appreciation in the company's stock. Due to the

equity side of the bond, which adds value, the coupon payments on the bond are lower for

the company, thereby reducing its debt-financing costs.

IX. Derivatives

A derivative is a financial instrument whose characteristics and value depend upon

the characteristics and value of some underlying asset typically commodity, bond, equity,

currency, index, event etc. Advanced investors sometimes purchase or sell derivatives to

manage the risk associated with the underlying security, to protect against fluctuations in

value, or to profit from periods of inactivity or decline. Derivatives are often leveraged, such

that a small movement in the underlying value can cause a large difference in the value of

the derivative.

X. Exchange Traded Funds

An exchange-traded fund (or ETF) is an investment vehicle traded on stock

exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at

approximately the same price as the net asset value of its underlying assets over the course

of the trading day.

Most ETFs track an index, such as the S&P 500 or Sensex. ETFs may be attractive as

investments because of their low costs, tax efficiency, and stock-like features, and single

security can track the performance of a growing number of different index funds (currently

the NSE Nifty)


TYBFM Mithibai 33

XI. Gold ETF

A Gold Exchange Traded Fund (ETF) is a financial instrument like a mutual fund

whose value depends on the price of gold. In most cases, the price of one unit of gold ETF

approximately reflects the price of 1 gram of gold. As the price of gold rises, the price of the

ETF is also expected to rise by the same amount. Gold exchange-traded funds are traded on

the major stock exchanges including Zurich, Mumbai, London, Paris and New York There

are also closed-end funds (CEF's) and exchange-traded notes (ETN's) that aim to track the

gold price.


TYBFM Mithibai 34

CHAPTER 5:

TYPES OF CAPITAL MARKET

5. INTRODUCTION

Any government or corporation requires capital (funds) to finance its operations and

to engage in its own long-term investments. To do this, a company raises money through the

sale of securities - stocks and bonds in the company's name. These are bought and sold in

the capital markets.

Thus there are two types of capital market as follows:

Debt or Bond Market

Stock or Equity Market

5.1.A. Debt or Bond Market

The bond market (also known as the debt, credit, or fixed income market) is a

financial market where participants buy and sell debt securities, usually in the form of

bonds.

References to the "bond market" usually refer to the government bond market,

because of its size, liquidity, lack of credit risk and, therefore, sensitivity to interest rates.


TYBFM Mithibai 35

Because of the inverse relationship between bond valuation and interest rates, the bond

market is often used to indicate changes in interest rates or the shape of the yield curve.

Besides other causes, the decentralized market structure of the corporate and

municipal bond markets, as distinguished from the stock market structure, results in higher

transaction costs and less liquidity.

Bond markets in most countries remain decentralized and lack common exchanges

like stock, future and commodity markets. This has occurred, in part, because no two bond

issues are exactly alike, and the variety of bond securities outstanding greatly exceeds that of

stocks.

With a large section of population underprivileged, the welfare commitments of the

Indian state have to be supported by a large government borrowing program. The

outstanding marketable government debt has grown from 4.3 trillion in 200001 to 29.9

trillion in 201213. The size of the annual borrowing of the central government through

dated securities has grown from 1.0 trillion to 5.6 trillion during this period. It is no mean

achievement to manage such large issuances in a non-disruptive manner in the post Fiscal

Responsibility & Budget Management (FRBM) regime and declining SLR.

The liquidity in the secondary market has also increased significantly from a daily

average trading volume of 9 billion in February 2002 to 344 billion in March, 2013. The

development of the debt and the derivatives market in India needs to be seen from the

perspective of a central bank and a financial sector regulator which has a mandate to

facilitate development of debt markets of the country.

In many countries, debt market (both sovereign and corporate) is larger than equity

markets. In fact, in matured economies, the debt market is three times the size of the equity

market. However, in India like in emerging economies, the equity market has been more

active, developed and has been the centre of attention be it in media or otherwise.

Nevertheless, the Indian debt market has transformed itself into a much more vibrant trading

field for debt instruments from the elementary market about a decade ago. Further, the

corporate debt market in developed economies like US is almost 20% of their total debt

market. In contrast, the corporate bond market (i.e. private corporate sector raising debt

through public issuance in capital market), is only an insignificant part of the Indian debt

market. Amongst the most important reforms is the development and deepening of the non-

public debt capital market (DCM), where growth has been lack lustre in contrast to a soaring

equity market.


TYBFM Mithibai 36

The stock of listed non-public-sector debt in India is currently estimated at about

USD 21 billion, or about 2% of GDP, just a fraction of the public-sector debt outstanding

(around 35% of GDP), or the equity market capitalisation (now close to 100% of GDP).

To strengthen the Indian financial systems it is now pertinent to develop the

environment for corporate debt market in India.

The limitations of public finances as well as the systemic risk awareness of the

banking systems in developing countries have led to a growing interest in developing bond

markets. It is believed that well run and liquid corporate bond markets can play a critical

role in supporting economic development in developing countries, both at the

macroeconomic and microeconomic levels. Though the corporate debt market in

India has been in existence since the Independence in 1947; it was only after 1985-

86, following some debt market reforms that the state owned public enterprises (PSUs)

began issuing PSU bonds. However, in the absence of a well functioning secondary market,

such debt instruments remained highly illiquid and unpopular among the investing

population at large.

5.1.B. Types of Bond Market in India

Corporate Bond Market

Municipal Bond Market

Government and Agency Bond Market

Funding Bond Market

Mortgage Backed and Collateral Debt Obligation Bond Market

5.1.C. Types of Debt Instruments

There are various types of debt instruments available that one can find in Indian debt

market.

Government Securities:

It is the Reserve Bank of India that issues Government Securities or G-Secs on

behalf of the Government of India. These securities have a maturity period of 1 to 30 years.

G-Secs offer fixed interest rate, where interests are payable semi-annually.


TYBFM Mithibai 37

Corporate Bonds:

These bonds come from PSUs and private corporations and are offered for an

extensive range of tenures up to 15 years. Comparing to G-Secs, corporate bonds carry

higher risks, which depend upon the corporation, the industry where the corporation is

currently operating, the current market conditions, and the rating of the corporation.

However, these bonds also give higher returns than the G-Secs.

Certificate of Deposit:

These are negotiable money market instruments. Certificate of Deposits (CDs),

which usually offer higher returns than Bank term deposits, are issued in Demat form and

also as a Usance Promissory Notes. There are several institutions that can issue CDs. Banks

can offer CDs which have maturity between 7 days and 1 year. CDs from financial

institutions have maturity between 1 and 3 years. There are some agencies like ICRA,

FITCH, CARE, CRISIL etc. that offer ratings of CDs. CDs are available in the

denominations of ` 1 Lac and in multiple of that.

Commercial Papers:

There are short term securities with maturity of 7 to 365 days. CPs is issued by

corporate entities at a discount to face value.

Zero Coupon bonds (ZCBs):

ZCBs are available at a discount to their face value. There is no interest paid on these

instruments but on maturity the face value is redeemed from the RBI. A bond of face value

100 will be available at a discount say at Rs 80 and the date of maturity is after two years.

This implies an interest rate on the instrument. When the bonds are redeemed Rs 100 will be

paid. The securities do not carry any coupon or interest rate i.e. unlike dated securities no

interest is paid out every year. When the bond matures the face value is returned. The

difference between the issue price (discounted price) and face value is the return on this

security.

5.1.D. Recent developments in the corporate debt market in India

In the recent past, the corporate debt market has seen a high growth of innovative

asset-backed securities. The servicing of debt and related obligations for such instruments is

backed by some sort of financial assets and/or credit support from a third party. Over the


TYBFM Mithibai 38

years greater innovation has been witnessed in the corporate bond issuances, like floating

rate instruments, zero coupon bonds, convertible bonds, callable (put-able) bonds and step-

redemption bonds.

These innovative issues have provided a gamut of securities that caters to a wider

segment of investors in terms of maintaining a desirable risk-return balance. Over

the last five years, corporate issuers have shown a distinct preference for private

placements over public issues. This has further cramped the liquidity in the market. The

dominance of private placement in total issuances is attributable to a number of factors.

Lengthy issuance procedure for public issues, in particular, the information disclosure

requirements

Costs of a public issue are considerably higher than those for a private placement

The quantum of money raised through private placements is typically larger than

those that can be garnered through a public issue. Also, a corporate can expect to

raise debt from the market at finer rates than the prime-lending rate of banks and

financial institutions only with an AAA rated paper. This limits the number of

entities that would find it profitable to enter the market directly.

5.1.E. Advantages of debt market

The biggest advantage of investing in Indian debt market is its assured returns. The

returns that the market offer is almost risk-free (though there is always certain amount of

risks, however the trend says that return is almost assured). Safer are the government

securities. On the other hand, there are certain amounts of risks in the corporate, FI and PSU

debt instruments. However, investors can take help from the credit rating agencies which

rate those debt instruments.

Another advantage of investing in India debt market is its high liquidity. Banks offer

easy loans to the investors against government securities.

5.1.G. Disadvantages of debt market

As the returns here are risk free, those are not as high as the equities market at the same

time. So, at one hand we are getting assured returns, but on the other hand, we are getting

less return at the same time. Retail participation is also very less here, though increased

recently.


TYBFM Mithibai 39

5.1.F. Different types of risks with regard to debt securities

Default Risk:

This can be defined as the risk that an issuer of a bond may be unable to make timely

payment of interest or principal on a debt security or to otherwise comply with the

provisions of a bond indenture and is also referred to as credit risk.

Interest Rate Risk:

It can be defined as the risk emerging from an adverse change in the interest rate

prevalent in the market so as to affect the yield on the existing instruments. A good case

would be an upswing in the prevailing interest rate scenario leading to a situation where the

investors money is locked at lower rates whereas if he had waited and invested in the

changed interest rate scenario, he would have earned more.

Reinvestment Rate Risk:

It can be defined as the probability of a fall in the interest rate resulting in a lack of

options to invest the interest received at regular intervals at higher rates at comparable rates

in the market.

Counter Party Risk:

It is the normal risk associated with any transaction and refers to the failure or

inability of the opposite party to the contract to deliver either the promised security or the

sale value at the time of settlement.

Price Risk:

Refers to the possibility of not being able to receive the expected price on any order

due to an adverse movement in the prices.

5.1.H. Bond market participants

Bond market participants are similar to participants in most financial markets and

are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often

both.

Participants include:

Institutional investors

Governments


TYBFM Mithibai 40

Traders

Individuals

Because of the specificity of individual bond issues, and the lack of liquidity in many

smaller issues, the majority of outstanding bonds are held by institutions like pension funds,

banks and mutual funds. In the India, approximately 10% of the market is currently held by

private individuals. Mortgage-backed bonds accounted for around a quarter of outstanding

bonds in the US in 2009 or some $9.2 trillion. The sub-prime portion of this market is

variously estimated at between $500bn and $1.4 trillion. Treasury bonds and corporate

bonds each accounted for a fifth of US domestic bonds. The outstanding value of

international bonds increased by 13% in 2009 to $27 trillion.

5.1.I. Bond market size

Amounts outstanding on the global bond market increased 10% in 2009 to a record

$91 trillion. Domestic bonds accounted for 70% of the total and international bonds for the

remainder. The US was the largest market with 39% of the total followed by Japan (18%).

5.1.J. Bond market volatility

For market participants who own a bond, collect the coupon and hold it to maturity,

market volatility is irrelevant; principal and interest are received according to a pre-

determined schedule.

But participants who buy and sell bonds before maturity are exposed to many risks,

most importantly changes in interest rates. When interest rates increase, the value of existing

bonds falls, since new issues pay a higher yield. Likewise, when interest rates decrease, the

value of existing bonds rise, since new issues pay a lower yield. This is the fundamental

concept of bond market volatility: changes in bond prices are inverse to changes in interest

rates. Fluctuating interest rates are part of a country's monetary policy and bond market

volatility is a response to expected monetary policy and economic changes.

5.1.K. Bond investments

Investment companies allow individual investors the ability to participate in the

bond markets through bond funds, closed-end funds and unit-investment trusts. Exchange -

traded funds (ETFs) are another alternative to trading or investing directly in a bond issue.


TYBFM Mithibai 41

These securities allow individual investors the ability to overcome large initial and

incremental trading sizes.

5.2.A. Equity or Stock Market

A stock market or equity market is a public market (a loose network of economic

transactions, not a physical facility or discrete entity) for the trading of company stock and

derivatives at an agreed price; these are securities listed on a stock exchange as well as

those only traded privately.

The size of the world stock market was estimated at about 36.6 trillion USD at the

beginning of October 2012. The total world derivatives market has been estimated at about

$791 trillion face or nominal value, 11 times the size of the entire world economy. The value

of the derivatives market, because it is stated in terms of notional values, cannot be directly

compared to a stock or a fixed income security, which traditionally refers to an actual value.

Moreover, the vast majority of derivatives 'cancel' each other out (i.e., a derivative 'bet' on

an event occurring is offset by a comparable derivative 'bet' on the event not occurring).

Many such relatively illiquid securities are valued as marked to model, rather than an actual

market price.

The stocks are listed and traded on stock exchanges which are entities of a

corporation or mutual organization specialized in the business of bringing buyers and sellers

of the organizations to a listing of stocks and securities together. The largest stock market in

the United States, by market cap is the New York Stock Exchange, NYSE, while in Canada,

it is the Toronto Stock Exchange. Major European examples of stock exchanges include the

London Stock Exchange, Paris Bourse, and the Deutsche Brse. Asian examples include the

Tokyo Stock Exchange, the Hong Kong Stock Exchange, the Shanghai Stock Exchange,

and the Bombay Stock Exchange. In Latin America, there are such exchanges as the

BM&F Bovespa.

5.2.B. Trading

Participants in the stock market range from small individual stock investors to large

hedge fund traders, who can be based anywhere. Their orders usually end up with a

professional at a stock exchange, who executes the order.


TYBFM Mithibai 42

Some exchanges are physical locations where transactions are carried out on a

trading floor, by a method known as open outcry. This type of auction is used in stock

exchanges and commodity exchanges where traders may enter "verbal" bids and offers

simultaneously. The other type of stock exchange is a virtual kind, composed of a network

of computers where trades are made electronically via traders.

Actual trades are based on an auction market model where a potential buyer bids a

specific price for a stock and a potential seller asks a specific price for the stock. (Buying or

selling at market means you will accept any ask price or bid price for the stock,

respectively.) When the bid and ask prices match, a sale takes place, on a first-come-first-

served basis if there are multiple bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between

buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide

real-time trading information on the listed securities, facilitating price discovery.

5.2.C. Market participants

A few decades ago, worldwide, buyers and sellers were individual investors, such as

wealthy businessmen, with long family histories (and emotional ties) to particular

corporations. Over time, markets have become more "institutionalized"; buyers and sellers

are largely institutions (e.g., pension funds, insurance companies, mutual funds, index

funds, exchange-traded funds, hedge funds, investor groups, banks and various other

financial institutions). The rise of the institutional investor has brought with it some

improvements in market operations. Thus, the government was responsible for "fixed" (and

exorbitant) fees being markedly reduced for the 'small' investor, but only after the large

institutions had managed to break the brokers' solid front on fees. (They then went to

'negotiated' fees, but only for large institutions.

However, corporate governance (at least in the West) has been very much adversely

affected by the rise of (largely 'absentee') institutional 'owners'.


TYBFM M

Blackbook Project- Indian Capital Market

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