FM&I module 2

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Capital Market

Capital market is a market for financial assets which havea long or indefinite maturity. Generally it deals with long termsecurities having a maturity period of above one year. Capitalmarket may be further divided into three parts i.e.

(i) Industrial security market

(ii) Govt. securities market(iii) Long term loan market

Capital market serves as a important source for theproductive use of economys savings and investment. These

savings and investments facilitate capital formation and throughthis facilitate increase in production and productivity in theeconomy. A capital market thus serves as an important linkbetween those who saves and those who aspire to invest their

savings.

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Capital markets Types

(i) Industrial Security Market

It is market where industrial concerns raise their

capital or debt by issuing instruments like equityshares or ordinary shares, preference shares,debentures or bonds. This market can be subdivided into:

(a) Primary Market or new issue market

(b) Secondary Market or stock Exchange

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Primary Market

It is a market for new issues and hence it is callednew issue market. It deals with securities which areissued to the public for the first time. There are

three ways through which capital is raised in primarymarket. These are:

- Public issue

- Right Issue - Private placement

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Secondary market

It is a market for secondary sale of securities i.e.securities which already passed through the newissue market are traded in this secondary market.Generally, such securities are quoted in stockexchange and it provides a continuous; andregular market for buying and selling of securities.

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(ii) Govt. Security Market It is a market where Long term Govt. securities are traded which

are issued by central Govt, State Govt, Semi Govt authoritieslike City Corporations, Port Trusts, Improvement Trusts, StateElectricity Boards, All India and State level financial institutions

and public sector organizations/enterprises are dealt in thismarket. Govt. Securities are in many forms such as:

- Stock Certificates or inscribed stock

- Promissory Notes

- Bearer bonds.

Govt securities are sold through public debt office of RBI.Interest on these securities influences price and yield in market.

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(iii) Long Term loan market

Commercial banks and development banks playa significant role in this market by supplyinglong term loans to corporate customers. Longterm loan market may further be classified into:

- Term loan market

- Mortgage Market - Financial guarantee Market.

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Term Loan Market In India many industrialfinance institutions have been created by Centraland State Govts. which provide medium and longterm loans to corporate customers. Institutions

like IDBI, IFCI, ICICI and other state financialcorporations come in this category.

Mortgage Market Refers to those centerswhich supply mortgage loan mainly to individualcustomers against security of immovable propertylike real estate.

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Financial guarantee Market

Refers to centers where finance is providedagainst the guarantee of reputed person infinancial circle. This guarantee may be in theform of (i) Performance guarantee or (ii)Financial guarantee. Performance guaranteecovers the payment of earnest money retentionmoney, advance payments and non compilation

of contracts etc. The financial guarantee coversonly financial contracts.

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Primary Market, Role of the Primary

market

A primary market issues new securities on anexchange.

The primary markets are where investors havetheir first chance to participate in a new securityissuance.

The key role of the primary market is to facilitatecapital growth by enabling individuals to convertsavings into investments.

Goingpublicmarks a milestone in a company'sgrowth

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Role of the Primary market Capital Generation Liquidity Diversification Cost Reduction

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Need for Companies to issue shares to the public

Most companies are usually started privately by theirpromoter's. However, the promoters' capital and theborrowings from banks and financial institutions may not be

sufficient for setting up or running the business over a longterm. So companies invite the public to contribute towards theequity and issue shares to individual investors. The way toinvite share capital from the public is through a 'Public Issue'.Simply stated, a public issue is an offer to the public to

subscribe to the share capital of a company. Once this is done,the company allots shares to the applicants as per theprescribed rules and regulations laid down by SEBI.

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Different kinds of Issues:

Capital instruments, namely, shares anddebentures can be issued to the market byadopting any of the four modes:

Public issues, Private placement,

Rights issues,

Bonus issues. Let us briefly explain these different modes of

issues.

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Public Issue

Only public limited companies can adopt thisissue when it wants to raise capital from thegeneral public. The company has to issue a

prospectus as per requirements of the corporatelaws in force inviting the public to subscribe tothe securities issued, may be equity shares,

preference shares ;or debentures/bonds.

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Private Placement

Private placement involves the company issuingsecurity places the same at the disposal offinancial institutions like mutual funds,

investment funds , banks the entire issue forsubscription at the mutually agreed upon pro-rata of interest.

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Right Shares

Whenever an existing company wants to issuenew equity shares, the existing shareholders willbe potential buyers of these shares. Generally

the Articles or Memorandum of Association ofthe Company gives the right to existingshareholders to participate in the new equity

issues of the company. This right is known as'pre-emptive right" and such offered shares arecalled Rightshares' or 'Right issue.

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Bonus Issues

Bonus issues are capital issues by companies toexisting shareholders whereby no fresh capital israised but capitalization of accumulated earnings

is done. The shares capital increases, butaccumulated earnings fall.

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SEBI General Guidelines for public

issues Subscription list for public issues should be kept open for at

least 3 working days and disclosed in the prospectus.

Rights issues shall not be kept open for more than 60 days.

Within 45 days of the closures of an issue a report in a

prescribed form with certificate from the chartered accountsshould be forwarded to SEBI to the lead managers.

The gap between the closure dates of various issue e.g.Rights and Indian public should not exceed 30 days.

SEBI shall have right to issue necessary clarification to theseguidelines to remove any difficulty in its implementation.

Any violation of the guidelines by the issuers/intermediarieswill be punishable by prosecution by SEBI under the SEBIAct.

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Prospectus

A large number of new companies float public issues. While a largenumber of these companies are genuine, quite a few may want toexploit the investors. Therefore, it is very important that an investorbefore applying for any issue identifies future potential of acompany. A part of the guidelines issued by SEBI (Securities and

Exchange Board of India) is the disclosure of information to thepublic. This disclosure includes information like the reason forraising the money, the way money is proposed to be spent, thereturn expected on the money etc.

This information is in the form of 'Prospectus' which also

includes information regarding the size of the issue, the currentstatus of the company, its equity capital, its current and pastperformance, the promoters, the project, cost of the project, meansof financing, product and capacity etc.

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Pricing an issue

The pricing of issues is done by companies inconsultation with Merchant bankers. An existingcompany with 5 years track record of profitability can

freely price the issue. The premium has to be decidedafter taking into account net asset value, profit earningcapacity and market price. The justification for price

has to be stated and included in the prospectus.

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Price discovery through Book

building process

Book Building: - Is a method of issuing / offeringshares to investors in which the price at which share areissued is discovered through bidding process. In this,

bidders (potential investors) have the flexibility to bidfor shares at a price they are willing to pay. BookBuilding is basically a process used in IPOs for efficientprice discovery. It is a mechanism where, during the

period for which the IPO is open, bids are collectedfrom investors at various prices, which are above orequal to the floor price. The offer price is determinedafter the bid closing date.

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Book Building Process

Book Building process is price discovery mechanism inan IPO. This process is helpful to discover a betteroffer prices based on the price and demand discovery

.under this process bids are collected from the investorsusing the network of BSE/ NSE, which are above ,below or equal to the floor price. Floor price is aminimum bid price it is decided at beginning of the

bidding process. Offer price is determined after the bidclosing date.

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Registrar to an Issue

The Registrar finalizes the list of eligible allottee's afterdeleting the invalid applications and ensures that thecorporate action for crediting of shares to the demataccounts of the applicants is done and the dispatch ofrefund orders to those applicable are sent. The LeadManager coordinates with the Registrar to ensurefollow up so that that the flow of applications fromcollecting bank branches, processing of the applications

and other matters till the basis of allotment is finalized,dispatch security certificates and refund orderscompleted and securities listed.

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Listing of securities

Listing of securities means that the securities are admittedfor trading on a recognized stock exchange. Transactionsin the securities of any company cannot be conducted onstock exchanges unless they are listed by them. Hence,listing is the very basis on stock exchange operations. It is

the green signal given to selected securities to get thetrading privileges of the stock exchange concerned.Securities become eligible for trading only through listing.Listing means admission of the securities for trading on the

stock exchange through a formal agreement between thestock exchange and the company. Securities are buy andsell in the recognized through members who are known asbrokers.

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Types of listing

Initial listing

Listing public issue of shares and debentures

Listing of right issue of shares and debentures Listing of Bonus issue of shares

Listing share issued on Amalgamation, mergers

etc.

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Minimum Listing Requirements for new

companies

The following revised eligibility criteria for listing ofcompanies on the Exchange, through Initial PublicOfferings (IPOs) & Follow-on Public Offerings

(FPOs), effective August 1, 2006. ELIGIBILITY CRITERIA FOR IPOs

a. Companies have been classified as large capcompanies and small cap companies. A large capcompany is a company with a minimum issue size ofRs. 10 crores and market capitalization of not less thanRs. 25 crores. A small cap company is a company otherthan a large cap company.

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Regulations Governing Primary

capital markets in India

The overall responsibility of development, regulation andsupervision of the stock market rests with the Securities &Exchange Board of India(SEBI), which was formed in 1992 asan independent authority. Since then, SEBI has consistently triedto lay down market rules in line with the best market practices. Itenjoys vast powers of imposing penalties on market participants,in case of a breach. Any company making a public issue or alisted company making a rights issue of value of more than Rs 50lakh is required to file a draft offer document with SEBI for itsobservations. The company can proceed further on the issueonly after getting observations from SEBI. The validity period ofSEBI's observation letter is three months only i.e. the companyhas to open its issue within three months period.

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Public issue in foreign capital

markets

Indian companies are permitted to raise foreigncurrency resources through two main sources: a)issue of foreign currency convertible bonds

more commonly known as 'Euro' issues and b)issue of ordinary shares through depositoryreceipts namely 'Global Depository Receipts

(GDRs)/American Depository Receipts(ADRs)' to foreign investors i.e. to theinstitutional investors or individual investors.

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The Secondary Market/ Stock

Exchanges The market where existing securities are traded is

referred to as the secondary market or stock market. Ina stock market, purchases and sales of securities

whether of Government or Semi-Government bodies

or other public bodies and also shares and debenturesissued by joint stock companies are affected. Thesecurities of government are traded in the stock marketas a separate component, called guilt edged market.Government securities are traded outside the trading

wing in the form of over the counter sales or purchases.Another component of the stock market deals withtrading in shares and debentures of limited companies.

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Control over Secondary Market