CAPITAL MARKET

CAPITAL MARKET The market where investment instruments like bonds,

equities and mortgages are traded is known as the capital market.

The primal role of this market is to make investment from investors who have surplus funds to the ones who are running a deficit.

The capital market offers both long term and overnight funds.

The different types of financial instruments that are traded in the capital markets are:

> equity instruments > credit market instruments, > insurance instruments, > foreign exchange instruments, > hybrid instruments and > derivative instruments.

Nature of capital market The nature of capital market is brought

out by the following facts: It Has Two Segments It Deals In Long-Term Securities It Performs Trade-off Function It Creates Dispersion In Business

Ownership It Helps In Capital Formation It Helps In Creating Liquidity

Types of capital marketThere are two types of capital

market: Primary market, Secondary market

Primary Market It is that market in which

shares, debentures and other securities are sold for the first time for collecting long-term capital.

This market is concerned with new issues. Therefore, the primary market is also called NEW ISSUE MARKET.

Secondary Market The secondary market is

that market in which the buying and selling of the previously issued securities is done.

The transactions of the secondary market are generally done through the medium of stock exchange.

The chief purpose of the secondary market is to create liquidity in securities.

SEBI

The Securities and Exchange Board of India (SEBI) was established in 1988. It got a legal status in 19992. SEBI was primarily setup 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. Te SEBI was setup with the fundamental objective, "to protect interest of investors in securities market and for matters connected therewith or incidental thereto."

The main functions of SEBI are:-

To regulate the business of the stock market and other securities market.

To promote and regulate the self regulatory organizations.

To prohibit fraudulent and unfair trade practices in securities market.

To promote awareness among investors and training of intermediaries about safety of market.

To prohibit insider trading in securities market. To regulate huge acquisition of shares and

takeover of companies.

PRIMARY MARKET REFORMS

The issuing companies are required to make material disclosures about the risk factors in their offer documents.

Get their debt instruments rated Continuous disclosures are made by firms so as to

enable the investors to make a comparison between promises and performance

The due diligence certificate by the lead manager regarding the disclosure made in the offer document, has been made a part of the offer document for better accountability and transparency.

Improved disclosure standards, introduction of prudential norms and simplification of issue procedures.

SEBI also introduced a code for advertisement for public issues for ensuring fair and true picture

In order to reduce the cost of issue, yhe underwriting of issues has been made optional subject

The book building process introduced with a view to further strengthen the price fixing process.

Indian companies have been allowed to raise funds from abroad by issue of ADR/GDR/FCCB etc.

SECONDARY MARKET REFORMS

The floor based open out cry system has been replaced by on-line electronic system

The period settlement system has given away to the rolling settlement system

Physical share certificate system has been outdated by the electronic depository system.

Management system has been made more comprehensive with different types of margins introduced

FII’s have been allowed to participate in the capital market.

Stringent steps have been taken to check insider trading.

The interest of minority shareholders have been protected by introducing take over code.

Several type of derivative installment have been introduces for hedging

Securities market moved from T+3 settlement period to T+2 rolling settlement with effect from 1st April 2003.

Real time gross settlement also been introduced by RBI to settle inter-bank transactions online at real time mode.

TYPES OF ISSUE OF SECURITIES IN INDIAN CAPITAL MARKET

PUBLIC ISSUE THROUGH PROSPECTUS This method is most common method of issue of securities. The

securities are offered to the investors through a detailed statement of terms and conditions known as prospectus. The issue by prospectus method is adopted when the company wants to issue fixed number of securities at a fixed price. The entire issue process in terms of amount of issue types and mix of issue appears to be transparent .

one of the short coming of this method is that it is a expensive method. High cost of advertisement ,brokerage and underwriting are involved.

OFFER FOR SALE Under this method, the company does not directly offer its shares to

the public but through intermediaries such as issuing houses or firms of stock brokers. The prospectus with minimum content is distributed to the applicants. The issue is also underwritten to avoid the possibility of the issue largely remaining with the issuing houses.

ISSUE THROUGH PRIVATE PLACEMENT OF SECURITIES

In this case the issuing company does not offer the securities to investors in general. Instead the securities are offered to selected big institutional clients only. Other institutional investors may be selected in conformity with the merchant banker. Unlisted companies may also adopt this method. The shares of private placement in India has increased in the last 10 years.

OFFER THROUGH BOOK BUILDING PROCESS

It is a method of issuing shares to investors in which prices are discovered through a bidding process. It is a method of issue of shares based on floor price or price band which is indicated before the book building process. Under this method the company does not directly issue shares but invites bids from the merchant bankers to take up the full responsibility of the issue. Companies issuing securities through book building process are required to have a red herring prospectus

TRADING SYSTEM IN SECONDARY MARKET

NATIONAL STOCK EXCHANGE (NSE)The NSE was incorporated in Nov 1992 to provide nation wide stock

trading facilities. The NSE has a fully automated screen based trading system. It operates on the principles of an order driven market. The basic idea of setting up of NSE was to facilitate computerized trading in debt market instrument.

MARKET SEGMENTS OF NSE WHOLESALE DEBT MARKET SEGMENT CAPITAL MARKET SEGMENT FUTURES AND OPTION TRADING CURRENCY FUTURES TRADING

WHOLE SALE DEBT MARKET SEGMENT (WTM)WDM segments NSE offers financial services of higher value transactions. It

facilitates transactions for institutions banks in the instruments of public sector bonds, treasury bills, government securities, units of UTI, COD’s . The trading members of WDM consists of financial institutions, institutional members, subsidiaries of banks and body corporates.

CAPITAL MARKET SEGMENTThe capital market segment covers trading in equities and retail trade in

convertible or non convertible debentures and hybrids. The trading members of capital market may be either individual, registered firms or institutional members having a minimum net worth of 75 lakhs.

FUTURES AND OPTION MARKET SEGMENTSThe NSE deals in many products. It is active in the derivatives market. It

trades in NIFTY futures, NIFTY options, individual stock options and individual stock futures.

CURRENCY FUTURE TRADINGNSE started trading in currency futures w.e.f. august 2008. These are also

now being traded at USE and MCX-SX

OVER THE COUNTER EXCHANGE OF INDIA

OTCEI was incorporated in Oct 1990, with the objective of setting up a National, ringless, screen-based automated stock-exchange. The major participants of OTCEI are members such as merchant banks, mutual funds, banking and financial institutions and the dealers should be individuals, firm and body corporates.

Features:-1. OTCEI is a ringless and screen-based trading.2. Sponsorship ensures quality of the companys and enhance

liquidity for the scripts listed on OTCEI.3. There is transparency of transactions. This system ensures the

trades are done at the best prevailing quotation in the market.4. Bought out deals : through this concept, OTCEI allows companies

to place it equity with the sponsor member at a mutually agreed price.

5. There is Nation wide listing in OTCEI.

TRADING

The NSE trading system called ('National Exchange for Automated Trading' (NEAT) is a fully automated screen based trading system.

It is on line and nationwide trading system.

It adopts the principle of an order driven market.

Trading Mechanism In this system a member can

punch into the computer quantities of securities and prices at which he likes to transact.

The transaction is executed as soon as it finds a matching sale or buy order from a counter party.

MARGIN TRADING

Margin Trading is an arrangement whereby a investor purchases securities by borrowing a portion of the purchase value fro the authorised broker by using securities in his portfolio as collateral.

Only corporate brokers with net worth of at least Rs.3 Crores would be eligible to participate.

The total exposure of the broker shall be within self imposed prudential limits and not exceeding 50% of net worth.

INDICIES IN INDIAN CAPITAL MARKET

Indices are used to give information about the price movement of securities in the stock markets.

Important Indices in India are:-1. SENSEX(BSE)2. NIFTY(NSE)

EMERGING TRENDS IN INDIAN CAPITAL MARKET

Investors protection, grievance and education Depositories and dematerialisation Derivatives Book building Buy-back of shares Securities lending scheme Rolling settlement Green shoe option Merchant banker Portfolio manager Mutual funds

What is a Depository? A Depository (NSDL & CDSL) is an

organization like a Central Bank where the securities of a shareholder are held in the electronic form at the request of the shareholder through the medium of a Depository Participant.

Who is a Depository Participant?

A Depository Participant (DP) is your representative (agent) in the depository system providing the link between the Company and you through the Depository.

While the Depository can be compared to a Bank, DP is like a branch of your bank with whom you can have an account.

According to SEBI guidelines, Financial Institutions like banks, stockbrokers etc. can become participants in the depository.

How does the Depository System operate?

The Depository System functions very much like the banking system.

A bank holds funds in accounts whereas a Depository holds securities in accounts for its clients.

A Bank transfers funds between accounts whereas a Depository transfers securities between accounts.

In both systems, the transfer of funds or securities happens without the actual handling of funds or securities.

Depository system in India

Multiple depository model adopted because The geographical vastness of investors To promote competition among

depositories and bring down cost.In India, first depository was set up in 1996 as NSDLIn 1998, another depository CDL was set up by BSE.

Benefits to investors

Eliminate the risk and problem of delays Eliminate risk of bad deliveries No requisite of filling up the transfer deeds,

payment of transfer stamp duty, a lot of other paper work at the end of investor.

Fraudulent interception of certificates in postage or transits is eliminated.

Ownership transfer is immediate. Investment becomes more liquid. Problem of odd lot is eliminated. Only one account is required to be opened with a

DP. So its safe and user friendly.

Benefits to issuing companies

Saves a lot of paper work Saves postal cost Companies send a positive sign to its

shareholders about its concern for their welfare.

Book building Book-building is a process of price discovery

used in public offers.Types of book building in India:1.) 100% of the net offer to public through book building process.2.) 75% of the net offer through book building and 25% at price determined through book building. The issuer sets a floor price and a band within

which the investor is allowed to bid for shares. The upper price of the band can be a maximum

of 1.2 times the floor price. The investor had to bid for a quantity of shares

he wished to subscribe to within this band.

Book building

Bids to remain open for at least 5 days

Only electronic bidding is permitted Bidding demand is displayed at the

end of every day. The lead manager analyses the

demand generated and determines the issue price or cut-off price in consultation with the issuer.

Cut-off price The cut-off price is the price discovered by

the market. It is the price at which the shares are issued to the investors.

Investors bidding at a price below the cut-off price are ignored.

Let’s say a company wants to issue 10,00,000 shares. The floor price for one share of face value, Rs10, is Rs48 and the band is between Rs48 and Rs55.

At Rs55, on the basis of bids received, the investors are ready to buy 2,00,000 shares. So the cut-off price can not be set at Rs55 as only 2 lacs shares will be sold.

So as a next step, the price is lowered to Rs54. At Rs54, investors are ready to buy 4 lacs shares. So if the cut-off price is set at Rs54, 6 lacs shares will be sold. This still leaves 4 lacs shares to be sold.

The price is now lowered to Rs53. At Rs53, investors are ready to buy 4 lacs shares. Now if the cut-off price is set at Rs53, all ten lacs shares will be sold.

Investors who had applied for shares at Rs55 and Rs54 will also be issued shares at Rs53.

Book Building benefits and limitations

BENEFITS: To companies: fast and assured

collection of funds To investors: subscribe at a

realistic and fair price.LIMITATIONS: Appropriate only for big issue Issuing company must be well

known in the capital market.

Buy back……..Concept

What Does Buyback Mean?The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies will buy back shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking for a controlling stake

BUY-BACK OF SHARESBuy back is done by the company with the purpose to improve

liquidity in its shares and enhance the shareholders’ wealth. Under the SEBI (Buy Back of Securities)

Regulations, 1998, a company is permitted to buy back its shares or other specified securities

through any of the following methods: From the existing security holders on a proportionate basis

through a tender offer; From the open market through (i) the book building process,

and (ii) stock exchanges; From odd-lot holders.

The company has to disclose the pre and post-buy back holding of the promoters. To ensure the speedy completion of the buyback process, the regulations have stipulated a time limit for each step.

Why companies buyback Unused cash

Tax gains

Market perception

Exit option

Escape monitoring of accounts and legal contracts

Increase promoters stake

Legal aspects

Indian Companies Act 1956, Section 77A, SEBI (Buy Back of Securities) Regulations, 1998 are applicable

A special resolution has to be passed in general meeting of the shareholders If the buyback is more than 10% of the total paid up capital

Buyback should not exceed 25% of the total paid-up capital and free reserves

A declaration of solvency has to be filed with SEBI and Registrar Of Companies

The company should not make any further issue of securities within 2 years, except bonus, conversion of warrants

Procedures for Buyback Modes of Buy Back Letter of Offer Offer Procedure Payment Procedure Extinguishment of Share Certificate A return on buy-back of securities has to be filed

by the company with the ROC in a form specified in Annex- A to the Rules within 30 days of completion.

The company has to maintain a Register on shares bought back in a form supplied in Annex- B of the rules.

Modes of Buy Back

(a)    From the existing shareholders on a proportionate basis through private offers;(b)    By purchasing the securities issued to employed of the company pursuant to a scheme of stock option or sweat equity

special resolution is proposed to be passed has to be accompanied by

(i)     a full and complete disclosure of all material facts;(ii)    reasons for the necessity for the buy-back; (iii)   the class of security intended to be purchased under the buy-back(iv)   the amount to be invested under the buy-back; and(v)    the time limit for completion of buy-back (not exceeding 12 months from the date of passing of the special resolution).

Letter of Offer

A draft letter of offer containing particulars specified in Schedule- II of the rules has to be filed with the Registrar of Companies (ROC)

A declaration of solvency has to be filed in form No. 4A has to be filed with the ROC along with the letter of offer

Declaration states the company iscapable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration and has to be signed by at least two directors

Offer Procedure

Letter of offer to be dispatched within 21 days from the date of its filing with ROC

Offer to remain open from 15 to 30 days from date of dispatch of letter of offer

Acceptance to be on a proportionate basis if shares offered by members are more than the total number of shares to be bought back

Offers lodged deemed to be accepted unless rejection is communicated within 21 days of date of closure.

Payment Procedure

Immediately after conclusion of the date of offer, the company has to open a special account and deposit the entire amount to be paid as consideration for the buy-back

Extinguishment of Share Certificate

The share certificates bought back have to be physically destroyed in the presence of the Company Secretary in whole time practice within 7 days from the date of completion of buyback

The company has to furnish to the ROC a certificate duly verified by two directors including the managing director and the whole time Company Secretary regarding compliance with the abovementioned rule

Valuation of buy back

 Average closing price (which is a weighted average for volume) for a period immediately before to the buyback announcement

In the 2nd, shareholders are invited to sell some or all of their shares within a set price range

Generally, the price is fixed at a mark up over and above the average price of the last 12-18 months

Post debt equity ratio Post debt equity ratio should not

exceed more than 2:1

It should also be mentioned in the letter of offer

If any of the companies Debt-equity ratio will become more than 2:1 after the buy back, the company won’t be entitled to go for a buy back

EXAMPLE The cases of purchases through tender offers,

an offer for buy back should not remain open for less than 15 days and more than 30 days. The company should complete the verification of the offers received within 15 days of the closure of the offer and shares, or other specified securities. The payment for the accepted securities has to be made within seven days of the completion of verification, and bought back shares have to be extinguished and physically destroyed within seven days of the date of the payment. Further, the company making an offer for buy back will have to open an escrow account on the same lines as provided in the takeover regulations.

STOCK LENDING SCHEME

The stock lending and borrowing has been defined as lending of securities through an approved intermediary to a borrower under an agreement for a specified period with the condition that the borrower will return equivalent securities of the same type at the end of the specified period along with the corporate benefits accruing on the securities including dividend, right, bonus, redemption benefits or any other such right accruing on the securities lent.

Main constituents of the scheme are:- Lenders Borrowers and Intermediaries

Objectives:- To avoid the delivery defaults. To cover the settlement timing gap. To work as hedging strategies.

Rolling Settlement This is the Trading system of securities in

which the transaction can be squired up by a counter transaction on the same day only.

At NSE and BSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2nd working day.

For arriving at the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays and Sundays are excluded.

Typically trades taking place on Monday are settled on Wednesday, Tuesday's trades settled on Thursday and so on.

GREEN SHOE OPTION

Green shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post listing price.

It is a provision, in underwriting agreement, that allows the underwriter to sell the additional shares then the original number of shares offered.

Why GSO? This would normally done to reduce the risk of the

IPO (Initial Public offering). Also, when the public demand for the shares

exceeds expectations and the stock trades above the offering price.

Objectives

Price stability. Reduce the risk.

Working Mechanism Shares up to 15% of issue size allotted as a part

of IPO.

Money received on over allotment is deposited in GSO Bank A/C.

Promoters / Pre-issue shareholders holding more than 5% shares may lend their shares (Credited to GSO Demat a/c).

SA purchases shares from the market, if market price falls below the issue price.

Shares are transferred to lender(s); balance shares, if any, are issued to lender(s).

Balance in GSO Bank A/C is transferred to IEPF of DSE.

Example For example, if a company decides to publicly sell 1

lakh shares, the underwriters (or "stabilizers") can exercise their green shoe option and sell 1.15 lakh shares. When the shares are priced and can be publicly traded, the underwriters can buy back 15% of the shares. This enables underwriters to stabilize fluctuating share prices by increasing or decreasing the supply of shares according to initial public demand.

If the market price of the shares exceeds the offering price that is originally set before trading, the underwriters could not buy back the shares without incurring a loss. This is where the green shoe option is useful: it allows the underwriters to buy back the shares at the offering price, thus protecting them from the loss. 

Continued…..

If a public offering trades below the offering price of the company, it is referred to as a "break issue". This can create the assumption that the stock being offered might be unreliable, which can push investors to either sell the shares they already bought or refrain from buying more.

To stabilize share prices in this case, the underwriters exercise their option and buy back the shares at the offering price and return the shares to the lender.

MERCHANT BANKER

A merchant banker is a specialist intermediary whose main business is to help and advice the issuing company to raise finance from the capital market.

In banking, a merchant bank is a financial institution primarily engaged in offering financial services and advice to corporations and wealthy individuals on how to use their money. The term can also be used to describe the private equity activities of banking.

MERCHANT BANKING SERVICES

Corporate Counselling Project Counselling And Pre-Investment Studies Credit Syndication Issue Management and Underwriting Bankers to issue Portfolio Management Venture Capital Financing Leasing Non-Resident Investment Acceptance Credit And Bill Discounting

OBJECTIVES OF MERCHANT BANKING

Providing long term funds to the projects or companies.

Project counselling- loan syndication, project appraisal and arrangement of Working capital.

Deciding the capital structure. Portfolio Management Underwriting Corporate advisory & issue mgmt.

LEAD MANAGER SEBI (Merchant banker’s) regulations

1992 provides that all issues should be managed by atleast one merchant banker functioning as a lead merchant banker. A company may appoint more than 1 lead manager subject to the following:

Issue size No.of lead managers

Less than Rs 50 crores 2

Rs 50 cr – Rs.100 cr. 3

Rs 100 cr- Rs.200 cr. 4

Rs.200 cr- Rs.400 cr. 5

More than Rs.400 cr. 5 or more agreed by SEBI

Portfolio manager

The portfolio manager is a person who can build , supervise and manage a portfolio for an investor in return for a fee.

The portfolio manager may be of two types:Discretionary: exercises or may exercise any

degree of discretion as to management of portfolio of securities or funds of the client.

Non-discretionary: has to build and manage the portfolio in accordance with the guidelines of the client.

General responsibilities of portfolio manager

Has to build and manage the portfolio as per the instructions of the client.

Has to keep the funds of different clients in a fiduciary capacity. Shall not derive any direct or indirect benefit from the funds of

the clients. Shall not accept funds or securities from a client, worth less than

Rs. 5 lakhs. Should take proper and timely action on the complaint of the

client. Shall not indulge in speculative transactions with the funds of the

clients. Can participate in securities lending , if authorised by the client in

writing. Shall invest and manage the money of the client in the manner

given in the contract with the client.