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The document provides an overview of the capital market, detailing its role as a key segment of the financial system for medium and long-term funding through equity and debt instruments. It explains the functions of the primary and secondary markets, emphasizing their interrelationship in facilitating capital accumulation and liquidity for investors. Additionally, it outlines the components of the capital market, including the structure and classification of markets, and the importance of efficient capital markets in promoting economic growth and industrial development.
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0% found this document useful (0 votes)
7 views118 pagesunit 3 FMI-1
The document provides an overview of the capital market, detailing its role as a key segment of the financial system for medium and long-term funding through equity and debt instruments. It explains the functions of the primary and secondary markets, emphasizing their interrelationship in facilitating capital accumulation and liquidity for investors. Additionally, it outlines the components of the capital market, including the structure and classification of markets, and the importance of efficient capital markets in promoting economic growth and industrial development.
Uploaded by
gamerbot160505Copyright
© © All Rights Reserved
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/ 118
Financial Markets II -
Capital Market
CHAPTER OUTLINE
629) -5.1. Capital Market —An Introduction:
5.2, Role and Functions of Capital Market
5.3. Components / Structure of Capital Market
5.1. CAPITAL MARKET - AN INTRODUCTION
” Like money market, capital market also forms an important segment of the financial markets. Having
discussed the money market in chapter 3, this chapter explains the concept, features and the working of
+ capital market. 2
+ ‘The capital market is an important constituent of the financial system and represents an institutional
_ source of borrowing and lending of medium and Jong-term funds raised within and outside the country.
Itis a market for long term funds ~ both equity and debt. Supply of funds comes largely trom individuals
2nd households who deposit funds in banks and other financial institutions (such as insurance companies,
‘Mutual funds and specialised financial agencies) that use these funds to invest in bonds and stocks and
‘other capital market instruments, The demand for long term capital comes mainly from private and
Public corporations and the government that issue capital market securities to borrow funds to meet their
needs for long term investment. The Governments ~ both Central and the State, issue various capital
scarket securities such as long term bonds, dated government securities of various maturities to finance
tteir development needs and also to meet their deficit. The private and public corporations issue debt
and equity, to fund their investment opportunities,
i The securities in the capital market are traded either in the
‘While the primary market deals with the new issue of securities
uarket is a market where securities are traded afer bein
tarket and/or listed on the Stock Exchange,
Secondary market comprises equity marke
primary market or secondary market
(both equity and debi), the secondary
8 initially offered to the public in the primary
Majority of the trading is done in the secondary market.
ts and the debt markets, ‘There are mainly two types of
Ce
Anni? 70.0.0 A)
sy mobisingervings fr investment i productive
cca i te lowing WAYS
tr needy discussed in chapter 1, Prieary
me ever, Since they ac isued
ee ory meres of do hla see iter he
we Tenders, they are also calted direct securities For example, if a
rectly by the borrowers t0 the
directly by a company, this will result im transfer
(e) lasue of Primary Securities in Primary
‘buys a 7-year Goverment bond or equity shares of
refunds fro the sup sector (vi, household sector) to the deficit sector (viz. the government
|. = and corporate sector).
(0) Issue of Secondary Secorities in Primary Market: Secondary/indirect securities are issued by
financial intermediaries to. the ultimate savers/lenders. Indirect securities include ‘bank deposits,
Mutual fund units, insurance policies, special saving certificates issued by post offices, among
others, For example, Mr X invests money in State Bank of India Mutual fund or Kotak Money
Market Scheme. This would result in directing cash flow from surplus sector (viz. households)
to the deficit sector viz. finanéial intermediaries — both banking and non-banking, (e.g., SBI and
‘Kotak Mahindra).
Thus, primary markets enable the issuers of the securities, to raise funds by issuing primary
and secondary securities respectively through various types of issues, viz., IPO, FPO, Private
placement, Rights issue, efc. which will be explained in detail later in this chapter (section 5.7).
(©) Secondary Market. ‘Transactions in Outstanding Securities which Facilitate Liquidity: As
secondary are markets. for outstanding securities, they enable the existing/outstanding
securities to be: in the stock exchanges and hence facilitate liquidity and marketability of the
outstanding ity and debt instruments, ‘thereby creating demand for these securities. Investors
ase often reluctant to invest -n the capital market as it locks their funds for longer ‘period and thus
- involves more risk. By favilicating the outstanding securities to be traded in the secondary markets,
they encourage the investors to invest their fuinds in long term securities as investors are able to sell.
their securities in the stock ‘exchange (exit option) before maturity without much of a loss.
‘While the first two functions (a and b) discussed above directly result in accumulation of funds
for capital formation, the third function (c) helps in capital formation indirectly. The primary capital
+ market helps Government and industrial,concérns in raising funds by issuing various kinds of securities
(by actually receiving the proceeds of the sale) that directly leads to capital formation. On the contrary,
the secondary markets help in capital accumulation indirectly by providing liquidity to the outstanding
securities and thereby increasing the demand for these securities that may result in mobilising large
‘amount of savings to facilitate capital formation and economic growth.
oA Be addition Bs bale mel formation and economic growth by providing a mechanism for
raising capital, efficient capital markets also performs the following functions:
(0, Awell-developed and efficient capital market brings stability in the value of securities by
(GW) .Ithelps in faster valuation of financial securities ~equity and debt. aptiats
ii) ith fe eee lowing seer: eee eee
._ It offers cover against'price or market risk through the trading of various instruments (
+ (such
: va) aoe ai
_ speculative activities which encourages the investors to own a large range of productive
“ in financing of long-cerm projects of companies by helping in obtaining finance for
tensive prtifects with long gestation periods.
market tends to
iprove information quality. By providing continuous
curities that are traded in the stock markets, it helps the
() An efficient
information abo
‘companies in determining the price of the new issues,
through automated system which provides
ions and information and simplifying the
through its price mechanism allocates the scarce financial resources to
ow cost.
tates in the revival of sick units by modernisation and rehabilitation of industries.
helps in the promotion of incustrial growth by development of backward areas and providing
Sinance for large infra structural developments and thereby generating employment.
(©) Ttprovides funds for expansion, modemisation and upgradation of technology to promote industrial
development.
(xi) Itprovides a large: array of services to entrepreneurs such as ‘underwriting, credit rating, consultancy,
financial counselling services and a number of advisory services like Preparation of feasibility
Feports, providing training to entrepreneurs, et. to stimulate industrial entrepreneurship.
(a) ‘An efficient capital marke also provides a valuable source of external finance.
Thus, the development and growth of a deep and broad capital market plays a crucial role in
Spuring the growth rate of an economy. Capital market is an ‘important and efficient conduit to channel
and mobilise funds to the enterprises. and provide an effective Source of investment in the economy. It
Dilays aenitical role in mobilising sav-ngs for investment in Productive assets, witha view to enhancing
country’s long term growth prospects. It thus, acts a8 a major catalyst in transforming the economy into
more efficient, innovative and competitive marketplace in the'global arena,
5.3, COMPONENTS/STRUCTURE OF .
CAPITAL MARKET :
The structure and organisation of the capital market can be described by us i
: Y using. a number of criteria,
Cepia markets can be categorised in vatious ways d the ty ssificat
pack cope 8 depending on the type of lasfcation used, Most
(@) Primary markevNew Isue Market (NIM) and Secondary Man
ket/Stock Exchanges
(Debt market and Equity Market Th
Figure 5.1 shows different classifications of the cay
pital markets:
A detailed analysis of these classifications, viz,
e . » Primary market, second: market
guy markets is done inthe present chapter andthe Subsequent chapters oe 67 ine ™
uals Slaw: ‘ Financial Markets ari nstitanion®)
ae
a :
al with the new issues of the
a they det
tered othe publi fo he
+ new companies or existing enterprises
that new companies need not entirely Bs
dy in business but - an
sv
tal base
th
ie traded after they arc initially offered to the is
exchange. Thus, secondary market is a market ‘1
cied. The existing or outstanding seourities are the a
‘k exchange quotation. The secondary market may |
rasi¢ fuinction of the secondary markets is to provide |
1g the participants to sell their securities
ey enable’ the investors to adjust their ae
securities as a result of changes in their assessment of risk and retu ee markets also en:
true and fair dealing to the investors in securities in otder to protect er
‘There are two types of exchanges in the secondary markets for capital market securities: =
exchangesand over the counter exchanges, Whereas most money marke transactions originate over
phone, most capital market transactions, measured by the volume, occur in organised exchanges. An
‘organised exchange has a physical location where the securities (stocks, bonds, options and futures) are
traded. Exchange rules govern the trading to ensuré the efficient and legal opeta-ion of the exchange,
and the exchange board constantly reviews these rules to ensure that they result in competitive trading.
5.3.2. Difference between the Primary and Secondary Markets _—-
Primary/NIM have no geographical existence or location and that could probably be the reason why they
are not very well known to the public as compared to the secondary markets or stock exchanges. Primary
, markets do not have any particular administrative or organisational set up and are only recognised by the
services they provide to the investors in securities. For example, various investment banks, merchant
banks, brokers, underwriters are the important players in the NIM. Secondary markets, on the other
‘hand , have a physical existence and are located in a particular geographic spot, for example, New York
stock exchange, NASDAQ, NSE, BSE and major stock exchanges around the world.
Another important difference between the primary market and the secondary market is theit
contribution in raising funds for industrial financing and thus, in capital accumulation, In order to meet
theirrequirement of funds fr starting new ventures or for expansion or dversificston in their business,
Corporate enterprises usually issue various types of equity or debt instruments in the primary markets,
When individual and institutional investors buy these sécurities ( or subscribe to these securities), the
'ssuing corporations are able to acquire new/additional funds. Thus, primary thatkets have a direct role
incorporate financing as they facilitate direct transfer of funds from the savers to borrowers. :
_ Secondary markets, on the other hand, contribute in'the process of capital accumulation in an”
indiec! manner, When a person puchases a security in the secondary market; the money is teceived
by the person who has sold the security to him and ot by the company which has isued the security, sSeoc i
accumulation AS
and safety, se2ondary
subscribe to the new
‘between the primary and the secondary markets can be explained
s perform. The funetions performed by the primary and
in Section $3.4 in the present chapter and section 6.2 in
5.3.3, Relationship between the Primary Market (NIM)
and the Secondary Market
Despite their differences, primary and secondary ma
are the companents: of capital markets ich |
by SEB Securities traded in both the:
are, thus, interrelated to each other in the followii
(@) Listing of Securities:, To ensure fair dealings in securities, the new issues of securities in the
primary tarket have to be listed on the stock exchange. The issuing company is required to make
an application to recognised stock exchange forthe listing of their securities that are proposed to
be issued. The issuing company is required to file a prospectus 1 registrar of companies and
the detailed disclosure requirements of the prospectus are also specified. picts
(®) Control of New Issues by the Stock Exchanges: The companies seeking listing or quotation on
stock exchange have to comply with various rules and regulations framed by the stock exchanges.
In case 6f the non compliance by the companies,:stock exchanges can refuse the listing facility to
the companies floating new issues. Thus, through the listing requirement, stock exchanges exercise
‘2 great deal of control over the NIM.
(0) Discovery of Price: “The secondary market helps in the determining the price of the securities at
which these issues will be sold in the primary market. By providing continuous information about
the prices ofthe securities that are traded in the stock markets, the secondary markets help the
companies in determing the'price of the new issues.
(@ Volume, Pricing and Timing of New Issues: The volume, pricing and timing of new issues in
the primary market af influenced by returns in the stock market. The subscription in the primary
market to the new issues depends on how the secondary i
.o have many similarities. Both the markets
securities are traded. They are both regulated
‘on recognised stock exchanges. These markets
floating new issues in the primary market,
Be em issues are influenced by the price movements in the stock markets. Higher the
i of te ey he con mat higher wl eh pc at which he suing
is its issues in the primary market. Companies that perform well have higher prices of their
TE —— ita secondary
to the financial
in the primary market is
don their experience in
ary market depend, to a large
ry market, The
te mn the prices and f
Bsc iteatsivelopsd primary market is equally indispensable for the presence Ge
‘efficient secondary market. As more companies come out with new issues of securities in the
primary market, the level of activity inthe secondary markets increases as well. Larger the number
of new firms entering the primary market with new issues of securities, the mumber of instruments
‘that are traded in the secondary market increases, thus leading to greater depth of the secondary
market. Another way in which the primary markets may impact the’secondary markets is when
there are new issues of a large size and bunching of large issues in:the primdry market, it may
Girect funds from secondary market to primary market, thereby affecting the prices of securities in
secondary market, +
Thus, although the primary and secondary markets perform different types of functions, yet,
iney are complementary to each other and the health ofeach of these markets depends onthe
other market. When the secondary markets are in upward trend, it instils confidence amongst the
investors and they are encouraged to invest in the’ primary market. Thus, a buoyant secondary
} markt induce investors to subscribe tothe new issues inthe priniary market and leads to vibrant
f Primary market, Similarly, the larger number of issuing companiés with a wide Tange of financial
‘struments in the primary market increases the depth of the Secoridaty markets. Hence, neither of
‘wo markets can function effectively without the efficient working oF the other market.
534. Funetions of Primary/New Issue Market
The main function of the Primary market/ NIM is to
‘mobilise the funds ft
peas ise the rom the savers and transfer
the new issues into two types- new issues by the new
former is also called initial and the latter
ferms is not related to the aj
Stock exchange listing. The securities issued b
ry the cor
either after the incorporation or
‘issues while those issued by companies which alread,
u ly have stock exchange quotation, ei
co ia acisteh a ; a quotation, either by public
see ote shareho| Bi are classified'as further or old issues,
t ‘ New Issue market inainh important
Services — called triple Service function of NIM. These services are ae ieee cease
i efficiency and the level of development of NIM ction. The three
1 perform the triple service fun
depends on the presence ofthese specialised in al
services are 4g
(@) Origination: Origi
issue proposals an
to ensure the success
houses, merchant bank
fers (0 anal aluating and processil
ination refers t0 an
tc, Origination begins
1 of the viability of
detailed assessment
riginators/issuc houses un
.¢ technical, financial,
o
lertake a study of the
10 make sure that the company is
ses render their advice on the feasil
to provide their services to the
legal and economic viability of the
has good future prospects. Based on t!
the project.
“The inoue houses and the originators also fender their advice related to various aspects oF he ms
isomer in onder to improve the quality of the isues. After conducting a careful study of the market
trends they advise the companies on various matters lke the type of securities to be floated (equity,
preference shares, debentures, convertible/non-convertibe, ec.), the price of securities (at par oF
premium), most appropriate time ofthe fldatation of the issue, volume/magnitude of the issue, terms
and conditions related to the issue-and the method of an issue (IPO, Offer for sale, Book building,
etc). All these factors are important as they ensure that if the issue is floated, it will be subscribed to
by the public. For example, time of the issue is very crucial as a very promising issue may not get
‘200d public response, if it has been fiated at a time when the market is low. On the other hand, even
an ordinary issue may be oversubscribed if it comes during the buoyant stock market.
(®) Underwriting: According to SEBI Regulations, 2009, Underwriting is an agreement, with
‘or without conditions, 10 subscribe to the securities of a body corporate when the existing
shareholders of such body corporate or the public do not subscribe to the securities offered to
them. It is < form of institutional guarantee that the issue would be sold by eliminating the risk
arising from uncertainty of public. response and hence ensuring marketability of an issue. Under
this, the guarantor undertakes to purchase a certain specified number of shares in the event of their
not being invested by the public. This function is important both for issuing companies as well as
investing public,
Under the underwriting agreement, the guarantor promises to purchase a certain number of
shares in the event 6f their not being invested by public. The underwriter is pai i
Z is paid a commission
for underwriting 4 new issue, Mostly, underwriting of shares is undertaken b: fi
it ; eat, i Y group of financial
‘institutions. In India, the Underwriting function is performed by various institutions like LIC.
vn, peed Development Banks, Commercial Banks and brokers, :
er the original lines issue iti
jae uidel se a ci yy une el ii, 1992, underwriting was mandatory
fe aan ern 012% subscription was also mandatory foreach issue
rs 3 gui sued by SEBI on 10th October, 1994,
'¢ option of deciding whether the issue
i Id also be decided by the issuers,
bau pana of NIM is distribution,
investors. This involves the
(©) Distribution: Besides originati
istribution: origination and underwritii
Distribution is refered to as the sale'of securities (ii). Further Public Offer (FPO).
£ the two types of p
ic offering is the process of selling new shares to public in the primary market. When an_
unlisted company makes either afresh issue of shares ot convertible securities or offers its existing
or convertible securities for sale or both for the first time to the pul called an IPO. IPO
paves way for listing and trading of issuer's shares. or convertible securities on the stock exchange.‘
Thus, after an IPO, the company’s shares are listed and can be traded in the open market by the investors.
{PO js the most common method of issue of securities by companies where issuing companies
offer to the general pblic, through a prospectus, a fixed number of shares, at a stated price. The
f the prospectus are prescribed by the Companies Act, 1956 which also provides both
To ensure success of thé issues, they are generally under written. Further, to help the investors to
take the informed terests, SEBI has also laid down stringent
issues are not permitted in case the number
of prospective allottees is less than 1000.'An IPO cannot be made if there are outstanding convertible
securities entitling any person to receive equity shares after the IPO. In order to enable the investor to
assess new equity shares offered tarough an IPO, the issuing company has to get IPO grading done by
at least one SEBI registered credit rating agency as on the date of registering the prospectus with the
* Registrar of Companies. Dis¢losure of IPO grades is a mandatory requirement on the part of the issuing
company coming with an IPO,
The issuing company may be one of the following:
(9 Anew company coming for the public issue for the first time.
(ii) An existing private limited company or a closely held public limited company coming for public
issue forthe first time. | i
A public sector unit where the shares are sold for the purpose of privatisation/disinvestment.
. IPO enables listing and trading of the issuers securities in the securities market. The Initial Public
Offering can be made through the fixed price method or book building method. Sometimes issuing
companies can also use a combination of both the methods, These methods are discussed below:
3 paren Sccurites here: means any security which may be converted into or exchanged with equity shares
‘of the issuer at a later ddafe, with cr without the option of the holder of the security and includes convertible debt
instruments and converti
4. -hitps/wwv sbi. gov n/sebt_data/commondocs/subsection| |_p.pdf, www.sebi.gov.in. the issue price of the shares is decided by
‘and mentioned in the offer document.
(@) Fixed Price Method: Under thi
the issuing company before the is
As the issuer is not able
lay get under-subscribed or
n in case of companies that issue shares at’a premium,
The allotment of shares
to know the demand for shares
oversubscribed. This may particular
To overcome this problem, system of book building was started, .
(6) Book Building: To avoid the problem of over subscription and under subscription, the method
used presently for IPOs is Book Building Mechanism, SEBI guidelines, 1995 define Book building
as a process by which demand for the proposed issue ited and built-up and the price at
which securities will be issued is determined on basis of bids received. Thus, in book building, the
issuing company and the merchant bankers decide a floor price or a price band but the final price
is determined by the market forces. : in a
1, How does Book Building Work?
Book building is a Process of price and demand discovery. In the book building process, bids
ie colested from investors at various prices which.are above or equal to, the floor price,
during which the IPO is open. The floor price or pricé band
» ©795. Subsequently, these
making public issues been “ jal Marketsiand Institutions.
iia) Financial's re s
f . company. It is a route for promoters-to raise
company to divest their shareh
funds by offloading their holdings i
jonal Investors (FIls) and other companies can place
for can apply in the retail category of OFS,
investors,
(based on their
bid on the shares offered for
val
Seas Sievdety faiths nce ket, Non-promoter sharcholder with more than 10% of the
Stocks can also offer shares through OFS. At least 25% of the shares rust be for Mutual Funds and
Insurance Companies and 10% of the shares in OFS are reserved for retail investors. The company has
to inform the stock exchange at least 2 days before the OFS, OFS are procedurally simple and there
#S no requirement for the company to file any formal paper-Wwork and sale of shares typically takes
single trading day. Retail investors are often offered discount. It is a cost effective way for promoters
fo invest in equity as there is no additional charges applicable other than’ regular transaction and
Security Transaction Taxes (STT)
5.4.2, Rights Issue (RI)
SEBI (ICDR) Regulations define Rights Issue as an offer of specified securities (shares or convertible
existing shareholders as on a particular date fixed by the issuer (ie.
securities) by a listed issuer to
in a particular ratio to the number of shares or convertible securities
Tecord date). The rights are offered
held as on the record date.
Under the Rights Issue the existing
issues on pro-rata basis. This right is given t
offer to subscribe to new shares at a predeter
The right issue is made by companies usu:
increase the stake of the promoters or restruc
reholders are given pre-emptive rights to subscribe to new
0 existing shareholders only under which they are given an
mined prive in proportion of their existing shareholdings.
ly for varioug reasons, viz., expansion, diversification, to
turing their balance sheets, etc,
special resolution.
The important features of the Rights Issue are the following:
@ The issuing company raising funds througki Rights issue announces a Tecord date'to determine
the eligibility of the shareholders to whom the letter of offer has to be given. The issuer shall not
withdraw the Rights issue after announcing the record date. In case of the issuer withdrawing the
Rights Issue after it has announced the record date, it cannot apply for listing of its securities on a
recognised stock exchange for a period of 12 months from the record date,
@ The subscription to the ‘new shares through the Rights Issue is restricted to only existing shareholders
and not to the Mie at large. Often the company offers the shares under Rights Issue at a discount
12 order to make them attractive to the shareholders $0 as to make them subscribe to i
and at times also to reward them, Bt ae eae ms + by sending a letter of offer to the existing shareholders who |
“reholder has the following options on the receipt of the |
he price offered
his ight in favor of someone who may not be the existing shareholder orto sel
Ins by buying some shares while renouncing the
to buy 10 shares, he may buy 6 shares and sell 4
viz., options (a) to (c)
‘ares at the market price which may be
some profit/premium.
has outstanding fully or partly Convertible
(a) He may decide not to exercise any of the above o
“@ The shareholders who-renoimce their rights may se
@ Nocompany shall makea Rij
bt instraments at the time of making Rig!
5.4.3. Composite Issue
When the issue of shares of convertible securities by a listed issuer on public- cum-rights b
H the allotment in both public issue and rights issue is proposed to be made simultaneously,
composite iss
5.4.4, Private Placement
Under SEBI guidelines, when’an issuer makes an issue of shares or convertible securities to a select
coup of persons not exceeding 49, and which is neither a rights issue nor a public issue, itis called a
private placernent. Thus, private placement refers to direct sale of newly issued securities by the issuing
company to a small number of investors through merchant bankers.
Private placement is an altemative way of raising funds fot the companies in addition to IPO and
PO. ln private placement; instead of selling shares in the open market by inviting public at large, the
issuing company decides to place its shares with select group of investors
financial institutions life insurance companies, Mutual funds or ev.
ic. Thus, private placement falls neither in the category of a public issue nor a rights issue.
‘An impoztant advantage of private placement is that the issuing company has relatively fewer
regulatory requirements sind far lesser information disclosure requirements as compared to those
involved in the case of public issue or rights issue, It is a faster way of raising capital and the issuer
can save on the lengthy issue procedure. It is also more cost-efficient methottas the issuing company
does not haye to incur costs related to underwriting commission, application and allotment of shares,
advertisement ete. and many other expenses that are that are normally incurred in case of public issue,
Thus, this method is particularly useful for the small companies which are not in a position to spend
7 pikeos on meee and advertisement, Further, the success of an issue does not depend upon
Pees a lc to raise funds by placing the securities even at times when the
fects alge lic tesponse to the issue is doubtful, The disadvantage of this method is that
ey be concentrated in few hands who may take control of the company. « private placement are Mutual funds, banks,
securities are financi
‘company has to be listed ona stock exchange
level undertakings. The
to go fora private placement.
Private placement of shares or convertible securities by li
ier can be 07 three types.
group of persons in -erms of
preferential allotment. Taus,
Easis to any select person
technical collaborators, foreign
ssue of shares by a company on
preferential allotment refers
or group of persons, for example, those to promiot ig
partners, eve, The preferential allotment is normally made for various reasons, sometimes strategic in
nature viz. as a means of debt restructuring, to increase the stake of the promoters by issuing them
shares, fo issue shares asa tool of achieving Employee stock Option Plan or fer tekeover of.a company,
etc. The issuing company is required to comply various provisions which inter-alia include pricing, -
disclosures in the notice, lock-in and other requirements in addition to the requirements that are specified
Jn the Companies Actas well as these prescribed in SEBI (ICDR) Regulations,
5.4.4.2. Qualified Institutions Placement (QIP) s =
In order to make Indian markets more competitive and efficient, SEBI introduced anothér mode for
ie domestic market in the form: of “Qualified institutional
Under SEBI guidelines, Qualified Institutional Placement is an issue of equity shares or securities
convertible into equity shares by a listed Company to Qualified Institutional Buyers only a3 pe- the
Provisions of ‘Chapter VIL of SEBI them te
the secondary markets fact
‘outstanding equity and debt instru
exchanges. They provide an
securities. Thus, by creating the demand fe
route t
Therefore, stock exchanges/markets are also known as
xy reflect the market sentiments end the proferences of the
and sale
investors. Over the counter markets (OTC) are also
the OTC platforms, two or more parties trade the secur
Following are the important functions of the secondary markets,
2.1. Nexus between Savings and Investment
in floatation of new issues by performing various functions vis. acting as 2rokers and underwriters,
arranging preliminary distribution of new issue of capital offered through prospectus and helping
companies with regard to the listing requirements on the stock exchanges.
6.2.2. Provide Liquidity and Market Place
Sezondary markets provide a ready market place for the purchase and sale of securities and thereby
By providing a platfortn to large number of investors for continuous
ensure their free transferal
s they facilitate liquidity and marketability of outstanding equity and debt instruments
to the investors, The presence of organised stock exchanges provides assurance to the investors they will
be able to convert their securities into cash whenever they need to.
6.2.3. Continuous Price Formation
Secondary markets facilitate the instant valuation of various equity and debt instruments that helps in.
the measurement of cost of capital and the rate of return: for the purpose of making economic decisions,
‘They provide regular information about the value of the securities ‘to the investors. The Prices of,
securities are determined on the basis of their demand and supply. The securities of the companies that
have higher growth and profitability have higher demarid and therefore have higher prices.
6.2.4. Safety and Fair Dealing to Protect Tnyestor’s Interests
Stock markets protect the interests of the investors by Providing them safety and fair dealing, This is
because only listed securities are traded in the stock exchanges and in order to get themselves listed,
Companies have to function under stit rules and regulations by SEBI and other regulatory authorities.
Since trading takes place on electronic system, transactions executed in the secondary markets are _seeopary Mak@td= ‘
foci ee
va confidence and promotes rate of investment |
high!
‘country.
62.5. Induce Companies’ to Improv
Since market prices of the shares reflect the per
the investors, companies are it
companies are quoted 4
e Performance
tuced to improve their performance. The shat
hese companies to raise fresh capital in the
\
prices and thus enables t
market
6.26. Stimulate Raising of Funds in the Primary Markets
ir holdings in the organised stock exchanges, secondary
helping the issujag companies to raise funds
for capital accumulation.
6.2.7. Facilitates. Inflow of Capital from International Markets
‘Awell developed stock market also fa ital by enabling the companies to raise funds
in the international markets,
{es inflow of capi
6.2.8. Contributes to Economic Growth
Secondary mafkets contribute to economic growth by allocating
is result in capital formation and consequently the econo
funds to the most efficient sectors in the
mie growth. A
+ 6.2.9. Miscellaneous Services
(9: They help tiie invéstors in designing wider investment portfolios and thereby diversifying theit
+ risk by providing them securities wit wide range of yield and maturities.
Promotes the habits of savings and encourages people to invest securities of corporate or
government sector rather-than in unproductive assets. ‘This facilitates capital formation and
© economic growth in a country.
(ii) Providing market information tothe investors, goverament and creditors in the form of daily
quotations and trends in listed securities which may be useful for taking economic decisions
‘Thus, Secondary matkets acta a barometer ofthe state of the health ofthe economy by constantly \
- measuring its progress! Any major change i thé economy on account of economic, potitieal or other |
factors have a bearing on the secondary/stock market.
63. STRUCTURE/ORGANISATION OF
_ SECONDARY MARKETS
Secondary takes cn’ be clsifiedin various ways depending. pon the eter wsed for the \
“classification, Most commonly, they are classified into debt and equity markets or stock exchanges and
over the counter markets (OTC). They may algo be classified into the spot markets and future markets. \
Spot miarkets generally refer to the markets where securities are traded for immediate delivery and
Gi
1, Khan, M.Y. (2017). Sndian Financial System
Soe Sa pS a NUE i kc
f i. sometimes, called cash ‘markets. Future markets, on the other hand, are the
traded for future delivery and payment. °
tock exchanges or over the counter markets
tock exchanges are organised in nature
and conducted within the regulatory
payment. They are
markets where the sec
framework provided by SEBI arid other regulatory authorit
6.3.1. Stock Exchange :
A Stock exchange is a well-organised market for the sale and purchase of corporate, government, and
other securities, tis a market place where investors can buy and sell securities, including stocks, bonds,
derivatives, commodities and other financial instruments, The
(SCRA) 1956 defines a stock Exchange as “an association, organisation or body of individuals, whether
incorporated or not, established for the purpose of assisting, regulating and controlling, business in
buying, selling and deali The securities are traded in the stock exchanges according to
Some predefined rules and regulations and within the regulatory framework provided mainly by SEBL
Stock exchanges facilitate the companies to raise capital o fund their perations and expansion
Projects by mobilising funds from IPO markets as well as-act as invest int intermediaries for the
investors. By providing liquidity and real-time price information on company {hares, the stock exchange
‘ocation of capital. By providing
re fort stock exchanges encourage
People to invest in corporate and government securities, thereby chen ing the surplus savings of th
individuals to more productive uses, resulting in a more effcieet economy. :
The companies that ate listed on a stock exchange are constant! i
ly under the public scrutiny as th.
dave to conform to the reporting standards (eg. regular ‘eportng of their financial statements) set fe,
SEBI and other regulatory bodies. This eslts in higher eft
ensuring that the managemert will
6.3.2. Over the Counter Market (OTC) .
Tn the OTC markets, if, i Prices through electronic mei
Leite With a primary dante’ nt A450 buy of sella government securi ae
Fee iy dele «toast nssiten dice sy contact and
in India is regu
Exchange Board of India ited by four key lays ;
Depots hey ges 1982 (SEBI Act), tne Securities Contce ea 2 sat Seite and
es Ast CRA) and the Finantial Markets and Institutions
ee .
6.4.4. European New Exchange Technology (EURONEXT), pace rae
est oup in Ei ‘was established in 2000 with the merger o
Euronext is the largest stock exchange group in Europe Pv apnea
Amsterdam and Brussel
, Amsterdam, Brussels, Lisbon, Dublin, Oslo, and
three former national exchanges from Pari
exchange group and operates exchanges
Milan. It had a total market
European benchmark indices
20(Belgium), FTSE MIB (Italy),
Euronext,100, whi
most dominant index y
stocks. Some of the largest stocks on this exchange are Procter & Gambl
le AEX (Netherlands com3anies), BEL
| and PSI 20 (Portugal). The
comprises the largest and mest liquid 100
LVMH, Royal Dutch Shell,
Merck & Co,, and L'Oreal among others
6.4.5. Hong Kong Stock Exchange (HKEX), Hong Kong
Hong Kong Stock Exchange was established in the year 1891 and is the third largest exchange in Asia
major financial hub: And is the fastest growing stock exchange in Asia,
Itis considered to be the wor
As of 2022, 2597 companies were listed on the Hong Kong Stock Excharge, of which 50% are from
jon of listed companies in HKEX was $4.56 trillion as of October
2022, The most popular index on HKEX is the Hang Seng Index that comprises 50 stocks. The excharige
includes some of the biggest companies in the world such as HSBC Holdings, AIA, Hanz Seng Bank,
Bank of China, PetroChina, China Mobile, etc Bs
6.4.6. Tokyo Stock Exchange (TSE), Japan
Tokyo Stock Exchange was founded in the year 1898, It is also knows as Tosho ‘or. TSE/TYO, is a
Stock exchange located in Tokyo, Japan. TSE has more than 3800 companies listed whose cumulative
market capitalisation was $5.38 trillion as of October 2022. The most popular indices on TSE aie
0 Price Index (TOPIX). Nikkei 225 is a price-weighted equity index vihich consists
Nikkei 225 and Toky:
cof 25 stocks in the prime market of Tokyo Stock Exchange and is used around the globe as the premier
ge inc.ude Japanese
index of Japanese stocks. Some of the largest stocks that are traded on this exchan;
conglomerates such as Honda, Toyota, Sony, Suzuki’ etc
6.4.7. Shenzhen Stock Exchange (SZSE), China
Shenzhen Stock Exchange,
Shenzhen, China. It was fot
is located in the city of
xchange ia-China after
‘hich lists the rop 100 companies on the exchaiie.
6.4.8. London Stock Exchan
London Stock Exchange is a stock excl
established in 1801. Ir Secondary Markets
London Stock
‘The most popul
Exchange (FTS!
Cap Index, FTSE
Comporation, Astra Zeri
‘Smith Kline among others.
6.5. MAJOR STOCK EXCHANGES IN INDIA
xchanges |
of negotiable instruments
after the enactment of the
6.5.1, History of Stock
Companies Act; 1850. Indian stock market is known as one of the oldest
organised stock exchange in India was established in 1875 at Bombay called “The Native Share and Stock |
later known ‘as “Bombay Stock Exchange" (BSE) which is also stated to be oldest
fadras stock exchange in 1937. Calcutta stock exchange
‘was the largest stock exchange in India till 1960s when around 48% of the companies were listed on CSE
‘and another 25% on BSE, However, since mid-1960s, the nunr-ber of companies listed on CSE gradually 5
started declining whereas those on BSE’gained. BSE portant stock exchange
with many other regional stock exchanges in India till early 1990s. In 1956, the goverment of India
recognised BSE as the first national stock exchange under the Securities Contracts (Regulation) Act.
tion of economic reforms in 1991, significent changes took place in the stock market
in India resulting in transformation of the secondary market in India. Most important among these were:
« (a) Settinig up of OFCEL in 1992 to help small and medium size enterprises to generate capital which
was based.on the modé] of NASDAQ.
provide moder, fully automated, electronic trading system to the investors to facilitate easy trading.
(6) Setting up of Metropolitan Stock Exchange of India Lid (MSED), formerly known as MCX stock
Exchange to provide an eléctronic’platform for trading in capital market.
Since: economic reforms were undertaken, stock exchanges have grown in terms of tum over.
Gradually many other stock exchanges were established in other states as well. There were around
24 stock exchanges in.India, out of which’.20 were at regional level. Prominent among them were
Ahmedabad Stock Exchange (closed in 2018), Delhi Stock Exchange (closed in 2017), Gauhati Stock
_ Exchange (closed in 2015), Jaipur Stock Exchange (losed in 2015), Madhya Pradesh Stock Exchange
(closed in 2015), Madras Stock Exchange (MSE) (closed in 2015), OTC Exchange of India (closed in
2015), Pune Stock Exchange (closed in 2015), UP Stock Exchange (closed in 2015), Vadodara Stock
Exchange (closed in 2015), Bangalore ‘Stock Exchange (closed in 2014), Cochin Stock Exchange,
Kochi (trading sthpped in 2005, closed in 2014), Inte-ecnnected Stock Exchange of India (closed in
2014), Ludhiafia/Stock Exchange (closed in 2014); Bhubaneswar Stock Exchange (closed in 2005),
Coimbatore Stock Exchange (requested exiting trading in 2009), Hyderabad Stock Exchange (closed in
2007), Magadh Stock’ ‘xchange (closed in 2007), Mangalore Stock Exchange (closed in 2004). ‘Secondary Markers fate
5 jerivatives.
d
+ ahat are dealing solely in commodity ¢
In alton, there are two commodity exchanges” that nr dealing solely
They are
(@) Malti Commodi
(& National Commodity and Derivativ
Indian Commodity Exchange doesn’t
ity Exchange of India Lid
es Exchange Ltd. : os
ae the equity and equity derivatives permission any
India to create
t, this state-of-
global
1.1. Emergence of GIFT City ‘
be Gujarat peace Finance Tee-City (GIFT City) marks a pionsing inate © y
an avant-garde global finarcial and IT services hub. Positioned strategica ee ae
the-art city aims to provide a platforin.for world-class infrastructure and Facitlth O80 te ay
fancal hubs like London and Singapore. Central to GIFT City’s allure is the Interati ae
Services Centre (IFSC), which promises lucrative opportunities for financial institutions, back’ > ©
favorable regulatory environment. Within the bounds of the IFSC, two prominent stock exchanges :
ctablished their foothold: the India International Exchange (India INX) and NSE IFSC Ltd. Both these
exchanges were conceptualised to provide a diverse range of international financial services, playing a
pivotal role in fortifying India’s position in the global nancial landscape.
65.2, Bombay Stock Exchange (BSE)
BSE was formed in 1875 and was Asia's fist stock exchange and is known as fastest exchange in the
world. Presently itis one ofthe two leading stock exchanges in India. The major objective of BSE
is to provide an efficient and transparent market for trading in currencies, equities, debt instruments,
derivatives and mutual funds. As per offical website of BSE, its vision is to “emerge as premier Indian
stock exchange with best in class global practice in technology, product innovation and customer service”
Today, BSE is one ofthe largest stock exchanges inthe world with an overall market capitalisation of
2 26,175,144.27 crore as on 24 February, 2023, The number of listed companies is more than 5000 and
the number of registered investors on BSE stood at 12,55,87,952 on the same day.®
In 1850s, five stock brokers would gather under a banyan tree infront af Mumbai Town Hall to
conduct trade in securities. The location ofthese meetings changed multiple times to accommodate an
increasing numberof brokers tilt eventually moved to Dalal Stret in 1874, Brokers group became an
official organisation known as "The Native Skare and Stock Brokers Association” in 1875
one Aus 1987, the BSE besa the fi matoal sock exchange to be recognised by the
‘ li ue the Sects Cnts Regulation Act 1956, Since then it his ven
instrumental in promoting of Indian-c ct i " ee
In 207 BSE become the Ta ited sock ee art Bon svane rita
ansparent market for rading in equi, cures, debt instruments, derivatives marat ne
assert Sensex — SE's popular equity inde vhich i mos widely raked 35h mark
inde i ; ket
puis Sas introduced by BSE in the year 1986, I i traded internationally on the
China and Sourh Africa)
in more than 10 sectors. Apart from Sensex, BSE also has other important in
7, tps seb govinstck
eaiceneete ih
8. hapsifonbscndincomfbouthinl mn tee” Ss L-
1 Market (CM) segment of NSE provides a fully automated
of equity and preference shares, debentures, warrants and
known as the National Exchange for Automated Trading
.d to quote driven system."
(6) Capital Market Segment: The Capital
_Satcrebated trang system for tei
‘coupons, NSE adopted a trading System,
(NEAT) system, which is an order-driven system as oppose
to berate Segment: NSE commenced rading in dervaives wah he nunc of inde Funes
ren, Since the, futures and options have come along way in becoming popular fnanca)
rat The Futures and Option tracing systems called NEAT-F&O wading sytem. provides
Pry aotomated screen-based trading for SRP CNX Nifty futures on a nationwide basis and
aevatine monitoring and surveillance mechanism. Under the Derivatives segment, NSE offers
ae eave contracts on Equity, Indices, Currency, Interest Rates and Commodities
NSE had also played an important ok in the creation of National Securities Depository Limited
(NSDL) in 1995, NSDL allows the irvestors to hold and transfer shares electronically which
‘ns failated the hotding of financial instruments conveniently in electronic form and has also
resulted in lessening of fake certificate issues
Recently; RBI has identified NSE asthe only conduit for inter-bank security deals. NSE is an
order-driven-and not a quote driven ntarket and it allows trading memibers to trade from theit
offices through a common network.
6.5.3.1. Objectives. of NSE
“The main objectives of seting up of NSE were the following:
if To provide nation-wide equal access and fair. efficient and transparent system to the investors for
trading in equities debt instruments and hybrid securities through an appropriate communication
network.
To promoie a secondary market in government and corporate bonds and other debt instruments.
To provide an efficient and transparent security market ‘9 investors through an electronic trading
system.”
4. To provide sh
5. To bring Indian) stock market in line with internaticnal markets
NSE Index: The flagship index of NSE is Nifty 50 (also known as CNX 50) which covers 13 sectors
of the’ Indian econofy across 50 stocks/companies and is used for a variety of purposes such as
benchmarking fund portfolios, index-based derivatives and index funds. CNX Nifty tracks the behavior
of a portfolio of top 50 blue chip companies!” which are traded on NSE, It is extensively used by the
investors around the world to keep track of Indian capital market. Besides Nifty 50, there are many other
ingjces that are used/published by NSE. They are Nifty Next 50, Nifty 100, Nifty 200, Nifty $00, Nifty
500 Multicap, Nifty Total Market Index, Nifty Midcap!50, Nifty Midcap 50, Nifty Midcap 100, Nifty
settlement cyéles and book entry settlement system.
IE, When a matket is quote-drvea, prices are determined from bid and ask
Ws sty | letermined from bid and ask quotations made by sharket makers, dealers
_ & specials eter han he ingests. Deals work wih banks and broker and del o provide quotes for
tars see tere ces ne ara es ae te
driven market, on the other hand, dis westors’ bid an
ee ree er hand, displays individual investors bid and ask prices andthe
12. Blue chip companies are the most stable and reliable companies and are considered low risk investments. ENTIRE: SEE
Smallcap 250, Nifty Smalleap 50, Nifty Smallcap 100, Nifly MidSmalicap 400, Nifty Large Midcap
250, Nifty Microcap 250 index. ? +
At present, NSE has total market capitalisation value of USS 3.27 trillion and 2002 L:sted companies
as of January 2023, In terms of velume and tumover, NSE is far ahead of BSE. Its state-of-the-art
technology platform offers high levels of robustness, safety and resilience for trading and investment.
‘opportunities across all asset classes and for all categories of investors. NSE is also focused on investor
protection and disciplined development of the Indian capital market. By providing a common network
and making available stock price information to everyone, it has totally smodified the way in which
investors conduct trade in securities and has enabled the people sitting in their offices in any part of the
world to trade from anywhere,
6.6. DEMUTUALISATION OF
STOCK EXCHANGES t
Prior to 1991, all stock exchanges in India were primarily mutual organisations that were owned,
managed and controlled by the stock brokers, This, at times, resulted i conflict of interests between the
Investors and brokers whenever the interest of the brokers was given prominence over those of investors,
As a consequence, stock exchanges faced frequent payment crisis and many other problems, Thus,to
instill confidence in the minds of investors, corporatisation and demutualisation of stock exchanges was
approved by SEBI in November 2092, as recommended by Kania Committe, As per SCRA (Securities
Contract Regulation Act 1956), demutualisation means the segregation ofigwnership end management
from the trading rights of the members of a recognised stock exchange (RSE) in accordance with a
scheme approved by SEBI.
Demutualisation is a process by which a private, member-owned Company, such as a cooperative,
or a mutual life insurance company, legally changes its stricture, in order to become a public-traded
jomany owned by the shareholders. Corpoatisation & Demutualsation (C&D) of a stuck exchange
is, thus, a process to change the caganisational structure of the stock exchanges from non-corporate
@ profit making company and an entity paying taxes; +
The major stock exchanges in India have demutualised, where the members sell their shares in an ae
ee
jodities
in the financial, comm
STOCK MARKET INDEX
ints of stocks, bonds,
oe seth
pti
AAmindex is used to give information
or any other markets. Financial indexes are f
~ Toil and other forms of investments, Stock market indexes
roarket and they capture the overall behaviour of equity markers
Selecting a group of stocks that are representative of the whole mar
ofthe market, An Index is calculated with reference to a base perioe
Stock tarket indices are useful for a variety of reasons. Some of them
@ They provide a historical comparison of returns on money invested in the stock market against
forms of iavestments such as gold or debt.
@ They can be used as a standard against which to compare the per
@ tis a lead indicator of the performance of the overall economy or a scetor of
‘Stock indexes refect highly up to date information. Moder financial applications such as Index
Funds, Index Futures, Index options play'an important role in financial investments and risk
management.'* i
Thus, the stock market indexes are mainly.used to monitor the behavior of group of stocks to
provide an insight to the investors about the performance of the different group of stocks. By measuring
the market rate of retum and also predicting various market movements, they enable the investors to
smanage their portfolios and follow the financial markets to take investment decisions. The movement of
the stock index reflects the sentiments of the market and also the movement in prices of other financial
products including the commodities.
rice movements of products
overne
ructed to measure price mave :
ue ea ant to track the changes inthe stock
“A stock market index is created BY
et of a specified sector or segment
4 and a base index value
are
other
formance of an equity fund
the economy
67.1. Construction of a Stock Market Index
A stock mitt inden is erated by selecting group of stocks that are representative of the whole
market ora specified sector or segment of the market. A stock index is constructed by selecting the
securities tat ae listed onthe stock exchange. The criteria for choosing stocks forthe stock macket
index can be market capitalisation of the industry .
The following factors are considered while constructing a stock matket indey
Base year—an index cleulaled with reference toa base
year selected should bea noma year
# Sample th ‘
é. i = ean, ee should be reptebohtative of the entire population,
es ‘ighing te oe sy different weighing criteria that can by
index - ones are. Equally, weig eb hach vet
sale mie sees ao cl fll market cpt ee ee ees, Market
capitalisation weighted series or called free float M or All Mesip), Free Float masket
Most of the stock indices in India as well asin other on
Period and a base index value. The base
used in the calculation of Financial Markets and Institutions
(48 cha ae
4
f & —
6.9. \vIDELY USED STOCK INDICES IN INDIA
6.9.1, S&P BSE Sensex : ;
The S&P BSE Sensex is India’s most tracked index.'° The full form of Sensex.is the Sensitive Index as
As this index is the stock market index
it reflects the sentin§€nts of the stock market and the economy.
of the Bombay stock exchange, itis also called BSE Sensex. BSE adds S&P as a prefix before all the
indices because, in the year 2013, BSE and S&P Dow Jones Indices, a global resource for all index
related information announced a strategic partnership “to calculate, disseminate, and license the widely
followed suite of BSE indices”
S&P BSE Sensex is a market weighted stock index of 30 companies, that are, selected on the basis
of financial soundness and high performance across key sectors of the Indian economy. The companies
selected are usually large and well established and are listed on Bombay stock exchange. It is the oldest
stock index in India and was first compiled in 1986, It is considered to:be the benchmark index and is
based on globally accepted construction methodology and is scientifically designed. The base year of
the S&P Sensex was taken as 1978-79 and base value is 100 index points
6.9.1.1. How is Sensex Calculated?
The Sensex is calculated on the basis of a sample of 30 large, fivancially sound companies that are
fchresentatives of the various sectors of the Indian economy. The Companies are chosen based on the
liquidity, trading volume and industry representation. The base value of Sensex is 100 and the base
year is 1978-79 which is usually indicated by the notation 1978-79'= 100. It is calculated using the
Free-float Market Capitalisation method. Originally in 1986, S&P BSE Sensex was based on a market
capitalisation weighted methodology. However, since 2003, it is been calculated on Free Float market
capitalisation methodology. a fi
As diseussed in the previous section [section 6.8 (I D
West matket capitalisation = Market capitalisation x Free float factor
Where, Market capitalisation = Share price per share » ‘tumber of shares issued by the company
Free float factor is the percentage of
the. total shares of the company that
are readily available to the public. The
alu of Sensex is calculated using the
ef following formula.
Value of Sensex = [Total fee float market capitalisation hea
Base market capitalisation: “8S petiod index vane)
The companies that constitute the Sens
the Chapter (A 6,1), ;
Sensex reflects the movement in the
stock mark
B Intemational markets. An increase in Sensex indic
Findentks have increased. fallin Sensex, on the
oX 8 on 24th February, 2023 are shown in the Appendix to
et and is widely Teported in both domestic as'well
ates that on an Average the prices of the underlying: ns Rem he nee Gs '
‘The number of companies in the Sense is 30 Nifty tracks, $0 stocks,
a “The base year used in Seisex is 1978-79, Nifty $0 uses 1995 as the base year,
The base value of Sender is 100. The base value of Nifty is 1000.
BSE Sensex s traded dn EUREX and stock exchanges | Nifty 50s traded on Singapore Stock Exchange (SGX)
of BRCS nations ‘and Chicago Mercantile Exchange (CME)
or Om
6.10, DEPOSITORY SYSTEM
{With the opening up ofthe economies and rettant globalisation, there has been enormous inerease inthe
volume of transactions across the world. As aresult, the traditional system of trading securities in physical
form was gradually found to be inadequate due to its various operational inefficiencies. This necessitated
the need to have an alternative waiting and settlement system in place of the traditional system which would
~ je more efficient from the point of view of investors, issuers, intermediaries and would also increase market
eficiency which is a prerequisite: for a metute capital market, As a result, Government of India enacted
Depositaries Act, 1996'to introduce the depository system in India.The term “depository” is a registered
organisation which helps an investor to bury o- sell securities such as shares, debentures and bonds in an
electronic form.'” To understand the concept af depository system, it is pertinent to know the concept of
dematerialisation. Section 6.10.1 discusses the concept of dematerialisation and Demat account,
ee
6.10.1. Demat Account
Deimaterialisation is a process by which physiv.al certificates of an investor are converted to an equivalent
number of securities in digital form. A Demsit account, also referred to as dematerialisation account,
thus, converts the skarés from’the paper form into an electronic form, thereby makes the process of
holding investments like shates, government securities, bonds, Mutual Funds, ETFs, Insurance policies,
‘ete, easier by doing away with the problems of physical handling and maintenance of paper documents.
“The working of a Demat account is similar to that of a bank account. A Demat account holds physieal
seciirties in the same way ANbanks hold cash for their customers. It also helps to keep proper track of all
the investments an individual makes in stares, exchange-traded funds (ETFs), bonds, and mutual funds
in one place. One can éasily buy or sell sbares of differént companies using his Demat account.
~ ‘The concept of Demat account can b2 explained with the help of an example. Suppose an investor
‘wants to buy shares of a company X, these have to be transferred in his name. Earlier, the investor would
get these shares in physical form. with his name on them, This involved a lot of paperwork, apart ftom
their physical handling. Also, holding securities in the form of physical certificates was cumbersome to
store and transfer as cach time a security was bought and sold, a certificate had to be created. To do away
* with all these problems, Indie introduced Demat account system in 1996,
_ All Demat accounts are assocjatec with a depository which holds securities such as shares,
debentures, bonds, government securities, mutual fund units, efc. of the investors in electronic form
through 2 registered Depository Participant. A Depository Participant (DP) is an agent of the depository
through which it interfaces with the investor and provides depository services. DPs can be banks,
financial institutions, brokers ar uny ther entity that is eligible under SEBI guidelines to facilitate
transfer of shares from depositoties io investors. The investor, also known as beneficiary owner (BO) is
17, wwewsebi.gov.in a Capital Market Instruments
CHAPTER OUTLINE
7.1. Introduction - Concept and Types of Capital Market
Instruments
7.2. Ownership Securities
7.3. Debt/Creditorship Securities
¥ | 7.4. Innovative Debt Instruments/Securities
7.5. Derivatives
7.6. Financial Instruments for Mobilising Resources from
International Markets
amon
7.1. INTRODUCTION - CONCEPT AND TYPES
OF-CAPITAL MARKET INSTRUMENTS
‘The financial instruments, that are used for raising long term finance are known as capital market
instruments. As discussed in Chaptet 5, capital market refers to the institutional arrangement through
which funds are raised for medium and long term by the issue of various financial instruments ~ both
equity and debt. Capital markets.across the countries have widened and deepened considerably with the
‘emergence Of a wide range of-complex financial instruments. The instruments traded in the financial —
smarkéts broadly consist of ownership securities, creditorship/debt securities, and innovative instruments
(that carry characteristics of both equity and debt). In addition, increasing globalisation and accelerated
pace of finéncial innovation has resulted in the emergence of a large number of instruments to mobilise
funds from the overseas markets, particularly during the last few decades,
7.1.1. Types of Capital Market Instruments
‘Savings of the investors are mobilised through a wide range of complex financial securities that ace
used to raise funds for medium and long term, The following sections discuss the basic concept ard
sharacterstics of these ins:ruments that are available in the capital markets, Figure 7.1 shows the
Classification of capital mat'cet instruments, Calitat Market Instruments 1
an . ae ————) 7 i\
‘On conversion, thede shares becomé eligible for various Fights such as right to vote and participate \
Ta management, 10 receive dividends;and bonus shares, e¥ Sometimes, these shares are also
mown as quasi-ecuity shires :
(@ Fatty Convertible Cumulative Preference Sharet! These stares comp
pai iB, Part A i convertible into equity shares automaticaly and compulsorily on the date of
a otment without an application by the shareholder. Part B wil ‘be redeemed at par/converted into
cruity shares aftet« lock-in period atthe option of the investor © price, which would be 30
percent lower than the average market price. The conversiot into equity shares takes place after
pe lock-in period: The dividend is given only for part B shares
¥
7.3. DEBT: CREDITORSHIP SECURITIES
ise two parts viz., Part
7.3.1. Debentures'Bonds
pebentures or bonds are capital market instruments for raising medium and jong fam funds
public by the corporations and governments. ‘Under Section 2(30), Companies ‘Act, 2013, debentures
rane debenture stock, bors or any other instrument of a company evidencit debt, whether
constituting a chafge an the assets of the company or not, Thus, debentures are the debt instruments
which are an evidence of acknowledgement af a Joan to a company.
‘As long-term source offinance, debentures have some distinct ‘characteristics as compared to equity
shares, Debentures rearesent creditor ship securities ‘and debenture holders are long-term creditors of
the Company: Uiilike oquity capital, which is a variable income security, debentures are fixed income
scourities. Debenture/>0id hotders'get periodic interest payments (annually, semi-annually or quarterly)
serch ig called cbupon'rate. The coupon rate is tax deductible and can be either fixed or floating. A
Fostig rate is normally tied toa benchmark rate such as the yield or 5 year government bond and will
change as the benchmark changes. Generally, debentures are redeemable and repayable on a fixed date
st their par value depending on the maturity period which is known as tenure of a debenture/bond. The
maturity period represents the length of the time for the redemption of its par value.
“These debt instruments are executed under the common seal of the company called trust indenture!
deed which isa tegal and binding contract between the issuing corporation and the trustee that manages
the interest ofthe debenture holder. The indenture spécifies the amount of the loan, date of repayment,
coupon rate of interest and other details like method of calculation ‘of the interest and the timing of the
interest, efc. Debentures must be rated by a credit rating agency. The interest rate on the debentures
depends to 2 great exzent on the credit rating of the company and/or rating of the debenture. |
from the
7.3.2. Types of Debentures
‘Debentures’ may be’ classified irito. different classes on tl
convértbility, redemption, security, ec. Following are some
“eriteria that are commonly used °° :
, i |
he basis of different criteria used, viz.. |
‘of the classifications that are based on the |
73.2.1. On the Basis of Convertibility i
Convertible Debentures and Non-Convertible Debentures: Based on convertibility,
be classified into: 1p Sealer the
debentures can Si
f rr
can be converted into the equity ~
3): These debentures: c
S debenture holder on the expiry of specified period with
(a) Fully Convertible Debentures (FCI
shares of the company at the option of t
or without premium.
it CDs)
Non-Convertible Debentures (NC
eropuon of conversion into equity shares and, thus, the
n-convertible debentures do not carry
\: The hiolders of 00 barn)
ie xy are redeemed on the expiry Of the
specified period. , -
ee Convertible Debentures (PCDs): The Partially Convertible Debentures eee a ;
c convertible and non-convertible. While convertible portion is convertible into equity shares : -
specified date ata specified premium, non-convertible partis redeemable in fixed number of equal
instalments on the expiry of specified years from the date of allotment:
7.3.2.2. On the Basis of Redemption
Redeemable or Non-Redeemable Debentures: Debentures may also be classified as redeemable or
non-redeemable. As stated before, Redeemable Debentures are issued for a fixed period and the principal
amount is repayable at the expiry of that period or at the maturity. Non-Redeemabie Debentures, on the
other hand are redeemable/repayable only after the liquidation or closing down or winding up of the
company. a
7.3.2.3. On the Basis of Security
Secured or Unsecured Debentures: Secured debentuics aré secured ay a charge on} some or-all the
assets of a company. The principal amount and the tinpaid interest could be recovered ty the holder out
of the assets mortgaged by the company. Unsecured debentures, on the other hand, art not secured by
the assels or any other form of collateral of the company. They are backed only-by the creditworthiness
and reputation of the borrower.
7.3.3. Advantages and Disadvantages of Debentures
73.3.1. Advantages of Debentures
oe to the Investors: Debentures provide stablé returns to the investors as:the debenture
solders have a preferential claim on the assets of the company as compared to the shareholders, The :
oe i
lnterest of debenture holders is protected by the provisions,of the trust indenture deed and guidelines
exchanges, '
issued by SEBI. Debentures are liquid and could be traded an the stock e:
Advantages of Debentures to the Issuing Company: {5
debentures have and deb: instruments, As long-ter
‘OW Cost to company due to lower tisk and tax deductibility Re poy eco Tansy
~yest payment. As the. *
‘
i Set any voting right
stise long-term ithour dite nett Paising funds throu: cake
Fake funds Withost diluting the present Control, Tat pea Permits the company to»
it thinks iis over ; d
capitalised, it can easily Tedeem the debentures, Company has surphis funds or 7.4.4, Warrants
A warrant entitles its holders fo subscribe to uy the stock of the iesuing company during a specified
Aad ara stated price The holder nequits nly the right (option) but he has no obization to acquire
aerauity sharet Th thet respect, warrants Ae similar to options as both the instruments allow the
holder special rights to buy the securities. Warrants are generally issued in conjunction withitied to
ddebennures but warrants can be ised independently also. An important difference between warrants
snd convertible Webentures i that while the conversion option and the debenture are inseparabe in case
‘of CDs, warrants can be offeréd independently also.
«the warvnts are attached to bonds or preference shares so as to make them more attractive
to the potential investors by increasing their Yield. They also enable the issuing companies to pay lower
jnterest rates or dividends. Mostly, these warrants are detachable and can be sold independently of the
securities they are tied with.
7.45, Secured Premium Notes (SPNs)
‘The Secured Premium Note (SPN) is a secured debenture which can only be issued by listed companies
after getting Central Govt’s approval. It is.a financial instrument which is issued with a detachable
‘warrants and is redeemable after a certain:period at a premium over the face value. The redemption
period is generally four to seven years. Itis tradable instrument. There is lock in period during which
no interest is paid, SPNs are‘issued with a detachable warrant which are convertible into equity shares
within the specified time provided the SPNs are fully paid.
The SPN hiolder has the option to sell the SPN back to the issuing company at par, after the loci.
in period with in the time limit notified by the company. If the holder exercises this option, no interest!
premium will be paid on redemption. In case the SPN holder decides to hold it tll maturity, he will be
repaid the principal amount along with the additional amount of interest/premium on redemption in
instalments as decided by the compan. (
From the point of view of the issuing company, SPNs are a profitable proposition as no cash outflow
(es interest or as repayment of principal) js involved for the lock in period of the instrument. Thus, SPNS
free the firms of debt serving costs during the initial years.
TISCO and Bombay Dyeing were among the first ones to issue SPNs. In 1992, Tisco came out with.
rights issue of equity shares and SPNs aggregating to © 1,212 crore. Each SPN had a face value of ©
300 and there was no interest accruable‘on these SPN during the first three years after allotment. The
principal was to be redeemed in four equal instalments of @ 75 each (totalling ¥ 300) at the end of 4th to
7th year. In addition, % 75 was also payable as interest and redemption premium during 4th to 7th year.
Thus, investor would be receiving ® 150 each for 4 yéars (Total & 600), Alsoa warrant was attached with
cach SPN which entifed the holder to aequire an equity share fora cash payment of & 100.
7.4.6. Floating Rate Bonds (FRBs)_
The interest on Floafing’rate Bonds'is not fixed and is allowed to float depending on the market
conditions. FRBs primarily introdiiced to hedge the issuers and the investors against the volatility
in the interest rates. Ata time when the interest rates are fulling, the borrowers (issuers) benefit as
they can borrow the funds at lower cost whereas at times of rising interest rates, the investors or the.
lenders benefit’as they carn higher returns, Thus, FRBs were issued by the issuing companies to hedge i
:.
{
Financial Markets and Institutions:
es and provide them a cushion particularly at the time of
ives agains the volatility in interest rates and p ‘ eee
fling teres rates. In ato, these bonds also provide protection tothe investor ~ bh individ
and institutions, against the risk of inflation, Fs ies i Sa ae
pay a fixed rate of interest, float onds have a varia
inlke the fixed rate bonds that pay a fixe ‘inten
_ nosy ye mennpheieytnnt albeorsniary rtp torrente ithdiobas gular
poarie ba bebileack rua sls salle the eochor ris cold be the louewet pa trey bl] Sik
intervals. The benchmark rate, also ca
maximum terest on po ferest rate on fidating rate bonds has a fixed
rate of int term deposits. The int Kiating. ra Js has
rate or of interest ~
%
erly cern percentage pints higher tha Beach :
mre ing 2 021 - December 2021 has
a ceckg ee saving bond 2040 (aiabley for tne period Ja
Raindrop or 0304 ovr ling RS ran Wi the rat
of interest on NSC being 6.8%, the coupon rate on Floating rate saving bond 2020 was fixed at 7.15%
In India, SBI was the first to introduce bonds with floating rates fot retail investors. SBI Floating Rate
Bonds were linked to the Bank's term deposit rates which served as an anchor rate
7.5. DERIVATIVES
75.1. Derivatives — Concept
A derivative isa financial contract whose value is derived from the valueiof an asset, known as underlying
renv/security, a commodity, a currency or interest
asset. The underlying asset could be a financial instru
tate Tn commodity derivative, the underlying asset could be inthe form ofa commodity such as wheat
cotton, ccude oil, natural gus or a precious metals like gold, silver, etc, In financial derivative; the
underlying asset may be bonds, stock or shares, foreign exchange and Currency, interést rate or stoc
index. A derivative has no Meaning without the underlying asset. The value ‘of the derivative changes
whenever the price of the underlying asset changes. For example, ari increase in the price of goid
(underlying asset) would lead to an increase in the value of a gold Futures contract.
: ine ci bY the risk averse people to protect themselves froea
the fluctuation in prices of the commodities. Financial Gerivatives are relatively nore recent in ature
snd Came into existence inthe pes-1970 period. They account for dominant part of the financial
There are several risks inherent in financial transactions due.t
nt e.10. volatility in the prices of financial
deri inteest rates, exchange rates, currency rates, exe Many kinds of derivatives such as ae
ee peti derivatives, currency derivatives have emerged in tie financial markets to
hedge . Derivatives are, thus, risk sil fir s i
Be Doi risk shifting devices from those who are risk averse to those
Participants in the Derivative Markets:
There are 3 types of trades in the derivative market, They are
|. Hedger: a person who faces risk
ith price mov f ;
Beenie Pp jemment Of an ajset and who uses derivatives asa
2. Speculators a person, who buy: re designed to solve the problems thet exist in forward markets and are
‘Thus, Future contracts at
arty safer and more secure than the forward contract
signi
7.5.23. Options
Options are contracts that give the tnolder the option to buy or sell specific quantity of underlying asset
ata particular price on or before the specified time period. The underlying may be physical commodities
euch as cotton, wheat, rice, gold, silver, cil seeds; efc:) or financial instruments (such as equity, bonds,
srrency, efe:). ‘Option’ implies that the Holder of the options has the right but not the
the holder of the option does not have
