CAPITAL MARKETS

Ques.1) What do you mean by primary market? State the functions of primary market.

Answer:

Primary Market also called the New Issue Market, is the market for issuing new securities. The main
players of these markets are the private and public companies that offer equity or debt based securities
such as stocks and bonds in order to raise money for their operations such as business expansion,
modernization and so on.
They sell their securities to the public through an Initial Public Offering (IPO).
Features of Primary Market
It is the new issue market for the new long term capital.
Here the securities are issued by company directly to the investors and not through any
intermediaries.
On receiving the money from the new issues, the company will issue the security certificates to the
investors.
The amount obtained by the company after the new issues are utilized for expansion of the present
business or for setting up new ventures.
External finance for longer term such as loans from financial institutions is not included in primary
market. There is an option called going public in which the borrowers in new issue market raise
capital for converting private capital into public capital.
Functions of Primary Market
Functioning of primary market facilitates the capital formation by channelizing the funds from
individual retail savers into proper productive investments. Functions of the new issue market can be
split into three distinct services i.e. Origination, Underwriting and Distribution of new securities.

1. Origination:
Origination means processing of investigation and analysis of new issue proposal. Firstly, the
preliminary investigation that entails the careful studies of technical, economic, financial and
legal aspect of the project and company. Secondly, NIM renders the advisory services, which
improves the quality of capital issues.
 2. Underwriting of New Issues:
The term underwriting means guaranteeing purchase of a specified amount of new issue at a
fixed price. The purchase may be for sale to the public, for only ones portfolio or for both
the purposes.

If the underwriter fails to sell the guaranteed amount of shares to public, it will have to
purchase the unsold shares by itself. The underwriter is paid a commission for underwriting
the new issue. Mostly underwriting of a new issue is undertaken by a group of financial
institutions.

3. Distribution:
Distribution is selling of securities to the ultimate investors. It is a specialized job, which
can be performed best by brokers and dealers in securities, who maintain direct and regular
contact with ultimate investors

Ques.2) How the funds can be raised in primary market?

Answer:
New issue in the primary market can be placed as Public Issue, Offer for Sale, Private Placement and
Right Issue. It can be depicted as follows-

1.) Public Issue:

The most popular method for floating the issues in new issue market is through "prospectus"
which is viewed as a legal document. A common method followed by corporate enterprises to
raise capital through the issue of securities is by means of a prospectus inviting subscription from
the public.

Under this method, the issuing companies themselves offer directly to the general public a fixed
number of shares at a stated price known as the face value of the securities. Public issues can be
further classified into Initial Public Offerings (IPOs) and Further Public Offerings (FPOs). Initial
Public Offering (IPO) is the first sale of stock by a private company to the public and Further
Public Offering (FPO) is an issuing of shares to investors by a public company which is already
 listed on stock exchange. An FPO is essentially a stock issue of supplementary shares made by a
company that is already publicly listed and has gone through the IPO process.

2.) Offer for Sale:

Under this method, instead of issuing company itself offering its shares directly to the public, it
offers through the sponsoring intermediary of issue houses/merchant banks/investment banks or
firms of stockbrokers are hired to offer the share to the public. It is a method of floatation of
share through an intermediary and indirectly through an issue house for converting the
private company into public company.

3.) Private Placement:

As the name suggests it involves selling of securities privately to a group of investors. The sale
of securities to a relatively small number of selected investors as a way to raising capital is called
private placement. Investors involved in private placements are usually large banks, mutual
funds, insurance companies and pension funds.

4.) Right Issue:

This is the method of raising funds from existing shareholders by offering additional securities to
them on a pre-emptive basis. In the case of companies whose shares are already listed and
widely-held, then shares can be offered to the existing shareholders. Generally the issue price of
right issue is lower than the market price of the company's stock. Shares are offered to existing
shareholders in proportion to their current shareholding, respecting their pre-emption rights.

Ques.3) Write a detailed note on primary market intermediates.

Answer:
Primary Market Intermediaries
Parties Involved in the IPO
At present initial public offering involves a number of agencies. The rules and regulations, the changing
scenario of the capital market has made it necessary for a company to seek for the support of many
agencies to make the public issue a success.
These agencies have their respective role in the public issue.
They are
1.) Manager to the issue,
2.) Registrars to the issue,
3.) Underwriters,
4.) Bankers,
5.) Advertising agencies,
6.) Financial institutions and
7.) Government / statutory agencies.
1.) LEAD MANAGERS TO THE ISSUE
Lead managers are appointed by the company to manage the initial public offering campaign. Their
main duties are:

Drafting of prospectus
Preparing the budget of expenses related to the issue
Suggesting the appropriate timings of the public issue
 Assisting in marketing the public issue successfully
Advising the company in the appointment of registrars to the issue, underwriters, brokers, bankers
to the issue, advertising agents etc.
Directing the various agencies involved in the public issue.

Many agencies are performing the role of lead managers to the issue. The merchant banking division of
the financial institutions, subsidiary of commercial banks, foreign banks, private sector banks and
private agencies are available to act as lead managers.
Examples are : SBI Capital Markets Ltd., Bank of Baroda, Canara Bank, DSP Financial Consultant Ltd.
ICICI Securities & Finance Company Ltd., etc.
The company negotiates with prospective lead managers to its issue and settles its selection and terms of
appointment. Usually companies appoint lead managers with a successful background. There may be
more than one manager to the issue.
Sometimes the banks or financial institutions impose a condition while sanctioning term loan or
underwriting assistance to be appointed as one of the lead managers to the issue. The fee payable to the
lead managers is negotiable between the company and the lead manager. The fee agreed upon is
revealed in the memorandum of the understanding filed along with the offer document.
2.) REGISTRAR TO THE ISSUE
After the appointment of the lead managers to the issue, in consultation with them, the Registrar to the
issue is appointed. It is always ensured that the registrar to the issue has the necessary infrastructure like
Computer, Internet and telephone.
The Registrars receive the share application from various collection centers. They recommend the basis
of allotment in consultation with the Regional Stock Exchange for approval. They arrange for the
dispatching of the share certificates. They hand over the details of the share allocation and other related
registers to the company. Usually registrars to the issue retain the issuer records at least for a period of
six months from the last date of dispatch of letters of allotment to enable the investors to approach the
registrars for redressal of their complaints.

3.) UNDERWRITERS
Underwriting is a contract in which a person/institution gives an assurance to the issuer that he would
subscribe the securities offered in the event of non-subscription by the person to whom they were
offered.

The person who assures is called an underwriter. The underwriters do not buy and sell securities. They
stand as back-up supporters and underwriting is done for a commission.

Underwriting provides an insurance against the possibility of inadequate subscription. Underwriters are
divided into two categories:

1.) Financial Institutions and Banks 2.) Brokers and approved investment companies.
Some of the underwriters are financial institutions, commercial banks, merchant bankers, members of
the stock exchange, Export and Import Bank of India etc. The underwriters are exposed to the risk of
non-subscription and for such risk exposure they are paid an underwriting commission.
Before appointing an underwriter, the financial strength of the prospective underwriter is considered
because he has to undertake and agree to subscribe the non-subscribed portion of the public issue. The
other aspects considered are:
 Experience in the primary market
Past underwriting performance and default
Outstanding underwriting commitment
The network of investor clientele of the underwriter and
His overall reputation.

The company after the closure of subscription list communicates in writing to the underwriter the total
number of shares/debentures under subscribed, the number of shares/debentures required to be taken up
by the underwriter. The underwriter would take up the agreed portion. If the underwriter fails to pay, the
company is free to allot the shares to others or take up proceeding against the underwriter to claim
damages for any loss suffered by the company for his denial.
4.) BANKERS TO THE ISSUE
Bankers to the issue have the responsibility of collecting the application money along with the
application form. The bankers to the issue generally charge commission besides the brokerage, if any.
Depending upon the size of the public issue more than one banker to the issue is appointed. When the
size of the issue is large, 3 to 4 banks are appointed as bankers to the issue.
The number of collection centers is specified by the central government. The bankers to the issue should
have branches in the specified collection centers. In big or metropolitan cities more than one branch of
the various bankers to the issue are designated as collecting branches. Branches are also designated in
the different towns of the state where the project is being set up. If the collection centers for application
money are located nearby people are likely to invest the money in the company shares.
5.) ADVERTISING AGENTS
Advertising plays a key role in promoting the public issue. Hence, the past track record of the
advertising agency is studied carefully. Tentative program of each advertising agency along with the
estimated cost are called for. After comparing the effectiveness and cost of each program with the other,
a suitable advertising agency if selected in consultation with the lead managers to the issue. The
advertising agencies take the responsibility of giving publicity to the issue on the suitable media. The
media may be newspapers/magazines/hoardings/press release or a combination of all.
6.) THE FINANCIAL INSTITUTIONS
Financial institutions generally underwrite the issue and lend term loans to the companies. Hence,
normally they go through the draft of prospectus, study the proposed program for public issue and
approve them. IDBI, IFCI & ICICI, LIC, GIC and UTI are the some of the financial institutions that
underwrite and give financial assistance. The lead manager sends copy of the draft prospectus to the
financial institutions and includes their comments, if any in the revised draft.

7.) GOVERNMENT AND STATUTORY AGENCIES

The various regulatory bodies related with the public issue are:

Securities Exchange Board of India

Registrar of companies
Reserve Bank of India (if the project involves foreign investment)
Stock Exchange where the issue is going to be listed
Industrial licensing authorities
Pollution control authorities (clearance for the project has to be stated in the prospectus)

8.) COLLECTION CENTERS

Generally there should be at least 30 mandatory collection centers inclusive of the places where stock
exchanges are located. If the issue is not exceeding Rs.10 Cr (excluding premium if any) the mandatory
collection centers are the four metropolitan centers viz. Mumbai, Delhi, Kolkatta and Chennai and at all
such centers where stock exchanges are located in the region in which the registered office of the
company is situated. The regional divisions of the various stock exchanges and the places of their
locations are given in the following table.

Region Exchange City

Northern Ludhiana Stock Exchange Ludhiana

Region Delhi Stock Exchange Delhi
Jaipur Stock Exchange Jaipur
U P Stock Exchange Kanpur

Southern Hyderabad Stock Exchange Hyderabad

Region Bangalore Stock Exchange Bangalore
Mangalore Stock Exchange Managlore
Madras Stock Exchange Chennai
Coimbatore Stock Exchange Coimbatore
Cochin Stock Exchange Cochin

Eastern Calcutta Stock Exchange Kolkatta

Region Gawahati Stock Exchange Gawahati
Magadh Stock Exchange Patna
Bhubaneswar Stock Exchange Bhubaneswar

Western Bombay Stock Exchange Mumbai

Region National Stock Exchange Mumbai
OTCEL Stock Exchange Mumbai
M P Stock Exchange Indore
Pune Stock Exchange Pune
Vadodara Stock Exchange Vadodara
Ahmedabad Stock Exchange Ahmedabad
Sauashtra Kutch Stock Exchange Rajkot

In addition to the collection branch, authorized collection agents may also be appointed. The names and
addresses of such agent should be given in the offer documents. The collection agents are permitted to
collect such application money in the form of cheques, draft, and stock-invests and not in the form of
cash. The application money so collected should be deposited in the special share application account
with the designated scheduled bank either on the same day or latest by the next working day.

The application collected by the bankers to the issue at different centers are forwarded to the Registrar
after realization of the cheques, within a period of 2 weeks from the date of closure of the public issue.
The applications accompanied by stock-invests are sent directly to the Registrars to the issue along with
the schedules within one week from the date of closure of the issue. The investors, who reside in places
other than mandatory and authorized centers, can send their application with stock-invests to the
Registrar to the issue directly by registered post with acknowledgement due card.

Ques.4) Explain the trading procedure on stock exchanges.

Answer:

Trading Procedure on Stock Exchanges.

1. Selection of Broker: In order to trade on a stock Exchange first a broker is selected who should be a
member of stock exchange as they can only trade on the stock exchange.

2. Placing the order: After selecting a broker, the investors specify the type and number of securities
they want to buy or sell.

3. Executing the order: The broker will buy or sell the securities as per the instructions of the investor.

4. Settlement: Transactions on a stock exchange may be carried out on either cash basis or a carryover
basis (i.e. badla). The time period for which the transactions are carried forward is referred to as
accounts which vary from a fortnight to a month. All transactions made during one account are to be
settled by payment for purchases and by delivery of share certificates, which is a proof of ownership of
securities by an individual.

Earlier trading on a stock exchange took place through a public outcry or aution system which is non-
replaced by an online screen based electronic trading system. Moreover, to eliminate, the problems of
theft, forgery, transfer delays etc. an electronic book entry from a holding and transferring securities has
been introduced, which is called process of dematerialisation of securities.

Ques.5) Write a short note on NSE and OTCEI.

Answer:

NSE & OTCEI

National Stock Exchange of India (NSE)

NSE was set up by leading financial institutions, banks, insurance companies and other financial
intermediaries in 1992 and was recognised as a stock exchange in April 1993. It has provided a nation
wide screen based automated trading system with a high degree of transparency and equal access to
investors irrespective of geographical location. NSE was set up with the following objectives.

1. Establishing a nation-wide trading facility for all types of securities.

2. Ensuring equal access to investors all over the country through an appropriate communication
network.
3. Enabling shorter settlement cycles and book entry settlements.
4. Providing a fair, efficient and transparent securities market using electronic trading system.
5. Meeting international bench marks & standards.

NSE provides trading in following two segments:

1. Whole sale Debt Market Segment which provide platform for a wide range of fixed income
securities such as Government Securities, treasury bills, state development loans, PSU bonds etc.

2. Capital Market Segment which provide platform for equity shares, preference shares, debentures
etc. as well as retail Govt. securities.

Over the Counter Exchange of India (OTCEI)

OTCEI was promoted by UTI, ICICI, IDBI, IFCI, LIC, GIC, SBI Capital Markets and can Bank
Financial Services. It is a place where buyers seek sellers and vice-versa and then attempt to arrange
terms and conditions for purchase / sale acceptable to both the parties. It is fully computerised,
transparent, single window exchange which provide quicker liquidity to securities at a fixed and fair
price, liquidity for less traded securities. Following are the advantages of OTC Market.

1. It provides a trading platform to smaller and less liquid companies.

2. It is a transparent system of trading with no problem of bad or short deliveries.
3. Family concerns & closely held companies can go public through OTC.
4. Dealer can operate both in new issues & secondary market at their options.
5. It is cost effective as there is a lower cost of new issues and lower expenses of servicing the investors.

Ques.6) What do you understand by stock market index?

Answer:
Stock market indices are the barometers of the stock market. They mirror the stock market behavior.
There are around 7,000 companies listed on the Bombay stock exchange and it is not possible to look at
the prices of every stock to find out whether the market movement is upward or downward.

Therefore, stoct market indices are formed. The indices give a broad outline of the market movement
and represent the market. Some of the stock market indices are BSE Sensex, BSE- 200, Dollex, NSE-50,
CRISIL-500, Business Line 250 and RBI Indices of Ordinary Shares.

Usefulness of Indices

1. Indices help to recognize the broad trends in the market.

2. Index can be used as a bench mark for evaluating the investors portfolio.
3. Indices function as a status report on the general economy. Impacts of the various
economic policies are reflecting on the stock market.
4. The investor can use the indices to allocate funds rationally among stocks. To earn
returns on par with the market returns, he can choose the stocks that reflect the market
movement.
5. Index funds and futures are formulated with the help of the indices. Usually fund
managers construct portfolios to emulate any one of the major stock market index. ICICI
has floated ICICI index bonds. The return of the bond is linked with the index movement.
6. Technical analysts studying the historical performance of the indices predict the future
movement of the stock market. The relationship between the individual stock and index
predicts the individual share price movement.

Ques.7) Discuss how and why the stock market indices differ from one another. OR
Ques) What are the factors that differentiate one index from another? OR
Ques) What are the basic factors to be considered in the indices?

Answer:
Differences between the Indices

The indices are different from each other to a certain extent. Sometimes the Sensex (BSE Index) may
move up by 100 points but NIFTY (NSE Index) may move up only 40 points. The main factors that
differentiate one index from the other are given below:

1. The number of the component stocks

2. The composition of the stocks
3. The weights

1. The Number of the Component Stocks: The number of stocks in an index influence the capable of
reflecting the market movement. The sensex has 30 scrips. At the same time BSE-100 (National), BSE-
200, the RBI Index (338 stocks) and Nifty (50 stocks) are also widely used.

From the above examples it is clear that the number of scrips differs from one index to another and
hence their movements also vary. BSE National Index is considered to be more representative than
Sensex because it has 100 stocks.

2. The Composition of the Stocks: The composition of the stocks in the index should reflect the market
movement as well as the macro-economic changes.

3. The Weights: The weight assigned to each companys scrip also influences the movement of the
index. The indices may be weighted with the price or value. The stocks with high price influence the
index more than the low priced stock.

4. Base year: The choice of base year also leads to variations among the index. The base year differs
from each other in the various indices. The base year should be free from any unnatural fluctuations in
the market. If the base year is close to the current year, the index would be more effective in reflecting
the changes in the market movement. At the same time if it is too close, the investor cannot make
historical comparison.
The Sensex has the base year as 1978-79 and the next oldest one is the RBI index of ordinary shares
with 1980-81 as base year.

Ques.8) Write a note on SENSEX (BSE Index). OR

Ques) What are the basic requirement for a stock to be included in the Sensex? OR
Ques) Explain the criteria adopted in the selection of scrips for Sensex.

Answer:
The BSE Sensitive Index

The BSE Sensitive index has long been known as the barometer of the daily temperature of Indian
bourses. In 1978-79 stock market contained only private sector companies and they were mostly geared
to commodity production. Hence, a sample 30 was drawn from them. With the passage of time more and
more companies private as well as public came into the market.

Even though the number of scrips in the Sensex basket remained the same 30, representations were
given to new industrial sectors such as services, telecomms, consumer goods and auto sector.

The criteria adopted in the selection of 30 scrips are listed as follows:

1. Industry Representation: The index should be able to capture the macro-industrial situation through
price movements of individual scrips. The companys scrip should reflect the present state of the
industry. For example, ACC in the Sensex is a representative of the cement industry. The logic here is
that ACC reflects the fortunes of the cement industry that in turn is discounted by the market in the
scrips pricing. Care is taken in selecting scrips across all the major industries to make the index act as a
real barometer to the economy.
2. Market Capitalisation: The market capitalisation of the stock indicates the true value of the stock, as
the outstanding number of shares is multiplied by the price. Price indicates the demand and growth
potential for the stock. The outstanding shares depend on the equity base. These selected scrip should
have a wide equity base too.

3. Liquidity: The liquidity factor is based on the average number of deals of scrip. The average number
of deals in the two previous years is taken into account. The market fancy for the share can be found out
by the trading volumes..

4. The Market Depth: The market depth factor is the average deal as a percentage of companys shares
outstanding. The market depth depends upon the wide equity base. If the equity base is broad based then
number of deals in the market would increase. For example Reliance Industries has a wide equity base
and larger number of outstanding shares.

Ques.9) Explain the reforms in secondary market initiated by SEBI.

OR
Ques) What do you mean by listing of securities? What is the procedure of listing of securities?
OR
Ques) Briefly explain the steps taken by SEBI to increase the liquidity in the stock market.