2introduction-capital market

8/7/2019 2Introduction-Capital Market.

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INTRODUCTION

FINANCIAL MARKETS

Generally speaking, there is no specific place of location to indicate a financial

market. Wherever a financial transaction takes place, it is deemed to have taken place in

the financial market. Hence financial markets are pervasive in nature since financial

transactions are themselves very pervasive throughout the economic system. For

instance, issue of equity shares, granting of loan by term lending institutions, deposit of

money into a bank, purchase of debentures, sale of shares and so on.

However, financial markets can be referred to as those centers and arrangements

which facilitate buying and selling of financial assets, claims and services. Sometimes,

we do find the existence of a specific place or location for a financial market as in the

case of stock exchange.


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CHART

CLASSIFICATION OF FINANCIAL MARKETS

Organized Market Unorganised Market

Capital Market Money Market

Industrial Govt. Securities Long Term Call Money Commercial Treasury bill Short TermSecurities Market Loan Market Market Bill Market Market Loan Market

Market

Primary Secondary Term Loan Market Market for financial Money Lenders Indigenous,Market Market Market for Mortgage Guarantees Bankers etc.


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Classification of Financial Markets

The classification of financial markets in India is shown in chart.

Unorganized Markets

In these markets there are a number of money lenders, indigenous bankers, and

traders etc., who lend money to the public. Indigenous bankers also collect deposits from

the public. There are also private finance companies, chit funds etc., whose activities are

not controlled by the RBI. Recently the RBI has taken steps to bring private finance

companies and chit funds under its strict control by issuing non-banking financial

companies (reserve Bank) Directions, 1998. The RBI has already taken some steps to

bring the unorganized sector under the organized fold. They have not been successful.

The regulations concerning their financial dealings are still inadequate and their financial

instruments have not been standardized.

Organized Markets

In the organized markets, there are standardized rules and regulations governing

their financial dealings. There is also a high degree of institutionalization and

instrumentalisation. These markets are subject to strict supervision and control by the

RBI or other regulatory bodies.


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These organized markets can be further classified into two. They are:

(i) Capital market

(ii) Money market

Capital Market

The capital market is a market for financial assets which have a long or indefinite

maturity. Generally, it deals with long term securities which have a maturity period of

above one year. Capital market may be further divided into three namely:

(i) Industrial securities market

(ii) Government securities market and

(iii) Long term loans market

(i) Industrial Securities Market

As the very name implies, it is a market for industrial securities namely:

(i) Equity shares or ordinary shares, (ii) Preference shares and (iii) Debentures or bonds.

It is a market where industrial concerns raise their capital or debt by issuing appropriate

instrumental. It can be further subdivided into two. They are:

(i) Primary market or New issue market

(ii) Secondary market or Stock exchange.


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Primary Market

Primary market is a market for new issues or new financial claims. Hence, it is

also called New Issues market. The primary market deals with those securities which are

issued to the public for the first time. In the primary market, borrowers exchange new

financial securities for long term funds. Thus, primary market facilitates capital

formation. There are three ways by which a company may raise capital in a primary

market. They are:

(i) Public issue

(ii) Rights issue

(iii) Private placement

The most common method of raising capital by new companies is through sale of

securities to the public. It is called public issue. When an existing company wants to

raise additional capital, securities are first offered to the existing shareholders on a pre-

emptive basis. It is called rights issue. Private placement is a way of selling securities

privately to a small group of investors.

Secondary Market

Secondary market is a market for secondary sale of securities. In other words,

securities which have already placed through the new issue market are traded in this

market. Generally, such securities are quoted in the Stock Exchange and it provides a

continuous and regular market for buying and selling of securities. This market consists

of all stock exchanges recognized by the Government of India. The stock exchanges in


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India are regulated under the Securities Contracts (Regulation) Act, 1956. The Bombay

Stock Exchange is the principal stock exchange in India which sets the tone of the other

stock markets.

(ii) Government Securities Market

It is otherwise called Gilt-Edged securities Market. It is a market where

Government securities are traded. In India there are many kinds of Government

Securities short-term and long-term. Long-term securities are traded in this market

while short term securities are traded in the money market. Securities issued by the

Central Government, State Governments, Semi-Government authorities like City

Corporations, Port Trusts etc. Improvement Trusts, State Electricity Boards, All India

and State level financial institutions and public sector enterprises are dealt in this market.

Government securities are issued in denominations of Rs.100. Interest is payable

half-yearly and they carry tax exemptions also. The role of brokers in marketing these

securities is practically very limited and the major participant in this market is the

commercial banks because they hold a very substantial portion of these securities to

satisfy their S.L.R. requirements.

The secondary market for these securities is very narrow since most of the

institutional investors tend to retain these securities until maturity.

The Government securities are in many forms. These are generally:

(i) Stock certificates or inscribed stock

(ii) Promissory Notes

(iii) Bearer Bonds which can be discounted.


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Government securities are sold through the Public Debt Office of the RBI while

Treasury Bills (short term securities) are sold through auctions.

Government securities offer a good source of raising inexpensive finance for the

Government exchequer and the interest on these securities influences the prices and

yields in this market. Hence this market also plays a vital role in monetary management.

(iii) Long-Term Loans Market

Development banks and commercial banks play a significant role in this market

by supplying long term loans to corporate customers. Long-term loans market may

further be classified into:

(i) Term loans market

(ii) Mortgages market

(iii) Financial guarantees market

Term Loans Market

In India, many industrial financing institutions have been created by the

Government both at the national and regional levels to supply long-term and medium

term loans to co4porate customers directly as well as indirectly. These development

banks dominate the industrial finance in India. Institutions like IDBI, IFCI, ICICI, and

other state financial corporations come under this category. These institutions meet the

growing and varied long-term financial requirements of industries by supplying long-


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term loans. They also help in identifying investment opportunities, encourage new

entrepreneurs and support modernization efforts.

Mortgages Market

The mortgages market refers to those centers which supply mortgage loan mainly

to individual customers. A mortgage loan is a loan against the security of immovable

property like real estate. The transfer of interest in a specific immovable property to

secure a loan is called mortgage. This mortgage may be equitable mortgage or legal one.

Again it may be a first charge or second charge. Equitable mortgage is created by a mere

deposit of title deeds to properties as securities whereas in the case of a legal mortgage

the title in the property is legally transferred to the lender by the borrower. Legal

mortgage is less risky.

Similarly, in the first charge, the mortgager transfers his interest in the specific

property to the mortgages as security. When the property in question is already

mortgaged once to another creditor, it becomes a second charge when it is subsequently

mortgaged to somebody else. The mortgagees can also further transfer his interest in the

mortgaged property to another. In such a case, it is called a sub-mortgage.

The mortgage market may have primary market as well secondary market. The

primary market consists of original extension of credit and secondary market has sales

and re-sales of existing mortgages at prevailing prices.

In India, residential mortgages are the most common ones. The Housing and

Urban Development Corporation (HUDCO) and the LIC play a dominant role in

financing residential projects. Besides, the Land Development Banks provide cheap


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Mortgage loans for the development of lands, purchase of equipment etc. These

development banks raise finance through the sale of debentures which are treated as

trustee securities.

Financial Guarantees Market

A Guarantee market is a centre where finance is provided against the guarantee of

a reputed person in the financial circle. Guarantee is a contract to discharge the liability

of a third party in case of his default. Guarantee acts as a security from the creditors

point of view. In case the borrower fails to repay the loan, the liability falls on the

shoulders of the guarantor. Hence the guarantor must be known to both the borrower and

the lender and he must have the means to discharge his liability.

Through there are many types of guarantees, the common forms are:

(i) Performance Guarantee and (ii) Financial Guarantee. Performance guarantees cover

the payment of earnest money, retention money, advance payments, non-completion of

contracts etc. On the other hand financial guarantees cover only financial contracts. In

India, the market for financial guarantees is well organized.

The financial guarantees in India relate to:

(i) Deferred payments for imports and exports.

(ii) Medium and long-term loans rose abroad.

(iii) Loans advanced by banks and other financial institutions.

These guarantees are provided mainly by commercial banks, development banks,

Government both central and state and other specialized guarantee institutions like ECGC


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(Export Credit Guarantee Corporation) and DICGC (Department Insurance and Credit

Guarantee Corporation). This guarantee financial service is available to both individual

and corporate customers. For a smooth functioning of any financial system, this

guarantee service is absolutely essential.

Financial markets, across the globe, are undergoing profound, unprecedented and

fast-paced changes. Technology has revolutionized the process and the information

explosion has sparked off remarkable changes in the way the world has been operating.

The India securities market is in transition.

The capital market is one of the most vibrant sectors in the financial systems,

marking an important contribution to economic development. Today India has two

national stock exchanges.

The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).

Foreign brokers account for 29 of these. Two major reasons why Indian securities are not

increasing regarded as attractive to international investors are the relatively high returns

compared with the more developed global markets as well as the low correlation with

world markets.

The recent years witnessed significant reforms in the capital market. It is well

known that trading platform has become automatic, electronic, anonymous, overdriven,

and nationwide and screen base. The reform was needed to address the inadequacies

and enhance the efficacy of the market.

Other aspects of the market such as the increasing sophistication and the range of

tradable financial products add to the attractiveness of the market as a whole. The

availability of derivative projects including index futures, index options, individual stock


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futures and individual stock options reinforces the overall attractiveness of this market to

foreign and domestic investors. The derivatives market in only two years has shown

spectacular growth. We shall analyze such growing trends in the Indian capital Market

Scenario.

IMPORTANCE OF CAPITAL MARKET

Absence of capital market acts as a deterrent factor to capital formation and

economic growth. Resources would remain idle if finances are not funneled through the

capital market. The importance of capital market can be briefly summarized as follows:

The capital market services as an important source for the productive use of the

economys savings. It mobilizes the savings of the people for further investment and thus

avoids their wastage in unproductive uses.

(i) It provides incentives to saving and facilities capital formation by offering

suitable rates of interest as the price of capital.

(ii) It provides an avenue for investors, particularly the household sector to invest

in financial assets which are more productive than physical assets.

(iii) It facilitates increase in production and productivity in the economy and thus,

enhances the economic welfare of the society. Thus, it facilitates the

movement of stream of command over capital to the point of highest yield

towards those who can apply them productively and profitably to enhance the

national income in the aggregate.


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(iv) The operations of different institutions in the capital market induce economic

growth. They give quantitative and qualitative directions to the flow of funds

and bring about rational allocation of scares resources.

(v) A healthy capital market consisting of expert intermediaries promotes stability

in values of securities representing capital funds.

(vi) Moreover, it serves as an important source for technological up gradation in

the industrial sector by utilizing the funds invested by the public.

Thus, a capital market services as an important link between those who save and

those who aspire to invest their savings.

THE SECURITIES MARKET

Money Market: Money market is a market for debt securities that pay off in the

short term usually less than one year, for example the market for 90 days treasury bills.

This market encompasses the trading and issuance of short-term non-equity debt

instruments including treasury bills, commercial papers, bankers acceptance, certificates

of deposits, etc.

Capital Market: Capital market is a market for long-term debt and equity shares.

In this market, the capital funds comprising of both equity and debt are issued and traded.

This also includes private placement sources of debt and equity as well s organized

markets like stock exchanges. Capital market can be further divided into primary and

secondary markets.


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A stock, bond or other investment instrument issued by a corporation, government or

organization that signifies an ownership position or creditor relationship is termed as

securities. In other words an instrument that signifies an ownership position in a

corporation (a stock), a creditor relationship with a government body (a bond), or rights

to ownership (e.g. option) is a security.

Security markets provide a platform for the trade of such securities between

different investors.

Securities generally have two stages in their lifespan. The first stage is when the

company initially issues the security directly from its treasury at a predetermined offering

price.

This is Primary Market offering. It is referred to as the initial public offering

(IPOs). Investment dealers frequently buy initial offerings on the primary market and

result the securities on the Secondary Market. This promotes the goal of equal access to

information for everyone. The second stage is when an investor or dealer makes the

shares, bought from a company treasury, available for sale to other investors on the

secondary market. In the secondary market, the trading of shares in between investors.

This trading usually takes place through such as the Toronto, New York, Montreal or

CDNX Stock Exchange.

In the primary market, securities are offered to pubic for subscription for the

purpose of raising capital or fund. Secondary market is an equity-trading avenue in

which already existing/pre-issued securities are traded amongst investors. Secondary


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market could be either auction or dealer market. While stock exchange is the part of an

auction market, over-the-Counter (OTC) is a part of the dealer market.

Equity: The ownership interest in a company of holders of its common and

preferred stock. The various kinds of equity shares are as follows:

Equity Shares: An equity share, commonly referred to as ordinary share also

represents the form of fractional ownership in which a shareholder, as a fractional owner,

undertakes the maximum entrepreneurial risk associated with a business venture. The

holders of such shares re members of the company and have voting rights. A company

may issue such shares with differential rights as to voting, payment of dividend, etc.

Rights Issue / Rights Shares: The issue of new securities to existing shareholders

at a ratio to those already held.

Bonus Shares: Shares issued by the companies to their shareholders free of cost

by capitalization of accumulated reserves from the profits earned in the earlier

years.

Preferred Stock/Preference shares: Owners of these kinds of shares are entitled to

a fixed dividend or dividend calculated at a fixed rate to be paid regularly before

dividend can be paid in respect of equity share. They also enjoy priority over the

equity shareholders in payment of surplus. But in the event of liquidation, their

claims rank below the claims of the companys creditors, bondholders / debenture

holders.


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Cumulative Preference Shares: A type of preference shares on which dividend

accumulates if remains unpaid. All arrears of preference divided have to be paid

out before paying dividend on equity shares.

Cumulative Convertible Preference Shares: A type of preference shares where the

dividend payable on the same accumulates, if not paid. After a specified date,

these shares will be converted into equity capital of the company.

Participating Preference Share: The right of certain preference shareholders to

participate in profits after a specified fixed dividend contracted for is paid.

Participation right is linked with the quantum of dividend paid on the equity

shares over and above a particular specified level.

Security Receipts: Security receipt means a receipt or other security, issued by a

securitization company or reconstruction company to any qualified institutional.

Buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder

thereof, of an undivided right, title or interest in the financial asset involved in

securitization.

Government securities (G-secs): These are sovereign (credit risk-free) coupon

bearing instruments which are issued by the Reserve Bank of India on behalf of

government of India, in lieu of the Central Governments market borrowing

programme. These securities have a fixed coupon that is paid on specific dates on

half-yearly basis. These securities are available in wide range of maturity dates,

from short dated (less than one year) to long dated (upto twenty years).

Debentures: Bonds issued by a company bearing a fixed rate of interest usually

payable half yearly on specific dates and principal amount repayable on particular


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date on redemption of the debentures. Debentures are normally secured/charged

against the asset of the company in favour of debenture unsecured.

Bond: A negotiable certificate evidencing indebtedness. It is normally unsecured.

A company municipality or government agency generally issued a debt security.

A bond investor lends money to the issuer and in exchange, the issuer promises to

repay the loan amount the loan amount on a specified maturity date. The issuer

usually pays the bondholder periodic interest payments over the life of the load.

The various types of Bonds are as follows-

Zero Coupon Bond: Bond issued at a discount and rapid at a face value. No

periodic interest is paid. The difference between the issue price and redemption

price represents the return to the holder. The buyer of these bonds receives only

one payment, at the maturity of the bond.

Convertible Bond: A bond giving the investor the option to convert the bond into

equity at a fixed conversion price.

Commercial Paper: A short-term promise to repay a fixed amount that is placed

on the market either directly or through a specialized intermediary. It is usually

issued by companies with a high credit standing in the form of a promissory note

redeemable at par to the holder on maturity and therefore, doesnt require any

guarantee. Commercial paper is a money market instrument issued normally for

tenure of 90-days.

Treasury Bills: Shore-term (upto 91 days) bearer discount security issued by the

Government as a means of financing its cash requirements.


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WORKING OF THE CAPITAL MARKET

Trading in Indian Stock exchanges is limited to listed securities of public limited

companies. They are broadly divided into two categories, namely, specified securities

(forward list) and non-specified securities (cash list). Equity shares of dividend paying,

growth-oriented companies with a paid-up capital of at least Rs.50 million and a market

capitalization of at least Rs.100 million and having more than 20,000 shareholders are

normally, put in the specified group and the balance in non-specified group.

Two types of transactions can be carried out on the Indian stock exchanges: (a)

Spot delivery transactions; for delivery and payment within the time or on the date

stipulated when entering into the contract which shall not be more than 14 days following

the date of the contract and (b) forward transactions delivery and payment can be

extended by further period of the contract. The latter is permitted only in the case of

specified shares. The brokers who carry over the outstanding pay carry over charges

(catango or backwardation), which are usually determined by the rtes of interest

prevailing.

A member broker in an Indian stock exchange can act as an agent, buy and sell

securities for his clients on a commission basis and also can act as a trader or dealer as a

principal, buy and sell securities on his own account and risk, in contrast with the practice

prevailing on New York and London Stock Exchanges, where a member can act as a

jobber or a broker only.


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The nature of trading on Indian stock exchange are that of age old conventional

style of face-to-face trading with bids and offers being made by open outcry. However,

there is a great amount of effort to modernize the Indian stock exchanges in the very

recent times. Brokers of stock trading get membership at stock exchange after fulfilling

conditions. Brokers maintain an online link with the stock exchange. He is constantly

updated with the real quotes in the market, their position, and the demand and supply

rates, number of buyers or sellers at various rates.

Customer toes to the office of the broker of gives him a call regarding the sale or

the purchase of a particular number of shares. Broker, after receiving the order, enters it

into the online system. If an appropriate match is established with reference to the price

available at the market that is both the buy and sell rates match. This implies that the

deal is struck. If there is no match then the order is stacked in the system until a matched

counter order emerges and transaction is closed at that point of time.

The trading system of the national Stock exchange provides enormous flexibility

to trading members. Members can easily exercise the various options available to them

on a trading floor and when entering the order can place limit on either the number or the

higher order and accordingly the order is matched at the best price available. Members

have the option of canceling all outstanding orders in one stock if necessary or he may

choose the entire order to be carried out as one deal or in smaller lots. This kind of a

system provides full transparency. Identity of trading members entering order in the


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system will be protected and will have direct participation by large players also without

the fear of their orders influencing the state of the market.

There is a book entry transfer system for securities, which will operate just, like a

passbook system in a bank. Accounts will be maintained against each member detailing

the securities held in trading members name. At the end of each trading day exchange

computer will generate a report of matched traders of each trading member, which in turn

would be received by each trading member and the money refundable or deliverable to

the cleaning agency.

This will reduce the bank office work of the trading member, thus allowing them

provide better service to the investors. In order to expedite the settlement process a

depository has been established. Through this system, the trade transactions have shown a

tremendous growth both in value and volume.

PROFORMS IN THE INDIAN CAPITAL MARKET

Screen based trading:

The recent years witnessed significant in the capital market. It is well known that

trading platform has become automatic, electronic, anonymous, out driven and

nationwide and screen base. Shouting and gesticulations have given way to punching and

clicking. Speed and efficiency are the hallmark of the present system. Across the system

multitude of the market participants trade with one another anonymously and

simultaneously. On any trade day more then 10,000 terminals come alive, in around 400

towns and cities. Transparency is ensured in respect of dissemination of information,


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prices and quantum of order; but members identity is to be hidden to prevent any bias in

response.

Trading Cycle:

An investor today need that wait with his fingers crossed for a fortnight or more

for getting crossed cheques or crisp notes for the sale proceeds of his securities. The

trading cycle has been shortened to T+2. This shortening of the cycle has been done in a

phased manner, all in a matter of two years.

Dematerialization:

Another material development that proved to be a relief to the investors was

dematerialization of scripts. Now 99% of the scrips in the market are dematerialized.

Almost 100% of the shares are in Demat form. Inconvenience of physical custody and

transfer, tedium of indicating change of address and problems of bad delivery, late

delivery, non-delivery and risk of forgery and frauds have virtually disappeared. The

benefit is relished but not the cause.

Settlement Guarantee Fund (SGF):

Each exchange has a settlement guarantee fund to meet with unpredictable

situation and a negligible trade failure of 0.003%. The Clearing Corporation of the

exchanges assumes the counter party risk of each member and guarantees settlement

through a fine tuned risk management system and an innovative method of online

position monitoring. It also ensures the financial settlement of trades on the appointed


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day and time irrespective of default by members to deliver the required funds and/or

securities with the help of the SGF.

Derivatives market:

Sensex is the branded equity index of the BSE, Asias oldest stock exchange with

a 128 years history. Analysts and the business media track Indias stock market

performance by trading the Sensex.

The beginning of index futures trading on June 9, 2000 was perhaps the defining

moment for the BSE in the context of equity derivatives. Few events thereafter matched

the grand and epochal launch. The BSE currently accounts for about 3 per cent of Indias

equity derivatives volume.

It is quite likely the BSE does not mind the insignificance of its share. It had

resolutely regarded equity derivatives as inapt substitutes for babla; a system of carry-

forward trading that defined the BSEs prestige. It had resolutely argued that India was

not ready for equity derivatives. Yet, the BSE was the first to launch equity derivatives.

Though index futures and index options were listed ahead of stock options and

stock futures, stock futures have raced ahead of all other contracts. Stock futures

accounted for over 60 per cent of the NSEs and, therefore, Indias total derivatives

activity by number of contracts and turnover in May 2003. Stock options accounted for


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about 22 per cent of total derivatives activity by number of contracts and about 24 per

cent of turnover.

Stock derivatives have equity shares of companies, say, Reliance and Satyam

Computer Services, as the underlying. The securities and Exchange Board of India

(SEBI) approved 31 stocks on which call and put options could be listed by the BSE and

NSE in July 2001.

The same set of 31 stocks applied to the listing of stock futures by the BSE and

NSE in November 2001. In January 2003, SEBI extended the approved list by 31 more

stocks. Stock derivatives dominate the marketplace, and some may regard this as going

against the run of play.

Book Building:

Book Building is basically a capital issuance process used in Initial Public Offer

(IPO), which aids price and demand discovery. It is a process used for marketing a

public offer of equity shares of a company. It is a mechanism where, during the period

which the book for the IPO is open, bids are collected from investors at various prices,

which are above or equal to the floor price. The process aims at tapping both wholesale

and retail investors. The offer/issue price is then determined after the bid closing date

based on certain evaluation criteria.


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The crucial milestones in the future of institutional development in Indias

securities markets may now be summarized as:

Transition to rolling settlement. SEBI should not have a policy through which

stock market trading should only be allowed to take place using rolling

settlement, starting with the largest stocks in the country and covering all stocks

over a period of two years. This process can commence now.

Onset of index futures and index options. This process can commence the

movement the SCRA is amended. Under the best scenario, we can expect to see

index futures trading in November 1998 and index is December 1998.

Exchange-traded derivatives on interest rates and currencies. The logical next

step, once exchange-traded derivatives exists, is to trade derivatives which enable risk

management on fluctuations of interest rates and the dollar-rupee. This will be an

outcome of the confidence the RBI has in the quality of NSEs derivatives exchange and

SEBIs policy governing exchange-traded derivatives.

2introduction-capital market

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