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Generally, the personal savings of an entrepreneur along with

contributions from friends and relatives are the source of fund to start
new or to expand existing business. This may not be feasible in case
of large projects as the required contribution from the entrepreneur
(promoter) would be very large even after availing term loan; the
promoter may not be able to bring his / her share (equity capital). Thus
availability of capital can be a major constraint in setting up or
expanding business on a large scale. However, instead of depending
upon a limited pool of savings of a small circle of friends and relatives,
the promoter has the option of raising money from the public across
the country by selling (issuing) shares of the company. For this
purpose, the promoter can invite investment to his or her venture by
issuing offer document which gives full details about track record, the
company, the nature of the project, the business model, the expected
profitability etc. If you are comfortable with this proposed venture,
you may invest and thus become a shareholder of the company.
Through aggregation, even small amounts available with a very large
number of individuals translate into usable capital for corporates. Your
small savings of, say, even ` 5,000 can contribute in setting up, say, a `
5,000 crore Cement or Steel plant. This mechanism by which
corporates raise money from public is called the primary markets.

Importantly, when you, as a shareholder, need your

money back, you can sell these shares to other or new investors. Such
trades do not reduce or alter the companys capital. Stock exchanges
bring such sellers and buyers together and facilitate trading.
Therefore, companies raising money from public are required to list
their shares on the stock exchange. This mechanism of buying and
selling shares through stock exchange is known as the secondary
markets. As a shareholder, you are part owner of the company and
entitled to all the benefits of ownership, including dividend (companys
profit distributed to owners). Over the years if the company performs
well, other investors would like to become owners of this performing
company by buying its shares. This increase in demand for shares
leads to increase in its price. You then have the option of selling your
shares at a higher price than at which you purchased it. You can thus
increase your wealth, provided you make the right choice. The reverse
is also true! Apart from shares, there are many other financial
instruments (securities) used for raising capital. Debentures or bonds
are debt instruments that pay interest over their lifetime and are used
by corporates to raise medium or long-term debt capital. If you prefer
fixed income, you may invest in these instruments, which may give
you higher rate of interest than bank fixed deposit, because of the
higher risk. Besides, equity and debt, a combination of these
instruments, like convertible debentures, preference shares are also
issued to raise capital. If you have constraints like time, wherewithal,
small amount etc. to invest in the market directly, Mutual Funds (MFs),
which are regulated entities, provide an alternative avenue. They
collect money from many investors and invest the aggregate amount
in the markets in a professional and transparent manner. The returns
from these investments net of management fees are available to you
as a MF unit holder

1.1 Definition of Capital Market

Capital markets are financial markets for the buying and

selling of long-term debt or equity-backed securities. These markets
channel the wealth of savers to those who can put it to long-term
productive use, such as companies or governments making long-term

1.1.B. Reforms in Capital Market of India

The major reform undertaken in capital market of India includes:

Establishment of SEBI:

The Securities and Exchange Board of India (SEBI) was established in

1988. It got a legal status in 1992. SEBI was primarily set up to
regulate the activities of the merchant banks, to control the
operations of mutual funds, to work as a promoter of the stock
exchange activities and to act as a regulatory authority of new issue
activities of companies.

Establishment of Creditors Rating Agencies:

Three creditors rating agencies viz. The Credit Rating Information

Services of India Limited (CRISIL - 1988), the Investment Information
and Credit Rating Agency of India Limited (ICRA - 1991) and Credit
Analysis and Research Limited (CARE) were set up in order to assess
the financial health of different financial institutions and agencies
related to the stock market activities. It is a guide for the investors
also in evaluating the risk of their investments.

Increasing of Merchant Banking Activities:

Many Indian and foreign commercial banks have set up their merchant
banking divisions in the last few years. These divisions provide
financial services such as underwriting facilities, issue organizing,
consultancy services, etc.

Rising Electronic Transactions:

Due to technological development in the last few years, the physical

transaction with more paper work is reduced. It saves money, time
and energy of investors. Thus it has made investing safer and hassle
free encouraging more people to join the capital market.

Growing Mutual Fund Industry:

The growing of mutual funds in India has certainly helped the capital
market to grow. Public sector banks, foreign banks, financial
institutions and joint mutual funds between the Indian and foreign
firms have launched many new funds. A big diversification in terms of
schemes, maturity, etc. has taken place in mutual funds in India. It has
given a wide choice for the common investors to enter the capital

Growing Stock Exchanges:

The numbers of various Stock Exchanges in India are increasing.
Initially the BSE was the main exchange, but now after the setting up
of the NSE and the OTCEI, stock exchanges have spread across the
country. Recently a new Inter-connected Stock Exchange of India has
joined the existing stock exchanges.

Investor's Protection:

Under the purview of the SEBI the Central Government of India has set
up the Investors Education and Protection Fund (IEPF) in 2001. It
works in educating and guiding

investors. It tries to protect the interest of the small investors from

frauds and malpractices in the capital market.

Growth of Derivative Transactions:

Since June 2000, the NSE has introduced the derivatives trading in the
equities. In November 2001 it also introduced the future and options
transactions. These innovative products have given variety for the
investment leading to the expansion of the capital market.

Commodity Trading:

Along with the trading of ordinary securities, the trading in

commodities is also recently encouraged. The Multi Commodity
Exchange (MCX) is set up. The volume of such transactions is growing
at a splendid rate. These reforms have resulted into the tremendous
growth of Indian capital market

1.1.C. Factors Affecting Capital Market in India

A range of factors affects the capital market. Some of the factors that
influence capital market are as follows: -

Performance of domestic Companies: -

The performance of the companies or rather corporate earnings is

one of the factors that have direct impact or effect on capital market
in a country. Weak corporate earnings indicate that the demand for
goods and services in the economy is less due to slow growth in per
capita income of people. Because of slow growth in demand there is
slow growth in employment that means slow growth in demand in the
near future. Thus weak corporate earnings indicate average or not so
good prospects for the economy as a whole in the near term. In such a
scenario the investors (both domestic as well as foreign) would be
wary to invest in the capital market and thus there is bear market like
situation. The opposite case of it would be robust corporate earnings
and its positive impact on the capital market.

Environmental Factors: -

Environmental Factor in Indias context primarily means- Monsoon. In

India around 60 % of agricultural production is dependent on monsoon.
Thus there is heavy dependence on monsoon. The major chunk of
agricultural production comes from the states of Punjab, Haryana &
Uttar Pradesh. Thus deficient or delayed monsoon in this part of the
country would directly affect the agricultural output in the country.
Apart from monsoon other natural calamities like Floods, tsunami,
drought, earthquake, etc. also have an impact on the capital market of
a country.

Macro Economic Numbers: -

The macroeconomic numbers also influence the capital market. It

includes Index of Industrial Production (IIP) which is released every
month, annual Inflation number indicated by Wholesale Price Index
(WPI) which is released every week, Export Import numbers which
are declared every month, Core Industries growth rate (It includes Six
Core infrastructure industries Coal, Crude oil, refining, power,
cement and finished steel) which comes out every month, etc. This
macro economic indicators indicate the state of the economy and the
direction in which the economy is headed and therefore impacts the
capital market in India.

Global Cues: -

In this world of globalization various economies are interdependent

and interconnected. An event in one part of the world is bound to
affect other parts of the world; however the magnitude and intensity of
impact would vary. Thus capital market in India is also affected by
developments in other parts of the world i.e. U.S., Europe, Japan, etc.
Global cues includes corporate earnings of MNCs, consumer
confidence index in developed countries, jobless claims in developed
countries, global growth outlook given by various agencies like IMF,
economic growth of major economies, price of crude oil, credit rating
of various economies given by Moodys, S & P, etc.

Political stability and government policies: -

For any economy to achieve and sustain growth it has to have

political stability and pro- growth government policies. This is because
when there is political stability there is stability and consistency in
governments attitude that is communicated through various
government policies. The vice- versa is the case when there is no
political stability .So capital market also reacts to the nature of
government, attitude of government, and various policies of the

Growth prospectus of an economy: -

When the national income of the country increases and per capita
income of people increases it is said that the economy is growing.
Higher income also means higher


2.1Primary Market

Companies issue securities from time to time to raise funds in order to

meet their financial requirements for modernization, expansions and
diversification programs. These securities are issued directly to the
investors (both individuals as well as institutional) through the
mechanism called primary market or new issue market. The primary
market refers to the set-up, which helps the industry to raise the funds
by issuing different types of securities. This set-up consists of the type
of securities available, financial institutions and the regulatory
framework. The primary market discharges the important function of
transfer of savings especially of the individuals to the companies, the
mutual funds, and the public sector undertakings. Individuals or other
investors with surplus money invest their savings in exchange for
shares, debentures and other securities. In the primary market the
new issue of securities are presented in the form of public issues,
right issues or private placement. Firms that seek financing, exchange
their financial liabilities, such as shares and debentures, in return for
the money provided by the financial intermediaries or the investors
directly. These firms then convert these funds into real capital such as
plant and machinery etc. The structure of the capital market where
the firms exchange their financial liabilities for long-term financing is
called the primary market.

2.1.A. Activities in the Primary Market

Appointment of merchant bankers

Collection of money

Pricing of securities being issued

Minimum subscription

Communication/ Marketing of the issue

Listing on the stock exchange(s)

Information on credit risk

Allotment of securities in demat/ physical mode

Making public issues

Record keeping

2.1.B. Function of Primary Market


Deals with the origin of the new issue. The proposal is analyzed in
terms of the nature of the security, the size of the issued timings of
the issue and flotation method of the issue.


Underwriting is a kind of guarantee undertaken by an institution or

firm of brokers ensuring the marketability of an issue. it is a method
whereby the guarantor makes a promise to the stock issuing company
that he would purchase a certain specific number of shares in the
event of their not being invested by the public.


The third function is that of distribution of shares. Distribution means

the function of sale of shares and debentures to the investors. This is
performed by brokers and agents. They maintain regular lists of clients
and directly contact them for purchase and sale of securities.

2.1.C. Role of Primary Market

Capital formation

It provides attractive issue to the potential investors and with this

company can raise capital at lower costs.

As the securities issued in primary market can be immediately sold in

secondary market the rate of liquidity is higher.


Many financial intermediaries invest in primary market; therefore

there is less risk if there is failure in investment as the company does
not depend on a single investor. The diversification of investment
reduces the overall risk.

Reduction in cost

Prospectus containing all details about the securities are given to the
investors hence reducing the cost is searching and assessing the
individual securities.

2.1.D. Features of Primary Market

It is the new issue market for the new long-term capital.

Here company issues the securities 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

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


Secondary market refers to the network/system for the subsequent
sale and purchase of securities. An investor can apply and get allotted
a specified number of securities by the issuing company in the primary
market. However, once allotted the securities can thereafter be sold
and purchased in the secondary market only. An investor who wants to
purchase the securities can buy these securities in the secondary
market. The secondary market is market for subsequent sale/purchase
and trading in the securities. A security emerges or takes birth in the
primary market but its subsequent movements take place in
secondary market. The secondary market consists of that portion of
the capital market where the previously issued securities are
transacted. The firms do not obtain any new financing from secondary
market. The secondary market provides the life-blood to any financial
system in general, and to the capital market in particular. The
secondary market is represented by the stock exchanges in any
capital market. The stock exchanges provide an organized market
place for the investors to trade in the securities. This may be the most
important function of stock exchanges. The stock exchange,
theoretically speaking, is a perfectly competitive market, as a large
number of sellers and buyers participate in it and the information
regarding the securities is publicly available to all the investors. A
stock exchange permits the security prices to be determined by the
competitive forces. They are not set by negotiations off the floor,
where one party might have a bargaining advantage. The bidding
process flows from the demand and supply underlying each security.
This means that the specific price of a security is determined, more or
less, in the manner of an auction. The stock exchanges provide market
in which the members of the stock exchanges (the share brokers) and
the investors participate to ensure liquidity to the latter. In India, the
secondary market, represented by the stock exchanges network, is
more than 100 years old when in 1875, the first stock exchange
started operations in Mumbai. Gradually, stock exchanges at other
places have also been established and at present, there are 23 stock
exchanges operating in India. The secondary market in India got a
boost when the Over the Counter Exchange of India (OTCEI) and the
National Stock Exchange (NSE) were established. Out of the 23 stock
exchanges, 20 stock exchanges are operating at Mumbai (BSE),
Kolkata, Chennai, Ahmadabad, Delhi, and Indore. Bangalore,
Hyderabad, Cochin, Kanpur, Pune, Ludhiana, Guwahati, Mangalore,
Patna, Jaipur, Bhubaneswar, Rajkot, Vadodara and Coimbatore.
Besides, there is one ICSE established by 14 Regional Stock
Exchanges. It may be noted that out of 23 stock exchanges, only 2,
i.e., the NSE and the Over the Counter Exchange of India (OTCEI) have
been established by the All India Financial Institutions while other
stock exchanges are operating as associations or limited companies.
In order to protect and safeguard the interest of the investors, the
operations, functioning and working of the stock exchanges and their
members (i.e., share brokers) are supervised and regulated by the
Securities Contracts (Regulations) Act, 1956 and the SEBI Act, 1992.

2.2.A. Activities in the Secondary Market

Trading of securities

Risk management

Clearing and settlement of trades

Delivery of securities and funds

2.2.B. Importance of Secondary Market:

Providing liquidity and marketability to existing securities

Pricing of securities

Safety of transaction

Contribution to economic growth

Providing scope for speculation

2.2.C. Role of Secondary Market

For the general investor, the secondary market provides an efficient

platform for trading of his securities. For the management of the
company, Secondary equity markets serve as a monitoring and control
conduitby facilitating value-enhancing control activities, enabling
implementation of incentive-based management contracts, and
aggregating information (via price discovery) that guides management

2.2.D. Products in secondary markets

Equity Shares

Rights Issue/ Rights Shares

Bonus Shares

Preferred Stock/ Preference shares

Cumulative Preference Shares

Cumulative Convertible Preference Shares

Participating Preference Share


Zero Coupon Bond

Convertible Bond


Commercial Paper


Treasury Bills

2.2.E. The OTC Market

Sometimes you'll hear a dealer market referred to as an over-the-

counter (OTC) market. The term originally meant a relatively
unorganized system where trading did not occur at a physical place,
as we described above, but rather through dealer networks.


There are several major players in the primary market. These include
the merchant bankers, mutual funds, financial institutions, foreign
institutional investors (FIIs) and individual investors. In the secondary
market, there are the stock exchanges, stock brokers (who are
members of the stock exchanges), the mutual funds, financial
institutions, foreign institutional investors (FIIs), and individual
investors. Registrars and Transfer Agents, Custodians and
Depositories are capital market intermediaries that provide important
infrastructure services for both primary and secondary markets.

I. Custodians:

In the earliest phase of capital market reforms, to get over the

problems associated with paper-based securities, large holding by
institutions and banks were sought to be immobilized. Immobilization
of securities is done by storing or lodging the physical security
certificates with an organization that acts as a custodian - a securities
depository. All subsequent transactions in such immobilized securities
take place through book entries. The actual owners have the right to
withdraw the physical securities from the custodial agent whenever
required by them. In the case of IPO, a jumbo certificate is issued in
the name of the beneficiary owners based on which the depository
gives credit to the account of beneficiary owners. The Stock Holding
Corporation of India Limited was set up to act as a custodian for
securities of a large number of banks and institutions who were mainly
in the public sector. Some of the banks and financial institutions also
started providing "Custodial" services to smaller investors for a fee.

II. Depositories

The depositories are important intermediaries in the securities market

that is scripless or moving towards such a state. In India, the
Depositories Act defines a depository to mean "a company formed and
registered under the Companies Act, 1956 and which has been granted
a certificate of registration under sub-section (IA) of section 12 of the
Securities and Exchange Board of India Act, 1992." The principal
function of a depository is to dematerialise securities and enable their
transactions in book-entry form. Dematerialisation of securities occurs
when securities issued in physical form is destroyed and an equivalent
number of securities are credited into the beneficiary owner's
account. In a depository system, the investors stand to gain by way of
lower costs and lower risks of theft or forgery, etc. They also benefit in
terms of efficiency of the process. But the implementation of the
system has to be secure and well governed. All the players have to be
conversant with the rules and regulations as well as with the
technology for processing. The intermediaries in this system have to
play strictly by the rules.

III. Depository Participants

A Depository Participant (DP) is described as an agent of the

depository. They are the intermediaries between the depository and
the investors. The relationship between the DPs and the depository is
governed by an agreement made between the two under the
depositories Act, 1996. In a strictly legal sense, a DP is an entity who
is registered as such with SEBI under the provisions of the SEBI Act.
As per the provisions of this Act, a DP can offer depository related
services only after obtaining a certificate of registration from SEBI.
SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50
lakh for theapplicants who are stockbrokers or non-banking finance
companies (NBFCs), for granting a certificate of registration to act as
a DP. For R & T Agents a minimum net worth of Rs. 10 crore is
prescribed in addition to a grant of certificate of registration by SEBI.
If a stockbroker seeks to act as a DP in more than one depository, he
should comply with the specified net worth criterion separately for
each such depository. If an NBFC seeks to act as a DP on behalf of any
other person, it needs to have a networth of Rs. 50 cr. in addition to
the networth specified by any other authority.

IV. Merchant Bankers

Among the important financial intermediaries are the merchant

bankers. The services of merchant bankers have been identified in
India with just issue management. It is quite common to come across
reference to merchant banking and financial services as though they
are distinct categories. The services provided by merchant banks
depend on their inclination and resources - technical and financial.
Merchant bankers (Category I) are mandated by SEBI to manage public
issues (as lead managers) and open offers in take-overs.

Merchant banks are rendering diverse services and functions.

These include organising and extending finance for investment in
projects, assistance in financial management, raising Eurodollar loans
and issue of foreign currency bonds. Different merchant bankers
specialise in different services. However, since they are one of the
major intermediaries between the issuers and the investors, their
activities are regulated by:

SEBI (Merchant Bankers) Regulations, 1992.

Guidelines of SEBI and Ministry of Finance.

Companies Act, 1956.

Securities Contracts (Regulation) Act, 1956.

V. Registrar:

The Registrar finalizes the list of eligible allottees after deleting the
invalid applications and ensures that the corporate action for crediting
of shares to the demat accounts of the applicants is done and the
dispatch of refund orders to those applicable aresent. The Lead
manager coordinates with the Registrar to ensure follow up so that
that the flow of applications from collecting bank branches,
processing of the applications and other matters till the basis of
allotment is finalized, dispatch security certificates and refund orders
completed and securities listed.

VI. Bankers to the issue:

Bankers to the issue, as the name suggests, carries out all the
activities of ensuring that the funds are collected and transferred to
the Escrow accounts. The Lead Merchant Banker shall ensure that
Bankers to the Issue are appointed in all the mandatory collection
centers as specified in DIP Guidelines. The LM also ensures follow-up
with bankers to the issue to get quick estimates of collection and
advising the issuer about closure of the issue, based on the correct

VII. Underwriters:

Underwriting is an agreement, entered into by a company with a

financial agency, in order to ensure that the public will subscribe for
the entire issue of shares or debentures made by the company. The
financial agency is known as the underwriter and it agrees to buy that
part of the company issues which are not subscribed to by the public
in consideration of a specified underwriting commission. The
underwriting agreement, among others, must provide for the period
during which the agreement is in force, the amount of underwriting
obligations, the period within which the underwriter has to subscribe
to the issue after being intimated by the issuer, the amount of
commission and details of arrangements, if any, made by the
underwriter for fulfilling the underwriting obligations. The underwriting
commission may not exceed 5 percent on shares and 2.5 percent in
case of debentures. Underwriters get their commission irrespective of
whether they have to buy a single security or not.

VIII.Credit Rating Agencies:

The 1990s saw the emergence of a number of rating agencies in the

Indian market. These agencies appraise the performance of issuers of
debt instruments like bonds or fixed deposits. The rating of an
instrument depends on parameters like business risk, market position,
operating efficiency, adequacy of cash flows, financial risk, financial
flexibility, and management and industry environment. The objective
and utility of this exercise is two-fold. From the point of view of the
issuer, by assigning a particular grade to an instrument, the rating
agencies enable the issuer to get the best price. Since all financial
markets are based on the principle of risk/reward, the less risky the
profile of the issuer of a debt security, the lower the price at which it
can be issued. Thus, for the issuer, a favorable rating can reduce the
cost of borrowed capital. From the viewpoint of the investor, the grade
assigned by the rating agencies depends on the capacity of the issuer
to service the debt. The 1990s saw an increase in activity in the
primary debt market. Under the SEBI guidelines all issuers of debt
have to get the instruments rated. They also have to prominently
display the ratings in all that marketing literature and advertisements.
The rating agencies have thus become an important part of the
institutional framework of the Indian securities market.

IX. Collective Investment Schemes:

Collective Investment Scheme is a scheme in whatever form, including

an openended investment company, in pursuance of which members of
the public are invited or permitted to invest money or other assets in a
portfolio, and in terms of which:

Two or more investors contribute money or other assets to and hold

a participatory interest;

The investors share the risk and benefit of investment in proportion

to their participatory interest in a portfolio of a scheme or on any other
basis determined in the deed.

X. Unit Trust:

A Unit Trust Scheme is a Fund into which small sums of monies from
individual investors are collected to form a pool for the purpose of
investing in stocks, shares and money market instrument by
professional fund managers on behalf of the contributors called unit
holders [subscribers]. By investing in a unit trust scheme, the unit
holders enjoy the benefits of diversification and professional
management of their fund at low cost.

There are two types of Unit Trust Schemes, viz;

This is a Fund that continuously creates issues and redeems units
after the initial public offering. The price is based on the Net Asset
Value (NAV), which is total asset of the fund minus liabilities as at
date of purchase or redemption.


In a ClosedEnded Fund, there is no additional issue of new units or

redemption of units. The Fund is usually listed and traded on the Stock
Exchange and its price will be determined by the market forces of
supply and demand. A unit holder who wants to redeem his unit will
therefore have to go through his Stockbroker.

XI. Venture Capital Funds:

It is early stage financing of new and young companies seeking to

grow rapidly. It is defined as a profit seeking venture by an
entrepreneur, whose primary objective is to provide fund not otherwise
available to new and growing business venture for the purpose of
making profit in the long term. For a Venture Capital Fund to exist
there must be the presence of the following:-

Risk-Takers, who are prepared to invest in Venture Capital Fund and

wait for long term gains rather than short term profits (Venture

There must be a Venture Capital Company to collect the money from

the risk-takers and offer them shares in return with a promise of high
return in future.

The process for a Venture Capital activity involves:

Fund raising

Real flow/investment

Monitoring/value enhancement

Exit stage.
XII. Foreign direct investment:

Foreign direct investment pertains to international investment in

which the investor obtains a lasting interest in an enterprise in
another country. Mostly it takes the form of buying or constructing a
factory in a foreign country or adding improvements to such a facility
in form of property, plants or equipments and thus is generally long
term in nature.

XIII.Private equity investment:

Private equity investment is one made by foreign investors in Indian

Venture Capital Undertakings (VCU) and Venture Capital Funds (VCF).

XIV. Foreign portfolio investment:

It is a short-term to medium- term investment mostly in the financial

markets and is commonly made through foreign Institutional Investors
(FIIs), non resident Indian (NRI) and persons of Indian origin (PIO).

XV. Foreign Institutional Investors:

The term FIIs used to denote an investor, mostly in the form of an

institution or entity which invests money in the financial markets of a
country different from the one where in the institution or the entity is
originally incorporated. According to Securities and Exchange Board of
India (SEBI) it is an institution that is a legal entity established or
incorporated outside India proposing to make investments in India
only in securities. These can invest their own funds or invest funds on
behalf of their overseas clients registered with SEBI. The client
accounts are known as sub - accounts. A domestic portfolio manager
can also register as FII to manage the funds of the sub-accounts. From
the early 1990s, India has developed a framework through which
foreign investors participate in the Indian capital market.

A foreign investor can either come into India as a FII or as a

sub-account. As on March 31, 2011, there were 1,722 FIIs registered
with SEBI and 5,686 sub-accounts registered with SEBI as on March
31, 2011 Basically FIIs have a huge financial strength and invest for
the purpose of income and capital appreciation.

XVI. R&T Agents - Registrars to Issue:

R&T Agents form an important link between the investors and issuers
in the securities market. A company, whose securities are issued and
traded in the market, is known as the Issuer. The R&T Agent is
appointed by the Issuer to act on its behalf to service the investors in
respect of all corporate actions like sending out notices and other
communications to the investors as well as despatch of dividends and
other non-cash benefits. R&T Agents perform an equally important role
in the depository system as well. These are described in detail in the
second section of this Workbook.

XVII. Stock Brokers:

Stockbrokers are the intermediaries who are allowed to trade in

securities on the exchange of which they are members. They buy and
sell on their own behalf as well as on behalf of their clients.
Traditionally in India, partnership firms with unlimited liabilities and
individually owned firms provided brokerage services. There were,
therefore, restrictions on the amount of funds they could raise by way
of debt. With increasing volumes in trading as well as in the number of
small investors, lack of adequate capitalisation of these firms exposed
investors to the risks of these firms going bust and the investors would
have no recourse to recovering their dues. In fact, NSE encouraged the
setting up of corporate broking members and has today only 10% of its
members who are not corporate entities.

XVIII. Mutual Funds:

Mutual funds are financial intermediaries, which collect the savings of

small investors and invest them in a diversified portfolio of securities
to minimise risk and maximise returns for their participants. Mutual
funds have given a major fillip to the capital market - both primary as
well as secondary. The units of mutual funds, in turn, are also tradable
securities. Their price is determined by their net asset value (NAV)
which is declared periodically.
There are various types of mutual funds, depending on whether
they are open ended or close ended and what their end use of funds is.
An open-ended fund provides for easy liquidity and is a perennial fund,
as its very name suggests. A closed-ended fund has a stipulated
maturity period, generally five years. A growth fund has a higher
percentage of its corpus invested in equity than in fixed income
securities, hence the chances of capital appreciation (growth) are
higher. In growth funds, the dividend accrued, if any, is reinvested in
the fund for the capital appreciation of investments made by the

An Income fund on the other hand invests a larger portion of its

corpus in fixed income securities in order to pay out a portion of its
earnings to the investor at regular intervals. A balanced fund invests
equally in fixed income and equity in order to earn a minimum return to
the investors. Some mutual funds are limited to a particular industry;
others invest exclusively in certain kinds of short-term instruments
like money market or government securities.

XIX. The Stock Exchanges:

A stock exchange is the marketplace where companies are listed and

where the trading happens. They provide a transparent and safe (risk-
free) forum of a market for investors to transact and invest their funds.
There are 23 Stock Exchanges registered withSEBI and under its
regulation. National Stock Exchange (NSE) and the Bombay Stock
Exchange (BSE) are the pre-dominant ones.

XX. Insurance Companies:

Insurance companies receive premium in exchange for insurance

policies and use these funds to purchase a variety of securities. Thus,
they invest the proceeds received from insurance in stocks and bonds.

XXI. Pension funds:

Many companies, corporations and government organizations and

agencies offer pension plans to their employers their employers or
both periodically contribute funds to such plans. The funds contributed
are invested in securities until they are withdrawn by the employees
upon their retirement.

XXII. Commercial Banks:

Commercial banks are those companies which are engage in

accepting deposits from savers and lending it back to deficit groups
who are demanding loans and advances in order to invest business.
Commercial banks are a major source of deposits collectors among
the all other kinds of financial institutions. They mobilize their
depository funds in many forms for example, lending to individuals and
corporations, invest in stock market and participate other forms of

XXIII. Saving Banks:

Like commercial banks, savings banks also accumulate the

scattered savings of the country and then create investment friendly
funds and lastly channelize these funds into productive investments.
Most savings banks are mutual in nature.

XXIV. Credit Unions:

Credit union differs from commercial savings banks in that they are
not profit oriented company and restrict their business to the main
members only. They use most of their funds to provide loans to their
internal members.

XXV. Finance Companies:

Most finance companies obtain funds by issuing securities and then

lend the funds to individuals and small businesses.

XXVI. Developmental Financial Institutions:

DFIs play the significant role as the source of long-term funds mainly
for the corporate firms. They supply fixed capital to the investors for
investment in fixed capital expenditures.


I. Secured Premium Notes:

SPN is a secured debenture redeemable at premium issued along with

a detachable warrant, redeemable after a notice period, say four to
seven years. The warrants attached to SPN gives the holder the right
to apply and get allotted equity shares; provided the SPN is fully paid.
There is a lock-in period for SPN during which no interest will be paid
for an invested amount.

II. Deep Discount Bonds:

A bond that sells at a significant discount from par value and has no
coupon rate or lower coupon rate than the prevailing rates of fixed-
income securities with a similar risk profile. They are designed to
meet the long term funds requirements of the issuer and investors who
are not looking for immediate return and can be sold with a long
maturity of 25-30 years at adept discount on the face value of

III. Equity Shares With Detachable Warrants:

A warrant is a security issued by company entitling the holder to buy a

given number of shares of stock at a stipulated price during a
specified period. These warrants are separately registered with the
stock exchanges and traded separately. Warrants are frequently
attached to bonds or preferred stock as a sweetener, allowing the
issuer to pay lower interest rates or dividends.

IV. Fully Convertible Debentures With Interest:

This is a debt instrument that is fully converted over a specified period

into equity shares. The conversion can be in one or several phases.
When the instrument is a pure debt instrument, interest is paid to the
investor. After conversion, interest payments cease on the portion that
is converted. If project finance is raised through an FCD issue, the
investor can earn interest even when the project is under
implementation. Once the project is operational, the investor can
participate in the profits through share price appreciation and dividend

V. Disaster Bonds:

Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-

yield debt instrument that is usually insurance linked and meant to
raise money in case of a catastrophe.

VI. Mortgage Backed Securities(MBS):

MBS is a type of asset-backed security, basically a debt obligation that

represents a claim on the cash flows from mortgage loans, most
commonly on residential property.

VII.Indian Depository Receipts:

As per the definition given in the Companies (Issue of Indian

Depository Receipts) Rules, 2004, IDR is an instrument in the form of a
Depository Receipt created by the Indian depository in India against
the underlying equity shares of the issuing company. In an IDR, foreign
companies would issue shares, to an Indian Depository (say National
Security Depository Limited NSDL), which would in turn issue
depository receipts to investors in India. The actual shares underlying
the IDRs would be held by an Overseas Custodian, which shall
authorize the Indian Depository to issue the IDRs.


A convertible bond is a mix between a debt and equity instrument. It is

a bond having regular coupon and principal payments, but these bonds
also give the bondholder the option to convert the bond into stock.
FCCB is issued in a currency different than the issuer's domestic

The investors receive the safety of guaranteed payments on the

bond and are also able to take advantage of any large price
appreciation in the company's stock. Due to the equity side of the
bond, which adds value, the coupon payments on the bond are lower
for the company, thereby reducing its debt-financing costs.

IX. Derivatives:

A derivative is a financial instrument whose characteristics and value

depend upon the characteristics and value of some underlying asset
typically commodity, bond, equity, currency, index, event etc.
Advanced investors sometimes purchase or sell derivatives to manage
the risk associated with the underlying security, to protect against
fluctuations in value, or to profit from periods of inactivity or decline.
Derivatives are often leveraged, such that a small movement in the
underlying value can cause a large difference in the value of the

X. Exchange Traded Funds:

An exchange-traded fund (or ETF) is an investment vehicle traded on

stock exchanges, much like stocks. An ETF holds assets such as
stocks or bonds and trades at approximately the same price as the net
asset value of its underlying assets over the course of the trading day.

Most ETFs track an index, such as the S&P 500 or Sensex.

ETFs may be attractive as investments because of their low costs, tax
efficiency, and stock-like features, and single security can track the
performance of a growing number of different index funds (currently
the NSE Nifty).

XI. Gold ETF:

A Gold Exchange Traded Fund (ETF) is a financial instrument

like a mutual fund whose value depends on the price of gold. In most
cases, the price of one unit of gold ETF approximately reflects the
price of 1 gram of gold. As the price of gold rises, the price of the ETF
is also expected to rise by the same amount.

Gold exchange-traded funds are traded on the major stock

exchanges including Zurich, Mumbai, London, Paris and New York
There are also closed-end funds (CEF's) and exchange-traded notes
(ETN's) that aim to track the gold price.



Any government or corporation requires capital (funds) to finance its

operations and to engage in its own long-term investments. To do this,
a company raises money through the sale of securities - stocks and
bonds in the company's name. These are bought and sold in the capital

Thus there are two types of capital market as follows:

Debt or Bond Market

Stock or Equity Market

5.1.A. Debt or Bond Market

The bond market (also known as the debt, credit, or fixed income
market) is a financial market where participants buy and sell debt
securities, usually in the form of bonds.

References to the "bond market" usually refer to the

government bond market, because of its size, liquidity, lack of credit
risk and, therefore, sensitivity to interest rates.

The stock of listed non-public-sector debt in India is currently

estimated at about USD 21 billion, or about 2% of GDP, just a fraction
of the public-sector debt outstanding (around 35% of GDP), or the
equity market capitalisation (now close to 100% of GDP).

To strengthen the Indian financial systems it is now

pertinent to develop the environment for corporate debt market in

5.1.B. Types of Bond Market in India

Corporate Bond Market

Municipal Bond Market

Government and Agency Bond Market

Funding Bond Market

Mortgage Backed and Collateral Debt Obligation Bond Market

5.1.C. Types of Debt Instruments

There are various types of debt instruments available that one can find
in Indian debt market.

Government Securities:

It is the Reserve Bank of India that issues Government Securities or

G-Secs on behalf of the Government of India. These securities have a
maturity period of 1 to 30 years. G-Secs offer fixed interest rate, where
interests are payable semi-annually.

Corporate Bonds:

These bonds come from PSUs and private corporations and are
offered for an extensive range of tenures up to 15 years. Comparing to
G-Secs, corporate bonds carry higher risks, which depend upon the
corporation, the industry where the corporation is currently operating,
the current market conditions, and the rating of the corporation.
However, these bonds also give higher returns than the G-Secs.

Certificate of Deposit:

These are negotiable money market instruments. Certificate of

Deposits (CDs), which usually offer higher returns than Bank term
deposits, are issued in Demat form and also as a Usance Promissory
Notes. There are several institutions that can issue CDs. Banks can
offer CDs which have maturity between 7 days and 1 year. CDs from
financial institutions have maturity between 1 and 3 years. There are
some agencies like ICRA, FITCH, CARE, CRISIL etc. that offer ratings
of CDs. CDs are available in the denominations of ` 1 Lac and in
multiple of that.
Commercial Papers:

There are short term securities with maturity of 7 to 365 days. CPs is
issued by corporate entities at a discount to face value.

Zero Coupon bonds (ZCBs):

ZCBs are available at a discount to their face value. There is no

interest paid on these instruments but on maturity the face value is
redeemed from the RBI. A bond of face value 100 will be available at a
discount say at Rs 80 and the date of maturity is after two years. This
implies an interest rate on the instrument. When the bonds are
redeemed Rs 100 will be paid. The securities do not carry any coupon
or interest rate i.e. unlike dated securities no interest is paid out every
year. When the bond matures the face value is returned. The
difference between the issue price (discounted price) and face value is
the return on this security.

5.1.D. Recent developments in the corporate debt market in India

In the recent past, the corporate debt market has seen a high growth
of innovative asset-backed securities. The servicing of debt and
related obligations for such instruments is backed by some sort of
financial assets and/or credit support from a third party. Over theyears
greater innovation has been witnessed in the corporate bond
issuances, like floating rate instruments, zero coupon bonds,
convertible bonds, callable (put-able) bonds and stepredemption

5.1.E. Advantages of debt market

The biggest advantage of investing in Indian debt market is its assured

returns. The returns that the market offer is almost risk-free (though
there is always certain amount of risks, however the trend says that
return is almost assured). Safer are the government securities. On the
other hand, there are certain amounts of risks in the corporate, FI and
PSU debt instruments. However, investors can take help from the
credit rating agencies which rate those debt instruments.
Another advantage of investing in India debt market is its high
liquidity. Banks offer easy loans to the investors against government

5.1.G. Disadvantages of debt market

As the returns here are risk free, those are not as high as the equities
market at the same time. So, at one hand we are getting assured
returns, but on the other hand, we are getting less return at the same
time. Retail participation is also very less here, though increased

5.1.F. Different types of risks with regard to debt securities

Default Risk:

This can be defined as the risk that an issuer of a bond may be unable
to make timely payment of interest or principal on a debt security or to
otherwise comply with the provisions of a bond indenture and is also
referred to as credit risk.

Interest Rate Risk:

It can be defined as the risk emerging from an adverse change in the

interest rate prevalent in the market so as to affect the yield on the
existing instruments. A good case would be an upswing in the
prevailing interest rate scenario leading to a situation where the
investors money is locked at lower rates whereas if he had waited
and invested in the changed interest rate scenario, he would have
earned more.

Reinvestment Rate Risk:

It can be defined as the probability of a fall in the interest rate

resulting in a lack of options to invest the interest received at regular
intervals at higher rates at comparable rates in the market.

Counter Party Risk:

It is the normal risk associated with any transaction and refers to the
failure or inability of the opposite party to the contract to deliver either
the promised security or the sale value at the time of settlement.

Price Risk:

Refers to the possibility of not being able to receive the expected

price on any order due to an adverse movement in the prices.

5.2.A. Equity or Stock Market

A stock market or equity market is a public market (a loose network

of economic transactions, not a physical facility or discrete entity) for
the trading of company stock and derivatives at an agreed price;
these are securities listed on a stock exchange as well as those only
traded privately.

The size of the world stock market was estimated at about

36.6 trillion USD at the beginning of October 2012. The total world
derivatives market has been estimated at about $791 trillion face or
nominal value, 11 times the size of the entire world economy. The
value of the derivatives market, because it is stated in terms of
notional values, cannot be directly compared to a stock or a fixed
income security, which traditionally refers to an actual value.
Moreover, the vast majority of derivatives 'cancel' each other out (i.e.,
a derivative 'bet' on an event occurring is offset by a comparable
derivative 'bet' on the event not occurring). Many such relatively
illiquid securities are valued as marked to model, rather than an
actual market price.

5.2.B. Trading

Participants in the stock market range from small individual stock

investors to large hedge fund traders, who can be based anywhere.
Their orders usually end up with a professional at a stock exchange,
who executes the order.

5.2.C. Market participants

A few decades ago, worldwide, buyers and sellers were individual
investors, such as wealthy businessmen, with long family histories
(and emotional ties) to particular corporations. Over time, markets
have become more "institutionalized"; buyers and sellers are largely
institutions (e.g., pension funds, insurance companies, mutual funds,
index funds, exchange-traded funds, hedge funds, investor groups,
banks and various other financial institutions). The rise of the
institutional investor has brought with it some improvements in market
operations. Thus, the government was responsible for "fixed" (and
exorbitant) fees being markedly reduced for the 'small' investor, but
only after the large institutions had managed to break the brokers'
solid front on fees.