Corporate Finance Project

On

Capital Market: An overview

Submitted to:

Dr. Y. Papa rao

Faculty, Corporate Finance
By:

Kshitij Nawarang

Roll no. 88

Section B

Semester VII, B.A. LLB(Hons.)

Submitted on:

October 25, 2018

Hidayatullah National Law University

Uparwara Post, Abhanpur, New Raipur – 493661 (C.G.)

1
 Acknowledgements
I feel elated to work on the project “Capital market: An overview”. The practical
realisation of the project has obligated the assistance of many Persons. Firstly I
express my deepest gratitude towards Dr. Y. PapaRao, Faculty of Corporate
Finance, to provide me with the opportunity to work on this project. His able
guidance and supervision were of extreme help in understanding and carrying out
the nuances of this project.

I would also like to thank The University and the Vice Chancellor for providing
extensive database resources in the library and for the internet facilities provided by the
University.

Some printing errors might have crept in which are deeply regretted. I would
be grateful to receive comments and suggestions to further improve this project.

Kshitij Nawarang

Roll No. 88

Section B, Semester VII

2
 Contents

ACKNOWLEDGEMENT……………………………………………………………………….2

Chapter-1: INTRODUCTION…………………………………………………………..….....4

Objectives…………………………………………………………..……..5

Research methodology …………………….…..……………….………....5

Scope and limitation ……………… ………………..…….………5

Organization of study …………………………………….….……5

Mode of citation ………………………………………….….…..5

Chapter-2: Definition and types ………………….………..………..……..6

Chapter-3: Significance and Various Instruments…………………….…11

Chapter-4: Regulation of market ………………………………………….13

Conclusion ……………………………………………………………..….15

References…………………………………………………………………16

3
 Introduction
Financial market is a market where financial instruments are exchanged or traded and helps in
determining the prices of the assets that are traded in and is also called the price discovery
process.

(a) Organizations that facilitate the trade in financial products.

(b) Coming together of buyer and sellers at a common platform to trade financial
products is termed as financial markets, i.e. stocks and shares are traded between
buyers and sellers in a number of ways including: the use of stock exchanges; directly
between buyers and sellers etc.1

Financial markets may be classified on the basis of:

• Types of claims – debt and equity mark

• Maturity – money market and capital market

• Trade – spot market and delivery market

• Deals in financial claims – primary market and secondary market

Indian Financial Market consists of the following markets:

• Capital Market/ Securities Market

Primary capital market

Secondary capital market

• Money Market

• Debt Market

The capital market is a vital of the financial system. Capital market provides the support of
capitalism to the country. The wave of economic reforms initiated by the government
has influenced the functioning and governance of the capital market. Capital market concerned
with the industrial security market, government securities markets, and long term loan market

The capital market is source of income for investors. When stock of other financial assets rise
in value, investors become wealthier, often they spend some of this additional wealth boost
sales and promoting economic growth.

1
Dr. G. Ramesh Babu, “The Financial Services In India”, New-Delhi, Concept Publishing Company. Year 2005

4
 RESEARCH METHODOLOGY
This Research Project is doctrinal in nature. Accumulation of the information on the topic includes
wide use of primary sources such as cases as well as secondary sources like books, e-articles etc. The
matter from these sources have been compiled and analysed to understand the concept and
reproduced it afresh in this project.

Websites, dictionary and articles have also been referred.

OBJECTIVES
The following are the objectives of this project:

1. To discuss the idea of capital market

2. To discuss the significance and instruments of capital market.

SCOPE OF THE STUDY

Due to time constraint this project aims to cover the idea about capital market. Its
significance, various instruments and regulation This project does not cover in detail
each mode. The project report is descriptive.

ORGANIZATION OF STUDY
In the first section there is Introduction. In second section there definition of capital market and
it’s type. In third I deal with significance and regulation of market. The fourth is about the
conclusion.

MODE OF CITATION
The mode of citation of this project is bluebook 19th Edition Citation format for footnotes and
bibliography.

5
The capital market is a place where people buy and sell securities. Securities in this sense is
simply a bundle of rights sold to the public by companies, authorities or institutions on which
people then trade in the capital market.2

According to Arun K. Datta, The capital market may be define as “ The capital market is a
complex of institutions investment and practices wit established links between the demand
for and supply of different types of capital gains”.

Capital market defined as “The market for relatively long-term financial instruments. It
consists of gilt edged market and the industrial securities market. The gilt edged market refers
to the market for government and semi-government securities backed by the RBI. The
securities traded in this market are stable in value and are much sought after by banks and other
institutions”.

According to F. Livingston defined the capital market as “In a developing economy, it is the
business of the capital market to facilitate the main stream of command over capital to the point
of the highest yield. By doing so it enables control over resources to pass into hands of those
who can employ them most effectively thereby increasing productive capacity and spelling
the national dividend”.

As per above definitions, meaning of capital market as follow:

1. The capital market is the market for securities, where companies and governments
can raise long-terms funds.

2. The market in which corporate equity and loner-term debt securities those maturing
in more than one year are issued and traded.

3. The capital market is market for long-term debt equity shares. In this market, the capital
funds comprising of both equity and debt are issued and traded.

4. The market in which long-term securities such as stocks and bonds are bought and sold.

5. The capital market comprises financial securities, government securities, semi-government

securities.

6. The capital market concerns two broad types of securities traded, debts and equity. Buying
stock allows investors to gain an equity interest in the company and become owner.

2
Developments of Capital Market In India At London School Of Economics On 2nd October, 2006.By G N
Bajpai

6
Types of Capital Market -The capital market has two interdependent and inseparable
segments, the primary market and stock (secondary market).

Primary Capital Market

The primary capital market is a market for new or fresh issues. It deals to the long-term flow
of fund from the surplus sector to the government and corporate sector through primary
issues and to banks and non-bank financial intermediary secondary issues, primary issues of the
corporate sector lead to capital formation. The Primary market for securities is the new issues
market which brings together the “supply and demand” or “sources and uses” for new capital
funds. The company will usually issue only primary shares, but may also sell secondary
shares. Typically, a company will hire an investment banker to underwrite the offering
and a corporate lawyer to assist in the drafting of the prospectus. The sale of stock is regulated
by authorities of financial supervision and where relevant by a stock exchange. It is usually a
requirement that disclosure of the financial situation and prospects of a company be made to
prospective investors.3

The issue of securities by companies can take place in any of the following methods:-

a. Initial public offer (securities issued for the first time to the public by the company;

b. Further issue of capital;

c. Rights issue to the existing shareholder (on their renunciation, the shares can be sold by the
company to others also);

d. Offer to public

e. Bonus Issue.

Secondary Capital Market

The secondary market also called "aftermarket” is the financial market for trading of
securities that have already been issued in its initial private or public offering. Stock
exchanges are examples of secondary markets. Alternatively, secondary market can refer to the
market for any kind of used goods. Secondary market is also called share market. Share market
includes exchange of those securities which are already sold and listed in the Primary
market. Any transaction in the share market can be executed by the members of the exchange

3
Dr. S. Guruswami, “Capital Market”, The Mcgraw-Hill, Company, 2nd Edition, Year- 2010, Chapter-3

7
keeping in mind the rules and regulations of the SEBI. If any normal investor wants to buy or
sell any security then he or she will have to contact with any broker of the exchange. Then the
broker shall buy or sell the contemplated security on behalf of the investor and thus will be
entitled to a certain brokerage The secondary capital market is market where outstanding or
exciting securities are traded. An equity instrument being an external fund provides an all- time
market while a debt instrument, with a defined maturity period, is traded at the secondary
market till maturity. Unlike primary issues in the primary market which result in capital
formulation the secondary market facilitates only liquidity and marketability of outstanding
debt and equity instruments. The secondary market also provides instant valuation of
securities made possible by changes in the internal environment that is, companywide
and industry wide facilities the measurement of the cost of capital and rate of return of economic
entities at the micro level. The Indian secondary capital market classify into two ways as follow:

1. Secondary capital market for corporate and financial intermediaries.

2. Secondary capital market for government securities and public sector bonds.

Instruments of Capital market

Classification of Instruments can be classified into three categories: 1. Pure, 2. Hybrid, and 3.
Derivatives.

Pure instruments: Pure instruments can be classified into Equity Shares, preference shares and
debentures/ bonds which were issued with their basic characteristics in tact without
mixing features of other classes of instruments are called Pure instruments

Equity shares- equity shares commonly referred to as ordinary share also represents the form
of fractional ownership in which a shareholder, as a fractional owner, undertake the
maximum entrepreneurial risk associated with business a business venture. The holder
of such shares is member of the company and has voting rights. A company may issue shares
with differential rights as to voting, payment of dividend etc.

Preference shares- Owners of this kind 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 shares. They also enjoyed privity over the equity shareholders in payment of
surplus. But in the event of liquidation their claims rank below the claims of company's

8
creditors, bondholders/ debenture holders. Following kinds of preference shares are dealt
with by the companies-

a). Cumulative preference shares- In the case of this type of share the dividend payable
every year becomes a first claim while declaring dividend by the company. In case the
company does not want to pay preference dividend, it gets accumulated for being paid
subsequently.

b). Non cumulative preference shares- In the case of these shares, dividend does not
accumulate. If there are no profits or the profits are inadequate in any year, the shares are not
entitled to any dividend for that year. Unless there is a specific provision in the Articles of
Association of the company.

c). Convertible preference share- If the term of issue of preference shares includes a right for
converting them into equity shares at the end of a specified period they are called convertible
preference shares.

d). Redeemable preference shares- If the articles of a company so authorize, redeemable

preference shares can be issued. This in contrast to the principle that the company normally can
not redeem or buy back its own shares vide section 77 of the companies act, 1956, except by
following the procedure for reduction of capital and getting the sanction of the high court in
pursuance of sections 100 to 104 or section 402 of the companies act.

e). Irredeemable preference shares- If the terms of issue provide that the preference shares are
not redeemable except on the happening of 10 certain specified events which may not
happen for an indefinite period such as winding up, these are called irredeemable preference
shares.

f). Participating preference shares- Preference shareholders are not entitled to dividend more
than what has been indicated as part of the terms of issue, even in a year in which
the company has mad huge profits. Subjects to provision in the terms of issue these shares can
be entitled to participate in the surplus profits left, after payment of dividend to the preference
and the equity shareholders to the extent provided therein.

g). Non participating preference shares- Unless the terms of issue indicate specifically
otherwise, all preference shares are to be regarded as non participating preference shares.

9
Debenture4 - Debenture includes debenture stock, bonds and any other securities of a
company, whether constituting a charge on the assets of the company or not. Debenture is a
documents evidencing a debt or acknowledging it. Debentures are issued in the following
forms:-

(a) Naked or unsecured debentures – Debentures of this kind do not carry any charge on
the assets of the company.
(b) Secured Debentures- Debentures that are secured by a mortgage of the whole or part
of the assets of the company are called mortgage debentures of secured debentures.

(c) Redeemable Debentures- Debentures that are redeemable on expiry of certain period
are called redeemable debentures. Such debentures after redemption can be reissued
in accordance with the provisions of section 121 of the Companies act 1956.

(d) Perpetual Debentures- If the debentures are issued subject to redemption on the
happening of specified events which may not happen or an indefinite period, i.e. winding
up, they are called perpetual debentures.

(e) Bearer Debentures – Such debentures are payable to bearer and are transferable by mere
delivery. The name of the debenture holder is not registered the books of the
company, but the holder is entitled to claim interest and principal as and when due.

(f) Registered debentures- Such debentures are payable to the registered holders whose
name appears on the debentures certificate / letter of allotment and is registered on the
companies register of debenture holder maintained as per section 152 of the Companies Act,
1956. Based on convertibility, debentures can be classified under three categories-

(g) Fully convertible debentures (FCDs)- These are converted into equity shares of the
company with or without premium as per terms of the issue on the expiry of specified period
or periods.

(h) Non Convertible Debentures (NCDs) – These debentures do not carry the option of
conversion into equity shares and are therefore redeemed on the expiry of the specified
period or periods.

4
Section 2 (12) of the companies Act, 1956

10
 (i) Partly Convertible Debentures (PCDs)- These may consist of two kinds namely-
convertible and non convertible. The convertible portion is to be converted into
equity shares at the expiry of specified period.

Hybrid Instruments- Hybrid instruments are those which are created by combining the
features of equity with bond, preference and equity etc. Examples of hybrid instruments are :
Convertible Preference shares, Cumulative convertible preference shares, non convertible
debentures with equity warrants, partly convertible debentures, partly convertible with
Khokha (buy back arrangement) , optionally convertible debenture, warrants convertible into
debentures or shares, secured premium notes with warrants etc.

Secured premium notes- These instruments are issued with detachable warrants and are
redeemable after a notified period say 4 to 7 years. The warrants enable the holder to get
equity shares allotted provided the secured premium notes are fully paid. During the lock in
period no interest is paid. The holder has an option to sell back the SPN to the
company at par value after the lock in period.

Equity shares with Detachable Warrants- Essar Gujarat, Ranbaxy and Reliance issued
this type of instrument. The holder of the warrant is eligible to apply for the specified
number of shares on the appointed date at the predetermined price. These warrants are
separately registered with the stock exchanges and traded separately. The practice of
issuing non convertible debentures with detachable warrants also exists in the Indian
market. Reliance has used this method.

Deep Discount bond- IDBI and SIDBI had issued this type of instrument. For a
deep discount price of Rs. 2700/- in IDBI the investor got a bond with face value
of Rs.
100000/-. The bond appreciates to its face value over the maturity period of 25
years. Alternatively, the investor can withdraw from the investment periodically after 5
years.

Tracking Stocks – Dr. JJ Irani Expert Committee constituted by the Government to make
recommendation on the Concept Paper on Company Law has recommended in its report for
the introduction of ‘Tracking Stocks’ in the Indian Capital Market. A Tracking stock is a
type of common stock that “tracks” or depends on the financial performance of a
specific business unit or operating division of a company, rather than the operations of the
company as a whole. As a result, if the unit or division performs well, the value of the
tracking stocks may increase, even if the company’s performance as a whole is not up to
mark or satisfactory. The opposite may also be true.
Derivatives- Derivatives are contracts which derive their value from the value of one or more of
others assets. A derivative is a financial instrument, whose value depends on the values of basic
underlying variable. In the sense, derivatives is a financial instrument that offers return based on
the return of some other underlying asset, i.e the return is derived from another instrument.

Major types of derivatives Derivative contracts have several variants. Depending upon
the market in which they are traded, derivatives are classified as 1) exchange traded and 2) over
the counter. The most common variants are forwards, futures, options and swaps.

Forward contract is a customized contract between two entities, where settlement takes place
as a specific date in the future at today’s predetermined price.

Options are of two types – call and put. Calls give the buyer the right but not the obligation to
buy a given quantity of the underlying asset, at a given price on or before a given future date.
Puts give the buyer the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.

Warrants are options generally have maturity period of three months, majority of options
that are traded on exchanges have maximum maturity of nine months. Longer-traded options
are called warrants and are generally traded over-the-counter.

Swaps are private agreement between two parties to exchange cash flows in the future
according to a pre-arranged formula. They can be regarded as portfolio of forward contracts.

Significance of Capital Markets

A well functioning stock market may help the development process in an economy through the
following channels:

1. Growth of savings,

2. Efficient allocation of investment resources,

3. Better utilization of the existing resources.

12
In market economy like India, financial market institutions provide the avenue by which
long-term savings are mobilized and channelled into investments. Confidence of the investors
in the market is imperative for the growth and development of the market. For any
stock market, the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy. Stock index is created to provide investors
with the information regarding the average share price in the stock market. The ups and downs
in the index represent the movement of the equity market. These indices need to represent the
return obtained by typical portfolios in the country. Generally, the stock price of any company
is vulnerable to three types of news: • Company specific • Industry specific • Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels out the
stock and sector specific news and events that affect stock prices, (law of portfolio
diversification) and reflect the overall performance of the company/equity market and
the news affecting it. The most important use of an equity market index is as a benchmark for
a portfolio of stocks. All diversified portfolios, belonging either to retail investors or
mutual funds, use the common stock index as a yardstick for their returns. Indices are
useful in modern financial application of derivatives.

Regulations of the Capital Market

Securities and Exchange Board of India (SEBI) was set up as an administrative arrangement in
1988.In 1992, the SEBI Act was enacted, which gave statutory status to SEBI. It mandates SEBI
to perform a dual function: investor protection through regulation of the securities market
and fostering the development of this market. SEBI has been vested most of the functions
and powers under the Securities Contract Regulation (SCR) Act, which brought stock
exchanges, their members, as well as contracts in securities which could be traded under
the regulations of the Ministry of Finance. It has also been delegated certain powers under the
Companies Act. In addition to registering and regulating intermediaries, service providers,
mutual funds, collective investment schemes, venture capital funds and takeovers, SEBI is also
vested with the power to issue directives to any person(s) related to the securities market or to
companies in areas of issue of capital, transfer of securities and disclosures. It also has powers
to inspect books and records, suspend registered entities and cancel
registration.

13
 The securities market is regulated by various agencies such as the Department of Economic
Affairs (DEA), The Department of company affairs (DCA), the Reserve Bank of India and the
SEBI. The activities of these agencies are coordinated by a high level committee on
capital and financial markets.

The capital market for equity and debt securities is regulated by the Securities and
Exchange Board of India. The SEBI has full autonomy and authority to regulate and develop
the capital market. The government has framed rules under the Securities Contracts Act
(SCRA), the SEBI Act and the Depositories Act. The power in respect of the contracts for sales
and purchase of government securities, money market securities and ready forward
contracts in debt securities are exercised concurrently by the RBI. The four main legislations
governing the capital market are as follows:

1. The SEBI Act, 1992 which establishes the SEBI with four fold objectives of protection of
the interests of investors in securities, development of the securities market, regulation of the
securities market and matter connected therewith and incidental thereto.

2. The Companies Act, 1956 which deals with issue, allotment and transfer of transfer
of securities, disclosures to be made in public issues, underwriting, rights and bonus issues and
payment of interest and dividends.

3. The Securities Contracts Regulation Act, 1956 which provides for regulations of securities
trading and the management of stock exchanges.

4. The Depositories Act, 1996 which provides for establishment of depositories for electronic
maintenance and transfer of ownership of demat securities.

14
 Conclusion

The capital market is a place where the suppliers and users of capital meet to share
one another’s views, and where a balance is sought to be achieved among diverse market
participants. Examples of capital markets are markets for buying and selling stocks and
bonds. They include primary markets, where newly issued stocks and bonds are sold to
investors, and secondary markets in which existing stocks and bonds are traded. Capital
markets play an important role in the economy. Through primary capital markets, businesses
and entrepreneurs can issue stocks and bonds to raise financial capital to start or expand
businesses. Through both the primary and the secondary capital markets, savers are able to buy
financial assets from which they hope to gain returns and build wealth. A stock is a share of
ownership in a company. A bond is a certificate of indebtedness issued by a government or
corporation. The lack of an advanced and vibrant capital market can lead to underutilization of
financial resources. The developed capital market also provides access to the foreign
capital for domestic industry. Thus capital market definitely plays a constructive role in the
over all development of an economy.

15
 References

Books

1. Bharti V. Pathak, “The Indian Financial System”, Pearson Education [India] Ltd. 2nd
Edition, Year 2006 Pg. 102-104.
2. Dr. G. Ramesh Babu, “The Financial Services In India”, New-Delhi, Concept
Publishing Company. Year 2005 Pg. 45-46.
3. Dr. S. Guruswami, “Capital Market”, The Mcgraw-Hill, Company, 2nd Edition, Year-
2010, Chapter-3, Page No 47-48.
4. Gaurav Akrani, Economics, Study Notes, What Is Capital Market?
Meaning,Functions And Role Date : 9/23/2010 01:06:00 PM IST, Http://Kalyan-
City.Blogspot.In/2010/09/What-Is-Capital-Market-Meaning.Html.
5. Reforms In Indian Capital Market” Presentation Of C.S. Mohapatra, Director, Capital
Market Devision Ministry Of Finance.

Websites

www.wekipidia.com
www.indiainfo.com
www.capitalmarket.com
www.bseindia.com

16