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Unit III Capital market

Meaning and concept of capital

• Capital Market is one of the significant aspect of every financial market.
Hence it is necessary to study its correct meaning. Broadly speaking the
capital market is a market for financial assets which have a long or
indefinite maturity.
• Unlike money market instruments the capital market instruments become
mature for the period above one year. It is an institutional arrangement to
borrow and lend money for a longer period of time. It consists of financial
institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of
lenders in the capital market.
• Business units and corporate are the borrowers in the capital market.
Capital market involves various instruments which can be used for
financial transactions. Capital market provides long term debt and equity
finance for the government and the corporate sector.
• Capital market can be classified into primary and secondary markets. The
primary market is a market for new shares, where as in the secondary
market the existing securities are traded.
Definition of capital market
• “ It is a market for long term funds. It focuses on
financing of fixed investment in contrast to
money market which is institutional source of
working capital finance” M.Y khan
• “ The capital market is a market for long term
funds. Capital markets discharge the important
functions of transfer of savings especially of the
household sectors to companies, governments
and public sector bodies” HR. Machiraju
Capital market structure in india
Functions of capital market
• Mobilization of Savings : Capital market is an
important source for mobilizing idle savings from the
economy. It mobilizes funds from people for further
investments in the productive channels of an economy.
In that sense it activate the ideal monetary resources
and puts them in proper investments.
• Capital Formation : Capital market helps in capital
formation. Capital formation is net addition to the
existing stock of capital in the economy. Through
mobilization of ideal resources it generates savings; the
mobilized savings are made available to various
segments such as agriculture, infrastructure etc.
• Provision of Investment Avenue : Capital market raises
resources for longer periods of time. Thus it provides an
investment avenue for people who wish to invest resources
for a long period of time. It provides suitable interest rate
returns also to investors. Instruments such as bonds,
equities, units of mutual funds, insurance policies, etc.
definitely provides diverse investment avenue for the
• Speed up Economic Growth and Development : Capital
market enhances production and productivity in the
national economy. As it makes funds available for long
period of time, the financial requirements of business
houses are met by the capital market. It helps in research
and development.
• Service Provision : As an important financial set
up capital market provides various types of
services. It includes long term and medium term
loans to industry, underwriting services,
consultancy services, export finance, etc.
• Proper Regulation of Funds : Capital markets not
only helps in fund mobilization, but it also helps
in proper allocation of these resources. It can
have regulation over the resources so that it can
direct funds in a qualitative manner.
• Continuous Availability of Funds : Capital
market is place where the investment avenue
is continuously available for long term
investment. This is a liquid market as it makes
fund available on continues basis. Both buyers
and seller can easily buy and sell securities as
they are continuously available.
Book building process
• it is a process used in IPOs for efficient price discovery. The price at which
securities would be offered is not known initially. It is known only after the closure
of the book building process. It is a common method of marketing of new issues in
several developed countries. In book building method, the market discovers the
price instead of the company determining the price.
• No price is fixed for the shares; instead, the company fixes a price band at which a
share can be sold. The maximum price cannot be more than 120% of the floor
price. Bids are then invited for the shares. The IPO should be kept open for a
minimum of three days and bids are invited during this period. Investors can bid at
the floor price or within the price band. The actual price of the share is arrived at
depending on the number of bids (depending on the price band) received from
• The Lead Manager known as the Book runner determines the level of interest from
investors at various price levels and obtains commitments. As the book is being
built, the demand at various prices can be known and investors can submit their
bids accordingly.
• Bids are collected from investors during the IPO period. The bids may be above or
at the floor price. The offer price is then finalized based on the bids received and is
fixed after the bid closing date.
Structure of book building in india
Process of Book Building
Features of primary markets include:

• the securities are issued by the company directly

to the investors.
• The company receives the money and issues new
securities to the investors.
• The primary markets are used by companies for
the purpose of setting up new
• ventures/ business or for expanding or
modernizing the existing business
• Primary market performs the crucial function of
facilitating capital formation in the economy
Advantages :-
• 1. Mobilisation of savings
• 2. Channelising savings for productive use
• 3. Source of large supply of funds
• 4. Rapid Industrial growth due to increase in
production and productivity in the economy.
Disadvantages :-
• 1. Possibility of deceiving investors
• 2. No fixed norms for project appraisal
• 3. Lack of post issue seriousness eg. Facebook
• 4. Ineffective role of merchant bankers
• 5. Delay in allotment process
Methods of issuing securities in the
primary market are
• Initial public offering;
• Rights issue (for existing companies)
• Preferential issue.
• Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or
an offer for sale of its existing securities or both for the first time to the public. This paves way for
listing and trading of the issuer’s securities.

• A Further public offering (FPO) is when an already listed company makes either a fresh issue of
securities to the public or an offer for sale to the public, through an offer document. An offer for
sale in such scenario is allowed only if it is made to satisfy listing or continuous listing obligations.

• Rights Issue (RI) is when a listed company which proposes to issue fresh securities to its existing
shareholders as on a record date. The rights are normally offered in a particular ratio to the number
of securities held prior to the issue. This route is best suited for companies who would like to raise
capital without diluting stake of its existing shareholders unless they do not intend to subscribe to
their entitlements.

• A private placement is an issue of shares or of convertible securities by a company to a select
group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a
public issue. This is a faster way for a company to raise equity capital.

• A Qualified Institutions Placement is a private placement of equity shares or securities convertible
in to equity shares by a listed company to Qualified Institutions Buyers only in terms of provisions
of Chapter XIIIA of SEBI (DIP) guidelines. The Chapter contains provisions relating to pricing,
disclosures, currency of instruments etc.
• Definition: Preferential Allotment is the process by which allotment of securities/shares is done on
a preferential basis to a select group of investors.
Factors to be considered by investors

• Promoters
• Credibility
• Project Details
• Product
• Financial data
• Risk factors
• Auditors report
Intermediaries in primary market
• Merchant Bankers: In modern times, importance of
merchant banker is very much, because it the key
intermediary between the company and issue of
capital. Main activities of the merchant bankers are –
determining the composition of the capital structure,
drafting of prospectus and application forms,
compliance with procedural formalities, appointment
of registrars to deal with the share application and
transfer, listing of securities, arrangement of
underwriting / sub-underwriting, placing of issues,
selection of brokers, bankers to the issue, publicity and
advertising agents, printers and so on.
• Underwriters
• Another important intermediary in the new issue/
primary market is the underwriters to issue of capital
who agree to take up securities which are not fully
subscribed. They make a commitment to get the issue
subscribed either by others or by themselves. Though
underwriting is not mandatory after April 1995, its
organization is an important element of primary
market. Underwriters are appointed by the issuing
companies in consultation with the lead managers /
merchant bankers to the issues
• Bankers to an Issue: The bankers to an issue are
engaged in activities such as acceptance of applications
along with application money from the investor in
respect of capital and refund of application money.
• Brokers to the Issue: Brokers are persons mainly
concerned with the procurement of subscription to the
issue from the prospective investors. The appointment
of brokers is not compulsory and the companies are
free to appoint any number of brokers. The managers
to the issue and the official brokers organize the
preliminary distribution of securities and procure direct
subscription from as large or as wide a circle of
investors as possible.
• Registrars to an Issue and Share Transfer Agents: The
registrars to an issue, as an intermediary in the primary
market, carry on activities such as collecting
applications from the investors, keeping a proper
record of applications and money received from the
investors or paid to the sellers of securities and
assisting companies in determining the basis of
allotment of securities in consultation with the stock
exchanges, finalizing the allotment of securities and
processing / dispatching allotment letters, refund
orders, certificates and other related documents in
respect of the issue of capital.
• Debenture Trustees
• A debenture trustee is a trustee for a trust deed
needed for securing any issue of debentures by a
company. To act as a debenture trustee a
certificate from the SEBI is necessary. Only
scheduled commercial banks, PFIs, Insurance
companies and companies are entitled to act as a
debenture trustees. The certificate of registration
is granted to suitable applicants with adequate
infrastructure, qualified manpower and requisite
• Portfolio Managers
• Portfolio manager are defined as persons who in pursuance
of a contract with clients, advise, direct, undertake on their
behalf the management/ administration of portfolio of
securities/ funds of clients. The term portfolio means the
total holdings of securities belonging to any person. The
portfolio management can be (i) Discretionary or (ii) Non-
discretionary. The first type of portfolio management
permits the exercise of discretion in regard to investment /
management of the portfolio of the securities / funds. In
order to carry on portfolio services, a certificate of
registration from SEBI is mandatory.
Factors affecting capital market in
India :-
• a)Performance of domestic companies:-
• The performance of the companies or rather corporate earnings is one of the
factors which has 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 which 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.
• b)Environmental Factors :-
• Environmental Factor in India’s 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.
• c)Macro Economic Numbers :-
• The macro economic numbers also influence the capital
market. It includes Index of Industrial Production (IIP) which
is released every month, annual Inflation numberindicated
by Wholesale Price Index (WPI) which is released every
week, Export –Import numbers which are declared every
month, Core Industries growth rate ( Itincludes Six Core
infrastructure industries – Coal, Crude oil, refining, power,
cementand finished steel) which comes out every month,
etc. This macro –economicindicators indicate the state of
the economy and the direction in which the economyis
headed and therefore impacts the capital market in India