Capital Market

Unit II: Primary

Syllabus- Unit II
• Capital Market - Primary
• Capital Market: Meaning-Functions –Constituents –
classification.
• Primary Market: Meaning - Functions- Constituents-
Issue of securities- IPO, Private Placement-Right
Issue-Bonus Issue-Qualified Institutions Placement
(QIP) –IPO process-Book Building- Merchant Bankers-
Lead Managers- Prospectus –Types –Red Hiring
Prospectus- Price band- Determination of Price –
Allotment of Shares- Application Supported Blocked
Amount (ASBA)-
• Anchor Investor-Green Shoe Option - Listing of
Shares-Capital Market Instruments.
• Book (Indian financial system - Bharti Pathak)
 Capital Market
Meaning (Pg. 99)
• 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.
• Includes financial instruments with more than
one year maturity
 Nature of Capital Market
• It has two segments.
• It deals in long term securities.
• It perform trade off function.
• It creates dispersion in business ownership.
• It helps in capital formation.
• It helps in creating liquidity.
 Functions (Pg. 99)
• Mobilise long term savings to finance long term investments.
• Provide insurance against market risk and price risk.
• Provide liquidity with a mechanism enabling investors to sells
financial assets.
• Enable wider participation by enhancing the width of the
market.
• Improves efficiency of capital allocation through a competitive
pricing mechanism.
• Encourage broader ownership of productive assets.
• Direct the flow of funds into different channels through
Investment, disinvestment and reinvestment.
Constituents/Classification of Capital Market (Pg. 100-
101)

• Primary Market (Types)

• Secondary Market (Types)
 Secondary Market Instruments/Types

Ownership securities
• Equity shares
• Preference shares
Creditorship securities
• Debentures
• Bonds
Derivatives
 EQUITY SHARES

• It represents the owners capital in a company.

• The holders of these shares are the real owners of the
company.
• They have a control over the working of the company.
• They are paid dividend after paying it to the preference
shareholders.
• Rate of dividend depends upon the profits of the
company.
• Equity capital is paid after meeting all the
claims(including prf.shareholders)
 PREFERENCE SHARES
• Certain preferences as compared to other
type of shares.
• Preference over the payment of dividend.
• Preference in the repayment of capital during
liquidation.
• Fixed rate of dividend
• Do not have voting rights except if their own
rights are affected.
 TYPES OF PREFERENCE SHARES

• Convertible preference shares

• Non- Convertible preference shares
• Redeemable preference shares
• Irredeemable preference shares
• Participating preference shares
• Non-Participating preference shares
• Cumulative preference shares
• Non-Cumulative preference shares
• Convertible preference shares posses an option or right
whereby they can be converted into an ordinary equity
shares at some agreed terms and condition.
• Non-convertible simply does not have this option but
has all other normal characteristics of a preference share.
• Redeemable preference share is very commonly seen
preference share which has a maturity date on which
date the company will repay the capital amount to the
preference shareholders and discontinue the dividend
payment thereon.
• Irredeemable preference shares does not have any
maturity date which makes this instrument very similar
to equity except that the dividend of these shares is
fixed.
• Participating preference shares has an additional
benefit of participating in profits of the company
apart from the fixed dividend.
• Other preference shares who do not participate are
called non participating preference shares.
• If the shares are cumulative preference shares, the
dividends are accumulated and therefore paid before
anything paid to equity shareholders.
• Whereas, for non-cumulative preference shares, if
company does not pay dividend in current year, claim
of preference shareholder is lost to that extent.
 DEBENTURES and BONDS

• A debenture is an acknowledgement of debt.

• A debenture holder is creditor of company
• A fixed rate of interest is paid on debentures.
• Floating charge over the assets of company.
• Secured debentures are given priority over all
other creditors.
• Redeemable Debentures are issued for a fixed period.
• Principal amount of such debentures is paid off to the
debenture holders on the expiry of such period.
• Such debentures can be redeemed by annual drawings or
by purchasing from the open market.
• On the other hand, irredeemable Debentures are not
redeemed in the life time of the company.
• Such debentures are paid back only when the company
goes into liquidation.
• Convertible debenture holders have an option of
converting their holdings into equity shares.
• Non-convertible debentures are simple debentures with
no such option of getting converted into equity.
• Secured Debentures: These instruments are secured by a
charge on the fixed assets of the issuer company. So if the
issuer fails on payment of either the principal or interest
amount, his assets can be sold to repay the liability to the
investors.
• Unsecured Debentures: These instrument are unsecured in
the sense that if the issuer defaults on payment of the
interest or principal amount, the investor has to be along with
other unsecured creditors of the company.
• Coupon Rate Debentures are usually issued with a specified
rate of interest. This specified rate is called Coupon rate. It
may be either fixed or floating. The floating interest is usually
linked with the bank rate and yields on treasury bond plus a
reward for risk
• Zero Coupon
A zero coupon bond is one which does not carry a specified rate
of interest. In order to compensate the investors such bonds are
issued at a substantial discount .The difference between the face
value and issue price is the total amount of interest related to
the duration of the bond.
• Registered Debentures
These are debentures which are payable to the registered
holders. The names of the holders of these debentures appear
both on the debenture certificate and in the company’s register
of debenture holders.
• Bearer Debentures
Debentures which are payable to the bearer are called bearer
debentures .The names of the debenture holders are not
recorded in the register of debenture holders. They are treated
as negotiable instruments and as such they are transferable by
mere delivery.
Bond
• Bond are known as Fixed income securities because
you the exact amount of cash you will get if you hold
till maturity.
• Bond issued by Govt. municipality, (state and local
government), corporations.
• Bond pay interest every year.
• By purchasing debt (bond) an investor becomes
creditor to the corporation.
• A creditor has higher claim on asset than
stockholders if company goes bankrupt. The risk of
bankruptcy or non-payment by the issuer is called
“default risk “.
Derivatives
• A derivative is a financial instrument whose value is
derived from the value of another asset, which is known
as the underlying.
• When the price of the underlying changes, the value of
the derivative also changes.
• A Derivative is not a product. It is a contract that derives
its value from changes in the price of the underlying.
• Example :The value of a gold futures contract is derived
from the value of the underlying asset i.e. Gold.
• Types of derivatives: Forwards, Futures, options (only
futures and options are traded in Indian market), Swap.
Primary Market
 Meaning
• Primary Market is a Market for new issue of securities,
which are issued to public for first time.
• The company issues new shares and debentures for
collecting long term funds. The purchaser of new
shares and debentures may be businessmen,
customers of the company, employees of the company,
existing shareholders, etc.
• The issue of securities is made through the prospectus.
• Functioning of primary markets facilitates
the capital formation by channelizing of funds from
individual savers into proper productive investments.
 Functions
Role and functions of primary market are:
• Origination
• Underwriting
• Distribution
 ORIGINATION
• It refers to the work of investigation, analysis and
processing of new project proposals.
• It starts before an issue is actually floated in the
market.
• This function is done by merchant bankers who may
be commercial banks, all India financial institutions
or private firms.
• At present, financial institutions and private firms
also perform this service.
 UNDERWRITING
• It is an agreement whereby the underwriter promises
to subscribe to a specified number of shares or
debentures or a specified amount of stock in the event
of public not subscribing to the issue.
• If a part of share issues remains unsold, the
underwriter will buy the shares or else he is not liable.
• Thus, underwriting is a guarantee for marketability of
shares. There are two types of underwriters in India -
Institutional ( LIC, UTI, IDBI, ICICI) and Non-institutional
are brokers.
Distribution
• It is the function of sale of securities to
ultimate investors.
• This service is performed by brokers and
agents who maintain a regular and direct
contact with the ultimate investors.
 Types/Issue of securities (Pg.132-148)
• IPO (Initial Public Offer)
• Follow - on Public Offering (FPO)
• Private Placement
• Preferential Issue
• Right Issue
• Bonus Issue
• Qualified Institutions Placement (QIP)
 IPO (Initial Public Offer) (pg.132)
• Initial Public Offer (IPO), is the first sale of
shares by the privately owned company to the
public.
• Prospectus is a document that contains
information relating to the various aspects of
the issuing company. The document is
circulated to the public
• Two Types issue – Fixed Price and Book
Building method.
Fixed Price
• Under fixed price, the company going public determines a
fixed price at which its shares are offered to investors. The
investors know the share price before the company goes
public.
• Demand from the markets is only known once the issue is
closed. To partake in this IPO, the investor must pay the full
share price when making the application.
Book Building (Pg. 120-121) , 123(Determination of price), 126)
• Under book building, the company going public offers a
20% price band on shares to investors. Investors then bid on
the shares before the final price is settled once the bidding
has closed.
• Investors must specify the number of shares they want to buy
and how much they are willing to pay.
• The lowest share price is known as the floor price, while the
highest share price is known as the cap price. The final share
price is determined using investor bids.
• Allotment to IPO’s to various investor categories: In Case of
Book Built Issue and In Case of Fixed Price Issue(pg. 135)
Types of book building (pg. 127)
• Pure Auction is an additional method of book building in
which the bidders would be free to bid at any price above the
floor price and allotment would be on price priority basis and
at differential prices. This method can be used only for FPOs
• Reverse book building is a price-discovery mechanism for
companies who want to delist their shares or buy-back shares
from the shareholders
The Bidding Process
• The Issuer who is planning an IPO nominates a lead
merchant banker as a 'book runner'.
• The Issuer specifies the number of securities to be
issued and the price band for orders.
• The Issuer also appoints syndicate members with
whom orders can be placed by the investors.
• Investors place their order with a syndicate member
who inputs the orders into the 'electronic book'. This
process is called 'bidding' and is similar to open
auction.
• A Book should remain open for a minimum of 5 days.
• Bids cannot be entered less than the floor price.
• Bids can be revised by the bidder before the issue
closes.
• On the close of the book building period the
'book runner evaluates the bids on the basis of
the evaluation criteria which may include - Price
Aggression · Investor quality · Earliness of bids,
etc.
• The book runner and the company concludes the
final price at which it is willing to issue the stock
and allocation of securities.
• Generally, the numbers of shares are fixed; the
issue size gets frozen based on the price per
share discovered through the book building
process.
• Allocation of securities is made to the successful
bidders.
Follow - on Public Offering (FPO) (pg. 137)
• When a listed company comes out with a fresh issue of
shares or makes an offer for sale to the public to raise
funds it is known as FPO.
• FPO is the consequent issue to the public after initial
public offering (IPO). The word FPO came into news after
the YES Bank announcement to raise Rs. 2,000 crore
through FPO and debt.
• A company can either issue fresh securities or offer its
existing securities to public. However, if the same
company comes out with another issue to the public, the
second issue would be called an FPO. For instance, ICICI
Bank was a listed entity but came out with FPO of around
Rs 8,750-crore equity shares in July 2007.
 PRIVATE PLACEMENT (pg. 143)
• A company makes the offer of sale to individuals and
institution privately without the issue of a prospectus.
• The private placement route offers several advantages to
the issuer for raising resources.
• The time taken by, as well as the cost of issue for the
private placement route is much less for the issuer as
compared to the public and rights issues.
• Privately placed issues can be tailor-made to suit the
requirements of both the issuer and the investor, to give
them greater flexibility than public or rights issues.
• In India, privately placed securities are admitted for trading,
but are not listed. Banks do not trade these securities and
hold them till maturity. Hence, there is no secondary
market for such securities. There is not much depth in the
market as the number of investors is quite low.
Preferential Issue (pg. 147-148)
• A preferential issue is an issue of shares or of convertible
securities by listed companies to a select group of persons
under Section 81 of the Companies Act, 1956.
Preference for Preferential Issues:
• To enhance holding of promoters Can be pledged with banks
• Easier Norms
• Low cost
• Management control to institutional
• Investors
 RIGHT ISSUE (pg. 138
• According to the section 81 of the companies Act 1956, if
a public company wants to increase its subscribed capital
by allotment of further share after two years from the
date of its formation or one year from the date of its
allotment, whichever is earlier, should offer share first to
its existing shareholders in proportion to the share held
by them at the time of offer.
• When an existing company issue shares to its existing
shareholders in proportion to the number of share held
by them, it is known as Rights Issue
• Pg.139 Right issue vs public issue.
 BONUS SHARES
• Bonus shares are additional shares given to the
current shareholders without any additional cost,
based upon the number of shares that a
shareholder owns. These are company's
accumulated earnings which are not given out in
the form of dividends, but are converted into free
shares.
• If Investor “A” holds 200 shares of a company and
a company declares 4:1 bonus, that is for every
one share, he gets 4 shares for free. That is total
800 shares for free and his total holding will
increase to 1000 shares.
 QUALIFIED INSTITUTIONAL PLACEMENT (QIP)
(pg. 149-features)
• Qualified institutional placement (QIP) is simply
means whereby a listed company can issue equity
shares, fully and partly convertible debentures, or
any securities which are convertible to equity
shares to a Qualified Institutional Buyer (QIB).
• The Securities and Exchange Board of India (SEBI)
introduced the QIP process in 2006, to prevent
listed companies in India from developing an
excessive dependence on foreign capital.
Basic terms
• Offer document (Pg. 139)
• Listed company(Pg. 139)
• Offer for sale (Pg. 139)
• Public issue (Pg. 139)
• Issuer company (Pg. 139)
• Lock-in (pg.147)
• Promoter (pg.147)
Allotment/Allocation in Book Built Issue
In case an issuer company makes an issue of 100 per cent of
the net offer to public through 100 per cent book building
process:
• not less than 35 per cent of the net offer to the public
shall be available for allocation to retail individual
investors;
• not less than 15 per cent of the net offer to the public
shall be available for allocation to non institutional
investors i.e., investors other than retail individual
investors and qualified institutional buyers;
• not more than 50 per cent of the net offer to the public
shall be available for allocation to qualified institutional
buyers.
Conti..
Under Rule 19(2)(b) of Securities Contract (Regulation) Rules
1957 (issues for less than 25 per cent of the post-issue capital
of the company)
• 60 per cent mandatory allocation to qualified institutional
buyers,
• the percentage allocation to retail individual investors shall
be 30 per cent
• non-institutional investors, 10 per cent, respectively.
In an issue made through the book building process,
• the issuer may allocate up to 30 per cent of the portion
available for allocation to qualified institutional buyers to
an anchor investor.
• Out of the portion available for allocation to qualified
institutional buyers, 5 per cent shall be allocated
proportionately to mutual funds.
Instruments under international capital markets (pg. 161)
ADR/GDR
• There is no legal or technical difference between an ADR and a GDR. Dollar
denominated instrument listed on the New York Stock Exchange (NYSE)
and the NASDAQ (National Association of Securities Dealers Automated
Association) .
• It represent a certain number of equity shares and are quoted and traded
in dollar terms but the shares are denominated in rupees.
• The shares are issued by the issuing company to intermediary called
depository. The equity shares are registered in the name of depository and
who subsequently issues the GDR to the investors.
FCEB (Foreign currency exchangeable bond)
• FCEB is a foreign currency bond issued by an Indian company which is a
part of the promoter group of offered company and exchangeable into
equity shares of the offered company
Foreign Currency Convertible Bonds (pg. 167)
• FCCBs are bonds issued by Indian companies and subscribed to by a
non-resident in foreign currency.
• They carry a fixed interest or coupon rate and are convertible into a
certain number of ordinary shares at a preferred price.
• They are convertible into ordinary shares of the issuing company
either in whole, or in part, on the basis of any equity-related
warrants attached to the debt instruments.
• These bonds are listed and traded abroad.
External Commercial Borrowings (pg. 165)
• External Commercial Borrowings are borrowings raised from the
international markets by corporates.
• These overseas borrowings are governed by an ECB policy which is
administered by the finance ministry
• along with the RBI. Indian companies can access funds on a first-
come-first-serve basis within an overall
• limit set in the ECB guidelines.
 Prospectus
• A prospectus is a legal document issued by
companies that are offering securities
for sale.
• It contains information about the company's
financial status, business plan, recent
performance and other operating and
financial matters.
• Its purpose is to give potential investors the
ability to analyze the growth and profitability
prospects of the selling company.
 Types of Prospectus
• Red Herring Prospectus
• Abridged Prospectus
• Shelf Prospectus
• Deemed Prospectus
 Red Herring Prospectus
• A red herring is a preliminary prospectus filed
with the SEC (Securities and Exchange
Commission), usually in connection with an IPO—
excludes key details of the issue, such as price
and number of shares offered.
• The document states that a registration
statement has been filed with the SEC but is not
yet effective.
• Information in a red herring is subject to change
and the SEC merely ensures all proper
information is disclosed.
Abridged Prospectus
• According to Sec. 2(1) of the Companies Act of 1956, a
company cannot issue applications for issue of share or
debentures. It cannot do so if it does not contain the salient
features of the prospectus of the memorandum. This is known
as ‘abridged prospectus’. In other words ‘abridged prospectus’
is a one that contains the salient features of the
memorandum of the prospectus.
Deemed prospectus
• A prospectus that is deemed to have been made by the
issuer, though it is actually offered to the public by a third
party or the so-called issue house (Indian terminology).
The issuer saves the underwriting expenses in selling its
securities.
Shelf prospectus
• A prospectus that describes a set of unissued, but registered
securities. It is used in situations where securities are issued
in consecutive stages over a period of time because the size of
issue is too large (and funds to be raised are enormous,
making the filing of prospectus each time very expensive).
Later on, an issuer will only need to file the so- called
information memorandum with the relevant securities
commission
 Intermediaries to the Issue (pg. 118)
• Merchant Bankers
• Registrar to the Issue
• Bankers to the Issue
 Merchant Bankers
• Registered with SEBI as per SEBI Regulations 1992.
• Act as a book running lead managers (BRLM) to an
issue.
• Pre-issue and post-issue
• Pre-issue- due diligence of company operations,
management, business plan, legal, drafting and
designing offer documents, etc.
• With prescribed formalities with stock exchange and
registrar of companies (ROC)
• Post-issue- management of escrow accounts,
coordinating, coordination with registrar for
dispatching of funds, etc.
Registrar to the Issue
• To finalize the list of allottees
• Ensure crediting of shares in demat account of
allottees
Bankers to the Issue
• They are appointed in all mandatory collection
center, collecting application amount,
dispatching the refund amount.
Terms Associated with IPO process
Application Supported Blocked Amount (ASBA)(pg.123-
process)
• ASBA is an application by retail investors for subscribing to an issue,
containing an authorization to block the application money in a
bank account.
• A retail investor is one who can bid in a book-built issue or applies
for securities for a value of not more than Rs. 1,00,000.
• ASBAs can be accepted only by Self-certified Syndicate Bank
(SCSBs), whose names appear in the list of SCSBs displayed in SEBI’s
website.
• The public issue of 20 microns was the first IPO to hit the market in
September 2008 with ASBA facility for retail investors.
Anchor Investor (pg. 125)
• They are qualified institutional buyers that buy a large chunk
of shares a day before an IPO opens.
• Up to 30 per cent of the portion available for allocation to
qualified institutional buyers shall be available to anchor
investor(s) for allocation/allotment (anchor investor portion).
• One-third of the anchor investor portion shall be reserved for
domestic mutual funds.
• They help arriving at an approximate benchmark price for
share sales and generate confidence in retail investors
Green Shoe Option (pg. 129)
• A green shoe is a clause contained in the underwriting
agreement of an initial (IPO) that allows underwriters to
buy up to an additional 15% of company shares at the
offering price.
• A green-shoe option means an option of allocating
shares in excess of the shares included in the public issue
and operating a post listing price stabilizing mechanism
for a period, not exceeding 30 days.
Why GSO?
• This would normally done to reduce the risk of the IPO
(Initial Public offering). Also, when the public demand for
the shares exceeds expectations and the stock trades
above the offering price.
• It is mainly practiced in US and European Market.
On-line IPOs
• The on-line issue of shares is carried out via the electronic network
of the stock exchanges.
• The issuer company is required to enter into an agreement with
stock exchanges which have the requisite system for an on-line
offer and has to appoint brokers and registrars to the issue having
electronic connectivity with stock exchanges (Sections 55−68A of
the Companies Act, 1956 and Disclosure and Investor Protection
(DIP) guidelines).
Indian Depository Receipts (pg.142-features)
• An IDR is an instrument denominated in Indian rupees in the form
of a depository receipt against the underlying equity of issuing
company to enable foreign companies to raise funds from the
Indian capital market.
• IDRs can be purchased by any person who is resident in India as
defined under FEMA. NRIs and FIIs cannot purchase or possess IDRs
unless special permission of the Reserve Bank of India is taken.