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WHAT IS A FINANCIAL MARKET?WHAT IS A FINANCIAL MARKET?

When an enterprise is in need of funds, it When an enterprise is in need of funds, it approaches the investing public, both individuals approaches the investing public, both individuals and institutions, to subscribe to its issue of and institutions, to subscribe to its issue of capital or funds.capital or funds.

Financial markets facilitate the flow of funds and Financial markets facilitate the flow of funds and thereby allow financing and investing by thereby allow financing and investing by households, firms, and government agencies.households, firms, and government agencies.

It is a market that facilitates flow of funds from It is a market that facilitates flow of funds from

SURPLUS UNITSSURPLUS UNITS to to DEFICIT UNITSDEFICIT UNITS..

Those who have excess fund (Surplus units)

Those who need funds(Deficit units)

Market facilitates

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WHAT IS A FINANCIAL MARKET?WHAT IS A FINANCIAL MARKET?

• Funds are transferred in financial markets when one party purchases financial assets previously held by another party.

• Each financial market is created to satisfy particular preferences of market participants.

• Period for which they want to deposit – short-term period or long term period

• Level of risk they are willing to tolerate

• Some may prefer to borrow, whereas others may prefer to issue stocks

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WHAT ARE TYPES OF FINANCIAL MARKET?WHAT ARE TYPES OF FINANCIAL MARKET?

The financial markets that facilitate the transfer of debt securities are commonly classified by the maturity of the securities. One that facilitates the flow of funds of short-term funds

(with maturities less than one year) is known as money market.

One that facilitates the flow of long-term funds is known as capital market.

The securities floated by the issuing companies are subsequently purchased and sold among the individual and institutional investors.

Two stagesTwo stages

• Acquiring the securities from the issuing companies

• Purchased and sold continuously among the investors without any involvement of the companies

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Depending upon of transactions further classification as Primary market and Secondary Market

Primary market (NIM) Secondary market Facilitates issuance of new

securities. Issuance of new corporate stocks (or new Treasury securities) is its transaction.

Facilitates trading of existing (old) securities. Sale of existing corporate stock (or treasury securities) is its transaction

Here transactions provide funds to the initial issuer of securities. Thus the contribution to company financing is direct.

Here transactions do not provide funds. Hence in no circumstances SM can supply additional funds to the company as it is not involved in transaction.

It is not rooted in any particular spot and has no geographical existence.

Stock exchanges have organizationally speaking, physical existence and are located in a particular geographical area. It has neither any tangible form nor

any administrative organisational setup like that of stock exchanges nor is it subjected to any centralised control and administration for the consummation of its business.

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CLASSIFICATION OF NEW ISSUESCLASSIFICATION OF NEW ISSUES

Based on whether by a new or an old company

INITIAL ISSUES

• The securities issued by companies for the first time either after the incorporation or conversion from private to public companies are designated as initial issues.

OLD OR FURTHER ISSUES

• Those issued by companies which already have stock exchange quotation, either by public issues or by rights to existing shareholders, are referred to as old or further issues.

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CLASSIFICATION OF NEW ISSUESCLASSIFICATION OF NEW ISSUES

Based on companies seeking quotations

NEW MONEY ISSUES

• Refers to the issues of capital involving newly created shares.

• This provides funds to enterprises for additional capital investment or for wholly or partly repay debt.

• New money refers to the sum of money equivalent to the number of newly created shares multiplied by the price per share minus all the administrative cost associated with the issues

NO NEW MONEY ISSUES

• Represents the sale of securities already in existence and sold by their holders

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FUNCTIONS OF NEW ISSUES/PRIMARY FUNCTIONS OF NEW ISSUES/PRIMARY MARKETMARKET

Channeling of investible funds into industrial enterprises through the triple-service function

• Origination

• Underwriting

• Distribution

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FUNCTIONS OF NEW ISSUES/PRIMARY FUNCTIONS OF NEW ISSUES/PRIMARY MARKETMARKET

Origination• Refers to the work of investigation and analysis and processing of

new proposals. Preliminary investigation refers to a careful study of technical, economical, financial and legal aspects of the issuing companies.

• It warrants the backing of the issue houses in the sense of lending their name to the company and thus gives the issue the stamp of respectability. Earns good market prospects.

• In the process of origination, the sponsoring organisation render the following services.

• Determination of class of security to be issued and the price of the issues in the light of market conditions

• Timing and magnitude of issues

• Methods of floatation

• Techniques of selling

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FUNCTIONS OF NEW ISSUES/PRIMARY FUNCTIONS OF NEW ISSUES/PRIMARY MARKETMARKET

Underwriting• Refers to contractually guaranteeing subscription to shares or

other securities. An underwriting agreement serves as back-up in the event of inadequate subscription to a public subscription.

• The adequate institutional arrangement for underwriting is of crucial importance both to the issuing companies as well as investing public. In India, merchant bankers, stockbrokers, banks and financial institutions offer underwriting commitments and receive commission on the amount underwritten. In some western countries, underwriting means purchase of securities from a company by investment bankers, who subsequently sell it to investors,

• In the context of insurance, this term refers to the function of assuming the risk of financial loss due to death or a mishap, in return fro Premium.

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FUNCTIONS OF NEW ISSUES/PRIMARY FUNCTIONS OF NEW ISSUES/PRIMARY MARKETMARKET

Distribution• Success of an issue depends on the issues being acquired

by the investing public.

• The sale of securities to ultimate investors is called as distribution,

• It is a specialist job which can be performed by brokers and dealers in securities, who maintain regular and direct contact with the ultimate investor.

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ISSUE MECHANISMISSUE MECHANISM

• Public issue through prospectus

• Tender/book building

• Offer for sale

• Placement/Private placement

• Rights issue

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PUBLIC ISSUE THROUGH PROSPECTUS

• Corporate enterprise raise capital through issue of securities by means of prospectus

• Issuing companies themselves offer directly to the general public a fixed number of shares at a stated price, which

o in the case of new companies is invariably the face value of the securities (issue at par), and

o in the case of existing companies, it may include a premium amount, if any (issue at premium)

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PUBLIC ISSUE THROUGH PROSPECTUS

• Another feature of this method is that generally the issues are underwritten to ensure success arising out of public response.

Advantage Transaction is carried on in the full light of publicity

coupled approach to entire investing public

Allotted among applicants on a non-discriminatory basis

Share ownership is widely diffused, thereby contributing to the prevention of concentration of wealth and economic power

Because of the increased scrutiny, public companies can usually get better rates when they issue debt.

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PUBLIC ISSUE THROUGH PROSPECTUS

Advantage Being on a major stock exchange carries a considerable

amount of prestige.

As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.

Disadvantage It is a highly expensive method

In view of high cost involved in raising capital, it is suitable for large issues and not for small issues

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PROSPECTUS

DEFINITION• Any document described or issued as prospectus

and includes any notice, circular, advertisement or other document inviting deposits from public or inviting offers from the public for the subscription or purchase of any shares in or debenture of a body corporate (Sec 2(36) of the Company Act)

• Two essential features

o It invites subscription to shares or debentures or invites deposits

o The invitation is made to public

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PROSPECTUS

CONTENTS

(Sec 56 of the Company Act and SEBI Guidelines 2000)

• Three parts

o Part 1 (General information)

o Part 2 (Detailed information)

o Part 3 (Explanation of certain terms and expressions used under Part – I and Part – II)

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PROSPECTUSPart – I (General information)

1. General information

2. Capital Structure of the company

3. Term of the present issue

4. Particular of the issue

5. Company management and project

6. Certain prescribed particulars in regard to the company

7. Outstanding litigation relating to financial matters, criminal proceedings against the company or directors

8. Management perception of risk factor (e.g. FE rate fluctuation, difficulty is availability of raw materials, etc.

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PROSPECTUSGENERAL INFORMATION

a) Name and address of registered office of the company

b) Name (s) of the stock exchanges where application for listing is made

c) Declaration about refund of issue if minimum subscription of 90% is not received within 120 days from the closure of the issue

d) Declaration about the issue of allotment letter/refunds within period of 10 weeks and interest in case of default at the prescribed rate given in S-73

e) Dates of opening and closing of the issue

f) Names and addresses of auditors and lead managers

g) Rating from CRISIL and any rating agency

h) Names and addresses of the underwriters and the amount underwritten by them

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PROSPECTUSCAPITAL STRUCTURS OF THE COMPANY

a) Authorised, issued, subscribed and paid-up capital

b) Size of the present issue, giving separately reservation for preferential allotment to promoters and others

TERMS OF THE PRESENT ISSUE

a) Terms of payment

b) How to apply

c) Any special tax benefit

PARTICULARS OF THE ISSUE

a) Objects

b) Project cost

c) Means of financing (including contribution of promoters)

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PROSPECTUSCOMAPANY MANAGEMENT AND PROJECT

a) History ad main objects and present business of the company

b) Promoters and their background

c) Location of the project

d) Collaboration, if any

e) Nature of product (s) and export possibilities

f) Future prospects

g) Stock market date. For share/debenture of the company high and low price in each of the last three years including monthly high and low during the last six months, if applicable.

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PROSPECTUSPART – II (Detailed information)

• Sub part I: General information

• Sub part II: Financial information

• Sub part III: Statutory and other information

GENERAL INFORMATION

a) Consent of directors, auditors, solicitors, managers to the issue, Registrar to the issue, bankers of the company and experts

b) Change, if any, in directors and auditors, during the last 3 years and reasons therefor

c) Procedure and time schedule for allotment and issue of certification

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PROSPECTUSGENERAL INFORMATION

d) Names and addresses of Company Secretary, , Legal Adviser, Lead Manager, Co-manager, Auditors, Bankers to the issue

e) Authority for the issue and details of resolution passed therefor

FINANCIAL INFORMATION

a) Reports of the auditors of the company with respect to profits and losses and assets and liabilities and the dividends paid during the last 5 years immediately preceding the issue of prospectus

b) Report by the accountant on the profits and losses for the preceding 5 years (this must not be more than 120 days before date of issue of prospectus)

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PROSPECTUSSTATUTORY AND OTHER INFORMATION

a) Minimum subscription

b) Expenses of the issue

c) Underwriting commission and brokerage

d) Previous public or rights issue, if any, giving particulars about date of allotment, premium/discount, etc.

e) Issue of shares (sweat equity) other than for cash

f) Commission or brokerage on previous issue

g) Particulars about purchase of property, if any

h) Revaluation of assets, if any

i) Debentures and redeemable preference shares or other instrument issued but remaining outstanding on the date of prospectus and terms of their issue.

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ABRIDGED PROSPECTUSSec 56(3) requires that no one shall issue any form of

application for shares in or debenture of a company unless the same is accompanied by a memorandum containing such salient features as may be prescribed.

Thus instead of appending full prospectus, only an abridged prospectus need only be appended to the application form. However, for full version of prospectus can be seen from the lead manager’s offices.

Special features of abridged prospectus

• It shall not contain matters which are extraneous to the contents of the prospectus

• It shall be printed at least in point 7 size with proper spacing and enough space should be provided for investors to fill in the details

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• It is the issue of new shares in which the existing shareholders are given preemptive rights to subscribe to the new issue on a pro-rata basis

• The right is given in the form of an offer to existing shareholders to subscribe to a proportionate number of fresh, extra shares at a price. A shareholder has four options

1. Exercise his rights and buy new shares at the offered price.

2. Renounce the right and sell them in open market

3. Renounce part of his rights and exercise the remainder

4. Choose to do nothing.

RIGHTS ISSUERIGHTS ISSUE

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS• Pricing of issues

Differential pricing Firm allotment Offer to public

Price band Floor and cap prices Composite issue and justification

Payment of discount or commission

Denomination of share (as specified by SEBI) If the issue price ≥ Rs 500 then face value can be

below Rs 10 subject to a minimum of Re 1 per share If the issue price ≤ Rs 500 then face value would be

Rs 10

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

Denomination of shares Disclosure about the face value of the share,

including a statement about the issue price being “X” times the face value in the offer/advertisement

Shares should not be issued in a denomination of a decimal of a rupee

At any given time, there should be only one denomination for the share of the company

Company can change the denomination if their memorandum and articles of association permit so. But, denomination of the share cannot be altered to a decimal of a rupee

Company should adhere to the disclosure and accounting norms specified by SEBI from time to time.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

• Promoters’ contribution

For unlisted companies: 20% of the post-issue capital

For listed company: 20% of the proposed issue capital or to ensure shareholding to the extent of20% of the post-issue capital

For composite issues: At the option of the promoters, the contribution would be either 20% of the proposed public issue capital or 20% of the post-issue capital excluding the rights issue component

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

• Exemption from Promoters’ contribution

Public issue by a company listed on a stock exchange for at least 3 years and having a track record of dividend payment for at least 3 immediately preceding years

Rights issue

Where no identifiable promoter/promoter group exists????

• Lock-in requirements of promoters’ contribution

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

• Lock-in requirements of promoters’ contribution

Minimum period of 3 years

The lock-in period would start from the date of allotment in the proposed issue or from the date of commercial production whichever is later.

Other requirements

Pledge of security with the banks/FIs

Inscription of non-transferability during the lock-in period

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BOOK BUILDINGBOOK BUILDING• It is a process used to ascertain and record the

indicative subscription bids of interested investors to a planned issue of securities. It is a mechanism through which an offer price for IPOs based on investor’s demand is determined.

• It is basically an auction of shares.

• SEBI requirements

75 percent book building process

100 percent book building process

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BOOK BUILDING PROCESSBOOK BUILDING PROCESS1. The company appoints a book runner, a merchant

bank.

2. The book runner prepares draft documents and submitted to SEBI and obtains acknowledgement card.

3. The issuer and the book runner decide to offer shares at a price within a specified price band (range).

4. Offers regarding the demand for securities at different price levels are invited from the syndicate members consisting of eligible brokers, merchant bankers, underwriters, financial institutions, mutual funds, and others in the form of a bid. Ad should mention the opening and the closing dates for the bids. The bid is normally open for five working days.

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BOOK BUILDING PROCESSBOOK BUILDING PROCESS5. Based on the bids received, the issuer arrives at a

final cut-off rate and the final allocation in consultation with the book runner and lead manager.

6. The issuer and the book runner may impose restriction on the number of shares that can be allotted to each client so as to avoid any future takeover threat.

7. The final prospectus is filed with the Registrar of Companies (ROC) along with the procurement agreement.

8. The placement portion opens for subscription only after the prospectus is filed with the ROC.

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BOOK BUILDING PROCESSBOOK BUILDING PROCESS9. The placement portion closes a day before the public

issue portion.

10. The public portion opens and the allotment and listing of this portion is done. The price determined in the book building process is applicable to the public portion.

11. In case the public portion stands oversubscribed, then the allotment is made on a proportionate basis. In case, the public portion remains undersubscribed, the shortfall is distributed amongst those who have opted for placement. In case the placement portion is undersubscribed, the size of the public issue is enhanced.

Thus the book building enables issuers to reap benefits arising from price and demand discovery.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

INITIAL PUBLIC OFFERING (IPO)• The first sale of stock by a private company to the

public, i.e., if the company has never issued equity to the public, it's known as an IPO.

DIRECT PUBLIC OFFERING (DPO)

• Where a company raises capital by marketing its shares directly to its own customers, employees, suppliers, distributors and friends in the community. DPOs are an alternative to underwritten public offerings by securities broker-dealer firms where a company's shares are sold to the broker's customers and prospects.

• Direct public offerings are considerably less expensive than traditional underwritten offerings. On the other hand, a DPO will typically raise much less than a traditional offering.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

GREENSHOES OPTIONS• An option that allows the underwriting of an IPO

to sell additional shares to the public if the demand is high.

UNDERWRITING• New issues are usually brought to market by an

underwriting syndicate in which each firm takes the responsibility (and risk) of selling their specific allotment. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt).

• The process of issuing insurance policies.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

NEGOTIATED UNDERWRITING• A process in which both the purchase price

and the offering price for a new issue are negotiated between the issuer and a single underwriter.

• The underwriter pays the issuer a purchase price, and the public pays the offering price. The spread between the purchase price and the public offering price represents the proceeds to the underwriter.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

FREE PRICING REGIME – a regime after 1992

BOOK BUILDING• It is a mechanism through which an offer

price for IPOs based on investor’s demand is determined.

• It is basically an auction of shares.

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A FEW PRIMARY MARKET TERMSA FEW PRIMARY MARKET TERMS

PLACEMENT PORTION• It is the portion of the issue offered to the public

through the syndicate by way of the book building process. That is all the investors are free to have share in the public portion but they can do so through the syndicate members.

PUBLIC PORTION• It refers to the offer to the public. By and large, it

is responded to by retail offering. The price arrived at in the book building method is applicable to the public offer.

FINANCIAL SECURITYFINANCIAL SECURITY

A A SecuritySecurity is a certificate that represents is a certificate that represents a claim on the issuer.a claim on the issuer.

Money market securitiesMoney market securities– Maturity less than a yearMaturity less than a year– High degree of liquidityHigh degree of liquidity– Low expected return but also a low degree of Low expected return but also a low degree of

riskrisk

Capital market securitiesCapital market securities

Capital market securitiesCapital market securitiesBonds/Debentures and MortgagesBonds/Debentures and Mortgages– Bonds/debentures are long-term debt obligations issued by Bonds/debentures are long-term debt obligations issued by

corporations and government agencies to support operation, whereas corporations and government agencies to support operation, whereas mortgages are long-term debt obligations created to finance the mortgages are long-term debt obligations created to finance the purchase of real estate. purchase of real estate.

– If investors does not want to hold it, or requires money, debt securities If investors does not want to hold it, or requires money, debt securities can be sold in the secondary market can be sold in the secondary market

– Provide a return to investor in the form of interest income at a given rate Provide a return to investor in the form of interest income at a given rate and periodicity. At maturity, investors are paid the principal amount and periodicity. At maturity, investors are paid the principal amount

– Expected return is higher than money market securities, but has more Expected return is higher than money market securities, but has more risk as well.risk as well.

StocksStocks– They are certificates representing partial ownership in the corporations They are certificates representing partial ownership in the corporations

that issued themthat issued them– It has no maturity so they are classified as capital market securities.It has no maturity so they are classified as capital market securities.– Some co. provide income to the stockholders by distributing a portion Some co. provide income to the stockholders by distributing a portion

of their earnings, while may retain and reinvest all or part of their of their earnings, while may retain and reinvest all or part of their earnings for subsequent expansion or growth.earnings for subsequent expansion or growth.

– Investors can earn a capital gain from selling the stocks for a higher Investors can earn a capital gain from selling the stocks for a higher price than they paid for it, if co is doing well. Alternatively, they lose if price than they paid for it, if co is doing well. Alternatively, they lose if co is not well.co is not well.

– Exhibit higher degree of riskExhibit higher degree of risk

Capital market securitiesCapital market securitiesSweat EquitySweat Equity– Equity shares allotted to certain employees Equity shares allotted to certain employees

of a company either on discount or for of a company either on discount or for consideration other than cash, as a reward consideration other than cash, as a reward for providing know-how or sharing for providing know-how or sharing intellectual rights or some other value intellectual rights or some other value addition to the company.addition to the company.