investment management - uc chapter 1

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Module-I

Indian financial system

The Indian financial system can be broadly classified into,

Formal (organised) financial system

Informal (unorganised) financial system.

The formal financial system comprises of

Ministry of Finance, RBI, SEBI and other regulatory bodies, financial institutions, financial

markets, financial instruments and financial services.

The informal financial system consists of

individual money lenders, groups of persons operating as funds or associations, partnership

firms consisting of local brokers, pawn brokers, and non-banking financial intermediaries

such as finance, investment and chit fund companies, financial institutions, financial markets,

financial instruments and financial services.

Financial System

It is a set of institutions instruments and markets which fosters saving and channels

them to their most efficient use.-(H.R. Machiraju)

In the worlds of Van Horne, financial system allocates savings efficiently in an

economy to ultimate users either for investment in real assets or for consumption.

A financial system or financial sector functions as an intermediary and facilitates the

flow of funds from the areas of surplus to the areas of deficit. A Financial System is a

composition of various institutions, markets, regulations and laws, practices, money manager,

analysts, transactions and claims and liabilities.

The financial system is the network of institutions and individuals who deal in

financial claims to various instruments. Financial System of any country consists of financial

markets, financial intermediation and financial instruments or financial products.


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Structure of Indian Financial System

Components/ Constituents of Indian Financial system

The following are the four main components of Indian Financial system

1. Financial institutions

2. Financial Markets

3. Financial Instruments/Assets/Securities

4. Financial Services.[[1. Financial institutions:

Financial institutions are the intermediaries who facilitate smooth functioning of the

financial system by making investors and borrowers meet. They mobilize savings of the

surplus units and allocate them in productive activities promising a better rate of return.

Financial institutions also provide services to entities seeking advice on various issues

ranging from restructuring to diversification plans.

2. Financial Markets:

Finance is a prerequisite for modern business and financial institutions play a vital

role in economic system. It's through financial markets the financial system of an economy

works.


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The main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity;

2. to serve as intermediaries for mobilization of savings;

3. to assist process of balanced economic growth;

4. to provide financial convenience

3. Financial Instruments

Another important constituent of financial system is financial instruments. They

represent a claim against the future income and wealth of others. It will be a claim against a

person or an institution, for the payment of the some of the money at a specified future date.

4. Financial Services:

Efficiency of emerging financial system largely depends upon the quality and variety

of financial services provided by financial intermediaries. The term financial services can be

defined as "activities, benefits and satisfaction connected with sale of money that offers to

users and customers, financial related value".

Following Developments took place in the Indian financial system:

1. Nationalisation of financial institutions

2. Establishment of Development Banks

3. Establishment of institution for housing finance

4. Establishment of Stock Holding Corporation of India (SHCIL)

5. Establishment of mutual funds and venture capital institutions

6. New Economic Policy of 1991

Functions/important and role of financial system

1. It links the savers and investors. It helps in mobilizing and allocating the savings

efficiently and effectively. It plays a crucial role in economic development through

saving-investment process. This savings investment process is called capital

formation.

2. It helps to monitor corporate performance.

3. It provides a mechanism for managing uncertainty and controlling risk.

4. It provides a mechanism for the transfer of resources across geographical boundaries

5. It offers portfolio adjustment facilities (provided by financial markets and financial

intermediaries).

6. It helps in lowering the transaction costs and increase returns. This will motivate

people to save more.

7. It promotes the process of capital formation.


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8. It helps in promoting the process of financial deepening and broadening. Financial

deepening means increasing financial assets as a percentage of GDP and financial

broadening means building an increasing number and variety of participants and

instruments.

Money Market

A segment of the financial market in which financial instruments with high liquidity

and very short maturities are traded. The money market is used by participants as a means for

borrowing and lending in the short term, from several days to just under a year. Money

market securities consist of negotiable certificates of deposit (CDs), bankers acceptances,

U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase

agreements

A money market is a market for borrowing and lending of short-term funds. It deals in

funds and financial instruments having a maturity period of one day to one year. It is a

mechanism through which short-term funds are loaned or borrowed and through which a

large part of financial transactions of a particular country or of the world are cleared.

Money market is a segment of financial market. It is a market for short term funds. It

deals with all transactions in short term securities. These transactions have a maturity period

of one year or less. Examples are bills of exchange, treasury bills etc.

According to Crowther, Money market is a collective name given to various firms

and institutions that deal in the various grades of near money.

It includes all organizations and institutions that deal in short term financial

instruments.

Character istics of Money Market

1. It is basically an over the phone market.2. It is a wholesale market for short term debt instruments.

3. It is not a single market but a collection of markets for several instruments.

4. It facilitates effective implementation of monetary policy of a central bank of a

country.

5. It is a market for short term financial assets that are close substitutes of money.

6. Transactions are made without the help of brokers.

7. It establishes the link between the RBI and banks.

8. The players in the money market are RBI, commercial banks, and companies.


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Functions of Money Market Money

1. Facilitating adjustment of liquidity position of commercial banks, business

undertakings and other non-banking financial institutions.

2. Enabling the central bank to influence and regulate liquidity in the economy through

its intervention in the market.

3. Providing a reasonable access to users of short term funds to meet their requirements

quickly at reasonable costs.

4. Providing short term funds to govt. institutions.

5. Enabling businessmen to invest their temporary surplus funds for short period.

6. Facilitating flow of funds to the most important uses.

Money market instruments

Important money market instruments are

1. Call/Notice Money

2. Inter-Bank Term Money

3. Treasury Bills

4. Term Money

5. Certificate of Deposit

6. Commercial Papers

7. REPO

8. MMMF

9. ADR/GDR

1. Call / Notice-Money

Call/Notice money is the money borrowed or lent on demand for a very short period.

When money is borrowed or lent for a day, it is known as Call (Overnight) Money.

Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on

a day and repaid on the next working day, (irrespective of the number of intervening

holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14

days, it is "Notice Money".

2. Inter-Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the term

money market. The entry restrictions are the same as those for Call/Notice Money except

that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.


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3. Treasury Bills.

Treasury Bills are short term (up to one year) borrowing instruments of the union

government. It is an IOU (I owe you- Debt instrument)of the Government. It is a promise by

the Government to pay a stated sum after expiry of the stated period from the date of issue

(14/91/182/364 days i.e. less than one year).

They are issued at a discount to the face value, and on maturity the face value is paid

to the holder. The rate of discount and the corresponding issue price are determined at each

auction.

Types of T-Bills

1. Ordinary or Regular T-Bills

2.Ad hoc T-Bills (91-Day T-Bills, 14-Day T-Bills, 182-Day T-Bills, 364-Day T-Bills

4. Certificate of Deposits

Certificates of Deposit (CDs) is a negotiable money market instrument and issued in

dematerialised form or as a Promissory Note, for funds deposited at a bank or other eligible

financial institution for a specified time period. Guidelines for issue of CDs are presently

governed by various directives issued by the Reserve Bank of India, as amended from time to

time.

5. Commercial Paper

CP is an unsecured promissory note privately placed with investors at a discount rate

to face value determined by market forces. CP is freely negotiable by endorsement and

delivery.

6. Repurchase Agreements (REPO)

REPO is basically a contract entered into by two parties (parties include RBI, a bank

or NBFC. In this contract, a holder of Govt. securities sells the securities to a lender and

agrees to repurchase them at an agreed future date at an agreed price. At the end of the period

the borrower repurchases the securities at the predetermined price. The difference between

the purchase price and the original price is the cost for the borrower. This cost of borrowing

is called repo rate.


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7. Money Market Mutual Funds (MMMFs)

Money Market Mutual Funds mobilise money from the general public. The money

collected will be invested in money market instruments. The investors get a higher return.

They are more liquid as compared to other investment alternatives. The MMMFs were

originated in the US in 1972. In India the first MMMF was set up by Kothari Pioneer in

1997.But this did not succeed.

8. American depository receipt and Global depository receipt

ADRs are instruments in the nature of depository receipt and certificate. These

instruments are negotiable and represent publicly traded, local currency equity shares issued

by non - American company. For example, an NRI can invest in Indian Companys shares

without bothering dollar conversion and other exchange formalities.

If the facilities extended globally, these instruments are called GDR. ADR are listed

in American Stock exchanges and GDR are listed in other than American Stock exchanges,

say Landon, Luxembourg, Tokyo etc.,

Components / Composition of Money Market (Structure of Money Market)

Money market consists of a number of sub markets. All submarkets collectively

constitute the money market. Each sub market deals in a particular financial instrument. Themain components or constituents or sub markets of a money markets are as follows :

1. Call money market

2. Commercial bill market

3. Treasury bill markets

4. Certificates of deposits market

5. Commercial paper market

6. Acceptance market7. Collateral loan market


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1. Call money market /Notice Money Market/ Inter-Bank Money Market

The market for extremely short-period is referred as call money market. Under call

money market, funds are transacted on overnight basis.

The participants are mostly banks. Therefore it is also called Inter-Bank Money Market.

Under notice money market funds are transacted for 2 days and 14 days period. The lender

issues a notice to the borrower 2 to 3 days before the funds are to be paid. On receipt of

notice, borrowers have to repay the funds.

In this market the rate at which funds are borrowed and lent is called the call money rate.

The call money rate is determined by demand and supply of short term funds.

In call money market the main participants are commercial banks, co-operative banks

and primary dealers. They participate as borrowers and lenders. Discount and Finance House

of India (DFHI), Non-banking financial institutions like LIC, GIC, UTI, NABARD etc. are

allowed to participate in call money market as lenders.

Call money markets are located in big commercial centres like Mumbai, Kolkata,

Chennai, Delhi etc. Call money market is the indicator of liquidity position of money market.

RBI intervenes in call money market as there is close link between the call money market and

other segments of money market.

Objective of Call Money Market

To provide a parking place to employ short term surplus funds.

To provide room for overcoming short term deficits.

To enable the central bank to influence and regulate liquidity in the economy through its

intervention in this market.

To provide a reasonable access to users of short-term funds to meet their requirement

quickly, adequately at reasonable cost.

Importance of call Money Market

Development of trade & industry.

Development of capital market. Smooth functioning of commercial banks. Effective central bank control. Formulation of suitable monetary policy. Non-inflationary source of finance to government. To provide help to the industry and trade.


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2. Commercial bill market

Commercial bill marketrefers to the marketwhere treasury billsare bought and

sold.

A commercial bill is one which arises out of a genuine trade transaction, i.e. credit

transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the

amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein

after a certain specified date. Thus, a bill of exchange contains a written order from the

creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill

of exchange is a self-liquidating paper and negotiable/; it is drawn always for a short period

ranging between 3 months and 6 months.

Trade bills are called commercial bills when they are accepted by commercial banks.

If the bill is payable at a future date and the seller needs money during the currency of the

bill, he may approach his bank to discount the bill.

Commercial bill is a short term, negotiable, and self-liquidating instrument with low

risk. It enhances he liability to make payment in a fixed date when goods are bought on

credit. According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a

written instrument containing an unconditional order, signed by the maker, directing to pay a

certain amount of money only to a particular person, or to the bearer of the instrument

Features of Commercial Bills

1. These are negotiable instruments.

2. These are generally issued for 30 days to 120 days. Thus these are short term credit

instruments.

3. These are self-liquidating instruments with low risk.

4. These can be discounted with a bank. When a bill is discounted with a bank, the holder

gets immediate cash. This means bank provides credit to the customers. The credit is

repayable on maturity of the bill. In case of need for funds, the bank can rediscount thebill in the money market and get ready money.

5. These are used for settling payments in the domestic as well as foreign trade.

6. The creditor who draws the bill is called drawer and the debtor who accepts the bill is

called drawee.

3. Treasury bill markets

Treasury bill marketrefers to the marketwhere treasury billsare bought and sold.


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This market deals in Treasury Bills of short term duration issued by RBI on behalf of

Government of India. At present three types of treasury bills are issued through auctions,

namely 91 day, 182 day and364day treasury bills. State government does not issue any

treasury bills. Interest is determined by market forces. Treasury bills are available for a

minimum amount of Rs. 25,000 and in multiples of Rs. 25,000. Periodic auctions are held for

their Issue.

T-bills are highly liquid, readily available; there is absence of risk of default. In India

T-bills have narrow market and are undeveloped. Commercial Banks, Primary Dealers,

Mutual Funds, Corporates, Financial Institutions, Provident or Pension Funds and Insurance

Companies can participate in T-bills market.

T-bills are short-term securities that mature in one year or less from their issue date.

They are issued with three-month, six-month and one-year maturities. T-bills are purchased

for a price that is less than their par (face) value; when they mature, the government pays the

holder the full par value. Effectively, your interest is the difference between the purchase

price of the security and what you get at maturity.

4. Certificates of deposits market

A certificate of deposit (CD) is a time deposit with a bank. CDs are generally issuedby commercial banks but they can be bought through brokerages. They bear a specific

maturity date (from three months to five years), a specified interest rate, and can be issued in

any denomination, much like bonds.

Certificates of deposit (or CDs for short) are debt instruments issued by banks and

other financial to investors. In exchange for lending the institution money for a predetermined

length of time, the investor is paid a set rate of interest. Maturities on certificates of deposit

can range from a few weeks to several years, with the rate earned by the investor increasing

in proportion to the time his capital is tied up in the investment under most yield rate

environments.

A certificate of deposit is a promissory note issued by a bank. It is a time deposit that

restricts holders from withdrawing funds on demand. Although it is still possible to withdraw

the money, this action will often incur a penalty.

CDs are generally issued by commercial banks and are insured by the FDIC. The term

of a CD generally ranges from one month to five years.


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5. Commercial paper market

Commercial Papers were introduced in January 1990. The Commercial Papers can be

issued by listed company which has working capital of not less than Rs. 5 crores. They could

be issued in multiple of Rs. 25 lakhs. The minimum size of issue being Rs. 1 crore. At present

the maturity period of CPs ranges between 7 days to 1 year. CPs are issued at a discount to its

face value and redeemed at its face value.

Commercial paper is anunsecured,short-term loan issued by a corporation, typically

for financingaccounts receivableand inventories. It is usually issued at adiscount,reflecting

current market interest rates. Maturities on commercial paper are usually no longer than nine

months, with maturities of between one and two months being the average.

For the most part, commercial paper is a very safe investment because the financial

situation of a company can easily be predicted over a few months. Furthermore, typicallyonly companies with highcredit ratingsand credit worthiness issue commercial paper.

CP is an unsecured promissory note privately placed with investors at a discount rate

to face value determined by market forces. CP is freely negotiable by endorsement and

delivery

Gilt Edged Securities Market

Gilt-Edged Securities 'High-grade bonds that are issued by a government or firm. Thistype of security originally boasted gilded edges, thus the name. In the case of a firm, a gilt-

edged security is a stock or bond issued by a company that has a strong record of consistent

earnings and can be relied on to cover dividends and interest.

Gilt-edged securities are a high-grade investment with very low risk. Typically, these

are issued by blue chip companies that dependably meet dividend or interest payments

because they are well-established and financially stable.

Gilt edged bonds are considered sufficiently lowriskthat the law allowsbanksto invest in them. In a

ddition to being low-risk, investment-grade bonds are low

return, greatly reducing the cost on theissuer.It is a private-issued,investment

gradebond.Onlyblue chip

companiesissue gilt edged bonds and, for that reason, they have highratings
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Their value will be affected by inflation, other types of investment available and the

remainder of time left until maturity. The optimum time to purchase Gilts is when interest

rates are high and are on the brink of falling. As interest rates fall, the value of the stock will

rise and therefore can be sold at a profit.

The gilt market is split into three classifications, according to their redemption date or

maturity, classified as:

Shorts (less than five years)

Mediums (five to fifteen years)

Longs (more than fifteen years)

Characteristics of Gilt-edged Securities Market

Gilt-edged securities market is one of the oldest markets in India. The market in thesesecurities is a significant part of Indian stock market. Main characteristics of government

securities market are as follows:

Supply of government securities in the market arises due to their issue by the Central,

State of Local governments and other semi-government and autonomous institutions

explained above.

Government securities are also held by Reserve Bank of India (RBI) for purpose and

sale of these securities and using as an important instrument of monetary control.

The securities issued by government organisations are government guaranteed

securities and are completely safe as regards payment of interest and repayment of

principal.

Gilt-edged securities bear a fixed rate of interest which is generally lower than interest

rate on other securities.

These securities have a fixed maturity period.

Interest on government securities is payable half-yearly.

Capital Market

Capital market is the part of a financial system concerned with raising capital by

dealing in shares, bonds, and other long-term investments.

Capital market may be defined as a market for borrowing and lending of long term

capital funds required by business enterprises.

The markets where investment instruments like bonds and equities are Capital

markets arefinancial marketsfor the buying and selling of long-termdebtorequity-

backedsecurities
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Capital markets channel savings and investment between suppliers of capital such as

retail investors and institutional investors, and users of capital like businesses, government

and individuals.

Capital markets are vital to the functioning of an economy, since capital is a critical

component for generating economic output. Capital markets include primary markets, where

new stock and bond issues are sold to investors, and secondary markets, which trade existing

securities.

Capital markets have numerous participants including individual investors,

institutional investors such as pension funds and mutual funds, municipalities and

governments, companies and organizations and banks and financial institutions. Suppliers of

capital generally want the maximum possible return at the lowest possible risk, while users of

capital want to raise capital at the lowest possible cost.

Different types of financial instruments that are traded in the capital markets are

Equity instruments

Credit market instruments

Insurance instruments

Foreign exchange instruments

Hybrid instruments

Derivative instruments

Debenture & Bonds

Company Fixed Deposit

Capital market reforms

The Indian capital market has witnessed major reforms in the decade of 1990s and

thereafter. It is on the verge of the growth. Thus, the Government of India and SEBI has

taken a number of measures in order to improve the working of the Indian stock exchanges

and to make it more progressive and vibrant.

The 1990s have witnessed the emergence of the securities market as a major source of

finance for trade and industry in India.


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Reforms in Capital Market

1) Establishment of SEBI India

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.

The SEBI was set up with the fundamental objective, "to protect the interest of

investors in securities market and for matters connected therewith or incidental thereto."

The main functions of SEBI are:-

To regulate the business of the stock market and other securities market. To promote and regulate the self-regulatory organizations.

To prohibit fraudulent and unfair trade practices in securities market. To promote awareness among investors and training of intermediaries about safety of

market.

To prohibit insider trading in securities market. To regulate huge acquisition of shares and takeover of companies.

2) Establishment of Creditors Rating Agencies:

Three creditors rating agencies viz. The Credit Rating Information Services ofIndia 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.

3) 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. It has proved as a helping

hand to factors related to the capital market.

4) Candid Performance of Indian Economy:

In the last few years, Indian economy is growing at a good speed. It has attracted a

huge inflow of Foreign Institutional Investments (FII). The massive entry of FIIs in the


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Indian capital market has given good appreciation for the Indian investors in recent times.

Similarly many new companies are emerging on the horizon of the Indian capital market to

raise capital for their expansions.

5) Rising Electronic Transactions:

Due to technological development in the last few years. The physical transaction with

more paper work is reduced. Now paperless transactions are increasing at a rapid rate. 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.

6) 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 market.

7) 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 , stock exchanges havespread across the country. Recently a new Inter-connected Stock Exchange of India has

joined the existing stock exchanges.

8) Investors Protection:

Under the preview of the SEBI the Central Government of India has set up the

Investors Education and Protection Fund (IEPF) in2001. 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.

9) 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 capitalmarket.


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10) Insurance Sector Reforms:

Indian insurance sector has also witnessed massive reforms in last few years. The

Insurance Regulatory and Development Authority (IRDA) were set up in 2000. It paved the

entry of the private insurance firms in India. As many insurance companies invest their

money in the capital market, it has expanded.

11) 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. Apart from these reforms the setting up of Clearing

Corporation of India Limited (CCIL), Venture Funds, etc., have resulted into the tremendous

growth of Indian capital market.

12) Other development

Dematerialization of Shares Corporatization of exchange memberships Banning of Badla / ALBM Introduction of Derivative products - Index / Stock Futures & Options Reforms/Changes in the margining system STP (straight through processing)- electronic contracts Margin Lending and Securities Lending

Nature of capital market

The nature of capital market is brought out by the following facts

It Has Two Segments ( Primary and Secondary)

It Deals In Long-Term Securities

It Performs Trade-off Function

It Creates Dispersion In Business Ownership

It Helps In Capital Formation

It Helps In Creating Liquidity

Functions of a capital market

Mobilization of Savings & acceleration of Capital Formation

Promotion of Industrial Growth

Raising of long term Capital

Ready & Continuous Markets

Proper Channelization of Funds

Provision of a variety of Services

Disseminate information efficiently


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Enable quick valuation of financial instrumentsboth equity and debt

Provide insurance against market risk or price risk

Enable wider participation

Provide operational efficiency through(Simplified transaction procedure, Lowering

settlement timings and Lowering transaction costs)

Develop integration among (Real sector and financial sector, Equity and debt

instruments, Long term and short term funds,Private sector and government sector

and, Domestic funds and external funds)

Direct the flow of funds into efficient channels through (Investment, Disinvestment,

Reinvestment)

Types of capital market

There are two types of capital market

1. Primary market

2. Secondary market

I. Primary Market

It is that market in which shares, debentures and other securities are sold for the first

time for collecting long-term capital.

This market is concerned with new issues. Therefore, the primary market is also

called NEW ISSUE MARKET.

In this market, the flow of funds is from savers to borrowers (industries), hence, it

helps directly in the capital formation of the country. The money collected from this market is

generally used by the companies to modernize the plant, machinery and buildings, for

extending business, and for setting up new business unit.

Features of Primary Market

It is related with new issues

it has no particular place

Market for new long term equity capital

The process of selling new issues to investors is called underwriting

It has various methods of float capital: following are the methods of raising capital in

the primary market: i) public issue ii) offer for sale iii) private placement iv) right

issue v) electronic-initial public offer

it comes before secondary market


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Functions

Right issue

Book building (Process of generating, capturing and recording investor demand for

shares during an IPO and securities in order to support efficient price discovery)

Private placement (Private placement is the opposite of a public issue, in which

securities are made available for sale on the open market.)

Stock exchange

Methods of raising capital in the primary market

1. Public issue2. Offer for sale3. Private placement4. Right issue

5. Electronic-initial public offer6. Preferential Issue7. Green Shoe Option

1. Public issue or Initial public offering (IPO)

The issuing company directly offers to the general public/institutions a fixed number

of securities at a stated price or price band through a document called prospectus. This is the

most common method followed by companies to raise capital through issue of the securities

2. Offer for sale

It consists in outright sale of securities through the intermediary of issue houses or

share brokers. It consists of two stages: the first stage is a direct sale by the issuing company

to the issue house and brokers at an agreed price. In the second stage, the intermediaries resell

the above securities to the ultimate investors. The issue houses purchase the securities at a

negotiated price and resell at a higher price. The difference in the purchase and sale price is

called turn or spread.

3. Private placement

It involves sale of securities to a limited number of sophisticated investors such asfinancial institutions, mutual funds, venture capital funds, banks, and so on. It refers to sale of

equity or equity related instruments of an unlisted company or sale of debentures of a listed

or unlisted company

4. Right issue

When a listed company proposes to issue securities to its existing shareholders, whose names

appear in the register of members on record date, in the proportion to their existing holding,

through an offer document, such issues are called Right Issue. This mode of raising capital

is the best suited when the dilution of controlling interest is not intended.


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5. Electronic-initial public offer

In E-IPO the companies are now allowed to issue capital to the public through the on-line

system of the stock exchanges. For making such on-line issues, the companies should comply

with the provisions contained in Chapter 11A of SEBI (Disclosure and Investor Protection)

Guidelines, 2000

6. Preferential Issue

An issue of equity by a listed company to selected investors at a price which may or may not

be related to the prevailing market price is referred to as preferential allotment in the Indian

capital market. In India preferential allotment is given mainly to promoters or friendly

investors to ward off the threat of takeover.

7. Green Shoe Option

It denotes an option of allocating shares in excess of the shares included in the public issue.

SEBI guidelines allow the issuing company to accept over subscriptions, subject to a ceiling,say 15% of the offer made to public. It is extensively used in international IPOs to stabilized

the post-listing price of new issued shares.

II. Secondary Market

The secondary market is that market in which the buying and selling of the previously

issued securities is done. The transactions of the secondary market are generally done through

the medium of stock exchange.

The chief purpose of the secondary market is to create liquidity in securities. If an

individual has bought some security and he now wants to sell it, he can do so through the

medium of stock exchange to sell or purchase through the medium of stock exchange requires

the services of the broker presently, there are 24 stock exchange in India.

Features of Secondary Market

It Creates LiquidityIt Comes After Primary Market

It Has A Particular Place

It Encourages New Investments

Aids In Financing The Industry

Ensures Safe & Fair Dealing( Media Broadcasting)


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Public issue Global market

Indian companies are permitted to raise foreign currency resources through two main

sources:

a) Issue of foreign currency convertible bonds more commonly known as 'Euro' issues

b) Issue of ordinary shares through depository receipts namely

'Global Depository Receipts (GDRs)

American Depository Receipts (ADRs)'

.

1. Global depository receipts (GDR)

A global depository receipt(GDR), also known as international depository

receipt(IDR), is a certificate issued by adepository bank, which purchasessharesof foreign

companies and deposits it on theaccount.They are the global equivalent of the originalAmerican

depository receipts(ADR) on which they are based. GDRs represent ownership of an underlying

number ofsharesof a foreign company and are commonly used to invest in companies from

developing oremerging marketsby investors in developedmarkets.

Global Depository Receipts (GDRs) may be defined as a global finance vehicle that

allows an issuer to raise capital simultaneously in two or markets through a global offering.

GDRsmay be used in public or private markets inside or outside US. GDR,a negotiable

certificate usually represents company's traded equity/debt. The underlying shares correspond to the

GDRs in a fixed ratio say 1 GDR=10 shares.

GDRs are securities available in one or more markets outside the companys home country.

GDR represents one or more (or fewer) shares in a company. The shares are held by the custody of

the depositary bank in the home country. A GDR investor holds the same rights as the shareholders

of ordinary shares, but typically without voting rights. Sometimes voting rights can be the executed

by the depositary bank on behalf of the GDR holders.

Prices of global depositary receipt are based on the values of related shares, but they are

traded and settled independently of the underlying share. Typically, 1 GDR is equal to 10

underlying shares, but any ratio can be used. It is a negotiable instrument which is denominated in

some freely convertible currency. GDRs enable a company, the issuer, to access investors in capital

markets outside of its home country.
http://en.wikipedia.org/wiki/Depository_bankhttp://en.wikipedia.org/wiki/Depository_bankhttp://en.wikipedia.org/wiki/Depository_bankhttp://en.wikipedia.org/wiki/Share_(finance)http://en.wikipedia.org/wiki/Share_(finance)http://en.wikipedia.org/wiki/Share_(finance)http://en.wikipedia.org/wiki/Account_(accountancy)http://en.wikipedia.org/wiki/Account_(accountancy)http://en.wikipedia.org/wiki/Account_(accountancy)http://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/Shareshttp://en.wikipedia.org/wiki/Shareshttp://en.wikipedia.org/wiki/Shareshttp://en.wikipedia.org/wiki/Emerging_marketshttp://en.wikipedia.org/wiki/Emerging_marketshttp://en.wikipedia.org/wiki/Emerging_marketshttp://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Emerging_marketshttp://en.wikipedia.org/wiki/Shareshttp://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/American_Depository_Receiptshttp://en.wikipedia.org/wiki/Account_(accountancy)http://en.wikipedia.org/wiki/Share_(finance)http://en.wikipedia.org/wiki/Depository_bank


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Several international banks issue GDRs, such asJPMorgan Chase,Citigroup,Deutsche Bank,The

Bank of New York Mellon.GDRs are often listed in theFrankfurt Stock Exchange,Luxembourg

Stock Exchange,and theLondon Stock Exchange,where they are traded on the International Order

Book (IOB).

Characteristics

1. It is an unsecured security2. It may be converted into number of shares

3. Interest and redemption price is public in foreign agency

4. It is listed and traded in thestock exchange

2. American Depository Receipts (ADR)

American Depositary Receipts are US securities representing an indirect ownership of a

non-US company. Each certificate stands for a depositary share (American Depositary Share

ADS11), which is safe kept by the depositary bank (depositary). ADRs allow American investors to

invest into non-US companies without having to worry about the complexities associated with the

cross-border transactions.

ADRs can list on any American stock exchange, most frequently on New York Stock

Exchange (NYSE), American Stock Exchange (AMEX) and are also traded in National Association

of Securities Dealers Automated Quotation System (NASDAQ) or in the over-the-counter (OTC)

market.

A negotiable certificate issued by a U.S. bank representing a specified number of shares (orone share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S.

dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help to

reduce administration and duty costs that would otherwise be levied on each transaction.

ADRs are denominated and traded in US dollars; also the dividends and other payments are

made in US dollars. Investors receive annual reports and proxy materials in English.

Types of ADR

OTC ADR (Level 1):These are not listed on any US exchange and can be traded only in the over-

the-counter (OTC) market. These ADRs are not subject to very stringent regulations from the SEC.

They represent shares of foreign companies that do not qualify for a US exchange listing or choose

not to list on the exchange.

Investors can buy unsponsored OTC ADRs, which can be issued by more than one bank.

Sponsored OTC ADRs are generally confined to being issued by one sponsoring bank. They are

also more structured than unsponsored ones.
http://en.wikipedia.org/wiki/JPMorgan_Chasehttp://en.wikipedia.org/wiki/Citigrouphttp://en.wikipedia.org/wiki/Deutsche_Bankhttp://en.wikipedia.org/wiki/The_Bank_of_New_York_Mellonhttp://en.wikipedia.org/wiki/The_Bank_of_New_York_Mellonhttp://en.wikipedia.org/wiki/Frankfurt_Stock_Exchangehttp://en.wikipedia.org/wiki/Luxembourg_Stock_Exchangehttp://en.wikipedia.org/wiki/Luxembourg_Stock_Exchangehttp://en.wikipedia.org/wiki/London_Stock_Exchangehttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/Stock_exchangehttp://en.wikipedia.org/wiki/London_Stock_Exchangehttp://en.wikipedia.org/wiki/Luxembourg_Stock_Exchangehttp://en.wikipedia.org/wiki/Luxembourg_Stock_Exchangehttp://en.wikipedia.org/wiki/Frankfurt_Stock_Exchangehttp://en.wikipedia.org/wiki/The_Bank_of_New_York_Mellonhttp://en.wikipedia.org/wiki/The_Bank_of_New_York_Mellonhttp://en.wikipedia.org/wiki/Deutsche_Bankhttp://en.wikipedia.org/wiki/Citigrouphttp://en.wikipedia.org/wiki/JPMorgan_Chase


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Listed ADR (Level 2):These are typically listed on the NASDAQ or the NYSE and are subject to

stricter SEC regulations which all listed companies need to comply with.

Public Issues (Level 3): Some ADRs may be offered through a public issue by the sponsoring

bank. The foreign company can raise substantial funds from the American markets with these

ADRs. Publicly issued ADRs require the most stringent adherence to SEC rules.

Guidelines On Issue Of ADR and GDR

The Indian company issuing shares through ADR/GDR route, shall furnish to the Reserve

Bank, full details of such issue in the prescribed form, within thirty (30) days from the

date of closing of the issue.

The Indian company issuing shares against ADR/GDR shall furnish a quarterly return in

the prescribed form to the Reserve Bank within fifteen (15) days of the close of thecalendar quarter.

The issue related expenses (covering both fixed expenses like under writing commissions,

lead managerscharges, legal expenses and other reimbursable expenses) shall be subject

to a ceiling of 4% in the case of GDRs and 7% in the case of ADRs. Issue expenses

beyond the said ceiling would need prior approval of the Reserve Bank.

Indian companies are permitted to retain funds raised abroad through ADRs/GDRs for

any period to meet their future forex requirements.

In terms of Foreign Currency Convertible Bonds and Ordinary Shares (Through

Depository Receipts Mechanism) Scheme, 1993, the issuer company is required to obtain

RBI approval for overseas investment/business acquisitions (where GDR proceeds are to

be utilized for overseas investment) prior to the GDR issue.

Indian companies can raise foreign currency resources abroad through the issue of ADRs/

GDRs, in accordance with the Scheme for issue of Foreign Currency Convertible Bonds

and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and

guidelines issued by the Government of India.

A company can issue ADRs / GDRs, if it is eligible to issue shares to persons resident

outside India under the FDI Scheme. Unlisted companies, which have not yet accessed

the ADR/GDR route for raising capital in the international market, would require prior or

simultaneous listing in the domestic market, while seeking to issue such overseas

instruments. Unlisted companies, which have already issued ADRs/GDRs in the


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international market, have to list in the domestic market on making profit or within three

years of such issue of ADRs/GDRs

After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated

in the RBI Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from

time to time. The company is also required to file a quarterly return in Form DR-

Quarterly as indicated in the RBI Notification ibid.

There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban

on investment in real estate and stock markets. Erstwhile OCBs which are not eligible to

invest in India and entities prohibited to buy, sell or deal in securities by SEBI will not be

eligible to subscribe to ADRs / GDRs issued by Indian companies.

The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at

a price determined under the provisions of the Scheme of issue of Foreign Currency

Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism)

Scheme, 1993 and guidelines issued by the Government of India and directions issued by

the Reserve Bank, from time to time.

Under the limited Two-way fungibility Scheme, a registered broker in India can purchase

shares of an Indian company on behalf of a person resident outside India for the purpose

of converting the shares so purchased into ADRs/ GDRs.

Two-way fungibility Scheme: Under the limited two-way fungibility Scheme, a

registered broker in India can purchase shares of an Indian company on behalf of aperson resident outside India for the purpose of converting the shares so purchased

into ADRs/GDRs.

The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full

details of such issue in the Form enclosed in Annex -10, within 30 days from the date

of closing of the issue.

The company should also furnish a quarterly return in the Form enclosed in Annex -

11, to the Reserve Bank within 15 days of the close of the calendar quarter.

The quarterly return has to be submitted till the entire amount raised through

ADR/GDR mechanism is either repatriated to India or utilized abroad as per theReserve Bank guidelines.

In case of private placement, details of investors and ADRs/GDRs issued to each of

them:

o Number of GDRs/ADRs issuedo Ratio of GDRs/ADRs to the underlying shareso Details of Issue related expenseso Details of listing arrangements

o Amount raised and the amount repatriated


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Main agreements to be executed and related documents

In Case of GDR issue

Escrow Agreement to be executed by the Escrow Agent. Placing Agreement to be executed by the Lead Manager and the Issuer.

Deposit Agreement to be executed by the Depository. Offering Circular.

Procedural requirements for a GDR/ADR issue

The procedural requirements for issue of GDRs/ADRs are briefly set out here below:

U.S. Generally Accepted Accounting Principles ("GAAP")

Preliminary Meetings

Authorization by Board of Directors

Organizational Meetings

Legal and accounting due diligence on Issuer

Authorization by the share holders

Statutory Approvals

Application for listing the additional shares on the Indian Stock Exchange

Filings

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