3.

0 Learning Objectives Capital

Market
After learning this unit, you will be able to understand:

 Functions and Types of Capital Market

 Reforms in the capital Market

 Intermediaries

 Issue Mechanisms

 Types of Primary Issues

 Public Rights and Private Placement

 ADRs, GDRs, and ECBs.

3.1 Introduction
Capital Market may be defined as a market dealing in medium and long-
term funds. It is an institutional arrangement for borrowing medium and long-term
funds and which provides facilities for marketing and trading of securities. So it
constitutes all long-term borrowings from banks and financial institutions,
borrowings from foreign markets and raising of capital by issue various securities
such as shares debentures, bonds, etc. In the present chapter let us discuss about
the market for trading of securities. The market where securities are traded known
as Securities market. It consists of two different segments namely primary and
secondary market. The primary market deals with new or fresh issue of securities
and is, therefore, also known as new issue market; whereas the secondary market
provides a place for purchase and sale of existing securities and is often termed as
stock market or stock exchange.

3.2 Meaning
The capital market is the sector of the financial market where long-term
financial instruments issued by corporations and governments trade. Here “long-
term” refers to a financial instrument with an original maturity greater than one
year and perpetual securities (those with no maturity). There are two types of
capital market securities: those that represent shares of ownership interest, also
called equity, issued by corporations, and those that represent indebtedness, or
debt issued by corporations and by the state and local governments.

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Introduction to The Capital market is a market for financial investments that are direct or
Financial Markets, indirect claims to capital. It is wider than the Securities Market and embraces all
Money Market and
Capital Market
forms of lending and borrowing, whether or not evidenced by the creation of a
negotiable financial instrument. The Capital Market comprises the complex of
institutions and mechanisms through which intermediate term funds and long-term
funds are pooled and made available to business, government and individuals. The
Capital Market also encompasses the process by which securities already
outstanding are transferred.

Check your progress 1

1. The _________market is the sector of the financial market where long-term
financial instruments issued by corporations and governments trade.
a. capital

b. money
2. The Capital market is a market for _________investments that are direct or
indirect claims to capital.
a. long term

b. financial

3.3 Functions and Types of Capital Market

Functions of Capital market
Like the money market capital market is also very important. It plays a
significant role in the national economy. A developed, dynamic and vibrant
capital market can immensely contribute for speedy economic growth and
development.
Let us get acquainted with the important functions and role of the capital
market.
1. Mobilization of Savings: Capital market is an important source for
mobilizing idle savings from the economy. It mobilizes funds from people
for further investments in the productive channels of an economy. In that
sense it activates the ideal monetary resources and puts them in proper
investments.

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2. Capital Formation: Capital market helps in capital formation. Capital Capital
formation is net addition to the existing stock of capital in the economy. Market

Through mobilization of ideal resources it generates savings; the mobilized

savings are made available to various segments such as agriculture, industry,
etc. This helps in increasing capital formation.

3. Provision of Investment Avenue: Thus it provides an investment avenue

for people who wish to invest resources for a long period of time. It
provides suitable interest rate returns also to investors. Instruments such as
bonds, equities, units of mutual funds, insurance policies, etc. definitely
provides diverse investment avenue for the public.
4. Speed up Economic Growth and Development: Capital market enhances
production and productivity in the national economy. As it makes funds
available for long period of time, the financial requirements of business
houses are met by the capital market. It helps in research and development.
This helps in, increasing production and productivity in economy by
generation of employment and development of infrastructure.

5. Proper Regulation of Funds: Capital markets not only helps in fund

mobilization, but it also helps in proper allocation of these resources. It can
have regulation over the resources so that it can direct funds in a qualitative
manner.

6. Service Provision: As an important financial set up capital market provides

various types of services. It includes long term and medium term loans to
industry, underwriting services, consultancy services, export finance, etc.
These services help the manufacturing sector in a large spectrum.

7. Continuous Availability of Funds: Capital market is place where the

investment avenue is continuously available for long term investment. This
is a liquid market as it makes fund available on continues basis. Both buyers
and seller can easily buy and sell securities as they are continuously
available. Basically capital market transactions are related to the stock
exchanges. Thus marketability in the capital market becomes easy.

37
Introduction to Types of Capital Market
Financial Markets,
Money Market and There are two types of capital market
Capital Market
1. Primary market
The primary market is that part of the capital markets that deals with the
issuance of new securities. Companies, governments or public sector institutions
can obtain funding through the sale of a new stock or bond issue. This is typically
done through a syndicate of securities dealers. The process of selling new issues
to investors is called underwriting. In the case of a new stock issue, this sale is an
initial public offering (IPO). Dealers earn a commission that is built into the price
of the security offering, though it can be found in the prospectus.

Features of primary markets are:

This is the market for new long term equity capital. The primary market is
the market where the securities are sold for the first time. Therefore it is also
called the new issue market (NIM).
In a primary issue, the securities are issued by the company directly to
investors. The company receives the money and issues new security certificates to
the investors. Primary issues are used by companies for the purpose of setting up
new business or for expanding or modernizing the existing business. The primary
market performs the crucial function of facilitating capital formation in the
economy. The new issue market does not include certain other sources of new
long term external finance, such as loans from financial institutions. Borrowers in
the new issue market may be raising capital for converting private capital into
public capital; this is known as “going public.”

2. Secondary market
The secondary market, also known as the aftermarket, is the financial
market where previously issued securities and financial instruments such as stock,
bonds, options, and futures are bought and sold. The term “secondary market” is
also used to refer to the market for any used goods or assets, or an alternative use
for an existing product or asset where the customer base is the second market (for
example, corn has been traditionally used primarily for food production and
feedstock, but a second- or third- market has developed for use in ethanol
production). Another commonly referred to usage of secondary market term is to
refer to loans which are sold by a mortgage bank to investors such as Fannie Mae
and Freddie Mac.

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 With primary issuances of securities or financial instruments, or the primary Capital
market, investors purchase these securities directly from issuers such as Market

corporations issuing shares in an IPO or private placement, or directly from the

federal government in the case of treasuries. After the initial issuance, investors
can purchase from other investors in the secondary market.

The secondary market for a variety of assets can vary from loans to stocks,
from fragmented to centralized, and from illiquid to very liquid. The major stock
exchanges are the most visible example of liquid secondary markets – in this case,
for stocks of publicly traded companies. Exchanges such as the New York Stock
Exchange, Nasdaq and the American Stock Exchange provide a centralized, liquid
secondary market for the investors who own stocks that trade on those exchanges.
Most bonds and structured products trade “over the counter,” or by phoning the
bond desk of one‟s broker-dealer. Loans sometimes trade online using a Loan
Exchange

Check your progress 2

1. _________market is an important source for mobilizing idle savings from
the economy.
a. Capital

b. money
2. Capital market raises resources for __________ periods of time.
a. Shorter

b. longer
3. The __________market is that part of the capital markets that deals with the
issuance of new securities.
a. Primary

b. secondary
4. In a ________issue, the securities are issued by the company directly to
investors.
a. Secondary

b. primary

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Introduction to 3.4 Reforms in the Capital Market
Financial Markets,
Money Market and
The major reforms undertaken in capital market of India includes:-
Capital Market
1. Establishment of SEBI: 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:-

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

c) To prohibit fraudulent and unfair trade practices in securities market.

d) To promote awareness among investors and training of intermediaries
about safety of market.
e) To prohibit insider trading in securities market.

f) 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 of India 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 organising, 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

40
 Indian capital market has given good appreciation for the Indian investors in Capital
Market
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 and the OTCEI, stock exchanges have spread
across the country. Recently a new Inter-connected Stock Exchange of India
has joined the existing stock exchanges.
8. Investor's Protection: Under the purview of the SEBI the Central
Government of India has set up the Investors Education and Protection Fund
(IEPF) in 2001. 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 capital
market.
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

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Introduction to Exchange (MCX) is set up. The volume of such transactions is growing at a
Financial Markets, splendid rate.
Money Market and
Capital Market 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.

Check your progress 3

1. The Securities and Exchange Board of India (SEBI) was established in
__________.
a. 1988

b. 1978
2. To regulate the business of the stock market and other securities market is
the function of ________.
a. RBI

b. SEBI
3. Under the purview of the SEBI the _______has set up the Investors
Education and Protection Fund (IEPF) in 2001.
a. Central Government of India

b. RBI

3.5 Intermediaries
Capital markets intermediaries are licensed and regulated under the
Securities and Futures Act. They may provide the whole range of capital markets
services as specified in the 2nd schedule of the Securities and Futures Act with the
appropriate Capital Markets Services licence. Currently, these services or
regulated activities include dealing in securities; trading in futures contracts;
leveraged foreign exchange trading; advising on corporate finance; fund
management; real estate investment trust management; securities financing;
providing custodial services for securities; and providing credit rating services.
Individuals who are employed by the capital markets intermediaries to carry
out such regulated activities are required to be representatives under the Securities
and Futures Act

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 Firm or person (such as a broker or consultant) who acts as a mediator on a
Capital
link between parties to a business deal, investment decision, negotiation, etc. In Market
money markets, for example, banks act as intermediaries between depositors
seeking interest income and borrowers seeking debt capital. Intermediaries usually
specialize in specific areas, and serve as a conduit for market and other types of
information is also called a middleman or intermediation.
1. Intermediaries are service providers in the market, including stock brokers,
sub-brokers, financiers, merchant bankers, underwriters, depository
participants, registrar and transfer agents, FIIs/ sub accounts, mutual Funds,
venture capital funds, portfolio managers, custodians, etc.
2. A stockbroker is a regulated professional individual, usually associated with
a brokerage form firm or broker-dealer, who buys and sells stocks and other
securities for both retail and institutional clients, through a stock exchange
or over the counter, in return for a fee or commission. Stockbrokers are
known by numerous professional designations, depending on the license
they hold, the type of securities they sell, or the services they provide.

3. is a person OR a business entity who makes their money from investments,

typically involving large sums of money and usually involving private
equity and venture capital, leveraged buyouts, corporate finance, investment
banking and/or large scale asset management. A financier makes money
through this process when his or her investment is paid back with interest,
from part of the company's equity awarded to them as specified by the
business deal, or a financier can generate income through commission,
performance, and management fees

4. A merchant bank is a financial institution that provides capital to companies

in the form of share ownership instead of loans. A merchant bank also
provides advisory on corporate matters to the firms they lend to. Both
commercial banks and investment banks may engage in merchant banking
activities. Historically, merchant banks' original purpose was to facilitate
and/or finance production and trade of commodities, hence the name
"merchant". Few banks today restrict their activities to such a narrow scope.
5. A company or other entity that administers the public issuance and
distribution of securities from a corporation or other issuing body. An
underwriter works closely with the issuing body to determine the offering
price of the securities, buys them from the issuer and sells them to investors
via the underwriter's distribution network EX- MB and syndicate members.

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Introduction to 6. Depository system introduced in India in the year 1996. In India, a
Financial Markets, Depository Participant (DP) is described as an agent of the depository. They
Money Market and
Capital Market
are the intermediaries between the depository and the investors. The
relationship between the DPs and the depository is governed by an
agreement made between the two under the Depositories Act. Service
provided Dematerialization, Re-materialization, Transfers of securities,
settlement of trades. In India- NSDL & CDSL are the two entities.

7. Registrar is the trusts or institutions that register and maintain detailed

records of the transactions of investors for the convenience of mutual fund
houses. Registrar or transfer agents are the trusts or institutions that register
and maintain detailed records of the transactions of investors for the
convenience of mutual fund houses.
8. A mutual fund is a type of professionally managed collective investment
scheme that pools money from many investors to purchase securities. While
there is no legal definition of the term "mutual fund", it is most commonly
applied only to those collective investment vehicles that are regulated and
sold to the general public. They are sometimes referred to as "investment
companies" or "registered investment companies. Most mutual funds are
"open-ended," meaning investors can buy or sell shares of the fund at any
time

9. Venture capital (VC) is financial capital provided to early-stage, high-

potential, high risk, growth start-up companies. The venture capital fund
makes money by owning equity in the companies it invests in. The typical
venture capital investment occurs after the seed funding round as the first
round of institutional capital to fund growth (also referred to as Series A
round) in the interest of generating a return through an eventual realization
event, such as an IPO or trade sale of the company. Venture capital is a
subset of private equity. Therefore, all venture capital is private equity, but
not all private equity is venture
10. A portfolio manager is either a person who makes investment decisions
using money other people have placed under his or her control or a person
who manages a financial institution's asset and liability (loan and deposit)
portfolios. On the investments side, they work with a team of analysts and
researchers, and are ultimately responsible for establishing an investment
strategy, Portfolio managers are presented with investment ideas from
internal buy-side analysts and sell-side analysts from investment banks. It is
their job to sift through the relevant information and use their judgment to

44
 buy and sell securities. Throughout each day, they read reports, talk to Capital
company managers and monitor industry and economic trends looking for Market

the right company and time to invest the portfolio's capital.

11. A financial professional who has expertise in evaluating the

creditworthiness of individuals and businesses. Credit analysts determine
the likelihood that a borrower will be able to meet financial obligations and
pay back a loan, often by reviewing the borrower's financial history and
determining whether market conditions will be conducive to repayment.

Check your progress 4

1. ___________markets intermediaries are licensed and regulated under the
Securities and Futures Act.
a. Capital

b. money

2. ___________is/are service providers in the market.

a. RBI
b. Intermediaries

3. A ___________is a regulated professional individual, usually associated

with a brokerage form firm.

a. Stockbroker
b. banks

3.6 Issue Mechanisms

As we all know that capital market (securities markets) is the market for
securities, where companies and the government can raise long-term funds. The
capital market includes the stock market and the bond market. Financial
regulators, oversee the capital markets in their respective countries to ensure that
investors are protected against fraud. The capital markets consist of the primary
market, where new issues are distributed to investors, and the secondary market,
where existing securities are traded.

45
Introduction to Primary markets
Financial Markets,
Money Market and The primary market is that part of the capital markets that deals with the
Capital Market issuance of new securities. Companies, governments or public sector institutions
can obtain funding through the sale of a new stock or bond issue. This is typically
done through a syndicate of securities dealers. The process of selling new issues
to investors is called underwriting. In the case of a new stock issue, this sale is an
initial public offering (IPO). Dealers earn a commission that is built into the price
of the security offering, though it can be found in the prospectus.

Secondary markets
The secondary market is the financial market for trading of securities that
have already been issued in an initial private or public offering. Alternatively,
secondary market can refer to the market for any kind of used goods. The market
that exists in a new security just after the new issue is often referred to as the
aftermarket. Once a newly issued stock is listed on a stock exchange, investors
and speculators can easily trade on the exchange, as market makers provide bids
and offers in the new stock.

In the secondary market, securities are sold by and transferred from one
investor or speculator to another. It is therefore important that the secondary
market be highly liquid and transparent. Before electronic means of
communications, the only way to create this liquidity was for investors and
speculators to meet at a fixed place regularly. This is how stock exchanges
originated.

Check your progress 5

1. The _________markets consist of the primary market, where new issues are
distributed to investors.
a. capital
b. secondary

2. The ________market is a place where existing securities are traded.

a. primary

b. secondary

46
 3. The _______market is that part of the capital markets that deals with the Capital
issuance of new securities. Market

a. primary

b. secondary

3.7 Types of Primary Issues

Primarily, issues can be classified as a Public, Rights or Preferential issues
(also known as private placements). While public and rights issues involve a
detailed procedure, private placements or preferential issues are relatively simpler.
The classification of issues is illustrated below:
Initial Public Offering (IPO) is when an unlisted company makes either a
fresh issue of securities or an offer for sale of its existing securities or both for the
first time to the public. This paves way for listing and trading of the issuer's
securities.
A follow on public offering (Further Issue) is when an already listed
company makes either a fresh issue of securities to the public or an offer for sale
to the public, through an offer document.

Rights Issue is when a listed company which proposes to issue fresh

securities to its existing shareholders as on a record date. The rights are normally
offered in a particular ratio to the number of securities held prior to the issue. This
route is best suited for companies who would like to raise capital without diluting
stake of its existing shareholders.
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 which is neither a rights issue nor a public issue. This is a faster way for a
company to raise equity capital. The issuer company has to comply with the
Companies Act and the requirements contained in the Chapter pertaining to
preferential allotment in SEBI guidelines which inter-alia include pricing,
disclosures in notice, etc.

47
Introduction to
Financial Markets,
Check your progress 6
Money Market and
1. __________is when an unlisted company makes either a fresh issue of
Capital Market
securities or an offer.

a. IPO
b. BPO

2. ___________is when a listed company which proposes to issue fresh

securities to its existing shareholders as on a record date.

a. IPO
b. Rights Issue

3. A ________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 which is neither a rights issue nor a public issue.
a. Preferential

b. Equity

3.8 Public Rights and Private Placement

A rights issue involves selling securities in the primary by issuing rights to
the existing shareholders, When a company issues additional equity capital, it has
to be offered in the first instance to the existing shareholders on a pro rata basis.
This is required under Section 81 of the Companies act, 1956. The shareholders
however may be a special resolution forfeit this right, partially or fully to enable a
company to issue additional capital the public.

Procedure for rights issue: A company making rights issue sends a letter of offer
along with a composite application form consisting of four forms (A, B, C and D)
to the shareholders. Form A is meant for the acceptance of the rights and
application of additional shares. This form also shows the number of rights shares
the shareholders is entitled to. It also has a column through which a request for
additional shares may be made. Form B is to be used if the shareholder wants to
renounce the rights in-favour of someone else. Form C is meant for application by
the renounces in whose favour the rights have been renounced by the original
allotted, through Form B. Form D is to be used to make a request for split forms.
The composite application form must be mailed to the company within a specific
period which is usually 30 days.
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Private Placement or Preferential allotment: In private placement, funds are
Capital
raised in the primary market by issuing securities privately to some investors Market
without resorting to underwriting. The investors in this case may be financial
institutions, commercial banks, other company‟s shareholders of promoting
companies, and friends and associates of the promoters.

The merits of private placement are: (1) the process of raising funds is fairly
simple. The elaborate procedure required in the case of a public issue is more or
less by passed. (2) The issues cost is minimal. (3) In the case of a debenture issue,
negotiated directly between the issuing company and the few investors, there may
be greater flexibility with respect to terms and conditions. The disadvantageous of
private placement are: (1) The Quantum of funds that can be raised may be rather
limited, (2) The cost of capital of funds raised by way of private placements may
be somewhat higher.

Private Placement of Debentures: Private placement of debentures has

become very popular in recent years. The principal buyers of such debentures
have been mutual funds, insurance companies, financial institutions, Army Group
Insurance, Navy Group Insurance, Air Group and so on.

Check your progress 7

1. A ________involves selling securities in the primary by issuing rights to the
existing shareholders.
a. rights issue

b. bonus issue
2. In__________, funds are raised in the primary market by issuing securities
privately to some investors without resorting to underwriting.
a. Public issue

b. private placement

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Introduction to 3.9 Resource Mobilization from International
Financial Markets,
Money Market and Capital Markets
Capital Market
Funds can be raised in the primary market from the domestic market as well
as from international markets. After the reforms were initiated in 1991, one of the
major policy changes was allowing Indian companies to raise resources by way of
equity issues in the international markets. Earlier, only debt was allowed to be
raised from international markets. In the early 1990s foreign exchange reserves
had depleted and the country‟s rating had been downgraded. This resulted in a
foreign exchange crunch and the government was unable to meet the import
requirement of Indian companies. Hence allowing companies to tap the equity and
bond market In Europe seemed a more sensible option. This permission
encourages Indian companies to become global.

India companies have raised resources from international capital markets

through Global depository receipts (GDRs) / American Depository Receipts
(ADRs), Foreign Currency Convertible Bonds (PCCBs) and External Commercial
Borrowings (ECBs). The last are used as a residual source after exhausting
external equity as a main source of finance for large value projects.

3.9.1 ADRs
ADRs are negotiable instruments denominated in dollars, and issued by the
US Depository Bank. A non-US company that seeks to list in the US, deposits its
shares with a bank and receives receipts which enable the company to issue
American Depository Shares (ADSs). These ADS‟s serve as stock certificates and
are used interchangeably with ADRs which represent ownership of deposited
shares. There is no legal or technical difference between an ADR and a GDR. As
they are listed on the New York Stock Exchange (NYSE) and NASDAQ
(National Association of Securities Dealers Automated Association), ADR issued
offer access to the US institutional and retail markets while GDR issues offer
access only to the US institutional market. GDR listing requires comprehensive
disclosures and greater transparency as compared to GDR listing.

3.9.2 GDRs
GDRs essentially equity instruments issued abroad by authorized overseas
corporate bodies against the shares/bonds of Indian companies held with
nominated domestic custodian banks. The issue of GDR creates equity shares of
50
the issuing company which are kept with a designated bank. GDRs are freely Capital
transferable outside India and divided in respect of the share represented by the Market
GDR is paid in Indian rupees only. They are listed and traded on a foreign stock
exchange. Trading takes place between professional market makers on an OTC
(over the counter) basis. A GDR may represent one or more shares of the issuing
company. The shares correspond to other GDR in a fixed ratio. A holder of a
GDR can, at any time, convert it into the number of shares that it represents. Till
conversion, the GDRs do not carry any voting rights and once conversion takes
place the underlying shares are listed and traded on the domestic exchange. Most
of the Indian companies have their GDR issues listed on the Luxembourg Stock
Exchange and the London Stock Exchange. Indian GDRs are primarily sold to
institutional investors and the major demand is in the UK, US, Hong Kong,
Singapore, France and Switzerland. Rule 144 A of the Securities and Exchange
Commissions (SEC) of the US permits companies from outside the US to offer
their GDRs to qualified institutional buyers.
GDRs can be converted into ADRs by surrendering the existing GDRs and
depositing the underlying equity shares with the ADR depository in exchange for
ADRs. The company has to comply with the Securities and Exchange
Commission requirements to materialize this exchange offer process. However,
the company does not get any funds by this conversion. The trend is towards the
conversion of GDRs into ADRs as ADRs are more liquid and cover a wider
market. Besides these, many European investors have been disappointed by poor
performance of Indian GDRs in traditional industries and are unwilling to provide
more capital.

3.9.3 ECBs
An external commercial borrowing (ECB) is an instrument used in India to
facilitate the access to foreign money by Indian corporations and PSUs (public
sector undertakings). ECBs include commercial bank loans, buyers' credit and
suppliers‟ credit, securitised instruments such as floating rate notes and fixed rate
bonds, etc. credit from official export credit agencies and commercial borrowings
from the private sector window of multilateral financial Institutions such as
International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs
cannot be used for investment in stock market or speculation in real estate. The
DEA (Department of Economic Affairs), Ministry of Finance, Government of
India along with Reserve Bank of India, monitors and regulates ECB guidelines
and policies. For infrastructure and green-field projects, funding up to 50%

51
Introduction to (through ECB) is allowed. In telecom sector too, up to 50% funding through
Financial Markets, ECBs is allowed. Recently Government of India allowed borrowings in Chinese
Money Market and
Capital Market
currency Yuan. Corporate sectors can mobilize USD 750 million via automatic
route, whereas service sectors and NGO's for microfinance can mobilize USD 200
million and 10 million respectively.

Borrowers can use 25 per cent of the ECB to repay rupee debt and the
remaining 75 per cent should be used for new projects. A borrower cannot
refinance its entire existing rupee loan through ECB. The money raised through
ECB is cheaper given near-zero interest rates in the US and Europe, Indian
companies can repay part of their existing expensive loans from that.

Check your progress 8

1. Funds can be raised in the ___________market from the domestic market as
well as from international markets.
a. Primary

b. secondary
2. _____________are negotiable instruments denominated in dollars, and
issued by the US Depository Bank.
a. GDR

b. ADRs
3. ______________essentially equity instruments issued abroad by authorized
overseas corporate bodies against the shares/bonds of Indian companies held
with nominated domestic custodian banks
a. GDRs

b. ADRs
4. A ____________is an instrument used in India to facilitate the access to
foreign money by Indian corporations and PSUs.
a. GDRs

b. ECB

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3.10 Primary Market Capital
Market
The Primary Market consists of arrangements, which facilitate the
procurement of long-term funds by companies by making fresh issue of shares
and debentures. You know that companies make fresh issue of shares and/or
debentures at their formation stage and, if necessary, subsequently for the
expansion of business. It is usually done through private placement to friends,
relatives and financial institutions or by making public issue. In any Business
case, the companies have to follow a well-established legal procedure and involve
a number of intermediaries such as underwriters, brokers, etc. who form an
integral part of the primary market. You must have learnt about many initial
public offers (IPOs) made recently by a number of public sector undertakings
such as ONGC, GAIL, NTPC and the private sector companies like Tata
Consultancy Services (TCS), Biocon, Jet-Airways and so on.

3.10.1 Scenario in India

In the Financial Year 2008, India saw the greatest year in Indian capital
Market raised when the Total Capital raised went Northwards of US$ 9 Billion.

 India has seen a tremendous growth of its Capital Markets with close to 500
Initial Public Offerings (IPO) second only US. While India Ranked IV with
respect to the amount of Capital raised contributing to 3.7% of global IPO
share.

 At the end of F.Y 12,the P/E ratio of BSE Sensex and S & P CNX NIFTY
were 17.8 and 18.7 respectively as compared to 21.2 and 22.1 respectively
as at the end of F.Y11 1st Development in Primary Market

 The Overall growth of GDP at factor Cost at contrast Prices, as per

Advanced Estimates, is estimated at 6.9 percent in F.Y12 as compared to the
revised growth of 8.4% during F.Y11

 Industrial Growth measured by Index of Industrial Production reached 2.9%

during F.Y12 as compare to 8.2% in F.Y11 2nd Development in Primary
Market •Among the 17 listed companies that were approved for ordinary
share issue, 16 have completed their Initial Public Offering(IPO) and among
them 12 have already been listed in the Secondary Market too.

 In order to create efficient Capital Market QFI‟s been allowed to directly

invest in the Indian Equity Market in Jan 2012.

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Introduction to  It is mandatory for Companies to issue IPO of 100 and above in electronic
Financial Markets, form through Nation Wide Broker Network of Stock Exchanges. 3rd
Money Market and
Capital Market Development in Primary Market Resources mobilized in primary market 0
50 100 150 200 250 300 350 400 450 FY08 FY09 FY10 FY11 FY12 IPOs
FPOs Bond/NCD Right Issues Source: SEBI Source: BSE

Check your progress 9

1. The___________Market consists of arrangements, which facilitate the
procurement of long-term funds by companies by making fresh issue of
shares and debentures.
a. Primary

b. Secondary
2. India has seen a tremendous growth of its __________Markets with close to
500 Initial Public Offerings(IPO)Second only US
a. Primary

b. Capital

3.11 Debt Market: Private Corporate

Debt market refers to the financial market where investors buy and sell debt
securities, mostly in the form of bonds. Entire debt segment is generally consists
of 2/3 of primary market and 4/5 of secondary market. The Indian debt market is
today one of the largest in Asia and includes securities issued by the Government
(Central & State Governments), public sector undertakings, other government
bodies, financial institutions, banks and corporates.
Debt Market Can Be Broadly Classified in To:-
1) Govt. securities market)

2) Corporate debt market. The government debt market is the market for bonds
and securities issued by the central govt., state govt. and the semi govt.
authorities which includes local govt. authorities like city corporations,
metropolitan authorities public sector corporations and other govt. agencies
such as IDBI, IFCI, SFCs. In broader terms Corporate bonds are fixed
income securities issued by corporates i.e. entities other than Government.

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Corporate debt market can be classified into:- Capital
Market
• Primary market
• Secondary market

Primary market for corporate debt:-The corporate sector can raise debt funds
either through prospectus or private placement. It is a market wherein debt
securities of corporate i.e., debentures, bonds, commercial papers, certificate of
deposits, etc. of private & public sectors are issued for the first time.

Secondary market for corporate debt:-It is a market where the corporate debt
securities of both private sector & public sector undertakings are traded. These
securities are traded on Wholesale Debt Segment (WDM) segment of NSE,
OTCEI &BSE.

Corporate bonds can be issued in two ways:-Public issue in public issue,

corporations issue bonds to the market as a whole. Institutions as well as retail
investors can participate in this issue. The cost of borrowing is little high in case
of public issue. Private placement in private placement corporate, generally park
the bond issuance with few institutions. In India, more than 90% of the corporate
bonds are issued through private placement. It is an easiest and cheapest way of
borrowing corporate bonds.

Structure of corporate debt market in India The primary market for

corporate debt is mainly dominated by private placements (93 per cent of total
issuance in 2011-12) as corporates prefer this route to public issues because of
operational ease, i.e., minimum disclosures, low cost, tailor made structures and
speed of raising funds. Banks/FIs (42.3 per cent of total issuances) followed by
finance companies (26.4 per cent) were the major issuer‟s in2011-12. India lacks a
long-term debt market for pure project finance. Corporate bonds issued in India
usually carry a rating of AAA indicating lack of interest in bonds of lower rated
borrowers in the debt market. Institutional participants, such as, banks, primary
dealers, mutual funds, insurance companies, pension funds, corporates, etc. are the
major players in this market.
According to SEBI, the total trading volume in the secondary corporate
bond market has increased from Rs.961 bn in FY2008 to Rs.2,207 bn in
FY2010CAGR of over 50% over the last two years.• SeFY2008 16,547
967FY2009 21,651 1,487Fy2010 20,933 2,20711/28/2012

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Introduction to
Financial Markets,
Check your progress 10
Money Market and
1. __________market refers to the financial market where investors buy and
Capital Market
sell debt securities, mostly in the form of bonds.

a. Debt
b. share

2. The ___________sector can raise debt funds either through prospectus or

private placement.

a. Government
b. corporate

3.12 Role of SEBI in the Capital Market

Repealing of CCI Act: SEBI guidelines were issued after the repeal of the
CCI Act where by the CCI guidelines became out of date. New guidelines by
SEBI were issued starting from the month of June 1992. Some CCI guidelines
were still retained, as in the case of those for premium fixation.

Guidelines for new issues made by new companies: They have to be issued
at par. Free pricing is permitted only if the new company is promoted by the
existing company with not less than 50% of equity.
Guidelines for new issues made by private limited companies: New issues
made by Private Limited Companies and Closely held companies could be made
by free pricing, for listing purposes if such companies have had three years of
track record of consistent profitability out of last 5 years. Not less than 20% of
equity is to be offered to the public, in such cases.
Guidelines for new issues made by existing listed companies: Public issues
by existing listed companies can be made through free pricing, if they are further
issues and if they are disclosed in the prospectus. The NAV and the market price
have to be considered for the last 3 years. The companies with foreign holding
wishing to enhance the limit up to 51% will have to get the prices approved in the
general body meeting by a special resolution under Sec. 81 (A) of the Companies
Act, and subject to RBI approval.

Listing of shares on the OTC: If the new issues are made through OTC,
normal guidelines will apply if the sponsor is not taking any share. If the shares
are taken by the sponsor, subsequent offer to the public may be made at such a
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price as the sponsor may deem fit. The promoters should retain 25% quota with a Capital
lock in period of 5 years, the sponsor should act as market maker for a period of at Market
least 3 years and also find another market maker for compulsory market making.
This condition was relaxed recently to encourage OTC Listing.
Underwriting issues: Underwriting is optional if the issue is made to the
public and should not include reserved or preferential quota or employees' quota.
If the subscription is not up to 90% of the total issue from the public including
contribution of underwriters, the public should be refunded of their subscription
within 120 days from the date of opening the issue. The compulsory underwriting
provision was also waived for smaller issues.
Composite issues: Issues to the public by existing company can be priced
differently as compared to the rights issued to shareholders.
FCD & PCD: The issues of Fully Convertible Debentures (FCDs) with a
conversion period of more than 36 months will not be permissible unless
conversion is optional. In case FCDs are convertible after 18 months, credit rating
is compulsory; credit rating is now made compulsory for all issues made to public,
other than equity. In case, the non-convertible portion of the Partially Convertible
Debentures is to be rolled over, non-maturing debenture holders should have
option to withdraw from the scheme.
New Financial Instruments: The terms and conditions of the new instrument
such as Deep Discount Bonds, debentures with warrants and secured premium
notes etc. Should be disclosed clearly so that the investor can assess the risk and
return scenario of the instrument.
Reservation in issues: The unreserved portion offered to public should not
be less than the minimum required for listing purposes. Preferential allotment can
be made to promoters, companies and shareholders of those companies, NRIs,
employees and associate companies of the same group. The allotment shall be
subject to a lock in period of three years, if it is made on firm basis, outside public
issue.
Deployment of issue proceeds: Where the total proceeds exceed Rs.250
crores, the company will voluntarily disclose the arrangements made to utilize
proceeds. When the total issue proceeds exceed Rs.500 crores, there is need for
making compulsory disclosure and for the financial institutions to monitor the
deployment of funds, to the stock exchanges.

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Introduction to Minimum interval between two issues: 12 months should elapse between
Financial Markets, the public or rights issue and bonus issue. The promoters should bring in their
Money Market and
Capital Market
share of the capital before the public issue.

Employee's stock option scheme: The reservation for employees should not
be more than 10% at present and this quota is non-transferable for 3 years and
subject to a maximum allotment of 200 shares per employee, and the lock in was
removed later.

The Lock in period for Promoters' quota is 5 years and the lock in period for
preferential allotment for associates and friends is 3 years.

Bonus shares: Bonus issues are to be made out of free reserves, the share
premium collected in cash, Development Rebate Reserves and Investment
Allowance Reserve. Contingent liabilities disclosed in the audited accounts should
be deducted from net profit for calculation of residual reserves. Residual reserves
after the bonus issues should be at least 40% of the increased paid-up capital. 30%
of the average profits before tax for the previous 3 years should yield a rate of
dividend of 10% on the expanded capital base. Reserves out of revaluation should
not be used for bonus payment. Bonus issue cannot be made in lieu of dividends,
and if there are partly paid up shares; no bonus issue is permitted. Expanded paid-
up capital after bonus issue should not exceed authorized share capital. When a
company has PCD or FCD, pending conversion, no bonus issue can be made
unless this right is kept open to the holders of FCD and PCD falling due for
conversion within 12 months.

Debenture issues: All debentures, which have a life of more than 18 months,
should have a DRR created by company out of profits. DRR should be created
only for non-convertible portion of the debentures. Contribution to DRR should
commence from the date of commercial production and when there are profits
after tax, interest and depreciation. The DRR will be considered as a part of the
general reserves for payment of the bonus issues. DRR should be created and
maintained at 50% of the amount of the debentures before repayment starts. The
company should have already redeemed some liability. DRR and the creation of
Debentures Trust are necessary only if the debentures have a maturity period
exceeding 18 months. The Lead Institution for each issue should monitor the use
of debenture funds either from the working capital or from the project finance.
The SEBI now insists on prior licensing of debenture Trustees; Trust deed
should be ready within 6 months from the date of allotment. Recent amendment:
By a recent amendment to Listing Agreement, the Companies have been asked to
provide unabridged Balance Sheet to Shareholders. The companies have to give

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