Capital Market

 Capital Market is an important constituent of the financial system.

 Capital Market is a market for long term funds both equity and debt and
funds raised within and outside the country.

Functions of Capital Market

 Mobilise long term saving to finance long term
investments.
 Encourage broader ownership of productive assets.
 Provide the liquidity with a mechanism enabling the
investor to sell financial assets.
 Enable quick valuation of financial instruments.
Primary market
• Primary Market: This refers to long term flow of funds
from surplus sector to the government and corporate
sector (through primary issues). Primary issues of the
corporate sector lead to capital formation.
• The primary market is a market for new issues. It is also
called new issue market (market for fresh capital).
• Funds are mobilised in the Primary market through
public issue (IPO or FPO) by prospectus, right issues, and
private placements.
• Public issue: Where securities are issued to the
members of general public. It is most popular method of
raising long term funds.
 • A public issue is a method of raising funds through the
issue of shares to investors in the primary market by
companies. Public issue is further classified into:
• Initial Public Offer
• Follow on Public offer
• Initial Public offer: It is an offering of either a fresh issue
of securities or an offer for sale of existing securities or
both by an unlisted company for first time to public.
• In IPO the availability of information regarding the past
performance of the company and its track record is
generally inadequate and lacks credibility.
• Follow on Public offer :
• It is an offering of either a fresh issue of securities or an
offer for sale to the public by an already listed company
through offer document.
• Investors participating in these offering take informed
decision based on its track record and performance.
• The Companies Act 2013 provides that where the offer
or invitation to subscribe for shares or debentures is
made to 200 or more persons then such an offer or
invitation shall be deemed to be public offering and
shall have to comply with all the provisions of the act as
well as SEBI guidelines for public offering.
Intermediaries to an issue
Merchant Banker:
 A merchant banker should be registered with SEBI
as per SEBI (Merchant Bankers) Regulations 1992
to act as book running lead manager to an issue.
 The lead merchant banker performs pre issue
tasks drafting and designing offer document,
finalising the prospectus, drawing up marketing
strategies for the issue, completion of prescribed
formalities with the stock exchanges and registrar
of companies.
 The notification of Ministry Of Finance in India
defines Merchant Banker as
 “any person who is engaged in the business of
issue management either by making arrangements
regarding selling, buying, or subscribing to the
securities as manager, consultant, adviser in
relation to such an issue management”. In general
the merchant banks are the financial institution
which provides financial services, solutions, &
advice to corporate houses.
 Eg:In India there are many banks which are into
the field of merchant banking some of the banks
are ICICI, State Bank Of India, Punjab National
Bank etc.
 Functions of Merchant Bankers:
• Project counseling
• Market survey and forecasting
• Estimating the amount of funds required.
• Raising funds from capital market.
• Raising of funds through new instruments

 Underwriters
 Underwriters to the issue of capital are the one
who agree to take up securities which are not fully
subscribed. The make a commitment to get the
issue subscribed either by others or by themselves.
 For this purpose, the underwriter who guarantees
for the sale of shares, is given a commission.

 Registrar to the Issue: The role of the registrar is

to finalise the list of eligible allottees, ensure
crediting of shares to the demat accounts of the
eligible allottees and dispatch refund orders.
 Bankers to the issue: They are appointed in all the
mandatory collection centres and by lead
merchant bankers to carry out activities relating to
collection of application amounts, transfer of
amount to escrow account, dispatching refund
amounts.
 Participants of the Securities Market
 The issuer: Corporate entities issue equity shares,
debentures, while financial institutions and public
sector enterprises issue equity shares as well as
bonds.
 The buyer: The buyer segment consists of
domestic institutional investors, corporate entities,
banks, pension funds, mutual funds, retail
investors, and foreign institutional investors who
are registered with SEBI.
 Market Intermediaries: Merchant bankers,
clearing and settlement houses, credit rating
agencies, depositories, banks, brokers act as
market intermediaries at various levels.
 The regulators: SEBI, Ministry of Finance, RBI

Methods of determining the offer price

The company and Merchant banker are required to give
full disclosures of the parameters which they consider
while deciding issue price.
There are two types of issues :
• Fixed Price
• Book Building

Fixed Price
It is when a company and lead manager (LM)
fix a price prior to offer and allocation called
Fixed price.
Fixed price offering were made to uninformed
investors.
Empirical evidence supports the view that
fixed price offering results in high cost of
capital for firms due to underpricing of shares
for attractive subscription.

Book Building
Book building is a mechanism through which
an offer price for IPOs based on investors
demand is determined.
The SEBI guidelines define book building as a
process undertaken by which a demand for
securities proposed to be issued by a
corporate body is elicited and built up and the
price for such securities is assessed for
determination of the quantum of such
securities to be issued by means of notice,
circular, advertisement, information or offer
document.
It is basically auction of shares.
• The issue of securities through book building
prior to August 2009 could be done in either
of the following two ways:
75 percent book building known as Partial
book building The SEBI allowed partial book
building with 75 percent of the total issue
allotted for the book built portion ; remaining
25 percent has to be offloaded in general
market at a fixed price discovered during book
building process.
100 percent known as One stage book
building.
(The option of 100 percent book building
was available only to those issuer companies
which are to make an issue capital of or above
100 crores . Later ceiling got reduced from
100 crores to 25 crores.
Book Building was first introduced in 1999
with the concept of a price band.
Price band includes the floor price and the
cap price. For example PNB issue price band
was Rs 350 to 390. Rs 350 (Floor Price) and Rs
390 (cap price).
In 2000, April SEBI moved to the concept of
fixed floor price which lead to underpricing
as maximum bids were received at or just
above floor price.
SEBI reintroduced moving price band the
range may be moved up or down depending
on the demand and direction in which the
book is built. The band can be moved 20
percent either way.

 The basis of issue price, floor price or price

band shall be disclosed on the basis of
following information:
A. Earning per share and diluted earning per
share, pre issue for the last three years.
B. Price earning ratio pre issue
C. Average return on networth in last three
years.
D. Minimum return on increased networth
required to maintain pre-issue EPS
E. Net assets value per share based on last
balance sheet,
F. Net asset value per share after issue and
comparison thereof with issue price.
  Comparison of all accounting ratios of the
issuer as mentioned with the industry
average and the accounting ratios of the
peer group should be mentioned

Determination of Price
The issuer shall in consultation with lead
book runner , determine the issue price based
on the bids received.
On determination of price, the number of
specified securities to be offered shall be
determined .
Once the final price (cut off price ) is
determined all those bidders whose bids
have been found to be successful ( i.e. at or
above the final price or cut off price) shall be
entitled for allotment of specified securities.
Allotment in Book Built Issue
In case an issuer company makes an issue of
100 percent of the net offer to public through
100 percent book building process:
(a) not less than 35 percent of the net offer to the
public shall be available for allocation to retail
individual investors.
(b) not less than 15 percent of the net offer to the
public shall be available for allocation to non –
institutional investors i.e. investors other than
retail individual investors and QIBs.
© Not more than 50 percent of the net offer to
the public shall be available for allocation to QIBs
Benefits of Book Building
Helps in price and demand discovery.
Have the issue pre-sold and preclude chances
of under subscription.
The procedure is simplified.
The possibility of price falling below par after
listing is remote.

Public Issue
Primary Issue are classified into
• Public issue (IPO and FPO)
 • Right issue
• Private placement
SEBI has laid entry norms for entities raising
funds through IPO and FPO:
• Entry Norm I:
• It is called Profitability Route.
• The Company desiring to tap the primary
market shall meet the following
requirements:
Net tangible assets of at least Rs 3 crores for
three full years , of which not more than 50
percent is held in monetary assets.
Distributable profits in atleast three out of
preceding five years both on stand alone as
well as consolidated basis with a minimum
average pre-tax operating profits during the
three most profitable years of Rs 15 crore.
Issuers not meeting with this requirement may
come out with IPOs if the issuer undertakes to
allot at least 75 percent of the net offer to
QIBs.
Net worth of atleast Rs 1 crore in three years.
If there is change in the company’s name
atleast 50 percent revenue from preceding one
year should be earned from new activity.
The issue size should not exceed 5 times the
pre-issue net worth as per audited balance
sheet of the last financial year.
• To provide sufficient flexibility and also to
ensure that genuine companies are not
deprived an access to the primary market on
account of rigidity of the parameters, SEBI has
provided two other alternatives route to
company not meeting any of the above
mentioned requirements. They are as follows:
Entry Norm II
It is through QIB route:
Issue shall be through a book building route,
with atleast 50 percent of the issue to be
mandatorily allotted to QIBs, failing which
money shall be refunded.
The minimum post issue face value capital
shall be Rs 10 crores or there shall be
 compulsory market making for at least 2
years.
SEBI exempted the following entities from
entry norms
Private sector Banks
Public sector Banks
An infrastructure company whose project has
been appraised by PFI or IDFC or IL &FS or a
bank which was earlier a PFI and not less than
5 percent of the project cost is financed by
any of these institutions.
Right issue by listed companies.
A company cannot make a public or right
issue of debt instruments (whether
convertible or not), unless it fulfills the
following two conditions:
 Credit rating of not less than investment
grade is obtained from not less than two SEBI
registered credit rating agencies and it should
not be in the list of willful defaulters of RBI.
Moreover it should not have defaulted
payment of interest or repayment of principal
if any for a period of more than six months.
A company shall not make a public or right
issue of equity share or any security
convertible at later date into equity share
unless all the existing partly paid up shares
have been fully paid or forfeited in a manner
specified in the guidelines.
In case of a public issue by an unlisted
company, the promoters shall contribute not
less than 20 percent of the post issue capital
which should be locked in for a period of
three years.
Fresh Issue of securities vs Offer for sale
In case of IPOs as well as FPOs company
makes a fresh issue of securities to the public
or an offer for sale to the public.
Offer for sale: SEBI states that Offer for sale
means offer of securities by existing
shareholders (i.e. promoters and other
 shareholders of the company) to the public
for subscription through offer document.
In case of public issues (either IPOs and
FPOs) the company makes only:
(i) fresh issue of securities to the public
through offer document /red herring
prospectus.
(ii) makes fresh issue of securities to the
public along with offer for sale through offer
document /red herring prospectus.
Right Issue
Meaning: Rights issue means an issue of
capital under Sub-section (1) of Section 81 of
the Companies Act,1956, to be offered to the
existing shareholders of the company through
a letter of offer.
The SEBI (ICDR) Regulations define rights issue
as an offer of specified securities by a listed
issuer to the shareholders of the issuer as on
the record date fixed for the said purpose;
  Purpose: Companies offer shares on rights
basis either to expand, diversify, restructure
their balance sheet or raise promoter stake.
In case of right issue company offers rights
issues at attractive price often at a discount to
the market price due to a variety of reasons.
Firstly, they want to get their issues fully
subscribed to.
Secondly, to reward their shareholders.
Thirdly, it is possible that the market price
does not reflect a stock’s true worth or that it
is overpriced, prompting promoters to keep
the offer price low.
Fourthly, to hike their stake in their
companies, thus, avoiding the preferential
allotment route which is subject to lot of
restrictions. Moreover, funds can be raised by
a company through this route without diluting
the stakes of both its existing shareholders
and promoters.
A shareholder has different options in case of
rights:
 The first is to exercise his rights, i.e., buy new
shares at the offered price,
Second is to renounce his rights and sell them
in the open market. (Renunciation means to
give up the right to subscribe to allotted
shares in the right issue or sell such rights for
a consideration).
 Third is to renounce part of his rights and
exercise the remainder.
Private Placement
Meaning
• Private placement refers to the direct sale of
newly issued securities by the issuer to a small
number of investors through merchant
bankers.
• These investors are selected clients such as
financial institutions, corporates, banks, and
high net worth individuals.
• The number of investors can go only upto 49
in one go.
Features of Private Placement
 Companies offering securities through private
placement shall not release any public
advertisements or utilise any media,
marketing or distribution channels or agents
to inform the public at large about such an
offer.
As per rules private placement offer letter
shall be accompanied by an application form
serially numbered and addressed specifically
to the person to whom the offer is made and
no person other person so addressed in the
application form shall be allowed to apply
through such application form.
A return of allotment of securities shall be
filed with registrar of Companies within 30
days of allotment along with a complete list of
security holders containing full name,
address, permanent account number and
email id of such security holder.

The private placement route offers several

advantages to the issuer for raising resources:
 The time taken by, as well as the cost of issue
for the private placement route is much less
for the issuer as compared to the public and
rights issues.
Privately placed issues can be tailor-made to
suit the requirements of both the issuer and
the investor, to give them greater flexibility
than public or rights issues.
Moreover, private placement does not
require detailed compliance of formalities,
rating, and disclosure norms as required in
public or rights issues.
Types of Private Placement
Preferential Allotment
Qualified Institutional Placement
Preferential Allotment
Such allotments are made to various strategic
groups including promoters, foreign partners,
technical collaborators, and private equity
funds.
 Companies need to seek approval from
shareholders for preferential allotment of
shares. An issuer need not file an offer
document in case of preferential allotment.
The SEBI (ICDR) Regulations define ‘preferential
issue’ as an issue of specified securities by a listed
issuer to any select person or group of persons on
a private placement basis and does not include an
offer of specified securities made through a public
issue, rights issue, bonus issue, employee stock
option scheme, employee stock purchase scheme
or qualified institutions placement or an issue of
sweat equity shares or depository receipts issued
in a country outside India or foreign securities.
Advantages
Companies use the preferential allotment
route to raise working capital.
One of the reasons why companies prefer to
allot preferential shares to their promoters is
that they can be pledged with banks either to
release their earlier holdings which are not
under lock-in or to release fresh funds to cash
in on the bull run.
 Preferential issues enable quick fund raising at
low cost and allow a company to take on
board its business partners like technology
collaborators, to raise their commitment to
the company.
Moreover, increase in investments by
promoters and institutional investors boosts
the confidence of retail investors.

Qualified Institutions Placement (QIP)

Qualified Institutions Placement is a private
placement of equity shares or convertible
securities into equity shares by a listed
company to Qualified Institutions Buyers.
QIBs means:
Mutual funds, venture capital funds and
foreign venture capital investor registered
with the Board.
A scheduled commercial bank.
A state industrial development corporation
Insurance company registered with IRDA
SEBI issued guidelines for Qualified
Institutions Placement on May 8, 2006. Key
features of the same are:
Issuer: A company whose equity shares are
listed on a stock exchange having nation-wide
trading terminals for a period of atleast one
year and which is complying with the
prescribed requirements of minimum public
shareholding of the listing agreements will be
eligible to raise funds in domestic market by
placing securities with Qualified Institutional
Buyers (QIB).
Securities: Securities which can be issued
through QIP are equity shares, or any
securities other than warrants which are
convertible into or exchangeable in equity
shares.
Issue Size: The aggregate funds that can be
raised through QIPs in one financial year shall
not exceed five times of the networth of the
issuer at the end of its previous financial year.