MODULE 2

ii. CAPITAL MARKET

What is Capital market? Difference between Money and Capital markets Role of Capital market Methods of Raising Capital Role of SEBI (Brief) Recent Developments in Indian capital Market Cap market Reforms- Objectives and Measures Stock Market Volatility

CAPITAL MARKET
Pace of economic development is conditioned, among other things, by the rate of long term capital investment and capital formation. And, capital formation is conditioned by the mobilisation, augmentation and channelisation of investible funds. Capital market serves this function by pooling capital resources and making them available to investors.
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Difference between Money market and Capital Market

Money market Term Concerned with short term funds(<12 months) Capital Market Concerned with long term funds

Instruments
Level of Risk Magnitude Secondary market

TBs, CPs, CDs, Bills of Exchange etc.

Low Each single instrument is of large amount Generally none

Shares, debentures, Govt bonds etc.

High Each single instrument holds a small amount Secondary market exists Exists. E.g., Stock Exchange Existence of authorised dealers
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Formal Place None of Transaction Role of Broker Transactions conducted without broker

Interdependence of the Two Markets

Economy requires both types of fundsboth short term and long term. Both markets are supportive of each other. Both contribute to the flow of funds and liquidity in varying time frames.

Structure of Capital Market

Market for medium and long term capital and all the facilities and institutional arrangements thereof. Consists of 2 Constituents- Organised and unorganised Constituents of Organised Capital Market: 1. Govt Securities Market 2. Industrial Securities Market 3. Development Financial Institutions (DFIs) 4. Financial Intermediaries
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Structure of Capital Market

Govt Securities Market

- Also known as Gilt-edged market - These securities carry fixed interest and are dated - Investors are mainly FIs like commercial banks, LIC, GIC, PFs etc - Sometimes these are captive markets - RBI plays an important role here through OMO
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Structure of Capital Market

2. Industrial Securities Market: - Deals with shares and debentures of new and existing companies -Divided into Primary market and Secondary market Primary market: Helps raise new capital through shares and debentures Secondary market: Deals with securities already issued by the companies; Operates through stock exchanges This Market helps corporates to raise equity and provides liquidity to investors because securities can be readily bought and sold.
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Structure of Capital Market 3. Development Financial

Institutions (DFIs) These were set up to provide medium and long term financial assistance to private industrial sector- once known as term lending institutions, now DFIs. Play a very useful role by subscribing to shares and debentures of old and new companies, giving loans, underwriting new issues etc; LIC and UTI mobilise resources from public and place them with the capital market.
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Structure of Capital Market-DFI

All- India DFIs: Industrial Finance Corporation of India (IFCI)
- Small Industries Devt Corporation (SIDBI) - Industrial Investment Bank of India

Specialised Financial Institutions: EXIM Bank

Infrastructure Development Corporation of India

Investment Institutions:

- LIC, UTI, GIC etc

State Level Institutions :
- State Financial corporations (SFCs) - State Industrial Development Corporations (SIDC)

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Structure of Capital Market

4. Financial Intermediaries: These help in mobilising savings and supplying funds to the capital market
Merchant banks- Manage and underwrite new issues and advise corporate clients on fund raising and other financial aspects. Leasing companies: Provide finance for acquiring plant and machinery, especially for SMEs Mutual Funds: Mobilise funds from general public and invest in capital market Venture Capital companies: Provide financial support to new ideas, introduction and adoption of new technologies
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Role of Capital Market

1. 2. 3. 4. Mobilisation of savings: Network of institutions and various types of financial assets Providing liquidity: Enabling transactions to be made quickly and easily (Covenience and speed of converting assets into cash) Determining a fair price for securities (Price Discovery) Channelisation of funds into investments: Financial intermediaries have specialised knowledge, expertise, information and huge resources to allocate resources to most viable projects Minimising Transaction Costs i.e., the cost of transferring resources from lenders to borrowers and also the risk of default, flouting contract etc Industrial Devt: Providing funds for diversified purposes like setting up new units, expansion, modernisation, upgradation of technology

5. 6.

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Role of Capital Market

6. Modernisation and rehabilitation of industries: Institutions like IFCI, ICICI and IDBI help in replacing obsolete technology and tech upgradation- these also solve problems of foreign exchange by channelising funds from international agencies like International Finance Corporation 7.Technical assistance: Advisory services for preparing Feasibility studies, training of entrepreneurs 8. Encouraging investors to invest in securities: By providing facilities for continuous regular and ready buying and selling of securities 9. Reliable guide to performance: The capital market is a guide to the performance and financial position of companies
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Methods of Fund Raising

Primary market is market for fresh capital. Funds raised through three categories i. Initial Public Offer ii. Rights Issue iii. Private Placement Players: Issuer Investor Intermediary
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Initial Public Offering (IPO)

An IPO or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises. Many companies that undertake an IPO also request the assistance of an investment banking firm acting in the capacity of an underwriter to help them correctly assess the value of their shares, that is, the share price

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IPO
When a company lists its securities on a public
exchange, the money paid by investors for the newly issued shares goes directly to the company (in contrast to a secondary market trade of shares on the exchange, where the money passes between investors). An IPO, therefore, allows a company to tap a wide pool of investors to obtain capital for future growth, repayment of debt or working capital.

.
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Rights Issue
A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings. A rights issue is, therefore, a way of raising new cash from shareholders - this is an important source of new equity funding for publicly quoted companies.

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Private Placement
It is direct sale of newly issued securities to a group of investors ( i.e. FI, banks, corporate, HNI) by issuer through merchant bankers. Advantages Time and cost is less compared to IPO and right issue. It can be customised for both issuer and investor. It does not require detailed compliance of formalities, ratings, and disclosure norms Major issuers All India Financial Institutions, PSUs, central and state level undertakings (i.e. AEC bonds), banks Major subscribers - Banks, Provident funds, MF, HNI

Private Placement
Reasons for the Growth of Private Placement Market
1. Prolonged unfavorable conditions in primary market 2. PP was not bound to any regulatory system- (though, in sept 2003, SEBI issued stringent disclosure norms which was still unregulated). 3. No lock-in period for promoters 4. No compliance system for merchant bankers 5. Operational flexibility and attractive pricing 6. Private sector can tap this route to retire their old expensive bonds/ debt instruments

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Private Placement
Current Scenario- PP now regulated. Disclosure needs to be made through company on the site of exchanges. Credit rating is compulsory. (investment grade is necessary) RBI has barred FIs from investing in unrated securities and securities below minimum credit rating. All debt issuers must have redemption reserve and must appoint trustee. Securities issued and traded in demat form All securities must be executed on exchanges only.

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Resource Mobilisation through international market

How Companies can mobilise resources through international market: Global Depository Receipts (GDRs)

American Depository Receipts ( ADRs)

Foreign currency convertible bonds (FCCB)

External Commercial Borrowing (ECBs)

Euro Issues
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Secondary Market
Major Constituents of Secondary Market Different Stock exchanges (BSE, NSE, OTCEI, regional stock exchanges) Brokers SEBI (Regulator) Buyers
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SEBI
SEBI is the regulatory authority covering all the operations of the capital market. Its main functions are: Protection of investors interest Guidelines on capital issue Regulation of the working of MFs Regulating the activities of stock brokers Restriction on insider trading Dematerialization of shares Other functions

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Recent Developments in capital market

Earlier, the functioning of stock exchanges was characterised by long delays, lack of transparency, vulnerability to price rigging and insider trading. A number of measures have been taken to overcome these problems.

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Objectives of Capital Market Reforms

To provide effective control of stock exchange operations To enhance transparency by increasing the flow of information To protect the interest of investors To check insider trading To improve operational efficiency of the stock markets To promote healthy development of the capital market
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Capital Market Reforms in India Cherunilam, p.257-261

1. IPO guidelines- Free Pricing: Provided that SEBI guidelines on disclosures and investor protection are met, issuers of capital are able to price their issues according to their assessment of the market conditions. Transition from open outcry system to electronic trading- leading to transparency, more efficient price discovery and reduction in transaction cost More Instruments (Deepening) and More Market Participants such as MFs and FIIs(widening) Improvement in Trading, Clearing and Settlement of transactions- Shortening of settlement cycle, acceleration of book entries through depository system
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2.

3. 4.

Capital Market Reforms in India Cherunilam, p2576-261 5. Dematerialization of accounts- increased speed and safety reduced transaction cost 6. Reduction in risks: All stock exchanges in the country have established clearing houses through which transactions are settled. Earlier this was the case only with some transactions, while others were directly settled between members. Routing transactions through clearing houses has reduced credit risk. 7. Structure of Information flows: Companies offering securities in capital market are required to make public disclosures of all relevant information; also furnish unaudited quarterly financial results
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8. Emphasis on fair Trading Practices: According to SEBI

Act, 1992, insider trading is prohibited; there are also separate regulations governing take-overs and acquisitions and protection of minority share holders interest 9. Increasing Integration of Different Segments of the Securities market: Between regional exchanges, in terms of interest rate structure etc.
10. Measures of investor protection

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Volatility
Volatility is one of the most important characteristics of any stock market; it is also an important basic statistical risk measure. Can be used to measure the market risk of a single instrument or the entire portfolio of instruments. Today, volatility is calculated for all sorts of variables, such as stock returns, interest rates, market value of a portfolio etc. Stock return volatility is the variation of the stock returns in time. It is the standard deviation of daily stock returns around the mean value.
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Volatility of Indian Stock market

The stock market barometer Sensex fell by 5,054 points during 2011 to end at 15,454.92 points. The total investor wealth, measured in terms of cumulative market value of all listed stocks, dipped by Rs 19.46 lakh crore to Rs 53,48,644.8 crore ($1.002 trillion). In percentage terms, the losses in the stock market were 24.6 per cent In contrast, 2012 saw indian stock markets doing very well Currently Sensex is trading close to -------.

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Gold appreciated by 32 per cent and silver by 10 per cent during 2011. Gold prices began the year 2011 at Rs 20,890 per ten gram and ended at Rs 27,640. During 2011, prices of precious metals had also been volatile. Gold had risen to close to Rs 30,000 level, while silver had gone close to Rs 60,000 at one point of time.. Currently gold is trading above ---- and silver around----.
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Factors Influencing Stock Market Volatility Stock market volatility may be related to: Global crude prices: Stock returns tend to be lower after an increase in crude oil price and higher if crude oil price falls in the previous month. In general, a decrease in this months crude price on the average indicates a higher stock market return in the coming month. i.e, stock market tends to move in the opposite direction to crude oil. Global gold prices: Investors typically include in their portfolio investments that have historically exhibited an inverse relationship with stock market movement as risk insurance. Gold has an increasing price trend in recent years and considered to be a hedge against inflation. During inflation, stocks are usually valued low and gold acts as a better investment portfolio. US Stock market reflected by Dow Jones Industrial Average: Some large firms are entirely export-driven and global volatility affects their customers. FII Flows: Move towards safe countries 32

Volatility in 2013
Domestically, the outcomes of the elections in five states, the Budget of 2013 (which may be populist due to the 2014 general Elections) and the rate at which inflation comes down (which will also result in interest rates coming down) will be events to be watched in the first half of calendar year 2013. It would also depend on whether funds perceive India as a stable investment destination against a backdrop of volatile global markets and policy flip-flops.. Global economic uncertainty will continue to plague us as it has since the year 2008. The movement in world capital markets would be determined by the events in Europe, China and USA.
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Recap Quiz
1. 2. A company selling common shares is not required to repay the capital to investors. T/ F Direct sale of newly issued securities to a group of investors ( i.e. FI, banks, corporate, HNI) by issuer through merchant bankers is called ________ ____________. Indian companies can go directly for ADRS without domestic offering T/ F ________ is the regulatory authority covering all the operations of the capital market. FCCB can be converted into _________ of issuing company either in whole or in part. Only companies with large _________ ________ potential opt for FCCB. Rcom, Hotel Leela Ventures, JSW Steel, Suzlon Energy, Sterling Biotech faced FCCB __________ between Feb and June12
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3. 4. 5. 6. 7.

Recap Quiz
1. A company selling common shares is not required to repay the capital to investors. T (DEBT needs to be repaid; share implies ownership and so it need not be repaid)
Direct sale of newly issued securities to a group of investors ( i.e. FI, banks, corporate, HNI) by issuer through merchant bankers is called Private Placement

2.

3. 4. 5. 6. 7.

Indian companies can go directly for ADRS without domestic offering T SEBI is the regulatory authority covering all the operations of the capital market FCCB Can be converted into ordinary shares of issuing company either in whole or in part (Hence convertible) Only companies with large forex earnings potential opt for FCCB. Rcom, Hotel Leela Ventures, JSW Steel, Suzlon Energy, Sterling Biotech all had FCCB redemptions between Feb and June12

Recap Quiz
1. A prospectus, which does not have complete particulars on the price of the securities offered and quantum of securities offered is called _________________. A rights issue is a way of raising -------- cash from ---------- shareholders _________manage and underwrite new issues and advise corporate clients on fund raising and other financial aspects. ________ mobilise funds from general public and invest in capital market. ___________provide financial support to new ideas, introduction and adoption of new technologies.

2. 3.

4. 5.

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Recap Quiz
1. A prospectus, which does not have complete particulars on the price of the securities offered and quantum of securities offered is called Red Herring prospectus. A rights issue is a way of raising new cash from existing shareholders Merchant banks manage and underwrite new issues and advise corporate clients on fund raising and other financial aspects. Mutual Funds mobilise funds from general public and invest in capital market. Venture Capital companies provide financial support to new ideas, introduction and adoption of new technologies.

2.

3.
4. 5.