Capital Markets

Topics
1. Meaning and Significance of capital Markets
2. Constituents of capital Market
3. Capital Market instruments
4. Stock exchanges and its functions
5. SEBI- Role, Importance
6. OTCEI- Need objectives trading
7. Scrip less Trading-Meaning Need and advantages
8. Depositaries-Meaning and need
9. E-broking- meaning and operations
10. Listing of securities

Capital Markets

1. It is a market for long term funds

2. Its main focus is on financing of Fixed investments in contrast to working capital
financing by the money market
3. It is regulated by SEBI
4. The capital/Securities Market has two main segments

New Issue market-NIM and The secondary market or the Stock exchange

New issue market

- First time issued securities
- Source of capital formation
- Does not have any organizational set up in any particular place and is recognized
in respect of the triple services that it performs of
- Origination- Investigation , analysis and processing of new proposals
Underwriting- Guarantee that the issue would be taken up irrespective of the
public
- Distribution of securities to investors

Secondary market or stock exchange

- Olds securities listed on the stock exchange
- Provides an indirect role by providing liquidity to the investments already made
- It has a physical existence and is located in a particular geographical area
- The SE discharges three vital functions in terms of liquidity, Nexus between
savings and investment and Continuous Price formation
 Significance of Capital Markets

1. For Financing five year Plans

2. Nexus between Savings and Investment

3. Continuous Price formation

4. Ready and continuous market

5. Liquidity

Constituents of Capital Market

Financial Intermediaries

The financial institutions or intermediaries serve as institutional sources of Finance to

industry
They act as a link between the ultimate savers and the investor
Their main function is to convert the direct assets/Instruments/securities issued by
corporate into indirect securities. These indirect securities offer to individual investors
better investments alternatives than the direct/Primary security through the pooling
method.

Commercial Banks

Savings in the form of deposits and traditionally finance working capital requirements of
corporate. Also play a role in terms of direct term-lending particularly in the
infrastructure business. There are three groups of Banks- Public, Private and MNC. They
are a vital link between the capital market and the money market in India, The
commercial banks today also perform an important function relating to the new issues
which is termed as the underwriting function
They have also taken up the lead in development of Venture capital companies, leasing
companies, mutual funds etc to mobilize the savings for investment in Industrial
securities.
Non banking financial Companies- NBFC
1. They provide a variety of fund based and non fund based services, most of the
funds raised are in the form of public deposits. Depending on the nature of
services rendered they are categorized into
- Leasing companies
- Consumer Finance
- Housing Finance
- Venture capital Funds
- Merchant banking organizations
- Credit rating agencies
- Factoring services

Development/Public Financial Institutions- They are essentially a result of state

sponsorship

They consist of National Level institutions such as ICFI ltd, ICICI ltd, IDBI, SIDBI,
also there are state level institutions such as SII. With the conversion of ICICI and
IDBI into banks, they are poised to disappear form the financial scene in the
country

MF- Mutual funds

Insurance Organizations- Have massive access to funds and with the opening up of
the insurance sector they have become major players in the capital market as
investment Institutions.

Specialized Financial Intermediaries; The GOI has recently set up certain

specialized Financial Intermediaries
- Risk Capital and technology corporation of India Ltd- This corporation
provides assistance in terms of technology finance and risk capital
- Technology Development and Information Company of India Ltd-
Whenever new technology ventures are undertaken, this company assist in
the form of project Finance

Foreign Capital- FII

Stock exchanges
Capital Market instruments

The strength of the financial system depends to a large extent upon the variety of
financial instruments to serve the heterogeneous needs of the investors. In a way they
represent a financial product innovation

The basic three categories of Financial Instruments are Equity, Preferred stock and
Debentures.

A variety of innovative debt instruments have come out in the market- Namely they are
as follows

Participating debentures- Right to participate in profits after distribution of equity

dividend

Debt-Equity swaps- These are offers to swap debentures for equity

Warrants- They are also referred to as sweeteners. A warrant is a security which entitles
the holders to purchase a specified number of shares at a stated price before a stated
period. They are issued with debentures or equity shares.

Floating rate Bonds- The interest on such bonds is linked to a benchmark rate such as
bank rate, prime lending rate. The floating rate is quoted in terms of a margin above or
below the benchmark rate- The FRB ensure that neither the borrowers nor the lenders
suffer in case of changes in interest rates.

Zero coupon Bonds - They are sold at a discount and no interest is paid. The return to the
investor is the difference between the acquisition value and the redemption Value

Growth Bonds- These bonds are redeemed at maturity after 10 years. However Put
options can be exercised at the end of five years and seven years respectively

Stock exchange and its Functions

Stock exchange- Meaning

Functions

Stock exchanges discharge three vital functions in the orderly growth of capital formation
 • Nexus between Savings and Investment
• Market place
• Continuous Price formation

Nexus between savings and investment

• The savings of the community are mobilized and channelized by stock exchanges
for investment into those sectors and unitsb which are favoured by the
community at large
• It is the preference of investors for individual units as well as industry groups
which is reflected in the share prices , that decided the mode of investment
• Stock exchanges ensure that the listing modalities are complied with by the
companies that seek to list their issues on the exchange. These listing modalities
are framed with an objective of Investor protection
• Members of stock exchanges also assist in the floatation of new issues by acting
a s brokers, underwiters

Market place
• They provide a ready market place for the purchase and sale of securities,
enjabling free transferability and liquidty of investsments

Continuous Price formation

• Stock exchanges involve a process of continuous price formation. An investor
can at any times turn to the stock exchange and determine the value of his
investments at any point in time. The ever changing demand and supply position
result in continuous revaluation of assets with todays prices beign yesterdays
prices altered corrected and adjusted
• Stock exchanges act as Barometer of the state of health of a nations economy by
constantly measuting its progress

Procedure of Trading in the stock exchange

- differs from one stock exchange to another
- Placing an order with the broker- In SE only members are allowed to transact the
business . Outsiders interested in transactions must act through members. The
client places an oder with the member broker- The order may be a Limit order or
a spot order or an option order the broker has to execute the order
- Execution of the order- as soon as the order is recived the broker or his agent
approaches that part of the stock exchange in which the particular security is
traded . The clerk asks for the quotation or may quote his own price . short notes
ar taken down I pencil regarding the deals such as description of security ,
number of securities, price and name of the part etc.
- After the completion of the transaction it is recorded in the boks of the broker .
the contract note is prepared and sent to the client . the contarct note gives details
 abt the securities purchased or sold . In case of sales the client has to hand over
the share certificates to the broker
- Setllemne tof Transactions- Depending on the nature of te transaction there are
two ways of settlement . In case of ready delivry transactions the payment has to
be made immediately on the transfer of securities or within a specified short
period. The settlement may be made either directly through the clearning house
or directly without the clearing house

In case of forward transactions the settlement is done on a fixed day. The stock exchange
announces the settlement programme for different group of securities periodically. All
forward transactions are settled through the clearing house which simplifies payment for
and delivry of securities. If the transactions of two members are equal they are crossed
out, If they are not equal the net balance is paid or received. There is a system of carry
over to the next settlement if agreed upon by both the parties.

In stock exchanges there are speculative transactions also. Such transactions are
undertaken by brokers on their own behalf or on behalf of the clients. The intention of
speculative transactions is to gain from the benefit of differences in Prices. Securities are
purchased and sold but transfer of securities is rare.

SEBI- Organization, functions and Powers

The Securities and Exchange board of India –SEBI was established on April 12 1988
through an extraordinary notification of the GOI in the gazette of India, was given stat
recognition with the promulgation of the SEBI ordinance on January 30 1992. The
ordinance was replaced by the SEBI act from April 4 1992

Constitution of SEBI
The SEBI act 1992 provides for the establishment of a Board
The Board consists of a chairman and 5 other members
One each from Ministry of Finance and the Ministry of Law, Justice and company affairs
and one from the RBI and two others to be appointed by the central government.
The basic aim of SEBI is to regulate the functioning of the capital market to protect the
interests of the investors

Organization of SEBI

After it became a Stat body, SEBI restructured its organization and rationized it in line
with its expanded scope and range of activities. It has divided its activities into five
operational departments, each one headed by the executive director. Apart from these ,
there are two other departments Legal department and investigation Dept, also head by an
official. All these departments are further divided into divisions , each headed by a
division chief with a specific responsibility.
Primary market department- Policy issues and regulatory matters for the Primary market
and its intermediaries

The issue management and Intermediaries department- Vetting of documents and other
things like registration, regulation and monitoring of issue related intermediaries

The secondary market department- Policy issues and regulatory matters for the secondary
market and its intermediaries

The Institutional investment department- Looks after M and A, Frames polices for FII,
MF and others

SEBI also has two advisory committees one each for the primary and the secondary
market , to provide advisory inputs in framing policies and regulations. These are
constituted from among the market players, Instritutional investors and eminent
personalities associated with the capital market. The committees howver are non-stat in
nature and SEBI is not bound by the advisory committees. Besides the above
departments SEBI has recently opened regional offices at New Delhi, Calcutta and
Madras , Bombay beign the HQ. The regional offices shall cover the operations in
northern, eastern and southern regions respectively.

Functions and Role of SEBI

SEBI is mainly intended for the facilitation of the resources through the securites market
and its efficient allocation .The SEBI act inter-alia provides SEBI with the power to
• Regulate the business in the stock exchange and any other securities market
• Registering and regulating the working of stock brokers, sub brokers, share
transfer agents, bankers to the issue, registrars to the issue, merchant bankers
underwriters, portfolio Managers investment advisors and such other
intermediaries who may be associated with the securities market in any manner
• Registering and Regulating the working of collective investment schemes
including mutual funds
• Promoting and regulating self-regulatory organizations
• Prohibiting Fraudulent and unfair trade practices in securities market
• Promoting investor education and training of intermediaries in securities market
• Prohibiting Insider trading in securities
• Regulate and Register matters pertaining to issue
• To regulate take over deals, mergers and amalgamation
• Calling for information from < undertaking inspection , conducting enquiries,
and audits of stock exchanges and intermediaries and self-regulating
organizations in the securities market
 • Performing such functions and exercising such powers under the provisions of
the SCRA 1956 as may be delegated to it by the central government
• Conducting investment research and analysis

Powers of SEBI

The powers vested with the central government under various provisions of the SCRA
shall also be vested with SEBI. They Include inter-alia amongst others the following

• Power to call for periodic returns from stock exchange

• Power to call upon the stock exchange or any member of the stock exchange to
furnish the relevant information
• Power to appoint any perso to make inquiries into the affairs of the stock
exchange
• Power to amend bye laws of the stock exchange
• Power to compel a public company to list its shares in the stock exchange

Critical Evaluation of the working of SEBI

A fair and a well regulated capital market are of immense importance for the
development of a country. SEBI was a step towards ensuring the same. Various measures
have been introduced by SEBI which have brought abt investor awarness, improved the
credibility and have bought abt a better disclosure of information SEBI ahs benefited
investors in many ways
Reduction in Malpractices through regulations
Investor education- Assocuiations have been encourage to spread information through
newsletters, conferences etc
Better disclosure of information and registration of Intermediaries, capital adequacy
norma have been laid down for brokers SEBI has improved the flow of information to
investors thereby enabling them to arrive at proper investement decisions

Drawbacks/Limitations in the functioning of SEBI

• Bureaucratic attitude and long winding procedures
• No action on misleading disclosures- SEBIs moves in the primary market have
not been as successful as claimed- Example the disclosure norms in the
prospectus. The financial Projections required to be reported in the prospectus
mislead the investors. In one case the companies prospectus projected the total
income at one figure while its press release projected half the figure. No action
has been taken by SEBI on such mis-representation
• Counter Productive guidelines- Some of the SEBI guidelines seem to be counter-
productive- Example: The regulations requiring a minimum capital of Rs 1
 crore for a class one merchant banking firm. This will adversely affect the new
entrants in the market and growth of such services will be hampered.
• Inability in implementing a number of reforms- SEBi is handicapped by a weak
legislation and is therefore not in a position to implement a number of reforms.
The stock exchanges and the brokers seek help under the SCRA and companies
act because of which SEBI faces problems in implementing its regulations
• Lack of adequate powers- Many of SEBIs problems can be attributed to the lack
of adequate powers. The SEBi act does not provide sufficient powers . Under the
act SEBI can only recommend action to the government. It cannot launch direct
action against any erring capital market operator. Ideally SEBI as a regulatory
body should have been established with powers comparable to those of
institutuions like the SEC in US and Sib in the YK. The SEC in the US can ipose
penalties and prosecute anyone directly
• Mechanical Procedures- The procedures of SEBI are too mechanical and due to
this it is not possible for SEBI to complete its task of Investor protection
effectively. Several companies with unreliable projects are taking investors for a
ride. This is due to the mechanical verification procedure.
• Wrong practice in framing regulations- SEBI has followed a wrong practice in
framing regulations, ideally the best lawyers should be deployed to frame
regulations , the draft regulations should then be published for public comment ,
however in case of SEBI, badly drafted regulations have been often published.

Over the Counter exchange of India

Rationale behind OTCEI

Companies differ in their paid up equity capital, assets, earnings , size, financial strength
etc. For example Fresh issues by new and unknown business men are not the same as
issues of known entrepreneurs. Similarly new issues of new companies and new issues
of old companies are at a different tier . All this calls for differentiation as between the
companies and for a multiple structure of placing the companies according to their
strength and tradeability.

From investors point of view a type of product differentiation si required in roder to

enable them to select the right type of companies as their risk profile. The companies
have different degrees of risk, marketibuility , liquidity . Theinvestor should have the
choice of selecting shares which suit his requirements from the market segment . This
necessitates a muti structure system of placing companies for trading

A Multi-ter system of exchange is the need of the hour , it would promote investement
and in turn the growth of capital market in India
With this objectives in mind the OTC exchange of India was eatablished as a company
incorporated under section 25 of the companies act 1956. OTC exchange recongnized as
a stock exchange under section 4 of the SCRA 1957

OTC is a market where buyers seek out sellers and vice versa and then attempt to arrange
terms and conditions for purchase/sale acceptable to both parties. It is a negotiated
market place that exsists anywhere and everywhere as opposed to atock exchange .
There is no particular market place in geographical terms

The OTC has been promoted by All India financial institutions such as UTI, ICICI,
IDBI, LIC etc.

Main Features of OTC

Rightly called the market for the future

Operations: ringless and screen based- The Trading is not in the traditional ring but is
screen based

Sponsporship and market making- The scrips listed on the oTCEI will be sponsored by its
members . Members when they sponser research the scrip and recommend investment
worthiness of the scrip . As sponsers memberes will be compulsorily market making in
that scrip which ensures liquidity.

Faster Transfers and trading without shares: OTC trading also provides for transfer of
shares by registrars upto a certain percentage per folio. This results in Faster transfers.
The concept of immediate settlement instead of longer settlement periods makes it better
for the investor . Investor will treade not wioth share certificates but with the different
tradeable document caller CR- Counter receipt . However he can always exercise the
right of having a share certificate by surrendering the cR and again exchanging the share
certificate for the CR when he wants to trade.

Objectives of OTCEI

OTCEI facilitates small investors, Traditional stock exchanges have failed to provide
liquidity to small scrips and access to small investors

To protect small investors from the malpractices of the brokers as well as the promoters
by quoting reasonable prices a s judged by fundamentals and at competitive spread.

To create a market place for all tradeable securities listed as well as unlisted and to crate
a market for odd lots as well as convertible and non-convertible securities.
No speculative effects of rigging is possible in the market and therefore investors have a
better chance of security

Natural Market- Provides immediate liquidity and quicker transactions and this ultimately
helps in the formation of a natural market.

Advantages and Limitations of OTCEI

Lower costs and expenses- Lower cost of new issues and lower expenses of services to
investors

Provides market for smaller companies through which they can sell their issue to the
public

Freedom of choice- In both the primary and secondary market greater freedom of choice
to select stocks by dealers for market-making

Adoption of regulatory measures- and a strict code of conduct for the members

Free flow of information- The Information flows are freer and more direct from market
makers to customers due to close contact between firms and market makers

Trading operations in OTCEI are such that there is less scope for manipulation
speculation and malpractices thereby benefiting investors

Correct share pricing has become too difficult because of rigging and speculation in the
share market . also the investors may be overcharged brokerages and commissions , they
are prone to be misguided by flowery prospectus , this problem can be reduced if the
OTCEI were to operate in such a way that fair prices are fixed and advertised by the
market makers.

Weaknesses in The OTCEI

Lack of Liquidity
• Mushrooming growth of companies
• Non-Viable and therefore not well traded , The market for such securities is not
well developed.

Inadequate supply of good scrips

• Leading to supply and demand problems
 • The Financial Institutions are holding large chunks of these scrips which do they
not part with
• The management in India are guarding themselves against possible take overs ,
outside interference and threat to their family interests. They generally do not
part with their shares due to fear of possible management interference or take over

Incorrect Share pricing

Due to rigging and speculation in the secondary market the correct share values are not
known

Manifold problems of Investors

- Neglect of small and less educated investors
- They do not have knowledge of the operations and are cheated by the investors
- The share prices are not known and unfair as they are manipulated by speculative
forces
- The investors are overcharged due to brokerages and commissions etc
- The investors are misguided by the investment magazines , brokers and sub
brokers about the prospects of the companies

Listing of securities

What is meant by ‘Listing of Securities’?

Listing means admission of securities of an issuer to trading privileges
(dealings) on a stock exchange through a formal agreement. The prime
objective of admission to dealings on the exchange is to provide liquidity
and marketability to securities, as also to provide a mechanism for effective
control and supervision of trading.
What is a ‘Listing Agreement’?
At the time of listing securities of a company on a stock exchange, the
company is required to enter into a listing agreement with the exchange.
The listing agreement specifies the terms and conditions of listing and the
disclosures that shall be made by a company on a continuous basis to the
exchange.

Listing compulsion under the companies act –section 73

Compulsory only if public issue is made

Sub section 1 of section 73 provides the compulsory listing of shares and debentures
of all public companies compulsory with one or more recognized stock exchanges.
This sub section provides that every company intending to offer shares and
debentures to the public for subscription by the issue of prospectus shall before such
issue make an application to the one or more recognized stock exchanges for
obtaining permission. for the shares and debentures to be offered to be dealt with
and quoted at the stock exchanges.

Advantages of Listing
- Listing of securities confers the advantages of liquidity, marketability and
free transfer of securities and accordingly listed securities receive
preferential treatment for investment by Institutional and foreign investors.
- Listed securities enjoy more public confidence due to the regulation of the
stock exchanges, trading procedures, greater liquidity, reduced risk etc
- Transactions in listed securities are published widely in leading newspapers
and journals. This leads to greater publicity for the company concerned on
one hand and allows the investing public to assess the working results of the
company on the other hand.
- Listing adds to the prestige and importance of listed companies
- Listed securities command higher collateral value for the purposes of bank
credit
- The listed companies are under obligation to inform the shareholders about
the various corporate details from time to time. Thus the investors remain
abreast with the performance details of the company they have invested in.

Procedural requirements of Listing

A company has to satisfy certain conditions for enlisting. Some of the important
requirements and obligations are as follows:-

The MOA and AOA must contain prescribed provisions

The company must offer for public subscription through a prospectus at least the
prescribed minimum percentage of issued capital
The company should inform the exchange authorities about the dividend
distribution immediately after the BOD
The company should give an undertaking that it will comply with the provisions of
the companies act and the securities contract regulation act and the provisions
framed there under
Scrip less Trading- Meaning, Need and Advantages

Traditionally, settlement system on Indian stock exchanges gave rise

to settlement
risk due to the time that elapsed before trades were settled by physical
movement
of certificates. There were two aspects: First relating to settlement of
trade in stock
exchanges by delivery of shares by the seller and payment by the
buyer. The stock
exchange aggregated trades over a period of time and carried out net
settlement
through the physical delivery of securities. The process of physically
moving the
securities from the seller to his broker to Clearing Corporation to the
buyer’s
broker and finally to the buyer took time with the risk of delay
somewhere along
the chain. The second aspect related to transfer of shares in favour of
the purchaser
by the issuer. This system of transfer of ownership was grossly
inefficient as every
transfer involved the physical movement of paper securities to the
issuer for
registration, with the change of ownership being evidenced by an
endorsement on
the security certificate. In many cases the process of transfer took
much longer
than the two months as stipulated in the Companies Act, and a
significant
proportion of transactions wound up as bad delivery due to faulty
compliance of
paper work. Theft, mutilation of certificates and other irregularities
were rampant,
and in addition the issuer had the right to refuse the transfer of a
security. Thus the
buyer did not get good title of the securities after parting with good
money. All this
added to the costs and delays in settlement, restricted liquidity and
made investor
grievance redressal time-consuming and at times intractable.
To obviate these problems, the Depositories Act, 1996 was passed to
provide for
the establishment of depositories in securities with the objective of
ensuring free
transferability of securities with speed, accuracy and security by
In order to streamline both the stages of settlement process, the
Depositories Act
envisages transfer of ownership of securities electronically by book
entry without
making the securities move from person to person.
The owner of securities intending to avail of depository services
opens an account with a depository through a depository participant
(DP). The
securities are transferred from one account to another through book
entry only on
the instructions of the beneficial owner.
In order to promote dematerialisation of securities, NSE joined hands
with leading
financial institutions to establish the National Securities Depository Ltd.
(NSDL),
the first depository in the country, with the objective of enhancing the
efficiency in
settlement systems as also to reduce the menace of fake/forged and
stolen
securities. This has ushered in an era of dematerialised trading and
settlement.
SEBI has made dematerialised settlement mandatory in an ever-
increasing number
of securities in a phased manner, thus bringing about an increase in
the proportion
of shares delivered in dematerialised form.

Advantages of Scripless Trading or Dematerialization

Investors
• Speedy settlement, greater liquidity and reduction in delay in registration
• Prompt receipt of dividends and rights bonus issues
• Faster transfer at reduced costs
• Elimination of problems and risks due to loss, forgery or mutilation of
securities.
• Immediate trading after allotment of shares.

Companies
• A record date will eliminate need for long book closure
• Prompt communication with investors regarding meetings, accounts, dividend
etc
• Ready and upto date availaibility of names and addresses of security holders
• Better service to foreign instiutions

Intermediaries
• Less risky settlement with implementation of collateral base payment system
• Higher earnings due to large trading volume
 • Improved cash flow due to reduction in settlement period
• Specilaisation in services of jobbers and brokers
• Arranging pledges without physical movement of scrips.

E- Broking –Short Notes

E-broking is the trading of shares over open networks like the internet
It is much faster and simpler than the conventional stock trading system
The use of e-broking eliminates operating costs like machinery and personnel which
would normally be incurred in the conventional means
It facilitates global reach
Any indivisual having a bank account with mandated bank is the basic prerequisite
of e-brokibng
The investor opens an e-broking account with an e-broker by filing an application
form on line
The e-broker after checking the validity of investors bank accounts allots him with a
login and password for e-broking