2Introduction-Capital Market.
-
Upload
ratna-kranthi -
Category
Documents
-
view
225 -
download
0
Transcript of 2Introduction-Capital Market.
-
8/7/2019 2Introduction-Capital Market.
1/23
INTRODUCTION
FINANCIAL MARKETS
Generally speaking, there is no specific place of location to indicate a financial
market. Wherever a financial transaction takes place, it is deemed to have taken place in
the financial market. Hence financial markets are pervasive in nature since financial
transactions are themselves very pervasive throughout the economic system. For
instance, issue of equity shares, granting of loan by term lending institutions, deposit of
money into a bank, purchase of debentures, sale of shares and so on.
However, financial markets can be referred to as those centers and arrangements
which facilitate buying and selling of financial assets, claims and services. Sometimes,
we do find the existence of a specific place or location for a financial market as in the
case of stock exchange.
-
8/7/2019 2Introduction-Capital Market.
2/23
CHART
CLASSIFICATION OF FINANCIAL MARKETS
Organized Market Unorganised Market
Capital Market Money Market
Industrial Govt. Securities Long Term Call Money Commercial Treasury bill Short TermSecurities Market Loan Market Market Bill Market Market Loan Market
Market
Primary Secondary Term Loan Market Market for financial Money Lenders Indigenous,Market Market Market for Mortgage Guarantees Bankers etc.
-
8/7/2019 2Introduction-Capital Market.
3/23
Classification of Financial Markets
The classification of financial markets in India is shown in chart.
Unorganized Markets
In these markets there are a number of money lenders, indigenous bankers, and
traders etc., who lend money to the public. Indigenous bankers also collect deposits from
the public. There are also private finance companies, chit funds etc., whose activities are
not controlled by the RBI. Recently the RBI has taken steps to bring private finance
companies and chit funds under its strict control by issuing non-banking financial
companies (reserve Bank) Directions, 1998. The RBI has already taken some steps to
bring the unorganized sector under the organized fold. They have not been successful.
The regulations concerning their financial dealings are still inadequate and their financial
instruments have not been standardized.
Organized Markets
In the organized markets, there are standardized rules and regulations governing
their financial dealings. There is also a high degree of institutionalization and
instrumentalisation. These markets are subject to strict supervision and control by the
RBI or other regulatory bodies.
-
8/7/2019 2Introduction-Capital Market.
4/23
These organized markets can be further classified into two. They are:
(i) Capital market
(ii) Money market
Capital Market
The capital market is a market for financial assets which have a long or indefinite
maturity. Generally, it deals with long term securities which have a maturity period of
above one year. Capital market may be further divided into three namely:
(i) Industrial securities market
(ii) Government securities market and
(iii) Long term loans market
(i) Industrial Securities Market
As the very name implies, it is a market for industrial securities namely:
(i) Equity shares or ordinary shares, (ii) Preference shares and (iii) Debentures or bonds.
It is a market where industrial concerns raise their capital or debt by issuing appropriate
instrumental. It can be further subdivided into two. They are:
(i) Primary market or New issue market
(ii) Secondary market or Stock exchange.
-
8/7/2019 2Introduction-Capital Market.
5/23
Primary Market
Primary market is a market for new issues or new financial claims. Hence, it is
also called New Issues market. The primary market deals with those securities which are
issued to the public for the first time. In the primary market, borrowers exchange new
financial securities for long term funds. Thus, primary market facilitates capital
formation. There are three ways by which a company may raise capital in a primary
market. They are:
(i) Public issue
(ii) Rights issue
(iii) Private placement
The most common method of raising capital by new companies is through sale of
securities to the public. It is called public issue. When an existing company wants to
raise additional capital, securities are first offered to the existing shareholders on a pre-
emptive basis. It is called rights issue. Private placement is a way of selling securities
privately to a small group of investors.
Secondary Market
Secondary market is a market for secondary sale of securities. In other words,
securities which have already placed through the new issue market are traded in this
market. Generally, such securities are quoted in the Stock Exchange and it provides a
continuous and regular market for buying and selling of securities. This market consists
of all stock exchanges recognized by the Government of India. The stock exchanges in
-
8/7/2019 2Introduction-Capital Market.
6/23
India are regulated under the Securities Contracts (Regulation) Act, 1956. The Bombay
Stock Exchange is the principal stock exchange in India which sets the tone of the other
stock markets.
(ii) Government Securities Market
It is otherwise called Gilt-Edged securities Market. It is a market where
Government securities are traded. In India there are many kinds of Government
Securities short-term and long-term. Long-term securities are traded in this market
while short term securities are traded in the money market. Securities issued by the
Central Government, State Governments, Semi-Government authorities like City
Corporations, Port Trusts etc. Improvement Trusts, State Electricity Boards, All India
and State level financial institutions and public sector enterprises are dealt in this market.
Government securities are issued in denominations of Rs.100. Interest is payable
half-yearly and they carry tax exemptions also. The role of brokers in marketing these
securities is practically very limited and the major participant in this market is the
commercial banks because they hold a very substantial portion of these securities to
satisfy their S.L.R. requirements.
The secondary market for these securities is very narrow since most of the
institutional investors tend to retain these securities until maturity.
The Government securities are in many forms. These are generally:
(i) Stock certificates or inscribed stock
(ii) Promissory Notes
(iii) Bearer Bonds which can be discounted.
-
8/7/2019 2Introduction-Capital Market.
7/23
Government securities are sold through the Public Debt Office of the RBI while
Treasury Bills (short term securities) are sold through auctions.
Government securities offer a good source of raising inexpensive finance for the
Government exchequer and the interest on these securities influences the prices and
yields in this market. Hence this market also plays a vital role in monetary management.
(iii) Long-Term Loans Market
Development banks and commercial banks play a significant role in this market
by supplying long term loans to corporate customers. Long-term loans market may
further be classified into:
(i) Term loans market
(ii) Mortgages market
(iii) Financial guarantees market
Term Loans Market
In India, many industrial financing institutions have been created by the
Government both at the national and regional levels to supply long-term and medium
term loans to co4porate customers directly as well as indirectly. These development
banks dominate the industrial finance in India. Institutions like IDBI, IFCI, ICICI, and
other state financial corporations come under this category. These institutions meet the
growing and varied long-term financial requirements of industries by supplying long-
-
8/7/2019 2Introduction-Capital Market.
8/23
term loans. They also help in identifying investment opportunities, encourage new
entrepreneurs and support modernization efforts.
Mortgages Market
The mortgages market refers to those centers which supply mortgage loan mainly
to individual customers. A mortgage loan is a loan against the security of immovable
property like real estate. The transfer of interest in a specific immovable property to
secure a loan is called mortgage. This mortgage may be equitable mortgage or legal one.
Again it may be a first charge or second charge. Equitable mortgage is created by a mere
deposit of title deeds to properties as securities whereas in the case of a legal mortgage
the title in the property is legally transferred to the lender by the borrower. Legal
mortgage is less risky.
Similarly, in the first charge, the mortgager transfers his interest in the specific
property to the mortgages as security. When the property in question is already
mortgaged once to another creditor, it becomes a second charge when it is subsequently
mortgaged to somebody else. The mortgagees can also further transfer his interest in the
mortgaged property to another. In such a case, it is called a sub-mortgage.
The mortgage market may have primary market as well secondary market. The
primary market consists of original extension of credit and secondary market has sales
and re-sales of existing mortgages at prevailing prices.
In India, residential mortgages are the most common ones. The Housing and
Urban Development Corporation (HUDCO) and the LIC play a dominant role in
financing residential projects. Besides, the Land Development Banks provide cheap
-
8/7/2019 2Introduction-Capital Market.
9/23
Mortgage loans for the development of lands, purchase of equipment etc. These
development banks raise finance through the sale of debentures which are treated as
trustee securities.
Financial Guarantees Market
A Guarantee market is a centre where finance is provided against the guarantee of
a reputed person in the financial circle. Guarantee is a contract to discharge the liability
of a third party in case of his default. Guarantee acts as a security from the creditors
point of view. In case the borrower fails to repay the loan, the liability falls on the
shoulders of the guarantor. Hence the guarantor must be known to both the borrower and
the lender and he must have the means to discharge his liability.
Through there are many types of guarantees, the common forms are:
(i) Performance Guarantee and (ii) Financial Guarantee. Performance guarantees cover
the payment of earnest money, retention money, advance payments, non-completion of
contracts etc. On the other hand financial guarantees cover only financial contracts. In
India, the market for financial guarantees is well organized.
The financial guarantees in India relate to:
(i) Deferred payments for imports and exports.
(ii) Medium and long-term loans rose abroad.
(iii) Loans advanced by banks and other financial institutions.
These guarantees are provided mainly by commercial banks, development banks,
Government both central and state and other specialized guarantee institutions like ECGC
-
8/7/2019 2Introduction-Capital Market.
10/23
(Export Credit Guarantee Corporation) and DICGC (Department Insurance and Credit
Guarantee Corporation). This guarantee financial service is available to both individual
and corporate customers. For a smooth functioning of any financial system, this
guarantee service is absolutely essential.
Financial markets, across the globe, are undergoing profound, unprecedented and
fast-paced changes. Technology has revolutionized the process and the information
explosion has sparked off remarkable changes in the way the world has been operating.
The India securities market is in transition.
The capital market is one of the most vibrant sectors in the financial systems,
marking an important contribution to economic development. Today India has two
national stock exchanges.
The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
Foreign brokers account for 29 of these. Two major reasons why Indian securities are not
increasing regarded as attractive to international investors are the relatively high returns
compared with the more developed global markets as well as the low correlation with
world markets.
The recent years witnessed significant reforms in the capital market. It is well
known that trading platform has become automatic, electronic, anonymous, overdriven,
and nationwide and screen base. The reform was needed to address the inadequacies
and enhance the efficacy of the market.
Other aspects of the market such as the increasing sophistication and the range of
tradable financial products add to the attractiveness of the market as a whole. The
availability of derivative projects including index futures, index options, individual stock
-
8/7/2019 2Introduction-Capital Market.
11/23
futures and individual stock options reinforces the overall attractiveness of this market to
foreign and domestic investors. The derivatives market in only two years has shown
spectacular growth. We shall analyze such growing trends in the Indian capital Market
Scenario.
IMPORTANCE OF CAPITAL MARKET
Absence of capital market acts as a deterrent factor to capital formation and
economic growth. Resources would remain idle if finances are not funneled through the
capital market. The importance of capital market can be briefly summarized as follows:
The capital market services as an important source for the productive use of the
economys savings. It mobilizes the savings of the people for further investment and thus
avoids their wastage in unproductive uses.
(i) It provides incentives to saving and facilities capital formation by offering
suitable rates of interest as the price of capital.
(ii) It provides an avenue for investors, particularly the household sector to invest
in financial assets which are more productive than physical assets.
(iii) It facilitates increase in production and productivity in the economy and thus,
enhances the economic welfare of the society. Thus, it facilitates the
movement of stream of command over capital to the point of highest yield
towards those who can apply them productively and profitably to enhance the
national income in the aggregate.
-
8/7/2019 2Introduction-Capital Market.
12/23
(iv) The operations of different institutions in the capital market induce economic
growth. They give quantitative and qualitative directions to the flow of funds
and bring about rational allocation of scares resources.
(v) A healthy capital market consisting of expert intermediaries promotes stability
in values of securities representing capital funds.
(vi) Moreover, it serves as an important source for technological up gradation in
the industrial sector by utilizing the funds invested by the public.
Thus, a capital market services as an important link between those who save and
those who aspire to invest their savings.
THE SECURITIES MARKET
Money Market: Money market is a market for debt securities that pay off in the
short term usually less than one year, for example the market for 90 days treasury bills.
This market encompasses the trading and issuance of short-term non-equity debt
instruments including treasury bills, commercial papers, bankers acceptance, certificates
of deposits, etc.
Capital Market: Capital market is a market for long-term debt and equity shares.
In this market, the capital funds comprising of both equity and debt are issued and traded.
This also includes private placement sources of debt and equity as well s organized
markets like stock exchanges. Capital market can be further divided into primary and
secondary markets.
-
8/7/2019 2Introduction-Capital Market.
13/23
A stock, bond or other investment instrument issued by a corporation, government or
organization that signifies an ownership position or creditor relationship is termed as
securities. In other words an instrument that signifies an ownership position in a
corporation (a stock), a creditor relationship with a government body (a bond), or rights
to ownership (e.g. option) is a security.
Security markets provide a platform for the trade of such securities between
different investors.
Securities generally have two stages in their lifespan. The first stage is when the
company initially issues the security directly from its treasury at a predetermined offering
price.
This is Primary Market offering. It is referred to as the initial public offering
(IPOs). Investment dealers frequently buy initial offerings on the primary market and
result the securities on the Secondary Market. This promotes the goal of equal access to
information for everyone. The second stage is when an investor or dealer makes the
shares, bought from a company treasury, available for sale to other investors on the
secondary market. In the secondary market, the trading of shares in between investors.
This trading usually takes place through such as the Toronto, New York, Montreal or
CDNX Stock Exchange.
In the primary market, securities are offered to pubic for subscription for the
purpose of raising capital or fund. Secondary market is an equity-trading avenue in
which already existing/pre-issued securities are traded amongst investors. Secondary
-
8/7/2019 2Introduction-Capital Market.
14/23
market could be either auction or dealer market. While stock exchange is the part of an
auction market, over-the-Counter (OTC) is a part of the dealer market.
Equity: The ownership interest in a company of holders of its common and
preferred stock. The various kinds of equity shares are as follows:
Equity Shares: An equity share, commonly referred to as ordinary share also
represents the form of fractional ownership in which a shareholder, as a fractional owner,
undertakes the maximum entrepreneurial risk associated with a business venture. The
holders of such shares re members of the company and have voting rights. A company
may issue such shares with differential rights as to voting, payment of dividend, etc.
Rights Issue / Rights Shares: The issue of new securities to existing shareholders
at a ratio to those already held.
Bonus Shares: Shares issued by the companies to their shareholders free of cost
by capitalization of accumulated reserves from the profits earned in the earlier
years.
Preferred Stock/Preference shares: Owners of these kinds of shares are entitled to
a fixed dividend or dividend calculated at a fixed rate to be paid regularly before
dividend can be paid in respect of equity share. They also enjoy priority over the
equity shareholders in payment of surplus. But in the event of liquidation, their
claims rank below the claims of the companys creditors, bondholders / debenture
holders.
-
8/7/2019 2Introduction-Capital Market.
15/23
Cumulative Preference Shares: A type of preference shares on which dividend
accumulates if remains unpaid. All arrears of preference divided have to be paid
out before paying dividend on equity shares.
Cumulative Convertible Preference Shares: A type of preference shares where the
dividend payable on the same accumulates, if not paid. After a specified date,
these shares will be converted into equity capital of the company.
Participating Preference Share: The right of certain preference shareholders to
participate in profits after a specified fixed dividend contracted for is paid.
Participation right is linked with the quantum of dividend paid on the equity
shares over and above a particular specified level.
Security Receipts: Security receipt means a receipt or other security, issued by a
securitization company or reconstruction company to any qualified institutional.
Buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder
thereof, of an undivided right, title or interest in the financial asset involved in
securitization.
Government securities (G-secs): These are sovereign (credit risk-free) coupon
bearing instruments which are issued by the Reserve Bank of India on behalf of
government of India, in lieu of the Central Governments market borrowing
programme. These securities have a fixed coupon that is paid on specific dates on
half-yearly basis. These securities are available in wide range of maturity dates,
from short dated (less than one year) to long dated (upto twenty years).
Debentures: Bonds issued by a company bearing a fixed rate of interest usually
payable half yearly on specific dates and principal amount repayable on particular
-
8/7/2019 2Introduction-Capital Market.
16/23
date on redemption of the debentures. Debentures are normally secured/charged
against the asset of the company in favour of debenture unsecured.
Bond: A negotiable certificate evidencing indebtedness. It is normally unsecured.
A company municipality or government agency generally issued a debt security.
A bond investor lends money to the issuer and in exchange, the issuer promises to
repay the loan amount the loan amount on a specified maturity date. The issuer
usually pays the bondholder periodic interest payments over the life of the load.
The various types of Bonds are as follows-
Zero Coupon Bond: Bond issued at a discount and rapid at a face value. No
periodic interest is paid. The difference between the issue price and redemption
price represents the return to the holder. The buyer of these bonds receives only
one payment, at the maturity of the bond.
Convertible Bond: A bond giving the investor the option to convert the bond into
equity at a fixed conversion price.
Commercial Paper: A short-term promise to repay a fixed amount that is placed
on the market either directly or through a specialized intermediary. It is usually
issued by companies with a high credit standing in the form of a promissory note
redeemable at par to the holder on maturity and therefore, doesnt require any
guarantee. Commercial paper is a money market instrument issued normally for
tenure of 90-days.
Treasury Bills: Shore-term (upto 91 days) bearer discount security issued by the
Government as a means of financing its cash requirements.
-
8/7/2019 2Introduction-Capital Market.
17/23
WORKING OF THE CAPITAL MARKET
Trading in Indian Stock exchanges is limited to listed securities of public limited
companies. They are broadly divided into two categories, namely, specified securities
(forward list) and non-specified securities (cash list). Equity shares of dividend paying,
growth-oriented companies with a paid-up capital of at least Rs.50 million and a market
capitalization of at least Rs.100 million and having more than 20,000 shareholders are
normally, put in the specified group and the balance in non-specified group.
Two types of transactions can be carried out on the Indian stock exchanges: (a)
Spot delivery transactions; for delivery and payment within the time or on the date
stipulated when entering into the contract which shall not be more than 14 days following
the date of the contract and (b) forward transactions delivery and payment can be
extended by further period of the contract. The latter is permitted only in the case of
specified shares. The brokers who carry over the outstanding pay carry over charges
(catango or backwardation), which are usually determined by the rtes of interest
prevailing.
A member broker in an Indian stock exchange can act as an agent, buy and sell
securities for his clients on a commission basis and also can act as a trader or dealer as a
principal, buy and sell securities on his own account and risk, in contrast with the practice
prevailing on New York and London Stock Exchanges, where a member can act as a
jobber or a broker only.
-
8/7/2019 2Introduction-Capital Market.
18/23
The nature of trading on Indian stock exchange are that of age old conventional
style of face-to-face trading with bids and offers being made by open outcry. However,
there is a great amount of effort to modernize the Indian stock exchanges in the very
recent times. Brokers of stock trading get membership at stock exchange after fulfilling
conditions. Brokers maintain an online link with the stock exchange. He is constantly
updated with the real quotes in the market, their position, and the demand and supply
rates, number of buyers or sellers at various rates.
Customer toes to the office of the broker of gives him a call regarding the sale or
the purchase of a particular number of shares. Broker, after receiving the order, enters it
into the online system. If an appropriate match is established with reference to the price
available at the market that is both the buy and sell rates match. This implies that the
deal is struck. If there is no match then the order is stacked in the system until a matched
counter order emerges and transaction is closed at that point of time.
The trading system of the national Stock exchange provides enormous flexibility
to trading members. Members can easily exercise the various options available to them
on a trading floor and when entering the order can place limit on either the number or the
higher order and accordingly the order is matched at the best price available. Members
have the option of canceling all outstanding orders in one stock if necessary or he may
choose the entire order to be carried out as one deal or in smaller lots. This kind of a
system provides full transparency. Identity of trading members entering order in the
-
8/7/2019 2Introduction-Capital Market.
19/23
system will be protected and will have direct participation by large players also without
the fear of their orders influencing the state of the market.
There is a book entry transfer system for securities, which will operate just, like a
passbook system in a bank. Accounts will be maintained against each member detailing
the securities held in trading members name. At the end of each trading day exchange
computer will generate a report of matched traders of each trading member, which in turn
would be received by each trading member and the money refundable or deliverable to
the cleaning agency.
This will reduce the bank office work of the trading member, thus allowing them
provide better service to the investors. In order to expedite the settlement process a
depository has been established. Through this system, the trade transactions have shown a
tremendous growth both in value and volume.
PROFORMS IN THE INDIAN CAPITAL MARKET
Screen based trading:
The recent years witnessed significant in the capital market. It is well known that
trading platform has become automatic, electronic, anonymous, out driven and
nationwide and screen base. Shouting and gesticulations have given way to punching and
clicking. Speed and efficiency are the hallmark of the present system. Across the system
multitude of the market participants trade with one another anonymously and
simultaneously. On any trade day more then 10,000 terminals come alive, in around 400
towns and cities. Transparency is ensured in respect of dissemination of information,
-
8/7/2019 2Introduction-Capital Market.
20/23
prices and quantum of order; but members identity is to be hidden to prevent any bias in
response.
Trading Cycle:
An investor today need that wait with his fingers crossed for a fortnight or more
for getting crossed cheques or crisp notes for the sale proceeds of his securities. The
trading cycle has been shortened to T+2. This shortening of the cycle has been done in a
phased manner, all in a matter of two years.
Dematerialization:
Another material development that proved to be a relief to the investors was
dematerialization of scripts. Now 99% of the scrips in the market are dematerialized.
Almost 100% of the shares are in Demat form. Inconvenience of physical custody and
transfer, tedium of indicating change of address and problems of bad delivery, late
delivery, non-delivery and risk of forgery and frauds have virtually disappeared. The
benefit is relished but not the cause.
Settlement Guarantee Fund (SGF):
Each exchange has a settlement guarantee fund to meet with unpredictable
situation and a negligible trade failure of 0.003%. The Clearing Corporation of the
exchanges assumes the counter party risk of each member and guarantees settlement
through a fine tuned risk management system and an innovative method of online
position monitoring. It also ensures the financial settlement of trades on the appointed
-
8/7/2019 2Introduction-Capital Market.
21/23
day and time irrespective of default by members to deliver the required funds and/or
securities with the help of the SGF.
Derivatives market:
Sensex is the branded equity index of the BSE, Asias oldest stock exchange with
a 128 years history. Analysts and the business media track Indias stock market
performance by trading the Sensex.
The beginning of index futures trading on June 9, 2000 was perhaps the defining
moment for the BSE in the context of equity derivatives. Few events thereafter matched
the grand and epochal launch. The BSE currently accounts for about 3 per cent of Indias
equity derivatives volume.
It is quite likely the BSE does not mind the insignificance of its share. It had
resolutely regarded equity derivatives as inapt substitutes for babla; a system of carry-
forward trading that defined the BSEs prestige. It had resolutely argued that India was
not ready for equity derivatives. Yet, the BSE was the first to launch equity derivatives.
Though index futures and index options were listed ahead of stock options and
stock futures, stock futures have raced ahead of all other contracts. Stock futures
accounted for over 60 per cent of the NSEs and, therefore, Indias total derivatives
activity by number of contracts and turnover in May 2003. Stock options accounted for
-
8/7/2019 2Introduction-Capital Market.
22/23
about 22 per cent of total derivatives activity by number of contracts and about 24 per
cent of turnover.
Stock derivatives have equity shares of companies, say, Reliance and Satyam
Computer Services, as the underlying. The securities and Exchange Board of India
(SEBI) approved 31 stocks on which call and put options could be listed by the BSE and
NSE in July 2001.
The same set of 31 stocks applied to the listing of stock futures by the BSE and
NSE in November 2001. In January 2003, SEBI extended the approved list by 31 more
stocks. Stock derivatives dominate the marketplace, and some may regard this as going
against the run of play.
Book Building:
Book Building is basically a capital issuance process used in Initial Public Offer
(IPO), which aids price and demand discovery. It is a process used for marketing a
public offer of equity shares of a company. It is a mechanism where, during the period
which the book for the IPO is open, bids are collected from investors at various prices,
which are above or equal to the floor price. The process aims at tapping both wholesale
and retail investors. The offer/issue price is then determined after the bid closing date
based on certain evaluation criteria.
-
8/7/2019 2Introduction-Capital Market.
23/23
The crucial milestones in the future of institutional development in Indias
securities markets may now be summarized as:
Transition to rolling settlement. SEBI should not have a policy through which
stock market trading should only be allowed to take place using rolling
settlement, starting with the largest stocks in the country and covering all stocks
over a period of two years. This process can commence now.
Onset of index futures and index options. This process can commence the
movement the SCRA is amended. Under the best scenario, we can expect to see
index futures trading in November 1998 and index is December 1998.
Exchange-traded derivatives on interest rates and currencies. The logical next
step, once exchange-traded derivatives exists, is to trade derivatives which enable risk
management on fluctuations of interest rates and the dollar-rupee. This will be an
outcome of the confidence the RBI has in the quality of NSEs derivatives exchange and
SEBIs policy governing exchange-traded derivatives.