Capital Market - TM

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ISLAMIC INSURANCE AND SOCIAL SECURITY

TM.Rimsan - (SEU/IS/06/IA/036) Page 1

TM . R im s anS E U / I S / 0 6 / I A / 0 3 6

F I N A L Y E A R

F I R S T S E M A S T E R

0 6 / J u l y / 2 0 1 1

FINANCIAL

MARKET

IAIB-4104

ISLAMIC INSURANCE AND SOCIALSECURITY

SOUTH EASTERN UNIVERSITY OF SRI LANKA -

OLUVIL

ASSINGMENT


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Table of Contents

1 Executive summary ........................................................................................................ 4

1.1 Importance of capital market to economic and social development of the country . 6

1.2 Characteristics of a good market............................................................................. 8

2 Available securities in capital market of Sri Lanka ......................................................... 10

2.1 Characteristics and transaction procedures .......................................................... 12

2.1.1 Fixed Income Securities ................................................................................... 12

2.1.2 Debt and Equity Securities ............................................................................... 13

2.1.3 Loans, Debt Securities, and Disintermediation ................................................. 13

2.1.4 Key Features and Terminology of Fixed Income Securities ............................... 14

2.1.5 A Comparison of Bond Sectors and the Sri Lankan Fixed Income Securities Market ..... 18

3 Primary financial markets ............................................................................................. 21

3.1 Types of share issues ............................................................................................ 21

3.1.1 Equity shares: .................................................................................................. 21

3.1.2 Preference shares: ........................................................................................... 21

3.1.3 Deferred shares: .............................................................................................. 22

3.1.4 Income Shares ................................................................................................. 22

3.1.5 Growth shares ................................................................................................. 22

3.1.6 Cyclical Shares ................................................................................................. 22

3.1.7 Defensive shares .............................................................................................. 22

3.1.8 Speculative shares ........................................................................................... 22

3.1.9 Cumulative & Non cumulative shares............................................................... 23

3.1.10 Redeemable & Non-redeemable .................................................................... 23

3.1.11 Convertible & Non-convertible shares ........................................................... 23

3.1.12 Bonus shares: ................................................................................................ 23

3.1.13 Other classifications of shares:- ..................................................................... 24

3.2 IPO methods- Initial Public Offering (IPO) ............................................................. 25

3.3 Private placement................................................................................................. 27

4 Secondary financial markets ......................................................................................... 28

4.1 Basic trading system ............................................................................................. 28

4.2 Pure auction market ............................................................................................. 29

4.3 Dealer markets ..................................................................................................... 29

4.4 Call and continuous markets ................................................................................. 294.4.1 Call Markets ..................................................................................................... 29


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The report should be include the following

1 Executive summary

Sri Lanka is a country with a small open economy and an estimated population of 19.9million growing at an annual average growth rate of 1.1 per cent. The economy has grown atan average of 5 per cent over the past 15 years. The gross domestic product (GDP) in 2006was estimated to be $23.2 billion with a per capita income of $1,340 which places the countryin the group of lower middle income countries in the world. The economy has moved to apath of high growth and has been able to maintain growth in real terms of over 6 per cent inthe recent past.

The economy achieved a growth rate of 8 per cent in the first half of 2006 and is estimated togrow by over 7 per cent in real terms during the year as a whole. The country expects tomaintain an annual growth rate exceeding 8 per cent over the next 10 years enabling it toreach a per capital income level of around $3,000. The economic activities are broad-basedand overall production is dependent on the performance of the three main sectors in theeconomy - services, industry and agriculture.

The services sector has shown a steady growth in its share of overall production and atpresent accounts for over 55 per cent of the output of the economy. The main activities of thissector are international and domestic trade, financial services and transportation which

account for 70 per cent of the output. The share of industry in total output has remainedaround 27 per cent during last three decades. At present, the factory, industry andconstruction sub-sectors account for over 75 per cent of total industrial output.

The agriculture sector which was the major sector five decades earlier contributes only 17per cent of the total output. The food and plantation crops sub-sectors account for over 80 percent of the sector output which is highly sensitive to the prevailing weather conditions.Although Sri Lanka is an island economy with unlimited marine resources, the share fishproduction in overall output is less than 2 per cent. The capital market is important to acountrys economic and social system. It plays the crucial roles of capital raising for bothpublic and private sectors, promoting balance and stability in the financial system, decreasing

dependency on the banking sector, driving the economy forward and creating jobs, as well asbeing an alternative method for savings.

The economy has been operating continuously with a domestic resource gap where thecountrys investments are higher than national savings with the gap being financed from

foreign sources. Both investments and national savings are on an upward trend and reached26.5 per cent and 23.3 per cent of GDP respectively in 2005. This level of savings andinvestment is not adequate for the economy to achieve the targeted growth path in asustainable manner. In view of this, the medium-term macroeconomic strategy expects toincrease the countrys investment to over 30 per cent of GDP giving higher priority to themore productive sectors of the economy.


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The Government has reiterated the necessity of improving the fiscal position to ensure fiscaland debt sustainability in the country. Persistent high government budget deficits which weremainly financed by commercial domestic borrowings resulted in the stock of public sectordebt mounting in recent years. Consequently, servicing of public debt became a major issuein the government budget and the management of public debt became a complex task which

required drastic changes in the overall fiscal management of the economy. In view of theemerging threat to the fiscal position, the Government approved the Fiscal ManagementResponsibility Act (FMRA) in 2003 to improve fiscal discipline through rule-based fiscalmanagement.

Macroeconomic management in Sri Lanka has focused on fiscal and monetary policies toenable the economy to achieve sustainable high economic growth with balanced regionaldevelopment. Fiscal policy has been formulated to achieve fiscal consolidation whilemonetary policy focused on prudent monetary management and an independent floatingexchange rate system. This process has been complemented by broadening and deepeningstructural reforms to ensure efficiency in policy transmission and targeted outcomes are

achieved in the future.

Money market operations in Sri Lanka comprise two active markets. The first is the interbankcall money market and the second is the Treasury bill (primary and secondary) market. Othermoney market operations such as those for commercial paper and central bank securities arenot significant in the domestic market.

A strong capital market will lessen the impact of economic fluctuations which can becompounded by the fast-flowing nature of capital. However, there are still many issuesbesetting the Thai capital market: few institutional investors, small retail investor base,limited financial products, high transaction costs, and lack of efficient regulatory enforcement

are some examples. Moreover, Thailands capital markets in recent times have grown at avery slow pace. The size of the stock market compared to GDP is only 51% (as of June 2009)which is smaller than other countries in the region such as Hong Kong (845%), Singapore(202%), Malaysia (104%) and South Korea (66%). Should this trend continue, Thailandscapital market will stagnate and become increasingly marginalized. Various studies haveshown that inadequate development of the capital markets will impact its ability to raise,channel and monitor resources efficiently. In the end, this will lead to loss of growthopportunities, standard of living and prosperity.

A capital market is a market for long term debt and equity securities, where businessenterprises (companies) and governments can raise funds for long term investment. It is

normally divided into two broad categories - the stock market and the bond market. The stockmarket is the market where equity securities such as stocks representing ownership shares inparticular corporations issuing the securities are traded. These instruments are usually issuedby big corporations and promise a return (in the form of dividends) based solely onperformance of the issuing corporation. In addition, investors can gain from appreciation ofstock prices.

And the capital markets are markets where people, companies, and governments with morefunds than they need (because they save some of their income) transfer those funds to people,companies, or governments who have a shortage of funds (because they spend more thantheir income). Stock and bond markets are two major capital markets. Capital markets

promote economic efficiency by channeling money from those who do not have animmediate productive use for it to those who do. The principal actors in the international


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capital markets of the late 1990s were banks, non-bank financial institutions, corporations,and government agencies.

Private capital became very important to development in the late 1990s. During the 1990s,the sources of capital for developing countries changed drastically. In 1990, a World Bank

publication listed aggregate net long-term resource flows to developing countries (private andpublic sources of capital) as 101.9 billion U.S. dollars. Of that number, approximately 57%was from official loans or grants, and the remaining 43% came from private sources. Just fiveyears later, in 1995, only 28% of the resources were from official sources, with the remaining72% from private sources. During the course of those five years, official funding remainedrelatively constant. Private funding, however, skyrocketed. From the 1990 figure of $44billion, private sources increased almost 400% to $167 billion. 1

In a market economy, the role of the capital market is very important. The good functioningof the capital market is vital in the contemporary economy, in order to achieve an efficienttransfer of monetary resources from those who save money toward those who need capital

and who succeed to offer it a superior utilization; the capital market can influencesignificantly the quality of investment decisions. The gathering of temporary capitals that areavailable in the economy, the reallocation of those that are insufficiently or inefficiently usedat a certain moment and even the favoring of some sartorial reorganizations, outline thecapital markets place in the economy of many countries.

The well functioning of the capital market is a solid foundation for the insurance of a lastinggrowth, on a long term, of the national economy; the financial market and first of all thecapital market represents in many countries and it also could represent in Romania, too the engine for the economic development.

Although the capital market has suffered profound transformations in the developed countriesduring the last decades, the modernization was rather institutional and organizational and lessfrom the specific mechanisms point of view. From some points of view, the transitional

countries have made many progresses lately with a view to the capital market, especially thesecondary one, approaching the level of the countries with tradition in the domain.Unfortunately, the modern infrastructures, computers, the preferment telecommunicationsystem, the adequate software, are not enough. In order to have a functioning stock marketmechanism, fulfilling its primordial function, we need savings, trust in the economys

perspectives, and an increasing production.2

1.1 Importance of capital market to economic and social development of the countryThe importance of the capital market in an economy is given by the significant role played inthe firms and states financing, by the weight of the direct financing among the financing

modalities. Beside the apparent important thing the large transaction volume on the stockmarketwhat it really matters is the place which is taken by the (primary) capital market inthe development of the joint-stock companies (direct financing), and this thing is sometimesforgotten, or appears as secondary.

1http://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtml

2http://papers.ssrn.com/sol3/papers.cfm?abstract-id=951278
http://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtmlhttp://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtmlhttp://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtmlhttp://papers.ssrn.com/sol3/papers.cfm?abstract-id=951278http://papers.ssrn.com/sol3/papers.cfm?abstract-id=951278http://papers.ssrn.com/sol3/papers.cfm?abstract-id=951278http://papers.ssrn.com/sol3/papers.cfm?abstract-id=951278http://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtml


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The global capital markets became critical to development in an open economy. Developingcountries, like all countries, must encourage productive investments to promote economicgrowth. Domestic savings could be used to make productive investments. Typically,developing countries have suffered from low domestic savings rates (although this is not trueof the Asian economies of the late 1990s). The global capital, however, developing countries

added to domestic savings by borrowing savings from abroad. The capital market is aninstrument for the economic development of a country.

Provides an important alternative source of long-term finance for long-term productive

investments. This helps in diffusing stresses on the banking system by matching long-term

investments with long-term capital. Provides equity capital and infrastructure development

capital that has strong socio-economic benefits - roads, water and sewer systems, housing,

energy, telecommunications, public transport, etc. - ideal for financing through capital

markets via long dated bonds and asset backed securities

Provides avenues for investment opportunities that encourage a thrift culture critical inincreasing domestic savings and investment ratios that are essential for rapid

industrialization. The Savings and investment ratios are too low, below 10% of GDP.3

The capital market promotes public-private sector partnerships to encourage participation of

private sector in productive investments. The need to shift economic development from

public to private sector to enhance economic productivity has become inevitable as resources

continue to diminish. It assists the public sector to close resource gap, and complement its

effort in financing essential socio-economic development, through raising long-term project

based capital. It also attracts foreign portfolio investors who are critical in supplementing the

domestic savings levels. It facilitates inflows of foreign financial resources into the domestic

economy.4

Assists the Government to close resource gap, and complement its effort in financing

essential socio-economic development, through raising long-term project based capital. The

capital market not only reflects the general condition of the economy, but also smoothens and

accelerates the process of economic growth. Various institutions of the capital market, like

nonbank financial intermediaries, allocate the resources rationally in accordance with the

development needs of the country. The proper allocation of resources results in the expansion

of trade and industry in both public and private sectors, thus promoting balanced economicgrowth in the country

The capital market facilitates lending to the businessmen and the government and thusencourages investment. It provides facilities through banks and nonbank financialinstitutions. Various financial assets like shares, securities, bonds, etc., induce savers to lendto the government or invest in industry. With the development of financial institutions,capital becomes more mobile, interest rate falls and investment increases.5

3

http://www.cma.or.ke/index.php?option=com_content&task=view&id=42&Itemid=107 4http://www.centralbank.org.ls/publications/Econo_Rev_August_2009.pdf5http://www.preservearticles.com/201012281813/functions-and-importance-of-capital-market.html
http://www.cma.or.ke/index.php?option=com_content&task=view&id=42&Itemid=107http://www.cma.or.ke/index.php?option=com_content&task=view&id=42&Itemid=107http://www.cma.or.ke/index.php?option=com_content&task=view&id=42&Itemid=107http://www.centralbank.org.ls/publications/Econo_Rev_August_2009.pdfhttp://www.centralbank.org.ls/publications/Econo_Rev_August_2009.pdfhttp://www.centralbank.org.ls/publications/Econo_Rev_August_2009.pdfhttp://www.preservearticles.com/201012281813/functions-and-importance-of-capital-market.htmlhttp://www.preservearticles.com/201012281813/functions-and-importance-of-capital-market.htmlhttp://www.preservearticles.com/201012281813/functions-and-importance-of-capital-market.htmlhttp://www.preservearticles.com/201012281813/functions-and-importance-of-capital-market.htmlhttp://www.centralbank.org.ls/publications/Econo_Rev_August_2009.pdfhttp://www.cma.or.ke/index.php?option=com_content&task=view&id=42&Itemid=107


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The capital market tends to stabilize the values of stocks and securities and reduce the

fluctuations in the prices to the minimum. The process of stabilization is facilitated by

providing capital to the borrowers at a lower interest rate and reducing the speculative and

unproductive activities

1.2 Characteristics of a good marketGenerally, investors have a variety of investment solutions to choose from. Some of them

include stocks, bonds, US treasuries, foreign exchange and many others. However, regardless

of which one you have selected the general condition of the market matters most regarding

the success of the investments you will make.

The basics characteristics that a beneficial market should possess are:

Market Liquidity Low transaction costs Transparency Trends

Market LiquidityLiquidity refers to the state of the market which best explains the easiness of entering andexiting the market. The process of executing trades involves:

Opening of a position Closing of the same position

Liquidity is connected with volume. The latter represents the number of trades that are

executed. So, liquidity describes the easiness with which investors can enter and exit the

positions they have established.

If the market is liquid enough, then traders can execute large number of trades without any

effect on the prices of the investments they make. Thus, markets can be qualified as

beneficial to investors if they manage to offer them the possibility of making a large number

of trades without any effect on the prices of stocks.

In contrast, markets that lack liquidity will result in delays regarding the execution of trades.

Additionally, the market order fills will result in different prices than the initially set ones at

the time the order was placed. What is more, illiquid markets possess barriers to exiting the

market when needed, which may result in higher cost of trades.


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Low Transaction CostsAnother factor that may be directly reflected on the liquidity of the market is transaction cost.

The latter may have a negative effect on the profits you have during times of winning stocks.

On the other hand, if you are incurring losses, transaction costs may deteriorate the condition.

So, low transaction costs are a major trait of good markets. Active traders, in particular, look

for markets that present low transaction costs since they execute numerous trades every day.

Transaction costs may be classified as:

Explicit costs - e.g. commission fees Implicit costs - these costs may have hidden effects to the inexperienced

investor.

Faulty executions tend to significantly increase transaction costs. This is observed in the caseof having an artificially inflated actual price which greatly differs from the price at which the

market clears the investment.

Degree of TransparencyIn today's information age, investors have access to myriads of information through many

sources. Thus, the transparency of the market is of high importance. It represents the ability

of investors to easily get in touch with data concerning trading processes that take place on

the market.

Information is one of the best tools that you can have, thus you should try to stay informed as

much as possible. The lack of knowledge may be directly reflected on your investment

decisions.

When you have the necessary knowledge you will be better able to construct your investment

strategies that will eventually lead you to the achievement of your financial goals.

Additionally, market transparency will enable you to stay focused and apply the necessary

discipline, which are a prerequisite for successful investments in the dynamic stock market.

Furthermore, market transparency enables investors to more accurately determine their levelof risk tolerance, which is crucial in selecting investments that best fit to the investor's

portfolio. In order to qualify a market as being transparent, it should provide investors with

the possibility of executing trades by live prices. If this is not provided, investors will be ill at

ease and delays in the fill of the orders may be experienced, which in turn may result in

discrepancy between the fill price and the market rate.

TrendsThe economy is characterized as following a particular pattern of ups and downs. If

the market lacks this trending, investors may find it difficult to synchronize their trades whichmay lead to losses. Additionally, the application of technical analysis requires such cycles in


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order for the price movement to be effectively used. Many analysts use past performances asbasis for predicting future trends.6

To be successful at forex trading you need two main things - the knowledge and the right

trading platform. For a trading platform we can recommend you Easy Forex. It offers unique

features such as Inside Viewer, which will give you a unique insight of what other traders

are doing, competitive spreads, 24/7 support, etc. Start trading from as little as $25.

2 Available securities in capital market of Sri LankaIn the recent past investing in the Capital & Share Market in Sri Lanka has shown a rapid

growth. The Securities and Exchange Commission (SEC) regulates the securities market inSri Lanka & grants License to Stock Exchanges, Stockbrokers & dealers etc. Foreign

investors can freely purchase up to 100 percent of equity in Sri Lankan companies in

permitted sectors. In order to facilitate portfolio investments, country funds and regional

funds are also allowed to invest in Sri Lanka's stock market after prior approval. These funds

should make transactions through Share Investment External Rupee Accounts maintained in

commercial banks (SIERA).

The Colombo Stock Exchange (CSE), while small by big emerging market standards, is one

of the most efficient in the region. A fully computerized clearing and settlement system was

introduced through the establishment of a Central Depository System (CDS) in1991. In 1997,

the CSE commissioned a state of the art computer based automated order matching system.

The CDS was linked real time with the automated trading system. These developments

placed the CSE alongside the most technologically advanced exchanges in the world. In 1998

CSE became the first South Asian member of the world federation of Stock Exchanges. The

CDS also gained the membership in the Asia-Pacific Central Securities Group (ACG) in the

same year.

The CSE officially launched its Debt trading System (DEX) in March 2004. DEX enables the

trading of corporate debt instruments and the beneficial interest of Govt. bonds and treasurybills through the exchange. DEX has advanced features such as scrip less trading real-time

exposure management, multiple settlement cycles and compatibility with web based

technologies. Fifteen local and foreign joint venture brokers currently operate at the CSE.

A security is generally a fungible, negotiable financial instrument representing financialvalue. Securities are broadly categorized into debt securities (such as banknotes, bonds anddebentures) and equity securities, e.g., common stocks; and derivative contracts, such asforwards, futures, options and swaps. The company or other entity issuing the security is

6

http://www.forex-trading-gurus.com/forex-market/characteristics-of-a-good-market.html
http://en.wikipedia.org/wiki/Fungibilityhttp://en.wikipedia.org/wiki/Debthttp://en.wikipedia.org/wiki/Banknoteshttp://en.wikipedia.org/wiki/Bond_%28finance%29http://en.wikipedia.org/wiki/Debenturehttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Common_stockhttp://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Swap_%28finance%29http://www.forex-trading-gurus.com/forex-market/characteristics-of-a-good-market.htmlhttp://www.forex-trading-gurus.com/forex-market/characteristics-of-a-good-market.htmlhttp://www.forex-trading-gurus.com/forex-market/characteristics-of-a-good-market.htmlhttp://www.forex-trading-gurus.com/forex-market/characteristics-of-a-good-market.htmlhttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/Common_stockhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Debenturehttp://en.wikipedia.org/wiki/Bond_%28finance%29http://en.wikipedia.org/wiki/Banknoteshttp://en.wikipedia.org/wiki/Debthttp://en.wikipedia.org/wiki/Fungibility


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called the issuer. A country's regulatory structure determines what qualifies as a security. Forexample, private investment pools may have some features of securities, but they may not beregistered or regulated as such if they meet various restrictions.

Securities may be represented by a certificate or, more typically, "non-certificated", that is in

electronic or "book entry" only form. Certificates may be bearer, meaning they entitle theholder to rights under the security merely by holding the security, or registered, meaning theyentitle the holder to rights only if he or she appears on a security register maintained by theissuer or an intermediary. They include shares of corporate stockor mutual funds, bondsissued by corporations or governmental agencies, stock options or other options, limitedpartnership units, and various other formal investment instruments that are negotiable andfungible.

Securities may be classified according to many categories or classification systems:

#- Currency of denomination

#- Ownership rights

#- Term to maturity

#- Degree of liquidity

#- Income payments

#- Tax treatment

#- Credit rating

#- Industrial sector or "industry"

#- Region or country Market capitalization

#- State

Securities that are represented in paper (physical) form are called certificated securities.They may be bearer or registered. Bearer securities are completely negotiable and entitle the

holder to the rights under the security

In the case ofregistered securities, certificates bearing the name of the holder are issued, butthese merely represent the securities. A person does not automatically acquire legalownership by having possession of the certificate. Instead, the issuer (or its appointed agent)maintains a register in which details of the holder of the securities are entered and updated asappropriate. A transfer of registered securities is affected by amending the register.

Non-certificated securities and global certificates -Modern practice has developed toeliminate both the need for certificates and maintenance of a complete security register by theissuer. There are two general ways this has been accomplished.
http://en.wikipedia.org/wiki/Issuerhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Bond_%28finance%29http://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Industryhttp://en.wikipedia.org/wiki/Industryhttp://en.wikipedia.org/wiki/Stock_optionhttp://en.wikipedia.org/wiki/Bond_%28finance%29http://en.wikipedia.org/wiki/Mutual_fundhttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Issuer


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Non-certificated securities - In some jurisdictions, such as France, it is possible for issuers ofthat jurisdiction to maintain a legal record of their securities electronically.

Global certificates, book entry interests, depositories - To facilitate the electronic transfer ofinterests in securities without dealing with inconsistent. This depository is called The

Depository Trust Company, or DTC.

Divided and undivided security - The terms "divided" and "undivided" relate to theproprietary nature of a security. Each divided security constitutes a separate asset, which islegally distinct from each other security in the same issue. Pre-electronic bearer securitieswere divided. Each instrument constitutes the separate covenant of the issuer and is a separatedebt. With undivided securities, the entire issue makes up one single asset, with each of thesecurities being a fractional part of this undivided whole. Shares in the secondary markets arealways undivided.

Fungible and non-fungible security -The terms "fungible" and "non-fungible" are a feature

of assets. If an asset is fungible, this means that if such an asset is lent, or placed with acustodian, it is customary for the borrower or custodian to be obliged at the end of the loan orcustody arrangement to return assets equivalent to the original asset, rather than the specificidentical asset. In other words, the redelivery of fungibles is equivalent and not in specie.

Over the past few years, Sri Lanka has been working to develop its local currency bondmarkets, particularly for government securities, but for corporate securities as well. Thisstudy considers the prospects for developing corporate bond markets in Sri Lanka and theimpediments to such efforts. It covers issues ranging from economic policy to the specifics oftrading, clearing and settlement, and ways to facilitate bond market development. The SriLankan bond market consists of government securities (T-bills and T-bonds), corporate andbank bonds listed at the stock exchange, and unlisted corporate bonds.

Whereas government securities come under the central banks market rules and regulations,

equities traded on a formal exchange must abide by SEC and CSE rules, although somechanges have recently been made for corporate debt. There are many securities (like treasury

bond, treasury bills, Yield, stocks, derivatives, agency securities. etc) are issued by capital

market of Sri Lanka. Mainly two types of securities are fixed income securities and debtsecurities.

2.1 Characteristics and transaction procedures2.1.1 Fixed Income Securities

Fixed Income Securities are tradable financial instruments that make up a series of pre-

determinable future cash flows. By virtue of being securities, they acquire the ability to be

traded, meaning, that the holder of a security can sell the security to another party thereby

transferring all the rights and obligations. Typically, these are debt obligations where debt

obligations unlike equity form pre-determinable future cash flows. These debt obligations are

securities and not loans, where the securities can be traded, whereas the loans are not

tradable.
http://en.wikipedia.org/wiki/The_Depository_Trust_Companyhttp://en.wikipedia.org/wiki/The_Depository_Trust_Companyhttp://en.wikipedia.org/wiki/Fungiblehttp://en.wikipedia.org/wiki/In_speciehttp://en.wikipedia.org/wiki/In_speciehttp://en.wikipedia.org/wiki/Fungiblehttp://en.wikipedia.org/wiki/The_Depository_Trust_Companyhttp://en.wikipedia.org/wiki/The_Depository_Trust_Company


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2.1.2 Debt and Equity SecuritiesDebt securities are those securities issued in confirmation of debt obligations. A debt

obligation arises between a borrower and a lender. A debt security typically carries a maturity

value, and a series of interest payments that make up a series of pre-determinable cash flows.

Hence, they make up Fixed Income Securities (FISs). Equity Securities are those issued in

confirmation of investments in the equity of a firm. While debt obligations create borrower

and lender relationships, the equity securities result in ownership. Those who invest in equity

securities become shareholders, whereas those who buy debt securities being lenders become

debt holders of the issuer concerned. The term investment is commonly used to represent

investment in equity as well as debt securities. Unlike a debt security, an equity security does

not provide a pre-determinable series of cash flows Hence, they are not Fixed Income

Securities. There are hybrid instruments such as preference shares and convertible

debentures, or bonds that show both debt and equity characters, and can be classified as Fixed

Income Securities depending on the extent to which the future cash flows can be pre-determinable.

2.1.3 Loans, Debt Securities, and DisintermediationA loan is a financial obligation between a borrower and a lender. The transaction is on a one

to one basis, and the settlement too is between the two parties. The loan does not result in a

tradable security. Hence, under normal circumstances, the lender cannot sell the loans

without the consent of the borrower, except where there are provisions for transfer and

assignment.

A debt security too arises from a financial obligation between a borrower and a lender, but

they create a tradable security as a result of the transaction. Such security can be traded by the

debt holder (lender), without the prior consent of the issuer (the borrower). The foregoing

analysis shows that there are two market segments arising from debt obligations viz. Debt

Securities Market and Loan Market.

The debt securities market can also be identified as the Fixed Income Securities market as the

debt securities form Fixed Income Securities. In this market, the party having funds to invest

directly invests with the borrower. Such investment is facilitated by two types of market

players viz. debt brokers and dealers. In the loan market, the lending, typically, is done by afinancial intermediary such as a bank or a finance company.

The ultimate lender would be a depositor of such bank or the finance company. The

intermediary assumes liability to the depositors, and raises funds which are in turn lent to the

borrowers. Such borrowers are identified as Deficit Units, whereas the depositors are

identified as Surplus Units. The financial institutions act as the intermediaries between the

surplus units and deficit units. In the debt securities market, however, there is no such

intermediation, and the surplus units directly invest with the deficit units. The obligations of

the deficit units are direct to the surplus units and not to the intermediary. This is the key

difference between the intermediary driven loan market and the disintermediation through the


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debt securities market. However, even the securities market requires facilitation by market

players such as dealers and brokers.

2.1.4 Key Features and Terminology of Fixed Income Securities2.1.4.1 Bills and Bonds

A Bill is a security that, typically, has a short maturity period up to one year. Further, the Bill

is issued at a discount, and there is no coupon interest attached to the Bill. Treasury Bills are

the most common of Bills that represent a segment of the Fixed Income Securities market.

Treasury Bills are a secure investment. The investor assumes the credit risk of theGovernment. This is known as Sovereign Risk and is presumed to be the safest in the country

Bills are issued in tenures 91,182 and 364 days respectively Bills are tendered for every Wednesday and are issued on Friday, hence the maturity of a Bill

will always be on a Friday. Central Bank accepts/rejects bids at the auction and the results arepublished

Treasury bills that have been issued at earlier auctions are also available for purchase in theSecondary market

Primary dealers provide liquidity in the secondary market by quoting a two-way price A 364-day basis is used to calculate prices

Treasury Bill is a Negotiable Instrument issued by the Government of Sri Lanka tofinance short-term government expenditure and/or maintain monetary policy.

A Bond typically has a maturity in excess of two years. There is, of course, no hard

and fast rule as to the definition of a period. The most common Bonds are those issued by thegovernments, being Treasury Bonds. Debentures are also instruments similar to Bonds. Inmost markets, the two terms are used interchangeably. In certain markets, unsecuredcorporate debt is called debentures, whereas secured debt and government securities arereferred to as Bonds.

Treasury Bonds in Sri Lanka are currently issued in tenures of 2,3,4,5 and 6 years These bonds carry a semi-annual coupon Bonds are auctioned regularly by the Central Bank on behalf of the government, and bids are

accepted only via Primary Dealers

There is an active Secondary Market for Bonds with Primary Dealers providing liquidity viatwo-way pricing.

A Treasury Bond is a tradable security issued by the Government in order to finance theirborrowing requirement.7

A Bond typically has a maturity in excess of two years. There is, of course, no hard and fast

rule as to the definition of a period. The most common Bonds are those issued by the

governments, being Treasury Bonds. Debentures are also instruments similar to Bonds. In

7http://www.hsbc.lk/1/2/commercial/treasury-and-capital-markets
http://www.hsbc.lk/1/2/commercial/treasury-and-capital-marketshttp://www.hsbc.lk/1/2/commercial/treasury-and-capital-marketshttp://www.hsbc.lk/1/2/commercial/treasury-and-capital-marketshttp://www.hsbc.lk/1/2/commercial/treasury-and-capital-markets


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most markets, the two terms are used interchangeably. In certain markets, unsecured

corporate debt is called debentures, whereas secured debt and government securities are

referred to as Bonds. Different types of Fixed Income securities will be discussed later in the

paper.

2.1.4.2 Par Value of a BondThis is the value at which the instrument is recorded in the books of the issuer. This is most

likely to be the maturity value and face value as well. Unless otherwise stated, a bonds par

value is considered to be 100 units of the currency, e.g. LKR 100. Interest on a bond is

calculated based on the par value.

2.1.4.3 Maturity ValueThis is the value paid at the maturity of the bond. Generally, this is the same as the par value.

This could also be the redemption value which is the value at which the bond will beredeemed.

2.1.4.4 Face valueThis is the value stated on the face of the bond. It is most likely that the face value is the same

as the par value and also the maturity value.

2.1.4.5 Coupon rate

The coupon rate is the rate at which interest is calculated on a Bond. The value of the interestpayment is equal to the par value multiplied by the coupon rate.

2.1.4.6 Interest CouponsThe interest payments on a Bond are calculated based on the par value and the coupon rate as

stated above. A bond will carry the interest coupons for the purpose of claiming the interest

payments by the holders. The value of the interest coupon is the par value multiplied by the

coupon rate. This value is called the coupon value.

2.1.4.7 Coupon FrequencyA bond may have interest payments taking place either semi-annually or annually. Some

issuers do have interest payment made quarterly or monthly.

2.1.4.7.1 Annual Coupon BondsThese bonds will pay interest once a year.


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2.1.4.7.2 Semi-Annual Coupon BondsThese bonds will pay interest once in six months. The value of the semi-annual coupon will

be calculated by multiplying the par value by the coupon rate, and then taking half of the

value as applicable for six months.

2.1.4.8 Term to MaturityThis is the period to maturity from a given point of time. In other words, it is the unexpired

period to maturity.

2.1.4.9 Issue PriceThis is the price at which a security is issued to the market. The issue price is normally

decided by the issuer, or allowed to be market determined where an auction process will

determine the issue price.

2.1.4.10 Market PriceThis is the price at which a bond is traded in the market. The bond price will vary according

to the demand for and supply of bonds. This, in turn, would be a function of the interest rates.

The price of a Bond is equal to the present value of its future coupon payments and the

maturity proceeds. The rate of return applicable for discounting to arrive at the present value

is the prevailing interest rate. If it is a government security, then, it is the risk free return

applicable for the term of the bond. If it is any other type of bond, a credit risk premium may

be applied over and above the risk free return.

When interest rates go up, the present value of future cash flows will go down. Similarly,

when interest rates go down, the present value goes up. Accordingly, the price of a bond will

go down or up in the opposite direction to that of the change of the interest rates. Hence, the

Bond prices have an inverse relationship to the changes of the interest rates.

2.1.4.11 Discounts and PremiumsA bond is traded at a discount, if the bond price is below par value. The difference between

the par value and the price is the discount.

A bond is traded at a premium, if the market price is above the par value. The price less the

par value is the premium. A bond is supposed to sell at par if the price is equal to par value.

2.1.4.12 Yield to Maturity (YTM)A bond has a series of cash flows associated with it. The bond holder pays the price to

acquire it, and the price paid is the outflow. Then, he receives the regular coupons as a series

of inflows, and finally, the maturity proceeds. The effective return that the bond holder gets,

considering the outflow and the series of inflows calculated and considering the timing of thecash flows as well, is the Yield to Maturity (YTM) of the bond. The Yield to Maturity is the


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IRR (Internal Rate of Return) of the investment in the bond. When the market interest rates

go up, the YTM demand of a bond goes up. When the YTM goes up, the price goes down, as

explained, given the inverse relationship.

2.1.4.13 Fixed Rate v Floating Rate BondsA fixed rate bond is a bond of which the coupon rate applicable for the entire tenure of the

bond is fixed at the time of issue. Therefore, the coupon value will not change in the future.

A Floating rate bond (A Floater) is a bond of which the coupon rate is linked to some kind of

a reference rate with or without a margin. The reference rate has to be a transparent, and

readily determinable rate. For example, a five-year floating rate bond may be issued with the

rate stated as two percentage points over the six months Treasury Bill Rate. Accordingly, the

coupon rate applicable on this bond will be re-priced every six months based on the

prevailing Treasury Bill rate with the margin. The advantage of a floater is that the holder

gets interest that varies based on the market interest rates. The disadvantage would be that the

holder cannot fix the rate of return for the entire duration.

In a floater, the coupon adjusts according to the market return. Therefore, when determining

the price, both the coupon as well as the required interest rate are changed at the same time. If

the rates go up, then the coupons go up, and also, the required return go up too. Hence, the

present value of the future cash flows of the bond tend to be around the par value. Therefore,

floating rate bonds have less price volatility. This is in contrast with the fixed rate bonds

where the coupons are fixed, and hence, the cash flows are fixed. When the required return

changes due to changes in the market interest rates, the bond price will keep changing.

2.1.4.14 Zero Coupon BondsA zero coupon bond is a bond of which the coupon rate is zero, and hence, no coupon

payments. Treasury Bills are zero coupon instruments. A zero coupon bond is issued at a

sufficient discount such that the value of the discount makes up the required return on the

bond.

2.1.4.15 Deep Discount BondsThese are bonds issued at significant discounts to the par value. The reason for the deep

discount would be a very low coupon. The return not compensated by the coupon rate will be

compensated by the deep discount.

2.1.4.16 Secured v Unsecured BondsA secured bond is issued with the backing of collateral so that in the event of default by the

issuer the bond holder could take steps to realize the security. An unsecured bond does not

have such backing of collateral.


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2.1.4.17 Redeemable v Irredeemable BondsTypically, bonds are redeemable. The maturity value is paid at maturity. However,

there are also bonds that may not be redeemable. They would be similar to shares issued bythe company with no provision for buy back. The holder can convert the bond into cash by

selling in the secondary market. Irredeemable bonds are extremely rare and not popular.8

2.1.5 A Comparison of Bond Sectors and the Sri Lankan Fixed Income SecuritiesMarket

Sri Lankan bond market is by and large dominated by the Government securities market. The

Government is the single largest issuer of fixed income securities. The key reason for this is

nothing but continuous fiscal deficits encountered by successive governments that make it

necessary to go to the public to raise funds by way of borrowings.

The following Table illustrates the total domestic government securities outstanding at the

end of 2006. As indicated in the table the total outstanding local currency securities was Rs

1,143.7 bn. Of this, Rs 257.7 bn was in the form of Treasury Bills, while Rs 885.9 bn was in

the form of Treasury Bonds. The total domestic public debt of Rs 1,475 bn also comprised of

other forms of borrowings including Rupee Loans 116.7 bn which are non tradable loans that

do not come under the fixed Income securities category. The total Treasury Bills outstanding

as of December 26, 2007 was Rs 300.2 bn, whereas the total Treasury Bonds outstanding was

Rs 1060.3 bn, totaling to Government Securities of Rs 1,360.5 bn. There are hardly any

reported instances of government agencies or government corporations raising funds by

issuing bonds in the domestic market.

This, in fact, is a serious vacuum in the bond market and lost opportunities for the

government agencies that have the potential to raise funds in this manner. In Sri Lanka, there

are also no debt issues by the local governments. Hence, the Municipality Bonds are another

missing sector. The Corporate Bond market in Sri Lanka is confined to a very limited number

of issues of securities particularly the listed debentures issued by commercial banks to raise

funds for capital adequacy purpose. The total outstanding amount of listed debentures is

estimated to be around Rs 25 bn at the end of 2006. The above table illustrates the

insignificant size of the Corporate Debt market particularly in relation to the Government

Securities market.

Transaction procedures

Securities investment and trading are among the most publicized and exciting activities weobserve in the financial services industry. Buyers and sellers of securities, trading either newissues or seasoned issues, are motivated by two basic reasons. The first reason trade

8

http://www.juliusandcreasy.com/inpages/publications/pdf/securitisation_in_sri_lanka.pdf
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securities for cash or cash for securities is because of normal variation in consumption orbusiness needs for cash. Traders making portfolio adjustments requiring offsetting changesin cash and securities in response to factors unrelated to events in the securities markets arecalled liquidity traders. An individual selling stock to finance a child's education or aninsurance company buying bonds to finance future payment of claims are both liquidity

traders motivated by their specific portfolio considerations.

A second type of trader knows something that the rest of the participants in the market do notknow. This information may be that a lawsuit has been filed or that a takeover attempt isimminent. Traders placing buy or sell orders based on private knowledge are calledinformation traders. Information traders expect to profit because they buy securities at priceswhich are low relative to their true values or sell them at prices which are high relative towhat they will sell for when the information the trader possesses becomes available to themarket. Individual and institutional investors prefer securities to portfolio investments.

A broker finds a buyer for a seller. Because most traders are not continuously buying and

selling securities, they turn to professional brokerage firms to complete their trades. Often, abuyer or seller wants to trade sooner than would be required by waiting for a counterpartseller or buyer to show up in the market. Financial institutions which facilitate quick tradesby buying or selling securities on their own accounts are called market makers or dealers insecurities. When offering new securities to investors, firms raising funds require guidance ashow to design and price newly issued securities in order to make them attractive to investors.This guidance is one of the functions performed by financial service firms assistingborrowing entities with securities origination.

Brokers and dealers of securities buy and sell a wide range of financial instruments toflexibility for investors or issuers in their portfolio or balance sheet composition. The variety

of securities makes it possible to fine-tune investments or fund raising to particular investoror borrower needs. Most of us are familiar with securities in the form of common stocks andvarious types of bonds. Stocks and bonds represent ownership or debt claims against theearnings and underlying income producing assets of firms. These traditional securities are asignificant part of trading volume in today's markets.

Stocks and bonds are important but relatively simple securities. To achieve an optimalcombination of risks and returns against a variety of future economic scenarios, issuers andinvestors often look for more innovative securities designs. If these securities achieve abetter risk and return combination in terms of investors' and issuers' preferences than existingsecurities, they will be more marketable. Classic examples are convertible bonds, preferred

stock, and warrants. Newer examples are collateralized mortgage obligations and indexoptions.

There is an unlimited number of possible risks investors or borrowers may be concernedabout. For example, a financial instrument which pays higher returns with higher inflationwould offer protection against inflation risks. A security which pays off more if automobiledemand drops might be useful to some particular investors. Conceptually there are an infinitenumber of possible future outcomes which could be of concern to individual investors andborrowers.

Creating financial instruments which pay future cash flows under economic conditions

offering new protection to market participants is a move toward completing the market. Acomplete securities market offers securities which pay returns under every conceivable


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circumstance, for example which pays $1 if Mongolia attacks India next year and zerootherwise.

It is not possible to define much less trade the infinite number of securities which would benecessary to complete financial markets. Practically speaking, financial markets will never

be complete. With inventive and aggressive people active in the securities industry, however,there are always opportunities for inventing and trading new securities for which sufficientdemand exists because customers desire security payoffs under circumstances importantenough to worry about.

Securities can be classified by type of issuer: foreign or domestic corporations, governments,or issues based on consumer borrowing. They can be classified by the nature of the claim onborrowers. Debt provides investors a fixed claim on the income and assets of issuers. Equityrepresent a residual claim against income and assets firms after other claims are met.Securities can be convertible into other securities, callable or redeemable for cash, and soforth. Securities can pay in any currency or in amounts indexed to commodities.

Securities Originations: Relation Between Participants

(1), (2)

(3) (3)

(3) (Best Efforts)

(1) Advising

(2) Underwriting

(3) Distribution9

And Sri Lanka is planning to introduce the Inter-bank electronic fund transfer system orSLIPS to the countrys capital market. The system will be introduced to all types of

transactions taking place in the capital market. Accordingly, it will coverIPO payments,dividend paymentsfor investors at the CSE and also share market transactions. They arelooking at the entire clearing and settlement mechanism of the capital market. As of now,most of the transactions at the CSE are conducted via cheques. To engage in SLIPS

transaction, what the investor requires is only have a bank account. Introducing this systemwill help reduce transaction time in the capital market. At present refunding of IPO cash takesabout 10 days. Currently the SEC is holding discussions with the industry and the idea is tomake the electronic fund transferring system mandatory for all capital market transactions inthe future. Electronic Funds Transfer is movement of funds from one account to anotherwithout the corresponding piece of paper to authorize or prove that the transfer had occurred.

9www.marshallinside.usc.edu/dietrich/FS-FI-Value Securities.doc

Investor

Security

OriginatorIssuer
http://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.dochttp://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.dochttp://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.dochttp://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.dochttp://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.dochttp://www.marshallinside.usc.edu/dietrich/FS-FI-ValueSecurities.doc


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3 Primary financial markets

The financial market is divided in to two. Capital market and money market. Capital marketis divided in two primary market and secondary market. So the primary market is that part of

the capital markets that deals with the issuance of new securities. Companies, governments orpublic sector institutions can obtain funding through the sale of a new stockor bond issue.This is typically done through a syndicate of securities dealers. Primary markets creates longterm instruments through which corporate entities borrow from capital market. Primarymarkets are markets where firms raise funds by issuing new securities, e.g. stocks, bonds,commercial paper, to finance new projects, expansion, construction of new buildings, R&D,etc., for which the firms do not have sufficient internal funds.

Features of primary markets are:

This is the market for new long term equity capital. The primary market is the marketwhere the securities are sold for the first time. Therefore it is also called the new issuemarket (NIM).

In a primary issue, the securities are issued by the company directly to investors. The company receives the money and issues new security certificates to the investors. Primary issues are used by companies for the purpose of setting up new business orfor expanding or modernizing the existing business.

The primary market performs the crucial function of facilitating capital formation inthe economy.

The new issue market does not include certain other sources of new long termexternal finance, such as loans from financial institutions. Borrowers in the new issuemarket may be raising capital for converting private capital into public capital; this is

known as "going public." The financial assets sold can only be redeemed by the original holder.

3.1 Types of share issues3.1.1 Equity shares:

These shares are also known as ordinary shares. They are the shares which do not enjoy any

preference regarding payment of dividend and repayment of capital. They are given dividend

at a fluctuating rate. The dividend on equity shares depends on the profits made by a

company. Higher the profits, higher will be the dividend, where as lower the profits, lower

will be the dividend.

3.1.2 Preference shares:These shares are those shares which are given preference as regards to payment of dividend

and repayment of capital. They do not enjoy normal voting rights. Preference shareholders

have some preference over the equity shareholders, as in the case of winding up of the

company, they are paid their capital first. They can vote only on the matters affecting their
http://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Fundinghttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Fundinghttp://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Capital_market


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own interest. These shares are best suited to investors who want to have security of fixed rate

of dividend and refund of capital in case of winding up of the company.

3.1.3 Deferred shares:These shares are those shares which are held by the founders or pioneer or beginners of thecompany. They are also called as Founder shares or Management shares.

In deferred shares, the right to share profits of the company is deferred, i.e. postponed till all

the other shareholders receive their normal dividends. Being the last claimants of the profits,

they have a considerable element of speculation or uncertainty and they have to bear the

greatest risk of loss. The market price of such shares shows a very wide fluctuation on

account of wide dividend fluctuations. Deferred shares have disproportionate voting rights.

These shares have a small denomination or face value.

Deferred shares are not transferable if issued by a private company. Deferred shareholders donot enjoy the right of priority to have shares offered in case of the issue of shares by the

company. If the company goes into liquidation the deferred shareholders can get refund of

capital and participate in the surplus capital, if any, after the rights of preference and equity

shareholders have been satisfied.

3.1.4 Income SharesThese are the shares of the companies which have stable operations. The companies have a

high dividend payout ratio and when the dividends paid are high it implies that the profits

saved for company is less and hence less opportunities of growth.

3.1.5 Growth sharesThese are the shares of companies which have secured their positions in a particular industry.

These shares have less dividend payout ratio and hence high growth potential.

3.1.6 Cyclical SharesThere is a definite business cycle that keeps on operating and these are the shares of that

company whose performance varies with the stages of the cycle. It means to say that theprices of the shares are affected by the variations in the economy.

3.1.7 Defensive sharesThese are the shares of the company whose performance does not change with the changes in

the economy.

3.1.8 Speculative sharesThese are the shares which are traded in the company which have a lot of speculations.

Shares cannot be put into one category strictly because the characteristics of the shares are


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overlapping in the sense that the blue-chip shares which are in great demand in the market

fall under blue-chip shares and speculative shares.

3.1.9 Cumulative & Non cumulative sharesSuppose a company does not make any profits for two successive years and makes hugeprofits in the third year. Then the people who have cumulative shares will get the interest of

the three years and in case of non-cumulative share holders they do not receive the interest of

past two years.

3.1.10 Redeemable & Non-redeemableThe redeemable shares are redeemed within the life time of the company or before the

company closes down or to say that these shares have a maturity period. In case of

nonredeemable shares they mature only upon closing down of the company.

3.1.11 Convertible & Non-convertible sharesClasses of shares which can be converted to other forms of shares or securities are called as

convertible shares. Whether they are converted to equity shares, debentures depend on the

rules laid down by the company. If the shares are not convertible to any other security on

their maturity period are called as non-convertible shares.

3.1.12 Bonus shares:

The word bonus means a gift given free of charge. Bonus shares are those shares which areissued by the company free of charge as bonus to the shareholders. They are issued to the

existing shareholders in proportion to their existing share holdings. It is a kind of gift to the

shareholders from the company. It is bonus in the form of shares instead of cash. It is given

out of accumulated profits and reserves. These shares have all types of preferences which are

available to the existing shares. For example. two bonus shares for five equity shares. The

issue of bonus shares is also termed as capitalization of undistributed profits.

Bonus shares is a type of windfall gain to the equity shareholders. They are advantageous to

the equity shareholders as they get additional shares free of cost and also they earn dividend

on them in future.

3.1.12.1 Conditions for issue of bonus shares:(i) Sufficient amount of undistributed profits: There must be sufficient amount of

undistributed profits for the issue of bonus shares.

(ii) Provision in the articles: There must be a provision in the articles of association regarding

the issue of bonus shares. If there is a provision in the articles regarding the issue of bonus

shares the company can issue bonus shares if there is no provision, the company cannot issue

the bonus shares.


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(iii) Suitable Resolution: The Board of Directors must pass a suitable resolution in the Board

meeting for the issue of bonus shares.

(iv) Shareholders approval: The shareholders must give formal approval for the issue of

bonus shares in the Annual General Meeting.

(v) When a company can issue: A company can issue bonus shares only twice in a period of

five years.

(vi) Fully paid up shares: Bonus shares can be issued only when the existing shares are fully

paid up.

3.1.13 Other classifications of shares:-3.1.13.1Blue Chip SharesThe shares of some of the companies which have been doing extremely well in the past few

years. These are usually well established companies. The word blue-chip shares came into

existence when IBM Company was doing very well and shares of that company were trading

at higher prices. The companies which come under this umbrella are never fixed as the

performance of some of the companies may suddenly fall down and some of the companies

which never did well start to do extremely well. Hence it can be said that list of blue-chip

companies keeps on changing each year. The companies which come under this are market

leaders and have the potential to dictate terms.

3.1.13.2Slow GrowersLarge companies which have the growth rate equal to the industry growth rate or their

growth is equal or slightly faster than the GDP (Gross Domestic Product).

3.1.13.3Fast GrowersShares of newly started successful companies which have a very good growth rate (the rate is

usually 10 to 25 percent) per year.

3.1.13.4StalwartsShares of very large companies which have stable growth. The dividend payout ratio is high.

These companies are growing but not rapidly as in the case of fast growers.

3.1.13.5Turn-aroundThe shares of the companies which have started performing very well. These companies

were fairing badly in the past and all of a sudden there is a turn-around in their performance.


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3.1.13.6Asset playsThe shares of the companies who are not given any recognition though they have a large

asset base.10

3.2 IPO methods- Initial Public Offering (IPO)The first sale of shares by a private company to the public. IPOs are often issued, seeking

capital to expand, but can also be done by large privately owned companies looking to

become publicly traded. In an IPO, the issuer may obtain the assistance of an underwriting

firm, which helps it determine what type of security to issue, best offer price and time to

bring it to market. Also applicable to first sale of debentures and units of closed end funds.

An IPO can either be an Offer for Sale or an Offer for Subscription.

An initial public offering (IPO), referred to simply as an "offering" or "flotation", is when a

company (called the issuer) issues common stock or shares to the public for the first time.

They are often issued by smaller, younger companies seeking capital to expand, but can also

be done by large privately owned companies looking to become publicly traded.

IPOs generally involve one or more investment banks known as "underwriters". The

company offering its shares, called the "issuer", enters a contract with a lead underwriter to

sell its shares to the public. The underwriter then approaches investors with offers to sell

these shares.

The sale (allocation and pricing) of shares in an IPO may take several forms. Common

methods include:

Best efforts contract Firm commitment contract All-or-none contract

Bought deal

Dutch auctionA large IPO is usually underwritten by a "syndicate" of investment banks led by one or more

major investment banks (lead underwriter). Upon selling the shares, the underwriters keep

a commission based on a percentage of the value of the shares sold (called the gross spread).

Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO,

take the highest commissionsup to 8% in some cases.

10http://www.icasrilanka.com/journal/V42No4/Fixed%20Income%20Securities.pdf
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Multinational IPOs may have many syndicates to deal with differing legal requirements in

both the issuer's domestic market and other regions. For example, an issuer based in the E.U.

may be represented by the main selling syndicate in its domestic market, Europe, in addition

to separate syndicates or selling groups for US/Canada and for Asia. Usually, the lead

underwriter in the main selling group is also the lead bank in the other selling groups.

Because of the wide array of legal requirements and because it is an expensive process, IPOs

typically involve one or more law firms with major practices in securities law, such as

the Magic Circle firms of London and the white shoe firms of New York City.

Public offerings are sold to both institutional investors and retail clients of underwriters. A

licensed securities salesperson ( Registered Representative in the USA and Canada ) selling

shares of a public offering to his clients is paid a commission from their dealer rather than

their client. In cases where the salesperson is the client's advisor it is notable that the financial

incentives of the advisor and client are not aligned.

IPOs generally involve one or more investment banks as "underwriters." The companyoffering its shares, called the "issuer," enters a contract with a lead underwriter to sell itsshares to the public. The underwriter then approaches investors with offers to sell theseshares. Investment banks help companies and governments raise money by issuing andselling securities in the capital markets (both equity and debt), as well as providing advice ontransactions such as mergers and acquisitions. A majority of investment banks also offerstrategic advisory services for mergers, acquisitions, divestiture or other financial services forclients, such as the trading of derivatives, fixed income, foreign exchange, commodity, andequity securities.

When a company wants to go public, the first thing it does is hire an investment bank. Acompany could theoretically sell its shares on its own, but realistically, an investment bank isrequired. Underwriting is the process of raising money by either debt or equity (in this casewe are referring to equity). Underwriters are middlemen between companies and theinvesting public.

Two general types of primary market issues. One is IPO, e.g. Ebay had an IPO in 1998,selling 3.5m shares at $18, raising $63m for Ebay. Price went to $54 in a few days, thefounder kept 14.7m shares, and was worth $700m on paper. Next is subsequent to an IPO, afirm could issue additional shares of stock at a later date, to raise additional funds, e.g. AlliedHealthcare International sold 14.5m additionalshares of stock to raise $71m in May 2004.

There are several disadvantages to completing an initial public offering, namely:

Significant legal, accounting and marketing costs Ongoing requirement to disclose financial and business information Meaningful time, effort and attention required of senior management Risk that required funding will not be raised Public dissemination of information which may be useful to competitors, suppliersand customers.11

11http://www.slideshare.net/arunspeaker/finance-ipo
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3.3 Private placementThe sale of securities directly to an institutional investor, such as a bank, unit trust, insurance

company, pension fund, foundation or retail investor, without an Initial Public Offering

(IPO). Usually, the securities are bought for investment purposes rather than resale.

Private placement (or non-public offering) is a funding round of securities whichare sold without an initial public offering, usually to a small number of chosen privateinvestors. In the United States, although these placements are subject to the Securities Act of1933, the securities offered do not have to be registered with the Securities and ExchangeCommission if the issuance of the securities conforms to an exemption from registrations asset forth in the Securities Act of 1933 and SEC rules promulgated there under. Most privateplacements are offered under the Rules known as Regulation D. Private placements maytypically consist of stocks, shares of common stock or preferred stock or other forms ofmembership interests, warrants or promissory notes (including convertible promissory notes),and purchasers are often institutional investors such as banks, insurancecompanies or pension funds. Most private placements are offered under the Rules known

asRegulation D. Private placements may typically consist ofstocks,sharesof common stockor preferred stock or other forms of membership interests,warrantsorpromissorynotes(including convertible promissory notes), and purchasers are often institutional

investorssuch asbanks,insurance companiesorpension funds. Alternatively, a primarymarket sale can be through a private placement, where the entire issue is sold to a private

investment group, usually an institutional investor such as a pension fund, or a group ofinstitutional buyers.12

Private placement trading programs usually involves trading with medium term bank notes(MTNs) or Treasury Bills called T-Bills. PPP refers specifically to private placement tradingprograms with a high return on the investment associated with humanitarian project fundingprograms or Fed programs as compared to capital enhancement programs. These programsprovide the traders with fresh issues of MTNs or T-Bills that produce high profit margins.This is known as the first tier. In the commercial world this would be called the B2Bwholesale market. Now we all know that end users usually do not have access to the pricesoffered in the wholesale market, so they buy goods in the convenience store and not direct

from the producer.

Most of the time these programs require the investors to use a portion of their earnings forprojects of humanitarian, social, or economic development in nature to make sure that part ofthese Profits are put back into the economy. Even after deducting the portion of earnings tobe used for projects, the investor is still left with a very substantial profit for their owninvestments. Performing PPP programs are difficult to find and are not always available.Only a very restricted number of high-level traders can get access to these type of programs.

12http://en.wikipedia.org/wiki/Private_placement
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Many capable investors have been looking around for PPPs for years and are unable to find aperforming provider. Often they have wasted large sums of money by sending MT760s to

banks and so called traders that simply cannot perform. Genuine programs are without risk tothe investor what so ever, as the credit line raised against the capital is underwritten by thetrading group. The (Investor) therefore is involved for the purpose of audit only, as it is by

law that Financial institutions are not allowed to participate and therefore have to find aPrivate entity either a private person or company. At no time are the investors or bettercalled Audit Fund Providers funds used for the trade.

The procedures to enter are simple and fairly standard, however the Audit Fund Provider willhave to adhere to strict compliance and non-disclosure. Many claim to be next to traders, thisis 99.99% not the case. Traders are very busy people and have no time to sit down and have achat. Therefore they have a structure in place where the first contact is with a complianceofficer who will go through the submission papers and sort out the good from the nonsense.13

4 Secondary financial marketsSecondary markets are for the subsequent trading (buying and selling) of securities after aprimary market issue, in the bond and stock markets (NYSE, AMEX and NASDAQ are allsecondary markets for stocks). In the secondary market, funds are transferred from oneinvestor to another (institutional or individual), without no effect on the cash flows of theissuing firm. Secondary markets provide an efficient, liquid market for the purchase and saleof securities at low transaction costs. Even though it gets no direct funds from sales of itssecurities in the secondary market, the issuing firm is very concerned about the prices of itsstock, which is largely determined by the secondary market. The current market pricereflects the current and expected future success of the firm, provides daily feedback about thefirm's operations and the value of the firm (both to the firm and to investors).

4.1 Basic trading systemThere are who are interested in the purchase of shares of different companies on one side

,while there are certain shareholders who are interested in selling the share they hold on the

other. There for in order to match their needs the service of intermediary is essential. it is the

brokering firms who fill this gap. Currently there are fifteen brokering firms who provide

these intermediary service. each of them is a member of the CSE. each broker is linked withother co-brokers through the CSE. there they match their transaction. Earlier this was done

at the trading floor operated in the CSE. at present it is done through an automated trading

system.

Now we will discuss how the sellers and buyers access the brokers. First the persons who

are interested in buying or selling shares go through information about secondary market

activities and find out the profitable shares to invest in or make a sale. Then they go to a

brokering firm and place an order. Buyers place buy orders and sellers place sells orders. A

buyers of shares has to open an account with the central depository system(CDS)before an

13 http://www.articlesbase.com/investing-articles/what-is-a-private-placement-program-1083242.html
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order is placed to buy shares. This has to be done by filling in an application form which is

then handed over to the broker.

4.2 Pure auction marketAn auction is a process of buying and selling goods or services by offering them up for bid,taking bids, and then selling the item to the highest bidder. In economic theory, an auction

may refer to any mechanism or set of trading rules for exchange.

There are several variations on the basic auction form, including time limits, minimum or

maximum limits on bid prices, and special rules for determining the winning bidder(s) and

sale price(s). Participants in an auction may or may not know the identities or actions of other

participants. Depending on the auction, bidders may participate in person or remotely through

a variety of means, including telephone and the internet. The seller usually pays a

commission to the auctioneer or auction company based on a percentage we of the final sale

price.

A market in which buyers enter competitive bids and sellers enter competitive offers at the

same time. The price a stock is traded represents the highest price that a buyer is willing to

pay and the lowest price that a seller is willing to sell at. Matching bids and offers are then

paired together and the orders are executed.

4.3 Dealer marketsA market in which transactions occur between principals acting as dealers buying and selling

for their own accounts, rather than between brokers acting as agents for buyers and sellers.One example is the market for Treasuries.

The market for traders who are trading on their own accounts, as opposed to traders to

conduct transactions on behalf of clients. Dealer markets exist to create the greatest liquidity

possible for other transactions. One of the most prominent dealer markets is NASDAQ. See

also: Dealer, Broker-dealer

A market where dealers are assigned for specific securities. The dealers create liquid markets

by purchasing and selling against personal inventory. Unlike auction markets, the benefit of

this type of market is the rapid access that investors have to buyers and sellers ofa particular

security. The best example of a dealer market is the Nasdaq.

4.4 Call and continuous markets4.4.1 Call Markets

Where a stock can only trade at a specific time. Bids for the stock are collected and then

traded at a specific time and at one price. It is typically only used for smaller markets.


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It is typically only used for smaller markets. A type of market in which each transaction takesplace at predetermined intervals and where all of the bid and ask orders are aggregated andtransacted at once. The exchange determines the market clearing price based on the numberof bid and ask orders. A call market is contrasted to an auction market, where orders arefilled as soon as a buyer/seller is found for any given order at an agreed upon price. In a call

market, the price is set by the exchange so the market will clear, or almost clear, every timeorders are filled. This is in stark contrast to the auction market, where prices are determinedby buyers and sellers. Because the call market groups transactions together, there is

Capital Market - TM

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