UNIT-II

Capital market – New issue market and stock exchange in India- BSE – NSE – OTCEI – Kinds
of trading activity- Listing of securities – SEBI and its role and guidelines.

Primary Market - The New Issues Market

The industrial securities market in India consists of New Issue Market and Stock Exchange. The new
issue market deals with the new securities which were not previously available to the investing public,
i.e., the securities that are offered to the investing public for the first time. It is also known as Primary
Market.

The new issue market deals with the new securities which were not previously available to the
investing public, i.e., the securities that are offered to the investing public for the first time. The
market, therefore, makes available a new block of securities for public subscription. All financial
institutions which contribute, underwrite and directly subscribe to the securities are part of new issue
market.There are various intermediaries like registrars, custodians and merchant bankers that are
involved in this activity of issuing new securities.

Functions of New Issue Market

The main function of a new issue market is to facilitate transfer of resources from savers to the users.
The savers are individuals, commercial banks, insurance companies etc. The users are public limited
companies and the government. It is not only a platform for raising finance to establish new
enterprises but also for expansion/ diversification/ modernization of existing units.

In this basis the new issue market can be classified as:-

1. Market where firms go to the public for the first time through initial public offering (IPO).
2. Market where firms which are already trading raise additional capital through seasoned equity
offering (SEO).

The main functions of a new issue market can be divided into a triple service functions:

1. Origination: It refers to the work of investigation, analysis and processing of new project
proposals. It starts before an issue is actually floated in the market. This function is done by
merchant bankers who may be commercial banks, all India financial institutions or private
 firms. At present, financial institutions and private firms also perform this service. Though this
service is highly important, the success of the issue depends, to a large extent, on the
efficiency of the market.
2. Underwriting: It is an agreement whereby the underwriter promises to subscribe to a
specified number of shares or debentures or a specified amount of stock in the event of public
not subscribing to the issue. If the issue is fully subscribed, then there is no liability for the
underwriter. If a part of share issues remains unsold, the underwriter will buy the shares. Thus,
underwriting is a guarantee for marketability of shares. There are two types of underwriters in
India - Institutional (LIC, UTI, IDBI, ICICI) and Non-institutional are brokers.
3. Distribution: It is the function of sale of securities to ultimate investors. This service is
performed by brokers and agents who maintain a regular and direct contact with the ultimate
investors.
Methods of Floating New Issue

The various methods which are used in the flotation of securities in the new issue market are :

1. Public issues
2. Offer for sale
3. Placement
4. Rights issues

1. Public Issues

Under this method, this issuing company directly offers to the general public/ institutions a fixed
number of shares at a stated price through a document called prospectus. This is the most common
method followed by joint stock companies to raise capital through the issue of securities. The
prospectus must state the following:

* Name of the company

* Address of the registered office

* Existing and proposed activities

* Location of the industry

* Names of Directors
* Minimum subscription

* Names of brokers/ underwriters/ bankers/ managers and registrars to the issue.

2. Offer for Sale

This method of offer of sale consists in outright sale of securities through the intermediary of Issue
Houses or share-brokers. In other words, the shares are not offered to the public directly. This
method consists of two stages: The first stage is a direct sale by the issuing company to the issue
house and brokers at an agreed price. In the second stage, the intermediaries resell the above
securities to the ultimate investors. The issue houses or stock brokers purchase the securities at a
negotiated price and resell at a higher price. The difference in the purchase and sale price is called
spread. It is otherwise called Bought out deals (BOD).

This method is used generally in two instances:

1. Offer by a foreign company of a part of it to Indian investors.

2. Promoters diluting their stake to comply with requirements of Stock exchange at the time of listing
of shares.

3. Placement

Under this method, the issue houses or brokers buy the securities outright with the intention of
placing them with their clients afterwards. Here the brokers act as almost wholesalers selling them in
retail to the public. The brokers would make profit in the process of reselling to the public. The issue
houses or brokers maintain their own list of clients and through customer contact sell the securities.
There is no need for a formal prospectus as well as underwriting agreement.

4. Rights Issue

It is a method of raising funds in the market by an existing company. A right means an option to buy
certain securities at a certain privileged price within a certain specified period. Shares, so offered to
the existing shareholders are called rights shares. Rights shares are offered to the existing
shareholders in a particular proportion to their existing share ownership. The ratio in which the new
shares or debentures are offered to the existing share capital would depend upon the requirement of
capital. The rights themselves are transferable and sale-able in the market. Section 81 of the
Companies Act deals with rights issue. The cost of issue is minimum. There is no underwriting,
brokerage, advertising and printing of prospectus expenses. It prevents the directors from issuing new
shares in their own name or to their relatives at a lower price and get controlling right.

Principal Steps in Public Issue

Now, we see the main steps involved in Public issue. They are in following order:

1. Draft Prospectus

It is prepared giving all details that have been stated earlier under public issue. Any company or a
listed company making a public issue or a rights issue of value more than Rs. 50 lakhs has to file a
draft offer document with SEBI for its observation. The company can proceed further only after
getting observations from the SEBI. The company has to open its issue within three months from the
date of SEBI's observation letter.

2. Fulfillment of Entry Norms

The SEBI has laid down certain parameters for accessing the primary market. If a company fulfills
these parameters (entry norms), then only it can enter into the primary market.

The Entry norms are as follows -

Entry norm I :

 The company should have Net Tangible Assets of at least Rs. 3 crores for three full years.
 It should have distributable profits in at least three years.
 It should possess Net Worth of atleast Rs.1 crore in 3 years.
 The issue size should not exceed 5 times the pre-issue net worth.
 If it has to change its name, at least 50% revenue for the preceding one year should be from the
new activity.

To ensure that genuine companies don't suffer due to the rigidity of those parameters, the SEBI has
laid down two more alternative routes for accessing the primary market.

Entry Norm II

If the issue is through book building route, at least 50% of the issue should be allotted to Qualified
Institutional Buyers (QIBs)
  The minimum post-issue face value capital shall be Rs. 10 crore or there shall be a compulsory
market-making for at least two years.

Entry Norm III

 The company should have at least 1000 prospective allottees

 The project should be appraised and participated to the extent of 15% by Financial Institutions
and scheduled commercial banks of which at least 10% comes from the appraisers.
 The minimum post-issue face value capital shall be Rs. 10 crore or there shall be a compulsory
market-making for at least 2 years.

The above entry norms are not applicable to the private and public sector banks, listed companies
right issue and an infrastructure company whose project has been appraised by a financial institution
or a bank and not less than 5% of the project cost is financed by these institutions.
3. Appointment of Underwriters

They are appointed to shoulder the liability and subscribe to the shortfall in case the issue is under-
subscribed. For this commitment they are entitled to get a maximum commission of 2.5% on the
amount undertaken.

4. Appointment of Bankers

Bankers act as collecting agents I.e., the banks along with their branch network act as collecting
agencies and process the funds during the public issue.

5. Initiating Allotment Procedure

The next step is that the Registrars process the application forms, tabulate the amounts collected
during the issue and initiate the allotment procedures

6. Brokers to the issue

They are recodnised members of the stock exchange and are appointed as brokers to the issue for
marketing the issue. They are eligible for a maximum brokerage of 1.5%.

7. Filing of Documents

The draft prospectus, along with the copies of the agreements entered into with the lead manager,
underwriters, bankers, registrars and brokers to the issue have to be filed with the Registrar of
companies of state where the registered office of the company is located.

8. Printing of Prospectus And Application Forms

9. Listing the Issue

10. Publication in Newspapers

11. Allotment of shares

12. Underwriters liability

13. Optional Listing

Principal Steps Of Private Placement

It may be done in respect of equity shares, preference shares, bonds and debentures. Generally, the
private placement of bonds and debentures is very popular.

The following steps are involved -

1. Terms and conditions

They include the value of the instrument, maturity period, yield rate, issue and redemption details,
etc.

2. Credit rating

It is mandatory to obtain credit rating from a recognised credit rating agency who will evaluate the
various aspects concerned with the instrument.

3. Confidential Information Memorandum (CIM)

It is just like the offer document in the case of shares. An investor can have a thorough knowledge
about the issue by going through this document.

4. Trustees to the issue

The next step is to appoint trustees (usually banks or other financial institutions) to the issue to
protect the interest of investors.

5. Pre-launching formalities

Just one or two days before the launching date, the CIM is sent to the prospective investors inviting
them to subscribe to the issue.

6. Pricing the issue

Sometimes pre-marketing campaign may be conducted by the issue houses to ascertain the investors
towards private placement and the probable prices. Since book building method is adopted by many
companies, this campaign is not generally resorted to.

7. Post-issue Steps

Decision is taken on allotment and the certificates are issued. Over subscriptions are refunded. The
details of the issue are sent to the stock exchange where it is likely to be listed.
Principal Steps Involved in The case of Offer For Sale

1. Agreement with the merchant banker or sponsor group laying down the terms and
conditions of the issue.
2. Registration of the agreement with the stock exchange concerned.
3. Default - It is default is committed by the sponsor, it will be referred to an arbitrage committee
set up by the stock exchange.
4. Offloading - Sponsor can Offload his position provided the promoter's post-issue holding will
not be less than 20% with a 3 year lock in period.
5. Market Maker - The sponsor should agree to act as a market maker for the companies share
for 18 months and should also identify another market maker for such compulsory market
making.

Players In The Primary Market

There are many players in the new issue or primary market. The important of them are:

1. Merchant Bankers - They are the issue managers, co-managers, and are responsible to the
company and SEBI. They are registered by SEBI under category I, II, III and IV based on the
capital adequacy and track record.
2. Registrars to the issue - They are an important category of intermediaries who undertake all
activities connected with new issue management. They are appointed in consultation with the
merchant bankers. A networth of Rs. 6 Lakhs is essential for Registrars.
3. Collecting and Co-ordinating Bankers - They collect information on subscriptions and co-
ordinate the collection work.
4. Underwriters and Brokers - Brokers along with the network of sub-brokers market the new
issues. They send their own circulars and applications to the clients and do follow up work to
market securities.
 Advantages & Disadvantages of Primary Market

Advantages :-

1. Mobilisation of savings

2. Channelising savings for productive use

3. Source of large supply of funds

4. Rapid Industrial growth due to increase in production and productivity in the economy.

Disadvantages :-

1. Possibility of deceiving investors

2. No fixed norms for project appraisal

3. Lack of post issue seriousness eg. Facebook IPO

4. Ineffective role of merchant bankers

5. Delay in allotment process

SECONDARY MARKET:

Secondary market comprises the buyers and sellers of shares and debentures subsequent to the
original issue. Section 73 of Companies Act of companies act requires that every company
intending to offer shares or debentures to the public for subscription thro’ issue of a prospectus,
must seek enlistment with one or more stock exchanges. Therefore stock exchanges represent
the secondary market.

Definition in the Act: The securities contracts (Regulation) Act of 1956 defines a stock
exchange as "an association, organization or body of individuals whether incorporated or not,
established for the purpose of assisting, regulating and controlling business in buying or dealing
in the securities",
 CHARACTERISTICS OF THE STOCK EXCHANGE:
1. Voluntary association: The stock exchanges are voluntary associations registered by certain statutory laws.
These exchanges do not conduct business for themselves but provide facilities to their members to transact with
the corporate securities.
2. Control of the Governing body: The members of the exchange elect a governing body,
which exercises proper and adequate control over its members. The body is empowered with
wide authorities and rights over the members and controls their activities directly.
3. Rules and regulations: The members should obey the rules and regulations formulated by
the stock exchange. Any member who acts against the rules of the exchange can be removed
from the membership. Admission of new members is also subject to the over all control and
discretion of the governing body.
4. Listed securities: Securities enlisted in the official list of the stock exchange can alone be
transacted in the exchanges. Enlisting of securities is very essential to safeguard the interests
of the investors from unscrupulous brokers and dealers in the stock exchanges. The securities
are enlisted only after a thorough investigation of the financial standing of the company
issuing such securities. Now it is provided that every public company in India should get its
shares listed.

Functions of a stock exchange

1. Ready and continuous market for securities: The stock exchange provides and ready
and continuous market for existing securities. Anybody can buy or sell securities in the stock
exchange during the business hours. Thus stock exchange provides liquidity, marketability,
price continuity and transferability to capital already invested.

2. Evaluation of securities: The evaluation, in fact, is a continuous process and the value of
the securities are determined as close as possible to their investment values based on the present
and future income yielding prospects of various enterprises. This function is performed quickly
at a comparatively cheaper cost. The price prevailing in the stock exchange is called market
quotation. This quotation will enable the investor to ascertain the value of his shareholding.
3. Safety of capital and fair dealing: The stock exchange transactions are made publicly
under well-defined rules and regulations and buy-laws. The members of the exchange are bound
to obey the rules and regulations. This factor ensures a great measure of safety and fair dealings
to the average investors.

4. Agency for capital formation: The stock exchange plays an active role in the capital
formation in the country. It creates the habit of saving, investing and risk bearing amongst the
investing public. Industrial investments are stimulated in preference from the unproductive
investments in land, gold etc., this mobilization of funds towards corporate securities results in
fostering the industrial growth and economic development of the country.

5. Proper canalisation of capital: Stock exchange directs the flow of savings into the most
productive and profitable channels. If the securities of a company are being sold above par i.e.,
above the face value, it is an indication that the company has good prospects. Since market
quotations for different securities are given wide publicity, the investors can invest their savings
in the securities of profitable companies and reap a good harvest in the form of dividend. Such
companies can also raise additional capital by fresh issues very easily.

6. Regulation of company management: The companies, which want to get their

securities listed in the stock exchange, should have to follow certain rules and fulfill certain
conditions. Such companies should also furnish all reasonable informations concerning the
financial affairs of them every year. They should also safeguard the interests of the minority
shareholders. The rules and regulations, the stock exchanges exercise wholesome influence on
the working and management of the companies. This factor safeguards the interest of the
investing public and also regulates company management.

7. Facilities for speculation: Healthy speculation is essential to equate demand and supply
of securities at different places. Besides, it also regulates the prices of securities considerably.
The stock exchange encourages healthy speculation and provides opportunities to shrewd
businessmen to peculate and reap rich profits from fluctuations in security prices.

8. Barometer of business progress: Stock exchanges act as a barometer of the business

conditions in the country. Booms and depressions are reflected by the index of prices of various
securities maintained by the stock exchange. By analysing the ups and downs of the market
quotations, the causes for the changes in the business climate can be ascertained.

SERVICE OF THE STOCK EXCHANGE

Services to investors
1.The investors are assured of a ready and continuous market for the securities held by them.
Hence, they can realise the securities in times of need.
2.Listed securities can be given to the bankers as a security for the loans. Since the stock market
provides negotiability to the securities, bankers will also accept them as a good security for
advance.
3.The investors can easily ascertain the value of the securities held by them. They can also find
out the variations in their value from the market quotation published by the stock exchange
either daily or periodically
4.The investor is also assured safety of his funds and fair dealings in them. The rules and
regulations of the exchange ensure fair dealings and protect the investors against loss from
fraud.
5.The risk in the investment is minimised and liquidity is ensured.

Services to corporation
1. When the securities of a company are listed in the stock exchange, it will enhance the
reputation and prestige to the company.
2. It widens the market for the securities, which is beneficial from the viewpoint of the
corporation. Wider the market, lesser will be the opportunity for group opposition against its
management. It facilitates smooth operation of the concern.
3. Reputed companies can raise further capital very easily. The investors will readily subscribe
for the new issues floated by such companies.
4. Price fluctuations are minimized. Therefore, the companies whose securities are listed in the
stock exchange shall enjoy the confidence of the investors.
5. In relation to the earnings, dividends and property values, the market price of listed securities is
generally high and this helps the corporation in merger plans. In such a situation, it would be
able to fetch more prices.
Services to the community
1. Financing for development: It helps in the financing of the economic development of
the country. There is no exaggeration to say that the sharp increase in industrial activities in our
country since independence is mainly because of the stock exchanges functioning in our country.

2. Promotion of new industries: It provides necessary instrument to the state

(Government) in raising sufficient finance so necessary for rapid industrialisation of a
developing economy. In developing countries, the state should take initiative in the promotion
and management of industrial projects.

3. Capital formation: In the absence of a well-organized stock exchange, it is impossible to

develop the habit of saving, investing and risk taking in the investors. The stock exchanges
facilitate the process of capital formation regular and continuous.
4. Productive use of funds: By generating the habit of savings in the corporate securities,
the stock exchange can help the country to channelise the savings in productive purposes and
thereby avoid funds being diverted to wasteful source.

Classification of members

The membership of the London stock exchange is divided into two classes,
namely 1. Brokers and 2. Jobbers.

1. Brokers: A broker is a mere commission agent. He acts on behalf of non-members.

The investing public buys and sells securities only through the broker. Thus, he does not
ordinarily deal for himself. He deals in all varieties of stocks and shares. He is paid a
commission on the purchases and sales made through him.

2. Jobber: Jobber acts for himself i.e., he is not the agent of any non-member. He buys
and sells securities in his own name. The difference between the two prices i.e., purchase
price and selling price of the securities is the profit earned by the jobber. It is technically
called as "Jobber's Turn". The jobber is generally a specialist who deals in certain types of
securities only.
National Stock Exchange of India (NSE)

With the liberalisation of the Indian economy during the 1990s, it was inevitable that the
Indian stock market trading system be raised to the level of international standards. The high
powered committee on stock exchanges known as Pherwani Committee recommended, in 1991,
the setting up of a new stock exchange as a model exchange and to function as a national stock
exchange. It was envisaged that the new exchange should be completely automated in terms of
both trading and settlement procedures. On the basis of the recommendations of the Pherwani
committee, a new stockexchange was promoted by the premier financial institutions of the
country, namely 1DB!,ICICI, IFCI, all insurance corporations, selected commercial banks and
others. The new exchange was incorporated in 1992 as the National Stock Exchange (NSE). It
started functioning in June 1994. The purpose of setting up the new exchange was to create a
world-class exchange and use it as an instrument of change in the Indian stock market through
competitive pressure. Technology has been the backbone of NSE. It chose to harness technology
in creating a new market design. Its trading system, called National Exchange for Automated
Trading (NEAT), is a state-of-the-art client-server based application. The NSE also uses satellite
communication technology for trading. Its trading system has shifted the trading platform from
the trading hall in the premises of the exchange to the computer terminals at the premises of the
trading members located at different geographical locations in the country. It has been
instrumental in bringing about many changes in the trading system such as reduction of
settlement cycle, dematerialisation and electronic transfer of secure ties, establishment of
clearing corporations, professionalisation of trading members, etc. All the stock exchanges in the
country, starting with the Bombay Stock Exchange, have shifted to the new computerised trading
system which facilitates screen-based trading. As a consequence, the stock market today uses the
state-of-the-art information technology tools to provide an efficient and transparent trading,
clearing and settlement mechanism at par with international standards. The National Stock
Exchange has played a leading role as a change agent in transforming the Indian stock market to
its present form. Since its inception, the NSE has been playing the role of a catalytic agent in
reforming the stock market and evolving the best market practices. The NSE has brought about
unparalleled transparency, speed and efficiency, safety and market integrity. In this process the
NSE has become the largest stock exchange in the country, relegating the Bombay Stock
Exchange to the second place.
Over the Counter Exchange of India (OTCEI)

The traditional trading mechanism (floor trading using open outcry system), which
prevailed in the Indian stock exchanges, resulted in much functional inefficiency such as absence
of liquidity, lack of transparency, undue delay in settlement of transactions, fraudulent practices,
etc. With the objective of providing more efficient services to investors, the country’s first
electronic stock exchange which facilitates ringless, scripless trading was set up in 1992 with the
name Over the Counter Exchange of India (OTCEI). It was sponsored by the country’s premier
financial institutions such as UTI, ICICI, IDBI, SBI Capital Markets, IFCI, GIC and its
subsidiaries and Canbank Financial services. The exchange was set up to aid enterprising
promoters in raising finance for new projects in a cost effective manner and to provide investors
with a transparent and efficient model of trading. The OTCEI had many novel features. It
introduced screen based trading for the first time in the Indian stock market. Trading takes place
through a network of computers of over the counter (OTC) dealers located at several places,
linked to a central OTC computer using telecommunication links. All the activities of the OTC
trading process are fully computerised. Moreover, OTCEI is a national exchange having a
country-wide reach. OTCEI has an exclusive listing of companies, that is, it does not ordinarily
list and trade in companies listed in any other stock exchanges. For being listed in OTCEI the
companies have to be sponsored by members of OTCEI. It was the first exchange in the country
to introduce the practice of market making, that is, dealers in securities providing two-way
quotes (bid prices and offer prices of securities).

Trading System in Stock Exchange

A stock exchange is a market for trading in securities. But it is not an ordinary market; t
is a market with several peculiar features. In a stock exchange, buyers and sellers do not directly
meet and interact with each other for making their trades. The investors (buyers and sellers of
securities) trade through brokers who are members of a stock exchange. In stock exchanges,
trading procedures are fully automated and member brokers interact and trade through a
networked computer system. Trading in a stock exchange takes place in two phases; in the first
phase, the member brokers execute their buy or sell orders on behalf of their clients (or
investors) and, in the second phase, the securities and cash are exchanged.
Trading System

The system of trading prevailing in stock exchanges for many years was known as floor
trading. In this system, trading took place through an open outcry system on the trading floor or
ring of the exchange during official trading hours. In floor trading, buyers and sellers transact
business face to face using a variety of signals. Under this system, an investor desirous of buying
a security gets in touch with a broker and places a buy order along with the money to buy the
security. Similarly, an investor intending to sell a security gets in touch with a broker, places a
sell order and hands over the share certificate to be sold. After the completion of a transaction at
the trading floor between the brokers acting on behalf of the investors, the buyer investor would
receive the share certificate and the seller investor would receive the cash through their
respective brokers. In the new electronic stock exchanges, which have a fully automated
computerized mode of trading, floor trading is replaced with a new system of trading known as
screenbased trading. In this new system, the trading ring is replaced by the computer screen and
distant participants can trade with each other through the computer network. The member
brokers can install trading terminals at any place in the country.