Financial Markets -Training document

Contents
1. About Financial Market
 Financial systems & structures
 Role of financial & securities markets
 Classification of financial market
 Flow of funds in financial markets?
 Financial Intermediaries
 Methods of issuing capital in primary market
 Sources and uses of funds
 Announce of new equity & the value of the firm
2. All about IPO
 Criteria & guidelines by SEBI for IPO
 Factors determining price of IPO
 Intermediary structure
 IPO process & timeline
3. Source of Capital
 Fund Sourcing
 Capital Structure
 Venture Capital investing
 Crowdfunding

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What are Financial Markets ?

Market

Financial Market

Low
transaction
cost

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Financial systems and Structures

Organized vs Unorganized Structures

 Organized
 Regulators, Financial Institutions, Financial Markets, Financial Instruments.
 Unorganized
 No physical location (Networks of dealers)
 Over the counter Money lenders, Local bankers, Landlords, Pawn brokers, Chit Funds.

Role of an Efficient and Effective Financial System

 Efficient: Ability to channelize the funds from a Surplus Unit to a Deficit Unit.

 Effective: Ability to bring the investors and borrowers with matching maturities/investment horizons
together.

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Role of Financial/Securities Markets

 Price Discovery Process

 Liquidity

 Reduction of search & information costs

 Transfer of risk ( derivatives market)

 Capital raising

 Integrating global markets with the financial market

 Speed up the economic growth and development

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Classification Of Financial Market

Capital Market Money Market

Primary Secondary Primary Secondary

Call Treasury Short term

Debt Equity Derivatives
money Bills Loans

Wholesale Retail Commercial

Segment Segment Bills

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Primary and Secondary Market
Primary Market

 Sale of new debt or equity securities which have come to life for the first time
(IPO, FPO, Rights, Private Placements)
 Primary investors buy share directly from the company
 Underwriter (usually the investment banker) provides facility of (in IPO, FPO):
• Origination
• Book Building
• Risk bearing
 Private Placements
• Sale directly to the investors with help of an investment bank
• Lower issuance cost for the firm
• Lower issue price since there is no active secondary market for
such privately allotted securities

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Primary and Secondary Market
Secondary Market
 Trading of securities previously issued are now exchanging hands.

 Investors who have already invested during IPO can make an exit by selling their stake to other investors.

 Liquidity increases – boost to the securities prices.

 No cash flow impact for the subject company or entity.

 Listing requirements are stringent.

 Issuer pays the exchange for Initial listing fee and Annual listing fees

• Floor Trading and Electronic Trading

• Quote-driven, Order-driven, Brokered Markets

 Stock prices fluctuates depending on demand and

supply.

 Unlimited time frame

 Brings many interested parties together.

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Classification

Classification of Financial/Securities Markets on the basis of:

 Maturity of Claim

• Money Market, Capital Market

 Type of Claim/Security

• Debt market, Equity Market, Commodity Market, Derivatives Market

 Type of Issuance (New or Seasoned Issue)

• Primary Market, Secondary Market

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Capital Markets and Money Markets
Capital Markets

 Long-term markets consisting of securities having maturities greater than one year.

 Include Bonds, Common Stock, Preferred Stock, and Convertible Securities, forex instruments,
derivatives.

 These securities comprise a firm’s capital structure.

 Higher expected return and more risk than money market.

 Credit instruments are more heterogeneous.

 Institutions – stock exchange, commercial banks,

Mortgage banks.

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Capital Markets and Money Markets
Money Markets

 Short-term markets comprising of securities with maturities of one year or less.

• Include Treasury bills, commercial paper, certificates of deposits, call money.

• Allow government to raise funds.

• Determine short term interest rates

• Implement monetary policy.

 Characteristics :

• Liquid & short maturities, low expected return, low degree of risk.

• Homogeneous instruments.

• Over the counter and wholesale level transactions.

• High transaction cost

 Institutions : central banks, commercial banks NBFI’s.

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Flow of funds in financial markets ?

Avg Indian household

saving rate 31.6%

• Facilitates the efficient allocation of fund throughout the economy.

• Greater flow of funds increases the accommodation of individual’s preference for spending &

saving.

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Financial Intermediaries
Different forms of
intermediaries/Participants

 Brokers/dealers/exchange - they facilitate the trade and provide important services.

 Depository Institution

 Insurance Company: Credit Default Swaps (CDS)

 Arbitrageurs

 Clearing House and Custodians – Quasi – regulatory in nature, reduce a lot of risk in the

investment process.

 PSU’s & development Banks and financial institutions, SEBI.

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Methods of issuing capital in Primary market
 IPO
Public issue of share for the first time.

Underwriter (investment banking company)

Appointment of underwriters to ensure the minimum subscription.

 FPO
Public issue made by a listed company for one or more time i.e. Follow-on-public offer.
 E-IPO
Issue capital through online system of stock exchange with the compliance of the SEBI-
(chapter-11A)

 Offer for sale

 Private Placement

 Right issue

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Sources and Uses of Funds
Three general sources of corporate funds
• Internally generated Cash

• Short-term External Funds

• Long-term External Funds

Uses of Cash Flow Sources of Cash Flow

(100%) (100%)

Capital Internal Cash

spending Flows (retained
earnings plus Internal
depreciation) Cash Flow
Financial
Net Working Deficit
Capital plus
Long-term Debt External
other uses
and Equity Cash Flow

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Announcement of New Equity & the Value of the Firm

The market value of existing equity generally drops on the announcement of a new issue of common
stock

Reasons include

 Managerial Information

• Since the managers are the insiders, perhaps they are selling new stock because they think it is
overpriced

 Debt Capacity

• If the market infers that the managers are issuing new equity to reduce their debt-to-equity ratio
due to the specter of financial distress the stock price will fall

 Falling Earnings

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Contents
1. About Financial Market
 Financial systems & structures
 Role of financial & securities markets
 Classification of financial market
 Flow of funds in financial markets?
 Financial Intermediaries
 Methods of issuing capital in primary market
 Sources and uses of funds
 Announce of new equity & the value of the firm
2. All about IPO
 Criteria & guidelines by SEBI for IPO
 Factors determining price of IPO
 Intermediary structure
 IPO process & timeline
3. Source of Capital
 Fund Sourcing
 Capital Structure
 Venture Capital investing
 Crowdfunding

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IPO Process

BRLM= Book running lead manager

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Criteria & guidelines by SEBI for IPO.

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Criteria & guidelines by SEBI for IPO.

 Issue shall be open within 12 months & allotment within 15 days.

 Listing with just 10 % holding with the public provided the minimum offer Rs 100 crore,

20 lakh shares through book building.

 Minimum threshold level of public holding 25%.

 Pre-issue net worth > 1cr (3 of 5 preceding years).

 Trak record of distributing dividends for at least 3 of 5 preceding years).

 Offer should not exceed five times net worth as per latest audited accounts.

 If not only through book building process (60% to QIB’s)

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Criteria & guidelines by SEBI for IPO.

 Minimum promotors contribution (i.e. 20% of post issue capital) is locked in for 3years

and excess of required minimum % must be locked for 1 year.

 Pre issue capital held by other than promotors must be locked in for 1 year.

 All partly paid up equity shares into fully paid up.

 SEBI allows free pricing of equity shares in IPO

 Issuer may announce a price band 2 working days before bid opening.

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Factors determining price of IPO.

 Objects of the issue.

 Financials of the company – Net worth, EPS, profit margin.

 Industry P/E ratio.

 Future prospects in the relevant industry.

 Background of promotors & Board.

 External and internal risks.

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Intermediary structure

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IPO timeline
Activity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Preparation phase
2 weeks

Due diligence
4-5 weeks

Filing of draft document

1 week

SEBI Observation
4-8 weeks

Finalization & filing of

offer document 3 weeks

Issue Period
3 days

Post issue activities

2-3 weeks

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IPO timeline

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Contents
1. About Financial Market
 Financial systems & structures
 Role of financial & securities markets
 Classification of financial market
 Flow of funds in financial markets?
 Financial Intermediaries
 Methods of issuing capital in primary market
 Sources and uses of funds
 Announce of new equity & the value of the firm
2. All about IPO
 Criteria & guidelines by SEBI for IPO
 Factors determining price of IPO
 Intermediary structure
 IPO process & timeline
3. Source of Capital
 Fund Sourcing
 Capital Structure
 Venture Capital investing
 Crowdfunding

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 Where do business get money from ?

Sources of capital
Entrepreneur
Angel investors
Venture capital
Friends & family
Commercial banks
Quasi Government agencies
Public capital markets
operations

• Equity – IPO’s , FPO’s, Private equity, right shares preference shares

• Debt – Loans from banks & financial institutions, overdrafts, Bonds

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Capital Structure
 Capital structure decision affects financial risk and, hence, value of the company.

 The capital structure theory helps us understand the factors most important in the
relationship between capital structure and the value of the company.

 The Optimal Capital Structure.

• We cannot determine the optimal capital structure for a given company, but we know that it
depends on the following:

• The business risk of the company.

• The tax situation of the company.

• The degree to which the company’s assets are tangible.

• The company’s corporate governance.

• The transparency of the financial information.

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What is Venture capital ?
 Financing that investors provide to start-up companies and small businesses

 Believed to have long-term growth potential.

 Venture capital generally comes from well-off investors, investment banks and any other

financial institutions.

 lack access to capital markets, bank loans or other debt instruments.

 Investors usually get equity in the company, and thus a say in company decisions.

 venture capital focus on emerging companies seeking substantial funds for the first time

 Private equity tends to fund larger, established companies seeking an equity infusion or

founders transferring their ownership stake.

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Venture capital Process
Angel investors
1. Business Plan
Venture capital Firm

Company, products
2. Firm do the due diligence of
Business model, management

Pledge’s Capital

3. . Company Firm

Equity

4. All at once/ rounds

5. Exits at 4- 6years

6. By M&A & IPO’s

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Venture capital investment satges

Majorly a private equity source of

financing

• Suppliers of venture capital:

•Angel Investors and Wealthy

families

•Private partnerships and

corporations

•Large industrial or financial

corporations with established
venture-capital subsidiaries

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Venture Capital
Stages of Financing
Seed-Money Stage:

• Small amount of money to prove a concept or develop a product

Start-Up:
• Funds are likely to pay for marketing and product refinement

First-Round Financing:
• Additional money to begin sales and manufacturing

• Second-Round Financing:
• For a firm that is currently selling its product but still losing money
• Funds earmarked for working capital

• Third-Round Financing:
• For firm that is at least breaking even and contemplating expansion

• Fourth-Round Financing:
• For a firm that is likely to go public within six months; a.k.a. bridge financing

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Crowd funding
 Meaning: raising many small amounts of money from a large number of people.

 Why crowdfunding? Crowdfunding is the practice of funding a project or venture.

 Crowdfunding is a form of crowdsourcing and of alternative finance.

 Crowdsourcing refers to the practice of soliciting services, ideas or content from a large
group of people online.

Equity or investment crowdfunding Reward based crowdfunding

It enables accredited investors to invest in you will only receive a “reward” for your
companies fundraising on crowd funder and contribution to the company.
gain ownership or a promise of future
returns.

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Reward based crowd funding Equity based crowd funding
Provides with working capital in exchange for
Set funding
goals a piece of your company

Take in your
Pros:
money and get Devise a reward
ready to deliver strategy • It is smart money
Cons:
the rewards • There are potentially
• Increased
larger sums of
transparency
How it works? fundraising
• Expensive
• Easier investor
Post your fundraising
relations
campaign to a
Get social
crowdfunding
platform

Pros: Cons:
• Access to cheap • The pressure is on
money • Lot of work,
• Pre-funding your potentially little
next product payoff

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