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 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Contents
INTRODUCTION TO CAPITAL MARKET ............................................................................... 2
What is Primary market? .................................................................................................. 2
Functions of New Issue market (NIM) or primary market .............................................. 2
1. Origination ......................................................................................................... 2
2. Underwriting ...................................................................................................... 2
3. Distribution ........................................................................................................ 3
Major reforms in the primary market after 1991 ........................................................... 3
Methods of mobilizing funds in the primary market ...................................................... 3
1) Prospectus ...................................................................................................... 3
2) Rights issue ..................................................................................................... 3
3) Private placement ........................................................................................... 3
4) Bonus issue ..................................................................................................... 3
Issue mechanisms in primary market ............................................................................ 4
Public issue through prospectus ................................................................................ 4
Tender/ book building method ................................................................................. 4
Red herring prospectus ............................................................................................. 5
Anchor Investor ........................................................................................................ 5
Offer for sale ............................................................................................................ 5
Placement method.................................................................................................... 5
Rights issue-.............................................................................................................. 5
Bonus issue-.............................................................................................................. 6
Secondary market (Stock Exchange) ................................................................................. 6
Functions of secondary market ..................................................................................... 6
Major reforms in the secondary market after 1991 ....................................................... 7
What is Margin Trading? ..............................................................................................10
Present structure of secondary market in India ............................................................10
Comparison between NSE & BSE ..............................................................................10
Regulation of Stock Markets in India ............................................................................11
Risk Management in Stock Exchanges ..........................................................................11
Relationship between new issue market/ primary market and stock exchange/ secondary
market ............................................................................................................................11
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

INTRODUCTION TO CAPITAL MARKET

• Indian capital market lay dormant till mid 1980s. The long-term needs of corporate
sector were met by DFIs (Development Financial Institutions) and other investment
institutions like LIC, UTI etc. The reasons for dormancy were strict and restrictive
rules and regulations, administered structure of interest rates and easy availability of
credit in banks and FIs.

• The capital market is a market for long-term funds. Its focus is on financing of fixed
investments in contrast to money market, which is the institutional source of
working capital finance. Capital market can be further divided into Primary Market
and Secondary Market.

Private
Placement
Primary Market

Public Issue
Equity Market

Money Market Secondary

BSE, NSE, OTCEI
Financial Market
Markets
Future,
Capital Market
Derivatives Forward,
Options

Corporate Debt
Market
Debt Market
Government
Securities
Market

What is Primary market?

Primary market is the market for dealing in new securities, that is, securities which were not
issued previously and are offered to the investors for the first time. As primary market
provides additional funds to corporates, it results in capital formation.

Functions of New Issue market (NIM) or primary market

NIM performs the "triple service function"-

1. Origination - origination refers to the work of investigation, analysis and

processing of new proposals by specialist agencies.

2. Underwriting - the process by which investment companies undertake guarantee

that the issues would be sold by eliminating risk arising from uncertainty of public
response. When new issues are made by corporates in primary market, they are
often not sold directly on the market. Investment companies undertake
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

guarantee that these issues would be sold and any deficiency in sale will be
covered by these investment companies by purchasing them from the issuing
corporate. Investment companies charge premium for providing such
underwriting and guarantee.

3. Distribution - sale of securities to the ultimate investors is referred to as

distribution. Success of an issue is determined by final issue to investing public.

Major reforms in the primary market after 1991

• Disclosure and investor protection guidelines issued

• Disclosure based regime
• Pricing of public issues determined by the market
• System of proportional allotment of shares introduced
• Banks, PSUs and FI’s allowed to raise funds from primary market
• Accounting standards made closer to international standards
• Corporate governance guidelines issued
• FIIs allowed to invest in primary issues
• Mutual funds are encouraged
• Private placement of debt- guidelines issued
• Self-regulatory organizations promoted by SEBI

(NOTE: Private Placement- Private placement (or non-public offering) is a funding round of
securities which are sold not through a public offering, but rather through a private offering,
mostly to a small number of chosen investors. The security is not offered to the public but to
a small number of investors privately. Private placement saves time and expenses of issuing
a security directly to the public)

Methods of mobilizing funds in the primary market

1) Prospectus
2) Rights issue
3) Private placement
4) Bonus issue (no fresh capital raised)
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Issue mechanisms in primary market

Prospectus

Book Building
Method

Primary Market
Red Herring
Prospectus

anchor investor

Offer for sale

Placement
Method

Rights Issue

Bonus Issue

Public issue through prospectus

• Public issue is when issuing companies themselves offer directly to the general public a fixed
number of shares at a stated price. Generally, public issues are underwritten to ensure
success in case of unsatisfactory response. Public issue is a highly expensive method.
Whenever an offer or invitation to subscribe for shares is made to 50 or more persons, then
such an offer or invitation shall be deemed to be public offering.

Tender/ book building method

• It is similar to public issue with the difference that price is determined by the investing public
rather than by the company itself. The company determines a range of pricing and number
of securities it wishes to issue. The public replies by putting a value on the security of the
issuing company. The best possible price is taken as the final price of issue by the issuing
company. In book building range of price, the gap between floor and cap cannot be more
than 20%
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Red herring prospectus

• The lead merchant banker of a share undergoing book building is required to draft a
red herring prospectus containing all disclosures including total issue size. The red
herring prospectus does not include details like price of the issue and number of
securities to be offered (price and volume)

Anchor Investor
• Anchor investors or cornerstone investors (as they are called globally) are
institutional investors like sovereign wealth funds, mutual funds and pension funds
that are invited to subscribe for shares ahead of the Initial Public Offer to boost the
popularity of the issue and provide confidence to potential IPO investors.

Offer for sale

• In an offer for sale, the company issues securities through the intermediary of issue
house/ merchant bank/ investment bank/ firms of stockbrokers. It is unlike a public
issue, where securities were issued directly to the public. Offer for sale is carried out
in two stages- in stage 1, it is offered to the issuing houses and in stage 2, it is offered
by the intermediary to investing public. The difference between purchase price of
intermediary and its selling price is called as “turn” and it is the profit that the
intermediary earns in case the selling price is greater than purchase price for the
intermediary.

Placement method
• Placement is similar to offer for sale with a difference in stage 2. In stage 2 in
placement, the issuing house issues the security to its own client investors rather
than the public. Placing of unquoted securities (securities that are no longer listed on
SE) is called private placing. Placing newly quoted securities is called stock exchange
placing. Private placement provides access to capital more quickly and is inexpensive
than public issue.

Rights issue-
• offering new securities to existing shareholders in proportion to the number of
shares held by them is called rights issue. Rights issue ensures that existing
shareholders are able to maintain their proportion holding in the company. In the
absence of rights issue, new issues might be purchased by other investors, making
the existing investors less powerful in long term.
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Bonus issue-
Bonus issues is one of the ways to raise capital but it does not bring in any fresh capital.
Companies can distribute profit to existing shareholders by the way of fully paid bonus
shares instead of paying them a dividend. Bonus is the capitalization of free reserves. Higher
the free reserves, higher are the chances of a bonus issue forthcoming from a company.
Companies issue bonus shares to expand their equity base, to increase the number of shares
available for trading and to bring down the stock price as a high price of equity share deters
retail investors from buying a stock.

Secondary market (Stock Exchange)

The secondary market is a market for existing securities, that is, those securities
already issued and listed on the stock exchange. SM plays only an indirect role in
industrial financing by providing liquidity to investments already made. It has a
physical existence and is located in a particular geographical area.

Functions of secondary market

The secondary market performs 3 vital functions in growth of capital formation:
1. Nexus between Savings and Investments- Stock exchange provides a platform to
savers to invest their money in those sectors and units which are favored by the
community at large. Investments by savers are made on the basis of such criteria
as good return, appreciation of capital and so on. Stock exchange provides
platform for distribution of new issues of capital as well as sale of existing
securities, in an orderly and systematic manner.

2. Liquidity to investors- as stock exchanges provide a marketplace for purchase

and sale of securities, they provide liquidity to investors whereby investors can
buy and sell their securities immediately in the market. This guarantees saleability
to one who has already invested and surety of purchase to the other who desires
to invest.

3. Continuous price formation- This function is closely related to the second

function. In a stock exchange, many people are operating simultaneously in the
market, resulting in emergence of large buyers and sellers, which has the effect of
bringing about changes in levels of security prices, thereby evening out wide
swings in prices. A continuous change in demand and supply conditions result in
continuous revaluation of assets, which completes the function of “price
formation” in the stock exchange.
CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Major reforms in the secondary market after 1991

Screen based trading system- introduced in NSE in 1992

Depositories act 1996- under the depositories act, 2 depositories were set up,
central depository services limited (CDSL) and national security depository
limited (NSDL). They resulted in dematerialization of securities.

Setting up of clearing houses/ corporations, which handle confirmation,

settlement and delivery of transactions. Clearinghouses provide guarantee to
the investor that her money with brokers is safe.

Introduction of securities related exchange traded derivatives

Mandatory registration of market intermediaries

Capital adequacy norms for brokers and stock exchanges

Settlement cycle shortened to T + 2

FIIs allowed to invest in Indian capital market since 1992

CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

SEBI prohibited fraudulent and unfair trade practices, including insider trading

Margin trading, short selling and securities lending and borrowing introduced

Indonext- separate trading platform for SME sector introduced

Demutualization of stock exchanges- demutualization means that stock exchanges are

owned and regulated by a set of governors/ administration rather than by brokers.
Before 1991, stock exchanges were owned and controlled by brokers and
intermediaries, bringing in conflict of interest in the market because brokers traded on
the stock exchange and at the same time owned these exchanges, putting their
interests over the interest of investors.

Investor protection fund/ settlement and trade guarantee fund set up.

Securities appellate tribunal set up

After demutualization, stock exchanges have become corporate entities, changing

from non-profit making company to a profit and tax paying company.

Kania Committee- recommended setting up of stock exchanges as companies, limited by

shares. It also recommended conversion of existing stock exchanges into companies. SEBI
approved recommendations of Kania committee in 2002. Following this, it is mandatory
that stock exchange distribute 51% of their shareholding to the public. The maximum
shareholding of brokers is 49%.
CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

What is Margin Trading?

Margin trading is a practice where investor/trader uses borrowed funds from a broker
buy/short sell a financial asset. The financial asset forms the collateral for borrowed funds.
It is buying stocks without having the entire money to do it. The investor/trader just has a
pay margin money, which is a small part of the value of shares bought. To do margin
trading, a margin account needs to be opened with broker.

Initial margin
It is the minimum amount, calculated as a percentage of the transaction
value, to be placed by the client, with the broker, before the actual purchase. The broker
may advance the balance amount to meet full settlement obligations.

Maintenance margin
It is the minimum amount, calculated as a percentage of market value of the securities,
calculated with respect to last trading day’s closing price, to be maintained by client with
the broker.

Present structure of secondary market in India

Currently there are only 3 recognised stock exchanges: NSE, BSE and Calcutta Stock
Exchange Ltd.
Comparison between NSE & BSE

BSE NSE

Full form Bombay Stock Exchange National Stock Exchange

1992 (formed based on
1875 (as The Native Share &
Year of establishment Pherwani Committee Report of
Stock Broker’s Association)
1991)
Year of recognition
1957 1993
under SCRA
First demutualized exchange of
Distinguishing feature Oldest stock exchange of Asia
India

Headquarters Mumbai Mumbai

Benchmark index Sensex Nifty

BOLT (Bombay Online Trading): NEAT (National Exchange for
Trading system
started in 1995 Automated Trading)
Order driven or quote
Order driven Order driven
driven market system
ICCL (Indian Clearing NSCCL (National Securities
Clearing corporation
Corporation Limited) Clearing Corporation Limited)
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Regulation of Stock Markets in India

• Presently, stock markets in India are regulated by central government under

securities contracts (regulation) act 1956. The act provides for recognition,
supervision, control of stock exchanges.
• SEBI act provides for establishment of SEBI for protecting investor’s interests and
promote and regulate the securities market in India.

Risk Management in Stock Exchanges

• Risk management is done to mitigate market, operational and systemic risks.

• Risk management in stock exchanges is carried out through:

o Trading rules and regulations for brokers, which ensures that unfair trade
practices and insider trading is not carried out.
o Market surveillance system to curb excess volatility
o Settlement guarantee fund to ensure timely settlement even when a
member defaults
o Clearing Corporation to guarantee financial settlement of all trades and
thereby reduce credit risk in settlement system.

• Circuit breakers - Introduced in 1995, circuit breakers suspend trading automatically

if and when market prices vary unusually on either side, that is, move out of a pre-
specified band. Movement of Indices like SENSEX, NSE S&P CNX NIFTY etc. is tracked
to activate a circuit breaker.

Relationship between new issue market/ primary market and stock

exchange/ secondary market

Differences:

• Primary market deals with new securities, which have been offered to the public for
the first time. Stock exchange deals with old securities and provides a market for
buying and selling of already existing securities.
• Primary market provides additional funds to the issuing companies i.e direct
financing. Secondary market does not supply any additional funds to the issuing
company. They provide indirect finance by providing liquidity and marketability to
the security.
• Primary market has no geographical location, no administrative setup, and no
centralized control and administration. Secondary markets are rooted in a particular
location.
 CAPITAL MARKET- PRIMARY MARKET AND SECONDARY MARKET

Similarities:

• Securities issued in primary market are invariably listed on a recognized stock

exchange for dealings in them. Stock exchanges exercise considerable control over
new issues as new issues are listed on stock exchanges and abide by their regulatory
framework.