FINANCIAL MARKET AND OPERATIONS

MODULE II – PRIMARY MARKET

SECTION A 2 MARKS

1. What do you meant by primary market?

The primary market refers to the market where securities are created and first issued.
The primary market is the part of the capital market that deals with the issuance and sale
of equity-backed securities to investors directly by the issuer. Investors buy securities that
were never traded before.

2. What is public issue?

When an issue / offer of securities is made to new investors for becoming part of
shareholders' family of the issuer, it is called a public issue. Public issue can be further
classified into Initial Public Offer (IPO) and Follow on Public Offer (FPO).
3. What do you meant by right issue?
The right offering (rights issue) is a group of rights offered to existing shareholders to
purchase additional stock shares, known as subscription warrants, in proportion to their
existing holdings. These are considered to be a type of option since it gives a company's
stockholders the right, but not the obligation, to purchase additional shares in the
company.
4. What is underwriting?

Underwriting is the process through which an individual or institution takes on financial

risk for a fee. Underwriting ensures that a company filing for an IPO will raise the
amount of capital needed, and provides the underwriters with a premium or profit for
their services.

5. Explain an offer document.

Offer document' is a document which contains all the relevant information about the
company, promoters, projects, financial details, objects of raising the money, forms of the
issue etc.

6. Who is a syndicate member?

Syndicate members are commercial or investment banks, usually registered with market
regulator, SEBI in India, or registered as brokers with stock exchanges, responsible for
underwriting IPOs. They work as intermediaries between the issuer company and
investors who bid for IPO stocks.
7. What is FPO?
FPO (Follow on Public Offer) is a process by which a company, which is already listed
on an exchange, issues new shares to the investors or the existing shareholders, usually
the promoters. FPO is used by companies to diversify their equity base.

8. What is IPO?
An initial public offering (IPO) refers to the process of offering shares of a private
corporation to the public in a new stock issuance. After IPO, the company’s shares are
traded in an open market. Those shares can be further sold by investors through
secondary market trading.

9. What is meant by prospectus?

A prospectus is defined as a legal document describing a company’s securities that have
been put on sale. The prospectus generally discloses the company’s operations along with
the purpose of the securities being offered.

10. What is bonus issue?

A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of free
additional shares to existing shareholders. A company may decide to distribute further
shares as an alternative to increasing the dividend payout.

11. Explain private placement.

A private placement is a sale of stock shares or bonds to pre-selected investors and
institutions rather than on the open market. It is an alternative to an initial public offering
(IPO) for a company seeking to raise capital for expansion.

12. Explain ESOP.

An employee stock ownership plan (ESOP) is an employee benefit plan that gives
workers ownership interest in the company. ESOPs give the sponsoring company, the
selling shareholder, and participants receive various tax benefits, making them qualified
plans.

13. What do you meant by statement in lieu of prospectus?

The Statement in Lieu of Prospectus is a document filed with the Registrar of the
Companies ( ROC ) when the company has not issued prospectus to the public for
inviting them to subscribe for shares. It is similar to a prospectus but contains brief
information.

14. What is redherring prospectus?

Red herring prospectus, as a first or preliminary prospectus, is a document submitted by a
company (issuer) as part of a public offering of securities.red herring prospectus is issued
to potential investors, but does not have complete particulars on the price of the securities
offered and quantum of securities to be issued.

15. What do you meant by preferential issue?

 Preferential Issue is the fastest way for a company to raise capital. A preferential issue is
an issue of shares or convertible securities by listed or unlisted companies to a select
group of investors, but it is neither a rights issue nor a public issue.
16. Explain QIB.
Qualified Institutional Buyers are those institutional investors who are generally
perceived to possess expertise and the financial muscle to evaluate and invest in the
capital markets. QIB's can be a corporation that the Securities and Exchange
Commission’s (SEC) Rule 501 of Regulation D classifies as an accredited investor,
banks, trust funds, pension plans or any entity comprised of sophisticated investors.

17. Explain QIP.

QIP or Qualified Institutional Placement is largely a fund raising tool for the listed
companies. QIP is a process which was introduced by SEBI so as to enable the listed
companies to raise finance through the issue of securities to qualified institutional buyers
(QIBs).

18. What is shelf prospectus?

Shelf prospectus is a type of prospectus issued by companies making multiple issues of
bonds for raising funds. A prospectus is a notice, advertisement or any other document
inviting the public to subscribe for securities. It is compulsory for public limited
companies to issue a prospectus before issuing securities.

19. Who is retail individual investor?

These are non-professional investors who purchase assets such as stocks, bonds,
securities, mutual funds, and exchange traded funds (ETFs). They are only able to make
these purchases by going through another party such as a brokerage firm, investment
adviser, investment manager, or other financial professional.

20. Who are book runners?

A book runner is the primary underwriter or lead coordinator in the issuance of new
equity, debt, or securities instruments. In investment banking, the book runner is the lead
underwriting firm that runs or is in charge of the books during the issuance of new equity
of a client firm.

21. Who are merchant bankers?

As per SEBI rules, a merchant banker refers to, “any person who is engaged in the
business of issue management either by making arrangement regarding buying, selling or
subscribing to securities or acting as manager, consultant or rendering corporate advisory
services in relation to such issue management”.

22. What do you meant by new issue market?

The market that deals with these new issues is called the new issue market.
A primary market is a market that issues new securities on an exchange, facilitated by
underwriting groups
23. What is undersubscription.?
Undersubscribed is a situation in which the demand for an initial public offering (IPO)
or another offering of securities is less than the number of shares
issued. Undersubscribed offerings are often a matter of overpricing the securities for
sale.

24. What are the shares with differential voting rights?

Differential voting right (DVR) shares are same as ordinary equity shares except such
stock does not dilute the promoters voting rights and makes it difficult for hostile
takeovers. On the other hand, DVR shares have been described as an instrument that is
more beneficial to the issuers than to investors, and it often leads to problems of low
liquidity.

25. What is book building ?

Book building is the process by which an underwriter attempts to determine the price at
which an initial public offering (IPO) will be offered. The process of price discovery
involves generating and recording investor demand for shares before arriving at an issue.

26. Explain ASBA.

ASBA abbreviated as Application Supported by Blocked Amount is an IPO application
process developed by SEBI. It is an application containing an authorization to block the
application money in the bank account, for subscribing to an IPO issue. You cannot use
the blocked amount for any purpose.

27. Distinguish between undersubscription and oversubscription.

Oversubscription is referred to as the situation where a company receives more
applications from share buyers than the number of shares made available for public.
Undersubscribed is a situation in which the demand for an initial public offering (IPO) or
another offering of securities is less than the number of shares issued. This situation is
also known as an “underbooking,” and may be contrasted with oversubscribed when
demand for an issue exceeds its supply.
28. Distinguish between right issue and bonus issue.
Bonus shares are given to the shareholders free of cost, while right shares are offered to
the shareholders at a discounted price. The primary objective of the right issue is to fetch
additional capital to the firm. Whereas, the bonus issue aims to increase the liquidity by
increasing the number of outstanding shares.
29. Distinguish between bookbuilt issue and fixed price issue.
In Book Building securities are offered at prices above or equal to the floor prices,
whereas securities are offered at a fixed price in case of a public issue. In case of Book
Building, the demand can be known everyday as the book is built.

30. What is green shoe option?

 Greenshoe option is an over-allotment option. In the context of an initial public offering
(IPO), it is a provision in an underwriting agreement that grants the underwriter the right
to sell investors more shares than initially planned by the issuer if the demand for a
security issue proves higher than expected.

SECTION B
SHORT ESSAY QUESTIONS
1.Who are the participants in new issue market?
The important intermediaries/players in the new issue market are: 1. Merchant Bankers
(Managers to the Issue) 2. Underwriters 3. Registrars to the Issue 4. Brokers to the Issue
5. Banker to the Issue 6. Syndicate Members.
• Merchant banker means any person/institution who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing to
securities as manager, consultant, advisor or rendering corporate advisory services in
relation to such issue management. The lead merchant bankers appointed by the Issuer
Company are referred to as the Book Running Lead Managers (BRLM) or Book Runners
(If the issue is through book building process).
• Underwriters are financial institutions who make a firm commitment that they will take
up the shares up to a certain amount if the public does not subscribe to it. This is an
agreement with one or more institutions and a guarantee of the marketability of shares.
• Brokers are persons authorized to market the issues. Companies can engage any number
of brokers to market the new issue.
• Registrars to the issue agent plays a significant role in a public issue along with the lead
managers. Registrars are persons appointed in consultation with lead managers to assist
the issue management functions. Their work relates to pre-issue management,
management during the currency of issue, pre- allotment Work, allotment work and post
allotment work.
• Bankers to the issue collect the application forms and the money in cash, cheque or
ASBA. Depending on the size of the issue there may be many collection centers and
many bankers. They are appointed in consultation with lead manager.
• The Book Running Lead Managers to the issue appoint the Syndicate Members, who
enter the bids of investors in the book building system. Syndicate Members are
commercial or investment banks registered with SEBI who also carry on the activity of
underwriting in IPO.

2. Explain the book building process.

Book building is the process by which an underwriter attempts to determine the price at
which an initial public offering (IPO) will be offered.
 1. The issuing company hires an investment bank to act as an underwriter who is tasked
with determining the price range the security can be sold for and drafting a prospectus
to send out to the institutional investing community.

2. The investment bank invites investors, normally large scale buyers and fund
managers, to submit bids on the number of shares that they are interested in buying
and the prices that they would be willing to pay.

3. The book is ‘built’ by listing and evaluating the aggregated demand for the issue from
the submitted bids. The underwriter analyzes the information and uses a weighted
average to arrive at the final price for the security, which is termed the cutoff price

4. The underwriter has to, for the sake of transparency, publicize the details of all the
bids that were submitted.
5. Shares are allocated to the accepted bidders.

3. What are the kinds of underwriting?

Underwriting is the process of vetting risks so that only calculated risks are taken
to protect investors, banks, applicants and the market in certain financial contracts.
Firm underwriting: Firm underwriting is an underwriting agreement where an
underwriter agrees to buy a definite number of shares or debentures in addition to the
shares or debentures he has already promised to subscribe under the underwriting
agreement. In firm underwriting, the underwriters are liable to take up the agreed
number of shares or debentures even if the issue is over subscribed.
Complete underwriting: when the whole issue of shares or debentures of a
company is underwritten, it is called complete underwriting. In such a case the whole
issue is underwritten either by an individual/institution agreeing to take the entire risk
or by a number of firms or institutions, each agreeing to take the risk to a limited
extent.
Partial underwriting. When only a part of the issue of shares or debentures of a
company is underwritten, it is known as partial underwriting. In such a case the part
of the issue is underwritten either by an individual/institution or by a number of firms
or institutions each agreeing to take the risk to a limited extent.
Syndicate Underwriting: When the issue is very big and it is impossible to be
underwritten by a single underwriter syndicate underwriting comes to rescue. In
syndicate underwriting, few underwriting firms form a syndicate and jointly
undertake to underwrite the issue.
Joint Underwriting: In Joint underwriting, when the issue is too large, the issuer
company itself appoint more than one underwriter to reduce the burden from a single
underwriter. Each Underwriter underwrites for a specified amount and in a specified
ratio.

4. Explain different types of offer document.

 ‘Offer document’ is a document which contains all the relevant information about the
company, promoters, projects, financial details, objects of raising the money, forms of
the issue etc. and is using for inviting subscription to the issue being made by the
issuer. Offer document is called ‘Prospectus’ in case of a public issue and letter of
offer in case of rights issue.
Red herring prospectus A red herring prospectus (RHP) is a preliminary registration
document that is filed with SEBI in the case of book building issue which does not
have details of either price or number of shares being offered or the amount of issue.
This means that in case price is not disclosed, the number of shares and the upper and
lower price bands are disclosed.
Abridged Prospectus is an abridged version of offer document in public issue and is
issued along with the application form of a public issue. It contains all the salient
features of the prospectus.
Shelf prospectus is a prospectus which enables an issuer to make a series of issues
with in a period of 1 year without the need of filing a fresh prospectus every time
Letter of offer is an offer document in case of a Right issue of shares or convertible
securities and is filed with stock exchanges before the issue opens.
Placement document is an offer document for the purpose of Qualified Institutional
Placement and contains all the relevant and material disclosures.

5. Explain different types of private placement

Private placement is a sale of stock shares or bonds to pre-selected investors and

institutions rather than on the open market. It is an alternative to an initial public
offering (IPO) for a company seeking to raise capital for expansion.
a. Preferential issue
Preferential Issue is the fastest way for a company to raise capital. A preferential
issue is an issue of shares or convertible securities by listed or unlisted companies
to a select group of investors, but it is neither a rights issue nor a public issue.
b. Qualified institutional placement
QIP or Qualified Institutional Placement is largely a fund raising tool for the
listed companies. Description: QIP is a process which was introduced by SEBI so
as to enable the listed companies to raise finance through the issue of securities to
qualified institutional buyers (QIBs)
c. Institutional placement program
Institutional placement program” means a further public offer of eligible
securities by an eligible seller, in which the offer, allocation and allotment of such
securities is made only to qualified institutional buyers
6. Discuss different types of ESOP.

Employee stock ownership plan (ESOP) is an employee benefit plan that gives
workers ownership interest in the company. ESOPs give the sponsoring company,
the selling shareholder, and participants receive various tax benefits, making them
qualified plans. Companies often use ESOPs as a corporate-finance strategy to
align the interests of their employees with those of their shareholders.
Employee Stock Option Scheme (ESOS)
 Employee Stock Option Schemes are the most commonly used form for employee
ownership. The option granted under the plan confers a right but not an obligation
on the employee. Stock options are subject to vesting, requiring continued service
over a specified period of time. Upon vesting of options, employees can exercise
the options to get shares, by paying the pre-determined exercise price.
Employee Stock Purchase Plan (ESPP)
Employee Stock Purchase Plans allow Employee to purchase Company’s shares,
often at a discount from Fair Market Value. The terms of the Plan determines the
tenure and price for possession of the Company’s shares by the Employees.
Usually, ESPPs are being framed for offering shares as a part of public issues.
Restricted Stock Units (RSU)
Under Restricted Stock Units Plan, an Employee is awarded with the right to
receive shares on a pre-determined date subject to occurrence of a specified event
or fulfillment of specified conditions. In such kind of incentive plans, the
Employee becomes shareholder only upon occurrence of a specified event or
fulfillment of specified conditions.
Stock Appreciation Rights (SARs)
Although, SARs are not technically employee stock options, companies often use
them in a like manner. SARs provide employees with cash payments equal to the
appreciation of the company’s stock over a specified duration. Thus, unlike other
options, SARs provide employees with equity upside without exposure to any
downside.
Phantom Stocks
Phantom stock is a form of long-term deferred compensation using the Company
shares as the measuring device for calculating the value of the deferred
compensation. It simulates the Company shares in everything except that does not
represent true ownership. The Company simply credits these phantom shares on
its books and as the value of the company shares rises and falls, so does the value
of the phantom stock.

7. Distinguish between IPO and FPO.

When a company is going for a process of getting listed on the stock exchange
and publicly traded, IPO is the first public offering, it is the main source of the
company in acquiring money from the general public to finance its projects and
the company allots shares to the investors in return.

The process of FPO starts after an IPO. FPO is a public issue of shares to
investors at large by a publicly listed company. In FPO, the company goes for a
further issue of shares to the general public with a view to diversifying its equity
base.
 SECTION C 15 MARKS
1.BOOK BUILDING
Book building is the process of determining the price at which an initial
public offering will be offered. Book building refers to the process of generating,
capturing and recording investor demand for shares during an initial public offe r.
Definition of Book building
SEBI guidelines 2000 defines the term book building as “A process
undertaken by which a demand for the securities proposed to issued by a body
corporate is elicited and built up and price for such securities is assessed for
determination of the quantum of such securities to be issued by m eans of a notice,
circular, advertisement, document or information, memorandum or offer
document.
Itcan be understood that collecting orders from qualified institutional
buyers, Non institutional investors and retail investors based on price band. The
price band consists of a floor price and a cap price.floor price is the minimum
price and cap price is the maximum price in which can be made.
Book runners are the intermediaries in the book building process. They
Assist the company in the book building process.
BOOK BUILDING PROCESS
1.The issuer who is planning an offer,appoints a lead merchant banker as book
runner or Book running lead manager.
 2.Book runner prepares the draft red herring prospectusand other documents to be
filled with SEBI and ROC
3.The issuer specifies the number of securities to be issued the price band for the
bids and the the minimum bid size in the RHP.
4.The book runner circulates the draft prospectus filed with SEBI to different
categories of investors.
5.The issuer also appoints syndicate members ,stock brokers &SCBS for the
purpose of accepting bids, applications and placing orders with the issue.
6. The book built issue normally remains open for a period of 3 to 7 working days.
7.Bids can be revised by the bidders before the book closes.
8.On the close of the book building period,the book runners eval uate the bids on
the basis of the demand at various price levels
9.The book runners and the issuer decide the final price at which the securities
shall be issued.
10.Generally the number of shares are fixed,the issue size gets frozen based on the
final price per share.
11.Allocation of securities is made to the successful bidders the rest get refund
orders
Thus book building is a price mechanism in which the issuer company
before filing of the prospectus,builds-up and ascertains the demand for the
securities being issued and assess the price at which such securities may be issued
and ultimately determines the quantum of securities to be issued.

2. INTERMEDIARIES IN NEW ISSUE MARKET

The primary market is the part of the capital market that deals with issuing
of new securities. In a primary market companies, government, or public sector
institutions can raise funds through bond issue and corporations can raise capital
through the sale of new stock through an Initial Public Offering (IPO). A new
issue is a reference to a security that has been registered and issued and is being
sold on a market to the public for the first time. It is also known as Initial Public
Offering.
Intermediaries in new issue market
a. Merchant Bankers
b. Underwriters
c. Bankers to the issue
d. Registrars to the issue
e. Brokers to the issue
f. Debenture Trustees
a. Merchant Bankers – Merchant Banker means any person or institution
who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as
manager, consultant, advisor or rendering corporate advisory services in
relation to such issue management. Management of public issues is the
most important function of merchant banker.

Categories of Merchant Banking

Category Role Fees charged
Category I ✓ Issue management + 2.5 Lakhs for first 2
✓ Advisor years
✓ Consultant + 1.5 Lakhs for 3 rd year
✓ Manager
✓ Underwriter
✓ Portfolio manager

Category II ✓ Advisor + 1.5 Lakhs for first 2

✓ Consultant years
✓ Underwriter + 50000 for 3 rd year
✓ Portfolio manager
✓ Co- manager

Category III ✓ Underwriter + Minimum 50000

✓ Advisor
✓ Consultant
Category IV ✓ Advisor + Minimum 50000
✓ Consultant

b. Underwriters – Underwriters are financial institutions who makes a firm

commitment that they will take up the shares up to a certain amount of
the public does not subscribe to it. This is an agreement with one or
more institutions and guarantees of the marketability of shares.
Underwriting is mandatory for the public issue. Underwriters are
appointed by company in consultation with the managers to the issue.
Financial institutions, bankers, members of stock exchange etc can act
as underwriter. Underwriter charged a commission for their service
which is known as underwriting commission.
c. Bankers to the issue – Bankers who are engaged in the function of
acceptance of application for share and debenture along with application
money to the respect of issue of securities and also refund of application
money to the applicant to whom securities could not be allotted.
d. Registrar to the issue – Registrars are persons appointed in consultation
with lead managers to assist the issue management functions. Their
work relates to pre-issue management, pre-allotment work and post
 allotment work. It is their duty to collect the application forms from
bankers to the issue, process them for allotment and issue certificate of
allotment.
e. Brokers to the issue – Brokers are persons authorised to market the
issues. They are the intermediaries that are responsible for procuring the
subscription to the issue from the prospective investors. They provide a
vital connection between the prospective investors and the issuer. They
assist the speedy subscription of the issue by the public.
f. Debenture Trustees – Trustees who are appointed to safe guard the
interest of the debenture holders are called debenture trustee. They are
to be appointed before issue of debenture by a company. No person can
act as debenture trustee unless a certificate of registrar has been
obtained from the SEBI for the purpose.

3. METHODS OF FLOATING NEW ISSUES

Basically issues made by an Indian can be classified as
a. Public issue
b. Private placement
c. Right issue
d. Bonus issue
e. Employees stock option plan

A. Public issue
A public issue is an issue where anybody can subscribe the securities. When an
issue or offer of securities is made to new investors for becoming part of
shareholders family of the issuer it is called public issue. Public issue can be
further classified into;
a. Initial public offer (IPO)
Initial Public Offer(IPO) means an offer of securities by an unlis ted
issuer to the public for subscription for the first time. It is the first sale
of stock by a company to the public. IPO enables listing and trading of
the issuers securities in the securities market.
b. Further Public Offer (FPO)
When a listed company makes either a fresh issue of securities to the
public or in offer for sale to the public, It is called FPO. It is also called
follow on public offer.
The methods of offering a public issue (IPO/FPO) can be of two
1. Offer through prospectus
Public issue through prospectus is the most popular method of
distribution of share of a company. Prospectus is an offer document
 containing details of the company. The name of the company, address,
location of the industry, paid up and subscribed capital, name of the
board of directors and other important data must be included in the
prospectus.
Following are the advantages of issue through prospectus
a. Large number of investors could be contacted through prospectus
b. Services of intermediaries are not necessary for this
c. Concentration of shares in few hands is avoided
Disadvantages
a. It is suitable only for large issues
b. The company has to incur additional expense on advertisement,
banks commission, listing fee, legal charges etc
2. Offer of Sale
This is out rate sale of shares through intermediaries like issue house,
brokers etc. Shares are not offered to the public directly in the
intermediaries after buying the entire shares, resell them to the investing
public. Then it can be called Offer for sale.

B. Private Placement
Shares can be distributed through out right sale by companies to select
group of persons(u/s of the companies act 1956). This is known as
private placement. In other words when an issuer makes an issue o f
securities to a select group of persons not exceeding 49 and which is
neither a right issue nor a public issue it is called private placement.
Private placement of securities by listed issuer can be of two types
1. Preferential allotment
It means an issue of specified securities by a listed issuer to any select
person or group of persons on a private placement basis.
2. Qualified Institutions Placement(QIP)
When a listed issuer issues equity shares or securities convertible into
equity shares to qualified institutions buyers on private placement basis,
it is call a QIP.

C. Right Issue
Shares offered to the existing shareholders of a company are called
right issues. The shares are offered in a particular proportion to the
existing share ownership. The proportion may be decided on the basis
of capital requirement of the company. Right issue is the advantages to
the company as the cost of issue is minimum. Underwriting,
advertising, brokerage expense could be avoided in this case. The
control of the company is undistributed as the shareholders get shares
according to the proportion of existing number of shares held.

D. Bonus Issue
 Bonus Issue is the issue of shares to the existing shareholders out of the
free reserves of the company. The existing shareholders get this as a
bonus without payment of any money. Companies usually adopt this
method to bring up the value of shares with market value. A listed
company can issue bonus shares if;
a. It is authorized by its articles of association for issue of bonus
shares.
b. It has not defaulted in payment of interest or principal in respect
of fixed dep0osits issued by it.
c. It has not defaulted in respect of the payment of statutory dues of
the employees.
d. It has made partially paid up shares into fully paid up.

E. Employees Stock Option Plan

It is a stock option plan given to the whole time directors, officer or
employees of a companyto purchase the securities offered by the
company at a predeterminedprice, at a future date. ESOP means a plan
under which the company grants this option to the employees.