Unit 1 – Capital Markets in India

Securities

Securities refer to tradable financial instruments or assets that have economic value.
Companies issue these instruments to raise capital for financing their activities, like
shares, bonds, options, etc.

Overview of the Indian Securities Market

Indian Securities Market

The Indian Securities Market (ISM) is a financial ecosystem where various entities,
including companies and the government, raise capital by issuing securities like

stocks and bonds. It provides a platform for investors to buy and sell these
securities, enabling wealth creation, financial planning, and economic growth.

Regulated by institutions like the Securities and Exchange Board of India (SEBI),
the market promotes transparency, accountability, and investor protection.

Functions of the Indian Securities Market–

1. Facilitates Capital Formation: Companies and the government can raise funds by
issuing securities like stocks and bonds. This allows them to finance their projects,

operations, or initiatives.
2. Provides Liquidity: It offers a marketplace where investors can buy or sell

securities easily. This ensures that investments can be converted into cash relatively
quickly.

3. Pricing Mechanism: Through the interaction of supply and demand, the securities
market helps determine the prices of these financial instruments. This reflects the

perceived value of a company's assets and future earnings potential.

4. Risk Diversification: Investors can spread their investments across different types

of securities and sectors. This reduces the overall risk associated with their
investments.

5. Promotes Transparency: The market enforces regulations to ensure that

companies disclose all relevant information to the public. This promotes

transparency and helps protect investors.

6. Ensures Fair Practices: Regulators, such as the Securities and Exchange Board of

India (SEBI), oversee the market to ensure fair practices, protect investor interests,
and maintain market integrity.

Intermediaries in Indian Securities Market:

1. Stock brokers: Stock brokers act as intermediaries between investors and stock

exchanges. They facilitate the buying and selling of securities on behalf of clients.
Stock brokers can be individuals or firms licensed by SEBI.

2. Depository Participants (DPs): DPs are institutions that provide a platform for
holding and trading securities in electronic form. They maintain Demat accounts

for investors, allowing them to hold and transact in securities electronically.

3. Merchant Bankers: Merchant bankers are involved in activities related to the

issuance of securities in the primary market. They advise companies on the IPO

process, pricing of securities, and help in the preparation of documents for

regulatory approval.
4. Clearing Corporations: Clearing corporations act as intermediaries between the

stock exchange and its member brokers. They ensure the smooth settlement of
trades by guaranteeing the fulfilment of obligations.

5. Credit Rating Agencies: Credit rating agencies assess the creditworthiness of

companies, government entities, and their securities. They assign credit ratings that

help investors evaluate the risk associated with investing in those entities.
6. Underwriters: Underwriters commit to purchase unsold securities in an IPO or a

bond issue. They provide a guarantee to the issuing company, ensuring that the
entire issue is successfully subscribed.

Securities and Exchange Board of India (SEBI):

The primary regulatory body responsible for safeguarding the interests of investors in

the Primary Market is the Securities and Exchange Board of India (SEBI). SEBI plays a
pivotal role in ensuring that the issuance of securities is conducted in a transparent

and fair manner. Key functions of SEBI related to investor protection are as follows:

1. SEBI formulates rules and regulations governing the issuance of securities in the

primary market.
2. SEBI mandates that companies looking to issue securities in the primary market

must provide comprehensive and accurate information about their operations,

financial performance, risks, and future prospects.

3. SEBI actively monitors and takes action against fraudulent practices, such as insider
trading, price manipulation, and misleading statements.

4. SEBI oversees various intermediaries involved in the primary market, including

merchant bankers, underwriters, and registrars.

5. SEBI establishes mechanisms for resolving disputes between investors and

companies or intermediaries.
Capital Market:

The Capital Market is a broad financial market where long-term securities are bought

and sold. It encompasses both the primary market (where new securities are issued)
and the secondary market (where existing securities are traded). Here are some

examples of instruments within the Capital Market:

1. Stock Market (Equity Market)

2. Bond Market (Debt Market)

3. Mutual Funds
4. Exchange-Traded Funds (ETFs)

5. Preferred Stock

What is Primary Market?

▪ The primary market, also known as the "new issue market," is where companies

and the government issue new securities for the first time to raise capital.
▪ In the primary market, companies issue stocks (ownership shares) or bonds (debt

securities) directly to investors. This is often done through processes like Initial
Public Offerings (IPOs) for stocks and bond offerings for debt securities.

▪ The promoters can bring their own money or borrow from financial institutions or
mobilize capital by issuing securities.

▪ The funds may be raised through issue of fresh shares at par, premium and
discount.

Purpose:

• To promote a new company

• To expand an existing company

• To diversify the production

• To meet the regular working capital requirements

• To capitalize the reserve

Various methods of new issues:

1. Public Issue: This involves inviting subscription from the public through issue of

prospectus. A prospectus makes a direct appeal to investors to raise capital,

through an advertisement in newspapers and magazines.

2. Offer for Sale: Securities are not issued directly to the public but are offered for
sale through intermediaries like issuing houses or stock brokers.

3. Private Placement: The allotment of securities by a company to institutional

investors and some selected individuals. It helps to raise capital more quickly than

a public issue.
4. Rights Issue: This is a privilege given to existing shareholders to subscribe to a new

issue of shares according to the terms and conditions of the company. The
shareholders are offered the ‘right’ to buy new shares in proportion to the number

of shares they already possess.

IPO (Initial Public Offering)

Initial public offering (IPO) is a type of public offering in which shares of a company

are sold to institutional and retail/individual investors.

Refers to the process of offering shares of a private corporation to the public in a new
stock issuance.

• Qualified Institutional Bidders (Max. 50%, Min. 75%)

• Non-Institutional Bidders (Min. 15%, Max. 15%)

• Retail Investors (Min. 35%, Max. 10%)

Journey of a company towards and IPO

Ideation Phase

• In this phase, entrepreneurs have an idea or concept for a business. They often
use their personal savings, borrow from friends or family, or utilize
crowdfunding platforms to fund the initial stages of development and testing.
Prototyping Phase:

• Once the idea is more developed, entrepreneurs create prototypes or minimum

viable products (MVPs) to demonstrate feasibility. Angel investors, government

grants or schemes, and business incubators may provide funding and support

during this phase.

Market Entry & Scaling up Phase:

• With a proven concept, the company moves into the market entry phase. They

focus on customer acquisition, product refinement, and initial growth.

Incubators and accelerators continue to provide support. Additionally, Venture

Capitalists and High Net Worth Individuals may invest for further expansion.

Growth & Expansion Phase:

• In this phase the company focuses on scaling its operations. They may seek
larger investments from venture capital firms or private equity investors. Banks

may also provide loans or lines of credit for expansion.

Pre-IPO Phase:

• As the company approaches an IPO, it might undergo a final round of funding

from private equity firms or institutional investors. This phase is aimed at
preparing the company for public listing.

Process of Floating an IPO:

1. Preparing the prospectus: The prospectus is a legal document that provides

detailed information about the company, its business, and its financial

performance. It is used to attract investors and inform them of the risks

associated with investing in the company. The prospectus must be prepared in

accordance with the SEBI guidelines.

2. Filing the IPO documents with SEBI: Once the prospectus is prepared, the
company must file it with SEBI for approval. SEBI will review the prospectus to
 ensure that it contains all of the required information and that it is accurate and

fair. If SEBI finds any deficiencies, it will ask the company to make corrections
before approving the IPO.

3. Bidding process: Once the IPO is approved by SEBI, it enters the bidding
process. Investors can bid for shares of the company at a fixed price. The

bidding price is determined by the company and its underwriters, who are
investment banks that help companies to go public.

4. Allotment of shares: After the bidding process is closed, the company, in

consultation with regulatory authorities, determines the final allotment of

shares. This process is called book-building. The company will consider factors
such as the number of bids received, the size of the bids, and the type of

investors when allocating shares.

5. Listing on the stock exchange: Once the shares have been allotted, they are

listed on the stock exchange. This means that the shares can be traded freely
on the stock market.

Red Herring Prospectus (DRHP & MRHP):

Aspect Draft Red Herring Prospectus (DRHP) Main Red Herring Prospectus (MRHP)

Preliminary version of the prospectus Finalized version of the prospectus with all
Definition
filed with SEBI for review. key details

Contains essential information about the

Includes all information present in DRHP, plus
Contents company excluding offer price and
offer price and number of shares.
number of shares.

Certain key details like offer price are left

All key details, including offer price, are
Red Herring blank to prevent premature valuation
provided, removing the "red herring" aspect.
conclusions.

Not made available to the public; used Circulated among potential investors to
Release to
for regulatory review and initial provide comprehensive information about the
Public
marketing efforts. IPO.
Allotment of shares:

The Pro-rata Allotment Ratio is typically determined by the company going public
(the issuer) in consultation with the underwriters and regulatory authorities The ratio
is set based on various factors, including:

▪ Demand-Supply Dynamics
▪ Regulatory Guidelines
▪ Market Conditions
▪ Underwriter's Recommendations
▪ Historical Precedents

As per Regulatory Guidelines, the allotment of shares should be basis the below
Investment categories:

1. Qualified Institutional Bidders (QIBs) (Max. 50%, Min. 75%): QIBs are large
financial institutions, mutual funds, insurance companies, and other entities with a
substantial amount of funds available for investment. They play a crucial role in the

capital market. In an IPO, a minimum of 75% of the shares is reserved for QIBs.
However, they cannot be allotted more than 50% of the total shares on offer.

2. Non-Institutional Bidders (Min. 15%, Max. 15%): Non-Institutional Bidders are

individuals or entities that do not fall under the category of QIBs. This can include

High Net Worth Individuals (HNIs) and corporate bodies. They are typically allotted

a minimum of 15% and a maximum of 15% of the shares in an IPO.

3. Retail Investors (Min. 35%, Max. 10%): Retail Investors are individual investors

who invest relatively smaller amounts of money in the market. They are allotted a
minimum of 35% of the shares in an IPO, and they cannot be allotted more than

10% of the total shares.

Key Investor Protections:

1. Full Disclosure: Companies are required to provide complete and accurate

information in their prospectus, which is a legal document that details the offering.

This includes information on the company's business, financials, management, and

risk factors.
2. Fair Allotment Process: SEBI ensures that the allocation of securities during an

IPO is done fairly and transparently.

3. Time-bound Refunds: In case of oversubscription, where the demand for shares

exceeds the supply, SEBI ensures that refunds to unsuccessful applicants are made
promptly.

4. Prohibition of Insider Trading: SEBI strictly prohibits individuals with privileged,

non-public information from trading in the company's securities.

5. Continual Monitoring: SEBI continuously monitors the activities of companies and

intermediaries to detect any irregularities or non-compliance with regulations.