Stock Markets

Prof. A. K Banerjee
Points of Discussion

• About stock markets, functioning and Regulation

• Participants in stock markets
• Trading Process and Flow process
• Initial Public Offering(IPO)
• Follow on Public Offering (FPO)
• Private Placement Process
Characteristics of Stock Market
In India stock market a made up of stock exchanges such as the BSE, NSE, Kolkata Stock Exchange
etc.
• Aids in raising long term borrowings.
• Provides transparency in trading which determines the price of the stock according to demand
and supply, bid and ask.
• Lesser chances of information asymmetry.
• provides a degree of protection to investors through oversight by the SEBI.
• As Leading Economic Indicator.
Regulator
The formation of the Securities and Exchange Board of India (SEBI) was done on 12th April 1988.
This was followed by the establishment of the SEBI Act on 30th January 1992, which gave SEBI their
powers and functions.
Functions of SEBI
• Quasi-Legislative Functions: These include drafting legislature with respect to the capital markets.
• Quasi-Executive Functions: The implementation of the legislation also falls to SEBI. And when
necessary they can conduct investigations as well about any wrongdoings.
• Quasi-Legal Functions: The SEBI also has the authority to conduct hearings and pass rulings and
judgments.
Powers of SEBI

• Has control of the bylaws of every stock exchange in the country. Any change in bylaws needs
SEBI approval and even if required SEBI can also ask the authorities to amend the laws.

• The SEBI can also inspect the books of accounts of any stock exchange to check for irregularities.
Stock exchanges must provide any accounts/books/documents as requested.

• SEBI can also inspect books of accounts for financial intermediaries.

• And SEBI can ask any company to list their shares on more than one stock exchange if they feel it
would be more beneficial to the market.
Investing in Stocks

1. Represents ownership 4. Right to vote for directors and on

in a firm certain issues
2. Earn a return in 5. Two types
two ways ─ Common stock
─ Price of the stock rises
• Right to vote
over time
─ Dividends are paid to the stockholder • Receive dividends
─ Preferred stock
3. Stockholders have claim on all assets
• Receive a fixed dividend
• Do not usually vote
Trading Process
Flow Process
Computing the Price of Common Stock

• Valuing common stock is, in theory, no different from valuing debt securities:
─ determine the cash flows
─ discount them to the present
Computing the Price of Common Stock: The
One-Period Valuation Model

• Simplest model, just taking using the expected dividend and price over the next year.
 Computing the Price of Common Stock: The
One-Period Valuation Model

What is the price for a stock with an expected dividend and price next year of ₹0.16 and ₹60,
respectively? Use a 12% discount rate
Answer:
Computing the Price of Common Stock: The
Generalized Dividend Valuation Model
• Most general model, but the infinite sum may not converge.

• Rather than worry about computational problems, we use a simpler version, known as the
Gordon growth model.
Computing the Price of Common Stock: The
Gordon Growth Model
• Same as the previous model, but it assumes that dividend grow at a constant rate, g. That is,
Computing the Price of Common Stock: The
Gordon Growth Model
The model is useful, with the following assumptions:
• Dividends do, indeed, grow at a constant rate forever
• The growth rate of dividends, g, is less than the required return on the equity, ke.
IPO (Initial Public Offering)

• Definition: A company’s first equity issue made available to the public.

• This issue occurs when a privately held company decides to go public
• Also called an “unseasoned new issue.”
Why do companies go public?

• New capital
• Expansion of the business
• Future capital
• Once public, firms have greater and easier access to capital in the future
• Mergers and acquisitions
• Its easier for other companies to notice and evaluate a public firm for potential synergies
• IPOs are often used to finance acquisitions.
What goes against IPO

Expensive
• A typical firm may spend about 15-25% of the money raised on direct expenses
Reporting responsibilities
• Public companies must continuously file reports with the SEC and the stock exchange they list
on
Loss of control
• Ownership is transferred to outsiders who can take control and even fire the entrepreneur
When it is good to bring IPO

Determinants of suitability:
• The general stock market condition
• The industry market condition
• The frequency and size of all IPO’s in the financial cycle
• Investors eagerness to enter capital markets.
IPO process
1. Select an Lead Bank (&Underwriter)
2. Register IPO with the SEBI
3. Print Red Herring document
4. Present roadshow
5. Price the IPO
Float a fixed price IPO or Book Building Issue, the price or price band is fixed
6. Sell the securities to the public (offer document is available both offline and online)
7. Going through the IPO
stakeholders and under-writers work together to decide how many shares will every
investor receive.
Investors will usually get full securities unless it is oversubscribed.
Lead Bank/Underwriter

• A bank overseeing the arrangement of a loan syndication or securities underwriting, recruiting

syndicate members
• An underwriter/lead bank is an investment firm that acts as an intermediary between a company
selling securities and the investing public.
• The underwriter is the principal player in the IPO.
• Typically, the underwriter buys the securities for less than the offering price and accepts the risk
of not being able to sell them.
Types of Underwriter

• Firm commitment underwriting:

• The underwriter buys the entire issue, assuming full financial responsibility for any unsold
shares
• Most prevalent type of underwriting in the U. S.
• Best efforts underwriting:
• The underwriter sells as much of the issue as possible, but can return any unsold shares to
the issuer without financial responsibility
Examples of Underwriters in India

• ICICI bank
• LIC
• Axis Bank
Underwriter, needs of certificate of registration from SEBI to act as underwriter
Register IPO with SEBI

• The firm must prepare a registration statement and file it with the SEC
• The registration statement discloses all material information concerning the corporation making a
public offering
Print prospectus

• The prospectus is a legal document describing the details of the issuer and the proposed offering
to potential investors
• The preliminary prospectus is sometimes called a “red herring”
Promotion of the IPO

• Presented to institutional investors around the country

• Advertising the issue/ road shows to raise interest in the company and thus the price
• Allows the firm and its underwriters to gather information from potential purchasers
Price the security

• Based on Valuations model

• Net Present Value
• Earnings/Price ratios
Available to public

• The prospectus and application forms are made available to public online and offline.

• People can get a form from any designated banks or broker firms and submit form carrying a
cheque of designated amount.

• SEBI has fixed the period of availability of an IPO to public, which is usually 5 working days.
Going through with the IPO
• Once the price is finalized.

• Shares allocation takes place (stakeholders and under-writers work together to decide how many
shares will every investor receive).

• Usually investors gets full subscription unless it is oversubscribed. 

Follow on IPO
•• A follow-on
  offering, also called a secondary offering, is a sale of stock by a company or by an
existing shareholder of a company that is already publicly held.
• Company generally hires an investment bank to underwrite the offering
• Follow on IPO is registered it with the SEBI
• And IB takes the onus to handle the sale.
• The company receives the proceeds from the sale of the shares.
• A follow-on offering can be either of two types (or a mixture of both): dilutive and non-dilutive.
• In case of dilutive FPO new shares are issued which increases the total shares outstanding thus
having a dilutive effect

Where:
O = original number of shares , OP = Current share price , N = number of new shares to be issued ,IP
= issue price of new shares
Example

• For example, if there is a 3-for-10 issue, the current price is ₹50., the issue price ₹32, we have
• O = 100, OP = ₹50, N = 30, IP =₹32, and
• TDP = ((100x50)+(30x32))/(100+30) = ₹45.85
Note: In non dilutive FPO no new shares are offered.
Rights issue

• A rights issue is an invitation to existing shareholders to purchase additional new shares in the
company.

• With the rights, the shareholder can purchase new shares at a discount
Why Rights issue & takeaways

• A rights issue is one way for a cash-strapped company to raise capital often to pay down debt.
Note: Companies with healthy balance sheets might also raise money through a rights issue to
acquire a competitor or open new facilities.

• Shareholders can buy new shares at a discount for a certain period.

• With a rights issue, because more shares are issued to the market, the stock price is diluted and
will likely go down.
How does Right Issue Work

•  Let's say you own 1,000 shares in Telecom Company, currently worth ₹5.50.
• The company is in financial trouble and needs to raise cash to cover its debt obligations.
• Announces a rights offering through which it plans to raise ₹30 million by issuing 10 million
shares.
• Offers existing investors at a price of ₹ 3 each.
• But this issue is a three-for-10 rights issue.
• In other words, for every 10 shares you hold, telecom co. will offer you another three at a deeply
discounted price of ₹3.
• This price is 45% less than the ₹5.50 price at which Telecom stock trades.
Options available to investors

(1) Subscribe to the rights issue in full,

(2) ignore your rights, or

(3) sell the rights to someone else. 

Who is the pricing calculated

1,000 existing shares at ₹5.50 ₹5,500

300 new shares for cash at ₹3 ₹900

Value of 1,300 shares ₹6,400

Ex-rights value per share ₹4.92 (₹6,400.00/1,300 shares)

Gain or loss to the investor

• The result of the introduction of new shares at the deeply discounted price, the value of each of
your existing shares will decline from ₹5.50 to ₹4.92. 
• The loss on your existing shareholding is offset exactly by the gain in share value on the new
rights
Private Equity

• (PE) is that equity – that is, shares representing ownership of or an interest in an entity – that is
not publicly listed or traded.
• A source of investment capital, private equity actually derives from HNI’s and firms that purchase
shares of private companies or acquire control of public companies with plans to take them
private.
• Eventually becoming delisted from public stock exchanges.
• Most of the private equity industry is made up of large Institutional investors as pension funds,
and large private equity firms funded by a group of accredited investors.
• The basis of private equity investment is a direct investment into a firm, often to gain a significant
level of influence over the firm's operations.
• Since a large capital outlay is required, which is why larger funds with deep pockets dominate the
industry. 
• The underlying motivation for such commitments is, of course, the pursuit of achieving a
positive ROI.
Thank you