FINANCIAL MARKETING

TOPIC:

CAPITAL MARKET
AND ITS INSTRUMENTS

CAPITAL MARKET
Capital market is a place where buyers and sellers indulge in trade
(buying/selling) of financial securities like bonds, stocks, etc. The
trading is undertaken by participants such as individuals and institutions.

Types of Capital Market

Capital market consists of two types i.e. Primary and Secondary.

There are five types of instruments in capital market:

1) Stock
Stocks represent ownership of a company.
2) Bonds
Bonds are debt securities that trade on the stock exchange.
3) Exchange Trade funds
Exchange-traded funds are a collection of investors’ financial
resources used to purchase a variety of capital market instruments,
including shares, debt securities like bonds, and derivatives.
4) Derivatives
Derivatives are the instruments of the capital market that derive
their values from the underlying assets. These assets include
currency, bonds, stocks, etc.
5) Currency
Foreign markets represent currency as a financial instrument. Spot,
outright forwards and currency swap are the three types of
currency agreements.

There are three types of intermediaries:

Brokers
A broker assists in buying and selling shares for a commission.

Stock exchanges
For example, National Stock Exchange (NSE), Bombay Stock
Exchange(BSE), etc

Regulators
Securities Exchange Board of India (SEBI) governs the capital markets
in India.

PRIMARY MARKET

In a primary market, securities are created for the first time for investors
to purchase. New securities are issued in this market through a stock
exchange, enabling the government as well as companies to raise capital.

For a transaction taking place in this market, there are three entities
involved. It would include a company, investors, and an underwriter. A
company issues security in a primary market as an initial public offering
(IPO), and the sale price of such new issue is determined by a concerned
underwriter, which may or may not be a financial institution. An
underwriter also facilitates and monitors the new issue offering.
Investors purchase the newly issued securities in the primary market.
Such a market is regulated by the Securities and Exchange Board of
India (SEBI).

The entity which issues securities may be looking to expand its

operations, fund other business targets or increase its physical presence
among others. Primary market examples of securities issued include
notes, bills, government bonds or corporate bonds as well as stocks of
companies.

FUNCTIONS OF PRIMARY MARKET

The functions of Primary Market are:

New Issue Offer

The primary market organizes an offer of a new issue which had not
been traded on any other exchange earlier. Due to this reason, it is also
called a New Issue Market. Organizing new issue offers involves a
detailed assessment of project viability, among other factors. The
financial arrangements for the purpose include considerations of
promoters’ equity, liquidity ratio, debt-equity ratio and requirement of
foreign exchange.

Underwriting Services
Underwriting is an essential aspect while offering a new issue. An
underwriter’s role in a primary marketplace includes purchasing unsold
shares if it cannot manage to sell the required number of shares to the
public. A financial institution may act as an underwriter, earning a
commission on underwriting.

Investors rely on underwriters for determining whether undertaking the

risk would be worth its returns. It may so happen that an underwriter
ends up buying all the IPO issue, and subsequently selling it to investors.

Distribution of New Issues

A new issue is also distributed in a primary marketing sphere. Such
distribution is initiated with a new prospectus issue. It invites the public
at large to buy a new issue and provides detailed information on the
company, issue, and involved underwriters.

SECONDARY MARKET

A secondary market is any market in which financial instruments or

other assets are bought and sold among investors. Prices are set in a
secondary market based on supply and demand. The bulk of all trading
occurs in secondary markets. The only parties not involved in a
secondary market are the initial issuers of financial instruments or other
assets.

Functions of secondary markets

1) Maintaining fair price

Capital markets run on the basis of supply and demand of shares.
Secondary markets maintain the fair price of shares depending on
the balance of demand and supply. As no single agent can
influence the share price, the secondary markets help keep the fair
prices of securities intact.

2) Offering liquidity and marketability

The shareholders usually use the share markets as the place where
there is enough liquidity and marketability of shares. That means
that the secondary markets play the role of a third party in the
exchange of shares.

3) Facilitating capital allocation

 Secondary markets facilitate capital allocation by price signaling
for the primary market. By signaling the prices of shares yet to be
released in the secondary market, the secondary markets help in
allocating shares.

4) Adjusting the Portfolios

Secondary markets allow investors to adapt to adjusting portfolios
of securities. That is, the secondary markets allow investors to
choose shares for buying as well as for selling to build a solid
portfolio of shares that offers.

DIFFERENCE BETWEEN PRIMARY AND SECONDARY

MARKET
EXAMPLES OF PRIMARY MARKET

1) INITIAL PUBLIC OFFER

 MEANING:
An Ipo is the selling of securities to the public in the primary
market. It is the largest source of funds with long or indefinite
maturity for the company. An IPO is an important step in the
growth of a business. It provides a company access to funds
through the public capital market.

TYPES OF IPO

1) A FIXED PRICE ISSUE

Fixed Price IPO can be referred to as the issue price that

some companies set for the initial sale of their shares. The
investors come to know about the prices of the stocks that the
company decides to make public.

2) A BOOK BUILDING ISSUE

In the case of book building, the company initiating an IPO

offers a 20% price brand on the stocks to the investors. The
interested investors bid on the shares before the final price is
decided. Here, the investors need to specific the number of
shares they intend to buy and the amount they are willing to
pay per share.

2) PRIVATE PLACEMENT
A private placement is a sale of stock shares or bonds to pre-
selected investors and institutions rather than publicly on
the open market. It is an alternative to an initial public
offering (IPO) for a company seeking to raise capital for
expansion. Private placements are regulated by the U.S.
Securities and Exchange Commission under Regulation D.

Investors invited to participate in private placement

programs include wealthy individual investors, banks and
other financial institutions, mutual funds, insurance
companies, and pension funds.

TYPES:
1) Preferential allotment
A listed company issues securities at a certain price to a
select group of entities, for example, institutions or
promoters. The eligibility of investors is determined
according to Chapter XIII of SEBI (DIP) guidelines.

2) Qualified institutional placement

A listed company issues shares or convertibles to
institutional buyers. The eligibility of investors is
determined by the provisions of Chapter XIIIA of SEBI
(DIP) guidelines.

3) RIGHTS ISSUE
A rights issue is an invitation to existing shareholders to
purchase additional new shares in the company. It is an
offering of rights to the existing shareholders of a company
that gives them an opportunity to buy additional shares
directly from the company at a discounted price rather than
buying them in the secondary market. The number of
additional shares that can be bought depends on the existing
holdings of the shareowners.

Why Issue a Rights Offering?

Companies most commonly issue a rights offering to raise
additional capital. A company may need extra capital to meet
its current financial obligations. Troubled companies typically
use rights issues to pay down debt, especially when they are
unable to borrow more money. However, not all companies
that pursue rights offerings are in financial trouble. Even
companies with clean balance sheets may use rights issues.
These issues might be a way to raise extra capital to fund
expenditures designed to expand the company's business, such
as acquisitions or opening new facilities for manufacturing or
sales.

Features of a Rights Issue

Companies undertake a rights issue when they need cash for

various objectives. The process enables the company to raise
money without incurring underwriting fees.
 A rights issue gives preferential treatment to existing
shareholders, where they are given the right (not obligation) to
purchase shares at a lower price on or before a specified date.
Existing shareholders also enjoy the right to trade with other
interested market participants until the date at which the new
shares can be purchased. The rights are traded in a similar
way as normal equity shares.

Existing shareholders can also choose to ignore the rights;

however, if they do not purchase additional shares, then their
existing shareholding will be diluted post issue of additional
shares.
The number of additional shares that can be purchased by the
shareholders is usually in proportion to their existing
shareholding.

For example, Hatsun Agro declares 1:30 rights issue as on

December 19th 2022.

4) PREFERRED ALLOTMENT

Preferential Allotment is the process by which allotment of

securities/shares is done on a preferential basis to a select group of
investors.
For raising funds, it is not always preferable or feasible for a
company to issue securities to the public at large as it is time
consuming as well as an expensive option. In such situations, the
securities can be offered to a comparatively smaller group of
individuals, such as the directors or the existing shareholders. This
entire process is known as preferential allotment.
 REASONS FOR PREFERENTIAL ALLOTMENT OF
SHARES BY COMPANY

● Help in the company in securing equity participation.

● To assist the company in raising funds.

● Preferential Allotment increases the flow of capital in the

economy.

● To provide an option for venture capitalists, promoters,

financial institutions, suppliers, or buyers to increase their
stake in the company.

EXAMPLES OF SECONDARY MARKET

1) OVER THE COUNTER EXCHANGE

ITCEI was incorporated in 1990 under Section 25 of the

Companies Act, 1956 and is recognised as a stock exchange under
Section 4 of the Securities Contracts Regulation Act, 1956.
There is no central place of exchange and all trading occurs
through electronic networks.
It is India's first exchange for small and medium companies as well
as the first screen-based nationwide stock exchange in India.
 The exchange was set up with an objective to provide an exchange
for raising finance for new projects in a cost effective manner and
to provide investors with a transparent and efficient mode of
trading.
FEATURES OF OTCEI

● RESTRICTION:
Stock listed in other exchanges will not be listed in OTCEI.
Similarly, stocks listed in OTCEI will not be listed in other
stock exchanges. No company with the issued equity share
capital of more than Rs 25 crores is permitted for listing.

● COMPUTERIZATION:
First nationwide electronically operated stock exchange.
OTC designed dealers operate through their computer
terminals which are hooked to a central computer. All quotes
and transactions are recorded and processed here.

● LOCK-IN-PERIOD:
All the companies listed in the OTCEI has minimum lock-in-
period of three years. After three years, these companies may
either choose to remain on the OTCEI or seek listing on other
stock exchanges.

There is total transparency and fairness so far as the deals are

concerned. However, despite being in existence for a number
of years, the exchange does not have a major presence
amongst stock exchange of the country.

ELIGIBILITY TO GET LISTED AT OTCEI

 ● A company should have a minimum paid-up capital of Rs 30 lakhs.
● The minimum offer to the public should be 25% of the issued
capital or Rs 20 lakhs worth of shares in face value, whichever is
higher.
● SEBI guidelines on Disclosure and Investor Protection will be
applicable to all the OTCEI issues also.
● Every company that intends to get listed has to be sponsored by a
merchant banker (Member/Sponsor) of the exchange.
● Relaxation in listing norms as compared to other stock exchanges:
3 year dividend paying record in the last 5 years.
● The sponsor of the issue must arrange for market makers yo give
buy and sell quotes in the securities for an initial period of 18
months.
NOTE: These market makers have to offer buy and sell quotes for a
period of at least 18 months from the commencement of initial trading in
the company's scrip.

ADVANTAGES OF MARKET MAKERS:

TO COMPANIES:
● Continuous source of liquidity for the company's scrips.
● Provides valuation for the company's scrips.
● Company benefits from the analysis and information
dissemination function of the market makers.

TO INVESTORS:
● Continuous source of liquidity, which means he/she can
liquidate his investment any time he/she chooses.
 ● Competition among market makers reduces spreads and
produces efficient pricing.
● Source of company information.

2) STOCK EXCHANGE

Stock exchange, securities exchange, or bourse is an

exchange where stockbrokers and traders can buy and sell
securities, such as shares of stock, bonds and other
financial instruments.

Securities traded on a stock exchange include stock issued

by listed companies, unit trusts, derivatives, pooled
investment products and bonds.

Stock exchange is an important factor in the capital market.

The purpose of a stock exchange is to help in capital

formation and act as intermediary between companies and
investors by providing a common platform for exchange.

EXAMPLES

Some of the largest exchanges are the New York Stock

Exchange (NYSE), the NASDAQ, and the Tokyo Stock
Exchange (JPX). Other well-known stock exchanges
include the London Stock Exchange (LSE), the Shanghai
 Stock Exchange (SSE) and the Bombay Stock Exchange
(BSE).

● NATIONAL STOCK EXCHANGE (NSE)

The National Stock Exchange of India Limited (NSE) is India’s

largest financial market. Incorporated in 1992, the NSE has
developed into a sophisticated, electronic market, which ranked
fourth in the world by equity trading volume.

NSE was set up by leading financial institutions, banks, insurance

companies, and other intermediaries.

NSE has a total market capitalization of more than US $3.06

trillion. It is the world’s 9th largest stock exchange as of june
2022. More than 3000 companies have been listed in NSE.

Nifty 50 was introduced as the bench mark index of NSE in 1996.

The CNX (Nifty50) signifies the weighted average of the 50
companies across 17 sectors.

● BOMBAY STOCK EXCHANGE (BSE)

It was established in 1875 as the Native Share and Stock Brokers'

Association.
BSE is Asia's first exchange and the largest securities market in
India.
 It has been instrumental in developing India's capital markets.
The BSE is known for its electronic trading system.
Investors can trade in equities, currencies, debt instruments &
mutual funds.
The BSE also provides important capital market trading services.

BSE has the following objectives:

● To provide an efficient and transparent market for trading in
equities, debt instruments, derivatives and mutual funds.
● To provide a trading platform for equities of small and
medium enterprises.
● To ensure active trading and safeguard market integrity
through an electronicicall-driven exchange.
● To provide other services to capital market participants like
risk management, clearing settlements, market data, and
education.
● To conform to international standards

INSTRUMENTS OF CAPITAL MARKET

1) EQUITIES

Equities are the share in the ownership of the company and are one
of the most traded financial instruments on the exchange. But why
do investors and traders swarm towards equity? This is because it
has the ability to multiply your capital by generating higher returns
as compared to other financial instruments.
These shares are the prime source of finance for a public limited or
joint-stock company. When individuals or institutions purchase
 them, shareholders have the right to vote and also benefit from
dividends when such an organization makes profits. Shareholders,
in such cases, are regarded as the owners of a company since they
hold its shares.
This instrument is issued by companies only and can also be
obtained either in the primary market or the secondary market.
Investment in this form of business translates to ownership of the
business as the contract stands in perpetuity unless sold to another
investor in the secondary market. The investor therefore possesses
certain rights and privileges (such as to vote and hold position) in
the company. Whereas the investor in debts may be entitled to
interest which must be paid, the equity holder receives dividends
which may or may not be declared.
The risk factor in this instrument is high and thus yields a higher
return (when successful). Holders of this instrument however rank
bottom on the scale of preference in the event of liquidation of a
company as they are considered owners of the company.

Other features that make it the most preferred Avenue are:

● Buying shares/stocks give you the part-ownership in the

company.
● Har better liquidity, which means you can easily sell your
shares in the market.
● Its inherent volatility offers investors to book short term
profits based on stock price fluctuations.

2) BONDS
 A bond is a debt security, similar to an IQU. Borrowers issue
bonds to raise money from investors willing to lend them money
for a certain amount of time.
When you buy a bond, you are lending to the issuer, which may be
a government, municipality, or corporation. In return, the issuer
promises to pay you a specified rate of interest during the life of
the bond and to repay the principal, also known as value or par
value of the bond, when it “matures,” or comes due after a set
period of time.

Why do people buy bonds?

Investors buy bonds because:
● They provide a predictable income stream. Typically, bonds
pay interest twice a year.
● If the bonds are held to maturity, bondholders get back the
entire principal, so bonds are way to preserve capital while
investing.
● Bonds can help offset exposure to more volatile stock
holdings.Companies, governments and municipalities issue
bonds to get money for various things, which may include:
● Providing operating cash flow
● Financing debt
● Funding capital investment in schools, highways, hospitals,
and other projects.

3) DEBENTURES
A debenture is a type of bond or other debt instrument that is
unsecured by Collateral. Since debentures have no collateral
backing, they must rely on the creditworthiness and reputation of
the issuer for support. Both corporations and governments
frequently issue debentures to raise capital or funds. Similar to
most bonds, debentures may pay periodic interest payments called
coupon payments.

Like other types of bonds, debentures are documented in

an indenture An indenture is a legal and binding contract between
bond issuers and Bondholders The contract specifies features of a
debt offering, such as the Maturity date , the timing of interest or
coupon payments, the method of interest calculation, and other
features. Corporations and governments can issue debentures.
Governments typically issue long-term bonds—those with
maturities of longer than 10 years. Considered low-risk
investments, these government bonds have the backing of the
government issuer.
Corporations also use debentures as long-term loans. However, the
debentures of corporations are unsecured.1 Instead, they have the
backing of only the financial viability and creditworthiness of the
underlying company. These debt instruments pay an interest rate
and are redeemable or repayable on a fixed date. A company
typically makes these scheduled debt interest payments before they
pay stock dividends to shareholders. Debentures are advantageous
for companies since they carry lower interest rates and longer
repayment dates as compared to other types of loans and debt
instruments.

FEATURES OF DEBENTURE
 Debentures are usually the unsecured form of bonds which are not
backed by any asset or collateral. Instead, the investors consider
the issuer’s Creditworthiness as a primary parameter for the
purchase.
They can be easily exchanged in the stock market, just like
other securities. Thus, they are a flexible debt instrument
A real-world example is L & T FINANCE LTD planning to issue
secured, redeemable non-convertible debentures in 2012.

4) DERIVATIVES

Financial derivatives are financial instruments that are linked to a

specific financial instrument or indicator or commodity, and
through which specific financial risks can be traded in financial
markets in their own right. The value of a financial derivative
derives from the price of an underlying item, such as an asset or
index. Unlike debt instruments, no principal amount is advanced to
be repaid and no investment income accrues. Financial derivatives
are used for a number of purposes including risk management,
hedging, arbitrage between markets, and astrating value.

Financial derivatives contracts are usually settled by net payments

of cash. This often occurs before maturity for exchange traded
contracts such as commodity futures. Cash settlement is a logical
consequence of the use of financial derivatives to trade risk
independently of ownership of an underlying item. However, some
financial derivative contracts, particularly involving foreign
currency, are associated with transactions in the underlying item.
 The final decision on the classification of these financial
derivatives was promulgated in 2002. See Classification of
Financial Derivatives Involving Affiliated Enterprises in the
Balance of Payments Statistics and the International Investment
Position (IIP) Statement.

5) EXCHANGE-TRADED FUNDS

An exchange-traded fund (ETF) is a type of pooled investment

security that operates much like a mutual fund. Typically, ETFs
will track a particular index, sector, commodity, or other assets, but
unlike mutual funds, ETFs can be purchased or sold on a stock
exchange the same way that a regular stock can. An ETF can be
structured to track anything from the price of an individual
commodity to a large and diverse collection of securities. ETFs
can even be structured to track specific investment strategies.
An ETF is called an exchange-traded fund because it’s traded on
an exchange just like stocks are. The price of an ETF’s shares will
change throughout the trading day as the shares are bought and
sold on the market. This is unlike mutual funds which are not
traded on an exchange, and which trade only once per day after the
markets close.
Additionally, ETFs tend to be more cost-effective and more liquid
compared to mutual funds.

6) FOREIGN EXCHANGE INSTRUMENTS

● Foreign exchange forwards:

 A foreign exchange forwards is a contract to deal with the
exchange of currencies. It entails an agreement to buy or sell
any specific currency at a predetermined date in the future
with a rate agreed upon, called the forward rate. In this case,
if a buyer and seller agree on an exchange rate for a future
date, the transaction will take place on that date regardless of
the market rates.
● Currency Futures:
Currency futures are an exchange-traded futures contract that
specify the price in one currency at which
another currency can be bought or sold at a future date.
Currency futures contracts are legally binding
and counterparties that are still holding the contracts on the
expiration date must deliver the currency amount at the
specified price on the specified delivery date.
● Currency Swap:
A currency swap, sometimes referred to as a cross-currency
swap, involves the exchange of interest—and sometimes of
principal—in one currency for the same in another currency
can be bought or sold at a future date.
Companies doing business abroad often use currency swaps
to get more favorable loan rates in the
local currency than if they borrowed money from a local
bank.
● Currency Option:
A currency option (also known as a forex option) is a
contract that gives the buyer the right, but not the
obligation, to buy or sell a certain currency at a specified
exchange rate on or before a specified date. For this right, a
premium is paid to the seller.
7) PREFERENCE SHARES

The capital of a company is divided into small units of fixed

amount. These units are called shares. The shares which can be
issued by a company are of two types
1. Preference shares
2. Equity shares

Preference shares are the shares which have the following two
preferential rights over the equity shares.
a) Preference shares towards the payment of dividend at a fixed
rate during the lifetime of the company.
b) Preference towards the repayment of the capital on winding up
of the company.

TYPES OF PREFERENCE SHARES

Its types can be divided on the basis of following terms:
1 .Convertibility
2. Redeemable
3. Participation
4. Cumulative
5. Shares with callable option

CONVERTIBLE AND NON CONVERTIBLE

1. Convertible shares possess an option or right whereby they can
be converted into an ordinary equity share at some agreed terms
and conditions.
2. Non convertible shares simply do not have this option but have
all other normal characteristics of a preference shares.

REDEEMABLE AND IRREDEEMABLE

1. Redeemable preference shares have a maturity date on which

date the company will repay the capital amount to the preference
shareholders and discontinue the dividend payment.
2. Irredeemable preference shares does not have any maturity date.
The dividend of these shares are fixed.

PARTICIPATING AND NON PARTICIPATING

1. Participating preference shares has an additional benefit of

participating in profits of the company apart from the fixed
dividend.
2. Other preference shares who do not participate are called non
participating preference shares.

CUMULATIVE AND NON CUMULATIVE

1. Cumulative shares- the dividends are accumulated and therefore

paid before anything paid to equity shareholders.
2. Non cumulative –if a company does not pay a dividend in the
current year, the claim of preference shareholders is lost to that
extent.
SHARES WITH CALLABLE OPTION

1. Company has a right to redeem preference shares in between

such preference shares will be redeemed at a premium, if redeemed
in between.
2. The company will exercise such an option, if rate of preference
dividend is falling in the market.

8) DEBT INSTRUMENTS

A debt instrument is an asset that an entity, such as an individual,

business, or the government, uses to raise capital or to generate
investment income.
A debt instrument is also known as “Certificate of indebtedness".
They can be classified as Secured, Unsecured, revolving or
mortgaged.
Common debt instruments are Bonds, Promissory Notes, Leases,
Certificates, Mortgages, Treasury Bills.

Debt instruments are classified into:

● Long term debt instruments
1. Debentures - Long term loans
2. Bonds - Mortgage
● Medium and Short term debt instruments
1. Working capital loans
2. Short term loans - Treasury bills