Ch.2-Primary, Secondary & Debt Market

8/13/2019 Ch.2-Primary, Secondary & Debt Market

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PRIMARY MARKETSECONDARY MARKET

DEBT MARKET


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THE PRIMARY MARKET

Primary Market : meaning A market for new issues

It is a market for fresh capital . Also called the new issues market.


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Primary Market .

In India , new capital issues are floated by Governmentcompanies, non Govt. Limited companies, public sector

undertakings, banks and financial institutions.

Under section 67 of Companies Act 2000, an offer tosubscribe for shares or debentures is made to 50 or

more persons ,such an offer is deemed public offering

and shall have to comply with all provisions of SEBI

relating to public offerings.

All public issues are open to the general public.


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Free Pricing Regime Prior to 1992 all new issues controlled by the CCI,

and every co. had to obtain prior approval of the CCIfor raising funds from the primary market.

CCI decided the price, timing and quantum of theissue.

New cos price at par, Existing companies withreserves price at premium.

Post 1992 , CCI repealed. All controls on raising

resources from the primary market removed. The co. with its merchant bankers decided the issue

price. There fore emergence of FREE PRICINGREGIME.


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Free Pricing Regime impact This led to very high premiums on most issues by dishonest

promoters and greedy merchant bankers.

Moreover cos. With negative bottom line came back with repeated

issues at a premium. But on listing due to non performance of the

cos. They stock prices crashed. Of the 4000 issues that hit the market in 1992-96 , more than 3000

quoted , below the offer price on the day of listing.

The regulator therefore brought in strict regulations for merchant

bankers, and others and guidelines for full disclosures for investor

protection were brought in.


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Methods for determining the Offerprice

Fixed price : The firm and the merchantbanker decided an offer price without takinginto account the investors feedback.

Book Building : It is a process by whichdemand for the proposed issue is elicited and

built-up and the price at which the securitieswill be issued is determined on the bases ofbids received.


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Allocation in Book Built Issue

If the issuer company makes an issue of100% to public than:

1. 35% for the retail indv.2. 15% for non institutional investor3. 50% for the qualified institutional buyer


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QIBs are prohibited to withdraw their bids

after the close of the IPO . Retail and non institutional bidders can

withdraw till the date of allotment


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QIBs

A public financial institutional as defined insection 4 A of the Company Act 1956.

Scheduled comm. Bank Mutual funds Venture capital funds registered with the SEBI.


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Benefits of Book Building Method

Aim of this process is to have the issue pre sold anddecrease the chances of under subscription

The cost and time of making public issue is lowered The public issue benefits the investor The possibility of price falling below par after listing

is removed.


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Limitations of Book Building

It relies on much interaction among firms , merchantbankers, and investors which is absent in India .

Lack of transparency and absence of strong

regulations Issuers may have to sell in cheap due to collective

bargainig.


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AUCTION BASED BOOK BUILDING

In this method bidders are free to bid at any priceabove the floor price and allotment would be onprice priority basis and at differential prices. Thismethod can be used only for FPOs.

REVERSE BOOK BUILDINGIt is a price discovery mechanism for companies whowants to delist their shares or buy back shares fromthe shareholders.


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GREEN SHOE OPTION

It is also referred as an over allotment options. It is amechanism to provide post listing price stability to anIPO.

GREEN SHOE company was the first to issue this typeof option, hence the name green shoe option.


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PRIMARY ISSUE

PUBLIC ISSUE IPO: Initial public offering

It is an offering either a fresh issue of securities or an

offer for sales of existing securities or both by anunlisted co. for the first time to the public. ENTRY NORM I :- Profitability Route ENTRY NORM II :- QIB Route ENTRY NORM III:- Appraisal Route


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FPO: Follow on public offeringIt is an offer of sale of security by listed co. It is alsoknown as subsequent or seasonal public offering

For such offering SEBI provide guidelines for listed co. Listed co. issues FPO to finance their growth

plan


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Rights Issue : Rights issue is the issue of new shares in which

existing shareholders are given rights to subscribe tothe new issue on a pro-rata basis.

Done by sending a letter of offer to the shareholders

whose names are recorded in the books on aparticular date . Share holder has a right to exercise his right in full or

in part , renounce his rights and sell them in theopen market or choose do nothing.


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IDRs: Indian Depository Receipts

Foreign co. can issue their share to Indian national inIndia.The first ever issue of IDRs was by Standard ChartedBank on MAY 28 th 2010 of 240 millions IDRs sold36million IDRs were placed with Anchor Investors10 IDRs of Standard charted = 1Share

It enables foreign co. to raise capital in India It also enables Indian investors to diversify risk. Enables globalisation of Indian Stock exchanges


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Eligibility for issue of IDRs:-

1. Eligibility criteria is specified in rule 4of IDR Rules.2. It should be listed in their home country .3. It has not been prohibited to issue securities by any

regulatory body.4. It has good track record with respect to compliances

with securities market regulation.5. Minimum issue size should not be less than Rs. 50

crore.


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Pvt. Placement

The direct sale of securities by a company to some select

people or to institutional investors is called private

placement.

No prospectus is issued.

Covers equity shares, preference shares and debentures.

Quicker access to capital and inexpensive on account of

absence of various issue expenses.


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Private Placement Market :

Prolonged subdued conditions in the new issues market.

The resources raised through private placement has

increased by four times in the years from 1997-98 to2000-01.

The share of resources raised from private placement in

these years accounted for 88% of the total resourcesmobilized from the primary market.


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This indicates it is a preferred mode for raising resources

in the primary market for both public and private sector

companies. Some other reasons being :

No lock in period , no compliance system for the

merchant bankers as in case of public issues, no limit on

a Banks investment on debt, which has made this

market more buoyant , organizations use this issue

proceeds to repay outstanding loans to banks and FIs.

Etc.


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Resource mobilization from InternationalCapital Markets

Global Depository Receipts American Depository Receipts Foreign Currency Convertible Bonds External Commercial Borrowings


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Global Depository Receipts GDRs are essentially equity instruments issued abroad by authorized overseas

corporate bodies against the shares/bonds of Indian companies, held withnominated domestic custodian banks.

GDR issue creates equity shares , which are kept with the designated bank.

A GDR may represent one or more shares in a fixed ratio of the issuing

company. The holder may convert the GDR into the shares at any time, andthen they can be listed on domestic stock exchange and traded.

GDRs are freely transferable outside India, and dividend on shares

represented by the GDR are paid in Indian Rupees only.

They are listed on a Foreign Stock Exchange. Indian GDRs are usually listed on

the Luxemburg Stock Exchange/London Stock Exchange. They are primarily

sold to institutional investors in US, UK, Hongkong, Singapore, France and

Switzerland .


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American Depository Receipts ADRs are negotiable instruments, denominated in

dollars and issued by the US Depository Bank. A non US company, which seeks to List in the US, can

deposit shares with a bank and receive a receipt,which enables the company to issue AmericanDepository Shares .

NO Technical and legal difference between the ADRand GDR.

ADR issues offer access to the US institutional andretail markets while GDR offer access only to the USinstitutional market.


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Process for issuing ADR/GDR

Board approval

Tendering of the share by the share holders

Conversion to ADRs/GDRs

Sale of ADRs/GDRs to overseas investors

Repartition of proceeds to India within one month Distribution of proceeds to share holders


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EXTERNAL COMMERCIAL BORROWING(ECB)

These are the borrowing raise from the internationalmarket by the corporates

It is governed by the ECB policy, which is administered by

the finance ministry along with RBI It refers to commercial loan avail from non resident

lenders

Minimum maturity period is 3years


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It can be accessed under two routes

1. Automatic route For investment in real sector industrial and

infrastructure i.e. they dont require RBI/ govt.approval

Maximum amt of ECB can raised US $ 5002. Approval route

ECBs do not come under the automatic route areconsidered by an empowered committee of RBI for approval


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FOREIGN CURRENCY CONVERTIBLE BOND(FCCBs)

FCCBs are the bond issued by Indian co. to a nonresident in foreign currency

Carry fixed interest rate and are convertible intoordinary shares either in whole or in part

These are listed and traded abroad Interest rate is low but exchange risk is high because

interest is paid in foreign currency Foreign co. prefers FCCB while Indian companies

prefer to issue GDR


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SECONDARY MARKET

Secondary market is a market in which existingsecurities are sold or traded.

Function : To facilitates liquidity and marketability To contribute to economy growth through allocation of funds Provide instant evaluation (ROI) To ensure measures and safety and fair dealing.

To induce to improve performance. Market price at exchange reflects performance


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Post Reforms

Regional stock exchanges 19 The National Stock Exchange 1

The Over The Counter Exchange of India - 1


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Regulation of Stock Exchange

SEBI- Security Exchange Board Of IndiaObjective

To protect investors interest in securities andto promote and regulate the security market.


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Demutualisation of Stock Exchange

It is the process by which any member-ownedorganisation can become a shareholderowned company.

It separate the ownership and control of stockexchange form trading rights of its member.


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Listing of Securities A company has to list its securities on the

exchange so that they are available fortrading.

A company can list on more than one stockexchange but compulsory to list on neareststock exchange to its registered office.

CLA Central Listing Authority regulatesprelisting and post listing procedure, monitorfor which the funds are used.


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Circuit Breakers

To contain excessive volatility in price SEBIintroduce scrip wise daily circuit breaker/priceband.

Circuit breakers dont halt but no order ispermitted order is out of specified price range.


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Trading & settlement : Trading & settlement

cycle timed from 14 days to 7 days. Dematerialisation of Securities : To prevent

problems such as fake, transfer delay,

paperwork. An electronic book entry form of holding and

transferring securities has been introduced.

Risk management Internet trading


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Stock Market Index

It is most important indices of all as itmeasures overall market sentiment through aset of stock that are representative of market.

Function : To serve as barometer of equitymarket.

To serve as benchmark for portfolio of stock. To serves as under laying for future & option.


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Methodology for calculating indices

(1) Market capitalisation weighted(a) Full market capitalisation(b) Free float market capitalisation

(2) Price weighted index(3) Equal weighting index


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Global Stock Markets : Dow Jones, NASDAQ,NASDAQ 100, The MSCI indices.

Major Indices in India : Sensex, S&P CNXexchange

Badla (carry forward) : Badla is postponement

of the delivery of or payment for purchase ofsecurities from one settlement period toanother.

It increases trading activity of BSE. Types of Badla : Teji Badla & Mandi Badla.


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Listing Categories

A group : consist large turn over and highfloating stock with large market capitalisation.

B1 group : includes scrip of quality companieswith an equity above Rs. 3 crore with highgrowth potential and drawing frequency.

B2 group : it includes companies with an equitybelow Rs. 3 crores.


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National security clearing corporation ltd.

It has been set up in April 1995, a wholly ownedsubsidiary to undertake clearing & settlement at theexchange.

Functions: Clear all trades Determine obligation of members Arranges for pay in & pay out of funds Receive funds & securities Collects & maintain margin Process for shortage in finds & securities


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OTCEIPromoted jointly by ICICI, UTI, IDBI, SBI Capital Markets Ltd., Canbank

Financial Services Ltd., GIC & LIC.

Recognized as Stock Exchange under Securities Contracts Act, 1956.

Based on NASDAQ (National Association of Securities Dealers AutomatedQuotation) model.

Set-up to provide small & medium companies an access to capital marketsfor raising finance. Allowed companies with paid-up capital as low as Rs. 30lacs.

Securities traded are divided into 3 categories:i. Listedii. Permittediii. Initiated


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Market making is a unique concept of OTCEI.

Market makers are merchant bankers willing to make market insecurities by continuously offering buy & sell quotes.

They act as dealers-cum-stockists & do not charge any commission orbrokerage.

The Spread between bid & offer price is their profit margin.


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Causes of Decline of RSEAbolition of Badla Introduction of uniform trading cycles at all the stock exchange, led to diminished

opportunities for arbitrage transactions.

Introduction of compulsory rolling settlements, accelerated the reduction inturnover at the RSEs.

Major operators are all these exchanges acquired memberships of either NSE orBSE.

RSEs have managed to survive so far because of the annual listing fees that arebeing received from the listed companies.


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ISEIPromoted by 12 Regional Stock Exchanges

It was the dwindling fortunes of RSEs that brought them together to establishthe Inter-connected Stock Exchange of India Ltd. (ISE). ISE was launched withan objective of converting small, fragmented and illiquid markets into large,liquid national-level markets.

Failure of ISE was, due to the bigger brokers of the participating RSEs failingto support any interest in trading on ISE due to commercial considerations. As

a result, it becomes virtually impossible for ISE to create any worthwhileliquidity in its markets in competition with the breadth and depth of NSE andBSE.


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Measures to boost Liquidity in theMarket

Investment by FIIs in the market.

Buy-back of shares

Market Making System

Stock Lending

Rolling settlement

Straight Through Processing

Continuous Net Settlement


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Investment by FIIs Can Invest through three routes:

i. Direct A broad based fund which has at least 20 shareholders andeach has no more than 10% share or units of the fund.

ii. P-notesInstruments issued by registered FIIs to overseas

investors without registering with market regulatorSEBI.

i. Sub-AccountsInclude foreign companies, foreign individuals, Institutions,funds or portfolio, etc.

FIIs were initially allowed to invest only in equity shares. But were later allowed to invest in debt market, including dated

government securities & Treasury bills.


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FIIs & their Impact

Screen based trading & Depository Services.

Corporate Governance

Eased pressure on rupee from BOP position.

First to identify potential in Indian Technologystocks.

They play as trendsetters & market makers.Corporatization of broking firms.

Rolling Settlement Introduced.


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Buy Back of SharesWhen a company repurchases its own shares, it is buy back.

A company with surplus cash can buy back because it carries minimum risk

compared to other investment avenues.

A company facing a threat of hostile takeover would buy back.

A company may think to alter its capital structure.

Panic driven fall can be arrested.

A company intending to improve market quotes as it signals managementconfidence.


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Buy Back Method

Tender OfferFrom the existing shareholders on a proportionate basis

Open MarketBook BuildingStock Market

A company may buyback its shares without shareholders resolution, to the

extent of 10% of its paid up equity capital and reserves. However, if a companyintends to buyback its shares to the extent of 25% of its paid up capital andreserves/ then the same has to be approved by Shareholders Resolution asspecified in Section 77 A of Companies Act, 1956.


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Market Making SystemMarket Maker is an individual or firm who givestwo way buy & sell quotes for a stock.

To provide liquidity to illiquid scrips, market makers arerequired.

He makes buy & sell quotes simultaneously.

Thus he creates a market for scrips wherein it can be easilybought & sold.

This is called market making mechanism.


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Stock Lending

Enables a seller to borrow shares from SEBI registered intermediary &deliver them to a buyer against outstanding commitments.

When price declines, he replaces borrowed shares by buying from the

market .

Borrowers pay lender interest on the value of securities .


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Advantages of Stock Lending

Provide avenue for Institutional Investors to earn income by lendingidle stock.

Increases liquidity of the stock.

Enables investors to take arbitrage activities.


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Rolling SettlementIt is a system of settling transaction in a fixed

number of days after the trade is agreed.

It was introduced in form of T + 5 settlementsystem where T is the trade date & 5 is thenumber of business days on which delivery ofsecurities & cash payments are due forsettlement.


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Advantages of Rolling SettlementEliminates arbitrage opportunities.

Lowers trading costs & reduces the risk of counter party failure.

Helps in reducing volatility.

Eliminates fluctuation of prices which takes place around settlement

dates.

Encourages wider participation s shorter delay in settlement.

Reduces settlement risks & narrow the bid-ask spreads due to its

transparent nature.


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Straight Through ProcessingStraight-through processing (STP) enables the entire trade process forcapital markets and payment transactions to be conducted electronicallywithout the need for re-keying or manual intervention.

The goal was to minimize settlement risk for the execution of a tradeand its settlement and clearing to occur simultaneously .

When fully realized, STP provides financial services players withtremendous benefits, including greatly shortened processing cycles,reduced settlement risk and lower operating costs.


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Continuous Net Settlement

Automated system of tracking securities and cash balances.

An automated accounting system that uses a central clearing house to clear andsettle securities transactions, maintaining complete records of companies' moneybalances.


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The Debt Market


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What is Debt Market?The debt market is any market situation where the tradingdebt instruments take place. Examples of debt instrumentsinclude mortgages, promissory notes, bonds, and Certificatesof Deposit. A debt market establishes a structuredenvironment where these types of debt can be traded with

ease between interested parties.Roles :

Efficient Mobilization and allocation of resources in the economy. Financing Development activities of the government Facilitating liquid management in tune with short-term and Long-

term objectives Pricing of nongovernment Securities in financial markets


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Regulation of debt market : RBI regulates the govt.securities and money market. Corporate debt market underSEBI.

Link between Money Market &Debt Market Moneymarket deals in short term debt instruments, while Debtmarket deals in long term debt, but former essentialprerequisite for development of debt market .

Characteristics of Debt Market : competitive structure ,low transaction cost, safe market infrastructure, high levelmarket heterogeneity among market participants.


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Participants of Debt Market

Central & State govts. Primary dealers Public sector

undertakings Corporates Banks

Mutual funds

FIIs Provident Funds Charitable institutions

and trusts


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Primary & Secondary Segments of Debt Market

In Primary Mkt, Private Placement is very popular because of low cost ofraising funds

In 2006 US Private Placement Market was opened for Indian CompaniesNSE set up a separate segment for trading in debt securities known asWholesale Debt Market (WDm) segment

Two Markets Under it: Continuous Market Negotiated Merket


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The Private Corporate Debt Market

It is a Market wherein debt securities of Corporate are issued and traded

Its Investors include Banks, MFs, Insurance Companies as they seek Steadyreturns

Debt is raised through issuance of Debentures which can beConvertible or Non-Convertible


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Importance Aids in Economic growth by Providing long-term Capital Supplements the Banking System A Stable Source of Finance Reduces Cost of Capital Fosters Market Discipline Enables Investors to hold a Diversified Portfolio

SEBI regulates Primary & Secondary Markets


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Private Corporate Debt Market A small segment of the Debt Market. Debt issues comprises debentures and bonds. Primary Market :- Corporate sector can raise funds through prospectus or private placement.- In recent years, the bond issue has dominated the primary corporate debt market.- Bought out deals flooded the bond market in 2002, where the entire issue is

picked up by a single investor, unlike a pvt. placement, where the where the debtpaper is sold to several investors. It has infact become the preferred route forcorporates , as funds raised within a short time and with little disclosure.

Secondary Market : - corporate debt securities traded on WDM segment of NSE, OTCEI & BSE. -secondary market not yet fully developed in India


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Private Corporate Debt Market The volumes traded quite low. Reasons : -very low transparency in this market. - Absence of benchmark rate, restricts the

development of new & innovative instruments. The corporate bond market needs well capitalized

market makers. Cooperative banks and charitable trusts allowed on

case to case basis only , to invest in corporate paper.

Measures to Promote Corporate Debt


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Measures to Promote Corporate DebtMarket

Interest Rate Ceiling is removed Conversion has been made optional Listing of Privately placed debt paper in the secondary market is allowed It is possible for debt of Corporate to be listed even though Equity may not

be listed FII is permitted to participate in CDM BSE and NSE have launched trading and reporting platforms to capture all

Information relating to trading in corporate bonds Shut period in Corporate Bonds has been reduced to align it with that

applicable to Government Securties Repo Transaction in Corporate Debt Securities is allowed

Public Sector Undertaking Bond


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Public Sector Undertaking BondMarket

They are medium and long term obligations issued by public Sectorundertakings, they are privately placed with Banks or Large Investors Many of these are issued by Infra Related Govt. Companies i.e. Railway

and Power Companies PSUs are permitted to issue 2 types of Bonds: Taxable, Non-Taxable Interest on these Bonds are Calculated on actual /365 days PF were allowed to invest 30% of their Incremental Deposits in PSUs As Per Guidelines minimum maturity of tax free bonds should be 7 years Investors include NBFC, Banks, Insurance co. , PFs , Mfs and Individuals


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Secondary Market in PSU Bonds

PSU Bonds are generally issued and traded in the form ofPromissory notes or Certificates

It dont require transfer deed for registration so no Stampduty is levied

Repos are Permitted if PSU Bonds are in Demat Form


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The Government Securities Market

It is referred to as SLR Securities as they are Eligible forMaintenance of the SLR ratio by Banks

Importance : Critical for bringing effective transmission channel for use of

Indirect Instruments of Money Control .i.e. OMO & SLR. Provides Highest degree of Security

Acts as benchmark for pricing debt Securities Facilitates government borrowings at reasonable cost

Issuers Investors Types of Govt


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Issuers , Investors, Types of GovtSecurities

G-secs are issued by Central, State, Semi-Govt. authorities including localGovt. Authorities Major Investors include Banks as they need to fulfill their reserve

requirements Investors can be Classified into

1. Wholesale Market Segment : Banks, Financial Institutions, Insurance,MFs, Individuals

2. Middle Segment : PFs, NBFC, Small Coop having liquidity from 7-25crores

3. Retail : Individuals

Insurance Co. are 2 nd Largest Investors as they need to fulfill their 20%assets of General Insurance & 25% of Life Insurance business as per rulesby IRDA


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STRIPS in G-securities Separate Trading for registered interest and Principal of Securities is a

Process of Converting 1 underlying Security into number of zero-couponsecurities

It increases breadth and depth of the Market which helps improvingliquidity

It allows issuer to issue securities with long term maturity for any amount Banks can issue STRIPS against securities held by them


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Guidlines

Any entity holding govt. Sec can strip these securities as notified by RBIfrom time to time, Demat account is necessary Holders of Govt Sec shall place their request for Strip/reconstruction with

an authorized entity Can be done at any time between issuance and maturity of Security All Dated Govt sec having Coupon payment date on Jan 2 and July 2 ,

irrespective of year of maturity shall be eligible for stripping

M t P t R t il T di g i G t S iti


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Measures to Promote Retail Trading in Govt Securities

Bank allowed to freely buy and sell securities Exempted from TDS Support to Primary Dealers Setting up of mutual funds dealing exclusively in these securities A non-Competitive bidding facility Depositories are allowed to open 2 nd SGL account

Ch.2-Primary, Secondary & Debt Market

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Transcript of Ch.2-Primary, Secondary & Debt Market