Lecture On Capital Market1

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Presentation on Capital Markets

WHAT IS FINANCIAL MARKET? • Provides and facilitates orderly exchange of financial claims. Medium for mobilising finance out of savings and making it available to users.A linkage between source and use. • Has two components : Capital market and Money market • Capital market : Capital market is a broad term which includes primary markets, secondary markets and intermediaries who are engaged in providing long-term capital (equity or debt). Stock exchange is a division of the capital market but is regarded as synonymous • Money market : Place for trading in money and short-term financial assets that are close substitutes for money. Instruments are liquid eg. T Bills, Certificate of Deposit, Commercial Paper, call money etc • Can also be categorised as Primary Market and Secondary

WHAT IS FINANCIAL MARKET? (Contd) • Primary market : Market for new issues or for mobilisation of resources by companies and government undertakings, where investors apply directly to issuer for allotment and pay application money to issuer’s account. Includes IPOs, rights issues, issue of debt instruments. • Secondary market : Shares hitting primary market mandatorily required to list shares on stock exchanges. These shares are traded in the secondary market through brokers. Secondary market provides i) ready market for securities ; ii) liquidity iii) easy negotiability iv) helps in distribution of new securities v) members provide investment advice

Capital market instruments • Funds can be raised through issue of equity shares (par/premium), debentures, bonds, preference shares. • Equity share – represents ownership or equity interest in company. Share is a share in the capital of the company. Carry voting rights and share both risk and profits. • Preference shares – Features of equity and debt. Dividend rate fixed. Shareholders have preferential right to payment of dividend and for repayment of capital on winding up. Can be cummulative/non-cummulative, redeemable/nonredeemable, convertible/non-convertible

Capital market instruments (Contd) • Debentures – instrument for raising long term capital. Does not result in dilution of control. Can be secured, convertible, redeemble • Equity warrants – instrument attached to NCDs which gives holder right to apply for equity shares of company at future date. • Derivatives - Financial contracts whose value is derived from the underlying asset, Futures and options, forward etc. Forward is an agreement between two parties agreeing to sell or buy underlying assets at predetermined price at future date and done over the counter .Future is a forward contract which is traded on exchanges. Options – put and call. Options gives the right to buyer. • Put – gives buyer the right to sell or not, however the seller is obligated to buy . Call – Gives buyer option to buy or not seller will have to sell.

Genesis • • •

• • • • • • •

First stock exchange set up in London (1675) First stock exchange in Asia – BSE (1875) In 1947, Capital Issues (Control) Act passed, formalised and continued controls on issue of securities imposed during Second World War. Administered by office of Controller of Capital Issues (CCI), part of MOF In 1956, Securities Contract (Regulation) Act enacted which brought SE, members and contract in securities under regulation of CG. Incorporation, regulation and liquidation of companies under purview of Companies Act, 1956. Administered by DCA. For 4 decades after independence, capital market did not develop in consonance with rest of economy Dilution of holdings of MNCs at low prices in late 70s briefly kindled interest of lay investors Interest livened when economic policies of Rajiv Gandhi provided a stimulus in addition to paucity of funds of FIs However, trading and settlement infrastucture was poor, disclosure norms rampant, poor enforcement of regulations, hardly any penal action against violators Need for independent regulator felt, SEBI set up.

Regulatory framework - SEBI Act, 1992 - SEBI set up initially (12/4/88), later as statutory body (30/1/92 ) – milestone in history of capital market - Objectives of SEBI i) to protect the interests of investors in securities ii) to promote the development of the securities market iii) to regulate the securities market Orders of SEBI appellable before Securities Appellate Tribunal (SAT)

Regulatory framework - Companies Act, 1956 -

Sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities and disclosures to be made in public issues

- Securities Contract (Regulation) Act, 1956 -

Provides for regulation of transactions in securities through control over stock exchanges

- Depositories Act, 1996 -

Provides for electronic maintenance and transfer of ownership of demat securities

Capital market intermediaries • Primary Market -

Merchant bankers, underwriters, portfolio managers, bankers, registrar, share transfer agent, rating agencies

• Secondary Market - Stock brokers, - Depository/Depository participant, - Custodian

Major changes in Stock Market • Trading system -

‘Public outcry’ – inefficient system, lack of transparency, OTCEI first exchange to introduce SBTS. Orders matched on price/time priority

• Depository • An entity which holds securities in electronic form on behalf of investor after dematerialisation • Dematerialisation – Process by which physical certificates are destroyed and an equivalent number of securities are credited to the account of the investor • Problems of physical certificates : physical storage and transfer of securities, risk of bad delivery, transaction costs higher. - NSDL first depository – set up in 1996

Major changes in Stock Market - Clearing mechanism -

National Securities Clearing Corporation (NSCC) set up, bears the counterparty risk in all trading deals

- Settlement system -

Earlier calendar system of settlement eg A group (14 days), Trading week not uniform leading to arbitrage- now dispensed with. Earlier there was T+5, T+3 SYSTEMS WHICH IS ALSO DISPENSEDWITH Rolling settlement introduced – T+2 settlement

- Carry forward system -

Banned carry forward transactions (badla/undha badla) Derivatives introduced

- Margin system • •

Lack of stringent margin requirements and laxity in collection led to chaos, whenever default Mark to market margin( DAY TO DAY MARKING)

Major changes in Stock Market (Contd.) • Capital adequacy -

Brokers operated on small capital base, introduced minimum capital norms

- Indices -

Important tool to measure price behaviour of overall market, used as benchmarks to monitor markets and judge performance Construction and maintenance of well designed and responsive indices Main criteria for inclusion of stocks – Market capitalisation, liquidity, floating stock

- Derivatives -

Futures and options introduced

Main indices - In the world -

Nasdaq 100 (USA), FTSE 100 (UK), Hang Seng (Hong Kong), Dow Jones (USA), Nikkei 225 (Japan)

- In India - Sensex -

30 stock large MC index

• S&P CNX Nifty -

50 stock large MC index

- S&P CNX Defty -

US $ denominated Index of S&P CNX Nifty

- S&P CNX Industy Indices -

In 73 industy sectors, each sector forms an index by itself

- CNX Nifty Junior •

50 stock index which comprise the next rung of large and liquid stocks after S&P CNX Nifty

• CNX Midcap 200 -

A midcap index of 200 stocks

- CNX PSE/MNC/IT/FMCG Index

Terms and terminology • • • • • • • • • • • • • • • • • •

Arbitrage Bad delivery Book Building Bid/Ask Blue Chip Bulls/bears/stag/wolf Cum dividend/cum bonus Day trader Ex dividend/ex bonus EPS Greenshoe option Insider trading IPO P/E multiple Put/call option Private placement Stop loss order Zero coupon bond

Events of importance • Sensex crossed its all time high (6697 on 4/1/2005) • Nifty at its all time high (2120 on 4/1/2005) • FII inflow crossed $ 8.5 bn during the year • IDBI closed at its all time high (for adjusted price) at Rs.124 on jan 2005

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