Fundamentals of Capital Market

1. Concept of Primary Market

The primary market is the segment of the capital market where new securities (shares, debentures, bonds) are issued for
the first time by companies or governments. Funds raised in the primary market go directly to the issuer, helping them
meet long-term capital requirements such as expansion, diversification, modernization, or repayment of debt.

2. Importance of Primary Market

▪ Capital Formation: Helps companies raise fresh capital for growth and development.
▪ Economic Development: Promotes industrial growth and employment generation.
▪ Mobilization of Savings: Channels household savings into productive investments.
▪ Liquidity Creation: Securities issued can later be traded in the secondary market.
▪ Investor Opportunity: Allows investors to invest directly in new companies and projects.
3. Types of Issues in the Primary Market
a) Initial Public Offering (IPO)
An IPO is the first time a private company offers its shares to the public and gets listed on a stock exchange.
▪ Helps companies raise large funds
▪ Increases transparency and public ownership
b) Follow-on Public Offering (FPO)
An FPO is when an already listed company issues additional shares to the public.
▪ Used for expansion or debt reduction
▪ Dilutes existing shareholding but increases capital base
c) Rights Issue
A Rights Issue is an offer of new shares to existing shareholders in proportion to their current holdings, usually at a
discounted price.
▪ Protects ownership rights of existing shareholders
▪ Cost-effective method of raising capital
d) Private Placement
Private Placement involves selling securities to a selected group of investors such as financial institutions, banks, or
mutual funds instead of the general public.
▪ Faster and less expensive than public issues
▪ Suitable for companies needing quick funds
 Types of Capital in a Company

In company finance, capital refers to the funds raised by a company through the issue of shares. Based on different
stages of issue and payment, capital is classified into the following types:

Summary Flow
Authorised → Issued → Subscribed → Called-up → Paid-up

1. Authorised Capital (Registered Capital)

Authorised capital is the maximum amount of share capital that a company is allowed to raise as per its

Memorandum of Association.
▪ It sets the legal limit for capital issuance
▪ A company cannot issue shares beyond this limit without altering its memorandum
▪ Example: If authorised capital is ₹10 crore, the company cannot issue shares beyond this amount

Importance:
It defines the company’s capital structure and growth capacity.
2. Issued Capital
Issued capital is the portion of authorised capital that is actually offered to the public for subscription.
▪ May be less than or equal to authorised capital
▪ Represents the shares the company intends to raise funds through
Example:
Authorised capital ₹10 crore, issued capital ₹6 crore

3. Subscribed Capital
Subscribed capital is the part of issued capital that is taken up by investors.
▪ Shows investors’ response to the share issue
▪ If an issue is fully subscribed, subscribed capital equals issued capital
Example:
Issued capital ₹6 crore, subscribed capital ₹5.5 crore
4. Called-up Capital
Called-up capital is the portion of subscribed capital that the company has called upon shareholders to pay.
▪ Shares are often paid in installments (application, allotment, calls)
▪ Company may not demand full payment immediately
Example:
Subscribed capital ₹5.5 crore, called-up capital ₹4 crore

5. Paid-up Capital
Paid-up capital is the part of called-up capital that has been actually paid by shareholders.
▪ Represents the real funds available with the company
▪ Paid-up capital is shown on the liabilities side of the balance sheet
Example:
Called-up capital ₹4 crore, paid-up capital ₹3.9 crore (₹0.1 crore unpaid)
 Difference between Bonus Shares and Rights Shares
(Based on Companies Act, 2013 – India)
1. Meaning
▪ Bonus Shares are shares issued free of cost to existing shareholders out of the company’s accumulated profits or
reserves.
▪ Rights Shares are shares offered to existing shareholders at a specified price (usually below market price) in
proportion to their existing holdings.

2. Legal Provision (Companies Act, 2013)

▪ Bonus Shares: Section 63 of the Companies Act, 2013
▪ Rights Shares: Section 62(1)(a) of the Companies Act, 2013

3. Source of Issue
▪ Bonus Shares: Issued out of
o Free reserves
o Securities premium
o Capital redemption reserve
▪ Rights Shares: Issued by raising fresh capital from shareholders
4. Payment Requirement
▪ Bonus Shares:
o Issued fully paid-up
o No cash payment required from shareholders
▪ Rights Shares:
o Shareholders must pay the issue price
o Payment may be in installments

5. Objective
▪ Bonus Shares:
o Capitalisation of profits
o Reward existing shareholders
o Improve liquidity of shares
▪ Rights Shares:
o Raise additional funds
o Finance expansion, diversification, or debt repayment

6. Effect on Company’s Financial Position

▪ Bonus Shares:
o No change in total shareholders’ funds
o Only reserves are converted into share capital
▪ Rights Shares:
o Increase in share capital and cash resources
o Improves liquidity position of the company
7. Pricing of Shares
▪ Bonus Shares: Issued free of cost
▪ Rights Shares: Issued at a concessional price

8. Accounting Treatment
▪ Bonus Shares:
o Transfer from reserves to share capital
o No cash inflow
▪ Rights Shares:
o Cash inflow recorded
o Increase in share capital on allotment
 Difference between Memorandum of Association (MOA) and Articles of Association (AOA)
The Memorandum of Association (MOA) and Articles of Association (AOA) are the two most important legal documents
of a company under the Companies Act, 2013. While MOA defines the scope and limits of a company’s activities, AOA
lays down the rules and regulations for internal management.

1. Meaning
▪ MOA: The MOA is the charter of the company. It defines the company’s objectives, powers, and relationship with the
outside world.
▪ AOA: The AOA contains the internal rules and regulations governing the management of the company and the
relationship between the company and its members.

2. Purpose
▪ MOA: Determines the field of operations beyond which the company cannot act.
▪ AOA: Regulates the day-to-day administration of the company.

3. Legal Status
▪ MOA: Supreme document of the company; all activities must be in conformity with it.
▪ AOA: Subordinate to the MOA and must not contradict it.
 4. Contents
MOA includes:
▪ Name Clause
▪ Registered Office Clause
▪ Object Clause
▪ Liability Clause
▪ Capital Clause
▪ Subscription Clause
AOA includes:
▪ Details regarding the share capital
▪ Voting rights
▪ Appointment and powers of directors
▪ Meetings and proceedings
▪ Dividends and reserves
▪ Accounts and audit

5. Relationship with Outsiders

▪ MOA: Regulates the company’s relationship with outsiders.
▪ AOA: Regulates the relationship between the company and its members.

6. Scope
▪ MOA: Defines the maximum scope of the company’s activities.
▪ AOA: Defines the procedures within that scope.
7. Alteration
▪ MOA: Alteration is difficult and requires special procedures, approvals, and in some cases, government consent.
▪ AOA: Can be altered more easily by passing a special resolution.

8. Mandatory Nature
▪ MOA: Mandatory for all companies.
▪ AOA: Mandatory for private companies; optional for public companies.

9. Doctrine of Ultra Vires

▪ MOA: Acts beyond MOA are ultra vires and void.
▪ AOA: Acts beyond AOA can be ratified if they are within MOA and law.
 Book-building process and price discovery

1. Meaning of Book-Building
The book-building process is a market-driven mechanism used to determine the issue price of securities (mainly
shares) during an Initial Public Offering (IPO).

Instead of fixing the price in advance, the issuing company collects bids from investors at different prices within a
specified range and builds a “book” of demand.

The final price is discovered based on investor demand.

▪ Introduced in India in 1999, book-building is regulated by SEBI and is now the most common IPO pricing method.

2. Objectives of Book-Building
▪ To ensure fair price discovery
▪ To reflect true market demand
▪ To reduce underpricing or over-pricing
▪ To encourage participation from institutional investors
▪ To improve transparency and efficiency in IPOs
3. Participants in the Book-Building Process

Participant Role
Issuing Company Offers shares to the public
Merchant Banker / Book Runner Manages the IPO and bidding
Institutional Investors (QIBs) Provide informed price signals
Retail Investors Participate at cut-off price
Stock Exchanges Electronic bidding platform
SEBI Regulatory oversight
 4. Steps in the Book-Building Process
Step 1: Appointment of Book Runner
The issuing company appoints one or more merchant bankers (called Book Running Lead Managers – BRLMs).
Step 2: Filing of Draft Red Herring Prospectus (DRHP)
▪ Contains company details, risks, financials
▪ Does not mention the final issue price
▪ Filed with SEBI
Step 3: Price Band Announcement
The company announces a price band, for example:
₹90 – ₹100 per share
▪ Floor Price: Minimum bid price
▪ Cap Price: Maximum bid price
SEBI rule: Cap price ≤ 20% of floor price
Step 4: Opening of Issue and Bidding
▪ IPO opens for 3–5 working days
▪ Investors submit bids specifying:
o Number of shares
o Price (within band)
Step 5: Building the Order Book
All bids are recorded electronically, showing:
▪ Quantity demanded
▪ At various price levels
This demand schedule is called the order book.
Step 6: Price Discovery
The issue price is determined based on:
▪ Maximum shares sold
▪ Highest demand
▪ Market conditions
The final price is called the Cut-off Price.
Step 7: Allotment of Shares
Shares are allotted according to SEBI norms:
▪ QIBs – 50%
▪ Non-Institutional Investors – 15%
▪ Retail Investors – 35%
▪ Oversubscription → Proportionate allotment
Step 8: Listing on Stock Exchange
▪ Shares are listed on NSE/BSE and start trading in the secondary market.
 Meaning of Price Discovery
Price discovery is the process of determining the fair value of a security through interaction of demand and supply.
In book-building:
▪ Investors reveal their willingness to pay
▪ Institutional investors play a key role
▪ The final price reflects market consensus

Example of Price Discovery during IPO and FPO

Bid Price (₹) Shares Demanded
100 3 lakh
98 6 lakh
95 10 lakh
90 15 lakh

If the company wants to issue 10 lakh shares, the cut-off price = ₹95
Price Discovery in the Secondary Market (Daily Trading)
In the secondary market, price discovery happens continuously during trading hours.

Example:
Suppose shares of ABC Ltd. are trading in the market.
▪ Buyers place orders at: ₹98, ₹99, ₹100
▪ Sellers place orders at: ₹100, ₹101, ₹102

The highest buying price (₹100) matches the lowest selling price (₹100).
▪ Market price is discovered at ₹100 per share.

If suddenly:
▪ ABC Ltd. announces higher-than-expected profits, more buyers enter
▪ Buyers are now ready to pay ₹105

❖ New price gets discovered at around ₹105, reflecting new information.

 DRHP, RHP, and Prospectus
DRHP (Draft Red Herring Prospectus)
▪ DRHP is a preliminary draft document filed by a company with SEBI before launching an IPO. It contains
detailed information about the company, its business, financials, risks, and management, but does not contain
the issue price or final issue size.
▪ Its main purpose is regulatory scrutiny and transparency.

RHP (Red Herring Prospectus)

▪ RHP is a revised offer document issued to the public after SEBI approval. It contains the price band and other
issue-related details, but not the final issue price.
▪ It is used during the book-building process, allowing investors to apply and bid for shares.

Prospectus (Final Prospectus)

▪ The Prospectus is the final and legally binding offer document filed after the IPO closes. It includes the final
issue price, number of shares allotted, and other confirmed details.
▪ It serves as the official legal record of the public issue.
1. Basic Meaning and Stage
Aspect DRHP RHP Prospectus (Final Prospectus)
Full Form Draft Red Herring Prospectus Red Herring Prospectus Prospectus
Nature Draft / preliminary document Revised offer document Final legal offer document
After SEBI approval, before issue After issue closing and price
Stage Before SEBI approval
opening discovery

2. Purpose
DRHP RHP Prospectus
Regulatory scrutiny by SEBI Invitation to public to bid Formal invitation to invest
Disclosure review Subscription and bidding Legal record of issue
3. Price-Related Information
Aspect DRHP RHP Prospectus
Face Value Mentioned Mentioned Mentioned
Price Band Not included Included Not applicable
Final Issue Price Not included Not included Included
Number of Shares Tentative Tentative Final

4. Use in Book-Building Process

Aspect DRHP RHP Prospectus
Used Before Book-Building Yes No No
Used During Book-Building No Yes No
Used After Book-Building No No Yes
5. Regulatory Filing
Aspect DRHP RHP Prospectus
Filed With SEBI Registrar of Companies (RoC) Registrar of Companies (RoC)
SEBI Observations Not incorporated Incorporated Fully incorporated
6. Legal Status and Liability
Aspect DRHP RHP Prospectus
Legal Validity to Raise Funds No Yes Yes
Legal Liability for Misstatement Low High Very High
Binding on Company No Yes Yes

7. Investor Perspective
Aspect DRHP RHP Prospectus
Investor Action Allowed Informational only Investors can bid Investors can verify final terms
Decision-Making Role Early evaluation Price and quantity decision Confirmation of investment

8. Capital Market Significance

▪ DRHP ensures regulatory transparency
▪ RHP enables price discovery through market demand
▪ Prospectus provides final legal certainty and protects investors
 Merchant Bankers in the Capital Market
Meaning
Merchant bankers are SEBI-registered financial intermediaries who manage, advise, and coordinate capital market
activities such as public issues, private placements, and mergers. They act as a link between companies and investors in
the primary market.

Role of Merchant Bankers

1. Issue Management (Primary Market)
This is their most important function.
▪ Advising companies on type of issue (IPO, FPO, rights issue, private placement)
▪ Determining issue size and pricing strategy
▪ Managing the book-building process
▪ Preparing and filing DRHP, RHP, and Prospectus
▪ Coordinating with:
▪ SEBI
▪ Stock exchanges
▪ Registrars
▪ Bankers to the issue
▪ Ensuring regulatory compliance
2. Advisory Services
▪ Corporate restructuring
▪ Capital structure planning
▪ Valuation of companies
▪ Financial feasibility analysis
3. Underwriting
▪ Agreeing to subscribe to unsold shares if the issue is not fully subscribed
▪ Reduces risk for issuing companies
▪ Enhances investor confidence
4. Marketing and Distribution
▪ Organising roadshows and investor meetings
▪ Preparing issue advertisements
▪ Promoting the issue to institutional and retail investors
5. Post-Issue Management
▪ Finalization of allotment
▪ Refund of excess application money
▪ Listing of securities on stock exchanges
▪ Addressing investor grievances
Regulatory Framework (India)
▪ Regulated by SEBI (Merchant Bankers) Regulations, 1992
▪ Must obtain SEBI registration
▪ Required to follow strict code of conduct
▪ Responsible for due diligence and disclosures

Importance in Capital Market

▪ Ensure efficient mobilization of capital
▪ Promote investor protection
▪ Improve market transparency
▪ Support fair price discovery

Examples (India)
▪ SBI Capital Markets
▪ ICICI Securities
▪ Axis Capital
▪ Kotak Mahindra Capital
▪ JM Financial
 1. Underwriting in the Capital Market
Meaning
Underwriting is an arrangement in which a financial intermediary (underwriter) guarantees to subscribe to the unsubscribed
portion of a public issue if investors do not fully subscribe to it.
Parties Involved
▪ Issuing company
▪ Underwriters (banks, financial institutions, merchant bankers)
▪ Investors
Types of Underwriting
▪ Firm underwriting – Underwriter commits to buy a fixed number of shares.
▪ Partial underwriting – Underwriter covers only a part of the issue.
▪ Joint underwriting – More than one underwriter shares risk.
Functions of Underwriting
▪ Ensures successful completion of public issues
▪ Reduces risk for issuing companies
▪ Increases investor confidence
▪ Stabilizes the primary market
Underwriting Commission
▪ Underwriters receive a commission for bearing the risk.
▪ Regulated by SEBI (limits apply).
 2. Brokerage in the Capital Market
Meaning
Brokerage is the fee or commission paid to brokers for mobilizing investors and facilitating subscriptions to securities in the
primary market.

Role of Brokers
▪ Act as intermediaries between company and investors
▪ Promote and distribute securities
▪ Assist investors in application and bidding process

Brokerage Commission
▪ Paid per application or per share
▪ Regulated by SEBI guidelines
▪ Encourages wider participation in public issues

Difference from Underwriting

▪ Brokers do not bear risk of unsubscribed shares
▪ Underwriters guarantee subscription
 3. Investor Protection in Primary Markets
Meaning
Investor protection refers to measures taken to safeguard the interests of investors when they invest in new securities issued in the
primary market.
Regulatory Framework for Investor Protection
Role of SEBI
▪ Regulates public issues and intermediaries
▪ Ensures full disclosure in offer documents
▪ Prevents fraudulent and unfair practices
Key Investor Protection Measures
1. Disclosure Requirements
Mandatory disclosure of:
▪ Business details
▪ Financial performance
▪ Risk factors
▪ Use of issue proceeds
2. Due Diligence by Merchant Bankers
▪ Merchant bankers certify correctness of information
▪ Liable for misstatements or omissions
3. ASBA (Application Supported by Blocked Amount)
▪ Investor’s funds remain in bank account until allotment
▪ Prevents misuse of investor money
4. Fair Allotment and Refund
▪ Transparent allotment procedure
▪ Timely refunds for unallotted shares
5. Grievance Redressal Mechanism
▪ Investors can approach:
▪ Company
▪ Registrar
▪ Stock exchanges
▪ SEBI (SCORES platform)
6. Importance of Investor Protection
▪ Builds trust in capital markets
▪ Encourages retail investor participation
▪ Promotes market stability and growth
▪ Reduces chances of scams and manipulation

Conclusion
Underwriting ensures that public issues are fully subscribed by guaranteeing the purchase of unsubscribed shares, while brokerage
facilitates distribution of securities by mobilizing investors. Investor protection in primary markets is ensured through SEBI
regulations, mandatory disclosures, due diligence by intermediaries, ASBA, and effective grievance redressal mechanisms.
 Difference between Ordinary Resolution and Special Resolution
(as per the Companies Act, 2013)

Under the Companies Act, 2013, decisions of shareholders in a general meeting are taken by passing resolutions. These
resolutions are mainly of two types: Ordinary Resolution and Special Resolution. They differ in terms of voting requirement,
importance, and legal use.

1. Ordinary Resolution
Meaning: An Ordinary Resolution is a resolution passed by a simple majority of the shareholders present and voting in a general
meeting.

Voting Requirement
▪ Votes in favour > votes against [Simple majority (>50%)]
▪ Example: If 100 votes are cast, at least 51 votes must be in favour.
Legal Provision
▪ Defined under Section 114(1) of the Companies Act, 2013.
Nature
▪ Used for routine and regular business of the company.
Examples of Ordinary Resolution
▪ Appointment of directors
▪ Appointment or removal of auditors
▪ Approval of financial statements
▪ Declaration of dividend
2. Special Resolution
Meaning: A Special Resolution is a resolution passed by a super-majority, i.e., at least 75% of the votes cast in favour.
Voting Requirement
▪ Votes in favour ≥ 75% of total votes cast
▪ Example: If 100 votes are cast, at least 75 votes must be in favour.
Legal Provision
▪ Defined under Section 114(2) of the Companies Act, 2013.
Additional Conditions
i. The intention to propose the resolution as a special resolution must be clearly stated in the notice of the meeting.
ii. Proper notice must be given to members.
Nature: Used for important and exceptional matters affecting the company’s structure or powers.
Examples of Special Resolution
▪ Alteration of Memorandum of Association (MOA)
▪ Alteration of Articles of Association (AOA)
▪ Change of company name
▪ Reduction of share capital
▪ Issue of shares at a discount
▪ Shifting of registered office from one state to another
3. Key Differences Between Ordinary and Special Resolution
Basis Ordinary Resolution Special Resolution
Majority required Simple majority (>50%) Special majority (≥75%)
Section of Act Section 114(1) Section 114(2)
Nature of business Routine / ordinary matters Important / special matters
Notice must specify it as special
Notice requirement Normal notice
resolution
Degree of approval Lower Higher
Legal impact Limited Significant

Conclusion
An Ordinary Resolution requires a simple majority and is used for day-to-day decisions, whereas a Special Resolution requires
at least 75% shareholder approval and is used for significant matters affecting the company’s constitution or powers under the
Companies Act, 2013.