Fundamentals of Stock Market
Overview of the Indian Securities Market
Indian securities market is an organized financial system through which securities like shares,
bonds, debentures, and derivatives are floated, traded, and regulated. It is a strong driving force
in the creation of capital by facilitating investors to come in touch with businesses and
government authorities requiring funds. The market can be broadly categorized into two
divisions: the primary market, from where new issues are floated (e.g., IPOs), and the
secondary market, where existing securities are traded between investors (e.g., stock exchanges
like NSE and BSE).
One of the distinguishing characteristics of the Indian security market is its strong regulatory
system, headed by the Securities and Exchange Board of India (SEBI). SEBI maintains
transparency, safeguards the interests of investors, and avoids fraudulent transactions by
imposing stringent disclosure requirements, monitoring insider trading, and overseeing
intermediaries like brokers and mutual funds. The market also has regulation through the
Depository System, in which institutions like NSDL and CDSL keep securities electronically,
avoiding risks related to physical share certificates.
The Indian capital market has undergone radical change with technological upgradation, such
as online trading, algorithmic trade, and real-time settlement systems. In spite of this, issues
like market volatility, illiquidity in small-cap stocks, and educating retail investors still exist.
In spite of all these, the market keeps expanding, fuelled by rising domestic participation, FIIs,
and government initiatives like the Insolvency and Bankruptcy Code (IBC), which has further
boosted investor sentiment. Overall, it is an indicator of India's economic health, reflecting
corporate performance trends, policy shifts, and global financial flows.
Primary Market – Definition
The Primary Market (also known as the New Issue Market) is a segment of the capital market
where new securities are issued and sold for the first time to investors by companies,
governments, or public sector institutions.
The primary market is the financial market by which governments, corporations, and other
organizations acquire funds by issuing new securities to investors. As opposed to the secondary
market (where securities are traded), the primary market trades only new issues, and therefore
it is an important source of capital formation in the economy.
If a firm requires cash for expansion, debt repayment, or new ventures, it can raise funds by
issuing shares, bonds, or other securities directly to investors via avenues like:
- Initial Public Offerings (IPOs) (e.g., when a private firm like Zomato becomes listed).
- Rights Issues (existing shareholders have the first right to purchase more shares).
- Private Placements (issues sold to specified institutional investors).
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The Securities and Exchange Board of India (SEBI) oversees the primary market to introduce
transparency, fair pricing (e.g., through the book-building mechanism), and investor protection.
Companies have to reveal financial information in a prospectus so that informed choices are
made by investors.
An efficient primary market contributes to economic development through allowing companies
to raise funds while giving investors early access to be part of company growth narrative. Risks
such as subscription risks (new issue underperformance) or regulatory delays can, however,
affect outcomes.
Book Building Process – Definition and Steps
Book building is an investor-focused and disciplined mechanism used by companies for fixing
the best price of securities in public issues. It is an open price discovery process in which the
issue price is fixed based on genuine demand from different classes of investors. In contrast
with fixed-price issues, the process enables companies to test the market mood and investor
demand before fixing the price. The process is especially relevant to IPOs and FPOs since it
enables companies to fix a fair market value of the securities while providing investors with
the choice of bidding at the desired price levels within a range. Based on real-time data of
demand, book building reduces the risk of pricing and increases the efficiency of primary
market mobilization of capital.
Steps in the Book Building Process
1. Finding the Price Range
The firm, assisted by its merchant bankers, sets a price band (say, ₹500–₹550 per share).
This spread allows room for bidders to offer at a price they believe is reasonable.
2. Bidding Phase
Institutional investors (including mutual funds and foreign institutional investors) and retail
investors bid either through brokers or internet trading websites.
The offer period is usually kept open for 3–5 days, during which investors are allowed to update
their offers.
3. Demand Analysis
The lead underwriter (book runner) aggregates all the bids and approximates demand at various
prices throughout the band.
A demand curve is graphed to determine the price level that produces the greatest subscription.
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4. Final Price Determination
The cut-off price (last issue price) is determined from the analysis of bids from investors.
For example, if the bids come predominantly at ₹540, the company can set this as the issue
price.
5. Allotment and Refunds
Successful bidders are assigned shares, and the retail investors are usually given preferential
treatment.
The excess paid by the investor (if any) is refunded. Suppose an investor pays ₹550 but the cut-
off is ₹540, then the excess of ₹10 is refunded.
Practical Example In 2021, the Zomato IPO followed the book building path with a price band
of ₹72–₹76. Because of the huge demand, the issue price was finally set at the higher end of
the band (₹76).
Intermediaries for the Primary Market
The main system of markets comprises a number of important intermediaries that facilitate the
issuance and dispensation of new securities with ease. Each of them plays a unique role of
ensuring regulatory compliance, investor protection, and effective capital-raising.
1. Issuer Company
The issuer firm is the firm attempting to raise capital by offering new securities. Being the
primary beneficiary, it is required to comply with SEBI regulations, make proper disclosure
documents (such as the prospectus), and aid other intermediaries involved in the issue process.
The financial condition, future prospects, and corporate governance of the firm significantly
affect the faith of the investors in the issue.
2. Book Running Lead Manager (BRLM)
BRLMs are merchant banks which are the prime coordinators of public issues. They undertake
important roles such as:
- Identification of the right price range and issue size
- Document preparation of the offer and coordination with regulators
- Promoting the cause to prospective investors
- Overseeing the book building process and final allotment
- Adherence to all requirements by the law
3. Underwriters
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Underwriters offer a cushion to the issuer by agreeing to buy any excess shares in the event of
under-subscription. They:
- Evaluate the risk and feasibility of the issue
- Offer to buy a certain percentage of the shares if needed
- Charge an underwriter's fee for this risk coverage
Their involvement increases investor confidence in the success of the issue.
4. Registrars
Registrars deal with the technical and administrative side of the problem:
- Process application forms and keep records
- Regulate the process of allotment
- Handle refunds for unsuccessful candidates
- Dematerialize share allotments through a process
- Keep records of post-issue investors
5. Bankers to the Issue
These are the banks that are appointed to handle the finances:
- Collect application funds from investors
- Process refunds for unallotted shares
- Hold escrow accounts to keep issue proceeds
- Coordinate other flows of funds with intermediaries
6. Stock Exchanges
Approved stock exchanges offer the platform for:
- Issuance and trading of newly issued securities
- Supervision of compliance with listing rules
- Enabling price discovery at listing
- Facilitating transparency in the issuance process
Summary: Interdependence and Workflow
These intermediaries act in a collaborative fashion:
1) The issuer appoints BRLMs who build the team
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2) Underwriters evaluate and manage risk
3) Registrars and bankers manage logistics
4) Stock exchanges offer the listing platform
5) The whole process is regulated by SEBI for compliance
Functions of the Primary Market
The primary market is the backbone of the capital markets since it enables firms and
governments to raise fresh funds directly from the investors. It contributes to the performance
of a series of essential roles that benefit economic growth, financial inclusion, and efficient
capital allocation.
1. Capital Formation
The primary market aids capital formation by making finance available to firms to issue new
capital in the long term. Firms utilize funds for expansion, modernization, repaying debt, or
new ventures. The process converts savings into productive investment, driving economic
growth.
2. Mobilization of Savings
Through the provision of investment opportunities, the primary market directs household and
institutional savings into financial instruments such as stocks and bonds. This serves to
transform dormant savings into capital that can be utilized by companies to drive growth,
ensuring effective resource utilization within the economy.
3. Facilitates Initial Sale of Securities
The primary market is a formal market for the first-time issue of securities (e.g., IPOs, FPOs,
bonds). It offers proper issue of new financial instruments to the public in an orderly and
transparent fashion, with adequate disclosures to safeguard investors.
4. Facilitates Industrial and Economic Growth
By giving companies access to finance, the fundamental market facilitates industrial growth,
infrastructural development, and innovation. Fundraising by startups and mature businesses
creates employment opportunities, technological innovation, and economic growth overall.
5. Facilitates Price Discovery for New Securities
Through processes such as book building, the primary market ensures the fair market price of
new securities is established. The price is determined by investor demand and supply
conditions to provide appropriate valuation to issuers while investors pay a price determined
by the market.
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6. Encourages Broadening of Ownership Base
The primary market opens up investment opportunities to the general public by allowing retail
and institutional investors to purchase new issues. This enhances shareholder base, weakens
promoter control, and enhances corporate accountability.
7. Regulates Fundraising through Disclosure Norms:
SEBI sets stringent disclosure and transparency requirements for money-raising companies.
Prospectuses, financials, and risk factors must be disclosed, allowing investors to make
informed decisions. Such a rule reduces fraud and promotes market trust.
Methods of Floatation of Capital
1. Public Issue (through IPO):
A Public Issue is the most popular means of raising funds by companies to expand their size or
to achieve other financial objectives. Under this process, shares are floated on the market to
the general public by means of an Initial Public Offering (IPO). This implies that any investor—
retail, institutional, or high net-worth—can tender for the shares of the firm. The firm must
obtain prior approval of SEBI before issuing and make detailed disclosures regarding its
finance, business operations, and future plans through offerings such as the Draft Red Herring
Prospectus (DRHP). After the successful conduct of the IPO, the shares are listed on recognized
stock exchanges such as NSE or BSE, where they can be freely bought and sold. This process
enables companies to raise enormous funds but at the expense of heavy regulation compliance
and expense.
2. Rights Issue:
A Rights Issue is an invitation extended by a company to its current shareholders to buy more
shares in proportion to their current holding. These shares are offered at a price less than the
market price, which is a benefit to shareholders. The purpose is to raise funds with current
investors being offered preference and not watering down equity. It is an economical technique
since it does not involve listing and underwriting. However, shareholders are not obligated to
avail of this offer, and if they do not, the company can sell the unsubscribed portion to other
investors.
3. Private Placement:
Private Placement is when a company offers securities to a small group of investors, such as
institutional investors such as banks, mutual funds, insurance companies, or even individual
investors. It is a faster and more convenient process than a public issue with fewer regulatory
procedures and fees. It is not a public announcement and is adopted by companies that would
like to raise funds strategically or quietly. Easier though, private placements must follow SEBI
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guidelines, especially when it comes to pricing and disclosure obligations. This mode is ideally
suited for raising funds without diluting too much control or exposing oneself to market
volatility.
4. Preferential Allotment: Preferential Allotment is an exercise where shares are issued to a
targeted group of investors, usually promoters, strategic partners, or high-net-worth
individuals, at a predetermined price. This is approved by the company's shareholders in a
special resolution. It enables companies to increase their capital base, introduce strategic
partners, or raise emergency funds in haste. Although more discriminatory than a public issue,
SEBI has stringent restrictions to avoid abuse, such as lock-in periods and price norms. It is
extensively utilized in mergers, acquisitions, or when companies desire to introduce long-term
investors.
Challenges with regards to New Issue Market
1. Lack of Investor Awareness and Financial Literacy:
The greatest problem is on account of retails investors being largely unaware of how the
primary market operates. Most potential investors lack knowledge about the IPO systems, may
not know all of the risks involved, or may not know how to interpret offer documents like
prospectuses. Hence there is meagre participation, especially from the rural and semi-urban
fronts. Uninformed investors might shy away from the market or may even become a victim
of speculative or financially hazardous investments.
2. Mispricing of IPOs:
Most often, companies overpriced their IPOs, especially when market conditions are bullish.
This mispricing brings a phase of considerable post-listing under-performance, with shares
hitting below the issue price and losses on investors. Unfair pricing deters future participation
and questions the valuation mechanisms used, thereby signalling a lack of transparency or due-
diligence on the part of intermediaries, coupled with a wink-and-nod spirit of over-optimism
from promoters.
3. High Cost of Issuance:
It is an expensive exercise to raise capital in the primary markets. The companies must contend
with towering regulatory, legal, marketing, and underwriting charges. Costs for preparing the
detailed offer document, hiring merchant bankers to manage the complex biz, conducting
roadshows, and marketing soar sky-high. For the small and medium enterprises (SMEs), the
high expense can become a roadblock to market access.
4. Delay in Regulatory Approvals:
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Although so many processes have been streamlined by SEBI, delay in the granting of
regulatory approvals, and the completion of compliance formalities, still stands as an obstacle
to smooth entry of securities in the market. Longer documentation and approval cycle during
an issue procedure cause delay in promoting a company to securities exchange and thereby
missing opportunities, especially in volatile situations.
5. Under-subscription and Uncertainty of Demand:
There always lies the possibility of a high-risk factor of under-subscription. Under-subscription
is a big risk, especially if the market sentiment is low, or the company trying to raise capital
lacks a brand image. Under-subscription can lead to either cancellation of the issue or
downsizing of the issue and subsequent delay in funds for the company. It also leads to further
uncertainty of demand from a good investor base for the issue, which at the same time, weakens
the long-term commitment from investors to the company.
6. Role of Unethical Practices and Grey Market:
Unethical practices involving promoter manipulation, insider trading, and pre-listing trading in
the grey market hurt the transparency and credibility of the new issuances sector. On occasions,
investors get swayed by market rumours or false hype, influencing demand and pricing. Such
acts hamper the trust and open the door to regulatory interventions.
7. Limited Participation from Institutional Investors in Smaller Issues:
Big institutional investors, such as mutual funds, insurance companies, and pension funds,
generally like to participate in big, well-known IPOs. Smaller companies or SMEs find it
difficult to attract large investors, thus making the demand weak and leading to the loss of
credibility of their issue.
8. Post-listing Volatility:
Before and after a successful IPO, the company's shares appear prominently exposed to market
speculation, global trends, or just plain investor sentiment on the listing day. Post-listing
volatility tends to discourage relatively risk-averse investors to step in into the future IPOs.
SEBI Guidelines for IPO
SEBI, or the Securities and Exchange Board of India, is a regulatory authority that controls and
monitors all capital market activity in India. The measure of governance is provided by it to
companies wishing to raise capital by Initial Public Offering (IPO), and the objective is
maintaining transparency, safeguarding investor interests, and maintaining market integrity.
1. Eligibility Criteria for IPO
• The company must have net tangible assets of at least ₹3 crore in each of the preceding
3 years.
• It must have a net worth of ₹1 crore in each of the past 3 years.
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• The company must have minimum average pre-tax profits of ₹15 crore in at least three
out of the last five years.
• If the company does not meet these conditions, it may still go for an IPO through the
book-building route with Qualified Institutional Buyers (QIBs) holding at least 75% of
the issue.
2. Draft Red Herring Prospectus (DRHP)
• The company must file a Draft Red Herring Prospectus with SEBI through the lead
manager.
• The DRHP contains complete information about the company, its promoters, financial
statements, risks, and intended use of funds.
• SEBI reviews the DRHP and may ask for clarifications before approving it for public
circulation.
3. Minimum Promoter Contribution
• Promoters must contribute at least 20% of the post-issue capital.
• This contribution is locked in for a period of 3 years, ensuring promoter commitment
to the company after listing.
4. Pricing of the Issue
• SEBI allows companies to decide the price either through a fixed price method or book-
building method.
• In the book-building process, a price band is declared and bids are collected from
investors to determine the final price.
5. Reservation for Different Categories of Investors
SEBI mandates that shares in an IPO must be allocated in specific proportions to ensure fair
access for different classes of investors. The division is as follows:
• Qualified Institutional Buyers (QIBs) are allotted 50% of the issue. These include
mutual funds, insurance companies, pension funds, and foreign institutional investors.
Their participation adds credibility to the IPO.
• Non-Institutional Investors (NIIs), such as high-net-worth individuals (HNIs), get 15%
of the issue.
• Retail Individual Investors (RIIs) are allotted 35%. These are individuals investing up
to ₹2 lakh. This ensures retail participation and broader ownership.
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This structure helps balance the investor base, improves price discovery, and brings long-term
stability to the capital market.
6. Mandatory Listing
Once the IPO is completed, SEBI requires the company to list its shares on a recognized stock
exchange (such as NSE or BSE). As per the revised rules (as of 2023), the listing must happen
within T+3 working days, where T is the date of IPO closure. This faster listing reduces market
risk, enhances investor confidence, and provides early liquidity to shareholders.
7. Disclosure Requirements
Transparency is a core requirement in any IPO. SEBI requires the company to fully disclose
all material facts in the Draft Red Herring Prospectus (DRHP) and final prospectus. These
disclosures include:
• Business operations and strategy
• Financial performance for the last three years
• Legal proceedings and pending litigations
• Risk factors affecting the company
• Use of IPO proceeds
Any attempt to mislead investors through omissions or misstatements can lead to legal action,
rejection of the issue, or debarment from the market.
8. Use of Issue Proceeds
SEBI insists that the company clearly state the specific purpose for which the IPO funds will
be used. These may include:
• Expanding business operations or opening new plants
• Repaying existing debts or loans
• Funding working capital requirements
• General corporate purposes
The company cannot use the funds arbitrarily. For issues above ₹100 crore, SEBI requires the
appointment of a monitoring agency to ensure that the funds are used only for the stated
objectives.
9. Appointment of Intermediaries
To ensure a smooth and compliant IPO process, SEBI requires companies to appoint various
registered intermediaries, each with a distinct role:
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• Merchant Banker (Book Running Lead Manager - BRLM): Coordinates the IPO
process, drafts documents, and handles SEBI communications.
• Registrar to the Issue: Manages applications, share allotment, and refunds.
• Underwriters: Take the risk of subscribing to any portion of the IPO that remains
unsubscribed.
• Bankers to the Issue: Accept IPO application money.
• Depositories (NSDL/CDSL): Enable dematerialized allotment of shares to investors.
These intermediaries ensure investor protection and regulatory compliance throughout the IPO
process.
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