CHAPTER 2

Capital Market:
Primary Market
And

Secondary Market

By
Burla Nitin Niranjan
 CONTENTS
1. Primary Market
2. Secondary Market
3. SEBI
4. Accessing International Capital Market
INTRODUCTION TO CAPITAL MARKETS

 The capital market provides the resources needed

by medium and large-scale industries for
investment purposes
 Capital market deals in long-term sources of funds
(with more than 1 year maturity).
 CONTD….
 Thus, the capital market functions as an
institutional mechanism to channel long-term
funds from those who save, to those who need
them for productive purposes.
 It serves as a medium to bring together

entrepreneurs, initiating activity involving huge

financial resources and savers, individuals or
institutions, seeking outlets for investment.
 Structure of the Capital Market
 The capital market consists of the primary markets
and the secondary markets and there is a close link
between them.
 The primary market creates long-term instruments

through which corporate entities borrow from the

capital market.
 While secondary market is the one which provides

liquidity and marketability to these instruments.

 Primary Market
 Companies raises capital through issue of securities
(shares and debentures) in the primary market.
 Capital issues of the companies were controlled by
the Capital Issue Control Act, 1947.
 Pricing of the issues was determined by the
Controller of Capital Issues.
 The CCI Controls on Issue of Capital by the
companies have been substituted by the transparent
and simplified guidelines issued by the Securities
Exchange Board of India under the SEBI Act, 1992.
 Secondary Market
 The secondary market is that segment of the capital
market where the outstanding securities (securities
already issued) are traded.
 From the investors’ point of view the secondary
market imparts liquidity to the long-term securities
held by them by providing an auction market for
these securities.
 The secondary market operates through the medium
of stock exchanges which regulates the trading
activities in this market and ensures a measure of
safety and fair dealing to the investors.
 Primary Markets Secondary Markets

When companies need financial The place where such securities

resources for its expansion, they are traded by these investors is
borrow money from investors known as the secondary market.
through issue of securities.

Equity shares is issued by the Equity shares are tradable

under writers and merchant through a private broker or a
bankers on behalf of the brokerage house.
company.
 Primary Markets Secondary Markets

People who apply for these Securities that are traded are
securities are: traded by the retail investors.
a) High net worth individual
b) Retail investors
c) Employees
d) Financial Institutions
e) Mutual Fund Houses
f) Banks

One time activity by the Helps in mobilizing the funds

company. for the investors in the short
run.
 Primary Market
 Types of Instruments
 Types of Issues
 Steps in Public Issue
 Role of various agencies in public
 Concept of Book Building
 TYPES OF INSTRUMENTS
 Debentures
 Preference Shares
 Equity Shares
 Types of Capital
Long Term Capital

Share Capital Borrowed Funds

Equity Preference Debenture Capital

Redeemable Cumulative Convertible

or or or
Non-redeemable Non-cumulative Non-convertible

Partly Convertible Non-convertible Fully Convertible

 Types of Debentures
 Non Convertible Debentures (NCDs)

 Fully Convertible Debentures (FCDs)

 Partly Convertible Debentures (PCDs)

 Secured Premium Notes (SPNs)

Non Convertible Debentures (NCDs)
 These debentures cannot be converted into
equity shares and will be redeemed at the
end of the maturity period.
Fully Convertible Debentures (FCDs)
 These debentures will be converted into
equity shares after a specified period of time at
one stroke or in installments.

 These debentures may or may not carry

interest till the date of conversion.
 Partly Convertible Debentures
(PCDs)
 These are debentures, a portion of which will
be converted into equity share capital after a
specified period, whereas the non-convertible
(NCD) portion of the PCD will be redeemed as
per the terms of the issue after the maturity
period.
 Partly Convertible Debentures
(PCDs)
 The non-convertible portion of the PCDwill carry
interest right up to redemption whereas the
interest on the convertible portion will be only up
to the date immediately preceding the date of
conversion.
 Secured Premium Notes (SPNs)
 This is a kind of NCD with an attached warrant
that has recently started appearing in the Indian
Capital Market.
 This was first introduced by TISCO which issued
SPNs aggregating ` 346.50 Crores to existing
shareholders on a rights basis.
 Each SPN is of `.300 face value.
 Secured Premium Notes (SPNs)
 No interest will accrue on the instrument during
the first 3 years after allotment.
 Subsequently the SPN will be repaid in 4 equal
installments of `.75 each from the end of the
fourth year together with an equal amount of
`.75 with each installment.
 This additional `.75 can be considered either as
interest (regular income) or premium on
redemption (capital gain) based on the tax
planning of the investor.
 TYPES OF ISSUES
 Public issue
 Rights Issue
 Private placement
 Bought out Deals
 Public issue
 Public issue is the most popular method of raising
capital and involves raising of funds direct from
the public.
 The most common method of public issue is
through PROSPECTUS.
 Sections 55 – 68A of Companies Act deal with
issue of Prospectus.
 Prospectus set out the prospects of the company
and the purpose for which Capital is required.
 Prospectus
 Sec 2 (36) defines, It is any document described or
issued as prospectus and includes any notice,
circular, advertisement or other document inviting
deposits from the public or inviting offers from the
public for the subscription of purchase of any
shares in or debentures of a body corporate.
 A document is not a prospectus unless it is an
invitation to the public to subscribe for shares in or
debentures of company
 Prospectus
 An invitation to public can only be made by public
limited company.
 PROSPECTUS 1

 PROSPECTUS 2
 Shelf Prospectus
 The Working Group on Companies Act has
recommended the adoption of shelf prospectus
with a validity of 365 days subject to updates on
material facts, material litigation and changes in
financial position between the previous offering
and the next one.
 The facility would be limited to public sector banks
and financial institutions and those companies
specializing in infrastructure finance.
 Underwriting
 Underwriting agreement is a contract between an
underwriter who is usually a merchant banker or FI
and the Company issuing Capital.
 The underwriter agrees to subscribe or procure
subscription to a portion of the capital to be issued
in case the issue is not fully subscribed.
 In case of Public issue – Underwriting assistance
 In case of Right issue – Stand-by assistance.
 The maximum liability of underwriter is restricted to
the amount underwritten by him.
 Rights Issue
 Rights issue is the method of raising additional
finance from existing members by offering
securities (shares and debentures) to them on pro
rata basis.
 A company proposing to issue securities on rights
basis should send a ‘letter of offer’ to the
shareholders giving adequate disclosure as to how
the additional amount received by the issue is used
by the company.
 Rights Issue
 Sec 81 of Companies Act, provides that where a
company increases its subscribed capital by issue
of new shares, either after two years of its
formation or after one year of first issue of shares,
whichever is earlier, these have to be offered to the
existing shareholders with a right to renounce
them in favour of nominee.
 Bonus Issue
 Some companies distribute profits to existing
shareholders by way of fully paid bonus shares in
lieu of dividend.
 Bonus shares are issued in the ratio of existing
shares held.
 The shareholders do not have to make any
additional payment for these shares.
 Recent Bonus Issues:
◦ Reliance Power
◦ Dabur
 Private Placement
 It is the direct sale by a public limited company or
private limited company, of private as well as
public sector, of its securities (shares and
debentures) to a limited number of sophisticated
investors like UTI, LIC, GIC, State Finance
Corporations and Pension and Insurance Funds.
 The intermediaries are credit rating agencies and
trustees (example, ICICI) and financial advisors
such as merchant bankers.
 Private Placement
 Public limited companies too small to finance
public issue, as it is costly due to various statutory
and non-statutory expenses, can resort to this
type of market.
 The maximum time-frame required for private
placement market is only 2 to 3 months.
 Private Placement can be made out of promoter’s
quota
 Bought out Deals
 A small project costing around ` 5-6 crores of
rupees finds it costly to go in for a public issue
which would eat up 20% of project funds. Bought-
out Deals come to the rescue of the promoters of
such a project.
 A company initially places its equity shares, which
are to be offered to the public at a later date, to a
sponsor/merchant banker, who in turn offloads the
shares at the appropriate time.
 Bought out Deals
 In a BOD, the sponsor is also an intermediate
investor who buys stakes in the company and
disinvests in favor of the public at an appropriate
time.
 In a BOD, the shares are generally offloaded
through the mechanism of the Over the Counter
Exchange of India (OTCEI) or a recognized stock
exchange.
 Bought out Deals
 Generally, the sponsors prefer the OTCEI route
because of the following reasons:
◦ OTCEI mechanism ensures a total fair play because the
bought-out agreement between the sponsor and the
company has to be registered with the OTCEI.

◦ The promoters’ post-issue holding will be at least 25

percent, with a 5-year lock-in period.

◦ The sponsor agrees to act as a market maker for the

company’s shares for 18 months and also identifies an
additional market maker for such compulsory market
making.
Bought out Deals
 Bought out Deals
 Advantages
◦ Promoters are assured of immediate funds.

◦ Companies can avoid the time-consuming and costly public

issue.

◦ Easier to convince a wholesale investor rather than the general

public about the merits of a project.

◦ Cheapest and quickest source of finance for small to medium-

sized companies

 Disadvantage
◦ Misuse of power by the sponsor.
 Types of Public Issues
ISSUE TYPE Fixed Price Issues Book Building Issues
OFFER PRICE Price at which the securities A 20 % price band is offered
are offered and would be by the issuer within which
allotted is made known in investors are allowed to bid
advance to the investors and the final price is
determined by the issuer only
after closure of the bidding.
DEMAND Demand for the securities Demand for the securities
offered is known only after the offered , and at various prices,
closure of the issue is available on a real time
basis on the BSE website
during the bidding period..
 Types of Public Issues
ISSUE TYPE Fixed Price Issues Book Building Issues
PAYMENT 100 % advance payment is 10 % advance payment is
required to be made by the required to be made by the
investors at the time of QIBs along with the application,
application. while other categories of
investors have to pay 100 %
advance along with the
application.

RESERVATIONS 50 % of the shares offered 50 % of shares offered are

are reserved for reserved for QIBS, 35 % for
applications below Rs. 1 small investors and the balance
lakh and the balance for for all other investors.
higher amount applications.
 Concept of Book Building
 Book Building is essentially a process used by
companies raising capital through Public
Offerings-both Initial Public Offers (IPOs) or
Follow-on Public Offers ( FPOs) to aid price and
demand discovery.
 The process is directed towards both the
institutional as well as the retail investors.
 Concept of Book Building
 It is a mechanism where, during the period for
which the book for the offer is open, the bids are
collected from investors at various prices, which
are within the price band specified by the issuer.
 The issue price is determined after the bid
closure based on the demand generated in the
process.
 The Process
 The Issuer who is planning an offer nominates lead
merchant banker(s) as 'book runners'.
 The Issuer specifies the number of securities to be

issued and the price band for the bids.

 The Issuer also appoints syndicate members with

whom orders are to be placed by the investors.

 The syndicate members input the orders into an

'electronic book'. This process is called 'bidding'

and is similar to open auction.
 The Process
 The book normally remains open for a period of 5
days.
 Bids have to be entered within the specified price

band.
 Bids can be revised by the bidders before the book

closes.
 On the close of the book building period, the book

runners evaluate the bids on the basis of the

demand at various price levels.
 The Process
 The book runners and the Issuer decide the final
price at which the securities shall be issued.
 Generally, the number of shares are fixed, the

issue size gets frozen based on the final price per

share.
 Allocation of securities is made to the successful

bidders. The rest get refund orders.

 Glossary
 Bid: A bid is the demand for a security on behalf of
an investor that is entered by the syndicate/sub-
syndicate members in the system. The two main
components of a bid are the price and the quantity. 
 Bidder: The person who has placed a bid in the
Book Building process. 
 Order Book: It is an 'electronic book' that shows
the demand for the shares of the company at various
prices on a real time basis.
 Glossary
 Book Running Lead Manager: The lead merchant
bankers appointed by the Issuer Company are referred to
as the Book Running Lead Managers. The names of the
Book Running Lead Managers are mentioned in the offer
document of the Issuer Company. 

 Floor Price: The minimum offer price below which

bids can not be entered. The Issuer Company in
consultation with the Book Running Lead Managers fixes
the floor price. 
 Glossary
 Merchant Banker: An entity registered under
the Securities and Exchange Board of India
(Merchant Bankers) Regulations, 1999. 
 Syndicate Members: The Book Running Lead
Managers to the issue appoint the Syndicate
Members, who enter the bids of investors in the
book building system. Syndicate Members are
intermediaries registered with SEBI who also carry
on the activity of underwriting. 
Secondary Market
 Constituents of Secondary Market
 Stock Exchanges
 Trading on stock exchanges
 Role of Clearing House
 Introduction to E-Trading
 Introduction to Derivatives on stock exchanges
 BSE Sensitive Index and Nifty.
Constituents of Secondary Market
 SEBI
 Stock Exchanges
 Stock Brokers
 NSDL / CSDL
 Depository Participants
 Stock Exchanges
 Stock Exchanges are an organised marketplace,
either corporation or mutual organisation, where
members of the organisation gather to trade
company stocks and other securities.
 The members may act either as agents for their
customers, or as principals for their own accounts.
 Stock Exchanges
 Stock exchanges also facilitate for the issue and
redemption of securities and other financial
instruments including the payment of income and
dividends.
 The record keeping is central but trade is linked to
such physical place because modern markets are
computerised.
 The trade on an exchange is only by members and
stock broker do have a seat on the exchange. 
History of Stock Exchanges In India
 In 1860, the exchange flourished with 60 brokers.
In fact the 'Share Mania' in India began when the
American Civil War broke and the cotton supply
from the US to Europe stopped. Further the brokers
increased to 250.
 At the end of the war in 1874, the market found a
place in a street (now called Dalal Street).
 In 1887, "Native Share and Stock Brokers' Association"
was established.
 In 1895, the exchange acquired a premise in the street
which was inaugurated in 1899.
 List of Stock Exchanges
Sr. No. Name of the Stock Exchange
1 OTC Exchange of India (OTCEI)
2 The Uttar Pradesh Stock Exchange Association Ltd.
3 Jaipur Stock Exchange Ltd.
4 Madras Stock Exchange Ltd.
5 Cochin Stock Exchange Ltd.
6 Bangalore Stock Exchange Ltd.
7 National Stock Exchange of India Ltd. (NSE)
8 Gauhati Stock Exchange Ltd.
9 The Ludhiana Stock Exchange Ltd.
10 The Calcutta Stock Exchange Association Ltd.
 List of Stock Exchanges
Sr. No. Name of the Stock Exchange
11 Bhubaneshwar Stock Exchange Ltd.
12 The Delhi Stock Exchange Ltd.
13 Vadodara Stock Exchange Ltd.
14 Ahmedabad Stock Exchange Ltd.
15 Madhya Pradesh Stock Exchange Ltd.
16 Pune Stock Exchange Ltd.
17 Bombay Stock Exchange Ltd. (BSE)
18 Inter connected Stock Exchange of India Ltd.
19 MCX Stock Exchange Ltd
20 Coimbatore Stock Exchange
21  United Stock Exchange (USE)
 List of Stock Exchanges
Sr. No. Name of the Stock Exchange
1 Hyderabad Stock Exchange
2 Magadh Stock Exchange
3 Saurashtra Kutch Stock Exchange (SKSE)
4 Mangalore Stock Exchange
 Recognition of Stock Exchanges
1. Application
2. Conditions
3. Terms
4. Withdrawal
5. Periodical Returns
6. Inquiries
7. Annual Reports
8. Make / Amend Rules
9. Bye-Laws
10. Powers of SEBI
 Stock Brokers
 A stockbroker is a member of a recognized stock
exchange who buys, sells or deal in securities.
 A certificate of registration from SEBI is mandatory
to act as broker.
 As a member of stock exchange, the stockbroker
will have to abide by its rules, regulations and bye-
laws, etc.
 Stock Brokers
 Registration:
◦ Apply through Stock Exchange.

 Fees:
◦ Registration fee to SEBI based on annual turnover.
◦ Upto ` 1 crore: ` 5000 fees
◦ Excess ` 1 crore: ` 5000 + 0.001 % of T/O above ` 1 Cr.

 Minimum Base Capital

◦ ` 2 lakh - ` 5 Lakh deposit with Stock Exchange
 Sub-Brokers
 A sub-broker acts on behalf of a stockbroker as an
agent or otherwise assisting investors buying,
selling or dealing in securities through such
broker, but he is not a member of a stock
exchange.
 A certificate of registration from SEBI is mandatory
to act as sub-broker.
 Sub-Brokers
 Registration:
◦ Apply through Stock Exchange.
◦ Submit application along with (1) Recommendation from
Stock broker & (2) Two references, including one from his
banker.

 Fees:
◦ Annual fee ` 1000 for initial 5 years
◦ After 5 years, annual fee of ` 500
Depository
SEBI
 Role of SEBI in capital market
Accessing international capital market
 Various instruments in the market
 Introduction to NASDAQ and leading stock

exchanges.