Composition of the Indian Capital Market,

Indian Economy | Money Market and Capital

Market structure in India | B Com
Indian Economy

Created by: Arshit Thakur

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B Com : Composition of the Indian Capital Market, Indian Economy

The document Composition of the Indian Capital Market, Indian Economy is a part of
the B Com Course Indian Economy.
The components are:
1. New Issue Market
2. Secondary Market
3. Financial Institutions.

Capital Market: Component # 1. New Issue Market:

The new issue market represents the primary market where new securities, i.e., shares or bonds that have never
been previously issued, are offered. Both the new companies and the existing ones can raise capital on the new
issue market.

The prime function of the new issue market is to facilitate the transfer of funds from the willing investors to the
entrepreneurs setting up new corporate enterprises or going in for expansion. Diversification, growth or
modernisation. Besides, helping corporate enterprises in securing their funds, the new issue market canalizes the
savings of individuals and others into investments.

The two facets of this market, i.e. supply and demand, are represented by the issuing companies and the investors
respectively. But then the organisation of the new issue market is not complete without the specialised agencies,
intermediaries and institutions, etc., which promote issues of new securities and help in selling, transferring,
underwriting etc.

These agencies include financial institutions, underwriters, brokers, merchant bankers, etc.

As the new issue market directs the flow of savings into long-term investments, it is of paramount importance
for the economic growth and industrial development of a country. The availability of financial resources for
corporate enterprises, to a great extent, depends upon the status of the new issue market of the country.

It must also be noted that although the functions and organisation of the new issue market are quite different
from that of the secondary (stock) market, the sentiment in the stock market influences the activity in the new
issue market.

The stock market is more sensitive and reacts fast to the changes in the economic, political and business
conditions of a country. But then this affects the new issue market also. The historical study of the activity in the
two markets show that whenever there has been boom in the stock market, there has been increased activity in
the new issue market also.

Capital Market Instruments:

Primary market is a market for raising long-term finance by the issue of new corporate securities.

The corporate securities that are dealt in primary market can be classified under two categories:

1. Ownership Securities or Capital Stock, and

2. Creditorship Securities or Debt Capital.

Capital Market: Component # 2. Secondary Market:

The secondary market is a market where existing securities are purchased and sold. Stock market represents the
secondary market where existing securities (shares and debentures) are traded; Stock exchange provides an
organised mechanism for purchase and sale of existing securities. By now, we have 23 stock approved stock
exchanges in our country.

The investors want liquidity for their investments. The securities which they hold should easily be sold when
they need cash. Similarly there are others who want to invest in new securities. There should be a place where
the securities may be purchased and sold.
Stock exchanges provide such a place where securities of different companies can be purchased and sold. Stock
exchange is a body of persons, whether incorporated or not, formed with a view to helping, regulating and
controlling the business of buying and selling of securities.

Stock exchanges are organised and regulated markets for various securities issued by corporate sector and other
institutions. The stock exchanges enable free purchase and sale of securities as commodity exchange allow
trading in commodities. The following definitions explain the meaning and scope of stock exchanges.

Definitions of Stock Exchange:

Pyle. “Security exchanges are market places where securities that have been listed thereon may be bought and
sold for either investment or speculation.”

Stock exchanges allow trading in securities both to the genuine investors and speculators.

Securities Contract (Regulation) Act, 1956. “Stock exchange means anybody of individuals, whether
incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying,
selling in securities.”

According to this definition, the stock exchange allows trading in securities under certain rules and regulations.

Hartely Withers “A Stock Exchange is something like a vast warehouse where securities are taken away from
the shelves and sold across the countries at a fixed price in a catalogue which is called the official list.”

Hartley calls stock exchange a warehouse where all securities are kept and traded on specified prices. It may not
always be that every type of security is purchased for sale; there may be investors who do not bring their
securities to the market but keep them only as investments.

Husband and Dockeray “Securities or stock exchanges are privately organised markets which are used to
facilitate trading in securities.” As per this definition the stock exchanges are the organised places where
securities are purchases and sold.

Capital Market: Component # 3. Financial Institutions:

Special Financial institutions are the most active constituent of the Indian capital market. Such organisations
provide medium and long-term loans on easy installments to big business houses Such institutions help in
promoting new companies; expansion and development of existing companies and meeting the financial
requirement of companies during economic depression.

The need for establishing financial institutions was felt in many countries immediately after the Second World
War in order to re-establish their war-shattered economies. In underdeveloped countries, the need for such
institutions was much more due to a large number of organisational and financial problems inherent in the
process of industrialisation.

After independence, a number of financial institutions have been set up at all India and regional levels for
accelerating the growth of industries by providing financial and other assistance.

The following are the main special institutions that are most active constituents of the Indian capital
market:

i. The Industrial Finance Corporation of India (I.F.C.I.)

ii. The Industrial Credit and Investment Corporation of India (I.C.I.C.I.)

iii. The Refinance Corporation of India (R.F.C.)

iv. State Financial Development Corporations (S.F.Cs.)

v. National Industrial Development Corporation (N.I.D.C.)

vi. State Industrial Development Corporation (S.I.D.Cs)

vii. National Small Industries Corporation (N.S.I.C )

viii. Industrial Development Bank of India (1.D.B.I.)

ix. Unit Trust of India (U.T.I.)

x. Life Insurance Corporation of India (L.I.C.)

xi. Nationalised Commercial Banks (N.C.Bs)

xii. Merchant Banking Institutions (M.B.Is.)

xiii. National Industrial Reconstruction Corporation of India (N.I.R.C.)

xiv. The Credit Guarantee Corporation of India (C.G.C.)

Financial Instruments Used in a

Capital Market | Financial
Management
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ADVERTISEMENTS:

Financial instruments mean documents that evidence the claims and

income or asset as “any contract that gives rise to both a
financial asset on one enterprise and a financial liability or
equity instrument of another enterprise”.
1. Securities:
‘Securities’ is a general term for a stock exchange investment.
Securities Contract (Regulation) Act, 1956 defines securities
as to include:
ADVERTISEMENTS:

1. Shares, Scripts, Stocks, Bonds, Debentures.

2. Government Securities.

3. Such other instruments as may be declared by the Central

government to be securities.

4. Rights or interests in securities and,

ADVERTISEMENTS:

5. Derivatives

6. Securitized instruments

Securities are generally classified into ownership securities and

creditorship securities. Equity shares and preference shares are
ownership securities. They are also known as capital stock.
Creditorship securities are bonds, debentures etc. They are referred to
as debt capital.

2. Equity Shares:
Equity Shares are the ordinary shares of a limited company. It is an
instrument, a contract, which guarantees a residual interest in the
assets of an enterprise after deducting all its liabilities- including
dividends on preference shares. Equity shares constitute the
ownership capital of a company. Equity holders are the legal owners of
a company.

ADVERTISEMENTS:

Equity shares are regarded as the cornerstones of the capital structure

of a company. They are the source of permanent capital which does
not have a maturity date. As the owners of equity shares, the equity
shareholders participate in the management of the company through
the elected board of directors, and through the voting rights in
important decisions. They share the profits and assets in proportion to
their holding in the net assets of the company.

Advantages of Equity Shares:

Following are the advantages of equity shares:
1. Permanent Capital:
ADVERTISEMENTS:

It provides permanent capital to the company. The capital need not be

repaid as long as the company is a going concern.

2. No Fixed Charge on Income:

Payment of dividend is a management policy. Company is not legally
bound to declare dividend even if there is sufficient earnings. Dividend
payment can be postponed. This adds flexibility.

3. Base for Further Borrowings:

ADVERTISEMENTS:

Lenders generally lend on the basis of paid up capital and reserve. This
is the net worth of the company. A higher net worth increases financial
capability.

4. Trading on Equity is Possible:

When borrowing becomes cheaper, company can borrow money and
invest. The whole earnings after the interest belongs to the
shareholders.

5. Voting Rights:
ADVERTISEMENTS:

As the owners of capital equity shareholders can express their opinion

on all important matters through their voting right.

Blue Chip Shares:

These are shares of Blue Chip Companies. Blue Chip Companies are
growth oriented companies showing signs of expansion,
diversification, modernization of technology etc. They have consistent
profitability and profit margins to sustain consistent dividend
distribution. Colgate, Hindustan Lever, L&T, Reliance etc. are some
examples of blue Ship companies. Thus, blue chips are common stock
in a company known nationally for the quality and wide acceptance of
its products or services.

Blue chips are of two types viz. emerging blue chip and established
blue chips. Emerging blue chip companies are those which are turn-
around companies and exhibit potentiality to grow and expand in sales
and in net profit. Established blue chips are those companies who are
leaders in the Industry like Reliance, Raymonds, TISCO etc.

ADVERTISEMENTS:

They have a strong capital base and net worth, organized and
professionalized management etc. There are uninterrupted dividends,
bonus issues, right issues for investors. Such companies’, shares are
worth holding for long and are recommended in all portfolios on
investors.

Equity Shares with Detachable Warrants:

Fully paid up shares can be issued with detachable warrants. This will
enable the warrant holder to apply for specified number of equity
shares at determined price. Detachable warrants are registered
separately with the stock exchange and traded separately.

Sweat Equity Shares:

These are equity shares issued by the company to employees or
directors at a discount or for consideration other than cash.

3. Preference Shares:
The Companies Act (Sec, 85), 1956 describes preference shares as
those which Carry a preferential right to payment of dividend during
the life time of the company and Carry a preferential right for
repayment of capital in the event of winding up of the company.

Preference shares have the features of equity capital and features of

fixed income like debentures. They are paid a fixed dividend before
any dividend is declared to the equity holders.

Features of Preference Shares

Following are the features of Preference Shares:
1. Priority to Dividend:
Preference share dividend is payable on a fixed rate. Usually the
dividend is a percentage of the par value of the share. It must be paid
before any equity dividend is paid.

2. Cumulative Nature:
Cumulative nature means that when dividends are not paid in a
particular year they will be accumulated in the coming years. No
dividend can be paid on equity shares until all arrears on preference
stock are paid up. However, there are non- cumulative preference
stock also. In this case, there is no guarantee that the unpaid dividend
will be paid in future even if the profitability of the concern improves.
Hence, the cumulative feature is necessary to project the right of
preference shareholders.

3. Non-Participatory:
This means that the holders of such shares are not entitled for a share
in the extra profit earned by the company. Their return will remain at
the agreed rate whatever be the profit level of the company. There are,
however, occasional issues of participating preferences shares also.

4. Preference as to Assets on Winding Up:

Preference shares are given preference in liquidation. Where the
company dissolved, the funds from the sale of the assets go first to the
various classes of creditors according to the seniority of their claims.
The preference shareholders get the next priority.

5. Convertibility:
Convertible preferences shareholders are allowed to convert their
preferential holdings, fully or partly into equity shares at a specified
conversion rate during a given period of time. This right of conversion
is exercised by preference shareholders mostly to participate in the
excess earnings of the company or to gain ownership control.

6. Non-Voting:
Preference shareholders have no voting right on ordinary matters of
corporate policy.

Types of Preference Shares:

1. Redeemable Preference Shares:
These shares are redeemed after a given period.

Such shares can be repaid by the company on certain

conditions, viz.;
a. The shares must be fully paid up.

b. It must be redeemed either out of profit or out of reserve fund for

the purpose.

c. The premium must be paid if any.

A company may opt for redeemable preference shares to avoid fixed

liability of payment, increase the earnings of equity shares, to make
the capital structure simple or such other reasons.

2. Irredeemable Preference Shares:

These shares are not redeemable except on the liquidation of the
company.

3. Convertible Preference Shares:

Such shares can be converted to equity shares at the option of the
holder. Hence, these shares are also known as quasi equity shares.
Conversion of preference shares in to bonds or debentures is
permitted if company wishes. The conversion feature makes
preference shares more acceptable to investors. Even though the
market for preference shares is not good at a point of time, the
convertibility will make it attractive.

4. Participating Preference Shares:

These kinds of shares are entitled to get regular dividend at fixed rate.
Moreover, they have a right for surplus of the company beyond a
certain limit.

5. Cumulative Preference Shares:

The dividend payable for such shares is fixed at 10%. The dividend not
paid in a particular year can be cumulated for the next year in this
case.

6. Preference Shares with Warrants:

This instrument has certain number of warrants. The holder of such
warrants can apply for equity shares at premium. The application
should be made between the third and fifth year from the date of
allotment.

7. Fully Convertible Cumulative Preference Shares:

Part of such shares, are automatically converted into equity shares on
the date of allotment. The rest of the shares will be redeemed at par or
converted in to equity after a lock in period at the option of the
investors.

4. Debentures:
Debenture is an instrument under seal evidencing debt. The essence of
debenture is admission of indebtedness. It is a debt instrument issued
by a company with a promise to pay interest and repay the principal
on maturity. Debenture holders are creditors of the company. Sec 2
(12) of the Companies Act, 1956 states that debenture includes
debenture stock, bonds and other securities of a company. It is
customary to appoint a trustee, usually an investment bank- to protect
the interests of the debenture holders. This is necessary as debenture
deed would specify the rights of the debenture holders and the
obligations of the company.
Types of Debentures:
1. Secured Debentures:
Debentures which create a charge on the property of the company is a
secured debenture. The charge may be floating or fixed. The floating
charge is not attached to any particular asset of the company. But
when the company goes into liquidation the charge becomes fixed.
Fixed charge debentures are those where specific asset or group of
assets is pledged as security. The details of these charges are to
be mentioned in the trust deed.
2. Unsecured Debentures:
These are not protected through any charge by any property or assets
of the company. They are also known as naked debentures. Well
established and credit worthy companies can issue such shares.

3. Bearer Debentures:
Bearer debentures are payable to bearer and are transferable by mere
delivery. Interest coupons are attached to the certificate or bond. As
interest date approaches, the appropriate coupon is ‘clipped off by the
holder of the bond and deposited in his bank for collection. The bank
may forward it to the fiscal agent of the company and proceeds are
collected. Such bonds are negotiable by delivery.

4. Registered Debentures:
In the case of registered debentures the name and address of the
holder and date of registration are entered in a book kept by the
company. The holder of such a debenture bond has nothing to do
except to wait for interest payment which is automatically sent him on
every payment date.

When such debentures are registered as to principals only, coupons

are attached. The holder must detach the coupons for interest
payment and collect them as in the case of bearer bonds.

5. Redeemable Debentures:
When the debentures are redeemable, the company has the right to
call them before maturity. The debentures can be paid off before
maturity, if the company can afford to do so. Redemption can also be
brought about by issuing other securities less costly to the company in
the place of the old ones.

6. Convertible Debentures:
When an option is given to convert debentures in to equity shares after
a specific period, they are called as convertible debentures.

7. Non-Convertible Debentures With Detachable Equity

Warrants:
The holders of such debentures can buy a specified number of shares
from the company at a predetermined price. The option can be
exercised only after a specified period.

5. Bonds:
Bonds are debt instruments that are issued by
companies/governments to raise funds for financing their capital
requirements. By purchasing a bond, an investor lends money for a
fixed period of time at a predetermined interest (coupon) rate. Bonds
have a fixed face value, which is the amount to be returned to the
investor upon maturity of the bond.

During this period, the investors receive a regular payment of interest,

semi-annually or annually, which is calculated as a certain percentage
of the face value and known as a ‘coupon payment.’ Bonds can be
issued at par, at discount or at premium. A bond, whether issued by a
government or a corporation, has a specific maturity date, which can
range from a few days to 20-30 years or even more.

Both debentures and bonds mean the same. In Indian parlance,

debentures are issued by corporates and bonds by government or
semi-government bodies. But now, corporates are also issuing bonds
which carry comparatively lower interest rates and preference in
repayment at the time of winding up, comparing to debentures.
The government, public sector units and corporates are the dominant
issuers in the bond market. Bonds issued by corporates and the
Government of India can be traded in the secondary market.

Basically there are two types of bonds viz.:

1. Government Bonds – are fixed income debt instruments issued by
the government to finance their capital requirements (fiscal deficit) or
development projects.

2. Corporate Bonds – are debt securities issued by public or private

corporations that need to raise money for working capital or for
capital expenditure needs.

The different types of bonds are:

i. Zero Coupon Bonds:
Zero Coupon Bonds are issued at a discount to their face value and at
the time of maturity, the principal/face value is repaid to the holders.
No interest (coupon) is paid to the holders. The difference between
issue price (discounted price) and redeemable price (face value) itself
acts as interest to holders. These types of bonds are also known as
Deep Discount Bonds.

ii. Mortgage Bonds:

This is the common type of bond issued by the corporates. Mortgage
bonds are secured by physical assets of the corporation such as their
building or equipment.

iii. Convertible Bonds:

This type of bond allows the bond holder to convert their bonds into
shares of stock of the issuing corporation. Conversion ratio (number of
equity shares in lieu of a convertible bond) and the conversion price
(determined at the time of conversion) are pre-specified at the time of
bonds issue.

iv. Step-Up Bonds:

A bond that pays a lower coupon rate for an initial period which, then
increases to a higher coupon rate.
v. Callable and Non-Callable Bonds:
If a bond can be called (redeemed) prior to maturity, the bond is said
to be callable. If a bond cannot be called prior to maturity, it is said to
be non-callable.

vi. Option Bonds:

In this type, the investors have the option to choose between
cumulative or non-cumulative bonds. In the case of cumulative bonds
interest is accumulated and is payable on maturity only. In non-
cumulative type interest is paid periodically.

vii. Bonds with Warrants:

A warrant allows the holder to buy a number of equity shares at a pre-
specified price in future. Bonds are issued with warrants to make it
more attractive.

viii. Floating Rate Bonds:

Floating rate bonds are bonds wherein the interest rate is not fixed
and is linked to a benchmark rate.

6. Government Securities:
Securities issued by the central government or state governments are
referred to as government securities (G-Secs).

A Government security may be issued in one of the following

forms, namely:
1. A Government promissory note payable to or to the order of a
certain person, or

2. A bearer bond payable to bearer, or

3. A stock, or

4. A bond held in a ‘bond ledger account,

They have the safety and security of investments made in them with
regularity of return. These are guaranteed by the government. The
papers issued by the Bank of England used to have gift-edged borders.
The term is believed to have originated from there. Thus, gilt edged
securities or gilt securities have the strong consistent record of
earnings and can be relied on the cover dividends and interest.

The central government raises funds through the issue of dated

securities (securities with maturity period ranging from two years to
30 years, long-term) and treasury bills (securities with maturity
periods of 91 or 364 days, short-term).

State governments go about raising money through State

Development Loans (SDLs). Local bodies of various states like
municipalities also tap the bond market from time to time.

They are issued in denominations of Rs. 100 or Rs. 1000. The interest
is payable half yearly. They are issued through the public debt office of
RBI (PDO). The Public Debt Office (PDO) of RBI manages the
government issues. G-secs may be issued in Physical form or in
dematerialised form. They are issued by RBI in consultation with
Government, through auctions conducted electronically.

Types of Government Securities:

Following are the types of Government Securities:
1. Promissory Notes:
Promissory Notes are instruments containing the promises of the
Government to pay interest at a specified rate. Interests are usually
paid half yearly. Interest is payable to the holder only on presentation
of the promissory notes. They are transferable by endorsement and
delivery.

2. Stock Certificates (Inscribed Stock):

Stock certificate, also known as Inscribed Stock, is a debt held in the
form of stock. The owner is given a certificate inserting his name after
registering in the books of PDO of RBI. The execution of transfer deed
is necessary for its transfer. Since liquidity is affected, these are not
much favoured by investors. One will have to wait till maturity to get it
encashed.
3. Bearer Bonds:
A bearer bond is an instrument issued by government, certifying that
the bearer is entitled to a specified amount on the specified date.
Bearer bonds are transferable by mere delivery. Interest Coupons are
attached to these bonds. When the periodical interest falls due, the
holder clips off the relevant coupon and presents it to the concerned
authority for payment of interest.

4. Dated Securities:
They are long term Government securities or bonds with fixed
maturity and fixed coupon rates paid on the face value. These are
called dated securities because these are identified by their date of
maturity and the coupon, e.g., 12.60% GOI BOND 2018 is a Central
Government security maturing in 2018, which was issued on
23.11.1998 bearing security coupon 400095 with a coupon of 12.06 %
payable half yearly. At present, there are Central Government dated
securities with tenure up to 30 years in the market. Dated securities
are sold through auctions. They are issued and redeemed at par.

5. Zero Coupon Bonds:

These bonds are issued at discount to face value and to be redeemed at
par. As the name suggests there is no coupon/interest payments.
These bonds were first issued by the GOI in 1994 and were followed by
two subsequent issues in 1995 and 1996 respectively.

6. Partly Paid Stock:

This is a stock where payment of principal amount is made in
installments over a given time frame. It meets the needs of investors
with regular flow of funds and the needs of Government when it does
not need funds immediately. The first issue of such stock of eight year
maturity was made on November 15, 1994 for Rs. 2000 crore. Such
stocks have been issued a few more times thereafter.

7. Floating Rate Bonds:

These are bonds with variable interest rate, which will be reset at
regular intervals (six months). There may be a cap and a floor rate
attached, thereby fixing a maximum and minimum interest rate
payable on it. Floating rate bonds of four year maturity were first
issued on September 29, 1995.

8. Bonds with Call/Put Option:

These are Govt. bonds with the features of options where the Govt.
(issuer) has the option to call (buy) back or the investor can have the
option to sell the bond (Put option) to the issuer. First time in the
history of Government Securities market RBI issued a bond with call
and put option in 2001-02. This bond was due for redemption in 2012
and carried a coupon of 6.72%. However the bond had call and put
option after five years i.e. in the year 2007. In other words, it means
that holder of bond could sell back (put option) bond to Government
in 2007 or Government could buy back (call option) bond from holder
in 2007.

9. Capital Indexed Bonds:

These are bonds where interest rate is a fixed percentage over the
wholesale price index. The principal redemption is linked to an index
of inflation (here wholesale price index). These provide investors with
an effective hedge against inflation. These bonds were floated on
December, 1997 on an on tap basis. They were of five year maturity
with a coupon rate of 6 per cent over the wholesale price index.

10. Fixed Rate Bond:

Normally government securities are issued as fixed rate bonds. In this
type of bonds the coupon rate is fixed at the time of issue and remains
fixed till redemption.

Gold bonds, National Defence bonds, Special Purpose Securities,

Rural Development bonds, Relief bonds, Treasury bill etc. are other
types of Government securities.

The major investors in G-Secs are banks, life insurance companies,

general insurance companies, pension funds and EPFO. Other
investors include primary dealer’s mutual funds, foreign institutional
investors, high net-worth individuals and retail individual investors.
Most of the secondary market trading in government bonds happens
on OTC (Over the Counter), the Negotiated Dealing System and the
wholesale debt-market (WDM) segment of the National Stock
Exchange.