Fundamentals of

Capital Market
Introduction to Capital Market

 A) Overview of Capital Market - Indian Capital Market, Authorities

Governing Capital Markets in India, Profile of Securities Market, Securities
Market Reforms and Regulatory Measures to Promote Investor Confidence,
Features of Developed Capital Market: IOSCO , Overview of Depository
System in India.
 B) Capital Market Instruments and Rating- Capital Market Instruments:
Equity, Debentures, Preference Shares, Sweat Equity, Non-Voting Shares,
Share Warrants, Derivatives and Hybrid Instruments.
 C) Rating and Grading of Instruments: Concept, Scope, Significance and
Factors influencing Ratings of Instruments.
Indian Capital Market

 The market where investment instruments like bonds, equities and

mortgages are traded is known as the Capital Market.
 The primal role of this market is to make investment from investors who
have surplus funds to the ones who are running a deficit.
Authorities Governing Capital Markets
in India

 The Ministry of Finance (MoF), the Securities & Exchange Board of India
(SEBI) and the Reserve Bank of India (RBI) are the three regulatory
authorities governing Indian capital markets.
Authorities Governing Capital Markets
in India

 Ministry of Finance (MoF)

 The Department of Economic affairs directly manages the Capital Markets
segment under the directions of MoF. This segment formulates the rules for the
efficient growth of the Stock Market which includes derivatives, debt, and
equity. It also formulates regulations for safeguarding the interest of the
investors.
 This segment regulates the Indian Capital Markets through the following laws:
 1)Depositories Act, 1996
 2) Securities Contract (Regulation) Act, 1956
 3) Securities and Exchange Board of India Act, 1992
Reserve Bank of India (RBI)

 The Reserve Bank of India Act, 1934 governs policies framed by the Reserve
Bank of India. The functions of RBI in this regard are as follows:
 Implementation of Monetary and Credit policies
 Issuance of Currency Notes
 Government’s Banker
 Banking System Regulator
 Foreign Exchange through Foreign Exchange Management Act, 1999
 Managing payment & settlement system
 Apart from the above functions, RBI is also actively involved in developing the
financial market
Securities & Exchange Board of India
(SEBI)

 The Primary function of SEBI are:

 1) Protective Function
 2) Development Function
 3) Regulatory Function
Profile of Securities Market

 Public & Right Issue

 Resource mobilization by Mutual Funds
 Depository Accounts
 Mutual Funds Investment
 Investment by Foreign Portfolio Investors (FPIs)
Public & Right Issue

 A rights issue is a way by which a listed company can raise additional

capital. However, instead of going to the public, the company gives its
existing shareholders the right to subscribe to newly issued shares in
proportion to their existing holdings.

For example, 1:4 rights issue means an existing investor can buy one extra
share for every four shares already held by him/her. Usually the price at
which the new shares are issued by way of rights issue is less than the
prevailing market ..
Resource mobilization by Mutual
Funds

 Mutual funds have come as a boon to the small and medium investors and
they have emerged as the popular media through which small and medium
investors can reap the benefits of good investing. There is no other safe way to
enter in the capital market, except the mutual funds. Mutual fund is a specific
type of investment institution, which collects the savings of the community and
invests large funds in a fairly large and well diversified portfolio of sound
investments. It is set-up in the form of a trust. Mutual funds are the vehicles
through which savings from individuals are mobilized to the capital market.
With the emerge of mutual funds; a change is taking place in the composition
of investors. The traditional investors, who used to invest in mutual funds,
keeping in view the college education for children and retirement age, are
giving way to youngest generation with shorter time horizon and greater
expectations. The realization that no single investment product could meet all
the financial needs of investors, had led the mutual funds to develop a wide
variety of products
Depository Accounts

 DEPOSITORY ACCOUNT are those accounts where assets; e.g. cash or

securities; are placed on deposit in favor of the depositor.
Mutual Funds Investment

 A Mutual Fund basically pools money from multiple investors, such as you, and
invests them in baskets of investments. These baskets form what is called a
portfolio.
 This means, your money is invested in a group of investments (either stocks or
debt instruments), and in a simple, as well as accessible manner. On a basic
level, mutual funds are classified as equity funds, debt funds, and money
market funds on the basis of where they invest.
 Equity Mutual Funds are the most numerous as well as popular form of Mutual
Funds you will come across
 Equity Mutual Funds invest the pooled investor money into shares of various
companies. The gains or losses arising from the rise or drop in prices of these
shares in the stock market decide the performance of the Mutual Fund.
Investment by Foreign Portfolio
Investors (FPIs)

 What is 'Foreign Portfolio Investment - FPI'

 Foreign portfolio investment (FPI) consists of securities and other financial
assets passively held by foreign investors. It does not provide
the investor with direct ownership of financial assets and is relatively liquid
depending on the volatility of the market. Foreign portfolio
investment differs from foreign direct investment (FDI), in which a domestic
company runs a foreign firm, because although FDI allows a company to
maintain better control over the firm held abroad, it may face more
difficulty selling the firm at a premium price in the future.
 Differences Between FPI and FDI
 FPI lets an investor purchase stocks, bonds or other financial assets in a foreign country.
Because the investor does not actively manage the investments or the companies that
issue the investments, he does not have control over the securities or the business.
However, since the investor’s goal is to create a quick return on his money, FPI is more
liquid and less risky than FDI.
 In contrast, FDI lets an investor purchase a direct business interest in a foreign country. For
example, an investor living in New York purchases a warehouse in Berlin so a German
company can expand its operations. The investor’s goal is to create a long-term income
stream while helping the company increase its profits.
 The investor controls his monetary investments and actively manages the company into
which he puts money. He helps build the business and waits to see his return on
investment (ROI). However, because the investor’s money is tied up in a company, he
faces less liquidity and more risk when trying to sell his interest.
Securities Market Reforms and
Regulatory Measures to Promote
Investor Confidence
 Control over issue of Capital
 Establishment of Regulator
 Screen Based Trading
 Risk Management
 Depositories Act
 Derivatives
 Settlement Guarantee
 Securities Market Awareness
 Green Shoe Option
 Securities Lending and Borrowing
 Corporate Governance
 Debt Listing Agreement
 Gold Exchange traded funds in India
 Guidelines of Issue of Indian Depository Receipts
 Grading Of IPOs
 Mandatory requirement of PAN
 SEBI – ASBA Facility
Features of Capital Market

 1. Link between Savers and Investment Opportunities

 2. Deals in Long Term Investment:
 3. Utilises Intermediaries:
 4. Determinant of Capital Formation:
 5. Government Rules and Regulations:
Features of Developed Capital
Market: IOSCO , Overview of
Depository System in India
B) Capital Market Instruments and
Rating-

 Capital Market Instruments: Equity, Debentures, Preference Shares, Sweat

Equity, Non-Voting Shares, Share Warrants, Derivatives and Hybrid
Instruments.
Equity

 Known as ordinary Shares

 Equity capital is known as “Owned Capital”
 Distinctive Number
 Voting rights
 Limited Liability
 Capital appreciation
Preference Share

 Preference share are known as preferred share.

 Preference share capital has two priorities i.e. in the repayment of capital
and payment of dividend.
 Preferred stocks usually carry no voting rights.
Non –Voting Share

 non-voting shares or ‘A’

shares ORDINARYSHARES which do not have any voting rights at a
company's ANNUAL GENERAL MEETING. Non
voting shares often arose because company founders or directors sought
to raise new share capital without diluting their control, by issuing large
numbers of nonvoting shares but retaining control of
the original voting shares. Holders of voting shares have an advantage in c
ompany takeovers or disputes about company
policy and so may have a higher market value than non-
voting shares. Most STOCK MARKETS discourage companies from
issuing new non-voting shares.
SWEAT EQUITY

 Sweat equity is the time and effort that people contribute to a project.
 HOW IT WORKS (EXAMPLE):
 Sweat equity is used to describe the non-financial investment that people contribute to
the development of a project such as a start-up business. For example, sweat equity is
counted from the founders of the company, as well as advisors and board members.
 In many situations where some members of a partnership are contributing
their money and others are spending time, the partnership may be composed
of cash and non-cash (or sweat equity). Ultimately, sweat equity is rewarded the same as
cash equity through a distribution of stock or other forms of equity in a start-up venture.
 Sweat equity can also be considered literal. For example, a homeowner may spend time
fixing, repairing, and renovating their home. The value of their efforts is considered sweat
equity and adds to the value of the home
WHY IT MATTERS:
SWEAT EQUITY

 Sweat equity is important to the successful start-up of a new venture,

especially when cash is in short supply. However, it is important to value
sweat equity carefully. In early stages, it is easy to overvalue
it, offering stock in exchange for effort. However, over time, such trades
can become very expensive and erode the equity available to follow-on
investors. Sweat equity should be measured in terms of the long term value
of the effort, the long term commitment of the participants, and the value-
added by the participants to the overall goals of the venture.

What is a Share Warrant?

 A Share Warrant is a document issued by the company under its common

seal, stating that its bearer is entitled to the shares or stock specified
therein. Share warrants are negotiable instruments. They are transferable
by mere delivery without registration of transfer.
Conditions for issuing share warrants

 The following conditions should be satisfied for issuing share warrants.

 1. Only a public company can issue share warrants.
 2. It must be authorized by the Articles of Association.
 3. The shares must be fully paid-up.
 4. The approval of the Central Government is necessary.
 On the issue of the share warrant, the company must strike off the name of the member in its
Register of Members and must enter the following particulars:
 1. The fact of the issue of the share warrant,
 2. A statement of the shares included in the warrant, distinguishing each share by its number,
and 3. The date of issue of the warrant.
 It is a negotiable instrument and mere delivery transfers the ownership of the shares. Coupons
are attached to each warrant, bearing the dates on which the dividend will be paid by the
company as it cannot know who the shareholder or who is entitled to the dividends. The person
who produces the appropriate coupon can receive payment of the dividend.
Bonds and Debentures

 Every organization requires financing for setting up as well as daily survival.

These funds can be set up either by the issuance of debt or equity
instruments. Most of the organizations will prefer debt since it does not
involve personal funds being utilized and can also be used for leverage.
Two of the major sources of funds through debt route are bonds and
debentures
 Though both terms may be used interchangeably but are distinctly
different. Bonds are essentially loans secured by a specific physical asset.
A debenture is a debt security issued by a Corporation not secured by
assets but by the Credit rating of the organization. This is a preferred
instrument by both Government as well as Private Organisations
 A bond is a more secure instrument than a debenture. A debenture does
not have any collateral backing; whereas a bond will always have
collateral attached to it.
 For an example in layman’s terms, if an issuing company fails to pay
interest or the principal to the bondholders, the amount can be realised by
selling the collateral i.e. the asset that is kept as a security. Whereas in
case of debentures, selling any asset and realising money is not an
option. This is because it is not backed by any security. Against the
security, the debenture holders only relied upon the credibility of the
company while investing money and the credibility is not saleable in open
market
Derivatives and Hybrid Instruments.

 Definition of Derivatives
 A derivative can be defined as a financial instrument whose value
depends on (or derives from) the value of other basic underlying variables
Usually, the underlying variables are the prices of traded assets, e.g. −
 Stocks (Microsoft, ArcelorMittal, BNP Paribas,…) −
 Equity indices (S&P500, Nikkei225, CAC40,…) −
 Bonds (government, corporate, senior/subordinate,…) −
 Commodities (gold, platinum, corn, CO2,…) −
 Interest rates indices (Libor…..
Classification of Derivatives

 Linear Instruments
 Swaps
 Non-Linear Instruments
 Structured Products
 Hybrid Products
Rating and Grading of Instruments

 Concept, Scope, Significance and Factors influencing Ratings of

Instruments