Finance and Capital Markets

• A securities market is where securities are bought and sold based on demand and supply, within the wider financial market.
• It includes stock, bond, and derivatives markets where prices are determined and professionals and non-professionals participate.

Market Levels

• Primary markets issue new securities.
• Secondary markets facilitate the buying and selling of existing securities.
• Secondary markets include organized exchanges and over-the-counter (OTC) transactions where parties buy/sell directly.
• The existence of secondary markets encourages people to hold securities, increasing firms' ability to issue them.

Participants

• Professional participants include: brokerages, broker-dealers, market makers, investment managers, speculators, clearing houses, and securities depositories.
• A securities market attracts capital, transfers real assets into financial assets, determines prices, and provides short and long-term investment options.

Security Market Definition

• An economic institute where securities are traded based on demand and supply.
• Markets are categorized by what's traded and their structure.

Primary Market

• Deals with the issuance of new securities
• The secondary market (aftermarket) is where previously issued securities like stocks, bonds, options, and futures are traded.
• Investors purchase from other investors in the secondary market after the initial issuance.

Structure of Securities Market in India

• The Industrial Securities Market deals with shares and bonds of existing and new companies.
• It divides into the New Issue Market (NIM) and the Old Issue Market.
• The New Issue Market = Primary Market.
• The Old Issue Market = Secondary Market or Stock Exchange.
• The New Issue Market and Stock Exchange are interlinked, with the former dealing with new securities and the latter with previously issued ones.

Primary Market Focus

• Focuses on the floatation of new shares or bonds.
• Firms raising funds can be new or existing companies planning expansions.
• Merchant Banking Divisions advise on issue viability before it is floated.

Company Approach

• Stock-issuing companies approach institutional underwriters like LIC, UTI, ICICI, and IDBI to ensure marketability.
• Underwriters may purchase securities from the New Issue Market to hold in their asset portfolios.

Secondary Market Focus

• Deals in existing securities, providing liquidity and marketability; securities can be bought/sold at a small transaction cost.
• Firms issuing new securities register on a Stock Exchange for listing.

Primary Market Definition

• The Primary Market deals with the issuance and sale of equity-backed securities directly from the issuer.
• Investors buy securities that have never been traded before,.
• Primary markets create long-term instruments for corporate entities to raise funds and is known as the New Issue Market.

Primary Market Operations

• Primary markets issue new securities for companies, governments, etc., to obtain financing through debt or equity.
• Underwriting groups of investment banks facilitate primary markets by setting a price range and overseeing the sale.

Follow-on Trading

• Further trading occurs on the secondary market after the initial sale.

Primary Market Concept

• Companies, governments, and public sector institutions raise funds through bond issues; corporations raise capital through IPOs.
• Investment banks or finance syndicates of securities dealers often facilitate this.
• Underwriting involves selling new shares to investors; dealers earn a commission built into the security offering price.
• Corporations may directly issue debt/stock to institutional investors or the public, or seek additional capital from existing shareholders

Company Role

• Companies receive money and issue new security certificates when securities are directly issued to investors.
• The primary market facilitates capital formation, with securities issued at face value, premium value, or at par value.
• Securities typically trade on a secondary market after issuance.

Equity Capital Market (ECM)

• The ECM is where financial institutions help companies raise equity capital and stocks are traded
• It includes the primary market for private placements, IPOs, and warrants.
• It also includes a secondary market where existing shares, futures, options, and swaps are traded.

ECM Definition

• Financial institutions and companies trade financial instruments and raise equity capital in this market.
• It is riskier than debt markets but offers potentially higher returns.
• ECM is a market that involves "companies and financial institutions" aimed at benefitting from the company.

ECM Examples

• The company provides financial information to the institution, which increases profits through "market transactions."
• Institutions may be involved in IPOs, convertible bonds, and other services involving equity.
• It was reported that ECM profits were peaking in 2006-2007, but now are beginning to normalize.

Instruments in the Equity Capital Market

• Equity capital is raised by selling a portion of a claim/right to a company's assets for money.
• The value of equity capital is based on the company's current assets and business.

Common Shares

• Represent ownership capital.
• Holders are paid dividends out of the company's profits and have a residual claim to the company's income and assets.
• Common shareholders are entitled to a profits claim only after preferred shareholders and bondholders have been paid.

Preferred Shares

• Considered a hybrid security that combines features of debentures and common equity stock.
• There is a fixed/stated rate of dividend like debentures, have a claim to the company's income and assets before equity
• There is no claim to the income/assets, and no conferral of voting rights to shareholders.
• Preferred dividends are not tax deductible, like common equity dividends.

Types of Preferred Shares

• Irredeemable
• Redeemable
• Cumulative
• Non-Cumulative
• Participating
• Convertible
• Stepped.

Private Equity

• Equity investments made through private placements are called known as private equity.
• Private equity is raised by private limited enterprises and partnerships that cannot trade shares publicly.
• Start-ups and/or small/medium sized companies raise capital through this route through institutional investors and/or wealthy individuals because
• They have limited access to bank capital due to unwillingness to lend to an enterprise without a proven track record
• Limited access to public equity on account of no large or active shareholder base.

Examples

• Venture capital funds, leveraged buyouts, and private equity funds represent some important sources of private equity.

American Depository Receipts (ADR)

• It is a certificate of ownership issued in the name of a foreign company by an American bank, against foreign shares deposited in the bank by the said foreign company.
• Certificates are tradable and represent ownership of shares in the foreign company.
• This promotes trading of foreign shares in America via admitting the shares of domestic companies into a well developed stocked market.
• ADRs often represent a combination of many foreign shares (for instance, lots of 100 shares).
• ADRs and their associated dividend are denominated in US dollars.

Global Depository Receipts (GDRS)

• Negotiable receipts issued against the shares of foreign companies by financial institutions in developed countries.

Futures

• A futures contract is a forward contract traded on an organized exchange.
• They are entered into and executed through clearing houses
• Clearing houses act as an intermediary between buyers and sellers of the futures contract.

Agreement Guarantee

• The clearinghouse guarantees that both parties adhere to the contract.

Options

• A one-sided contract, an option provides one party with the right but not the obligation to sell or buy an underlying asset on or before a pre-determined date.
• A premium is paid to acquire this right. An option to buy is known known as a call option while an option which confers the right to sell is a put option.

Swaps

• A swap is a transaction under which streams of cashflow are exchanged for another between two parties.

Functions of an Equity Capital Market

• Marketing and distribution of issues
• Allocation of new issues
• Initial public offerings (IPOs) and private placements
• Trading derivatives and accelerated book building

Participants in the Equity Capital Market

• Large, mid and small cap companies can be listed on the equity capital market
• Investment banks, retail investors, venture capitalists, angle investors, and securities firms are the dominant traders on the ECM.

Structure of the Equity Capital Market

• Primary Equity Market
  • Private Placement Market
  • Public Market
• Secondary Equity Market
  • Stock Exchange
  • Over-The-Counter (OTC) Markets

Primary Equity Market Definition

• Allows companies to raise capital from the market for the first time
• Divides into two sections.

Private Placement Market

• Allows companies to raise private equity through unquoted shares.
• Provides a platform where companies can sell their securities to investors directly
• Companies do not need to register securities with the securities exchange commission(SEC) as they are not subject to the same regulatory requirements as listed securities.
• Market is illiquid and risky, so investors demand a risk premium to compensate.

Primary Public Market

• Deals with two activities.
  • Initial Public Offering(IPO): An IPO is the process by which a company issues equity publicly for the first time and becomes listed on the stock exchange
  • Seasoned Equity Offering(SEO)/Secondary Public Offering (SPO): An SEO/SPO is the process by which a company already listed on the stock exchange issues new/additional equity.
• A firm may issue stock on the stock exchange without creating new shares, where they may exchange unquoted stock for quoted stock.
• If the firm creates new shares, the proceeds from the sale of those shares are created with the company.
• Investment banks play a major role due to underwriting services

Secondary Equity Market

• This provides a platform for the sale and purchases of existing shares.
• No new capital is created in the secondary market.
• Instead, it is the holder of the security that receives proceeds of the sale.
• Can be divided into two parts.

Stock Exchanges

• A central trading location where shares of listed companies are traded.
• The criteria for listing includes;
  • Minimum Earnings
  • Market Capitalization
  • Net tangible assets
  • Number of shares held publicly

Over-The-Counter (OTC) Markets

• A network of dealers which facilitates the trading of stocks bilaterally between two parties, without intermediation.
• OTC Markets are not centralized or organized so are easier to manipulate.

Debt Capital Markets

• The Debt Capital Markets team is responsible for providing advice on raising debt for acquisitions, refinancing, and restructuring.
• A debt Capital Markets Group helps clients organize borrowing and access the global pool of investors.

Raising Capital

• Debt is often cheaper than financing through equity and can add diversity to funding.
• A debt Capital Market is a market where companies and governments raise funds through trading debt securities
• Including corporate and government bonds and Credit Default Swaps etc.

Debt Market vs. Equity Market

• Debt market and equity market are broad terms for two categories of investments
• Debt Market, or Bond Market, is the arena where the investment in loans are bought or sold.
• There is also no physical exchange for bonds as transactions are mostly made between brokers or large institutions, or by individual investors.

Investments

• Investments typically involve less risk than equity investments but involve less return on investment.
• Debt investments fluctuate less than stocks.
• If a company is liquidated, bond holders are prioritized.

Bonds

• Corporate and government bodies issue to raise capital for operations and generally carry a fixed interest rate.
• Issuers are unsecured but are rated by agencies like Moody's, to indicate the integrity of the issuer.

Derivative

• Derivatives are financial securities that rely/derive from an asset or group of assets a benchmark
• The derivative itself is a contract between two+ parties.
• The price is based on fluctuations in the underlying asset.
• Common underlying assets are stocks, bonds, commodities, currencies, interest rates, and market indexes.
• Purchased through brokerages.

Derivative of a Function

• It measures a function value's sensitivity to change with respect to a change in its argument
• Derivatives are a fundamental tool of calculus, like measuring velocity of changing object's position with time.
• The derivative is the slope of the tangent line to the graph of the chosen input value and is the best linear simplification of the function to the input value.
• Described as the ratio of the instantaneous change in the dependent variable to that of the independent variable.
• In this instance, the derivative is re-interpreted as a linear transformation in which the graph is the best approximation of the original function.
• Jacobian Matrix; It represents linear transformation with respect to the basis of independent and dependent variables.
• Differentiation = Finding the Derivative
• Anti-differentiation = the Reverse process of differentiation
• The fundamental theorem of calculus links anti differentiation with integration, in which constitute two fundamental operations in single-variable calculus.

Derivatives Market

• Derivatives are financial securities and instruments traded on a financial market, like future contracts.
• The derivatives market is divided into exchange traded derivatives and over-the -counter derivatives
• The legal nature of these products are different, as well as their method of trade.
• The derivatives market in Europe has a notional amount of €660 trillion.

Derivatives Market Participants

• Grouped using their trading rationales
• Arbitrageurs: Use price differences between two different markets.
• Hedgers: Minimize risk buying insurance.
• Speculators: Take high risks for gains.

Stock Market Intermediaries

• Serve as substitute services for financial lenders / savers that have a choice in regards to risk, return, and liquiditiy in both segments of then financial system.
• Both segments can offer different services and investments for firm's that are not substitutes.
• Financial markets provide lower cost arms length between debt/equity to smaller firms that obtain, whereas financial offers finance with higher cost relating reflecting the uncoveroing of information and ongoing monitoring.
• May also provide complementary services to many firms.
• Hindrance from challenges from intermediaries that prevent conflict between vis-a-vis investors and issuers may raise the cost of investment.

India's Conflicts

• Based on intermediaries, accountability and liability in conflict of interest situations are fixed using India's predominant rules.
• The principle of compliance is more commonly seen in major capital markets.
• Rules alone don't help with conflict, so there must be ethical business conduct for these situations.
• The regulation combined with external control would establish this culture.
• Recommendation to combat interest conflicts and lower risks while scrutinizing India's practical approach.

SEBI and Indian Markets

• The creation of SEBI- Registered Self-Regulatory Organizations for market intermediaries is expected at par with international markets.
• Primary Market Intermediaries

Merchant Bankers

• Merchant bankers play a key part in the issue management.
• Lead bank managers should ensure correctness and compliance to SEBI rules, as well as Guidelines for Disclosures and Investor Protection.
• SEBI must receive a due diligence certificate that assures information is true and enable prospective investors to make well-informed investment decisions.
• SEBI's various operational guidelines addresses to enhance disclosure standards, as well as ensuring a further registration criteria of merchant bankers.
• An increase in net worth requirements, helps their capital be commensurate by activity.
• In 1996-97, merchant bankers had a net worth of 5 crore, following amended regulations in 1992 to require fees for SEBI.

Underwriters

• Underwriters must be registered with SEBI, per Underwriters Rules and Regulations, 1993.
• As well as merchant bankers for I.II, and III, stockbrokers and mutual funds registered with SEBI can perform as underwriters.
• In 1996-97, these regulations were mainly regarding certain procedural matters.

The Role of Issue Banks

• Scheduled banks acting as bankers to an issue must be registed with SEBI in terms of the SEBI(Bankers to the issue) rules and Regulations, 1994.
• Regulations dictate eligibility and requirements for registration of bankers to an issue.

Portfolio Managers

• Portfolio managers must be registered with SEBI, per Portfolio Managers Rules and Regulations, 1993.
• Registered and authorized managers are able to proceed with management activities with permission from I and II merchant bank categories.

Debenture Trustees

• Debenture Trustees must be registered with SEBI, per SEBI Debenture Trustees Rule and Regulations, 1993.
• SEBI has been monitoring details regarding compliance to debenture holders; interest payment, trustee's duties, creation of security.

Share Transfer Agents

• Registrars(RTI) and agents(STA) must be registered with SEBI following regulations from 1993.
• Registration happens under two categories to act as agent and registrar, and to act as one, as there is growth in the depository network.

Secondary Markets and Stocks

• Stock Brokers dealing in securities register with SEBI via the SEBI Brokers and Sub Brokers Regulation, 1992.
• As of March 1997, there was membership of 8,867 with additional brokers registered.

Sub Brokers

• Individuals often transact securities via sub brokers, so the market is imperative in regulating this class.
• Sub brokers failed to register with SEBI in March of the same year, as they are reluctant in taking responsibility.
• SEBI brought many sub brokers under the regulatory oversight.

Securities Market Intermediaries Role

• Serves to match the market's supply and demand.
• Intermediaries help economies confront issues for savings.
• Intermediaries can either make or break economies due to their ability to match available savings to capital.
• It can also determine if investors depict diverse heterogeneous characteristics that markets can connect and manage via efficient and sophisticated middle men.

SEBI and Intermediaries decisions

• Relies more on investors to make decisions via intermediaries, especially for retail investors who may have a lack of information
• Intermediaries do not have investors, but have the resources to reach out to individual investors.
• Intermediaries also play a key role in making market matrixes more anonymous and smooth.

Intermediary Regulations

• Designed a Regulatory market for Intermediaries and Regulations, but hasn't notified rules with enforcement orders.
• Here are regulation examples;
• The SEBI(Stock Brokers and Sub Brokers),1992
• The SEBI(Depositories and Participants),1996
• The SEBI(Bankers to an Issue),1994; Merchants Bankers Regulations,1992
• The SEBI(Registrar)1993
• The SEBI(Underwriters)1993

Merchants Bankers Role

• Play and integral part in the role of issue management of IPO and FPO(issue management)
• Manage Issues for raising funds with companies
• Can be defined by corporations for securities
• India is carried by merchant bankers equipped with issues and functions.

What does a Banker do

• Is an advisor for rendering services in Issue Management.
• Growing economies show scope for Issue management, which relies on a merchant bank's skill and knowledge
• This in turn helps corporate sectors through corporate security issues and capital issues
• Funds are raised for projects, diversify existing units, ad augment long term funds.
• Discloses details to SEBI and are fundamentally financial institutions.

Role of Businesses

• Engages in Business loan, as well as underwriting and the ability to cater to individuals of higher income.
• Offers consultancy regarding finances, marketing, management and law, to assist finance, modernize, and revamp current business models.
• Does not manage the function of depositories, instead act as an intermediary to assist with transnational corporations.
• Number of application, investors, application money, refund to name a few.
• Books of accounts can be maintained for three years or longer to keep records of company dealings.

Rules for the Company

• Keep records and company data like details on investment. Number of collection centres, application money received, statements, amongst others.

Conduct Rules

• RBI action on merchants must be conveyed to SEBI
• High Integrity is paramount in working with clientele and maintaining the disclosure and facts surrounding all information.

Code of Ethics

• Help to facilitate primary market activities through advisement and guidance.
• Help to prepare financial statements for marketing purposes
• Conduct/underwrite deals as requested by SEBI.

Initial Public Financial Offering

• IPO's or market stocks, are the sale of company shares to institutional and retail investors.
• Through the process of investing new share by banks and brokers, the opportunity can turn a privately held company into a publicly traded company.
• With shares being traded at the public level via IPO's, new capital is generated.

IPO and Shares

• Shares are able to be traded in the open market, per the free float term, which stocks stipulate on a minimum.
• There are benefits which offset ongoing banking fees.
• In order to proceed forward with transparency, there is requirement to disclose sensitive information regarding the purchase.
• IPO are made with help from underwriting as well as assessment of the shares with price and sale.

Follow on Process

• If a Follow IPO is released, the market and experts can explore Alternative processes of assessment and approval.
• Shares are issued with the intent of the company to receive investment, so it can operate amongst the market.
• Once the stock is added to market share, it is available to trade and the overall price is determined via fair share or equity amount.
• FPO can range amongst shareholders.

At-The-Market

• At-the-market is another type of FPO, by which a company sets prices depending on the prevailing market.
• All prices are set to retain capital in the best form, with help to reduce debt along the way.

Diluent

• The transfer of shares is split using new diluent and non dilenut sharing.

IPO vs FPO

• IPO: the first offer; FPO's can be second, third, or fourth offers.
• IPO: issued by the company before it is listed FPO issued after listing from stock exchanges.

Explore key concepts in finance and capital markets. Questions cover stock exchange listings, debt vs. equity financing, the role of Debt Capital Markets (DCM), bondholder and stockholder repayment priorities, debt and equity market differences, OTC market manipulation, derivative valuation, rating agency influence on bond issuance, options for startups to raise finance, and how American banks operate in foreign markets.