Semester III

WEALTH-
MANAGEMENT

Prof. D. C. Pai
STOCKS
FINANCIAL STATEMENTS
MEANING

Financial statement consists of Balance Sheet, Profit and Loss Account, Sources and Uses of Funds Statements,
and Auditors’ Notes to the financial statements. The Balance sheet shows the financial position of the firm at a
particular point of time. The profit and loss account (Income Statement) shows the financial performance of the firm
over a period of time. The sources and uses of funds statements reflect the flow of funds through the business during
a given period of time.

TYPES OF FINANCIAL STATEMENTS

Balance Sheet

The balance sheet of a company, according to the Companies Act, should be either in account form or the report
form.

Balance Sheet: Account Form

Liabilities Assets

Share Capital Fixed Assets

Reserves and Surplus Investments

Secured loans Current Assets, loans and Advances

Unsecured loans Miscellaneous expenditure

Current liabilities and provisions

Liabilities:

 Share Capital: Share capital has been divided into equity capital and preference capital. The share capital
represents the contribution of owners of the company. Equity capital does not have fixed rate of dividend.
The preference capital represents contribution of preference shareholders and has fixed rate of dividend.

 Reserves and Surplus: The reserves and surpluses are the profits retained in the company. The reserves
can be divided into revenue reserves and capital reserves. Revenue reserves represent accumulated
retained earnings from the profits of business operations. Capital reserves are those gained which are not
 related to business operations. The premium on issue of shares and gain on revaluation of assets are
examples of the capital reserves.

 Secured and Unsecured Loans: Secured loans are the borrowings against the security. They are in the form
of debentures, loans from financial institutions and loans from commercial banks. The unsecured loans are
the borrowings without a specific security. They are fixed deposits, loans and advances from promoters,
inter-corporate borrowings, and unsecured loans from the banks.

 Current Liabilities and Provisions: They are amounts due to the suppliers of goods and services brought on
credit, advances payments received, accrued expenses, unclaimed dividend, provisions for taxes,
dividends, gratuity, pensions, etc.

Assets:

 Fixed Assets: These assets are acquired for long-terms and are used for business operation, but not meant
for resale. The land and buildings, plant, machinery, patents, and copyrights are the fixed assets.

 Investments: The investments are the financial securities either for long-term or short-term. The incomes
and gains from the investments are not from the business operations.

 Current Assets, Loans, and Advances: This consists of cash and other resources which can be converted
into cash during the business operation. Current assets are held for a short-term period. The current assets
are cash, debtors, inventories, loans and advances, and pre-paid expenses.

 Miscellaneous Expenditures and Losses: The miscellaneous expenditures represent certain outlays such as
preliminary expenses and pre-operative expenses not written off. Though loss indicates a decrease in the
owners’ equity, the share capital can not be reduced with loss. Instead, Share capital and losses are shown
separately on the liabilities side and assets side of the balance sheet.

Balance Sheet: Report Form

I. Sources of Funds

1. Shareholders’ Funds

(a) Share Capital

(b) Reserves & surplus

2. Loan Funds

(a) Secured loans

(b) Unsecured loans

II. Application of Funds

(i) Fixed Assets

(ii) Investments

(iii) Current Assets, loans and advances

Less: Current liabilities and provisions

Net current assets

(iv) Miscellaneous expenditure and losses

Profit and Loss Account

Profit and Loss account is the second major statement of financial information. It indicates the revenues and
expenses during particular period of time. The period of time is an accounting period/year, April-March. The profit and
loss account can be presented broadly into two forms: (i) usual account form and (ii) step form. The accounting report
summarizes the revenue items, the expense items, and the difference between them (net income) for an accounting
period.

Mere statistics/data presented in the different financial statements do not reveal the true picture of a financial position
of a firm. Properly analyzed and interpreted financial statements can provide valuable insights into a firm’s
performance. To extract the information from the financial statements, a number of tools are used to analyse such
statements. The popular tools are:

1. Comparative Financial Statements,

2. Common Sized Statements, and

3. Ratio Analysis.

Comparative Financial Statements

This involves putting statements for two periods/organizations in a comparative form and indicating differences
between them in terms of rupees and percentages.
Example 12: Financial statement of XYZ Ltd. for the years 2005 and 2006 are compared as under:

__________________________________________________________________________

Particulars Amount (in Rs. Lakh) Increase/Decrease

2005 2006 Amount_(%)______

Equity Share Capital 15.00 15.00 - -

Debentures 9.00 6.00 (-) 3.00 (-) 33.33

Current Liabilities 10.00 10.50 (+) 0.50 (+) 5.00

Land and Building 13.00 13.00 - -

Investments 8.00 10.00 (+) 2.00 (+) 25.00

Current Assets 13.00 8.50 (-) 4.50 (-) 34.62

__________________________________________________________________________

Common Size Statements

This involves putting statements for two years/organizations in a comparative form, where the items appear in
percentage to total, rather than in absolute rupee form. This indicates relative importance of each item in the total and
significant changes in the composition of the items.

Example 13: Common size statement of ABC Ltd. for the years 2005 and 2006 is as under:

__________________________________________________________________________

Particulars Amount (in Rs. Lakh) Percentage

2005 2006 2005 2006_____

Equity Share Capital 15.00 15.00 44.11 47.62

Debentures 9.00 6.00 26.47 19.05

Current Liabilities 10.00 10.50 29.42 33.33

Land and Building 13.00 13.00 38.23 41.27

Investments 8.00 10.00 23.53 31.75

Current Assets 13.00 8.50 38.24 26.98

__________________________________________________________________________

Ratio Analysis

Financial ratio is a quantitative relationship between two items/variables. Financial ratios can be broadly classified
into three groups: (I) Liquidity ratios, (II) Leverage/Capital structure ratio, and (III) Profitability ratios.

(I) Liquidity ratios

Liquidity refers to the ability of a firm to meet its financial obligations in the short-term which is less than a year.
Certain ratios which indicate the liquidity of a firm are: (i) Current Ratio, (ii) Acid Test Ratio, (iii) Turnover Ratios. It is
based upon the relationship between current assets and current liabilities.

Current . Assets
(i) Current ratio = Current . Liabilities

The current ratio measures the ability of the firm to meet its current liabilities from the current assets. Higher the
current ratio, greater the short-term solvency (i.e. larger is the amount of rupees available per rupee of liability).

Quick . Assets
(ii) Acid-test Ratio= Current . Liabilities

Quick assets are defined as current assets excluding inventories and prepaid expenses. The acid-test ratio is a
measurement of firm’s ability to convert its current assets quickly into cash in order to meet its current liabilities.
Generally speaking 1:1 ratio is considered to be satisfactory.

(iii) Turnover Ratios:

Turnover ratios measure how quickly certain current assets are converted into cash or how efficiently the assets are
employed by a firm. The important turnover ratios are:

-Inventory Turnover Ratio,

-Debtors Turnover Ratio,

-Average Collection Period,

-Fixed Assets Turnover and

-Total Assets Turnover

Cost of Goods Sold

Inventory Turnover Ratio = Average Inventoty

Where, the cost of goods sold means sales minus gross profit. ‘Average Inventory’ refers to simple average of
opening and closing inventory. The inventory turnover ratio tells the efficiency of inventory management. Higher the
ratio, more the efficient of inventory management.

NetCreditSales
Debtors’ Turnover Ratio = AverageAccounts Re ceivable (Debtors )

The ratio shows how many times accounts receivable (debtors) turns over during the year. If the figure for net credit
sales is not available, then net sales figure is to be used. Higher the debtors turnover, the greater the efficiency of
credit management.

AverageDebtors
Average Collection Period = AverageDailyCreditSales
Average Collection Period represents the number of days’ worth credit sales that is locked in debtors (accounts
receivable).

Please note that the Average Collection Period and the Accounts Receivable (Debtors) Turnover are related as
follows:

365 Days
Average Collection Period = DebtorsTurnover

Fixed Assets turnover ratio measures sales per rupee of investment in fixed assets. In other words, how efficiently
fixed assets are employed. Higher ratio is preferred. It is calculated as follows:
 Net . Sales
Fixed Assets turnover ratio = NetFixedAssets

Total Assets turnover ratio measures how efficiently all types of assets are employed.

Net . Sales
Total Assets turnover ratio = AverageTotalAssets

(II) Leverage/Capital structure ratios

Long term financial strength or soundness of a firm is measured in terms of its ability to pay interest regularly or
repay principal on due dates or at the time of maturity. Such long term solvency of a firm can be judged by using
leverage or capital structure ratios. Broadly there are two sets of ratios: First, the ratios based on the relationship
between borrowed funds and owner’s capital which are computed from the balance sheet. Some such ratios are:
Debt to Equity and Debt to Asset ratios. The second set of ratios which are calculated from Profit and Loss Account
is: The interest coverage ratio and debt service coverage ratio are coverage ratio for leverage risk.

(i) Debt-Equity ratio reflects relative contributions of creditors and owners to finance the business.

Debt
Debt-Equity ratio = Equity

The desirable/ ideal proportion of the two components (high or low ratio) varies from industry to industry.

(ii) Debt-Asset Ratio: Total debt comprises of long term debt plus current liabilities. The total assets comprise of
permanent capital plus current liabilities.

Total Debt
Debt-Asset Ratio = Total Assets
The second set or the coverage ratios measure the relationship between proceeds from the operations of the firm
and the claims of outsiders.

Earnings Before Interest and Taxes

(iii) Interest Coverage ratio = Interest

Higher the interest coverage ratio better is the firm’s ability to meet its interest burden. The lenders use this ratio to
assess debt servicing capacity of a firm.

(iv)Debt Service Coverage Ratio (DSCR) is a more comprehensive and apt to compute debt service capacity of a
firm. Financial institutions calculate the average DSCR for the period during which the term loan for the project is
repayable. The Debt Service Coverage Ratio is defined as follows:

Pr ofit .after. tax+Depreciation+OtherNoncashExpenditure+Interest. on .term.loan

Interest on term loan+Re payment of term loan
(III) Profitability ratios

Profitability and operating/management efficiency of a firm is judged mainly by the following profitability ratios:

Gross Pr ofit
(i) Gross Profit Ratio = Net Sales

Net Profit
(ii) Net Profit Ratio = Net Sales

Some of the profitability ratios related to investments are:

Net Income
(iii) Return on Total Assets = Average Total Assets
 Net Pr ofit
(iv)Return on Capital Employed = Capital Employed

(Here, Capital Employed = Fixed Assets + Current Assets - Current Liabilities)

Net Income After Tax

Return on Shareholders’ Equity = Average Total Shareholders' Equity or NetWorth

(Net worth includes Shareholders’ equity capital plus reserves and surplus)

A common (equity) shareholder has only a residual claim on profits and assets of a firm, i.e., only after claims of
creditors and preference shareholders are fully met, the equity shareholders receive a distribution of profits or assets
on liquidation. A measure of his well being is reflected by return on equity. There are several other measures to
calculate return on shareholders’ equity:

(i) Earnings Per Share (EPS): EPS measures the profit available to the equity shareholders per share, that is, the
amount that they can get on every share held. It is calculated by dividing the profits available to the shareholders by
number of outstanding shares. The profits available to the ordinary shareholders are arrived at by net profits after
taxes and preference dividend.

It indicates the value of equity in the market.

Net Profit
EPS = Number of Ordinary Shares Outs tan ding

EPS¿
Market Price per Share¿ ¿
(ii) Price-earnings ratios = P/E Ratio = ¿
(iii) Cash Earnings per share (CPS/CEPS):
 Net Profit−Preference Dividend+Depreciation
CPS/CEPS = Number of Equity Shares

Illustration:

Balance Sheet of ABC Co. Ltd. as on March 31, 2006

(Amount in Rs. Crores)

Liabilities Amount Assets Amount

Share Capital 16.00 Fixed Assets (net) 60.00

(1,00,00,000 equity shares

of Rs.10 each)

Reserves & Surplus 22.00 Current Assets: 23.40

Secured Loans 21.00 Cash & Bank 0.20

Unsecured Loans 25.00 Debtors 11.80

Current Liabilities & Provisions 16.00 Inventories 10.60

Pre-paid expenses 0.80

Investments 16.60

Total 100 Total 100

Profit & Loss Account of ABC Co. Ltd. for the year ending on March 31, 2006:

Particulars Amount Particulars Amount

Opening Stock 13.00 Sales (net) 105.00

Purchases 69.00 Closing Stock 15.00

Wages and Salaries 12.00

Other Mfg. Expenses 10.00

Gross Profit 16.00

Total 120.00 Total 120.00

Administrative and Personnel Expenses 1.50 Gross Profit 16.00

Selling and Distribution Expenses 2.00

Depreciation 2.50

Interest 1.00

Net Profit 9.00

Total 16.00 Total 16.00

Income Tax 4.00 Net Profit 9.00

Equity Dividend 3.00

Retained Earning 2.00

Total 9.00 Total 9.00

Market price per equity share - Rs. 20.00

Current Ratio = Current Assets / Current Liabilities

= 23.40/16.00 = 1.46

Quick Ratio = Quick Assets / Current Liabilities

=Current Assets-(inventory + prepaid expenses)/Current Liabilities

= [23.40-(10.60+0.8)]/16.00 = 12.00/16.00 = 0.75

Inventory Turnover Ratio = Cost of goods sold/Average Inventory

= (Net Sales-Gross Profit)/ [(opening stock + closing stock)/2]

= (105-16)/ [(15+13)/2] = 89/14 = 6.36

Debtors Turnover Ratio= Net Sales/Average account receivables (Debtors)

=105/11.80 =8.8983

Average Collection period = 365 days / Debtors turnover

= 365 days/8.8983 = 41 days

Fixed Assets Turnover ratio = Net Sales / Net Fixed Assets

= 105/60 = 1.75

Debt to Equity Ratio = Debt/ Equity

= (21.00+25.00)/(16.00+22.00) = 46/38 = 1.21

Gross Profit Ratio = Gross Profit/Net Sales

= 16.00/105.00 = 0.15238 or 15.24%

Net Profit Ratio = Net Profit / Net Sales

= 9/105.00 = 0.0857 or 8.57 %

Return on Shareholders’ Equity = Net Profit after tax/Net worth

= 5.00/(16.00+22.00) =0.13157 or 13.16

SECURITIES MARKET IN INDIA

The securities market in India is an important component of Indian Financial system.

FUNCTIONS OF SECURITIES MARKET:

Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell
shares, bonds, debentures etc. Further, it performs an important role of enabling corporates, entrepreneurs to raise
resources for their companies and business ventures through public issues. Transfer of resources from those having
idle resources (investors) to others who have a need for them (corporates) is most efficiently achieved through the
securities market. Stated formally, securities markets provide channels for reallocation of savings to investments and
entrepreneurship.

Mobilization of savings and acceleration of capital formation

In developing countries like India, plagued by the paucity of resources and increasing demand for investments by
industrial organizations and governments, the importance of the capital market is self evident. In this market, various
types of securities help mobilize savings from various sections of the population. The twin features of reasonable
return and liquidity in the stock exchange are definite incentives to the people to invest in securities. This accelerates
the capital formation in the country.

Promotion of industrial growth

The capital market is a central market through which resources are transferred to the industrial sector of the
economy. The existence of such an institution encourages the people to invest in productive channels rather than in
the unproductive sectors like real estate, bullion etc. Thus, it stimulates industrial growth and economic development
of the country by mobilizing funds for investment in the corporate sector.

Raising long-term capital

The existence of a stock exchange enables companies to raise permanent capital. The investors cannot commit their
funds for a permanent period but companies require funds permanently. The stock exchange resolves this clash of
interests by offering an opportunity to investors to buy or sell their securities while permanent capital with the
company remains unaffected.

Ready and continuous market

The stock exchange provides a central convenient place where buyers and sellers can easily purchase and sell
securities. The element of easy marketability makes investment in securities more liquid as compared to other
assets.

Proper channelization of funds

An efficient capital market not only creates liquidity through its pricing mechanism but also functions to allocate
resources to the most efficient industries. The prevailing market price of a security and relative yield are the guiding
factors for the people to channelise their funds in a particular company. This ensures effective utilization of funds in
the public interest.

Provision of a variety of services

The financial institutions functioning in the securities market provide a variety of services, the more important ones
being the following :

(i) grant of long-term and medium-term loans to entrepreneurs to enable them to establish, expand or
modernize business units;
(ii) provision of underwriting facilities;
(iii) assistance in the promotion of companies (this function is done by the developing banks like IDBI);
(iv) participation in equity capital
(v) expert advice on management of investment in industrial securities.

MARKET SEGMENTS IN SECURITIES MARKET

The securities market has two interdependent and inseparable segments, the new issues (primary) market and the
stock (secondary) market.

PRIMARY MARKET
The primary market provides the channel for creation and sale of new securities, while the secondary market deals in
securities previously issued. The securities issued in the primary market are issued by public limited companies or by
government agencies. The resources in this kind of market are mobilized either through the public issue or through
private placement route. It is a public issue if anybody and everybody can subscribe for it, whereas if the issue is
made available to a selected group of persons it is termed as private placement. There are two major types of issuers
of securities, the corporate entities who issue mainly debt and equity instruments and the government (central as well
as state) who issue debt securities (dated securities and treasury bills).

Secondary Market
The secondary market enables participants who hold securities to adjust their holdings in response to changes in
their assessment of risks and returns. Once the new securities are issued in the primary market they are traded in the
stock (secondary) market. The secondary market operates through two mediums, namely, the over-the-counter
(OTC) market and the exchange-traded market. OTC markets are informal markets where trades are negotiated.
Most of the trades in the government securities are in the OTC market. All the spot trades where securities are traded
for immediate delivery and payment take place in the OTC market. The other option is to trade using the
infrastructure provided by the stock exchanges.
The secondary market is a market in which existing securities are resold or traded. This market is also known as the
stock market. In India, the secondary market consists of recognised stock exchanges operating under rules, bye laws
and regulations of regulators. According to Securities Contracts (Regulation) Act 1956, a stock exchange is defined
as any body of individuals, whether incorporated or not, constituted before corporatisation and demutualization or a
body corporate incorporated under the Companies Act 1956 whether under a scheme of corporatisation and
demutualization or otherwise for the purpose of assisting, regulating or controlling the business of buying, selling or
dealing in securities.
The exchanges in India follow a systematic settlement period. All the trades taking place over a trading cycle (day=T)
are settled together after a certain time (T+2 day). The trades executed on exchanges are cleared and settled by a
clearing corporation. The clearing corporation acts as a counterparty and guarantees settlement. A variant of the
secondary market is the forward market, where securities are traded for future delivery and payment. A variant of the
forward market is Futures and Options market. Presently only two exchanges viz., National Stock Exchange of India
Ltd. (NSE) and Bombay Stock Exchange (BSE) provide trading in the Futures & Options.

HISTORY OF SECURITIES MARKET

The securities market in India dates back to the 18th century when the securities of the East India Company were
traded in Mumbai and Kolkata. The brokers used to gather under a Banyan tree in Mumbai and under a neem tree in
Kolkata for the purpose. However the real beginning came in the 1850’s with the introduction of joint stock companies
with limited liability. The 1860’s witnessed feverish dealings in securities and reckless speculation. This brought
brokers in Bombay together in July 1875 to form the first formally organised stock exchange in the country viz. The
Stock Exchange, Mumbai. Ahmedabad Stock Exchange in 1894, Calcutta in 1908 and Madras in 1937 and 22 others
followed this in the 20th century. In order to promote the orderly development of the stock market, the central
government introduced a comprehensive legislation called the Securities Contract (Regulation) Act, 1956.

The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960’s. However, during the later
half of the 1960s the relative importance of the CSE declined while that of the BSE increased sharply.

Till the early 1990s, the Indian secondary market comprising of various regional stock exchanges was plagued with
the many problems like uncertainty of execution price, uncertain delivery and settlement periods, lack of
transparency, absence of risk management, herd mentality of brokers etc.

Emergence of NSE

The National Stock Exchange of India Limited (NSE) was conceptualized at a time when the industry suffered from
extreme infirmities of opacity, inefficiency of processes and poor infrastructure. It was the time when a section of
powerful brokerage firms mostly located in metropolitan cities dominated the securities industry. NSE wrote for itself
the mandate to create a world-class exchange and use it as an instrument of change for the industry as a whole
through competitive pressure. NSE incorporated in 1992 was given recognition as a stock exchange in April 1993
and started operation in June 1994 with the following objectives

(a) establish a nationwide trading facility for all types of securities,

(b)ensure equal access to all investors all over the country through an appropriate communication network,

(c) provide for a fair, efficient and transparent securities market using electronic trading system,

(d) enable shorter settlement cycles and book entry settlements, and
(e) meet the international benchmarks and standards. Within a short span of time, the above objectives have been
realized and the exchange has played a leading role as a change agent in transforming the Indian Capital Markets to
its present form.

The process of reforms has led to a pace of growth almost unparalleled in the history of any country. Securities
market in India has grown exponentially as measured in terms of amount raised from the market, number of stock
exchanges and other intermediaries, the number of listed stocks, market capitalisation, trading volumes and turnover
on stock exchanges, investor population and price indices. Along with this, the profiles of the investors, issuers and
intermediaries have changed significantly. The market has witnessed fundamental institutional changes resulting in
drastic reduction in transaction costs and significant improvements in efficiency, transparency and safety. Indian
market is now comparable to many developed markets in terms of a number of parameters, as may be seen from the
table below.

Table: International Comparison: end December 2007

Ger- Singa- Hong

Particulars USA UK Japan many pore Kong China India

No. of listed
Companies 5,130 2,588 3,844 658 472 1,029 1,530 4,887

Market
Capitalisation (US
$
Bn.) 19,947 3,859 4,453 2,106 353 1,163 6,226 1,819

Market
Capitalisation
Ratio (%) 149 157.1 90.25 69.43 274.41 583.89 237.6 200.1

Turnover
( US $
Bn.) 42,613 10,324 6,497 3,363 384 917 7,792 1,108

Turnover Ratio
(%) 216.5 270.1 141.6 179.7 122 89.1 180.1 84

Note: Market Capitalisation Ratio is computed as a percentage of GNI 2006

There are very few countries that have higher turnover ratio than India. Market Capitalisation as a percentage of GNP
compares favorably even with advanced countries and much better than emerging markets. In terms of number of
companies listed on stock exchanges, India is second.
MARKET PARTICIPANTS IN SECURITIES MARKET
In every economic system, some units, individuals or institutions, are surplus-generating, who are called savers,
while others are deficit- generating, called spenders. Households are surplus-generating and corporates and
Government are deficit generators. Through the platform of securities markets, the savings units place their surplus
funds in financial claims or securities at the disposal of the spending community and in turn get benefits like interest,
dividend, capital appreciation, bonus etc. These investors and issuers of financial securities constitute two important
elements of the securities markets. The third critical element of markets is the intermediaries who act as conduits
between the investors and issuers. Regulatory bodies, which regulate the functioning of the securities markets,
constitute another significant element of securities markets. The process of mobilisation of resources is carried out
under the supervision and overview of the regulators. The regulators develop fair market practices and regulate the
conduct of issuers of securities and the intermediaries. They are also in charge of protecting the interests of the
investors. The regulator ensures a high service standard from the intermediaries and supply of quality securities and
non-manipulated demand for them in the market.
Thus, the four important participants of securities markets are the investors, the issuers, the intermediaries and
regulators.

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Investors
An investor is the backbone of the capital markets of any economy as he is the one lending his surplus resources for
funding the setting up of or expansion of companies, in return for financial gain.

Investors in Stock Markets can broadly be classified into Retail Investors and Institutional Investors.

Retail Investors are individual investors who buy and sell securities for their personal account, and not for another
company or organization. This category also includes High Networth Individuals (HNI) which comprise of people with
large personal financial holdings.

Institutional Investors comprise of domestic Financial Institutions, Banks, Insurance Companies, Mutual Funds and
FIIs (Foreign Institutional investor is an entity established or incorporated outside India that proposes to make
investments in India).

Issuers
Both PSUs and private companies tap the securities market to finance capital expansion activity and growth plans.
Even banks, financial institutions raise resources from securities market. Other important issuers are mutual funds
which are important investment intermediaries which mobilize the savings of the small investors. Funds can rise in
the primary market from the domestic market as well as from international markets. After the reforms initiated in
1991, one of the major policy change was allowing Indian companies to raise resources by way of equity issues in
the international markets. Indian companies have raised resources from international capital markets through Global
Depository Receipts (GDRs)/American Depository Receipts (ADRs), Foreign Currency Convertible bonds (FCCBs)
and External Commercial Borrowings (ECBs). GDRs are essentially equity instruments issued abroad by authorized
overseas corporate bodies against the shares/bonds of Indian companies held with nominated domestic custodian
banks. ADRs are negotiable instruments, denominated in dollars and issued by the US Depository Bank. FCCBs are
bonds issued by Indian companies and subscribed to by a non-resident in foreign currency. They carry a fixed
interest or coupon rate and are convertible into a certain number of ordinary shares at a preferred price. ECBs are
commercial loans (in the form of bank loans, buyers, credit, suppliers credit, securitised instruments (floating rate
notes and fixed rate bonds) availed from any internationally recognised source such as bank, export credit agencies,
suppliers of equipment, foreign collaborators, foreign equity holders and international capital market. ECBs
supplement domestically available resources for expansion of existing capacity as well as for fresh investment. Indian
companies have preferred this route to raise funds as the cost of borrowing is low in the international markets.

Intermediaries

The term market intermediary is usually used to refer to those who are in the business of managing individual
portfolios, executing orders, dealing in or distributing securities and providing information relevant to the trading of
securities. The market mediators play an important role on the stock exchange market; they put together the
demands of the buyers with the offers of the security sellers. A large variety and number of intermediaries provide
intermediation services in the Indian securities markets.

Stock Exchanges: The stock exchanges provide a trading platform whereby the buyers and sellers can meet to
transact in securities. The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‘Stock Exchange’ as any body
of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the
business of buying, selling or dealing in securities. Stock exchange could be a regional stock exchange whose area
of operation/jurisdiction is specified at the time of its recognition or national exchanges, which are permitted to have
nationwide trading since inception. Currently, there are 20 stock exchanges in India.

Stock Exchanges in India

Ahmedabad Stock Exchange Ltd. MCX Stock Exchange Ltd

Bangalore Stock Exchange Ltd. National Stock Exchange of India Ltd.

Bhubaneswar Stock Exchange Ltd. OTC Exchange of India

Bombay Stock Exchange Ltd. Pune Stock Exchange Ltd.

Calcutta Stock Exchange Association Ltd., Uttar Pradesh Stock Exchange Association Ltd.

Cochin Stock Exchange Ltd.

Delhi Stock Exchange Ltd.

 Gauhati Stock Exchange Ltd.

Interconnected Stock Exchange of India Ltd.

Jaipur Stock Exchange Ltd.

Ludhiana Stock Exchange Ltd.

Madhya Pradesh Stock Exchange Ltd

Madras Stock Exchange Ltd.

Clearing Corporation: A Clearing Corporation is a part of an exchange or a separate entity and performs three
functions, namely, it clears and settles all transactions, i.e. completes the process of receiving and delivering
shares/funds to the buyers and sellers in the market, it provides financial guarantee for all transactions executed on
the exchange and provides risk management functions. National Securities Clearing Corporation (NSCCL), a 100%
subsidiary of NSE, performs the role of a Clearing Corporation for transactions executed on the NSE.

Stock Brokers and Sub–brokers: Stock Broker means a member of a Stock Exchange and Sub-broker means any
person not being a member of Stock Exchange who acts on behalf of a Stock broker as an agent or otherwise for
assisting the investors in buying, selling or dealing in securities through such stock brokers.

Depository : A bank or company which holds funds or securities deposited by others, and where exchanges of these
securities take place.

Depository Participant (DP): The Depository provides its services to investors through its agents called depository
participants (DPs). These agents are appointed by the depository with the approval of SEBI. According to SEBI
regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and SEBI registered trading
members can become DPs.

Custodian: A Custodian is basically an organisation, which helps register and safeguard the securities of its clients.
Besides safeguarding securities, a custodian also keeps track of corporate actions on behalf of its clients:

 Maintaining a client’s securities account

 Collecting the benefits or rights accruing to the client in respect of securities
 Keeping the client informed of the actions taken or to be taken by the issue of securities, having a bearing
on the benefits or rights accruing to the client.

Merchant Bankers: Merchant bankers means any person who is engaged in the business of issue management
either by making arrangements regarding selling, buying or subscribing to securities or acting as a manager,
consultant , adviser or rendering corporate advisory services in relation to such issue management. Merchant
Bankers. Merchant banks are also called investment banks and are most significant institutions in the financial
markets. The merchant banking activity in India is governed by SEBI (Merchant Bankers) Regulations 1992. Each
merchant banker is required to have capital adequacy with prescribed net worth.

Foreign Institutional Investors: Foreign Institutional Investors means an institution established or incorporated outside
India which proposes to make investment in India in securities. Currently, entities eligible to invest under the FII route
are as follows:

a) As FII:

(i) an institution established or incorporated outside India as a pension fund, mutual fund, investment trust, insurance
company or reinsurance company;

(ii) an International or Multilateral Organization or an agency thereof or a Foreign

Governmental Agency, Sovereign Wealth Fund or a Foreign Central Bank;

(iii) an asset management company, investment manager or advisor, bank or institutional portfolio manager,
established or incorporated outside India and proposing to make investments in India on behalf of broad based funds
and its proprietary funds, if any;

(iv) a Trustee of a trust established outside India, and proposing to make investments in India on behalf of broad
based funds and its proprietary funds, if any

(iv) university fund, endowments, foundations or charitable trusts or charitable societies ‘broad based fund” means a
fund established or incorporated outside India, which has at least twenty investor with no single individual investor
holding more hat fort-nine percent of the shares or units of the fund

(b) As Sub-accounts: Sub-accounts means any person resident outside India, on whose behalf investments are
proposed to be made in India by a FII and who is registered as a Sub-account under SEBI (FII) Regulations, 1995.

Mutual Funds: A mutual fund is a company that pools money from many investors and invests the money in stocks,
bonds, short-term money-market instruments, other securities or assets, or some combination of these investments.
Mutual Funds are essentially investment vehicles where people with similar investment objective come together to
pool their money and then invest accordingly. SEBI defines mutual funds as ‘A fund established in the form of a trust
to raise money through the sale of units to the public or a section of the public under one or more schemes for
investing in securities, including money market instruments or gold or gold related instruments or real estate assets.

Collective Investment Scheme (CIS): A Collective Investment Scheme (CIS) is any scheme or arrangement made or
offered by any company, which pools the contributions, or payments made by the investors, and deploys the same.
Venture Capital Funds: Venture Capital Fund (VCF) is a fund established in the form of a trust or a company
including a body corporate having a dedicated pool of capital, raised in the specified manner and invested in Venture
Capital Undertakings (VCUs). VCU is a domestic company whose shares is not listed on a stock exchange and is
engaged in a business for providing services, production, or manufacture of article. A company or body corporate to
carry on activities as a VCF has to obtain a certificate from SEBI and comply with the regulations prescribed in the
SEBI (Venture Capital Regulations) 1996.

Credit Rating Agency: Credit Rating Agency means a body corporate which is engaged in or proposes to be engaged
in the business of rating of securities offered by way of public or rights issues.

Debenture Trustee: Debenture Trustee means a trustee of a Trust deed for securing any issue of debentures of a
body corporate.

The table below presents an overview of market participants in the Indian securities market.
Market Participants As on March 31 As on
March 31,
  2007 2008 2009

Securities Appellate Tribunal (SAT) 1 1 1

Regulators* 4 4 4

Depositories 2 2 2

Stock Exchanges

With Equities Trading 22 19 20

With Debt Market Segment 2 2 2

With Derivative Trading 2 2 2

With Currency Derivatives - - 3

Stock Brokers 9,443 9487 9628

Sub-brokers 27,541 44,074 60,947

FIIs 996 1319 1626

Portfolio Managers 158 205 232

Custodians 15 15 16
 Registrars to an issue & Share Transfer
Agents 82 76 71

Primary Dealers 17 16 16

Merchant Bankers 152 155 134

Bankers to an Issue 47 50 51

Debenture Trustees 30 28 30

Underwriters 45 35 19

Venture Capital Funds 90 106 132

Foreign Venture Capital Investors 78 97 129

Mutual Funds 40 40 44

Credit Rating Agencies 4 5 5

Collective Investment Schemes 0 0 0

* DCA, DEA, RBI & SEBI.

Source: SEBI Bulletin.

The market intermediary has a close relationship with the investor with whose protection the Regulator is primarily
tasked. As a consequence a large portion of the regulation of a securities industry is directed at the market
intermediary. Regulations address entry criteria, capital and prudential requirements, ongoing supervision and
discipline of entrants, and the consequences of default and failure.
One of the issue concerning brokers is the need to encourage then to corporatize. Presently, 44% of the brokers are
corporates. Corporatisation of their business would help them compete with global players in capital markets at home
and abroad. Corporatisation brings better standards of governance and better transparency hence increasing the
confidence level of customers.

Regulators
The absence of conditions of perfect competition in the securities market makes the role of regulator extremely
important. The regulator ensures that the market participants behave in a desired manner so that securities market
continues to be a major source of finance for corporate and government and the interest of investors are protected.
The responsibility for regulating the securities market is shared by Department of Economic Affairs (DEA), Ministry of
Company Affairs (MCA), Reserve Bank of India (RBI) and SEBI. The activities of these agencies are coordinated by
a High Level Committee on Capital Markets. The orders of SEBI under the securities laws are appellable before a
Securities Appellate Tribunal.
Most of the powers under the SCRA are exercisable by DEA while a few others by SEBI. The powers of the DEA
under the SCRA are also con-currently exercised by SEBI. The powers in respect of the contracts for sale and
purchase of securities, gold related securities, money market securities and securities derived from these securities
and ready forward contracts in debt securities are exercised concurrently by RBI. The SEBI Act and the Depositories
Act are mostly administered by SEBI. The rules under the securities laws are framed by government and regulations
by SEBI. All these are administered by SEBI. The powers under the Companies Act relating to issue and transfer of
securities and non-payment of dividend are administered by SEBI in case of listed public companies and public
companies proposing to get their securities listed. The SROs ensure compliance with their own rules as well as with
the rules relevant for them under the securities laws.

COMPONENTS OF SECURITIES MARKET

Securities Market is classified into following markets and different types of instruments are traded in these markets.

Cash/Equity Markets & Its Products

The equity segment of the stock exchange allows trading in shares, debentures, warrants, mutual funds and ETFs.
These products are explained in detail below.

Shares:

Equity Shares: An equity share, commonly referred to as ordinary share, represents the form of fractional ownership
in a business venture. Equity shareholders collectively own the company. They bear the risk and enjoy the rewards of
ownership. Equity shares are further classified into:

 Blue chip shares: Shares of large, well established and financially strong companies with an
impressive record of earnings and dividends
 Growth shares: Shares of companies that have a fairly entrenched position in a growing market
and which enjoy an above average rate of growth as well as profitability
 Income shares: Shares of companies that have fairly stable operations, relatively limited growth
opportunities and high dividend payout ratios.
 Cyclical Shares: Shares of companies that have a pronounced cyclicality to their operations.
 Speculative Shares: Shares that tend to fluctuate widely because there is lot speculative trading in
them.
 Defensive Shares: Shares of companies that are relatively unaffected by the ups and downs in
general business conditions.

Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a ratio to those already
held, at a price. For e.g. a 2:3 rights issue at Rs. 125, would entitle a shareholder to receive 2 shares for
every 3 shares held at a price of Rs. 125 per share.

Bonus Shares: Shares issued by the companies to their shareholders free of cost based on the number of
shares the shareholder owns.
 Preference shares: Owners of these kinds of shares are entitled to a fixed dividend or dividend calculated at
a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy
priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank
below the claims of the company’s creditors, bondholders/debenture holders.

Cumulative Preference Shares:  A type of preference shares on which dividend accumulates if remained
unpaid.  All arrears of preference dividend have to be paid out before paying dividend on equity shares.

Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the
same accumulates, if not paid.  After a specified date, these shares will be converted into equity capital of
the company.

Difference between Equity shareholders and Preferential shareholders:

Equity Shareholders are supposed to be the owners of the company, who therefore, have right to get dividend, as
declared, and a right to vote in the Annual General Meeting for passing any resolution.

The act defines a preference share as that part of share capital of the Company which enjoys preferential right as to:
(a) payment of dividend at a fixed rate during the life time of the Company; and (b) the return of capital on winding up
of the Company.

But Preference shares cannot be traded, unlike equity shares, and are redeemed after a pre-decided period. Also,
Preferential Shareholders do not have voting rights.

Debentures: An instrument for raising long term debt. Debentures in India are typically secured by tangible assets.

Convertible debentures can be converted at the option of the holder into ordinary shares of the same company under
specified terms and conditions. Thus it has features of both debenture as well as equity.

Non Convertible debentures are pure debentures without a feature of conversion They are repayable on maturity.
These debentures are issued at a highly discounted issue price.

Partly Convertible debentures have features of convertible and non-convertible debentures.

Warrants: A company may issue equity shares or debentures attached with warrants. Warrants entitle an investor to
buy equity shares after a specified time period at a given price.
PRIMARY MARKET
The primary market is a market for new issues i.e. a market for fresh capital. The primary market provides the
channel for sale of new securities. Primary market provides opportunity to issuers of securities; government as well
as corporates, to raise resources to meet their requirements of investment and/or discharge some obligation.

They may issue the securities at face value, or at a discount/premium and these securities may take a variety of
forms such as equity, debt etc. They may issue the securities in domestic market and/or international market.

The primary market issuance is done either through public issues or private placement. A public issue does not limit
any entity in investing while in private placement, the issuance is done to select people. In terms of the Companies
Act, 1956, an issue becomes public if it results in allotment to more than 50 persons. This means an issue resulting in
allotment to less than 50 persons is private placement. There are two major types of issuers who issue securities.
The corporate entities issue mainly debt and equity instruments (shares, debentures, etc.), while the governments
(central and state governments) issue debt securities (dated securities, treasury bills).

The price signals, which subsume all information about the issuer and his business including associated risk,
generated in the secondary market, help the primary market in allocation of funds.

The issuers may issue securities in domestic market and international market through ADR / GDR route.

DIFFERENT KINDS OF ISSUES

Most companies are usually started privately by their promoter(s). However, the promoters’ capital and the
borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a
long term. So companies invite the public to contribute towards the equity and issue shares to individual investors.
The way to invite share capital from the public is through a ‘Public Issue’. Simply stated, a public issue is an offer to
the public to subscribe to the share capital of a company. Once this is done, the company allots shares to the
applicants as per the prescribed rules and regulations laid down by SEBI.

Issues can be classified as a Public, Rights or preferential issues (also known as private placements). While public
and rights issues involve a detailed procedure, private placements or preferential issues are relatively simpler. The
classification of issues is illustrated below:

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PUBLIC ISSUE

When an issue / offer of securities is made to new investors for becoming part of shareholders’ family of the issue3 it
is called a public issue. Public issue can be further classified into Initial public offer (IPO) and Further public offer
(FPO). The significant features of each type of public issue are illustrated below:

IPO

Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or an offer for sale
of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s
securities in the Stock Exchanges.

An IPO can either be a fresh issue or an offer for sale i.e. offering of securities by existing shareholders of the
company to the public.

FPO

A Further public offering (FPO) is when an already listed company makes either a fresh issue of securities to the
public or an offer for sale to the public, through an offer document. An offer for sale in such scenario is allowed only if
it is made to satisfy listing or continuous listing obligations.

RIGHTS ISSUE

When an issue of securities is made by an issuer to its shareholders existing as on a particular date fixed by the
issuer (i.e. record date), it is called a rights issue. The rights are offered in a particular ratio to the number of
securities held as on the record date.

BONUS ISSUE

When an issuer makes an issue of securities to its existing shareholders as on a record date, without any
consideration from them, it is called a bonus issue. The shares are issued out of the Company’s free reserve or share
premium account in a particular ratio to the number of securities held on a record date.
PRIVATE PLACEMENT
When an issuer makes an issue of securities to a select group of persons not exceeding 49, and which is neither a
rights issue nor a public issue, it is called a private placement. Private placement of shares or convertible securities
by listed issuer can be of two types:

Preferential allotment

When a listed issuer issues shares or convertible securities, to a select group of persons in terms of provisions of
Chapter XIII of SEBI (DIP) guidelines, it is called a preferential allotment. The issuer is required to comply with
various provisions which inter alia include pricing, disclosures in the notice, lock in etc, in addition to the requirements
specified in the Companies Act.

Qualified institutions placement (QIP)

When a listed issuer issues equity shares or securities convertible in to equity shares to Qualified Institutions Buyers
only in terms of provisions of Chapter XIIIA of SEBI (DIP) guidelines, it is called a QIP.

Usually, the term private placement is used for unlisted companies and the term preferential issue is used for listed
companies. QIP is also for listed companies.

Funds mobilized in Primary Market

2008-09 2007-08

Particulars Amount Amount

No. of issues No. of issues
(Rs. Cr.) (Rs. Cr.)

a) Public Issues 21 2082.35 92 54511

(I) IPOs 21 2082.35 85 42101.8

(ii) FPOs 0 0 7 11915.8

b) Rights Issues 25 12637.16 32 32518

c) QIP 2 188.82 36 25525

TOTAL 48 14908.33 160 112554

* excluding preferential allotments

OFFER DOCUMENTS

Offer document is a document which contains all the relevant information about the company, promoters, projects,
financial details, objects of raising the money, terms of the issue etc and is used for inviting subscription to the issue
being made by the issuer.

Offer Document is called Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights
issue.

The terms used for offer documents are defined below.

Draft offer document

Draft offer document is an offer document filed with SEBI for specifying changes, if any, in it, before it is filed with the
Registrar of companies (ROCs). Draft offer document is made available in public domain including SEBI website, for
enabling public to give comments, if any, on the draft offer document.

RED HERRING PROSPECTUS

Red herring prospectus is an offer document used in case of a book built public issue. It contains all the relevant
details except that of price or number of shares being offered. It is filed with RoC before the issue opens.

PROSPECTUS

Prospectus is an offer document in case of a public issue, which has all relevant details including price and number
of shares being offered. This document is registered with RoC before the issue opens in case of a fixed price issue
and after the closure of the issue in case of a book built issue.

LETTER OF OFFER
Letter of offer is an offer document in case of a Rights issue and is filed with Stock exchanges before the issue
opens.

Abridged prospectus is an abridged version of offer document in public issue and is issued along with the application
form of a public issue. It contains all the salient features of a prospectus.
Abridged letter of offer is an abridged version of the letter of offer. It is sent to all the shareholders along with the
application form.

Shelf prospectus is a prospectus which enables an issuer to make a series of issues within a period of 1 year without
the need of filing a fresh prospectus every time. This facility is available to public sector banks /Public Financial
Institutions.

PLACEMENT DOCUMENT

Placement document is an offer document for the purpose of Qualified Institutional Placement and contains all the
relevant and material disclosures.

UNDERSTANDING THE OFFER DOCUMENT

Cover Page

Under this head full contact details of the Issuer Company, lead managers and registrars, the nature, number, price
and amount of instruments offered and issue size, and the particulars regarding listing. Other details such as Credit
Rating, IPO Grading, risks in relation to the first issue, etc are also disclosed if applicable.

Risk Factors

Under this head the management of the issuer company gives its view on the Internal and external risks envisaged
by the company and the proposals, if any, to address such risks. The company also makes a note on the forward
looking statements. This information is disclosed in the initial pages of the document and also in the abridged
prospectus. It is generally advised that the investors should go through all the risk factors of the company before
making an investment decision.

Introduction

Under this head a summary of the industry in which the issuer company operates, the business of the Issuer
Company, offering details in brief, summary of consolidated financial statements and other data relating to general
information about the company, the merchant bankers and their responsibilities, the details of brokers/syndicate
members to the Issue, credit rating (in case of debt issue), debenture trustees (in case of debt issue), monitoring
agency, book building process in brief, IPO Grading in case of First Issue of Equity capital and details of underwriting
Agreements are given. Important details of capital structure, objects of the offering, funds requirement, funding plan,
schedule of implementation, funds deployed, sources of financing of funds already deployed, sources of financing for
the balance fund requirement, interim use of funds, basic terms of issue, basis for issue price, tax benefits are also
covered.

About us

Under this head a review of the details of business of the company, business strategy, competitive strengths,
insurance, industry]regulation (if applicable), history and corporate structure, main objects, subsidiary details,
management and board of directors, compensation, corporate governance, related party transactions, exchange
rates, currency of presentation and dividend policy are given.

Financial Statements

Under this head financial statement and restatement as per the requirement of the Guidelines and differences
between any other accounting policies and the Indian Accounting Policies (if the Company has presented its
Financial Statements also as per either US GAAP/IFRS) are presented.

Legal and other information

Under this head outstanding litigations and material developments, litigations involving the company, the promoters
of the company, its subsidiaries, and group companies are disclosed. Also material developments since the last
balance sheet date, government approvals/licensing arrangements, investment approvals (FIPB/RBI etc.), technical
approvals, and indebtedness, etc. are disclosed.

Other regulatory and statutory disclosures

Under this head, authority for the Issue, prohibition by SEBI, eligibility of the company to enter the capital market,
disclaimer statement by the issuer and the lead manager, disclaimer in respect of jurisdiction, distribution of
information to investors, disclaimer clause of the stock exchanges, listing, impersonation, minimum subscription,
letters of allotment or refund orders, consents, expert opinion, changes in the auditors in the last 3 years, expenses
of the issue, fees payable to the intermediaries involved in the issue process, details of all the previous issues, all
outstanding instruments, commission and brokerage on, previous issues, capitalization of reserves or profits, option
to subscribe in the issue, purchase of property, revaluation of assets, classes of shares, stock market data for equity
shares of the company, promise vis-à-vis performance in the past issues and mechanism for redressal of investor
grievances is disclosed.

Offering information

Under this head, terms of the Issue, ranking of equity shares, mode of payment of dividend, face value and issue
price, rights of the equity shareholder, market lot, nomination facility to investor, issue procedure, book building
procedure in details along with the process of making an application, signing of underwriting agreement and filing of
prospectus with SEBI/ROC, announcement of statutory advertisement, issuance of confirmation of allocation
note("can") and allotment in the issue, designated date, general instructions, instructions for completing the bid form,
payment instructions, submission of bid form, other instructions, disposal of application and application moneys, ,
interest on refund of excess bid amount, basis of allotment or allocation, method of proportionate allotment, dispatch
of refund orders, communications, undertaking by the company, utilization of issue proceeds, restrictions on foreign
ownership of Indian securities, are disclosed.

Other Information

This covers description of equity shares and terms of the Articles of Association, material contracts and documents
for inspection, declaration, definitions and abbreviations, etc.

REGULATION FOR DIFFERENT KINDS OF ISSUES

SEBI DIP GUIDELINES

SEBI (Disclosure & Investor Protection) Guidelines, 2000 are applicable to all public issues by listed and unlisted
companies, all offers for sale and rights issues by listed

companies whose equity share capital is listed, except in case of rights issues where the aggregate value of
securities offered does not exceed Rs.50 lakhs in case of the rights issue where the aggregate value of the securities
offered is less than Rs.50 lakhs, the company is required to prepare the letter of offer in accordance with the
disclosure requirements specified in the DIP guidelines and file the same with SEBI for its information. Unless
otherwise stated, all provisions in these guidelines are also applicable to public issues by unlisted companies shall
also apply to offers for sale to the public by unlisted companies.

SEBIs role in an Issue

Any company making a public issue or a rights issue of securities of value more than Rs 50 lakhs is required to file a
draft offer document with SEBI for its observations. The validity period of SEBIs observation letter is twelve months
only i.e. the company has to open its issue within the period of twelve months starting from the date of issuing the
observation letter.

There is no requirement of filing any offer document / notice to SEBI in case of preferential allotment and Qualified
Institution Placement (QIP). In QIP, Merchant Banker handling the issue has to file the placement document with
Stock Exchanges for making the same available on their websites.

(a) Till the early nineties, Controller of Capital Issues used to decide about entry of company in the market and also
about the price at which securities should be offered to public. However, following the introduction of disclosure
based regime under the aegis of SEBI, companies can now determine issue price of securities freely without any
regulatory interference, with the flexibility to take advantage of market forces.

(b) The primary issuances are governed by SEBI in terms of SEBI (Disclosures and Investor protection) guidelines.
SEBI framed its DIP guidelines in 1992. The SEBI DIP Guidelines over the years have gone through many
amendments in keeping pace with the dynamic market scenario. It provides a comprehensive framework for issuing
of securities by the companies.

(c) Before a company approaches the primary market to raise money by the fresh issuance of securities it has to
make sure that it is in compliance with all the requirements of SEBI (DIP) Guidelines, 2000. The Merchant Banker are
those specialised intermediaries registered with SEBI, who perform the due diligence and ensures compliance with
DIP Guidelines before the document is filed with SEBI.

(d) Officials of SEBI at various levels examine the compliance with DIP guidelines and ensure that all necessary
material information is disclosed in the draft offer documents.

SEBI does not recommend any issue nor does it take any responsibility either for the financial soundness of any
scheme or the project for which the issue is proposed to be made. The submission of offer document to SEBI does
not imply that the same has been cleared or approved by SEBI. The Lead manager certifies that the disclosures
made in the offer document are generally adequate and are in conformity with SEBI guidelines for disclosures and
investor protection in force for the time being. This requirement is to facilitate investors to take an informed decision
for making investment in the proposed issue. The investors are required take an informed decision purely by
themselves based on the contents disclosed in the offer documents. SEBI is not associated with any issue/issuer.
Investors are advised to study all the material facts pertaining to the issue including the risk factors before
considering any investment.

ISSUE REQUIREMENTS

SEBI has laid down eligibility norms for entities accessing the primary market through public issues. There is no
eligibility norm for a listed company making a rights issue as it is an offer made to the existing shareholders who are
expected to know their company. There are no eligibility norms for a listed company making a preferential issue.

A) Entry Norms

SEBI has laid down entry norms for entities making a public issue/ offer. Entry norms are different routes available to
an issuer for accessing the capital market.
(i) An unlisted issuer making a public issue i.e. (making an IPO) is required to satisfy the following provisions:

Entry Norm I (commonly known as Profitability Route)

The Issuer Company has to meet the following requirements:

(a) Net Tangible Assets of at least Rs. 3 Crores in each of the preceding three full years.

(b) Distributable profits in atleast three of the immediately preceding five years.

(c) Networth of at least Rs. 1 crore in each of the preceding three full years.

(d) If the company has changed its name within the last one year, atleast 50%

revenue for the preceding 1 year should be from the activity suggested by the new name.

(e) The issue size does not exceed 5 times the pre] issue net worth as per the audited balance sheet of the last
financial year.

To provide sufficient flexibility and also to ensure that genuine companies do not suffer on account of rigidity of the
Parameters, SEBI has provided two other alternative routes to the companies not satisfying any of the above
conditions, for

accessing the primary Market, as under:

Entry Norm II (Commonly known as “QIB Route”)

(a) Issue should be through book building route, with at least 50% to be mandatory allotted to the Qualified
Institutional Buyers (QIBs).

(b) The minimum post-issue face value capital shall be Rs. 10 Crores or there shall be a compulsory market-making
for at least 2 years.

Entry Norm III (commonly known as Appraisal Route)

(a) The “project” is appraised and participated to the extent of 15% by Financial Institutions / Scheduled Commercial
Banks of which at least 10% comes from the appraiser(s).
(b) The minimum post issue face value capital shall be Rs. 10 Crores or there should be a compulsory market-
making for at least 2 years.

In addition to satisfying the aforesaid entry norms, the Issuer Company should also

satisfy the criteria of having at least 1000 prospective allotees in its issue.

(ii) A listed issuer making a public issue (FPO) is required to satisfy the following requirements:

(a) If the company has changed its name within the last one year, atleast 50% revenue for the preceding 1 year
should be from the activity suggested by the new name.

(b) The issue size does not exceed 5 times the pre] issue net worth as per the audited balance sheet of the last
financial year. Any listed company not fulfilling these conditions shall be eligible to make a public issue by complying
with QIB Route or Appraisal Route as specified for IPOs.

(iii) Certain category of entities which are exempted from the aforesaid entry norms, are as under:

(a) Private Sector Banks

(b) Public sector banks

(c) An infrastructure company whose project has been appraised by a Public Financial Institution or IDFC or IL&FS or
a bank which was earlier a PFI and not less than 5% of the project cost is financed by any of these institutions.

Mandatory Norms

An issuer making a public issue is required to inter alia comply with the following provisions mentioned in the
guidelines:

Minimum Promoter’s contribution and lock-in: In a public issue by an unlisted issuer, the promoters are required to
contribute not less than 20% of the post issue capital which should be locked in for a period of 3 years. “Lock in”
indicates a freeze on the shares. The remaining pre issue capital should also be locked in for a period of 1 year from
the date of listing. In case of public issue by a listed issuer [i.e. FPO], the promoters are required to contribute not
less than 20% of the post issue capital or 20% of the issue size. This provision ensures that promoters of the
company have some minimum stake in the company for a minimum period after the issue or after the project for
which funds have been raised from the public is commenced.
IPO Grading: IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial public
offering (IPO) of equity shares or other convertible securities. The grade represents a relative assessment of the
fundamentals of the IPO in relation to the other listed equity securities. Disclosure of “IPO Grades”, so obtained is
mandatory for companies coming out with an IPO.

No unlisted company can make an IPO of equity shares or any other security which may be converted into or
exchanged with equity shares at a later date, unless the following conditions are satisfied as on the date of filing of
Prospectus (in case of fixed price issue) or Red Herring Prospectus (in case of book built issue) with ROC:

 the unlisted company has obtained grading for the IPO from at least one credit rating agency;
 disclosures of all the grades obtained, along with the rationale/ description furnished by the credit rating
agency(ies) for each of the grades obtained, have been made in the Prospectus (in case of fixed price
issue) or Red Herring Prospectus (in case of book built issue)
 the expenses incurred for grading IPO have been borne by the unlisted company obtaining grading for
IPO.)

Other Conditions are:

 No unlisted company can make a public issue of equity share or any security convertible at later date into
equity share, if there are any outstanding financial instruments or any other right which would entitle the
existing promoters or shareholders any option to receive equity share capital after the initial public offering.
 No company can make a public or rights issue of equity share or any security convertible at later date into
equity share, unless all the existing partly paid-up shares have been fully paid or forfeited in a manner
specified in clause
 No company shall make a public or rights issue of securities unless firm arrangements of finance through
verifiable means towards 75% of the stated means of finance, excluding the amount to be raised through
proposed Public/ Rights issue, have been made.)

Credit Rating of Debt Instruments: No issuer company should make a public issue or rights issue of convertible debt
instruments, unless the following conditions are satisfied, as on date of filing of draft offer document with SEBI and
also on the date of filing a final offer document with ROC/ Designated Stock Exchange:

(i) credit rating is obtained from at least one credit rating agency registered with SEBI and should be disclosed in the
offer document;

(ii) The company should not be in the list of willful defaulters of RBI;

(iii) The company should not have defaulted in payment of interest or repayment of principal in respect of debentures
issued to the public, if any, for a period of more than 6 months.
If the credit ratings are obtained from more than one credit rating agencies, all the ratings, including the unaccepted
ratings, should be disclosed in the offer document. All the credit ratings obtained during the three (3) years preceding
the pubic or rights issue of debt instrument (including convertible instruments) for any listed security of the issuer
company should be disclosed in the offer document.

FAST TRACK ISSUES (FTI)

SEBI introduced FTI in order to enable well established and compliant listed companies satisfying certain specific
entry norms/conditions to access Indian Primary Market in a time effective manner. Such companies can proceed
with FPOs / Right Issues by filing a copy of RHP / Prospectus with the RoC or the Letter of Offer with designated SE,
SEBI and Stock Exchanges. Such companies are not required to file Draft Offer Document for SEBI comments and
to Stock Exchanges. Entry Norms for companies seeking to access Primary Market through FTI’s in case aggregate
value of securities including premium exceeds Rs. 50 lakhs:

(i) The shares of the company have been listed on any stock exchange having nationwide terminals for a period of at
least three years immediately preceding the date of filing of offer document with RoC/ SE.

(ii) The “average market capitalisation of public shareholding” of the company is at least Rs. 10,000 Crores for a
period of one year up to the end of the quarter proceeding the month in which the proposed issue is approved by the
Board of Directors / shareholders of the issuer.

(iii) The annualized trading turnover of the shares of the company during six calendar months immediately preceding
the month of the reference date has been at least two percent of the weighted average number of shares listed
during the said six months period.

(iv) The company has redressed at least 95% of the total shareholder / investor grievances or complaints received till
the end of the quarter immediately proceeding the month of the date of filing of offer document with RoC/ SE.

(v) The company has complied with the listing agreement for a period of at least three years immediately preceding
the reference date.
(vi) The impact of auditors’ qualifications, if any, on the audited accounts of the company in respect of the financial
years for which such accounts are disclosed in the offer document does not exceed 5% of the net profit/ loss after tax
of the company for the respective years.

(vii) No prosecution proceedings or show cause notices issued by the Board are pending against the company or its
promoters or whole time directors as on the reference date.

(viii) The entire shareholding of the promoter group is held in dematerialised form as on the reference date.

PRICING BY COMPANIES ISSUING SECURITIES

Public/Rights Issue by Listed Companies

A listed company whose equity shares are listed on a stock exchange, can freely price its equity shares and any
security convertible into equity at a later date offered through a public or rights issue.

Public Issue by Unlisted Companies

An unlisted company eligible to make a public issue and desirous of getting its securities listed on a recognised stock
exchange pursuant to a public issue, may freely price its equity shares or any securities convertible at a later date
into equity shares.

Initial Public Issue by Banks

The banks (whether public sector or private sector) may freely price their issue of equity shares or any securities
convertible at a later date into equity share subject to the approval by the Reserve Bank of India.

Differential Pricing

Any unlisted company or a listed company making a public issue of equity shares or securities convertible at a later
date into equity shares, may issue such securities to applicants in the firm allotment category at a price different from
the price at which the net offer to the public is made, provided that the price at which the security is being offered to
the applicants in firm allotment category is higher than the price at which securities are offered to public. The net offer
to the public means the offer made to the Indian public and does not include firm allotments or reservations or
promoters’ contributions.

An unlisted company or a listed company making a public issue of equity shares or securities convertible at a later
date into equity shares may issue such securities to retail individual investors and/or retail individual shareholders at
a price lower than the price at which net offer is made to other categories of public. However, the difference between
the price at which the securities are issued to retail individual investors and/or retail individual shareholders and the
price at which the net offer is made to other categories of public, is not more than 10% of the price at which securities
are offered to other categories of public.)

Price Band

Issuer company can mention a price band of 20% (cap in the price band should not be more than 20% of the floor
price) in the offer documents filed with SEBI and actual price can be determined at a later date before filing of the
offer document with ROCs. If the Board of Directors have been authorised to determine the offer price within a
specified price band such price shall be determined by a Resolution to be passed by the Board of Directors. The
Lead Merchant Bankers should ensure that in case of the listed companies, a 48 hours notice of the meeting of the
Board of Directors for passing resolution for determination of price is given to the Designated Stock Exchange.

 In case of public issue by listed issuer company, issue price or price band may not be disclosed in the draft
prospectus filed with SEBI.
 In case of a rights issue, issue price or price band may not be disclosed in the draft letter of offer filed with
SEBI. The issue price may be determined anytime before fixation of the record date, in consultation with the
Designated Stock Exchange.)

The final offer document should contain only one price and one set of financial projections, if applicable. No payment,
direct or indirect in the nature of a discount, commission, allowance or otherwise shall be made either by the issuer
company or the promoters in any public issue, to the persons who have received firm allotment in such public issue.

Determining Denomination of Shares for Public/Rights Issues

An eligible company is free to make public or rights issue of equity shares in any denomination determined by it in
accordance with Sub-section (4) of Section 13 of the Companies Act, 1956 and in compliance with the following and
other norms as may be specified by SEBI from time to time.

In case of Initial public offer by an unlisted company:

a. If the issue price is Rs. 500/- or more, the issuer company has a discretion to fix the face value below Rs. 10/- per
share subject to the condition that the face value however it should not be less than Rs. 1 per share. However, this
does not apply to initial public offer made by any government company, statutory authority or corporation or any
special purpose vehicle set up by any of them, which is engaged in infrastructure sector.

b. If issue price is less than Rs. 500 per share, the face value should be Rs. 10/- per share;
Indian primary market ushered in an era of free pricing in 1992. Following this, the guidelines have provided that the
issuer in consultation with Merchant Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI
does not play any role in price fixation. The company and merchant banker are however required to give full
disclosures of the parameters which they had considered while deciding the issue price. There are two types of
issues one where company and Lead Merchant banker fix a price (called fixed price) and other, where the company
and Lead Manager (LM) stipulate a floor price or a price band and leave it to market forces to determine the final
price (price discovery through book building process).

PRICING OF AN ISSUE

On the basis of Pricing, an issue can be further classified into Fixed Price issue or Book Built issue.

Fixed Price Issue: When the issuer at the outset decides the issue price and mentions it in the Offer Document, it is
commonly known as Fixed price issue.

Book built Issue: When the price of an issue is discovered on the basis of demand received from the prospective
investors at various price levels, it is called Book Built issue’.

BOOK BUILDING

Book building is a process of price discovery. The issuer discloses a price band or floor price before opening of the
issue of the securities offered. On the basis of the demands received at various price levels within the price band
specified by the issuer, Book Running Lead Manager (BRLM) in close consultation with the issuer arrives at a price
at which the security offered by the issuer, can be issued.

Price Band

The price band is a band of price within which investors can bid. The spread between the floor and the cap of the
price band should not be more than 20%. The price band can be revised. If revised, the bidding period shall be
extended for a further period of three days, subject to the total bidding period not exceeding thirteen days.

Process of Book Building

Book building is a process of price discovery. A floor price or price band within which the bids can move is disclosed
at least two working days before opening of the issue in case of an IPO and atleast one day before opening of the
issue in case of an FPO. The applicants bid for the shares quoting the price and the quantity that they would like to
bid at. After the bidding process is complete, the ‘cut off’ price is arrived at based on the demand of securities. The
basis of Allotment is then finalized and allotment/refund is undertaken. The final prospectus with all the details
including the final issue price and the issue size is filed with ROC, thus completing the issue process. Only the retail
investors have the option of bidding at ‘cutoff’.

Cut off option is available for only retail individual investors i.e. investors who are applying for securities worth up to
Rs 1,00,000/ only. Such investors are required to tick the cut off option which indicates their willingness to subscribe
to shares at any price discovered within the price band. Unlike price bids (where a specific price is indicated) which
can be invalid, if price indicated by applicant is lower than the price discovered, the cut off bids always remain valid
for the purpose of allotment

One can change or revise the quantity or price in the bid using the form for changing/revising the bid that is available
along with the application form. However, the entire process of changing or revising the bids is required to be
completed within the date of closure of the issue. One can also cancel the bid anytime before the finalization of the
basis of allotment by approaching/ writing/ making an application to the registrar to the issue.

TYPES OF INVESTORS & ALLOTMENTS MADE TO THEM

Allotment of issues is made to different categories of Investors. Let us understand the types of investors for allotment
purpose.

Retail individual Investor (RIIs)

Retail individual Investor (RIIs) means an investor who applies or bids for securities for a value of not more than Rs.
1,00,000.

Qualified Institutional Buyer

Qualified Institutional Buyer means:

a) a public financial institution as defined in section 4A of the Companies Act, 1956;

b) a scheduled commercial bank;

c) a mutual fund registered with the Board;

d) a foreign institutional investor and sub]account registered with SEBI, other than a sub account which is a foreign
corporate or foreign individual;

e) a multilateral and bilateral development financial institution;

f) a venture capital fund registered with SEBI;

g) a foreign venture capital investor registered with SEBI;

h) a state industrial development corporation;

i) an insurance company registered with the Insurance Regulatory

and Development Authority (IRDA);

j) a provident fund with minimum corpus of Rs. 25 Crores;

k) a pension fund with minimum corpus of Rs. 25 Crores);

l) National Investment Fund

Non Institutional Investors (NIIs)

Non Institutional Investors are those who do not fall under the categories of Retail Individual Investor and Qualified
Institutional Investor.

ALLOTMENT TO VARIOUS KINDS OF INVESTORS

In case of Book Built issue

1. In case an issuer company makes an issue of 100% of the net offer to public through 100% book building process
—

(a) Not less than 35% of the net offer to the public shall be available for allocation to retail individual investors;

(b) Not less than 15% of the net offer to the public shall be available for allocation to Non institutional investors i.e.
investors other than retail individual investors and

Qualified Institutional Buyers;

(c) Not more than 50% of the net offer to the public shall be available for allocation to Qualified Institutional Buyers:

2. In case of compulsory Book Built Issues at least 50% of net offer to public being allotted to the Qualified
Institutional Buyers (QIBs), failing which the full subscription money will be refunded.
3. In case the book built issues are made pursuant to the requirement of mandatory allocation of 60% to QIBs in
terms of Rule 19(2)(b) of Securities Contract (Regulation) Rules, 1957, the respective figures are 30% for RIIs and
10% for NIIs.

In case of fixed price issue

The proportionate allotment of securities to the different investor categories in a fixed price issue is as described
below:

1. A minimum 50% of the net offer of securities to the public shall initially be made available for allotment to retail
individual investors, as the case may be.

2. The balance net offer of securities to the public shall be made available for allotment to:

a. Individual applicants other than retail individual investors, and

b. Other investors including corporate bodies/ institutions irrespective of the number of securities applied for.

FIRM ALLOTMENT INVESTOR CATEGORIES

SEBI (DIP) guidelines provide that an issuer making an issue to public can allot shares on firm basis to some
categories as specified below:

(i) Indian and Multilateral Development Financial Institutions,

(ii) Indian Mutual Funds,

(iii) Foreign Institutional Investors including Non]Resident Indians and Overseas Corporate Bodies and

(iv) Permanent/regular employees of the issuer company.

(v) Scheduled Banks

OCBs are prohibited by RBI to make investment.

Reservation on Competitive Basis is when allotment of shares is made in proportion to the shares applied for by the
concerned reserved categories. Reservation on competitive basis can be made in a public issue to the following
categories:
(i) Employees of the company.

(ii) Shareholders of the promoting companies in the case of a new company and shareholders of group companies in
the case of an existing company.

(iii) Indian Mutual Funds.

(iv) Foreign Institutional Investors (including non resident Indians and overseas corporate bodies).

(v) Indian and Multilateral development Institutions.

(vi) Scheduled Banks.

In a public issue by a listed company, the reservation on competitive basis can be made for retail individual
shareholders and in such cases the allotment to such shareholders shall be on proportionate basis

There is no discretion in the allotment process. All allotees are allotted shares on a proportionate basis within their
respective investor categories.

INTERMEDIARIES INVOLVED IN THE ISSUE PROCESS

Intermediaries which are registered with SEBI are Merchant Bankers to the issue (known as Book Running Lead
Managers (BRLM) in case of book built public issues), Registrars to the issue, Bankers to the issue & Underwriters to
the issue who are associated with the issue for different activities. Their addresses, telephone/fax numbers,
registration number, and contact person and email addresses are disclosed in the offer documents.

Merchant Banker

Merchant banker does the due diligence to prepare the offer document which contains all the details about the
company. They are also responsible for ensuring compliance with the legal formalities in the entire issue process and
for marketing of the issue.

Registrars to the Issue

They are involved in finalizing the basis of allotment in an issue and for sending refunds, allotment etc.

Bankers to the Issue

The Bankers to the Issue enable the movement of funds in the issue process and therefore enable the registrars to
finalize the basis of allotment by making clear funds status available to the Registrars.

Underwriters

Underwriters are intermediaries who undertake to subscribe to the securities offered by the company in case these
are not fully subscribed by the public, in case of an underwritten issue.

ASBA

To make the existing public issue process more efficient, SEBI introduced a supplementary process of applying in
public issues, viz, the ‘Applications Supported by Blocked Amount (ASBA) in July 2008. ASBA is an application
containing an authorization to block the application money in the bank account, for subscribing to an issue. If an
investor is applying through ASBA, his application money is debited from the bank account only if his/her application
is selected for allotment after the basis of allotment is finalized, or the issue is withdrawn/failed .In case of rights issue
his application money is debited from the bank account after the receipt of instruction from the registrars. The ASBA
process is available in all public issues made through the book building route. In September 2008, the ASBA facility
was extended to Rights Issue.

Meaning

ASBA stands for ‘Application Supported by Blocked amount’. ASBA is an application containing an authorization to
block the application money in the bank account, for subscribing to an issue. If an investor is applying through ASBA,
his application money will be debited from the bank account only if his/her application is selected for allotment after
the basis of allotment is finalized, or the issue is withdrawn/failed .In case of rights issue his application money shall
be debited from the bank account after the receipt of instruction from the registrars.

ASBA Investor

ASBA Investor means an Investor who intends to apply through ASBA process and is a Resident Retail Individual
Investor, is bidding at cut-off, with single option as to the number of shares bid for; is applying through blocking of
funds in a bank account with the SCSB; has agreed not to revise his/her bid; is not bidding under any of the reserved
categories.

An investor can apply through ASBA process in a public issue through book building route provided he/ she:

a. is a “Resident Retail Individual Investor” i.e. applying for shares/ securities up.

b. is bidding at cut off, with single option as to the number of shares bid for.

c. is applying through blocking of funds in a bank account with the SCSB;

d. has agreed not to revise his/her bid;

e. is not bidding under any of the reserved categories.

SEBI has permitted ASBA process in rights issue on pilot basis. All shareholders of the company as on record date
are permitted to use ASBA for making applications in rights issue provided he /she:

a. is holding shares in dematerialised form and has applied for entitlements or additional shares in the issue in
dematerialised form;

b. has not renounced its entitlements in full or in part;

c. is not a renouncee to the Issue;

d. applies through a bank account maintained with SCSBs.

Advantages of ASBA

(i) The investor need not pay the application money by cheque rather the investor submits ASBA which
accompanies an authorization to block the bank account to the extent of the application money.

(ii) The investor does not have to bother about refunds, as in ASBA only that much money which is required for
allotment of securities, is taken from the bank account only when his application is selected for allotment after the
basis of allotment is finalized.

(iii) The investor continues to earn interest on the application money as the same remains in the bank account.

(iv) The application form is simpler.

(v) The investor deals with the known intermediary i.e its own bank.
Self certified Syndicate Bank (SCSB)

SCSB is a bank which is recognized as a bank capable of providing ASBA services to investors. Names of such
banks would appear in the list available in website of SEBI.

In case of an issue, an investor can apply either through ASBA or through existing system of payment through
cheque. If an applicant applies through both ASBA as well as non ASBA then the both the applications having the
same PAN, will be treated as multiple application and hence rejected.

CONCEPT CLARIFIERS FOR PRIMARY MARKET

Face Value of a share/debenture

The nominal or stated amount (in Rs.) assigned to a security by the issuer. For shares, it is the original cost of the
stock shown on the certificate; for bonds, it is the amount paid to the holder at maturity. It is also known as par value
or simply par. For an equity share, the face value is usually a very small amount (Rs. 5, Rs. 10) and does not have
much bearing on the price of the share, which may quote higher in the market, at Rs. 100 or Rs. 1000 or any other
price. For a debt security, face value is the amount repaid to the investor when the bond matures (usually,
Government securities and corporate bonds have a face value of Rs. 100). The price at which the security trades
depends on the fluctuations in the interest rates in the economy.

Premium and Discount

Securities are generally issued in denominations of 5, 10 or 100. This is known as the Face Value or Par Value of the
security as discussed earlier. When a security is sold above its face value, it is said to be issued at a Premium and if
it is sold at less than its face value, then it is said to be issued at a Discount.

Cut-Off Price
In a Book building issue, the issuer is required to indicate either the price band or a floor price in the prospectus. The
actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is
called “Cut-Off Price”. The issuer and lead manager decides this after considering the book and the investors’
appetite for the stock.

Collection Centre means a place where the application for subscribing to the public or rights issue is collected by the
Banker to an Issue on behalf of the issuer company;

Composite Issues means an issue of securities by a listed company on a public cum rights basis offered through a
single offer document wherein the allotment for both public and rights components of the issue is proposed to be
made simultaneously;
Convertible Debt Instrument means an instrument or security which creates or acknowledges indebtedness and is
convertible into equity shares at a later date, at or without the option of the holder of the instrument or the security of
a body corporate, whether constituting a charge on the assets of the body corporate or not.

Credit Rating Agency means a body corporate registered under Securities and Exchange Board of India (Credit
Rating Agencies) Regulations, 1999;

Lock-in indicates a freeze on the sale of shares for a certain period of time. SEBI guidelines have stipulated lock-in
requirements on shares of promoters mainly to ensure that the promoters or main persons, who are controlling the
company, shall continue to hold some minimum percentage in the company after the public issue.

Listing of securities means admission of securities of an issuer to trading privileges (dealings) on a stock exchange
through a formal agreement. The prime objective of admission to dealings on the exchange is to provide liquidity and
marketability to securities, as also to provide a mechanism for effective control and supervision of trading.

Listing Agreement: At the time of listing securities of a company on a stock exchange, the company is required to
enter into a listing agreement with the exchange. The listing agreement specifies the terms and conditions of listing
and the disclosures that shall be made by a company on a continuous basis to the exchange.

Delisting of securities means permanent removal of securities of a listed company from a stock exchange. As a
consequence of delisting, the securities of that company would no longer be traded at that stock exchange.

Green shoe Option is a price stabilizing mechanism in which shares are issued in excess of the issue size, by a
maximum of 15%. From an investor’s perspective, an issue with green shoe option provides more probability of
getting shares and also that post listing price may show relatively more stability as compared to market volatility.

Issue price means the price at which a company's shares are offered initially in the primary market is called as the
Issue price. When they begin to be traded, the market price may be above or below the issue price.

Market Capitalisation means the market value of a quoted company, which is calculated by multiplying its current
share price (market price) by the number of shares in issue is called as market capitalization. E.g. Company A has
120 million shares in issue. The current market price is Rs. 100. The market capitalisation of company A is Rs. 12000
million
In a safety net scheme or a buy back arrangement the issuer company in consultation with the lead merchant banker
discloses in the RHP that if the price of the shares of the company post listing goes below a certain level the issuer
will purchase back a limited number of shares at a pre specified price from each allottee.

Open book/closed book: In an open book building system the merchant banker along with the issuer ensures that the
demand for the securities is displayed online on the website of the Stock Exchanges. Here, the investor can be
guided by the movements of the bids during the period in which the bid is kept open. Indian Book building process
provides for an open book system. In the closed book building system, the book is not made public and the bidders
will have to take a call on the price at which they intend to make a bid without having any information on the bids
submitted by other bidders.

Hard underwriting is when an underwriter agrees to buy his commitment before the issue opens. The underwriter
guarantees a fixed amount to the issuer from the issue. Thus, in case the shares are not subscribed by investors, the
issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares. The underwriter
bears a risk which is much higher than soft underwriting.

Soft underwriting is when an underwriter agrees to buy the shares at stage after the issue the issue is closed. The
risk faced by the underwriter as such is reduced to a small window of time.

Differential pricing: When one category of investors is offered shares at a price different from the other category it is
called differential pricing. An issuer company can allot the shares to retail individual investors at a discount of
maximum 10% to the price at which the shares are offered to other categories of public.

Basis of Allocation/Basis of Allotment: After the closure of the issue, for example, a book built public issue, the bids
received are aggregated under different categories i.e., firm allotment, Qualified Institutional Buyers (QIBs), Non
Institutional Buyers (NIBs), Retail, etc. The oversubscription ratios are then calculated for each of the categories as
against the shares reserved for each of the categories in the offer document. Within each of these categories, the
bids are then segregated into different buckets based on the number of shares applied for. The oversubscription ratio
is then applied to the number of shares applied for and the number of shares to be allotted for applicants in each of
the buckets is determined. Then, the number of successful allotees is determined. This process is followed in case of
proportionate allotment. Thus allotment to each investor is done based on proportionate basis in both book built and
fixed price public issue.

Firm Allotment means allotment on a firm basis in public issues by an issuing company made to Indian and
Multilateral Development Financial Institutions, Indian Mutual Funds, Foreign Institutional Investors including non-
resident Indians and overseas corporate bodies and permanent/ regular employees of the issuer company.
Networth means aggregate of value of the paid up equity capital and free reserves (excluding reserves created out of
revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off
(including miscellaneous expenses not written off) as per the audited balance sheet.)

Offer Document means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights
issue.

Offer for Sale means offer of securities by existing shareholder(s) of a company to the public for subscription, through
an offer document.

Preferential Allotment means an issue of capital made by a body corporate in pursuance of a resolution passed
under Sub-section (1A) of Section 81 of the Companies Act, 1956.

Public Issue means an invitation by a company to public to subscribe to the securities offered through a prospectus;

Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate when
the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them.

Unlisted Company means a company which is not a listed company.

Mutual Funds
Mutual Funds
A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-
term money-market instruments, other securities or assets, or some combination of these investments. Mutual Funds
are essentially investment vehicles where people with similar investment objective come together to pool their money
and then invest accordingly.

SEBI defines mutual funds as ‘A fund established in the form of a trust to raise money through the sale of units to the
public or a section of the public under one or more schemes for investing in securities, including money market
instruments or gold or gold related instruments or real estate assets’.

A Mutual Fund will have a fund manager who is responsible for investing the pooled money into specific securities
(usually stocks and bonds). When you invest in a MF, you are buying shares (or portions) of the MF and become a
shareholder of the fund. Mutual Funds (MFs) are considered a good route to invest and earn returns with reasonable
safety.

The basis of a Mutual Fund is a ‘pooling’ concept. A Mutual Fund is an investment vehicle that pools the savings of
several investors who share a common financial goal. The money thus collected is then invested in capital market
instruments such as shares, debentures and other securities. The income earned through these investments and the
capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them.
Advantages of Mutual Funds

 Number of available options: equity funds, debt funds, gilt funds and many others are available that cater to the
different needs of an investor.

 Diversification: Mutual funds diversify the risk of the investor by investing in a basket of various stocks.

 Managed by Skilled Professionals: Investors who lacks time, the inclination or the skills to actively mange their
investment risk in individual securities can delegate this role to the mutual funds which are managed by a team of
professional fund managers who manages them with in-depth research inputs from investment analysts.

 Liquidity: When in need of liquidity, the money can be withdrawn or redeemed at the Net Asset Value related
prices anytime, without much reduction in yield (unlike penalty on premature fixed deposit withdrawal). Some
mutual funds however, charge exit loads for withdrawal within a specified period.

 Well Regulated: All investments have to be accounted for & decisions judiciously taken. SEBI acts as a true
watchdog through regulations, designed to protect the investors’ interests and impose penalties on the AMCs at
fault.

 Transparency: Being under a regulatory framework, mutual funds have to disclose their holdings, investment
pattern and all the information relating to the investment strategy, outlooks of the market and scheme related
details to all investors frequently to ensure that transparency exists in the system.
 Flexible, Affordable and a Low Cost affair: Mutual Funds provide the benefit of cheap access to expensive stocks.

 Tax benefits: Mutual Funds (MFs) are undoubtedly an important product innovation in the financial field, as an
instrument of raising capital from the wider public for corporate enterprise growth. Historically MFs originally
called unit trusts in the United Kingdom were invented for the mass of relatively small investors. Investors are
issued ‘units’, thus for an investor, investments in MF imply buying shares (or portions) of the MF and becoming
the shareholders of the fund.

Structure of Mutual Funds:

A typical MF in India has the following constituents:

Fund Sponsor - A ‘sponsor’ is a person who, acting alone or in combination with another corporate body, establishes
a MF. The sponsor should have a sound financial track record of over five years, have a positive net worth in all the
immediately preceding five years and integrity in all his business transactions.
In case of an existing MF, such fund which is in the form of a trust and the trust deed has been approved by the
Board; the sponsor should contribute at least 40% of the net worth of the AMC (provided that any person who holds
40 % or more of the net worth of an asset management company should be deemed to be a sponsor and would be
required to fulfill the eligibility criteria specified in the SEBI regulations).

Trustees - The MF can either be managed by the Board of Trustees, which is a body of individuals, or by a Trust
Company, which is a corporate body. Most of the funds in India are managed by a Board of Trustees. The trustees
are appointed with the approval of SEBI. Two thirds of trustees are independent persons and are not associated with
sponsors or be associated with them in any manner whatsoever. The trustees, being the primary guardians of the
unit holders’ funds and assets, have to be persons of high repute and integrity. The Trustees, however, do not
directly manage the portfolio of MF. It is managed by the AMC as per the defined objectives, in accordance with trust
deed and SEBI (MF) Regulations.

Asset Management Company - The AMC, appointed by the sponsor or the Trustees and approved by SEBI, acts like
the investment manager of the Trust. The AMC should have at least a net worth of Rs. 10 crore. It functions under
the supervision of its Board of Directors, Trustees and the SEBI. In the name of the Trust, AMC fl oats and manages
different investment ‘schemes’ as per the SEBI Regulations and the Investment Management agreement signed with
the Trustees. The regulations require non-interfering relationship between the fund sponsors, trustees, custodians
and AMC.

Custodians - A custodian is appointed for safe keeping the securities or gold or gold related instruments or other
assets and participating in the clearing system through approved depository. Custodian also records information on
stock splits and other corporate actions. No custodian in which the sponsor or its associate holds 50 % or more of the
voting rights of the share capital of the custodian or where 50 % or more of the directors of the custodian represent
the interest of the sponsor or its associates should act as custodian for a mutual fund constituted by the same
sponsor or any of its associate or subsidiary company.

Registrar and Transfer agent - Registrar and transfer agent maintains record of the unit holders’ account. A fund may
choose to hire an independent party registered with SEBI to provide such services or carryout these activities in-
house. If the work relating to the transfer of units is processed in-house, the charges at competitive market rates may
be debited to the scheme. The registrar and transfer agent forms the most vital interface between the unit holder and
mutual fund. Most of the communication between these two parties takes place through registrar and transfer agent.

Distributors/ Agents - To send their products across the length and breadth of the country, mutual funds take the
services of distributors/agents. Distributors comprise of banks, non-banking financial companies and other
distribution companies.
TYPES OF MFs/SCHEMES

A wide variety of MFs/Schemes caters to different preferences of the investors based on their financial position, risk
tolerance and return expectations.

Funds by Structure/Tenor

Open ended Scheme

An open-ended fund provides the investors with an easy entry and exit option at NAV, which is declared on a daily
basis.

Close ended Scheme

In close-ended funds, the investors have to wait till maturity to redeem their units, however, an entry and exit is
provided through mandatory listing of units on a stock exchange. The listing is to be done within six months of the
close of the subscription.

Assured return schemes

Assures a specific return to the unit holders irrespective of performance of the scheme, which are fully guaranteed
either by the sponsor or AMC.

Interval Fund

This kind of fund combines the features of open-ended and closed-ended schemes, making the fund open for sale or
redemption during pre-determined intervals.
 Open Ended Scheme Close Ended Scheme

1) An Open Ended Scheme accepts funds from 1) The subscription to a closed ended scheme is
investors by offering its units or shares on a kept open only for a limited period (usually one
continuing basis. month to three months)

2) It permits investors to withdraw funds on a 2) It does not allow investors to withdraw funds as
continuing basis under a re-purchase arrangement. and when they like.

3) Open Ended scheme has no maturity period. 3) A close ended scheme has a fixed maturity period
(usually five to fifteen years).

4) The open ended schemes are ordinarily not listed. 4) The close ended schemes are listed on the
secondary market.

5) They offer greater liquidity and relatively lower 5) They offer lesser liquidity and higher returns
returns. compared to Open Ended Scheme.

Regulation of Mutual Funds

The MFs are regulated under the SEBI (MF) Regulations, 1996. All the MFs have to be registered with SEBI. The
regulations have laid down a detailed procedure for launching of schemes, disclosures in the offer document,
advertisements, listing and repurchase of close-ended schemes, offer period, transfer of units, investments, among
others.

In addition, RBI also supervises the operations of bank-owned MFs. While SEBI regulates all market related and
investor related activities of the bank/FI-owned funds, any issues concerning the ownership of the AMCs by banks
fall under the regulatory ambit of the RBI.

Further, as the MFs, AMCs and corporate trustees are registered as companies under the Companies Act 1956, they
have to comply with the provisions of the Companies Act. Many close-ended schemes of the MFs are listed on one
or more stock exchanges. Such schemes are, therefore, subject to the regulations of the concerned stock
exchange(s) through the listing agreement between the fund and the stock exchange. MFs, being Public Trusts are
governed by the Indian Trust Act, 1882, are accountable to the office of the Public Trustee, which in turn reports to
the Charity Commissioner, that enforces provisions of the Indian Trusts Act.

Constitution of a Mutual Fund, Asset Management Company

A mutual fund is constituted in the form of a trust and the instrument of trust should be in the form of a deed, duly
registered under the provisions of the Indian Registration Act, 908 (16 of 1908), executed by the sponsor in favour of
the trustees named in such an instrument. A trust is appointed with the approval of the Board. The sponsor or, if so
authorised by the trust deed, the trustee, would appoint an asset management company, which has been approved
by the Board.

The trustees and the asset management company should with prior approval SEBI enter into an investment
management agreement which should contain clauses necessary for the purpose of making investments. (Clauses
are in the forth schedule chapter III SEBI Mutual Fund Regulation 1996).

Index Funds

Index funds are those funds which track the performance of an index. This is usually carried out by either investing in
the shares comprising the index or by buying a sample of shares making up the index or a derivative based on the
likely performance of the index. The value of the fund is linked to the chosen index so that if the index raises so will
the value of the fund. Conversely, if the index falls so will the value of the fund. In the Indian context, the index funds
attempt to copy the performance of the two main indices in the market viz., Nifty 50 or Sensex. This is done by
investing in all the stocks that comprise the index in proportions equal to the weightage given to those stocks in the
index. Unlike a typical MF, index funds do not actively trade stocks throughout the year. They may at times hold their
stocks for the full year even if there are changes in the composition of index; this reduces transaction costs. Index
funds are considered, particularly, appropriate for conservative long term investors looking at moderate risk,
moderate return arising out of a well-diversified portfolio. Since index funds are passively managed, the bias of the
fund managers in stock selection is reduced, yet providing returns at par with the index. As of March 2009, there
were 35 Index Funds available.

  Index Funds as of March 2009

S.No. Scheme Name Benchmark Index

1 JM Nifty Plus Fund - Dividend S&P Nifty

2 JM Nifty Plus Fund - Growth S&P Nifty

3 ICICI Prudential Index Fund - IP - Dividend S&P Nifty

4 Canara Robeco Nifty Index - Dividend S&P Nifty

5 Canara Robeco Nifty Index - Growth S&P Nifty

6 Franklin India Index Fund - NSE Nifty Plan - Growth S&P Nifty

7 ING Nifty Plus Fund - Dividend S&P Nifty

8 ING Nifty Plus Fund - Growth S&P Nifty

9 Tata Index Fund - Nifty Plan - Option A S&P Nifty

  Index Funds as of March 2009

10 LIC MF Index Fund - Nifty Plan - Dividend S&P Nifty

11 LIC MF Index Fund - Nifty Plan - Growth S&P Nifty

12 Birla Sun Life Index Fund - Dividend S&P Nifty

13 Birla Sun Life Index Fund - Growth S&P Nifty

14 HDFC Index Fund - Nifty Plan S&P Nifty

15 ICICI Prudential Index Fund S&P Nifty

16 SBI Magnum Index Fund - Dividend S&P Nifty

17 SBI Magnum Index Fund - Growth S&P Nifty

18 Franklin India Index Fund - NSE Nifty Plan - Dividend S&P Nifty

19 UTI Nifty Fund – Dividend S&P Nifty

20 UTI Nifty Fund – Growth S&P Nifty

21 PRINCIPAL Index Fund - Dividend S&P Nifty

22 PRINCIPAL Index Fund - Growth S&P Nifty

23 Benchmark S&P CNX 500 Fund - Dividend CNX500

24 Benchmark S&P CNX 500 Fund - Growth CNX500

25 Franklin India Index Fund - BSE Sensex Plan - Dividend BSE Sensex

26 Franklin India Index Fund - BSE Sensex Plan - Growth BSE Sensex

27 Tata Index Fund - Sensex Plan - Option A BSE Sensex

28 LIC MF Index Fund - Sensex Advantage Plan - Div BSE Sensex

29 LIC MF Index Fund - Sensex Advantage Plan - Growth BSE Sensex

30 LIC MF Index Fund - Sensex Plan - Dividend BSE Sensex

31 LIC MF Index Fund - Sensex Plan - Growth BSE Sensex

32 HDFC Index Fund - Sensex Plan BSE Sensex

33 HDFC Index Fund - Sensex Plus Plan BSE Sensex

34 UTI Master Index Fund - Dividend BSE Sensex

35 UTI Master Index Fund - Growth BSE Sensex

Exchange Traded Funds

An Exchange Traded Fund (ETF) is a type of Investment Company whose investment objective is to achieve similar
returns as in case of a particular market index. An ETF is similar to an index fund, but the ETFs can invest in either
all of the securities or a representative sample of securities included in the index. Importantly, the ETFs offer a one-
stop exposure to a diversified basket of securities that can be traded in real time like an individual stock. ETFs first
came into existence in USA in 1993. Some of the popular ETFs are: SPDRs (Spiders) based on the S&P 500 Index,
QQQs (Cubes) based on the Nasdaq-100 Index, iSHARES based on MSCI Indices, TRAHK (Tracks) based on the
Hang Seng Index and DIAMONDs based on Dow Jones Industrial Average (DJIA).

Like index funds, ETFs are also passively managed funds wherein subscription/redemption of units implies exchange
with underlying securities. These being exchange traded, units can be bought and sold directly on the exchange,
hence, cost of distribution is much lower and the reach is wider. These savings are passed on to the investors in the
form of lower costs. The structure of ETFs is such that it protects long-term investors from inflows and outflows of
short-term investor. ETFs are highly flexible and can be used as a tool for gaining instant exposure to the equity
markets.

The first ETFs in India, based on Nifty 50, were the Nifty Benchmark Exchange Traded Scheme (Nifty BeES). This
was launched by Benchmark Mutual Fund in December 2001. It is bought and sold like any other stock on NSE. Over
the years more and more ETFS have been introduced. As on October 2008 there were 15 Exchange trade funds in
India, out of which 5 are gold exchange traded funds. The various ETFs are detailed below. As on March 2009 there
were 12 ETFs in India.

List of Exchange traded Funds in India:

Exchange Traded Funds (ETFs)

1 BANKBEES Benchmark Asset Management Company Pvt. Ltd.

2 JUNIORBEES Benchmark Mutual Fund-Nifty Junior Benchmark ETF

3 UTISUNDER UTI Mutual Fund

4 LIQUIDBEES Benchmark Asset Management Company Private Limited

5 NIFTYBEES Benchmark Mutual Fund

6 KOTAKPSUBK Kotak Mahindra Mutual Fund

PSUBNKBEES Benchmark Mutual Fund - PSU Bank Benchmark Exchange

7 Traded Scheme.

8 RELBANK Reliance Mutual Fund -Banking Exchange Traded Fund (ETF)

9 QNIFTY Quantum Index Fund -Exchange Traded Fund (ETF)

 Exchange Traded Funds (ETFs)

SHARIABEES Benchmark Mutual Fund - Shariah Benchmark Exchange Traded

10 Scheme (ETF)

11 ICICI SPICE ICICI SENSEX Exchange Traded Fund

12 Kotak Sensex ETF Kotak SENSEX Exchange Traded Fund

Gold Exchange Traded Fund

A gold exchange traded fund unit is like mutual fund units whose underlying asset is Gold and is held in demat form.
It is typically an Exchange traded Mutual Fund unit which is listed and traded on a stock exchange. Every gold ETF
unit is representative of a definite quantum of pure gold and the traded price of the gold unit moves in tandem with
the price of the actual gold metal. The GETF aims at providing returns which closely correspond to the returns
provided by Gold. In India gold ETFs came about in the year 2007, the first being Gold Bees. This Gold fund was
introduced in India by Benchmark Asset Management Company. It offers investors an innovative, cost-efficient and
secure way to access the gold market. As on March 2009 there were 5 Gold ETFs in India.

  GOLD ETFs on NSE

Benchmark Mutual Fund - Gold Benchmark Exchange Traded

1 GOLDBEES Scheme

GOLDSHAR
2 E UTI Mutual Fund - UTI Gold Exchange Traded Fund

3 KOTAKGOLD Kotak Mutual Fund - Gold Exchange Traded Fund

4 RELGOLD Reliance Mutual Fund - Gold Exchange Traded Fund

5 QGOLDHALF Quantum Gold Fund -Exchange Traded Fund (ETF)

BONDS
Debt Market
The debt market is one of the most critical components of the financial system of any economy and acts as the
fulcrum of a modern financial system. Debt market consists of Bond markets, which provide financing through the
issuance of Bonds, and enable the subsequent trading thereof. Instruments like bonds/debentures are traded in this
market. These instruments can be traded in OTC or Exchange traded markets.
The debt market in most developed economies is many times bigger than other financial markets including equity
market. In India, the debt market is broadly divided into two parts- G-Sec or government securities market /gilt edged
market and Corporate Bond Market.

The debt market plays a key role in the efficient mobilisation and allocation of resources in the economy, financing
the development activities of the government, facilitating liquidity management, framing monetary policy and pricing
of non-government securities in financial markets. Debt market can provide returns commensurate to the risk.

G-Sec Market: The government needs enormous amount of money to perform various functions such as maintaining
law and order, justice, national defense, central banking, creation of physical infrastructure. The government
generates revenue in the form of taxes and income from ownership of assets. Besides, it borrows extensively from
banks financial institutions and public to finance its expenditure. One of the important sources of borrowing funds is
the government securities market. The government raises short term and long term funds by issuing securities.
These securities do not carry risk as the government guarantees the payment of interest and the repayment of
principal. They are therefore referred to as gilt edged securities. Government securities are issued by the central
government, state government and semi government authorities. The major investors in this market are banks,
insurance companies, provident funds, state governments, FIIs. Government securities are of two types- treasury
bills and government dated securities. One of the important Dated Govt. securities consists of zero credit risk
(sovereign), Coupon bearing and non coupon (zero) bearing bonds Longer maturity government debt products are
the Government of India Treasury Bonds (ranging from greater than a year up to 30 years). Treasury bonds issued
have face value of all treasury products, both bonds and bills, is Rs.100 and the maturity of bonds issued goes from
over a year, all the way out to 30 years. All GOI bonds are coupon bearing bonds, with coupons being paid
semiannually. The maturity and the coupon of each bond are defined at the date.
Corporate Bond Market: Corporate bonds are bonds issued by firms and are issue to meet needs for expansion,
modernization, restructuring operations, mergers and acquisitions. The corporate debt market is a market wherein
debt securities of corporates are issued and traded therein. The investors in this market are banks, financial
institutions, insurance companies, mutual funds, FIIs etc. Corporates adopt either the public offering route or the
private placement route for issuing debentures/bonds.

Other instruments available for trading in the debt segment are T-Bills, Commercial Papers and Certificate of
Deposits.

Regulation of Debt Market: The RBI regulates the government securities market and money market while the
corporate debt market comes under the purview of the SEBI.

Participants in the Debt Market

The participants in the debt market are a small number of large players which has resulted in the debt market.
U
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PARTICIPANTS IN DEBT MARKET
Primary and Secondary Segments of Debt Market
In the primary market, new debt issues are floated either through public prospectus, rights issue or private
placement.

Collective Investment Vehicles

A collective investment vehicle is any entity that allows investors to pool their money and invest the pooled funds,
rather than buying securities directly as individuals. The most common types of collective investment vehicles are
mutual funds, exchange traded funds, collective investment schemes and venture capital funds. The Collective
Investment Scheme is well established in many jurisdictions and now serves as an investment vehicle for a wide
range of investment opportunities around the world.

In India, there are three distinct categories of collective investment vehicles in operation namely, Mutual Funds
(MFs), Exchange Traded Funds and Index Funds.

BOND FUNDAMENTALS

Bonds

A company needs funds to expand into new markets, while governments need money for everything,
from creating infrastructure to executing social programs. Large organizations need bigger sums of
money than one institution can provide. Hence, they raise money by issuing bonds (or other debt
instruments) to the public. Thousands of investors then each lend a portion of the capital needed. A
bond represents a defined unit of the loan and each investor holds certain number of bonds.

The organisation that sells a bond is known as the issuer. The bond is a promise to pay principal and
interest given by a borrower (the issuer) to a lender (the investor). The issuer of a bond must pay the
investor something extra for the privilege of using his or her money. This comes in the form of interest
payments, which are made at a predetermined rate and schedule. The interest rate is referred to as the
coupon rate. The date on which the issuer has to repay the amount borrowed (known as face value) is
called the maturity date. Bonds are often known as fixed-income securities because the exact amount of
cash that will be repaid is known in advance if the security is held until maturity. This is particularly true
for fixed coupon bonds. In floating coupon bonds, the coupon rate is linked to some benchmark as the
benchmark changes, so does the coupon rate on the bond.

If an investor buys a bond with a face value of INR 1000, a coupon of 8%, and a maturity of ten years, he
will receive a total of INR 80 (INR 1000*8%) of interest per year for the next ten years. Actually, because
most bonds pay interest semi-annually, he will receive two payments of INR 40 a year for ten years.
When the bond matures after a decade, he will get his original investment back.

Bonds are Different from equity

Bonds are debt, whereas stocks are equity. This is an important distinction between the two securities.
By purchasing equity (stock), an investor becomes a part owner in the company, with voting rights and
the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the
company (or government). The primary advantage of being a creditor is a bigger claim on assets than
shareholders. That means that in bankruptcy, a bondholder will get paid before the shareholder.
Shareholders only have a residual claim on the assets of the company. The bondholders, however, do
not share in the profits if a company does well—he or she is entitled only to the principal plus interest.
There is generally less risk in owning bonds compared to stocks, but this comes at the cost of lower
returns.

Face Value/Par Value

The face value (also known as the par value or principal) is the amount of money a holder will receive
once a bond matures. This is also the value which is printed on the ‘face’ of the bond certificate. A newly
issued bond usually sells at the par value.

Price

After issue of the bond, its price need not be equal to its face value. A bond’s price fluctuates in
response to a number of variables. When a bond’s price trades above the face value, it is said to be
selling at a premium, and when sold below face value, it is said to be selling at a discount.

Coupon (The Interest Rate)

The coupon is the amount the bondholder will receive as interest payments. It is called a coupon
because sometimes there are physical coupons that are issued towards interest. This was common in
the past, but at present records is more likely to be kept electronically. Funds are also now transferred
electronically.

As previously mentioned, most bonds pay interest every six months, but it is possible to be paid
monthly, quarterly, or annually. However, higher frequency increases the cost of the bond. The coupon
is expressed as a percentage of the par value. A rate that stays as a fixed percentage of the par value is a
fixed-rate bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In
this case the interest rate is tied to market rates through an index, such as the rate on Treasury bills.

Maturity

The maturity date is the day on which the investor’s principal will be repaid. Maturities can range from
one day to 30 years (though bonds of a term of 100 years have also been issued)

A bond that matures in one year is more predictable and thus less risky than a bond that matures in 20
years. In general, the longer the time to maturity, the higher the interest rate. Also, generally, the price
of a longer-term bond will fluctuate more than that of a shorter-term bond.

Measuring Return with Yield/current yield

Yield is a measure of the return on a bond. The simplest version of yield (called current yield) is
calculated by the following formula:

Coupon Amount
Yield=
Current Market Price

If the bond trades at par, yield is equal to the coupon interest rate. When the price changes, so does the
yield.

Let us consider an example. If one buys a bond at its par value of INR 1000 with a 10% coupon, the yield
is 10% (100/1 000). But if the price goes down to INR 800, then the yield goes up to 12.5%. This happens
because the guaranteed INR 100 return is earned on an asset that is worth INR 800 (INR 100/INR 800).
Conversely, if the bond goes up to INR1200 the yield shrinks to 8.33%(INR 100/INR 1200)

Yield To Maturity (YTM)

Often, when bond investors refer to yield, they mean yield to maturity (YTM). YTM is a more advanced
calculation that shows the total return one will receive if one holds the bond to maturity. YTM thus
equates the present value of all future cash flows in the form of coupon receipts and redemption
amount with the current price. It equals all the interest payments the investor will receive (and assumes
that the investor will reinvest the interest payment at the same rate as the YTM on the bond) plus the
amount due on maturity (including premium, if any) with the prevailing price through a time adjustment
process.

Bond Valuation

There are different approaches to the valuation of a bond. The most common is the net present value
approach. Under this approach various cash inflows that are committed to the bond are determined
along with their timings. The cash inflows include coupon payments and redemption amounts. The
market value of a bond is thus the net present value of all the future cash flows. This can be stated as
follows.
n n
C1 Ft
P=∑ t
+ ∑ t
t =1 ( 1+ y ) t=1 (1+ y )

where,

P= Price of the bond including accrued interest

C = Coupon payment at time t

F t = Principal repayment at time t (often this would be only at time t with one bullet repayment)

t = Number of periods to each payment

T= Total time to final maturity, i.e. when the entire principal is repaid.

Y= the yield to maturity of the bond

It may be noted that instead of the price of the bond, yield to maturity itself is used to compare its
market value. The yield’s relationship with price can be summarized as: when price goes up, yield goes
down and vice versa. Technically, it can be said that the bond’s prices and its yield are inversely related.

Price in the Market: Role of Prevailing Interest Rates

So far, we’ve discussed the factors of face value, coupon, maturity; the issuer and yield. All these
characteristics play a role in a bond’s price. However the factor that influences a bond most is the level
of prevailing interest rates. When interest rates rise, the prices of bonds fall, thereby raising the yield of
the older bonds and bringing them in line with the newer bonds being issued with a higher coupon.

When interest rates fall, the prices of bonds rise, lowering the yield of the older bonds and bringing
them in line with the newer bonds being issued with a lower coupon. E.g. a government issues bonds
bearing a coupon of 12% in 1994 maturing in the year 2014. Let us visualize the scenario in 2004, when
the bond is only ten years to maturity. Assume the interest rates have been falling since 2000. If the
government now issues 10-year bonds in 2004 with interest rates of 6%, an investor has a choice. He can
invest in either of the bonds, and obviously his choice would be in favour of a bond that gives a coupon
of 12%. However, every investor who wishes to enhance his return would do that. The result would be a
great demand for the 12% bond and no takers for the 6% bond. This demand will come to a halt when
the price of the 12% bond gets adjusted so that it starts yielding 6% for the remaining ten years of its
life. Thus the price of this bond has gone up with the falling interest rate scenario. The reverse would
happen when the interest rates rise, i.e. the price of the bond would fall. From a time value perspective,
if the prevailing interest rates fall, the present value of all the future cash flows would go up, thus
resulting in a higher present value than what was prevailing before. Thus, the price would go up.

Issuer

The issuer is extremely important in assessing the credibility of a debt investment. The financial strength
and stability of the company provide the main assurance of being repaid. For example, the US
Government is far more creditworthy than any corporation. Their default risk (the chance of the debt
not being paid back) is extremely small, so small that US Government securities are known as risk- free
securities. The reason for this is that a government will always be able to bring in future revenue
through taxation, can print money and has mechanisms to back it. A company on the other hand must
continue to make profits, which is not guaranteed. This means the corporations must offer a higher yield
in order to entice investors – this is called the risk/ return tradeoff.

The bond rating system helps investors distinguish a company’s credit risk. Blue chip firms, have a high
rating while risky companies have a low rating. The chart below illustrates the different bond rating
scales from the major rating agencies in the United States: Moody’s, Standard and Poor’s, and Fitch
Ratings:

Table 1: Bond rating scale

Bond Rating Grade Risk

Moody’s S&P/Fitch
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative
Caa/Ca/C CCC/CC/C Junk Highly Speculative
 C D Junk In Default

Note that if the company falls below a certain credit rating, its grade changes from investment quality to
junk status. Junk bonds are aptly .named: they are the debt of companies in some sort of financial
difficulty. Because they are so risky, they have to offer far higher yields than any other debt instrument.

Fixed income market could be classified into various categories based on the issuers of the debt
instruments:

 Government or Sovereign bonds: Issued by central or federal governments.

 Government guaranteed bonds: Issued by an agency of the government or guaranteed by the
government
 State government bonds: issued by state government
 Municipal bonds: issued by municipal bodies or counties
 Bonds issued by financial institutions including banks, insurance companies, etc.
 Corporate Bonds: Issued by manufacturing companies and utilities

Government bonds

In general, government securities are classified, particularly in the US context, according to the length of
time before maturity. These are the three categories:

Treasury Bills— debt securities maturing in less than one year

Notes—debt securities maturing in one to ten years

Bonds—debt securities maturing in more than ten years

Marketable securities from the US Government—known collectively as Treasuries—follow this guideline

and are issued as Treasury bonds, Treasury notes, and Treasury bills (T-bills).

All debt issued by the US Government is regarded as extremely safe, as is the debt of any stable country.
The debts of many developing countries, however, do carry substantial risk. Just like companies,
countries can default on payments.

Government guaranteed bonds

This category includes bonds that have been issued by government agencies or those guaranteed by the
federal government to ensure availability of finance and funding for causes that are supported by public
policy.

Although most agency securities do not carry the government’s full-faith-and-credit guarantee, their
credit quality is enhanced by their government—sponsored status. Investors in agency securities are
primarily institutional and include state and local governments, mutual funds, pension funds, investment
trusts and foreign investors.
State government and municipal bonds

More than 50,000 state and local governments in the US and their agencies borrow money by issuing
bonds to build, repair or improve schools, streets, hospitals, water and sewer systems, ports, and other
public works. Projects funded by municipal bonds have a positive impact on the surrounding
communities by creating jobs, strengthening the infrastructure and improving the quality of life.

Municipal issuers repay their debts in two ways: Community Projects related debt is repaid out of tax
revenues. Specific User Group Projects are funded by revenue bonds which are often repaid with fees
collected from people who use the services or facilities.

The federal income tax law in the US exempts interest on municipal bonds from federal taxation. As a
result, state and local governments can borrow at interest rates that are, on an average, 25— 30% lower
than otherwise possible. The municipal securities market has a record of safety second only to that of
the US Treasury securities market. Individuals directly or through funds hold over 70% of the municipal
debt outstanding.

Bonds issued by financial institutions

Banks have finance as their basic raw material. Ensuring the availability of funds of desirable maturity is
an essential aspect of Asset Liability Management. Banks are therefore major issuers of bonds. Similarly,
insurance companies as well as issuers of Asset Backed Securities also issue bonds.

Corporate bonds

A company can issue bonds just like stock. Large corporations have a lot of flexibility as to how much
debt they can issue: the limit is whatever the market will bear. Generally a short term corporate bond is
less than five years; intermediate is five to 12 years, and long-term is over 12 years. Corporate bonds are
characterized by higher yields because there is a higher risk of a company defaulting than a government.
The advantage is that they can also be more rewarding investments. The company’s credit quality is very
important: the higher the quality, the lower the interest rate the investor receives.

Variations of this are convertible bonds, which the holder can convert into stock, and callable bonds,
which allow the company to redeem an issue prior to maturity.

There are different types of instruments. The most common types are:

1. Fixed coupon bond: These bonds pay a fixed rate of interest and the principal is typically repaid on
maturity. It may also be repaid in a couple of installments towards the end of the period.

2. Zero coupon bonds: This is a type of bond that makes no coupon payments but instead is issued at a
discount to par value. For example, a zero coupon bond with a INR 1000 par value and ten years to
maturity might be trading at INR 600. The difference between the two indicates the interest that would
be earned and compounded over this period.
3. Annuities: This involves a fixed amount being repaid to the investor over a period of time, which
includes interests as well as repayment of a part of the principal.

4. Perpetual bonds: These bonds do not have a set redemption or maturity date. Their value is derived
from interest earnings only. They are also called Consols.

5. Floating rate bonds: In these bonds, the rate of interest is not fixed. It varies in accordance with the
performance of a benchmark, like London Inter-bank Offered Rate.

6. Structured notes: In case of these bonds, the pattern of coupon payment is tailored to the
requirements of the investor class.

Bonds could also have added option features. When these features are added, the bond types that
emerge are:

1. Callable bonds: These are the bonds which can be called back by the issuer on a specified date at a
specified price against repayment of the principal. This option is likely to be exercised, for example, in a
fixed rate bond, where after the issuance of the bonds, the interest rates have come down significantly.

2. Puttable bonds: This option rests with the investor to sell the bonds back to the issuer at a
predetermined date and price before its natural maturity. The option is likely to be exercised if the
interest rate offered on the bond is much lower than the market interest rate. The investor may sell this
bond back to the issuer to invest in a better yielding instrument.

3. Convertible bonds: This bond offers an option to the investor to convert the bond into equity stock at
a predetermined price on a specified date.