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FINANCIAL MARKETS AND SERVICES(F){5TH SEM}

UNIT-2 PRIMARY AND SECONDARY MARKET:
PRIMARY MARKET:
 The primary market is the part of the capital market that deals with issuing of new
securities. Primary markets create long term instruments through which corporate
entities raise funds from the capital market.
 In a primary market, companies, governments or public sector institutions can raise
funds through bond issues and corporations can raise capital through the sale of new
stock through an initial public offering (IPO).
 This is often done through an investment bank or finance syndicate of securities
dealers.
 The process of selling new shares to investors is called underwriting. Dealers earn a
commission that is built into the price of the security offering, though it can be found
in the prospectus.
 Instead of going through underwriters, corporations can make a primary issue or
right issue of its debt or stock, which involves the issue by a corporation of its own
debt or new stock directly to institutional investors or the public or it can seek
additional capital from existing shareholders.
 Once issued, the securities typically trade on a secondary market such as a stock
exchange, bond market or derivatives exchange.

THE MAIN FEATURES OF PRIMARY MARKETS ARE:

1) This is the market for new long term equity capital. The primary market is the market
where the securities are sold for the first time. Therefore, it is also called the new
issue market (NIM).
2) In a primary issue, the securities are issued by the company directly to investors.
3) The company receives the money and issues new security certificates to the
investors.
4) Primary issues are used by companies for the purpose of setting up new business or
for expanding or modernizing the existing business.
5) The primary market performs the crucial function of facilitating capital formation in
the economy.
6) The new issue market does not include certain other sources of new long term
external finance, such as loans from financial institutions. Borrowers in the new issue
market may be raising capital for converting private capital into public capital; this is
known as "going public."
its share can be issue in face value, premium value & par value.
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BOOK BUILDING:
 Book building is a price discovery mechanism that is used in the stock markets while
pricing securities for the first time. When shares are being offered for sale in an IPO,
it can either be done at a fixed price.
 However, if the company is not sure about the exact price at which to market its
shares, it can decide a price range instead of an exact figure.
 This process of discovering the price by providing the investors with a price range
and then asking them to bid on it is called the book building process.
 It is considered to be one of the most efficient mechanisms of pricing securities in
the primary market.
 This is the preferred method which is recommended by all major stock exchanges
and as a result is followed in all major developed countries in the world.

Book Building Process

The detailed process of book building is as follows:
1) Appointment of Investment Banker: The first step starts with appointing the lead
investment banker. The lead investment banker conducts due diligence. They
propose the size of the capital issue that must be conducted by the company. The
lower end of the price range is known as the floor price whereas the higher end is
known as the ceiling price. The final price at which securities are indeed offered for
sale after the entire book building process is called the cut-off price.
2) Collecting Bids: Investors in the market are requested to bid to buy the shares. They
are requested to bid the number of shares that they are willing to buy at varying
price levels. These bids along with the application money are supposed to be
submitted to the investment bankers. It must be noted that it is not a single
investment banker who is engaged in the collection of bids.
3) Price Discovery: Once all the bids have been aggregated by the lead investment
banker, they begin the process of price discovery. The final price chosen in simply
the weighted average of all the bids that have been received by the investment
banker. This price is declared as the cut-off price. For any issue which has received
substantial publicity and which is being anticipated by the public, the ceiling price is
usually the cut-off price.
4) Publicizing: In the interest of transparency, stock exchanges all over the world
require that companies make public the details of the bids that were received by
them. It is the lead investment banker’s duty to run advertisements containing the
details of the bids received for the purchase of shares for a given period of time (let’s
say a week). The regulators in many markets are also entitled to physically verify the
bid applications if they wish to.
5) Settlement: Lastly, the application amount received from the various bidders has to
be adjusted and shares have to be allotted. For instance, if a bidder has bid a lower
price than the cut-off price then a call letter has to be sent asking for the balance
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money to be paid. On the other hand, if a bidder has bid a higher price than the cut-
off, a refund cheque needs to be processed for them.
PARTIAL BOOK BUILDING
Partial book building is another variation of the book building process. In this process,
instead of inviting bids from the general population, investment bankers invite bids from
certain leading institutions. Based on their bids, a weighted average of the prices is created
and cut-off price is decided. This cut-off price is then offered to the retail investors as a fixed
price. Therefore, the bidding only happens at an institutional level and not at a retail level.

UNDERWRITING :
 Underwriting is the process by which investment bankers raise investment capital
from investors on behalf of corporations and governments that are issuing either
equity or debt securities.
 The word "underwriter" originated from the practice of having each risk-taker write
his name under the total amount of risk he was willing to accept at a specified
premium.
 This centuries-old practice continues, in a way, as new issues are usually brought to
market by an underwriting syndicate, in which each firm takes the responsibility, as
well as the risk, of selling its specific allotment.
 Underwriting services are provided by some large specialist financial institutions,
such as banks, insurance or investment houses, whereby they guarantee payment in
case of damage or financial loss and accept the financial risk for liability arising from
such guarantee.
 An underwriting arrangement may be created in a number of situations including
insurance, issue of securities in primary markets, and in bank lending, among others.
Types of underwritings:
1) Securities underwriting: Securities underwriting is the process by which investment
banks raise investment capital from investors on behalf of corporations and
governments that are issuing securities (both equity and debt capital).
 The services of an underwriter are typically used during a public offering in a
primary market.
 This is a way of distributing a newly issued security, such as stocks or bonds,
to investors.
 Underwriters make their income from the price difference (the
"underwriting spread") between the price they pay the issuer and what they
collect from investors or from broker-dealers who buy portions of the
offering.
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2) Bank underwriting: In banking, underwriting is the detailed credit analysis preceding

the granting of a loan, based on credit information furnished by the borrower; such
underwriting falls into several areas:
 Consumer loan underwriting includes the verification of such items as employment
history, salary and financial statements; publicly available information, such as the
borrower's credit history, which is detailed in a credit report; and the lender's
evaluation of the borrower's credit needs and ability to pay. Examples include
mortgage underwriting.
 Commercial (or business) underwriting consists of the evaluation of financial
information provided by small businesses including analysis of the business balance
sheet including tangible net worth, the ratio of debt to worth (leverage) and
available liquidity (current ratio).
 Underwriting can also refer to the purchase of corporate bonds, commercial paper,
government securities, municipal general-obligation bonds by a commercial bank or
dealer bank for its own account or for resale to investors.
 Bank underwriting of corporate securities is carried out through separate holding-
company affiliates, called securities affiliates or Section 20 affiliates.
3) Insurance underwriting: Insurance underwriters evaluate the risk and exposures of
potential clients. They decide how much coverage the client should receive, how
much they should pay for it, or whether even to accept the risk and insure them.
Underwriting involves measuring risk exposure and determining the premium that
needs to be charged to insure that risk. The function of the underwriter is to protect
the company's book of business from risks that they feel will make a loss and issue
insurance policies at a premium that is commensurate with the exposure presented
by a risk.

ON-LINE IPO’S
 It stands for Electronic Initial Public Offer. When a company wants to offer its shares
to the public it can now also do so online. An agreement is signed between the
company and the relevant stock exchange known as the e-IPO.
 This system was introduced in India some three years ago by the SEBI. This makes
the process of the IPO speedy and efficient. The company will have to hire brokers to
accept the applications received. And a registrar to the issue must also be appointed.
 An external initial public offering team is formed, comprising an underwriter,
lawyers, certified public accountants and Securities and Exchange Commission
experts.
 Information regarding the company is compiled, including financial performance and
expected future operations. This becomes part of the company prospectus, which is
circulated for review.
 The financial statements are submitted for an official audit.
 The company files its prospectus with the SEC and sets a date for the offering.
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Offer through Prospectus

This is a method of public issue. It is also the most used method in the primary market to
raise funds. Here the company invites the investors (general members of the public) to
invest in their company via an advertisement also known as a prospectus.
After a prospectus is issued, the public subscribes to shares, debentures etc. As per the
response, shares are allotted to the public. If the subscriptions are very high, allotment will
be done on lottery or pro-rata basis.
The company can sell the shares directly to the public, but it generally hires brokers and
underwriters. Merchant banks are another option to help out with the process, especially
Initial Public Offerings.

SECONDARY MARKET:
 The secondary market, also called the aftermarket and follow on public offering is
the financial market in which previously issued financial instruments such as stock,
bonds, options, and futures are bought and sold.
 The term "secondary market" is also used to refer to the market for any used goods
or assets, or an alternative use for an existing product or asset where the customer
base is the second market (for example, corn has been traditionally used primarily
for food production and feedstock, but a "second" or "third" market has developed
for use in ethanol production).
 With primary issuances of securities or financial instruments, or the primary market,
investors purchase these securities directly from issuers such as corporations issuing
shares in an IPO or private placement, or directly from the federal government in the
case of treasuries. After the initial issuance, investors can purchase from other
investors in the secondary market.
 The secondary market for a variety of assets can vary from loans to stocks, from
fragmented to centralized, and from illiquid to very liquid. The major stock
exchanges are the most visible example of liquid secondary markets - in this case, for
stocks of publicly traded companies.
 Exchanges such as the New York Stock Exchange, London Stock Exchange and
Nasdaq provide a centralized, liquid secondary market for the investors who own
stocks that trade on those exchanges.
 Most bonds and structured products trade “over the counter,” or by phoning the
bond desk of one’s broker-dealer. Loans sometimes trade online using a Loan
Exchange.
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ORGANISATION OF STOCK EXCHANGE :

Stock Exchange:
 A stock exchange, securities exchange is a facility where stock brokers and traders
can buy and sell securities, such as shares of stock and bonds and other financial
instruments.
 Stock exchanges may also provide for facilities the issue and redemption of such
securities and instruments and capital events including the payment of income and
dividends.
 Securities traded on a stock exchange include stock issued by listed companies, unit
trusts, derivatives, pooled investment products and bonds. Stock exchanges often
function as "continuous auction" markets with buyers and sellers consummating
transactions at a central location such as the floor of the exchange.
 Many stock exchanges today use electronic trading, in place of the traditional floor
trading.
Functions:
1) Economic Barometer: A stock exchange is a reliable barometer to measure the
economic condition of a country.Every major change in country and economy is
reflected in the prices of shares. The rise or fall in the share prices indicates the
boom or recession cycle of the economy. Stock exchange is also known as a pulse of
economy or economic mirror which reflects the economic conditions of a country.
2) Pricing of Securities: The stock market helps to value the securities on the basis of
demand and supply factors. The securities of profitable and growth oriented
companies are valued higher as there is more demand for such securities. The
valuation of securities is useful for investors, government and creditors. The
investors can know the value of their investment, the creditors can value the
creditworthiness and government can impose taxes on value of securities.
3) Safety of Transactions: In stock market only the listed securities are traded and
stock exchange authorities include the companies names in the trade list only after
verifying the soundness of company. The companies which are listed they also have
to operate within the strict rules and regulations. This ensures safety of dealing
through stock exchange.
4) Contributes to Economic Growth:In stock exchange securities of various companies
are bought and sold. This process of disinvestment and reinvestment helps to invest
in most productive investment proposal and this leads to capital formation and
economic growth.
5) Spreading of Equity Cult: Stock exchange encourages people to invest in ownership
securities by regulating new issues, better trading practices and by educating public
about investment.
6) Providing Scope for Speculation: To ensure liquidity and demand of supply of
securities the stock exchange permits healthy speculation of securities.
7) Liquidity: The main function of stock market is to provide ready market for sale and
purchase of securities. The presence of stock exchange market gives assurance to
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investors that their investment can be converted into cash whenever they want. The
investors can invest in long term investment projects without any hesitation, as
because of stock exchange they can convert long term investment into short term
and medium term.
8) Better Allocation of Capital: The shares of profit making companies are quoted at
higher prices and are actively traded so such companies can easily raise fresh capital
from stock market. The general public hesitates to invest in securities of loss making
companies. So stock exchange facilitates allocation of investor’s fund to profitable
channels.
9) Promotes the Habits of Savings and Investment: The stock market offers attractive
opportunities of investment in various securities. These attractive opportunities
encourage people to save more and invest in securities of corporate sector rather
than investing in unproductive assets such as gold, silver, etc.

National Stock Exchange:

 The National Stock Exchange of India Limited (NSE) is the leading stock exchange of
India, located in Mumbai. The NSE was established in 1992 as the first demutualized
electronic exchange in the country.
 NSE was the first exchange in the country to provide a modern, fully automated
screen-based electronic trading system which offered easy trading facility to the
investors spread across the length and breadth of the country.
 Vikram Limaye is Marging Director & Chief Executive Officer (MD & CEO) of NSE.
 National Stock Exchange has a total market capitalization of more than US$2.27
trillion, making it the world’s 11th-largest stock exchange as of April 2018.
 Unlike countries like the United States where nearly 70% of the GDP is derived from
larger companies and the corporate sector, the corporate sector in India accounts
for only 12-14% of the national GDP (as of October 2016).
 Of these only 7,800 companies are listed of which only 4000 trade on the stock
exchanges at BSE and NSE. Hence the stocks trading at the BSE and NSE account for
only around 4% of the Indian economy, which derives most of its income related
activity from the so-called unorganized sector and households.
NSE offers trading and investment in the following segments

 Equity
 Equities
 Indices
 Mutual Funds
 Exchange Traded Funds
 Initial Public Offerings
 Security Lending and Borrowing Scheme etc.

Derivatives
 Equity Derivatives (including Global Indices like CNX 500, Dow Jones and FTSE )
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 Currency Derivatives
 Interest Rate Futures
 Debt
 Corporate Bonds

BOMBAY STOCK EXCHANGE AND OTCEI:

BSE: Bombay Stock Exchange.
 The Bombay Stock Exchange (BSE) is an Indian stock exchange located at Dalal
Street, Mumbai (formerly Bombay).
 Established in 1875, the BSE (formerly known as Bombay Stock Exchange Ltd.) is
Asia’s first stock exchange. It claims to be the world's fastest stock exchange, with a
median trade speed of 6 microseconds.
 The BSE is the world's 10th largest stock exchange with an overall market
capitalization of more than $2.3 trillion on as of April 2018.
 Bombay Exchange was founded by Premchand Roychand. He was one of the most
influential businessmen in 19th-century Bombay.
 A man who made a fortune in the stockbroking business and came to be known as
the Cotton King, the Bullion King or just the Big Bull. He was also the founder of the
Native Share and Stock Brokers Association, an institution that is now known as the
BSE.
 The BSE is also a Partner Exchange of the United Nations Sustainable Stock Exchange
initiative, joining in September 2012.
 BSE established India INX on 30 December 2016. India INX is the first international
exchange of India.
OCTCEI: Over the counter exchange of India
 The OTC Exchange Of India (OTCEI), also known as the Over-the-Counter
Exchange of India, is based in Mumbai, Maharashtra.
 It is India's first exchange for small companies, as well as the first screen-based
nationwide stock exchange in India.
 OTCEI was set up to access high-technology enterprising promoters in raising
finance for new product development in a cost-effective manner and to provide a
transparent and efficient trading system to investors.
 OTCEI is promoted by the Unit Trust of India, the Industrial Credit and
Investment Corporation of India, the Industrial Development Bank of India, the
Industrial Finance Corporation of India, and other institutions, and is a recognised
stock exchange under the SCR Act.
 The OTC Exchange Of India was founded in 1990under the Companies Act 1956
and was recognized by the Securities Contracts Regulation Act, 1956 as a stock
exchange. The OTCEI is no longer a functional exchange as the same has been de-
recognised by SEBI vide its order dated 31 Mar 2015.
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LISTING OF SECURITIES
Listing means the admission of securities of a company to trading on a stock exchange.
Listing is not compulsory under the Companies Act. It becomes necessary when a public
limited company desires to issue shares or debentures to the public. When securities are
listed in a stock exchange, the company has to comply with the requirements of the
exchange.
Objectives of Listing:
1. To provide ready marketability and liquidity of a company’s securities.
2. To provide free negotiability to stocks.
3. To protect shareholders and investors interests.
4. To provide a mechanism for effective control and supervision of trading.
Listing requirements:
A company which desires to list its shares in a stock exchange has to comply with the
following requirements:
1. Permission for listing should have been provided for in the Memorandum of Association
and Articles of Association.
2. The company should have issued for public subscription at least the minimum prescribed
percentage of its share capital (49 percent).
3. The prospectus should contain necessary information with regard to the opening of
subscription list, receipt of share application etc.
4. Allotment of shares should be done in a fair and reasonable manner. In case of over
subscription, the basis of allotment should be decided by the company in consultation with
the recognized stock exchange where the shares are proposed to be listed.
5. The company must enter into a listing agreement with the stock exchange. The listing
agreement contains the terms and conditions of listing. It also contains the disclosures that
have to be made by the company on a continuous basis.

Minimum Public Offer

A company which desires to list its securities in a stock exchange, should offer at least sixty
percent of its issued capital for public subscription. Out of this sixty percent, a maximum of
eleven percent in the aggregate may be reserved for the Central government, State
government, their investment agencies and public financial institutions.
The public offer should be made through a prospectus and through newspaper
advertisements. The promoters might choose to take up the remaining forty percent for
themselves, or allot a part of it to their associates.
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Fair allotment
Allotment of shares should be made in a fair and transparent manner. In case of over
subscription, allotment should be made in an equitable manner in consultation with the
stock exchange where the shares are proposed to be listed.
Listing Procedure:
The following are the steps to be followed in listing of a company’s securities in a stock
exchange:
1. The promoters should first decide on the stock exchange or exchanges where they want
the shares to be listed.
2. They should contact the authorities to the respective stock exchange/ exchanges where
they propose to list.
3. They should discuss with the stock exchange authorities the requirements and eligibility
for listing.
4. The proposed Memorandum of Association, Articles of Association and Prospectus should
be submitted for necessary examination to the stock exchange authorities
5. The company then finalizes the Memorandum, Articles and Prospectus
6. Securities are issued and allotted.
7. The company enters into a listing agreement by paying the prescribed fees and submitting
the necessary documents and particulars.
8. Shares are then and are available for trading.

TRADING AND SETTLEMENT PROCEDURE ON STOCK EXCHANGE:

Trading Procedure on a Stock Exchange:
The Trading procedure involves the following steps:
1. Selection of a broker: The buying and selling of securities can only be done through SEBI
registered brokers who are members of the Stock Exchange. The broker can be an
individual, partnership firms or corporate bodies. So the first step is to select a broker who
will buy/sell securities on behalf of the investor or speculator.
2. Opening Demat Account with Depository: Demat (Dematerialized) account refer to an
account which an Indian citizen must open with the depository participant (banks or stock
brokers) to trade in listed securities in electronic form. Second step in trading procedure is
to open a Demat account.
Depository participant will maintain securities account balances of investor and intimate
investor about the status of their holdings from time to time.
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3. Placing the Order:After opening the Demat Account, the investor can place the order. The
order can be placed to the broker either (DP) personally or through phone, email, etc.
Investor must place the order very clearly specifying the range of price at which securities
can be bought or sold. e.g. “Buy 100 equity shares of Reliance for not more than Rs 500 per
share.”
4. Executing the Order: As per the Instructions of the investor, the broker executes the
order i.e. he buys or sells the securities. Broker prepares a contract note for the order
executed. The contract note contains the name and the price of securities, name of parties
and brokerage (commission) charged by him. Contract note is signed by the broker.

SETTLEMENT:
This means actual transfer of securities. This is the last stage in the trading of securities done
by the broker on behalf of their clients. There can be two types of settlement.
(a) On the spot settlement: It means settlement is done immediately and on spot
settlement follows. This means any trade taking place on Monday gets settled by
Wednesday.
(b) Forward settlement:
It means settlement will take place on some future date.

INTERNET TRADING :
 Online trading is the act of purchasing and selling financial products on the Internet.
The trader buys and sells using an online trading platform. Online trading may
include trading in bonds, stocks (shares), futures, international currencies, and other
financial instruments.
 Most people trade online through an online broker. An online broker is a brokerage
firm that offers its services on the Internet. Unlike traditional brokers, the investor
does not meet the broker face-to-face or via the telephone. Everything happens on
the web.
 ‘online’ means ‘on the Internet.’
 Brokerage firms make online trading platforms available to anybody who wishes to
trade in financial securities.
 “Online trading is basically the act of buying and selling financial products through an
online trading platform.”
 Online trading forms part of E-Commerce, which stands for Electronic Commerce.