Basics of Capital Market

Lesson
LESSON 1
Basics of Capital Market
1
KEY CONCEPTS
Financial Markets
n Money Market n Capital Market n Primary Market n Secondary Market
Financial Markets Participants
n Qualified Institutional Buyers n Foreign Portfolio Investors n Alternate Investment Funds n Venture Capital
n Private Equity n Anchor Investors n High Net worth Individuals n Pension Funds
Financial Instruments
n Equity Shares n Preference Shares n Debentures n Bonds n Indian Depository Receipts n Warrants
n Real Estate Investment Trusts n Infrastructure Investment Trusts

Learning Objectives
To understand:
 The financial system in India
 The structure of financial market in India
 The regulatory framework for securities market in India
 The financial institutions that provide a variety of financial products and services to cater to needs
of the commercial sector
 The categories of financial institutions e.g. Insurance Companies, Pension Fund, Mutual Fund,
Capital Market Intermediaries etc.
 Various types of new instruments like REITs and InvITs
 Various regulators in the financial market including SEBI, RBI, IRDAI and PFRDA
 The different categories of Investment Institutions include Venture Capital, Private Equity, Hedge
Funds, Qualified Institutional Buyer, Pension Funds, Foreign Portfolio Investor etc.
 The Capital market instruments including different instruments like equity shares, shares with
differential voting rights, preference shares, debentures, bonds, etc.

Lesson Outline
 Financial System in India  Capital Market Instruments
 Financial Markets of India  Lesson Round-Up
 Regulatory Framework for Securities Markets  Test Yourself
in India
 List of Further Readings
 Need for regulators in Capital Market
 Other References
 Participants of Capital Markets

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EP-CM&SL Basics of Capital Market

Regulatory Framework
l Securities & Exchange Board of India Act, 1992

l Reserve Bank of India Act, 1934

l SEBI (Foreign Portfolio Investors) Regulations, 2019

l SEBI (Alternative Investment Funds) Regulations, 2012

l Companies Act, 2013 and the rules made thereunder

l SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018

Financial System in India

Every modern economy is based on a sound financial system which helps in production, capital and economic
growth by encouraging savings habits, mobilising savings from households and other segments and allocating
savings into productive usage such as trade, commerce, manufacture etc.

Financial system covers both credit and cash transactions. All financial transactions are dealt with by cash
payment or issue of negotiable instruments like cheque, bills of exchanges, hundies etc. Thus, a financial
system is a set of institutional arrangements through which financial surpluses are mobilised from the units
generating surplus income and transferring them to the others in need of them. The activities include production,
distribution, exchange and holding of financial assets/instruments of different kinds by financial institutions,
banks and other intermediaries of the market. In a nutshell, financial market, financial assets, financial services
and financial institutions constitute the financial system.

Various factors influence the capital market and its growth. These include level of savings in the household
sector, taxation levels, health of economy, corporate performance, industrial trends and common patterns of
living.

The strength of the economy is calibrated by different economic indicators like growth in GDP (Gross Domestic
Product), Agricultural production, quantum and spread of rain fall, interest rates, inflation, position on balance
of payments and balance of trade, levels of foreign exchange reserves and investments and growth in capital
formation.

The traditional form of financing companies projects consist of internal resources and debt financing, particularly
from financial institutions for modernisation, expansion and diversification. The upsurge in performance of
certain large companies and the astounding increase of their share prices boost the market sentiment to
divert the savings more and more into equity investments in companies. This lead to the growth of equity
cult among investors to contribute resources not only for companies but even for financial institutions and
banks.

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Basics of Capital Market LESSON 1

* Other Market Intermediaries are given in Lesson No. 2 of this Study.

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FINANCIAL MARKETS IN INDIA

Introduction
Indian Financial Market, has been one of the oldest
across the globe and is definitely the fastest growing
and best among other financial markets of the
emerging economies. The history of Indian capital
markets is more than 200 years old, around the end of
the 18th century. It was at this time that India was under
the rule of the East India Company. The capital market
of India initially developed around Mumbai; with
around 200 to 250 securities brokers participating in
active trade during the second half of the 19th century.
Today, Bombay Stock Exchange (BSE), one among the
world’s largest exchange in terms of trading turnover
in the same city. Indian Financial market is one of the
well-developed markets in the world.
A Financial market enables efficient trade of securities, and transfer of funds, between lenders and borrowers
and also creates securities for investment. People who have surplus funds invests in these securities to earn
return on their investments.

Functions of Financial Market

l It facilitates mobilisation and channelization of savings into the most productive uses.
l It helps in determining the price of the securities, on the basis of their demand and supply in the market.
l It provides liquidity to tradable assets, by facilitating the exchange, as the investors can readily sell
their securities and convert assets into cash.
l It reduces cost by providing valuable information, regarding the securities traded in the financial market.
l It facilitates exchange of assets without physical delivery.

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The financial markets are mainly divided into:

a. Money Market
Money Market is a segment of the financial market where
borrowing and lending of short-term funds take place. The
maturity of money market instruments ranges from one day
to one year. In India, this market is regulated by both RBI (the
Reserve bank of India) and SEBI (the Securities and Exchange
Board of India). The nature of transactions in this market is
such that they are large in amount and high in volume. Thus,
we can say that the entire market is dominated by a small
number of large players.
The market consists of negotiable instruments having
characteristics of liquidity (quick conversion into money),
minimum transaction costs and no loss in value such as treasury bills, commercial papers, certificate of
deposit, etc.
It performs the crucial role of providing an equilibrating mechanism to even out the short-term liquidity, surpluses
& deficits and therefore, facilitates the conduct of monetary policy of an economy.

b. Capital Market
Capital Market is a part of the financial system that is
concerned with the industrial securities market, government
securities markets, and long- term loan market.
A market that serves the medium & long-term liquidity
needs of borrowers & lenders and therefore embraces all
terms of lending & borrowing. The capital market comprises
institutions and mechanisms through which intermediate
terms funds and long-term funds are pooled and made
available to business, government and individuals. The
capital market also encompasses the process by which securities already outstanding are transferred. This
market is also referred to as the Barometer of the Economy.
It deals with instruments like shares, stocks, debentures and bonds. Companies turn to capital markets to raise
funds needed to finance for the infrastructure facilities and corporate activities.
The capital market is a vital part of any financial system. The wave of economic reforms initiated by the
government has influenced the functioning and governance of the capital market. The Indian capital market
has undergone structural transformation since liberalisation. The main aim of the reforms exercise is to improve
market efficiency, make stock market transactions more transparent, curb unfair trade practices and to bring
our financial markets up to international standards. Further, the consistent reforms in Indian capital market,
especially in the secondary market resulting in modern technology and online trading have revolutionized the
stock exchange.

Need for Capital Market

Capital market plays an extremely important role in promoting and sustaining the growth of an economy.
– It is an important and efficient conduit to channel and mobilize funds to enterprises, both private and
government.

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– It provides an effective source of investment in the economy.

– It plays a critical role in mobilizing savings for investment in productive assets, with a view to enhancing
a country’s long-term growth prospects, and thus acts as a major catalyst in transforming the economy
into a more efficient, innovative and competitive marketplace within the global arena.
– In addition to resource allocation, capital markets also provide a medium for risk management by
allowing the diversification of risk in the economy.
– A well-functioning capital market tends to improve information quality as it plays a major role in
encouraging the adoption of stronger corporate governance principles, thus supporting a trading
environment, which is founded on integrity.
– Capital market has played a crucial role in supporting periods of technological progress and economic
development throughout history.
– Among other things, liquid markets make it possible to obtain financing for capital-intensive projects
with long gestation periods. This certainly held true during the industrial revolution in the 18th century
and continues to apply even as we move towards the so-called “New Economy”.
– Capital markets make it possible for companies to give shares to their employees via ESOPs.
– Capital markets provide a currency for acquisitions via share swaps.
– Capital markets provide an excellent route for disinvestments to take place.
– Venture Capital and Private Equity funds investing in unlisted companies get an exit option when the
company gets listed on the capital markets
– The existence of deep and broad capital market is absolutely crucial in spurring the growth our country.
An essential imperative for India has been to develop its capital market to provide alternative sources
of funding for companies and in doing so, achieve more effective mobilisation of investors’ savings.
Capital market also provides a valuable source of external finance.
For a long time, the Indian market was considered too small to warrant much attention. However, this view has
changed rapidly as vast amounts of both international and domestic investment have poured into our markets
over the last decade. The Indian market is no longer viewed as a static universe but as a constantly evolving
one providing attractive opportunities to the investing community.

Functions of the Capital Market

The major objectives of capital market are:
– To mobilize resources for investments.
– To facilitate buying and selling of securities.
– To facilitate the process of efficient price discovery.
– To facilitate settlement of transactions in accordance with the predetermined time schedules.

Securities Market
Securities Market is a place where companies can raise funds by issuing securities such as equity shares, debt
securities, derivatives, mutual funds, etc. to the investors (public) and also is a place where investors can buy
or sell various securities (shares, bonds, etc.). It is therefore, a market where financial instruments/claims are
commonly & readily available for transfer by means of sale. Once the shares (or securities) are issued to the
public, the company is required to list the shares (or securities) on the recognized stock exchanges. Securities
Market is a part of the Capital Market.

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Functions of Securities Market

The Securities Market allows people to do more with their savings than they would otherwise could. It also
provides financing that enables people to do more with their ideas and talents than would otherwise be
possible. The people’s savings are matched with the best ideas and talents in the economy. Stated formally,
the Securities Market provides a linkage between the savings and the investment across the entities, time and
space. It mobilises savings and channelises them through securities into preferred enterprises.
The Securities Market also provides a market place for purchase and sale of securities and thereby ensures
transferability of securities, which is the basis for the joint stock enterprise system. The existence of the Securities
Market makes it possible to satisfy simultaneously the needs of the enterprises for capital and the need of
investors for liquidity.

Takeaways
Securities Market –
l is a link between investment & savings
l mobilises & channelises savings
l provides Liquidity to investors
l is a market place for purchase and sale of securities

The liquidity, the market confers and the yield promised or anticipated on security ownership may be sufficiently
great to attract net savings of income which would otherwise have been consumed. Net savings may also occur
because of other attractive features of security ownership, e.g. the possibility of capital gain or protection of
savings against inflation.
A developed Securities Market enables all individuals, no matter how limited their means, to share the
increased wealth provided by competitive private enterprises. The Securities Market allows individuals
who can not carry an activity in its entirety within their resources to invest whatever is individually possible
and preferred in that activity carried on by an enterprise. Conversely, individuals who can not begin an
enterprise, they can attract enough investment from others to make a start. In both cases individuals who
contribute to the investment made in the enterprise share the fruits. The Securities Market, by allowing
an individual to diversify risk among many ventures to offset gains and losses, increases the likelihood of
long-term, overall success.
Securities market has two inter-dependent & inseparable segments which are as follows-
1. Primary Market : The primary market deals with the issue of new instruments by the corporate sector
such as equity shares, preference shares and debt instruments. Central and State Governments, various
public sector undertakings (PSUs), statutory and other authorities such as state electricity boards and
port trusts also issue bonds/debt instruments.
This market is of great significance for the economy of a country as it is through this market that funds
flows for productive purposes from investors to entrepreneurs. The strength of the economy of a
country is gauged by the activities of the Stock Exchanges. The primary market creates and offers the
merchandise for the secondary market.
The primary market in which public issue of securities is made through a prospectus is a retail market
and there is no physical location. Offer for subscription to securities is made to the investing community.
It is also known as Initial Public Offer (IPO) Market.

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There are two major types of issuers of securities:

l Corporate Entities (companies) which mainly issue equity instruments (shares) and debt instruments
(bonds, debentures, etc.).
l Government (Central as well as State) which issues debt securities (dated securities and treasury
bills). In addition to IPOs, the Company has other options to raise capital.
l Qualified institutional placements (listed company issuing shares to Qualified Institutional Buyers
(QIB).
l In International markets through the issuance of American Depository Receipts (ADR), Global
Depository Receipts (GDRs), External Commercial Borrowings (ECB) etc.
2. Secondary Market: The secondary market or stock exchange is a market for trading and settlement
of securities that have already been issued. The investors holding securities sell securities through
registered brokers/sub-brokers of the stock exchange. Investors who are desirous of buying securities,
purchase them through registered broker/sub-broker of the stock exchange. It may have a physical
location like a stock exchange or a trading floor. Since 1995, trading in securities is screen-based and
Internet-based trading has also made an appearance in India.
The secondary market provides a trading place for the securities already issued, to be bought and
sold. It also provides liquidity to the initial buyers in the primary market to re-offer the securities to any
interested buyer at any price, if mutually accepted. An active secondary market actually promotes
the growth of the primary market and capital formation because investors in the primary market are
assured of a continuous market and they can liquidate their investments. It is also known as Further
Public Offer Market (FPO).
Difference between Primary and Secondary Market

Basis for comparison Primary Market Secondary Market

Meaning The market place for issuing fresh The market place for trading already
securities issued securities
Objectives To raise funds Capital Appreciation
Scope Includes issuance of new securities Includes the further trading of
through Initial Public Offer (IPO) securities already offered to the public
Another name New issue market / IPO Market After issue market / FPO Market
Purchasing of securities Investors can purchase securities Purchase and sale of securities is done
directly from the Company by the investors among themselves
Financing Primary market provides funds to new It does not provide funding to
and old companies for their expansion companies
and diversification
Parties to transactions Company and Investors Investors among themselves
Major Intermediaries Underwriters Brokers
Price Price as given in the offer document / Price fluctuates i.e. depends on
red herring prospectus demand and supply forces
Utilisation of fund Fund gained from primary market Fund received from secondary market
becomes the capital of the company becomes income of investors

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Basics of Capital Market LESSON 1

REGULATORY FRAMEWORK FOR SECURITIES MARKET

It is important to ensure smooth working of capital market, as it is the arena for the players associated with the
economic growth of the country. Various laws have been passed from time to time to meet this objective. The
financial market in India was highly segmented until the initiation of reforms in 1992-93 on account of a variety
of regulations and administered prices including barriers to entry. The reform process was initiated with the
establishment of Securities and Exchange Board of India.

SEBI Act, 1992

The SEBI Act, 1992 establishes SEBI with statutory powers for
(a) protecting the interests of investors in securities,
(b) promoting the development of the securities market, and
(c) regulating the securities market.
Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities, in
addition to all intermediaries and persons associated with securities market. It can conduct enquiries, audits
and inspection of all concerned and adjudicate offences under the Act. It has powers to register and regulate
all market intermediaries and also to penalise them in case of violations of the provisions of the Act, Rules
and Regulations made there under. SEBI has full autonomy and authority to regulate and develop an orderly
securities market.

Securities Contracts (Regulation) Act, 1956

It provides for direct and indirect control of virtually all aspects of securities trading and the running of stock
exchanges and aims to prevent undesirable transactions in securities. It gives central government/SEBI regulatory
jurisdiction over (a) stock exchanges through a process of recognition and continued supervision, (b) contracts
in securities, and (c) listing of securities on stock exchanges. As a condition of recognition, a stock exchange
complies with prescribed conditions of Central Government. Organised trading activity in securities takes place
on a specified recognised stock exchange. The stock exchanges determine their own listing regulations which
have to conform to the minimum listing criteria set out in the Rules.

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Depositories Act, 1996

The Depositories Act, 1996 provides for the establishment of depositories in securities with the objective of
ensuring free transferability of securities with speed, accuracy and security by (a) making securities of public
limited companies freely transferable subject to certain exceptions; (b) dematerializing the securities in the
depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order to
streamline the settlement process, the Act envisages transfer of ownership of securities electronically by book
entry without making the securities move from person to person. The Act has made the securities of all public
limited companies freely transferable, restricting the company’s right to use discretion in effecting the transfer
of securities, and the transfer deed and other procedural requirements under the Companies Act have been
dispensed with.

Companies Act, 2013

The Companies Act, 2013 envisage to strengthen the existing regulatory framework on Corporate Governance.
It deals with issue, allotment and transfer of securities and various aspects relating to company management. It
provides for standard of disclosure in public issues of capital, particularly in the fields of company management
and projects, information about other listed companies under the same management, and management
perception of risk factors. It also regulates underwriting, the use of premium and discounts on issues, rights and
bonus issues, payment of interest and dividends, supply of annual report and other information.

NEED FOR REGULATORS IN CAPITAL MARKET

In 1980’s the development of stock markets attracted investments by individual shareholders. Once the stock
markets started flourishing, there were many malpractices like non adherence to rules and regulation, price
rigging, unofficial self-modulated merchant bankers, delayed delivery issues, etc. As a result, investors felt
deceived and were losing trust in securities.
It was also this time when the Indian Financial Markets witnessed one of the biggest scams of the century
– The Harshad Mehta Scam or other wise called as the Scam, 1992 which involved more than ` 4000
crores of market manipulations. The Indian Stock Market gradually crashed when the information came
out.
As a measure, the Government sensed an urgent need to regulate the smooth and systematic functioning of
exchanges and thus resulting in formation of SEBI. Before formation of SEBI, controller of capital issues was
responsible for regulation of capital markets.
Indian Capital Markets are regulated and monitored by the Ministry of Finance, The Securities and Exchange
Board of India and The Reserve Bank of India.
The Ministry of Finance regulates through the Department of Economic Affairs - Capital Markets Division. The
division is responsible for formulating the policies related to the orderly growth and development of the securities
markets (i.e. share, debt and derivatives) as well as protecting the interest of the investors. In particular, it is
responsible for :
l institutional reforms in the securities markets,
l building regulatory and market institutions,
l strengthening investor protection mechanism, and
l providing efficient legislative framework for securities markets.
Before 1992, many factors obstructed the expansion of equity trading. Fresh capital issues were controlled
through the Capital Issues Control Act. Trading practices were not transparent, and there was a large amount of
insider trading. Recognizing the importance of increasing investor protection, several measures were enacted
to improve the fairness of the capital market.

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SEBI – The Capital Markets Regulator

The Securities and Exchange Board of India (SEBI) was established in 1988 through an administrative order,
but the Act was passed after about four years and it became a statutory and really powerful Institution only
since 1992. The Controller of Capital Issues was repealed and its office was abolished in 1992 and SEBI was
established on 21 February, 1992 through an ordinance issued on 30 January, 1992. The SEBI Act replaced the
ordinance on 4 April, 1992. Certain powers under certain sections of Securities Contracts Regulation Act (SCRA)
and Companies Act (CA) have been delegated to the SEBI.
The regulatory powers of the SEBI were increased through the Securities Laws (Amendment) Ordinance of
January 1995, which was subsequently replaced by an Act of Parliament.
The SEBI is under the overall control of the Ministry of Finance, and has its head office at Mumbai. It has now
become a very important constituent of the financial regulatory framework in India. After the 2002 amendment,
SEBI has been given powers to even pass interim orders, to investigate and to hold an enquiry and then to
pass a final order, which can be a cease and desist order or it can be a monetary penalty. In the area of policy
making, SEBI consults the government, RBI, IRDA, PFRDA etc. and after those consultations it can come out with
its policy.
SEBI was established with the statutory powers to:
l Protecting the interest of investors;
l Promoting the development of the securities market; and
l Regulating the securities market.
SEBI acts as a watchdog for all the capital market participants and its main purpose is to provide such an
environment for the financial market enthusiasts that facilitate efficient and smooth working of the securities
market.
Through SEBI, the regulation model which is sought to be put in place in India is one in which every aspect
of securities market regulation is entrusted to a single highly visible and independent organization, which is
backed by a statute, and which is accountable to the Parliament and in which investors can have trust.
To ensure this the three main participants of the financial market should be taken care of, i.e. issuers of securities,
investor, and financial intermediaries.

Issuers of securities: These are entities in the corporate field that raise funds from various sources in the
market. SEBI makes sure that they get a healthy and transparent environment for their needs.

Investor: Investors are the ones who keep the markets active. SEBI is responsible for maintaining an
environment that is free from malpractices to restore the confidence of general public who invest their
hard-earned money in the markets.

Financial Intermediaries: These are the people who act as middlemen between the issuers and investors.
They make the financial transactions smooth and safe.

SEBI necessarily has the twin task of regulation and development. Its regulatory measures are always meant
to be subservient to the needs of the market development. Underlying those measures is the logic that rapid
and healthy market development is the outcome of well-regulated structures. In this spirit, the SEBI endeavors

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to create an effective surveillance mechanism and encourage responsible and accountable autonomy on the
part of all players in the market, who are expected and required to discipline themselves and observe the rules
of the market.

PARTICIPANTS OF CAPITAL MARKET

Qualified Institutional Buyers

Qualified Institutional Buyers (QIBs) are investment institutions who buy the shares of a company on a large
scale. QIBs are those institutional investors who are generally perceived to possess expertise and the financial
proficiency to evaluate and to invest in the Capital Markets.
If the investor is not capable, either by his/her individual financial limit or not permitted, to invest individually till
he invests a specified statutorily fixed amount, then he usually participates indirectly through certain institutions,
through which he can invest limited sums according to the viability of both, himself and institution.
The institution is usually a collective group of people in which a large number of investors repose faith and
the institution collects a large investible sum from various investors to invest in the market. When investing
through the institution, investors usually have limited control on their investments in comparison to the individual
investment as they hand over the amount for investment to the institution and they, in turn, engage experts to
have a vigil on the market.
There are various types of institutions defined in the rules and regulations, but to qualify as a ‘Qualified
Institutional Buyer’ (QIB), certain regulations formulated by the SEBI needs to be kept in mind. As the name
itself suggests, it is in the form of an institution and under the institutionalized mechanism, they invest in the
company.
According to Regulation 2(1)(ss) of Securities and Exchange Board of India (Issue of Capital and Disclosure
Requirements) Regulations, 2018, Qualified Institutional Buyer comprises of —
(i) a mutual fund, venture capital fund, Alternative Investment Fund and foreign venture capital investor
registered with SEBI;
(ii) foreign portfolio investor other than individuals, corporate bodies and family offices;
(iii) a public financial institution;
(iv) a scheduled commercial bank;
(v) a multilateral and bilateral development financial institution;
(vi) a state industrial development corporation;
(vii) an insurance company registered with the Insurance Regulatory and Development Authority;
(viii) a provident fund with minimum corpus of twenty five crore rupees;
(ix) a pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by the Government of India;
(xi) Insurance funds set up and managed by army, navy or air force of the Union of India;
(xii) Insurance funds set up and managed by the Department of Posts, India;
(xiii) Systemically important non-banking financial companies.

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Foreign Portfolio Investor

Foreign Portfolio Investor (FPI) means a person who has been registered under Chapter II of SEBI (Foreign
Portfolio Investors) Regulations, 2019 which shall be deemed to be an intermediary in terms of the provisions of
the SEBI Act, 1992.
Categories of FPI
Category I FPIs include:
(i) Government and Government related investors such as central banks, sovereign wealth funds,
international or multilateral organizations or agencies including entities controlled or at least 75%
directly or indirectly owned by such Government and Government related investor(s);
(ii) Pension funds and university funds;
(iii) Appropriately regulated entities such as insurance or reinsurance entities, banks, asset management
companies, investment managers, investment advisors, portfolio managers, broker dealers and swap
dealers;
(iv) Entities from the Financial Action Task Force member countries, or from any country specified by the
Central Government by an order or by way of an agreement or treaty with other sovereign Governments,
which are–
I. appropriately regulated funds;
II. unregulated funds whose investment manager is appropriately regulated and registered
as a Category I foreign portfolio investor. However the investment manager undertakes the
responsibility of all the acts of commission or omission of such unregulated fund;
III. university related endowments of such universities that have been in existence for more than five
years.
(v) An entity (A) whose investment manager is from the Financial Action Task Force member country and
such an investment manager is registered as a Category I foreign portfolio investor; or (B) which is at
least seventy-five per cent owned, directly or indirectly by another entity, eligible under sub-clause
(ii), (iii) and (iv) of clause (a) of this regulation and such an eligible entity is from a Financial Action
Task Force member country. However such an investment manager or eligible entity undertakes the
responsibility of all the acts of commission or omission of the applicants seeking registration under this
sub-clause.
Category II FPIs include all the investors not eligible under Category I foreign portfolio investors such as –
(i) appropriately regulated funds not eligible as Category-I foreign portfolio investor;
(ii) endowments and foundations;
(iii) charitable organisations;
(iv) corporate bodies;
(v) family offices;
(vi) individuals;
(vii) appropriately regulated entities investing on behalf of their client, as per conditions specified by the
Board from time to time;
(viii) Unregulated funds in the form of limited partnership and trusts.

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Explanation: An applicant incorporated or established in an International Financial Services Centre shall be

deemed to be appropriately regulated.

Alternative Investment Funds

Alternative investment funds (AIFs) are defined in Regulation 2(1)(b) of the SEBI (Alternative Investment Funds)
Regulations, 2012. It refers to any privately pooled investment fund, (whether from Indian or foreign sources),
in the form of a trust or a company or a body corporate or a Limited Liability Partnership (LLP) which are not
presently covered by any Regulation of SEBI governing fund management (like, Regulations governing Mutual
Fund or Collective Investment Scheme) nor coming under the direct regulation of any other sectoral regulators
in India-IRDA, PFRDA, RBI. Hence, in India, AIFs are private funds which are otherwise not coming under the
jurisdiction of any regulatory agency in India.
According to SEBI (AIF) Regulations, 2012, “Alternative Investment Fund” means any fund established or
incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate
which,-
(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign,
for investing it in accordance with a defined investment policy for the benefit of its investors; and
(ii) is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes)
Regulations, 1999 or any other regulations of SEBI to regulate fund management activities.
However, the following shall not be considered as Alternative Investment Fund for the purpose of these
regulations; –
(i) Family trusts set up for the benefit of ‘relatives’ as defined under Companies Act, 2013.
(ii) ESOP Trusts set up under the SEBI (Shares Based Employee Benefits) Regulations, 2014 or as permitted
under Companies Act, 2013.
(iii) Employee welfare trusts or gratuity trusts set up for the benefit of employees.
(iv) Holding companies within the meaning of Section 2(46) of the Companies Act, 2013.
(v) Other special purpose vehicles not established by fund managers, including securitization trusts,
regulated under a specific regulatory framework.
(vi) Funds managed by securitisation company or reconstruction company which is registered with the
Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002.
(vii) Any such pool of funds which is directly regulated by any other regulator in India.
Thus, the definition of AIFs includes venture capital fund, hedge funds, private equity funds, commodity funds,
Debt Funds, infrastructure funds, etc., while, it excludes Mutual funds or collective investment schemes, family
trusts, employee benefit schemes, employee welfare trusts or gratuity trusts, ‘holding companies’ within the
meaning of Section 2(46) of the Companies Act, 2013, securitization trusts regulated a specific regulatory
framework, and funds managed by securitization company or reconstruction company which is registered with
the RBI under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002.
One AIF can float several schemes. Investors in these funds are large institutions, high net worth individuals and
corporates. In India, AIF is regulated by the SEBI (Alternative Investment Funds) Regulations, 2012.

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Categories of Alternative Investment Funds

l Category I : which invests in start-up or early stage ventures or social ventures or SMEs or infrastructure
or other sectors or areas which the government or regulators consider as socially or economically
desirable and shall include venture capital funds (VCF), SME Funds, social venture funds (SVF),
infrastructure funds and such other Alternative Investment Funds as may be specified;
l Category II : which does not fall in Category I and III and which does not undertake leverage or borrowing
other than to meet day-today operational requirements and as permitted in these regulations;
l Category III : which employs diverse or complex trading strategies and may employ leverage including
through investment in listed or unlisted derivatives.

Venture Capital
Venture Capital is one of the innovative financing resource for a company in which the promoter has to give
up some level of ownership and control of business in exchange for capital for a limited period, say, 3-5 years.
Venture Capital is generally equity investments made by Venture Capital funds, at an early stage in privately
held companies, having potential to provide a high rate of return on their investments. It is a resource for
supporting innovation, knowledge-based ideas and technology and human capital-intensive enterprises.

“Venture Capital Fund” means an Alternative Investment Fund which invests primarily in unlisted securities
of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new
services, technology or intellectual property right based activities or a new business model and shall
include an angel fund.

Essentially, a venture capital company is a group of investors who pool investments focused within certain
parameters. The participants in venture capital firms can be institutional investors like pension funds, insurance
companies, foundations, corporations or individuals but these are high risk investments which may give high
returns or high loss.

Areas of Investment
Different venture groups prefer different types of investments. Some specialize in seed capital and early
expansion while others focus on exit financing. Biotechnology, medical services, communications, electronic

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EP-CM&SL Basics of Capital Market

components and software companies seem to be the most likely attraction of many venture firms and receiving
the most financing. Venture capital firms finance both early and later stage investments to maintain a balance
between risk and profitability.

In India, software sector has been attracting a lot of venture finance. Besides media, health and pharmaceuticals,
agri-business and retailing are the other areas that are favoured by a lot of venture companies.

Private Equity
Private equity is a type of equity (finance) and one of the asset classes who takes securities and debt in
operating companies that are not publicly traded on a stock exchange. Private equity is essentially a way to
invest in some assets that isn’t publicly traded, or to invest in a publicly traded asset with the intention of taking
it private. As a source of investment capital, private equity comes from High Net-worth Individuals (HNI) & firms
that purchase stakes in private companies or acquire control of public companies with plans to make them
private & consequently delist from the stock exchange. Unlike stocks, mutual funds, and bonds, private equity
funds usually invest in more illiquid assets companies.

By purchasing companies, the firms gain access to those assets and revenue sources of the company, which
can lead to very high returns on investments. Another feature of private equity transactions is their extensive
use of debt in the form of high-yield bonds. By using debt to finance acquisitions, private equity firms can
substantially increase their financial returns.

Private equity consists of investors and funds that make investments directly into private companies or conduct
buyouts of public companies. Capital for private equity is raised from retail and institutional investors, and can
be used to fund new technologies, expand working capital within an owned company, make acquisitions, or
to strengthen a balance sheet. The major of private equity consists of institutional investors and accredited
investors who can commit large sums of money for long periods of time.

Private equity investments often demand long holding periods to allow for a turn around of a distressed
company or a liquidity event such as IPO or sale to a public company. Generally, the private equity fund raise
money from investors like angel investors, institutions with diversified investment portfolio like – pension funds,
insurance companies, banks, funds of funds etc.

Types of Private Equity

Private equity investments can be divided into the following categories:

l Leveraged Buyout (LBO): This refers to a strategy of making equity investments as part of a transaction
in which a company, business unit or business assets is acquired from the current shareholders
typically with the use of financial leverage. The companies involved in these type of transactions that
are typically more mature and generate operating cash flows.

l Venture Capital: It is a broad sub-category of private equity that refers to equity investments made,
typically in less mature companies, for the launch, early development, or expansion of a business.

l Growth Capital: This refers to equity investments, mostly minority investments, in the companies that
are looking for capital to expand or restructure operations, enter new markets or finance a major
acquisition without a change of control of the business.

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Basics of Capital Market LESSON 1

Angel Fund

Angel fund refers to money pool created by high networth individuals or companies (generally known as
Angel Investor), for investing in start up business. Angel fund is defined in SEBI (Alternate Investment
Funds) (amendment) Regulations, 2013 as a sub-category of Venture Capital Fund under category I-AIF
that raises funds from angel investors and invests in accordance with rugulations specified by SEBI.

An angel investor or angel (also known as a business angel, informal investor, angel funder, private investor,
or seed investor) is an affluent individual who provides capital for a business start-up, usually in exchange for
convertible debt or ownership equity. A small but increasing number of angel investors invest online through
equity crowd funding or organize themselves into angel groups or angel networks to share research and pool
their investment capital, as well as to provide advice to their portfolio companies.
Angel investments are typically the earliest equity investments made in start-up companies. They commonly
band together in investor networks. Often these networks are based on regional, industry investor or academic
affiliation. Angel Investors are often former entrepreneurs themselves, and typically enjoy working with
companies at the earliest stages of business formation.
The effective Angels help entrepreneurs to shape business models, create business plans and connect to
resources - but without stepping into a controlling or operating role. Often Angels are entrepreneurs who have
successfully built companies, or have spent a part of their career in coaching young companies.

Anchor Investors
Anchor investor means a Qualified Institutional Buyer (QIB) who makes an application for a value of at least
10 crore rupees in a public issue on the main board made through the book building process or makes an
application for a value of atleast `2 crore for an public issue on the SME exchange made in accordance with
Chapter IX of the SEBI (ICDR) Regulations, 2018.
Allocation to the anchor investors shall be on a discretionary basis, subject to the following:
(I) In case of public issue on the main board, through the book building process:
(i) maximum of 2 such investors shall be permitted for allocation up to `10 crore;
(ii) minimum of 2 and maximum of 15 such investors shall be permitted for allocation above `10 crore
and up to `250 crore, subject to minimum allotment of `5 crore per such investor;
(iii) in case of allocation above `250 crore; a minimum of 5 such investors and a maximum of 15 such
investors for allocation up to `250 crore and an additional 10 such investors for every additional
`250 crore or part thereof, shall be permitted, subject to a minimum allotment of `5 crore per such
investor.
(II) In case of public issue on the SME exchange, through the book building process:
(i) Maximum of 2 such investors shall be permitted for allocation up to two crore rupees;
(ii) Minimum of 2 and maximum of 15 such investors shall be permitted for allocation above 2 crore
rupees and up to 25 crore rupees, subject to minimum allotment of 1 crore rupees per such investor;
(iii) In case of allocation above 25 crore rupees; a minimum of 5 such investors and a maximum of 15
such investors for allocation up to 25 crore rupees and an additional 10 such investors for every
additional 25 crore rupees or part thereof, shall be permitted, subject to a minimum allotment of 1
crore rupees per such investor.

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EP-CM&SL Basics of Capital Market

The bidding for anchor investors shall open one day before the issue opening
date allocation to Anchor Investors shall be completed on the day of bidding Test your Knowledge:
by Anchor Investors. Shares allotted to the Anchor Investor shall be locked- State the differeces between
in for 30 days from the date of allotment in the public issue. Angel Funds and Anchor
Upto 60% of the portion available for allocation to QIB shall be available to Investors
anchor investor(s) for allocation/ allotment (“anchor investor portion”) and
one-third of the anchor investor portion shall be reserved for domestic mutual funds.

High Net Worth Individuals

HNIs or high net worth individuals is a class of individuals who are distinguished from other retail segment based
on their net wealth, assets and investible surplus. While there is no standard put forth for the classification, the
definition of HNIs varies with the geographical area as well as financial markets and institutions.

Though there is no specific definition, generally in the Indian context, individuals with over ` 2 crore investible
surplus may be considered to be HNIs while those with investible wealth in the range of ` 25 lac - ` 2 crore may
be deemed as Emerging HNIs.

Explanation: If you apply for amount under ` 2 lakhs, you are considered as a retail investor. There may be so
many ways in which HNIs are categorized and defined, there is no single bracket that could put them under
one roof.

Pension Fund
Pension Fund means a fund established by an employer to facilitate and organize the investment of employees’
retirement funds which is contributed by the employer and employees. The pension fund is a common asset
pool meant to generate stable growth over the long term, and provide pensions for employees when they
reach the end of their working years and commence retirement. Pension funds are commonly run by some sort
of financial intermediary for the company and its employees like National Pension Scheme (NPS) is managed
by UTIAMC (Retirement Solutions), although some larger corporations operate their pension funds in-house.
Pension funds control relatively large amounts of capital and represent the largest institutional investors in
many nations.

Pension funds play a huge role in development of the economy and it play active role in the Indian equity market.
This pension fund ensures a change in their investment attitudes and in the regulatory climate, encouraging
them to increase their investment levels in equities and would have a massive impact on capital market and on
the economy as a whole.

Legislations
There are three defining Acts for pensions in India:

1. Pensions under the EPF & MP Act 1952: These include the Employees, Provident Fund, Employees,
Pension Scheme, and Employees, Deposit Linked Insurance Scheme.

2. Pensions under the Coal mines PF & MP Act 1948: These include Coal mines provident fund, Coal
mines pension scheme & Coal mines linked insurance scheme.

3. Gratuity under the Payment of Gratuity Act, 1972: There are other provident funds in India like Assam
Tea Plantations PF, J&K PF, and Seamens PF etc.

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Basics of Capital Market LESSON 1

Pensions broadly divided into two sector:

A-Formal sector Pensions
Formal sector pensions in India can be divided into three categories; viz pensions under an Act or Statute,
Government pensions and voluntary pensions.
B-Informal sector Pensions
This scheme will cover unorganized workers who are working or engaged as home based workers, street
vendors, agriculture workers, construction workers, among others.
Note: Capital Market Intermediaries are given in Lesson No. 2 and Lesson No.6 in brief.

CAPITAL MARKET INSTRUMENTS

Equity shares
Equity shares, commonly referred to as ordinary share also represents the form of fractional ownership in which
a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business
venture. The holder of such shares is the member of the company and has voting rights.
According to explanation (i) to Section 43 of Companies Act, 2013 ‘‘equity share capital’’, with reference to any
company limited by shares, means all share capital which is not preference share capital. Section 43 further
provides for equity share capital (i) with voting rights, or (ii) with differential rights as to dividend, voting or
otherwise in accordance with such rules as may be prescribed.
Equity capital and further issues of equity capital by a company are generally based on the condition that they
will rank pari passu along with the earlier issued share capital in all respects. However, as regards dividend
declared by the company such additional capital shall be entitled to dividend ratably for the period commencing
from the date of issue to the last day of the accounting year, unless otherwise specified in the articles or in the
terms of the issue.

Equity shares, have voting rights at all general

meetings of the company. These votes have the affect
of controlling the management of the company.

Equity shares have the right to share the profits

of the company in the form of dividend (cash) and
bonus shares. However, even equity shareholders
Important characteristics cannot demand declaration of dividend by the
company which is left to the discretion of the Board of
Directors.

When the company is wound up, payment towards

the equity share capital will be made to the respective
shareholders only after payment of the claims of all
the creditors and the preference share capital.

Equity share holders enjoy different rights as members under the Companies Act, 2013 such as:
(a) The right to vote on every resolution placed before the company – (Section 47)

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EP-CM&SL Basics of Capital Market

(b) The rights to subscribe to shares at the time of further issue of capital by the company (Pre-emptive
Right) – (Section 62)
(c) Right to appoint proxy to attend and vote at the meeting on his behalf – (Section 105)
(d) Right to receive copy of annual accounts of the company – (Section 136)
(e) Right to receive notice of the meeting of members – (Section 101)
(f) Right to inspection of various statutory registers maintained by the company – (Section 94)
(g) Right to requisition extraordinary general meeting of the company – (Section 100)
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 also specifies that the listed entity
shall seek to protect and facilitate the exercise of the following rights of shareholders:
(a) right to participate in, and to be sufficiently informed of, decisions concerning fundamental corporate
changes,
(b) opportunity to participate effectively and vote in general shareholder meetings,
(c) Being informed of the rules, including voting procedures that govern general shareholder meetings,
(d) opportunity to ask questions to the board of directors, to place items on the agenda of general meetings,
and to propose resolutions, subject to reasonable limitations,
(e) Effective shareholder participation in key corporate governance decisions, such as the nomination and
election of members of board of directors,
(f) exercise of ownership rights by all shareholders, including institutional investors,
(g) adequate mechanism to address the grievances of the shareholders,
(h) protection of minority shareholders from abusive actions by, or in the interest of, controlling shareholders
acting either directly or indirectly, and effective means of redress.

Shares with Differential Voting Rights

Shares with differential voting rights (“DVR”) refer to equity shares holding differential rights as to dividend and/
or voting. Section 43 (a) (ii) of the Companies Act, 2013 allows a company limited by shares to issue DVRs as
part of its share capital. Introduced for the first time in 2000 and issued by Tata Motors first, DVRs are seen
as a viable option for raising investments and retaining control over the company at the same time Section
43(2) of the Companies Act 2013 read with Companies ( Share Capital & Debenture) Rules, 2013 provides that
companies can issue equity shares with differential rights subject to the following conditions including:
l Articles of association of the company must authorize the issue;
l The voting power in respect of shares with differential rights of the Company shall not exceed 74% of
total voting power including voting power in respect of equity shares with differential rights issued at
any point of time;
l Approval of shareholders by passing ordinary resolution in General Meeting;
l The Company should not have defaulted in:
l filing annual returns and financial statements for the last three years;
l repayment of matured deposits or declared dividend;
l redemption of its preference shares/debentures which are due for redemption;

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Basics of Capital Market LESSON 1
l repayment of term loan taken from any public financial institution or state level financial institution
or from a scheduled bank that has become due and payable;
l statutory dues of the employees of the company.

Preference Shares
Preference shares are that part of a company’s share capital which carry a preferential right to:
l dividend at a fixed rate or amount; and
l repayment of capital in case of winding-up of the company.
Preference shares enjoy a preferential right to dividend and repayment of capital in case of winding-up of the
company. Governed by the provisions of Section 55 of the Companies Act, the main drawback of preference
shares is that they carry limited voting rights. Generally, an equity share confers on its holder a right to vote
on all resolutions that require shareholder approval under the Act, any other law, or the articles of association
of the company. A preference share carries voting rights only with respect of matters which directly affect the
rights of the preference shareholders.

In this regard, the Act clarifies a resolution relating to winding-up and repayment or reduction of capital is
deemed to directly affect the rights of the preference shareholders. Due to these limitations on voting rights,
a preference shareholder does not have much control over the company. However, a preference shareholder
may acquire voting rights on par with an equity shareholder if the dividend on preference shares is in arrears.

Issuer desirous of making an offer of non-convertible redeemable preference shares to the public is required
to list on one or more recognized stock exchanges. Issuer may list its non-convertible redeemable preference
shares issued on private placement basis on a recognized stock exchange. [This section has been discussed
in Lesson No. 4 of Company Law Subject (Executive Programme)]

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EP-CM&SL Basics of Capital Market

Debentures
Section 2(30) of the Companies Act, 2013 defines debentures. “Debenture” Debenture is a document
includes debenture stock, bonds or any other instrument of a company evidencing a debt or
evidencing a debt, whether constituting a charge on the assets of the acknowledging it and any
company or not. document which fulfils
However, either of these conditions is
a Debenture.
(a) the instruments referred to in Chapter III-D of the Reserve Bank of
India Act, 1934; and
(b) such other instrument, as may be prescribed by the Central Government in consultation with the Reserve
Bank of India, issued by a company, shall not be treated as debenture.
The important features of a debenture are:
1. It is issued by a company as a certificate of indebtedness.
2. It usually indicates the date of redemption and also provides for the repayment of principal and payment
of interest at specified date or dates.
3. In case of secured debentures, it creates a charge on the undertaking or the assets of the company.
4. Debentures holders do not have any voting rights.
5. Company shall pay interest, irrespective of profits.
6. While issuance of debentures, the company shall ensure that the parameters for designation of deposits
under Companies (Acceptance of Deposits) Rules, 2014 are not triggered.

Categories of Debentures
Based on convertibility, debentures can be classified under three categories:
l Fully Convertible Debentures (FCDs) : These are converted into equity shares of the company with
or without premium as per the terms of the issue, on the expiry of specified period or periods. If the
conversion is to take place at or after eighteen months from the date of allotment but before 36 months,
the conversion is optional on the part of the debenture holders in terms of SEBI (ICDR) Regulations.
Interest will be payable on these debentures upto the date of conversion as per transfer issue.
l Non Convertible Debentures (NCDs) : These debentures do not carry the option of conversion into
equity shares and are therefore redeemed on the expiry of the specified period or periods. The issuer
is required to list its Public issue of NCDs on stock exchange as per SEBI (Issue and Listing of Debt
Securities) Regulations, 2008. NCDs can be also issued on private placement basis.
l Partly Convertible Debentures (PCDs) : These may consist of two kinds namely-convertible and non-
convertible. The convertible portion is to be converted into equity shares at the expiry of specified
period. However, the non-convertible portion is redeemed at the expiry of the stipulated period. If
the conversion takes place at or after 18 months, the conversion is optional at the discretion of the
debenture holder.

Optionally Fully Convertible Debenture (OFCD)

The Optionally Fully Convertible Debenture is a kind of debenture which can be converted into shares at the
expiry of a certain period at a predetermined price, if the debt holder (investor) wishes to do so. The “securities”
as defined u/s 2(81)) of Companies Act, 2013 means securities as defined in clause (h) of section 2 of the

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Basics of Capital Market LESSON 1

Securities Contracts (Regulation) Act, 1956, and includes hybrids. Hence after analysing the above definition
of “OFCD”, “hybrid” and “securities” it could be rightly concluded that an OFCD being a hybrid security falls
under the definition of “securities” as defined u/s 2 (h) of securities Contract (Regulation) Act, 1956 and u/s 2(81)
of Companies Act, 2013 as it inherits the characteristics of debentures initially and also that of the shares at a
later stage if the option to convert the securities into shares being exercised by the security holder. [This section
has been discussed in Lesson No. 6 of Company Law Subject (Executive Programme)]

Bonds
Bonds are the debt security where an issuer is bound to pay a specific rate of interest agreed as per the terms
of payment and repay principal amount at a later time. The bond holders are generally like a creditor where a
company is obliged to pay the amount. The amount is paid on the maturity of the bond period. Generally these
bonds duration would be for 5 to 10 years.

Characteristics of a Bond
1. Bond has a fixed face value, which is the amount to be returned to the investor upon maturity.
2. Fixed maturity date, which can range from a few days to 20-30 years or even more.
3. All bonds repay the principal amount after the maturity date.
4. Provides regular payment of interest, semi-annually or annually.
5. Interest is calculated as a certain percentage of the face value known as a ‘coupon payment’.
6. Generally considered as less risky investment as compared to equity.
7. It helps to diversify and grow investor’s money.

Types of Bond

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EP-CM&SL Basics of Capital Market

Test your Knowledge:

How is a Bond different from a Debenture?

Foreign Currency Convertible Bonds (FCCBS)

‘Foreign Currency Convertible Bond’ (FCCB) means a bond issued by an Indian company expressed in foreign
Currency, and the principal and interest in respect of which is payable in foreign currency.
The FCCBs are unsecured instruments which carry a fixed rate of interest and an option for conversion into
a fixed number of equity shares of the issuer company. Interest and redemption price (if conversion option is
not exercised) is payable in dollars. FCCBs shall be denominated in any freely convertible Foreign Currency.
However, it must be kept in mind that FCCB, issue proceeds need to conform to ECB end use requirements.
Foreign investors also prefer FCCBs because of the Dollar denominated servicing, the conversion option and,
the arbitrage opportunities presented by conversion of the FCCBs into equity shares at a discount on prevailing
Indian market price. In addition, 25% of the FCCB proceeds can be used for general corporate restructuring.
Example
Suppose a company ‘A’ issues bonds with following terms –
Issue Price of the Bond ` 1000 Coupon rate 2% Maturity 2 years
Convertible into equity shares @ `800 per share
Now suppose an investor subscribes to 4 of these bonds. Thus the total investment is `4000. On this
investment, he is entitled to get an interest @ 2% for 2 years. On the maturity date, i.e. after 2 years, the
investor will have an option – to either claim full redemption of the amount from the company or get the
bonds converted into fully paid equity shares @ ` 800 per share. Thus if he goes for the conversion he will
be entitled to 5 (4000/800) equity shares. The choice he makes will depend on the market price of the
share on the date of conversion.
If the shares of the company ‘A’ is trading at lower than `800, let’s say `500, the investor will be better off
by claiming full redemption of his bonds and buying the shares from the market. In this case, he will get 8
(4000/500) equity shares as against 5 which he was getting on conversion. Similarly if the market price of
the share is higher than ` 800, the investor will benefit by getting its shares converted. Thus, on the day
of maturity, an investor will seek full redemption if the conversion price is higher than the current market
price, and will go for conversion if the conversion price is less than the current market price.

Foreign Currency Exchangeable Bonds (FCEBs)

The FCEB is used to raise funds from the international markets against the security and exchangeability of
shares of another company. Foreign Currency Exchangeable Bond (FCEB) means –
l A bond expressed in foreign currency.
l The principal and the interest in respect of which is payable in foreign currency.
l Issued by an issuing company, being an Indian company.
l Subscribed by a person resident outside India.
l Exchangeable into equity shares of another company, being offered company which is an Indian
company. Either wholly or partly or on the basis of any equity related warrants attached to debt
instruments. It may be noted that issuing company to be the part of promoter group of offer or company

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Basics of Capital Market LESSON 1

and the offeror company is to be listed and is to be eligible to receive foreign investment. Under this
option, an issuer company may issue FCEBs in foreign currency, and these FCEBs are convertible into
shares of another company (off company) that forms part of the same promoter group as the issuer
company.

Example: Company ABC Ltd. issues FCEBs, then the FCEBs will be convertible into shares of company
XYZ Ltd. that are held by company ABC Ltd. and where companies ABC Ltd. and XYZ Ltd. form part of the
same promoter group. Unlike FCCBs that convert into shares of issuer itself, FCEBs are exchangeable into
shares of Offered Company (OC). Also, relatively, FCEB has an inherent advantage that it does not result in
dilution of shareholding at the OC level.

Can you now differentiate between Foreign Currency Convertible Bond (FCCB) and Foreign Currency
Exchangeable Bond (FCEB)?

Indian Depository Receipts

According to Section 2(48) of the Companies Act, 2013 Section 390 of the Companies Act, 2013 and rule 13
“Indian Depository Receipt” means any instrument in of Companies (Registration of Foreign Companies)
the form of a depository receipt created by a domestic Rules, 2014 lays down the procedure for issue
depository in India and authorized by a company of Indian Depository Receipts. Apart from this a
incorporated outside India making an issue of such company has to comply with Chapter X and XA
depository receipts. of SEBI (ICDR) Regulations, 2018 to issue IDRs or a
An IDR is an instrument denominated in Indian Rupee in rights issue of IDRs.
the form of a depository receipt created by a domestic
depository (Custodian of securities registered with
SEBI) against the underlying equity of issuing company to enable foreign companies to raise funds from Indian
Securities Markets. In an IDR, foreign companies would issue shares, to a domestic (Indian) depository, which
would in turn issue depository receipts to investors in India. The actual shares underlying the IDRs would be held
by an Overseas Custodian, which shall authorize the Indian depository to issue the IDRs. To that extent, IDRs are
derivative instruments because they derive their value from the underlying shares. Standard Chartered PLC is
only company to offer IDR in the Indian market. The foreign company issuing IDRs need to comply with the
requirements of rules prescribed under Companies Act, SEBI Regulations and RBI notifications/ circulars.

Derivatives
Derivatives can be of different types like futures, options, swaps,
A derivative is a financial instrument
caps, floor, collars etc. The most popular derivative instruments
that derives its value from an
are futures and options.
underlying asset. This underlying
The term Derivative has been defined in Securities Contracts asset can be stocks, bonds, currency,
(Regulations) Act, as:- commodities, metals and even
intangible, assets like stock indices.
Derivative includes: -
(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument
or contract for differences or any other form of security;
(B) a contract which derives its value from the prices, or index of prices, of underlying securities;
(C) commodity derivatives; and
(D) such other instruments as may be declared by the Central Government to be derivatives.

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EP-CM&SL Basics of Capital Market

Warrant
Warrant means an option issued by a company whereby the buyer is granted the right to purchase a number of
shares (usually one) of its equity share capital at a given exercise price during a given period.
The holder of a warrant has the right but not the obligation to convert them into equity shares. Thus in the true
sense, a warrant signifies optional conversion. In case the investor benefits by conversion of warrant, then he
will convert the warrants, else he may simply let the warrant lapse. The companies listed on the Exchange can
issue warrants in accordance with SEBI (ICDR) Regulations, 2018.

For example if the conversion price of the warrant is ` 70/-and the current market price is `110/-, then
the investor will convert the warrant and enjoy the capital gain of `40/-. In case the conversion is at
`70/- and the current market price is `40/-, then the investor will simply let the warrant lapse without
conversion.

Real Estate Investment Trusts (‘REITs’)

A real estate investment trust (“REIT”) is a collective investment scheme that owns, operates or finances income-
producing real estate. REITs provide all investors the chance to own valuable real estate, present the opportunity
to access dividend-based income and total returns, and help communities grow, thrive, and revitalize.
REITs allow anyone to invest in portfolios of real estate assets the same way they invest in other industries –
through the purchase of individual company stock or through a mutual fund or exchange traded fund (ETF). The
stockholders of a REIT earn a share of the income produced through real estate investment – without buying
any finance property. Benefits of REITs include:
l Less Capital Intensive: Direct investment in real estate property is very capital intensive. But each
shares of REITs will be comparatively more affordable (it will not require large capital outflows).
l Suitable for small Investors: Investing through REITs will eliminate dealing with builders, thereby
avoiding potential exposure to big builders.
l Transparency: REITs stocks are listed in stock market, hence details will be available on public domain.
l Assured Dividends: REITs generates income in form of dividend. REITs dividend payment is relatively
assured as most of their income is in the form of rental (lease) income.
l Tax Free: Dividend earned by the investors of REIT will be tax free.
l Fast Capital Appreciation: Capital appreciation can be phenomenal.
l Easy to buy: Investment in REITS easier than investment in Real Estate properties.

REITs are similar to mutual funds and shares and they provide income by way of :
l Dividend to its shareholders.
l Capital Appreciation as REIT stocks are listed in BSE and NSE.

Infrastructure Investment Trusts (‘InvITs’)

Considering the importance of infrastructure sector with an aim to provide a suitable platform for financing /
refinancing infrastructure projects and allow the investors to participate in the growth story of infrastructure,
the Government introduced a new investment vehicle named Infrastructure Investment Trusts (‘InvITs’) in
2014.

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Basics of Capital Market LESSON 1

The primary objective of InvITs is to promote the infrastructure sector of India by encouraging more
individuals to invest in it. Typically, such a tool is designed to pool money from several investors to be
invested in income-generating assets. The cash flow thus generated is distributed among investors as
dividend income. When compared to Real Estate Investment Trust or REITs, the structure and operation of
both are quite similar.
An InvIT is established as a trust and is registered with the SEBI. Typically, infrastructure investment trust SEBI
comprises 4 elements, namely –
l Trustee : They are required to be registered with SEBI as debenture trustees. Also, they are required to
invest at least 80% into infra assets that generate steady revenue.
l Sponsor : Typically, a body corporate, LLP, promoter or a company with a net worth of at least ` 100
crore classifies as a sponsor. Further, they must hold at least 15% of the total InvITs with a minimum
lock-in period of 3 years or as notified by any regulatory requirement. When it comes to a public-private
partnership or PPP projects, sponsors serve as a Special Purpose Vehicle (SPV).
l Investment manager : As a body corporate of LLP, an investment manager supervises all the operational
activities surrounding InvITs.
l Project manager : The authority is mostly responsible for executing projects. However, in the case of
PPP projects, it serves as an entity that also supervises ancillary responsibilities.

Securitized Debt Instruments

Securitized debt instruments are financial securities that are created by securitizing individual loans (debt).
Securitization is a financial process that involves issuing securities that are backed by assets, most commonly
debt. The assets are transformed into securities, and the process is called securitization. The owner of the
securities receives an income from the underlying assets; hence, the term asset-backed securities.
Securitized debt instruments come with various advantages over conventional forms of investing and are more
valuable to a portfolio. One of the most common types of securitized debt is mortgage-backed securities.
Securitized debts can lower interest rates and free up capital for the bank, but they can also encourage lending
for reasons other than making a profit. SEBI had laid down the framework for public offer and listing of securitized
debt instruments vide SEBI (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008 and had
specified listing agreement for Securitized Debt Instruments. A few privately placed SDIs have already been
listed on exchanges.

Municipal Bonds
Municipal bonds are also referred to as ‘muni bonds’. The urban local government and agencies issue these
bonds. Municipal bonds are issued when a government body wants
to raise funds for projects such as infra-related, roads, airports,
railway stations, schools, and so on. SEBI issued guidelines in 2015
for the urban local bodies to raise funds by issuing municipal bonds.
Municipal bonds exist in India since the year 1997. Bangalore
Municipal Corporation is the first urban local body to issue
municipal bonds in India. Ahmedabad followed Bangalore in the
succeeding years. The municipal bonds lost the ground after the
initial investors’ attraction it received and failed to raise the desired
amount of funds. To revive the municipal bonds, SEBI came up with
guidelines for the issue of municipal bonds in 2015.

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EP-CM&SL Basics of Capital Market

Municipality should meet the following eligibility criteria to issue municipal bonds in India:
l The municipality must not have a negative net worth in each of the three previous years.
l The municipality must have no default in the repayment of debt securities and loans availed from the
banks or non-banking financial companies in the last year.
l The municipality, promoter and directors must not be enlisted in the willful defaulters published by the
Reserve Bank of India (RBI). The municipality should have no record of default in the payment of interest
and repayment of principal with respect to debt instruments.

LESSON ROUND-UP

l Securities Market is a place where companies can raise funds by issuing securities such as equity
shares, debt securities, derivatives, mutual funds, etc. to the investors (public) and also is a place where
investors can buy or sell various securities (shares, bonds, etc.).
l The primary market deals with the issue of new instruments by the corporate sector such as equity
shares, preference shares and debt instruments.
l The secondary market or stock exchange is a market for trading and settlement of securities that have
already been issued. The investors holding securities sell securities through registered brokers/sub-
brokers of the stock exchange
l SEBI was established with the statutory powers to protect the interest of investors; promote the
development of the securities market; and regulate the securities market.
l Venture Capital is generally equity investments made by Venture Capital funds, at an early stage in
privately held companies, having potential to provide a high rate of return on their investments.
l Debenture is a document evidencing a debtor acknowledging it and any document which fulfils either
of these conditions is a debenture.
l The FCCBs are unsecured instruments which carry a fixed rate of interest and an option for conversion
into a fixed number of equity shares of the issuer company.
l A real estate investment trust (“REIT”) is a company that owns, operates or finances income-producing
real estate.

TEST YOURSELF

(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. Briefly explain the Financial System in India ?
2. Capital Market is referred as engine for economic growth. Explain.
3. Distinguish between Primary Market and Secondary Market.
4. Distinguish between Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs).
5. “Bonds are the debt security where an issuer is bound to pay a specific rate of interest.” Explain.
6. “Define Alternate Investment Fund. Explain in brief different categories of AIF.
7. Explain in brief the regulators in Indian Capital Markets?

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Basics of Capital Market LESSON 1

LIST OF FURTHER READINGS

l SEBI Circulars, Notifications, Orders, Manual

l Regulations/Rules/Guidelines/Circulars issued by SEBI, RBI, MCA etc. from time to time

OTHER REFERENCES (Including Websites/Video Links)

l www.sebi.gov.in

l www.mca.gov.in

l www.icsi.edu

l www.nseindia.com

l www.bseindia.com

l www. nsdl.co.in

l www.cdslindia.com

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