Financial Markets -Training document

Capital Markets and Money Markets

Capital Markets

 Long-term markets consisting of securities having maturities greater than one year.

 Include Bonds, Common Stock, Preferred Stock, and Convertible Securities, forex instruments,
derivatives.

 These securities comprise a firm’s capital structure.

 Higher expected return and more risk than money market.

 Credit instruments are more heterogeneous.

 Institutions – stock exchange, commercial banks,

Mortgage banks.

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Criteria & guidelines by SEBI for IPO.

 Issue shall be open within 12 months & allotment within 15 days.

 Listing with just 10 % holding with the public provided the minimum offer Rs 100 crore,

20 lakh shares through book building.

 Minimum threshold level of public holding 25%.

 Pre-issue net worth > 1cr (3 of 5 preceding years).

 Trak record of distributing dividends for at least 3 of 5 preceding years).

 Offer should not exceed five times net worth as per latest audited accounts.

 If not only through book building process (60% to QIB’s)

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Criteria & guidelines by SEBI for IPO.

 Minimum promotors contribution (i.e. 20% of post issue capital) is locked in for 3years

and excess of required minimum % must be locked for 1 year.

 Pre issue capital held by other than promotors must be locked in for 1 year.

 All partly paid up equity shares into fully paid up.

 SEBI allows free pricing of equity shares in IPO

 Issuer may announce a price band 2 working days before bid opening.

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Factors determining price of IPO.

 Objects of the issue.

 Financials of the company – Net worth, EPS, profit margin.

 Industry P/E ratio.

 Future prospects in the relevant industry.

 Background of promotors & Board.

 External and internal risks.

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Intermediary structure

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IPO timeline
Activity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Preparation phase
2 weeks

Due diligence
4-5 weeks

Filing of draft document

1 week

SEBI Observation
4-8 weeks

Finalization & filing of

offer document 3 weeks

Issue Period
3 days

Post issue activities

2-3 weeks

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IPO timeline

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 Where do business get money from ?

Sources of capital
Entrepreneur
Angel investors
Venture capital
Friends & family
Commercial banks
Quasi Government agencies
Public capital markets
operations

• Equity – IPO’s , FPO’s, Private equity, right shares preference shares

• Debt – Loans from banks & financial institutions, overdrafts, Bonds

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Capital Structure
 Capital structure decision affects financial risk and, hence, value of the company.

 The capital structure theory helps us understand the factors most important in the
relationship between capital structure and the value of the company.

 The Optimal Capital Structure.

• We cannot determine the optimal capital structure for a given company, but we know that it
depends on the following:

• The business risk of the company.

• The tax situation of the company.

• The degree to which the company’s assets are tangible.

• The company’s corporate governance.

• The transparency of the financial information.

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Reward based crowd funding Equity based crowd funding
Provides with working capital in exchange for
Set funding
goals a piece of your company

Take in your
Pros:
money and get Devise a reward
ready to deliver strategy • It is smart money
Cons:
the rewards • There are potentially
• Increased
larger sums of
transparency
How it works? fundraising
• Expensive
• Easier investor
Post your fundraising
relations
campaign to a
Get social
crowdfunding
platform

Pros: Cons:
• Access to cheap • The pressure is on
money • Lot of work,
• Pre-funding your potentially little
next product payoff

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Capital Markets and Money Markets
Money Markets

 Short-term markets comprising of securities with maturities of one year or less.

• Include Treasury bills, commercial paper, certificates of deposits, call money.

• Allow government to raise funds.

• Determine short term interest rates

• Implement monetary policy.

 Characteristics :

• Liquid & short maturities, low expected return, low degree of risk.

• Homogeneous instruments.

• Over the counter and wholesale level transactions.

• High transaction cost

 Institutions : central banks, commercial banks NBFI’s.

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Flow of funds in financial markets ?

Avg Indian household

saving rate 31.6%

• Facilitates the efficient allocation of fund throughout the economy.

• Greater flow of funds increases the accommodation of individual’s preference for spending &

saving.

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What are Financial Markets ?

Market

Financial Market

Low
transaction
cost

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Financial systems and Structures

Organized vs Unorganized Structures

 Organized
 Regulators, Financial Institutions, Financial Markets, Financial Instruments.
 Unorganized
 No physical location (Networks of dealers)
 Over the counter Money lenders, Local bankers, Landlords, Pawn brokers, Chit Funds.

Role of an Efficient and Effective Financial System

 Efficient: Ability to channelize the funds from a Surplus Unit to a Deficit Unit.

 Effective: Ability to bring the investors and borrowers with matching maturities/investment horizons
together.

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Role of Financial/Securities Markets

 Price Discovery Process

 Liquidity

 Reduction of search & information costs

 Transfer of risk ( derivatives market)

 Capital raising

 Integrating global markets with the financial market

 Speed up the economic growth and development

Classification Of Financial Market

Capital Market Money Market

Primary Secondary Primary Secondary

Call Treasury Short term

Debt Equity Derivatives
money Bills Loans

Wholesale Retail Commercial

Segment Segment Bills

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Primary and Secondary Market
Primary Market

 Sale of new debt or equity securities which have come to life for the first time
(IPO, FPO, Rights, Private Placements)
 Primary investors buy share directly from the company
 Underwriter (usually the investment banker) provides facility of (in IPO, FPO):
• Origination
• Book Building
• Risk bearing
 Private Placements
• Sale directly to the investors with help of an investment bank
• Lower issuance cost for the firm
• Lower issue price since there is no active secondary market for
such privately allotted securities

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Primary and Secondary Market
Secondary Market
 Trading of securities previously issued are now exchanging hands.

 Investors who have already invested during IPO can make an exit by selling their stake to other investors.

 Liquidity increases – boost to the securities prices.

 No cash flow impact for the subject company or entity.

 Listing requirements are stringent.

 Issuer pays the exchange for Initial listing fee and Annual listing fees

• Floor Trading and Electronic Trading

• Quote-driven, Order-driven, Brokered Markets

 Stock prices fluctuates depending on demand and

supply.

 Unlimited time frame

 Brings many interested parties together.

Financial Intermediaries
Different forms of
intermediaries/Participants

 Brokers/dealers/exchange - they facilitate the trade and provide important services.

 Depository Institution

 Insurance Company: Credit Default Swaps (CDS)

 Arbitrageurs

 Clearing House and Custodians – Quasi – regulatory in nature, reduce a lot of risk in the

investment process.

 PSU’s & development Banks and financial institutions, SEBI.

Methods of issuing capital in Primary market
 IPO
Public issue of share for the first time.

Underwriter (investment banking company)

Appointment of underwriters to ensure the minimum subscription.

 FPO
Public issue made by a listed company for one or more time i.e. Follow-on-public offer.
 E-IPO
Issue capital through online system of stock exchange with the compliance of the SEBI-
(chapter-11A)

 Offer for sale

 Private Placement

 Right issue

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Sources and Uses of Funds
Three general sources of corporate funds
• Internally generated Cash

• Short-term External Funds

• Long-term External Funds

Uses of Cash Flow Sources of Cash Flow

(100%) (100%)

Capital Internal Cash

spending Flows (retained
earnings plus Internal
depreciation) Cash Flow
Financial
Net Working Deficit
Capital plus
Long-term Debt External
other uses
and Equity Cash Flow

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Announcement of New Equity & the Value of the Firm

The market value of existing equity generally drops on the announcement of a new issue of common
stock

Reasons include

 Managerial Information

• Since the managers are the insiders, perhaps they are selling new stock because they think it is
overpriced

 Debt Capacity

• If the market infers that the managers are issuing new equity to reduce their debt-to-equity ratio
due to the specter of financial distress the stock price will fall

 Falling Earnings