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FMBO (205 FIN) Unit III - Capital Market
FMBO (205 FIN) Unit III - Capital Market
FMBO (205 FIN) Unit III - Capital Market
1) Capital market refers to all facilities and institutional arrangements for borrowing
and lending medium-term and long-term funds. Capital market also known as
Securities Market as it deals with securities such as shares, stocks, bonds,
debentures, etc.
Mobility of capital
Economic dynamism
3.2) Primary Market (New Issue Market) (Market for New Securities)
1) Primary Market deals with new or fresh issue of securities, hence it is also
known as New Issue Market. Primary market is an important constituent of
capital market.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
4) Primary market deals with issue of new / fresh instruments by corporate sector.
This includes equity shares, preference shares, debentures, bonds, depository
receipts, etc.
5) Primary market plays a key role in raising maximum monetary resources for
capital formation in the country. Thereby, it also ensures balanced and
diversified industrial and economic growth.
Promoters of Company
Merchant Bankers
Stock Brokers
Underwriters
Bankers to Issue
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
Financial Institutions
Advertising Agencies
Individual Investors
4) Stock exchanges provide ready and continuous market for willing and desired
investors who comes together to transact in securities.
5) A well organised and properly regulated stock market ensures greater safety
and fair dealing to investors. This is because all transactions on stock
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
exchanges are made under well defined rules, regulations, guidelines and bye –
laws.
6) This helps to develops confidence in the minds of savers and investors. This
further encourages them to save more and invest these funds in securities which
have better prospects and higher returns. Secondary market helps in allocating
scare and limited available resources in proper and profitable avenues.
1) Both primary market and secondary market are interdependent and inseparable.
They cannot exist without each other. There is a symbolic relationship between
primary market and secondary market.
2) The process of new capital formation takes place in primary market; whereas,
secondary market provides a continuous market for various financial securities.
3) These securities are purchased and sold in volume with variation in current
market prices. Secondary market also provides easy liquidity and ready market
to initial buyers in primary market. Thus, they can further reinvest the same
funds in some other securities.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
Hence, capital market which include primary market and secondary market are
considered as backbone of financial system in any economy.
1) Preference shareholders are the ones who get preference / priority over and
above equity shareholders during payment of dividend and repayment of
principal capital at the time of liquidation of company. This dividend is paid
out of profits earned by the company at a fixed rate.
4) They do not enjoy voting rights and do not share profits of company.
5) They are hybrid securities that exhibit characteristics of both equity shares as
well as debt / borrowed securities. Hence, they are also known as Quasi Equity.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
paying off all claims and liabilities. It cannot be redeemed during lifetime of
company.
3) Shareholders can claim their share in profitability (income) only when claims
of creditors and preference shareholders are paid off.
4) Even if sufficient income is leftover after meeting all obligations, still equity
shareholders cannot legally force company to pay them.
5) Cost of equity capital is higher than all other long-term sources of capital.
Dividend is not tax-deductible expenditure like interest.
6) Equity shareholders are last claimants to assets of the firm. In case of winding-
up of company, claims of outside creditors and preference shares are paid
before equity shareholders from business assets.
7) Every equity shareholder has right to vote on every resolution during the
meeting. These voting rights are in proportion to their shares in paid-up capital.
This further helps shareholders to control and direct the affairs and operations
of the company.
8) Equity shares are major source of financing for a company. Legally, the equity
shareholders are owners of company.
10) Disadvantages: higher risks, most costly source of capital, dividend is non-tax
deductible expenses, dilutes control of promoters.
1) Non-voting shares (unlike equity shares) do not enjoy any voting rights. These
are ordinary shares issued by public listed companies that do not have voting
powers at the annual general meeting (AGM) of company.
2) These are issued by promoters of company who wants to raise new capital
without losing control over company. Voting rights of promoters are retained
with their ownership of original shares.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
3) Company may issue non-voting shares to its employees because they want
them to be able to benefit from profits or dividend but do not want them to
participate in decision making.
3.4.4) Debentures
2) Debentures are major source of long term funds for company. From investors’
point of view, debentures are long term security yielding fixed rate of interest.
4) They are required to be fully paid-up and the price / conversion formula needs
to be determined upfront at the time of issue.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
5) Advantages: generally issued at discount, lower interest rate, offer tax rebate,
tax deductible expenses, preferential right of payment over equity shareholders,
transparent (all terms and conditions are clear for investors).
1) Fixed Deposits Accounts / Term Deposits are used by financial entities like
banks to mobilize savings of people for long term period. Principal amount is
repaid only at the time of maturity.
2) A lumpsum amount is deposited for a fixed tenure during which amount cannot
be withdrawn. If depositors withdraw money before end of maturity period,
then banks may levy penalty for pre-mature withdrawal. This penalty is mostly
out of interest, which depositors get on these fixed deposits.
3) Some portion of interest will not be paid to depositors. Bank provide highest
rate of interest on this type of account. Interest is paid on monthly or quarterly
or half yearly or annual basis.
3.4.7) Bonds
2) Bond holders are creditors to the issuer of bonds. Bonds are used by corporates,
municipalities, states and sovereignty Governments to finance projects and
operations. A bond has maturity period. At the end of maturity period, principal
amount of loan is due to be paid to bond holders / investors.
4) Issuers issued bonds that include terms of loan, interest payments (coupon rate)
that will be made and the time at which the principal amount must be paid back
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
to investors (maturity date). At the time of maturity period, the face value of
bond is paid back to bond investors.
5) In matured markets, such bonds are public traded. Actual market price of bond
then keeps on fluctuating on basis of number of factors.
6) Coupon rate of bond depends upon credit ratings of bond issuer which are
generated by credit rating agencies.
4) They are treated for ownership and transfer purposes in the same way as US
share certificates. An ADR certificate will show the depository bank in the
USA and indicate the liability of that bank to pay dividends declared, as well as
matters relating to proxies, rights issues and fees relating to underlying shares.
3) Global Depository Receipts facilitate trade of shares, and are commonly used
to invest in companies from developing or emerging markets.
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
5) Govt. of India can take decision to start new stock exchange in India only after
getting advice from SEBI. If SEBI thinks that any stock exchange operates against
rules and regulations, SEBI can ban any stock exchange to trade in shares, stocks
and securities.
3.5.2) Role Played by SEBI in regulating and controlling Indian capital market:
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
To regulate takeovers
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Financial Markets and Banking Operations (205 FIN)
Unit III: Capital Market
To prohibit insider trading in securities
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