As far as the Indian Capital markets are concerned, there are two methods to float new issues:
1. Public issues, and
2. Rights issues
Public issues:
A Prospectus is an Open invitation to the public at large to subscribe to the shares of that organization. It is a legal document and the most popular method for floating securities in the primary market (IPO). Shares are usually issued at a premium to the public at large. Premium means something extra above the face value of the shares. Public is ready to buy at a premium as they value the shares at such a high price. Many IPOs (public offering) have also gone flop – as in public did not subscribe to it as they felt that the offer price was very high – above its fair value. (We shall see more on this topic under the chapter: Valuation)
Rights issues:
Rights issues are issued by companies whose shares are normally already listed on stock exchanges. Rights issues is a Right of the existing shareholders to buy new shares as per the proportion of currently held shares by them (as per their current holding)
Example: 8:5 – meaning if you hold 8 shares, then you have the right to buy 5 more shares in this Right Issues if you wish to buy.
Private Placement:
The private placements can be made by a company to the investors at any agreed price and quantity as such private equity issues are not regulated by SEBI. The Securities and Exchange Board of India (SEBI) has effected several reforms in the New Issue Market. These reforms seek improved disclosure standards, prudential norms and simplification of issue procedures.
An unlisted company which wants to raise equity funds but is not yet prepared to make an IPO may place privately its equity or equity related instruments with one or more sophisticated investors such as financial institutions, mutual funds, venture capital funds, banks etc.
Secondary Market
Secondary Market is for Securities already in existence – which were issued by that organization earlier to public.This market provides both liquidity and marketability to such securities. It implies that it is a market where a security can be bought or sold at small transaction cost. Although the Secondary Market deals with the purchase and sale of old securities, the firms issuing new securities get themselves registered on a Stock Exchange by applying for listing of shares. Listing offers the investor a ‘market’ for the sale of his stock.
Existing holders get an option to exit from their investment by selling in the secondary market. The risk in a security investment is transferred from one investor (seller) to another (buyer) in the secondary markets. Thus, the primary market creates financial assets, and the secondary market makes them marketable.
The secondary market functions via; Stock Exchanges, and Over the Counter (OTC) Market
Stock Exchange
Stock Exchange is an organised market for the purchase and sale of second hand listed industrials and financial securities {i.e., shares and debentures of corporate companies). Listed securities are those securities which appear on the approved list of a Stock Exchange. Only listed securities are traded on the floor of the Stock Exchange. It is to be noted that an organised Stock Exchange is an ‘auction’ type of market, where the prices of traded securities are settled by open bids and offers on the floor of the exchange.
Transactions on a stock exchange are mainly done with two motives:
Investment transactions, and
Speculative transaction
Investment Transactions:
An investment transaction in securities is that transaction which is concerned with the purchase of securities, with a view to investing funds to get an income as annual dividends from these securities and gain from the sale of these securities. The basic feature of an investment transaction is that it involves the actual delivery of the security and payment of its full price. An investment transaction is motivated by the considerations of safety of investment and security of income.
Speculative Transactions:
The speculative transaction in securities is that transaction which is concerned with the purchase or sale of securities for the sake of capital appreciation. The basic feature of a speculative transaction is that the delivery of securities or the payment of the full price are rare.
The speculator neither takes delivery of the securities sold by him; instead he only receives or pays the difference between the purchase and sale prices, as the case may be. The trading in securities, without the intention of taking delivery or making payment, is called forward trading. Under the Securities Contract (Regulation) Act. 1956 forward trading was perfectly legal till it was suspended in 1969 along with all the regulatory and penal measures.
(Stock badla)
Badla
The suspension of forward trading created a real vacuum in the stock market. The stock brokers devised the extra-legal badla system to fill up this vacuum. Under this badla system, securities contract was turned into a carry-forward instrument merely by closing the contract on the 14th day and replacing it by a new hand-delivery contract between the same buyer and seller in respect of the same securities.
(SEBI bans the Badla system)
Thus, only the difference between the ‘contract price’ and the ‘market price’ would change hands between the buyer and the seller. Badla transactions became the predominant form of Stock Exchange transactions. Since real transactions involving the transfer of securities became a microscopic minority, serious problem of excessive speculation developed in the stock market. In short, the badla system led to excessive speculation and short-selling often amounting to gambling. The Securities and Exchange Board of India (SEBI) banned the badla system in December 1993.
There was an increasing demand for the legitimate forward trading to give boost to the stock market. Since stock market quotations are often considered as the barometers of a country’s economy, the SEBI and the Government should stimulate stock market. The SEBI, therefore, reintroduced badla (forward trading) on July 27, 1995. Now, with the introduction of derivatives in stock market the same purpose is served by the derivatives called futures as the old badla system.
The Bombay Stock Exchange is one of the recognized Stock Exchanges in India. This Stock Exchange is popularly known as Dalal Street Stock Market. It handles around three-fourth of the total trading in securities in India.
The number of companies listed on the Bombay Stock Exchange at the December-end 1993 was 3,585.
The BSE is the world’s 11th largest stock exchange with an overall market capitalization of more than $ 2 Trillion as of July, 2017.
More than 5500 companies are publicly listed on the BSE (2017)
BSE is listed on NSE.
(We shall read more about Stock exchanges and its functioning in the later chapters)