Classifications of sources of finance

General Classifications of sources of finance are classified into two:

1 Long term sources of finance and
2.Short term sources of finance.
1 Long term sources of finance
The following points highlight the long-term sources of fund. The long-term sources
are:
1. Equity Shares
2. Preference Shares
3. Debentures
4. Loans from Financial Institutions and
5. Retained Earnings.

1. Equity Shares:

It represents the ownership capital of a firm. A public limited company may raise funds from
public or promoters as equity share capital by issuing ordinary equity shares.

Ordinary shareholders are those the owners of which receive their dividend and return of
capital after the payment to preference shareholders.

They undertake the risk of the company. They elect directors and have total control over the
management of the company. These shareholders are paid dividends only when there are
distributable profits. As equity shares are paid only on liquidation, this source has the
minimum risk.

The liability of equity shareholders is limited up to the face value of the shares. Further,
equity share capital provides a security to other investors of funds. Hence, it will be easier to
raise further funds for companies having adequate equity share capital.

Advantages and Disadvantages:

Advantages:

The equity share capital offers the following advantages:

It is one of the most important long-term source of funds.

2. There are no fixed charges attached to ordinary shares. If a company earns enough
divisible profits it will be able to pay a dividend but there is no legal obligation to pay
dividends.

3. Equity share capital has no maturity date and hence the company has no obligation to
redeem.
4. The firm with the longer equity base will have greater ability to raise debt finance on
favourable terms. Thus issue of equity share increases the creditworthiness of the firm.

5.Dividend earnings are exempted from tax in the hands of investors. However, the company
paying equity dividend will have to pay tax on it.

6. The equity shareholders enjoy full voting right and participate in the management of the
company.

7. The company can issue further share capital by making right issue or bonus issue etc.

8. If the company earns more profit, more dividend is paid. So the value of goodwill of the
company increases, It ultimately leads to appreciate the market value of equity shares of the
company.

9. In India, returns from the sale of ordinary shares in the form of capital gains are subject to
capital gains tax rather than corporate tax.

Disadvantages:

The following are the disadvantages in raising finance by issue of ordinary shares:

1. Dividends payable to ordinary shareholders are not deductible as an expense for the
purpose of computation of tax but debenture interest is tax deductible. So, the cost of equity
capital is usually higher than other source of funds. Further, the rate of return required by
equity shareholders are higher than the rate of return required by other investors.

The company has no statutory obligation for the payment of dividend on equity shares. So,
the risk of getting the dividend by the equity shareholders is very high. They may get higher
rate of dividend or lower rate of dividend or no dividend at all.

3. The issue of new equity shares to outsiders dilutes the control of existing owners. So small
firms normally avoid equity financing as they may not like to share control with outsiders.

4. The problem of over-capitalisation may arise because of excess issue of equity shares.

5. Trading on equity is not possible, if the entire capital structure is composed of equity
shares.

Unlike debenture holders, equity shareholders do not get fixed rate of return on their
investment. So the investors expecting regular flow of permanent income are not interested to
invest equity shares.

Sweat Equity Shares:

Section 79 A of the Companies Act, 1956, has defined sweat equity shares as those shares
which are issued by a company to its employees or directors at a discount or for consideration
other than cash for providing know-how or making available rights in the nature of
intellectual property rights or value addition. Such shares are treated as the reward to the
employees or directors.
The company may issue sweat equity shares if it has been authorised by a special resolution
passed in the general meeting and not less than one year has elapsed since the date of
commencement of business. The sweat equity shares of the company must be listed on a
recognised stock exchange and all the restrictions and provisions relating to equity shares
shall be applicable to sweat equity shares.

Right Shares:

If an existing company wants to make a further issue of equity shares, the issue must first be
offered to the existing shareholders. The method of issuing shares is called right issue. The
existing shareholders have right to entitlement of further shares in proportion to their existing
shareholding.

or a shareholder who does not want to buy the right shares, his right of entitlement can be
sold to someone else. The price of right shares will be generally fixed above the nominal
value but below the market price of the shares.

Section 81 of the Companies Act, 1956, provides for the further issue of shares to be first
offered to the existing members of the company, such shares are known as ‘right shares’ and
the right of the members to be so offered is called the ‘right of pre-emption’.

Bonus Shares:

Sometimes a company may not be in a position to pay cash dividends in spite of adequate
profits because of the adverse effect on the working capital of the company. However, to
satisfy the equity shareholders, the company may issue shares—without payment being
required to— its existing equity shareholders.

These shares are known as bonus shares or capitalisation of retained earnings. These shares
are issued out of accumulated or undistributed profits to shareholders. Bonus shares may also
be issued when a company wants to build up cash resources for expansion, or other purposes
like repayment of liability.

2. Preference Shares:

These are shares which carry the following two rights:

(i) The right to receive dividend at a fixed rate before any dividend is paid on other shares.

(ii) The right to return of capital in the case of winding-up of company, before the capital of
the equity shareholders is returned.

Long-term funds from preference shares are raised by a public issue of shares. It does not
require any security nor ownership of a firm is affected. It has some characteristics of equity
capital and some of debt capital. It resembles equity as preference dividend, like equity
dividend is not tax deductible payment.
Again, it is similar to debt capital in the following ways:

(i) The rate of preference dividend is fixed,

(ii) Preference share capital is redeemable in nature, and

(iii) Preference shareholders do not enjoy the right to vote.

If preference dividend is not paid in a year of loss, it is carried over to the subsequent year till
there is sufficient profits to pay the cumulative dividends. Cumulative convertible preference
shares (CCPS) carry a cumulative dividend specified limit for a period, say 3 years on expiry
of which these shares are compulsorily converted into equity shares.

These shares are generally issued to finance new projects, expansion programme,
modernisation scheme etc. and also to provide further working capital.

Advantages and Disadvantages of Preference Shares:

The advantages of preference shares are:

1. The company can raise long-term funds by issuing preference shares.

2. Preference shareholders normally do not carry voting right. Hence, there is no dilution of
control.

3. There is no legal binding to pay preference dividend. A company will not face any legal
action if it fails to pay dividend.

There is no take-over risk. The shareholders become sure of their dividend from such
investment.

5. There is a leveraging advantage since it has fixed charges.

6. Preference share capital is generally regarded as part of net worth. Hence it increases the
creditworthiness of the firm.

7. Assets are not secured in favour of preference shareholders. The mortgageable assets of the
company are freely available.

8. Preference shareholders enjoy the preferential right as to the payment of dividend and
return of capital.

The disadvantages of preference shares are:

The dividend paid to preference shareholders is not a tax deductible expense. Hence it is a
very expensive source of financing.

2. Preference shareholders get voting right if the company fails to pay preference dividends
for a certain period.
Types of Preference Shares:

The various types of preference shares are:

(i) Cumulative Preference Shares:

The holders of these shares have the right to receive the arrears of dividend if for any year it
has not been paid because of insufficient profit

ii) Non-cumulative Preference Shares:

The holders of these shares have the right to receive dividend out of the profits of any year. In
case profits are not available in a year, the holders get nothing, nor can they claim unpaid
dividends in subsequent years.

(iii) Participating Preference Shares:

The holders of these shares are entitled to a fixed preferential dividend and in addition, carry
a right to participate in the surplus profits along with equity shareholders after dividend at a
certain rate has been paid to equity shareholders.

Again, in the event of liquidation of the company, if after paying back both the preference
and equity shareholders, there is still any surplus left, then the participating preference
shareholders get additional shares in the surplus assets of the company.

(iv) Non-participating Preference Shares:

These preference shares have no right to participate in the surplus profits of the company on
its liquidation. Such shareholders are entitled to a fixed rate of dividend only.

(v) Convertible Preference Shares:

These preference shares can be converted into equity shares after a specified period of time.
The conversion of such shares can be made as per the provisions of the Articles of
Association.

(vi) Non-convertible Preference Shares:

Non-convertible preference shares are those shares which cannot be converted into equity
shares.

(vii) Redeemable Preference Shares:

These preference shares are redeemed before liquidation of the company as per terms of issue
in accordance with the provisions of Articles of Association.
(viii) Irredeemable Preference Shares:

These preference shares are not redeemed before liquidation of the company. Such shares are
not redeemed unless a company is liquidated. After the Commencement of Companies
(Amendment) Act, 1988, no company can issue irredeemable preference shares or preference
shares which are redeemable after the expiry of a period of ten years from the date of their
issue.

3. Debentures:

A debenture is a document of acknowledgement of a debt with a common seal of the

company. It contains the terms and conditions of loan, payment of interest, redemption of the
loan and the security offered (if any) by the company.

According to Section 2(12) of the Companies Act, 1956, debenture includes debenture stock,
bonds and any other securities of a company, whether constituting a charge on the assets of
the company or not.

Thus, a debenture has been defined as acknowledgement of debt, given under the common
seal of the company and containing a contract for the repayment of the principal sum at a
specified date and for the payment of interest at fixed rate/per cent until the principal sum is
repaid and it may or may not give the charge on the assets to the company as security of loan.
It is an instrument for raising long-term debt.

Debenture holders are the creditors of the company. They have no voting rights in the
company. Debenture may be issued by mortgaging any asset or without mortgaging the asset,
i.e., debentures may be secured or unsecured.

Interest on debenture is payable to debenture holders even when the company does not make
profit. The cost of debenture is very low as the interest payable on debentures is charged as
an expense before tax.

Types of Debentures:

Debentures may be classified as:

1. Bearer Debentures:

These debentures are transferable like negotiable instruments, by mere delivery. The holder
of such debenture receives the interest when it become due. The transfer of such debenture is
recorded in the register of the company.

2. Secured or Mortgage Debenture:

These debentures are secured by creating a charge on the assets of the company. The charge
may be fixed or floating. If a company fails to pay debentures interest in due time or repay
the principal amount, the debenture holders can recover their dues by selling the mortgaged
assets.
Redeemable Debentures:

These are debentures which are issued for a specified period of time. On the expiry of that
specified time the company has the right to pay back the debenture holders. The redemption
may be effected by direct payment or by purchase and cancellation of own debenture or by
annual drawings or by periodical instalments etc.

5. Registered Debentures:

These are the debentures regarding which the names, addresses and other particulars of
holdings of the debenture holders are recorded in a register maintained by the company.
Transfer of these debentures will take place only on the execution of the transfer deed.
Interest is payable to the person whose name is registered with a company.

3. Simple or Naked Debentures:

When debentures are issued without any charge on the assets of the company, such
debentures are called naked or unsecured debentures.

Irredeemable Debentures:

These are the debentures which are not repayable during the lifetime of the company and will
be repaid only when the company goes into liquidation.

7. Convertible Debentures:

A company may issue convertible debentures in which case an option is given to the
debenture holders to convert them into equity or preference shares at stated rates of exchange,
after a certain period. Such debentures—once converted into shares cannot be reconverted
into debentures. Convertible debentures may be fully or partly convertible.

8. Non-Convertible Debentures:

These are the debentures which are not converted into shares and are redeemed at the expiry
of specified period.

9. Right Debentures:

These debentures are issued to augment working capital finance in a long-term basis.

II. Advantages and Disadvantages of Debentures:

The advantages of debentures may be summarised:

(i) The cost of debenture is much lower than the cost of equity or preference share capital
since interest on debenture is a tax-deductible expense.

(ii) There is a possibility of trading on equity (i.e., greater return on equity capital can be
given, if the company is able to earn higher rate of return than the fixed rate of interest paid to
the debenture holders.)
(iii) There is no dilution of control of the company by the issue of debentures. As the
debenture holders have no voting rights, so the issue of debenture does not affect the
management of the company.

(iv) Interest on debenture is a charge against profit. It is an admissible expense for the
purpose of taxation. Hence; tax liability on the company’s profits is reduced which result in
the debentures as a source of finance.

(v) Investors prefer debenture investment than equity or preference investment as the former
provides a regular flow of permanent income.

(vi) During inflation, debenture issue is advantageous. The fixed monetary outgo diminishes
in real terms as the price level rises.

(vii) Debentures are secured on the assets of the company and, therefore, carry lesser risk and
assured return on investment.

(viii) At the time of winding-up, the debenture holders are placed before the equity or
preference share capital providers.

(ix) Debentures can be redeemed when a company has surplus fund.

The disadvantages of debentures can be summarised:

(i) The cost of issuing debentures is very high because of higher rate of stamp duty.

(ii) Debenture financing involves fixed interest and principal repayment obligation. Any
failure to meet these obligations may paralyze the company’s operations.

(iii) Debenture financing increases the financial risk of the company. This will, in turn
increase the cost of capital.

(iv) Trading on equity is not always possible.

(v) There is a limit to the extent to which funds can be raised through long-term debt.

(vi) The debenture holders are treated as creditors of the company. They have no voting
rights of the. company so the debenture holders become less interested in the affairs of the
company.

4. Loans from Financial Institutions:

In India specialised financial institutions provide long-term financial assistance to private and
public firms. Generally firms obtain long-term debt by raising term loans. Term loans, also
referred to as term finance, represent a source of debt finance which is repayable in less than
10 years.

Before giving a term loan to a company the financial institutions must be satisfied regarding
the technical, economical, commercial, financial and managerial viability of project for which
the loan is needed. Term loans are secured borrowings and a significant source of finance for
investment in the form of fixed assets and also in the form of working capital needed for new
project.

The following financial institutions provide long-term capital in India:

(i) All Nationalized Commercial Banks.

(ii) Development Banks which include.

(a) Industrial Development Bank of India

(b) Small Industries Development Bank of India

(c) Industrial Finance Corporation of India

(d) Industrial Credit and Investment Corporation of India

(e) Industrial Reconstruction Bank of India.

(iii) Government Financial Institutions which include.

(a) State Finance Corporation

(b) National Small Industries Corporation

(c) State Industrial Corporation

(d) State Small Industries Development Corporation.

(iv) Other investment institutes which include.

(a) Life Insurance Corporation of India

(b) General Insurance Corporation of India

(c) Unit Trust of India.

5. Retained Earnings:

Retained Earnings (RE) are the accumulated portion of a business’s profits that are not
distributed as dividends to shareholders but instead are reserved for reinvestment back into
the business. Normally, these funds are used for working capital and fixed asset purchases
(capital expenditures) or allotted for paying off debt obligations.

When a company retains a part of undistributed profits in the form of free reserves and the
same is utilised for further expansion and diversification programmes, is known as ploughing
back of profit or retained earnings. These funds belong to the equity shareholders. It increases
the net worth of the business.
Although it is essentially a means of long-term financing for expansion and development of a
firm, and its availability depends upon a number of factors such as the rate of taxation, the
dividend policy of the firm, Government policy on payment of dividends by the corporate
sector, extent of profit earned and upon the firm’s appropriation policy etc.

Advantages and Disadvantages:

The advantages of ploughing back of profits are:

1. It is the cheapest method of raising capital

2. It has no specific cost of capital

3. It increases the net worth of business

4. There is no dilution of control of present owners

5. It does not require any pledge, mortgage etc. like other loans.

6. It provides required capital for expansion and development.

7. Firms do not need to depend on lenders or outsiders if retained earnings, are readily
available.

8. It increases the reputation of the business.

It suffers from the following limitations:

1. It may lead to cause of dissatisfaction among the shareholders as they receive-a low rate of
dividend.

2. Management may fail to properly use the profits retained.

3. Ploughing back or reinvestment of profit means depriving the shareholders a portion of the
earning of the company. As a result, share price may come down in the market.

4. It may lead to over-capitalisation because of capitalisation of profits.

Financial Market/Security Market

 Definition: Financial Market refers to a marketplace, where creation and trading of

financial assets, such as shares, debentures, bonds, derivatives, currencies, etc. take
place. It plays a crucial role in allocating limited resources, in the country’s economy.
It acts as an intermediary between the savers and investors by mobilising funds
between them.
 The financial market provides a platform to the buyers and sellers, to meet, for trading
assets at a price determined by the demand and supply forces.
Functions of Financial Market

1. It facilitates mobilisation of savings and puts it to the most productive uses.

2. It helps in determining the price of the securities. The frequent interaction between
investors helps in fixing the price of securities, on the basis of their demand and
supply in the market.
3. It provides liquidity to tradable assets, by facilitating the exchange, as the investors
can readily sell their securities and convert assets into cash.
4. It saves the time, money and efforts of the parties, as they don’t have to waste
resources to find probable buyers or sellers of securities. Further, it reduces cost by
providing valuable information, regarding the securities traded in the financial market.
5. The financial market may or may not have a physical location, i.e. the exchange of
asset between the parties can also take place over the internet or phone also.

Classification of Financial Market

MONEY MARKET

Meaning and Features of Money Market

The money market is a market for short-term instruments that are close substitutes for
money. The short term instruments are highly liquid, easily marketable, with little
change of loss. It provides for the quick and dependable transfer of short term debt
instruments maturing in one year or less, which are used to finance the needs of
consumers, business agriculture and the government.

The money market consists of call and notice market, commercial bills market,
commercial paper market, treasury bills market, inter-bank market and certificates of
deposit market. All these markets are closely interrelated so as to make the money
market.

Instruments of the Money Market

1. Treasury Bills

Treasury bills, also known as T-bills, are short term money market instruments. The RBI
on behalf of the government to curb liquidity shortfalls. It is a promissory note with a
guarantee of payment at a later date. The funds collected are usually used for short term
requirements of the government. It is also used to reduce the overall fiscal deficit of the
country.

Treasury bills or T-bills have zero-coupon rates, i.e. no interest is earned on them.
Individuals can purchase T-bills at a discount to the face/value. Later, they are redeemed
at a nominal value, thereby allowing the investors to earn the difference. For example, an
individual purchase a 91-day T-bill which has a face value of Rs.100, which is discounted
at Rs.95. At the time of maturity, the T-bill holder gets Rs.100, thus resulting in a profit
of Rs.5 for the individual.

Therefore, it is an essential monetary instrument that the Reserve Bank of India uses. It
helps RBI to regulate the total money supply in the economy as well as raising funds.

2. Certificate of Deposit

The Certificate of Deposit (CD) is an agreement between the depositor and the bank
where a predetermined amount of money is fixed for a specific time period

Issued by the Federal Deposit Insurance Corporation (FDIC) and regulated by the
Reserve Bank of India, the CD is a promissory note, the interest on which is paid by the
bank

The Certificate of Deposit is issued in dematerialised form i.e. issued electronically and
may automatically be renewed if the depositor fails to decide what to do with the matured
amount during the grace period of 7 days
It also restricts the holder from withdrawing the amount on demand or paying a penalty,
otherwise. When the Certificate of Deposit matures, the principal amount along with the
interest earned is available for withdrawal.

3. Commercial Paper

Commercial paper, also called CP, is a short-term debt instrument issued by companies to
raise funds generally for a time period up to one year. It is an unsecured money market
instrument issued in the form of a promissory note and was introduced in India for the
first time in1990. Companies that enjoy high ratings from rating agencies often use CPs
to diversify their sources of short-term borrowings. This gives investors an additional
instrument. They are typically issued by large banks or corporations to cover short-term
receivables and meet short-term financial obligations, such as funding for a new project.

CPs have a minimum maturity of seven days and a maximum of up to one year from the
date of issue. However, the maturity date of the instrument should typically not go
beyond the date up to which the credit rating of the issuer is valid. They can be issued in
denominations of Rs 5 lakh or multiples thereof.

4. Banker’s Acceptance

A banker’s acceptance is a short-term debt instrument issued by a non-financial

institution but guaranteed by a commercial bank. It is created by a drawer, providing the
bearer the right to the money indicated on its face at a specified date. It is often used in
international trade because of the benefits to both the drawer and bearer. The holder of the
acceptance may decide to sell it on a secondary market, and investors can profit from the
short-term investment. The date of maturity ranges between one month and six months
from the date of issue.

5. Repurchase Agreements

Repurchase agreements, or repos, are a form of short-term borrowing used in the money
markets, involving the purchase of securities with the agreement to sell them back at a
specific date, usually for a higher price.

Repurchase agreements or repos and reverse repros represent the same transaction, but
are titled differently depending on which side of the transaction you're on. For the party
originally selling the security (and agreeing to repurchase it in the future) it is a
repurchase agreement (RP). For the party originally buying the security (and agreeing to
sell in the future) it is a reverse repurchase agreement (RRP) or reverse repo.

Although it is considered a loan, the repurchase agreement involves the sale of an asset
that is held as collateral until it the seller repurchases it at a premium
 Capital market

Definition: The capital market is a market which deals in long-term finance.Capital market
is a market where buyers and sellers engage in trade of financial securities like bonds,
stocks, etc. The buying/selling is undertaken by participants such as individuals and
institutions. Capital markets are composed of primary and secondary markets.

Types of Capital Market

PRIMARY MARKET

The primary market is the financial market where new securities are sold. A company offers
securities to the general public to raise funds to finance its long-term goals. The primary
market may also be called the New Issue Market (NIM). In the primary market, securities
are directly issued by companies to investors.

New Issue Market (NIM).

A new issue is a stock or bond that is being sold to investors for the first time. ... The
market that deals with these new issues is called the new issue market

Why do companies issue shares to the public?

Companies come to the primary market to raise money for several reasons. Some of them are
for business expansion, business development, and improving infrastructure, repaying its debts
and many more. This helps the company to increase its liquidity. Also, it provides a scope for
more issuance of shares in raising further capital for business.
The company can raise capital through –

• Equity: when the company raises money by issuing shares to the public. It is termed as
stock capital, also known as share capital of the company.
• Debt: the companies raise capital by taking loans where interest is payable on it.

When a company requires capital, the primary source of funds is loans from banks. However,
raising funds from banks requires interest payments to them. Consequently, when a company
raises funds from the public, there is no commitment to fixed interest payout. Also, there is
profit-sharing among the shareholders in proportion to the number of shares held by them.
There are two ways in which the company shares the profits among its shareholders –

• Dividend Payout
• Capital appreciation

Thus, the money raised in the primary market goes directly to the issuing company. This is
where the capital formation of the company takes place.

Types of primary market issues

Public issue

The public issue is one of the most common methods of issuing securities to the public. The
company enters the capital market to raise money from kinds of investors. Here, the securities
are offered for sale to new investors. The new investor becomes the shareholder of the issuing
company. This is called a public issue.

Classification of the public issue

1.Initial Public Offer

As the name suggests, it is a fresh issue of equity shares or convertible securities by an unlisted
company. These securities are traded previously or offered for sale to the general public. After
the process of listing, the company’s share is traded on the stock exchange. The investor can
buy and sell securities after listing in the secondary market.

2.Further Public Offer or Follow on Offer or FPO.

When a listed company on the stock exchange announces fresh issues of shares to the general
public. The listed company does this to raise additional funds.

3.Private placement

Private placements mean that when a company offers its securities to a small group of people.
The securities may be bonds, stocks, or other securities. The investors can be either individual
or institution or both.

Comparatively, private placements are more manageable to issue than an IPO. The regulatory
norms are significantly less. Also, it reduces cost and time. The private placement is suitable
for companies that are at early stages (like startups). The company may raise capital through
an investment bank or a hedge fund or ultra-high net worth individuals (HNIs)
4.Preferential issue

The preferential issue is one of the quickest methods for a company to raise capital for their
business. Here, both listed and unlisted companies can issue shares. Usually, these companies
issue shares to a particular group of investors.

It is important to note that the preferential issue is neither a public issue nor a rights issue. In
the preferential allotment, the preference shareholders receive dividends before the ordinary
shareholders receive it.

5.Qualified institutional placement.

Qualified institutional placement is another type of private placement. Here, the listed company
issues equity shares or debentures (partly or wholly convertible) or any other security not
including warrants. These securities are convertible in nature. Qualified institutional buyer
(QIB) purchases these securities.

QIBs are investors who have requisite financial knowledge and expertise to invest in the capital
market. Some of the QIBs are –

Foreign institutional investors who are registered with SEBI.

• Alternate investment funds

• Foreign venture capital investors
• Mutual funds
• Public financial institutions
• Insurers
• Scheduled commercial banks
• Pension funds

6.Rights issue

This is another type of issue in the primary market. Here, the company issues shares to its
existing shareholders by offering them to purchase more. The issue of securities is at a
predetermined price.

In a rights issue, the investors have a choice of buying shares at a discount price within a
specific period. It enhances the control of the existing shareholders of the company. It helps
the company to raise funds without any additional costs.

7. Bonus issue

When a company issues fully paid additional shares to its existing shareholders for free. The
company issues shares from its free reserves or securities premium account. These shares are
a gift for its current shareholders. However, the issuance of bonus shares does not require fresh
capital.
How to apply through an Initial Public Offering IPO?

To apply for an IPO, the investor needs to choose for the IPO and apply for it. Next, the
investor needs the following accounts –

1. Demat account – it is mandatory for an investor to have a Demat account and hold
the shares in electronic form.
2. Bank account – for making the payment for shares. It is done via Application
Supported by Blocked Amount (ASBA) facility.
3. Trading account – one can open this account with any of the brokerage firms
which offer trading facilities.

Concepts related to the primary market

Offer document

The offer document means prospectus. This document covers all the relevant information
about the company. The data is about the company, its promoters, the project, financial details
and past performance, objects of raising money, terms of issue, etc. This helps the investor to
make their investment decision.

Companies issue offer document while raising capital from the public. Companies issue offer
document in case of a public issue or offer for sale. For a rights issue, a letter of offer is issued.
The company files the offer document with the Registrar of Companies (ROC) and stock
exchanges.

Price band

The price band of an IPO is the offer price of the company’s shares. The lead manager decides
the price band for any IPO. There is no specific or standard calculation for it. It is determined
by looking at the company’s valuation and prospects. The company announces its price band,
and then investors make their bid. Once the company receives the requests, it decides a
particular price for the listing of shares.

For example, the IPO of an ABC Ltd., opens on 20th September 2020 and closes on 23rd
September 2020. The company fixes the share price band at Rs.1000-Rs.1010.

The spread between the floor price and the cap price shall not be more than 20%. The price
band can be revised. If the price revises, then the bidding period also extends for three more
days.
Cut off price

A cut off price is any price that an investor can bid. In other words, the investor is ready to pay
whatever price the company decides at the end of the book-building process. The retail
investors pay the highest price while placing the bid at cut-off price. If the company chooses
the final price lower than the highest price, the remaining amount is returned to the investor.

The company’s employees are eligible to bid in the employee reservation portion. Also, the
retail investors are allowed to bid at the cut-off price. However, QIBs (including anchor
investors) and non-institutional investors are not allowed to bid at the cut off price.

Floor price

The floor price is the lowest price in the share price band. It is the price at and above which
investors can place their bids. On the other hand, the highest price in the price band is called
the cap price.

For example, the IPO of an XYZ company opens on 20th September 2019 and closes on 23rd
September 2019. The company fixes the share price band Rs.1000-Rs.1010. Here, the lower
end range that is Rs.1000 is called as the floor price. This is the minimum price at which IPO
is issued. On the other hand, the upper limit of the price band is Rs.1010, which is the cap price
or maximum price.

Face value

The face value of a share is the value at which the share is listed on the stock market. Face
value is also called par value. The face value is determined when the company issues shares to
raise capital. Hence, one cannot calculate the face value. It remains fixed and never changes.
However, if a company decides to split the shares, then the face value can change.

Mostly, Indian company shares have a face value of Rs.10. The face value is significant in the
stock market for legal and accounting reasons. When a shareholder buys a stock, the company
issues a share certificate that has face value mentioned. Dividend can be given based on the
face value. For example, XYZ ltd., declared dividend of 20%, dividend per share is Rs.2(Face
Value per share Rs.10*20%)

To conclude, when an investor decides to invest in the stock market, they need to keep an eye
on the primary market too. Also, the investors do a thorough study of the company they select
to invest in. One needs to study the company’s financials, its past performance, reasons for
raising capital, etc. The reason is IPOs have a great potential to offer returns to investors. One
needs to understand the concepts related to the primary market to help them invest better.
Secondary Market/Stock or share Market/Stock Exchange

 Meaning of 'Secondary Market'

This is the market wherein the trading of securities is done. Secondary market consists
of both equity as well as debt markets. Securities issued by a company for the first time
are offered to the public in the primary market. Once the IPO is done and the stock is
listed, they are traded in the secondary market. The main difference between the two is
that in the primary market, an investor gets securities directly from the company
through IPOs, while in the secondary market, one purchases securities from other
investors willing to sell the same. Equity shares, bonds, preference shares, debentures,
etc. are some of the key products available in a secondary market. SEBI is the regulator
of the same.

A secondary market is a platform wherein the shares of companies are traded among
investors. It means that investors can freely buy and sell shares without the intervention
of the issuing company. In these transactions among investors, the issuing company
does not participate in income generation, and share valuation is rather based on its
performance in the market. Income in this market is thus generated via the sale of the
shares from one investor to another.

Securities trading in the Secondary/Stock Markets

The following securities are trading in the stock exchange/stock market:

1.Equity shares

2.Debentures

3.Bonds

4.Mutual Fund Units

5.Derivative Instruments

Key Players in the Stock/Share Market/Stock Exchange

The following are the key players in the stock market:

1. Retail investors.
2. Advisory service providers and brokers comprising commission brokers and
security dealers, among others.
3. Financial Intermediaries including Non-Banking Financial Companies(NBFCs),
Insurance Companies, Banks and Mutual Funds.
Functions of Secondary Market

• A stock exchange provides a platform to investors to enter into a trading transaction of

bonds, shares, debentures and such other financial instruments.
• Transactions can be entered into at any time, and the market allows for active trading
so that there can be immediate purchase or selling with little variation in price among
different transactions. Also, there is continuity in trading, which increases the liquidity
of assets that are traded in this market.
• Investors find a proper platform, such as an organised exchange to liquidate the
holdings. The securities that they hold can be sold in various stock exchanges.
• A secondary market acts as a medium of determining the pricing of assets in a
transaction consistent with the demand and supply. The information about transactions
price is within the public domain that enables investors to decide accordingly.
• It is indicative of a nation’s economy as well, and also serves as a link between savings
and investment. As in, savings are mobilised via investments by way of securities.

Advantages of Secondary Market

1. Investors can ease their liquidity problems in a secondary market conveniently.

Like, an investor in need of liquid cash can sell the shares held quite easily as a
large number of buyers are present in the secondary market.
2. The secondary market indicates a benchmark for fair valuation of a particular
company.
3. Price adjustments of securities in a secondary market takes place within a short span
in tune with the availability of new information about the company.
4. Investor’s funds remain relatively safe due to heavy regulations governing
a secondary stock market. The regulations are stringent as the market is a source
of liquidity and capital formation for both investors and companies.
5. Mobilisation of savings becomes easier as investors’ money is held in the form of
securities.

Disadvantages of Secondary Market

1. Prices of securities in a secondary market are subject to high volatility, and such
price fluctuation may lead to sudden and unpredictable loss to investors.
2. Before buying or selling in a secondary market, investors have to duly complete the
procedures involved, which are usually a time-consuming process.
3. Investors’ profit margin may experience a dent due to brokerage commissions
levied on each transaction of buying or selling of securities.
4. Investments in a secondary capital market are subject to high risk due to the
influence of multiple external factors, and the existing valuation may alter within a
span of a few minutes.
Difference between Primary and Secondary Market
Primary Market Secondary Market

Securities are initially issued in a primary

Trading of already issued securities takes
market. After issuance, such securities are listed
place in a secondary market.
in stock exchanges for subsequent trading.

Investors enter into transactions among

Investors purchase shares directly from the
themselves to purchase or sell securities.
issuer in the primary market.
Issuers are thus not involved in such trading.

Prices of the traded securities in a secondary

The stock issue price in a primary market
market vary according to the demand and
remains fixed.
supply of the same.

Sale of securities in a primary market generates Transactions made in this market generate
fund for the issuer. income for the investors.

Issue of security occurs only once and for the

Here, securities are traded multiple times.
first time only.

Primary markets lack geographical presence; it A secondary market, on the contrary, has an
cannot be attributed to any organisational set- organisational presence in the form of stock
up as such. exchanges.

Securities and Exchange Board of India (SEBI)

Securities and Exchange Board of India (SEBI) is a statutory regulatory body entrusted with
the responsibility to regulate the Indian capital markets. It monitors and regulates the securities
market and protects the interests of the investors by enforcing certain rules and regulations.

SEBI was founded on April 12, 1992, under the SEBI Act, 1992. Headquartered in Mumbai,
India, SEBI has regional offices in New Delhi, Chennai, Kolkata and Ahmedabad along with
other local regional offices across prominent cities in India.

Objectives of SEBI:

SEBI has following objectives-

1. Protection to the investors

The primary objective of SEBI is to protect the interest of people in the stock market and
provide a healthy environment for them.

2. Prevention of malpractices

This was the reason why SEBI was formed. Among the main objectives, preventing
malpractices is one of them.
 3. Fair and proper functioning

SEBI is responsible for the orderly functioning of the capital markets and keeps a close check
over the activities of the financial intermediaries such as brokers, sub-brokers, etc.

Functions of SEBI:

SEBI primarily has three functions-

1. Protective Function
2. Regulatory Function
3. Development Function

Protective Functions

As the name suggests, these functions are performed by SEBI to protect the interest of investors
and other financial participants.

It includes-

• Checking price rigging

• Prevent insider trading
• Promote fair practices
• Create awareness among investors
• Prohibit fraudulent and unfair trade practices

Regulatory Functions

These functions are basically performed to keep a check on the functioning of the business in
the financial markets.

These functions include-

• Designing guidelines and code of conduct for the proper functioning of financial
intermediaries and corporate.
• Regulation of takeover of companies
• Conducting inquiries and audit of exchanges
• Registration of brokers, sub-brokers, merchant bankers etc.
• Levying of fees
• Performing and exercising powers
• Register and regulate credit rating agency

Development Functions

SEBI performs certain development functions also that include but they are not limited to-

• Imparting training to intermediaries

• Promotion of fair trading and reduction of malpractices
• Carry out research work
• Encouraging self-regulating organizations
 • Buy-sell mutual funds directly from AMC through a broker

Powers of SEBI:

1. When it comes to stock exchanges, SEBI has the power to regulate and approve any
laws related to functions in the stock exchanges.
2. It has the powers to access the books of records and accounts for all the stock exchanges
and it can arrange for periodical checks and returns into the workings of the stock
exchanges.
3. It can also conduct hearings and pass judgments if there are any malpractices detected
on the stock exchanges.
4. When it comes to the treatment of companies, it has the power to get companies listed
and de-listed from any stock exchange in the country.
5. It has the power to completely regulate all aspects of insider trading and announce
penalties and expulsions if a company is caught doing something unethical.
6. It can also make companies list their shares in more than one stock exchange if they see
that it will be beneficial to investors.
7. Coming to investor protection, SEBI has the power to draft legal rules to ensure the
protection of the general public.
8. It also has the power to regulate the registration of brokers and other middlemen who
will deal with investors in the market.