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FAQs on Capital Market - Part 1 Research Team | Posted On Tuesday, April 14,2009, 05:55 PM

FAQs on Capital Market - Part 1



1. What is capital market?

Capital market is a market for long-term debt and equity shares, in this market, the capital funds comprising of both equity and debt are issued and traded, this also includes private placement sources of debt and equity as well as structured markets like stock exchanges. Capital market can be further divided into primary and secondary markets.

2. What is meant by Secondary Market? 

Secondary Market refers to a market where securities are traded after being primarily offered to the public in the primary market and/or listed on the Stock Exchange. Greater part of the trading is done in the secondary market. Secondary market consists of equity markets and the debt markets.
For the general investor, the secondary market provides an able platform for trading of his securities. For the management of the company, Secondary equity markets provide as a monitoring and control conduit—by facilitating value-enhancing control activities, enabling implementation of incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions.
3. What is the difference between the primary market and the secondary market?
In the primary market, securities are offered to public for subscription for the use of raising capital or fund. Secondary market is an equity trading avenue in which already existing/pre- issued securities are traded among investors. Secondary market could be either auction or dealer market, while stock exchange is the division of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
4. What is SEBI and what is its role in the Secondary Market?
The SEBI is the regulatory authority established under Section 3 of SEBI Act 1992 to defend the interests of the investors in securities and to advance the development of, and to regulate, the securities market and for matters connected therewith and incidental thereto.
5. What are the various departments of SEBI regulating trading in the secondary market?
The following departments of SEBI take care of the activities in the secondary market.       

Sl. no
Name of the Department
Major Activities
Market Intermediaries Registration and Supervision department (MIRSD
Registration, supervision, compliance monitoring and inspections of all market intermediaries in respect of all part of the markets for example, equity, equity derivatives, debt and debt related derivatives
Market Regulation Department (MRD)
Formulating new policies and supervising the functioning and operations (except relating to derivatives) of securities exchanges, their subsidiaries, and market institutions such as Clearing and arrangement of organizations and Depositories (Collectively referred to as ‘Market SROs’.) 
Derivatives and New Products Departments (DNPD)
Managing trading at derivatives section of stock exchanges, introducing new products to be traded, and consequent policy changes

 6. What are the products dealt in the secondary markets?
Following are the main financial products/instruments dealt in the secondary market:
Equity: The ownership interest in a company of holders of its common and preferred stock, the various type of equity shares are as follows:-
Equity Shares:
An equity share, commonly referred to as common 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 owner of such shares is members of the company and has voting rights.
·         Rights Issue / Rights Shares: The issue of latest securities to existing shareholders at a ratio to those already held.
·         Bonus Shares: Shares issued by the companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the previous years.
·         Preferred Stock / Preference shares: Owners of these types of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy precedence over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank lower than the claims of the company’s creditors, bondholders / debenture holders.
·         Cumulative Preference Shares: A type of preference shares on which dividend accumulates if remains unpaid, all sum unpaid of preference dividend have to be paid out before paying dividend on equity shares.
·         Cumulative Convertible Preference Shares: A kind of preference shares where the dividend payable on the same accumulates, if unpaid, after a specified date, these shares will be converted into equity capital of the company.
·         Participating Preference Share: The right of certain preference shareholders to participate in profits after a specified set dividend contracted for is paid. Participation right is related with the quantum of dividend paid on the equity shares over and above a particular specified level.
·         Security Receipts: Security receipt means a receipt or other security, issued by a securitization company or reconstruction of company to any eligible institutional buyer pursuant to a scheme, evidencing the purchase or gaining by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitization.
·         Government securities (G-Secs): These are sovereign (credit risk-free) coupon bearing tool which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing program me. These securities have a set coupon that is paid on specific dates on half-yearly basis. These securities are available in broad range of maturity dates, from short dated (less than one year) to long date (up to twenty years).
·         Debentures: Bonds issued by a company bearing a predetermined rate of interest generally payable half yearly on specific dates and principal amount repayable on particular date on redemption of the debentures. Debentures are usually secured / charged against the asset of the company in favour of debenture holder.
·         Bond: A negotiable certificate evidencing indebtedness, it is usually unsecured. A debt security is usually issued by a company, municipality or government agency. A bond investor provides money to the issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date. The issuer generally pays the bond holder periodic interest payments over the life of the loan. The various kinds of Bonds are as follows-
a.     Zero Coupon Bond: Bond issued at a discount and pay back at a  face value. No periodic interest is paid, the distinction between the issue price and redemption value represents the return to the holder. The buyer of these bonds accepts only one payment, at the maturity of the bond.
b.    Convertible Bond: A bond giving the investor the option to convert the bond into equity at a fixed conversion price.
·         Commercial Paper: A short term promise to pay back a fixed amount that is placed on the market either directly or through a specialized intermediary. It is generally issued by companies with a high credit standing in the form of a promissory note redeemable at par to the holder on maturity and therefore, doesn’t require any guarantee. Commercial paper is a money market instrument issued usually for tenure of 90 days.
·         Treasury Bills: Short-term (up to 91 days) holder discount security issued by the Government as a means of financing its cash requirements.
7. What are the regulatory requirements specified by SEBI for corporate debt securities?
The term Corporate Bonds referred here comprise all debt securities issued by institutions such as Banks, Public Sector Undertakings, Municipal Corporations, bodies corporate and companies having a tenure of more than 365 days. Such an issue of bonds, if offered to the public shall be required to conform with the SEBI (Disclosure and Investor Protection Guidelines), 2000, a private placement of corporate bonds made by a listed company shall be required to comply with provisions contained in SEBI Circulars in this regard.
The SEBI Circulars dated September 30, 2003 and December 22, 2003 have laid out norms pertaining to the disclosure norms on issuance of such securities, which comprise compliance with Chapter VI of the SEBI (Disclosure and Investor Protection) Guidelines, 2000, Companies Act, 1956, listing agreement for debentures with the stock exchanges, rating to be acquired from a Credit Rating Agency registered with SEBI, requirement for appointing a debenture trustee registered with SEBI, mandatory trading in dematerialized form, etc.
In order to expand an exchange traded market for corporate bonds SEBI vide circulars dated December 12, 2006 and March 01, 2007 has authorized BSE and NSE to set up and maintain corporate bond reporting platforms to capture all information related to trading in corporate bonds as accurately and as close to execution as possible. As per the circulars, all issuers, intermediaries and contracting parties are granted entrée to the reporting platform for the purpose and transactions shall be reported within 30 minutes of closing the deal. The data reported on the platform is circulated on websites of BSE, NSE.
As a second phase of development, SEBI vide Circular dated April 13, 2007 has allowed BSE and NSE to have in place corporate bond trading platforms to enable efficient price discovery and reliable clearing and settlement in a regular manner. To begin with, BSE and NSE have commence an order driven trade matching platform which retains essential features of OTC market where trades are executed through brokers. OTC trades however carry on to be reported on the exchange reporting platforms. In order to encourage wider participation, the lot size for trading in bonds has been reduced to Rs.1lakh. Subsequently BSE and NSE may move towards anonymous order similar with clearing and settlement.
8. What is Overdraft against Shares?
This is a simple to use overdraft facility granted against approved shares owned either by the borrower or his immediate relatives (third party pledgers). It is the ideal method to get instant liquidity against shares without selling them.
Finance against Shares is an overdraft facility that gives the power to buy the most recent car, acquire real estate or invest in a new rights issue without having to sell and disturb your carefully built portfolio.
9. How much can I avail of under this scheme?
The sum can avail of under "Loans against Shares" depend on whether investors have physical or demat shares. Now overdraft of minimum Rs. 100,000 and maximum Rs. 1,000,000 for physical shares held by borrower and up to Rs 2,000,000 for Demat shares held by borrower.
The base price considered by the lender for analyze the value of the shares will be a major determinant of how much he can borrow.
The base value may be either the last traded price or the moving average of the last 10 days, the base value may well be different from the current market price.
10. Should my shares be only in demat form?
Ideally the shares should be in dematerialized form, several banks also admit physical shares but then keep a higher margin (50%).If the borrower have physical shares, the maximum facility he can avail of will be Rs 10 lakhs as per RBI guidelines.
In demat shares borrower get a bigger loan, faster, and can pay less interest and a smaller processing fee as compared to physical scrips.
11. How does Loans against Shares work?
If current account is opened initially for a 1 year period, and people are provided with a personalized cheque book. A number of banks also give them an ATM card and access to the Bank by Phone service. They can then use these to withdraw and deposit money from/into their account, and, access an exciting range of banking services. Of course, they can pay interest only for the amount and period for which their overdraft facility is utilized.
12. What are the common charges I have to pay while going for Loans against Shares?
Besides the interest rate; banks generally charge 1-1.5% on the loan sum sanctioned as processing fees. For existing customer of the bank, the processing costs might be lowered.
13. What is the purpose of loans against shares?
The use of loans against shares is to take care of all investment as well as personal needs, meet contingencies, subscribing to primary issues, rights issues. It is the best way to get liquidity without liquidating them.
It would make sense to avail of this facility when lender are expecting a certain amount of money a few months down the line and lender need some funds in the interim.
In case lenders are thinking of availing this facility to reinvest in the stock market it will be a High Risk – High Return Payoff. Taking a loan against equity with the intent of buying into a stock at the IPO price and selling it on listing to make a quick profit is a high-risk strategy.    
14. Should I consider other alternatives before I decide on Loans against shares?
Borrower must consider other options before he decide to avail of this facility.
If borrower ensures that the benefits he derives are above the cost he has to incur, then he can go for it. They should keep the interest rate as the benchmark but that generating returns upper than the cost of the loan (14-17 per cent) on a sustainable basis is difficult.
15. Can only one scrip be pledged?
Only one scrip lending is available against select scrips at higher margins. Various banks have a specific list for single scrip portfolios. In case single scrip is pledged, normally 40% of the market value is available as overdraft
16. What are the key features of loans against shares?
Loan sum anywhere between a minimum of Rs 1 lakh maximum of Rs 10 lakh (Physical) maximum Rs 20 Lakh (Demat). Usually 65% of the scrips pledged are available as overdraft (if shares are dematting) or 50% (if shares are physical). Usually physical shares are accepted in market lots only.
There is a lowest number of scrips and Maximum number of scrips which are accepted by banks. Usually minimum might be 1 and maximum 20; though for a few banks the maximum can be "no limit" Investments in mutual fund units that are accepted from capital gains tax (under Sections 54EA/EB) are not accepted as collateral. Loans against mutual fund units are based on their NAV (Net Asset Value) value. The base NAV could be the last closing NAV (Net Asset Value) or the average NAV of the earlier week. Compared with loans against shares, the level of funding against mutual funds is usually lower, at 40-50 per cent of the base NAV.
17. What does my limit depend on?
The limit depends on the valuation of the security, applicable margin, capacity to service and repay the loan and other conditions as applicable from time to time
18. What will be my drawing power?
Individuals can usually draw upto 65% of the current market value of the shares. The drawing power estimation is done at time decided by the bank from time to time as per the applicable market value/adopted by the bank. Drawing on the account will be regulated by the obtainable drawing power
19. What happens if my drawing power falls short of the out standings?
In case the drawing power falls short of the out standings, the borrower will be directed to either replenish extra securities or make cash payment. Borrower will be charged an additional 2 % interest p.a. on the amount by which his out standings go beyond the limit and for the period it is in excess.
20. What shares can I pledge to avail of Loans against Shares?
Borrower can pledge any company share which is on the permitted list of the bank. Several banks have a specific list for single scrip portfolios. It is important to remember that the permitted list of shares is revised periodically by the banks.

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