Capital MarketsCapital Markets

By:-By:-

Manveen KaurManveen Kaur

Lecturer in Management DeptLecturer in Management Dept

CAPITAL MARKETS

Relationship between New Issue Market and Stock Exchange

Functions of New Issues/Primary Market

Functions of Stock/Secondary Markets/Exchanges

Financial SystemFinancial System

Capital Markets are a sub-part of the financial system.

Financial System

Financial system includes a complex of institutions and mechanism which affects generation of savings and their transfer to those who invest.The main elements of the financial system are a variety of

1) Financial instruments/assets/securities,

2) Financial intermediaries/institutions and

3) Financial markets.

Financial Asset/Instrument/Security

A financial instrument/asset/security represents claims against the future income/wealth of an entity. The financial assets are:

1) Direct (e.g. shares and debentures of manufacturing companies),

2) Indirect (e.g. units of mutual funds) and 3) Derivatives (e.g. futures and options).

Financial Intermediaries

Financial intermediaries act as a link between savers and investors. Their main function is to convert a direct/primary security into an indirect security. In the process of conversion, they offer to the investors the benefits of convenience, low risk, expert management and lower risk. The indirect securities offer to the investors better investment alternative than the direct securities by pooling which they are created.

Financial Markets

Financial markets facilitate transfer of funds from savers to investors. They are a market for creation and exchange of financial assets. The two key financial markets are money market and capital/securities market.

Money Market

The money market is a market for short-term funds having maturities of one year or less. Short-term marketable securities are traded in the money market.

Capital Market

Capital market is the market for long-term funds. The backbone of the market is formed by the securities markets/exchanges comprising the new issue markets and the stock exchanges.

RELATIONSHIP BETWEEN NEW ISSUE MARKET (NIM) AND STOCK EXCHANGE

The new issue/primary market and secondary market/stock market/exchange differ from each other organisationally as well as in the nature of functions performed by them. While the primary market deals in new securities, that is, securities which were not previously available and are offered to the investors for the first time, the stock market is a market for old securities defined as those already issued and granted stock exchange quotations/listing. Functionally, they also differ in that the new issue market supplies funds to corporate enterprise directly but the secondary markets play only an indirect role in industrial financing by providing liquidity to investments already made.

The two parts of the securities market have organisational differences as well. The stock exchange has a physical existence and is located in a particular geographical area. The new issue market does not have any organisational set up in any particular place and is recognised only by the specialist institutional services that it renders to the lenders/borrowers of capital funds at the time of any particular operation.

The new issue market and the stock exchanges are inseparably

interconnected. The securities issued in the primary market are invariably listed on a recognised stock exchange for dealings in them. Moreover, the stock exchanges exercise considerable control over the organisation of new issues in terms of regulatory framework relating to the listing of securities.

Further, economically, the behaviour of the stock exchange as reflected in the prices of listed securities has a significant bearing on the level of activity in the new issue market in terms of its response to issue of capital. Similarly, the price of new issues are greatly influenced by the price movements in the stock market.

Functions of Stock/Secondary Functions of Stock/Secondary Markets/ExchangesMarkets/Exchanges

The stock markets, as an integral part of the industrial securities market, discharge three vital functions in the orderly growth of capital formation. First and foremost, they are a nexus between the savings and investments of the community. They also provide a market price for purchase/sale of securities. The process of continuous price formation is the third function discharged by the stock exchanges.

FUNCTIONS OF NEW FUNCTIONS OF NEW ISSUES/PRIMARY MARKETISSUES/PRIMARY MARKET

The main function of the new issue market, namely, the channelling of investible funds into industrial enterprises, is divided, in operational terms, into three distinct services:

1) Origination, 2) Underwriting and 3) Distribution.

The new issue market facilitates the transfer of resources of providing specialist institutional facilities to perform this triple-service function.

Origination Functions

The origination functions cover the work of investigation and analysis and processing of new issue proposals. Apart from a careful study of technical, economic, financial and legal aspects of the issuing companies to ensure that it warrants the backing of the issue houses/merchant banks/originators, it also refers to advices relating to the important aspects of the issue proposal such as class of security to be issued, price of an issue, timing and magnitude of issue, methods of flotation and so on.

Underwriting

The underwriting service provided by the new issue market organisation is a form of a guarantee that the issue would be sold by eliminating the risk arising out of uncertainty of public response.

Distribution

The distribution of securities is undertaken by brokers and dealers in securities who maintain regular and direct contact with the investors.

Issue MechanismIssue MechanismThe issue mechanism consists of five methods of flotation of securities:

1) Public issue through prospectus, 2) Offer for sale, 3) Placement, 4) Rights issues and 5) Tender/Book-building.

Under the first method, issuing companies offer the securities directly to the general public at a stated price. The cost of raising capital through this method is high. It is suitable for large issues. The offer for sale and placement methods are indirect methods of sale of securities through financial/investment institutions to the investing public. They are suitable for small issues of capital. The rights issue is a method to sell securities to the existing shareholders of a company. The pricing of issues is left to the investors in book building method.