FINANCIAL MARKETS

Course handled by Vijayaraghavan SV For LIBA, Chennai June-Aug 2010

5-Sep-12

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Module 2 Capital Markets

Definition of Capital Markets What are equity markets? What are primary markets and secondary markets? Why and when corporates need to approach capital markets? What is Corporate Life Cycle and how does it determine funding needs? Importance of market capitalisation and how is it determined? What is an IPO and SPO? The first right of refusal by existing shareholders how important is this? What is pricing of an IPO? How is it different from value of the share? Who fixes the price of the share? What is the role of the Merchant Banker in an IPO?

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Content credits : NCFM Course Materials

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Capital Markets - basics

By itself, Capital Markets refers to both Equity and Debt markets. We will now deal with equity segment of capital markets. What is a share? A share represents partial and proportionate ownership in a corporation/company An owner of an asset always has the opportunity to benefit from the growth in the value of the asset, unlike financiers of the asset (eg., house built with loan from HDFC) An owner also runs the risk of loss of value; a financier may have other opportunities to avoid the loss Who issues and for what period? Stocks are issued by corporations/companies for long term Debt securities are issued by companies for short term and long term but debt is always (well, almost always) redeemed. Ownership also gives the right to control in corporations it is might is right. Higher the ownership, better would be the right to control Types of shares Equity share capital and Preference share capital (quasi debt/quasi equity) Listing of shares All securities debt, preference, equity can be listed on a stock exchange, subject to rules and regulations Listing of securities means admitting a security for dealings among investors, investors and prospective investors by a recognized stock exchange Listing of equity markets is the core characteristic of equity markets 5-Sep-12 Slide 3 Who regulates the markets?

Market Regulator - SEBI

Who is the current Chairman of SEBI? Operating Departments Each headed by an Executive Director
Primary Market Department: It deals with all policy matters and regulatory issues relating to primary market, market intermediaries and redressal of investor grievances. Issue Management and Intermediaries Department: This department is concerned with vetting of offer documents and other things like registration, regulation and monitoring of issue related intermediaries Secondary Market Department: This department looks after all the policy and regulatory issues for the secondary market, administration of the major stock exchanges and other matters related to it. Institutional Investment Department: This department is concerned with framing policy for foreign institutional investors, mutual funds and other matters like publications, membership in international organization etc. Legal Department and Investigation Department.

Support Departments

SEBI has two advisory committees, one each for Primary & Secondary market.

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What is a stock exchange?

A stock exchange is an organised trading floor for members (brokers) to buy and sell stocks on behalf of their customers (and for themselves too)
However, in a demutalised stock exchange, a trading member need not be a shareholder and a shareholder need not a member. The demutalised SE also ensures trading members are not the Management.

How are stock exchanges organised?

Stock exchanges usually start as association of persons and/or partnerships and then graduate to Private Limited Companies and Public Limited Companies and finally Listed Public Limited Companies For instance, BSE was formed as an AOP, was corporatized in May 2005 When they are formed, stock exchanges need to be recognized by the law of the land in India, for instance, all stock exchanges have to be recognized under Section 4 of the Securities Contract (Regulation) Act, 1956 (by the Govt) Stock exchanges have various Councils (committees) which execute its functions

Once listed on a stock exchange, corporate securities get traded

BSE Ringing the OpeningSlide of Bell 5 Reliance Comm. March 6, 2006

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How many stk. Ex. are there in India?

We all know about NSE and BSE? What else is there? Regional Stock Exchanges 16 nos excl Interconnected Stock Exch. Of India OTCEI

A consistent financial discipline has helped the Exchange to reduce its expenses and the exchange will be able to report positive earnings in the BSE next year due to increase in interest earnings on our Fixed Deposits with banks From Directors Report of OTCEI for FY 2006-07 Regional Stock Exchanges Dead/Alive?

Ahm, Patna, Indore

Kolkata, Delhi, Bangalore, Cochin, Kanpur, Guwahati, Ludhiana, Magalore and Chennai Hyderabad, Pune, Rajkot, Magadh

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Post 1990 Milestones in Reforms

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1992 - Repeal of CCI Office and replacing with SEBI, established to (a) protecting the interests of investors in securities, (b) promoting the development of the securities market, and (c) regulating the securities market. Disclosure and Investor Protection (DIP Guidelines) Screen based trading in stock exchanges Trading cycles from 14 and 30 days to week settlements to T+5 to T+3 to present T+2 (April 2003) rolling settlements a near cash market. Carry forward system abolished Derivatives trading since June 2000; Fx.Futures Aug 208, Fx.Options Oct 2010 IRF Aug 2009 Entry of FIIs Demutualisation separation of ownership, management and trading Demat-ing and Depository of securities Investor Education and Protection Fund established Risk management and Market integrity of operators Globalisation ADRs and GDRs placement and two way fungibility; IDRs Short selling and securities lending and borrowing (SLB) Direct Market access (DMA) for brokers clients to trade on the system Cross margining between stocks (cash markets) and off-setting positions in futures markets

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Initial Public Offerings

An Initial Public Offering (IPO) is a first time offering of shares by a public limited company to the public the IPO will enable the company to be listed Most often than not, companies are started by entrepreneurs who follow the FFF route to fund the capital requirements of the business. There comes a time when borrowings are not possible, unless and otherwise they shed a portion of their ownership to the public In a way this is much better situation than to give the chunk of shares to a few other individuals/companies and thus cede total control on the business It is quite possible that a company, promoted by entrepreneurs reach a mid-term stage where they are too early for capital markets (read equity market). In such situations they place their shares in bulk with PEs/VCs (essentially financiers). Such Institutions after a period of time, cash out their investment by asking the company to go public, even if the company does not require the money. Since IPO companies are not much known to the public (not always the case any example?), and their financial details available in public domain are meager, such firms need to prepare an elaborate document (under DIP Guidelines). This document is called offer document or prospectus (legal terminology) To help the company to carry out the various rigourous formalities, Merchant Bankers (Investment Bankers in overseas markets) step in. It costs a company approximately 7%-10% of the issue amount as issue costs
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Pre-issue formalities

The Prospectus (offer document) that the company files with the Registrar of Companies (ROC) is the authentic disclosure document SEBI vets the document for ensuring adherence to the DIP norms The company has to file the draft offer document with SEBI, through a merchant banker, at least 30 days before filing with the ROC (though in actual practice, this runs to many more days than just 30!) Prior to filing of the prospectus, the Company has to obtain an approval from the stock exchanges where it proposes to list the shares (the stock exchanges usually give an in principle approval only). Prior to filing the prospectus, the Company should have entered into an agreement with a depository for the purpose of dematerialisation of the shares, a copy of which needs to be filed alongwith the prospectus A company cannot access the primary market if it has been prohibited from doing so by an order of the SEBI Credit rating is mandatory for all debt instruments, irrespective of their maturity or conversion period and the same should be disclosed in the offer document. In the case of split credit rating, all ratings should be disclosed.
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Who can come out with IPO?

Entry Requirement 1
Net tangible assets of minimum Rs.1 crore for last 3 audited financial years, out of which not less than 50% in non-monetary assets The company has earned distributable profits in 3 out of 5 preceding years The company has a net worth of at least Rs.1 crore in each of last 3 years If the company has changed its name, a minimum of 50% of revenue from the income stream from the activity suggested by new name during last one year Issue size (incl. all issues during last one year) should not exceed 5 times its pre-issue net worth

Entry Requirement 2
Issue only thro Book-building route with minimum 50% place with QIBs Minimum face value of the post-issue capital shall be Rs.10 crores Compulsory market making in the security for at least 2 years (SEBI initially had fixed minimum size of issue at Rs.100 crores under BBR but has relaxed it to Rs.25 crores)
The Project for which funds are mobilised unded IPO is appraised by a Sch.Bank/FI The Sch.banks/FIs participate in the issue to a minimum extent of 15% The appraiser takes a minimum of 10% under the 15% required in the previous clause Compulsory market making in the security for at least 2 years Slide 14

Entry Requirement 3

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Source : SEBI Bulletin June 2011

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Developing a Prospectus

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The Prospectus (offer doc.) is signed by the Board of Directors of the Coy. Hence they are responsible for each word there, even though it is the Merchant Banker who assists the company in preparing the document The work begins months ahead of the target date for the IPO (refer Mah.Holidays) The draft document is filed with SEBI for its vetting the document carries a due diligence certification by the Merchant Banker(s) that they have carried out the first level verification and stick their neck out! SEBIs executives interact with the LM and the Company officials and advise necessary corrections mainly will relate to additional disclosures Once approved, the Company will file the red-herring prospectus to SEBI, a prospectus that is incomplete as to the amount and date of opening and closing of the issue The LM and the Company then will discuss this document with the Designated Stock Exchange officials and get their concurrence. The Companys Board of Directors at this point approve the Red Herring Prospectus to be filed with Registrar of Companies and give a copy of the same to SEBI and Stock Exchanges where shares are proposed to be listed The issue opens and closes and price is discovered The Final Offer Document is filed with ROC before allotment, filling up all the blanks

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Pricing the IPO

The most important aspect of the IPO is pricing at what price should the shares be offered?
Most often the prospective investors are either seduced or intimidated by the IPO pricing (Economic Times, Aug 10, 2009)

What is the theoretical [utopian] solution to this question? Interpret the following observations
Adanis offer price of Rs.90-100, while Tata Power trades at Rs.1200 NHPC IPO offered at Rs.30-36 price band, while NTPC is Rs.200 a share Adani Power IPO oversubscribed by 21 times NHPC oversubscribed 36 times

Therefore, pricing is not so simple. Now tune your readings with the following additional information
Adanis post issue equity size is Rs.2,180 crores and Tata Power is Rs.222 cr.! NHPC at Rs.30 was asking for 30 times its Price Multiple, whereas NTPC is available at just 20!

The book building band gives some leeway to the issuing company and the Merchant Banker; whereas on a vanilla offer it is a Fixed Price
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Statutory rules for Pricing an IPO

When CCI was abolished in 1991 and SEBI was established, SEBI allowed free pricing of securities SEBI was nave to allow this. In no time, there were spate of issues priced with no relevance to the intrinsic worth of the shares. The markets absorbed these securities heady days of LPG. Stock prices were scaling new heights. In less than 2 years, the euphoria died down and the promoters vanished from the markets. SEBI started tightening the screws on terms and conditions for pricing the IPOs A new company started by entrepreneurs and without any track record can price the issue only at par A new company started by existing company(ies) which has at least five years of consistent profitability will be allowed to freely price its shares, provided it subscribes to at least 50% of the capital at the same price that is being offered to the public An existing private limited or closely held public limited company with three years of consistent profitable track record is permitted to freely price its offering An existing listed company is allowed to freely price its subsequent offering (then this is not an IPO!)

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Underwriting an Issue

Underwriting is insuring an issue buying peace against an uncertain response from the investing public. The premium payable is underwriting commission Why is underwriting done? If a company fails to mobilize at least 90% of the subscription amount, then the issue should be called off and all subscribed monies returned, if the issue is not underwritten (one mistake that can be credited to NMurthy!)
If the issue is underwritten, and if the company does not receive 90% of the subscription, including money from underwriters within 60 days of closure of the issue, then also the issue is to be called off.

Will such a situation arise at all? Well, read the CIPLA case

Not everyone can offer underwriting services the underwriter has to be registered with the SEBI for the service and pay hefty registration fee. Underwriting commission is payable on the gross amount underwritten by the underwriter. If there is any shortfall in the subscription, the underwriter will be asked to subscribe to the issue Devolvement is underwriters nightmare An issue devolves on underwriters if it is underwritten and fails to garner 90% subscription
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Not a well known fact about Infosys

Infosys came out with its IPO in February 1993 at a price of Rs.95 (ie., Rs.10 plus Rs.85 as premium) Lead managed by Enam Consultants and SBI Capital Markets The known story is that the issue got oversubscribed by 1.06 times The not known story is that the issue bombed at the box-office There was a bail-out by the Companys merchant bankers Enam Consultants and by Morgan Stanley (13% of the subscription placed by Vallabh Bansali of Enam) At one point of time, the market news is that Vallabh Bansali controlled more stocks than all the stocks of the promoter group! Times change!!

Material will be deleted in uploaded AIS, since fit for class room discussions only
5-Sep-12 Nothing official about it! Slide 20

The CIPLA Pharma Case Study

CIPLA made a rights issue in April 1995. The price for the rights issue was fixed at Rs.10+650 when the market price of its shares were around Rs.700. The issue was lead managed by Alpic Finance Limited Size of the issue Rs.96 crores plus. Fully underwritten with about 25+ underwriters commission at 2.5% When the issue was thrown open, the price of CIPLAs shares in secondary markets were around Rs.350. No wonder the issue bombed. 2% subscription 20 underwriters paid up, but the remaining few underwriters protested paying up because . (precursor to Satyam?)

The protesting underwriters obtained a stay from Bombay High Court, which sanctioned the same. CIPLA appealed to the Division Bench, which vacated the stay
The scene shifts to Supreme Court and the proceedings there. In July 1996, SC dismissed the petition of the underwriters and asked SEBI to intervene and resolve the matter The matter was protracting without a solution and finally in July 1999, all parties decided to withdraw their complaints and the matter was resolved amicably. The reason CIPLAs price was ruling at Rs.1950 at that time! Times change!!

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IPO timing

One of the most important questions asked by investors in markets (whichever segment) is is it possible to time the markets? ie., can I enter and exit at the right time?

Similarly, the question that has defied answers for an issuer for a long time is when should I enter the IPO market?
Empirical studies show that IPOs galore during bullish stock markets because there is no overpricing in a bullish market It has been noticed that worthless issues get multiple subscription and investors end up realising that they could have bought much bigger quantity and quality of toilet paper for the price they paid from supermarket than what they got from financial markets Case study of IPO timing : Mahindra Holidays and Resorts Limited

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Mahindra Holidays IPO

First draft Prospectus filed with SEBI for vetting on December 14, 2007
Sensex on 15/10/07 and 29/10/07 at 19,000 points and 20,000 points respectively Sensex hits record 21,000 points on Jan 8, 2008 Draft prospectus size 317 pages Draft mentions in documents SEBI Observation letter dated xx/xx/xxxx

Company files revised Draft Prospectus with SEBI on September 30, 2008 size of document 337 pages
No mention about SEBI Observation letter in documents Sensex closed at 12,860 on Sept 30, 2008 Sensex crashed to 10,527 on Oct 10, 2008

On May 18, 2009, Sensex gains 2,111 points on a single day to reach 14,184
On June 12, 2009, the Company files Red Herring Prospectus with ROC to open the IPO on June 23, 2009 to June 26, 2009 - at a price range of Rs.275-Rs.325 On June 27, 2009, the Company files the Final Prospectus with ROC (412 pages) to complete the IPO process at Rs.300 Time taken to complete the IPO process 18 months!! Amount sourced? Rs.176 crores for the company. What happens to the Business Plans of FY 2008-09, 2009-10 and so on?
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Group Assignment - 1
Identify a BSE-200 company that announced a bonus issue during the last one year (July 1, 2011 to June 30, 2012). Track its market price for one month before announcement, on the day and the second day after announcement, then upto record date and then for one month after the record date.

What is your interpretation?

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Promoters Contribution to IPO

The promoters contribution in case of public issues by unlisted companies and promoters shareholding in case of offers for sale should not be less than 20% of the post issue capital. In case of public issues by listed companies, promoters should contribute to the extent of 20% of the proposed issue or should ensure post-issue holding to the extent of 20% of the post-issue capital. The promoters should bring in the full amount of the promoters contribution (incl.) premium at least one day prior to the issue opening date

The requirement of promoters contribution is not applicable in case of

(i) public issue of securities which has been listed on a stock exchange for at least 3 years and has a track record of dividend payment for at least 3 immediate preceding years, (ii) companies where no identifiable promoter or promoter group exists, and (iii) rights issues.

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Lock-in for promoters contribution

The minimum promoters contribution is locked in for a period of 3 years. If the promoters contribution exceeds the required minimum contribution, such excess is locked in for a period of one year. The locked-in securities held by promoters may be pledged only with banks or FIs as collateral security for loans granted by such banks or FIs, provided the pledge of shares is one of the terms of sanction of loan. Securities allotted in firm allotment basis are also locked in for a period of one year. Details of securities pledged by promoters need to be continuously disclosed in quarterly financial results post Satyam scam learning by SEBI.

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Follow on Public Offering

Once a company is listed with an IPO, it does not mean that its visit to the equity markets is over! Periodically companies issue shares in what is called SPOs or FPOs
SPO Seasoned Public Offer (sometimes also called as Secondary Public Offer, though wrongly) FPO Follow on/up Public Offer

No pricing regulations in such cases as in IPOs, because a fair market price benchmark is already available Usually FPOs are resorted to more by Banks, due to periodic banking regulations such as Basel 1 and Basel 2, requiring banks to shore up their Tier 1 and Tier 2 capital and also by Infrastructure companies, which require frequent infusion of equity capital to provide borrowing platform

Usually the size of the FPOs will be relatively large. Also resorted to by companies which are in the acquisition mode eg. Tata Group

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Rights Offering

Rights issue is a technically a FPO however, it is offered only to the existing shareholders as on a record date. It is offered proportionately; but shareholders have the right to renounce

Rights offer is best suited for companies who would like to raise capital without diluting stake of its existing shareholders.
Rights offer is actually a pre-emptive right of the existing shareholders of the company. Every time a company wants to raise equity share capital, it should offer it first to the existing shareholders only (Sec 81 of the Companies Act, 1956). Only if the existing shareholder rescind acquiring the new shares offered, they can be given to the public. The abrogation of this right has to be approved by the shareholders in a general meeting with a Special Resolution (not applicable to a private limited company) Companies come out with composite offers both SFO and Rights offer at the at the same time with differential pricing which will be priced higher?

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Preferential Offering

As the name goes, this is placement of shares or convertible securities with a large investor such as the existing promoters, Private Equity, Hedge Fund, Collaborator, etc. This is neither a Public Issue nor a Rights Issue. This placement/offer also has to be approved by the Shareholders in their meeting with a special resolution The advantage is that it enables the issuing company to mobilize a large chunk of capital with minimum fuss and delay This is a method followed by promoters when they fear hostile acquisition they place to themselves a large block of preferential convertible securities with minimum upfront payment acts as a repellent SEBI has come out with detailed guidelines as to the procedure to be followed, pricing of such securities, payment for such offers, etc.

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Secondary Markets

The largest Stock Exchanges in the world are ______

_____ accounts for over 80% of the transactions in the US

The largest stock exchanges in India are NSE and the BSE, accounting for 99.98% of all turnover in Indian stock exchanges
End of last week, market capitalisation on NSE at Rs 62,29,136 crores on 06/08/2010 End of last week, market capitalisation on BSE at Rs.60,91,264 crores on 06/08/2010 The Dalal Street bandicoots must be more worried! NSE Rs.12,731 crores as against Rs.4,816 crores in BSE Reason ? YOUR NEXT ASSIGNMENT ! The trading platform and clearing and payment mechanisms are considered to be far superior at NSE

The daily volume on the two Indian stock exchanges on 06/08/ 2010 was

The regional stock exchanges such as Madras Stock Exchange (MSE) or Jaipur Stock Exchange (JSE) now exist on paper, with tie-ups with NSE (currently Coimbatore Stock Exchange is leasing its building to companies for their office requirements!). The best illustration of this ridiculous situation is that of Interconnected Stock Exchanges of India it has become a broker on NSE!! NSE is the first SE in the world to offer satellite connectivity. Its VSATs (approximately 3,000 nos) are operational in about 250 cities .

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How easy is it to get NSE membership?

By the way, in 1875, 318 persons paid Re. 1 to became members of what today is called Bombay Stock Exchange Limited (BSE)
Source : BSE Website
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Trading Platform

Just as we saw on the debt markets, all trading systems work on anonymous order matching mechanism which works on Price and Time as the differentiators Initially trading happened on open outcry method in the well/ring of the exchange This has now been replaced by automated trading platforms NSE is the first exchange in the world to use Satellite communication technology! NSEs National Exchange for Automated Trading (NEAT) is considered to be a state of art client-server architecture application. Two efficiency parameters are tracked for NEAT (a) Uptime ( >99.7%) and (b) response time (< 1 second)

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A brief note on Trading Cycle

1/2

Once upon a time, the trading cycle varied from 14 days for specified securities to 30 days for others. All transactions of the brokers were aggregated during this period and then clubbed together and final positions netted to enable delivery of securities and payment for delivery. The settlement took almost 2 weeks to complete as the systems were manual remember that there was no automated systems at that time. Further, different stock exchanges had different settlement periods for different securities. Because of the inefficiencies, quite often the netting and settlement did not happen as per schedule, resulting in accumulation of undesirable open positions and resulting defaults and settlement risks. Since the advent of automated trading systems, the trading cycle has been reduced over a period of time to a week. Still the problem of different weekly trading cycles and settlement periods continued BSE on Friday and NSE on Wednesday. This resulted in shifting positions from one exchange to another!!
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A brief note on Trading Cycle

2/2

Rolling settlement on T+5 basis was introduced in respect of specified scrips reducing the trading cycle to one day. For non-specified scrips, uniform weekly trading cycle was introduced for all exchanges In December 2001, all scrips (both specified and non-specified) were moved to rolling settlement, ie., T+5 In April 2002, T+5 was reduced to T+3 In April 2003, T+3 was reduced to T+2 Once upon a time, BSE was known as badla market. Badla system is a form of carry forward system where outstanding positions of traders were carried forward to next settlement this is a deferral product Currently there are no deferral products in fact, all deferral products have been banned. The market has since moved to spot/cash market. This is why you would have seen in earlier slides of SEBI, the stock exchanges would be referred to as cash market
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A brief note on Impact Cost

What is the cost of buying and selling on the exchanges? We normally tend to see the outright costs such as brokerage, interest cost on margin, where required, etc. Normally, one can reasonably estimate that the cost per share transacted would be lower as the volume of trade is higher Is this true in all cases? - NO There is one intangible cost which we never get to realise impact cost In a way, impact cost measures the cost of illiquidity to the investor Impact costs are different for buy and sell and are calculated at a particular point of time for a particular value or number of shares Impact cost is of special importance to index fund managers index funds mirror index securities and if the impact cost is large, the portfolio return and the index return could be significantly different NSEs requirement for Nifty stocks is that the stock should have impact cost < 1.5 per cent for trades worth Rs 50 lakh.
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So, what is Impact Cost?

We have here the bid and sell details for Infosys stock at 13.30 hours on Aug 3, 2011 Calculate impact cost for (a) buying 250 shares (b) selling 120 shares

Buy Qty. Buy Price Sell Price Sell Qty. 1 2,721.25 2,721.90 124 35 2,721.20 2,722.00 50 100 2,721.10 2,722.90 46 17 2,721.05 2,723.00 31 60 2,721.00 2,723.70 52 1,24,211 Total Quantity 1,51,646

First Calculate the Ideal Price. Ideal price = (2721.25+2721.90)/2 = 2721.58

(a) To buy 250 shares, look at the Sell side of the Order Book 124+50+46+30 = 250; (124x2721.9+50x2722+46x2722.9+2723x30)/250 = 2722..24 Impact cost for 250 shares = (2722.24-2721.58)/2721.58 = 0.024% (b) To sell 120 shares, look at the buy side of the Order Book 1+35+84 = 120

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Broking Members Risk Mgmnt

One of the most important indicators of the robustness of any market is the integrity of the transactions if market integrity is lost, markets dont exist. This integrity is facilitated by the enforcement of law and control and regulations established by the market regulators such as SEBI and RBI. The current risk management system for the broking segment includes the following mechanisms at the broking member level
Capital adequacy of the member brokers Adequate margin money requirements Limits on exposure and turnover Indemnity insurance On-line position monitoring Automatic disablement Market surveillance system to monitor excessive volatility Detention and prevention of price manipulations Trade/settlement guarantee funds for meeting shortages arising out of non-fulfillment/ partial fulfillment of funds obligations by the members in a settlement. Index-based market-wide circuit breakers Novation implemented by NSCCL (for NSE) and _______ (for BSE) since 1996 Slide 38

Apart from the above, at the market level

The result of all this protective system is the establishment of market confidence

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Global Integration of Indian Stk. Markets

Increasing integration with the global investment community Indian companies have been permitted to issue ADRs/GDRs/ECBs/FCCBs ADRs/GDRs have two way fungibility Overseas companies have since been allowed to issue IDRs. No two way fungibility has been offered for such IDRs. SCB is the only IDR on Indian markets, as on date NRIs and OCBs are allowed to invest in Indian Companies. FIIs have been allowed in invest in all types of securities including G-Secs, with capital account convertibility FIIs are allowed to invest upto 24% of the paid up capital of any company under portfolio investment scheme. This can be further increased upto the maximum allowed under sectoral scheme subject to the company passing necessary formalities Board Resolution and share holder resolution Stock exchanges have now been allowed to set up trading platforms overseas linked through the internet Mutual funds are permitted to set up off-shore mutual funds to invest in overseas corporates Indian investors can invest in overseas corporates upto $200,000 annually

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Direct Market access (DMA) for clients

DMA facility to the clients of institutional investors is allowed since April 2008. DMA allows brokers to offer clients direct access to the exchange trading system through the brokers infrastructure without manual intervention by the broker. DMA facility give clients direct control over orders, help in faster execution of orders, reduce the risk of errors from manual order entry and lend greater transparency and liquidity. DMA also leads to lower impact cost for large orders, better audit trails and better use of hedging and arbitrage opportunities through the use of decision support tools/algorithms for trading.

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Categorization of Scrips on BSE

1/2

BSE has classified the listed stocks into various categories to provide guidance to investors. The categories are :- A, B1, B2, S, T, TS, & Z The classification is on the basis of several factors like market capitalization, trading volumes and numbers, track record, profits, dividends, shareholding patterns, and some qualitative aspects.
Group F:

Fixed Income Securities (Bonds and Debentures) Government Securities It is the most tracked class of scrips consisting of about 220 scrips. Market capitalization is one key factor in deciding which scrip should be classified in Group A. Once upon a time these were the stocks where carry forward facility (badla) was available. Residuary Group. All companies other than in Group A, S, T, TS or Z. Until March 2008, there was a ranking (hierarchy) of B1 and B2 based on market capitalisation of these securities. Now merged together.

Group G:

Group A:

Group B:

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Categorization of Scrips on BSE

Group C:

2/2

Odd lot Group is otherwise known as C Group W.e.f. January 2005, this new segment S Group was introduced. It consists of B group on BSE and scrips forming part of the BSE-Indonext segment. W.e.f July 1999, the Z group was introduced by BSE it is the isolation ward. Includes the companies that dont comply with listing requirements and/or dont resolve investor complaints or dont have arrangements for dematerialization of their securities Group T consists of scrips which are traded on trade to trade basis as a surveillance measure TS Group consists of scrips in the BSE-Indonext segments which are settled on a trade to trade basis as a surveillance measure.

Group S:

Group Z:

Group T:

Group TS:

A proposal is pending with BSE since March 2009 to have only two groups A and B for equity stocks. F&G will remain. Z will be delisted. There is only one category apart from EQ on NSE BE, which is T2T
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5-Sep-12

How do corporates reward shareholders?

First and most important reward is Dividend

Counterpoint Berkshire Hathaway and Microsoft

Second comes capital appreciation

Point Berkshire Hathaway

What we call as Shareholder Value Creation Check the market price of Berkshire Hathaway Class A shares Third comes Bonus shares Check BRK policy on Bonus Shares Fourth comes Stock Split
What is the difference between Indian Stock Split and US Stock Split? Illustration of the impact of stock-split

Fifth comes Buy back of shares Sixth comes differential pricing on Rights
Composite offers at differential pricing for existing shareholders Theoretical value of a right

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Slide 44

A detailed view on Rights

A Rights issue is a pro-rata issue of shares to existing shareholders, usually at a concessional rate compared to the prevailing market prices This is one way of rewarding the shareholders Existing shareholders can either invest or renounce in favour of others After rights is announced and before rights issue opens up, the rights can be bought and sold (ie, if renounced by the existing shareholders) Some important terms
Subscription price- price that must be paid to obtain new share by existing shholder Ex-rights price - price paid for the share which excludes the right to subscribe to the rights issue (that just closed). If the subscription price is lower than the current market price, the ex-rights price should get adjusted to a lower level based on the theoretical value of a right per share Cum-rights - price paid for the share that includes the right to subscribe to the rights issue (that is now on) Theoretical value of a right the fair price at the which the rights can be expected to be traded at a particular point of time

5-Sep-12

Slide 45

Rights calculations

The theoretical value of a right is given as Value of One Right (R) = N (CMP - S) N+1

where : N = number of shares required to obtain one right CMP = Current market price, ie., market price of a share cum-rights S = subscription price

The market price of a share ex-rights (Pex): Pex = CMP - R

Theoretically a rights issue has no value to shareholders.

5-Sep-12

Slide 46

Illustration of Rights Issue dynamics

A firm is considering a rights issue to raise Rs.80 crores. The present market cap of the company is Rs.180 crores at market price of Rs.60 per share. The rights offer is at Rs.40 per share. (a) How many shares must be sold to raise the desired funds? (b) How many shares must a shareholder own in order to have 1 right? (c) Calculate the value of one right and (d) Calculate the theoretical (justified/fundamental/fair) ex-rights price

Number of shares currently issued = Rs.180 cr / Rs.60 = 3 crores Number of new rights shares to be issued = Rs.80 crores / Rs.40 = 2 crores Every current share issued will be offered 2/3 = 0.6667 new shares. In other words, to have one right, a shareholder should own 1.50 shares Value of one right R = 1.5(60 40) / (1.5+1) = Rs.12 Therefore, value of right per share = Rs.12/1.5 = Rs.8 Therefore, ex-rights value = Rs.60 8 = Rs.52 5-Sep-12 This value can also be derived as (1.5*60 + 1*40)/(1.5+1) = Rs.52 Slide 47

Market Index and Capitalisation

5-Sep-12 Slide http://www.nseindia.com/live_market/dynaContent/live_watch/live_index_watch.htm 48

Market Capitalization

5-Sep-12 Slide 49 http://www.worldexchanges.org/files/file/stats%20and%20charts/July%202010%20WFE%20Market%20Highlights.pdf

What is market index?

An index is a single descriptive statistic (ie., a number) that summarizes the relative change in an underlying group of variables. In an equity index, such as the S&P CNX Nifty or BSE Sensex, the underlying variables are stocks. The main differences among indexes (or indices) is the types of securities held and the weighting scheme in the portfolio Indexes are narrow or broad based the number of stocks in the index construction is one of the major differentiator, but not necessarily the only one. For instance, Nifty (50) stocks represent more than 70% of the market capitalisation as on March 31, 2012. Index weightings could be
Equal weights eg. S&P 500 Equal Weight Index (each stock has .2% weight) Price weights Dow Jones Industrial Average (DJIA) (ave. of all prices) Just imagine what would happen if they include BRK! Market cap. weights S&P 500, S&P CNX Nifty, BSE Sensex

5-Sep-12

Slide 50

What is market capitalisation?

In finance, we refer to Market Capitalisation of a company as Number of issued shares x Market price per share In stock market index construction, there are two concepts
Full float market capitalisation Free float market capitalisation (NSE since June 2009, BSE since Sept. 2003)

Full float market capitalisation considers all stocks issued by the company Free float market capitalisation considers only stocks that freely float which means non-trading stocks such as promoters controlling interest stocks, locked-in shares, employee welfare trust holdings, etc. are not considered for calculation of market capitalisation Market capitalisation (size) is an important factor for inclusion and exclusion of stocks from the index. Hence, the importance of FFAF.
Chicken and Egg Does volume of trade drives inclusion of a stock in index or inclusion of the stock in index drives its volume up?

See the next slide for Sensex Composition

Slide 51

5-Sep-12

BSE FREE FLOAT ADJUSTMENT FACTOR

% FreeFloat >0 - 5% >5 - 10% >10 - 15% >15 - 20% >20 - 25% >25 - 30% >30 - 35% >35 - 40% >40 - 45% >45 - 50%

Free-Float Factor 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45 0.50

% FreeFloat >50 - 55% >55 - 60% >60 - 65% >65 - 70% >70 - 75% >75 - 80% >80 - 85% >85 - 90% >90 - 95% >95 - 100%

Free-Float Factor 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

5-Sep-12

Slide 52

Basis for selection of Index stocks

First and foremost differentiator Market capitalisation

For instance, NSE has the criteria that to be included in Sensex, the stocks rank in market capitalisation has to be less than 500

Second important factor is Liquidity ie., the stock should have a good demand and supply
For instance, NSEs criteria is that the stocks trading frequency should be at least 90% in the last six months. BSE says every day trading during last 3mon,

General market acceptability of the company, as evidenced by past history, financial soundness, track record, promoters, etc. History of Recent Replacements in SENSEX Other factors, for example

Date 12-Jan-09 29-Jun-09 3-May-10 26-May-10

Satisfies balanced industry/sector representation (BSE) Scrips Excluded Scrips Included At least 10% Ltd. Satyam Computers floating stock (NSE) Industries Ltd. Sun Pharmaceutical Companys turnover rank should be less than 500 (NSE CNX Bank Index) Ranbaxy Laboratories Ltd. Hero Honda Motors Ltd. Company should have positive networth (NSE CNX Bank Index)

Sun Pharmaceutical Industries Ltd. Cipla Ltd. Grasim Industries Ltd. Jindal Steel & Power Ltd.

5-Sep-12

Slide 53

Basic ideas about Nifty, Sensex

Sensex base year is 1978-79 and NSEs base year is Nov 3, 1995 Sensex base index value is 100 and NSEs base index value is 1,000 Composition review BSE, quarterly and NSE, half yearly Ownership Sensex with BSE; Nifty with India Index Serv.&Prod.Ltd Trademark Sensex Deepak Mahoni and BSE are at loggerheads for the ownership of the word Sensex and the matter is sub-judice in Pune Court

5-Sep-12

Cartoon source : http://www.mydigitalfc.com /2008/brand-sensex-tussle-ownership

Slide 54

Margins

Assume you place an order at 10.00 am on 22-08-2012 on your broker to buy 100 shares of Bajaj Auto at Rs.1,200 For T+2, you need to pay your broker Rs.1200x100 = Rs.120,000 by 23rd and the broker will have to pay this to the exchange on 24th Due to any number of reasons, you may not be able to pay on 23rd, which will create problems for the broker on 24th. Therefore, the broker will ask you to pay some margin as security deposit. So is the case if you are a seller, you may not be able to give delivery of the shares This is like Earnest Money Deposit keeps away non-serious players Assume that the margin is 12%. Then you pay Rs.14,400. Let us assume that the price falls down to Rs.1,000 by end of the day. Therefore, the loss suffered by you is Rs.200 x 100 = Rs.20,000, if you execute the contract. Therefore, you may not turn up and forget about the margin paid But the broker is in trouble!
Slide 55

Margins

The reverse situation can happen if you have placed a buy order and price goes up by Rs.200 Therefore, it is not enough if just a initial margin is collected, but also a margin to protect the notional loss that can be incurred Therefore, a notional loss margining system is implemented so that market players complete their transactions Such margin obviously cannot be decided with precision because the losses that can be suffered by price movements are closely related to the volatility of the stock prices in other words, we need to bring in the statistical calculations to make a fair estimate of the amount of money that can be collected from buyers and sellers before they put thro their trades. Volatility of stock prices is an estimate of the uncertainty/risk in stock price movements and is usually referred by the parameter s of the stock returns
Slide 56

Zee 1-Sep-10 285.830 2-Sep-10 287.470 3-Sep-10 286.800 6-Sep-10 293.490 7-Sep-10 293.380 8-Sep-10 290.750 9-Sep-10 292.310 13-Sep-10 293.830 14-Sep-10 294.670 15-Sep-10 294.020 16-Sep-10 290.660 17-Sep-10 288.390 20-Sep-10 288.240 21-Sep-10 294.790 22-Sep-10 302.190 23-Sep-10 307.080 24-Sep-10 303.370 27-Sep-10 307.330 28-Sep-10 307.360 29-Sep-10 303.780 30-Sep-10 298.480 1-Oct-10 301.250 4-Oct-10 305.930 5-Oct-10 303.630 6-Oct-10 297.360 7-Oct-10 295.450 8-Oct-10 292.860 Standard Deviation

0.57% -0.23% 2.31% -0.04% -0.90% 0.54% 0.52% 0.29% -0.22% -1.15% -0.78% -0.05% 2.25% 2.48% 1.61% -1.22% 1.30% 0.01% -1.17% -1.76% 0.92% 1.54% -0.75% -2.09% -0.64% -0.88% 1.26%

Havells 1-Sep-10 807.58 2-Sep-10 803.69 3-Sep-10 802.90 6-Sep-10 802.96 7-Sep-10 804.24 8-Sep-10 799.46 9-Sep-10 799.26 13-Sep-10 798.58 14-Sep-10 796.06 15-Sep-10 801.72 16-Sep-10 802.04 17-Sep-10 804.52 20-Sep-10 799.38 21-Sep-10 791.58 22-Sep-10 777.98 23-Sep-10 777.17 24-Sep-10 796.98 27-Sep-10 812.97 28-Sep-10 797.44 29-Sep-10 795.90 30-Sep-10 801.09 1-Oct-10 826.14 4-Oct-10 858.46 5-Oct-10 881.17 6-Oct-10 878.34 7-Oct-10 863.44 8-Oct-10 859.82 Standard Deviation

-0.48% -0.10% 0.01% 0.16% -0.60% -0.03% -0.09% -0.32% 0.71% 0.04% 0.31% -0.64% -0.98% -1.73% -0.10% 2.52% 1.99% -1.93% -0.19% 0.65% 3.08% 3.84% 2.61% -0.32% -1.71% -0.42% 1.45%

Bajaj 1-Sep-10 2,779.12 2-Sep-10 2,785.39 3-Sep-10 2,837.70 6-Sep-10 2,985.39 7-Sep-10 3,015.45 8-Sep-10 2,956.48 9-Sep-10 2,934.70 13-Sep-10 2,933.26 14-Sep-10 2,966.42 15-Sep-10 2,957.24 16-Sep-10 2,920.14 17-Sep-10 2,906.38 20-Sep-10 2,898.50 21-Sep-10 2,915.30 22-Sep-10 2,891.44 23-Sep-10 2,885.10 24-Sep-10 2,889.00 27-Sep-10 2,930.38 28-Sep-10 2,904.88 29-Sep-10 2,959.64 30-Sep-10 2,982.32 1-Oct-10 3,051.56 4-Oct-10 3,116.14 5-Oct-10 3,113.76 6-Oct-10 3,197.78 7-Oct-10 3,188.08 8-Oct-10 3,104.04 Standard Deviation

0.23% 1.86% 5.07% 1.00% -1.97% -0.74% -0.05% 1.12% -0.31% -1.26% -0.47% -0.27% 0.58% -0.82% -0.22% 0.14% 1.42% -0.87% 1.87% 0.76% 2.30% 2.09% -0.08% 2.66% -0.30% -2.67% Slide 1.61%

57

Margins

In equity market segment, we have three types of margins Value At Risk (VaR) Margin Extreme Loss Margin and Mark-To-Market (MTM) Margin VaR asks the question say with 95% confidence level, how much would this stock go up or down from its existing level of Rs.400 by end of tomorrow? In other words, three reference points are here

1. high level of confidence 2. a stated time period (one day here) 3. like amount of variation

VaR is computed using exponentially weighted moving average (EWMA) methodology. Based on statistical analysis, 94% weight is given to volatility on T-1 day and 6% weight is given to T day returns.

Illustration on VaR calculation is given in the next slide

VaR margin is collected upfront

Slide 58

VaR calculation

We will not get into the theory of calculation of VaR. VaR calculation in Indian stock markets works like this Get first the volatility of a stock on day-on-day basis Volatility on T0 = Sq.Root of [94% of (Volatility on day T-1)2 + 6% of (LN returns of T0)2]

To get the VaR for different companies, companies are categorised into three groups based on their liquidity (Impact cost) G1 is good liquidity and low impact cost (less than 1%) G2 is good liquidity and higher impact cost (more than 1%) The rest of the crowd

Slide 59

VaR

For Group 1, the VaR is higher of

7.5% or 3.5% times the volatility

For Group 3, the VaR is

5 times the volatility of the SE Index x 1.732051 (ie., sq of 3)

For Group 2, the VaR is

Max [3.5 times scrip volatility, 3.0 times x Min (5.0, SE index volatility)] x 1.730251

Infoysis VaR screenshot is given in next slide

Slide 60

Slide 61

Extreme Loss Margin

The Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LN returns of the stock price in the last six months or 5% of the value of the position. This margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis for the past six months.

Slide 62

MTM Margin

The notional loss suffered by the buyer or seller at the end of the day, comparing the closing price with the contract price needs to paid in by the broker to the exchange In our earlier illustration, Rs.14,400 will be the MTM margin to be paid to the exchange Suppose a broker has bought 100 Bajaj Auto and sold 100 Bajaj Auto, would he have to bring in MTM margin? Yes, and the formula is MTM Profit/Loss = [(Total Buy Qty X Close price) Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close price)] And this arises because the prices at which sales and buy could be effected can be different and the closing price is one!!
Slide 63

Some dividend Policies

Mr. Buffett:: "We will either pay large dividends or none at all if we can't obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% of earnings as dividends every year." Berkshire has not declared a cash dividend since 1967. Annual Report of Berkshire Hathaway, 2008 Infosys Annual Report 2009 The Dividend Policy is to distribute not more than 30% of the Profit after Tax (PAT) as Dividend. Microsoft Corp. yesterday (January 16, 2003) acted to quiet shareholders clamoring for some of the company's $43.4 billion cash surplus, promising to issue its first-ever dividend this year. The world's largest software maker also announced a 2-for-1 stock split ..The dividend declaration comes on the heels of President Bush's Jan. 7 tax-reform plan, which would exempt shareholders from income tax on dividends from tax-paying corporations. But Microsoft said the two developments aren't connected.Now Microsoft's cash "can be delivered to shareholders, including (Microsoft Chairman) Bill Gates," . Microsoft 5-Sep-12 Corporation was founded on April 4, 1975
Slide 64

BRKs view about Bonus Shares

Warren Buffets views on bonus shares (Stock split) dont be upset! Stock splits have three consequences: they increase transaction costs by promoting high share turnover; they attract shareholders with short-term, market-oriented views who unduly focus on stock market prices; and, as a result of both of those effects, they lead to prices that depart materially from intrinsic business value.
Shareholders funds belongs to shareholders Shareholders funds are made up of 1. Equity capital 2. Retained earnings The market price of one equity share represents both 1 and 2 above When a bonus issue is made, the company says, give me your One hundred rupee note and take two fifty notes from me and also a kiss from me And the the market says how sweet of you, if it were to reward this action If it stops there, you have an enlightened set of investors otherwise, you are willing to pay a price (notional) for that kiss! Slide 65

5-Sep-12

Stock Split Stock market response

Gammon Infrastructure Projects stock split has been approved by the board today. Mr. The company in their board meeting held today has approved and announced to the stock exchanges. Gammon Infrastructure stock split has been approved in the ratio of 1:5 - equity shares of face value of Rs 10 each split into 5 equity shares of Rs 2 each Shares of the company gained Rs 4.9, or 4.97%, to trade at Rs 103.55. News item dated Aug 12, 2009

MVL gained 2.33% to Rs 160 at 11:44 IST on BSE after its board approved splitting one share of face value Rs 10 into five shares of face value Rs 2 each.
The company made this announcement during trading hours today, 18 August 2009 News item dated Aug 18, 2009

5-Sep-12

Slide 66

Impact of Rights Issue news on Mkt

Fortis Healthcare Board Approves 1000 Crore Rights Issue As the decision of Board 2009 News item dated Aug 12, of Directors was announced, the shares of the company gained Rs 2.5, or 3.6%, to trade at Rs 72. News item dated Dec 24, 2008

5-Sep-12

Slide 67