Concept of Primary & Secondary Markets, Instruments etc.

1. Primary Markets and
Secondary Markets
Presented by:
Maksudul Huq Chowdhury

2. Capital Markets
for long-term funds (More than one year)
A capital market is one in which individuals and institutions
trade financial securities. Organizations and institutions in the
public and private sectors also often sell securities on the capital
markets in order to raise funds. Thus, this type of market is
composed of both the primary and secondary markets.

3. A. Stock Markets
Stock markets allow investors to buy and sell shares in publicly
traded companies. They are one of the most vital areas of a
market economy as they provide companies with access to
capital and investors with a slice of ownership in the company
and the potential of gains based on the company's future
performance.
This market can be split into two main sections: the primary
market and the secondary market. The primary market is where
new issues are first offered, with any subsequent trading going
on in the secondary market.

4. Primary Markets vs. Secondary Markets
A primary market issues new securities on an exchange.
Companies, governments and other groups obtain financing
through debt or equity based securities. Primary markets, also
known as "new issue markets," are facilitated by underwriting
groups, which consist of investment banks.

5. Primary Markets vs. Secondary Markets
The primary markets are where investors have their first chance
to participate in a new security issuance. The issuing company
or group receives cash proceeds from the sale, which is then
used to fund operations or expand the business.
Cont ….

6. Primary Markets vs. Secondary Markets
The secondary market is where investors purchase securities or
assets from other investors, rather than from issuing companies
themselves. The Securities and Exchange Commission (SEC)
registers securities prior to their primary issuance, and then
they start trading in the secondary market or other venue where
the securities have been accepted for listing and trading.
Cont ….

7. B. Bond Markets
A bond is a debt investment in which an investor loans money
to an entity (corporate or governmental), which borrows the
funds for a defined period of time at a fixed interest rate. Bonds
can be bought and sold by investors on credit markets around
the world. This market is alternatively referred to as the debt,
credit or fixed-income market.

8. Fundamentals of Capital Market
 Capital market channels the supply and demand for long-term
capital – Debt and Equity (debt market and Equity/Stock
market).
 Capital market facilitates transaction on financial securities,
which is important for allocation of capital within the
economies.
 Capital market is also extremely important for distributing
national income (corporate earnings).

9. Regulatory Framework
 Securities and Exchange Ordinance 1969
 SEC Merchant Banker and Portfolio Manager Regulations 1996
 Listing Regulation of Stock exchange
 SEC Public Issue Rules 1998
 SEC Right Issue Rules 1998
 SEC Depository Act 1999
 Margin Rules 1999
 SEC Mutual Fund Rules 2001
 SEC Capital Issue Rules 2001
 SEC (Acquisition of Substantial shares, merger & take over)
Rules 2002.

10. Major Operators
 Merchant Bankers
 Asset Management Companies
 Brokers/ Dealers

11. Investment Banking
Investment banking is concerned with the allocation of
financial resources. It works as an intermediary which deals with
how and why money is moved from those who have it
(investors) to those who need it (issuers).
 In traditional sense, the role of investment banking is one of
intermediation in resource allocation.
 Investment banking had been narrowly defined as those
financial services associated with the issuance or floatation of
new (mainly corporate) securities.

12. Investment Banking
 This definition confines its activities to primary market making
for securities.
 At a little broader level, investment banking is also understood
to include secondary market making.
 Now-a-days, investment banking is meant include primary
market making, secondary market making, trading, corporate
restructuring, financial engineering, advisory services,
merchant banking, investment management, consulting,
clearing, research, internal finance and information services.
Cont ….

13. Investment Banking Activities
Investment Bank
Revenue Generating Activities
Primary Market Making
* Corporate Finance
* Municipal Finance
* Treasury & Agency Finance
Secondary Market Making
* Dealer Activity
* Brokerage Activity
Trading
* Speculation
* Arbitrage
Corporate Restructuring
* Expansion
* Contraction
* Ownership and Control
Financial Engineering
* Zero Coupon Securities
* Mortgage Backed- Securities
* Asset Backed- Securities
* Derivative Securities
Other Activities
* Advisory Services
* Investment Management
* Merchant Banking
* Venture Capital
* Consulting
Support
Activities
Clearing
Research
Internal Finance
Information Service

14. Investment Banking vs.
Commercial Banking
 Earlier it was prohibited the commercial banks to perform
investment-banking activities. The main objective of this
separation was to restrain the commercial banks from
undertaking risky activities that may go against the interest of
depositors.
 However, because of the advancement of risk management, the
prohibitions on securities underwriting had been relaxed. They
were allowed to underwrite general bonds, industrial bonds and
some corporate issues.

15. Investment Banking vs.
Commercial Banking
 Now-a-days, both investment banks and commercial banks
became players for the new range of services (as the Act did not
restrict commercial banks to perform these functions).
 These services include swaps, notional contracts, structured
solutions (to solve financial problems), etc.
 In Bangladesh, commercial banks can perform the functions of
investment banks.
Cont ….

16. Three Distinct Functions of
Investment Banker
 Origination: It involves development and registration of
securities.
 Underwriting: It involves purchase of securities from the issuer
by the underwriting syndicate for subsequent sale to the public.
 Distribution: It involves the final sale of the securities to the
public.

17. Corporations issue different
types of securities
 Equity Security – Common stock
 Hybrid Security – Preferred Stock
 Debt Security – Mortgage bond, debenture or notes, commercial
papers etc.

18. Two fundamental ways to intermediate
between issuers and investors
 Public Offering - where securities that are issued are offered for
sale to the public investor.
 Private Placement -where the securities are placed, through
negotiations, in the hands of a small group of sophisticated,
usually institutional investors.

19. The Public Offering Process
For making public offering, issuers must satisfy a number of
well-defined criteria and in Bangladesh, an issuer has to get the
prospectus approved from the Securities and Exchange
Commission (SEC).

20. The Public Offering Process
The public offering process involves a tedious, sometimes
complex and time-consuming undertaking that can expose the
corporate officers and directors to financial and even criminal
liabilities.
 At the first step, the investment bank negotiates a mandate to
“do the deal” and prepare the issuance to the satisfaction of the
SEC. This part of the process is called origination. The process
involves an investigation of the issuer, preparation and filing of
required documents, and organization of an underwriting
syndicate.
Cont ….

21. The Public Offering Process
 In the underwriting phase, the investment banker negotiated,
on behalf of an underwriting syndicate, with the issuer for (1) an
offering price for securities and (2) the size of the issuance. They
must also negotiate the underwriting spread – the difference
between the offering price to the public and the proceeds to the
issuer. This is also known as the gross spread or underwriting
discount.
Cont ….

22. The Public Offering Process
 In the distribution phase, an underwriting syndicate and an
affiliated selling group distribute the securities to the public.
Together, the underwriting syndicate and the selling group
constitute the distribution syndicate.
Cont ….

23. Reasons for approaching investment
bankers
1. Assistance in issuing securities;
2. Cashing out by the owners of a privately held grown up firm;
3. Acquiring capital to effect a transition of ownership and
control –as in the case of the sale of junk bonds.
4. Altering the capital structure – the debt-equity ratio. Firms
leverage up when earning prospect is high and leverage down
when debt load is heavy compared to earning prospect.

24. Steps for Issuance Preparation
1. Conversion to Public Limited Company and Decision to Go
Public
2. Appointment of Issue Manager (Merchant Banker)
 Finalizing terms and agreement
 Signing of agreement

25. Steps for Issuance Preparation
3. Issue Managers Due Diligence
 Review valuation of the company to determine issue price
 Proposing offer price along with adequate justification
 Review VAT/TAX/CIB status of the company and its directors
 Review previous audited and current management account
 Company business appraisal, due diligence visit
 Preparing company’s and directors’ brief profile
 Analyzing financial ratio and other indicators
 Preparing pre-IPO placement documents (if any)
Cont ….

26. Steps for Issuance Preparation
4. Close of Accounts and Audit
 Finalize accounts
 Conduct audit by appointed auditor
5. Finalize terms of issue
 Offer price
 Size and structure of the issue
 Premium of the issue (if any)
 Confirmation of appointment of other participants
Cont ….

27. Steps for Issuance Preparation
6. Preparation of prospectus
 According to detailed guideline from SEC
7. Pre-IPO private placement
 Obtain consent from SEC
 Placing IM to prospective subscriber
 Signing share purchase agreement
 Collection of pre-IPO subscription
Cont ….

28. Steps for Issuance Preparation
8. Necessary Appointments
 Underwriters
 Bankers to the issue
 Rating agency
 Post-issue manager
 Central Depository Bangladesh Limited (CDBL)
Cont ….

29. Steps for Issuance Preparation
9. Obtain necessary approvals
 Company’s auditor
 Underwriting agreement and due diligence from the underwriter
 Investment advisor (if any)
 Due diligence certificate from the issue manager
 Consent from Banker to the issue
 Board of Directors
Cont ….

30. Steps for Issuance Preparation
10. Obtain SEC approval
 File all documents according to SEC checklist in compliance with
SEC Public Issue Rules 1998. Also file draft prospectus to the stock
exchange. Prospectus should be submitted to the RJSC within 24
hours from receiving consent from SEC.
Cont ….

31. Steps for Issuance Preparation
11. Application for enlistment
 Application should be submitted to DSE and CSE within 5 (five)
days from publication of prospectus.
12. Printing and Dispatch Issue Materials
 Printing og prospectus, application form, press release and other
materials
 Co-ordinate printers and advertising agency
 Dispatch to Banks, Brokers, Merchant Bank and other Financial
Institutions
Cont ….

32. Steps for Issuance Preparation
13. Publicly Campaign
 Complete prospectus must be published at least in 1 (one) national
daily
 Short version of prospectus to be published at least in 2 (two)
widely circulated dailies
 Information relating to publication of prospectus to be published
in 4 (four) national dailies.
Cont ….

33. Steps for Issuance Preparation
14. Open and Close of Subscription
 Subscription shall be start after 25 (twenty five) days from the date
of publication of prospectus
 Subscription shall remain open for 5 (five) consecutive banking
days.
Cont ….

34. Steps for Issuance Preparation
15. Data Processing
 Banker to the issue submits status report to the company
 Processing of the data on receipt of applications
 Verification of applications
 Statement prepared for applications rejected and accepted
Cont ….

35. Steps for Issuance Preparation
16 Reporting subscription status to SEC
 Company and issue manager jointly submit report to SEC.
Preliminary status of the subscription within 7 days of closure and
final status within 21 days of closure.
Cont ….

36. Steps for Issuance Preparation
17. Under subscription
 Issuer notifies the underwriters to take up their respective portions
within 10 days of subscription
 Underwriter have to take up unsubscribed portion within 15 days of
issuer’s notice
 Issuer notice to SEC about the take up of unsubscribed shares.
Cont ….

37. Steps for Issuance Preparation
18. Allotment
 In case of over subscription allotment shall be made by lottery.
 Shares will be issued in dematerialized form.
19. Issue Refund warrant
 The company shall refund application money for unsuccessful
applications.
20. Registration with CDBL
 Registration with CDBL complying with Central Depository Act
Cont ….

38. Underwriting
a. Firm
commitment
b. Best
Efforts
c. Standby
Underwriting

39. a. Firm commitment
 Underwriters guarantee that they will sell a specified minimum
quantity of issuance at the offer price. If they fail to sell the quantity,
they must take it themselves.
 An insurance against issue failure.
 The risk is transferred to the underwriter.
 The underwriting spread is generally higher.
 But the issuer may become biased to make underpricing.
 This may create a natural friction between issuer and underwritier.
 Most of the deals are on firm commitment basis.

40. b. Best Efforts
 Underwriters do not make any guarantee. They simply sell
securities.
 Unsold securities are returned to the issuer.

41. c. Standby Underwriting
Standby underwriting is employed when the issuer makes right offering
and uses the underwriter only as a backup for any securities not taken
through the right offering.

42. Tentative Cost Structure for IPO
(5.87% of issue size)
 Issue Management : 1.00%
 Underwriter : 1.00%
 Printing and Publication : 0.55%
 Bankers and Brokerage : 1.25%
 Post Issue : 1.65%
 Listing : 1.00%
 SEC and CDBL : 0.42%
Cost may vary with the issue size.

43. Private Placement
The sale of an entire issue of unregistered securities (usually
bonds) directly to one purchaser or a group of purchasers
(usually financial intermediaries).
 Eliminates the underwriting function of the investment
banker.
 The dominant private placement lender in this group is the
life-insurance category (pension funds and bank trust
departments are very active as well).
 Allows the firm to raise funds more quickly.
 Eliminates risks with respect to timing.
 Eliminates SEC regulation of the security.
 Terms can be tailored to meet the needs of the borrower.
 Flexibility in borrowing smaller amounts more frequently
rather than a single large amount.

44. Seasoned Public Offering
Seasoned public offering is a new offering of securities to the
public by a firm that has already issued securities. Three distinct
types of seasoned public offering:
 Primary seasoned offering - An offering of a new issue by a
firm that has already done an IPO. Its primary purpose is to
raise new capital for the firm.
 Secondary public offering (secondary placement) - A public
offering of securities that are purchased by the underwriters
directly from the pre-public owners and not from the firm.
Usually used by firm’s founders, other pre-public owners and
some post public holders of securities to cash out of the firm.

45. Seasoned Public Offering
 Combined offering - It is partly primary and partly
secondary. It is used to both raise new capital for the firm
and to cash out some of the pre-public owners. Often it is
difficult to persuade the investors that the stock is
attractively priced when insiders are selling out.
Cont ….

46. SECONDARY MARKET MAKING
 Secondary market is the market in where previously issued
securities trade among investors and between investors and
dealers.
 The broker/dealer activities of investment banks and other
securities firms give financial claims greater liquidity.
 Purchases and sales of existing stocks and bonds occur in the
secondary market.

47. SECONDARY MARKET MAKING
 Transactions in the secondary market do not provide additional funds
to the firm.
 The secondary market increases the liquidity of securities outstanding
and lowers the required returns of investors.
 Composed of organized exchanges the over-the-counter (OTC) market.
Cont ….

48. Dealing versus Brokering
A dealer is securities buy and sells in his/her own account with
objective of making a margin. The margin essentially comes
from the difference between his buying price (or bid price) and
his selling price (or ask price or offer price). The difference
between the bid and ask prices is called the bid-ask spread.

49. Unlike a dealer, a broker in securities is not a principal to the
transactions in which he is involved when he is acting in the
capacity of a broker. A dealer is the principal in the transaction
and as a result he does not earn commission for his own role.
But a broker is an agent of the customers and gets commission
on the transactions.
Cont ….
Dealing versus Brokering

50.  Brokering;
 Monitor margin accounts;
 Offer investment management services
(e.g., collect dividend and interest, cash management service);
 Assist in structuring portfolios; and
 Provide research and recommendations.
Brokerage Activity in the Financial
Markets

51. 1. Bucket Shops: Bucket shops are securities firms (usually small) that
take orders from customers, but do not execute them immediately.
Instead they wait to see whether the price moves away from the price
stipulated in the customer’s order.
For example, a customer places an order to buy at Taka 75 when the
stock was being traded at around Taka 75. Later the price declined to
Taka 73 and the broker bought at Taka 73. But the broker informed the
customer that the order was executed at Taka 75.
Possible Abuses by Brokers

52. 2. Boiler Rooms: Boiler room operations are firms that use high-
pressure sales tactics to sell securities, often to naïve investors.
The boiler room sales personnel get high percentage of
commission (even by 50% or more) by underwriting worthless
or bad issues.
Possible Abuses by Brokers
Cont ….

53. 3. Churning: It refers to excessive trading of a customer’s account to earn
commissions or bid-ask spreads.
This may occur when the client has granted discretionary trading
authority, but it may also happen if the client routinely takes advice
from the broker.
4. Suitability: The broker may trade unsuitable securities for its clients.
For example, option trading is unsuitable for an elderly person.
Possible Abuses by Brokers
Cont ….

54. 5. Front running (trading ahead of a customer): transactions
made by a securities firm for its own trading accounts in
anticipation of trades that are to be made by a client.
 For example, if a broker gets an order to buy a large number of a
share, it can anticipate that the order will drive the price up. In
anticipation, it buys shares in its own account. Then it fills the
order for the customer and as the price rises, the broker sells out
its own position at higher price.
 It is also possible to engage in inter market front running when
the stock is a component of an important market index (on
which futures are available).
Possible Abuses by Brokers
Cont ….

55. 6. Poor fills: A broker is entrusted by his customer to fill an order at best
possible price. This obligation passes from the account representative
to the floor broker. Sometimes, floor brokers, working in concert with
the floor trader, trade for customers at disadvantageous prices.
Possible Abuses by Brokers
Cont ….