Structure of Capital Market – Securities Laws and Capital Markets Important Questions

Question 1.
Distinguish between: Money Market & Securities Market [June 2006 (2 Marks), Dec 2006 (2 Marks)]
Answer:
Following are the main points of distinction between money market & securities market:

Points	Money Market	Securities Market
Meaning	The money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs. It is the market for dealing in monetary assets of short-term nature. Funds are available in this market for periods ranging from a single day up to a year.	A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The main instruments used in the securities market are stocks, shares, debentures, bonds, securities of the government.
Maturity period	It deals in the lending and borrowing of short-term finance (i.e., for 1 year or less)	It deals in the lending and borrowing of medium and long-term finance.
Credit instruments	The main credit instruments of the money market are call money, collateral loans, acceptances, bills of exchange.	The main instruments used in the securities market are stocks, shares, debentures, bonds, securities of the government.
Major constituents	The banking industry, Mutual funds, Foreign institutional investors, large corporations, and the RBI are the major constituents of the Indian money market.	Major constituents are Stock Exchanges, Domestic Institutional Investors (DII), Foreign Institutional Investors (FII), and small investors.
Risk	The degree of risk is small in the money market.	The risk is much greater in the securities market.
Basic role	The basic role is that of liquidity adjustment.	The basic role is that of putting capital to work, preferably to long-term, secure and productive employment.
Market Regulation	The money market is closely regulated by RBI.	The securities market is closely regulated by SEBI.

Question 2.
Discuss briefly the regulatory framework governing the securities in India. [June 2009 (4 Marks)]
Answer:
Following are the important statutes, which governs the Indian securities markets:

Securities Exchange Board of India Act, 1992
Securities Contracts (Regulation) Act, 1956
Depositories Act, 1996
Companies Act, 2013
Foreign Exchange Management Act, 1999 (FEMA)

Agencies involved in the relation of securities market are:

Ministry of Finance
Ministry of Corporate Affairs (MCA)
Department of Economic Affairs (DEA)
The Reserve Bank of India (RBI)
The Securities & Exchange Board of India (SEBI)
Stock Exchanges

Question 3.
“Primary market is of great significance to the economy.” Comment. [June 2010 (4 Marks)]
Answer:
The primary market is that part of the capital market that deals with the issuance of new securities. Companies, governments, or public sector institutions can obtain funding through the sale of new shares or bond issues. The primary market is the market where the securities are sold for the first time. 1 Therefore, it is also called the New Issue Market.

Features of Primary Markets:

This is the market for new long-term equity capital.
In a primary issue, the securities are issued by the company directly to investors.
The company receives the money and issues new security certificates to the investors.
Primary issues are used by companies for the purpose of setting up a new business or for expanding or modernizing the existing business.
The primary market performs the crucial function of facilitating capital formation in the economy.

The primary market is of great significance to the economy of a country. It is through the primary market that funds flow for productive purposes from | investors to entrepreneurs. The latter use the funds for creating new products and rendering services to customers in India & abroad. The Strength of the economy of a country is gauged by the activities of the stock exchanges. The primary market creates and offers the merchandise for the secondary market.

Question 4.
“A well functioning securities market is conducive to the sustained economic growth of a country.” Comment and discuss briefly the regulatory framework of the securities market in India. [Dec 2010 (7 Marks)]
Answer:
Following are the important statutes, which governs the Indian securities markets:

Securities Exchange Board of India Act, 1992
Securities Contracts (Regulation) Act, 1956
Depositories Act, 1996
Companies Act, 2013
Foreign Exchange Management Act, 1999 (FEMA)

Agencies involved in the relation to the securities market are:

Ministry of Finance
Ministry of Corporate Affairs (MCA)
Department of Economic Affairs (DEA)
The Reserve Bank of India (RBI)
The Securities & Exchange Board of India (SEBI)
Stock Exchanges

Question 5.
The securities market has two interdependent and inseparable segments. Comment. [June 2012 (5 Marks)]
Answer:
The Indian financial system has two major components:
1. Money Market: The money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs. It is the market for dealing in monetary assets of short-term nature. Funds are available in this market for periods ranging from a single day up to a year.

Instruments used in the money market are generally had:

Low default risk,
Maturities below 1 year.
High marketability.

2. Capital Market: Capital Market is a market for financial investments that are direct or indirect claims to capital. It is wider than the securities market and embraces all forms of lending and borrowing. It is a market, where business enterprises and governments can raise long-term funds. Securities Market: Securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The main instruments used in the securities market are stocks, shares, debentures, bonds, securities of the government.

The securities market has the following two interdependent and inseparable segments:
(a) Primary Market: Primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments, or public sector institutions can obtain funding through the sale of new shares or bond issues. The primary market is the market where the securities are sold for the first time. Therefore it is also called the New Issue Market (NIM).

Issue of securities by companies can take place in any of the following methods:

Initial public offer
Further issue of capital
Rights issue
Firm allotment
Offer to public
Bonus issue

(b) Secondary Market: The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold.

The stock market or secondary market ensures free marketability, negotiability, and price discharge. The secondary market has further two components:

Spot Market: Where securities are traded for immediate delivery and payment.
Futures Market: Where the securities are traded for future delivery and payment.

Question 6.
The capital market and the stock exchange in particular are referred to as the barometer of the economy. Comment. [June 2016 (4 Marks)]
Answer:
The Capital Market is a market for financial investments that are direct or indirect claims to capital. It is wider than the securities market and embraces all forms of lending and borrowing, whether or not evidenced by the creation of a negotiable financial instrument. The capital market comprises the complex of institutions and mechanisms through which intermediate-term funds and long-term funds are pooled and made available to businesses, governments, and individuals. The capital market also encompasses the process by which securities already outstanding are transferred.

The capital market and in particular the stock exchange is referred to as the barometer of the economy. The government’s policy is so molded that the creation of wealth through products and services is facilitated and surpluses and profits are channelized into productive uses through capital market operations. Reasonable opportunities and protection are afforded by the Government through special measures in the capital market to get new investments from the public and the Institutions and to ensure their liquidity.

Question 7.
“Financial instruments that are used for raising capital resources are affected by the preference factors for choosing and it is different for issuers and for the investor.” Explain briefly and also classify the instruments. [Dec 2017 (5 Marks)]
Answer:
The instruments used by the corporate sector to raise funds are selected on the basis of:

Investor preference for a given instrument and
The regulatory framework, where under the company has to issue the security.

Investor preferences vary with their attitude towards risk, and their investment goals and investment horizon.
The tax liability of the investor affects the choice of investment media.

The firm, on the other hand, is affected by the debt-equity ratio permissible, SEBI Regulations on the issue of capital, and the formalities to be complied with while raising an issue.

The tax liability of the company, the purpose for which funds are required, debt servicing ability, and willingness to broad base the shareholding of the company, all influence the choice of the instrument.

The corporate sector and financial/investment institutions have been issuing new instruments to attract investors. However, the range of instruments used is still very narrow.

A convertible debenture is the most popular instrument in the current scenario to raise funds from the markets.

The attraction for the instrument for both the corporate sector and the investor lies in:
(a) The investor gets a reasonable return during the initial years, followed by equity participation on conversion, and
(b) The issue involves a lower post-tax cost of capital, thereby entailing a lesser strain on liquidity.

Question 8.
“A well functioning securities market is conducive to sustained economic growth.” Explain. [June 2016 (5 Marks)]
Answer:
A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The securities market has two segments viz. primary market & secondary market.

Various functions performed by securities markets are as follows:
1. Continuous & ready market for securities: Securities market provides a ready and continuous market for the purchase and sale of securities. It provides a ready outlet for buying and selling securities.

2. Evaluation of securities: Securities market is useful for the evaluation of securities. This enables investors to know the true worth of their holdings at any time. Comparison of companies in the same industry is possible through a securities market price list.

3. Encourages capital formation: Securities market accelerates the process of capital formation. It creates the habit of saving, investing, and risk-taking among the investing class and converts their savings into a profitable investment. It acts as an instrument of capital formation.

4. Safety in dealings: Securities market provides safety in dealings as transactions are conducted as per well-defined Rules and Regulations. The managing body of the exchange keeps control of the members. Fraudulent practices are also checked effectively.

5. Regulates company management: Listed companies have to comply with rules and regulations of the concerned securities market and work under the vigilance of various authorities.

6. Public borrowing: Securities market serves as a platform for marketing Government securities. It enables the government to raise public debt easily and quickly.

7. Clearinghouse facility: Securities market provides a clearinghouse facility to members. It settles the transactions among the members quickly and with ease. The members have to pay or receive only the net dues because of the clearinghouse facility.

8. Healthy speculation: Normal speculation is not dangerous but provides more business to the exchange. However, excessive speculation is undesirable as it is dangerous to investors & the growth of the corporate sector.

9. Economic barometer: Securities market indicates the state of health of companies and the national economy. It acts as a barometer of economic conditions.

10. Bank lending: Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities.

Question 9.
Explain: Functions of Securities Market [June 2017(3 Marks)]
Answer:
A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The securities market has two segments viz. primary market & secondary market.

5. Regulates company management: Listed companies have to comply with rules and regulations of the concerned securities market and work under the vigilance of various authorities.

6. Public borrowing: Securities market serves as a platform for marketing Government securities. It enables the government to raise public debt easily and quickly.

9. Economic barometer: Securities market indicates the state of health of companies and the national economy. It acts as a barometer of economic conditions.

10. Bank lending: Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities.

Question 10.
Private equity funds are just like hedge funds. Comment. [Dec 2010 (3 Marks)]
Answer:
A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Private equity funds concentrate their investments in unregistered (and typically illiquid) securities. Like hedge funds, private equity funds also rely on the exemption from registration of the offer and sale of their securities.

The investors in private equity funds and hedge funds typically include high net worth individuals and families, pension funds, endowments, banks, and insurance companies. Private equity funds, however, differ from hedge funds in terms of the manner in which contribution to the investment pool is made by the investors.

Private equity investors typically commit to invest a certain amount of money with the fund over the life of the fund and make their contributions in response to “capital calls” from the fund’s general partner. Private equity funds are long-term investments, provide for liquidation at the end of the term specified in the fund’s governing documents and offer little if any, opportunities for investors to redeem their investments. A private equity fund may distribute cash to its investors when it sells its portfolio investment, or it may distribute the securities of a portfolio company.

Question 11.
Write a short note on Venture capital fund [June 2011 (2 Marks)]
Answer:
Venture capital fund means an Alternative Investment Fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities, or a new business model and shall include an angel fund.

Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.

A firm engaged in providing venture capital and related service is referred to as a venture capitalist. Venture Capital firms are generally private partnerships, or closely-held private companies, funded by private pension funds. Venture Capital is also referred to as Risk Capital.

Question 12.
Write a short note on Private Equity Funds [Dec 2012 (3 Marks)]
Answer:
A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Private equity funds concentrate their investments in unregistered (and typically illiquid) securities. Like hedge funds, private equity funds also rely on the exemption from registration of the offer and sale of their securities. The investors in private equity funds and hedge funds typically include high net worth individuals and families, pension funds, endowments, banks, and insurance companies. Private equity funds, however, differ from hedge funds in terms of the manner in which contribution to the investment pool is made by the investors.

Question 13.
Write a short note on Alternative Investment Fund [June 2013 (4 Marks)]
Answer:
Alternative Investment Fund means any fund established in the form of a trust or a company or an LLP or a body corporate.

It is a privately pooled investment vehicle that collects funds from investors for investing it in accordance with a defined investment policy for the benefit of its investors.

The following shall not be considered as AIF:

Mutual funds
Collective Investment Schemes
Family trusts set up for the benefit of ‘relatives.
ESOP Trusts.
Employee welfare trusts or gratuity trusts.
Holding companies
Other special purpose vehicles including securitization trusts
Funds managed by a securitization company or reconstruction company which is registered with the RBI u/s 3 of the Securitisation & Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and
Any funds which are directly regulated by another regulator in India.

Question 14.
Write a short note on Social Venture Fund [Dec. 2013 (3 Marks)]
Answer:
A social venture fund means an Alternative Investment Fund that invests; primarily in securities or units of social ventures and which satisfies social I performance norms laid

Question 15.
Discuss briefly the various categories of alternative investment funds. [Dec. 2013 (5 Marks)]
Answer:
Registration of Alternative Investment Funds [Regulation 3]: No entity or person shall act as an Alternative Investment Fund unless it has obtained a certificate of registration from the SEBI.

Alternative Investment Funds shall seek registration in one of the categories mentioned below:
(a) Category-I AIF: It invests in start-up or early-stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME funds, social venture funds, infrastructure funds, and such other AIF as may be specified.

(b) Category-II AIF: It does not fall in Category-I and III and does not undertake leverage or borrowing other than to meet day-to-day operational requirements.

(c) Category-Ill AIF: It employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

An application for grant of the certificate shall be made in Form A as specified in the First Schedule and shall be accompanied by a non-refundable application fee as specified in Part A of the Second Schedule to be paid in the manner specified in Part B thereof.

Question 16.
A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Explain the concept of a private equity fund and distinguish it from a hedge fund. [June 2015 (5 Marks)]
Answer:
A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The securities market has two segments viz. primary market & secondary market.

5. Regulates company management: Listed companies have to comply with rules and regulations of the concerned securities market and work under the vigilance of various authorities.

6. Public borrowing: Securities market serves as a platform for marketing Government securities. It enables the government to raise public debt easily and quickly.

9. Economic barometer: Securities market indicates the state of health of companies and the national economy. It acts as a barometer of economic conditions.

10. Bank lending: Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities.

Question 17.
What do you understand by Alternative Investment Funds? How they differ from mutual funds? [Dec. 2015 (3 Marks)]
Answer:
Alternative Investment Funds are very similar in structure compared to Mutual Funds. However, the AIF regulations ensure that AIF remains within reach of only the sophisticated and knowledgeable investors, while Mutual Funds are targeted at mainly retail investors.

Thus, AIF has the freedom to structure the fees, can undertake leverage, and have no capital requirements as they can only be brought by knowledgeable j investors. Following are the key areas of differences between AIF and AIF:

Points	Alternative Investment Fund	Mutual Fund
Meaning	Alternative Investment Fund means any fund which is established by a privately pooled investment vehicle that collects funds from investors for investing it in accordance with a defined investment policy for the benefit of its investors.	A mutual fund is a trust that pools the resources of like-minded investors for investment in the capital market. By investing in the units of mutual funds, the investor becomes a part-owner of the assets of the mutual funds.
Legal Structure	An AIF can be a Trust/Company/ LLP/Body Corporate which is established in India	A mutual fund is set up as a trust, which has a sponsor, trustees, AMC, and custodian.
Registration	An AIF can seek registration under any three categories specified in the SEBI (Alternative Investment Funds) Regulations, 2012.	The three-way structure of Trustees, Sponsor, AMC, has to be registered as per the SEBI (Mutual Funds) Regulations, 1996.
Fund type	Category I & II AIFs should be Closed-Ended; Category III AIF can be both Closed-Ended and Open-Ended.	A Mutual Fund can be both Closed-Ended and Open-Ended funds.
Minimum Tenure	No scheme of an AIF can have a tenure shorter than 3 years	No minimum tenure for mutual funds.
Number of Investors	An AIF cannot have more than 1000 investors in any scheme.	There is no such ceiling in the case of mutual funds.
Minimum Investment	Required from Inves-tor Minimum investment size for an AIF is ₹ 1 Crore. However, if investors are employees/directors of the AIF or employees/directors of the Manager, then the minimum investment value is reduced to ₹ 25 lakh.	No minimum investment amount specified for mutual funds.

Question 18.
A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Explain the concept of a private equity fund and distinguish it from a hedge fund. [June 2015 (5 Marks)]
Answer:
A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures, etc. The securities market has two segments viz. primary market & secondary market.

5. Regulates company management: Listed companies have to comply with rules and regulations of the concerned securities market and work under the vigilance of various authorities.

6. Public borrowing: Securities market serves as a platform for marketing Government securities. It enables the government to raise public debt easily and quickly.

9. Economic barometer: Securities market indicates the state of health of companies and the national economy. It acts as a barometer of economic conditions.

10. Bank lending: Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities.

Question 19.
SEBI has classified Alternative Investment Fund (AIF) into broad categories i.e. Category-I, Category-II & Category-III. Discuss the key feature of AIF Categories. [June 2018 (5 Marks)]
Answer:
Registration of Alternative Investment Funds [Regulation 3]: No entity or person shall act as an Alternative Investment Fund unless it has obtained a certificate of registration from the SEBI.

(b) Category-II AIF: It does not fall in Category-I and III and does not undertake leverage or borrowing other than to meet day-to-day operational requirements.

(c) Category-Ill AIF: It employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

Question 20.
Write short note on Private Equity [Dec. 2018 (3 Marks)]
Answer:
Private equity is a type of equity (finance) and one of the asset classes that take securities and debt in operating companies that are not publicly traded on a stock exchange. Private equity is essentially a way to invest in some j assets that are not publicly traded or to invest in a publicly traded asset with the intention of taking it private.

Unlike stocks, mutual funds, and bonds, private equity funds usually invest in more illiquid assets. By purchasing companies, the firms gain access to those assets and revenue sources of the company, which can lead to very high returns on investments.

Another feature of private equity transactions is their extensive use of debt | in the form of high-yield bonds. By using debt to finance acquisitions, private | equity firms can substantially increase their financial returns.

Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies. Capital for S private equity is raised from retail and institutional investors and can be used to fund new technologies, expand working capital within an owned company, 1 make acquisitions, or strengthen a balance sheet. The major of private equity j consists of institutional investors and accredited investors who can commit large sums of money for long periods of time.

Private equity investments often demand long holding periods to allow for a turnaround of a distressed company or a liquidity event such as IPO or sale to a public company. Generally, private equity fundraises money from investors like Angel investors, Institutions with diversified investment portfolios like – pension funds, insurance companies, banks, funds of funds, etc.

Types of Private Equity: Private equity investments can be divided into the j following categories:
(a) Leveraged Buyout (LBO): This refers to a strategy of making equity investments as part of a transaction in which a company, business unit, or business assets is acquired from the current shareholders typically with the use of financial leverage. The companies involved in these types of transactions are typically more mature and generate operating cash flows.

(b) Venture Capital: Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.

(c) Growth Capital: This refers to equity investments, mostly minority investments, in the companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business.

Question 21.
Write short note on Venture Capital [Dec. 2018 (3 Marks)]
Answer:
Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.

Venture Capitalists:

Finance new and rapidly growing companies.
Purchases equity shares
Assist in the development of new products or services
Add value to the enterprise through active participation in management.

Venture Capitalists invest in:

First-generation businesses promoted by first-generation entrepreneurs.
Untried products and untested products and technology.
High-risk projects that have high risk but if successful have enormous rewards.

Question 22.
Write short note on Pension Fund [Dec. 2018 (3 Marks)]
Answer:
Pension Fund means a fund established by an employer to facilitate and organize the investment of employees’ retirement funds which is contributed by the employer and employees. The pension fund is a common asset pool meant to generate stable growth over the long term and provide pensions for employees when they reach the end of their working years and commence retirement.

Pension funds are commonly run by some sort of financial intermediary for the company and its employees like the NPS scheme is managed by UTIAMC (Retirement Solutions), although some larger corporations operate their pension funds in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors in many nations.

Pension funds play a huge role in the development of the economy and they play an active role in the Indian equity market. This pension fund ensures a change in their investment attitudes and in the regulatory climate, encouraging them to increase their investment level inequities and would have a massive impact on the capital market and on the economy as a whole.

Pensions broadly divided into two sectors:

Formal sector Pensions
Informal sector Pensions

Question 23.
Write short note on High Net Worth Individuals [June 2019 (3 Marks)]
Answer:
High Net-worth Individuals (HNIs) is a class of individuals who are distinguished from other retail segments based on their net wealth, assets, and investible surplus. While there is no standard put forth for the classification, the definition of HNIs varies with the geographical area as well as financial markets and institutions.

Though there is no specific definition, generally in the Indian context, individuals with over ₹ 2 Crore investible surplus may be considered to be HNIs while those with investible wealth in the range of ₹ 25 lakh to ₹ 2 Crore may be deemed as emerging HNIs.

If you are applying for IPO of equity shares in an Indian company, generally, if you apply for amounts in excess of ₹ 2 lakh, you fall under the HNI category. On the other hand, if you apply for amounts under ₹ 2 lakh, you are considered a retail investor. There may be so many ways in which HNIs are categorized J and defined; there is no single bracket that could put them under.

Question 24.
“An Alternative Investment Fund which has been granted registration under a particular category cannot change its category subsequent to registration, except with the approval of the SEBI”. Enumerate the conditions for approval of SEBI. [June 2019 (5 Marks)]
Answer:
As per Regulation 7(2) of the SEBI (Alternative Investment Funds) Regulations, 2012, “An Alternative Investment Fund which has been granted registration under a particular category cannot change its category subsequent to registration, except with the approval of the SEBI”

In this regard, the SEBI has issued circular CIR /IMD/DF/12/2013dated August 7,2013 which provides the following conditions for change in category subsequent to registration.
1. Only AIFs who have not made any investments under the category in which they were registered earlier shall be allowed to make applications for change in the category.

2. Any AIF proposing to change its category shall make an application to SEBI for the same along with application fees of ₹ 1 lakh. The application shall include the updated Form A, other updated supporting documents if any, and rationale for the proposed change. Registration fees shall not apply for such applications.

3. If the AIF has received commitments/raised funds prior to application for change in category, the AIF shall be required to send letters/emails to all its investors providing them the option to withdraw their commitments/ funds raised without any penalties/charges. Any fees collected from investors seeking to withdraw commitments/funds shall be returned to them. Partial withdrawal may be allowed subject to compliance with the minimum investment amount required under the AIF Regulations.

4. The AIF shall not make any investments other than in liquid funds/bank deposits until approval for change in category is granted by SEBI.

5. On approval of the request from SEBI, the AIF shall send a copy of the revised placement memorandum and other relevant information to all its investors.

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