7th Semester BBA Finance

University of Chittagong

Course Title: Financial Markets and

Institutions

Financial Market and Institutions - Jeff

Madura.
 Chapter - 5

Organization and Structure of

Market
Primary market and
underwriting of securities
Secondary Markets
 Meaning of Primary Market:

• A primary market is a source of new securities. Often

on an exchange, it's where companies, governments,
and other groups go to obtain financing through debt-
based or equity-based securities. Primary markets are
facilitated by underwriting groups consisting of
investment banks that set a beginning price range for a
given security and oversee its sale to investors.
• The primary market deals with the new securities which
were not previously available to the investing public i.e.
the securities that are offered to the investing public for
the first time. This market, therefore, makes available
new securities for public subscription.
 Meaning of Primary Market:

• The new issue market plays an important role in

economic growth by mobilizing the funds from the
savers and transferring them to borrowers for
production purposes. It is not only a platform for raising
finance to establish new enterprises but also for
expansion/ diversification/ modernization of existing
units.
• The primary market is a capital market where new debt-
based, equity-based, or other asset-based securities are
created and directly purchased by the investors from the
issuer.
 Parties involved in Primary Market:

• There are a few parties involved in the primary market

in the context of Bangladesh:
1. Regulators Bangladesh Security Exchange Commission
2. Market Makers DSE & CSE
3. Issuing Company Public Limited Company
4. Investors i. Institutional Investors,
ii. Individual Investors (Nationals/Non Residents of
Bangladesh

5. Management i. Issue Manager

ii. Underwriter,
iii. Register to the issue
iv. Banker to the issue

6. Facilitators i. Chartered Accountancy Firm,

ii. Valuation Agent,
iii. Register of Joint Stock Company
iv. Credit Rating Agency
v. Others
 Functions of Primary Market:

• Function:1. To facilitate raising funds by means of

raising shares and securities:
– 1. Equity:
• Common Stock
• Option (3 months)
• Warranty (9 months)
• Unit Certificate
-2. Preference Share
- 3.Corporate Bond
- 4. Corporate Debenture
- 5. Treasury Bills
- 6. Treasury Notes
• That means, the new issue market facilitates transfer of
 Functions of Primary Market:

• resources from savers such as individuals, and

commercial banks, insurance company etc. to the users
such as public limited companies and the government.
• Function:2. To channelize funds from surplus units to
deficit units.
• Function:3. To allocate risk through the allocation of
funds
• Function:4. To carry the decisions of both surplus units
and deficit units.
What are the sources for raising capital in the primary market?
Sources of Raising Capital in the Primary Market
Public Issue This is the most common way to issue
securities to the general public. Through an
IPO, the company is able to raise funds.
Company issues the prospectus and invites the
public to purchase its shares and debentures.
Offer for Sale New securities are offered to an intermediary
firm or stockbroker at a fixed price only to be
resold to the general public.
Private Company sells securities to the institutional
Placement brokers or investors instead of selling them to
the general public. The securities are then sold
to selected clients at a higher price.
What are the sources for raising capital in the primary market?
Sources of Raising Capital in the Primary Market
Rights Issue When a company wants to raise more capital
from existing shareholders, it may offer the
shareholders more shares at a price
discounted from the prevailing market price.
The number of shares offered is on a pro-rata
basis. This process is known as a Rights Issue.
E-IPOs The securities are issued through the digital
mode. The company issuing the securities first
enters into a contract with any of the stock
exchanges. For that, a SEBI-registered broker
has to be appointed, who then works as the
communication channel.
What are the sources for raising capital in the primary market?
Sources of Raising Capital in the Primary Market
Preferential When a listed company issues shares to a
Allotment few individuals at a price that may or may
not be related to the market price, it is
termed a preferential allotment. The
company decides the basis of allotment and
it is not dependent on any mechanism such
as pro-rata or anything else.
 Types of Primary market
• Primary markets are classified into four categories based
on the issues they come up with.
• 1. Public issue/Initial Public Offering (IPO)
• 2. Rights issue
• 3. Private placement
• 4. Preferential issue

• 1. Public issue/Initial Public Offering (IPO):

• The first type is the public issue, whereby the assets and
securities are put for sale to the public as soon as they
are created. It is this feature of this market that makes
the offering be called an Initial Public Offering (IPO).
 Types of Primary market
• 2. Rights issue: The next is the rights issue. This is
where companies that have already issued securities
earlier on the platform invite their existing shareholders
to buy the new shares they launch on a pro-rata basis. As
the process involves the retention of rights of the
existing shareholders with the same company, it is
referred to as a rights issue.
• 3. Private placement: The private placement market is
where firms introduce securities for sale to a small
group of investors. Here, the companies can maintain
private status. Usually, start-up ecosystem participants
opt for such issuance to approach ultra-high-net-worth
individuals (UHNWIs) to raise capital.
 Types of Primary market
• 4. Preferential issue : The preferential issue deals
with issuing stocks, bonds, notes, bills, and other
assets to a selected group of investors. Both listed
and unlisted firms can issue securities in this market,
which are neither public issues nor rights issues.
 Types of Selling Securities
Securities of a company can be sold by the following
two ways:
1. Public Offering: Public offering refers to the selling
of securities in the public market like organized
exchange or over-the counter markets.
Advantages:
• i. A firm can be able to collect greater amount of
funds through public market.
• ii. The attendant prestige of a public security may be
helpful in bank negotiations, executive recruitment,
and the marketing of products.
• iii. The investors can be able to receive a higher
degree of liquidity and to diversify his/her portfolio.
 Types of Selling Securities(Cont..)
• Disadvantages:
i. A company must made all information available to the
public through SEC.
ii. Time consuming.
iii. Expensive.
iv. Tremendous pressure for short time performance.
2. Private placement:
• Private placement refers to the selling of securities
directly to insurance companies, pension funds and
wealthy individuals rather than through the security
markets. Many firms do not use investment banker in
case of private placement.
 Types of Selling Securities(Cont..)
• This financing device may be employed by growing
firm that wishes to avoid public offering. It is also
employed by a publicly traded company that wishes to
incorporate private funds into its financing packages.
• Advantages:
i. Speed of transaction
ii. Flexibility / fewer formalities.
iii. Reduced flotation costs.
• Disadvantage:
• Higher rate of return required to compensate the
investors.
 Government Securities Market in Bangladesh
• Government Security Market of Bangladesh consists of
Treasury Bill, Bangladesh Government Treasury Bond
(BGTB) and Bangladesh Government Investment Sukuk
(BGIS). Banks, Non-bank Financial Institutions,
Insurance companies and Individuals can invest in
Government securities.
• Non-resident individuals/institutions can also purchase
Bangladesh Government Treasury Bond (BGTB) and
Bangladesh Government Investment Sukuk (BGIS) from
Primary and Secondary market through Primary Dealers
and other Banks in Bangladesh using funds deposited in
their non Resident Foreign Currency Account (NFCA) or
a Non Resident Investors Taka Account (NITA) with a
 Government Securities Market in Bangladesh
• bank in Bangladesh in name of purchaser. Coupon and
principal amount can be repatriated freely.
• Bangladesh Government Treasury Bill
Main features:
i. Short term government securities (Up to One year)
ii. Three tenors are available namely 91days, 182 days and
364 days.
iii.Interest rate is determined by auction.
iv.Tradable in the secondary market.
v. Bid can be submitted for TK. 1,00,000/- or any amount
of its multiple on auction.
 Government Securities Market in Bangladesh
• Bangladesh Government Treasury Bill
Eligibility: Resident individuals and institutions of
Bangladesh such as
• i. Banks, non-bank financial institutions.
• Ii. Insurance companies.
• Iii. Corporate bodies.
• Iv. Authorities responsible for the management of
provident funds, pension funds etc.
• V. Individuals.
• Method of Investment:
• Primary Market: From weekly (usually on Sunday)
auctions through Primary Dealers (Nominated Banks/ FI).
 Government Securities Market in Bangladesh
• Secondary Market: From any bank or financial
institution at anytime.
• Bangladesh Government Treasury Bonds (BGTB)
Main features:
i. Long term government securities (More than One year).
ii. Maturities are available for 2, 5, 10, 15 & 20 years.
iii.Coupon is paid half yearly and the principal is repaid on
maturity.
iv.Coupon Rate is determined by auction.
v. Tradable in the secondary market.
vi. Bid can be submitted for TK. 1,00,000/- or any amount
of its multiple on auction.
 Government Securities Market in Bangladesh
• vi. Tax Rebate Facilities are available for Individual
Investors for investing in Treasury Bond According to
Finance Act-2020, (Under Section 51 of Income Tax
Ordinance, 1984) .
• Eligibility: Resident individuals and Institutions of
Bangladesh such as-
i. Banks, non-bank financial institutions.
ii. Insurance companies.
iii.Corporate bodies.
iv. Provident funds, pension funds etc.
v. Individuals.
 Government Securities Market in Bangladesh
• Method of Investment:
i. Primary Market: From weekly (usually on Tuesday)
auctions through Primary Dealers.
ii. Secondary Market: From any bank or financial
institution at anytime.
• Non-resident individuals/institutions can also purchase
Bangladesh Government Treasury Bond (BGTB) from
Primary and Secondary market through Primary Dealers
and other Banks in Bangladesh using funds deposited in
their non Resident Foreign Currency Account (NFCA) or
a Non Resident Investors Taka Account (NITA) with a
bank in Bangladesh in name of purchaser. Coupon and
principal amount can be repatriated freely.
 Government Securities Market in Bangladesh
• Bangladesh Government Investment Sukuk
(BGIS)
• Main features :
• i. Shariah based government security.
• Ii. Tenor and mode of investment of Sukuk contact
determined on the basis of the project.
• Iii. Profit can earned after every six months and the
principal can be obtained after the end of tenor.
• Iv. Bid can be submitted for TK. 10,000/- or any
amount of its multiple on auction.
• Eligibility & Method of Investment: BGIS were
Government Securities Market in Bangladesh
• first issued 29th December, 2020 to utilize the
funds of shari’ah based banks, FI’s, Insurances and
individual investors. Investors can invest amounts
in multiples of Tk.10,000/00. Tenor of Sukuk may
vary based on the underlying investment contract.
Profit and principal amount can be repatriated
freely. It can be traded in the secondary market.
 Initial Public Offering
• An initial public offering (IPO) is the first public equity
issue made by a firm as it goes from private ownership to
public ownership. It is referred to as unseasoned new
issue because no previous publicly owned common stock
existed. Many firms engage in an IPO when they have
feasible business expansion plans, but are already near
debt capacity. Initial public offering can be of following
two types:
• a. General cash offer:
• General cash offer involves the sale of new securities to
all interested invertors and typically involves merchant
banker (Investment Banker). All public offerings of debt
are cash-offers, whereas equity is sold by a combination
of cash offering and rights offering.
 Initial Public Offering(Cont…)
• b. Privileged subscription or rights offering: Instead
of selling new securities to all interested investors at
large, a company sometimes gives its existing
shareholders the right of first refusal. Such issues are
known as privileged subscription or rights offering.
• A firm relies less heavily of merchant banker or
investment banker when issuing new securities through
rights offering. In case of rights offering it is necessary
for the management of a company to determine the
subscription price of the right issue very precisely. The
subscription priced of the right issue should be well
below the market price of common stock. Otherwise,
the stockholders are not interested in buying and as
such the issue will fail.
 Initial Public Offering(Cont…)
Advantages:
i. The Shareholders control position is protected.
ii. Lower flotation cost because there is usually
no underwriting fee.
Disadvantage:
It crates losses to forgetful stockholders.
 Initial Public Offering Process
• The Initial Public Offering IPO Process is where
a previously unlisted company sells new or
existing securities and offers them to the public
for the first time.
• Prior to an IPO, a company is considered to be
private – with a smaller number of shareholders,
limited to accredited investors (like angel
investors/venture capitalists and high net worth
individuals) and/or early investors (for instance,
the founder, family, and friends).
 Initial Public Offering Process
• How shares and securities are issued to the investors
in the primary market?/ or What is the role of parties
in the primary market?
• Issuing Company: Public Limited Company
• A firm that engages in an IPO ( ie. Issuing company)
must develop a prospectus that is filed with the SEC to
get a letter of approval and does a road show to promote
its offering.
• How to get it??
• Below are the steps a company must undertake to go
public via an IPO process:
• 1. Select a bank, 2. Due diligence and filings
• 3. Pricing , 4. Stabilization, 5.
Transition
Initial Public Offering Process
 Initial Public Offering Process
• Step 1: Select an investment bank
• The first step in the IPO process is for the issuing
company to choose an investment bank to advise the
company on its IPO and to provide underwriting
services. The investment bank is selected according to
the following criteria:
• Reputation
• The quality of research
• Industry expertise
 Initial Public Offering Process
• Distribution, i.e., if the investment bank can provide
the issued securities to more institutional investors or to
more individual investors.
• Prior relationship with the investment bank
• Step 2: Due diligence and regulatory filings
• SEC hires an underwriter to help with the prospectus
and road show and to place the shares with investors.
• Underwriting is the process through which an
investment bank (the underwriter) acts as a broker
between the issuing company and the investing public
to help the issuing company sell its initial set of shares.
 Initial Public Offering Process
• The following underwriting arrangements are available to the
issuing company:
• Firm Commitment: When the investment banking firm agrees
to buy the securities from the issuer at a set price , the
underwriting arrangement is referred to as firm commitment.
• Under such an agreement, the underwriter purchases the whole
offer and resells the shares to the investing public. The firm
commitment underwriting arrangement guarantees the issuing
company that a particular sum of money will be raised.
• Best Efforts Agreement: Under such an agreement, the
underwriter does not guarantee the amount that they will raise
for the issuing company. It only sells the securities on behalf of
the company.
• All or None Agreement: Unless all of the offered shares can
be sold, the offering is cancelled.
 Initial Public Offering Process
• Syndicate of Underwriters: Public offerings can be
managed by one underwriter (sole managed) or by
multiple managers. When there are multiple managers,
one investment bank is selected as the lead or book-
running manager. Under such an agreement, the lead
investment bank forms a syndicate of underwriters by
forming strategic alliances with other banks, each of
which then sells a part of the IPO. Such an agreement
arises when the lead investment bank wants to diversify
the risk of an IPO among multiple banks.
• An underwriter must draft the following documents:
• Engagement Letter: A letter of engagement typically
includes:
 Initial Public Offering Process
• 1. Reimbursement clause: This clause mandates
that the issuing company must cover all out-of-the-
pocket expenses incurred by the underwriter, even if the
IPO is withdrawn during the due diligence stage, the
registration stage, or the marketing stage.
• 2. Gross spread/underwriting discount: Gross
spread is arrived at by subtracting the price at which the
underwriter purchases the issue from the price at which
they sell the issue.
• Gross spread = Sale price of the issue sold by the
underwriter – Purchase price of the issue bought by the
underwriter
 Initial Public Offering Process
• Typically, the gross spread is fixed at 7% of the
proceeds. The gross spread is used to pay a fee to the
underwriter. If there is a syndicate of underwriters,
the lead underwriter is paid 20% of the gross spread.
60% of the remaining spread, called “selling
concession”, is split between the syndicate
underwriters in proportion to the number of issues
sold by the underwriter. The remaining 20% of the
gross spread is used for covering underwriting
expenses (for instance, roadshow expenses,
underwriting counsel, etc.).
• Letter of Intent: A letter of intent typically contains
the following information:
 Initial Public Offering Process
• 1. The underwriter’s commitment to enter an
underwriting agreement with the issuing company
• 2. A commitment by the issuing company to provide
the underwriter with all relevant information and, thus,
fully co-operate in all due diligence efforts.
• 3. An agreement by the issuing company to provide
the underwriter with a 15% over allotment option.
• The letter of intent does not mention the final offering
price.
• Underwriting Agreement: The letter of intent remains in
effect until the pricing of the securities, after which the
Underwriting Agreement is executed. Thereafter, the
underwriter is contractually bound to purchase the issue
from the company at a specific price.
 Initial Public Offering Process
• Registration Statement: The registration statement
consists of information regarding the IPO, the
financial statements of the company, the background
of the management, insider holdings, any legal
problems faced by the company, and the ticker
symbol to be used by the issuing company once listed
on the stock exchange. The SEC requires that the
issuing company and its underwriters file a
registration statement after the details of the issue
have been agreed upon. The registration statement has
two parts:
• The Prospectus: This is provided to every investor
who buys the issued security
 Initial Public Offering Process
• Private Filings: this is comprised of information
which is provided to the SEC for inspection but is not
necessarily made available to the public.
• The registration statement ensures that investors have
adequate and reliable information about the securities.
The SEC then carries out due diligence to ensure that
all the required details have been disclosed correctly.
• Step 3: Pricing
• After the IPO is approved by the SEC, the effective
date is decided. On the day before the effective date,
the issuing company and the underwriter decide the
offer price (i.e., the price at which the shares will be
sold by the issuing company) and the precise number
 Initial Public Offering Process
• of shares to be sold. Deciding the offer price is
important because it is the price at which the issuing
company raises capital for itself. The following
factors affect the offering price:
• The success/failure of the roadshows (as recorded in
the order books)
• The company’s goal
• Condition of the market economy
• IPOs are often underpriced to ensure that the issue is
fully subscribed/ oversubscribed by the public
investors, even if it results in the issuing company not
receiving the full value of its shares.
 Initial Public Offering Process
• Step 4: Stabilization
• After the issue has been brought to the market, the
underwriter has to provide analyst recommendations,
after-market stabilization, and create a market for the
stock issued.
• The underwriter carries out after-market stabilization
in the event of order imbalances by purchasing shares
at the offering price or below it.
• Stabilization activities can only be carried out for a
short period of time – however, during this period of
time, the underwriter has the freedom to trade and
influence the price of the issue as prohibitions against
price manipulation are suspended.
 Initial Public Offering Process
• Step 5: Transition to Market Competition
• The final stage of the IPO process, the transition to
market competition, starts 25 days after the initial
public offering, once the “quiet period” mandated by
the SEC ends.
• During this period, investors transition from relying
on the mandated disclosures and prospectus to relying
on the market forces for information regarding their
shares. After the 25-day period lapses, underwriters
can provide estimates regarding the earning and
valuation of the issuing company. Thus, the
underwriter assumes the roles of advisor and
evaluator once the issue has been made.
 The Investment Banker
• The Investment Banker is the link between the
corporation in need of funds and the investors.
As a middleman the investment banker is
responsible for designing and packaging a
security offering selling the securities to the
public. Therefore investment banker is the most
active participant in the primary market.
Investment banker is the specialist involved in
the issuance of new securities and other
corporate financial matters.
 Functions of Investment Bankers:
• 1. Advisory functions: Investment banker provides
advice during the planning stage as it is an expert in
selling securities. This advice typically covers the
following aspects of the issue:
i. Which securities to sell.
ii. The number of the new securities.
iii. The price of new securities.
v. The non-price feature, for example, on a bond issue,
the maturity, coupon interest rate, provision for sinking fund.
• 2. Underwriting function: Under this function, the
investment banker takes the responsibility to sell the
securities at any rate. In such case, the risk of the issuer is
transferred to the investment banker.
 Functions of Investment Bankers(Cont..):
• So, we can view underwriting function as an issuance
function. The securities of the renowned companies
are sold by the investment banker on underwriting
basis. In case of new company, the investment banker
critically evaluates investor’s response to that
company, market condition, and other relevant
Symptoms. The investment banker takes decision
after the evaluation is made. In case of a large issue
underwriting syndicate is formed by the investment
bankers to protect themselves. Underwriting syndicate
is a group of investment bankers that handles a large
and risky issue of securities. This spreads the risk of
failure over several investment bankers.
Functions of Investment Bankers (Cont…):
• 3. Agency function: Sometimes the investment banker
works as an agent of the issuer. In such case the
investment banker does not actually buy the new
securities but tries his best to sell them and as a result
the risk of failure will be in the hand of the issuer. The
securities of small and riskier firms are sold by the
investment banker on agency basis or best-effort basis.
Occasionally strong firms will issue securities through a
best-effort offering if they are very confident that the
new issue will be well received by the market.

• 4. Market maker: By engaging in the buying and

selling of securities the investment banker ensures a
liquid market.
Arrangements between Investment Banker
and Issuing Firms
• Arrangements between investment banker and issuing firms
are of following two types:
• a. Negotiated Offering: The negotiated offering is an
arrangement in which the firm selects an investment banker
or group of investment banker at the beginning of the
planning stage and negotiates and works with the banker to
decide on all details of the planned issue. In such an
arrangement the investment banker provides advice
regarding the issue.
• b. Competitive bids: The competitive bid is an
arrangement in which the firm does not select an
investment banker or group of investment banker at the
beginning of the planning stage.
 Arrangements between Investment Banker and
Issuing Firms(Cont…)
• The firm decides the kind of securities it will issue
and other associated details and then asks investment
banker to bid on the issue. The firm then takes the
best offer. In such an arrangement the firm does not
use investment banker as an advisor. The main
objective of the competitive bid arrangement is to
minimize cost. But this advantage is offset by the fact
that the firm loses the expert advice of the investment
banker. A public offering without the help of
investment banker may turn to be relatively
unattractive to investors which lead to lower net
proceeds from the issue.
 VARIATIONS IN THE UNDERWRITING PROCESS

Not all deals are underwritten using the

traditional syndicate process we have described.
Variations in the United States, the Euromarkets,
and foreign markets include the bought deal for
the underwriting of bond, the auction process
for both stocks and bonds, and a rights
offering for underwriting common stock.
 Bought Deal
The bought deal was introduced in the Eurobond
market in 1981 when Credit Suisse First Boston
purchased from General Motors Acceptance
Corporation a $100 million issue without lining
up an underwriting syndicate prior to the
purchase. Thus, Credit Suisse First Boston did not
use the traditional syndication process to diversify
the capital risk exposure associated with an
underwriting.
 Bought Deal (Cont…)
• The mechanics of a bought deal are as follows. The
lead manage or group of managers offers a potential
issuer of debt securities a firm bid to purchase a
specified amount of the securities with a certain
interest (coupon) rate and maturity. The issuer is
given a day or so (maybe even only a few hours) to
accept or reject the bid. If the bid is accepted, the
underwriting firm has bought the deal. It can, in turn,
sell the securities to other investment banking firms
for distribution to their clients and/or distribute the
securities to its clients. Typically, the underwriting
firm that buys the deal will have resold most of the
issue to its institutional clients.
 Auction process
• Another variation for underwriting securities is the
auction process. In this method, the issuer announces
the terms of the issue, and interested parties submit
bids for the entire issue. The auction form is
mandated for certain securities of regulate public
utilities and many municipal debt obligations. It is
more commonly referred to as a competitive bidding
underwriting. For example, suppose that a public
utility wishers to issue $100 million of bonds. Various
underwrites will form syndicates and bid on the issue.
The syndicate that bids the lowest yield (i.e., the
lowest cost to the issuer) wins the entire $100 million
bond issue and then reoffers it to the public.
 Auction process(Cont..)

In a variant of the process, the bidders indicate

the price they are willing to pay and the
amount they are willing to buy. The security is
then allocated to bidders from the highest bid
price (lowest yield in the case of a bond) to the
lower ones (higher yield in the case of a bond)
until the entire issue is allocated. For example,
suppose that an issuer is offering $500 million of a
bond issue, and nine (9) bidders submit the
following yield bids:
 Auction process(Cont..)
Bidder Amount (in millions) Bid
A $ 150 5.1%
B 110 5.2
C 90 5.2
D 100 5.3
E 75 5.4
F 25 5.4
G 80 5.5
H 70 5.6
I 85 5.7
 Auction process(Cont..)
• The first four bidders-A, B, C and D- will be allocated
the amount for which they bid because they submitted
the lowest-yield bids. In total, they will receive $450
millions of the $500 million to be issued. That leaves
$50 million to be allocated to the next-lowest bidders.
Both E and F submitted the next lowest yield bid, 5.4%.
In total, they bid for $100 million. Since the total they
bid for exceeds the remaining $50 million, they will
receive an amount proportionate to the amount for which
they bid. Specifically, E will be allocated three-quarters
($75 million divided by $ 100 million [(75/100)*50] of
the $50 million or $37.5 million, and F will be allocated
one-quarter ($25 million divided by$100 million) of the
$50 million or $12.5 million.
 Auction process(Cont..)
• The next question concerns the yield that all of the six
winning bidders- A, B, C, D, E, and F-will have to pay
for the amount to the issue allocated to them. One way
in which a competitive bidding can occur is all bidders
pay the highest winning yield bid (or equivalently, the
lowest winning price). In our example, all bidders
would buy the amount allocated to them at 5.4%. This
type of auction is referred to as a single price auction
or a Dutch auction. Another way is for each bidder to
pay whatever each one bid. This type of auction is
called a multiple-price auction. Historically both
procedures have been used in the auctioning of U.S.
Treasury securities as well as in Bangladesh Treasury
securities .
 Problem: 01
A corporation is issuing a bond on a competitive bidding basis.
The corporation has indicated that it will issue $200 million of an
issue. The following yield bids and the corresponding amounts
were submitted:-
Bidder Amount (in million) Bid
A $ 20 7.4%
B 40 7.5
C 10 7.5
D 50 7.5
E 40 7.6
F 20 7.6
G 10 7.7
H 10 7.7
I 20 7.8
J 25 7.9
K 28 7.9
L 20 8.0
M 18 8.1
Requirements:
a. Who are the winning bidders?
b. How much of the security will be allocated to
each winning bidder?
c. If this auction is a single-price auction, at what
yield will each winning bidder be awarded the
security?
d. If this auction is a multiple-price auction, at
what yield will each wining bidder be awarded
the security?
 Problem:02
• A corporation is issuing a common stock on a competitive
bidding basis. The corporation has indicated that it will issue
$250 million of an issue. The following stock price per share
and the corresponding amount were submitted:
Bidder Amount (in million ) Stock price per share

A $40 150
B 50 145
C 35 140
D 45 140
E 50 135
F 40 130
G 60 130
H 25 128
I 65 125
Requirements:
a) Who are the winning bidders? Who are the
“Shut out” bidders?
b) How much of the security will be allocated to
each winning bidder?
c) If this auction is a single-price auction, at what
price will each winning bidder be awarded the
security?
d) If this auction is a multiple-price auction, at
what price will each winning bidder be awarded
the security?
 Preemptive Rights Offering

• A corporation can issue new common stock directly to

existing shareholders via preemptive rights offering. A
preemptive right grants existing shareholders the right
to buy same proportion of the new shares issued at a
price below market value. The price at which the new
shares can be purchased is called the subscription price.
A rights offering ensures that current shareholders may
maintain their proportionate equity interest in the
corporation. In the United States, the practice of issuing
common stock via a preemptive rights offering is
uncommon. In other countries it is much more common;
in some countries, it is the only means by which a new
offering of common stock may be sold.
 Preemptive Rights Offering

• For the shares sold via a preemptive rights

offering, the underwriting services of an
investment banker are not needed. However, the
issuing corporation may use the services of an
investment banker for the distribution of
common stock that is not subscribed to. A
standby underwriting arrangement will be
used in such instances. This arrangement calls
for the underwriter to buy the unsubscribed
shears. The issuing corporation pays a standby
fee to the investment banking firm.
 Preemptive Rights Offering(Cont..)
To demonstrate how offering works, the effect on the
economics wealth of shareholders, and how the terms set
forth in a rights offering affects whether or not the issuer
will need an underwriter, we will use an illustration.
Suppose that the market price of the stock of XYZ
Corporation is $20 per share and that there are 30,000
shares outstanding. Thus, the capitalization to this firm is
$600,000. Suppose that the management of XYZ
corporation is considering a right offering in connection
with the issuance of 10,000 new shares. Each current
shareholder would receive one right for every three shares
owned. The terms of the rights offering are as follows: for
three rights and $17 (the subscription price) a new share
can be acquired. The subscription price must always be
 Preemptive Rights Offering(Cont..)
• less than the market price or the rights will not be
exercised. In our illustration, the subscription price is 15%
($3/20) below the market price.

• In addition to the number of rights and the subscription

price, there are two other elements of a rights offering
that are important. First is the choice to transfer the
rights. This is done by selling the right in the open market.
This is critical since, as we will see, the right has a value
and that value can be captured by selling the right. The
second element is the time when the right expires (that is,
when it can no longer be used to acquire the stock).
Typically, the time period before a right expires is short.
 Preemptive Rights Offering(Cont..)
• The value of a right can be found by calculating the
difference between the price of a share before the rights
offering and the price of a share after the rights offering.
• That is,
• Value of a right = Price before rights offering- Price
after rights offering
• Or, equivalently,
• Value of a right = Share price rights on- Share price
ex rights

• Alternatively, the value of a right can be found as follows.

• (Price after rights offering – Subscription price) /
Number of rights required to buy a share
 Preemptive Rights Offering(Cont..)
• Table 1 (in the next slide) shows the impact of the rights
offering on the price of a share. The price after the rights
offering will be $19.25. Therefore, the value of a right is $0.75
($20 - $19.25).
• The difference between the price before the rights offering and
after the rights offering expressed as a percentage of the
original price is called the dilution effect of the rights issue. In
the present case, the dilution effect is $0.75/$20, or 3.75%.
The large the dilution, is the larger the ratio of old and new
shares is, and the larger the discount is.
• Alternatively, the dilution effect = Discount % / 1 + (Ratio of
old to new shares)
• In our illustration the discount is 15% and the ratio of old to
new share is 30,000/10,000 or 3, so the dilution effect is
15%/4, or 3.75%
 Preemptive Rights Offering(Cont..)
• Table 1: Analysis of Rights Offering on the Market Price of XYZ
Corporation
i. Before rights issue
1. Capitalization $600,000
2. Number of shares 30,000
3. Shares price (rights on) $20.00
ii. After issuance of shares via rights offering
4. Number of shares 40,000 (= 30, 00+ 10,000)
5. Capitalization $770,000 (= $600, 000 + 10,000  $17)
6. Shares price ( ex rights) $19.25 (= $770,00/40,000)
7. Value of one right $0.75 (= $20.00 - $19.25)
iii. Net gain or loss to initial stockholder
8. Loss per share due to dilution $0.75 (= 3.75%  $20)
9. Gain per share from selling or exercising
a right $0.75
10. Net gain or loss. $0
 Preemptive Rights Offering(Cont..)
• The last section of Table 1 shows the net gain or loss
to the initial shareholder as a result of the rights
offering. The loss per share due to dilution is $0.75,
but that is exactly equal to the value of a right which,
if the shareholder desires, can be sold in the market.
This result is important because it shows that the
rights offering as such will not affect the sum of the
value of the share without rights (referred to as ex
rights) plus the value of the rights the shareholder
receives, no matter how much the dilution or the
initial discount offered is. This is because a large
dilution is exactly compensated by the increase in the
value of the rights.
 Problem:
The market price of the stock of the Bernstein Corporation is $50
per share and there are one million shares outstanding. Suppose
that the management of this corporation is considering a rights
offering in connection with the issuance of 500,000 new shares.
Each current shareholder would receive one right for every two
shares owned. The terms of the right offering are as follows: For
two rights and $30(The subscription price), a new share can be
acquired.
Requirements:
A. What would be the share price be after the rights offering?
B. What is the value of one right?
C. Demons the effect on the economic well being of the initial
shareholders as a result of the right offering.
D. Calculate the percentage of discount.
E. Calculate the percentage of dilution effect.
Secondary Market
 Secondary Market

Secondary Market and Its Classification:

• Secondary market is a place where primarily
issuing securities are sold directly from one
investor to another. It means that, secondary
market is the market for existing securities that
are currently traded between investors. It is also
the market that creates the prices and allows for
liquidity. If Secondary market does not exist,
investors would have no place to sell their
securities and without liquidity many people
would not invest at all.
 Secondary Market
• The secondary market, also called aftermarket, is the
financial market in which previously issued
financial instruments such as stock, bonds, options, and
futures are bought and sold.
• Another frequent usage of "secondary market" is to refer
to loans which are sold by a mortgage bank to investors
such as Fannie Mae and Freddie Mac.
• The term "secondary market" is also used to refer to the
market for any used goods or assets, or an alternative use
for an existing product or asset where the customer base
is the second market (for example, corn has been
traditionally used primarily for food production and
feedstock, but a "second" or "third" market has developed
for use in ethanol production).
Structure/classification of Secondary Market
It can be classified in the following two ways
from the view point of Regulatory perspective:
• a) Organized Exchanges: Organized
exchanges have a central trading location where
securities are bought and sold through the
auction process by brokers act as agents for the
buyer and seller. Securities usually trade at
various trading posts on the floor of the
exchange. Dhaka stock exchange and
Chittagong Stock exchange are the two
organized exchanges in our country.
Classification of Secondary Market(Cont..)
• b) Over-the-counter (OTC) market: The term Over-
the-counter was originally used to describe the manner
in which securities are traded many years ago when
investors literally bought stock and bonds ‘Over the
counter’ at their lock bank. Today the term Over-the-
counter continues to be used as a designation for the
unlisted securities trading market, even though the
OTC market is one of the most modern and active
securities market in the world. The Over-the-counter
market is not physically located in any one place.
Rather, it consists of a number of broker and dealers
throughout the country who are linked together
through an electronic communication network.
Classification of Secondary Market(Cont..)
• It is really difficult to collect exact data on OTC
trading since it is not a centralized market. In Over-
the-counter market the buyers and sellers of securities
not always obey the rules and regulations.
• Differences between Organized Secondary Market
(OSM) & OTC Market:
Features OSM OTC
Form of Standardized Not Standardized
Transaction (Transaction is regulated (No specific law)
by specific law)
Size of Limited by law It is not limited
contract
Classification of Secondary Market(Cont..)
Features OSM OTC
Parties involved Brokers Original buyers &
sellers
Margin Yes No
Credit Risk Yes No
Diversification
Commission Yes No
Payment (Costs of
trading)
Classification of Secondary Market(Cont…)
• Secondary market can also be classified into
four heads.
a. 1st market: First market refers to the organized
exchange where buyers and sellers of a security
meet together to settle trading with the existence of
brokers acting as agent for the buyers and sellers.
Only the listed securities are traded in a 1st market.
b. 2nd market: Second market refers to the Over-
the-counter market where unlisted securities are
traded between buyers and sellers. In a second
market, the involvement of brokers is not
essentially necessary.
Classification of Secondary Market(Cont…)
c. 3rd market: The third market refers to the trading of
listed securities in Over-the-counter market. Dealers
in the market are not members of an exchange and,
therefore never charged the fixed minimum
commissions once set by the exchange. The third
market grew as institutional investors used it in the
early 1960s to avoid fixed minimum commissions.
d. 4th market: It is not always necessary for two
parties to a transaction to use the services of a broker
or dealer to execute a trade. The direct trading of
securities between two transistors without the use of a
broker is called the fourth market.
 Market structures
• From the view point of Trading concept:
• a) Continuous Market (DSE & CSE) : Many
secondary markets are continuous, Which means that
prices are determined continuously throughout the
trading day as buyers and sellers submit orders. For
example, given the order flow at 10:00 A.M., the
market clearing price of a stock on some organized
stock exchange may be $70; at 11:00 A.M. of the same
trading day, the market clearing price of the same
stock, but with different order flows, may be $70.75.
Thus in a continuous market, prices may vary with the
pattern of orders reaching the market and not because
of any change in the basic situation of supply and
demand.
 Market structures(Cont…)
• b) Call market: A contrasting market structure is the
call market, in which orders are batched or grouped
together for simultaneous execution at the same price.
That is, at certain times in trading day (or possibly more
than once in a day), a market maker holds an auction for
a stock. The auction may be oral or written. In either
case, the auction will determine or fix the market
clearing price at a particular time of the trading day.
• Currently some markets are mixed, using elements of the
continuous and call frameworks. For example, the New
York Stock Exchange begins trading (at 9:30 A.M.) with
a call auction. With opening price set in that manner,
trading proceeds in a continuous way until closing.
 Market structures
• From the view point of Economic concept:
• a) Perfect market: A market in which buyers and sellers
have complete information about a particular product and
it is easy to compare prices of products because they are
the same as each other etc.
• A perfect market results when the number of buyers and
sellers is sufficiently large, and all participants are small
enough relative to the market so that no individual market
agent can influence the commodity’s price. Consequently,
all buyers and sellers are price takers and market price is
determined where there is equality of supply and demand.
This condition is more likely to satisfied if the commodity
traded is fairly homogeneous (for example, corn or rice).
 Market structures (Contd.)
• But a market is not perfect only because market
agents are price takers. A perfect market is also
free of transaction costs and any impediments to
the interaction of supply and demand for the
commodity. Economists refer to these various
costs and impediments as frictions. The costs
associated with frictions generally result in
buyers paying more than in the absence of
frictions and/ or in sellers receiving less.
 Market structures (Cont…)
In the case of financial markets, frictions would include:
 Commission charged by brokers
 Bid-ask spread charged by dealers
 Order handling and clearance charges
 Taxes (notably on capital gains) and government imposed
transfer fees
 Cost of acquiring information about the financial asset
 Trading restrictions, such as exchange imposed
restrictions on the size of a position in the financial asset
that a buyer or seller may take.
 restrictions on market makers
 Halts to trading that may be imposed by regulators where
the financial asset is traded.
 Market structures (Contd…)
• b) Imperfect Market: A market in which suppliers or
consumers have an impact on supply or demand. Four
types is available:
• i. Monopoly
• Ii. Duopoly
• Iii. Oligopoly
• Iv. Monopolistic
Particulars Perfect Monop Duopoly Oligopol Monop
Market oly y olistic
Market Suppliers Many 1 2 7-8 Large
Particip
ants Buyers Many low low large Larger

Products Many 1 1 Many Many

 Market structures (Contd…)
Particulars Perfect Monop Duopoly Oligopol Monopo
Market oly y listic
Barriers Entry Yes in
No Yes Yes some No
Exit extent

Competition Yes (Most) No No Yes Yes

Price is fixed Demand/ Supplier Supplier Syndicate D/S to a

by (Through) Supply large
extent

Investment Nominal/
Opportunity Normal Abnorm Abnorm Higher Higher
al al
Profit
Opportunity
 Market structures (Cont…)
• From the view point of Financial Perspective:
 A) Efficient Market: Market where all pertinent
information is available to all participants at the same
time, and where prices respond immediately to new
information.
 Features of Efficient Markets are :
1. Adequacy: There are large number of buyers, sellers
and products,
2. Sensitivity: Price is sensitive to the information
(Private and public)
3. Competition: Price is fixed by an interaction of
demand and supply.
4. Equilibrium : Investors can compare return with the
 Market structures (Cont…)
• perceive risk.
5. Economy: Transaction is friction less (Free Flow of
information)
6. Perfect market: The market is perfect.
• b) Inefficient Market: A market where parties do not
always reflect available information as accurately as
possible.
 Basic Functions of Secondary Market

• 1. Providing Liquidity: One of the primary functions

of this market is to provide liquidity to investors. By
offering a marketplace for buying and selling
securities, it allows investors to easily convert their
investments into cash whenever needed. This
liquidity enables investors to manage their
investment portfolios more efficiently and reduces
the risk of holding assets that cannot be easily
liquidated.
• 2. Market Efficiency: Secondary markets contribute
to the overall efficiency of financial markets. By
enabling the transfer of securities from less to more
efficient investors, these markets promote the
 Basic Functions of Secondary Market

• allocation of capital. Efficient secondary markets also

ensure that the prices of securities accurately reflect
all available information, minimizing the potential for
arbitrage opportunities.
• 3. Trading Securities : Trading various types of
securities can be a profitable strategy to improve your
financial health; however, these transactions can be
risky if not done properly.
• Secondary market depositories, such as the Dhaka
Stock Exchange (DSE) and Chittagong Stock Exchange
(CSE), monitor all listings and trades as per the
guidelines of the SEC.
 Basic Functions of Secondary Market

• 4. Price Discovery: The secondary market is essential

for determining the market price of securities. Through
the interaction of buyers and sellers, the perceived
value of a security is established based on its supply and
demand. This price discovery mechanism helps
investors make informed decisions about their
investments and reflects the overall health of the
financial market.
• 5. Economic Boost: Businesses and individuals invest
capital in secondary markets in the hopes of turning a
profit. Investing and reinvesting the returns results in a
repetitive cycle. This boosts the economic growth of a
nation and also ensures proper utilisation of the capital
of a nation.
 Basic Functions of Secondary Market

• 6. Credit Quality: The value of investment portfolios

in the secondary market helps the Government and
lenders understand the creditworthiness of the
nation’s population.
• 7. Easy Access to Securities : Primary and secondary
capital markets provide retail investors access to
various types of securities that are associated with
high liquidity.
• Most retail investors fail to tap into the primary
market for various reasons. Hence, the secondary
market gives retail investors the chance to invest in
liquid securities with minimum capital.
 Secondary market of Government securities in
Bangladesh
• Bangladesh Bank initiated to automate the process of
trading and settlement of Government securities
transactions in October 2011. The secondary market of
Government securities of Bangladesh is comprised of
Over the Counter (OTC) and Trader Work Station
(TWS). Both the procedure are the integral parts of
Market Infrastructure Module (MI Module)-the
automated auction and trading platform of government
securities.
• Over-the-Counter (OTC):
• In OTC market participants are required to submit
sale/buy order in the OTC platform while counter party
conform the order. Once they complete the trading
 Secondary market of Government securities in
Bangladesh
• process and the system accepts trades, the data
automatically flows to Core Banking System (CBS) for
clearing and settlement of funds for completion of the
settlement of funds in CBS. Further, the trading
securities have been transferred automatically to the
buyer securities account in MI.
• Trader Work Station (TWS):
• Bangladesh Bank has introduced the Trader Work
Station (TWS)- an Order Matching system. The TWS is
an electronic, screen based, order driven trading system
for dealing in Government securities. In addition, the
platform highlights the existing facility of
 Secondary market of Government securities in
Bangladesh
• Over-The-Counter (OTC) market in Government
securities. Further, the TWS brings transparency in
secondary market transactions in Government securities.
Members can place bids (buy orders) and offers (sell
orders) directly on the TWS screen. The system is order
driven that matches all bids and offers focusing
price/time. In particular, among the similar price orders,
it matches the order on first come and first serve basis.
The TWS facilitates Straight-Through-Processing (STP)
system. In that system, trades that are automatically sent
to the CBS for settlement.
Secondary market of Government securities in Bangladesh
Secondary market of Government securities in Bangladesh
Market participants/Parties to the Secondary Market:
• A. Market-makers : Market makers are financial
institutions that continuously offer to buy and sell
securities at specified prices, thereby ensuring
liquidity in the market. By standing ready to trade,
market makers narrow the bid-ask spread and help
maintain an orderly and efficient market.
• Functions of market makers are as follows:
 Regulate trading
 Provides avenue for trading (System)
 Aid – Settlement of transaction
 Aid – Clearing Transaction
 Aid -Transferring Share
Market participants/Parties to the Secondary Market:
 Aid -Transferring Risk
 Aid -Transferring Funds
 Provides information
 Provides output of research and development
 Provide support to BSEC
 Facilitates issuing share and securities
 Provide training for educated investors
• B. Stock Exchanges: Chittagong Stock Exchange
(CSE) and Dhaka Stock Exchange (DSE) or types
of organized marketplaces where securities are
traded. They provide a transparent and regulated
platform for investors to trade securities and ensure
Market participants/Parties to the Secondary Market:
• that transactions are executed according to
established rules.
• Functions of Issuing Company:
 Supply / Issues share and securities,
 Ensure liquidity
• C. Brokerage Firms: Brokerage firms act as
intermediaries between buyers and sellers in the
secondary market. They facilitate transactions by
executing trades on behalf of their clients and may
also provide additional services, such as investment
advice or research. Brokerage firms earn revenue
through commissions on the trades they execute.
Market participants/Parties to the Secondary Market:
• Trade intermediaries (Brokers) functions are:
 Trading on behalf of a client
 Bring buyers and sellers in the market,
 Provides information to the buyers and sellers,
 Advice investors ( Prohibited in Bangladesh)
 Receives and executes order,
 Settle transactions
 Keep all the investors in the right track,
 Generate more investor class,
 Aids in issuing share and securities,
 Make the market crowded with investors, issuing
company and securities
Market participants/Parties to the Secondary Market:
• D. Institutional and Retail Investors: Institutional
investors, such as mutual funds, insurance
companies, pension funds, as well as retail
investors, actively participate in the secondary
market. Their trading activities influence the supply
and demand dynamics of the market and contribute
to price discovery.
• Functions of Investors:
 Provides funds to the Market,
 Exchange Securities,
 Buy and sells enables fixing price on demand and
supply
Market participants/Parties to the Secondary Market:

• E. Custodian’s function:
 Keep all shares and securities under its custodian
 Transfer shares from seller account to buyer
account through book keeping methods.
 Dealers:
• Dealers : Dealers are people or firms who buy and
sell securities for their own account, whether
through a broker or otherwise. A dealer acts as a
principal in trading for its own account, as opposed
to a broker who acts as an agent who executes
orders on behalf of its clients.
• Dealers are important figures in the market. They
make markets in securities, underwrite securities,
and provide investment services to investors. That
means dealers are the market makers who provide
the bid and ask quotes you see when you look up
the price of a security in the over-the-counter
market. They also help create liquidity in the
markets and boost long-term growth.
 Dealers:
• Characteristics of dealers:
• Dealers buy and sell securities for their own account.
• Dealers are important figures in the market because they
are market makers, create liquidity, and help promote
long-term growth in the market.
• Dealers must be registered with the Securities and
Exchange Commission (SEC) and must comply with all
state requirements before they can begin working.
• Dealers are different from traders and brokers—the
former buys and sells for one's own account, while the
latter does not trade for its portfolio.
• Dealers are regulated by the SEC.
 Dealers:
Role /functions of Dealer in the real market
• Dealers performs three functions in the markets:
• 1. They provide the opportunity for investors to trade
immediately rather than waiting for arriving of sufficient
orders on the other side of the trade (immediacy), and they
do this while maintaining short run price stability
(continuity).
• 2. They offer price information to market participants.
• 3. In certain market securities, dealers serve as auctioneers
in bringing orders and fairness to a market. Dealers buy
for their own account and maintain inventories of assets,
and their profits come from selling assets at higher prices
than the prices at which they purchased them.
 Brokers:
• A broker is an individual or firm that acts as an
intermediary between an investor and a securities
exchange. Because securities exchanges only accept
orders from individuals or firms who are members of that
exchange, individual traders and investors need the
services of exchange members.
• Brokers provide that service and are compensated in
various ways, either through commissions, fees, or
through being paid by the exchange itself. Investopedia
regularly reviews all of the top brokers and maintains a
list of the best online brokers and trading platforms to
help investors make the decision of what broker is best
for them.
 Role/functions/services of broker in real markets
• Buying and Selling of Securities
• One of the primary functions of a stock broker is to buy
and sell securities on behalf of the clients based on the
order placed by them through the broker’s terminal.
• Advisory Services
• Stock brokers are well-versed with the working of the
stock market and possess expertise related to the
performance of stocks, market trends and so on.
Furthermore, they have access to valuable databases and
research findings. This helps them offer outstanding
investment advice to their clients.
 Role/functions/services of broker in real markets
• Limited Banking Services
• Stock brokers also provide limited banking services
such as interest-bearing accounts, electronic deposits
and withdrawals, etc.
• Other Investments
• Apart from securities, stock brokers also offer
different investment products such as mutual funds,
exchange-traded funds, bonds, commodity trading,
futures, options, etc.
 Market efficiency
• Efficient capital market can be described in two
distinct contexts:
i) Operationally (or internally) efficient market;
ii) Pricing (or externally) efficient capital market.
Operational efficiency:
• In an operationally efficient market, investors can
obtain transaction services as cheaply as possible,
given the costs associated with furnishing those
services.
• In other word, a market is operationally efficient if it
offers investors reasonably priced services related to
buying and selling.
 Market efficiency
Pricing efficiency:
• Pricing efficiency refers to a market where prices
at all times fully reflect all available information
that is relevant to the valuation of securities. That
is, investors quickly adjust the demand and
supply schedules for a security when new
information about it becomes available, and those
actions quickly impound the information into
prices of the security. In such a market, active
strategies pursued will not consistently produce
superior returns after adjusting for risk and
transaction costs.
Thank you