Capital markets deal in both debt and equity. The governments both central and state raise money in the capital market, through the issue of government securities. Capital markets refer to all the institutes and mechanisms of raising medium and long-term funds, through various instruments available like shares, debentures, bonds etc. The private sector as well as the public sector raises thousands of crores of rupees in these markets. The government, through Reserve Bank of India, as well as financial institutions also raises a lot of money from these markets.
There are two important operations carried on in these markets:
» The raising the new capital
» Trading in securities already issued by the companies.
The important constituents of the capital market are: The stock exchanges, Banks, the investment trusts and companies, specialized financial institutions or development banks. Mutual funds, Post office saving banks, Non-banking financial institutions and International financial investors and institutions are the prime mode of savings. The supply in the capital market comes from saving from different sectors of the economy. These come from the following sources: Individuals, Corporate, Governments, Foreign countries, Banks, Provident funds and financial institutions. In an efficient financial capital market, investment returns will reflect economic fundamentals. In the case of a company’s stock, this means that the market value of the stock will accurately reflect the fundamental value of the company. Investors typically use one or two methods for screening financial instruments. The first is a fundamental economic analysis in which investors estimate the fundamental or intrinsic value of an instrument based on microeconomic and macroeconomic data, including but not limited to expected future returns and market growth. The second is a technical analysis in which an investor uses price history and expected trader sentiment to predict a future price. Attractive investments would include instruments in which trader sentiment is expected to rise, and therefore tend to push up the price of such instruments. This second form of investment can cause market prices to deviate from their fundamental economic values. Overvaluation is defined as the occurrence of the market price of an instrument being greater than its fundamental value. Undervaluation is defined as the occurrence of the market price of an instrument being less than its fundamental value. Concerns with overvaluation and undervaluation in financial markets are the focus of behavioural economics and finance [Barberis and Thaler, (2003)]. There are several ratios by which we can gauge the level of development in the stock market. The first popular ratio for the valuation of share is Price-earnings ratio. The price-to-earnings ratio is a stock’s share price divided by earnings per share for the company’s most recent four quarters. The method of calculation P/E is to divide the latest share price by last twelve-month earnings per share (EPS). It also acts as a measure of the market’s enthusiasm for a company. At the end of March 2013, the P/E ratio of S&P CNX Nifty and BSE Sensex were 17.6 and 16.9 percent respectively. However, on March 2012, it was 18.7 and 17.8 for S&P CNX Nifty and BSE Sensex correspondingly. The price to book value ratio is another important ratio to measure the net returns left for shareholders after paying all liabilities of a company. The P/B ratio for CNX nifty was at 3.0 percent going inline the BSE stood at 2.9 only. To select the best among the two indices i.e. BSE or NSE, we refereed to Market Capitalization to GDP ratio. The BSE’s Market Capitalization to GDP ratio was 63.7 percent in contrast the NSE’s Market Capitalization to GDP ratio was 62.2 percent. Therefore, we have selected top 20 BSE listed companies as per market capitalization on 31 March 2013.
Keyword: Overvaluation, Undervaluation, market capitalization, BSE Sensex
Prof. Raj Kumar Shraddha Mishra