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Financial markets and instruments

INTRODUCTION OF FINANCIAL SYSTEM

The economic development of any country depends on the existence of a

well organized financial system. It is the financial system which supplies

the necessary financial inputs for the production of goods and services

which in turn promote the well being and standard of living of the people

of a country. Thus, the financial system is a broader term which brings

under its fold the financial markets and the financial institution which

support the system. The ma!or assets traded in the financial system are

money and monetary assets. The responsibility of the financial system is

to mobilize the savings in the form of money and monetary asset invest

them to productive ventures. "n efficient functioning of the financial

system facilitates the free flow of funds to more productive activities and

thus promotes investment. Thus, the financial system provides the

intermediation between savers and investors and promotes faster

economic development.

Financial system

Financial Financial Financial FinancialInstitution Markets Instruments Services

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STRUCTURE OF FINANCIAL SYSTEM

The financial system implies a set of complex and closely connected

institution, agents, practices and markets. The financial system of any

country consist of

'( %pecialized and non&specialized financial institution.

)( *rganized and unorganized financial markets.

+( Financial instruments and services which facilitate transfer of

funds.

rocedures and practices adopted in the markets, and financial

interrelationship are also part of the system. These parts are not always

mutually exclusive. The financial system is concerned about money,

credit and finance. The terms intimately related yet somewhat different

from each other. -oney refers to the current medium of exchange or

means of payment. redit is a sum of money to be returned normally with

interest. Finance is a monetary resource comprising debt and ownership

funds of the state, company or person.

Financial institutions

Financial institutions are the business organization that acts as a

mobilizes and depositories of savings, and as purveyors of credit or

finance. They also provide various financial services to the community.

They differ from the non&financial business organization in respect of

their wares. The distinction between the financial sector and the /real

sector0 should not be taken to mean that there is something ephemeral or

unproductive about finance. "t the same time, it means that the role of the

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financial sector should not be overstressed. The activities of different

financial institution may be either specialized or they may overlap. 1et,

we need to classify the financial institution and this is done on such basis

as their primary activity or the degree of their specialization with relation

to savers or borrowers with whom they customarily deal or the manner of

their creation. In other words, the functional, geographic, sectoral scope

of activity or the type of ownership are some of the criteria which are

often used to classify a large number and variety of financial institution

which exist in the economy. 2owever, it should be kept in mind that such

classification is likely to be imperfect and tentative.

Financial services

" financial service is any kind of service of a financial nature offered by a

financial provider. "ll banking and insurance related services are included

in this concept. These services are intangible and invisible. There should

be proximity between the service provider and the consumer in order to

complete a service transaction. These services cover a wide range of

economic activities. Financial services have developed to meet the needs

of companies. 3anking and insurance are traditional financial services.

The modern financial services include over the counter services. %hare

transfer, pledging of shares, mutual funds, factoring, discounting, venture

capital and credit cards. Financial services have started long back in

western countries.

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FINANCIAL MARETS

Financial markets are the centers or arrangements that provide facilities

for buying and selling of financial claims and services. The corporations,

financial institution, individuals, and governments trade in financial

products on these markets either directly or through brokers and dealers

on organized exchanges or off&exchanges. The participants on the demand

and supply sides of these markets are financial institution, agents,

brokers, dealers, borrowers, lenders, savers, and others who are

interlinked by the laws, contracts, and communication networks.

Financial markets are in the forefront in the developing

economies. $fficient financial markets are an essential for speedy

economic development. The vibrant financial market enhances the

efficiency of capital formation. 4r. 5han has opined that6 a variegated

financial market can appeal to the security, motivation and other such

aspects of savers and attracts more savings by the creation of an array of

attractive attractive financial asset. It also tends to promote the

development financial structure. The role of financial market in the

financial system is 7uite uni7ue. The relevance of financial market in the

financial system is not merely 7uantitative but also supportive. Thus,

financial market bridges one set of financial intermediaries with another

set of players. " well developed financial market enlarges the range of

financial services.

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FUNCTION OF FINANCIAL MARETS

'( Financial markets aim to establish regular cost effective links

between buyers and sellers, savers and investors and so on.

)( Financial markets ensure efficient allocation of financial resources

for socially desirable and economically productive purposes.

+( Financial market influences both the 7uality and pace of economic

development.

8( It provides platform to the central bank of country for intervention

there by affecting the li7uidity in the economy.

9( -arket provides a mechanism for li7uidity mismatch e7ualization.

:( Financial markets provide an arrangement for raising short term

and long term resources at market driven prices.

;( It provides a mechanism for cash management.

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arbitrage. 2ence, such markets are imperfect market and do not

provide for efficient use of capital.

CLASSIFICATION OF FINANCIAL MARETS

The financial system in India can be broadly classified into two

main categories and they are organized markets and unorganized market.

'( Or'ani(e# markets= & In the organized market, there are standardized

rules and regulations governing their financial dealings. There is also a

high degree of institutionalization and instrumentalisation. These markets

are sub!ect to strict supervision and control by the >3I or other regulatory

bodies.

These organized markets can be further classified into two. They are=

'( Ca$ital market )securities market*

)( Money market

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CA!ITAL MARET+,

The capital market is a market for financial assets which have a long or

indefinite maturity. ?enerally, it deals with long term securities which

have maturity period of more than a year

Im$ortance o- ca$ital market+

"bsence of capital market acts as a deterrent factor to capital formation

and economic growth. >esources would remain idle if finances are not

funneled through the capital market. The importance of capital market

can be briefly summarized as follows=

The capital market serves as an important source for the productive

use of the economys saving. It mobilizes the saving of the people

for further investment and thus avoids their wastage inunproductive uses.

It provides incentives to saving and facilitates capital formation by

offering suitable rate of interest as the price of the capital.

It provides an avenue for investors, particularly the household

sector to invest in financial asset which are more productive than

physical assets. It facilitates increase in production and productivity in the

economy and thus, enhances the economic welfare of the society.

Thus, it facilitates /the movement stream of command over capital

to the point of highest yield0 towards those who can apply them

productively and profitably to enhance the national income in the

aggregate.

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The operation of different institution in the capital market induces

economic growth. They give 7uantitative and 7ualitative direction

to the flow of funds and bring about rational allocation of scarce

resources.

" healthy capital market consisting of expert intermediaries

promotes stability in values of securities representing capital funds.

-oreover, it serves as an important source for technological up

gradation in the industrial sector by utilizing the funds invested by

the public.

Thus, a capital market serves as an important link between those who

save and those who aspire to invest their saving.

The capital market may be further being divided into three namely=

./ 0overnment securities market

1/ Lon' term loan market

2/ In#ustrial securities market

A* 0O3ERNMENT SECURITIES MARET=&

" market where the government securities are bought and sold is

called government securities market. The securities are bonds, treasury

bills, and special rupee securities in payment of India subscriptions to

I-F, I3>4, "43, I4" etc. the special rupee securities are treated as a

part of internal floating debt of the government. These securities are

issued by the central government, state government, and semi&

government authorities, which include local government authorities likeity orporation and municipalities, port trusts, state electricity board,

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ublic %ector orporation and other agencies like I43I, IFI, %$s,

%I4s, @"3">4 and housing boards. These agencies are suppliers of

government securities and banks, financial institutions and investors

demand these securities in the market.

?overnment securities offer a safe avenue of investment through

guaranteed payment of interest and repayment of principal by the

government. They offer relatively a lower fixed rate of interest compared

to investment on other securities. These securities are issued in the

denomination of >s 'AA or >s 'AAA. They have a fixed maturity period.

Interest is paid half yearly. >3I services loans as these are the liabilities

of the government of India and the state governments. These securities

are safe and risk free. These securities are also eligible as %B>

investment. "s the date of maturity is specified in the securities they are

also called as dated government securities.

>3I plays a special role in the purchase and sale of securities as

part of its monetary management exercise. There is no underwriting or

guaranteeing re7uired in the sale of government securities. 4ealing in the

securities takes place through the mechanism provided by the >3I. The

brokers and dealers are approved by the >3I. " striking feature of these

securities is that they offer wide ranging tax incentive to the investors.Therefore, these securities are more popular. Cnder the income tax act,

rebates are allowed for the investment in these securities. $ach purchase

and sale has to be negotiated separately, the gilt&edged market is the over

the over the counter market. This market has two segment namely

primary market and secondary market. In the primary market, the issuers

are central and the state government. The secondary market comprises

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banks, financial institution, insurance companies, provident funds, trusts,

primary dealers and the >3I.

The securities of central and the state government are issued in

the form of stock certificate, promissory notes and bearer bonds. These

securities are traded at 3ombay %tock $xchange. In terms of size, the

primary market for government securities is much bigger than the

industrial securities market. " notification for the issue of securities is

made a few days before the ublic subscription is open. The opening of

the subscription depends on the response of the market and varies

between two to three days. The issue is made in number of branches in a

year. The offices of >3I and %3I receive the application for securities.

The ?overnment, reserves the right to retain over subscription up to a

pre&specified percentage which is generally 'A percent, of the notified

amount. The mechanism of trading in ?overnment %ecurities takes place

through the direct sale, securities general ledger accounts and bank

receipts method. The government may issue securities through the

following modes=

Issue o- securities t%rou'% auction

Issue o- securities &it% $re,announce# cou$on rates

Issue o- securities t%rou'% ta$ sale

Issue o- securities t%rou'% conversion

The securities can be issued through auction either on price basis or

yield basis. The coupons on such securities are announced before the date

of floatation and the securities are issued at par. @o aggregate amount is

indicated in the notification in the respect of the securities sold on tap.

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The holders of treasury bills of certain specified maturities and holder of

specified dated securities are provided an option to convert the respective

treasury bills or dated securities at specified prices into new securities

offered for sale.

3( Lon',term loans market+,

4evelopment banks and commercial banks play a significant role in

this market by supplying long term loans to corporate customers. Bong&

term loans market may further be classified into=&

./ Term loans market

1/ Mort'a'es market

2/ Financial 'uarantees market

'( TERM LOAN MARET+,

In India, many industrial financing institutions have been created by the

government both at the national and regional levels to supply long&term

and medium term loans to corporate customers directly as well as

indirectly. These development banks dominate the industrial finance in

India. Institutions like I43I, IFI, III, and other state financial

corporation come under this category. These institutions meet thegrowing and varied long&term financial re7uirements of industries by

supplying long&term loans.

)( MORT0A0ES MARET=&

The mortgages market refers to those centers which supply mortgage

loans mainly to individual customers. " mortgage loan is a loan against

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the security of immovable property like real estate. The transfer of

interest in a specific immovable property to secure a loan is called a

mortgage. This mortgage may be e7uitable mortgage or illegal one. "gain

it may be a first charge or second charge. $7uitable mortgage is created

by a mere deposit of title deeds to properties as securities where as in the

case of a legal mortgage the title in the property is legally transferred to

the lender by the borrower. Begal mortgage is less risky.

%imilarly, in the first charge, the mortgager transfers his interest in the

specific property to the mortgagee as security. Ehen the property in

7uestion is already mortgaged once to another creditor, it becomes a

second charge when it is subse7uently mortgaged to somebody else. The

mortgagee can also further transfer his interest in the mortgaged property

to another. In such a case, it is called a sub&mortgage.

2* FINANCIAL 0UARANTEES MARET+,

" ?uarantee market is a center where finance is provided against the

guarantee of reputed person in the financial circle. ?uarantee is a contract

to discharge the liability of a third party in case of his default. ?uarantee

acts as a security from the creditors point of view. In case the borrower

fails to repay the loan, the liability falls on the shoulders of the guarantor.2ence the guarantor must be known to both the borrower and the lender

and he must have the means to discharge his liability.

Though there are many types of guarantees, the common forms are=

'( erformance ?uarantee, and

)( Financial ?uarantee.

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erformance guarantees cover the payment of earnest money, retention

money, advance payments, non&completion of contracts etc. *n the other

hand financial guarantees cover only financial contracts.

In India, the market for financial guarantees is well organized. The

financial guarantees in India relate to=

'( 4eferred payments for imports and exports.

)( -edium and long&term loans rose abroad.

+( Boans advanced by banks and other financial institutions.

These guarantees are provided mainly by commercial banks,

development banks, ?overnments both central and states and other

specialized guarantee institutions like $? $xport redit ?uarantee

orporation( and 4I? 4eposit Insurance and credit guarantee

orporation(. This guarantee financial service is available to both

individual and corporate customers. For smooth functioning of any

financial system, this guarantee service is absolutely essential.

* INDUSTRIAL SECURITIES MARET+,

Industrial securities market being the ma!or segment of the Indian

financial system has witnessed the most profound transformation inrecent years. From being a marginal institution in the mid&eighties, the

securities market has emerged as the most important mechanism for

allocating resources in the economy. The emerging significance of the

securities market is elo7uently borne out by the rapid expansion in the

7uantum of fund raised and the number of investors in the primary

market, as also number of increase in the stock exchanges and listed

stocks, speedy rise in the market capitalization and the volume of trade,

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entry of sophisticated investors like the foreign institutional investors and

mutual funds. The structure of both the segment of the market that is the

primary and the secondary market has witnessed significant changes in

the recent years.

Industrial market securities offer an ideal market for corporate securities

such as shares, debentures and bonds. Industrial securities market is much

smaller in India than that in other industrialized countries. This is because

of the industrial structure, investment habit and the level of education of

investors in India. The volume of industrial securities in relation to

government securities, their role in financing the private sector and their

significance as a saving medium indicate that the industrial securities

market in India can be regarded as the barometer of economic activity.

Industrial securities market comprises of the following segments=&

.* !rimary market

1* Secon#ary market

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!RIMARY MARET

rimary market is a market for raising fresh capital in the form of shares

and debentures. ublic limited companies that are desirous of raising

capital funds through the issue of securities, approach this market. The

public limited companies and the government companies are the issuers

and individuals, institutions and mutual funds are the investors in this

market. The primary market allows for the formation of capital in the

country and the accelerated industrial and economic development.

$verywhere in the world capital markets have originated as the new issue

markets. *nce industrial companies are set up in a big number and with

them a considerable volume of business comes into existence a market

for outstanding issues develops. In order to sell securities, the company

has to fulfill various re7uirements and decide upon the appropriate timing

and method of issue. It is 7uite normal to obtain the assistance of

underwriters, merchant banks or special agencies to look after these

aspects. This primary market is also called as the new issue market.

2ence, the primary market is that part of the capital markets that deals

with the issuance of new securities. ompanies, governments or public

sector institutions can obtain funding through the sale of a new stock orbond issue. This is typically done through a syndicate of securities

dealers. The process of selling new issues to investors is called

underwriting. In the case of a new stock issue, this sale is called an initial

public offering I*(. 4ealers earn a commission that is built into the

price of the security offering, though it can be found in the prospectus

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NE4 ISSUE MARET+,

The following table throws light on the new issue activity in India during

the year 'D9' to )AA)&A+.

Fresh capital issues by non&government public limited companies

Figures in crores(

eriod $7uity

shares

4ebentures reference

shares

Total "nnual

average

'D9'&

'D:A

)A) 88 +D )s )< crore during the 'D9As to

>s ':++9 crore during the 'DDAs which declined to >s 8)D8 crore during

'DD;&D< to )AA)&A+. 3oth e7uity capital and debenture capital have

contributed to this growth and decline. The stock market capital has

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financed three to 8) percent of the total capital formation in the private

corporate sector in different years during 'D9; to 'DD8&D9. it may be

noted that the capital market in India has financed hardly three to five

percent of private corporate sectors capital formation during 'DD;&D< to

)AA)&A+.

The years 'DD+&D8 and 'DD8&D9 have been the most active ones in the

history of new issue market so far6 the public and private sectors raised

more than >s +A,AAA crore of fresh capital on each of these years. The

mobilization of funds by the public sector on new issue market has taken

place primarily in the form of bonds. The bond issues by public sector

units and public sector banks and financial institution have been the

ma!or part of total funds raised by the public sector.

FUNCTION OF NE4 ISSUE MARET=&

The ma!or function of a new issue market is to facilitate transfer of

resources from savers to the users. The savers are individuals,

commercial banks, insurance companies etc. The users are public limited

companies and the government. The new issue market plays an important

role of mobilizing the funds from the savers and transfers them to

borrowers for production purposes, an important re7uisite of economicgrowth. It is not only a platform for raising finance to establish new

enterprises but also for expansion, diversification and modernization of

existing units. In this basis the new issue market can be classified as=&

'( -arket where firms go to the public for the first time through initial

public offering.

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)( -arket where firms which are already trading raise additional capital

through seasoned e7uity offering

The main function of a ne& issue marketcan be divided into a triple

service function=&

.* Ori'ination

1* Un#er&ritin'

2* Distri5ution

.* ORI0INATION=&

*rigination refers to the work of investigation, analysis and processing of

a new pro!ect proposals. *rigination starts before an issue is actually

floated in the market. There are two aspects in this function=

'( " careful study of the technical, economic and financial viability to

ensure soundness of the pro!ect. This is a preliminary investigation

undertaken by the sponsors of the issue.

)( "dvisory services which improve the 7uality of capital issues and

ensure its success.

The a#visory servicesinclude=

a( Type of issue. This refers to the kind of securities to be issued whether

e7uity share, preference share, debenture or convertible debenture

b( -agnitude of issue.

c( Time of floating an issue

d( ricing of an issue

e( -ethods of issue

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f( Techni7ue of selling the securities

The function of origination is done by merchant bankers who may be

commercial banks, all India financial institution or private firms. Initially

this service was provided by specialized division of commercial banks. "t

present, financial institution and private firms also perform this service.

Though this service is highly important, the success of the issue depends,

to a large extent, on the efficiency of the market.The origination itself

does not guarantee the success of the issue. Cnderwriting, a specialized

service is re7uired in this regard.

+( UNDER4RITIN0+&

Cnderwriting is an agreement whereby the underwriter promises to

subscribe to a specified number of shares and debentures or a specified

amount of stock in the event of public not subscribing for the issue. If the

issue is fully subscribed, then there is no liability to the underwriter. If the

part of the share issues remains unsold, the underwriter will buy the

shares. Thus, underwriting is a guarantee for the marketability of the

shares.

MET6ODS OF UNDER4RITIN0+&

"n underwriting agreement may undertake any of the following three

forms=&

'( Stan#in' 5e%in# t%e issue+

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Cnder this method, the underwriter guarantees the sale of a specified

number of shares with in a specified period. If the public do not subscribe

to the specified amount of issues, the underwriter buys the balance in the

issue.

1* Outri'%t $urc%ase+,

The underwriter, in this method, makes outright purchase of shares and

resells them to the investors.

+( Consortium met%o#+,

Cnderwriting is basically done by the group of underwriters in this

method. The underwriters form a syndicate for this purpose. This method

is adopted for large issues.

AD3ANTA0ES OF UNDER4RITIN0=&

Cnderwriting assumes great significance as it offers the following

advantages to the issuing company=&

The issuing company is relieved from the risk of finding buyers for

the issue offered to the public. The company is assured of raising

ade7uate capital. The company is assured of getting the minimum subscription

within the stipulated time, a statutory obligation to be fulfilled by

the issuing company.

Cnderwriter undertakes the burden of highly specialized function

of distributing securities.

ublic confidence on the issue is enhanced when underwritten isdone by the reputed underwriters.

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They provide expert advice with regard to the timing of the issue,

the pricing of the issue, the size and the type of securities to be

issued etc.

2* DISTRI"UTION=&

Cnderwriting is however only a stop&gap arrangement to guarantee the

success of an issue. The success of an issue, in the ultimate analysis,

depends on the issue being ac7uired by the investing public. The sale of

securities to the ultimate investors is referred to as distribution. It is a

specialized !ob which can be best performed by the brokers and the

dealers in securities, who maintain a regular and direct contact with the

ultimate investors.Thus the new issue market is a complex of institution

through which funds can be obtained by those who re7uire them from

investors who have savings. The ability of the @I- to cope with the

growing re7uirement of the expanding corporate sector would depend on

the presence of specialist agencies to perform the function of origination,

underwriting and distribution.

MET6OD OF FLOATIN0 NE4 ISSUES=&

The various methods which are used in the floatation of securities in thenew issue market are=

'( ublic issues

)( *ffer for sale

+( lacement

8( >ight issues

!U"LIC ISSUES=&

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Cnder this issuing method, the issuing company directly offers to the

general public institution a fixed number of shares at stated prices

through a document called prospectus. This is the most common method

followed by !oint stock companies to raise capital through the issue of

securities. The prospectus must state the following=

'( @ame of the company

)( "ddress of the registered office of the company

+( $xisting and proposed activities

8( Bocation of the industry

9( @ame of the directors

:( "uthorized and proposed issue capital to the public

;( 4ates of opening and closing the subscription list

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'( %ale through the prospectus has the advantage of inviting a large

section of the investing public through advertisement.

)( It is a direct method and no intermediaries are involved in it.

+( %hares, under this method, are allotted to a large section of

investors on a non&discriminatory basis. This procedure helps wide

dispersion of shares and to avoid concentration of wealth in few.

DEMERITS OF ISSUE T6ROU06 !ROS!ECTUS=&

'( It is an expensive method. The company has to incur expenses on

printing of prospectus, advertisement, banks commission,

underwriting commission, legal charges, stamp duty, listing fee and

registration charges.

)( This method is suitable only for large issues.

OFFER FOR SALE=&

The method of offer for sale consists in outright sale of securities through

the intermediary of issue houses or share brokers. In other words, the

shares are not offered to the public directly. This method consist of two

stages= The first stage is a direct sale by the issuing companies to the

issue houses and brokers at an agreed price. In the second stage,intermediaries resell the above securities to the ultimate investors. The

issue houses or the stock brokers purchase the securities at a negotiated

price and resell at a higher price. The difference in the purchase price and

the sales price is called spread. It is otherwise called brought out deals.

The ma!or advantage of this method is that the company is relieved from

the problem of printing and advertisement of prospectus and making

allotment of shares. *ffer for sale is not common in India.

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!LACEMENT+,

Cnder this method, the issue houses or brokers buy the securities outright

with the intention of placing them with their clients afterwards. 2ere the

brokers act as almost wholesalers selling them in retail to the public. The

broker would make profit in the process of reselling to the public. The

issue houses and the brokers maintain their own list of clients and

through customers contact sell the securities. There is no need for a

formal prospectus as well as underwriting agreement.

!LACEMENT 6AS T6E FOLLO4IN0 AD3ANTA0ES=&

'( Timing of issue is important for successful floatation of shares. In a

depressed market condition when the issues are not likely to get

public response through prospectus, placement method is a useful

method of floatation of shares.

)( This method is suitable when small company issue their shares.

+( It avoids delays involved in the public issue and it also reduces the

expenses involved in public issue.

It maintains confidentiality in issue and removes the fear of takeovers.The main disadvantage of this method is that the securities are not widely

distributed to the large section of investors. This method of a private

placement is used to a limited extent in India. The promoters sell the

shares to their friends, relatives and well wishers to get minimum

subscription which is a precondition for issue of shares to the public.

RI06T ISSUE+,

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>ight issue is a method of raising funds in the market by an existing

company. " right means an option to buy certain securities at a certain

privileged price with in a within a specified period. %hares, so offered to

the existing shareholders are called right shares. >ight shares are issued to

the existing shareholders in a proportion to their existing share

ownership. The ratio in which the new shares or debentures are offered to

the existing share capital would depend upon the re7uirement of capital.

The right themselves are transferable and saleable in the market.

%ection

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)( It ensures e7uitable distribution of shares to all existing

shareholders and so control of company remains undisturbed as

proportionate ownership in the company remains the same.

+( It prevents the directors from issuing new shares in their own name

or to their relatives at a lower price and get controlling right.

SE"I7S 0UIDELINES FOR I!OS=&

The %$3I has been issuing guidelines from time to time with regard to

I*s so as to protect the interest of investors and also to promote a

healthy capital market in the country. %ome of the important guidelines

pertaining to I*s are=

'( "ll allotments have to be made within +A days of the closure of the

public issue and 8) days in the case of a right issue.

)( The set offer to the general public has to be at least )9G of the total

issue size for listing on a stock exchange. For listing an I* on the

@%$ =

a( The paid up capital should be >s.)A crores.

b( The issuing company should have a track record of

profitability.

c( The pro!ect should be appraised by a financial institution ora commercial bank or category ' merchant banker.

+( In case an issue exceeds more than >s.'AA crore, the issue is

allowed to place the whole issue through book&building.

8( " minimum of 9AG of the net offer to the public has to be reserved

for investors applying for less than 'AAA shares.

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9( "ll listing formalities for a public issue have to be completed

within ;A days from the date of closure of the subscription list.

:( There should be at least 9 investors for every >s. ' lakh of e7uity

offered.

;( The "@ or ?I> number should be compulsory 7uoted in the

application where the monetary value of investment is >s.9A,AAA or

above.

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In the new issue market, the merchant bankers provide various services.

The merchant bankers act as lead managers, issue managers, portfolio

managers, consultants, advisers to the issue, underwriter to the issue.

Lea# mana'ers+,

-erchant bankers act as lead managers. "s per %$3I guidelines it is

mandatory that all public issues should be managed by the merchant

bankers in the capacity of lead managers. *nly in the case of right issues

not exceeding >s.9A lakhs such an obligation is not necessary. The

number of lead managers to be appointed by a company depends upon the

size of the issue.

!ort-olio mana'ers=&

-erchant bankers provide portfolio management services to their clients.

ortfolio basically refers to investment in different kinds of securities

such as shares, debentures or bonds issued by different companies and

securities issued by the government. ortfolio management refers to

maintaining proper combination of securities in a manner that they give

maximum return with minimum risk.

Issue mana'ement=&

It is one of the important services provided by the merchant bankers.-anagement of the issue involves marketing of corporate securities such

as e7uity shares, preference shares and debentures or bonds by offering

them to public. -erchant bank act as intermediary whose main !ob is to

transfer capital from those who own it to those who need it.

)( RE0ISTRARS+,

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>egistrars are one of the important intermediaries who undertake all the

activities connected with new issue management. They are appointed by

the company in consultation with the merchant bankers to the issue.

>egistrars have a ma!or role to play in respect of servicing of investors.

;uali-ication -or re'istrars to t%e issue=&

To be appointed as registrar to the issue, registration with %$3I is

essential. The criteria adopted by %$3I for registration are the

competency and expertise, 7uality of manpower, their track record, and

ade7uacy of infrastructure such as computers, storage space etc." net

worth of >s. : lakhs is essential for registrars. %$3I has laid down a code

of conduct for their observance. They have to maintain proper books of

accounts and registrars for a period of three years.

+( COLLECTIN0 AND CO,ORDINATIN0 "ANERS=

ollecting bankers collects the subscription in cash, che7ues, stock invest

etc. co&coordinating bankers collect information on subscription and co&

ordinate the collection work. They monitor the work and inform it to the

registrars and merchant bankers. ollecting bankers and co&coordinating

bankers may be the same bank or different banks.

8( UNDER4RITERS AND "ROERS+,

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The function and the role of underwriters are basically to guarantee the

minimum subscription of the issue. 3rokers along with the net work of

sub&brokers market the new issues. They send own circulars and

application to the clients and do follow up to market the securities.

9( S6ARE TRANSFER A0ENTS=&

%hare transfer agents maintain an up to date record of all shareholders of

a company with details of number of securities held, folio number and

bank account details, their address etc. These agents assist the company

in recording subse7uent transfer between shareholders. The records of

this agents play a vital role in respect of deciding the correct beneficiaries

on a record dates for payment of dividend, eligibility for bonus shares,

right shares etc. all such agents are re7uired to be registered with %$3I

and are re7uired to adopt stipulated code of conduct.

:( DE"ENTURE TRUSTEE=&

4ebenture trustees can be defined as individual, or institutions who agree

to act as trustee for the debentures issued by a company. There role is to

maintain a record of assets forming the security against which debentures

are issued, verifying the state of this assets, their valuation, maintenanceetc. debenture trustees are expected to show due diligences in assuring

safety of debenture holders interest. "ll such trustees are expected to be

registered with %$3I which is empowered to inspect their records

regarding the discharge of their services.

SECONDARY MARET

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" market which deals in securities that have been already issued by the

companies is called as secondary market. It is also known as stock

market. It is the base upon which the primary market is depending. For

the efficient growth of the primary market, a sound secondary market is

an essential re7uirement. The secondary market offers an important

facility of transfer of securities.

The activities of buying and selling of securities in a secondary market

are carried out through the mechanism of stock exchanges. There are at

present )8 stock exchanges in India, recognized by the government.

There are three important stock exchanges in 3ombay namely the

3ombay %tock $xchange, @ational %tock $xchange and *ver the ounter

$xchange of India. There has been a substantial growth of capital market

in India during the last )9 years which is evident from the following

table=&

0ro&t% o- Ca$ital Market

1ear 'D;9&;: 'DD

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substantial growth in the number of stock exchanges, listed companies,

and market value of capital. There was a lack of sufficient investment

support in the stock market in 'DD9&D: and 'DD:&D; facing a downside in

the prices of scrips.

Stock E

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+' -arch, )AA'. Total turnover of all the stock exchanges during )AAA&

)AA' was >s.)

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For the efficient and active functioning of a stock exchange, 7uality

securities are absolutely essential. >ealizing the fact, the %$3I has

announced recently revised norms for companies accessing the capital

market so that only 7uality securities are listed and traded in stock

exchanges.

8* !ro%i5ition o- insi#er tra#in'

Insider can easily enter into manipulative dealings against the interest of

the public on the basis of any unpublished price sensitive information

available to them because of their position in the company. @ow, there is

a ban on insider trading and hence, an insider is prevented from dealing in

securities of any listed company on the basis of any unpublished price

sensitive information. %$3I Insider Trading( "mendment >egulation,

)AA) have been formed giving more powers to %$3I to curb insider

trading.

9* Trans$arency o- accountin' $rinci$les

To ensure correct pricing mechanism and wider participation, all attempts

are being taken to achieve transparency in trading and accounting

procedures. 3rokers are asked to show their prices, brokerage, service taxetc separately in the contract notes and their accounts.

:* Strict su$ervision o- stock market o$erations

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The ministry of finance and the %$3I supervise the operations in stock

exchanges very strictly. The %$3I monitors the operations of stock

exchanges very closely with a view to ensure that dealings are conducted

in the best interest of the overall financial environment in the country in

general and the investors in particular. %trict rules have been framed with

regard to recognition of stock exchanges, membership, management,

maintenance of accounts etc. %$3I organizes inspection of brokers firms

and their accounts.

:* !revention o- $rice ri''in'

?reater powers have been given to %$3I under %$3I rohibition of

fraudulent and unfair trade practices relating to security market(

>egulation, 'DD9 to curb price rigging. Infact the %$3I exercised its

powers in 'DD: for the first time by issuing show&cause notices to the

various parties&promoters, brokers and clients involved in price rigging.

Further, certain procedural changes have been planned in the auction

route to curb price rigging. Thus all efforts are being taken to protect the

interest of the investors.

>* Free $ricin' o- securities

" new era in the capital market has begun with the process of

liberalization started from Hune 'DD' onwards. In -ay 'DD), the capital

issues control act was abolished and the functions of the controller of

capital issues were entrusted to %$3I. @ow, any company is free to enter

the capital market to raise the necessary capital at any price that it wants.

#ery recently, the %$3I has permitted companies to issues shares below

the face value of >s 'A and liberalized the norms for initial public

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offerings. This is mainly to permit companies with intrinsic value of

shares below >s 'A to tap the market at a low price. $ven existing

companies can split up their shares accordingly.

?* Freein' o- interest rates

Interest rates on debentures and on %C bonds were freed in "ugust 'DD'

with a view to raising funds from the capital market at attractive rates

depending on the credit rating. ompanies can now offer any rate to the

public and mobilize the savings.

.@* Settin' u$ o- Cre#it Ratin' A'encies

redit rating agencies have been set up for awarding credit rating to the

money market instruments, debt instruments, deposits and even to e7uity

shares also. @ow, all debt instruments must be compulsorily credit rated

by a credit rating agency so that the investing public may not be deceived

by financially unsound companies. It is a healthy trend towards a

developed capital market.

..* Reserve "ank o- In#ia7s Measures

The >3I is also taking measures to revive the capital market which is

undergoing a period of sluggishness. It has permitted commercial banks

to invest up to 9G of their incremental deposits in ordinary shares of the

corporate sector including %Cs. "gain, banks are allowed to extend

loans to corporate against shares held by them so as to enable them to

meet promoters contribution to the e7uity in new companies. The >3I

has also increased the ceiling for banks advances to individuals against

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shares and debentures. Further, financial institutions have been allowed to

purchase and sell treasury bills.

.1* International listin'

The big event in the history of Indian capital market is the listing of an

Indian companys share on an "merican %tock $xchange. The 3angalore

based Infosys Technologies shares have been listed on the @"%4"

exchange under the symbol of I@F.

MONEY MARET

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-oney market is a market for short&term loans or financial assets. It is a

market for the lending and borrowing of short term funds. "s the name

implies, it does not actually deal in cash or money. 3ut it actually deals

with the near substitutes of money or near money like trade bills,

promissory notes and government papers drawn for a short period not

exceeding one year. These short term instruments can be converted into

cash readily without any loss and at low transaction cost.

-oney market is the center for dealing mainly in short&term money

assets. It meets the short&term re7uirements of borrowers and provides

li7uidity or cash to lenders. It is the place where short&term surplus funds

at the disposal of financial institution and individuals are borrowed by

individuals, institutions and also the government.

The money market does not refer to a particular place where short&term

funds are dealt with. It includes all individuals, institutions and

intermediaries dealing with short term funds. The transaction between

borrowers, lenders and middlemen takes place through telephone,

telegraph, mail and agents. @o personal contact or presence of the two

parties is essential for negotiation in a money market. 2owever, a

geographical name may be given to a money market according to its

location.

O"ECTI3ES OF MONEY MARET+,

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The following are the important ob!ectives of a money market=

To provide a parking place to employ short&term surplus funds.

To provide room for overcoming short&term deficits.

To enable the central bank to influence and regulate li7uidity in the

economy through its intervention in this market.

To provide a reasonable access to users of short&term funds to meet

their re7uirements 7uickly, ade7uately and at a reasonable cost.

COM!OSITION OF MONEY MARET

The money market is not a single homogeneous market. It consists of a

number of sub&markets which collectively constitute the money market.

The following are some of the main component of the money market=&

.* Call money market

1* Commercial 5ills market

2* Treasury 5ill market

8* Certi-icate o- #e$osit market

9* Commercial $a$ers market

CALL MONEY MARET=&

The call money market refers to the market for extremely short

period loans6 say one day to fourteen days. These loans are repayable on

demand at the option of either the lender or the borrower. These loans are

given to brokers and dealers in stock exchange. %imilarly, banks with

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surplus funds lend to other bank with deficit funds in the call money

market. Thus, it provides an e7uilibrating mechanism for evening out

short term surplus and deficits. -oreover, commercial banks can 7uickly

borrow from the call market to meet their statutory li7uidity

re7uirements. They can also maximize their profits easily by investing

their surplus funds in the call market during the period when call rates are

high and volatile. The >3I has set up two institution called as Discount

an# Finance 6ouse o- In#ia )DF6I* an# Securities Tra#in'

Cor$oration o- In#iato act as a market maker in this market.

O$eration in t%e call money market+,

3orrowers and lenders in a call market contact each other over the

telephone. 2ence, it is basically over&the&telephone market. "fter the

negotiation over the phone, the borrowers and the lenders arrive at a deal

specifying the amount of loan and the rate of interest. "fter the deal is

over, the lender issues F3B che7ue in favour of the borrower. The

borrower in turn issues call money borrowing receipt. Ehen the loan is

repaid with interest, the lender returns the duly discharged receipt.

Instead of negotiating the deal directly, it can be routed through the

4iscount and Finance 2ouse of India 4F2I(. The borrower and thelenders inform the 4F2I about their fund re7uirement and availability at

a specified rate of interest. *nce the deal is confirmed, 4eal %ettlement

"dvice is exchanged. In case the 4F2I borrows, it issues a call deposits

receipts to the lender and receives >3I che7ue for the money borrowed.

The reverse takes place in case of lendings by the 4F2I. The duty

discharged call deposit receipts are surrendered at the time of settlement.

!ure Inter5ank call money market=&

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In 'DD3I set up a committee called the @arsiman committee to

conduct a study of Indian banking sector and to recommend the process

of liberalizing the sector. *ne of the recommendations of this committee

was to convert the existing call money market into a pure interbank

market. $ffectively, it means eliminating presence of financial institution,

mutual funds and corporate from this market. 3efore such

recommendation could be implemented it was essential to make banking

sector self&sufficient in terms of their fund re7uirement. "ccordingly, on

)Dth"pril, )AA), the >3I introduced measures to reduce the reliance of

bank on outside funds. These measures are as follows=

'( 4aily lending outstanding were not to exceed )9G of net owned

funds as per the previous balance sheet as on +'stmarch.

)( 4aily borrowing outstanding not to exceed 'AAG of net owned

funds or )AG of aggregate deposits as per the previous balance

sheet as an +'stmarch, whichever was higher.

Treasury 5ills market+,

" treasury bill is nothing but a promissory note issued by the government

under discount for a specified period stated therein. The governmentpromises to pay the specified amount mentioned therein to the bearer of

the instrument on the due date. The period does not exceed a period of

one year. It is purely a finance bill since it does not arise out of any trade

transaction. It does not re7uire any grading or endorsement or

acceptance since it is a claim against the government.

Treasury bills are issued only by the >3I on behalf of the government.

Treasury bills are issued for meeting temporary government deficits. The

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Treasury bill rate or the rate of discount is fixed by the >3I from time&to&

time. It is the lowest one in the entire structure of interest rates in the

country because of short&term maturity and high degree of li7uidity and

security.

Ty$es o- treasury 5ills+,

In India, there are two types of treasury bills such as ordinary and ad

hoc. *rdinary treasury bills are issued to the public and other financial

institution for meeting the short&term financial re7uirement of the central

government. These bills are freely marketable and they can be brought

and sold at any time and they have secondary market also. *n the other

hand ad hoc are always issued in favour of the >3I only. They are not

sold through tender or auction. They are purchased by the >3I on tap and

the >3I is authorized to issue currency notes against them. They are not

marketable in India. 2owever the holders of these bills can always sell

them back to the >3I.

*n the basis of periodicity, treasury bills may be classified into three and

they are=

.* ?. #ays treasury 5ills1* .>1 #ays treasury 5ills

+( 2:8 #ays treasury 5ills

D' days treasury bills are issued at a fixed discount rate of 8G as well as

through auction. +:8 days treasury bills do not carry any fixed rate. The

discount rate on these bills are 7uoted in auction by the participants and

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accepted by the authorities. %uch a rate is called as cut off rate. In the

same way, the rate is fixed for D' days Treasury bill sold through auction.

D' days treasury bills can be rediscounted with the >3I at any time after

'8 days of their purchase.

O$eration an# $artici$ants+,

The >3I holds D' days treasury bills and they are issued on tap basis

throughout the week. 2owever, +:8 days bills are sold through auction

which is conducted once in a fortnight. The date of auction and the last

date of submission of tenders are notified by the >3I through a press

release. Investors can submit more than one bid also. *n the next working

day of the date of the auction, the accepted bills with the price are

displayed. The successful bidders have to collect letters of acceptance

from the >3I and deposit the same along with a che7ue for the amount

due on >3I within )8 hours of the announcement of auction results. The

establishment of the 4F2I has imparted greater li7uidity in the treasury

bills market.

Commercial 5ills market+,

" commercial bill is one which arises out of a genuine trade transactioni.e., credit transaction. "s soon as goods are sold on credit, the seller

draws a bill on the buyer for the amount due. The buyer accepts it

immediately agreeing to pay the amount mentioned therein after a certain

specified date. Thus, a bill of exchange contains a written order creditor

to the debtor, to pay a certain sum, to a certain person, after a certain

period. It is a negotiable instrument.

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De-inition+,

%ection 9 of the @egotiable Instrument "ct defines a bill of exchange as

/an instrument in writing containing an unconditional order, signed by the

maker, directing a certain person to pay a certain sum of money only to,

or to the order of a certain person or to the bearer of the instrument0

Ty$es o- 5ills+,

-any types of bills are in circulation in a bill market. They can be

classified as follows=

.* Deman# an# Usance 5ills

1* Clean an# Documentary 5ills

2* Inlan# an# Forei'n 5ills

8* E

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4iscount market refers to the market where short term genuine trade bills

are discounted by financial intermediaries like commercial banks. Ehen

credit sales are affected, the seller draws a bill on the buyer who accepts

it promising to pay the specified sum at the specified period. The seller

has to wait until the maturity of the bill for getting payment. 3ut the

presence of the bill market enables him to get payment immediately. The

seller can ensure the payment immediately by discounting the bill with

some financial intermediary by paying a small amount of money called

discount rate. *n the date of maturity, the intermediary claims the

amount of the bill from the person who has accepted the bill.

Acce$tance market+,

The acceptance market refers to the market where short&term genuine

trade bills are accepted by financial intermediaries. "ll trade bills cannot

be discounted easily because the parties to the bill may not be financially

sound. In such cases the bills are accepted by the financial intermediaries

like banks, the bills earn a good reputation and such bills can be readily

discounted anywhere.

Certi-icate o- #e$osit market=&

ertificate of deposit is one of the new instruments which is been

introduced in the money market with an aim to provide greater flexibility

to the investors in the deployment of their short term funds. ertificate of

deposit can be defined as /a receipt given to a depositor by a bank or any

other eligible institution for the funds deposited with it. It is a marketable

instrument or a document of title to a time deposit for a specified period.


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Features+,

a( " certificate of deposits being a negotiable instrument cannot be

pledged as security for borrowing, in case of need the instruments

is to be sold in the secondary market.

b( " certificate of deposit is a usance promissory note and is

therefore sub!ect to stamp duty.

c( 3ank can issue certificate of deposit for a period ranging from '9

days to +:8 days. Ehere as eligible financial institution can issue

certificate of deposit up to + years.

d( ertificates of deposit are issued at a discount to face value and

are redeemed at par to face value. The difference between

redemptions price and issue price constitutes the yields to the

investors. ertificate of deposits are issued in the lot of >s 9 lakh

and additional investment is in multiples of >s ' lakh.

e( *nly commercial and co&operative banks can issue certificate of

deposits.

f( 3anks are re7uired to maintain B> and %B> on the issue price of

certificate of deposits and not on the face value.

g( Floating rate certificate of deposits are permitted to be issued in

India. >esetting of interest rate is to be done by bench marketing

to an established market rate.h( @o premature repayment of 4s is permitted. This ensures that

funds to the extent of 4s issued are available to the bank till

maturity.

i( roceeds collected on account of 4s are reflected in the banks

balance sheet as liability to others.

!( @ormally, 4s yield rates are higher than the corresponding fixed

deposit rate.

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k( In terms of section 8) of the >3I "ct, banks are re7uired to furnish

a fortnightly return of the 4s issued by them.

Commercial $a$ers market+,

The commercial papers have come into existence in the money market

since Hanuary, 'DDA. ommercial papers can be defined /as debt

instrument issued by corporate for raising short term resources from

money market. This instrument is based on leveraging of good credit

rating by corporate to reduce the cost of banks borrowing.

Features+,

a( These debt instruments are unsecured in nature.

b( These instruments are generally issued in India for period ranging

from '9 days to +:8 days.

c( They are issued in the form of promissory notes which are payable

at par. 3y implication this instrument are issued at a discount.

d( The difference between the face value and issue price of the

instrument is called as discount. This provides the return to the

investors. This instruments are issued only in the demat form.

e( The corporate issuing the commercial papers re7uire to haveminimum credit rating of &) from >I%IB.

f( There is no bench market interest rate and corporate are permitted

to issue commercial papers at discount in keeping with their

standing in the market.

g( ommercial papers can be issued in the minimum lot of >s )9 lakh

and additional investment in denomination of >s 9 lakh each.

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h( ommercial papers can be issued only through commercial banks

who act as issuing and paying agents. The logic behind this

re7uirement is that the 7uantum of commercial papers issued by a

corporate are reduced from maximum permissible bank finance

available to a corporate from the banking industry.

i( *nly a corporate having a minimum net worth of 8 crores and

permissible bank finance of 8 crore are permitted to issue

commercial papers.

!( orporate issuing the commercial papers are re7uired to have a

current ratio of not less than '.++

k( Financial Intermediary -oney -arket "ssociation FI--4"( has

prescribed various procedures, documentation, and prudential

safeguards to be followed while issuing commercial papers.

The success of the commercial papers and the development of the market

for commercial papers depend upon the emergence and the growth of

secondary market for such commercial papers. 4F2I can help in the

growth of commercial papers market in the near future.

T%e Reserve 5ank o- In#ia

The >3I, as the central bank of the country, is the center of the Indian

financial system and monetary system. "s the apex institution, it has been

guiding, monitoring, regulating, controlling, and promoting the destiny of

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the Indian financial system since its inception. It is 7uite young compared

with such central banks as the bank of $ngland, >iksbank of %weden, and

the Federal >eserve 3oard of the C%. 2owever, it is perhaps the oldest

among the central banks in the developing countries. It started

functioning from 'st"pril, 'D+9 on the terms of the reserve bank of India

"ct, 'D+8. It was a private shareholders institution till Hanuary 'D8D, after

which it became a state&owned institution under the >eserve 3ank

Transfer to ublic *wnership( of India "ct, 'D8

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event of a difference of opinion or conflict, the government view or

position can always be expected to prevail. The preamble of the >3I

"ct,'D+8 states that /whereas it is expedient to constitute a >eserve 3ank

for India to regulate the issue of bank notes and the keeping of reserves

with a view to securing monetary stability in India( and generally to

operate the currency and credit system of the country to its advantage0.

%ome of the important functions of the >3I are specified as follows=

a( To maintain monetary stability so that the business and economic

life can deliver welfare gains of a properly functioning mixed

economy.

b( To maintain financial stability and ensure sound financial

institution so that monetary stability can be safely pursued and

economic units can conduct their business with confidence.

c( To maintain stable payment system so that financial transaction can

be safely and efficiently executed.

d( To ensure that credit allocation by the financial system broadly

reflects the national economic priorities and societal concerns.

e( To regulate the overall volume of money and credit in the economy

with a view to ensure a reasonable degree pf price stability.

Role o- R"I+,

T%e $rinci$al role $laye# 5y t%e R"I inclu#es t%e -ollo&in'=

.* In-ormation $rovi#er

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"fter incorporation of chapter III " in >3I "ct in the year 'D:), the >3I

is empowered to collect credit information from banking companies and

furnish such information to the government as well as to other banks. The

>3I thus acts as a database of credit information for entire financial

sector.

1* !romoter

"s the custodian of the Indian financial system, the >3I has helped to

develop and promote several entities which are as follows=

a( Institution such as 4I?, I4F, 4F2I, %TI, etc.

b( Financial institution like I43I, III, IFI, %I43I, etc

c( @"3">4, "gricultural ollege at pune, >egional >ural 3ank for

the rural development.

d( $JI- 3ank for foreign trade.

e( @23 for housing finance.

f( Indian 3ank "ssociation, Indian Institute of bank, @ational

Institute of 3ank -anagement, 3ankers trading college etc

2* Su$ervisor

"s the principal regulatory authority over the Indian financial system, the

>3I is expected to exercise supervision over the Indian financial system.

This aspect has been entrusted to the board of financial supervision set up

under >3I regulation in 'DD8. ommercial banks, financial institution,

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@3F and certain specified institution are covered under this regulation.

The board for financial supervision ensures compliance in the areas of

credit management, asset classification, income recognition, and capital

ade7uacy provisioning and treasury norms. "s per section +9 of 3anking

>egulation "ct, provides >3I with power to inspect books and accounts,

suspend operation of bank, issue directors etc. section +93( permits >3I

the authority to appoint the chairman, managing director and the whole

time directors.

8* Custo#ian

>3I acts as custodian for domestic currency as well as foreign currency

denominated securities which act as assets of country. The distribution of

domestic currency notes is handled by issue department of the >3I which

has '< representatives offices across the country. This act as currency

chests. This mechanism helps to facilitate expansion and contraction of

currency in circulation. "dditional chest are operated through %3I, public,

and private sector bank. These centers maintain ready stock of new and

re&usable notes and coins. "ll moneys held at this chest are owned by the

>3I. The presence of these offices eliminates the necessity for the

physical transfer of shares. They essentially help in making li7uid cash

available in every corner of the country and additionally provide safemechanism for withdrawing soiled and unusable

Securities an# E

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securities market and investor protection and to advice the government on

all these matters.

%$3I was given statutory status and powers through an ordinance

promulgated on +Ath Hanuary, 'DD). The ordinance provided for the

establishment of a board to protect the interest of investors in securities

and to promote the development of and to regulate the securities market.

The statutory powers and function of %$3I were strengthened through the

promulgation of the securities law "mendment( ordinance on )9th

Hanuary, 'DD9, which was subse7uently replaced by an "ct of parliament.

In term of this act, %$3I has been vested with regulatory powers over

corporate in the issuance of capital, and other related matter.

O5Bectives o- SE"I+,

'( To promote orderly and healthy growth of the securities market in

India.

)( To protect the rights and interest of the investors through necessary

regulation.

+( To create proper market environment for orderly functioning of

securities market.

8( To regulate operation of financial intermediaries such as brokers,underwriters, portfolio managers, and mutual funds. In addition to

promote professionalism among the intermediaries.

9( To create healthy market environment so as to enable companies to

raise ade7uate funds for their business through the sale of

securities.

:( To provide suitable education and guidance to investors so as to

enable them to protect their interest.

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In short, %$3I is for the protection of investors, regulation of stock

exchanges and financial intermediaries and healthy growth of capital

market in India.

Functions o- SE"I+,

Section .. o- t%e SE"I Act s$eci-ies t%e -unction as -ollo&s+

.* Re'ulatory -unction

a( >egulation of stock exchange and self regulatory organization

b( >egistration and regulation of stock brokers, sub&brokers, registrar

to all the issue, merchant bankers, underwriters, portfolio&

managers, and such other intermediaries who are associated with

securities market.

c( >egistration and regulation of the working of collective investment

schemes including mutual funds.

d( rohibition of fraudulent and unfair trade practices relating to

securities market.

e( rohibit insider trading in securities.

1* Develo$ment -unction

a( romoting investors education

b( Training of intermediaries.


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c( onducting research and published information useful to all market

participants.

d( romotion of fair practices. ode of conduct for self regulatory

organizations.

!o&ers o- SE"I=&

%$3I has been vested with the following powers=

ower to call periodic returns from recognized stock exchanges.

ower to call any information or explanation from the recognized

stock exchanges or their members.

ower to direct en7uiries to be made in relation to affairs of stock

exchanges or their members.

ower to grant approval to bye&laws of recognized stock

exchanges.

ower to make or amend bye&laws of recognized stock exchanges.

ower to compel listing of securities by public companies.

ower to control and regulate stock exchanges.

ower to grant registration to market intermediaries.

ower to levy fees or other charges for carrying out the purpose of

regulation.

SE"I 0ui#elines=&


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%$3I has brought out a number of guidelines separately, from time to

time, for primary market and secondary market. They are as follows=

.* !rimary market

Ne& com$any= & " new company is the one which has completed ')

months of commercial production and does not have audited results and

where the promoters do not have a track record. %uch a company will

have to issue shares only at par.

Ne& com$any set u$ 5y t%e es 'AA crores of issue, 8AG on

next >s )AA crores, +AG on next >s +AA crores and '9G on the balance

amount.

Reservation o- issues=&

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>eservation under public subscription for various categories of persons is

made in the following manner=

'( ermanent employees && 'AG

)( Indian -utual funds && )AG

+( Foreign Institutional Investors && '9G

8( 4evelopment financial Institution && )AG

9( %hareholders of group of companies && 'AG

1* Secon#ary market

Stock eegistration of brokers and sub&brokers is made compulsory.

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)( In order to ensure that brokers are professionally 7ualified and

financially solvent, capital ade7uacy norms for registration of

brokers have been evolved.

+( ompulsory audit of brokers book and filing of audit report with

%$3I have been made mandatory.

8( To bring about greater transparency and accountability in the

broker&client relationship, %$3I has made it mandatory for brokers

to disclose transaction price and brokerage separately in the

contract notes issued to client.

9( @o brokers are allowed to underwriters more than 9G of the public

issue.

DERI3ATI3ES MARET

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4erivatives are becoming increasingly important in world market as a

tool for risk management. 4erivatives instrument can be used to

minimize risk. 4erivatives are used to separate the risk and transfer them

to parties willing to bear these risks. The kind of hedging that can be

obtained by using derivatives is cheaper and more convenient than what

could be obtained by using cash instruments. It is so because, when we

use derivatives for hedging, actual delivery of the underlying asset is not

at all essential for settlement purposes. The profit or loss on derivatives

deal alone is ad!usted in the derivatives market.

De-inition+,

/4erivatives are the instruments which make payments calculated

using price of interest rates derived from on balance sheet or cash

instrument, but do not actually employ those cash instruments to funds

payments0

in#s o- Financial Derivatives=&

Some o- t%e im$ortant -inancial #erivatives are as -ollo&s+

.* For&ar#s

1* Futures

2* O$tions

8( S&a$s

For&ar#s=&

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" forward contract is an agreement between bank and its customer in

terms of which bank agrees to buy or sell a specified amount of a given

currency at a pre&determined rate for delivery on specific future date.

Features o- a -or&ar# contract+,

'( " forward contract is a customized contract and a customer is

therefore able to buy or sell a specific amount of foreign currency

as per his trade liability.

)( This is only instrument which provides 'AAG hedge against

transaction risk.

+( The contracts are customized in terms of delivery date also ie = the

customer can sell or buy the re7uisite amount of foreign currency

on any specific future date.

8( " forward contract is over the counter contract *T( between the

bank and customer.

9( %ince both the customer and the bank can theoretically fail before

maturity of the contract such contract carry 'AAG credit risk.

:( ancellation of forward contract or any amendment to existing

contract is possible only with same counter party. This reduces the

negotiability in such contracts.

Futures+&

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" futures contract is very similar to a forward contract in all respects

excepting the fact that it is completely a standardized one. 2ence, a future

contract is nothing but a standardized forward contract. It is legally

enforceable and it is always traded on an organized exchange. " future

contract is one where there is an agreement between two parties to

exchange any asset or currency or commodity for cash at a certain future

date, at an agreed price. 3oth the parties must have mutual trust between

them.

Features o- -uture contract=&

'( Futures are standardized and legally enforceable. 2ence, they are

traded only in organized future exchanges. It is also difficult to

modify the agreement according to the needs of the contracting

parties.

)( The contracting parties need not pay any down payment at the time

of agreement. 2owever, they deposit a certain percentage of

contract prices with the exchange and it is called initial margin.

This gives the guarantee that the contract will be honored.

+( The main feature of the future contract is to hedge against price

fluctuation. The buyers of a future contract hope to protect

themselves from future spot price increases and the sellers fromfuture spot decreases. arties enter into future agreement on the

basis of their expectation of the future price in the spot market for

the asset in 7uestion.

8( Future contract is nothing but a standardized forward contract

which possesses the property of linearity. arties to the contract get

symmetrical gains or losses due to price fluctuation of the

underlying asset on either direction.

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9( In case of the future contract, the delivery of the asset in 7uestion is

not essential on the date of maturity of the contract. ?enerally,

parties simply exchange the difference between the future and spot

prices on the date of maturity.

:( Future contract attract margin re7uirement ie when buying and

selling any security on the exchange margin money account has to

be maintained with the exchange. The daily variation in the market

rate as against the contracted rate is credited or debited to the

margin money account.

;( " professional trader prefers to use future contract because of the

speed and the transparency of its operation.

O$tions contract=&

Traders and operators dealing in foreign currencies, commodities, or

securities often undertake liabilities devolving in the future which may or

may not occur. Forward contract and Future contract both re7uire

mandatory settlement. Therefore in order to overcome this limitation, the

options contract has been developed.

"n option contract can be defined as a right but not an obligation to buy

or sell the underlined security, commodity, or currency. *ption contractare purchased i.e. they involve payment called as premium for ac7uiring

this entitlement. This right may be to purchase or to sell. *ption contract

which provide the right but not the obligation to buy the underlined

security are called as call option. %imilarly, option contract which provide

the right but not the obligation to sell the underlined security are called

put option. remium paid for ac7uiring option contract are notrefundable. The payment of premium is not dependent upon the contract

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being exercised or being abandoned. The price at which the underlined

security is to be brought or sold is called strike price.

Features o- o$tion contract=&

'( *ption contract are exchange traded contract and en!oy the benefit

of novation.

)( *ption contract are standardized in terms of number of securities.

+( "ll option contracts for a given calendar month mature on last

Thursday of the month in India.

8( *ption which can be exercised on any day up to the maturity date

are called "merican options which can be exercised only on

maturity date are called $uropean options.

9( *ption do not provide 'AAG hedge against future liabilities due to

their standardized nature.

:( *ptions always involve payment of premium to the option seller on

the date of contract. This premium is non&refundable due to this

factor options tend to be costlier than forward contract or future

contract.

S4A!S=&

It i

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