Financial Markets Final

8/3/2019 Financial Markets Final

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I N D E X

Chapter 1. Financial Markets

1.1 Introduction

1.2 History

1.3 Types

1.4 Indian Scenario

Chapter 2. Capital markets

2.1 Introduction

2.2 Nature & Constituents

2.3 Importance & Rule

2.4 Functions of Capital Markets

2.5 Components of Capital Markets

2.6 Features of Capital Markets

2.7 Risk in Capital Markets

2.8 Types of Capital Markets

2.8.1 Primary Market

2.8.2 Secondary Market


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Chapter 3. Money Market

3.1 Introduction

3.2 Features & Objectives

3.3 Characteristics of Developed Money Market

3.4 Importance of Money Market

3.5 Types of Money Market

3.5.1 Call Money Market

3.5.2 Commercial Bills Market

3.5.3 Acceptance Market

3.5.4 Treasury Bill Market

3.6 Financial Institutions of Money Market

3.7 Money Market Instruments

3.7.1 Commercial Paper

3.7.2 Certificate of Deposits

3.7.3 Inter Bank Participation Certificate

Chapter 4. Debt Market and Instruments

4.1 Introduction

4.2 Features

Chapter 5. Equity Market

5.1 Introduction

5.2 Equity Markets in India- An Overview

Chapter6. Derivatives Market

6.1 Introduction


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6.2 Financial Derivatives

6.3 Derivatives Products

6.3.1 Forwards

6.3.2 Options

6.3.3 Warrants

6.3.4 Leaps

6.3.5 Baskets

6.3.6 Swaps

6.4 Types of Derivatives Market

6.4.1 Forwards

6.4.2 Futures

Chapter 7. Case studies

Chapter 8. Conclusion

Bibilography


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Chapter 1

Financial Market

1.1 IntroductionIndia Financial Market is one of the oldest in the world and is

considered to be the fastest growing and best among all the

markets of the emerging economies. The history of Indian

Capital markets dates back 200 years towards the end of the

18th Century when India was under the rule of the East India

Company. The Development of the capital market in India

concentrated around Mumbai where no less than 200 to 250securities brokers were active during the second half of the 19 th

century. However the stock markets in India remained stagnant

due to stringent controls on the market economy that allowed

only a handful of monopolies to dominate their respective

sectors. The corporate sector wasnt allowed into many

industry segments, which were dominated by the state

controlled public sector resulting in stagnation of the economyright up to the early 1990s. Thereafter when the Indian

economy began liberalizing and the controls began to be

dismantled or eased out, the securities markets witnessed a

flurry of IPSs that were launched. This resulted in many new

companies across different industry segments to come up with

newer products and services.

A remarkable feature of the growth of the Indian economy in

recent years has been the role played by its securities markets

in assisting and fuelling that growth with money rose within the

economy. This was in marked contrast to the initial phase of

growth in many of the fast growing economies of East Asia that

witnessed huge doses of FDI (Foreign Direct Investment)

spurring growth in their initial days of market decontrol.During this phase in India much of the organized sector has


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been affected by high growth as the Financial Markets played

an all-inclusive role in sustaining financial resource

mobilization. Money PSUs (Public Sector Undertakings) that

decided to offload part of their equity were also helped by thewell-organized securities market in India.

Financial market is a market where financial instruments are

exchanged or traded and helps in determining the prices of the

assets that are traded in and is also called the price discovery

process.

1. Organizations that facilitate the trade in financial products.For e.g. Stock exchanges.

(NYSE, Nasdaq) facilitate the trade in stocks, bonds and

warrants.

2. Coming together of buyer and sellers at a common platformto trade financial products is termed as financial markets,

i.e. stocks and shares are traded between buyers and sellers

in a number of ways including: the use of stock exchanges;

directly between buyers and sellers.

1.2 History India Financial Market :

This is one of the oldest in the world and is considered to be the

fastest growing and best among all the markets of the emerging

economies. The history of Indian Capital Markets dates back

200 years toward the end of the 18 th Century when India was

under the rule of the East India Company. The development of

the capital market in India concentrated around Mumbai where

no less than 200 to 250 securities brokers were active during

the second half of the 19th century.


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The financial market in India today is more developed than

many other sectors because it was organized long before with

the securities exchanges of Mumbai, Ahmadabad and Kolkata

were established as early as the 19th

Century. By the early1960s the total number of securities exchanges in India rose to

eight, including Mumbai, Ahmadabad and Kolkata apart from

Madras, Kanpur, Delhi, Bangalore and Pune. Today there are

21 regional securities exchanges in India in addition to the

centralized NSE (National Stock Exchange) and OTCEI (Over the

Counter Exchange of India).

However the stock markets in India remained stagnant due to

stringent controls on the market economy that allowed only a

handful of monopolies to dominate their respective sectors. The

corporate sector wasnt allowed into many industry segments,

which were dominated by the state controlled public sector

resulting in stagnation of the economy right up to the early

1990s. Thereafter when the Indian economy began liberalizing

and the controls began to be dismantled or eased out, the

securities markets witnessed a flurry of IPOs that were

launched. This resulted in many new companies across

different industry segments to come up with newer products

and services.

A remarkable feature of the growth of the Indian economy in

recent years has been the role played by its securities markets

in assisting and fuelling that growth with money rose within the

economy. This was in marked contrast to the initial phase of

growth in many of the fast growing economies of East Asia that

witnessed huge doses of FDI (Foreign Direct Investment)

spurring growth in their initial days of market decontrol.

During this phase in India much of the organized sector has

been affected by high growth as the financial markets played an


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all-inclusive role in sustaining financial resource mobilization.

Many PSUs (Public Sector Undertakings) that decided to offload

part of their equity were also helped by the well-organized

securities market in India.

The launch of the NSE (National Stock Exchange) and the

OTCEI (Over the Counter Exchange of India) during the mid

1990s by the government of India was meant to usher in an

easier and more transparent form of trading in securities. The

NSE was conceived as the market for trading in the securities of

companies from the large-scale sector and the OTCEI for thosefrom the small-scale sector. While the NSE has not just done

well to grow and evolve into the virtual backbone of capital

markets in India the OTCEI struggled and is yet to show any

sign of growth and development. The integration of IT into the

capital market infrastructure has been particularly smooth in

India due to the countrys world class IT Industry. This has

pushed up the operational efficiency of the Indian Stock market

to global standards and as a result the country has been able to

capitalize on its high growth and attract foreign capital like

never before.

The regulating authority for capital markets in India is the SEBI

(Securities and Exchange Board of India). SEBI came into

prominence in the 1990s after the capital markets experienced

some turbulence. It had to take drastic measures to plug many

loopholes that were exploited by certain market forces to

advance their vested interests. After this initial phase of

struggle SEBI has grown in strength as the regulator of Indias

capital markets and as one of the countrys most important

institutions.


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1.3 Indian Financial Market consists of the following markets :

1. Capital Market / Securities Marketi. Primary Capital Marketii. Secondary capital Market

2. Money Market3. Debt Market4. Equity Market5. Derivatives Market

1.4 Indian Financial Market Overview

As might be expected, the main impact of the global financial

turmoil in India has emanated from the significant change

experienced in the capital account in 2009-10 so far, relative to

the previous year. Total net capital flows fell from US$17.3

billion in April-June 2009 to US$13.2 billion in April-June

2009. While Foreign Direct Investment (FDI) inflows have

continued to exhibit accelerated growth (US$ 16.7 billion during

April-August 2009 as compared with US$ 8.5 billion in the

corresponding period of 2008), portfolio investments by foreign

institutional investors (FIIs) witnessed a net outflow of about

US$ 6.4 billion in April-September 2009 as compared with a net

inflow of US$ 15.5 billion in the corresponding period last year.

Similarly, external commercial borrowings of the corporate

sector declined from US $ 7.0 billion in April-June 2008 to US

$1.6 billion in April-June 2009, partially in response to policy

measures in the face of excess flows in 2009-10, but also due to

the current turmoil in advanced economics. Whereas the real

exchange rate appreciated from an index of 104.9 (base 1993-

94 = 100) (US $1 = Rs. 46.12) in September 2008 to 115.0 (US

$1 = Rs. 40.34) in September 2008, it has now depreciated to a

level of 101.5 (US $1 = Rs. 48.74) as on October 8, 2009.


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Chapter 2

CAPITAL MARKET

2.1 Introduction :

The capital market is the market for securities, where

companies and governments can raise long term funds. It is

market in which money is lent for periods longer than a year. A

nations capital market includes such financial institutions as

banks, insurance companies and stock exchanges that channel

long-term investment funds to commercial and industrial

borrowers. Unlike the money market, on which lending is

ordinarily short term, the capital market typically finances fixed

investments like those in buildings and machinery.

2.2 Nature and Constituents :

The capital market consists of number of individuals and

institutions (including the government) that canalize the supply

and demand for long term capital and claims on capital. The

stock exchange, commercial banks, co-operative banks, saving

banks, development banks, insurance companies, investment

trust or companies, etc. are important constituents of the

capital markets. The capital market, like the money market,

has three important components, namely the suppliers of

loanable funds, the borrowers and the intermediaries who deal

with the leaders on the one hand and the borrowers on the

other.

The demand for capital comes mostly from agriculture,

industry, trade and the government. The predominant form of

industrial organization developed capital Market become a

necessary infrastructure for fast industrialization. Capital

market not concerned solely with the issue of new claims on

capital, but also with dealing in existing claims.


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2.3 Importance and role of Capital Market :

The capital market serves a very useful purpose by pooling the

capital resources of the country and making them available tothe enterprising investors well-developed capital markets

augment resources by attracting and lending funds on the

global scale.

A developed capital market can solve this problem of paucity of

funds. For an organized capital market can mobilize and pool

together even the small and scattered savings and augment theavailability of investible funds. While the rapid growth of

capital markets, the growth of joint stock business has in its

turn encouraged the development of capital markets.

A developed capital market provides a number of profitable

investment opportunities for small savers.

Mobilization of Savings & acceleration of Capital Formation

Promotion of Industrial Growth Raising of long term Capital Ready & Continuous Markets Proper Channelization of Funds Provision of a variety of Services.

2.4 Functions of a Capital Market

Disseminate information efficiently Enable quick valuation of financial instruments both

equity and debt

Provide insurance against market risk or price risk Enable wider participation


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Provide operational efficiency through-simplified transactionprocedure-lowering settlement timings and lowering

transaction costs.

Develop integration among-real sector and financial sector-equity and debt instruments long term and short term

funds.

Private sector and government sector and Domestic fundsand external funds.

Direct the flow of funds into efficient channels through investment disinvestment reinvestment.

2.5 Components of Capital Market :

Capital Market Consists of : EQUITY MARKETS {STOCK

MARKET}, which provide financing through the issuance of

shares, and enable the subsequent trading thereof. DEBT

MARKETS {BOND MARKET}, which provide financial through

the issuance of bonds, and enable the subsequent trading

thereof.

2.6 Features of Capital Market:

1. Channelization of Funds: The primal role of the capital

market is to channelize investments from investors who

have surplus funds to the ones who are running a deficit.

The capital market offers both long term and overnight

funds.

2. Trading Platform: The primary role of the capital market isto raise long-term funds for governments, banks, and

corporations while providing a platform for the trading of

securities.

3.

Ready & Continuous Market: Fund-raising in the capitalmarket is regulated by the Performance of the stock and


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bond markets within the capital market. The member

organizations of the capital market may issue stocks and

bonds in order to raise funds. Investors can then invest in

the capital market by purchasing those stocks and bonds.

4. Regulation of the Capital Market: Every capital market inthe world is monitored by financial regulators and their

respective governance organization. The purpose of such

regulation is to protect investors from fraud and deception.

Financial regulatory bodies are also charged with

minimizing financial losses, issuing licenses to financial

service providers, and enforcing applicable laws.

5. The Capital Markets Influence on International Trade :Capital market investment is no longer confined to the

boundaries of a single nation. Todays corporations and

individuals are able, under some regulation, to invest in

the capital market of any country in the world. Investment

in foreign capital markets has caused substantialenhancement to the business of international trade.

2.7 Risk involved in Capital Market:

The capital market, however, is not without risk. It is

important for investors to understand market trends before

fully investing in the capital market. Any investor should

consider the following factors of risk while investing in theCapital Markets:-

1. VOLATILITY RISK AND RISK OF CONTAGIONS: Highvolatility is the characteristic of any capital market,

especially in emerging markets. They are immature and

sometimes vulnerable to scandal. They often lack legal and

judicial infrastructure to enforce the law. Accountingdisclosure, trading and settlement practices may at times


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seem overly arbitrary and nave. Against this backdrop,

many emerging markets have had to cope with

unprecedented inflows and outflows of capital. The sudden

withdrawal of highly speculative, short-term capital has thepotential of taking with it much of a markets price support.

Such sudden flights of capital triggered by events in one

emerging market can spread instantly to other markets

through contagion effects even when those markets have

quite different conditions.

2.LIQUIDITY RISK: Many emerging markets are small andilliquid. Volumes of trade are quite low. This kind of thin

trading often leads to higher costs because large

transactions have a significant impact on the market. Thus,

buyers of large blocks of shares may have to pay more to

complete the transaction, and sellers may receive a lower

price.

3. CLEARANCE AND SETTLEMENT RISK: Inadequatesettlement procedures still exist in many of the emerging

markets. They lead to high FAIL rates. A fail occurs when a

trade fails to settle on the settlement date.

4. POLITICAL RISK: In most of the developing countries thepolitical systems are less stable comparative to the

development countries. This scenario does not give thepolitical system to concentrate more on the capital market

happenings and restrict any kind of malfunctions or

practices.

5. CURRENCY RISK: The trade in capital markets will behighly impacted by the fluctuations in the foreign exchange

rates. The currencies of the emerging countries are not

stable enough to complete with those of the developed


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countries. This leads towards unexpected losses for the

investors in the markets.

6. LIMITED DISCLOSURE & INSUFFICINT LEGALINFRASTRUCTURE: As it is already mentioned earlier that

disclosure levels will not be up to the required extent in

emerging markets, the investors will not have a bright

picture of the company in which they are investing, and this

may lead toward losses.

Indian Capital Market:

Factors contributing to growth of Indian Capital Market

Establishment to growth of Indian Capital Market Legislative measures Growing public confidence Increasing awareness of investment opportunities Growth of underwriting business Settling up of SEBI Mutual Funds Credit Rating Agencies

2.8 Types of Capital Market:

Capital market divided into two main parts they are as follows :

1. Primary Capital Market2. Secondary Capital Market

2.8.1 Primary Market

Primary market is the place where issuers create and issue

equity, debt or hybrid instruments for subscription by the public; the

secondary market enables the holders of securities to trade them.

Primary market is a market for raising fresh capital in the form of

shares. Public limited companies that are desirous of raising capital

funds through the issue of securities approach this market. The


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public limited and 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 economicdevelopment.

Everywhere in the world capital markets have originated as the

new issues markets. Once 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 the absence

of secondary market or the stock exchange, the capital market will beparalyzed. This is on account of the reason that the business

enterprises borrow money from the capital market for a very long

period but the investors or savers whose savings are canalized

through the capital market generally wish to invest only for a short

period. Existence of the stock exchange provides a medium through

which these two ends can be reconciled. It enables the investors to

sell their shares for money whenever they wish to do so. Thus, the

business enterprises keep the possession of permanent capital; the

shares can keep on changing hands.

In order to sell securities, the company has to fulfill various

requirements and decide upon the appropriate timing and method of

issue. It is quite normal to obtain the assistance of underwriters,

merchant banks or special agencies to look after these aspects.

2.8.1 a] METHODS OF MARKETING IN PRIMARY MARKET

1. PUBLIC ISSUE:

A public limited company can raise the amount of capital by

selling its shares to the public. Therefore, it is called public

issue of shares or debentures. For this purpose it has to

prepare a Prospectus. A prospectus is a document that


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contains information relating to the company such as name,

address, registered office and names and addresses of company

promoters, managers, Managing Director, Directors, company

secretary, legal advisors, auditors and bankers. It also includesthe details about project, land location, technology,

collaboration, products, export obligations etc. The company

has to appoint brokers and underwriters to sell the minimum

number of shares and it has to fix the date of opening and

closing of subscription list.

2. PRIVATE PLACEMENT:

A Company makes the offer of sale to individuals and

institutions privately without the issue of a prospectus. This

saves the cost of issue of securities. The securities are placed

at higher prices to individuals and institutions. Institutional

investors play a very important role in the private placement.

This has become popular in recent days.

This method is less expensive and time saving. The company

has to complete a very few formalities. It is suitable for small

companies. This method can be used when the stock market is

bull. However, the private placement helps to concentrate

securities in the few hands. They can create artificial scarcity

and increase the prices of shares temporarily and then sell the

shares in the stock market and mislead the common and small

investors. This method also deprives the common investors of

an opportunity to subscribe to the issue of shares.

3. OFFER FOR SALE:

A Company sells the securities through the intermediaries such

as issue houses, and stockbrokers. This is known as an offer

for sale method. Initially, the company makes an offer for sale

of its securities to the intermediaries stating the price and other


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terms and condition. The intermediaries can make negotiations

with the company and finally accept the offer and buy the

shares from the company. They these securities or shares are

re-sold to the general investors in the stock market normally ata higher price in order to get profit. The intermediaries have to

bear the expenses of this issue. The object of this issue is to

save the time, cost and get rid of complicated procedure

involved in the marketing of securities. The issues can also be

underwritten in order to ensure full subscription of the issue.

The general publics get the shares at a higher price the

middlemen are more benefited in this process.

4. BOUGHT OUT DEALS

A Company makes an outright sale of equity shares to a single

sponsor or the lead sponsor and such deals are known as

bought out deals. There are three parties involved in the

bought out deals. The promoters of the company, sponsors and

co-sponsors, sponsors are merchant bankers and co-sponsors

are the investors. There is an agreement in which an outright

sale of a chunk of equity shares is made to a single sponsor or

the lead sponsor. The sale price is finalized through

negotiations between the issuing company and the purchasers.

It is influenced by various factors such as project evaluation,

reputation of the promoters, current market sentiments etc.

Bought out deals are in the nature of fund-based activity where

the funds of the merchant bankers are locked in for at least for

a minimum period. These shares are sold at over the Counter

Exchange of India or at a recognized stock exchange. Listing

takes place when the company gets profits and performs well.

The investor-sponsors make profits because the shares are

listed at higher price.


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5. INITIAL PUBLIC OFFER:-

When a company makes public issue of shares for the first

time, it is called Initial Public Offer. The securities are sold

through the issue of prospectus to successful applicants on thebasis of their demand. The company has to appoint

underwriters in order to guarantee the minimum subscription.

An underwriter is generally an investment banking company.

The underwriter agrees to pay the company a certain price and

buy a minimum number of shares, if they are not subscribed by

the public. The underwriter charges some commission for this

work. He can sell these shares in the market afterwards andmake profit. There may be two or more underwriters in the case

of large issue.

The company has to issue a prospectus giving full information

about the company and the issue. It has to issue share

application forms through the brokers and underwriters. The

brokers collect orders from their clients and place orders with

the company. The company then makes the allotment of shares

with the help of stock exchange. The share certificate are

delivered to the investors or credited to their demat accounts

through the depository. This method saves time and avoids

complicated procedure of issue of shares.

With more and more companies coming out with tempting IPO

or additional offers, there is greater need to exert caution and

pick the best IPO investments. Following four critical factors

should be studied in an IPO offer document, before making an

IPO investment: Promoter, Performance, Prospects and Price.

1. Check Promoter Standing

This by far is the most important factor in any investment

decision. A good promoter or management team is important


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for any business, especially over long periods. While

businesses may have their ups and downs, a good management

will take all necessary steps to ensure profitable performance.

Secondly, they would be constantly looking at new businessopportunities, thereby ensuring regular growth in the company.

Thirdly, we are reasonably certain that the company money will

not be deliberately misused or siphoned off to the detriment of

the shareholders.

Therefore, look at the promoters background, the experience he

has in the industry, the performance of the other companiespromoted by him, his track record, investor complaints etc.

Read the risk factors very carefully especially those pertaining

to the promoter / management. Check for any serious litigation

against the promoter or the company. See whether the

company is a defaulter to the banks/FIs and the reason thereof.

2. Study Company Performance

The share price is the reflection of the operational performance

of the company. Poor numbers say the sales, profit, EPS etc.

would mean poor performance on the stock exchange.

Therefore, it is important that the company has a track record

of good operational performance. Look for any window

dressing. Are the numbers in line with the similar companies

in the industry? Is there any sudden improvement in the

numbers just before the issue, without any justifiable reasons ?

Also look at the performance of the group companies and the

inter-company transaction within the group. Ensure that there

are no dubious transactions. Look at the loans given to group

companies. Are they paying reasonable interest ? Is the loan

likely to be repaid ?


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3. Understand Future Prospects

The future prospects of the Company and the industry would

play an important role in the performance of the scrip on the

stock exchange. Check the objects. How will they impact thefuture prospects? How will the funds raised be utilized? Will it

additionally benefit the company? Is the money being raised for

a project, which will add to the bottom-line of the company?

If its an offer-for-sale, it means the existing shareholders are

selling a part of their stake in the Company. The amounts

raised from the issue will not go to the Company. Therefore,the Company will not benefit from an offer for sale. If the

purpose of the issue is to list the company on the stock

exchange and the 4 Ps are positive, then one can consider

investing.

4. Look at the Price

Finally of course every product / Scrip has a right price based

on its fundamentals and industry prospects. Even if the above

3 Ps were favorable, a high price is likely to reduce the

prospects of appreciation at the exchange, thereby defeating

your purpose of investing.

Look at the average industry PE and the companies EPS and

try to estimate the fair price. Compare this with the issue price

to see if it is undervalued or overvalued scrip. A little time

spent in reading the offer document and analyzing the IPO on

the above factors will help you to make right investment

decisions and prevent you from ending-up holding a dud stock.

5. RIGHT ISSUE

When an existing company issues shares to its existing

shareholders in proportion to the number of shares held by


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them, it is known as Rights Issue. Rights issue is obligatory for

a company where increase in subscribed capital is necessary

after two years of its formation or after one year of its first issue

of shares, whichever is earlier.

SEBI has issued guidelines for issue of right shares.

Accordingly, only a listed company can make right issue.

Rights issue can be made only in respect of fully paid up

shares. No reservation is allowed for rights issue of fully or

partly convertible debentures. The company has to make

announcement of rights issue and once the announcement ismade it cannot be withdrawn. The company has to make the

appointment Registrar but underwriting is optional. It has also

to appoint category I Merchant Bankers holding a certificate of

registration issued by SEBI. Letter of offer should contain

disclosures as per SEBI requirements. The rights issue should

be open for minimum period of 30 days, and maximum up to 60

days. The company has to make an agreement with the

depository for materialization of securities to be issued in demat

form. A minimum subscription of 90 per cent of the issue

should be received. A no complaints certificate is to be filed by

the Lead Merchant Banker with the SEBI after 21 days from the

date of issue of offer document.

6. BONUS ISSUE:-

Bonus shares are the shares allotted by capitalization of the

reserves or surplus of a company. Issue of bonus shares

results in conversion of the companys profits or reserves into

share capital. Therefore, it is capitalization of companys

reserves. Bonus shares are issued to the equity shareholders in

proportion to their holdings of the equity share capital of the

company. Issue of bonus shares does not affect the total

capital structure of the company. It is simply a capitalization of


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that portion of shareholders equity which is represented by

reserves and surplus. The issues of bonus shares are issued

subject to certain rules and regulations. Issue of bonus shares

reduces the market price of the companys shares and keeps itwithin the reach of ordinary investors. The company can retain

earnings and satisfy the desire of the shareholders to receive

dividend. Issue of bonus shares is generally an indication of

higher future profits. Receipt of bonus shares as compared to

cash dividend generally results in tax advantage to the

shareholders.

7. BOOK-BUILDING:

Companies generally raise capital through public issue. In these

cases companies decide the size of the issue and also the price

at which the shares are to be offered to the investors. However

in this system the issuer is not able to ascertain the price that

the market may be willing to pay for the shares, before

launching the issue. This is where book building can come to

their aid. This method is also known as the price discovery

method. This is a mechanism whereby the price is determined

on the basis of actual demand as evident from the offers given

by the various institutional investors and the underwriters.

In the actual public offer process, investors are not involved in

determining the offer price, whereas in book building pricing is

determined on the basis of investor feedback which assures

investor demand. Since the issue price after the issue

marketing there is flexibility in the issue size and the price of

the shares.


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2.8.1 b] INTERMEDIARIES IN PRIMARY MARKET

1. MERCHANT BANKERS:-

Merchant bankers carry out the work of underwriting andportfolio management, issue management etc. They are

required to get separate registration with SEBI as portfolio

managers. Underwriting can be done without any additional

registration. Only body corporate with a net worth of Rs. 5

crores are allowed to work as category I merchant bankers.

They have to carry out the work relating to new issue such as

determination of security mix to be issued, drafting ofprospectus, application forms, allotment letters, appointment of

registrars for handling share applications and transfer, making

arrangement for underwriting placement of shares,

appointment of brokers and bankers to issue, making publicity

of the issue. They are also known as lead managers to an issue.

Category II merchant bankers can act as consultants, advisers,

portfolio managers and co-managers. Category III merchant

bankers can act as underwriters, advisors and consultants and

category IV merchant bankers can act only as advisers or

consultants to a public issue. Merchant bankers have to fulfill

the prescribed minimum capital adequacy norms in terms of

net worth and they should have adequate and necessary

infrastructure. They should also employ experts having

professional qualifications.

2. UNDER WRITERS:

The issuing company has to appoint underwriters in

consultation with the merchant bankers or lead manager. The

underwriters play an important role in the development of the

primary market. The underwriters are the institutions or

agencies, which provide a commitment to take up the issue of


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securities in case the company fails to get full subscription from

the public. They get commission for their services. The

underwriting services are provided by the brokers, investment

companies commercial banks and term lending institutions.

3. BANKERS TO THE ISSUE:-

The bankers play an important role in the working of the

primary market. They collect applications for shares and

debentures along with application money for investors in

respect of issue of securities. They also refund the application

money to the applicants to whom securities could not beallotted on behalf of the issuing company. A company is not

authorized to collect the application money. The Companies

Act, 1956, provides that the money on account of issue of

shares and debentures should be collected through the banks.

Therefore, an issuing company has to appoint bankers to collect

money on behalf of the company.

4. REGISTRARS AND SHARES TRANSFER AGENTS:-

Registrar is an intermediary which carries out functions sub as

keeping a proper record of applications and money received

from investors assisting the companies in determining the basis

of allotment of securities as per stock exchange guidelines and

in consultation with stock exchanges assist in the finalization of

allotment of securities and processing and dispatching of

allotment letters, refund orders, share certificates and other

documents related to the capital issues. Share Transfer Agents

are also intermediaries who carry out functions of maintaining

records of holders of securities of the company for and on

behalf of the company and handling all matters related to

transfer and redemption of securities of the company,


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They also function as Depository Participants, Registrar and

share transfer agents are of two categories. Category I carry out

the activities of both registrars to an issue and of share transfer

agents. Category II carries out the activity fielder of a registrarto an issue or as a share transfer agent.

5. BROKERS TO AN ISSUE:

Brokers are the middlemen who provide a vital connecting link

between the prospective investors and the issuing company.

They assist in the subscription of issue by the public. However,

appointment of brokers is not mandatory. Brokers get theircommission from the issuing company according to the

provisions of the Companies Act and rules and regulations.

There is an agreement between the brokers and the issuing

company. The maximum brokerage rate is 1.5 per cent of the

capital raised in case of public issue and 0.5 per cent in case of

private placement. The brokerage covers the cost of mailing,

canvassing and all other expenses relating to the subscription

of the issue.

The brokers should have an expert knowledge, professional

competence and integrity in order to carry out the overall

functions of an issue. They have to obtain consent from the

stock exchange to act as a broker to the issuing company. The

names and addresses of the brokers to the issue are disclosed

in the prospects by the company help the investors to make a

choice of the company for making their investments.

2.8.2 SECONDARY MARKET

A market, which deals in securities that have been already

issued by companies, is called as secondary market. It is also

known as stock market. It is the base upon which the primary


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market is depending. For the efficient growth of the primary

market a sound secondary market is an essential requirement.

The secondary market offers an important facility of transfer of

securities activities of securities.

Secondary market essential comprises of stock exchanges,

which provide platform for purchase and sale of securities by

investors. In India, apart from the Regional Stock Exchanges

established in different centers, there are exchanges like the

National Stock Exchange (NSE), who provide nationwide trading

facilities with terminals all over the country. The tradingplatform of stock exchanges in accessible only through brokers

and trading of securities in confined only to stock exchanges.

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

carried out through the mechanism of stock exchange. There

are at present 24 Stock Exchanges in India, recognized by the

government. The first organized stock exchange was

established in India at Bombay in 1887. When the Securities

Contracts (Regulation) Act was passed in 1956, only 7 stock

exchanges were recognized. There are three important stock

exchanges in Bombay namely the Bombay Stock Exchange,

National Stock Exchange and over the Counter Exchange of

India. There has been a substantial growth of capital market in

India during the last 25 years.

2.8.2a] REASONS FOR TRANSITING IN SECONDARY MARKET

There are two main reasons why individuals transact in the

secondary market:

1. INFORMATION MOTIVATED REASONS: - Informationmotivated investors believe that they have superior


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information about a particular security than other market

participants. This information leads them to believe that the

security is not being correctly period by the market. If the

information is good, this suggests that the security iscurrently under-priced, and investors with access to such

information will want to buy the security. On the other

hand, if the information is bad, the security will be currently

overpriced and such investors will want to sell their holdings

of the security.

2.LIQUIDITY MOTIVATED REASONS: - Liquidity motivatedinvestors, on the other hand, transact in the secondary

market because they are currently in a position of either

excess or insufficient liquidity. Investors with surplus cash

holdings (e.g., as result of an inheritance) will buy securities,

where as investors with insufficient cash (e.g. to purchase a

Car) will sell securities.

2.8.2b] FUNCTION OF THE SECONDARY MARKET

1.To facilitate liquidity and marketability of the outstandingequity and debt instruments.

2.To contribute to economic growth through allocation offunds to the most efficient channel through the process of

disinvestments to reinvestment.

3.To provide instant valuation of securities caused by changesin the internal environment (that is, company-wide and

industry wide factors). Such valuation facilitates the

measurement of the cost of capital and the rate of return of

the economic entities at the micro level.


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4.To ensure a measure of safety and fair dealing to protectinvestors interest. To induce companies to improve

performance since the market price at the stock exchanges

reflects the performance and this market price is readilyavailable to investors.

2.8.2c] Products in the Secondary Markets

Following are the main financial products / instruments dealt

in the Secondary market which may be divided broadly into Shares

and Bonds.

1. Shares : Equity Shares: An equity share, commonly referred to as

ordinary share, represents the form of fractional ownership

in a business venture.

Rights Issue / Rights Shares: The issue of new securitiesto existing shareholders at a ratio to those already held, at

a price. For e.g. a 35 2:3 rights issue at Rs. 125, would

entitle a shareholder to receive 2 shares for every 3 shares

held at a price of Rs. 125 per share.

Bonus Shares: Shares issued by the companies to theirshareholders free of cost based on the number of shares

the shareholder owns.

Preference shares: Owners of these kind of shares areentitled to a fixed dividend or dividend calculated at a fixed

rate to be paid regularly before dividend can be paid in

respect of equity share. They also enjoy priority over the

equity shareholders in payment of surplus. But in the


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event of liquidation, their claims rank below the claims of

the companys creditors, bondholders/debenture holders.

Cumulative Preference Shares: A type of preference shareson which dividend accumulates if remained unpaid. All

arrears of preference dividend have to be paid out before

paying dividend on equity shares.

Cumulative Convertible Preference Shares: A type ofpreference shares where the dividend payable on the same

accumulates, if no paid. After a specified date, these

shares will be converted into equity capital of the company.

2. Debenture :

The term Debenture is derived from the Latin word debere

which means to owe a debt. A debenture is an

acknowledgement of debt, taken either from the public or a

particular source. A debenture may be viewed as a loan,

represented as marketable security. The word bond may be

used interchangeably with debentures.

A stock market index is the reflection of the market as a whole.

It is a representative of the entire stock market. Movements in

the index represent the average returns obtained by the

investors. Stock market index is sensitive to the news of:

Company specific Country Specific

Thus the movement in the stock index is also the reflection of

the expectation of the future performance of the companies

listed on the exchange.


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Stock Exchange in India

The financial market in India today is more developed than

many other sectors because it was organized long before withthe securities exchanges of Mumbai, Ahmadabad and Kolkata

were established as early as the 19th Century. By the early

1960s the total number of securities exchanges in India rose to

eight, including Mumbai, Ahmadabad and Kolkata apart from

Madras, Kanpur, Delhi, Bangalore and Pune. Today there are

21 regional securities exchanges in India in addition to the

centralized NSE (National Stock Exchange) and OTCEI (Over theCounter Exchange of India).

Following are Stock Exchanges in India

Mangalore Stock Exchange Hyderabad Stock Exchange Utter Pradesh Stock Exchange

Coimbatore Stock Exchange Cochin Stock Exchange Bangalore Stock Exchange Saurashtra Kutch Stock Exchange Pune Stock Exchange National Stock Exchange OTC Exchange of India Calcutta Stock Exchange Inter-connected Stock Exchange (NEW) Madras Stock Exchange Bombay Stock Exchange Madhya Pradesh Stock Exchange Vadodara Stock Exchange The Ahmadabad Stock Exchange Magadha Stock Exchange


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Aquatic Stock Exchange Bhubaneswar Stock Exchange Jaipur Stock Exchange Delhi Stock Exchange Assoc Ludhiana Stock Exchange


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Chapter 3

Money Market

3.1 Introduction:

Money market is a market for short-term loan or financial

assets. It as a market for the lending and borrowing of short

term funds. As the name implies, it does not actually deals

with near substitutes for 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.

Money market is the centre for dealing mainly in short-term

money assets. It meets the short-term requirements of

borrowers and provides liquidity or cash to lenders. It is the

place where short-term surplus funds at the disposal of

financial institutions and individuals are borrowed byindividuals, institutions and also the Government.

The money market does not refer to a particular place where

short-term funds are dealt with. In includes all individuals,

institutions intermediaries dealing with short-term finds. The

transactions between borrowers, lenders and middleman take

place through telephone, telegraph, mail and agents. No

personal contact or presence of the two parties is essential for

negotiations in a money market. However, a geographical name

may be given to a money market according to its location. For

example. The London market operates from Wall Street. But,

they attract funds from all over the world to be lent to

borrowers from all over the globe. Similarly, the Mumbai Money

market is the centre for short-term loan able funds of not only

Mumbai, but also the whole of India.


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DEFINITION OF MONEY MARKET

According to Geottery Growther, The money market is the

collective name given to the various firms and institutions thatdeal in the various grades of near money

3.2 Features of a money market;

The following are the general features of a money market :

1. It is market purely for short-term funds or financial assetscalled near money.

2. It deals with financial assets having a maturity period up toone year only.

3. It deals with only those assets which can be converted intocash readily without loss and with minimum transaction

cost.

4. Generally transactions take place through phone i.e. oralcommunication. Relevant documents and written

communications can be exchanged subsequently. There is

no formal place like stock exchange as in the case of a

capital market.

5.Transactions have to be conducted without the help ofbrokers.

6.The components of a money market are the Central Bank,Commercial Banks, Non-banking financial companies,

discount houses and acceptance house. Commercial banks

generally play a dominant in this market.


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OBJECTIVES

The following are the important objectives of a money market :

(i) To provide a parking place to employ short-term surplusfunds.

(ii) To provide room for overcoming short-term deficits.(iii) To enable the Central Bank to influence and regulate

liquidity in the economy through its intervention in this

market.

(iv) To provide a reasonable access to users of Short-termfunds to meet their requirements quickly, adequately and

at reasonable costs.

3.3 Characteristic of a Developed Money Market:

In order to fulfill the above objections, the money market

should be fully developed and efficient. In every country of the

world, some type of money market exists. Some of them are

highly developed while others are not well developed. Prof. S.N.

Sen has described certain essential features of a developed

money market.

(i) Highly organized banking systemThe commercial banks are the nerve centre of the whole

money market. They are principal suppliers of short-term

funds. Their policies regarding loans and advances have

impact on the entire money market. The commercial

banks serve as vital link between the central bank and

the various segments of the highly organized banking

system co-exist. In an underdeveloped money market,

the commercial banking system is not fully developed.

(ii) Presence of A Central BankThe Central Bank acts of the bankers bank. It keeps

their cash reserves and provides them financial


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accommodation in difficulties by discounting their eligible

securities. In other words, it enables the commercial

banks and other institutions to convert their assets into

cash in times of financial crisis. Through its open marketoperations, the central bank absorbs surplus cash during

off-seasons and provides additional liquidity in the busy

seasons. Thus, the central bank is the leader, guide and

controller of the money market. In an underdeveloped

money market, the central bank is in the infancy and not

in a position to influence and control the money market.

(iii) Availability of Proper Credit InstrumentsIt is necessary for the existence of a developed money

market a continuous available of readily acceptable

negotiable securities such as bills of exchange, treasury

bills etc. In the market. There should be a number of

dealers in the money market to transact in these

securities. Availability of negotiable securities and the

presence of dealers and brokers in large number to

transact in these securities are needed for the existence of

a instruments as well as dealers to deal in these

instruments in an underdeveloped money market.

(iv) Existence of Sub-MarketsThe number of sub-markers determines the development

of a money market. The lager the number of sub-makers,

the broader and more developed will be the structure of

money market. The several sub-makers together make a

coherent money market. In an underdevelopment money

market, the various sub-makers, particularly the bill

market, are absent. Even of sub-makers exist, there is no

co-ordination between them. Consequently, different


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money rates prevail in the sub-makers and they remain

unconnected with of funds.

(v)

Ample ResourcesThere must be availability of sufficient funds to finance

transactions in the sub-makers. These funds may come

from within the country and also from foreign countries.

The London, New York and Paris money markets attract

funds from all over the world. The underdeveloped money

markets are starved of funds.

(vi) Existence of Secondary MarketThere should be an active secondary market in these

instruments.

(vii) Demand and Supply of FundsThere should be a large demand and supply of short-term

funds. It presupposes the existence of a large domestic

and foreign trade. Besides, it should have adequate

amount of liquidity in the form of large amounts maturing

within a short period.

Other Factors

Besides the above, other factors also contribute to the

development of a money market. Rapid industrial development

leading to the emergence of stock exchange, large volume of

international trade leading to the system of bills exchange,

political stability, favorable conditions for foreign investment,

price stabilization etc. are the other factors that facilitate the

development of money market in the country.


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London Money Market is a highly developed money market

because it satisfies all requirements of a developed money

market.

If any one or more of these factors are absent, then the money

market is called an underdeveloped one.

3.4 Importance of Money Market:

A developed money market plays an important role in the

financial system of a country by supplying short-term funds

adequately and quickly to trade and industry. The moneymarket is an integral part of a countrys economy. Therefore, a

developed money market is highly indispensable for the rapid

development of the economy. A developed money market helps

the smooth functioning of the financial system in any economy

in the following ways:

(i) Development of Trade And IndustryMoney market is an important source of financing trade

and industry. The money market, through discounting

operations and commercial papers, finances the short-term

working capital requirements of trade and industry and

facilities the development of industry and trade both

national and international.

(ii) Development of Capital MarketThe short-term rates of interest and the conditions that

prevail in the money market influence the long-term

interest as well as the resource mobilization in capital

market. Hence, the development of capital depends upon

the existence of a development of capital money market.


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(iii) Smooth Functioning of Commercial BanksThe money market provides the commercial banks with

facilities for temporarily employing their surplus funds in

easily realizable assets. The banks can get back the fundsquickly, in times of need, by resorting to the money market.

The commercial banks gain immensely by economizing on

their cash balances in hand and at the same time meeting

the demand for large withdrawal of their depositors. It also

enables commercial banks to meet their statutory

requirements of cash reserve ratio (C R R) and Statutory

Liquidity Ration (SLR) by utilizing the money marketmechanism.

(iv) Effective Central Bank ControlA developed money market helps the effective functioning

of a central bank. It facilities effective implementation of

the monetary policy of a central bank. The central bank,

through the money market, pumps new money into the

economy in slump and siphons if off in boom. The central

bank, thus, regulates the flow of money so as to promote

economic growth with stability.

(v) Formulation of Suitable Monetary PolicyConditions prevailing in a money market serve as a true

indicator of the monetary state of an economy. Hence, it

serves as a guide to the Government in formulating and

revising the monetary policy then and there depending

upon the monetary conditions prevailing in the market.

(vi) Non-Inflationary Source of Finance to GovernmentA developed money market helps the Government to raise

short-term funds through the treasury bills floated in the

market. In the absence of a developed money market, the


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government would be forced to print and issue more money

or borrow from the central bank. Both ways would lead to

an increase in prices and the consequent inflationary trend

in the economy.

3.5 Composition of Money Market

As stated earlier, the money market is not a single

homogeneous market. It consists of a number of sub-markets

which collectively constitute the money market. There should

be competition within each sub-market as well as betweendifferent sub-markets. The following are the main sub-markets

of a money market:

1. Call Money market2. Commercial Bills Market or Discount Market3. Acceptance Market4.Treasury bill Market.

3.5.1 Call Money market

The call money market refers to the market for extremely short

period loans; say one day to fourteen days. These loans are

repayable on demand at the option of either the lender or the

borrower. As stated earlier, these loans are given to brokers

and dealers in stock exchange. Similarly, banks with surplus

lend to other banks with deficit funds in the call money

market. Thus, it provides an equilibrating mechanism for

evening out short term surpluses and deficits. Moreover,

commercial bank an quickly borrow from the call market to

meet their statutory liquidity requirement. They can also

maximum their profits easily by investing their surplus funds in

the call market during the period when call rates are high and

volatile.


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Operations in Call Market

Borrowers and lenders in a call market contact each other over

telephone. Hence, it is basically over-the-telephone market.After negotiations over the phone, the borrowers and lenders

arrive at a deal specifying the amount of loan and the rate of

interest. After the deal is over, the lender issues FBL cheque in

favor of the borrower. The borrower is turn issues call money

borrowing receipt. When the loan is repaid with interest, the

lender returns the lender the duly discharges receipt.

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

the Discount and Finance House of India (DFHI), the borrowers

and lenders inform the DFHI about their fund requirement and

availability at a specified rate of interest. Once the deal is

confirmed, the deal settlement advice is lender and receives RBI

cheque for the money borrowed. The reverse is taking place in

the case of landings by the DFHI. The duly discharged call

deposit receipt is surrendered at the time of settlement. Call

loans can be renewed on the back of the deposit receipt by the

borrower.

Call Loan Market Transitions and Participants:

1.To commercial banks to meet large payments, largeremittances to maintain liquidity with the RBI and so on.

2.To the stock brokers and speculators to deal in stockexchange and bullion markets.

3.To the bill market for meeting matures bills.4.To the Discount and Finance House of India and the

Securities Trading Corporation of India to activate the call

market.


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5.To individuals of very high status for trade purposes to saveinterest on O.D. or cash credit.

The participants in this market can be classified into categoriesviz.

1.Those permitted to act as both lenders and borrowers of callloans.

2.Those permitted to act only as lenders in the market.

The first category includes all commercial banks, Co-operative

Banks, DFHI and STCI. In the second category LIC, UTI, GIC,

IDBI NABARD, specified mutual funds etc., are included. They

can only lend and they cannot borrow in the call market.

Advantages

In India, commercial banks play a dominant role in the call loan

market. They used to borrow and lend among themselves and

such loans are called inter-bank loans. They are very popular

in India. So many advantages are available to commercial

banks. They are as follows :

1. High LiquidityMoney lent in a call market can be called back at any time

when needed. So, it is highly liquid. It enables commercial

banks to meet large sudden payments and remittances by

making a call on the market.

2. High ProfitabilityBanks can earn high profiles by lending their surplus funds

to the call market when call rates are high volatile. It offers


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a profitable parking place for employing the surplus funds of

banks temporarily.

3.Maintenance of SLRCall money enables commercial bank to minimum their

statutory reserve requirements. Generally banks borrow on

a large scale every reporting Friday to meet their SLR

requirements. In absence of call market, banks have to

main idle cash to meet their reserve requirements. It will tell

upon their profitability.

4. Safe and CheapThough call loans are not secured, they are safe since the

participants have a strong financial standing. It is cheap in

the sense brokers have been prohibited form operating in the

call market. Hence, banks need not pay brokers on call

money transitions.

5. Assistance to Central bank OperationsCall money market is the most sensitive part of any financial

system. Changes in demand and supply of funds are quickly

reflected in call money rates and give an indication to the

central bank to adopt an appropriate monetary policy.

Moreover, the existence of an efficient call market helps the

central bank to carry out its open market operations

effectively and successfully.

Drawbacks

The call market in India suffers from the following drawbacks :

1. Uneven Development:

The call market in India is confined to only big industrial

and commercial centers like Mumbai, Kolkata, Chennai,


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Delhi, Bangalore and Ahmadabad. Generally call markets

are associated with stock exchanges. Hence the market is

not evenly development.

2. Lack of Integration:

The call markets in different centers are not full integrated.

Besides, a large number of local call markets exist without

any integration.

3. Volatility in Call Money Rates :Another drawback is the volatile nature of the call moneyrates. Call rates vary to greater extant indifferent centers

indifferent seasons on different days within a fortnight. The

rates are between 12% and 85%. One cannot believe 85%

being charged on call loans.

3.5.2 Commercial Bills Market or Discount Market

A commercial bill is one which arises out of a genuine trade

transaction, i.e. credit transaction. As 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 amount

mentioned therein after a certain specified date. Thus, a bill of

exchange contains a written order from the creditor to the

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

creation period. A bill of exchange is a self-liquidating paper

and negotiable; it is drawn always for a short period ranging

between 3 months and 6 months.

Definition

Section 5 of the negotiable Instruments Act defines a bill

exchange a follows : An instrument in writing containing an

unconditional order, signed by the maker, directing a certain


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person to pay a certain sum of money only to, or to the order of

a certain person or to the beater of the instrument.

Types of BillsMany types of bills are in circulation in a bill market. They can

be broadly classified as follows:

1. Demand and usince bills2. Clean bills and documentary bills3. Inland and foreign bills4. Export bills and import bills.5.

Indigenous bills

6. Accommodation bills and supply bills.

1. Demand and Usince BillsDemand bills are others called sight bills. These bills are

payable immediately as soon as they are presented to the

drawer. No time of payment is specified and hence they are

payable at sight.

Usince bills are called time bills. These bills are payable

immediately after the expiry of time period mentioned in the

bills. The period varies according to the established trade

custom or usage prevailing in the country.

2. Clean bills and documentary billsWhen bills have to be accompanied by documents of title to

goods like Railways, receipt, Lorry receipt, Bill of Lading etc.

the bills are called documentary bills. These bills can be

further classified into D/A bills and D/P bills. In the case of

D/A bills, the documents accompanying bills have to be

delivered to the drawer immediately after acceptance.

Generally D/A bills are drawn on parties who have a good

financial standing.


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On the order hand, the documents have to be handed over to

the drawer only against payment in the case of D/P bills.

The documents will be retained by the banker. Till thepayment of such bills. When bills are drawn without

accompanying any documents they are called clean bills. In

such a case, documents will be directly sent to the drawee.

3. Inland and foreign billsInland bills are those drawn upon a person resident in India

and are payable in India. Foreign bills are drawn outsideIndia and they may be payable either in India or outside

India. They may be drawn upon a person resident in India

also. Foreign boils have their origin outside India. They also

include bills drawn on India made payable outside India.

4. Export bills and import bills.Export bills are those drawn by Indian exports on importers

outside India and import bills are drawn on Indian importers

in India by exports outside India.

5. Indigenous billsIndigenous bills are those drawn and accepted according to

native custom or usage of trade. These bills are popular

among indigenous bankers only. In India, they called

hundis the hundis are known by various names such as

Shah Jog, Nam Jog, Jokhani, Termain Jog, Darshani,

Dhanijog, and so on.

6. Accommodation bills and supply bills.If bills do not arise out of genuine trade transactions, they

are called accommodation bills. They are known as kite

bills or wind bills. Two parties draw bills on each other


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purely for the purpose of manual financial accommodation.

These bills are discounted with bankers and the proceeds

are shared among themselves. On the due dates, they are

paid.

Supply bills are those neither drawn by suppliers or

contractors on the government departments for the goods

nor accompanied by documents of title to goods. So, they

are not considered as negotiable instruments. These bills

are useful only for the purpose of getting advances from

commercial banks by creating a charge on these bills.

Operations in Bill Market

From the operations point of view, the bill market can be

classified into two viz.

Discount Market Acceptance Market

A] Discount Market

Discount market refers to the market where short-term

genuine trade bills are discounted by financial

intermediaries like commercial banks. When credit sales are

affected, the seller draws a bill on the buyer who accepts in

promising to pay the specified sum at the specified period.

The seller has to wait until the maturity of the bill for gettingpayment. But, the presence of a bill market enables him to

get payment immediately. The seller can ensure payment

immediately by discounting the bill with some financial

intermediary by paying a small amount of money called

Discount rate on the date of maturity, the intermediary

claims the amount of the bill from the person who has

accepted the bill.


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In some countries, there are some financial intermediaries

who specialize in the field of discounting. For instance, in

London Money Market there are specialize in the field

discounting bills. Such institutions are conspicuouslyabsent in India. Hence, commercial banks in India have to

undertake the work of discounting. However, the DFHI has

been established to activate this market.

3.5.3 Acceptance Market

The acceptance market refers to the market where short-term

genuine trade bills are accepted by financial intermediaries. All

trade bills cannot be discounted easily because the parties to

the bills may not be financially sound. In case such bills are

accepted by financial intermediaries like banks, the bills earn a

good name and reputation and such bills can readily

discounted anywhere. In London, there are specialist firms

called acceptance house which accept bills drawn by trades and

import greater marketability to such bills. However, their

importance has declined in recent times. In India, there are no

acceptance houses. The commercial banks undertake the

acceptance business to some extent.

Advantages or Importance

1. Liquidity2. Certainty of Payment3. Ideal Investment4. Simple Legal Remedy5. High and Quick Yield6. Easy Central Bank Control


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3.5.4 Treasury Bill Market

Just like commercial bills which represent commercial debt,

treasury bills represent short-term borrowing of the

Government. Treasury bill market refers to the market wheretreasury bills are bought and sold. Treasury bills are very

popular and enjoy higher degree of liquidity since they are

issued by the government.

Meaning and Feature

A treasury bills nothing but promissory note issued by the

Government under discount for a specified period stated

therein. The Government promises to pay the specified amount

mentioned therein to the beater 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 require any grading or endorsement

or acceptance since it is claims against the Government.

Treasury bill are issued only by the RBI on behalf of the

Government. Treasury bills are issued for meeting temporary

Government deficits. The Treasury bill rate of discount is fixed

by the RBI 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 degree of liquidity and security.

Types of Treasury Bills

In India, there are two types of treasury bills viz. (i) ordinary or

regular and (ii) ad hoc known as ad hocs ordinary treasury

bills are issued to the public and other financial institutions for

meeting the short-term financial requirements of the Central

Government. These bills are freely marketable and they can be


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bought and sold at any time and they have secondary market

also.

On the other hand ad hocs are always issued in favour of theRBI only. They are not sold through tender or auction. They

are purchased by the RBI on top and the RBI is authorized to

issue currency notices against them. They are marketable sell

them back to the RBI. Ad hocs serve the Government in the

following ways:

I.

They replenish cash balances of the central Government.Just like State Government get advance (ways and means

advances) from the RBI, the Central Government can raise

finance through these ad hocs.

II. They also provide an investment medium for investing thetemporary surpluses of State Government, Semi-

Government departments and Foreign Central Banks.

On the basis of periodicity, treasury bills may be classified into

three they are:

I. 91 days treasury billsII. 192 days treasury bills andIII. 364 days treasury bills

Ninety one days treasury bills are issued at a fixed discount

rate of 4% as well as through auctions. 364 days bills do not

carry any fixed rate. The discount rate on these bills are quoted

in auction by the participants and accepted by the authorities.

Such a rate is called cut off rate. In the same way, the rate is

fixed for 91 days treasury bills sold through auction. 91 days

treasury bills (top basis) can be rediscounted with the RBI at


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any time after 14 days of their purchase. Before 14 days a

penal rate is charged.

Operations and Participants

The RBI holds days treasury bills (TBs) and they are issued on

top basis throughout the week. However, 364 days TBs are sold

through auction which is conducted once in a forthnight. The

date of auction and the last date of submission of tenders are

notified by the RBI through a press release. Investors can

submit more than one bid also. One the next working day of

the date auction, the accepted bids with prices are displayed.

The successful bidders have to collect letters of acceptance from

the RBI and deposit the same along with cheque for the amount

due on RBI within 24 hours of the announcement of auction

results.

Institutional investors like commercial banks; DFHI, STCI, etc.

maintain a subsidiary General Ledger (SGL) account with the

RBI. Purchases and sales of TBs are automatically recorded in

this account invests who do not have SGL account can

purchase and sell TBs though DFHI. The DFHI does this

function on behalf of investors with the help of SGL transfer

forms. The DFHI is actively participating in the auctions of

TBs. It is playing a significant role in the secondary market

also by quoting daily buying and selling rates. It also gives buy-

back and sell-back facilities for periods up to 14 days at an

agreed rate of interest to institutional investors. The

establishment of the DFHI has imported greater liquidity in the

TB market.


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3.6 Financial Institutions

The participants in this market are the followers:

i. RBI and SBIii.

Commercial banks

iii. State Governmentsiv. DFHIv. STCIvi. Financial Institutions like LIC, GIC, UTI, IDBI, ICICI,

IFCI, NABARD, etc.

vii. Corporate Customers.viii.

Public

Through many participants are there, in actual practice, this

market is in the hands at the banking sector. It accounts for

nearly 90% of the annual sale of TBs.

3.7 Money Market Instrument

A variety of instruments are available in a developed money

market. In India, till 1986, only a few instruments were

available. They were :

i. Treasury bills in the treasury marketii. Money at call and short notice in the call loan market.iii. Commercial bills, promissory notices in the bill market.

Now, in additional to the above, the following new instruments

are available.

i. Commercial Papersii. Certificate of depositiii. Inter-bank participation certificatesiv. Repo Instruments.


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3.7.1 COMMERCIAL PAPERS

Introduction

During the 1980s wave of financial liberalization and innovationin financial instruments swept across the world. A basic

feature of the many innovations is the trend towards

securitization, i.e. raising money direct from the investors in the

form of negotiable securities as a substitute for the bank credit.

The companies found it cheaper to borrow directly from public

as it involved lower information and transaction cost. This also

suits the interest of many investors as it provides them with awide spectrum of financial instruments to choose from and in

placing their instrument used for financing working capital

requirements of corporate enterprises.

A commercial paper is an unsecured promissory note issued

with a fixed maturity by a company approved by RBI, negotiable

by endorsement and delivery, issued in bearer form and issued

at such discount on the face value as may be determent by the

issuing company.

1. Commercial paper is a short-term money marketinstrument comprising ursine promissory note with a fixed

maturity.

2. It is a certificate evidencing an unsecured corporate debtof short term maturity.

3. Commercial paper is issued at a discount to face valuebasis but it can be issued in interest bearing form.

4. The issuer promises to pay the buyer some fixed amounton some future period but pledge no assets, only his


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liquidity and established earning power, to guarantee that

promise.

Commercial paper can be issued directly by a company to

investors or through banks / merchant banks.

Advantages of Commercial Paper

1. Simplicity2. Flexibility3. Easy to Raise Long Term Capital

Commercial Paper in India

In India, on the recommendations of the Vaghul working Group,

the RBI announced on 27th March, 1989, that commercial paper

will be introduced soon in Indian Money Market. The

recommendations of the Vaghul Working Group on introduction

of commercial paper in Indian money market are as flowers :

1. There is a need have limited introduction of commercialpaper. It should be carefully planned and the eligibility

criteria for the issuer should be sufficiently rigorous to

ensure that the commercial paper market develops on

healthy lines.

2. Initially, access to the commercial paper market should beregistered to rated companies having a new worth of Rs. 5

Crore and above with good dividend payment record.

3. The commercial paper market should function within theoverall discipline of CAS. The RBI would have to

administer the entry on the market, the amount if each

issues the total quantum that can be raised in a year.


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4. Ni restriction be placed on the commercial paper marketexcept by way of minimum size of note. The size of single

issue should not be less than Rs. 1 Crore and the size of

each lot should not be less than Rs. 5 lakhs.

5. Commercial paper should be excluded from thestipulations on insecure advances in the case of banks.

6. Commercial paper would not be tied to any transactionand the maturity period may be 7 days and above but not

exceeding six months, backed up if necessary by a

revolving underwriting facility of less than three years.

7. The using company should have a net worth of net lessthan Rs. 5 crores, a debt quality ratio of not more than

105, current ratio of more than 1033, a debt servicing

ratio closer to 2, and be listed on the stock exchange.

8. The interest rate on commercial paper would be markeddominated and the paper could be issued at a discount to

face value or could be interest bearing.

9. Commercial paper should not be subject to stamp duty atthe time of issue as well as at the time transfer by

endorsement and delivery.

On the recommendations of the Vaghul Working Group, the RBI

announced on 27th March, 1989 that commercial paper will be

introduced soon in Indian money market. Detailed guidelines

were issued in December, 1989, through non-banking

companies (acceptance of Deposits through commercial paper)

Direction, 1989 and finally the commercial papers were

instructed in India from 1st January, 1990.


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3.7.2 CERTIFICATE OF DEPOSIT (CD)

Certificate of deposits are short term deposit instruments

issued by banks and financial institutions to raise large sumsof money.

Features of Certificate of Deposit

1. Document of title to time deposit2. Unsecured negotiable promotes3.

Freely transferable by endorsement and delivery

4. Issued at discount to face value5. Repayable on a fixed date without grace days.6. Subject to stamp duty like the usince promissory notes.

The banks in USA in 1960s introduced CDs which are freely

negotiable and marketable any time before maturity. The CDs

were issued by big banks in the USA of $1 million at face value

bearing fixed interest with a maturity generally ranging from 1

to 6 months. Banks sold CDs direct to investors or through

dealers who subsequently traded this instrument in secondary

market. The American banks issued for the first time dollar

CDs in London in 1966. The bank of England gave permission

to around 40 banks to make CD issue.

The feasibility of introducing CDs in India was examined by the

Tamb Working Group in 1982 which did not, however, favour

the introduction of this instrument. The manner was again

studied in 1987 by the Vaghul Working Group on the Money

Market. The Vaghul Group recognized that CP world by

attractive both the banker and investor in that the bank is not

required to encase the deposit prematurely while the investor


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can liquefy the instrument before its maturity in the secondary

market.

On the recommendations of the Vaghul Committee, the RBIformulated a scheme in June 1989 permitting scheduled

commercial banks (excluding RRBs) to issue CDs. It terms of

the scheme, CDs can be issued by scheduled commercial banks

at discount on face value and the discount rates are market

determined. The RBI has issued detailed guidelines for the

issue of CDs and, with the changes introduced subsequently,

the scheme for CDs has been liberalized.

RBI Guidelines

1. The denomination of CDs could be in multiples of Rs. 5lakh subject to a minimum size of an issue to a single

investor being Rs. 25 lakh. The CDs above Rs. 25 lakh

will be in multiples of Rs. 5 lakh. The amount rates to

face value (not mortuary value) of CDs issued.

2. The CDs are short-term deposit instruments with maturityperiod ranging from 3 months to one year. The banks can

issues at their discretion the CDs for any member of

months / days beyond the minimum usince period of

three months and within the maximum usince of one year.

3. CDs can be issued to individuals, corporations,companies, trut funds, associations, etc. non-resident

Indians (NRIs) can also subscribe to CDs but only on a

non-repatriation.

4. CDs are freely transferable by endorsement and deliverybut only after 45 days of the date of issue the primary


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investor. As such, the maturity period of CDs available in

the market can be anywhere between 1 day and 320 days.

5. They are issued in the form of usince promissory notespayable on a fixed date without days of grace. CDs are

subject to payment of stamp duty like the usince

promissory notes.

6. Banks have to maintain CRR and SLR on the issue price ofCDs and report them as deposits to the RBI. Banks are

neither permitted to grants loans against CDs nor to buy

them back prematurely.

7. From October 17, 1992, the limit for issue of CDs byscheduled commercial banks (excluding Regional Rural

Banks) has been raised from 7 per cent to 10 per cent of

the fortnightly aggregate deposits in 1989-90. The ceiling

on outstanding of CDs at any point of time are prescribed

by the Reserve Bank of India for each bank. Banks are

advised by the RBI to ensure that the individual bank wise

limits prescribed for issue of CDs are not exceeded at any

time.

At present the total permissible limits for issue of

certificates of deposits (CDs). By the banking system

amounts to Rs. 15,038 crore equivalents to 10 percent of

the fortnightly average outstanding aggregate deposits in

1989-90. The outstanding amount of CD issued by 50

scheduled commercial banks as on February 5, 1998

amounted to Rs. 10,261 crore and formed 7

Documents

Financial Markets Final