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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
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