FINANCIAL INSTITUTIONS & MARKETS

SHORT NOTES

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NOTE: DATA BELOW HAS BEEN COPIED FROM VARIOUS SOURCES.
(UTILIZE AT YOUR OWN DISCRETION, FOR REFERENCE PURPOSES ONLY)

Unit I
Structure of Indian Financial System
The Indian Financial system can be broadly classified into the formal (organized) financial
system and the informal (unorganized) financial system. The formal financial system comes
under the purview of the Ministry of Finance (MoF), the Reserve Bank of India (RBI), the
Securities and Exchange Board of India (SEBI), and other regulatory bodies.
The informal financial system consists of:
 Individual money lenders such as neighbors, relatives, landlords, traders, and store
owners.
 Groups of persons operating as ‘funds’ or ‘associations.’ These groups function under
a system of their own rules and use names such as ‘fixed fund,’ ‘association,’ and
‘saving club.’
 Partnership firms consisting of local brokers, pawnbrokers, and non-bank financial
intermediaries such as finance, investment, and chit-fund companies.
In India, the spread of banking in rural areas has helped in enlarging the scope of the formal
financial system.

Components of the formal financial system

1. Financial Institutions: These are the intermediaries that mobilize savings and facilitate
the allocation of funds in an efficient manner. They can be classified as banking and
non-banking financial institutions. Banking institutions are creators and sellers of
credit while non-banking financial institutions are sellers of credit. In India the
developmental financial institutions (DFI’s) and non-banking financial companies
(NBFC) as well as housing finance companies are the major sellers of credit. They
can be of following types:
 Term-finance institutions such as IDBI, ICICI etc.
 Specialized finance institutions such as export import bank of India (EXIM),
NABARD etc.
 Investment institutions dealing with mutual funds like Unit Trust of India (UTI),
public-pvt mutual funds and insurance activity of LIC, GIC etc.
 State level FI’s such as State Financial Corporation (SFC’s) and State Industrial
Development Corporation (SIDC) etc.
Post-reforms era, the role of FI’s have undergone change. Banks now undertake non-bank
activities, while FI’s have undertaken banking functions.

2. Financial Markets: Financial markets are a mechanism enabling participants to deal in

financial claims. The markets also provide a facility in which their demands and requirements
interact to set a price for such claims.
 The main organized financial markets in India are the money market and the capital
market. The first is a market for short-term securities while the second is a market for
long-term securities, i.e., securities having a maturity period of one year or more.
  Financial markets can also be classified as primary and secondary markets. While the
primary market deals with new issues, the secondary market is meant for trading in
outstanding or existing securities.
 There are two components of the secondary market: over-the-counter (OTC) market
and the exchange traded market. The government securities market is an OTC market.
In an OTC market, spot trades are negotiated and traded for immediate delivery and
payment while in the exchange-traded market, trading takes place over a trading cycle
in stock exchanges.
(Recently, the derivatives market (exchange traded) has come into existence)

3. Financial Instruments: A financial instrument is a claim against a person or an

institution for payment, at a future date, of a sum of money and/or a periodic payment in the
form of interest or dividend. The term ‘and/or’ implies that either of the payments will be
sufficient but both of them may be promised. Financial instruments represent paper wealth
shares, debentures, like bonds and notes. Many financial instruments are marketable as they
are denominated in small amounts and traded in organized markets. This distinct feature of
financial instruments has enabled people to hold a portfolio of different financial assets
which, in turn, helps in reducing risk.
Financial securities are financial instruments that are negotiable and tradeable. Financial
securities may be primary or secondary securities.
 Primary securities are also termed as direct securities as they are directly issued by the
ultimate borrowers of funds to the ultimate savers. Examples of primary or direct
securities include equity shares and debentures.
 Secondary securities are also referred to as indirect securities, as they are issued by
the financial intermediaries to the ultimate savers. Bank deposits, mutual fund units,
and insurance policies are secondary securities.
Financial instruments help financial markets and financial intermediaries to perform the
important role of channelizing funds from lenders to borrowers.

4. Financial Services: The major categories of financial services are funds

intermediation, payments mechanism, provision of liquidity, risk management, and financial
engineering.
 Funds intermediating services link the saver and borrower which, in turn, leads to
capital formation. New channels of financial intermediation have come into existence
as a result of information technology.
 Payment services enable quick, safe, and convenient transfer of funds and settlement
of transactions
 Liquidity is essential for the smooth functioning of a financial system. Financial
liquidity of financial claims is enhanced through trading in securities. Liquidity is
provided by brokers who act as dealers by assisting sellers and buyers and also by
market makers who provide buy and sell quotes
 Financial services are necessary for the management of risk in the increasingly
complex global economy. They enable risk transfer and protection from risk.
Financial services are necessary for the management of risk in the increasingly
complex global economy. They enable risk transfer and protection from risk.
 Financial engineering refers to the process of designing, developing, and
implementing innovative solutions for unique needs in funding, investing, and risk
management.
The producers of these financial services are financial intermediaries, such as, banks,
insurance companies, mutual funds, and stock exchanges.

Interactions Among Financial System Components

The four financial system components discussed do not function in isolation. They are
interdependent and interact continuously with each other in the following ways:
1. Financial institutions mobilize savings by issuing various types of financial
instruments which are traded in the financial markets. To facilitate the credit-
allocation process, these institutions render specialized financial services.
2. Financial institutions have close links with financial markets, and make these markets
larger, more liquid and stable, while also relying on them to raise funds as needed.
This increases the competition between markets and institutions for attracting
investors and borrowers.
3. The development of sophisticated markets has led to the development of complex
securities, the evaluation of which requires the expertise of financial intermediaries
who provided financial services.
4. Financial markets also impact the financial intermediaries such as banks and financial
institutions, which are changed ad the bulk of the service fees or non-interest income
they derive is linked with financial market related activities.

Functions of a financial system

 Mobilize and allocate savings by linking savers to the investors
 Monitors corporate performance of the investments, and exerts corporate control via
threaten of hostile takeovers of under-performing firms
 Provide payment and settlement systems for exchange of goods and services to ensure
funds move safely and timely
 Optimum allocation of risk-bearing and reduction, by trading the risks involved in
mobilizing savings and allocating credit
 Disseminate price related information to those who need to take economic and
financial decisions
 Offer portfolio adjustment facility i.e. providing a quick, cheap and safe way of
selling a wide variety of financial assets
 Lower the cost of transactions, increasing rate of return to savers, and reduced cost to
borrowers
 Promote the process of financial deepening (increase in financial assets as a
percentage of GDO) and broadening (building and increasing number and variety of
participants and instruments)

Financial Sector Reforms

Context
The pre-reforms period, i.e., the period from the mid-1960s to the early 1990s was
characterized by administered interest rates, industrial licensing and controls, dominant
public sector, and limited competition. This led to the emergence of an economy
characterized by uneconomic and inefficient production systems with high costs. For 40
years, India’s growth rate averaged less than 4 per cent per annum
 The Indian government, therefore, initiated deregulation in the 1980s by relaxing the
entry barriers, removing restrictive clauses in the Monopolies and Restrictive Trade
Practices (MRTP) Act, allowing expansion of capacities, encouraging modernization of
industries, reducing import restrictions, raising the yield on long-term government
 securities, and taking measures to help the growth of the money market. These measures
resulted in a relatively high growth in the second half of the 1980s, but its pace could not
be sustained
 In the beginning of the 1990s, an increase in world oil prices due to the Gulf war coupled
with a sharp drop in the remittances of migrant workers in the Gulf created a foreign
exchange crisis in India. This crisis became aggravated as there was an outflow of foreign
currency owing to a fear of default by the Indian government on its external
commitments.
 Thus, the task before the government was twofold: to restore macro-economic stability by
reducing the fiscal as well as the balance of payments deficit and to complete the process
of economic reforms which had been initiated in the 1980s.

Pre-Reform Period Issues

1. After 1947, India adopted a state-dominated development strategy, where all
allocation decisions were made by the government. Accelerated capital accumulation
by increasing domestic savings was considered to be key to development which was
achieved by high taxes, suppressing consumption, and appropriating profits via
ownership of commercial enterprises.
2. The role of the financial system was limited, where banks were the dominant players
for accumulation of savings and financing of trade/industrial activities. There was
limited incentive for savings (low capital accumulation) as interest rates were
repressed
3. Allocation efficiency of the funds was reduced due to government interference, where
banks directed credits to priority sectors at subsidized rates decided by the
government, while charging higher rates from other borrowers and paying lower rates
to depositors.
4. Thus, the Indian financial system till the early 1990’s was closed, restricted,
segmented and highly regulated.
5. In 1990’s there was a shift from a state-dominated to a market-determined strategy,
which was on account of government failure in achieving a higher growth rate. On
one hand the government could not generate resources for investment or public
services, on the other there was an erosion in public savings.
Above factors made reforms inevitable which were aimed at improving operational and
allocative efficiency of the financial system.

Objectives
The government initiated economic reforms in June 1991 to provide an environment of
sustainable growth and stability. Economic reforms were undertaken keeping in view two
broad objectives.
1. Reorientation of the economy from one that was statist, state-dominated, and highly
controlled to one that is market-friendly. In order to achieve this, it was decided to reduce
direct controls, physical planning, and trade barriers.
2. Macro-economic stability by substantially reducing fiscal deficits and the government’s
draft on society’s savings.

Improving the efficiency of the financial system is one of the basic objectives of regulators.
An efficient financial system is one which allocates savings to its most productive use
(optimal allocation of financial resources). It also ensures:
 Information arbitrage efficiency i.e. whether market prices reflect all available
information
  Fundamental valuation efficiency i.e. whether company valuations are reflected in
stock prices
 Full insurance efficiency i.e. whether economic agents can insure against all future
contingencies

Financial Sector Reforms since 1991

The weaknesses of the banking system were extensively analyzed by the committee (1991)
on financial sector reforms, headed by Narasimham. The committee found that the banking
system was both over-regulated and under-regulated. The reforms taken were as follows:

A. Narsimham Committee on Banking Sector Reforms (I)

1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR): This
was one so more bank credit was available to the industry, trade and agriculture. SLR
was as high as 39%, while CRR was 15%. (CRR could be reduced by reduction of the
monetized budget deficit of govt., SLR could be reduced by govt. efforts to reduce
fiscal deficit and hence its borrowing requirements)
2. End of Administered Interest Rate Regime: The old regime facilitated the fund
allocation to priority sectors by cross subsidization i.e. concessional rate charged from
primary sector and higher rates from non-concessional borrowers. This system was
totally done away with and banks today have freedom to choose the different interest
rates for different lending types.
3. High Capital Adequacy Ratio: To ensure that the financial system operates on a sound
and competitive basis, prudential norms (a financial regulation requiring financial
firms to control risk and hold adequate capital as defined by capital requirements)
with regards to capital adequacy ratio were introduced. Capital adequacy is the ratio
of the paid-up capital and reserves to the bank deposits. The capital base of Indian
banks has been very low and in fact declined over time. (8% capital adequacy norm
was set up)
4. Competitive Financial System: After nationalization of 14 large banks in 1969, no
bank had been allowed to be set up in the private sector. It was however recognized
that there was an urgent need for introducing greater competition in the Indian money
market which could lead to higher efficiency of the financial system. Accordingly,
private sector banks such as HDFC, Corporation Bank, ICICI Bank, UTI Bank, IDBI
Bank and some others have been set up which led to substantial contribution to
housing finance, car loans and retail credit (credit card), making possible wider use of
plastic money namely Debit and Credit cards. competition has also sought to be
promoted by permitting liberal entry of branches of foreign banks, therefore, CITI
Bank, Standard Chartered Bank, Bank of America, American Express, HSBC Bank
5. Recovery of Debts: GoI passed the Recovery of Debts due to Banks & Financial
Institutions Act 1993, to facilitate and speed up the recovery of debts. Six special
recovery tribunals have been set up.
6. Prudential Norms: Started by RBI in order to impart professionalism in commercial
banks. The purpose of prudential norms includes proper disclosure of income,
classification of assets and provision for Bad debts so as to ensure that the books of
commercial banks reflect the accurate and correct picture of financial position.
7. Other Measures: Banks were enabled to raise capital through public issue, Freedom
was given to open new branches, Local Area Banks were allowed to be set up.
B. Narsimham Committee on Banking Sector Reforms (II): In 1998 the government
appointed yet another committee under the chairmanship of Mr. Narsimham. It is better
known as the Banking Sector Committee. It was told to review the banking reform
progress and design a programme for further strengthening the financial system of India.
1. Strengthening Banks in India: The committee considered the stronger banking system
in the context of the Current Account Convertibility ‘CAC’. Suggested that banks must
be capable of handling domestic liquidity and exchange rate management and
recommended the merger of strong banks which will have ‘multiplier effect’ on the
industry.
2. Narrow Banking: Those days many public sector banks were facing a problem of the
Non-performing assets (NPAs). Some of them had NPAs as high as 20 percent of their
assets. Thereby it recommended ‘Narrow Banking Concept’ where weak banks will be
allowed to place their funds only in the short term and risk-free assets.
3. Capital Adequacy Ratio: Recommended that the Govt. should raise the prescribed
capital adequacy norms. Currently, the capital adequacy ratio for Indian banks is at 9
percent.
4. Bank ownership: Felt that the government control over the banks in the form of
management and ownership and bank autonomy does not go hand in hand and thus it
recommended a review of functions of boards and enabled them to adopt professional
corporate strategy.
5. Review of banking law: The committee considered that there was an urgent need for
reviewing and amending main laws governing Indian Banking Industry like RBI Act,
Banking Regulation Act, State Bank of India Act, Bank Nationalization Act, etc. This
up gradation will bring them in line with the present needs of the banking sector in
India.

Liquidity Adjustment Facility (Introduced Under above stated Banking Reform) (LQP)
A liquidity adjustment facility (LAF) is a tool used in monetary policy, primarily by the
Reserve Bank of India (RBI), that allows banks to borrow money through repurchase
agreements (repos) or for banks to make loans to the RBI through reverse repo agreements.
This arrangement manages liquidity pressures and assures basic stability in the financial
markets. The facilities are implemented on a day-to-day basis as banks and other financial
institutions ensure they have enough capital in the overnight market. The transacting of
liquidity adjustment facilities take place via an auction at a set time of the day. An entity
wishing to raise capital to fulfill a shortfall engages in repo agreements, while one with
excess capital does the opposite – executes a reverse repo.
 The RBI can use the liquidity adjustment facility to manage high levels of inflation. It
does so by increasing the repo rate, which raises the cost of servicing debt. This, in
turn, reduces investment and money supply in India’s economy.
 Conversely, if the RBI is trying to stimulate the economy after a period of slow
economic growth, it can lower the repo rate to encourage businesses to borrow, thus
increasing the money supply.
This was pursuant to the recommendations of the Narasimham Committee Report on banking
reforms. The LAF was introduced in stages. In the first stage, with effect from June 5, 2000
the RBI will introduce variable repo auctions with same day settlement. According to this
scheme, the amount of repo and reverse repo will be changed by the RBI on a daily basis to
manage liquidity.

Future Agenda of Reforms

The Indian financial system is fairly integrated, stable, and efficient. There are weaknesses in
the system which need to be addressed. These include a high level of non-performing assets
in some banks and financial institutions, disciplinary issues with regard to non-banking
financial companies, government’s high domestic debt and borrowings, volatility in financial
markets, absence of a yield curve, and co-operative bank scams. The growth rate of GDP has
increased since 2003–04 but it needs to be sustained. India still has a long way to go. We can
achieve a growth rate of 8 per cent for which we need reforms in key areas such as
agriculture, power and labor. Greater consolidation and competition among banks and other
financial intermediaries such as mutual funds and insurance companies is needed to lower the
costs of intermediation and expand the availability of credit and insurance in the rural areas.

Recent Reforms
Payments Bank - LQP
In August 2015, the banking regulator cleared 11 organizations for setting up payment’s
banks. The idea was to introduce more un-banked or under-banked Indians to formal
channels. Last year, Airtel Payments Bank was forbidden from adding new customers for a
few months after it was revealed that it had violated certain norms by opening accounts
without customers’ consent. Now, Paytm and Fino Payments banks are also in a similar soup.

Recently, the central bank declared that the KYC done by these firms before launching their
respective banks won’t be valid. This has increased operational costs. “Customer acquisition
has become even more difficult now. Earlier it was easy to get customers on-board as the
KYC level was really basic. But now things have changed. Earlier, payments bank customers
were expected to start off with basic digital transactions with payments banks, and graduate
to more complex banking, including loans and investments, in the long run. Digital
transactions were also expected to reduce their costs. However, with the coming of the
government’s Unified Payments Interface and the entry of several other payment firms, the
digital edge has been lost. Even existing banks have upped the ante online. One of the most
important concerns is that these banks are not allowed to lend and, therefore, the revenue
stream is limited, raising serious doubts over the model’s viability. Also, they are allowed to
invest only in government securities which offer lesser returns compared to other avenues
such as mutual funds.
The next leg of growth for payments banks may now come only by acquiring merchants,
explain analysts. But this will require significant investments. Since profitability remains
elusive, many may not be keen to pump in more funds at this point.

Monetary Policy Committee - LQP

The Monetary Policy Committee (MPC) is a committee of the Central Bank in India
(Reserve Bank of India), headed by its Governor, which is entrusted with the task of
fixing the benchmark policy interest rate (repo rate) to contain inflation within the
specified target level. The MPC replaces the current system where the RBI governor,
with the aid and advice of his internal team and a technical advisory committee, has
complete control over monetary policy decisions. A Committee-based approach will
add a lot of value and transparency to monetary policy decisions. Its functions are
stated as below:
1. Under the Monetary Policy Framework Agreement, the RBI will be responsible
for containing inflation targets at 4% (with a standard deviation of 2%) in the
medium term.
 2. The newly designed statutory framework would mean that the RBI would have
to give an explanation in the form of a report to the Central Government, if it
failed to reach the specified inflation targets.
3. Further, RBI is mandated to publish a Monetary Policy Report every six
months, explaining the sources of inflation and the forecasts of inflation for the
coming period of six to eighteen months
Given this backdrop, MPC decides the changes to be made to the policy rate (repo
rate) so as to contain the inflation within the target level specified to it by the Central
Government.

Insolvency & Bankruptcy Code 2016 - LQP

The code was enacted to address the troubling shortcomings in the existing insolvency laws
in India, and to bring them under one umbrella. At present insolvency resolution takes around
4.3 years in India (UK – 1 year). The code is a critical legislation introduced in recent years
impacting the ease of doing business. Its salient features are given as below:
1. The new code will construct a constitutional framework consisting of IBBI
(Insolvency & Bankruptcy Board of India) as regulating authority, insolvency
professionals, information utilities (credit info storing units) and adjudicatory
mechanism to facilitate time bound insolvency resolution.
2. Part II of the Code titled ‘Insolvency Resolution and Liquidation for Corporate
Persons’ applies to matters relating to insolvency and liquidation of corporate debtors
where the minimum amount of default is Rs.1,00,000/-.
3. Chapter II in Part II is titled ‘Corporate Insolvency Resolution Process”. It has
following important sections:
 Section 6: Where any corporate debtor commits a default, a
financial/operational/corporate debtor itself may initiate the corporate
insolvency resolution process
 Section 7/8: Initiation of process by financial creditor/operational creditor
 Section 9: Application for initiation of corporate insolvency resolution process by
operational creditor
4. Chapter III deals with the “Liquidation Process”, section 33 thereunder provides for
initiation of liquidation, where the adjudicating authority does not deceive the resolution plan
or rejects it, then it shall pass an order requiring the corporate debtor to be liquidated in the
manner laid down in Chapter III.
 Section 33 (5) provides that subject to Section 52, no suit or legal proceedings shall
be instituted by or against the corporate debtor except with prior approval of
adjudicating authority
 Section 34 deals with appointment of a liquidator, and provides that where the
adjudicating authority has passed an order for liquidation of the corporate debtor
under section 33, the resolution professional appointed for the resolution process shall
act as a the liquidator for the purpose of liquidation, with the power to sell the
immovable/moveable/actionable claims of the corporate debtor by public auction or
private contract.
5. Part V of the code deals with ‘Miscellaneous’ provisions under Section 224 to 255.
Section 238 stipulates that the provision of the code shall have effect notwithstanding
anything inconsistent therewith contained in any other law for the time being in force or any
instrument having effect by virtue of any such law.

GST (Short Note)

Goods and Service Tax (GST) is an indirect tax levied on the supply of goods and
services. This law has replaced many indirect tax laws that previously existed in India.
“GST is a comprehensive, multi-stage, destination-based tax that is levied on every value
addition.”
 Multi Stage: GST is levied at each stage of the value chain be it purchase of raw
material, or sale to wholesaler.
 Destination Based: Goods manufactures in UP are sold to the final consumer in Delhi.
Since GST is levied at the point of consumption, entire tax revenue will go to Delhi.
 Value Addition: GST is levied only on the value addition, i.e. the monetary value
added at each stage to achieve the final sale to the end customer.
Advantages – Removes cascading tax effect, Simpler procedures, Lesser compliances,
increased logistical efficiency, regulates unorganised sector.

Regulation of Banks, NBFCs & FIs

Banking Regulation Act 1949

It came into force on March 16, 1949. The act provides a framework using which commercial
banking is supervised and regulated. Its purpose is to
 Provide safety in the interest of depositors
 Prevent misuse of power by managers of bankers
Initially, the law was applicable only to banking companies, but it was amended in 1965 to
include cooperative banks under its purview. The Act gives RBI the power to license banks,
have regulation over shareholding and voting rights of shareholders; supervise the
appointment of the board and management; regulate the operations of the banks; lay down
instructions for audits; control moratorium (authorization to debtors to postpone payment),
mergers and liquidation; issue directives in the interest of public good and on banking policy
and impose penalties. The details of the powers of RBI are:
1. Power to call for and publish the information.
2. Prior approval from RBI for appointment of managing directors
3. Removal of managerial and any other person from office
4. Power of RBI to appoint additional directors
5. Moratorium under the orders of High Court
6. Winding up of banking companies
7. Scheme of amalgamation to be sanctioned by the RBI
8. Power of RBI to examine the record of proceedings and tender advice in winding up
proceedings
9. Power of RBI to inspect and make its report to winding up
10. Power of RBI to call for returns and information from the liquidator of the banking
company
11. Issue of NOC for change of name
12. Issue of NOC for alteration of memorandum of banking company

RBI Act 1934

The Reserve Bank of India Act 1934 is an Act to constitute a Reserve Bank of India (RBI)
and provide the central bank (RBI) with various powers to act as the central bank of India.
RBI Act 1934.
1. Section-3 Section 3 of the RBI act provides for establishment of Reserve Bank of India
for taking over the management of the currency from Central Government and of carrying
on the business of banking in accordance with the provisions of the act
2. Section 4 Section 4 of the RBI Act defines the capital of RBI which is Rs. 5 crores.
3. Section 7 of the RBI Act empowers the central government to issue directions in public
interest from time to time to the bank in consultation with RBI governor.
4. Section 17 This section deals with the functioning of RBI. The RBI can accept deposits
from the central and state governments without interest. It can purchase and discount bills
of exchange from commercial banks. It can purchase foreign exchange from banks and
sell it to them. It can provide loans to banks and state financial corporations. It can
provide advances to the central/state government. It can buy or sell government securities.
It can deal in derivative repo, and reverse repo.
5. Section 18 describes emergency loans to banks
6. Section 21 assigns RBI the duty of being banker to the central government and manage
public debt.
7. Section 22 grants power to RBI to issue the currency
8. Section 23 has the provision that highest denomination note could be Rs. 10,000
9. Section 28 empowers the RBI to form laws concerning the exchange of damaged and
imperfect notes
10. Section 31 provides that in India RBI and central government only can issue and accept
promissory notes that are due on request
11. Section 42 (1) provides that every scheduled bank needs to hold on average daily balance
with the RBI
Note: RBI defines the scheduled banks which are mentioned in the 2 Schedule of the Act.
nd

These are banks which have paid up capital and reserves above 5 lakhs.

Role of RBI as a central banker

RBI is the central bank of the country. Role of RBI differs from other banks since it does not
get engaged in day to day retail banking instead it is the Bankers’ Bank and formulates the
monetary guidelines and policies which are to be followed by all the banks operating in the
country. The key functions of the RBI are stated below:
1. Currency Issue: Reserve bank of India is the only authority who is authorized to issue
currency in India. RBI also works to prevent counterfeiting of currency by regularly
upgrading security features of currency.
2. Banker to the GoI: RBI maintains its accounts, receive and make payments out of
these accounts. RBI also helps GoI to raise money from public via issuing bonds and
government approved securities.
3. Supervisor of Banks: Bankers’ Bank: RBI also works as banker to all the scheduled
commercial banks. All the banks in India maintain accounts with RBI which help
them in clearing & settling inter-bank transactions and customer transactions
smoothly & swiftly. Maintaining accounts with RBI help banks to maintain statutory
reserve requirements. RBI also acts as lender of last resort for all the banks.
4. RBI as Country’s Foreign Exchange Manager: RBI has an important role to play in
regulating & managing Foreign Exchange of the country. It manages the forex and
gold reserves of the nation.
5. RBI as Controller of Credit: Regulator of Money supply: RBI formulates and
implements the Monetary Policy of India to keep the economy on a growth path.
Monetary Policy refers to the process employed by RBI to control availability & cost
of currency and thus keeping Inflationary & deflationary trends low and stable. The
measures adopted by RBI can be broadly categorized as:
Quantitative Tools: Quantitative measures of credit control are applicable to the entire money
and banking system without discrimination.
  CRR (4%): The ratio specifies minimum fraction of the total deposits of customers,
which commercial banks have to hold as reserves either in cash or as deposits with the
central bank.
 SLR (19.25%): The share of net demand and time liabilities that banks must maintain
in safe and liquid assets, such as government securities, cash and gold is SLR.
 Bank Rate (6.5%): When banks want to borrow long term funds from RBI, it is the
interest rate which RBI charges from them.
 Repo Rate (6.25%): If banks want to borrow money (for short term, usually
overnight) from RBI, the banks have to pay this interest rate. Banks have to pledge
government securities as collateral.
 Reverse Repo Rate (6%): Reverse repo rate is just the opposite of repo rate. If a bank
has surplus money, they can park this excess liquidity with RBI and central bank will
pay interest on this.
 Open Market Operations (OMO): Open market operation is the activity of buying and
selling of government securities in open market to control the supply of money in
banking system. (When there is excess supply of money, RBI sells government
securities thereby taking away excess liquidity and vice versa)
 Marginal Standing Facility (MSF) (7%): Banks can borrow up to 2.5% of their
respective Net Demand and Time Liabilities. he important difference with repo rate is
that bank can pledge government securities from SLR quota (up to 1%).

Qualitative Tools: Qualitative measures of credit control are discriminatory in nature and are
applied for specific purpose or to specific financial institutions which are violating the
monetary policy norms.
 LTV or Margin Requirements: Loan to Value (LTV) is the ratio of loan amount to the
actual value of asset purchased. RBI regulates this ratio so as to control the amount
bank can lend to its customers.
 Selective credit control: RBI can specifically instruct banks not to give loans to
traders of certain commodities. This prevents speculations/hoarding of commodities
using money borrowed from banks.
 Moral Suasion: RBI persuades bank through meetings, conferences, media statements
to do specific things under certain economic trends. An example of this measure is to
ask banks to reduce their Non-performing assets (NPAs).

Recent RBI Examples: RBI well played its role as a central bank, proven by following points
(under Rajan’s regime):
1. Inflation: brought down retail inflation to 3.78%, lowest since 1990’s.
2. CPI was adopted as a key indicator of inflation, which is a global norm, despite
government recommending otherwise.
3. India’s forex reserve is about 30% stronger than it was two years back.
4. Two universal banks have been licensed and 11 payments banks have been given the
nod. This is expected of extending the banking services to nearly 2/3 population.
rd

MCLR (Shifting from Base Rate to MCLR & effect on Pricing of Loans - LQP)
RBI linked the base rate (minimum rate set by RBI below which banks are not allowed to
lend to its customers) for loans given by banks to the MCLR starting 1 April 2018.
 MCLR: Marginal Cost of Funds based Lending Rate: It is an internal reference rate
for banks to decide what interest they can levy on loans, for this they take into
account the incremental cost of arranging additional rupee for the prospective
 borrower. (Interest rates will be determined as per relative riskiness of individual
customers)
 This system was introduced to tackle base rate regime problems where the banks were
reluctant to cut their lending rates, or did so with time lag.
 Under the MCLR, the banks have to review and declare overnight, 1-3-6 months and
1-2-3-year rates each month.
 However, when it comes to lending, the interest rate of home loans will get re-priced
on a periodical basis.
 Primary reason to switch from base rate to MCLR has been the inactiveness seen in
banks towards passing the benefit of RBI rate cuts to borrowers. The MCLR takes
into account the marginal cost of funds which includes the rate at which the bank
receives deposits and other costs of borrowings, which has largely helped banks in
passing on the benefits to the customers.
 The base rate borrowers have two options either to switch to MCLR based lending
with the same bank or else get the loan refinanced from another bank on MCLR
mode. One may also continue the loan on base rate, if it is nearing the end.

Retail Banking
Retail banking refers to the division of a bank that deals directly with retail customers. Also
known as consumer banking or personal banking, retail banking is the visible face of banking
to the general public, with bank branches located in abundance in most major cities.
Banks that focus purely on retail clientele are relatively few, and most retail banking is
conducted by separate divisions of banks. Customer deposits garnered by retail banking
represent an extremely important source of funding for most banks. Some of the retail
banking products are:
 Bank accounts like checking/demand accounts (come with a debit card for making
purchases and the ability to pay bills online), saving accounts and retirement accounts.
 Money Market accounts pay marginally high, with a few limitations on how often one
can spend the money
 Certificate of Deposits (CD) pay more than savings account, but money must be left
untouched for several months to avoid early withdrawal penalties
 Home Loans to buy home, second mortgages to allow borrowers to refinance existing
loans, Auto Loans, unsecured personal loans (no collateral), lines of credit (credit
cards) allow borrowers to spend and repay repeatedly without applying for new loans
 Safe deposit boxes
 Net-Banking facility via RTGS (Real Time Gross Settlement) & NEFT (National
Electronic Funds Transfer)

Corporate Banking
Corporate banking, also known as business banking, refers to the aspect of banking that deals
with corporate customers and provides them loans for growth. Corporate banking is a key
profit center for most banks; however, as the biggest originator of customer loans, it is also
the source of regular losses due to bad loans. Several new types of products have been
introduced in the corporate banking sector as listed below:
 Industrial Loans: Providing loans to large industrial corporations. Since mega corps
can obtain funds directly from the market, they can avoid the intermediary costs (of
the banks). The primary business of banks is declining, to combat this the banks offer
debt market advisory, which is a major product sold to corps.
 Project Finance: Bankers finance the project as an individual entity. The parent
company sponsoring the project has limited liability in case of a bad loan.
  Syndicated Loans: Banks can combine to offer huge syndicated loans to corporations
because the debt requirements may be so huge that an individual bank can’t fulfill
them. There is a lead financier bank who is entitled to a special fee for coordinating
with other banks.
 Leasing: A form of off-balance sheet financing, where the company has control over
the leased asset without leveraging the balance sheet of the given corporation. Leases
are signed by companies for majorly acquiring fixed assets.
 Foreign Trade Financing: Rampant foreign trade establishes its need. Banks provide
letters of credit (letters issued by one bank to another to serve as a payment
guaranteed to a specific person), export financing and other services to help MNC’s
conduct efficient foreign trade.

BASIS RETAIL BANKING CORPORATE BANKING

Number of Large number of Small number of clients as compared to retail
clients clients banking.
Cost Low processing cost High processing cost
Medium level of
Relationship High level of relations
relations
lower value
Transactions Higher level value transactions
transactions

Investment Banking: Provides services like raising financial capital, underwriting debt
(guaranteeing payment) or equity issuance, assisting in mergers and acquisitions to corps,
govts, and individuals.

Private Banking: Banking and financial services provided to high net worth individuals, on a
much personal level than traditional retail banks.

Universal Banking
Universal banking is a combination of Commercial banking, Investment banking,
Development banking, Insurance and many other financial activities. It is a place where all
financial products are available under one roof. Universal banking is done by very large
banks. These banks provide a lot of finance to many companies. So, they take part in the
Corporate Governance (management) of these companies. These banks have a large network
of branches all over the country and all over the world. They provide many different financial
services to their clients.
In India, two reports in 1998 mentioned the concept of universal banking. They are, the
Narasimham Committee Report and the S.H. Khan Committee Report. Both these reports
advised to consolidate (bring together) the banking industry through mergers and integration
of financial activities. That is, they advised a combination of all banking and financial
activities.
In 2000, ICICI asked permission from the RBI to become a universal bank.

Advantages
1. Investor Trust: Universal Banks (UB) holds stakes of many companies. These
companies can gain investor confidence, due to the credibility arising from UB
closely watching their activities.
 2. Economies of Scale: UB will have higher efficiency arising due to lower costs, higher
output and better products, due to a consolidation of operations.
3. Profitable Diversification: UB can diversify its activities, thus using the same
financial experts to provide a variety of different financial services.
4. Easy Marketing: UB’s can easily sell their products through many branches. They can
ask their existing clients to buy their other products which requires less marketing due
to a well-established name.
5. One-Stop Shopping: All financial products under one roof saving time and transaction
costs, increasing speed of work for bank as well as clients.

Certain Disadvantages: Different rules and regulations, Monopolisation, Failure can be costly
(Lehman Brothers), Conflict of operations.

RBI guidelines: RBI recently unveiled guidelines for on-tap licensing of new private banks,
to initiate universal banking ventures. Under the guidelines, the resident professionals with 10
years’ experience in banking and finance are eligible to promote universal banks. Large
industrial houses are excluded as entities, but can invest in the banks up to 10 per cent.
 A non-operative financial holding company (NOFHC) is not mandatory for setting up
a bank
 In case a bank is set up via NOFHC, a promoter should not hold less than 51% of the
total paid-up equity capital in the holding company
 Existing NBCFs controlled by residents with a track record of at least 10 years are
also eligible as promoters
 Initial minimum paid-up voting equity capital has been left unchanged at Rs.500 crore

Core banking solution (CBS): Core Banking Solution (CBS) is networking of branches,
which enables Customers to operate their accounts, and avail banking services from any branch
of the Bank on CBS network, regardless of where he maintains his account. The customer is
no more the customer of a Branch. He becomes the Bank’s Customer. It offers invariably all
information that a bank's customer would need if he/she visits a bank branch in person. These
are as follows:
 To make enquiries about the balance or debit or credit entries in the account.
 To obtain cash payment out of his account by tendering a cheque.
 To deposit a cheque for credit into his account.
 To deposit cash into the account.
 To get the statement of account
 To transfer funds from his account to some other account

Internet Banking: Online banking allows a user to conduct financial transactions via the
internet. Online banking is also known as internet banking. Online banking offers customers
almost every service traditionally available through a local branch including deposits,
transfers, and online bill payments. Online banking requires a computer or other device, an
internet connection, and a bank or debit card. Some banks also allow customers to open up
new accounts and apply for credit through online banking portals. Two major electronic
payment system for inter-bank fund transfer maintained by RBI are:

RTGS: Fund transfer takes place on a real time basis i.e. at the time the request is received.
It is one of the fastest interbank money transfer facilities available through banking channels
in India. The beneficiary bank has to credit the recipient's account within 30 minutes of
receiving the funds transfer message. (8 AM – 4:30 PM on Weekdays & Working Saturdays,
Minimum 2 lakh)

NEFT: On the other hand, NEFT operates on a deferred settlement basis. Fund transfer under
NEFT is settled in batches as opposed to the real-time settlement process in RTGS. The
batches are settled in hourly time slots. (8 AM to 7 PM, no minimum amount)

Note: Customers having savings or current accounts are eligible to avail NEFT/ RTGS
service. Individuals who do not have a bank account can also deposit cash at the NEFT-
enabled branches.

NBFC
According to the Reserve Bank of India (Amendment Act) 1997, A Non-Banking Finance
Company means:
(i) A Financial Institution which is a company;
(ii) A non-banking institution which is a company and which has as its principal business the
receiving of deposits under any scheme or arrangement or in any other manner or lending in
any manner;
(iii) Such other non-banking institutions or class of such institutions as the bank may with the
previous approval of the Central Government specify.
Non-banking finance companies consist mainly of finance companies which carry on hire
purchase finance, housing finance, investment, loan, equipment leasing or mutual benefit
financial companies but do not include insurance companies or stock exchanges or stock-
broking companies. They can help to fulfill the credit needs of both wholesale and retail
customers.

Types:
1. Equipment Leasing Company is a company which carries on the business of leasing
of equipment or the financing of such activity.
2. Hire Purchase Finance Company is a company which carries on the hire purchase
transactions or the financing of such transactions.
(Hire-purchase finance is a system under which term loans for purchase of goods, producer
goods or consumer goods and services are advanced which have to be liquidated under an
installment plan.)
3. Housing Finance Company is a company which carries on the financing of the
acquisition or construction of houses/plots of lands for construction of houses.
4. Investment Company means any company which carries on as its principle business
the acquisition of securities.
5. Loan Company is a company which carries on as its principle business, the providing
of finance whether by making loans or advances or otherwise for any activity other than its
own.

Banks vs. NBFCs.

Basic NBFCs Banks

Meaning They provide banking It is a government authorized financial

services to people without intermediary which aims at providing
holding Bank License banking services to the public.
 Regulated under Companies Act 2013 Banking Regulation Act 1949

Demand Deposit Cannot be Accepted Can be Accepted

Foreign Allowed up to 100% Allowed up to 74% for Private Sector

Investment Bank

Payment and Not a part of the System An Integral part of the System
Settlement
system*

Maintenance of Not Required Mandatory

Reserve Ratios

Deposit Insurance Not Available Available

Facility*

Credit Creation NBFC does not create Bank create Credit

Credit

Transaction Cannot be provided by Provided by Bank

Services* NBFC

* Terms
Deposit Insurance Facility – Allowed to depositors by deposit insurance and credit guarantee
corporation
Transaction Services – Overdraft facility, issue of traveller’s cheque, transfer of funds etc.
Payment & Settlement System – Common rules, procedures for implementation of clearing
(settlement of accounts), transfer of funds and execution of final settlement
 Unit II

Introduction to Financial Markets in India

Financial Markets
Financial markets are a mechanism enabling participants to deal in financial claims. The
markets also provide a facility in which their demands and requirements interact to set a price
for such claims.
 The main organized financial markets in India are the money market and the capital
market. The first is a market for short-term securities while the second is a market for
long-term securities, i.e., securities having a maturity period of one year or more.
 Financial markets can also be classified as primary and secondary markets. While the
primary market deals with new issues, the secondary market is meant for trading in
outstanding or existing securities.
 There are two components of the secondary market: over-the-counter (OTC) market
and the exchange traded market. The government securities market is an OTC market.
In an OTC market, spot trades are negotiated and traded for immediate delivery and
payment while in the exchange-traded market, trading takes place over a trading cycle
in stock exchanges.
(Recently, the derivatives market (exchange traded) has come into existence)

Importance/Role of Financial Markets

 Financial markets create and open and regulated system for companies to acquire
large amounts of capital. This is done via the stock and bond market.
 Markets also allow these businesses to offset risk. They do this with commodities,
forex futures contract and other derivatives.
 Since markets are public, they provide and open and transparent way to set prices on
everything trade. They reflect all available knowledge about everything traded. This
reduces to cost of obtaining information as it’s already incorporated into the prices.
 The sheer size of the financial markets provides liquidity. In other words, sellers can
unload assets whenever they need to raise cash. The size also reduces the cost of
doing business.
 There are a variety of markets each serving a special purpose (described in-depth
later), for instance the stock market deals with issue, buying and selling of stock and
is considered a capital market because it provides financing for long-term
investments. The bond market is one where financing is provided by issue, sale and
purchase of bonds, also considered a capital market.

Features of Indian Financial Markets

 The financial market in India at present is more advanced than many other sectors as
it became organized as early as the 19th century with the securities exchanges in
Mumbai, Ahmedabad and Kolkata.
 The Indian stock markets till date have remained stagnant due to the rigid economic
controls in early years. It was only in 1991, after the liberalization process that the
India securities market witnessed several IPOs. The market saw many new companies
spanning across different industries entering the markets.
 The launch of the NSE (National Stock Exchange) and the OTCEI (Over the Counter
Exchange of India) in the mid-1990s helped in regulating a smooth and transparent
form of securities trading.
  The regulatory body for the Indian capital markets was the SEBI (Securities and
Exchange Board of India). The capital markets in India experienced turbulence after
which the SEBI came into prominence.
 Indian financial market comprises of Indices (BSE 30, Sensex charts, Sector Indexes),
Stock News (BSE, Sensex 30, S&P, CNX-Nifty), Fixed income securities (Corporate
bonds, Government securities, Money Market), Foreign Investments, Global equity
indexes (Dow Jones, Morgan Stanley), Currency Indexes, Mutual Funds, Insurance,
Loans, Forex and so on.

Financial Markets Types

Financial markets can be broadly classified as below:

Money Market
The money market is a market for short-term funds, which deals in financial assets whose
period of maturity is up to one year. It should be noted that money market does not deal in
cash or money as such but simply provides a market for credit instruments such as bills of
exchange, promissory notes, commercial paper, treasury bills, etc. These financial
instruments are close substitute of money. These instruments help the business units, other
organizations and the Government to borrow the funds to meet their short-term requirement.
Money market does not imply to any specific market place. Rather it refers to the whole
networks of financial institutions dealing in short-term funds, which provides an outlet to
lenders and a source of supply for such funds to borrowers. Most of the money market
transactions are taken place on telephone, fax or Internet. The Indian money market consists
of Reserve Bank of India, Commercial banks, Co-operative banks, and other specialized
financial institutions. The Reserve Bank of India is the leader of the money market in India.
Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC,
GIC, UTI, etc. also operate in the Indian money market. (Instruments are covered in detail in
4 Unit)
th

Capital Market
Capital Market may be defined as a market dealing in medium and long-term funds. It is an
institutional arrangement for borrowing medium and long-term funds and which provides
facilities for marketing and trading of securities. So, it constitutes all long-term borrowings
from banks and financial institutions, borrowings from foreign markets and raising of capital
by issue various securities such as shares debentures, bonds, etc. The market where securities
are traded known as Securities market. It consists of two different segments namely primary
and secondary market. The primary market deals with new or fresh issue of securities and is,
therefore, also known as new issue market; whereas the secondary market provides a place
for purchase and sale of existing securities and is often termed as stock market or stock
exchange.

Difference between Primary & Secondary market

Currency Market: The International Currency Market is a market in which participants from
around the world buy and sell different currencies. Participants include banks,
corporations, central banks, investment management firms, retail forex brokers. The
International Currency Market is the largest financial market in the world, with an average
daily trading volume of $5 trillion. In this market, transactions do not occur on a single
exchange, but in a global computer network of large banks and brokers from around the
world.

Debt Market/Bond Market: The debt market, or bond market, is the arena in which
investment in loans are bought and sold. There is no single physical exchange for bonds.
Transactions are mostly made between brokers or large institutions, or by individual
investors. Investments in debt securities typically involve less risk than equity investments
and offer a lower potential return on investment. Debt investments by nature fluctuate less in
price than stocks. Even if a company is liquidated, bondholders are the first to be paid. Bonds
are the most common form of debt investment. These are issued by corporations or by the
government to raise capital for their operations and generally carry a fixed interest rate. Most
are unsecured but are issued with a rating by one of several agencies such as Moody's to
indicate the likely integrity of the issuer. (Detailed information in Unit 4)
Factors affecting Financial Markets
There are 4 major forces that affect the financial markets, primarily described as below:
1. Government: Government holds much control over free markets. The fiscal and monetary
policies that governments and central banks put in place have a profound effect on the
financial marketplace. (Monetary – increasing/decreasing interest rates & Fiscal –
changing interest rates)
2. International Transactions: The flow of funds between countries effects the strength of a
country's economy and its currency. The more money that is leaving a country, the
weaker the country's economy and currency. The money inflow via export can be
reinvested and stimulates the financial markets within the country.
3. Speculation & Expectation: Consumer, investor and politicians hold different views about
where they think the economy will go in the future which affects their current actions.
Sentiment indicators are used to gauge how certain groups feel about the current economy
which can be analyzed and can create a bias towards the future price rates and trends.
4. Supply & Demand: Prices & rates change with changes in the supply & demand factors
which affects the financial market changes at the very basic level.

Linkages Between Economy and Financial Markets

The simple response is that well-developed, smoothly operating financial markets play an
important role in contributing to the health and efficiency of an economy. There is a strong
positive relationship between financial market development and economic growth. Financial
markets help to efficiently direct the flow of savings and investment in the economy in ways
that facilitate the accumulation of capital and the production of goods and services. The
combination of well-developed financial markets and institutions, as well as a diverse array
of financial products and instruments, suits the needs of borrowers and lenders and therefore
the overall economy.

Integration of Indian Financial Markets with Global Financial Markets

In recent years, the Indian economy has seen a great transformation from a closed, controlled,
slow growing economy to a more open, liberalized and one of the fastest growing economies
of the world. Indian markets have established themselves as providing decent opportunities to
investors. There are benefits of international financial integration, as it positively affects the
total factor productivity, increasing the depth and breadth of domestic financial markets, and
increasing the degree of efficiency in the intermediation process by lowering costs and
excessive profits.
(FII’s impact is very high on Indian market, for instance the Sensex lost almost 687 points in
2008 – Lehman Brother crisis, this happened because when FII’s tend to withdraw money,
domestic investors become fearful and also withdraw money)

Primary Market for Corporate Securities in India

A primary market issues new security on an exchange for companies, governments and other
groups to obtain financing through debt-based or equity-based securities. Primary markets are
facilitated by underwriting groups consisting of investment banks that set a beginning price
range for a given security and oversee its sale to investors. Issue of Corporate Securities takes
place in the following ways:
1. Public Issue through Prospectus: Under this method, the company issues a prospectus
to the public inviting offers for subscription. The investors who are interested in the
securities apply for the securities they are willing to buy. Advertisements are also issued
in the leading newspapers. Under the Company Act it is obligatory for a public limited
company to issue a prospectus or file a statement in lieu of prospectus with the Registrar
of Companies made in accordance with the provisions of the companies act and
guidelines of SEBI. Once subscriptions are received, the company makes allotment of
securities keeping in view the prescribed requirements.
This method enables a company to raise funds from a large number of investors widely
scattered throughout the country. This method ensures a wider distribution of securities
thereby leading to diffusion of ownership and avoids concentration of economic power in
a few hands.

2. Green Shoe option (LQP): A green shoe option is an over-allotment option. In the
context of an initial public offering (IPO), it is a provision in an underwriting
agreement that grants the underwriter the right to sell investors more shares than initially
planned by the issuer if the demand for a security issue proves higher than expected.
Over-allotment options are known as green shoe options because, in 1919, Green Shoe
Manufacturing Company was the first to issue this type of option. A green shoe option
provides additional price stability to a security issue because the underwriter can increase
supply and smooth out price fluctuations. It is the only type of price stabilization measure
permitted, (Option is the extent of 15% of the issue size).

Guidelines related to Green Shoe Option:

 The company shall appoint one of the merchant bankers or Book Runner, as the
“stabilizing agent” (SA), who will be responsible for the price stabilization process.
 The SA shall also enter into an agreement with the promoter(s) or pre issue
shareholders who will lend their shares, which shall not be in excess of 15% of the
total issue size.
 The SA shall open a special account with a bank to be called the Special Account for
GSO.
 The money received from the applicants against the overallotment in the green shoe
option shall be kept in the GSO Bank Account,
 The shares bought from the market by the SA, if any during the stabilization period,
shall be credited to the GSO Demat Account. The shares lying in the GSO Demat
Account shall be returned to the promoters immediately after the close of the
stabilization period.
 On expiry of the stabilization period, in case the SA does not buy shares, the issuer
company shall allot shares in dematerialized form to the GSO Demat Account, within
five days of the closure of the stabilization period. These shares shall be returned to
the promoters.
 The SA shall remit an amount equal to (further shares allotted by the issuer company
to the GSO Demat Account) * (issue price) to the issuer company from the GSO Bank
Account.

3. Offer for sale: Under this method, the issuing company allots or agrees to allot the
security to an issue house at an agreed price. The issue house or financial institution
publishes a document called an ‘offer for sale’. It offers to the public shares or debentures
for sale at higher price. Application form is attached to the offer document. After
receiving applications, the issue house renounces the allotment in favor of the applicants
who become direct allottees of the shares or debentures. This method saves the company
from the cost and trouble of selling securities directly to the investing public.
4. Private Placement: A private placement involves the sale of securities to a relatively
small number of select investors. Investors targeted include wealthy accredited investors,
large banks, mutual funds, insurance companies and pension funds. A private placement
is different from a public issue in which securities are made available for sale on the open
market to any type of investor. A private placement has minimal regulatory requirements
and standards that it must abide by. The investment does not require a prospectus and in
many cases, detailed financial information is not disclosed.
5. Rights Issue: Right issue means an issue of new securities to be offered to the
existing shareholder of the company at a specified price within a subscription period.
Right issue to the existing shareholder is generally at a discount to the market price of the
shares. Company can issue rights by sending a letter of offer to the shareholders who in
turn have the option either to exercise their right and buy new shares at offered price, or
they can renounce their rights and sell them in open market, or shareholders can choose to
do nothing.
6. On-Line IPO: Public issue can be made either through the existing banking channels
or through the online system. SEBI has certain guidelines on online issues for instance
there must be an agreement with the stock exchange, a SEBI registered broker must be
appointed who collects money from clients and transfers to the registrar the issue.
Prospectus should include names of everyone involved, and the allotment should be made
within 15 days from closure of issue.
7. ESOP: It’s a method of marketing the securities whereby its employees are
encouraged to
take up shares. It’s a voluntary scheme. As per SEBI guidelines a special resolution is
required for ESOP, and its operations are guided under the remuneration committee of
Board of Directors. ESOP are not from promoters, however there is no restriction on
maximum no. of shares that can be issued to an individual employee.
8. Preferential Issue: It is an issue of shares or convertible securities by listed
companies to a select group of persons. Such allotments are generally made to the
promoters, foreign partners and private equity funds. A listed company is allowed to
make a preferential issue in terms of equity shares, partly/fully convertible debentures or
any other instruments convertible into equity shares.
9. Bonus Issue: Bonus share is also one of the ways to raise capital but it does not bring
any fresh capital. Companies distribute profit to the existing shareholders by way of fully
paid bonus share instead of Dividend. Only enables the company to restructure its capital.
It is not included in Primary Issue.

Bought out Deal: Bought deal is a securities offering in which an investment

bank commits to buy the entire offering from the client company. A bought deal
eliminates the issuing company’s financing risk, ensuring that it will raise the intended
amount. However, the client firm will likely get a lower price by taking this approach
instead of pricing it via the public markets with a preliminary prospectus filing. It is a
method of marketing of securities in which promoters of an unlisted company make a sale
of equity shares to a single sponsor or the lead sponsor. Three participants in bought out
deals are A) Promoters B) Sponsors C) co-sponsor. Selling price is determined through
negotiation between issuing company and the purchaser.

Book Building of Shares: Book building is the process of determining the price at which
an IPO will be offered. The quantum and price of the securities to be issued will be
decided on the basis of the bids received from the prospective shareholders. The
 companies are bound to adhere to SEBI’s guidelines for book building offers in the
following manners:
 75% Book Building Process: Here 25% of the issue is to be sold at the fixed price and
75% through book building process
 100% Book Building Process: As the name suggests.
Process:
1. Company appoints one or more merchant banker as lead book runner (names
disclosed in red herring prospectus) who files with SEBI a draft red herring
prospectus
2. Issuer shall enter into agreement with one or more stock exchanges while a stock
broker is appointed to accept bids
3. There is an issue price band say 350 (floor) - 390 (cap), SEBI introduced the moving
band concept in which range can be moved up/down 20% depending on demand.
4. Allotment norms include 35% of net offer to retail investors, 15 – non-institutional
investor (say high net worth), 50 – QIB’s (Qualified Institutional Buyers)

ASBA (Application Supported by Blocked Amounts)

SEBI launched an alternate payment system for book built public issue in August 2008.
ASBA exempts retail investors from making the full payment & instead lets certain amount
facilitate the application till the completion of the allotment. It contains authorization to block
the application money in a bank account. After 2010 this facility was extended to Right issue
also.

Here the ASBA investor must submit an ASBA amount to SCSB (Self-certified syndicate
bank) who blocks the application money in bank account till finalization of allotment. It also
uploads the details of electronic bidding of NSE & BSE. After allotment is finalized, SCSB
transfers the amount to issuers account.

Divestment of PSU
Disinvestment can also be defined as the action of an organization (or government) selling or
liquidating an asset or subsidiary. It is also referred to as ‘divestment’ or ‘divestiture.’ The
new economic policy initiated in July 1991 clearly indicated that PSUs had shown a very
negative rate of return on capital employed. Inefficient PSUs had become and were
continuing to be a drag on the Government’s resources. Hence, the need for the Government
to get rid of these units and to concentrate on core activities was identified. The Government
also took a view that it should move out of non-core businesses, especially the ones where the
private sector had now entered in a significant way.
PSU are henceforth called White elephants, i.e. a possession that is useless or troublesome,
especially one that is expensive to maintain or difficult to dispose of.

Private Equity: Private equity is an alternative investment class and consists of capital that is
not listed on a public exchange. Private equity is composed of investors that directly invest in
private companies, or that engage in buyouts (purchase of controlling share) of public
companies. Institutional and retail investors provide the capital for private equity, that can be
utilized to fund new technology, make acquisitions, expand working capital, and solidify a
balance sheet.
A private equity fund has Limited Partners (LP), who typically own 99 percent of shares in a
fund and have limited liability, and General Partners (GP), who own 1 percent of shares and
have full liability. The latter are also responsible for executing and operating the investment.
Corporate Listings:
Listing of Corporate Stocks
Listing means admission of securities on a recognized stock exchange. The securities may be
of any public limited company, Central or State Government or other financial
institutions/corporations.

The objectives of listing are mainly to:

# provide liquidity to securities;
# mobilize savings for economic development;
# protect interest of investors by ensuring full disclosures.

A company, desirous of listing its securities on the Exchange, shall be required to file an
application, in the prescribed form, with the Exchange before issue of Prospectus by the
company, where the securities are issued by way of a prospectus or before issue of 'Offer for
Sale', where the securities are issued by way of an offer for sale

Delisting of Corporate Stocks

Delisting of securities means removal of the securities of a listed company from the stock
exchange.
1. Compulsory delisting refers to permanent removal of securities of a listed company
from a stock exchange as a penalizing measure for not making submissions/complying
with various requirements set out in the Listing agreement within the time frames
prescribed.
2. In voluntary delisting, a listed company decides on its own to permanently remove its
securities from a stock exchange. This happens mainly due to merger or amalgamation
of one company with the other or due to the non-performance of the shares on the
particular exchange in the market.

Venture Capital (VC)

Venture Capital refers to an equity or equity related investment in growth oriented small or
medium business. VC firms invest in these early-stage companies in exchange for equity or
an ownership stake and take on the risk of financing risky start-ups in the hope that some of
them will boom. The startups are usually from high technology industries such as information
technology, bio-technology. VC provide strategic advice to the firm’s executives on its
business model. VC have an interest in generating a return through an exit event such as an
IPO or merger/acquisition.

Stages: VC Financing can be broadly classified into the following 6 stages:

1. Seed Capital: Investment towards product development, market research, building a
team, developing B-Plan. (Serious risk, Provided by angel investors)
2. Startup Financing: New activity launched. Funding for marketing and product
development.
3. Early Stage Financing: Capital provided to initiate commercial manufacturing and
sales after completion of the initial development stage.
4. Expansion Financing: Finance provided to the expansion or growth of the company
say increased production capacity.
5. Replacement Financing: Financing for the purchase of the existing shares from the
entrepreneurs. (Old VC exit and new investor come in prior to IPO)
6. Turnaround Financing: Financing to enterprise that has become unprofitable after
launching commercial production.
Methods/Instruments: VC Financing can be done via the methods described below:
1. Equity Financing: A venture in its initial stage is not able to give timely returns to its
investor, for which equity financing proves beneficial. (Equity for investor is not more
than 49%, thereby ultimate power rests with entrepreneur)
2. Conditional Loan: The ones that do not carry interest and are repayable to the lender
in the form of royalty.
3. Participating Debentures: The interest on participating debentures is payable at three
rates: Nil at Startup phase, Low Rate – Initial operation phase, High Rate – After a
particular level of operations.
4. Convertible Loans: The loans which are convertible into equity when interest on the
loan is not paid within the stipulated period.

Investment Nurturing: It is a process by which VC companies continue to involve themselves

in their investments. They provide continued guidance and support to optimize the benefits of
investment. Build a joint relationship to tackle operational problems of the business. The
style of nurturing can vary depending on the specialization of VC company, stage of
investment, financing model etc.
There are three main kinds:
1. Hands-On: Continuous and constant involvement in operations by representation on
the board of directors. This style is essential in early stage of the project. Guidance is
provided on business planning, technology development, financial planning,
marketing strategy and so on.
2. Hands-Off: VC do not actively participate in formulating strategies, in spite of the
right to do so. The style is apt in syndicated venture financing where angels back a
syndicate led by a notable angel investor. It can also be apt when the initial plan of
venture is over and business is running smoothly.
3. Hand-holding Nurturing: VC Company takes part in the management only when
approached by the units. They provide either in-house assistance or outside expert
guidance.

Evaluating a VC Investment
1. Fundamental Analysis: Involves analysis various parameters of the company such as
its history, management quality, products, market size, manufacturing, risks etc.
2. Financial Analysis: Evaluating the growth potential of the earnings, future expected
cash flows, expected value at the time of divestment, time lag b/w investment and
return.
3. Portfolio Analysis: Portfolio of a VC can be evaluated on following grounds:
 Size of investment: Amount of money per investment
 Stage of Development: Some may be in startup while others may be in development
 Geographic Location: International diversity holds importance for a local fund
 Industry sectors – Diversify portfolio to offset slow growth investment

Exits available: The last stage of venture capital investment is to make the exit plan based on
the nature of investment, extent and type of financial stake etc. The exit plan is made to make
minimal losses and maximum profits. The venture capitalist may exit through:
 IPO Method: When an IPO is issued, the VC sells its take. IPO facilitates liquidity of
investment and commands higher price of securities.
 Sale of Share: Sale of share is undertaken by VC to entrepreneurs who have promoted
the venture.
  Puts & Calls: VC company enters into formal exit agreement with entrepreneur at a
price based on a pre-determined formula. (Put is the right to sell, Call is the right of
the entrepreneur to buy)
 Trade Sales: Entire investee company is sold to another company at an agreed price.
This takes place through Management Buy-Out which is the acquisition of a company
from existing owners by a team of existing management/employees. Management
Buy-in involves bringing in a team for, outside.
Disadvantages
1. Forced Management Changes: There might be unwanted additional management
intervention on part of the VC, when the owner does not want any.
2. Loss of Equity Stake: VC give large sums of money at low risks; it then becomes
obvious that large equity would be foregone in return.
3. Decision Making Ability: Owners may have to consult the VC before making crucial
decisions in capital making which can constrain autonomy.
4. Delay in Funding: All fund may not be disseminated at the same time, and milestone
may have to be achieved, which may put additional pressure on them.

Market Based Financial System vs. Bank Based Financial System (Unit 1 Topic)
Basis Market Based Financial Bank Based Financial System
System

Definition Financial markets take the A few large banks play a pivotal role in
centre stage with banks in mobilising savings, allocating capital,
mobilising the society savings overseeing investment decisions of corporate
for firms, exerting corporate managers and providing risk management
control and easing risk facilities. This tends to be stronger in
management. countries where the governments have a
direct hand in industrial development say
India.

Side-Role The banking industry is much The stock market does not play an important
less concentrated. role.

Advantages -Provides attractive terms to -Close relationship with parties

both investors and borrowers -Provides tailor-made contracts and financial
-Facilitates diversification products
-Allows risk sharing -No free rider problem as private incentives
-Allows financing of new to gather information are higher
technologies
 Drawbacks -Prone to instability -Retards innovation & growth (inherent
-Exposure to market risk preference for low risk)
-Free rider problem (some -Impedes competition (collude with firm
individual consumes more managers to produce entry barriers)
than their share or pay less
than their share of the cost of
shared resource) *

Country USA Germany

*This problem arises whenever there is a separation of ownership from control, for instance
shareholders take little interest in the management of their companies hoping someone else
will monitor their executives, thereby in a market-based system, the free rider problem blunts
the incentive to gather information

Capital formation and redistribution of funds

Financial markets facilitate capital creation by providing a forum for individuals and organisations to invest in
businesses through the purchase of stocks and bonds. In turn, this investment facilitates firms' access to the
capital it needs to prosper, stimulating the economy and creating more employment.

Further, financial markets are important as they allow for the redistribution of funds, laying the groundwork for
the ongoing reorganisation of the economy essential to its expansion.

Allocation of resources in the most effective way

A financial market also plays a vital role by allocating resources effectively. It ensures that the economy makes
good use of its resources and promotes productivity by directing funding towards the businesses with the
greatest potential for development and profit.

Managing risks
Financial markets are helpful when they come to risk management. Businesses participate in derivative
markets to protect themselves from possible financial losses, such as those for futures on commodities and
currency exchanges.

Liquidity
Liquidity is a crucial factor in the financial market. Notably, markets may have a more challenging time finding
buyers or sellers for their assets if they need more liquidity, which might increase transaction costs and widen
bid-ask gaps.

As a consequence, enterprises and individuals may find it tough to access money and obtain cash for
investment, which may lead to a drop in market activity and overall growth of the economy.
 Unit III

Secondary Market in India

Introduction to Stock Markets
Secondary market is the market in which existing securities are resold or traded. This market
is also known as stock markets. In India, the secondary market consists of recognized stock
exchanges operating under rules and regulations approved by the government, and constitute
an organized market where securities issued by central-state govts., public bonds, and joint
stock companies are traded.

Functions of Secondary Market

 Facilitate liquidity and marketability of outstanding debt/equity instruments
 Promote economic growth by allocating funds to most efficient channel via process of
divestment and reinvestment
 Provide instant valuation of securities caused by changes in the internal environment,
and induce companies to improve their performance
 Ensure safety and fair dealing to protect investors’ interests

Regional Stock Exchanges (RSE): RSE is a stock exchange situated outside a country’s
primary financial center, on which trading of publicly held equity is undertaken. They trade
in OTC & localized companies which are too small to register on national exchange. By
increasing market participation, RSE can increase overall liquidity and competition in
financial markets. There are 23 stock exchanges in India. Among them 2 are national level
stock exchanges namely BSE & NSE. The rest 21 are RSEs.

Modern Stock Exchanges: NSE & BSE. (Secondary Market definition)

International Stock Exchanges: The growth of global stock markets outside US & Europe is a
key reason that the number of public firms continues to grow. The US still has the largest
exchange in the world, but many of the largest exchanges now reside in Asia, which continue
to grow influence on the world stage. NYSE (New York Stock Exchange) is one of the
primary exchanges in the world and the largest in terms of the nearly $10 trillion stock
market capitalization. Tokyo Stock Exchange (TSE) is largest exchange in Japan, and no. 2
behind NYSE in terms of more than $3 trillion m-cap with a stronger national currency is a
part of the reason. (Nikkei 225 index is one of the primary and most popular indices that
represents some of the largest business’ in Japan). BSE also exercises its impact on global
markets with $2.1 trillion m-cap.

Demutualization of Exchanges
All the stock exchanges in India (except NSE & OTCEI) were broker-owned and controlled.
This led to a conflict where the interests of the broker were preserved over those of the
investors. Instances of price rigging, recurring payment crisis, and power abuse by broker
was discovered.
 Demutualization is the process by which any member-owned organization can become
a shareholder-owned company. Such a company could be either listed on a stock
exchange or be closely held by its shareholders.
  Through this process, a stock exchange becomes a corporate entity, changing from a
non-profit making company to a profit and tax (paying) company.
 Demutualization separate the ownership and control of stock exchange from the
trading rights of its members. This reduces the conflict of interest between the
exchange and the brokers and the chances of the brokers using the stock exchange for
personal gains.
 With demutualization, stock exchanges have access to more funds for investment in
technology, merger/acquisition or strategic alliance with other exchanges.
 This process is similar to a company going public where owners are given equity
shares. The process seeks to give majority control (51%) to investors who do not have
a trading right, to allow better regulation of exchange.
 Once listed as a public company, the exchange will be governed by corporate-
governance codes to ensure transparency.

Comparison between BSE and NSE

Basis BSE NSE
Definition The stock exchange provides a NSE is the leading stock exchange in
transparent and systematic mechanism India, that provides a variety of
for trading in various products (below) services like trading, clearing and
along with clearing, settlement, risk settlement* in equity along with
management services. The S&P BSE products (below). NIFTY represents a
SENSEX comprises of the most weighted average of the 50 most
actively traded and financially strong highly liquid and frequently traded
Indian companies on BSE. Indian companies listed on NSE.
Year of 1875 1992
Establishment
Position Most ancient stock exchange of Asia Largest stock exchange in India
Products Facilitates trading in equity, currencies, Facilitates trading in equity, currency
Offered debt instruments, derivatives & MFs derivatives, debt and equity
derivative segments
Benchmark Sensex (30) NIFTY (50)
Index
M-Cap $2.1 trillion $2.27 trillion
No. of listed 5089 2000
entities
Position in 10 Largest Stock Exchange
th
11 Largest Stock Exchange
th

World
Index Value 34, 300 (Approx.) 10, 300 (Approx.)

*Clearing & Settlement: It is a two-way process involving transfer of funds and securities on
the settlement dates. NSE clearing has devised mechanism to handle various exceptional
situations like security shortages, bad delivery, auction settlement etc.

Raising Funds in International Markets

Below listed are the instruments that can be used by domestic firms to raise money from the
international markets:
ADRs: An American depositary receipt (ADR) is a negotiable certificate issued by a U.S.
depository bank representing a specified number of shares—or as little as one share—
 investment in a foreign company's stock. The ADR trades on markets in the U.S. as any stock
would trade. ADRs represent a feasible, liquid way for U.S. investors to purchase stock in
companies abroad. Foreign firms also benefit from ADRs, as they make it easier to attract
American investors and capital—without the hassle and expense of listing themselves on U.S.
stock exchanges. The certificates also provide access to foreign listed companies that would
not be open to U.S. investment otherwise.

GDRs: A global depositary receipt (GDR) is very similar to an American depositary receipt
(ADR). It is a type of bank certificate that represents shares in a foreign company, such that a
foreign branch of an international bank then holds the shares. The shares themselves trade as
domestic shares, but, globally, various bank branches offer the shares for sale. Private
markets use GDRs to raise capital denominated in either U.S. dollars or euros. When private
markets attempt to obtain euros instead of U.S. dollars, GDRs are referred to as EDRs.

FCCB: A foreign currency convertible bond (FCCB) is a type of convertible bond issued in a
currency different than the issuer's domestic currency. In other words, the money being raised
by the issuing company is in the form of a foreign currency. A convertible bond is a mix
between a debt and equity instrument. It acts like a bond by making regular coupon and
principal payments. A bondholder with a convertible bond has the option of converting the
bond into a specified number of shares of the issuing company. Convertible bonds have
a conversion rate at which the bonds will be converted to equity.

Euro Issues: A Eurobond is denominated in a currency other than the home currency of the
country or market in which it is issued. These bonds are frequently grouped together by the
currency in which they are denominated, such as Eurodollar or euro yen bonds. Issuance is
usually handled by an international syndicate of financial institutions on behalf of the
borrower, one of which may underwrite the bond, thus guaranteeing purchase of the entire
issue. The popularity of Eurobonds as a financing tool reflects their high degree of flexibility
as they offer issuers the ability to choose the country of issuance based on the regulatory
market, interest rates and depth of the market. They are also attractive to investors because
they usually have small par values and high liquidity.

Indian Stock Indices and their Construction

The stock market index is the most important indices of all as it measures overall market
sentiment
through a set of stocks that are representative of the market. It is a barometer of market
behavior, and reflects market direction while indicating the day to day fluctuations in stock
prices. A well-constructed index must also represent the return obtained by a typical portfolio
investing in the market. These indices are termed as leading economic indicators as they
reflect what direction the economy is headed towards. An efficient index must contain stocks
having high market cap and high liquidity.
The index is calculated as the percentage of the aggregate market value of the stocks in the
index on that day to the average market value of the same stock during the base period.

Methodologies for Calculating the Index

Market Capitalization Weighted
1. Full m-cap method: The no. of shares o/s times the market price of the company
determines the stock’s weight in the index (S&P CNX Nifty). Stocks with highest

The BSE has taken a lead on free-floating the indices. It made a beginning by launching on July 11,
2001, the country’s first free-float index, ‘BSE-TECK Index,’ an index for technology, entertainment,
communication, and other knowledge-based sectors. The BSE has introduced this methodology in the
case of the BSE sensex since September 1, 2003.
 m-cap would have higher weightage and would be most influential in this type of
index.
2. Free float m-cap method: Free-float is the percentage of shares that are freely
available for purchase in the market excluding the stake held by govt./controlling
shareholders/management/ESOP etc. The weight of a stock is based on the free
float m-cap which is less than the total m-cap. (Closely held companies would
have lower weightage than company with high investible shares)
Note; Free-float can be seen superior, as it avoids undue influence of closely held large cap
stocks, avoids multiple counting through cross holding, useful for active fund managers who
benchmark returns using investible index.
(If free float of a accompany is 16% then it is rounded off to higher multiple of 10 i.e. 20% in
this case which is multiplied by full m-cap to arrive at free float cap)

(Adjustment for corporate actions (rights, bonus and stock split;) on index: Numerical Topic)

Badla System: The carry forward system i.e. Badla is the postponement of the delivery of (or
payment for) the purchase of securities from one settlement period to another. In essence it’s
the facility for carrying forward the transaction from one settlement to another. This facility
provided liquidity and breadth to the market. It was invented by BSE. Badla involved 4
parties: the long buyer – a buy position in the stock without the capacity to take the delivery
of the same, the short seller – a sell position without having the delivery in hand, the financier
and the stock lender.

Classification of Securities to be included in the Index

Before Badla was resumed in 1996, there were only two categories of securities listed on
BSE, the specified group of shares comprising the securities in which carry forward deals
were allowed, and the cash group shares in which no forward deals were permitted. BSE later
decided to regroup the existing A & B group shares into three categories:
1. A Group: This group consists of large turnover and high floating stock, with large
market capitalization. In other words, scrips included in this group are blue-chip
companies. Carry-forward deals and weekly settlement were allowed in this group. At
present, there are 150 scrips in this group.
2. B1 Group: This group includes scrips of quality companies with an equity above Rs. 3
crores, with high growth potential and trading frequency. No carry-forward facility
was allowed in this group. As on 12 December 2009, there were 205 scrips in this
group.
3. B2 Group: This group of scrips were just like those of B1 but with a fortnightly
settlement. This group consists of low trading volume scrips, with an equity below Rs.
3 crores, and surveillance measures initiated against most of them for suspected price
manipulations.
However, in September 1996, the BSE introduced a weekly settlement for all scrips listed on
the exchange, thus doing away with the distinction between the B1 and B2 groups.
4. Z group: It was introduced in 1999 with scrips of companies that do not meet the
rules,
regulations and stipulations laid down by the exchange. It is a buyer-beware company. There
are some 300 scrips in the group.
5. F Group pertains to debt-market segment and G group pertain to the government
securities market.
6. S Group: BSE setup the BSE INDONext market as a separate trading market on its
BOLT system as S group.
7. T-Group: The scrips (stocks) are transferred on a trade-to-trade basis from the regular
segment to T-group.

Bulls Markets: Bull markets are characterized by optimism, investor confidence and
expectations that strong results should continue for an extended period of time. It is difficult
to predict consistently when the trends in the market might change. Part of the difficulty is
that psychological effects and speculation may sometimes play a large role in the markets.
There is no specific and universal metric used to identify a bull market. Nonetheless,
perhaps the most common definition of a bull market is a situation in which stock prices
rise by 20%, usually after a drop of 20% and before a second 20% decline. Bull markets
generally take place when the economy is strengthening or when it is already strong. They
tend to happen in line with strong gross domestic product (GDP) and a drop in
unemployment and will often coincide with a rise in corporate profits.
Bear Markets: A bear market is a condition in which securities prices fall 20 percent or more
from recent highs amid widespread pessimism and negative investor sentiment. Typically,
bear markets are associated with declines in an overall market or index like the S&P 500, but
individual securities or commodities can be considered to be in a bear market if they
experience a decline of 20 percent or more over a sustained period of time - typically two
months or more.
 A secular bear market can last anywhere from 10 to 20 years and is characterized by
below average returns on a sustained basis.
 A cyclical bear market can last anywhere from a few weeks to several years.

Factors influencing the movement of stock markets

1. Economic Growth: Higher economic growth, better profitability of firms due to
higher demand for goods.
2. Interest Rates: Lower interest rates boost economic growth by increasing demand, and
also make shares relatively more attractive than saving money in banks.
3. Stability: Stock markets dislike shocks, and tend to fall on news of terror attacks of oil
price spikes.
4. P/E ratio: P/E ratio can guide the long-term performance of shares.
5. Confidence & Expectations: Optimistic news results in investors buying more shares,
and will sell in case of pessimistic news. Investors always try to predict future. If they
feel the worst is over, then the stock market can start rising again.
6. Bandwagon effect: Tendency of market to over-react to certain events. When prices
fall, herd mentality can result in people selling stocks rapidly.

Market Indicators: Market indicators are quantitative in nature and seek to interpret stock or
financial index data in an attempt to forecast market moves. Market indicators are a subset of
technical indicators and are typically comprised of formulas and ratios. They aid investors'
investment / trading decisions.
The two most common types of market indicators are:
Market Breadth indicators compare the number of stocks moving in the same direction as a
larger trend. For example, the Advance-Decline Line looks at the number of advancing stocks
versus the number of declining stocks.
Market Sentiment indicators compare price and volume to determine whether investors are
bullish or bearish on the overall market. For example, the Put Call Ratio looks at the number
of put options versus call options during a given period.
New Highs-New Lows - The ratio of new highs to new lows at any given point in time. When
there are many new highs, it's a sign that the market may be getting frothy (market bubble),
while many new lows suggest that a market may be bottoming (reaching low price) out.
Moving Averages: Many market indicators look at the percentage of stocks above or below
key moving averages, such as the 50- and 200-day moving averages.
Major Instruments traded in stock markets
Equity Shares & Debentures

(PTO)
BASIS FOR
SHARES DEBENTURES
COMPARISON

Meaning The shares are the owned The debentures are the borrowed
funds of the company. funds of the company.

What is it? Shares represent the Debentures represent the debt of

capital of the company. the company.

Holder The holder of shares is The holder of debentures is known

known as shareholder. as debenture holder.

Status of Holders Owners Creditors

Form of Return Shareholders get the Debenture holders get the interest.
dividend.

Payment of return Dividend can be paid to Interest can be paid to debenture

shareholders only out of holders even if there is no profit.
profits.

Voting Rights The holders of shares have The holders of debentures do not
voting rights. have any voting rights.

Conversion Shares can never be Debentures can be converted into

converted into debentures. shares.

Repayment in the event Shares are repaid after the Debentures get priority over
of winding up payment of all the shares, and so they are repaid
liabilities. before shares.

Myths attached to Investing in Stock Markets

There are 5 common myths as described below:
1. Investing in stocks equates to Gambling: Assessing the value of a company is
complex as many variables are involved, and over the long term a company is
supposed to be worth the present value of the profits it will make. Gambling in
contrast is a zero-sum game, where the money is transferred from loser to winner, no
value is very created, while in case of investing the overall wealth of the economy
increases.
2. The stock market is an exclusive club for brokers and rich people: Internet has made
the data much more accessible to the public, and research tools that can be used by
 individuals (previously available only to brokerages), thus expanding investing as a
choice to even the common man.
3. Fallen Angels will go back up, eventually: Stock A reached $50 and now has fallen to
$10, while Stock B has risen from $5 to $10. As per this myth, majority of people will
buy B because they think it will rise back again. Thereby price is only one part of the
investing equation, the goal must be to buy growth companies at reasonable prices.
4. Stocks that go up, must come down: Over 20 years ago Berkshire Hathaway’s stock
rose from around 7k USD to 17k. the stock rose again to 308k in Feb 2019. Thereby
stock prices may fall, since they are a reflection of a company, yet it is not necessary
that this will happen.
5. Little Knowledge is better than none: It is crucial for investors to have a clear
understanding of what they are doing with their money, and those who lack time
should consider employing the services of an advisor.

Trading of securities on a stock exchange

Functions of Stock Exchange – Helps in Price Determination, Provides Safety via regulation,
Stimulates Economy (by mobilizing and channelizing funds which may sit idle), Spreading
Equity (wider ownership of stocks), Encourages Speculation which enhances liquidity and
price determination

Process of Trading Securities

1. Selecting a broker/sub-broker: A person cannot trade on the stock market in his own
individual capacity, transactions can only occur through a broker/sub-broker. Broken
can be an individual or partnership or a company or a financial institution (bank)
registered under SEBI.
2. Opening A Demat Account: All securities are in electronic format. The dematerialized
account must thereby be opened to trade electronic securities. Demat account can be
opened up with depository participant, there are two in India namely Central
Depository Services Ltd. & National Depository Services Ltd.
3. Placing Orders: The order will be placed via the broker. The order instruction should
be very clear. Ex. Buy 100 shares of XYZ Co. for a price of Rs. 140 or less. The
broker will then act according to your demand, and place and order for the share at the
price mentioned or even at a better price if available, following which he will issue an
order confirmation slip to the investor.
4. Execution of the Order: Once the broker receives order from the investor, he executes
it, and within 24 hours he must issue a contract note, which is a document containing
necessary information about the transaction like the number of shares transacted,
price-date-time of transaction, brokerage amount etc. In case of a legal dispute, it is an
evidence of the transaction and contains the Unique Order Code assigned to it by the
stock exchange.
5. a9Settlement: Here the actual securities are transferred from the buyer to the seller.
And the funds will also be transferred. Here too the broker will deal with the transfer.
There are two types of settlements,
- On the Spot settlement: Here we exchange the funds immediately and the settlement
follows the T+2 pattern. So, a transaction occurring on Monday will be settled by
Wednesday (by the second working day)
-Forward Settlement: Simply means both parties have decided the settlement will take
place on some future date. Can be T+9 etc.

Settlement mechanism at BSE & NSE

Compulsory Rolling Settlement Segment (CRS): With effect from December 31, 2001,
trading in all securities takes place in one market segment, viz., Compulsory Rolling
Settlement Segment (CRS).
All transactions in all groups of securities (even ‘G’) in the Equity segment and Fixed Income
securities listed on BSE are required to be settled on T+2 basis. A T+2 settlement cycle
means that the final settlement of transactions done on T, i.e., trade day by exchange of and
securities between the buyers and sellers respectively takes place on second business day
(excluding Saturdays, Sundays, bank and Exchange trading holidays) after the trade day. "Z"
group or "T" group, are settled only on a gross basis and the facility of netting of buy and sell
transactions in such Securities is not available

Kinds of brokers
1. Commission Broker: Executes orders of their customers by buying and selling
securities on the exchange. Charge a specified commission of the sale value.
2. Floor Brokers: Execute orders for brokers and receive a share in brokerage
commission that a commission broker charges to his client.
3. Jobbers: Professional independent brokers engaged in buying/selling specified
securities in their own name, and quote two-way prices.
4. Odd Lot Dealers: Buy/Sell securities in odd lots at lesser prices.
5. Badliwalas – Financiers who facilitate the carry over business by financing carry over
transactions and earn interest for the amount financed (badla)
6. Arbitrageurs – Keep close watch on price of shares, and buy low, sell high.

Margin Trading
In the stock market, margin trading refers to the process whereby individual investors buy
more stocks that they can afford to by the means of trading via borrowed securities. As
margin trading can be done on both buy/sell side, it helps in increasing demand and supply of
funds in the market, in turn contributing towards better liquidity.
Ex. An investor purchases Rs.100 worth of X, with a sum of Rs.50 of his own money, and
rest 50 is the borrowed money (Margin is 50%). If X rises to 110, he will earn a return of
20% (10/50*100), if X falls by 10%, he will lose 20%. Thus, margin trading exposes clients
to higher potential gain/loss.

Note: A client interest to do margin trading is required to sign an agreement with lender of
funds to formalize the agreement for margin trading which provides the margin rate and the
extent of the margin.

Margin Rate: It is the bank rate plus a markup amount depending on the exposure in the
margin account. The interest in continuously compounded (daily basis). The agreement
provides for two types of margin:
1. Initial Margin: Portion of purchase value which the client deposits with the lender of
the funds before the actual purchase. The securities then purchased are kept as
collateral with the lender.
2. Maintenance Margin: In addition, the client is required to maintain a certain minimum
equity in the margin account which is called maintenance margin.
For example, assume that the initial and maintenance margins are 50% and 25% respectively.
A client has bought securities for Rs. 100. The price depreciates by 40%. The value of
portfolio reduces to Rs. 60. The equity becomes Rs. 10 (Rs. 60 – Rs. 50 (debt)), which is less
than Rs. 15 (25% of the value of securities). The client is required to bring in Rs. 5. When the
equity in the margin account falls below the maintenance margin, the lender makes a margin
call. If margin call is not met, the lender can sell the collateral, partially or fully, to increase
the equity.
(SEBI requires the initial margin to be minimum of 50%, and maintenance margin to be min
40% paid in cash)

Margins (Way of Risk Management)

1. VaR Margin: Value at Risk margin is mandated by SEBI and is internationally accepted
as the best margining system. In general, VAR means by how much the portfolio can go
up or down as per historical data analysis in one day. The VaR margin is a margin
intended to cover the largest loss that can be encountered on 99% of the days (99% value
at risk).
 For liquid stocks, the margin covers one day losses, while for illiquid stocks it covers
three-day losses so as to allow the exchange to liquidate the position over three days.
 For liquid stocks, the VaR margins are based only on the volatility of the stock, while
for other stocks, the volatility of the market index is also used in the computation.
Security Sigma – volatility of the security computed as at the end of the previous trading day
Security VaR – higher of 7.5% or 3.5 security sigma (3.5 times the volatility)
Index Sigma – daily volatility of the market index computed as at the end of the previous
trading day
Index VaR – higher of 5% or 3 index sigma

2. MTM (Market to Market Margin): Market to Market loss is calculated by marking

each transaction in security to the closing price of the security at the end of the trading. In
case it is not traded on a particular day, then latest NSE closing price is considered to be its
closing prices. MTM is collected from the member before the start of the trading of the next
day.

Algorithmic Trading
Algorithmic trading is a type of trading that uses powerful computers to run complex
mathematical formulas for trading. An algorithm is a set of directions for solving a problem.
An example of an algorithm is an algebraic equation, combined with the formal rules of
algebra. With these two elements, a computer can derive the answer to that equation every
time. Algorithmic trading makes use of much more complex formulas, combined with
mathematical models and human oversight, to make decisions to buy or sell financial
securities on an exchange. Algorithmic traders often make use of high-frequency
trading technology, which can enable a firm to make tens of thousands of trades per second.
Algorithmic trading can be used in a wide variety of situations including order execution,
arbitrage, and trend trading strategies..

Advantages: Algorithmic trading is mainly used by institutional investors and big brokerage
houses to cut down on costs associated with trading. According to research, algorithmic
trading is especially beneficial for large order sizes that may comprise as much as 10% of
overall trading volume. Algorithmic trading also allows for faster and easier execution of
orders, making it attractive for exchanges

Disadvantages: The speed of order execution, an advantage in ordinary circumstances, can

become a problem when several orders are executed simultaneously without human
intervention. The flash crash of 2010 has been blamed on algorithmic trading. Another
disadvantage of algorithmic trades is that liquidity, which is created through rapid buy and
sell orders, can disappear in a moment, eliminating the change for traders to profit off price
changes.

Additional Topics
Circuit Breakers: Circuit breakers are pre-defined values in percentage terms, which trigger
an automatic check when there is a runaway move in any security or index on either
direction. The values are calculated from the previous closing level of the security or the
index. Usually, circuit breakers are employed for both stocks and indices. Many steps can
possibly be taken after the breach of the circuit breakers:

1. Halting of trade in a security or index for a certain period (few minutes to hours to let
participants absorb any sudden news and thereafter take a rational approach)
2. Halting of trade in a security or index for the entire trading day (in the event that the above
step fails)

Circuit Breakers prevent true price discovery in a stock for the limited time they are imposed,
and can allow early investors to gain advantage while restricting the moves of other investors.

Impact Cost: It is the cost a buyer or seller incurs while executing a transaction. This cost is
dependent on the existing market liquidity, i.e. it is the cost of executing a transaction of a
given security, with specific predefined order size at any given point of time.
Suppose you want to buy 5,000 shares of, say, BHEL. The NSE terminal tells you that there
is a buy order for 1,000 shares for Rs 200 and a sell order for 2,000 shares for Rs 202. The
price of the buy and sell order is, therefore, Rs 201 (ideal price) You should ideally expect to
buy or sell shares of BHEL at this price. (Even I couldn’t infer the logic, kindly refer other
source too)
But suppose you were able to buy 1,000 shares of BHEL at an average cost of Rs 203. Your
impact cost is, therefore, 1 per cent.
Impact Cost = (Avg. Price – Ideal Price)/Ideal Price *100

S&P BSE SENSEX: It is a basket of 30 constituent stocks representing a sample of large,

liquid and representative companies. The base year is taken as 1978-79 with 100 base value.
The index operates on a free-float methodology. The securities in SENSEX are selected on
the basis of following criteria:
 Market Capitalization: The security should figure in top 100 companies listed by full
m-cap. Weight of each security based on free-float should be at least 0.5% of the
index.
 Trading Frequency: Security should have been traded on each and every day for the
last one year.
 Average Daily Trades: The Security should be among the Top 150 companies listed by
average number of trades per day for the last one year.
 Average Daily Turnover: The Security should be among the Top 150 companies listed
by average value of shares traded per day for the last one year.
 Listed History: The Security should have a listing history of at least one year on BSE.

How to get listed on BSE (IPO/FPO – Follow-on Public Offering)

Listing means admission of securities to dealings on recognized stock exchanges. The
securities may of company, government, or any other financial institution. The objective of
listing is to provide liquidity to securities, mobilize savings for economic development and
protect investor interest via full disclosures.
Eligibility Criteria
 Minimum post issue paid-up capital for the applicant company shall be 10 crores for
IPO & 3 crore for FPO
 Minimum issue size shall be 10 crores
 Minimum m-cap shall be 25 crores

Process
1. Company desiring to list their shares are compulsorily required to obtain prior
permission of BSE to use their name in their prospectus and other documents prior to
filing the same with ROC.
2. A letter of application must be submitted to all the designated stock exchanges where
it wants to have its securities listed before filing the same with ROC.
3. Within 30 days of the date of closure of the subscription list, a company is required to
complete the allotment of shares and then approach the designated stock exchange for
approval of the basis of allotment
4. Company should then take permission as per SEBI guidelines, while completing all
formalities for trading which are required for all the designated stock exchanges
within 7 working days of finalization of the basis of allotment
5. By 30 April of each financial year, all listed companies are required to pay BSE
th

listing fees as per the schedule of the listing fees prescribed from time to time
 Unit IV
Money Market
Money market means a market where money or its equivalent can be traded. The market
consists of financial institutions and dealers in money or credit who wish to generate liquidity
or manage their short-term cash needs. Money market is only a part of the financial markets
where instruments have high liquidity and very short-term maturities are traded. Due to
highly liquid nature of securities and their short-term maturities, money market is treated as a
safe place. Hence money market is a market where short-term obligations such as T-bills,
commercial papers and banker’s acceptances are bought and sold.

Benefits & Functions of Money Market (MM)

 MM exists to facilitate the efficient transfer of short-term funds between holders and
borrowers of cash assets.
 For lender/investor it provides a decent return on their funds
 For borrower, it enables rapid and relatively inexpensive acquisition of cash to cover
short term liabilities
 Primary function of MM is to provide a focal point for RBI’s intervention towards
influencing liquidity and interest rates in the economy and make them consistent with
the monetary policy objectives

MM vs Capital Market
 Money market is different from capital market, as it is a place for short term lending
and borrowing typically within a year, whereas capital markets refer to stock market
i.e. trading in shares and bonds of companies on recognized stock exchanges.
 Individual players cannot invest in money market as the value of investment is large,
whereas in capital market anybody can make investments through a broker.
 Stock market is associated with high risk and high return, whereas money market is
more secure
 In MM deals are transacted through phone or electronic systems, whereas in capital
market trading is done through recognized stock exchanges

MM Instruments: Investment in money market is done through money market instruments,

which meet the short-term needs of the borrowers and provide liquidity to the lenders.

Call Money/Notice Money Markets (CMM)

i.CMM is a market where overnight loans can be availed by banks to meet its liquidity. Banks
who seek liquidity approach the call market as borrower and the ones having excess liquidity
participate there as lenders.
ii.Banks can access CMM (Mon-Fri) to meet their CRR/SLR requirement. The call money is
usually availed for one day, if the bank needs funds for more days it can be availed through
notice market where loan is provided from 2-14 days.
iii.Participants: Scheduled Commercial Banks, Co-operative Banks, Primary Dealers (who buy
govt. securities directly from the government, thus acting as market maker of g-sec)
iv.Loans are availed through auction/negotiation. The auction is made on interest rate where
highest bidder (highest interest rate) can avail the loan. Dealing in call money is done through
Negotiated Dealing System (NDS)
v.Higher Call Rate (avg. int. rate) indicates liquid stress in economy which RBI may follow up
with liquidity support measures like cutting CRR, or allowing more repos.

Treasury Bill Markets

 i.T-Bills are one of the safest money market instruments, are short term borrowing instruments
of the central government of the country issued through RBI. It is a promise to pay a said sum
after a specified period.
ii.T-Bills are short-term securities and mature in one year or less (91, 182, 364 days) from their
issue date
iii.They are zero risk instruments and hence the returns are not so attractive. It is available in
primary & secondary markets.
iv.T-Bills are issued at a price less than their face value (par value) and bear a promise to pay
the full-face value on maturity. The difference between the purchase price and the maturity
value is the interest income earned by the purchaser of the instrument.
v.T-Bills are issued through a bidding process at auctions which can be prepared competitively
or non-competitively.
vi.T-Bill auctions are held on a Negotiated Dealing System (NDS) and the members
electronically submit their bids on the system,
vii.RBI issues these instruments to absorb liquidity from the market by contract the money
supply, in banking terms this is called Reverse Repurchase (Reverse Repo), and when RBI
purchases back these instruments at a specified date mentioned at the time of transaction,
liquidity is infused in the market. This is called Repurchase transaction (Repo).

Commercial Paper (CP)

i.It is a low-cost alternative to bank loans. It is a short term unsecured promissory note issued
by corporates and financial institutions at a discount on the face value.
ii.It is usually issued with fixed maturity between 1 to 270 days and for financing the accounts
receivables, inventories and meeting short term liabilities.
iii.Say a company has receivables worth 1 lakh with credit period of 6 month. Company needs
funds which it won’t be able to liquidate prior to 6 months. The company issues commercial
papers at a discount of 10% on face value of 1 lac to be matured after 6 months, and since it
has a strong credit rating it finds buyers easily. The company is able to liquidate its
receivables immediately and the buyer is able to earn interest of 10k over 6 months.
iv.CP yields higher returns compared to T-Bills but are less secure. The chances of default are
almost negligible but they are not zero risk instruments.
v.CP is not backed by only collateral, thereby only firms with high credit rating will find
buyers easily with minimal discounts.
vi.CP are traded actively in secondary market since they are issued in the form of pro-note
and are freely transferable in demat form.

Commercial Bills
i.Normally the traders buy good from wholesalers on credit, where the sellers get
payment after the end of the credit period. But if any seller does not want to wait or is in
immediate need of money, then he/she can draw a bill of exchange in favor of buyer,
which when accepted by the buyer becomes a negotiable instrument which can be
discounted by a bank before maturity.
ii.This trade bill when accepted by the commercial bank are known as commercial bills.
iii.Commercial Bills are issued by the seller (drawer) on the buyer (drawee) for the value
of the goods delivered by him. The maturity periods are of 30, 60 or 90 days.
iv.If seller is in need of funds then he may draw a bill and send it to buyer, where the buyer
accepts the bill and promises to make payment on the due date, or he may approach the
bank to accept the bill.
 v.The bank charges a commission for acceptance of the bill and promises to make the payment
if the buyer defaults. Once this process is accomplished, the seller can sell it in the market, by
which a commercial bill becomes a marketable security.
vi.Usually the seller will go to the bank for discounting the bill, and the bank will pay him after
deducting interest of the remaining period of the bill and service charge.

Certificate of Deposit (CD)

i.It is a pro-note issued by a bank in the form of a certificate entitling the bearer to receive
interest. The certificate bears the maturity date, the fixed rate of interest and the value.
ii.It can generally range from 3 months to 5 years and restricts the holder to withdraw funds on
demand, unless a penalty is paid.
iii.Return on CD is higher than T-Bill because it assumes higher level of risk. Returns can be
based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR)
iv.In APY interest earned is based on compounded interest calculation, in APR simple
interest rate calculation is done. Thereby if interest is paid annually then both methods
offer equal returns, however if paid more than once a year then APY is preferable over
APR.

Repurchase Agreements
i.Repurchase transactions called Repo or Reverse Repo are short term loans in which two
parties agree to sell and repurchase the same security. They are usually used for overnight
borrowing.
ii.These transactions can only be done between parties approved by RBI and in RBI approved
securities (T-Bills, Corporate Bonds, GOI & State Govt. Securities)
iii.Under repurchase agreement the seller sells specified securities (repo) with an agreement to
repurchase the same at a mutually decided future date and price, similarly the buyer
purchases the securities (reverse repo) with an agreement to resell the same to the seller on an
agreed date at a predetermined price (Seller - Repo transaction, Buyer – Reverse Repo
transaction)
iv.Lender/Buyer is entitled to receive compensation for the use of funds by the other party,
whereas the seller of the security that borrows the money has to pay interest on the same.
v.Rate of interest agreed upon is the repo rate, whereas the time period of the
lending/borrowing is the reverse repo rate.

CBLO: It is a money market segment operated by the Clearing Corporation of India Ltd
(CCIL). In the CBLO market, financial entities can avail short term loans by providing
prescribe securities as collateral. In terms of functioning and objectives, the CBLO market is
almost similar to the call money market.
 The borrowers of fund have to provide collateral in the form of government securities
and lender will get it while giving loans
 Institutions participating in CBLO are entities who have either no access or restricted
access to the inter-bank call money market (National/Pvt/Foreign Banks, MF’s,
Insurance Companies, Primary Dealers, NBFC etc.)

Role of STCI & DFHI in money market

DFHI (Discounting & Finance House of India)
The Vaghul Committee had endorsed the recommendation regarding setting up specialized
institutions as autonomous financial intermediary for developing the money market and
providing liquidity to the instruments. Thereby DFHI was incorporated under the Companies
Act, 1956. SBI is the majority stake in DFHI. The main objectives of DFHI are:
 To increase the transaction (in) or turnover of money market assets
 To facilitate the smoothening of short-term liquidity imbalance by developing and
integrating the money market
 Facilitate money market transactions of small & medium sized institutions that are not
regular participants in the market

DFHI deals with majority of the money market instruments as stated above along with
Interest Rate Swaps & Forward Rate Agreements. Role of DFHI is stated as below:
 To discount, purchase and sell the money market instruments like T-bills, CB, CP, CD
etc.
 To play an important role as a lender, borrower or broker in the inter-bank call MM
 To promote and support company funds, trust and other organizations for the
development of MM
 To advise govt., banks and FI’s in evolving schemes for growth and development of
MM
DFHI stabilizes the call and short-term deposit rates through large turnovers. Two regular
bid-offer quotes offered in money market instruments are provided as a base by DFHI giving
them an assured liquidity.

STCI
STCI (Securities Trading Corporation of Indian Ltd.) was set up by the RBI with an objective
to promote the secondary market in government securities and public sector bonds. As one of
the leading primary dealers in the country, the company was a market maker in g-sec’s,
corporate bonds, and money market instruments. In order to diversify into new activities,
company now has lending activity as its core business and is established as an NBCF while
Primary Dealership business is now a 100% separate subsidiary. STCI Finance Ltd. is a
diversified mid-market B2B NBC.

Debt Market: Introduction and meaning

Debt Market is the market where fixed income securities of various types and features are
issued and traded. The securities are issued by Central & State Governments, Municipal
Corporations, Govt. Bodies, Financial Institutions banks etc. These fixed income securities
offer a predictable stream of payments by means of the interest and repayment of principal at
the time of maturity.
 Investor can neutralize the default risk on their investment by investing in Govt
Securities (G-Sec) normally referred to as risk free investments due to sovereign
guarantee. Debt securities enable efficient portfolio diversification for investors.
 Debt market allows govt. to raise money to finance the development activities of the
government and plays a crucial role in mobilization and allocation of resources in the
economy
 Debt market serves the funding needs for public and private sector projects.

Debt Markets are primarily classified into:

1. Government Securities Market (G-Sec): it consists of central and state government
securities representative of the loans that are taken by them and holds a dominant
position in the debt market.
 2. Bond Market: It consists of Financial Institution bonds, Corporate bonds and
debentures and PSU bonds. They are issued to meet the financial requirements and
remove uncertainty by having a fixed financial cost.

Advantages: The returns are assured and almost risk free, although certain risks exist in
corporate, FI, PSU instruments yet help can be taken from credit agencies who rate those
instruments. Also, the Indian Debt market is highly liquid, with banks offering easy loans to
investors against g-sec’s,

Disadvantages: As the return is almost risk free, they are not as high as equity market returns.
Retail participation is also lower in debt markets, due to issues related to liquidity and price
discovery as the retail debt market is not quite developed.

Debt Market Instruments

1. Government Securities: It is the Reserve Bank of India that issues Government
Securities or G-Secs on behalf of the Government of India. These securities have a
maturity period of 1 to 30 years. G-Secs offer fixed interest rate, where interests are
payable semi-annually. For shorter term, there are Treasury Bills or T-Bills, which are
issued by the RBI for 91 days, 182 days and 364 days.
 Zero Default risk is one of the best reasons for investment in G-Sec
 All G-Sec in India have a face value of Rs. 100 and are issued by RBI. G-Sec’s have
semiannual coupon or interest payments with a maturity of 5 to 30 years.
 Higher leverage is available in case of borrowings against G-Secs
 G-Sec bear no TDS on interest payments, while have a tax exemption on the interest
earned up to 3000 over and above the limit of 12,000
2. Corporate Bonds: These bonds come from PSUs and private corporations and are
offered for an extensive range of tenures up to 15 years. There are also some perpetual bonds.
Comparing to G-Secs, corporate bonds carry higher risks, which depend upon the
corporation, the industry where the corporation is currently operating, the current market
conditions, and the rating of the corporation. However, these bonds also give higher returns
than the G-Secs.
3. Certificate of Deposits: These are negotiable money market instruments available in
denominations of Rs. 1 lac and multiples. (Details stated in Money Market)
4. Commercial Paper: There are short term securities with maturity of 7 to 365 days.
CPs are issued by corporate entities at a discount to face value. (Details stated in Money
Market)
5. T-Bills: Refer money market
6. State Government Securities: Issued by RBI on behalf of each of the state
governments and are coupon bearing bonds with a face value of Rs. 100 and a fixed maturity
period. They account for 3-4% of daily trading volume. State development loan is a form of
bond which is sold in the market. Each state is allowed to issue securities up to a certain limit
each year. Coupon rates are marginally higher than those of GOI secs. They are sold via
auction process; interest payment is half-yearly and other modalities remain similar to G-
Secs.
7. Municipal Bonds: Local municipalities have limited revenue channels to borrow from
the market. Municipal Bonds are issued by local bodies to finance infrastructural projects,
and offer tax incentives to attract investment in certain domains. (They have a tax-free status
if they conform to certain rules and their interest rates are market linked)

Types of Risk related to Debt Securities

 1. Default Risk: This can be defined as the risk that an issuer of a bond may be unable to
make timely payment of interest or principal on a debt security
2. Interest Rate Risk: can be defined as the risk emerging from an adverse change in the
interest rate prevalent in the market so as to affect the yield on the existing
instruments. (Say interest rates have risen, and investors’ money is locked at lower
rates)
3. Reinvestment Rate Risk: can be defined as the probability of a fall in the interest rate
resulting in a lack of options to invest the interest received at regular intervals at
higher rates at comparable rates in the market.

Note:
 G-Sec accounts for 90-95% of the daily trading volumes while State Govt. Securities
and T-Bills account for 3-4% of the daily trading volumes.
 RBI regulates and facilitates the government bonds and other securities on behalf of
the governments, while SEBI regulates the corporate bonds, both PSU & Private
Sector

Secondary Debt Market

Secondary Debt Market based on the characteristics of the investors and the structure of the
market can be broadly classified into:
1. Wholesale Debt Market: where the investors are mostly Banks, Financial Institutions,
RBI, Primary Dealers, Insurance Companies, MF’s, Corporates & FII’s. Most of the deals
take place through telephones and are reported to the exchange for confirmation. The
commercial banks and FI’s are the most prominent participants. FII’s have been permitted
to invest 100% of their funds in the debt market (from 30%). There are two primary types
of trade:
i.Outright Sale or Purchase, where there is no intended reversal of the trade at the point of
execution of the trade
ii.Repo Trade: where the said trade is intended to be reversed at a later point of time at a rate
which will include the interest component for the period between two opposite legs of the
transaction (Repo for seller, Reverse Repo for buyer)
2. Retail Debt Market: involves participation by individual investors, provident funds,
pension funds, NBFC’s and other legal entities in addition to the wholesale investor class
The Retail trading in Central Government Securities commenced on January 16, 2003
through the BOLT System of the Exchange. Central Government Securities (G-Secs.) are
currently listed at the Exchange under the G Group.

Issuance process of G-Secs

Auctions: Auctions for government securities are either yield based or price based.
Yield Based Auction: A yield-based auction is generally conducted when a new
Government security is issued. Investors bid in yield terms up to two decimal places (for
example, 8.19 per cent, 8.20 per cent, etc.). Bids are arranged in ascending order and the cut-
off yield is arrived at the yield corresponding to the notified amount of the auction. The cut-
off yield is taken as the coupon rate for the security. Successful bidders are those who have
bid at or below the cut-off yield. Bids which are higher than the cut-off yield are rejected.
Price Based Auction: A price-based auction is conducted when Government of India re-
issues securities issued earlier. Bidders quote in terms of price per Rs.100 of face value of the
security (e.g., Rs.102.00, Rs.101.00, Rs.100.00, Rs.99.00, etc., per Rs.100/-). Bids are
arranged in descending order and the successful bidders are those who have bid at or above
the cut-off price.
Method of auction: There are two methods of auction which are followed-
In a Uniform Price auction, all the successful bidders are required to pay for the allotted
quantity of securities at the same rate, i.e., at the auction cut-off rate, irrespective of the rate
quoted by them. On the other hand, in a Multiple Price auction, the successful bidders are
required to pay for the allotted quantity of securities at the respective price / yield at which
they have bid.

Other Technicalities of an Auction:

 The amount of securities to be issued is notified prior to the auction date, for
information of the public.
 Devolvement: RBI may participate as a non-competitor in the auctions. The
unsubscribed portion is devolved (transferred) on the Primary Dealer if the auction has
been underwritten by them at the cut-off price/yield.
 For the purpose of auctions, bids are invited from Primary Dealers, one day before
wherein they indicate the amount to be underwritten by them and the underwriting fee
expected by them,
 The auction committee of the RBI examines the bids and based on the market
conditions takes a decision in respect of the amount to be underwritten and the fee to
be paid to the underwriters
 Incase auction is fully subscribed; the underwriters don’t have to subscribe to the issue
(unless they have a bid for it)
 Oversubscription: When the demand for g-sec is greater than the number of securities
issued, then underwriters or others offering the security can adjust the price or offer
more securities to reflect the higher than anticipated demand.

Corporate Debt Market

The Indian Primary market in Corporate Debt is basically a private placement market with
most of the corporate bond issues being privately placed among the wholesale investors i.e.
the Banks, Financial Institutions, Large Corporates etc. The proportion of public issues in the
total quantum of debt capital issued annually has decreased in the last few years.

The Secondary Market for Corporate Debt can be accessed through the electronic platform
offered by the Exchanges. BSE offers trading in Corporate Debt Securities through the
automatic BOLT system of the Exchange. The Debt Instruments issued by Development
Financial Institutions, Public Sector Units and the debentures and other debt securities issued
by public limited companies are listed in the 'F Group' at BSE.

Various Instruments in the Corporate Debt Market are: Non-Convertible Debentures, Partly
Convertible Debentures, Deep Discount Bonds, PSU Bonds, Tax-Free Bonds etc.

Why Corporate Debt Market is not as popular as Equity Market

 Much of the corporate bond sales in India take place via the private placement route
(about 95%), with the proportion of public issues in the total quantum of debt capital
issued annually has decreased in the last few years.
 Corporate bond market forms a very small size contrasted with the size of the India
economy
 Ownership of government securities is skewed with commercial banks accounting for
40% and insurance companies and provident funds for another 29%.
  As a source cites, the absence of corporate bond market fidns its roots in the
recommendations of the Narsimham Committee decided to close down the major
development financial institutions (IDBI, IFCI, ICICI) converting them into
commercial banks, which do not reserve special funding rights.
 Liquidity also stands to be an issue, with many bonds remaining highly illiquid in the
market

Before investing in debt markets, it is important for investor to check the following details:
1. Coupon (or discount in case of zero-coupon bonds) and the frequency of interest
payments.
2. Timing of cash flows: whether at one single point or different points of time
3. Information about issuer and credit rating: background, business operation, financial
position, credit rating issued by major rating agencies
4. Other terms of issue such as secured/unsecured nature of bond, assets underlying the
security, credit worthiness etc.

Note: LAF was already described in Unit 1. Additional info is stated as below:
The operations of LAF are conducted by way of repurchase agreements (repos and reverse
repos) with RBI being the counter-party to all the transactions. Repo or repurchase option is a
collaterised lending i.e. banks borrow money from Reserve bank of India to meet short term
needs by selling securities to RBI with an agreement to repurchase the same at predetermined
rate and date. The rate charged by RBI for this transaction is called the repo rate. Repo
operations therefore inject liquidity into the system. Reverse repo operation is when RBI
borrows money from banks by lending securities. The interest rate paid by RBI is in this case
is called the reverse repo rate. Reverse repo operation therefore absorbs the liquidity in the
system.
The collateral used for repo and reverse repo operations comprise of primarily Government
of India securities. In fact, Reverse Repos and Repos can be undertaken in all SLR-eligible
transferable Government of India dated Securities/Treasury Bills.
Ways & Means Advances: The Reserve Bank of India gives temporary loan facilities to the
center and state governments as a banker to government. This temporary loan facility is
called Ways and Means Advances (WMA). The WMA scheme was designed to meet
temporary mismatches in the receipts and payments of the government. This facility can be
availed by the government if it needs immediate cash from the RBI. The WMA is to be
vacated after 90 days. Interest rate for WMA is currently charged at the repo rate. The limits
for WMA are mutually decided by the RBI and the Government of India. Reserve Bank of
India (RBI) in consultation with the government of India has set the limits for Ways and
Means Advances (WMA) for the first half of the financial year 2019-20 (April 2019 to
September 2019) at Rs 75000 crore. Under the WMA scheme for the State Governments,
there are two types of WMA – Special (against collateral of G-Sec) and Normal WMA
(based on 3-year average of actual revenue and capex of the state)

Numerical:
https://drive.google.com/file/d/1BLGafA32HAnYxzE1-H4eKuV-
Pg49R6fi/view?usp=sharing
1. Right Issue, Stock Splits, Bonus Issues
2. Calculating Index Value
3. Calculating Yields of Government Securities
4. Calculating Returns
5. Calculating Margins
Written Notes Available at:
https://drive.google.com/open?id=1L4snpBRW5JggU_xO7coEnoG6U6wkWhDL

“EGOTISM = ALTRUISM”