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Innovativefinancial
instrumentsinIndia
Methodology

Collectionofsecondarydata:
HistoricaldatafromsitesofNSE,BSE,SEBIetc
GettingDatafromnewspapers
GettingdatafromtheVariousResearchpaperspublished.
CollectingdatafromvariousBooksavailableonthetopic.
ReviewofPreviousManagementResearchReports
GettingAccesstoInstrumentsavailableinIndiafromSEBIwebsites.
FindingsandConclusions
InIndiafinancialmarketmajorlydenotesequitymarkets.
Indiandebtmarketisnotwelldevelopedandstill80%ofmarketisunder
Governmentsecurities.
SecuritizationhastobedoneonassetsheldbyBanks.
Bondmarketneedsagreatconsiderationintermsofjunkbonds
AneffortcanbemadetodevelopCarbonEmissionandNationalgrowthindex.
CommoditiesOptionsshouldbedevelopedinIndia.
Creditderivativesshouldbedevelopedwithconsiderationofallthepossibletypes
ofCreditderivatives.
InacountrywithmajorincomefromAgriculture,Weatherderivativesshouldbe
introducedtoprotecttheinterestofvariousinvolvedparties.
TomitigatetheCatastrophehazardsnewtechniqueforriskmanagementshouldbe
introduced.
FinancialdevelopmentIndextomeasurethedevelopmentsinvariousparameters
toconcludegrowthinrealterms.
Conclusion
Despitetheacceleratedindustrialgrowthexperiencedthisdecadefromrecent
economicreforms,mostmajorinvestorsaroundtheglobedonotyetseeIndiaas
anidealcountryforforeigninvestment.Thecompetitionforglobalcapitalwill
onlygettougherintheyearstocome,andunlessthepolitical,judicialand
economicenvironmentsareright,Indiawilllagbehindmanyotheremerging
nations.Moreimportantly,therisingexpectationsofthemiddleclass,widening
incomeandwealthinequalitiesbetweenthehavesandhavenots,requireefficient
initiativesfromGovernmentandcorporatetoattractandaccommodatethefunds
available.

Varietyoffinancialproductslikemutualfunds,insurance,shares,debentures,
derivativeinstruments,etc.areavailableinIndia.However,thereachofthese
productsisverylimitedandthefeaturesofmanyoftheseproductsareverybasic
innature.Furtherdevelopmentandinnovationintheseproductswouldbefasterif
theyareaccessedbyallclassesofinvestorsinurbanaswellasruralareas.The
thrustliesmainlyonthedevelopmentofnewfinancialproductstodeepenthe
improvementsintheproductdistributionitself.Theresponsibilityofensuring
theseimprovementsvestswithallthestakeholdersinthefinancialservices
industry.

ABSTRACT
TheIndianfinancialmarkethasbeenprimarilydividedintothreecategories
namely:Equity;Debt;Derivatives.Everycategoryhasitsownimportanceinthe
developmentoffinancialmarkets.Inmostofthedevelopednationsafterthe
developmentofEquitynowthemajorfocusisonDebtandDerivativesmarket.
Thereasonforthisfocuscanbemanysupportivebenefitswhichaccruetoa
marketbydevelopmentofdouble'D'market.

Surprisinglyinfinancialmarketisusedasasynonymforequitymarketwhichhas
completelyunderdeployedDebtandderivativemarkets.Theimportanceand
potentialsofdebtmarketarestillunderadoubtfulimpressioninIndiaandno
majorrevolutionhasbeenbroughttothiseffectintherecentperiods.Focusof
moreandmoretojustequitymarketshascreatedsaturationinIndianstock
market.Sowillinglyorunwillinglynowthefocushastobeshiftedtowardsother
possibleavenues.

Someofthepossibleavenueshavebeencategorizedduringthisresearch
conductedonvariousinstrumentswhicharegloballyavailablebutcannotfind
placeinIndianmarkets.Nowtheseinstrumentsarealsocategorizedinthevarious
formsandaccruetoaspecificmarket.

FirstlythefocusislaidonsocalledBackboneofIndianFinancialsystemVisthe
Indianequitymarket,whichhasincorporatedeverypossibleinstrumentwhichcan
beaccommodatedinIndianfamilyofEquityinstruments.Fewinstrumentshas
beenrecognizedwhichcanbeabsorbedinIndianmarket,whichcanbeIndian
DepositoryReceipt(IDR),NonVotingShares,Cumulativeconvertiblepreference
shares(CCPS),Debtequityswap.

SecondlyitcomesthemostawaitedDebtmarketwhichneedsgreatdevelopment
especiallyincaseofcorporatebonds.InIndia80%ofbondsareGovt.issuedand
80%ofremainingbyinstitutionalinvestors.Sotherehastohappenlotofworkby
GOI(GovernmentofIndia).Inthisfewinstrumentswhichcanbeofutmost
importanceforIndianenvironmentcanbeInflationlinkedbonds(ILB),junk
bonds,Specializeddebtfundforinfrastructurefunding,securitizationofdebt.

Thirdlyitcomestothefundsofmassesi.e.pensionfundsandretirementschemes
whicharealwaysbackedbygovernmentandalsohasgainedsupportfromthe
government.InthiscaseoneofthemajorinnovativeworkscanbeonNew
PensionScheme.

Fourthly,itcomestomutualfundswhichhastheroleofUTI,SEBI,RBI,AMFI
andothersuchauthoritieswhichareregulatingtheworkingsofmutualfundsin
India.OneofNewDirectioninmutualfundscanbeInvestmentfundsin
internationalMarkets.

Fifthlyitcomestothederivativesmarket,whichcanbedividedintwomajor
formsfuturesandoptions.Infuturemajordevelopmentcanbeinthenewly
arrivedconceptswhichcanbecome,

Instrumentsofmasses.TheseincludeFuturesontheIndexofIndustrialand
EconomygrowthandIndexandfuturesforCarbonEmissioninthecountry.
Furtheroptionmarketagainhasalotofscopeforimprovementsinthefieldsof
Weatherderivatives,CommodityOptions,Creditderivatives.

Lastbutnottheleastthereisanopencategorywhichalsohasfewinnovative
instrumentstobecaptured.ThesecanbeIndexforNaturalDisasterandrisk
ManagementandFinancialdevelopmentIndex.

ImportantconsiderationtobenoticedhereisthatIndiaisagreatEconomywith
tremendousgrowthopportunitieshastocaterwithongoingglobalcompetitionin
termsofcapitalandMoneymarketsdevelopments.

AnotherimportantissuehereisthatIndiahastobalanceitsFinancialmarketwith
theequitableshareofdebtandequity.

Itshouldbeopenforlatestandinnovativetypesofinstrumentssuitableforthe
growthanddevelopmentoffinancialsystem.

NewconceptslikeCarbonEmissionindexshouldbeagivenaproperresearchand
findoutthewaystodevelopandimplementit.

INTRODUCTION

INTEGRATIONOFGLOBALCAPITAL
MARKETS
Inthisageofglobalizationandliberalizationdomesticmarketsalonecannotcater
tothegrowingneedsofcorporateandindividuals.Asaresultofwhichthereisa
needoffinancefromvariousnewsourceswhichhasledtotheintegrationofworld
markets.Asaresultwehaveseendevelopmentofvariousfinancialproductsin
pastfewyears.Financialglobalizationhasbroughtconsiderablebenefitsto
economiesandtoinvestorsandhasalsochangedthestructureofmarkets,creating
newrisksandchallengesformarketparticipantsandpolicymakers.Globalization
hasalsoincreasedthescopeofmanynewfinancialproducts.

Twodecadesago,someonebuildinganewfactorywouldprobablyhavebeen
restrictedtoborrowfromadomesticbank.Todayithasmanymoreoptionsto
choosefrom.Itcanalsoshoparoundtheworldforloanwithlowerinterestrate
andcanborrowinforeigncurrencyifforeigncurrencyloansoffermoreattractive
termsthandomesticcurrencyloans;itcanissuestocksorbondsineitherdomestic
orinternationalcapitalmarkets.

Theevolutionofnewfinancialproductshasincreasedthesizeofglobalcapital
marketsconsiderablyovertheyears.Marketcapitalizationandyeartodate
turnoveroftwentymajorstockexchangesisgivenbelow:

THEINDIANCAPITALMARKET
Acapitalmarketisaplacewherebothgovernmentandcompaniesraiselongterm
fundstotradesecuritiesonthebondandthestockmarket.Itconsistsofboththe
primarymarketwherenewsecuritiesareissuedamonginvestors,andthe
secondarymarketswherealreadyexistentsecuritiesaretraded.Inthecapital
market,commodities,bonds,equitiesandothersuchinvestmentfundsaretraded.

Thereare22stockexchangesinIndia,firstbeingtheBombayStockExchange
(BSE),whichbeganformaltradingin1875.Overthepastfewyears,therehas
beenaswiftchangeintheIndiancapitalmarkets,especiallyinthesecondary
market.Intermsofthenumberofcompaniesandtotalmarketcapitalizationin
sharemarket,theIndianequitymarketisconsideredlargerelativetothecountry's
stageofeconomicdevelopment.

CONVENTIONALPRODUCTSIN
INDIANCAPITALMARKETS

EQUITY
Equitysharesareissuedbythecompaniesinprimarymarkettoraisecapitalfrom
publicandcorporatehouses.Itprovidesashareintheearningsofthecompany
andtheequityshareholdercanparticipateindecisionmakingofthecompanyalso.

Therearethreebasictypesofequity:

Commonstockorordinaryshares[1]
Commonstock,asitisknownintheUnitedStates,orordinaryshares,according
toBritishterminology,isthemostimportantformofequityinvestment.Anowner
ofcommonstockispartowneroftheenterpriseandisentitledtovoteoncertain
importantmatters,includingtheselectionofdirectors.Commonstockholders
benefitmostfromimprovementinthefirm'sbusinessprospects.Buttheyhavea
claimonthefirm'sincomeandassetsonlyafterallcreditorsandallpreferred
stockholdersreceivepayment.Somefirmshavemorethanoneclassofcommon
stock,inwhichcasethestockofoneclassmaybeentitledtogreatervotingrights,
ortolargerdividends,thanstockofanotherclass.Thisisoftenthecasewith
familyownedfirmswhichsellstocktothepublicinawaythatenablesthefamily
tomaintaincontrolthroughitsownershipofstockwithsuperiorvotingrights.

Preferredstock[2]
Alsocalledpreferenceshares,preferredstockismoreakintobondsthanto
commonstock.Likebonds,preferredstockoffersspecifiedpaymentsonspecified
dates.Preferredstockappealstoissuersbecausethedividendremainsconstantfor
aslongasthestockisoutstanding,whichmaybeinperpetuity.Someinvestors
favorpreferredstockoverbondsbecausetheperiodicpaymentsareformally
considereddividendsratherthaninterestpayments,andmaythereforeoffertax
advantages.Theissuerisobligedtopaydividendstopreferredstockholders
beforepayingdividendstocommonshareholders.Ifthepreferredstockis
cumulative,unpaiddividendsmayaccrueuntilpreferredstockholdershave
receivedfullpayment.Inthecaseofnoncumulativepreferredstock,preferred
stockholdersmaybeabletoimposesignificantrestrictionsonthefirminthe
eventofamisseddividend.

Warrants[3]
Warrantsoffertheholdertheopportunitytopurchaseafirm'scommonstock
duringaspecifiedtimeperiodinfuture,atapredeterminedprice,knownasthe
exercisepriceorstrikeprice.Thetangiblevalueofawarrantisthemarketpriceof
thestocklessthestrikeprice.Ifthetangiblevaluewhenthewarrantsare
exercisableiszeroorlessthewarrantshavenovalue,asthestockcanbeacquired
morecheaplyintheopenmarket.Afirmmaysellwarrantsdirectly,butmore
oftentheyareincorporatedintoothersecurities,suchaspreferredstockorbonds.
Warrantsarecreatedandsoldbythefirmthatissuestheunderlyingstock.Ina
rightsoffering,warrantsareallottedtoexistingstockholdersinproportiontotheir
currentholdings.Ifallshareholderssubscribetotheofferingthefirm'stotalcapital
willincrease,buteachstockholder'sproportionateownershipwillnotchange.The
stockholderisfreenottosubscribetotheofferingortopasstherightstoothers.
IntheUKastockholderchoosesnottosubscribebyfilingaletterofrenunciation
withtheissuer.

RECENTDEVELOPMENTINEQUITY
MARKET
1. FreepricingTheabolitionofofficeofthecontrollerofcapitalissueresultedin
theemergenceofnewerainprimarymarkets.Allcontrolsondesigning,pricing
andtenurewereabolished.Theinvestorsweregiventhefreedomtopricean
instrument.
2. EntryNormsHithertonorestrictionsforacompanytotapthecapitalmarkets.
Thisresultedinmassivesurgeofsmallcapissues.Theneedfortransparentfree
entrywasfeltbySEBI.
3. Disclosuresthequalityofdisclosureintheofferdocumentwasreallypoor.Alot
ofvitaladverseinformationwasnotdisclosed.SEBIstringentdisclosernorms
wereintroduced.
4. BookBuildingItistheprocessofpricediscovery.Oneofthedrawbacksoffree
pricingwaspricemechanism.Theissuepricehastobedecidedaround6070days
beforetheopeningatissue.Introductiontopricebuildinghasovercomethe
limitationofpricemechanism.
5. Streamliningtheproceduresalltheprocedureswasstreamlined.Manyaspectsof
theoperationshavebeenmadetransparent.
SCOPEOFFURTHEREQUITY
INSTRUMENTS

INDIANDEPOSITORYRECEIPTS(IDR)
AfterthesuccessofAmericanDepositoryReceiptsandGlobalDepository
ReceiptstheIndianregulatorybody,SEBIalsoallowedforeigncompaniestoraise
capitalinIndiathroughINDIANDEPOSITORYRECEIPTS(IDRs).IDRscanbe
understoodasamirrorimageofwellknownADRs/GDRs.InanIDR,foreign
companiesissuethesharestoanIndianDepository,whichwould,issue
DepositoryReceiptstoinvestorsinIndia.TheDepositoryReceiptswouldbelisted
inIndianstockexchangesandwouldbefreelytransferable.Theactualsharesof
theIDRswouldbeheldbyanOverseasCustodian,whoshallauthorizetheIndian
DepositorytoissuetheIDRs.TheOverseasCustodianmustbeaforeignbank
havingbusinessinIndiaandneedsapprovalfromtheFinanceMinistryforacting
asacustodianwhiletheIndianDepositoryneedstoberegisteredwiththeSEBI.

FollowingruleswereestablishedbySEBIforlistingthroughIDR:

ISSUERSELIGIBILITYCRITERIA:[4]
Musthaveanaverage;turnoverofUS$500millionduringtheprevious3financial
years.
MusthavecapitalandfreereserveswhichmustaggregatetoatleastUS$100
million.
Mustbemakingaprofitfortheprevious5yearsandmusthavedeclareda
dividendof10%ineachsuchyear.
Thepreissuedebtequityratiomustbenotmorethan2:1.
Mustbelistedinitshomecountry.
Mustnotbeprohibitedbyanyregulatorybodytoissuesecurities
Musthaveagoodtrackrecordwithcompliancewithsecuritiesmarketregulations.
MustcomplywithanyadditionalcriteriasetbySEBI
REASONSFORDORMANCYINISSUE
OFIDR:
StringentrulessetbySEBImadeforeigncompaniesstayawayfromIndian
market.
TherulesweremademorestringentaftertheGlobaleconomiccrisis.
Availabilityofeasyfundsinforeignmarkets.
Rateofinterestinforeignbanksisalsolesswhichmadethemprimesourceof
fundsforcompanies.
UncertaintyofsubscriptioninIndianmarkets.
Indiancompanieshavebeenhighlyactiveinforeignmarketsbyraisingfunds
throughADRandGDRbuttilldatenoforeigncompanyhasraisedmoneythrough
IDRs.StandardCharteredisthefirstcompanytoallowitsplantoissueIDRand
hasreceivedtheclearancefromRBIalso.Thebankhasyettoannouncethesizeof
theIDRissue,thoughthefiguresareexpectedtovaryfromRs2,500toRs5,000
crore.
NonVotingShares
Anonvotingshareismoreorlesssimilartotheordinaryequitysharesexceptthe
votingrights.Itisdifferentfromapreferenceshareinthesensethatincaseofa
possiblewindingupofthecompany,thepreferenceshareholdersgettheirshares
ofdividendsrepaidbeforetheownersofthenonvotingshareholders.The
companieswiththeconstanttrackrecordandastrongdividendhistorycanissue
thesekindsofinstruments.Theyarebasicallyfocusedtosmallinvestorswhoare
normallynotinterestedinthemanagementofthefirm.Hencenonpromoting
shareareagoodtoolforthepromotersofthecompanytoincreasetheshare
capitalwithoutdilutingthecontrol.Howeverifthecompanydoesnotfulfillthe
commitmentofhigherdividendthenthesesharesareautomaticallyconvertedto
shareswithvotingrights.

Henceitisveryimportantforthecompaniestoassessthecharacteristicsoffuture
cashflowanddeterminewhetherpayingahigherrateofdividendispracticable
forthemornot.

Debtforequityandequityfordebtswaps
Adebtforequityswapisnotaninstrumentbutasituationwhereacompanyoffers
itsshareholdersandcreditorsdebtinexchangeforequityorstock.Thevalueof
thestockisdeterminedoncurrentmarketrates.Thecompanymay,however,offer
ahighervaluetoattractmoreshareholdersanddebtholderstoparticipateinthe
swap.Equityfordebtswapistheoppositeoftheaboveprocess.Inthisswap,the
creditorstothecompanyagreetoexchangethedebtforequityinthebusiness.

Howdocreditorsbenefit
Creditorssuchasbanksandotherfinancialinstitutionsprovidecapitaltolarge
businesses.Ifthebusinessgetsintofinancialtrouble,itmaysometimesnotbea
goodideatoallowthecompanytoclosedownandgobankrupt.Inthese
situations,thesecreditorsfinditeasiertoallowthebusinesstotaketheformof
goingconcernandbecometheshareholdersinthisbusiness.Thedebtortheassets
ofthecompanymaybesobigthattherewouldbenoanyprofitoradvantageto
thebanksinseekingitsclosure.Attimes,thecompanymayalsobeseekinga
restructuringofitscapitalforcertainreasons.Theseincludemeetingcontractual
obligations,takingadvantageofcurrentstockvaluationinthemarketortoavoid
makingcouponandfacevaluepayments.

Howdebtforequityswaptakesplace
Letusassumethatashareholderorinvestorofsomecompanyhas$1000worthof
stock.Thecompanyofferstheoptiontoswapequitywithdebtatarateof1:1.This
meansthatfor$1000worthofstock,theinvestorwouldget$1000worthofdebt
orbondsinthecompany.Attimes,thecompanymayofferaratioof1:2toattract
morestockforitsdebt.Thiscouldmeananadditionalgainintheformof$1000
worthofstockfortheinvestor.Butitisalsoimportanttonotethattheinvestor
wouldlosetheirrightsasashareholder,themomentheswapshisstockorequity
fordebt.Originalshareholdersoftenfindthemselvesdeprivedoftheirvoting
rightswhensuchswapstakeplace.

DEBTMARKET
Traditionally,theIndiancapitalmarketsaremoresynonymouswiththeequity
marketsbothonaccountofthecommoninvestors'preferencesandthehuge
capitalgainsitofferednomatterwhattherisksinvolvedare.Ontheotherhand,
theinvestor'spreferencefordebtmarkethasbeenrelativelyarecentphenomenon
anoutcomeoftheshiftintheeconomicpolicy,wherebythemarketforceshave
beenaccordedagreaterleewayininfluencingtheresourceallocation.Ifwetalk
abouttheIndiandebtmarketbondmarkethasformeditsownplaceinthe
financialsystems.Alltherecentdevelopmentsareaccruedtobondsmarketin
India.

Sizeofdebtmarket
Ifwelookatworldwidescenario,debtmarketsarethreetofourtimeslargerthan
equitymarkets.However,thedebtmarketinIndiaisverysmallincomparisonto
theequitymarket.Thisisbecausethedomesticdebtmarkethasbeenderegulated
andliberalizedonlyrecentlyandisatarelativelynascentstageofdevelopment.

Interestratederegulation
ThelasttwodecadeswitnessedagradualmaturingofIndia'sfinancialmarkets.
Since1991,keystepsweretakentoreformtheIndianfinancialmarkets.Withthe
introductionofauctionsystemsforrisingGovernmentdebtinthe1990s,along
withthedecisiontoputanendtothemonetizationofGovernmentdeficits,started
thegradualprocessofderegulationofinterestrates.Whiletheimmediateeffectof
deregulationofinterestrateswasassociatedwithrisinginterestrates,deftdebt
managementpolicybytheRBIandtheimprovementsinthemarketmicro
structuresawagradualdeclineintheinterestrates.

Abolitionoftaxdeductionatsource
Taxdeductionatsource(TDS)usedtobemajorbarriertothedevelopmentofthe
governmentsecuritiesmarketinIndia.Recognizingthis,theRBIconvincedthe
Governmenttoabolishit.TheremovalofTDSonGovernmentsecuritieswas
apparentlyasmallbutamajorreforminremovingpricingdistortionsfor
Governmentsecurities.

Introductionofauctions
ForAuctionsamajorpolicyshiftfromadministeredinterestrateregimetoa
marketbasedregime,thechoiceofauctionsystemneededtobecarefullydrawn,
inordertogiveacomfortleveltothegovernmentasaborrowerasalsoto
moderatetherisksthatmightbefacedbytheuninitiatedmarketparticipants.
Accordingly,itwasdecidedtobeginwith"thesealedbidauctionsystemwitha
postbidreserveprice"(sincetheRBIasanagenttogovernmentparticipatesinthe
auctionsasanoncompetitivebidder.)

BanksinvestmentsinGovernmentsecurities
valuation/accountingnorms
Concomitantly,regulatoryinitiativesinintroducinginternationalbestpracticesin
valuation/accountingnormsforthebanks'investmentportfolios(comprising
mainlygovernmentsecurities)alsonecessitatedthebankstomarktomarkettheir
investmentportfoliosandforcedthemtoactivelytrade.Thisgaveanadded
impetustotheincipienttradingactivity.
Consolidationofstocks
Primaryissuancestrategywasfurtherfinetunedtowardsissuanceofbenchmark
securitiestoimproveliquidity.Alignmentofcouponpaymentdatesforthenew
issuanceshasbeenconsciouslyattemptedtopromotestrippingofgovernment
securities(STRIPS),whichifoncematerializes,canfacilitatetheestablishmentof
zerocouponyieldcurveandalsocantakecareofthesegmentalneedsintermsof
assetliabilitymatching.

Zerocouponcurveforpricing[5]
Tobringfurtherimprovementsinthepricingmechanismindebtmarket,aneed
wasfelttopromoteazerocouponyieldcurve(ZCYC).Asindicatedearlier,
STRIPS(SeparateTradingofRegisteredInterestandPrincipalofSecurities)can
facilitateaZCYC.ThiscurveisbeingusedforpricingNSE'sinterestratefutures
transactions.FIMMDA/PDAI,publishesamonthlyZCYCforthemarket
participantstovaluetheirgovernmentsecuritiesportfolios.However,theZCYC
basedpricinghasnotbeenpopularwiththeIndianmarketparticipants.

SCOPEOFINNOVATIONSINBOND
MARKET

Inflationlinkedbonds(ILB)[6]
TherecentMonetaryPolicyreleasedbyRBIlaiditsthrustoncontrollingthe
spiralinginflation,especiallythefoodpriceinflation.Oneofthereasonsbehind
theCRRhikewasto"curtailtherisinginflationaryexpectations(higherexpected
pricetrends)"

InthepastRBIhasbeenconcernedaboutthefactthatacommonmandoesnot
haveanyprotectionagainstrisingprices,VisNoInflationHedge.Thecommon
manhastorelyontraditionalbutinefficientmethodstohedgetherealinflation
risks,suchasGoldandrealassetssuchascommoditiesorrealestateoreven
excessivestockingofgoods
IndevelopedmarketslikeUS,thegovernmenthasissues"TreasuryInflation
ProtectedSecurities"knownasTIPS.GloballymorethanUSD1trillionworth
inflationlinkedbondsmustbeoutstanding.

Inflationlinkedbonds(ILB)securitiesgiveanopportunitytomarketparticipants
andinvestorstohedgeagainstinflation.Thecoupon(interestrate)ofILBisfixed
buttheunderlyingprincipalwouldmoveintandemwiththeinflationlevelsinthe
country.Atredemptionofthesecuritiesthehigherofthevalue(addinginflation)
thusarrivedorfacevalueispaidoff.BanksandFinancialInstitutionsusuallybuy
wholesaleandcreateretailmarketforsuchsecurities.Withrightaccessretail
investorcaneasilybuysuchsecuritiestoprotecthimselffrominflationandthis
couldhavefollowingadvantagetoinvestorsandthegovernment.

1. Theinflationlinkedbondscanmakethegovernmentsaccountableforhigher
inflationsincethecostofborrowingswillbelinkedtoinflation(ifcouponpaidis
inflationhedged).Risinginflationwillalsoraisetherepaymentofinflationlinked
bonds.
2. Itwillhelpgovernmenttobroadentheinvestorbasebyofferinginflationlinked
bondsattheretaillevel,wheretheparticipationnowisminimal.
3. Governmentcandiversifythedebtservicecostsinadeflationary(fallingprices)
scenario.
4. Itisverylikelythattheexistenceofinflationlinkedbondsmightreducethe
inflationriskpremiumembeddedingovernmentbonds.
5. FortheinflationlinkedbondstobeaneffectivehedgeGOIshouldensurethatthe
underlyinginflationindexisrepresentativeofrealoractualinflationonthestreets.
6. RBIcanpreciselyquantify&controltheinflationaryexpectationsembeddedin
theeconomyaswellasinthemarkets.RBIcanuseinferencesfromtradingin
suchbondsinformulatingitsmonetarypolicystance
7. Theonusonmonetarypolicytoolssuchasinterestrates,tocontaininflationwill
reduceifRBIcanguideorinfluencetheinflationaryexpectationsthroughthe
demand/supplyofinflationlinkedbondsandwithanexcellentcommunication
policy.
ForInvestorsingeneral,inflationlinkedbondswouldprovidedistinctadvantages:

1. Itallowsinvestorstohedgethepurchasingpower(inflation)risk.Thecapitalis
inflationriskprotectedandtheincome(coupon)canbestructuredthatwaytoo.
2. Inflationlinkedbondsuniversallyareregardedasaseparateassetclass&would
providediversificationbenefitstoaportfolioduetoitsnegativecorelationwith
returnsfromtraditionalassetclasses.
3. Suchbondsprovidepositiveriskrewardrelationshiptoo.
4. Inflationlinkedbondsareeffectivevehicleforhedgingrisksforinstitutional
investors,wherethelongtermliabilitiesareinflationlinkedorlinkedtofuture
wagelevelsorbankswhofacetheinflationriskontheirassetssideduetotheir
GOIBondholdings.
5. AccessofFIIstotheinflationlinkedbondscanallowthemtohedgetheirinflation
risksinIndiawhicharecurrentlyexpressedinthecurrencymarkets.The
USD/INR(currency)volatilitycanhencecomedownhence.
Junkbonds
SharpmovementsintheIndianequitymarketmaybeparforthecourse.Butwhen
itcomestothemarketforcorporatebonds,it'sconstantlystagnant.Thereasonis,
wedon'thaveacorporatebondmarket.Butthisisoverwhelminglydominatedby
governmentsecurities(about80%ofthetotal).Oftheremaining,closeto80%
againcomprisesprivatelyplaceddebtofpublicfinancialinstitutions.Anefficient
bondmarkethelpscorporatereducetheirfinancingcosts.Itenablescompaniesto
borrowdirectlyfrominvestors,bypassingthemajorintermediaryroleofa
commercialbank.OneoftheimportantinstrumentsincorporatemarketisJunk
BondswhichcouldbegreatsourceoffinancingforcountrieslikeIndiawhere
marketsarenotmuchregulated.

AspeculativebondratedBBorbelow."Junkbonds"aregenerallyissuedby
corporationsofquestionablefinancialstrengthorwithoutproventrackrecords.
Theytendtobemorevolatileandhigheryieldingthanbondswithsuperiorquality
ratings."Junkbondfunds"emphasizediversifiedinvestmentsintheselowrated,
highyieldingdebtissues.Thus,thesearehighyielding,highrisksecuritiesissued
bycompanieswithlessrobustfinances.[7]

NeedforJunkBondsinIndia
ThemajorissueamongstIndianbondmarketshasbeenhowcompanieswith
poorerratingscanraisefunds.AttimesthebanksandFIsarereluctanttoinvestin
eventhe'AAArated'companies.Infactforprogressofadevelopingnationlike
India,thiswouldgiveawonderfulopportunityforthesmallercompaniestoget
fundsandimplementtheirideas.However,aproperregulatorymechanismalso
needstobesetuptoavoidhighriskofdefaultinthecaseofjunkbonds.

Currently,thereareonlytwoinstrumentsthatFIIscaninvestinIndia,i.e.,equity
anddebt.ThecaponFIIdebtinvestmentvariesfromtimetotimebetween$1.5
billionand$2billion.TheAssetReconstructionCompanyofIndiaLtd.(ARCIL),
India'sfirstassetreconstructioncompany,hasviedforpermittingFIIstoinvestin
anewinstrumentinIndiadistressedassets.ARCILhasrecommendedSEBI,RBI
andtheFinanceMinistrytoallowFIIinvestmentinanewcategory,whichis
neitherequitynordebtbutaseparatelucrativeinstrumentsecurityreceiptswith
underlyingdistressedassets.

ProposedJunkBondMarketinIndia
Scenario(Optimistic&Realistic)
Anoptimisticscenariowouldbehavingjunkbondsinthemarketideallyfor
fundingbyFIIsandInstitutionsforfinancingthesmallIndiancompanies.
However,consideringtheriskassociatedwiththesebondsitmightnotbepossible
innearfuturebecauseeconomyisstillinitsnascentphaseandonafast
developmenttrack.Soanymovewhichisriskyandcanaffectfutureinflowsof
foreignfundsandinvestorconfidencewouldnotbeideal.

Theonlywayaninvestorshouldinvestinjunkbondsisbydiversifying.A
selectionofatleasthalfadozenissueswillaffordtheinvestorsomeprotection.
Highriskisinherentinhighyieldbonds.Nevertheless,yourportfoliomaywell
haveaplaceforsomeofthesesecuritiesifyouarenotriskaverse.Byhavingjunk
bondmarkets,itwouldinfactsignifydeepeningandmaturingofIndiandebt
markets.InIndia,companiesarehamstrungbythefactthatinvestmentrelaxations
maycomeinonlywhenthedebtmarketsgetdeeper,sothatinsurancecompanies
canincreasetheirportfolioyieldwithoutexposingthemselvestoriskforlong
tenuresbyinvestinginjunkbonds.

ImpactofJunkBondsonIndian
Economy[8]
Awellfunctioningcorporatebondmarketallowsfirmstotailortheirassetsand
liabilityprofiles.Ifcompaniesfeartheywillnotbeabletoraiselongterm
resources,theyarelikelytostayawayfromlongterminvestmentsor
entrepreneurialventuresthathavealongtermpayoff.Inthelongrun,thiscan
affecteconomicgrowth.Thecorporatebondandthejunkbondmarketcouldfill
thisvacuum.Intheabsenceofacorporatebondmarket,alargepartofdebt
fundingcomesfrombanks.Intheprocess,banksassumeasignificantamountof
riskduetomaturitymismatchbetweenshorttermdepositsthatcanbereadily
withdrawnandrelativelylongtermilliquidloanassetsresultinginhighNPAs.
Anactiveandefficientbondmarketgivescompaniesanalternativemeansof
raisingdebtcapitalintheeventofacreditcrunch.Italsoleadstobetterpricingof
creditrisk(sinceexpectationsofallmarketparticipantsareincorporatedintobond
prices).

FIIsaremajorplayersintheequitiesmarket.However,thankstotheceilingon
theirinvestmentinthedebtmarket(currently,thereisacumulativesubceilingof
$0.5bnoninvestmentincorporatedebt),theyarepresentonlyinalimitedwayin
thebondmarket.

Pensionfundsandtheinsurancesectorcouldbeanotherconstituency,butthe
absenceofpensionfundsandlowinsurancepenetrationhasmeantlimiteddemand
forlongtermbonds.Allthesewouldhelpinestablishingacorporatebondmarket
forsubinvestmentgrade.

Specializeddebtfundsforinfrastructure
financing[9]
AsrecommendedbytheHighLevelExpertCommitteeonCorporateBondsand
Securitization(HLECCBS),thereisacaseforcreationofspecializedDebtFunds
tocatertotheneedsoftheinfrastructuresector.SuchDebtFundsregisteredwith
SEBIshouldbegiventhesametaxtreatmentastheoneextendedtoventure
capitalfunds.

TheresourcerequirementsforinfrastructuredevelopmentinIndiaareenormous.
AnestimateindicatesthattherequirementsaretothetuneofUS$150billionor
moreduringthenextfiveyears.Consideringthelonggestationperiodinvolvedin
infrastructureprojectsandgiventheirliabilities(mainlydeposits)whichareshort
tomediumterminnature,banksareconstrainedtofinancethissectorsincetheir
assetliabilitysideisshortterminnature.Thiscertainlyrequiresbondfinancing.

ThereexistsastrongcaseforcreationofspecializedlongtermDebtFundstocater
totheneedsoftheinfrastructuresector.Aregulatoryandtaxenvironmentthatis
suitableforattractinginvestmentsfromQualifiedInvestmentBanksisthekeyfor
channelinglongtermcapitalintoinfrastructuredevelopment.Currently,most
bankslackinhousecapacitytoevaluateprojectfinancerisk.Assuch,they
providedebtfinancingforinfrastructureprojectslargelyonlytotheextentthat
theyareabletoparticipateinloansyndicatesledbyahandfulofspecialists.

FacilitatingthecreationofinfrastructurefocusedDebtFundsandmakingiteasier
forbankstoparticipateinsuchfundswouldallowmuchlargervolumesofdebt
financingfromthebankstobedeployedtoinfrastructuredevelopmentwhile
distributingtheassociatedrisksmoreevenlyacrossagreatervarietyofprojects.

SecuritizationofDebt[10]
Securitizationisastructuredfinanceprocessthatdistributesriskbyaggregatingdebt
instrumentsinapool,thenissuesnewsecuritiesbackedbythepool.Theterm
"Securitisation"isderivedfromthefactthattheformoffinancialinstrumentsused
toobtainfundsfromtheinvestorsaresecurities.Asaportfolioriskbackedby
amortizingcashflowsandunlikegeneralcorporatedebtthecreditqualityof
securitizeddebtisnonstationaryduetochangesinvolatilitythataretimeand
structuredependent.Ifthetransactionisproperlystructuredandthepoolperforms
asexpected,thecreditriskofalltranchesofstructureddebtimproves;if
improperlystructured,theaffectedtrancheswillexperiencedramaticcredit
deteriorationandloss.Allassetscanbesecuritizedsolongastheyareassociated
withcashflow.Hence,thesecuritieswhicharetheoutcomeofSecuritisation
processesaretermedassetbackedsecurities(ABS).Fromthisperspective,
Securitisationcouldalsobedefinedasafinancialprocessleadingtoanissueofan
ABS.

Averybasicexamplewouldbeasfollows.XYZBankloans10people$100,000a
piece,whichtheywillusetobuyhomes.XYZhasinvestedinthesuccessand/or
failureofthose10homebuyersifthebuyersmaketheirpaymentsandpayoffthe
loans,XYZmakesaprofit.Lookingatitanotherway,XYZhastakentheriskthat
someborrowerswon'trepaytheloan.Inexchangefortakingthatrisk,the
borrowerspayXYZapremiuminadditiontotheinterestonthemoneythey
borrow.XYZwillthentakethesetenloans,andputtheminapool.Theywillsell
thispooltoalargerinvestor,ABC.ABCwillthensplitthispool(whichconsists
ofhighriskloansandlowriskloans)intoequalpieces.Thepieceswillthenbe
soldtoothersmallerinvestors,(asbonds).

MortgageBackedSecurities(MBS)[11]
Atypeofassetbackedsecuritythatissecuredbyamortgageorcollectionof
mortgages.Thesesecuritiesmustalsobegroupedinoneofthetoptworatingsas
determinedbyaaccreditedcreditratingagency,andusuallypayperiodic
paymentsthataresimilartocouponpayments.Furthermore,themortgagemust
haveoriginatedfromaregulatedandauthorizedfinancialinstitution.Whenyou
investinamortgagebackedsecurityyouareessentiallylendingmoneytoahome
buyerorbusiness.AnMBSisawayforasmallerregionalbanktolendmortgages
toitscustomerswithouthavingtoworryaboutwhetherthecustomershavetheassets
tocovertheloan.Instead,thebankactsasamiddlemanbetweenthehomebuyer
andtheinvestmentmarkets.

Thistypeofsecurityisalsocommonlyusedtoredirecttheinterestandprincipal
paymentsfromthepoolofmortgagestoshareholders.Thesepaymentscanbe
furtherbrokendownintodifferentclassesofsecurities,dependingontheriskiness
ofdifferentmortgagesastheyareclassifiedundertheMBS.

However,thelongtermtenureofMBSandthelackofliquidityinthesecondary
marketdiscourageinvestorsfromgettingactivelyinvolvedinthemarket.Also
homeloansinIndiagetprepaidorrepriced,thusexposingthestructuresto
significantinterestrateriskandleadingtohighercreditenhancement
requirements.

IssuesfacedbysecuritizationinIndia[12]

Regulatoryissues
StampDuty:Oneofthebiggesthurdlesfacingthedevelopmentofthe
securitizationmarketisthestampdutystructure.Theprocessoftransferofthe
receivablesfromtheoriginatortotheSPVinvolvesanoutlayonaccountofstamp
duty,whichcanmakesecuritizationcommerciallyunviableinseveralstates.

ForeclosureLaws
Lackofeffectiveforeclosurelawsalsoprohibitsthegrowthofsecuritizationin
India.Theexistingforeclosurelawsarenotlenderfriendlyandincreasetherisks
ofMBSbymakingitdifficulttotransferpropertyincasesofdefault.

Taxationrelatedissues
TaxtreatmentofMBSSPVTrustsandNPLTrustsisunclear.Currently,the
investors(PTCandSRholders)paytaxontheincomedistributedbytheSPV
TrustsandonthatbasisthetrusteesmakeincomepayoutstothePTCholders
withoutanypaymentorwithholdingoftax.

LegalIssues
ListingofPTCsonstockexchange:Currently,theSCRAdefinitionof'securities'
doesnotspecificallycoverPTCs,Whilethereisindeedalegalviewthatthe
currentdefinitionofsecuritiesintheSCRAincludesanyinstrumentderivedfrom,
oranyinterestinsecurities,thenatureoftheinstrumentandthebackgroundofthe
issueroftheinstrument,notbeinghomogenousinrespectoftherightsand
obligationsattached,acrossinstrumentsissuedbyvariousSPVs,hasresultedina
degreeofdiscomfortamongexchangeslistingtheseinstruments.Someissues
undertheSARFAESIAct:TheambiguityaboutwhetherornotAsset
ReconstructionCompanies(ARCs)andSecuritizationCompanies(SCs)registered
withtheRBIcanestablishmultipleSPVTrusts,hasbeenresolvedbyaspecific
provisionintheformofsec.7(2A)oftheSARFAESIAct.Inviewofthis,itis
nowpossibletounambiguouslyadoptthetrustSPVstructureevenunderthe
SARFAESIActforMBS,ABSorNPLsecuritization.

SoallthesecontributetotheproblemsthatarefacedbySecuritizationinIndia.

PENSIONFUNDSANDRETIREMENT
SCHEMES[13]
Internationalexperienceshowsthatpensionfundshaveindeedprovidedthemuch
neededboosttothedevelopmentofcorporatedebtmarketsbothintermsof
demandforcorporatebondsasalsoliquidityapartfromimprovingthemarket
microstructure.Pensionfundshavealsobeenmajorstimulatorsoffinancial
innovationastheyhavedirectlyorindirectlysupportedproductinnovationby
supportingthedevelopmentofassetbackedsecurities,structuredfinance,
derivativeproductsandsoon.Pensionfundpresenceinthebondmarketislikely
toincreasetheavailabilityoflongtermfundsinthemarket,whichinturnwill
improvetheassetliabilitymismatchthatoftenarisesinprojectswithlong
gestationperiods.

RecentGovernmentInitiativesandPension
FundReform
Twoparallelsetsofinitiativeshavebeentakenduringthelast45years.Thefirst
initiativewasfortheorganizedsectorandthesecondinitiativewasforthe
unorganizedsector.OASIS(OldAgeSocialandIncomeSecurity)projectwas
commissionedbytheMinistryofSocialJusticeandEmpowerment,which
submitteditsreportinJanuary2000.OASISreportrecommendedaschemebased
onIndividualRetirementAccounts(IRAs)tobeopenedanywhereinIndia.Banks,
PostOfficesetc.,wereidentifiedtoserveas"PointsofPresence"(POPs)where
theaccountscouldbeopenedorcontributionsdeposited.Theirelectronic
interconnectivitywouldensure"portability"astheworkermovesfromone
place/employmenttoanother.TherewouldbeadepositoryforCentralizedrecord
keeping,fundmanagerstomanagethefundsandannuityproviderstoprovidethe
benefitaftertheageof60.TheOASISreportbroughtforthimportantreformsin
thefieldofpensionfundinvestmentsandpavedthewayforlaterinitiativeslike
theannouncementoftheNewPensionSystemintheBudgetof200304,which
gotintroducedon1January2007.

ScopeofDevelopment

TheNewPensionSystem(NPS)
TheNewPensionSystem(NPS)isapensionsystemthatisintendedtoinitially
catertonewlyrecruitedCentralGovernmentemployees(exceptthearmedforces)
andtoworkersintheunorganizedsector.Evenwithinunorganizedsector,the
NPSwillcatertoonlyworkerswhoaretaxpayersandcanbemotivatedtojointhe
schemethroughtaxincentives.AswithGovernmentemployees,theycanaskfor
investmentprotectionguaranteesoninvestmentsundervariouspensionschemes
offeredbyPensionFunds.However,thisguaranteewouldbeimplementedusing
privatefinancialmarkets.PersonsbeingcoveredbyschemesofferedbytheEPFO
andotherprovisionsadministeredunderanystatuteswouldnotbecoveredunder
thisNPSscheme.Thus,noexistingarrangementofpensionprovisionapplicable
toalreadyexistingpersonsareproposedtobechanged,onlynew/additional
personsaregoingtoavailthebenefitoftheNPS.AlthoughtheNPShasstarted
withcoveringCentralGovernmentemployeeswhojoinedserviceafter1January
2007,StateGovernmentsarelikelytojointhisNPSschemegoingforward.Indue
course,privatesectoremployeestoomayjointheNPSscheme.
TheuniquenessoftheNPSistwofold:

i. ItcreatesasystemwhereboththeGovernmentemployeesaswellasworkersin
theunorganizedsectorarecoveredbyoneschemeandsupervisedbyoneregulator
and
ii. Thechoiceaboutfundmanagersoraboutdifferentschemesofafundmanagercan
beexercisedindependentofthefundmanagerthroughthemechanismofthe
CentralRecordkeepingAgency(CRA).
MUTUALFUNDS[14]
Mutualfundsaresupposedtobethebestmodeofinvestmentinthecapitalmarket
sincetheyareverycostbeneficialandsimple,anddonotrequireaninvestorto
figureoutwhichsecuritiestoinvestinto.Amutualfundcouldsimplybedescribed
asafinancialmediumusedbyagroupofinvestorstoincreasetheirmoneywitha
predeterminedinvestment.

Theresponsibilityforinvestingthepooledmoneyintospecificinvestment
channelslieswiththefundmanagerofsaidmutualfund.Thereforeinvestmentin
amutualfundmeansthattheinvestorhasboughtthesharesofthemutualfund
andhasbecomeashareholderofthatfund.DiversificationofinvestmentInvestors
areabletopurchasesecuritieswithmuchlowertradingcostsbypoolingmoney
togetherinamutualfundratherthantrytodoitontheirown.Howeverthebiggest
advantagethatmutualfundsofferisdiversificationwhichallowstheinvestorto
spreadouthismoneyacrossawidespectrumofinvestments.Thereforewhenone
investmentisnotdoingwell,anothermaybedoingtakingoff,therebybalancing
therisktoprofitratioandconsiderablycoveringtheoverallinvestment.

Thebestformofdiversificationistoinvestinmultiplesecuritiesratherthaninjust
onesecurity.Mutualfundsaresetupwiththepreciseobjectiveofinvestingin
multiplesecuritiesthatcanrunintohundreds.Itcouldtakeweeksforaninvestor
toinvestigateonthiskindofscale,butwithinvestmentinmutualfundsallthis
couldbedoneinamatterofhours.

ScopeofInnovationinmutualfunds

InvestingInInternationalMarkets
In2007RBIincreasedthelimitsofinternationalinvestmentsforindividualsfrom
$50,000to$100,000andforMutualfundsfrom3billionto4billiondollars.This
hasmadealotofmutualfundshaveofferedproducttoIndiancustomersthat
investabroad.Performanceofsomeofthoseproductsis:

Thoughsomeofthesefundsgivebetterreturnsthannormaldomesticequityand
providebetterdiversificationbutstillpeoplearereluctantininvestingabroaddue
tofollowingreasons:

CHANGEINEXCHANGERATES
Whentheexchangeratebetweentheforeigncurrencyofaninternational
investmentandtheIndianRupeechanges,itcanincreaseorreduceyour
investmentreturn.Duetothisreasonitgetsmorecomplicatedandriskyforpeople
notonlytheirinvestmentshouldbeinrightstock/fundtheforeignexchangerate
shouldalsoworkintheirfavor

POLITICALSOCIALANDECONOMIC
EVENTS
Itisdifficultforinvestorstounderstandallthepolitical,socialandeconomic
factorsthatinfluenceforeignmarkets.Thesefactorsprovidediversification,but
theyalsocontributetotheriskofinternationalinvesting.

COSTOFINVESTMENT
InternationalinvestingcanbemoreexpensivethaninvestinginIndiancompanies.
Insmallermarkets,youmayhavetopayapremiumtopurchasesharesofsome
popularcompanies.Transactioncostssuchasfees,broker'scommissions,and
taxesoftenarehigherthaninIndianmarkets.Mutualfundsthatinvestabroad
oftenhavehigherfeesandexpensesthanfundsthatinvestinIndianstocks,inpart
becauseoftheextraexpenseoftradinginforeignmarkets.

RELIANCEONFOREIGNLEGAL
REMEDIES
Ifyouhaveaproblemwithyourinvestment,youmaynotbeabletosuethe
companyinIndia.Youmayhavetorelyonwhateverlegalremediesareavailable
inthecompany'shomecountry.

DERIVATIVESININDIA
TheNationalStockExchangeofIndiaLimited(NSE)commencedtradingin
derivativeswiththelaunchofindexfuturesonJune12,2000.Thefutures
contractsarebasedonthepopularbenchmarkS&PCNXNiftyIndex.The
ExchangeintroducedtradinginIndexOptions(alsobasedonNifty)onJune4,
2001.NSEalsobecamethefirstexchangetolaunchtradinginoptionson
individualsecuritiesfromJuly2,2001.Futuresonindividualsecuritieswere
introducedonNovember9,2001.FuturesandOptionsonindividualsecuritiesare
availableon179securitiesstipulatedbySEBI.

Futures[15]
A'Future'isacontracttobuyorselltheunderlyingassetforaspecificpriceata
predeterminedtime.Ifyoubuyafuturescontract,itmeansthatyoupromiseto
paythepriceoftheassetataspecifiedtime.Ifyousellafuture,youeffectively
makeapromisetotransfertheassettothebuyerofthefutureataspecifiedprice
ataparticulartime.Everyfuturescontracthasthefollowingfeatures:

Buyer
Seller
Price
Expiry
Someofthemostpopularassetsonwhichfuturescontractsareavailableare
equitystocks,indices,commoditiesandcurrency.

Thedifferencebetweenthepriceoftheunderlyingassetinthespotmarketandthe
futuresmarketiscalled'Basis'.(As'spotmarket'isamarketforimmediate
delivery)Thebasisisusuallynegative,whichmeansthatthepriceoftheassetin
thefuturesmarketismorethanthepriceinthespotmarket.Thisisbecauseofthe
interestcost,storagecost,insurancepremiumetc.,Thatis,ifyoubuytheassetin
thespotmarket,youwillbeincurringalltheseexpenses,whicharenotneededif
youbuyafuturescontract.Thisconditionofbasisbeingnegativeiscalledas
'Contango'.
Sometimesitismoreprofitabletoholdtheassetinphysicalformthanintheform
offutures.Foreg:ifyouholdequitysharesinyouraccountyouwillreceive
dividends,whereasifyouholdequityfuturesyouwillnotbeeligibleforany
dividend.

Whenthesebenefitsovershadowtheexpensesassociatedwiththeholdingofthe
asset,thebasisbecomespositive(i.e.,thepriceoftheassetinthespotmarketis
morethaninthefuturesmarket).Thisconditioniscalled'Backwardation'.
Backwardationgenerallyhappensifthepriceoftheassetisexpectedtofall.

Itiscommonthat,asthefuturescontractapproachesmaturity,thefuturesprice
andthespotpricetendtocloseinthegapbetweenthemi.e.thebasisslowly
becomeszero.

ScopeofinnovationinfuturesMarket

Economygrowthfutures
ThisisauniquetypeoffuturescontractthatcanberaisedinIndiaasinthisthere
shouldbeanindexwhichmeasurestheeconomygrowthandfuturescanbe
predictedontheunderlyinggrowth.Inthisthereshouldbeahypotheticalindex
createdonthebasisofgrowthofaneconomy.Itcanbemeasuredonthegrowth3,
6,9,12months.Everyquarterthegrowthcanbemeasuredandcomparedwith
futurecontract.Basedontheconditionsprevailingintheeconomyandalsothe
worldscenarioshouldbepredictedandaccordinglythemomentofthefuture
contractcanbedecided.

CarbonEmissionIndexandfutures
Weallknowoneissuethatistroublingthewholeworldisglobalwarmingand
climaticchanges.TheadverseeffectsofglobalwarmingontheIndian
subcontinentvaryfromlowlyingislandsandcoastallandstothemeltingof
glaciersintheHimalayas,threateningthehugeflowrateofmanyofthemost
importantriversofIndiaandSouthAsia.InIndia,sucheffectsareprojectedto
impactbillionsoflives.Asaresultofincreasedcarbonemmisions,theclimateof
Indiahasbecomeincreasinglyvolatileoverthepastseveraldecades;thistrendis
expectedtocontinue.Anotherconsiderationinthisaspectiseverycountrydoesn't
wanttotakeresponsibilityforcontributingtoGlobalWarming.Oneofthestepsin
thiscontextisforminganIndexforCarbonEmissionwhichmeasuresthecarbon
emissionofeachcountrybasedonthepresetparameters.Nowonthatindexthere
canbeFuturecontractwhichcanjustbookthelevelofindexbasedonwhichthe
premiumandallshouldbedecided.

Aninterestingfacttonoticehereisthatthevalueofcontactwillbedirectly
measuredbythecentralauthorityformedforthispurpose.

AnotherimportantguidelineformeasuringtheemissionisIndustrialProduction
Index(IPI).

Options[16]
Optionisadifferenttypeofinvestment,whichisveryusefulandcanprovidereal
protectiontotheinvestorswhenthemarketsaregoingdown.Atthesametime,the
charactersoftheoptionsaredesignedinsuchamannerthattheymeetthe
investorsneedinanysituation.Sothatitcanbeusedforbothasaprotective
measureandalsoasaninvestmenttool,whichcanproducehighyields.

Optionsareessentiallysecuritiesandprovidetheholderwiththerighttotradean
assetoncertaintimeandvalue.Ontheotherhandtheholderisnotboundtodothe
tradeandthewholeprocessoftradingdependsontheopinionoftheholder.Ifthe
holderdoesnotsellstheoptiononaparticulardate,thepriceoftheoption
becomeszeroandtheholderfaces100%lossoftheprice,whichhasbeenpaidfor
theoption.Butinsomeparticularsituations,theholdersfollowsthistypeof
strategy.

Theoptiongetsorderivesitsvaluefromthestockortheindexandthusitis
dependentonsomeotherassetsforitsvalue.Forthisreason,optionsarealso
calledderivatives.Therearetwotypesofoptionavailableinthemarket.Theseare
calledCallandPut.

The'call'providestheholderwiththerighttopurchaseaparticularsecurity.But
thepriceforpurchasingthesecurity,thetimeofexecutingthepurchaseandthe
amountofthesecurity,allremainfixed.Atthesametime,theholderisnotbound
todothetradeanditalldependsonhisorherownconcern.Withthegrowthin
thestockprice,thecallalsogainssomeextravalueandbecauseofthistheholders
alwaysexpectthestockvaluetorise.Thereareseveralexchangesthatusesthe
callperiodasanimportanttimetomatchandcarryoutabulkofordersbeforethe
openingandclosing.

Ontheotherhandthe'put'holdersalwaysexpectthestockpricestogodown
becauseinsuchsituations,theputholderscanhaveextraprofit.Atthesametime
itprovidestheholderwiththerighttosellaparticularamountofstock(underlying
asset)atacertainpriceandtime.

COMMODITYTRADING[17]
CommodityTradinginIndiastartedlongtimeback,butthecommoditytradingin
thecountrygainedits'momentumafterremovalofcertainrestrictionsbythe
IndianGovernment.

HistoryofCommodityTradinginIndia
TheCommodityTradingMarketofestablisheditselfinIndiaasadominant
marketformmuchbeforethe1970s.Infact,inthelastphaseof1970s,the
commoditytradingmarketofIndiastartedtolosingits'vibrancy.Thishappened
because,fromthelate1970s,numerousregulationsandrestrictionsstartedtobe
introducedinthecommoditymarketofIndiaandtheserestrictionswereactingas
obstaclesinthepathofsmoothfunctioningofthecommoditytradingmarket.

Intherecentyears,manyrestrictions,whichwerenegativelyaffectingcommodity
tradingmarket,havebeenremoved.So,nowthecommoditytradingmarketof
Indiahasagainstartedtogrowinafastpace.

InordertopromotethecommodityfuturestradinginIndia,ForwardMarkets
Commissionhasbeenformed.ThisForwardMarketsCommissionactually
regulatesthefuturestradeincommodities.

InIndia,thereare21commodityexchanges,whichenhancetheefficiencyand
competitivenessofthecommoditytradingmarket.Manyofthesecommodity
exchangesareregional,whilemanyofthemarecommodityspecific.Someof
these21commodityexchangesprovideonlinecommoditytradingfacility.

GovernmentInitiativesforpromoting
CommodityTrading
Intheyear2003,theIndianGovernmentapprovedtheestablishmentplanoffour
commodityexchangesofnationallevel.Thesenationalcommodityexchanges
wouldoperatefuturestradingcontractsformultiplecommodities.TheIndian
Governmenthasincludedmorecommoditiesinthelistofpermittedcommodities,
constructedundertheForwardContracts(Regulation)Act.
Earliertherewasarulethateveryspotmarkettransactionhastobecompleted
within11days.Inordertopromotecommoditytrading,theGovernmentofIndia
hasremovedthisrestriction.IndianGovernmenthasremovedNTSD(Non
TransferableSpecificDeliveryContract)optionfromtheForward
Contracts(Regulation)Act.
COMMODITYDEREVATIVES

HISTORY
AftertheIndianeconomyembarkedupontheprocessofliberalizationand
globalizationin1990,theGovernmentsetupaCommitteein1993toexaminethe
roleoffuturestrading.TheCommittee(headedbyProf.K.N.Kabra)
recommendedallowingfuturestradingin17commoditygroups.Italso
recommendedstrengtheningoftheForwardMarketsCommission,andcertain
amendmentstoForwardContracts(Regulation)Act1952,particularlyallowing
optionstradingingoodsandregistrationofbrokerswithForwardMarkets
Commission.TheGovernmentacceptedmostoftheserecommendationsand
futurestradingwaspermittedinallrecommendedcommodities.

CommodityfuturestradinginIndiaremainedinastateofhibernationfornearly
fourdecades,mainlyduetodoubtsaboutthebenefitsofderivatives.Finallya
realizationthatderivativesdoperformaroleinriskmanagementledthe
governmenttochangeitsstance.Thepolicychangesfavouringcommodity
derivativeswerealsofacilitatedbytheenhancedroleassignedtofreemarket
forcesunderthenewliberalizationpolicyoftheGovernment.Indeed,itwasa
timelydecisiontoo,sinceinternationallythecommoditycycleisontheupswing
andthenextdecadeisbeingtoutedasthedecadeofcommodities.[18]

WHYARECOMMODITY
DERIVATIVESREQUIRED
Indiaisamongthetop5producersofmostofthecommodities,inadditionto
beingamajorconsumerofbullionandenergyproducts.Agriculturecontributes
about22%totheGDPoftheIndianeconomy.Itemployeesaround57%ofthe
laborforceonatotalof163millionhectaresofland.Agriculturesectorisan
imposrtantfactorinachievingaGDPgrowthof810%.Allthisindicatesthat
Indiacanbepromotedasamajorcenterfortradingofcommodityderivatives.

ItisunfortunatethatthepoliciesofFMCduringthemostof1950sto1980s
suppressedtheverymarketsitwassupposedtoencourageandnurturetogrow
withtimes.Itwasamistakeotheremergingeconomiesoftheworldwouldwantto
avoid.However,itisnotinIndiaalonethatderivativesweresuspectedofcreating
toomuchspeculationthatwouldbetothedetrimentofthehealthygrowthofthe
marketsandthefarmers.Suchsuspicionsmightnormallyariseduetoa
misunderstandingofthecharacteristicsandroleofderivativeproduct.

Itisimportanttounderstandwhycommodityderivativesarerequiredandtherole
theycanplayinriskmanagement.Itiscommonknowledgethatpricesof
commodities,metals,sharesandcurrenciesfluctuateovertime.Thepossibilityof
adversepricechangesinfuturecreatesriskforbusinesses.

Derivativesareusedtoreduceoreliminatepriceriskarisingfromunforeseenprice
changes.Aderivativeisafinancialcontractwhosepricedependson,orisderived
from,thepriceofanotherasset.Twoimportantderivativesarefuturesandoptions.
[19]

FUTUREPROSPECTS
Afterthesettingupoffirstcommodityderivativeexchangein2002ourmarkets
havetravelledalongdistance.Whileonly8commoditieswereallowedforfutures
tradingin2000thefigureincreasedto80in200304andmarketsizeincreased
from1trillionUSDin2006from3trillionin2009.

COMMODITYOPTIONS:
Tradingincommodityoptionscontractshasbeenbannedsince1952.Themarket
forcommodityderivativescannotbecalledcompletewithoutthepresenceofthis
importantderivative.Bothfuturesandoptionsarenecessaryforthehealthy
growthofthemarket.Whilefuturescontractshelpaparticipant(sayafarmer)to
hedgeagainstdownsidepricemovements,itdoesnotallowhimtoreapthe
benefitsofanincreaseinprices.Nodoubtthereisanimmediateneedtobring
aboutthenecessarylegalandregulatorychangestointroducecommodityoptions
tradinginthecountry.Thematterissaidtobeundertheactiveconsiderationof
theGovernmentandtheoptionstradingmaybeintroducedinthenearfuture.

Likefutures,optionsarealsofinancialinstrumentsusedforhedgingand
speculation.Thecommodityoptionholderhastheright,butnottheobligation,to
buy(orsell)aspecificquantityofacommodityataspecifiedpriceonorbeforea
specifieddate.Optioncontractsinvolvetwopartiestheselleroftheoptionwrites
theoptioninfavorofthebuyer(holder)whopaysacertainpremiumtotheseller
asapricefortheoption.Therearetwotypesofcommodityoptions:a'call'option
givestheholderarighttobuyacommodityatanagreedprice,whilea'put'option
givestheholderarighttosellacommodityatanagreedpriceonorbeforea
specifieddate(calledexpirydate).

Theoptionholderwillexercisetheoptiononlyifitisbeneficialtohim;otherwise
hewilllettheoptionlapse.Forexample,supposeafarmerbuysaputoptionto
sell100Quintalsofwheatatapriceof$25perquintalandpaysa'premium'of
$0.5perquintal(oratotalof$50).Ifthepriceofwheatdeclinestosay$20before
expiry,thefarmerwillexercisehisoptionandsellhiswheatattheagreedpriceof
$25perquintal.However,ifthemarketpriceofwheatincreasestosay$30per
quintal,itwouldbeadvantageousforthefarmertosellitdirectlyintheopen
marketatthespotprice,ratherthanexercisehisoptiontosellat$25perquintal.
[20]

WeatherDerivatives[21]

Introduction
Aweatherderivativecontractmaybetermedasafinancialweatherdependent
contractwhosepayoffwillbedeterminedbyfutureweatherevents.Thesettlement
valueoftheseweathereventsassociatedwithaparticularinstrumentisdetermined
fromaweatherindex,expressedasvaluesofaweathervariablemeasuredata
statedlocationataparticulartime.Thesederivativesarefinancialinstrumentsthat
canbeusedbyorganizationsorindividualstoreducetheriskassociatedwith
adverseorunexpectedweatheroutcomes.Thedifferencefromotherderivativesis
thattheassociatedasset(rain/temperature/snow)hasnodirectvaluetopricethe
weatherderivative.WeatherDerivativescanbeanimportanttooltohedgeagainst
lossesoccurringfromuncertainweatherconditionsandcanhelpreducetheimpact
ofadverseweatheronacompany'sprofitability.

ConceptofWeatherDerivative
Thefirsttransactionintheweatherderivativestookplacein1997intheU.S.The
firstexchangetradedweatherderivativetradingwasdoneonSeptember22,1999
attheChicagoMercantileExchange.TheseDerivativesareuniqueinmanyways.
Theprimarybeing,thereisnophysicalunderlyingasset.Theunderlyingassetis
theweatherchange.Thevaluesofweatherderivativesarecalculatedbasedona
centralizedweatherindex.TheindexcanberepresentedeitherasaHeating
DegreeDay(HDD)oraCoolingDegreeDay(CDD).AHeatingDegreeDay
(HDD)isthedifferencebetweenabaselinetemperatureandtheaverage
temperatureforadayinwinters.ACoolingDegreeDay(CDD)isthetemperature
differencebetweentheaveragetemperatureforadayandabaselinetemperature
insummers.Thebaselinetemperatureisfixedas65oFahrenheitintheU.Sand
18oCelsiusinEurope.TheEarthSatelliteCorporation,anindependent
organisation,calculatesHDDandCDDindexensuringtransparencyinthe
benchmark.

UtilityofWeatherDerivatives
Let'stakeafarmergrowingWheatinavillageinRajasthan.Heisworrieddueto
theexpectationsoflowrainfallinthestatethisyear.Heusuallyproduces1000
quintalsofWheatinhisfarmbutthisyear,hethinkstheproductionwilldropto
800quintals.TheMinimumSupportPriceforWheatisRs.1000perquintal.This
meansthatthefarmerfearslosingRs2,00,000thisseasonduetopoorrainfall.If
thefarmerhadknowledgeandaccesstoweatherderivativesinIndia,hecould
haveboughtorsold(dependingonthefutureoutlookforrainfall)raindayfutures
contractstodayandenteredintoanequalbutoppositecontractatalaterdate,
makingaprofitonthetransaction,thusoffsettingthelossesduetolowvolumes
produced.Apartfromusingweatherderivativeforhedgingriskagainstadverse
weatherconditionsitcanalsobeusedasthemodeoftradinginderivatives.

BeneficiariesOfWeatherDerivatives
Anycompanyorprofessionwhoserevenueisaffectedbyweatherchangeshasa
potentialneedforweatherderivatives.Someoftheseindustriesinclude
Agriculture
Softdrinksandconfectioneryretailers
Hotelsandleisureindustry
Sports
Engineeringandconstructionindustry
Energyproducersanddistributors
Insurance,reinsurancecompanies
Banksandfinancialinstitutions
Breweries,pubsandrestaurants
Transportanddistributioncompanies
WeatherDerivativesinIndia
Indiaisacountrywherestillagricultureisthemajorsourceofincomeformajority
ofthepopulation.Agricultureandtherelatedindustriessupportaround60%of
Indianpopulation.Accordingtotheeconomicsurveyagriculturecontributesmore
than25%ofthetotalGDPofIndia.ButtheIndianagricultureperformanceisstill
dependentheavilyonthesouthwestmonsoons.Everyyearalotofcropsget
destroyedbecauseoffloodsordraught.Butitstilldoesn'thaveanefficient
irrigationsystemtosupportitsfarmers.Thesouthwestmonsoonisveryimportant
totheagricultureperformanceofIndia.HenceWeatherDerivativeshaveagood
scopeanditismostlikelythatweatherderivativesinIndiashouldhavethe
monsoonorrainfallastheirunderlying.

WeatherinstrumenttradinginIndiahasalongwaytogo.Untilandunlessthe
regulatorybodiesallowtradingonintangiblessuchasraininfinancialmarkets,
weathertradingwillbeadream.Evenifthebillispassedandweatherinstruments
aretradedontheexchangeaverystronginfrastructureisrequiredsoastohavea
farreachingeffect.Farmersfromeachandeverypartofthecountryshouldbe
abletohedgeoftheirrisks.Thiscanbedonewithproperprogramsthroughthe
localGramPanchayatsandechoupals.Farmersandtradersshouldbegiven
exposureandeducatedproperlyaboutthebenefitsofweathertrading.

.InIndiaABNAmroBankisexploringsalesofweatherderivativesand
catastrophebondsforthefirsttime.Thebankistalkingtodifferentcompaniesin
thebeverageandcementsectors,toairlinesandoilmajorstogettheminterested
intheproduct.

CREDITDERIVATIVESININDIA
Creditderivativesareoverthecounterfinancialcontracts.Theyareusually
definedas"offbalancesheetfinancialinstrumentsthatpermitoneparty
(beneficiary)totransfercreditriskofareferenceasset,whichitowns,toanother
party(guarantor)withoutactuallysellingtheasset".It,therefore,"unbundles"
creditriskfromthecreditinstrumentandtradesitseparately.[22]

Typesofcreditderivatives

TheCreditDefaultSwaps(CDS)
CDShavegrownrapidlyinthecreditriskmarketsincetheirintroductioninthe
early1990s.Itisbelievedthatcurrentusageisbutasmallfractionofwhatitwill
ultimatelyrepresentinthecreditriskmarkets.Inparticular,theCDSmarketwill
becomeascentraltothemanagementofcreditriskastheinterestrateswapmarket
istothemanagementofmarketrisk.

TheCreditLinkedNote(CLN)
CLNmarketisoneofthefastestgrowingareasinthecreditderivativessector.It
is,acombinationofaregularnote(bondordeposit)andacreditoption.Sinceitis
aregularnotewithcoupon,maturityandredemption,itisanonbalancesheet
equivalentofacreditdefaultswap.Underthisstructure,thecouponorpriceofthe
noteislinkedtotheperformanceofareferenceasset.Itoffersborrowersahedge
againstcreditriskandinvestorsahigheryieldforbuyingacreditexposure
syntheticallyratherthanbuyingitinthepubliclytradeddebt.

CreditLinkedDeposits(CLDs)
CLDarestructureddepositswithembeddeddefaultswaps.Conceptuallytheycan
bethoughtofasdepositsalongwithadefaultswapthattheinvestorsellstothe
deposittaker.Thedefaultcontingencycanbebasedonavarietyofunderlying
assets,includingaspecificcorporateloanorsecurity,aportfolioofloansor
securitiesorsovereigndebtinstruments,orevenaportfolioofcontractswhich
giverisetocreditexposure.Ifnecessary,thestructurecanincludeaninterestrate
orforeignexchangeswaptocreatecashflowsrequiredbyinvestor.
CollateralisedDebtObligations(CDOs)
CDOsarespecializedrepackagedofferingsthattypicallyinvolvealargeportfolio
ofcredits.BothinvolveissuanceofdebtbyaSPVbasedoncollateralof
underlyingcredit(s).Theessentialdifferencebetweenarepackagingprogramme
andaCDOisthatwhileasimplerepackagingusuallydeliverstheentirerisk
inherentintheunderlyingcollateral(securitiesandderivatives)totheinvestor,a
CDOinvolvesahorizontalsplittingofthatriskandcategorizinginvestorsinto
seniorclassdebt,mezzanineclassesandajuniordebt.CDOmaybesubjectto
localdebtregistration/regulatoryrequirements.

NeedandScopeforCreditDerivativesin
India
Creditriskrequiresaneffectivetransmissionmechanism.Itisnowimperativethat
amechanismbedevelopedthatwillallowforanefficientandcosteffective
transmissionofcreditriskamongstmarketparticipants.Thecurrentarchitectureof
thefinancialmarketiseithercharacterizedbylumpinessincreditriskwiththe
banksanddevelopmentfinancialinstitutions(DFIs)orlackofaccesstocredit
marketbymutualfunds,insurancecompanies,etc.

ThemajorhedgingmechanismnowavailablewithbanksandDFIstohedgecredit
riskistoselltheloanassetorthedebenturesitholds.BanksandDevelopment
FinancialInstitutionsrequireamechanismthatwouldallowthemtoprovidelong
termfinancingwithouttakingthecreditriskiftheysodesire.Theycouldalsolike
toassumecreditriskincertainsectors/obligors.

Ontheotherside,investors,includingbanksandDFIs,wouldalsobelookingfor
additionalyields.Inanenvironmentofdecliningyields,investorswouldwelcome
mechanismswheretheycanearnanadditionalyieldbytakingoncreditrisk.
ThereexistsnowinIndiaaninvestorbase,whichcanbesegmentedalongtenor
lines.

Creditderivativeswillgivesubstantialbenefitstoallkindsofparticipants,
includingthefinancialsystemasawhole,suchas:

Bankswouldstandtobenefitfromcreditderivativesmainlyduetotworeasons
efficientutilisationofcapitalandflexibilityindeveloping/managingatargetrisk
portfolio.

Currently,banksinIndiafacetwobroadsetsofissuesonthecreditlegoftheir
assetblockageofcapitalandlossofopportunities,forexample:

i. Banksgenerallyretainassetsandhence,creditrisktillmaturity.Thisresultsin
ablockingupofbank'scapitalandimpairsgrowththroughchurningofassets.
ii. Duetoexposurenormsthatrestrictconcentrationofcreditriskontheirbooks,
banksareforcedtoforegoattractiveopportunitiesonexistingrelationships.
Creditderivativeswouldhelpresolvetheseissues.Banksandthefinancial
institutionsderivefourmainbenefitsfromcreditderivatives:

Creditderivativesallowbankstotransfercreditriskandhencefreeupcapital,
whichcanbeusedinproductiveopportunities.

Bankscanconductbusinessonexistingclientrelationshipsinexcessofexposure
normsandtransferawaytherisks.

SOMEOTHERINNOVATIVE
CONCEPTSINFINANCIALMARKET
InnovativeFinancialInstrumentsforNaturalDisasterRiskManagement

Naturaldisasterscancauseimmensedamagestopeople,theirproductiveassets
andtheoveralleconomicinfrastructureofentireregions.Thismayhaveadverse
effectsoneconomicdevelopmentwhencatastrophicnaturaleventsstrikedensely
populatedareaswithhighconcentrationsofeconomicassets.Thepatternsare
recognizableacrosstheworld,buttheeconomiceffectshavebeenmostprominent
indevelopingcountrieswherehumanandsocialvulnerabilityishigh.Dueto
betterriskmitigationandinsurancecoveragethesocioeconomicconsequencesare
generallylessdramaticindevelopingcountries.

Majorlosseshappenedintheworldintherecentpast.

Asconditionsforthereinsuranceofcatastropheriskexposurecontinuedtotighten
inthemid1990s,therewasasearchforalternativefinancialstructurestotransfer
catastropherisk.Withafinitereinsurancecapacity,insurancecompanieslooked
towardthelargeglobalcapitalmarketfortakersofcatastropheriskexposures.

Thefirstcapitalmarketinstrumentthatislinkedtocatastropheriskwasplacedin
thecapitalmarketin1994whenKover,acaptiveofHannoverRe,issuedaUS$85
millioncatastrophebondlinkedtoworldwidepropertylossesduetocatastrophes.
Sincethisinauguraltransaction,manyotherrisklinkedsecuritiestransactions
havefollowed,amountingtoatotalcoverageofaroundUS$6billion.Themarket
fordisasterrisklinkedsecuritiesisnowwellestablished.

TheCatastropheRiskExchange(CATEX)wasestablishedinearly1996inUSas
anInternetbasedbusinesstobusinessexchangeforalltypesofinsurance
contractsandrelatedriskmanagementproducts.CATEXdoesnottrade
standardizedfuturesandoptionscontractsbutprovidesatechnologyplatformthat
allowsmultinationalinstitutionstopostparticularinsuranceneedstoawide
internationalaudienceofinsuranceandreinsurancecompanies.

Throughtheissuanceofcatastropherisklinkedbonds,generallyreferredtoascat
bonds,theissuer(typicallyaninsuranceorreinsurancecompany)wasableto
obtaincoverageforparticularexposures(e.g.,propertydamage,autoliability,
etc.),incaseofpredefinedcatastrophicevents,suchaswindstorms,hurricanesand
earthquakes.Thenewcatastropherisktransferopportunitieshaveprimarilybeen
exploitedbyinsuranceandreinsurancecompaniesasawaytoobtain
complementarycoverageinthecapitalmarket.

Therisktransfercharacteristicsofcatbondscanbereplicatedthrougha
mechanismcalledcatastropheriskswaps.Intheriskswapthecedantmakesfixed
paymentsequaltothepremiumspaidinacatbondstructureagainstreceiptof
claimscompensationincaselossesoccur(indemnitybasis).Justliketherisk
linkedsecurities,thecatastropheriskswapcanbebasedondifferenttypesof
triggerssuchasindemnitylosses,lossindices,physicalindicators,orparametric
formulas.

Theeventualchoiceofrisktransfermechanismisinfluencedbythecharacteristics
ofthefinancialinstrumentsandtheirimplicationsformoralhazard,adverse
selection,basisriskandcreditriskexposures.

Wecanseetheabovediagramthattheprocessofcatastropherisktransferwhich
showsthecombinationTraditionalInsuranceprocesstomitigatetheriskandalso
thecombinationofsecuritizationprocesswhichgivestheinvestorstoinvestinthe
riskatareturnthatisthepremiumpaidbytheinsured.

FinancialDevelopmentIndex[23]
Therehavebeenattemptstomeasurefinancialdevelopmentofeconomiesusing
differentsetsofindicators.Theindicatorstraditionallyusedincludemonetary
measures(suchasnarrowmoneytoGDP,centralbankdomesticcreditas
percentageofGDP,moneymultiplieretc),financialinstitutionsassetstoGDP,
stockmarketliquidity,regulationandsupervisionofbanks,coverageandstructure
ofdepositinsuranceschemes,indicatorsofbarrierstobankingaccessin
developinganddevelopedcountriesetc.However,therewashardlyanattempt
madetodevelopacomprehensiveindexoffinancialdevelopment.

Inarecentdevelopment,theInternationalFinancialCooperationoftheWorld
BankGroupcommencedpublishinga"DoingBusinessDatabase"forover183
countriessince2003.ThisDatabaseprovidesaquantitativemeasureofregulations
forstartingabusiness,dealingwithconstructionpermits,employingworkers,
registeringproperty,gettingcredit,protectinginvestors,payingtaxes,trading
acrossborders,enforcingcontractsandclosingabusinessastheyapplyto
domesticsmallandmediumsizeenterprises.AfundamentalpremiseofDoing
Businessisthateconomicactivityrequiresgoodrules.

Inanotherattempttomeasurefinancialdevelopment,anoccasionalpaperofthe
EuropeanCentralBank,broughtoutinApril20091,constructscompositeindices
tomeasuredomesticfinancialdevelopmentin26emergingeconomiesfor2008.
Thestudyuses22variables,groupedaccordingtothreebroaddimensions:

i. institutionsandregulations;
ii. sizeofandaccesstofinancialmarketsand(iii)marketperformance.Accordingto
thisindex,SouthKoreaisranked6among30countries,China14andIndiaisat
theposition22.ThispaperfindsthatIndiaperformedrelativelybetterasregards
itsfinancialmarketsandnonbankinstitutions,butrequiresimprovementsinthe
businessenvironmentaswellasbiggerandefficientbanks.
TheFDRrecognizesthatlimitationsalsoexistinthelightofrapidlychanging
environmentandtheuniquecircumstancesofsomeoftheeconomiescovered.
Yet,initsattempttoestablishacomprehensiveframeworkandameansfor
benchmarking,itprovidesausefulstartingpoint.TheReportisuniqueinthe
comprehensivenessoftheframeworkitprovidesandtherichnessofrelevantdata
itbringstobearonfinancialsystemdevelopment.

"Oneofthereasonsthiscrisiscouldtakeplaceisthatwhilemanyagenciesand
regulatorswereresponsibleforoverseeingindividualfinancialfirmsandtheir
subsidiaries,noonewasresponsibleforprotectingthewholesystemfromthe
kindsofrisksthattiedthesefirmstooneanother.Regulatorswerechargedwith
seeingthetrees,butnottheforest.Andeventhen,somefirmsthatposedaso
called"systemicrisk"werenotregulatedasstronglyasothers;theybehavedlike
banksbutchosetoberegulatedasinsurancecompanies,orinvestmentfirms,or
otherentitiesthatwereunderlessscrutiny.

Asaresult,thefailureofonefirmthreatenedtheviabilityofmanyothers.The
effectmultiplied.Therewasnosysteminplacethatwaspreparedforthiskindof
outcome.Andmoreimportantly,noonehasbeenchargedwithpreventingit."The
proposalofUSGovernmentistocreateanoversightcouncil,asputforwardby
PresidentObama,asfollows:

"Andevenasweplacetheauthoritytoregulatetheselargefirmsinthehandsof
theFederalReservesothatlinesofresponsibilityandaccountabilityareclear
wewillalsocreateanoversightcounciltobringtogetherregulatorsfromacross
marketstocoordinateandshareinformation,toidentifygapsinregulation,andto
tackleissuesthatdon'tfitneatlyintoanorganizationalchart.We'regoingtobring
everyonetogethertotakeabroaderviewandalongerviewtosolveproblems
inoversightbeforetheycanbecomecrises."

Conclusion
ThereisunanimityintheopinionthatIndiahascomealongwayonthepathof
developmentofitsfinancialsectorderegulating,liberalizingandincreasing
competitivenessalongtheway.However,thereisnoroomforcomplacency.The
imperativesofchangingtime,technologyandneedsoftheeconomy,requireusto
takefurtherstepstobuilduponthefinancialsector'scapabilities,already
achieved,intheformofthenextgenerationreforms.Thiswouldhelpourfinancial
marketsachievetheirfullpotentialgrowth.TheCFSRaptlysummarisesthe
necessityoffinancialreformsas"Financialsectorreformisbothamoraland
economicimperative".

Thestartingpointforthesamecouldbeworkingonthelinesofrecommendations
oftwoimportantrecentgovernmentcommitteereports,viz.HPEConMIFCand
CFSR.

Findingsoftheproject
InIndiafinancialmarketmajorlydenotesequitymarkets.
Indiandebtmarketisnotwelldevelopedandstill80%ofmarketisunder
Governmentsecurities.
SecuritizationhastobedoneonassetsheldbyBanks.
Bondmarketneedsagreatconsiderationintermsofjunkbonds
AneffortcanbemadetodevelopCarbonEmissionandNationalgrowthindex.
CommoditiesOptionsshouldbedevelopedinIndia.
Creditderivativesshouldbedevelopedwithconsiderationofallthepossibletypes
ofCreditderivatives.
InacountrywithmajorincomefromAgriculture,Weatherderivativesshouldbe
introducedtoprotecttheinterestofvariousinvolvedparties.
TomitigatetheCatastrophehazardsnewtechniqueforriskmanagementshouldbe
introduced.
FinancialdevelopmentIndextomeasurethedevelopmentsinvariousparameters
toconcludegrowthinrealterms.
CONCLUSION
Despitetheacceleratedindustrialgrowthexperiencedthisdecadefromrecent
economicreforms,mostmajorinvestorsaroundtheglobedonotyetseeIndiaas
anidealcountryforforeigninvestment.Thecompetitionforglobalcapitalwill
onlygettougherintheyearstocome,andunlessthepolitical,judicialand
economicenvironmentsareright,Indiawilllagbehindmanyotheremerging
nations.Moreimportantly,therisingexpectationsofthemiddleclass,widening
incomeandwealthinequalitiesbetweenthehavesandhavenots,requireefficient
initiativesfromGovernmentandcorporatetoattractandaccommodatethefunds
available.

Varietyoffinancialproductslikemutualfunds,insurance,shares,debentures,
derivativeinstruments,etc.areavailableinIndia.However,thereachofthese
productsisverylimitedandthefeaturesofmanyoftheseproductsareverybasic
innature.Furtherdevelopmentandinnovationintheseproductswouldbefasterif
theyareaccessedbyallclassesofinvestorsinurbanaswellasruralareas.The
thrustliesmainlyonthedevelopmentofnewfinancialproductstodeepenthe
improvementsintheproductdistributionitself.Theresponsibilityofensuring
theseimprovementsvestswithallthestakeholdersinthefinancialservices
industry

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