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Financial system and its role:

A financial system is a network of financial institutions, financial markets, financial instruments and
financial services to facilitate the transfer of funds. The system consists of savers, intermediaries, instruments
and the ultimate user of funds. The level of economic growth largely depends upon and is facilitated by the
state of financial system prevailing in the economy. Efficient financial system and sustainable economic
growth are corollary. The financial system mobilises the savings and channelizes them into the productive
activity and thus influences the pace of economic development. Economic growth is hampered for want of
effective financial system. Broadly speaking, financial system deals with three inter-related and
interdependent variables, i.e., money, credit and finance.

The functions of financial system can be enumerated as follows:

• Saving function: Public saving find their way into the hands of those in production through the
financial system. Financial claims are issued in the money and capital markets which promise future
income flows. The funds with the producers result in production of goods and services thereby
increasing society living standards.
• Liquidity function: The financial markets provide the investor with the opportunity to liquidate
investments like stocks bonds debentures whenever they need the fund.
• Payment function: The financial system offers a very convenient mode for payment of goods and
services. Cheque system, credit card system etc are the easiest methods of payments. The cost and
time of transactions are drastically reduced.
• Risk function: The financial markets provide protection against life, health and income risks. These
are accomplished through the sale of life and health insurance and property insurance policies. The
financial markets provide immense opportunities for the investor to hedge himself against or reduce
the possible risks involved in various investments.
• Policy function: The government intervenes in the financial system to influence macroeconomic
variables like interest rates or inflation so if country needs more money government would cut rate
of interest through various financial instruments and if inflation is high and too much money is there
in the system then government would increase rate of interest.
• Financial system works as an effective conduit for optimum allocation of financial resources in an
• It helps in establishing a link between the savers and the investors.
• Financial system allows ‘asset-liability transformation’. Banks create claims (liabilities) against
themselves when they accept deposits from customers but also create assets when they provide loans
to clients.
• Economic resources (i.e., funds) are transferred from one party to another through financial system.
• The financial system ensures the efficient functioning of the payment mechanism in an economy. All
transactions between the buyers and sellers of goods and services are effected smoothly because of
financial system.
• Financial system helps in risk transformation by diversification, as in case of mutual funds.
• Financial system enhances liquidity of financial claims.
• Financial system helps price discovery of financial assets resulting from the interaction of buyers and
sellers. For example, the prices of securities are determined by demand and supply forces in the
capital market.
• Financial system helps reducing the cost of transactions.

Financial assets and its role:

Financial assets serve two principal economic sfunctions. First, financial assets transfer funds from those
parties who have surplus funds to invest to those who need funds to invest in tangible assets. As their second
function, they transfer funds in such a way as to redistribute the unavoidable risk associated with the cash
flow generated by tangible assets among those seeking and those providing funds. However, the claims held
by the final wealth holders generally differ from the liabilities issued by the final demanders of funds because
of the activity of entities operating in financial markets, called financial intermediaries, who seek to
transform the final liabilities into different financial assets proffered by the public.

Mrinalini Shankar (FK-1847)


A capital market is a market for securities (debt or equity), where business enterprises (companies) and
governments can raise long-term funds. It is defined as a market in which money is provided for periods
longer than a year[1], as the raising of short-term funds takes place on other markets (e.g., the money market).
The capital market includes the stock market (equity securities) and the bond market (debt). Financial
regulators, such as the UK's Financial Services Authority (FSA) or the U.S. Securities and Exchange
Commission (SEC), oversee the capital markets in their designated jurisdictions to ensure that investors are
protected against fraud, among other duties.

Industrial Govt. Long Foreign
Securities Securities Term Loan Exchange
Market Market Market Market

Primary Secondary Term Mortgage Financial

Market Market Loan Market Guarantees
Market Market

Public Right
Industrial Securities Market: - Private
It includes equity shares, debentures, long term loans, preference shares,
Issue Issue Placement
mortgage loans etc. It is further sub divided into
i) Primary market or New issue market: - The primary market is that part of the capital markets that deals
with the issuance of new securities. Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers.
The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale
is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus. Primary market creates long term instruments through
which corporate entities borrow from capital market.
It is further subdivided into 3 parts:-
(A) Public Issue: - when company needs long term funds they sell shares to the public like IPO.
(B) Right Issue: - When a company coming up with second offer a portion of shares is to offer to the existing
share holders. It is mandatory according to the rules of SEBI.
(C) Private Placement: - When the company needs funds in a short period of time, they cannot offer IPO due
to lack of time & other constraints. So they offer to certain groups for to raise their funds. This is called
private placement.
ii) Secondary Market: - The secondary market, also known as the aftermarket, is the financial market
where previously issued securities and financial instruments such as stock, bonds, options, and futures are
bought and sold. The term "secondary market" is also used to refer to the market for any used goods or assets,
or an alternative use for an existing product or asset where the customer base is the second market (for
example, corn has been traditionally used primarily for food production and feedstock, but a "second" or
"third" market has developed for use in ethanol production). Another commonly referred to usage of
secondary market term is to refer to loans which are sold by a mortgage bank to investors.

Govt Securities Market: - Govt. accepts & sells securities in the securities market . It includes govt.
institutions, RBI.
Long term Loan Market :- It is further subdivided into 3 parts: -
(A) Term loan market:- those loans whose maturity varies between 10-15 years.
(B) Mortgage Market: - The loans which are given to the public by mortgaging any fixed assets. E.g.: -
housing loans.
(C) Financial guarantee Market: - Takes active role in export transactions. It facilitates the transactions in the
financial market.

Foreign Exchange Market: - The foreign exchange market (forex, FX, or currency market) is a
worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centres
around the world function as anchors of trading between a wide range of different types of buyers and sellers
around the clock, with the exception of weekends. The foreign exchange market determines the relative
values of different currencies.

The primary purpose of the foreign exchange is to assist international trade and investment, by allowing
businesses to convert one currency to another currency. For example, it permits a US business to import
British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports
speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest
in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some


The money market is a component of the financial markets for assets involved in short-term borrowing and
lending with original maturities of one year or shorter time frames. Trading in the money markets involves
Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived
mortgage- and asset-backed securities.[1] It provides liquidity funding for the global financial system. The
money market consists of financial institutions and dealers in money or credit who wish to either borrow or
lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market
trades in short-term financial instruments commonly called "paper." This contrasts with the capital market for
longer-term funding, which is supplied by bonds and equity.


Defination: - commodity markets are markets where raw or primary products are exchanged. These raw
commodities are traded on regulated commodities exchanges, in which they are bought and sold in
standardized contracts.

This article focuses on the history and current debates regarding global commodity markets. It covers physical
product (food, metals, electricity) markets but not the ways that services, including those of governments, nor
investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond
markets and currency markets cover those concerns separately and in more depth.

Debanil Chakraborty
Roll no: - FK-1848


A commercial bill is one which arises out of a genuine trade transaction, i.e. credit transaction. As soon as
goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it
immediately agreeing to pay amount mentioned therein after a certain specified date. Thus, a bill of exchange
contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a
creation period. A bill of exchange is a ‘self-liquidating’ paper and negotiable/; it is drawn always for a short
period ranging between 3 months and 6 months.

Definition of a bill

Section 5 of the negotiable Instruments Act defines a bill exchange a follows:

“an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of a certain person ort to the beater of the instrument”.

Types of Bills:

Many types of bills are in circulation in a bill market. They can be broadly classified as follows:

1. Demand and usince bills.

2. Clean bills and documentary bills.
3. Inland and foreign bills.
4. Export bills and import bills.
5. Indigenous bills.
6. Accommodation bills and supply bills.

Demand and Usince Bills

Demand bills are others called sight bills. These bills are payable immediately as soon as they are presented to
the drawee. No time of payment is specified and hence they are payable at sight. Usince bills are called time
bills. These bills are payable immediately after the expiry of time period mentioned in the bills. The period
varies according to the established trade custom or usage prevailing in the country.

Clean Bills and Documentary Bills

When bills have to be accompanied by documents of title to goods like Railways, receipt, Lorry receipt, Bill
of Lading etc. the bills are called documentary bills. These bills can be further classified into D/A bills and
D/P bills. In the case of D/A bills, the documents accompanying bills have to be delivered to the drawee
immediately after acceptance. Generally D/A bills are drawn on parties who have a good financial standing.
On the order hand, the documents have to be handed over to the drawee only against payment in the case of
D/P bills. The documents will be retained by the banker. Till the payment o0f such bills. When bills are drawn
without accompanying any documents they are called clean bills. In such a case, documents will be directly
sent to the drawee.

Inland and Foreign Bills

Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills are drawn
outside India an they may be payable either in India or outside India. They may be drawn upon a person
resident in India also. Foreign boils have their origin outside India. They also include bills drawn on India
made payable outside India.
Export and Foreign Bills

Export bills are those drawn by Indian exports on importers outside India and import bills are drawn on Indian
importers in India by exports outside India.

Indigenous Bills

Indigenous bills are those drawn and accepted according to native custom or usage of trade. These bills are
popular among indigenous bankers only. In India, they called ‘hundis’ the hundis are known by various
names such as ‘Shah Jog’, ‘Nam Jog’, Jokhani’, Termainjog’. ‘Darshani’, ‘Dhanijog’, and so an.

Accommodation Bills and Supply Bills

If bills do not arise out of genuine trade transactions, they are called accommodation bills. They are known as
‘kite bills’ or ‘wind bills’. Two parties draw bills on each other purely for the purpos4 of mutual financial
accommodation. These bills are discounted with bankers and the proceeds are shared among themselves. On
the due dates, they are paid. Supply bills are those neither drawn by suppliers or contractors on the
government departments for the goods nor accompanied by documents of title to goods. So, they are not
considered as negotiable instruments. These bills are useful only for the purpose of getting advances from
commercial banks by creating a charge on these bills.

Operations in Bill Market:

From the operations point of view, the bill market can be classified into two viz.

• Discount Market
• Acceptance Market

Discount Market

Discount market refers to the market where short-term genuine trade bills are discounted by financial
intermediaries like commercial banks. When credit sales are effected, the seller draws a bill on the buyer who
accepts it promising to pay the specified sum at the specified period. The seller has to wait until the maturity
of the bill for getting payment. But, the presence of a bill market enables him to get payment immediately.
The seller can ensure payment immediately by discounting the bill with some financial intermediary by
paying a small amount of money called ‘Discount rate’ on the date of maturity, the intermediary claims the
amount of the bill from the person who has accept6ed the bill.
In some countries, there are some financial intermediaries who specialize in the field of discounting. For
instance, in London Money Market there are specialise in the field discounting bills. Such institutions are
conspicuously absent in India. Hence, commercial banks in India have to undertake the work of discounting.
However, the DFHI has been established to activate this market.

Acceptance Market

The acceptance market refers to the market where short-term genuine trade bills are accepted by financial
intermediaries. All trade bills cannot be discounted easily because the paties to the bills may not be financially
sound. In case such bills are accepted by financial intermediaries like banks, the bills earn a good name and
reputation and such bills can readily discounted anywhere. In London, there are specialist firms called
acceptance house which accept bills drawn by trades and import greater marketability to such bills. However,
their importance has declined in recent times. In India, there are no acceptance houses. The commercial banks
undertake the acceptance business to some extant.

Advantages of commercial bills:

Commercial bill market is an important source of short-term funds for trade and industry. It provides liquidity
and activates the money market. In India, commercial banks lay a significant role in this market due to the
following advantages:

• Liquidity: Bills are highly liquid assets. In times of necessity, bills can be converted into cash
readily by means of rediscounting them with the central bank. Bills are self-liquidating in character
since they have fixed tenure. Moreover, they are negotiable instruments and hence they can be
transferred freely by a mere delivery or by endorsement and delivery.
• Certainty Of Payment: Bills are drawn and accepted by business people. Generally, business
people are used to keeping their words and the use of the bills imposes a strict financial discipline on
them. Hence, bills would be honored on the due date.
• Ideal Investment: Bills are for periods not exceeding 6 months. They represent advances for a
definite period. This enables financial institutions to invest their surplus funds profitably by selecting
bills of different maturities. For instance, commercial banks can invest their funds on bills in such a
way that the maturity of these bills may coincide with the maturity of their fixed deposits.
• Simple Legal Remedy: In case the bills are dishonored\, the legal remedy is simple. Such
dishonored bills have to be simply noted and protested and the whole amount should be debited to
the customer’s accounts.
• High And Quick Yield: The financial institutions earn a high quick yield. The discount is dedicated
at the time of discounting itself whereas in the case of other loans and advances, interest is payable
only when it is due. The discounts rate is also comparatively high.
• Easy Central Bank Control: The central bank can easily influence the money market by
manipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken by
adjusting the bank rate depending upon the monetary conditions prevailing in the market.

Drawbacks of commercial bills:

In spite of these merits, the bill market has not been well developed in India. The reasons for the slow growth
are the following:

• Absence Of Bill Culture: Business people in India prefer O.D and cash credit to bill financing
therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their
customers. Hence bills are not popular.
• Absence Of Rediscounting Among Banks: There is no practice of re-discounting of bills between
banks who need funds and those who have surplus funds. In order to enlarge the rediscounting
facility, the RBI has permitted financial institutions like LIC, UTI, GIC and ICICI to rediscount
genuine eligible trade bills of commercial banks. Even then, bill financial is not popular.
• Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of required
denomination are not available.
• Absence Of Secondary Market: There is no active secondary market for bills. Rediscounting
facility is available in important centers and that too it restricted to the apex level financial
institutions. Hence, the size of the bill market has bee curtailed to a large extant.
• Difficulty In Ascertaining Genuine Trade Bills: The financial institutions have to verify the bills
so as to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose,
invoices have to be scrutinized carefully. It involves additional work.
• Limited Foreign Trade: In many developed countries, bill markets have been established mainly
for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to national income
remains small and it is reflected in the bill market also.
• Absence Of Acceptance Services: There is no discount house or acceptance house in India. Hence
specialised services are not available in the field of discounting or acceptance.
• Attitude Of Banks: Banks are shy rediscounting bills even the central bank. They have a tendency
to hold the bills till maturity and hence it affects the velocity of circulation of bills. Again, banks
prefer to purchase bills instead of discounting them.


Just like commercial bills which represent commercial debt, treasury bills represent short-term borrowings of
the Government. Treasury bill market refers to the market where treasury bills are brought and sold. Treasury
bills are very popular and enjoy higher degree o9f liquidity since they are issued by the government.
Meaning and Features of Treasury Bills:

A treasury bills nothing but promissory note issued by the Government under discount for a specified period
stated therein. The Government promises to pay the specified amount mentioned therein to the beater of the
instrument on the due date. The period does not exceed a period of one year. It is purely a finance bill since it
does not arise out of any trade transaction. It does not require any ‘grading’ or’ endorsement’ or ‘acceptance’
since it is clams against the Government. Treasury bill are issued only by the RBI on behalf of the
Government. Treasury bills are issued for meeting temporary Government deficits. The Treasury bill rate of
discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of interest rates in
the country because of short-term maturity and degree of liquidity and security.

Types of Treasury Bills

In India, there are two types of treasury bills viz. (I) ordinary or regular and (ii) ‘ad hoc’ known as ‘ad hocs’
ordinary treasury bills are issued to the public and other financial institutions for meeting the short-term
financial requirements of the Central Government. These bills are freely marketable and they can be brought
and sold at any time and they have secondary market also.

On the other hand ‘ad hocs’ are always issued in favour of the RBI only. They are not sold through tender or
auction. They are purchased by the RBI on top and the RBI is authorised to issue currency notes against them.
They are marketable sell them back to the RBI. Ad hocs serve the Government in the following ways:

• They replenish cash balances of the central Government. Just like State Government get advance
(ways and means advances) from the RBI, the Central Government can raise finance through these
ad hocs.
• They also provide an investment medium for investing the temporary surpluses of State Government,
semi-government departments and foreign central banks.

On the basis of periodicity, treasury bills may be classified into three they are:

1. 91 Days treasury bills,

2. 182 Days treasury bills, and
3. 364 Days treasury bills.

Ninety one days treasury bills are issued at a fixed discount rate of 4% as well as through auctions. 364 days
bills do not carry any fixed rate. The discount rate on these bills are quoted in auction by the participants and
accepted by the authorities. Such a rate is called cut off rate. In the same way, the rate is fixed for 91 days
treasury bills sold through auction. 91 days treasury bills (top basis) can be rediscounted with the RBI at any
time after 14 days of their purchase. Before 14 days a penal rate is charged.
Operations and Participants

The RBI holds day’s treasury bills (TBs) and they are issued on top basis throughout the week. However, 364
days TBs are sold through auction which is conducted once in a fortnight. The date of auction and the last
date of submission of tenders are notified by the RBI through a press release. Investors can submit more than
one bid also. On the next working day of the date auction, the accepted bids with prices are displayed. The
successful bidders have to collect letters of acceptance from the RBI and deposit the same along with cheque
for the amount due on RBI within 24 hours of the announcement of auction results.

Institutional investors like commercial banks, DFHI, STCI, etc, maintain a subsidiary General Ledger (SGL)
account with the RBI. Purchases and sales of TBs are automatically recorded in this account invests who do
not have SGL account can purchase and sell TBs though DFHI. The DFHI does this function on behalf of
investors with the helps of SGL transfer forms. The DFHI is actively participating in the auctions of TBs. It is
playing a significant role in the secondary market also by quoting daily buying and selling rates. It also gives
buy-back and sell-back facilities for period’s upto 14 days at an agreed rate of interest to institutional
investors. The establishment of the DFHI has imported greater liquidity in the TB market.

The participants in this market are the followers:

1. RBI and SBI

2. Commercial banks
3. State Governments
6. Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABARD, etc.
7. Corporate customers
8. Public

Through many participants are there, in actual practice, this market is in the hands at the banking sector. It
accounts for nearly 90 % of the annual sale of TBs.

Importance of Treasury Bills:

• Safety: Investments in TBs are highly safe since the payment of interest and repayment of principal
are assured by the Government. They carry zero default risk since they are issued by the RBI for and
on behalf of the Central Government.
• Liquidity: Investments in TBs are also highly liquid because they can be converted into cash at any
time at the option of the inverts. The DFHI announces daily buying and selling rates for TBs. They
can be discounted with the RBI and further refinance facility is available from the RBI against TBs.
Hence there is a market for TBs.
• Ideal Short-Term Investment: Idle cash can be profitably invested for a very short period in TBs.
TBs are available on top throughout the week at specified rates. Financial institutions can employ
their surplus funds on any day. The yield on TBs is also assured.
• Ideal Fund Management: TBs are available on top as well through periodical auctions. They are
also available in the secondary market. Fund managers of financial institutions build portfolio of TBs
in such a way that the dates of maturities of TBs may be matched with the dates of payment on their
liabilities like deposits of short term maturities. Thus, TBs help financial manager’s it manage the
funds effectively and profitably.
• Statutory Liquidity Requirement: As per the RBI directives, commercial banks have to maintain
SLR (Statutory Liquidity Ratio) and for measuring this ratio investments in TBs are taken into
account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR (Cash Reserve
Ratio). TBs are very helpful. They can be readily converted into cash and thereby CRR can be
• Source Of Short-Term Funds: The Government can raise short-term funds for meeting its
temporary budget deficits through the issue of TBs. It is a source of cheap finance to the Government
since the discount rates are very low.
• Non-Inflationary Monetary Tool: TBs enable the Central Government to support its monetary
policy in the economy. For instance excess liquidity, if any, in the economy can be absorbed through
the issue of TBs. Moreover, TBs are subscribed by investors other than the RBI. Hence they cannot
be mentioned and their issue does not lead to any inflationary pressure at all
• Hedging Facility: TBs can be used as a hedge against heavy interest rate fluctuations in the call
loan market. When the call rates are very high, money can be raised quickly against TBs and
invested in the call money market and vice versa. TBs can be used in ready forward transitions.

Defects of Trasury Bills:

• Poor Yield: The yield form TBs is the lowest. Long term Government securities fetch more interest
and hence subscriptions for TBs are on the decline in recent times.
• Absence Of Competitive Bids: Though TBs are sold through auction in order to ensure market rates
for the investors, in actual practice, competitive bids are competitive bids are conspicuously absent.
The RBI is compelled to accept these non-competitive bids. Hence adequate return is not available. It
makes TBs unpopular.
• Absence Of Active Trading: Generally, the investors hold TBs till maturity and they do not come
for circulation. Hence, active trading in TBs is adversely affected

The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-
counter financial market for the trading of currencies. Financial centers around the world function as anchors
of trading between a wide range of different types of buyers and sellers around the clock, with the exception
of weekends. The foreign exchange market determines the relative values of different currencies.

The primary purpose of the foreign exchange is to assist international trade and investment, by allowing
businesses to convert one currency to another currency. For example, it permits a US business to import
British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports
speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest
in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some

In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of
another currency. The modern foreign exchange market began forming during the 1970s when countries
gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed
as per the Bretton Woods system.

The foreign exchange market is unique because of

• its huge trading volume, leading to high liquidity;

• its geographical dispersion;
• its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday
until 22:00 GMT Friday;
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with other markets of fixed income; and
• the use of leverage to enhance profit margins with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding
currency intervention by central banks. According to the Bank for International Settlements, as of April 2010,
average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of
approximately 20% over the $3.21 trillion daily volume as of April 2007.

Market size and liquidity

The foreign exchange market is the largest and most liquid financial market in the world. Traders include
large banks, central banks, institutional investors, currency speculators, corporations, governments, other
financial institutions, and retail investors. The average daily turnover in the global foreign exchange and
related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated
by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs $1.7
trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot foreign exchange transactions and $2.5 trillion
was traded in outright forwards, FX swaps and other currency derivatives.

Trading in London accounted for 36.7% of the total, making London by far the most important global center
for foreign exchange trading. In second and third places respectively, trading in New York City accounted for
17.9%, and Tokyo accounted for 6.2%.

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years,
reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency
derivatives represent 4% of OTC foreign exchange turnover. FX futures contracts were introduced in 1972 at
the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled
since 2004.[The increase in turnover is due to a number of factors: the growing importance of foreign
exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of
retail investors as an important market segment. The growth of electronic execution methods and the diverse
selection of execution venues have lowered transaction costs, increased market liquidity, and attracted greater
participation from many customer types. In particular, electronic trading via online portals has made it easier
for retail traders to trade in the foreign exchange market. By 2010, retail trading is estimated to account for up
to 10% of spot FX turnover, or $150 billion per day .


The interbank market caters for both the majority of commercial turnover and large amounts of speculative
trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on
behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. Until
recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching
anonymous counterparts for large fees. Today, however, much of this business has moved on to more efficient
electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in
most trading rooms, but turnover is noticeably smaller than just a few years ago.

Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to
pay for goods or services. Commercial companies often trade fairly small amounts compared to those of
banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade
flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational
companies can have an unpredictable impact when very large positions are covered due to exposures that are
not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets. They try to control the money
supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies.
They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the
effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if
they make large losses, like other traders would, and there is no convincing evidence that they do make a
profit trading.

Forex Fixing

Forex fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that
central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange
rates reflects the real value of equilibrium in the forex market. Banks, dealers and online foreign exchange
traders use fixing rates as a trend indicator.

Hedge funds as speculators

About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or
institution that bought or sold the currency has no plan to actually take delivery of the currency in the end;
rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a
reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may
borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency,
if the economic fundamentals are in the hedge funds' favor.

Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension
funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For
example, an investment manager bearing an international equity portfolio needs to purchase and sell several
pairs of foreign currencies to pay for foreign securities purchases.
Some investment management firms also have more speculative specialist currency overlay operations, which
manage clients' currency exposures with the aim of generating profits as well as limiting risk. Whilst the
number of this type of specialist firms is quite small, many have a large value of assets under management
(AUM), and hence can generate large trades.

Retail foreign exchange brokers

Retail traders (individuals) constitute a growing segment of this market, both in size and importance.
Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and
regulated in the USA by the CFTC and NFA have in the past been subjected to periodic foreign exchange
scams. To deal with the issue, the NFA and CFTC began (as of 2009) imposing stricter requirements,
particularly in relation to the amount of Net Capitalization required of its members. As a result many of the
smaller, and perhaps questionable brokers are now gone.

There are two main types of retail FX brokers offering the opportunity for speculative currency trading:
brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market,
by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They
charge a commission or mark-up in addition to the price obtained in the market. Dealers or market makers, by
contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are
willing to deal at—the customer has the choice whether or not to trade at that price.

Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments to private
individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do
not offer speculative trading but currency exchange with payments. I.e., there is usually a physical delivery of
currency to a bank account. Send Money Home offers an in-depth comparison into the services offered by all
the major non-bank foreign exchange companies.

It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange
Companies.[13] These companies' selling point is usually that they will offer better exchange rates or cheaper
payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in
that they generally offer higher-value services.

Money transfer/remittance companies

Money transfer companies/remittance companies perform high-volume low-value transfers generally by
economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion
of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and
the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000
agents globally followed by UAE Exchange & Financial Services Ltd.[citation needed]

Trading characteristics

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-
border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of
interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a
single exchange rate but rather a number of different rates (prices), depending on what bank or market maker
is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by
arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is
usually the London market price. A joint venture of the Chicago Mercantile Exchange and Reuters, called
Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important
centers as well. Banks throughout the world participate. Currency trading happens continuously throughout
the day; as the Asian trading session ends, the European session begins, followed by the North American
session and then back to the Asian session, excluding weekends.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of
changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing
power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect),
budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions.
Major news is released publicly, often on scheduled dates, so many people have access to the same news at
the same time. However, the large banks have an important advantage; they can see their customers' order

Determinants of FX rates

The following theories explain the fluctuations in FX rates in a floating exchange rate regime (In a fixed
exchange rate regime, FX rates are decided by its government):

(a) International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic
Fisher effect, International Fisher effect. Though to some extent the above theories provide logical
explanation for the fluctuations in exchange rates, yet these theories falter as they are based on
challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in
the real world.
(b) Balance of payments model : This model, however, focuses largely on tradable goods and
services, ignoring the increasing role of global capital flows. It failed to provide any explanation for
continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current
account deficit.
(c) Asset market model :views currencies as an important asset class for constructing investment
portfolios. Assets prices are influenced mostly by people’s willingness to hold the existing quantities
of assets, which in turn depends on their expectations on the future worth of these assets. The asset
market model of exchange rate determination states that “the exchange rate between two currencies
represents the price that just balances the relative supplies of, and demand for, assets denominated in
those currencies.”

None of the models developed so far succeed to explain FX rates levels and volatility in the longer time
frames. For shorter time frames (less than a few days) algorithm can be devised to predict prices. Large and
small institutions and professional individual traders have made consistent profits from it. It is understood
from above models that many macroeconomic factors affect the exchange rates and in the end currency prices
are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge
melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly
shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses
(and distills) as much of what is going on in the world at any given time as foreign exchange.

Supply and demand for any given currency, and thus its value, are not influenced by any single element, but
rather by several. These elements generally fall into three categories: economic factors, political conditions
and market psychology.

Economic factors

These include: (a)economic policy, disseminated by government agencies and central banks, (b)economic
conditions, generally revealed through economic reports, and other economic indicators.

• Economic policy comprises government fiscal policy (budget/spending practices) and monetary
policy (the means by which a government's central bank influences the supply and "cost" of money,
which is reflected by the level of interest rates).
• Government budget deficits or surpluses: The market usually reacts negatively to widening
government budget deficits, and positively to narrowing budget deficits. The impact is reflected in
the value of a country's currency.
• Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods
and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and
deficits in trade of goods and services reflect the competitiveness of a nation's economy. For
example, trade deficits may have a negative impact on a nation's currency.
• Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in
the country or if inflation levels are perceived to be rising. This is because inflation erodes
purchasing power, thus demand, for that particular currency. However, a currency may sometimes
strengthen when inflation rises because of expectations that the central bank will raise short-term
interest rates to combat rising inflation.
• Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity
utilization and others, detail the levels of a country's economic growth and health. Generally, the
more healthy and robust a country's economy, the better its currency will perform, and the more
demand for it there will be.
• Productivity of an economy: Increasing productivity in an economy should positively influence the
value of its currency. Its effects are more prominent if the increase is in the traded sector.

Political conditions

Internal, regional, and international political conditions and events can have a profound effect on currency

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political
upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of
coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly,
in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally
responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative
interest in a neighboring country and, in the process, affect its currency.

Financial instruments

• Spot
• Forward
• Swap
• Future
• Option
• Speculation.
Risk aversion in forex

Risk aversion in the forex is a kind of trading behavior exhibited by the foreign exchange market when a
potentially adverse event happens which may affect market conditions. This behavior is caused when risk
averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty

Srilakshmy Srikumar


By- JOBIN JOY, FK-1856


The primary market is that part of the capital markets that deals with the issuance of new securities.
Companies can obtain funding through the sale of a new stock issue. This is typically done through a
syndicate of securities dealers. In the case of a new stock issue, this sale is an initial public offering (IPO).
Dealers earn a commission that is built into the price of the security offering, which can be found in
the prospectus. Primary markets create long term instruments through which corporate entities borrow from
capital market.

Features of primary markets are:

 This is the market for new long term equity capital. The primary market is the market where the
securities are sold for the first time. Therefore it is also called the new issue market (NIM).
 In a primary issue, the securities are issued by the company directly to investors.
 Primary issues are used by companies for the purpose of setting up new business or for expanding or
modernizing the existing business.
 The primary market performs the crucial function of facilitating capital formation in the economy.
 The new issue market does not include certain other sources of new long term external finance, such
as loans from financial institutions. Borrowers in the new issue market may be raising capital for
converting private capital into public capital; this is known as "going public."
Resource mobilization through New Issue Market- Domestic Market
 New Issue- IPO

 Private Placement market

 Preferential issue

Resource Mobilization through New issue Market - international market

 GDRs

 ADRs


 ECBs

 Euro Issues

An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an
unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both
for the first time to the public. This paves way for listing and trading of the issuer’s securities. The sale of
securities can be either through book building or through normal public issue.
Fixing prices
The company and merchant banker are however required to give full disclosures of the parameters which they
had considered while deciding the issue price. There are two types of issues, one where company and Lead
Merchant Banker fix a price (called fixed price) and other, where the company and the Lead Manager (LM)
stipulate a floor price or a price band and leave it to market forces to determine the final price (price
discovery through book building process). Book Building is basically a process used in IPOs for efficient
price discovery. It is a mechanism where, during the period for which the IPO is open, bids are collected from
investors at various prices, which are above or equal to the floor price. The offer price is determined after the
bid closing date
Private placement occurs when a company makes an offering of securities not to the public, but directly to an
individual or a small group of investors. Such offerings do not need to be registered with the Securities and
Exchange Commission (SEC) and are exempt from the usual reporting requirements. Private placements are
generally considered a cost-effective way for small businesses to raise capital without "going public" through
an initial public offering (IPO).
Private placements offer small businesses a number of advantages over IPOs. Since private placements do not
require the assistance of brokers or underwriters, they are considerably less expensive and time consuming. In
addition, private placements may be the only source of capital available to risky ventures or start-up firms.
"With loan criteria for commercial bankers and investment criteria for venture capitalists both tightening, the
private placement offering remains one of the most viable alternatives for capital formation available to
When a listed company doesn't want to go for further public issue and the objective is to raise huge capital by
issuing bulk of shares to selected group of people, preferential allotment is a good option.

A private placement is an issue of shares or of convertible securities by a company to a select group of

persons under Section 81 of the Companies Act, 1956, which is neither a rights issue nor a public issue. This
is a faster way for a company to raise equity capital.

A private placement of shares or of convertible securities by a listed company is generally known by name of
preferential allotment. A listed company going for preferential allotment has to comply with the requirements
contained in Chapter XIII of SEBI (DIP) Guidelines, in addition to the requirements specified in the
Companies Act. In short, preferential issue means allotment of equity to some selected people by a company
which has its share already listed.
• It is equity instrument issued in abroad market by overseas corporate bodies against the shares/bonds
of Indian companies held with domestic custodian bank.

• An issuing company can raise funds through ordinary equity shares but these shares would be
transferred in GDRs in some ratios. i.e. 1 GDR – 10 shares.

• GDRs are freely transferable outside Indian and divided in respect of shares GDR is paid in Indian
rupees only.

• They are listed and traded on foreign stock exchange and OTC market.

• The holder of GDR can convert it into no of shares at any time.

• Till conversion GDR does not have any voting rights but once converted it is listed on Indian stock

• Most of Indian companies have their GDRs issues listed on Luxembourg stock exchange and the
London stock exchange.

• Indian companies are free to raise ECBs from any internationally recognized source such as bank,
export credit agencies, suppliers of equipment, foreign collaborators, foreign equity holders and
international capital markets.

FCCB (Foreign currency convertible bonds)

• It is issued by Indian companies and subscribed by non-resident in foreign currency.

• It carries fixed interest or coupon rate and is convertible into a certain number of ordinary shares at
preferable price.

• It can be converted into ordinary shares of issuing company either in whole or in pat on the basis of
any equity related warrants attached to the debt instruments.

• Till conversion, the company has to pay interest in dollars and if conversion option is not exercised,
the redemption is also made in dollars.

• Interest rate is low but exchange risk is more.

• Only companies with low debt equity ratios and large forex earnings potential opt for FCCB.

• Euro issue market comprises FCCB, GDRs/ADRs.

• Infosys was the first company to tap international market in March 1999 (listed on NASDAQ), than
ICICI (NYSE) and satyam (NASDAQ). Satyam then was not listed any of Indian stock exchange.

• Investors (From abroad) respond highly to Indian ADRs

• was the first dot company to list nearly at 100% premium on NASDAQ even bypassing

• Indian companies can go directly for ADRS without domestic offering as the scrip appreciates more
in US market as concept of futuristic stocks is stronger in US.


The debt market in India comprises of two main segments, viz., the government securities market and the
corporate securities market. The market for government securities is the most dominant part of the debt
market in terms of outstanding securities, market capitalization, trading volume and number of participants. It
sets benchmark for the rest of the market. The short-term instruments in this segment are used by RBI as
instrument of
Monetary policy. The main instruments in the government securities market are fixed rate bond, floating rate
bonds, zero coupon bonds and inflation index bonds, partly paid securities, securities with embedded
derivatives, treasury bills and the state government bonds.
The corporate debt segment includes private corporate debt, bonds issued by public sector units (PSUs) and
bonds issued by development financial institutions (DFIs). This segment is not very deep and liquid. The
market for debt derivatives has not yet developed appreciably.

Market Subgroups
The various subgroups in debt market in India are discussed below:
· Government securities form the oldest and most dominant part of the debt market in India. The market for
government securities comprises the securities issued by the central government, state governments and
statesponsored entities. In the recent past, local bodies such as municipal corporations have also begun to tap
the debt market for funds. The Central Government mobilises funds mainly through issue of dated securities
and T-bills, while State Governments rely solely on State Development Loans. The major investors in
sovereign papers are banks, insurance companies and financial institutions, which generally do so to meet
statutory requirements.

· Bonds issued by government-sponsored institutions like DFIs, infrastructure-related institutions and the
PSUs, also constitute a major part of the debt market. The gradual withdrawal of budgetary support to PSUs
by the government since 1991 has increased their reliance on the bond market for mobilising resources. The
preferred mode of raising capital by these institutions has been private placement, barring an occasional
public issue. Banks, financial institutions and other corporate have been the major subscribers to these issues.

· The Indian corporate sector relies, to a great extent, on raising capital through debt issues, which comprise of
bonds and Commercial Papers (CPs). Of late, most of the bond issues are being placed through the private
placement route. These bonds are structured to suit the requirements of investors and the issuers, and include
a variety of tailor made features with respect to interest payments and redemption. Corporate bond market has
seen a lot of innovations, including securitized products, corporate bond strips, and a variety of floating rate
instruments with floors and caps. In the recent years, there has been an increase in issuance of corporate
bonds with embedded put and call options. While some of these securities are traded on the stock exchanges,
the secondary market for corporate debt securities is yet to fully develop.

· In addition to above, there is another segment, which comprises of short term paper issued by banks, mostly
in the form of certificates of deposit (CDs). This segment is, however, comparatively less dominant.

· The Indian debt market also has a large non-securitised, transactions based segment, where players are able
to lend and borrow amongst themselves. This segment comprises of call and notice money markets, inter-
bank market for term money, market for inter-corporate loans, and market for ready forward deals (repos).
Typically, short-term instruments are traded in this segment.

· The market for interest rate derivatives like FRAs, IRSs, and OISs (Overnight Index Swaps) is emerging to
enable banks, PDs and FIs to hedge interest rate risks.

Debt instruments represent contracts whereby one party lends money to another on pre-determined terms with
regard to rate of interest to be paid by the borrower to the lender, the periodicity of such interest payment, and
the repayment of the principal amount borrowed. In the Indian securities markets, we use the term ‘bond’ for
debt instruments issued by the Central and State governments and public sector organisations, and the term
‘debentures’ for instruments issued by private corporate sector. In this workbook the terms bonds, debentures
and debt instruments have been used inter-changeably.

The principal features of a bond are:

Maturity: In the bond markets, the terms maturity and term-to-maturity, are used quite frequently. Maturity
of a bond refers to the date on which the bond matures, or the date on which the borrower has agreed to repay
(redeem) the principal amount to the lender. The borrowing is extinguished with redemption, and the bond
ceases to exist after that date. Term to maturity, on the other hand, refers to the number of years remaining for
the bond to mature. Term to maturity of a bond changes every day, from the date of issue of the bond until its
Coupon: Coupon refers to the periodic interest payments that are made by the borrower (who is also the
issuer of the bond) to the lender (the subscriber of the bond). Coupon rate is the rate at which interest is paid,
and is usually represented as a percentage of the par value of a bond.
Principal: Principal is the amount that has been borrowed, and is also called the par value or face value of the
bond. The coupon is the product of the principal and the coupon rate.


Debt markets are pre-dominantly wholesale markets, with institutional investors being major participants.
Banks, financial institutions, mutual funds, provident funds, insurance companies and corporates are the main
investors in debt markets. Many of these participants are also issuers of debt instruments. The small number
of large players has resulted in the debt markets being fairly concentrated, and evolving into a wholesale
negotiated dealings market. Most debt issues are privately placed or auctioned to the
participants. Secondary market dealings are mostly done on telephone, through negotiations. In some
segments, such as the government securities market, market makers in the form of primary dealers have
emerged, which enable a broader holding of treasury securities. Debt funds of the mutual fund industry,
comprising of liquid funds, bond funds and gilt funds, represent a recent mode of intermediation of retail
investments into the debt markets.
The market participants in the debt market are described below:
(a) Central Government raises money through bond and T-bill issues to fund budgetary deficits and other
short and long-term funding requirements.
(b) Reserve Bank of India (RBI), as investment banker to the government, raises funds for the government
through dated securities and T-bill issues, and also participates in the market through open-market operations
in the course of conduct of monetary policy. RBI also conducts daily repo and reverse repo to moderate
money supply in the economy. RBI also regulates the bank rates and repo rates, and uses these rates as tools
of its monetary policy. Changes in these benchmark rates directly impact debt markets and all participants in
the market as other interest rates realign themselves with these changes.
(c) Primary Dealers (PDs), who are market intermediaries appointed by RBI,
underwrite and make market in government securities by providing two way quotes, and have access to the
call and repo markets for funds. Their performance is assessed by RBI on the basis of their bidding
commitments and the success ratio achieved at primary auctions. In the secondary market, their outright
turnover has to three times their holdings in dated securities and five times their holdings in treasury bills.
Satellite dealers constituted the second tier of market makers till December 2002.
(d) State governments, municipal and local bodies issue securities in the debt markets to fund their
developmental projects as well as to finance their budgetary deficits.
(e) Public Sector Undertakings (PSUs) and their finance corporations are large issuers of debt securities. They
raise funds to meet the long term and working capital needs. These corporations are also investors in bonds
issued in the debt markets.
(f) Corporates issue short and long-term paper to meet their financial requirements. They are also investors in
debt securities issued in the market.
(g) Development Financial Institutions (DFIs) regularly issue bonds for funding their financing requirements
and working capital needs. They also invest in bonds issued by other entities in the debt markets. Most FIs
hold government securities in their investment and trading portfolios.
(h) Banks are the largest investors in the debt markets, particularly the government securities market due to
SLR requirements. They are also the main participants in the call money and overnight markets. Banks
arrange CP issues of corporates and are active in the inter-bank term markets and repo markets for their short
term funding requirements.
Banks also issue CDs and bonds in the debt markets. They also issue bonds to raise funds for their Tier-II
capital requirement.
(i) The investment norms for insurance companies make them large participants in government securities
(j) Mutual funds have emerged as important players in the debt market, owing to the growing number of debt
funds that have mobilized significant amounts from the investors. Most mutual funds also have specialised
debt funds such as gilt funds and liquid funds. Mutual funds are not permitted to borrow funds, except for
meeting very short-term
liquidity requirements. Therefore, they participate in the debt markets pre-dominantly as investors, and trade
on their portfolios quite regularly.
(k) Foreign Institutional Investors (FIIs) are permitted to invest in treasury and corporate bonds, within certain
(l) Provident and pension funds are large investors in the debt markets. The prudential regulations governing
the deployment of the funds mobilized by them mandate investments pre-dominantly in treasury and PSU
bonds. They are, however, not very active traders in their portfolio, as they are not permitted to sell their
holdings, unless they have a funding
requirement that cannot be met through regular accruals and contributions.
(m) Charitable institutions, trusts and societies are also large investors in the debt markets. They are, however,
governed by their rules and byelaws with respect to the kind of bonds they can buy and the ma nner in which
they can trade on their debt portfolios.
(n) Since January 2002, retail investors have been permitted submit noncompetitive
bids at primary auction through any bank or PD. They submit bids for amounts of Rs. 10,000 and multiples
thereof, subject to the condition that a single bid does not exceed Rs. 1 crore. The noncompetitive bids upto a
maximum of 5% of the notified amount are
accepted at the weighted average cut off price / yield.
(o) NDS, CCIL and WDM are other participants which are discussed in greater detail in subsequent sections.

The matrix of issuers, investors, instruments in the debt market and their maturities are presented below
Participants and Products in Debt Markets Issuer Instruments Maturity Investors

Issuance Process-Government securities

The issue of government securities is governed by the terms and conditions specified in the general
notification of the government and also the terms and conditions specified in the specific notification issued in
respect of issue of each security. The terms and conditions specified in the general notification are discussed
in this section.
Any person including firm, company, corporate body, institution, state government, provident fund, trust,
NRI, OCB predominantly owned by NRIs and FII registered with SEBI and approved by RBI can submit
offers, including in electronic form, for purchase of government securities. Payment for the securities are
made by the applicants on such dates as mentioned in the specific notification, by means of cash or cheque
drawn on RBI or Banker's pay order or by authority to debit their current account with RBI or by Electronic
Fund Transfer in a secured environment. Government securities are issued for a minimum amount of
Rs.10,000/- (face value) and in multiples of Rs.10,000/- thereafter. These are issued to the investors by credit
to their SGL account or to a Constituents’ SGL account of the institution as specified by them, maintained
with RBI or by credit to their Bond Ledger Account maintained with RBI or with any institution authorised
by RBI, or in the form
of physical certificate. These are repaid at Public Debt Offices of RBI or any other institution at which they
are registered at the time of repayment. If specified in the specific notification, the payment for securities and
the repayment thereof can be made in specified installments.

Government issues securities through the following modes:

(a) Issue of securities through auction: The securities are issued through auction either on price basis or on
yield basis. Where the issue is on price basis, the coupon is pre-determined and the bidders quote price per
Rs.100 face value of the security, at which they desire to purchase the security. Where the issue is on yield
basis, the coupon of the security is decided in an auction and the security carries the same coupon till
maturity. On the basis of the bids received, RBI determines the maximum rate of yield or the minimum offer
price as the case may be at which offers for purchase of securities would be accepted at the auction. The
auctions for issue of securities (on either yield basis or price basis) are held either on ‘Uniform price’ method
or on ‘Multiple price’ method. Where an auction is held on ‘Uniform price’ method, competitive bids offered
with rates up to and including the maximum rate of yield or the prices up to and including the minimum offer
price, as determined by RBI, are accepted at the maximum rate of yield or minimum offer price so
determined. Bids quoted higher than the maximum rate of yield or lower than the minimum price are rejected.
Where an auction is held on ‘Multiple price’ method, competitive bids offered at the maximum rate of yield
or the minimum offer price, as determined by RBI, are accepted. Other bids tendered at lower than the
maximum rate of yield or higher than the minimum offer price are accepted at the rate of yield or price as
quoted in the respective bid. Bids quoted higher than the maximum rate of yield or lower than the minimum
price are rejected. Individuals and specified institutions (read ‘retail investors’) can participate in the auctions
on ‘non-competitive’ basis. Allocation of the securities to non-competitive bidders are made at the discretion
of RBI and at a price not higher than the weighted average price arrived at on the basis of the competitive bids
accepted at the auction or any other price announced in the specific notification. The nominal amount of
securities that would be allocated to retail investors on non-competitive basis is restricted to a maximum 5
percentage of the aggregate nominal amount of the issue, within or outside the nominal amount which is
issued at the weighted average price of the issue at the auction.
(b) Issue of securities with pre-announced coupon rates: The coupon on such securities is announced
before the date of floatation and the securities are issued at par. In case the total subscription exceeds the
aggregate amount offered for sale, RBI may make partial allotment to all the applicants.
(c) Issue of securities through tap sale: No aggregate amount is indicated in the notification in respect of the
securities sold on tap. Sale of such securities may be extended to more than one day and the sale may be
closed at any time on any day.
(d) Issue of securities in conversion of maturing treasury bills/dated
The holders of treasury bills of certain specified maturities and holders of specified dated securities are
provided an option to convert their holding at specified prices into new securities offered for sale. The new
securities could be issued on an auction/pre-announced coupon basis. RBI may participate in auctions as a
‘non-competitor’ or subscribe to the government securities in other issues. Allotment of securities to RBI are
made at the cut off price/yield emerging in the auction or at any other price/yield decided by the government.
In order to maintain a stable interest rate environment, RBI accepts private placement of government
securities. Such privately placed securities and securities that devolve on RBI are subsequently offloaded
through RBI’s open market operations.

Government issues the following types of Government securities:

(a) Securities with fixed coupon rates: These securities carry a specific coupon rate remaining fixed during
the term of the security and payable periodically. These may be issued at a discount, at par or at a premium to
the face value and are redeemed at par.
(b) Floating Rate Bonds: These securities carry a coupon rate which varies according to the change in the
base rate to which it is related. The description of the base rate and the manner in which the coupon rate is
linked to it is announced in the specific notification. The coupon rate may be subject to a floor or cap.
(c) Zero Coupon Bonds: These are issued at a discount and redeemed at par. No interest payment is made on
such bonds before maturity. On the basis of the bids received through tenders, RBI determines the cut-off
price at which tenders for purchase such bonds would be accepted at the auction.
(d) Securities with Embedded Derivatives: These securities are repaid at the option of government/holder of
the security, before the specified redemption date, where a ‘call option’/‘put option’ is specified in the
specific notification and repaid on the date of redemption specified in the specific notification, where neither a
‘call option’ nor a ‘put option’ is specified/ exercised.
(e) Indexed Bond: Interest payments of these bonds are based on Wholesale Price Index/ Consumer Price

Primary dealers (PDs) are important intermediaries in the government securities markets. There are 19 PDs
operating in the market. They act as underwriters in the primary market for government securities, and as
market makers in the secondary market. PDs underwrite a portion of the issue of government security that is
floated for a pre-determined amount. Normally, PDs are collectively offered to underwrite up to 100% of the
notified amount
in respect of all issues where amounts are notified. The underwriting commitment of each PD is broadly
decided on the basis of its size in terms of its net owned funds, its holding strength, the committed amount of
bids and the volume of turnover in securities. Several facilities have been extended to PDs given their special
role in the government debt market. RBI provides liquidity support to the PDs through LAF against collateral
of government
securities and through repo operations/refinance. PDs are also given favoured access to the RBI’s open
market operations. PDs are permitted to borrow and lend in the money market, including call money market.
PDs can also raise funds through CPs and have access to finance from commercial banks as any other
corporate borrower.

Satellite dealers (SDs) formed the second tier of trading and distribution of Government securities. They were
expected to further strengthen the infrastructure of distribution, enhance liquidity, provide a retail outlet and
encourage holding among a wider investor base. They were given the facility of SGL, CSGL, current
accounts, liquidity support through reverse repo, issue of CPs, etc. However, the Satellite Dealers Scheme
was discontinued since December 2002.


Trading of Government Securities on Stock Exchanges

With a view to encouraging wider participation of all classes of investors, including retail, trading in
government securities through a nationwide, anonymous, order driven screen based trading system on stock
exchanges and settlement through the depositories, in the same manner in which trading takes place in
equities, has been introduced with effect from January 16, 2003. Accordingly, trading of dated Government of
India (GOI) securities in
dematerialized form has started on automated order driven system of the National Stock Exchange (NSE),
The Bombay Stock Exchange, Mumbai (BSE) and the Over the Counter Exchange of India (OTCEI).This
trading facility is in addition to the reporting/trading facility in the Negotiated Dealing System. Being a
parallel system, the trades concluded on The exchanges will be cleared by their respective clearing
corporations/clearing houses. The trades of RBI regulated entities have to be settled either directly with
clearing corporation/clearing house (in case they are clearing members) or else through clearing member
Primary Dealers (PDs) are expected to play an active role in providing liquidity to the government securities
market and promote retailing. They may, therefore, make full use of proposed facility to distribute
government securities to all categories of investors through the process of placing and picking-up orders on
the exchanges. PDs may open demat accounts with a Depository Participant (DP) of NSDL/CDSL in addition
to their accounts with RBI. Value free transfer of securities between SGL/CSGL and demat accounts is
enabled by PDO-Mumbai subject to operational guidelines being issued by our Department of Government
and Bank Accounts (DGBA).

By- JOBIN JOY, FK-1856



An investment bank is a financial institution that assists individuals, corporations and governments in raising
capital by underwriting and/or acting as the client's agent in the issuance of securities. In addition to the
acquisition of new funds, investment banking also offers advice for a wide range of transactions a company
might engage in. An investment banking firm also does a large amount of consulting. Unlike commercial
banks and retail banks, investment banks do not take deposits. There are two main lines of business in
investment banking. Trading securities for cash or for other securities (i.e., facilitating transactions, market-
making), or the promotion of securities (i.e., underwriting, research, etc.) is the "sell side", while dealing with
pension funds, mutual funds, hedge funds, and the investing public (who consume the products and services
of the sell-side in order to maximize their return on investment) constitutes the "buy side".


The origin of investment banking in India can be traced back to the 19th
century when European merchant banks set-up their agency houses in the
country to assist in the setting of new projects. In the early 20th century, large
business houses followed suit by establishing managing agencies which
acted as issue house for securities, promoters for new projects and also
provided finance to Greenfield ventures. The peculiar feature of these
agencies was that their services were restricted only to the companies of the
group to which they belonged. A few small brokers also started rendering
Merchant banking services, but theirs was limited due to their small capital

In 1967, ANZ Grindlays bank set - up a separate merchant banking division

to handle new capital issues. It was soon followed by Citibank, which started
rendering these services. The foreign banks monopolized merchant banking
services in the country. The banking committee, in its report in 1972, took
note of this with concern and recommended setting up of merchant banking
institutions by commercial banks and financial intuitions. State bank of India
ventured into this business by starting a merchant banking bureau in 1972.
In 1972, ICICI became the first financial institution to offer merchant
banking services. JM finance was set-up by Mr. Nimesh Kampani as an
exclusive merchant bank in 1973. The growth of the industry was very slow
during this period. By 1980, the number of merchant banks rose to 33 and
was set-up by commercial banks, financial institutions and private sector.
The capital market witnessed some buoyancy in the late eighties. The advent
of economic reforms in 1991 resulted in sudden spurt in both the primary
and secondary market. Several new players entered into the field. The
securities scam in may, 1992 was a major set back to the industry. Several
leading merchant bankers, both in public and private sector were found to be
involved in various irregularities. Some of the prominent public sector
players involved in the scam were Can bank financial services, SBI capital
markets, Andhra bank financial services, etc. leading private sector players
involved in the scam included Fairgrowth financial services and Champaklal
investments and finance (CIFCO).

The market turned bullish again in the end of 1993 after the tainted shares
problem was substantially resolved. There was a phenomenal surge of
activity in the primary market. The registration norms with the SEBI were
quite liberal. The low entry barriers coupled with lucrative opportunities lured many new entrants into this
industry. Many of the top rung Indian merchant banks, who had string domestic base, started entering into
joint ventures with the foreign banks.
This energy resulted in synergies as their individual strength complemented
each other

Globally, Investment banks handle significant fund-based business of their own in the capital market along
with their non-fund services portfolio which is offered to clients.

All these activities are segmented across three broad platforms-equity market activity, debt market activity
and merger and acquisitions. The global mergers and acquisitions business is very large. Investment bank
plays a lead advisory role in this booming segment of financial advisory business. Besides, they come in as
investors in management buy-outs and management buy-in transactions. On other occasions wherein
investment banks manage private equity fund and they also represent their investors such buy-out deals.
Investment bank plays a major role as institutional investors in trading and having large holdings of capital
market securities. As a dealer, they take the positions and make a market for many securities both in equity
and derivatives segments. They hold large inventories and therefore influence the direction of market.
Nimi K. Parvathy

Q. Core Business portfolios of Investment Banking (Equity Portfolio and Debt Portfolio)
Ans: Globally, investment banks handle significant fund-based business of their own in the capital market
along with their non-fund service portfolio which is offered to clients.

Business Portfolio of Investment Banking:

Investment banking mainly is divided into two portfolios. They are:
• Core Business Portfolio

• Support Activity portfolio





Banking (Issue management), Private Underwriting, market making


management, private placement, market making
structured finance issuances such as

M&A-- Mergers and acquisitions M&A PORTFOLIO—Investing in

advisory, corporate advisory, project private equity, LBOs and MBOs


Equity portfolio- Equity broking, Equity Portfolio- proprietary

distribution, asset management, trading and portfolio investing,
research and analysis managing equity and asset

Debt portfolio- Debt market

broking, distribution, asset
Debt Portfolio- Trading,
management , research underwriting, market making and
investment on own account in debt
instruments and securitised
Derivative Portfolio- Derivative
broking, risk management, custodial
services Derivative portfolio- Proprietary
trading, managing hedge funds

Core Services:
Merchant Banking, underwriting and book running:
The function of merchant banking is to provide intermediation in the capital market. It consists of assisting
the issuers to raise capital by placement of securities issued by them with investors. Financial institutions have
been raising funds via public offer of unsecured bonds. Investment banks have been managing the public
offers and hand holding them in the private placements as well.
Mergers and Aquisitions Adivisory:
One of the creamy activities of investment banks has always been M&A advisory. The larger investment
banks specialize in M&A as a core activity.
Corporate Advisory:
Investment banks in India also have a large practice in corporate advisory services relating to project
financing, corporate restructuring, capital restructuring through equity, raising private equity, structuring
joint-ventures and strategic partnerships and other value added specialized areas.

Name: Budi Kalpana

Roll no. FK-1870


In an increasingly globalised world, M&As are essential mechanisms of shareholder value enhancement.
M&A is facilitating access to new markets, capacities and technologies, as well as enabling organisations to
focus on core competencies. Well-planned and strategic M&As are transforming a number of corporations
into global or regional powerhouses and enabling unprecedented growth beyond geographical market

At the same time, M&As are not without risks. Corporations need to secure the right deal at the right time and
price, and integrate the acquisition to realise their strategic objectives. Just as importantly, corporations need
to evaluate investment opportunities carefully, carry out due diligence thoroughly and know when to walk
away. With so many moving parts to get right, it is no surprise that many acquisitions fall short of what
acquirers looked for.

In recent years, private equity (PE) has emerged as an important source of capital. The proliferation of private
equities in Asia is increasing competition for investments and pushing up valuation. It is now even more
critical for private equities to identify the right deals, understand the target’s potential and maximise the value
in deal structuring. Post-deal value creation and the right exit strategy are also crucial to achieving the desired

Mergers and Acquisition advisory services provided relates to the planning and execution of mergers,
acquisitions and divestures. Focus is on creating value for clients by serving as an intermediary to manage
and facilitate the acquisition process. Advisory services are dedicated to understanding clients investment
criteria and proactively identifying valuable acquisition targets that have tremendous growth opportunity,
while promising a smooth transaction process.

Advisory services includes :

• Identifying opportunities and counterparties
• Assisting with the negotiation of letters of intent and purchase agreements
• Managing the transaction process
The issues unique to undertaking these transactions are understood and they help clients succeed in getting
the deal they want at the best possible price

Underwriting involves the issuing company using one or (usually) more companies who are each responsible
for placing a certain amount of the new issue. The underwriting firms contact potential investors to gauge
interest and sell the issue. Underwriters guarantee the price for a certain number of shares of the new issue.

Underwriting is a good technique of marketing the securities. The importance of under-writing can be adjudged
by the following advantages
1) Assurance of Adequate Finance.
Underwriting is a guarantee given buy the underwriters to take up the whole issue or remaining shares, not
subscribed by public. In the absence an underwriting agreement, a company may face a situation where even
minimum subscription is not received and, it will have to go, into liquidation. In case of an existing company, it
may have to postpone its projects for which the issue was meant. As a result of an underwriting contract, a
company has not to wait till the shares have been subscribed before entering into the required contracts for
purchase of fixed assets etc. it can go ahead with its plan confidently. Thus, underwriting agreement assures of
the required funds within a reasonable or agreed time.
2) Benefit of Expert Advice
An incidental advantage of underwriting is that the issuing company gets the benefit of expert advice. An
underwriter of repute would go into the soundness of the plan put forward by the company before entering into
an agreement and suggest changes wherever necessary, enabling the company to avid certain pitfalls.
3) Increase in Goodwill of the Company.
The good underwriters being men or firms of financial integrity an established reputation. As we have already
explained that underwriters satisfy themselves with the financial integrity of the company and viability of the
plan, the investors therefore, runs much less risk when they buy shares or debentures which have been
underwritten by them. They assure of the soundness of eh company. Thus, good underwriters increase the
goodwill of the company.
4) Geographical Dispersion of Securities.
Generally, underwriters maintain working arrangement with other underwriters and broken throughout the
country and in other countries too and as such, they are able to tap the financial resources for the company not
only in on particular area but also in other areas as well. In this way marketability of securities increases and
geographical dispersion of shares and debentures in promoted.
5) Service to Prospective Buyers.
Underwriters render useful services to the perspective buyers of securities by giving them expert advice
regarding the safe investment in sound companies. Sometimes they publish information and their expert
opinion in respect of various companies. Thus, they render useful services to the buyers of securities too.

The main functions of underwriters are as follows:-

1) Purchase of Securities.
The main function of underwriters is to purchase the securities of financially sound Companies either direct
from the company or from the market. Thus, they maintain their goodwill in the market a stockists of good
2) Distribution of Securities.
Underwriters distribute the securities to the real investors after entering the agreement with the issuing
company. The underwriters take up securities under an obligation under underwriting contract or sometimes
make firm underwriting and distribute such securities to the investors by selling them into the market at the
3) Supplying Information of Companies.
Underwriters supply important information in regard to investor’s attitude, market conditions etc. to the
issuing company and to suggest necessary changes in their financial plans.
4) Supplying Information of Companies
Customers or investors in securities get valuable information from underwriters regarding the financial
position and the policies of different companies. Sometimes their expert advice are published in journals etc.

5) Exchange in Securities.
Underwriters provide stability in the price of securities by purchasing and selling the various securities by
maintaining equilibrium in the demand and supply position of the securities and thus keep the market alive.
6) Other Services.
Underwriters sometimes finance the projects of the company. They also inform the investors about
opportunities but this type of service is not popular in India. It is much popular in U.S.A.

The following underwriting agencies have been working in India

1) Private Firms.

Some important firms of stock brokers are busy in underwriting the issues. These are M/s Place, Siddons and
Gough, M/s Batiliwala and Karni, M/s Dalal and Co., M/s Kothari and Co., and M/s Wright and Co.

2) Investment Companies and Trusts.

In the late thirties, managing agents organised a number of investment banks and trusts, like Industrial
Investment Trusts of Bombay, Birds Investment Ltd., Calcutta, Devkaran nanji Investment co., and In
vestment Trust of India Ltd. which had been underwriting the issues of companies managed mostly by their
managing agents. Now Managing Agency system has been abolished in April 1970 but these firms are still

3) Indian Commercial Banks.

Since independence, commercial banks have also participated in the race of underwriting and played an
important role in this field. They have been working at present as group underwriters.

4) Life Insurance Corporation.

5) Industrial Finance Corporation.

The underwriting operation was included into the objects of the Corporation but it took interest in the field on
underwriting only after 1957.

6) Industrial Credit and Investment Corporation of India.

The start of underwriting business has been with the start of the corporation in 1955 and it played a significant
role in the field of underwritings.
7) Industrial development Bank of India.

It is now the largest institutional underwriter in India.

8) Unit Trust of India.

It is also one of the four largest underwriters in India.

9) State Financial Corporations.

Almost in every state, there is a financial corporation of the lines of Industrial Finance Corporation of India.
These corporations have also shown interest in underwriting.


When corporation sells new securities to raise funds, the offering is called a primary issue. The agent
responsible for finding buyers for these securities is called the investment banker. The investment banker
purchase primary issue from corporation and arranges immediate resell of these securities to the investors.
With the advice of investment bankers, an institution can generate funds in two different ways. It may draw
on public funds through the capital market by selling its stock. Alternatively, it may seek out venture
capitalists or private equity to become stakeholders in the company. Investment banking firms also engage in
financial consulting and offer advice to companies on how to handle acquisitions and mergers. They also
notify their client companies on when to make public offerings and how best to manage the assets. The
function of mergers and acquisitions come under the corporate finance function of an investment bank.
Broadly investment bankers (investment banking firms) perform three functions: Investigation, Analysis and
Research (Origination), Underwriting (Public Cash offerings) and Distribution. Most of time a single investor
banker performs all functions, however some investment bankers are specialized in certain functional areas

Investigation, Analysis and Research (Origination): Origination includes the subsidiary operations of
discovery, investigation, and negotiation. Discovery is the finding of a prospective issue of securities;
investigation is the testing of the investment credit of the prospective security issuer, and the intrinsic
soundness of the issue; negotiation is the determination of the amount, the price, and the terms of the
proposed issue. Investigation usually involves an analysis of the financial history of the corporation by
accountants, investigation of legal factors, a survey of its physical property by engineers, and in-depth review
of operations. The purpose of investigation and analysis is to determine whether a proposed issue has
sufficient merit to be offered to investment community. In other words, function of investment banking is
careful analysis of the soundness and reliability of the corporation whose securities are seeking the investment
market. The task of investigation and analyzing the numerous factors, which govern the value of investment
securities, varies considerably with the different types of issuing bodies.

Underwriting (Public Cash offerings): When a corporation wishes to issue new securities and sell them to the
public, it makes an arrangement with an investment banker whereby the investment banker agrees to purchase
the entire issue at a set price, known as underwriting. Underwriting also refers to the guarantee by the
investment banker that the issuer will receive a certain minimum amount of cash for their new securities. The
investment banker buys a new security issue, pays the issuer, and markets the securities. The underwriter’s
compensation is the difference between the price at which the securities sold to the public, and the price paid
to the company for the securities. Underwriting can be done either through negotiations between underwriter
and the issuing company (called negotiated underwriting) or by competitive bidding. A negotiated
underwriting is a negotiated agreed arrangement between the issuing firm and its investment banker. Most
large corporations work with investment bankers with whom they have long-term relationship. In competitive
bidding, the firm awards offering to investment banker that bid the highest price.

In certain cases, for large or risky issues a number of investment bankers get together as a group, they are
referred to as syndicate. A syndicate is a temporary association of investment bankers brought together for the
purpose of selling new securities. One investment banker is selected to manage the syndicate called the
originating house, which does underwriting of the major amount of the issue. There are two types of
underwriting syndicates, divided and undivided. In a divided syndicate, each member group has liability of
selling a portion of offerings assigned to them. However, in undivided syndicate, each member group is liable
for unsold securities up to the amount of its percentage participation irrespective of the number of securities
that group have sold.

Distribution: Another function of investment banker it to market the security issues. The investment banker
acts as a specialist to distribute securities efficiently for the corporation. It can be very expensive and
ineffective for a corporation to sell an issue by establishing marking and selling organization by its own.
Investment banker has established marketing and sales network to distribute securities. For a reputed invest
banker, with its past history of selecting good companies and pricing securities builds a broad client base over
time, and further increases the efficiency with which securities can be sold.

Invest banker offers security to both corporation issuing securities and investors buying securities. For
corporations investment banker offers definite price guaranty on a certain date for securities to offer. The
corporation runs no risk of the uncertainties of the market and do not have to spend on resources with which it
is not equipped with.
To the investor, the responsible investment banker offers protection against unsafe securities. The offering of
a few unsound issues can caused serious loss to its reputation, and hence loss of business. Therefore,
investment banker play very important role in issuing new security offerings.


Q) Growth of investment banks in India. Structure of investment banks in India & Regulatory

Growth of investment banks in India

Growth of Primary market:

If the primary market grows and number of issues increases, the scope of investment banking will be

Entry of Foreign Investors:

Now India capital market directly taps foreign capital through euro issues. FDI is increased in capital market.
So investment bankers are required to advice them for their investment in India. The increasing number of
joint ventures also requires expert services of investment Bankers. If more and more NRIs participate in
capital market, there will be great demand for investment banker services.

Changing policy of Financial Institutions:

Now the lending policies of financial institutions are based on project orientation, so the investment banker
services will be needed by corporate enterprise to provide expert guidance.

Development of debt markets:

If the debt market is enhanced, there will be tremendous scope for investment bankers. Now NSE and OTCEI
are planned to raise their fund through debt instruments.

Corporate restructuring:
Due to liberalization and globalization Companies are facing lot of competition. In order to compete, they
have to go for restructuring, merger, acquisitions or disinvestments. They may offer good opportunities to
merchant bankers

The scope could be extended to:

1. Advising the company on designing of its Capital Structure.
2. Advising the company on the instrument to be offered to the public.
3. Pricing of the instrument.
4. Advising the company on Legal/ regulatory matters and interaction with SEBI/ROC/ Stock Exchanges and
other regulatory authorities.
5. Assisting the company in marketing the issue.
6. In channelizing the financial surplus of the general public into productive investment avenues.
7. To coordinate the activities of various intermediaries to the share issue such as the registrar, bankers,
advertising agency, printers, underwriters, brokers etc.
8. To ensure the compliance with rules and regulations governing the securities market


1. Planning and industrial policy of the country i.e. India in this case
2. Prevailing Economic condition of the country
3. Regulatory system of the market and economy prevailing in India
4. Confidence of the people, traders, buyers, marketers, business houses, financial institutions etc
5. The economic environment of the outside world.
6. Competition among the existing players and the upcoming entrance of new companies.

Structure of Investment banks in India

An investment bank is split into the so-called front office, middle office, and back office. While large service
investment banks offer all of the lines of businesses, both sell side and buy side, smaller ones sell side
investment firms such as boutique investment banks and small broker-dealers focus on investment banking
and sales/trading/research, respectively.

Investment banks offer services to both corporations issuing securities and investors buying securities. For
corporations, investment bankers offer information on when and how to place their to an investment bank's
reputation, and hence loss of business. Therefore, investment bankers play a very important role in issuing
new security offerings.

Front Office:
Investment banking (corporate finance) is the traditional aspect of investment banks which also involves
helping customers raise funds in capital markets and giving advice on mergers and acquisitions (M&A). This
may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a
merger target. Another term for the investment banking division is corporate finance, and its advisory group is
often termed mergers and acquisitions. A pitch book of financial information is generated to market the bank
to a potential M&A client; if the pitch is successful, the bank arranges the deal for the client. The investment
banking division (IBD) is generally divided into industry coverage and product coverage groups. Industry
coverage groups focus on a specific industry, such as healthcare, industrials, or technology, and maintain
relationships with corporations within the industry to bring in business for a bank. Product coverage groups
focus on financial products, such as mergers and acquisitions, leveraged finance, project finance, asset finance
and leasing, structured finance, restructuring, equity, and high-grade debt and generally work and collaborate
with industry groups on the more intricate and specialized needs of a client.

Sales and trading: On behalf of the bank and its clients, a large investment bank's primary function is buying
and selling products. In market making, traders will buy and sell financial products with the goal of making
money on each trade. Sales is the term for the investment bank's sales force, whose primary job is to call on
institutional and high-net-worth investors to suggest trading ideas (on a caveat emptor basis) and take orders.
Sales desks then communicate their clients' orders to the appropriate trading desks, which can price and
execute trades, or structure new products that fit a specific need. Structuring has been a relatively recent
activity as derivatives have come into play, with highly technical and numerate employees working on
creating complex structured products which typically offer much greater margins and returns than underlying
cash securities. In 2010, investment banks came under pressure as a result of selling complex derivatives
contracts to local municipalities in Europe and the US. Strategists advise external as well as internal clients on
the strategies that can be adopted in various markets. Ranging from derivatives to specific industries,
strategists place companies and industries in a quantitative framework with full consideration of the
macroeconomic scene. This strategy often affects the way the firm will operate in the market, the direction it
would like to take in terms of its proprietary and flow positions, the suggestions salespersons give to clients,
as well as the way structurers create new products. Banks also undertake risk through proprietary trading,
performed by a special set of traders who do not interface with clients and through "principal risk"— risk
undertaken by a trader after he buys or sells a product to a client and does not hedge his total exposure. Banks
seek to maximize profitability for a given amount of risk on their balance sheet. The necessity for numerical
ability in sales and trading has created jobs for physics, mathematics and engineering Ph.D.s who act
as quantitative analysts.

Research is the division which reviews companies and writes reports about their prospects, often with "buy"
or "sell" ratings. While the research division may or may not generate revenue (based on policies at different
banks), its resources are used to assist traders in trading, the sales force in suggesting ideas to customers, and
investment bankers by covering their clients. Research also serves outside clients with investment advice
(such as institutional investors and high net worth individuals) in the hopes that these clients will execute
suggested trade ideas through the sales and trading division of the bank, and thereby generate revenue for the
firm. There is a potential conflict of interest between the investment bank and its analysis, in that published
analysis can affect the bank's profits. Hence in recent years the relationship between investment banking and
research has become highly regulated, requiring a Chinese wall between public and private functions.

Other businesses that an investment bank may be involved in

 Global transaction banking is the division which provides cash management, custody services,
lending, and securities brokerage services to institutions. Prime brokerage with hedge funds has been an
especially profitable business, as well as risky, as seen in the "run on the bank" with Bear Stearns in

 Investment management is the professional management of various securities (shares, bonds, etc.)
and other assets (e.g., real estate), to meet specified investment goals for the benefit of investors.
Investors may be institutions (insurance companies, pension funds, corporations etc.) or private
investors (both directly via investment contracts and more commonly via collective investment
schemes e.g., mutual funds). The investment management division of an investment bank is generally
divided into separate groups, often known as Private Wealth Management and Private Client Services.

 Merchant banking is a private equity activity of investment banks. Current examples

include Goldman Sachs Capital Partners and JPMorgan's One Equity Partners. (Originally, "merchant
bank" was the British English term for an investment bank.)

 Commercial banking

Middle office:

 Risk management involves analyzing the market and credit risk that traders are taking onto the
balance sheet in conducting their daily trades, and setting limits on the amount of capital that they are
able to trade in order to prevent "bad" trades having a detrimental effect on a desk overall. Another key
Middle Office role is to ensure that the economic risks are captured accurately (as per agreement of
commercial terms with the counterparty), correctly (as per standardized booking models in the most
appropriate systems) and on time (typically within 30 minutes of trade execution). In recent years the risk
of errors has become known as "operational risk" and the assurance Middle Offices provide now includes
measures to address this risk. When this assurance is not in place, market and credit risk analysis can be
unreliable and open to deliberate manipulation.

 Corporate treasury is responsible for an investment bank's funding, capital structure management,
and liquidity risk monitoring.

 Financial control tracks and analyzes the capital flows of the firm; the Finance division is the
principal adviser to senior management on essential areas such as controlling the firm's global risk
exposure and the profitability and structure of the firm's various businesses. In the United States and
United Kingdom, a Financial Controller is a senior position, often reporting to the Chief Financial

 Corporate strategy, along with risk, treasury, and controllers, also often falls under the finance

 Compliance areas are responsible for an investment bank's daily operations compliance with
government regulations and internal regulations. Often also considered a back-office division.

Back office:

 Operations involve data-checking trades that have been conducted, ensuring that they are not
erroneous, and transacting the required transfers. While some believe that operations provide the greatest
job security and the bleakest career prospects of any division within an investment bank, many banks
have outsourced operations. It is, however, a critical part of the bank. Due to increased competition in
finance related careers, college degrees are now mandatory at most Tier 1 investment banks. A finance
degree has proved significant in understanding the depth of the deals and transactions that occur across
all the divisions of the bank.

 Technology refers to the information technology department. Every major investment bank has
considerable amounts of in-house software, created by the technology team, who are also responsible
for technical support. Technology has changed considerably in the last few years as more sales and
trading desks are using electronic trading. Some trades are initiated by
complex algorithms for hedging purposes.

Regulatory Framework for Investment Banking in India

Investment Banking in India is regulating in its various facets under separate legislations or guidelines issued
under statute. The Regulatory powers are also distributed between different regulators depending upon the
constitution and status of Investment Bank. Pure investment banks which do not have presence in the lending
or banking business are governed primarily by the capital market regulator (SEBI). However, Universal banks
and NBFC investment banks are regulated primarily by the RBI in their core business of banking or lending
and so far as the investment banking segment is concerned, they are also regulated by SEBI. An overview of
the regulatory framework is furnished below:

1. At the constitutional level, all invest banking companies incorporated under the Companies Act,1956 are
governed by the provisions of that Act.

2. Investment Banks that are incorporated under a separate statute such as the SBI or IDBI are regulated by
their respective statute. IDBI is in the process of being converted into a company under the Companies Act.

3. Universal Banks that are regulated by the Reserve Bank of India under the RBI Act, 1934 and the Banking
Regulation Act which put restrictions on the investment banking exposures to be taken by banks.

4. Investment banking companies that are constituted as non-banking financial companies are regulated
operationally by the RBI under sections 45H to 45QB of Reserve Bank of India Act, 1934. Under these
sections RBI is empowered to issue directions in the areas of resources mobilization, accounts and
administrative controls.

5. Functionally, different aspects of investment banking are regulated under the Securities and Exchange
Board of India Act, 1992 and guidelines and regulations issued there under.

6. Investment Banks that are set up in India with foreign direct investment either as joint ventures with Indian
partners or as fully owned subsidiaries of the foreign entities are governed in respect of the foreign investment
by the Foreign Exchange Management Act, 1999 and the Foreign Exchange Management (Transfer or issue
of Security by a person Resident outside India) Regulations, 2000 issued there under as amended from time to
time through circulars issued by the RBI.

7. Apart from the above specific regulations relating to investment banking, investment banks are also
governed by other laws applicable to all other businesses such as – tax law, contract law, property law, local
state laws, arbitration law and the other general laws that are applicable in India.

FK – 1874