Financial Markets and Instruments

Document: I

Class Notes: Financial Markets and Instruments

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COURSE OUTLINE
SVKM’s Narsee Monjee Institute of Management Studies

Mukesh Patel School of Technology Management & Engineering

Course: FIM
Program : B Tech and MBA Tech. (Open Elective) Semester: VI/ VII/ VIII

Course: FIM Code:

Teaching Scheme Evaluation Scheme
Internal
Term End
Lecture Continuous
Examinations
(Hours per Practical Tutorial Credit Assessment
(TEE)
week) (ICA)
(weightage)
(weightage)
3 --- --- 3 50 50
Objectives:
1. To provide the participants with an exposure and thorough understanding of the Indian
Financial systems and its components.
2. Understand the concept and characteristics of Leasing, Hire purchase Factoring and
Forfeiting
Course Outcomes: After completion of the course, students would be able to:

1. Students will be able to understand about the financial system of our Economy.
2. Students will be able to understand the functioning and role of Financial Services sector in the
economy
Pedagogy: Case Study, PowerPoint Presentations, QUIZ, Class Assignment and
Project Work
Detailed Syllabus:

Unit Description Duration

 (Hours)
1 Indian Financial System, International Financial System. Impact of 03
Liberalization on Financial Institutions and Markets

2 Financial Regulators: Reserve Bank of India, Security Exchange Board of 04

India, Insurance Regulatory Development Authority. Role of Other
Institutions like- Association of Mutual Funds of India, Pension Fund
Regulatory and Development Authority, National Housing Bank & AMBI
(Association of Merchant Bankers of India)

3 Financial Institutions: Development Financial Institutions Banking and 05

Non- Banking Financial Institutions
4 Rural Banking and Micro financing: Micro Finance Institution, Role of Non 05
–governmental Organization in micro financing, Formation and types of
Self-Help Group, Models of Micro financing. (Bandhan, Grameen Bank,
Swayam Krishi Sangam Micro finance etc.)

5 Financial Markets: Capital and Money, Debt and Equity, Primary and 05
Secondary, Role of Markets, Anomalies, Bubbles etc

6 Financial Instruments: Equity, Debts & Derivatives: Plain Vanilla to exotic, 05

risk-hedging instruments.

7 Financial Service: Fund-based and Fee based services 05

 Financial Institutions, Markets, Instruments
and Services

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Introduction to Financial Markets

Reference Book and other study materials for the course:

⮚ CFA module Study Materials
⮚ NISM Module V Workbook
⮚ NISM Debt Module workbook
⮚ NISM Derivatives Module workbook
⮚ Financial Markets and Institutions: L M Bhole, Tata McGraw Hill
Publication
⮚ Microfinance – Concepts and Applications, Sanjay Sinha
⮚ Financial Services: M Y Khan, Tata McGraw Hill Publication
⮚ Business News Channels
 ⮚ Magazines and Newspapers

Unit Description Duration

(Hours)
1 Indian Financial System, International Financial System. 03
Impact of Liberalization on Financial Institutions and
Markets

FUNDAMENTALS OF FINANCE

A business organization is an aggregate of multiple activities linked together.

These business organizations operate in various forms like enterprises,
institutions, entity or business entities, business houses, organizations,
companies, firms, corporations, concerns, conglomerates, establishments,
industrial units, ventures, transnationals, multinationals, syndicates and many
more. There can be different names by which organizations are known however
all of them have commonalities in their operations. The common relation
between all these forms of business organization is their functional structure. It
is a matter of general observation that all the business organization engage
themselves in some or other form of business activity. These activities are
characterized by one or more than one of the following:
❖ An element of sale, purchase or transfer

❖ Regularity of transactions

❖ Recording of financials

❖ Profit Motive or wealth enhancement

The activities carried out by organizations as mentioned above are called as

economic activities. All business organizations conduct economic activities for
sustainability and growth. To conduct economic activities smoothly and
efficiently, business organizations classify these activities in different functions
like production & operations, marketing & distribution, accounting & finance,
human resource management & industrial relations, distribution & supply chain
management et el. Majority of these functions are part of all the prosperous
organization. They are known as functional departments of the business entity.
Few of these functional departments are Marketing, Finance, Operations,
Information Technology and others. Among these functional departments, the
finance department is considered as very important because it is believed that
finance is life blood of all the corporations. The department of finance is
antecedent as compared to any other functional area of business world. In the
horizon of economic landscapes, finance plays a pivotal role in a way that
businesses begin with capital and when they get dissolved, it again generates
capital. Simply put, finance is soul of all corporations. Finance as a functional
department has four main interlinked activities: firstly, the Financing function
which involves methods of raising capital by the business corporations.
Secondly, the Investment function looks after the management of return on
investments in the light of risk and uncertainly analysis. Thirdly, Working
Capital function that deals with management of day-to-day requirement of
capital by corporations. The fourth function is Dividend function that relates to
meeting the expectation of shareholders by sharing the profits with them
generally called as dividends. The important functions of finance as a
specialized department is the formulation of monetary and fiscal policies. The
domain of finance is very vast and continuous monitoring becomes an integral
part of it. To ensure smooth conduct of transactions in field of finance, there are
regulators. The regulators of Money markets, Insurance and Capital markets are
Reserve Bank of India (RBI), Insurance Regulatory and Development Authority
(IRDA) and Securities and Exchange Board of India (SEBI) respectively.

Finance and Job Prospects

The number of business houses are ever increasing and accordingly the field of
finance is on rise. Finance professionals are supposed to ensure in the industry,
company or an organization financial resources are distributed in such a manner
that all the functional areas of business are performing at their highest
efficiency.

There can be many reasons for studying finance as a specialization however few
of the most pertinent reasons are:

1. Decision Making Approach: It prepare students to take big financial

decision pertaining to investment and setting up of business concerns

2. Enhancement of Analytical thinking: It imparts requisite skill set to

students for the enhancement of their analytical thinking and personality
development through discussion of current economic affairs, Capital
Market functioning and many more

3. Best job prospects: The world of finance is growing at higher pace as

compared to other functional areas of management and hence it offers the
highest job opportunities to its students
 4. Financially most rewarding career: Financial as a functional area offers
highly rewarding professional career

The world of finance offers myriad career opportunities for its professionals
which can be broadly classified into two categories viz. the realm of Traditional
Finance and sunrise segment of Alternative Finance. A glimpse of career in
these two categories are:

Traditional Finance

● Accounting

● Corporate Finance

● Multinational Financial Management

● Investment Banking

● Financial Planning

● Stock Markets

● Rating Agencies

● Insurance companies

● Merchant Bankers and Commercial banks

● Credit Unions

● Taxation

● Corporate Restructuring and Valuations

● Venture Capitals

● Mutual Funds

● Hedge Funds

● Stock Market Intermediaries and many more

Alternative Finance

● Microfinance

● Community Based Funding like Islamic banking and finance, Jain

Finance and many more

● Crowd Funding

● Peer to Peer Lending

● Crypto Currencies (Bit Coins and others)

● Digital Funding Platforms and many more

Introduction to the Financial Markets

To understand what is financial market, we will first try to understand what

is a market?

Economists define market as 'a central place where sale and purchase of
goods and services takes place.'

Financial Markets refer to set of all Financial Institutions (FIs) in an

economy which helps in the smooth flow of capital from places where it is
surplus to the areas where it is required or consumed. These Financial
Institutions may be banking or non-banking financial corporations (NBFCs).
A more appropriate definition of financial markets has been given by Eugene
F Brigham

“Financial Markets is the place where people and organizations wanting to

borrow money are brought together with those having surplus of funds.”

Indian Financial System : The most vibrant sector of the economy is the
financial sector. An extensive financial and banking sector supports the rapidly
expanding Indian economy. India boasts of a wide and sophisticated banking
network. The sector also has a number of national and state level financial
institutions. These include foreign and Institutional Investors, Investment
Funds, Equipment Leasing Companies, Venture Capital Funds etc. Further, the
country has well established stock market, with over 9000 listed companies.

Different types of sub-markets within financial markets

a. Physical asset markets and Financial asset markets: Physical assets

markets are real markets or tangible markets where industrial produce (TV,
Refrigerators, Laptops, Machines, Electrical and Electronics goods etc) or
agricultural commodities (Sugar, Sugarcane, Jeera, Rice, Maize, Wheat,
Cardamom etc) or physical commodities (Petroleum Crude, Gold, Silver,
Copper etc) are traded. In Financial asset markets financial securities such as
shares, bonds, debentures are traded.

b. Spot markets and Futures markets: Spot markets are those markets
wherein the assets are bought or sold on-the-spot. It means the assets are
available and transaction gets completed immediately. In Stock markets they
are called as Cash segment. In the Futures markets the parties agree to enter
into a contract wherein the assets will be change hands on a future date. This
segment is known as Futures & Options (F&O) in stock markets.

c. Capital and Money markets: Money markets are those markets wherein
the funds are traded for a short period of time not exceeding a year. Few
such instruments are Certificate of Deposits (CD), Commercial Paper (CP),
Treasury Bills (T-bills) and others. Capital markets are those markets
wherein funds are traded for a period of over one year. Few such instruments
are Debentures, Corporate bonds, Treasury Bonds and others. They are
further classified as Short, Medium- and Long-term capital markets.

d. Primary markets and Secondary markets: Primary markets are those

markets in which new capital is raised by the companies. They are also
known as Initial Public Offer (IPO) markets. The companies create new
capital (say equity capital) and issue it for the first time to investors, this
would qualify as primary market transaction. However, when the buyers of
these equity capital comes back for re-sale of this capital, the market in
which it would be sold is called as secondary market. Stock exchange are the
places where this re-sale transactions are carried out. In short, Bombay Stock
Exchange (BSE) and National Stock Exchange (NSE) are the secondary
market for the equity capital issued by a company.

e. Private markets and Public markets: Private markets are those markets
in which the issuer of the capital directly enters into a deal with the investor.
Thus, the company issues equity shares to the investors and the investor
provides capital to the issuing company. This is essentially a two-party
transaction (bi-partite agreement). However, when the company goes ahead
with issuance of shares to public it is known as public market transaction.
Under this transaction, there are large number of persons holding the shares
of the company or shares are issued to public at large.

Genesis and Development of Financial Markets:

The genesis of the Indian financial markets since the independence is

marked by four distinct phases as given below:

The period between 1950 to 1960: This period can be termed as phase of
Transition as banking system were getting strengthened by a process of
merger & acquisitions of small and weak banks. The other major activity of
this period is the efforts that were made to strengthen the co-operative
financial institutions.

The period between 1960 to 1969: This phase can be termed as phase of
Growth and Diversification. In this phase, a lot of financial institutions were
established, and Indian financial market diversified into development
banking, mutual funds etc.
 The period between 1969 to 1990: This phase is marked by Consolidation
of various banking and non-banking financial institutions. The major thrust
was provided by the nationalization of banks. Government also started the
lead banking schemes.

The period from 1991 onwards: This phase is most import for Indian
economy and it is a phase of re-invention in-line with the change in policy
adopted by the central government generally referred as Liberalization-
Privatization-Globalization (LPG).

Sweeping reforms were carried out in financial markets and new financial
instruments viz Reverse Repo, Derivatives, Securitization, Reverse
Mortgages and others were introduced.

Impact of LPG on financial Institutions

a) There was a quantum jump in the Indian companies buying overseas

assets / takeover of foreign companies like TATA Steel‘s acquisition of
Corus (UK), Tata Motors’s acquisition of Daewoo Motors (Trucking
Unit) in South Korea, Tata Motor’s acquisition of JLR
b) Private Sector Banks were given licences in a big manner and few of the
banks which were in public sector were made private like ICICI bank,
HDFC bank and many more
c) Stock markets suddenly started gaining higher values in sensitive index.
NSE was set up and made very powerful intermediary for facilitation
share market trading (Currently NSE handles around 90% of trading in
Cash Segment and 99% in F & O)
d) Rating agencies were given specific instructions to conduct rating
activities
e) Mutual Fund business has seen newer highs post 1990
f) SEBI was made as the market regulator for the capital markets in India.
New Takeover code known as Substantial Acquisition of Shares and
Takeover Act was passed by Government.
g) Government initiative towards Disinvestments (Divestment) and there
were separate ministries to conduct disinvestment. The objective was to
 reduce the fiscal deficit and increase government spending on welfare /
developmental activities
h) Beginning of the Derivatives trading in India (Stock markets started
giving the facility in the F&O trading)
i) Private participation in large infrastructural constructions
j) Sweeping reforms in the Airline industry (few of them were backed by
Financial Institutions)
k) Introduction of new instruments like Repos by RBI

Functions of Financial Markets

The most important function of financial markets is to transfer capital or
funds from those people and institutions which have surplus of it with those
who need it. The important functions of financial markets are given below:

a. Provision of Liquidity: Liquidity refers to cash or money and other

financial assets, which can be readily converted into cash without any
significant loss of time and value.

b. Mobilization of savings: By transferring the small and large savings of

individuals as well as corporations, financial markets speed-up consumption
and investment.

c. National growth: In contributes to national growth by ensuring an

unaffected flow of surplus funds to deficit units.

d. Financial Support to Entrepreneurs: By providing capital to set up the

new projects of ventures through venture capital, the financial markets
supports the budding entrepreneurs.
 e. Industrial development: Financial markets helps in accelerated growth of
Industrial and economic development.

Other functions of Financial Markets

a. Enhancement of income: By investing in financial instruments like Term

Deposits, interest can be earned on otherwise idle surplus cash. Similarly, by
investing in shares, dividends can be earned. Thus, financial markets provide
an opportunity for enhancement of income

b. Capital formation: The twin act of savings and investment clubbed

together is known as capital formation. Since financial markets helps in
transfer of funds from surplus areas to consumption (investment) areas, it
helps in capital formation

c. Price determination: The price of traded funds is decided by the financial

markets

d. Sale Mechanism: The financial markets lay down clearly the code of
conduct under which the funds would be traded thus it devises the sale
mechanism

e. Information dissemination: One of the functions of financial markets is

proper dissemination of information so that the prospective investors may
make an informed decision.

Class Quiz
Largest producer of Gold in the world (To be verified as on July 19, 2021)
1. China
2. USA / South Africa
3. Russia
4. Ghana
Answer: China
Unit Description Duration
(Hours)
2 ❖ Financial Regulators: 05
❖ Reserve Bank of India (RBI)
❖ Security Exchange Board of India (SEBI)
❖ Insurance Regulatory Development Authority.
❖ Role of Other Institutions like- Association of
Mutual Funds of India, Pension Fund Regulatory
and Development Authority,
❖ National Housing Bank
❖ AMBI (Association of Merchant Bankers of India)

Regulation of Financial Markets

OBJECTIVES OF REGULATION

Regulators act in response to a perceived need for rules. Regulation is

needed when market solutions are insufficient for a variety of reasons.
Understanding the objectives of regulation makes it easier for industry
participants to anticipate and comply with regulation. The broad
objectives of regulation include the following:

1 Protect consumers. Consumers may be able to quickly determine the

quality of clothing or cars, but they may not have the skill or the
information needed to determine the quality of financial products or
services. In the context of the financial services industry, consumers
include borrowers, depositors, and investors. Regulators seek to protect
consumers from abusive and manipulative practices—including fraud—in
financial markets. Regulators may, for instance, prevent investment firms
from selling complex or high-risk investments to individuals.

2 Foster capital formation and economic growth. Financial markets

allocate funds from the suppliers of capital—investors—to the users of
capital, such as companies and governments. The allocation of capital to
productive uses is essential for economic growth. Regulators seek to
ensure healthy financial markets in order to foster economic
development. Regulators also seek to reduce risk in financial markets.

3 Support economic stability. The higher proportion of debt funding used

in the financial services industry, particularly by financial institutions,
and the inter-connections between financial service industry participants
create the risk of a systemic failure—that is, a failure of the entire
financial system, including loss of access to credit and collapse of
financial markets. Regulators thus seek to ensure that companies in the
financial services industry, both individually and as an industry, do not
engage in practices that could disrupt the economy.

4 Ensure fairness. All market participants do not have the same

information. Sellers of financial products might choose not to
communicate negative information about the products they are selling.
Insiders who know more than the rest of the market might trade on their
inside information. These information asymmetries (differences in
available information) can deter investors from investing, thus harming
economic growth. Regulators attempt to deal with these asymmetries by
requiring fair and full disclosure of relevant information on a timely basis
and by enforcing prohibitions on insider trading. Regulators seek to
maintain “fair and orderly” markets in which no participant has an unfair
advantage.
 5 Enhance efficiency. Regulations that standardise documentation or how
to transmit information can enhance economic efficiency by reducing
duplication and confusion. An efficient dispute resolution system can
reduce costs and increase economic efficiency.

6 Improve society. Governments may use regulations to achieve social

objectives. These objectives can include increasing the availability of
credit financing to a specific group, encouraging home ownership, or
increasing national savings rates. Another social objective is to prevent
criminals from using companies in the financial services industry to
transfer money from illegal operations to other, legal activities—a
process known as money laundering. As a consequence of the transfer,
the money becomes “clean”. Regulations help prevent money laundering,
detect criminal activity, and prosecute individuals engaged in illegal
activities

TYPES OF REGULATIONS

Regulations can broadly be classified into 2 categories

1. Rule based Governance

They clearly specify the Dos and Don’ts (Code of Conduct)
In short, a long list of activities which are permitted is released or formulated.
⮚ Most important function of the regulator is to audit and ask compliances
(Reports)
⮚ If the individual / organization do not follows the Dos, they are penalized.

Examples of regulators are RBI, SEBI, IRDA and others.

2. Principle based Governance
Nowhere Dos and Don’ts are specified. In place of Dos and Don’t, the
regulators provide broad framework of Ethical Practices.
The most important feature of this style is the Surveillance
The be benefit is large number of SROs prevalent in these economies. Self-
Regulatory organizations (SROs). They have legal powers
Examples of SROs in India are: ICAI, IMA, CHS, Bar at Law, etc
Quasi SROs in India are: AMFI, AMBI
Examples are SEC (USA). SEC is the equivalent of SEBI of India

If every individual and every company acted ethically, the need for regulation
would be greatly reduced. But the need would not disappear altogether because
regulation does not just seek to prevent undesirable behaviour but also to
establish rules that can guide standards that can be widely adopted within the
investment industry. The existence of recognised and accepted standards is
important to market participants, so trust in the investment industry depends, in
no small measure, on effective regulation. Some important points to remember
include the following:
■ Regulations are rules carrying the force of law that are set and enforced by
government bodies and other entities authorised by government bodies. It is
important that all investment industry participants comply with relevant
regulation. Those that fail to do so face sanctions that can be severe.

■ Financial services and products are highly regulated because a failure or

disruption in the financial services industry, which includes the investment
industry, can have catastrophic consequences for individuals, companies, and
the economy as a whole.

■ Regulation is necessary for many reasons, including to protect consumers; to

foster capital formation and economic growth; to support economic stability; to
promote fair, efficient, and transparent financial markets; and to improve
society.
■ A typical regulatory process involves determination of need by a legal
authority; analysis, including costs and benefits; public consultation on
proposals; adoption and implementation of regulations; monitoring for
compliance; enforcement, including penalties for violations; dispute resolution;
and review of the effectiveness of regulation.

■ Regulation may be principles-based or rules-based and merit-based or

disclosure-based.

■ The types of regulations that have been developed in response to perceived

needs include rules on gatekeeping, operations, disclosure, sales practice,
trading, proxy voting, anti-money-laundering, and business continuity planning.

■ Corporate policies and procedures are rules established by companies to

ensure compliance with applicable laws and regulations, to establish processes
and desired behaviours, and to guide employees.

■ Documentation is important for demonstrating regulatory compliance.

■ Employees’ activities can have negative consequences for managers

(supervisors) and companies. It is vital to make sure that employees are
competent and of good character. They should receive training to ensure that
they are familiar with their regulatory responsibilities, corporate policies and
procedures, and ethical principles. Employees’ behaviour and actions should be
adequately supervised and monitored.

■ Failure to comply with regulation and policies and procedures can have
significant consequences for employees, managers, customers, the firm, the
investment industry, and the economy.

FUNCTIONS OF RBI

Reserve Bank of India (RBI): It the central banker of India. It is entrusted with
the responsibility of managing liquidity in the financial markets. RBI also
auctions G Secs on behalf of governments. The important function of RBI:
Chief functions of RBI
1. Bank of Issue: RBI prints the currency through its subsidiary (Currency
Printing Press) Most of the currency notes are printed at Devas (MP).
Coins are manufactured at various Mints located in the cities of Nasik,
Kolkata
2. Banker to the government: It actions the T-bills, facilitates the transfer of
funds of government
3. Lender of Last Resort (Banker’s Bank)
4. Controller of Credit * : In this function, it controls the money market
hence RBI in India is the regulator of MM. (Explanation) of terms like
Call Money, SLR, CRR, PLR, MCLR etc
5. Controller of Forex in India / Custodian of Forex (hence in this function it
is the regulator of Forex markets)
Other Functions of RBI
1. It carries out the audit of the banks
2. It gives permission to banks for operating in India. Earlier RBI
permission was mandatory for opening branches in Indian by all banks.
Now it is only applicable to Foreign banks.
3. They provide suggestions for ensuring the safety of SDVs and other
vaults of the banks.
4. They provide suggestions for enhancing the efficiency of the banks

* Ensure monetary policies are directed towards broad objectives of economic

growth. Under this function, RBI acts as a regulator of Money Markets in
India. The role of RBI in money markets to control the liquidity in the financial
markets. Liquidity control essentially leads to dear money or tight money policy
of RBI on one hand and Cheap money policy on the other hand. Price stability
leads to control of inflation.
 A brief idea of Inflation

A discussion on economics is always incomplete without touching upon certain

intricately connected factors. One of the most predominant them being inflation.
Eventually everything in economics depends upon the cost and benefits of
various resources available to mankind, the efficient utilisation of which finally
determines the success of all players in the game right from micro level firm
and individuals to global conglomerates and governments.

Inflation is an increase in the price of a basket of goods and services that is

representative of the economy as a whole. The rate at which the price of various
goods and services changes over a period of time reflects the efficiency with
which an economy operates. Inflation is usually associated with growing
economic activity and employment.

For instance, consider that the rate of inflation prevalent in the economy is 5%.
This would mean that at the end of a particular time period, say a year,
something bought at Rs. 10 would cost Rs. 10.50 entailing a reduction in the
purchasing power of rupee. The same Rs. 10 next year would be of a worth
lesser compared to this year.

In fact, inflation also determines the interest rates prevalent in an economy. But
what are interest rates? And why are they relevant in discussion on economics?
Well economics as we know is the study of money. Simply put, money like any
other commodity has its own cost. This cost of money is nothing but interest.
Interest rates are primarily market determined today, but until recently were
regulated by the central banker. This is one factor that has been affecting
performance of the economy very profoundly of late. The cost of money is
lowest in decades and levels not seen before, though they are rising. The lower
interest rates have had a positive impact on many sub-segments of the economy
especially developments in infrastructure which are a vital ingredient of
economic prosperity.

From the above paragraphs, it can be stated that Inflation is a function of Money
Supply and Goods produced in the economy.
I = ∫ (MS, GP)
Where I is inflation, MS is Money Supply in the economy, GP is goods
produced in the economy.

Rate of Inflation

Considering, Inflation as a function of money supply versus the goods

produced in the economy.

Suppose there is a primitive economy which is producing only 4 eggs and

money supply is only Rs 10.
In this situation, the selling price of 1 egg will be
P0 = Rs 10 / 4 = Rs 2.50 per egg
After some time, there is increase in economic activities and also there is
expansion of money supply.
The total goods produced is now 6 eggs and money supply is Rs 18.
The new price of on egg will be
P1 = Rs 18 / 6 = Rs 3.00 per egg
Since, there is an increase in the price of the commodity, hence, we conclude
that there is inflationary pressure on the economy.
The inflation can be calculated as

I = [ (P1 - P0 ) / P0 ] x 100
= [ (3.00 – 2.50) / 2.50] x 100
= 20%

NOTE : Inflation rate has a bearing on rate of interest prevalent in the economy. How?
Inflation Adjusted Returns 🡪 The instruments which bear fixed returns (assured
returns) like ARS bonds, US 64 bonds, FDs do not take into account the rate of
inflation.

Thus, assume that return on you fixed deposit is 6 % while the rate of inflation
is 8%. In this of type of situation your actual return on investment is negative.
In short in spite of the fact that your money is growing but actually its value is
falling.

Discussion on inflation…. Cont.

RBI increases the Credit Rates

Money Supply will reduce
Banks will not have money for loans (Credit)
Purchasing power of people at large will decrease
(Example: Not many people buy Houses and Automobiles with accumulated
savings, Now a days people buy laptops also on loans)
As a result Demand of Industrial and other good will decreases
These products / goods will be lying in the showrooms (And will attract
depreciation). Hence, they will be sold at discount.
This will lead to lowering of the price of these products and a situation in
which value of money will increase and value of goods will decrease.

This is a situation which is reverse of inflation (deflation).

People will have tendency to lower their consumption and start saving more as
interest rates are higher.

As a result, the companies will stop producing which further will lead to
reduction in the manpower.
It will further lead to loss of jobs, and impact will be further lower of demand.
This finally, will end in very low inflation but loss of GDP value and
employment

Fiscal Policies of the Government: It is the excess of planned expenditure in

future over the expected revenue in future. Governments at times print extra
currency.
Fiscal deficit is monetized by printing extra currency. Since extra money is
pumped into the financial markets hence it increases the Money Supply which
leads to Inflation.

Methods of Financial Regulation: Case Study 1

Read the following points carefully about a country which is very different from
other countries of the same region. It is a landlocked country with borders
touching two economies that produce high end products of fashion and
engineering.

a) It has a famous financial institution

b) The stock exchange of the country can be represented through one of
the Arabic numerals and was founded more than one hundred fifty years
 back. It is located in its financial capital and not in the administrative
capital. The market cap of the exchange is $ 1.46 trillion in March 2017
(The market cap of BSE is $ 1.6 trillion).
c) The GDP growth has been projected at 1.5 % for the next few years (from
2018)
d) The market regulator of the country is known as REGULATOR (say R).
There are more than dozen SROs recognized by R. Few of them are: R
-Verein, R - VF, R-VoV and many more.
e) R is independent financial-markets regulator. Its mandate is to supervise
banks, insurance companies, exchanges, securities dealers, collective
investment schemes, and their asset managers and fund management
companies. It also regulates distributors and insurance intermediaries. It
is charged with protecting creditors, investors and policyholders.
f) When R commenced its activities on a new year day, it was given a
greater degree of independence by the parliament of the country.
g) The country’s GDP is approximately $ 500 billion and it occupies a rank
among the top 25 countries of world on the basis of GDP
h) The main industries are – Machinery, chemicals, precision instruments,
banking and insurance and high-end fashion accessories.

Questions:

(i) Identify the country:

(ii) Explain the strength of its financial markets

ALTMASH AZAD
Part A- Switzerland
Part B- because of its rule based corporate governance also because of its tax
rates and high wages
2-International Financial Center, headquarter of international groups and
organizations
Methods of Financial Regulation: Case Study 2
Country A discovered large reserves of Oil in 1970. Since then, its relatively
small population has acquired large sums of wealth. The country is currently
ruled by a military government that has been in place since a coup in 1975.
The overall goal of financial regulation is to create a dynamic market that can
serve as a centre for the region as a whole, and facilitate international
investment opportunities.
The securities industry of County A is regulated by the Executive Committee of
the Stock Exchange (the Committee) the Central Bank of A (the Bank) and the
Ministry of Business Affairs (the Ministry).

THE MINISTRY is responsible for licensing securities market intermediaries

and for the regulation and supervision of the primary market.
THE BANK is responsible for the supervision of Collective Investment
Schemes (CISs).
The market has regained momentum and has grown fast since a crash of 1987
and following the promulgation of the new market law in 1988. THE
COMMITTEE was established in the same year. While the market crash in
1987 resulted in a total loss of investors' confidence and consequently market
dormancy for some time, trust was gradually regained and the market became
active, particularly with the introduction of the Country A On-line Trading
System (OATS) in 1995.

The companies were also allowed to list on the exchange. This development has
activated the market and boosted investors' confidence and trust, In August
2001, the market was opened to all foreign investors, but interest has been
limited and sporadic from Europe and the US.

The regulatory framework is basically concerned with the organization of the

secondary market with less attention given to the primary market and the
securities industry.

The exchange is the only national stock exchange in Country A. It is a

government public entity and operates as a cash market. In 2005, 85 companies
were listed on the exchange. The total volume of traded shares is about 27,834
million.
The regulatory system in Country A does not explicitly and clearly recognize
and organize self-regulation.
There is a basic legal setting, tax system, bankruptcy law, efficient court system,
and accounting framework, within which the securities markets can operate.
Although these are in place, there is still room for improvement.
The need for market awareness and education is obvious and crucial. Such a
need of company directors, managers, investment intermediaries and others
involved in the securities industry can be met by the THE COMMITTEE. The
THE COMMITTEE seeks to implement information and education program for
all securities market participants, however it lacks the funding al1d clear
authority to do so.
The clearing and settlement system prevents to a great extent payment default in
case of the failure of a participant to meet his obligations. Dematerialization of
securities cannot be efficiently and promptly implemented in the absence of a
compelling law. It is expected, therefore, that the risk of delay in securities
delivery would remain high and more so in the event of a bankruptcy of a
clearing member. The plan to establish an investor protection fund (IPF) has so
far not been implemented.
There are no SROs at present in a proper sense. Although the legal framework
does not prohibit self regulation, it does not provide a set of clear rules for this
purpose.
THE COMMITTEE has the power to enforce the relevant laws and regulations
with respect to brokers only and can enforce sanctions (limited to warnings and
revocation of licenses) but not fines. It uses an electronic surveillance system to
detect any irregularities in market prices that might reflect attempts at market
manipulation. Insider trading is not legally prohibited.
....... Best of Luck ........

Answer the following questions on the basis of the above case.

Q 1 : Identify the country giving sufficient reasoning for the selection.
Country: Nigeria and reasons in support of the answer.
Q 2 : List out the important weaknesses in the financial market of Country A.
Q 3 : Why Country A needs a good financial framework?
Q 4 : You have been appointed as the Honorary Economic Advisor to the Head
of the State of Country A. Give the set of recommendations to restructure the
financial markets of country A.

Suggestions:
1. Use the various concepts of financial markets to answer the questions.
2. You can write down the answers in bullet points or in paragraph format.
3. Do not repeat a point / suggestion. All points / suggestions should be distinct
from each other.
4. Use numerical values for lucid illustrations.
 Unit Description Duration
(Hours)
3 Financial Institutions: Development Financial Institutions 05
Banking and Non- Banking Financial Institutions

Commercial Banking System

It acts a catalyst for economic growth. It transfers the surpluses / savings of the
individuals and companies to the areas where funds can be utilized for
developing infrastructure, promoting industrial development etc.
The organized banking system in India can be broadly divided in three
categories – the Central bank, the Commercial banks, and the Co-operative
banks.

RBI

Commercial Banks RRB Co-operative

Banks
Public Sector banks MNC / Pvt. Sector banks

Nationalization of banks : 14 banks were nationalized on 1969, another 6 in

1980.
(SBI was nationalized in 1955): Earlier name was Imperial Bank of India

Reserve Bank of India (RBI) : It is the central bank and regulator of the
banking industry in India. It formulates the ‘monetary policy’ of the nation.
The main objectives of the monetary policy are – (a) speed up economic
development in the country to raise national income and standard of living and
(b) to control and reduce inflationary pressure in the economy.

Bank Rate : It is used as an instrument of RBI’s monetary policy. This is the

rate at which the central bank (RBI) rediscounts the approved bills.
Cash Reserve Ration (CRR) – It is the amount of money which the commercial
banks are required to keep with RBI (The rate is fixed by RBI from time to
time).
Statutory Liquidity Ratio (SLR) - Commercial banks will have to maintain
liquid assets in the form of cash, gold etc equal to not less 25 percent (as fixed
by RBI from time to time) of their total demand and time deposits.
Detailed discussion on MM will be the part of Module 4 under MM
instruments

Merchant banking: They manage and underwrite new issues, they undertake
syndication of credit, they advise corporate clients on fund raising and other
financial aspects, unlike merchant banks abroad, Indian merchant banks do not
undertake banking business viz. deposit banking, lending and foreign
exchange(forex). They also provide consultancy services like formulation and
appraisal of new projects and with regards to marketing of new capital issues
i.e., technical and professional.
Leasing and Hire Purchase companies – Leasing has proved a popular
financing method for acquiring plant and machinery especially for small and
medium sized enterprise. Their growth is due to advantage of speed, informality
and flexibility to suit individual needs.

Mutual Funds – Pooling of the resources of the investors so that the corpus so
aggregated can be reinvested into the capital market as per the scheme
provisions and specifications laid down in the offer document.

Advantages over other Investment Instruments

(i) A large variety of funds to suit the needs the requirement of almost
every individual.
(ii) Chances of capital appreciation are higher than the other investment
instruments
(iii) Investments is made in the capital market through persons (fund
mangers) who have specialized knowledge of the stock market
(iv) Simple entry and exit route
(v) Return on Investment are independent of the rate of inflation

Venture Capital Funds: Venture capital refers to financial investment needed

for the formation and promotion of high-risk entrepreneurial business with
untried ideas and new technologies having a potential for rapid growth. Unlike a
conventional financier that demands collateral and offers loans that must be
repaid, a venture capitalist judges the potential of the firm’s products, plans
chalked out for growth, management strategy to beat competition before
investing the moolah required in return for a percentage. In the USA; George
Doriot created the industry some fifty years ago. Venture capital has given rise
to several large corporations such as Digital. In fact, the entire Silicon Valley is
a testimony to the success of venture capital in the USA. In Indian this concept
was introduced in 1985. The current ‘dotcom’ revolution has attracted venture
capitalists on a large scale. The importance of venture capital companies is to
give commercial support to new ideas and for the introduction and adaptation of
new technologies. There is high degree of risk involved in venture capital
financing.
Other nomenclature of Venture Capital Funds are:

⮚ Angel Funds
⮚ Private Equity (Private Placement – QIP and QIB)
⮚ Seed Capital / Expansion funding
⮚ Crowd Funding
⮚ Peer-to-peer Lending
⮚ Community Based Funding (CBF) – Jain Funding, Islamic funding, other
community based fundings

Other Financial Intermediaries

IL & FS - Setup in 1988, focuses on leasing of equipment and infrastructure

development. The company has been provided a mandate for structuring the
finance of major projects in power and transportation sector.

Credit Rating Agencies:

Credit Rating: In the case of a debenture issue containing Non convertible
portion exceeding 18 months, credit rating by an authorized institution is
compulsory.
CRISIL - Credit Rating Information Services of India Limited, is a credit
rating agency. It undertakes the rating of fixed deposits, convertible and non-
convertible debentures and also credit of assessment companies.
RATINGS
AAA : Highest Safety
AA : High Safety
A : Adequate Safety
BBB : Moderate Safety
BB : Inadequate Safety
B : Risk prone
C : Substantial Risk
 D : Default

ICRA – Investment Information and Credit Rating Agency

CARE – Credit Analysis and Research Ltd.

Custodial Services in India

SHCIL – Stock Holding Corporation of India Limited. – It is sponsored by
seven financial institutions like IDBI, ICICI, UTI, IFCI, LIC, IRBI and GIC.
The principal objective of all corporation is to introduce a book entry system for
the transfer of shares and other type of securities replacing the present system
that involves voluminous paper work. It also provides Custodial services.
Housing Finance Companies – HUDCO, HDFC, NHB etc – They primarily
issue bonds to the public and companies. The money so aggregated is used to
provide loans for the construction of houses and building by individuals and
organizations.

Development Financial Institutions

With the end of the Second World War, there was great urge for speedy
industrial expansion. At the same time, there was also a great need for
modernization and replacement of obsolete machinery in already established
industries. The usual agencies meant to provide finance for large scale
industries were either apathetic or were found in-adequate and hence
government came forward with a series of financial institutions to provide funds
to the large industrial sector.
IFCI (Industrial Finance Corporation of India Limited) – Set up in 1948
with the objective of providing medium to long term credit to industries.
ICICI (Industrial Credit and Investment Corporation of India Limited) –
Setup in 1955 to help industrial growth. It provided underwriting facilities also.
Now, it has been merged with ICICI Bank.
IDBI (Industrial Development Bank of India) – Set up in 1964. It was earlier
a wholly owned subsidiary of RBI, later on in 1976, it became an autonomous
institution. It was designated as apex lending organization in the field of
industrial credit.
UTI (Unit Trust of India) – Unit Trust of India, was set up in 1963, and
commenced business from 01/07/1964. The primary aim of UTI was to
encourage and mobilize savings of the community and channelize them into
productive corporate investments so as to promote growth and diversification of
the country’s economy.

Some other large Financial Institutions are IRBI (Industrial Reconstruction

Bank of India – now called as IIBI), Exim Bank, LIC, GIC, SIDBI, SFC.
In Rural Segment also there are multiple financial institutions like
NABARD, PO, MFIs etc. They are part of Unit 4 and will be discussed
after the completion of Unit 5 and 6.
A brief Idea of Stock Exchanges

Stock Exchanges: The stock exchange is the market where stocks, shares and
other securities are bought and sold. It is the market where the owners may
dispose of their securities as and when they like. In short, a stock exchange is
the central place or organized market where industrial securities /financial
instruments (better known as securities a) are bought and sold under a code of
rules and regulations.

(a) The term securities include stocks, bonds, options and futures.

Stock exchanges and the performance of companies are mentioned through the
stock market indexes. An index is a way to measure the overall performance of
the market.
The important functions of Stock Exchanges are:
1. Protection to investors
2. Promotion of industrial growth
3. Raising long term capital
4. Central convenient place and common platform.
5. Safety and equity in dealings.
6. Continuous Ready and broad market which can provide maximum
liquidity, marketability and price uniformity for securities.
7. Correct evaluation of securities.
8. Economic Barometer.

Utility :-
National utility :- i) Accelerated economic development ii) Optimum and
suitable utilization of source financial resources.

Company utility :- i) Listed companies have greater good will and credit
standing in market. ii) Wider and ready market. iii) Higher bargaining power in
the event of growth.
Investor utility :- i) marketability and liquidity. ii) Security of loan.

At the time of initial listing companies has to fulfil a host of requirements and
subsequently follow the rules and regulations laid down by the stock exchanges
regarding the disclosure of information. This keeps the management under
constant supervision. Second as the prices of securities are publicly quoted, a
company is induced to regulate and improve its performance. It is an indicator
to assess the performance of the corporate sector. Companies doing
extraordinary well usually witness an increase in their prices while loss making
companies sees the decrease in the prices of its shares.

GLOBAL STOCK EXCHANGES AND THEIR INDICES

Given below are some of the important stock exchanges and their indexes.
There are two other important indexes. One of them is Dow Jones Industrial
Average (DJIA). The “Dow”, as it is often called, is the world’s most widely
followed stock market indicator. It is the most popular measurement of stock
market performance for the New York Stock Exchange (NYSE). It comprises of
30 blue chip US stocks. Another index is the Standard & Poor ’s composite
Index of 500 stocks (S&P 500). It is a broad-based measurement of the average
performance of 500 widely held industrial, transportation, financial, and utility
stock that include the stock of companies that are or have been leaders in their
respective industries and are listed on the New York Stock Exchange, the
American stock Exchange and the NASDAQ market system.
NASDAQ is a term that refers to the National Association of Securities Dealers
Automated Quotations system. It is the first electronic exchange and
predominantly registered with it are hi-tech companies. The index at NASDAQ
is NASDAQ Composite Index. NASDAQ (National Association of Security
Dealers Automated Quotations) is the system adopted by wall street to map
stocks. The NASDAQ system allows brokers to deal over a computer terminal
at a great speed; with the result that the market now responds to whatever is
happening in the World’s financial markets at a much swifter pace than ever
before. Located in New York’s Time Square, it is an electronic stock exchange,
which flashes the stocks indices of technology driven and net based companies
on its giant size electronic bill board, the largest of its kind. NASDAQ has some
functional resemblance to the OTCEI.

Wall Street: Wall Street is the financial district of New York and has been the
second organized stock exchange since 1792.

NOTE: In India, the Bombay stock exchange (BSE) is the premier stock
exchange. Its index is the Sensex or the Bombay stock exchange Sensitive
index. It is composed of 30 of the largest and most actively traded stocks on the
BSE. S & P CNX Nifty is the index of the National Stock Exchange (NSE). It is
a well diversified 50 stock index accounting for 23 sectors of the economy and
is owned and managed by India Index Services and products Ltd. (IISL), a joint
venture between NSE and CRISIL.

Global Sensitive Indexes

Stock Exchanges Index
 Canada TSE 300 Index
France CAC – 40
Germany Xetra DAX
Hong Kong Hang Seng Stock Exchange
London Stock Financial Times Stock Exchange (FTSE) 100
Exchange
Singapore Straits Times Industrial Index (STI)
South Korea Korea Kopsi 200 Index
Tokyo Stock Nikkei 225
Exchange
New York Dow (DJIA)

National Stock Exchange (NSE) – It was set in November 1992 by IDBI, UTI
and other financial institutions. NSE commenced operations in wholesale debt
segment (WDM) in June 1994. The WDM is concerned with trading in
government securities, Treasury bills, PSU bonds, CDs CPs and corporate
debentures. The main participants in this market are banks, financial institutes
and large corporate houses.

Important Characteristics

(i) The physical floor is replaced by anonymous computerized order

matching with strict price time priority
(ii) Satellite terminals all over the country
(iii) Not owned by brokers. It is a Limited Liability Company

Over The Counter Exchange of India (OTCEI) – It is promoted by ICICI,

UTI, SBI, GIC, LIC, Canbank Financial Services Ltd etc. It was constituted on
August 23, 1989. The OTC exchange is a ring less, electronic and national
exchange listing entirely new set of companies of small size. Companies with
issued capital from Rs 30 Lakhs to 25 crores can be listed at the exchange.
SEBI (Securities and Exchange board of India) : It is the apex regulatory
body of the capital market. It was set up in 1988 and was given the statutory
recognition in 1992. The main aims of SEBI are

(i) Regulating the business in stock markets and other securities.

(ii) Registering and regulating the working of collective investment schemes
including mutual funds
(iii) Prohibiting fraudulent and unfair trade practices relating to securities
markets.
(iv) Regulating substantial acquisition of shares and takeovers of companies.
(v) Prohibiting insider trading in securities (When any sensitive
information which may influence the price of a scrip is procured or
used from sources other than normal course of information output
for unscrupulous inducement of volatility or personal profits, it is
called insider trading)

Digital Library by Government of India

Government of India has created National Digital Library for students for all
subjects.

Below is the link:

Ndl.iitkgp.ac.in

It contains 4 crore 60 lakhs books on this portal

Class Quiz
Largest producer of Diamonds the world (To be verified as on July 19, 2021)
1. Russia (Name of the company: Alros, listed in Moscow SE)
2. Botswana
 3. Congo (Leopoldville)
4. South Africa
Answer: Russia

Unit Description Duration

(Hours)
4 This unit will be discussed after Unit 5 & 6.

Duration
(Hours)
Unit Description
Unit5 & 6 Merged together for Classroom Discussion
5 Financial Markets: Capital and Money, Debt and Equity, 05
Primary and Secondary, Role of Markets, Anomalies,
Bubbles etc
 6 Financial Instruments: Equity, Debts & Derivatives: Plain 05
Vanilla to exotic, risk-hedging instruments.

FINANCIAL MARKETS & INSTRUMENTS (Module 5 and 6 have been

combined together)
Money market may be defined as the market for lending and borrowing of
short-term funds.
Organized Sector of the Indian Money Market

Sub-markets Participating Institutions

Instruments

Call Money Market - RBI - Treasury bills

Treasury Bill Market - Banks - Repos
The Repo market - Institutional Investors - Inter bank
Call money
MMMF - Mutual Funds - bills

Indian Money Market has two seasons:

⮚ Busy Season: October to April
⮚ Slack Season: May to September

Money Market Instruments (MMI)

MM: It is market in which funds are traded for a period of maximum 1 year. In
other words, the life of these instruments does not go beyond 365 days. Few of
the instruments of MM:
a. Call Money
b. Treasury Bills (TB)
 c. Commercial Paper (CP)
d. Certificate of Deposits (CD)
e. Liquid Funds
f. LAF
g. Other Instruments like Banker’s cheques, DDs and other such instruments
which are covered under the category of NI Act.

Benefits of MM Instruments

1. More liquid than capital market instruments

2. Easy to enter or exit
3. Less Risk as investment horizon is shorter
4. On Demand Deposits are also available

Call Money
It is an inter-bank transaction in majority of the cases however, call money is
transacted between a commercial bank and a financial institution which is not a
banking organization. Call Money market operates for a period of maximum 14
days or fortnight. All the players are primarily banks.
Current Call Money rate is 2% approximately (Saturday, September 12,
2020)
Call money rate is the interest rate on the loans banks make to brokerage firms
that are borrowing to fund transactions in their clients' margins accounts.
Sometimes the call money rate is also called the "broker loan rate," and it is a
rate that is generally not available to individuals. The call money rate is a cost
brokerage firms pay to finance margin accounts or trade for their own accounts.
Because call loans are unsecured and callable, they are in some ways riskier
than other loans, but they also provide short-term liquidity to the financial
markets.

There few organizations in the Call MM which are not banking institutions but
they operate in Call MM.
⮚ Examples DFHI: Discount and Finance House of India (They are not
allowed to act as banker however they operate in Call MM both as
Lender and Borrowers)
 ⮚ Insurance and Mutual Fund Companies are allowed to operate in Call
MM only as Lenders
⮚ Pension Funds (NPS) and Provident Fund Organizations (EPFO) are not
allowed to operate as borrower. However, they can operate as lender.

NOTE: What is the difference between Call Money, Notice Money and
Term Money?
❖ Call Money: When money is transacted for only 1 day
❖ Notice Money: When money is transacted for a period between 2 days to
14 days
❖ Term Money: When money is transacted for a period of more than 15
days but less than one year.

Problems in the Call MM

1. At times the rates were very high. It reached to the level 65% and it
created a problem for the genuine institutions in need of money at
extremely short period of time.
2. Wide fluctuations in the Call M rates
3. Call Money rates are considered as most sensitive part of the economy
and hence it needs to be monitored, however, call Money rates cannot be
decided by regulator.
Committee were set up in the Call MM
1. Sukhumoy Chakraborty Committee
2. Vaghul Committee Report
On the suggestions of Vaghual Committee, govt had set up a financial
institution

DFHI

Why Insurance Companies get maximum amount of funds between Jan to Mar
every year in India?
Ans: Most of the people keep an eye on the tax benefits that insurance policies
provide them. Under 80 C of Income Tax Act, the policy holder holders can
claim tax benefits.
People tend to invest in the tax saving schemes more between January to March
as March 31, happens to the cut-off date of claiming benefits for any financial
year.
Hence, most of the insurance companies have loads of funds between Jan to
March. They put it in Call MM and afterwards decide where to invest them.

Questions:
Call money rates can be used to understand the current market (financial
market) or economic conditions of any country. How?
Answer:
a) Low call money rates signify the lower volume of transaction by the
financial institutions in the extremely short interval of time. It can be
lower requirement of cash by the banks.
b) The lower amount of cash at short notices may lead to lesser purchasing
power in the hands of large section of society who are at the bottom of
the pyramid.
c) Since the Indian Economy is not fully utilizing the digital platforms
hence cash is an important medium of exchange of goods and services.
d) Higher levels of cash transacted has a positive impact of low-end
products thereby indirectly increasing the GDP
e) The low call money rates does indicate lower economic activity and
possibly indicate that economy is in recession.

TREASURY BILLS
Treasury Bills – In India Treasury bills are short term liability of Central
Government. Theoretically Treasury bills should be issued for meeting
temporary deficits of the government arising due to excess expenditure over
revenue at some point of time. Except for RBI there are no major holders of
Treasury bills.
There are 4 types of T bills
T – 14 (7 * 2)
T – 91 (7 * 13)
T – 182 (7 * 26)
T – 364 (7 * 75)

T is abbreviated form of Treasury bills

- Is separator
Number mentioned is the number of days to maturity of the T Bills
SLR: between 18 to 20%
Illustration 1:
For example, if PNB has corpus of Rs 500 000 Cr. Approximately, how much
amount of money they need to put in securities which are highly liquid for the
maintenance of SLR (Assume SLR as 20%)
SLR = 20% of Rs 500000
= Rs 1 Lakh Cr
If one Treasury bill (T – 364) is traded for a value of Rs 1000 Crores, how many
TB, they need to buy?
No. of bills for PNB = 100
Generally, the SLR requirement of the commercial banks are fulfilled by the
purchase of TB

Illustration 2: The corpus of PNB has fallen to Rs 4 Lakh Cr. How many TBs
now they need to hold?
New requirement = 80
The excess of 20 TBs can be sold and the money received by the bank can be
utilized for disbursal of loans at a higher rate of interest than receivable from
TBs.
For Example, if TBs is providing return of 8%, PNB can disburse loan at 10%.
It will increase their fee-based earning.
T- 14
T – 14 is primarily the T bill of Call MM. Governments issue them only to
manage temporary liquidity issues in the financial markets.
a) To suck out liquidity due to too much of money lying in the Current
Accounts
b) High amount of money with the PF, PPF, EPFO, Insurance companies.

T -91
It is having a life span of 3 months. A span of 3 months is taken as a quarter.
There are 4 quarters Q1 to Q4, hence any short-term liability can be fulfilled by
issuing bills for one quarter.
a) Three months period is considered as one season. Hence to meet the
seasonal requirements of capital, these bills are issued.
b) Hence, companies also get more or less funds depending upon the season.
T -182
The period of six months is considered as half a year and hence it is expected
that individuals as well as organizations will devote some time to look back in
the timeline to assess the current situation and possibly the way forward.
Hence, many a times, organizations have surplus of money and simultaneously,
governments assess that they are falling back on certain projects due to lack of
capital.
a) Governments infuse capital in ongoing projects by issuing bills
b) The excess liquidity can be sucked out.
c) Banks can also buy T bills to meet their SLR requirements
T -364
Most important instrument among various Treasury bills. It has the maximum
possible life ie., nearly one year. T – 364 is considered as very important
instrument for the commercial banks because they maintain their SLR
requirements by investing in this bill. All financial institutions keep on tracking
the yield of T-364 because it acts as the base rate for all fixed income securities
in India:
a) It is considered as Risk Free Rate of Return (Rf) in India.
b) The Yield of T – 364 is taken as Rf in India.
c) T-364 are valued by commercial banks to manage their SLR
 CALCULATION OF YIELD OF T-BILLS
Treasury bills are very important instruments in the hands of the governments.
They are primarily Government Securities (G-secs). The instruments of G-Sec
markets are known as Gilt Edged funds
T bills are tradable in nature, it means they can be bought and sold by the
holder. However, issuer (RBI) promises to pay the value of the bill on the date
of maturity. The financial institutions they buy and sell T bills on the rate which
is quoted for any particular day. The rate varies marginally based upon demand
and supply of T bills.
The benefits of holding T bills is calculated by a term ‘Yield’
FV – IP 364
Y = ----------- x --------- x 100
IP n

Question
Q 1: Find out the yield of Treasury bill with the help of following information:
❖ It is a Discounted market instrument issued by Central Banker at a price
of 96.2125
❖ T-Bill is expected to mature on 31 March 2020
❖ Floated in the market as on 01/10/2019

100 – 96.2125 364

Y = ---------------------- x -------------- x 100
96.2125 182 *

Issue date = 01 / 10 2019

*Calculation
Oct 19 = 31
Nov 19 = 30
Dec 19 = 31
Jan 20 = 31
Feb 20 = 29
Mar 20 = 31
-------------
182
-------------
n = 182
Y = 7.87%
Question 2
Find out the Yield of T – 182 issued today at a discounted price of 94.3434
Answer : 11.99% (DIVYANSH)

Q 3: Find out the yield of Treasury bill with the help of following information:

❖ It is a Discounted market instrument issued by Central Banker at a price

of 95.9999
❖ T-Bill expected to mature on 31 March 2019
❖ Floated in the market on 25/10/2018

Answer: 9.66 %
Certificate of Deposits (CD)
CDs are issued by financial institutions. They are used to meet short term need
of finance and carry generally a higher rate of return than fixed deposits.
Features
a) They are instruments of Money Market
b) They carry fixed rate of interest
c) They are instruments of discount market (However, they can be issued at
par).
d) Their benefits are calculated through a concept known as Annual
Percentage Rate (APR)
 e) Most of the Credit Card bills follow the concept of CD return for the
issuer (Card issuer bank or institution)
f) They are issued by Financial Institutions when they face liquidity crisis
on short term basis

Differences between FD and CDs

Features FD CD
Returns On the basis of On the basis of APR
Interest rate
Horizon Any duration is Not more than one
possible (however, year
upper limit rarely
exceeds 10 years)
Tradability Non-tradable Tradable
Collateral Not required They can be Asset
backed securities
Amount of investment Not mentioned Based upon the
prospectus
Non-Negotiable Yes NO
Tax Benefits Available on long Not Available
term FDs (5 years)

Calculations of benefits of CDs

As stated earlier the benefits are known as APR
Calculation of Return on the FDs
Q1: Calculate the maturity value of Rs 1000 after 5 years invested in FD with
the applicable rate of interest of 8% p.a.
Ans: A = P (1 + r/100)n
The above formula is used in mathematics and known ad Compound Interest
(CI) formula.
However, in the world of finance, the notations used are slightly different
P1 = Future value of money [receivable after a period of time (t= 1)] = A
P0 = Money in hand [t present time, i.e., time (t = 0)] = P
R= rate of interest (here it is replaced with ‘i’)

New formula will be

P1 = P0 (1 + i)n
P1 = 1000 ( 1 + 0.08)5
= 1469.32

Q2: What will be the maturity value of Rs 1000 invested in FD with

compounding on half yearly basis. Data of earlier question to be used.
Answer:
P1 = 1000 ( 1 + 0.04)10
= 1480.24
Answers by Pranav

Q3: With reference to the data of Q1 above, calculate the maturity value of FD,
if compounding happens on quarterly basis:
Answer:
P1 = 1000 (1+0.02)20
= 1485.94
Question Amount Rate of Maturity Compounding
 Interest Value
1 1000 8% 1469.32 Yearly
2 1000 8% 1480.24 Half Yearly
3 1000 8% 1485.94 Quarterly

Theorem: Compounding more number of times increases

interest on interest

Calculation of APR for CDs

The upper limit of CDs are only 12 months (or 365 days), hence their returns
are calculated on the basis of compounding period.

Q4: Calculate the APR (Annual Percentage Rate) of a CD having the following
details:
Amount = 1000
Rate = 12% p.a.
CD maturity date: 12 months
Compounding = quarterly
P1 = P0 (1 + i)n
= 1000 (1+0.03)4
= 1125.20
P1 - P0
Rate of Change (RoC) = ------------ x 100
P0

APR is the Rate of Change (RoC)

APR = [( 1125.20 – 1000 )/ 1000 ] * 100
12.52%
Q2: A credit card company has a system of generating monthly statements. At
the time of generation of monthly statements, the entire amount which remains
unpaid attracts interest. The credit card company charges 3% interest on unpaid
amount in each statement. The Credit card company claims that the annual
interest payment will be 36%. Find out whether their claim is genuine or not?

Answer:

Assuming that credit card holder has unpaid balance of Rs 1000 in the monthly
statements.

P0 = 1000

i = 3% = 0.03

n = 12

P1 = P0 (1 + i)n

P1 = 1000 (1 + 0.03)12

= 1000 (1.425)

= 1425

P1 - P 0

APR = ------------ x 100

P0

APR = [(1425 – 1000) / 1000] * 100

42.50%

NOTE: Assume that there are 10 lakh credit card holders of any Bank
(Issuer) and average unpaid amount is Rs 10000.
The interest income for the bank will be

= 1000 000 * 100 00 * 12 * 0.4250

= 1000 000 * 12 * 4250

= 510 Cr

Q3: UNSOLVED (Practice question)

There are 3 CDs floating in the market. All these 3 CDs have different maturity
period and different rate of interest. The details are given below:

Details CDA CDB CDC

Maturity 1 year 1 year 1 year
Rate of Interest 10.20 10.30 10.40

in % p.a.
Compounding Half Yearly Quarterly Monthly

Identify which CD is best for the investor.

[HINT: The higher is the APR, the better will be the CD for the investor]

UNSOLVED (Practice question): SOLUTION

There are 3 CDs floating in the market. All these 3 CDs have different maturity
period and different rate of interest. The details are given below:

Details CDA CDB CDC

Maturity 1 year 1 year 1 year
Rate of Interest 10.20 10.30 10.40
in % p.a.
Compounding Half Yearly Quarterly Monthly

Identify which CD is best for the investor.

Solution:

We need to identify the best CD from the perspective of Investor.

Assume Rs 1000 has been invested by the investor.

For CDA

P1 = 1000 ( 1 + 0.0510)2

= 1104.601

APR = [(1104.601 – 1000) / 1000] * 100

= 10.46%

Commercial Papers (CPs)

They are issued to manage the short-term liabilities of industrial corporations

generally manufacturing companies. They try to manage the immediate
requirement of capital for day to day running of the business. In short, to
manage the gap between the working capital requirements and cash at hand,
these companies issue CPs
In general, there can be a requirement cash (capital) on urgent basis. These
requirements are fulfilled by issuing Commercial papers. Few of the features of
commercial papers are:

a) They are generally issued at discount and mature at par value

b) Their yield is calculated for the period of issue and maturity
c) They can be transferred
d) Manufacturing companies generally issue CPs
e) They are also used to meet the seasonal requirement of capital.
f) CPs do have issuance expenses and mostly it is handled by third party
(Banking Institutions)
g) They are subject to stamp duty and other local taxes

Calculation of Yield of CPs.

They use the same formula that has been used in calculation of Yield of T Bills
except for the fact that in place of number of day to maturity, it used number of
months to maturity.

The benefits of holding T bills is calculated by a term ‘Yield’

FV – IP 12

Y = ----------- x --------- x 100

IP n

Y = Yield

FV = par value of the CP

IP = The issue price of the CP

n = no of months to maturity.
Q 1: What will be the yield of a CP based upon the information given below:

FV = 10000

IP = 9000

Issue date: July 1, 2020

Maturity date: November 30, 2020

FV – IP 12

Y = ----------- x --------- x 100

IP n

10000 – 9000 12

Y= ----------------- x --------- x 100

9000 5

= 26.66 %

Q 2: There is a manufacturing company which is in need of cash and it issues

CPs. The CPs are issued at a par value of Rs 1 lakhs. The issue price is 93000.

The Issue date is March 1. 2020 and maturity date will be October 31, 2020.

The Issuance expenses are:

Stamp Duty: 0.5% of FV

Incidental charges: 1% of FV.

Find out the total cost of capital (cost of raising funds) for the issuer?

Ans:

Yield = [(100000 – 93000)/93000] * [12/8] * 100

= 11.30 %

Hence, the Cost of capital or cost of borrowing funds will be:

Cost of Capital (CoC) = Yield (going to investors) + All other charges paid to
intermediaries

CoC = 11.30 % + 0.5% + 1.0% = 12.80 %

Q: Which financial instrument recovers interest component before principal.

Answer: Housing Loans

In the initial few months, up to 90% of repayment is only for interest

component, thereafter, the interest component reduces to 75% and principal
component to 25%.

With further passage of time, interest component and principal become 50 fifty.

Towards the last few months, only principal remains as entire interest amounts
already gets recovered.

Commercial papers are good instruments for industrial companies or

manufacturers for meeting the short-term requirement of capital be it seasonal
or for any other reason.
Cost of capital basics

A person borrows Rs 10000 from another person. After one year, what will be
his payment if rate of interest is 10%

P1 = 10000 (1+ 0.10)1

= 11000

RoC = [(11000 -10000)/ 10000] * 100 = 10%

In the above situation, the amount received by the borrower has to be repaid
with interest the time of repayment. As a result, the borrower has to pay Rs
11000 with includes both principal and interest component.

Calculations are very simple and based upon the formula of Future value of
money.

Cost of capital means the cost of borrowing the funds. Herein case, it is
10%.

In another situation, the lender had deducted Rs 1000 upfront (at the time of
disbursal) of credit. Hence, the borrower receives only Rs 9000. The maturity
payment will be Rs 10000 only because the interest component has already been
taken by the lender.

RoC = [ (10000 – 9000) / 9000] * 100

= 11.11 %

In this case, the cost of borrowing (cost of capital) is higher.

Hence, the cost of capital refers to the overall burden in percentage

to the borrower.
 Liquid funds

Liquid funds are those funds which are equivalent to cash. It means that they
can be readily convertible into cash with minimum possible loss of time and
value.

Liquid funds are special type of mutual fund schemes which seeks
investment from those people who want to convert cash into a mutual fund
investment and vice-versa at short notices.

Liquid funds are considered to very good investment tools in the hands of those
people who transact businesses on high frequency dealing in payment and
receipts on instantaneous basis.

The most liquid asset is considered as CASH.

Gold is also considered as highly liquid asset.

Measurement of liquidity of an asset is carried out by two important factors:

⮚ Loss of Time
⮚ Loss of Value

Value (Loss)

DEBENTURES

BONDS
 GOLD

CASH

Time (Loss)

NOTE: Liquid Funds are also known as Money Market Mutual Funds
(MMMF).

MMMF – Introduced and regulated by RBI initially. From March 7, 2000 they
were brought under the purview of SEBI. The objective of the scheme was to
provide an additional short-term avenue to the individual investors.

Examples: Aditya Birla Liquid Fund

DSP Liquid Fund

Features:

(a) They are highly liquid in the sense that the money can be redeemed in
one day’s time (maximum 48 hours)
(b) Few of the liquid funds offer even cheque writing facility.
(c) Liquid funds are those funds who invest their corpus in the MM
instruments
(d) The NAV (Net Asset Value) of all the Liquid funds keeps on increasing
with passage of time. Hence any investor of these funds will not have risk
of losing capital at any point of time.

LAF (Liquidity Adjustment Facility)

NOTE: What is liquidity in the financial system and how it is different
from liquidity of assets?

Liquidity of Assets: It refers to the loss that a person has to undergo while
converting the asset into cash. In other words, liquidity means how quicky an
asset can be converted into cash. The delay leads to loss of time and value.
Hence, highly liquid assets are readily convertible into cash without much loss
of value and time. The most liquid asset is CASH. There is practically not loss
of time and value.

Liquidity of Financial System:

Liquidity in the financial system is considered as equivalent to the concept of

Momentum (as studied in the branch of Study of Physics)

Momentum = mass x velocity

Momentum in Physics means how much will be the impact of any moving
body or anything that is in motion. It is considered that higher is the velocity,
the more will be the impact. Also, higher will be the mass, the more will be the
impact. Hence, mass and velocity put together decides the real impact.

Similarly, in the financial markets, liquidity actually means momentum. It

future means that how much impact the currency of the country is creating in
the financial system.

Hence Mass = Value of the Currency (Denomination like 2000, 500, 100 etc)
Velocity = number of hands it changes (example, revenue earned by Cos, Salary
distributed, Expenditure incurred, more demand will be created and hence
companies will earn more revenue)

Liquidity in financial System = Denomination x no of hands currency

changes

Illustration

A currency notes of Rs 2000 changes hands 4 time. The liquidity in the system
will be

L = 2000 x 4 = 8000

Liquidity in the financial markets keeps on changing, sometimes, it is high and

sometimes, it is low. RBI as a central banker in India continuously monitors the
liquidity situation and adjusts it.

This adjustment of liquidity is known as LAF.

LAF has two instruments – Repo and Reverse Repo

Repo-Market – Repo is a money market instrument which helps in collaterised

short-term borrowing and lending through sale / purchase operations in debt
instruments. Under a repo transaction, securities are sold by their holder to an
investor with an agreement to repurchase them at a predetermined rate and date

Repo Transaction: It is a transaction between two financial institutions to buy

back the security at predetermined rate and date.
In India, it is generally, the RBI and the banks. The RBI disburses the money to
the banks and banks sign a contract for returning the money on a set date with
applicable rate of interest. Hence, when in need of funds the banks (or other
financial institutions) they borrow from RBI. This transaction is known as Repo

Repo = Repurchase Agreement.

Money (or Funds)

RBI Banks or Financial

Institutions.

Contract to repay of a set date with interest

Reverse Repo: Reverse of Repurchase Agreement.

It is the mirror image of the Repo transaction and in a Rev Repo, the banks park
their excess of funds to RBI and RBI pays them interest on the maturity of the
contract.

Hence, both repo and reverse repo are used by RBI to infuse liquidity or reduce
liquidity in the financial markets.

Illustration
When there is very high liquidity in the system, RBI increase the Reverse Repo
Rate, as a result the banks find it lucrative to park the money with RBI than to
disburse it to the customers.

However, when the liquidity in the financial system is low, RBI reduces the
Repo rate so that banks and other financial institutions they can borrow money
from RBI. The banks in turn start lending more to the customers, as a result,
there will be more liquidity in the financial markets, it further leads to demand
creation and economic growth increases.

The current Repo rate is 4.00 % (September 29, 2020)

The current Reverse Repo rate is 3.35 % (September 29, 2020)

NOTE: Any reasons why Reverse Repo rate is lower than Repo rate

Since, RBI has to pay interest on Reverse Repo hence, they keep reverse repo at
a lower value so that banks cannot borrow from RBI and put it back to RBI.

Other Instruments of RBI

❖ SLR
❖ CRR
❖ Bank Rate
❖ PLR

Few more instruments of Financial markets

❖ MCLR (mostly used by FIs)

❖ LIBOR and MIBOR
❖ MSF
❖ CBLO
 ❖ 4 Cs of Credit

SLR: Statutory Liquidity Ratio

The current SLR rate is 18.50 % (September 29, 2020)

It is the minimum amount of corpus (total funds) of commercial banks that

needs to be kept in highly liquid assets so that it can be converted back at
shortest possible time. The most preferred instrument of SLR by banks is T
bills.

Statutory liquidity ratio refers to the amount that the commercial banks require
to maintain in the form of gold or government approved securities before
providing credit to the customers.  Statutory Liquidity Ratio is determined and
maintained by the Reserve Bank of India in order to control the expansion of
bank credit. The maximum limit of SLR is 40% and minimum limit of SLR is
23% In India.

The main objectives for maintaining the SLR ratio are the following:

a. To control the expansion of bank credit. By changing the level of SLR, the
Reserve Bank of India can increase or decrease bank credit expansion.

b. To ensure the solvency of commercial banks.

c. To compel the commercial banks to invest in government securities like

government bonds.

SLR rate = (liquid assets / (demand + time liabilities)) × 100%

Current SLR is 18.5%.

 Cash Reserve Ratio (CRR)

CRR is the minimum rate that is applied to the corpus of banks. All the banks
are under obligation to keep this minimum amount with RBI. RBI does not pay
any interest on this amount.

The amount lies in an account held by all banks with RBI.

RBI uses this amount for providing guarantee to all the customers that if bank
default, they will be paid Rs 10000 maximum on their liquid assets and Rs 1
lakhs for the FDs provided FD amount is more than 1 Lakhs. In case amount is
less than 1 lakhs, the entire amount will be paid.

Main objectives of cash reserve ratio:

a. Cash reserve ratio ensures that a part of the bank’s deposit is with the Central
Bank and is hence, safe

b. The second and a very important reason is for the purpose of combating
inflation. To keep the liquidity in check, the RBI resorts to increasing and
decreasing the Cash Reserve Ratio

RBI uses CRR to regulate the money supply, level of inflation and liquidity in
the country. The higher the CRR, the lower is the liquidity with the banks and
vice-versa.
 Broad Perspectives on SLR and CRR

a) Both these instruments are used by RBI to control liquidity in the

financial markets
b) CRR deposits totally goes beyond the control of banks however SLR
deposits can be invested in T Bills for earning benefits.
c) Both these instruments are used to control the inflationary pressure on the
economy.
d) It decides the sensitiveness of credit rates which are used by different
Financial Institutions for transacting business in funds.

Bank Rate (BR)

Bank rate is the rate at which the Central Banker of any country re-discounts the
approved bills of exchange.

Bank Rate (BR) is a major monetary policy instrument of the RBI. BR is the
rate at which the RBI rediscounts the approved bills of exchange. Effectively, it
is also the rate at which the central bank gives loans to the commercial banks.
BR affects both the cost and availability of credit. It is by through the Bank Rate
that the RBI influences the overall interest rate in the economy. A bank rate is
the interest rate at which a nation's central bank lends money to domestic banks,
often in the form of very short-term loans. Lower bank rates can help to expand
the economy by lowering the cost of funds for borrowers, and higher bank rates
help to reign in the economy when inflation is higher than desired.
Example:

Assume there is a transaction between two banks say Dena bank and SBI bank.

Dena bank borrows Rs 10 Cr from SBI for a period of 4 months. The rate of
interest charged by RBI on this transaction is 9% p.a.

However, on the date of maturity, Dena bank fails to honour its commitment of
repayment of capital with interest.

SBI approaches RBI for settlement of the bill. RBI says that they will definitely
pay the amount by deducting it from the deposit of Dena bank kept in RBI,
however, they have a standard policy of payment of interest @6% on all such
re-discounted bills.

Here, it needs to be mentioned that, if Dena bank had repaid the money with
interest to SBI, then the transaction was discounting of bill. However, if RBI
pays the money to SBI, the transaction will be re-discounting of bill of
exchange.

The rate of interest applied by RBI is known as ‘Bank Rate’ for all such
rediscounted instruments.

In common language, Bank rate is the rate at which RBI lends money to
commercial banks.

PLR (Prime Lending Rate)

It is the rate at which banks lends money to their customers. The financial
institutions may charge different rate of interest to different persons or entities
based upon their credit history and other financial records.
PLR is the standardized rate of interest that is charged by any Financial
Institution (FI) while disbursal of loans. However, it may vary from case to case
and in general there can be a variation of ±1 %.

If a person does not have good credit history, the FIs tend to charge additional
rate of interest to cover their risk. However, it is a double-edged sword because
of the reason that if a person is not able to repay past loans at a rate of interest
(say 10%), it will be difficult for the same person to bear the extra rate of
interest. Hence, loans disbursed above and below PLR are riskier than the
lending on PLR.

The lending below PLR is known as sub-prime lending. In 2008 – 2009, there
was a big financial crisis in the world that had arisen from USA and impacted
all the countries of the world. One of the reasons of the above crisis was Sub
Prime lending. Later on it was called as SUB PRIME CRISIS

Credit history can be known by the CIBIL (Credit Information Bureau India
Limited) scores. They maintain credit history by keeping a record of all
transactions carried out.

Minimum and Maximum score can be: Generally, it remains between 300 to
850.

Credit score of -1 indicates:

Credit Information Bureau India Limited (CIBIL) Score

The CIBIL score in the range of 750 to 800 is considered as very good. Majority
of the FIs will be interested in disbursal of loans to people having score in the
above range.
 MCLR (Marginal Cost of funds-based Lending Rate)

Base rate

Base rate is the minimum interest rate at which a bank can lend. More than that,
base rate is the standard interest rate for each bank. Base rate is modified by
introducing MCLR in the determination of base rate. The base rate may differ
from one bank to the other. But the following four components usually
determine the base rate of particular bank. These components are:

a) Cost for the funds (interest rate given for deposits),

b) Operating expenses,

c)Minimum rate of return (profit), and

d)Cost for the CRR (for the four percent CRR, the RBI is not giving any interest
to the banks)

Current Base rate ranges between %- %. ( / / 2021)

MCLR is the most widely practiced method of deciding about the rate of
interest to be charged to the borrowers.
Marginal Cost of Funds based Lending Rate (MCLR) is the minimum interest
rate, below which a bank is not permitted to lend. The RBI introduced the base
rate system in the year 2010. This was a replacement to the Prime Lending Rate
(PLR) system. The base rate is the minimum rate of interest that is fixed by all
banks. The base rate sought to ensure that banks do not lend to customers below
a certain benchmark. The RBI also wanted to make sure that any changes in
interest rate policy were handed down to borrowers. But the transmission of
interest rates was not effective in the base rate system. Even if the RBI cut the
repo rate, banks did not always follow suit. They did not pass on the full benefit
to the customer. Or, there was a big-time delay, which defeated the goal of the
rate cut. To improve the process, the MCLR system came into play in April
2016.

Banks and other FIs, they continuously receive deposits from the investors. All
these investors, they demand rate of interest prevailing at the time of their
deposit. Hence, if there is continuous increase in the rate of interest, the
depositor’s expectation will be higher. For example,

Year 1 2 3 4 5
RoI 6% 7% 8% 9% 10%
Amount 10 Cr 10 Cr 10 Cr 10 Cr 10 Cr
Int Amt 60 L 70 L 80 L 90 L 100 L
Year 5 is the Current Year
Question 1: If a borrower approaches the bank and seeks loan of Rs 50 Cr, what
will be rate of interest that the bank needs to charge to the borrower.

Answer: The banks calculate the rate of interest by using the concept of
marginal cost of funds.
Marginal Cost of Funds is the weighted average of all the deposits w.r.t their
rate of interest. For example.

10 10 10 10 10
Marginal Cost = ---- x 6% + ----- x 7% + ------ x 8% + ------ x 9% + ---- x 10%
50 50 50 50 50

10
= ------ ( 6% + 7% + 8% + 9% 10%)
 50

= (1 / 5) x 40
= 8%
Assuming that the bank has an operating expenditure of 1% and they expect
interest earning of 2%. The MCLR will be

MCLR = Marginal Cost of funds + Operating Expenditure + Interest Earnings

Thus, MCLR = 8% + 1% + 2+ = 11%

Question:2
Year 1 2 3 4 5
RoI 10% 9% 8.5% 8% 6.5%
Amount 520 Cr 455 Cr 315 Cr 200 Cr 110 Cr
Int Amt
Year 5 is the Current Year
A borrower has approached the bank which has the above shown deposits
aggregated in past 5 years. There is a general tendency of interest rate in the
financial markets to decline. The borrower is seeking funds from the bank for
Rs 1600 crores. The banks have operating expenditure of 1.5% and the
expectation of interest earning is 2%.

Find out the MCLR and comment on the results.

Answer:
Marginal Cost of Funds is the weighted average of all the deposits w.r.t their
rate of interest.

520 455 315 200 110

Marginal Cost = ---- x 10% + ----- x9% + ---- x8.5% +----- x 8% + ---- x 6.5%
1600 1600 1600 1600 1600
1
= ------ ( 52 + 40.95 + 26.775 + 16+ 7.15)
1600
= (1 / 1600) x 142.875
= 0.089
= 8.9%
MCLR = Marginal Cost of funds + Operating Expenditure + Interest Earnings
Thus, MCLR = 8.9% + 1.5% + 2+ = 12.9%

Question: 3 (PRATICE QUESTION)

Year 1 2 3 4 5
RoI 10% 9% 8.5% 8% 6.5%
Amount 110 Cr 200 Cr 315 Cr 455 Cr 520 Cr
Int Amt
Year 5 is the Current Year
A borrower has approached the bank which has the above shown deposits
aggregated in past 5 years. There is a general tendency of interest rate in the
financial markets to decline. The borrower is seeking funds from the bank for
Rs 1600 crores. The banks have operating expenditure of 1.5% and the
expectation of interest earning is 2%.

Find out the MCLR and comment on the results.

Answer:
MIBOR (Mumbai Interbank Offer rate)
Mumbai Inter-Bank Offer Rate (MIBOR) is one iteration of an interbank rate,
which is the rate of interest charged by a bank on a short-term loan to another
bank. Banks borrow and lend money to one another on the interbank market in
order to maintain appropriate, legal liquidity levels, and meet reserve
requirements placed on them by regulators. Interbank rates are made available
only to the largest and most creditworthy financial institutions. The Mumbai
Interbank Offered Rate (MIBOR) is calculated everyday by the National Stock
Exchange of India (NSEIL) as a weighted average of lending rates of a group of
banks, on funds lent to first-class borrowers.

Current MIBOR is: ( / / 2021)

LIBOR (London Interbank Offer rate)

LIBOR is a benchmark rate that represents the interest rate at which banks offer
to lend funds to one another in the international interbank market for short-term
loans. LIBOR is an average value of the interest-rate which is calculated from
estimates submitted by the leading global banks on a daily basis. It stands for
London Interbank Offered Rate and serves as the first step to calculating interest
rates on various loans throughout the world.

Libor Rates (USD) Latest Wk ago High Low

Libor Overnight 2.18475 2.17188 2.18475 1.18250

Libor 1 Week 2.21988 2.22606 2.23494 1.43475

Libor 1 Month 2.44013 2.38325 2.44013 1.47703

Libor 2 Month 2.58494 2.54275 2.58494 1.52182

Libor 3 Month 2.77750 2.76575 2.77900 1.58849

Libor 6 Month 2.89225 2.89113 2.89638 1.75575

Libor 1 Year 3.10125 3.12575 3.14413 2.03856

Marginal Standing Facility of RBI

Definition: Marginal standing facility (MSF) is a window for banks to borrow

from the Reserve Bank of India in an emergency situation when inter-bank
liquidity dries up completely.
Description: Banks borrow from the central bank by pledging government
securities at a rate higher than the repo rate under liquidity adjustment facility or
LAF in short. The MSF rate is pegged 100 basis points or a percentage point
above the repo rate. Under MSF, banks can borrow funds up to one percentage
of their net demand and time liabilities (NDTL).

The RBI has deployed a number of liquidity support measures for banks to
ensure that there will be enough liquidity in the banking system. Most popular
of these measures is the ‘work horse’ liquidity support arrangement called repo.
Under repo, loan is provided for just one day and hence it is an overnight
facility. Another feature of repo is that there should be eligible securities with
the bank to avail money from the RBI by pledging them. Eligible securities are
first class securities (including government bonds, T Bills etc) held by a bank
over the SLR requirement. This means that the securities held by a bank above
19.5% (SLR as on 14th of November 2017) of its liabilities (deposits) can be
pledged by the bank with the RBI to avail funds.
What is Marginal Standing Facility?
 Marginal Standing Facility is a liquidity support arrangement provided by RBI
to commercial banks if the latter doesn’t have the required eligible securities
above the SLR limit.

Launch of Marginal Standing Facility (MSF)

The MSF was introduced by the RBI in its monetary policy for 2011-12 after
successfully test firing it from December 2010 onwards.
Under MSF, a bank can borrow one-day loans form the RBI, even if it doesn’t
have any eligible securities excess of its SLR requirement (maintains only the
SLR).  This means that the bank can’t borrow under the repo facility.
In the case of MSF, the bank can borrow up to 1 % (can be changed by the RBI)
below the SLR (means 1% of Net Demand and Time Liabilities or liabilities
simply).
The working of MSF is thus related with SLR. For example, imagine that a
bank has securities holding of just 19.5 % (of NDTL). This is equal to its
mandatory SLR holding. The bank can’t borrow using the repo facility. But as
per the MSF, the bank can borrow 1 % of its liabilities from the RBI.
Sometimes the RBI increases the limit of borrowings to 2% of NDTL. As in the
case of repo, the bank has to mortgage the securities with the RBI.
MSF rate and the Repo rate
But the main condition is that for such borrowings the bank has to give higher
interest rate to the RBI. The interest rate for MSF borrowing was originally set
at one percent higher than the repo rate. As on November 2017, the RBI has
lowered the difference between repo rate and MSF to 0.25%. Repo rate is 6.0%
whereas the MSF rate is 6.25%. Both the MSF rate and Bank rate are equal.
Difference between the Repo rate and the MSF rate can be changed in
accordance with the policy perspective of the RBI. Following are the main
features of the MSF.
1. Eligibility: All Scheduled Commercial Banks having Current Account
and SGL Account with Reserve Bank, Mumbai will be eligible to
participate in the MSF Scheme. 
2. Tenor and Amount: Under the facility, the eligible entities can avail
overnight, up to one per cent of their respective Net Demand and Time
Liabilities (NDTL) outstanding at the end of the second preceding
fortnight.
3. Timing: The Facility will be available on all working days in Mumbai,
excluding Saturdays.
 4. Rate of Interest: The rate of interest on amount availed under this facility
will be 100 basis points above the LAF repo rate, or as decided by
the Reserve Bank from time to time.
5. Discretion to Reserve Bank: The Reserve Bank will reserve the right to
accept or reject partially or fully, the request for funds under this facility.
6. Mechanics of operations: i) The requests will be submitted electronically
in the Negotiated Dealing System (NDS). Eligible members facing
genuine system problem on any specific day, may submit physical
requests in sealed cover in the box provided in the Mumbai Office,
7. Minimum request size: Requests will be received for a minimum amount
of Rs. one crore and in multiples of Rs. one crore thereafter.
8. Eligible Securities: MSF will be undertaken in all SLR-eligible
transferable Government of India (GoI) dated Securities/Treasury Bills
and State Development Loans (SDL).

Difference between MSF and the LAF Repo

Under LAF Repo, banks can borrow from RBI at the Repo rate by pledging
government securities over and above the statutory liquidity requirements. In
the case MSF, banks can borrow funds up to one percentage of their NDTL, at a
rate of one percentage higher than the repo rate. The rate of interest and amount
of borrowing can changed depending upon the monetary policy decisions by the
RBI.

4 C’s of CREDIT

The following paragraphs discusses about the 4 C’s of Credit as a general

overview.
FIRST C is CAPACITY

The Capacity of the business is one of the most important criteria that they need
to know about. The capacity is defined as the ability of the business to make a
payment of the business loan that they take.

Some income documents are collected by the banks so that they can know all
about the ability of the business to pay the money. They will have a look at the
approach that the businesses take for earning money.

Also, they will have a look at the different ways in which they earn money and
also the period of earning as well. Apart from that, there are some other details
about the debt that the businesses take.

SECOND C IS CREDIT

This is another one of the criteria that the banks view when they have to give
the loan to the businesses these days. To know about the credit, the banks will
have to take a look at the credit report that you have, and that report will have
all the details of the credit cards whether it is an open one or a closed one.

There is also some information such as the mortgages and the instalment loans
that they will look at to ascertain the credibility of the business.

Apart from that, there are some details about the balance as well as the current
balance and the payment histories in there so that the banks can have a clear
idea about the mortgage that you tend to take always.

THIRD C IS CAPITAL

Now, this is where they will learn about the cash of the business. The
underwriters who are responsible for providing you with the loans will have a
look at the money of the business and where it is coming from.
They will also need to track records of the savings and the earnings of the
business as well. Apart from that, they will also make sure that whether the
business is capable of making the down payment of the loans and the closing
costs along with the mortgage payment as well.

So, it is needless to say that it is also one of the most important criteria that
people need to think about when they are trying to get a business loan from the
lender.

FOURTH C IS COLLATERAL

Here we have another important criterion that the lender will have to see in
order to ascertain your credit.

The Collateral is specifically considered to be important because it will help in

reviewing the value as well as the condition for the property which is owned by
the business.

When there is an appraiser that is independent, they will assess the property and
the condition that it has and that also includes the information which is
presented from the neighbourhood.

The appraiser will then create a report on the basis of the information which will
be then sent to the lender for reviewing and deciding all about the credit.

Collateralized Borrowing and Lending Operations (CBLO)

Financial Institutions (FIs) often need liquidity or ready case to meet their
needs.

Usually, the repo facility of the RBI gives one day loans to scheduled
commercial bank. Another mechanism is the Call Money Market where FIs can
avail loans from one day a fortnight.

In the same way, quick money or short-term money can be obtained by financial
institutions from the Collateralized Borrowing and Lending Obligations
Markets (CBLO)

CBLO Market

CBLO market is within the Money Market segment operated by Clearing

Corporation of India Limited (CCIL). In the CBLO market, the FIs avail short-
term credit by providing prescribed securities as collateral. The functioning of
CBLO market is similar to Call Money Markets

The uniqueness of CBLO is that lenders and borrowers use collateral for their
activities. For example, borrowers of fund have to provide collateral in the form
of government securities (say T Bills) and lenders will get it while giving loans. 
There is no such need of a collateral under the call money market.

FIs participating in CBLO are entities who have either no access or restricted
access to the inter -bank call money market. Still, institutions active in the call
money market can participate in the CBLO market. Nationalized Banks, Private
Banks, Foreign Banks, Co-operative Banks, Insurance Companies, Mutual
Funds, Primary Dealers, Bank cum Primary Dealers, NBFC, Corporate,
Provident/ Pension Funds etc., are eligible for CBLO membership. These
institutions have to avail a CBLO membership to do activities in the market
CBLO is a discounted instrument available in the electronic book entry form for
the maturity period ranging between one day to one year.

The CCIL provides the Dealing System through Indian Financial Network
(INFINET) and Negotiated Dealing System for participating in the market.

In the CBLO market, members can borrow or lend funds against the collateral
of eligible securities. Eligible securities are Central Government securities
including Treasury Bills, and such other securities as specified by the CCIL.
Borrowers in CBLO have to deposit the required amount of eligible securities
with the CCIL. For trading, the CCIL matches the borrowing and lending orders
(order matching) submitted by the members. Borrowers have to pay interest to
the lenders in accordance with the bid.
DISCUSSION ABOUT INTERNAL COMPONENT OF EVALUATION
(ICA)

All MCQs on the basis of what we have already studied.

Attempt them.

Q1 The funds raised through Treasury bills goes to whom (a) Commercial
Banks (b) State PSUs (c) Government (d) RBI

Q 2: Treasury Bills are traded on: (a) Primary market (b) Secondary market (c)
Commodity market (d) they are non-tradable

Q 3: Treasury Bills are auctioned by ____ on behalf of Government: (a) SEBI

(b) RBI (c) Commercial Banks (d) DFHI

Q4: 91 days Treasury Bills in India are issued on: (a) Weekly Auction Basis (b)
Fortnightly Auction Basis (c) Monthly Auction Basis (d) Seasonal Auction

Q5: When money is borrowed/lent only for ONE day, it is said to be

__________ transaction: (a) Notice Money (b) Call Money (c) Lent Money (d)
dear money

Q 6: When was the first treasury bill issued in India? (a) 1917 (b) 1950 (c)1987
(d) 2013

Objective of the above test: To conduct a test through Online platform for 20
marks.
All will be MCQs. It will be an alternative of viva because viva of 45 students
will be time consuming business. Hence this is the idea.

All of you can discuss among yourself and let me know in my next class.
Time will be 20 minutes and questions will be 20

Capital Market : A business enterprise can raise capital from various source.
Long term funds can be raised either through issue of securities or by borrowing
from certain institutions. Short term funds can also be borrowed from various
agencies. The market which trades the funds for long term is known as Capital
market.

Structure of Capital Market –

(I) Gilt Edged Market - the market of government securities thus both
principal and interest are guaranteed. Since government cannot default
on its payment obligations, the government securities are risk free and
hence it is known as gilt edged which means ‘of the best quality’.

(II) Corporate Securities Market – the market where securities viz. shares,
debentures and bonds issued by the companies are bought and sold. It
 consists of the new issue market (the primary market) and the stock
exchanges (the secondary market)

Primary Market – IPOs of Companies, MFs, Public sectors bonds

Secondary Market – It comprises Stock exchanges, OTCEI, NSE

Capital Market in India

Govt. Securities Industrial Securities Development Financial

Financial
Market Institutions
Intermediaries
(Primary & Secondary) (IFCI, ICICI, IDBI)

Merchant Bankers, Mutual Funds, Leasing Companies, Venture Capital

Companies