FINANCIAL INSTITUTIONS & MARKETS

SHORT NOTES

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

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

Components of the formal financial system

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

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

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

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

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

The producers of these financial services are financial intermediaries, such as, banks, insurance
companies, mutual funds, and stock exchanges.

Interactions Among Financial System Components

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

Functions of a financial system

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

Financial Sector Reforms

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

Pre-Reform Period Issues

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

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

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

Financial Sector Reforms since 1991

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

A. Narsimham Committee on Banking Sector Reforms (I)

 1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR): This was one so
more bank credit was available to the industry, trade and agriculture. SLR was as high as 39%,
while CRR was of 15%. (CRR could be reduced by reduction of monetized budget deficit of
govt., SLR could be reduced by govt. efforts to reduce fiscal deficit and hence its borrowing
requirements)
2. End of Administered Interest Rate Regime: The old regime facilitated the fund allocation to
priority sectors by cross subsidization i.e. concessional rate charged from primary sector and
higher rates from non-concessional borrowers. This system was totally done away with and banks
today having freedom to choose the different interest rates for different lending types.
3. High Capital Adequacy Ratio: To ensure that financial system operates on sound and competitive
basis, prudential norms (a financial regulation requiring financial firm to control risk and hold
adequate capital as defined by capital requirements) with regards to capital adequacy ratio were
introduced. Capital adequacy is the ratio of the paid-up capital and reserves to the bank deposits.
The capital base of Indian banks has been very low and in fact declined over time. (8% capital
adequacy norm was setup)
4. Competitive Financial System: After nationalization of 14 large banks in 1969, no bank had been
allowed to be set up in the private sector. It was however recognized that there was urgent need
for introducing greater competition in the Indian money market which could lead to higher
efficiency of the financial system. Accordingly, private sector banks such as HDFC, Corporation
Bank, ICICI Bank, UTI Bank, IDBI Bank and some others have been set up which led to
substantial contribution to housing finance, car loans and retail credit (credit card), making
possible wider use of plastic money namely Debit and Credit cards. competition has also sought
to be promoted by permitting liberal entry of branches of foreign banks, therefore, CITI Bank,
Standard Chartered Bank, Bank of America, American Express, HSBC Bank  
5. Recovery of Debts: GoI passed the Recovery od Debts due to Banks & Financial Institutions Act
1993, to facilitate and speed up the recovery of debts. Six special recovery tribunals have been set
up.
6. Prudential Norms: Started by RBI in order to impart professionalism in commercial banks. The
purpose of prudential norms includes proper disclosure of income, classification of assets and
provision for Bad debts so as to ensure that the books of commercial banks reflect the accurate
and correct picture of financial position.
7. Other Measures: Banks were enabled to raise capital through public issue, Freedom was given to
open new branches, Local Area Banks were allowed to be setup.

B. Narsimham Committee on Banking Sector Reforms (II): In 1998 the government appointed yet
another committee under the chairmanship of Mr. Narsimham. It is better known as the Banking
Sector Committee. It was told to review the banking reform progress and design a programme for
further strengthening the financial system of India. 
1. Strengthening Banks in India: The committee considered the stronger banking system in the
context of the Current Account Convertibility ‘CAC’. Suggested that banks must be capable of
handling domestic liquidity and exchange rate management and recommended the merger of
strong banks which will have ‘multiplier effect’ on the industry.
2. Narrow Banking: Those days many public sector banks were facing a problem of the
Non-performing assets (NPAs). Some of them had NPAs as high as 20 percent of their assets.
Thereby it recommended ‘Narrow Banking Concept’ where weak banks will be allowed to place
their funds only in the short term and risk-free assets.
3. Capital Adequacy Ratio: Recommended that the Govt. should raise the prescribed capital
adequacy norms. Currently, the capital adequacy ratio for Indian banks is at 9 percent.
 4. Bank ownership: Felt that the government control over the banks in the form of management and
ownership and bank autonomy does not go hand in hand and thus it recommended a review of
functions of boards and enabled them to adopt professional corporate strategy.
5. Review of banking law: The committee considered that there was an urgent need for reviewing
and amending main laws governing Indian Banking Industry like RBI Act, Banking Regulation
Act, State Bank of India Act, Bank Nationalization Act, etc. This up gradation will bring them in
line with the present needs of the banking sector in India.

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

Future Agenda of Reforms

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

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

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

Monetary Policy Committee - LQP

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

Insolvency & Bankruptcy Code 2016 - LQP

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

GST (Short Note)

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

Regulation of Banks, NBFCs & FIs

Banking Regulation Act 1949

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

RBI Act 1934

The Reserve Bank of India Act 1934 is an Act to constitute a Reserve Bank of India (RBI) and provide
the central bank (RBI) with various powers to act as the central bank of India. RBI Act 1934.

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

Role of RBI as a central banker

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

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

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

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

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

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

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

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

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

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

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

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

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

Core banking solution (CBS): Core Banking Solution (CBS) is networking of branches, which enables
Customers to operate their accounts, and avail banking services from any branch of the Bank on CBS
network, regardless of where he maintains his account. The customer is no more the customer of a
Branch. He becomes the Bank’s Customer. It offers invariably all information that a bank's customer
would need if he/she visits a bank branch in person. These are as follows:
o To make enquiries about the balance or debit or credit entries in the account. 
o To obtain cash payment out of his account by tendering a cheque. 
o To deposit a cheque for credit into his account. 
o To deposit cash into the account. 
o To get the statement of account
o To transfer funds from his account to some other account
Internet Banking: Online banking allows a user to conduct financial transactions via the internet.
Online banking is also known as internet banking. Online banking offers customers almost every service
traditionally available through a local branch including deposits, transfers, and online bill payments.
Online banking requires a computer or other device, an internet connection, and a bank or debit card.
Some banks also allow customers to open up new accounts and apply for credit through online banking
portals. Two major electronic payment system for inter-bank fund transfer maintained by RBI are:

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

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

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

NBFC
According to the Reserve Bank of India (Amendment Act) 1997, A Non-Banking Finance Company
means:
(i) A Financial Institution which is a company;
(ii) A non-banking institution which is a company and which has as its principal business the receiving of
deposits under any scheme or arrangement or in any other manner or lending in any manner;
(iii) Such other non-banking institution or class of such institutions as the bank may with the previous
approval of the Central Government specify.

Non-banking finance companies consist mainly of finance companies which carry on hire purchase
finance, housing finance, investment, loan, equipment leasing or mutual benefit financial companies but
do not include insurance companies or stock exchanges or stock-broking companies. They can help to
fulfill the credit needs of both wholesale and retail customers. 

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

Meaning They provide banking services It is government authorized financial

to people without holding Bank intermediary which aim at providing banking
License services to the public.

Regulated under Companies Act 2013 Banking Regulation Act 1949

Demand Deposit Cannot be Accepted Can be Accepted

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

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

Maintenance of Not Required Mandatory

Reserve Ratios

Deposit Insurance Not Available Available

Facility*

Credit Creation NBFC does not create Credit Bank create Credit

Transaction Cannot be provided by NBFC Provided by Bank

Services*

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

Introduction to Financial Markets in India

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

Importance/Role of Financial Markets

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

Features of Indian Financial Markets

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

Financial Markets Types

Financial markets can be broadly classified as below:

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

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

Difference between Primary & Secondary market

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

Debt Market/Bond Market: The debt market, or bond market, is the arena in which investment in loans
are bought and sold. There is no single physical exchange for bonds. Transactions are mostly made
between brokers or large institutions, or by individual investors. Investments in debt securities typically
involve less risk than equity investments and offer a lower potential return on investment. Debt
investments by nature fluctuate less in price than stocks. Even if a company is liquidated, bondholders are
the first to be paid. Bonds are the most common form of debt investment. These are issued by
corporations or by the government to raise capital for their operations and generally carry a fixed interest
rate. Most are unsecured but are issued with a rating by one of several agencies such as Moody's to
indicate the likely integrity of the issuer. (Detailed information in Unit 4)

Factors affecting Financial Markets

There are 4 major forces that affect the financial markets, primarily described as below:
1. Government: Government holds much control over free markets. The fiscal and monetary policies
that governments and central banks put in place have a profound effect on the financial marketplace.
(Monetary – increasing/decreasing interest rates & Fiscal – changing interest rates)
2. International Transactions: The flow of funds between countries effects the strength of a country's
economy and its currency. The more money that is leaving a country, the weaker the country's
economy and currency. The money inflow via export can be reinvested and stimulates the financial
markets within the country.
3. Speculation & Expectation: Consumer, investor and politicians hold different views about where they
think the economy will go in the future which affects their current actions. Sentiment indicators are
used to gauge how certain groups feel about the current economy which can be analyzed and can
create a bias towards the future price rates and trends.
4. Supply & Demand: Prices & rates change with changes in the supply & demand factors which affects
the financial market changes at the very basic level.

Linkages Between Economy and Financial Markets

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

Integration of Indian Financial Markets with Global Financial Markets

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

Primary Market for Corporate Securities in India

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

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

Guidelines related to Green Shoe Option:

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

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

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

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

ASBA (Application Supported by Blocked Amounts)

SEBI launched an alternate payment system for book built public issue in August 2008. ASBA exempts
retail investors from making the full payment & instead lets certain amount facilitate the application till
the completion of the allotment. It contains authorization to block the application money in a bank
account. After 2010 this facility was extended to Right issue also.
Here the ASBA investor must submit an ASBA amount to SCSB (Self-certified syndicate bank) who
blocks the application money in bank account till finalization of allotment. It also uploads the details of
electronic bidding of NSE & BSE. After allotment is finalized, SCSB transfers the amount to issuers
account.

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

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

Corporate Listings:
Listing of Corporate Stocks
Listing means admission of securities on a recognized stock exchange. The securities may be of any
public limited company, Central or State Government or other financial institutions/corporations.

The objectives of listing are mainly to:

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

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

Delisting of Corporate Stocks

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

Venture Capital (VC)

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

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

1. Seed Capital: Investment towards product development, market research, building a team,
developing B-Plan. (Serious risk, Provided by angel investors)
2. Startup Financing: New activity launched. Funding for marketing and product development.
3. Early Stage Financing: Capital provided to initiate commercial manufacturing and sales after
completion of the initial development stage.
4. Expansion Financing: Finance provided to the expansion or growth of the company say increased
production capacity.
5. Replacement Financing: Financing for the purchase of the existing shares from the entrepreneurs.
(Old VC exit and new investor come in prior to IPO)
6. Turnaround Financing: Financing to enterprise that has become unprofitable after launching
commercial production.

Methods/Instruments: VC Financing can be done via the methods described below:

1. Equity Financing: A venture in its initial stage is not able to give timely returns to its investor, for
which equity financing proves beneficial. (Equity for investor is not more than 49%, thereby
ultimate power rests with entrepreneur)
2. Conditional Loan: The ones that do not carry interest and are repayable to the lender in the form
of royalty.
3. Participating Debentures: The interest on participating debentures is payable at three rates: Nil at
Startup phase, Low Rate – Initial operation phase, High Rate – After a particular level of
operations.
4. Convertible Loans: The loans which are convertible into equity when interest on the loan is not
paid within the stipulated period.

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

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

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

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

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

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

Advantage -Provides attractive terms to both -Close relationship with parties

s investors and borrowers
-Facilitates diversification
-Allows risk sharing
-Allows financing of new
technologies
-Provides tailor-made contracts and financial
products
-No free rider problem as private incentives to
gather information are higher

Drawbacks -Prone to instability -Retards innovation & growth (inherent

-Exposure to market risk
-Free rider problem (some individual
consumes more than their share or
pay less than their share of the cost
of shared resource) *
preference for low risk)
-Impedes competition (collude with firm
managers to produce entry barriers)

Country USA Germany

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

Secondary Market in India

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

Functions of Secondary Market

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

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

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

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

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

Comparison between BSE and NSE

Basis BSE NSE
Definition The stock exchange provides a NSE is the leading stock exchange
transparent and systematic mechanism in India, that provides a variety of
for trading in various products (below) services like trading, clearing and
along with clearing, settlement, risk settlement* in equity along with
management services. The S&P BSE products (below). NIFTY
SENSEX comprises of the most actively represents a weighted average of
traded and financially strong Indian the 50 most highly liquid and
companies on BSE. frequently traded Indian companies
listed on NSE.
Year of 1875 1992
Establishment
Position Most ancient stock exchange of Asia Largest stock exchange in India
Products Offered Facilitates trading in equity, currencies, Facilitates trading in equity,
debt instruments, derivatives & MFs currency derivatives, debt and
equity derivative segments
Benchmark Index Sensex (30) NIFTY (50)
M-Cap $2.1 trillion $2.27 trillion
No. of listed 5089 2000
entities
Position in World 10th Largest Stock Exchange 11th Largest Stock Exchange
Index Value 34, 300 (Approx.) 10, 300 (Approx.)

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

Raising Funds in International Markets

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

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

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

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

Indian Stock Indices and their Construction

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

Methodologies for Calculating the Index

Market Capitalization Weighted
1. Full m-cap method: The no. of shares o/s times the market price of the company determines
the stock’s weight in the index (S&P CNX Nifty). Stocks with highest m-cap would have
higher weightage and would be most influential in this type of index.
2. Free float m-cap method: Free-float is the percentage of shares that are freely available for
purchase in the market excluding the stake held by govt./controlling
shareholders/management/ESOP etc. The weight of a stock is based on the free float m-cap
which is less than the total m-cap. (Closely held companies would have lower weightage than
company with high investible shares)
Note; Free-float can be seen superior, as it avoids undue influence of closely held large cap stocks, avoids
multiple counting through cross holding, useful for active fund managers who benchmark returns using
investible index.
(If free float of a accompany is 16% then it is rounded off to higher multiple of 10 i.e. 20% in this case
which is multiplied by full m-cap to arrive at free float cap)

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

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

Classification of Securities to be included in the Index

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

Bulls Markets: Bull markets are characterized by optimism, investor confidence and expectations that
strong results should continue for an extended period of time. It is difficult to predict consistently when
the trends in the market might change. Part of the difficulty is that psychological effects and speculation
may sometimes play a large role in the markets. There is no specific and universal metric used to identify
a bull market. Nonetheless, perhaps the most common definition of a bull market is a situation in
which stock prices rise by 20%, usually after a drop of 20% and before a second 20% decline. Bull
markets generally take place when the economy is strengthening or when it is already strong. They tend to
happen in line with strong gross domestic product (GDP) and a drop in unemployment and will often
coincide with a rise in corporate profits.

Bear Markets: A bear market is a condition in which securities prices fall 20 percent or more from recent
highs amid widespread pessimism and negative investor sentiment. Typically, bear markets are associated
with declines in an overall market or index like the S&P 500, but individual securities or commodities can
be considered to be in a bear market if they experience a decline of 20 percent or more over a sustained
period of time - typically two months or more.
- A secular bear market can last anywhere from 10 to 20 years and is characterized by below
average returns on a sustained basis.
- A cyclical bear market can last anywhere from a few weeks to several years.

Factors influencing the movement of stock markets

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

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

Major Instruments traded in stock markets

Equity Shares & Debentures

(PTO)
 BASIS FOR
SHARES DEBENTURES
COMPARISON

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

What is it? Shares represent the capital Debentures represent the debt of
of the company. the company.

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

known as shareholder. as debenture holder.

Status of Holders Owners Creditors

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

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

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

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

Conversion Shares can never be Debentures can be converted into

converted into debentures. shares.

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

Myths attached to Investing in Stock Markets

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

Trading of securities on a stock exchange

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

Process of Trading Securities

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

Settlement mechanism at BSE & NSE

Compulsory Rolling Settlement Segment (CRS): With effect from December 31, 2001, trading in all
securities takes place in one market segment, viz., Compulsory Rolling Settlement Segment (CRS).
All transactions in all groups of securities (even ‘G’) in the Equity segment and Fixed Income
securities listed on BSE are required to be settled on T+2 basis. A T+2 settlement cycle means that the
final settlement of transactions done on T, i.e., trade day by exchange of and securities between the buyers
and sellers respectively takes place on second business day (excluding Saturdays, Sundays, bank and
Exchange trading holidays) after the trade day. "Z" group or "T" group, are settled only on a gross basis
and the facility of netting of buy and sell transactions in such Securities is not available
Kinds of brokers
1. Commission Broker: Executes orders of their customers by buying and selling securities on the
exchange. Charge a specified commission of the sale value.
2. Floor Brokers: Execute orders for brokers and receive a share in brokerage commission that a
commission broker charges to his client.
3. Jobbers: Professional independent brokers engaged in buying/selling specified securities in their
own name, and quote two-way prices.
4. Odd Lot Dealers: Buy/Sell securities in odd lots at lesser prices.
5. Badliwalas – Financiers who facilitate the carry over business by financing carry over
transactions and earn interest for the amount financed (badla)
6. Arbitrageurs – Keep close watch on price of shares, and buy low, sell high.

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

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

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

Margins (Way of Risk Management)

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

2. MTM (Market to Market Margin): Market to Market loss is calculated by marking each transaction
in security to the closing price of the security at the end of the trading. In case it is not traded on a
particular day, then latest NSE closing price is considered to be its closing prices. MTM is collected
from the member before the start of the trading of the next day.

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

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

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

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

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

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

S&P BSE SENSEX: It is a basket of 30 constituent stocks representing a sample of large, liquid and
representative companies. The base year is taken as 1978-79 with 100 base value. The index operates on a
free-float methodology. The securities in SENSEX are selected on the basis of following criteria:
- Market Capitalization: The security should figure in top 100 companies listed by full m-cap.
Weight of each security based on free-float should be at least 0.5% of the index.
- Trading Frequency: Security should have been traded on each and every day for the last one year.
- Average Daily Trades: The Security should be among the Top 150 companies listed by
average number of trades per day for the last one year.
- Average Daily Turnover: The Security should be among the Top 150 companies listed by average
value of shares traded per day for the last one year.
- Listed History: The Security should have a listing history of at least one year on BSE.

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

Listing means admission of securities to dealings on recognized stock exchanges. The securities may of
company, government, or any other financial institution. The objective of listing is to provide liquidity to
securities, mobilize savings for economic development and protect investor interest via full disclosures.

Eligibility Criteria
- Minimum post issue paid-up capital for the applicant company shall be 10 crores for IPO & 3
crore for FPO
- Minimum issue size shall be 10 crores
- Minimum m-cap shall be 25 crores

Process
1. Company desiring to list their shares are compulsorily required to obtain prior permission of BSE
to use their name in their prospectus and other documents prior to filing the same with ROC.
2. A letter of application must be submitted to all the designated stock exchanges where it wants to
have its securities listed before filing the same with ROC.
3. Within 30 days of the date of closure of the subscription list, a company is required to complete
the allotment of shares and then approach the designated stock exchange for approval of the basis
of allotment
4. Company should then take permission as per SEBI guidelines, while completing all formalities
for trading which are required for all the designated stock exchanges within 7 working days of
finalization of the basis of allotment
5. By 30th April of each financial year, all listed companies are required to pay BSE listing fees as
per the schedule of the listing fees prescribed from time to time
 Unit IV
Money Market
Money market means a market where money or its equivalent can be traded. The market consists of
financial institutions and dealers in money or credit who wish to generate liquidity or manage their
short-term cash needs. Money market is only a part of the financial markets where instruments have high
liquidity and very short-term maturities are traded. Due to highly liquid nature of securities and their
short-term maturities, money market is treated as a safe place. Hence money market is a market where
short-term obligations such as T-bills, commercial papers and banker’s acceptances are bought and sold.

Benefits & Functions of Money Market (MM)

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

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

MM Instruments: Investment in money market is done through money market instruments, which meet
the short-term needs of the borrowers and provide liquidity to the lenders.

Call Money/Notice Money Markets (CMM)

i. CMM is a market where overnight loans can be availed by banks to meet its liquidity. Banks
who seek liquidity approach the call market as borrower and the ones having excess liquidity
participate there as lenders.
ii. Banks can access CMM (Mon-Fri) to meet their CRR/SLR requirement. The call money is
usually availed for one day, if the bank needs funds for more days it can be availed through
notice market where loan is provided from 2-14 days.
iii. Participants: Scheduled Commercial Banks, Co-operative Banks, Primary Dealers (who buy
govt. securities directly from the government, thus acting as market maker of g-sec)
iv. Loans are availed through auction/negotiation. The auction is made on interest rate where
highest bidder (highest interest rate) can avail the loan. Dealing in call money is done through
Negotiated Dealing System (NDS)
v. Higher Call Rate (avg. int. rate) indicates liquid stress in economy which RBI may follow up
with liquidity support measures like cutting CRR, or allowing more repos.
Treasury Bill Markets
i. T-Bills are one of the safest money market instruments, are short term borrowing instruments of
the central government of the country issued through RBI. It is a promise to pay a said sum after
a specified period.
ii. T-Bills are short-term securities and mature in one year or less (91, 182, 364 days) from their
issue date
iii. They are zero risk instruments and hence the returns are not so attractive. It is available in
primary & secondary markets.
iv. T-Bills are issued at a price less than their face value (par value) and bear a promise to pay the
full-face value on maturity. The difference between the purchase price and the maturity value is
the interest income earned by the purchaser of the instrument.
v. T-Bills are issued through a bidding process at auctions which can be prepared competitively or
non-competitively.
vi. T-Bill auctions are held on a Negotiated Dealing System (NDS) and the members electronically
submit their bids on the system,
vii. RBI issues these instruments to absorb liquidity from the market by contract the money supply,
in banking terms this is called Reverse Repurchase (Reverse Repo), and when RBI purchases
back these instruments at a specified date mentioned at the time of transaction, liquidity is
infused in the market. This is called Repurchase transaction (Repo).

Commercial Paper (CP)

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

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

Certificate of Deposit (CD)

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

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

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

Role of STCI & DFHI in money market

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

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

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

Debt Market: Introduction and meaning

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

Debt Markets are primarily classified into:

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

Advantages: The returns are assured and almost risk free, although certain risks exist in corporate, FI,
PSU instruments yet help can be taken from credit agencies who rate those instruments. Also, the Indian
Debt market is highly liquid, with banks offering easy loans to investors against g-sec’s,
Disadvantages: As the return is almost risk free, they are not as high as equity market returns. Retail
participation is also lower in debt markets, due to issues related to liquidity and price discovery as the
retail debt market is not quite developed.

Debt Market Instruments

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

Types of Risk related to Debt Securities

1. Default Risk: This can be defined as the risk that an issuer of a bond may be unable to make
timely payment of interest or principal on a debt security
2. Interest Rate Risk: can be defined as the risk emerging from an adverse change in the interest rate
prevalent in the market so as to affect the yield on the existing instruments. (Say interest rates
have risen, and investors’ money is locked at lower rates)
3. Reinvestment Rate Risk: can be defined as the probability of a fall in the interest rate resulting in
a lack of options to invest the interest received at regular intervals at higher rates at comparable
rates in the market.
Note:
- G-Sec accounts for 90-95% of the daily trading volumes while State Govt. Securities and T-Bills
account for 3-4% of the daily trading volumes.
- RBI regulates and facilitates the government bonds and other securities on behalf of the
governments, while SEBI regulates the corporate bonds, both PSU & Private Sector

Secondary Debt Market

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

Issuance process of G-Secs

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

Method of auction: There are two methods of auction which are followed-
In a Uniform Price auction, all the successful bidders are required to pay for the allotted quantity of
securities at the same rate, i.e., at the auction cut-off rate, irrespective of the rate quoted by them. On the
other hand, in a Multiple Price auction, the successful bidders are required to pay for the allotted
quantity of securities at the respective price / yield at which they have bid.

Other Technicalities of an Auction:

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

Corporate Debt Market

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

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

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

Why Corporate Debt Market is not as popular as Equity Market

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

Before investing in debt markets, it is important for investor to check the following details:
1. Coupon (or discount in case of zero-coupon bonds) and the frequency of interest payments.
2. Timing of cash flows: whether at one single point or different points of time
3. Information about issuer and credit rating: background, business operation, financial position,
credit rating issued by major rating agencies
4. Other terms of issue such as secured/unsecured nature of bond, assets underlying the security,
credit worthiness etc.
Note: LAF was already described in Unit 1. Additional info is stated as below:
The operations of LAF are conducted by way of repurchase agreements (repos and reverse repos) with
RBI being the counter-party to all the transactions. Repo or repurchase option is a collaterised lending i.e.
banks borrow money from Reserve bank of India to meet short term needs by selling securities to RBI
with an agreement to repurchase the same at predetermined rate and date. The rate charged by RBI for
this transaction is called the repo rate. Repo operations therefore inject liquidity into the system. Reverse
repo operation is when RBI borrows money from banks by lending securities. The interest rate paid by
RBI is in this case is called the reverse repo rate. Reverse repo operation therefore absorbs the liquidity in
the system.
The collateral used for repo and reverse repo operations comprise of primarily Government of India
securities. In fact, Reverse Repos and Repos can be undertaken in all SLR-eligible transferable
Government of India dated Securities/Treasury Bills.

Ways & Means Advances: The Reserve Bank of India gives temporary loan facilities to the center and
state governments as a banker to government. This temporary loan facility is called Ways and Means
Advances (WMA). The WMA scheme was designed to meet temporary mismatches in the receipts and
payments of the government. This facility can be availed by the government if it needs immediate cash
from the RBI. The WMA is to be vacated after 90 days. Interest rate for WMA is currently charged at the
repo rate. The limits for WMA are mutually decided by the RBI and the Government of India. Reserve
Bank of India (RBI) in consultation with the government of India has set the limits for Ways and Means
Advances (WMA) for the first half of the financial year 2019-20 (April 2019 to September 2019) at Rs
75000 crore. Under the WMA scheme for the State Governments, there are two types of WMA – Special
(against collateral of G-Sec) and Normal WMA (based on 3-year average of actual revenue and capex of
the state)

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

Written Notes Available at:

https://drive.google.com/open?id=1L4snpBRW5JggU_xO7coEnoG6U6wkWhDL

“EGOTISM = ALTRUISM”