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Unit-3 Financial Markets
Unit-3 Financial Markets
Financial Market
Financial Market refers to a marketplace, where creation and trading of financial assets or
securities, such as shares, debentures, bonds, derivatives, currencies, etc. take place. It plays a
crucial role in allocating limited resources, in the country‟s economy. It acts as an
intermediary between the savers and investors by mobilizing funds between them.
The financial market provides a platform to the buyers and sellers, to meet, for trading assets
at a price determined by the demand and supply forces.
1. By Nature of Claim
Debt Market: The market where fixed claims or debt instruments, such as debentures or
bonds are bought and sold between investors.
Equity Market: Equity market is a market wherein the investors deal in equity instruments. It
is the market for residual claims.
2. By Maturity of Claim
Money Market: The market where monetary assets such as commercial paper, certificate of
deposits, treasury bills, etc. which mature within a year, are traded is called money market. It
is the market for short-term funds. No such market exist physically; the transactions are
performed over a virtual network, i.e. fax, internet or phone.
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Capital Market: The market where medium and long term financial assets are traded in the
capital market. It is divided into two types:
Primary Market: A financial market, wherein the company listed on an exchange, for the first
time, issues new security or already listed company brings the fresh issue.
3. By Timing of Delivery
Cash Market: The market where the transaction between buyers and sellers are settled in real-
time.
Futures Market: Futures market is one where the delivery or settlement of commodities takes
place at a future specified date.
4. By Organizational Structure
Exchange-Traded Market: A financial market, which has a centralised organisation with the
standardised procedure.
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Money Market
The money market is a market for short term funds which deals in monetary assets whose
period of maturity is upto one year.
Money market is a tool that manages the lending of short term funds (less than one year). It is
a subdivision of the financial market in which financial instrument with high liquidity and
very short maturities are traded. It is an important part of the financial system that helps in
fulfilling the short term and very short term requirements of the companies, banks, financial
institution, government agencies and so forth.
The main participants of money market are Government of different countries, Central Banks
of different countries, Private and Public Banks, Mutual Funds Institutions, Insurance
Companies, Non-Banking Financial Institutions, RBI and Commercial Banks.
l. Treasury Bills: They are issued by the RBI on behalf of the Central Government to meet
its short-term requirement of funds. They are issued at a price which is lower than their face
value and arc repaid at par. They are available for a minimum amount of Rs.25000 and in
multiples thereof. They are also known as Zero Coupon Bonds. They are negotiable
instruments i.e. they are freely transferable.
2. Commercial Paper: It is a short term unsecured promissory note issued by large credit
worthy companies to raise short term funds at lower rates of interest than market rates. They
are negotiable instruments transferable by endorsement and delivery with a fixed maturity
period of 15 days to one year.
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3. Call Money: It is short term finance repayable on demand, with a maturity period of one
day to 15 days, used for interbank transactions. Call Money is a method by which banks
borrow from each other to be able to maintain the cash reserve ratio as per RBI. The interest
rate paid on call money loans is known as the call rate.
5. Commercial Bill: It is a bill of exchange used to finance the working capital requirements
of business firms. A seller of the goods draws the bill on the buyer when goods are sold on
credit. When the bill is accepted by the buyer it becomes marketable instrument and is called
a trade bill. These bills can be discounted with a bank if the seller needs funds before the bill
maturity
Treasury Bills, also known as T-bills are the short-term money market instrument, issued
by the central bank (RBI in India) on behalf of the government to curb temporary
liquidity shortfalls.
It is a kind of promissory note that the government issues. The government has many short-
term obligations to fulfill. For instance, it needs to focus on reducing the country‟s fiscal
deficit and regulating the total currency in circulation. For these objectives, the government
needs short-term funds. So, the RBI issues T-bills on behalf of the government in India.
Treasury bills do not pay any interest to the holder. Instead, they are issued at a discount
initially and redeemed at par. This means they are redeemed at their nominal value. So, T-
bills offer a profit when they are redeemed. However, since they do not pay any interest, they
carry zero-coupon rates.
Depending on the tenure for which they are issued, treasury bills in India can be any one of
three types.
The maturity of these T-bills is 91 days. These securities are also auctioned every week, and
they are issued in multiples of Rs. 25,000.
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182-day treasury bills:
These T-bills mature 182 days after their issue date. They are auctioned every other week and
are sold in multiples of Rs. 25,000.
364-day treasury bills mature 364 days after issue, and they are also auctioned every other
week. The issue is made in multiples of Rs. 25,000.
Other types:
Ordinary Bill: These are issued to the public and the RBI for enabling the government to
meet the needs of supplementary short term finance.
Ad hoc TBs: The instrument of Ad hoc treasury and the system of issuing it were introduced
in india in 1937. ad hocs are always issued in favour of RBI only . They are purchased by
RBI on the top and RBI is authorized to issue currency note against them.They are
marketable ,sell them to RBI back.ad hoc serve govt in following ways:
They replenish the cash balance of Central Govt.The central govt raise finance
through ad hocs.
They also provide an investment medium for investing temporary surplus of state
govt ,semi govt departments and foreign central banks.
1. Form: Treasury bills can be issued in a physical form as a promissory note or dematerialized
form by crediting to SGL account (Subsidiary General Ledger Account).
2. Minimum Bid Amount: Treasury bills are issued at a minimum price of Rs.25000 and in the
same multiples thereof.
3. Issue Price: Treasury bills are issued at a discounted price. However, they are redeemed at
par value at the time of maturity.
4. Eligibility: Individuals, companies, firms, banks, trust, insurance companies, provident fund,
state government and financial institutions are eligible to purchase T-bills.
5. Highly Liquid: Treasury bills are highly liquid negotiable instruments. They are available in
both financial markets, i.e. primary and secondary market.
6. Auction Method: The 91 day T-bill follows a uniform auction method, whereas, 364 day T-
bill follows a multiple auction method.
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7. Issued By: T-bills are the short-term money market instrument, issued by the central
bank on behalf of the government
8. Zero Risk: The yields are assured. Hence, they have zero risks of default.
9. Day Count: For treasury bills, the day count is 364 days in a year.
The RBI holds day‟s treasury bills (TBs) and they are issued on top basis throughout the
week. However, 364 days TBs are sold through auction which is conducted once in a
fortnight. The date of auction and the last date of submission of tenders are notified by the
RBI through a press release. Investors can submit more than one bid also. On the next
working day of the date auction, the accepted bids with prices are displayed. The successful
bidders have to collect letters of acceptance from the RBI and deposit the same along with
cheque for the amount due on RBI within 24 hours of the announcement of auction results.
Institutional investors like commercial banks, DFHI, STCI, etc, maintain a subsidiary
General Ledger (SGL) account with the RBI. Purchases and sales of TBs are automatically
recorded in this account invests who do not have SGL account can purchase and sell TBs
though DFHI. The DFHI does this function on behalf of investors with the helps of SGL
transfer forms. The DFHI is actively participating in the auctions of TBs. It is playing a
significant role in the secondary market also by quoting daily buying and selling rates. It also
gives buy-back and sell-back facilities for period‟s upto 14 days at an agreed rate of interest
to institutional investors. The establishment of the DFHI has imported greater liquidity in the
TB market.
Through many participants are there, in actual practice, this market is in the hands at the
banking sector. It accounts for nearly 90 % of the annual sale of TBs.
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Importance of Treasury Bills:
1. Safety: Investments in TBs are highly safe since the payment of interest and repayment of
principal are assured by the Government. They carry zero default risk since they are issued by
the RBI for and on behalf of the Central Government.
2. Liquidity: Investments in TBs are also highly liquid because they can be converted into cash
at any time at the option of the inverts. The DFHI announces daily buying and selling rates
for TBs. They can be discounted with the RBI and further refinance facility is available from
the RBI against TBs. Hence there is a market for TBs.
3. Ideal Short-Term Investment: Idle cash can be profitably invested for a very short period in
TBs. TBs is available on top throughout the week at specified rates. Financial institutions can
employ their surplus funds on any day. The yield on TBs is also assured.
4. Ideal Fund Management: TBs are available on top as well through periodical auctions.
They are also available in the secondary market. Fund managers of financial institutions build
portfolio of TBs in such a way that the dates of maturities of TBs may be matched with the
dates of payment on their liabilities like deposits of short term maturities. Thus, TBs help
financial manager‟s it manage the funds effectively and profitably.
5. Statutory Liquidity Requirement: As per the RBI directives, commercial banks have to
maintain SLR (Statutory Liquidity Ratio) and for measuring this ratio investments in TBs are
taken into account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR
(Cash Reserve Ratio). TBs are very helpful. They can be readily converted into cash and
thereby CRR can be maintained.
6. Source of Short-Term Funds: The Government can raise short-term funds for meeting its
temporary budget deficits through the issue of TBs. It is a source of cheap finance to the
Government since the discount rates are very low.
7. Non-Inflationary Monetary Tool: TBs enable the Central Government to support its
monetary policy in the economy. For instance excess liquidity, if any, in the economy can be
absorbed through the issue of TBs. Moreover, TBs are subscribed by investors other than the
RBI. Hence they cannot be mentioned and their issue does not lead to any inflationary
pressure at all.
8. Hedging Facility: TBs can be used as a hedge against heavy interest rate fluctuations in the
call loan market. When the call rates are very high, money can be raised quickly against TBs
and invested in the call money market and vice versa. TBs can be used in ready forward
transitions.
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Drawbacks of Treasury Bills:
1. Poor Yield: The yield form TBs is the lowest. Long term Government securities fetch more
interest and hence subscriptions for TBs are on the decline in recent times.
2. Absence of Competitive Bids: Though TBs are sold through auction in order to ensure
market rates for the investors, in actual practice, competitive bids are competitive bids are
conspicuously absent. The RBI is compelled to accept these non-competitive bids. Hence
adequate return is not available. It makes TBs unpopular.
3. Absence of Active Trading: Generally, the investors hold TBs till maturity and they do not
come for circulation. Hence, active trading in TBs is adversely affected.
2. COMMERCIAL PAPER
Definition
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Who can issue Commercial Paper (CP)
1. Highly rated corporate borrowers, primary dealers (PDs) and satellite dealers (SDs) and
all-India financial institutions (FIs) which have been permitted to raise resources through
money market instruments under the umbrella limit fixed by Reserve Bank of India are
eligible to issue CP.
2. A company shall be eligible to issue CP provided - (a) the tangible net worth of the
company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working
capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore
and (c) the borrowal account of the company is classified as a Standard Asset by the
financing bank/s.
Rating Requirement
All eligible participants should obtain the credit rating for issuance of Commercial Paper,
from either the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment
Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and
Research Ltd. (CARE) or the Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India) or
such other credit rating agency as may be specified by the Reserve Bank of India from time
to time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or such
equivalent rating by other agencies. Further, the participants shall ensure at the time of
issuance of CP that the rating so obtained is current and has not fallen due for review.
Maturity
CP can be issued for maturities between a minimum of 15 days and a maximum upto one
year from the date of issue. If the maturity date is a holiday, the company would be liable to
make payment on the immediate preceding working day.
Denominations
1. Simplicity: The advantage of commercial paper lies in its simplicity. It involves hardly any
documentation between the issuer and investor.
2. Flexibility: The issuer can issue commercial paper with the maturities tailored to match the
cash flow of the company.
3. Easy To Raise Long Term Capital: The companies which are able to raise funds through
commercial paper become better known in the financial world and are thereby placed in a
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more favorable position for rising such long them capital as they may, form time to time, as
require. Thus there is in inbuilt incentive for companies to remain financially strong.
4. High Returns: The commercial paper provides investors with higher returns than they could
get from the banking system.
Introduction
Most banks have to maintain some minimum cash balance as per the instructions of the RBI,
known as the cash reserve ratio (CRR). This ratio changes from time to time as per the
liquidity in the economy. So banks sometimes borrow money from each other for a short
duration to maintain their CRR. This is known as the call money market. The interest rate on
such call money is known as the call rate.
Meaning
The call money market refers to the market for extremely short period loans; say one day to
fourteen days. These loans are repayable on demand at the option of either the lender or the
borrower.
The money that is lent for one day in this market is known as “Call Money”, and
If it exceeds one day but less than 15 days it is referred to as “Notice Money”.
Term Money refers to Money lent for 15 days or more in the Inter Bank Market.
These loans are given to brokers and dealers in stock exchange. Similarly, banks with
„surplus‟ lend to other banks with „deficit funds‟ in the call money market. Thus, it provides
an equilibrating mechanism for evening out short term surpluses and deficits. Moreover,
commercial banks can quickly borrow from the call market to meet their statutory liquidity
requirements. They can also maximize their profits easily by investing their surplus funds in
the call market during the period when call rates are high and volatile.
1. Call money is an instrument for ultra-short period management of funds and is easily
reversible.
2. It is primarily a “telephone” market and is therefore, administratively convenient to manage
for both borrowers and lender.
3. Being an instrument of liability management, it provides incremental funds and adds to the
size of balance sheet of banks.
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Operations in Call Market
Borrowers and lenders in a call market contact each other over telephone. Hence, it is
basically over-the-telephone market. After negotiations over the phone, the borrowers and
lenders arrive at a deal specifying the amount of loan and the rate of interest. After the deal is
over, the lender issues FBL cheque in favour of the borrower. The borrower is turn issues call
money borrowing receipt. When the loan is repaid with interest, the lender returns the lender
the duly discharges receipt.
Instead of negotiating the deal directly, it can be routed through the Discount and Finance
House of India (DFHI), the borrowers and lenders inform the DFHI about their fund
requirement and availability at a specified rate of interest. Once the deal is confirmed, the
Deal settlement advice is lender and receives RBI cheque for the money borrowed. The
reverse is taking place in the case of landings by the DFHI. The duly discharged call deposit
receipt is surrendered at the time of settlement. Call loans can be renewed on the back of the
deposit receipt by the borrower
1. To commercial banks to meet large payments, large remittances to maintain liquidity with the
RBI and so on.
2. To the stock brokers and speculators to deal in stock exchanges and bullion markets.
3. To the bill market for meeting matures bills.
4. To the Discount and Finance House of India and the Securities Trading Corporation of India
to activate the call market.
5. To individuals of very high status for trade purposes to save interest on O.D or cash credit
The participants in call money market can be classified into categories viz.
The first category includes all commercial banks. Co-operative banks, DFHI and STCI. In the
second category LIC, UTI, GIC, IDBI, NABARD, specified mutual funds etc., are included.
They can only lend and they cannot borrow in the call market
In India, commercial banks play a dominant role in the call loan market. They used to borrow
and lend among themselves and such loans are called inter-bank loans. They are very popular
in India. So many advantages are available to commercial banks. They are as follows:
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1. High Liquidity: Money lent in a call market can be called back at any time when needed. So,
it is highly liquid. It enables commercial banks to meet large sudden payments and
remittances by making a call on the market.
2. High Profitability: Banks can earn high profiles by lending their surplus funds to the call
market when call rates are high volatile. It offers a profitable parking place for employing the
surplus funds of banks temporarily.
3. Maintenance Of SLR: Call market enables commercial bank to minimum their statutory
reserve requirements. Generally banks borrow on a large scale every reporting Friday to meet
their SLR requirements. In absence of call market, banks have to maintain idle cash to meet5
their reserve requirements. It will tell upon their profitability.
4. Safe And Cheap: Though call loans are not secured, they are safe since the participants have
a strong financial standing. It is cheap in the sense brokers have been prohibited form
operating in the call market. Hence, banks need not pay brokers on call money transitions.
5. Assistance To Central Bank Operations: Call money market is the most sensitive part of
any financial system. Changes in demand and supply of funds are quickly reflected in call
money rates and give an indication to the central bank to adopt an appropriate monetary
policy. Moreover, the existence of an efficient call market helps the central bank to carry out
its open market operations effectively and successfully.
1. Uneven Development: The call market in India is confined to only big industrial and
commercial centers like Mumbai, Kolkata, Chennai, Delhi, Bangalore and Ahmadabad.
Generally call markets are associated with stock exchanges. Hence the market is not evenly
development.
2. Lack Of Integration: The call markets in different centers are not fully integrated. Besides, a
large number of local call markets exist without an\y integration.
3. Volatility In Call Money Rates: Another drawback is the volatile nature of the call money
rates. Call rates vary to greater extant indifferent centers indifferent seasons on different days
within a fortnight. The rates vary between 12% and 85%. One can not believe 85% being
charged on call loans.
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4. Certificate of Deposit (CD)
Definition:
In finer terms, certificate of deposit is a fixed interest bearing term deposit, which has a fixed
maturity. It limits the access to the funds, until the lock-in period of the investment, i.e. the
depositor cannot withdraw funds, on demand.
Eligibility: All scheduled commercial bank, not including regional rural bank and
cooperative bank, are eligible to issue the certificate of deposit. It can be issued by the bank
to individuals, companies, trust, funds, associations, etc. On the non-repatriable basis, it can
be issued to Non-Resident Indians (NRIs) also.
Maturity period: The CDs are issued by the bank at a discount to face value, at market-
related rates, ranging from 3 months to one year. When a financial institution issues CD, the
minimum term is one year and maximum three years. In addition to this, no grace period is
allowed for the repayment of CD.
Reserve requirement: Banks are required to keep CRR and SLR on the issue price of the
certificate of deposit.
Format: Banks and financial institutions can issue CD in dematerialised form only. Although
the investor, at their discretion, can seek a certificate in traditional form. Moreover, it attracts
stamp duty.
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Banks issue certificate of deposit when the deposit growth is comparatively slow, and credit
demand is high, and there is a tightening trend in the call rate. These are high-cost liabilities,
and banks take recourse of CD‟s only when there exist stiff liquidity conditions in the market.
RBI Guidelines
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5. Commercial Bills Market or Discount Market
Introduction
A commercial bill is one which arises out of a genuine trade transaction, i.e. credit
transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the
amount due. The buyer accepts it immediately agreeing to pay amount mentioned therein
after a certain specified date. Thus, a bill of exchange contains a written order from the
creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill
of exchange is a „self-liquidating‟ paper and negotiable/; it is drawn always for a short period
ranging between 3 months and 6 months.
Section 5 of the negotiable Instruments Act defines a bill of exchange as “an instrument in
writing containing an unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of a certain person or to the beater of the
instrument”.
Types of Bills
Many types of bills are in circulation in a bill market. They can be broadly classified as
follows:
1. Demand and Usince Bills: Demand bills are others called sight bills. These bills are payable
immediately as soon as they are presented to the drawee. No time of payment is specified and
hence they are payable at sight. Usince bills are called time bills. These bills are payable
immediately after the expiry of time period mentioned in the bills. The period varies
according to the established trade custom or usage prevailing in the country.
2. Clean Bills and Documentary Bills: When bills have to be accompanied by documents of
title to goods like Railways, receipt, Lorry receipt, Bill of Lading etc. the bills are called
documentary bills. These bills can be further classified into D/A bills and D/P bills. In the
case of D/A bills, the documents accompanying bills have to be delivered to the drawee
immediately after acceptance. Generally D/A bills are drawn on parties who have a good
financial standing. On the order hand, the documents have to be handed over to the drawee
only against payment in the case of D/P bills. The documents will be retained by the banker.
Till the payment o0f such bills. When bills are drawn without accompanying any documents
they are called clean bills. In such a case, documents will be directly sent to the drawee.
3. Inland and Foreign Bills: Inland bills are those drawn upon a person resident in India and
are payable in India. Foreign bills are drawn outside India an they may be payable either in
India or outside India. They may be drawn upon a person resident in India also. Foreign boils
have their origin outside India. They also include bills drawn on India made payable outside
India.
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4. Export and Foreign Bills: Export bills are those drawn by Indian exports on importers
outside India and import bills are drawn on Indian importers in India by exports outside India.
5. Indigenous Bills: Indigenous bills are those drawn and accepted according to native custom
or usage of trade. These bills are popular among indigenous bankers only. In India, they
called „hundis‟ the hundis are known by various names such as „Shah Jog‟, „Nam Jog‟,
Jokhani‟, Termainjog‟. „Darshani‟, „Dhanijog‟, and so an.
6. Accommodation Bills and Supply Bills: If bills do not arise out of genuine trade
transactions, they are called accommodation bills. They are known as „kite bills‟ or „wind
bills‟. Two parties draw bills on each other purely for the purpose of mutual financial
accommodation. These bills are discounted with bankers and the proceeds are shared among
themselves. On the due dates, they are paid. Supply bills are those neither drawn by suppliers
or contractors on the government departments for the goods nor accompanied by documents
of title to goods. So, they are not considered as negotiable instruments. These bills are useful
only for the purpose of getting advances from commercial banks by creating a charge on
these bills.
Discount Market
Acceptance Market
1. Discount Market
Discount market refers to the market where short-term genuine trade bills are discounted by
financial intermediaries like commercial banks. When credit sales are effected, the seller
draws a bill on the buyer who accepts it promising to pay the specified sum at the specified
period. The seller has to wait until the maturity of the bill for getting payment. But, the
presence of a bill market enables him to get payment immediately. The seller can ensure
payment immediately by discounting the bill with some financial intermediary by paying a
small amount of money called „Discount rate‟ on the date of maturity, the intermediary
claims the amount of the bill from the person who has accepted the bill.
In some countries, there are some financial intermediaries who specialize in the field of
discounting. For instance, in London Money Market there are specialise in the field
discounting bills. Such institutions are conspicuously absent in India. Hence, commercial
banks in India have to undertake the work of discounting. However, the DFHI has been
established to activate this market.
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2. Acceptance Market
The acceptance market refers to the market where short-term genuine trade bills are accepted
by financial intermediaries. All trade bills cannot be discounted easily because the paties to
the bills may not be financially sound. In case such bills are accepted by financial
intermediaries like banks, the bills earn a good name and reputation and such bills can readily
discounted anywhere. In London, there are specialist firms called acceptance house which
accept bills drawn by trades and import greater marketability to such bills. However, their
importance has declined in recent times. In India, there are no acceptance houses. The
commercial banks undertake the acceptance business to some extant.
Commercial bill market is an important source of short-term funds for trade and industry. It
provides liquidity and activates the money market. In India, commercial banks lay a
significant role in this market due to the following advantages:
1. Liquidity: Bills are highly liquid assets. In times of necessity, bills can be converted into
cash readily by means of rediscounting them with the central bank. Bills are self-liquidating
in character since they have fixed tenure. Moreover, they are negotiable instruments and
hence they can be transferred freely by a mere delivery or by endorsement and delivery.
2. Certainty of Payment: Bills are drawn and accepted by business people. Generally, business
people are used to keeping their words and the use of the bills imposes a strict financial
discipline on them. Hence, bills would be honored on the due date.
3. Ideal Investment: Bills are for periods not exceeding 6 months. They represent advances for
a definite period. This enables financial institutions to invest their surplus funds profitably by
selecting bills of different maturities. For instance, commercial banks can invest their funds
on bills in such a way that the maturity of these bills may coincide with the maturity of their
fixed deposits.
4. Simple Legal Remedy: In case the bills are dishonored, the legal remedy is simple. Such
dishonored bills have to be simply noted and protested and the whole amount should be
debited to the customer‟s accounts.
5. High and Quick Yield: The financial institutions earn a high quick yield. The discount is
dedicated at the time of discounting itself whereas in the case of other loans and advances,
interest is payable only when it is due. The discounts rate is also comparatively high.
6. Easy Central Bank Control: The central bank can easily influence the money market by
manipulating the bank rate or the rediscounting rate. Suitable monetary policy can be taken
by adjusting the bank rate depending upon the monetary conditions prevailing in the market.
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Drawbacks of Commercial Bills
1. Absence of Bill Culture: Business people in India prefer O.D and cash credit to bill
financing therefore, banks usually accept bills for the conversion of cash credits and
overdrafts of their customers. Hence bills are not popular.
3. Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of required
denomination are not available.
4. Absence of Secondary Market: There is no active secondary market for bills. Rediscounting
facility is available in important centers and that too it restricted to the apex level financial
institutions. Hence, the size of the bill market has bee curtailed to a large extant.
5. Difficulty in Ascertaining Genuine Trade Bills: The financial institutions have to verify the
bills so as to ascertain whether they are genuine trade bills and not accommodation bills. For
this purpose, invoices have to be scrutinized carefully. It involves additional work.
6. Limited Foreign Trade: In many developed countries, bill markets have been established
mainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to
national income remains small and it is reflected in the bill market also.
8. Attitude of Banks: Banks are shy rediscounting bills even the central bank. They have a
tendency to hold the bills till maturity and hence it affects the velocity of circulation of bills.
Again, banks prefer to purchase bills instead of discounting them.
Capital/Securities Market
Meaning
Capital Market is the market for long term finance with the maturity period more than
one year.
The Capital Market deals with the stock markets which provide financing through the
issuance of shares or common stock in the primary market, and enable the subsequent trading
in the secondary market. Capital Markets also deals with Bond Market which provide
financing through issuance of Bonds in the primary market and subsequent trading thereof in
the secondary market.
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Structure of the securities market
The structure of the securities market which is divided into government securities and
corporate securities
In India, the Central Government issues both, treasury bills and bonds or dated securities
while the State Governments issue only bonds or dated securities, which are called the State
Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called
risk-free gilt-edged instruments.
The term „gilt edged‟ means the „best quality‟. Since Government Securities are of best
quality in the sense of liquidity and zero degree of the risk of default, so these are called gilt-
edged securities. In the Gilt-edged Market, the securities of the Government of India and of
the State Governments are traded in.
The importance of Government Securities Market, that is, Gilt-edged Market, as a segment of
the capital market, emanates from the fact that this market provides a mechanism for the
management of public debt and open market operations to the Reserve Bank of India (RBI).
The Gilt-edged Market has two segments: Treasury Bill Market and Government Bond
Market.
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Note: Treasury Bill Market has already been explained earlier in depth.
There are several types of government securities offered by the Reserve Bank of India
explained as under.
Treasury bills or T-bills, which are money market instruments, are short term debt
instruments issued by the Government of India and are presently issued in three tenors,
namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay no
interest. Instead, they are issued at a discount and redeemed at the face value at maturity. For
example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20, that
is, at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-. The
return to the investors is the difference between the maturity value or the face value (that is
Rs.100) and the issue price. It is yield (return) on Treasury Bills.
Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is
paid on the face value, on half-yearly basis. Generally, the tenor of dated securities ranges
from 5 years to 40 years.
The investors investing in dated government securities are called primary dealers.
There are nine different types of dated government securities issued by the Government of
India given below:
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5) Floating Rate Bonds
6) Fixed Rate Bonds
7) Special Securities
8) Inflation Indexed Bonds
9) STRIPS
State Governments also raise loans from the market which are called SDLs. SDLs are dated
securities issued through normal auction similar to the auctions conducted for dated securities
issued by the Central Government.
Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date.
Like dated securities issued by the Central Government, SDLs issued by the State
Governments also qualify for SLR. They are also eligible as collaterals for borrowing through
market repo as well as borrowing by eligible entities from the RBI under the Liquidity
Adjustment Facility (LAF) and special repo conducted under market repo by CCIL.
Besides providing a return in the form of coupons (interest), G-Secs offer the
maximum safety as they carry the Sovereign‟s commitment for payment of interest
and repayment of principal.
They can be held in book entry, i.e., dematerialized/ scripless form, thus, obviating
the need for safekeeping. They can also be held in physical form.
G-Secs can be sold easily in the secondary market to meet cash requirements.
G-Secs can also be used as collateral to borrow funds in the repo market.
Securities such as State Development Loans (SDLs) and Special Securities (Oil
bonds, UDAY bonds etc) provide attractive yields.
The settlement system for trading in G-Secs, which is based on Delivery versus
Payment (DvP), is a very simple, safe and efficient system of settlement. The DvP
mechanism ensures transfer of securities by the seller of securities simultaneously
with transfer of funds from the buyer of the securities, thereby mitigating the
settlement risk.
G-Sec prices are readily available due to a liquid and active secondary market and a
transparent price dissemination mechanism.
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2. Corporate/Industrial Securities Market:
The Industrial securities market refers to the market for shares and bonds of the existing
companies, as well as those of new companies.
This market is further divided into New Issue Market (NIM) and Old Issue Market. The New
Issue Market is also called Primary Market. Likewise, the Old Issue Market is also called
Secondary Market or Stock Exchange.
Primary market
This market for new issues and when companies sell their shares, Debentures, etc. for the first
time to raise fresh capital it is known as the primary market. Therefore Primary market deals
with the issue of new securities to investors for the first time. Hence this market is also
known as New Issues Market or primary market.
The main function of the primary market is to facilitate capital formation. The Primary
market can be classified as the Equity market and Debt market. In the Equity market,
securities like Equity shares, Preference Shares, Rights Issues, etc. are issued. In the Debt
market, debentures, bonds, fixed deposits, etc. are issued.
Secondary market
The secondary market is more commonly known as the stock market or the stock
exchange. The Secondary Market deals in existing securities. This market provides both
liquidity and marketability to such securities.
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Difference between the primary and the secondary market
The main difference between the primary and the secondary market is that in the primary
market only new securities are issued, whereas in the secondary market the already existing
securities are traded. There is no fresh issue in the secondary market
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Primary market Secondary market
Basis
Recipient on a
It happens to be the investors in
gain on sale of Company
the case of secondary markets.
shares
Listing of company/securities
Every company which operates in a market of high demand has a good scope of growing and
scaling. From the inception of a company, most companies are privately limited. Private
limited means that these companies are funded privately, or the source of the capital is just
normal private people or organisations behind the promoting chair. Hence, they operate on a
limited capital that they can privately afford to fuel the operations at that company. Some
companies, however, go ahead and become big national companies that need huge cash flows
to fund their activities. At the point when companies become big and quite popular in a
nation, the promoters or the chair people will be needing more capital.
In corporate finance, a listing refers to the company's shares being on the list of stocks
that are officially traded on a stock exchange. Thus, listing means that anyone from the
public or a retail investor can now take part in a company by buying its shares. The general
public will be buying a company‟s shares to earn capital appreciation or dividends.
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The Process of Listing (Initial Public Offering)
Now we will discuss the cherry of the cake, the process of listing. It is also known by the
name of initial public offering because it is the first time (Initial) when the shares will be
offered to the public. This is a very strict process and both the National and the Bombay stock
exchange take it very heartedly. It goes without saying at this point that the company which is
trying to list itself has to follow dedicated guidelines of the desired exchange. However, the
most common checkpoints to be ticked are listed here -
The Lead Manager has to work closely with the company to prepare the DRHP. DRHP stands
for draft red herring prospectus. He also has to underwrite shares, which is agreeing to buy all
the unsold shares. He then has to help the company to reach a decision on a reasonable price
band of the offering. Thus, these are all the major functions that a merchant banker does.
For example, The merchant banks (book running lead managers) for the issue are Morgan
Stanley India, Goldman Sachs (India), ICICI Securities, Axis Capital, JP Morgan, Citigroup
Global Markets India and HDFC Bank.
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6. Marketing the IPO
After DRHP is issued and is made public, it is important to float some marketing about the
IPO. The company would want to reach the maximum audience of investors for the purpose
of its public offering. So they take support of print media and other sorts of media to market
the IPO more.
8. Book building
Book building is the process of capturing and recording investor demand for shares. For
example, if the price band is between Rs.100 and Rs.150 then the public can choose. They
can choose what is the right amount per share that the company deserves. The process of
book building is to collect these price points along with respective qualities of shares and
demand. Book building is perceived as an effective price discovery method.
9. Closing date
After the book building process is done and completed, it is said as the closing date.
Generally, it is open for two to three days and maybe more in some exceptions. Thus, then
the price point is selected which has the most bids from investors. That price becomes the
listing share price of the company.
When the shares are being bid, they lay a foundation for future selling values. This happens
when investors choose the desired price from the given price band. This whole arrangement
around the date of issue is known as the “Primary Markets”. After the initial bidding has
stopped and the stock gets listed on the stock exchange, the share starts to trade normally like
any other listed company. This situation in this share is known as the “Secondary Markets”.
Once the stock transitions from primary markets to secondary markets, it gets traded daily on
the stock exchange. People start buying and selling the stocks regularly and normally like any
other company.
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Trading and Settlement Procedure on a Stock Exchange
1) Selection of a Broker
The first step is to select a broker who buys/sells securities on behalf of the investors or
clients. The buying and selling of securities can only be done through SEBI registered
brokers who are members of the Stock Exchange. The investor approaches a registered
broker or sub-broker for trading. The investor has to sign a broker-client agreement and a
client registration form before placing an order to buy or sell securities. The investor has to
provide certain details and information about himself including:
A broker acts as an intermediary between the buyers and sellers. After the completion of the
above formalities, the broker opens a trading account in the name of the investor.
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2) Opening Demat Account with Depository
Second step in trading procedure is to open a Demat account. The investor has to open a
„Demat‟ account or „beneficial owner‟ (BO) account with a depository participant (DP)
for holding and transferring securities in the demat form. He will also have to open a bank
account for cash transactions in the securities market.
E.g. “Buy 200 equity shares of Reliance for not more than Rs. 700 per share.”
Contract note contains details of the number of shares bought or sold, the price, the
date and time of deal, and the brokerage charges.
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8) Settlement before T+2
Cash is paid or securities are delivered on pay-in day, which is before the T+2 day as the deal
has to be settled and finalised on the T+2 day. The settlement cycle is on T+2 day on a
rolling settlement basis, w.e.f. 1 April 2003.
SEBI advises certain guidelines in issue of fresh share capital, first issue by new companies
in Primary Market and functioning of secondary markets in order to maintain quality
standards. A few such guidelines and objectives of the Securities and Exchange Board of
India (SEBI) are discussed here.
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New company cannot issue shares at a premium. The dividend on preference shares
should be within the prescribed list.
All the details of the underwriting agreement.
Allotment of shares to NRIs is not allowed without the approval of RBI.
Details of any firm allotment in favor of any financial institutions.
Declaration by secretary or director of the company.
A new company which has not completed 12 months of commercial operations will
not be allowed to issue shares at a premium.
If an existing company with a 5-year track record of consistent profitability, is
promoting a new company, then it is allowed to price its issue.
A draft of the prospectus has to be given to the SEBI before public issue.
The shares of the new companies have to be listed either with OTCEI or any other
stock exchange.
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