Financial Markets

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Financial Markets
The %inancial market is the market in an economy where funds are exchanged between
fund-surplus and fund-scarce individuals and groups. The transaction is based on either
interest or dividend
Financial Markets – Functions
1. Mobilization of Savings
• A %inancial market facilitates the transfer of savings from savers to investors.
• It provides savers with a variety of investment options, assisting in the allocation of
surplus funds to the most productive use.
2. Facilitating Price Discovery
• Households are the suppliers of funds in the %inancial market, while businesses are
the demand.
• Their interaction contributes to the establishment of a price for the %inancial asset
traded in that market.
3. Providing Liquidity to Financial Assets
• Financial markets make it simple to buy and sell %inancial assets.
• As a result, they provide liquidity to %inancial assets, allowing them to be easily
converted into cash when needed.
• Asset holders can easily sell their %inancial assets using the %inancial market's
mechanism.
4. Reducing Transaction Costs
• Financial markets provide valuable information about the securities that are traded
in the market.
• It saves time, effort, and money that both buyers and sellers of a %inancial asset would
otherwise have to spend trying to %ind each other.
• As a result, the %inancial market serves as a common platform where buyers and
sellers can meet to ful%il their individual needs.
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Financial Markets can be classiFied based on various criterion.

Organised Vs Unorganised (Based on regulation)
1. Organised Markets
• These are %inancial markets that operate in accordance with the laws, rules, and
regulations enacted by the government and overseen by the central bank of the
country (RBI) or another regulatory body.
• Financial markets that are organised are further classi%ied as:
o Money Markets - The money market is primarily concerned with short-term
credit transactions.
o Capital Markets - The capital market is concerned with medium and long-term
credit and %inancial transactions.
2. Unorganised Markets
• Unorganized markets are those that are not governed or controlled by the central
bank, and they primarily consist of money lenders, indigenous bankers, and others
who provide credit to the public.
Equity Vs Debt (Based on nature of the instrument)
Equity and debt are two primary forms of %inancing for companies in %inancial markets.
Here's a breakdown of each:
1. Equity:
• Equity represents ownership in a company. When an investor buys equity
(such as stocks), they are buying a portion of the company.
• Equity investors become shareholders and have a claim on the company's
assets and earnings. They may also have voting rights, depending on the type
of shares they hold.
• Returns to equity investors come in the form of dividends (if the company
distributes pro%its) and capital appreciation (if the stock price increases).
• Equity investments are considered riskier than debt because equity holders
are the last in line to be paid if a company faces %inancial dif%iculties or goes
bankrupt.
2. Debt:
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• Debt represents borrowed money that must be repaid with interest over time.
• Debt can take various forms such as bonds, loans, or other debt securities.
• Debt investors (such as bondholders) are creditors to the company. They lend
money to the company with the expectation of receiving repayment of the
principal amount plus interest.
• Unlike equity investors, debt holders typically do not have ownership rights or
voting privileges in the company.
• Debt investments are generally considered less risky than equity because debt
holders have a higher priority claim on the company's assets in case of
bankruptcy.
Capital Market Vs Money Market (Based on tenor)
Capital markets and money markets are both components of the broader Financial
market, but they serve different purposes and cater to different types of
participants. Here's a breakdown of each:
1. Capital Market:
• De%inition: The capital market is where long-term(more than 1 year) securities
such as stocks, bonds, and other instruments are bought and sold. It facilitates
the %low of capital between investors and entities raising funds for various
purposes.
• Participants: Investors, businesses, governments, %inancial institutions, and
other entities looking to raise long-term funds or invest excess capital.
• Instruments: Stocks, bonds, mutual funds, exchange-traded funds (ETFs),
derivatives, and other long-term investment vehicles.
• Purpose: It provides a platform for businesses and governments to raise
capital for expansion, projects, or other long-term needs. Investors participate
in the capital market to invest their savings in assets that offer potential
returns over the long term.
2. Money Market:
• De%inition: The money market deals with short-term debt securities and
instruments that have a maturity of one year or less. It facilitates the
borrowing and lending of short-term funds.
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• Participants: Banks, %inancial institutions, corporations, governments, and

investors looking for short-term investment opportunities or liquidity
management.
• Instruments: Treasury bills, commercial paper, certi%icates of deposit (CDs),
repurchase agreements (repos), and other short-term debt instruments.
• Purpose: The money market serves as a mechanism for institutions to manage
short-term liquidity needs, %inance temporary de%icits, and invest excess cash
in low-risk, short-term assets. It also provides a source of short-term funding
for businesses and governments.
Primary Vs Secondary (Based on the whether the instrument is new or already

issued)
In %inancial markets, the primary market and the secondary market are two distinct
components where securities and %inancial assets are bought and sold.
1. Primary Market:
• Also known as the "new issue market," the primary market is where new
securities are issued and sold for the %irst time by issuers.
• In this market, companies, governments, or other entities raise capital by
issuing new stocks, bonds, or other securities.
• Investors in the primary market purchase securities directly from the issuer,
and the proceeds from these sales go to the issuer.
• The primary market helps companies and governments raise funds for various
purposes, such as expansion, research and development, or debt repayment.
2. Secondary Market:
• The secondary market is where existing securities are traded among investors
after their initial issuance in the primary market.
• In this market, investors buy and sell previously issued securities such as
stocks, bonds, options, and derivatives from other investors, rather than from
the issuing companies or entities.
• The secondary market provides liquidity to investors by allowing them to buy
and sell securities easily.
• Prices in the secondary market are determined by supply and demand
dynamics, investor sentiment, company performance, and other factors.
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Capital Market Instruments
What is a Bond?
A bond is a debt instrument in which an investor loans money to an entity (typically

corporate or government) which borrows the funds for a defined period of time at a
variable or fixed interest rate. Bonds are used by companies, municipalities, states and
sovereign governments to raise money to finance a variety of projects and activities.
Owners of bonds are debt holders, or creditors, of the issuer.
What is a Government Security (G-Sec)?
A Government Security (G-Sec) is a tradeable instrument issued by the Central

Government or the State Governments. It acknowledges the Government’s debt
obligation. Such securities are short term (usually called treasury bills, with original
maturities of less than one year) or long term (usually called Government bonds or
dated securities with original maturity of one year or more). 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.
Dated G-Secs
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 Public Debt Office (PDO) of the Reserve Bank of India acts as
the registry / depository of G-Secs and deals with the issue,
interest payment and repayment of principal at maturity. Most
of the dated securities are fixed coupon securities.
The nomenclature of a typical dated fixed coupon G-Sec contains the following features -
coupon, name of the issuer, maturity year. For example, - 7.17% GS 2028 would mean:
Coupon : 7.17% paid on face value

Name of Issuer : Government of India
Date of Issue : January 8, 2018
Maturity : January 8, 2028
: Half-yearly (July 08 and January
Coupon Payment Dates
08) every year
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Minimum Amount of
: ₹10,000
issue/ sale
Fixed Rate Bonds – These are bonds on which the coupon rate is fixed for the entire life
(i.e. till maturity) of the bond. Most Government bonds in India are issued as fixed rate
bonds.
For example – 8.24%GS2018 was issued on April 22, 2008 for a tenor of 10 years
maturing on April 22, 2018. Coupon on this security will be paid half-yearly at 4.12%
(half yearly payment being half of the annual coupon of 8.24%) of the face value on
October 22 and April 22 of each year.
Floating Rate Bonds (FRB) – FRBs are securities which do not have a fixed coupon rate.
Instead it has a variable coupon rate which is re-set at pre-announced intervals (say,
every six months or one year). FRBs were first issued in September 1995 in India.
Capital Indexed Bonds – These are bonds, the principal of which is linked to an
accepted index of inflation with a view to protecting the Principal amount of the
investors from inflation. A 5 year Capital Indexed Bond, was first issued in December
1997 which matured in 2002.
Inflation Indexed Bonds (IIBs) - IIBs are bonds wherein both coupon flows and
Principal amounts are protected against inflation. The inflation index used in IIBs may
be Whole Sale Price Index (WPI) or Consumer Price Index (CPI). Globally, IIBs were first
issued in 1981 in UK. In India, Government of India through RBI issued IIBs (linked to
WPI) in June 2013. Since then, they were issued on monthly basis (on last Tuesday of
each month) till December 2013. Based on the success of these IIBs, Government of India
in consultation with RBI issued the IIBs (CPI based) exclusively for the retail customers
in December 2013.
Bonds with Call/ Put Options – Bonds can also be issued with features of optionality
wherein the issuer can have the option to buy-back (call option) or the investor can have
the option to sell the bond (put option) to the issuer during the currency of the bond. It
may be noted that such bond may have put only or call only or both options. The first G-
Sec with both call and put option viz. 6.72% GS 2012 was issued on July 18, 2002 for a
maturity of 10 years maturing on July 18, 2012. The optionality on the bond could be
exercised after completion of five years tenure from the date of issuance on any coupon
date falling thereafter. The Government has the right to buy-back the bond (call option)
at par value (equal to the face value) while the investor had the right to sell the bond
(put option) to the Government at par value on any of the half-yearly coupon dates
starting from July 18, 2007.
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Special Securities - Under the market borrowing program, the Government of India
also issues, from time to time, special securities to entities like Oil Marketing Companies,
Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds,
fertiliser bonds and food bonds respectively) as compensation to these companies in
lieu of cash subsidies These securities are usually long dated securities and carry a
marginally higher coupon over the yield of the dated securities of comparable maturity.
These securities are, however, not eligible as SLR securities but are eligible as collateral
for market repo transactions. The beneficiary entities may divest these securities in the
secondary market to banks, insurance companies / Primary Dealers, etc., for raising
funds.
State Development Loans (SDLs)
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.
Bonds Vs Debentures
Bonds are typically secured by speci%ic assets, offering lower risk to investors. Debentures,
however, are unsecured, carrying higher risk but potentially higher returns. Bonds are more
liquid and have lower interest rates, while debentures offer higher interest rates. Both are
issued by corporations and governments, but with varying terms and conditions.
Convertible and non-convertible bonds or debentures are two types of debt securities
issued by corporations or governments to raise capital. Here's a breakdown of each:
1. Convertible Bonds or Debentures:
• Convertible bonds are debt instruments that can be converted into a
predetermined number of the issuing company's shares at the bondholder's
discretion within a speci%ied time frame.
• These bonds offer investors the potential for capital appreciation if the issuer's
stock price rises signi%icantly.
• They typically carry a lower interest rate compared to non-convertible bonds
because of the added feature of conversion.
2. Non-Convertible Bonds or Debentures:
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• Non-convertible bonds are traditional debt securities that cannot be converted

into equity shares of the issuing company.
• They pay a %ixed rate of interest over a speci%ied period and return the
principal amount to the bondholder upon maturity.
• Non-convertible bonds are generally considered less risky than convertible
bonds because their returns are %ixed and do not depend on the issuer's stock
performance.
• They may offer higher interest rates compared to convertible bonds due to
their lack of conversion privilege.
Money Market Instruments
The money market provides investment avenues of short term tenor. Money market
transactions are generally used for funding the transactions in other markets
including G-Secs market and meeting short term liquidity mismatches. By definition,
money market is for a maximum tenor of one year. Within the one year, depending
upon the tenors, money market is classified into:
i. Overnight market (Call money market) - The tenor of transactions is one working
day.
ii. Notice money market – The tenor of the transactions is from 2 days to 14 days.
iii. Term money market – The tenor of the transactions is from 15 days to one year.
Money market instruments include call money, repos, T- Bills, Cash Management
Bills , Commercial Paper, Certificate of Deposit and Collateralized Borrowing and
Lending Obligations (CBLO).
Treasury Bills (T-bills)
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 ₹100/- (face
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value) may be issued at say ₹ 98.20, that is, at a discount of say, ₹1.80 and would
be redeemed at the face value of ₹100/-. The return to the investors is the difference
between the maturity value or the face value (that is ₹100) and the issue price.
Cash Management Bills (CMBs)
In 2010, Government of India, in consultation with RBI introduced a new short-term

instrument, known as Cash Management Bills (CMBs), to meet the temporary
mismatches in the cash flow of the Government of India. The CMBs have the generic
character of T-bills but are issued for maturities less than 91 days.
Call money market
Call money market is a market for uncollateralized lending and borrowing of funds.
This market is predominantly overnight and is open for participation only to
scheduled commercial banks and the primary dealers.
Repo market
Repo or ready forward contact is an instrument for borrowing funds by selling

securities with an agreement to repurchase the said securities on a mutually agreed
future date at an agreed price which includes interest for the funds borrowed.
The reverse of the repo transaction is called ‘reverse repo’ which is lending of funds
against buying of securities with an agreement to resell the said securities on a
mutually agreed future date at an agreed price which includes interest for the funds
lent.
It can be seen from the definition above that there are two legs to the same
transaction in a repo/ reverse repo. The duration between the two legs is called the
‘repo period’. Predominantly, repos are undertaken on overnight basis, i.e., for one
day period
Triparty Repo
"Tri-party repo" means a repo contract where a third entity (apart from the borrower
and lender), called a Tri-Party Agent, acts as an intermediary between the two
parties to the repo to facilitate services like collateral selection, payment and
settlement, custody and management during the life of the transaction.
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Commercial Paper (CP)
• Commercial Paper (CP) is a short-term unsecured money market instrument

issued in the form of a promissory note (legal instrument).
• In India, it was introduced in 1990 on the recommendation of the Vaghul
Committee to enable highly rated corporate borrowers to diversify their short-
term sources of borrowing and to provide an additional instrument to investors.
Maturity Minimum: 7 Days and Maximum: 1 Year from the date

of issuance.
Denomination ₹5 Lakh or Multiple thereof (Single investment should
not be less than ₹5 Lakh (face value)).
Eligible Companies, NBFCs, InvITs, REITs All-India Financial
Issuers Institutions (AIFIs) and any other body corporate with a
minimum net-worth of ₹100 crore, provided that the
body corporate is statutorily permitted to incur debt or
issue debt instruments in India, are eligible to issue CPs
subject to the condition that any fund-based facility
availed of from bank(s) and/or financial institutions is
classified as a standard asset by all financing
banks/institutions at the time of issue.
Other entities like co-operative societies/unions and
limited liability partnerships with a net worth of ₹100
crore subject to the condition as specified above.
Any other entity specifically permitted by the RBI.
Rating Eligible issuers, whose total CP issuance during a
calendar year is ₹1000 crore or more, shall obtain credit
rating for issuance of CPs from at least two CRAs
registered with SEBI and should adopt the lower of the
two ratings. When both ratings are the same, the
issuance shall be for the lower of the two amounts for
which ratings are obtained.
The minimum credit rating for a CP shall be 'A3' as per
the rating symbol and definition prescribed by SEBI.
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Regulators RBI and FIMMDA (Market Self-Regulatory Organisation

- SRO).
Certificate of Deposits
• The CD was introduced in 1989 on the recommendation of the Vaghul

Committee.
• Certificate of Deposits (CDs) are the unsecured, negotiable money market
instruments, which is equivalent to pro missionary note.
• The government initiated the market of CD’s in order to widen the range of
money market instruments and to provide a higher flexibility to investors for
investing their surplus money for the short term.
Features of Certificate of Deposits
• CDs are either issued in demat form or in the form of usance promissory note
(Physical form).
• CD’s can be issued by scheduled commercial banks (excluding Regional Rural
Banks and Local Area Banks); and Financial Institutions (FIs) that have been
permitted by RBI to raise short-term resources within the umbrella limit fixed by
RBI.
• The minimum deposit that could be accepted from a single subscriber should not
be less than INR 1 Lakh. Therefore, the minimum amount that can be invested in
CD’s is 1 Lakh and the maximum amount could be multiple of 1 lakh.
• CD’s issued by banks should not be less than 7 days and not more than one year
from the date of issue. FI’s can issue CDs for a period not less than 1 year and not
exceeding 3 years from the date of issue.
Issuance of Certificate of Deposits
• Scheduled commercial banks or financial institutions in India that have been

granted the permission by RBI can issue certificates of deposit
• CDs can only be issued to individuals, companies, fund houses, and such
• Co-operative banks and regional rural banks cannot issue these certificates
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Commercial Bills: They are also called Trade Bills or Bills of Exchange. Commercial
bills are drawn by one business firm to another in lieu of credit transaction. It is a
written acknowledgement of debt by the maker directing to pay a specified sum of
money to a particular person. They are short-term instruments generally issued for a
period of 90 days. These are freely marketable. Banks provide working capital
finance to firms by purchasing the commercial bills at a discount; this is called
‘discounting of bills’.
Gold Monetisation Scheme
§ The scheme was launched in November 2015 along with sovereign gold bonds
and India gold coins.
§ It facilitates the depositors of gold to earn interest on their metal accounts.
Once the gold is deposited in metal account, it starts earning interest on the
same.
§ Under the scheme, a depositor gets 2.25% interest annually for a short-term
deposit of one year to three years. Medium- and long-term deposits get 2.5%
interest rate.
§ Objective: To mobilize the gold held by households and institutions in the
country to put this gold into productive use and in the long run to reduce the
current account deficit by reducing the country’s reliance on imports of gold to
meet the domestic demand.
Sovereign Gold Bond (SGB) Scheme
• SGBs are government securities denominated in grams of gold.

• The SGB Scheme was first launched by the Government of India (GOI) on
October 30, 2015.
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• They are substitutes for holding physical gold. Investors have to pay the issue
price, and the bonds will be redeemed upon maturity.
• The bond is issued by Reserve Bank on behalf of the GOI.
• Who is eligible to invest in the SGBs? The bonds will be restricted for sale
to resident Indian entities, including individuals (in their capacity as individuals, or
on behalf of minor child, or jointly with any other individual), Hindu Undivided
Family (HUF), Trusts, Universities and Charitable Institutions.
• What are the minimum and maximum limits for investment?
o The bonds are issued in denominations of one gram of gold and in
multiples thereof.
o The minimum investment in the bond shall be one gram, with
a maximum subscription limit of 4 kg for individuals, 4 kg for HUFs, and 20
kg for trusts and similar entities notified by the government from time to
time per fiscal year.
o In case of joint holding, the investment limit of 4 KG will be applied to the
first applicant only.
• Tenor: The tenor of the bond will be for a period of 8 years, with an exit option in
the 5th, 6th, and 7th years, to be exercised on the interest payment dates.
• Who are the authorized agencies selling the SGBs? Bonds are sold through
offices or branches of Nationalised Banks, Scheduled Private Banks, Scheduled
Foreign Banks, designated Post Offices, Stock Holding Corporation of India Ltd.
(SHCIL), and the authorised stock exchanges either directly or through their
agents.
Consol Bonds/Perpetual Bonds
Perpetual bonds, also known as perpetuities or perpetual securities, are a type of

bond with no maturity date. Unlike conventional bonds, which have a defined
term until the principal amount is repaid to the bondholder, perpetual bonds do
not mature. Instead, they offer regular interest payments to investors indefinitely,
often at fixed intervals such as annually or semi-annually.
Consols have a long history in the UK, dating back to the 18th century. They
were initially issued to finance wars and other government expenses.
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Masala Bonds
Masala bonds are rupee-denominated bonds issued outside India. The term
"Masala" reflects the Indian origin of the bonds, while "bonds" represent the debt
instrument. These bonds are typically issued to overseas investors by Indian
Entities allowing them to raise funds in Indian rupees without facing currency
risk. They were introduced to enable Indian entities to diversify their borrowing
base and reduce dependence on foreign currency-denominated bonds. Masala
bonds offer a way for Indian companies to tap into international capital markets
and attract foreign investment. They also provide investors with exposure to the
Indian market without having to deal with foreign exchange fluctuations.
Credit Default Swap
A credit default swap (CDS) is a financial swap arrangement in which the buyer
is compensated by the seller in the event of a debt default (by the debtor) or
another credit event.
• A credit event is a trigger in the CDS market that triggers the protection buyer to
terminate and settle the contract.
• Bonds and other debt securities carry the risk of the borrower defaulting on the
debt or its interest payments.
• The CDS seller protects the buyer against the default of a reference asset.
• The CDS buyer pays the seller a series of payments (the CDS "fee" or "spread")
in exchange for the possibility of receiving a payoff if the asset defaults.
. NDS-OM
In August 2005, RBI introduced an anonymous screen-based order matching

module called NDS-OM. This is an order driven electronic system, where the
participants can trade anonymously by placing their orders on the system or
accepting the orders already placed by other participants. Anonymity ensures a
level playing field for various categories of participants. NDS-OM is operated by the
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CCIL on behalf of the RBI. Direct access to the NDS-OM system is currently
available only to select financial institutions like Commercial Banks, Primary
Dealers, well managed and financially sound UCBs and NBFCs, etc. Other
participants can access this system through their custodians i.e. with whom they
maintain Gilt Accounts. The custodians place the orders on behalf of their
customers. The advantages of NDS-OM are price transparency and better price
discovery.
What is the role of the Clearing Corporation of India Limited (CCIL)?
The CCIL is the clearing agency for G-Secs. It acts as a Central Counter Party (CCP)
for all transactions in G-Secs by interposing itself between two counterparties. In
effect, during settlement, the CCP becomes the seller to the buyer and buyer to the
seller of the actual transaction. All outright trades undertaken in the OTC market
and on the NDS-OM platform are cleared through the CCIL. Once CCIL receives the
trade information, it works out participant-wise net obligations on both the
securities and the funds leg. The payable / receivable position of the constituents
(gilt account holders) is reflected against their respective custodians
Stock Markets and their components
Stock markets are platforms where buyers and sellers come together to trade
shares of publicly listed companies. These markets provide liquidity to investors,
allowing them to buy and sell ownership stakes in companies. When you buy a
stock, you are purchasing a small portion of ownership in that company. The value
of stocks fluctuates based on factors such as company performance, economic
conditions, market sentiment, and geopolitical events. Stock markets play a crucial
role in the economy by facilitating capital formation, allowing companies to raise
funds for growth and expansion.
Stock Exchanges
The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are two
of the major stock exchanges in India. They provide platforms for buying and selling
securities such as stocks, bonds, and derivatives. Here's a brief overview of each:
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1. National Stock Exchange (NSE):

• Established in 1992, the NSE is headquartered in Mumbai, India.
• It is the largest stock exchange in India in terms of trading volume and
market capitalization.
• The NSE uses an electronic trading system, which facilitates faster and
more efficient trading compared to traditional open outcry systems.
• It offers trading in various instruments including equities, derivatives, debt
instruments, and currency futures.
2. Bombay Stock Exchange (BSE):
• Established in 1875, the BSE is one of the oldest stock exchanges in Asia.
It is also headquartered in Mumbai.
• While historically it was the leading stock exchange in India, it has been
surpassed by the NSE in terms of trading volume and market capitalization.
• The BSE also provides a platform for trading in various financial
instruments such as equities, derivatives, mutual funds, and bonds.
• It is known for the SENSEX, an index that represents the performance of
the 30 largest and most actively traded stocks on the BSE.
Stock Broking Platforms
Stock broking platforms in India serve as intermediaries between investors and the
stock market. They provide online platforms for buying and selling stocks, facilitating
transactions, offering research tools, and providing access to market data. These
platforms play a crucial role in democratizing access to the stock market, enabling
individuals to invest in stocks easily and conveniently from anywhere with an internet
connection.
Examples: zerodha, 5paisa, ICICI Direct
Depositories
• A depository is similar to a bank, except that the deposits are electronic securities
(such as shares, debentures, bonds, government securities, units, and so on). A
Depository is similar to a bank in that it maintains funds for depositors. Banks
and depositories have numerous commonalities.
• Depositories hold securities in an account, while the bank holds funds in an
account.
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• While a bank moves money between accounts on the account holder's request, a
Depository transfers securities between accounts on the account holder's
request.
There are two Depositories in India
• National Securities Depository Limited (NSDL)

• Central Depository Services India limited
What is NSDL?
NSDL, one of the largest Depositories in the World, established in August 1996 has
established a state-of-the-art infrastructure that handles most of the securities held
and settled in dematerialized form in the Indian capital market. Although India had a
vibrant capital market which is more than a century old, the paper-based settlement
of trades caused substantial problems like bad delivery and delayed transfer of title,
etc. The enactment of Depositories Act in August 1996 paved the way for
establishment of NSDL.
What is CDSL?
• It is a government-registered share depository, alongside its other state-owned

counterpart National Securities Depository Ltd (NSDL).
• Share depositories hold shares in an electronic or dematerialised form and are
an enabler for securities transactions, playing a somewhat similar role to what
banks play in handling cash and fixed deposits.
• CDSL was founded in 1999. It is a Market Infrastructure Institution or MII that
is deemed as a crucial part of the capital market structure, providing services
to all market participants, including exchanges, clearing corporations, depository
participants, issuers and investors.
Clearing Corporation of India Limited (CCIL):
• It was set up in April 2001 to provide guaranteed clearing and settlement

functions for transactions in money, G-Secs, foreign exchange,
and derivative markets.
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• Promoters: State Bank of India, IDBI Bank Ltd, ICICI Bank Ltd, Life Insurance
Corporation of India (LIC), Bank of Baroda and HDFC Bank Ltd.
• The company was incorporated with an authorised equity share capital of Rs.
50 crores.
• CCIL’s adherence to the stringent principles governing its operations as a
Financial Market Infrastructure (FMI) has resulted in its recognition as a
Qualified Central Counterparty (QCCP) by the Reserve Bank of India in 2014.
Different Types of Shares

Shares, preference shares, cumulative preference shares, and non-cumulative preference
shares are all distinct types of equity ownership in a company, each with its own set of
characteristics:
1. Shares: In general, shares represent ownership in a company. Shareholders typically
have the right to vote on important company matters, such as the election of the
board of directors, and they may receive dividends if the company distributes pro%its
to its shareholders.
2. Preference Shares: Preference shares, also known as preferred shares, are a type of
stock that gives shareholders certain rights and privileges over common
shareholders. These rights often include priority in receiving dividends and priority
in the distribution of assets in the event of liquidation. Preference shares may also
have other features, such as the absence of voting rights or the ability to be converted
into common shares.
3. Cumulative Preference Shares: Cumulative preference shares are a type of
preference share where any unpaid dividends accumulate and must be paid in full
before common shareholders can receive dividends. This means that if the company
skips dividend payments in one period, it must make up for them in future periods
before paying dividends to common shareholders.
4. Non-Cumulative Preference Shares: Non-cumulative preference shares, on the
other hand, do not accumulate unpaid dividends. If the company skips dividend
payments in one period, shareholders of non-cumulative preference shares do not
have the right to claim those missed dividends in future periods. The company is only
obligated to pay dividends in periods when they are declared
What is Mutual Fund?
19
• A mutual fund is a form of financial vehicle that invests in securities such as

stocks, bonds, money market instruments, and other assets by pooling money
from multiple investors.
• Professional money managers manage mutual funds, allocating assets and
attempting to generate capital gains or income for the fund's investors.
• The portfolio of a mutual fund is built and managed to meet the investment
objectives indicated in the prospectus.
• Mutual funds pool money from investors and use it to purchase other securities,
most commonly stocks and bonds.
• The mutual fund company's worth is determined by the performance of the
securities it purchases.
• As a result, when you purchase a mutual fund unit or share, you are purchasing
the portfolio's performance or, more specifically, a portion of the portfolio's
value.
• Instead of a single holding, a mutual fund share represents investments in a
variety of stocks (or other securities).
• The net asset value (NAV) per share is the price of a mutual fund share because
of this.
• The NAV of a fund is calculated by dividing the total value of the securities in
the portfolio by the number of shares in the fund.
Angel Investors, Venture Capitalists, and Private Equity Firms are all types of investors,
but they differ in their focus, investment stage, and the size of investments they make.
1. Angel Investors:
• Angel investors are typically individuals who invest their own money into
early-stage startups, usually during the seed or early stages of
development.
• They often provide funding in exchange for equity ownership in the
company.
• Angel investors may also offer mentorship, advice, and networking
opportunities to the startups they invest in.
• Their investments are typically smaller compared to venture capitalists and
private equity firms.
2. Venture Capitalists (VCs):
• Venture capitalists are firms or groups of investors that provide financing to
startups and early-stage companies that have high growth potential.
20
• VCs raise funds from various sources, including institutional investors, to

invest in startups.
• They typically invest in companies that have already demonstrated some level
of market traction or potential for rapid growth.
• Venture capitalists often take an active role in the companies they invest in,
providing not only capital but also guidance, expertise, and connections.
• VCs usually invest larger amounts of money compared to angel investors, but
their investments are still focused on early-stage and high-growth companies.
3. Private Equity Firms:
• Private equity firms invest in more mature companies that are either privately
held or publicly traded but looking to be taken private.
• Private equity investments often involve buying a significant stake in a
company, restructuring it, and then either selling it for a profit or taking it
public again through an initial public offering (IPO).
• Private equity investments are typically larger and involve more substantial
stakes in companies compared to angel investments and venture capital.
• Private equity firms often focus on improving the operational efficiency and
financial performance of the companies they invest in, rather than just
providing capital.
Qualified Institutional Placement (QIP)
A Qualified Institutional Placement (QIP) is a method through which listed companies in

India can raise capital by issuing securities to qualified institutional buyers (QIBs) such as
mutual funds, banks, financial institutions, insurance companies, and foreign institutional
investors (FIIs). QIPs are regulated by the Securities and Exchange Board of India (SEBI)
and provide an avenue for companies to raise funds without the need for a public issue.
This method allows companies to raise capital quickly and efficiently from sophisticated
investors.
Social Stock Exchanges
What are SSEs and why do we need them?

SSEs are trading platforms that allow social businesses and non-pro%its to raise capital by
attracting ethical investors willing to invest in organisations that have a dual corporate and
social mission.
21
At present, the social-development sector in India receives funding through multiple sources
spanning corporate social responsibility (CSR), philanthropy, government funding and
retail charity. An SSE would attempt to bring coherence across to diverse platforms with
uniform frameworks of funding, utilisation, impact-creation, measurement, disclosures, and
reporting.
With this in mind, and with an aim to enhance the ability of social enterprises and voluntary
organisations to raise capital through debt, equity and/or mutual funds, India’s Finance
Minister announced plans to set up an India-based SSE in 2019.
Which entity can identify itself as a social enterprise?
Social Stock Exchange identi%ies the following two forms of social enterprises that are
engaging in the activity of creating positive social impact and that meets primacy of their
social intent.
• For Pro%it Social Enterprise

• Not for Pro%it Organization
The entity must target underserved or less privileged population segments or regions which
have recorded lower performance in the development priorities of central or state
governments.
Further, to be identi%ied as a social enterprise, it shall demonstrate that 67% of its activities
qualifying as eligible activities to the target population shall be demonstrated by either of the
following:
i. At least 67% of its revenue of the immediately preceding 3-year average of revenues
comes from providing eligible activities to members of the target population. or
ii. At least 67% of the immediately preceding 3-year average of expenditure has been
incurred for providing eligible activities to members of the target population. or
iii. Members of the target population to whom the eligible activities have been
provided constitute at least 67% of the immediately preceding 3-year average of
the total customer base and/or total number of bene%iciaries.
However, corporate foundations, political or religious organizations or activities, professional

or trade associations, infrastructure, and housing companies, except affordable housing, shall
not be eligible to be identi%ied as a Social Enterprise.
22
What are the ways in which a Not-for-profit organization can raise funds through
Social Stock Exchange?
A Not-for-Profit organization after registering with Social Stock Exchange may raise funds
on Social Stock Exchange through
• Issuance of Zero Coupon Zero Principal Instruments [through private placement or

public issuance]
• Donations through Mutual Fund Schemes (where returns are donated to not for
profit organization for their activities)
How can a for profit social enterprise raise funds through Social Stock Exchange?
For Profit Social Enterprise may raise funds through
• Issue of Equity Shares

• Issue of Equity Shares to an Alternative Investment Fund including Social Impact
Fund
• Issue of Debt Instruments
Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)
Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are
financial instruments designed to allow investors to invest in real estate and infrastructure
projects, respectively, without directly owning the underlying assets. Both REITs and InvITs
function as trusts that own and manage income-generating properties or infrastructure
assets, and they distribute the income generated from these assets to their unit holders.
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1. REITs (Real Estate Investment Trusts):

• REITs primarily invest in income-generating real estate assets such as
commercial buildings, office spaces, malls, hotels, and residential complexes.
• In India, REITs were introduced in 2014 by the Securities and Exchange Board
of India (SEBI). They allow investors to invest in large-scale, income-producing
real estate assets through the purchase of units in a listed trust.
• REITs are required to distribute at least 90% of their income generated from
rent or lease of their properties to unit holders as dividends, making them
attractive for investors seeking regular income streams.
• They are listed and traded on stock exchanges, providing liquidity to investors.
• REITs are managed by professional management teams who handle the
acquisition, management, and sale of properties within the trust.
2. InvITs (Infrastructure Investment Trusts):
• InvITs invest in income-generating infrastructure assets such as roads,
highways, power transmission lines, renewable energy projects, and other
infrastructure projects.
• Similar to REITs, InvITs were introduced in India by SEBI in 2014 to provide a
platform for infrastructure developers to monetize their completed and
revenue-generating projects.
• InvITs raise funds from investors by issuing units, which represent ownership
in the trust.
• They are required to distribute a significant portion of their income to unit
holders, typically around 90%, in the form of dividends.
• InvITs provide an avenue for investors to participate in infrastructure projects
with relatively lower investment amounts compared to direct ownership.
• Like REITs, InvITs are listed and traded on stock exchanges, providing
liquidity to investors.
What are Alternative Investment Funds?
• AIFs are any privately pooled investment fund (whether from Indian or foreign
sources) in the form of a trust, a company, a body corporate, or a Limited
Liability Partnership, as defined by the Securities and Exchange Board of India
(Alternative Investment Funds) Regulations, 2012.
What are Category I AIFs?
AIFs which invest in start-up or early stage ventures or social ventures or SMEs or
infrastructure or other sectors or areas which the government or regulators consider as
socially or economically desirable and shall include venture capital funds, SME Funds,
24
social venture funds, infrastructure funds and such other Alternative Investment Funds
as may be specified.
What are Category II AIFs?
AIFs which do not fall in Category I and III and which do not undertake leverage or
borrowing other than to meet day-to-day operational requirements and as permitted in
the SEBI (Alternative Investment Funds) Regulations, 2012. Various types of funds such
as real estate funds, private equity funds (PE funds), funds for distressed assets,
Debt funds, fund of funds etc. are registered as Category II AIFs.
What are Category III AIFs?

AIFs which employ diverse or complex trading strategies and may employ leverage
including through investment in listed or unlisted derivatives. Various types of funds such
as hedge funds, PIPE Funds, etc. are registered as Category III AIFs.
What are Participatory Notes?

• Participatory Notes are Overseas Derivative Instruments with Indian stocks as
underlying assets that allow foreign investors to invest in Indian stock exchanges
without having to register with SEBI.
• Participatory notes are not traded on Indian stock exchanges and are sold in a
directory to foreign investors who purchase them through the FII to dodge taxes and
regulations.
Working of the Participatory Notes
Through a series of steps, P-Notes can be used to purchase any Indian security desired by
an investor:
• An investor deposits money with a registered foreign institutional investor (FII),
such as HSBC in the United States.
• The bank is then notified of the Indian security or securities that the investors desire
to purchase.
• The investor transfers funds to the FII account, and the FII issues participatory notes
to the client and purchases the underlying stock or equities in the appropriate
quantities from the Indian market.
• Dividends, capital gains, and any other payouts due to stockholders owning shares in
the Indian firm are available to the investor.
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• The FII reports all of its issuances to Indian regulators every quarter, but it is
required by law not to reveal the identity of the real investor.
Derivatives
Derivatives are financial instruments that derive their value from an underlying asset, such
as stocks, commodities, currencies, or indices.
1. Call Option:
• A call option gives the holder the right, but not the obligation, to buy an
underlying asset at a specified price (the strike price) within a specific period
of time (until expiration).
• The buyer of a call option pays a premium to the seller (writer) of the option.
• Example: Suppose you buy a call option on Company XYZ stock with a strike
price of $100 and an expiration date one month from now. If the stock price
rises above $100 during that month, you can exercise your option and buy the
stock at $100, even if the market price is higher. If the stock price remains
below $100, you can let the option expire, and your loss will be limited to the
premium you paid for the option.
2. Put Option:
• A put option gives the holder the right, but not the obligation, to sell an
underlying asset at a specified price (the strike price) within a specific period
of time (until expiration).
• The buyer of a put option pays a premium to the seller (writer) of the option.
• Example: Let's say you buy a put option on Company XYZ stock with a strike
price of $50 and an expiration date one month from now. If the stock price falls
below $50 during that month, you can exercise your option and sell the stock
at $50, even if the market price is lower. If the stock price remains above $50,
you can let the option expire, and your loss will be limited to the premium you
paid for the option.
3. Forwards: A forward contract is an agreement between two parties to buy or sell an
asset at a predetermined price (the forward price) at a specified future date. The
underlying asset can be commodities, currencies, stocks, or indices. Here's an
example:
Let's say Company A expects to need 1,000 barrels of oil in six months. However,
they're worried about the price of oil increasing before then, which could hurt their
26
profits. So, they enter into a forward contract with Company B to buy 1,000 barrels of
oil at $60 per barrel in six months.
• If, in six months, the price of oil is $70 per barrel, Company A still buys the oil
at $60 per barrel as agreed in the forward contract. They benefit from the
lower price.
• Conversely, if the price of oil drops to $50 per barrel, Company A is obligated
to buy the oil at $60 per barrel, which results in a loss compared to the current
market price.
4. Futures: Futures contracts are similar to forwards but are standardized and traded
on exchanges. They have clearinghouses to guarantee the trades. Futures contracts
are often used for speculative purposes, as well as hedging. Here's an example:
Let's say Trader X believes that the price of gold will increase over the next three
months. They buy a gold futures contract, agreeing to purchase 100 ounces of gold at
$1,800 per ounce in three months.
• If, in three months, the price of gold has risen to $1,900 per ounce, Trader X
can buy gold at $1,800 per ounce as agreed in the futures contract and
immediately sell it at $1,900 per ounce, making a profit.
• On the other hand, if the price of gold drops to $1,700 per ounce, Trader X is
still obligated to buy gold at $1,800 per ounce, resulting in a loss compared to
the current market price.
Bitcoins
Bitcoin is a digital currency that operates independently of a central bank or government. It's
based on a decentralized technology called blockchain, which securely records all
transactions across a network of computers.
Bitcoins can be bought, sold, and transferred electronically, making them a form of digital
cash. Transactions are veri%ied by network nodes through cryptography and recorded in a
public ledger, ensuring transparency and security. Payments or transfers using bitcoins can
be done anonymously.
UPSC PYQs (2013-2023)
1. Supply of money remaining the same when there is an increase in demand for money, there
will be (2013)
(a) a fall in the level of prices
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(b) an increase in the rate of interest

(c) a decrease in the rate of interest
(d) an increase in the level of income and employment
Answer- b
Direct application based question. If the demand increase when the supply is same, it will
lead to an increase in prices or in this case rate of interest to be charged.
2. With reference to ‘Bitcoins’, sometimes seen in the news, which of the following statements
is/are correct?
1. Bitcoins are tracked by the Central Banks of the countries.
2. Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a
Bitcoin address.
3. Online payments can be sent without either side knowing the identity of the other.
Select the correct answer using the code given below. (2016)
(a) 1 and 2 only
(b) 2 and 3 only
(c) 3 only
(d) 1, 2 and 3
Answer – b
Bitcoin is a digital currency that is not tied to a bank or government and allows users to spend
money anonymously. The coins are created by users who ''mine'' them by lending computing
power to verifying other users' transactions. They receive bitcoins in exchange. The coins also
can be bought and sold on exchanges with U.S. dollars and other currencies.
Bitcoins have become popular because transactions can be made anonymously, making the
currency popular with libertarians as well as tech enthusiasts, speculators - and criminals.
3. What is/are the purpose/purposes of Government’s ‘Sovereign Gold Bond Scheme’ and
‘Gold Monetization Scheme’?
1. To bring the idle gold lying with Indian households into the economy.
2. To promote FDI in the gold and jewellery sector
3. To reduce India’s dependence on gold imports
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer – c
The government had launched three ambitious schemes to reduce the physical demand for
gold and %ish out 20,000 tonnes of the precious metal worth $800 billion lying idle with
households. PM launched the maiden sovereign gold bond, gold monetisation and the Indian
28
gold coin scheme. The main objectives of the schemes is to reduce India's gold imports and
bring all the gold lying idle with individuals and households.
4. Which of the following is issued by registered foreign portfolio investors to overseas

investors who want to be part of Indian stock market without registering themselves directly?
(2019)
(a) Certi%icate of Deposits
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Answer- d
• A Participatory Note (PN or P-Note) is a derivative instrument issued in foreign
jurisdictions, by a SEBI registered Foreign Institutional Investor (FII) or its sub-accounts or
one of its associates, against underlying Indian securities. The underlying Indian security
instrument may be equity, debt, derivatives or may even be an index.
• A promissory note is a %inancial instrument that contains a written promise by one party to
pay another party a de%inite sum of money, either on demand or at a speci%ied future date.
• Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. CPs are short -term instruments and the maturity period varies from seven
days to up to one year. It was introduced to enable highly rated corporate borrowers to
diversify their sources of short -term borrowings, and also to provide an additional
instrument to investors.
• Certi%icate of Deposits -It is a saving certi%icate with a %ixed maturity date at %ixed interest
rate. It is issued by commercial banks and %inancial institutions. It is issued in the form of
promissory note in exchange of funds deposited in banks for speci%ied period.
5. With reference to the Indian economy, consider the following statements:

1. 'Commercial Paper' is a short-term unsecured promissory note.
2. 'Certi%icate of Deposit' is a long-term instrument issued by the Reserve Bank of India to a
corporation.
3. 'Call Money' is a short-term %inance used for interbank transactions.
4. 'Zero-Coupon Bonds are the interest bearing short-term bond issued by the Scheduled
Commercial Banks to corporations.
Which of the statements given above is/are correct? (2020)
(a) 1 and 2 only
(b) 4 only
(c) 1 and 3 only
(d) 2, 3 and 4 only
Answer – c
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1. Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. It can be issued for maturities between a minimum of 7 days and a
maximum of up to one year from the date of issue (short-term). Hence statement 1 is correct.
2. Certi%icate of Deposit (CD) is a negotiable money market instrument and is issued in
dematerialised form against funds deposited at a bank or other eligible %inancial institution
for a speci%ied time period. Issued by the Federal Deposit Insurance Corporation (FDIC) and
regulated by the Reserve Bank of India, the CD is a promissory note, the interest on which is
paid by the %inancial institution. Hence statement 2 is incorrect.
3. Call money rate is the rate at which short term funds are borrowed and lent in the money
market among banks on a day-to-day basis. Banks resort to this type of loan to %ill the asset
liability mismatch, comply with the statutory CRR and SLR requirements and to meet the
sudden demand of funds. Hence statement 3 is correct.
4. Bonds are a type of debt instrument. Zero Coupon Bonds are issued at a discount and
redeemed at par. No interest payment is made on such bonds at periodic intervals before
maturity. Hence statement 4 is incorrect.
6. In the context of the Indian economy, non-%inancial debt includes which of the following?
1. Housing loans owed by households
2. Amounts outstanding on credit cards
3. Treasury bills
Select the correct answer using the code given below: (2020)
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
Answer – d
Non-%inancial debt consists of credit instruments issued by governmental entities,
households and businesses that are not included in the %inancial sector. (The %inancial sector
comprises commercial banks, insurance companies, non-banking %inancial companies, co-
operatives, pension funds, mutual funds and other smaller %inancial entities). Non-%inancial
debt includes household or commercial loans, Treasury bills and credit card balances. They
share most of the same characteristics with %inancial debt, except the issuers are non-
%inancial. Hence correct answer is option (d).
7. Indian Government Bond Yields are in%luenced by which of the following?

1. Actions of the United States Federal Reserve
2. Actions of the Reserve bank of India
3. In%lation and short-term interest rates
(a) 1 and 2 only
30
(b) 2 only
(c) 3 only
(d) 1, 2 and 3
Answer – d
Bond yield is the return an investor gets on that bond or on a particular government security.
It depends on the price of the bond which is impacted by its demand. The major factors
affecting the yield is the monetary policy of the Reserve Bank of India, especially the course
of interest rates, the %iscal position of the government and its borrowing programme, global
markets, economy, and in%lation.
Actions of the United States federal reserve can impact the investments %lowing in India. The
investments by foreign players in government securities can be effected by this. This will lead
to change in demand of government securities and thereby impacting its yield. Hence
statement 1 is correct.
Actions of Reserve bank determine the liquidity and also the cost of funds available in the
economy through its various in%lation management tools. The cost of funds will directly
impact the demand of government securities in the market and thereby in%luencing its yield.
Hence statement 2 is correct.
In%lation and short term rates determine the purchasing capacity of the people in the
economy. Therefore, this also has impact on the demand and price of the government -
securities thereby in%luencing the yield. Hence statement 3 is correct.
8. With reference to India, consider the following statements:

1. Retail investors through demat account can invest in 'Treasury Bills' and 'Government of
India Debt Bonds' in primary market.
2. The 'Negotiated Dealing System-Order Matching' is a government securities trading
platform of the Reserve Bank of India.
3. The 'Central Depository Services Ltd' is jointly promoted by the Reserve Bank of India and
the Bombay Stock Exchange.
Which of the statements given above is/are correct? (2021)
(a) 1 only
(b) 1 and 2
(c) 3 only
(d) 2 and 3
Answer – b
In February, 2021, RBI allowed retail investors to directly purchase government bonds by
opening gilt accounts with RBI. RBI has provided retail investors with online access to the
government securities market (primary and secondary) through the RBI (Retail Direct).
Hence statement 1 is correct.
Previously, retail investors can purchase government bonds by registering themselves on
stock exchanges for non-competitive bids. Other route for retail investors is to buy
31
government bonds is government securities (gilt) mutual funds. These are mutual funds
which in turn invest in government securities. Negotiated Dealing System-Order
Matching(NDS-OM) is a screen based electronic anonymous order matching system for
secondary market trading in Government securities owned by RBI. The membership of the
system is open to entities like Banks, Primary Dealers, Insurance Companies, Mutual Funds
etc. i.e. entities who maintain SGL accounts with RBI. Hence, statement 2 is correct.
Central Depository Services Ltd (CDSL) was promoted by BSE Ltd. jointly with leading banks
such as State Bank of India, Bank of India, Bank of Baroda, HDFC Bank, Standard Chartered
Bank and Union Bank of India. CDSL was set up with the objective of providing convenient,
dependable and secure depository services at affordable cost to all market participants. A
Depository facilitates holding of securities in the electronic form and enables securities
transactions to be processed by book entry. Hence, statement 3 is not correct.
9. With reference to the Indian economy, what are the advantages of "In%lation-Indexed Bonds
(IIBs)" ?
1. Government can reduce the coupon rates on its borrowing by way of IIBs.
2. IIBs provide protection to the investors from uncertainty regarding in%lation.
3. The interest received as well as capital gains on IIBs are not taxable.
Which of the statements given above are correct ? (2022)
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer – a
In%lation-indexed bonds in India were issued by the Reserve Bank of India (RBI) in 2013 and
were benchmarked to Wholesale Price Index (WPI).
In%lation-indexed bonds are %inancial instruments that attempt to protect the bonds'
purchasing power by tying interest and principal payments to an index of price changes.
Indexed bonds include two types of compensation, a real rate of return plus a compensation
for the erosion of purchasing power. In%lation component on principal will not be paid with
interest but the same would be adjusted in the principal by multiplying principal with index
ratio (IR). At the time of redemption, adjusted principal or the face, whichever is higher, would
be paid. Interest rate will be provided protection against in%lation by paying %ixed coupon rate
on the principal adjusted against in%lation. Hence statement 2 is correct.
Economists have argued that in%lation indexed bonds could reduce government borrowing
costs. If the market overestimates future in%lation, government will reduce borrowing costs
by issuing in%lation indexed bonds rather than nominal bonds. This may occur because, for
example, investors• expectations are not completely forward-looking or rational.
Alternatively, the government, because it is able to in%luence in%lation through its policies,
may have better information about the future course of in%lation, or perhaps has more faith
32
in its commitment to contain it than the public does. In these cases a treasury can lower its
costs by issuing indexed bonds. For example, if coupon rate of IIBs is %ixed 1.5 % above WPI
(Whole sale price index) and current WPI is 4%, so effective rate will be 5.5% (4+1.5). In
future, when WPI falls from 4% to 2%, then effective coupon rate will become 3.5% (i.e.
2+1.5) and thus government can reduce the coupon rates on its borrowing by way of IIBs
through reducing in%lationary trends. Hence statement 1 is correct.
Extant tax provisions will be applicable on interest payment and capital gains on IIBs. There
will be no special tax treatment for these bonds. Hence statement 3 is not correct.
10. With reference to the Indian economy, consider the following statements :
1. A share of the household %inancial savings goes towards government borrowings.
2. Dated securities issued at market-related rates in auctions form a large component of
internal debt.
Which of the above statements is/are correct ? (2022)
(a) 1 only
(b) 2 only
(c) Both l and 2
(d) Neither 1 nor 2
Answer – c
Household %inancial savings refer to currency, bank deposits, debt
securities, mutual funds, pension funds, insurance, and investments in small savings schemes
by households. The net household %inancial savings was 11.5 percent of GNDI (gross national
disposal income) in 2020- 21. A part of this %inancial saving goes toward government
borrowing. As government borrows through the issue of government securities called G-secs
and Treasury Bills. It borrows from the market, small savings funds, state provident funds,
external assistance and short-term borrowings. Any adverse movement in the household
savings will have a signi%icant bearing on banks, insurance companies and mutual/provident
funds, who, in turn, are key investors in government securities. Hence statement 1 is correct.
The Central Government Debt includes all liabilities of Central Government contracted
against the Consolidated Fund of India (de%ined as Public Debt). Public debt is further
classi%ied into internal and external debt. Internal debt consists of marketable debt and non-
marketable debt. Marketable debt comprises of Government dated securities and Treasury
Bills, issued through auctions. Nonmarketable debt comprises of intermediate Treasury Bills
(14 days ITBs) issued to State Governments/UTs as well as select Central Banks, special
securities issued against small savings, special securities issued to public sector banks/EXIM
Bank, securities issued to international %inancial institutions, and compensation and other
bonds.
All marketable securities i.e. Dated securities and Treasury bills are issued through auctions
as per the schedule noti%ied through halfyearly/quarterly auction calendars. As at end-March
33
2021, outstanding amounts under dated securities stood at 71.7 lakh crore (36.3 per cent of
GDP) and accounted for 68.1 per cent of the total Public Debt. Hence statement 2 is correct.
11. With reference to Convertible Bonds, consider the following statements:

1. As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate
of interest.
2. The option to convert to equity affords the bondholder a degree of indexation to rising
consumer prices.
Which of the statements given above is/are correct?
(a) 1only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer – c
A convertible bond is a %ixed-income corporate debt security that yields interest payments,
but can be converted into a predetermined number of common stock or equity shares. It
offers investors a type of hybrid security that has features of a bond, such as interest
payments, while also having the option to own the underlying stock.
Issuing convertible bonds can help companies minimize negative investor sentiment that
would surround equity issuance. Further, issuing convertible bonds can also help provide
investors with some security in the event of default. A convertible bond protects investors'
principal on the downside, but allows them to participate in the upside should the underlying
company succeed. However, convertible bonds tend to offer a lower coupon rate or rate of
return in exchange for the value of the option to convert the bond into common stock.
Companies bene%it since they can issue debt at lower interest rates than with traditional bond
offerings. However, not all companies offer convertible bonds. Hence statement 1 is correct.
The option to convert to equity affords the bondholder a degree of indexation to rising
consumer prices. As indexation will ensure that prices are adjusted with in%lation over a
period of time. With the help of indexation, bondholders will be able to lower their longterm
capital gains (as their investment will be adjusted with in%lation) even when converting bonds
into equity, which brings down their taxable income. Hence statement 2 is correct.
12. Consider the following markets:

1. Government Bond Market
2. Call Money Market
3. Treasury Bill Market
4. Stock Market
How many of the above are included in capital markets? (2023)
(a) Only one
(b) Only two
34
(c) Only three

(d) All four
Answer – b
A capital market is a %inancial market where long-term debt or equity-backed securities are
bought and sold.
It includes
1. Government Bonds - In India, fall under the broad category of government securities (G-
Sec) and are primarily long term investment tools issued for periods ranging from 5 to 40
years. It can be issued by both Central and State governments of India.
2. Capital market refers to a broad spectrum of tradeable assets that includes the stock market
as well as other venues for trading different %inancial products.
Treasury bills are money market instruments issued by the Government of India and call
money market is an essential part of the Indian Money Market, where the day-to-day surplus
funds (mostly of banks) are traded.
13. In the context of %inance, the term 'beta' refers to (2023)

(a) the process of simultaneous buying and selling of an asset from difference platforms.
(b) an investment strategy of a portfolio manager to balance risk versus reward.
(c) a type of systemic risk that arises where perfect hedging is not possible.
(d) a numeric value that measures the %luctuations of a stock to changes in the overall stock
market.
Answer – d
Beta (β) is a measure of the volatility—or systematic risk—of a security or portfolio
compared to the market as a whole. Equities having a beta value larger than one, or high beta
stocks, are often known as volatile stocks. The slightest adjustments in stock market
indicators have a big in%luence on them. A security that is comparatively more stable is a low
beta stock i.e. has a beta rating below 1.

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Financial Markets

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Financial Markets can be classiFied based on various criterion.

• Participants: Banks, %inancial institutions, corporations, governments, and

Primary Vs Secondary (Based on the whether the instrument is new or already

Capital Market Instruments

A bond is a debt instrument in which an investor loans money to an entity (typically

What is a Government Security (G-Sec)?

A Government Security (G-Sec) is a tradeable instrument issued by the Central

Coupon : 7.17% paid on face value

State Development Loans (SDLs)

• Non-convertible bonds are traditional debt securities that cannot be converted

Money Market Instruments

Treasury Bills (T-bills)

Cash Management Bills (CMBs)

In 2010, Government of India, in consultation with RBI introduced a new short-term

Call money market

Repo or ready forward contact is an instrument for borrowing funds by selling

Commercial Paper (CP)

• Commercial Paper (CP) is a short-term unsecured money market instrument

Maturity Minimum: 7 Days and Maximum: 1 Year from the date

Regulators RBI and FIMMDA (Market Self-Regulatory Organisation

• The CD was introduced in 1989 on the recommendation of the Vaghul

Features of Certificate of Deposits

Issuance of Certificate of Deposits

• Scheduled commercial banks or financial institutions in India that have been

Gold Monetisation Scheme

Sovereign Gold Bond (SGB) Scheme

• SGBs are government securities denominated in grams of gold.

Consol Bonds/Perpetual Bonds

Perpetual bonds, also known as perpetuities or perpetual securities, are a type of

Credit Default Swap

In August 2005, RBI introduced an anonymous screen-based order matching

What is the role of the Clearing Corporation of India Limited (CCIL)?

Stock Markets and their components

1. National Stock Exchange (NSE):

Stock Broking Platforms

Examples: zerodha, 5paisa, ICICI Direct

There are two Depositories in India

• National Securities Depository Limited (NSDL)

• It is a government-registered share depository, alongside its other state-owned

Clearing Corporation of India Limited (CCIL):

• It was set up in April 2001 to provide guaranteed clearing and settlement

Different Types of Shares

What is Mutual Fund?

• A mutual fund is a form of financial vehicle that invests in securities such as

• VCs raise funds from various sources, including institutional investors, to

Qualified Institutional Placement (QIP)

A Qualified Institutional Placement (QIP) is a method through which listed companies in

Social Stock Exchanges

What are SSEs and why do we need them?

Which entity can identify itself as a social enterprise?

• For Pro%it Social Enterprise

However, corporate foundations, political or religious organizations or activities, professional

• Issuance of Zero Coupon Zero Principal Instruments [through private placement or

For Profit Social Enterprise may raise funds through

• Issue of Equity Shares

1. REITs (Real Estate Investment Trusts):

What are Alternative Investment Funds?

What are Category I AIFs?

What are Category II AIFs?

What are Category III AIFs?

What are Participatory Notes?

UPSC PYQs (2013-2023)