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Financial Markets and Services

Indian Financial System Module 1

Financial System

An institutional framework existing in a country to enable financial transactions Three main parts

Financial assets (loans, deposits, bonds, equities, etc.) Financial institutions (banks, mutual funds, insurance companies, etc.) Financial markets (money market, capital market, etc.)

Regulation is another aspect of the financial system (RBI, SEBI, IRDA, )

Financial assets/instruments

Enable channelising funds from surplus units to deficit units There are instruments for savers such as deposits, equities, mutual fund units, etc. There are instruments for borrowers such as loans, overdrafts, etc. Like businesses, governments too raise funds through issuing of bonds, Treasury bills, etc.

Financial Institutions

Includes institutions and mechanisms which

Affect generation of savings by the community Mobilisation of savings Effective distribution of savings

Institutions are banks, insurance companies, mutual funds- promote/mobilise savings Individual investors, industrial and trading companies- borrowers

Financial Markets

Money Market- for short-term funds (less than a year) Capital Market- for long-term funds

Primary Issues Market Stock/secondary Market

Money Market
Definition money market is a collective name given to the various forms of and institutions that deals with various grades of near money - Geoffrey Crowther

Money Market Instruments

Commercial Bills Treasury Bills Call and short notice money Certificate of deposit Commercial paper Repurchase agreement ADRs/ GDRs

Commercial bills
Commercial bill or bill of exchange is a written document signed by the drawer, directing a certain person to pay certain sum of money only to, or order of certain person, or to the bearer of the instrument at a fixed time in the future or on demand.

Reasons for poor development of CBs

Preference to cash to bills Lack of uniform practices with regard to bills Lack of specialised discount houses Preference of cash credit and overdraft from commercial banks

Treasury bills
Treasury bill represents short term borrowings of the governments. Treasury bill market refers to the market where treasury bills are bought and sold Types of treasury Bills 14 day treasury bill- weekly auction 91 days treasury bills a) Ordinary treasury bills b) Adhoc TBs

182 treasury Bills- monthly issue 364 treasury bills- fortnight

Call and short notice money

Call money refers to a money given for a very short period of time. It may be taken for a day or overnight but not exceeding seven days in any circumstance Another variation of call money is notice money which is for a period up to 14 days

Certificate of Deposit (CDs)

Certificate of deposits are marketable receipts in bearer form of funds deposited in a bank for a specified period of time at a specific interest rate. They are freely transferable Can be traded in the secondary market They are liquid and riskless in terms of default of payment of interest and principal RBI launched a scheme in june 1989 permitting banks to issue CDs

The minimum denomination of CD is 5 lakh Maturity period- varies from 91 days to 1 year CDs to be issued on discounting basis CD are transferable after a lock-in period of 45 days All scheduled banks other than RRBs are allowed to issue CD without any ceiling CDs cannot to bought back nor any loan can be given against CDs by the issuing institutions

Commercial papers
A commercial paper is an unsecured promissory note issued with a fixed maturity by a company approved by RBI, negotiable by endorsement and delivery, issued in bearer form and issued at such discount on face value as may be determined by the issuing company

RBI guidelines

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note It was introduced in India in 1990. Corporate, primary dealers (PDs) and the AllIndia Financial Institutions (FIs) are eligible to issue CP.

A corporate would 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. company has been sanctioned working capital limit by bank/s or all-India financial institution/s;

The company should have a minimum credit rating of p2 from CRISIL and A2 from ICRA CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. CP can be issued in denominations of Rs.5 lakh or multiples thereof. Only a scheduled bank can act as an IPA for issuance of CP.

Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, NonResident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs

It can be held as dematerialized form Underwriting not allowed

REPO(Repurchase Agreement)

Repo is a money market instrument which enables collateralized short-term borrowing and lending through sale and purchase of this instrument Under repo, a holder of securities sells them to investor with an agreement to purchase it at a later date and a rate. The forward price set in advance at a level different from the spot rate by considering the RBI repo rate

Regulated by SCR act 1956 and RBI Repo- seller point of view Reverse repo- supplier of funds/ buyer point of view

Significance of money market

Economic development Profitable investment Borrowings by the government Importance of central bank Mobilization of funds Self-sufficiency of commercial banks Savings and investment

The institutions of money market

Commercial banks Central bank Acceptance houses/ bill brokers Non banking financial intermediaries

Characteristics of a developed money market

Developed commercial banking system Presence of central bank Near money assets Availability of ample resources Integrated interest- rate structure

Capital market
Meaning- capital market refers to the institutional arrangements for lending and borrowing of long term funds It consists of series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities

Functions of capital market

Mobilsation of financial resources on a nation wide scale Securing the foreign capital to fill up the deficit in the required resources for economic growth at a faster rate Effective allocation of the mobilized financial resources

Components of Capital market

New issue market/ primary market Stock market/ secondary market Financial institutions

Capital market instruments

Ownership securitiesCreditorship securities

Financial Services

Fund based Non fund based

Fund based
Fund based activities / services are those where funds of financial institutions are involved such as: Underwriting of investments in shares, debentures Equipment leasing Hire purchase Bill discounting Venture capital

Housing finance Insurance services Factoring etc..,

Non fund based

Non-Fund based activities/services are those where funds are not involved and financial institution gets income in the form of fee such as Issue management Portfolio management Loan syndication

Credit rating Stock broking

Secondary Market
Definitionsecurity exchanges are market places where securities that have been listed thereon may be bought and sold for either investment or speculation -pyle


It is a place where securities purchased and sold A stock exchange is an association of persons The trading in stock exchange is strictly regulated and rules and regulations are prescribed for various transactions Both genuine and speculators buy and sell shares

The securities of corporations, trusts, governments, municipal corporation etc.., are allowed to be dealt in stock exchange

Functions of a stock exchange

Ensure liquidity of capital Continuous market of securities Evaluations of securities Mobilizing surplus funds Safety in dealings Listing of securities Platform for public debt Clearing house of business information

Listing of securities
Meaning- listing of securities means permission to quote shares and debentures officially on the trading floor of the stock exchange.the stock exchange fix certain standards which the company must fulfill before getting listed

Requirements for listing

MOA & AOA Copies of all prospectus and statement inlieu of prospectus Copies of B.S, audited accounts, agreements with promoters, underwriters,brokers Letter on consent from controller of capital issues, now replaced by SEBI Details of shares and debentures forfeited

Details of bonuses and dividends declared History of company in brief An undertaking regarding the compliance with the provisions of companies act 1956 and securities contracts regulation act of 1956

Objectives of listing

To ensure proper supervision and control in the dealings in securities The protect the interest of the investors To avoid concentration of economic power To assure marketing facilities for securities To ensure liquidity of securities

Advantages of listing

Publicity of securities Protection of investors interest Ensures liquidity Better goodwill

Criteria for listing

At least 60% of each class of securities listed must be offered to public for subscription and the minim um issued capital should be 3 crores It must be offered through advertisement in newspaper at least for a period of 2 days The company should be of a fair size having broad based capital structure and public interest in its securities

There must be at least 10 public shareholders for every Rs 1 lakh shares of fresh issue of capital and it is 20 in case of subsequent issue of shares A company having its paid up share capital of more than 5 crores must list its securities in more than one recognized stock exchange The co must pay interest on the excess application money received at the rates ranging between 4% and 15% depending on the delay beyond 10 weeks from the date of closure of subscription

the existing companies must adhere to the ceiling in expenditure of public issues A certificate to the effect that shares from promoters quota are not sold or transferred for a period of 3 years must be submitted

Players in stock market

Jobbers Taraniwalas Commission brokers Sub-Brokers/remisiers Authorized clerks

Method of Trading in a Stock Exchange

Choice of broker Placement of order a) At best order b) Limit order c) Immediate or cancel order d) Discretionary order e) Limited discretionary order f) Open order g) Stop loss order

Execution of orders Preparation of contract notes Settlement of transactions a) Spot delivery b) Hand delivery system- DoA or 14 days WEE c) Clearing settlement d) Special settlement

Depository system

Depository - A depository is a provider for holding and transacting securities in electronic form. National Securities Depository Limited (NSDL), and Central Depository Service Limited (CDSL)

Depository Participant- A Depository Participant (DP) is an agent of the depository and provides depository services to investors. To avail the services of the depository, the investors has to open an account with a DP

Beneficial Owner -is a person in whose name a demat account is opened with CDSL for the purpose of holding securities in the electronic form and whose name is recorded with CDSL. Issuer -means any entity making an issue of securities

Dematerialisation: The model adopted in India provides for dematerialisation of securities. This is a significant step in the direction of achieving a completely paper-free securities market. Dematerialization is a process by which physical certificates of an investor are converted into electronic form and credited to the account of the depository participant

In order to dematerialise physical securities one has to fill in a DRF (Demat Request Form) which is available with the DP and submit the same along with physical certificates one wishes to dematerialise. Separate DRF has to be filled for each ISIN no.. The complete process of dematerialization is outlined below: Bullet Surrender certificates for dematerialization to your depository participant.

Depository participant intimates Depository of the request through the system. Depository participant submits the certificates to the registrar. Registrar confirms the dematerialization request from depository. After dematerializing certificates, Registrar updates accounts and informs depository of the completion of dematerializations.

Depository updates the accounts and informs the depository participant. Depository participant updates the accounts and informs the investor.


If one wishes to get back your securities in the physical form one has to fill in the RRF form (Remat Request Form) and one request your DP for rematerialisation of the balances in your securities account. The process of rematerilisation outlined below: One makes a request for rematerialisation. Depository Participant intimates depository of the request through the system.

Depository confirms rematerialisation request to the registrar. Registrar updates accounts and prints certificates. Depository updates accounts and downloads details to depository participant. Registrar dispatches certificates to the investor.

Benefits of depository system

Elimination of bad deliveries Elimination of all risks associated with physical certificates No stamp duty Immediate transfer and registration of securities Faster settlement cycle T+2 Elimination of problems related to change of address of investor

Elimination of problems related to transmission of demat shares

SEBI(April 12 1988)
Objectives To protect the interests of investors so that there is a steady flow of savings into the capital market To regulate the securities market and ensure fair practices by the issuers of the securities so that they can raise resources at minimum cost

To promote efficient services by brokers, merchant bankers and other intermediaries so that they become competitive and professional


Regulatory functions Developmental functions

Regulatory functions

Regulation of stock exchange Registration and regulation of stock brokers, sub-brokers, registrar to all issue, merchant bankers, underwriters, portfolio managers and such other intermediaries, who are associated with securities market Registration and regulation of working of collective investment schemes including mutual funds

Prohibition of fraudulent and unfair trade practices relating to securities market Prohibition of insider trading Regulating substantial acquisition of shares and take over a company

Developmental functions
Promoting investors education Training of intermediaries Conducting research and published information useful to all market participants Promotion of fair practices. Code of conduct in the stock exchange Promotion of self-regulatory orgainsations Association of Merchant Bankers of India (AMBI) Association of Mutual Funds of India (AMFI)


Power to call periodical returns from recognised stock exchange Power to call any information or explanation from recognised stock exchange and their members Power to direct enquiries to be made in relation to affairs of stock exchange or their members Power to grant approval to bye-laws of recognised stock exchange

Power to make or amend bye-laws of recognised stock exchanges Power to compel listing of securities by public companies Power to control and regulate stock exchange Power to grant registration to market intermediaries


6 members A chairman and two members are appointed by central government One member is appointed by RBI Two members having experience in the securities market appointed by the central government

Organisational departments of SEBI

Primary market department Issue management and intermediaries department Secondary market department Institutional investment department