Money and Capital Markets

Money Market Instruments

Money Market Instruments are simply the instruments or tools which can help one operate in the money market. These instruments serve a dual purpose of not only allowing borrowers meet their short-term requirements but also provide easy liquidity to lenders. Money market instruments allow governments, financial organizations and businesses to finance their short-term cash requirements.

Some of the notable characteristics of money market instruments are as follows:

• Liquidity – Money market instruments are highly liquid because they are fixed-income securities which carry short maturity periods of a year or less.
• Safety – Issuers of money market instruments have strong credit ratings, which automatically means that the money instruments issued by them will also be safe.
• Discount Pricing – Another important characteristic feature of money market instruments is that they are issued at a discount on their face value.

 Types Of Money Market Instruments

Treasury Bills (T-Bills)

• Issued by the Central Government, Treasury Bills are known to be one of the safest money market instruments available. However, treasury bills carry zero risk. I.e. are zero risk instruments. Therefore, the returns one gets on them are not attractive.
• Treasury bills come with different maturity periods like 3-month, 6-month and 1 year and are circulated by primary and secondary markets. Treasury bills are issued by the Central government at a lesser price than their face value. The interest earned by the buyer will be the difference of the maturity value of the instrument and the buying price of the bill, which is decided with the help of bidding done via auctions.
• Currently, there are 3 types of treasury bills issued by the Government of India via auctions, which are 91-day, 182-day and 364-day treasury bills.

Q. Consider the following statements:
1. The Reserve Bank of India manages and services Government of India Securities but not any State Government Securities.
2. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
3. Treasury bills offer are issued at a discount from the par value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 only
(c) 2 and 3 only
(d) 1, 2 and 3

Certificate of Deposits (CDs)

• A Certificate of Deposit or CD, functions as a deposit receipt for money which is deposited with a financial organization or bank. However, a Certificate of Deposit is different from a Fixed Deposit Receipt in two aspects. The first aspect of difference is that a CD is only issued for a larger sum of money. Secondly, a Certificate of Deposit is freely negotiable.
• First announced in 1989 by RBI, Certificate of Deposits have become a preferred investment choice for organizations in terms of short-term surplus investment as they carry low risk while providing interest rates which are higher than those provided by Treasury bills and term deposits.
• Certificate of Deposits are also relatively liquid, which is an added advantage, especially for issuing banks. Like treasury bills, CDs are also issued at a discounted price and their tenor ranges between a span of 7 days up to 1 year. However, banks issue Certificates of Deposits for durations ranging from 3 months, 6 months and 12 months. They can be issued to individuals (except minors), trusts, companies, corporations, associations, funds, non-resident Indians, etc.

 Commercial Papers (CPs)

• Commercial Papers are can be compared to an unsecured short-term promissory note which is issued by highly rated companies with the purpose of raising capital to meet requirements directly from the market.
• CPs usually feature a fixed maturity period which can range anywhere from 1 day up to 270 days. Highly popular in countries like Japan, UK, USA, Australia and many others, Commercial Papers promise higher returns as compared to treasury bills and are automatically not as secure in comparison.
• Commercial papers are actively traded in secondary market.

 Repurchase Agreements (Repo)

• Repurchase Agreements, also known as Reverse Repo or simply as Repo, loans of a short duration which are agreed upon by buyers and sellers for the purpose of selling and repurchasing.
• These transactions can only be carried out between RBI approved parties Repo / Reverse Repo transactions can be done only between the parties approved by RBI. Transactions are only permitted between securities approved by the RBI like treasury bills, central or state government securities, corporate bonds and PSU bonds.

Call Money Market:

Collateral Borrowing and Lending Obligations:

Q. With reference to the Indian economy, “Collateral Borrowing and Lending Obligations” are the instruments of:
(a) Bond market
(b) Forex market
(c) Money market
(d) Stock market

 Bills of Exchange

According to the Negotiable Instruments Act 1881, a bill of exchange is defined 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 bearer of the instrument.

A bill of exchange is generally drawn by the creditor upon his debtor. It has to be accepted by the drawee (debtor) or someone on his behalf. It is just a draft till its acceptance is made.

For example, Amit sold goods to Rohit on credit for Rs. 10,000 for three months. To ensure payment on due date Amit draws a bill of exchange upon Rohit for Rs. 10,000 payable after three months.
Before it is accepted by Rohit it will be called a draft. It will become a bill of exchange only when Rohit writes the word “accepted” on it and append his signature thereto communicate his acceptance.

Parties to a Bill of Exchange

There are three parties to a bill of exchange:

1. Drawer is the maker of the bill of exchange. A seller/creditor who is entitled to receive money from the debtor can draw a bill of exchange upon the buyer/debtor. The drawer after writing the bill of exchange has to sign it as maker of the bill of exchange.
2. Drawee is the person upon whom the bill of exchange is drawn. Drawee is the purchaser or debtor of the goods upon whom the bill of exchange is drawn.
3. Payee is the person to whom the payment is to be made. The drawer of the bill himself will be the payee if he keeps the bill with him till the date of its payment.

The payee may change in the following situations:

• In case the drawer has got the bill discounted, the person who has discounted the bill will become the payee;
• In case the bill is endorsed in favour of a creditor of the drawer, the creditor will become the payee.

Letter of Credit(LOC):
A letter of credit (LOC) is a promise from a bank to make a payment after verifying that somebody meets certain conditions.

The easiest way to understand how LOCs work is to see an example, and this describes the process step-by-step.

For this example, we assume that an importer is buying goods from an exporter. However, LOCs are useful in several types of transactions. Standby letters of credit, for example, can work for a variety of services, including building projects, signing up for electrical service, and more. If you want to see how a LOC works for common domestic transactions, replace the terms “importer” and “exporter” with a customer or service provider in your industry.

 For example:

• The exporter could be an electric utility company that sells power. The importer would be a customer that buys energy from the utility.
• The exporter could be a contractor that promises to complete a project by a specific date. The importer would be the contractor’s customer.

First, a buyer (importer) and seller (exporter) decide to do business together. They agree on a price, quantity, and other terms, and they specify how and when the goods will be shipped to the buyer. As part of the contract, we assume that the seller requires the buyer to use a letter of credit (LOC).

Why does the seller demand a letter of credit? The seller wants more confidence that the buyer will pay. Perhaps this buyer and seller have never worked together, or the order might be large enough to cause severe financial hardship if something goes wrong.

For example, if the seller spends money to produce and ship goods, the seller wants to recoup those costs. The buyer might not pay for several reasons (the buyer’s assets could be seized for some reason, the buyer might go bankrupt, and so on).

The sales agreement is not part of a letter of credit. The sales agreement is between the buyer and the seller only, and the LOC relies on information in the agreement, but the LOC is a separate document issued by a bank.

Letter of Undertaking(LOU):

Capital Market

Equity Market

The capital market is divided into two segments viz:

• Primary Market
• Secondary Market

Primary Market: Primary markets are basically the platform where an investor gets the first opportunity to purchase a new security.

The group or company that issues the security gets the money by selling a certain amount of securities. They sell their securities to the public through an Initial Public Offering (IPO).

The securities can be directly bought from the shareholders (of issuing organisation), which is not the case for the secondary market. Many companies have entered the primary market to earn profit by converting their capital, which is basically a private capital, into a public one, releasing securities to the public.

This phenomena is known as “public issue” or “going public”. After trading in the primary market, the security will then enter the secondary market, where numerous trades happen every day. The primary market accelerates the process of capital formation in a country’s economy.

Initial Public Offer (IPO): An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately owned companies looking to become publicly traded.

Secondary Market:

Secondary market is the market where previously issued securities, such as stocks and bonds, are traded among investors. It is also the market where investors buy securities from other investors, and not from the issuing organization.

The sale proceeds from the secondary market go to the investor, and not the issuing company. A primary market, on the other hand, is the place where the securities are given by the issuing organization for the first time and the proceeds go towards the capital of that organization.

Secondary markets include all stock exchanges where investors buy or sell their securities with other investors. Because investors who deal with securities needed a place to exchange their offerings for money, the stock exchange emerged. Today, it is highly sophisticated and uses advanced technologies to provide real-time prices of any share.

Secondary markets provide the liquidity for investors and even for the economy as a whole. In general, the higher the number of investors, the greater the liquidity for that market. It is also in tune with the investors’ preference for liquidity because most investors would not prefer to lock up their funds for long periods of time and the secondary market gives them the platform to have liquidity when they want it.

Q. In the context of finance, the term ‘beta’ refers to
(a) The process of simultaneous buying and selling of an asset from different 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 fluctuations of a stock to changes in the overall stock market

Institutions and Investors:

Investment Bank: An investment bank is a special type of financial institution that works primarily in high finance by helping companies access the capital markets (stock market and bond market, for instance) to raise money for expansion or other needs.

Ex: If Coca-Cola Enterprises wanted to sell 10 crores worth of bonds to build new bottling plants in Orissa, an investment bank would help it find buyers for the bonds and handle the paperwork, along with a team of lawyers and accountants.

Investment banks are often divided into two camps: the buy side and the sell side. Many investment banks offer both buy side and sell side services.

The sell side typically refers to selling shares of newly issued IPOs, placing new bond issues, engaging in market making services, or helping clients facilitate transactions.

The buy side, in contrast, works with pension funds, mutual funds, hedge funds, and the investing public to help them maximize their returns when trading or investing in securities such as stocks and bonds.

Insurance Companies: Insurance companies pool risk by collecting premiums from a large group of people who want to protect themselves and/or their loved ones against a particular loss. Insurance helps individuals and companies manage risk and preserve wealth. By insuring a large number of people, insurance companies can operate profitably and at the same time pay for claims that may arise.

Brokerages: A brokerage acts as an intermediary between buyers and sellers to facilitate securities transactions. Brokerage companies are compensated via commission after the transaction has been successfully completed. For example, when a trade order for a stock is carried out, an individual often pays a transaction fee for the brokerage company’s efforts to execute the trade.

Investment Companies: Investment companies only exist to invest. They make a profit by buying and selling shares, property and other assets. An investment manager decides what assets to buy in order to build a diverse, managed portfolio. When you buy shares of an investment company you make an investment that includes a share of all those assets. It’s a simple way of expanding your portfolio and spreading your risk.

You’re not investing alone. Different people contribute money to the company. When you invest you become one of its shareholders. This means investment companies are a type of collective investment fund, like unit trusts.

Collective Investment Schemes (CISs): These are those in which people invest to create a pool of money which is then utilised to realise some income for the investors, or acquire some produce, or some properties which are then looked after by a manager on behalf of the investors.
In some countries, a mutual fund is also called a collective investment scheme. But in India, the definition of a CIS excludes mutual funds or unit trusts. Collective Investment Schemes are regulated in India by SEBI under the SEBI (Collective Investment Schemes) Regulations, 1999.

Under the definition of Section 11AA of SEBI Act, CIS is any scheme or arrangement, which satisfies the following conditions:

• Call it by whatever name, but Money is pooled and utilized by the contributors / investors.
• Such contribution is made to earn material profits.
• The investors don’t have day to day control over the management or operation of the scheme / arrangement.
• According to a SEBI ordinance of July 2013, any pooling of funds which involves a minimum of Rs. 100 Crore corpus, is deemed to be a Collective Investment Scheme.

Mutual Fund: A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.

Any investor can buy mutual fund ‘units’, which basically represent his share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund’s current net asset value (NAV). These NAVs keep fluctuating, according to the fund’s holdings. So, each investor participates proportionally in the gain or loss of the fund. All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor.
The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.

Closed Ended Funds:

Open Ended Funds:

Eg:

Exchange Traded Funds(ETF):

Gold ETF:

Hedge Funds: Hedge fund is a private investment partnership and funds pool that uses varied and complex proprietary strategies and invests or trades in complex products, including listed and unlisted derivatives.
Put simply, a hedge fund is a pool of money that takes both short and long positions, buys and sells equities, initiates arbitrage, and trades bonds, currencies, convertible securities, commodities and derivative products to generate returns at reduced risk. As the name suggests, the fund tries to hedge risks to investor’s capital against market volatility by employing alternative investment approaches.

Eg: 

Alternative Investment Funds (AIFs): Alternative Investment Funds are a class of investment entities that are not covered under the usual SEBI regulatory framework for investment institutions. AIFs refers to any privately pooled investment fund – a trust or a company or a body corporate or an LLP (Limited Liability Partnership) which are not presently covered by any Regulation of RBI, SEBI, IRDA and PFRDA. They may be foreign or Indian. Some of the alternative investments include the commodities, private equity, hedge funds, venture capital, and financial derivatives as well as assets such as paintings, other arts, wines, antiques coins and stamps.

Private Equity(PE) Fund: A private equity fund typically refers to a general partnership formed by PE firms which are utilized to invest in private companies. The private equity fund may have general investment criteria (meaning it invests in different industries) or have specific industry criteria.

Eg:

Venture Capital Funds: These funds are investment funds that manage the money of investors who seek private equity stakes in start-up and small- to medium-sized enterprises with strong growth potential. These investments are generally characterized as high-risk/high-return opportunities. These companies are not listed and do not include-NBFCs, Financing etc.

Eg:

Angel Funds: These are the funds that pool money from many individual ‘angels’ so that they can invest sizeable amounts into start-ups and enjoy better negotiating power while doing so.

Angel Investor vs Venture Capitalist:

Angel Investor

• An individual investor
• May be willing to invest in early-stage or start-up businesses, as well as established companies
• Have experience and contacts to contribute
• May be willing to be “hands-off” or “hands-on” adding important skills

Eg: 

Venture Capital

• A company or business rather than an individual
• Seldom interested in early-stage, unless compelling reasons (e.g. high tech with already successful founders)
• Have contacts
• Require seat on board

Eg:

Q. What does venture capital mean? 
(a) A short-term capital provided to industries
(b) A long-term start-up capital provided to new entrepreneurs
(c) Funds provided to industries at times of incurring losses
(d) Funds provided for replacement and renovation of industries

Qualified Institutional Placement (QIP): A QIP is a capital raising tool wherein a listed company can issue equity shares, fully and partly convertible debentures, or any security (other than warrants) that is convertible to equity shares. Apart from preferential allotment, this is the only other speedy method of private placement whereby a listed company can issue shares or convertible securities to a select group of investors.

But unlike in an IPO or an FPO (further public offer), only institutions or qualified institutional buyers (QIBs) can participate in a QIP issuance. QIBs include mutual funds, domestic financial institutions such as banks and insurance companies, venture capital funds, foreign institutional investors, and others.
There are a few rules to follow. The market regulator has stated that there should be at least two QIBs if the issue size is less than Rs.250 crore, and at least five investors if the size is more than Rs.250 crore. A single investor cannot be allotted more than 50% of the issue.

Who are Foreign Portfolio Investors?

Foreign Portfolio Investors includes investment groups of Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs) (Qualified Foreign Investors) and subaccounts etc. NRIs doesn’t comes under FPI.
After the new SEBI guidelines, the RBI stipulated that Foreign Portfolio Investors include Asset Management Companies, Banks, Pension Funds, Mutual Funds, and Investment Trusts as Nominee Companies, Incorporated/Institutional Portfolio Managers or their Power of Attorney holders, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies etc. Sovereign Wealth Funds are also regulated as FIIs.

Who is a Foreign Institutional Investor?

FII is an institution like a mutual fund, insurance company, pension fund etc. According to SEBI, “an FII is an institution established or incorporated outside India which proposes to make investments in India in securities”. FII is an institution who is registered under the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995. FIIs comprised of a pension fund, a mutual fund, investment trust, insurance company or a reinsurance company.

Eg:

Q. Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note

Who is a Qualified Foreign Investor?

QFI is an individual, group or association which is a resident in a foreign country. The QFI should compliant with the Financial Action Task Force standard and should be a signatory to the International Organisation of Securities Commission.

The FIIs are big and hence they have the capacity to make large-scale investment. On the other hand, small investors and individuals under QFI category can’t match FIIs in terms of business volume. So, often when we hear about foreign investment in the share market, it is the FIIs who steal the attention.

Invits and REITS:

Eg:

Q. Consider the following statements:
Statement-I: Interest income from the deposits in Infrastructure Investment Trusts (InvITs) distributed to their investors is exempted from tax, but the dividend is taxable.
Statement-II: InviTs are recognized as borrowers under the ‘Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002’.
Which one of the following is correct in respect of the above statements?
(a) Both Statement-I and Statement-II are correct and Statement-II is the correct explanation for Statement-1
(b) Both Statement-I and Statement-II are correct and Statement-II is not the correct explanation for Statement-1
(c) Statement-1 is correct but Statement-II is incorrect
(d) Statement-I is incorrect Statement-II is correct

What are Participatory Notes?

P-Notes or Participatory Notes are Overseas Derivative Instruments that have Indian stocks as their underlying assets. They allow foreign investors to buy stocks listed on Indian exchanges without being registered. The instrument gained popularity as FIIs, to avoid the formalities of registering and to remain anonymous, started betting on stocks through this route.

Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is made on behalf of these foreign investors by the already registered brokers in India. For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors.
Any dividends or capital gains collected from the underlying securities go back to the investors. The brokers that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to SEBI for each quarter.

History of Indian Stock Market:

Indian stock market marks to be one of the oldest stock market in Asia. It dates back to the close of 18^th century when the East India Company used to transact loan securities. In the 1830s, trading on corporate stocks and shares in Bank and Cotton presses took place in Bombay. Though the trading was broad but the brokers were hardly half dozen during 1840and 1850.

An informal group of 22 stockbrokers began trading under a banyan tree opposite the Town Hall of Bombay from the mid-1850s, each investing a (then) princely amount of Rupee 1.
The informal group of stockbrokers organized themselves as the Native Share and Stock brokers Association which, in 1875, was formally organized as the Bombay Stock Exchange (BSE). In 1956, the Government of India recognized the Bombay Stock Exchange as the first stock exchange in the country under the Securities Contracts (Regulation) Act.

The stock exchange performs the following functions:

• Provide trading platform to investors and provide liquidity
• Facilitate Listing of securities
• Registers members – Stock Brokers, sub brokers
• Make and enforce by-laws
• Manage risk in securities transactions
• Provides Indices

Who owns the Stock Markets? Please note that broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well.

However, there can be two cases viz, Mutualized and Demutualized exchanges. In a mutual exchange, the three functions of ownership, management and trading are concentrated into a single Group. This at times can lead to conflicts of interest in decision making.

A demutualised exchange, on the other hand, has all these three functions clearly segregated, i.e. the ownership, management and trading are in separate hands.

Why Demutualisation: Historically stock exchanges started as a mutually governed, self-regulated structures where profit was not a very strong motive. The stock exchanges were authorized to promulgate by-laws to govern their functioning.

They were physical locations with trading floors. The stock exchanges had a mutually dependent, co-operative structure. However with technological innovation came electronic trading system. The concept of floor trading no longer held ground, hence the physical presence of the trader was no longer important, which in turn meant that the cost of inducting additional member fell drastically, reducing the overall trading cost. The membership fee did not have much of significance. This in turn reduced the importance of mutual dependence and cooperation. The outcome of this was demutualization.

What is Demutualization: It means converting non-profit body into a corporate body where management and trading activities are separated. This is necessary to ensure that stock brokers do not have access to sensitive information and do not misuse their position. Hence SEBI had issued directives on 10/1/2002 that no stock broker shall be an office bearer of stock exchange. The whole idea is to separate ownership, management and trading rights from each other.

Bombay stock Exchange (BSE)

Established in 1875, BSE (formerly known as Bombay Stock Exchange Ltd.), is Asia’s first & the Fastest Stock Exchange in world with the speed of 6 micro seconds and one of India’s leading exchange groups.
Over the past 141 years, BSE has facilitated the growth of the Indian corporate sector by providing it an efficient capital-raising platform.

It also has a platform for trading in equities of small-and-medium enterprises (SME). India INX, India’s 1^st international exchange, located at GIFT CITY IFSC in Ahmedabad is a fully owned subsidiary of BSE. BSE is also the 1^st listed stock exchange of India.
BSE’s popular equity index – the S&P BSE SENSEX – is India’s most widely tracked stock market benchmark index.

S&P BSE SENSEX: It first compiled in 1986, was calculated on a ‘Market Capitalization-Weighted’ methodology of 30 component stocks representing large, well-established and financially sound companies across key sectors.

National Stock Exchange (NSE)

The National Stock Exchange (NSE) is the leading stock exchange in India and the fourth largest in the world by equity trading volume in 2015, according to World Federation of Exchanges (WFE).

NIFTY 50: It is a diversified 50 stock index accounting for 22 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.

Securities and Exchange Board of India (SEBI)

SEBI is the key regulator of securities market in India. It was established in 1988 by the Government of India and is established and incorporated through section 3 of SEBI Act, 1992.

Objectives of SEBI:

The preamble of SEBI Act, 1992 states its objectives as; “An Act to provide for the establishment of a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith or incidental thereto.”
The primary objective of SEBI is to promote healthy and orderly growth of the securities market and secure investor protection. However, other objectives of SEBI can be categorized as:-

• Ensuring fair practices in securities market.
• Promoting efficient, competitive and professional services by merchant bankers, brokers, advisors, underwriters, portfolio managers and other intermediaries.
• Formulate rules and regulations for the securities market in India.
• Settlement of investor’s grievances in securities market.

Functions of SEBI

SEBI is the Nodal agency for protecting the interests of an investor in Indian Market through various methods as prescribed in Section 11 of SEBI Act, 1992 which describes powers and functions of the board. However, the functions of SEBI can be generalized as under:-

Regulatory Functions

• Inspecting books and accounts of financial intermediaries.
• Monitor and check share trading in securities market.
• Registration and regulation of brokers, advisors, underwriters, merchant bankers, portfolio managers and other intermediaries.
• Registration and regulation of Mutual Funds, Venture Capital Funds and Collective Investment Schemes.
• Prohibiting unfair, fraudulent and illegal practices in securities market.
• Prohibiting insider trading through Stock Watch System and by imposing penalties
• Regulating substantial acquisition of shares and takeovers.

 Development Functions

• Promotion of fair practices in securities market.
• Promoting Investor education and professional training of intermediaries.
• Promotion of self-regulatory organizations.
• Publishing informative research useful to all participants.

As for now Indian securities market is considered as a weak market because the participants of stock market aren’t aware of the required essential knowledge; therefore to counter this issue SEBI has become a vigilant watchdog for securing the interests of the investors on one side and promoting information related to securities market on the other hand.

Insider Trading: Insider trading is defined as a malpractice wherein trade of a company’s securities is undertaken by people who by virtue of their work have access to the otherwise non-public information which can be crucial for making investment decisions.
When insiders, e.g. key employees or executives who have access to the strategic information about the company, use the same for trading in the company’s stocks or securities, it is called insider trading and is highly discouraged by the Securities and Exchange Board of India to promote fair trading in the market for the benefit of the common investor.

Insider trading is an unfair practice, wherein the other stock holders are at a great disadvantage due to lack of important insider non-public information.

Rolling Settlement: Rolling Settlement is a mechanism of settling trades done on a stock exchange on T i.e. trade day plus “X” trading days, where “X” could be 1,2,3,4 or 5 days. In other words, in T+3 environment, a trade done on T day is settled on the 3th working day excluding the T day. in the Rolling Settlements, trades done on each single day are settled separately from the trades done on earlier or subsequent trading days. The netting of trades is done only for the day and not for multiple days. As of now, the trades in all the scrips listed and traded on the exchange are  settled on T+1 basis.

Commodity Exchange:

A commodities exchange is an entity, usually an incorporated non-profit association, that determines and enforces rules and procedures for the trading of commodities and related investments, such as commodity futures. Commodities exchange also refers to the physical centre where trading takes place. The two important commodity exchanges in India are as follows:

• Multi Commodity Exchange of India (MCX)
• National Commodities and Derivatives Exchange Limited (NCDEX)
• National Multi Commodity Exchange,
• Indian Commodity Exchange Ltd and
• ACE Derivatives and Commodity Exchange

 Functions of Commodity Exchanges:

1. Providing a Market Place: A commodity exchange provides a convenient place where the members can meet at fixed hours and transact busi­ness in a commodity according to certain well established rules and regulations.
2. Regulating Trading: As organised markets commodity exchanges establish and enforce rules and regulations with a view to facilitating trade on sound lines.
3. Collecting and Disseminating Market In­formation: The buyers and sellers on the commod­ity exchange enter into deals for settlement in fu­ture after making an assessment the trends of price and the prospects of a rise or fall in prices of a com­modity.
4. Grading of Commodities: Commodities which are traded on the commodity exchanges have to be graded according to quality.
5. Settling Disputes through Arbitration: The commodity exchange provides machinery for the arbitration of trade disputes.

Forward Market Commission (FMC):

FMC is a regulatory authority for commodity futures market in India. FMC is the chief regulator of forward and futures markets in India. FMC is a legal body set up under Forward Contracts (Regulation) Act 1952.

Commodities traded on these exchanges comprise:

• Edible oilseeds: Groundnut, mustard seed, cotton seed, sunflower, rice bran oil, soy oil, etc.
• Food grains: Wheat, gram, dals, bajra, maize etc.
• Metals: Gold, silver, copper, zinc etc.
• Spices: Turmeric, pepper, jeera etc.
• Fibres: Cotton, jute, etc.
• Others: Gur, rubber, natural gas, crude oil etc.

 Why FMC is now merged with SEBI:

• The FMC only regulated the exchanges, and had no direct control over brokers. Also, Sebi has a far superior surveillance, risk-monitoring and enforcement mechanism that market participants say will give more confidence to investors, and may help businesses grow. Among other powers, Sebi now also has the power to access call data records.
• The capacity of the regulator — in this case the Forward Markets Commission or FMC, which was not an independent regulator — being just an arm of the Department of Consumer Affairs, and without adequate capacity and resources to supervise a growing market segment.
• Capacity of FMC was also exposed when National Spot Exchange Limited (NSEL) scam hit the headlines, exposing the manipulation in the commodities market, and the associated regulatory inadequacies.
• The rationale for a similar integration in India that was put forward was that fragmentation had an impact on costs, economies of scale, and the fact that brokers, investors and other participants were virtually the same.

Depository Institutions:

Depository is a place where financial securities are held in dematerialised form. It is responsible for maintenance of ownership records and facilitation of trading in dematerialised securities.

In India, there are two depositories: National Securities Depositories Ltd (NSDL) and Central Securities Depositories Ltd (CDSL). Both the depositories hold your financial securities, like shares and bonds, in dematerialised form and facilitate trading in stock exchanges. However, to make use of the depositories and start your investing journey, you must open a Demat account and a trading account.

American Depository Receipts (ADRs): An American Depositary Receipt (ADR) is a certificate that represents shares of a foreign stock owned and issued by a U.S. bank. The foreign shares are usually held in custody overseas, but the certificates trade in the U.S. Through this system, a large number of foreign-based companies are actively traded on one of the three major U.S. equity markets (the NYSE, AMEX or Nasdaq).

Global Depository Receipts(GDR): These are negotiable financial instruments that are traded on foreign stock exchange. The individuals holding depository receipt are considered to have an ownership interest in the shares of the company like ordinary shareholders. The difference is that these are the receipts which are traded outside the home country of the company to increase the visibility of the company in the global world and to expand the capital investment in other countries.

A global depositary receipt (GDR) is similar to an ADR, but is a depositary receipt sold outside the United States and outside the home country of the issuing company. These are widely used nowadays by almost all the companies in the world to gain accessibility to the capital markets of the world.

Depository banks: GDRs are usually backed by depository banks that provide companies, investors and traders opportunities to make global investments. These are banks whose primary task is to hold shares of companies based in another country. Such banks essentially sell the GDRs.
They also ensure that investors receive their dividends and capital gains. Depository banks also handle all tax-related issues in the company’s home country. Since all GDR transactions have to go through a depository bank, investments made in them are safe. However, their valuations are always associated with normal market risks.

Rupee Bond/Masala Bond: Masala bonds are Indian rupee denominated bonds issued in offshore capital markets. These will be offered and settled in US dollars to raise Indian rupees from international investors for infrastructure development in India.

Masala bonds, like any other off-shore bonds, are intended for those foreign investors who want to take exposure to Indian assets, yet constrained from doing it directly in the Indian market or prefer to do so from their offshore locations. The settlement of the bonds will be in US dollars but since they are pegged to the Indian currency -rupee-, investors will directly take the currency risk or exchange rate risks. Settlement is done in US dollars because of the limited convertibility of rupee.

Buy Back of Shares: It can be described as a procedure which enables a company to go back to the holders of its shares and offer to purchase the shares held by them.
When a company has substantial cash resources, it may like to buy its own shares from the market particularly when the prevailing rate of its shares in the market is much lower than the book value or what the company perceives to be its true value.

Buy-back helps a company by giving a better use for its funds than reinvesting these funds in the same business at below average rates or going in for unnecessary diversification or buying growth through costly acquisitions.

Debt Market

Debt market is where investors buy and sell debt securities, mostly in the form of bonds. Debt market in India is one of the largest in Asia. Like all other countries, Indian debt market is also considered a useful substitute to banking channels for finance.

One of the largest Debt Market in Asia and includes debt securities issued by the Government (Central & State Governments), public sector undertakings, other government bodies, financial institutions, banks and corporates.

The debt market in India consists of mainly two categories — the government securities or the G-Sec markets comprising central government and state government securities, and the corporate bond market.

In order to finance its fiscal deficit, the government floats fixed income instruments and borrows money by issuing G-Secs that are sovereign securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India. The corporate bond market (also known as the non-Gsec market) consists of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures.
Issuing a bond increase the debt burden of the bond issuer because contractual interest payments must be paid to the bondholders. In debt market, bondholders do not gain ownership in the business or have any claims to the future profits of the borrower.

The borrower’s only obligation is to repay the loan with interest. Bonds are considered to be less risky investments for at least two reasons. First, bond market returns are less volatile than stock market returns. Second, should the company run into trouble, bondholders are paid first, before other expenses are paid.

Q. What is the importance of the term “Interest Coverage Ratio” of a firm in India?
1. It helps in understanding the present risk of a firm that a bank is going to give loan to.
2. It helps in evaluating the emerging risk of a firm that a bank is going to give loan to.
3. The higher a borrowing firm’s level of Interest Coverage Ratio, the worse is its ability to service its debt.
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3

Regulatory Structure

• The issue and trading of fixed income securities are regulated by different bodies in India.
• Government securities and issues by Banks, Financial Institutions are regulated by the R B I .
• Debt securities issued by Corporates are regulated by S E B I.

Structure of Indian Debt Market

Q. 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?
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 2 and 3 only

Prominent Investors in Debt Market:

• Commercial Banks
• Co-operative Banks
• Regional Rural Banks
• Insurance Companies
• Mutual Funds
• Provident and Pension Funds
• Foreign Institutional Investors (FII’s)
• Partnership Firms
• Corporate Treasuries
• Individuals & H U Fs

Q. In India, which of the following can trade in Corporate Bonds and Government Securities
1. Insurance Companies
2. Pension Funds
3. Retail Investors
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3

Q. With reference to the Indian economy, consider the following statements:
1. ‘Commercial Paper’ is a short-term unsecured promissory note.
2. ‘Certificate of Deposit’ is a long-term instrument issued by the Reserve Bank of India to a corporation.
3. ‘Call Money’ is a short-term finance used for interbank transactions.
4. ‘Zero-Coupon Bonds’ are the interest bearing short-term bonds issued by the Scheduled Commercial Banks to corporations.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 4 only
(c) 1 and 3 only
(d) 2, 3 and 4 only

Debentures:

Non – Convertible Debentures (NCD): The debentures which can’t be converted into shares or equities are called non-convertible debentures (or NCDs). Non-convertible debentures are used as tools to raise long-term funds by companies through a public issue. To compensate for this drawback of non-convertibility, lenders are usually given a higher rate of return compared to convertible debentures.

Partially Convertible Debentures (PCD): A type of convertible debenture, part of which will be redeemed by the issuing company after a specified period of time and part of which is convertible into equity or preference shares at the end of the specified period. The ratio of conversion for the partially convertible debenture is decided by the issuer when the debenture is issued.

Fully Convertible Debentures (FCD): A type of debt security where the whole value of the debenture is convertible into equity shares at the issuer’s notice. Upon conversion, the investors enjoy the same status as ordinary shareholders of the company.

Optionally Convertible Debentures (OCD): Similar to fully convertible debenture, but the option is to convert it or not is with the investor.

Foreign Currency Convertible Debentures (FCCB):

Q. 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) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Credit Rating Agencies:

Q. Consider the following statements:
1. In India, credit rating agencies are regulated by Reserve Bank of India.
2. The rating agency popularly known as ICRA is a public limited company.
3. Brickwork Ratings is an Indian credit rating agency.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3

Derivative Market

A derivative is a contract with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon value of the asset or assets. Its value is determined by fluctuations in the underlying asset.

So if the price of this underlying asset changes, the value of derivative also changes. For example, the value of a gold futures contract derives from the value of the underlying asset, i.e., gold.

To understand it lets take an example of commodity as cotton, which is the raw material for the textile industry. It may happen that the price of cotton rises before and after harvest a but falls at the time of harvest.

The farmer, who is exposed to such price fluctuations, can eliminate this a risk by selling his harvest at a future date by entering into a forward or future, contract. This forward and future contract takes place in the derivatives market.

The prices in the derivatives market are driven by the spot or cash market price of the underlying asset, which is cotton in this example. The common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.

The derivatives market is like any other market, financial market for derivatives, instruments like futures contracts or options, which are derived from other forms of assets. It’s is highly leveraged market in the sense that profit/loss can be magnified compared to initial margin, it’s is the only market where an investor can go long and short on the same asset at the same time.

Major types of financial derivatives are:
1. Forwards
2. Futures
3. Options
4. Swaps

Forwards: Forward contracts are the simplest form of derivatives that are available today. Also, they are the oldest form of derivatives. A forward contract is nothing but an agreement to sell something at a future date. The price at which this transaction will take place is decided in the present.

However, a forward contract takes place between two counterparties. This means that the exchange is not an intermediary to these transactions. Hence, there is an increase chance of counterparty credit risk. Also, before the internet age, finding an interested counterparty was a difficult proposition.

Another point that needs to be noticed is that if these contracts have to be reversed before their expiration, the terms may not be favourable since each party has one and only option i.e. to deal with the other party. The details of the forward contracts are privileged information for both the parties involved and they do not have any compulsion to release this information in the public domain.

Futures: A futures contract is very similar to a forwards contract. The similarity lies in the fact that futures contracts also mandate the sale of commodity at a future data but at a price which is decided in the present. However, futures contracts are listed on the exchange.

This means that the exchange is an intermediary. Hence, these contracts are of standard nature and the agreement cannot be modified in any way. Exchange contracts come in a pre-decided format, pre-decided sizes and have pre-decided expirations.

Also, since these contracts are traded on the exchange they have to follow a daily settlement procedure meaning that any gains or losses realized on this contract on a given day have to be settled on that very day. This is done to negate the counterparty credit risk.

An important point that needs to be mentioned is that in case of a futures contract, they buyer and seller do not enter into an agreement with one another. Rather both of them enter into an agreement with the exchange.

Options: The third type of derivative i.e. option is markedly different from the first two types. In the first two types both the parties were bound by the contract to discharge a certain duty (buy or sell) at a certain date. The options contract, on the other hand is asymmetrical.

An options contract, binds one party whereas it lets the other party decide at a later date i.e. at the expiration of the option. So, one party has the obligation to buy or sell at a later date whereas the other party can make a choice. Obviously the party that makes a choice has to pay a premium for the privilege.

There are two types of options i.e. call option and put option. Call option allows you the right but not the obligation to buy something at a later date at a given price whereas put option gives you the right but not the obligation to sell something at a later date at a given pre decided price.

Swaps: Swaps are probably the most complicated derivatives in the market. Swaps enable the participants to exchange their streams of cash flows. For instance, at a later date, one party may switch an uncertain cash flow for a certain one. The most common example is swapping a fixed interest rate for a floating one. Participants may decide to swap the interest rates or the underlying currency as well.

Swaps enable companies to avoid foreign exchange risks amongst other risks. Swap contracts are usually not traded on the exchange. These are private contracts which are negotiated between two parties. Usually investment bankers act as middlemen to these contracts. Hence, they too carry a large amount of exchange rate risks.

Q. Consider the following:
1. Exchange-Traded Funds (ETF)
2. Motor vehicles
3. Currency swap
Which of the above is/are considered financial instruments?
(a) 1 only
(b) 2 and 3 only
(c) 1, 2 and 3
(d) 1 and 3 only

Q. In the context of the Indian economy, non-financial debt includes which of the following?
1. Housing loans owed by households
2. Amounts outstanding on credit cards
3. Treasury bils
Select the correct answer using the code given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3

Sugested Reading:

Financialization of Indian Economy, It’s Impact