FINANCIAL MARKETS.pdf

31 PGDFM POST GRADUATE DIPLOMA IN FINANCIAL MANAGEMENT FINANCIAL MARKETS  © UNIVERSITY OF MUMBAI Dr. Sanjay Deshmukh Vice Chancellor, University of Mumbai Dr. Ambuja Salgaonka...

31 PGDFM POST GRADUATE DIPLOMA IN FINANCIAL MANAGEMENT FINANCIAL MARKETS  © UNIVERSITY OF MUMBAI Dr. Sanjay Deshmukh Vice Chancellor, University of Mumbai Dr. Ambuja Salgaonkar Dr. Dhaneswar Harichandan Incharge Director, Incharge Study Material Section, Institute of Distance and Institute of Distance and Open Learning, Open Learning, University of Mumbai. University of Mumbai. Programme : Dr. Madhura Kulkarni Co-ordinator Lecturer-Cum.Asst. Director IDOL, Universityof Mumbai Ms. Megha Bansal IDOL, Universityof Mumbai Course Writer : Prof. Radha Iyer Alkesh Dinesh Mody Institute Universityof Mumbai : Prof. Mohan Iyer Vidyalankar College, Wadala (E), Mumbai : Ms. Megha Bansal IDOL, Universityof Mumbai December 2016, Post Graduate Diploma in Financial Management, Financial Markets Published by : Incharge Director Institute of Distance and Open Learning , University of Mumbai, Vidyanagari, Mumbai - 400 098. DTP Composed : Ashwini Arts Gurukripa Chawl, M.C. Chagla Marg, Bamanwada, Vile Parle (E), Mumbai - 400 099. Printed by :  CONTENTS Unit No. Title Page No. Module I 1. Financial System 01 2. Indian Financial System 08 3. Regulatory Institutions 16 Module II 4. Capital Markets 28 5. Secondary Market 61 6. Stock Exchanges 82 7. National Stock Exchange of India 102 Module III 8. Introduction of Money Market 132 9. Call Money Market 138 10. Commercial Bill Market / Discount Markets 144 11. Treasury Bill Market 150 Module IV 12. Foreign Exchange Market 158 13. Foreign Exchange Transaction 173 14. Foreign Exchange Rates 192 15. Currency Convertibility 207   I Syllabus PGDFM - Post Graduate Diploma in Financial Management Financial Markets Unit Syllabus Weight in Paper I Financial system - Structure of financial system - 25% Indian financial system - Financial Development - Savings and Investment - Financial Integration - Regulation and Deregulation - Regulatory Institutions II Capital Markets - 25% Industrial securities, Primary markets, Secondary markets, Stock exchanges, Stock market index - Buying and selling securities on the stock exchanges - Stock exchange terms. III Money Market - 25% Call money markets - Commercial Bill market, - Markets for commercial papers and Certificate of deposits, The discount market, Government securities market, - treasury bills. IV Foreign exchange market 25% Nature, Organization and Participants, Exchange rates, devaluation and depreciation, Currency convertibility. Market for futures, Options and other Derivatives Reference Books : 1) Financial Markets and Institutions - L. M. Bhole 2) Financial Markets - Dr. P. K. Bandgar   1 MODULE - I 1 FINANCIAL SYSTEM Unit Structure 1.1 Introduction 1.2 Structure of a Financial System 1.3 Summary 1.1 INTRODUCTION  This Unit presents bare elements of a financial system.  It discusses the constituents, economic developmental contribution and constraints, and performance criteria of the financial system and certain concepts in its development. 1.2 STRUCTURE OF A FINANCIAL SYSTEM The financial system or financial sector of any country consists of specialised and non-specialised financial institutions, of organised and unorganised financial markets, of financial instruments and services which facilitate transfer of funds. Procedures and practices adopted in the markets, and financial interrelationships are also parts of the system. These parts are not always mutually exclusive; for example, financial institutions operate in financial markets and are, therefore, a part of such markets. The word "system" in the term "financial system", implies a set of complex and closely connected or interlinked institutions, agents, practices, markets, transactions, claims and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Money refers to the current medium of exchange or means of payment. Credit or loan is a sum of money to be returned, normally with interest; it refers to a debt of economic  2 unit. Finance is a monetary resources comprising debt and ownership funds of the state, company or person. Figure 1.1 presents the typical structure of a financial system in any economy. Financial Institutions are business organisations that act as mobilisers and depositories of savings and as purveyors of credit or finance. They also provide various financial services to the community. They differ from non-financial (industrial and commercial) business organisations in respect of their dealings, i.e. while the former deal in financial assets such as deposits, loans, securities and so on, the latter deal in real assets such as machinery, equipment, stocks of goods, real estate and so on. The distinction between the financial sector and the "real sector" should not be taken to mean that there is something unproductive (ephemeral) about finance. At the same time, it means that the role of financial sector should not be overemphasised. The activities of different financial institutions may be either specialised or they may overlap; quite often they overlap. Yet we need to classify financial institutions and this is done on the basis of their primary activity or the degree of their specialisation with relation to savers or borrowers with whom they customarily deal or the manner of their creation. In other words, the functional, geographic, sectoral scope of activity or the type of ownership are some of the criteria which are often used to classify a large number and variety of financial institutions which exist in the economy. However, it should be kept in mind that such classification is likely to be imperfect and tentative. According to one classification, financial institutions are divided into banking and non-banking institutions. The banking institutions have quite a few things in common with the non-banking ones, but their distinguishing character lies in the fact that, unlike other institutions. they participate in the economy's payments mechanism, i.e., they provide transactions services, their deposit liabilities constitute a major part of the national money supply, and they can, as a whole, create deposits or credit, which is money.  3 Banks, subject to legal reserve requirements, can advance credit by creating claims against themselves, while other institutions can lend only out of resources put at their disposal by the savers. The distinction between the two has been highlighted by Sayers by characterising the former as "creators" of credit, and the latter as mere "purveyors" of credit. While the banking system in India comprises the commercial banks and co-operative banks, the examples of non-banking financial institutions are Life Insurance Corporation (LIC), Unit Trust of India (UTI) and Industrial Development Bank of India (IBDI). Financial institutions are also classified as intermediaries and non-intermediaries. As the term indicates, intermediaries intermediate between savers and investors; they lend money as well as mobilise savings; their liabilities are towards the ultimate savers; while their assets are from the investors or borrowers. Non- intermediary institutions do the loan business but their resources are not directly obtained from the savers. All banking institutions are intermediaries. Many non-banking institutions also act as intermediaries and when do so they are known as Non-Banking institutions also act as intermediaries and Insurance Corporation (GIC) are some of the NBFIs in India. Non-intermediary institutions like IDBI, Industrial Finance Corporation (IFC), and National Bank for Agriculture and Rural Development (NABARD) have come into existence because of governmental efforts to provide assistance for specific purposes, sectors and regions. Their creation as a matter of policy has been motivated by the philosophy that the credit needs of certain borrowers might not be otherwise adequately met by the usual private institutions. Since they have been set up the government, we can call them Non-Banking Statutory Financial Organisations (NBSFO).  4 Financial markets are the centres or arrangements that provide facilities for buying and selling of financial claims and services. The corporations, financial institutions, individuals and governments trade in financial products in these markets either directly or through brokers and dealers on organised exchanges of off-exchanges. The participants on the demand and supply sides of these markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers and others who are interlinked by the laws, contracts, covenants and communication networks. Financial markets are sometimes classified as primary (direct) and secondary (indirect) markets. The primary markets deal in the new financial claims or new securities and, therefore, they are also known as new issue markets. On the other hand, secondary markets deal in securities already issued or existing or outstanding. The primary market mobilise savings and supply fresh or additional capital to business units. Although secondary markets do not contribute directly to the supply of additional capital, they do so indirectly by rendering securities issued on the primary markets liquid. Stock markets have both primary and secondary market segments. Very often financial markets are classified as money markets and capital markets, although there is essential difference between the two as both perform the same function of transferring resources to the producers. This conventional distinction is based on the differences in the period of maturity of financial assets issued in these markets. While money markets deal in the short-term claims (with a period of maturity of one year or less), capital markets do so in the long-term (maturity period above one year) claims. Contrary to popular usage, the capital market is not only co-existence with the stock market; but it is also much wider than the stock market. Similarly, it is not always possible to include a given participant in either of the two (money and capital) markets alone. Commercial banks, for example, belong to both. While treasury bills market, call money market, and commercial bills markets are examples of money market, stock market and government bonds markets are examples of capital market. Keeping in view different purposes, financial markets have also been classified into the following categories: a. Organised and unorganised b. Formal and informal c. Official and parallel and d. Domestic and foreign.  5 There is no precise connotation with which the words unorganised and informal are used in this context. They are quite often used interchangeably. The financial transactions which take place outside the well-established exchanges or without systematic and orderly structure or arrangements constitute the unorganised markets. They generally refer to the markets in villages or rural areas, but they exist in urban areas also. Interbank money markets and most foreign exchange markets do not have organised exchanges. But they are not unorganised markets in the same way the rural markets are. The informal markets are said usually involve families and small groups of individuals lending and borrowing from each other. This description cannot be strictly applied to the foreign exchange markets, but they are also mostly informal markets. As mentioned earlier, financial systems deal in financial services and claims or financial assets or securities or financial instruments. These services and claims are many and varied in character. This is so because of the diversity of motives behind borrowing and lending. The stage of development of the financial system can often be judged from the diversity of financial instruments that exist in the system. The financial assets represent a claim to the payment of a sum of money sometime in the future (repayment of principal) and / or a periodic (regular or not so regular) payment in the form of interest or dividend. With regard to bank deposit or government bond or industrial debenture, the holder receives both the regular periodic payments and the repayment of the principal at a fixed date. Whereas with regard to ordinary share or perpetual bond, only periodic payments are received (which are regular in the case of perpetual bond but may be irregular in the case of ordinary share). Financial securities are classified as primary (direct) and secondary (indirect) securities. The primary securities are issued by the ultimate investors directly to the ultimate savers as ordinary shares and debentures, while the secondary securities are issued by the financial intermediaries to the ultimate savers as bank deposits, units, insurance policies, and so on. For the purpose of certain types of analysis, it is also useful to talk about ownership securities (viz., shares) and debt securities (viz. debentures, deposits). Financial instruments differ from each other in respect of their investment characteristics which, of course, are interdependent and interrelated. Among the investment  6 characteristics of financial assets of financial products, the following are important: 1. Liquidity 2. Marketability 3. Reversibility 4. Transferability 5. Transaction Costs 6. Risk of default or the degree of capital and income uncertainty and a wide array of other risks 7. Maturity period 8. Tax Status 9. Options such as call-back or buy-back options 10. Volatility of prices and 11. The rate of return-nominal, effective and real. 1.3 SUMMARY  The financial system or financial sector of any country consists of specialised and non-specialised financial institutions, of organised and unorganised financial markets, of financial instruments and services which facilitate transfer of funds. Procedures and practices adopted in the markets, and financial interrelationships are also parts of the system. These parts are not always mutually exclusive; for example, financial institutions operate in financial markets and are, therefore, a part of such markets.  The word "system" in the term "financial system", implies a set of complex and closely connected or interlinked institutions, agents, practices, markets, transactions, claims and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other.  Financial Institutions are business organisations that act as mobilisers and depositories of savings and as purveyors of credit or finance. They also provide various financial services to the community. They differ from non-financial (industrial and commercial) business organisations in respect of their dealings, i.e. while the former deal in financial assets such as deposits,  7 loans, securities and so on, the latter deal in real assets such as machinery, equipment, stocks of goods, real estate and so on. 1.4 QUESTIONS 1. What are financial markets? Explain their basis. 2. Explain the constituents of financial markets. 3. State the functions of financial markets.   8 2 INDIAN FINANCIAL SYSTEM Unit Structure 2.1 Background 2.2 Indian Financial System at Present 2.3 Indicators of Financial Development 2.4 Flow-Of-Funds Accounts 2.5 Trends in Savings and Investment 2.6 Financial Integration 2.7 Regulation and Deregulation 2.8 Summary 2.9 Questions 2.1 BACKGROUND The politico-economic background of the financial development in India has been determined by the nature our mixed economic system. The objectives of this system with respect to growth, sectoral priorities, distribution have influenced the functioning and development of IFS. Some of the marked characteristics of Indian economy during the past 50 years are continuous inflation, increasing internal (fiscal) and external deficits, industrialisation, urbanisation and significant structural transformation. Functioning within this context, all sectors of the economy, including the financial markets, have undergone significant changes. Further, there has been a close interaction between the financial and economic systems. 2.2 INDIAN FINANCIAL SYSTEM AT PRESENT A striking feature of the IFS is its prodigious growth in the past 50 years in terms of size, diversity, sophistication, and complexity. Money supply, savings, bank deposits and credit, primary and secondary issues and so on have increased tremendously, the supportive factor being the continuous and high rate of inflation. While the prices in 1996 were about 18times the prices in 1950, the commercial banks' deposits, to take just one  9 example, in 1997 were more than 618 times their deposits in 1951. The bank deposits have increased from Rs. 909 crore in 1951 to Rs. 5, 61, 982 crore at the end of March 1997. This is a very remarkable growth indeed, particularly as, with the passing years, it occurred on an expanding base. The quantitative growth of the IFS has been accompanied by significant diversification and innovations in respect of an array of financial institutions, instruments, and services. India has witnessed all types of financial innovations, during the past 50 years. A large number of totally new institutions catering to almost every sector have been set up since 1950. As a result, today we have a highly diversified structure of financial institutions. Similarly, a large number of new financial instruments have come to be introduced, as a result of which we now have a fairly diversified portfolio of financial claims. Further, significant reorganisation, gloabalisation, privatisation, deregulation, automation, computerisation, changes in ownership, consolidation and mergers of financial institutions have been effected. A veritable financial revolution appears to have occurred in India, as elsewhere, over the years. Table 1 reflects the richness, diversity, complexity and well- developed nature of the IFS as it stands today. It lists all the major financial institution, financial instruments and financial services which now exist in India. For the sake of clarity, only the major markets have been specifically mentioned. Table 1 only mentions only the main types of financial institutions and instruments, while their sub types are not mentioned. The commercial banks, co- operative banks, mutual funds, industrial debentures, preference shares, treasury bills, bank deposits, for example, have many sub types. 2.3 INDICATORS OF FINANCIAL DEVELOPMENT The financial development of a country is usually studied by examining changes in the following indicators: a. Finance ratio - measures the total issues of primary and secondary claims in relation to national income. b. Financial Inter-relation Ratio (FIR) - ratio of financial assets to physical assets, and it indicates the relationship between financial structure and real assets structure of the economy. c. New Issue Ratio (NIR) - ratio of primary issues to the physical capital formation and it indicates how far investment has been financed by direct issues to the savers by the investing sectors.  10 d. Intermediation Ration (IR) - ratio of secondary issues to primary issues. IR indicates the importance of financial institutions or intermediaries as mobilisers of funds relative to real sectors as direct mobilisers of funds. It indicates the institutionalisation of financing in the economy. These four indicators of financial development for the span of more than 40 years (1951-94) are presented in Table 2. They have all increased significantly implying the growing importance of financial institutions in the economy and the growth of financial flows in relation to economic activity, both in the form of direct and indirect finance. The levels and changes in FIR indicate that the financial structure in India has grown more rapidly than the national income. Changes in FR indicate that there has been a marked rise in the institutionalisation of financing investment, and that separation between the acts of saving and investment has grown. 2.4 FLOW-OF-FUNDS ACCOUNTS Flow-of-funds accounts (FOFA) of a country are also very useful in understanding the structure of financial institutions, assets-structure, financial behaviour and inter-relationships and the nature of financial development in that country. Before we turn to the study of flow-of-accounts in India, it would be useful to first understand the meaning and general nature of flow-of-accounts. The Flow-of-Funds Accounts are financial counterpart of the National Income Accounts of the real sector of the economy. They contain all - sectoral and aggregate-sources and uses of funds for a given economy. The sources and uses of funds in the form of various financial claims for a selected number of sectors are presented in the form of matrix, and the complexity of the matrix depends upon the number of sectors and the number of types of assets/liabilities or securities chosen. The sectors are subdivisions of the economy and are more or less homogeneous in respect of their functional and operational characteristics. In India, for this purpose the economy is divided into six sectors, namely, banking, other financial institutions, private corporate business, Government, household and the rest of the World. In the USA, the number of sectors for this purpose is nine. The FOFA may be prepared and presented either for each quarter or year. In India, only the yearly Flow-of-Funds tables are available so far. In order to avoid confusion, it is necessary to understand the interrelationships between the flows in the form of saving, investment, sources, uses, assets, liabilities, borrowing and lending. Roughly speaking, while uses, assets, lending and  11 investment fall on one side; sources, liabilities, borrowing, and saving fall on the other side. The FOFA matrix is prepared by examining the balance sheets of various sectors at the beginning and at the end of the period. The convention is to treat increase in assets as uses of funds and increase in liabilities as sources of funds. Thus, although constructed out of sectoral stock statements, these tables contain changes or flows of funds between two points of time. It may be noted that only net increases in assets are treated as use of funds; dept repayment or dis-saving, which are in fact, uses of funds are treated as negative sources of funds. In the same fact, sources of funds, are treated as negative uses. Further, the sectoral flows are also shown on the net basis i.e. while the inter-sectoral flows are included, intra-sectoral transactions are not recorded. For example, a loan from one household to another would not be reflected in the FOFA tables. The sources and uses of funds for each sector and for the entire economy must balance in theory. However, in practice they often do not balance and we get discrepancies for the sector totals and for aggregate totals. The lack of balance reflects the enormous difficulties in combining transactions and sectors in sources and uses matrix. Analytically, the lack of balance may evidence the nature of likely future developments. The distinguishing characteristic FOFA which emerges is that they present net flows of funds between sectors and between two points of time. To summarise, "the flow of funds is an interlocking, complete system that depicts the balanced sources and uses of funds for each sector, the inter-relationship among sectors, and the saving, investment, borrowing, lending and money flow totals for a 3-month or 1-year period." The examples of FOFA matrices for India are presented in Table form relating to the years respectively. The position of any item in a column shows the place of the item in the particular sector's total assets (uses) and liabilities (sources). A sector's position in the row shows the share of that sector's holding of a particular asset or liability in the national total of assets/liabilities. Percentages of items to respective column totals are given in brackets. These tables can be interpreted to reveal a good deal of information regarding the institutional and assets structure in India over the span of 20 years. However, we mention below two or three important points only by way of illustration. The total net financial flows have increased from Rs. 3771 crores to Rs. 113, 751 crores, i.e by 3116 percent during 1966-67 and 1987-88. In terms of their quantitative importance in 1987-88, different financial liabilities in India can be ranked in this  12 descending order: currency and bank deposits, loans and advances; central Government securities, provident fund, securities of other financial institutions and corporate securities in the total liabilities have increased marginally, that of loans and advances, the Government securities has declined. While the share of banking and other financial institutions in the total sources of funds has increased, that of private corporate business, Government, and households has declined. The assets-wise distribution of financial savings of the household sector to be presented later also would show that now bank deposits, provident fund, other claims on the government, life insurance policies, deposits with companies, corporate securities and units are important in this descending order as media for household savings. The importance of contractual claims in India has increased over this period. Since this change has occurred in the face of inflation, the hypothesis that inflation discourages contractual savings needs to be reviewed. The top position of bank deposits in India throughout this period is in contrast with the developments in other countries, where the importance of banking system was observed to have declined with the financial development. 2.5 TRENDS IN SAVINGS AND INVESTMENT At this point the major changes that have occurred in the savings and investment trends should be noted. We may do so by studying either the net saving and investments or gross saving and investment, the difference between the gross and net quantities being equal to fixed capital consumption allowance. In 1988-89 the gross domestic saving was 84 times and the investment 98 times of 1950-51. The rates of saving and capital formation (i.e. each of them as percent of GDP) have shown a remarkable increase from about 10% to 21 and 24 % respectively. These rates of increase in India have been higher than in many developing as well as developed countries. Thus, the IFS has amply fulfilled one of its basic functions, namely the promotion of saving and investments. Also we understand that the major part of saving has been due to the household sector. The household sector saving as percentage of the total savings has increased from 74% in 1950-51 to 81% in 1988-89. The contribution of the private corporate and public sectors together with the national savings has not been even one fourth of that and it has remained at that low level. Thus India differs from many other countries where "household savings play a minor role, with corporations generally playing the dominant role in the accumulation of national surplus, with some tendency for  13 governments to compensate where the corporations share falls below the median." The household sector has been the only surplus sector in India, while the investment of private corporate and public sectors has always far exceeded their respective savings. A detailed study of the pattern of financing of investment of different sectors has shown that the dependence of the private corporate and public sectors on the household sector and financial institutions for the purpose of financing their investment, has increased substantially over time. 2.6 FINANCIAL INTEGRATION The financial system has now become much more integrated than ever before. The dividing lines between the so-called "organised" and "unorganised" sectors, between the "busy" and "slack" seasons, are getting increasingly imperceptible. Among the factors that are behind greater integration are: a. The Government entry in a very big way in the wholesale trading of a large number of commodities. b. An unprecedented expansion of the network of rural branches of banks. c. The transformation in the perception of the role of financial institutions. d. The evolution of financial institutions as multifunction (mixed) institutions. The banks and term lending financial institutions have become more integrated through such methods as the use of "participation certificates"; the adoption of "participation approach" to granting loans and offering financial services like underwriting and guaranteeing; and their activities in the markets for call loans, commercial bills, and so on. The refinance and rediscounting schemes of institutions like IDBI and NABARD, have also contributed to greater integration. 2.7 REGULATION AND DEREGULATION The financial sector in India today, is almost entirely owned and controlled by the Government. One of the "commanding heights" of the economy is almost totally in the hands of the Government. This has been achieved in two ways: a. Through the nationalisation, one after another, of financial institutions. This process started with the nationalisation of the RBI  14 in 1949, followed by that of the Imperial Bank of India, the life insurance companies, commercial banks, and general insurance companies. b. Through the creation of a host of new financial institutions in the public sector. This process began with the setting up of the IFC in 1949 followed by many other institutions mentioned earlier. Apart from direct public ownership, the authorities closely monitor, regulate and control the policies of financial institutions in respect of personnel, expansion, and the pricing and distribution of credit. Almost every single rate of interest and return on financial claims is administered by the Government authorities. Further, the allocation of credit is effected mainly through direct credit controls, credit ceilings, and fixation of credit targets. The policies of public ownership, administrative regulations and controls, and consolidation have led to the growth of monopolistic/oligopolistic market structures in the Indian financial sector. Financial markets in India are quite imperfect, and the institutional structure is characterized by a very high degree of centralisation and concentration. The unparalleled Government control of financial institutions can hardly be said to have served the objectives of social justice. The Government-owned and Government controlled financial system has, in fact, promoted the interests of large private business organisations; it has helped rather than curbed the concentration of economic power in the hands of the powerful. It has, of course, helped the Government sector also to appropriate huge sums of money easily and at concessional cost. In fact, advancing credit to the Government sector has become, ipso facto, justifiable and desirable. All this have, in the recent past, generated much discussion in India, as in other countries, regarding the restructure, deregulation and liberalization of the financial system. The authorities have therefore liberalized the financial systems in many ways. They have removed certain regulations in respect of the stock market (viz. regarding bonus issues, issues of fresh capital), and they have removed the interest rate ceiling in the call money market. Banks have been freed from ceiling on their lending rates; interest rates on CDS, CPS, participation certificates are market determined; the Credit Authorization Scheme has been discontinued. It has been rightly pointed out in this context that financial regulation and deregulation have to be relevant to both time and  15 space, and we cannot apply a priori, simplistic and borrowed ides to this subject. In India, regulation promoted financial and institutional development; it did not have the text-book effect of restructuring the growth of financial intermediation. But it has also meant high cost of branch expansion of banks, low quality and low return on assets, low profitability of banks, and so on. Therefore, liberalisation should be brought about through sequenced and structured steps rather than suddenly. It would help to effect slow and progressive freezing of interest rates, and discontinuation of the policy of direct credit allocation. 2.8 SUMMARY  The politico-economic background of the financial development in India has been determined by the nature our mixed economic system.  The objectives of this system with respect to growth, sectoral priorities, distribution have influenced the functioning and development of IFS.  Some of the marked characteristics of Indian economy during the past 50 years are continuous inflation, increasing internal (fiscal) and external deficits, industrialisation, urbanisation and significant structural transformation.  Functioning within this context, all sectors of the economy, including the financial markets, have undergone significant changes. Further, there has been a close interaction between the financial and economic systems. 2.9 QUESTIONS Q1. Explain Indian Financial System at present. Q2. Discuss on saving and investments in the financial markets. Q3. Write explanatory notes on regulation and deregulation.   16 3 REGULATORY INSTITUTIONS Unit Structure 3.1 Introduction 3.2 Sebi (Guidelines for Disclosure and Investor Protection), 2000 3.3 Sebi (Issue and Listing of Debt Securities) Regulations, 2008 3.4 Filing of Draft Offer Document 3.5 Fimmada 3.6 Stock Exchanges in India 3.7 Major Financial Institutions in India 3.8 Foreign Investment Promotion Board 3.9 Summary 3.10 Questions 3.1 INTRODUCTION Financial Sector in India has experienced a better environment to grow with the presence of higher competition. The Financial system in India is regulated by independent regulators in the field of banking, insurance, mortgage and capital market. Government of India plays significant role in controlling the financial markets in India. Ministry of Finance, Government of India control the financial sector in India. Every year the Finance Ministry presents the annual budget. The Reserve Bank of India (RBI) is an apex institution in controlling the banking system in the country. It's monetary policy acts as a major weapon in India's financial market. Securities Exchange Board of India (SEBI) is one of the regulatory authority of India's Capital Market. Here in this Chapter a focus on major financial regulatory bodies in financial market is made. The debt markets in India are regulated by two agencies ---- RBI and SEBI. In a notification issued by the Government on March 2, 2000, the area of responsibility between RBI and SEBI have been clearly delineated. In terms of this notification, the contracts  17 for sale and purchase of government securities, gold related securities, money market securities and securities derived from these securities and ready forward contracts in debt securities shall be regulated by the RBI. However, regulation of money market mutual funds, which predominantly invest in money markets, is done by the SEBI, which is the regulatory authority for the mutual fund industry. SEBI is the regulating agency for the stock markets and the member-brokers of the stock exchanges, and therefore, regulates the listing and trading mechanism of debt instruments. Regulation of corporate debt issuance is also under the purview of SEBI. The issuance of debt instruments by the government is regulated by the Government Securities Act 2006. The issuance of corporate securities is regulated by the SEBI Guidelines for Disclosure and investor protection. The Fixed Income Money Market & Derivatives Association of Indian (FIMMDA), formed in 1998, is the Self-regulatory Organisation for debt markets. Its objective is to enable market development by involving market participants in the creation of good market practices, uniform market conventions and high levels of integrity in the debt markets. INDIAN DEBT MARKET: REGULATIONS AND SECURITY LEGISLATION Reserve Bank of India a) Regulates - Investment pattern of banks - Money Markets - NBFCs b) Prescribes capital adequacy norms and accounting policies for banks SEBI a) Regulates Securities Markets b) Protects investors’ interest and stipulates disclosure guidelines NSE Expected to regulate secondary market activities in debt instruments Companies Act, 1956 Requirements of a prospectus to be drawn up when a company issues new shares or debentures  18 Securities Contract a) Listing of Securities (Regulation) Act, 1956 b) Right of appeal against refusal to list securities c) Free transferability of securities GOVERNMENT SECURITIES ACT, 2006 With a view to consolidating and amending the law relating to the Government Securities and its management by the Reserve Bank of India, the Parliament had enacted the Government Securities Act, 2006. The Act received the presidential assent on August 30, 2006. The Government Securities Act also provides that RBI may take regulations to carry out the purpose of the Act. Government Securities Act, 2006 and Government Securities Regulations, 2007 have come into force with effect from December 1, 2007. The Government Securities Act applies to Government securities created and issued by the Central and State Governments. The new Act and Regulations would facilitate widening and deepening of the Government Securities market and its more effective regulation by the Reserve Bank. GOVERNMENT SECURITIES REGULATIONS, 2007 Government Securities Regulations, 2007 have been made by the Reserve Bank of India to carry out the purpose of the Government Securities Act. The Government Securities Regulations provides for transfer of Government securities held in different forms. a. Government security held in the form of Government Promissory Notes is transferable by endorsement and delivery. b. A bearer bond is transferable by delivery and the person in possessions of the bond shall be deemed to be the holder of the bond. c. Government Securities held in the form of Stock Certificates, Subsidiary General Ledger account including a constituent Subsidiary General Ledger Account & Bond Ledger Account are transferable, before maturity, by executive of forms – III, IV & V respectively appended to the Government Securities Regulations. d. Government Securities held in subsidiary general ledger account including a constituent subsidiary general ledger account or bond  19 ledger account, shall also be transferable by execution of a deed in an electronic form under digital signature. 3.2 SEBI (GUIDELINES FOR DISCLOSURE AND INVESTOR PROTECTION), 2000 SEBI Guidelines for issuance of corporate debentures is stipulated in Chapter X of the DIP, 2000. Some of its major provisions are:- Requirement for Credit Rating No company shall make a public issue or rights issue of debt instruments (whether convertible or not), unless credit rating is obtained from at least one credit rating agency registered with the board and disclosed in the offer document. Where ratings are obtained from more than one credit rating agencies, all the ratings including the unaccepted credit ratings, shall be disclosed in the offer document. All the credit ratings obtained during the three years (3) preceding the public or rights issue of debt instrument (including convertible instruments) for any listed security of the issuer company shall be disclosed in the offer document. Requirement in respect of Debenture Trustee No company shall issue a prospectus or a letter of offer to the public for subscription of the debentures, unless the company has appointed one or more debenture trustees for such debentures in accordance with the provisions of the Companies Act, 1956. Creation of Debenture Redemption Reserves (DRR) For the redemption of the debentures issued, the company shall create debenture redemption reserve in accordance with the Provisions of the Companies Act, 1956. Distribution of Dividends In case of the companies which have defaulted in payment of interest on debentures or redemption of debentures or in creation of security as per the terms of issue of the debentures, any distribution of dividend shall require approval of the Debenture Trustees and the Lead Institution, if any, dividends may be distributed out of profit of particular years only after transfer of requisite amount in DRR. Redemption The issuer company shall redeem the debentures as per the offer document.  20 Disclosures in Respect of Debentures The offer document shall contain: i. Premium amount on conversion, time of conversion. ii. In case of PCDs/NCDs, redemption amount, period of maturity, yield on redemption of the PCDs/NCDs. iii. Full information relating to the terms of offer or purchase including the name(s) of the party offering to purchase the khokhas (non-convertible portion of PCDs). iv. The discount at which such offer is made and the effective price for the investor as a result of such discount. v. The existing and future equity and long term debt ratio. vi. Servicing behaviour on existing debentures, payment of due interest on due dates on term loans and debentures. 3.3 SEBI (ISSUE AND LISTING OF DEBT SECURITIES) REGULATIONS, 2008 Issue Requirements for Public Issues General Conditions a. No issuer should make any public issue of debt securities if as on the date of filling of draft offer document and final offer document as provided in these regulations, the issuer or the person in control of the issuer, or its promoter, has been restrained or prohibited or debarred by the Board from accessing the securities market or dealing in securities and such direction in order is in force. b. The following conditions have to be satisfied by an issuer for making any public issue of debt securities as on the date of filing of draft offer document and final offer document. i. If the issuer has made an application to more than one recognised stock exchange, the issuer is required to choose one of them as the designated stock exchange. Further, where any of such stock exchanges have nationwide trading terminals, the issuer should choose one of them as designated stock exchange. For any subsequent public issue, the issuer may choose a different stock exchange subject to the requirements of this regulation. ii. The issuer has to obtain in principle approval for listing of its debt securities on the recognised stock exchanges where the application for listing has been made.  21 iii. Credit rating has been obtained from at least one credit rating agency registered with SEBI and is disclosed in the offer document. If the credit ratings have been obtained from more than one credit rating agency, then all ratings including the unaccepted ratings have to be disclosed in the offer document. iv. It has to enter into an arrangement with a depository registered with SEBI for dematerialisation of debt securities that are proposed to be issued to the public in accordance with the Depositories Act 1996 and regulations made there under. c. The issuer should appoint one or more merchant bankers registered with SEBI at least one of whom should be a lead merchant banker. d. The issuer should appoint one or more debenture trustees in accordance with the provision of Section 117 B of the Companies Act, 1956 and SEBI (Debenture Trustee) Regulations 1993. e. The issuer should not issue debt securities for providing loan to or acquisition of shares of any person who is part of the same group or who is under the same management. 3.4 FILING OF DRAFT OFFER DOCUMENT No issuer should make a public issue of debt securities unless a draft of offer document has to be filed with the designated stock exchange through the lead merchant banker. The draft offer document filed with the stock exchange has to be made public by posting the same on the website of the designated stock exchange for seeking public comments for a period of seven working days for the date of filing the draft offer document with such exchange. The draft offer document may also be displayed on the website of the issuer, merchant bankers. The lead merchant bankers should ensure that the draft offer document clearly specifies names and contact particulars of the compliance officer of the lead merchant banker and the issuer including the postal and email address, telephone and fax numbers. The lead merchant banker should also ensure that all comments received on the draft offer document are suitably addressed prior to the filing of the offer document with the Registrar of Companies. A copy of the draft and final offer document should be forwarded to SEBI for its records, simultaneously with filing of these documents with the designated stock exchanges. The lead merchant bankers should prior to filing of the offer document with the Registrar of Companies, furnish to SEBI a due  22 diligence certificate as per the format provided in Schedule II of SEBI (Issue and Listing of Debt Securities) Regulations, 2008. Electronic Issuance An issuer proposing to issue debt securities to the public through the on-line system of designated stock exchange should comply with the relevant applicable requirements as may be specified by SEBI. Price Discovery through Book Building The issuer may determine the price of debt securities in consultation with the lead merchant banker and the issue may be at fixed price or the price may be determined through the book building process in accordance with the procedure as may be specified by SEBI Minimum Subscription The issuer may decide the amount of minimum subscription which it seeks to raise by issue of debt securities and disclose the same in the offer document. In the event of non-receipt of minimum subscription all application moneys received in the public issue shall be refunded forthwith to its applicants. Listing of Debt Securities An issuer desirous of making an offer of debt securities to the public has to make an application for listing to one or more recognised stock exchanges in terms of sub-section (1) Section 73 of the Companies Act, 1956 (I of 1956). The issuer has to comply with the conditions of listing of such debt securities as specified in the Listing Agreement with the Stock Exchanges where such debt securities are sought to be listed. 3.5 FIMMDA The Fixed Income Money Market and Derivatives Association of India (FIMMDA), an association of Scheduled Commercial Banks, Public Financial Institutions, Primary Dealers and Insurance Companies was incorporated as a Company under Section 25 of the Companies Act, 1956 on June 3, 1998. FIMMDA is a voluntary market body for the bond, money and derivatives markets. FIMMDA has members representing all major institutional segments of the market. The membership includes Nationalised Banks such as State Bank of India, its associate banks and other nationalised banks; Private Sector Banks such as ICICI Bank, HDFC Bank, IDBI Bank, Foreign Banks such as Bank of America, ABN Amro, Citibank, Financial institutions such as IDFC, EXIM  23 Bank, NABARD, Insurance Companies like LIC, ICICI Prudential Life Insurance company, Birla Sun Life Insurance Company and all Primary Dealers. The FIMMDA represents market participants and aids the development of the bond, money and derivatives market. It acts as an interface with the regulators on various issues that impact the functioning of these markets. It also undertakes developmental activities, such as, introduction of benchmark rates and new derivatives instruments etc. FIMMDA releases rates of various Government securities that are used by market participants for valuation purposes. FIMMDA also plays a constructive role in the evolution of best market practices by its members so that the market as a whole operates transparently as well as efficiently. 3.6 STOCK EXCHANGES IN INDIA 3.6 (a) NATIONAL STOCK EXCHANGE OF INDIA In the year 1991 Pherwani Committee recommended to establish National Stock Exchange (NSE) in India. In 1992 the Government of India authorised IDBI for establishing this exchange. In NSE, there is trading of equity shares, bonds and government securities. India's stock exchanges particularly National Stock Exchange (NSE) has achieved world standards in the recent years. The NSE India ranked its 3rd position since last four years in terms of total number of trading per calendar year. Presently, there are 24 stock exchanges in India, out of which 20 have exchanges, National Stock Exchange (NSE), Over The Counter Exchange of India Ltd. (OTCEI), and Inter-connected Stock Exchange of India Ltd (ISE) have nation-wide trading facilities. New NSE Reference Rates Both MIBOR (Mumbai Inter Bank Offer Rate) and MIBID (Mumbai Inter Bank Bid Rate) are the two new references rates of National Stock Exchanges. These two new reference rates were launched on 15 June1998 for the loans of inter-bank call money market. Both MIBOR and MIBID work simultaneously. The MIBOR indicates lending rates for loans while MIBID is the rate for receipts. 3.6 (b) BOMBAY STOCK EXCHANGE (BSE) BSE is one of the oldest stock exchanges in Asia and was established in the year 1875 in the name of "The Native Share and Stock Brokers Association."  24 BSE is located at Dalal Street, Mumbai, India. It got recognition in the year 1956 from the Government of India under Securities Contracts (Regulation) Act, 1956. Presently BSE SENSEX is recognised world-wide. Trading volumes have drawn the attention over the globe. BSE INDICES The well known index is BSE SENSEX. Others include BSE 500, BSEPSU, BSEMIDCAP, BSEMLCAP and BSEBANKEX. BSE 100 Index: The equity share of 100 companies from the list of 5 major stock exchanges such as Mumbai, Calcutta, Delhi, Ahmedabad and Madras are selected for the purpose of compiling the BSE National Index. The year 1983-84 is taken as the base year for this index. The method of compilation here is same as that of the BSE SENSEX. BSE 200 Index: The BSE 200 Index was launched on 27th May 1994. The companies under BSE 200 have been selected on the basis of their market capitalisation, volumes of turnover and other fundamental factors. The financial year 1989-90 has been selected as the base year. BSE 500 Index: BSE 500 Index consisting of 500 scrips is functioning since 1999. Presently BSE 500 Index represents more than 90% of the total market capitalisation on Bombay Stock Exchange Limited. BSE PSU Index: BSE PSU Index has been working since 4th June 2001. This index includes major Public Sector Undertakings listed in the Exchange. The BSE PSU Index tracks the performance of listed PSU stocks in the exchange. RESERVE BANK OF INDIA Reserve Bank of India is the apex monetary Institution of India. It is also called as the central bank of the country. The bank was established on April1, 1935 according to the Reserve Bank of India act 1934. It acts as the apex monetary authority of the country. The preamble of the reserve bank of India is as follows: "...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage."  25 3.7 MAJOR FINANCIAL INSTITUTIONS IN INDIA This is a list on the major financial institutions in India and their respective date of starting operations. Financial Institution Date of Starting Imperial Bank of India 1921 Reserve Bank of India April 1, 1935 Industrial Finance corporation of India 1948 State Bank of India July 1, 1955 Unit Trust of India Feb. 1,1964 IDBI July 1964 NABARD July 12,1982 SIDBI 1990 EXIM Bank January 1, 1982 National Housing Bank July 1988 Life Insurance Corporation (LIC) September 1956 General Insurance Corporation (GIC) November 1972 Regional Rural Banks Oct. 2, 1975 Risk Capital and Technology Finance Corporation Ltd. March 1975 Technology Development & Information Co. of India Ltd. 1989 Infrastructure Leasing & Financial Services Ltd. 1988 Housing Development Finance Corporation Ltd. (HDFC) 1977 3.8 FOREIGN INVESTMENT PROMOTION BOARD The Foreign Investment Promotion Board is a special agency in India dealing with the matters relating to Foreign Direct Investment. This special board was set up with a view to raise the volume of investment to the country. The sole aim of the board is to create a base in the country by which a larger volume of investment can be drawn to the country. On 18 February 2003, the board was transferred to the Department of Economic Affairs (DEA) Ministry of Finance.  26 Important functions of the Board are as follows:  Formulating proposals for the promotion of investment.  Steps to implement the proposals.  Setting friendly guidelines for facilitating more investors.  Inviting more companies to make investment.  To recommend the Government to have necessary actions for attracting more investment.  With regards to the structure of the Foreign Investment Promotion Board, the board comprises the following group of secretaries to the Government:  Secretary to Government Department of Economic Affairs, Ministry of Finance- Chairman.  Secretary to Government Department of Industrial Policy and Promotion, Ministry of commerce and Industry.  Secretary to Government, Department of Commerce, Ministry of Commerce and Industry.  Secretary to Government, Economic Relations, Ministry of External Affairs.  Secretary to Government, Ministry of Overseas Indian Affairs.  In the recent years, particularly after the implementation of the new economic policy, the Government has undertaken many steps to attract more investors for investing in the country. The new proposals for the foreign investment are allowed under the automatic route keeping in view the sectoral practices. 3.9 SUMMARY  Financial Sector in India has experienced a better environment to grow with the presence of higher competition. The Financial system in India is regulated by independent regulators in the field of banking, insurance, mortgage and capital market. Government of India plays significant role in controlling the financial markets in India.  Ministry of Finance, Government of India control the financial sector in India. Every year the Finance Ministry presents the annual budget. The Reserve Bank of India (RBI) is an apex institution in controlling the banking system in the country. It's monetary policy acts as a major weapon in India's financial market.  27  Securities Exchange Board of India (SEBI) is one of the regulatory authority of India's Capital Market. 3.10 QUESTIONS Q1. Name the regulatory Institutions. Q2. Explain the role and functions of SEBI, RBI. Q3. Write explanatory notes on the following: a. Financial Institutions of India. b. Foreign Investment Promotion Board.   28 MODULE - II 4 CAPITAL MARKETS Unit Structure 4.0 Learning Objectives 4.1 Introduction 4.2 Definitions of Capital Market 4.3 Importance of Capital Market 4.4 Functions of Capital Market 4.5 Players in the Capital Market 4.6 The Growth of the Capital Market 4.7 Components of the Capital Market 4.8 Structure of Capital Market in India 4.9 Nature and Constituents 4.10 Industrial Securities 4.0 LEARNING OBJECTIVES After studying this unit, learner will be able to understand:  The meaning, structure, components, players of capital markets.  The learner will comprehend industrial securities market.  The learner will understand the meaning of primary markets.  The learner will understand the characteristics of primary markets, the meaning of IPO and how IPO is issued.  The learner will also comprehend the process of book-building and the meaning of red herring prospectus.  The learner will understand the meaning of secondary markets, need for secondary market, role of secondary market, equity and debt market.  The learner will further understand the working of stock exchanges.  29  The learner will understand how the shares are bought and sold in stock exchanges, gain knowledge on stock indices. 4.1 INTRODUCTION Capital Market is a market for long-term sources of finance to the industrial and corporate sector. The development of a nation depends upon the rapid growth of industrialisation of a country. Asset formation is the crucial factor for prosperity of nation. The asset creation is based on supply of capital and technology. Capital alone will not create prosperity. The prosperity is the combination of Technology, Capital and Human Resources. The chemistry of these factors will definitely help the underdeveloped countries towards developed nation. 4.2 DEFINITIONS OF CAPITAL MARKET According to Arun K. Datta the capital market may be defined as, "the capital market is a complex of institutions investment and practices with established links between the demand for and supply of different types of capital gains". According to F. Livingston the capital market may be defined as, "In a developing economy, it is the business of the capital market to facilitate the main stream of command over capital to the point of the highest yield. By doing so, it enables, control over resources to pass into the hands of those who can employ them must effectively thereby increasing production capacity and spelling the national dividend." 4.3 IMPORTANCE OF CAPITAL MARKET Capital market deals with long-term funds. These funds are subject to uncertainty and risk. It supplies long and medium term funds to the corporate sector. It provides the mechanism for facilitating capital fund transactions. It deals in ordinary shares, bond debentures and stocks and securities of the government. In this market the funds flow will come from savers. It converts financial assets into productive physical assets. It provides incentives to savers in the form of interest or dividend to the investors. It leads to capital formation. The following factors play an important role in the growth of the capital market: 1. A strong and powerful Central Government 2. Financial dynamics 3. Speedy industrialisation 4. Attracting Foreign Investment  30 5. Investments from NRIs 6. Speedy Implementation of policies 7. Regulatory changes 8. Globalisation 9. The level of savings and investment pattern of the household sectors 10. Development of financial theories 11. Sophisticated technological advances 4.4 FUNCTIONS OF CAPITAL MARKET Capital market plays a vital role in the development by mobilising the savings to the needy corporate sector. In recent years there has been a substantial growth in the Capital Market. The Capital Market involves in various functions and significance. They are presented below: i. Coordinator ii. Motivation to savings iii. Transformation to investments iv. Enhances economic growth v. Stability vi. Advantages to the investors vii. Barometer i. Coordinator The Capital Market functions as coordinator between savers and investors. It mobilises the savings from those who have surplus fund and divert them to the needy persons or organisations. Therefore, it acts as a facilitator of the financial resource. In this way it plays a vital role in transferring the surplus resources to deficit sectors. It increases the productivity of the industry which ultimately reflects in GDP and national income of the country. It increases the prosperity of the nation. ii. Motivation of Savings The Capital Market provides a wide range of financial instruments at all times. India has a vast number of individual savers and the crores of rupees are available with them. These resources can be attracted by the capital market with nature. The banks and non-banking financial institutions motivate the people to save more and more. In less developed countries, there is no efficient capital market to tap the savings. In underdeveloped countries there are very little savings due to various factors. In those countries they invest mostly in unproductive sector. iii. Transformation of Investment The Capital Market is a place where the savings are mobilised from various sources, is at the disposal of businessmen  31 and the government. It facilitates lending to the corporate sector and the government. It diverts the savings amount towards capital formation of the corporate sector. It creates assets by helping the industry. Thus, it enhances the productivity and leads to industrialisation. The industrial development of the country depends upon the dynamic nature of the capital market. It also provides facilities through banks and non-banking financial institutions. The development of financial institutions made the way easy to capital market. The capital has become more mobile. The interest rate fall lead to an increase in the investment. iv. Enhances economic growth The development of the Capital Market is influenced by many factors like the level of savings with the public, per capita income, purchasing capacity, and the general condition of the economy. The capital market smoothens and accelerates the process of economic growth. The Capital Market consists of various institutions like banking and non-banking financial institutions. It allocates the resources very cautiously in accordance with the development of needs of the country. The balanced and proper allocation of the financial resources leads to the expansion of the industrial sector. Therefore, it promotes the balances regional development. All regions should be developed in the country. v. Stability The Capital Market provides a stable security prices in the stock market. It tends to stabilise the value of stocks and securities. It reduces the fluctuations in the prices to the minimum level. The process of stabilisation is facilitated by providing funds to the borrowers at a lower interest rate. The speculative prices in the stock market can be reduced by supply of funds. The flow of funds towards secondary market reduces the prices at certain level. Therefore, the Capital Market provides funds to the stock market at a low rate of interest. vi. Advantages to the Investors The investors who have surplus funds can invest in long- term financial instruments. In Capital Market, a number of long-term financial instruments are available to the investor at any time. Hence, the investors can lend their money in the Capital Market at reasonable rate of interest. The Capital Market helps the investors in many ways. It is the coordinator to bring the buyer and seller at one place and ensure the marketability of investments. The stock market prices are published in newspapers everyday which enables the investor to keep track of their investments and channelise them into most profitable way. The Capital Market safeguards the interest of the investors by compensating from the stock exchange compensating fund in case of fraud and default.  32 vii. Barometer The development of the Capital Market is the indicator of the development of a nation. The prosperity and wealth of a nation depends, upon the dynamic capital market. It not only reflects the general condition of the economy but also smoothens and accelerates the process of economic growth. It consists a number of institutions, allocates the resources rationally in accordance with the development needs of the country. A good allocation of resources leads to expansion of trade and industry. It helps both public and private sector. Generally, the corporate sector requires funds not only for meeting their long-term requirements of funds for their new projects modernisation, expansion and diversification programmes but also for covering their operational needs. Therefore, their requirement of capital is classified as given below: a. Long-term capital b. Short-term capital c. Venture capital d. Export capital Long-term capital represents the amount of capital invested in the form of fixed assets. Fixed assets are such as land, building, plant and machinery necessary for every company at the initial stage of the commencement of the production. Heavy amount of capital is required by the companies when they are going for modernisation or expansion or diversification. Therefore, the requirement of long-term capital is supplied by the capital market. This is also referred to as Fixed Capital. Usually the corporate sector mobilises the fixed capital from the Capital Market through various long-term maturity financial instruments. Therefore, it provides adequate funds to the corporate sector by offering various financial instruments. They mobilise the funds through issue of Equity shares. Preference shares, debentures, bonds etc. These financial instruments have a longer maturity period and they are treated by the companies as permanent capital. Some instruments have no maturity until the close down of a business unit. Short-term capital represents the amount of capital invested in current assets. The Current Assets consist of cash, bank balances, inventory, debtors etc. The short-term capital is required to meet the need of working capital of the corporate sector. Working capital is required for meeting the operating cost of the business concern. They are required to pay different amounts to different parties as per their schedule. Hence, they procure the working capital from the commercial banks. In India a majority of the corporate sector is funded by the banks through different modes of finance. The working capital is known as circulating  33 capital. An adequate supply of working capital leads to smooth functioning of production of goods. There are some other avenues available to the corporate sector to meet the needs of the working capital. Venture capital is the capital which invested in highly risky ventures. It is also known as seed capital. It is a quite recent entrant in the capital market. It has great significance in helping technocrat entrepreneurs at the commencement stage of the concern. It has technical expertise. But it lacks finance. Export capital refers for making payment in International Trade. The payment of international trade involves in bills of exchange and other instruments. 4.5 PLAYERS IN THE CAPITAL MARKET Capital Market is a market for long-term funds. It requires a well-structured market to enhance the financial capability of the country. The market consists of a number of players. They are categorised as: 1. Companies 2. Financial Intermediaries 3. Investors 1. Companies Generally every public company can access the capital market. The companies which are in need of finance for their projects can approach the market. The capital market provides funds from the savers of the community. The companies can mobilise the resources for their long-term needs such as project cost, expansion and diversification of projects and other expenditure items. In India, the companies should get the prior permission from the SEBI (Securities Exchange Board of India) to raise the capital from the market. The SEBI is the most powerful organisation to monitor, control and guide the capital market. It classifies the companies for the issue of share capital as new companies, existing, and unlisted existing listed companies. According to its guidelines a company is a new company, if it satisfies all the following conditions: a. The company shall not have completed 12 months of commercial operations. b. Its audited operative results are not available. c. The company may set-up by entrepreneurs with or without track record. A company can be treated as existing listed company, if its shares are listed in any recognised stock exchange in India. A  34 company is said to be an existing listed company if it is a closely held or private company. 2. Financial Intermediaries Financial intermediaries are those who assist in the process of converting savings into capital formation in the country. A strong capital formation process is the oxygen to the corporate sector. Therefore, the intermediaries occupy a dominant role in the capital formation which ultimately leads to the growth of prospering to the community. Their role in this situation cannot be neglected. The government should encourage these intermediaries to build a strong financial empire for the country. They can also be called as financial architectures of the Indian digital economy. Their network cannot be ignored. Their financial capability cannot be measured. They take active role in the capital market. The major intermediaries in the capital market are: a. Brokers b. Stock-brokers and sub-brokers c. Merchant Bankers d. Underwriters e. Registrars f. Mutual Funds g. Collecting agents h. Depositories i. Agents j. Advertising agencies 3. Investors The capital market consists of many number of investors. All types of investor's basic objectives are to get good returns on their investment. Investment means, just parking one's idle fund in a right parking place for a stipulated period of time. Every parked vehicle shall be taken away by its owners from parking place after a specific period. The same process may be applicable to the investment. Every fund owner may desire to take away the fund after a specific period. Therefore, safety is the most important factor while considering the investment proposal. The investors comprise the financial and investment companies and the general public companies. Usually, the individual savers are also treated as investors. Return is the reward to the investors. Risk is the punishment to the investors who wrongly made investment decision. Return is always chased by the risk. An intelligent investor must always try to escape the risk and capture the return. All rational investors prefer return, but most investors are risk averse. They attempt to get maximum capital gain. The return can be made available to the investors in two types and they are in the form of revenue or capital appreciation. Some investors will prefer for revenue receipt and others prefer capital appreciation. It depends  35 upon their economic status and the effect of tax implications. The institutions and companies raise the resources from the market by designing various schemes to meet the needs and convenience of the investors. They schemes can be framed to attract all types of investors, who are selling in the capital market. The main objective of any type of investor are safety, profitability, liquidity and capital appreciation. Distinction between Capital and Money Market Money market is different from Capital Market on the basis of the following characteristics: 1. Period of time 2. Financial Instruments 3. Purpose of Loan 4. Risk 5. Market Regulation 6. Liquidity 7. Monitoring 8. Players 1. Period of time The money market is a market for lending and borrowing of the short-term finance. The term short-term period refers to finance available for one year or less to the borrowers. Generally the borrowers will procure the fund for meeting their working capital requirements. Usually the working capital of the corporate sector is supplied by commercial banks and players of the money market. The capital market is a market where the long-term funds are available at reasonable rates of interest to the borrowers. Usually the fixed capital of the corporate sector will be met by the long-term nature of financial instruments. These financial instruments are available in the capital market only. The fund will be supplied to the corporate sector by capital market for the purpose of project expansion, diversification and other needs. 2. Financial Instruments The companies generally raise the fund from market by issuing a number of financial instruments. The money market consists of short-term financial instruments such as call money, CDs, Bills and collateral loans etc. On the other hand, the main instruments are used in the capital market for long-term basis. These financial instruments such as shares, debentures and bonds are issued by the companies for their requirements. 3. Purpose of loans The companies enter the money market to meet the needs of their short-term finance. The money market issues different types of financial instruments for one year period to meet the needs of  36 working capital. The working capital arrangements will be adjusted by the money market while the fixed capital by the capital market. The long-term needs of finance will be adjusted by the capital market to the corporate sector. 4. Risk Generally the financial markets involve some degree of risk. The level of degree of risk depends upon the nature of market. The money market involves less risk level while the capital markets consist of higher levels of risk. The money market maturity period is one year. On the other hand, capital market caters to the long-term credit needs for the corporate sector and arrangements will be made for fixed capital to but land or machinery. 5. Market Regulation In India, the market is closely observed by the prudential authorities. It is necessary to regulate the market operations for better functioning of the financial system. In the capital market the institutions are not much regulated. The money market is regulated by RBI, SEBI and Ministry of Finance. 6. Liquidity Liquidity is the most important factor in the money market. The role of money market is creation of liquidity. The money market is a ready market for its financial assets. The basic role of capital market is providing funds to work on long-term basis. The financial instruments which are available in the capital market are productive employment and generation of assets in the economy. Asset formation is made by the capital market. 7. Monitoring The money market is closely associated with the Central Bank of the country. The Central Bank in India is RBI. The RBI is the supreme authority in the money market. It is directly linked with the Central Bank of India. But the capital market is regulated, observed and monitored by the SEBI. The RBI has less control on capital market. 8. Players The important players in the money market are Central Bank, Acceptance house, Commercial Banks, non-banking financial institutions, Bill brokers etc. But in capital market stock exchanges, insurance companies, mortgage banks, non-banking institutions are important players. The secondary market for money market is not active in India. But the secondary market for capital market is very active. The investment in money market is highest safety whereas the investment in capital market is not so safe. The accessibility to money market by individual is not possible but capital market provides easy accessibility to the individuals.  37 4.6 THE GROWTH OF THE CAPITAL MARKET The Indian financial system is both developed and integrated today. Integration has been through a participatory approach in granting loans as well as in saving schemes. The expansion in size and number of 59 institutions has led to a considerable degree of diversification and increase in the types of financial instruments in the financial sector which are wholly owned by the government. The development banks in the Indian financial system have witnessed vast changes in the planning periods. Now the development banks constitute the backbone of the Indian Capital Market. The relevant of the development banks in the industrial financial system is not merely qualitative, but they have overwhelming qualitative dimensions in terms of their promotional and innovational functions. The growth of the capital market is determined by the following factors: 1. Economic Development 2. Rapid Industrialisation 3. Level of savings and investment of the household sector 4. Technological advances 5. Corporate performance 6. Regulatory framework 7. Participation of foreign institutional investors in the capital market 8. Development of financial services 9. Liquidity factors 10. Political stability 11. Globalisation 12. Financial Innovation 13. Economic and financial sector reforms 14. International developments 15. Agency costs 16. Emergence of financial intermediaries 17. Specialisation among investment managers 18. Incentives 19. Speed in acquiring, processing and acting upon information 20. NRIs investment. 4.7 COMPONENTS OF THE CAPITAL MARKET In a capital market, banks and financial institutions are the important components. They act as catalysts in the economic development of any country. These institutions mobilise financial  38 savings from household, corporate and other sectors of the economy and channelise the into productive investments. They act as a Reservoir of resources of Financial Markets and form the backbone of the economic and financial system. The Banking industry has undergone a sea change during the last three decades. After the modernisation of banks, they not only lend for the Social and Economic causes but also participated in the development programmes of Central Government and State Government. The main components of the capital market in India are: 1. New-issue Market (Public issues) (Primary Market) 2. Secondary Market (Stock Market) these topics will be covered in forthcoming units. The Indian Capital Market is regulated by The Securities and Exchange Board of India (SEBI). 4.8 STRUCTURE OF CAPITAL MARKET IN INDIA The structure of the capital market has undergone vast changes in recent years. The Indian capital market has transformed into a new appearance over the last four and half decades. Now it comprises an impressive network of financial institutions and financial instruments. The market for already issued securities has become more sophisticated in response to the different needs of the investors. The specialised financial institutions were involved in providing long-term credit to the corporate sector. Therefore, the premier financial institutions such as ICICI, IDBI, UTI, LIC and GIC constitute the largest segment. A number of new financial instruments and financial intermediaries have emerged in the capital market, Usually the capital markets are classified in two ways: 1. On the basis of issuer. 2. On the basis of instruments. On the basis of issuer the capital markets can be classified again into two types 1. Corporate securities market. 2. Government securities market. On the basis of financial instruments the capital markets are classified into two kinds: 1. Equity Market 2. Debt Market Recently there has been a substantial development of the Indian Capital Market. It comprises various sub-markets. Equity  39 market is more popular in India. It refers to the market for equity shares of existing and new companies. Every company shall approach the market for rising of funds. The equity market can be divided into two categories: 1. Primary Market 2. Secondary Market. Debt Market represents the market for long-term financial instruments such as debentures, bonds etc. 4.9 NATURE AND CONSTITUENTS The Capital Markets consist of a number of individuals and institutions. The Government is also an important player in the capital market. The players in the capital market channalise the supply and demand for the long-term capital. The constituents of the capital markets are, the stock exchange, commercial banks, cooperative banks, saving banks, development banks, insurance companies, investment trusts and companies etc. 4.10 INDUSTRIAL SECURITIES Industrial Securities Market As the very name suggests, it is a market for industrial securities namely: 1. Equity shares or ordinary shares 2. Preference Shares 3. Debentures or bonds. It is a market where industrial concerns raise their capital or debt by issuing appropriate instruments. It can be further divided into two. They are: a. Primary Market or New Issue Market b. Secondary Market or Stock Exchange. a. Primary Market Primary Market is a market for new issues or new financial claims. Hence, it is also called New Issue Market. The primary market deals with these securities which are issued to the public for the first time. There are three ways by which a company may raise capital in a primary market. They are: a. Public issue b. Rights issue c. Private Placement  40 The most common method of raising by new companies is through sale of securities to the public. It is called public issue. When an existing company wants to raise additional capital, securities are first offered to the existing shareholders on a pre- emptive basis. It is called rights issue. Private placement is a way of selling securities privately to a small group of investors. b. Secondary Market Secondary Market is a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the Stock Exchange and it provides a continuous and regular market for buying and selling of securities. This market consists of all stock exchanges recognised by the Government of India. The stock exchanges in India are regulated under the Securities Contracts (Regulation) Act, 1956. The Bombay Stock Exchange is the principal stock exchange in India which sets the tone of the other stock markets. SUMMARY  Capital Market is a market for long-term sources of finance to the industrial and corporate sector.  Capital market deals with long-term funds. These funds are subject to uncertainty and risk. It supplies long and medium term funds to the corporate sector. It provides the mechanism for facilitating capital fund transactions. It deals in ordinary shares, bond debentures and stocks and securities of the government. In this market the funds flow will come from savers. It converts financial assets into productive physical assets. It provides incentives to savers in the form of interest or dividend to the investors. It leads to capital formation.  Capital market plays a vital role in the development by mobilising the savings to the needy corporate sector. In recent years there has been a substantial growth in the Capital Market. The Capital Market involves in various functions and significance.  Generally, the corporate sector requires funds not only for meeting their long-term requirements of funds for their new projects modernisation, expansion and diversification programmes but also for covering their operational needs. Therefore, their requirement of capital is classified as given below: a. Long-term capital b. Short-term capital c. Venture capital d. Export capital  41  Capital Market is a market for long-term funds. It requires a well- structured market to enhance the financial capability of the country. The market consists of a number of players. They are categorised as: 1. Companies 2. Financial Intermediaries 3. Investors  The Indian financial system is both developed and integrated today. Integration has been through a participatory approach in granting loans as well as in saving schemes. The expansion in size and number of 59 institutions has led to a considerable degree of diversification and increase in the types of financial instruments in the financial sector which are wholly owned by the government. In a capital market, banks and financial institutions are the important components. They act as catalysts in the economic development of any country. The main components of the capital market in India are: 1. New-issue Market (Public issues) (Primary Market) 2. Secondary Market (Stock Market) these topics will be covered in forthcoming units. The Indian Capital Market is regulated by The Securities and Exchange Board of India (SEBI).  The structure of the capital market has undergone vast changes in recent years. The Indian capital market has transformed into a new appearance over the last four and half decades. Now it comprises an impressive network of financial institutions and financial instruments.  The Capital Markets consist of a number of individuals and institutions. The Government is also an important player in the capital market. The players in the capital market channalise the supply and demand for the long-term capital. The constituents of the capital markets are, the stock exchange, commercial banks, cooperative banks, saving banks, development banks, insurance companies, investment trusts and companies etc. CHECK YOUR PROGRESS 1. Fill in the blanks with appropriate words: a. Capital Market is a market for long-term finance to the ------------- ------- and ----------------- sectors. (Industrial, banking, retailing, corporate) b. Capital market supplies ----------------- and ------------ terms funds to the corporates. (long, short, medium, very-long)  42 c. The role of money market is creation of ------------------- (liquidity, time deposits, term deposits, foreign exchange). d. Long-term capital represents the amount of capital invested in the form of ----------------. (fixed assets, immovable assets, movable assets, money markets) e. Short-term capital represents the amount of capital invested in -- --------- assets. (fixed, current, movable, immovable) 2. Answer in one sentence: 1. What is Capital Market? 2. What is venture Capital? 3. What is Export Capital? 4. What is meant by primary market? 5. What is meant by secondary market? 6. What is the role of industrial securities market? 3. Answer briefly: 1. Explain the functions of Capital Market. 2. Who are the players in Capital Market? 3. Explain the structure of Capital Market. 4. Comment on the components of capital market. 5. Write explanatory note on industrial securities market. PRIMARY MARKET 1 INTRODUCTION Capital market consists of primary and secondary market. Primary market is that part of the capital market that deals with the issuance of new securities. Primary market is otherwise called as New Issue Market (NIM). In the primary market the securities are purchased directly from the issuer. This is the market for new long- term or permanent capital. In other words, the money raised from the primary market provides long-term capital to the companies. Primary market is a market which accelerates the process of capital formation in a country’s economy. Primary market provides opportunity to corporates and the government to raise resources to meet their investment requirements and to discharge their obligations. The companies use these funds either for setting up of new businesses or to expand the existing ones. At the same time, the funds collected through the primary capital market, are also used for modernisation of business. The securities are issued in the primary market either at face value, or at a discount or premium. Companies will issue the securities either in domestic market or in the international market through American Depository Receipt (ADR) or Global Depository Receipt (GDR) or External Commercial Borrowings (ECB) route.  43 2 CHARACTERISTICS OF PRIMARY MARKET Primary capital markets are those security markets where the equity and debt securities of corporations are offered to the investors for the first time. Important features of primary market are the following: 1. Primary market is the market for new long term capital. 2. In a primary market, the securities are issued for the first time by the company to investors. 3. In primary market securities are issued by the company directly to the investors. 4. In primary market the company receives the money and issues new security certificates to the investors. 5. In primary market it is difficult to accurately gauge the investor demand for a new security until several days of trading have occurred. 6. Primary market dost not include certain other sources of new long-term external finance, such as loans from commercial banks and other financial institutions. 7. Primary issues are used by companies for setting up new business for expanding or modernising the existing business or for providing permanent working capital. 8. The primary market performs the crucial function of facilitating capital formation in the economy. 3 KINDS OF ISSUES There are different ways for offering new issues in the primary capital market. Primary issues made by Indian Companies can be classified as follows: a. Public Issue b. Rights Issue c. Bonus Issue d. Private Placement. Public and rights issues involve a detailed procedure whereas private placements or preferential issues and bonus issues are relatively simple. a. Public Issue This is one of the important and commonly used methods for issuing new issues in the primary capital market. When an existing company offers its shares in the primary market, it is called public issue. It involves direct sale of securities to the public for a fixed price. In this kind of issue, securities are offered to the new  44 investors for becoming part of shareholders’ family of the issuer. If everybody can subscribe to the securities issued by a company, such an issue is termed as a public issue. In terms of the Companies Act of 1956, an issue becomes public if it is allotted to more than 50 persons. SEBI defined public issue as “an invitation by a company to public to subscribe to the securities offered through a prospectus.” Public issue can be further classified into two: 1. Initial Public Offer (IPO) 2. Further Public Offer (FPO) 1. Initial Public Offer (IPO) An IPO is referred simply an offering or flotation of issue of shares to the public for the first time. Initial Public Offer is the selling of securities to the public in the primary market. When an unlisted company makes either a fresh issue of securities or offers its existing securities for sale or both for the first time to the public, it is called an Initial Public Offer (IPO). The sale of securities can either be through book building or through normal public issue. IPOs are made by companies going through a transitory growth period or by privately owned companies looking to become publicly traded. IPO paves the way for listing and trading of the issuer’s securities in the stock exchanges. Initial Public Offering can be a risky investment. For the individual investor, it is tough to predict the value of the shares on its initial day of trading and in the near future since there is often little historical data with which to analyse the company. 2. Further Public Offer (FPO) When an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public it is called FPO is otherwise called as Follow on Offer. 3. DIFFERENCES BETWEEN IPO AND FPO Often Initial Public Offer (IPO) and Further Public Offer (FPO) are used interchangeably. When the company offers its shares to the investors for the first time it is called initial public offering (IPO). At the time of IPO the companies’ shares are not listed on any stock exchange. When an existing company subsequently issue more new shares in the primary market, it is called Further Public Issue (FPO) and is not considered to be an IPO. b. Rights Issue When a listed company which proposes to issue fresh securities to its existing shareholders existing as on a particular dated fixed by the issuer (i.e. record date), it is called as right issue. The rights are offered in a particular ration to the number of  45 securities held as on the record date. The route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders. c. Bonus Issue When an issuer makes an issue of shares to its existing shareholders as on a record date, without any consideration from them, it is called a bonus issue. The shares are issued to the existing shareholders out of company’s free reserves or share premium account in a particular ratio to the number of securities held on a record date. d. Private Placement When a company offers its shares to t select group of persons not exceeding 49, and which is neither a rights issue nor a public issue, it is called a private placement. Often a combination of public issue and private placement can be used by the companies for the issue of securities in the primary market. Privately placed securities are often not publicly tradable and may only be bought and sold by sophisticated qualified investors. As a result, the secondary market is not liquid as in the case of a private issue. There are SEBI guidelines, which regulate the private placement of securities by a company. Private placement is the fastest way for a company to raise equity capital. Private placement can be of two types viz., preferential allotment and qualified institutional placement. 4 PRINCIPAL STEPS OF A PUBLIC ISSUE The new shares/debentures may be offered either directly to the public through a prospectus or indirectly through an offer for sale involving financial intermediaries or issuing houses. 1. Draft Prospectus 2. Fulfilment of Entry norms (EN) 3. Appointment of underwriters 4. Appointment of Bankers 5. Initiating allotment procedure 6. Brokers to the issue 7. Filing Documents 8. Printing of prospectus and application forms 9. Listing the issue 10. Publication in news papers 11. Allotment of shares 12. Underwriters Liability 13. Operational Listing.  46 5 REASONS FOR LISTING IN IPO The following are the reasons for listing in IPO: 1. When a company lists its shares on a public exchange, it will almost invariably look