FMS Unit 2 PDF - Financial Markets & Services

Financial Markets & Services Unit – II Money Market & Capital Market MISSION VISION CORE VALUES CHRIST is a nurturing ground for an individual’s Excellence and Service...

Financial Markets & Services Unit – II Money Market & Capital Market MISSION VISION CORE VALUES CHRIST is a nurturing ground for an individual’s Excellence and Service Faith in God | Moral Uprightness holistic development to make effective contribution to Love of Fellow Beings the society in a dynamic environment Social Responsibility | Pursuit of Excellence  CHRIST Deemed to be University Financial Markets and Services Contents: Money Market: Meaning, Functions, Players and intermediaries, Instruments - treasury bills, commercial paper, commercial bills, certificate of deposit, Call money market, Corporate funding through money market. Capital Market: Meaning, Relevance of capital market to corporate finance, Components of capital market, Primary and Secondary markets, Role of stock exchanges in India, SEBI and investor protection. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Meaning of Money Market: The money market is a market for financial assets that are close substitutes for money. It is a market for overnight to short- term funds and instruments having a maturity period of one or less than one year. The major participants in the market are the commercial banks, the other financial intermediaries, large corporates and the Reserve Bank of India (RBI). Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Functions of Money Market: A money market, by providing profitable investment opportunities for short-term surplus funds, helps to enhance the profit of financial institutions. A money market enhances the liquidity available to the entire country. A well-developed money market helps to avoid wide seasonal fluctuations in interest rates. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services A well-developed money market, through a quick transfer of funds from one place to another, helps to avoid the regional gluts and stringencies of funds. A money market augments the supply of funds by providing various kinds of credit instruments suitable and attractive for different sections. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Objectives of Money Market: The main objective is to provide borrowers with short-term funds at reasonable rates. And since the securities are all short-term, the lenders will also benefit from liquidity. Turns savings and idle funds of the public into effective investments. Allows the Reserve Bank of India to regulate the levels of liquidity in the economy. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Companies and corporations have short-term deficits from time to time. They may also need help with their working capital requirements. The money market will facilitate the funds necessary. It helps the government implement monetary policies via its open market operations, which are direct and effective in nature. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Instruments of Money Market: Treasury Bills: Treasury bills are short-term instruments issued by the Government of India to tide over short-term liquidity shortfalls. The government uses this instrument to raise short-term funds to bridge seasonal or temporary gaps between its receipts (revenue and capital) and expenditure. Treasury Bills were first issued in India in 1917. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Features of Treasury Bills: They are negotiable securities. They are highly liquid as they are of shorter tenure. There is an absence of default risk. Currently, there are 14-day, 91-day, 182-day, and 364-day T- bills in vogue. The T-bills are auctioned by the RBI every alternate Wednesday. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Treasury bills are zero coupon securities and pay no interest. Instead, they are issued at a discount and redeemed at face value at maturity. T-bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Types of Treasury Bills: 14-day Treasury bill These bills complete their maturity on 14 days from the date of issue. They are auctioned on Wednesday, and the payment is made the following Friday. The auction occurs every week. These bills are sold in multiples of Rs.1lakh and the minimum amount to invest is also Rs.1 lakh, and it has been introduced effective from 1996-97. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services 91-day Treasury bill These bills complete their maturity on 91 days from the date of issue. They are auctioned on Wednesday, and the payment is made the following Friday. They are auctioned every week. These bills are sold in multiples of Rs.25000 and the minimum amount to invest is also Rs.25000. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services 182-day Treasury bill: The introduction of the 182-day T-bill market in 1986 was a significant development from the point of view of the money market. These bills complete their maturity on 182 days from the date of issue. They are auctioned on Wednesday, and the payment is made on the following Friday when the term expires. They are auctioned every alternate week. These bills are sold in multiples of Rs.25000, and the minimum investment amount is Rs.25000. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services 364-day Treasury bill These bills complete their maturity 364 days from the date of issue and were introduced by GOI in April 1992. They are auctioned on Wednesday, and the payment is made on the following Friday when the term expires. They are auctioned every alternate week. These bills are sold in multiples of Rs.25000, and the minimum investment amount is Rs.25000. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Commercial Paper: The Working Group on Money Market in 1987 suggested the introduction of commercial paper (CP) in India. The Reserve Bank introduced commercial papers in January 1990. A commercial paper is an unsecured short-term promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services It is generally issued at a discount by the leading creditworthy and highly rated corporates to meet their working capital requirements. Depending upon the issuing company, commercial paper is also known as finance paper, industrial paper, or corporate paper. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Participants: Highly rated corporate borrowers and Private Sector Companies Primary Dealers NBFC’s Requirements for issuing CP: A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crores Excellence and Service  CHRIST Deemed to be University Financial Markets and Services All eligible participants should obtain the credit rating for issuance of Commercial Paper, specified by the Reserve Bank of India from time to time, for the purpose. The minimum credit rating shall be A3 as per the rating symbol prescribed by SEBI. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Features of Commercial Paper: Commercial paper is a short-term money market instrument comprising a usance promissory note with a fixed maturity. It is a certificate evidencing an unsecured corporate debt of short-term maturity. CPs are issued at a price below their face value (discounted), and the difference represents the return to investors. Used by corporations and financial institutions to meet short- term working capital needs or other temporary funding requirements. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services CPs are generally issued in large denominations (e.g., ₹5 lakh in India or $100,000 in the U.S.), making them more suitable for institutional investors than retail investors. Once issued, CPs cannot be redeemed before maturity. Investors must wait for the specified duration to receive the payment. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services RBI guidelines on the Issue of Commercial Paper: A tangible net worth of not less than Rs. 4 crores as per the latest balance sheet; A minimum current ratio of 1.33:1 The company is listed on a stock exchange The issuing company would need to obtain credit rating from anyone of the SEBI registered credit rating agencies. The commercial paper shall be issued in multiples of Rs. 5 lakhs. The minimum amount to be invested by a single investor shall be Rs. 5 Lakhs. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services The commercial paper shall be issued for a minimum maturity period of 7 days and a maximum of 1 year from the issue date. There will be no grace period on maturity. The issue of commercial paper cannot be underwritten or co- opted in any manner. Every issuer must appoint an IPA for the issuance of CP. Issuers may buy back the CP issued by them to the investors before maturity but not before a minimum of 7 days from the date of issue. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Advantages of Commercial Paper: Simplicity: The advantage of commercial paper lies in its simplicity. It involves little documentation between the issuer and the investor. Flexibility: The issuer can issue commercial paper with maturities tailored to match the company’s cash flow. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Easy To Raise Long-Term Capital: The companies that can raise funds through commercial paper become better known in the financial world and are placed in a more favorable position for raising such long capital. High Returns: The commercial paper provides investors higher returns than they could get from the banking system. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Movement of Funds: Commercial paper facilities securitize loans, creating a secondary market for the paper and efficient movement of funds providing cash surplus to cash deficit entities. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Certificate of Deposit: CDs are short-term deposit instruments banks and financial institutions issue to raise large sums of money. CDs are issued in the form of usance promissory notes. They are negotiable and are in a marketable form bearing specific value and maturity. The CDs are transferable from one party to another. Due to their negotiable nature, they are also known as negotiable certificates of deposit. India introduced CDs in the year 1989. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Issuers: The issuers of certificates of deposits are commercial banks and financial institutions. Subscribers: CDs are available for subscription by individuals, corporations, trusts, associations, and NRIs. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Features of Certificate of Deposit: CDs can be issued in India for a minimum deposit of ₹1 lakh and subsequent multiples of it. Scheduled Commercial Banks (SCBs) and All-India Financial Institutions can issue a CD. Cooperative Banks and RRBs cannot issue a CD. CDs issued by SCBs have a term period of between 7 days to a year. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services CDs issued by financial institutions have a term period ranging from 1–3 years. One cannot issue a loan against a CD. A certificate of deposit is fully taxable under the Income Tax Act. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Advantages of Certificate of Deposits: Security: A certificate of deposit or FD will not eat up your capital due to market volatility. It is a secure financial instrument with an assured sum at maturity, similar to traditional insurance. The money you put into your CD will continue to increase predictably, and there is no risk of any loss. It is a very secure short to mid-term investment. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services High-Interest Rate: This benefit is what attracts most investors toward a CD. They offer more significant rates of interest, which can go as high as 7.8% on the lump sum deposited, than traditional savings accounts, whose interest rates average around 4%. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Low to Minimum Maintenance Costs: When it comes to the market, there are always brokerage costs for the delivery, buying, and selling of shares. There are usually no additional costs associated with a CD. You only pay what you invest with some banks. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Commercial Bill: A commercial bill is a short-term, negotiable, and self-liquidating instrument with low risk. It enhances the liability to make payments on a fixed date when goods are bought on credit. Definition: Section 5 of the NI Act defines a bill as, ‘An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or the order of a certain person or to the bearer of the instrument.’ Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods delivered to him. Such bills are called trade bills. When commercial banks accept trade bills, they are called commercial bills. Banks, when in need of money, can also get such bills rediscounted by financial institutions such as LIC, UTI, GIC, and ICICI. The maturity period of the bills varies from 30 days, 60 days, or 90 days, depending on the Excellence andcredit Service extended in the industry.  CHRIST Deemed to be University Financial Markets and Services Features or Merits of Commercial Bills: Liquidity: Bills are highly liquid assets. In times of necessity, bills can convert into cash readily using rediscounting them with the central bank. Bills are self-liquidating in character since they have fixed tenure. Moreover, they are negotiable instruments and can transfer freely by mere delivery or endorsement and delivery. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services The certainty of Payment: Bills draw and accept by business people. Generally, business people use to keeping their word and the use of the bills imposes strict financial discipline on them. Hence, bills would honor on the due date. Simple Legal Remedy: In the case of the dishonor of the bill, the legal remedy is simple. Such dishonor bills have to note and protested, and the whole amount should debit to the customer’s accounts. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Ideal Investment: Bills are for periods not exceeding three months. They represent advances for a definite period. This enables financial institutions to invest their surplus funds profitably by selecting bills of different maturities. For instance, commercial banks can invest their funds in bills so that the maturity of these bills may coincide with the maturity of their fixed deposits. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services High and Quick Yield: The financial institutions earn a high quick yield. The discount is dedicated at the time of discounting itself, whereas, in the case of other loans and advances, interest is payable only when it is due. The discount rate is also comparatively high. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Central Bank Control: The central bank can easily influence the money market by manipulating the bank rate or the rediscounting rate. Suitable monetary policy can be by adjusting the bank rate depending on the market’s prevailing conditions. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Types of Bills: Demand and Using Bills: Demand bills are otherwise called sight bills. These bills are payable immediately as soon as they present to the drawer. No time of payment specify, and hence they are payable at sight. Using bills are called time bills. These bills are payable immediately after the expiry of the period mentioned in the bills. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Clean Bills and Documentary Bills: When bills have to be accompanied by documents of title to goods like Railways, receipts, Lorry receipts, bills of Lading, etc., the bills call documentary bills. When bills are drawn without accompanying documents, they are called clean bills. In such a case, documents will be directly sent to the Drawee. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Inland and Foreign Bills: Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills draw outside India, and they may be payable either in India or outside India. They may draw upon a person resident in India also. Foreign bills have their origin outside India. They also include bills drawn in India but made payable outside India. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Export and Foreign Bills: Export bills are those drawn by Indian exports on importers outside India, and import bills draw on Indian importers in India by exports outside India. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Accommodation Bills and Supply Bills: They call accommodation bills if they do not arise from genuine trade transactions. They know as “kite bills” or “wind bills.” Two parties draw bills on each other purely for mutual financial accommodation. These bills are discounted with bankers, and the proceeds are shared among themselves. Supply bills are those neither drawn by suppliers or contractors on the government departments for the goods nor accompanied by documents of title to goods. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Drawbacks of Commercial Bills: The Absence of Bill Culture: Business people in India prefer O.D. and cash credit to bill financing. Therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their customers. Hence bills are not popular. Stamp Duty: Stamp duty discourages the use of bills. Moreover, stamp papers of the required denomination are not available. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Difficulty in Ascertaining Genuine Trade Bills: The financial institutions have to verify the bills to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose, invoices have to scrutinize. It involves additional work. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Limited Foreign Trade: In many developed countries, bill markets have been established mainly for financing foreign trade. Unfortunately, foreign trade as a percentage of national income in India remains small and is reflected in the bill market. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services The attitude of Banks: Banks are shy about rediscounting bills, even the central bank. They tend to hold the bills till maturity, affecting the velocity of the circulation of bills. Again, banks prefer to purchase bills instead of discounting them. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Call Money Market: The call money market refers to the market for extremely short period loans; say one day to fourteen days. The money that is lent for one day in this market is known as “Call Money”, and if it exceeds one day (but less than 15 days) it is referred to as “Notice Money”. These loans are given to brokers and dealers in stock exchange. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Similarly, banks with ‘surplus’ lend to other banks with ‘deficit funds’ in the call money market. Moreover, commercial banks can quickly borrow from the call market to meet their statutory liquidity requirements. They can also maximize their profits easily by investing their surplus funds in the call market during the period when call rates are high and volatile. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Operations in Call Money Market: Borrowers and lenders in a call market contact each other over telephone. Hence, it is basically over-the-telephone market. After negotiations over the phone, the borrowers and lenders arrive at a deal specifying the amount of loan and the rate of interest. Instead of negotiating the deal directly, it can be routed through the Discount and Finance House of India (DFHI), the borrowers and lenders inform the DFHI about their fund requirement and availability at a specified Excellence and Service rate of interest.  CHRIST Deemed to be University Financial Markets and Services The participants of call money market: Those permitted to act as both lenders and borrowers of call loans. Those permitted to act only as lenders in the market. The first category includes all commercial banks. Co- operative banks, DFHI and STCI. The second category includes LIC, UTI, GIC, IDBI, NABARD, specified mutual funds, etc., are included. They can only lend, and they cannot borrow in the call market. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Advantages of Call Money Market: High Liquidity: Money lent in a call market can be called back at any time when needed. So, it is highly liquid. It enables commercial banks to meet large sudden payments and remittances by making a call on the market. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services High Profitability: Banks can earn high profiles by lending their surplus funds to the call market when call rates are high volatile. It offers a profitable parking place for employing the surplus funds of banks temporarily. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Maintenance of SLR: The call market enables commercial banks to maintain their statutory reserve requirements. Generally, banks borrow on a large scale every reporting Friday to meet their SLR requirements. In the absence of a call market, banks have to maintain idle cash to meet5 their reserve requirements. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Safe and Cheap: Though call loans are not secured, they are safe since the participants have a strong financial standing. It is cheap in the sense brokers have been prohibited form operating in the call market. Hence, banks need not pay brokers on call money transitions. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Assistance To Central Bank Operations: The existence of an efficient call market helps the central bank to carry out its open market operations effectively and successfully. Changes in demand and supply of funds are quickly reflected in call money rates and indicate the central bank to adopt an appropriate monetary policy. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Drawbacks of the Call Money Market: Uneven Development: The call market in India is confined to only big industrial and commercial centers like Mumbai, Kolkata, Chennai, Delhi, Bangalore, and Ahmadabad. Generally, call markets are associated with stock exchanges. Hence the market is not evenly developed. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Volatility In Call Money Rates: Another drawback is the volatile nature of the call money rates. Call rates vary greatly in different centers in different seasons on different days within a fortnight. The rates vary between 12% and 85%. One cannot believe 85% being charged on call loans. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Deficiencies of the Indian Money Market: Existence of an Un-organised Money Market: The most critical defect of the Indian money market is the existence of an unorganized segment. The unorganized sector comprises indigenous bankers. The indigenous banks will follow their own rules of banking and finance. This segment undermines the role of the RBI in the money market. Efforts of RBI to bring indigenous bankers within the statutory framework have not yielded much result. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Lack of Integration: Another important deficiency is the lack of integration of different segments or functionaries. However, with the enactment of the Banking Companies Regulation Act 1949, the position has changed considerably. The RBI is now almost fully effective under various provisions of the RBI Act and the Banking Companies Regulation Act. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services The disparity in Interest Rates: There have been too many interest rates prevailing in the market at the same time, like borrowings rates of government, the lending rates of commercial banks, the rates of cooperative banks, and rates of financial institutions. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Seasonal Diversity of Money Market: A notable characteristic is a seasonal diversity. There are wide fluctuations in the interest rates in the money market from one period to another in the year. November to June is a busy period. During this period, crops from rural areas are moved to cities and parts. The wide fluctuations create problems in the money market. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Lack of Proper Bill Market: Indian Bill market is an underdeveloped one. A well- organised bill market or a discount market for short-term bills is essential for establishing an effective link between credit agencies and the Reserve Bank of India. The reasons for this situation are historical, like the preference for cash over bills. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Limited Instruments: The supply of money market instruments like bills, TBs, etc., is very limited and inadequate, considering the varied requirements of short-term funds. In fact, in a developed money market, there should be a well-diversified mix of money market instruments to meet the varied requirements of borrowers and lenders. Excellence and Service  CHRIST Deemed to be University Financial Markets and Services Limited Secondary Markets: The secondary market is very limited in the case of money market instruments. Practically speaking, it is restricted to rediscounting commercial and treasury bills. Limited Participants: Entry into the market is strictly regulated. There are larger numbers of borrowers but a few lenders. Hence, the market is not very active, broad, and vibrant. Excellence and Service