Financial Market

INDIAN ECONOMY

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Indian Financial Market

Money Market and Capital Market

Money Market
 The market that deals with the need and demand for funds for a short period of time – less than 1 year is
called the Money Market.

 The need for finance in the money market is for working capital requirements, repayment of loans,
consumption etc.

 The money market for short-term funds has maturities ranging from overnight to one year.

 These transactions could be both secured (with collateral) and unsecured (clean, without collateral).

Capital Market
 It may be defined as a market dealing in medium and long-term funds i.e funds for a long period of time –
more than a year.

Comparison between Money Market and Capital Market

BASIS MONEY MARKET CAPITAL MARKET

DURATION Short term, less than 1 year Medium and long term, more than 1 year

Treasury bills, Commercial paper, Equity share, preference shares, bonds and
INSTRUMENTS TRADED certificate of deposit etc. debentures

EXPECTED RETURN Generally less than capital market More than money market

SECURITY More secure Lesser

Individual as well as institutional Earlier, individual or retail investors were not

PARTICIPATION investors allowed. RBI changed this is 2021

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Money Market in India

 Chakravarthy Committee (1985) for the first time, underlined the need for an organised money market
in the country.

 Vaghul Committee (1987) laid the blueprint for its development.

The Segments in the Indian Money Market

 Unorganised Money Market.

 Organised Money Market.

Unorganised Money Market

The unorganised sector includes the following:

1. Indigenous Bankers: These are financial intermediaries that function similar to banks but are mostly
limited to certain social strata.

 They generally deal in indigenous short-term credit instruments such as hundi.

 There are, basically, four such bankers in the country

 Gujarati Shroffs: In Mumbai, Kolkata

 Multani or Shikarpuri Shroffs: In Mumbai, Kolkata, Assam tea gardens and North-Eastern
India.

 Marwari Kayas: In Gujarat, Mumbai and Kolkata.

 Chettiars: In Chennai and at the ports of southern India.

2. Money Lenders: Moneylenders mostly operate in the villages and charge a high rates of interest.
Agricultural labourers, small and marginal farmers, etc.

3. Unregulated Non-Bank Financial Intermediaries:

What is a Non-Banking Financial Company (NBFC)?

 NBFC is a company registered under the Companies Act, 1956

 It is engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/

securities, insurance business, chit business

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 It does not include any institution whose principal business is that of agriculture activity, industrial activity
etc.

Difference between NBFCs and Banks

 NBFCs lend and make investments and hence their activities are akin to that of banks. However, there are
a few differences as given below:

BANKS NBFC

Financial intermediary providing banking services to the

public by providing a bank license. NBFCs provide banking services without holding a bank
license

Is incorporated under Banking Regulations Act, 1949 Incorporated under Companies Act

Loan disbursal is more regulated and strict. Comparatively faster and easier loan disbursal.

Deposit insurance facility of Deposit Insurance and Credit The deposit insurance facility of Deposit Insurance and
Guarantee Corporation (DICGC) is available upto Rs. 5 Credit Guarantee Corporation (DICGC) is not available to
lakhs. depositors of NBFCs

They accept demand deposits. NBFC cannot accept demand deposits.

NBFCs do not form part of the payment and settlement

They form part of the payment and settlement system system and cannot issue cheques drawn on themselves.

Overdraft facility is available Not available

Maintenance of Reserve Ratios is compulsory Maintenance of Reserve Ratios is conditional

Types of NBFC (Unregulated)

A. Chit Fund

 A chit fund is a type of saving scheme where a specified number of subscribers contribute payments in
instalments over a defined period.

 Each subscriber is entitled to a prize amount determined by lot, auction or tender depending on the na-
ture of the chit fund.

 Typically, the prize amount is the entire pool of contributions minus a discount which is redistributed to
subscribers as a dividend.

 Supreme Court has read chit funds as being part of the Concurrent List of the Indian Constitution. Hence
both the centre and state can frame legislation regarding chit funds.

Role of RBI and SEBI

 The Reserve Bank of India (RBI) is the regulator for banks and other non-banking financial companies
(NBFCs) but does not regulate the chit fund business.
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 As the regulator of the securities market, SEBI regulates collective investment schemes. But the SEBI Act,
1992 specifically excludes chit funds from their definition of collective investment schemes.

 There is a Central Chit Funds Act 1982, apart from a number of state chit fund Acts.

 There is an office of the registrar of chit funds in every state that monitors their operations.

 Utilisation and appropriation of subscriber’s money is strictly prohibited.

 The first step of regulation comes at the state level.

 Hence, it's the state government's responsibility for any fraudulent activities by chit fund
companies.

 However, the RBI can provide guidance to state governments on regulatory aspects like
creating rules or exempting certain chit funds.

B. Nidhi:

 It is also the type of mutual benefit fund where members make a regular contributions.

 Loans are provided to members at reasonable rates of interest.

C. Loan companies:

 These are finance companies that provide loans to traders, small-scale industries and self-employed
persons.

 Being unregulated, they charge a high rate of interest on loans.

NBFC Crisis
 Started when IL&FS one of the prominent companies in the NBFC sector, experienced projects getting
stalled, and payments delayed to the firm due to economic slowdown.

 IL&FS defaulted to SIDBI in 2018 on ICD.

 Due to mismatch in the Asset Liability Management (ALM) delayed payment on CPs.

 lenders refused to invest in the next set of CPs resulting in the liquidity drying up and the company being
unable to raise funds.

 The mismatch of assets and liabilities created a lot of panic and credit rating degradation.

 Fresh funding from investors as well as banks completely dried up or came in at an increased cost.

 It was followed by crises in DHFL, Reliance Capital Finance as well as Reliance Home Finance, etc.

 The loans in balance sheets of the banks became NPAs (non-performing assets).

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 Effect was felt on the entire financial ecosystem and the liquidity crisis made banks and NBFC wary of
lending.

 Borrowers dependent on NBFC lending got into distress, and this distress further declined the asset
quality of banks and NBFC.

 The financial stress of delays, accumulation of interest, and difficult business conditions led to a vicious
cycle of market recession.

Organised Money Market

1. Bill Market (Both Commercial Bills & Treasury Bills)

2. Certificates of Deposit (CD)

3. Commercial Paper (CP)

4. Call Money Market

5. Money Market Mutual Fund

6. Repos and Reverse Repos

7. Cash Management Bills

1. Commercial Bill
 Traders usually buy items on credit from wholesalers or manufacturers, and the sellers are paid at the
end of the credit period.

 But if any seller does not want to wait or is in immediate need of money, he/she can draw a bill
of exchange in favour of the buyer.
 When the buyer accepts the bill, it becomes a negotiable instrument and is termed as Bill of
Exchange or Trade Bill.

 Before the trade bill matures, it can now be discounted with a bank.

 The bank receives payment from the drawee, or the buyer of commodities when the loan matures.

 So, commercial Bills are trade bills that are accepted by commercial banks.

 As a result, a trade bill is an instrument that allows the bill's drawer to obtain funds for a limited period of
time in order to meet working capital requirements.

2. Treasury Bills
 Treasury bills (T-bills) are short-term investment opportunities, generally up to 1 year. Thus, they are
useful in managing short-term liquidity.

 At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day,
182-day and 364-day.
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 There are no treasury bills issued by State Governments.

 Treasury bills are issued at a discount and are redeemed at par.

 They are available in the primary and secondary markets.

 Treasury bills are zero-coupon securities and pay no interest.

 The return to the investors is the difference between the maturity value or the face value and the
issue price.

 The usual investors in these instruments are banks, insurance companies, FIs etc.

 T-bills auctions are held on the Negotiated Dealing System (NDS) and the members electronically submit
their bids on the system.

3. Certificates of Deposit (CDs)

 Certificate of deposit (CD) is issued by scheduled commercial banks and financial institutions (FI).

 Regional Rural Banks and Local Area Banks cannot issue CDs.

 CD is a negotiable promissory note and is secure.

 A CD is issued at a discount to the face value, the discount rate being negotiated between the issuer and
the investor.

 The maturity period of CDs issued by banks = 15 days – 1 year.

 The FIs can issue CDs for a period of 1 year - 3 years from the date of issue.

 The minimum deposit that could be accepted from a single subscriber should not be less than Rs. 1 Lakh
and in multiples of Rs. 1 Lakh thereafter

 CDs can be issued to individuals, corporations, companies, trusts, funds, associations etc.

4. Commercial Paper
 It is a short-term debt instrument issued by companies to raise funds generally for a time period of up to
one year.

 It is an unsecured money market instrument issued in the form of a promissory note.

 Corporates that enjoy a high rating can diversify their sources of short-term borrowings using CPs.

 It is typically issued by large corporations to meet short-term financial obligations, such as funding for a
new project.

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 Minimum maturity = 7 days

Maximum = up to 1 year from the date of issue.

 They can be issued in denominations of ₹ 5 lakh or multiples thereof.

 Individuals, banking companies, other corporate bodies (registered or incorporated in India) and
unincorporated bodies, non-resident Indians and foreign institutional investors etc can invest in CPs.

 Investment by FIIs would be within the limits set for them by the Securities and Exchange Board of India.

5. Call Money
 Call money is a type of inter-bank financing that is repayable on demand and has a maturity period of one
to fourteen days.

 In this market, money lent for one day is referred to as "call money," and money lent for more than one
day is referred to as "notice money."

 Call money is a way by which banks lend to one another in order to keep their cash reserve ratios in check.

 The call rate is the interest rate paid on call money.

 There is no set timeline for paying interest and principal.

 It aids in meeting short-term liquidity requirements.

6. Money Market Mutual Funds (MF)

 It's a sort of mutual fund that puts its money into high-quality short-term debt securities, cash, and cash
equivalents.

 They carry a risk-free rate of return since they are deemed exceptionally low risk on the investing
spectrum.

 A money market fund produces income (taxable or tax-free, depending on the fund's portfolio) but little
capital growth.

7. Repo and Reverse Repo

 If banks run out of money, they can borrow it from the RBI or other banks.

 The Repo Rate is the rate at which the RBI lends money to commercial banks in exchange for government
assets.

 Banks and financial institutions purchase government securities from the RBI in Reverse Repo (basically
here the RBI is borrowing from the banks and the financial institutions).

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8. Cash Management Bills

 They are similar to T-bills in that they are issued at a discount and redeemed at face value (par) at
maturity, but they are issued for maturities less than 91 days.

9. Inter Bank Term Money

 The Inter-Bank Term Money Market refers to the market for deposits with maturities of more than 14 days
but less than three months.

10. Promissory Note

 It is a written instrument (not a banknotes or a currency note) that contains an unconditional pledge
signed by the manufacturer to pay a certain amount of money only to the holder of the instrument.

 There are two parties in a promissory note: the maker and the payee.

11. Bill of exchange

 It's a written instrument holding an unconditional order, signed by the maker, commanding a specific
person to pay a certain sum of money solely to or on the order of a specific person, or to the bearer of the
instrument.

 There are three parties in a bill of exchange: the drawer, the drawee, and the payee.

Discount and Finance House of India (DFHI)

 Set up in 1988 by RBI to strengthen the bill market and to deal in money market instruments in order to
provide liquidity.

 Facilitates the smoothening of the short-term liquidity imbalances by developing an active money market
and integrating the various segments of the money market.

At present DFHI’s activities are:

 Dealing in Treasury Bills

 Re-discounting short term commercial bills.

 Participating in the inert bank call money, notice money and

term deposits.

 Dealing in Commercial Paper and Certificate of deposits.

 Government dated Securities.

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Money Market Reforms

Recommended by
 Sukhmoy Chakravarty Committee and the Narasimhan Committee

Reforms made in the Indian Money Market are

 Deregulation of the Interest Rate.

 Money Market Mutual Fund (MMMFs) are allowed to sell units to corporates and individuals.

 Discount and Finance House of India (DFHI) was set up in 1988 to impart liquidity in the money market.

 It was set up jointly by the RBI, Public sector Banks and Financial Institutions.

 Liquidity Adjustment Facility (LAF)

 LAF adjusts liquidity in the market through absorption and or injection of financial resources (i.e.,
Repo and Reverse Repo) by the RBI.

 In order to impart transparency and efficiency in the money market transaction, the electronic dealing
system has been started.

 It is useful for the RBI to watchdog the money market.

 Establishment of the CCIL: The Clearing Corporation of India Limited (CCIL) in 2001.

 Development of New Market Instruments like CMBs.

 Market Stabilization Scheme since 2004 that was useful in 2016 post-demonetisation.

 The Standing Deposit Facility (SDF) permits the Reserve Bank of India (RBI) t to absorb liquidity (deposits)
from commercial banks without having to give the banks government securities in exchange.

Current Issues in Money Market

RBIs Retail Direct Scheme
 One stop solution for individual investors to facilitate investment in Government Securities in the primary
market.

 Individual investors can open Gilt Securities account-Retail Direct Gilt Account with the RBI.

 Participation of RDG account holders in the primary market to be on a non competitive basis.

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Falling Bond Yields

 Launch of The G-Sec Acquisition Programme, G-SAP by RBI in April 2021 caused a decrease in G-sec yields
which has continued since then.

 Further, economic uncertainties due to the pandemic also aided it.

 Falling Bond yields result in money diverted to equity markets.

Capital Market
 It refers to the market for funds having a maturity of one year or more, also known as Term Funds.

 These funds are in high demand from both the government and the private sector for investment
purposes.

 The main market participants include banks, public financial institutions like LIC and GIC, development
financial institutions, and mutual funds.

Types of Capital Market

Primary Market
 It is the segment of the capital markets that handle a company's direct issue of new securities to investors
through an initial public offering (IPO).

 This sale is known as an initial public offering (IPO) in the case of a new stock issuance (IPO).

 A Follow-on Public Offer (FPO) occurs when a company has already issued shares and is re-entering the
market with a new offering (FPO).

Secondary Market
 It is the financial market for the trading securities that have already been issued in an initial public
offering.

Capital Market – Examples

Bond Market
The bond market is a financial market where players can buy and sell debt securities or issue fresh debt
(known as the primary market). Following are some different types of bonds --

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Bond

 A secured loan instrument with a set or floating rate of interest issued for a specific time to raise funds
through borrowing.

 You can borrow money from a bank, a friend, or a stranger, for example.

Junk Bonds

 A junk bond is a debt instrument that has received a poor credit rating from a rating agency, below
investment grade, making it riskier because the odds of the issuer defaulting or experiencing a credit
event are higher.

 Investors are paid with higher interest rates as a result of the higher risk, which is why trash bonds are
also known as High-Yield Bonds.

Gilt – Edged securities

 The government often requires funding at periods, when tax collections are low and some affirmative
actions are to be funded.

 Government issues treasury bonds through the Reserve Bank of India.

 Governments usually return the principle and interest rates.

 As a result, government bonds are given higher credit ratings (AA).

 Similarly, well-known corporations with high credit ratings (AA) issue bonds with low-interest rates.

These are referred to as 'Gilt-Edged Securities.'

Bearer Bonds

 Bearer bonds are similar to regular bonds, but

they lack the "Holder's Name." on them.

 These bearer bonds come with coupons

attached. So, if you don't want to withdraw
the entire amount,
you can cut a few coupons and sell them to a
broker to withdraw a portion of it.

 Because there are no "names," "addresses," or records, no one can keep track of who withdrew the
money, who is buying, and who is selling.

Concepts Related to Bond

Bond Yield

A bond's
INDIAN yield |may
ECONOMY be defined
Financial Market as the expected earnings on a fixed-income investment over a particular
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Factors Affecting Bond Yield

 Bond Price: bond yields have an inverse relationship with the price of bonds. If demand for bonds rises,
the price of bonds goes up and the yield goes down.

 Interest rates: bond yields have a direct relationship with the interest rates. Thus, if the Central Bank
cuts base interest rates, this will tend to reduce bond yields as well.

 Inflation. Inflation has the capacity to reduce the real value of the bond. Thus, higher inflation will re-
duce demand for bonds and lead to higher bond yields.

 Prospects for economic growth. If there is strong economic growth, then the preference for equity in-
vestments go up, therefore bonds become relatively less attractive and yields go up.

 Credit Risk: If investors fear the possibility of government debt default, it is likely they will demand
higher bond yields to compensate for the risk.

Inverted Yield Curve

 An inverted yield curve refers to a condition in which long-term debt instruments have lower yields than
short-term debt instruments of the same credit quality.

 An inverted yield curve is a strong indicator of an impending recession.

Negative Bond Yield

 A negative bond yield is when an investor receives less money at the bond's maturity than the original
price of the bond.

 In times of economic uncertainty, investors might also be interested in negative bond yields if the
loss is less than it would be with another investment.

Other Concepts

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Inflation Indexed Bonds

 Inflation indexed bonds refer to bonds that release interest payments on the basis of a particular price
index.

 Benefit of Inflation indexed bonds is that it provides inflation-adjusted returns to the investors.

 These are designed to hedge the inflation risk of a bond.

Sovereign Gold Bond

 The Sovereign Gold Bond Scheme was launched by the Government in November 2015, under the Gold
Monetisation Scheme.

 Under the scheme, the issues are made open for subscription in tranches by RBI in consultation with GOI.

Bonds in News

 Masala Bond:

 Bonds issued outside India but denominated in Indian Rupees, rather than the local currency.

 Debt instrument issued by an Indian entity in foreign markets to raise money

 Can be issued by both government and private entities.

 The funds raised can be used for:

 Address climate change in India

 To refinance rupee loans and non-convertible debentures.

 Developing affordable housing projects.

 Provide working capital to corporations.

 Municipal Bonds

 Debt securities issued by state and local governments.

 Are used to fund public works such as parks, libraries, highways & roads, and other social
infrastructure.

 SEBI circulated detailed guidelines in 2015 for the urban local bodies to raise funds by issuing
municipal bonds.

 As per SEBI, municipal bonds must have a rating above the investment-grade for the public issue.

 Green Bonds

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 Debt instrument designed specifically to support specific climate-related or environmental

projects.

 They are used to finance projects aimed at energy efficiency, pollution prevention, sustainable
agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean
transportation, clean water, and sustainable water management as well as the mitigation of
climate change.

 These may come with tax incentives

 Blue Bonds

 Debt instrument that is issued to support investments in healthy oceans and blue economies.

 earnings are generated from the investments in sustainable blue economy projects.

 Issued in multiples of Rs. 1000. Rs. 10,000, Rs. 1 lakh, Rs. 10 lakh and 1 crore.

 No maximum limit.

 Electoral Bonds

 Bearer instrument in the nature of a Promissory Note with an interest free banking instrument.

 A citizen of India or a body incorporated in India will be eligible to purchase the bond.

Stock Market
A stock market, equity market or share market is the aggregation of buyers and sellers of stocks, which
represent ownership claims on businesses.

Equity

 Equity refers to the amount of money a company's owner has invested or owned.

 A company's total equity capital is divided into equal units of tiny denominations, each referred to as a
share.

 A share is a percentage of a company's or financial asset's ownership.

 A company's whole equity capital of Rs 5,00,00,000, for example, is divided into 50,00,000 units of
Rs 10 apiece.

 A Share is a name given to each of these Rs 10 units.

 As a result, the corporation is stated to have a total of 50,00,000 equity shares worth Rs 10 apiece.

 Companies require capital for investment and other smaller needs, which they can obtain from their own
reserves (earnings), borrow, or raise share capital through the issuance of shares.

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 Investors who hold shares of any company are known as Shareholders

 The person who starts the company is called the promoter.

 He retains the majority of shares generally and sells the rest to the public.

Stock

 Stock is the capital raised by a corporation through the sale of shares.

Shares vs Stocks

 Shares denote ownership of a specific corporation, whereas stock denotes ownership of any company.

 Stock is a basic collection of a company's shares, whereas shares signify the company's
ownership percentage.

 When we say "share," we're referring to a certain firm. However, when we say stock, we are not
referring to a specific investment.

Components of the Capital Market in India

 Government securities

 Industrial securities that include the shares and debentures of Indian companies- both the [primary and
secondary market]

 Development Banks

 Merchant Banks

 Mutual funds

 Venture capital companies and others.

Government Securities (G-Sec)

 A G-Sec is a marketable instrument that acknowledges the Government's debt obligation and is issued by
the Central Government or State Governments.

 These securities can be either short-term (treasury bills) or long-term (Government bonds or dated
securities with original maturity of one year or more).

 In India, the central government issues both treasury bills and bonds or dated securities, whereas state
governments exclusively issue bonds or dated securities, known as State Development Loans (SDLs).

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 G-Secs are risk-free gilt-edged products since they have almost little danger of default.

 Gilt-edged securities are high-grade investment bonds offered by governments and large
corporations as a means of borrowing funds.

 The Reserve Bank of India has recently allowed retail investors to register gilt accounts with the central
bank in order to invest directly in Government securities (G-secs) without intermediaries.

 NRIs and Foreign Institutional Investors (FIIs) who are registered with SEBI and permitted by the Reserve
Bank of India can also invest.

 G-Secs are available in both Demat and physical form, with a minimum investment of Rs 10,000.

Types of G-Secs

1. Dated Securities

 They have fixed maturity and fixed coupon rates payable half-yearly and are identified by their year of
maturity.

2. Floating Rate Bonds

 Floating rate bonds have a variable rate of interest, unlike conventional bonds, which pay a fixed rate of
interest.

 A floating rate bond's interest rate is tied to a benchmark rate and is reset on a regular basis. So, when
interest rates are high, these bonds will provide a bigger return and when interest rates are low, they
will provide low returns.

3. Capital Indexed Bonds

 They are bonds where the interest rate is a fixed percentage over the inflation rate: WPI or CPI depending
on the terms.

State Development Loan (SDL)

 SDLs are dated securities issued by the state government through the Reserve Bank of India (RBI) similar to
those held for dated securities issued by the Central Government.

 Interest is paid at half-yearly intervals, and the principle is reimbursed on the maturity date.

Consolidated Sinking Fund

 Established by the Reserve Bank in 1999–2000 to enable states to repay their debt easily.

 23 states have set up consolidated sinking funds presently

 Fund managed by the Reserve Bank of India.

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 Money deposited in the fund is used only to repay the debt of the state government and not for any
other purpose.

 Sinking fund also known as Debt Remittance Fund

 Every state government deposits 1% to 3% of its total debt in the state’s consolidated sinking fund to
repay the due loan / due bond payment.

Development Finance Institution (DFI) or Development Bank

 A development finance institution (DFI) is a non-commercial financial institution that provides risk
capital for economic development projects.

 DFIs are frequently established and owned by governments or non-profit organisations to finance
projects that would otherwise be unable to obtain financing from commercial lenders.

 Depending on their geographic range of operation, they can be classified as All-India or State/Regional
level institutions.

 All-India institutions can be classified as

 term-lending institutions (IFCI Ltd, IDFC Ltd.) extending long-term finance to different industrial
sectors.

 refinancing institutions (NABARD, SIDBI, NHB) extending refinance to banking as well as

non- banking intermediaries for finance.

 sector-specific/specialised institutions (EXIM Bank, HUDCO Ltd.)

 investment institutions (LIC, UTI, GIC)

Merchant Banks/Investment Banks

 Merchant banks provide services such as foreign financing, corporate loans, and underwriting.

 Underwriting services is basically a guarantee, some significant financial organisations - banks,

insurance firms, and investment houses - provide to pay in the event of damage or financial loss.

 Merchant banks provide assistance to businesses and high-net-worth individuals.

 Investment banking is either fee-based or based on funds, and it offers a larger range of services to its
clients.

 Institutional investors, governments, and businesses are among the investment banking clientele.

Collective Investment Scheme (CIS)

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 It's an investment strategy in which a group of people pool their money to invest in assets and split the
profits.

 It doesn't include mutual funds.

 They are governed by SEBI.

Alternative Investment Funds (AIF)

 As per the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, AIFs
are any privately pooled investment fund (whether from Indian or foreign sources) in the form of a trust, a
company, a body corporate, or a Limited Liability Partnership.

AIFs are private funds that are not subject to the oversight of any Indian regulatory body.

Categories

1. Category I

 Mainly invests in startups, SME’s or any other sector which Govt. considers economically and socially
viable.

2. Category II

 These include AIFs such as private equity funds or debt funds for which no specific incentives or
concessions are given by the government or any other Regulator.

3. Category III

 AIFs such as hedge funds or funds that trade with a view to make short term returns or such other funds
that are open-ended and for which no specific incentives or concessions are given by the government or
any other Regulator.

Mutual Funds
 A mutual fund is a trust that pools money from a group of individuals with similar investing goals.

 The money is then invested in stocks, bonds, money market instruments, and/or other securities.

 The income/gains earned from this collective investment are dispersed equally between the investors after
deducting certain fees, as determining by the scheme's "Net Asset Value or NAV."

 It is one of the most accessible investment options for the average person since it allows them to invest in
a diversified, professionally managed portfolio of securities at a cheap cost.

 All funds carry some level of risk. But with mutual funds, one may lose some or all of the money
invested, because the securities held by a fund can go down in value.

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 The Securities and Exchange Board of India (SEBI) is the regulatory agency in charge of overseeing and
regulating the Indian securities market and mutual fund industry.

 Mutual funds include infrastructure investment trusts (InvIts) and real estate investment trusts (ReITs).

Types of Mutual Funds

1. Open-ended funds

 An investor can
invest, enter,
redeem, or exit an
open-ended
mutual fund at any
time.

 it does not have a

defined maturity
period.

2. Close-ended funds

 Closed-ended mutual funds have a defined maturity date, and an investor can only invest or enter these
types of schemes during the New Fund Offer (NFO) period.

 On the maturity date, his/her investment will be immediately redeemed.

 They can be listed on a stock exchange also.

Hedge Fund
 It is like mutual funds, in which high-net-worth individuals combine their money to invest in high-risk,
high-return assets.

 Trading strategies
are significantly
more complicated
than mutual fund
strategies.

 Hedge funds can

make a profit even
if the stock market
is falling.

 SEBI expects Indian hedge funds to start at 1 crore rupees, while foreign (offshore) hedge funds to start
at $5 lakhs.

Venture Capital
 It is the money provided by financial institutions who invest in start-ups generally that have the
INDIAN ECONOMY | Financial Market PAGE 20
potential to develop into significant economic contributors.
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 They provide the financing that a startup company requires to get off the ground, usually at a lower
interest rate or ownership in the firm.

 Angel investors frequently prefer to keep their investments confidential.

Private Equity
 Private equity (PE) refers to capital investment made into companies that are not publicly traded.

 Most PE firms are open to accredited investors or those who are deemed high-net-worth, and successful
PE managers can earn millions of dollars a year.

Qualified Institutional Placement (QIP)

 It's a quick type of private placement in which a publicly-traded corporation issues shares or convertible
instruments to a small group of investors.

 Only institutions or qualified institutional buyers (QIBs) can participate in a QIP issuance, unlike an IPO
or an FPO (further public offering).

 Mutual funds, local financial institutions including banks and insurance firms, venture capital funds, foreign
institutional investors, are some examples of QIBs.

External Commercial Borrowings (ECB)

 An ECB is a loan taken out by an Indian company from a non-resident lender/overseas funds.

 Foreign commercial banks and other institutions provide the majority of these loans.

 The ECB guidelines and policies are monitored and regulated by the Ministry of Finance's DEA (Department
of Economic Affairs) and the Reserve Bank of India.

 The money is available for a long period of time, and that too on lower interest rates, when compared to
domestic funds.

Debentures
 A debenture is a type of capital market instrument used to raise medium- or long-term financing from the
general public.

 A debenture is a legal document that acknowledges a debt.

 It comes in the form of a Debenture Deed, which is a certificate issued under the company's seal.

 It usually displays the loan's amount and due date.

 It has an interest rate and an interest payment due date.

 Debentures can be secured or unsecured against the company's assets..

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 Debentures are normally transferable by the holder of the debenture.

 Debenture holders have no right to vote in the company’s general meetings of shareholders, but they
may have separate meetings or votes e.g., on changes to the rights attached to the debentures.

Types of debentures on the basis of convertibility:

Convertibility in debentures denotes the conversion of a debenture to equity shares.

1. Convertible Debenture

 These are debentures in which investors have the option to convert their debenture holdings into a firm’s
equity shares.

2. Non - Convertible Debenture

 The debentures which do not have the option to be converted into equity shares are non-convertible
debentures.

3. Partly Convertible Debentures

 A part of these instruments is converted into Equity shares in the future at the notice of the issuer.

 The issuer decides the ratio for conversion.

 This is normally decided at the time of subscription.

Types of Debentures on the Basis of Security:

1. Secured Debentures

 Those debentures which borrow money with collateral.

2. Unsecured Debentures

 Unsecured debt is money that is borrowed without collateral.

Types of Debentures on the Basis of Redemption:

1. Redeemable Debentures

 Instruments having a fixed maturity period.

2. Irredeemable Debentures

 In this there is no fixed date or duration for redemption. Interest is paid at a certain interval.

Other Recent Topics on Capital market

Sovereign Wealth Fund

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 Is a state-owned investment fund that invests in real and financial assets

 Sovereign wealth funds invest globally.

 Investment is in stocks, bonds, real estate, precious metals, or in alternative investments such as private
equity funds or hedge funds.

 Financial experts suggest India having its own Sovereign wealth Fund

CPSE ETF

 is a passive investment fund with no lock-in period

 Launched in 2017, it was created to help the Government of India in its initiative to dis-invest some of its
stake in selected CPSEs through the innovative ETF route.

 The ETF is based on the Nifty CPSE index and includes 11 listed Central Public Sector Enterprises, CPSE.

Stock Market

Stock Exchange
 A stock exchange is an organisation that provides a trading platform for shares.

 Investors buy and sell shares and other financial goods through stockbrokers in a wide range of listed
companies on a stock exchange.

Important Terms used in Stock Marketing

Authorised Capital
 The limits up to which shares can be issued by a company—also known as the nominal or registered
capital.

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Paid-up Capital
 The part of the authorised capital of a company that has actually been paid by shareholders.

Initial Public Offer (IPO)

 It is an event of share issuing when a company comes up with its share/securities issued for the first
time.

Initial Coin Offering (ICO)

 It is equivalent to an initial public offering (IPO) in cryptocurrency.

 It is a popular fundraising method used primarily by startups wishing to offer products and services,
usually related to the cryptocurrency and blockchain space.

Bear
 Bear is an investor who believes that the market will go down.

Bull
 Bull is an investor who believes that the market will go up.

Credit Default Swap (CDS)

 It is a financial swap arrangement, in which the seller of CDS compensates the buyer in the event of a debt
default. So, the CDS buyer is compensated, while the CDS seller gains possession of the defaulted loan.

 It is a derivative or contract that allows an investor to swap or offset his credit risk with another investor.

Hedging
 It is a risk management strategy that is employed to offset losses in investments.

 Hedging though reduces the risk associated with the assets but also reduces the potential profits.

Securitization
 It is a process, in which a firm consolidates its many financial assets/debts into a consolidated financial
instrument that is issued to investors, with the investors receiving interest in return.

 Though the process enhances liquidity in the market, it can also increase the chances of fraud and
manipulation. For example, the 2008 economic crisis was precise because of securitisation.

 Also, if a company has already issued a large number of loans to its customers and wants to further add to
the number, then the practice of securitization can come to its rescue.

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 In such a case, the company can club its assets/debts, form financial instruments and then issue them to
investors. This enables the firm to raise capital and provide more loans to its customers.

Insider Trading
 It is a sort of malpractice, in which people trade on a company's stocks about whom they have access to
otherwise non-public/confidential information that can be vital for making investment decisions.

 These insiders could be employees or executives with access to strategic information about the firm.

Types of Company
Private Company
 It must have a minimum paid-up capital of Rs.1 lakh and a maximum of 200 members (i.e., the people
who own its equity).

 The phrase "Private Limited" must appear at the end of this company's name.

 It cannot borrow from the general public.

Public Company
 It has minimum paid-up capital of Rs.5 lakh.

 Requires minimum 7 members to start a public company.

 It can borrow from the general public via IPOs and Bonds.

The word ‘limited’ means that the liability of the company in case of winding up is limited to the assets of the
company and not that of any other company of the group or the personal wealth of the promoters and
other shareholders.

Current Issues in Capital Market

+1 Settlement System

 Currently, trades on the Indian stock exchanges are settled in two working days after the transaction is
done (T+2).

 T+1 settlement means market trade-related settlements will need to be cleared within one day of the
actual transactions taking place.

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 Will help in earlier settlement and will not lead to fragmentation of liquidity.

RBI Report on ARCs

Findings:

 ARC industry growth has not been consistent over time

 ARCs not synchronous with the trends in Non-Performing Assets (NPAs) of banks NBFCs.

 Concentration of Business among a few ARCs

 There has been a decline in ‘Assets Under Management’

Stock Exchanges in India

There are 5 stock exchanges in the country:

 Bombay Stock Exchange (BSE)

 National Stock Exchange (NSE)

 United Stock Exchange (USE)

 MCX Stock Exchange Ltd (MCX-SX)

 India International Exchange (INX)

Bombay Stock Exchange (BSE)

 BSE is Asia’s first stock exchange and the world's 11th largest stock exchange.

 There are at present four indices connected with the BSE:

 Sensex

 The BSE SENSEX (aka the S&P Bombay Stock Exchange Sensitive Index) is a market-
weighted, free-float stock market index comprised of 30 well-established companies
listed on the Bombay Stock Exchange.

 These businesses reflect the Indian economy's various industrial sectors.

 BSE-200

 This is a 200 stock share index of the BSE (including the 30 stocks of the Sensex) which has
its Dollar version too—the Dollex.

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 BSE-500

 It is a 500-stock index representing major industries and many sub-sectors of the economy
with information technology getting a significant weightage.

 National Index

 An index of 100 stocks being quoted nationwide (Bombay, Delhi, Kolkata, etc.) was
developed to give a broader/wider representation of the stock market since the Sensex
consists of only 30 stocks.

 The 30 stocks of the sensex are included in the National Index.

National Stock Exchange (NSE)

 It is a stock exchange in Mumbai, India, with a 50-share index and a 500-share index, respectively, known
as the S&P CNX-50 (Nifty Fifty) and the S&P CNX-500.

 The NSE and BSE are India's two most important stock exchanges, accounting for the great bulk of share
transactions.

United Stock Exchange of India (USE)

 It is the 4th pan India exchange launched for trading financial instruments in India.

 USE’s shareholders include Indian public sector banks, private banks, international banks (Standard
Chartered) and corporate houses.

India International Exchange (INX) 2017

 The India International Market (INX) is India's first international stock exchange, having established in
2017.

 It is located in Gujarat's GIFT City at the International Financial Services Centre (IFSC).

 It is the Bombay Stock Exchange's wholly-owned subsidiary (BSE).

BSE SME and NSE Emerge

 In 2012, the BSE and NSE introduced their Small and Medium-Sized Enterprises (SMEs) exchange
platforms, allowing SMEs to raise money and become publicly traded companies.

 BSE's SME platform was launched under the name BSE SME Exchange.

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Other Stock Exchanges

Commodity Exchanges
 Commodity exchanges are entities that provide a trading platform for commodity futures, similar to how
stock exchanges provide space for equities trading.

 They play an important part in price discovery when multiple buyers and sellers interact to identify the
best cost-effective pricing for a product.

 Trading in ‘commodity futures' in a variety of commodities is available on Indian commodity exchanges.

 Presently, the regulator, SEBI allows futures trading in over 120 commodities.

 Currently, 6 national exchanges operate forward trading in commodities, viz

 Multi Commodity Exchange, Mumbai (MCX),

 National Commodity and Derivatives Exchange, Mumbai (NCDEX),

 National Multi Commodity Exchange, Ahmedabad (NMCE),

 Indian Commodity Exchange Ltd., Mumbai (ICEX),

 ACE Derivatives and Commodity Exchange, Mumbai (ACE)

 Universal Commodity Exchange Ltd., Navi Mumbai (UCX)

 There are 11 Commodity specific exchanges recognized for trading in various commodities approved by
the Commission under the Forward Contracts (Regulation) Act, 1952.

 The commodities traded at these Exchanges comprise the following:

 Edible oilseeds complexes like a Mustard seed, Cottonseed, Soybean oil etc.

 Foodgrains — Wheat, Gram, Bajra, Maize etc.

 Metals — Gold, Silver, Copper, Zinc etc.

 Spices — Turmeric, Pepper, Jeera etc.

 Fibres — Cotton, Jute etc.

 Others — Sugar, Gur, Rubber, Natural Gas, Crude Oil etc.

 Gold, Crude oil, Silver, Copper, Natural Gas, Lead, Soy Oil, Zinc, Soybean and Castor seed.

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Forward Markets Commission (FMC)

 It was India's primary regulator of commodity futures markets.

 The Ministry of Finance oversees this financial regulatory organisation, which is based in Mumbai.

 In 2015, the FMC and the Securities and Exchange Board of India (SEBI) amalgamated to strengthen
commodity futures market regulation.

Spot Exchanges
 The Warehousing Development and Regulatory Authority (Electronic Warehouse Receipts) Regulations,
2011 define a spot exchange as "a body corporate incorporated to facilitates the purchase and sale of
specified commodities, including agricultural commodities, metals, and bullion by providing spot delivery
contracts in the commodities.

 However, today's spot exchange is more than simply a warehouse receipt. They are electronic markets,
where a farmer or trader can discover national commodity prices through the purchase or sale of goods
instantaneously (i.e., on the "spot") to anybody across the country.

 All contracts on the exchange are compulsory delivery contracts. It means that all outstanding positions at
the end of the day are marked for delivery, which implies that the seller has to give delivery and the buyer
has to take the delivery.

Spot Exchanges in India

At present, there are four spot exchanges operating in the country:

 National Spot Exchange Limited (NSEL)

 It was set up in 2008

 It is a national level commodity spot exchange promoted by the Financial Technologies India Ltd
(FTIL) and National Agricultural Cooperative Marketing Federation of India Limited (NAFED).

 After the FTIL was found involved in irregularities, the FMC (Forward Market Commission), by end-
March 2014 asked it to exit the spot exchange.

 National Commodity and Derivatives Exchange Limited (NCDEX)

 NCDEX Spot Exchange Ltd was established in October 2006 by NSE).

 Reliance Spot Exchange Ltd. (R-Next)

 Indian Bullion Spot Exchange Ltd.

 It is online over the counter spot exchange.

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Demutualisation
 Demutualization is the legal process by which a private organisation, such as a co-op or a mutual life
insurance company, transforms itself into a publicly-traded firm.

 The members' interests convert into shareholdings, which can then be traded like a stock.

 By revising the Securities and Contract (Regulations) Act, the government has made demutualization of
stock exchanges necessary.

 Under the act, the representation of brokers in the governing body of a corporatized exchange
cannot exceed 25% and their holding cannot exceed 49% of the capital.

 The ordinance also says that 51% of the equity of exchange should be held by the public, other
than shareholders having trading rights.

Securities and Exchange Board of India (SEBI)

 SEBI is a statutory body established on April 12, 1992, in accordance with the provisions of the Securities
and Exchange Board of India Act, 1992.

 Objective

 To protect the interests of investors in securities and to promote and regulate the securities
market.

Background
 Initially, SEBI was a non-statutory body. However, the SEBI Act 1992 gave it autonomy and statutory
powers.

 The SEBI has its headquarters in Mumbai.

 The regional offices of SEBI are located in Ahmedabad, Kolkata, Chennai and Delhi.

Structure
 SEBI Board consists of a chairman and several other whole time and part-time members.

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Structure
 SEBI Board consists of a chairman and several other whole time and part-time members.

Securities Appellate Tribunal (SAT)

 SAT is a statutory body established under the provisions of the Securities and Exchange Board of India Act,
1992.

 A Securities Appellate Tribunal (SAT) has been constituted to protect the interest of entities that feel
aggrieved by SEBI’s decision.

 SAT consists of a Presiding Officer and two other Members.

 It has the same powers as vested in a civil court.

 Further, if any person feels aggrieved by SAT’s decision or order can appeal to the Supreme Court.

 SAT hears and disposes of appeals against orders passed by

 Pension Fund Regulatory and Development Authority (PFRDA) under the PFRDA Act, 2013.

 Insurance Regulatory Development Authority of India (IRDAI) under the Insurance Act, 1938.

 General Insurance Business (Nationalization) Act, 1972

Powers and Functions of SEBI

 SEBI is a quasi-legislative and quasi-judicial agency with the authority to create regulations, conduct
investigations, issue judgements, and levy penalties.

 Its purpose is to meet the needs of three distinct groups of people:

 Issuers – By creating a marketplace for issuers to expand their funding.

 Investors – By ensuring the security and availability of precise and accurate data.

 Intermediaries – By enabling a competitive professional market for intermediaries.

 The SEBI Chairman has the authority to order "search and seizure operations.

 SEBI board can also seek information, such as telephone call data records, from any persons or entities
in respect to any securities transaction being investigated by it.

 SEBI perform the function of registration and regulation of the working of venture capital funds and
collective investment schemes including mutual funds.

 It also works for promoting and regulating self-regulatory organizations and prohibiting fraudulent and
unfair trade practices relating to securities markets.
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International Securities Identification Number or ISIN Code

 Unique code that is used to identify securities.

 It is an essential system implemented to identify a specific securities issue.

 The ISIN code is a 12-character alpha-numerical code. It does not contain information characterizing
financial instruments but serves for uniform identification of a security through normalization of the
assigned National Number.

Derivatives
 A derivative is a financial instrument whose value is derived from the value of an underlying asset.

 The underlying asset can be a stock, a currency, a commodity, or anything else.

 For example, if some wheat growers want to sell their harvest at a later date so as to avoid the
danger of price fluctuations. They can create derivatives with the spot price of wheat as the
“underlying” asset.

 The Securities Contracts (Regulation) Act of 1956 establishes the regulatory framework for derivatives
trading.

Derivative Contract Instruments

Forwards
 A forward contract is a flexible derivative contract in which two parties agree to buy or sell an asset at a
predetermined price at a future date.

Futures
 A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the
future at a certain price.

 Difference between forward and a future:

 A forward contract is a private and customizable agreement that is traded over the counter. A
futures contract has standardized terms and is traded on an exchange.

 So, it is easy to buy and sell futures on the exchange. It is harder to find a counterparty over-the-
counter to trade in forward contracts that are non-standard.

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Options
 Options are basically a future contracts with the freedom to execute or not at the reagreed date in the
future.

 Options are of two types – calls and puts.

 Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a
given price on or before a given future date.

 Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a
given price on or before a given date.

Warrants
 Options generally have a life of up to 1 year, the majority of options traded on options exchanges having
a maximum maturity of nine months.

 Longer-dated options are called warrants and are generally traded over the counter.

LEAPS (Long-Term Equity Anticipation Securities)

 These are options having a maturity of up to 3 years.

Swaps
 Swaps are private agreements between two parties to swap future cash flows according to a
predetermined formula.

 They can be seen as forward contract portfolios.

 The two commonly used swaps are:

 Interest rate swaps:

This entails swapping only the interest related cash flows between the parties in the same
currency.

 Currency swaps
This entails swapping both principal and interest between the parties, with the cash flows in one
direction being in a different currency than those in the opposite direction.

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Buyback of Shares or Share Repurchase

 When a corporation buys its own outstanding shares to lower the number of shares accessible on the
open market, this is known as a buyback.

 Companies repurchase stock for a variety of reasons.

 To reduce the shares in the market to improve the value of the remaining shares.

 To prevent other shareholders from gaining a majority position in the company.

Types of Investors
Foreign Portfolio Investment (FPI)
 FPI consists of securities and other financial assets passively held by foreign investors.

 It does not give any direct ownership of financial assets and is relatively liquid depending on market
volatility.

 FPI is a component of a country's capital account and appears on its Balance of Payments statement (BOP).

 The investor does not actively manage or influence the assets held by the FPIs. Their purpose is to
generate a speedy return on their investment.

 FPI is more liquid and riskier than Foreign Direct Investment (FDI). That is why it is often referred to
as “hot money”.

K. Chandrasekhar committee recommendation on FPIs

 Portfolio investment by a single investor or group of investors should not exceed 10%; otherwise, it should
be classified as FDI.

 A new investor class is formed by combining FIIs, Sub-Accounts, and QFIs called Foreign Portfolio Investors.

 In 2018, the Reserve Bank of India (RBI) allowed Foreign institutional investors (FIPs) are allowed to invest
in corporate bonds with a minimum residual maturity of one year.

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Foreign Institutional Investor (FII)

 The institution created or incorporated outside of India that intends to invest in securities in India and
are registered with the SEBI are called as FII.

 Banks, insurance companies, retirement or pension funds, and mutual funds are all examples of FIIs.

 Foreign institutional investors (FIIs) are permitted to invest in India's primary and secondary capital
markets through portfolio investment schemes (PIS).

 FII is referred to as "hot money" since it can leave the country at the same rate as it enters.

Reasons for FII having India as a favourite destination:

 Growing economy

 Corporate profits are high

 Government policies are encouraging

 Well-developed stock market

 Sound regulation by SEBI

Foreign Direct Investment (FDI) vs Foreign Institutional Investor (FII)

S.No FDI FII

 FDI is when a foreign company brings capital  FII is when a foreign company buys equity in a
into a country or an economy to set up company through the stock markets.
1. production or some other facility.  Therefore, in this case, FII would not give the
 FDI gives the foreign company some control in foreign company actual control over the
the operations of the company. company.

 FDI involves direct production activity & also of a  FII is a short term investment mostly in
2.
medium to long term nature. the financial markets & it consists of FII.

 It does not involve obtaining a degree of control

3.  It enables a degree of control in the company. in a company.

4.  FDI brings long term capital.  FII brings short-term capital.

Qualified Financial Investor (QFI)

 A qualified financial institution (QFI) is an individual, group, or association based in a foreign country that
is a member of the Financial Action Task Force (FATF) or a signatory to the International Organization of
Securities Commissions (IOSCO).
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 They are permitted to invest directly in India, subject to the SEBI’s and RBI's approval.

 Its goal is to broaden the class of investors, attract more foreign funds, reduce market volatility, and
deepen the Indian capital market.

 QFIs need not be registered with SEBI.

Trends Related to Foreign Investment in India

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Some International Institutions

International Organization of Securities Commissions (IOSCO)
 The International Organization of Securities Commissions (IOSCO) is an association of organisations that
regulate the world’s securities and futures markets.

 The organization's role is to assist its members in promoting high standards of regulation and to act as a
forum for national regulators to cooperate with each other and other international organisations.

 IOSCO has members from over 100 countries representing about 90% of the world's securities markets.

 India is a member of the organisation.

Financial Action Task Force (FATF)

 It is an inter-governmental body established in 1989 during the G7 Summit in Paris.

 The FATF assesses the strength of a country’s anti-money laundering and anti-terror financing
frameworks.

Headquarters
 Its Secretariat is located at OrganisationforEconomicCooperationand
the
Development (OECD) headquarters in Paris.
Member Countries
 The FATF currently has 39 members, including the European Commission and the Gulf Cooperation
Council.

 India is a member of the FATF.

Lists under FATF

1. Grey List

 Countries that are considered safe haven for supporting terror funding and money laundering are
put on the FATF grey list.

 This inclusion serves as a warning to the country that it may enter the blacklist.

2. Black List

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 Countries are known as Non-Cooperative Countries or Territories (NCCTs) are put on the
blacklist.

 These countries support terror funding and money laundering activities.

 The FATF revises the blacklist regularly, adding or deleting entries.

Some Instruments used in Investment

Participatory Notes (P-Notes)
 Participatory Notes or P-Notes (PNs) are financial instruments issued by a registered foreign institutional
investor (FII) to an overseas investor, who wishes to invest in Indian stock markets without registering
themselves with the market regulator, the Securities and Exchange Board of India (SEBI).

 P-Notes are Offshore Derivative Investments (ODIs) with equity shares or debt securities as underlying
assets.

 They provide liquidity to the investors as they can transfer the ownership by endorsement and delivery.

 SEBI has recently imposed the KYC norms on P notes also.

Global Depository Receipts (GDR)

 A Global Depositary Receipt (GDR) is a bank-issued certificate that reflects shares in a foreign stock
traded on two or more global exchanges.

 GDRs are commonly traded on American stock exchanges, as well as those in the Eurozone and Asia.

 GDRs and their dividends are priced in the local currency of the exchanges where the shares are traded,
making them a convenient and liquid way for worldwide investors to buy foreign stocks.

Depositories
 A depository keeps electronic copies of an investor's securities (such as shares, debentures, bonds,
Government Securities, units, and so on).

 A depository also offers services linked to securities transactions.

 A depository reduces the amount of paperwork necessary in transferring securities and lowers
transaction costs.

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National Securities Depository Limited (NSDL)

 It is an Indian central securities depository situated in Mumbai that is governed by the Ministry of Finance
of the Government of India.

 It was founded in August 1996 as India's first nationwide computerised securities depository.

Central Depository Services Ltd

 It is the first listed Indian central securities depository and a division of the Securities and Exchange Board
of India

 It was initially promoted by the BSE Ltd. which thereafter divested its stake to leading banks.

 Main function involves facilitating holding of dematerialised securities enabling securities transactions.

INDIAN ECONOMY | Financial Market PAGE 39